The IFC (International Finance Corporation), a member of the World Bank Group, has established its reputation as a leader in promoting corporate governance reform in emerging markets. IFC believes that long term success in any business is contingent on good corporate governance practices. With the backdrop of the global financial crisis – partially resulting from major corporate meltdowns and frauds – the importance of corporate governance has come into greater focus. IFC Advisory Services in the Middle East and North Africa launched the Pakistan Corporate Governance project in 2006 in partnership with Canada, France, the Islamic Development Bank, Japan, Kuwait, the Netherlands, the United Kingdom, and the United States. Khawar Ansari, Mohsin Ali Chaudhry, and Mahwesh Bilal Khan– the people behind this project – talk to Blue Chip about corporate governance practices in the country and the efforts being made to implement a more effective system of governance.
As the members of the Pakistan Corporate Governance project, what are your views on corporate governance and current corporate governance levels in Pakistan?
Khawar Ansari: “I think the first thing to do is to explain what corporate governance is. If you look at the formal definition, it’s how companies are directed and controlled. Put simply, corporate governance is: what directors do; how do they work more effectively; how do they relate to shareholders and to the top management; and where do you draw the line between directors and senior management. The dominant perception in Pakistan is that the majority of organizations are complying with good corporate governance practices in letter but not in spirit. The market need for education on the ‘real’ benefits of good corporate governance, such as improved operational efficiency and financial performance, better access to capital at lower costs, higher reputation, and better retention rates of employees still persists.”
Mohsin Ali Chaudhry: “Over the past few years, the corporate governance regime in Pakistan has witnessed important developments. A corporate governance code for listed companies was issued by the Securities and Exchange Commission of Pakistan in 2002. The State Bank of Pakistan has, in addition, issued prudential regulations for banks that, among other things, regulate their governance practices. A recent ruling of the High Court of Sindh has paved the way for a thorough scrutiny by government agencies of corporate governance practices of bidders for various state-owned assets. The emphasis should be on benchmarking local governance practices with global practices and procedures and building sufficient corporate governance training and advisory capacity in the country to strengthen the existing legal and policy framework. IFC’s Pakistan Corporate Governance project has been at the forefront in stimulating a debate over global corporate governance practices and creating capacity to improve the corporate governance of Pakistani companies and banks. For example, the Pakistan Institute of Corporate Governance (PICG), a corporate governance institute based in Karachi, has been running a certified board training program since 2007 in association with IFC. In addition, IFC, through its investments, has been helping client companies improve their corporate governance in accordance with international best practices.”
You’re targeting the corporate sector, bank, and family-run businesses as well. What recommendations would you make to them?
Mahwesh Bilal Khan: “Since inception, our project has been focused on improving corporate governance of key stakeholders. We have been active in creating awareness and providing training and advisory services to banks and companies to improve their corporate governance. We have, in addition, worked with journalists, lawyers, judges, and educational institutions to create momentum for our work. The project has increased its outreach and diversified services over time. Initially, there were a lot of awareness-raising workshops and seminars to educate companies about corporate governance and how it was going to benefit them. Over time, we have started to target specific segments of the market such as microfinance institutions, family owned companies, collectively, as well as individually. We work directly with companies. How do we do that? Now that we feel that the market knows about corporate governance and is more receptive towards the idea, we are working on a one-on-one basis with companies. The kind of recommendations that we make to them and the kind of presentations we give them are tailored to the kind of business that they are in. For banks, it is going to be more focused on risk management and internal control procedures. For family-owned businesses, it is more focused on internal controls and succession planning, because these businesses are based on a hierarchy and most family businesses in Pakistan are either in their second or third generation. We also do formal corporate governance assessments for companies, which are very intense. During these assessments, we identify governance challenges for organizations and provide recommendations, which are very company specific. Increasingly, we are working with the PICG.”
KA: “One of our project objectives is to help make the PICG become self-sustainable.
The PICG is providing director training to improve good corporate governance practices of banks and companies in Pakistan. Developed by IFC, the training is internationally accredited. The whole idea is to have at least one director who understands corporate governance best practice on each board of a listed company. The other thing they are doing is increasing membership. They have corporate membership as well as individual membership, and the corporate membership is split into two: affiliated member and full member. The full member has to allow its corporate governance practices to be scrutinized by the PICG methodology designed for this purpose.
You may ask: who would want to have these kinds of workshops? Well, these are the companies that are looking for external funding, or wanting to do a joint venture with somebody from another country, or exporting their products, or setting up business abroad, or selling a part of their company — all of these are cases for director workshops. They know that as soon as they go to a third party, the third party will ask about their corporate governance. Then, there comes a realization that they do need to improve, and they may ask for a review or an assessment, which is a more detailed analysis. We look through all the papers, investigate the trends, look at board meeting minutes, at declarations they’ve made, check their website and company literature, and interview directors and senior management. It is a very thorough process followed by a report including recommendations for a three-year time period.”
