The corporate governance (CG) regime in Pakistan has witnessed important developments over the past few years. The major push for CG reforms came from Securities and Exchange Commission of Pakistan (SECP) when it issued a first country code for corporate governance of listed companies in 2002. Given its mandatory nature, stock exchanges in Pakistan have been empowered to enforce the code since. Swapping a voluntary code — such as the UK Combined Code — for the one which is mandatory —the so called “command-and-control” model — must rely, heavily, on the effectiveness of implementation mechanisms for its success.
This article attempts to highlight key challenges that regulators face in ensuring effective implementation of good CG practices and what strategies can increase compliance by companies of good CG practices. While some of the issues discussed below are fundamental to the design of a regulatory framework (such as precise regulations, specialised codes, etc.), others are more of the nature of consistently developing an effective regulatory regime (by building capacity of regulators, increasing investors’ awareness, and so on).
1. Developing precise CG codes/laws: Regulating CG has always been a challenge since some aspects of CG do not easily lend themselves to “objective monitoring and/or evaluation”. Resulting codes or laws suffer from this inherent lack of specificity in certain CG areas. For example, board independence is intuitively understood but often difficult to encapsulate in an all-encompassing definition that a board could rely upon for determining which members are truly independent.
The legislative processes should do more than merely inviting comments from stakeholders over some daft legislation, more so where such rule-making has been delegated to a specialised agency or regulator which is ideally positioned to accommodate industry views in proposing laws. Regulators should in addition develop guidelines to interpret regulations that can lead to competing interpretations. Statutory definitions (of difficult concepts such as board independence) that are hard to amend (without going through a time-consuming legislative process) should be avoided by relying more on industry examples.
2. Justifying the cost of CG improvement: While some CG reforms are cost effective, others can involve sufficient expenditure. Similarly, the level of CG improvement also determines the cost for such intervention. For instance, the lower a company on the governance ladder, the more the cost of improving its corporate governance! This is another reason for companies to shy away from effective implementation of good CG practices. To compound this problem further, the pay off from good CG is not always easy to attribute. In a dynamic business or organisational environment, several factors can be at play to ensure “positive results” thus making CG-related efficiencies hard to measure as a stand-alone factor.
Therefore, a business case for good CG should be developed for the board and the senior management. National codes must expressly spell out policy objectives (e.g. operational efficiency, access to capital, etc.) to appeal to the interests of the business community. Further, the perceived value of improving CG is an important factor. Organisations feel that it is not worth improving CG in all areas therefore improvement is seen as expensive and not urgent. Consequently, customised CG solutions need to be developed for different categories of companies (e.g. small-, medium-, and large-companies, family-owned companies, state-owned enterprises, etc.) as opposed to wholesale CG improvement programs. This would help improve the cost benefit equation and attribute clear benefits to specific CG-related improvements.
3. Building capacity of regulators: While most of its principles stem from ethical and moral values of accountability, responsibility, transparency and fairness, CG has its share of technical rules and procedures that demand a thorough understanding of key CG concepts and accompanying rules. A regulator that has limited conceptual understanding of various CG rules and fails to communicate the rationale for various CG reforms risks effective implementation by companies of CG laws.
Helping stock exchanges (where they act as the regulators) develop better understanding of CG regulations is likely to improve implementation of CG codes and the impact of regulation. Their continuous capacity building should be a priority to ensure effective implementation of these regulations.
4. Enacting specialised codes: CG isn’t one-size-fits-all. A family owned enterprise is likely to face different governance challenges than a state-owned company, for instance. Or at least the priority for various CG improvements may vary with these two types of organisations. Yet both these companies may be subject to a CG code that uses the paradigm of a listed company as it basic reference point.
Specialised codes for segments of the market that merit tailor-made solutions can enhance their relevance. Resultantly, such codes would be more precise in their application leaving little room for companies to avoid compliance.
5. Enhancing board’s ownership of good CG practices: The board remains at the centre of the implementation debate. A board that shies away from embracing the role of a “front-line regulator” to improve CG of an organisation encourages “creative compliance” by these companies. CG should primarily remain self-regulated for it to succeed notwithstanding national CG codes or laws.
In order to encourage board’s ownership of CG, regulation should lay out the benefits of good CG practices to businesses. Moreover, directors can be made personally liable for certain decisions. Their continuous capacity building in addition should be a priority.
6. Increasing awareness of investors: Minus pressure from right-aware minority shareholders, a company is more likely to indulge in “box-ticking” as opposed to implementing good CG practices in spirit.
Where shareholder activism is scant, there is a need for minority shareholders to group and protect their rights as a class. In Pakistan, the court-sectioned process for the protection of minority interests needs to be improved by increasing capacity of courts and amending relevant laws.