Current Views on Corporate Governance in Sri Lanka

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Current Views on Corporate Governance in Sri Lanka: Evidence from Sri Lankan Corporate Boards

Current Views on Corporate Governance in Sri Lanka: Evidence from Sri Lankan Corporate Boards Dr. Hareendra Dissa Bandara Director – Financial Services Academy Securities & Exchange Commission of Sri Lanka & Senior Lecturer in Corporate Governance & Finance Faculty of Management Studies & Commerce University of Sri Jayewardenepura

Disclaimer Clause Views expressed herein are those of the presenter. They do not necessarily

Disclaimer Clause Views expressed herein are those of the presenter. They do not necessarily reflect views of the Securities & Exchange Commission of Sri Lanka or University of Sri Jayewardenepura or other staff members of the respective institutions.

Importance To Whom Why To enhance the governance level of Company Directors respective companies

Importance To Whom Why To enhance the governance level of Company Directors respective companies & thereby the country’s governance Capital Market Professionals To advice clients in a broader sense Regulators To regulate or to provide specific guidelines

Contents 1. 2. 3. 4. 5. 6. 7. 8. 9. What is corporate governance?

Contents 1. 2. 3. 4. 5. 6. 7. 8. 9. What is corporate governance? Governance structures Need for greater corporate accountability? Major concerns of corporate governance Objectives of the study Methodology What is CGS? Results: Adherence to the CG Essentials Current View

What is Corporate Governance? • “Corporate governance is about promoting corporate fairness, transparency and

What is Corporate Governance? • “Corporate governance is about promoting corporate fairness, transparency and accountability. ” accountability (J. Wolfensohn, President - World bank, as quoted by an article in Financial Times, June 21, 1999) Dissa 5

What is Corporate Governance? Contd… “Corporate governance is the system by which business corporations

What is Corporate Governance? Contd… “Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attending those objectives and monitoring performance. ” (Cadbury, OECD, April 1999) Dissa 6

What is Corporate Governance? Contd… ‘Corporate governance is the mechanism by which companies are

What is Corporate Governance? Contd… ‘Corporate governance is the mechanism by which companies are rationalized, directed, controlled and monitored. Corporate Governance coordinates different types of stakeholders such as shareholders, directors, managers, employees, creditors, customers, global environment and the rest of the society to enhance corporate performance and wellbeing as a common goal. Major considerations of a system of corporate governance are: Ø how successfully companies formulate the rational; the reason for existence & future direction Ø how effectively corporate decisions are made; guidelines and procedures Ø how well the board on behalf of shareholders appraise managers’ decision making, and monitor the execution Ø how fruitfully the different stakeholders are facilitated to achieve the goals’ (Dissa Bandara, 2006)7 Dissa

Governance Structures

Governance Structures

US Governance Structure Stockholder Report Appoint Chairman Board of Directors Appoint 1. 2. 3.

US Governance Structure Stockholder Report Appoint Chairman Board of Directors Appoint 1. 2. 3. 4. 5. Nomination Committee Reward Committee Inspection Committee Finance Committee Executive Committee Report CEO Executive Management Dissa Source: Based on Dissa Bandara (2003) 9

Japanese Governance Structure Appointment /dismissal of Directors (Board of) Statutory Auditors at least majority

Japanese Governance Structure Appointment /dismissal of Directors (Board of) Statutory Auditors at least majority must be outside auditors in case of a large company Source: Based on Dissa Bandara (2003) Duty of Care Decide the administration of affairs of the company Supervise execution of duties of directors

Sri Lankan Governance Structure t men ern v o G External Governance Mechanism Shareholders

Sri Lankan Governance Structure t men ern v o G External Governance Mechanism Shareholders CEO Foreign, Insti Individua tutional, l Investor s Internal Governance Mechanism: BOD Executive & Non. Executive Directors Committees (Ind) External Auditors The relationship among various components in determining the rational, direction and performance Employees Cus tom ers Creditors Dissa 11

SHAREHOLDERS External Auditor Shareholders delegate power to the board of directors BOARD OF DIRECTORS

