Corporate democracy, its meaning, purpose and risk
Tuesday, 8 April 2008
Imtiyaz Husain
We are increasingly turning to the market and away from rigid regulation and control officialdom. As a result, the importance of governance of the companies and the role of the Board of Directors in governance is taking a heightened sense of importance. The Board of Directors is the focal point of voluntary efforts by firms to improve corporate governance given the Board's key role in ensuring that an effective team of managers is in place and efficiently and competitively uses the companies' assets. One of the principle characteristics of efficient corporate governance is the ability of directors to independently approve the companies' strategy and major decisions, independently hiring managers and monitoring their performance.
Corporate democracy which is imbedded in our Companies Law remains one of the key issues in development of a civilised and efficient business environment. It is a concept which justifies the process of selection of directors. It also gives meaning to pass on the wide range of authority to manage the company to the directors. Albeit there is little practice of true democratic principles, yet our directors are elected and never selected. We have a show of an election process as detailed in the statutes and matters are decided by the brute force of the number of votes. This is different from our national vote where one man has one vote. In the corporate world there is loyalty to what one has at stake; so one vote paradigm is generally not acceptable. Without the strength of shares we would never have proxy fights or otherwise we would have the culpable democracy of the masses swayed by the crowd often voting for ends without means.
Surely we have learned a lesson from what happened in the mid 1990s. The sheer brutal manipulation of voting along with vote rigging and the influence of Investment Corporation of Bangladesh (ICB), some people, who should never be there, were elected directors of several state enterprises which were by then listed company. Their misfeasance is common knowledge. How the state enterprises survived is not known but these directors without stock clout were able to manipulate the business of these companies. In other words we had undesirable elements holding such important positions. A few were able through the same strategy to enter the board of a public sector bank where they were known to take cuts from almost all loan applicants.
Even today we have the Queen of the Kerb market sitting on the board of a non-banking financial institution for which one may thank the investment house of Bangladesh for orchestrating the entire election process.
The lack of truly professional directors on Boards of enterprises represents a significant obstacle to the investment attractiveness of issuers and creates room for violations of rights and infringement of legitimate interests of investors and shareholders. In an effort to improve the quality of corporate governance of enterprises, the Securities and Exchange Commission (SEC) has introduced the concept of independent directors to the boards of companies. The selection process of such independent directors with the exception of directors of banks and insurance companies has been left to the companies.
The most recent issue of directors has been made by the Bangladesh Bank in respect of not only downsizing the boards but is also to consider ways and means to induct stakeholder directors. How successful the central bank will be is a matter of conjecture. So far the government opaque record of nominating directors from retired and functioning civil servants as well as friendly university teachers with the right kind of attitude have failed to deliver dividend. Here lies one of the problems in endeavouring to introduce independent directors. Often such positions are considered a reward to be used by the government. The direct interference and demand for perks and services by Chairmen of state-owned banks and other public sector enterprises is not unknown. Many have offices and cars when such facilities are not just in terms of good governance. The most recent move is to have such directors from the depositors.
The issue of independence has also been straddled with absence of quality and competence. The issues of quality and qualifications are often forgotten. Their job description and the limits of their authority remain unlisted and unknown and therefore unregulated. Private likes and dislikes or loyalty are the main issues for selection of directors. Also there is a big list of exclusions which is arbitrary. It is commendable that both the central bank and the SEC are trying to device a system to select independent directors which is really trying to fit a square peg in a round hole.
Firstly, if we look into the corporate tradition, we may see a complete absence of competence in the selection of directors -- competence in the corporate world means not ones private skills but specific ones that must benefit the company. Secondly, issue relates to our total misunderstanding of the concept and origin of corporate existence. To a great extent, the Ministry of Finance and the Bangladesh Bank are responsible for highlighting the concept of "sponsor" which does not exist in law but is dominant in practice. This was one way for the government to tie up the founders and promoters of companies so that they do not default on their loans.
Regrettably the concept of "sponsor director" has now become a transferable asset. It has become a property, which can be inherited or passed down to successors. In many private banks, the central bank had in the past approved and introduced of a separate class of "sponsor" shareholders who have special powers and right, despite the equitable nature of all shares. It is also not unknown to see the sale of such special "sponsor" shares at a premium. The fact the government has overlooked is that equity share may be passed down to one's heirs but positions on board cannot be - these positions have to be attained through fair and equitable election. To redeem the matter both the Bangladesh Bank and the SEC may introduce 'model Articles of Association' in order to ensure a true corporate entity in listed companies and equality of all paid-up shares.
