JEDDAH, 3 November 2003 — The Arab economies are more and more adopting market-based operations, and the role of the state is declining while the role of the private sector is evolving. Therefore, corporate governance has been achieving more attention, with particular reference to disclosure, transparency and accountability. Better disclosure would allow governments and companies to react to economic problems in a more timely manner, and is needed to avoid corporate scandals. Moreover, unrestricted capital flows and thus global integration of capital markets can contribute to the spread of best practices in corporate governance, accounting rules, and legal traditions, as well as it limits the ability of governments to pursue bad policies.
While there is no single model for corporate governance, there are common elements which can be custom tailored to companies. Therefore, corporate governance is an evolutionary process.
The main principles of corporate governance are to protect and guarantee shareholders’ rights, which will increase investor confidence and capital utilization deficiency. Companies whose governance systems are not compatible with international standards will lose out. Hence, corporate governance is not an optional extra for national companies but essential in attracting local and foreign investment and stimulating economic growth.
From a Saudi point of view, I would like to focus on the developments of private sector companies in the Kingdom and the role of the new capital market law in enhancing corporate governance. Many of the large main companies in the private sector of the Saudi economy are family-owned business. There are around 11,000 family businesses, of which only 126 are joint stock companies. For the Kingdom moving forward in an age of globalization, and for these companies to continue to exist, they will have to be publicly listed and ownership and management have to be separated. Moreover, having large companies listed on the Saudi stock exchange could help to define and analyze their entire industry. According to past international experiences, large institutions could collapse in a few generations if they don’t widen the base of ownership, and this could lead to mass destruction in the national economy. But if they are publicly listed and their shares to be traded in the stock exchange, they have to implement adequate corporate governance to protect the right of their shareholders.
Since corporate governance is a set of rules of conduct, it has to be supervised and monitored by an independent commission. In Saudi Arabia the new released Capital Market Law made provision for the establishment of “Saudi Stock Exchange Commission” (SSEC), which would set the rules and regulations that should be adopted by listed joint stock companies, supervise the implementation of these rules and penalize companies that fail to execute them. A watchdog body like the SSEC is a plus for the Saudi financial system. Although protecting small investors is not an easy task, creating laws to enforce high standards of disclosure and transparency will minimize their risk. The SSEC should also focus on increasing board independence, clarify and harmonize the applicability of certain quantitative listing standards of the companies, and restrict the implementation periods that listed companies have to comply with.
While fraud can never be eliminated, it can be prosecuted to protect innocent investors in this market. In the past some Saudi listed joint stock companies have failed to publish their financial statements for a few quarters and were not penalized or prevented from trading their stocks in the market. The expectation under the new law is that such practice will not be tolerated. The Saudi stock market appreciated by 60 percent since the beginning of year and total market cap exceeded 80 percent of GDP (SR565 billion). Although this gain was partially driven by fundamentals (corporate earnings rose by 43 percent), higher oil prices, and optimism on economic reforms there has been some speculative movements in prices which lead to corrections and hurt small investors.
The dealers are divided into three types; investors that enter the market for long-term investment, traders for short-term investment, and speculators. There is a lot of hope that these speculative aspects will be limited through transparency and accountability in the market by having access to relevant information, which requires sizeable investment in Information technology to build sophisticated and advanced data basis.
One of the new elements in the new capital market law is to allow companies to issue corporate bonds either conventional or Islamic asset backed bonds. That would require a greater role by the independent commission to ensure that this structure meet global standards. Corporate governance is crucial in this regard, revealing all the different aspects concerning ownership, performance, and the strategic objective of these companies. As this is a new experience for Saudi Arabia, and in order to avoid any setbacks, the independent authority must try its best to guarantee successful turnout of those bonds. Any default, especially for new issuance, would raise doubt and shake investor confidence.
But reform of the state-controlled enterprises is also considered as a basic instrument in the effort that many countries (especially developing ones) make in order to rationalize public sector management, to improve public finances, and promote growth and development. The setting of clear realistic targets, transparency and better services to the public will only be achieved if the public company’s management is flexible, independent of political intervention, and operates like a private company.
Likewise, corporate governance is not only vital to the private sector in the Kingdom but should be first implemented by the public sector enterprises which have the largest share so far in the Saudi economy in general and the companies listed in the stock market in particular. The international experience shows that this will lead to some more benefits in terms of public revenue, improved efficiency, increased investment, and better quality of services.
Therefore, applying corporate governance practices to the state-owned companies in the Kingdom will enhance their credibility and encourage investors to buy their stocks when they are privatized. This will help the government in its privatization process and with it accelerate economic reforms in the country.
(Dr. Nahed M. Taher is a senior economist at the National Commercial Bank, Jeddah.)