Corporate governance: The role of Institute of Directors

"Corporate governance is not working in the United States in the way it should. The problem is not the system of laws, regulations and judicial decision which are the framework of corporate governance.  It is the failure of too many boards of directors to make the system work the way it should."
The above is the first sentence of a report Martin Lipton and W. Lorsch presented to the American Bar Association. The year was 1992 and the place was the USA.  In the UK the things were also not right.  Cadbury committee was engaged there to elaborate the code of corporate governance.
A first look at the status of corporate governance in our place and in our time, the above comment appears perfectly relevant.
The directors of the board have a number of pleas to ignore Corporate Governance. It is widely thought that the concepts are too philosophical. The words 'philosophical' and 'implementable' tend to be synonymous to unschooled people in this agricultural delta. No society can implement the law and the grammar of the culture without any philosophical argument.  The problem of ignorance affects each and every segment of society. Principles and philosophy is at the foundation and to be regarded for every socio-economic political system.  Our focus should be in the private sector corporate world, the segment that generates and distributes wealth of the nations.
Corporate governance is the cultural grammar that ties up three entities in  capitalism for orchestrated advancement:  (1) fund providing shareholders, (2) executive managers who are shareowners' agents and (3) non-executive directors to oversee the process.
Shareholders entrust their money to none but professional managers.  Managers are agents of the shareowners.
This straight-forward relation may lead a two-fold problem.  First, the desire and goal of the agent and principal may become conflicting. The principal will not be able to verify if there is any conflict of interest with the agent or to see what actually the agent is doing with the money.  Second, the principal and the agent may have a different degree of risk appetite.
These agency problems lead companies to have the overseeing body, the board of directors.
The management is the receiver and custodial of shareholders' money and acts as shareholders' agent. The management reports to board, not to the shareowners.
The board is responsible to oversee the management work and report to the shareowners.  Board members are appointed and removed by the shareholders.
It is important that managers are neither appointed by the shareowners nor removed by them.  Managers will have their own standard (or cutomised) operation procedure to plan, organise, direct and control their constituents.
Lipton and Lorsch mentioned the failure of good governance theory is due to the failures on part of the board of directors. They fail to recognise their duties and bounds.  This is a case very common among the underperformed companies in Bangladesh.  Two hurdles are prominent: 1) selection of directors, specially the non-executive and independent ones; 2) boards' formation in relation to executive management for effective communication; 3) education, training or at least some orientation in corporate governance theory and codes
First, according to the agency theory, directors should only be appointed by the shareowner. There may be election among the shareholders, which complies the international code as well as the company's own articles of association.  The problem arises when, in the name of good governance itself, independent directors are hosted.
In general with a few exceptions,  the prime criterion of selection of an independent director is that the incumbent has to be a friend of the chairman or the managing director.  This hidden 'friendship only' appointment poses severe threats to corporate governance principles of agency theory.  Independent directors can not be selected by the board in its meeting.  Even there is no post facto approval.  Endorsement are often taken from the regulators where required, for example, in banks and in the stock exchanges.  Nevertheless, the problem can not be eliminated unless and until the independent directors are able to represent the shareowners with honest mind and ability to do so.
Second point is a question of boards' boundary.  The board members who are not part of the full-time executive body, are non-executive director (NED).   Executives in hierarchy may form a board without any NED, outside or independent director.
More common in the developed country is a mixture of NED and EDs.  The ratio may vary from a majority of executives to majority of NEDs.  Rationally this ratio will depend on the nature of business the company is in.  A fully NED board bear a high risk.  On the other hand, an ED only will defy the norms of independent supervision. Balance is a critical issue.  
Thirdly, directorship of a company is often a decorative position.  But the non-executive selected directors may enjoy their position in a corporate board.  The things may be other way round where the company will boast of having celebrities as NEDs.  In the companies where public brand image is important, celebrities are in the board.  
Besides the agency theory, stewardship is the second mast of the whole corporate governance. While agency involves transfer of fund of shareowners to the management, stewardship is the leadership.  Board members have to give this stewardship.
The quality of leadership can mostly be learnt while technical issues play critical role.  Not all directors go to school for learning finance and accounting or the business his/her company is engaged.  This is a fact worldwide.  Institutes of directors (IoD) in many countries are grooming the directors.  IoDs are source of recruiting qualified directors.  In Thailand, IoD qualification is a must for becoming an independent director.  The IoD, India offers qualifying courses.  So does New Zealand, to name a few.  Bangladesh Institute of Directors is in the offing.
Directors, whether executive or non-executive, have to be appointed by the shareholders.  Directors must have the stewardship and the qualification of stewardship.  The principle of good corporate governance is all about separation of ownership and effective control in a balanced manner.  It is obscure unless and until the corporate society recognises the principles of agency and stewardship and establish good corporate governance enhancing shareholders' wealth.
The writer is a freelance consultant for capital market regulations and trainer of corporate governance.
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