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Table of contents :
Contents
1 Introduction
2 A brief history of South African corporate governance
3 Determinants and outcomes of good corporate governance
4 Trends in South African corporate governance
5 Preliminary evidence on the drivers and implications of South African corporate governance
6 Assurance
7 Corporate governance by not-for-profit organisations
8 Emerging forms of corporate reporting, governance and accountability
9 Summary and areas for future research
References
List of Figures
List of Tables
List of acronyms/ abbreviations
Appendices
Appendix A The integrated reporting capitals and reporting principles
Appendix B Members of the King committee
Appendix C King IV disclosures applicable to the audit committee
Appendix D Scope of the King IV sector supplements
Appendix E The King Codes: A summary of similarities and differences
Appendix F Summary of select corporate scandals in South Africa
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Warren Maroun, Dannielle Cerbone Corporate Governance in South Africa

De Gruyter Studies in Corporate Governance

Series Editor Jill Atkins

Volume 2

Warren Maroun, Dannielle Cerbone

Corporate Governance in South Africa

Authors Warren Maroun University of the Witwatersrand School of Accountancy Dannielle Cerbone University of the Witwatersrand School of Accountancy

ISBN 978-3-11-061828-0 e-ISBN (PDF) 978-3-11-062126-6 e-ISBN (EPUB) 978-3-11-061833-4 ISSN 2570-1673 Library of Congress Control Number: 2019957134 Bibliographic information published by the Deutsche Nationalbibliothek The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data are available on the Internet at http://dnb.dnb.de. © 2020 Walter de Gruyter GmbH, Berlin/Boston Typesetting: Integra Software Services Pvt. Ltd. Printing and Binding: CPI books GmbH, Leck www.degruyter.com

Contents 1 1.1 1.2

Introduction 1 Contribution 3 A conceptual model for explaining the drivers and consequences of good governance 4

2 2.1 2.2 2.3 2.4 2.5 2.6

A brief history of South African corporate governance 9 South Africa before democracy in 1994 10 Corporate governance under King-I (1992–1994) 12 From King-I to King-II (1994–2002) 16 King-III and the introduction of integrated reporting 21 King-IV: Outcomes-based governance 24 Timeline, summary and conclusion 30

3 3.1 3.1.1 3.1.2 3.1.3 3.2 3.2.1 3.2.2 3.2.3 3.3 3.3.1 3.3.2 3.4 3.4.1 3.4.2 3.4.3 3.5 3.5.1 3.5.2 3.5.3 3.6

Determinants and outcomes of good corporate governance 35 External drivers of South African corporate governance 36 The economic and political context 36 Stakeholder pressures and the legal environment 38 The effects of institutionalised corporate governance 40 Internal drivers of corporate governance 42 Organisational characteristics 42 Attitudes to and understanding of corporate governance 44 Summary 46 Interpretive schematics 48 The regulatory environment 49 On the relevance of stakeholder activism 50 Proactivity 51 Management and operating systems 51 The accounting infrastructure 52 Stakeholder engagement, corporate reporting and assurance Outcomes of good governance 55 Financial and manufactured capital 56 Human, social and relationship and intellectual capital 58 Natural capital 61 Summary and conclusion 62

4 4.1 4.1.1 4.1.2 4.1.3

Trends in South African corporate governance Overview of the King Codes 66 The board of directors 68 Committees of the board 70 Risk management 71

66

53

VI

4.1.4 4.1.5 4.1.6 4.1.7 4.1.8 4.2 4.2.1 4.2.2 4.2.3 4.3 5 5.1 5.1.1 5.2 5.2.1 5.2.2 5.2.3 5.3 6 6.1

Contents

Auditors and audit committees 72 Stakeholders and reporting 75 Ethics 79 Alternative dispute resolution and business rescue King-IV practices 80 Trends in corporate governance practices 80 Composition of boards of directors 82 Functions of the committees of the board 88 Corporate governance disclosures 93 Summary and conclusion 98

80

Preliminary evidence on the drivers and implications of South African corporate governance 100 Development of research questions 101 Defining corporate governance 102 Analysis 105 Correlation analysis 105 Drivers of good governance 105 Outcomes of good governance 113 Summary and conclusion 116

6.2 6.3 6.4 6.5

Assurance 118 Background on ESG assurance in accordance with the international literature 119 Combined assurance under the King Codes 119 Trends in South African assurance practice 125 Proposed changes to assurance models 132 Summary, conclusion and future research 134

7 7.1 7.2 7.3 7.4

Corporate governance by not-for-profit organisations King IV sector supplements 137 Reporting by NGOs 137 Governance trends in NPOs 148 Summary and conclusion 150

8

Emerging forms of corporate reporting, governance and accountability 152 Integrated reporting 152 The effect of corporate governance on integrated report quality 154 Biodiversity reporting 159 Guidance provided by the GRI and the academic literature

8.1 8.1.1 8.2 8.2.1

136

160

Contents

8.2.2

Evidence of biodiversity reporting by South African companies 162 Emancipatory accounting 164 Circular economy 169 The governance of technology and information 172 Conclusion 173

8.2.3 8.3 8.4 8.5 9 9.1

Summary and areas for future research 175 Summary of South African-specific corporate governance research 176 Contribution 179 Areas for future research 181

9.2 9.3

References List of Figures List of Tables

183 203 205

List of acronyms/ abbreviations

207

Appendices A B C D E F

The integrated reporting capitals and reporting principles 211 Members of the King committee 215 King IV disclosures applicable to the audit committee 219 Scope of the King IV sector supplements 221 The King Codes: A summary of similarities and differences 223 Summary of select corporate scandals in South Africa 237

Index

243

VII

1 Introduction There is no single definition of “corporate governance”. In broad terms, corporate governance can be understood as being concerned with how companies behave and the rules according to which they operate (Claessens and Yurtoglu, 2013). Early studies on corporate governance were grounded in finance and economic theories with the result that corporate governance was framed according to a shareholdercentric perspective and the need to reduce agency costs (Brennan and Solomon, 2008). As explained in the opening to one of the seminal papers on the topic: Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers? (Shleifer and Vishny, 1997, p. 737)

These questions arise with the emergence of the joint stock and limited liability company which saw a separation of the owner and manager functions. Capital markets, on which companies’ shares and debt are traded, operate in such a way that providers of financial capital can be (and often are) completely removed from the day-to-day operations of the organisation in which they hold a financial interest. Responsibility for managing the organisation is delegated to agents, but there is no guarantee that they will act in the best interest of their principals when the parties’ objectives diverge (Berle and Means, 1932; Jensen and Meckling, 1976; Eisenhardt, 1989; Bathala and Rao, 1995). In terms of agency and transaction cost theories, resulting in agency losses require a monitoring and control system to reduce information asymmetry, lower transaction costs and mitigate residual losses for shareholders (Berle and Means, 1932; Jensen and Meckling, 1976; Fama and Jensen, 1983). To this end, corporate governance becomes concerned with finding: ways of bringing the interests of the two parties [management and investors] into line and ensuring that firms are run for the benefit of investors. (Mayer, 1997, p. 154)

As agency costs increase, internal controls and “systems of checks and balances” must be widened to allow the shareholder to exercise more control over corporate insiders (Bathala and Rao, 1995; Deakin and Hughes, 1997; Mitchell et al., 1997; Singh and Davidson III, 2003; Solomon, 2013). The focus is on ensuring that the firm’s structures, processes, systems and cultures maximise efficiency and minimise residual losses for investors (Keasey et al., 1997). In this way, from an agency theory perspective, The importance of corporate governance is essentially only relevant where there is a division between the owners of the equity and the directors of the business. With an independent company the owner of the equity and the directors are effectively merged. As soon as the owner of

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1 Introduction

capital is dependent on directors to control the business or the directors are dependent on other persons to finance the company, a good system of corporate governance is imperative. (Institute of Directors in Southern Africa (IOD), 1994, p. 5).

Many of the earliest codes on corporate governance were firmly grounded in agency theory. This includes the Cadbury Report (1992) and Combined Code (1998) in the United Kingdom (UK) and in laws promulgated in the United States of America (USA) in the early 2000s, most notably the Sarbanes Oxley Act (Brennan and Solomon, 2008; Solomon, 2013). A slightly broader view of corporate governance focuses on ensuring that a firm is co-ordinated correctly and controlled to maximise efficient use of resources. According to this logic, if markets are efficient, a firm which pursues the interests of its shareholders will automatically maximise resource allocation (Allen, 2005). At the same time: Corporate governance is not just about controls, it also involves developing and implementing effective accounting and business polices and long-term strategic objectives. From a broader perspective, therefore, corporate governance may be regarded as a framework for effective monitoring, regulation, and control of companies, which allows alternative internal and external mechanisms for achieving the underlying objectives. These mechanisms include both those internal to the firm and its organization, and those external to the firm, such as statutory requirements and the operation of markets. Internal mechanisms include board composition, managerial ownership, and non-managerial large shareholding including institutional shareholding. External mechanisms include a statutory audit, the market for corporate control manifested in hostile takeovers, and the stock market evaluation of corporate performance. (Demirag et al., 2000, p. 348, emphasis added)

An economic logic which stresses the importance of maximising shareholder wealth is still present. Corporate governance is, however, seen as more than a control function operating at a single point in time. In the context of using resources efficiently, corporate governance is concerned with setting and achieving long-term objectives after taking into account the firm’s internal mechanisms and the external context in which it operates. In other words, corporate governance is an essential mechanism for ensuring management accountability but it is also concerned with providing direction to a firm (King, 2012; Solomon, 2013). If this view of corporate governance is combined with stakeholder theory, corporate governance can be explained as the management of constraints which would otherwise limit the quasi-rents or profits generated from the relationships between an organisation and all its stakeholders (Claessens and Yurtoglu, 2013). This will include co-ordination and control of management actions and the satisfaction of legitimate “expectations of accountability and regulation by interests beyond the corporate boundaries” (Tricker, 1984). For this purpose, “profit”, “co-ordination” and “control” do not need to be understood only in economic terms. Under stakeholder theory, generating a financial return is still a legitimate business consideration but the organisation must also take steps to ensure that it maximises value for

1.1 Contribution

3

society as a whole, rather than just for shareholders (IOD, 2009; Claessens and Yurtoglu, 2013; Solomon, 2013). This means that, in addition to managing economic considerations, social and environmental imperatives must be taken into account and cannot be seen as subordinate to generating a financial return (IOD, 2009; King, 2018). Focusing on the benefits provided to stakeholders can also be justified on the grounds that markets are seldom perfectly efficient. As a result, the assumption that maximising shareholder wealth produces an optimal outcome for society as a whole is questionable (Allen, 2005). Solomon (2013, p. 14) provides a definition of corporate governance framed according to a stakeholder perspective: [C]orporate governance is the system of checks and balances, both internal and external to companies, which ensures that companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity. (emphasis added)

The definition is based on the view that companies can only maximise value creation and ensure efficient utilisation of resources if they act in a manner which is cognisant of the legitimate expectations of their stakeholders (Solomon, 2013). A stakeholdercentric approach to corporate governance is also essential for fulfilling what is increasingly being seen as a moral duty for organisations to ensure that their activities do not undermine the rights and benefits of future generations and the realisation that companies cannot be seen as independent from the broader social context (King and Atkins, 2016; King, 2018). This logic is at the heart of South Africa’s codes on corporate governance which are the primary focus of this research.

1.1 Contribution The majority of the prior corporate governance research is based in an Anglo-Saxon setting with the result that we know very little about the history, application and consequences of corporate governance (or the lack thereof) in Africa (Brennan and Solomon, 2008; Mangena and Chamisa, 2008). This is true even for South Africa despite its status as one of the largest and most developed capital markets on the Continent. There has been some research on the political and institutional forces which have contributed to the development of codes on corporate governance in South Africa (see, for example, Rossouw et al., 2002; Armstrong et al., 2005; Vaughn and Ryan, 2006; Andreasson, 2011). The evolution of African governance has also been touched on (Rossouw, 2005; West, 2009). Research by Harvey Pamburai et al. (2015) and Ntim et al. (2012a; 2012b) confirms that the relationship between good governance and firm value documented by the international literature holds in a South African setting. The link between corporate governance and corporate social responsibility (CSR) has also been considered, although to a lesser extent (Ntim and Soobaroyen, 2013b).

4

1 Introduction

This book complements the prior South African-specific research. It provides a detailed account of the history of corporate governance in South Africa which draws on both the academic literature and South Africa’s codes of best practice. At the same time, it provides the first accounts of corporate governance in South Africa over an extended period (1994–2018) complemented by a review of the similarities and differences in King Codes. This includes a review of some of the most recent trends in South African corporate governance, a review of the internal and internal factors which influence governance practices and preliminary evidence of the benefits of good governance. Unlike the prior research, which has focused on select governance mechanisms, this book adopts a more conceptual approach by using a model for explaining the drivers and consequences of good governance to frame the development and application of South African codes on corporate governance. This is discussed in more detail below.

1.2 A conceptual model for explaining the drivers and consequences of good governance Research on the drivers and benefits of good corporate governance is vast. Most are based on the USA or the European Community but findings may be equally applicable in a South African context. Figure 1.1 presents a conceptual model which summarises the most common determinants of corporate governance. It shows how these interact with different interpretive schemes to yield benefits for an organisation which, for this book, are framed according to the capitals outlined by the International Integrated Reporting Council (IIRC, 2013). These are financial, manufactured, social and relationship, intellectual and human and natural capital. Detailed definitions can be found in Appendix A. Starting from the left, the model distinguishes between external pressures, organisational characteristics and attitudes to and awareness of corporate governance. Organisation-specific determinants include, for example, the size of the firm, dispersion of ownership and industry characteristics. How an organisation internalises corporate governance should also be taken into account. This will be affected by, inter alia, managers’ attitude to governance, firm culture, institutional values and the extent to which governance is seen as part of an organisation’s strategic positioning and risk management. Added to these internal drivers are external pressures, such as stakeholder activism and South Africa’s complex socio-economic context (adapted from Alrazi et al., 2015; De Villiers et al., 2017a). Interpretive schemes explain how organisations internalise and respond to the demand for good governance. They provide a basis for delineating stakeholders’ expectations, categorising requirements and formulating specific actions (Goffman, 1986). Interpretive schemes can be defined by laws, regulations and codes of best practice.

Stakeholders Institutional investors Accounting profession Media NGOs Assurance services

Reporting models

Stakeholder engagement

Companies Act Other external regulation Johannesburg Stock Exchange

Management control systems

Integrated reporting (IIRC) Sustainability reporting (GRI) Accountability principles Accounting systems

Operating systems

Reporting frameworks

Regulatory environment

Proactivity

King I – King IV Codes on responsible investment

Codes on corporate governance

Interpretive schemes

Figure 1.1: Determinants, interpretation and consequences of corporate governance.

Institutional values Resource dependency views Efforts to regulate practice ‘Comply and explain’ rather than ‘comply or explain’

Attitudes and awareness

Organisational characteristics Firm size Firm age Industry Leverage Profitability Variability in equity returns Extent of R&D activity Number of segments/business units Concentration of shareholdings Presence of institutional investors Director shareholdings Exposure to litigation risk

External pressures Socio-economic context Cultural context Investment activity Social/environmental awareness Stakeholder pressures Institutional investors Legal/regulatory environment Institutional context

Determinants

Natural

Intellectual and human

Social and relationship

Financial and manufactured

Effect on organisational capitals

Legitimacy

Effective control

Good peformance

Ethical culture

Outcomes

1.2 A conceptual model for explaining the drivers and consequences

5

6

1 Introduction

They are also “drawn from the background of the individuals who support them (cognitive structures) and existing institutional logics (social structures)” (Roussy and Brivot, 2016, p. 716) which coalesce to provide a dominant perspective or framing of acceptable practice (Ascui and Lovell, 2011; Bay, 2011). Generally accepted customs, guides issued by the accounting profession and heuristics emerging from engagement with investor and other stakeholders are examples. For the purpose of this research, the primary schematics are South Africa’s codes on corporate governance. South Africa issued a code on good governance, The King Report on Corporate Governance (King-I), in 1994. It was second only to the UK where the Cadbury Report was published in 1992. King-I was followed in 2002, 2009 and 2016 by updated codes of best practice which took international and local developments in the social, economic and political environment into account. The codes include: – the King Report on Corporate Governance for South Africa 2002 (King-II) – the King Report on Corporate Governance for South Africa 2009 (King-III) – the King-IV Report on Corporate Governance for South Africa 2016 (King-IV) The history of King Codes is discussed in Chapter 2. How the Codes frame corporate governance in South Africa should be interpreted in the context of the country’s socio-political situation, regulatory environment and changing stakeholder expectations. Firm-specific factors provide additional context. According to the international research findings, variables such a company size (Boone et al., 2007), concertation of shareholdings (Ntim et al., 2012b)., the involvement of institutional investors (Andreasson, 2011), and the extent to which managers adhere to a compliance logic (Tremblay and Gendron, 2011). Can influence the internalisation and applications of recommended governance practice. These internal and external determinants are examined in Chapter 3 and impact what Alrazi et al. (2015) and Melnyk et al. (2003) refer to as organisational proactivity. South Africa has moved away from a shareholder-centric governance model to one which stresses the need for accountability to a broad group of stakeholders (Solomon, 2013; King and Atkins, 2016). This would require the development of operating and management control systems to drive the principles and practices of good governance. The accounting infrastructure must be in place to ensure that performance can be monitored. Given the emphasis placed on stakeholder inclusivity and transparency by King-IV (IOD, 2016), companies will also be expected to engage with key constituents as part of the process of discharging accountability while ensuring detailed reporting on corporate governance processes and systems. Each of these proactivity elements is also covered in Chapter 3 which concludes by outlining the outcomes of good governance.1

1 King IV and the IIRC define outcomes as “the internal and external consequences (positive and negative) for the capitals as a result of an organisation’s business activities outputs”. Outcomes

1.2 A conceptual model for explaining the drivers and consequences

7

According to King-IV, these include ethical and effective leadership, effective control,2 good performance and, ultimately, legitimacy (IOD, 2016). Given the emphasis placed on integrated thinking in the South African corporate governance environment, governance outcomes cannot be understood in only economic terms. Companies with high proactivity will be expected to enjoy good performance measured according to each of the capitals defined by the IIRC (2013) namely: financial, manufactured, social and relationship, intellectual, human and relationship capital (see Chapter 3 and Appendix A). As for performance according to the economic, environmental and social dimensions improves, the demand for good corporate governance increases, leading to revisions of interpretive schemes and refined organisational proactivity. Given the dearth of South African-specific research, Chapters 4 and 5 provide empirical evidence on trends in local governance practice and some of the drivers and benefits of good governance respectively. Chapter 4 includes an overview of the changes in the content of the King Codes, followed by a review of common features of corporate governance systems. Examples include the composition of South African boards of directors; the role of board committees and what companies are disclosing about their corporate governance in annual, integrated or sustainability reports. Chapter 5 goes into more detail on how variables such as firm size, industry and the number of identified stakeholders may be driving demand for better corporate governance. For this purpose, factors such as the integration of risk, strategy and performance, the governance of technology, stakeholder responsiveness and the extensiveness of monitoring and review systems are used to construct a composite score which serves as a proxy for corporate governance quality. Preliminary evidence on the association between stronger corporate governance and measures of financial, social and environmental performance is presented. How assurance contributes to the operationalisation of corporate governance is seldom considered (Farooq and De Villiers, 2017; Maroun, 2018b) and is, therefore, the focus of Chapter 6. This covers the recommendations concerning the use of internal and external assurance by King-III (IOD, 2009) and King-IV (2016) as part of a combined assurance model for enhancing corporate governance. Chapter 7 deals

also incorporate “the internal and external consequences of the business activities and outputs” in the context of the economy, society and environment in which the organisation operates. “Outputs” are the “products, by-products and waste that are produced by an organisation” (IOD, 2016, p. 15). 2 Effective control is broader than an organisations control environment (including its system of internal controls). It refers to how those charged with governance exercise control over the organisation as part of the application of King IV’s recommended principles and practices. This is discussed in more detail in Chapter 3.

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1 Introduction

with the application of the King Codes by non-governmental organisations (NGOs). Chapter 8 explores emerging forms of corporate governance and how they may evolve in response to rapid social, environmental and technological changes are dealt with briefly. Chapter 9 summarises key findings and identifies areas for future research.

2 A brief history of South African corporate governance The late 1990s and early 2000s saw a proliferation of codes of corporate governance (Solomon, 2013). Often explained in terms of finance theories, the objective is to develop monitoring systems which protect investors by lowering agency costs, decreasing information asymmetry and increasing firm value (see La Porta et al., 1997; Shleifer and Vishny, 1997). The drive for better corporate governance has gained momentum as companies come under increasing scrutiny for their social and environmental performance (Solomon, 2013). They are being expected to provide more transparent reporting on environmental, social and governance (ESG) issues (De Villiers et al., 2017a; KPMG, 2017) and to modify their strategies, systems and process in the interest of sustainable development (IIRC, 2014b; King and Atkins, 2016). South Africa offers an interesting case study for examining developments in corporate governance practices and how information is being reported to stakeholders (Malherbe and Segal, 2001; West, 2006; Ntim, 2009; Ntim et al., 2012b; Ahmed Haji and Anifowose, 2016; Ahmed Haji and Hossain, 2016; Ahmed Haji and Anifowose, 2017). As a major African economy, it boasts a significant gross-domestic product relative to its neighbours and a comparatively diversified economy (West, 2009). South Africa has a well-developed and regulated capital market (Yartey, 2007), ranks among the top in the world for the quality of its financial reporting and assurance practices (World Economic Forum, 2018) and is widely regarded as a pioneer in corporate governance and emerging forms of external reporting, including integrated reporting (Solomon, 2013; Atkins and Maroun, 2015). This should be juxtaposed with sluggish economic growth (Gyimah-Brempong, 2002; Hodge, 2009), high levels of inequality (Gyimah-Brempong, 2002; Assouad et al., 2018), rampant corruption in the public sector (Lodge, 1998; De Sardan, 1999; Mbaku, 2000; Gyimah-Brempong, 2002; Lawal, 2007; Carr, 2009; Chanda et al., 2017) and a colonial legacy which has been difficult to overcome despite 25 years of democracy (West, 2006). In this way, while South Africa maintains a “first world” financial market infrastructure, it is also a developing economy which faces a host of economic, social and political challenges which are bound to influence the development and application of codes of best practice dealing with corporate governance. To examine this thesis in more detail, Section 2.1 provides a brief history of South Africa before democratic elections in 1994. This is followed by a review of the context in which King-I (Section 2.2), King-II (Section 2.3), King-III (Section 2.4) and King-IV (Section 2.5) were developed. The objective is not to deal with the details on each of the Codes in detail but to provide background for a more detailed analysis of the external and internal determinants of South Africa corporate governance provided in Chapter 3.

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2 A brief history of South African corporate governance

2.1 South Africa before democracy in 1994 South Africa’s economy is heavily dependent on the mining sector which is mainly responsible for the country’s industrialisation and modernisation. The industry is a significant source of employment and export revenues while also contributing indirectly to the economy by supporting a host of support services and related industries (Crush and James, 1991; Armstrong et al., 2005). As a result, between 1950 and 1990 mining contributed an average of 12% per annum of South Africa’s gross domestic product (Armstrong et al., 2005). During the same period, the country’s mining houses amassed significant financial reserves allowing them to diversify their operations and investment holdings3 (Armstrong et al., 2005). By the 1990s, they controlled several different investments placing them in a critical position in the South African economy. One of the dominant mining houses was Anglo American (Anglo). Anglo was founded in South Africa in 1917 and during the 1960s and 1970s the company was able to diversify beyond mining into many sectors of the South African economy. In 1976, the Anglo American Corporation held key interests in most economic sectors, except for agriculture4 (Innes, 1984). This was possible because of the significant income generated from mining operations and the fact that South Africa had been isolated from the international capital market because of Apartheid (Rossouw et al., 2002; Armstrong et al., 2005). The South African economy had performed relatively well from 1946 to 1975 with real growth at an effective rate of 4.9% but the 1970s and 1980s saw an economic slowdown (De Villiers and van Staden, 2006). South Africa was systematically excluded from international markets. Key trade partners imposed political and economic sanctions following calls from the then banned African National Congress (ANC) for the international community to take action to end Apartheid (Catchpowle and Cooper, 1999; Malherbe and Segal, 2001). To preserve capital and prevent the devaluation of the South African Rand (ZAR), the National Party Government introduced exchange control regulations which forced successful South African companies, and the country’s wealthiest families, to invest surpluses locally rather than diversify by moving funds abroad. Complex groups emerged with multiple cross-holdings. By the time Apartheid was abolished, four conglomerates, one of which was Anglo, were estimated to control approximately 75% of the market capitalisation of the Johannesburg Stock Exchange (JSE) (Catchpowle and Cooper, 1999).

3 These companies are the predecessors of two of the world’s largest and most well-known mining corporations, BHP Billiton and Anglo American. 4 Anglo had the capacity and the drive to tackle complex metals such as Highveld Steel and vanadium. In 1963, Anglo built a full-scale vanadium plant, becoming one of the largest vanadium producers in the world and the second largest producer of steel (after Iscor) in South Africa (Innes, 1984)

2.1 South Africa before democracy in 1994

11

On the socio-economic front, South Africa’s mining houses were inextricably linked with colonial and apartheid policies. In particular, a migrant labour system was established to provide a cheap source of unskilled labour to work on South Africa’s mines. Workers were housed in large and crowded single-sex hostels (Catchpowle and Cooper, 1999). In addition to disrupting the community and family dynamics, the hostels became synonymous with crime, prostitution and, as discovered only during the 1980s and 1990s, the transmission of infectious diseases, including Tuberculosis and Human Immunodeficiency Virus (Tutu, 2003). Many of the ills associated with the country’s labour movements were acknowledged during the 1970s. Little action was taken due to the financial cost involved (Hamann and Kapelus, 2004) and the lack of political interest given that the affected communities were primarily black African and of little concern to the Apartheid Government (Catchpowle and Cooper, 1999). Nevertheless, some mining houses were taking steps to improve social conditions for disenfranchised South Africans. For example, following the Soweto Uprising in 1976,5 the Chair and Vice-Chair of Anglo American Corporation (Harry Oppenheimer and Anton Rupert, respectively) established the Urban Foundation. The foundation sought to assist with educating people living in Soweto, promote improvements in the quality of workers’ lives and provide a platform for peaceful discussion of socio-economic challenges (Hamann and Kapelus, 2004; Hamann, 2006). The Urban Foundation (and similar initiatives) were, however, met with suspicion and criticism. Trade unionists saw them as “something companies were forced to do because of anti-capitalist resistance and the disinvestments campaign” and “as a smokescreen for underlying structural problems” (Hamann et al., 2005, p. 7). In other words, there was no guarantee that these social initiatives were resulting in meaningful changes to companies’ policies and operations (Laufer, 2003). By the 1990s, the effects of Apartheid meant that the majority of South Africans had been excluded from the formal economy. Unemployment was estimated to be more than 40%. Exchange reserves were among the lowest in the world while the prime lending rate was one of the highest. Direct foreign investment was almost nonexistent (Catchpowle and Cooper, 1999; De Villiers and van Staden, 2006). Overall, the South African economy was crippled. The cost of maintaining the Apartheid system had virtually bankrupted the government (Catchpowle and Cooper, 1999) Significant utilities, including energy generation and telecommunications, were state-owned monopolies (Rossouw et al., 2002; Hamann, 2006). Corporate practices and regulatory systems had fallen far behind international standards (Malherbe and Segal, 2001). In the absence of significant competition, the private sector had become complacent

5 The uprising was a protest against the use of Afrikaans (1 of 11 official languages in democratic South Africa) as a medium of instruction in so-called ‘black schools’. The protest soon became a focal point for anti-Apartheid activism and was one of the most violent uprisings in South African history.

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2 A brief history of South African corporate governance

(Armstrong et al., 2005) a situation aggravated by the fact that a small number of insurance, pension and mining firms controlled the capital and money markets. In this environment, mechanisms for holding companies accountable for their economic performance were limited and standards to ensure good social and environmental practices had not been developed (Hamann and Kapelus, 2004). Poor corporate governance resulted in significant information asymmetry which made it difficult for the capital market to attract new investors, even after the establishment of a democratic government in 1994. Weaknesses in the systems of checks and balances, which should have been in place to protect investors, also contributed to a number of corporate failures during the 1990s such as the collapse of Masterbond (1991) and MacMed Health Care (1999) (discussed in more detail in Appendix F) (World Bank, 2003; Sarra, 2004). In short, by the time the ANC assumed power in 1994, it, inherited an economy which despite being the most vibrant on the continent, with a Gross Domestic Product equal to 75% of that of the rest of sub-Saharan Africa, had a catalogue of problems that would test even the most experienced of economists. (Catchpowle and Cooper, 1999, p. 716)

What was needed was a clear position by the newly elected government to reignite the local economy (De Villiers and van Staden, 2006) and a concerted effort by the private sector to improve the way in which companies were being managed and controlled (IOD, 1994; Demirag et al., 2000; Iatridis, 2010). The result was South Africa’s first code on corporate governance, issued on 29 November 1994.

2.2 Corporate governance under King-I (1992–1994) Following the release of the UK’s Cadbury Report in 1992, the King Committee was established under the chairmanship of Professor Mervyn King.6 The primary purpose of the King Committee was to consider how to promote the highest standards of corporate governance in South Africa (IOD, 1994). The King Committee was formed at the instance of IOD and had no official mandate (Rossouw et al., 2002; Armstrong et al., 2005; West, 2009). It received significant support from the South African business community represented by the South African Institute of Chartered Accountants

6 Professor Mervyn King attended the University of the Witwatersrand, where he earned his Bachelor of Arts, Bachelor of Law, and a higher diploma in tax law. He was a practising attorney and became an advocate to the Supreme Court of South Africa, specialising in commercial law. He became a judge of the Supreme Court of South Africa in 1977 from which he resigned in 1980. He has acted as a company inspector and commissioner of inquiry into the affairs of companies, and has chaired many meetings to effect compromises for company creditors and on behalf of shareholder interests. Mervyn King holds a number of Director and Chairman positions internationally and locally and is a founding member of the Arbitration Foundation of Southern Africa. In 2010, the University of the Witwatersrand awarded Mervyn King an honorary doctorate.

2.2 Corporate governance under King-I (1992–1994)

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(SAICA), the South African Chamber of Business, the Chartered Institute of Secretaries and Administrators, the South African Institute of Business Ethics and the JSE (IOD, 1994) (see Appendix B for details on the members of the King Committee at the time). When the King Committee was formed, South Africa was in the middle of political transition. The ANC had been unbanned and Nelson Mandela had only recently been released from prison.7 A referendum on introducing political and economic reforms had been held in 1992 and won majority support (West, 2009).8 Following the ANC’s success in the first democratic election in 1994, a policy of economic liberalisation was adopted. Contrary to earlier fears, the emphasis was on corporate renewal, capital market growth and the reintroduction of South Africa to the global economy rather than on radical economic reorganisation along Marxist or similar lines (Armstrong et al., 2005; De Villiers and van Staden, 2006). King-I was an integral part of this, calling for an inclusive approach to doing business which recognised the legitimate interests of stakeholders while also accepting the importance of entrepreneurial activity and the need to protect investor interests (Aguilera and Cuervo‐Cazurra, 2009). Structure of King-I King-I defined corporate governance as “the system by which companies are directed and controlled” (IOD, 1994, p. 1). Largely as a result of the country’s colonial past, South African corporate structures are similar to those in the UK. Company law was influenced strongly by the English Companies (Consolidation) Act of 1908 which was adopted in South Africa in 1973 (with relatively few changes) after a local review (West, 2009). It is, therefore, no surprise that King-I was informed by the Cadbury Report (IOD, 1994; Mangena and Chamisa, 2008; West, 2009) and followed an AngloAmerican style centred on the importance of a unitary board of directors (Rossouw et al., 2002; Armstrong et al., 2005; Aguilera and Cuervo‐Cazurra, 2009). King-I was not, however, a replication of the Cadbury Report. The Code drew attention to the importance of a properly functioning board of directors as a critical element of good corporate governance (Armstrong et al., 2005) and the need to balance the interests of stakeholders while not losing sight of the importance of investor protection. For its time, provisions dealing with stakeholder engagement and business ethics were seen as being at the cutting edge of governance practice and what would come to be seen as the sustainable development movement (IOD, 1994; Rossouw et al., 2002; Solomon, 2007; West, 2009).

7 The Apartheid government classified the ANC as a terrorist organisation and banned it on 8 April 1960. Many of its political leaders had been arrested and imprisoned on Robben Island (off the coast of Cape Town). On 2 February 1990, the ANC was unbanned and the release of Nelson Mandela followed on 11 February 1990. 8 At the time only Caucasian people (i.e. South Africans of European decent) participated in the referendum

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King-I did not have the direct force of law and was applied voluntarily according to a comply or explain model. The Code did, however, call for its recommendations to be included as part of the JSE’s listing requirements, something which came into effect in 1995 (JSE, 1995). Table 2.1 summarises the contents of King-I. Table 2.1: Structure of King-I. Chapter

Brief overview

Chapter  – Introduction and background

Background to corporate governance – explains the role of corporate governance as part of a system of checks and balances designed to champion accountability

Chapter  – The King Committee, its task groups and terms of reference

Provides background to the King Committee, their objectives in issuing a report on governance as well as the different task teams established to address different areas of governance

Chapter  – The application of the recommendations

Explains to which entities the report applies

Chapter  – The board of directors

Explains the main functions of the board of directors

Chapter  – The directors

Discusses guidelines for all directors to adhere to, as well as delegates specific responsibilities to the directors of an entity

Chapter  – The non-executive director

Discusses the roles and responsibilities of a nonexecutive director (these are in addition to those of all directors addressed in Chapter )

Chapter  – The Chairman (chair)

Discusses the qualifications necessary to be appointed as the Chairman and the Chairman’s role on the board of directors

Chapter  – Remuneration

Discusses the compensation of executive and nonexecutive directors

Chapter  – Nomination committee

Discusses the need for a nomination committee

Chapter  – Training of directors

Requires that the board of directors have the necessary skills to perform their duties and, where this is not the case, they are trained sufficiently to perform their duties

Chapter  – Board sub-committees

Discusses the establishment of sub-committees to which the board delegates responsibility

Chapter  – Stakeholders and stakeholder communications

Highlights the importance of stakeholders and guides an organisation’s interaction with stakeholders

2.2 Corporate governance under King-I (1992–1994)

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Table 2.1 (continued ) Chapter

Brief overview

Chapter  – Auditing

The chapter discusses the importance of the independence of the external auditor, guides the establishment of an Audit Committee and suggests what reports ought to be audited. In addition, it suggests that a review panel be established to assess the quality of audit engagements.

Chapter  – Internal auditors

Discusses the scope and establishment of an internal audit department

Chapter  – The company secretary

Discusses the role of the company secretary

Chapter  – Stakeholder links

Defines the relationship between stakeholders and the organisation and the organisations’ responsibility to maintain the relationship

Chapter  – Affirmative action

Discusses the historical background of South Africa and the need to correct the past injustices

Chapter  – Ethics

The chapter discusses the need for ethics in enterprise, as well as the responsibility of management to maintain ethics. In maintaining ethics, the Code suggests the establishment of a code of ethics

Chapter  – Recommendations

Based on the discussion in Chapters  to , the Code summarises the main points as guidance for each respective section

Chapter  – The code of corporate practices and conduct

Provides a code of corporate practice and conduct for specific entities. This code details specific roles and responsibilities over several governance areas

Chapter  – Implementation and keeping the code up-to-date

Provides the effective date of the King Code and suggests that the Code will need to be updated to remain relevant

Chapter  – Compliance

States that the Code should be implemented and stakeholders have a role to play in ensuring compliance with the Code; suggests that the listing requirements of the JSE be amended to include compliance with the Code

Chapter  – Acknowledgements and appreciation

Acknowledges other codes of corporate governance and specific contributions to the King Code be persons

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Table 2.1 (continued ) Chapter

Brief overview

Appendices

Six appendices are included, which provide further information and guidance. The appendices include: – the King Committee members – terms of reference – remuneration committee – information for the users of financial statements and the auditors – audit committees – key overseas compliance initiatives

King-I’s recommendations were focused on “affected organisations” which include all companies listed on the main board of the Johannesburg Stock Exchange, large public entities as defined in the Public Entities Act, banks, financial and insurance entities as defined in the various Financial Services Acts, large unlisted dependent companies, large quasi-state en(IOD, 1994, p. 5) tities such as control boards and co-operatives.9

The broad application of King-I’s recommendations was intended to promote the highest standards of corporate governance in the South African economy (IOD, 1994). In order to achieve this objective, King-I focused on six broad areas: the board of directors and its committees, auditors, stakeholders, corporate reporting, ethics and compliance. Each was researched by the King Committee which developed best practice. Findings are presented in the form of a discussion in Chapters 4 to 18 with more specific recommendations found in Chapters 19 and 20 of the Code. These aspects of King-I are discussed in more detail in Chapter 4 (Section 4.1).

2.3 From King-I to King-II (1994–2002) Internationally, essential developments in corporate governance were taking place during the early 2000s. For example, the Cadbury Report was superseded by the Combined Code in 1998 (Ntim et al., 2012b). Corporate governance principles by the Organisation for Economic Co-operation and Development (OECD) were released in 1999 (Cheffins, 2013). In 2000 a report by management consultancy McKinsey & Co. indicated that institutional investors would pay a premium of nearly 30% for shares

9 ‘Large’ companies were defined as having shareholder equity of ZAR50 million (approximately USD5 million) or more. Nevertheless, King-I suggested that other organisations with a large turnover, a significant number of employees or which are important for the wider community should also follow the recommended practices.

2.3 From King-I to King-II (1994–2002)

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in well-governed companies operating in countries believed to have weak shareholder rights (Cheffins, 2013). The demise of Enron in 2001 illustrated this point. At the same time, the Global Reporting Initiative (GRI) had been formed and was publishing draft guidance on the “triple-bottom-line” or ESG reporting (GRI, 2015). The proliferation and increasing sophistication of corporate governance worldwide necessitated a review of South African practice. Changes taking place in the South African economy also had to be taken into account. By the early 2000s, the government had moved away from its Reconstruction and Development Programme, initially intended to prioritise redistribution overgrowth, and adopted the Growth, Employment and Redistribution (GEAR) economic plan (West, 2009). Under GEAR, the ruling ANC passed several laws on black economic empowerment (BEE) and HIV/Aids. These were aimed at addressing historical, socio-economic challenges and a growing national health crisis. They needed to be incorporated as part of mainstream corporate governance (Ntim et al., 2012b). In addition, while mining and agricultural sectors continued to play an important role in the South African economy, manufacturing had become increasingly significant (Armstrong et al., 2005). The financial services sector, stimulated by construction, also grew significantly (Armstrong et al., 2005; West, 2009). The increased importance of financial services was not unique to South Africa. Under neoliberal economic policies, the USA and the UK were moving towards serviceoriented economies with smaller governments and less state intervention. This saw an increase in investor activity, both locally and abroad, which emphasised the importance of corporate governance as monitoring and investor protection tool (La Porta et al., 2002; Defond and Hung, 2004). Given the developments taking place both locally and internationally, a second King Committee was formed in 2000. In 2002, King-I was superseded by King-II. There were three reasons for the release of a new code. Firstly, King-I was criticised for not enhancing the independence of companies’ boards (Malherbe and Segal, 2003) and for not providing sufficiently specific guidance on key stakeholder issues such as HIV/AIDS, BEE and the environment (Rossouw et al., 2002; Malherbe and Segal, 2003). Secondly, a number of legislative changes had been promulgated, as detailed in Section 2.3, which were incorporated in King-II (Armstrong et al., 2005). Thirdly, South Africa had experienced several high profile corporate failures since 1994 which highlighted weaknesses in existing governance models. Examples include Macmed (1999), LeisureNet (2000), and Regal Treasury Bank (2001). These are discussed in more detail in Appendix F. The effect of corporate failures was amplified by the 1997–1998 Asian economic crisis. Material losses suffered by investors (Ntim, 2009) confirmed that macro-economic difficulties could be worsened by the systematic failure of corporate governance systems (IOD, 2002).

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Structure of King-II Changes introduced by King-II are similar to those in the UK with King-II, the Combined Code, the Turnbull Guidance, the Smith Guidance and the Higgs Report covering similar issues (West, 2006). These include: the composition of the boards of directors, directors’ remuneration, internal control and risk management, accounting and audit. King-II also built on many of the principles outlined in King-I. In particular, it iterated the importance of a stakeholder-centric corporate governance model (West, 2006; 2009) grounded in an inclusive approach to doing business which recognises that stakeholders such as the community in which the company operates, its customers, its employees and its suppliers need to be considered when developing the strategy of a company. (IOD, 2002, p. 8)

This does not marginalise the role of entrepreneurship and the need for companies to generate financial returns for investors but also takes into account the legitimate interests of other stakeholders. In this way, [t]he key challenge for good corporate citizenship is to seek an appropriate balance between enterprise (performance) and constraints (conformance), so taking into account the expectations of shareowners for reasonable capital growth and the responsibility concerning the interests of other stakeholders of the company. (IOD, 2002, p. 8)

With this in mind, King-II – drawing on earlier emerging markets research – refers to seven defining features of good governance. These are summarised in Figure 2.1. King-I referred to a “balanced” approach to corporate governance (IOD, 1994, p. 3). King-II discusses an “inclusive or instrumental” model (IOD, 2002; West, 2006; West, 2009). It expressly acknowledges the interconnection between the firm and its stakeholders and their inter-dependence: There is growing pressure from society on companies to acknowledge their duty to act as responsible corporate citizens [. . .] The realisation of greater interdependence is consistent with the notion of Ubuntu [. . .] The board of directors must ensure that an appropriate balance is maintained between the individual interests of stakeholders and the collective good of the company in which their interests converge. (IOD, 2002, p. 99)

In other words, good corporate citizenship is not just a moral imperative or necessary for securing legitimacy; it accords benefits and is essential for the organisation to continue as a going concern (IOD, 2002). Exclusion of stakeholders’ interests would also run counter to the traditional African values of co-existence, collectiveness and consensus (IOD, 2002). For an inclusive governance model to be implemented, stakeholder groups need to be identified. The organisation needs to understand how its stakeholders contribute to its operations and, in turn, the impact which business activities have on those stakeholders. As a result, King-II maintains and strengthens the Anglo-American features of

2.3 From King-I to King-II (1994–2002)

Discipline A commitment by a company's senior management to adhere to behaviour that is universally recognised and accepted to be correct and proper.

Transparency The ease with which an outsider is able to make meaningful analysis of a company's actions, its economic fundamentals and the non-financial aspects pertinent to that business.

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Independence The extent to which mechanisms have been put in place to minimise or avoid potential conflicts of interest that may exist

Social responsibility

Accountability

A well-managed company will be aware of, and respond to, social issues, placing a high priority on ethical standards.

Individuals or groups in a company, who make decisions and take actions on specific issues, need to be accountable for their decisions and actions.

Essential features of good governance

Fairness

Responsibility

The systems that exist within the company must be balanced in taking into account all those that have an interest in the company and its future.

Refers to behaviour that allows for corrective action and for penalising mismanagement.

Figure 2.1: Essential features of good governance. (see IOD, 2002, pp. 11–12)

King-I. It also addresses the current socio-economic context by dealing explicitly with key issues such as the company’s role in combatting HIV/AIDS, promoting BEE and protecting the environment. In this way, King-II is a hybrid of the Anglo-American model (which stresses investor protection) and the Continental European-Asian model (which takes cognisance of stakeholders’ concerns) (Armstrong et al., 2005; Ntim, 2009; Andreasson, 2011; Ntim, 2013). King-II is intended to be applied by “affected companies” which are defined in a similar way to the definition in King-I. The definition is, however, expanded to include all JSE-listed companies, instead of only those listed on the main board. The Code is also more specific about which public sector entities should apply its

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recommendations.10 Like King-I, King-II did not enjoy the direct force of law and the comply-or-explain-basis application continues to hold. The contents of King-II are summarised in Table 2.2. Table 2.2: Structure of King-II. Section

Brief overview

Section  – Boards and directors

Discusses and guides the different governance areas concerning the board of directors and the sub-committees. These include: – role and function of the board – role and function of the Chairperson – role and function of the Chief Executive Officer – role of the Executive and Non-Executive Director – Director selection and development – Board and Director appraisal – disqualification of Directors – Board Committees – the Business Judgement Rule – role and function of the Company Secretary

Section  – Risk management

Introduces risk management as a responsibility of the board. King-II defines risk management and provides guidance as to what processes ought to be in place to identify and respond to risk.

Section  – Internal audit

Discusses and provides guidance on the role of internal audit and its responsibilities.

Section  – Integrated sustainability reporting

Introduces integrated reporting and discusses the importance of meeting stakeholder needs through reporting. Also addresses South African specific environmental and social issues.

Section  – Accounting and auditing

Discusses and provides guidance on the role of the external auditors and ensuring their independence. Provides guidance on the responsibility on the Audit Committee concerning the audit and the financial statements. Discusses concerns regarding the non-assurance services provided by the external auditor. auditing

10 These are all public sector entities falling under the Finance Management Act and the Local Government: Municipal Finance Management Bill (which was still to be promulgated at the time King-II was released)

2.4 King-III and the introduction of integrated reporting

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Table 2.2 (continued ) Section

Brief overview

Section  – Compliance and enforcement

Discusses the compliance with the Code and the different parties whom the Code can assist and who is responsible for ensuring compliance.

