Corporate governance needs reform

Awareness on the importance of effective corporate governance is increasing in the region – but steps need to be taken to improve standards, says a new report.

The two largest barriers to the implementation of reforms are a lack of internal governance know-how and a shortage of external qualified specialists, according to Hawkamah, a Dubai-based association of regional and international governance practitioners, regulators and institutions.

The group's report, Corporate Governance Survey of Listed Companies and Banks Across the Middle East And North Africa, is based on a survey of 1,044 banks and listed companies from 11 countries. It says 53 per cent of respondents were unable to properly define corporate governance, confusing the term with corporate social responsibility or corporate management.

Most respondents cited improved compliance (60.7 per cent) and reputation (61.3 per cent) as benefits of higher governance standards rather than access to capital (34.7 per cent) or lower cost of equity (19.3 per cent).

Not a single bank or listed company could claim to have applied corporate governance reforms holistically or to have followed a set of 32 indicators which could reasonably qualify them as following best practice.

Just under half the surveyed banks (47 per cent) and listed companies (49 per cent) assign the responsibility for corporate governance to the board – in line with good practice. "The survey demonstrates that the role of the board – to provide strategic guidance to and oversight over management – is not always understood in practice," says the report.

"Banks and listed companies should thus review, clarify and formalise the role of the board vis-à-vis management and shareholders in a corporate governance code or board charter." Corporate governance, it adds, should be treated with the utmost importance even in emerging markets.

Hawkamah Executive Director Dr Nasser Saidi said poor corporate governance was costing regional listed companies up to $300 billion (Dh1.1 trillion) a year.

He said the report showed investors were willing to pay an additional premium of 15 to 30 per cent for shares in well-governed companies across the Gulf region. This could translate to between $200 bn and $300 bn in fresh investment, he added.

Saidi said the UAE and other Gulf countries could attract such investment by following best practices in corporate governance or introducing systems for directing and controlling companies.

"We really need to grow the capital market this time because we have this historic liquidity," he added. "We could even be financing the global capital markets."

Boards in the Mena region are the right size, with eight or more members. Bank boards usually have 10 or more members while the boards of listed companies typically have eight to 10.

However 57 per cent of all listed companies and 54.3 per cent of the surveyed banks do not have any independent directors or have only one.

The independence of audit committees, though they are well represented in the region, also needs to be strengthened. Currently, only 26.4 per cent of such committees have a majority of independent directors.

The report suggests company shareholders and regulators should continue to encourage firms to separate the positions of chairman and CEO. A significant majority of respondents (65 per cent) say the positions are held by different individuals in line with best practice.

While 72 per cent of the banks follow this convention, 42.3 per cent of listed companies continue to combine the two functions.

Banks and listed companies in Mena generally comply with good practice and financial disclosure regulations, but non-financial disclosure remains weak.

Figures from the survey show 92 per cent of respondents provide financial statements to shareholders through the local press, general assemblies, annual reports or the company's website. But while 68 per cent of respondents disclose their corporate objectives, disclosure in other areas remains lackluster, particularly in the disclosure of corporate governance related information.

About 53 per cent of respondents say they do not make corporate governance related information available to shareholders.

Web-based disclosure also needs to be improved. Only 61 per cent of the listed companies say that their annual report is published on a website, while 82 per cent of the banks say they do.

And while financial disclosure in annual reports remains relatively strong at 88 per cent, non-financial disclosure, again, remains weak and should be subject to urgent reform given the importance of annual report for shareholders and investors.

The survey shows that few respondents included a section in 'management's discussion analysis' (28 per cent) or the firm's policies towards corporate social responsibility (33 per cent) or corporate governance (32 per cent).

The report urges Mena law and rule-makers to continue to push for the full adoption of internationally recognised financial reporting standards. Sixty-seven per cent of respondents say they disclose information based on International Financial Reporting Standards (IFRS) and interpretations adopted by the International Accounting Standards Board (IASB), and only 4.6 per cent followed the US Generally Accepted Accounting Principles (GAAP).

The US GAAP provisions differ from those of the IFRS, though efforts are under way to reconcile the differences so that financial statements created under international standards will be considered acceptable within the US and US GAAP financial statements will be acceptable internationally.

Most central banks in Mena require the banking sector to report in accordance with IFRS, in contrast to the market regulators, and as a result 77 per cent of banks say their financial reporting is carried out in accordance with IFRS compared with 58 per cent of listed companies.

Although a large majority of banks and listed companies that are part of groups, produce consolidated financial reports, the report says regulators should ensure full compliance with this best practice. Listed companies are less likely to produce consolidated reports than banks. The main barrier to the full implementation of best practice in disclosure cited by banks and listed companies is a lack of legislation, particularly in the area of non-financial disclosure, again confirming the compliance-driven understanding of corporate governance.

Regulators should safeguard shareholder's rights to share in the profits of the organisation, focusing on the effective enforcement of existing legal provisions, says Hawkamah.

There are many ways in which this fundamental shareholder right can be evaded or eroded, primarily through insider dealing and conflicts of interest, and regulators should be vigilant in enforcing violations against this principle. And 54.7 per cent of respondents thought directors failed to avoid conflicts of interest and that 62.7 per cent used inside information for their benefit.

Under best practices standards shareholders, have a say on extraordinary transactions and banks and companies should adopt specific processes regulating when and how shareholders approve extraordinary transactions in their articles of associations, says Hawkamah.

About 70 per cent of respondents say their board is generally responsible for approving extraordinary transactions, regardless of their value. An important minority said the competence to approve extraordinary transactions above a certain threshold – 50 per cent of book value – is assigned to the shareholders.

And while there is much debate in the corporate governance community as to whether shareholders are best placed to vote on such transactions, Hawkamah says it may well be prudent to give them the final vote on such matters.