Why boards matter, and what can investors, companies, and the government do to fix them?
In my career in the corporate sector and now as a strategy consultant I have often seen corporate boards of listed companies fail to do the right thing for the company, its customers, employees, and its wider stakeholders.
I am of the firm opinion that most corporate failures start and end in the board room. Whether public listed or privately held, companies are most impacted by decisions taken right at the top, starting with the board and the leadership team.
In this piece, I will discuss why the listed companies’ governance structure in Pakistan is misplaced and needs a complete overhaul. It is my contention that the code of corporate governance propagated by the Securities and Exchanges Commission of Pakistan (SECP) is redundant, reads like a standard operating procedure (SOP) of an elementary school morning assembly and plays no role in the quality of decision making. It is also unfortunate that most companies themselves do not invest time and effort in making qualitative improvements to their governance.
There are three points which support my observations; first the selection of directors in a listed company cannot pass the test of true independence; second, the recruitment process for directors in a listed company is weak; and last but not the least, the quality of engagement of listed company directors remains shallow. We will discuss each, but first let us just remind ourselves about what a board is supposed to do.
Ideally, a board of directors of an organisation is responsible for creating the reason for existence for a company – spelling out its mission and vision. It is also responsible for setting strategic direction and to ensure that the strategy is implemented via appropriate recruitment of top management. It is the board’s role to assure all stakeholders that appropriate governance structures are in place and regulatory compliance is effective. It needs to take ownership of company culture and ensure work practices are in line with moral and ethical standards.
In his book Owning up, Ram Charan, a leading governance guru, talks about various ‘lenses’ which ought to be used by boards to visualise their responsibilities. He suggests that boards use the financial vulnerability lens, the strategy and operations lens, the political and geopolitical lens, the reputation lens, and the people and culture lens. Charan points out that “boards have to think broadly about risk and dig deep to understand its many sources.”
Unfortunately, the Pakistani code of corporate governance covers few qualitative aspects. Instead, it focuses on reporting, the number of directors, the number of independent board members, the number of female board members, etc. These are all nice to have but, in my view, they should come after the basic purpose of regulation – to improve governance – has been covered. This is typical of our society I suppose – we always focus on the imagery but leave aside the real substance.
So how do Pakistani listed company boards stack up against all this? It is expected that listed company boards are staffed with qualified and experienced individuals who demonstrate a commitment to all stakeholders and not just the company shareholders. It is also expected that (for those who are declared as an independent) these highly qualified men and women will be truly independent and will exercise their own judgements in voting upon critical decisions.
However, this expectation is in complete contradiction to how board members are recruited which stems from the very shareholding structure itself. Almost all publicly listed companies in Pakistan have majority shareholders of some kind – be it the government, a Pakistani family-owned conglomerate, or a multinational.
Typically, the majority of shareholding means someone has over 50% of the total shares and thus controls all decisions made by the company. Many multinationals actually operate at over 75% shareholding in order to ensure they can mathematically carry any special resolutions. Many companies have offered only 10% of their total shares for public listing. (Surely these companies have no reason to be called ‘listed’ and would be better as fully private entities).
In any case, as a result of this shareholding pattern, all company directors are nominated and approved by the majority shareholders and cannot pass the true test of independence no matter what the code says. They would not be directors but for the backing of the majority shareholder. Even the directors nominated by the National Investment Trust (NIT) for company boards where it has a shareholding, cannot be approved without the blessings of the majority shareholders.
Therefore, the major criteria for qualifying as a director are the potential board member’s likelihood to remain in line with the controlling group. If he or she does not comply once elected, the best they will have is a single 3-year term (they cannot be asked to leave unless their term ends) and they will be ousted after that. This makes a mockery of the independence requirement so vigorously asserted in the code.
The second problem is the process of recruitment itself. Board members are recruited from a list of published potential Directors – approved and listed by various organisations like the Pakistan Institute for Corporate Governance (PICG). If you have undertaken a directors’ certification program from PICG or any other certification body approved by Securities and Exchange Commissions (SECP), you enlist as a potential director. Companies will then peruse this list and contact anyone they feel would be a good match for their company.
While there is nothing wrong with this process as a bare minimum, I believe it is not at all sufficient for selection into such a key role. Board members should be sought out for their core competencies, experience, and personal characteristics and the process should not be too different from what an organisation would use in selecting the CEO and the leadership team. I am not aware of many organisations in Pakistan who would follow a rigorous process for board selection.
The current process prescribed by SECP only ends up creating a market for professional board members – in fact for more compliant board members! In this aspect, companies are more to blame than the regulator. Don’t get me wrong: there are many competent people on listed company boards, but this is despite the process not because of it.
Finally, the quality of debate and discussion in the board room is a fallout from the first two problems. Board members consider code requirements and regulatory compliance to be much more important than discussions on strategy, customer service and culture. Hence they are happy to relegate these critical areas to ‘any other business’. Rarely do board members take the pains to obtain an in-depth understanding of the business and the industry.
The expectation is that the majority shareholder and the management will have all the knowledge required to run the business and plan for the long term. Since the leadership team is also appointed by the majority shareholder, the board is mostly used to rubber stamp decisions which have already been taken. The net result is that board meetings do happen but mostly to comply with the code of governance while the agenda is set to suit the major shareholder and the management. Conversations about business-critical issues such as long-term strategy and sustainability take a back seat. Furthermore, a bunch of strangers working together mostly for the first time hardly qualifies for good team spirit and this shows up in the quality of discussions frequently.
I hear another version of the code of corporate governance is about to be released by the current government. I hope when the SECP revisits the code of corporate governance this time, that they find ways of actually helping boards and companies improve the quality of discussions and participation by directors. If they cannot find a way to get truly independent board members and improve the quality of participation then I wonder about the utility of the code of corporate governance and in such a case, there should be an objective evaluation of the need to have a code.
The best protection for minority shareholders and other stakeholders is for companies to be better managed and if there is to be any regulation, it should focus on this instead of ticking the boxes for compliance to an arbitrary code. But companies themselves ought to take responsibility for improving their recruitment process and ensuring time is spent by boards in good quality discussions around critical areas. Public listing is a good thing for everyone but only if done right. There are many examples of well managed and well governed privately held companies which can show the way. Something for all of us to think about.