Appendices

Fourteen appendices are included, which provide further information and guidance. The appendices include: – members of the King Committee on corporate governance – terms of reference of review and membership of task teams – Directors’ legal duties – Board self-evaluation – model terms of reference for board committees – Sample Internal Audit Charter – risk management and internal controls – key decisions in developing a code of ethics – UN Global Compact – the global Sullivan principles of corporate social responsibility – Aa1000 standard – executive summary – recommendations of the GRI – select bibliography – useful websites on corporate governance

2.4 King-III and the introduction of integrated reporting In 2003, the Department of Trade and Industry (DTI) initiated a broad legislative reform programme. It included a review of existing securities regulations, as well as corporate governance structures and practices (Barac and Moloi, 2010). The overall objective of the proposed changes was to promote growth, innovation, stability, good governance, confidence and international competitiveness (DTI, 2004). In 2004, a policy document on corporate reform, South African Company Law for the 21st Century: Guidelines for Corporate Law Reform, was published (DTI, 2004). It set out the basis for a redraft of the Companies Act (1973). Considered by many to be long overdue, the aim was to bring the country in line with international developments in company law and investor protection (West, 2009). Proposed changes included: – simplifying company formation – reducing the financial reporting requirements for smaller companies – specifying the qualifications, standards of conduct and liabilities of directors (including liability for false or misleading financial statements)

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– the establishment of a Takeover Panel to deal with mergers and acquisitions and a Financial Reporting Standards Council to provide independent monitoring and review of the quality of financial reporting (DTI, 2004) At the same time, the decision was taken to adopt formally International Financial Reporting Standards (IFRS) (International Accounting Standards Board (IASB), 2014). A 2005 deadline was set for companies to make the transition from South African Generally Accepted Accounting Practice11 (SAICA, 2012; Ames, 2013). As part of the redraft of the Companies Act (1973) – and as suggested originally by King-I (see IOD, 1994) – the need for legal backing for the use of specified financial reporting standards was tabled. The formal adoption of IFRS was important for fortifying the country’s image as a legitimate developing economy in the eyes of the international investor community (Maroun et al., 2014; Atkins and Maroun, 2015). The release of the Companies Act (2008) – which repealed the Companies Act (1973) – is, however, cited by the third King Committee as the primary reason for the release of King-III in 2009.12 As with King-II, King-III was influenced by international developments, including the effects of the 2007–2009 global financial crisis (IOD, 2009). The Code signalled the growing importance of risk management, internal auditing and the need to integrate the management of and reporting on economic, environmental and social metrics (IOD, 2009). Structure of King-III As with King-I and King-II, the King Committee wanted to be seen as leaders in corporate governance. This was achieved by explaining how South Africa’s now wellestablished stakeholder model included “putting financial results in perspective” by complementing traditional financial statements with reporting on – “how a company has, both positively and negatively, impacted on the economic life of the community in which it operated during the year under review” and – “how the company intends to enhance those positive aspects and eradicate or ameliorate the negative aspects in the year ahead”. (IOD, 2009, p. 5) King-II identified seven features/characteristics of good governance (see Figure 2.1). In King-III, the focus is on three core aspects or elements: effective leadership, sustainability and corporate citizenship. Refer to Figure 2.2.

11 The SAICA harmonisation and improvement project would culminate in South Africa being one of the first countries to adopt formally IFRS in 2002. 12 King-III was issued in draft form in September 2009 and replaced King-II in March 2010.

2.4 King-III and the introduction of integrated reporting

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Ethical leadership Leaders should embody the ethical values of responsibility, accountability, fairness and transparency and based on moral duties that find expression in the concept of Ubuntu.

Essential features of good governance Corporate citizenship

Sustainability

The company is a person and enterprise should be conducted in a manner that is sustainable.

Nature, society, and business are interconnected in complex ways that should be understood by decision-makers.

Figure 2.2: The philosophy of King-III. (see IOD, 2009, pp. 10–11)

As with the previous Codes, compliance with King-III was voluntary in the sense that King-III does not have direct legal backing. Following the enactment of the Sarbanes Oxley Act (SOX), the King Committee justified the decision to refrain from a regulatory approach to corporate governance (referred to as the “comply or else” approach) on the grounds of efficiency. There were concerns that mandating specific practices would reduce the flexibility and broad applicability of King-III while promoting a compliance-based approach to corporate governance rather than adherence to the principles of codes of best practice (IOD, 2009, p. 5). In addition to the added cost of compliance, the need to regulate South African corporate governance further was considered moot. Some of the recommendations in King-I and King-II had already been included in the Companies Act (2008) (see Section 2.2 for details). The JSE decided to require listed companies to explain how they complied with King-II and requires the listed company to include the extent of compliance and reasons for non-compliance (IOD, 2009). At the same time, South African companies had become well regarded by international investors for the quality of their financial reporting, external audit and corporate governance systems (Maroun et al., 2014). Finally, the Commonwealth (of which South Africa is a member) and European Community, including the UK, opted to refrain from adopting the USA’s external regulatory approach. Consequently, despite “populist calls for more general legislative corporate governance reforms” in the aftermath of the 2007–2009 global financial crisis (IOD, 2009, p. 8), King-III remained

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principles-based and non-legislated. Nevertheless, it was an important reference for directors seeking additional guidance on how to meet their fiduciary duties in terms of the new Companies’ Act (2008) and, as a result, the Code was only issued after the legislation was promulgated (De Beer, 2019). Unlike King-II which was largely applicable to listed firms and other companies, King-III is intended to be applied by all entities (IOD, 2009, p. 12). There is also a subtle change from “comply or explain” (per King-I and King-II) to “apply or explain”. This is operationalised as follows: It is the legal duty of directors to act in the best interests of the company. In following the “apply or explain” approach, the board of directors, in its collective decision-making, could conclude that to follow a recommendation [in King-III] would not, in the particular circumstances, be in the best interests of the company. The board could decide to apply the recommendation differently or apply another practice and still achieve the objective of the overarching corporate governance principles of fairness, accountability, responsibility and transparency. Explaining how the principles and recommendations were applied, or if not applied, the reasons, results in compliance. In reality, the ultimate compliance officer is not the company’s compliance officer or a bureaucrat ensuring compliance with statutory provisions, but the stakeholders. (IOD, 2009, p. 7)

In other words, King-III takes the position that organisations comply with the code by adhering to its recommendations, tailoring these according to the entity’s context or circumstances or by indicating which recommendations have not been adopted and the reasons for this decision. There is also the tacit assumption that, as pressure to demonstrate that organisations are acting sustainably and as a good corporate citizen increases, there is little practical choice but to apply King-III to, at least, some extent. The contents of King-III are summarised in Table 2.3.

2.5 King-IV: Outcomes-based governance Inequality, globalised trade, social tensions, climate change and population growth have continued to present major challenges, both in South Africa and internationally (IOD, 2016). On the economic front, UK’s exit from the European Union, planned for 2019, has created uncertainty in capital markets. The effects of the financial and sovereign funds crisis have yet to be resolved (IOD, 2009). How the USA’s protectionist stance under President Donald Trump, the growing influence of China and continuing instability in Africa will influence South Africa’s political and economic policies in the long-run also remains to be seen. South Africa needs to tackle severe environmental and social risks as outlined in the United Nations Sustainable Development Goals13 (SDGs, 2015), the Africa

2.5 King-IV: Outcomes-based governance

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Table 2.3: Structure of King-III. Section

Brief overview

Introduction and background

Explains the need for King-III and provides a governance compliance framework

Chapter  – Ethical leadership and corporate citizenship

Describes the terms “ethical leadership” and “corporate citizenship”. In addition, provides ethical and leadership principles which the board of directors should apply

Chapter  – Board and directors

Discusses and provides principles on the different governance areas concerning the board of directors and the sub-committees. These include: – role and function of the Board – role and function of the Chairperson – role and function of the Chief Executive Officer – role of the Executive and Non-Executive Director – Director Selection and Development – Board and Director Appraisal – remuneration – role and function of the Company Secretary

Chapter  – Audit committees

Provides principles regarding the governance areas of the audit committee. These include the membership of the committee and the roles and responsibilities of the committee.

Chapter  – The governance of risk

Highlights the governance of risk as a board responsibility. Provides principles to assist in the assessment, response and monitoring of risk which should be applied. In addition, recommends that risks be disclosed to stakeholders promptly

Chapter  – The governance of information technology

Provides guidance and principles regarding the governance of information technology (IT). Recommends that IT be aligned with the performance and sustainability of the entity and form a part of risk management. Suggests the establishment of an IT committee to assist the board.

Chapter  – Compliance with laws, code, rules and standards

Details the responsibility of the board to ensure that it complies with the relevant laws and regulations

Chapter  – Internal audit

Highlights the need for a risk-based internal audit. In addition, it provides principles for the roles and the responsibilities of the internal audit department

Chapter  – Governing stakeholder relationships

Provides principles which highlight the interdependence of stakeholders and organisations and suggests ways to resolve the dispute

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Table 2.3 (continued ) Section

Brief overview

Chapter  – Integrated reporting and Details the importance of reporting in an integrated manner. disclosure Provides principles which require an organisation to prepare an integrated report which includes financial and sustainability disclosures Glossary of terms

List of terms in the Code

Research references

List of references

King Committee

Provides detail of the King Committee responsible for King-III

2063 Agenda14 (African Union, 2013) and the National Development Plan 203015 (Commission, 2013). Under the leadership of the ANC’s Jacob Zuma, the South African economy has stagnated. Gross domestic product only increased by 0.3% in 2016, and the country entered a technical recession in 2018. Whether or not technological disruptions, being referred to by some as the 4th Industrial Revolution, will alleviate or compound South Africa’s socio-economic woes is still unclear (Mason, 2017; Productivity Commission, 2017). Against this backdrop, the King Committee issued King-IV during 2016. Unlike King-III, King-IV was not necessitated by legislative changes but by ongoing political, economic, social and environmental uncertainty and the risks which they pose to the sustainable development agenda. King-IV takes cognisance of three shifts in the corporate landscape: – Financial measures are no longer accepted as providing a complete account of performance and value creation. “Inclusive capitalism” recognises the interconnection between economic, environmental and social “capitals” and their combined importance for ensuring long-term sustainability. – The dangers of seeking short-term financial gains were highlighted by the 2008–2009 financial crisis. Policy makers, institutional investors and other

13 The Sustainable Development Goals are the United Nations’ blueprint to achieve a better and more sustainable future. They cover a number of global challenges, including poverty, inequality, climate, environmental degradation, prosperity, and peace and justice. 14 The Agenda 2063 is a strategic framework by the African Union for the socio-economic transformation of the Continent. It seeks to accelerate the implementation of past and existing continental initiatives for growth and sustainable development. 15 The National Development Plan offers a long-term perspective of growth in South Africa. The National Development Plan aims to eliminate poverty and reduce inequality by 2030.

2.5 King-IV: Outcomes-based governance

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key stakeholders have taken note of the need for ensuring responsible and sustainable growth in the long-run. This requires a move away from financial reporting, complemented by a separate sustainability report. Integrated reporting is needed to explain the link between an organisation’s strategy, risks, and business models according to the economic, environmental and social context. – Stakeholder engagement has become paramount. Directors owe a fiduciary duty to a company and not exclusively to the shareholder. The organisation must be directed and managed in a way that achieves long-term sustainability and satisfies the legitimate interests of stakeholders, even if this is to the detriment of short-term financial gains. (IOD, 2016) Structure of King-IV King-IV is applicable for financial years commencing on or after 1 April 2017. KingIV frames corporate governance as the exercise of ethical and effective leadership by the governing body aimed at achieving four outcomes: (1) ethical culture, (2) good performance, (3) effective control and (4) legitimacy (IOD, 2016, p. 20). These outcomes are discussed in more detail in Chapter 3. The objectives of King-IV (2016, p. 26) are to – “Promote corporate governance as integral to running an organisation and delivering governance outcomes such as an ethical culture, good performance, effective control and legitimacy”; – “Broaden the acceptance of the King-IV by making it accessible and fit for implementation across a variety of sectors and organisational types”; – “Reinforce corporate governance as a holistic and interrelated set of arrangements to be understood and implemented in an integrated manner”; – “Encourage transparent and meaningful reporting to stakeholders” and – “Present corporate governance as concerned with not only structure and process, but also with an ethical consciousness and conduct”. Like King-III, King-IV is intended to apply to all organisations (IOD, 2016, p. 35). To ensure its broad application, King-IV provides sector supplements which deal with the applicability of the Code in different contexts (see Appendix C) the terminology in King-IV is also generic to cater for situations other than those encountered with listed companies. King-IV uses an “apply and explain” approach in terms of which organisations are expected to apply governance principles on the basis that these “are basic and fundamental to good governance”. An explanation should be provided (in narrative form) of the recommended and other practices which have been adopted and how these “demonstrate the application of the [respective]

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principles” (IOD, 2016, p. 37). The governance outcomes are achieved by internalising each of King-IV’s principles and adopting and applying practices “so that they support and give effect to the aspiration as expressed in [the respective] principle” (IOD, 2016, p. 36). Practically, this means that King-IV is applied on a proportionate basis at the practice level.16 This allows for variations in how and the extent to which different practices are used to achieve core principles based on the organisation’s complexity, size and availability of resources (IOD, 2016, p. 37). The principles are summarised in Table 2.4. The reduction in the number of principles from King-III to King-IV is in keeping with the decision to refrain from legislating South African corporate governance or creating the impression that the Code is rules-based. The principles are intended to be applicable to and useful for any organisation irrespective of its size, structure or purpose negating the need for a detailed list of governance prescriptions. Instead, King-IV encourages application based on substance rather than a compliance approach to corporate governance (IOD, 2016). (For additional details on changes in the format and content of the King Codes, see Chapter 4, Section 4.1). King-IV reiterates the inclusive approach to governance, outlined in King-III, and focuses on sustainable development. This is defined as “development that meets the needs of the present without compromising the ability of future generations to meet their needs” (IOD, 2016, p. 27). Sustainable development is achieved with integrated thinking, seeing the organisation as an integral part of society, corporate citizenship and stakeholder inclusivity (IOD, 2016, p. 23). Integrated thinking is a result of the organisation taking cognisance of the interconnection between the different factors (both financial and non-financial) which affect the organisation’s ability to create value over time. This can only be achieved if the organisation operates as an integral part of society while following a stakeholder-inclusive approach to business which recognises the legitimate interests of stakeholders and the inter-dependency between stakeholders and the organisation’s ability to continue as a going concern. Those charged with governance must appreciate that the organisation has citizen status which means that it enjoys rights accorded to it by society but also has obligations to society and the environment on which it depends (IOD, 2009, p. 23). These philosophies are discussed in more detail in Chapter 3 (Section 3.4).

16 The principles are “fundamental to good corporate governance and hold true across all organisations”. As a result, an organisation should apply all of the principles and explain how it uses appropriate practices to give effect to or demonstrate the application of each of the principles. The only exception is Principle 17 which is specific to institutional investors (IOD, 2016, p. 36).

2.5 King-IV: Outcomes-based governance

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Table 2.4: King-IV’s principles and guiding philosophy. Principle

Detail

Principle :

The governing body should lead ethically and effectively.

Principle :

The governing body should govern the ethics of the organisation in a way which supports the establishment of an ethical culture.

Principle :

The governing body should ensure that the organisation is and is seen to be a responsible corporate citizen.

Principle :

The governing body should appreciate that the organisation’s core purpose, its risks and opportunities, strategy, business model, performance and sustainable development are all integral elements of the value creation process.

Principle :

The governing body should ensure that reports issued by the organisation enable stakeholders to make informed assessments of the organisation’s performance and its short-, medium- and long-term prospects.

Principle :

The governing body should serve as the focal point and custodian of corporate governance in the organisation.

Principle :

The governing body should comprise the appropriate balance of knowledge, skills, experience, diversity and independence for it to discharge its governance role and responsibilities objectively and effectively.

Principle :

The governing body should ensure that its arrangements for delegation within its structures promote independent judgement, and assist with balance of power and the effective discharge of its duties.

Principle :

The governing body should ensure that the evaluation of its performance and that of its committees, its chair and its members, support continued improvement in its performance and effectiveness.

Principle :

The governing body should ensure that the appointment of, and delegation to, management contribute to role clarity and the effective exercise of authority and responsibilities.

Principle :

The governing body should govern risk in a way which supports the organisation in setting and achieving its strategic objectives.

Principle :

The governing body should govern technology and information in a way that supports the organisation setting and achieving its strategic objectives.

Principle :

The governing body should govern compliance with applicable laws and adopted, non-binding rules, codes and standards in a way which supports the organisation being ethical and a good corporate citizen.

Principle :

The governing body should ensure that the organisation remunerates fairly, responsibly and transparently to promote the achievement of strategic objectives and positive outcomes in the short-, medium- and long-term.

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Table 2.4 (continued ) Principle

Detail

Principle :

The governing body should ensure that assurance services and functions enable an effective control environment and that these support the integrity of information for internal decision-making and of the organisation’s external reports.

Principle :

In the execution of its governance role and responsibilities, the governing body should adopt a stakeholder-inclusive approach which balances the needs, interests and expectations of material stakeholders in the best interests of the organisation over time.

Principle :

The governing body of an institutional investor organisation should ensure that responsible investment is practised by the organisation to promote good governance and the creation of value by the companies in which it invests.

Reproduced from IOD (2016, p. 44 & 45).

2.6 Timeline, summary and conclusion Before 1994, the Companies Act (1973) – which drew mainly on the English Companies Act (1908) – was the only reference dealing with corporate governance in South Africa. The development and release of the country’s first code on corporate governance coincide with the lifting of Apartheid-related sanctions in 1991 and attainment of democracy in 1994. On the international stage, King-I is published less than two years after the UK issued its Cadbury Report which made world-first recommendations for improving corporate governance. The period from 1994 to 2002 is characterised by several local and international developments. South Africa’s economy starts to diversify with manufacturing and financial services beginning to play a more important role. In an effort to spur economic growth and address rampant inequality, the South African government replaced its Reconstruction and Development Programme with the GEAR plan. As discussed in more detail in Chapter 3, aspects of King-I are incorporated in statute and legislation explicitly designed to address the effects of Apartheid and enhance public sector governance are enacted. Steps are taken to internationalise South African financial reporting practices, and the JSE updates its listing requirements for the introduction of the King-I. In the same year as King-II is published, fraud at Saambou Bank and mismanagement at Fedsure, two large South African listed companies, are revealed. These scandals were predated by the collapse of Masterbond (1991), MacMed Health Care (1999) and Regal Bank (2001). In the UK, the Greenbury (1995), Hampbell (1998) and Turnbull (1999) reports follow the Cadbury Report while the USA deals with the immediate aftermath of the demise of Enron in 2001. At approximately the same

2.6 Timeline, summary and conclusion

South Africa

1973

International

The adoption of the Companies Act No.61 of 1973 strongly influenced by the English Companies Act of 1908. 1986 Due to Apartheid, sanctions were placed on South Africa by international trading parties. 1991 US President Bush lifted the1986 sanctions imposed on South Africa. Masterbond collapse. 1992 After the release of the Cadbury report the King Committee was formed.

Cadbury report released in the UK prescribing corporate governance measures. 1994

The ANC elected as government of South Africa. Shortly thereafter King-I was released. 1995 Post King-I, legislative reform took place the first act was the Labour Relations Act. Additionally the JSE listing requirements were revised.

Greenbury Report released in the UK.

1997 Basic Conditions of Employment Act was promulgated.

The Asian financial crisis occurred this proceeded into 1998. 1998

Thabo Mbeki was elected president after Nelson Mandela. Three more legislative changes occurred the National Environmental Management Act, Employment Equity Act and Insider Trading Act.

Hampel Report released in the UK.

1999 Public Finance Management Act was promulgated. SAICA embarked on a harmonisation project. MacMed Health Care collapse.

Turnbull Report released in the UK.

Figure 2.3: Timeline of changes and events locally and internationally which have affected South African corporate governance.

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South Africa

2000

International

Revision to the JSE listing requirements was done and the Leisure Net collapse unveiled. 2001 Regal Bank collapse.

Enron scandal revealed.

2002 The King Committee released of King-II. Saambou Bank fraud and the Fedsure mismanagement unveiled. 2003 Higgs &Smith Report released in the UK. Additionally, the UK revised its Combined Code of corporate governance. 2005 JCI-Randgold fraud unveiled. JSE listed companies required to prepare financial statements using IFRS. 2007 Fidentia Ponzi scheme unveiled. Jacob Zuma was elected to presidency after a vote of no confidence in Thabo Mbeki. 2008 The Companies Act No.73 of 2008 was released and adopted. This alone is considered to be one of the biggest changes to the economic environment of South Africa.

The Global financial crisis occurred with this came the US Capital crisis and the EU Sovereign debt crisis.

2010 Although King-III was released on 1 September 2009 the effective date was only 1 March 2010. 2011 On 25 January, South Africa’s Integrated Reporting Committee (IRC) released a world-first Discussion Paper entitled Framework for Integrated Reporting and the Integrated Report. Figure 2.3 (continued)

2.6 Timeline, summary and conclusion

South Africa

2012

33

International

Formalisation of the adoption of IFRS as per the Companies Act. 2013 Release of the IIRC Framework entitled The International Framework Integrated Reporting. 2016 The most recent King report, King-IV, was released.

In the UK a vote and decision to exit the EU was made. Referred to as Brexit. 2018

Grand Parade Investments investor activism. VBS collapse and fraud unveiled. Professor Mervyn King handed over the role of chairperson of the King Committee to Professor Suresh Kana. Figure 2.3 (continued)

time, the importance of good governance and, related closely to this, the need for sustainable development was starting to be better understood. For example, the OECD issued its principles on corporate governance in 1999. The GRI was founded in 1997 and in, 2002, issued its G2 guidelines in the hope of encouraging a more sustainable approach to doing business (Mock et al., 2013). The early and mid-2000s see a proliferation of ever more sophisticated codes on corporate governance and a significant increase in local and international investment which takes advantage of the protections accorded by more robust governance systems. Significant reforms to South African company law are introduced in response to changing international trends and to bolster the competitiveness and appeal of the local capital market. The release of the Companies Act (2008) and the effects of the 2007–2008 global financial crisis are specifically taken into account by the King Committee which issues King-III in 2009. Climate change, income inequality, political instability and trade tensions between the world’s two largest economies are only some of the challenges which characterise the period from 2010 to date. This coincides with the realisation that emphasising short-term financial gains has come at the detriment of long-term sustainability and the release of a South-African lead discussion paper on integrated reporting in 2011 followed by an international framework on the topic in 2013.

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Issued in 2016, King-IV takes a strong stance on integrated reporting and thinking which it identifies as defining philosophies of effective governance and sustainable development. A table summarising the key differences and similarities between the King Codes can be found in Appendix E. King-I to King-III span a period of just over ten years. How the latest of South Africa’s codes on corporate governance will assist organisations in dealing with challenges of the next decade remains to be seen. Figure 2.3 provides a timeline of the history of South African corporate governance. It includes some of the key local and international events which had a direct or indirect effect on the King Codes. A summary of the corporate scandals referred to by Figure 2.3 can be found in Appendix F.

3 Determinants and outcomes of good corporate governance A large body of work takes a deterministic perspective on how external factors, organisational characteristics, interpretive schematics and the level of proactivity contribute to better quality environmental, sustainability or integrated reporting (Melnyk et al., 2003; De Villiers and Maroun, 2018). Alrazi et al. (2015) is an excellent example. These researchers identify several company features (such as firm size, industry and strategic attitudes), stakeholder pressures and a firm’s geographical location as determinants of environmental reporting. Environmental management systems, environmental accounting and stakeholder engagement form the basis of ”environmental proactivity” and are essential for an organisation to produce high-quality environmental reports and ensure sound environmental performance. De Villiers et al. (2017a) follow a comparable approach to explain the development and benefits of integrated reporting. External pressures and internal or firmspecific characteristics contribute to a demand for higher quality corporate reporting. This is interpreted in the context of prevailing guidelines and stakeholder expectations and operationalised according to the firms’ accounting infrastructure and management systems to yield integrated reports which satisfy stakeholders’ information needs to varying degrees. The same logic can be applied, by analogy, to the development of broader corporate governance systems. Section 3.1 deals with the external drivers of corporate governance. These include the economic and political context in which the King Codes were developed (Section 3.1.1), the relevance of stakeholder pressures and regulatory changes (Section 3.1.3) and the effect of the institutionalisation of South African corporate governance (Section 3.1.3). These factors drive the development and application of codes of best practice but do not result in a completely standardised or consistent approach to corporate governance. On the contrary, variability in how the King Codes are interpreted and applied is to be expected because of differences in the organisational context. How the codes are internalised is affected by each organisation’s unique situation including managers’ attitudes to and understanding of the importance of governance (Section 3.2) and how the interpretive schemes used to frame and operationalise governance are applied (Section 3.3). The systems, accounting infrastructure and reporting protocols which need to be in place to support the application of the King Codes (Section 3.4) are also relevant. For Alrazi et al. (2015) and De Villiers et al. (2017a) high-quality reporting and, in turn, legitimacy are the outcomes of “proactivity”. To provide a more refined analysis, the benefits of good governance according to the different capitals which an organisation is expected to manage to ensure long-term sustainability are examined in Section 3.5. These are financial, manufactured, human, social and relationship, intellectual and natural capitals (see IIRC, 2013). In this chapter, the focus is not on the https://doi.org/10.1515/9783110621266-003

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quality of an organisation’s reporting to stakeholders but on the tangible and intangible benefits which accrue from the application of the King Codes.

3.1 External drivers of South African corporate governance External pressures arise in the context of South Africa’s socio-political challenges, in particular, the need to transform from Apartheid to democracy. Over time, changing stakeholder expectations and the maturation of the country’s legal environment serve as additional drivers of change. The institutionalised environment in which South Africa operates must also be taken into account. Each of these factors is discussed in detail below.

3.1.1 The economic and political context Corporate governance reforms in most Anglo-American countries are often driven by high profile business failures and the need to bolster protection for shareholders (Vaughn and Ryan, 2006; Ntim et al., 2012b). While South Africa is not immune to corporate scandal, Chapter 2 explained how its first code on corporate governance was written in the context of significant social, political and economic instability following the end of Apartheid in the early 1990s. The Code echoed the nationbuilding efforts of the first democratic government to promote an inclusive approach to doing business, mindful of the fact that Apartheid resulted in the exclusion of the majority of South Africans from the formal economy (Rossouw et al., 2002; Rossouw, 2005; West, 2006). The transition from Apartheid to democracy did not result in immediate economic transformation. Consequently, a capital-centric approach to corporate governance, followed in the USA and by early UK codes, to champion shareholder protection would be inconsistent with the prevailing socio-economic milieu (Rossouw, 2005; Andreasson, 2011; King, 2012; Ntim et al., 2012b). The Anglo-American corporate environment is centred on individual property rights and shareholder protection. This stands in stark contrast with the “communitarian nature of South African society at a basic level” and the view that “communal rights [are] at least equal in value to, if not greater than, individual rights” (West, 2006, p. 439). Similarly, a free market doctrine stresses the importance of financial wealth creation and the power of the director to make strategic decisions in the interest of maximising shareholder value (Monem, 2013). In Africa, decision-making should be by consensus and mindful of the need for social justice in the interest of national development (West, 2006). The shareholder-centric model at the heart of AngloAmerican corporate governance can be useful for promoting financial capital generation but, by overlooking stakeholders’ concerns, was at risk of deepening already

3.1 External drivers of South African corporate governance

37

serious economic and social inequality (Kakabadse and Korac-Kakabadse, 2001). It was unlikely that the ruling ANC would have supported a neoliberal governance model. While the governing party was focused on developing a stable macroeconomic environment, it remained committed to strong socialist policies and the view that corporate South Africa should play an active role in addressing the country’s social and environmental challenges (see De Villiers and van Staden, 2006; Maroun, 2018c). In this context, [u]nlike its counterparts in other countries at the time, the King Report 1994 went beyond the financial and regulatory aspects of corporate governance in advocating an integrated approach to good governance in the interests of a wide range of stakeholders having regard to the fundamental principles of good financial, social, ethical and environmental practice. (IOD, 2002, p. 7)

The King Codes are about more than just establishing a stakeholder-inclusive approach to business management as a practical means of addressing the socioeconomic effects of Apartheid. Attaining democracy in 1994 did not resolve the uncertainties of the international community following more than 60 years of political and economic isolation.17 In 1994, the ANC was inexperienced, and its left-leaning policies stood in stark contrast with the free market doctrine espoused by the USA (De Villiers and van Staden, 2006).18 In this context, while it was essential to signal that South Africa was taking progressive steps to build a democratic society characterised by stakeholder inclusivity, the interests of international financial capital could not be ignored. As a result, King-I included several Anglo-American governance features (such as the requirement for a unitary board comprised of a majority of non-executive directors) to align South African corporate governance with international trends and accord a measure of investor protection. There is an important, although subtle, emphasis on balancing the need for stakeholder inclusion with the essential principles of the free capital market. While it is of utmost importance that companies operate from a base of integrity, we believe that the focus must be on a participative entrepreneurial approach rather than a dominant one. Likewise, the participation process must not become so dominant that it stifles or obstructs notions of business risk for reward in a free enterprise system. (IOD, 1994, p. 5, emphasis added)

This balanced approach was essential for winning the confidence of international capital providers necessary for re-igniting the local economy post-Apartheid (Rossouw

17 Following a referendum in October 1960, South Africa withdrew from the Commonwealth in 1961. Its official policies on racial separation (Apartheid) resulted in the country being politically, socially and economically marginalised until democracy in 1994. 18 The ANC also had close ties with the former Soviet Union and the South African Communist Party. Today it is in a formal political alliance with the South African Communist Party and the Congress of South African Trade Unions.

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et al., 2002; Vaughn and Ryan, 2006; West, 2006; Maroun et al., 2014) and preventing a loss of trust in the aftermath of the emerging markets crises of 1997–199819 (Vaughn and Ryan, 2006).

3.1.2 Stakeholder pressures and the legal environment While South Africa does not have the same levels of stakeholder activism reported in more established democracies (Ntim and Soobaroyen, 2013b), there are signs that stakeholders are taking a greater interest in companies’ activities and engaging with them on their economic, social and environmental performance (Vaughn and Ryan, 2006; Atkins and Maroun, 2015). This is especially true as advancements in technology facilitate access to and rapid dissemination of information making it easier for stakeholders to voice their concerns and hold organisations accountable (Mervyn King, Foreword, IOD, 2016). Following King-I, international investment in South Africa increased significantly, resulting in a decrease in concentrated and family-held share blocks. Many South African companies also decided to list both locally and on international boards (Rossouw et al., 2002; Armstrong et al., 2005; Vaughn and Ryan, 2006). The result was the need for more specific codes on corporate governance to safeguard assets, define responsible business practice and ensure that managers could be held accountable for a firm’s performance. Mounting scientific evidence on human impact on the environment, coupled with persistent socio-economic challenges, provided further impetus for the development of corporate governance systems which deal with environmental and social issues in addition to financial performance (IOD, 2002; 2009). In particular, institutional investors are starting to recognise the impact which social and environmental factors can have on an organisation driving demand for an expanded corporate governance system which is focused on more than just direct economic imperatives (IOD, 2011; Solomon et al., 2011; IOD, 2016; King and Atkins, 2016). Consequently, King-II, King-III and King-IV are increasingly concerned with sustainability performance and integrated reporting and cover social and environmental matters to a far greater extent than did King-I (see Chapter 4). Codes on corporate governance, including South Africa’s King Codes, are supported by many international institutions such as the United Nations, the World Bank and OECD. These, in turn, influence national governments and policymakers to champion the development and enforcement of good corporate governance. Consequently, while results are mixed, the prior research suggests that higher levels of state or institutional investor ownership tend to be associated with better

19 This involved Russia, Brazil and several Asiatic countries but resulted in negative investor sentiment towards developing markets, including South Africa, as a whole.

3.1 External drivers of South African corporate governance

39

corporate governance and higher levels of CSR practices (Ntim and Soobaroyen, 2013b). In other words, even though the King Codes do not enjoy the direct force of law, stakeholders’ expectations give rise to material coercive pressures to develop suitable corporate governance systems. Stakeholder pressures are amplified by the fact that there is an overlap between recommendations found in South Africa’s codes on corporate governance and statute. This is intended to ensure good governance standards – as per the King Codes – are being applied and sustained in the interest of protecting stakeholders (Andreasson, 2011). Complementing some of the provisions or principles in the King Codes with external regulation is also useful signalling that government is taking corporate governance seriously and is holding the private sector accountable (see Andreasson, 2011; Maroun and Atkins, 2014). For example, both King-IV and the Companies Act (2008) deal with issues such as the membership of committees of a board of directors and the responsibilities of individual board members. At the same time, the JSE has taken the position of requiring listed companies to comply with the King Codes or provide reasons for not doing so (JSE, 2013) effectively mandating corporate governance for most of the country’s largest organisations. Even if the statute or the JSE listing requirements are not directly applicable, it is unlikely that the relevance of the King Codes could be understood without reference to the South African legal context. As explained in King-IV (IOD, 2016, p. 35) [g]ood governance does not exist separately from the law, and a corporate governance code that applies on a voluntary basis may also trigger legal consequences. A court considers all relevant circumstances in determining the appropriate standard of conduct for those charged with governance duties, including what the generally accepted practices for a particular setting and situation are. Voluntary governance codes such as King-IV recommend leading practices for how governance duties should be discharged, and therefore influence and affect what practices are considered and eventually adopted and implemented by governing bodies. The more widely certain recommended practices in codes of governance are adopted, the more likely it is that a court would regard conduct that conforms to these practices as meeting the required standard of care. In this way, the provisions of voluntary codes of governance find their way into jurisprudence to become part of the common law.

The result is that a company (and, in some instances, its directors) may be held liable for a failure to meet minimum governance standards despite the fact that these were not outlined in statute or listing requirements. This is especially true when considering that a director’s duty of care may extend beyond the shareholder and result in directors being held accountable for actions which are not in the best interest of a company or its stakeholders (Esser and Du Plessis, 2007; Companies Act, 2008, s76(3)(b)).

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3 Determinants and outcomes of good corporate governance

3.1.3 The effects of institutionalised corporate governance In explaining the development and application of codes of corporate governance, the relevance of normative and mimetic isomorphism should not be overlooked (Ntim and Soobaroyen, 2013b).20 South Africa’s codes on corporate governance have a relatively long-history with the country widely regarded as a leader in the area (Solomon, 2013). Some of South Africa’s finest business and legal minds have contributed to the development of the King Codes which have come to constitute the very discourse for defining, articulating and gauging good governance. The result, according to DiMaggio and Powell (1983), is considerable normative pressures to ensure that companies adhere to the guidance contained in the King Codes. There can be variations on how codes on corporate governance are interpreted and applied (King, 2016). In this dynamic environment, companies may replicate the behaviours and practices of the most prominent or successful industry members as a means of resolving uncertainty about the application of codes of best practice and securing legitimacy by adopting already established norms (see Meyer and Rowan, 1977; DiMaggio and Powell, 1983). The same logic may apply at the macrolevel. As discussed Chapter 2, the demand for corporate governance and revisions to codes of best practice in South Africa have been influenced to, at least, some extent by local and international financial scandals21 (IOD, 2002) and the experiences from developing and applying King-I. For example, the need to bolster transparency, to monitor directors’ interests and ensure that block shareholdings do not compromise governance practices were identified as specific areas for improvement when developing King-II (Kakabadse and Korac-Kakabadse, 2001). Instability in the global economy (IOD, 2016) and “changes in international governance trends” (IOD, 2009, p. 5) are additional considerations. In particular, it is worth repeating that, as part of the process of drafting King-III, the King Committee reviewed best practices in other jurisdictions (IOD, 2009, pp. 5–6). King-III does not indicate precisely which provisions are aligned with or based on international norms but states

20 ‘”Isomorphism” – which has been co-opted from natural sciences to describe a process of homogenisation – is synonymous with “compliance” and “convergence”. It can also be understood as a process of socialisation in terms of which aspects of everyday life are codified, formalised and institutionalised, ensuring their general acceptance and rendering alternate practices unimaginable’ (Maroun and Van Zijl, 2016, p. 221) 21 King-II was released in the aftermath of high-profile international governance failures such as Enron, WorldCom and Parmalat as well as local corporate scandals (such as Masterbond in the 1990s). Governance developments were similar to those seen in the UK. Issues such as director remuneration, board independence and the integrity of internal controls were tackled to address weaknesses identified in the application of King-I (Kakabadse and Korac-Kakabadse, 2001). They were also seen as an indirect response to a series of corporate failures which had shaken the confidence of the capital market (West, 2009).

3.1 External drivers of South African corporate governance

41

that these were taken into account when revising South Africa’s codes on corporate governance. This is to be expected. South Africa is a relatively small economy and significantly dependent on international trade and investment. For the country to be accepted as a legitimate part of the capital market, the mechanisms used to hold organisations accountable and protect investors need to be consistent with international trends which favour sophisticated systems of corporate reporting, monitoring and accountability (consider Rwegasira, 2000; Rossouw et al., 2002; De Villiers and van Staden, 2006; Andreasson, 2011; Maroun and Atkins, 2014; Chanda et al., 2017). As explained by Andreasson (2011, p. 661), isomorphic pressures result [. . .] not only [from] global institutional investors but also [from] corporations, banks, and other market actors that are concerned about investing in what are considered relatively highrisk markets.

Consequently, while South Africa’s codes on corporate governance are regarded as some of the most progressive in the world, they contain principles which have become a generally accepted part of the governance discourse. Stakeholder-centrism, monitoring and review, accountability and the triple context22 are examples. Isomorphic pressure does not, however, mean that South African corporate governance is a simple replication of international practice. While the King Codes have been influenced by international trends, they also acknowledge that a single approach to governance which ignores differences in culture, regulation and business conventions will be bound to fail (IOD, 2002; 2009; 2016). With this in mind, South Africa has only adopted some aspects of the Anglo-American governance model, rather than replicating it entirely. In particular, the country has resisted calls for the King Codes to follow a more regulatory governance model. The USA’s Sarbanes Oxley Act epitomises a legalistic or rules-based approach to corporate governance which stands in stark contrast to a more flexible principlesbased system followed by the UK and adopted by the King Codes. South Africa’s close ties with the UK, first as a colony and later as part of the Commonwealth, provide one explanation for the country’s decision to avoid an external regulatory model for driving corporate governance (see West, 2006; 2009). At the same time, despite its status as a developing economy, it also boasts some of the most sophisticated corporate reporting and governance systems in the world (Andreasson, 2011). As a result, the corporate governance model complements other systems designed to protect investors rather than substituting for their absence. This negates the need for a regulation-driven model on corporate governance. Companies are also encouraged to adhere to voluntary codes of best practice in order to avoid the promulgation of additional, and potentially costly, regulation by the state (Andreasson, 2011).

22 King-IV refers to the triple context which it defines as “the combined context of the economy, society and environment in which the organisation operates” (IOD, 2016, p. 24).

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3.2 Internal drivers of corporate governance For ease of analysis, we deal with internal drivers of corporate governance by distinguishing between organisational characteristics (Section 3.1.1) and a firm’s attitude to and awareness of the need for good governance (Section 3.1.2).

3.2.1 Organisational characteristics There are few examples showing how organisational characteristics affect South African corporate governance practice. The international research may, however, be relevant in a South African context and some of the key findings are discussed here. In terms of agency theory, corporate governance is an essential part of the system of checks and balances designed to reduce information asymmetry, lower agency costs and hold managers accountable (Demirag et al., 2000; Solomon, 2013). These benefits will probably be more significant for larger and multi-national organisations where the nexus of contracts between agents and principals become more complex and the probability of material agency costs being incurred increases (consider Jensen and Meckling, 1976; Fama and Jensen, 1983). For example, an American-based study by Boone et al. (2007) finds that board size and the number of independent directors on boards increases as firms grow and diversify over time. The number of business segments, the extent to which an organisation is engaged in research and development activity and variances in equity returns can also have an impact on board size and independence (Boone et al., 2007; Monem, 2013). Similarly, firms with multiple operating and financial structures, greater leverage or with businesses in different regions or sectors are more likely to have larger boards of directors with a greater number of independent members (Boone et al., 2007; Coles et al., 2008; Linck et al., 2008). While the prior research has produced mixed results on the effect of different determinants on board characteristics, the general positon is that, as firm complexity grows, the benefits of additional monitoring and strategic direction provided by more effective boards will exceed their cost (Boone et al., 2007; Monem, 2013). The type and concentration of shareholding are related considerations. For example, the number of independent directors on a board may be affected by the level of venture capital backing received by the respective organisation (Boone et al., 2007). The monitoring activities of the board of directors may be further bolstered by institutional investors. They have more experience, expertise and resources than smaller shareholders and, as a result, are more likely to hold managers accountable and restrain unnecessarily risky behaviour (Grossman and Hart, 1983; Shleifer and Vishny, 1986; McConnell and Servaes, 1990; Ferreira and Matos, 2008). Conversely, high levels of managerial influence and the presence of takeover

3.2 Internal drivers of corporate governance

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defences reduce the effect and increase the cost of independent monitoring. These features are, therefore, associated with smaller and less independent boards (Mak and Li, 2001; Boone et al., 2007; Linck et al., 2008). A Singaporean-based study finds that an increase in the number of external directors on a board is associated with a reduction in voluntary reporting, probably because the governance mechanism substitutes for the need to provide additional disclosure as a means of monitoring organisational performance (Mak and Li, 2001; Eng and Mak, 2003). Higher levels of ownership by “outside directors” may also increase monitoring benefits while lowering monitoring costs, something which may encourage larger boards (see also Raheja, 2005; Aman and Nguyen, 2013). In contrast, when ownership is concentrated, an Australian study finds that shareholders may be able to maximise their wealth by joining the board of directors and the benefit of having an independent board might reduce. This suggests that, in low litigation risk jurisdictions, ownership concentration substitutes for the effect which directors’ legal exposure has in enhancing the board’s monitoring role (Monem, 2013). Research on the relevance of concentration of ownership on South African companies’ corporate governance is limited, but there have been some studies which provide interesting insights. Ntim et al. (2012b) find that an increase in block ownership reduces voluntary corporate governance disclosures, implying that these substitute for each other as monitoring mechanisms. In contrast, higher levels of ownership by institutional investors amplify the amount of disclosure. A possible inference is that bock owners may behave in a similar way to firm insiders and seek to benefit from reduced levels of transparency (Shivdasani, 1993; Ajinkya et al., 2005). This is especially relevant in a South African context, given the high concentration of ownership of listed companies during the early to mid-1990s and a culture of secrecy and mistrust cultivated by Apartheid (Malherbe and Segal, 2001; World Bank, 2003; Mangena and Chamisa, 2008), as discussed in Chapter 2. A dominant shareholder may be able to exert undue influence on the board of directors and management, compromising the independence of the board and undermining its monitoring functions (Malherbe and Segal, 2001; World Bank, 2003) a problem which the IOD (2002) and World Bank (2003) describe as “shadow directorship”. Finally, while not explicitly addressed by the prior research, it is possible that organisations under the greatest scrutiny from stakeholders (such as those in high environmental or social impact sectors) will benefit from the additional monitoring and reduced information asymmetry associated with more advanced corporate governance systems. From a signalling theory perspective, these companies will also gain from transparent reporting on their corporate governance policies and practices. This is because a company’s corporate governance mechanisms can be used to signal the appropriateness of internal management and the quality of financial and non-financial reporting (consider Simnett et al., 2009; Ismail and El‐Shaib, 2012).

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3.2.2 Attitudes to and understanding of corporate governance Codes on corporate governance usually refer to a board of director’s monitoring function and its role in advising management and providing strategic direction (Solomon, 2013). Whether or not the former is valued to a greater extent than the latter will probably be affected by institutional values. For example, the USA places emphasis on free market systems and wealth creation. In this environment, the role of the board as a control mechanism plays a secondary role and the same individual is usually the Chief executive officer (CEO) and chairman. In contrast, Australia – which adheres to more socialist ideals – favours separation of functions in the interest of enhancing transparency and accountability (Monem, 2013). The same appears to apply in Singapore where individuals controlling large blocks of shares place pressure on companies to separate the function of the CEO and chairman as a means of bolstering board independence (Mak and Li, 2001). As a result, how corporate governance is understood and applied in different jurisdictions can vary according to the prevailing context with implications for the development of specific governance practices (see Claessens and Yurtoglu, 2013; Khlif et al., 2015; Chanda et al., 2017). The relevance of organisational characteristics for corporate governance can also be evaluated in terms of resource dependency theory which argues that an organisation attempts to maximise available resources (Zahra and Pearce, 1989). For some companies, corporate governance is understood as an important part of the accountability machinery and something which provides internal benefit and value for stakeholders (King, 2016; 2018). Voogt (2010), for example, shows that South African Chief Financial Officers are beginning to see corporate governance as one of their core roles. More broadly, King and Atkins (2016) argue that South Africa’s corporate governance landscape has evolved to a point where directors are both morally and legally obligated to ensure that their company acts as a responsible corporate citizen. As a result, directors are beginning to understand that their role is to guide and to monitor a company in a way which creates value for a broad group of stakeholders, rather than only maximising financial returns for shareholders (see also Esser and Du Plessis, 2007). In other cases, “companies may prioritise certain key resources, such as banking or legal expertise, over compliance with [provisions on codes on good governance] such as independence of nonexecutive directors” (Shrives and Brennan, 2015, p. 88). In these instances, corporate governance can be seen as a compliance exercise or something which provides only limited benefit to stakeholders. The adoption and application of codes of best practice become symbolic, rather than substantive (Tremblay and Gendron, 2011; Seidl et al., 2013; Shrives and Brennan, 2015). For example, a Tanzanian-based study examines how mining companies produce voluntary codes of conduct and CSR reports as a means of signalling that they conduct business in a socially responsible way. At the same time, details on foreign investment agreements – which constrain the Tanzanian government’s power to

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enforce human rights – are omitted (Lauwo and Otusanya, 2014). Similar to the criticism of sustainability reporting, in general, corporate reporting and codes of best practice are used to construct an image of a responsible corporate which is de-coupled from the possibility that business activities are eroding human rights (see also Milne et al., 2009; Tregidga et al., 2014). The same may be true in South Africa where – even though codes on corporate governance stress the importance of managing social and environmental impact (see Chapter 2) – financial performance remains a priority. Consequently, generic statements on governance and accountability can substitute for evidence of actions taken to mitigate the social and environmental costs of doing business (consider Haji and Anifowose, 2016; du Toit et al., 2017; Maroun, 2018a; 2018c). The possibility of companies only paying lip service to codes of corporate governance provides the basis for the regulation of corporate governance practices (Andreasson, 2011; Tremblay and Gendron, 2011). To, at least, some extent, codes of best practice can be seen as ad hoc responses to specific corporate failures or prevailing public concerns, rather than part of a coordinated approach to controlling corporate behaviour (Demirag et al., 2000; Dewing and Russell, 2000; West, 2006; Ntim et al., 2012b). In this context, external regulation can serve as a control mechanism which heightens managers’ awareness of corporate governance practices, sanctions non-compliance and limits variations in the application of codes on corporate governance (Stein, 2008). External regulation may, however, result in a legalistic approach to corporate governance (IOD, 2016) and the entrenchment of a shareholder-centric logic which does little to promote the rights of stakeholders and a holistic view of corporate responsibility (Merino et al., 2010). How external regulation can be used to complement the self-regulatory framework espoused by the King Codes has not been explicitly considered but some inferences are possible. Raemaekers et al. (2016), for example, raise concerns about the quality of risk management practices and disclosures by some of South Africa’s largest listed companies. Similarly, Van Zijl et al. (2017) question the extent to which companies are incorporating sustainability-related issues in their strategy and business model development. More widespread are the concerns about generic or superficial corporate reporting identified by reviews of South African annual, integrated and sustainability reports by the academic (du Toit, 2017; McNally et al., 2017) and professional accounting community (Solomon and Maroun, 2012; PricewaterhouseCoopers (PWC), 2015). Specific regulatory measures are not proposed but the prior research raises the possibility of detailed practice guidelines, minimum standards for non-financial reporting and an expanded external assurance model as possible measures for driving better application of the King Codes and existing corporate reporting frameworks (see Haji and Anifowose, 2016; Raemaekers et al., 2016; Maroun, 2017a). How codified reporting standards (van Zijl and Maroun, 2017), independent reviews by a panel of independent experts (Lowe and Maroun, 2016) and statutory mechanisms for blowing the whistle on corporate wrong-doing (Maroun and Atkins, 2014) can enhance corporate

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governance and reporting has also been considered in a South African-specific setting (see also Dewing and Russell, 2000).23 Perhaps the most pertinent illustration of efforts to regulate broader corporate governance practice is the decision to introduce a “comply and explain” approach in King-IV rather than relying on the traditional “comply or explain” model. As discussed in Chapter 2, King-IV consists of 17 principles which are seen “as aspirations and ideas that an organisation should strive for in its journey towards good governance”. The Code stops short of introducing specific mandatory provisions but it states that the principles are “basic and fundamental to good governance, and the application thereof is assumed” (IOD, 2016, p. 37). As a result, companies are expected to comply with each of the principles and provide stakeholders with an explanation of the specific practices which have been implemented to achieve the outcomes of good governance: an ethical culture, good performance, effective control and legitimacy (IOD, 2016 p. 41). In other words, King-IV is not rules-based but there is a presumption that, because the principles are broadly applicable, a company ought to comply with them. The organisation is expected to exercise judgement only when determining which practices to adopt to give effect to each of the principles. 3.2.3 Summary Table 3.1 summarises the different theoretical frameworks used to explain the emergence and development of corporate governance by international literature. Table 3.1: Summary of determinants by theory. Theory

Framing of corporate governance

Agency theory

Corporate governance is a mechanism for reducing information asymmetry and lowering associated agency costs for the benefit of financial capital providers. Investments in corporate governance continue to the point where the marginal benefits from additional monitoring and control are exceeded by the marginal costs.