MAC: “The following steps could be instrumental in improving corporate governance practices of local companies and ensuring effective implementation of corporate governance regulations in Pakistan. First, there is a need to strengthen the role of independent, non-executive directors in Pakistan to ensure objective decision-making and effective managerial oversight by corporate boards. Second, alternative dispute resolution methods (such as mediation) for resolving corporate governance-related disputes need to be encouraged by building capacity of corporate governance institutes to mediate these disputes. Third, a court-sanctioned process in Pakistan for minority shareholders’ protection is fraught with unnecessary delays, expense, and uncertain outcome. The process should be speedy and more accessible to aggrieved shareholders. Last, stock exchanges (which regulate compliance with the code as part of their listing regulations) should build their capacity to improve implementation of good corporate governance practices.”
Have you witnessed a shift in attitude in Pakistan? We are plagued by the Sethmentality and the benefits of devolving power and delegations are not always fully understood and there is often a failure to institutionalize big organizations.
KA: “It is a gradual thing. The situation now is that there is almost an obligation for Pakistani companies to change attitudes and behavior. People ask me why corporate governance is important to Pakistan. The simple answer is that Pakistani companies need to compete globally. Pakistan is the sixth largest country in the world in terms of population, so we need to create employment. And where is the employment going to come from? It is not going to come from the government or the public sectors, it has to come from the private sector and, therefore, the private sector needs to grow and become more robust. The only way this can be achieved is if the directors behave according to international best practice. Their planning, decision-making, and risk management have to be of international quality. That means corporate governance has to follow international best practice.”
MBK: “To answer your question very specifically, before joining IFC, I had been working with the securities regulator where I witnessed opposition by owners of family businesses to improving their corporate governance. There was very strong resistance, and, over the last four to five years, you can see that they have accepted the fact that this is for their own good. There has been a shift in mentality. There are still people and organizations who say that this doesn’t really apply to their business because they are a small business or because they are doing business locally so are not affected by globalization.”
How do you persuade them that this is applicable and beneficial when organizations resist change?
MBK: “You have to realize that when you are giving international benchmarks, you are conscious of the peculiarities of the local market. Being a country project, we have to tailor our services to local business needs and that is what we try to tell them also.”
KA: “The other way we convince boards of adopting good practice is by giving them examples from personal experience. What we found is that whenever we have done a workshop or had a discussion with directors, initially there is resistance, but when they begin to understand what we are saying, they realize it’s in their own best interest to improve corporate governance practices. For example, one of the components of good practice is to make sure that directors are responsible for corporate strategy. Many companies don’t even have a strategy, so when the board realizes it ought to think and plan ahead, determine where the market is going, what the competition is doing, how to mitigate risk, and how to have a board where responsibility is shared, it all adds up.”
In terms of individual corporations, what kind of legal standards need to be implemented to enhance governance levels?
MAC: “Major corporate governance improvement areas for a company include board composition, transparency and disclosure, internal controls, risk management, and protection of shareholders. However, a corporate governance reform agenda must be owned by a company. Without commitment from its directors and senior executives, corporate governance practices of a company are hard to change. A board of directors of a company that hasn’t fully embraced its role as a ‘front-line regulator’ in implementing good corporate governance practices encourages window-dressing by the company. The business case for good corporate governance should, therefore, be built for the board and the senior management.
Further, the perceived value of improving corporate governance is an important factor. Some corporate governance improvement criteria are more important than others. Organizations that feel that it is not worth improving corporate governance in all areas therefore see improvement as expensive and not urgent. Consequently, customized solutions need to be developed for different categories of companies (such as, small, medium, large, family owned, listed companies and state-owned enterprises) as opposed to wholesale corporate governance improvement programs. In its second phase, the project intends to engage specifically with family-owned companies, microfinance institutions, and Islamic financial institutions in Pakistan.”
How can adherence to international best practices be ensured?
MAC: “To start with, it is of critical importance to have buy-in from owners and managers of companies to internationally accepted corporate governance practices which are invariably more stringent than the local standards. The benefits of global corporate governance practices to businesses should in addition be clearly spelt out to encourage board’s ownership of these practices. Training opportunities for directors and senior managers through various programs being offered by the PICG are important in highlighting global governance practices and associated benefits to encourage convergence of corporate governance standards.”
On an international level, what kind of legal requirements do you feel will be implemented in the wake of the current financial crisis?
MAC: “Corporate governance areas that have recently been scrutinized in the wake of the current global financial crises include executive remuneration, effective risk management, and adequate exercise of shareholder rights. There is also an ongoing debate on the role of credit rating agencies as they face potential conflict of interest in rating (and getting paid by) clients. Further, the OECD has been working on developing a set of corporate governance recommendations since the onslaught of global financial crises to deal with some of the above governance challenges.”
What is your vision for the future with regard to this project?
KA: “We have to get business leaders to embrace good corporate governance practice, project what they’ve achieved, and correlate this with their success. We have to demonstrate to the Pakistani market that good corporate governance practices make business sense and lead to improved good business performance and enhance share value — the vision is to be able to communicate that to the market. The other part is to segment and develop the market for corporate governance so that all the key players are included.”
