Enhancing Board Effectiveness: Institutional, Regulatory, and Functional Perspectives for Developing and Emerging Markets 9781138048324, 9781315169477

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Enhancing Board Effectiveness

This innovative book draws together authors from diverse disciplinary backgrounds to examine the role of boards of directors. An important contribution that it makes is to focus on the board’s role and effectiveness in developing emerging markets. The editors stress the salience of context through their adoption of a New Institutional Economics framework emphasising the importance of culture influencing institutions and their effectiveness. Contributions to the volume cover theoretical approaches as well as examining the practical and policy problems that arise in developing and emerging markets. The book is an essential contribution to our understanding of the role of directors in developing and emerging markets. —Professor Frank H. Stephen, University of Manchester, UK Enhancing Board Effectiveness seeks to examine the conceptualization and role of the board in a variety of contexts and articulate solutions for improving the effectiveness of the board, especially in developing and emerging markets. Enhancing Board Effectiveness will therefore address the following central questions: • •

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To what extent is the concept and role of the board evolving? What rights, powers, responsibilities, and other contemporary and historical experiences can enhance the effectiveness of the board, especially in the particular contexts of developing and emerging markets? What socio-economic, political, regulatory, and institutional factors/actors influence the effectiveness of the board and how can the policies and practices of such actors exert such influences? In what ways can a reconstructed concept of the board serve as a tool for theoretical, analytical, regulatory, and pragmatic assessment of its effectiveness?

In examining these issues, Enhancing Board Effectiveness will investigate theoretical, socio-economic, historical, empirical, regulatory, comparative, and inter-disciplinary approaches. Academics in the relevant fields of accounting, behavioural psychology/economics, development studies, financial regulation, law and management/organizational studies, political economy, and public administration will find this book of high interest. Franklin N. Ngwu is a Senior Lecturer in Strategy, Finance and Risk Management, Lagos Business School, Pan-Atlantic University, Nigeria. Onyeka K. Osuji is a Reader in Law and Coordinator of the Commercial Law Research Cluster, School of Law, University of Essex, UK. Chris Ogbechie is a Professor of Strategic Management and Corporate Governance, Lagos Business School, Pan-Atlantic University, Nigeria. David Williamson is an Honorary Senior Research Fellow, School of Law, University of Manchester, UK.

Routledge Studies in Corporate Governance

Green Business, Green Values, and Sustainability Edited by Christos N. Pitelis, Jack Keenan and Vicky Pryce Credit Rating Governance Global credit gatekeepers Ahmed Naciri Mergers and Acquisitions and Executive Compensation Virginia Bodolica and Martin Spraggon Governance and Governmentality for Projects Enablers, Practices, and Consequences Edited by Ralf Müller The Making of Shareholder Welfare Society A Study in Corporate Governance Alexander Styhre Resource Security and Governance The Globalisation of China’s Natural Resources Companies Edited by Xinting Jia and Roman Tomasic Corporate Governance in Action Regulators, Market Actors and Scrutinizers Edited by Lars Engwall Enhancing Board Effectiveness Institutional, Regulatory, and Functional Perspectives for Developing and Emerging Markets Edited by Franklin N. Ngwu, Onyeka K. Osuji, Chris Ogbechie, and David Williamson For more information about this series, please visit: www.routledge.com/ Routledge-Studies-in-Corporate Governance/book-series/RSCG

Enhancing Board Effectiveness Institutional, Regulatory, and Functional Perspectives for Developing and Emerging Markets Edited by Franklin N. Ngwu, Onyeka K. Osuji, Chris Ogbechie, and David Williamson

First published 2019 by Routledge 52 Vanderbilt Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2019 Taylor & Francis The right of Franklin N. Ngwu, Onyeka K. Osuji, Chris Ogbechie, and David Williamson to be identified as the authors of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data A catalog record for this book has been requested ISBN: 978-1-138-04832-4 (hbk) ISBN: 978-1-315-16947-7 (ebk) Typeset in Sabon by Apex CoVantage, LLC

Contents

Foreword by Emilios Avgouleas 1 Introduction: Enhancing Board Effectiveness: Institutional, Regulatory, and Functional Perspectives for Developing and Emerging Markets

viii

1

ONYEKA K. OSUJI, FRANKLIN N. NGWU, CHRIS OGBECHIE AND DAVID WILLIAMSON

PART I

Board of Directors, Effectiveness, and Corporate Governance

13

2 Principles of Corporate Governance and Effective Boards

15

FOLAJIMI ASHIRU, FRANKLIN NAKPODIA AND EMMANUEL ADEGBITE

3 Codes for Boards of Directors: A Law and Morality and Organisational Differences Perspective

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DAVID WILLIAMSON AND GARY LYNCH-WOOD

4 The Nature of Boards in Developing and Emerging Markets

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CHRIS OGBECHIE

5 Corporate Governance and Business Growth: Evidence From China JIA LIU, DIMITRIOS STAFYLAS, JUNJIE WU AND CHRISTOPHER MUGANHU

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vi

Contents

6 Board Effectiveness: Do Committees Really Matter? Evidence From Turkey

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EMEK TORAMAN ÇOLGAR

7 Individualism in Boards or Directors: Why Good Board Members Make Bad Decisions

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CHRIS VAN DER HOVEN AND KALU OJAH

8 Tone at the Top, Organizational Culture and Board Effectiveness

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SURENDRA ARJOON

PART II

Institutions, Regulations, and Corporate Governance 9 Institutions and Board Effectiveness: Any Link? The United Kingdom, United States and Nigeria in Perspective

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FRANCIS A. OKANIGBUAN, JR .

10 Club Theory and Directors’ Performance Evaluation

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ONYEKA K. OSUJI

11 Corporate Governance Codes for Public Sector, Private Sector and Not-for-Profit Boards: Varied Rules and Structure or One Size Fits All

184

OLAWALE AJAI

12 Reporting by the Companies: Development and Challenges

202

INDRAJIT DUBE AND MIA MAHMUDUR RAHIM

13 Director’s Selection, On-Boarding and Disqualification Process

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CHRIS OGBECHIE

14 Directors’ Duties and Accountability, Personal Liability and Lifting the Veil of Incorporation

234

NGOZI OKOYE

15 Money Laundering, Tax Havens and Transparency: Any Role for the Board of Directors of Banks? EUPHEMIA GODSPOWER-AKPOMIEMIE AND KALU OJAH

248

Contents 16 The Journey to Board Effectiveness: The Case of Indonesia

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SYLVIA VERONICA SIREGAR

PART III

Issues in Improving the Functional Effectiveness of the Board

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17 Board Roles in Business Groups and Multinational Enterprises in Emerging Markets

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GÜL OKUTAN NILSSON

18 The Board in the Financial and Social Performance of Firms

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OGECHI ADEOLA AND EUGENE OHU

19 Director Remuneration in Developing and Emerging Markets (DEMs): Issues, Challenges and Prospects

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FRANKLIN N. NGWU

20 Board Composition and Diversity in Developing and Emerging Markets

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ENASE OKONEDO

21 Shareholders and Institutional Investment

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KALU OJAH AND CHRIS VAN DER HOVEN

22 Board Effectiveness and Regulation: Explaining the Deficit

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GARY LYNCH-WOOD AND DAVID WILLIAMSON

23 Effective Boards in Developing and Emerging Markets: Looking Ahead

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DAVID WILLIAMSON, CHRIS OGBECHIE, ONYEKA K. OSUJI AND FRANKLIN N. NGWU

List of Contributors Index

382 393

Foreword

This book is a great and insightful collection of essays by respected academic experts on the most important question surrounding corporate governance: board effectiveness. Given how multifaceted this issue is in the developed world, one can only imagine how much more complex and challenging is the achievement of board effectiveness in the developing world, given the conflicting cultures and expertise barriers firms face to select the best qualified directors and maintain an effective system of board monitoring. The wealth of jurisdictions covered by the authors’ solid research is very impressive, ranging from sub-Saharan Africa to China. These are countries where not only traditional western corporate governance concepts/mechanisms may be an ill fit or entirely inapplicable but also jurisdictions where the company ownership structure and property rights, and especially shareholder rights, have different content and powers attached to them than in the west. And as if this very complex and challenging environment is not enough, other considerations like the identification/building consent about the general direction/goal of the company that the board should uphold is not at all a given in the developing world, where shareholder primacy in all of its modifying variations (e.g., stakeholder theory, corporate social responsibility etc.) is a much more recent concept in these countries with shallow roots. Thus, the biggest virtue of this book is that it tackles this extensive and most challenging list of issues heads on, possibly the only book in the field that is doing so to this extent and with so much coherence and analytical lucidity as well as pluralism of methodologies. But this is not to say that the book is a mere in-depth survey of obstacles to effective corporate governance in the developing world, it is much broader and at the same more focused than that. The book also articulates solutions for improving board effectiveness especially in developing and emerging markets. It explores different mechanisms that could augment board effectiveness, especially from an emerging markets perspective and explores the extent to which international best practices could be put into local application. Namely, the authors of the book seek to identify bespoke solutions while retaining wider accountability and trust, thus placing ‘good practice’ into

Foreword

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contextually dependent application without it losing value within developing and emerging markets. And while this begs the question of whether by doing so corporate boards can possibly be integrated into local communities, the book explores certain ways to co-opt all these path dependent avenues and social traditions to help policy-planners and corporate boards to achieve the desired corporate governance objectives. The direction of enquiry in most of the essays in this volume is, as it should be, strongly socio-economic and interdisciplinary, surveying the particular political, regulatory and institutional factors/actors that may influence board effectiveness in the developing world. The wealth of contributions and topics and the novelty of approaches are simply impressive. It is quite an accomplishment that the editors managed to gather such a large number of authors from such diverse backgrounds and fully integrate them into a coherent thematic volume. At the same time, it is the wealth, breadth and depth of analysis and suggested solutions that make this book a most valuable companion for all policy-makers, corporate directors, and company law and corporate governance practitioners who do not just wish to enhance their knowledge and understanding of corporate governance and board effectiveness in the developing world, but also to search for comprehensive and sustainable outcomes to overcome the multitude of obstacles. Professor Emilios Avgouleas PhD(LSE), LLM(LSE), LLB(Hons)(Ath) Chair in International Banking Law and Finance Old College Champion University of Edinburgh and EBA

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Introduction Enhancing Board Effectiveness: Institutional, Regulatory, and Functional Perspectives for Developing and Emerging Markets Onyeka K. Osuji, Franklin N. Ngwu, Chris Ogbechie and David Williamson

The growing popularity of corporate governance can be traced to the fact that companies are almost indispensable to individual entrepreneurship, societal welfare and national economic growth. The interdependence of corporate governance and societies is growing globally, including in developing and emerging markets. This is due to a number of factors. First, the emergence of the corporate form as a form of economic organization has led to globally wide-ranging progress. Companies have driven progress by matching entrepreneurship and the benefits it gives to individuals with societal development. Companies have been one of the vital catalysts for accelerated development to the extent that one can confidently argue that global economic, technological and other progress could not have been achieved without companies. Second, the 2007–2008 global financial crisis and other corporate scandals have demonstrated a link between the governance of companies and the wellbeing of other components of society. Third, the proper governance of companies therefore has both internal and external impacts. Internally, a properly run company benefits the shareholders and the managers, while its external stakeholders include employees and their families, consumers, communities and society. Fourth, globalization, especially of cross-border dimensions of ideas, standards and practices, has created a vibrant platform for assessing the performance of companies in a wide range of areas, including non-traditional fields of private business. Fifth, some states lack the capacity and ability to regulate companies and other business forms, leading to suggestions for self-regulatory and alternative regulatory models for companies. Sixth, there is no universal code of corporate governance at the global level that addresses specific issues in different national contexts, including in developing and emerging markets. As the institutional theoretic model shows, problems vary according to contexts, and for proposed solutions, therefore, there is a need to consider differences in institutional make-ups and contexts (North, 1990; Nissanke and Aryeetey, 1998; Menski, 2006).

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Institutions can be defined as rules and laws, values and norms of the society that provide the procedures and incentives that support and sustain human relations and interactions. They can be formal or informal and, through the incentives and procedures provided, organizations such as firms, individuals or groups of individuals pursue their different interests and goals within the standard constraints of economic theory. As organizations are varied, such as economic, educational, social, political and religious, so are their goals, such as profit maximization, winning a game, leaking of sensitive information and exploitation of minority shareholders. Nevertheless, institutions are dynamic and change through interactions with organizations which determine development and governance outcomes. Applying this to corporate governance arguably implies that achieving higher board effectiveness will depend on both micro and macro institutional make-ups and incentives on one hand and on the other their interactions with the organizations (boards). While the micro level relates to the internal norms and values (organizational culture), the macro level is about how the firm, through the board, interacts with the prevalent societal institutional incentives to achieve their goal, for instance, profit maximization. However, as the micros (firms) make up the macro, the macro institutional make-up and incentives expectedly influences the micro level and vice versa. A better understanding of the macro level can be achieved through Williamson’s (2000) Levels of Social Analysis model. Dividing the levels of social analysis into four—(1) social embeddedness, (2) institutional environment (political and legal system), (3) governance and (4) resource allocation—Williamson maintains that each of the levels is constrained by the preceding level except for the social embeddedness level. While social embeddedness (informal institutions, customs and norms, including religion) constrains the institutional environment (formal rules of the game), the institutional environment constrains the governance level (the play of the game), which in turn constrains the resource allocation level. Williamson notes that while there are feedbacks in the reverse direction such as from the fourth level (resource allocation) to the third (governance) and then to the second (institutional environment) and the first (embeddedness), the emphasis in terms of socio-economic outcomes is mainly on the constraints among the levels. Moreover, as the constraints start from the level of embeddedness (informal institutions), which on its own is not constrained by another level, it can be argued that the informal institutions are of immense importance in understanding socio-economic outcomes (board effectiveness). In the same vein, as social embeddedness (informal institutions’ norms and values) relate to higher contextual influences, which has been noted as the case in developing and emerging markets, enhancing board effectiveness in developing and emerging markets might therefore require a

Introduction

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deeper examination of how institutions influence governance outcomes (board effectiveness). It is clear that corporate governance–related social embeddedness is an imperative at the level of the board of directors. In the preface to Guidance on Board Effectiveness, March 2011 (FRC, 2011: 1), Baroness Hogg, the chairman of the Financial Reporting Council, UK, observed that the UK Corporate Governance Code has always placed great importance on clarity of roles and responsibilities, and on accountability and transparency. It has become increasingly clear in the intervening period that, while these are necessary for good governance, they are not sufficient on their own. Boards need to think deeply about the way in which they carry out their role and the behaviours that they display, not just about the structures and processes that they put in place. At the centre of the corporate governance discourse, therefore, is the board of directors, collectively and its members individually. Nevertheless, the board has faced increased scrutiny from both state and non-state actors in its roles and functions. The main function of the board is to run the company properly and ensure optimum benefit for shareholders (shareholder primacy and enlightened shareholder value models of corporate governance) or stakeholders (stakeholder model of corporate governance). The role, composition, performance and evaluation of the board are therefore considered vital to the proper governance of companies. For example, the UK Corporate Governance Code (FRC, 2016) makes provisions for membership of the board, the role of non-executive directors and directors’ performance evaluation, albeit on a ‘comply or explain’ basis. The focus on the board in corporate governance debate is also due to its role in influencing organizational practices and culture, including ethical behaviour, through filtering down the ‘tone at the top’ to the different levels of the company. Nonetheless, corporate governance models differ and the powers influence and responsibilities of the board vary from country to country and even within the same national jurisdiction and similar industries. This book examines the conceptualization and role of the board in a variety of contexts and articulates solutions for improving the effectiveness of the board, especially in developing and emerging markets. This book addresses the following central questions: To what extent is the concept and role of the board evolving? What rights, powers, responsibilities and other contemporary and historical experiences can enhance the effectiveness of the board, especially in the particular contexts of developing and emerging markets? What socio-economic, political, regulatory and institutional factors/actors influence the effectiveness of the board and how can the policies and practices of such actors exert such influences? In what ways can a reconstructed concept of the board serve as

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a tool for theoretical, analytical, regulatory and pragmatic assessment of its effectiveness? These questions are addressed in 22 chapters that reflect theoretical, socio-economic, historical, empirical, regulatory, comparative, inter-disciplinary and other approaches and provide insights from national and global practices. This book is organized into three parts. Part I, ‘Board of Directors, Effectiveness, and Corporate Governance’, contains seven chapters on some applicable corporate governance principles and linkages between directors’ effectiveness and corporate governance. In Chapter 2, ‘Principles of Corporate Governance and Effective Board’, Folajimi Ashiru, Franklin Nakpodia and Emmanuel Adegbite examine the relevance of the board and the attendant differences in board structures and practices, taking into consideration the different governance models prevalent in different institutional contexts. The chapter is an attempt to deconstruct the role of boards given the persistence of firm failures despite the existence of regulations and increased focus on the corporate governance practices of firms. It proceeds on the basis that corporate governance is a mechanism that can guarantee the long-term going concern of firms and that boards of directors are an essential component of corporate governance given their monitoring, control and supervisory functions. Having shown that firms still undergo crises and in some circumstances fail despite the composition of boards, the authors provide insights into relevant theories that guide corporate governance and board behaviour in different jurisdictions. In Chapter 3, ‘Codes for Boards of Directors: A Law and Morality and Organisational Differences Perspective’, David Williamson and Gary Lynch-Wood critically assess the efficacy of codes of ethics and codes of conduct for boards, drawing on the work of Fuller (1964) and their own work on the conditions of regulation and firm differences. The authors argue that additional mandatory measures are likely to be needed to complement codes of ethics and codes of conduct. In relation to developing and emerging economies, the authors provide an important caveat that in the absence of an institutional environment to protect contractual exchange, and when it is seen to be bona fide and taken to reflect good practice, a code then provides that contractual protection. The nature and peculiar characteristics of boards in several developing and emerging markets, especially the BRICS and MINTS countries, are examined by Chris Ogbechie in Chapter 4, ‘The Nature of Boards in Developing and Emerging Markets’. The chapter was motivated by the literature’s wide extension of traditional corporate governance classification to developing and emerging economies without considering the countries’ unique peculiarities. It explores the nature of boards in developing and emerging economies and explains the failing corporate governance practices and corporate scandals in several of the countries. In particular, the author examines the contemporary roles of boards, especially risk and strategy equilibrium, on the basis that boards are expected to formulate strategies to help mitigate, if not eliminate, risk. Unlike many

Introduction

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developed markets where private or outsider entrepreneurs dominate, in those developing and emerging countries, the nature of business ownership as either family-owned (FOBs) or state-owned (SOEs) encourages dominant ownership. The author finds that the dominant shareholder model ubiquitous in several developing and emerging economies can be rectified by requiring their organizations to go public. The argument is that in an environment in which ownership and management are widely separated, the owners are unable to exercise dominant control over the management or the board. In Chapter 5, ‘Corporate Governance and Business Growth: Evidence from China’, Jia Liu, Dimitrios Stafylas, Junjie Wu, and Christopher Muganhu argue that the implementation of an effective system of corporate governance is now of critical importance to China’s drive for economic growth. The chapter provides evidence that is of value in policy development and practice to China and other economies pursuing similar trajectories. The findings indicate the extent to which China’s system of corporate governance has so far failed to achieve its objectives, and in what ways reforms are needed in order to enhance market credibility, enterprise competitiveness and economic growth. The chapter evaluates the Chinese government’s relevant policy and practice and discusses fundamental issues such as ownership structure and the establishment of corporate governance and the interaction of corporate governance with the internal and external institutional environments. The chapter also provides significant insights into the problems and prospects of corporate governance in today’s China through an empirical analysis of the role of corporate governance in business growth. It examines mergers and acquisitions in China to present evidence showing how corporate governance practice has influenced value creation and company growth. It highlights the need for the government to accelerate the reform of the ownership structure so as to give managers incentives to maximize company value and the imperativeness of installing and maintaining an effective corporate governance mechanism, under which board independence is real and not merely decorative, and directors’ decision-making is guided and constrained by sound and transparently applied principles. Chapter 6, ‘Board Effectiveness: Do Committees Really Matter? Evidence from Turkey’, considers the role of board committees in promoting the effectiveness of directors, using Turkey as the context. In the chapter, Emek Toraman Çolgar examines the efficiency and socio-economic, political and regulatory factors affecting the adoption of regulations for boards of directors and board committees under Turkey’s corporate and capital markets laws. The chapter provides proposals for legislative amendments in relation to the formation, duties, powers and responsibilities of the board with a view to increasing its efficiency. It also demonstrates how regulations can create firm value in practice. In Chapter 7, ‘Individualism in Boards or Directors: Why Good Board Members Make Bad Decisions’, Chris van der Hoven and Kalu Ojah

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argue that business failures represent failures of governance by owners or their agents and the persistent leadership failures suggest that boards of directors and board members do not always act in the best interests of the firm and shareholders despite their key roles in firms. While they acknowledge that firms are a cornerstone element of technological and economic progress, the authors argue that if boards are not adding value, then they are likely destroying it. The authors reason that value destruction can be caused by board members, collectively or individually, when they have miscalculated, delayed or left decisions unmade or made ethical errors. In contending that part of the reasons for persistent and increasing moral missteps in business is a noticeable shift from collectivism to individualism, the authors provide some mental scaffolding with discussions about culture and individualism, dominant logic, dynamic capabilities, ethics, biases and groupthink. In support of their proposal for a more collectivist mindset in decision-making amongst board members, the authors draw on Nonaka and Takeuchi, who note that knowledge does not always translate into wisdom and that wise decisions are those that serve society. In Chapter 8, Surendra Arjoon’s ‘Tone at the Top, Organizational Culture and Board Effectiveness’ develops a conceptual framework that shows the inter-relationship between the ‘tone at the top’, organizational culture and board effectiveness. The author demonstrates that while the tone at the top is set by the senior executives and reflects the organization’s shared set of values that provide a network of cues that govern tolerance attitudes toward ethical breaches and compliance, organizational culture refers to the overall ethos including psychological and structural elements that affect behaviours and perceptions. Board effectiveness includes task outcomes, board composition and leadership, attitudes and receptiveness. Following a literature review, the author finds that the tone at the top defines organizational culture, while elements of the tone at the top and board effectiveness interact with each other and provide a conceptual model of the hypothesized relationships that serve as a platform for empirical work. The chapter concludes with strategies and recommendations for improving the tone at the top including consideration of ethical codes of conduct and measures for dealing with ethical breaches and promoting compliance, risk assessments and management systems and promotion of board engagement and board effectiveness. In Part II, ‘Institutions, Regulations, and Corporate Governance’, there are eight chapters that examine the relationship between certain institutional and regulatory rules and actors in promoting board effectiveness for effective corporate governance. In Chapter 9, ‘Institutions and Board Effectiveness: Any Link? The United Kingdom, United States and Nigeria in Perspective’, Francis A. Okanigbuan, Jr. argues that informal institutional environments should be considered in designing a framework for promoting board effectiveness. The chapter evaluates the extent to which institutional make-up and incentives such as the enforcement

Introduction

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processes of governance rules and sanctions can affect board effectiveness. It identifies the role of regulation by reference to the main streams of economics of institutions, to ascertain effective ways that local practice and customs as informal institutions can influence the development of formal rules as formal institutions. It reviews the role of the institutional regulatory framework in promoting board effectiveness in Nigeria and makes comparative references to the United Kingdom and United States to show that, while some aspects of corporate governance regulation may be considered to be ‘world best practices’, the successful implementation of these practices across the globe is largely dependent on the extent to which peculiar local circumstances permit. In Chapter 10, Onyeka K. Osuji’s ‘Club Theory and Directors’ Performance Evaluation’ applies the club theoretic model to contextualize voluntary clubs in public interest regulation through corporate governance, particularly in developing and emerging markets. Drawing on the political theory of corporation and the institutional perspective, the chapter proposes an enforced self-regulatory system for directors’ individual and collective performance evaluation centred on voluntary clubs and propped up by facilitative public regulation. It argues that when properly and legally equipped, voluntary clubs effectively perform corporate governance regulatory roles, and directors, shareholders, market participants, stakeholders and society can all benefit. While it frames corporate governance clubs within regulatory institutional frameworks, the chapter demonstrates the impact of voluntary rules, standards and procedures on individual director and board effectiveness and therefore aligns private governance with broader society expectations. It highlights internal, external and independent quantitative and qualitative methods for evaluating board performance and demonstrates how barriers to improvement can be tackled, and positive effectiveness factors can be improved on. The proposals include research, training, education and other methods for continuous individual and collective development, operation of stringent voluntary clubs at industry and sub-sector levels, preventative, retributive and corrective enforcement measures, club membership as a prerequisite, performance-related certification, licensing and disqualification and facilitative public regulation. In Chapter 11, ‘Corporate Governance Codes for Public Sector, Private Sector and Not-for-Profit Boards—Varied Rules and Structure or One Size Fits All’, Olawale Ajai examines the corporate governance codes of public companies, SMEs, not-for-profits and public sector organizations, particularly in BRICS and African countries. The author argues that the institutional peculiarities of developing and emerging markets need to characterize their corporate governance codes and, along with training, better public governance, hand holding and an empowering regulatory approach, can make the codes more practical and effective. Following reflections on the efficacy and impact of codes on corporate governance quality, it is also argued that different rules and structures are required

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for each type and probably for different categories within each type of organization, rather than a one-size-fits-all approach. The chapter proceeds on the basis that national corporate governance codes are a critical component of a global strategy to upgrade corporate governance quality and, due to the nature of the boards of directors as the fulcrum of corporate governance, the codes dwell on the role, structure, composition, authority, processes and responsibilities of boards. Corporate reporting is the focus of Chapter 12, ‘Reporting by the Companies: Development and Challenges’. In the chapter, Indrajit Dube and Mia Mahmudur Rahim note the absence of a generally accepted corporate reporting style notwithstanding significant efforts towards the creation of an overarching global style. It is shown that many countries appear to lack general corporate reporting laws and company directors tend to follow their own formats for preparing non-financial reports and appear to disseminate only information necessary to promote a positive corporate image. The authors argue that this trend undermines the capacity of reporting to act as a mechanism for promoting corporate accountability. Following an assessment of the development and challenges of corporate reporting, the authors suggest that companies need to provide clear information in their non-financial reports regarding the economic benefits they create and the social cost attached to the creation of economic benefits. In Chapter 13, ‘Director’s Selection, On-Boarding and Disqualification Process’, Chris Ogbechie examines the roles of board selection, integration of new board members and disengagement of underperforming directors and provides practical recommendations. The chapter provides certain evaluation criteria for assessing individual directors and boards of directors. With respect to selection and recruitment, the author uses the Independent Director Council’s framework to outline the steps that must be taken to ensure proper selection of board members. There are suggestions for procedures to enhance soft landing for new directors by integrating them into the board (on-boarding). In supporting regular and holistic evaluations for each board member to determine their contributions, the author recommends the setting of board objectives at the beginning of each year for ease of check-listing during the evaluation stage. The chapter also considers various disengagement processes for underperforming directors through resignation or termination. It is suggested that before activating the termination option after an evaluation, the board chair should explore further training and capacity development programmes for any underperforming board member. The focus of Chapter 14, ‘Directors’ Duties and Accountability, Personal Liability and Lifting the Veil of Incorporation’ by Ngozi Okoye, is the company as a legal construct. The chapter examines the legal responses in the common law and statutory regulation in some jurisdictions to the agency issues through the establishment of directors’ duties aimed at ensuring that directors act on behalf of shareholders in the best interests of the company. It explores the duties and personal liabilities

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of directors and the approach of corporate law in relation to the characteristics of separate legal personality, limited liability and centralized management as well as the foundations of the tensions created by these characteristics which include accountability and responsibility, lifting the veil of incorporation and ascription of liability and agency issues. The author presents critical arguments as to the implications of these legal issues in relation to director effectiveness and corporate governance. In Chapter 15, ‘Money Laundering, Tax Havens and Transparency: Any Role for the Board of Directors of Banks?’, Euphemia GodspowerAkpomiemie and Kalu Ojah explore boards’ interventions with their focus on money laundering and banks as both legitimate and ‘ubiquitous’ financial services institutions that engage primarily in financial intermediation. The authors question whether the levers of control over banks’ involvement in money laundering and other financial crimes are more effective when pulled from the outside by government or by a less than arm’s-length role for banks’ boards of directors by way of appropriately nuanced corporate governance. The chapter places emphasis on the potential productive role of banks’ boards in examining the meaning of money laundering and its antecedents and support mechanisms, and how it can be tamed. The authors recommend that, at a general and/or high level, the intervention of banks’ boards need to focus or insist on: (1) the primacy of transparency and upholding of both real and perceived reputational capital of the bank, and (2) ascertaining that their banks’ relations with corresponding banks across national borders, or association with banks domiciled in notorious tax havens, are demonstrably above board. Sylvia Veronica Siregar provides a country study of Indonesia in Chapter 16, ‘The Journey to Board Effectiveness: The Case of Indonesia’. The chapter examines changes, including laws, regulations and initiatives undertaken by regulators and other entities to improve corporate governance implementation in Indonesia following the 1997/1998 Asian financial crisis. These changes include board effectiveness provisions in Indonesia’s Company Law and by the Indonesia Financial Services Authority (Otoritas Jasa Keuangan/OJK) and Indonesia Stock Exchange (IDX). Based on corporate governance assessments by the World Bank (2010, 2014) and Asian Development Bank in partnership with ASEAN Capital Market Forum, the chapter notes corporate governance implementation weaknesses that persist in Indonesia, including in relation to the responsibilities of the board. It identifies several factors affecting board effectiveness such as board size, independence, directorship, meeting, tenure, nomination and remuneration, removal, qualification, training, performance assessment and committees. Proposals for improvement include more stringent rules on independent commissioners’ tenure and sufficient information about board candidates’ qualifications in annual general meeting invitations. It is also argued that regulations alone cannot guarantee board effectiveness and need to be complemented by socialization, education and training, as well as strong laws and regulatory

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enforcement by regulators, issuers, public companies and other relevant persons. There are six chapters in Part III, ‘Issues in Improving the Functional Effectiveness of the Board’ that highlight specific issues that can enhance the functional effectiveness of directors. In Chapter 17, ‘Board Roles in Business Groups and Multinational Enterprises in Emerging Markets’, Gül Okutan Nilsson examines the roles attributed to the board in a standalone company change in business groups, particularly in emerging economies. The author argues that board roles in corporate groups depend on whether the board belongs to the controlling entity or the subsidiary. It is also argued that, besides monitoring, service and strategy roles, the board of the controlling entity assumes a coordination role while the subsidiary may have diminished roles of monitoring or strategy if it is wholly owned or its operations do not require local knowledge or expertise. It is further argued that the service role of the subsidiary board may be enhanced in a multinational group, due to distance and differences in the national institutional environment where the subsidiary is active. In Chapter 18, ‘The Board in the Financial and Social Performance of Firms’, Ogechi Adeola and Eugene Ohu examine the role of the board of directors in the financial success of the company and in corporate social responsibility and sustainable development. This is considered a value-added contribution, as most studies treat financial and social performance of firms as separate issues. The authors argue that for a company to be a success, it must have a well-functioning and effective board and, for increased financial performance, boards need to pay attention to factors such as duality, diversity, tenure, composition, competences and size of the board. It is also pointed out that beyond financial success, boards are also expected to maintain the highest standards of internal governance while promoting ethics in alignment with stakeholders and society’s aspirations. For increased social success, boards are therefore expected to become integrated throughout their decision-making processes and business operations with local communities, maximize the positive effects of their operations on such communities and thereby contribute to sustainable development. The linkage between remuneration and directors’ effectiveness is the theme of Chapter 19, ‘Director Remuneration in Developing and Emerging Markets: Issues, Challenges and Prospects’ by Franklin N. Ngwu. The author argues that proper remuneration is necessary for the board of directors of a firm to effectively perform tasks such as strategy, operational and financial reviews and controls. While it may be preferable that remuneration should be linked to firm performance, it is noted that this is not the case in several developing and emerging markets where board of directors’ remuneration is not linked to performance and remuneration-related information is limitedly disclosed or not disclosed at all. The author therefore argues in favour of reforms to link remuneration to performance and for proper disclosure requirements in developing and emerging markets.

Introduction

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However, as reforms through hard laws and regulations sometimes achieve limited results, it is argued that soft laws and other mechanisms such as self-regulation can also be used to advance reforms. Chapter 20, ‘Board Composition and Diversity in Developing and Emerging Markets’ by Enase Okonedo, emphasizes the relevance of improved corporate governance practices to board effectiveness and examines relevant factors to be considered in constituting board membership and the effect on the processes and effectiveness of the board in developing and emerging markets. It describes the nature and roles of board committees, as well as the roles of the chair and chief executive officer within public companies in Nigeria, Kenya and South Africa. Drawing from existing codes of corporate governance, empirical research and available information from publicly listed companies, the author discusses the codes of corporate governance in those three African countries, the composition of boards, gender diversity and independence of directors. Chapter 21, ‘Shareholders and Institutional Investment’ by Kalu Ojah and Chris van der Hoven, proceeds on the basis of empirical evidence on the changing ownership pattern of corporations between individual and institutional investors in favour of institutions. The key questions addressed by the chapter are: (1) How does such a shift enhance corporate governance in general and particularly via board effectiveness?; (2) Is such institutional investor-oriented effectiveness equally achievable in emerging economies, especially in light of their relatively less efficient institutional infrastructures and/or dominance of culture-based informal arrangements?; and (3) Are there ways to strengthen the corporate governance usefulness of institutional investment in the emerging market context? While the chapter highlights useful lessons in response to these questions, there is an argument in favour of the attainment of ownership mix-based enhancement of board effectiveness that relies on some grouping of institutional investors that protect minority rights in the emerging economy context. Focusing mainly on the UK Corporate Governance Code, Gary LynchWood and David Williamson examine the effectiveness of the regulatory framework for corporate governance in Chapter 22, ‘Board Effectiveness and Regulation: Explaining the Deficit’. Although the chapter adopts a largely Western, market economy viewpoint, it offers some comments on how the issues raised might be equally relevant for other jurisdictions. The authors argue that regulation functions on the basis of ‘conditions’ and suggest that the presence or absence of these conditions, which are determined by organizational differences, will either support or undermine the effectiveness of particular regulatory tools and initiatives. It is then argued that this provides the basis for understanding how and why the governance code will or will not work and might indicate ways of improving its performance. Overall, these chapters provide perspectives from accounting, sociology, behavioural psychology, economics, development studies, financial

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regulation, law, management, organizational studies, political economy, public administration and other fields. The chapters draw on the experiences and practices of developed, developing and emerging markets to offer insights for the latter group of countries. Policymakers and practitioners in developing and emerging economies can learn appropriate theoretical, regulatory and functional frameworks for improving the effectiveness of boards of directors and raising the standards of corporate governance in their jurisdictions, which will arguably lead to a more sustainable and mutually beneficial management of companies and increased national economic development. The insights provided by the chapters are also useful for policymakers and practitioners in more developed economies. As the world becomes increasingly inter-connected by the forces of globalization, and as some developing and emerging countries become important global economic players, the effectiveness of directors and boards is an issue that demands global attention irrespective of their location. After all, corporate mismanagement induced by directors’ and boards’ ineffectiveness in an important economy can have a significant impact on national and global financial stability.

References Financial Reporting Council (FRC) (2011). Guidance on board effectiveness, March 2011. [online] Available at: https://www.frc.org.uk/getattachment/11f9659a686e-48f0-bd83-36adab5fe930/Guidance-on-board-effectiveness-2011.pdf [accessed 27 December 2018]. Financial Reporting Council (FRC) (2016). The UK corporate governance code April 2016. [online] Available at: https://www.frc.org.uk/getattachment/ca7e 94c4-b9a9-49e2-a824-ad76a322873c/UK-Corporate-Governance-CodeApril-2016.pdf [accessed 27 December 2018]. Fuller, L.L. (1964). The morality of law (revised edition, 1969). New Haven: Yale University Press. Menski, W.F. (2006). Comparative law in a global context: the legal systems of Asia and Africa. Cambridge: Cambridge University Press. Nissanke, M. and Aryeetey, E. (1998). Financial integration and development: Liberalization and reform in Sub-Saharan Africa. London and New York: Routledge. North, D. (1990), Institutions, institutional change and economic performance. Cambridge: Cambridge University Press. Williamson, O.E. (2000). The new institutional economics: taking stock, looking ahead. Journal of Economic Literature, 38(3), pp. 595–613. World Bank (2010). Report on the observance of standards and codes (ROSC). Corporate governance country assessment Indonesia April 2010. [online] Available at: http://documents.worldbank.org/curated/en/514561468039867553/pdf/ 691570ESW0ROSC0overnance0April02010.pdf [accessed 27 December 2018]. World Bank (2014). The Indonesia corporate governance manual first edition. [online] Available at: http://documents.worldbank.org/curated/en/55147148 7074479045/pdf/112585-WP-ID-Indonesia-CG-Manual-Feb2014-PUBLIC. pdf [accessed 27 December 2018].

Part I

Board of Directors, Effectiveness, and Corporate Governance

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Principles of Corporate Governance and Effective Boards Folajimi Ashiru, Franklin Nakpodia and Emmanuel Adegbite

Introduction This chapter examines an important instrument for corporate governance that is the corporate board. Corporate governance continues to evolve even though its practice remains tied to the dated legal concept of the firm (Tricker, 2015). The collapses among corporate firms, the cyclical financial crisis, the financial incentive of contemporary investors, globalisation concerns and more recently, the technological advances in audit and assurance have all combined to necessitate good corporate governance practices by firms. This explains the increased prominence of corporate governance in the last three decades (Tricker, 2015). Moreover, firms are key actors in business environments (Coase, 1937); hence good corporate governance is sought in view of its benefits to shareholders and to the wider stakeholder community. The separation of ownership and control is one of the early features of the corporate governance literature (Fama & Jensen, 1983). Corporate governance is thus synonymous with the changing composition of companies where company owners might be distinct from the people managing the company. This changing structure of the firm means that a group of individuals help to monitor management to ensure the maximisation of shareholder wealth. These groups of individuals are referred to as a ‘board of directors’. Indeed, most state laws explicitly indicate that firms need a board of directors to assume the fiduciary role for the firm (Shleifer & Vishny, 1997; Majumdar, 2017). Therefore, the board assumes overall responsibility and liability for the firm. In addition, boards provide assurances to the public and other stakeholders while projecting the going concern nature of their firm. The debates on the motives of managers, protection of shareholders’ investment and wealth maximisation for shareholders have focused scholarly attention on the role of boards. Despite the interest in corporate boards, corporate failures and mismanagements are widely reported. This problem necessitates the following questions: Are boards essential? If they are, what is their role and how should they be constituted? Do boards perform similar functions in all countries/regions? Does the

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institutional environment influence board functions or necessity for boards? We examine these questions by evaluating the different models of corporate governance that dominate different climes, with a discussion of how boards function in each of those models. This chapter proceeds by providing some theoretical frameworks for our subsequent discussions on the role of the board in corporate governance. Following on, the chapter examines the different types of boards, and then highlights the varying nature of board practices of firms in different corporate governance contexts.

Corporate Governance and Theory An understanding of the roles and importance of boards requires a review of some important theories of corporate governance. This is because corporate governance has benefitted from inputs originating from a wide range of scholarly efforts. This interest has led to the generation of different practices that are not only intended to aid the generation of insights into the concept but also to provide a framework for understanding the variations in the concepts, as occasioned by differences in institutional environments. This section proceeds to examine three dominant theories of corporate governance. To start with, the agency theory emphasises the relationship between principals (shareholders) and agents (managers) in corporations. Agency theory is concerned with resolving problems that may exist in agency relationships due to unaligned goals or different aversion levels to risk. The agency theory assumes a conflict of interest between managers and shareholders of large corporations due to the separation of ownership from control (Fama & Jensen, 1983). This view of the agency theory suggests that managers are sometimes motivated to pursue self-interest, which may conflict with shareholders’ wealth maximisation objectives (Jensen & Meckling, 1976; Shleifer & Vishny, 1997). Furthermore, there is the likelihood of information asymmetry between shareholders (principals) and managers (agents) (Fama & Jensen, 1983; Jensen & Meckling, 1976). In mitigating these concerns, corporate governance provides a framework by which shareholders protect their investments. It can also minimise the problems emanating from the separation of ownership and control in the most efficient manner using the market efficiency mechanism (Fama & Jensen, 1983). The literature articulates two other types of principal–agent problems, besides the aforementioned classical agency problem. First, the relationship between majority and minority shareholders, otherwise known as the principal–principal agency problem (Renders & Gaeremynck, 2012). Second, the relationship between a company and its other stakeholders other than shareholders (Tricker, 2015). Policy makers and companies have adopted the instrumentality of boards in addressing these classes of agency manifestations. This is evident in the establishment of guidelines

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relating to board composition, structure and powers, with considerable emphasis on enhancing board effectiveness (Mallin, 2007). However, the majority of these efforts focus on minimising the classical agency problem, to the detriment of the other two expressions of agency problems (Tricker, 2015). Although policymakers are increasingly demanding that firms pay more attention to other stakeholders, these calls deserve a robust sanction mechanism. Stewardship theory, rooted in sociology and psychology, offers an alternative theoretical view to the agency theory (Davis, Schoorman & Donaldson, 1997). Rather than assume a divergence of principal and agent interests, stewardship theory defines human relationships around a more robust behavioural model (Pfeffer & Salancik, 1978). It proposes instances wherein a convergence of interests can occur, resulting in a more collaborative approach to governance. The theory emphasises the original legal view of a company, relying on the concept that a set of shareholders own a single or group of related companies and appoint directors (Pfeffer & Salancik, 1978). Stewardship theory argues that managers have many motives other than just self-interest to perform. These motives include recognition, intrinsic satisfaction and a feeling of success (Etzioni, 1975; Marris, 1964). As a result of this more trusting perception of management, stewardship theory does not, for example, advocate for board independence. Rather, it favours a majority of inside directors who bring company and industry knowledge and skills (Davis et al., 1997). The basis of the theory connects with firms with few majority shareholders, which may be inconsistent with the large minority shareholding structure that dominates modern businesses. Similarly, on stakeholder theory, Freeman (1984) defines stakeholders as those who can affect or are affected directly or indirectly by the firm’s success or otherwise. The underlying philosophy of stakeholder theory is broader than the agency theory, as it accommodates the internal and external stakeholders connected to corporations (Donaldson & Preston, 1995). The theory advocates that society expects organisations to behave in a manner that not only guarantees their going concern but also befits their social and economic roles and relevance. Advocates of the stakeholder theory argue that failure to take into account the concerns of stakeholders may undermine the continued existence of organisations. This does not imply that shareholders are ignored but highlights that other stakeholders can equally lay claim to the firm (Gamble & Kelly, 2001; Turnbull, 1994, 1997).

Corporate Governance and the Role of the Board The focus of corporate governance, inter alia, is to minimise the conflict between management and shareholders (Shleifer & Vishny, 1997). The rules and practices that govern the relationship between managers and shareholders in corporations aim to promote corporate growth and

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stability. In fact, were it possible for shareholders to make all the decisions in corporations, agency challenges would have been minimised. As a result, the day-to-day management of the company rests with a mix of experts and management typically referred to as the board of directors. These experts govern the activities of firms by relying on governance principles. According to the OECD (2015), most components of corporate governance codes in many institutional contexts relate to one or more of these principles. Leadership: Boards are effective when they steer the company to the attainment of set business objectives, both in the short and long run. Capability: The board should have an appropriate mix of skills, experience and independence to enable its members to discharge their duties and responsibilities effectively. Accountability: The board should be responsible to all stakeholders. Stakeholder’s (especially shareholders) need to have a fair, balanced and understandable assessment of how the company is achieving its business purpose and meeting its other responsibilities. This demands that the board should communicate to the company’s shareholders and other stakeholders at regular intervals. Sustainability: The going concern nature of a company is crucial. The board should ensure that the organisation creates value to reinforce the perpetual succession potentials of the organisation. Integrity: The board should lead the company to conduct its business in a fair and transparent manner that can withstand scrutiny by stakeholders. The modern era where the firm is a dominant actor that shapes society surely necessitates that firms have a board of directors. Indeed for publicly quoted firms, the law in most jurisdictions makes the board of directors compulsory (Shleifer & Vishny, 1997). Consequently, it is expected that the board assumes a considerable role in corporate decision-making. The concept of corporate governance describes the action of governing, and the manner of managing and administering in businesses (Claessens & Yurtoglu, 2013). At the company level, corporate governance seeks to structure the distribution of power and responsibilities among shareholders, directors and management (Dalton, Daily, Ellstrand & Johnson, 1998). Mainly, it defines how the power of various factors of decision and control can attain equilibrium, and how the tools for both shareholders and other stakeholders in the capital of an entity can be implemented (Bhagat & Black, 1999). From the description in Dalton et al. (1998), the key players in a corporate governance framework are shareholders, directors and management.

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These three players denote the ‘corporate governance triangle’. While shareholders are the providers of funds to the company, they are also the ultimate decision-makers in the organisation. The efficient utilisation of the funds provided by shareholders is the preserve of management, who also oversee the day-to-day operations of the company. Directors are a hybrid concept. Whereas the majority of management can be directors, some directors can also acquire shares in the organisation thereby qualifying as shareholders. However, the preceding view espouses the narrow agency theory conceptualisation of corporate governance while paying limited attention to the arguments of proponents of the broad view of the concept (Letza, Sun & Kirkbride, 2004). Recent developments and descriptions of corporate governance, along with the stakeholder and stewardship theories, have emphasised the broader conceptualisation of corporate governance (Huse, 2005). By adopting a broader perspective of corporate governance, the players in the corporate governance framework models can be extended to include management, directors, shareholders (individual, family and institutional investors), government agencies, stock exchanges, self-regulatory organisations and consulting firms. These consulting firms advise corporations and shareholders on corporate governance and proxy voting. Nonetheless, corporate governance issues, such as disclosure and the mechanisms for communication between corporations and shareholders have largely been resolved through means such as audited financial statements. Therefore, to enable effective and trustworthy reports, the board composition and board representation remain important shareholder concerns in any governance model (Lorsch & MacIver, 1989; Tricker, 2015). Research by Hillman and Dalziel (2003) indicates that in many cases, a relationship exists between lack of effective oversight by the board of directors and poor corporate financial performance. Nonetheless, it is apparent that the model of corporate governance adopted in a country considerably influences the composition of boards in that country. Legally, boards are required to protect shareholder’s interest and maximise shareholder’s wealth (Shleifer & Vishny, 1997). The board of directors supervises management on behalf of shareholders (Fama & Jensen, 1983), hence the company law tends to interchange management and board of directors. This development implies that a weak board might allow management to become unaccountable (Useem, 1993). Boards are an internal control mechanism that corporations impose on themselves. Board members are usually appointed through voting by shareholders. Nader, Green, Seligman and Soderquist (1976) contend that the impact of boards, board composition and ownership structure not only impacts the success of companies but also influences the likelihood of management or ownership change. Broadly, board responsibilities range from

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supervising managerial actions, determining the level and structure of top management compensation and replacing poor performing managers.

Models of the Board in Different Corporate Governance Systems Whereas the UK/US (Anglo-American) model is the most popular corporate governance model worldwide, the institutional environment in other countries has compelled the use of distinct models. Given practices such as the Japanese Keiretsu, the dominant state influence in China, the partnership of employee and capital providers in Germany, and the influence of politics and strongmen in Africa and other developing countries, the articulation of a universal governance model is unpractical (Adegbite, 2015). Therefore, in promoting an understanding of corporate governance, this section examines four models of corporate governance and their implications for the board of directors. The Anglo-American Model Here we refer to the corporate governance systems in the US and in the UK. The governance model in the UK is principle-based requiring companies to self-govern (Tricker, 2015). This model does not provide explicit regulations that guide corporate governance practice in firms. Instead, organisations rely on self-regulated codes of corporate governance provided by relevant regulatory bodies. This model relies on the ‘comply or explain’ principle. Given that compliance is voluntary, companies either ‘comply’ with laid down codes or ‘explain’ the reasons for non-compliance (Tricker, 2015). Regulators typically facilitate information sharing thereby ensuring that investors (existing or potential) have adequate information to support their decision-making process. In the principles-based model, the code of corporate governance demands the separation of powers between the CEO and chairperson, the presence of independent non-executive directors on the board, the establishment of various committees such as audit, remuneration and nomination among others. These requirements foster higher levels of transparency and accountability (Fama & Jensen, 1983; Majumdar, 2017). Given the benefits of the principles-based model, it is widely adopted in many countries especially among the Commonwealth countries. Nonetheless, this model has attracted criticism. For instance, Sama and Shoaf (2005) argued that the model is devoid of consistency of approach and application owing to its subjective nature. In addition, this model promotes a ‘level playing field’ that prevents firms from gaining competitive advantage given the subjectivity of compliance. Arjoon (2006) also noted that owing to the broad spectrum of the principles-based model, decisionmakers might find it difficult to interpret.

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As such, in comparison with the UK corporate governance model, US company law derives from common laws and is rooted in the legislation of each constituent state (Nader et al., 1976). These rule-based regulations prescribe in detail how to behave (Arjoon, 2006; Sama & Shoaf, 2005). To ensure uniformity, corporate features such as investor protection, financial disclosures and reporting remain the responsibility of the federal government, hence the US Securities Exchange Commission (SEC) oversee these tasks. In contrast to the UK’s self-regulatory ‘comply or explain’ system, the SEC and stock exchange listing requirements in the US demand the mandatory establishment of important board committees (Sarbanes-Oxley Act, 2002). The mandatory governance mechanisms of the rule-based approach are inflexible, providing strict regulatory and enforcement machinery for corporate governance. For instance, the Sarbanes-Oxley Act (2002) made directors more responsible for their companies’ compliance with governance codes by applying penalties to directors. The rule-based model also gave more powers to regulators to strengthen compliance with corporate governance codes, as mandated by the SEC. In companies that adopt the Anglo-American model, the board of directors includes both ‘insiders’ and ‘outsiders’ (Jensen & Meckling, 1976; Mallin, 2007). An ‘insider’ is a director who is either employed by the company (an executive, manager or employee) or who has significant personal or business relationships with management and/or the company. In contrast an ‘outsider’ is a person or institution that has no direct relationship with the company or the company’s management. Sometimes, the outsider may be a non-executive director or an independent director. In the UK, Filatotchev and Wright (2005) report that most companies have boards that largely consist of insider directors while some others have no outsider directors (Filatotchev & Wright, 2005). However, in recent times, there is a discernible trend towards greater inclusion of ‘outsiders’ in both US and UK corporations. Similarly, the literature examining the composition of boards has also examined the fusion (or separation) of the position of CEO and chairperson of boards. Traditionally, one person has served as both chairperson of the board and CEO of a company. Bhagat and Black (1999) describe the fusion of responsibilities as CEO duality, which lends itself to abuses relating to the concentration of powers in the hands of an individual. Furthermore, under the Anglo-American governance model, shareholders are required to elect directors and appoint auditors. In the discharge of their responsibilities, there is an important distinction between the US and the UK. In the US, shareholders do not have the right to vote on the dividend proposed by the board of directors. The reverse is the case in the UK, where shareholders can vote on the dividend proposal (Tricker, 2015; Lorsch & MacIver, 1989). The responsibilities vested in shareholders further highlights the notion that the Anglo-American model epitomises

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the inherent problem in agency relationships (Ungureanu, 2012). This is because the Anglo-American model establishes a complex, well-regulated system for communication and interaction between shareholders, boards and corporations (Lorsch & MacIver, 1989). The model also ensures that a wide range of regulatory and independent organisations play an important role in corporate governance (Dalton et al., 1998; Filatotchev & Bishop, 2002). This multi-layered governance check ensures boards are more responsive and aware of their functions. Continental European Two-Tier Model The majority of European countries operate a two-tier board system. In Europe, corporate governance typically has social elements embedded within the company regulations, which is largely rule-based. The European Union (EU) company laws enacted for the European company (the Societas Europaea) allow countries to practice either the Anglo-American (UK/US) or continental European governance approaches (OECD, 2015). However, many EU countries tend towards a social governance system that gives prevalence to a stakeholder orientation of companies. In Germany, for instance, ownership is concentrated, hence banks are influential in the corporate affairs of companies because the market for corporate control is weak. There are also supervisory boards of companies, split equally with one-half comprising employee representative directors elected by trade unions while the other half consists of directors elected by shareholders. As a result, employees influence the corporate decision-making process. This power enjoyed by employees erodes the benefits inherent in the separation of the roles of chairperson and CEO. However, in France and Italy, a concentrated family shareholding structure dominates corporate ownership. In spite of the positives linked to this model, it has equally attracted criticisms. For instance, information asymmetry can be prevalent, owing to potential manipulation of the information available to members of the public. Further, company management can determine board members since employees that form half of the supervisory board, might be influenced by management. However, some EU organisations, in an attempt to expand their reach and to promote the maximisation of shareholder value, are applying strategies that prioritise shareholders (Tricker, 2015). As with agency theory, the stakeholder theory has relevance with all governance models, but the continental European model best represents where the features of the stakeholder theory are expressed. Boards of directors in continental Europe are a representation of many stakeholders. For example, in Germany where employees control up to 50 percent of the board seats (Tricker, 2015; Mallin, 2007), it is assumed that the company is responsible to the wider environment and not a narrow group of shareholders. Under the continental European governance model,

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companies assign some control rights, rewards and responsibilities to its stakeholders such as employees (OECD, 2015). The Asian Model Here we refer to the corporate governance systems in Japan and in China. The Japanese form of corporate governance is different from the AngloAmerican model. In Japan, the social system is well-knit, and this is emphasised amongst Japanese organisations (Aoki, Gregory & Miyajima, 2007). Consequently, Japan operates a classical model where companies interrelate through cross-holdings and interlocking directors (known as keiretsu). Traditionally, the boards of directors are large, with membership often determined by loyalty. In effect managers secure promotions to boards as a form of reward for loyalty and tenure in the job. A criticism of this method of board membership is that it can produce mediocre directors since membership is not linked to performance (Aoki et al., 2007). However, the Japanese model encourages continuous dialogue along the management continuum and hierarchy, resulting in generally agreed positions on issues. Thus, boards are more decision ratifying rather than strategic or decision taking (Tricker, 2015). The presence of outside directors is rare in the Japanese model as the Japanese are unconvinced about the usefulness of an independent director. They contend that people who are working on the inside possess better knowledge about the company than outsiders do. The lack of independent directors makes the market for corporate control largely non-existent. This approach minimises the possibility of a hostile takeover in Japan. As a check, the system mandates the engagement of full-time statutory auditors who report any observed corporate infringements to the board. Owing to stagnant growth in the Japanese economy and pressures from international investors, an increasing number of Japanese organisations are embracing the notion of independent directors. Indeed, Aoki et al. (2007) note that Japanese regulations recommend that independent outside directorship, if present in a company, should form a supervisory committee separate from the board of directors (Aoki et al., 2007). This shift from the traditional Japanese model has led observers to suggest that Japan might soon adopt the Anglo-American governance model (Tricker, 2015). The Chinese governance model emphasises the influence of Chinese families in Asia. Most companies that dominate Asian economies have major Chinese ownership or influence (Zhang, 2008). In the governance of these Asian organisations, the board plays a supportive role rather than decision-making role, because the main powers lie with the dominant family owners (Tricker, 2015; Zhang, 2008). In the majority of these Asian countries, the codes of corporate governance demand the appointment of independent directors onto boards, but most regulatory

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authorities attach less importance to independent directors (Zhang, 2008). In its place, regulators focus on disclosures and related party transactions. Tricker (2015) further noted that amongst Asian organisations, the independence of directors is less important compared to their loyalty, trustworthiness and business acumen. As noted earlier, the growing role of institutional investors and the introduction of stringent regulations have compelled an increase in outside directors in the UK and the US. Unlike in the UK and the US, however, the Asian countries offer a different proposition. Given that companies in these countries encourage promotion to boards based on trust and family ties rather than competences or reputation (ISI Publications, 2004), the CEO and chairperson roles are often merged. Where there is a separation of roles, a dominant family shareholder dictates and influences corporate decisions. This may be explained by the primary responsibility of boards in Asian countries, as boards focus on decision ratifying rather than actual decision-making (Zhang, 2008). Furthermore, and in accordance with the stewardship theory, managers in the Asian model are not motivated by individual goals, but rather are stewards whose motives are aligned with the objectives of their principals (Aoki et al., 2007). The steward perceives greater utility in cooperative behaviour and behaves accordingly. Trust is the key factor in securing promotion to director or top management positions under the Asian model. While in the Anglo-American environment, dispersed share ownership is prevalent, and the presence of institutional owners complicates companies’ ownership and reporting (Mallin, 2007; Triole, 1996; Useem, 1993; Nader et al., 1976), in the Japanese stakeholder-orientation model, the ‘keiretsu’ network of directors is widespread and includes representatives from financial institutions, other companies in the network and representatives of suppliers (Aoki et al., 2007). The Japanese commercial code requires directors be elected by the board and appointment of individuals as full-time statutory auditors (Aoki et al., 2007). Specifically, Japanese company law does not provide for independent outside directors (Aoki et al., 2007). The Japanese model is similar to the Chinese approach in many respects, but there are still distinctions. In the Chinese family-based model, regulatory authorities tend to emphasise the importance of disclosure and the control of related third-party transactions (Zhang, 2008). In China, regulatory laws require independent outside directors, but most Asian companies pay little attention to this requirement. This is because trust and loyalty are more important in these environments (Zhang, 2008). The African Model The majority of African countries adopt versions of the Anglo-American corporate governance models (Nakpodia, Adegbite, Amaeshi & Owolabi, 2018; Okike & Adegbite, 2012). Typically, their codes of corporate

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governance follow a unitary system where the board makes decisions. However, the presence of politically connected individuals (usually referred to as strongmen/women) is prevalent in many of the organisations in these countries (Adegbite, Amaeshi, & Amao, 2012). Adegbite (2012) argued alliances with government officials are a key determinant of corporate success. Moreover, most businesses have dominant shareholders, and most of these organisations are either family owned or family influenced (Adegbite, 2015). This raises challenges for board independence. Corporate governance regulators in African countries tend to react to international guidelines from more developed countries and may impose governance principles on the companies in their respective operating domains (Osemeke & Adegbite, 2016). Yet the weak institutional environment prevalent in these countries has frustrated the success of the strategy. The weaknesses in their institutional environments play major roles in truncating the impact of corporate governance. Despite the numerous challenges confronting companies in these climes, there is a growing belief in the principles that embed corporate governance. This belief has propelled constant improvements towards achieving acceptable standards in corporate governance. The Anglo-American model has also influenced corporate governance approaches among African and other developing economies, hence the credence given to boards (Okike, Adegbite, Nakpodia & Adegbite, 2015). The African and other developing countries model is replete with the agency problem, particularly the principal–principal agency problem (Nakpodia et al., 2018), due largely to the failure of its institutions to check the excesses of key players (Adegbite, 2015). The presence of powerful family or individual shareholders leads to a situation where information is available to select shareholders to the disadvantage of minority shareholders. This practice is possible because, in many instances, the board of directors are either family members or individuals nominated by the dominant shareholder (Claessens & Yurtoglu, 2013). The dominant shareholder and dominant shareholder-related director relationship is prevalent in all governance models but very much less so in the Anglo-American model where the financial market is not only sophisticated but also possesses the capacity to check the corporate infractions among shareholders and directors. In Africa, the board of directors becomes not only essential but serves to improve the reputation of firms who are operating in a weak institutional context, challenged by corruption and weak enforcement of laws, amongst other problems (Adegbite & Nakajima, 2011; Anderson & Reeb, 2004)

Conclusions and Areas for Further Research The foregoing discussions have revealed some shared anchorage as well as differences between the different models of corporate governance and

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their attendant board structures and practices. While there are some pointers to the universalised Anglo-American corporate governance model and the resulting convergence of practices (Adegbite, Amaeshi & Nakajima, 2013), discussions have also noted that corporate governance reacts to institutional peculiarities (Nakpodia & Adegbite, 2018). The differences in culture and institutions have encouraged the adoption of a variety of corporate governance approaches in different countries. This has meant that, despite the similarity in underlying principles, diverse governance models exist. Institutions (regulatory, normative and cognitive) in their respective environment dictate the approach to governance by firms. Ultimately, the key to board relevance lies in substance not form. It is more about the way directors of a company create and develop governance models, business strategies, firms’ visions and missions to fit the particular circumstances of the firm. Moreover, despite the contemporary ubiquitous nature of corporate governance, the differences in culture, social cognition and institutional environments guarantees that there will always be differences in the corporate governance principles and models of firms operating in their different countries and jurisdictions. On the one hand, some factors such as corporate governance codes, securities regulations, international accounting standards and technological developments seem to be leading towards a convergence. On the other hand, factors such as legal differences, ownership structures, culture and state of institutions are indicators of continued divergence among firms in different countries. This chapter has identified four main models of corporate governance. We have also used the dominant theories of corporate governance to explain why distinct governance models are adopted in varieties of capitalism and the consequent implications for board practice. In doing this, we identify an important area that deserves scholarly attention. Corporate governance as a predictive tool for stakeholders remains an under-researched area. Despite advances in governance and reliance on corporate governance literature, scholars have not been able to identify why and when corporate failures are likely to occur and the role of boards in preventing this. Furthermore, beyond financial and other verifiable facts, why do board members make the decisions they make? Future research should seek to examine the cognitive reasoning behind the decisions taken by stakeholders especially management and directors.

References Adegbite, E. (2012). Corporate governance in the Nigerian banking industry: Towards a strategic governmental engagement. International Journal of Business Governance and Ethics, 7(3), 209–231. Adegbite, E. (2015). Good corporate governance in Nigeria: Antecedents, propositions and peculiarities. International Business Review, 24(2), 319–330.

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Adegbite, E., Amaeshi, K., & Amao, O. (2012). The politics of shareholder activism in Nigeria. Journal of Business Ethics, 105(3), 389–402. Adegbite, E., Amaeshi, K., & Nakajima, C. (2013). Multiple influences on corporate governance practice in Nigeria: Agents, strategies and implications. International Business Review, 22(3), 524–538. Adegbite, E., & Nakajima, C. (2011). Corporate governance and responsibility in Nigeria. International Journal of Disclosure and Governance, 8(3), 252–271. Anderson, R., & Reeb, D. (2004). Board composition: Balancing family influence in S&P 500 firms. Administrative Science Quarterly, 49, 209–237. Aoki, M., Gregory, J., & Miyajima, H. (2007). Corporate Governance in Japan: Institutional Change and Organisational Diversity. New York: Oxford University Press. Arjoon, S. (2006). Striking a balance between rules and principles-based approaches for effective governance: A risk-based approach. Journal of Business Ethics, 68(1), 53–82. Bhagat, S., & Black, B. (1999). The uncertain relationship between board composition and firm performance. The Business Lawyer, 54(3), 921–963. Claessens, S., & Yurtoglu, B. B. (2013). Corporate governance in emerging markets: A survey. Emerging Markets Review, 15, 1–33. Coase, R. H. (1937). The nature of the firm. Economica, New Series, 4(16), 386–405. Dalton, D. R., Daily, C. M., Ellstrand, A. E., & Johnson, J. L. (1998). Metaanalytic reviews of board composition, leadership structure, and financial performance. Strategic Management Journal, 19(3), 269–290. Davis J. H., Schoorman F. D., & Donaldson L. (1997). Toward a stewardship theory of management. Academy of Management Review, 22(1), 20–47. Donaldson, T., & Preston, L. E. (1995). The stakeholder theory of the corporation: Concepts, evidence, and implications. Academy of Management Review, 20(1), 65–91. Etzioni, A. (1975). A Comprehensive Analysis of Complex Organizations (rev. ed.). New York, NY: Free Press. Fama, E. F., & Jensen, M. C. (1983). Separation of ownership and control. Journal of Law and Economics, 26(2), 301–325. Freeman, R. (1984). Strategic Management: A Stakeholder Approach. Boston, MA: Pitman. Filatotchev, I., & Bishop, K. (2002). Board composition, share ownership, and ‘underpricing’ of UK IPO firms. Strategic Management Journal, 23(10), 941–955. Filatotchev, I., & Wright, M. (2005). Corporate Governance Life Cycle. London: Elgar. Gamble, A., & Kelly, G. (2001). Stakeholder value and the stakeholder debate in the UK. Corporate Governance: An International Review, 9(2), 110–117. Hillman, A. J., & Dalziel, T. (2003). Boards of directors and firm performance: Integrating agency and resource dependence perspectives. Academy of Management Review, 28(3), 383–396. Huse, M. (2005). Accountability and creating accountability: A framework for exploring behavioural perspectives of corporate governance. British Journal of Management, 16(1), S65–S79. ISI Publications. (2004). The Practitioner’s Guide to Corporate Governance in Asia. Retrieved from www.BooksonBiz.com.

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Jensen. M., & Meckling, W. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. Letza, S., Sun, X., & Kirkbride, J. (2004). Shareholding versus stakeholding: A critical review of corporate governance. Corporate Governance: An International Review, 12(3), 242–262. Lorsch, J. W., & MacIver, E. (1989). Pawns or Potentates: The Reality of America’s Corporate Boards. Boston, MA: Harvard Business School. Majumdar, A. B. (2017). The fiduciary responsibility of directors to preserve intergenerational equity. Journal of Business Ethics. 1–12. doi: 10.1007/s10551-0173739–4 Mallin, C. (2007). Corporate Governance. 2nd ed. Oxford: Oxford University Press. Nader, R., Green, M., Seligman, J., & Soderquist, L. D. (1976). Taming the Giant Corporation. New York, NY: Norton. Nakpodia, F., & Adegbite, E. (2018). Corporate governance and elites. Accounting Forum, 42(1), 17–31. Nakpodia, F., Adegbite, E., Amaeshi, K., & Owolabi, A. (2018). Neither principles nor rules: Making corporate governance work in sub-Saharan Africa. Journal of Business Ethics, 151(2), 391–408. OECD (2015). Growth Companies, Access to Capital Markets and Corporate Governance. OECD Report to G20 Finance Ministers and Central Bank Governors. Retrieved from https://www.oecd.org/g20/topics/framework-strong-sustainable-balanced-growth/OECD-Growth-Companies-Access-to-Capital-Marketsand-Corporate-Governance.pdf, accessed on 18 July 2017 Okike, E. N. M., & Adegbite, E. (2012). The code of corporate governance in Nigeria: Efficiency gains or social legitimation. Corporate Ownership and Control, 9(3–2), 262–275. Okike, E. N. M., Adegbite, E., Nakpodia, F., & Adegbite, S. (2015). A review of internal and external influences on corporate governance and financial accountability in Nigeria. International Journal of Business Governance and Ethics, 10(2), 165–185. Osemeke, L. & Adegbite, E. (2016) Regulatory multiplicity and conflict: Towards a combined code on corporate governance in Nigeria. Journal of Business Ethics, 133(3), 431–451. Pfeffer, J., & Salancik, G. R. (1978). The External Control of Organizations: A Resource Dependence Perspective. New York: Harper & Row. Renders, A., & Gaeremynck, A. (2012). Corporate governance, principal-principal agency conflicts, and firm value in European listed companies. Corporate Governance: An International Review, 20(2), 125–143. Sama, L. M., & Shoaf, V. (2005). Reconciling rules and principles: An ethicsbased approach to corporate governance. Journal of Business Ethics, 58(1), 177–185. Sarbanes-Oxley Act. (2002). Sarbanes-Oxley Act. Retrieved from http://citeseerx. ist.psu.edu/viewdoc/download?doi=10.1.1.474.2105&rep=rep1&type=pdf, accessed 11 December 2018. Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. Journal of Finance, 52(2), 737–783. Tricker, B. (2015). Corporate Governance: Principles, Policies and Practices (3rd ed.). Oxford, UK: Oxford University Press.