Stakeholder theory

Under stakeholder theory, corporate governance lowers agency costs but also enhances accountability to a broad group of stakeholders and promotes sustainable management of economic, social and environmental issues in the short-, medium- and long-term.

23 This body of work is focused specifically on financial reporting but may be more broadly applicable to corporate reports dealing with both financial and non-financial information.

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Table 3.1 (continued ) Theory

Framing of corporate governance

Signalling theory

In the absence of perfect information, disclosures about a company’s corporate governance systems can be used as a signal that the organisation is well managed, that its corporate reporting is sound and that it is taking cognisance of the interests of key stakeholders.

Institutional theory – isomorphic behaviour

Companies feel compelled to follow codified best practices (normative isomorphism). Stakeholder expectations, minimum standards set by listing requirements, and the fact that some aspects of codes on corporate governance are legislated give rise to coercive pressures to introduce and maintain appropriate governance mechanisms. In the context of uncertainty, characterised by the rapid development of principles-based governance practices, companies may also feel compelled to replicate the behaviour of already legitimised behaviour (mimetic isomorphism).

Institutional theory – legitimacy

The application of codes on corporate governance is designed to secure legitimacy by demonstrating that the organisation is aligned with prevailing social norms and stakeholder expectations. Developing codes of best practice may also be important for gaining or maintaining legitimacy at the national level.

Institutional theory – de-coupling and counter-coupling

There may be a disconnect between corporate governance disclosure and action. For example, how a company explains its culture of or commitment to corporate governance may not be consistent with how governance is practised at the operational level. Alternately, disclosures on corporate governance may be used to negate the need for substantive action.

Resource dependency theory

Corporate governance can be viewed as a core part of the business model and something which is carefully managed and applied. In other cases, such as when decoupling or counter-coupling occurs, it is used either as a superficial legitimacy management tool or a means of further managers’ self-interests

Theories of power and control

External regulation can complement the development and application of self-regulatory codes of best practice. Then provide a mechanism of power and control over organisations and individual managers which can frame how corporate governance is understood, promote compliance with perceived best practice and limit variability in how governance prescriptions are applied.

24 While legitimacy theory is often considered as a separate theory in its own right, Suchman (1995) explains that legitimacy can be understood either as a strategic resource or as a social/institutional construct. A detailed review of these framings of legitimacy is beyond the scope of this book.

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3.3 Interpretive schematics According to Demirag et al. (2000, p. 348), the effectiveness of an organisation’s corporate governance depends on how internal and external mechanisms (such as the composition of the board, shareholdings and the prevailing legal system) interact with and regulate a firm’s behaviour. In the authors’ opinion, specific governance mechanisms also need to be understood in terms of the prevailing “schemata of interpretation” (Goffman, 1986, p. 21) which are used to frame or contextualise corporate governance. In a South African context, the King Codes are the dominant discourse for describing and explaining corporate governance. These are discussed in Chapter 2. Because of the emphasis which King-IV places on integrated thinking, the IIRC’s framework on integrated reporting is also relevant (King and Atkins, 2016). The Integrated Reporting Committee of South Africa (IRCSA) issued a discussion paper on the preparation of an integrated report as part of the broader corporate governance environment in South Africa (see IRCSA, 2011). This was followed by the release of a framework on integrated reporting by the IIRC in 2013. According to the IIRC (2013, p. 7), an integrated report is a concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term.

Integrated reporting should be supported by an integrated thinking philosophy. This focuses on the interconnection between different types of capital which an organisation uses or affects in order to encourage a more holistic approach to strategy development, risk management and business practice. The ultimate aim is to promote genuine long-term sustainability (Eccles et al., 2015). Examining the development and application of integrated reporting principles is beyond the scope of this research (for details see de Villiers et al., 2014; 2017a; De Villiers and Maroun, 2018; Rinaldi et al., 2018). What is relevant is that South Africa has taken a leading role in promoting integrated reporting which is becoming the primary means of communication between companies and their stakeholders. The value-relevance of some integrated reports may be questionable (PwC, 2015; Haji and Anifowose, 2016; du Toit et al., 2017) but there are also indications of integrated reporting have a positive effect on governance practices, stakeholder engagement and the extent to which social and economic issues are being internalised as legitimate business considerations (Barth et al., 2017; McNally and Maroun, 2018).25

25 South African companies rely on the IIRCs framework for preparing their integrated reports. The framework is not intended to be overly prescriptive and does not provide detail on exactly what information to include in an integrated report. As a result, many companies refer to the recommended reporting practices issued by the GRI (GRI, 2016) and AccountAbility (2008) for additional guidance.

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3.3.1 The regulatory environment As discussed in Chapter 2 and Section 3.1.2, while the King Codes are voluntary, they are interpreted and applied in the context of a number of external regulatory measures. For example, South Africa has legislated what is referred to broadly as BEE. Most notably, the Labour Relations Act (1995), the Basic Conditions of Employment Act (1997), the National Environmental Management Act (1998) and the Employment Equity Act (1998) were promulgated. These are aimed at addressing structural issues in the South African labour market, at affording legal protection to the country’s working class and at improving working conditions. In particular, legislation dealing with employment equity was an attempt to improve the participation of individuals previously discriminated against under Apartheid in the formal economy (see IOD, 2002; West, 2006; Maroun, 2018c). Legislation dealing with the protection of the environment and holding companies accountable for environmental performance has also been introduced (see De Villiers and van Staden, 2006; Usher and Maroun, 2018). In the authors’ opinion, the provisions of the King Codes dealing with social and environmental issues would need to be interpreted and applied in conjunction with the respective statutory provisions. Similarly, prohibitions on insider trading, amendments to banking regulation and statute designed to combat and prevent fraudulent activities have been promulgated and bolster corporate governance provisions contained in the King Codes (Kakabadse and Korac-Kakabadse, 2001). The Public Finance Management Act (enacted in 1999) seeks to drive efficient management of public funds and state resources at the national and provincial government level (Kakabadse and Korac-Kakabadse, 2001). As discussed in Chapter 2, this has been complemented by the adoption of IFRS and revisions to local company law (West, 2009; Maroun et al., 2014). Following the release of King-I’s recommendations, many amendments to the Companies Act (1973) were tabled including, inter alia, compelling disclosure of the identity of beneficial owners of shares held by nominees. The Companies Act (1973) was repealed when the Companies Act (2008) was issued (see also Section 2.4). The former introduces mandatory governance requirements for companies with high public interest such as the formation of an audit committee and social and ethics committee (see Chapter 4 for details) and enhanced for protection of non-controlling shareholders (Andreasson, 2011). In addition to the above statutory developments, the JSE Listings Requirements have been consistently revised to keep up to date with legal changes, international and local developments in corporate governance and market regulation. For example, revisions to the listing requirements in 1995 made it compulsory for listed companies to disclose the extent of their compliance with the King Report (JSE, 1995; Malherbe and Segal, 2001; Vaughn and Ryan, 2006). In 2003, the JSE listing rules were again comprehensively updated to require listed companies to comply with the recommendations contained in King-II or to explain their lack of compliance (Vaughn and Ryan, 2006).

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Particularly relevant given the increased emphasis placed on sustainability and integrated reporting by King-III and King-IV (see Chapter 2) is the JSE’s position on corporate governance as part of the broader sustainability agenda: The imperative to build a long term business model that takes cognisance of the impacts, risks and opportunities in relation to the environmental, social and economic contexts within which an organisation operates, is increasingly becoming part of the licence to operate for companies the world over. At its core a governance issue, sustainability requires particular focus given the planetary boundaries and the need to understand the impacts of any entity on society and the environment. (JSE, 2015)

To this end, 2004 saw the launch of the first sustainability index for emerging markets in an effort to raise awareness of the need for sustainable business practice (IOD, 2009). The JSE is also a signatory to the UN-backed Principles for Responsible Investment (JSE, 2015) and supports the Code for Responsible Investing in South Africa which frames ESG issues as primary, rather than less important, investment considerations (IOD, 2011). While these measures do not provide direct legal support for King-IV, they contribute significantly to the credibility of integrated thinking and reporting as a core feature of South African corporate governance (see de Villiers et al., 2014; Atkins and Maroun, 2015).26

3.3.2 On the relevance of stakeholder activism Finally, how codes of corporate governance are interpreted and applied will be influenced by the level of stakeholder activism. As explained by King-III: An “apply or explain” market-based code of good practice in the context of listed companies, such as King III, is stronger if its implementation is overseen by those with a vested interest in the market working, i.e. the institutional investor. Recent experience indicates that market failures in relation to governance are, at least in part, due to an absence of active institutional investors. (IOD, 2009, p. 10)

The extent to which institutional investors engage with and hold companies responsible for their performance has not been investigated in detail. Similarly, the role played by environmental or social action groups, the media and academic institutions as mechanisms of accountability has not been formally researched. Most writers only touch on the topic. They consider if the limited use of (Rensburg and Botha, 2014) or challenges encountered when preparing an integrated report (McNally et al., 2017) may undermine the intended benefits of integrated reporting and, associated closely with this, contemporary systems of corporate governance. What little has been done on the

26 A detailed analysis of the JSE Listing Requirements from 1994 to date is beyond the scope of this text.

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interaction between institutional investors, NGOs or other stakeholders and South African corporates (see Yamahaki and Frynas, 2016; Atkins et al., 2018) does not reach a strong conclusion on how these relationships contribute to the understanding and application of the King Codes.

3.4 Proactivity King-IV requires an organisation’s governing body to provide strategic direction and guidance on how to approach specific areas of governance. This should form the basis of any strategic and operational policies or plans which are, in turn, approved by the governing body. The implementation and execution of those plans should be overseen by those charged with governance who, in essence, carry out a monitoring and review function. Accountability is ensured by a sound system of internal control, formal lines of reporting and adequate disclosure to external stakeholders (IOD, 2016). Although not explicit in King-IV, for the governing body to discharge its roles and responsibilities, appropriate operating, management control and accounting systems should also be in place. These should be supported by a coherent approach to stakeholder engagement and external reporting, the integrity of which is ensured by internal and external sources of assurance. Collectively, these “elements” of the corporate governance model are referred to as proactivity (adapted from Alrazi et al., 2015; De Villiers and Maroun, 2018).

3.4.1 Management and operating systems In a sustainability reporting context, operating and management systems are the formal systems and database which [integrate] procedures and processes for the training of personnel, monitoring, summarising, and reporting of specialized environmental performance information to internal and external stakeholders of the firm. (Melnyk et al., 2003, p. 332)

Applied to corporate governance, appropriately designed operating and management systems allow an organisation to identify key risks, develop appropriate mitigating policies and implement specific actions either to lower risk exposure or to capitalise on identified opportunities. Operating and management systems ensure that governance principles outlined by King-IV are internalised and become part of day-to-day organisational practice, rather than being dealt with only superficially to prepare a sustainability or an integrated report (adapted from De Villiers and Maroun, 2018).

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3.4.2 The accounting infrastructure For those charged with governance to provide strategic direction and discharge their monitoring function, the accounting system must be capable of providing accurate, complete and relevant data. The financial reporting infrastructure usually poses the least challenge because IFRS and well-established management accounting practices define the boundaries of data collection. These provide a generally accepted framework for measuring changes in financial and manufactured capital (consider Hopwood, 1987). Accounting for the so-called non-financial capitals is more problematic because there is no single basis for determining the unit of account and exactly how each capital should be defined, disaggregated and measured. Possible considerations for those charged with governance include – defining each capital in the context of the organisation’s business model and a basis for determining which capitals or parts of the capitals are material, – identification of strategic issues and risks specific to the relevant capitals, – concluding on how to measure changes in each of the capitals,27 – setting key performance indicators, – evaluating the impact on each of the capitals including how actual performance compares with budgeted or targeted outcomes and – revising policies, plans or systems to correct deficient performance or to capitalise further on any efficiencies. (adapted from Solomon and Lewis, 2002; Jones and Solomon, 2013; Cuckston, 2018; Maroun and Atkins, 2018) The traditional accounting system is one-dimensional in the sense that it records measures of financial position, performance and cash flows. Most accounting software is not sophisticated enough to account for the different types of capital referred to by the IIRC and King-IV. As a result, the accounting infrastructure will need to be modified, taking into consideration the data which are required on each capital; the format in which the data are accumulated; charts of accounts for organising the data and an understanding of how the data are organised to provide reports on economic, social and environmental performance. The financial and management accounting literature provides many examples of how the “calculable infrastructure” of contemporary systems of accounting and management reporting can be used to bolster accountability and alter organisational or individual behaviour (Hoskin and Macve, 1986; Cowton and Dopson, 2002; Mennicken and Miller, 2012; van Zijl and Maroun, 2017). By analogy, it is possible

27 For example, should natural capital should be gauged according to area of natural habitats, number of species of plants or animals, total energy emissions, quantity of waste recycled or other measures?

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that the process of collecting data on different dimensions of firm performance can make organisations more aware of their economic, environmental and social impact. This, in turn, can promote changes to how they do business as part of a genuine commitment to good governance and long-term sustainability (consider Atkins et al., 2015; Guthrie et al., 2017; McNally and Maroun, 2018). Conversely, where the underlying management, operating and accounting systems are underdeveloped, the organisation is unable to identify clearly the link between its operations and different capitals and develop policies or actions which maximise stakeholder value. Reporting to stakeholders becomes generic and the link between strategy, risk, business model and value creation cannot be clearly explained (see Solomon and Maroun, 2012; KPMG, 2015; PwC, 2015; Raemaekers et al., 2016).

3.4.3 Stakeholder engagement, corporate reporting and assurance The IIRC (2013) frames the providers of financial capital as the primary users of an integrated report, something which critics argue undermines the sustainability agenda (Flower, 2015; Dumay et al., 2017). King-IV, however, makes it clear that an organisation is responsible to a broader group of stakeholders and the interests of shareholders do not automatically rank above those of other constituents or the organisation’s ability to function as a good corporate citizen (IOD, 2016, pp. 24–27). In practical terms, an organisation will identify its most influential stakeholders and take steps to ensure that their legitimate interests are served and their information requirements are met (Mitchell et al., 1997). This is essential for ensuring that key stakeholder do not withdraw their support for the organisation, leading to difficulties in accessing resources, increased operating challenges and a loss of legitimacy (Bebbington et al., 2008; Ntim et al., 2012a; Claessens and Yurtoglu, 2013). In particular, firms which mitigate adverse social and environmental impacts and provide a detailed account of their broader sustainability performance are able to reassure stakeholders and secure legitimacy (Melnyk et al., 2003; Alrazi et al., 2015). King-IV takes a similar approach. It sees the integrated report as the outcome of a stakeholder-centric integrated thinking philosophy summarised by Figure 3.1. Sustainable development28 is achieved by adopting an integrated approach to business management which recognises the importance of social, economic and environmental imperatives. Consequently, the organisation cannot be seen as separate from the prevailing social context. It has internal and external stakeholders who are directly involved in its core operations but is also dependent on the broader society for essential human, intellectual, relationship and natural capitals

28 This is defined by King-IV as “development that meets the needs of the present without compromising the ability of future generations to meet their needs” (IOD, 2016, p23).

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Integrated thinking Sustainable development achieved by an integrated approach to business management

Societal context

Inclusive governance

Rights and obligations

The organisation is framed as an integral part of society

Stakeholder-centrism at the hear of corporate governance

The organisation is a corporate citizen with associated right and obligations

Integrated reporting

Figure 3.1: Integrated thinking. (adapted from IOD, 2016)

(IOD, 2016). This is consistent with an institutional perspective of the firm which sees the organisation as a social construction which operates, not only because of its rational technical activities but by virtue of being accepted as legitimate by its key constituents (Dowling and Pfeffer, 1975; O’Donovan, 2002). As an integral part of society, the organisation enjoys legal and social rights with corresponding obligations to act in society’s best interests and according to its prevailing norms (IOD, 2016). In a South African context, this means adopting a stakeholderinclusive approach to governance which requires an organisation to balance the competing expectations of stakeholders and not prioritising financial capital over the other sources of value creation (IOD, 2016). This will require the development of methods for identifying stakeholders, assessing their influence on the organisation and determining how the firm’s activities impact them. Formal systems for communicating with stakeholders, identifying their expectations, managing any disputes and tracking the quality of relationships will also be required.29 Those charged with governance should assume ultimate responsibility for stakeholder engagement and approve appropriate policies for managing the firm’s interactions with its stakeholders (IOD, 2016, p. 71).

29 In a corporate environment, this will include proactive engagement with stakeholders by the directors and the firm’s external auditors at the company’s annual general meeting (IOD, 2016).

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Integrated thinking should culminate in high-quality integrated reports. Practically, this will necessitate well-designed management control systems, the necessary accounting infrastructure and a comprehensive approach to stakeholder engagement (Alrazi et al., 2015). As explained by De Villiers and Maroun (2018, p. 45): Engagement with [key] stakeholders is essential for understanding their concerns, expectations and requirements. In turn, the focus of information included in integrated and sustainability reports can be adjusted to meet specific information needs, address criticism of the reports and, ultimately, ensure higher quality integrated/sustainability reporting. This can feed back to the underlying management and accounting systems as the organizations improves its internal processes and controls to refine information reported to stakeholders. Opportunities for stakeholders to interact with management can also be useful for addressing emerging concerns, bolstering confidence in the organization and providing a complete and transparent account of the business. As a result, effective stakeholder engagement is seen as a key part of sustainability performance and accountability.

An organisation’s accounting infrastructure provides the data which form the basis for reporting to stakeholders. Without the operating, management control and accounting systems, reporting will lack substance. It would be difficult for an organisation to provide a detailed explanation of exactly how it is managing different types of capitals in order to generate sustainable returns for its stakeholders. Monitoring by those charged with governance, formal systems of internal control and the use of internal and external assurance may also be required to ensure that integrated reports are accurate and complete and provide relevant information to stakeholders (see Simnett et al., 2009; IIRC, 2013; Maroun, 2018d). (For additional details on external and internal sources of assurance, refer to Chapter 6).

3.5 Outcomes of good governance According to King-IV, corporate governance “is the exercise of ethical and effective leadership by the governing body towards the achievement of governance outcomes”. These include: ethical culture, good performance, effective control and legitimacy (IOD, 2016, p. 11). King-IV defines “ethical leadership” as exemplified by integrity, competence, responsibility, accountability, fairness and transparency. It involves the anticipation and prevention, or otherwise amelioration, of the negative consequences of the organisation’s activities and outputs on the economy, society and the environment and the capitals that it uses and affects. (IOD, 2016, p. 20)

Effective leadership is results-driven. It is about achieving strategic objectives and positive outcomes. Effective leadership includes, but goes beyond, an internal focus on effective and efficient execution. (IOD, 2016, p. 20)

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The prior research deals predominantly with the interconnection between corporate governance and performance. Legitimacy is usually explained in pragmatic terms as the outcome of effective internal control and high financial returns. It can also be evaluated according to the moral duty of a company to adhere to high levels of corporate governance and gain the benefits which accrue from aligning the organisation with codified and institutionalised practice. Given the emphasis which King-IV places on integrated thinking and reporting, the possible outcomes of corporate governance can also be organised according to a multi-capital framework which considers the different capitals referred to by the IIRC (2013). This is not King-IV’s expressly adopted approach but is in keeping with the fact that the Code defines “outcomes” as “the internal and external consequences [. . .] for the capitals as a result of an organisation’s activities and outputs” (see IOD, 2016 p. 15, emphasis added).

3.5.1 Financial and manufactured capital Most of the prior research frames corporate governance as an accountability mechanism which provides financial benefits to shareholders (Brennan and Solomon, 2008). This research is grounded in the seminal work by La Porta et al. (1997; 1998; 1999) which established the relationship between legal systems, investor protection and economic returns. For example, research from developed economies reports a positive relationship between firm-level governance characteristics and corporate value. Ammann et al. (2011) construct a governance index based on board accountability, financial disclosures and internal controls, shareholder rights, remuneration and market control. Data are collected from 22 developed economies from 2003 to 2007. The researchers conclude that the information and monitoring benefits of corporate governance mechanisms exceed their costs, resulting in higher cash flows to investors and lower costs of capital (see also Chen et al., 2011). This may be particularly true when governance-related disclosures are used to complement the financial information used by analysts to predict an organisation’s future earnings (Bhat et al., 2006). As argued by Brown and Caylor (2006) and Dittmar and Mahrt-Smith (2007), different corporate governance practices can have a positive effect on firm performance30 and the value and use of cash holdings respectively. As an added benefit, stronger corporate governance may moderate the effect of adverse economic events on share price volatility (Claessens and Yurtoglu, 2013). Akbar et al. (2016) question whether compliance with corporate governance prescriptions is a determinant of corporate performance. Similarly, Bhagat and Bolton (2008) find that, while governance measures are positively correlated with

30 Measured according to Tobin’s Q.

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accounting-based measures of performance, they are not necessarily driving market performance or fluctuations in share prices. Nevertheless, most prior research suggests that better corporate governance is associated with improved operating performance and higher market values for firms, especially in situations where corporate governance substitutes for weaknesses in the legal systems which if not followed would protect investors (Klapper and Love, 2002; Coles et al., 2008; Aguilera and Cuervo‐Cazurra, 2009; Ararat et al., 2017; Pillai and Al-Malkawi, 2018). A different stream of research considers the link between corporate governance and the quality of financial reporting. Davidson et al. (2005) and Lopes and Walker (2012) find that firms with sound corporate governance mechanisms are less likely to engage in opportunistic financial reporting practices (see also Demirag et al., 2000; Klein, 2002; Bassett et al., 2007; Biondi and Rebérioux, 2012) and may have a lower risk of business failure (Hsu and Wu, 2014). An increase in disclosure quality can lower information asymmetry, leading to better credit ratings, greater access to funding and lower debt and equity costs (Ashbaugh-Skaife et al., 2006; Claessens and Yurtoglu, 2013; Tran, 2014). An increase in the accuracy of analysts’ forecasts is also possible because better corporate governance tends to result in more informative corporate reporting (Beekes and Brown, 2006). Information asymmetry can be further reduced by the monitoring function of larger boards of directors which are independent and institutional shareholders31 (Bhojraj and Sengupta, 2003; Ashbaugh-Skaife et al., 2006; Aman and Nguyen, 2013). The benefits of good governance may be especially relevant in developing economies where firm-level corporate governance can substitute for weak investor protection regulation and allow organisations to access debt and equity financing more readily and at lower rates (Chen et al., 2009). Another area of research considers how the sub-committees and the diversity of board members contribute to the effectiveness of the board of a directors’ advisory and monitoring roles. For example, the function of the remuneration (Liu and Taylor, 2008), nomination (Vafeas, 1999) and audit committee (Turley, 2003; Barako et al., 2006) and how these moderate or enhance the activity of the board have been investigated in detail. Whether or not gender diversity (Willows and van der Linde, 2016), experience (Kiel and Nicholson, 2003) and tenure (Kiel and Nicholson, 2003; Hsu and Wu, 2014) can strengthen governance mechanisms and contribute to better accounting or market-based performance has also been considered. Overall, the prior research points to two forces at work. Stronger corporate governance accords better protection to investors by controlling management behaviour and lowering information asymmetry. This results in a reduction of risk, makes it easier for firms to raise debt and equity and lowers the cost of the capital (see, for example, Brown and Caylor, 2006; Ammann et al., 2011). The net effect is an

31 When, however, institutional shareholdings become concentrated, credit ratings and bond yields can be adversely affected (Bhojraj and Sengupta, 2003).

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increase in firm value (typically measured by Tobin’s q or ratios of book to market values). At the operational level, those charged with the organisation’s governance are involved in setting and guiding the achievement of strategic objectives in addition to playing a monitoring role (Ingley and Van der Walt, 2001; IOD, 2016). The result is a stronger corporate governance environment which can lead to better internal management, operating policies and asset utilisation (Gupta et al., 2008; Claessens and Yurtoglu, 2013) while also mitigating adverse environmental or social impact (King, 2018), as discussed in more detail below. An examination of precisely which features of the corporate governance system contribute most significantly to financial and manufactured capital has, however, produced mixed results (Aguilera and Cuervo‐Cazurra, 2009). For example, evidence from a developing economy suggests that better corporate disclosure may have a positive effect on firm value but that this is not the case for other governance practices (Ararat et al., 2017). One of the few South African-specific studies on the value relevance of corporate governance finds that the proportion of non-executive directors on a board may have a positive effect on firm performance (measured according to Tobin’s q) but that board size and the number of board meetings are not necessarily determinants of better performance (Harvey Pamburai et al., 2015). Similarly, Brown and Caylor (2006) find that board attendance and policies for option-based remuneration for directors are value relevant, while audit committee composition and rotation of the external auditor are not. Contrary to expectations, Bhagat and Bolton (2008) find a negative relationship between board independence and accounting performance and propose the value of equity held by board members as a primary performance determinant. From a broader perspective, debt and equity holders can have differing views on the use and effectiveness of different corporate governance mechanisms (Tran, 2014). The prior research has also considered if “an overemphasis on monitoring and control by independent directors may come at the expense of the contributions that [non-executive directors] can make to wealth creation” (Hsu and Wu, 2014, p. 226). Table 3.2 provides a summary of select papers on the possible impact of corporate governance on financial capital.

3.5.2 Human, social and relationship and intellectual capital Maug (1997, p. 134) argues that managers invest in “firm-specific human capital” but that, unlike most business decisions, human capital decisions cannot be contracted. Even in cases in which an implicit contract with a firm can be established, there is no guarantee that it will not be breached; this necessitates the use of a system of checks and balances to protect human capital development (see also Jensen and Meckling, 1976; Gibson, 2003). Independent directors form a key part of this system because they can access information about a firm at relatively low cost and can objectively evaluate how managers invest in and protect a firm’s human capital (Maug, 1997). Their impartiality and expertise make independent directors more likely to hold

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Table 3.2: Select papers on the financial benefits of good governance. Study

Jurisdiction

Period

Summary of findings

Ammann et al. ()

International – Corporate governance has a positive effect on firm value and financial performance

Aman and Nguyen ()

Japan

,  Active monitoring (by institutional shareholders and and  larger boards) and reduced information asymmetry (because of better quality reporting) mitigate agency problems, improve credit ratings and lower the cost of debt financing

Ararat et al. ()

Turkey

– Better corporate governance (primarily in the form of enhanced disclosure) is associated with a higher firm value (measured according to Tobin’s-q).

Ashbaugh-Skaife USA et al. ()



Bhat et al. ()

– Governance transparency can enhance the accuracy of analysts’ earnings forecasts and complement the financial information being used to predict future cash flow

USA

Credit ratings are negatively associated with, inter alia, CEO power and the number of block shareholders. Board independence, stock ownership and expertise are positively associated with credit ratings

Bhojraj and USA Sengupta ()

– Governance mechanisms (including institutional shareholder involvement and independent directors), lower agency costs by monitoring managerial behaviour and addressing information asymmetry, leading to lower bond yields but concentrated institutional shareholdings, can have an adverse effect on credit ratings and yields

Dittmar and Mahrt-Smith ()

USA

– Good governance has a positive impact on the value and use of cash holdings and, in turn, future operating performance

Klapper and Love ()

Developing economies

/ Firm-level corporate governance has a positive effect on performance and value, especially in countries with weak shareholder protection and inefficient legal systems

Lopes and Walker ()

Brazil

– Firms adopting voluntary corporate governance practices are less likely to engage in opportunistic financial reporting

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executives, including the CEO, accountable for poor performance (Guo and Masulis, 2015). Independent directors may also play a role in ensuring that an organisation is taking adequate steps to manage its human and social capitals responsibly. From a different perspective, a study of UK-based firms shows that better corporate governance has a positive effect on reporting on community involvement and engagement (Yekini et al., 2015). Companies with effective corporate governance mechanisms are better equipped to identify key stakeholders, understand their information needs and co-opt them in decision-making processes (see also Mitchell et al., 1997). The risk of human capital depletion and increased exposure to legal liability may be higher for companies with poor corporate reporting and other governance practices (consider Bebbington et al., 2008; Claessens and Yurtoglu, 2013). Companies with poor labour relations may also find it more difficult to raise funding at affordable rates (Bae et al., 2011) and performance may suffer due to underlying conflict with key stakeholders (Claessens and Yurtoglu, 2013). From a resource dependency view, an organisation is dependent on different stakeholders to provide it with essential resources. They may only be prepared to do this if the company is responsive to their needs (Jensen, 2002) and maintains a good corporate reputation (Branco and Rodrigues, 2008) by maintaining high governance standards (Ntim et al., 2012a). In terms of institutional theory, companies face significant coercive and normative pressures to comply with codes of best practice (see Section 4.1). Replicating corporate governance systems outlined by already institutionalised codes on corporate governance can confer legitimacy (see Suchman, 1995; Deegan, 2002; De Villiers and Maroun, 2018) allowing the organisation to win support from influential stakeholders and gain access to additional financial, manufactured or human capital (consider Dowling and Pfeffer, 1975). Engaging in and reporting on CSR initiatives is a way of signalling corporate governance quality, with the result that better-governed organisations tend to place greater emphasis on CSR practices than weaker ones (Ntim and Soobaroyen, 2013b). On one level, CSR may be seen as a moral imperative, important for addressing inequality and necessary for securing organisational legitimacy (IOD, 1994). In this way, it becomes an extension of the broader corporate governance system focused on principles of transparency, fairness and honesty (MacMillan et al., 2004; Jamali et al., 2008). King-IV stresses that an organisation’s fiduciary duty is not only characterised by generating financial returns for shareholders but also through responsible management of economic, environmental and social considerations (IOD, 2016). As a result, the relationship between corporate governance and CSR can also be explained in terms of stakeholder accountability. In addition to acting as a signalling mechanism, when managers have understood and internalised the spirit of good governance, CSR becomes an integral part of the business model and essential for discharging responsibilities to a wider group of stakeholders (Rossouw, 2005; Jamali et al., 2008; King, 2018). As explained by Wixley and Everingham (2005, pp.115–116 in Andreasson, 2011)

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a general concern with the role of business in society [. . .] [which] involves an awareness that the stakeholders in an enterprise are not merely the shareholders who provide capital, but persons contracting with the business [. . .] and those with a non-contractual relationship, such as local communities, non-governmental organizations and the like [and, second, to] qualitative issues which influence the ability of the enterprise to create value in the future [. . .] [such as] investments in human and other related intellectual capital [. . .] maintenance of the reputation of the enterprise and the like.

Effectively managing social and relationship capital can also have a positive effect on the other capitals (IIRC, 2013). For example, CSR can be used to differentiate the firm and bolster its competitiveness (see Porter and van der Linda, 1995; Mangaliso, 2001; Van Zijl et al., 2017). Firms with a better CSR track record may find it easier to attract and retain essential employees (Bebbington et al., 2008) and build better relationships of different stakeholders which can result in lower operating risks and improved efficiency (Claessens and Yurtoglu, 2013). A commitment to CSR can also be used to demonstrate that managers have a better understanding of the risks facing their company and the associated opportunities (García Sánchez et al., 2011; Van Zijl et al., 2017) and win the confidence of sustainability-inclined investors (King, 2016) with positive implications for financial capital. As a result, corporate governance has a moderating effect on both CSR and firm performance, something which would not be the case if CSR was being used only as a superficial legitimacy management tool32 (Ntim and Soobaroyen, 2013b). The exact extent to which CSR leads to better operating or social performance and, in turn, financial returns has not, however, been established by the prior research (Claessens and Yurtoglu, 2013).

3.5.3 Natural capital While most of the research focuses on the financial benefits of good corporate governance, there are some studies which examine the impact of corporate governance mechanisms on how companies manage natural capital. Haque (2017), for example, examines carbon reduction initiatives by UK-based companies from 2002 to 2014. Board independence, gender diversity on the board and environmental-based remuneration policies are associated with more proactive management of greenhouse gas emissions. The results are largely consistent with an Australian-based study on the positive effect which board diversity (measured according to gender representation, tenure and the holding of multiple directorships) can have on CSR reporting (Rao and Tilt, 2016). A meta-analysis of 64 studies from developed and developing countries shows that board size, composition and delegation of authorities to an audit committee can also have a positive effect on voluntary reporting (Samaha

32 This finding is based on data from South African listed firms from 2002 to 2009.

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et al., 2015).33 This will include the extent to which a company reports on its environmental impact.

3.6 Summary and conclusion The King Codes are the product of the country’s socio-economic and political milieu, particularly during the early 1990s. A shareholder-centric model, which neglected social and environmental imperatives, would have been at odds with the objective of broadening economic participation and addressing high levels of inequality following the attainment of democracy in 1994. It was also inconsistent with African values systems which favour collective decision-making and do not place individual rights above communal interests. Much of South Africa’s corporate governance discourse is, however, informed by the need to normalise the country’s relationship with its trade partners and to win investor confidence. As a result, the King Codes cannot ignore developments in the world’s major economies. They become internationally accepted as a legitimate codification of good practice precisely because they reflect features of Anglo-American models which emphasise the importance of property rights and shareholder value. The need to balance the South African Government’s social objectives with the more neoliberal expectations of the capital markets yields a stakeholder-centric approach to corporate governance which stresses the importance of inclusive capitalism rather than the rejection of free market principles in favour of radical social and economic reorganisation. In this way, while South African corporate governance is often characterised as being closely aligned with the outside model,34 it is best understood as a hybrid which draws on the strengths of different systems to provide recommended best practices suited to the South African environment and mindful of the country’s position on the international stage (see IOD, 1994, p. 2). Over time, the King Codes have attained what Suchaman (1995) describes as a state of taken-for-granted or cognitive legitimacy. Codified practices constitute the basis for describing and gauging good governance, something which, practically, leaves organisations seeking to gain or maintain credibility with little choice but to comply. Stakeholder expectations and the legal system add to this.

33 South Africa is not included in the meta-analysis. 34 While the practice has been criticised for oversimplifying corporate governance, governance systems are often categorised as following an insider or outsider model (Solomon, 2013). The former is characterised by closely-held firms where the shareholder is closer to management. This is in contrast to the outsider systems where shareholders are independent of management and a strong legal system is used to protect investors’ interests (for details see Shleifer and Vishny, 1986; 1997; La Porta et al., 1998).

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Stakeholders are keenly aware of the importance of corporate governance systems for safeguarding assets and ensuring minimum levels of performance. As more international capital is invested in South Africa and greater emphasis is placed on mitigating adverse social and environmental risks, the demand for sophisticated corporate governance systems is driven higher. The fact that the country’s most prominent organisations are also those which adhere to the King Codes (see also Chapter 4) and that South Africa is regarded internationally as a corporate governance thought leader increases the pressure to follow recommended practices. The more widely the King Codes are applied, the more likely it is that these are used to gauge how well organisations and their leaders have discharged their statutory and contractual duties and the extent to which have they have acted as good corporate citizens worthy of society’s continued support. At the internal level, it is likely that organisational characteristic such as firm size, the complexity of the business model and the industry in which the firm operates will have an impact on specific governance features. Examples include board size, the number of non-executives on a board and the number of board committees. This is in keeping with the general position that, as agency-related risks increase, more effective monitoring and control is required (Boone et al., 2007; Monem, 2013). Shareholder structure is an additional consideration. As is the case in other efficient or semi-strong efficient markets, active involvement by institutional investors may substitute for the monitoring provided by boards of directors. These investors will have a clear interest in minimising agency costs and have the resources and expertise to engage with and hold managers accountable for poor performance. In contrast, when block holdings increase, an independent system of checks and balances is required to mitigate the risk that shareholders act to reduce transparency and marginalise the interests of other stakeholders (see Grossman and Hart, 1983; McConnell and Servaes, 1990; Ferreira and Matos, 2008; Ntim et al., 2012b). Internal drivers work hand-in-hand with the attitude to and awareness of good governance. When managers understand corporate governance as adding value for stakeholders, the emphasis is on the spirit of codes of best practice, and corporate governance can have a positive effect on how organisations behave (see King and Atkins, 2016). This is especially true in the context of the approach followed by the King Codes. Rather than rely on an external regulatory model, a more flexible principles-based approach is followed. Companies are expected to evaluate their operating environment, engage with stakeholders and reflect on how governance mechanisms can be used to achieve legitimate objectives. The endorsement of good governance by powerful institutions (such as the JSE and the OECD), adds further impetus to the drive for improved governance practices. Good governance requires more than just detailed disclosure in an annual report. The appropriate management and operating systems must be in place to ensure effective monitoring and enable those charged with governance to provide strategic direction. This, in turn, requires a well-developed accounting system which is capable of

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producing the accurate, complete and reliable information necessary for decision making and high-quality reporting. Formal processes for engaging with stakeholders, identifying their concerns and responding to their legitimate expectations will also be required. Where necessary, internal and external assurance may be needed to ensure the integrity and to signal the quality of corporate reporting and the underlying governance structures. Not all companies will have the expertise and financial resources to support the level of proactivity required for corporate governance systems to operate optimally. At the same time, while King-IV is principles-based, the possibility of it being interpreted and applied as a compliance exercise cannot be precluded. Coupled with the fact that South Africa does not have the same levels of investor and other stakeholder activism as seen in developed economies, there will be some organisations which have not internalised the spirit of the King Codes and so adopt its recommendations only symbolically. For those who are able or are prepared to invest in more sophisticated corporate governance systems, international research points to numerous benefits. By lowering agency costs, reducing information asymmetry and enabling better direction and monitoring by managers, corporate governance can enhance manufactured and financial capitals. At the market level, examples include lower financing costs, higher credit ratings, better access to equity and debt providers and improved share price performance (see, for example, Brown and Caylor, 2006; Ammann et al., 2011). From an operational or business management perspective, stronger corporate governance can also enable better risk identification, robust internal control and more efficient resource utilisation (Gupta et al., 2008; Claessens and Yurtoglu, 2013). Where a system of checks and balances are in place, abuse of authority by those charged with an organisation’s governance becomes less likely. Non-executives, shareholders and other stakeholders can hold executives accountable for both financial and non-financial performance. Social and environmental matters – which would otherwise have been seen as “soft issues” – are actively managed and form part of what the IIRC (2013) and King-IV (IOD, 2016) describe as an integrated approach to directing and coordinating a business. As a result, companies which are well governed are better equipped to engage with and reduce the adverse impact of their business models on stakeholders (Yekini et al., 2015). This, in turn, reduces the risk of human capital depletion, exposure to legal liability and the adverse reputational implications of conflict with stakeholders (consider Bebbington et al., 2008; Claessens and Yurtoglu, 2013; Ntim and Soobaroyen, 2013b). Good governance can also be an effective means of differentiating an organisation from its competitors and attracting essential skills. It can enable a company to internalising environmental risks, explore innovative solutions to tackling social and environmental challenges and realise synergistic benefits from healthy stakeholder relationships (see García Sánchez et al., 2011; Van Zijl et al., 2017; McNally and Maroun, 2018).

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An organisation’s fiduciary duty is not only to shareholders but to a broader group of stakeholders (Rossouw, 2005; Jamali et al., 2008; King, 2018) with the result that it is compelled to ensure that its operations do not undermine the rights of current and future generations to satisfy their legitimate needs (IOD, 2016). At the same time, the King Codes do not ignore capital market imperatives. Good governance does not mean that a company has to forgo financial returns. On the contrary, the aim is to ensure that economic, environmental and social capitals are well managed so that stakeholders are able to benefit from the organisation in the short-, medium- and long-term. What is also clear is that companies cannot continue to understand society and environment as ancillary considerations. Perhaps the most important outcome of good governance is the realisation that neglecting so-called non-financial factors today can have dire consequences for tomorrow’s financial performance. Much of the prior research dealing with the determinants and benefits of good governance is based on international experience. What has been done on the South African situation is relatively dated and does not consider some of the most recent developments in King-III and King-IV. To address this problem, Chapter 4 deals with some of the key trends in South African governance practices and Chapter 5 provides preliminary evidence on possible drivers and outcomes of better corporate governance. The chapters deal specifically with the period from 2012 to 2017 to provide a more current account of South African corporate governance.

4 Trends in South African corporate governance International studies on corporate governance trends and whether or not specific governance practices impact on firm valuation and financial performance are numerous (see, for example, Klapper and Love, 2002; Coles et al., 2008; Aguilera and Cuervo‐Cazurra, 2009; Ararat et al., 2017; Pillai and Al-Malkawi, 2018). South Africa-specific studies are rarer. Andreasson (2011), Rossouw (2002; 2005) and West (2006; 2009) provide a conceptual review of early corporate governance developments drawing mainly on the country’s social, political and economic context to explain the emergence of King-I and changes introduced by King-II (see Chapter 3 for details). Few provide empirical evidence on how corporate governance has changed in South Africa during the 1990s and early 2000s. Ntim et al. (2012a; 2012b) are exceptions. They study South African corporate governance from 2002 to 2007. The conclusion is that, while compliance with the King Codes varies considerably, corporate governance improved over this period and had a positive effect on firm value. In a later study, spanning 2002 to 2009, Ntim and Soobaroyen (2013a) report that better-governed organisations are more socially responsible and that the combined effect of corporate governance and CSR initiatives contributes to stronger financial performance. This chapter complements the existing South African research by evaluating trends in the King Codes and changes in governance practices from 2012 to 2017. The chapter begins with a discussion of the composition of each King Code (Section 4.1) and the guidance provided on the function of the board of directors, the appointment of committees and the role played by auditors. The development of risk management practices, the relevance of stakeholder engagement and changes in the focus of corporate reporting are discussed. How King-I to King-IV address the importance of ethics is also considered. Section 4.2 deals with trends in corporate governance practices. A governance schematic, based on principles and practices outlined in King-III and King-IV is developed and used to assess how companies have been applying these codes. The emphasis is on the composition of boards of directors, the functions of committees of board and reporting on corporate governance practices to stakeholders.

4.1 Overview of the King Codes The King Codes have a comparable structure. Broadly, they include an introduction and background. All of the Codes have sections dedicated to boards of directors, different functional areas of corporate governance systems, communication and reporting and application guidance/appendices. The composition of each Code, based on pages dedicated to the respective topic, is shown in Figure 4.1. https://doi.org/10.1515/9783110621266-004

4.1 Overview of the King Codes

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King-IV

King-III

King-II

King-I 0% Introduction and background Boards and directors Governance functional areas Communication and reporting Other

20% King-I 4 16 10 4 40

40% King-II 16 28 44 28 169

60% King-III 24 45 30 14 29

80%

100% King-IV 35 18 10 3 62

Figure 4.1: Composition of the King Codes.

The introductions and backgrounds35 explain the rationale for introducing the Codes and outline their objectives. The aim is to provide context which assists with understanding the approach adopted by the King Committees and the different principles and practices. King-I to King-IV includes detailed discussions on the boards and directors (IOD, 1994; IOD, 2002; IOD, 2009; IOD, 2016). These cover the roles, responsibilities and composition of the board, the duties of individual directors and different board committees. Functional areas in the corporate governance system include, for example, the accounting, external auditing, internal auditing, risk management and compliance functions. The Codes are centred on the governance of risk (either implicitly or explicitly) which includes the identification of risk, the establishment of risk tolerance levels and the design and implementation of an appropriate response to material risks (IOD, 1994; 2002; 2009; 2016). All four documents deal with various aspects of communication and reporting to different extents. As discussed in more detail below, King-I is primarily concerned with financial reporting. King-II, III and IV turn their attention to providing more detailed accounts

35 In King-I, II and IV, this includes the preamble or foreword. King-III does not have a separate foreword.

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of economic, environmental and social performance (referred to as the triple-bottomline or triple context) in the form of sustainability or integrated reports (IOD, 2009; IOD, 2016). Finally, the Codes provide different levels of application guidance, usually in appendices. In the case of King-IV, this includes sector supplements which deal with the application of Code in different contexts (see Appendix D). To provide a better sense of the similarities and differences in recommended practices, we focus in more detail on the provisions of King-I to King-IV dealing with – boards of directors, – committees of the board, – auditors, – risk management, – stakeholders and reporting and – ethics.