SHAREHOLDERS External Auditor Shareholders delegate power to the board of directors BOARD OF DIRECTORS Chairman Non-executive Directors CEO and Executive Directors Audit Committee Financial Reporting F u n c ti o n s Risk Management Internal Controls Remuneration Committee M o n it o ri n g Nomination Internal Auditor Committee Conduct of the business and other operational matters Board delegates the powers to management MANAGEMENT Dissa EMPLOYEES 12

Need for Greater Corporate Accountability? Separation of ownership and control – Berle and Means

Need for Greater Corporate Accountability? Separation of ownership and control – Berle and Means (1932) recognise that the separation of ownership and control gives rise to a conflict of interest between insiders (managers) and outsiders (shareholders) with diffuse ownership. Dissa 13

1932

1932

Separation of Ownership and Control Ownership Shareholder Control 1 Director 2 Management Board of

Separation of Ownership and Control Ownership Shareholder Control 1 Director 2 Management Board of Directors leads the company and is the link between ‘Owners’ and ‘Managers’ 1. Determine the Future Direction: Aims, policies & strategies on behalf of the owners 2. Monitor the progress of Management Execution

Separation of Ownership and Control Contd… – Agency Problem: The greater the degree of

Separation of Ownership and Control Contd… – Agency Problem: The greater the degree of separations, the greater the agency problem. – Agency Cost: Because of the costs of information and the difficulties in monitoring managers, rational managers undertake behaviour which shifts wealth from shareholders to themselves. This results in agency costs: loss in market value relative to the value if no agency problems existed. Dissa 16

Major Concerns of Corporate Governance ØAlign the interests of managers and shareholders ØPrevent managers

Major Concerns of Corporate Governance ØAlign the interests of managers and shareholders ØPrevent managers from pursuing own interests ØPrevent high and excessive executive pay ØOvercome agency costs associated with the separation of ownership and control ØAvoid abuse of power Dissa 17

Objectives of the Study • To examine the level of compliance of Sri Lankan

Objectives of the Study • To examine the level of compliance of Sri Lankan companies on corporate governance (CG) principles based on a proposal of Governance Research Institute of Sri Lanka (GRIS) • To understand the current views on Sri Lankan corporate boards 10/24/2020 Dissa 5 18

Methodology 10/24/2020 Dissa 5 19

Methodology 10/24/2020 Dissa 5 19

Sample, Data & Time Period • Sample: 59 Companies Listed on the CSE •

Sample, Data & Time Period • Sample: 59 Companies Listed on the CSE • Data: Bo. D related Qualitative & Quantitative Data • Method of Data Collection: TRIANGULATION; Questionnaire Survey, Informal Interviews, Annual Reports & Publications, Governance Database of Governance Research Institute of Sri Lanka (GRIS) • Time Period: 2006 - 2010 10/24/2020 Dissa 5 20

Sample Sector No 1 Bank Finance & Insurance 2 Beverage Food & Tobacco Chemicals

Sample Sector No 1 Bank Finance & Insurance 2 Beverage Food & Tobacco Chemicals & 3 Pharmaceuticals Construction & 4 Engineering 5 Diversified Holdings 6 Footwear and Textiles 7 Health care 8 Hotels & Travels 9 Information Technology 10 Investment Trust 11 Land & Property 12 Manufacturing 13 Motors 14 Oil Palms 15 Plantations 16 Power & Energy 17 Services 18 Stores & supplies 19 Telecommunications 20 Trading Total No. of Companies 35 20 Access Restrictions (20) (13) 9 1 st Sample Incomplete Data Final Sample 15 7 (9) 3 0 3 (3) 11 4 6 32 2 9 18 33 6 5 18 4 7 4 2 8 236 (6) (4) (23) (2) (9) (11) (23) (6) (5) (12) (4) (7) (4) 0 (5) (165) 5 4 9 7 10 6 2 3 71 (4) (2) (3) (12) 5 9 7 10 6 59