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Triole, J. (1996). The Theory of Corporate Finance. Princeton, NJ: Princeton University Press. Turnbull, S. (1994). Stakeholder democracy: Redesigning the governance of firms and bureaucracies. The Journal of Socio-Economics, 23(3), 321–360. Turnbull, S. (1997). Corporate governance: Its scope, concerns and theories. Corporate Governance: An International Review, 5(4), 181. Ungureanu, M. (2012). Models and Practices of Corporate Governance Worldwide. Centre for European Studies (CES), Working Papers, 4, 625–635. Useem, M. (1993). Executive Defence: Shareholder Power and Corporate Reorganization. Cambridge, MA: Harvard University Press. Zhang, W. (2008). Related Transactions: Analysis of China’s Listed Companies. The 2008 Asian Round Table on Corporate Governance, Shanghai Stock Exchange Research Centre, China, OECD, Hong Kong, SAR.

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Codes for Boards of Directors A Law and Morality and Organisational Differences Perspective David Williamson and Gary Lynch-Wood

Introduction Following a review of codes of ethics and codes of conduct for boards of directors (BoD), the chapter goes on to explore the factors that can influence their efficacy and performance. While there might be many ways of doing this, the internal morality of law, which Lon Fuller (1964) provides as a measure of legal efficacy, alongside firm differences and what we refer to as the ‘conditions’ of regulation, provide the basis for our assessment. An evaluation of the UK Corporate Governance Code (2016), and, to a lesser extent, bespoke voluntary codes of ethics and conduct, is then undertaken. This leads us to infer that additional mandatory measures might be needed if we are to improve code efficacy and the corporate governance of firms more generally. The same is held to be true in developing and emerging markets (DEMs), with the important caveat that in the absence of an institutional environment to protect contractual exchange, and when a code is seen to be bona fide and taken to reflect BoD good practice, that it then provides that contractual protection.

Ethics and Conduct Codes: A Review In simple terms, codes of ethics and codes of conduct specify the values and the types of behaviour and practices that are expected from those to which they apply (Lichtenberg 1996; Cleek and Leonard 1998; Stevens 1994; Bondy et al. 2004; Harris 2004; Kaptein 2004). Codes have been, and still are, widely used. In fact, there are numerous examples of the use of codes in different contexts and settings. This includes, for example, the use of professional codes, such as the Hippocratic Oath in medical practice, codes of conduct for solicitors and legal practice, and the International Ethics Standards Board of Accountants. Adding sport to the list, we could consider the International Netball Federation Anti-Corruption Code or the British Lawn Tennis Association’s Code of Conduct. If and when codes are used, then the terms ethics and conduct are often exchangeable, although important differences can be drawn

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between the two. Codes that have a more ethical orientation tend to guide behaviour and strategy through principles and values, while codes that govern conduct aim to prevent or promote specific types of behaviours or practices (see Stapenhurst and Pelizzo 2004). This being so, it might be expected that they are used in different settings and that they have different approaches for securing compliance. The nature of codes should therefore relate to their particular purpose. This, for a BoD in the UK, would necessitate that we consider bespoke codes that are internal to the firm as well as external codes, by which we mean the use and application of the UK Corporate Governance Code (2016) to listed companies. Many large corporations have codes of ethics (that often incorporate codes of conduct), which apply to the firm as a whole, and so by default to the BoD. These include general duties on matters such as conflicts of interest as well as matters around compliance with the law. They can also include commitments towards social, environmental and sustainability concerns, a supportive, inclusive and diverse corporate culture, the protection of company information and reputation, and of course, responsibilities around product and service quality (White and Montgomery 1980; Sanderson and Varner 1984; Cleek and Leonard 1998; Bondy et al. 2004; Kapstein 2004; O’Dwyer and Madden 2006). In addition to being aspirational, internal codes can include rules and punishments, even if such punishments are rarely used. (In the absence of empirical data on sanctions in relation to breaches of ethical codes in listed companies, we infer from the work of Downe et al. 2016, who show that in public organisations, which we might expect to be more ethically proactive and where rules are frequently embedded in ethical codes, there is a reluctance to use sanctions). It is worth noting that the evidence on the positive impact of ethical codes on corporate behaviour would appear to be mixed (Pierce and Henry 1996; Schwartz 2001; Peterson 2002; Healy and Isles 2002; Farrell et al. 2002; McKendall et al. 2002; Kaptein and Schwartz 2008; Helin and Sandström 2010; Hodges 2016). By way of contrast to bespoke ethical codes, all listed firms in the UK are obliged to sign up to the UK Corporate Governance Code (2016). The code, which is a core component of the regulatory framework affecting the governance of large firms, was first established in 1992. It has been amended on several occasions since its introduction. Importantly, the code adopts a ‘comply or explain’ approach. It encourages firms to comply, although at the same time it allows them not to, so long as they explain their reasons. The code, which operates on disclosure of information, is thought to provide a comprehensive framework for good corporate governance, covering issues such as the relationship between the chairman and chief executive, the role of non-executive directors, nominations to the board, executive remuneration and risk and auditing. Such is the esteem attached to the code that it is considered an exemplar for the use of a soft governance approach and

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has provided a template for the rest of the EU (Keay 2014). The UK code is regarded as providing an approach to governance that businesses and investors can trust. A central premise of the code is that it has reflexive elements, which means it provides for an ongoing process of self-reflection and learning (Scott 2008; Cankar et al. 2010). That said, it is apparent that reflexivity does not exist outside of its cultural and institutional setting, with the inference being that it reflects and sustains dominant values (Ailon 2011; Spira and Slinn 2013; Veldman and Willmott 2016). If the UK Corporate Governance Code (2016) is self-serving to the interests of firms, then its ability to act as a constituency-wide control and aspirational guide on corporate behaviour would appear to be somewhat compromised. In addition to this qualification, there is the added issue, which may be a consequence of a lack of reflexivity, that compliance with the code is patchy. In fact, overall compliance stood at 57 percent when measured in 2015 (Grant Thornton 2015), and there are said, amongst other things, to be issues around the use of ‘boilerplating’ and generic disclosure.1

Factors Affecting the Efficacy of Codes of Ethics and Conduct Given the bespoke nature of ethics codes across firms, and the self-serving potential of the UK Corporate Governance Code (2016), we can now turn to consider if regulatory strengths and weaknesses of bespoke codes and The UK Corporate Governance Code can be better understood, and if they should be repositioned, in a regulatory sense, through an application of the work Fuller (1964). This is considered appropriate because codes of ethics and codes of conduct are predicated on law and morals coinciding: i.e. we adhere to the codes because they seem to have some widespread moral standing or meaning. That is, codes guide behaviour using rules in a manner that is not too dissimilar to law. For this view to be valid, codes should have equivalent integrity to those in law, which lends itself to an assessment using a common set of criteria (i.e. using the criteria set out by Fuller 1964). This is why all mandates compelling compliance cannot be legitimately treated as law. Putting aside the substantive aims of codes of ethics and codes of conduct, the question for their use therefore hinges on whether they can be rightfully treated as law, and if they can, whether they are correctly positioned on what Fuller (1964) represents as a pointer on a moral scale, where the bottom of the scale is seen as being essential for social life and the top an aspiration of human excellence. On that scale, the law on employment rights is an imposed obligation on firms while an ethics code allows firms to aspire to a higher level, beyond what society deems a minimum duty. The question of whether the pointer is correctly positioned for codes of ethics and conduct (i.e. does the pointer need to go down or up) is, according to Fuller (1964), one around finding a balance between security and freedom, where security necessitates a duty enshrined in law and freedom

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allows adaptive fluidity for those aspiring to excellence. However, o matter the position of the codes on the scale, to be internally moral in law there remains the need for them to strive to meet the eight criteria, or desiderata, which themselves involve a movement up the moral scale because of the demands they make on the capacity of human beings for their achievement. In that sense, they are both necessary in degree as well as what should be aspired to for perfection. Let us take a brief look at these desiderata. The first criterion is there must be rules and that these must be general by applying to all cases, otherwise their idiosyncratic disregard will provide for a disintegration of law. The rules can be precise or broad, as long as they are able to incorporate all or some of the remaining seven criteria. The second criterion is promulgation. The rules need to be communicated to those they are intended to affect. As Fuller himself points out, the effort involved in educating people on the rule depends upon the level of shared views on what happens to be right or wrong. And while not everyone needs to know every rule that potentially affects them, there is nevertheless the need that those affected by the rule have an awareness of what is expected of them. Third is the need to minimise as much as possible retroactive application. As Fuller (1964, 53) comments: ‘Law has to do with the governance of human conduct by rules. To speak of governing or directing conduct today by rules that will be enacted tomorrow is to talk in blank prose’. Rules therefore need to be prospective. Where retroactive action is needed to address concerns over previously unforeseen impairments to the principal to legality, such as to the meaning of a rule, then there needs to be a proper functioning dispute resolution process. The fourth criterion is the need for clarity in law, so that incoherent and vague rules do not impair the understanding and application of law and thus undermine the rule of law. Fifthly, law needs to avoid contradicting itself, as when a person is forbidden and commanded at the same time. It is important that compliance is possible, so one rule should not undermine the functioning of another. Turning to the sixth criterion, requirements need to be achievable, whether it be the determination of fault or that all firms excel in achieving all the elements in a code of ethics. The seventh criterion is that law is consistent through time. If law changes too quickly, then we increase the likelihood of retroactive actions and legislative inconsistency. Law that changes too quickly may undermine the legitimacy of the law. Finally, the eighth criterion requires that law and official action are aligned. This congruence can be undermined in many ways, with Fuller (1964, 81) citing ‘mistaken interpretation, inaccessibility to the law, lack of insight into what is required to maintain the integrity of a legal system, bribery, prejudice, indifference, stupidity, and the drive toward personal power’. Mechanisms to address incongruence include procedural due process, which may necessitate an overseeing agency.

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Turning back to codes of ethics and codes of conduct for the BoD, how, if at all, do they correspond to these eight criteria? Before we attempt this, however, we ought to offer some thoughts on the effect of differences across firms, how this affects their rule-following behaviour, and the implications of this in relation to the legitimacy of the codes that are used.2 The essence of the argument here is that firms learn to follow rules differently due to their knowledge being bespoke to them—by which we mean their knowledge is a practical ability which has been learnt within a specific context (Bourdieu 1984). This practical ability provides the skills to navigate the regulatory and governance landscape differently. Alongside this, regulation such as codes assume that the firm has an understanding of the code (i.e. it can satisfy the knowledge requirement of the code), that they have the resources, which can be both tangible and intangible in form, to be able to respond (i.e. it can satisfy the substantive compliance resource requirement of the code), as well as the willingness and incentives to respond (i.e. it can satisfy the agreement requirement of the code). If we can bring this together, we can now start to see that codes, if they are to perform well, must satisfy the eight criteria that shape the internal morality of law, and that this can be undermined by the requirements of the code because of the conditions the code demands of firms, and in relation to those requirements, the effect of firm differences on the ability of the firm to satisfy those conditions.

Assessing the Efficacy of Codes The UK Corporate Governance Code (2016), at the time of writing, covers 970 with a combined market capitalisation of £2.4 trillion. From this, we are able to assume these firms have the knowledge and resources to adhere to the UK Corporate Governance Code (2016). This then suggests that non-conformance, when it exists, is the result of a lack of proper willingness to fully engage. In contrast, bespoke codes of ethics and codes of conduct span the full spectrum of medium and large companies in the UK: 7, 000 large firms with a turnover of £1, 834 billion and 34, 000 medium firms with a turnover of £541 billion (House of Commons 2017). Given their number we can likewise assume that some of these firms will lack one or all of the three conditions for compliance (i.e. knowledge, resources, willingness). In broad terms, we can thus assume that the UK Corporate Governance Code (2016) will be largely complied with by the BoD as long as there is a willingness to comply, and that bespoke codes of ethics and codes of conduct for BoD would have a much greater possibility of non-adherence due to a lack of willingness, knowledge and resources. Given the above likelihoods of adherence to codes, we also need to consider, for those firms that do seek to adhere, whether the codes are

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in tune with the eight internal criteria for the morality of law? The first criterion, which is that there must be rules and these must be general by applying to all cases appears to be satisfied. This accords with The UK Corporate Governance Code (2016) since it applies to all listed companies in equal measure. In comparison, we would expect the rules in bespoke codes to vary significantly across firms, such that they only have relevance within their own particular setting. Promulgation, the second criterion, also appears to be satisfied by the UK Corporate Governance Code (2016), as the code is very clearly communicated to its intended audience and there is very little reason to doubt that they would understand what is expected of them. In the absence of any empirical evidence, we cannot assume that the same is true for bespoke codes. The third criterion, which is retroactive application, does not operate for the UK Corporate Governance Code or bespoke codes, since both are prospective in intent. The fourth criterion of clarity, to safeguard against vagueness undermining the application of the code, is a problem for both. The UK Corporate Governance Code and bespoke codes. The UK Corporate Governance Code (2016) is discretionary, with, as previously noted, with compliance standing at 57 percent. The discretion is also evident in the code being principles-based and open to interpretation, and it is this combination of discretion and interpretation, which has been, and remains, a source of controversy (see Anand 2005; Hooghiemstra and van Ees 2011; Keay 2014). We would anticipate that bespoke codes would be equally weak in relation to clarity. The fifth criterion, that codes need to avoid contradictions, both with themselves and with other regulatory instruments, appears to be satisfied for the UK Corporate Governance Code (2016) in the absence of evidence to suggest otherwise. However, we might suspect that this will not be the case for some bespoke codes, since there is no wider institutional apparatus to highlight and censure contradictions. In the case of the sixth criterion that the requirements of the code are achievable, it is self-evidently the case that both the UK Corporate Governance Code (2016) and bespoke codes will satisfy this criterion when the principles they contain are open-ended obligations with a low minimum expectation. However, if they are intended to produce tangible outcomes on issues such as gender equality then they have proven more difficult to deliver (Torchia 2011; Doldor et al. 2012). For the seventh criterion, which is that the code should not change too quickly through time (i.e. that it is consistent through time), it is clear that the UK Corporate Governance Code (2016) has been consistently applied through the addition of supplementary iterations since its inception with the Cadbury Report in 1992. In the absence of empirical data, we can only infer that bespoke codes would be relatively consistent over time in the absence of external pressure on individual firms. The eighth and final criterion, that the code and official action are aligned, can be said to exist with the Financial

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Reporting Council being the overseeing agency. In contrast, there is no equivalent framework for bespoke codes. If we take Fuller’s (1964) moral counter as our assessment tool, the UK Corporate Governance Code (2016) and bespoke codes are more aspirational than an imposed obligation. Yet, at the same time, the eight criteria that determine the internal morality of the codes suggest a more mixed picture. For example, the discretion and interpretation that is central to a code appears to undermine general compliance as well as top end excellence. Moreover, this is for a group of firms that are the most economically and socially important nationally and internally. For those other firms, those firms that are less well-resourced and visible, and where bespoke codes exist, we would expect these problems to be exacerbated. Taking this as our cue, what then, are the implications for codes of ethics and codes of conduct for BoD in developing and emerging markets?

Developing and Emerging Markets (DEMs) The key point we wish to pursue here is that, from a theoretical perspective, Anglo-American modes of corporate governance in DEMs (for a detailed review, see Ngwu 2016) will be no different than the UK explanation given above. In general terms, we would also expect it to apply to all DEMs—they would be an extension of the argument rather than a new argument. As such, and not wishing to repeat the previous analysis, which to recap requires for codes to perform well the satisfaction of Fuller’s (1964) eight criteria and the lessening of their subjugation as a consequence of variation in the conditions of regulation across firms, we would expect the situational context in DEMs to be no more supportive than in developed nations. Likewise, if significant negative situational differences do exist between DEMs and developed nations, that the ability of codes to perform their intended function would be worsened. That being the case, the standard response to differences between DEMs and developed nations, which is that these can be addressed by institutional reform, fails to recognise the fundamental character of the challenge, which is that codes will only ever work for a limited number of firms when we apply the yardstick provided by Fuller (1964). Looking more closely at this, the standard view is that it is the institutional environment of a country and their governance structures that determine the magnitude of transaction costs, and it is this which determines economic success (see Williamson 1975, 1985, 1998, 2000, and for a detailed review, Stephen 2016). North (1991) presents this as the institutional environment setting the rules of the game. Within this view, we would expect codes to reduce transaction costs for them to be relevant. Now, if we assume that developed nations have more robust institutional environments (e.g. legal and banking structures), and within those institutional environments that codes where they do operate effectively, do reduce transaction costs, then we could argue that policy should

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support those contexts. Likewise, if we assume that DEMs have less welldeveloped institutional environments and that codes therefore have less chance of operating successfully because there is no transactional benefit accruing from their use, then it makes little sense to rely on codes as a form of governance. However, this misses an important additional point. It is precisely because DEMs have less well-developed institutional environments that codes for certain firms can be an effective form of governance of BoDs! The reason is simple: it reduces transaction costs in an institutional environment where transaction costs for firms using a code would otherwise be higher. Hence, in an institutional environment that fails to protect contractual exchange, a firm with a respected ethical code can provide that missing security. In other words, the code then becomes a substitute for an effective institutional environment.

Conclusion A question which has been inferred throughout much of our analysis and discussion relates to whether voluntary codes of ethics and conduct should in fact be made compulsory. In some respects, this has been affirmed. It seems clear that variations in the conditions of regulations across many firms means we would expect bespoke voluntary codes to be incredibly hit and miss, so to speak. That being the case, they are likely to fail many of the eight criteria provided by Fuller (1964). At the same time, there is a contradiction in this as voluntary codes are also aspirational, so to make them an imposed obligation puts them at the bottom end of the moral scale. Likewise, to suggest that the UK Corporate Governance Code (2016), with all of the institutional weight that underpins it and the resources of the firms themselves, and with it having many aspirational criteria, lies at the upper end of the moral scale, is to ignore aspects of the emperor wearing no cloths. Yet as Fuller (1964, 145) also notes, ‘. . . law [must] be viewed as a purposeful enterprise, dependent for its success on the energy, insight, intelligence, and conscientiousness of those who conduct it, and fated, because of this dependence, to fall always somewhat short of a full attainment of its goals’. On that account, some compulsory clothing may still be needed, although, given differences across firms, any legal framework would need to be carefully thought through. The same is also true for DEMs, with the important caveat that in the absence of an institutional environment to protect contractual exchange, that codes can, when they are bona fide and hence respected, provide that protection.

Notes 1. www.frc.org.uk/directors/corporate-governance-and-stewardship/uk-corpo rate-governance-code/25th-anniversary-of-the-uk-corporate-governance-co/acode-review-is-not-enough-companies-must-take-o (accessed 22 March 2018)

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2. For more on organisational differences, see Lynch-Wood and Williamson in this volume. See also Lynch-Wood and Williamson (2011).

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Hooghiemstra, R. and van Ees, H. (2011). Uniformity as response to soft law: Evidence from compliance and non-compliance with the Dutch corporate governance code. Regulation & Governance, Vol. 5, Issue 4, pp. 480–498. House of Commons (2017, December 28). Business statistics. Briefing Paper 06152. The House of Common Library. Kaptein, M. (2004). Business codes multinational firms: What do they say? Journal of Business Ethics, Vol. 50, Issue 1, pp. 13–31. Kaptein, M. and Schwartz, M. (2008), “The Effectiveness of Business Codes: A Critical Examination of Existing Studies and the Development of an Integrated Research Model.” Journal of Business Ethics, 77(2), 111–127. Keay, A. (2014). Comply or explain in corporate governance codes: In need of greater regulatory oversight? Legal Studies, Vol. 34, Issue 2, pp. 279–304. Lichtenberg, J. (1996). What codes of ethics are for? In Coady, M. and Bloch, S. (Eds.), Codes of ethics and the professions. Melbourne: Melbourne University Press. Lynch-Wood, G. and Williamson, D. (2011). The receptive capacity of firms: Why differences. Journal of Environmental Law, Vol. 23, Issue 3, pp. 383–413. McKendall, M., DeMarr, B. and Jones-Rikkers, C. (2002). Ethical compliance programs and corporate illegality: Testing the assumptions of corporate sentencing guidelines. Journal of Business Ethics, Vol. 59, Issue 4, pp. 55–67. Ngwu, F.N. (2016). Development of the Anglo-American model of corporate governance in developing and emerging markets. In Ngwu, F.N., Osuji, O.K. and Stephen, F.H. (Eds.), Corporate governance in developing and emerging markets. Abingdon: Routledge, pp. 31–44. North, D.C. (1991). Institutions. Journal of Economic Perspectives, Vol. 5, Issue 1, pp. 97–112. O’Dwyer, B. and Madden, G. (2006). Ethical codes of conduct in Irish companies: A survey of code content and enforcement procedures. Journal of Business Ethics, Vol. 63, Issue 3, pp. 217–236. Peterson, D. (2002). The relationship between unethical behavior and the dimensions of the ethical climate questionnaire. Journal of Business Ethics, Vol. 41, Issue 4, pp. 313–326. Pierce, M.A. and Henry, J.W. (1996). Computer ethics: The role of personal, informal and formal codes. Journal of Business Ethics, Vol. 15, Issue 4, pp. 425–437. Sanderson, G.R. and Varner, I. (1984). What’s wrong with corporate codes of conduct? Management Accounting, Vol. 66, Issue 1, pp. 28–32. Schwartz, M.S. (2001). The nature of the relationship between corporate codes of ethics and behavior. Journal of Business Ethics, Vol. 32, Issue 3, pp. 247–262. Scott, C. (2008). Reflexive governance, meta-regulation and corporate social responsibility: The ‘Heineken effect’. In Boeger, N., Murray, R. and Villiers, C. (Eds.), Perspectives on corporate social responsibility. Cheltenham: Edward Elgar Publishing, pp. 170–185. Spira, L.F. and Slinn, J. (2013). The Cadbury committee: A history. Oxford: Oxford University Press. Stephen, F.H. (2016). New Institutional Economics, culture and corporate governance. In Ngwu, F.N., Osuji, O.K. and Stephen, F.H. (Eds.), Corporate governance in developing and emerging markets. Abingdon: Routledge, pp. 45–60. Stevens, B. (1994). An analysis of corporate ethical code studies: Where do we go from here? Journal of Business Ethics, Vol. 30, Issue 2, pp. 63–69.

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Stapenhurst, R. and Pelizzo, R. (2004). Legislative ethics and codes of conduct. Research Collection School of Social Sciences, Paper 37. http://ink.library.smu. edu.sg/soss_research/37 Torchia, M., Calabrò, A. and Huse, M. (2011). Women directors on corporate boards: From tokenism to critical mass. Journal of Business Ethics, Vol. 102, Issue 2, pp. 299–317. The UK Corporate Governance Code (2016). Financial reporting council. www. frc.org.uk/getattachment/ca7e94c4-b9a9-49e2-a824-ad76a322873c/UKCorporate-Governance-Code-April-2016.pdf Veldman, J. and Willmott, H. (2016). The cultural grammar of governance: The UK code of corporate governance, reflexivity, and the limits of ‘soft’ regulation. Human Relations, Vol. 69, Issue 3, pp. 581–603. White, B.J. and Montgomery, B.R. (1980). Corporate codes of conduct. California Management Review, Vol. 23, Issue 2, pp. 80–87. Williamson, O.E. (1975). Markets and hierarchies: Analysis and antitrust implications: A study in the economics of internal organization. New York: The Free Press. Williamson, O.E. (1985). The economic institutions of capitalism: Firms, markets, relational contracting. London: Collier Macmillan. Williamson, O.E. (1998). Transaction cost economics: How it works: Where it is headed. De Economist, Vol. 146, Issue 1, pp. 23–58. Williamson, O.E. (2000). The new institutional economics: Taking stock, looking ahead. Journal of Economic Literature, Vol. 38, Issue 3, pp. 595–613.

4

The Nature of Boards in Developing and Emerging Markets Chris Ogbechie

1. Introduction Corporate governance (CG) as an important determinant of a firm’s performance has been an important topic in management theories and practices. It has become more pronounced perhaps, with the corporate scandals at Enron, WorldCom, Barings Bank and other giants, albeit as a theoretical concept, it has been in the mind of scholars and practitioner for nearly half of the century (Zelenyuk & Zheka, 2006). Corporate governance is commonly referred to as the way in which companies are directed and controlled (Organization for Economic Cooperation and Development, OECD, 2015). Companies play a significant role in society by creating wealth, providing employment, paying taxes and generating investment returns. The globalization of the capital market and capital flow, newly emerging economies, increasing international nature of businesses and investment and corporate scandals, coupled with regulatory responses to these corporate scandals are encouraging demands from companies and investors for consistency in corporate governance practices across borders so as to reduce complexity and confusion within the discourse. Corporate governance essentially involves balancing the interest of a company’s many stakeholders viz shareholders, management, customers, suppliers, financiers, government and society. A good corporate governance framework should therefore set out the respective functions of the boards and their powers and responsibilities (OECD, 2004; Wirtz, 2011). A good corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board and the board’s accountability to the company and shareholders (OECD, 2015). Some of the world’s biggest companies such as Microsoft, Amazon, Netflix, among others have market capitalizations larger than the gross domestic product of some nations. The governance and accountability of such companies are therefore highly important as summed up by Anne Simpson (2005): Corporate governance is the meeting of the private interest and public good . . . for companies, it underpins both enterprise (governance)

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Chris Ogbechie and accountability; for the wider community transparency and accountability in governance is vital for ensuring prosperity and the contribution to the public purse upon which social welfare relies.

Nonetheless, difficulties arise in striving to achieve a single, global approach to CG practice. There are too many deep-rooted cultural and structural differences for a single approach to work equally well in all countries and for all companies regardless of their stage of business and development. To this end, all countries have their own unique system of corporate governance reflecting different economic, cultural and legal circumstances. Since governance in any context must reflect the value system of the society in which it operates (King IV Report on Corporate Governance for South Africa, 2016). Boards play a key role in ensuring effective corporate governance. It is against this backdrop that this chapter will focus on the nature and roles of boards in DEMs. The intent is to examine the peculiarities and nuances of board characteristic in DEMs and to explore emerging issues in corporate governance in these economies. The rest of the chapter is organized as follows: Section 2 will focus on the globally acceptable roles and duties of boards. Section 3 shall examine the institutional features of DEMs. In section 4, the nature of boards in DEMs will be examined. Section 5 will emphasize the key developmental issues in emerging market boards, while section 6 will be the conclusion and recommendation.

2. Contemporary Roles and Duties of Boards In most countries, boards are empowered to manage the affairs of the company and may delegate certain responsibilities to executive directors and board committees (ICAEW, 2015). These powers, roles and duties are provided for in the respective countries’ company laws and company’s incorporation documents. The effectiveness of corporate governance is influenced by the stipulated roles and duties of the board of directors. The board’s key purpose is to ensure the company’s prosperity by collectively directing the company’s affairs, whilst meeting the appropriate interests of its stakeholders. Globally, it has been recognized that balancing the legitimate and reasonable needs, interest and expectations of all organizations’ material stakeholders in decision-making is a key duty of the governing body, i.e. boards (Kings IV report, 2016). In addition to financial and business issues, board of directors must deal with challenges and issues relating to corporate governance, corporate social responsibilities and ethics. Former UK SEC commissioner, Cynthia Glassman in her personal anecdote of the duties of the board in 2005: The boards’ role in corporate governance process includes several important components. First, the board must make sure the company

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has the right management leadership.  .  . . Furthermore, the board monitors the performance of the company, focusing on both risks and returns. The board must understand the drivers of performance and set the tolerance for risk. This covers oversight of operation, financial performance and reporting as well as regulatory compliance and risk management issues. Again, the overall goal of the governance structure and process is to maximize shareholder value through the effective use of the firm’s capital. Other contemporary roles and responsibilities of the board of directors according to Brefi roup (2017) include: • •

•

•

Boards establish the vision, mission and values of the company to guide and set the pace for its current operation and future development; Set strategy and structure by reviewing and evaluating present and future opportunities, strengths, threats and risks both within the company and in the external environment; Boards should delegate authority and responsibility to management and monitor and evaluate the implementation of policies, strategies and organizational plan, and finally; Boards should be accountable to the shareholders and be responsible to other relevant and material stakeholders. Boards should ensure that proper communication both to and from shareholders and relevant stakeholders are effective. It must also take into account the interest and needs of all the stakeholders.

According to the Nigeria’s Securities and Exchange Commission’s (SEC) Code of Corporate Governance 2011, the board is responsible and accountable for the performance and affairs of the company. It should define the company’s strategic goals and ensure its human and financial resources are effectively deployed towards the attainment of those goals. The primary responsibility of ensuring good corporate governance also lies with the boards. Accordingly, the board should ensure that the company carries out its business in accordance with its article and memorandum of association and in conformity with the law of the country (S. 2.4, sec Code 2011). The duties of the board according to Nigeria’s SEC code on corporate governance, 2011 and the King IV report on corporate governance (2016) can be summed up as follows: • • • • •

Define the purpose of the company; Define the values by which the company will perform its daily duties; Overseeing the effectiveness and adequacy of internal control system; Performance appraisal and compensation of board members; Ensure the integrity of financial report;

44 • •

Chris Ogbechie Ensure that high ethical standards are maintained; Ensure compliance with the laws of the land.

In the age of exponential change where both risk and opportunity abound, for companies to survive and thrive, they should recognize the opportunities at hand and take deliberate action. Board members have a unique role to play in guiding transformation, challenging the basic assumptions of an organization and helping foster a positive culture of exploration and experimentation to help keep the business evolving as its environment changes.

3. Features of Developing and Emerging Markets Different countries have their own unique system of corporate governance codes reflecting their different economic, legal and cultural circumstances (ICAEW, 2011). The adoption of a corporate governance code in DEMs increases the interest in studying the impact of good corporate governance on business performance in the context of social, economic and political factors, which differ from those of developed countries (Borlea, Achim & Mare, 2017; Mahadeo, Soobaroyen & Hanuman, 2012). Despite the ubiquitous use of the term, DEMs have not been uniformly defined in the literature (Rottig, 2016). Nevertheless, the categorization in the literature is to first define what a developed market is and then consider all other markets as DEMs (Rottig, 2016; Buckley et al., 2007). The meaning of what constitutes an “emerging market” has changed from the inception of the term, when it was meant to replace the term “the third world” or “developing world” (Rottig, 2016; The Economist, 2010). The two classifications refer to entirely different group of countries. The main difference is that while emerging economies are growing rapidly and becoming more important on the world economic stage, developing economies in comparison are struggling and still need help from trade partners around the world After extensive literature review, the key economic and institutional differences between developing and emerging markets can be explained by Table 4.1. In a similar vein, there are lines of symmetry between these phenomena, namely heterogeneous CG landscape, predominance of state-owned enterprises (SOEs) and family-owned businesses (FOBs) and the power of dominant shareholders, limited disclosure and transparency and a weak institutional framework. As governance in any context reflects the value system of the society in which it operates. It would be pertinent to observe and to take account of the heterogeneity and peculiarities of social, economic and political considerations in emerging and developing economies. Good corporate governance in DEMs will indicate the willingness to run responsible and

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Table 4.1 Key Economic and Institutional Differences between DEMs and Developed Markets Emerging Markets

Developing Markets

• Marginally developed capital • market with low level of • liquidity • High income inequality and low per capita income • Rapid economic growth and • development • Volatile financial and capital • inflow • High level of inflation • • Modernization of • infrastructure • Dominance of manufacturing and labour-intensive Industries • • High GDP growth rate • • Decreasing trade barriers Institutional • Non transparent political and • Conditions regulatory environment • Moderate to high level • government intervention in businesses • Moderate to high human • development index (HDI) • Moderate degree of political and economic freedom • • Young and expanding working population •

Economic Conditions

Poorly developed capital market with level of liquidity High poverty incidence and low levels of per capita income Stuttering economic growth and stagnant productivity Unnecessary bureaucracy stifling innovation, enterprise and trade Higher inflationary level High dependence on agriculture and other primary product for export High trade barriers Low GDP growth rate Absence of specialized intermediaries and regulatory systems Constraining government policies hinder global integration Low human development index (HDI) Moderate to high risk of social unrest and war. Poor educational system and high level of illiteracy

Source: Extracted and adapted from Marquis and Raynard (2015).

decent organizations. This will help improve the ease of doing business and attract foreign direct investment.

4. Boards in Developing and Emerging Markets: Peculiarities and Nuances Board Structural Issues: Board Composition, Dynamics and Diversity Board structural issues focus on configurations that encompass the board characteristics needed to sufficiently understand the workings of boards. These structural measures include board composition, board dynamics and diversity. In DEMs, the board of directors is an important governance vehicle and so the interest in its composition. Various features related to board structure and composition are considered

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as important characteristics of effective corporate governance needed to boost business performance (Al-Matari et al., 2012; Achim & Borlea, 2013; Borlea, Achim & Mare, 2017). Other dimensions of board structure include number and types of board committees, committee membership, flow of information and pattern of committee membership (Ong & Wan, 2001; Zahra & Pearce, 1989). Board Composition This refers to the size of board membership and the proportion of inside directors to outside directors. It also concerns issues relating to board independence (including independence of board committees), diversity (including gender diversity) of board members and CEO duality (Financial Times Lexicon, 2016). In general, there are three categories of directors that some categorize as executive (inside) and non-executive directors (related outside directors and independent outside directors). Inside directors (management or executive directors) are salaried employees such as the company’s managing director, chief executive officer (CEO), chief financial officer (CFO) and chief risk officer (CRO). They are responsible for the day-to-day running of company’s affairs. They occupy dual status as alter ego as well as employees of the company. As alter ego, they sit at the board meetings formulating policy direction for the company, and as employees, they are in charge of implementation of the company policies (CAMA, 2004; Onyekachi, 2016). Affiliated directors are those who have a pre-existing relationship with the firm such as family relatives and retired executives. They are nonemployee directors with personal or business relationship with the company (Ogbechie & Koupofoulos, 2010). Independent outside directors are those that have no personal connection or dealing with the company. Taken together, board independence refers to a corporate board that has a majority of independent outside directors (Financial Times, 2016). Unanimously, scholars agreed that an outsider-dominated board is believed to be more vigilant and unbiased in monitoring managerial behaviors and decision-making for the firm. The size of the board and the number of committees will depend on the size of the company, the complexity of the business and its industry. Board Dynamics and Diversity Diversity depicts the varied personal characteristics that make the workforce heterogeneous (De Cenzo & Robbins, 2005). Board diversity can be said to be those varied personal characteristics and physical differences in people who are members of the board that make the board heterogeneous (Ogbechie & Koupofoulos, 2010). Board diversity involves

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a variety of observable demographics, such as race, gender and age, and non-visible attributes, such as marital status, educational level, tenure and occupations of board members (FT, 2016). For boards to be effective there is a need for diverse perspectives to confront the thinking of management (Ogbechie & Koupofoulos, 2010). New research makes it increasingly clear that companies with more diverse workforces perform better financially and operationally (McKinsey, 2015). Specifically, McKinsey’s findings indicated that companies in the top quartile for gender, racial and ethnic diversity are more likely to have financial returns above their national industry medians. Hence, companies that commit themselves to diverse leadership are more likely to be successful. Diverse companies are more likely to be able to win top talent and improve their customer orientation, employee satisfaction and decision-making, and all that will lead to a virtuous cycle of increasing returns. In most DEMs, board diversity and human capital are important board structural factors that impact board effectiveness. Lack of expertise among directors is a perennial problem, and so there is the need for companies to put in place processes that enable them select directors who have the expertise to properly evaluate the information they get from managers and add value to the companies (Ogbechie and Koupofoulos & Argyropoulou 2009). One primary responsibility of the board is to ensure strategic guidance of the company (OECD, 2014), as well as help to constructively challenge and help to develop proposals for strategy. In this light, Forbes and Milliken (1999) argue that each of the various aspects of the board demography are likely to have multiple and contrasting effects on the processes that contribute to effective board performance. Therefore, whilst board structure conditions board effectiveness, it is the behavioral dynamics of a board and the web of interpersonal and group relationships between executive and independent directors that determine board effectiveness (Roberts et al., 2005). Therefore, “good” corporate governance drivers may also be associated with factors that affect board dynamics and interrelationships, such as the role of a chairperson, information flow inside and outside the firm and coalition formation (Ogbechie & Koupofoulos, 2010). Peculiarities and Nuances of Board Characteristics in DEMs Of the three models of CG recognized in traditional scholarship, the Anglo-American CG style has been prominently adopted in many DEMs, and this is not unconnected with the global socio-politicoeconomic influences of the United Kingdom and United States (Ngwu, Osuji & Stephen, 2017). However, the governance outcomes from the DEMs continued to swerve against popular expectation despite its relative success in the developed economies. The differences in outcome

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can be attributed to the varying economic and institutional differences between these economies. First, the structure of ownership is predominantly concentrated in many DEMs with many SOEs and FOBs. This gives rise to the presence of dominant ownership (or the majority vs. minority shareholder debacle). The problem in many of these climes, esp. in Nigeria, India and China, is that of disciplining dominant shareholders and protecting minority shareholders. Second, the institutional contexts in these countries have either not been fully developed or totally absent (e.g. India). The capital market is limitedly developed and oligopolistic in nature with profitability and expansion driven only by political connections, shady dealings and other factors outside efficient competition (Ngwu, Osuji & Stephen, 2017). Third, stuttering sociopolitico-economic environment such as weak legal, accounting and regulatory systems, limited availability of skilled workforce, bureaucratic bottlenecks and poor compliance to extant governance rules. The quality of CG in many DEMs is lower relative to developed economies with matured markets and institutions (Ajai, 2017). In many DEMs, the structure of the board is tilted more towards the stakeholder participation model of CG, where the law primarily requires the boards to advance the interest of material shareholder (Ajai, 2017; King IV report, 2016). Though to a small extent, some adopt the Japanese model of the oriented governance system where the interest of employees, suppliers, customers and other material stakeholders are accommodated (Ajai, 2017). Conspicuously, the dominant shareholder system is prevalent in many DEMs. As a result, the influences of vested interest and exploitation of minority shareholders’ rights persist in many DEMs (Ngwu, Osuji & Stephen, 2017). Assessment of Board Effectiveness in Developing and Emerging Markets A key element in corporate governance practice is board evaluation. It has been argued that what allows improper activities to occur is a board’s lack of strategic performance evaluation processes that result in inadequate oversight and control. Mounting stakeholders’ expectation, challenges faced by companies to operate under fluctuating macroeconomic conditions, pressures of globalization and increased regulatory requirement have brought about the need for scrutiny of the boards’ activities. Deloitte Report (2014, 2017) observed that most DEMs company boards have recognized the importance of continually assessing how effectively they are performing their roles against the objectives and the goals set for them. This growing recognition has resulted in board evaluation becoming widely established. Board evaluation has also been seen as a critical structural tool for assessing board effectiveness and efficiency.

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It may be recalled that boards perform three key leadership roles in an organization: direction, control and advisory. Board evaluation typically examines how these roles are being carried out, the entailing responsibilities and assesses how effectively these are fulfilled by the board. According to Deloitte on Performance Evaluation of Board and Directors report 2015 for emerging markets, the effectiveness of the board depends on a variety of parameters viz board structure (its composition, constitution and diversity): dynamics and functioning of the boards (annual board calendar, information availability and interactions and communication with CEO and senior executives); business strategy governance, monitoring role and supporting and advisory role. The evaluation of the board is essentially an assessment of how the board has performed on all of these parameters. Ogbechie identified some parameters that are appraised in the process of performance evaluation viz structure and composition of the board, committee performances, individual director’s performance, board information flow, meetings, board style and dynamics, board development and overall assessment. For most companies in DEMs, board evaluation is an annual exercise by choice or by regulatory prescription (e.g., S. 15 of the Nigerian SEC Corporate Governance Code, chapter 3.5 of South Africa King IV report, etc.). The evaluation process is usually tailored to the requirements of the company, the specific situation it is in, the stage of the company’s lifecycle, the corporate structure, the board culture and the embedded processes. Unless otherwise prescribed by regulation, the annual evaluation is perhaps the most commonly followed evaluation cycle. In Nigeria, most large corporations and banks make the evaluation cycle consistent with the annual planning cycle adopted by the boards, while others tie it to the strategy implementation process. The different corporate governance codes provide that the evaluation system should include criteria and key performance indicators and targets for the board, its committees, the chairman and each individual committee member (S. 15, SEC 2011; S2.8 of CBN code for Banks, 2014). The Acts provide that while the chairman and the CEO/ MD should oversee the annual evaluation (S. 15.3 of SEC code), the result of the board performance evaluation should be communicated and discussed by the board as a whole (S. 15.4.); while those of individual directors should be communicated and discussed with them by the chairman. In the circumstance where the performance of the board is unsatisfactory, the director concerned should be made to undergo further training or otherwise be removed in accordance with extant provision of established procedures. In emerging economies, like in the developed ones, the board performance evaluation is carried out either by engaging the services of external consultants (S. 15.6 of SEC code), or independent consultant as CBN code puts it (S 2.8.3) or use of internal evaluation as some companies

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do in Nigeria. While internal evaluation has many benefits, in certain circumstances, engaging external/independent consultants/advisors may work better. One view favoring independent external evaluation is that the evaluation process becomes more transparent and impartial. Thus, while internal evaluation tends to be mechanical, external evaluation could bring in fresh perspectives and approaches.

5. Emerging Issues in Developing and Emerging Markets (DEMs) Boards While there is intensive debate about the particular values of corporate governance, there is a unilateral agreement that it creates better companies through improved access and lower cost of capital as well as better risk management. Both points are of particular relevance for emerging markets to become winners of tomorrow even faster (Strenger et al., 2012). Emerging markets and developing economies play an increasingly important role in the global economy, given their high economic growth prospects and rapid infrastructural and industrial growth. These countries account for nearly 60 percent of global gross domestic product overtaking that of the developed economies. The importance of such markets to global corporations and investors is demonstrated by the proliferation of emerging market typologies such as BRICS Brazil, Russia, India, China and South Afrcia), CIVITS (China, India, Vietnam, Indonesia, Turkey and South Africa), MINTS (Mexico, Indonesia, Nigeria, Turkey) and EAGLE (an acronym by a Spanish bank for emerging and growth-leading economies of Korea, Indonesia, Turkey and Taiwan). Over the last decades, these fast growing economies have increasingly employed corporate governance to improve the quality of their companies and thereby the wealth of their people (Strenger et al., 2012). For many investors, emerging markets offer an attractive opportunity, but they also involve multifaceted risks at the country and company levels. Some of the emerging issues include; Governance Structural Issues Emerging markets have heterogeneous corporate governance landscapes, thus making governance structure more industry-specific, such that the structure that works with one industry might not be optimal in another industry within the same economy despite extant regulations. This explains the reasons for the legions of corporate governance codes for different industries, for instance in Nigeria, SEC Code of Corporate Governance for Public Companies 2003, revised and launched in 2011; Code of Corporate Governance for Banks, issued by CBN in 2006, re-launched in 2011; Code of Corporate Governance for Insurance Companies issued by National Insurance Commission (NAICOM) and

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Code of Corporate Governance for Pension Operators—issued by the Nigerian Pension Commission (PENCOM) in 2011. In a similar vein, the corporate governance framework is firm-specific. The indicator that underlies the firm-specific context is the structure of ownership. This influence is what makes the decision-making process for investors complex. One of the major challenges of governance in emerging market is the problem of “the power of dominant shareholders”, often family members. Unlike in developed markets where the challenge is more of CEO Chairman duality, in emerging economies, it is more of leadership style. A board that is composed of bossy individuals, dissenting voices and repressive chairmen will be to the detriment of the organization’s progress. A good corporate governance framework should entrench practices to overcome dominant ownership and leaderships. Otherwise, the inescapable problem will be the uneven balance of power; controlling shareholders will be receptive to such proposals only if these proposals are demonstrably in their own interests and not necessarily best governance practice. Studies have shown that controlling shareholders capitalize on weak rule of law and poor transparency to engage in abusive behaviors, such that judicial recourse is not to the advantage of minority investors. As a result of this, investors in emerging markets should not be naïve. They are expected to shape corporate governance practice through informed voting, and, perhaps more importantly, ongoing engagement with companies and regulators. There are individual cases that illustrate the risks in practice e.g. Savannah Bank in Nigeria demonstrate a controlling owner can perpetrate fraud at the expense of minority shareholders. Congruous to this is the case of Satyam Computer Services in India. Sibir Energy in Russia agreed to engage in uneconomic property transaction to accommodate one of its largest shareholders. Another peculiar board governance issue in many emerging and developing economies is the challenge of over-reverence to charisma. For instance, a board that is made up of elderly people or traditional leaders or political leaders together with their followers will tend to be an “all yes” board without constructive criticism. Such reverence is likely to be to the detriment of the organization. Corporate governance also lies at the heart of global corporate social responsibility (CSR) discussion—the concept of sustainable investing. Businesses all over the world have begun to engage in activities to enhance their positive impact on societies and corporate governance is the basis of this. CG and CSR are both value-driven (Strenger et al., 2012). Both CG and CSR foster democratic values of fairness, accountability, responsibility and transparency in corporations and enterprises. Thus, with an effective CG foundation, CSR can always build on it to promote sustainable development. Companies are looking into longer term considerations and the interest of a wider range of constituents to

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cope with this rapidly growing part of business and their impact on the environment and the community in which they operate. The focus on sustainability has necessitated the emergence of non-financial disclosure as a guideline for corporate responsibility. Although, many DEMs still have long way to go in this regard. In Nigeria, governance issues have gained traction, though some business owners are yet to realize the relevance of corporate governance. As Jim Obaze, Executive Secretary/Chief Executive Officer of the Financial Reporting Council (FRC) of Nigeria puts it, despite the plethora of benefits of corporate governance, little had been achieved in promoting good corporate governance in Nigeria. He submitted that “Granted that businesses must be run according to their objectives and policies, but it must be in line with effective accountability”. By so doing, corporate governance can be an essential ingredient for national economic growth and development. James D. Wolfensohn, a former President of the World Bank, noted that “the proper governance of companies will become crucial in the world economies as the proper governance of countries” (Monk & Minnow, 2008, p. 352). To this end, it will be particularly relevant to our current national drive to enthrone probity, annihilate corruption and foster excellent and ethical leadership. Finally, one of the main and largely ignored governance issues within corporate governance framework is the alignment of the goals of the individual, firm, the economy and society. Ultimately, this alignment is the main aim of the corporate governance mechanism (Cadbury, 2000). The aim is therefore to align as nearly as possible the interests of the individual, corporation and society. Linking Risk Appetite and Strategy Since the aftermath of the global financial crisis, boards have intensified their focus on risk oversight, yet it is only recently that most organizations within the emerging and developing economies started formally defining their risk appetite (Archer, 2017). According to Deloitte’s Director Alert 2018, the board in recent times exercises oversight over three critical areas of which strategy and risk appetite is key. Oversights of strategy and risk appetite are at the heart of the board’s responsibilities (Deloitte, 2018). This is particularly true in the current setting where it is essential to take risks to create value while also avoiding risks that can erode value. Digital innovation also drives growth in many organizations but holds risks that must be overseen by boards when it comes to the digital space. Boards need to hone their knowledge and capabilities continuously. Despite the plethora of the board’s efforts to mitigate risks (Deloitte, 2018), risks and challenges continue to multiply and management and boards must continually revise strategies in pursuit of organizational

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goals. As a result, boards are being driven to move their oversight of risk to the next level of maturity (COSO, 2012). One way which boards are enhancing their risk oversight practices is by clarifying and formally approving the organization’s risk appetite. This is the aggregate level of risk management an organization is willing to take in pursuit of its strategy. The board must as a first step first sign off on the management strategy. By formally articulating the organization’s risk appetite and linking it to the strategy, this helps management and the board to acknowledge all the risks and the related opportunities the organization faces in the pursuit of strategy. This will in turn enable the organization to determine whether it is taking the right risk, assuming too much or too little risk, and whether to consider alternative strategies for reaching its goals, i.e. whether alternative strategies would present more attractive risk/return trade-offs, given the organization’s risk appetite. At the nucleus of risk appetite and strategy is the protection of the organization’s reputation. This is especially the case in recent times when reputational risk has never been more threatened. Reputation risks are usually generated and accompanied by other risks such as culture, cyber and third-party risks. If serious enough, a risk of any type can create significant reputational risk, particularly if it goes unchecked. For this reason, boards and management teams are increasingly seeking ways to identify and manage sources of reputational risk. Risk management and strategic decisions have a profound impact on an organization’s reputation (Deloitte, 2018). When the board is confident that risks are not only well managed but are also appropriate to the enterprise’s strategy, the reputation of the organization is protected. The role of the board of directors in enterprise-wide risk management (EWRM) oversight is increasingly demanded as expectations for engagement are at an all-time high. Risk is a pervasive part of everyday business and organizational strategy, however, the growing complexity of business transactions, digital innovation, globalization, speed of product cycles and overall pace of change have increased the complexity and volume of risks facing companies over the last decades. This means the board of directors has a duty, as an essential part of strategy formulation “to develop comprehensive, integrated risk management policies as an integral part of corporate governance processes and associated risk-based approaches to internal control systems”. Other related risk concepts that firms are recently aligned to include risk capacity, risk tolerance, risk profile etc. Diversity (Skills, Gender, Professions and Ethnicity) In DEMs CG context, regulative institutions are weak, incentivizing “cronyism” (Ajai, 2017; Johnson & Mitton, 2003) and unethical behavior. Firm-level governance quality is therefore, generally weak. This is due

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to a lack of diversity on the board, a defect that is adversely impacting board effectiveness. Organizations in recent times are cognizant of the need for boards to have a balance of skills, experience, independence and quite recently, diversity (King IV report, 2016). Efforts are being focused in these markets to strengthen boards through diversity. Changes have been introduced in the corporate governance codes in some jurisdictions placing greater importance on board independence and diversity. For instance, countries like Malaysia have articulated the goal of having 30 percent women on boards. In Nigeria, there are corporate entities, who in trying to meet their social obligations, allow a blend of diversity across skills, races and ethnicity in their boards’ composition. This is not unconnected with the prevalence of informal institution and the need to project the so-called federal character principle in appointment. Nonetheless, companies are doing it in recent times to take advantage of changing dynamics in corporate governance. On the whole, corporate governance issues are yet to be of regular concern in the DEMs which are characterized by a weak private sector and emergent capital market (Change, 2012). Relevant codes (where they exist) have been promulgated fairly recently with necessary sensitization and training programs yet to be undertaken. Most of the domestic legislations such as companies acts and others acts have not been properly tailored to reflect these international standards. As a result, there is a lack of clarity concerning statutory requirements on issues such as disclosure by companies, shareholder protection, conflict of interest, insider trading etc. In Africa, corporations continue to be seen in terms of big multinationals and conglomerates, while the more prevalent small and medium enterprises (SMEs) are ignored. Corporate social responsibility (CSR) is not well understood and is rather widely regarded as a philanthropic gesture of goodwill rather than an attribute of good corporate citizenship (Change, 2012; Ibuakah, 2012). Other challenges as applicable to most DEMs including amongst other things: high ownership structure (the presence of many state-owned enterprises (SOE) and family-owned businesses (FOBs)), underdeveloped external monitoring systems, lack of independence among directors, shortage of trained corporate experts, lawyers and accountants to meet the needs of the domestic enterprises etc.

6. Conclusion and Recommendation For many years, economists and other scholars have analyzed corporate governance as an agency problem. Berle and Mean (1932) identified the divorce of ownership from control as an issue for the modern corporation. The modern agency theory reconceptualizes the problem as one of aligning the incentives of agents within the corporation with the interest of its principal. A small step transforms this into that of aligning the

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incentives of managers with that of the owner. It is on this premise that the author examines the nature of boards in developing and emerging markets (DEMs). DEMs play an important role in the global economy given their high economic prospects and their improving physical and legal infrastructure (Dallas, 2012; Ararat & Dallas, 2011). They can offer an attractive opportunity for investors. At the same time, investors face multifaceted risks, both at country and individual company levels. This therefore requires a much better understanding of the firm-level governance factors, which is the focus of this chapter. Some of the specific risk concerns investors encounter in developing and emerging markets relative to developed economies are as follows (Dallas, 2012): • • • •

Rule of law; Regulatory quality; Corruption; Influence of controlling shareholders.

The first three factors can be substantiated through recognized country indicators such as those released by World Bank Governance Indicator (WGI) and Transparency Corruption Perception Index. The fourth factor is a clear reality in many developing and emerging countries. But the combination of these factors suggest a potentially dangerous omen that can create a macro environment in which emerging markets companies and their controlling shareholders can act in ways to pursue private benefits of control that conflict with the interest of minority shareholders and creditors—whether they are domestic or overseas investors. This chapter has been able to examine the nature of boards in developing and emerging markets, exploring more deeply into the recent global issues in corporate governance. Notable among which are better risk management and developing appropriate risk appetite and tolerance level, governance issues—especially the challenge of dominant or controlling shareholders, the need for diversity on the board especially with the emerging digital and technological trend etc. In recent times, organizations are seeking greater board engagement when it comes to organizational strategy and risk oversight than was the case when enterprises were emerging from the global financial crisis. Yet, many boards in DEMs still need to better understand the interplay of strategy and risk and do more to foster that understanding across the executive team. As the ultimate steward of value and overseer of risk, boards in DEMs must grasp the relationship between strategy and risk and assist management not only in gaining understanding but in putting it to practical use.

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Another contentious issue that deserve recommendation is how to make boards accountable to the shareholders. It must be pointed out that boards are the cornerstone of accountability, integrity and transparency that build trust with the material stakeholders (CBN Code, 2014). As such there must be a clear element of “independence”. One way to ensure this is to link their compensations to performance and positive evaluation. As shareholders remuneration is determined by share appreciation and declared dividends, the remunerations of directors must also be publicly known to prevent any unethical practice. The author believes that by diffusing the ownership structures of companies either by going public or through other means, proper accountability can be guaranteed.

References Achim, M.V., & Borlea, N.S. (2013): Corporate Governance and Business Performances. Mannheim: LAP Lambert Academic Publishing Germany. Achim, M.V., Borlea, N.S., & Mare, C. (2016): Corporate governance and business performance: Evidence for the Romanian economy. Journal of Business Economics and Management, 17, 458–474. doi: 10.3846/16111699.2013.834841. Ajai, O. (2017). Improving corporate governance in developing and emerging markets: The politics, economics and law. In Corporate Governance in Developing and Emerging Markets. New York: Routledge. Al-Matari, E.H., Al-Swidi, A.K., Fadzil, F.H., & Al-Matari, Y.A. (2012): The impact of board characteristics on firm performance: Evidence from nonfinancial listed companies in Kuwaiti stock exchange. International Journal of Accounting and Financial Reporting, 2, 310–332. Ararat M. and Dallas G.S. (2011): Corporate Governance in Emerging Markets: Why It Matters to Investors-and What They Can Do about It, Ptivate Sector Opinion, IFC Global Corpoarte Governance Forum, 2011, p. 1–24. Archer, T. (2017): Strengthening the Link between Risk and Strategy: Global Centre for Corporate Governance. Deloitte Director’s Alert 2018: Linkage to Successes. Berle, A.A. & Mean, G. (1932): The Modern Corporation and Private Property. New York: Harcourt, Brace & World. Borlea, N.S., Achim, M.V., & Mare, C. (2017): Board Characteristics and Firm Performances in Emerging Economies. Lessons from Romania: Economic Research-Ekonomska Istraživanja, Routledge. Buckley, P.J., Clegg, L.J., Cross, A.R., Liu, X., Voss, H., & Zheng, P. (2007): The determinants of Chinese outward foreign direct investment. Journal of International Business Studies, 38(4), 499–518. Cadbury, S.A. (2000). The corporate governance agenda. Corporate Governance: An International Review, 8(1), 7–15. Companies and Allied Matters Act (CAMA, 1990) as amended in 2004: CAP C20, Laws of the Federal Republic of Nigeria, 2004. CAC Change Evelynn (2012): Corporate Governance Reforms in Africa: Key Consideration. A Lecture Presented at the Global Corporate Governance Forum, Leipzig, Germany. COSO (2012): Risk Assessment in Practice, Thought leadership in Enterprise Risk Management; Deloitte & Touche LLP.

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Cynthia G. (2005): A remark at the ICAEW. Beyond the Myth of AngloAmerican Corporate Governance Roundtable, Washington, DC, 6 December, 2005. Dallas G.S. (2012): Corporate Governance in Emerging Markets; cited in Key Corporate Governance Issues in Emerging Markets: Theory and Practical Execution, HHL Leipzig Graduate School of Management. De Cenzo, D.A., & Robbins, S.P. (2005): Fundamentals of Human Resource Management, 8th ed. New York: John Wiley & Sons. Deloitte (2014): Performance Evaluation of Boards and Directors. Deloitte publication in www.deloitte.com/in Deloitte (2017): The Role of the Board in an Age of Exponential Change: On the Board’s Agenda. Deloitte LLP Center for Board Effectiveness. Deloitte (2018): Director’s Alert: Linkage to Success. Global Centre for Corporate Governance. The Economist (2010, April 15): An emerging challenge, p. 69. https://www. economist.com/business/2010/04/15/an-emerging-challenge Financial Times (FT) Lexicon (2016): https://www.ft.com/content/45602ae8-74d111e6-bf48-b372cdb1043a Forbes & Milliken (1999): Cognition and corporate governance: understanding boards of directors as strategic decision-making groups. Acad. Manag. Rev. 24, 489e505. Ibuakah, I. (2012). Key Issues and Challenges in Corporate Governance Reform in Nigeria. Key Corporate Governance Issues in Emerging Markets: Theory and Practical Execution. ICAEW (2011): Effective Corporate Governance Frameworks: Encouraging Enterprise and Market Confidence. Dialogue in corporate governance. ICAEW (2015): Dialogue in corporate governance. Johnson, S., & Mitton, T. (2003): Cronyism and capital control: Evidence from Malaysia. Journal of Financial Economics, 351–352. King IV report on corporate Governance (2016): Institute of Directors Southern Africa. Mahadeo, J.D., Soobaroyen, T., & Hanuman, V.O. (2012): Board composition and financial performance: Uncovering the effects of diversity in an emerging economy. Journal of Business Ethics, 105, 375–388. McKinsey (2015): Board governance Insights to help CEOs and directors improve board effectiveness. McKinsey & Company. Monks, R.A.G. and Minow, N. 2008. Corporate governance. 4th ed. Chichester: John Wiley and Sons. Ngwu, F.N., Osuji, O.K., & Stephen, F.H. (2017): Corporate Governance in Developing and Emerging Markets. New York: Routledge. OECD (2004): Principles of Corporate Governance. Paris: OECD. OECD (2015): G20/OECD Principle of Corporate Governance. Turkey. OECD. Ogbechie, C., & Koupofoulos, D.N. (2010): Corporate Governance and Board Practices in the Nigerian Banking Industry. SSRN: https://ssrn.com/abstract= 1543811 or “https://dx.doi.org/10.2139/ssrn.1543811”http://dx.doi.org/10.2139/ ssrn.1543811 Ogbechie, C., Koufopoulos, D.N., & Argyropoulou, M. (2009). Board characteristics and involvement in strategic decision making: The Nigerian perspective. Management Research News, 32(2), 169–184.

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Ong, C.H., & Wan, T.W.D. (2001). Board structure, board process and board performance: A review & research agenda. Journal of Comparative International Management, 4(1). Onyekachi, Duru Esq (2016): www.legalemperors.com Roberts, J., McNulty, T., & Stiles, P. (2005). Beyond agency conceptions of the work of the non-executive director: Creating accountability in the boardroom. British journal of management, 16, S5–S26. Rottig, D. (2016): Institutions and emerging markets: Effects and implications for multinational corporations. International Journal of Emerging Markets, 11(1), 2–17. https://doi.org/10.1108/IJoEM-12-2015-0248 Simpson, A. (2005): Introduction to the International Corporate Governance (ICGN) Network Yearbook. https://www.icgn.org/information/yearbook Strenger, C., Kleindiek, A., Schmelzle, L., & Volynets, A. (2012): Key Corporate Governance Issues in Emerging Markets. International Conference HHL Leipzig Graduate School of Management Leipzig, Germany, June 11–12, 2012. Wirtz, P. (2011): The cognitive dimension of corporate governance in fast growing entrepreneurial firms. European Management Journal, 29, 431–447. www.brefigroup.co.uk/directors/directors_roles_and_responsibilities. html, 2017. Zahra, S., & Pearce, J. (1989): Boards of directors and corporate financial performance: A review and integrative model. Journal of Management, 15(2), 291–334. Zelenyuk, V., & Zheka, V. (2006): Corporate governance and firm’s efficiency: The case of a transitional country Ukraine. Journal of Productivity Analysis, 25(1–2), 143–157.

5

Corporate Governance and Business Growth Evidence From China Jia Liu, Dimitrios Stafylas, Junjie Wu and Christopher Muganhu

1. Introduction Since 1978, China has progressively embraced market principles, establishing an increasingly free market economy and financial system. Stateowned enterprises (SOEs) have gradually become privatised corporations, regulated by laws and codes of practice for the control of markets and investor protection, creating strong foundations for the development of a market economy. These advances have helped China to become the second greatest economy in the world (World Bank in China, 2017). Corporate governance in China has undergone a revolution, driven by the economic reforms of 1978. Between 1945 and 1978, the economy was dominated by state owned and controlled enterprises. However, the policies adopted from 1978 encouraged entrepreneurship. Two stock exchanges now channel funds to the corporate sector and security policies and governing bodies have been established at central and local levels. Ownership reform has reduced state control of commerce and industry from 100 percent in 1978 to 51 percent in 2009 and to 30  percent in 2015, increasing investors’ confidence in markets, based on the CSMAR database. This has also been reinforced by the Code of Corporate Governance of 2002, which strengthened the Chinese corporate sector. However, despite these achievements, political connections strongly influence institutional change, with the state acting as both regulator and actor in commerce. A dual-share ownership structure maintains state dominance, and listed firms have ineffectual boards of directors that undermine attempts to protect investors. In this chapter, we evaluate Chinese corporate governance and its interactions with the internal and external institutional environments. We perform an empirical analysis of mergers and acquisitions, presenting evidence to show how corporate governance has influenced company growth. Our findings will be of value to China and other economies that are now or will in future pursue similar trajectories. In Section 2, we review corporate governance reforms, issues and challenges. Section 3 presents an empirical analysis of corporate governance

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and value creation by investigating mergers and acquisitions in China. Section 4 concludes with policy recommendations.

2. Corporate Governance Mechanism in China Evolution of Corporate Governance Mechanism in China In China, corporate governance was considered insignificant until the mid-1990s. The first attempt at reform was the PRC Company Law of 1994, which established the foundations of what was to follow. In 2002, the China Securities Regulation Commission (CSRC) and the State Economic and Trade Commission published the Code of Corporate Governance for Listed Firms in China, based on the principles of the Organisation for Economic Cooperation and Development (Principles of Corporate Governance, 1999). The primary objective was to regulate shareholders’ meetings, directors’ roles and the constitution of boards, the role of supervisory boards, performance measurement and incentives, disciplinary systems and investor protection. This helped to increase investors’ confidence and to stabilise Chinese companies. Another significant reform was of the share-split structure of publicly listed companies, whose objective was to reduce state domination by transforming non-tradable state-owned shares into tradable ‘A’ shares, for trading by foreign and domestic private investors. This will reform corporate control and enhance the monitoring and accountability of listed companies (Liu and Li, 2014; Liu et al., 2018). Nevertheless, the institutional framework remains weak and regulations are difficult to apply (Ye et al., 2018). Canada’s Centre for International Governance Innovation placed China first out of ten Asian countries in adopting OECD principles, but ninth in applying these in practice (Liang & Useem, 2009). Considerable improvements are thus required to eliminate such deficiencies. Issues of Internal Corporate Governance in China Despite state regulation, China’s economic system has unique problems, whose resolution is essential for the creation of effective systems of internal and external governance. State Ownership and Ownership Concentration Directly or indirectly, state agencies retain control of two-thirds of listed firms’ shares, and state-controlled shares are non-tradable. Even though centralised control has been reduced by the split-share structure reform of 2005, enterprise in China is still dominated by the state.

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Most firms have a single, controlling stockholder, with a direct or indirect relationship with government or government agencies. By the end of 2000, the median of the largest, individual shareholder’s holding was 42.6  percent, while the second largest held only 5 percent of shares and the third 1.9 percent, and there were few private investors. Ownership by managers and employees is limited in listed firms, as is ownership by foreign noninstitutional investors (Chen et al., 2009). According to our data (Table 5.2), the state controls 30 percent of listed firms’ share capital, institutional investors hold only 17 percent and management own less than 2 percent. Given the state’s dominance, ownership structure often takes the form of ‘pyramid holdings’, with shares being held by the state or its agencies (Kakabadse et al., 2010). The management structure in state enterprises is hierarchical, with power exerted by the government through the China State-owned Assets Management Bureaucracy and the Local State-owned Assets Management Bureau (LSAMB). The latter appoints managers to SOEs at local government level, but it does not have enough resources to monitor such companies. The managers of SOEs themselves lack serious motivation to maintain and add value to the state assets they control ‘because they do not hold the absolute ownership of these assets’ (Wei & Geng, 2008). Consequently, the LSAMB cannot affect the real control needed for motivating directors and managers. Political Connections Most listed firms were originally owned and managed by the state and listed with the state as majority shareholder. Such firms have two-thirds of directors who are either directly or indirectly state appointed. Previous studies of such firms in developing and emerging countries demonstrate that they enjoy extensive advantages and gain significantly from their political connections (e.g. La Porta et al., 1999; La Porta et al., 2000; Khwaja & Mian, 2005; Faccio, 2006; Bunkanwanicha & Wiwattanakantang, 2009). They also benefit from lower tax rates, have a greater market share than competitors without political connections (Khwaja & Mian, 2005), and are more likely to receive financial support in financial distress (Faccio et al., 2006). They can also lobby government in pursuit of favourable policies and maintenance of the status quo (Liu & Pang, 2009; Guo et al., 2018). Research evidence shows that political connections exert a positive, short-term effect on a firm’s performance, especially when they are with senior members of government, although in the long-term political connections have a negative effect on firm performance (Faccio, 2006). Fan et al. (2007) show that a CEO’s political ties result in more government officials being appointed to the board than professional managers. This is attributed to the distinctive political culture that prevails in the Chinese economic system.

