By Michael S. Olympios
Chief Consultant
Allied Business Consultants
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“There is no definitive method for appraising a board’s effectiveness and performance†according to an IOD report on good boardroom practice. Although text-book prescriptions are hard to find, ownership structures are found to be key in assessing corporate governance risk.
In emerging markets Fitch Ratings have found that state-owned banks engage in massive government lending and their boards are hardly independent. Appointment of management and decisions on how these people are paid may be based more on whom the government wants to favour than on who will be best for the bank.
This means that issues such as unrestricted related party lending, fraud and corruption are likely to be more prevalent. Other private or political issues may come into play when a company or a bank is either privately controlled or government controlled as decisions will favour whatever is to the controlling shareholder’s short term advantage, which may not be in the best interest of the organization and other stakeholders, such as creditors.
Corporate governance risks that arise from ownership structure are mainly related to private benefits enjoyed by the controlling shareholders, related party transactions and lack of transparency with the later becoming a science to avoid the public radar. Sometimes companies are providing too little information too late (or the last minute at best) and investors find it difficult to decide whether a particular transaction or a resolution are indeed to the best interest of the company and its shareholders. Poor regulation and weak public oversight are creating a breeding ground for scrupulous controlling shareholders-managers to device ways to siphon shareholder wealth.
Even where laws and regulations exist, in practice in a number of emerging markets such as
When banks are held by controlling shareholders, which also control the nomination and rumination committees, these tend to dominate and control in effect the entire board.
In addition, the limited supply of experienced professionals who could be independent directors means that these weaknesses are likely to be more prevalent than in larger, developed markets. The area of poor governance that comes up most frequently for banks in emerging markets is related party transactions.
To the extent that board members’ own interests are not aligned with those of the shareholders, board members may have selective incentives to: seek to maximize personal power and authority at the board level by creating committees and sub-committees that essentially fragment the decision rights of the board as a whole; seek to minimize personal discomfort and anxiety by giving uncritical approval to the directives, initiatives and suggestions of top managers; seek to maximize personal bargaining power and authority by using their own networks to influence, in sub-optimal ways, the pattern of associations, alliances and contractual relationships of the firm; seek to maximize personal self-esteem by continually undermining the initiatives, suggestions and directives of top management and other directors at the expense of shareholder value; seek to maximize personal self-esteem and psychological security by filtering out information that is damaging to their own credibility, notwithstanding the value of that information to the critical decision making power of the board; seek to maximize personal self-esteem by colluding to avoid discussion and deliberation on difficult topics (such as the removal or reprimand of top managers, or the admission of failures of competence or integrity of certain board members).
These issues and many more will continue to draw the attention of governance experts as agency costs continue to evolve in greater complexity and are thus harder to detect and evaluate.
