Accounting Article

Disciplining the Corporate Sector

The chairman of the board of directors of a public company can no longer don two hats at the same time that of the chairman as well as the managing director. The ‘Code of Corporate Governance (CCG) 2012’ launched by the Securities and Exchange Commission of Pakistan (SECP) recently, among other things proposes this important reform of separation of the board from the management.

The chairman of the board is often the majority shareholder in a company and therefore, regardless of the company having public stake, a single person directs as well as manages company affairs. This raises the spectre of conflict of interest.

But the chairman is not altogether powerless. Though distanced from ‘involvement in day-to-day operations of the company,’ which are left to the CEO or the managing director, the CEO would be ‘under the oversight of the board’.

Section (4) of 4 proposes that every company “shall elect the chairman of the board from amongst the independent directors so as to achieve an appropriate balance of power, increase accountability and improve the board’s capacity for exercising independent judgment.” The CEO’s wings have been further clipped as the appointment, remuneration and terms and conditions of employment of the chief financial officers (CFO), company secretary and the head of internal audit of listed companies would be determined by the board rather than by the MD.

Some other reforms related to the board include, at least one seat for ‘independent director’ while it is preferred that a third of the total members on the company boards be ‘independent directors’. The new code has also expanded the criteria for assessment of independence.

The section 2(e) of the code defines ‘independent director’, as a person who is not connected or does not have any other relationship with the public sector company, its associated companies, subsidiaries, holding company or directors. The test of independence principally emanates from the fact whether such person can be reasonably perceived as being able to exercise independent judgment without being subservient to any form of conflict of interest. The company shall disclose in the annual report non-executive, executive and independent directors.

“The transparency through enhanced disclosure is the purpose of introduction of a reformed Code 2012” SECPchairman says, underscoring the point: “The code will result in availability of enhanced information to market participants and hence it will provide better protection of the rights of all investors, particularly minority shareholders.”

Most corporate law experts say that of what they have read of the Code 2012, it seems to provide reforms, which if implemented in letter and in spirit could bring revolutionary changes in the way affairs are carried out in public sector listed companies. A former commissioner of the SECP, however, said that the issue was ‘implementation’. He observed that there was bunch of laws that were in place but lacked implementation.

Investors in public listed companies have forever looked forward to those happy prospects of separation of ownership from management, empowerment of independent directors and safeguarding interest of small shareholders.

Most market participants believe that the dual role of chairman and CEO of the same person has been at the heart of many ills.

The appointment of chairman of the board from independent directors would forestall many corporate wrongdoings, one being the unjustified inter-corporate financing.

“For every listed company there are on average eight subsidiaries and non-listed smaller entities,” to which such companies extend loans and advances only to write off a year or two latter.

But regulators are now moving to frame laws that would give minority shareholders the voice that would be heard. There is a global small shareholders’ activism. They seek new rights to influence the policy of the companies they invest in, through independent directors.

Many corporate experts say that though well-intentioned, the idea of ‘independent directors’ seem impractical. “Minority shareholders are disorganised and election of candidates through cumulative voting by stockholders is a difficult task”, says one expert, adding that “the sitting sponsor directors, on the other hand, would be perfectly pleased to put puppets on the board, though that would clearly be seen as ‘conflict of interest’.”

It is understandable then that the revolutionary step of empowering minority shareholders through ‘independent directors’ on the board would possibly be met by enormous resistance from powerful sponsoring directors.

There is also the possibility of listed companies making a dash for the exit door. Already only one out of hundred among the 60,000 registered companies have sought listings at the stock exchanges. With more stringent code in place, there exists the possibility of more ‘de-listings’ than new listings. “So be it”, says an official at the regulatory agency.

“Transparency and good governance cannot be sacrificed in quest for greater number of companies on stock exchanges” he says, adding: “Companies with clean record and desirous of mobilising cheaper funds from public, would, in any case, enter the capital markets.”