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Weak Internal Corporate Governance The Chinese system of corporate governance incorporates both AngloSaxon and German principles. The Code requires a two-tier board, comprising a supervisory board and the board of directors. The supervisory board monitors the executive board and advises senior executives, but it takes no direct part in running a company. Chinese supervisory boards are effectively powerless, having no authority to appoint or dismiss directors, unlike supervisory boards in Germany. Some studies show that supervisory boards in China exert scant influence, merely endorsing management’s decisions (Ding et al., 2009). Clearly supervisory boards play only a symbolic role and are merely decorative (Liu et al., 2014). In China, corporate governance is effectively directed by a single board of directors, strongly influenced by the largest shareholders. Independent directors exert only a token influence because of the active intervention of controlling shareholders (Lin et al., 2009). To protect shareholders’ interests, the CSRC promulgated the Guideline on Establishment of Independent Director System in Listed Companies in 2007, requiring at least one-third of a board’s seats to be held by independent directors. However, almost all companies comply with this regulation only for the sake of appearance. In fact, most so-called ‘independent’ directors are appointed by controlling shareholders, representing the owners rather than minority shareholders.

External Corporate Governance Environment The strength of the corporate governance mechanism is determined by its internal structure and its external environment. However, the latter holds the greater power of enforcement, particularly for the protection of ownership rights, the enforcement of the rule of law, the regulation of market competition, the imposition of an information disclosure mechanism, the creation of independent audit systems and the market for corporate control. Hence, external monitoring systems perform a vital role in determining conduct and governance. Effective corporate governance is founded upon the strength and probity of the environment in which companies operate. To improve stock market efficiency and safeguard shareholders’ interests, the CSRC established a corporate disclosure regulatory framework and a series of regulations requiring listed firms to make disclosures that are truthful, accurate, complete and timely, enabling investors to make informed decisions. Further, the two stock exchanges have developed systems of corporate governance, issuing a series of rules and regulations to protect investors’ interests and increase transparency of disclosure. However, legal defects still abound, and insider trading and earnings management are rampant among Chinese listed firms.

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Certified accountants tend not to issue modified audit reports (Ke et al., 2015) and the falsification of financial reports remains a significant problem (Firth et al., 2011). With dominant interests rampant, systems of governance will inevitably be compromised. In China, continual government intervention undermines laws meant to protect investors. Corporate funds raised for legitimate purposes are frequently appropriated by dominant shareholders for improper uses without shareholders’ consent. Both stock exchanges have sought to control such malfeasances by regulating information disclosure, developing robust systems to promote transparency and publicising breaches. Nevertheless, public shareholders are yet to receive effective protection. Dominant shareholders seek to maximise social welfare instead of corporate value to conform to political demands. Managers have little incentive to maximise corporate value as they are more strongly motivated to implement the decisions of the controlling shareholders who appointed them (Liu et al., 2016). In particular, state intervention and hierarchical ownership structures protect managers from the consequences of poor decision-making as reflected by capital markets. The weak institutional environment makes it difficult for rules to be enforced, which undermines the system of corporate control. In summary, corporate governance in China is significantly shaped by high ownership concentration, characterised by state dominance and political affiliations. State control degrades a company’s corporate governance system as well as the rights of minority shareholders. Management and board decisions favour the interests of the controlling shareholders who appointed them. This has inevitably led to agency problems in the form of tunnelling of resources and management’s pursuit of political interests to the detriment of minority shareholders. Internal governance is further weakened by ineffective enforcement of regulations and laws and by an inefficient financial market. These factors have exacerbated conflicts of interest between dominant and minor shareholders, leaving the latter unprotected. Our inquiry is grounded in this unique economic environment, and the results of our empirical analysis will explain how the corporate governance mechanism shapes company growth in China. To this end, we shall investigate the case of mergers and acquisitions (M&A) undertaken by Chinese companies, which have been largely encouraged by the restructuring of state ownership following the share-split structural reform that began in 2005. Acquisitions have focused on restructuring state-owned assets, with local governments reallocating assets from the target company to the acquirer. They are primarily motivated by social, non-economic concerns, ignoring economic considerations, as large state holdings protect them. The state sees M&A activities as a key driver of the reform process, using this mechanism to rescue failing SEOs by combining them with healthy firms. Against this socio-economic background,

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the impact of mergers and acquisitions on corporate governance and control will be significant. It is therefore important to investigate a strong example of such a case.

3. The Role of Corporate Governance in Business Growth: Evidence From Mergers and Acquisitions in China Theoretical Background and Research Questions Managers claim to maximise corporate value by their M&A activity (Berkovitch & Narayanan, 1993). Given efficient markets and rational managers, synergistic M&As should create value for shareholders (Gaughan, 2010; Petitt & Ferris, 2013). Gains are achieved by improved operational efficiency, greater market power and the more efficient employment of limited capital. However, if markets are inefficient and managers irrational, M&As destroy value due to managerial hubris (Roll, 1986; Wang & Hickson, 2009; Weitzel & McCarthy, 2011) or lead to private utility maximisation (Campbell et al., 2011). Managers of acquiring firms, motivated by personal interests, may fail to recognise potential economic gains from a merger or a takeover; or they may miscalculate the target firm’s value due to cognitive limitations, paying more than it is worth. Acquiring firms in China are mainly large and powerful, with the state as the majority shareholder. Target firms are mainly privately owned, financially distressed and small, and are usually cowed into accepting lower bidder valuations of their firms. Earlier studies suggest that M&As in China create no value for the shareholders of acquiring firms because they fail to undertake due diligence. Moreover, the State exerts pressure through local governments, compelling listed companies to acquire bankrupt firms (Zhang, 2003). Government involvement in the M&A process, as both player and regulator, has interfered with the functioning of internal governance systems, undermining board effectiveness and management accountability. This is certain to influence corporate investment decisions and hence the corporate value to be gained through a merger and acquisition. The foregoing discussions lead to our research questions: (1) Do corporate governance mechanisms facilitate business growth at the firm level?; (2) Can an integral system of corporate governance enhance corporate value?; (3) What influences can acquirers’ characteristics, deal characteristics and industry-level features, which are associated with M&A activities, have on corporate growth? Data and Sampling Our study examines M&A deals that were successfully completed between 2002 and 2015 by Chinese listed firms. We employ the Mergers and

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Acquisitions Database, China’s Stock Market Database, the Corporate Governance Database and the Accounting Research Database supplied by CSMAR. We include the firms and M&A deals that satisfy the following criteria: 1) the acquirer is a firm with Class ‘A’ shares traded on the Shanghai or Shenzhen Stock Exchanges; 2) the target firm can be a publicly listed firm or a private firm; and 3) M&As are undertaken by companies that operate in the financial sector. Our final sample comprises 2, 639 M&A transactions involving 1, 127 acquiring firms.

Empirical Modelling To perform empirical analyses, we adopt cross-sectional ordinary least squares (OLS) regression analysis with clusters. There are cases where a particular firm was involved in more than one acquisition over the course of the fourteen-year study period. The business growth of these firms may not be independent, which can lead to residuals that are not independent between the firms. To address this potential problem, we use standard errors adjusted for heteroscedasticity, as suggested by White (1980). The cross-sectional regression model is specified below. Firm growth i,t = α0 +

∑ (control variables

∑ (corporate governance

i,t )β 2

i,t )β1 +

+ ε i,t

(1)

where Firm growth i, t is measured by market-book ratio. We employ a range of variables, which are structured so as to examine systematically the possible outcomes as a result of mergers and acquisitions. Specifically, we examine if, and how, the possible outcomes of merger and acquisition activities are themselves shaped by the strength of corporate governance structures. Our first set of variables focuses on the corporate governance of acquiring firms, which comprised two groups of variables: (1) ownership: state ownership, institutional ownership and executive ownership; (2) corporate governance: director independence, CEO/chairman duality and board size; and (3) corporate governance index. The vector of control variables includes three sets of variables: (1) acquirers’ characteristics: stock price run-up, sales growth, return on assets, leverage, firm size, geographical focus, related party transactions; (2) deal characteristics: value of the transaction, method of payment, listing status of the target firm (private target), diversifying (focusing) acquisition and previous M&A experience; (3) product market competition variables: competitive industry and unique industry. In addition, year and industry dummies are also included as control variables to account for year and industry effects in the estimations. Variable definitions are presented in Table 5.1.

Stock Price Run-Up Sales Growth Return on Assets Leverage Firm Size

Board Size Corporate Governance Index

CEO/Chairman Duality

State Shares Institutional Shares Executive Shares Independent Directors

Market-Book Ratio

Table 5.1 Variable Definitions

Acquirers’ Characteristics3 An acquirer’s buy and hold abnormal returns during 12 months before the M&A announcement Sales growth rate Operating income before depreciation and taxes divided by total assets Ratio of total debt over total assets Logarithm of market value of equity

Corporate Governance Characteristics2 Percentage of state ownership in total ownership of an acquiring firm Percentage of institutional ownership in total ownership of an acquiring firm Percentage of executive ownership in total ownership of an acquiring firm Dummy variable assigned a value of 1 if over 33 percent of acquirers’ directors are independent, or 0 otherwise Dummy variable assigned a value of 1 if the chairman and CEO positions of an acquiring firm are held by the same person, or 0 otherwise Total number of directors serving on the board of directors of an acquiring firm Dummy variable assigned a value of 1 for good corporate governance, or 0 otherwise Corporate governance index is the summary measure of corporate governance that is an equally weighted aggregation of the sum of the following six dichotomous governance variables defined as: 1) OWNstate: 1 if state ownership is less than the sample median, or 0 otherwise; 2) OWNinstitution: 1 if institutional ownership is greater than the sample median, or 0 otherwise; 3) OWNexecutive: 1 if executive ownership is greater than the sample median, or 0 otherwise; 4) CGboardsize:1 if board size is greater than the sample median, or 0 otherwise; 5) CGCEO/CHAIRduality:1 if the roles of CEO and board chairperson are held by different individuals, or 0 otherwise; and 6) CGdirectorindependence: 1 if proportion of independent directors is greater than 33 percent, or 0 otherwise The median value for the summed values is 4.10. An acquiring firm with values of 4.10 and above is classified as having strong corporate governance; and the one with values below 4.10 are classified as having weak corporate governance.

Business Growth at the Firm Level1 Ratio of market value of equity over total assets

Product Market Competition5 Dummy variable assigned a value of 1 if the acquirer’s industry is in the bottom quartile of all CSRC (2001) industries, annually sorted by the Industry Herfindahl index, or a value of 0 otherwise. The Industry Herfindahl index is computed as the sum of squared market shares of all listed firms within the same CSRC (2001) industry. Dummy variable assigned a value of 1 if the acquirer’s industry is in the top quartile of all CSRC (2001) industries, annually sorted by median industry product uniqueness, or a value of 0 otherwise. Product uniqueness is defined as selling expenses scaled by sales within the same CSRC (2001) industry.

M&A Deal Characteristics4 Logarithm of the value of the M&A deal in US dollars Dummy variable assigned a value of 1 if the target is a private firm, or 0 otherwise Dummy variable assigned a value of 1 if an M&A deal is all paid in cash, or 0 otherwise Dummy variable assigned a value of 1 if an M&A deal is all paid for by stock, or 0 otherwise Dummy variable assigned a value of 1 if acquiring firms and target firms operate in different industries, as per CSCR (2001) classification, or 0 otherwise

Dummy variable assigned a value of 1 if acquiring and target firms fall under the same local government administration, or 0 otherwise Dummy variable assigned a value of 1 if it is a related party transaction, or 0 otherwise The number of acquiring firms that have successfully completed more than one M&A deal

Notes: 1 The derivations of corporate growth measures are based on the MB ratio after the M&A deals have been successfully completed. 2 The derivations of corporate governance variables are based on data from the 12 months before the M&A deals have been successfully completed. 3 The derivations of acquirers’ characteristics variables are based on data from the 12 months before the M&A deals have been successfully completed. 4 The derivations of M&A deal characteristics are based on data collected at the time of the M&A announcement. 5 The derivations of product market competition measures are based on data from 12 months before the M&A deals have been successfully completed.

Unique Industry

Competitive Industry

Deal Value Private Target All Cash All Stock Diversifying Acquisition

Related Party Transaction Acquisition Experience

Geographical Focus

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Empirical Results and Discussions Descriptive Statistics Table 5.2 presents distribution of M&A deals by the year of announcement. Generally, M&A activities increased in both the number of deals and the value of the transactions over the sample period. The M&A deals increased from 91 in 2002 to 302 in 2015. The mean value of M&A deals increased from US $16.03 million in 2002 to US $141.89 million in 2015. The mean acquirers’ market value of equity increased from US $551.36 in 2002 to US $1302.27 in 2015, suggesting that large firms are engaging more in M&A activities, especially from 2008. Overall, these statistics demonstrate that during the reference period, Chinese companies became increasingly active in M&A undertakings, in particular after 2005 when the split-share structure reform was introduced. Table 5.3 presents the summary statistics of the variables for the estimations. The average MB ratio is 2.34, which implies that acquiring firms may be overvalued. The statistics shows some salient features of corporate governance mechanism in China. On average, state ownership accounts for 29.19 percent; institutional ownership accounts for 17.42  percent, while executive ownership is almost negligible at 0.61 percent. There has been a quite significant reduction in state ownership as shown by our sample, compared to 84.0 percent in 2001 and 46.6 percent in 2005

Table 5.2 Distribution of M&A Deals by the Calendar Year

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Number of M&A Deals

M&A Deal Value (USD Millions, Mean)

Acquirers’ Market Value of Equity (USD Millions, Mean)

91 121 130 107 106 186 182 201 206 207 256 265 279 302

16.029 24.816 16.667 14.358 24.167 39.294 74.170 63.501 59.228 38.528 42.014 82.109 87.536 141.893

551.356 652.867 782.404 348.468 684.367 618.245 1970.531 2377.238 1978.357 1687.248 1488.252 1569.883 1401.065 1302.272

Note: The sample consists of 2, 639 successfully completed mergers and acquisitions undertaken by Chinese firms between 2002 and 2015.

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Table 5.3 Summary Statistics Mean Dependent Variable MB Ratio Ownership Structure State Shares Institutional Shares Executive Shares Board Structure Independent Directors CEO/Chairman Duality Board Size Acquirers’ Characteristics Stock Price Run-Up Sales Growth Return on Assets Leverage Firm Size Geographical Focus Related Party Transactions Deal Characteristics Deal Value (USD Millions) Private Target All Cash All Stock Diversifying Acquisition Acquisition Experience Product Market Competition Competitive Industry Unique Industry Observations

Standard Minimum Deviation

Maximum

2.338

0.259

0.000

0.863

29.191 17.421 0.610

25.979 22.732 3.685

0.000 0.000 0.000

86.286 84.456 45.900

33.836 30.82 9.478

9.375 0.323 2.081

0.000 1.000 5.000

66.667 2.000 19.000

−24.956 26.434 5.265 0.309 1.335 0.735 0.605

95.011 48.809 6.086 0.196 7.208 0.442 0.489

−462.923 −79.225 −32.214 0.000 0.026 0.000 0.000

463.222 610.681 49.697 0.932 241.169 1.000 1.000

42.948 200.767 0.945 0.157 0.918 0.244 0.036 0.183 0.902 0.298 0.734 0.444

1.001 0.000 0.000 0.000 0.000 0.000

4, 801.538 1.000 1.000 1.000 1.000 1.000

0.000 0.000

1.000 1.000

0.322 0.264 2, 017

0.467 0.441 2, 017

2, 017

2, 017

Note: The sample consists of 2, 639 successfully completed mergers and acquisitions undertaken by Chinese firms between 2002 and 2015. The variable definitions are in Table 5.1.

reported by Liu and Sun (2005) and Chi et al. (2011), respectively. The reduction is largely ascribed to the share-split structure reform introduced in 2005. Despite the reduction, the ownership structure of Chinese firms has maintained the government’s power to control their operations. In respect of the board structure and composition, independent directors account for 33.84 percent of the board, which is in compliance with the CSRC’s requirement that independent directors should constitute at least one-third of a board. CEOs holding dual positions account for 30.82 percent of our sample. The total number of board directors is in a range of 5 to 19, with an average board size being 9.48.

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With regards to acquirers’ characteristics, RUNUP is -24.96 percent on average, which suggests that the market lacks confidence in acquiring firms in the period of leading up to the M&A announcement. The average sale growth is at 26.43% with a considerable variation among acquiring firms. Acquirers have an average return on assets of 5.27, with values falling between a minimum of -32.21 and a maximum of 49.70. On average, at a level of 0.14, leverage for our sample is lower than the values of 0.50 and 0.24 reported by Li, Feng & Cao (2011) and Pukthuanthong-Le and Visaltanachoti (2009), respectively. The size of firms varies considerably, as evidenced by the high standard deviation. Further, 73.50 percent of acquiring firms and target firms fall under the same local authority administration; and 60.50 percent of M&A deals are attributable to related party transactions between target firms and the acquiring firms who control them. With regards to deal-specific characteristics, the average value of transactions is US$42.95 million, with a high standard deviation, indicating that target firms vary considerably in size. Among the acquired firms, 94.50 percent of them are private firms, while 5.50 percent are public targets, which is consistent with prior evidence on China (Chi et al., 2011). The popularity of private targets may be because their lower capitalisation and relative weakness make them vulnerable to political bullying by state-controlled firms. Over 90 percent of M&A transactions are paid by cash; stock-financed M&A deals constitute 4.60% which implies that other payment methods account for 4.60 percent. This is consistent with previous studies in which Chi et al. (2011) record 87.00 percent cash transactions, and Tao and Fie (2010) record 80.00 percent cash transactions. Further, 90.20 percent of acquiring firms engage in diversification deals, suggesting a possibility that acquirers attempt to achieve risk diversion through engaging in M&A deals across different industries. In addition, 73.40 percent of acquiring firms have successfully completed more than one M&A deal during the sample period, suggesting that the acquirers in China are, in general, experienced. Concerning product market competition measures, 32.20 percent of acquiring firms operate the competitive industry category, and 26.40 percent of them operate in the unique industry category. These statistics indicate that more acquirers in competitive industries than in unique industries are actively engaged in M&A activities in China, which may account for managerial behaviour and their decision-making in M&As. Empirical Results and Discussions Table 5.4 presents the regression results derived from the relationship between the corporate governance mechanism and firm growth, controlling for acquirer characteristics, deal characteristics and product market competition measures. Model 1 focuses on the main variables, ownership and board structure variables. Model 2 introduces acquirers’ characteristics variables. Model 3 incorporates deal characteristics variables.

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Model 4 includes the product market competition variables. Model 5 incorporates a single dichotomous variable, the corporate governance index, into the estimation. The results demonstrate that ownership structure is a distinctive element in the generation of corporate growth. State shares record significant, negative coefficients across all five regression models. These results are significant as they are clear evidence indicating that state ownership hampers corporate growth of the resulting company. Managers in statecontrolled acquiring firms may engage in M&As to implement the government policy of maximising social welfare. Managers are encouraged to conform to state policy at the expense of economic success, as this confers considerable personal benefits. More significantly, executive ownership has a highly significant, positive impact on corporate growth. This shows that when the executives own shares, they have an incentive to make rational M&A decisions to enhance corporate growth. The finding lends support to the agency hypothesis that managerial ownership helps to align managers’ and shareholders’ interests (Jensen & Meckling, 1976). We, however, find little evidence that institutional ownership influences corporate growth, which runs counter to our hypothesis and the findings of Chi et al. (2011). Although it is commonly observed that institutional ownership favours value maximisation, in China it has much less influence upon firm growth. This suggests the possibility that the state which through its agencies, owns about one-third of all institutional shares, compromises the power of institutional investors (Liu et al., 2014 Liu, 2013). We find mixed evidence in relation to corporate governance measures. The positive relationship identified between the size of a board and corporate growth indicates that a large board, where members have diversified expertise and experience, can make a positive, collective contribution to M&A decisions. A smaller board can be easily dominated by a chairman or CEO, who can abuse their power to engage in activities that impair value. This is more likely to occur in Chinese corporate practice, where the right of control is typically concentrated in the hands of a few board members. However, there is little evidence that CEO/Chairman duality significantly affects corporate growth, though negatively signed. Conspicuously, directors’ independence has no impact upon corporate growth (p>0.05). This is clear evidence to suggest that including independent directors on corporate boards does not contribute towards value-creating M&A decisions. Given the insignificance of boards of directors in corporate growth, we consider next if, and how, an integrated corporate governance mechanism may influence firm growth, constructing a corporate governance index in line with DeFond et al. (2005). Our summary measure is constructed from an equally weighted aggregation of the six fundamental governance characteristics comprised of three ownership variables and three board of director variables, to characterise firms as having strong or weak corporate governance. The median value for the summed values

Deal Characteristics Deal Value Private Target All Cash All Stock Diversifying Acquisition Acquisition Experience

Acquirers’ Characteristics Stock Price Run-Up Sales Growth Return on Assets Leverage Firm Size Geographical Focus Related Party Transactions

Board Structure Independent Directors CEO/Chairman Duality Board Size Corporate Governance Index

Ownership Structure State Shares Institutional Shares Executive Shares

Model (2)

0.004 (0.035) 0.767 (0.586) 0.273** (0.103)

(0.016) (0.034) (0.005) (0.171) (0.233) (0.004) (0.062)

−0.003 (0.043) 0.595 (0.357) 0.268** (0.105)

−0.0004 0.047 0.019*** 0.365** 0.139 −0.008** −0.222***

Model (3)

0.114 1.284 −1.809** 1.299*** 0.018*** 0.010**

(0.146) (0.910) (0.095) (0.363) (0.005) (0.004)

(0.005) (0.091) (0.004) (0.342) (0.215) (0.004) (0.041)

−0.005 (0.032) 0.720 (0.535) 0.193** (0.083)

−0.007 0.016* 0.021*** 0.690** 0.159 −0.007* −0.155***

Model (4)

0.117 1.284 −1.734** 1.252*** 0.019*** 0.014**

−0.005* 0.014 0.023** 0.727* 0.186 −0.008** −0.136***

−0.006 0.631 0.192**

Model (5)

(0.138) (0.923) (0.874) (0.387) (0.006) (0.007)

(0.003) (0.013) (0.012) (0.373) (0.312) (0.003) (0.034)

(0.038) (0.553) (0.086)

Std. Error

0.211 1.284 −1.816** 1.306*** 0.021** 0.042**

−0.003 0.008 0.011*** 0.450** 0.095 −0.107** −0.175***

(0.136) (0.956) (0.092) (0.334) (0.007) (0.022)

(0.005) (0.009) (0.005) (0.226) (0.238) (0.053) (0.038)

0.685*** (0.183)

Std. Error Coeff.

−0.027** (0.011) 0.008 (0.028) 0.242*** (0.071)

Std. Error Coeff.

−0.024** (0.012) 0.007 (0.014) 0.248*** (0.057)

Std. Error Coeff.

−0.031** (0.013) 0.015 (0.016) 0.234*** (0.062)

Std. Error Coeff.

−0.026** (0.012) 0.014 (0.018) 0.231*** (0.041)

Coeff.

Model (1)

Table 5.4 Regression Results of Corporate Governance on Corporate Growth

0.026 2, 017

2, 017

0.061 2, 017

2.775* 2, 017

(0.166) 0.145 2, 017

−1.187* 2, 017

(0.518) 0.144 2, 017

1.286** −1.816** −0.992* 2, 017

(0.570) (0.913) (0.590) 0.140 2, 017

1.379** (0.599) −1.965** (0.852) 0.973* (0.574)

Notes: The sample consists of 2, 639 successfully completed mergers and acquisitions undertaken by Chinese firms between 2002 and 2015. The dependent variable is the market-book ratio, and the variable definitions are in Table 5.1. The figures in parentheses are standard errors adjusted for heteroscedasticity (White, 1980) and bidder clustering. *, ** and *** stand for statistical significance based on two-sided tests at the 10 percent, 5 percent or 1 percent level, respectively. We control for year and industry effects by employing year and industry dummy variables in the regressions. In the unreported results, some of the coefficients of year and industry dummies are significant.

R-squared No. of Observations

Product Market Competition Competitive Industry Unique Industry Constant −0.054** (0.026)

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is 4.10. Hence, acquiring firms with values of 4.10 and above are classified as having strong corporate governance, while those with values below 4.10 are classified as having weak corporate governance. The results show that 64.26 percent of sample firms have strong corporate governance while 35.74 percent have weak corporate governance. The regression results are presented in Model 5. It appears that a good, integrated corporate governance mechanism generates a significant, positive effect on the MB-ratio (β = 0.685, p < 0.05). This clearly demonstrates that an integral corporate governance mechanism plays an important role in aligning congruence of interests between management and shareholders when a company makes an M&A decision. Such an integrated mechanism can effectively reduce counter-productive agency problems by self-interested parties, enabling truly independent boards on which CEOs, chairmen, independent directors and other directors can fulfil their responsibilities and so enhance the value and sustainability of the combined companies. Concerning acquirers’ characteristics, return on assets has a significant, positive effect, indicating that the greater returns generated from corporate assets will facilitate corporate growth of combined companies. Leverage has a significant, positive impact, providing evidence supporting the agency hypothesis that debt aligns managerial interests with shareholders’ thus enhancing corporate growth. Further, M&A deals that involve acquirers and targets operating in the same administrative provinces has a negative effect, suggesting that geographically diversifying M&A deals helps to optimise resource reallocation, and at the same time reduce costs, which is in line with the operational synergy hypothesis. The positive effect may also be attributable to favourable support that the companies may possibly gain for cross-provincial M&A deals from central or local governments, as suggested by Chi et al. (2011). As expected, related party transactions between target firms and the acquiring firms that control them generate a highly significant and negative impact, providing clear evidence to support the argument that the transfer of assets or liabilities between them is perceived by investors to be a stratagem adopted by dominant shareholders for tunnelling resources and disenfranchising minority shareholders. Cheung et al. (2010) have provided evidence that supports the findings of our study. Other variables embodying acquirers’ characteristics, such as stock price run-up, sale growth and firm size, have no significant effect on corporate growth. With regards to deal characteristics, the two different methods of payment generate opposite effects on corporate growth. Deals paid for by stock have a positive effect, consistent with the findings of Faccio et al. (2006); whereas, deals paid for in cash have a negative effect. This suggests that the market does not perceive cash payments to be a means of investing idle cash holdings in a value-enhancing merger; rather, it is seen as management squandering money by investing in M&A projects that fail to maximise wealth. Further, there is consistent

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evidence that diversifying acquisitions generate positive effects, which suggests that the synergistic gains are realised through economies of scope and scale, greater market and pricing power, elimination of duplicates, and/or reduced agency costs as in Lins and Servaes (2002) or/and more efficient use of human capital as in Trautwein (1990). Further, the positive effect of repeat acquirers indicates that directors with prior acquisition experience help in making value-creating acquisitions. This lends support to the strategic momentum hypothesis that firms tend to follow established strategies that have worked successfully in the past (Pangarkar, 2000). All the other deal characteristics variables are statistically insignificant. Further, we look at how product market competition influences business growth of firms that are engaged in M&A activities. We introduce two proxies for product market competition: competitive industry and unique industry (See Table 5.1 for definitions), as in Masulis et al. (2007). The results show that competitive industry has a positive effect on the MB ratio, while unique industry has a negative effect. They indicate that acquiring firms in competitive product markets make better decisions, supporting the findings of Masulis et al. (2007); whereas, takeovers by acquirers operating in the unique industry category are suggestive of a lack of competition within that sector. Such managers may seek to increase monopoly power alone, enabling them to control prices in a particular market rather than making synergetic gains that impair firm value.

4. Conclusions and Policy Implications In this chapter, we have discussed the internal and external corporate governance mechanisms that China has developed over the past 30 years. Our investigation provides evidence to demonstrate how these systems influence value creation and business growth, emerging from the results of our empirical study into mergers and acquisitions undertaken by Chinese firms between 2002 and 2015. Our empirical investigation has incorporated a wide range of determining factors, representing corporate governance, acquirers’ characteristics, deal characteristics and product market competition, and provide significant insights into the problems and prospects of corporate governance in China today. Our analyses of these factors demonstrate that an integral system of corporate governance, which is respected by boards of directors and constrains and informs their decision-making, will exert a positive effect on corporate growth. However, when we consider the role of independent directors alone, we find that their independence has not exerted a significant influence on corporate growth. These findings are new evidence to support our argument that corporate value creation relies less upon the independence of directors than on an effective, fully integrated system of corporate governance. Indeed, we have observed that ‘board independence’ in China is not always what it seems. The perceived inefficiencies

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of state ownership that pursues social objectives is unlikely to be mitigated by boards whose members have no stake in the companies they run or a lack of independence to run them and, as we have found, merely nod through managerial decisions. This undoubtedly has a negative effect on corporate growth, which is a clear indication that the market associates state-dominated ownership with managerial inefficiencies. On the other hand, corporate executives with shareholdings in an acquiring firm have a positive influence on firm growth, suggesting an alignment of interests between agents and principals. Overall, our study highlights the need for the state to accelerate the reform of the ownership structure, and, in particular, to develop policies that encourage executive ownership, thus helping to align the interests of management and shareholders. Ultimately, it is imperative to install and maintain an effective corporate governance mechanism, in which board independence is real and not merely decorative, and whose decision-making is guided and constrained by the principles of corporate governance. We believe that our findings are practically relevant because they will direct the attention of managers, investors and the state towards those factors that best enhance corporate value and business growth. Such mature commercial awareness is particularly relevant now that China is faced with global financial instability and slowing growth in the aftermath of the financial crisis. We would argue that our work also has implications for public policy, which should concentrate on building sound internal corporate governance mechanisms and a strong, external regulatory environment. Our findings have implications for other emerging markets too, where weak corporate governance has had a negative effect on much needed inward investment. For example, Okpara and Wynn (2011) note that investment in Nigeria is constrained by weak corporate governance in respect of ‘protection of shareholders’ rights, lack of commitment of boards of directors, regulatory framework, enforcement and monitoring, ownership concentration, and transparency and disclosure.’ Khanna and Zyla (2010) also observe that improved governance systems in Indian companies increased their market valuations and that studies in Russia and Korea have established a causal relationship between the creation of governance mechanisms and firms’ improved performance and increased valuations. The evidence of our study, which consistently shows the importance of an effective corporate governance mechanism in enhancing corporate value and business growth, has shed light on how strong systems of internal corporate governance control, reinforced by external regulation, can work to limit the incentives of managers to engage in value-destroying acquisitions. A corporate governance structure that is strongly influenced by government carries the risk of constraining or of even undermining economic decisions taken for the benefit of commercial activity. Our results demonstrate that a limitation of government intervention can enhance the influence of corporate governance on corporate growth.

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However, this effect cannot be achieved without the presence of efficient and transparent legal and governance systems. The findings of this study further contribute towards an understanding of the importance of internal and external institutional governance creation, so as to enhance investment efficiency and long-term corporate growth. Our research on China is timely and practically relevant, given the current global economic situation, because our evidence will help to inform the state, managers and investors on how best to improve corporate governance mechanisms so that managers’ and shareholders’ interests are aligned. The evidence invites government and commerce to ponder the nature, function and independence of boards of directors, and how managers can be empowered to stimulate corporate growth. It is clear that emerging economies in particular will benefit from creating an environment that favours the development of internal systems of governance supported by external regulation. This will reduce the adverse effects of agency problems and tunnelling and facilitate investment efficiency and business growth as a whole. We should also ponder the significance of these issues for the global community. In the Western world, during the last two or three decades, society has slowly, but surely developed a global conscience. One force driving this movement has been a growing understanding of climate change and its consequences for future generations. First Europe, then the US, and latterly China have sought to limit the production of greenhouse gases, albeit with differing degrees of success. That apart, the growing willingness of nations to adopt policies increasingly benign to the world as a whole, even though detrimental to their individual economies in the short-term, represents, fundamentally, the acceptance that, to use a phrase beloved of David Cameron, ‘We are all in this together.’ Once we accept our responsibility to one another on a global scale, we must also accept the need to change systems of governance to the benefit of us all. The so-called ‘credit crunch, ’ that had its origin in the US, drove Europe and the rest of the world into a decade of austerity from which we are now only just beginning to emerge. This begs the question, why did not the systems of governance then in place detect and prevent the creation of the ‘junk bonds’ that undermined our wealth? Where were the ‘big four’— or is it the ‘big three,’ or maybe even the ‘big two’ audit firms now?—that ‘bestride the narrow [accounting] world like a colossus’? Why, if they are so powerful and efficient, did they not prevent yet another massive financial crisis? Had these giants of the accounting world forgotten the examples of Polly Peck and Enron, to list but two in a long gestation of disasters? Whatever the cause, this represents a chronic failure of governance in the western world and acts as a dire warning to future generations and ourselves that we teeter on the brink of financial Armageddon almost on a daily basis. Why?—because our systems of governance and control have failed us yet again and will continue to do so until they are perfected.

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Even in societies with long traditions of accounting probity, this objective is proving difficult enough to achieve. Imagine, therefore, how much more difficult it will be now that China, with its exponentially growing economy and fundamentally flawed systems of governance, increasingly moves centre stage? Will the next global financial disaster originate in Beijing? Is it possible even to foresee what form this might take? As for the possible trajectory of future research, our argument so far has led us to the conclusion that China’s systems of corporate governance are primitive and at an early stage of development. In the country’s pell-mell pursuit of economic strength, a sense of global social responsibility seems lacking. Similar comments might be applied to other emerging economies, which undoubtedly suffer from comparable deficiencies. Future research might therefore consider issues of social responsibility and ethical behaviour in takeovers; the levels of commitment to, and enforcement of, corporate governance; firm specific features, such as product quality, employee diversity and the quality of industrial relations and M&A related-issues, including the benefits of synergy and investor protection mechanisms. Our findings, and those of future research programmes, will have significant policy implications for the state, investors and a rising generation of business managers in the world’s emerging economies.

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Fan, J., Wong, T. J., & Zhang, T. (2007). Politically Connected CEOs Corporate Governance, and Post-IPO Performance of China’s Newly Partially Privatized Firms. Journal of Financial Economics, 84, 265–590. Firth, M. A., Rui, O. M., & Wu, W. (2011). Cooking the Books: Recipes and Costs of Falsified Financial Statements in China. Journal of Corporate Finance, 17(2), 371–390. Gaughan, P. A. (2010). Mergers, Acquisitions and Corporate Restructurings. Hoboken, NJ: John Wiley & Sons. Jensen, M. C., & Meckling, W. H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3, 305–360. Kakabadse, N. K., Yang, H., & Sanders, R. (2010). The Effectiveness of NonExecutive Directors in Chinese State-Owned Enterprises. Management Decision, 48, 1063–1079. Ke, B., Clive, S. L., & Xin, Q. (2015). The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits. The Accounting Review, 90(4), 1591–1619. Khanna, V., & Zyla, R. (2010). Corporate Governance Matters to Investors in Emerging Market Companies. International Finance Corporation, World Bank Group. Retrieved from https://www.ifc.org/wps/wcm/connect/dbfd8b004afe7d 69bcb6bdb94e6f4d75/IFC_EMI_Survey_web.pdf?MOD=AJPERES Khwaja, A., & Mian, A. (2005). Do Lenders Favour Politically Connected Firms? Rent Provision in an Emerging Financial Market. Quarterly Journal of Economics, 120, 1371–1411. La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate Ownership Around the World. The Journal of Finance, 54(2), 471–518. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (2000). Investor Protection and Corporate Governance. Journal of Financial Economics, 58, 3–27. Li, S., Feng, G., & Cao, G. (2011). Private Benefits of Managerial Control, Government Ownership, and Bidder Returns: Evidence from the Chinese StateControlled Listed Companies. Canadian Journal of Administrative Sciences. doi: 10.1002/cjas.222 Liang, N., & Useem, M. (2009). Corporate Governance in China. In Institute of Directors (Ed.), Handbook of International Corporate Governance (pp. 167–175). London: Institute of Directors, United Kingdom. Lin, C., Ma, Y., & Su, D. (2009). Corporate Governance and Firm Efficiency: Evidence from China’s Publicly Listed Firms. Managerial & Decision Economics, 30(3), 93–209. Lins, K. V., & Servaes, H. (2002). Is Corporate Diversification Beneficial in Emerging Markets? Financial Management, 31, 5–31. Liu, G. S., & Sun, P. (2005). The Class of Shareholdings and its Impacts on Corporate Performance: A Case of State Shareholding Composition in Chinese public Corporations. Corporate Governance: An International Review, 13, 46–59. Liu, J. (2009). Financial Factors and Company Investment Decisions in Transitional China. Managerial and Decisions Economics. 30(2), 91–108. Liu, J. (2013). Fixed Investment, Liquidity, and Access to Capital Markets: New Evidence. International Review of Financial Analysis. 29, 189–201. Liu, J. and Li. D. R. (2014). The Life Cycle of Initial Public Offering Companies in China. Journal of Applied Accounting Research. 15(3), 291–307.

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6

Board Effectiveness: Do Committees Really Matter? Evidence From Turkey Emek Toraman Çolgar

Introduction This chapter aims to explain the regulations in Turkish corporate law and capital markets law with respect to the board of directors and the committees established within the board and aims to answer the question whether or not these regulations serve as an efficient system. Unfortunately, as it is also the case in other emerging and developing markets, there are very few systemic studies in Turkey on corporate governance (Ararat and Yurtoğlu, 2006, p. 201). In order to determine whether or not the committees function efficiently, the provisions of the legislation currently in force will be addressed briefly. Subsequently, whether these regulations are sufficient to ensure efficient and productive functioning of the committees will be questioned and finally the effects of the current committees on firm value will be considered.

Legal Regulations The fundamental legislative resource of Turkish corporate law is the Turkish Commercial Code (TCC) No. 6102, which entered into force in 2012. The TCC does not restrict such principles as objective justice, accountability, transparency, responsibility and equal treatment—which are the pillars of the corporate governance philosophy—to the stock exchange companies, but it aims to ensure that these principles are adopted by all limited liability and joint stock companies (Tekinalp, 2008, pp. 635, 636). Capital Market Law dated 6 December 2012 and the communiqués issued by the Capital Markets Board (CMB), which has the authority to issue secondary legislation, apply to the publicly held companies. Such communiqués constitute the most important resources of capital markets law. The first regulation on corporate governance in Turkey was issued in 2003 based on the OECD’s Corporate Governance Principles (CMB, 2003, Preamble; Okutan Nilsson, 2007; Yenice and Dölen, 2013, p. 201). These principles, which were amended in 2005, 2011 and 2012, were subject to the principle of “comply or explain”.

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The Corporate Governance Communiqué, which is currently in effect, was issued on 3 January 2014 and all previous communiqués were repealed. With the communiqué of 2014, the “comply or explain” approach was partially abandoned, and thus, mandatory rules were adopted for such issues as independent and non-executive directors, board committees and related party transactions that must be submitted to shareholder vote etc. (Okutan Nilsson, 2017, p. 188).

Board of Directors in General The Turkish joint stock company has a one-tier board system. TCC adopts the principle of a professional board of directors. For that reason, the obligation for the board of directors’ members to be shareholders was removed, and it is allowed for the board to consist of a single person and that member may be either a real person or a legal entity. According to Art. 4.3.1. of the communiqué, the number of members of the board of directors shall not be less than five. As of February 2016, there are 3367 memberships of the board of directors in 513 BIST (Borsa İstanbul A.Ş. Equity Market) companies. It shows that the average number of the members of the board of directors is 6.5. Likewise, in order to ensure a further degree of professionalism in the board of directors, the TCC commission set a rule stating that at least half of the board members must have a higher education diploma. But upon objections, the said provision was removed just before the TCC entered into force. In addition, the TCC regulated for the first time the exclusive powers of the board of directors and, thereby, intended to prevent shareholders interfering with management (Tekinalp, 2008, p. 639). In a survey, 54 percent of companies stated that the standards set for board members are more comprehensive than the statutory standards (Türkiye Kurumsal Yönetim Haritası, 2005, p. 23). Anonim Ortaklıklarda Yönetim Organının Yapılanması ve İşlevleri (2007, p. 4) recommends regulation of the qualifications that should be met by the members of the board of directors in the articles of association for the elimination of arbitrary practices and the concretisation of qualifications. The board of directors convenes and adopts decisions whenever the necessity arises. There is no provision in the law as to the minimum number of meetings. In the author’s opinion, no need exists for such a provision. A study covering the BRICS countries and Turkey reveals that there is a negative relationship between the number of board meetings and company performance (Aras, 2015, p. 20). Listed companies must have a majority of non-executive directors and at least one third of all directors must be “independent”. The ratio of independent members is below NYSE and NASDAQ regulations, which stipulate that independent members to constitute the majority of the board of directors. Arguments have been advanced by different scholars that

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monitoring will increase as the number of independent members rise and that will result in a decrease of the exploitation of the minority shareholders’ interests by the majority (Aras, 2015, p. 11). Moreover, a study asserts that companies with a higher ratio of independent members create higher firm value. Claessens and Yurtoğlu (2013, pp. 22, 26) emphasised the importance of independent directors especially in emerging markets and developing countries, where there are not sufficient measures against self-dealing transactions. The shareholding structure in Turkey is mostly in the form of a closed family type that is controlled by one or several shareholders (Hacımahmutoğlu, 2001, p. 103; Ararat, Orbay and Yurtoğlu, 2010, p. 14; Okutan Nilsson, 2017, p. 183). This causes the board of directors to be exposed to the influence of majority shareholders. As a consequence of the concentrated family-type shareholding structure in Turkey, the oldest member of the family usually manages the company. This sometimes leads to a lack of professionalism and institutionalism (Okutan Nilsson, 2017, p. 186). The study by Orbay and Yurtoğlu revealed that the controlling shareholder structure has a negative effect on the company’s performance (Orbay and Yurtoğlu, 2006, p. 361). On the other hand, concentrated ownership is considered to be useful as it allows the monitoring of the board of directors and good governance can be attained even in family companies with the right strategies (Leyens, 2012, p. 190; Okutan Nilsson, 2017, p. 184). For instance, 77.54 percent of the capital of Vestel Elektronik A.Ş. is owned by Zorlu Holding, the management of which is controlled by the Zorlu family, and this company is at the top of Corporate Governance Index with a score of 94.86.

Board Committees in General The only committee explicitly regulated under the TCC is the committee for early detection of risks. This committee, which is envisaged for early detection of causes that threaten the company’s existence, development and continuation, as well as for applying the measures and solutions in order to eliminate such threats, is only mandatory to be established in listed companies. In other joint stock companies, if the auditor finds it necessary and informs the board of directors in writing, this committee should be established immediately. Beside the said committee, in accordance with TCC 366/2, it is possible for the board of directors to set up committees to monitor the progress of the businesses, to execute their decisions, or to conduct internal audits. Therefore, both listed and non-listed companies can establish board committees even though their articles of association do not have a relevant provision. According to Article 4.5.1. of the communiqué, it is the board of directors’ exclusive duty to form an “Audit Committee”, “Early Detection of

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Risk Committee”, “Corporate Governance Committee”, “Nomination Committee”, “Compensation Committee” in order to fulfil its duties and responsibilities in a reliable way. Unlike Swiss or German law, the general assembly cannot form these committees (see No 22 Swiss Best Practice, German Kodex 5.4.6.). Before the communiqué was adopted, it was only mandatory for listed companies to establish an audit committee. Apart from the audit committee, the “comply or explain” approach was applied. However, taking into account the market discipline in Turkish corporate governance, the efficiency of this approach in terms of compliance with the establishment of committees has been questioned by some scholars (Hacımahmutoğlu, 2007, p. 144). As a matter of fact, according to the survey results answered by 123 company officials representing a broad group of companies conducted between 2004 and 2005, the subcommittees of the board of directors are considered to be useful particularly in issues that require specialisation; but such committees are not common practice among companies. It is stated that 60 percent of the companies participating in the survey have an audit committee, 32 percent have a rewarding committee and 5 percent have an appointment committee (Türkiye Kurumsal Yönetim Haritası, 2005, pp. 4, 6, 19). On the other hand, although there was no obligation, large-scale closed companies also had committees. The results of a study conducted by Deloitte between August and November 2014 with 62 participating companies with 50 or more employees and over 10 million TRY annual turnover that were not listed on any stock exchange, revealed that 87 percent of the participant companies have a strategic planning committee, 81 percent have a risk management committee, 73 percent have an audit committee, 63 percent have a risk management or investments committee and 53 percent have an appointment and remuneration committee (Deloitte, 2017, p. 2). Formation of the Committees Formation of the board of directors and the committees in a right composition and their functioning, efficiency and working principles constitute important components of corporate governance. The communiqué contains detailed rules for the formation of committees. According to Art. 4.5.3. committees shall be composed of at least two members. In cases where there are two members, both of them shall be non-executive members of the board of directors; in cases where there are more than two members, the majority of them shall be comprised of non-executive members of the board of directors. The chairman of each committee shall be elected from among the independent members of the board of directors. Similar to NYSE all members of the audit committee shall be comprised

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of the independent members of the board of directors. Article 4.5.4. does not allow the chief executive officer/general manager to take part in the committees which ensures that the committees are able to perform their functions to monitor the board of directors. It is very important that the entire audit committee as well as the chairmen of other committees are composed of independent members since it is considered that the independent members who are free from shareholder influence make better monitors (Arıoğlu, 2015, p. 259). Moreover, as the committee members can be asked questions regarding the company’s financial statements and be informed regarding any potential legal problems, the independent board members will have the opportunity to access information that has not yet been shared with them (Klein and Coffee, 1996, pp. 130, 131, cited in Bohrer, 2005, p. 96). Therefore, the number of independent members is an assurance of corporate governance (Aras, 2015, p. 11). Article 4.5.3 regarding the formation of committees is mandatory, and the abandonment of the principle of “comply or explain” is positive. Because, in a survey among 257 companies establishing audit committees in 2008, only 33 (13 percent) of these companies elected the chairman of the committee from among the independent members (Baker Tilly Güreli, 2008). Another study revealed that the independent members elected were generally retired employees of the companies (Selekler-Goksen and Yıldırım Öktem, 2009, p. 199). Besides the employees of the company, it was determined that former politicians, bureaucrats and army members were appointed to the boards between 2006–2008. It has been observed that independent members in the boards formed in this way do not have a positive effect on the company’s performance (Ararat, Orbay and Yurtoğlu, 2010, p. 1). With the new rules, the committee members will no longer be “the retired persons who attend the meetings once a month” and who are ignorant of company affairs, thus, avoiding their incurring costs on the company without contributing thereto (Ararat and Yurtoğlu, 2012, p. 28). As of 2016, there are 2659 board members in 382 companies whose shares are traded on the stock exchange. The rate of independent board members is 26 percent for all BIST companies and 31 percent for companies whose shares are traded on the stock market. (BIST Yönetim Kurulları Araştırması, 2016). Unlike the repealed communiqué, pursuant to the current communiqué, shareholders or share classes with the privilege of nominating candidates for the board of directors under TCC 360 are allowed to use these privileges also for independent members. This is criticised in scholarly works. As it is mandatory for candidates of privileged shareholders to be elected by the general assembly, it has been claimed that small investors cannot prevent the election of the proposed independent member candidates, and thus, the independent membership institution cannot provide

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the expected benefits (Ararat and Yurtoğlu, 2012, p. 21). Another criticism is that such privilege reduces the value of the company. The study of 218 publicly listed companies in 2006 shows that stipulating the privilege for selection of the board of directors and the audit committee worsens companies’ investment performance and lowers their market valuation (Orbay and Yurtoğlu, 2006, p. 361). In the author’s view, the main issue would lie in the recognition of privilege in favour of the shareholders who are deprived of the voting power to take decisions alone, rather than the recognition of privilege in favour of the group with the majority that can take decisions in the general assembly. This is on the ground that thanks to the privilege granted to the said shareholders who would otherwise have to act with other shareholders and elect common candidates as independent members, they will be able to make this choice on their own. On the other hand, it has been stated that independence of a member elected by the majority in the general assembly may be questioned, and therefore, the recognition of privilege in favour of the minority in accordance with TCC 360 may be useful in achieving the result of an independent membership regime (Hacımahmutoğlu, 2007, p. 145). According to the communiqué, specialists who are not a member of the board of directors may become a member of the committees (TCC 366/2, Communiqué 4.5.3). However a member of the audit committee must be selected from among the board of the directors. The author believes that this regulation not allowing the experts other than the members of the board of directors to be in the audit committee, must be questioned given that although detailed independence criteria are regulated in the communiqué (Art 4.3.6), it would be appropriate to allow expert and independent third parties to be members of the audit committee, if needed. There is no regulation in the communiqué on the number of women and men. As of 2016, there are 428 female board members in 277 of the 513 companies that make up the entire BIST companies (BIST Yönetim Kurulları Araştırması, 2016). The communiqué has no general criterion for specialisation or training except for the audit committee. However, in order for the committees to work efficiently, the members must be professionals and those who are experts in accounting and finance should take part in the committee for early detection of risk in addition to the audit committee (Arıoğlu and Tuan, 2015, pp. 1, 2). Likewise, in order for the committees to work in an effective way, the working principles must be written (Art. 4.5.8.). Committees shall keep a record of all their work in writing. Committees shall submit the information on their work and the reports containing the meeting results to the board of directors. Although Art. 4.5.8. is not mandatory, many corporate companies stipulate in the working principles of the committees that the minutes of the meeting be submitted to the board of directors (See Koç Holding, Denetimden Sorumlu Komite

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Çalışma Esasları). This is useful so that the process preceding the decision taken in the committee can be examined (Anonim Ortaklıklarda Yönetim Organının Yapılanması ve İşlevleri, 2007, p. 6). Types of Committees Audit Committee The main functions of the audit committee are to supervise the corporation’s accounting system, public disclosure of financial information, independent auditing and the operation and efficiency of internal control and internal audit systems. According to the communiqué, the independent audit institution shall be determined by the audit committee and submitted for the approval of the board of directors. However, this provision cannot be applicable on the ground that Article 399 of TCC states that the independent auditor must be appointed by the general assembly, and Article 408 of TCC provides that this authority cannot be delegated to any other body or person. Therefore, in light of those provisions, the audit committee can only give recommendations to the general assembly with respect to the appointment. After the election, the work of the independent audit at all levels shall be conducted under the supervision of the audit committee. Another important responsibility of the audit committee is to designate the applicable method and criteria in regard to the review of complaints regarding the accounting and internal control system of the corporations and the independent audit. Therefore, the committee should evaluate whether the independent audit is actually independent. For instance, in case the independent audit no longer meets the independence criteria stated in Article 400 of TCC, the audit committee should inform the board of directors, so that the board can file a lawsuit to dismiss the independent auditor. However, according to Article 399 of TCC, this lawsuit must be filed within three weeks after the appointment is announced in the Trade Registry Gazette. The said provision is criticised because it is not always possible to file a lawsuit within three weeks, since the grounds for losing independence may arise later (Kendigelen, 2016, pp. 292, 293). Therefore, the said provision must be interpreted such that these three weeks would start following the instance that the independence criteria are no longer met. According to Art. 4.5.9., the audit committee shall convene at least four times a year, provided that it is once in three months. However, there is no sanction for members who do not attend the meeting up to a certain point (Compare German Kodex Art. 5.4.7). In a study conducted by Aras, it has been concluded that there was not a significant correlation between the frequency of the audit committee meetings and the financial structure of the company (Aras, 2015, p. 21).

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At least one of the members responsible for the audit shall have 5 years of experience in audit/accounting and finance (Art. 4.3.10). It would have been more efficient if a majority of the audit committee members were required to be financially literate as stated in the Swiss Best Practice No 23. It has been argued that the audit committee can be authorised regarding issues that are not listed in the communiqué, for instance regarding areas of liability in relation to environment and antitrust issues (Klein and Coffee, 1996, p. 152 cited in Bohrer, 2005, p. 97). Also in the author’s opinion, it should be possible to transfer non-exclusive powers of the board of directors, however such transfer would not remove the liability of the board (TCC 371/7). This being said, it is argued by scholars that the committee, whose powers have been extended, would not be able to undertake its duties in the best way, and therefore it will not be able to work efficiently (Böckli, 1996, p. 156). It is suggested that the audit committee would contribute to the value of the company, since it would prevent fraudulent actions (Arıoğlu and Tuan, 2015, p. 2). In contrast, according to a scholarly view, audit committees in Turkey are established just for appearances, and they are not fully functional. Despite the fact that information on the members of the committees formed within the structure of the board of directors and the meeting frequency of these committees should be published on the website of the company but given that this provision is not obligatory, many companies do not announce the names of their audit committee members (Ararat and Yurtoğlu, 2012, p. 28). Corporate Governance Committee The main function of the corporate governance committee is to assure that the company implements the corporate governance understanding and to ensure that unique mechanisms for such principles become effective. According to Art. 4.5.10., the corporate governance committee shall determine whether principles of corporate governance apply, or if not applied, state the grounds of why they do not; shall identify any presence of conflict of interest which arises due to non-compliance with these principles; shall give advice to the board of directors in order to enhance the implementation of corporate governance and supervise the work of the investor relations department. Before the enactment of the communiqué, and despite that the corporate governance committee was the second most established committee, certain studies indicate that corporate governance committees had been established in very few companies (Ararat and Yurtoğlu, 2012, p. 28). It has been stated in a study dated 2008 that among the companies traded at İMKB only 23 percent of the companies have established such committees (Baker Tilly Güreli, 2008). This rate had increased to 58 percent with a survey dated 2011 (Tahiroğlu Würsching, 2011, p. 39).

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Nomination Committee According to Art. 4.5.11., the nomination committee is in charge of establishing a transparent system on the nomination, evaluation and training of the candidates suitable for the positions of the board of directors and executives and to determine policies and strategies in this regard. Pursuant to Art. 4.3.7, the nomination committee shall evaluate the proposed candidacies for independent membership and report its evaluations for the approval of the board of directors. The board of directors shall compile a list of independent member candidates within the framework of this report of the nomination committee and send this list to the Capital Markets Board. In case the Capital Markets Board has an adverse opinion it shall notify the corporation. A person who has been subject to the adverse opinion of the Capital Markets Board cannot be submitted as an independent member candidate in the general assembly meeting. In the author’s opinion, such provision is theoretically problematic since it restricts the exclusive appointment powers of the general assembly regarding the board members. It has been a reasonable step to abandon the “comply or explain” principle in the establishment of the nomination committee. It has been stated that as a result of a survey dated 2011, only one-fifth of the companies had such committees. This has been interpreted as an indication that the managers do not tend to yield power to others (Murat Yalnızoğlu, member of Yıldız Holding Board of Directors, Tahiroğlu Würsching, 2011, p. 40). Committee of Early Detection of Risk The committee is responsible for early detection of risks that pose a threat to the existence, development and continuation of the corporation, taking the necessary measures with respect to detected risks and working on risk management. It is argued that early detection, management and reporting of risk would initiate an important transformation process for Turkish commercial life especially with regard to transparency and accountability principles (Saka and Kahraman, 2008, p. 2). Under the TCC, the committee of early detection of risk shall evaluate the risks in its reports to be submitted once in every two months. These risks can be general risks that can affect all joint stock companies or sectorial risks that only companies active in a certain sector come across. Remuneration Committee The main task of the remuneration committee is to determine the remuneration policy of top-level management. The remuneration committee is in charge of designations of principles, criteria and implementations to be used in the remuneration of

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the members of the board of directors and its executives. The committee has discretion to determine the remuneration policy. Therefore, the compensation system can contain fixed or variable components, since the amount that the other companies pay constitutes a benchmark, companies can consult experts to be aware of the market average. Finally, it should be underlined that since remuneration of the board members and determination of their financial rights are exclusive powers of the general assembly, the opinion of the committee is solely advisory. Ad Hoc Committees and Special Purpose Committees In addition to the above mentioned committees, board of directors may also constitute committees for special purposes (TCC Art. 374). In fact, a prudent board of directors (TCC Art. 369) is expected to establish an ad hoc committee if a decision requires expertise and detailed scrutiny. Otherwise it may be a matter of liability for acting contrary to the duty of care (Karpuzoğlu, 2010, p. 283). For example, in Borsa İstanbul A.Ş., in addition to mandatory committees, there is a disciplinary committee and a dispute committee while Koç Holding A.Ş. has an executive committee established to ensure effective coordination between the board of directors and the administrative structure.

Correlation Between Good Corporate Governance and Firm Value In scholarly works, good corporate governance is believed to reduce the cost of capital, increase the liquidity and funding facilities and make it easier to overcome a crisis (Claessens and Yurtoğlu, 2013, p. 13). It is argued that firms with good governance have lower investment risk and higher return rate and equity price (Li, Liu and Niu, 2007, p. 999). It is also argued that sustainable financial success is achieved and firm value is increased through the application of principles such as transparency and public disclosure (Büyükşalvarcı and Abdioğlu, 2012, pp. 21, 22). In addition, corporate governance reduces agency costs and protects the rights of minority shareholders, resulting in more dividend distribution, which contributes positively to firm value as minority shareholders invest in the company (Claessens and Yurtoğlu, 2013, p. 14). Country level studies suggest that good corporate governance has a significant impact on improving the prestige of the country and increasing foreign capital investments, as well as the competitiveness of the economy and capital markets and effective distribution of resources (Yenice and Dölen, 2013, p. 200; Büyükşalvarcı and Abdioğlu, 2012, p. 20; CMB, 2005, p. 2). Unfortunately, there are not many studies in Turkey investigating the effect of efficient functioning committees on corporate value. Nevertheless, there are further studies examining the relationship between

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good corporate governance and firm value. The said studies are summarised below. The relationship between corporate governance practices and efficiency of ten deposit banks traded on İMKB was examined between 2005 and 2015, and it was concluded that the free float rate and the number of independent board members have a negative and significant effect on the efficiency of banks. On the other hand, it was determined that there is a positive correlation between effectiveness and the variables of capital share of the largest shareholder and the size of the board of directors (Soba, Erem and Ceylan, 2016, pp. 306, 318). Between 2007 and 2011 Yenice and Dölen studied whether the corporate governance rating scores of the companies that are included in the Corporate Governance Index have an effect on the stock market value of the companies. For this purpose, stock exchange values were compared 30 days before and 30 days after the public disclosure of the rating scores, and the result was that the rating score had a significant effect on the stock market value (Yenice and Dölen, 2013, p. 199). Likewise, an event study by Sakarya concluded that there is a correlation between the announcement of the rating scores of the companies included in the corporate governance index and their stock yields (Sakarya, 2011). Gürbüz and Ergincan studied the compliance of the company’s articles of association with the criteria established by the CMB’s Corporate Governance Principles guidelines. It was concluded that companies that better implement corporate governance principles have higher stock market performances than companies that do not sufficiently implement these principles; that the companies implementing corporate governance principles at a higher level have higher return on equity; that the companies with high free float rates are implementing advanced corporate governance principles and that better managed companies give a sense of reliability to creditors, and thus, have more opportunities to benefit from external financing (Gürbüz and Ergincan, 2004). On the other hand, the study by Kılıç (2011, p. 52) shows that only 60 percent of the companies included in the Corporate Governance Index in Turkey provide a positive yield for their investors for the first few days, but such yield is not a significant amount except for two shares, and that the effects of being included in the Corporate Governance Index has declined significantly for these companies after a few days. Furthermore, the research conducted by Çarıkçı, Kalaycı, Gök argued that there is no relation between the performance of companies listed on the stock exchange and compliance with corporate governance principles (Çarıkçı, Kalaycı and Gök, 2009, p. 71). Similarly, the survey conducted by Koç, Yavuz and Yalın on companies operating in food and textile sectors revealed that the impact of corporate governance on company performance is 29 percent and 8 percent respectively (Koç, Yavuz and Yalın, 2004).

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Büyükşalvarcı and Abdioğlu investigated the impact of corporate governance practices on stock yields for the five-year periods before and after 2005 on 119 companies. Their research showed that corporate governance practices produced statistically significant differences on stock yields in the sectors of technology, wholesale and retail trade, hotels and restaurants and financial institutions, while there was no significant difference for the sectors of education, health, sports and other social services sector, electricity, gas and water sector, construction and public works, transportation, communication and storage (Büyükşalvarcı and Abdioğlu, 2012, p. 39).

Correlation Between Board Committees and Firm Value According to TCC, the board of directors is authorised to make decisions in all matters other than those left to the authority of the general assembly under the code and articles of association. However, due to the fact that these authorities are so broad and some issues in their field of duty require expertise, it is compulsory to seek assistance from experts and experienced persons and committees. In this context, the committees serve the specialisation function within the board (Karpuzoğlu, 2010, p. 282). The monitoring function of the board of directors is achieved through the board committees (Bohrer, 2005, p. 96; Hacımahmutoğlu, 2007, p.  144; Arıoğlu and Tuan, 2015, pp. 1, 11; Arıoğlu, 2015, p. 264). In addition, the committees play an important role in protecting the interests of minority shareholders, in identifying the risks that the company may face, and in taking the necessary precautions (Arıoğlu and Tuan, 2015, p. 1). In the absence of the committees, the board of directors has to carry out detailed studies and analysis on the issues related to the field of committees together with the strategic issues. Therefore, a significant portion of the time is spent on analytical work and the duration of work on strategic issues is reduced (Karpuzoğlu, 2010, p. 296). Kesner argues that the most important board resolutions are held at the committee level (Kesner, 1988, p. 67). For this reason, it can be asserted that efficiently working committees will lead to better management of the company. Indeed, there are many studies in scholarly works published outside of Turkey that argue that efficient working committees increase firm value (Bohrer, 2005, p. 99). Klein argues that accounting and finance committees have positive effects on a company’s performance (Klein, 1998, p. 279). Similarly, it is claimed that companies with audit committees give a sense of reliability to their investors and that reliability increases the firm value (Li, Liu and Niu, 2007, pp. 1005, 1006). The research conducted by Soba, Erem and Ceylan using the panel data regression method indicates that the number of committees has a

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positive and significant effect on the activity of ten deposit banks traded on İMKB (Soba, Erem and Ceylan, 2016, pp. 305, 306, 319). Ararat, Orbay and Yurtoglu argued that the performance of companies with functional audits and corporate governance committees was influenced positively in 2010, when only the audit committee was mandatory, but the establishment of a corporate governance committee was subject to the principle of “comply or explain”. In this study, the authors considered that companies that disclose the board members have functional committees (Ararat, Orbay and Yurtoğlu, 2010, p. 34). According to research conducted by Klein, there is no relationship between composition of a certain committee and share price of the company (Klein, 1998, pp. 286, 287). However, a negative relation between the independence of audit committees and abnormal accruals in performance was revealed by the same researcher in subsequent research (Klein, 2002, p. 390). On the other hand, the study by Arıoğlu and Tuan covering 111 risk committees, 43 governance committees and 16 audit committees by public companies quoted at BIST from January 1, 2012 to June 30, 2014 investigated the market reaction to formation of a committee, appointment of committee members and the expertise required for the committee members. Arıoğlu and Tuan suggest that, although a positive market reaction has been observed recently, investors in Turkish capital markets do not value committees of boards highly and committees do not create market reactions. The authors attribute these results to the fact that corporate governance is a relatively new concept in Turkish capital markets (Arıoğlu and Tuan, 2015, p. 12). Similarly, it was concluded that the expertise of the members selected to the committees does not necessarily lead to market reaction. However, it was found that the market is more responsive to the expertise of the audit committee members. The authors attributed this to the fact that the studies concentrate more on the audit committee (Arıoğlu, 2015, pp. 11, 12).

Conclusion The author is of the opinion that the regulations in Turkish corporate law and capital markets law with respect to the board of directors and the committees serve as an efficient system. In particular, the partial abandonment of the “comply or explain” principle and introduction of mandatory rules regarding the formation of the committees is an appropriate legal policy. However, despite the good law, corporate governance is a relatively new concept in Turkish capital markets, and as it is argued by different scholars that committees are established just for appearances and that they are not fully functional, and investors in Turkish capital markets do not value committees of boards highly, and committees do not create market reactions.

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References Anonim Ortaklıklarda Yönetim Organının Yapılanması ve İşlevleri (2007) Available at: www.tkyd.org/files/downloads/faaliyet_alanlari/yayinlarimiz/tkyd_yayinlari/ anonim_ortakliklarda_yonetim_organinin_yapilanmasi_ve_islevleri.pdf. Ararat, M., Orbay, H. and Yurtoğlu, B.B. (2010) The Effects of Board Independence in Controlled Firms: Evidence from Turkey. Available at: https://papers. ssrn.com/sol3/papers.cfm?abstract_id=1663403. Ararat, M. and Yurtoğlu, B.B. (2006) Corporate Governance in Turkey: An Introduction to the Special Issue, Corporate Governance: An International Review, 14 (4). Ararat, M. and Yurtoğlu, B.B. (2012) Sermaye Piyasası Kurulunun “Kurumsal Yönetim” Konulu Tebliğleri ile İlgili Genel Değerlendirme ve Yorum. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2040376. Aras, G. (2015) The Effect of Corporate Governance Practices on Financial Structure in Emerging Markets: Evidence from BRICK Countries and Lessons for Turkey, Emerging Markets Finance & Trade, 51. Arıoğlu, E. (2015) Market Reaction to Director Independence at Borsa Istanbul. Available at: www.sciencedirect.com. Arıoğlu, E. and Tuan, K. (2015) Committees of Boards: En Event Study on an Emerging Market. Electronic Copy available at: http://ssrn.com/abstract=2597607. Baker Tilly Güreli (2008) İMKB’de İşlem Gören Şirketler Kurumsal Yönetim Araştırması. [online] Available (in Turkish) at: www.vergikilavuzu.com/Assets/ Content/file/5_IMKB2.pdf. BIST Yönetim Kurulları Araştırması (2016) Available at www.tkyd.org/files/images/ content/faaliyet_alanlari/yayinlarimiz/tkyd_yayinlari/BYKA.pdf. Böckli, P. (1996) Corporate Governance: The “Cadbury Report” and the Swiss Board Concept of 1991, SZW/RSDA, 4. Bohrer, A. (2005) Corporate Governance and Capital Markets Transactions in Switzerland: The Mechanics of Mergers, Acquisitions, Buyouts, Private Equity Transactions and Corporations under Swiss Law, Schultess Juristische Medien. Büyükşalvarcı, A. and Abdioğlu, H. (2012) Kurumsal Yönetim Uygulamalarının Hisse Senedi Getirileri Üzerine Etkisi: İMKB Şirketleri Üzerine Ampirik Bir Uygulama. MÖDAV, 1. Capital Markets Board (2003) Corporate Governance Principles. [online] Available (in Turkish) at: www.ecgi.org/codes/documents/kyy_tr.pdf. Capital Markets Board (2005) Corporate Governance Principles. [online] Available at: www.cmb.gov.tr/regulations/files/corporate_governance.pdf. Claessens, S. and Yurtoğlu, B.B. (2013) Corporate Governance in Emerging Markets: A Survey. Emerging Markets Review, 15. Çarıkçı, İ.H., Kalaycı, Ş. and Gök, İ.Y. (2009) Kurumsal Yönetim-Şirket Performansı İlişkisi: İMKB Kurumsal Yönetim Endeksi Üzerine Ampirik Bir Çalışma, Alanya İşletme Fakültesi Dergisi, 1 (1). Deloitte.com.tr (2017) Kurumsal Yönetim Halka Açık Olmayan Şirketlerin de Gündeminde. Available at: www2.deloitte.com/tr/tr/pages/about-deloitte/articles/ kurumsal-yonetim-halka-acik-olmayan-sirketlerinde-gundeminde.html. Gürbüz, A.O. and Ergincan Y. (2004) Kurumsal Yönetim: Türkiye’deki Durumu ve Geliştirilmesine Yönelik Öneriler, Literatür Yayıncılık.