4.1.1 The board of directors King-I recommends that a board of directors should provide appropriate monitoring and review and strategic direction for the organisation. To do this, the board of directors should establish a strategy which should include a review of the type of business activity which the company should and should not undertake. The implementation and subsequent monitoring of the strategy are emphasised, as well as the importance of the board of directors ensuring that the company acts ethically while executing its strategy. King-I suggests that the board of directors comprise an equal number of executive and non-executive directors. It defines a non-executive as “a director who is not involved in the day to day affairs or running of the business of the company as an employee of the company” (IOD, 1994, p. 11, Chapter 6.12). Non-executives should be “independent of management and, where possible, free from any business relationship with the company”, with the result that they “have no executive responsibility” (IOD, 1994, Chapter 6.16). The definition of a non-executive director in King-I implies that independence is preferred but not required (IOD, 1994, p. 12). An independent, non-executive director should be appointed to chair the board subject to the fact that skills shortages at the time could make this a challenge (IOD, 1994, p. 13). Consequently, instead of mandating an independent chair, King-I suggests that, in cases where the chair is not independent, there should be, at least, two non-executives on the board. Ideally, the chair should not be the chief executive officer. Directors should ensure that they have the time, skills and expertise to perform their respective duties and discharge their responsibilities to the company. Consistent with the Companies Act (1973), directors must act in the best

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interests of the company and owe a fiduciary duty to the company.36 Under KingI, non-executives have three primary roles: – to bring their expertise and knowledge to bear on the strategy, enterprise, innovations and the business planning of the company – to monitor and review the performance of executive management objectively – to assist in resolving conflicts of interest and bring balance of authority to the board Like King-I, King-II calls for a unitary board with a balance between executive and non-executive members. Ideally, the majority of the board should be made up of the latter. King-II addresses one of the primary criticisms of King-I by recommending that “a sufficient number” of non-executives should also be independent (IOD, 2002, p. 23). For this purpose, an independent director is a non-executive who: – “does not have the ability to control or significantly influence management; – has not been employed by the company, or the group, in any executive capacity for the preceding three financial years; – is not a member of the immediate family of an individual who is, or has been in any of the past three financial years, employed by the company or the group in an executive capacity and – is free from any business or other relationship which can be seen to materially interfere with the individual’s capacity to act in an independent manner”. (IOD, 2002, p. 25) An independent, non-executive director should serve as the chairperson. In the interest of ensuring a balance of power, the role of the chair of the board and the chief executive officer should be separated. King-III adopts a similar approach to King-II. It requires that the majority of directors should be appointed in a non-executive capacity (most of whom should be independent). In addition, at least two executive directors – the CEO and director responsible for the company’s financial affairs (Chief financial officer (CFO)) – should serve on the board of directors (IOD, 2009). The Code provides guidance on the rotation of directors, precludes non-executives from participating in share option schemes and suggests that a company’s memorandum of incorporation should allow for the removal of the CEO without necessarily having shareholders’ approval.37 The characteristics of an independent director in King-III are consistent with those in King-II, except that King-III also requires a company to consider the number of other board appointments which each non-executive director holds as well

36 The Companies Act (2008) retained this. 37 The modification to the memorandum of incorporation would be required in terms of the Companies Act (2008).

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as each non-executive director’s indirect or direct interest in the company (IOD, 2009, Principle 2.18). To bolster accountability of the board, its performance should be formally and regularly reviewed. Shareholders should be involved in the approval of directors’ remuneration, and a remuneration policy should be tabled at a general meeting for a non-binding advisory vote by the shareholders (IOD, 2009, Principle 2.27).

4.1.2 Committees of the board King-I recommends that affected corporations form an agenda and an executive committee. The agenda committee is established to communicate minority interests and should have a minority representative. This was important given concentrated ownership of JSE-listed companies in the mid-1990s (see Rossouw et al., 2002; Armstrong et al., 2005; Vaughn and Ryan, 2006). The executive committee could be established to meet more often than the board and assist with the monitoring and control of management decisions (IOD, 1994, Chapter 11). In contrast to the subsequent King Codes, King-I takes a firm stance against the establishment of a nominations committee stating that it is the board’s responsibility to appoint members and that this duty should not be delegated. Concerning remuneration, King-I recommends the establishment of a remuneration committee, comprising mainly of non-executives. A company’s annual report should provide full disclosure of director remuneration with a breakdown of amounts paid to directors as salaries, directors’ fees, pensions, bonuses, and perquisites.38 King-II is more specific about the types and functions of committees of the board than was King-I. It recommends the formation of, at least, an audit and a remuneration committee both of which should be comprised mainly of and chaired by independent non-executives. The board may form any other committees as it sees fit including, for example, a risk and nominations committee. Although King-I was opposed to the establishment of a nominations committee, King-II acknowledges that this committee can enhance an organisation’s corporate governance (IOD, 2002, Chapter 5). On the matter of director remuneration, King-II recommends the establishment of a remuneration committee comprising entirely or mainly of independent non-executives. The membership of the committee should be disclosed in the annual report. King-II retains the disclosure requirements of King-I. It also calls for the remuneration policy to be developed transparently and to be consistent with the organisation’s remuneration ethos. Additionally, King-II suggests that a

38 This would need to be applied in conjunction with Schedule A to the Companies Act (1973) which prescribed detailed disclosures of director remunerations applicable for both executive and non-executive directors.

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substantial portion of the total remuneration of executive directors should be performance-based and that share options can be granted to non-executive directors, subject to approval from shareholders. In terms of the committees of a board, King-III extends on King-II which recommended the establishment of, at least, an audit and a remuneration committee. King-III also recommends the establishment of a risk, remuneration, nomination and IT steering committee. King-III reiterates that the committees do not absolve the board from their responsibilities (IOD, 2009, Chapter2). The committees established, with the exception of the risk committee, should comprise of members of the board and should have a majority of non-executive directors. The majority of the non-executive directors serving on these committees should be independent. Additionally, independent non-executive directors should chair these committees (IOD, 2009, Chapter 2).

4.1.3 Risk management Unlike the earlier Codes, King-III introduces risk management as a specific element of the governance model (IOD, 2002; Ntim et al., 2012b). Chapter 4 of the Code requires the board to accept responsibility for the governance of risk (IOD, 2009, Principle 4.1) determining risk tolerance levels (IOD, 2009, Principle 4.2) and monitoring the risk management process (IOD, 2009, Principles 4.3–4.8). King-III defines “risk” as “uncertain future events that could influence the achievement of a company’s objectives” (IOD, 2002, p. 73, Chapter 1.2). Risks are classified as financial or non-financial. Financial risk is defined generally as possible losses in the financial markets which are largely internal and monetary. Nonfinancial risks are external and non-monetary. They have indirect and longer-term effects on corporate assets and liabilities (IOD, 2002). Risk management is concerned with the identification and evaluation of actual and potential risk areas as they pertain to the company as a total entity, followed by a process of either termination, transfer, acceptance (tolerance) or mitigation of each risk. (IOD, 2002, p. 73, Chapter 1.4)

The board of directors is ultimately responsible for the organisation’s risk management and should form an opinion on the effectiveness of the policies, processes and systems used to identify, assess and mitigate risks. Management is accountable to the board for designing and implementing risk management policies (including a system of internal controls) and incorporating risk management practices in the organisation’s day-to-day operations (IOD, 2002, Chapter 1). A risk management committee, consisting of executive and non-executive directors and chaired by an independent non-executive director, should be formed to review the risk management

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process on an ongoing basis. Given the growing importance of IT, King-III proposes that material systems, processes and databases should be governed at the board level as part of the overall approach to risk management. This includes ensuring the alignment of IT functions with business objectives and sustainability issues (IOD, 2009 Principle 5.1).

4.1.4 Auditors and audit committees King-I deals with the importance of the audit of financial statements as “part of the checks and balances” required for an effective system of corporate governance (IOD, 1994, p. 18, Chapter 13). The Code frames audit in terms of accountability to shareholders and focuses on the importance of auditor independence. It also touches on the role of practice reviews by the SAICA to ensure compliance with auditing standards and the establishment of a review panel which would examine published financial statements for compliance with generally accepted accounting practice (IOD, 1994, p. 18).39 In addition to the audit of financial statements, King-I calls for interim reports be subject to review by the external auditor and for the directors’ report to include a clear statement on a company’s ability to continue as a going concern (IOD, 1994). In addition to appointing an external auditor, King-I encourages affected organisations to establish a well-resourced internal audit function with suitable standing. Internal audit can be tasked with – reviewing “the reliability and integrity of financial and operating information”, the processing of that information and the systems of internal controls designed to ensure compliance with internal policies, laws and regulations and any generally accepted best practices, – reviewing the controls/processes for safeguarding assets and verifying their existence, – appraising “the economics and efficient management of the company’s financial, human and other resources and the effective conduct of its operations” and – reviewing “operations and programmes to ascertain whether or not results are consistent with established objectives and goals and whether or not the operations are being carried out as planned”. (IOD, 1994, p. 21, Chapter 14)

39 The GAAP Monitoring Panel was subsequently established by the JSE and SAICA in 2002. It was superseded by the Financial Reporting Investigations Panel during 2011 (for details, see Lowe and Maroun, 2016; Flowers, 2019).

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Finally, given the importance placed on internal controls and assurance, King-I calls for the establishment of an audit committee which is responsible for reviewing, inter alia, the appropriateness of the financial statements, the effectiveness of external and internal audit and the operation of management information systems (IOD, 1994, Chapter 13). An audit committee should be comprised primarily of nonexecutives who have the necessary expertise to perform an effective monitoring and review function (IOD, 1994, p. 20). King-II continues to identify external audit as a cornerstone of the corporate governance system. Guidance is provided on the performance of non-assurance services by the external auditor including the role played by audit committees in assessing and setting principles for using the external auditors to provide nonaudit services. A detailed description of the services rendered by the external auditor to the firm should be included in the annual financial statements (IOD, 2002, Chapter 5). Recommendations for interim reports to be independently reviewed, for the directors to comment on their company’s ability to continue as a going concern and for the formation of an audit committee to enhance the governance and control environment were retained (IOD, 2002, p38). King-II is more explicit about the scope of internal audit which it defined as including risk management, financial and operating control and “evaluating and recommending improvements to processes” which ensure that governance objectives are achieved (IOD, 2002, p. 90). Under King-II, internal audit should provide – “assurance that the management processes are adequate to identify and monitor significant risks; – confirmation of the effective operation of the established internal control systems; – credible processes for feedback on risk management and assurance and – objective confirmation that the board receives the right quality of assurance and information from management and that this information is reliable”. (IOD, 2002, p. 90, Section 3) As an indication of a more integrated logic when it came to assurance, King-II recommended that internal audit should be used to complement the work of the external auditors and that management should encourage the consultation and collaboration between the two assurance providers (IOD, 2002, p. 129). King-II pays particular attention to the role of the audit committee. Audit committees should comprise predominantly of independent non-executives and members who are financially literate. The chair of the audit committee should be independent and should not also chair the board of directors (IOD 2002, p39). An audit committee’s responsibilities can include, among other things: – a review of the risk management process, including internal controls, and significant risks facing the organisation (IOD, 2002, pp. 75 & 130)

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– overseeing the standing, operation and organisation of the internal audit function (IOD, 2002, p. 86) – reviewing the accuracy of financial information used for internal management or reported to stakeholders (IOD, 2002, p. 130) – dealing with any accounting or auditing concerns, compliance with laws and regulations and the use of internal and external audit services (IOD, 2002, p. 130) – reviewing the nature of non-audit services provided to the firm by its external auditors and ensuring that there is adequate disclosure of these services (including the fee charged) in the annual financial statements (IOD, 2002, p. 130) The guidance in King-III dealing with the members of an audit committee mirrors the provisions of the Companies Act (2008). In terms of the legislation, shareholders of the company must appoint the audit committee at a general meeting. The audit committee should consist of at least three members of which none should be involved in the day-to-day activities of the entity (Companies Act, 2008). King-III also requires that all members be independent (IOD, 2009). Many of the core principles and recommendations in King-I and King-II dealing with the responsibilities of audit committees, external auditors and the internal audit function are retained by King-III. Several changes were also introduced. To ensure that it discharges its responsibilities for the governance of risk, the board must obtain assurance regarding the effectiveness of risk management policies and practices and should ensure that there are processes in place enabling complete, timely, relevant, accurate and accessible risk disclosure to stakeholders (IOD, 2009, Chapter 4). A risk-based internal audit function which is embedded as part of the risk management framework plays a key role in this regard (IOD, 2009; Forte and Barac, 2015). Under King-I and King-II, internal audit was seen as primarily concerned with compliance. Under King-III, internal audit must consider if “controls are effective in managing the risks which arise from the strategic direction that a company, through its board, has decided to adopt” (IOD, 2009, p. 15). Importantly, internal audit is not concerned only with financial statements and related controls. Detailed monitoring and reporting by management, the work of internal audit and findings from the external auditor are mutually reinforcing and provide what King-III refers to as a “combined assurance” over the effectiveness of the risk management process and, as discussed in Section 4.1.5, the organisation’s integrated report (IOD, 2009, Principle 4.9). (Combined assurance is covered in more detail in Chapter 6).

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4.1.5 Stakeholders and reporting When King-I was released, South Africa was yet to adopt IFRS and accounting standards being applied at the time did not have direct legal backing.40 King-I discusses the inherent subjectivity involved when preparing financial statements and stresses the need for financial statements to be clear and understandable. It also discusses the importance of the annual general meeting as an opportunity for shareholders to engage with and hold directors accountable (IOD, 1994, p. 17). Details on improving financial reporting are contained in Chapter 13 of King-I (which deals with auditing). Recommendations include, for example: – the use of an audit committee to oversee the integrity of the financial statements (as discussed above) – high quality internal and external audit services – requiring directors to disclose in the financial statements (as part of the directors’ report) whether or not there are reasons to believe that the company will not continue as a going concern – encouraging directors to report on the effectiveness of internal financial controls with the auditors confirming the appropriateness of this report – developing high-quality financial reporting standards which have appropriate legal backing and – the formation of an independent review body to monitor the quality of financial statements prepared by listed companies41 (IOD, 1994, Chapter 5 & Appendix IV) Despite an explicitly stated objective to serve the interests of stakeholders,42 King-I did not have a separate principle or chapter dealing specifically with sustainability or integrated reporting. Chapter 12, focusing on stakeholder communication, states “information directed to all stakeholders, and not only shareholders, should be part of the non-statutory section of the financial statements” (IOD, 1994, p. 17). This report could include: – details on “employment, such as staff training levels, skills levels, new jobs created, retrenchments, affirmative action policy, unionisation, training programmes, etc.”

40 IFRS was formally adopted in South Africa in 2002. The Companies Act (2008) specifies which companies are required to use IFRS for the purpose of preparing general purpose financial statements. 41 This would subsequently be done by the JSE, in partnership with the SAICA (Lowe and Maroun, 2017). 42 King-I identifies three groups of stakeholders: shareholders, parties who contract with the company and parties who have a non-contractual relationship with the company.

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– “Environmental matters, such as planned pollution control, the environs of the business itself, etc.” – “Social responsibility activities or programme and any large donations” – “Customer interest matters”. (IOD, 1994, p. 17) Many of these disclosures are commonplace in current sustainability reporting, but the guidance provided on ESG disclosures is a far cry from the detailed frameworks which would be developed by the GRI and IIRC in later years. Section 4 of King-II is dedicated to “integrated sustainability reporting” and defines sustainability as ensuring that an organisation balance[s] the need for long-term viability and prosperity – of the enterprise itself and the societies and environment upon which it relies for its ability to generate economic value – with the requirement for short-term competitiveness and financial gain. (IOD, 2002, p. 91)

In line with the approach taken by the GRI (2016), King-II recognises that compromising longer-term prospects purely for short-term benefit is counterproductive. A balance must be struck and failure to do so will prove potentially irreparable, and have farreaching consequences, both for the enterprise and the societies and environment within which it operates. Social, ethical and environmental management practices provide a strong indicator of any company’s intent in this respect. (IOD, 2002, p. 91)

The Code introduces the idea of the “triple bottom line” or economic, social and environmental performance to South African corporate governance. In keeping with the stakeholder model in King-I, King-II stresses the need for organisations to see themselves as an integral part of society and to appreciate that economic gains cannot be realised while compromising on social and environmental imperatives (IOD, 2002, Section 4, Chapter 1).43 In this way, while the board of directors owes a fiduciary duty to the company and is accountable to shareholders (see Companies Act, 1973), it cannot ignore other stakeholders: The inclusive approach advocated in [King-II], recognises that stakeholders such as the community in which the company operates, its customers, its employees and its suppliers, amongst others, need to be considered when developing the strategy of a company. The inclusive approach requires that the purpose of the company should be defined, and the values by which the company will carry on its functions should be identified and communicated to all stakeholders. The stakeholders relevant to the company’s business should also be identified. These factors must be integrated into the strategies developed for the company for it to achieve its goals. (IOD, 2002, p. 98)

43 This is framed in terms of the African philosophy umuntu ngumuntu ngabantu or “I am because you are; you are because we are”

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Drawing on guidance being developed by the GRI at the time, King-II recommends that effective communication with stakeholders involves a three-stage process. The company should explain which codes of practice and sustainable development principles have been adopted and the extent of compliance. Implementation of recommended practice is dealt with in the second stage. This is followed by a postimplementation review and an explanation of resulting changes to policies and actions (IOD, 2002, Section 4, Chapter 2). King-II refers to several guidelines which can assist with stakeholder engagement and sustainability reporting and management. They are also elaborated in the supporting appendices to King-II. Examples include the guidance published by the GRI, ISO 900044 and ISO 14000,45 In addition, King-II goes into detail on the importance of safety, health and the environment (IOD, 2002, Section 4, Chapter 4) managing social considerations (IOD, 2002, Section 4, Chapter 5) and the relevance of human capital (IOD, 2002, Section 4, Chapter 6). Examples of recommended practices include: – integration of safety, health and environmental management principles in business activities and processes – investment in local communities and skills development; – a committed effort to reduce adverse social and environmental impacts and – reporting at least annually on sustainability practices with a focus on key issues for South Africa such the AIDS pandemic,46 BEE47 and promotion of gender equality (IOD, 2002, pp. 121–123) Significant developments in sustainability management and reporting took place in the years after the release of King-II. This includes, for example, the publication of the Global Compact and Principles for Responsible Investment by the United Nations. The GRI-G2 guidelines were published in 2002 followed by GRI-G3 in 2006 (GRI, 2015). In 2007, amendments to UK company law which require directors to consider social and environmental impacts in their decision-making processes came into effect (IOD, 2009). This coincided with regulatory developments in several developed economies,

44 ISO 14000 is a part of standards related to environmental management which exists to help organizations minimize how their operations negatively affect the environment, comply with applicable laws, regulations, and other environmentally oriented requirements and to continually improve in the above. 45 ISO 9000 is part of quality management systems standards which is designed to help organizations ensure that they meet the needs of customers and other stakeholders while meeting statutory and regulatory requirements related to a product or service. 46 At the time of King-II, South Africa was struggling to deal with the rapid transmission of HIV and treatment of people suffering from AIDS-related illnesses. At the time of completing this research, South Africa still ranked among the countries worst affected by HIV/AIDS. 47 This includes statutory and non-statutory measures being taken to assist South Africans who were not able to participate in the formal economy under Apartheid.

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such as France, Japan and Australia, which required listed companies to report on social and environmental issues (Mock et al., 2013; KPMG, 2017). A key limitation of sustainability reporting is that it can be applied superficially, rather than as part of a genuine commitment to and drive for sustainable development and good corporate citizenship (see, for example, Milne et al., 2009; Tregidga et al., 2014; Atkins and Maroun, 2018). As a result, King-III requires those charged with leading an organisation to “make sustainability issues mainstream” and, as part of this, recognise that “strategy, risk, performance and sustainability are inextricably intertwined” (IOD, 2009, p. 12). This has several important implications: – While King-I refers to the importance of stakeholders in corporate governance, it frames corporate governance in terms of mitigating agency costs arising from the separation of the owner and management functions (see IOD, 1994, p5). As a result, it may be argued that there is an enlightened shareholder sentiment, rather than a fully-developed stakeholder logic. A possible interpretation is that the stakeholder, while important, is ultimately secondary to shareholder and their interests should be evaluated in terms of the benefits for providers of financial capital (consider Kakabadse and Korac-Kakabadse, 2001; Rossouw, 2005; Vaughn and Ryan, 2006). In contrast, King-III makes it clear that “the board of directors considers the legitimate interests and expectations of stakeholders on the basis that this is in the best interests of the company, and not merely as an instrument to serve the interests of the shareholder”. Consequently, the shareholder does not automatically rank above other parties with an interest in the organisation, the broader society or the environment (IOD, 2009, p. 13). – In South Africa’s stakeholder-centric environment, the board of directors should appreciate how stakeholders perceive the organisation can affect its reputation (IOD, 2009, Principle 8.1). Whether or not stakeholders accept an organisation as a legitimate part of society will affect its performance and, in turn, its ability to continue as a going concern (see also O’Donovan, 2002; De Villiers and Maroun, 2018). As a result, the company should proactively manage its relationships with its stakeholders; promote constructive stakeholder engagement and effective resolution of disputes; strive to achieve the correct balance among stakeholder groups; ensure equitable treatment of shareholders and promote mutual respect among the company and its stakeholders (IOD, 2009, Principle 8.2–8.6). – Managers and directors cannot understand and assess value in financial terms only. Companies need to focus on integrated performance and realise that business decisions can involve a trade-off between accounting profits and the impact on society and the environment. The objective of the board of directors is to encourage a holistic approach to manage the business and avoid the use of performance incentives which lead to short-term financial gains to the detriment of long-term sustainability (IOD, 2009, pp. 12–13). – Financial statements play an important role in reducing information asymmetry and facilitating capital allocations. Financial statements alone are, however,

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insufficient. They are focused on historic information and deal only with financial capital. Similarly, sustainability reporting provides information on important ESG issues but does not provide financial context. As a result, “sustainability reporting and disclosure should be integrated with the company’s financial reporting” (IOD, 2009, Principle 9.2). – As discussed in more detail in Chapter 6, the internal and external audit functions cannot focus on financial controls and financial statements only. Assurance needs to ensure the integrity of the risk management process, aid with the monitoring of integrated performance and ensure the integrity of the integrated report (IOD, 2009, Principle 9.1 & 9.3).

4.1.6 Ethics Unlike the recommendations which apply to “affected organisations”, the provisions of King-I dealing with ethics are applicable to all organisations. King-I articulates business ethics in terms of a formal and informal relationship between an organisation and its stakeholders, characterised by rights, obligations and the importance of trust. The aim is to ensure that the company and its stakeholders deal with one another in good faith (IOD, 1994 p. 24–25). King-I advocates for the board of directors to “determine the moral and ethical climate of the business” and develop a code of ethics which is interpreted and applied throughout the firm (IOD, 1994, p. 24). Similar to King-I, King-II stresses the importance of establishing a culture of ethics and tasks the board of directors with developing codes to guide ethical business practice. These need to take prevailing laws and regulations into account but must also be mindful of South Africa’s cultural diversity and the implications which this has for differentiating between acceptable or unacceptable conduct. For this reason, King-II recommends that stakeholders be engaged while developing ethics standards which should deal with – responsibilities to shareholders and the financial community (such as preventing insider trading or financial conflicts of interests), – relationships with customers and suppliers, – employment practices (including, for example, occupational health and safety and preventing discrimination) and – responsibilities to the broader community (including the mitigation of adverse social and environmental impact). (IOD, 2002, Section 4, Chapter 3) While the board of directors is ultimately responsible for an organisation’s culture of ethics, other stakeholders have a role to play in ensuring ethical business practice. In particular, managers, employees and parties contracting with the firm need to be aware of and ensure that they adhere to a company’s code of ethics.

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King-III signals the importance of ethics by identifying it as the first set of principles. Following a similar approach to King-II, the board of directors is expected to promote ethical leadership and a culture of ethics at the organisation (IOD, 2009, Principle 1.1). This includes taking steps to ensure that the company acts as, and is also accepted as being, a good corporate citizen (IOD, 2009, Principle 1.2). Risks to the organisation’s ethics and reputation as a good corporate citizen should be identified and managed. The board of directors should lead by example and provide direction to the organisation’s members by overseeing the development and enforcement of a code of conduct which can be applied as part of day-to-day operations (IOD, 2009, Principle 1.3).

4.1.7 Alternative dispute resolution and business rescue As discussed in Chapter 2, the King Committee was mindful of developments in international corporate governance and changes to South African company law taking place from 2002 to 2008. This saw the introduction of alternative dispute resolution (ADR) and business rescue processes in King-III. Litigation is not always the best means of resolving disputes. As part of its overall duty to act in the best interests of the company, the board should ensure an effective and efficient resolution of disputes through mediation. Similarly, the possibility of rescuing economically viable companies experiencing financial difficulties rather than defaulting to the liquidation of the business can avoid a loss of shareholder and other stakeholder value. As a result, King-III requires that directors should be aware of the practicalities of business rescue.

4.1.8 King-IV practices The recommended practices in King-IV are very similar to those in King-III. Table 4.1 deals with some of the recommended practices in King-IV. It is not intended to be exhaustive.

4.2 Trends in corporate governance practices In this section, we consider changes in specific corporate governance practices by the top 40 companies listed on the JSE from 2012–2017.48 We focus specifically on – the composition of the board of directors (Section 4.2.1)

48 Based on market capitalisation

4.2 Trends in corporate governance practices

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Table 4.1: Emerging trends in corporate governance. Feature

Discussion

Boards of directors and committees of the board

The Code gives guidance on the composition of governing bodies and their committees. The aim is to ensure a balance of power and that the governing body has the collective skills, expertise and independence to discharge its leadership responsibilities. Committees referred to specifically by King-IV include: – Audit committees – Risk committees – Nomination committees – Remuneration committees – Social and ethics committees The functions of these committees are discussed in detail in Chapter 4 (Section 4.2.2). Additional guidance is given on the delegation of responsibility and authority by the board to its committees and members of management.

Combined assurance

King-IV reiterates the importance of combined assurance. It explains how internal and external sources of assurance are an integral part of the organisation’s governance of risk and are essential for ensuring the integrity of information reported to stakeholders. This is discussed in more detail in Chapter .

Governance of risk

As in King-III effective risk management, including risks associated with IT, is a focal point. King-IV frames risk in terms of the uncertainty of future events, their likelihood and impact. It requires the entity to assess the positive and negative implications of uncertain events.

Integrated reporting

Companies are encouraged to prepare an integrated report either as a stand-alone report or as separate and distinguished part of another report. The report should be easily available to stakeholders and will include suggested disclosures on an organisation’s governance practices as recommended by King-IV.

Ethics

Ethics remains a defining feature of King-IV and is covered as part of the first three principles. The guidance is largely consistent with what was included in King-III.

Stakeholder activism

While King-III referred to the importance of institutional investors for holding organisations accountable, King-IV takes this further by specifically referring to the duties of these stakeholders as a separate principle. Grounded in the position that institutional investors owe a fiduciary duty to their principals, they are expected to engage actively with an organisation and incorporate ESG indicators in their investment appraisal processes (IOD, , Principle ).

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– the function of the committees of the board (Section 4.2.2) and – corporate governance disclosures in annual, integrated and sustainability reports (Section 4.2.3). The results presented below are intended to provide a sense of how select corporate governance practices have changed over the specified period. This coincides with the release of the IIRC’s framework on integrated reporting (2013) and the publication of King IV (2016). The JSE has also made revisions to its listing requirements (see JSE, 2012; JSE, 2013; JSE, 2016; JSE, 2017) The extent to which each of these developments has contributed to changes in specific governance practices is deferred for future research.

4.2.1 Composition of boards of directors King-IV stresses the importance of diversity in the governing body across a variety of attributes relevant for promoting better decision-making and effective governance, including field of knowledge, skills and experience, as well as age, culture, race and gender. (IOD, 2016, Principle 7, para 10)

To promote this diversity, King-IV recommends setting targets for race and gender representation (IOD, 2016, Principle 7, para 11). The board should develop a succession plan and have rotation of members to “invigorate its capabilities by introducing members with new expertise and perspectives” while ensuring continuity of the board and the retention of essential skills and experience (IOD, 2016, Principle 7, para 12–13). To evaluate the application of these principles, the researchers examined the composition of the boards of directors of the specified sample of companies. Results are presented below. Figure 4.2 shows that from 2012 to 2017 approximately 81% of directors are male. Only 19% of directors are female although there is a slight upward trend in the number of female directors, particularly from 2016 to 2017. Male directors have an average age of 58. They are slightly older than their female counterparts whose average age is 51. Female directors have an average tenure of 5 years, compared to 7 years for male directors. These results are consistent with Willows and van der Linde (2016) who find that the boards of directors of South Africa’s largest listed companies are male-dominated. Figure 4.3 provides additional information on the gender-age profile. The majority of male and female directors are over the age of 45. Male and female directors under the age of 45 account for just under 8% and 5% of the total number of directors respectively. In this age category, female directors account for 37% of the total number of directors, compared to 16% in the over-45 age bracket. This suggests that, while the majority of directors are men, as younger members join the board, a larger number of these are women.

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70.00

100% 90%

60.00 80%

Proportions

50.00

70% 60%

40.00

50% 30.00

40% 30%

20.00

20% 10.00 10% -

2012

2013

2014

2015

2016

2017

Proportions - Female

18%

17%

19%

19%

19%

23%

Proportions - Male

82%

83%

81%

81%

81%

77%

Average of Age - Female

50.84

51.07

51.19

51.49

51.68

50.85

Average of Age - Male

57.39

57.79

57.54

58.17

58.91

56.54

Average service - Female

4.77

4.64

4.41

4.50

4.74

4.74

Average service - Male

7.15

7.08

6.63

6.70

7.67

7.45

0%

Figure 4.2: Directors by age, tenure and gender.

100.00% 90.00% 80.00%

Proportions

70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00%

2012

2013

2014

2015

2016

2017

45 or older - Male

74.53%

75.11%

72.41%

73.81%

74.37%

68.25%

45 or older - Female

12.79%

12.56%

14.56%

14.97%

14.12%

16.51%

Under 45 - Male

7.48%

7.99%

9.07%

6.84%

6.95%

9.21%

Under 45 - Female

5.20%

4.34%

3.96%

4.39%

4.56%

6.03%

Figure 4.3: Director age profile by gender.

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In terms of race, most directors are Caucasian (average = 68%) with a downward trend from 2012 (70%) to 2017 (66%). African directors account for just under a quarter of the total (average = 23%) with Indian, Mixed and Asian directors holding less than 10% of the seats at boardroom tables (see Figure 4.4). 100.00% 90.00% 80.00%

Proportions

70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Asian Mixed Indian African Caucasian

2012 0.73% 2.71% 4.99% 21.96% 69.61%

2013 0.57% 2.05% 5.59% 22.03% 69.75%

2014 0.77% 2.18% 5.64% 22.69% 68.72%

2015 0.52% 2.71% 6.32% 21.55% 68.90%

2016 0.79% 2.72% 5.89% 21.18% 69.42%

2017 1.15% 2.30% 6.39% 24.08% 66.07%

Figure 4.4: Directors by race.

Figure 4.4 should not be interpreted as companies neglecting to take steps to ensure their boards’ racial diversity. The absence of a dramatic change in the composition of boards can be attributed to the fact that South Africa has, traditionally, suffered from a shortage of skills (IOD, 1994; King, 2018). There is a limited number of individuals with the necessary experience to provide the required level of monitoring and strategic direction envisaged by the King Codes (IOD, 1994; 2002). This is especially true when considering that Apartheid-era policies would have excluded the majority of South Africans from tertiary institutions and the formal economy. As a result, we classify the directors by age and race to control for the removal of racial discrimination post-1990. Refer to Figure 4.5.

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100% 90% 80%

Proportions

70% 60% 50% 40% 30% 20% 10% 0% ACI Caucasian

2012 50% 50%

2013 47% 53%

2014 47% 53%

2015 51% 49%

2016 46% 54%

2017 52% 48%

Figure 4.5: Directors under the age of 45 by race.

Figure 4.5 shows that Caucasians and non-Caucasians (or ACI49) are approximately evenly represented with a slight upward trend from 2012 to 2017 in the number of non-white directors. This suggests that, as older directors retire or step down from a board, incoming members are more likely to be younger and non-Caucasian (see also Figure 4.3). In other words, companies are retaining experienced directors and meeting diversity targets by recruiting new directors from under-represented groups as board vacancies occur. Moving from race and gender, Figure 4.6 shows the proportions of executive and non-executive directors serving on companies’ boards. As recommended by King-IV (IOD, 2016, Principle 7, para. 8) and King-III (IOD, 2009, Principle 2.18), the majority of companies’ directors are non-executives. The proportion of non-executives remains relatively constant from 2012 (72%) to 2017 (74%). Of the non-executives, most are independent (77%). In total, more than half of directors (56%) are classified as independent. Figure 4.7 shows the directors’ areas of expertise. Most have qualifications in accounting and finance (54%) including, for example, chartered accountancy, financial management and taxation. Directors with science and engineering or legal qualifications account for 15% and 11% of the total respectively. The former tend to be most common in the mining, petrochemicals and industrial sectors. Approximately 6% of the directors have an arts or humanities background. Two percent come from the medical field while only 1.8% are multi-disciplinary in the sense that they hold formal qualifications in two or more disciplines.

49 African, coloured and Indian (ACI) is a commonly used categorisation for distinguishing between European and non-European racial groups.

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100.00% 90.00% 80.00%

Proportions

70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00%

2012

2013

2014

2015

2016

2017

Non executive - Independent

56.26%

54.64%

55.26%

54.87%

57.61%

57.88%

Non executive - Not independent

16.07%

19.90%

16.49%

16.00%

18.11%

16.47%

Executive

27.66%

25.45%

28.25%

29.13%

24.28%

25.65%

Proportions

Figure 4.6: Executive v non-executive.

100.00% 90.00% 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00%

Multi-disciplinary Medical Economics and business management Business administration and management Arts and humanities Legal Science and engineering Accounting and finance

2012 0.75% 1.71% 4.39% 5.67% 7.39% 10.81% 15.95% 53.32%

2013 2.73% 2.13% 5.57% 4.62% 6.52% 11.97% 15.76% 50.71%

2014 1.30% 2.33% 4.54% 5.84% 7.65% 10.64% 13.75% 53.96%

2015 1.07% 2.26% 5.46% 6.26% 6.39% 11.32% 13.98% 53.26%

2016 3.31% 2.13% 6.85% 4.84% 4.84% 9.21% 14.52% 54.31%

2017 1.65% 1.87% 3.53% 5.62% 5.40% 9.37% 15.10% 57.44%

Figure 4.7: Directors’ areas of expertise.

As shown in Figure 4.8, the range of skills between the executive and nonexecutive directors is approximately consistent. In particular, accounting and finance, science and engineering and legal qualifications are the most common for both types of directors.

4.2 Trends in corporate governance practices

87

70.00% 60.00%

Percentages

50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Accounting and finance Science and engineering Legal Arts and humanities Business administration and management Economics and business management Medical Multi-disciplinary

Executive 60.30% 14.24% 9.82% 2.51% 5.54% 4.35% 1.55% 1.70%

Non-executive 51.53% 15.16% 10.77% 7.78% 5.45% 5.26% 2.22% 1.82%

Figure 4.8: Expertise of executive and non-executives.

60.00%

Percentages

50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Accounting and finance

Caucasian 57.16%

ACI 46.73%

Science and engineering

15.83%

12.88%

Legal

10.05%

11.56%

Arts and humanities

3.84%

11.81%

Business administration and management

5.34%

5.72%

Economics and business management

4.94%

5.21%

Medical

1.21%

3.89%

Multi-disciplinary

1.62%

2.20%

Figure 4.9: Expertise of directors by race.

Directors with backgrounds in accounting and finance or science and engineering continue to be most common when comparing qualifications by race groups (see Figure 4.9). In total, these make up 73% and 60% of the Caucasian and ACI groups

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respectively. The main difference is in arts and humanities which account for approximately 12% of ACI directors’ qualifications compared with just under 4% for Caucasian directors. There are slightly higher proportions of ACI directors with backgrounds in medicine, economics, and business management and administration. Approximately 2.2% of ACI directors have multi-disciplinary qualifications compared to 1.6% for Caucasian directors. Finally, we consider expertise by gender. Figure 4.10 shows that accounting and finance are the most common qualifications for both male and female board members. Backgrounds in science and engineering are more prominent among male directors while more female directors have legal or arts and humanities qualifications than male directors. 60.00%

Percentages

50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Accounting and finance Science and engineering Legal Arts and humanities Business administrationand management Economics and business management Medical Multi-disciplinary

Female 47.31% 9.24% 14.87% 13.78% 4.20% 5.29% 3.78% 1.51%

Male 55.55% 16.42% 8.71% 4.70% 5.91% 5.18% 1.54% 2.00%

Figure 4.10: Expertise of directors by gender.

4.2.2 Functions of the committees of the board King-IV does not mandate the formation of specific committees of the board. The governing body should determine if and when to delegate particular roles and responsibilities to an individual member or members of the governing body, or to standing or ad hoccommittees. The exercise of judgement by the governing body in this regard, is subject to legal requirements and should be guided by what is appropriate for the organisation and achieving the objectives of the delegation. (IOD, 2016, Principle 8, para 39)

Similarly, the Companies Act (2008), allows a board of directors to appoint “any number of committees of the board” and to “delegate to any committee any authority

4.2 Trends in corporate governance practices

89

of the board”50 (s72(1)). Barring some exceptions, the establishment of an audit committee is, however, mandatory for public companies51 (Companies Act, 2008, s94(2)) and is recommended as “a matter of leading practice” for any company which “issues audited financial statements” (IOD, 2016, Principle 8, para 55). Audit committees The Companies Act (2008) prescribes the following duties for an audit committee: – to nominate the company’s external auditor and ensure that the external auditor’s appointment complies with the relevant legislation – to determine the fees to be paid to the auditor and the terms of the audit engagement; – to determine and pre-approve where applicable, the nature and extent of any non-audit services provided by the external auditor – to prepare a report commenting on the company’s financial statements, accounting policies and internal controls, describing how the audit committee discharged its duties and explaining whether or not the audit committee is satisfied that the external auditor is independent – to receive and deal with any concern or complaints concerning the company’s accounting practices, internal auditor, the content and audit of the company’s financial statement, internal financial controls and any related matters – to make submissions to the board “on any matter concerning the company’s accounting policies, financial control, records and reporting” – “to perform such other oversight functions as may be determined by the board” (Companies Act, 2008, s94(7)) These duties are consistent with those outlined by King-IV which tasks an audit committee with providing independent monitoring and review of the effectiveness of an organisation’s assurance functions and services; the sound operation of the company’s finance function and the “integrity of the financial statements” and other external reports to stakeholders (IOD, 2016, Principle 8, para 51–52). This will require the audit committee to “oversee the management of financial and other risks which affect the integrity of external reports issued by the organisation” (IOD, 2016, Principle 8, para 51–52). The board of directors should delegate the responsibility for the organisation’s governance of risk which would extend beyond the risks specific to the company’s external reporting to a committee (IOD, 2016, Principle 8, para 53 & 62). In practical terms, this would fall to the audit or a separate risk committee.

50 This will be subject to any limitation in a company’s memorandum of incorporation. 51 In a group of companies, a subsidiary of another company may rely on the audit committee of its parent (or ultimate parent) to perform the necessary activities on its behalf (Companies Act, 2008, s94(2)(a&b)).

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Social and ethics committee In addition to an audit committee, state-owned companies, listed public companies and any other company with a high level of public interest52 are required to form a social and ethics committee53 (Companies Regulations, 2011, Regulation (43)(1)). The committee should monitor: – the company’s social and economic development, including its standing according to codes of best practice and applicable rules and regulations such as BEE legislation, the United Nations Global Compact and applicable recommendation issued by the OECD – whether or not the company is acting as a good corporate citizen considering factors such as prevention of discrimination, combatting corruption, community development and charitable activity – the company’s impact on the environment, health and public safety – consumer relationships – fairness of labour practices taking into account employment conditions and the company’s standing in terms of the International Labour Organizations Protocol on working conditions and wages (Companies Regulations, 2011, Regulation (43)(5)(a)) The social and ethics committee should report material matters to the board and shareholders (at the annual general meeting) as required (Companies Regulations, 2011, Regulation (43)(5)(a&b)). The above duties are in line with those outlined broadly by King-IV. In terms of King-IV, an organisation’s governing body may assign responsibility for overseeing and reporting on “organisational ethics, responsible corporate citizenship, sustainable development and stakeholder relationships” to an appropriate committee (IOD, 2016, p. 29). Remuneration, nomination and risk committee A board of directors may choose to delegate responsibility for remuneration and nomination of directors, succession planning and performance evaluation of the governing body to an existing or a separate nomination and remuneration committee (IOD, 2016, Principle 8, para 60 & 65). The governing body should also consider delegating authority for risk governance to a committee with the necessary

52 This would include any company which has a public interest score about 500 points (as calculated for the purpose of Regulation 26(2) of the Companies Act (2008)) in any two of the preceding 5 years (Companies Regulations, 2011, Regulation 43(1)(c)). 53 As with an audit committee, the function of a social and ethics committee may be performed by a parent of a subsidiary company. The Companies’ Tribunal can also grant an exemption for the formation of a social and ethics committee under certain circumstances (Companies Regulations, 2011, Regulation 43(2)).

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4.2 Trends in corporate governance practices

skills, expertise and resources (IOD, 2016, Principle 8, para 62). As discussed above, this will usually fall to an audit or a separate risk committee. A review of the functions of committees of the board The audit committee’s functions are summarised in Figure 4.11. Almost all of the companies under review deal explicitly with how their audit committees oversee financial risk management (Average = 93%) and the application of combined assurance models (Average = 92%) which include the internal (Average = 95%) and external (Average = 94%) audit functions. Assessing the performance of the finance function (Average = 85%) and overseeing the preparation of the integrated report (Average = 81%) are discussed in the majority of cases but are not as frequently discussed when compared to the audit committees’ other activities. 1.00 0.95

Proportions

0.90 0.85 0.80 0.75 0.70 0.65 0.60 Oversees financial risk management Assesses the performance, expertise and skills of the finance function Audit committee applies a combined assurance model Oversees internal audit function Evaluates independence and credentials of the external auditor Evaluates performance of the external auditor Oversees the preparation of the integrated report Reports to the board and shareholders how it carried out its responsibilities

2012 0.93

2013 0.93

2014 0.93

2015 0.92

2016 0.93

2017 0.94

0.85

0.87

0.82

0.82

0.83

0.90

0.94

0.91

0.90

0.93

0.91

0.95

0.96

0.96

0.96

0.95

0.96

0.97

0.95

0.91

0.96

0.96

0.89

0.96

0.91

0.92

0.90

0.92

0.95

0.94

0.77

0.83

0.76

0.78

0.86

0.87

0.94

0.93

0.90

0.93

0.95

1.00

Figure 4.11: Functions of the audit committees.

The activities of audit and risk committees often overlap. Some companies rely on an audit committee to deal with risks specific to the financial reporting while the risk committee assumes responsibility for the broader governance of risk. In other cases, the audit committee focuses on a wide range of risks, including those pertaining to financial statements. Similarly, a board of directors may delegate responsibility for

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monitoring ethical standards, social and environmental performance and corporate citizenship to a social and ethics, social and environmental or risk committee. An audit committee may also be tasked with overseeing aspects of ESG-related risk and management practices (see also IOD, 2016; Raemaekers et al., 2016; 2014). In the interest of brevity, functions dealing broadly with financial and nonfinancial risks were evaluated in aggregate and presented as part of the risk committees’ mandate. These included monitoring the risks associated with a company’s social, environmental and ethical practices which, according to the Companies Act (2008) are duties of a social and ethics committee. Results are presented in Figure 4.12. 1.00 0.95

Proportions

0.90 0.85 0.80 0.75 0.70 0.65 0.60 Key financial risks and quantified where possible Non-financial risks and quantified where possible. Explanation of how the identified financial risks will be addressed Explaination of how identified nonfinancial risks will be addressed Risk tolerance level set Effectiveness of the company’s riskmanagement processes discussed

2012

2013

2014

2015

2016

2017

0.83

0.92

0.82

0.83

0.91

0.90

0.81

0.88

0.77

0.80

0.89

0.87

0.80

0.88

0.76

0.79

0.82

0.83

0.81

0.83

0.75

0.80

0.83

0.82

0.69

0.73

0.73

0.76

0.75

0.82

0.90

0.95

0.87

0.93

0.92

0.96

Figure 4.12: Functions of the risk committee.

On average, 87% of companies dealt with how their risk committees (or equivalent) were identifying and evaluating key financial risks. Non-financial risks were covered 84% of the time. Disclosures dealing with risk tolerance levels and how both types of risk were being managed featured in 75% and 81% of the corporate reports under review. In total 92% of companies disclose how their board committees engaged with the governance risk. Nevertheless, the extent of reporting is less detailed than the disclosures dealing with the work of audit committees (see Figure 4.11). Finally, disclosures dealing with the activities of the remuneration and nomination committees were considered (see Figure 4.13). On average, 91% of companies explained

4.2 Trends in corporate governance practices

93

how their remuneration committee was responsible for monitoring and approving remuneration policies and recommending individuals’ remuneration to the board of directors. Just under 82% included details on the appointment and removal of directors being handled by nomination committees in their corporate reports. The Companies Act (2008) does not mandate these committees and King-IV does not provide detailed guidance on the scope of their activities. As a result, the lower levels of reporting, when compared to the audit and risk committees, is to be expected. 1.00 0.95

Proportions

0.90 0.85 0.80 0.75 0.70 0.65 0.60 Remuneration of executive and non- executive directors proposed and evaluated Appointment and dismissal of executive and non-executive directors evaluated Nominations reviewed and presented to board for approval

2012

2013

2014

2015

2016

2017

0.89

0.92

0.87

0.87

0.95

0.94

0.86

0.83

0.75

0.78

0.87

0.86

0.80

0.81

0.75

0.76

0.83

0.85

Figure 4.13: Functions of the remunerations and nominations committees.

