Most of us, when we hear corporate governance, tend to think of codes, like the well-known Cadbury Code, that have emerged over the past few years. These governance codes usually recommend that companies change their board structures and procedures to make the company more accountable to shareholders. Often they suggest increasing the number of independent directors on boards, separating the position of chairman and chief executive officer, introducing new board committees – such as the audit committee – and so on.
If this were all that corporate governance was about, then one could legitimately ask, why the OECD, an intergovernmental organisation whose mandate is to advise on public policy matters, is interested in the topic at all. Isn’t corporate governance something that should be handled by corporations, as the name implies?
No. Governance is more than just board processes and procedures. It involves the full set of relationships between a company’s management, its board, its shareholders and its other stakeholders, such as its employees and the community in which it is located. The quality of governance is directly linked to the policy framework. Governments play a central role in shaping the legal, institutional and regulatory framework within which governance systems are developed. If the framework conditions are not in order, the governance regime is unlikely to be either.
The policy framework covers considerations such as the legal rights of shareholders and their ability to obtain redress in case their rights are violated. The framework includes the protection of shareholders through regulation and through requirements for full disclosure of risks. These are just two examples. There are a great number of other factors that impact the way the company is controlled, managed and held accountable, and many of these factors fall squarely in the realm of policymakers.
The root of a crisis
Why should we care about the quality of governance? There are several reasons. An immediate one is that poor governance can harm national economic performance and ultimately global financial stability. The financial crises in Asia, Russia and elsewhere have demonstrated this beyond question. Though circumstances differed, what crisis countries all had in common was distorted governance structures that led to inefficient economic decision-making. When imbalances became too large to be ignored, they prompted a rout in financial markets, setting back the development efforts of entire countries and regions.
Problems specific to each country were important too. In Asian countries, interest groups linked to large financial institutions, even to the state, ran vast conglomerates under conditions that prevented external scrutiny. Because of their high-level connections and the perception of implicit government guarantees, these conglomerates had easy access to external debt and equity finance without having to go through the appropriate controls. However, minority shareholders – domestic and foreign – as well as creditors, were given neither the information nor the authority to monitor corporate operations. Lack of transparency and accountability led, in turn, to distorted incentive structures, over-investment and dangerously high corporate indebtedness. Poor disclosure and audit procedures only made the situation worse by preventing early warning of the deteriorating financial conditions of corporations.
In the context of countries making the transition from centrally -planned to market economies, corporate governance must respond to the needs of the different stages of reform. In many transition countries, weak corporate governance has been blamed for the delay in restructuring after privatisation. In other words, while privatisation succeeded in transferring ownership of enterprises from public to private hands, ambiguous property rights and an inadequate regulatory and institutional framework resulted in unchecked control by corporate insiders and opaque ownership and control structures. In many cases the rights of minority shareholders were very poorly protected indeed. At the end of the day, this poor governance undermined confidence in the markets and held the whole financial system hostage.
It is also worth noting that the challenge to improve governance is not limited to emerging market and transition economies. All countries stand to gain from improving the way their enterprises operate. Even the most advanced economies are discussing, questioning and working towards better practices. In the United States the separation of the chairman and chief executive – preferred by many investors – is unusual. European countries face mounting calls for better treatment of minority shareholders and greater transparency in mergers and acquisitions. In Japan, efforts to rekindle economic dynamism clearly require improvements in areas such as information disclosure and board practices. In Australia, the United Kingdom, France, Germany and Sweden, important long-term efforts have been undertaken in the area of company law and the regulation of take-overs.
One of the implications of the communications revolution and the increasingly integrated global economy is that, unfortunately, capital is rarely “patient”. In their constant search for investment opportunities, investors will not hesitate to take their money around the globe. If companies are to attract and retain long-term capital from a large pool of investors, they need credible and recognisable corporate governance arrangements. Companies and governments have to respond.
Of course, governance is not simply an issue relevant to foreign investors. Yes, it is true that they often sound the initial warning. However, by far the most investment in almost all countries comes from home-grown sources. Strengthening domestic confidence in a country’s own corporations and stock markets matters greatly to the long-term competitiveness of businesses and to the overall health and vitality of national economies. It should not be surprising that studies have shown that countries with weaker investor protection tend to have smaller, less liquid, capital markets.
It is in the context of growing awareness of the importance of good corporate governance that the OECD has developed a set of Principles of Corporate Governance. The results represent a collective view of the most important core elements of a good corporate governance framework. They are designed to leave adequate flexibility for implementation according to specific circumstances, cultures and traditions in different countries. The Principles are non-binding. They are intended to serve as a reference point for governments as they review and refine their frameworks for corporate governance. They also provide guidance for stock exchanges, investors, private corporations and national commissions on corporate governance as they elaborate best practices, listing requirements and codes of conduct.
The OECD Principles cover five main areas: the rights of shareholders and their protection; the equitable treatment of all categories of shareholders; the role of employees and other stakeholders; timely disclosure and transparency of corporate structures and operations; and the responsibilities of the board towards the company, shareholders and other stakeholders.
To get to the heart of the matter, the Principles can be summarised in terms of four values. These are equitable treatment, responsibility, transparency and accountability. The Principles identify those core values or principles that we feel hold true in all countries – principles that underpin the development of a strong governance framework which, in turn, supports the development of a sound capital market.
These values also link corporate governance to other important elements of governance in a broader sense: the battle against bribery and corruption; corporate responsibility and ethics; public sector governance; and regulatory reform. The pursuit of good governance requires co-ordinated efforts in all of these interconnected areas, so that nations can reap the full benefits of the globalising economy.
Now that the Principles have been completed, the real work is only just beginning. At present, the main task for the OECD is to encourage a process of examination, dialogue and ultimately change. We are seeking to promote governance reforms in close co-operation with other international organisations, in particular, under a joint programme with the World Bank, and with the participation of the IMF, the regional development banks and other bilateral partners.
The OECD’s main responsibility within the context of this co-operative effort is to organise a set of regional corporate governance roundtables, bringing together senior policymakers, regulators and market participants from the region in order to improve their understanding of governance and help them develop reasoned, robust policy. Roundtables are now in operation for Asia, Latin America, and Russia and further roundtables are planned for Eurasia, which is basically the CIS countries – except Russia – plus Mongolia and Africa.
In the 21st century, stability and prosperity will depend on the strengthening of capital markets and the creation of strong corporate governance systems. While it is encouraging to see emerging economies rebound from the traumatic financial crises of the last several years, it is important that the momentum for reform of corporate governance regimes be maintained. The OECD can work alongside governments, stock exchanges and other private parties around the world to assist them in their own efforts to strengthen their economies. The Principles of Corporate Governance can help in the process too. They might not be able to prevent shocks from occurring completely, but if adhered to, they could prevent a shock from becoming a crisis.
©OECD Observer No 221/222, Summer 2000