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Hacımahmutoğlu, S. (2001) AT Komisyonu’nun Ortaklığın Kontrolünü Ele Geçirme Aracı Olarak Pay Alım Önerisine İlişkin 13. Ortaklıklar Hukuku Yönerge Teklifi Üzerine Bir İnceleme, BATİDER, 21 (1). Hacımahmutoğlu, S. (2007) Problems of Minority Protection and Their Solutions, Journal of Banking Regulation, 8 (2). Karpuzoğlu, E. (2010) Kurumsal Yönetişimde Yönetim Kurulu, Hayat Yayınları. Kendigelen, A. (2016) Türk Ticaret Kanunu Degişiklikler, Yenilikler ve İlk Tespitler, 3rd ed. XII Levha Yayıncılık. Kesner, I.F. (1988) Directors’ Characteristics and Committee Membership: An Investigation of Type, Occupation, Tenure, and Gender, The Academy of Management Journal, 31. Kılıç, S. (2011) İMKB Kurumsal Yönetim Endeksine Dâhil Olan Şirketlerin Getiri Performanslarının Ölçülmesi, Finans Politik & Ekonomik Yorumlar, 48 (552). Klein, A. (1998) Firm Performance and Board Committee Structure, The Journal of Law and Economics, 41. Klein, A. (2002) Audit Committee, Board of Director Characteristics, and Earnings Management. Journal of Accounting and Economics, 33. Koç, İ. Ö., Yavuz, N. and Yalın, P. (2004) AB’ye Entegrasyon Sürecinde Kurumsal Yönetim ve Öncü İki Sektör Üzerine Uygulama, Geleneksel Finans Sempozyumu, Marmara Üniversitesi, Bankacılık ve Sigortacılık Enstitüsü & Bankacılık ve Sigortacılık Yüksekokulu, 27–28 Mayıs, İstanbul. Koç Holding (2017) Denetimden Sorumlu Komite Çalışma Esasları. Available at: www.koc.com.tr/tr-tr/yatirimci-iliskileri/kurumsal-kimlik-ve-yonetim/kurum sal-yonetim/Komiteler/Denetim%20Komitesi%20%C3%87al%C4%B1% C5%9Fma%20Esaslar%C4%B1.pdf. Leyens, P. (2012) Corporate Governance in Europe: Foundations, Developments and Perspectives. In: T. Eger and H. Schäfer, eds., Research Handbook on the Economics of European Union Law, Edward Elgar. Li, S., Liu, X. and Niu, J. (2007) The Effectiveness of Board Committees and Governance Premium. Available at: http://ieeexplore.ieee.org/abstract/document/ 4421976. Okutan Nilsson, G. (2007) Corporate Governance in Turkey, EBOR, 8. Okutan Nilsson, G. (2017) Turkey, Corporate Governance in Turkey. In: Ngwu, Osuji and Stephen, eds., Corporate Governance in Developing and Emerging Markets, Routledge. Orbay, H. and Yurtoğlu, B. B. (2006) The Impact of Corporate Governance Structures on the Corporate Investment Performance in Turkey. Available at: https:// papers.ssrn.com/sol3/papers.cfm?abstract_id=914242. Saka, T. and Kahraman, E. (2008) Türk Ticaret Kanunu Tasarısı ve Kurumsal Risk Yönetimi. Available at: www.kurumsalyonetimkutuphanesi.com/Articles/ Details/e1ada543-c5c8-4846-988f-19b5b24acbc7. Sakarya, Ş. (2011) İMKB Kurumsal Yönetim Endeksi Kapsamındaki Şirketlerin Kurumsal Yönetim Derecelendirme Notu ve Hisse Senedi Getirileri Arasındaki İlişkinin Olay Çalışması (Event Study) Yöntemi ile Analizi, ZKÜ Sosyal Bilimler Dergisi, 13. Selekler-Gökşen, N. and Yıldırım-Öktem, Ö. (2009) Countervailing Institutional Forces: Corporate Governance in Turkish Family Business Groups, Journal of Management & Governance, 13 (3).

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Soba, M., Erem, I. and Ceylan, F. (2016) The Impact of Corporate Governance Practices on Bank Efficiency: A Case of Turkey, Süleyman Demirel Üniversitesi Sosyal Bilimler Enstitüsü Dergisi, 3 (25). Tahiroğlu Würsching, F. (2011) Bağımsız Yönetim Kurulu Üyeliği Zamanı Geldi mi? Ne Söylüyor, Ne Düşünüyorlar?, Hayat Yayıncılık. Tekinalp, Ü. (2008) Türk Ticaret Kanunu Tasarısının Kurumsal Yönetim Felsefesine Yaklaşımı, In: Uğur Alacakaptan’a Armağan, İstanbul Bilgi Üniversitesi Yayınları. Türkiye Kurumsal Yönetim Haritası (2005). Available at: www.tkyd.org/files/ downloads/faaliyet_alanlari/yayinlarimiz/tkyd_yayinlari/bcgraporweb.pdf. Yenice, S. and Dölen, T. (2013) İMKB’de İşlem Gören Firmaların Kurumsal Yönetim İlkelerine Uyumunun Firma Değeri Üzerindeki Etkisi, Uluslararası Yönetim İktisat ve İşletme Dergisi, 9 (19).

References to Legislation CML (Capital Market Law) No. 6362 of 06.12.2012-OG 30.12.2012, 28513. Communiqué No. II-17.1-OG 03.01.2014, 28871. TCC (Turkish Commercial Code) No. 6102 of 13.1.2011, OG 14.02.2011, 27846.

7

Individualism in Boards or Directors Why Good Board Members Make Bad Decisions Chris van der Hoven and Kalu Ojah

Introduction One of the central tenets of this book is that companies play a key role and are a cornerstone element of economic and technological progress. If we accept this premise, then it follows that the boards of these companies have a key role to play, and by extension the same is true of the board members. However, persistent leadership failures are a warning that boards and board members do not always act in the best interests of the company and the shareholders. Also, the impact of these actions can extend to employees and beyond the boundaries of the firm to the community and society at large. It is common cause that if corporate boards are not adding value, then they are likely to be destroying it. Furthermore, there is no shortage of examples of value destroying decision-making. Enron (US), WorldCom (US), Equitable Life (UK), Bell Pottinger (UK), MTN (Nigeria) and Steinhoff International (South Africa) are specific examples of the outcome of value destroying behaviour. These examples share the fact that they represent failures of governance by owners or their agents on their boards. Collectively or individually, board members have miscalculated; delayed or left decisions unmade, and have made ethical misjudgements that have caused value destruction. At best they have been misinformed or uninformed, although in many cases seemingly blatant unethical decisions were made. Generally through corporate history, acquisitions have been an extreme form of value destruction. Sirower (1997) points out that more than 60 percent of acquisitions fail to deliver on the promise of the motivating business case. His research shows that despite these failures companies will spend up to three times as much on acquisitions than they do on R&D. Also, that the trend is towards more acquisitions and higher numbers that amount to trillions of US dollars annually. This is paradoxical given that fears of disruption have become more prevalent in recent times and one would therefore expect higher investment in R&D. Although the idea of disruption (Christensen and Raynor 2003) has been challenged periodically (Hopp et al., 2018), examples are

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top-of-mind for good reason. Kodak missed the digital camera, Motorola aimed too high with the Iridium phone, Barnes & Noble lost out to Amazon.com, and Encyclopaedia Britannica was displaced by Wikipedia. There are many examples of similar disruptions that are rooted in poor decision-making. For the purposes of this chapter, the nature of these examples is of interest. Decision-making around disruption is notoriously difficult and often directors would not even recognise the real dangers they face. Decision-making around acquisitions is more obviously risky, but is often driven by hubris and ego, so is more problematic. Finally, decisions that are self-serving and damaging to the company or society are clearly avoidable but directors choose to act despite the ethical shortcomings of their actions. The question we ask is pertinent to all of these decisions, but more so to unethical decision-making. That is, does a propensity towards individualism amplify compromised decision-making outcomes? Before elaborating, it may be helpful to set out the definitions of some key terms.

Definitions 1. Individualism: Describes a culture in which self-interest has primacy; 2. Collectivism: Describes a culture in which the group is given prominence; 3. Board meetings: The formal platform for tabling agenda items and making decisions is the board meeting. This is so because the formality is intended to ensure that the agenda is agreed, a quorum is present and that a record is kept in the form of minutes. It is important to recognise at the outset that not all boards comply with this approach. Broadly it is our contention that part of the reason for the persistent and increasing number of moral missteps in business is a noticeable shift from collectivism to individualism. To explore this, we have discussed culture and individualism, dominant logic, dynamic capabilities, ethics, biases and groupthink. In the end we endorse the work of Nonaka and Takeuchi (1995) who point out that knowledge does not always translate into wisdom. This means that having the data, being able to do the analysis, and finding a set of well-founded options does not mean that directors will make the “right” decision for a particular time and context. They contend that wise decisions are those that serve society. In our view this supports the need for a more collectivist mind-set in decision-making. Culture and Individualism Culture has been described in many ways and essentially boils down the shared, taken-for-granted assumptions about the way things are done by

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a community or collective. This could be very local as would be the case of a football team and their fans, or in a business sense at the level of a department in a firm, or more generally across a region or nation. Culture suggests shared values, beliefs, rituals, stories and symbols and imprints a paradigm on its adherents that creates a sense of belonging. Culture tends to steer the behaviour of individuals and groups so that behaviour is the visible manifestation of culture. Academics such as Hofstede (1983), Hofstede and Hofstede (2005) and others make a distinction of the influences within culture between individualism and collectivism; where individualism is characterised as a focus on self-interest and collectivism has to do with the interest of the group. There appears to be support for the suggestion that there is a trend towards greater individualism world-wide, even though collectivism is still firmly in place in many regional cultures (LeFebvre and Franke, 2013). Whether this is so or not, the unit of analysis for the purposes of understanding the outcomes of board room deliberations and dynamics remains the board member operating in a group setting. It is useful therefore to consider the board and the board member as two sides of the same coin. Additionally, one could argue that these elements—board and board member—are indivisible from their context and the tasks they undertake. It is for this reason that we unpack various ideas that we feel make a contribution to understanding this fascinating topic. These ideas include dominant logic, dynamic managerial capabilities, ethics, cognitive biases and groupthink. Strategists will recognise that while these concepts overlap into various academic fields, they are predominantly from the field of strategy with a strong psychology bias. This orientation may well have left our economics colleagues cold in days gone by, but the growing adherence to the wonderful field of behavioural economics would suggest that we may be moving in a similar direction. Dominant Logic, Diversification and Change Dominant logic is a term used by strategy scholars to describe a situation in which decision-making may be predictable because decision-makers think in the same or a similar way. In practice, this makes it difficult for managers to effect change. In their widely cited work, Bettis and Prahalad (1995) shared their view of dominant logic in the mid 1980s, and then updated their work roughly a decade later. Dominant logic is about a mind-set and patterns of thinking, and about mental models that get in the way of diversification and change. This is highlighted when industry structures and/or production technology shift and managers need to respond. They elaborate the concept to include strategic and cognitive variety, learning and unlearning, and response speed. Their ideas are framed as a managerial balancing factor to the prevailing economic orientation in strategic management scholarship.

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An important aspect of dominant logic is that managers deem certain data in the organisational intelligence gathering process to be relevant, and they select this data for use in strategy formation. By implication, they deliberately or subconsciously de-select certain other data. They therefore inevitably formulate strategies that sustain the historical trajectory and status quo of the firm. If we now insert the Kodak case of missing out on digital cameras, then it becomes clear why this behaviour happens so frequently and is so difficult to spot. The local optimisation of the financial position of Kodak is dominant in the minds of the board members, and this displaces the need to re-think the strategic position when there is in fact a potential industry shift in play—i.e. the shift from traditional film to digital. The solution for Bettis and Prahalad (1995: 10) is that organisational knowledge needs to be “unlearned” and that “[t]his need to unlearn may suggest why new competitors often displace incumbents in an industry when major structural change occurs.” Thinking of organisations as complex systems, in which multiple agents interact in multiple ways on a continuous basis, highlights a useful link between the individual decision maker and dominant logic. As an agent of change, the individual is subconsciously directed to a pattern of predictable outcomes and behaviours by heuristics that emerge from the dominant logic. This is useful for the most part because these heuristics simplify decision-making and help to speed up the decision-making process, which in turn allows the organisation to anticipate and change as the context changes. The unfortunate side-effect of these heuristics is that if there is a shift in the industry logic—for example away from a previous competitive and industry structure—then the adaptation may be inappropriate. The new dominant logic would require a different set of heuristics for decision-making and thus the need to unlearn what has gone before. An inability to unlearn a historical and current dominant logic is at the heart of many corporate failures. Dynamic Managerial Capabilities More recently strategy scholars have linked the workings of the executive team with the work on dominant logic through the concept of dynamic capabilities. For example, Kor and Mesko (2013: 233) who cite Helfat et al. (2007) in defining dynamic capabilities as, “the capacity of an organisation to purposefully extend, create, or modify its resource base, enabling the firm to achieve evolutionary fitness through adaptation to and/or shaping of the external environment.” Additionally, they draw a distinction between dynamic organisational capabilities and dynamic managerial capabilities. Here we focus on the latter which includes the capabilities to sense, seize and reconfigure the organisation to take advantage of new opportunities as the environment changes.

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In practice senior executives often bemoan the interference of board members in the day-to-day running of the business. This is why Drotter (2011) has found traction with numerous corporates around the world for the research that resulted in his ideas around the “performance pipeline.” In the pipeline Drotter (2011) suggests different levels of activity, each with a distinct emphasis where the CEO and directors are very specifically focused on the long-term and on the vision, mission and values. This sits well with the work on dynamic capabilities because senior managers may emphasise the profitability of chosen markets and segments, but the CEO and board need to focus on organisational renewal and relevance. They should not be deploying operational capabilities, but rather dynamic capabilities that help the organisation to shift as the industry logic changes and customer preferences adjust. Dominant logic and dynamic capabilities can be thought of as opposing forces in decision-making processes. The dominant logic anchors decisionmakers in legacy mind-sets and causes them to repeat myopic decisions that result in predicable outcomes. Dynamic capabilities of directors improve awareness of opportunities as they emerge through sensing. They further denote the ability to seize these opportunities and to transform the organisation to ensure it remains relevant to the markets it serves. Furthermore, culture and individualism are elements that shape the prevailing heuristics that underpin and reinforce a dominant logic toward a self-serving outcome. As stated above, a culture that reinforces could be useful to speed up decision-making and make these processes less stressful. The problem arises when directors have no ethical compass because they cannot see the bigger picture highlighted by the nature of their acts of individualism. Where a society is dominated by a “what’s-in-it-for-me” mind-set, ethics are a matter of personal choice and are more difficult to moderate. Ethical Considerations Jones and Liu (2015: 76) draw on the work of various scholars in their work and define ethics as, “involving the alignment of morals, what is good, bad, right, and wrong with desirable and appropriate societal expectations.” Furthermore, that “[b]usiness ethics are often governed by legal and stakeholder expectations. These stakeholders may hold differing ethical focuses which can create ethical dissonance for the business in terms of what is ethical and what is not.” They point out that individuals making decisions that they would consider ethical in their own community may find these decisions to be judged unethical in another community. This suggests that directors would either need to be part of the community that is relevant to the firm or have a high level of empathy and understanding of that community. In global businesses learning and experience in different cultures would increase awareness of the code of conduct in a particular region. In some instances, ethical codes are

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formal—such as organisational or professional codes of conduct—and in others, the organisation may simply appeal to common sense. However, even with the existence of policies and diligent auditing of compliance against these codes, they have not prevented failures from occurring. The conflicts that arise because of different interpretations, differing personal views and the lack of clarity about what is ethical for an organisation (i.e. ethical dissonance), is in fact not too surprising. Furthermore, as Jones and Liu (2015: 77) put it, “There are many other factors which can contribute to this difference in ethical perception of decisions such as self-interest, lack of clarity on the rationale for a decision, differing values, or simply a different point of view.” What makes these ideas pertinent to the discussion about the role of board directors, is that ethics clearly links individual action to broader societal preferences. It may be interesting to contemplate the nature of the link between an individual on a board of directors and the society within which the firm operates. For example, how does a value system imbedded in the culture of a society influence the behaviour of an individual on a board? Is there any causality and does it flow from the society to the individual or the other way around? The prevalence of “monopoly capital” across many markets seems to suggest that in many instances, the flow of influence is from corporations to society. The impact of business on governments through overt and covert lobbying, and the increases in the gaps between rich and poor globally would also seem to support this view. Jones and Liu (2015) extract 3 commonly used models of decisionmaking from the literature. All of these models—the Four Component Model, the Issue Contingent Model and the Person-Situation Interactionist Model—focus on ethical decision-making. However, they differ in that the Four Component Model highlights the role of the individual, the Issue Contingent Model focuses on the nature of the issue and the Person-Situation Interactionist Model combines the perspective of the individual’s development stage and the context of the decision. Additionally, the “Person-Situation Interactionist Model considers the individual’s cognition in ethical decision-making. This invokes an interesting prospect in the domain of psychology—that of cognitive bias—which is discussed next. Cognitive Biases One of the most influential theories in the field of cognition is attributed to George Kelly (1955). Kelly formulated what he called a “theory of personal constructs.” In essence, his theory was based on a central postulate that individuals continually check the sense they make of their context and deploy this in anticipating the future. He assumes that repeated themes within this world view form a construct system. Each individual has a limited (finite) set of constructs. These constructs each have

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confirming and disconfirming characteristics as if at opposite ends of a pole. The idea that individuals construct their perspective, and that the constructs each have a confirming and disconfirming extreme, are examples of two of a further eleven corollaries that Kelly identified. The first is called the construction corollary, and the second the dichotomy corollary. Of the remaining corollaries three are pertinent for their application in this chapter. These are the individuality corollary, the sociality corollary, and the commonality corollary. The individuality corollary suggests that individuals perceive their world view in unique ways. There is a link to the construction corollary in that each individual has a finite number of constructs in their construct system. Since these constructs differ between individuals, it follows that their view of a particular problem or choice would be unique. Then there is the sociality corollary. This suggests that an individual’s view of the world to some extent reflects their perception of the views of other individuals. This perception is mediated by social interaction with these individuals on an ongoing basis (hence the “sociality” corollary). This has implications for group interaction in a problem solving or negotiating situation, where success may hinge on the degree to which individuals are capable of empathising with each other. Finally, where individuals are in social settings, the commonality corollary may play out in the extent to which they can reach agreement about their view of the future. In their widely cited study, Bougon et al. (1977: 606) make links between the individual, the organisation and the environment. To do this they describe organisations as, “snapshots of ongoing processes selected and controlled by consciousness and attentiveness.” They then go on to suggest that individuals acquire information and construct their perspective of context through, “snapshots of ongoing cognitive processes.” These “snapshots” are modified and updated through an ongoing iterative process. Furthermore, they contend that the cognitive construction in the mind, and the context, are two sides of the same reality. In other words, an understanding of the cognitive processes would improve our understanding of both the individual and the context. A well-researched aspect of managerial cognition is the notion of cognitive bias. In this chapter so far, we have discussed dominant logic, dynamic managerial capabilities and the ethical side of decision-making. Schwenk (1988) further illuminates our understanding of the complexities of the task of decision-making pointing out a number of distorting biases that affect managers. These are set out in Table 7.1 below and then discussed. An example of the illusion of control bias is highlighted by Schwenk (1988) when he cites Langer (1983). He points out that the illusion of control bias may cause individuals to overestimate their skills or how these affect an outcome. This may occur because they seek evidence to

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Table 7.1 Selected Biases Bias

Effects

1 Availability 2 3 4 5 6 7 8 9 10

Judgements of probability of easily recalled events distorted Selective perception Expectations may bias observations of variables relevant to strategy Illusory correlation Encourages belief that unrelated variables are correlated Conservatism Failure sufficiently to revise forecasts based on new information Law of small numbers Overestimation of the degree to which small samples are representative of populations Regression bias Failure to allow for regression to the mean Wishful thinking Probability of desired outcomes judged to be inappropriately high Illusion of control Overestimation of personal control over a situation Logical reconstruction “Logical” reconstruction of events which cannot be accurately recalled Hindsight bias Overestimation of predictability based on past events

Source: Schwenk (1988: 44).

support their point of view while ignoring or playing down information that does not. Schwenk goes on to suggest that this bias reduces the perceived need to explore alternatives and may therefore overlook the correct or optimal approach. A variation on this bias occurs where a manager makes incorrect assumptions about the skills of another individual (i.e. a third party) who is central to the solution. He also says that there is evidence to support the idea that certain biases impact others. The example used is the availability bias—which suggests that managers may use a distorted probability in a decision situation because of the inability to invoke complete recall of related experience. The availability bias assumes that events that occur more frequently in the experience of the manager are more readily recalled. Schwenk points out that while this is so, managers are also likely to easily recall dramatic events. Nevertheless, the availability bias may contribute to the illusion of control bias and thus compound the erroneous perception that an executive can control some aspect of their environment. Schwenk (1988) notes that the effect of these various biases feed into the assumptions used by managers when faced with complex problems and choices. His point is that because these assumptions form the basis of their frames of reference, it is necessary to find ways to help surface biases and the related assumptions. One commonly used technique in selling ideas and decisions is the use of analogies. Analogies are similar situations possibly from perceived parallel settings such as a successful technology introduction or a particular prototypical organisation setting (e.g., R&D laboratory, battlefield,

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client meeting, ship, etc.). Analogies may unlock a solution, but they may also reinforce a cognitive bias or set of biases. Schwenk (1988) says that the novelty of a problem or choice will affect the approach used by a manager. Pre-existing mental models—he notes that analogies are predeveloped schema—are likely to be drawn into the current model where the problem or choice seems familiar to the manager. This is useful if the pre-existing perspective is sufficiently similar in terms of inputs and possible outcomes. The effect may be to speed up the resolution of a problem or the achievement of a choice for a course of action. However, if the similarities do not match, or if the situation is novel, the manager will need to formulate a new mental model. This is not only potentially more time consuming but is also more taxing because of the need to search for more information and to do more diagnosis. Schwenk (1988) also points out that although analogies can be used to help managers unlock aspects of an existing mental model and effectively move to a new one, the opposite result is also possible. A problem arises when managers do not carefully analyse the similarities and differences between the analogy selected and the problem at hand. In this circumstance, the analogy may only serve to reinforce a flawed view, particularly if the incorrect assumptions about the causes and outcomes of the analogous setting or problem are widely held, e.g., a number of managers working together. A common problem in group settings is that appropriate closure—getting to the best decision—and agreement, may be elusive. The notion of closure in these deliberations about decision-making has been a part of the debate around the groupthink phenomenon. Groupthink In seeking to get closure in a group setting, an approach that is too rigid (inflexible) may detract from the need for reanalysis. On the other hand, too little attention to closure may simply cause the process to deteriorate into “analysis paralysis.” With regard to “agreement,” the risk at one extreme is the phenomenon known as “groupthink” (Janis 1982). Groupthink has the disadvantage that a diversity of views is not incorporated into the solution or present in the agreement. This has the effect of making a solution suboptimal, and also—since by definition it ignores contrary evidence—may not have take-up outside of the decision group. Of course, the opposite extreme to groupthink is the inability to reach agreement, i.e. a state of fragmentation. The detrimental impact of either of these extremes should be self-evident. It would seem then that we could add the groupthink phenomena and the cognitive biases to problems caused by dominant logic and reinforced by culture. Even the moral rudder of ethics is problematic given that what is ethical is a matter of opinion and may be different depending on the social context. So, this poses a significant dilemma for leaders in

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organisations who are intent on “doing the right thing.” This leads us to an idea about a possible future for board leadership.

The Future for Board Leadership CEOs, boards and regulatory bodies have already focused their attention on structures and procedures for sound governance. They have governance protocols that are published and that have been carefully reviewed and refined. They have regimes that are embedded through professional accreditation of directors and compulsory compliance assessments intended to raise governance awareness and reinforce good practice. Some industries have reinforced the need to control operational risk in order to protect customers. Most companies are audited by external professional auditors. It is widely conceded by business that imposed—extrinsically motivated— compliance systems have not halted the steady stream of governance failures. Indeed, recent events involving the audit industry have found even the compliance watchdogs wanting. Auditing firms have succumbed to the pursuit of fees at the expense of ethics and continue to pay a heavy price in reputation terms. They have found willing collaborators in the regulatory space and government, and naturally in the firms they are tasked to audit. This trajectory might suggest the need for further oversight—a regulator to watch the regulator—which is patently going too far. We would therefore consider mechanisms that speak to the intrinsic motivation of businesses, their auditors and the regulatory bodies. Intrinsic motivation provides its own reward in the form of professional pride and possibly social harmony. To explore the future of board leadership we turn to Nonaka and Takeuchi (2011). In their reflections on knowledge and wisdom, Nonaka and Takeuchi (2011) mention the paralysis felt by CEOs in the face of certain challenges. They point out that, “It isn’t uncertainty alone that has paralyzed CEOs today” and that “[m]any find it difficult to reinvent their corporations rapidly enough to cope with new technologies, demographic shifts, and consumption trends.” They state that these CEOs have difficulty developing truly global businesses. Most importantly for our discussion in this chapter is that: leaders find it tough to ensure that their people adhere to values and ethics. It is telling that they summarise by saying that employees today will primarily focus on, “What’s in it for me?” rather than “What’s good, right, and just for everyone?” (Nonaka and Takeuchi 2011: 59). We feel that the concern about the focus of employees speaks directly to the notions of individualism and collectivism, despite the framing

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around knowledge and wisdom. We agree that having the knowledge does not necessarily translate into wisdom. So, we set out the approach of Nonaka and Takeuchi with the discussion in this chapter by reviewing their “six abilities of phronetic leaders.” Our intention is to provide support to directors by framing these as board level leadership norms. We submit that all of these elements form the backdrop to the decisionmaking landscape of the board. They assume that individual directors will be aligned by the letter of the doctrines imposed. That they will learn and comply with what they know about governance (their knowledge) in a way that reflects the best interests of the company and society. They assume that knowledge will translate into wisdom. Our view is that without an explicit steer, there will always be a risk that this translation is weak or does not happen. Hence there is the need to assimilate the six abilities. The six abilities are: 1. Judging goodness: Here leadership is looking for profit, but with a purpose that is noble and good. The contributors to being able to lead in this way are experience—particularly of failure—ethics, the pursuit of excellence and an understanding of philosophy, history, literature and the fine arts. In the board room this may suggest refined purpose (vision), mission and values and diversity of skills and perspectives around the table. 2. Grasping the essence: A clear vision of the possible outcome is critical to understanding the consequences of a decision. This requires an ability to seek out the underlying drivers of the problem. Also, there is benefit from paying close attention to detail and from being persistent. To grasp the essence, directors need to establish the basis of the challenge using three mind-stretching techniques. First by asking why over and over again to understand the basics and purpose. Then, being holistic while simultaneously attending to detail—being able to retain perspective on the big picture. Finally, retaining a view of what customers would want and concept testing or prototyping. Grasping the essence may require decisions to be made in phases. 3. Creating shared contexts: Seeking new meaning by inviting staff— senior and line staff—to share and explore ideas together. This also has the effect of enhancing networking and relationships across the business both vertically and horizontally. This suggests a degree of humility and openness about where ideas come from and how they are refined. 4. Communicating the essence: Directors need to be able to tell stories and use metaphors and analogies. This makes the difference between communications that are routine and those that feel special and are likely to stick because they capture the imagination. Nonaka and Takeuchi (2011: 65) state that “Rhetoric counts, because effective

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communicators touch people’s hearts and minds.” For our purposes, contemplating the telling of a story to staff or shareholders, or customers or suppliers or to the local community, should have a moderating effect on directors making decisions. 5. Political power: This is about getting people on board—aligned and engaged, and motivated to take action. There is a need for clarity around the direction and the target to be achieved. Here the authors introduce the notion of dialectical thinking—being able to simultaneously hold two opposing views to be correct or true. This is the ability to abstract ideas rather than only see a binary option. Being able to rise to an abstract level of thought requires imagination and vision. 6. Practical wisdom in others: The final element is the need to foster a distributed wisdom. In other words directors need to foster these “wisdoms” as broadly across the organisation as possible. This requires that leadership be more broadly held than just the board or the CEO and that they have a responsibility to ensure that this expectation is nurtured and understood. One highlighted route-to-market is for the board to “role-model” the approach. The point made so strongly in the “phronetic leader” approach is that CEOs need to be idealistic pragmatists. They cannot rely solely on data, analysis and deductive reasoning because the future cannot always be a logical extension of the past. When markets, customers and industries shift, the next steps for the company may have to be a leap-of-faith rather than a neat extrapolation of a trend. If this is the case, then idealism helps leaders to imagine new futures that have not been contemplated. Pragmatism helps them to choose a future and get it implemented. Central to these is the confidence that practical wisdom will steer the enterprise towards a future that is both profitable and prosocial.

Conclusion Why do individuals who espouse an alternative point of view get ignored or shouted down? Also, why do individuals avoid speaking out when they disagree? Any of these outcomes diminish the quality of the deliberations of a board. In the former scenario, it may be that the individual is wrong, is persistently negative, lacks the appropriate experience and judgement, is driving an inappropriate agenda, among other things. In the latter scenario—that of the individual who says nothing—there may be a fear factor related to gaining pariah status or a false sense of duty to a dominant voice because of prior patronage or future prospects. In a brief reference to the public policy implications of his research on acquisitions, Sirower says, “Although the academic debate over what motivates executives to make value-destroying acquisition decisions will

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continue, suffice it to say, from a policy perspective, that managers make these decisions because they can” (Sirower 1997: 141). Our view is that this is too simplistic. The debate has progressed in practice and in academia. One such academic debate helpfully connects managers to culture and context in a way that better explains their decision-making behaviours. Minichilli et al. (2012: 194) cite DiMaggio and Powell (1983) and Scott (2001) and point out that “[a]ccording to the institutional perspective, human and social behaviours are driven by the influence of countrylevel institutions, such as norms, routines and historical patterns, which determine isomorphism among individuals and organizations.” In other words, even individualistic behaviour cannot escape the moderation of culture. Of course, where individualism does manage to override the collective preference this suggests wilful intent, naivety or ignorance. These behaviours may then be explained by ethical misjudgements or cognitive biases. Where collectivism fails to provide an optimal or correct outcome this may be explained by dominant logic or groupthink. We have also established that being right or wrong is not clear cut. A point of view may be held to be true by one individual and simultaneously untrue by another. This happens despite apparently having grounded this view in identical data. Neither individual is wrong. This is because the contrasting “realities” of the individuals and their subjective interpretations flow from these realities. They genuinely believe their points of view to be correct. This suggests the need for an approach that externalises the competing realties of the individuals involved. While this may not solve the differences, it would make them easier to fathom and potentially provide grounds for compromise. We recognise that a board of directors may in fact be representative of multiple cultures—as is often the case in multi-national businesses—and could therefore simultaneously demonstrate traits of both individualism and collectivism. In these situations, the active development of leadership with a high level of awareness and skill in deploying dynamic capabilities would seem to be essential. That is, with the caveat that technical skill in arenas of dynamic capabilities are complemented by the practical wisdom of “phronetic leadership.” Penultimately, there are many very skilled directors and many very effective boards going about their daily business and delivering excellent results. Their firms operate ethically, are relevant in the markets that they serve and are socially responsible. Despite focusing on the hurdles and imperfections around boards and decision-making it would be wrong to collude with the populist view that corporate behaviour is perpetually compromised. Companies remain the building blocks of economic, technological and (increasingly) social progress. Finally, we sense that the future holds a major adjustment for the paradigm of business as political systems and social systems become more transparent and communities increasingly take control of their own destiny.

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References Bettis, R., & Prahalad, C. (1995). The dominant logic: Retrospective and extension. Strategic Management Journal, 16: 5–14. Bougon, M., Weick, K., & Binkhorst, D. (1977). Cognition in organizations: An analysis of the Utrecht Jazz Orchestra. Administrative Science Quarterly, 22(4): 606–639. Christensen, C. M., & Raynor, M. E. (2003). The innovator’s solution: Creating and sustaining successful growth. Boston, MA: Harvard Business School Press. DiMaggio, P. J., & Powell, W. W. (1983). The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Sociological Review, 48(2): 147–160. Drotter, S. (2011). The performance pipeline: Getting the right performance at every level of leadership. San Francisco: Jossey-Bass, Wiley. Helfat, E., Finkelstein, S., Mitchell, W., Peteraf, M., Singh, H., Teece, D., & Winter, S. (2007). Dynamic capabilities: Understanding strategic change in organizations. New York: Wiley-Blackwell. Hofstede, G. (1983). The cultural relativity of organizational practices and theories. Journal of International Business Studies, 14: 75–89. Hofstede, G., & Hofstede, G. J. (2005). Cultures and organizations: Software of the mind. New York: McGraw-Hill. Hopp, C., Antons, D., Kaminski, J., & Salge, T. O. (2018). The topic landscape of disruption research: A call for consolidation, reconciliation, and generalization. Journal of Product Innovation Management, 35: 458–487. Janis, I. L. (1982). Groupthink: Psychological studies of policy decisions and fiascos. Boston: Houghton Mifflin. Jones, K. J, & Liu, A. C. (2015). Ethical decision-making: A model demonstrating collectivism and individualism decision influences. Academy of Research Journal, 3: 74–82. Kelly, G. A. (1955). The psychology of personal constructs: Volume 1: A theory of personality. New York: W. W. Norton and Company. Kor, Y., & Mesko, A. (2013). Dynamic managerial capabilities: Configuration and orchestration of top executives’ capabilities and the firm’s dominant logic. Strategic Management Journal, 34: 233–244. Langer, E. (1983). The psychology of control. Beverly Hills: Sage Publications. LeFebvre, R., & Franke, V. (2013). Culture matters: Individualism vs. collectivism in conflict decision-making. Societies, 3(1): 128–146. Minichilli, A., Zattoni, A., Nielsen, S., & Huse, M. (2012). Board task performance: An exploration of micro- and macro-level determinants of board effectiveness. Journal of Organizational Behaviour, 33: 193–215. Nonaka, I., & Takeuchi, H. (1995). The knowledge-creating company: How Japanese companies create the dynamics of innovation. New York: Oxford University Press. Nonaka, I., & Takeuchi, H. (2011). The wise leader. Harvard Business Review, 89: 5. Schwenk, C. R. (1988). The cognitive perspective on strategic decision making. Journal of Management Studies, 25(1): 41–55. Scott, W. R. (2001). Institutions and organizations, (2nd ed). California: Sage, Thousand Oaks. Sirower, M. L. (1997). The synergy trap: How companies lose the acquisition game. New York: The Free Press.

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Tone at the Top, Organizational Culture and Board Effectiveness Surendra Arjoon

Introduction—The Tone at the Top Many researchers have defined ‘tone at the top’ in a number of different ways. Amernic et al. (2010) documented a number of these definitions. To begin, Cunningham (2005, p. 6) defined it as “the shared set of values that an organisation has emanating from the most senior executives.” It is something that reflects the actions of the executives and can be strengthened with the use of written codes and other policies. Additionally, Sheeder (2005, p. 35) defined it as “the company’s ‘integrity DNA’—the foundation of all that it does [where] ‘integrity’ generally means the possession and consistent adherence to high moral principles or professional standards that one refuses to change.” Furthermore, the IFAC’s Transnational Auditors Committee (2007) stated that it is “the standard set by the organization’s leadership whereby performance is measured; the culture within which the members of the organization operate; the tone set by senior management; irrespective of management’s documented strategy and policies, it is the force that drives individual professionals; the ‘unseen hand’ that directs activities regardless of management’s proximity to the action; and a commitment to the quality of care clients receive” (IFAC, 2007, p. 8). Amernic et al. (2010) articulated that the tone at the top is considered a (positive and negative) network of cues which governs work ethics, management pressure, and control. Positive cues include: implementing a zero-tolerance attitude for fraud, strictly adhering to ethical values such as honesty, loyalty, responsibility, and fairness, and ensuring that there is openness in financial reports. Negative cues include: harvesting a corporate culture that is solely based on arrogance, combativeness, and intractability; forcing clients to hamper with and impede the activities of regulators so as to make sure that the interests of the organization are upheld; partaking in incorrect and false accounting practices, for example, income smoothing and failure to establish internal control systems; having an attitude that is mainly built upon passivity and complacency; endorsing a culture filled with deception and

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misrepresentation; and engaging in behaviours that are intimidating of and bullying to other employees. Mahadeo (2006, p. 1) enunciated that the tone at the top is “the ethical (or unethical) atmosphere that is created in the workplace by an organisation’s leadership.” More so Hunton et al. (2011) added that this atmosphere is formed by the leadership of the board of directors (BODs) and chief executive officers (CEOs). The BODs utilize policies and committees to preserve the integrity and ethical standards within organizations (Merchant and Rockness, 1994; Lamberton et al. 2005). Adding to this is Burke and Bristor (2016, p. 4) who articulated that the concept refers to the ethical environment created by senior management regarding the expected standards of conduct and importance of internal control. The benefits of a strong ethical Tone at the Top includes attracting: (1) more investors and stakeholders because the stable ethical environment creates and builds reassurance, confidence, and trust, (2) attract the best employees with strong ethical integrity as they will seek working environments that adheres to solid values and strong ethical standards, and (3) more consumers who tend to have a preference to purchase from entities that hold robust and strong histories of constancy to sustaining high ethical standards and publicly sensitive behaviour. The Tone at the Top can therefore be defined as an ethical atmosphere that exists within a work environment which is created by top leadership of that organization. It creates a trickledown effect within organizations so that whatever tone is set by the BODs and top management, it is passed down to all employees. The BODs and senior managers play a fundamental role in setting the tone at the top for first class ethics and compliance programs. This stems from their high degree of responsibilities to protect the reputations of shareholders and the organizations financial assets. For example, if BODs and top managers maintain a high degree of ethics and integrity, employees are more likely to adopt, adhere to, and behave in a similar manner. Such organization will less likely experience any risk violations or corruption issues. Evidently, the Tone at the Top must be right for all organizations since it creates a contagion effect throughout the entire organization. An organization’s regulatory values, together with its ethical environment, helps to determine the right Tone at the Top. Once these values are developed and supported, they form the basis on which its organizational culture is built. The key individuals responsible for setting the right Tone at the Top are the Chief Executive Officer (CEO), the BODs, and the Chief Compliance Officer (CCO). The CEO is the face that represents the organization and to whom the employees look up for supervision, management, control, and direction. The action of the CEO determines what matters, and who are compensated and disciplined. As such, Graham et al. (2017) found that more than half of executives feel that Tone at the Top is primarily set by the CEO.

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The BODs are primarily responsible for setting the Tone at the Top by executing their main responsibilities which entails: recruiting the CEO, authorizing strategies, observing, and overseeing the executions of plans, setting risk appetite and overseeing ways to combat risks, and maintaining and protecting the value of shareholders. Finch (2000) posited that the main responsibility of the BODs is to protect the interest of the organization’s shareholders by observing and monitoring the decisions pronounced by senior managers. Fama and Jensen (1983) added that the most important aspect of an organizations monitoring mechanism is the BODs because they hold power and authority to hire, fire, and reward top level managers’ decision-making, and approve and monitor priority. Graham et al. (2017) found that the BODs in fact do not directly develop the Tone at the Top; instead they influence it by choice of the CEO. The CCO adds to Tone at the Top both directly and indirectly. The CCO uses platforms to help support and strengthen organizational values. They are the ones to whom employees turn in instances of ethical dilemmas. This in itself creates a ‘speak up’ culture for employees and is a fundamental component for the Tone at the Top. Furthermore, the CCO is responsible for searching for new diagnoses on key ethical and compliance dilemmas that occur both internally and externally. More so, the CCO plays an important role in directly supporting and giving a helping hand to the BODs when it comes to understanding and performing their role in setting the Tone at the Top (Deloitte, 2014; NAVEX Global, 2015). In his review of best practices, Biegelman (2008) reports a number of measures that CEOs should consider to set the requisite tone at the top: keep a copy of the code on their desk, giving their CCOs real authority and have them report directly to the BODs, hold the CCOs them accountable by have them report on what they have done to further the compliance function in their business unit at Senior Executive meetings, have both sanctions for violation of company compliance policies and incentives for doing business in a compliant manner, walk the talk (for instance, turn down expensive dinners or trips offered by a vendor, pass on gifts, or turn down a transaction based upon ethical considerations), be seen at intra-company compliance training, recognize outstanding compliance efforts with companywide announcements and awards, recruit a nationally known compliance expert to sit on the company’s BOD and chair the Compliance Committee, obtain an independent review of the company’s compliance program and report the results to the Board’s Compliance Committee, mandate that all vendors in the Supply Chain embrace compliance and ethics as a business model, and talk to other CEOs and senior executives in their industry on how to improve your company’s compliance efforts. The Tone at the Top is an effective tool in preventing risk associated with any organizations. According to the Forensic Services Fraud,

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Corruption, and Business Ethics, a survey conducted by PricewaterhouseCoopers LLP (PWC, 2010) indicated that a total of ninety percent (90%) of survey respondents articulated that the way to mitigate any form of corruption, fraud, and ethical behaviours is by means of an effective and efficient organizational Tone at the Top. It is a fundamental tool for developing and preserving ethical integrity and compliance within organizations. As such, a lack of a robust Tone at the Top creates room for risks and events of things going wrong within an organization. Furthermore, the survey revealed that approximately forty-three percent (43%) of respondents indicated that not very often do leaders portray the settings for the right Tone at the Top. It is crucial and integral for senior managers and leaders to perform effectively and efficiently as role models by ensuring that their behaviours, actions, and words are in accordance to the organizations ethical and corporate culture. Amernic and Craig (2010) examined how the ‘language’ portrayed and set out by corporate leaders play an incremental role for shaping the corporate culture within an organization. They purported that: (1) the discourse of the CEO should be monitored so as to ensure that the Tone at the Top is more functional and ethical, (2) closer inspection and examination of leaders are needed by all stakeholders, and (3) it is necessary to examine and observe the top leadership of any organizations so as to identify signs of ‘perverse leadership behaviour’ in addition to distressing language signs. Patelli and Pedrini (2015) investigated the relationship among the Tone at the Top, financial reporting practices by the BODs, and elements of corporate governance. They found that those leadership characteristics which shape the Tone at the Top are directly related to unethical accounting practices. A review of the literature shows that the main components that relate to the Tone at the Top are Board Effectiveness and Organizational Culture. The foregoing discussions, based on the literature, propose a conceptual framework that posits a hypothesized relationship among these three (3) components (Figure 8.1). In short, the Tone at the Top defines the Organizational Culture, while elements of the Tone at the Top and Board Effectiveness interact with each other. However, further empirical work would be necessary to validate this hypothesized relationship. Board Effectiveness and Organizational Culture are discussed in the next two sections respectively. The chapter concludes with some strategies and recommendations for improving the Tone at the Top.

Board Effectiveness Dutra (2012) observes that the definition of ‘board effectiveness’ has shifted dramatically over the last decade and that BODs now confront not only complex oversight accountability, but also personal risk and

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ORGANIZATIONAL CULTURE (Governance, Risk Culture)

TONE AT THE TOP (Board Culture)

BOARD EFFECTIVENESS (Structure, Experience, Independence)

Figure 8.1 Conceptual Framework

liability. Nicholson and Kiel (2004) define board effectiveness as “being concerned with ‘task’ outcomes and occurs by fulfilling a role set.” It is the role of the BODs which is the most fundamental element to providing an effective board. The role of the BODs entails control, service, and strategy (Zahra and Pearce, 1989; Maassen, 1999). According to Hung (1998) and Maassen (1999), the BODs are regarded as an independent body that adds to moulding the tactical course of an organization, and guiding the role of management into accomplishing the missions and objectives of the organization. Finch (2000) further added that board ineffectiveness is more likely to happen when there is a dominant CEO. Felton and Watson (2002) explained that maintaining a balance between the board and management is essential to achieve a sense of balance, independence, and transparent leadership. They further added that, board effectiveness also comprises identifying business risks, guaranteeing that performance of the organizations are aligned to the expectations of the shareholders, rearranging management compensation, and transferring the mandatory information to the shareholders in an effective and efficient manner. The Financial Reporting Council (2011) defines an effective board as one that “develops and promotes its collective vision of the company’s purpose, its culture, its values and the behaviours it wishes to promote in conducting its business.” The key functions of an effective board are to: provide direction for management, demonstrate ethical leadership through promoting defined culture and values, create a performance culture that drives value creation without excessive risk, make well-informed and high-quality

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decisions, create the framework for helping directors meet their duties, be accountable, and think carefully about its governance arrangements and evaluate their effectiveness. Board effectiveness encompasses multiple factors including the chairman’s leadership, board composition, the quality of information provided to the BODs, the CEO’s attitude and receptiveness (Spencer Stuart, 2017). For instance, Thomas et al. (2007) suggested means by which organizations can seek to improve board effectiveness by: choosing the right directors, appointing the right chairman, making succession planning the first priority, focusing on a few key agenda items and reviewing the board’s collective and individual contributions. Coulson-Thomas (1994) added that it is the competency of directors and their level of commitment to that organization which contribute to board effectiveness. Van den Berghe and Baelden (2005) however believed that it is independence that contributes to board effectiveness. On the other hand, Alkhafaji (1990) stated that using committees (for instance, audit, and nominating committees) will help in enhancing board effectiveness. Furthermore, Levrau and Van den Berghe (2007) believed that it is the behavioural and attitudinal measures (such as cohesiveness, debate, and conflict norm) that determine board effectiveness. Mazars LLP (2017) identifies six (6) characteristics of an effective board: (1) works as a team led by the chairman, (2) has a chairman who demonstrates responsibility for corporate governance, (3) develops and clearly articulates the strategy of the organization, (4) evaluates its performance and acts on the conclusions, (5) regularly informs and engages with shareholders, and (6) has a balance of skills, experience, and independence. Thomas et al. (2007) examined the reasons why organizations failed to obtain value from their BODs and found five (5) primary problems related to: inadequate competencies, lack of diversity, underutilization of skills, dereliction of duties, and poor selection and assessment processes. Dutra (2012) found five elements or ‘disrupters’ that tend to hinder the progression of boards toward self-actualization and high performance: lack of clarity on the roles of individual directors and the board as a whole (for instance, role ambiguity slows decision-making and causes unnecessary director conflicts); poor process management hinders effective board preparation, meeting management, and communications all of which result in indecisiveness and a lack of urgency on critical challenges facing the organization; lack of alignment and agreement on company strategy causes disinterest among board members, who then simply default to tackling regulatory and compliance issues (for instance, poor strategic alignment hampers a board’s ability to prioritize issues and set their near-term agendas which causes board disruption and sends damaging signals to financial markets); poor team dynamics fracture boards and lead to power struggles (for instance, a board should comprised professional peers who respect and work well with each other); and board

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composition is a serious impediment (for instance, boards often lack the ability to objectively evaluate their makeup to determine if they have the right people and skills at the table).

Organizational Culture According to Anderson et al. (2015), culture is the result of the shared values, beliefs, and assumptions that shape the behaviour of the organization. These unwritten rules direct all decisions employees make throughout the organization on a day to day basis. Kreps (1990, p. 5) defined corporate culture as “an intangible asset designed to meet unforeseen contingencies as they arise.” Schein (1990) articulated that such asset comprises of shared assumptions, values, and beliefs that help employees understand which behaviours are and are not appropriate within an organization. In addition, according to Graham et al. (2016), corporate culture is regarded as more intangible and comprises of cultural values which employees are expected to fulfil, and social norms which comprise of the day-to-day activities that meet these values. Fletcher and Jones (1992, p. 30) stated that organizational culture “refers to the overall ethos of an organisation; those characteristics, including both psychological and structural elements, which affect the perceptions and behaviours of employees.” Ashforth et al. (2008, p. 673) defined organizational culture as: Organizational cultures evolve norms that guide employee practice. If those norms and practices operate mainly to serve the competitive interests of a company in an unbridled drive for profits at any cost, they run the risk of shouldering aside other norms that might serve the interests of other stakeholders, including those of the larger society. When that occurs, an organizational culture can appropriately be labelled corrupt, as can the organization itself. A strong organizational culture is the key element of a robust risk management program, especially for organizations that are likely to face threats. Organizations that lack proper ethics and compliance cultures have a greater chance of always being prone to scandals and risks. In a novel survey and interview-based analysis of one thousand, three hundred and forty-eight (1, 348) North American firms, executives characterise culture as a beliefs system, a coordination mechanism, an invisible hand, or how employee interact with one another. In addition, over half of senior executives believe that corporate culture is a top-three driver of firm value. Ninety-two percent (92%) believe that improving their culture would increase their firm’s value, while, surprisingly, only sixteen percent (16%) believe their culture is where it should be (Graham et al., 2017). Organizational culture has one of the most influential impacts on the performance and conduct of employees since it helps motivate ‘value

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change’ within the organization. It involves the organization and synchronization of mutual, assumptions, values, and beliefs, that help to bring about the manner in which employees behave within an organization. While the organizational culture differs in every organization, it is culture that plays a fundamental role in influencing and impacting on the conduct and behaviours of employees. Organizational culture should therefore be regarded as a board’s priority since it infiltrates and impacts on each aspect of all organizations. According to the Audit Committee Leadership Summit (July 12, 2015), corporate culture is seen as evolving as an imperative and significant concern for boards and audit working groups. However, the supervision, control, and management of corporate culture are presented with difficulty especially for non-executive directors and middle managers because they have restricted disclosure to much of the company’s strategies which limit practices for influencing corporate culture. In addition, directors who are not part of the day-to-day activities of the organizations but are still responsible for overlooking the culture of that organization, will experience much difficulty in influencing corporate culture. However, this difficulty can be resolved by making culture a top priority of the agenda for the board and audit committee, and by ensuring top managers have direct communication with employees. Wilkins (1983, p. 26) postulated that culture has a “powerful and sometimes overwhelming impact on the organisation’s decision making and performance.” Ashforth et al. (2008) stated that it is not the formal ethics which deems that an organization is corruption free, but it is the culture embedded within the organization which maintains ethical conduct throughout both the formal and informal systems. In addition, Ashkanasy and Jackson (2001) added that culture can exist in the form of unspoken values and attitudes that are held by people within organizations. When boards develop and expand their understandings of corporate culture and align it with the ethical and business standards of the entity including corporate strategies, it helps to create long-term shareholder value. Therefore, a high-performing organization that holds robust alliance and associations between their corporate culture and business strategy benefits from an increase in financial growth through bridging the formal ethics with embedded culture. Contrary, an organization that is not aligned with its corporate culture, ethical, and compliance standards are more likely to underperform, and result in lower customer satisfaction, internal clashes, and insufficient employee engagement. In order to better understand these dimensions of organizational culture, Martin and Frost (1996) put forward four (4) collective conceptualization: (1) integrationist which focuses on the commonalities and likeness within organizations, (2) differentiation which examines the differences that exists among organizations, (3) fragmentation which is grounded on the assumption that organizations are different and disordered, and

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(4) post-modern which explains that the study of organizational sensemaking is mediated through power relationships defined in the culture. Grant Thornton (2015) is of the view that organizational culture is the cornerstone of good governance. Pahuja and Bhatia (2012) articulated that once a board is effective, it aids in good corporate governance which helps maintain the competitive advantage that is fundamental to both economic, and social progress. Adding to this, Ogbalu (2007) who stated that when organizations are able to maintain good corporate governance, they are able to attract long-term foreign capital and investment that are essential for their development. Mazars LLP (2017) advises that organizations should focus on the following twelve (12)  principles of corporate governance The first six (6) deals with delivering growth in long-term shareholder value, and the latter six (6) addresses maintaining a flexible, efficient, and effective management framework within an entrepreneurial environment: (1) setting out the vision and strategy, (2) managing and communicating risk and implementing internal control, (3) articulating strategy through corporate communications and investor relations, (4) meeting the needs and objectives of shareholders, (5) meeting stakeholder and social responsibilities, (6) using cost effective and value added arrangements, (7) developing structures and processes, (8) being responsible and accountable, (9) having a balance board, (10)  having appropriate skills and capabilities on the board, (11) evaluating board performance and development, and (12) providing information and support.

Strategies and Recommendations for Improving the Tone at the Top There are some measures which companies can employ to maintain strong ethical integrity within an organization. Below are some strategies and recommendations for improving the Tone at the Top which incorporates organizational culture and board effectiveness. Setting the tone of the top is done by the leaders of the organization when they exhibit the importance of integrity and ethical values through their leadership, conduct, and behaviour, in order to achieve an effective system of internal governance. The following are some strategies and recommendations for improving the Tone at the Top, Building Organizational Culture, and Board Effectiveness: •

Standards of conduct define what is expected of employees and senior managers through procedures and practices which are used to assess the achievement, conduct, and efficiency of employees and teams. Any breach and aberration should be diagnosed and resolved in the most time efficient and reliable manner.

120 •

•

•

•

•

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Surendra Arjoon In order for ethical code of conduct and integrity within an organisation to remain robust, the BODs and senior management need to also invest in middle managers who are part of the day to day activities to help alleviate any potential risk. This in the short and long-run helps to build and improve organizational trust. Risk assessments play a fundamental role in creating strong ethics and compliance programs because they provide a profound view on any potential risks that an organization is likely to face. Risk assessment narrows the BODs and senior management concentrations on risks that can significantly affect the organisations. In addition, it also builds the foundation for defining the techniques to help avoid, mitigate, and resolve any potential risks that organisations are likely to encounter. Reward for principled performance entails formatting performance goals to incorporate both ethical and compliance practices for C-Suite executives and linking these goals directly to compensation. Organisations should point out and stand guard against other companies with respect to known incidents of misconducts since it is a reflection that such organization acts in accordance to its Tone at the Top principles. However, if the organisation pays no attention to issues and categorizes them as unimportant, this only reflects how the organisation does not conform to a culture which increases the amount of risks and further violations. Organisations should always safeguard against whistle-blowers and provide employees with a high degree of privacy especially when they want to report wrong-doings that can help protect the organization’s ethical integrity. Deloitte (2013) further identified ten (10) factors to evaluate and measure the effectiveness of the Tone at the Top: the extent and nature of wrongdoing, use of anonymity in incident reporting, social media reputation assessment, employee surveys, tone of management communications, group discussions, facility visits, exit interviews, interviews and focus groups, and customer complaints. BODs need to spend time on and evaluate the following questions: Whose responsibility is culture? How can boards foster a culture of good governance? What does ‘diversity’ really mean and how can it be encouraged? What skills do boards need now and in the future? Is there a conflict of interest between short-term profits and long-term growth? (Grant Thornton, 2015). Board effectiveness can be addressed across the following seven (7) themes: the role of the chairman, the role of the independent directors, progress on diversity, board succession and the work of the sub-committees, the purpose and impact of board evaluations, information flows to the board, and the role of investors (EY LLP, 2015). Boards should examine the following questions: (1) Have we

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clearly set the company’s purpose, strategy and values, identified the significant risks and provided enough direction for management? (2)  How do we obtain assurance that management is identifying and addressing future challenges and opportunities, for example as a result of technological change or changing stakeholder expectations? (3) How do we ensure that the board makes well-informed and high-quality decisions based on a clear line of sight into the business? (4) Have we considered its implementation, feasibility and impact on stakeholders as well as its impact on financial performance? (5) What percentage of board time is spent on financial and behavioural performance management and is the balance right? (6) How do we make sure the voice of the workforce, customers and wider stakeholders is heard at board-level and what impact has this had on our decisions? (7) How do we obtain assurance that the culture we are leading is open, accountable and aligned to purpose, strategy and values? (Financial Reporting Council, 2017). Move toward an engaged board in which: (1) board members are wholeheartedly united behind a common purpose and shared values, (2) recognition that setting the right Tone at the Top starts in the boardroom, (3) formal structures and processes facilitate effective boardroom dialogue, (4) a strong emphasis is placed on the value of informal connections outside of board meetings, and (5) a focus on having a balanced board with high quality recruitment and succession planning (Mazars LLP, 2017). An effective risk management system will (1) adequately identify the material risks that the company faces in a timely manner; (2) implement appropriate risk management strategies that are responsive to the company’s risk profile, business strategies, specific material risk exposures and risk tolerance thresholds; (3) integrate consideration of risk and risk management into strategy development and business decisionmaking throughout the company; and (4) adequately transmit necessary information with respect to material risks to senior executives and, as appropriate, to the board or relevant committees (Lipton, 2015).

References Alkhafaji, A. (1990). “Effective boards of directors: An overview.” Industrial Management & Data Systems 90, no. 4: 18–26. Amernic, J., and R. Craig. (2010). “Accounting as a facilitator of extreme narcissism.” Journal of Business Ethics 96, no. 1: 79–93. Amernic, J., R. Craig, and D. Tourish. (2010). Measuring and assessing tone at the top using annual report CEO letters. The Institute of Chartered Accountants of Scotland, Edinburgh. Anderson, G. M., M. J. Anderson, and J. B. Lee. (2015, February). “What do boards need to know about corporate culture?” Retrieved February 12, 2017 from

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www.spencerstuart.com/research-and-insight/what-do-boards-need-to-knowabout-corporate-culture Ashforth, B. E., D. A. Gioia, S. L. Robinson, and L. K. Trevino. (2008). “Re-viewing organizational corruption.” Academy of Management Review 33: 670–784. Ashkanasy, N., and C. Jackson (2001). “Organizational culture and climate.” In N. Anderson, D. Ones, H. Singangil and C. Viswesvaran (Eds.), Handbook of work and organizational psychology (pp. 398–415). London: Sage. Biegelman, M. (2008). Building a world-class compliance program: Best practices and strategies for success. Chichester: John Wiley and Sons Ltd Publication. Burke, M. M., and J. Bristor. (2016). “Academic integrity policies: Has your institution implemented an effective policy?” The Accounting Educators’ Journal 26. Coulson-Thomas, C. (1994). “Developing directors: Building an effective boardroom team.” Journal of European Industrial Training 18, no. 6: 29–52. Cunningham, C. (2005). “Section 404 compliance and ‘tone at the top’.” Financial Executive 21, no. 5: 6–7. Deloitte Editor. (2013). 10 Ways to Measure the Tone at the Top. Retrieved from http://deloitte.wsj.com/riskandcompliance/2013/04/11/10-ways-to-measurethe-tone-at-the-top/ Deloitte Editor. (2014). Building Tone at the Top: The Role of the CEO, Board and COO. Retrieved from http://deloitte.wsj.com/riskandcompliance/2014/12/15/ building-tone-at-the-top-the-role-of-the-ceo-board-and-coo/ Deloitte Editor. Building World-Class Ethics and Compliance Programs: Making a Good Program Great Five Ingredients for Your Program. Retrieved February 12, 2017 from www2.deloitte.com/content/dam/Deloitte/us/Documents/ risk/us-aers-g2g-compendium.pdf Dutra, A. (2012). “A more effective board of directors.” Harvard Business Review, November. EY LLP. (2015). Board Effectiveness: Continuing the Journey. Retrieved from ey.com/uk Fama, E. F., and M. C. Jensen. (1983). “Separation of ownership and control.” The Journal of Law and Economics 26, no. 2: 301–325. Felton, R. F., and Watson, M. (2002). “Change across the board.” The McKinsey Quarterly, no. 4. Financial Reporting Council. (2011). Guidance on Board Effectiveness. https:// frc.org.uk/getattachment/11f9659a-686e-48f0-bd83-36adab5fe930/Guidanceon-board-effectiveness-2011.pdf. Financial Reporting Council. (2017). Revised Guidance on Board Effectiveness. www.frc.org.uk/getattachment/fe7a3cc7-e076-4ee4-ad1e-5f6aa91b2159/ Proposed-Revisions-to-the-UK-Corporate-Governance-Code-Appendix-BDec-2017.pdf. Finch, E. M. (2000). Board effectiveness, and corporate governance. UMI Dissertation Services. Fletcher, B., and F. Jones. (1992). “Measuring organizational culture: The cultural audit.” Managerial Auditing Journal 7, no. 6: 30–36. Graham, J. R., C. R. Harvey, J. A. Popadak, and S. Rajgopal. (2016). “Corporate culture: Evidence from the field (No. w23255).” National Bureau of Economic Research. Graham, J. R., C. R. Harvey, J. A. Popadak, and S. Rajgopal. (2017). “Corporate culture: Evidence from the field.” National Bureau of Economic Research Working Paper 23255. Retrieved from www.nber.org/papers/w23255

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GrantThornton. (2015). “Corporate governance: The tone at the top.” Grant Thornton Global Governance Report. Retrieved from www.grantthornton.global Hung, H. (1998). “A typology of the theories of the roles of governing boards.” Corporate Governance 6, no. 2: 101–111. Hunton, J. E., R. Hoitash, and J. C. Thibodeau. (2011). “Retracted: The relationship between perceived tone at the top and earnings quality.” Contemporary Accounting Research 28, no. 4: 1190–1224. IFAC. (2007). Tone at the top and audit quality. New York: International Federation of Accountants. Kreps, D. (1990). “Corporate culture and economic theory.” In J. Alt and K. Shepsle (Eds.), Perspectives on positive political economy. Cambridge: Cambridge University Press. Lamberton, B., P. H. Mihalek, and C. S. Smith. (2005). “The tone at the top and ethical conduct connection.” Strategic Finance 86, no. 9: 36. Levrau, A., & Van den Berghe, L. A. (2007). Corporate governance and board effectiveness: Beyond formalism. ICFAI Journal of Corporate Governance 6, no. 4: 58–85. Lipton, M. (2015). “Risk management and the board of directors.” Harvard Law School Forum on Corporate Governance and Financial Reform. Retrieved from https://corpgov.law.harvard.edu/2015/07/28/risk-managementand-the-board-of-directors-3/ Maassen, G. F. (1999). An international comparison of corporate governance models: A study on the formal independence and convergence of one-tier and two-tier corporate boards of directors in the United States of America, the United Kingdom and the Netherlands. Vol. 31. Gregory Maassen, Amsterdam, The Netherlands. Mahadeo, S. (2006). “How management can prevent fraud by example.” Fraud, Nov/Dec. Retrieved April 12: 2007. Martin, J., and P. J. Frost. (1996). “The organizational culture war games: A struggle for intellectual dominance.” In S. Clegg, C. Hardy and W. Nord (Eds.), Handbook of organization studies (pp. 599–621). London: Sage. Mazars LLP. (2017). Focusing on Tone at the Top. Retrieved from www.mazars. co.uk/Home/Your-needs/Listed-and-large-corporate/Tone-at-the-top-Boardeffectiveness-questionaire Merchant, K. A., & Rockness, J. (1994). The ethics of managing earnings: An empirical investigation. Journal of Accounting and Public Policy 13 no. 1, 79–94. NAVEX Global. (2005). Ethics & Compliance Training Benchmark Report. www. navexglobal.com/en-us/benchmarking-reports/2015-ethics-compliance-trainingbenchmark-report?RcAssetNumber=318 Nicholson, G. J., and G. C. Kiel. (2004). “A framework for diagnosing board effectiveness.” Corporate Governance: An International Review 12, no. 4: 442–460. Ogbalu, C. (2007). “The role of effective board in corporate performance.” Punjab Journal of Business Studies 3, no. 1: 1–3. Pahuja, A., and B. S. Bhatia. (2012). “Linkage between board effectiveness and quality of corporate governance: Indian evidence.” Patelli, L., and M. Pedrini. (2015). “Is tone at the top associated with financial reporting aggressiveness?” Journal of Business Ethics 126, no. 1: 3–19. PWC. (2010). Tone from the Top: Transforming Words into Action. Retrieved from www.pwc.co.uk/fraud-academy/insights/tone-from-the-top-july-10.html

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Schein, E. H. (1990). “Organizational culture.” American Psychological Association 45, no. 2. Sheeder, F. (2005). “What exactly is ‘tone at the top, ’ and is it really that big of a deal.” Journal of Health Care Compliance 7, no. 3: 35–38. Spencer Stuart. (2017). Boardroom Best Practice: Lessons Learned from Board Assessments across Europe. www.spencerstuart.com. Thomas, C., D. Kidd, and C. Fernández-Aráoz. (2007). “Are you underutilizing your board?” MIT Sloan Management Review 48, no. 2: 71. Van den Berghe, L. A. A., and T. Baelden. (2005). “The complex relation between director independence and board effectiveness.” Corporate Governance: The International Journal of Business in Society 5, no. 5: 58–83. Wilkins, A. L. (1983). “The culture audit: A tool for understanding organizations.” Organizational Dynamics 12, no. 2: 24–38. Zahra, S. A., and J. A. Pearce. (1989). “Boards of directors and corporate financial performance: A review and integrative model.” Journal of Management 15, no. 2: 291–334.

Part II

Institutions, Regulations, and Corporate Governance

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Institutions and Board Effectiveness: Any Link? The United Kingdom, United States and Nigeria in Perspective Francis A. Okanigbuan, Jr.