The International Codes on Corporate Governance explicitly defines the concept of Independent Directors as those elected by the constituency of minority shareholders from them as an Independent Director. But it is a matter of regret that during the past thirty years, no listed company has chosen to provide for proportionate representation of shareholders on the Board of Directors in its Articles of Association. Simple but painful inference is that promoters want the money from the investors to invest in their companies but do not wish to provide them a berth on the Board, much less an opportunity to contribute to, and champion the cause of small investors for observance of principles of sound corporate governance. The SEC has the powers to structure the proxy system and therefore may decree proportional directors in all listed companies. This will enable minority shareholder to elect directors, which is not possible today. But the regulators must endeavour to ensure that funds, investment companies and merchant banks do not hog the process of corporate democracy.
The director must be truly independent in both their relationships with the company and the "sponsor" directors. They should not be the stooges of the sponsor directors, which is a common sight in some banks and insurance companies. No person with any financial link or dependence on a company should be allowed to become an independent director. Even nominees of the financial institution should not be considered as an independent director.
In fact such nominees may not be allowed to attend the Board meeting as observer. Since such persons have no responsibility as a Director much less a fiduciary relationship and fiduciary liability for the shareholders of the company. Moreover such nominees will have an access to all confidential information, which may be price sensitive information which is liable to be abused or misused as has been observed. Most international fund management companies distance themselves both from the board and the voting process, the tradition being that they actually hold in trust the assets of many shareholders and their true job is not to interfere in the affairs of the company unless they are so empowered by their eventual stakeholders. Moreover, the role of financial institution is to manage investors' funds and not to manage companies.
In order to truly bring about some kind of corporate democracy and governance it is probably the duty of the government and the various regulatory bodies to review the past history of corporate intolerance, abuse and excess. They should put their heads together and be able to device an operational meaning to the idea and create a process to fairly bring about equity into the system. Otherwise, equity shall have no meaning in corporate democracy.
We are increasingly turning to the market and away from rigid regulation and control officialdom. As a result, the importance of governance of the companies and the role of the Board of Directors in governance is taking a heightened sense of importance. The Board of Directors is the focal point of voluntary efforts by firms to improve corporate governance given the Board's key role in ensuring that an effective team of managers is in place and efficiently and competitively uses the companies' assets. One of the principle characteristics of efficient corporate governance is the ability of directors to independently approve the companies' strategy and major decisions, independently hiring managers and monitoring their performance.
Corporate democracy which is imbedded in our Companies Law remains one of the key issues in development of a civilised and efficient business environment. It is a concept which justifies the process of selection of directors. It also gives meaning to pass on the wide range of authority to manage the company to the directors. Albeit there is little practice of true democratic principles, yet our directors are elected and never selected. We have a show of an election process as detailed in the statutes and matters are decided by the brute force of the number of votes. This is different from our national vote where one man has one vote. In the corporate world there is loyalty to what one has at stake; so one vote paradigm is generally not acceptable. Without the strength of shares we would never have proxy fights or otherwise we would have the culpable democracy of the masses swayed by the crowd often voting for ends without means.
Surely we have learned a lesson from what happened in the mid 1990s. The sheer brutal manipulation of voting along with vote rigging and the influence of Investment Corporation of Bangladesh (ICB), some people, who should never be there, were elected directors of several state enterprises which were by then listed company. Their misfeasance is common knowledge. How the state enterprises survived is not known but these directors without stock clout were able to manipulate the business of these companies. In other words we had undesirable elements holding such important positions. A few were able through the same strategy to enter the board of a public sector bank where they were known to take cuts from almost all loan applicants.
Even today we have the Queen of the Kerb market sitting on the board of a non-banking financial institution for which one may thank the investment house of Bangladesh for orchestrating the entire election process.
The lack of truly professional directors on Boards of enterprises represents a significant obstacle to the investment attractiveness of issuers and creates room for violations of rights and infringement of legitimate interests of investors and shareholders. In an effort to improve the quality of corporate governance of enterprises, the Securities and Exchange Commission (SEC) has introduced the concept of independent directors to the boards of companies. The selection process of such independent directors with the exception of directors of banks and insurance companies has been left to the companies.