4.2.3 Corporate governance disclosures To provide a sense of companies’ corporate governance practices, the annual or integrated reports (referred to collectively as corporate reports) of the sample were reviewed to identify common disclosures. For most of the period under consideration, King-III was applicable. King-IV was effective for financial years commencing on or after 1 April 2017 although companies may have elected to commence applying King-IV after its release in 2016. As a result, recommended practices from King-III and King-IV were used to construct a corporate governance schematic54 which was used to code each corporate report. The data instrument consisted of 135 elements/disclosures which were

54 The recommendations in Appendix C were taken into account when developing the schematic in Table 4.2.

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4 Trends in South African corporate governance

grouped by the researchers under 11 broad governance themes. These comprised one or more of the principles in King-IV as shown in Table 4.2. Table 4.2: Corporate governance disclosure matrix. Disclosure theme (DT)

King-IV Examples of disclosures principles

 – Governance of ethics

Principle , &

– – –

 – Composition and Principle  function of the governing &  body

– – – –

 – Delegation of authority and functions to committees and management

Principle  & 

 – Performance evaluation and remuneration

Principle  Principle 

 – Combined assurance

Principle 

– – – – – – – – –

Ethical values (such as integrity, honesty, and objectivity) discussed in the integrated report. Reference to an explanation of codes of corporate conduct. An overview of the arrangements for governing and managing responsible corporate citizenship noting key areas of focus, measures taken and future plans. Formal director appointment process explained Board comprised of majority of non-executive directors who are primarily independent Chair of the board is a non-executive director. Company secretary appointed to assist the board in discharging its duties Explanation of the function and composition of committees of the board of directors Review of managerial functions and performance

Performance of the board evaluated according to specified targets Individual directors’ performance evaluation discussed Components of directors’ remuneration Remuneration policies Presence or absence of a combined assurance model Monitoring and review of internal financial and operating controls Audit committee’s role in monitoring internal and external assurance services

55 Principle 17 is applicable to institutional investors and is not considered separately for the purpose of this analysis.

4.2 Trends in corporate governance practices

95

Table 4.2 (continued ) Disclosure theme (DT)

King-IV Examples of disclosures principles

 – Integration of risk, strategy and performance

Principle  & 

– –



 – Governance of technology

Principle 

– – –

 – Compliance with laws and regulations

Principle 

– – –

 – Stakeholder awareness and responsiveness

Principle 

– – –

 – Integrated reporting

Principle 

– – – –

Risk management policies and thresholds Scope of risk management, strategy and business models including the focus on financial and nonfinancial risks. Role of the board of directors and committees of the board in overseeing risk management and strategy development. Presence or absence of a chief information officer Extent to which information-technology is included in the risk assessment process Role of the board of directors and committees of the board in overseeing significant investment in information and technology systems/processes Compliance functions established by the organization. Scope of compliance functions Disclosure of non-compliance with laws and regulations Key stakeholders identified Process for identifying and prioritising stakeholder issues explained Link between stakeholders’ concerns and disclosures in the integrated report explained Integrated report addresses the core capitals Materiality explained and applied Application of King-III or King-IV Use of applicable GRI reporting principles

Content analysis was used to code each corporate report. As explained by Guthrie et al. (2004, p. 286) this entails codifying qualitative and quantitative information into pre-defined categories in order to derive patterns in the presentation and reporting of information. Content analysis seeks to analyse published information systematically, objectively and reliably.

The corporate reports were read and analysed interpretively to identify corporate governance information and, more broadly, details on economic, environmental and social performance. For this purpose, individual paragraphs were used as the

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unit of analysis56 (adapted from Beattie et al., 2004). Each was considered and mapped to one or more corporate governance elements/disclosures. A score of 1 was used when a governance practice was disclosed or explained in a corporate report, and 0 was assigned if this was not the case. No effort was made to gauge the effectiveness of governance practices or quality of disclosures. This is an inherent limitation but was necessary for reducing the degree of subjectivity involved when coding the reports (adapted from Laine, 2010; Cho et al., 2015; Maroun, 2018a). The results were recorded in a frequency table. For ease of analysis, the scores for each of the 135 governance practices/elements were aggregated under the 11 theme headings in Table 4.2. The scores were expressed as a percentage of the total number of possible practices/ elements for each theme heading. Results are summarised in Figure 4.14. Most companies discussed the governance of ethics (DT1) in their corporate reports. This is probably due to the emphasis which King-III and King-IV place on ethical business practice (see IOD, 2009; 2016). The high disclosure scores from 2012 to 2017 are driven mainly by references to codes of conduct, whistle-blowing channels and policy statements on the importance of good governance. As a result, they should be interpreted with caution because a higher score does not guarantee that companies have internalised and applied codes of ethics. Combined assurance (DT5) and compliance with laws and regulations (D8) have the next highest scores. As discussed in Chapter 6, the majority of the largest listed companies make use of, at least, some form of external and internal assurance as part of a combined assurance model and report on the outcomes of these assurance engagements in their corporate reports. The role played by boards of directors, audit committees and risk committees in monitoring internal controls and ensuring compliance with laws and regulations also features in many corporate reports and forms part of the combined assurance model. The composition and function of the board (DT2) and delegation of authority (DT3) report above average scores. The same is true for the governance of risk, strategy and performance (DT6) and the performance evaluation and remuneration of the board (DT4). The above average scores are to be expected, given the emphasis placed on these aspects of corporate governance by institutional investors and other stakeholders. Many of the governance practices forming part of these disclosure themes are also dealt with in the Companies Act (2008b), IFRS or the JSE listing requirements. For example, the Companies Act (2008) deals with the size and function of the board of directors and select committees of the board.

56 Individual words or sentences were not used because this may result in important context, cross-referencing or integration among disclosures being overlooked.

97

Cumulative disclosure score

4.2 Trends in corporate governance practices

10.00

1.00

9.00

0.90

8.00

0.80

7.00

0.70

6.00

0.60

5.00

0.50

4.00

0.40

3.00

0.30

2.00

0.20

1.00

0.10

DT 10 DT 9 DT 8 DT 7 DT 6 DT 5 DT 4 DT 3 DT 2 DT 1 Average

2012 0.76 0.78 0.87 0.67 0.84 0.88 0.81 0.88 0.86 0.88

2013 0.72 0.81 0.88 0.64 0.89 0.90 0.83 0.87 0.87 0.94

2014 0.69 0.78 0.87 0.69 0.82 0.88 0.81 0.84 0.87 0.92

2015 0.69 0.80 0.89 0.71 0.85 0.89 0.80 0.85 0.87 0.89

2016 0.74 0.83 0.89 0.76 0.88 0.90 0.85 0.88 0.87 0.94

2017 0.76 0.85 0.88 0.71 0.90 0.92 0.86 0.92 0.91 0.93

-

Figure 4.14: Trends in corporate governance.57

IFRS 2, IAS 19 and IAS 24,58 read with the Companies Act (2008) and JSE’s provisions, specify minimum levels of disclosure for director remuneration (for details see IASB, 2011; 2012; JSE, 2016). While boards of directors appear to be focusing on the governance of risk (DT4), the extent to which the risks associated with technological developments are being specifically considered is less clear. DT 7 had the lowest score. Companies either do

57 Disclosure themes are denoted “DT” 58 More specifically, IAS 24 (read with IAS 19 and IFRS 2) requires the disclosure of short-term, post-employment, other long-term, and share-based payment benefits provided to key management personnel which will include executive and non-executive directors. S30(4) of the Companies Act (2008) prescribes additional disclosures for director remuneration, pensions, compensation for loss of office, shares issued to directors and details of service contracts.

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not identify IT as a separate risk which warrants management attention or have chosen to limit the extent of reporting on the applicable governance practices in King-III and King-IV. Finally, even though King-III introduced the concept of integrated reporting in 2009, the stakeholder engagement (DT9) and integrated reporting (DT10) themes reported below average scores. Companies focus their reporting on compliance-related issues such as the extent to which King Codes or the GRI’s guidelines were adhered to; whether or not disclosures were assured and the extent to which each of the capitals identified by the IIRC was discussed. Reporting on strategies, business model and the risk management process was less developed (see also Raemaekers et al., 2016; Van Zijl et al., 2017; Sukhari and De Villiers, 2018). Disclosures were often repetitive or generic with no clear indication of how stakeholder engagement was being used to drive the nature and extent of reporting (see Solomon and Maroun, 2012; Haji and Anifowose, 2016). There was also little detail on companies’ prospects, how their business models were being revised to deal with changing circumstances and how accounting and management systems were being developed to support more accurate and reliable integrated reporting (du Toit et al., 2017; McNally et al., 2017).

4.3 Summary and conclusion The structure and content of the King Codes illustrates that, at face value, the fundamental principles of good corporate governance have not varied dramatically from King-I to King-IV (see Appendix E:). Although the Codes have changed in composition and length, the topics covered remain similar. Differences are primarily the result of a change in emphasis with King-III and King-IV focusing on stakeholder engagement and sustainable development according to an integrated thinking philosophy to a greater extent than King-I and King-II (see also Chapter 2). In terms of specific governance practices, South African boards of directors are male-dominated with the majority of directors over the age of 55. There are, however, indications of boards improving in terms of diversity. As older directors either retire or rotate off of a board, their seats are more likely to be filled by younger and/or female directors. The same applies to race. For the full period under review, the proportion of ACI and Caucasian directors under the age of 45 is approximately equal. As suggested by King-III (IOD, 2009) and King-IV (IOD, 2016), the majority of directors are non-executives with the greatest proportion of the latter also being independent. A wide range of technical skills is represented. Directors with an accounting or finance background are most prominent, followed by those specialising in finance and engineering and then law. All of the companies under review rely on audit committees, supported in some cases by separate risk committees, to oversee the integrity of their risk management

4.3 Summary and conclusion

99

and internal controls (including the use of internal and external sources of assurance). Of particular relevance in the context of King-IV’s multi-capital approach is the increased emphasis being placed on evaluating non-financial risk, setting risk tolerance levels and ensuring that risk management processes are being adequately discussed and explained to stakeholders. The work of the audit and risk committee is complemented by remuneration and nomination committees which deal with the appointment, removal and remuneration of directors in terms of the provisions of the Companies Act (2008) and recommendations in King-IV. Finally, there has been a marginal improvement in corporate governance disclosures from 2012 to 2017 which is consistent with the development of detailed guidelines in King-III and King-IV. For this purpose, corporate governance is defined according to: – the governance of ethics – the composition and functions of the governing body – delegation of authority to and the functions of committees of the board of directors – performance evaluation and remuneration of directors – the design and operation of combined assurance models – strategy development, risk identification and management of the firm’s business model – the governance of IT – compliance with laws and regulations – stakeholder identification and engagement – integrated reporting processes and quality The governance of ethics, combined assurance and compliance with laws and regulations have the highest contribution to the total corporate governance scores. In light of the overlap between external regulation and the role of boards of directors and their committees, many companies are also disclosing these features in their corporate reports. In contrast, risk management disclosures are less extensive, particularly when it comes to the governance of IT. Stakeholder engagement and, as discussed in more detail in Chapter 3 (Section 3.4.3), integrated report disclosures are relatively limited. Overall, these findings suggest that, while South African corporate governance is progressing year-on-year, there is still room for improvement.

5 Preliminary evidence on the drivers and implications of South African corporate governance Chapter 2 and 3 deal with the history of South African corporate governance and how external and internal factors interact to influence the emergence and development of codified best practice. Examples include the country’s socio-political challenges, the effect of stakeholder pressures and the sophistication of an organisation’s policies, systems and processes. The discussion and analysis are mainly theoretical because South African-specific research dealing with the drivers and benefits of better corporate governance is limited. In this context, Chapter 4 provides an overview of the structure and content of the King Codes. Similarities and differences in their core recommendations or principles are considered. Empirical evidence on the composition of boards of directors, the functions of different committees of the board and the disclosures dealing with corporate governance practices in integrated and sustainability reports is also provided. Chapter 5 expands on the analysis of corporate governance trends by dealing specifically with some possible drivers of better corporate governance. These include: – firm size – social and environmental impact (as evidenced by industry type) – the age, tenure and independence of board members – race and gender diversity on the board – board size – the number of identified stakeholders In theory, better-governed firms should report improved performance across environmental (Rao and Tilt, 2016; Haque, 2017), financial (Klapper and Love, 2002; Ammann et al., 2011) and social lines (consider Bebbington et al., 2008; Claessens and Yurtoglu, 2013). This is considered by providing preliminary evidence on the association between composite corporate governance score, well-known financial performance measures and proxies for social and environmental performance. The results presented in this chapter are regarded as preliminary because only associations between drivers, performance measures and outcomes are addressed. Specification of a detailed model for establishing causal relationships is deferred for future research. In addition, due to the need to balance pragmatism with completeness, not all of the “elements” outlined in the conceptual framework for explaining the development of South African corporate governance in Chapter 1 are considered. Only the factors or variables which are most commonly dealt with by the prior literature are reviewed. These are material limitations. Nevertheless, the results presented below are an important first step in addressing the call for a more https://doi.org/10.1515/9783110621266-005

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101

detailed and up-to-date analysis of determinants and consequences of South African corporate governance.

5.1 Development of research questions South Africa has seen significant developments in corporate governance from 1994 to 2016 (Chapter 2). The proliferation of recommended governance practices has gone hand-in-hand with an increase in stakeholder pressure to ensure high-quality corporate governance (see, for example, Andreasson, 2011; Atkins and Maroun, 2015; King, 2018). At the same time, both the GRI (2016) and the IIRC (2013) stress the importance of a formal system of checks and balances for ensuring the integrity of an organisation’s sustainability or integrated reports. RQ1: Has there been an improvement in South African corporate governance from 2012 to 2017? In addition to the length of time a company has been in operation, internal drivers of corporate governance commonly considered by the prior literature include firm size and industry (see Chapter 3). The general position is that, as the size and complexity of a business increases, the monitoring benefits associated with better corporate governance are greater, justifying the cost of additional investment in corporate governance systems (Boone et al., 2007; Monem, 2013). This may be especially true for firms with a high social or environmental impact. These organisations are more likely to come under scrutiny for their ESG performance by investors, regulators and other stakeholders (see, for example, Patten, 2002; Cho and Patten, 2007). Effective corporate governance is important for managing risks (IOD, 2016) and signalling to stakeholders that companies are aware of and are taking steps to mitigate their impact on society and environment (consider Simnett et al., 2009; Ismail and El‐Shaib, 2012). With this in mind, the first point for consideration is: RQ2: Do larger firms, firms in an industry with a high social or environmental impact and those with a greater number of stakeholders have better corporate governance than do other organisations? The board of directors play a central role in the corporate governance system. As explained by King-IV (IOD, 2016, p. 21), those charged with the organisation’s governance are expected to provide strategic direction, approve management’s plans for achieving key objectives, monitor management’s actions and ensure high levels of accountability (see also Chapter 4). King-IV is not prescriptive in terms of exact size and composition of the board, but the prior research suggests that larger boards with a greater proportion of independent directors and more experienced members

102

5 Preliminary evidence on the drivers and implications

should result in better monitoring and control (Boone et al., 2007; Monem, 2013). More diverse boards may also be better equipped to discharge their monitoring and review functions. RQ3: Does the size and composition of a board of directors have any relevance for other corporate governance features/practices? Enhanced monitoring and control by a board of directors should have a positive effect on firm value by reducing agency costs and lowering information asymmetry (consider Klapper and Love, 2002; Ammann et al., 2011; Aman and Nguyen, 2013). As discussed in Chapter 3, a well operating board of directors may also result in more active community engagement (Yekini et al., 2015), better human capital management (consider Bebbington et al., 2008; Claessens and Yurtoglu, 2013) and enhanced environmental performance and reporting (consider Rao and Tilt, 2016; Haque, 2017). In theory, the ability of the board of directors to provide the monitoring and strategic direction necessary for ensuring that an organisation achieves its economic, environmental and social objectives should be improved by race, age and gender diversity (IOD, 2009; 2016). RQ4: Is there an association between corporate governance and financial, environmental and social performance? To address the above questions, a specified corporate governance schematic or measure is required. This is explained in Section 5.2 below.

5.1.1 Defining corporate governance In most cases, corporate governance is defined and measured according to indices based on the size, structure, composition and remuneration of the board of directors, ownership structures and how information on these variables are disclosed in corporate reports (see, for example, Ashbaugh-Skaife et al., 2006; Ammann et al., 2011; Ararat et al., 2017). In some instances, these metrics are complemented by, for example, an assessment of the transparency of financial reporting, evidence of social awareness, and external auditor independence (see Klapper and Love, 2002; Brown and Caylor, 2006). This research takes a broader approach. The disclosure themes outlined in Chapter 4, Table 4.2 (see Section 4.2.3) are used to construct an initial corporate governance score. This takes many of the above indicators into account (mainly as part of Disclosure Themes 1–4). The governance score also includes factors which, to the researchers’ best knowledge, have not been considered by prior studies. These include:

5.1 Development of research questions

103

– the design and operation of combined assurance models (Disclosure Theme 5); – how risks are identified and managed at the operational and strategic level (Disclosure Theme 6); – how information systems and the effect of technological changes are managed (Disclosure Theme 7); – how companies ensure compliance with laws and regulations (Disclosure Theme 8); – stakeholder engagement (Disclosure Theme 9) and – whether or not a company prepares an integrated report in accordance with the guidance provided by established reporting guidelines (Disclosure Theme 10). The first part of Table 5.1 below explains how the possible drivers of corporate governance under review in Chapter 4 are defined and measured. In the second part of the table, corporate governance, financial performance and social and environmental performance are explained.

Table 5.1: Definition of variables. Drivers

Explanation and measurement

Size

Following the same approach as those of Rao and Tilt () and Willows and van der Linde (), the size of the firm is measured according to market capitalisation.

Industry

Firms in the mining, industrials and petrochemical sectors are classified as having a high social and environmental impact (dummy variable = ). The financial services industry also has a high, although indirect, impact because they fund operations which can have a material social or environmental effect (dummy variable = ). All other companies are assigned a value of  (adapted from Simnett et al., ; Cho et al., ).

Board composition In line with the prior research, this includes the size of the board and the directors’ age and term on the board. Three dummy variables are included for gender (Male = ; Female = ) race (Caucasian = ; Non-Caucasian = ) and function on the board (Executive = ; Non-executive = ). Number of stakeholders

The number of stakeholders is an ordinal measure of the number of different stakeholders identified in companies’ corporate reports.

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5 Preliminary evidence on the drivers and implications

Table 5.1 (continued) Variables of interest

Explanation and measurement

Corporate governance (Adjusted score)

A composite score based on the corporate governance information found in corporate reports, corporate databases and where applicable, companies’ webpages. The score is computed based on the disclosure themes listed in Chapter , Table . (see Section ) and is used as a proxy for an organisation’s policies, processes, systems and activities, referred to collectively as governance practices. A higher score implies better corporate governance practices. For the purpose of this research, board composition (Disclosure Theme ) is treated as a driver of corporate governance practices. Consequently, disclosures dealing with the composition of a board and included in the initial corporate governance disclosure scores in Chapter , Figure ., (Section ..) are excluded.

Financial performance

In line with the prior research, return on assets (ROA) and equity (ROE) are used as accounting-based measures of financial performance. Tobin’s-q is used as a market-based proxy for firm value (Brown and Caylor, ; Willows and van der Linde, ).

Social and environmental performance

There is no generally-accepted basis for gauging social and environmental performance. As a result, a composite measure is developed based on scores assigned by the Carbon Disclosure Project (CDP), levels ofBEE and whether or not a company is included in the FTSE/JSE Responsible Investment Index Series (SRI). – The CDP score is informed by CO2 emissions but also takes into account a company’s awareness of climate change, steps taken to reduce greenhouse gas emissions and progress in achieving environmental objectives (CDP, 2017). – BEE is a direct response to exclusionary practices under Apartheid. A company’s BEE score is based on factors such as the percentage ownership by historically disadvantaged individuals, investment in skill development and the extent to which companies procure goods and services from organisations with a high BEE score (Republic of South Africa, 2013; DTI, 2015).59 – The SRI tracks companies’ social and governance performance including, for example, actions taken to reduce adverse environmental impact, health and safety standards and anticorruption (FTSERussell, 2015). Each element carries equal weight. The final social and environmental performance measurement score is the average of the individual scores and is expressed as a percentage where a value closer to 100% implies better performance.

59 These scores are obtained from an independent database.

5.2 Analysis

105

5.2 Analysis Univariate results are presented in Section 5.2.1. Potential drivers of better corporate governance are discussed in Section 5.2.2 Section 5.2.3 deals with possible outcomes of good governance as indicated by a higher governance score.

5.2.1 Correlation analysis Univariate correlations among the variables under review are provided in Table 5.2. The corporate governance score has a weak correlation with firm size and industry (rs 0.1). Similarly, correlations between director age, director experience, the size of the board and corporate governance are below 0.2 and statistically insignificant at the 10% level. In contrast, a greater proportion of non-executive directors (rs = 0.214, p < 0.01), gender diversity (rs = 0.246, p < 0.01) and race diversity (rs = 0.358, p < 0.01) are associated with better corporate governance, as suggested by King-III and King-IV (IOD, 2009; 2016). In addition, as the number of identified stakeholders increases, so does the corporate governance score (rs = 0.294, p < 0.01). There is a very weak correlation between corporate governance and ROA. The correlations between corporate governance, ROE (rs = 0.141, p < 0.05) and Tobin’s-q (rs = 0.152, p < 0.05) are stronger and statistically significant at the 5% level. The strongest correlation is with ESG performance (rs = 0.205, p < 0.01) which is also statically significant at the 1% level.

5.2.2 Drivers of good governance Given the exploratory nature of this study, the relatively small sample and the possibility of the results being affected by endogeneity, a regression model was not used to study changes in corporate governance scores.60 Not all of the data were normally distributed or continuous. As a result, a nonparametric Kruskal-Wallis test was used to address the first two research questions. Differences in the corporate governance practices were compared using firm size,61

60 For example, while corporate governance may result in better financial performance, it is also possible that firms with superior financial returns have the resources to invest in better corporate governance systems. The aim of this study is more exploratory. It is not our intention to establish a causal relationship and the direction of causality. 61 For this purpose, the firms were ranked by market capitalisation and grouped according to quartiles. Firms with a market capitalisations in the first quartile were categorised as small. Those between the first and second quartile were regarded as medium-sized. Firms between the second and third quartile were labelled as large and those above the third quartile were very large.

−.

.*

.**

.

−.

−.

ROE

Tobin Q

.**

.

.

−.**

−.

Gender diversity

Race diversity

.

.

.

ROE .**

.*

Tobin Q

.

−.

−.

.

.**

.**

.

−.

−.

.

−.

−.

.

.**

.

.**

.

Director −.

.

.**

age

−.

−.

−.

−.*

−.

.

.

Time on

−.

−.

.*

.**

.

Proportion .**

Non-exec

−.

−.

−.

−.*

−.**

.

.

.**

.**

.*

.

−.

.

−.

.

−.

.

−.** −.

.

board

.** −.

−.*

.** −.

−.

−.** −.** −.

.

ROA

.** −.

.**

.

−.** −.

.

−.

Proportion non-exec

Time on board

.**

.

−.

ROA

Director age

.

.*

.

ESG performance

.*

.

−.**

Industry

.*

−.**

ESG

.

Performance

Size

Size

Table 5.2: Correlation matrix.

Industry

Diversity

Gender

Race

.**

.

.

Number of −.*

.

−.

.**

Directors

−.**

.

.

.** −.**

.** −.

.**

.

−.** −.*

.** −.

−.

.**

.

.**

Diversity

−.** −.

−.

.

.**

.

.**

.*

.**

stakeholders Number of

.

.*

−.

.

.

.

.

.**

.

.

.*

score

Governance

.**

.**

.**

−.

−.

.*

.*

.

.**

.

.

106 5 Preliminary evidence on the drivers and implications

.

Performance

ESG .**

.

.

ROA .

.*

−.

ROE .

.

−.*

Tobin Q −.*

.

−.

age

Director .

.

.

Non-exec

Proportion

Time on −.

. .**

−.

.** −.

board

Spearman’s rho and Pearson’s correlation coefficients are reported above and below the diagonal respectively. *significant at the 5% level; ** significant at the 1% level. Significance based on a 2-tailed t-test.

−.

.

.**

Number of stakeholders

Governance score

−.

.

Industry

Number of directors

Size

Table 5.2 (continued )

Diversity

Gender .**

.**

−.*

Diversity

Race

Number of −.

.

Directors

.** −.

.

.

stakeholders

Number of .**

.

.

score

Governance

.

.**

−.

5.2 Analysis

107

108

5 Preliminary evidence on the drivers and implications

industry categorisation, and year as separate grouping variables. A JonckheereTerpstra post hoc test was used to determine the sign of any changes. Results are presented in Table 5.3. Table 5.3: Differences in corporate governance scores by size and industry. Driver

H-Statistic

J-T Statistic

Std. J-T Statistic

Size

.*

 

.

Industry

.*

 

.

.

 

.*

Year

*significant at the 10% level; **significant at the 5% level; *** significant at the 1% level. Grouping variable: size, industry or year.

Firm size (H = 7.452, p < 0.1) and industry (H = 5.713, p < 0.1) have, at least, some effect on firms’ corporate governance scores although the results are only significant at the 10% level. The Jonckheere’s Test reveals a positive trend in corporate governance scores as size (J = 12.136, p>0.1) and social and environmental impact (J = 10.665, p>0.1) increases but this is not statistically significant at the 10% level. The same applies when considering changes in corporate governance practices from 2012 to 2017. There is a positive trend in governance scores (J = 13.928, p < 0.1) which is significant at the 10% level but there has not been a significant change in corporate governance practices over the period under review (H = 4.851, p>0.1). Table 5.4 shows how the composition of the board varies with firm size, industry and over time. Large organisations have bigger boards (H = 23.692, J = 14 442, p < 0.01) made up of greater proportion of non-executive (H = 9.035, J = 13 439.5, p < 0.05), female (H = 23.402, J = 13 607, p < 0.05) and non-Caucasian members (H = 43.905, J = 14 029, p < 0.05). Logically, the size of the firm is a good predictor of the number of stakeholders taking an interest in its operations (H = 11.807, J = 13 154, p < 0.01).62 The same relationships hold when evaluating changes in industry except that the size of the board (H = 4.130, J = 8 878, p>0.1), and proportion of non-executives (H = 4.003, J = 9331, p>0.1) do not increase with social and environmental impact. Racial diversity continues to improve as social and environmental impact grows but is only significant at the 10% level (H = 4.070, J = 10 674, p>0.1). Finally, except for gender diversity (H = 10.030, p < 0.1), year-on-year changes in board composition are not significant.

62 This is according to what the companies have included in their corporate reports. As discussed in Section 4.2.3, on average, companies scored poorly in terms of their stakeholder engagement processes. It is, therefore, possible that the number of stakeholders identified in their corporate reports has been understated.

Size

 **

 ***

 ***

 ***

 ***

 

 ***

J-T Statistic

.***

.

.*

.***

.

.***

.***

H-Statistic

*significant at the 10% level; **significant at the 5% level; *** significant at the 1% level. Grouping variable: size, industry or year.

.***



.***

.

Race Diversity

Number of stakeholders

.***

.

Gender Diversity

.***

.**

.

Proportion Non-exec



.

.

Time on Board

Number of Directors

.***

H-Statistic

.

Averages (Total)

Director Age

Board characteristic

Table 5.4: Differences in board composition with changes in size, industry and year.

 



 *

 **

 

 ***

 

J-T Statistic

Industry

.

.

.

.*

.

.

.

H-Statistic

Year

 

 

 

 

 

 

 

J-T Statistic

5.2 Analysis

109

110

5 Preliminary evidence on the drivers and implications

Table 5.5 shows the results of the Kruskal-Wallis tests used to determine the effect of individual board characteristics on adjusted corporate governance scores.63 For this purpose, companies were grouped according to quartiles. The result was four groups for each driver considered separately: companies with a driver measure below the first quartile (Group 1), between the first and second quartile (Group 2) between the second and third quartile (Group 3) and above the third quartile (Group 4). A Jonckheere-Terpstra post hoc test is used to determine the sign of any changes from Group 1 to Group 4.

Table 5.5: Changes in drivers with variations in corporate governance. Corporate governance drivers Driver

Corporate governance score H-Statistic

J-T Statistic

.

.**

 *

Time on board

.

.

 

Proportion of non-executives

.

.**

 ***

Gender diversity

.

.***

 ***

Race diversity

.

.***

 ***

Director age

Number of directors Number of stakeholders

Averages (Total)

 

. .***

   ***

*significant at the 10% level; **significant at the 5% level; *** significant at the 1% level. Grouping variable: individual drivers (aggregated by quartile).

Director age (which is a proxy for experience) has a significant positive effect on a company’s corporate governance (H = 10.219, J = 11 791, p < 0.01). Similarly, boards of directors which have a larger proportion of non-executives (H = 9.355, J = 13 383, p < 0.05) and are more diverse in terms of gender (H = 19.311, J = 13 523, p < 0.01) and race (H = 33.515, J = 14 821, p < 0.01) promote stronger corporate governance practices. In contrast, director tenure (H = 3.427, J = 10 737, p>0.1) and the size of the board (H = 4.104, J = 11 232, p>0.1) are not contributing significantly to the corporate governance scores. Finally, companies with a greater number of identified stakeholders have higher corporate governance score (H = 21.722, J = 14 296, p < 0.01).

63 As explained in Table 5.2, the scores are adjusted because they exclude board composition originally taken into account when the total corporate governance scores, discussed in Section 4.2, were computed.

5.2 Analysis

111

Table 5.3 shows that firm size has some effect on corporate governance practices and is also influencing the composition of a board of directors (see Table 5.4). As a result, the board composition is compared with the corporate governance scores while holding firm size constant (Table 5.6). Results for the smallest companies on the JSE (Size – Quartile 1) are largely consistent with those in Table 5.5. Director experience (H = 2.623, p < 0.1), the proportion of non-executive directors (H = 8.259, p < 0.05), the number of women on the board (H = 10.840, p < 0.05), race diversity (H = 10.681, p < 0.05) and the number of stakeholders (H = 10.766, p < 0.05) continue to have a significant effect on corporate governance scores. Director terms (H = 2.266, p>0.1) and board size (H = 1.307, p>0.1) remain statistically insignificant at the 10% level. In contrast, as company sizes increase, more experienced or independent board do not necessarily result in better corporate governance. A greater number of stakeholders still appears to be a valid driver but the statistical significance of the relationship between corporate governance scores and the number of stakeholders decreases as firm size increases. The same applies to gender diversity. Only racial diversity consistently reports a statistically significant effect on corporate governance for each company grouping.64 Overall, the results suggest that firm size is moderating the effect which composition of the board is having on corporate governance practices. For example, larger firms may have the resources for more sophisticated management control and reporting systems, reducing the need for monitoring by the board. Similarly, greater scrutiny from analysts and involvement by institutional investors may substitute for some of the monitoring functions performed by a company’s directors. Equally possible is the fact that the largest companies on the JSE have already invested extensively in their corporate governance systems and have most competent individuals serving on their boards. As a result, beyond a given firm size, the marginal benefits of a change in board structure are too low to justify the costs of additional investments in those systems.65 The same logic for testing for the interaction between firm size, board composition and corporate governance practices is applied to industry. Variations in corporate governance scores in response to changes in board composition are evaluated separately for the mining and industrials, financial services and other sectors. Refer to Table 5.7.

64 This is probably due to the effects of BEE legislation. The South African government has introduced laws which require companies to appoint non-Caucasians in senior roles, including executive or non-executive positions on the board of directors. While BEE makes reference to gender diversity, the emphasis is placed firmly on achieving race targets. 65 To provide additional evidence in support of this interpretation, a plot of corporate governance scores against ranked firm size revealed a non-linear relationship. At some point between the first and second quartile of firm size, corporate governance scores still increase but at a decreasing rate.

***

.**

Race diversity

.*

.

.***

.

.

.

.***

H-Statistic

*



***

*





*

J-T Statistic

Size -Quartile 

.*

.

.*

.

.

.*

.

H-Statistic

.*

.







*



J-T Statistic

Size -Quartile 

Changes in corporate governance scores by firm size

*significant at the 10% level; **significant at the 5% level; *** significant at the 1% level. Grouping variable: individual drivers (aggregated by quartile).

Number of stakeholders

.***

**

.**

Gender diversity

.**

***

.**

Proportion non-exec

.



.

Time on the board

.



.*

Director age

Number of directors

J-T Statistic

Size – Quartile 

H-Statistic

Driver

Table 5.6: Sensitivity test for firm size.

.

.

.***

.

.

.

.

H-Statistic





***









J-T Statistic

Size -Quartile 

112 5 Preliminary evidence on the drivers and implications

113

5.2 Analysis

Table 5.7: Sensitivity test for industry. Changes in corporate governance scores by industry Driver

Mining and industrials

Financial services

H-Statistic

J-T Statistic

H-Statistic

J-T Statistic

Director age

.*



.**

Director experience

.***

.***

Low environmental and social impact H-Statistic

J-T Statistic

 

.



.

 

.



Proportion non-exec

.



.**

 **

.



Gender diversity

.*

*

.**

 **

.



***

.***

 ***

.



.



.**

 

.



.**

*

.***

 ***

.



Race diversity Number of directors Number of stakeholders

.**

*significant at the 10% level; **significant at the 5% level; ***significant at the 1% level. Grouping variable: individual drivers (aggregated by quartile).

The relationships between the characteristics of the board and corporate governance scores per Table 5.5 hold for the mining and industrials and financial services firms but are less pronounced for other companies. This is probably due to the fact that corporate governance systems are more essential as a signalling and organisational control mechanism when environmental and social impact grows and the corresponding level of stakeholder scrutiny increases.

5.2.3 Outcomes of good governance Table 5.8 shows that, as corporate governance practices improve, financial performance (measured according to Tobin’s-q) increases with the trend being statistically significant at the 1% level (H = 16.171, J = 8 853, p < 0.01). This is not the case for ROA (H = 3.726, p>0.1) and ROE (H = 4.522, p>0.1) although the latter reports an increasing trend as the corporate governance score improves which is significant at the 10% level (J = 12 252, p < 0.1). The results suggest that, while accounting measures of a firm’s financial performance are not affected by corporate governance practices, the market places, at least, some value on them.

114

5 Preliminary evidence on the drivers and implications

Table 5.8: Effect of drivers on corporate governance scores. Effect

H-Statistic

J-T Statistic

ROA

.

 

ROE

.

 *

.***

 ***

Social and environmental performance

.**

 ***

– CDP component

.

 *

– SRI component

.*

 **

– BEE component

.**

 **

Tobin Q

*significant at the 10% level; **significant at the 5% level; ***significant at the 1% level. Grouping variable: corporate governance scores aggregated by quartiles.

There is only a limited body of research dealing with the effect of corporate governance on environmental and social performance. Haque (2017), for example, finds that UK-based firms with more diverse and independent boards tend to have better policies and practices for managing and reporting on greenhouse gas emissions. An Australian study by Rao and Tilt (2016) and meta-analysis by Samaha et al. (2015) find a positive relationship between sustainability reporting and better corporate governance (see Chapter 3 for details). In South Africa, a stronger system of corporate governance does not necessarily equate to better environmental performance and reporting measured in terms of the CDP (H = 3.988, p < 0.1) although a Jockheere’s test revealed a positive trend between corporate governance and CDP scores at the 10% level (J = 5.653, p < 0.1). In contrast, social and environmental performance measured in terms of the SRI (H = 6.462, J = 5.709, p < 0.1) and BEE scores (H = 7.723, J = 5 846, p < 0.05) were significantly affected by corporate governance practices. Overall, South Africa corporate governance appears to be driving superior social and environmental performance (H = 9.600, p < 0.5; J = 6 058, p < 0.01). Table 5.9 controls for firm size. The effect of changes in corporate governance scores on ROA. ROE, Tobin’s- q and social and environmental performance is tested by grouping companies in quartiles based on market capitalisation. The results in Table 5.9 suggest that most of the variation in financial and social and environmental financial performance is being accounted for by the size of the firm. Just as firm size moderated the impact of board composition on corporate governance scores, it also reduces the effect of corporate governance on ROA, ROE, Tobin’s-q and social and environmental performance. This does not, however, mean that corporate governance is irrelevant. For the first quartile, corporate governance has some positive impact on ROA (H = 9.036, J = 739, p < 0.1),

115

5.2 Analysis

Table 5.9: Sensitivity test for firm size. Changes in outcome measures Driver

Quartile 

Quartile 

Quartile 

Quartile 

HJ-T HJ-T HJ-T Statistic Statistic Statistic Statistic Statistic Statistic

HJ-T Statistic Statistic

ROA

.*

.*

.



.



.



ROE

.*

.*

.



.



.



.**

.*

.



.

 .**

**

ESG performance

.

.

.



.



.



– CDP component

.



.



.



.



– SRI component

.



.



.



.



– BEE component

.



.



.



.



Tobin Q

*significant at the 10% level; **significant at the 5% level; ***significant at the 1% level. Grouping variable: corporate governance scores (aggregated by quartile).

ROE (H = 6.889, J = 729, p < 0.1) and Tobin’s-q (H = 11.204, p < 0.05, J = 509, p < 0.1). For the largest companies, better corporate governance is also driving higher Tobin’sq (H = 18.919, p < 0.05, J = 433, p < 0.05). When it comes to differences in industry, Table 5.10 shows that, for firms in the mining and industrial sectors, better corporate governance goes hand-in-hand with improved financial and non-financial performance measures. This holds in the financial services sector although differences in social and environmental performance are not as significant. For companies in other industries, better corporate governance appears to drive improved social and environmental performance (H = 11.025, J = 401, p < 0.1) but does not have a statistically significant effect on financial performance measures. In Table 5.11, the combined effect of industry and firm size is taken into account. In the interest of brevity only the significance of changes in Tobin’s-q and the composite social and environmental performance measure are reported. In the mining and industrials sector, both financial and non-financial performance measures are being affected by corporate governance practices with findings robust to variations in firm size. For the financial services industry and firms in other sectors, Tobin’-q and better social and environmental performance are positively affected by corporate governance systems, but firm size has a dampening effect.

116

5 Preliminary evidence on the drivers and implications

Table 5.10: Sensitivity test for firm industry. Driver

Mining and industrials

H-Statistic

Financial services

J-T Statistic

H-Statistic

J-T Statistic

Low environmental and social impact H-Statistic

J-T Statistic

ROA

.



.**

 

.



ROE

.**



.*

 *

.



Tobin Q

.***

*

.***

 **

.



ESG performance

.***

**

.*

 *

.*

*

– CDP component

.**

*

.



.*

*

– SRI component

.**

*

.**

*

.



– BEE component

.***

.*



***

.*

 *

Table 5.11: Sensitivity test for firm industry. Mining and industrials

Financial services

Low environmental and social impact

Large firms

Small firms

Large firms

Small firms

Large firms

Small firms

Driver

H-Statistic

H-Statistic

H-Statistic

H-Statistic

H-Statistic

H-Statistic

Tobin Q

.***

.*

.

.**

.

.*

.**

.*

.

.*

.

.*

ESG Performance

5.3 Summary and conclusion While corporate governance has improved from 2012 to 2017, the changes are not statistically significant at the 1%, 5% or 10% level. In general, larger firms have better corporate governance practices than do smaller organisations (measured according to market capitalisation). On average, the industry type, which provides a proxy for social and environmental impact, does not have an impact on corporate governance. The composition of the board has a material effect on corporate governance practices. Board diversity experience and proportion of non-executive members are good

5.3 Summary and conclusion

117

predictors of better corporate governance. The number of directors and their terms of the board do not appear to be relevant considerations. The effect of board composition on corporate governance is, however, moderated by firm size. It is possible that marginal benefits of additional investments in corporate governance systems diminish and that additional scrutiny by investors (and other stakeholders) substitutes for some of the monitoring performed by boards of directors.66 In addition to board composition, companies with a greater number of identified stakeholders in their corporate reports tend to have better corporate governance practices. This may be due to the fact that these firms are under greater scrutiny and require more sophisticated corporate governance systems to manage the expectations of a greater number of stakeholders. This conclusion should be interpreted with caution because the directionality of the interaction between a number of identified stakeholders and corporate governance has not been confirmed. For example, it is equally possible that companies with better corporate governance systems do a better job of identifying and reporting on their stakeholders. Establishing the relationship between stakeholders and a company’s corporate governance practices is deferred for future research. Finally, there is, at least, some evidence on the positive effect of corporate governance on financial, social and environmental performance. As with the impact of board composition on corporate governance practices, firm size accounts for the majority of the variation in returns on asset, returns on equity, Tobin’s-Q and ESG performance. Nevertheless, for firms with a high social and environmental impact, in particular, better corporate governance is having some impact on these indicators. Like any research of this type, findings need to be interpreted in the context of inherent limitations. Most notably, our data spans 2012 to 2017 and covers only the top 50 companies on the JSE. As the study is an exploratory one, no effort has been made to derive a model which describes South African corporate governance fully or predicts its effects. Related closely to this, the results presented in this chapter have not been tested for endogeneity effects. As a result, findings are not necessarily generalisable.

66 This chapter is exploratory and provides only a broad review of trends in and possible drivers of South African corporate governance. Additional research will be required to quantify the costs and benefits of corporate governance and any substitution effects.

6 Assurance As sustainability and integrated reporting grow in prominence (Howitt, 2016; KPMG, 2017), the need for these reports to be subject to some form of assurance has been raised. The GRI (2016) advises the use of external assurance as a means of enhancing the credibility of a sustainability report. Similarly, the IIRC (2013) does not mandate integrated report assurance but it states that the reliability of information is affected by its balance and freedom from material error. Reliability (which is often referred to as faithful representation) is enhanced by mechanisms such as robust internal control and reporting systems, stakeholder engagement, internal audit or similar functions, and independent, external assurance. (IIRC, 2013, p. 21)

There is already a large body of research which shows that users perceive sustainability reports which have been subject to independent verification as more credible (see Simnett et al., 2009; Kolk and Perego, 2010; Branco et al., 2014). The same is expected to apply in an integrated reporting context as these become more widely used to evaluate and hold companies accountable for their financial and non-financial performance (IIRC, 2014a; Maroun, 2017a). Assurance may also add value for preparers by corroborating their understanding of their business, identifying weaknesses in systems and processes and providing recommendations on how to improve operations, stakeholder engagement and reporting practices (consider AccountAbility, 2008a; IIRC, 2014a; Simnett and Huggins, 2015). For those charged with governance, assurance by an independent party “can provide comfort over the integrity of the reported information prepared by management” and allow them to discharge their responsibility for the reliability of their organisation’s integrated report (IIRC, 2014a, p. 10). In this context, King-IV recommends that: The governing body should ensure that assurance services and functions enable an effective control environment, and that these support the integrity of information for internal decisionmaking and of the organisation’s external reports. (IOD, 2016, p. 68)

This chapter examines the assurance practices of South African listed companies in more detail. To provide context the drivers and benefits of ESG assurance are dealt with briefly (Section 6.1). This is followed by a discussion of the combined assurance model advocated by King-IV and a review of emerging forms of assurance practice in South Africa (Section 6.2). Section 6.3 reviews trends in assurance practices. Proposed changes to assurance models are discussed in Section 6.4 Section 6.5 summarises and concludes.

https://doi.org/10.1515/9783110621266-006

6.2 Combined assurance under the King Codes

119

6.1 Background on ESG assurance in accordance with the international literature The number of companies which rely on some type of external assurance of their sustainability reporting has been increasing steadily (KPMG, 2012; 2015). Assurance can be focused on – verification of select ESG disclosures, – testing the systems, processes and controls which support an integrated or a sustainability report, – confirmation of compliance with reporting guidelines and – testing the methodology followed in compiling a sustainability or an integrated report. (Dando and Swift, 2003; Junior et al., 2014; Maroun, 2017a) ESG assurance can be provided by independent specialists/consultants. There are also examples of assurance coming from reviews of a company’s sustainability reports= by NGOs, academics and international institutions operating in the ESG reporting space (Junior et al., 2014; Green et al., 2017). Most of the external assurance engagements are provided by the Big 4. While the results are mixed, the prior research suggests that these firms provide better quality assurance engagements which are more valued by stakeholders than they are non-accountants and smaller accounting firms (for details, see Perego, 2009; Simnett et al., 2009; Pflugrath et al., 2011; Zorio et al., 2013). A detailed review of the determinants of ESG assurance per international literature is beyond the scope of this chapter. Figure 6.1 summarises the primary drivers of ESG assurance identified by Farooq and De Villiers (2018; 2017) and Maroun (2018b). The prior literature does not deal specifically with the interaction between ESG assurance and corporate governance practices. How assurance is framed by codes of best practice is also not addressed. This is covered in detail below.

6.2 Combined assurance under the King Codes As discussed in Chapter 4, King-I and King-II frame “assurance” in terms of the work performed by internal and external auditors (see Section 4.1.4). King-III and King-IV take a broader approach and introduce the concept of “combined assurance” to South African corporate governance. This has been defined as the co-ordination of operational management, risk management and independent assurance services in order to mitigate risk (Institute of Internal Auditors (IIA), 2013; Decaux and Sarens, 2015). In terms of King-IV, a combined assurance model.

Figure 6.1: Drivers of ESG assurance.

ESG assurance can add value by informing changes to internal operations and business processes. ESG assurance may also be a pre-requsite for accurate, complete and reliable sustainability or integrated reporting

Larger firms with a greater social or environmental impact rely on more ESG assurance. This can be in response to stakeholder scrutiny, the risk of additional ESG regulation and the need for legitimacy

ESG assurance can be costly. It is not mandated by statutes or listing requirements and may expose an organisation to legal liability. There is also no guarantee that ESG assurance adds value for stakeholders of the firm

Operating environment

Demand for ESG assurance

Factors inhibiting demand for ESG assurance

Current assurance technology Assurance is limited to specific elements of integrated or sustainability reporting. Effective assurance may only be possible if an organisation has already invested extensively in its systems, processes and reporting infrastructure (see Chapter 4 on proactivity)

Organisational characteristics

Stakeholder pressure for credible reporting, especially as ESG disclosures become more relevant for assessing firm performance

Stakeholders

ESG assurance may be a substitute for low levels of investor protection and weak regulatory systems for enforcing good ESG performance

Regulatory and legal systems

120 6 Assurance

6.2 Combined assurance under the King Codes

121

incorporates and optimises all assurance services and functions so that, taken as a whole, these enable an effective control environment; support the integrity of information used for internal decision-making by management, the governing body and its committees; and support the integrity of the organisation’s external reports. (IOD, 2016, p. 10)

In other words, “assurance” is conceptualised as more than the result of an opinion by an independent expert on the fair presentation of financial statements or select disclosures in an integrated or sustainability report (Maroun, 2017a; 2018d). In keeping with the view that integrated reporting is the outcome of integrated thinking, combined assurance functions by enhancing internal control and supporting management decision-making in addition to focusing on the information reported to stakeholders. Figure 6.2 outlines the core elements of a combined assurance model.

The governing body establishing the scope of combined assurance and assuming responsibility for the assurance model

Scope and design Principles-based approach emphasising the need to cover material risks and other dimensions of the business model

Insights from the academic literature Combined assurance is an essential feature enterprise risk management. Internal and external sources of assurance are used to address each material risk and opportunity to maximise benefits and reduce risk

Combined assurance objectives Enable an effective control environment Support the integrity of information for internal use

Other rules and regulations

JSE listing requirements

Statutory considerations Provisions of the Companies’ Act dealing with the assurance

Support the integrity of external reports

Internal assurance components risk management systems/ functions; internal auditors; forensic examiners; safety and process assessors; ESG compliance officers and audit and risk committees

External assurance components External auditors; ESG specialists; forensic specialists; Regulatory inspectors; and Stakeholder reviews

Figure 6.2: Combined assurance.