Background and Introduction The role of the board of directors of public companies and large private entities in enhancing the economic values of corporate entities has been the subject of much debate within the corporate law, corporate governance, economics, finance as well as accounting and management literature for several decades. This cross-disciplinary attention demonstrates the strategic position that company boards occupy in the governance and direction of corporate entities. Although, profit warnings and investors and stakeholders’ expectations of enhanced economic values of corporate entities, provide reasons for regular attention to the role of the board, corporate failures and scandals are becoming the dominant reasons for putting the effectiveness of corporate boards on the spotlight in different jurisdictions.1 The criteria for an effective board has been suggested to include; recognising the distinction between the supervisory role of boards and managerial role of managements; effective support mechanism to support the board, e.g. board committees; effective statutory and regulatory provisions and codes of best practice; effective regulators.2 An effective board ensures that the value-creation objective of the entity is achieved within the scope of corporate regulation.3 Lack of effective leadership4 has led to corporate scandals and failures globally.5 These scandals have influenced the review of institutional frameworks for corporate regulation. The historical development of corporate governance regulation in the United Kingdom indicates that financial reporting and corporate accountability scandals–especially the BCCI and Maxwell Corporation scandals–prompted the inauguration of the Committee on the Financial Aspects of Corporate Governance6 by the Financial Reporting Council.7 Further to this, corporate governance institutional framework has been developed with considerable focus on the effectiveness of the role of boards of directors.8 In the United States, statutory rules that challenge the role of company boards towards greater accountability have been established to promote board effectiveness as a response to corporate scandals including the

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Enron Corporation scandal.9 The collapse of HIH Insurance Company was caused by mismanagement on a high scale, which was unchecked by effective supervision by the board.10 This prompted the Australian government to inquire into the circumstances that led to the demise of the company; the terms of reference of the inquiry included possible recommendations that may be necessary for changes to the regulatory regime.11 These responses suggest that promoting board effectiveness may be attempted with the aid of effective institutional framework.12 Institutions are the humanly devised constraints that structure political, economic and social interaction; they are systems of established and prevalent social rules.13 Hence, an institutional framework is made up of informal institutions, social rules and formal institutions-established rules.14 The entire mechanisms that are established to ensure that company boards are capable of providing effective leadership to management-functions in corporate entities comprise of formal and informal institutions. Institutions that are developed in response to the challenges of a particular society must be specifically responsive to the peculiar societal challenges.15 Hence, it is identified in this chapter that the responses to corporate scandals in the United Kingdom and the United States have been approached distinctively.16 In developing economies such as Nigeria, there is an on-going attempt to strengthen board effectiveness.17 This has been demonstrated with the transformation of the existing institutional framework for corporate regulation towards board effectiveness.18 Despite these attempts, the challenges caused by ineffective boards, have not been clearly addressed. The challenges resulting from ineffective boards appear to have a wider scope in Nigeria than in the UK or the US, even though these challenges are not limited to Nigeria.19 Among these challenges are the dominant role of CEOs, the problem of lack of effective shareholder democracy, 20 ineffective supervision from the regulatory authorities, lack of effective sanctions, lack of accountability, delay in justice delivery and corrupt practices. In 2006 it was discovered that overstatements which were between thirteen to fifteen billion naira (currently approximately $40 million) were made in the financial accounts of Cadbury Nigeria Plc, spanning over a period of three years. The CEO and finance director were indicted for fraud.21 Also, in 2009, the Chief Executives of some commercial banks were accused of corrupt practices (Bank PHB, Oceanic Bank, Union Bank, Finbank, Afribank, Intercontinental Bank and Spring Bank).22 Typical of weak institutional environments, these corporate heads have not been successfully prosecuted. Recently, the Supreme Court of Nigeria, in a unanimous decision ruled that the trial of the former CEO and other officials of the defunct Bank PHB should proceed after six years. The bank officials were earlier arraigned in 2011. With delays, technicalities and other institutional challenges, the case is being referred to a new judge, for a re-trial.23 As at 2016, only the case against the former CEO of the

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defunct Oceanic Bank had been concluded.24 Despite the fact that government agencies have access to all the compliments of state apparatus in successfully prosecuting erring corporate heads, they face challenges and contextual bottlenecks. Therefore, it would arguably be a daunting task for shareholders with limited resources—including asymmetric information issues—to hold corporate heads accountable. This has the potential to undermine investors’ confidence and it has the capacity to deter foreign investors. In light of this, the establishment of the recently consolidated corporate governance codes in Nigeria is commendable, especially as it seeks to enhance board effectiveness in corporate entities in Nigeria. However, it is doubtful whether the recent code would have the capacity to address the agency problems that is undermining corporate governance development in Nigeria. One of the biggest challenges of corporate governance administration and regulation in Nigeria before the development of the recent code was a lack of effective mechanisms for implementing sanctions. This problem does not appear to have been addressed by the recent code.25 While observance of the code is stated to be mandatory, the process of enforcement is unclear. As discussed earlier, some of these challenges are not peculiar to Nigeria and they are being addressed in developed economies, especially in the United Kingdom and the United States. Thus, the chapter provides a comparative review of the role of institutions in promoting board effectiveness in Nigeria relative to the United Kingdom and the United States.26 It evaluates the extent to which institutional make-up and incentives can impact board effectiveness. It identifies the role of the regulatory framework of institutions by reference to the main streams of the economics of institutions, to ascertain the effective ways that formal and informal institutions can influence board performances. The chapter continues with a brief examination of the framework for institutional development. It identifies the relevance of the institutional foundations that are necessary for promoting board effectiveness. Next, the different levels of institutional development are examined. This includes an illustration of the ways that the development of formal institutions can be influenced by informal institutions. Then, it analyzes the relationship between institutional development and board effectiveness in the United Kingdom, the United States of America and Nigeria. It identifies some constraints to board effectiveness in Nigeria before concluding.

Framework for the Institutional Development of Effective Boards The establishment of institutions is influenced by the need to promote human interactions and exchange of resources at the least possible costs. The function of institutions is to facilitate the platforms where economic values can be freely determined by individual preferences.

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The new institutional economics emerged as a response to the limitations of the neo-classical economic and the ‘old’ institutional economics.27 It seeks to explain economic behaviour from an institutional perspective. While the new institutional economics emerged as a critique to the old economics theory, the old institutional economics was a response to the limitations of the much earlier neo-classical economics. The neo-classical economics28 assume that humans have the rational capacity to maximise utility, that firms can maximise profits and people act independently on the basis of full access to relevant information.29 Hence it assumes that institutions are unnecessary because economies are characterised by efficient markets, which depict a world of instrumental rationality where ideas do not matter. The neo-classical economics theory is based on the view that humans have perfect understanding of their surrounding environment and they have access to perfect information, hence, transactions are regulated by a perfect market where such transactions are costless.30 It depicts a world of functional and optimal efficiency which can exist in an ideal world. However, it apparently ignores the realistic characteristic of the human society which comprises scarcity and competition. In light of the emphasis on market functions and the assumption that transactions are regulated by perfect market, the ideology of neo-classical economics may not provide the needed foundation for promoting board effectiveness. The problems of information asymmetry and opportunism are indicative of the limitations of the market function. As earlier noted, 31 the development of institutions became a necessary response to corporate scandals, to regulate the role of company boards so that they can provide effective leadership to managements of corporate entities. A different proposition which rejects the neo-classical economics theory emerged. This became known as the ‘old’ institutional economics.32 The old classical institutional economics is concerned with resource allocation and the level at which resources are utilised. It suggests that economics should be socially determined through cultural change. The market is seen as an invisible hand which is used as an unproductive tactics by businesses to generate income for the privileged few, as opposed to the general welfare of the populace.33 It supports the view that the market should be replaced with institutions which are capable of enforcing and achieving social control for the purpose of ensuring that production and profits originates for purposes of social welfare.34 The major limitation of the old institutional economics is that it undermines the role of the market which serves as a platform where transactions and exchange occur. While neo-classical economics ignores the role of institutions, the old institutional economics promotes the role of institutions over market functions. Although, the market is presently characterised with a lot of imperfections, yet it remains relevant. Also institutions, as humanly

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devised constraint, are important for purposes of regulating the economic players to achieve efficient outcomes.35 The imperfections that institutions seek to address, which includes; opportunism, conflict of interests and information asymmetry occur at the level of the market. The institutional framework for promoting board effectiveness that has been developed as a response to corporate scandals seeks to regulate behaviour at the level of the market.36 To promote effective boards, the role of the markets cannot be ignored; institutions are effective only to the extent that they can successfully respond to market imperfections. Hence, the old institutional economics lacks the needed foundation for ensuring that the role of boards can be strengthened towards promoting market efficiency. The new institutional economics recognises that transactions are costly as a result of inadequate information and scarcity, leading to the existence of imperfect markets and competition; that individual choices can be influenced by the norms derived from cultural environments.37 In the absence of effective institutions, these norms which influence behaviour can promote market imperfections, such as ‘opportunism’. Thus, since the market is relevant for exchange, yet imperfect, institutions are important as a regulator for the purpose of limiting certain behaviour; to mitigate the uncertainties that lead to imperfect market towards ensuring efficient markets. Institutions that recognise the important role of the market can strengthen the role of company boards and ensure that boards have the capacity to provide leadership and direction for company managements to thrive in a competitive economy.

Levels of Institutional Development and Change The new institutional economics is different from previous economic theories because it accepts the market as a platform for economic interactions, strengthened by institutions to ensure efficiency of the market functions. Importantly, it is further concerned with how the institutions are created and developed.38 One of the hypotheses of the theory is that a study of the developmental processes of institutions will create an understanding of how institutions emerge and how they can be changed or transformed.39 Since institutions are relevant because they can be used to regulate the market towards efficiency, institutions are relevant only to the extent that they are actually capable of enhancing the market functions. Thus, institutions must be tailored towards the needs of the markets. The needed foundation of the structure for efficient markets can be determined by reference to cultural values and choices which govern human behaviour and relationships.40 Cultural values and choices emerge from the practices of particular local customs, and they influence the ways in which an entire institutional framework is created. The

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process of developing institutions has its foundation in informal institutions. These informal institutions comprise cultural value, culturally derived choices and other local practices. Since they influence the formation and development of formal institutions and the entire institutional framework, they can largely determine how institutional functions can effectively respond to the challenges that they were created to address.41 Thus, institutions may effectively relate to the markets where reference is made to local practices which are based on human relationships. In view of this, institutions emerge through cultural evolution, trade practices, and the constant value of human relationships.42 In recognition of these, four levels of institutional development and change emerged. These levels illustrate how institutions emerge, how they can be changed or transformed, and how they affect economics. They include informal institutions, formal institutions, level of governance, and the level of resource allocation—the market. The first level consists of informal institutions include customs, traditions, values, beliefs, and culture. At this level of institution, changes are very slow, because social institutions are largely embedded, 43 and they form part of the unique way people understand the environment around them. At the second level is the formal institution. It consists of formal rules such as constitutions and property rights.44 These rules change from time to time, and they are basically derived from the informal rules of level one. The function of institutions at this level is to provide a mechanism for the unification of the different close-knit societies within a larger macrocosm.45 Institutions at this level are not closely embedded; hence, changes may occur more frequently when compared with informal institutions. But the changes are not often cumulative; they can be triggered by sharp breaks from established principles which may be caused by political, civil or financial turmoil.46 The development of corporate governance regulations towards board effectiveness that have been largely influenced by corporate scandals globally47 is an indication of how the development of formal institutions can be triggered by financial turmoil. The third level is the level of governance. It is the level where the formal rules that have been developed from the informal rules are applied. This is the level where human behaviour which is exhibited through established organisations is controlled and co-ordinated through the formal rules. At this level, conflicts are mitigated, since organisations interact with the larger society. Ordinarily, in a perfect world, the rules which have been established at level two should govern human interaction to the exclusion of government intervention. But because of uncertainties and costs of transactions, the mere creation of rules is not sufficient in itself. The role of the Financial Reporting Council in the UK, the Securities and Exchange Commission in the United States, the Australian Securities and Investments Commission ASIC, and the Financial Reporting

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Council of Nigeria provide the relevant governance roles for financial reporting and corporate governance in these jurisdictions. Governance is necessary to enforce contractual relations for the purpose of mitigating conflicts to realise mutual gains.48 This has been described as a unit of transaction which encompasses conflict, mutuality, and order.49 The fourth level is the level of the market. It is the level of production that is carried out by a firm. It is the level of output that is engineered by the productive capacity of the firm after the rules that emerged from level two have been applied to level three. These levels of institutional framework function effectively through continuous interrelations.50 This is indicative of the major ideas of the new institutional economics namely, the formation of institutions, the way they emerge and the way they influence economics.51 The framework of the new institutional economics is mainly concerned with the ways in which the institutions that are the determinants of economics are formed. Since organisations52 are expected to engage in transactions according to existing institutional framework rules, the extent to which institutions can function effectively may be largely determined by the relevance which the organisations attach to the institutions. As such, institutions may function effectively only to the extent that they can be suitably applicable to the challenges and problems that exist within a given society. In view of this, it was rightly observed that the institutional framework which has been developed as a response to the challenges of an economic problem in a particular environment may not be successfully applied in a different environment. Frameworks may only be successfully applied to the extent that they can be adapted.53 Even though the challenges of board effectiveness exist in different jurisdictions, it may be impracticable to design a single approach that could be suitably applied to address the problem globally. Hence, enforcement procedures, sanctions for non-compliance and other aspects of regulatory response must be responsive to peculiar local circumstances. Some determinants of board effectiveness are examined next. The examination provides a comparative review of the approaches to corporate governance regulation in the United Kingdom, United States and Nigeria with particular focus on attempts at promoting board effectiveness.

Determinants of Board Effectiveness The description of a generally acceptable standard for determining an effective board may be elusive in view of the various interests that a corporate entity may seek to promote. This challenge is part of the question which seeks to identify whose interests corporate entities should serve. Mindful of this, the UK Financial Reporting Council sought to identify the characteristics of an effective board by reference of a wide scope that

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includes shareholder and potential stakeholder interests. The FRC guidanceon board effectiveness provides as follows. 54 An effective board develops and promotes its collective vision of the company’s purpose, its culture, its values and the behaviours it wishes to promote in conducting its business. In particular it • •

• • •

• •

provides direction for management; demonstrates ethical leadership, displaying—and promoting throughout the company—behaviours consistent with the culture and values it has defined for the organisation; creates a performance culture that drives value creation without exposing the company to excessive risk of value destruction; makes well-informed and high-quality decisions based on a clear line of sight into the business; creates the right framework for helping directors meet their statutory duties under the Companies Act 2006, and/or other relevant statutory and regulatory regimes; is accountable, particularly to those that provide the company’s capital; and thinks carefully about its governance arrangements and embraces evaluation of their effectiveness.

While financial stakeholders are clearly identified in the FRC guidance, the interests of non-financial stakeholders can also be included in the board’s ethical and corporate social responsibilities objectives. An effective board is pivotal to the success of a company because it has the capacity to ensure that corporate objectives are promoted within the framework of existing regulations. One of the prominent ways that board effectiveness has been attempted is the requirement for boards to be composed of certain numbers of independent directors to ensure that boards have the appropriate balance of skills, experience, and independence. Activist shareholders and corporate governance regulations are requiring boards of large companies to be composed of independent directors.55 Despite these requirements, there appears to be conflicting empirical evidence about the impact of the composition of boards on firm performance.56 It has been suggested that the capacity of outside directors to promote board effectiveness can largely be dependent on the extent to which they can develop a ‘functional’ working-relationship and actively engage with executive directors.57 Also, in view of the fact that non-executive directors are not employees in their capacity as non-executives, their contributions to board effectiveness may also be dependent on the extent to which they can be actively involved in their roles as outside directors58 to actively respond to the agency problem of separation of ownership and control.59

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In view of the conflicting empirical evidence on the effects of outside directors on board performance, the determinant of board effectiveness appears to transcend the requirement of the composition of boards with outside directors. The peculiarities of the informal institutions in different jurisdictions may indicate that the composition of boards with outside directors is merely a minimum requirement towards promoting good corporate governance. Regard to peculiar local circumstances60 in the informal institutions may be an important requirement. The composition of boards of independent non-executive directors is a corporate governance requirement in the United States and the United Kingdom, yet both jurisdictions enforce corporate governance regulation differently.61 While these different approaches are influenced by peculiar local circumstances in both jurisdictions, the institutional response to scandals and corporate governance challenges in Nigeria appears to be a mere box-ticking exercise. Corporate governance rules in Nigeria largely adopt the universal approach towards promoting board effectiveness, without reference to the particular circumstances in the Nigerian informal sector.62 Hence, the challenges caused by ineffective boards in Nigeria persist. Approaches to Board Effectiveness in the US, UK and Nigeria In light of the continuing expansion of business entities beyond national frontiers, it is increasingly becoming impracticable for corporate governance regulation to be limited to national boundaries. The need for a convergence towards international best practices may be imperative to promote and sustain international trade transactions, foreign direct investment, and foreign portfolio investment. However, the persistent challenges of corporate scandals,63 appears to indicate that mere convergence may not provide conclusive response to corporate governance challenges. Certain corporate governance requirements have been considered to be world best practices in view of the objectives that they seek to ultimately achieve. Some of these include the requirement for boards to be composed of executives and independent non-executive directors, board evaluation, financial and non-financial disclosure requirements, and boards’ relations with shareholders and stakeholders. The successful implementation of these requirements may be largely dependent on the extent to which local circumstances in the affected jurisdictions permit. For example, the requirement for boards to be composed of independent directors64 is one of the prominent ways of promoting board effectiveness. The successful implementation and enforcement of this requirement may be dependent on peculiar institutional structures that can clearly determine the appropriate incentives which can ensure that first, a board that is composed of non-executive directors can effectively provide a monitoring role, and second, the board, including

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executives and non-executive directors has the appropriate incentives to promote corporate value. In the United States, corporate scandals that were caused by agency problems65 led to the enactment of the Sarbanes Oxley Act 2002. Before the act was enacted, it was required that board of directors of public companies should be composed of independent directors. It was specifically required that members of the audit committee of large corporations should be independent directors.66 One of the scandals that made major headlines occurred as a result of the accounting fraud that involved some executives’ conspiracy with the external auditors of Enron.67 Interestingly, the audit committee of Enron, expectedly composed of independent directors, as required by the Securities Exchange Act, did not prevent the accounting fraud. Response to this scandal was the establishment of The Sarbanes-Oxley Act; a direct and stringent regulatory measure that prescribes personal liability for corporate scandal.68 This implies that, even though the composition of boards with independent directors may generally be considered as an acceptable best practice, boards that are composed of independent directors merely have the potential to make boards effective. They are not conclusive proof of board effectiveness. Hence, the requirement for personal liability in the Unites States is a response to the prevailing local practice, namely, the desire to increase management compensation, based on financial results. The UK Corporate Governance Code functions on the basis of ‘comply or explain’ Non-compliance with the provisions of the code must be explained to the shareholders of the company who can decide to use the mechanism of shareholder democracy to address any concerns that they may have. The successful implementation of this compliance mechanism is based on the considerations of the informal and formal institutions in the UK, which include shareholder enlightenment, shareholder democracy and access to justice.69 Although shareholder democracy and shareholder access to justice can apply in Nigeria, shareholders in Nigeria are often faced with the difficult task of using these mechanisms as incentives to promote board effectiveness. As observed earlier, in Nigeria, regulatory agencies are experiencing challenges in successfully prosecuting erring corporate heads; this implies that shareholders would encounter greater challenges70 because of limited resources and the problem of information asymmetry. Apparently aware of the limitations of shareholders, The Financial Reporting Council of Nigeria decided that the application of the recent code is to be made mandatory with sanctions for non-compliance. However, the mechanism for implementing sanctions is largely unclear. It is provided that compliance with the provisions of the code is mandatory and violations of the provisions of the code will occasion both personal sanctions against the persons directly involved in the violation and sanctions against the companies involved in such violation.71 This provision is commendable.

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However, the specific sanctions that are to be imposed in cases of violation are not clearly stated. This means that the extent to which shareholders in Nigeria can rely on the FRC to sanction erring corporate heads appears to be limited, especially in light of the inability of the regulatory agencies to successfully prosecute erring corporate heads in the past. Shareholders must remain vigilant and responsive; it is a daunting task that they should be ready to perform in view of the challenges of access to justice, corruption, and ineffective shareholder democracy in Nigeria.72 Prior to the financial scandals in Cadbury Nigeria Plc and the banking sector in Nigeria,73 the requirement for boards to be composed of independent non-executive directors was contained in the 2003 Code of Best Practices for Corporate Governance in Nigeria.74 The relevant corporate boards failed to prevent the scandals. Thus, it appears that the codes merely promote world best practice without ultimately promoting effective corporate governance in Nigeria.75 Strict rules for determining the status of an independent director may ensure that independent directors in Nigeria have the capacity and incentives to promote board effectiveness. Also, the scope of the responsibilities of independent directors and their functions outside of the companies where they act as independent directors should be determined. This is imperative because of the challenges of the informal and formal sectors in Nigeria, which includes shareholders’ limited powers, dominant shareholder effects, connected persons, and the challenges encountered by the regulatory agencies in ensuring that boards promote corporate objectives without being hindered by the agency problems. These can ensure that corporate governance regulation in Nigeria reflects world best practice and successfully responds to the peculiar problems of Nigeria. The United States’ response to the challenges of corporate scandal was a reaction to the informal institutions of its capitalist society where people could be driven to be ‘financially successful’ without much regards to ethical or moral conscience. As suggested by the Securities and Exchange Commission, the desire to increase management compensation, based on financial result is one of the factors that can encourage fraudulent practices in the United States.76 This recognises the influence of informal institutions on human behaviour. Hence, the formal institutions—corporate regulations—must be designed with regard to how the challenges of the informal institutions can be successfully addressed.77 This is consistent with the new institutional economics approach to protecting market functions by establishing formal institutional mechanisms such as the Sarbanes Oxley Act 2002 which are reflective of and responsive to informal institutions in regulating the markets.78 Effectively, the role of the Sarbanes Oxley Act within the framework of the new institutional economics is to recognise the need to respond to the characteristics of the informal institutions in ways that transparency and accountability can be enhanced, particularly in the United States.

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The responses to corporate scandals in the UK and the US were influenced by the informal institutions that are embedded in both jurisdictions. The vocal shareholder voice79 in the UK influenced the Financial Reporting Council to require shareholders and investors to determine satisfactory levels of compliance with the corporate governance codes, whereas in the United States, the powerful status of CEOs are restricted with personal liability where necessary.

Conclusion This chapter examined the role of institutions in promoting board effectiveness. It provided a comparative review of the role of institutions in promoting board effectiveness in Nigeria relative to the United Kingdom and the United States.80 It identified the role of institutions and the processes that are involved in the development of institutions. The chapter identified the need for formal institutions to be designed by reference to existing informal institutions to ensure that the role of the formal institutions—rules, codes, regulations, and enforcement—are not constrained by the peculiarities in the informal institutions. Hence, the chapter identifies some of the peculiarities in the informal sector in Nigeria that are hindering successful corporate governance administration, particularly as it relates to board effectiveness. In comparison, it showed how corporate governance administration in the United States and the United Kingdom were designed by reference to peculiar social contexts in these jurisdictions. It showed that while Nigeria merely incorporated world best practice in its corporate governance regulation, e.g. the requirement for independent non-executive directors, in the United Kingdom and the United States, similar regulatory framework has been influenced by local circumstances, even though the corporate governance problems are similar. The response to corporate scandals towards board effectiveness in Nigeria is commendable, especially its mandatory application and the provision for sanctions. However, as argued in this chapter, it is not clearly reflective of the informal institutions and the challenges that are peculiar to Nigerian society. In light of the challenges of corruption, the inability of shareholders to make boards accountable,81 access to justice, costs and delay in justice delivery, it is expected that the definition of an independent director should be more stringent. An independent director should not hold shares in the company as currently permitted under the 2016 code.82 Also, the responsibilities of independent directors in Nigeria outside the companies where they act as independent directors should be restricted. This can ensure that independent directors have sufficient time to engage in the companies where they act as independent directors. Also, in light of the rate of corruption, it should be mandatory for every director, especially non-executives and independent directors, in

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Nigeria to declare their assets before accepting their roles and to periodically re-declare their assets. Their assets should also be declared at least one year after ceasing to act as independent and non-executive directors. This could be made applicable to all directors of financial institutions, including executive directors. Further, remuneration and audit committees should be required to be composed only of independent, non-executive directors. Where necessary, an executive director may be invited to attend a meeting with a committee to provide information on certain matters as may be required by the committee.83 Also, the mechanisms for determining and imposing sanctions should be defined, including the particular sanctions that are to be imposed. These can ensure that sanctions that are to be imposed are considered as last resorts where the above requirements for asset declaration proved to be insufficient.84 These measures are not aimed at encouraging shareholders to be less vigilant, they can ensure that agency problems are limited, and the costs of monitoring management are mitigated by the active independent directors. The development of appropriate governance measures as recommended have the potential to ensure that boards provide direction for management in a responsible way.85 They can also ensure that boards promote corporate objectives by observing the relevant statutory rules and governance codes through accountability standards to their stakeholders.86 Although, the requirement for company boards to be composed of independent directors in the UK has not completely addressed the incidence of corporate scandals, the ability to respond to such scandals when they occur87 is an indication that accountability can ultimately be demanded from those who occupy positions of control in corporate entities. The argument that has been presented in this chapter is that the requirement for independent directors in corporate entities may not sufficiently promote effective boards in particular local circumstances. For example, disclosure requirements may be unaffected by local circumstances because information asymmetry issues can be addressed across jurisdictions where disclosure requirements are simply met. However, the procedure for implementation and sanctions may determine the extent to which entities are incentivised to comply. Hence, further research may be required to ascertain the extent to which basic corporate governance requirements such as the successful implementation of disclosure requirements may be dependent on peculiar local circumstances.

Notes 1. Company boards are required to manage the business of companies. UK Companies Act 2006, ss 171–177, Companies and Allied Matters Act Cap C20 (Laws of the Federation of Nigeria) (CAMA) 2004 s 244(1).

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2. Jean Jacques du Plessis et al., Principles of Contemporary Corporate Governance (3rd edn., Port Melbourne, VIC 3207, Australia Cambridge University Press, 2015), 114–120. The recipe for a good board has been suggested to include a good balance of power, effective communication, ethical standard and integrity, diversity, independence, risk taking, understanding of the company’s business, stakeholder engagement, regular training courses (induction and development) for directors, diversity, and frequent meeting (commitment of time). See Jill Solomon, Corporate Governance and Accountability (4th edn., Chichester, West Sussex, John Wiley & Sons, 2013), 106; Mark Cardale, ‘The Effective Board’ in Mark Cardale (ed.), A Practical Guide to Corporate Governance (5th edn., London, Sweet & Maxwell, 2014), 281. 3. It is the ultimate responsibility of boards to ensure that regulatory requirements are adhered to. See Caremark International Inc. Re 698 A2d 959 968–70 (Del Ch 1996); Sarbanes-Oxley Act. 2002, s. 404; the UK Companies Act 2006, s 414 relating to directors’ duty to ensure that company accounts comply with statutory requirements. 4. It was suggested that the global financial crisis was caused partly because boards did not have adequate understanding of the risks that their companies were running; they lacked the requisite information to function effectively. Andrew Chambers, Chambers Corporate Governance Handbook (7th edn., West Sussex, Bloomsbury Professional Ltd., 2017), 3. 5. These include Tyco Int’l Ltd (New Jersey, USA), 2005; Enron Corporation (Houston Texas, USA), 2001; Adelphia Communications Corp (Pennsylvania, USA), 2002; WorldCom (Virginia, USA), 2002; Barings Bank (London, UK), 1995; Barclays Bank Libor scandal (London, UK), 2012; Polly Peck International (London, UK), 1991; Bank of Credit and Commerce International (BCCI) scandal worldwide (including Hong Kong, Luxembourg, the UK the United States), 1991; Maxwell Communication Corporation Plc (London, UK), 1991; Parmalat (Italy), 2003; HIH Insurance (Australia), 2001. 6. See The Financial Reporting Council, ‘History of the UK Corporate Governance Code’ (1992), available at www.frc.org.uk/directors/corporategovernance-and-stewardship/uk-corporate-governance-code/history-of-theuk-corporate-governance-code accessed 5 March 2018. 7. The Financial Reporting Council was established to promote high quality financial reporting in the United Kingdom in the 1980s. Its responsibilities were extended to include auditing and accountancy regulation in 2004, after the Enron and WorldCom scandals in the United States. Paul George, (Financial Reporting Council), available at https://assets.publishing.service.gov.uk/ media/5329db50e5274a2268000045/financial_reporting_council_presenta tion.pdf accessed 4 March 2018. 8. Corporate governance administration in the United Kingdom has been transformed with considerable focus on board effectiveness from the first code on corporate governance; The Cadbury Report: The Financial Aspects of Corporate Governance 1992 (1, December). Some recommendations of the Cadbury Code include the role of CEO and chairman of companies should be separate; boards should have at least three non-executive directors, two of whom should have no financial or personal ties to executives; and each board should have an audit committee composed of non-executive directors. The codes have undergone reviews at interval. The most recent code is the UK Corporate Governance Code 2016. 9. Sarbanes Oxley Act 2002; see also the Securities Exchange Act 1934 (as amended 2012) Standards Relating to Audit Committees, (Independence) s 10A.

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10. John Farrar, Corporate Governance: Theories, Principles and Practice (3rd edn., South Melbourne, VIC, Oxford University Press, 2008), 506. See also Mark Westfield, HIH: The Inside Story of Australia’s Biggest Corporate Collapse (Milton, QLD, John Wiley & Sons Australia, 2003). 11. The HIH Royal Commission headed by Justice Neville Owen was established by the Australian Prime Minister in July 2001; the Commission’s report was submitted on 16th April 2003. 12. See section under heading Approaches to Board Effectiveness in the US, UK and Nigeria. 13. Douglas North, ‘Institutions’ (1991) 5(1) Journal of Economic Perspectives 97, 97; Jack Knight, Institutions and Social Conflict (Cambridge, Cambridge University Press, 1992), 2; Geoffrey Hodgson, ‘What Are Institutions?’ (2006) 40(1) Journal of Economic Issues 1, 2. 14. See section under heading Levels of Institutional Development and Change. 15. John C. Coffee, Jr. ‘A Theory of Corporate Scandals: Why the United States and Europe Differ’ in Joseph Norton, et al. (eds.), Corporate Governance Post Enron: Comparative and International Perspectives (London, British Institute of International and Comparative Law, 2006), 19. 16. The UK ‘comply or explain’ approach to corporate governance differs from the statutory approach of the United States. 17. Corporate regulation in Nigeria is used as a comparative basis to the United Kingdom and the United States in relation to her status as the ‘biggest’ economy in Africa in terms of GDP. See The World Bank GDP Ranking, 2016, available at https://data.worldbank.org/data-catalog/GDP-ranking-table accessed 1 December 2017. The UK and the US are among the leading countries in corporate governance regulations. Hence the UK, US, and Nigeria provide an ideal comparative basis in relation to the influence of institutions on board effectiveness in terms of the context of developed and developing countries. 18. The transformation includes the successive development of the following codes of corporate governance: The Code of Corporate Governance for Banks in Nigeria Post-Consolidation 2006, reviewed by the Code of Corporate Governance for Banks and Discount Houses 2014 and Code of Corporate Governance for Public Companies in Nigeria 2003, reviewed by the Code of Corporate Governance for Public Companies in Nigeria 2011. These and other allied codes of governance have now been harmonised and reviewed. Themost recent code, National Code of Corporate Governance for the Private Sector in Nigeria 2016 is currently under review . 19. For example, the dominant powers of chief executives were identified as a corporate governance problem in the United States in relation to the collapse of Enron. Jill Solomon, see note 2, 37. 20. Garba A. Yakasai, ‘Corporate Governance in a Third World Country with Particular Reference to Nigeria’ (2001) 9(3) Corporate Governance 238, 241. 21. Adenike Adewale, ‘An Evaluation of the Limitations of the Corporate Governance Codes in Preventing Corporate Collapses in Nigeria’ (2013) 7(2) Journal of Business and Management 110, 113–114. See also the allegation of fraud involving senior officials of the Nigerian Stock Exchange; Okaro S. Chukwunedu et al., ‘Corporate Fraud in Nigeria: A Two Case Study’ (2013) 6(3) International Journal of Research in Management, 9. 22. In August 2009, the chief executives of some commercial banks in Nigeria were removed from their positions by the Central Bank governor in exercising the oversight authority of the Central Bank governor for alleged corrupt practices and financial mismanagements. See Sahara Reporters online

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23. 24. 25. 26. 27. 28. 29.

30.

31. 32. 33. 34. 35. 36.

Francis A. Okanigbuan, Jr. (New York, 8 October 2010), available at http://saharareporters.com/newspage/former-md-oceanic-bank-cecilia-ibru-convicted-bank-fraud accessed 18  November 2017; Vanguard Newspaper (3 October 2009), available at www.vanguardngr.com/2009/10/cbn-sacks-adenuga-bank-phb-etb-springbank-mds/ accessed 11 November 2017. See Yomi Makanjuola, Banking Reforms in Nigeria: The Aftermath of the 2009 Financial Crisis (Basingstoke, Hampshire, Palgrave-Macmillan, 2015), 72. These examples are not meant to question the personal characters of the heads of the affected banks, they are meant to indicate a failure of institutional control and effective regulation. Also, the examples are highlighted because the banking sector in Nigeria has been experiencing problems relating to governance. This was heightened during the large scale mergers and acquisitions exercises involving banks in Nigeria which was informed by a review of the minimum capital requirement policy of the Central Bank of Nigeria between 2004 and 2005. Prior to this period, some banks in Nigeria were faced with certain challenges, including service delivery problems, and lack of effective corporate governance administration. See Appah Ebimobowei and John M. Sophia, ‘Mergers and Acquisition in the Nigerian Banking Industry: An Explorative Investigation’ (2011) 6(3) The Social Sciences, 213–220. See Vanguard Newspaper (28 September 2017), available at www.vanguardngr. com/2017/09/alleged-n25-7bn-fraud-s-court-okays-trial-defunct-bank-phbmd-atuche-wife/ accessed 30 November 2017. See Yomi Makanjuola, note 22, 76. The code apparently promotes international best practice without reflecting on the peculiar local circumstances in Nigeria. See note 17 on the relevance of the comparison. Its title ‘new’ institutional economics is meant to differentiate its concept from the previous economics theory which is now regarded as ‘old’ economics theory. ‘Neo-classical economics’ is believed to have its origin in Thorstein Veblen, ‘The Preconceptions of Economic Science’ (1900) 14(2) The Quarterley Journal of Economics 240, 261. Roy Weintraub, ‘Neo-Classical Economics’, The Concise Encyclopedia of Economics (Library of Economics and Liberty, 1993), available at www. econlib.org/library/Enc1/NeoclassicalEconomics.html accessed 20 November 2017. In the real world, transactions are costly. See generally Douglas North and John Wallis, ‘Measuring the Transaction Sector in the American Economy 1870–1970’ in Stanley N. Engerman and Robert E. Gallman (eds.), Long Term Factors in American Economic Growth (Chicago, University of Chicago Press, 1986), 95–162. See section under heading Background and Introduction. It emerged from the works of Thorstein Veblen, The Theory of the Leisure Class: An Economic Study of Institutions (New York, Macmillan & Co. Ltd., 1915). Malcolm Rutherford, ‘Intitutional Economics: Then and Now’ (2001) 5(3) The Journal of Economic Perspectives 1, 173, 175. Wesley C. Mitchell, ‘Making Goods and Making Money’ in Wesley C Mitchell (ed.), The Backward Art of Spending Money (New York, Augustine M. Kelley, 1923), 137–148. Douglas C. North, ‘Economic Performance through Time’ (1994) 84(3) The American Economic Review 359, 360–361. See notes 8 and 9; section under heading Levels of Institutional Development and Change.

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37. Douglas C. North, ‘Institutions and Economic Theory’ (1992) 36(1) The American Economist 3, 4–5. 38. Douglas C. North, ‘The New Institutional Economics’ (1986) 142(1) Journal of Institutional and Theoretical Economics 230, 230. 39. Ibid. at 234–235. 40. See the analysis in Ronald A. Heiner, ‘The Origin of Predictable Behaviour’ (1983) 73(4) The American Economic Review 560–573. 41. These types of challenges are peculiar to a particular society. 42. Cultural evolution depicts norms and values, and trade practices connect people of different cultural backgrounds through human relations. 43. Human interactions designed by cultures have been described as the most enduring of human association. Such interactions are believed to confer benefit on close-knit groups where individual actions are for the collective good, rather than for individual purposes. See Samuel P. Huntington, The Clash of Civilizations and the Remaking of the World Order (London, Simon & Schuster, 1996), 43–44; Victor Nee, ‘Sources of New Institutionalism’ in Mary C. Brinton and Victor Nee, New Institutionalism in Sociology (New York, Russell Sage Foundation, 1998), 8–10. 44. Douglas C. North, note 13, 97. 45. Constitutions and property rights are often used as grundnums. They serve as common restraints to the behavioural patterns of the different ideological perceptions which make up the national-state. 46. Oliver Williamson, ‘The New Institutional Economic: Taking Stocks, Looking Ahead’ (2000) 38(3) Journal of Economics Literature 595, 598. 47. See note 5. 48. See note 46, 599. 49. John R. Commons, ‘The Problem of Correlating Law, Economics and Ethics’ (1932–1933) 8(4) Wisconsin Law Review 1, 3–4. 50. The preceding levels impose constraints on the subsequent levels, but the levels are nevertheless interconnected through the response which originates from the lower levels back to the higher levels by way of feedback. 51. See note 46, 597. 52. Organisations are the actors. They consist of people or group of people who are connected by the same beliefs and views, such as political parties, religious organisations, trade unions, and professional bodies. 53. See Douglas C. North, The New Institutional Economics and Development (Washington, Washington University, 1993), 8, available at www.deu.edu.tr/ userweb/sedef.akgungor/Current%20topics%20in%20Turkish%20Economy/ north.pdf accessed 17 November 2017. 54. The UK Financial Reporting Council published its Guidance on Board Effectiveness on 11 March 2011. 55. The UK Corporate Governance Code 2016 section B recommends that boards in all companies with a premium listing of equity shares, regardless of whether they are incorporated in the UK or elsewhere, should have an appropriate combination of executive and non-executive directors (and, in particular, independent non-executive directors) such that no individual or small group of individuals can dominate the board’s decision-taking. The National Code of Corporate Governance for the Private Sector in Nigeria 2016 s. 5.6 recommends that the number of non-executive directors on the board shall not be less than two-thirds of the board, and the number of independent nonexecutive directors shall not be less than half of the number of non-executive directors. The United States Securities Exchange Act, 1934, s 10A; The South African King IV Code on Corporate Governance 2016, principle 7; The G20 Organisation for Economic Co-operation and Development (OECD) 2015

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56.

57.

58.

59.

Francis A. Okanigbuan, Jr. Principles of Corporate Governance VI (E); David A Carter et al., ‘Corporate Governance, Board Diversity and Firm Value’ (2003) 38(1) Financial Review 33; Kose John and Lemma W. Senbet, ‘Corporate Governance and Board Effectiveness’ (1998) 22 Journal of Banking & Finance 371, 380. Marc Moore and Martin Petrin, Corporate Governance: Law, Regulation and Theory (London, Palgrave, 2017), 186–188; Olayinka M. Uadiale, ‘The Impact of Board Structure on Corporate Financial Performance in Nigeria’ (2010) 5(10) International Journal of Business and Management 155; Peter F. Pope et al., ‘Outside Directors, Board Effectiveness, and Earnings Management’ (April 1998), available at SSRN: https://ssrn.com/abstract=125348 accessed 30 November 2017; Barry D. Baysinger and Henry N. Butler, ‘Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition’ (1985) 1(1) Journal of Law, Economics, & Organization 101; Kose John and Lemma W. Senbet note 55; Sanjai Bhagat and Bernard Black, ‘The Non-Correlation between Board Independence and Long Term Firm Performance’ (2002) 27 Journal of Corporation Law 231–273; Raymond K. Van Ness et al., ‘Board of Director Composition and Financial Performance in a Sarbanes-Oxley World’ (2010) 10(5) Academy of Business and Economics Journal 56; Mary M. Bange and Michael A. Mazzeo, ‘Board Composition, Board Effectiveness and the Observed Form of Takeover Bids’ (2004) 17(4) Review of Financial Studies 1185; Nicola F. Sharpe, ‘The Cosmetic Independence of Corporate Boards’ (2011) 34 Seattle University Law Report 1435; Dawna L. Rhoades et al., ‘Board Composition and Financial Performance: A Meta-Analysis of the Influence of outside Directors’ (2000) 12(1) Journal of Managerial Issues 76; Benjamin E. Hermalin and Michael S. Weisbach, ‘The Effects of Board Composition and Direct Incentives on Firm Performance’ (1991) 20(4) Financial Management 101; Geoffrey C. Kiel and Gavin J. Nicholson, ‘Board Composition and Corporate Performance: How the Australian Experience Informs Contrasting Theories of Corporate Governance’ (2003) 11(3) Corporate Governance: An International Review 189; Rita D. Kosnik, ‘Greenmail: A Study of Board Performance in Corporate Governance’ (1987) 32(2) Administrative Science Quarterly 163; Helen Kang et al., ‘Corporate Governance and Board Composition: Diversity and Independence of Australian Boards’ (2007) 15(2) Corporate Governance 194; Livia Bonazzi and Sardar M. N. Islam, ‘Agency Theory and Corporate Governance: A Study of the Effectiveness of Board in Their Monitoring of the CEO’ (2007) 2(1) Journal of Modelling in Management 7; Pablo de Andres et al., ‘Corporate Boards in OECD Countries: Size, Composition, Functioning and Effectiveness’ (2005) 13(2) Corporate Governance 197; Diane K. Denis and John J. McConnell, ‘International Corporate Governance’ (2003) 38(1) Journal of Financial and Quantitative Analysis 1; Stuart Rosenstein and Jeffrey G Wyatt, ‘Inside Directors, Board Effectiveness, and Shareholder Wealth’ (1997) 44(2) Journal of Financial Economics 229. John Roberts et al., ‘Beyond Agency Conceptions of the Work of the NonExecutive Director: Creating Accountability in the Boardroom’ (2005) 16 British Journal of Management S5–S26; Thomas Clark, ‘The Contribution of Non-Executive Directors to the Effectiveness of Corporate Governance’ (1998) 3(3) Career Development International Bradford 118. The impact of non-executive and independent directors on board effectiveness may be undermined by their commitments to other responsibilities outside the company, especially where they occupy executive or non-executive positions in other companies. The agency problems of separation of ‘ownership and control’ can undermine board effectiveness. As rightly observed; ‘The directors of such companies,

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61. 62. 63.

64. 65. 66. 67. 68. 69.

70.

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however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private co-partnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company’ at v.1.107 in Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (5th edn., first pub 1776, London: Metheun & Co., Ltd., 1904); Eugene E. Fama and Michael C. Jensen, ‘Agency Problems and Residual Claims’ (1983) 26(2) Journal of Law and Economics, 327; Adolf A. Berle and Gardiner Means, The Modern Corporation and Private Property (New York, Macmillan, 1932); Michael C. Jensen and William H. Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economy 305; Kathleen M. Eisenhardt, ‘Agency Theory: An Assessment and Review’ (1989) 14(1) Academy of Management Review 57. Different institutional arrangements may be used to achieve the same tasks in different countries. See Katharina Pistor, ‘Patterns of Legal Change: Shareholder and Creditor Rights in Transnational Economies’ in Merritt B. Fox and Michael A. Heller (eds.), Corporate Governance Lessons from Transitional Economy Reforms (New Jersey, Princeton University Press, 2006), 37–38. See section under heading Approaches to Board Effectiveness in the UK, US and Nigeria. See section under heading Approaches to Board Effectiveness in the UK, US and Nigeria. See notes 21 and 22 in relation to Nigeria, Polly Peck, Barings Bank, Equitable Life Society, Maxwell corporations and BCCI in the United Kingdom and Lehman Brothers, Adelphi Communications Corporation, Enron Corporation and MCI World Com in the United States. See note 55. These include Adelphi Communications Corporation, Enron Corporation and MCI World Com in 2001 and 2002. The Securities Exchange Act 1934 (as amended 2012), S 10A. Arthur Anderson LLP, a Chicago-based accounting company. S 302(a) (4) and (5). There is a pending suit (Lloyds/HBOS litigation) by the shareholders of Lloyds Group. The shareholders are alleging that some directors of Lloyds Group advised them that the acquisition of HBOS in 2008 would be in their best interests. The shareholders allege that the directors concealed the fact that HBOS was reliant on emergency liquidity assistance from the Bank of England, financial support from the Federal Reserve, and a loan from Lloyds Group. They claim that the acquisition led to a decline in their investments and that they would not have approved the acquisition if they knew of the poor financial conditions of HBOS. Jane Croft, ‘Lloyds Shareholders “Mugged” By Bank Over HBOS Takeover’ Financial Times (London, October 18, 2017), available at www.ft.com/content/aa4d38ae-b406-11e7a398-73d59db9e399 accessed 2 December 2017; Jill Treanor, ‘Lloyds Shareholders’ Court Case Over HBOS Takeover Set to Begin’ The Guardian (15 October 2017), available at www.theguardian.com/business/2017/oct/15/ lloyds-shareholders-court-case-over-hbos-takeover-set-to-begin accessed 2 December 2017. See note 23.

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71. The National Code of Corporate Governance (note 18) Sanctions—37.1. 72. Inam Wilson, ‘Regulatory and Institutional Challenges of corporate Governance in Nigeria Post Banking Consolidation’ (April–June 2006) 12(2) Nigerian Economic Summit Group (NESG) Economic Indicators, available at www.proshareng.com/admin/upload/reports/Templars-NESGCorpGovPa per.pdf accessed 19 December 2017. 73. See notes 21 and 22. 74. Para 2 (c) of the 2003 Code. See also, The National Code of Corporate Governance for the Private Sector in Nigeria 2016 s. 5.6; Yomi Makanjuola, note 22; see notes 21 and 22. 75. Levels of Institutional Development and Change; Elewechi Okike and Emmanuel Adegbite, ‘The Code of Corporate Governance in Sub-Saharan Africa: Efficiency Gains or Social Legitimation’ (2012) 9(3) Corporate Ownership and Control 262; Emmanuel Adedgite, ‘Corporate Governance Regulation in Nigeria’ (2012) 12(2) Corporate Governance 257. 76. Mark S. Beasley et al., ‘Fraudulent Financial Reporting’ 1998–2007 (2010), 3, available at www.coso.org/Documents/COSO-Fraud-Study-2010-001.pdf accessed 4 December 2017. 77. See section under heading Levels of Institutional Development and Change; Elewechi Okike et al., ‘A Review of Internal and External Influences on Corporate Governance and Financial Accountability in Nigeria’ (2015) 10(2) International Journal of Business Governance and Ethics 165. 78. Mark J. Roe, ‘Some Differences in Corporate Structure in Germany, Japan and the United States’ (1993) 102(8) The Yale Law Journal 1927; Andrei Shleifer and Robert W. Vishny, ‘A Survey of Corporate Governance’ (1997) 52(2) Journal of Finance 737; Ruth V. Aguilera and Gregory Jackson, ‘The Cross National-Diversity of Corporate Governance: Dimensions and Determinants’ (2003) 28(3) Academy of Management Review 447. 79. The ‘comply or explain’ approach can mostly be applicable in relation to institutional shareholders who have the capacity to challenge company managements. 80. See note 17 on the basis for comparison. 81. Except institutional shareholders. 82. National Code of Corporate Governance for the Private Sector in Nigeria 2016, Part C, 6.7.3 (a). 83. The 2016 code currently permits board committees to be composed of a director that may not be independent. 84. This can only deter persons from occupying position as directors where they doubt their own personal objectivity and integrity. 85. The ability of the board to provide direction for the effective management of a company may be dependent on incentives which can propel boards to promote corporate objectives for the interests of its stakeholders. 86. These include its financial stakeholders as providers of the company’s capital (shareholders and creditors). It could also include non-financial stakeholders such as employees, community and customers. 87. The trial of some senior management officials of Tesco Plc for the financial scandal in Tesco Plc of 2014, see Paul Sandle et al., ‘Trial to Begin of Former Tesco Executives Accused of Fraud’ Reuters Report (London, 25 September 2017), available at https://uk.reuters.com/article/uk-britain-tesco-fraud/trialto-begin-of-former-tesco-executives-accused-of-fraud-idUKKCN1C0299 accessed 7 December 2017; In 2014 Tesco Plc was alleged to have overstated its profit by about £250m, Kamal Ahmed, ‘Tesco, What Went Wrong?’ BBC News (22 October 2014), available at www.bbc.co.uk/news/business-29716885

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accessed 7 December 2017; Graeme Wearden, ‘£2bn Wiped Off Tesco’s Value As Profit Overstating Scandal Sends Shares Sliding: As It Happened’ The Guardian (22 September 2014), available at www.theguardian.com/ business/live/2014/sep/22/tesco-launches-inquiry-after-overstating-profitforecasts-by-250m-business-live accessed 7 December 2017; Caroline Binham and Mark Vandevelde, ‘Cost of Tesco Accounting Scandal Goes Beyond Fines’ Financial Times (28 March 2017), available at www.ft.com/content/ f50ca092-13ab-11e7-80f4-13e067d5072c accessed 7 December 2017. See also Lloyds Group shareholders action; see note 69.

References Adegbite, E. ‘Corporate Governance Regulation in Nigeria’ (2012) 12(2) Corporate Governance 257. Adewale, A. ‘An Evaluation of the Limitations of the Corporate Governance Codes in Preventing Corporate Collapses in Nigeria’ (2013) 7(2) Journal of Business and Management 110. Aguilera, R. A. and Jackson, G. ‘The Cross National-Diversity of Corporate Governance: Dimensions and Determinants’ (2003) 28(3) Academy of Management Review 447. Bange, M. M. and Mazzeo, M. A. ‘Board Composition, Board Effectiveness and the Observed Form of Takeover Bids’ (2004) 17(4) Review of Financial Studies 1185. Baysinger, B. D. and Butler, H. N. ‘Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition’ (1985) 1(1) Journal of Law, Economics, & Organization 101. Beasley, M. S. et al. Fraudulent Financial Reporting: An Analysis of US Public Companies 1998–2007 (Durham, US, Committee of Sponsoring Organizations of the Treadway Commission 2010). Berle, A. A. and Means, G. The Modern Corporation and Private Property (New York, Macmillan 1932). Bhagat, S. and Black, B. ‘The Non-Correlation between Board Independence and Long Term Firm Performance’ (2002) 27 Journal of Corporation Law 231–273. Bonazzi Livia, B. and Islam, S. M. N. ‘Agency Theory and Corporate Governance: A Study of the Effectiveness of Board in their Monitoring of the CEO’ (2007) 2(1) Journal of Modelling in Management 7. Cardale, M. ‘The Effective Board’ in M. Cardale (ed.), A Practical Guide to Corporate Governance (5th edn, London, Sweet & Maxwell 2014). Carter, D. A. et al. ‘Corporate Governance, Board Diversity and Firm Value’ (2003) 38(1) Financial Review 33. Chambers, A. Chambers Corporate Governance Handbook (7th edn, West Sussex, Bloomsbury Professional Ltd. 2017). Chukwunedu, O. S. et al. ‘Corporate Fraud in Nigeria: A Two Case Study’ (2013) 6(3) International Journal of Research in Management 9. Clark, T. ‘The Contribution of Non-Executive Directors to the Effectiveness of Corporate Governance’ (1998) 3(3) Career Development International Bradford 118. Coffee, J. C. Jr. ‘A Theory of Corporate Scandals: Why the United States and Europe Differ’ in Joseph Norton et al. (eds.), Corporate Governance Post

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Enron: Comparative and International Perspectives (London, British Institute of International and Comparative Law 2006). Commons, J. R. ‘The Problem of Correlating Law, Economics and Ethics’ (1932– 1933) 8(4) Wisconsin Law Review. de Andres, P. et al. ‘Corporate Boards in OECD Countries: Size, Composition, Functioning and Effectiveness’ (2005) 13(2) Corporate Governance 197. Denis, D. K. and McConnell, J. J. ‘International Corporate Governance’ (2003) 38(1) Journal of Financial and Quantitative Analysis 1. Ebimobowei, A. and Sophia, J. M. ‘Mergers and Acquisition in the Nigerian Banking Industry: An Explorative Investigation’ (2011) 6(3) The Social Sciences 213. Eisenhardt, K. M. ‘Agency Theory: An Assessment and Review’ (1989) 14(1) Academy of Management Review 57. Fama, E. E. and Jensen, M. C. ‘Agency Problems and Residual Claims’ (1983) 26(2) Journal of Law and Economics 327. Farrar, J. Corporate Governance: Theories, Principles and Practice (3rd edn, South Melbourne, VIC, Oxford University Press 2008). George, P. (Financial Reporting Council). Available at: https://assets.publish ing.service.gov.uk/media/5329db50e5274a2268000045/financial_reporting_ council_presentation.pdf accessed 4 March 2018. Heiner, R. A. ‘The Origin of Predictable Behaviour’ (1983) 73(4) The American Economic Review 560. Hermalin, B. E. and Weisbach, M. S. ‘The Effects of Board Composition and Direct Incentives on Firm Performance’ (1991) 20(4) Financial Management 101. Hodgson, G. ‘What are Institutions?’ (2006) 40(1) Journal of Economic Issues 1. Huntington, S. P. The Clash of Civilizations and the Remaking of the World Order (London, Simon & Schuster 1996) 43–44. Jacques du Plessis, J. et al. Principles of Contemporary Corporate Governance (3rd edn, Port Melbourne, VIC 3207, Australia, Cambridge University Press 2015). Jensen, M. C. and Meckling, W. H. ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economy 305. John, K. and Senbet, L. W. ‘Corporate Governance and Board Effectiveness’ (1998) 22 Journal of Banking & Finance 371. Kang, H. et al. ‘Corporate Governance and Board Composition: Diversity and Independence of Australian Boards’ (2007) 15(2) Corporate Governance 194. Kiel, G. C. and Nicholson, G. J. ‘Board Composition and Corporate Performance: How the Australian Experience Informs Contrasting Theories of Corporate Governance’ (2003) 11(3) Corporate Governance: An International Review 189. Knight, J. Institutions and Social Conflict (Cambridge, Cambridge University Press 1992). Kosnik, R. D. ‘Greenmail: A Study of Board Performance in Corporate Governance’ (1987) 32(2) Administrative Science Quarterly 163. Makanjuola, Y. Banking Reforms in Nigeria: The Aftermath of the 2009 Financial Crisis (Basingstoke, Hampshire, Palgrave-Macmillan 2015). Mitchell, W. C. ‘Making Goods and Making Money’ in W. C. Mitchell (ed.), The Backward Art of Spending Money (New York, Augustine M. Kelley 1923) 137–148.

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Moore, M. and Petrin, M. Corporate Governance: Law, Regulation and Theory (London, Palgrave 2017). Nee, V. ‘Sources of New Institutionalism’ in M. C. Brinton and V. Nee (eds.), New Institutionalism in Sociology (New York, Russell Sage Foundation 1998) 8–10. North, D. ‘Economic Performance through Time’ (1994) 84(3) The American Economic Review 359. ——— ‘Institutions’ (1991) 5(1) Journal of Economic Perspectives 97. ——— ‘Institutions and Economic Theory’ (1992) 36(1) The American Economist 3. ——— ‘The New Institutional Economics’ (1986) 142(1) Journal of Institutional and Theoretical Economics 230. ——— The New Institutional Economics and Development (Washington, Washington University 1993). North, D. and Wallis, J. ‘Measuring the Transaction Sector in the American Economy 1870–1970’ in S. N. Engerman and R. E. Gallman (eds.), Long Term Factors in American Economic Growth (Chicago, University of Chicago Press 1986). Okike, E. and Adegbite, E. ‘The Code of Corporate Governance in Sub-Saharan Africa: Efficiency Gains or Social Legitimation’ (2012) 9(3) Corporate Ownership and Control 262. Okike, E. et al. ‘A Review of Internal and External Influences on Corporate Governance and Financial Accountability in Nigeria’ (2015) 10(2) International Journal of Business Governance and Ethics 165. Pistor, K. ‘Patterns of Legal Change: Shareholder and Creditor Rights in Transnational Economies’ in M. B. Fox and M. A. Heller (eds.), Corporate Governance Lessons from Transitional Economy Reforms (Princeton, NJ, Princeton University Press 2006). Pope, P. F. et al. ‘Outside Directors, Board Effectiveness, and Earnings Management’ (April 1998). https://ssrn.com/abstract=125348 accessed 30 November 2017. Rhoades, D. L. et al. ‘Board Composition and Financial Performance: A MetaAnalysis of the Influence of Outside Directors’ (2000) 12(1) Journal of Managerial Issues 76. Roberts, J. et al. ‘Beyond Agency Conceptions of the Work of the Non-Executive Director: Creating Accountability in the Boardroom’ (2005) 16 British Journal of Management S5–S26. Roe, M. J. ‘Some Differences in Corporate Structure in Germany, Japan and the United States’ (1993) 102(8) The Yale Law Journal 1927. Rosenstein, S. and Wyatt, J. G. ‘Inside Directors, Board Effectiveness, and Shareholder Wealth’ (1997) 44(2) Journal of Financial Economics 229. Rutherford, M. ‘Institutional Economics: Then and Now’ (2001) 5(3) The Journal of Economic Perspectives 1, 173. Sharpe, N. F. ‘The Cosmetic Independence of Corporate Boards’ (2011) 34 Seattle University Law Report 1435. Shleifer, A. and Vishny, R. W. ‘A Survey of Corporate Governance’ (1997) 52(2) Journal of Finance 737. Smith, A. An Inquiry into the Nature and Causes of the Wealth of Nations (5th edn, first pub 1776, London, Metheun & Co., Ltd. 1904). Solomon, J. Corporate Governance and Accountability (4th edn, Chichester, West Sussex, John Wiley & Sons 2013).

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Uadiale, O. M. ‘The Impact of Board Structure on Corporate Financial Performance in Nigeria’ (2010) 5(10) International Journal of Business and Management 155. Van Ness, R. K. et al. ‘Board of Director Composition and Financial Performance in a Sarbanes-Oxley World’ (2010) 10(5) Academy of Business and Economics Journal 56. Veblen, T. ‘The Preconceptions of Economic Science’ (1900) 14(2) The Quarterley Journal of Economics 240. ——— The Theory of the Leisure Class: An Economic Study of Institutions (New York, Macmillan & Co. Ltd. 1915). Weintraub, R. ‘Neo-Classical Economics’ in David R. Henderson (ed), The Concise Encyclopedia of Economics (Carmel, Indiana, Library of Economics and Liberty 1993). Westfield, M. HIH the Inside Story of Australia’s Biggest Corporate Collapse (Milton, QLD, John Wiley & Sons Australia 2003). Williamson, O. ‘The New Institutional Economic: Taking Stocks, Looking Ahead’ (2000) 38(3) Journal of Economics Literature 595, 598. Wilson, I. ‘Regulatory and Institutional Challenges of Corporate Governance in Nigeria Post Banking Consolidation’ (April–June 2006) 12 (2) Nigerian Economic Summit Group (NESG) Economic Indicators. Yakasai, G. A. ‘Corporate Governance in a Third World Country with Particular Reference to Nigeria’ (2001) 9(3) Corporate Governance 238.

Newspaper and Online Reports Ahmed, K. ‘Tesco, What Went Wrong?’ BBC News (22 October 2014). Binham, C. and Vandevelde, M. ‘Cost of Tesco Accounting Scandal Goes beyond Fines’ Financial Times (28 March 2017). Croft, J. ‘Lloyds Shareholders “Mugged” by Bank over HBOS Takeover’ Financial Times (London 18 October 2017). Sahara Reporters, online (New York 8 October 2010). Sandle, P. et al. ‘Trial to Begin of Former Tesco Executives Accused of Fraud’ Reuters Report (London 25 September 2017). Treanor, J. ‘Lloyds Shareholders’ Court Case over HBOS Takeover Set to Begin’ The Guardian (15 October 2017). Vanguard Newspaper, online (3 October 2009). Vanguard Newspaper, online (28 September 2017). Wearden, G. ‘£2bn Wiped Off Tesco’s Value as Profit Overstating Scandal Sends Shares Sliding: As It Happened’ The Guardian (22 September 2014).

10 Club Theory and Directors’ Performance Evaluation Onyeka K. Osuji

Introduction Directors’ performance evaluation is a critical component of a regulatory framework for corporate governance (OECD, 2015a, p. 53). The G20/ OECD Principles of Corporate Governance (OECD, 2015a, p. 9) underscore this by stating that corporate governance “provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” Performance evaluation promotes directors’ accountability by clarifying their roles and responsibilities and providing relevant information for stakeholder decisions. It can lead to improved directors’ effectiveness by communicating performance expectations, values and standards, identifying skills gaps, experience and development needs, and facilitating efficient skills utilisation of individual directors and boards of directors for the benefit of directors, firms and stakeholders. Accordingly, this chapter proposes an enforced self-regulatory system for directors’ individual and collective performance evaluation that centres on voluntary clubs and is propped up by facilitative public regulation. The central message is that when voluntary clubs are properly and legally equipped to effectively perform corporate governance regulatory roles, directors, shareholders, stakeholders and society can all benefit. The chapter draws on the club theoretical model and the institutional perspective to demonstrate how market players in voluntary clubs can promote good corporate governance for the mutual benefit of market participants, stakeholders and society. While it places corporate governance clubs within regulatory institutional frameworks, the chapter demonstrates the impact of voluntary rules, standards and procedures on individual directors and board effectiveness, and therefore aligns private governance with broader society expectations. It highlights internal, external and independent quantitative and qualitative methods for evaluating board performance and demonstrates how barriers to improvement can be identified and tackled and how positive factors for effectiveness can be recognised and improved on.

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Within the corporate governance landscape, voluntary clubs in the form of corporate governance institutes and institutes of directors are increasingly being established to improve directors’ performance (OECD, 2015b, p. 68). The emergence of voluntary clubs can also be traced to the growing recourse to self-regulation and privatised regulation, especially in the transnational sphere (Buthe and Mattli, 2011). The financial sector is notable for the existence of voluntary clubs (Gorton and Mullineaux, 1987; Tilly, 1989). An example of a transnational financial industry club is the Group of Thirty which is a hybrid think-tank and advocacy organisation that intervenes in both the private and public sectors of financial governance. The group is known for its collective approach, high profile, elite and reputational consistency of membership (Tsingou, 2015). In the financial industry, there are also organisations like International Swaps and Derivatives Association (ISDA), Global Financial Markets Association, European Banking Federation (EBF), Alternative Investment Management Association (AIMA), Futures and Options Association, Investment Management Association, Wholesale Market Brokers’ Association, and London Energy Brokers’ Association (ISDA et al., 2011) that represent different sectors of the industry. Nonetheless, the established linkages between corporate scandals and ineffective corporate governance (Soltani, 2014) draw attention to directors’ performance and heighten the need for examining relevant regulatory frameworks for voluntary clubs. This relates back to the central issue of the need for appropriate regulatory approach to corporate governance. For example, the OECD Policy Framework for Investment (OECD, 2015b) argues that “[w]hile it is the role of businesses to act responsibly, governments have a duty to protect the public interest and a role in providing an enabling framework for responsible business conduct.” However, the G20/OECD Principles of Corporate Governance (OECD, 2015a, p. 13) suggests that “a sound legal, regulatory and institutional framework” for corporate governance can include a mix of “legislation, regulation, self-regulatory arrangements, voluntary commitments and business practices that are the result of a country’s specific circumstances, history and tradition.” In this regard, the club theoretical model facilitates the contextualisation of voluntary clubs in the regulation of private persons for the promotion of public interest in corporate governance. This is also significant due to the debate on the efficacy of voluntary regulation in developing and emerging markets. Stringent regulations are favoured by some due to the institutional environments of developing and emerging markets (Aaronson, 2005). The question then is what can work for those markets. This chapter’s proposal for enforced corporate governance clubs proceeds on the political theory of corporations. The political theory argues that the public-private divide does not apply to corporations and recognises that corporations occupy a distinct “corporate” regulatory

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space (Ciepley, 2013). This corporate space can be populated by mixed regulation methods. This chapter is organised as follows: first, there is an analysis of the club theoretical model which the chapter draws on in framing voluntary clubs in the institutional perspective, second, voluntary clubs are located within the regulation spectrum and third, the chapter examines how voluntary clubs can adapt to enhance their role in improving the performance evaluation and effectiveness of individual directors and boards of directors. The last part examines how the law can underpin voluntary clubs by facilitating an enforced self-regulation system. It outlines the components of the proposed voluntary clubs-based enforced self-regulation system.

Club Theory and Voluntary Clubs Generally, a club normally refers to an organisation of persons that share or pursue a common interest or activity. Therefore, an association of business persons or a code of conduct with business membership is possibly a voluntary club. Voluntary clubs are a common feature of the business environment of networks and alliances for promoting members’ common interests (Ozcan and Eisenhardt, 2009). The marine insurance industry is renowned for its voluntary mutual clubs to which the industry’s survival and success can largely be attributed. For example, the London Steam Ship Owners’ Mutual Insurance Protecting and Indemnity Association, popularly known as the London Club, has been in existence since 1866 and is run by a company limited by guarantee (Watson, 2016). The prevalence of national and transnational voluntary clubs in the financial industry is due to a shared interest in financial stability (Tsingou, 2008; Hafner-Burton and Montgomery, 2009; Bach and Newman, 2010; McKeen-Edwards and Porter, 2013; Oatley et al., 2013; Pagliari and Young, 2014; Selmier, 2014, 2017). Many examples abound across jurisdictions, including the Suffolk inter-bank payment system which is a transnational private cooperative system (Calomiris and Kahn, 1996). There are also some national voluntary clubs in the financial industry. For example, Germany has a privately managed deposit insurance scheme set up in 1975. The scheme’s reliance on peer monitoring by its member banks is reinforced by the country’s concentrated private banking market, strong institutions and anti-insolvency bias (Beck, 2002). India’s Chettiar banking system was a self-regulatory club that operated in the nineteenth century despite the absence of a central bank. It was an endogamy castebased system that provided rules for clearing houses, inter-bank lending and information sharing among banks (Nair, 2016). Nonetheless, the need to protect the public interest when juxtaposed with the nature and functions of voluntary clubs can trigger debates on the role of the law in reshaping clubs. For example, Tilly (1989, p. 197) pointed out that before 1944, the Bank of England was “a private, profit-making

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institution over which the government had no official controls. Increasingly, through most of the 19th century, it did a private business for the expressed benefit of its shareholders, whose annual dividends in the years from 1860 to 1913 have been estimated at 9.6%! Whether its directors pursued their own interests other than that is not easy to verify; but one may note that the directors were recruited by cooptation, not by government appointment, that they represented largely City financial interests.” It was therefore decided that the public interest could be protected only by changing the Bank of England’s private club status to a public body. The club theory offers an approach for understanding and assessing the potential regulatory roles of voluntary clubs. The club theory is underpinned by the institutional perspective that underscores the influence of regulatory environments on the behaviour of regulatory actors, the quality of rules, and compliance and non-compliance costs. The institutional perspective also acknowledges that institutions need not be formal, public or governmental as private arrangements can also constitute institutions. For example, the new institutional economics’ argument that “economic behaviour, whether by individuals or by firms, is affected by the institutional setting in which actors find themselves” (Ohnesorge, 2007, p. 268) reflects the broader approach to institutions and their effect on regulation. This broader institutional approach would include private informal arrangements like voluntary clubs that are organised to promote the members’ shared interests. Pioneered by Buchanan (1965), the club theory identifies clubs as institutions for the production and allocation of excludable benefits of goods that are not fully private or public to members. These goods are also regarded as non-rivalrous for being available for consumption by all club members who make direct payments to club sponsors (Prakash and Potoski, 2007, p. 776). In the traditional economic sense, therefore, the club theory is really about sharing production costs and consumption. However, political economy provides another perspective to the club theory (Potoski and Prakash, 2009; Prakash and Potoski, 2011). This perspective refers to voluntary clubs as requiring monetary and nonmonetary membership costs of committing to the clubs’ goal of production of positive social externalities for society welfare over and above government regulations (Prakash and Potoski, 2007, p. 776). In addition to benefits to society, voluntary club members can individually and collectively also enjoy benefits that non-members are excluded from. This is mainly due to the fact that club membership enables affiliations to the club’s brand and reputation and helps to positively resolve information asymmetries between members and external stakeholders (Prakash and Potoski, 2007, p. 777). Club membership therefore provides an efficient and cost effective mechanism for information gathering by external stakeholders like investors, supply chains, consumers and government regulators to enable them to provide rewards and sanctions in appropriate circumstances.

