Shyamal Majumdar: Governance lessons

THE HUMAN FACTOR

The latest guide to corporate governance around the world can be a useful tool kit for top managements.

Indian companies made $9.9 billion worth of overseas acquisitions in 2006 compared to $4.5 billion in 2005. By all available indications, the number will go up manifold in the new year. While the flurry of global acquisitions continues, Indian companies would do well to remember that over the past decade, the global corporate governance landscape has changed dramatically. As companies grapple with the complexity of doing business internationally, their boards would have to familiarise themselves with new regulations and best practices abroad.

Help is at hand, with Spencer Stuart, one of the world's leading executive search consulting firms, coming out with Governance Lexicon, 2007 "" a 200 page guide that helps directors understand major governance issues and the intricacies of international codes and regulations in 19 key markets. The latest edition, which was released in the US last month, has four new entries "" India, China, Russia and Singapore.

As the Spencer Stuart handbook reveals, there are quite a few common themes and issues despite the differences in governance around the world. One of these issues relate to markets where state- or family-owned businesses tend to dominate. The introduction of independent directors in these countries has been slow, made harder by the lack of qualified, available candidates.

Take the examples of two of the new entrants in the Lexicon "" China and Russia. The Lexicon says the control-based system in China is gradually making way for a more market-based governance system and the main shift in attitudes is from the old system of Guanxi (connections or networking), where success may depend on relationships and patronage, to a more rational and meritocratic system. Governance has evolved in an environment in which most listed companies were reformed state-owned enterprises, and in which the board's practical function was to act as the agency of major shareholders. China has also come out with a detailed corporate governance code.

But while the structure is in place, the implementation is not. First, there is weak enforcement. For example, while the China Securities and Regulatory Commission requires quarterly reports of its listed companies, insists on external directors, outlines guidelines for the appointment of independent directors and advocates fairly broad financial disclosures, no information is required on deviation from governance codes, on the selection of directors or on the establishment of the audit or nominations committee.

Also, there are conflicts of interest. The state has failed to build strong independent institutions, and this has left the Communist Party as a central agent of policy. Heads of state-owned enterprises have great power, and some also chair their local party committees. In some of these enterprises, these heads enjoy a status superior to that of the board. The notion of independent directors is still weak; in practice, they are often ill-qualified, ill-informed and ill-briefed by the company.

The situation isn't much better in Russia too where the main concern is weak execution and enforcement of law. Formal rules (law) often conflict with informal rules (culture and practice), which tend to win. The other area of concern is lack of transparency. Many Russian companies are reluctant to disclose their real owners or to disclose an exhaustive list of affiliated companies; and continue to act through offshore zones. For example, only 28 per cent of the total private ownership of Russia's 54 largest companies was made known by September 2005. The figure is even lower for banks: as recently as 2005, only 16 per cent of the aggregate private stakes in Russia's largest 30 banks had been disclosed. In essence, Russian law takes no account of the idea "" common in market economies "" of beneficial ownership, and does not require companies to disclose indirect stakes held by Russian shareholders. Nominee accounts and shell companies are therefore common.

The other common themes across countries are:

a) Top quality director recruitment is high on the agenda in every country. The desire for diversity and new blood in the boardroom is tempered by the need for experienced directors.

b) Board membership is increasingly the focus of shareholder activism but attention has shifted from the audit committee to the compensation committee, with pressure building to tighten the link between reward and performance and avoid excessive executive pay.

c) Non-executive director pay is steadily rising in most markets as a reflection of the ever-increasing workload and risk associated with the role.

d) Where single-tier boards operate there is debate over whether it is preferable to split the roles of chairman and CEO. This leads to the question of the chairman's independence.

e) Director liability is of great concern. The threat of disqualification, punitive fines and lengthy prison sentences, as well as reputational risk, is focusing directors' attention on the need for adequate insurance coverage.