King-IV’s fundamental premise refers to the board of director’s responsibility for providing strategic direction to an organisation and ensuring accountability for its performance and reporting (IOD, 2016, p. 21). Applied to combined assurance, the board is expected to guide the “arrangements for assurance services and functions”. The board must also ensure adequate monitoring and review so that the objectives of combined assurance are achieved (IOD, 2016, Principle 15, para 40). In practical terms, an audit committee would probably perform this monitoring function. The chief audit executive (or a person of equivalent standing and experience) would be expected to champion the operation of combined assurance (IOD, 2009; Deloitte, 2011).

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King-IV is not prescriptive about the scope or structure of the combined assurance model. The only guidance is that the governing body must ensure that “the combined assurance model is designed and implemented to cover the organisation’s significant risks and material matters effectively” (IOD, 2016, Principle 15, para. 42). Different types of assurance services or functions can be used, including a mix of internal and external sources of assurance. An example of the former is the internal mechanisms which an organisation has in place to identify, manage and report on material risks. The systems and processes for developing, implementing and reviewing the effects of risk mitigation strategies will form part of the internal assurance environment (for details see Solomon et al., 2000; Spira and Page, 2003; Segal et al., 2017). Verification and review by internal auditors, a firm’s occupational health and safety specialists or in-house ESG compliance staff are additional examples of internal sources of assurance (IOD, 2016, Principle 15, para 42). The role played by internal audit in combined assurance requires specific consideration because of the emphasis placed on the importance of this type of internal assurance by both King-III and King-IV. Internal audit should assist the board of directors with identifying and managing material risks. Formal assurance on the effectiveness of the risk management process should be provided with recommendations on how to address any weaknesses (Forte and Barac, 2015). The internal audit charter should also specify its role in the broader combined assurance model (IOD, 2016, Principle 15, para 49). This would include, inter alia, arrangements for supporting the audit of the financial statements; coordinating the effort of other internal and external sources of assurance; optimising the cost and efficiency of the combined assurance process and reporting to those charged with governance on the overall effectiveness of combined assurance (IOD, 2009; Forte and Barac, 2015). External auditors expressing an opinion on a financial statement form part of the combined assurance model (Maroun, 2017a). Independent assurance providers can also be tasked with testing internal systems and controls; the risk management processes and compliance with internal polices or external regulation (IOD, 2016). King-IV focuses specifically on the assurance of external reports, including the integrated report. Assurance may be sought for the underlying data, processes and internal controls; specific disclosures found in the reports; the extent of compliance with reporting frameworks or a combination of these elements. The scope of the assurance engagement should be determined by what the governing body requires to assume responsibility for the integrity of information reported to stakeholders (IOD, 2016, Principle 1, para 44–46). Either an external auditor or an ESG specialist/consultant will usually be engaged to provide the necessary assurance services. Some companies are also relying on stakeholders and third-party specialists to review and provide feedback on their integrated or sustainability reports (Junior et al., 2014; Maroun, 2018b).

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As discussed in Chapter 2 and Chapter 4, King-IV does not have the direct force of law but some recommended governance practices dealing with assurance overlap with provisions in South Africa’s company law and the JSE’s listing requirements. These are summarised in Table 6.1. Table 6.1: Assurance provisions included in the Companies Act (2008). Audit committees

In terms of the Companies Act (), most public companies must have an audit committee (s()). In addition to duties relating to the financial statement auditor, the audit committee is required to prepare a report which – describes how the committee carried out its functions.; – states whether or not the audit committee is independent and – comments on the company’s financial statements, internal financial controls and any related matter. (Companies Act, 2008, s94(7)(f)) The audit committee must also “receive and deal appropriately with any concerns or complaints, whether from within or outside the company or on its own initiative”, relating to – the company’s accounting practices or internal audit, – the content or auditing of the financial statements, – internal financial controls and – any related matter. (Companies Act, 2008, s94(7)(g)) Finally, the audit committee is expected to “make submissions” to the board of directors on “the company’s accounting policies, financial controls, records and reporting” (Companies’ Act, 2008, s94(7)(h)). The legislation does not deal directly with the integrated report or combined assurance, but it does require an audit committee to “perform such other oversight functions as may be determined by the board” (Companies’ Act, 2008, s94(7)(i)).

Mandatory audit

A public company’s annual financial statements must be audited (Companies’ Act, , s()(a)). In addition, a listed company can only be audited by an audit firm which has been accredited by the JSE (JSE, ). There is no requirement in the Companies’ Act () to prepare an integrated report and for this to be audited. Where, however, an integrated report accompanies the annual financial statements, the integrated report may be examined by the external auditor for inconsistencies with the financial statements (see Maroun and Wainer, ; IAASB, ).

67 For exceptions, see s94(1) and s94(2a&2b) of the Companies Act (2008). A private company may also be required to form an audit committee in terms of its memorandum of incorporation (see s34 (2) and s94(2) of the Companies Act (2008)).

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Table 6.1 (continued ) Interim financial statements

The JSE does not mandate the audit of an interim report but it does specify certain circumstances when an interim report should be reviewed. This will apply when, for example, the prior period’s financial statements received an adverse, disclaimed or qualified audit opinion (see JSE, , Section ).

Internal audit

King-IV makes several recommendations concerning the internal audit function. These include, inter alia: – adequate financial, human and intellectual capital to ensure the sound functioning of internal audit and – appointing a chief audit executive with defined roles/responsibilities and the necessary authority and standing in the organization (IOD, 2016, Principle 15, para 48–61). The JSE does not mandate the use of internal audit for listed companies, but it requires these companies to form an audit committee which is responsible for, inter alia, ensuring “appropriate financial reporting procedures and that those procedures are operating” (JSE, 2016, Section 3.84(g)). In the authors’ opinion, it would be difficult for an audit committee to discharge this duty without an effective internal audit mechanism. Furthermore, in any legal dispute, whether or not an audit committee and the board of directors acted reasonably in discharging their governance duties under the JSE’s Listing Requirements and the Companies Act (2008) will probably take into account the widespread use of internal audit by South African and international listed companies.

Comply and explain

Dealing with listing particulars, Section .F. of the Listing Requirements states: “An applicant issuer must implement the King Code through the application of the King Code disclosure and application regime” (JSE, ). In addition, “an issuer” must disclose in its annual report “the implementation of the King Code through the application of the King Code disclosure and application regime” (JSE, , Section ..). These provisions suggest that the comply and explain logic adopted by King-IV are also part of the JSE’s listing requirements. The implication is that the way companies have applied King-IV’s principles (including Principle  on combined assurance) and adopted recommended practices to give effect to the principles should be explained in the annual report. By inference, any non-compliance should also be identified and explained.

In seeking to identify and manage the reduction of risk, combined assurance can be seen as an integral part of a broader enterprise risk management (ERM) philosophy. In line with the Committee for Sponsoring Organisations of the Treadway Commission (COSO, 2004, p. 2):

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Enterprise risk management is a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.

ERM, supported by combined assurance, can enhance compliance and the application of governance practices (IIA, 2013; Forte and Barac, 2015). Although not explicit from the prior literature, many of the benefits of ERM may be amplified by combined assurance. These include, for example, more effective internal decision making; improved operating efficiency; a better understanding of material risks; an increased likelihood of achieving strategic objectives and enhanced reporting on risk exposure and management (see IOD, 2009; 2016). Both ERM and combined assurance “require the board, audit committee, management and internal audit to be role players” (Forte and Barac, 2015, p. 74). As discussed in Chapter 4 (Section 4.1.1), the board is responsible for the risk assessment, response and management which will include the effective use of internal and external sources of assurance. Those charged with governance play an integral role in providing monitoring and review of and strategic direction on the organisation’s approach to risk management (see IOD, 2009; 2016). As part of this process, material risks and opportunities should be identified and linked to the applicable operating activity or business process which are then subject to testing by internal and external assurance providers (Deloitte, 2011; Decaux and Sarens, 2015; Forte and Barac, 2015). The mix and extent of assurance will be influenced by factors such as the materiality of the operating activity or business process; the assessed level of risk and the suitability of assurance methodologies for addressing the identified risks. Care must be taken to avoid duplication of assurance and to ensure that the results of any assurance process are reported to those charged with governance and responded to by management. Ultimately, combined assurance can only be effective if the organisation has a well-designed risk management framework in place and that those charged with governance and management are committed to implementing and maintaining this (PwC, 2010; Ernst and Young (EY), 2013). Assurance needs to be understood as an integral part of this framework and not as a compliance-focused exercise or something which is used only to placate stakeholders (Decaux and Sarens, 2015; Maroun, 2017a).

6.3 Trends in South African assurance practice To evaluate assurance practices by South African listed firms in more detail, disclosures on ESG assurance in the annual, integrated and sustainability reports (referred to collectively as corporate reports) of the largest 100 companies listed on the JSE are

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examined. The period under review is 2013 to 2017. This coincides with the publication of the IIRC’s framework on integrated reporting and the release of King-IV.68 Figure 6.3 shows that, on average, 96% of companies include a statement acknowledging the board’s responsibility for the integrity of corporate reporting with little variability from 2013 (94%) to 2017 (97%). Statements on compliance with the IIRC’s framework and the GRI’s guidelines are less common with an average score of 63% and 73% respectively over the 5-year period. In contrast, 91% of companies make reference to King-IV compliance and 92% refer to the use of different sources of assurance for their corporate reports.

Statement that the reports are assured Statement on compliance with King Statement on compliance with GRI Statement on compliance with IIRC Board responsibility statement 0%

20%

40%

60%

80%

100%

120%

Board responsibility statement

Statement on compliance with IIRC

Statement on compliance with GRI

Statement on compliance with King

Statement that the reports are assured

2017

97%

77%

63%

91%

94%

2016

97%

72%

71%

91%

93%

2015

96%

61%

73%

92%

90%

2014

97%

60%

76%

91%

91%

2013

94%

44%

79%

90%

89%

Figure 6.3: Compliance with codes of best practice.

Ackers and Eccles (2015) report on the use of external assurance by South African listed companies from 2007 to 2012. They find that only 9% of the largest 200 companies provided independent assurance on ESG disclosures in 2007/2008, increasing to 26% by 2011/2012. These low percentages are probably due to the fact that only larger companies have the systems and processes in place to support external assurance (Maroun, 2018b) and are able to absorb the cost of independent assurance (see Simnett et al., 2009; Branco et al., 2014). When focusing on the top 80 companies, Ackers and Eccles

68 Not all of the 2018 reports were available at the time of data collection.

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6.3 Trends in South African assurance practice

(2015) find that just under 50% published an independent ESG assurance report as part of their corporate reports in 2011/2012. Figure 6.4 shows a significant growth in the use of ESG assurance from 2013 to 2017. This is to be expected in light of the increased emphasis on the importance of having ESG disclosures independently verified by the IIRC (2013) and GRI (2016). The higher proportions are probably also due to differences in approach followed to collect data. Ackers and Eccles (2015) appear to focus on whether or not an ESG assurance report was published. These are normally included as part of the primary report to stakeholders, but the authors of this research determined that this was not consistently the case. As a result, the search for ESG assurance statements was expanded to include secondary reports and company webpages. In addition, when a corporate report referred to external assurance but the assurance report was not published, the respective company was contacted directly to clarify whether external assurors were engaged.69 Consequently, the data in Figure 6.4 may not be entirely comparable with Ackers and Eccles (2015). 95%

Proportions

90%

85%

80%

75%

70%

2013

2014

2015

2016

2017

External assurance proportion

91%

91%

89%

88%

93%

Internal assurance proportion

79%

81%

79%

84%

81%

Figure 6.4: Use of internal and external assurance.

69 When only integrated and sustainability reports are referred to, the proportion of companies which appear to engage an external assuror decreases to 57% in 2013 and 60% in 2016 and 2017. The authors are grateful to Andre Prinsloo for his invaluable assistance with coding corporate reports, searching corporate webpages and contacting companies by which assurance statements were not published.

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There is a slightly positive trend in the use of external assurance from 2013 to 2017. External sources of assurance are preferred to internal ones. This may be due to the fact that stakeholders place more value on an assurance report issued by an independent expert than on a company’s internal assurance mechanisms. It is, however, also possible that companies have not formally reported on the outcome of their internal assurance processes in an effort to avoid overly complex and lengthy corporate reports.70 Figure 6.5 shows that the Big 4 account for the majority of external ESG assurance engagements from 2013–2017 (42%). Consistent with the prior international

2% 2%

Big 4

6%

Verification agency

6% Audit committee 43% Internal auditor

17%

Consultant Other audit firm Sustainability committee or equivalent

24%

Assurance provider

2013

2014

2015

2016

2017

Total

Big 4

41%

42%

42%

43%

44%

42%

Verification agency

24%

24%

23%

24%

25%

24%

Audit committee

16%

17%

17%

17%

19%

17%

Internal auditor

6%

6%

6%

7%

4%

6%

Consultant

6%

6%

5%

5%

6%

5%

Other audit firm

3%

3%

3%

2%

1%

2%

Sustainability committee or equivalent

3%

3%

3%

3%

1%

2%

Joint auditors

1%

0%

1%

0%

0%

1%

Review panel

0%

0%

0%

0%

0%

0%

Figure 6.5: Assurance providers.

70 For example, listed companies are expected to have an internal audit department (JSE, 2016) but not all companies report on the work performed by and findings from internal audit.

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research, the Big 4 are preferred to verification agencies or consultants (24%) and smaller audit firms (3%) (for details, see Perego, 2009; Simnett et al., 2009). In total, companies report on how an audit committee or internal auditor contributed directly to the combined assurance process in only 17% and 6%, respectively, of the corporate reports under review. Junior et al. (2014) find that reviews of companies’ sustainability reports by NGOs, academic, non-financial reporting institutions are an emerging form of assurance in international markets. In South Africa, only five instances of this taking place (less than 1%) are recorded. A variety of professional standards and guidelines is used in South African ESG assurance. Focusing on only external assurance, Ackers and Eccles (2015) find that International Standards on Assurance Engagements71 (ISAEs) and AA1000 Assurance Standard (AA1000AS) are most commonly used. The latter is issued by the International Auditing and Assurance Standard Board (IAASB) and provide guidance on the assurance of information other than audits or reviews of financial statements (IAASB, 2013; 2015). Either a high (reasonable) or moderate (limited) level of assurance is provided. Examples include engagements on water usage, greenhouse gas emissions, employee statistics and financial ratios. AA1000AS was issued by AccountAbility. It provides a platform to align the non-financial aspects of sustainability with financial reporting and assurance. It provides a means for assurance providers to go beyond mere verification of data, to evaluate the way reporting organisations manage sustainability, and to reflect that management and resulting performance in its assurance statements. (AccountAbility, 2008a, p. 6)

Similar to the ISAE’s either a reasonable or limited assurance engagement is performed. A Type-1 engagement requires a practitioner to evaluate and report on an organisation’s adherence to the principles of inclusivity, materiality and responsiveness.72 A Type-2 engagement extends this by concluding on the accuracy and reliability of sustainability disclosures (AccountAbility, 2008a). From 2013 to 2017, codes on good practice dealing with BEE73 were the most commonly used external assurance framework (20%) followed by the ISAEs (13%). AA1000AS (2%) and principles outlined by the GRI (1%) are relatively uncommon. Internal assurance is normally driven by company-specific charters informed by the

71 Specifically ISAE 3000, Assurance Engagements other than Audit or Reviews of Historical Information 72 Inclusivity – stakeholders are included in the process of developing a strategic response to sustainability and the entity accepts that it is accountable to a broad group of stakeholders for its sustainability performance. Materiality – the reporting entity assesses the relevance and significance of issue for its long-term sustainability. Responsiveness – the organisation responds reasonably to stakeholders’ concerns about sustainability performance. 73 This comprises a number of policies and statutes introduced to address racial and economic equality in South Africa following the end of Apartheid.

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6%

3% Internally generated and/or IIA guidelines 28%

14%

ISA’s Codes of good practice on BEE ISAE’s ISO Standards and/or GHG Protocol

21%

Not stated

28%

Framework

2013

2014

2015

2016

2017

Total

Internally generated and/or IIA guidelines

26%

28%

27%

27%

27%

27%

ISAs

27%

27%

27%

27%

26%

27%

Codes of Good Practice on BEE

21%

20%

20%

20%

21%

20%

ISAEs

13%

12%

14%

13%

13%

13%

ISO Standards and/or GHG Protocol

4%

6%

5%

6%

7%

6%

Not stated

4%

3%

3%

3%

3%

3%

AA1000AS (AccountAbility)

3%

3%

1%

1%

1%

2%

GRI or GRI with specified framework

1%

1%

2%

2%

1%

1%

Figure 6.6: Assurance frameworks used.

guidance provided by the IIA (27%). All financial statement audits are performed in accordance with International Standards on Auditing (see Figure 6.6). In terms of the scope of assurance, Figure 6.7 shows that most companies focus on financial capital (34%) while manufacture capital accounted for only 4% of the subject matter of combined assurance models.74 In keeping with an integrated thinking logic, companies are having their intellectual and human (27%), social and relationship (22%) and natural capital (13%) assured. Examples include reviews of anti-corruption policies and whistleblowing arrangements; confirmation of health and safety statics; tests of specific ESG disclosures; tests of stakeholder engagement processes and examination of operating policies and controls by either internal auditors or senior executives.

74 For a definition of the capitals, refer to Appendix A

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13%

34%

Financial capital Manufactured capital Social and relationship capital

27%

Intellectual and human capital Natural capital 4% 22%

Year

Financial capital

Manufactured capital

Social and relationship capital

Intellectual and human capital

Natural capital

2013

34%

5%

22%

26%

13%

2014

33%

5%

23%

26%

13%

2015

34%

5%

22%

26%

13%

2016

33%

4%

23%

27%

13%

2017

36%

3%

19%

30%

12%

Total

34%

4%

22%

27%

13%

Figure 6.7: Focus of assurance.

Number of subject matters

400 350 300 250 200 150 100 50 0

External Internal External Internal External Internal External Internal External Internal 2013 2014 2015 2016 2017 Natural capital 52 14 56 14 55 12 53 13 52 6 Intellectual and human capital 74 58 76 60 73 60 75 61 78 70 Social and relationship capital 88 26 91 27 90 26 87 30 86 7 Manufactured capital 21 7 19 6 19 7 12 7 11 4 Financial capital 104 71 101 74 101 73 95 73 106 71

Figure 6.8: Focus of internal vs external assurance.

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Both internal and external sources of assurance are being used to address the different capitals. For example, Figure 6.8 shows that external assurance included subject matter dealing with each of the capitals from 2013 to 2017 with no significant changes in composition over this period. The same is true for internal assurance which includes subject matter dealing with both financial and non-financial elements. As indicated in Figure 6.4, internal assurance is used or reported less often than external sources of assurance.

6.4 Proposed changes to assurance models While external sources of assurance appear to be preferred to internal ones, they are subject to inherent limitations. For example, tests and controls are common in financial statement audits but can be challenging in an integrated reporting environment where control objectives are undefined or if, as discussed in Chapter 3, the client’s accounting infrastructure is not sufficiently developed (Maroun and Atkins, 2015). Similarly, many of the substantive test procedures outlined by the professional assurance literature are described in quantitative or mathematical terms and are used to evaluate historical information. They may not be suited to qualitative or forwardlooking disclosures found in an integrated report (Dando and Swift, 2003; O’Dwyer, 2011; Cohen and Simnett, 2015; Maroun and Atkins, 2015; Simnett and Huggins, 2015). There are also concerns about conventional audit’s risk-based model. This is based on the risk of a material misstatement because of fraud or error. Concerns that an entity fails to identify core stakeholders relies on inappropriate key performance indicators or neglects non-financial capitals are relevant in a sustainability environment but are not considered explicitly by traditional audit (see Peecher et al., 2007; Stubbs and Higgins, 2015). Others question how materiality should be determined. The market- or shareholder-centric construction of materiality is applied in a financial reporting environment but will not be appropriate for guiding the assurance of a stakeholder-orientated approach to corporate governance and reporting. There is a growing body of research on the concept of materiality in sustainability reporting but exactly how this can be applied as part of a combined assurance model not has been covered by either the academic or the professional literature (see Wallage, 2000; Cohen and Simnett, 2015; Edgley et al., 2015; Simnett and Huggins, 2015). Perhaps the greatest challenge is the availability of suitable criteria by which to assess an integrated report. Unlike financial reporting standards, the IIRC’s framework is principles-driven and not prescriptive about the format or content of an integrated report. The result is a significant variation in exactly what and how companies report to their stakeholders (de Villiers et al., 2014; 2017a). In this dynamic reporting environment, external assurors are unable to conclude objectively on whether or not an integrated report meets the objectives outlined by the

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IIRC (2013) or the information needs of the relevant stakeholders. There “remains no generally accepted standard providing robust assurance for all aspects of an organisation’s sustainability reporting” (Dando and Swift, 2003, p. 196, emphasis added; Maroun, 2018b). To enhance the potential of external assurance, Dillard (2011) and O’Dwyer (2011) question if assurance can only be obtained by the independent expert performing test procedures on a specified subject matter. If assurance is understood as an analytical and interpretive process, it becomes possible to provide a conclusion, although normative, on a company’s sustainability or integrated reporting. For example, following a similar process to a qualitative researcher, assurance can be provided by considering if a company has provided sufficient detail for stakeholders to understand its business model and if the information included in the integrated report can be corroborated by or contrasted with external sources (see Peecher et al., 2007; Dillard, 2011). Following a similar line of thought, Maroun (2018d; 2017) considers how the focus of external assurance may need to shift from disclosures found in an integrated report to the systems and controls underlying those disclosures and the methodology followed by management to analyse and report information to stakeholders. To facilitate change, audit risk can be broadened by considering the risks which result from an entity’s operating and strategic context, relationships with key stakeholders and dependencies on financial and non-financial capitals (see also Bell et al., 2005; Morimoto et al., 2005; Peecher et al., 2007). This will leave auditors better place to test specific parts of an integrated or a sustainability report. Perhaps more valuable is a comprehensive risk assessment process to draw management’s attention to weaknesses in their business model, strategy development and operating practices (Morimoto et al., 2005; Dillard, 2011). In a combined assurance environment, it may also be possible for alternate sources of external assurance to complement the results of testing performed by an independent expert. For example, stakeholder reviews of the adequacy of integrated reports (Junior et al., 2014) can be combined with a formal assessment of the methods followed in compiling the documents by a multidisciplinary team of experts (Maroun, 2018d). This is especially true if stakeholders and ESG specialists have the collective expertise and understanding of the business to provide informed feedback of a company’s operations and challenge a company’s directors on ESG performance (Edgley et al., 2010, p. 554). At the same time, specific disclosures can be the subject of an ISAE or AA1000AS engagement while senior management, internal audit and those charged with governance focus on internal controls and the integrity of operating systems. The solution may be determining optimal combinations of different types of internal and external assurance which allows stakeholders to place their confidence in the organisation’s governance.

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6.5 Summary, conclusion and future research King-IV requires the “governing body [to] govern risk in a way that supports the organisation in setting and achieving its strategic objectives” (IOD, 2016, Principle 11). Risk governance requires an organisation to be cognisant of risks and opportunities arising from the organisation’s business model, strategic position and operating context. Risk identification and management should be integral to how the organisation does business and engages with its stakeholders. Effective risk management will also require assurance to confirm the appropriateness of risk management practices, identify weaknesses and propose recommendations (IOD, 2016). In this way, assurance should be understood as an integral part of the broader ERM philosophy rather than as a regulatory or compliance-focused initiative. Principle 15 of King-IV recommends the use of a combined assurance model as part of a risk governance framework. This relies on many sources of internal and external assurance to enable an effective control environment, ensure the reliability of information for internal purposes and bolster the quality of integrated reporting (IOD, 2016, Principle 15, para 40–43). Many South African organisations are already using combined assurance to address financial, regulatory and operational risks. It is also being used to support strategy development, risk identification and reviews of operating objectives (Forte and Barac, 2015; Prinsloo and Maroun, 2018). Internal and external auditors play a key role in the combined assurance model. Their services are complemented by the activities of audit and risk committees which King-IV additionally requires to assume overall responsibility of the governance of an organisation’s risk (IOD, 2016). When implemented effectively, combined assurance results in a co-ordinated approach to risk management and can be used to demonstrate that material risks are being addressed. In turn, the organisations with mature combined assurance models will be more comfortable reporting on the integrity of their risk management process and the steps taken to ensure that their integrated report is accurate, complete and reliable (Forte and Barac, 2015). Stakeholders’ confidence is also enhanced by the knowledge that companies have adopted combined assurance and that managers are, therefore, able to provide accurate assurances and not simply guesswork. (Deloitte, 2011, p. 4)

Not all companies are, however, making use of combined assurance. Some give only limited details on their combined assurance models in their reports. It is possible that the cost of assurance (Park and Brorson, 2005), limitations of existing assurance guidelines (Maroun and Atkins, 2015) and under-developed risk management systems (Decaux and Sarens, 2015) hinder the application and development of combined assurance. In some cases, organisations have not planned for and allocated the necessary resources to their assurance functions (Deloitte, 2011). The extent to which companies have internalised the strategic and operating benefits associated with

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135

combined assurance has also not been established. Consequently, in the absence of direct legal backing – as is the case with financial statement audits – investment in a broader combined assurance model may remain relatively limited. Research on combined assurance is scant (Decaux and Sarens, 2015). This chapter provides an overview of the provisions of the King Codes on the use of assurance as part of the broader corporate governance system. It also highlights trends in assurance practices by some of the JSE’s most established companies. Exactly how these organisations have interpreted and operationalised King-IV’s principles and practices on combined assurance has not been addressed. Additional research is required to understand the benefits and costs of combined assurance, the challenges encountered when implementing a combined assurance model and how these can be met. Stakeholders’ opinions about combined assurance will also need to be studied in more detail. There is a large body of work on the value-relevance of sustainability and integrated reporting but the extent to which and precisely how combined assurance contributes to broader sustainability and an integrated thinking agenda remain unexplored.

7 Corporate governance by not-for-profit organisations Not-for-profit (NFPs) or NGOs are important providers of public goods and services, often addressing needs which would not be met by either the state or the private sector. According to the GRI (2013, p. 8), these organisations: are formed for the purpose of serving a cause other than the pursuit or accumulation of profits for owners or investors. NGOs are by nature values-driven but involve a variety of activities (e.g., advocacy, service provision, research) devoted to a broad range of issues (e.g., human rights, environment, humanitarian assistance, development, education) and adopt a broad spectrum of organizational forms (e.g., federations, associations, foundations, coalitions, networks). NGOs may be large or small, raising funds from public and private sources for their own or partner activities.

The World Bank recognises the invaluable part played by NGOs in assisting governments in achieving development goals. Their unique skills, coupled with direct engagement with members of the public, allow them to identify vulnerable groups, ascertain their needs and provide the relevant information to policymakers. They can enable social and environmental activism, raise awareness of important issues and engage with governments on how to improve policies and practices (IOD, 2016). In this way, NGOs can be seen as an essential part of democratic institutions and the broader governance environment. Accounting academics have written extensively on NGOs from a developmental economics perspective. Internal management, cost efficiency and how NGOs raise donor funds have been the central focus (see Jones and Roberts, 2006; Unerman and O’Dwyer, 2006). A second stream of research considers how NGOs function as a mechanism of accountability by holding companies responsible for their social and environmental performance (see, for example, Brennan and Merkl-Davies, 2014; Apostol, 2015) and shaping the development of policies and acceptable practice at the organisational or state level (see Deegan and Blomquist, 2006; Afreen and Kumar, 2016). The factors which limit the work performed by NGOs have also been dealt with. Examples include the availability of resources, hegemonic challenges to the sustainability movement by powerful corporations and a lack of support for social and environmental activists (see Arts, 2002; Lauwo et al., 2016). Ironically, we know very little about how governance systems are developed by, and operate at, the NGOs. This is despite their important position in contemporary society and the fact that ‘across the NGO sector there is a diversity of approaches to governance and management and these approaches may differ significantly from those used in other sectors’ (GRI, 2013). What little has been done on NGO governance is also based on the USA, Europe of Australia. NGOs operating in Africa have been largely overlooked. https://doi.org/10.1515/9783110621266-007

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In this context, this chapter provides an initial review of corporate75 governance by South African NGOs. It discusses the Sector Supplements in King-IV which provide guidance on corporate governance for NGOs (Section 7.1). The chapter proceeds with an overview of sustainability or integrated reporting by some of the country’s most established NGOs (Section 7.2). Finally, trends in corporate governance practices and disclosures are discussed (Section 7.3). Section 7.4 summarises and concludes.

7.1 King IV sector supplements Good governance is important for all organisations, irrespective of their structure and objectives (IOD, 2016). This is especially true for NGOs which need to adhere to the highest standards of transparency, efficiency and ethical conduct in order to set an example for those they hold accountable for poor ESG performance. Donors, regulators and the communities will also expect effective systems of corporate governance to be in place. In addition to bolstering legitimacy, corporate governance can increase access to essential capitals; enhance internal control and operating efficiency; safeguard key assets and ensure the long-term sustainability of the NGO itself (GRI, 2013; IOD, 2016). Unlike the earlier Codes, King-IV includes guidance on the application of governance principles and practices in different sectors. Part 6.3 of the Sector Supplements deals with non-profit organisations. Key details are outlined in Table 7.1.

7.2 Reporting by NGOs As at the end of 2017, 40% of the NFP entities registered in South Africa have been engaged in delivering essential social services. Those dealing with development and housing account for 20% of the total, followed by religious bodies (12%) and healthcare service providers (11%). NFPs dealing with the environment make up only 1% of the total. Refer to Figure 7.1. Following Figure 7.2, most Non-profit organisations (NPOs) are located in Gauteng (33%) consistent with the fact that this province is home to the largest proportion of South Africa’s population and accounts for the majority of the country’s economic activity.

75 As explained by King-IV, “corporate” refers to any entity which is considered legally separate from its founders. A corporate is not necessarily formed to make a profit and can include the public sector and NGO space.













Governing the ethics of an organisation will require the governing body to assume responsibility “for its own charter and conduct” (IOD, 2016, p. 89). The governance of ethics is especially important in the NGO environment, considering the confidence which stakeholders, including vulnerable members of society, vest in NGOs (GRI, 2013; Maroun and Lodhia, 2018).

Ethical leadership includes compliance with applicable laws and regulations. For example, South African NGOs will need to consider the relevance of the Non-profit Organisations Act77 (1997). As a matter of law, the governing body owe their fiduciary duty to the NGO, rather than to the party which appointed them. Where a member of the governing body has been appointed by or to represent a donor or other stakeholder, care needs to be taken to avoid conflicts of interest (IOD, 2016, p. 89) The duties of the governing body laid out by King-IV and applicable statute are not diminished because the individual members receive no or below-market remuneration (IOD, 2016, p. 89). In terms of the guidance issued by the Department of Social Development (2001), ethical leadership requires the governing body to act with reasonable care, in good faith and mindful of the NGOs contractual and legal commitments.

Application

76 Only the principles covered in the Sector Supplement have been included in Table 7.1. The fact that additional guidance on these principles is not provided does not mean that they are irrelevant for South African NGOs (IOD, 2016, p. 75). 77 A review of this legislation is beyond the scope of this research.

Principle  The governing body should govern the ethics of the organisation in a way which supports the establishment of an ethical culture

Principle  The governing body should lead ethically and effectively.

Principle Detail

Table 7.1: Corporate governance provisions specific to NGOs.

138 7 Corporate governance by not-for-profit organisations

Managing economic, environmental and social dimensions of performance is especially relevant for NGOs. Private companies may be able to argue that environmental or social outcomes are important, but still secondary, part of their business model. This would not be the case for NGOs which are often tasked with achieving specific environmental or social objectives. In this context: – An NGO should have a detailed understanding of how its strategy, risks and business model interact as part of the value creation process (IOD, 2016, p. 90). – Care must be taken to ensure that its programmes meet stakeholders’ needs taking both financial and nonfinancial factors into account (Department of Social Development, 2001). – Systems and controls need to be put in place to ensure that resources are used efficiently and that assets are safeguarded (Department of Social Development, 2001). – In the interest of long-term sustainability, the NGO must establish a reliable source of funds and ensure that its actions and behaviour do not bring the NGO into disrepute (Department of Social Development, 2001).

Principle  The governing body should appreciate that the organisation’s core purpose, its risks and opportunities, strategy, business model, performance and sustainable development are all inseparable elements of the value creation process.

(continued )

The case for being a corporate citizen is easy to make for NGOs (IOD, ): – They play an active role in championing social and environmental issues and holding the private sector and the state accountable for their ESG performance (see Brennan and Merkl-Davies, 2014). – In many cases, NGOs serve as a link between an organisation and other stakeholders. They can share information, moderate relationships and provide technical and ethical support to the private sector (see Atkins et al., 2018). – While uncommon, NGOs may be approached to assist with the review of a company’s corporate governance systems (including its corporate reporting) as part of a combined assurance model (Junior et al., 2014). (See Chapter 6 for details on combined assurance).

Principle  The governing body should ensure that the organisation is and is seen to be a responsible corporate citizen.

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139

Effective reporting is important for an NGO to provide an account of its performance to key stakeholders and build its credibility in the eyes of the public. The benefits of good reporting are discussed in more detail in Section ..

The governing body should have a clear understanding of its responsibilities and how these change according to the context in which the NGO operates. “A governing body that meets the legal standards of its constitution and registration, in the performance of its duties, also positions the organisation for success through good management and ethical practices” (Department of Social Development, , p. ). It can be difficult to achieve the appropriate mix of experience and expertise on the governing body, especially if members are appointed to represent specific constituents. This can be addressed by following the recommended practices for a nomination, election and rotation of members of the governing body seen in the private sector. Many experienced individuals will also be willing to serve at NGOs for little or no remuneration out of a sense of duty to their community or the NGO’s cause (IOD, ). – The size and composition of the governing body will vary according to context and prevailing circumstances. – The governing body should remain open to change. Rotation of members or the admission of new members may form part natural development of corporate governance at an NGO. – The governing body should not be involved in routine operations. It should provide strategic direction and carry out an independent monitoring and dispute resolution function. – Care must be taken to ensure that there are sufficiently experienced senior staff, including a chief executive, to provide managerial support and execute key tasks. (Department of Social Development, 2001).

Principle  The governing body should serve as the focal point and custodian of corporate governance in the organisation

Principle  The governing body should consist of the appropriate balance of knowledge, skills, experience, diversity and independence to discharge its governance role and responsibilities effectively.

Application

Principle  The governing body should ensure that reports issued by the organisation enable stakeholders to make informed assessments of the organisation’s performance and its short-, medium- and long-term prospects.

Principle Detail

Table 7.1 (continued )

140 7 Corporate governance by not-for-profit organisations

An evaluation of the governing body’s progress and performances should take place every  to  years. The method for completing the performance evaluation is at the discretion of the governing body but should include, at a minimum, individual members’ knowledge of and commitment to the NGO, work ethic, “ability to give” and “influence in the client or donor community” (Department of Social Development, , pp. –).

Principle  The governing body should ensure that the evaluation of its own performance and that of its committees, its chair and its individual members, supports continued improvement in its performance and effectiveness.

(continued )

The principles dealing with the formation of different committees to assist the governing body are equally relevant for NGOs (IOD, , p. ). The governing body’s duties include, inter alia: – determining the organisation’s mission and purpose, – selecting, appointing and supporting the chief executive officer, – ensuring effective organisational planning, access to key resources and effective management of those resources, – determining and monitoring programmes and services, – moderating disputes among senior staff and – building and maintaining the NGO’s credibility. (Department of Social Development, 2001).

Principle  The governing body should ensure that its arrangements for delegation within its own structures promote independent judgement, and assist with balance of power and the effective discharge of duties.

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The governing body should ensure that the appointment of, and delegation to, management contribute to role clarity and the effective exercise of authority and responsibilities

In the execution of its “Participation of affected stakeholders in the design, implementation, monitoring and evaluation of policies and governance role and programs is a core value for many NGOs” (GRI, , p. ). This includes, inter alia, responsibilities, the – formal policies and processes for identifying stakeholders and determining their legitimate expectations; governing body should – active involvement by stakeholders in the form of “information sharing, dialogue, consultation, collaboration, adopt a stakeholderpartnership and empowerment/self-determination” and inclusive approach which – reporting on how stakeholders have been included in decision making processes and how any feedback balances the needs, received affected the NGO’s policies and actions. (GRI, 2013, p. 31) interests and expectations of material stakeholders in the best interests of the organisation over time

Principle 

According to the Department of Social Development (, p. ), in a mature NGO, the governing body is not tasked with day-to-day operating activities, the controls executed by the chief executives or managing inter-staff relations. Nevertheless, where activities are delegated to managers, this should not compromise the control environment or give rise to material threats to the governance of ethics (IOD, ).

Application

Principle 

Principle Detail

Table 7.1 (continued )

142 7 Corporate governance by not-for-profit organisations

7.2 Reporting by NGOs

1%

143

5% Business and professional associations, unions 20%

Culture and recreation Development and housing Education and research

40%

Environment Health International Law, advocacy, and politics 7% 1%

Philanthropic intermediaries and voluntarism promotion Religion Social services

11% 12%

1% 2% 0%

Figure 7.1: NFP entities in South Africa. (Department of Social Development, 2018)

10%

9% 5%

5% Eastern Cape Free State

6%

Gauteng Kwazulu Natal Limpopo 11%

Mpumalanga 33%

North West Western Cape

20% Figure 7.2: NFP entities by province. (Department of Social Development, 2018)

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The international literature on the extent of reporting by NGOs is limited.78 The little research which has been done focuses on different metrics used to gauge a NGO’s performance. Examples include ratios of fundraising expenses to total expenses or funds obtained from donors and the cost of a particular project, relative to total operating costs (Ryan and Irvine, 2012a; 2012b). The implications of the sustainability and integrated reporting movement which has had a significant effect on the private sector remains unclear (Glennie and Lodhia, 2013; Maroun and Lodhia, 2018). This is despite the fact that a multi-capital approach to business management and reporting may resonate with the strong social and environmental focus of the majority of NGOs. More specifically, high quality integrated reporting which explains exactly how an NGO creates value can be useful for: – building credibility with key stakeholders, including donors, which is essential for raising funding and gaining access to other important capitals – enabling an NGO to engage effectively with a broader group of stakeholders and demonstrate the impact which the NGO has on society – assessing the effectiveness and efficiency of policies and processes and informing better internal decision-making – reflecting on past performance and comparing the NGO with valid benchmarks in order to drive operational and strategic improvement (GRI, 2013; IOD, 2016) Neither the integrated reporting framework (IIRC, 2013) nor GRI-G4 (GRI, 2016) deal explicitly with reporting by NGOs but a GRI sector supplement is available. Read with King-IV’s guidance on integrated thinking and the triple context (see IOD, 2016, p. 24), effective reporting will require a detailed account of the NGOs economic, environmental and social performance. Using the guidelines provided by GRI (2013), each of the three focal areas can be analysed according to 64 core and 29 additional disclosure elements. These can provide an easy-to-apply outline (see Table 7.2) which is useful for analysing integrated or sustainability reports by South African NGOs. Campanella et al. (2018) study the extent to which 6 of South Africa’s best NGOs provide details on the economic, environmental and social performance in their annual, integrated or sustainability reports (referred to collectively as corporate reports) over a three-year period from 2015 to 2017. The disclosures in Table 7.2 are used to generate findings which are summarised in Figure 7.3.79 Figure 7.3 shows the aggregate disclosure per each of the 7 categories in Table 7.2 after controlling for repetition. Most of the disclosures deal with environmental metrics (28% of total elements disclosed) because of the chosen NGOs are primarily operating in this space. As NGOs use their corporate reports to engage

78 To the authors’ best knowledge there are no detailed South Africa-specific studies on this. 79 Figure 7.3 is based on the data used by Campanella et al. (2018).

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Table 7.2: Disclosure schematic. Categories

Aspects

Elements

. Environment

Materials Energy Water Biodiversity Emissions, effluents and waste

EN, EN EN, EN, EN, EN, EN EN, EN, EN EN, EN, EN, EN, EN EN, EN, EN, EN, EN, EN, EN, EN, EN, EN EN, EN EN EN EN

Products and services Compliance Transport Overall . Social – human rights

Investment and procurement practices Non -discrimination Freedom of association and collective bargaining Child labour Forced and compulsory labour Security practices Indigenous rights Assessment Remediation

HR, HR, HR

. Social – labour practices

Employment Labour/management relations Occupational health and safety Training and education Diversity and equal opportunity

LA, LA, LA, LA LA, LA, NGO LA, LA, LA, LA LA, LA, LA LA, LA

. Social – product responsibility

Customer health and safety Product and service labelling Marketing communications Customer privacy Compliance

PR, PR PR, PR, PR

. Social – society Local community and governance Corruption Public policy Anti-competitive behaviour Compliance

HR HR HR HR HR HR HR HR

PR, PR PR PR SO, SO, SO SO, SO, SO SO, SO SO SO

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7 Corporate governance by not-for-profit organisations

Table 7.2 (continued ) Categories

Aspects

Elements

. Economic

Economic performance Market presence Indirect economic impacts core Resource allocation Ethical fundraising

EC, EC, EC, EC EC, EC, EC EC, EC NGO NGO

. Programme effectiveness

Affected stakeholder engagement

NGO

Feedback, complaints and action Monitoring, evaluation and learning Gender and diversity Public awareness and advocacy Co-ordination

NGO NGO NGO NGO NGO

(per GRI, 2013; Campanella et al., 2018)

Society Product responsibility NGO Programme Effectiveness Labour practices Human Rights Environment Economic 0 Economic

10 Environment

20 Human Rights

30 Labour practices

40

50

60

NGO Product Programme responsibility Effectiveness

70 Society

GRI-Additional

2

44

5

17

0

0

6

GRI-Core

29

20

8

16

43

1

35

Total disclosure

31

64

13

33

43

1

41

Figure 7.3: Economic, environmental and social disclosures by select South African NGOs.

with key stakeholders and raise funds from donors (Ryan and Irvine, 2012a; 2012b), significant attention is paid to discussing the effectiveness of different projects in terms of both cost and impact (19% of total elements disclosed).

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How the NGOs manage different types of capital to achieve their objectives is not clear from the disclosure analysis. What should be noted is the fact that issues such as human rights, labour practices and governance are being incorporated as part of the explanation of NGOs’ various projects/initiatives. While a definitive conclusion cannot be reached, this suggests that there is a measure of integrated thinking at work. To provide further insights, the integrated reports of NGOs are evaluated.80 The authors have proprietary access to the analysis of integrated reports performed by the Chartered Secretaries Southern Africa (CSSA). This gauges integrated report quality (IRQ) on the basis of several metrics. Examples include the assessment and application of materiality, completeness of reporting, the integrity of the governance system and the clarity of the business model. The CSSA focuses on both the private sector and NGOs. Figure 7.4 shows the average quality scores (expressed as a percentage) for the same period as covered by Figure 7.3.

80% 78% 76% 74% 72% 70% 68% 66% 64% 62% 60% 2015

2016

2017

Figure 7.4: IRQ by select South African NGOs.

Figure 7.4 shows a positive trend in IRQ from 2015 to 2017. Together with the extent of reporting on economic, environmental and social performance (see Figure 7.3) it appears that established South African NGOs are capable of preparing reasonable integrated reports as part of their broader commitment to good corporate governance.

80 There is no generally-accepted basis for gauging integrated report quality. In addition to the reviews by the CSSA, the EY Excellence in Integrated Reporting Awards summarises report quality of South African companies based on the application of core principles/concepts in the IIRC’s framework. EY does not, however, include NGOs in their review of South African integrated reports.

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7 Corporate governance by not-for-profit organisations

7.3 Governance trends in NPOs To provide a sense of South African NGOs’ corporate governance practices, the 2017 annual or integrated reports of the same selection of NGOs as reviewed by the CSSA and Campanella et al. (2018) were considered. Recommended practices in King-IV (including the applicable sector supplements) were grouped under 7 disclosure themes, aligned with the core principles in King IV, and used to construct a governance outline. Refer to Table 7.3. (The disclosure themes are consistent with those used to analyse corporate governance disclosures in Chapter 4.)

Table 7.3: Corporate governance disclosure matrix. Disclosure theme (DT)

King-IV Examples of disclosures principles

 – Governance of ethics

Principle , ,  & 

– – – – –

 – Integration of risk, strategy and performance

Principle 

– –



 – Composition and function of the governing body

Principle , ,  & 

– –

– – –

Ethical values discussed in the integrated report. Reference to an explanation of codes of corporate conduct Compliance functions established by the organisation Scope of compliance functions Disclosure of non-compliance with laws and regulations Risk management policies and thresholds Scope of risk management, strategy and business models, including the focus on financial and nonfinancial risks. Role of the board of directors (or equivalents) and committees in overseeing risk management and strategy development. Formal director appointment process explained The board comprised of a majority of nonexecutive directors of which majority are independent Chair of the board is a non-executive director Explanation of the function and composition of committees of the board of directors Review of managerial functions and performance

81 Principle 17 is applicable to institutional investors and is not considered separately for the purpose of this analysis.

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149

Table 7.3 (continued ) Disclosure theme (DT)

Examples of disclosures King-IV principles

 – Performance evaluation and remuneration

Principle  & 

– – – –

 – Use of assurance

Principle 

– – –

 – Risk governance

Principle  & 

– – –

 – Stakeholder engagement and communication

Principle  & 

– – – – – –

Performance of the board evaluated according to specified targets Individual directors’ performance evaluation discussed Components of directors’ remuneration Remuneration policies Presence or absence of a combined assurance model Monitoring and review of internal financial and operating controls Audit committee’s role in monitoring internal and external assurance services Presence or absence of a chief information officer The extent to which information-technology is included in the risk assessment process Role of the board of directors and committees of the board in overseeing significant investment in information and technology systems/processes Key stakeholders identified Process for identifying and prioritising stakeholder issues explained The link between stakeholders’ concerns and disclosures in the integrated report explained The integrated report addresses the core capitals Materiality explained and applied Application of King-III or King-IV

As illustrated in Figure 7.5, most NGOs comply with the composition and function of their governing bodies (DT3) with an average score of 62%. This is followed by governance practices which comply with the integration of risk, strategy and performance (DT2 = 51%) and stakeholder engagement and reporting (52%). The governance of ethics (DT1 = 46%) and the use of assurance (DT5=46%) had the lowest scores. Overall, the disclosure themes report significantly lower scores than found for South Africa’s largest listed companies (see Chapter 4). This is to be expected. Most NGOs have limited financial resources and less developed systems and processes than well-funded listed organisations. Their smaller sizes and relatively simpler business models may also negate the need for very sophisticated governance models. As explained by King-IV, organisations do not have to implement every recommended practice. The fact that NGOs do not implement some practices to the same

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7 Corporate governance by not-for-profit organisations

Total

0%

10%

1 – Governance of ethics 2 – Integration of risk, strategy and performance 3 – Composition and function of the governing body 4 – Performance evaluation and remuneration 5 – Use of assurance 6 – Risk governance 7 – Stakeholder engagement and communication

20%

30%

40%

50%

60%

70%

Total 46% 51% 62% 49% 46% 48% 52%

Figure 7.5: Corporate governance practices by South African NGOs.

extent as do the profit-sector does not automatically mean that their corporate governance systems are inadequate.