What is CGS? Corporate Governance Score (CGS) is a measure of adherence to CG

What is CGS? Corporate Governance Score (CGS) is a measure of adherence to CG practices & policies (based on GRIS) • This CGS is; an assessment of individual companies based on their CG practices to measure the compliance with the CG standards / practices • NOT a kind of audit, a financial recommendation, credit rating nor an advice for a particular need • Again it is; NOT an indicator of financial or commercial performance 10/24/2020 Dissa 5 23

Basic Strata of CGS Principles & Sub Areas 14 Principles I. Mission & Role

Basic Strata of CGS Principles & Sub Areas 14 Principles I. Mission & Role of the BOD and CGS-BOD Committees 74 Sub areas 10 Principles II. Rights of Shareholders & Minorities CGS-Sh 46 Sub areas 10 Principles III. Relationship with Stakeholders CGS-Stake 40 Sub areas 12 Principles IV. Role & Leadership Responsibility of CGS-CEO 44 Sub areas 12 Principles V. Role of Executive Management CGS-Mgt 40 Sub areas 12 Principles VI. Disclosure and Transparency CGS-Dis. Trans 42 Sub areas Principle Areas CGS Category

Separation of Ownership and Control Ownership Shareholder Control 1 Director 2 Management Board of

Separation of Ownership and Control Ownership Shareholder Control 1 Director 2 Management Board of Directors leads the company and is the link between ‘Owners’ and ‘Managers’ 1. Determine the Future Direction: Aims, policies & strategies on behalf of the owners 2. Monitor the progress of Management Execution

Important Empirical Evidence Adherence to CG Principles/Practices 10/24/2020 Dissa 5 26

Important Empirical Evidence Adherence to CG Principles/Practices 10/24/2020 Dissa 5 26

Overall CGS - BOD Adherence

Overall CGS - BOD Adherence

General Compliance Details STD Range 7% 30% Min 39% Max 69% Mean 56% Maximum

General Compliance Details STD Range 7% 30% Min 39% Max 69% Mean 56% Maximum Possible CGSBOD 100% Maximum Mean Possible CGS-BOD Score 296 165 Max Min Range STD 203 115 88 20

Top 10 CGS-BOD Rank Order Company Sector Score 1 2 3 4 5 6

Top 10 CGS-BOD Rank Order Company Sector Score 1 2 3 4 5 6 7 8 9 10 AAA BBB CCC DDD EEE FFF GGG HHH III JJJ BFI DIV BFI BFI DIV Hotels Manu 203 199 198 197 192 191 188 187 186 185

Worst 10 CGS-BOD Rank Order Company Sector Score 1 2 ZZZ YYY Manu 115

Worst 10 CGS-BOD Rank Order Company Sector Score 1 2 ZZZ YYY Manu 115 119 3 XXX Land & Pro 120 4 5 WWW VVV BFI Manu 132 139 6 UUU Land & Pro 140 7 TTT Manu 140 8 SSS Land & Pro 143 9 RRR Plantation 143 10 QQQ Land & Pro 144

2 # CGS-BOD 200 -210 6 190 -199 11 180 -189 10 170 -179

2 # CGS-BOD 200 -210 6 190 -199 11 180 -189 10 170 -179 12 160 -169 6 150 -159 4 140 -149 1 130 -139 0 2 120 -129 2 110 -119 # of Companies Frequency Distribution of CGS-BOD 14 12 10 8 9 5 1

High & Low CGS-BOD Groups 1. High CGN Group: 9 firms with score greater

High & Low CGS-BOD Groups 1. High CGN Group: 9 firms with score greater than 185 2. Low CGN Group: 10 firms with score less than 145 10/24/2020 Dissa 5 32

High & Low CGS-BOD Groups

High & Low CGS-BOD Groups

High & Low CGS Japan - 2003 1 SD = 11. 2 Avg. 36.