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The club theory has been applied in fields such as environment, sustainability (Prakash and Potoski, 2006, 2007) and the chemical industry (King and Lenox, 2000), where voluntary programmes are designed and implemented to exceed governmental regulations. An example of such voluntary programmes is ISO 14001 of the International Organisation for Standardisation. ISO 14001 is designed to help firms to comply with governmental regulations and to also improve their environmental performance beyond the prescribed legal standards (Potoski and Prakash, 2004, 2005). Similarly, the UN Global Compact is considered a voluntary club (Berliner and Prakash, 2014) for promoting good standards in areas like human rights, labour standards, environmental protection and anti-corruption. This demonstrates that voluntary clubs can focus on particular issues such as corporate governance. In fact, the emergence of corporate governance institutes and institutes of directors across the globe shows the need for assessing the regulatory roles of corporate governance voluntary clubs.

Voluntary Clubs, Directors’ Effectiveness and Regulation The traditional theoretical perspectives for assessing and facilitating the effectiveness of boards of directors include the agency theory (Hillman et al., 2008; Davis, 2009) and the resource dependence theory (Hillman et al., 2009). The agency theory emphasises the board’s monitoring role on behalf of shareholders and suggests incentives such as independence and compensation to enhance their performance. The resource dependency theory addresses the board’s provision of resources such as legitimacy, advice and external organisational links and links the resources to board performance. In particular, the resource dependence theory focuses on board capital (Lester et al., 2008) and its relationship to resources provision for firms. The concept of board capital refers to human capital factors such as experience, expertise and reputation and the relational capital that covers the network of links to other firms and external entities. Hillman and Dalziel (2003) argue that board capital can affect both the board’s monitoring and resources provision functions, although incentives can play a moderating role. However, information obtaining, processing and sharing at the individual director, board and firm levels can affect the effectiveness of directors, especially the quality of the board’s monitoring role (Boivie et al., 2016). Voluntary corporate governance clubs attempt to plug some of the information gaps by raising awareness and conducting training programmes for directors (OECD, 2015b, p. 68). The club theory can be used to assess the roles of these clubs. By considering private governance arrangements and goals, the club theory is reflective of self-regulation by market participants. This is consistent with the view that regulation is not an exclusive preserve of governments and public agencies. The wider understanding of regulation

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has created room for existing and emerging regulatory spaces occupied by diverse private regulatory bodies applying private social norms, principles and customs and enforcing private rules and arrangements (Rosenau, 1992; Cutler et al., 1999; Lipschutz and Fogel, 2002, pp. 118– 125). Private regulators largely rely on non-coercive “soft” rules manifested in explicit standards, codes of conduct, recommendations and guidelines (Jacobsson and Sahlin-Andersson, 2006, pp. 247–254) on the one hand and tacit norms, conventions and cultural beliefs (McNichol, 2006, p. 351) on the other hand. Consequently, voluntary clubs can subsist within the umbrella of selfregulation, defined as “the possibility for economic operators, the social partners, non-governmental organisations or associations to adopt amongst themselves and for themselves common guidelines .  .  . (particularly codes of practice or sectoral agreements)” (Better Regulation Task Force, 2004, p. 27). However, the rules of voluntary clubs need to be regarded as “obligatory” on member firms and individuals for the clubs to be considered as a self-regulatory scheme. The obligatory element of rules and practices is a critical component of self-regulation that distinguishes it from mere cooperation (Cutler, 2002, pp. 27–28). As shown below, obligations under voluntary arrangements are dissimilar to binding obligations imposed by the law although the law can underpin privately agreed obligations through enforced self-regulation (see Figure 10.1).

Voluntary Clubs and Directors’ Performance Evaluation The club theory distinguishes voluntary clubs using different criteria. Voluntary clubs can be “mere gestures, ” “lenient” or “stringent, ” a classification scheme that reflects their approach to governmental regulations (Prakash and Potoski, 2007). Voluntary clubs are mere gestures when there is no real attempt to comply with regulations and the clubs refrain from imposing non-compliance costs on the members. While lenient clubs normally focus on compliance with minimum government regulations, stringent clubs demand higher standards and commitment to social objectives from their members and impose non-compliance costs. Nonetheless, stringent clubs actually exist in a spectrum which has professional self-regulatory bodies at one end (see Figure 10.2). Professional self-regulatory schemes can be distinguished from pure business clubs due to certain attributes of the former. Generally, professional selfregulatory regimes have the core functions of providing entry standards and training, rule making, monitoring and enforcement, complaints and disciplinary processes (Clementi, 2004). The entry standards and barriers to professions in addition to “ongoing disciplinary arrangements” are “designed to ensure a high level of competence and probity” (McGee, 1999, pp. 154–155). In most cases like the legal profession, professional

Free Market

Pure SelfRegulation {Individuals, Firms}

(Mere Gesture/Lenient) Voluntary Clubs

Private Regulation

Public Regulation

Pure Self-Regulation {Mere Gesture/Lenient Voluntary Clubs}

Disclosure

Pure Co-Regulation {Lenient/Stringent Voluntary Clubs}

Prescriptive Regulation

Enforced Self-Regulation {Stringent Voluntary Clubs}

Alternative Regulation {Voluntary Clubs}

Pure Co-Regulation {Lenient/Stringent Voluntary Clubs}

Enforced SelfRegulation {Stringent Voluntary Clubs}

Figure 10.1 Enforced Self-Regulation and Voluntary Clubs

Professional Self-Regulation

Pure Business Association

Stringent Voluntary Clubs

Figure 10.2 Stringent Voluntary Clubs

Entry standards Entry barriers Training Monitoring Enforcement Complaints procedures Disciplinary processes Fiduciary provisions Higher professional standards

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rules define the relationship between professional service providers and their counterparts as a fiduciary one. This enables the protection of persons dealing with the professionals to be bound by higher professional standards. These qualities, which suggest the relative success of selfregulation in professions, are largely absent in pure business clubs. The existing corporate governance clubs appear to the business club model and do not normally operate as professional self-regulatory bodies. Therefore, there may be the need for corporate governance voluntary clubs that desire to have a real influence on the conduct of member firms and individuals to mirror professional self-regulation as much as possible by adapting some of the latter’s features. In any event, efficiency is essential to the success of voluntary clubs as self-regulators. This is an issue of regulatory design and implementation because poorly designed measures can result in complexity and disproportionate compliance costs for performance evaluation. Although there is widespread support for the view that self-regulation enjoys cost advantages in compliance, administration and enforcement over prescriptive legal regulation (Better Regulation Commission, 2008, p. 15; Cutler, 2002, p. 31; Milgrom, et al., 1990; Ogus, 1994; Ogus, 1995, pp. 97–98; Posner, 2007; Sealy, 1984, pp. 26–29), cost is really a logical consequence of any regulatory system, whether external or internal. Nonetheless, high implementation costs (Wolf, Jr., 1994, pp. 162–163) can defeat regulatory aims irrespective of the regulators’ status. Corporate governance voluntary clubs therefore, need to avoid unnecessary and expensive requirements and formalities.

Voluntary Clubs and Transmission of Corporate Governance Values Corporate governance relates essentially to arrangements for management and administration of firms which are private entities and, as such, mechanisms like voluntary clubs can be used to promote it and the values necessary for its sustenance. In this regard, values are “general standards by which we formulate attitudes and beliefs and according to which we behave” (Posner et al., 1987, p. 376). Through the values they espouse, voluntary clubs can provide real meanings to the wide-ranging strategic, management, planning, monitoring, selection, rewarding and reporting functions of the board highlighted in the G20/OECD Principles of Corporate Governance (OECD, 2015a, pp. 47–54). Values can be transmitted to individuals and groups at different levels. Voluntary clubs for promoting performance evaluation and board effectiveness can be organised at industry, national, transnational and levels of potential shared values. Industry clubs seem to have several advantages over cross-sector clubs. Firms and business persons in particular sectors may have a common reputation to protect and are easier to organise for

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that reason. A collective identity (Kelman, 2006; Thornton et al., 2012) can engender the need for mutual trust and commitment. For instance, despite the apparent fierce competition in the banking sector, bankers’ common concern is the stability of the financial system (Murphy, 1994, p. 133). As the 2008 global financial crisis exemplified, problems in a firm can affect the reputation of other participant firms and the banking industry. This kind of industry impact also prompted the Bank for International Settlement to initiate the Basle Accord on Capital Adequacy due to the “effect of bank failures on the international financial system” (Braithwaite and Drahos, 2000, pp. 103–105). Moreover, it may be easier for voluntary clubs organised at the industry level to be aware of international best standards for that industry and incorporate and implement them in an accessible manner to the members and prioritise issues according to their importance to the industry. For example, the Basle Accord facilitates “international convergence of capital measurement and capital standards” and includes standards on issues such as authorisation, bank secrecy, external audit and information flows (Braithwaite and Drahos, 2000, pp. 103–105). While an exclusive banking club can easily reference the principles and standards of the Basle Accord, a more general non-banking club may not attach prominence and significance to them. Nevertheless, defining sectors can be problematic. There are business areas that undergo constant changes in terminology and practices and sometimes differ from country to country. For example, the banking, insurance and financial services sectors are not easily definable due to the fluidity of practices and participants. Innovative technologies have also had impacts on the nature and classification of business, leaving a terrain that can confuse policymakers and regulators (Osuji and Amajuoyi, 2015). However, these factors equally suggest that voluntary clubs of industry practitioners are in a good position to define their activity and design appropriate rules and standards of conduct for evaluating performance and effectiveness in that activity or sector. The clubs and their members will be able to identify sub-sectors and peculiar issues they may present, and the clubs can formulate provisions for the industry and its sub-sectors. Moreover, the more homogenous are clubs and their members, the more the likely the members are to identify with the club. The members’ shared identity facilitates mutual trust and confidence that has an impact on members’ relationships and conduct. The shared professional identity of accountants is an example (Brouard et al., 2017). In professional self-regulation such as accounting (Mescall et al., 2017), members’ close affinity to business associations can improve the quality of intraassociation disclosure, but the members are reluctant to make disclosures to outsiders such as public bodies. This is due to the members’ shared motivation for promoting professional private interests that the business association represents (Parker, 1994).

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Nevertheless, self-regulation may not be able to compel firms and individuals to behave in a responsible manner in the absence of sanctions and other consequences such as financial benefit and loss. Sanctions indicate an expectation of non-compliance costs for violating the applicable rules and standards, and when sanctions are lacking, attachment of responsibility for conduct is unrealistic. Voluntary clubs therefore need to tackle free-riding (Delmas and Keller, 2005) and ineffectual members’ commitments, which are some of the criticisms of business self-regulation. For example, the UN Global Compact as a voluntary club (Berliner and Prakash, 2014), is noted for its members’ shirking of obligations. The UN Global Compact has consequently been unable to make a meaningful impact despite its laudable commitments (Sethi and Schepers, 2014; Junaid et al., 2015). Free-riding and shirking can be addressed by effective monitoring and sanctions that increase the “costs of non-compliance” (Berliner and Prakash, 2014, p. 219). In the absence of sanctions, “benefits” of self-regulation also apply to organisations that refrain from participating or do not participate fully in the system (Gunningham and Rees, 1997, p. 393; Lenox and Nash, 2003; Sullivan, 2006, p. 186). In addition to promoting the credibility of voluntary clubs, non-compliance costs can provide information signals for stakeholders to “easily and confidently distinguish leaders (members) from laggards (non-members)” and extend appropriate reward and punishment (Prakash and Potoski, 2007, p. 779). Non-compliance costs can, for example, include publication of evaluation results, disciplinary proceedings and warnings. In addition to anticipating post-event non-compliance costs, voluntary clubs can make provisions for proactive and preventative promotion of good corporate governance which will include education and training. As noted previously, the success of professional self-regulation can be attributed to training provisions and other factors. Similarly, corporate governance voluntary clubs may need processes to ensure the education, training and continuous development of existing and potential directors and firms. These processes will raise and sustain awareness of international best practices, industry ethical standards and non-compliance costs. Education and training, for example by club-affiliated and independent institutes, can form the academic and vocational qualifications criteria for initial and continuing membership and can also be a monitoring and enforcement mechanism. It can help to increase the pool of human capital to serve as well-informed executive, non-executive and independent directors across an industry and encourage a problem-solving mind-set in addition to industry technical skills. Furthermore, voluntary clubs may need vibrant research and development divisions to enable them to gain and communicate knowledge of best international standards and practices. This also encourages evidence-based practices that will facilitate understanding of what works for particular sectors or jurisdictions.

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Limitations of Disclosure in Performance Evaluation There is no doubt that disclosure is an important component of regulation and is, in fact, a popular self-regulatory method by voluntary clubs. The G20/OECD Principles of Corporate Governance (OECD, 2015a, pp. 37–44) suggest that disclosure has a core role in promoting corporate governance. However, exclusive reliance on members’ disclosure has attracted criticism of self-regulatory schemes such as the UN Global Compact (Sethi and Schepers, 2014). This is due to the absence of mechanisms for ensuring that what is disclosed is in fact accurate, sufficient and reflects regulatory requirements and objectives. Secondly, enforcement is unlikely despite its critical role in ensuring that reality conforms to appearance, and infringements of the club rules and standards attract appropriate costs and consequences. Corporate governance clubs will need to engage in more substantive regulation of directors’ performance evaluation than simply requiring disclosure from firms and individuals (see Table 10.1 Voluntary Clubs’ SelfRegulatory Measures). In addition to disclosure, the clubs’ self-regulatory schemes can include substantive regulation components such as investigation, monitoring and verification by clubs, peers and independent persons. For example, professional auditing of reports (Manetti and Becatti, 2008) can help to ensure the accuracy of individual director and board performance reporting and improve the quality of performance evaluation and the credibility of the clubs’ self-regulatory schemes. Peer review can accompany disclosure to enhance the voluntary clubs’ credibility in promoting performance evaluation. The individual and collective reputation of voluntary clubs and their members will depend on

Table 10.1 Voluntary Clubs’ Self-Regulatory Measures Self-Regulatory Measures

Nature

Industry/Sub-sector Organisation Free-Riding, Shirking Education, Training, Research Post-Event Compliance Costs Disclosure, Substantive Regulation Efficiency Certification, Labelling

Design, Implementation

Peer Review, Monitoring, Verification, Enforcement Stakeholder Enforcement Dispute Resolution

Design, Implementation Design, Implementation Design, Implementation Design, Implementation Design and Implementation Design, Implementation, Enforcement, Compliance Costs Design, Implementation, Enforcement, Compliance Costs Design, Implementation, Enforcement, Compliance Costs Design, Implementation, Enforcement

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stakeholders’ confidence on the quality and rigour of verification mechanisms for members’ disclosures. Moreover, private arrangements such as business association membership and certification can constitute the basis for external evaluation of members’ performance, for example in social and environmental matters (Fransen, 2013, p. 217). Since reputation can be “a collective representation of a company’s past actions and future prospects and describes how key resource providers interpret a company’s initiatives and assess its ability to deliver valued outcomes” (Fombrun, 2001, p. 294), it is therefore the role of voluntary clubs to design and implement appropriate and consistent substantive regulation for performance evaluations and to ensure that reputations are true and well earned. This may require the clubs to maintain regular and efficient peer review mechanisms that can even rely on external or independent expertise, especially when reviews require “outside” expertise or reviewers need to have broad experience. Similarly, voluntary clubs can design and implement certification provisions with limited validity for individual directors and boards of directors. Certification can be generated from a combination of general and specific disclosures, peer review assessments, independent assessments, corporate statutory filings and other sources that can identify and align with performance indicators. It can use a scoring or ranking system that may be publicly available or be restricted to the club membership. This is a form of corporate governance “performance-labelling” for individual directors and boards of directors. It is similar to labelling schemes that are increasingly used by firms, business associations and independent agencies in different areas of public interest. The “fair-trade” movement is one example that links firms to their supply chains and consumers’ ethical concerns. The movement uses certification, labelling, monitoring and inspection as regulatory methods. It has been noted that the monitoring and inspection systems are critical to the effectiveness of the fair-trade movement (Dine and Shields, 2008, p. 144; Nicholls and Opal, 2005, p. 129). Another example is eco-labelling in environmentally sensitive fields such as the forestry sector (Meidinger, 2006). An eco-label is “a claim placed on a product, having to do with its production or performance, that is intended to enhance the item’s social or market value by conveying its environmentally advantageous elements” (Lipschutz and Fogel, 2002, p. 134). Eco-labels can contain claims by producers, in which case the only guarantee of accuracy is the producer’s reputation. Industry or industry-related bodies such as trade associations can also establish relevant criteria and conduct labelling for a sector. An example of wider industry labelling is the International Organisation for Standardisation (Cascio et al, 1996). The third type of labelling is normally an “independent” procedure by a “government agency, a non-profit group, a forprofit company, or an organization representing a combination of these three” (Lipschutz and Fogel, 2002, p. 134).

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Rather than affix labels on products and services, voluntary clubs can design schemes for highlighting the performance and effectiveness of individual directors and boards of directors using identifiable and verifiable criteria. This is consistent with the directors’ individual and collective responsibilities as legally recognised in English law, for example.1 In Re Westmid Lord Woolf MR stated that “the collegiate or collective responsibility of the board of directors of a company is of fundamental importance to corporate governance under English company law. That collegiate or collective responsibility must however be based on individual responsibility. Each individual director owes duties to the company to inform himself about its affairs and to join with his co-directors in supervising and controlling them.”2 When certification is coupled with voluntary clubs’ self-regulation, it may, for instance, mean that individuals need club certification to gain and remain in employment, and firms need certification to engage in certain activities or to be allowed to have certain members as business partners.

Promoting Accountability in Performance Evaluation While disclosure obligations are not sufficient for effective self-regulation by voluntary clubs, rules, standards and codes of conduct are inadequate without monitoring and enforcement. Regulation may set standards and rules of conduct, but enforcement helps to translate the values reflected in those rules and standards into actual social reality. One of the criticisms of private self-regulatory systems is the lack of monitoring and enforcement provisions, which in turn impede their effectiveness (Vogel, 2005, p. 164). Voluntary clubs therefore need effective monitoring and enforcement processes to be successful self-regulatory regimes. This is to promote accountability as part of the directors’ performance evaluation. Frink and Klimoski (1998, p. 9) described accountability as the “perceived need to justify or defend a decision or action to some audience(s) which has potential rewards and sanctions power, and where such rewards are perceived as contingent on accountability conditions.” Sanctions are therefore a key component of accountability. The effectiveness of voluntary clubs may depend on the availability of clear and enforceable redress avenues and sanctions within the clubs’ regulatory and enforcement scheme. The availability of sanctions will not detract from the clubs’ selling point as voluntary self-regulatory systems even if legal mechanisms are required to apply and enforce sanctions. For example, the UK City Panel on Takeovers and Mergers provided for sanctions even before it gained statutory recognition in Chapter 1, Part 28 of the UK Companies Act 2006. Non-compliance with the findings of the Panel could be a sanctions-attracting “regulatory offence.” The sanctions for non-compliance could include de-listing of offending firms by the Stock Exchange (Leader and Dine, 1998, pp. 221, 225).

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Furthermore, it is important to incorporate the stakeholder corporate governance model (Bridoux and Stoelhorst, 2014; Shahzad et al., 2016) to improve the effectiveness of self-regulatory regimes. A stakeholder enforcement model means that to promote directors’ effectiveness, voluntary clubs need to move on from the shareholder primacy model of corporate governance due to a number of factors. First, modern firms are often large with diversified shareholdings across different countries. In large enterprises, shareholders really constitute “an amorphous mass of people” (Crowther, 2004, p. 50). Secondly, many modern firms, especially the large ones, operate as multinational enterprises directly or indirectly through subsidiaries and affiliates in countries with diverse social and economic issues, which makes it difficult to combine shareholder interests and actions transnationally. Thirdly, directors are in a more dominant position than shareholders, especially in the Anglo-American corporate governance model with limited shareholder control of management. For instance, a US-based research study concluded that “shareholder litigation is a weak, if not ineffective, instrument of corporate governance, [and that] the principal beneficiaries of the litigation .  .  . appear to be the [claimant’s] attorneys” (Romano, 1991, p. 84). In the UK, derivative claims have had a modest impact despite the provisions of the Companies Act 2006 (Almadani, 2009; Gibbs, 2011; Gray, 2012). The US and UK embody the shareholder primacy corporate governance model that relies heavily on the shareholders’ central corporate governance role that includes directors’ performance evaluation and remedial measures. Nevertheless, cases like the BHS collapse in the UK (House of Commons Work and Pensions and Business, Innovation and Skills Committees, 2016) highlight difficulties that confront the shareholder primacy paradigm particularly when the board is incompetent, unable or unwilling to perform effectively. Another striking example is the Grasso case3 on the compensation packages for Richard Grasso who was the chairman and chief executive officer of the New York Stock Exchange between 1995 and 2003. In a public interest suit, the New York State Attorney General challenged the compensation packages agreed by the compensation committee handpicked by Mr Grasso and approved by the company’s board for being excessive and unreasonable. Although the Attorney General described the compensation packages as manifesting “a fundamental breakdown of corporate governance, ” the acquiescence of the appropriate corporate organs to Grasso’s compensation ultimately aborted the suit. The Attorney General relied on a statute that did not envisage public interest suits as a remedy for deficiencies in private corporate governance systems that enabled appropriate corporate organs to exercise business judgement, even if their decisions would be considered unreasonable. The weaknesses of the shareholder primacy model suggest the need for an alternative paradigm which the stakeholder model provides. In fact, the G20/OECD Principles of Corporate Governance (OECD, 2015a, pp. 35,

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46–47) suggests some roles for stakeholders in tackling illegal and unethical practices. A stakeholder model will recognise corporate and individual members of voluntary clubs as stakeholders with rights and obligations. The stakeholder model may allow professional advisers, business partners and independent agencies recognised by the voluntary clubs to raise concerns and complaints. Nonetheless, a limited stakeholder model is favoured to link enforcement interest to club membership or club rules and to align well with the private nature of voluntary clubs. It may mean that voluntary clubs need to have clearly designated, prompt and efficient dispute resolution procedures. These procedures, which can be within the clubs’ internal governance system or contracted out to independent agencies such as arbitral tribunals, can be more efficient than the regular judicial administration system. Similarly, some more recent international free trade agreements reflect the self-regulation approach by providing for private international commercial arbitration as the preferred dispute resolution mechanism instead of domestic judicial determination (Cutler, 2002, p. 31; Cutler, 2000; Picciotto and Mayne, 1999; Scheuerman, 1999).

“Enforcing” for Voluntary Clubs and Performance Evaluation Having shown that voluntary clubs can be used to promote board performance evaluation and effectiveness, the next issue is whether the clubs need external support, for instance the government using the instrumentality of the law. This issue relates to the broader debate on the effectiveness of self-regulatory schemes like voluntary corporate governance clubs. It is helpful that the G20/OECD Principles of Corporate Governance (OECD, 2015a, p. 13) acknowledge the need for both public and private regulation for corporate governance. Nonetheless, there is the question of the extent of the law, and whether its broad statement of public interest objectives can engage cooperatively with the self-regulatory schemes of voluntary clubs established to serve private members’ interest. For example, the telephone hacking scandal in the UK led to the acknowledgment of the failure of pure self-regulation by the Press Complaints Commission. The Leveson Inquiry (2012) recommended the creation of an industry body backed by legislation with the power to formulate and implement a code of conduct. This recommendation has not been implemented (BBC, 2016). Pure self-regulatory schemes are usually voluntary and lack the compulsive element of legislation and governmental support. Having been “viewed as essentially derived from contract” (Milman, 1999, p. 6), selfregulatory systems can exist independently of governments and formal legal systems and rely on private customs and contracts. There are some historical examples of self-regulatory systems (Braithwaite and Drahos, 2000; Lipschutz and Fogel, 2002, p. 121; Murphy, 1994). For instance, self-regulatory schemes in the legal and medical professions originated

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from medieval guilds, although these professions are now generally backed by legislation (Lipschutz and Fogel, 2002, p. 121). Similarly, medieval merchants created privately administered rules enforced in private tribunals that were independent of the legal system. The present private international trade law (or transnational commercial law) was pioneered in the medieval merchant system (Cutler, 2002, pp. 485, 30–31). However, the medieval examples of self-regulation where relatively small-sized and homogenous communities had incentives for fair practices could not justify self-regulation in modern business that seems to promote self-interest and profit (Corkin, 2008, pp. 47, 58–59). This is one of the criticisms of pure self-regulation. There is also the issue of legitimacy, which can be a difficult hurdle for self-regulatory schemes (Ogus, 1995, p. 98). Legitimacy requires that accountability mechanisms should be trusted when authority is delegated (Scott, 2000, p. 39), including by self-regulation. While legislation generally confers legitimacy, pure self-regulatory arrangements often limit debates to business executives. The result is that such arrangements can be “opaque and non-democratic as well as limited in scope” (Lipschutz and Fogel, 2002, p. 121). Moreover, sanctions imposed under selfregulatory schemes are more likely to be exposed to the risk of legal and other challenges if they do not have some legal backing. This is illustrated by Datafin4 and other cases brought against the UK Takeover Panel prior to its legislative endorsement. There is also a close link between legally reinforced rules and the desire for effective enforcement. Some argue that systems for creating a “maximum level of welfare for the maximum number of people” cannot afford to leave economic outcomes “entirely” (Smith and Walter, 2006, p. 228) to free market and pure self-regulation. In contrast to governmental regulation, self-regulatory bodies have limited sanctions and enforcement options. When legal backing is lacking, self-regulatory schemes will largely depend on reputation-focused extra-legal enforcement that may not be sufficient deterrence for recalcitrant persons. For example, Robert Maxwell was not deterred by corporate codes of practice while engaging in fraudulent activities as the dominant director of UK’s Mirror Group Newspapers (Ferran, 2001, p. 405). This prompted the investigating inspectors to recommend the enactment of legislative provisions and effective sanctions in addition to non-statutory corporate governance codes (TSO, 2001, para. 23.77). Voluntary clubs can represent pure self-regulation if they are uncoupled to statutory schemes and objectives. While self-regulation is closely linked to voluntarism, there are cases of self-regulatory schemes that are backed by the law and legally enforceable (Glinski, 2006). Legislative and other legal backing for corporate governance voluntary clubs can therefore be helpful in strengthening their regulatory and enforcement framework. This is a form of co-regulation which, in general, combines

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governmental regulation with self-regulation by firms, industry or trade associations autonomously or with the involvement of independent parties. Co-regulation using voluntary standards, and legal precepts can be particularly useful if business self-interest can clash with broader social expectations (Vogel, 2005, pp. 163–173). However, co-regulation can be distinguished from “enforced self-regulation” (Ayres and Braithwaite, 1992, pp. 101–112; Fairman and Yapp, 2005). As Saurwein, (2011, p. 351) stated, pure co-regulation is “carried out by private actors that operate on an explicit unilateral legal basis . . . which explicitly delegates regulatory powers from government to non-governmental actors.” While pure co-regulation is when the industry or trade association is the regulator and enforces rules it has formulated, enforced self-regulation is when rules originating from the regulated industry are enforced using administrative or governmental enforcement mechanisms. Compared to external governmental regulation, enforced self-regulation is arguably more flexible and cheaper to adopt. Enforced self-regulation is an ideal approach to corporate governance voluntary clubs due to the possibility of relying on the law’s coercive mechanisms, while applying industry-formulated flexible and technical rules of conduct. It addresses responsiveness of business practices, which is a concern in technical regulation (Riley, 2002, p. 187), by enabling statutory statements of broad objectives of corporate governance and directors’ performance and effectiveness, which are not dependent on technical factors. There are helpful precedents, for example in the UK tax law that accepts “generally accepted principles of accounting” in the determination of corporate profits.5 This shows that statutory statements of regulatory objectives can help to promote certainty and predictability, while the legislative frameworks anticipate the need for a dynamic regulatory scheme by supporting the voluntary clubs’ procedures and processes. This enables the clubs to play similar roles to subordinate legislation in providing detail and flesh to the bare statutory framework. The roles can even lead to greater scrutiny of voluntary clubs’ members and the establishment of higher standards for the clubs and their members. As the private interest professional accounting ethics model (Parker, 1994) shows, increased external or governmental pressure often expands the scope of self-regulatory measures and disciplinary sanctions that are aimed at demonstrating self-regulatory competence to ward off external regulation. In any event, the law’s role is to set guidelines and, when necessary for regulatory objectives, the law needs not be bound by expert or industry practice.6 In certain situations, the law needs to provide less flexible overarching rules for application by voluntary clubs. For example, the concept of fiduciary duty in company law is usually inflexible, 7 to the extent of forbidding its exclusion by private contracting (Clark, 1985, p. 55).

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Moreover, the law may deliberately refrain from securing the support of the regulatees and is enforced despite their reluctance (Better Regulation Commission, 2008, p. 13). For example, the European Commission imposed a compulsory delays and cancellations compensation scheme for air passengers through Regulation (EC) 261/2004 of the European Parliament and Council despite the active opposition of the airline industry that failed to provide one by self-regulation.8 Nonetheless, enforced self-regulation respects the private and voluntary character of corporate governance clubs and can promote meaningful cooperation and effective regulatory collaboration between regulators and regulates, especially in designing and implementing evidence-based rules and standards. The financial industry clubs’ role in the Basel Committee on Banking Supervision (Young, 2012) exemplifies the potential collaborative impact of clubs on the quality and legitimacy of regulations. As the Better Regulation approach recognises, regulation can be more effective if it receives industry support (Better Regulation Commission, 2008, p. 36). Voluntary clubs can provide collective identities (Kelman, 2006; Thornton et al., 2012; Brown et al., 2018) that are critical to norm observance and rule compliance. Furthermore, changing the expectations of the persons affected by legislation aids the effectiveness of legislation and observance of its tenets (McGee, 1999, pp. 158–160). Voluntary clubs can help to establish, sustain and spread regulation-aligned culture across their industry. When mutuality of regulation and industry culture is absent, rules may be observed more in the letter than in the spirit, and regulatory loopholes are easily exploited. In those situations, voluntary clubs exist as mere gestures and cosmetic attempts to mask reality. Nonetheless, the prevalence of creative compliance in the business world (McBarnet, 2005, 2007, pp. 47–54)suggests the desirability of enforced selfregulation by allowing rules and standards to be aligned with industry input and in cognisance of actual practices. Enforced self-regulation can also facilitate public scrutiny for enhancing the effectiveness of self-regulation by corporate governance voluntary clubs. In professional, self-regulation like accounting (Mescall et al., 2017), a correlation exists between increased public scrutiny and more stringent self-regulation measures. Another potential role of corporate governance clubs is to facilitate the resolution of jurisdictional disputes between regulators in a matter like corporate governance that may have transnational implications. For example, due to its network structure and interdependence the transnational finance industry actively sought the resolution of jurisdictional disputes between the US and the European Union and its member states (AIMA, 2009a, 2009b; ISDA et al., 2011; BBA, 2012; Quaglia, 2017).

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“Enforced” Components of Performance Evaluation The voluntary clubs-based enforced self-regulatory scheme for board effectiveness and corporate governance requires a number of components (see Figure 10.3). The starting point is facilitative governmental regulation which is imperative for four main reasons. First, a prescriptive approach will confute the clubs’ voluntary character which is essential to their legitimate existence in the view of members. Second, directors’ effectiveness in some sectors may well depend on technical factors that government and external agencies may not be conversant with and therefore unable to properly regulate prescriptively. Moreover, industry self-regulation can tackle complex and technical issues requiring high levels of expertise (Better Regulation Commission, 2008, pp. 7, 32). Third, facilitative regulations that respect industry voluntary arrangements and customs are more likely to enjoy widespread industry support. The commercial community often follows “customary law, ” arising voluntarily and spontaneously industry practices (Benson, 1989). Fourth, firms and business persons generally display reluctant and even hostile attitudes towards prescriptive regulations, including a “code of prescriptive rules or bureaucratic supervision by some central government agency” (Sealy, 1984, p. 22) and, believing that the law only “facilitates the conduct of trade, ”9 favour facilitative regulations.

Licencing A facilitative regulation can include broad objectives and standards that corporate governance voluntary clubs need to meet to gain legal

Individual and Firm Licensing

Individual Responsibility

Facilitative Governmental Regulation and Voluntary Clubs

Membership Disclosure

Legal and Judicial Enforcement

Figure 10.3 Facilitative Regulatory Reinforcement of Voluntary Clubs

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recognition. This can involve a statutory licensing scheme that addresses regulatory overreach concerns and enhances the legitimacy of voluntary clubs from the perspectives of the members and stakeholders. The facilitative regulation can also incorporate licensing requirements for individuals and firms that will enable voluntary clubs to design and implement detailed rules for actualising broad regulatory objectives. The clubs are in a good position to apply specialist field knowledge to determine issues like qualification and eligibility of individuals and firms. These issues are potential areas of corporate governance according to the G20/OECD Principles of Corporate Governance (OECD, 2015a, p. 40). A similar regulatory approach appears to exist in professional football organisation in England where the Football Association (2017) is empowered by the UK Border Agency, which previously managed football work visas directly, to provide detailed rules for the implementation of a points-based work permit system for foreign footballers from outside the European Union. The Football Association has, among other rules, provided sponsorship eligibility and application guidelines, and individual eligibility criteria consisting of a percentage of international matches played and national team ranking over a certain period. There are also work permit rules for foreign football managers, assistant managers, directors of football and performance managers. Club Membership Disclosure Even if membership of voluntary clubs is not compulsorily required, facilitative regulation needs to require individual directors, boards of directors and firms to disclose whether or not they are club members and subscribe to the clubs’ goals and codes of conduct. Mandatory disclosure of this type reflects enforced self-regulation by enabling a more effective self-regulation by market participants through the disclosure of relevant, timely and accurate information. When disclosure is publicly available, the market is empowered to play a regulatory role. While the market approach proceeds from the belief that pressure from investors and other market participants can and do influence corporate behaviour (Romano, 1998), the market influence is by reference to reputation that disclosure helps to establish. For example, references to the US Model of Business Principles (Scherer and Smid, 2000) and the UN Global Compact (Sethi and Schepers, 2014) can suggest to consumers that the firms are committed to promoting and responding to social and environmental issues. Similarly, the reputation derived from club membership can create and build brands that attract or repel investors, consumers and other market participants due to their expectations and perceptions of consistency of performance. Therefore, reputation can motivate firms to improve the corporate governance standards and the quality of directors’ performance evaluations.

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Moreover, commitments to the ideals of voluntary clubs can determine the boundaries of legal responsibility for firms and individuals. For example, the courts can reference codes of conduct of clubs in determining the reasonableness of commercial decisions. The courts normally acknowledge that “in all commercial matters where commercial people are much better able to judge of their own affairs than the court is able to, the court is accustomed to pay the greatest attention to what commercial people who are concerned with the transaction in fact decide.”10 On the one hand, this reflects deregulation, but on the other hand, the standards of the commercial community can assist the imposition of legal responsibility and resolution of disputes surrounding business conduct. For example, in the Batco Tobacco case, 11 the defendant firm’s annual report affirmed its commitment to the OECD Guidelines on corporate governance (OECD, 1999) which, among other matters, required firms to notify trade unions of any plans to relocate corporate operations. In an action brought by a trade union against the firm for non-compliance with the notification provisions, a Netherlands court held that the reference in the firm’s annual report to the OECD Guidelines on corporate governance was “not without significance.” Therefore, mandatory disclosure can indirectly compel firms to commit to industry best standards in the codes of conduct of voluntary clubs the market will ordinarily expect firms to belong to in order to gain good reputation and compete with others. Mandatory disclosure can also rely on market forces to achieve regulatory policy objectives indirectly by enabling the market to exert pressure leading towards the desired outcomes. By highlighting relevant reputation through disclosure, there are links to adverse consequences for disregarding regulatory goals and public expectations. For example, the obligatory disclosures of the US Toxics Release Inventory (Fung and O’ Rourke, 2000) and the Carbon Disclosure Project (Depoers et al., 2016) appeared to have resulted in substantial emissions reduction. Nevertheless, the Volkswagen car emissions scandal (Rhodes, 2016) demonstrates that disclosure obligations need to be backed up by sanctions, non-compliance costs and other consequences for inaccurate and misleading statements. Individual Responsibility Measures for promoting directors’ effectiveness need to recognise that even when firms appear to be doing well, the conduct and performance of individual directors and other management officers affects the board of directors and the firm. However, company laws of various jurisdictions (Mohanty and Bhandari, 2011) traditionally exclude personal liability of directors in carrying out functions on behalf of firms due to the twin concepts of corporate personality and limited liability.12 This can have an impact on directors’ performance and effectiveness by insulating them from liability. As previously noted, however, company law also recognises

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that directors have individual and collective responsibility in the performance of their duties. For example, in Re Barings plc (No. 5), Jonathan Parker J. observed that “Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them properly to discharge their duties as directors.”13 Explicit statutory statements linking the voluntary clubs’ codes and standards to director disqualification is one useful way of attaching individual responsibility. References to legally non-binding codes such as the UK Corporate Governance Code14 can ensure the flexibility that may be required for determining appropriate standards which voluntary clubs as industry representatives are in a position to identify from time to time. A statement that the courts disqualify directors for conduct that “fell short of the standard of conduct which is today expected of a director of a company which enjoys the privilege of limited liability”15 indicates that there could be various means for determining appropriate standards of director conduct. In fact, English cases suggest that director disqualification can reflect commercial practices and needs not be exclusively based on statutory duties.16 For example, directors have been disqualified for unfitness arising from lack of “probity and competence”17 and “commercial morality.”18 As the sources of standards for director conduct and performance evaluation can be formal and informal institutions (Osuji and Moore, 2017, pp. 272–273), voluntary clubs can play a significant role in disqualification procedures. Therefore, the role of voluntary clubs can be strengthened and individual responsibility can be promoted by linking the grounds for director disqualification to codes and standards of appropriate clubs. Enforcement As privately established mechanisms, private clubs can align well with the members’ expectations and values which can help to confer legitimacy. When legitimacy is perceived to exist, members are more likely to comply with voluntary clubs’ rules and standards. Generally, rule compliance may be instrumental (due to the deterrent value of penalties or attractiveness of incentives) or normative (in the sense of judgement or attitude arising from personal morality or perceptions of legitimacy) (Tyler, 2006, pp. 3–5). However, there is sometimes an “amoral sub-group of the population” (Shavel, 2004, p. 624) in society to who legitimacy provides an insufficient incentive for rule compliance. Notwithstanding the desire for normative compliance in voluntary clubs, recourse to instrumental rules can therefore enhance compliance, especially for those that need to be “persuaded” by reward and punishment. Due to its coercive elements, the law occupies a unique position when there are “habits of obedience on the

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part of all but an anti-social residuum” (Pound, 1997, p. 80). In contrast to voluntary clubs, the law can provide far reaching consequences that can compel instrumental compliance. As Pound (1997, p. 80) explained, “the acid test of theories of law is the attitude of the bad man—the man who cares nothing about justice or right or rights, but wants to know what will happen to him if he does or fails to do certain things.” In regulation, private enforcement (under the common law) and direct public regulation compete (Posner, 2007, p. 389). This means that market self-regulation, including voluntary clubs, normally relies on civil litigation as an external enforcement mechanism. Rules of private associations such as sailing clubs, sport federations and companies can be regarded as contractual in nature and effect for the members even when the membership and rules change from time to time and individual members have not negotiated and explicitly agreed to changes.19 Nonetheless, the issue is how enforced self-regulation can improve the accountability and effectiveness of litigation as an external enforcement mechanism for voluntary clubs. This is where express statutory recognition can be significant. Express statutory recognition of voluntary clubs can include incorporation in the private law of obligations in contract, tort and unjust enrichment and implication of excludable and non-excludable terms in employment and other contracts. Statutes can also create specific statutory duties that can be privately enforced in certain situations and reference due diligence, adequate procedures and other defences to voluntary clubs’ codes and standards. Statutory support for voluntary clubs can facilitate their judicial recognition and the enforcement of their rules and decisions. Voluntary clubs can receive judicial recognition in a number of ways. First, the courts can give formal recognition to the clubs’ codes of conduct and this can elevate the codes to contractual rights and obligations legally binding on the members. For example, in ex parte Datafin Plc the City Code on Takeovers and Mergers issued by the Takeover Panel received such formal judicial recognition.20 Second, the decisions of appropriate club organs can be binding and enforceable against the members. On the other hand, statutory recognition of voluntary clubs will also enable judicial reviews of the decisions of club organs. For example in ex parte Insurance Services, there was a judicial review of the decisions of a private advertising regulator.21

Conclusion: Regulatory Benchmarking Through Voluntary Clubs The existence of corporate governance voluntary clubs has provided opportunities and challenges for regulatory frameworks for directors’ performance evaluation in developing and emerging markets. Although

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the market approach may focus on the private nature of firms and support self-regulation, there is sufficient public interest in corporate governance and directors’ performance evaluation for legal interventions. It is instructive that the G20/OECD Principles of Corporate Governance (OECD, 2015a, p. 9) recognises the need for mandatory and voluntary regulatory frameworks that suit “country-specific economic, legal, and cultural differences.” While pure voluntary regulation is generally ineffective in developing and emerging markets due to their institutional contexts, a completely prescriptive approach is unlikely to be effective in a field like corporate governance that may need industry involvement in designing and implementing regulatory frameworks. This chapter has demonstrated that an enforced self-regulation model can provide an alternative collaborative regulatory framework for corporate governance, especially in developing and emerging markets. The chapter proceeds on the basis of the club theory that enables the analysis of collective actions and their effect on individual and group performances. Notwithstanding its original economic formulations (Buchanan, 1965), the club theory can apply to voluntary corporate governance arrangements. This is useful in assessing corporate governance clubs and improving their legitimacy and effectiveness for directors’ performance evaluation. Nonetheless, voluntary programmes with weak standards and inadequate monitoring, verification and enforcement measures are likely to lack legitimacy for members and stakeholders. This chapter therefore draws on institutional perspective to propose the use of stringent voluntary clubs for promoting performance evaluation and effectiveness of individual directors and boards of directors under an enforced self-regulation framework. Research, training, education and other methods for continuous individual and collective development are necessary to ensure a more proactive approach. Stringent voluntary clubs can operate at industry and sub-sector levels due to the members’ collective identities and shared interests and motivations. Another factor is the industry-wide reputational, financial and other impacts of nonperforming directors and boards. The banking industry is an example. Using corporate governance voluntary clubs for enforced self-regulation can encourage a preventative approach and stimulate retributive and corrective measures for enforcement. For example, club membership can be a prerequisite for individual employment, inter-firm private contracts and government contracts. Performance-related certification, licensing and disqualification can indicate appropriate standards for individual directors, boards of directors and firms. These measures, which are usually used in promoting desirable products and services and discouraging the emergence and spread of undesirable ones, can also apply to individuals and firms. They can be used to screen out individual directors, boards of directors and firms that neglect or fail to meet appropriate standards

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and to respond to those that are refractory to best international standards of directors’ performance. Although the measures may require criteria that exceed corporate law provisions, they can be formulated and implemented under an enforced self-regulation by voluntary clubs facilitated by the law. To support self-regulation by voluntary clubs, it may be necessary to provide a facilitative governmental regulation revolving around licensing of clubs, firms and individuals and providing for individual responsibility, membership disclosure and legal enforcement. These regulatory components can help to improve the effectiveness of private corporate governance systems in voluntary clubs. Individual directors, boards of directors, corporate governance clubs and their members, market participants, stakeholders and society can all benefit from a well-designed and properly implemented and enforced self-regulation system for directors’ performance evaluation.

Notes 1. See Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry v Griffiths [1998] 2 BCLC 646 at 654; Re Barings Plc (No.5) [1999] 1 BCLC 433 at 486; Re Kaytech International Plc, Secretary of State for Trade and Industry v Kazcer [1999] 2 BCLC 351 at 425; Re Landhurst Leasing Plc [1999] 1 BCLC 286 at 346; Secretary of State for Trade and Industry v Goldberg [2004] 1 BCLC 557 at 608 (Lewison J). 2. Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry v Griffiths [1998] 2 BCLC 646 at 653. 3. People v. Grasso, No. 120, 2008 N.Y. LEXIS 1821 (N.Y. June 25, 2008); People v. Grasso, No. 401620/04, 2008 N.Y. App. Div. LEXIS 5853 (N.Y. App. Div. 2008). 4. R v Takeover Panel ex parte Datafin Plc [1987] 2 WLR 699. 5. Gallagher v Jones; Threfall v Jones [1993] STC 537 (Court of Appeal); Johnston v Britannia Airways Ltd [1994] STC 763; Herbert Smith v Honour [1999] STC 173; Odeon Associated Theatres Ltd v Jones [1973] Ch 288, 48 TC 257. 6. Similar views were expressed in respect of accounting and tax law in Heather v PE Consulting Group [1973] 1 All ER 843 (Lord Denning). 7. Bray v Ford [1896] AC 44 (Lord Herschell); Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378; [1967] 2 AC 134 (Lord Russell); Quarter Master UK Ltd v Pyke [2005] 1 BCLC 245 at 263 (Paul Morgan QC). 8. Case C334/04- R. (on the application of International Air Transport Association) v Department of Transport, [2006] ECR 0, decided on 10 January 2006. 9. Schroeder v Music Publishing Co. Ltd v Macaulay [1974] 1 WLR 1308 at 1316 (Lord Diplock). 10. Re Bugle Press [1960] 2 WLR 658 (Buckley J). 11. Batco Tobacco, NJ 1980, 71, para. 6 (Court of Appeal of Amsterdam, 21 June 1979). 12. Salomon v Salomon & Co. [1897] AC 22; C Evans and Sons Ltd v Spritebrand Ltd [1985] BCLC 105; Safeway Stores Ltd v Twigger [2010] EWCA Civ 1472 Prest v Petrodel Resources Ltd [2013] UKSC 34.

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13. Re Barings plc (No. 5) [2000] 1 BCLC 523. 14. See Re AG (Manchester) Ltd, OR v Watson [2008] BCC 497. 15. Re Barings plc (No. 5) [1999] BCLC 433 at 486 (Jonathan Parker J.); Re Pamstock Ltd [1994] BCC 264 (Vinelott J.). 16. Secretary of State for Business, Enterprise and Regulatory Reform v Sullman [2009] 1 BCLC 397, [82]. 17. Re Grayan Building Services Ltd [1995] Ch 241, p. 253 (Hoffmann LJ). 18. Re Dawson Print Group Ltd (1987) 3 BCC 322, p. 324 (Hoffmann J). 19. Clarke v Dunraven (The Satanita) [1895] AC 248 affirmed [1897] AC 59; Modahl v British Athletic Federation Ltd (No.2) [2002] 1 WLR 1192; Rayfield v Hands [1960] Ch 1. 20. R v Takeover Panel ex parte Datafin Plc [1987] 2 WLR 699. 21. R v Advertising Standards Authority ex parte Insurance Services plc (1989) 133 Sol Jo 1545 (QBD).

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Tsingou, E. 2008. Transnational private governance and the Basel process: Banking regulation, private interests and Basel II. In J.C. Graz and A. Nölke (eds.), Transnational private governance and its limits. London: Routledge. pp. 58–68. Tsingou, E. 2015. Club governance and the making of global financial rules. Review of International Political Economy, 22(2), pp. 225–256. Tyler, T.R. 2006. Why people obey the law. Princeton: Princeton University Press. Vogel, D. 2005. The market for virtue. The potential and limits of corporate social responsibility. Washington, DC: The Brookings Institution. Watson, N. 2016. 150 years of the London P&I club 1866–2016. Leyburn, North Yorkshire: St. Matthew’s Press. Wolf, Jr., C. 1994. Markets or governments: Choosing between imperfect alternatives. 2nd ed. Cambridge, MA: The MIT Press. Young, K. 2012. Transnational regulatory capture? An empirical examination of the transnational lobbying of the Basel committee on banking supervision. Review of International Political Economy, 19(4), pp. 663–688.

11 Corporate Governance Codes for Public Sector, Private Sector and Not-for-Profit Boards Varied Rules and Structure or One Size Fits All Olawale Ajai Introduction Corporate governance (CG) rules are prescribed in companies’ legislation and supplemented by capital market codes. On the heels of periodic corporate governance failures, like that of Enron, and the wish to be competitive sources of investment, national CG codes have now become the holy grail of global strategy to upgrade corporate governance quality (Eller, 2014). These have since been extended to SMEs, not-for-profits and public sector organizations. The theory is that boards of directors are the fulcrum of corporate governance. CG codes dwell on the role, structure, composition, authority, processes and responsibilities of boards (Leblanc et al., 2004), and good CG ensures better performance, greater investor confidence (Chen et al., 2009) and national competitiveness. This is important for developing and emerging markets (DEMs) (Hugill et al., 2014). There is debate about the efficacy of CG codes on CG quality and whether there is or should be convergence of practices and their suitability in various institutional contexts (e.g., Barac et al., 2016). As CG is useful for socio-economic development, this chapter examines CG codes of public companies, SMEs, not-for-profits and public sector organizations, particularly in BRICS and African countries. It reflects on their efficacy and impact on CG quality and whether different rules and structures are required to make them more effective, rather than a one-size-fits-all approach (c.f., Saxena et al., 2015: 58). It argues that a nuanced and contextually suited approach is more logical and practical than a onesize-fits-all approach. The chapter opens with a literature review, and then presents an overview of codes of corporate governance, followed by an analysis of the considerations and strategy that inform the formulation of CG code for public, not-for-profit and the private sectors. A review of salient issues in the BRICs and African countries follows, and the chapter ends with a conclusion.

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Corporate Governance Theoretical Approaches Classical corporate governance theories include: agency, stewardship, resource dependency, stakeholder- and resource-based theories. The philosophical tension around managing conflicts in the web of corporate shareholder and stakeholder relationships is pervasive throughout the value chain of corporate activities and relationships and has attracted great attention, thus producing the binary paradigms of agency and stewardship theories (Klepczarek, 2017). Some argue that the predominant narrative of this tension and its effect are contestable as motivations are more complex (Davis et al., 1997). For example, Deutsch (2005) argued that increasing the numbers of independent directors as a cure for self-interested behaviour was not empirically proven to be helpful, a view apparently disproven by more recent work (Iwu-Egwuonwu, 2010: 190–198). Also that more inside directors ensure better strategic management, greater shareholder value-creation and performance (Gaur et al., 2015: 911–931) because of their greater knowledge and expertise (stewardship theory). Nicholson (2007) warned that uncritical application of stewardship theory could predispose organizations to governance failure and strategic drift, as that could reduce the quality of monitoring. Davis et al. (1997) counselled that neither theory is a magic bullet for good corporate governance. Stakeholder theory has gained prominence over time and is increasingly being codified into company law. Yet, most jurisdictions are loath to intrude by hard law into the governance role and powers of the board. (Greer et al., 2003: 40–56) argue that stakeholder theory could encourage overly large board size with emphasis on representation of constituencies rather than board level skills, resulting in lowest denominator reasoning and weak performance (Chambers et al., 2011). Governance requires performance, and more recent emphasis on resource-based theory (e.g., Pfeffer, 2003) focuses on the role of the board in accessing relevant resources for management and directors’ capabilities or networks of influence. Pfeffer (2003) argues that mediating between the internal and external coalitions and leveraging on their social capital is the main role of the board. Resource-based theories focus on firm, specific capabilities generated by the entrepreneurial, leadership, intellectual and social capital of boards and their ability to leverage these due to superior governance capabilities (Khanna et al., 2004: 484–485). The theory that board intellectual capital (Nicholson, 2003) determines the quality of corporate governance and performance is iteration on this theme. More recent dynamic capability perspective reflects on the adeptness of boards to navigate changing and volatile environments and to expand company resources (Helfat et al., 2011: 1243–1250). The managerial hegemony (power) theory (Huse et al., 2009), posits that corporate managers use boards as a tool for validating their de facto

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control of the company (for example by teleguiding the nomination process (Mahadeo et al., 2012). On the other hand Coombes et al. 2011) argue that top management is inherently political, contested and subject to shifting coalitions, therefore, power (including managerial ascendancy) ebbs and flows, so executive management is not imperatively ascendant. Transaction costs theory (Jensen et al., 1976) regards the objective of CG as that of curtailing costs that arise from managers’ incompetence and self-seeking behaviour. It proposes CG structures and mechanisms that provide checks and balance (audits, information disclosure, independent directors), as well as greater roles to shareholders (e.g., Abid et al., 2014). Principal cost theory posits that for similar reasons controlling shareholders also incur negative costs, therefore, ideal CG mechanisms and structures should minimize both type of costs and lawmakers should allow firms to custom design their CG based on the best trade-off those costs (Goshen et al., 2017). Institutional theories emphasize the role of isomorphic pressure of institutions in governing corporate organizations (Hillman et al., 2005) or shaping politics, economics, laws, socio-cultural relations and behaviour, and in turn, the principles, practice and quality of CG (Klepczarek, 2017). Allied is the conception that CG could be driven by rules and regulations, co-regulation, market forces, self and public governance. Optimal models may therefore be a mix or hybrid of these coordinating mechanisms. The Variety of Capitalisms theory is the theory that each institutional environment predisposes to certain models of CG that are optimal (Boateng, 2017), therefore, rendering impractical uncritical copying of models from other institutional environments (Chhillar et al., 2015). To improve the quality of boards, Chambers et al. (2011) highlight composition, structure, focus and dynamics. Composition theories reflect on various possible outcomes that different configurations of board composition allegedly generate on CG quality—size and skew of boards, board social and gender diversity, unitary versus two-tier boards and so on (Garcia-Torea et al., 2016). Board focus dwells on strategy, talent management (Useem, 2006), leadership, long term orientation. Board dynamics (Pye et al., 2005) reflects behavioural dimensions and processes: depth and breadth of knowledge, experience, on boarding, motivation and commitment, information channels, communication and emotional skills, trust and team dynamics working styles and so on. An apparent anomaly in literature is the conflating of shareholder and stakeholder paradigms in CG and CG code epitomes. That might well account for ineffectiveness in thinking, design and consequently in the operation of CG codes. However, Garcia-Torea et al. (2016) suggest that outcomes are generally the same using either paradigm. Secondly, and perhaps by reason of their evolution, the elucidation of principles in hard law and CG codes were based on the trading company (Eisenhardt,

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1989). CG principles based on shareholder models intuitively appear fallacious and unsuitable moulds for fashioning CG codes for non-profits which apparently do not generate the same agency problems (Chambers et al., 2011).

Board Roles Literature on board level theories analyse key activities of boards. The power theory reflects on the controlling function of boards in corporate governance. Johnson et al. (1996) propose three central roles of all types of boards (public, private and not for profit), as: (1) controlling the organization (monitoring management’s adherence to agency guidelines) and establishing its strategic direction; (2) providing advice to management, and (3) providing access to resources. McNulty et al. (1999) add a fourth—assisting in development of corporate strategy (subsumed with the controlling function by Johnson). Madhani (2017 also proposed a four part role: ‘(1) the control role; (2) the strategic role; (3) the service or resource provision role and (4) the advice and counsel role’. Chait et al. (2005 offer: fiduciary, strategic and generative; more suited to non-profits (Chambers et al., 2011), apparently because of the fiduciary terminology. The fiduciary and strategic role tally with the compliance and strategic roles in the earlier classifications discussed. The generative role could be perceived as being identical to performance. What the discussion so far suggests is that any one-size-fits-all approach to theories and construction of CG codes is illogical and impractical. Each theory is useful and a composite model, perhaps based on evidence, is required for constructing epitomes of CG codes suitable for different contexts and seasons in the life of organizations, sector regulation characteristics, competitive situations and institutional environments (Madhani, 2017: 13). Filatotchev et al. (2013) argue that governance needs vary across firms and different sociopolitical environments; therefore, requiring uniform board principles is not useful. For example, different principles appear to work better in crisis or calm seasons (Callen et al., 2010). A priori there would be intrinsic misfit if CG codes are not designed specifically for various types of companies, i.e. non-profit and the public sector (Ostrower et al., 2005).

Corporate Governance Codes in Developing and Emerging Markets The next section summarizes the main features of codes (see Table 11.1 for a sample) using the five part classification discussed in the previous section to highlight and critique trends in recent reforms directions. There is a great deal of similarity of CG codes in BRICS, African countries, UK and France.

Table 11.1 CG Code Provisions (Listed Companies) Brazil

Russia

India

China

Number of independent directors

At least 20% independents

At least one-third independents

Ditto

Ditto

Diversity and professional expertise

Ethical character

Professional, ethical character, etc.

Professional, ethical character, women directors

Professional

Separation of CEO and Chairman

Separated by dual structure or position

—

—

Three nonexecutives

—

Supervisory board chair must be a separate person Majority independents

Audit committee Non-directors composition appointed by shareholders Directors role Stakeholder and sustainability mention Strike against concentrated shareholding

Oversight, strategy, risk Ditto management, ethics, communication, etc. Yes (Stakeholder only) Minority protection and administrative action only

Ditto

+ Behavioural rules + Independent stipulated in directors Code, Independent directors

Ditto

+ Cumulative voting system for board elections and restrictions on controlling shareholders Ditto

Information

Accounting, corporate Ditto (minus governance, ethics, sustainability) sustainability, etc.

Performance evaluation required Enforcement

Yes

Yes

Accounting, corporate governance, ethics, sustainability, etc. Yes Yes

Comply or explain

Recommendations

Mandatory

Whistle blower provisions

—

Yes, under criminal law

—

Source: Author’s compilation.

Yes

South Africa

Nigeria

Egypt

N/A Majority Two-thirds non-executives non-executives (one half independents, ‘Lead’ independent liaise with chairman and establish formal links with shareholders) N/A Professional, Proportional ethical shareholders character, etc.

Mauritius

France

United Kingdom

At least 2

Minimum third

Half of the board

Professional, ethical character, women directors Separated

Ditto

Professional, ethical character, etc.

Separated by dual structure or position

Preferably separated

Separated

Separated

Preferably separated

At least three independents

Non-executives/ independents

Majority Ditto independents

At least three independent

Ditto

Three nonexecutives, three shareholders Ditto

Ditto

Ditto

Ditto.

Ditto

Yes

Yes

Yes

Yes

Yes

Yes

+ Restriction o number of family members

+ Independent directors

Ditto (minus ethics)

Ditto (plus employee data)

Accounting, corporate governance, etc.

Ditto

Ditto

Ditto

Yes

Yes

Yes

Yes

Yes

Yes

Apply or explain

Mandatory minimum standards Yes

Recommendations Comply or explain/ mandatory Yes

Yes

Recommendations Comply or explain Yes

Yes

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Monitoring—Compliance Most codes (see Table 11.1) require prevalence of non-executives or independent directors, and dual board structure is adopted in a relatively smaller number of countries reflecting agency theory concerns. In most countries the codes are meant for self-regulation on the ‘comply or explain’ basis (stewardship theory). Of course, many DEMs have large numbers of SMEs, larger companies are often family owned or controlled by dominant shareholders (Saxena et al., 2015). Most of the problems are, therefore, related to minority or investor protection and codes based on Anglo-American dispersed shareholding models are largely incongruent. Principal costs theory is appropriate in these environments because dominant shareholding is prevalent (Claessens et al., 2012: 9). More independent directors appear less equitable relative to financial stake in for-profit companies and even misguided in some DEMs, as they may easily be dismissed by dominant shareholders or marginalized in other ways (Pande, 2018; Pande et al., 2011: 21). Arguably, the problem of minority protection might be more directly addressed by increasing their powers through a cumulative voting system. Market control methods are relatively ineffective, as capital markets are shallow, regulatory enforcement poor and cronyism rife. The largest companies often have to adopt principles of the most advanced markets in order to win the trust of international investors and regulations. Board nominations and appointments are notionally meant to be controlled by non-executives, but patronage systems are pervasive and directorships tend to be privileged appointments and cosy network sinecures (managerial hegemony theory). Most codes provide for whistle blowing policy, some impose tenure limits for directors and strongly seek to dilute the hold of large shareholders and families on boards, apparently advancing stakeholder interest and theory (Nigeria’s and China’s, for example). The aim is to improve monitoring and ethical governance. These formal provisions may not advance the ‘independence’ of directors in practice, either because the idea of independence may be culturally misinterpreted as antagonistic behaviour, dissonant to mores of ‘saving face’ or mutual patronage (e.g., Guanxi in China) or group solidarity (e.g., Ubuntu in Nigeria). There may even be hidden loyalties, for example, directors appointed from foundations affiliated to the company or dependant on steady support from companies in that sector or even generally (De Masi et al., 2014). The same arguments apply to audit committee provisions meant to augment financial monitoring and compliance. Some codes advance roles for shareholder associations (the Nigerian SEC and FRC codes, for example). No doubt, activist shareholder associations can countervail against dominant shareholders or managerial capitalism and complement independent directors. They have no place in not-for-profit SMEs and public sector organizations, and code provisions

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providing for alternative stakeholder interfaces are not necessarily an effective equivalent monitoring device.

Strategy Role Director knowledge, competence and skills are generally thinly spread. Code provisions emphasize industry and financial knowledge, good character and professional diversity (resource dependency and resource-based theories). Financial expertise or commercial exposure seems less relevant for not-for-profits and non-commercial public sector boards, because profit considerations are not primary (e.g., De Masi et al., 2014). Appointment of a large number of independent directors, who tend to be either civil society types or ex-technocrats, is meant to help the strategy role and provide constraint against concentrated power management (composition theory). It is unlikely to help the strategic management role (Hillman et al., 2003) if they have little track record in business and organizational life or are peers of executive directors and have a disposition to ‘groupthink’.

Resource Provisions In institutional voids, countries networks are valuable, and directors are expected to provide relevant expertise and political connections to assist the organization navigate around the weak institutional environment and crony politics (resource dependency theory). However, code provisions on ethics prohibit corruption and conflict of interest. The problem is in assuring that technically competent persons possess the right ethical character. Appointment of larger numbers of independent directors, at best, representing an amorphous group—society or citizens (beholden to nobody but themselves), is not a panacea. There is no foolproof formula to protect against their ‘capture’ by management. In China it is reported that many are affiliated to controlling shareholders (Liu et al., 2011).

Advice and Counsel Almost all Codes (Table 11.1) explicitly require appointment of competent directors, training, annual performance evaluation and diversity, and few, the appointment of women. This reflects board composition, focus and dynamics theories. Directors are entitled to receive counsel from professional advisers. It is possible for directors to have a good track record, however, they require full and candid company information on internal matters in order to offer ‘tough love’ when necessary. This goes beyond formal provisions and depends on country business context and organizational culture, which in most BRICS and DEMs they are challenged by (Holmes et al., 2015).

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Performance Code provisions appear to contain provisions to facilitate the continuous pursuit of operational targets and organizational mission. These include: delineation of structures, roles and responsibilities, risk and audit processes and reporting, director expertise requirements, information disclosure to and consultations with shareholders and stakeholders, annual and sustainability reporting, director assessments and board performance evaluation and so on. In public sector organizations annual performance setting, ministerial supervision and oversight are featured in CG codes. The typical for-profit director duty is to promote the success of the entity. This is easier to measure in terms of profit performance but is more equivocal in not-for-profit and public sector governance. The English Good Governance Standard for Public Bodies translates this to a duty to promote the purpose of the organization and give good value to citizens, apparently measurable by quantitative metrics or customer surveys Effective stakeholder and environmental governance are enjoined but assuring compliance is a different matter.

Design Dynamics of Corporate Governance Codes CG codes were initially developed for the largest public companies (usually listed, although some codes equally apply to non-listed as well). The general paradigm appears to draw on the Anglo-American unitary board, as fewer countries have adopted dual board structures. Agency theory considerations predominated even when literature recognized that European capitalism, and to a greater extent developing emerging markets (DEMs), did not share the same level of dispersion in shareholdings and that family firms were more prevalent. Even family firms may yield to professional managers but policies in the USA and UK to augment shareholder control (O’Kelley et al., 2017) are irrelevant to countries with concentrated shareholding structure. Proposals in February 2018 by the UK Financial Reporting Council (FRC) to emphasize stakeholder and employee considerations (Meacham, 2018) are relevant given the fact that their codes emphasize stakeholder theory. Stakeholder theory has gained greater prominence in code requirements for the appointment of greater numbers of independent directors, sustainability reporting, stakeholder consultations and CSR. Resource dependency and resource-based value theories are also more enhanced by newer requirements for board diversity, director knowledge and experience (particularly financial literacy), performance assessments, information requirements for board reports, at least quarterly meetings and so on. These also reflect theories on board composition, focus and dynamics. In sum, there is greater reflection of multi-theory approaches, not necessarily from evidence based research but mostly as reactive measures after

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spectacular corporate scandals or by the pressure on DEMs to adopt OECD compliant codes by international organizations (Oliveira et  al., 2014), or the desire to attract investors. There is general convergence around theory and the structures and mechanisms used to address problems and around international best practices (Oliveira et al., 2014) (and also Europe-wide approaches in the EU). Differences in national codes are based on their institutional environments. One area of convergence is in the adoption of soft law approaches of voluntary CG codes based on a ‘comply or explain’ model that seems more prevalent than the mandatory approach favoured in Nigeria or hard law approach preferred under the Sarbanes-Oxley Act of 2002 in the USA (Ajai, 2017). Estrin et al. (2011) studied the role of informal institutions in BRIC countries. In most OECD countries informal institutions are usually complementary. The study argued that different institutional contexts require contextual and customized approaches in identifying the problem and solution to weaknesses in CG quality and against uncritical imitation and a onesize-fits-all approach. O’Kelley et al. (2017) shed light on this inference: In Japan, the concept of independence is relatively new and not understood in a Western context. Instead of focusing on precise compliance with this standard, institutional investors are focused on . . . ensuring that the board is not composed of any directors who are former senior executives from the same company and looking for other signs of board accountability. This suggests that merely packing the board with independent directors is insufficient in BRICS institutional contexts.