7.4 Summary and conclusion Despite their importance, we know relatively little about how codes on corporate governance are being interpreted and applied by NGOs. This chapter addresses this limitation by providing one of the first accounts of corporate governance practices by South African NGOs. It outlines King-IV’s core principles in the context of NGOs using the applicable sector supplement and guidance provided by the Department of Social Development (2001). This is followed by a review of reporting trends by some of the country’s best NGOs which are relying on the guidelines issued by the GRI to report on material economic, environmental and social indicators. These include, for example, human rights, environmental impact, ethical fundraising and programme effectiveness. NGOs have also made some effort to adopt the principle of integrated reporting outlined by King-IV (IOD, 2016) and IIRC (2013) with improvements in the quality of integrated reports noted from 2015 to 2017.

7.4 Summary and conclusion

151

In terms of governance practices, NGOs report lower governance scores than organisations in the private sector (see Chapter 4). Nevertheless, all of the NGOs under review are applying the practices recommended by King-IV to, at least, some extent in order to give effect to the core principles of good governance. These include, for example, the use of independent and competent members of the governing body; increasingly formal risk identification and management practices and policies and process for driving a culture of ethical fundraising and programme administration. It should be pointed out that the results of this preliminary research are based solely on what each NGO includes in its external report rather than on detailed engagement. Consequently, while NFP entities may not have as sophisticated governance systems as large profit-orientated organisations, it would be premature to conclude that corporate governance is lacking. Additional research will be required to understand better how corporate governance functions in the NFP space, stakeholders’ expectations and the cost-benefit trade-offs before more definitive conclusions can be reached.

8 Emerging forms of corporate reporting, governance and accountability As discussed in Chapter 2, South African corporate governance has a relatively long history. King-I provided only a broad outline of the elements of good governance and was focused mainly on financial reporting, the function of the board of directors and the use of internal and external audit as mechanisms of internal financial control. Just over 20 years later, King-IV has moved to a principles-based system where the board of directors is part of the multi-capital approach to business management. It is very likely that the next twenty years will see an even more rapid increase in the development and application of codes of best practice. This chapter deals with some of the emerging issues in South African corporate governance. These include integrated reporting (Section 8.1), advancements in accounting for and reporting on natural capital (Section 8.2) and how integrated thinking can be understood and applied using a circular economy framework (Section 8.3). How corporate governance may evolve in the context of the unpredicted technological development characterising the first part of the 21st century is also dealt with briefly (Section 8.4).

8.1 Integrated reporting Integrated reporting is not a new development in South African corporate governance. As discussed in Chapter 2, King-III introduced the formal recommendation for a company to prepare an integrated report with principles applicable to integrated reporting expanded by the IRCSA (2011) and King-IV (IOD, 2016). Nevertheless, as integrated reporting is widely regarded as one of the most recent developments in the broader sustainable management movement (Stubbs and Higgins, 2014; De Villiers et al., 2017b; De Villiers and Maroun, 2018), a brief review of integrated reporting in South Africa is appropriate. EY and CSSA review the quality of South African integrated reports. The former focuses on the extent to which companies apply the IIRC’s guiding and content principles (see Appendix A)82 (see IIRC, 2013). Application of the fundamental concepts

82 The guiding principles are: strategic focus of the reports and future orientation, connectivity of information, stakeholder relationships, materiality, conciseness, reliability, completeness, consistency and comparability. The content elements are: organisational overview and external environment, governance, business model, risks and opportunities, strategy and resource allocation, performance, outlook and finally basis of presentation and preparation (see IIRC, 2013, pp. 16–30). https://doi.org/10.1515/9783110621266-008

8.1 Integrated reporting

153

dealing with value creation and the six capitals83 are also taken into account (Graham in EY, 2016, p. 25). The EY Excellence in Integrated Reporting Awards covers the largest listed companies on the JSE. Integrated reports are scored on a scale from 1 (progress to be made) to 5 (top 10). The CSSA provides a broader review of integrated reporting. The Top 40 companies on the JSE are reviewed, as well as other listed companies, unlisted concerns and the public sector (see also Chapter 5). IRQ is gauged, according to: – the overall presentation of the reports (including consistency of reporting, assessment of materiality and readability) – how well an organisation explains its strategy and resource allocation – the extent to which performance is assessed and explained according to the different capitals in the context of a stated strategy and business model – the thoroughness of reporting on key risks and opportunities – the clarity of the business model – quality of corporate governance systems – whether or not an entity has explained its future challenges and any uncertainties which may affect its business model Figure 8.1 shows the IRQ for the Top 40 companies listed on the JSE, other listed concerns, public sector entities and any regional bodies and unlisted organisations which participated in the CSSA’s quality review from 2015 to 2017. The largest companies on the JSE produce the highest quality reports. This is consistent with the fact that they are subject to a greater amount of stakeholder scrutiny and have the resources and technical expertise to invest in their integrated reports. The quality of reporting by other listed concerns, the public sector, unlisted entities and regional bodies is relatively stable (see also Prinsloo and Maroun, 2018). There is a slight upward trend in report quality from 2015 to 2017 although the scores (expressed as a percentage) are relatively low (66% across all organisations for the 3 years combined). The result is in line with the un-tabulated average score for EY for the same period of approximately 3.2 out of a maximum of 5. Weaknesses in South African integrated reporting include: – repetitive and generic social and environmental disclosures which obfuscate key detail, – marked emphasis on historical information with little reporting on the organisations’ future prospects, – limited engagement with stakeholders to identify their information needs and conclude on weaknesses in current reporting practices,

83 These are financial, manufactured, natural, social and relationship, human and intellectual capital (see IIRC, 2013. p. 11)

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8 Emerging forms of corporate reporting, governance and accountability

90%

Quality score (percentage)

80% 70% 60% 50% 40% 30% 20% 10% 0% Other listed

Public sector

Regionals and nonlisted

Top 40

Average of Average 2017

64%

68%

65%

77%

Average of Average 2016

64%

66%

61%

66%

Average of Average 2015

67%

66%

66%

70%

Figure 8.1: Integrated report quality.

– under-developed strategies, risk assessments and business models which do not explain the links among types of capitals and the organisation’s core activities, – placing emphasis on disclosures dealing with policies, high-level objectives and positive accounts of the business while neglecting challenges encountered and the actions actually taken in response to emerging issues and – limited detail on how corporate governance systems (including the use of combined assurance) are used to manage core activities and ensure that integrated reports are accurate, reliable and complete. (for details, see Haji and Anifowose, 2016; Raemaekers et al., 2016; du Toit, 2017; McNally et al., 2017; Van Zijl et al., 2017; Naynar et al., 2018)

8.1.1 The effect of corporate governance on integrated report quality Table 8.1 reports correlations between IRQ, characteristics of organisations’ boards of directors (as per Chapter 5) and the use of external assurance. As not all of the data are normally distributed, the parametric and non-parametric correlations are provided. The size of the board and the proportion of non-executive directors have very low correlations with the IRQ. There is a moderately strong positive correlation between

.

−.**

.**

.** −.

.**

.**

.** −.

.

.*

.

−.

.

.**

.

.

Size

Industry

Director experience

Proportion non-exec

Gender diversity

Race diversity

Number of directors

.*

.

.

.**

.

Director experience .

−.

84 Variables are measured as explained in Chapter 4.

.

.** −.

.

.

−.**

.

.*

Year

Year

Industry

Size

Table 8.1: Correlation matrix.84

Proportion non-exec −.

.**

.*

.

.

−.

.**

.

Gender diversity −.*

.**

.

.

−.

.*

.**

.**

Race diversity

.

−.

.**

.

Number of directors

.

.

.

.

.** −.**

.** −.

−.**

.

.**

.

Assurance .

.**

.**

−.

ROA

.*

.**

.

−.

−.

.

−.*

.** −.

.**

.

ROE .**

−.

.

−.

Tobin’s Q

−.

.**

.*

.

IRQ .

−.

−.

(continued )

−.*

.**

.**

.

.** −.**

.** −.**

.**

.

−.*

−.** −.** −.

.

.** −.

ESG Performance

−.** −.

.**

.*

−.

8.1 Integrated reporting

155

−.*

−.

.*

−.

−.

.

ROE

Tobin’s Q

Director experience

Industry

.

.

−.

.** −.**

.** −.

.*

.

.*

.** −.*

Proportion non-exec .

−.

−.

−.

.

−.

Gender diversity .**

−.

.

.

.**

.**

Race diversity

−.

−.*

−.

.

.** −.

−.

−.

−.

.**

.** −.

Number of directors

Spearman’s rho and Pearson’s correlation co-efficients are reported above and below the diagonal respectively. *significant at the 5% level; ** significant at the 1% level. Significance based on a 2-tailed t-test.

IRQ

−.

.

ROA

.**

.**

.

−.

ESG Performance

Assurance

Year

Table 8.1 (continued )

Size

Assurance .**

.

.

.

.**

.

ROA

ESG Performance .**

.

.

.

.

.

.**

.**

.

−.

.** −.

ROE .

.**

.

.**

.

.

Tobin’s Q

.**

.**

IRQ .

.

.

.

−.

.

.** −.

−.

−.

156 8 Emerging forms of corporate reporting, governance and accountability

8.1 Integrated reporting

157

IRQ and a board’s gender (rs = 0.506, p < 0.01) and race diversity (rs = 0.477, p < 0.01). Director experience reports a weaker correlation with IRQ (rs = 0.228, p < 0.01), although this is still statistically significant at the 1% level. The strongest correlation is between IRQ and the use of external assurance (rs = 0.646, p < 0.01). The correlations between IRQ, firm size (rs = 0.166, p < 0.05) and industry (rs = 0.209, p < 0.01) suggests that high quality integrated reporting is not limited to only the largest companies on the JSE or those in a sector with a high social or environmental impact. Similarly, weak (and statistically insignificant) correlations between IRQ, ROA, ROE and Tobin’s-Q suggest that financial performance is not associated with higher quality integrated reports. In contrast, there is a strong correlation between good social and environmental performance85 and IRQ (rs = 0.482, p < 0.01). The exploratory nature of this study, relatively small sample and the possibility of the results being affected by endogeneity, precluded the use of a regression model for investigating the effect of corporate governance on IRQ.86 As not all of the data are normally distributed or continuous, a Kruskal-Wallis test is used to evaluate the impact of corporate governance on IRQ.87 A Jonckheere-Terpstra post hoc test was used to determine the sign of any trends. Results are presented in Table 8.2. Companies with more experienced boards of directors (H = 9.704, p < 0.051; J = 4 465, p < 0.01) made up of individuals serving longer terms (H = 23.549, J = 4 375, p < 0.01) prepare higher quality integrated reports. The proportion of non-executives (H = 10.493, J = 7 767, p < 0.01), female representation (H = 50.621, J = 7 767, p < 0.01) and race diversity (H = 40.237, J = 7 440, p < 0.01) have a positive effect on IRQ. Companies which make more use of external assurance are also more likely to have high-quality integrated reports (H = 73.301, J = 7 428, p < 0.01). Overall, more robust corporate governance practices (see Chapter 8, Table 8.1 88) appear to have a positive impact on IRQ (H = 5.174, J = 6 205, p < 0.05). The sample of companies is stratified by industry and firm size to test for the sensitivity of the effects of corporate governance on IRQ for these characteristics. Results are presented in Table 8.3. Director experience and race diversity continue to have a significant effect on IRQ across the stratified sample. Gender diversity is less relevant for the mining and industrial sector (H-statistics are insignificant at the 10% level) while the proportion

85 This is determined using the same composite measure as used in Chapter 4. 86 For example, while corporate governance may result in better integrated reports, it is possible that report quality is capturing the effect of more robust systems and processes in place at an organization, with the result that there is a circular reference between IRQ and corporate governance. 87 As with the approach followed in Chapter 4, corporate governance scores have been grouped based on quartiles. 88 Board characteristics have been included in the final corporate governance measure to provide an assessment of the aggregated impact of corporate governance on IRQ.

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8 Emerging forms of corporate reporting, governance and accountability

Table 8.2: Drivers of integrated reporting quality. Corporate governance drivers

IRQ

Driver

H-Statistic

J-T Statistic

.**

 ***

Term on board

.***

 ***

Proportion of non-executives

.**

Gender diversity

.***

 ***

Race diversity

.***

 ***

Director experience

 

.

Number of directors Assurance Corporate governance practices

 

.***

 ***

.**

 **

*significant at the 10% level; **significant at the 5% level; *** significant at the 1% level. Grouping variable: individual drivers (aggregated by quartile).

Table 8.3: Sensitivity test for industry and firm size. Driver

Director experience

Mining and industrials

Financial services

Low environmental and social impact

Large firms

Small firms

Large firms

Small firms

Large firms

Small firms

H-Statistic

H-Statistic

H-Statistic

H-Statistic

H-Statistic

H-Statistic

.***

.**

.*

.**

.***

.

.

.

.

.***

.

Term on board

.

Proportion of nonexecutives

.

Gender diversity

.

Race diversity

.***

.

.***

.

.

.***

.***

.**

.**

.**

.**

.***

.***

.**

Number of directors

.

.*

.

Assurance

.***

Corporate governance practices

.*

.

.

.**

.*

.

.***

.***

.***

.***

.**

.*

.*

.*

.*

.*

8.2 Biodiversity reporting

159

of non-executive directors appears to be driving IRQ only at smaller firms. The term of individual directors loses its significance except for large firms with a shallow social and environmental footprint. The effect of external assurance on IRQ is robust for both industry and firm size effects. Overall, corporate governance remains a valid driver of IRQ, although its effect is moderated, to some extent, by firm size and industry type.

8.2 Biodiversity reporting One of the criticisms of sustainability (Jones and Solomon, 2013) and integrated reports (Atkins and Maroun, 2018) is that they fail to provide an adequate account of the most pressing environmental concerns including the effect of climate change, over-population and habitat destruction on biodiversity. There are different definitions of biodiversity, but the one used by the GRI (2007, p. 7) is commonly referred to in the academic and professional literature: Biodiversity is the variability among living organisms from all sources and the ecological complexes of which they are part, ranging from birds in the air, fish in the sea, and microorganisms in the soil to genetic variety within agricultural crops and diversity of ecosystems. This variability is essential for ecosystems to function efficiently. Ecosystems provide “ecosystem services” to organizations and society as a whole, including food, fresh water, wood and fibre, medicines, soil fertility, climate regulation, building materials, inspiration for scientific and technical development, genetic resources, flood regulation, and recreation facilities. There is no organization that does not make use of one or more of these ecosystem services, either directly through their own activities or indirectly through supply chain partners.

In ensuring that an organisation “is and is seen to be a responsible corporate citizen”, those charged with governance should “oversee and monitor” key performance measures, including environmental indicators such pollution, disposal of waste and biodiversity impact (IOD, 2016, Principle 3, para 11&14). The core philosophy of sustainable development will also require an organisation to assess the implication of its strategy, business model and operations for biodiversity if it is genuinely committed to ensuring that the rights of future generations are not compromised (see IOD, 2016, pp. 23–24). There is a strong business case for conserving biodiversity. Scientists estimate that the value of ecosystem services to the South African economy is ZAR275 billion per annum (Wynberg, 2002; Turpie et al., 2017). Several insect species play a crucial role in the agricultural sector by controlling pests, recycling nutrients and pollinating crops. Plants and animals are farmed for food, medicine, personal use or sale on the international markets. South Africa’s wilderness areas are also an integral part of local culture and the eco-tourism industry (Melin et al., 2014; EWT, 2016). This anthropocentric view of nature frames its value according to the benefits which it provides people. At the deep ecological level, organisations also have a

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8 Emerging forms of corporate reporting, governance and accountability

moral duty to protect the planet’s flora and fauna which has an intrinsic value independent of humanity (Naess, 1973; Khisty, 2006). Some academics see a tension between a deep ecological and an anthropocentric view of the world (Gray, 1992; Gray and Milne, 2018). They can also be seen as mutually reinforcing in the sense that good governance requires an organisation to understand and to manage the interconnection between economic and environmental imperatives (see IOD, 2016). The undeniable reality is that modern business and society cannot exist independently of nature with the result that anthropocentric and deep ecological views of the world cannot be considered individually. As summarised by the GRI (2016, GRI-304, p. 4): Protecting biological diversity is important for ensuring the survival of plant and animal species, genetic diversity, and natural ecosystems. In addition, natural ecosystems provide clean water and air and contribute to food security and human health. Biodiversity also contributes directly to local livelihoods, making it essential for achieving poverty reduction, and thus sustainable development.

8.2.1 Guidance provided by the GRI and the academic literature In light of biodiversity’s importance at the ecological and economic level, the GRI has developed guidelines to assist companies with managing biodiversity-related issues. The benefits of biodiversity management and reporting include: – differentiation along the lines of environmental responsibility which can strengthen a company’s strategic position and offer new business opportunities – improved stakeholder relations by demonstrating that the organisation is aware of and responding to growing concerns about the state of the environment – risk reduction, operating efficiency and potential cost savings – securing future access to essential resources in the interest of long-term business continuity, – discharging the moral and social duty to protect biodiversity for current and future generations. (GRI, 2007) It is hoped that reporting on biodiversity can create an awareness of organisations’ environmental impact, allow stakeholders to hold them accountable and promote changes in business practices (Jones and Solomon, 2013). The primary components of biodiversity reporting identified by the GRI (2016, pp. 5–6) are summarised in Table 8.4. The disclosures in Table 8.4 are similar to those considered by environmental accounting research. Grabsch et al. (2012) and van Liempd and Busch (2013) provide a schematic for constructing a biodiversity report. The organisation should give appropriate context by defining biodiversity, providing a clear mission statement or

8.2 Biodiversity reporting

161

Table 8.4: Biodiversity reporting under the GRI. Code

Details

GRI-

“An explanation of how the organisation manages biodiversity, including the impact which it has on biodiversity, implications for stakeholders and the policy for biodiversity management”. A biodiversity strategy dealing with “prevention, management and remediation of damage to the natural habitats resulting from an organisation’s activities can also be provided.”

Examples – –

– –

GRI-- “Operational sites owned, leased, managed in, or adjacent to, protected areas and areas of high biodiversity value outside protected areas”

– –

GRI-- “Significant impacts of activities, products, and services on biodiversity.”

– –



– GRI-- “Habitats protected or restored.”

– – –

GRI-- “IUCN Red List species and national conservation list species with habitats in areas affected by operations”



Biodiversity strategy Risk analysis showing impact, likelihood and time-frame of biodiversity-related issues Key performance indicators Policies for identifying and mitigating biodiversity-related risks

Geographic locations affected Type and size of the operation at sites with a biodiversity impact The protected status of areas affected by operations Reduction of species Habitat conversion and ecological changes Quantity of missions Location and size of habitats protected or restored Numbers of species affected Methods used to perform remediation work and gauge outcomes Analysis of species affected by operations, conserved or reintroduced analysed by risk level per the IUCN

objective and giving a sense of its biodiversity impact in ecological terms. To prevent biodiversity loss, companies should engage with different stakeholders, including environmental specialists, communities affected by operations and NGOs. The aim is to assess biodiversity-related risks, identify incidents and conclude on material concerns. Possible solutions to environmental challenges should be explored and stakeholders must be consulted to ensure that their concerns are being addressed (see also Jones and Solomon, 2013). Policies and plans need to be supported by key performance indicators, specified objectives and detailed action plans championed by a biodiversity officer. An account of how well the company has performed in meeting its biodiversity targets, the total cost of actions taken to protect and/or restore biodiversity and the impact of any measures taken are a key part of

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8 Emerging forms of corporate reporting, governance and accountability

the biodiversity reporting framework (Grabsch et al., 2012; van Liempd and Busch, 2013). To avoid biodiversity reporting being seen as a separate part of the reporting process, it can be incorporated in existing corporate reports and complemented by the guidance given by other frameworks, codes on governance and recommended best practice (see, for example, Jones, 1996; Jones, 2003). Refer to Table 8.5.

Table 8.5: Biodiversity reporting themes. Theme

Explanation

Scene-setting

– –

Definitions of biodiversity Mission statement

Species- related reporting

– – – –

Details on biodiversity per site, region or business unit Specific species affected by the organisation’s activities Surveys of biodiversity impact and risk Reporting organised according to the IUCN Red List classifications

Social engagements

– – –

Partnerships Awards Stakeholder engagements

Risk

– – – –

Risk Risk management Incidents Materiality

Performance evaluation

– – – – –

Key performance indicators Target performance Actual versus planned performance Total costs Changes in biodiversity measures

Internal management

– –

Biodiversity action plans Biodiversity officer

External reports



GRI and other frameworks

(summarised from Grabsch et al., 2012; van Liempd and Busch, 2013).

8.2.2 Evidence of biodiversity reporting by South African companies van Liempd and Busch (2013) use the framework outlined in Table 8.5 to study biodiversity reporting in Denmark. Danish companies understand biodiversity management as an ethical issue but perform poorly when it comes to reporting on qualitative and quantitative aspects of biodiversity. Similar results are found in Sweden where low levels of biodiversity reporting may be due to a lack of stakeholder awareness and activism. At the international level, biodiversity reporting by the 150 Fortune Global is also limited (Adler et al., 2018).

8.2 Biodiversity reporting

163

One of the few papers dealing with biodiversity as an emerging component of integrated reporting and corporate governance in South Africa confirms that biodiversity reporting is under-developed (Mansoor and Maroun, 2016). This is despite the emphasis placed on stakeholder inclusivity and environmental awareness by the King Codes (see Chapter 2) and the leading role played by South Africa in advancing the sustainability management agenda. Limited stakeholder pressure and the lack of a detailed understanding of the importance of biodiversity by the investor community are possible reasons for the slow adoption of biodiversity management and reporting. The absence of detailed guidelines on the topic and the fact that companies may not be able to make the link between this specific environmental issue and their business model must also be taken into consideration (Atkins and Atkins, 2016; Maroun, 2017b). Usher and Maroun (2018) follow a similar approach to Mansoor and Maroun (2016) and van Liempd and Busch (2013) to gauge the scope of biodiversity reporting but also consider the quality of disclosures. They focus specifically on the South African seafood industry. Drawing on the prior research on sustainability reporting (see Michelon et al., 2015; Borghei et al., 2016), quality is defined according to: – the amount of information disclosed in tota, – the number of disclosures dealing with biodiversity relative to the length of the corporate reports – the emphasis placed on disclosing biodiversity details in the primary, rather than secondary, reports to stakeholders89 the extent to which disclosures deal with specific actions taken to mitigate biodiversity loss rather than provide only broad policy statements – whether or not disclosures are assured As in earlier research, the study finds that biodiversity reporting is limited when compared with disclosures on other environmental and social issues (Jones and Solomon, 2013) but that, over time, details are being included in the primary reports to stakeholders rather than in complementary sources. Companies are also giving more details on the conservation plans, steps which have been taken to mitigate losses of biodiversity and partnerships with NGOs aimed at reducing biodiversity impact (Usher and Maroun, 2018). There is, however, room for improvement. For example, biodiversity is not being dealt with at a strategic level. The risks posed by biodiversity loss are not always explicated and measures of how companies have performed against environmental targets are not consistently reported (see also De Villiers and van Staden, 2006; Van Zijl et al., 2017). Nevertheless, it appears that companies are beginning to internalise the relevance of protecting biodiversity as a

89 The primary reports are the annual or integrated reports. The secondary reports are the accompanying sustainability or environmental reports.

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business and moral imperative and starting to be more proactive in how they manage and report on their biodiversity impact (Usher and Maroun, 2018). These findings are supported by a broader study of the South African food producers and retailers. Some companies limit their biodiversity reporting to scene-setting or disclosures dealing with different species but without an explanation of the context. Others focus on actions already taken to reduce biodiversity loss in order to present their business in a favourable light. The aim is to convince stakeholders that these companies are behaving responsibly and taking reasonable steps to improve environmental performance without having to commit to a long-term plan of action which may affect financial returns adversely in the short- or medium-term. There are also indications of companies being in denial. They provide little or no account of biodiversity in their corporate reports (Maroun et al., 2018). In the absence of an environmental disaster which has a direct effect on their operations, companies do not automatically see biodiversity as a relevant part of their business model and, as a result, essential for long-term sustainability (see also Jones and Solomon, 2013). As corporate governance systems mature and, as part of this, integrated thinking begins to take hold, the approach to biodiversity changes. Companies become more aware of social and environmental responsibilities (see Atkins and Maroun, 2015; Guthrie et al., 2017; Al-Htaybat and von Alberti-Alhtaybat, 2018). They are prepared to invest in the development of the accounting and management systems necessary for managing and reporting on economic, environmental and social performance (see De Villiers et al., 2017a; McNally et al., 2017; Atkins et al., 2018; McNally and Maroun, 2018). With sufficient time, managers are also able to engage with and reflect on stakeholders’ legitimate concerns and expectations. The result is an active approach to biodiversity management which sees policies being developed to identify and reduce risks, steps taken to implement those policies and an explanation of biodiversity performance being reported to stakeholders (Atkins et al., 2018; Maroun et al., 2018).

8.2.3 Emancipatory accounting The literature on impression management in different types of environmental reporting and the adverse implications for the sustainability agenda is vast (see, for example, Gray et al., 1995; Milne et al., 2009; Tregidga et al., 2014). It is, however, possible for the mechanisms of accounting and accountability to be used to create awareness, empower activism and promote positive change (Gallhofer and Haslam, 1996; Gallhofer et al., 2013; 2015). Importantly, completely reconfiguring the free market system is not a prerequisite for accounting to be emancipatory:

8.2 Biodiversity reporting

165

[T]here is a move away [. . .] from the position that emancipatory accounting – if still a radically progressive notion – necessarily reduces to an accounting that is an instrument of revolutionary or grand radical transformation consistent with the position suggested in the Marxinspired line of thought pursued by [earlier critical theorists]. (Gallhofer and Haslam, 2017, p. 15)

Instead, new forms of accounting for society and environment are being developed using existing principles from accounting and, more recently, integrated reporting. Grounded in pragmatism, these attempt to balance deep ecological views with the business case for protecting the environment and recognise that, if companies are going to change, any form of emancipatory accounting must be framed in a way which they can understand and apply almost immediately (Atkins and Maroun, 2018; Atkins and Atkins, 2019). Cuckston (2013) and Ferreira (2017), for example, consider how offsetting arrangements common in conventional finance can be used to incorporate biodiversity in accounting measures and raise funds for conservation initiates. The possibility of full cost accounting systems being modified to include so-called non-financial issues and provide a complete measure of the total cost of business has also been examined (Freeman and Groom, 2013). Assigning a financial value to biodiversity may create the impression that natural capital is subordinate to financial capital or over-simplify the interconnection between the environment and the firm. As a result, Jones (2003; 1996), Siddiqui (2013) and Sullivan and Hannis (2017) explore the possibility of reporting on the “inventories” of different species affected by an organisation’s operations. Disclosures can be qualitative or quantitative and are organised in a matrix or geometrical structure. Similarly, Cuckston (2017) considers how the unit of account can be changed from the business or operating unit to ecosystems or habitats. The aim is to describe the complex interconnections between biodiversity and a firm’s business model in more detail than just reporting on, for example, the cost of conservation initiatives or the number of spices being protected (Russell et al., 2017; Cuckston, 2018). Emerging forms of accounting have limitations. Reporting on even the most pressing environmental issues can become descriptive or be applied legalistically with the result that any change potential is limited (Jones and Solomon, 2013). Efforts to include biodiversity in risk assessments of financial measures have also proven to be technically difficult. There is the added risk of understating the intrinsic value of nature with the result that the accounting system is used to justify the destruction of natural capital rather than its conservation (Freeman and Groom, 2013; Tregidga, 2013). Nevertheless, as discussed in Section 7.2, there are indications of companies taking a more proactive approach to managing and reporting on their natural capital in the interest of long-term sustainability (Atkins et al., 2018). Accounting does not offer a complete solution for environmental degradation but experimenting with innovative forms of accounting shows that companies are

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willing to invest in better systems of governance and accountability and are, at least, taking steps towards the sustainability goals espoused in King-IV (consider Atkins et al., 2015; Atkins and Atkins, 2016; King, 2018). A framework for natural capital governance The guidelines provided by the GRI and IIRC do not need to be ignored when constructing an emancipatory account. They can be combined with environmental accounting research to provide a schematic for managing and reporting on natural capital (Atkins and Maroun, 2018). Figure 8.2 provides an example.

Location 2 (A)

Location 1 (A) Species 1 (B)

Species 2 (B)

Stage 1

Ecosystem 1 (B)

Species 3 (B)

Species 4 (B)

Ecosystem 2 (B)

Ecosystem 3 (B)

Risk Analysis 2 (C)

Risk Analysis 1 (C) Description of species and population size (C1)

IUCN Classification (C2)

Description of ecosystem and biodiversity mass (C1)

Assessment of threat to ecosystem (C2)

Impact assessment (C3)

Fines, claims and disputes (C4)

Description of species and population size (C1)

IUCN Classification (C2)

Description of ecosystem and biodiversity mass (C1)

Assessment of threat to ecosystem (C2)

Impact assessment (C3)

Fines, claims and disputes (C4)

Stage 4 and 5

Stage 2 and 3

Action Reporting (D)

Action outline (D1)

Financial Staff and (D2) and community management and NGO capital (D3) involvement requirement (D4)

Technology, skills and experience utilised (D5)

Analysis Reporting (E)

Outcomes per KPIs (E1)

Cost and operational assessment (E2)

Training Research and and partnership development requirements requirements (E3) (E4)

Figure 8.2: A natural capital reporting framework. (reproduced from Maroun and Atkins, 2018, p. 13)

As suggested by the GRI (2016) and Cuckston (2017; 2018), details on specific species and ecosystems are provided (B). This gives context. The aim is to explain the natural capital on which the firm is dependent and the impact which its operations

8.2 Biodiversity reporting

167

have on biodiversity. The disclosures can be organised by business unit and by habitat or ecosystem (A). For each natural capital “location” (A), a detailed risk assessment is provided (C). Following the GRI’s (2016) recommendations, this is done at the species- or ecosystem-level (C1) with risks ranked according to the status of the species per the IUCN’s Red List and the overall threat to the ecosystem (C2). The biological account is followed by an impact assessment which contextualises environmental risks in terms of the organisation’s business model (C3) and includes an explanation of any fines, provisions and contingent liabilities (C4). The risk assessment should not focus only on environmental or financial issues; the implications for all of the capital should be considered. This could include, for example, a review of the consequences of poor environmental governance for the firm’s standing with stakeholders (social and relationship capital), ability to attract talented employees (human capital) and the differentiation of its business model (intellectual capital) (see Atkins and Maroun, 2018; Buchling and Maroun, 2019). Good governance requires the risk assessment to inform action (IOD, 2016). Risks should be linked to specific steps being taken to mitigate environmental degradation. A multi-capital model can be used both to design and report on action plans (D1). The firm should consider the financial resources and any changes to its systems and processes required to execute its actions (D2; D3). These may require investment in social and human capital such as staff training, joint ventures with NGOs and community engagement (D4). In some cases, research and development will be required to develop long-term solutions to material environmental issues (D5) (see Atkins and Maroun, 2018). Finally, those charged with governance should monitor the approach for managing natural capital and must assess performance (IOD, 2016). Key performance indicators will be required (E1) which focus on both the cost and operational dimensions of any conservation or environmental remediation initiatives (E2). The development of social and relationship, human and intellectual capitals (E3; E4) should also be evaluated where applicable. With performance assessed across each of the capitals, action plans and risk assessments can be revised accordingly (Maroun and Atkins, 2018). No single South African company provides a comprehensive account of its natural capital using the approach outlined in Figure 8.2 but there are indications of elements of this type of environmental governance taking hold. Companies are providing more details on biodiversity and its relevance in the context of their business models (Maroun et al., 2018). A growing awareness of the importance of natural capital is starting to affect the extent to which environmental issues are being internalised as business risks and affecting day-to-day operations (Atkins and Atkins, 2016; King and Atkins, 2016; McNally and Maroun, 2018). This is giving rise to more specific, action-focused reporting on how natural capital is being managed and, as part of this, the partnerships being formed with scientific groups, NGOs and

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regulatory bodies to mitigate the environmental impact (Atkins et al., 2018; Maroun and Atkins, 2018). The broadening of mechanisms of accounting and accountability Emancipatory accounting is broader than a company’s annual, sustainability or integrated report: it can include information on a firm’s social and environmental performance generated and shared by stakeholders in order to make an organisation aware of governance failures and promote change (Laine and Vinnari, 2017). Modern society is characterised by almost instantaneous access to data. In this environment, an integrated report’s account of organisation’s governance will, inevitably, be complemented by other channels such as information from the financial press and information sharing networks (such as Facebook and Twitter). These “shadow” or “counter-accounts”: [c]reate alternative representations of organisational conduct and construct and communicate new visibilities and knowledge of existing situations, in order to oppose and change something regarded as socially and environmentally harmful or undesirable. (Thomson et al., 2015, p. 810)

The change potential of counter-accounts may be amplified by conventional methods for holding companies accountable provided in company law and codes of good governance. As explained by Solomon (2007; 2009; 2013), investors ought to engage with companies on their economic, social and environmental performance and, where necessary, to use their voting rights to effect change at the executive and strategic level. Similarly, King-IV requires investment firms to “ensure that responsible investment is practiced by the organisation to promote the good governance and creation of value by the companies in which [they] invest” (IOD, 2016, Principle 17). Civil society, NGOs and the public sector also have their role to play. As discussed in Chapter 7, NGOs play an important part in the corporate governance system by engaging with companies on their social and environmental track records. They can provide a platform for the broader stakeholder community to voice their concerns, offer training and technical support and lobby for change (see, for example, Brennan and Merkl-Davies, 2014; Atkins et al., 2018; Maroun and Lodhia, 2018). According to Esser and Du Plessis (2007), South Africa’s legal and corporate governance framework may already provide the basis for holding a company’s directors accountable for failing to act in a company’s and its stakeholders’ best interests (see also Chapter 5). Finally, the international literature argues that governments need to be integrally involved in the development of sustainability policies which reinforce the principles of emancipatory accounting and, more broadly, stakeholder-inclusive governance (Lanka et al., 2017; Atkins and Maroun, 2018). They should set an example in sustainable development by actively protecting biodiversity and forming partnerships with the private sector to prevent environmental degradation. Perhaps

8.3 Circular economy

169

most important is the need to focus on more than just the integrated or sustainability reports of single organisations. The state is well placed to provide a “consolidated” account of natural capital and to make the link between the environment and the macro-economic context clearer (Gaia and Jones, 2017; Atkins and Maroun, 2018; Weir, 2018). Whether or not the South African government, which has been marred by allegations of corruption and maladministration, will be able to fulfil this role remains to be seen.

8.3 Circular economy Despite the growing emphasis on integrated reporting and thinking, performance is still understood as an economic construct with reference to individual firms. Even when a broader perspective is adopted, the focus is usually on the result of sustainability policies or programmes rather than on the underlying systems (see Gray et al., 1996; Atkins and Atkins, 2016; King and Atkins, 2016). In response, environmental accounting research proposes that a circular economy framework can be used to inform improvements to business processes and practices in the interest of sustainable development. The origin of the term “circular economy” is controversial.90 The circular economy has been applied in an environmental management and reporting context to describe a system by which the use of energy and raw materials is reduced, pollution is eliminated, efficiency is improved and environmental damage is corrected. This involves the design and operation of production, distribution and consumption processes to maximise the use of renewable energy and recycling, prevent the release of harmful elements into the environment and eliminate waste (Cooper, 1999; UNEP, 2006; Hu et al., 2011). The benefits of a circular economy framework at the organisational level can include – lower total costs of production and distribution, – lengthening product lifecycles by encouraging re-use and recycling, – reduced energy usage and emissions resulting in improved economic and environmental performance, – deriving value from waste materials which would otherwise have been discarded and – differentiation of products along the lines of sustainability and responsible business. (Ellen Macarthur Foundation, 2014; Murray et al., 2017)

90 Since the 1800s, the term has been used in Chemistry to describe a system where waste is reduced and, ideally, eliminated. A review of the origin and history of the term is beyond the scope of this research. For details, see Murray et al. (2017).

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The circular economy is not without its limitations. While it deals extensively with environmental issues, the social dimension is not explicitly taken into account. It can also result in over-simplified representations of systems and goals which limit insights and can result in unconsidered consequences (Murray et al., 2017).91 A circular economy logic has been applied extensively in countries like China (see, for example, Geng et al., 2008; Hu et al., 2011). It has not, however, been used widely in South Africa. Nevertheless, the circular economy may be useful for structuring an approach to multi-capital management as in King-IV, as shown by Figure 8.3.

Manufactured capital Product development and manufacturing Financial capital Cost benefit assessment Financing implications

Social and relationship

Intellectual capital

Multi-capital approach to corporate governance

Educating customers Partnering with NGOs Engaging with regulators

Product design & technological development

Natural capital Environmental impact assessment Waste reduction & recycling

Human capital Staff training Encouraging employees to achieve strategic goals

Figure 8.3: Application of a circular economy approach.

As suggested by King-IV, those charged with governance “steer the organisation and set its strategic direction” (IOD, 2016, p. 21). They should take responsibility for a firm’s culture and business strategy which values social and environmental responsibility, in addition to generating financial returns (IOD, 2016, pp. 23–25). In practical terms, this necessitates a multi-capital approach to business management which can be informed by a circular economy logic.

91 For example, Murray et al. (2017) explain how the emphasis placed on renewable fuels can result in unsustainable management of natural forests which are cleared to provide bio-fuel if wilderness areas are not specifically incorporated in the circular economy model.

8.3 Circular economy

171

As explained above, a circular economy reduces waste and energy usage in order to lower environmental impact. Applying the same logic in a social context, the organisation will seek to improve safety standards, maximise staff efficiency and reduce any rework in the production process. Achieving these outcomes will require careful product development and a strictly controlled manufacturing process. Existing management accounting techniques such as standard, activity-based and Kaizen costing can be modified to set production and operating targets, identify inefficiencies and track the effectiveness of any changes to the manufacturing process. Key performance indicators should be developed and used to hold managers accountable for achieving objectives. A circular economy logic will have implications for how intellectual, natural and human capitals are managed. For example, reducing the social and environmental impact of producing goods and services will require research and development to improve product features. When it comes to natural capital, this can include identification of areas where waste can be eliminated, re-incorporated in the production process or used for alternate purposes. A formal environmental impact assessment may also be undertaken. To maximise the use of human capital, employees may need to be trained in new production techniques and co-opted in the firm’s strategy of minimising the social and environmental costs of the firm’s outputs. Where any challenges are encountered or unexpected gains result, a type of feedback loop results in the sense that change in human, natural or intellectual capital inform operational developments and the transformation of manufactured capital. A circular economy does not have to be limited to the firm. It can include the broader-network of external stakeholders (Murray et al., 2017). For example, lowering waste, reducing environmental emissions and promoting the re-use of products may require a firm to engage with customers to explain any changes to its products. The firm may also need to educate customers on how to use products correctly, where to return unused items for re-purposing or recycling and how to dispose of them responsibly. This can be complemented by seeking support from civil society and NGOs (where applicable) or engaging with policymakers to set standards for recycling or waste disposal. Good governance does not mean that a company ignores financial imperatives. Those charged with governance would be expected to oversee changes applicable to each of the capitals, including financial capital (IOD, 2016, pp. 21–25). This may include a cost-benefit analysis, monitoring the availability of sufficient financial resources to achieve targets and establishing policies for ensuring that financing is raised from lenders who are also committed to the principles of good governance.

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8.4 The governance of technology and information King-IV requires those charged with governance “to govern technology and information in a way that supports the organisation setting and achieving its strategic objectives” (IOD, 2016, Principle 12, p. 62). This includes, for example, monitoring and review of the integration of technology in different parts of the business, the steps taken to mitigate the risks of system failure or security breaches and the ethical use of data and systems (IOD, 2016, Principle 12, para 13). Technological developments will also have implications for how corporate governance is operationalised in South Africa and internationally. Pressure on existing natural resources is expected to increase as populations continue to grow and the demand for energy rises exponentially. The rate of social, political and cultural change is also expected to accelerate as the costs and difficulties of accessing information are lowered. The result is that so-called “soft issues” – typically confined in secondary reports to stakeholders – are likely to become material strategic and operating concerns and a defining feature of an organisation’s risk governance. In terms of stakeholder engagement, many organisations are already able to track social media and articles in the popular press. Developments in XBRL, cloud computing and open source platforms will make it easier to complement internallygenerated data with information obtained directly from different stakeholders. This can allow the organisation to be more responsive to stakeholders’ concerns and, possibly, pre-empt emerging issues. The converse is also true. As stakeholders (including providers of financial capital) are able to access more information on an organisation and its performance, the pressure on those charged with governance to demonstrate effective and ethical leadership will increase. To facilitate better monitoring and review, accounting systems will need to develop to accumulate data on different types of capital and provide those charged with governance with a comprehensive database for measuring economic, environmental and social performance. This, in turn, can allow existing accounting techniques such as standard costing, budgeting and activity-based management to be expanded into what is currently being seen as non-financial information. Assurance services will also evolve. King-IV makes provision for the use of combined assurance as a core part of the corporate governance system (see Chapter 6). Advances in block chain, quantum computing and machine learning can be harnessed to expand the scope of internal and external sources of assurance and allow for real-time testing of every transaction originated by the accounting system, irrespective of the type of capital to which it relates. Improvements in monitoring, internal control and combined assurance will result in more accurate and reliable information for internal decision making. Coupled with the growing appreciation of the social and environmental challenges

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being faced, stakeholders will probably take advantage of advances in analytical techniques to process different types of data included in integrated reports and reach an informed conclusion on a firm’s long-term sustainability. The same technology could be used by those charged with governance to refine their understanding of an organisation’s risks and performance and inform changes to strategies and business models. As the accuracy and completeness of data are improved – and analysis techniques are honed – more detailed integrated reporting can be expected which will result in yet more engagement and review.

8.5 Conclusion South Africa is widely regarded as a pioneer in integrated reporting. It is currently one of the few jurisdictions where codes on corporate governance expressly call on firms to prepare an integrated report which “enables stakeholders to make informed assessments of the organisation’s performance and its short, medium and long-term prospects.” (IOD, 2016, Principle 5). These reports are not without limitations but there are indications of preparers making a concerted effort to report more clearly on the interconnections between different types of capitals and how these are being managed to secure strategic objectives and long-term sustainability. Preliminary evidence suggests that companies with more experienced and longer-serving board members tend to preparer better integrated reports. Director independence and board diversity may also have a positive effect on report quality. Exactly how and why these governance features contribute to higher quality reporting will need to be addressed by future research. Nevertheless, the results imply that how firms are interpreting and applying the King Codes has a positive effect on the quality of their integrated reports. Integrated reporting in South Africa is still developing but there are indications that it goes hand-in-hand with a more concerted effort by, at least, some companies to manage both financial and non-financial capitals more responsibly. Key examples include biodiversity reporting and extinction accounting. These are not intended to substitute for the guidance provided by the IIRC but provide more context-specific frameworks for broadening governance systems and dealing with key social and environmental challenges. One of the most recent developments is the application of a circular economy logic in an effort to manage the interconnections among economic, environmental and social factors more effectively and improve long-term sustainability. As advancements in information systems and data analytics take shape, the ability of those charged with governance to gauge performance at a multidimensional level can only improve. Identifying and tracking changes in the capitals on which organisations are dependent will become less costly and complement the unitary focus of conventional financial reporting systems. Risk identification,

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business model development and stakeholder engagement will benefit from access to and seamless analysis of data. How organisations define and measure their impact in economic, social and environmental terms will also become more refined. Precisely how corporate governance principles and practices will be applied and modified remains to be seen but the integrated thinking logic espoused by King-IV and the IIRC will provide a useful framework for guiding business management and reporting to stakeholders.

9 Summary and areas for future research The King Codes represent a modified form of the traditional Anglo-American governance model. South Africa has always had close ties with the UK and has often referred to the UK when developing or informing changes to regulations, business practices and professional standards (King, 2012). As an emerging economy, South Africa will also be influenced by policy decisions being taken by its economic and political partners. The country is heavily dependent on foreign investment and relies on internationally-aligned codes of best practice to reassure investors and signal the credibility of the local capital market (Vaughn and Ryan, 2006). For these reasons, none of the King Codes challenges the legitimacy of shareholders’ rights or the need for organisations to generate reasonable returns for providers of financial capital. At the same time, South Africa’s codes of corporate governance reflect the country’s socio-economic condition. The market-based approach to governance followed by the UK and USA may not be effective for South Africa’s capital market which is not as efficient as many developed markets (see Rwegasira, 2000; Allen, 2005). In a country with extremely high levels of inequality, framing corporate governance in a shareholder-centric discourse is unlikely to be sustainable. What is needed is an approach to corporate governance which encourages engagement with many stakeholders as a means of promoting socio-economic development and bolstering social and political stability (IOD, 1994; Rwegasira, 2000). A shareholder-centric or market logic would also be inconsistent with African value-systems which, in contrast to the free market doctrine espoused by American culture, emphasise the importance of community and social well-being rather than just the individual’s property rights (Mbeki, 1997 in Rossouw et al., 2002; West, 2006; Andreasson, 2011). In this way, developments in South African corporate governance are not independent of international trends but are also not intended to be a replication of codes on corporate governance or external regulatory measures being promulgated in developed economies.92 South Africa has chosen to follow a principles-based governance model/philosophy rather than an external regulatory one. This has raised some concerns about the extent to which corporate governance practices are being applied (Andreasson, 2011). Nevertheless, the prior research points to a positive trend in compliance with voluntary codes of best practice (Ntim et al., 2012b; Waweru, 2014). This is driven by internal characteristics such as larger boards and more active involvement by institutional investors (Ntim et al., 2012b; Waweru, 2014). Stakeholder pressures also have a role to play.