High & Low CGS Japan - 2003 1 SD = 11. 2 Avg. 36. 3 1 SD = 11. 2 Low CGN Group 25 Firms High CGN Group 25 Firms Source: Dissa Bandara (2003) 10/24/2020 Dissa 5 34

High & Low CGS Japan - 2008 1 SD = 12 Avg. 37. 8

High & Low CGS Japan - 2008 1 SD = 12 Avg. 37. 8 1 SD = 12 Low CGN Group 25 Firms High CGN Group 30 Firms Source: Dissa Bandara (2008) 10/24/2020 Dissa 5 35

Composition of CGS-BOD Specific Areas Point Allocation 1: Determining Future Direction 20 2: Policy

Composition of CGS-BOD Specific Areas Point Allocation 1: Determining Future Direction 20 2: Policy Formulating Practices 20 3: Engage in Strategic Thinking 20 and Planning 4: Board Structure & Practices 25 5: Board Membership & 16 Orientation 6: Board Meetings 25 7: Board Committees 45 8: Board-CEO & Senior 20 Management Relationship 9: Board – Staff Roles 20 10: Monitoring & Evaluation 25 Practices 11: Legal & Ethical Compliance 12 12: The Entity 12 13: Stakeholders 16 14: External Relations Practices 20 OVERALL 296 Score Obtained 13. 33 12. 88 Compliance Level 67% 64% 13. 38 67% 14. 28 57% 8. 52 53% 14. 49 24. 39 58% 54% 9. 93 50% 9. 17 46% 11. 68 47% 7. 72 7. 11 7. 76 10. 44 165 64% 59% 48% 52% 56%

Composition of CGS-BOD Specific Areas Point Score Allocation Obtained Compliance Level 3: Engage in

Composition of CGS-BOD Specific Areas Point Score Allocation Obtained Compliance Level 3: Engage in Strategic Thinking and Planning 20 13. 38 67% 1: Determining Future Direction 11: Legal & Ethical Compliance 20 20 12 13. 33 12. 88 7. 72 67% 64% 12: The Entity 12 7. 11 59% 6: Board Meetings 7: Board Committees 25 25 45 14. 49 14. 28 24. 39 58% 57% 54% 5: Board Membership & Orientation 16 8. 52 53% 14: External Relations Practices 20 10. 44 52% 8: Board-CEO & Senior Management Relationship 20 9. 93 50% 16 25 20 7. 76 11. 68 9. 17 48% 47% 46% 296 165 56% 2: Policy Formulating Practices 4: Board Structure & Practices 13: Stakeholders 10: Monitoring & Evaluation Practices 9: Board – Staff Roles OVERALL

3: Engage in Strategic Thinking and Planning Specific Areas 1 The organization’s corporate plan

3: Engage in Strategic Thinking and Planning Specific Areas 1 The organization’s corporate plan & annual budget is fully discussed by the board prior to its approval. The financial status of our organization is regularly reviewed 2 and needed board actions are taken thoughtfully but quickly. 3 Board leadership takes steps to ensure that financial reports are thoroughly understood by board members. 4 The annual report of the organization and independent auditor is reviewed and needed actions are taken in a timely way. Board members are well aware of their legal responsibilities 5 for the organization’s financial management.

1: Determining Future Direction Specific Areas Organization’s mission and purpose are clearly understood and

1: Determining Future Direction Specific Areas Organization’s mission and purpose are clearly understood and 1 accepted by the board. The members of the board have reached consensus on a vision that 2 indicates where the organization will be headed over the next 3 -5 years. The full board collaboratively reviews and updates the 3 organization’s strategic plan at least every two years. 4 Staff develops and carry out annual plans based on the board’s approved strategic plan. The board is well-briefed by the management on annual 5 plans/action plans developed by staff.

2: Policy Formulating Practices Specific Areas If a new policy is needed for the

2: Policy Formulating Practices Specific Areas If a new policy is needed for the board or the organization as a 1 whole, the issue is clearly presented to and discussed by the board. The full board approves all new organizational policies before 2 they are implemented. Policies exist for key areas such as finance, personnel, safety, 3 and ethics, and all functions unique to our organization’s work. Our organization’s policies are effectively communicated to all 4 board members. The Board reviews policies at least annually and updates them 5 as needed.