SMEs Scholars argue that better CG quality should aid SMEs’ performance and growth and spur economic transformation (Hove-Sibanda et al., 2017). Good CG could open doors to external financing for SMEs (AFDB, 2011). In DEMs many SMEs are ignorant of corporate governance or presume that it is meant for larger companies, or even for the multinationals. There has been little attention to fashioning CG codes for the SME sector until recently. Most SME codes are guidelines. They mainly encourage formalization of mission statements, board structures and practices, accounting and audit compliance, succession planning, outside directors, stakeholder relations and regard for minorities. These appear to be largely boilerplate provisions, given the great variety of SMEs, therefore, a merely watered down one-size-fits-all code derived from public company templates may not work well (ACCA, 2018: 9). Individual training to help

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them identify how to solve governance problems in their organizations (IFC, 2018) may lead to changes in attitudes and behaviour better than box-ticking compliance or mandatory codes replete with costly, time consuming bureaucratic and regulatory procedures for small and unsophisticated family businesses (Corrigan, 2014: 2 and 4). Suggestions by Saxena et al. (2015) that governance should be at the level of trade and industry clusters and regulators in a form of collaborative governance with SMEs is attractive.

Not-for-Profit Organizations Non-for-profit organizations (NPOs) are diverse in legal form, mission and size, ranging from the public-spirited individual to associations (unincorporated) and incorporated entities. For the latter, companies acts or non-profit regulatory statutes lay out formal minimum rules of CG. In other cases, strict fiduciary principles, non-distribution of earnings and prohibition of financial assistance to directors tend to be foundational regulation. As civil society grew as an important development partner, the number of NPOs, their role, influence and impact in national and international society has tremendously increased (Banks et al., 2012). Enhanced capacity, resources, accountability and mission fulfilment have become crucial for delivery of the promise of NPOs in sustainable development (USAID, 2016). Inculcating good CG could enhance their performance and stewardship; stakeholder’s theories are more relevant (Gaiku et al., 2016). Fund and resource mobilisation, recruitment of new directors and their competence are NPOs’ problem areas that mainstream CG codes struggle to address (Hendricks et al., 2010). NPOs clearly require specially designed or rationalized CG paradigms (Eller, 2014) and a one-size-fits-all code appears impractical (Palod, 2014: 23). A lot of sensitization, training and support may be required, especially in DEMs, given the lower levels of formal education, informality and lack of familiarity with western notions of CG.

Public Sector Organizations McCann FitzGerald et al. (2015) suggest that all corporate governance is concerned with securing the interests of stakeholders, therefore objectives are identical in public and private sector governance. Armstrong et al. (2005) argue, contrarily, that private sector profit objectives and public sector social service objectives means that there can be no convergence between the two. The codes generally position government as ‘shareholders’ and require autonomy for the boards of public sector organizations. They recommend application of as many of the commercial laws, GC code and principles of value creation and access to financing that apply to public companies as is

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possible. They require the appointment of competent independent and nonexecutive directors drawn from outside government and in larger numbers than executive directors. Oversight charters and annual operational and performance targets for the enterprises are to be drawn by the government or agreed with boards, who shall be subjected to an annual performance evaluation. Annual, audit, and directors’ report should be made public and available on a timely basis. It seems impractical to adopt a one-size-fits-all code for all public sector organizations (Hafele, 2008: 119). As far as BRICS and African nations are concerned it is doubtful that state owned enterprises can far exceed the quality of public governance and ethics. Privatization and reduction of the size of state owned commercial enterprises may be a more pragmatic option. Some of the principles, such as accountability, ethical conduct, competence and performance may be broadly convergent, but where the mandate and expected bottom lines are non-commercial it seems illogical to require conformity to forprofit expectations or norms. The problem of governance in public sector bodies arises from delinquency on the part of politicians and public officials (Campos et al., 2006), and the responsibility for change appears to primarily fall on them.

BRICS Countries Some studies on BRICS countries suggest that overall CG quality and enforcement is higher in India, followed by Brazil, Russia and China (Latteman, 2014). Formal convergence to recommended UN principles is rated very high in Brazil, Russia and South Africa, but is lower in China and lowest in India (Oliveira et al., 2014), reflective of their greater adherence to contextual and cultural considerations (Estrin et al., 2011). Capital markets are relatively thin (Estrin et al., 2011), as is the private sector in some of the countries. India most approximates to the UK unitary board (South Africa and Russia also have unitary boards) and norms because of colonial antecedents, whilst China and Brazil adopt the dual board system. China has a large state owned enterprises sector, only recently permitted private property. Patronage culture of guanxi is entrenched, and official capture and corruption is pervasive at local levels (Ahlstrom et al., 2008). India also has a preponderance of familial capitalism and interlocking board membership (Filatotchev et al., 2013). Cronyism, corruption and arbitrary regulatory activity are reported of Russia (Heugens et al., 2009), and to a much lesser extent in Brazil (Estrin et al., 2011). South Africa still has legacy apartheid capitalism, box-ticking CG and Black Economic Empowerment (BEE) policy that have spawned cronyism (ACCA, 2018; West, 2006). Clearly, in each country CG policy needs to be fashioned in light of institutional weaknesses and cultural realities. Nevertheless, Latteman (2014) argues that some of the largest BRIC companies go beyond national CG

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requirements to adopt and attain equivalent levels of international best practices due to investment seeking strategy and industry norms. Indeed, India mandated women directors on boards under section 149 of the Companies Act, 2013 and South Africa’s King Reports on Corporate Governance are globally well regarded and its internal audit practices more compliant to international benchmarks (Barac et al., 2016).

African Countries Improvement of Africa’s CG quality is being driven at the highest levels of continental governance, the African Peer Review Mechanism, and is being implemented in varying ways and speed at country level (ACGN, 2016). Its capital markets and infrastructure are relatively smaller and undeveloped (Markannen, 2015). The informal economy is large, and most firms are family owned. Regulatory supervisory quality and enforcement is patchy (AFDB, 2011). Corruption and crony capitalism is a challenge (Markannen, 2015). However, political stability and economic growth rates are in the right direction (ACGN, 2016). South Africa and Mauritius are bright spots and a commitment to reform efforts in Kenya (Armstrong, 2016) and Nigeria are good. With a population of up to a billion people and a growing middle-class, the continent has pent up demand for external financing. Corporate governance based on the most advanced international principles (Munisi et al., 2014) is in-place or ongoing in many countries. A more inward looking and customized approach, simplified CG codes and strengthening of institutional capacity would be more effective rather than blind copying of OECD models (AFDB, 2011). However, Akinkoye et al. (2014) found compliance to the Nigerian 2003 SEC CG code on disclosure and financial information at 98 percent, albeit with poorer performance on director remuneration. Africa could sell the concept of CG more effectively through multistakeholder led initiatives and allow it to evolve gradually (Armstrong, 2016), especially because supervisory capacity and enforcement is weak. Overbearing regulatory strategy and mandatory CG codes may be impractical (Ajai, 2017). Also, public governance and economic management should be upgraded simultaneously (Armstrong, 2016).

Conclusion This chapter examines CG codes of public companies, SMEs, not-forprofits and public sector organizations, particularly in BRICS and African countries and reflects on the efficacy and impact of CG Codes on CG quality. Different rules and structures are required for each type of organization and probably for different categories within each type of organization, rather than a one-size-fits-all approach. Institutional peculiarities

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of developing and emerging markets must characterize their codes along with training, better public governance, and an incentives-based and empowering regulatory approach to make them more practical and effective. The development of a culture and institutions for good corporate governance lies in the institutional and historical antecedents and values of nations and are best built up in an evolutionary and gradual process, rather than adopting box-ticking compliance or suffer benign neglect by the majority of organizations.

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Boateng, A. & Lua, J. (2017). Varieties of corporate governance models: A review and synthesis. In Ngwu, F. N., Osuji, O. K. & Stephen, F. H. (Eds.), Corporate Governance in Developing and Emerging Markets. Abingdon, UK: Routledge, 17. Callen, J. L., Klein, A. & Tinkelman, D. (2010). The contextual impact of nonprofit board composition and structure on organizational performance: Agency and resource dependence perspectives. Voluntas, Vol. 21, 101–125. Campos, E. & Lateef, S. (2006). Improving public sector governance: The grand challenge? In Economic Growth in the 1990s: Learning from a Decade of Reform. Washington, DC: World Bank. Available at: www1.worldbank.org/ prem/lessons1990s/Chap%209%20governance%20092104%20rw.pdf Chait, R. P., Ryan, W. P., & Taylor, B. E. (2005). Governance as Leadership: Reframing the Work of Nonprofit Boards. Hoboken, NJ: John Wiley & Sons. Chambers, N., Pryce, A., Li Y. & Poljsak. P. (2011). Spot the difference: A study of boards of high performing organisations in the NHS. Manchester: University of Manchester. Chen, K. C. W., Chen, Z. & Wei, K. C. J. (2009). Legal protection of investors, corporate governance, and the cost of equity capital. Journal of Corporate Finance, Vol. 15 (3), 273–289. Chhillar, P. & Banerjee, P. (2015) Management control systems and corporate governance: A theoretical review. Asia-Pacific Management Accounting Journal, Vol. 10 (2), 103–128. Claessens, S. & Yurtoglu, B. B. (2012). Corporate governance in emerging markets: A survey. Emerging Markets Review, Vol. 15, 1–33. Coombes, S. M. T., Morris, M. H., Allen, J. A. & Webb, J. W. (2011). Behavioural orientations of non-profit boards as a factor in entrepreneurial performance: Does governance matter? Journal of Management Studies, Vol. 48, 829–856. Corrigan, T. (2014). Building an African Corporate Governance. SAIIA Governance and APRM Programme—Policy Briefing 100. Available at: www.saia_ spb_101_corrigan_20140822.pdf Davis, J. H., Schoorman, F. D. & Donaldson, L. (1997). Toward a stewardship theory of management. Academy of Management Review, Vol. 22, 20–47. De Masi, S. & Paci, A. (2014). Board composition in the public utilities: A focus on independent directors. Network Industries Quarterly, Vol. 16 (3), 3–7. Available at: https://mir.epfl.ch/files/content/sites/mir/files/Newsletter/NIQ2014-3/ Board%20composition%20in%20the%20public%20utilities%20-%20 A%20focus%20on%20independent%20directors.pdf Deutsch Y. (2005). The impact of board composition on firms’ critical decisions: a meta-analytic review. Journal of Management, Vol. 31, 424–444. Eisenhardt, K. M. (1989). Agency theory: An assessment and review. Academy of Management Review, Vol. 14, 57–74. Eller, H. (2014). Corporate Governance in Non-Profit Organizations in Europe by Focusing the Governance Model. University of Latvia. Available at: http://c. ymcdn.com/sites/www.istr.org/resource/resmgr/WP2014/Eller_Corporate Governance_Co.pdf Estrin, S. & Prevazar, M. (2011). The role of informal institutions in corporate governance: Brazil, Russia, India and China compared. Asia Pacific Journal of Management, Vol. 28 (1), 41–67.

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Filatotchev, I., Jackson, G. & Nakajima, C. (2013). Corporate governance and national institutions: A review and emerging research agenda. Asia Pacific Journal of Management, Vol. 30 (4), 965–986. Gaiku, P. G. T., Mutuku Lewa, P. L. & Senaji, T. A. (2016). Corporate governance and performance of health sector non-governmental organizations in Nairobi county. European Journal of Business and Management, Vol. 8 (12), 9–108. Garcia-Torea, N., Fernandez-Feijoo, B. & de la Cuesta, M. (2016). Board of director’s effectiveness and the stakeholder perspective of corporate governance: Do effective boards promote the interests of shareholders and stakeholders? BRQ Business Research Quarterly, Vol. 19 (4), 246–260. Gaur, S. S., Bathula, H. & Singh, D. (2015). Ownership concentration, board characteristics and firm performance: A contingency framework. Management Decision, Vol. 53 (5), 911–931. Goshen, Z. & Squire, R. (2017). Principal costs: A new theory for corporate law and governance. Columbia Law Review, Vol. 117, 767–830. Greer, A., Hoggett, P. & Maile, S. (2003). Are quasi-governmental organisations effective and accountable. In Cornforth, C. (Ed.), The Governance of Public and Non-Profit Organisations: What Do Boards Do? London: Routledge, 40–56. Hafele, M. (2008). Public corporate governance for public-sector entities, scientific symposium Pforzheim, Josip Juraj Strossmayer University of Osijek, Faculty of Economics, Croatia, vol. 29, 115–123. Helfat, C. E. & Winter, S. G. (2011). Untangling dynamic and operational capabilities: Strategy for the (N)ever-changing world. Strategic Management Journal, Vol. 32 (11), 1243–1250. Hendricks, P. S. A. & Wyngarrd, R. G. (2010). South Africa’s King III: A commercial governance code determining standards for civil society organizations. The International Journal of Not-for-Profit Law, Vol. 12 (2). Available at: www. icnl.org/research/journal/vol12iss2/art_1.htm Heugens, P., Van Oosterhout, J. H. & van Essen, M. (2009). Meta-analyzing ownership concentration and firm performance in Asia: Towards a more fine-grained understanding. Asia Pacific Journal of Management, Vol. 26 (3), 361–609. Hillman, A. J. & Dalziel, T. (2003). Boards of directors and firm performance: Integrating agency and resource dependence perspectives. Academy of Management Review, Vol. 28 (3), 383–396. Hillman, A. J. & Wan, W. P. (2005). The determinants of MNE subsidiaries’ political strategies: Evidence of institutional duality. Journal of International Business Studies, Vol. 36 (3), 322–340. Holmes, M. & Wong, R. (2015). Why Corporate Governance Is Key to China’s Growth. ICAS. Available at: www.icas.com/ca-today-news/corporate-governancein-china-key-to-growth Hove-Sibanda, P., Sibanda, K. & Pooe, D. (2017). The impact of corporate governance on firm competitiveness and performance of small and medium enterprises in South Africa: A case of small and medium enterprises in Vanderbijlpark. Acta Commercii - Independent Research Journal in the Management Sciences, Vol. 17 (1), a446. https://doi.org/10.4102/ac.v17i1.446 Hugill, A. & Siegel, J. I. (2014). Which does more to determine the quality of corporate governance in emerging economies, firms or countries? Harvard

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Business School Strategy Unit Working Paper No. 13–055. Available at SSRN: https://ssrn.com/abstract=2192460 Huse, M., Nielsen, S. T. & Hagen, I. M. (2009). Women and employee-elected board members, and their contributions to board control tasks. Journal of Business Ethics, Vol. 89, 581–597. IFC. (2018). Corporate Governance and Small and Medium Enterprises. Available at: www.ifc.org/wps/wcm/connect/e4267212-baf6-401e-9c4e-165eb3e41908/ CG+SMEs+fact+sheet.pdf?MOD=AJPERES Iwu-Egwuonwu, R. C. (2010). Some empirical literature evidence on the effects of independent directors on firm performance. Journal of Economics and International Finance, Vol. 2 (9): 190–198. Jensen, M. C. & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, Vol. 3, 305. Johnson, J. L., Daily, C. M., & Ellstrand, A. E. (1996). Board of directors: A review and research agenda. Journal of Management, Vol. 22 (3), 409–438. Khanna, T. & Palepu, K. (2004). Globalization and convergence in corporate governance: Evidence from Infosys and the Indian software industry. Journal of International Business Studies, Vol. 35 (6), 484–485. Klepczarek, E. (2017). Corporate governance theories in the new institutional economics perspective: The classification of theoretical concepts. Studia Prawno-Ekonomiczne, Vol. 105, 243–258. Lattemann, C. (2014). On the convergence of corporate governance practices in emerging markets. International Journal of Emerging Markets, Vol. 9 (2), 316–332. Leblanc, R. & Gillies, J. (2004). Improving Board Decision-Making: An Inside View: Alternatives beyond Imagination. Port Douglas: Company Directors Conference. Liu, Q., Tian, G. & Wang, X. (2011). The effect of ownership structure on leverage decision: New 65 evidence from Chinese listed firms. Journal of the Asia Pacific Economy, Vol. 16 (2), 254–276. Madhani, P. M. (2017). Diverse roles of corporate board: Review of various corporate governance theories. The IUP Journal of Corporate Governance, Vol. 16 (2), 7–28. Mahadeo, J. D., Soobaroyen, T. & Hanuman, V. O. (2012). Board composition and financial performance: Uncovering the effects of diversity in an emerging economy. Journal of Business Ethics, Vol. 105, (3), 375–388. Markannen, S. (2015). Corporate Governance in Africa: Comparative Study. Accounting Master’s thesis, Department of Accounting Aalto University School of Business. Available at: http://epub.lib.aalto.fi/en/ethesis/pdf/14053/hse_ethesis_ 14053.pdf McCann FitzGerald & Institute of Directors in Ireland (2015). Corporate Governance in the Private and Public Sectors. IOD factsheet. Available at: www.iodire land.ie/sites/default/files/documents/IoD%20Factsheet%20-%20Corporate%20 Governance%20in%20the%20Private%20and%20Public%20Sectors.pdf McNulty, T. & Pettigrew, A. M. (1999). Strategists on boards, Organization Studies, Vol. 20, 47–74. Meacham, J. (2018). Corporate Governance Update. Quoted Company Alliance. Available at: www.theqca.com/information-centre/corporate-governance/140316/ corporate-governance-update-february-2018.thtml

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Munisi, G. H., Hermes, N. & Randøy, T. (2014). Corporate boards and ownership structure: Evidence from Sub-Saharan Africa. International Business Review, Vol. 23 (4), 785–796. Nicholson, G. J. & Kiel, G. C. (2003). Towards an integrative theory of Boards of Directors: The intellectual capital of the Board. Proceedings of the Annual Meetings of the Academy of Management. 1–34. Available at: http://www. effectivegovernance.com.au/wp-content/uploads/2012/10/Nicholson-Kiel2003-Toward-an-integrative-theory.pdf Nicholson, G. J. & Kiel, G. C. (2007). Can directors impact performance? A casebased test of three theories of corporate governance. Corporate Governance: An International Review, Vol. 15, 585–608. O’Kelley, R., Goodman, A. & Martin, M. (Russell Reynolds Associates). (2017). Global and Regional Trends in Corporate Governance for 2018. Harvard Law School Forum on Corporate Governance and Financial Regulation. Available at: https://corpgov.law.harvard.edu/2017/12/29/global-and-regional-trendsin-corporate-governance-for-2018/ Oliveira, M. C., Almeida, S. R., Stefe, R. & Cunha, G. (2014). Comparative analysis of the corporate governance codes of the five BRICS countries. Contabilidade, Gestão e Governança, Vol. 17(3), 49–70. Ostrower, F. & Stone, M. (2005). Boards of nonprofit organizations: Research trends, findings, and prospects for the future. In The Nonprofit Sector: A Research Handbook. New Haven, CT: Yale University Press. Palod, S. (2014). Governance in NGOs Proposal for Good Governance Benchmarks for NGOs Course of Independent Study Submitted to: Shankar Jaganathan. Available at: www.hidforum.org/uploads/default/files/reports/stuff/4073 0265db9ab2ea30d0d462bfe9325a.pdf Pande, S. (2018). Independent Directors and Well Performing Boards—Pointers for Indian Companies. Available at SSRN: https://ssrn.com/abstract=3118250 Pande, S. & Kaushik, K. (2011). Thought Arbitrage Research Institute, Indian Institute of Corporate Affairs and IIM Calcutta, 2011. Study on the State of Corporate Governance in India: Evolution, Issues and Challenges for the Future. Available at: http://iica.in/images/Evolution_of_Corporate_Governance_in_ India.pdf Pfeffer, J. & Salancik, G. R. (2003). The External Control of Organizations: A Resource Dependence Perspective. Stanford, CA: Stanford Business Books. Pye, A. & Pettigrew, A. (2005). Studying board context, process and dynamics: Some challenges for the future. British Journal of Management, Vol. 16, 27–38. Saxena, A. & Jagota, R. (2015). Should the MSMEs be governed the corporate way? Indian Journal of Corporate Governance, Vol. 8 (1), 54–67. USAID. (2016). The 2016 CSO Sustainability Index for Sub-Saharan Africa. Available at: www.usaid.gov/sites/default/files/documents/1866/2016_Africa_ CSOSI_-_508.pdf Useem M. (2006). How well-run boards make decisions. Harvard Business Review, Vol. 84, 130–136. West, A. (2006). Theorising South Africa’s corporate governance. Journal of Business Ethics, Vol. 68 (4), 433–448.

12 Reporting by the Companies Development and Challenges Indrajit Dube and Mia Mahmudur Rahim

Introduction Company reporting brings clarity to board approaches towards equitable treatment of all company constituents: internal control, financial risk management, organizational sustainability and governance. Company reporting serves as a useful reference for stakeholders, the general public and investors in the investment decision. Today, companies are under increasing scrutiny on how and what information they share (Langevoort, 2004; Levmore, 2002; Lowenstein, 1996; North, 2013). This chapter draws upon this perspective. Companies around the world produce reports on their financial and social performance.1 There has been a considerable increase in this form of reporting over the last 20 years. This increase is due to legal obligations for financial reporting, periodical disclosure, sustainability reporting, rise of sensitive consumerism and fierce competition between global companies through brand images. However, reporting does not provide much inherent benefit unless accurate and concrete performance is disclosed and is also easily comparable to reports presented by other companies. The problem lies in the use of reports as public relation tools rather as a form of accountability for companies in relation to their stakeholders (Haigh and Jones, 2006; Overland, 2007). For example, a company would be inherently drawn to display a favourable image of itself to stakeholders to increase its market share; thus, where possible, it would report the positive aspects of its activities while omitting the drawbacks (Rahim and Vicario, 2015). As a result, the report may obfuscate the real scenario, and hence the core value of the report is lost. Further, correct information does not automatically render a company report adequate, layout, clarity and presentation of the report also play essential roles. The remainder of this chapter is structured as follows. First, it assesses the rise of CG reporting and its different forms. Second, itassesses the challenges and opportunities associated with this reporting system. Finally, it concludes the chapter with the argument that all types of company reports should refer first to the same set of matters; second, follow

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a common structure; and third, comprehensively establish the estimated economic benefit and social cost of the companies’ various activities. The focus this book is an analysis of the strategies to enhance the effectiveness of the board of directors of the companies in emerging markets. This chapter fits well within the scope of this book for its assessment of the development and challenges of company reporting, since reporting is vital in building the relationship amongst the board of directors, company itself and its various constituents.

Development of Reporting by Companies It would be worth noting here that company reporting and disclosure are not the same. The company report is a document that provides a detailed account either on the whole performance of the company (such as an ‘integrated report’) or a particular matter of the company (such as financial report or the CSR report). While reporting denotes a complete document, disclosure is the response of the company on an extraordinary matter or as a response to a legal requirement. The form of a company disclosure is generally designed and controlled by the regulators. For instance, for disclosing information to the prospective buyers of shares, companies have to follow a format for preparing their disclosure documents; most of the stock exchanges require enlisted companies to disclose information on sensitive issues in a given format. However, the regulators are generally flexible in terms of formats for preparing reports on some company performance measures. A company may need to maintain a practice of continuous disclosure, although it produces its reports on a yearly or half-yearly basis. This chapter is about company reporting in general. Company reporting commenced with the introduction of the United States Security Regulation in the 1930s (Leuz, 2010). The primary objective of reporting was to protect the interests of small investors. Such an objective became well accepted in most countries, including developing countries such as India. In continental European countries, such as Germany, company reporting was extended for the benefit of creditors (Leuz, 2010). This additional objective of company reporting gained popularity and persisted as the primary driver of such reporting practice. Gradually this objective was extended even further, and today companies disclose classified internal information in their reports with the objective of offsetting their risk related to their brand, reputation, and compliance. This also increases market share as a result of firm support from society. While the reciprocation between business and society is the main driving force behind the development of this reporting practice, it is also fostered by global non-legal frameworks, legal regulations at the national level and the risk associated with the loss of brand image. Development

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is also influenced by political history [colonial dominance] and changes in market and legal structure at the country level. Past studies have found that colonial dominance affects countries’ institutional and regulatory infrastructure. Countries with a common law background (where disclosure is a requirement) possess higher levels of reporting, while countries influenced by Continental European colonies place less emphasis on reporting (Leuz, 2010). The ownership structure of a company is another factor that influences the development of company reporting. Market composition and structure are influenced by company ownership structure, with variations observed in reporting regimes in different countries. Where the ownership of a company is fragmented and diverse, countries typically adopt a robust disclosure regime as compared to those with concentrated company ownership. Verities in approaches for administering legal systems have also influenced company reporting practice. In particular, reporting styles differ due to variations in regulatory approaches. For instance, a regulatory system that is heavily influenced by the ‘contractual enforcement regime’ does not depend on providing prescriptions related to company reporting practice. The legal systems within this regime argue that the parties related to a business activity have either a direct or indirect contractual relationship, and corporate disclosure is both a result and a sign of this contractual relationship. Therefore, countries with efficient contractual enforcement regimes place more emphasis on sharing information through company reporting. The trajectory of company reporting development is a result of the debate regarding various approaches to a suitable regulatory framework. One side of this debate argues that this practice should be voluntary, where a company is able to decide whether it should deliver a report, and, if so, the precise nature of how and what to report. The other side of the debate rejects the credibility of the arguments for voluntary reporting, arguing that company reporting should be compulsory for two reasons: (1) a compulsory mode can ensure a level playing field, and (2) this mode will ensure that the corporate world fully acknowledges the information right of corporate stakeholders, including shareholders, investors, and the general public. In almost all countries, reporting regarding financial matters is compulsory for companies, and this reporting is heavily regulated through laws and organizational guidelines. Although reporting related to social and environmental matters is not compulsory (as yet), the number of laws and organizational guidelines related to the reporting of these matters is rapidly increasing. Nonetheless, there are currently 56 countries in the Commonwealth and 27 countries in the European Union (including the United Kingdom) that favour voluntary reporting of non-financial company performance. They have opted for voluntary reporting in the

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form of ‘comply or explain’ in addition to specific governance issues that are legislated (Africa, 2009).2 Proponents of voluntary reporting rely on basic market principles (i.e. demand and competition). From their perspective, the need for this reporting in the market is enough to raise the quantity and quality of this reporting. However, this basis for the voluntary mode of reporting is rapidly being eroded. It is widely argued that the voluntary mode has contributed to the rise of different types of reporting formats and a private ordering system (that contains thousands of vendors selling reporting guidelines and consultancies). As a result, it is difficult for stakeholders to assess the quality of this reporting. As this voluntary reporting style is based on private contracts and is customized according to market needs, the quality of corporate reports on non-financial matters has not improved. Comparative assessment of disclosure across companies remains difficult, representing an impediment for both stakeholders and companies alike. Proponents of compulsory reporting argue that it provides a reporting standard across all companies, reduces costs associated with this reporting (Coffee, 1984), and fulfils the objective of this reporting by ensuring quality and comparability in reports (Leuz, 2010). However, there are drawbacks to the compulsory mode of company reporting. Critics of this mode argue that compulsory disclosure can be viewed as a primarily political process where, in many instances, regulators cannot efficiently reflect on market demand and thus can be captured by companies. As noted earlier, the long-term underlying objective of company reporting is to gain legitimacy for corporate activities from constituents. The short-term objective of such reporting is to earn financial incentives from the market. Collecting, consolidating, and classifying any information is cost intensive for any company. If the market is not demanding and enforcement of private contracts is not efficient, companies are not motivated to conduct useful reporting. Further, countries with a concentrated ownership structure are likewise not keen to make reports. Financial disclosures and certain non-financial disclosures, such as information related to ‘business risk’, could place companies at a disadvantage against competitors. Thus companies, in general, have an aversion towards company reporting. In this situation, companies tend to report more efficiently in countries where information is valued by investors, creditors, rating agencies, investment advisors and regulators, etc. (Tetlock and Kim, 1987). Indeed company reporting practice is developing mainly due to its capacity to create a win-win position for companies and their stakeholders. This mutual benefit is mainly applicable to shareholders due to its focus ‘on the direct influence derived from agency or transactions cost theory and deal with monitoring cost and transaction cost’ (Ortiz and Marin, 2014). Reductions in information asymmetry reduce the cost of capital for a company (Leuz, 2010). This is because the win-win theory

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is closely connected to the concept of ‘triple bottom line’, (i.e. economic, social and environmental) and helps to meet different stakeholder interests (Ortiz and Marin, 2014). Some researchers emphasize that ‘while no one academic study is perfect, the total of the evidence accumulated across many studies using alternative measure, sample, and research designs lends considerable support to the hypothesis that greater disclosure reduces the cost of equity capital’ (Botosan, 2006). Efficient reporting means greater security and a well-governed company such that companies can decrease the cost of capital (Ortiz and Marin, 2014).

Styles in Company Reporting Company reporting must provide classified information useful to consumers in a timely, relevant and optimized manner. As mentioned earlier, there are distinctions between corporate disclosure and company reporting styles. Broadly, the former is included in the latter. ‘Disclosure’ enumerates discrete subject matters to be included in the list of information, whereas ‘reporting style’ indicates how and what is to be presented in the information published by the company. The subjects considered for inclusion in the corporate governance disclosure list have expanded over recent years (Kolk, 2008). Classified information includes disclosure regarding financial and non-financial data. The international financial crisis and resultant organizational meltdown have turned attention back to the methods of structuring and disclosure of crucial financial information by companies. Internationally, much work has been initiated regarding financial reporting at the local, national, and international levels (Leuz, 2010). At the local level, financial reporting is largely conducted through a private contract with the stock exchange, regulators, government and judiciary. In contrast, at the national level, several countries including the USA, India, and Canada have adopted the practice of using federal legislation or a national coordination statement. At the international level, the International Financial Reporting Standard (IFRS) has been adopted. Nonfinancial data comprises management information (especially capacity and orientation of human resources towards present business, and processes utilized by management in organizational decision-making, policy formulation and institutionalization of the same), risk factors involved in the business (not including financial risk), institutional relations, environment compliances and social commitments. There are two possible approaches adopted regarding corporate governance reporting worldwide: 1) putting components of the corporate governance report in separate sections of the annual report, and 2) a standalone corporate governance report (Bhasin and Reddy, 2011). Indeed, how a company should prepare its report depends more on the regulatory requirements of the country than international guidelines.

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Within a country, the influence of different institutions is vital in setting the accepted approach for report preparation. It is worth noting here that institutional arrangements for some countries are similar due to either cultural or colonial influence, and they can be segregated into clusters (Leuz, 2010). Information revealed in company reporting is not limited to the information required by regulations. Companies are keen to meet consumers’ and other agencies’ demand for information through this form of reporting. Retail and institutional investors, stock analysts, rating agencies, market watchdogs, news agencies, academics and others depend on company reporting for different purposes. For example, some of these parties require corporate reports to analyse ownership structure and the controlling pattern of the firm, management structure and independence of the board in decision-making, substantial interest in protecting stakeholder concerns, resource allocations, socio-environmental measures adopted by the company, etc. Although company reporting is predominantly based on historical information, it also provides accounts of the possible future actions of the company. From this perspective, the content of company reporting could be divided into two parts: financial reporting and non-financial reporting. Financial reporting is purely based on the past performance of the company, while non-financial reports are accounts of past achievements, and, to some extent, a prediction of future directions. The processes intrinsic in management decision-making, such as the initiation of new projects, rejuvenating or restructuring the present business, the risk involved in business and matters relating to investments comprise the historical data. In contrast, the management perspective regarding business and expected future growth comprise prediction of the future. However, it is frequently argued that the demand of non-regulatory stakeholders does not guide the nature of the content of these reports, rather this is guided by the perceptions of what management deems important. Today, investors seek forward-looking information and are not content with merely historical company data. The information they seek is not only confined to the financial statement (i.e. profit and loss, stock prices, etc.) but also includes future earning, brand stability, goodwill, quality of the board, management, reputation, strategy and other sustainability aspects (Africa, 2009). Through the information provided in a company report, consumers assess the quality of the company’s risk management and whether it has considered the sustainability issues pertinent to its business (Africa, 2009). There is a trend towards a holistic and comprehensive reporting of how a company has, positively or negatively, impacted the economic life of the community in which it operated during the year under review. Further, there is typically an examination of how the board intends to improve positive aspects and eradicate the negative ones over the coming years.

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A company may increase the level of trust and confidence of its stakeholders by issuing an integrated corporate governance report (ICGR). An ICGR can increase a company’s business opportunities and improve its risk management. By issuing it internally, a company evaluates its ethics, fundamental values and governance and externally improves stakeholder trust and confidence (Africa, 2009). It ‘should be focused on substance over form and should disclose information that is complete, timely, relevant, accurate, honest, and accessible and comparable with past performance of the company. It should also contain forward-looking information’ (Africa, 2009).

International Reporting Initiatives and Challenges Several international standards have been developed relating to company reporting. The International Financial Reporting Standards (IFRS) has attempted to design a standard global language pertaining to the finances of firms that can be widely understood. The objective of the financial statement of any company is to provide information about financial position, financial performance and cash flows. Further, the financing statement presents information about a company’s assets, liabilities, equity, income, expenses and contributions of investors. There are several essential features adopted by the IFRS, including fair presentation and compliance, accrual basis of accounting, the frequency of reporting and consistency of presentation. These have helped in the standardization of sharing of financial information. IFRS as an organization is consistently developing and evolving standards of financial reporting. It has assisted in harmonizing international financial reporting, many firms conducting cross-border business have aligned themselves with this standard. Many countries have adopted the International Financial Reporting Standards as part of domestic regulation (Africa, 2009; Leuz, 2010; Leuz and Verrecchia, 2000). The United Nations Global Compact encourages companies worldwide to adopt sustainable and socially responsible business practices. This principle-based framework covers large areas in the domain of human rights, labour issues, environmental matters and anti-corruption. It asks companies to internalize principle-based processes and report these in a similar manner to corporate publications. Global Compact has been adopted by many domestic and transnational companies and has had a high impact on the unification of reporting style internationally (Ortiz and Marin, 2014). It has also established standards for financial reporting. The Global Reporting Initiative (GRI) promotes economic sustainability through sustainability reporting (Ortiz and Marin, 2014). It requires all firms to provide sustainability reports regularly, though this is a form of non-financial reporting and is voluntary. These sustainability reports

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emphasize the internalization of sustainability reporting culture within a company, although they do not necessarily evolve from a position of inherent internal accountability. To this end, GRI has recently issued the G4 Sustainability Reporting guidelines that aid companies in preparing standard disclosure on environmental sustainability issues. The Carbon Disclosure Project questionnaire provides reporting guidelines comparable to GRI guidelines. This guideline is not for preparing general corporate reports; instead it provides a questionnaire following which a company can organize its information related to its emission and climate change related risk management. Joining this reporting program is voluntary. The companies that join this program are not bound to communicate this report to the public. The European Union Eco-Management and Audit Scheme and the ISO Standard 1404–1 are two other guidelines in the field of corporate environmental reporting. Amongst the recent development of company reporting regarding environmental management, the Sustainability Accountability Standards Board and the Climate Disclosure Standard Board initiatives are also noteworthy. These organizations are preparing reporting standards on substantive material issues and expanding their reporting framework ‘with the aim of integrating non-financial information into mainstream corporate reports’ (Baron, 2014, p. 13). Although mandatory instruments still dominate the regulation of sustainability reporting, there has been a recent surge of voluntary instruments to assist companies with this reporting (Bartels and Fogelberg, 2016, Bartels et al., 2016). Leading companies are increasingly adopting voluntary initiatives (Levy et al., 2010). The core assumptions of the above mentioned voluntary guidelines are that standardized reports (i.e. information) can be used for benchmarking and ranking companies, which will provide a valuable supplement to financial reporting for consumers, empowering them to demand higher corporate accountability (Levy et al., 2010). Many jurisdictions have accepted this assumption and recommended its adoption by domestic and transnational companies. The US is noteworthy in this regard amongst jurisdictions that depend on voluntary initiatives of companies for their reporting.3 However, there are many jurisdictions that have adopted the core of these voluntary guidelines into their legislation related to corporate disclosure. For example, Norway and France require their large companies to explain how they have incorporated the GRI and Global Compact principles into their strategies. Like many other stock exchanges, the Shanghai, Sao Paolo and Hong Kong stock exchanges have recently introduced sustainability reporting for their listed companies. The International Integrated Reporting Council (IIRC) functions as a global coalition of regulators, standard setters, and information consumers. The coalition shares views regarding the creation of business value through company reporting. The IIRC promotes the International

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Integrated Reporting Framework for the communication of quality information, a cohesive and efficient approach to company reporting, enhanced accountability and integrated thinking and decision-making. In the company reporting landscape, the IIRC aims to achieve ‘better reporting and not more reporting’, ‘to bring consistency to numerous development in company reporting’, ‘provide an impetus to global innovation in company reporting’ and emphasize both strategic focus and a futurebased orientation.4 The framework aims to accelerate and underpin the evolution of company reporting, reflecting developments in financial governance, management, disclosure and sustainable reporting. Overall the framework encourages informed decision-making that leads to an efficient allocation of capital and the creation and preservation of value. Different international agencies have created benchmarks for company reporting. These benchmarks identify relevant subject matter to be included in the report and stipulate the approach to be adopted while developing the report. Many transnational and domestic companies have included these benchmarks in their reports and have opted for further innovation regarding reporting.5 The emphasis is on achieving uniformity in reporting so that comparable standards can be evolved across sectors.6 However, the question here regards the quality of information instead of the quantity of information. It is also necessary to examine how best to judge the quality of information in the report published through different mediums. Quality of information measurement is a difficult task because the test of quality varies with different information seekers (Zairi, 1987). Companies publish information in a single document, except where the regulatory approach of a particular country mandates a different approach (Leuz, 2010). As a result, including only quality information in a unified manner is a challenging task. A wide range of different constituents acting independently of each other process the information published in the report. Often, the information is not only incomprehensive but also heavily historical in nature and meagrely relates to end-users needs (Zairi, 1987). While the international institutions mentioned above have addressed many of the above mentioned shortcomings, the question of presentation style of this information remains mostly unanswered. To a certain extent, the integrated report may be the answer. In simple terms, integrated reporting (IR) denotes an account of the financial and integrated performance of a company. Integrated performance includes the extra-financial performance of a company, including the socio-political and ethical performance that has an impact on the business model of the company (Baron, 2014). Therefore, integrated reporting is a disclosure document that contains information of a company’s ‘near, medium and long-term capacity to generate value, including material risks and opportunities related to all its capitals: financial, manufactured, intellectual, human, social and relationship, and natural’ (IIRC, 2003 cited in Baron, 2014, p. 7).

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IR is strongly related to the development of a company. The development of a company depends highly on its ability to create assets without decreasing the resources base, whether social, human or financial. Integrated reporting seeks to address these needs by focusing on what is strategically necessary in order to understand an organization’s capability to create and sustain value in the short, medium and long-term. Despite being more of a blueprint in its current form, this reporting attempts to provide a clear idea of the goals and benefits of corporate activities and also indicates key areas for a company’s overall development (PwC, 2012). It is argued that IR can also be designed to provide a competitive advantage to a company. This is because by integrating IR, a company can gain more capital and credit and also build healthy business relationships. Since this reporting includes a broad scope, it assists stakeholders in gaining a broader insight regarding the quality and durability of company performance by examining strategic priorities and the dynamics of the business model. The integration and alignment of internal processes aids a company in making better-informed decisions that again will foster better understanding for investors (PwC, 2012). The concept of integrated reporting aims to engender real alterations to the prevailing company reporting model, both external as well as internal. The IIRC, responsible for initiating discussions around integrated reporting, initially provided only a framework for external reporting. Despite increasing attention on the application of integrated reporting, there is still no universal compulsory reporting standard. The only exception is South Africa, where companies on the Johannesburg Stock Exchange have to provide annual integrated reporting according to the King III Code of Governance Principles (PwC, 2012). The IIRC offers initial proposals for the framework and provides examples that reflect how the integrated reporting principles could be inculcated. However, these examples do not paint a clear picture of what a well-integrated report should look like. Integrated reporting not only provides all necessary information for internal purposes, but at the same time also offers appropriate information to investors and other stakeholders. This involves a spectrum of data from which the company can select relevant data for specific purposes (e.g. financial reporting, non-financial reporting, etc.). Integrated reporting is thus a holistic design based upon a connection between different sets of data (PwC, 2012). According to the IIRC, integrated reporting aims to provide all material information related to company performance and future performance in a single report. The IIRC believes that this report should be the principal company disclosure document and that it should replace the reports that are currently prepared separately for separate issues. However, the replacement of the current reporting system with one short, integrated report is currently not realistic because of the numerous existing

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regulatory reporting requirements (Leuz, 2010; PwC, 2012). Therefore, firms will have to find alternative solutions for combining existing reports or preparing an integrated report alongside compulsory reporting. However, the integrated report should form the primary report, providing a reference point for others (such as detailed financial reports, other compliance information and detailed sustainability information) (PwC, 2012). Much of this information might move to an online platform, reducing clutter in the final report (PwC, 2012). In theory, every company can prepare an integrated report, but due to the size and complexity of an organization in addition to the relative maturity of its reporting, integrated reporting will require several preparations (PwC, 2012). Luckily many will not need to start from scratch as they already publish an investor-oriented annual report, sustainability information and other essentials required for integrated reporting (PwC, 2012). The only problem is that such information is often not connected to company strategies. Therefore, a step towards integrated reporting will necessitate restructuring the published reports and several internal processes. Some firms, due to the high level of complexity and fragmentation of structure, may even envision a new structure with processes explicitly designed for integrated reporting (PwC, 2012). There are several flaws in integrated reporting practice. The fundamental flaw is that it is still widely considered a managerial tool that minimizes risks by fostering positive perceptions for stakeholders. Hence the process related to its preparation is not only complex but also lacks a participatory mode. This reporting is not a process by which a company can ascertain its impacts on society and subsequently report its responsibility performance in social issues to the broader community (Owen et al., 2000). This could be because of the ability of the management of a company to control the entire reporting process. Directors generally have a vested interest in a company and are motivated to benefit stockholders; in general, they are not primarily accountable to society. They strategically collect and disseminate only the information they find necessary to progress the corporate image (Owen et al., 2000; Rahim, 2016). Therefore, there is a risk that this reporting format could be limited to use only as a management strategy to claim legitimacy for corporate operations, rather than as a mechanism for promoting transparent accountability practice. A sense of gamification related to this reporting style has already been shown to be detrimental and regressive in terms of earning legitimacy through accountability practice.

Conclusion Company reporting is vital for long-term company value creation, assisting companies to obtain societal legitimacy, reduce risk and positively influence the decisions of investors. Corporate governance must therefore

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efficiently evaluate company activities, stakeholders’ information needs, risks and decision-making processes. Although there have been significant efforts towards the creation of an overarching global style for company reporting, there is no currently accepted style. Most companies prepare their reports and disclosure documents according to the laws of the jurisdiction in which they are operating. However, many companies follow relevant laws while also practicing reporting styles advocated by private institutions. As discussed in this chapter, this reporting initiative can be viewed with some scepticism, as it appears to construct and legitimize corporate performance without displaying transparency in accountability practice. There is a theoretical and empirical tension between the perceived positive intentions of engaging in company reporting and the potentially negative actions of companies engaging in irresponsible or deceptive behaviour (Siano et al., 2017). To counter this disconnect, integrated company reporting has been touted as a mechanism that aims to provide a complete picture of a company to its constituents. The concept of integrated reporting is a notable addition to the development of trust around company reporting practice. Since this style of reporting aims to provide a complete understanding of company performance and future goals, it holds that corporate governance follows a transparent internal process and provides substantive materials in prepared reports. Nonetheless, this reporting practice is entirely controlled by the board of directors and does not allow input by external parties in any of the stages of report preparation and communication. Given an assessment of these issues in this chapter, we conclude that company reporting style has improved, but there is much scope for more improvement. We restate that companies should consider reporting a serious matter because there is a strong link between reporting practice and an increase in a company’s long-term value. At the juncture of experiments regarding different company reporting styles and a proliferation of compliances, general conclusions related to the progress of this reporting practice are as follows: 1. Including material information in the report is not enough. The report should inform stakeholders about how the company completed its information materiality process. 2. A company should report on stakeholder engagement. Information on this matter may include how the company responded to stakeholder concerns and management of its non-compliance incidents. 3. Integrated reporting practice should relate to an internal transformation of a company. The process related to this reporting should have an aim of moving ‘short-termism’ away from the corporate policy. 4. Specific isolated figures on finance and qualification of the directors in the company reports report fail to convey either the soundness of

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the financial position of the firm or ability of the directors to manage the business respectively. Financial projection in these reports should have a close relationship with the sustainable initiatives undertaken by the firm. Similarly, information on directors’ qualifications and experience should provide sufficient understanding that their functional capacities are aligned with a company’s day-to-day activities. 5. To bridge the gaps in the information provided in company reports, companies may consider developing a reporting template with an objective of interconnectivity in order to collate information from different units. This reporting template may include key performance indicators (KPIs) for different units. Once the information is collated, it may be sent to the board’s corporate governance subcommittee for quality assessment. On approval of the board, the collated information may be published as an integrated report in the public domain. 6. The company reports may be publicized in two different documents. One report may form a comprehensive synoptic part of the annual report of a company, and the other may constitute a detailed independent explanatory report on different facets of corporate performance. This detailed report may include, for example, an explanation of what management aims to achieve in the year under consideration and what improvements they intend to incorporate in the years to come.

Notes 1. This is a very recent trend. In the 1980s, CSR reporting of the world’s top 250 largest corporations was practically non-existent. Although an increase was witnessed in the 1990s, only 35 percent of the world’s top 250 largest corporations disclosed their CSR performance in 1999. One of the main reasons for such slow growth in the reporting practice is the fact that CSR reporting developed over this period as a voluntary policy. As such, corporations were at liberty to decide whether to report their CSR performance or not, as well as the extent and layout of their disclosure. 2. King III Report: www.library.up.ac.za/law/docs/king111report.pdf. Some believe that the ‘comply or explain’ stance is not reflective of a voluntary measure because the word ‘comply’ insinuates a binding character. 3. However, this country has legislation that holds its companies liable to report on specific issues, including transparency in governance structure, carbon emissions and payments to foreign governments. Key legislation on these matters in the US includes the Dodd-Frank Act, the Greenhouse Gas Rules and the Sarbanes-Oxley Act. 4. See the IIRC at www.theiirc.org/the-iirc/about/. 5. Including independent vetting of a company’s annual report by external agencies and publishing of their comments. 6. Such as IFRS, UN Global Compact, GRI, and IIRC.

References Africa, I. o. D. i. S. (2009). King report on governance for South Africa. Retrieved from www.library.up.ac.za/law/docs/king111report.pdf?

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Baron, R. (2014). The evolution of company reporting for integrated performance. Retrieved from Paris: www.oecd.org/sd-roundtable/papersandpubli cations/The%20Evolution%20of%20Corporate%20Reporting%20for%20 Integrated%20Performance.pdf Bartels, W., Fogelberg, T., Hoballah, A., & Van Der Lugt, C. T. (2016). Carrots and Sticks—Global trends in sustainability reporting regulation and policy: Rep. KMPG International, GRI, United Nations Environment Programme, and The Centre for Corporate Governance in Africa. Bhasin, M. L., & Reddy, M. (2011). Corporate governance disclosure practices: The portrait of a developing country. International Review of Business Research Papers, 7(1), 393–419. Botosan, C. A. (2006). Disclosure and the cost of capital: What do we know? Accounting and Business Research, 36(sup1), 31–40. Coffee Jr., J. C. (1984). Market failure and the economic case for a mandatory disclosure system. Virginia Law Review, 717–753. Haigh, M., & Jones, M. T. (2006). The drivers of corporate social responsibility: A critical review. The Business Review, 5(2), 245–251 Kolk, A. (2008). Sustainability, accountability and corporate governance: Exploring multinationals’ reporting practices. Business Strategy and the Environment, 17(1), 1–15. Langevoort, D. C. (2004). Technological evolution and the devolution of corporate financial reporting. William & Mary Law Review, 46, 1. Leuz, C. (2010). Different approaches to company reporting regulation: How jurisdictions differ and why. Accounting and Business Research, 40(3), 229–256. Leuz, C., & Verrecchia, R. E. (2000). The economic consequences of increased disclosure. Journal of Accounting Research, 91–124. Levmore, S. (2002). Simply efficient markets and the role of regulation: Lessons from the Iowa electronic markets and the Hollywood stock exchange. Journal of Corporate Law., 28, 589. Levy, D. L., Szejnwald Brown, H., & De Jong, M. (2010). The contested politics of corporate governance: The case of the global reporting initiative. Business & Society, 49(1), 88–115. Lowenstein, L. (1996). Financial transparency and corporate governance: You manage what you measure. Columbia Law Review, 1335–1362. North, G. (2013). Company disclosure in Australia. Sydney: Lawbook. Ortiz, E., & Marin, S. (Eds.). (2014). Intangible capital. Catalunya: Politechnic University of Catalunya. Overland, J. (2007). Corporate social responsibility in context: The case for compulsory sustainability disclosure for listed public companies in Australia. Macquarie Journal of International & Comperative Environmental Law, 4, 1. Owen, D. L., Swift, T. A., Humphrey, C., & Bowerman, M. (2000). The new social audits: accountability, managerial capture or the agenda of social champions?. European Accounting Review, 9(1), 81–98. PwC. (2012). Integrated reporting: The future of company reporting. Retrieved from www.pwc.nl/nl/assets/documents/pwc-handboek-integrated-reporting. pdf? Rahim, M. M., & Vicario, V. (2015). Regulating quality in CSR reporting in Australia. New Zealand University Law Review, 26(4), 839–868.

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Rahim, M. M., Islam M. T. & Kuruppu S. (2016). Global shipping corporations’ accountability for reducing greenhouse gas emissions in the seas. Marine Policy, 69, 159–170. Siano, A., Vollero, A., Conte, F., & Amabile, S. (2017). “More than words”: Expanding the taxonomy of greenwashing after the Volkswagen scandal. Journal of Business Research, 71, 27–37. Tetlock P. E. & Kim J. (1987). Accountability and judgment in a personality prediction task. Journal of Personality and Social Psychology, 52(4), 700–709.

13 Director’s Selection, On-Boarding and Disqualification Process Chris Ogbechie

Introduction The notion of corporate governance has continued to attract considerable attention both at the national and international level and is always at the top of the agenda of global corporate discourse. Companies play a significant role in society by creating wealth, providing employment, paying taxes and generating investment returns. In fact, some of the world’s biggest companies have market capitalizations larger than the gross domestic product of some nations (ICAEW, 2011). The concept of corporate governance has therefore grown rapidly during the last decade, prompted by crises associated with Enron, WorldCom and other corporate scandals (Ibrahim and Zulkafil, 2016). Bad corporate governance can cast doubt on a company’s reliability, integrity and obligation to shareholders. As a result, it has become apparent that the board of directors has a significant role to play in ensuring effective corporate governance in a firm, particularly in developing and emerging markets with weak institutions. The quality of boards is therefore important for good corporate governance. Since corporate governance has to do with setting priorities, delegating power and entrenching accountability, it receives high priority on the agenda of policymakers, institutional investors, companies and academics. On-going global financial repositioning has further reinforced the need that governance of firms, especially in financial institutions, should aim at protecting the interest of all stakeholders. According to the King IV report on corporate governance for South Africa in 2016, corporate governance is about exercising ethical and effective leadership by the governing boards of companies. Recent corporate governance scandals have put a searchlight on the effectiveness of boards of directors. In the wake of several corporate failures, numerous suggestions have been made about how to restructure the governance of corporate entities in order to build trust (Van Den Berghe and Levrau, 2007). At the heart of these corporate governance reforms is a common interest in the effectiveness of boards of directors. This is because the board is seen as a governance structure safeguard

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between firms and the owners of capital (Williamson, 2009). The board is the primary direct way that stakeholders influence corporate governance. Hence, there is a need to examine its composition, selection of constituents, its on-boarding process and its de-membership strategy. Corporate governance experts and activists have long advocated changes in the board structure. These changes, among other things, include the appointment of independent directors, the installation of committees in those areas where conflict of interest may arise and the separation of the role of the CEO from the chairman of the board (Van Den Berghe and De Ridder, 1999). It is against these backgrounds that this chapter will focus on board selection procedure. The purpose is to examine the role of the board in ensuring good corporate governance ethics. For many stakeholders, it is not just enough for the business to be profitable, it also needs to demonstrate good corporate citizenship through environmental awareness, ethical behavior and sound practices.

The Need for Boards and the Role of Directors Over time, every board, regardless of its size and structure, is faced with certain issues relating to its composition. After all, a board is not static— it changes as directors depart and new members join. The composition of a corporate board—in terms of total size, the proportion of independent directors to non-independent directors and the backgrounds of the individual directors and on-boarding process of new directors, among other variables—is heavily influenced by the facts and circumstances of the specific organization. A board should reassess its composition periodically to ensure that it is properly constituted to perform its oversight, advisory and strategic roles. As part of this process, a board may address issues relating to its members’ dexterity mix, experience and expertise; the board’s processes and criteria for recruiting and selecting new directors; and its processes for integrating or “on-boarding” new directors. Other practices that may contribute to maintaining effective board operations include continuing education, working to ensure a robust self-assessment process, limiting a director’s length of service, or establishing a mandatory retirement age and developing succession plans. There is the need for a corporate governance framework that sets out the respective functions of the boards, their powers and responsibilities (OECD, 2004; Wirtz, 2011). Efficient corporate governance practices are essential for achieving and maintaining public trust and confidence in the organization, which are critical for proper functioning of the economy as a whole (Ogbechie and Koufopoulos, 2010). Many corporate governance reforms have resulted from major corporate failures. These reforms put great emphasis on structural issues such as board independence, board leadership structure, board size and committees. These structural issues

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are assumed to be important means in enhancing the power of the board, protecting shareholders’ interest and hence increasing shareholder wealth (Van Den Berghe and Levrau, 2007; Westphal and Zajac, 1998). This can be adequately ensured by bringing the right people onto the corporate board. The critical constraint on the growth and success of any business is the ability to attract and keep “good” people, which in today’s world is an important responsibility of the leadership team. Roles of Directors The board of directors is the primary driver of values within the organization. Directors are elected by shareholders or are appointed by other board members, and they represent the shareholders of the company. The board is tasked with making important decisions such as senior management appointments, executive compensation and dividend policy. In some instances, their obligations stretch beyond financial optimization, when shareholder resolutions call for certain social and environmental concerns to be prioritized. Boards are often comprised of executive and non-executive directors. Some of the non-executive directors may be independent directors. The executive directors have management roles and are responsible for the day-to-day running of the company’s affairs. They occupy dual status as alter ego and employees of the company. As alter ego, they sit at the board meetings formulating policy direction for the company, and as an employees, they are in charge of implementation of the company’s policies (CAMA, 2004). The non-executive directors (NEDs) are duly appointed directors but are not involved in the day-to-day management of the company. The board of directors has a significant role to play in ensuring good corporate governance, and at the heart of the corporate governance debate is the view that the board of directors is the guardian of shareholders’ interest. The effectiveness of corporate governance is dependent on a myriad of factors and cannot be simply measured by profitability, growth or share performance. Most corporate governance codes in emerging markets recommend a board structure that has more non-executive directors than executive directors, with the chairman being a non-executive director. Some even recommend the number of independent directors. This is to ensure some degree of independence on the board. It is expected that the board should be of sufficient size relative to the scale and complexity of the company’s operation and be composed in such a way as to ensure diversity of experience without compromising independence, compatibility, integrity and members’ availability to attend meetings (SEC Nigeria, 2008). Boards are empowered to manage the affairs of a company and may delegate certain responsibilities to executive management and board committees. The roles of the board are provided for in the respective

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country’s company law and in company’s articles. The common law system provides that directors are obliged to exercise their powers in the best interest of the company. According to the Nigerian SEC Code (2014), the roles and responsibilities of the board of directors inter alia are responsibility and accountability for the performance and affairs of the company, proper management of the company, and ensuring sound or good corporate governance by ensuring that the company carries out its business in accordance with its articles and memorandum of association. Deloitte (2014) identified the following roles of directors and the board composition in modern emerging economies: boards provide direction (i.e. set the strategic direction for the company), controls (i.e. monitor the management) and provide support and advise (advisory role). Directors also owe duties to the company, the most fundamental being the fiduciary duty of loyalty and the duty of care. These obligations and duties are applicable to both executive and non-executive directors alike.

Roles of Board Committees Many boards consider identifying and recruiting new members as an ongoing function (Independent Directors’ Council, IDC, 2013). In the USA and UK, informal networks have been traditionally relied upon to nominate members, perpetuating a lack of diversity on the boards (ICAEW, 2011). However, most codes of corporate governance recommend that a board committee should be saddled with the responsibility of driving the process for director recruitment. This committee is usually referred to as nomination or governance committee, and it must have a written charter that addresses its purpose and responsibilities. The committee, which is composed solely of non-executive directors, is responsible for identifying and recommending board candidates, evaluating board compositions, considering diversity and succession planning and assessing the board’s leadership requirements (ICAEW, 2011). Some boards might establish an ad hoc committee for this purpose only when a position on the board needs to be filled. In Nigeria, in line with the increased recognition of the importance of transparent and fair procedures for the appointment of directors, the Central Bank of Nigeria (CBN) and Securities and Exchange Commission (SEC) corporate governance codes provide for the establishment of a Governance and Remuneration (or Nomination) committee (SEC, 2008; CBN, 2014) to make recommendations on all new board appointments. The process of nominating and appointing directors must be transparent and formal and guided by clearly defined criteria. It is in the best interest of the board to ensure that only suitably qualified persons who bring diverse experience, skills and relevant competencies to the board are appointed as directors. Before nominating a candidate for election

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to the board, the committee should consider the collective knowledge, skills and experience required by the board, the diversity of the board and whether the candidate meets the appropriate criteria. The search, selection process and recommendation to the board of prospective candidates should not be the prerogative of the chairman or the MD/CEO but that of the governance or nomination committee. It is expected that as a body composed of non-executive directors, a greater level of objectivity, transparency and independence in relation to the entire process is guaranteed. The committee is also expected to conduct background checks on board nominees to determine to a reasonable extent that the nominee is a fit and proper person and has not been disqualified from holding the office of a director. The background checks will also help to ascertain whether there is any real or potential conflict of interest, including whether the nominee is an interlocking director—a director serving on the board of multiple corporations (Bisi A, 2016). Defining criteria (reputation, qualification, relevant experience, industry knowledge, etc.), identifying specific competency gaps on the board (technical skills, industry credibility, influence, etc.) and codifying a diversity policy allow the board to have a say in the director’s selection process. Finally, the structure or membership of a board selection team or committee should be customized to suit the organization’s need as provided for in the organization’s bylaws. The role of the board governance or nomination committee within the corporate governance framework is critical, as it is responsible for ensuring that the board is well equipped to discharge its duties optimally and effectively. The board has a responsibility, through the governance or nomination committee to ensure that individuals that are put forward as directors for shareholders’ approval meet the minimum standards stipulated by law and the codes of corporate governance (SEC Code, 2008).

Directors’ Selection and Recruitment Process Numerous studies have investigated the importance of selection of directors and other board incumbents to ensure high performance of the board (Makhlouf, Laili and Basah, 2014). The process of selecting and recruiting directors is a continuous process. This is because the process of identifying and evaluating appropriate candidates can be somewhat lengthy. As such, boards often develop a timeline for the process. In many cases, the timing of board openings is predictable, such as when the board is going to replace a retiring director. In other cases, the board may decide to expand to fill a specific need or because of a change in the company’s business model or strategic needs, such as the introduction of a business line. The process that a board follows to identify and evaluate candidates generally will include the following steps as identified by the Independent Directors Council (2013):

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Define Search Criteria

Idenfy Candidates

Create a Short List

Conduct Background Checks

Interview

Find the Right “Fit”

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Figure 13.1 Selection and Recruitment Criteria Source: IDC (2013).

1. Define search criteria: When selecting a new board member, the board should take time to determine the type of candidate it is seeking, recognizing that its criteria may evolve during the process. The board might analyze the types of expertise and qualifications it needs by assessing the skills of its current members, thereby identifying the board’s existing strengths and weaknesses. When determining the type of experience and background it is seeking in candidates, a board may consider and, depending on its own circumstances, place varying levels of emphasis on the following: •

•

Independence: A large proportion of independent non-executive directors on a board are a common feature in most emerging economies’ corporate governance provisions. It is recommended that the board should have as many independent directors as it can accommodate. This becomes even more imperative in closely held companies as it may sometimes be necessary to neutralize the dominance of an overbearing majority shareholder. Many boards extend their analysis beyond the legal provision and its rules when determining independence and take a more holistic approach by considering any relationships or situations that might call into question an individual’s ability to independently discharge his or her fiduciary duties to the company and its shareholders. When speaking with prospective candidates during the interview process, the board and counsel to the company should engage in a broad and in-depth discussion about personal, business and professional relationships that exist or potentially could exist between the candidate (and his or her family members) and the company’s principal service providers and their affiliates and related individuals. General and specific industry experience: Boards typically consider the general types of experience, qualifications, attributes or skills that would be desirable in a candidate. These might include industry experience, prior service on boards or expertise focused in areas that may help add value to the company. A

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board also may focus on having at least one member with experience in each of the following areas: investment management, risk management, governance and audit. If the board is lacking in any one of these areas, it may try to find a candidate who could fill that gap. General and specific board experience: Prior board experience is a desired attribute, given the unique nature of different industries and businesses. Directors with experience in operation, distribution, regulatory compliance and other valuable aspects of the industry can contribute valuable insights on matters before the board. In addition, candidates who currently serve or have previously served, on another board can bring applicable and valuable experience to the board, particularly if the size of the company’s operation is comparable. In addition, these candidates can provide the board with knowledge about how others in the industry may have addressed various issues. Still, boards considering candidates with other sound board experience should be mindful of any potential conflicts or confidentiality issues. Boards have different views about whether current service on another board is desirable, and whether a board allows its members to serve on another board. Employment status: Some boards may prefer candidates who are currently employed, perhaps because the candidates may be more up-to-date with technology or corporate practices. Others may prefer candidates who are retired because they might have more flexible schedules, allowing them to attend board meetings and devote more time and attention to the position. Age: Some boards may want to strike a balance between candidates with sufficient background and experience and younger candidates who might have the ability to serve on the board for a number of years before reaching a mandatory retirement age, if applicable. Younger candidates may offer a fresh perspective on items such as technology, social media and derivatives or customized investment products. The board should recognize, though, that a relatively young director serving on a board without term limits may hold the position for a long time. Diversity: Many boards disclose that they take an expansive view of diversity and seek to construct a “well-rounded” board with members representing a mix of viewpoints, education, skills, gender, race (or tribe), and experiences. Boards do not normally set quotas or establish minimal numerical requirements regarding the gender or racial makeup of the board. In Nigeria, the CBN specified in its code that at least 30 percent of directors of banks in Nigeria should be female, ditto for Malaysia. Many

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2. Identify candidates: After defining the search criteria, the board will determine the method it will use to identify possible candidates. Boards identify directorial candidates in various ways, including any combination of the following: personal relationships, introductions at professional conferences, word-of-mouth, references from outside counsel and the use of executive search firms. Effective boards start with the right match between an individual with the talent and commitment to make a difference and the organization that is in need of the individual’s unique blend of skills and talents. Some boards outsource this phase to a consulting firm but with well-defined profiles of the candidates. 3. Create a shortlist: The agreed list of candidates will then be reviewed by the nomination committee or by a consulting firm contracted to do so. The goal at this stage is to identify a shortlist of potential qualified candidates that will fit the requirements of the board. 4. Conduct background checks: After the shortlist has been drawn up, the organization may want to conduct background checks on the candidates. In this case, the board may use independent counsel or an external consultant. 5. Interviews: Holding an interview with all potential candidates offers an opportunity to discuss the role and find out about the candidate’s background, skills, interest, qualifications and personal goals. Certainly the board will want to gain an in-depth understanding of each candidate’s qualifications and prior business experience. In addition, the board will want to understand each candidate’s view of—or willingness to learn—the role and responsibilities of the board, the candidate’s commitment to act for the benefit of stakeholders and whether the candidate will be able to devote the appropriate time and energy to the job. 6. Find the right “fit”: Critical to the effective operation of any board is finding a group of individuals who complement one another and can work cooperatively together in the interests of the company and all stakeholders. Determining “fit” can be challenging because this essential and subjective element of the selection process is an art, not a science. Boards may use a number of different techniques to try to assess a candidate’s compatibility. These might include formal or social one-on-one meetings between board members and the candidate or references from prior employers and business colleagues. 7. The task of recruiting board members might seem a little daunting, it is, however, important to take time to find the candidates with the right values, skills, attitude and commitment. Being a board member is a crucial leadership role as directors are responsible for the

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financial and cultural well-being of the organization, defenders and promoters of the company’s vision and mission, key spokespersons and drivers of its future. Wrong board member recruitment may have an adverse effect on the board, so it is important to have a recruitment process in place rather than a stop-gap measure. While a company may want to revisit the specific criteria on a regular basis to ensure it suits its current needs, having a recruitment process in place such as the one above helps to take the pressure off.

