AMMAN, 12 April 2004 — If a company in Lebanon, Jordan, Egypt or the Gulf is generating profits for its investors, would any body care if the company is following sound corporate governance or there is a clear and adequate separation between ownership and management, or how the board is organized and how often it meets, or if there are independent directors serving on the board, or if the posts of the chairman and the chief executive officer are separated, or if it has an effective internal audit committee? The answer to these questions is usually no.
However, besides existing shareholders, there are other stakeholders who are keen to know how the board and the management of the company are taking into consideration the interests of employees, depositors, consumers, minority shareholders and potential new investors as well as, the civil society and the economy at large. The far sighted boards do recognize that dealing fairly with all groups is consistent with building long-term value for shareholders. Regulators, on the other hand, would like to have in place good corporate governance that will render their domestic markets more attractive to local and international investors. Board members, management and regulators are appointed not just to look at today’s business but to ensure there will be a business to manage tomorrow.
During the 1980s and 1990s, specially after the collapse of the Soviet Union, governments have come to be seen as the problem not the solution, as obstacles not facilitators, and whose bureaucracies tend to restrict the entrepreneurial spirit of capitalism. Yet in the few years that followed the collapse of companies like Enron and Arthur Andersen among others, all this has changed. The US corporate model that involved a strong chairman/chief executive, with a compliant board combined with a litigation culture driven by powerful lawyers, has been discredited. Market participants worldwide have been calling on regulators to reform corporate governance.
It is well known that capital markets can function efficiently only if the highest standards of accounting, disclosure and transparency are observed. Central banks, monetary authorities and securities commissions in various Arab countries have been regulating their respective capital markets in an efficient and progressive way.
However, last year’s banking debacle in Jordan, the under performing Egyptian banking sector and the rising number of weak corporate performance in the Gulf suggest that the authorities should consider introducing additional regulations as part of reforming corporate governance in their respective countries.
Regulatory authorities in the region may want to consider requiring all public and private shareholding companies to have independent members serving on their boards. As independent directors, they should not be major shareholders of the company and should not have significant business relationship with it in order for them to bring an objective view to board deliberation. Many of the biggest public companies in the Gulf still have large family shareholdings, family representatives among their senior management and strong family representation on the board. There has also been weak protection of the rights of minority shareholders. This will invariably create potential conflict of interest between the companies and the controlling families.
Independent directors alone will not be sufficient to bring about better corporate governance. What is also needed is the separation of ownership and management which implies the separation of the often combined positions of chairman of the board and the chief executive officer (CEO). It is still common to see in the various Arab countries the chairman of the board to be also the CEO of the company.
When the CEO runs his company’s board, he will be in effect his own boss and a number of fundamental conflicts of interest can exist. It is much more difficult for a board to monitor and evaluate a chief executive’s performance and hold him accountable for results if the CEO of the company is also the chairman. It is a standard practice in the UK, continental Europe, Canada and Japan that the post of the chairman is separated from that of the CEO. In a recent survey of board members from 500 large US companies, McKinsey & Co. found similar views. Nearly 70 percent of respondents said a CEO should not run the board.
Only few corporations in the region have effective audit committees as part of the function of their boards, and when such committees do exist they are not formed of independent directors. Audit committees are expected to ensure compliance with policies, plans, procedures and regulations. They are the first line of defense against mismanagement and financial irregularities. A well managed committee insures the reliability and integrity of management and accuracy of financial information that the company produces. The scope of work of these committees includes as well the responsibility to identify suspected acts of fraud or conflict of interests involving the operation of the company.
Today, most members of audit committees of Arab companies tend to be major shareholders or represent strong shareholding interests rather than independent professionals. Audit committees typically meet twice to three times a year and only a few committee members bother to review their companies’ internal audit reports, let alone understand them. It is important therefore for committee members to be both independent and financially literate and for the audit committees on which they serve to meet at least once every two months and to have unrestricted access to the company’s financial records.
If year after year, there are companies who fail to generate profits then the problem has less to do with regional uncertainties and lack of sufficient macro-economic growth and a lot more with bad management, absence of vision, leadership and direction. We will never get very far in terms of real change if we take the easy road of blaming outside factors for our mistakes. Corporates who have been in the red year after year should take a very honest look at themselves and either change their senior management and revamp the board or shut down the company and exit the market. A strict regulation dealing with this issue should be put in place whereby a change in the management of those companies who have been consistently underperforming would become mandatory.
To conclude, Arab corporates, especially those listed on the region’s stock exchanges, need stronger independent board members, able to devote proper attention to the audit committees they serve on. It may be difficult to find good candidates to serve as independent board members, nevertheless companies should draw on retired directors, former CEOs, academics, expatriate professionals and public servants. We also need a well functioning audit committees, and a separation of the positions of the chairman of the board and the CEO. If the regulatory authorities in the region do not introduce more effective corporate governance and enforce compliance with these rules, they will be encouraging market participants to look elsewhere for investment. Capital will always go to those markets where the rules of investing are most transparent and where there is a sound system of corporate governance that protects the interest of minority shareholders and other stakeholders.
(Henry T. Azzam is chief executive officer at Jordinvest)