History has shown that the relationship between money, power and ambition can be very specious. This has often driven kings, business leaders and politicians to pursue policies that are not in the interest of the constituencies they oversee — these can be shareholders or stakeholders in the case of businesses or other enterprises; and the state in the case of those who claim to be political leaders. The underpinning of money, power and ambition is greed; and just as love is blind, greed is insatiable.
What makes the relationship very complex is the inevitable association of money with ownership of assets in some form or the other. Moreover, determination of ownership itself is not so easy; and what are the responsibilities of those who manage them? The clarity of roles between owners and managers is often facetiously forgotten. It is for no small reason that Adam Smith said that the butcher, the brewer, or the baker provides our dinner because of his regard to his own interest. It can also not be concluded from the Principles of Economics that self-interest generally is enlightened or that enlightened self-interest always operates in the public interest.
It is for this reason that a structure of rules, systems and processes is put in place in organisations, institutions and business enterprises to ensure good governance. The Merchant of Venice, (Act 1 Scene 1), feared for the safety of his argosies sailing out of sight on the high seas. How are owners’ interests to be protected? How is oversight to be exercised over those delegated to run the venture? Who sets the direction of the enterprise and ensures accountability? The great trading companies of the British and Dutch empires, established with the patronage of the monarch, operated under rules set by the state. Though practised for as long as there have been corporate entities, it is only since the 1980s that we have given this structure the name “corporate governance”. If management is about running the business, governance is about seeing that it is run properly. Corporate governance would allow people outside looking into a business to see that the people inside who are governing the business are actually running it well, taking decisions with intellectual honesty and applying care and skill in making business judgements. Hence the need for direction, control, responsibilities of the board, management and supervision, audit, disclosure, accountability, and so on. These principles of corporate governance would equally apply to the governance of any enterprise, be it a club or a company.
The importance of corporate governance becomes apparent when the structure breaks down. The enterprise is faced with disastrous consequences. We have seen a display of disaster and depravity in several companies in different countries at different times in the last three decades. Interestingly, all these failures in corporate governance fall into an identifiable pattern (see “Patterns in governance failures”, Business Standard, April 13, 2009).
Some of the distinguishing features of this pattern are that when there is an initial period of spectacular growth, it is never questioned; nobody asks “why?”. There is a sense of unerring infallibility leading to complacency, which translates into aggressive leadership style. Then, when signs of failure become evident, the following sequence of events takes place:
The sequence of events was seen in the case of Enron where Kenneth Lay was trying to convince the media, even as he was handcuffed, that he did nothing wrong and had no knowledge of any wrongdoing; the board of directors said it did not know anything. This is just one example from the corporate world. But such financial problems, which were till now the domain of the business world, have now started invading the world of Indian sports too, where big money and big spending are involved, suggesting the specious association of money power with ambition. We have seen an abundant display of this in the recently concluded Indian Premier League (see “Lessons in corporate governance”, Business Standard, May 10). We are now seeing a repeat of this in the Commonwealth Games.
At this point, the alphabet soup in the title needs to be explained to readers. RPT stands for related party transactions; CoI stands for conflict of interest, and CWG stands for Commonwealth Games. CG, which stands for corporate governance, is the thread that links the three terms. In most cases — be they in Europe, the US or India — RPTs and CoI are two of the areas over which concerns have been repeatedly raised in the light of recent corporate scandals. The IPL and the CWG are not exceptions to this rule.
RPTs are diverse complex business transactions between a company and its managers, or directors or principal owners. In public accounting, these are considered difficult to audit and a potential indicator of audit risk (American Institute of Certified Public Accountants, 2001). The Organisation for Economic Co-operation and Development has identified RPTs as one of the nine major reasons for leading companies to restate financial statements. Regulators, market participants and other corporate stakeholders commonly regard these transactions as potential CoIs, which can compromise management’s agency responsibility to shareholders or a board of director’s monitoring function. All RPTs are not abusive. But they have the potential to become abusive where a party in control of a company enters into a transaction to the detriment of non-controlling shareholders. According to the Guide on Fighting Abusive Related Party Transactions in Asia, 2009, it remains one of the biggest corporate governance challenges in Asia. A coherent regulatory system dealing with RPTs, particularly disclosure, board oversight and shareholder approval, should be established in each jurisdiction to facilitate implementation and enforcement efforts. Though there are Accounting Standards by the Institute of Chartered Accountants of India, this should remain a singular concern of boards of Indian companies. At present, this is not the case with many companies and their boards .
When private interests of individuals influence their public decisions, thereby enabling individuals to take advantage of their public position for personal benefit, situations of potential conflicts arise. In a sense, all issues related to CoI are integrally related to the overall governance of a company and its board’s effectiveness. Conflicts may often lead to compromising the company’s ability to enter into fair contracts and influence the independence, quality and integrity of the decision itself, which might weigh adversely on shareholder value.
These two areas, RPTs and CoI, should always remain matters of principal concern for the boards of companies. Well-governed companies, besides complying with the Accounting Standards, have instituted ways and means to deal with situations of RPTs and CoIs effectively. If not managed in a transparent and legal manner, these situations can impose a heavy burden on the financial resources of a company, distort competition, affect optimum allocation of resources, waste public resources and lead to corrupt practices. This should also be something which audit firms that care for reputational risk should keep under strict vigil, for the accounts to give a true and fair picture of the affairs of companies or enterprises they audit. Otherwise, they would be certifying falsehood and as it is said in The Merchant of Venice: “What a goodly outside falsehood hath?”
The author is associated with IFC’s Global Corporate Governance Forum and the World Bank; he was formerly the executive director of Sebi.
Views expressed are personal. pratipkar21@gmail.com