9: Board – Staff Roles Specific Areas The role and responsibilities of the board

9: Board – Staff Roles Specific Areas The role and responsibilities of the board are clearly defined and 1 separate from those of the management & staff (Monitoring vs Controlling). The board takes the primary responsibility for developing the 2 organization’s policies. Board members never assume roles and responsibilities that 3 belong to staff. The board delegates to the organization’s Chief Executive 4 sufficient authority to lead the staff and carry out the organization’s mission. When a problem or conflict arises between board and staff, 5 parties move quickly and effectively to resolve it.

10: Monitoring & Evaluation Practices 1 2 3 4 5 6 Specific Areas Board

10: Monitoring & Evaluation Practices 1 2 3 4 5 6 Specific Areas Board members are adequately knowledgeable about the organization’s programs/projects and services. Periodically review with the CEO the possibilities of adding new programs/projects and services, and modifying or discontinuing current programs/projects and services. The board keeps itself informed of the organization’s performance against predetermined plans and goals. The effectiveness of the board and committee structure is assessed every year. Annually assess the individual members’ satisfaction with their participation on the board. Regularly evaluate the effectiveness of the board meetings.

13: Stakeholders Specific Areas 1 Has the Board identified key stakeholders? 2 What is

13: Stakeholders Specific Areas 1 Has the Board identified key stakeholders? 2 What is the state of the relationship with the key stakeholders? 3 How well do entity's objectives reflect stakeholders’ expectations? 4 Is there a policy determining how the entity will relate with stakeholders?

Sector-wise CGS-BOD Point Allocation BFI BFT Manufact Plantation Overall Compliance 1: Future Direction 20

Sector-wise CGS-BOD Point Allocation BFI BFT Manufact Plantation Overall Compliance 1: Future Direction 20 16 13 13 14 11 12 13 13 2: Policy Formulating 20 14 13 13 13 11 12 14 13 3: Strategic Thinking 20 15 13 14 13 12 13 14 13 4: Board Structure 25 15 14 16 14 12 14 14 14 5: Board Membership 16 9 8 10 9 7 8 9 9 6: Board Meetings 7: Board Committees 25 45 15 26 14 24 16 27 14 24 13 21 14 23 15 25 14 24 8: Board-CEO & Mgt 20 10 10 11 10 9 10 10 10 9: Board – Staff 20 10 9 9 10 8 9 9 9 10: Monitoring 25 12 13 12 11 11 12 11: Legal compliance 12 10 7 8 7 6 7 7 8 12: The Entity 13: Stakeholders 12 16 7 8 8 10 7 8 6 6 7 8 7 8 14: External Relations 20 11 11 12 10 9 10 10 10 296 178 165 180 164 143 160 166 165 CGS-BOD Components Diversif Hotel & Trav Land & Property ied

Sector-wise Compliance Point Allocation BFI BFT Diversified Hotel & Trav Land & Property 1:

Sector-wise Compliance Point Allocation BFI BFT Diversified Hotel & Trav Land & Property 1: Future Direction 20 81% 67% 66% 69% 56% 62% 66% 67% 2: Policy Formulating 20 72% 63% 66% 63% 55% 62% 69% 64% 3: Strategic Thinking 20 74% 65% 70% 64% 59% 66% 69% 67% 4: Board Structure 25 61% 57% 65% 57% 49% 55% 57% 5: Board Membership 16 55% 53% 62% 53% 44% 52% 54% 53% 6: Board Meetings 25 60% 58% 64% 57% 50% 56% 60% 58% 7: Board Committees 45 58% 54% 60% 54% 48% 52% 55% 54% 8: Board-CEO & Mgt 20 52% 50% 54% 49% 43% 49% 51% 50% 9: Board – Staff 20 52% 44% 46% 50% 39% 45% 44% 46% 10: Monitoring 25 48% 52% 50% 44% 45% 44% 47% 11: Legal compliance 12 83% 61% 70% 62% 53% 60% 61% 64% 12: The Entity 12 62% 61% 68% 51% 57% 59% 13: Stakeholders 16 41% 51% 60% 48% 39% 49% 51% 48% 14: External Relations 20 55% 53% 59% 51% 45% 50% 52% OVERALL 296 61% 56% 48% 54% 57% 56% CGS-BOD Components Manufact Plantation Overall Compliance