92 Whether or not the King Codes have placed sufficient emphasis on African culture and values has been questioned. As discussed by West (2006), close ties with the UK means that South African corporate governance remains too Anglo-centric. https://doi.org/10.1515/9783110621266-009

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9 Summary and areas for future research

The King Codes are regarded as being at the cutting edge of international corporate governance (Solomon, 2013). They constitute the very discourse for describing acceptable practice in South Africa. As a result, companies face significant coercive and normative pressures to comply with the Codes if they are to be accepted as a legitimate part of the capital market system and gain access to important financial and non-financial resources (Ntim et al., 2012a). This is especially true considering the stakeholder-centric model adopted by the King Codes and the emphasis placed on balancing economic imperatives with sound environmental or social performance. In a country characterised by social inequality and increasing environmental awareness, stakeholders are paying attention to firms’ social and environmental impact. There is also the possibility of directors being held legally liable for failing to protect stakeholders’ legitimate interests (Esser and Du Plessis, 2007; IOD, 2016). In this context, compliance with the King Codes is essential for demonstrating how those charged with governance have discharged their fiduciary duties (IOD, 2016), avoiding the costs of additional regulation to moderate firm behaviour (Andreasson, 2011) and maintaining the relationships with stakeholders which are necessary for gaining access to important capitals (Ntim et al., 2012a) A growing body of international research points to the positive relationship between the integrity of corporate governance practices,93 operational performance and firm value (Gupta et al., 2008; Claessens and Yurtoglu, 2013), something which may be equally relevant for South African organisations. Effective corporate governance serves as a monitoring and control mechanism which can lessen information asymmetry and agency costs. Added to this are benefits of better stakeholder relations, improved access to intellectual and human capitals and reduced impact on natural capital. Finally, at the ethical level, those charged with governance are tasked with providing strategic direction and cultivating a culture of responsible business, something which should contribute to long-term value creation (IOD, 2016). In this way, institutional factors which promote good governance are amplified by the economic, environmental and social imperatives resulting in compliance with the King Codes (Ntim and Soobaroyen, 2013b; Atkins and Maroun, 2014).

9.1 Summary of South African-specific corporate governance research Table 9.1 provides a summary of the prior research dealing specifically with South African corporate governance.

93 These are not necessarily aligned with those described in King-IV.

9.1 Summary of South African-specific corporate governance research

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Table 9.1: Overview of South African-specific corporate governance research.94 Paper

Period Summary of key findings covered

Armstrong et al. ()

– Provides a chronological account of corporate governance reforms in South Africa. Drawing on the history of corporate governance in South Africa, it provides an account of some of the problems hindering corporate governance and suggests how to implement corporate governance.

Andreasson ()

– Provides a conceptual account of corporate governance developments in South Africa in the context of the country’s political and economic links with jurisdictions adhering to an Anglo-American model of corporate governance

Faure and de Villiers ()

– King-II provided detailed guidance of reporting on employee-related matters. Nevertheless, the top  companies on the JSE did not automatically comply with minimum reporting requirements

Ferreira ()

 Examines the importance of an audit committee’s composition and structure for discharging its governancerelated responsibilities

Harvey Pamburai et al. ()

 Companies with a greater proportion of non-executive directors perform better than other firms when performance is measured according to Tobin’s q. The size of the board and the frequency of board meetings may not necessarily contribute to better firm performance.

Kakabadse and KoracKakabadse ()

 Provides a short history of South African corporate governance and a review of the strengths and weaknesses of the then-draft King-II

Mangena and Chamisa ()

– The likelihood of being suspended from the JSE is greater for companies with a lower proportion of non-executives on their boards, block-share ownership or no audit committee.

Maroun et al. ()

– Developments in South African corporate governance reflect underlying institutional pressures, particularly the need to secure legitimacy for the South African capital market following the end of Apartheid.

94 This excludes meta-studies or multi-jurisdictional studies which include South Africa as one of the countries under review.

178

9 Summary and areas for future research

Table 9.1 (continued ) Paper

Period Summary of key findings covered

Ntim et al. (a)

– The disclosure of corporate governance practices focused on protecting shareholders increases firm value by reducing agency costs. By enabling access to resources and bolstering legitimacy, stakeholder-orientated corporate governance practice can also have a positive effect on firm value

Ntim et al. (b)

– Ownership structure and internal corporate governance mechanisms influence compliance with voluntary codes on corporate governance and disclosures on corporate governance practices. These vary significantly among listed South African firms

Ntim and Soobaroyen (b)

– Better governed organisations undertake more CSR-related activities. The combination of CSR and corporate governance practices has a positive effect on financial performance.

Ntim ()

– There is a positive relationship between corporate governance and financial performance.

Rossouw et al. ()

– Provides a brief history of South African corporate governance and explores some of the institutional and economic drivers of corporate governance in South Africa.

Rossouw ()

– Evaluates the development of codes of corporate governance in Africa with a focus on the relationship between business ethics and features of African corporate governance systems.

Vaughn and Ryan ()

– Reviews corporate governance initiatives in South Africa, external drivers of South African corporate governance developments and the leadership role played by South Africa in advancing corporate governance practice

Voogt ()

Waweru ()

 Explores changes in the roles of (CFOs at large listed companies. The results show that the CFO is taking on an increasingly strategic role rather than only a compliance one. – South African corporate governance is of high quality. Operating performance, audit quality and firm size are good predictors of better corporate governance.

9.2 Contribution

179

Table 9.1 (continued ) Paper West (; )

Willows and van der Linde ()

Period Summary of key findings covered – These two papers examine South African corporate governance following the end of Apartheid. They identify features of corporate governance which are unique to South Africa and different from the Anglo-American model. Tensions between governance principles and African value systems are also discussed.  Greater female representation on a board of directors is associated with better performance, measured according to accounting returns but not necessarily to superior market returns.

9.2 Contribution This book complements the sources in Table 9.1 by providing an up-to-date review of corporate governance trends and practices by some of South Africa’s most prominent organisations. For example, there are indications of companies working to improve the gender and race diversity of their boards and to ensure that directors have a range of skills. They are also relying on audit, risk, remuneration and nomination committees to support the monitoring and strategic functions of boards of directors (as suggested by King-IV) with a clear focus on risk management. Integral to the governance of risk is the use of combined assurance. South Africa’s largest listed companies are relying on a mix of internal and external sources of assurance focused on both financial and non-financial capitals. There are also signs of combined assurance models being developed to cope with the demand for integrated reports to be subject to, at least, some form of assurance. Overall, from 2012 to 2017 a marginal improvement is noted in the content which companies are disclosing about their corporate governance practices. This is not limited to the private sector. There has been a concerted effort by leading South African NGOs to engage with the King Codes and improve their corporate governance practices and disclosures. The result is that most of the NGOs under review and all of the Top 40 companies listed on the JSE are providing, at least, some information on: – the governance of ethics – the composition and functions of the governing body – delegation of authority to and the functions of committees of the board of directors – performance evaluation and remuneration of directors

180

9 Summary and areas for future research

– the design and operation of combined assurance models – strategy development, risk identification and management of the firm’s business model – the governance of IT – compliance with laws and regulations – stakeholder identification and engagement – integrated reporting processes and quality In general, the private sector, larger firms and those operating in socially or environmentally sensitive industries go to greater lengths to report on their corporate governance. The composition of the board is also important. More diverse boards, those with a greater proportion of non-executives and those with more experienced directors tend to have better corporate governance systems and practices. The effect of the board of directors is, however, moderated by firm size, suggesting that, as companies grow and stakeholder scrutiny increases, the marginal benefits of monitoring and review by directors diminishes. This view is supported by the fact that companies which identify a greater number of stakeholders in their annual or integrated reports also disclose more on the corporate governance practices.95 There is, of course, room for improvement. Details on exactly how companies are identifying and managing risks are limited. A more thorough explanation of how companies are engaging with stakeholders and are modifying their business models in response to changing circumstances can also be provided. Linked closely to this is the state of South African integrated reporting. Reviews by EY and CSSA show an improvement in the overall quality of South African integrated reports from 2010 to 2017 (see also Chapter 8) but also confirm a number of weaknesses identified by the professional and academic literature. These include, for example, repetitive and generic disclosure (Solomon and Maroun, 2012; PwC, 2015), reports which are difficult to read (du Toit, 2017; du Toit et al., 2017) and the need for a clearer explanations on the link between risk, strategy and financial and nonfinancial performance (McNally et al., 2017; Naynar et al., 2018). While some companies do not prepare high-quality integrated reports, there are indications that additional time and resources are being invested in improving the systems and processes necessary for preparing better quality reporting (EY, 2016; 2017). The results of this research also provide preliminary evidence on the relationship between corporate governance, integrated reporting and firm performance. In general, companies with more diverse, independent and experienced boards of directors prepare higher quality integrated reports. The decision to engage

95 This conclusion should be interpreted with caution. As discussed in Chapter 8, the directionality of the interaction between the number of identified stakeholders and corporate governance has not been confirmed.

9.3 Areas for future research

181

internal and external assurance providers also appears to be having a positive effect on integrated report quality. High quality integrated reporting, in turn, lowers information asymmetry and provides relevant information for capital market participants (Barth et al., 2017; Zhou et al., 2017). Companies with more sophisticated corporate governance practices, including higher quality integrated reporting, may also find it easier to identify and manage risks more effectively and generate sustainable returns for investors and other stakeholders (De Villiers and Maroun, 2018; McNally and Maroun, 2018). Finally, there is, at least, some evidence to suggest that better-governed firms (including those which prepare high-quality integrated reports) outperform their peers in financial and non-financial terms. This may be especially for firms operating in industries with high social and environmental impact (see also Guthrie et al., 2017; De Villiers and Maroun, 2018; McNally and Maroun, 2018).

9.3 Areas for future research As shown by Table 9.1, the determinants and consequences of corporate governance in South Africa have not been studied in detail. In keeping with a positivist tradition, future researchers can make an important contribution by establishing whether or not the drivers of corporate governance identified by the international literature hold in a South African setting. For example, this research provides some evidence on the relevance of firm characteristics such as board size, composition and experience for application of the King Codes, corporate reporting and value creation. The findings are consistent with earlier studies by Ntim et al. (2012a) and Ntim and Soobaroyen (2013b) but a more detailed longitudinal analysis of the possible drivers of corporate governance needs to be undertaken. In particular, this research is primarily exploratory and does not control for endogeneity and fixed year effects. Similarly, we know little about how factors such as dispersion of ownership, the nature of an organisation’s operations and managerial attitude impact the design and operation of corporate governance systems. The South Africa-specific research pre-dates important developments such as the adoption of a comply and explain logic under King-IV and the emergence and maturation of integrated reporting. How the drivers and benefits of corporate governance in South Africa compare with other developing and developed economies has also not been formally tested. Possible areas of enquiry for future researchers include the following: – Data from a larger sample of companies over an extended period can be used to quantify the impact which corporate governance has on different measures of firm performance. This will need to include a comprehensive range of control variables and a carefully designed model which is adjusted appropriately for endogeneity.

182

9 Summary and areas for future research

– This research deals with some, but certainly not the majority, of corporate governance drivers. Using the details provided in Chapter 4, future researchers can explore how a range of external drivers and firm characteristics contribute to better corporate governance and how these variables may be interacting with one another. – Following from the above, studies on the relevance of legal systems, investor protections and concentration of shareholdings for corporate governance and firm value are numerous (Brennan and Solomon, 2008). In contrast, we know little about the effects of culture, firm structure, individual behaviour and technical training on the interpretation and application of codes of best practice. How these factors may vary from country to country has also not been considered in detail. What little research has been carried out on South African corporate governance is based on inferential testing of proxy measures using finance theories as a basis (e.g. Ntim et al., 2012b; Ntim and Soobaroyen, 2013b). We know almost nothing about how corporate governance is understood and operationalised at the organisational level and by individual managers or directors. Interpretive studies which explore how corporate governance systems are designed; the reasons for any differences or similarities in these systems and the changes, if any, which corporate governance has on organisational behaviour would make a significant contribution to both the local and international literature (see Brennan and Solomon, 2008; Maroun and Jonker, 2014). Application of different theory and the study of new settings are additional avenues for future research. The relevance of the political economy, institutional pressures, power or control and cultural heuristics have not been considered in a South African context. Detailed context-specific case studies have not been conducted and precisely how stakeholders – including institutional investors – perceive corporate governance practices has only been touched on (see Rensburg and Botha, 2014; Atkins and Maroun, 2015). We also know very little about corporate governance practices in the public and NFP sectors (see Brennan and Solomon, 2008; De Villiers and Maroun, 2018). More than 20 years have passed since the publication of King-I. South Africa offers an excellent setting for exploring the evolution of codes of best practice, their financial and non-financial implications and the manner in which they are both shaped by and become an integral part of local custom. South African researchers are well placed to provide a detailed longitudinal account of corporate governance, identify successes and failures and advance informed recommendations for the benefits of practitioners and policy-makers.

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List of Figures Figure 1.1 Figure 2.1 Figure 2.2 Figure 2.3 Figure 3.1 Figure 4.1 Figure 4.2 Figure 4.3 Figure 4.4 Figure 4.5 Figure 4.6 Figure 4.7 Figure 4.8 Figure 4.9 Figure 4.10 Figure 4.11 Figure 4.12 Figure 4.13 Figure 4.14 Figure 6.1 Figure 6.2 Figure 6.3 Figure 6.4 Figure 6.5 Figure 6.6 Figure 6.7 Figure 6.8 Figure 7.1 Figure 7.2 Figure 7.3 Figure 7.4 Figure 7.5 Figure 8.1 Figure 8.2 Figure 8.3

Determinants, interpretation and consequences of corporate governance 5 Essential features of good governance 19 The philosophy of King-III 23 Timeline of changes and events locally and internationally which have affected South African corporate governance 31 Integrated thinking 54 Composition of the King Codes 67 Directors by age, tenure and gender 83 Director age profile by gender 83 Directors by race 84 Directors under the age of 45 by race 85 Executive v non-executive 86 Directors’ areas of expertise 86 Expertise of executive and non-executives 87 Expertise of directors by race 87 Expertise of directors by gender 88 Functions of the audit committees 91 Functions of the risk committee 92 Functions of the remunerations and nominations committees 93 Trends in corporate governance 97 Drivers of ESG assurance 120 Combined assurance 121 Compliance with codes of best practice 126 Use of internal and external assurance 127 Assurance providers 128 Assurance frameworks used 130 Focus of assurance 131 Focus of internal vs external assurance 131 NFP entities in South Africa 143 NFP entities by province 143 Economic, environmental and social disclosures by select South African NGOs 146 IRQ by select South African NGOs 147 Corporate governance practices by South African NGOs 150 Integrated report quality 154 A natural capital reporting framework 166 Application of a circular economy approach 170

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List of Tables Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 3.1 Table 3.2 Table 4.1 Table 4.2 Table 5.1 Table 5.2 Table 5.3 Table 5.4 Table 5.5 Table 5.6 Table 5.7 Table 5.8 Table 5.9 Table 5.10 Table 5.11 Table 6.1 Table 7.1 Table 7.2 Table 7.3 Table 8.1 Table 8.2 Table 8.3 Table 8.4 Table 8.5 Table 9.1

Structure of King-I 14 Structure of King-II 20 Structure of King-III 25 King-IV’s principles and guiding philosophy 29 Summary of determinants by theory 46 Select papers on the financial benefits of good governance 59 Emerging trends in corporate governance 81 Corporate governance disclosure matrix 94 Definition of variables 103 Correlation matrix 106 Differences in corporate governance scores by size and industry 108 Differences in board composition with changes in size, industry and year 109 Changes in drivers with variations in corporate governance 110 Sensitivity test for firm size 112 Sensitivity test for industry 113 Effect of drivers on corporate governance scores 114 Sensitivity test for firm size 115 Sensitivity test for firm industry 116 Sensitivity test for firm industry 116 Assurance provisions included in the Companies Act (2008) 123 Corporate governance provisions specific to NGOs 138 Disclosure schematic 145 Corporate governance disclosure matrix 148 Correlation matrix 155 Drivers of integrated reporting quality 158 Sensitivity test for industry and firm size 158 Biodiversity reporting under the GRI 161 Biodiversity reporting themes 162 Overview of South African-specific corporate governance research 177

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List of acronyms/ abbreviations ACI ANC BEE CDP CEO CFO CSR CSSA DT DTI ERM ESG EY GEAR GRI IAASB IASB IFRS IIA IIRC IOD IRCSA IRQ ISAE IT JSE NFP NGO NPO OECD PwC ROA ROE SAICA SME SOX SRI UK USA VBS ZAR

African, Coloured and Indian African National Congress Black economic empowerment Carbon Disclosure Project Chief executive officer Chief financial officer corporate social responsibility Chartered Secretaries Southern Africa Disclosure theme Department of Trade and Industry Enterprise risk management Environmental, social and governance Ernst and Young Growth, Employment and Redistribution Global Reporting Initiative International Auditing and Assurance Standards Board International Accounting Standards Board International Financial Reporting Standards Institute of Internal Auditors International Integrated Reporting Council Institute of Directors in Southern Africa Integrated Reporting Committee of South Africa Integrated report quality International Standards on Assurance Engagements information technology Johannesburg Stock Exchange Not-for-profit Non-governmental organisation Non-profit organisation Organisation for Economic Co-operation and Development PricewaterhouseCoopers Return on Assets Return on Equity South African Institute of Chartered Accountants Small and medium enterprises Sarbanes Oxley Act FTSE/JSE Responsible Investment Index Series United Kingdom United States of America Venda Building Society Mutual Bank South African Rand

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Appendices

Appendix A The integrated reporting capitals and reporting principles This research makes a number of references to different capitals. These are defined by the IIRC (2013) and are explained in Table A1.

Table A1: Explanation of different capitals. Capitals

Explanation

Financial capital

The pool of funds which is: – available to an organization for use in the production of goods or the provision of services – obtained through financing, such as debt, equity or grants, or generated through operations or investments

Manufactured capital

Manufactured physical objects (as distinct from natural physical objects) which are available to an organization for use in the production of goods or the provision of services. Examples include: – property, plant and equipment – inventories – head-office or administrative facilities which support productive processes – infrastructure

Intellectual capital

Organizational, knowledge-based intangibles, including: – intellectual property, such as patents, copyrights, software, rights and licences – “organizational capital” such as tacit knowledge, systems, procedures and protocols

Human capital

People’s competencies, capabilities and experience, and their motivations to innovate, including their: – alignment with and support for an organization’s governance framework, risk management approach, and ethical values – ability to understand, develop and implement an organization’s strategy – loyalties and motivations for improving processes, goods and services, including their ability to lead, manage and collaborate

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212

Appendix A The integrated reporting capitals and reporting principles

Table A1 (continued ) Capitals

Explanation

Social and relationship capital

The institutions and the relationships within and between communities, groups of stakeholders and other networks, and the ability to share information to enhance individual and group well-being. Social and relationship capital includes: – shared norms, and common values and behaviours – key stakeholder relationships, and the trust and willingness to engage which an organization has developed and strives to build and protect with external stakeholders – intangibles associated with the brand and reputation which an organization has developed – an organization’s social licence to operate

Natural capital

All renewable and non-renewable environmental resources and processes which provide goods or services which support the past, current or future prosperity of an organization. These include: – air, water, land, minerals and forests – biodiversity and eco-system health

(IIRC (2013), pp. 11–12)

Table A2: Principles and content elements of integrated reports. Guiding principles Strategic focus and future orientation

An integrated report should provide insight into the organization’s strategy, and how it relates to the organization’s ability to create value in the short, medium and long term, and to its use of and effects on the capitals

Connectivity of information

An integrated report should show a holistic picture of the combination, interrelatedness and dependencies between the factors which affect the organization’s ability to create value over time

Stakeholder relationships

An integrated report should provide insight into the nature and quality of the organization’s relationships with its key stakeholders, including how and to what extent the organization understands, takes into account and responds to their legitimate needs and interests

Materiality

An integrated report should disclose information about matters which substantively affect the organization’s ability to create value over the short-, medium- and long-term

Conciseness

An integrated report should be concise

Appendix A The integrated reporting capitals and reporting principles

213

Table A2 (continued ) Guiding principles Reliability and completeness

An integrated report should include all material matters, both positive and negative, in a balanced way and without material error.

Consistency and comparability

The information in an integrated report should be presented: (a) on a basis which is consistent; and (b) enables comparison with other organizations to the extent it is material to the organization’s own ability to create value.

Report content Organisational overview and external environment

What does the organization do and what are the circumstances under which it operates?

Governance

How does the organization’s governance structure support its ability to create value in the short, medium and long term?

Business model

What is the organization’s business model?

Risks and opportunities

What are the specific risks and opportunities which affect the organization’s ability to create value over the short, medium and long term and how is the organization dealing with them?

Strategy and resource allocation Where does the organization want to go and how does it intend to get there? Performance

To what extent has the organization achieved its strategic objectives for the period and what are its outcomes in terms of effects on the capitals?

Outlook

What challenges and uncertainties is the organization likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance?

Basis of preparation

How does the organization determine what matters to include in the integrated report and how are such matters quantified or evaluated?

(IIRC, 2013)

Appendix B Members of the King committee Table B1: Members of the King Committee. Committee Member

King-I

King-II

King-III

King-IV

Prof M E King

Chairman

Chairman

Chairman

Chairman

R C Andersen

Member

Member

Member

Member

M Borkum

Member

E Bradley

Member

P Joubert

Member

B Kardol

Member

M Katz

Member

Member

Member

E Mabuza

Member

E Molobi

Member

C Margo

Member

N Motlana

Member

S Motsuenyane

Member

E Patel

Member

G Smith

Member

P Wrighton

Member

P A Armstrong

Member

I Charnley

Member

D E Cooper

Member

Member

M D Dunn

Member

Member

M J Feinstein

Member

Member

Dr R Khoza

Member

Member

Member

Dr L Konar

Member

Member

Member

P du Plessis Kruger

Member

R M Loubser

Member

Adv. F D M Malunga

Member

N G Payne

Member

https://doi.org/10.1515/9783110621266-015

Member

Member

216

Appendix B Members of the King committee

Table B1 (continued ) Committee Member

King-I

King-II

I Sehoole

Member

B Sibiya

Member

A Swanepoel

Member

D Sylvester

Member

L I Weil

Member

King-III

King-IV

Member

Member

R S Wilkinson

Member

W S Yeowart

Member

L Engelbrecht

Member

Prof D Burdette

Member

R Connellan

Member

Dr G Cruywagen

Member

Member

M Judin

Member

Member

Dr S Kana

Member

Member

A van Wyk

Member

Member

M Adam

Member

Member

B Agulhas

Member

Member

J Burke

Member

Member

L de Beer

Member

Member

R de Lorenzo

Member

A D Dixon

Member

Dr I May

Member

V Mhlango

Member

E Muller

Member

F Nomvalo

Member

S Sadie

Member

V Sekese

Member

A van der Merwe

Member

J Vilakazi

Member

Member

Member

Member

Member

Appendix B Members of the King committee

217

Table B1 (continued ) Committee Member

King-I

King-II

King-III

King-IV

A Ramalho

Member

L Engelbrecht

Member

R Foster

Member

P Natesan

Member

S Sadat

Member

C Choeu

Member

F Dowie

Member

S Daniels

Member

J de Jager

Member

K Kweyama

Member

M Marweshe

Member

J Mazzocco

Member

J Methven

Member

J Nair

Member

M Lucky Phakeng

Member

Prof D Rossouw

Member

M Mokholo

Member

M van den Berg

Member

A Visser

Member

Adv R Voller

Member

(IOD, 1994; IOD, 2002; IOD, 2011; IOD, 2016).

Appendix C King IV disclosures applicable to the audit committee In addition to the information which the Companies Act (2008) required to be included in a company’s financial statements, King-IV recommends the following disclosures concerning the audit committee: a. A statement as to whether the audit committee is satisfied that the external auditor is independent of the organisation. The statement should specifically address: i. the policy and controls that address the provision of non-audit services by the external auditor, and the nature and extent of such services rendered during the financial year; ii. the tenure of the external audit firm and, in the event of the firm having been involved in a merger or acquisition, including the tenure of the predecessor firm; iii. the rotation of the designated external audit partner; and iv. significant changes in the management of the organisation during the external audit firm’s tenure which may mitigate the attendant risk of familiarity between the external auditor and management. b. Significant matters that the audit committee has considered in relation to the annual financial statements, and how these were addressed by the committee. c. The audit committee’s views on the quality of the external audit, with reference to audit quality indicators such as those that may be included in inspection reports issued by external audit regulators. d. The audit committee’s views on the effectiveness of the chief audit executive and the arrangements for internal audit. e. The audit committee’s views on the effectiveness of the design and implementation of internal financial controls, and on the nature and extent of any significant weaknesses in the design, implementation or execution of internal financial controls that resulted in material financial loss, fraud, corruption or error. f. The audit committee’s views on the effectiveness of the CFO and the finance function. g. The arrangements in place for combined assurance and the committee’s views on its effectiveness. g. The arrangements in place for combined assurance and the committee’s views on its effectiveness. (IOD, 2016, Principle 8, para 59) These disclosure recommendations have been taken into account when developing the corporate governance schematic summarised in Chapter 4, Section 4.2.3, Table 4.2.

https://doi.org/10.1515/9783110621266-016

Appendix D Scope of the King IV sector supplements Table D1: Scope of the King IV sector supplements. Sector

Application

Municipalities

This supplement applies to municipalities categorised by the Municipal Structures Act. These include municipalities with a collective executive or mayoral executive system. The municipalities can also have a sub-council or a ward participatory system. For example the City of Johannesburg Metropolitan is classified as a “Category A” municipality for the purpose of the Municipal Structures Act and would therefore be in scope for this supplement.

Non-profit organisations

This supplement applies to NPOs. The definition of an NPO includes NFP companies, charitable trusts, voluntary associations, clubs or funds. The supplement is not limited to NPOs which have been granted NPO status by the applicable South African legislation.

Retirement funds

This supplement applies to all retirement funds as defined by the Income Tax Act, No  (). This includes pension funds, provident funds, preservation funds and retirement annuity funds.

Small and medium enterprises (SME)

This supplement applies to SMEs. SMEs are defined as a private, forprofit company which has a public interest score in excess of .

State owned enterprises

This supplement applies to all public entities listed in Schedules  and  of the Public Finance Management Act. This includes entities such as Eskom, Denel, Brand SA and Telkom SA .

96 The Municipal Structures Act defines different municipalities based on their characteristics. A detailed review of this legislation is beyond the scope of this research. 97 The Non-Profit Organisations Act legislates NPOs. 98 As calculated in terms of regulation 26(2) of the Companies Act (2008). 99 The Public Finance and Management Act regulates the management of finances in national and provincial government. It sets out the procedures for efficient and effective management of all revenue, expenditure, assets and liabilities. It establishes the duties and responsibilities of government officials in charge of finances. The Act aims to secure transparency, accountability and sound financial management in government and public institutions. https://doi.org/10.1515/9783110621266-017

https://doi.org/10.1515/9783110621266-018

Comply or explain

Balanced

Understandable financial statements

Type of application

Type of approach

Type of reporting

Type of board

Composition of the board

Unitary

Yes. Subsequently became a JSE listing requirement

Recommends that it is a listing requirement

Board of directors

Affected companies defined in the Code

King-I

Applies to

Application

Area

Table E1: Key differences between King-I, -II, -III, -IV.

Unitary

Triple-bottom line

Inclusive

Comply or explain

N/A

Affected companies defined in the Code, however, suggests that all entities should try and apply the Code

King-II

Unitary

Integrated

Inclusive

Apply or explain

N/A

All entities

King-III

Unitary

Integrated

Inclusive

Apply and explain

N/A

All entities

King-IV

Appendix E The King Codes: A summary of similarities and differences

(continued )

Not addressed

Not addressed

Rotation of non-executives

Removal of the members of the governing body Not addressed

Not specifically addressed however states that there should be a rotation programme in place

Not addressed

At least  members on the board.  should be executive and the other  non-executive

Minimum number of directors on the board

Memorandum of Incorporations should be amended to allow for the removal of CEOs without shareholders’ approval

One third should rotate at the annual general meeting

At least two executive directors (CEO and CFO) and three non-executive directors so that the non-executives constitute the majority of board members

Majority non-executive Majority non-executive directors of whom a sufficient directors and the majority of number should be independent non-executive directors should be independent

Balance of executive and non-executive

King-III

Make-up of board

King-II

King-I

Area

Table E1 (continued )

Not addressed

Mentions the rotation however it does not require a third of the non-executive members to rotate on a yearly basis

At least two executive directors (CEO and CFO/Other designation) and three non-executive directors so that the non-executives constitute the majority of board members

The governing body should comprise a majority of nonexecutive members, most of whom should be independent

King-IV

224 Appendix E The King Codes: A summary of similarities and differences

A director who is not involved in the day to day affairs or running of the business of the company as an employee of the company

Independent of management and where possible free from any business relationship with the company

Yes

Definition of a non-executive

Independence

Addresses affirmative action

Yes

Yes

Yes

Non-executive

Independent

Separate from the CEO

Chairman of the board

A person involved in the dayto-day activities of an entity and is an employee of the company

Definition of an executive

Yes

Yes

Yes

Not specifically

Defined by a list of items however is summed up by: is free from any business or other relationship which could be seen to materially interfere with the individual’s capacity to act in an independent manner

an individual not involved in the day to day management and not a full-time salaried employee of the company or its subsidiaries

An individual that is involved in the day-to-day management and/or is in full-time salaried employment of the company and/or any of its subsidiaries

Yes

Yes

Yes

Not specifically

Independent non-executive directors should be independent in fact and the perception of a reasonably informed outsider

Not being involved in the management of the company defines the director as non-executive.

Involvement in the day-to-day management of the company or being in the full-time salaried employment of the company (or its subsidiary) or both defines the director as executive

Yes

Yes

Yes

Yes

(continued )

If it is concluded that there is no interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party

N/A

N/A

Appendix E The King Codes: A summary of similarities and differences

225

Not addressed

Not addressed

Not addressed

Can the CEO ever become the Chairman after retirement?

Reappointed annually

Appointment of a lead independent director

Not addressed

Should they be granted

Number of meetings per annum

At least one per quarter

Duties and miscellaneous

Not addressed

Can they be granted

Share options for non-executive directors

King-I

Area

Table E1 (continued )

At least one per quarter

Not addressed

Yes after approval of shareholders

Yes in circumstances where the Chairman is not independent

Not addressed

Not addressed

King-II

At least one per quarter

No, as it impairs objectivity

Yes, permitted by the Companies Act

Yes in circumstances where the Chairman is not independent

Yes

CEO should not become the chairman until three years have elapsed

King-III

Not addressed however needs to be disclosed

If they are, the company needs to assess the impact on independence.

Yes, permitted by the Companies Act

Yes to fulfil specific functions and if there are circumstances where the Chairman is not independent

CEO should not become the chairman until three years have elapsed

King-IV

226 Appendix E The King Codes: A summary of similarities and differences

The selection of directors should be planned, agreed on and managed by the board

Nomination

Yes

Not addressed

Suggests a remuneration committee

Suggests a risk committee

Suggests a nomination No committee

Yes

Suggests an audit committee

Board committees

Detailed by a list however, the list is not intended to be exhaustive. In consequence, the Committee does not support the suggestion contained in the Melamet Commission that there should be a statutory manual of director’s duties

Responsibilities Every board should have a charter setting out its responsibilities

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Directors should be appointed Shareholders are responsible through a formal process. however the procedure should Shareholders need to vote to be fair and transparent appoint members

Every board should have a charter setting out its responsibilities, which should be disclosed in its annual report

Yes

Yes

Yes

Yes

(continued )

Shareholders are responsible. However, the procedure should be fair and transparent and the governing body should state whether or not they support the candidate

The governing body should ensure that its role, responsibilities, membership requirements and procedural conduct are documented in a charter which it regularly reviews to guide its effective functioning

Appendix E The King Codes: A summary of similarities and differences

227

Yes

Suggests other committees

No

No

Not specifically precluded

Majority non-executive

Can the chairman of the board be the chair of the committee

Can the CEO be a member of the committee

The make-up of the committee

Majority independent

Yes

No, but can attend by invite

Yes

Yes

Not addressed

King-II

Can the chairman of No the board be a member of the committee

The chairman should be independent

Composition

Not explicitly mentioned however must be a non-executive

Not addressed

Suggests a social and ethics committee

Audit committee

King-I

Area

Table E1 (continued )

All independent

No, but can attend by invite

No

No, but can attend by invite

Yes

Yes

Refers to the statutory requirement

King-III

All independent

No, but can attend by invite

No

No, but can attend by invite

Yes

Yes

Yes

King-IV

228 Appendix E The King Codes: A summary of similarities and differences

Not addressed

Responsible for Yes overseeing the internal audit and the integrity of the annual financial statements

Ensure that a combined assurance model is applied to provide a coordinated approach to all assurance activities.

Duties

Minimum number of meetings



Yes

Should consist of at least three members

Meetings

Not addressed

Qualifications

Yes

Not addressed



Yes

Majority financially literate

Yes

Yes



Yes

Should have a good understanding of Integrated reporting, including financial reporting, and sustainability issues; internal financial controls and other matters

Yes

Yes

(continued )

Not addressed states that there needs to be a meeting with the external auditors

Yes

The members of the audit committee should, as a whole, have the necessary financial literacy, skills and experience to execute their duties effectively

Appendix E The King Codes: A summary of similarities and differences

229

Not addressed

Overseeing of Not addressed sustainability issues in the integrated report

Yes

Yes

Not specifically mentioned however should be a non-executive

Can the chairman of Not specifically precluded the board be a member of the committee

The chairman should be independent

Composition

Remuneration committee

Not addressed

Not addressed

Assist by overseeing the integrity of the integrated report

King-II Yes

King-I

Responsible for Yes recommending the appointment of the external auditor and overseeing the external audit process.

Area

Table E1 (continued )

Yes

Yes

Yes

Yes

Yes

King-III

Yes

Yes

Not specifically ascribed

Not specifically ascribed

Yes

King-IV

230 Appendix E The King Codes: A summary of similarities and differences

Majority non-executive

Not addressed

The make-up of the committee

Should consist of at least three members

The chairman should be independent

Nomination committee Composition

Responsibilities

Duties

Minimum number of meetings

Not addressed

Recommendations of the remuneration of the chair, chief executive and executive directors of the main board



Not specifically precluded

Can the CEO be a member of the committee

Meetings

Not specifically precluded

Can the chairman of the board be the chair of the committee

Yes

Work on behalf of the board and be responsible for its recommendations



Yes

Entirely or mainly of independent non-executive directors

No, but can attend by invite

Yes

Yes

Assist the board in its responsibility for setting and administering remuneration policies in the company’s long-term interests



Yes

Majority non-executive directors and the majority of non-executive directors should be independent.

No, but can attend by invite

No

Yes

(continued )

Oversight of remuneration

Not addressed

Yes

All members should be non-executive members of the governing body, with the majority being independent.

No, but can attend by invite

No

Appendix E The King Codes: A summary of similarities and differences

231

Not addressed

Should consist of at least three members

Number of meetings



Not addressed

The make-up of the committee

Meetings

Not addressed

Can the CEO be a member of the committee



Yes

All non-executive, majority independent

No

Yes

Not addressed

Can the chairman of the board be the chair of the committee

King-II Yes

King-I

Can the chairman of Not addressed the board be a member of the committee

Area

Table E1 (continued )



Yes

Majority non-executive directors and the majority of non-executive directors should be independent

No, but can attend by invite

Yes

Yes

King-III

Not addressed

Yes

All members should be non-executive members of the the governing body, with the majority being independent

No, but can attend by invite

Yes

Yes

King-IV

232 Appendix E The King Codes: A summary of similarities and differences

Not addressed

Can the CEO be a member of the committee Not addressed

No

Not addressed

Can the chairman of the board be the chair of the committee

Independence not addressed however a non-executive is suggested

Make recommendations to the board on the appointment of new executive and non-executive directors

Not addressed

Not addressed

Not addressed

Can the chairman of Not addressed the board be a member of the committee

The chairman should be independent

Composition

Risk committee

Responsibilities

Duties

Yes

No

Yes

Yes

To assist the board in the discharge of its duties and responsibilities in respect of risk management

Yes

Yes

Yes

Not addressed

(continued )

Oversight of: The process for nominating, electing and appointing members of the governing body; Succession planning in respect of governing body members and the evaluation of the performance of the governing body

Appendix E The King Codes: A summary of similarities and differences

233

Not addressed

Should consist of at least three members

Responsibilities

Duties

Minimum number of meetings

Not addressed

Not addressed

Not addressed

The make-up of the committee

Meetings

King-I

Area

Table E1 (continued )

To assist the board in the discharge of its duties relating to corporate accountability and the associated risk in terms of management, assurance and reporting



Not addressed

Should include an equal number of executive and non-executive directors. One member should be a non-executive on the Audit Committee

King-II

To assist the board in the discharge of its duties and responsibilities in respect of risk management



Yes

Should include executive and non-executive directors

King-III

Oversight of risk governance

Not addressed

Yes

Majority non-executive directors

King-IV

234 Appendix E The King Codes: A summary of similarities and differences

Not addressed

Not addressed

Not addressed

Can the CEO be a member of the committee

The make-up of the committee

Should consist of at least three members

Number of meetings

Not addressed

Not addressed

Not addressed

Can the chairman of the board be the chair of the Social and Ethics committee

Meetings

Not addressed

Can the chairman of Not addressed the board be a member of the Social and Ethics committee

Not addressed

Not addressed

Not addressed

Not addressed

Not addressed

Not addressed

The chairman should be independent

Composition

Social and ethics committee



Yes

Majority non-executive directors and the majority of non-executive directors should be independent

Not addressed

Not addressed

Not addressed

Not addressed

Not addressed

Yes

(continued )

Majority non-executive directors and the majority of non-executive directors should be independent

Yes

Yes

No

Yes Appendix E The King Codes: A summary of similarities and differences

235

Responsibilities

Duties

Area

Table E1 (continued )

Not addressed

King-I

Not addressed

King-II

Not addressed

King-III

Include its statutory duties (if applicable) and any other responsibilities delegated to it by the governing body

King-IV

236 Appendix E The King Codes: A summary of similarities and differences

Appendix F Summary of select corporate scandals in South Africa Due to the size of the South African capital market, local corporate scandals have not had the same international impact as the collapse of Enron and WorldCom. Nevertheless, they highlight how weaknesses in corporate governance can result in business failure with material losses for investors and other stakeholders.

Table F1: Summary of South African corporate failures. Year

Company

Summary of failure

 Masterbond

In  the collapse of Masterbond resulted in the loss of ZAR  million ($ million). The Masterbond failure involved a series of undetected fraudulent activities undertaken by the directors. Included in the activities were misrepresentations concerning investment schemes. The report by the Nel Commission, issued in April , exposed a history of abuse by directors and auditors and serious deficiencies in the supervisory systems. It also revealed weaknesses in the provisions of the Companies Act (), which were designed to protect investors (Nel, ). In addition to the direct financial cost, the failure of the external auditors to identify fraud resulted in a loss of public confidence in the auditing profession (Sarra, ) and contributed to the demise of the South African audit profession’s self-regulatory franchise (Nel, ).

 MacMed

In , the holding company of healthcare group, MacMed, entered into liquidation. At the time of liquidation,  banks were owed ZAR  billion in unsecured loans. The corporate failure was attributed to a number of factors, namely: – Macmed’s company secretary was an un-rehabilitated insolvent. – Profitable operations were diverted to the expansion of hospitals without due consideration of the effect. – The financial statements failed to disclose fairly the financial status of the company. – The former auditors did not report the irregularities in Macmed’s financial statements as required by auditing standards and external regulation at the time. – There were also allegations of insider trading. (Sarra, 2004)

https://doi.org/10.1515/9783110621266-019

238

Appendix F Summary of select corporate scandals in South Africa

Table F1 (continued ) Year

Company

Summary of failure

 LeisureNet

LeisureNet operated the Health and Racket Club in South Africa. In  the company collapsed, placing the livelihood of   employees at risk. At the time of the collapse, LeisureNet had debts totalling ZAR million and its previous financial statements had failed to disclose ZAR million in contingent liabilities. The company had a number of corporate governance mechanisms in place. Most notably, an audit committee was established and included  financial and accounting experts among its members. One of the oversights of the board was to leave the integrity of the financial reporting exclusively to the audit committee. This, in turn, allowed the audit committee to engage in fraudulent reporting. (Sarra, )

 Regal Bank

In , Regal Bank collapsed. The inquiry into the collapse revealed the following: – The CEO and Chair of the Board failed to act in good faith, with integrity and according to the best interests of the bank. – He engaged in self-dealing transactions,100 securing excessive cash bonuses, stock options and other benefits. – Adequate steps to ensure an appropriate balance of power on the board and its committees were not taken. In addition to the board of directors, the CEO chaired 5 of the 8 board committees and was able to remove directors who questioned his actions. In this environment, the audit committee could not act independently and failed to challenge the CEO’s actions and decisions. (Sarra, 2004)

100 Self-dealing transactions refers to transactions undertaken by a fiduciary in their own best interest rather than in the best interest of their clients.

Appendix F Summary of select corporate scandals in South Africa

239

Table F1 (continued ) Year

Company

 Saambou

Summary of failure In , Saambou, South Africa’s th largest bank at the time, collapsed. The corporate failure unveiled fraud to the amount of ZAR million. Saambou’s former director for personal banking and the general manager of the bank’s group finance department were accused of misconduct. Charges included: – conducting the business of Saambou Bank in a reckless manner – concealing or making false entries in the books, financial records and financial statements of Saambou Bank and Saambou Holdings – providing financial assistance for the purchase of shares of Saambou Bank in contravention of the provisions of the Companies Act (1973) These actions were not detected by the company’s internal controls (including the independent monitoring which should have been provided by the board and its committees) and adequate corrective action was not taken. (IOL, 2008a)

 Fedsure

Financial problems at Fedsure led to ZAR million in losses for investors, including retirement funds. Under the leadership of chief executive, Fedsure bought controlling stakes in a number of companies, including Norwich Life, Saambou Bank and FBC Fidelity Bank. The Chairman of the Board entered into a plea bargain in which he admitted to illegally assisting with the stripping surpluses from the employee retirement fund for the benefit of the company. The Financial Services Board investigating panel concluded that losses were attributable to mismanagement of the funds and the jumbling of assets into something called the “net main life fund”. With the collapse of Saambou in , Fedsure imploded. Investec stepped in and bought Fedsure. At the time of the Investec take-over, Fedsure had some of the finest accounting, legal and corporate governance minds serving on its board. (IOL, b)

 JCI-Randgold

The directors and the CEO of JCI-Randgold (JCI) misappropriated assets of the organisation to the detriment of the shareholders. A forensic report by KPMG showed that, between  and , the previous directors and other related parties benefited directly and indirectly to the tune of more than ZAR-million. Major misappropriations include: – ZAR266-million in JCI shares issued for worthless transactions and payments of approximately ZAR200-million to former directors and officers. – ZAR40-million of misappropriated Western Areas Limited shares were belonging to JCI. (IOL, 2006)

240

Appendix F Summary of select corporate scandals in South Africa

Table F1 (continued ) Year

Company

Summary of failure

 Fidentia

The Fidentia scandal concerned what amounted to a Ponzi scheme run by the company’s CEO for his own benefit. He is estimated to have spent the ZAR million in savings by   retirees. (Cordeur, )

 Africa Bank

African Bank Investments Limited (Africa Bank) was initially put under curatorship on  August  by the Minister of Finance, Nhlanhla Nene. However, from as early as , Africa Bank had come under increasing scrutiny from the South African Reserve Bank because of concerns about the level of unsecured debt. Africa Bank subsequently collapsed in  and resulted in a Rbn bail-in from the South African government. Findings included in the Myburgh Report on Africa Bank note that the directors breached their fiduciary and other duties to the bank. This included conducting business negligently and recklessly. (Myburgh, )

 Steinhoff

Steinhoff’s share price collapsed on  December , initiated by the resignation of the then CEO Markus Jooste and a report of accounting irregularities requiring further investigation (Lungisa, ; USB, ). A forensic investigation by PwC indicates that a number of former Steinhoff directors inflated profits and assets over a number of years through fictitious/irregular transactions with related parties. The related party transactions were made to appear as third party transactions while the contra-entries were posted to intercompany loan accounts (Steinhoff International Holdings BV, ).

101 As the South African government was a shareholder of Africa Bank at the time, the payment of R3bn is a bail-in rather than a bail-out (Myburg, 2016). A bail-in provides relief to a financial institution on the brink of failure by requiring the cancellation of debts owed to creditors and depositors. A bail-out involves a financial institution being rescued by external parties in an effort to protect creditors from losses.

Appendix F Summary of select corporate scandals in South Africa

241

Table F1 (continued ) Year

Company

 VBS Mutual Bank

Summary of failure In , Venda Building Society mutual bank (VBS) bank collapsed. The collapse of VBS is suspected to be the result of fraud. Investigations were still underway at the time of compiling this research. Funds appear to have been stolen by the company’s directors by paying large sums of money to various individuals for goods and services never delivered or rendered and bribing certain VBS directors and other related parties in order to buy their silence. Fictitious reporting of deposits and the implementation of poor governance systems allowed the misappropriations to be concealed. For example, – the Chairman was not an independent non-executive director. He held shares in VBS indirectly through his company, Brilliant Communications. – a close personal relationship between the Chairman and CEO appears to have resulted in collusion to override internal controls. The fraudulent reporting misled regulators into believing that VBS was in a financially sound position when, in fact, its liabilities exceeded its assets by about ZAR180 million, making it hopelessly insolvent as of 31 March 2017. (Motau, 2018)

The summary of corporate failures indicates that, although governance codes exist, it is possible to override them. The corporate failures also highlight some of the issues that the revisions of the King Code sought to address (Armstrong et al., 2005; Ntim et al., 2012b). The results of prior studies indicate that compliance with the corporate governance provisions generally improves over time (Patel et al., 2002; Collett and Hrasky, 2005; Barako et al., 2006; Henry, 2008; Ntim et al., 2012b). However, in South Africa, there is a high degree of heterogeneity among listed companies concerning the levels of compliance (Ntim et al., 2012b). This suggests that they place different levels of importance on corporate governance with the result that corporate failures due to weaknesses in governance systems and practices are likely to continue in the foreseeable future.