Making boards work for you: The World Bank singles out Pakistan as a leader in corporate governance reforms in South Asia: ‘Getting Finance in South Asia, 2009.’ Our challenge is to translate these reforms into world-class board performance.
The recent downturn in global financial markets has brought boards into sharp focus. In reaction to market volatility, boards became embroiled in crisis management as they appeared to have run out of strategic options. This is surprising, because signs of structural faults in companies were apparent long before the downturn took root. If companies had been able to anticipate the impending liquidity crisis they may have been able to reverse the downslide much earlier.
The question of how boards should respond to sharp and unpredictable changes in the market is central to IFC’s work in Pakistan. The Pakistan Corporate Governance Project is an IFC initiative working directly with companies, regulators, and the Pakistan Institute of Corporate Governance (PICG). Through this work more than 70 company directors have been internationally accredited on good corporate governance practice by PICG and four companies have been assessed by IFC on their corporate governance practices. The overall aim is to help companies attract capital, improve performance, and weather financial crises.
How then should boards face turbulent markets in the future? The first important ‘take-away’ is that anticipating risks and managing uncertainty should be an integral part of strategic planning, and not an afterthought. Boards are put in place to keep organizations centered on strategic priorities and mission. They have to exercise oversight in key areas, such as monitoring strategic objectives, overseeing the integrity of financial statements, assessing major risks and reviewing the performance and succession of senior management and the board. Moreover, boards need to ensure that sufficient time is allocated for oversight, not only in the boardroom, but also on important committees such as audit, risk management, nomination and succession planning.
These responsibilities place a heavy premium on directors’ time. Board members have to find time to sit on committees, attend board meetings, and analyze and review numerous documents. These would be onerous tasks for full time executives, so how do boards manage to juggle these multiple priorities with such limited time at their disposal?
My work with boards as chief executive, as an independent director, and with IFC in Pakistan has shown that the most successful boards are able to juggle multiple priorities primarily because they adopt a proactive approach to oversight. Such boards are well equipped with plans and are prepared ahead of time for all the risks they can foresee. Moreover, these plans are woven into strategy; ensuring plans are regularly reviewed and updated at board meetings.
Successful boards also stand out because they have the right balance of skill sets and expertise blended into their composition. This is important because boards require an appropriate mix of industry experience, specialized knowledge, and technical expertise to equip them to determine strategic priorities, oversee risks, decipher financial statements, and optimize human resource capacity.
Balance is critical to effective decision-making. The first priority in the decision-making process is to present facts and figures clearly so they can be easily assimilated by all members. Then it is up to the board chair to ensure that deliberations are well balanced to enable quality inputs and insights from board members with different perspectives and experience. Unfortunately, decision-making often ends up being lop-sided with the chair and the chief executive dominating proceedings whilst the rest of the board either acquiesces or becomes a partial player in the decision making process. This is dangerous because lop-sided decision-making leads to the polarization of views and limits creative thinking, making it difficult for the board to find optimal solutions to complex problems.
The right balance has to be found between independent, executive, and non-executive directors and their fit with a board of appropriate size. There is a difference between independent and non-executive directors. Truly independent directors do not have a stake in the company, are not related to owners, and are only present on the board to provide insight from their experience and expertise. This balance in board composition improves decision-making and oversight because bias is counter balanced with independent-opinion.
Companies should seriously consider the gender balance in their board composition. Several studies have linked greater gender diversity in senior posts with financial success. For example, according to a 2007 study by McKinsey and Company, European firms that had the highest proportion of women on their boards saw their stock value climb by 64 percent over two years. The message of women’s importance on boards is also reaching companies in Pakistan; to date, eight female directors have been certified, out of a total of 74, as part of the PICG Director Education Program, which is internationally accredited by the Risk Metrics Group.
Women’s presence on the board creates spaces for both women and men to develop their potentials and work together to be more effective. Taking gender issues seriously also makes good business sense since women make up over 50 percent of the population and a sizeable proportion of consumers.
As management guru Steven Covey points out, “The problems we face today are too complex to be solved by any one person. Our only chance is to bring people together, into a gender balanced environment, from a variety of backgrounds and disciplines, so we can refract a problem through the prism of complementary minds allied in common purpose.”
Boards are put in place to center organizations on key issues, risks and opportunities. If businesses are not centered they will whirl out of control – like a lump of clay on a potter’s wheel. The challenges faced by banks and companies are becoming more complex with time. Equipping boards with a well-rounded skill set and expertise is the best way to respond to these challenges. This translates into a board that is balanced from multiple perspectives: in the effective use of skills, experience, specialized expertise, and gender perspectives, supported by independent decision-making. Boards need to continually review their performance, skill sets, and experience to reduce the risk of the organization losing focus and losing control. Finding the right balance is a continuous process. It is a journey and not a destination.