Sector-wise Compliance CGS-BOD Point Allocation Components BFI BFT Diversified Hotel & Trav Land &

Sector-wise Compliance CGS-BOD Point Allocation Components BFI BFT Diversified Hotel & Trav Land & Property Manufac Plantation Overall Compliance 1 20 81% 67% 66% 69% 56% 62% 66% 67% 2 20 72% 63% 66% 63% 55% 62% 69% 64% 3 20 74% 65% 70% 64% 59% 66% 69% 67% 4 25 61% 57% 65% 57% 49% 55% 57% 5 16 55% 53% 62% 53% 44% 52% 54% 53% 6 25 60% 58% 64% 57% 50% 56% 60% 58% 7 45 58% 54% 60% 54% 48% 52% 55% 54% 8 20 52% 50% 54% 49% 43% 49% 51% 50% 9 20 52% 44% 46% 50% 39% 45% 44% 46% 10 25 48% 52% 50% 44% 45% 44% 47% 11 12 83% 61% 70% 62% 53% 60% 61% 64% 12 12 62% 61% 68% 51% 57% 59% 13 16 41% 51% 60% 48% 39% 49% 51% 48% 14 20 55% 53% 59% 51% 45% 50% 52% OVERALL 296 61% 56% 48% 54% 57% 56%

Evidence on International Status Indicator Belgium France Germany Japan Nethlnds Port UK US 1.

Evidence on International Status Indicator Belgium France Germany Japan Nethlnds Port UK US 1. 1 Best Practice Codes 5 9 6 3 4 4 9 9 1. 2 Non-executive Directors 8 9 5 1 10 3 6 8 1. 3 Board Independence 2 3 2 0 1 0 4 7 1. 4 Split Chairman/CEO 6 2 5 0 5 2 6 1 1. 5 Board Committees 3 4 1 0 3 3 6 8 21 Voting Rights 10 6 9 10 6 6 10 9 2. 2 Voting Issues 8 8 5 4 5 7 7 3 3. 1 Accounting Standards 2 3 7 0 6 2 9 10 3. 2 Executive Pay 3 10 2 2 8 2 10 10 4. 1 Takeover Barriers 3 4 3 0 1 2 10 7 Overall Score 5. 0 5. 8 4. 5 2. 0 4. 9 3. 1 7. 7 7. 2 Country Rank 4 3 6 8 5 7 1 2 10/24/2020 Source: Based on Dissa Bandara (2008) Dissa 5 47

Conclusions The extent of Adherence to CG Principles • • 10/24/2020 Actual CG practices

Conclusions The extent of Adherence to CG Principles • • 10/24/2020 Actual CG practices are considerably deviated from the expected standard (AVG compliance level 56%) A broad variation in CG practices across the firms (Max 69% & Min 39%) A considerable variation in CG practices across the industries (48% - 61%) Governance level is high in BFI & Diversified (high AVG score) Dissa 5 48

Conclusions The extent of Adherence to CG Principles Sri Lankan boards are good at;

Conclusions The extent of Adherence to CG Principles Sri Lankan boards are good at; – Strategic planning – Determining future direction – Policy formulating practices • Sri Lankan boards are weak at; – Board-staff roles (not clearly defined and separated) – Monitoring & evaluation (split the role of Chairman &CEO) – Relationship with the stakeholders •

Conclusions Contd… Emerging CG Characteristics • The degree of interest in the recent discussion

Conclusions Contd… Emerging CG Characteristics • The degree of interest in the recent discussion on CG is remarkably high (over 70%) • Through their CG system they hope to enhance the performance and speed up of decision-making • There is a growing tendency of introducing new features like Independent Directors, BOD training & IR activities 10/24/2020 Dissa 5 50

For Future … • Employ a multiple CGS, considering • • • Sri Lankan

For Future … • Employ a multiple CGS, considering • • • Sri Lankan CG Principles (to be finalized) OECD CG Principles Other Leading Sources like, Cal. Pers Use Case Study & Critical Incident Method as methodological tool External pressure should be increased to get the poor players to the track CG practices should be familiarized among corporate level 10/24/2020 Dissa 5 51