The most recent issue of directors has been made by the Bangladesh Bank in respect of not only downsizing the boards but is also to consider ways and means to induct stakeholder directors. How successful the central bank will be is a matter of conjecture. So far the government opaque record of nominating directors from retired and functioning civil servants as well as friendly university teachers with the right kind of attitude have failed to deliver dividend. Here lies one of the problems in endeavouring to introduce independent directors. Often such positions are considered a reward to be used by the government. The direct interference and demand for perks and services by Chairmen of state-owned banks and other public sector enterprises is not unknown. Many have offices and cars when such facilities are not just in terms of good governance. The most recent move is to have such directors from the depositors.
The issue of independence has also been straddled with absence of quality and competence. The issues of quality and qualifications are often forgotten. Their job description and the limits of their authority remain unlisted and unknown and therefore unregulated. Private likes and dislikes or loyalty are the main issues for selection of directors. Also there is a big list of exclusions which is arbitrary. It is commendable that both the central bank and the SEC are trying to device a system to select independent directors which is really trying to fit a square peg in a round hole.
Firstly, if we look into the corporate tradition, we may see a complete absence of competence in the selection of directors -- competence in the corporate world means not ones private skills but specific ones that must benefit the company. Secondly, issue relates to our total misunderstanding of the concept and origin of corporate existence. To a great extent, the Ministry of Finance and the Bangladesh Bank are responsible for highlighting the concept of "sponsor" which does not exist in law but is dominant in practice. This was one way for the government to tie up the founders and promoters of companies so that they do not default on their loans.
Regrettably the concept of "sponsor director" has now become a transferable asset. It has become a property, which can be inherited or passed down to successors. In many private banks, the central bank had in the past approved and introduced of a separate class of "sponsor" shareholders who have special powers and right, despite the equitable nature of all shares. It is also not unknown to see the sale of such special "sponsor" shares at a premium. The fact the government has overlooked is that equity share may be passed down to one's heirs but positions on board cannot be - these positions have to be attained through fair and equitable election. To redeem the matter both the Bangladesh Bank and the SEC may introduce 'model Articles of Association' in order to ensure a true corporate entity in listed companies and equality of all paid-up shares.
The International Codes on Corporate Governance explicitly defines the concept of Independent Directors as those elected by the constituency of minority shareholders from them as an Independent Director. But it is a matter of regret that during the past thirty years, no listed company has chosen to provide for proportionate representation of shareholders on the Board of Directors in its Articles of Association. Simple but painful inference is that promoters want the money from the investors to invest in their companies but do not wish to provide them a berth on the Board, much less an opportunity to contribute to, and champion the cause of small investors for observance of principles of sound corporate governance. The SEC has the powers to structure the proxy system and therefore may decree proportional directors in all listed companies. This will enable minority shareholder to elect directors, which is not possible today. But the regulators must endeavour to ensure that funds, investment companies and merchant banks do not hog the process of corporate democracy.
The director must be truly independent in both their relationships with the company and the "sponsor" directors. They should not be the stooges of the sponsor directors, which is a common sight in some banks and insurance companies. No person with any financial link or dependence on a company should be allowed to become an independent director. Even nominees of the financial institution should not be considered as an independent director.
In fact such nominees may not be allowed to attend the Board meeting as observer. Since such persons have no responsibility as a Director much less a fiduciary relationship and fiduciary liability for the shareholders of the company. Moreover such nominees will have an access to all confidential information, which may be price sensitive information which is liable to be abused or misused as has been observed. Most international fund management companies distance themselves both from the board and the voting process, the tradition being that they actually hold in trust the assets of many shareholders and their true job is not to interfere in the affairs of the company unless they are so empowered by their eventual stakeholders. Moreover, the role of financial institution is to manage investors' funds and not to manage companies.
In order to truly bring about some kind of corporate democracy and governance it is probably the duty of the government and the various regulatory bodies to review the past history of corporate intolerance, abuse and excess. They should put their heads together and be able to device an operational meaning to the idea and create a process to fairly bring about equity into the system. Otherwise, equity shall have no meaning in corporate democracy.