Induction and On-Boarding Process Understanding the business—its operations, strategy, risk, competitive landscape and management team—as well as the responsibilities and culture of the board and its committees often takes time. But a robust on-boarding and induction process—including essential information and briefing materials, quality discussions with key people and a roadmap for getting a good understanding of the company—can greatly accelerate a new director’s integration and contribution. Directors joining their first board face the added challenge of understanding the unique role they have to play in helping to oversee and guide the business forward (KPMG, 2016). In most organizations, formal orientation exercises are usually conducted for new directors, and it is important to ensure that these programs will help them have a good understanding of the board. In fact, many companies mistake the orientation for on-boarding. Orientation is a one-time event designed to welcome a new director to the company and the board, outline meeting schedules and board service logistics, define their role and provide an overview of the company. On-boarding, on the other hand, is a continuous process. It includes the orientation events and the integration of a new director into every aspect of the company’s business, culture and the competitive environment in which it operates, thereby facilitating meaningful contributions from directors and growth in long-term value for stakeholders. Moreover, the on-boarding needs of new directors will vary from director to director depending on a number of factors, such as the director’s background and experience, the role the director is expected to play on the board and on its committees. Boards employ a number of approaches to integrating a new director, and the approach should be tailored to the individual’s specific needs. The proper integration of a new director contributes to the effectiveness of both the new director and the board as a whole. A number of procedures for new directors to consider as part of an overall on-boarding framework as summed up by KPMG report, 2016 include; •

Suggested background reading materials: A new director may want to review a number of background materials early on including

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Chris Ogbechie information about the company, the board and its committees, the company’s strategic plan, analysts’ reports, the company’s compliance programme, reports or survey results assessing the company’s reputation, culture and strength of its brands, committee charter, company’s code of conduct, etc. Initial orientation session: Most companies provide an initial orientation session for members as earlier described. While the length and formality of the orientation may vary from company to company. It should include an overview of the business—including its products and services, its competitive position, financial status of the overall company, company’s near and long term strategy, company’s culture and risk management process. Face-to-face meetings with key executives and business unit managers: A new director should have a one-on-one discussion with all members of the top leadership team of the company to gain a better understanding of the business—culture, risk, strategy, areas of opportunities and concerns, etc.—and to get to know the leaders outside the formality of the boardroom. Business leaders such as chief executive officers (CEO), chief financial officers (CFO), leaders of sales, operations and human resource officers will also have important insights to offer on issues that are specific to their areas of focus and responsibilities. Board members can also get a good view of the company by going beyond the C-suite or C-level officers and visiting the operational bases of the company.

On-boarding is not a “one-size-fits-all” process, and may vary considerably depending on the company and the background, experience and areas of interest of the new director (KPMG, 2016). Ultimately, a good on-boarding process should provide information about the company that will enable a director to add value based on his or her own unique experience and perspectives. More so, on-boarding is essentially a process of continuing education. The three main elements of continuing education for board members are knowledge sharing, rotating committee assignments and offering opportunities to broaden and deepen their knowledge base through formal training. Continually seeking out relevant information and a deeper understanding of the business, the competitive landscape, and emerging opportunities and threats, will be essential in providing effective oversight and bringing insights and foresight into boardroom dialogue.

Directors’ Evaluation and Disengagement Process The board’s compositions and evaluation of performance are central to corporate governance. Ogbechie and Koufopoulos (2010) argue that just as professionalism in management today calls for assessment,

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performance reviews, training and development, so too should directors be evaluated. Increased scrutiny has recently focused on the activities of the board and its committees particularly post the global financial crisis and experience shows that a successful board is not guaranteed by just bringing together successful people (ICAEW, 2011). One of the main goals of board evaluation is to enable the board to purposefully identify and surmount the barriers that impede their effectiveness. Establishing an effective process for board evaluation can send positive signals to the organization that the board members are committed to doing their best. One size does not fit all and getting the scope of evaluation right is critical. The reasons for evaluation include clarification of individual and collective roles and responsibilities, particularly for each director, ensuring better attention to long term corporate strategy, attracting institutional investors and improving the working relationship between the board and management. Board appraisal could also be rationalized on the basis that it assists in identifying weaknesses and thereby helps boards and their members to enhance their performance (Ogbechie and Koufopoulos, 2010). These will also help to develop board development programmes for capabilities and so close the identified gaps in performance. Evaluations provide the opportunity to define the current and future role of the board and an opportunity to determine if the associated skills of the board and its members were appropriate (Ingley and Van der Walt, 2008). Evaluations can help directors assess their performance overtime as needs of a board shift, and provide a basis for deciding whether a director should be reappointed. These evaluations demonstrate to investors that the board is holding individual directors accountable for organizational performance (Conger and Lawler III, 2002; Deloitte, 2014). Board evaluation can bring tremendous benefits and a properly conducted evaluation can contribute significantly to performance improvement on three levels: organizational, board and individual member level. Following the board’s role, board evaluation typically examines these roles of the boards and the entailing responsibilities and assesses how these are fulfilled by the board. The evaluation of the performance of the boards is essentially an assessment of how the board has performed on all of these parameters. In most companies globally, the evaluation is an annual exercise by choice or by regulatory provisions. The evaluation methodology and process have some degree of flexibility and international variance. The process is usually tailored to the requirement of the company, the specific situation it is in, the stage of the company’s lifecycle, the corporate structure and board culture and embedded processes (Gupte and Paranjape, 2014). In Nigeria, S.15 of the SEC Corporate Governance Code for Companies provides for the board to undertake a formal and rigorous annual evaluation of its own performance, its committee, chairman and individual directors.

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Regular board evaluation helps to ensure that board standards are maintained, and the corporation is capable of ensuring long term viability and credibility. This is true for both profit and not-for-profit boards. Board evaluation can assess the board’s collective knowledge base, ability and commitment towards fulfilling their responsibilities. A thorough board evaluation will determine board effectiveness and whether its members are acting in the interest of the corporation and promoting the highest standards of corporate governance. In determining the best approach for evaluation, corporate governance experts suggest external, and it may also be quantitative (questionnaire administration) or qualitative (interviews). Whichever is used, the chairman often sets the tone at the top and plays a pivotal role in the evaluation. The method of assessment could be self-assessment or do it yourself (DIY) questions, where the board prefers to have each director complete a written questionnaire, then have a facilitator consolidate or summarize the various responses. The questionnaire may ask directors to rate how effectively the board is doing in each area, elicit open-ended responses, or a combination of both. Other boards might wish to engage in an informal discussion about the topics at meetings with all of the board members. Another option could be a self-assessment process bringing in an external third provider or outside counsel to issue an independent report or undertake an independent assessment of the whole board. The board may also engage the services of external consultants to facilitate the performance evaluation of the board, its committee or individual directors (SEC Act, 2008). How often the board evaluation process is carried out has also been another point for consideration— the board evaluation cycle. While some boards may decide to evaluate their performance on “needs basis”, others will prefer to conduct a major review every two or three years. Many boards conduct an annual or even semi-annual review, while others may even include it as a regular agenda item at each board meeting. Most large corporations make the evaluation cycle consistent with the annual planning cycle adopted by the boards, while others tie it to the strategy formulation process (Deloitte, 2014). While there are no divided opinions on board evaluation, opinion is still divided on whether performance evaluation of individual directors is a valuable exercise or whether it can inhibit board dynamics and group performance (Deloitte, 2014). Though similar to board evaluation methodology and processes (both have qualitative and quantitative parts— questionnaires with responses on a rating scale followed by interviews), the parameters of evaluation may differ. For example, the parameter for director evaluation could be contribution of the director to the board’s strategic thinking, leadership and commitment, participation in board and committee meetings, communication and interpersonal skills of the directors and ethical issues (Gupte and Paranjape, 2014). Similar to

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board evaluation, a director’s evaluation could be self-assessed or a peer evaluation. It is important for boards to build consensus on the approach to be adopted. In carrying out effective evaluation procedures, the author, a serving chairman on a bank board, innovated a practice called Director’s Day in his enterprise. This practice ensures that a director will be made to pick a day within the year to work in a specific unit within the bankfinance, human resource or marketing etc. sectors. This will not only further enhance the continuous education process for the director and give the director a hands-on experience of what goes on within (bridging the skills gap set), but also allows the organization to evaluate the contribution of each director. Another evaluation strategy could be the outlining of yearly board objectives, different for the corporate objectives of profitability, growth, among other things. The organization can take it further by assigning specific objectives to board members and then conducting regular appraisal/evaluation of progress made. By the provision of extant codes in Nigeria, the result of the performance evaluation is communicated and discussed by the board as a whole, while those of individual directors is communicated and discussed with them by the chairman. Board evaluation should therefore be seen as an opportunity to have confidential one-on-one discussions and where necessary assistance rendered to under-performing directors. Director’s Disengagement Process The directors’ disengagement is one of the ex post facto sanctions for directorial behavior aimed at improving CG (Osunji and Moore, 2017). Disqualification provisions are traditionally entrenched in CG codes to ensure prudent and responsible management of company affairs by preinforming managers of the consequences of their actions. As a general rule, a company’s constitution will deal with the disengagement process for a director. It will also provide for the procedures for filling the vacancies caused by a director leaving or retiring from the company. In Nigeria, S. 15.6 of the SEC Code on Corporate Governance, 2008 stipulates that where the performance of a director is unsatisfactory, the director concerned should be made to undergo further training, and where such is not feasible or practicable, the director may be removed in accordance with established procedures. Section 258 of the CAMA, LFN, 2004 further provides for the circumstances under which the office of a director shall be vacated viz bankruptcy, insanity, resignation or prohibitions under S. 254 (fraudulent acts and other forms of gross misconduct) and pursuant to S. 251 (shareholding qualification as stated in the company’s Article of Association). A survey of different companies acts in different

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countries provide for a number of ways in which a director may leave or be disengaged from the board. These include: •

•

•

Resignation: Directors can be disengaged by giving written notice to the company’s registered office as contained in the relevant provisions. It is very important for a director seeking to de-board to follow the laid down formalities. Otherwise, for example, if the corporation becomes insolvent while the director’s name is still on the record, then the director may face legal action for bankruptcy. There is a legal channel entrenched in most countries’ corporate governance codes for a resignation procedure. Resignation could also voluntarily come from a member, if there is a conflict of interest with the corporate’s objectives (CAMA, 2004). Rotation (or retirement) of directors: Another common de-boarding process for a director is through rotation. Directors are required to hold office subject to retirement by rotation or retirement. Section 259 of CAMA, C20, LFN, 2004 provides that unless there is a contrary provision, all directors (excluding life directors) shall at the first annual general meeting retire from office and at subsequent AGMs, one-third of them, or if the number is not in a multiple of three, the number nearest to one-third shall retire. In most listed companies, directors can hold office not more than three years or the third annual general meeting whichever is longer without re-election. However, a director may be required to stand for re-election more frequently than three years if this is set out in the company’s constitution. There is nonetheless a global debate within the corporate governance discourse as to whether the entire board should stand for election each year as a demonstration of accountability or whether staggered boards are desirable with directors standing for re-election every second or third year. The argument in favor of staggered boards is that it tends to promote continuity of the corporate memory (AICD, 2016). Retirement can also be in the form of setting tenure limits. For example a maximum of three terms of three years each. This practice is evident among some Nigerian banks. Given that Nigerian CBN corporate governance laws stipulate that the maximum tenure limit for a managing director is 10 years with 12 years for non-executive directors, the author believes that this will enhance the refreshment of board composition and allow for novel ideas to be introduced. Removal of a director: A director can also be removed by the shareholders. This is despite anything in the company’s constitution, agreement between the company and the director or an agreement between any or all the members of the company and the director (Australian Institute of Company Directors ACID, 2016). If a director is a representative of a particular class of shareholders or

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debenture holders, the resolution to remove the director does not take effect until a replacement representative has been appointed. Where a company decides to remove one or some of its directors, whether or not they are employees of the companies, the company must serve a special notice of the removal on all the directors of the company including the director that is proposed to be de-boarded. Where a notice of removal is not served, all the directors including the director or directors proposed to be removed, such removal will be declared by a properly constituted court as a nullity. The board or other directors cannot remove a director especially in public companies. This prevents a majority of public company directors from removing a director without the agreement of shareholders. Any resolution, request or notice of the directors of a public company which purports to remove another director is void (CAMA, 2004). S. 262 provided for the removal of a director and it is usually a last resort for the company. S. 262(1) states that a company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in the articles or in agreement between it and him. The notice of intention to move the resolution must be given to the company before the meeting is to be held. The director in question must also be given a copy of the notice as soon as practicable after it is received. This means that the so-called “pre-nuptial agreements”, where it is said that a director will resign if other directors request it, are not legally effective. For a private company, a director may be disengaged by resolution by the company and may by same appoint another person as a director instead. In this case, a director may also be removed by a majority of directors if the company’s constitution allows it. In doing this, especially if the person is an executive director, the company must be cautious of the terms/conditions of employment for that director, unfair dismissal laws and social (natural) justice requirements. Removal of a director can also come from the performance report of board evaluation. Expectedly, the removal of such a director is a difficult task and can be damaging to the organization.

Conclusions This chapter focuses on directors’ selection, on-boarding (or integration) processes, evaluation of their performances and how they may be disengaged or de-boarded. The compositions of the board will vary overtime and every board should periodically assess its composition to ensure that it continues to be properly constituted to effectively perform its oversight

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role on behalf of the company and its shareholders. The author itemizes the steps to be taken in selecting board members while also outlining the procedure for ease of on-boarding of new members into the board. Board evaluation procedure was also examined and suggestions were made on how to make them better. Board reviews and appraisals will be an expensive waste of time unless they improve the board’s effectiveness. To this end, the author submits that evaluation become an integral part of board development and should be undertaken within the appropriate ambit of the corporate governance code. Boards should be mindful of issues raised in this chapter, and where appropriate, adopt policies to remedy them.

References Australian Institute of Company Directors (ACID) (2016). Board Composition; Resignation or Removal of a Director: Director Tool. Bisi A. (2016). The Role of the Board Governance & Nomination Committee: The Government Business Journal. https://govandbusinessjournal.com.ng/the-roleof-the-board-governance-nomination-committee/ Borlea, N.S., Achim, M.V., & Mare, C. (2017). Board Characteristics and Firm Performances in Emerging Economies: Lesson from Romania: Economic Research. Abingdon, UK: Routledge. CAMA, Law of the Federation of Nigeria; LFN 2004. Central Bank of Nigeria (2014). Code of Corporate Governance for Banks and Discount Houses in Nigeria. https://www.cbn.gov.ng/out/2014/fprd/circular %20on%20code%20of%20circular%20on%20corporate%20governance%20 and%20whistle%20blowing-may%202014%20(3).pdf Deloitte (2014). Performance Evaluation of Boards and Directors. Deloitte publication in www.deloitte.com/in Gupte, A. & Paranjape, S. (2014). Evaluating Boards and Directors performance: Deloitte TTL, UK. Ibrahim, H.I. & Zulkafil, H. (2016). Corporate governance, HRM practices and organizational performance. Socio-Economic Problems and the State. Соціально-економічні проблеми і держава, 14(1), 30–40. ICAEW (2011). Effective corporate governance frameworks: Encouraging enterprise and market confidence. Dialogue in corporate governance. Beyond the myth of Anglo-American CG, ISBN-10 1-84152-396-8. IDC (2013). Considerations for Board Composition: From Recruitment through Retirement. Independent Directors’ Council, Washington, USA. Ingley, C. & Van der Walt, N. (2002). Board dynamics and the politics of appraisal. Corporate Governance: An International Review, Vol. 10, pp. 163–173. Institute of Directors Southern Africa (2016). Draft King IV Report on corporate governance for South Africa 2016 Company Directors published on 14/12/2016. J. & Lawler III (2002). Building a high performing board: How to choose the right members. first published: 6 January 2003: https://doi.org/10.1111/14678616.00179 KPMG (2016). New Director On-Boarding. Board Leadership Centre. KPMG LLP, Delaware.

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Makhlouf, M.H., Laili, N.H.B. & Basah, M.Y.A. (2014). Board of Directors Characteristics and Firms Performance among Jordanian Firms, Proposing Conceptual Framework. OECD. OECD (1999, 2004). Principles of Corporate Governance. Paris: OECD. Ogbechie, C., & Koupofoulos, D.N. (2010): Corporate Governance and Board Practices in the Nigerian Banking Industry. SSRN: https://ssrn.com/abstract=1543811 or http://dx.doi.org/10.2139/ssrn.1543811 Osunji, O. & Moore, I. (2017). Director Disqualification in Emerging Markets. New York: Routledge, Taylor and Francis. SEC Act (2008, 2014). Code of Corporate Governance for Public Companies in Nigeria. Securities and Exchange Commission, Nigeria. Van den Berghe, L.A. & De Ridder, L. (1999). International Standardization of Good Corporate Governance. Kluwer Academic Publishers. Springer, US. Van den Berghe, L.A. & Levrau, A. (2007). Corporate governance and board effectiveness: Beyond formalism. The European Academy of Management (EURAM) annual conference. Westphal, J.D. & Zajac, E.J. (1998). The symbolic management of stockholders: Corporate governance reforms and shareholder reactions. Administrative Science Quarterly. Vol. 43, No. 1 (Mar., 1998), pp. 127–153. Williamson, O.E. (2009). The Economic Institutions of Capitalism: Firms, Markets and Relational Contracting. New York: Macmillan. Wirtz, P. (2011). The cognitive dimension of corporate governance in fast growing entrepreneurial firms. European Management Journal, Vol. 29, pp. 431–447.

14 Directors’ Duties and Accountability, Personal Liability and Lifting the Veil of Incorporation Ngozi Okoye Introduction Economic contractual theory is based on the argument that free markets are the most efficient mechanisms for wealth creation.1 Flowing from this assertion, Coase’s theory of the firm argues that the reason why companies (types of firms) exist is because an entrepreneur cannot own all the factors of production such as capital and labour, and if these factors are sought outside the architecture of a firm, transaction costs will be higher due to the various contractual engagements required.2 It follows that in the typical construct of a company, the factors of production freely transact to aid the existence of the company. Therefore, the company is supposed to encompass an efficient platform for economic growth and development. From the era in which incorporation statutes were established,3 companies have been utilised by entrepreneurs and ownership of companies is often separated from control in cases where the investors of capital are not the professional managers. In the early times of limited liability companies, shareholders were usually present and involved in the management of companies, but, by the twentieth century and in economically progressive jurisdictions such as the UK and USA, many companies became large/complex with numerous and dispersed shareholders.4 It is important to note that companies in some other regions, for example in continental Europe and Asia, have concentrated ownership patterns. Berle and Means propounded the separation of ownership from control theory,5 arguing that this necessitated the appointment of directors to manage the affairs of the modern day company.6 Company law in various jurisdictions certainly provides that the directors are saddled with the responsibility of managing companies.7 The role and position of directors is influenced by the fact that company law evolved from the law of partnership, which is based on agency principles.8 Directors have been historically viewed as agents of the company’s shareholders, although in terms of control of the company, shareholders do not necessarily wield more power.9 The agency problems that arise from the separation of ownership from control was also articulated by

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Adam Smith who argued that the directors of companies being managers of other people’s money cannot be expected to watch over it with the same vigilance with which they watch their own.10 For the reason that directors are viewed as agents, they are subject to the fiduciary duties developed in equity to ensure that they do not benefit from their position of trust to the detriment of the principals. In Aberdeen Railway Co v Blaikie Bros [1854],11 Lord Cranworth encapsulated the position of directors as follows: The directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is of course the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. The fiduciary duties of directors also have their basis from trusteeship principles, since the earliest companies operated like trusts.12 In Towers v Premier Waste Management Ltd [2011], Mummery LJ explained the fiduciary nature of the directors’ role by stating that a director of a company is appointed to direct its affairs, and in doing so it is his duty to use his position in the company to promote its success and to protect its interests, and in accordance with equitable principles, the special relationship with the company generated fiduciary duties to the form of a duty of loyalty and a duty to avoid a conflict between his personal interests and his duty to the company.13 Considering the position of directors as explained above and thinking particularly in terms of the fact that corporate actions are simply the decisions of directors, issues can arise as to the extent of directorial liability for corporate actions. Barker argues that the primary function of the board of directors as the key organ of corporate governance is to provide human accountability for corporate behaviour.14 A shift has occurred from the traditional view that burdening directors with personal liability could be detrimental to the success of business endeavours to an approach arguing that it is necessary to hold directors accountable for corporate wrong-doing.15 Historically, from a common law perspective, the pivotal duties owed by directors to a company are those of loyalty and care.16 Although in the US, for instance, there is the Business Judgement Rule that prevents the courts from second-guessing the actions of directors done with due care and for a corporate purpose,17 directors generally have the responsibility to act in the best interest of the company. In discussing the issues around directors’ duties, their personal liability and the lifting of the corporate veil and its impact on director effectiveness, the chapter will proceed as follows: the first section will discuss the duties of directors in a number

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of jurisdictions with the UK and US being the major focus; the second section will discuss the personal liability of directors, engaging with case law and poignant arguments and the third section will discuss the ways in which the veil of incorporation is lifted and present arguments in relation to lifting the veil as regards directors’ duties and their personal liability. In conclusion, arguments will be made as to the nexus and impact of these issues on board effectiveness and corporate governance.

Directors’ Duties in UK, US, Australia, South Africa, Germany and Nigeria In order to buttress the point that directors owe duties to the company in most jurisdictions, an overview of directors’ duties in a number of countries is pertinent. In the UK, the duties of directors originated from common law fiduciary duties and has been codified in the Companies Act 2006. Sections 171–177 of this act enumerate the various duties that are the duty to act within powers, the duty to promote the success of the company, the duty to exercise independent judgement, the duty to exercise reasonable care, skill and diligence, the duty to avoid conflicts of interest, the duty not to accept benefit from third parties and the duty to declare interest in proposed transactions. Section 178(1) provides that the consequences of breach (or threatened breach) of these duties are the same as would apply if the corresponding common law rule or equitable principle applied. In the US, corporation law is within the purview of individual states and the state of Delaware has been recognised as the venue for most incorporations due to the favourability of its corporate law.18 Focusing on Delaware law, directors are charged with fiduciary duties to the company and its shareholders.19 The key fiduciary duties are those of care and loyalty. The duty of care requires a director to inform himself/herself prior to making a business decision, of all material information reasonably available to himself/herself.20 The issues taken into consideration by the courts in determining whether a director has abided by the duty of care include whether they have advance notice and documentation for meetings, are informed of all relevant developments, conduct extensive discussions with relevant parties, review relevant documents, engage in necessary enquiry and engage with relevant critique and whether they take sufficient time to act deliberately, considering and evaluating decisions.21 The duty of loyalty is described as one which prevents corporate directors from using their position of trust and confidence to further their private interests, emphasising that this rule requires an undivided and unselfish loyalty to the corporation demands that there be no conflict between duty towards the company and self-interests.22 In Australia, Sections 180–184 of The Corporations Act 2001 specifies directors’ duties as including the duty of care, the duty to act in good faith in the best interests of the company, duty not to improperly

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use their position, duty not to improperly use information and duty to disclose personal interest in issues.23 The South Africa Companies Act 2008 provides that directors owe duties as specified under Sections 75 and 76, and in Section 77 indicates that a director may held liable for breach of common law fiduciary duties. The duties stated in the act include the duties to act in good faith and in the best interests of the company, to disclose personal interests and to exercise care, skill and diligence. Directors in Germany owe similar fiduciary duties to the company, as is the case in the UK. Germany operates a dual board structure and these duties are specified under statutory provisions in the German Civil Code (BGB), the German Commercial Code (HGB), the Private Limited Companies Act (GmbHG) and the Stock Corporation Act (AktG). For example, Section 43 of the GmbHG specifies the duties of the managing director to include pursuing the business purpose, being loyal to the company and not to take advantage of his/her position. Section 93 of the AktG deals with the duty of care and provides that the members of the management board shall employ the care of a diligent and conscientious manager.24 Section 116 of the AktG provides that supervisory board members also owe a duty of care and are particularly bound to maintain confidentiality. Members of the management or supervisory board who have breached their duties are jointly and severally liable together with any colluding third party under Section 117 of the AktG. Under the Nigerian Companies and Allied Matters Act (CAMA 2004), the duties of directors are as provided under Sections 279, 280, 282 and 290. These duties can be grouped into fiduciary duties and the duty of skill/diligence.25 Section 279 provides that a director stands in a fiduciary relationship to the company and must observe the utmost good faith in any transaction with it or on its behalf. In accordance with Section 282, a director is expected to exercise the degree of skill, care and diligence as a reasonably prudent director would do in similar circumstances. The discussions in this section elicit the fact that directors certainly owe duties to the company, and these duties are somewhat similar across jurisdictions. In some jurisdictions, the duties are framed as being owed to the company, whilst other jurisdictions state that the duties are owed to the company and its shareholders. One underlying issue is that these duties are aimed at safeguarding the company and protecting the interests of all stakeholders. Today, the arguments underlying the theory of Adam Smith regarding separation of ownership and control, from which the fiduciary duties of directors have emerged, applies more than ever. The law is reasonable in enshrining the fiduciary duties of directors and extending those duties into statutory corporate law to ensure clarity and enhanced accountability. It is pertinent to now consider situations in which directors have indeed been held accountable for breach of their duties.

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Cases on Personal Liability and Collective Liability for Breach of Duties The UK jurisdiction has a clear codification of directors’ duties, and it is evident that directors can bear personal and collective responsibility for breach of their duties. As regards the rationale for holding directors responsible collectively for breach of duties, that could emanate from the notion that the board of directors acts as a body in corporate governance.26 In the case of Lexi Holdings Plc (in administration) v Luqman & Ors [2009], 27 the managing director was held liable for misappropriating about £59 million of the company’s funds. The Court of Appeal held that two other directors of the company were also liable for breach of duty due to their neglect in questioning the managing director’s actions. Their lack of care constituted a breach of their duty to exercise reasonable care, skill and diligence as provided under Section 174 of the Companies Act 2006 and substantial liability accrued to them. Section 178 of the Companies Act 2006 provides that the consequences of breaching the duties under Sections 170–177 would be the same as the consequences for breaching common law fiduciary duties, so, for instance, the director can be made to account for any benefits gained from the breach. Essentially, the principles enshrined in common law cases such as Regal (Hastings) Ltd v Gulliver [1942]28 and Cook v Deeks [1916]29 in relation to the duty to avoid conflict of interest and not to profit from corporate opportunities still hold true. In O’Donnell v Shanahan [2009],30 Rimer LJ explained that the ‘no conflict’ and ‘no profit’ rules serve to underpin the fiduciary’s duty of undivided loyalty to his beneficiary, and a director is not allowed to make decisions as to whether he/she can benefit from corporate opportunities. This is the case even where the company could not have taken advantage of the opportunities. In Towers v Premier Waste Management Ltd [2011],31 a director was held liable for breach of duty for accepting a free loan of equipment from a customer without disclosing the transaction. The Company Directors Disqualification Act 1986 also contains provisions that create personal liability for directors to the extent that under Section 6(1), a disqualification order can be made against a person whose conduct as a director makes him unfit to be concerned in the management of a company. In determining whether a person’s conduct renders him/her unfit to be a director, the court considers certain matters listed under Schedule 1 to the Act as substituted by the Small Business Enterprises and Employment Act 2015, which includes the breach of any fiduciary duty. An interesting case to consider here is Secretary of State for Business, Innovation and Skills v Drummond [2015],32 where the respondent, a director of West Court Developments (Dundee) Ltd was found liable for various dispositions aimed at removing the company’s assets from the reach of its creditors and was disqualified for ten years.

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The director’s conduct was held by the court to amount to grave misconduct and is arguably a breach of his duties under the Companies Act. In Re AG (Manchester) Ltd Official Receiver v Watson & anor [2008],33 Patten J disqualified the CEO who had been in breach of his duty of care to the company. In the US, in the case of Smith v Van Gorkom [1985], the Delaware Supreme Court held all the ten directors of Trans Union Corporation jointly and severally liable to the tune of $23.5 million for breaching their duty of care in approving the sale of the corporation.34 Interestingly, it has also been argued that directors’ liabilities in relation to breach of duty should be individual and not collective.35 Arguably, directors can be liable to differing extents in relation to a breach of duty, and it is only fair that liability is apportioned according to the level of contribution to the breach in question. From the cases discussed above, it appears that the courts generally take into cognisance the individual liability of directors as well as their collective liability. Surely, as the board of directors acts as a body, if there is collective responsibility for decisions and actions, then there should also be collective liability. However, in situations where a director was not involved in the decision making or in the conduct and was not even aware of the issues in question, it makes sense for the question of collective liability to be put at abeyance. The next issue to consider is whether directors should be held accountable for their role in ‘supposed’ corporate actions and when the veil of incorporation should be lifted.

Lifting the Veil of Incorporation and Directors’ Liabilities Lifting the veil of incorporation refers to situations in which the courts or indeed the legislature decides that the principle of separate legal personality of the company should not be upheld. Thus, the veil of incorporation which shields the entities within the company is removed to cast the light on those entities. For instance, actions which might have been considered corporate actions may then be ascribed to the individuals in control of the company. The issue of veil lifting has been particularly engaged with by courts in relation to corporate groups—that is parent companies and subsidiaries. There are statutory examples where the law allows veil lifting, for example in jurisdictions such as the UK, tax regimes allow for parent companies to produce a group account, and they are also required to provide details of their subsidiaries,36 thereby negating the separate legal personality of the subsidiaries. Corporate legislation also recognises that the separate legal personality principle can be abused and there are provisions in relation to utilising the corporate form for fraudulent purposes.37 Under the UK Insolvency Act 1986, Sections 213–215 provide for issues such as when the corporate form has

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been abused and ascribe personal liability to the person/s in control of the company. Section 213 requires that in cases of fraudulent trading, there is proof of actual dishonesty and real moral blame, and this can be a challenging standard to meet. Section 214 which deals with wrongful trading focuses on situations where negligence rather than fraud is combined with the abuse of the corporate form. The import of Section 214 is that a reasonable director should know the limit of risks to take the company through, and cease trading at an appropriate time if the company is undergoing difficulties. In the case of Re Produce Marketing Consortium Ltd (no 2) [1989],38 two directors were liable to contribute £75, 000 to the debts of the company under the provisions of Section 214 because they neglected to put the company into liquidation at the right time. Whilst Section 214 is particularly aimed at directors, Section 213 is wider and covers anyone who is involved in carrying on the business. Therefore, in effect, directors will be personally liable if the circumstances are such as are covered by Sections 213 or 214 of the Insolvency Act and the corporate veil would be lifted so that the actions of the company would be viewed as the actions of the directors. In terms of lifting the veil by the courts, the approach has been considerably inconsistent over many years, and case law indicates that the courts are minded to lift the veil in certain situations, but are opposed to veil lifting on other occasions. After the decision in Salomon v Salomon, the courts maintained an approach which bore heavily on the side of protecting the separate legal personality principle and applied restraint on lifting the veil of incorporation. However, in exceptional cases, the veil was lifted. Examples include the cases of Gilford Motor Co Ltd v Horne [1933],39 Re Bugle Press [1961]40 and Jones v Lipman [1962].41 In Littlewoods Mail Order Stores v IRC [1969],42 it was noted that the doctrine in Salomon v Salomon had to be watched carefully and that the courts can pull off the corporate veil. Lord Denning also argued in cases such as DHN Food Distributors Ltd v Tower Hamlets [1976] that a group of companies was actually in reality a single economic entity,43 but this argument met with disagreement in later cases such as Adams v Cape Industries Plc [1990],44 where the Court of Appeal narrowed the avenues by which the courts could embark on veil lifting. The court held that the veil of incorporation should only be lifted in three circumstances: 1) where the court is interpreting a statute or document, 2) where special circumstances exist to indicate that the corporate form is a mere façade, concealing the true facts beneath it and 3) where there is an express agency agreement or agency could be implied from conduct.45 So, this case significantly reduced the circumstances for veil lifting. However, there have been other developments. In relation to directors’ breaches of duties, the case of Trustor AB v Smallbone (No 2) [2001]46 is relevant. In that case, Smallbone was the managing director of Trustor at a point and transferred various sums of money in breach of his

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fiduciary duties from Trustor to another company owned and controlled by Smallbone. Trustor applied to the court to pierce (lift) the corporate veil in order to find Smallbone liable, because the company was a sham created to facilitate the breach of the director’s duties. The court agreed and emphasised that the connection between the director’s improper conduct and the utilisation of the corporate form to perpetuate it is key to the decision on lifting the veil. In truth, the courts have gone back and forth on the issue of veil lifting, and the decision of the UK Supreme Court in Prest v Petrodel Resources Ltd [2013] is interesting and provides useful insight on the current position of the law.47 The case was concerned with a post-divorce settlement, and the issue was whether the properties owned by two companies in which Mr Prest was the controlling shareholder actually belonged to him. The court decided that the corporate veil should not be lifted because there was no impropriety on the part of Mr Prest. Instead, the court held that the properties should be transferred to Mrs Prest because they were held by the companies on trust for Mr Prest. This is an intriguing decision to the extent that the court refused to lift the veil but found another route to achieve the very same thing that lifting the veil was going to achieve. A key point that was made in this case was that there is a limited principle of English law that applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction that he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court noted that in these cases, the veil may be pierced in order to deprive the company or that controller of the advantage they would have by virtue of the separate legal personality principle.48 Thinking about the argument of the court here, it becomes evident that a director who is a shareholder cannot actually hide behind the veil of incorporation, particularly as it relates to the breach of his/her duties. The empowering issue is that the Prest case indicates in terms of its final resolution that even where the court decides not to lift the veil, an outcome could be reached which in effect exposes the entities behind the veil and achieves justice. In the Prest case, Lord Sumption identified two underlying principles which would determine whether the veil could be lifted—the concealment principle and the evasion principle. It would appear that the courts generally adopt a restrictive view when it comes to veil lifting, as even in cases such as Chandler v Cape Plc [2012], in which a parent company was found liable for the actions of its subsidiary, the court argued that it was not lifting the veil but only attributing responsibility to the parent company, which the parent company already held in relation to the health and safety issues of its subsidiary’s employees.49 As regards directors’ liability for tort issues such as negligent misstatement, the courts are not usually willing to ascribe personal liability unless the director expressed personal responsibility so as to create a special relationship to the victim. In cases such as Williams v Natural Life

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Health Foods Ltd [1998]50 and Noel v Poland [2001],51 the court argued that there will be no personal liability if the director was simply acting on behalf of the company. However, in cases where a director has been deceitful, the court will be minded to ascribe personal liability.52 In MCA Records Inc v Charly Records Ltd (No 5) [2003], the court explained that if a director is only undertaking the duties entrusted to him, then the circumstances in which he could be held liable as a tortfeasor would be rare, but there is no reason why a director should not be personally liable if he is not acting constitutionally and his actions would render him liable if he were not a director.53 The court in MCA makes a reasonable argument to the extent that in situations where directors act to outwit their constitutionally derived power and authority, they should be held liable in their personal capacity and should not be allowed to hide behind the cloak of incorporation. Particularly as it relates to lifting the veil of incorporation, directors who are shareholders should abide by their duties and should not utilise the separate legal personality principle as a means to facilitate the breach of their fiduciary and statutory duties. However, as is indicated in the recent approach of the courts, veil lifting should be approached with caution because there is a need to protect the separate legal personality principle because of its legitimate value in encouraging the utilisation of companies as vehicles for business, along with the limited liability principle. But, the veil should be lifted when there is a clear reason to do so. To the extent that it can actually be done, arguably, if directors who are shareholders know that the veil of incorporation could be lifted to ascribe liability to them for purported corporate actions, then that is likely to negate their propensity to make improper decisions and take inappropriate actions in their governance of companies.

Recommendations and Conclusion The duties of directors are necessary in terms of balancing the advantages and possible abuses of the separate legal personality principle. It is widely acknowledged that the limited liability company is an efficient vehicle for wealth creation, however, it is important to recognise the fact that companies are managed by human beings who are capable of super-imposing their own interests in the guise of acting for the company. Particularly in the light of the separation of ownership and control in numerous large companies all over the world and to facilitate the flow of capital which can only be sustained by sustained confidence in the markets, then it is vital to ascribe accountability to company directors in a manner that ensures that corporate objectives are met successfully. It is certainly the case that the fear of accountability and liability can deter people from becoming directors and shrink the available pool, however, that is a consideration which should not be given enormous weight. This is because to the extent that we need to ensure that companies are governed effectively,

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we certainly need to ensure that the people who are directors are such as can be appreciative of the importance and necessity of their duties to the company. If a person is fearful of becoming a director on account of a reluctance to be held liable for breach of his/her duties, the more pertinent question to ask is whether that person should actually be allowed to become a director. The duties are reasonable and merely ensure good conduct and corporate success, therefore, there should be no overwhelming reason to want to evade them or their consequences. Also, there are certainly provisions such as Section 1157 of the UK Companies Act 2006 which ensure that directors are not held liable when they have acted honestly and reasonably. Surely, this provides the requisite balance needed and arguably, any director whose actions fall below the required standard should rightly be made to face the consequences of their actions. As regards corporate governance effectiveness, the potential for directors to be held personally and collectively liable for the breach of their duties is something which should impact positively on their behaviour. As has been argued frequently, the role of the law in society is to safeguard the interests of the public, and the role of company law, therefore, is to safeguard the interests of companies and their stakeholders.54 As far as enshrining the duties of directors and allowing lifting of the veil in appropriate circumstances is concerned, company law is simply fulfilling its purpose. In terms of enhancing board effectiveness in developing and emerging markets, the legal principles which have been discussed in this chapter are necessary and should be propagated as mechanisms that can contribute towards ensuring that directors are effective. The chapter engages with the salient issues that highlight the operationality of the principles, thereby allowing for a better understanding of their utility and application.

Notes 1. See A. Smith, The Wealth of Nations (London: J.M. Dent & Sons, 1910). 2. See R.H. Coase, ‘The Nature of the Firm’ (1937) Economica 386–405. 3. For instance, in the UK, general incorporation was allowed from 1844. The principle of limited liability was introduced with the Limited Liability Act 1855 and consolidated with the Companies Act 1862, while the decision in Salomon v Salomon & Co Ltd [1897] AC 22 promoted the separate legal personality principle. These developments have all contributed towards the popularity of the corporate form as a vehicle for the conduct of business. 4. See B. Tricker, Corporate Governance: Principles, Policies and Practices (3rd ed., Oxford: Oxford University Press, 2015), pp. 7–8. 5. See A. Berle and G. Means, The Modern Corporation and Private Property (New York: Macmillan, 1932). 6. Ibid. 7. See Ferguson v Wilson [1866] LR 2 Ch App 77, where it is reiterated that the company is an artificial entity and can only act through its human arm, the directors. Also, for example in the UK, the Model Articles for private as

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8. 9.

10. 11. 12. 13. 14.

15. 16. 17.

18. 19. 20. 21. 22. 23. 24. 25. 26.

Ngozi Okoye well as public companies in Art 3 provides that subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company. Note that Art 4 has some reserve power for the shareholders. In the US, in the State of Delaware Code, Title 8 has similar provisions as Art 3, providing under section 141 that the business and affairs of the corporation shall be managed by or under the direction of the board of directors. Section 155 of the UK Companies Act 2006 also requires that a company must have at least one directors who is a natural person. Recent legislation in the UK now prohibits corporate directorships generally. See A. Dignam and J. Lowry, Company Law (9th ed., Oxford: Oxford University Press, 2016), p. 269. See for instance cases such as Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34; Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89; Towcester Racecourse Co Ltd v Racecourse Association Ltd [2003] 1 BCLC 260 where the court emphasised that directors were not servants of shareholders and are persons who may by the regulations be entrusted with the control of the business. See Smith, note 1. [1854] 1 Macq 461. See Re Lands Allotment Co [1894] 1 Ch 616, where Lindley LJ explained that although directors are not trustees strictly speaking, they have always been considered as trustees of money which is actually under their control. [2011] EWCA Civ 923. See R. Barker, ‘The Duties and Liabilities of Directors: Getting the Balance Right’ in R. Leblanc and J. Fraser, eds., The Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not-For-Profit Board Members (New Jersey: John Wiley and Sons, 2016), p. 249. Ibid. Ibid., p. 254. See M. Conaglen and J.G. Hill, ‘Directors’ Duties and Legal Safe Harbours: A Comparative Analysis’ in D.G. Smith and A.S. Gold, eds., Research Handbook on Fiduciary Law (Cheltenham, UK: Edward Elgar Publishing 2017), ECGI Law Working Paper No 351/2017, p. 18 where the authors explain that the Business Judgement Rule assumes that directors, in making a business decision, have acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. See L.A. Bebchuk and A. Cohen, ‘Firms’ Decisions Where to Incorporate’ (2003) 46 Journal of Law and Economics 383–425. See Guth v Loft Inc. 5 A.2D 503, 510 (Del 1939). See W.M. Lafferty, L. A. Schmidt and D. J. Wolfe, Jr., ‘A Brief Introduction to the Fiduciary Duties of Directors under Delaware Law’ (2012) 116(3) Penn State Law Review 837–877 at 842. Ibid. at 843. See also Smith v Van Gorkom 488 A.2D 858–885 (Del 1985). See Guth v Loft Inc. note 19. See sections 180–183, 191, Corporations Act 2001. See the German Stock Corporation Act. Available at www.nortonroseful bright.com/files/german-stock-corporation-act-147035.pdf See J. Onele and A. Odaro, ‘Directors’ Liability: The Legal Position in Nigeria’ (2016). Available at SSRN https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=2715073 p. 5. See for example the UK Corporate Governance Code 2016, which states that every company should be headed by an effective board which is collectively responsible for the long-term success of the company.

Directors’ Duties and Accountability 27. 28. 29. 30. 31. 32. 33. 34. 35.

36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54.

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[2009] EWCA Civ 117. [1942] UKHL 1. [1916] 1 AC 554. [2009] EWCA Civ 751. [2011] EWCA Civ 923. [2015] CSOH 45. [2008] EWHC 64 (Ch). [Del 1985] 488 A.2d 858. See Re Emerging Communications Inc. Shareholders Litigation [2004] WL 1305745, where the Delaware Supreme Court held that only three out of seven directors of a company were liable for breach of their duties, because, according to the court, the liability of directors must be determined on an individual basis as the nature of their breach of duty can vary from one director to another. See sections 399 and 409 UK Companies Act 2006. See section 993 UK Companies Act 2006. [1989] 5 BCC 569. [1933] Ch 935. [1961] Ch 270. [1962] 1 WLR 832. [1969] 1 WLR 1241. [1976] 1 WLR 852. [1990] 1 Ch 433. Ibid. [2001] 2 BCLC 436. [2013] UKSC 34. Ibid. See Chandler v Cape Plc [2012] EWCA Civ 525. [1998] 1 BCLC 689. [2001] 2 BCLC 645. See Barclay Pharmaceuticals Ltd v Waypharm LP [2012] EWHC 306 (Comm). [2003] 1 BCLC 93. See J. Dine, The Governance of Corporate Groups (Cambridge: Cambridge University Press, 2000), p. 29.

References Barker, R., ‘The Duties and Liabilities of Directors: Getting the Balance Right’ in R. Leblanc and J. Fraser, eds., The Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not-For-Profit Board Members (New Jersey: John Wiley and Sons, 2016). Bebchuk, L.A. and Cohen, A., ‘Firms’ Decisions Where to Incorporate’ (2003) 46 Journal of Law and Economics 383–425. Berle, A. and Means, G., The Modern Corporation and Private Property (New York: Macmillan, 1932). Coase, R.H., ‘The Nature of the Firm’ (1937) Economica 386–405. Conaglen, M. and Hill, J. G., ‘Directors’ Duties and Legal Safe Harbours: A Comparative Analysis’ in D.G. Smith and A.S. Gold, eds., Research Handbook on Fiduciary Law (Cheltenham, UK: Edward Elgar Publishing 2017), ECGI Law Working Paper No 351/2017. Dignam, A. and Lowry, J., Company Law (9th ed., Oxford: Oxford University Press, 2016).

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Dine, J., The Governance of Corporate Groups (Cambridge: Cambridge University Press, 2000). Lafferty, W.M., Schmidt, L.A. and Wolfe, D.J. Jr., ‘A Brief Introduction to the Fiduciary Duties of Directors under Delaware Law’ (2012) 116(3) Penn State Law Review 837–877. Onele, J. and Odaro, A., ‘Directors’ Liability: The Legal Position in Nigeria’ (2016). Available at SSRN https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2715073 Smith, A., The Wealth of Nations (London: J.M. Dent & Sons, 1910). Tricker, B., Corporate Governance: Principles, Policies and Practices (3rd ed., Oxford: Oxford University Press, 2015).

Legislation Australian Corporations Act 2001. German Stock Corporation Act. Nigerian Companies and Allied Matters Act (CAMA), Laws of the Federation of Nigeria 2004. State of Delaware Code. UK Companies Act 2006. UK Corporate Governance Code 2016.

List of Cases Aberdeen Railway Co v Blaikie Bros [1854] 1 Macq 461 Adams v Cape Industries Plc [1990] 1 Ch 433 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34 Barclay Pharmaceuticals Ltd v Waypharm LP [2012] EWHC 306 (Comm) Chandler v Cape Plc [2012] EWCA Civ 525 Cook v Deeks [1916] 1 AC 554 DHN Food Distributors Ltd v Tower Hamlets [1976] 1 WLR 852 Ferguson v Wilson [1866] LR 2 Ch App 77 Gilford Motor Co Ltd v Horne [1933] Ch 935 Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89 Guth v Loft Inc. [Del 1939] 5 A.2D 503 Jones v Lipman [1962] 1 WLR 832 Lexi Holdings Plc (in administration) v Luqman & Ors [2009] EWCA Civ 117 Littlewoods Mail Order Stores v IRC [1969] 1 WLR 1241 MCA Records Inc v Charly Records Ltd (No 5) [2003] 1 BCLC 93 Noel v Poland [2001] 2 BCLC 645 O’Donnell v Shanahan [2009] EWCA Civ 751 Prest v Petrodel Resources Ltd [2013] UKSC 34 Re AG (Manchester) Ltd Official Receiver v Watson & anor [2008] EWHC 64 (Ch) Re Bugle Press [1961] Ch 270 Re Emerging Communications Inc. Shareholders Litigation [2004] WL 1305745 Re Lands Allotment Co [1894] 1 Ch 616 Re Produce Marketing Consortium Ltd (no 2) [1989] 5 BCC 569 Regal (Hastings) Ltd v Gulliver [1942] UKHL 1

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Salomon v Salomon [1897] AC 22 Secretary of State for Business, Innovation and Skills v Drummond [2015] CSOH 45 Smith v Van Gorkom [Del 1985] 488 A.2d 858. Towcester Racecourse Co Ltd v Racecourse Association Ltd [2003] 1 BCLC 260 Towers v Premier Waste Management Ltd [2011] EWCA Civ 923 Trustor AB v Smallbone (No 2) [2001] 2 BCLC 436 Williams v Natural Life Health Foods Ltd [1998] 1 BCLC 689

15 Money Laundering, Tax Havens and Transparency Any Role for the Board of Directors of Banks? Euphemia Godspower-Akpomiemie and Kalu Ojah 1. Introduction Among other characteristics, money laundering notably occurs across national borders and primarily through banks, mainly because banks, which are both legitimate and ‘ubiquitous’ financial services institutions, engage primarily in financial intermediation (Barry-Johnston 2005; Chaikin 2011, 2017; Tsingou 2010; Zucman 2015, and others). Therefore, as the natural logical choice of launderers of “soiled funds”, a key question implicit in this chapter is: could effective corporate governance in financial institutions, particularly banks, possibly mitigate or stop this corrupt use of formal financial services institutions and markets? Money laundering dates back many years and is linked to banking and investment transactions that are carried out in presumed “safe” environments. It mainly manifests in individuals and firms hiding their earnings and ill-gotten funds from authorities as to avoid being found out, circumventing taxes and/or the capturing of their pertinent data. Over time—from 2000 BC in China to September 11, 2001 in the US—there has been a flow of illicit funds in the guise of varying activities, and there have been counter efforts to discourage these largely due to the impact of the underlying illegal activities. This iterative process culminated in today’s set of anti-money laundering laws and initiatives such as FIU, FICA, AUSRAC, FATF, Patriot Act, and so on (Morris-Cotterill 2001; Unger 2013; Zucman 2015; and others). Clearly, for these mitigating and/or preventive initiatives to be effective, the levers for implementation must be in the grasp of government to a reasonable extent. The formal legitimate platforms co-opted into these illegal, if not nefarious activities, are financial services institutions, chief of which are banks.1 Therefore, an additional key question here is: are the levers of control over banks’ involvement in money laundering and other financial crimes more effective when pulled from outside by government or is there a less arm’s-length role for banks’ board of directors (by way of appropriately nuanced corporate governance articulation)?

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To see our way through to how banks’ boards of directors can assist, we need a good understanding of what the “animal” (money laundering) is like, how the animal comes to be and what efforts governments have made thus far to tame the animal, as it were. The next sections, therefore, address these necessary background issues. Then follows thoughts on how boards of directors of banks can contribute productively in better taming and curbing the money laundering menace.

2. Money Laundering Origins and Underlying Theories of Money Laundering Money laundering is the act of modifying proceeds from corrupt activities and crime (dirty money) into seemingly clean money (genuine resources). Money earned illegally from crimes and illegal or corrupt activities such as insider trading, extortion, illegal gambling, drug dealing, human trafficking, tax evasion, fraud, bribery, misappropriation of public funds, even armed robbery, is “dirty” and needs to be “cleaned” to seem legal and legitimate (Van Fossen 2003). The notion of money laundering has even expanded to include a variety of businesses and financial crimes, ranging from misuse of financial institutions/markets to financing of terrorism. Arguments persist on the origin of the term “money laundering”. Some believe money laundering originated from ownership of laundromats in the US in the 1920s, when some mafias attempted to legalize proceeds from illegal activities by using those proceeds to acquire legitimate businesses (Schneider 2008; Aluko and Bagheri 2012). Others believe the term was first used in the 1970s, during the Watergate scandal, when some illegal activities–“dirty tricks” (connected to cash/”black funds” used by a presidential re-election committee)–contributed to the resignation of President Richard Nixon.2 As the verb “to launder” means to wash or clean, the term “money laundering” simply adopts the figurative meaning of wash/clean to explain the act of legalizing dirty money (as pictorially illustrated in Figure 15.1). Different definitions of money laundering have emerged from different countries, jurisdictions, organizations and authors. Thus, no consensus original definition of money laundering exists. What seems clear is that most definitions in the extant literature are based on a seemingly universal definition put forth by the UN convention on Drugs and an EU-directive, which relates money laundering to the legalization of illegitimate/forbidden/unlawful proceeds from criminal activities. This definition has been adopted or modified and incorporated into national laws of member countries (Schneider and Windischbauer 2008; Schneider 2008). For example, the Financial Action Task Force

Figure 15.1 Figurative Meaning of Money Laundering

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(FATF), an intergovernmental body, defines money laundering as alteration of criminal earnings to disguise their illegitimate origin (Aluko and Bagheri 2012; Chaikin 2017). FATF went on to develop a theory of the process of money laundering (Gilmore 2004). Though money laundering can sometimes take a highly complex form, the FATF theory conceptualizes money laundering as involving a three-stage process: placement, layering and integration of funds. And these three predominant stages of the money laundering process can sometimes entail layers of arcane activities within one or two of these identifiable stages (Reuter and Edwin 2004). Placement Placement is the first identifiable stage of the laundering chain of activities, where the launderer moves the funds earned from illegal activities to a safe place that is less suspicious to law enforcement agencies. In most cases, the funds are deposited in bank accounts or lodged in other financial institutions or the retail economy; consequently, such funds become mingled in the financial system. According to the Australian Transaction Reports and Analysis Centre (AUSTRAC 2014),3 placement ranges from opening false bank accounts to placing cash deposits in multiple banks. The logic of using banks as a placement depot is that if illicit cash is deposited in a bank, the likelihood of tracing its criminal source is greatly minimized; thus, banks are the most attractive repository for placement of soiled money (Chaikin 2017). According to the Economist of 2014,4 in over 200 countries, trillions of dollars are transacted each year by no less than 11000 financial institutions via the Worldwide Interbank Financial Telecommunication (SWIFT) apparatus. Thus, there is a high probability that banks misuse SWIFT facilities for placement by shifting illegally generated funds to offshore jurisdictions (SWIFT 2016).5 Layering The second stage involves movement of the illicit funds through a series of deliberately intricate transactions, designed to make it more difficult to trace its original source. Indirectly, banks facilitate layering of illicit funds by allowing customers to operate multiple accounts with multiple banks across countries (AUSTRAC 2014). Further, advancement in financial production technologies and existence of offshore financial hubs and corporations form of business has facilitated funds movement across countries. Another means of clouding the original source of illicit monies is through the use/misuse of financial derivatives (Schneider and Windischbauer 2008).

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Integration At the integration stage, the process of money laundering is viewed to have come to completion. The illegal fund would have been integrated into the formal economy, such that there is no more differentiation between funds earned through legal and illegal means. Hereafter, the launderer can move his funds within a country, around the globe, or invest them in any legitimate business with little fear of detection. If the illicit fund had been moved offshore during the placement/layering stage, the launderer can now decide whether to move the fund back to home jurisdiction or allow it to remain offshore. And if the former is decided, the fund is moved back in a way that seems it had been legally earned abroad. The banking sector also plays an important and quite involving role at this stage just as in the first two stages. The integrated fund could be invested in property (backed by bank loans) or equity markets via brokerage or wealth management firms.

Sources of “Soiled Money” Needing Laundering Often the literature takes “as a given” that laundered monies simply appear “soiled” from nowhere, as it were, needing to be cleaned, without reflecting on their origins and why they need to be laundered. This is quite a significant omission that has bearing on the efficacy of measures put in place to combat the symptom of the problem (money laundering) instead of the sources of the soiled money (corrupt activities) and the antecedents of corruption. Understanding these linkages would enable governments and civil society to evolve mitigating measures at early stages (sources) of the problem. This, in turn, would attenuate the quantity of soiled monies needing to be laundered, and thus, make AML measures undoubtedly more efficacious. All else being equal, corrupt activities are more likely in countries characterized by ethnic and/or racial fractionalization (Alesina and Ferrara 2000; Burgess et al. 2011; Delavallade 2012; Franck and Rainer 2012; Fenske and Zurimendi 2017 and others). In the same vein, where there is a high distributional problem (income inequality) whether it be on the basis of social class, income, race, gender or whatever, there is more likely a sense of “it’s our turn to take our share of the national cake” than where members of a society have an overall sense of belonging (social cohesion) (Mustapha 2006 ; Franck and Rainer 2012; Dev et al. 2016; Alesina et al. 2016; Mthanti and Ojah 2017). Weak institutional infrastructures, especially legal and political ones, have been shown to wreck control of corruption (Gyimah-Brempong 2002; Mauro 2004; Delavallade 2012). The extent to which the populace

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of a country is educated affects both the degree of inequality based on significantly divergent incomes attributable to education gaps, and ability to hold leaders accountable and/or organize effective civil society bodies (e.g. Van Rijckeghem and Weder 1997; Dev et al. 2016). Consequences of Financial Crime and Money Laundering Countries have lost huge amounts of revenue through money laundering and financial crimes. Financial crimes have continued to increase in form and scale, as well as in the overall damage they cause both the global economy and individual national economies. According to the then Australian Crime Commission (ACC),6 as at December 2015, the cost of financial crimes in Australia was estimated to be about US$27.40 billion (A$36 billion Australian dollars) per year, which equates to US$1, 188.02 (A$1, 561 Australian dollars) out of every individual Australian’s pocket, and thus, adds 6.3 percent to each individual’s average cost of living. Similarly, as at 2013 and 2014, ACC estimated that the cost of organized crime in Australia stood at US$4.8 (A$6.3 Australian dollars) per capita. These figures are based on estimates, because the interconnectedness of legal and illegal financial activities thwarts efforts to correctly assess the exact magnitude of financial crime. Having highlighted Australia as an example, some of the notable cases of money laundering activities and estimated amounts involved across the world are summarized in Table 15.1.

3. Anti-Money Laundering (AML) Measures Prior to 1980, money laundering laws were meant to fight drug abuse and drug smuggling, mainly in the US. In fact, criminalization of drug abuse/smuggling in the 1920s was followed by several decades of the US government’s fruitless efforts to minimize drug smuggling. In the attempt to win the said “war on drugs”, the regime of former US President Bill Clinton came up with the idea to confiscate earnings from drug deals, based on a refrain: “If one could not get to drug dealers . . . then at least they should be discouraged, with the realization that they could not reap the monetary benefit of the illicit acts” (Unger 2013, p. 53). Due to high level interconnectedness of money laundering activities and the ease of moving illegal earnings between countries, a specialist organization was established in the 1980s to set up global regulatory standards for AML laws. The Financial Action Task Force (FATF) was established in 1989 by seven member countries and has now grown to 35 member countries as of 2017.19 The main objective of FATF is to issue recommendations with the aim of evolving legislations and policies for AML. For further insights on this, some selected national AML measures are summarized in Table 15.2.

Standard Chartered11

Charter House Bank12

Bank of New York13

2012 US

2006 Kenya

2005 US

US$7 billion

US sanctions

Monetary Authority of Singapore

Authority Imposing Fine

US$38 million

US government

Central Bank of Kenya

US$12.6 million UK Financial Conduct Authority Outright bank US federal authorities closure US$330 million US government agencies

US$8.9 billion

Outright bank closure

Amount Fined

More than US$1.5 Placed under billion statutory management

US$250 billion

Standard Bank, UK subsidiary9 Liberty Reserve10

2014 UK

Money laundering in the 2000s over a decade of 60,000 transactions worth hundreds of billions US$ for Iran Money laundering via multiple accounts of missing customer information. Money laundering via accounts controlled by bank executives in 1990s

BNP8 Paribas

2014 US

2013 US

Serious breaches of AML rules and poor management oversight of the bank Falsifying records and violation of US sanctions against Cuba, Iran and Sudan Failures in its AML controls Money laundering US$6 billion

BSI7

2016 Singapore

Amount Involved

Reason

Country

Bank

Year

Table 15.1 Notable Cases of Money Laundering Activities and Estimated Amounts Involved

Offshore shell banks16

Franklin Jurado-Rodriguez17

1998 Nauru

1996 US

1987 Italy

Institute for Works Religion (IOR)18

1991 Philippines Ferdinand Marcos and US

Sani Abacha14, 15

2000 Nigeria

Money laundering by former Nigerian military president, Sani Abacha and family in 1990s Russian criminal laundered money through Nauru banks Jurado-Rodriguez laundering for Cali Cartel in 1990s (Kochan 2011) Property deals of former Philippines head, Marcos. Govt. assets laundered via banks in US, Cayman Islands, Vatican, Singapore, Switzerland, etc. Suspected money laundering by the IOR to several Italian banks in 1980s US$218 million

Unknown, estimated in US$10 billion

About US$65 million

US$70 billion

Between US$2–5 billion

Russian central bank

Nigerian and Swiss governments

Italian authorities

Philippines and US

About two US government years imprisonment

Money to be returned to Nigeria

Financial Transactions & Reports Analysis Center of Afghanistan (FinTRACA) 2014 Australian Transaction Reports & Analysis Centre (AUSTRAC)

Financial Transactions & Reports Analysis Centre of Canada (FINTRAC)

Enforcement Directorate, Ministry of Finance, Department of Revenue

Indonesia’s FIU, known as the PPATK

Afghanistan

Canada

India

Indonesia

Australia

AML Regime

Country

Prevent money laundering; seize assets in money laundering To combat money laundering

To protect integrity of financial system by combating money laundering Assesses information from cash deals to mitigate money laundering Compliance with reporting, laws, regulations; stop terrorism financing and financial insecurity

Purpose of Regime

Table 15.2 Selected Examples of National AML Measures

2002

Indonesian Financial Transaction Reports and Analysis Center (INTRAC); incorporated fight against terrorism financing in 2007

Proceeds of Crime (Money Laundering) Act (PCMLA), amended in 2000 and called Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA). First enacted in 1991, amended in 2000, 2002 and 2006 Prevention of Money Laundering Act (PMLA) 2002, amended in 2013

1991

2002

Proceeds of Crime Act 1987; AML & Counter-Terrorism Financing Act 2006

FinTRACA was first established FIU under the AML and Proceeds of Crime Law in 2004

Laws and Acts

2006

2014

Date Initiated

Financial Intelligence Centre (FIC) and South Africa’s FIU

The Financial Conduct Authority (FCA)

Financial Crimes Enforcement Network (FinCEN), which is US’s FIU

South Africa

United Kingdom

United States

Fight financial crimes, including money laundering, tax evasion and terrorism financing FCA for all financial crime responsibilities formerly held by the British Financial Services Authority

2001

1. Terrorism Act (2000) contains UK AML laws 2. Anti-terrorism, Crime and Security Act (2001) 3. Proceeds of Crime Act (2002) 4. Money laundering regulations (2007) 5. Money laundering regulations, terrorist finance and transfer of funds regulations (2017) 1. Bank Secrecy Act (1970) 2. Money Laundering Control Act (1986) 3. Money Laundering and Financial Crimes Strategy Act (1998) 4. Annunzio-Wylie AML Act (1992) 5. Intelligent Reform and Terrorism Prevention Act (2004)

Financial Intelligence Centre Act (FICA), first amended in 2013; in 2017 FICA amended to incorporate risk-based approach

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4. Money Laundering, Tax Haven and Transparency The major question to be answered amidst the money laundering saga is: what attracts a country to the proceeds from illegal activities? According to a report for the European parliament (PANA), in March 2017,20 launderers were attracted to countries characterized by: developed financial institutions and markets, low record of corruption and most importantly high secrecy and relatively fewer AML rules. Per this report, large European countries have a high probability of being attractive to money launderers, with the UK on top of the list and exposed to billions of euros of laundering annually, followed by France, Belgium, Germany, Luxemburg, the Netherlands and Austria. However, according to Van Fossen (2003), since the 1970s, offshore financial centers in the Pacific Islands have been battling with the threat of being cut off from the global financial system, due to accusations that they, as offshore centers, promote money laundering and harmful tax practices. Activity of tax havens in this region was brought to light in the Nauru saga, when Nauru was involved in the Bank of New York scandal of money laundering, tax evasion and illegal capital movement involving Russia. It was then understood that tax havens around the world facilitate placement, layering and integration of hundreds of billions of dollars earned from illegal drug deals (Van Fossen 2003). According to Kudrle and Eden (2003), the term tax haven refers to countries with suspicious financial activities that appear large relative to the size of their total economy; thus, tilting their national policies toward creating: 1) Productive havens where comparatively low tax rates are used to attract investment from other countries, 2) Headquarters havens where firms are enticed with low tax rates to incorporate or re-incorporate in that jurisdiction, 3) Sham havens where firms keep funds out of reach of their countries of domicile and 4) Secrecy havens where investors disguise ownership of assets by investing offshore. Importantly, in 2012,21 the OECD identified four key factors that could be used to ascertain whether or not a country can be deemed a tax haven: 1. No taxes or only nominal taxes apply, 2. Lack of transparency, 3. Presence of policies that thwart or impede exchange of information for tax purposes, and 4. Absence of requirements for verifying tax related activities.

5. Financial Institutions and Compliance With AML Laws Given that without necessarily following the three identifiable phases of money laundering (placement, layering and integration), soiled money could still be laundered largely through financial institutions, the reality,

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therefore, is that financial institutions and markets are smack-dab in the middle of money laundering. From our summary of notable money laundering activities in Table 15.1, all those activities went through banks of different countries. Notably, some of those transactions went through multiple banks before reaching their final destinations. The core of banking—financial intermediation—makes banks susceptible to involvement in money laundering directly or indirectly and willingly or unwillingly. For example, the Australian Criminal Intelligence Commission (ACIC 2017)22 notes that major money laundering channels exist as legitimate banking services such as money transfers, remittances, etc. (Barry-Johnston and Abbott 2005; Chaikin 2011). Financial Institution Roles in Money Laundering and Possible Remedies Money laundering activities and other financial system abuses can potentially undermine the stability of financial institutions and markets or the global financial system as a whole. Money laundering activities can alter resource allocation and wealth distribution, and it can be costly for an economy to investigate, detect and eradicate these. Damages to an economy can also arise not just as a result of abuse of the financial system, but as a result of the negative perceptions of the country exposed to or engaged in money laundering (Bartlett 2002). Due to such detrimental effects, many laws and regulations have been evolved to combat money laundering activities, and they unsurprisingly target financial institutions, especially banks. According to Levi and Reuter (2006), the fight against money laundering can be envisaged to follow a twin-track or twin-pillar approach, with one pillar referred to as the preventive track (policy) and the second pillar referred to as the repressive or enforcement track. The preventive pillar aims to prevent money launderers from using financial institutions to carry out their illicit activities, with the core objective being to protect the integrity of the financial system as a whole. This approach sets out identification and reporting responsibilities for banks. The repressive approach sets out laws to discipline money launderers (Van den Broek and Addink 2013). Specific forms of these pillars follow. Customer Due Diligence This focus ensures that financial institutions know the identity of their customers, with the major aim being to prevent institutions from engaging with disguised clients who deal in suspicious activities traceable to money laundering or other financial crimes. The Basel Committee on Banking Supervision in 2001 noted that “know your customer (KYC)”

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policy is very crucial in safeguarding the soundness of banks and the integrity of the financial system as a whole. Reporting Requirements Under the preventive AML policy, financial institutions are required to report any transaction suspected to relate to money laundering, terrorist financing or any other form of financial crime to the country’s financial intelligent unit (FIU). There are variations in reporting methods globally, and each national jurisdiction usually decides the form of its report. While some financial institutions in some countries engage in defensive reporting to avoid potential penalties (rule-based), some in other countries report only significant suspicious transactions (risk-based), thereby risking criticism and penalties for failure to disclose sufficiently (Levi and Reuter 2006). Bergström et al. (2011) document that the risk-based approach in relation to customer due diligence has blurred the boundaries between private and public sectors and opine that involving the private sector in the process of setting the rules may compromise the normal understanding of accountability. However, some countries such as South Africa, as recently as June 2017, amended their Financial Intelligence Centre Act (FICA)23 and introduced the risk-based approach to reporting. Supervision Financial institutions are obligated to keep records of all identification and transactions in relation to the first focus of preventive (AML) policies (customer due diligence), for instance KYC documents, as well as archive or store data related to all transactions. This requirement is to enable regulatory authorities to be able to carry out their supervisory oversight function of banks and to facilitate investigation of suspicious cases. Sanctions Financial institutions are subjected to sanctions, penalties, fines and the like, as a consequence of breach of AML laws. As highlighted in Table  15.1, banks and other financial institutions have been fined or closed down due to breaches of AML laws. Notwithstanding several existing AML laws, banks surprisingly still expose themselves to fines, confiscation or freezing of assets, etc. Besides fines and sanctions, banks incur other costs (related to training, administration, technological upgrade, etc.) in the quest to comply with AML laws (Roth et al. 2004). Because of uncertainties in determining the true amount or extent of monies laundered and the cost of complying with AML laws, it is

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difficult to determine which AML techniques work better or which ones are more or less cost-effective. In light of this surmised and/or implicit relative inefficacy of extant money laundering mitigation mechanisms (AML policies) deployed by banks, could a more efficacious solution(s) be found elsewhere, especially within the bank’s ambit?

6. Any Role for the Board of Directors of Banks? According to a white paper for the Association of Certified AML Specialists (ACAMS) by Jeffrey Haude,24 banks’ boards of directors have the responsibility to oversee their activities, including AML compliance programs which, in turn, contribute to the safety and soundness of financial institutions and markets in general. These boards have the right to demand accurate, complete and timely data regarding money laundering or any other financial activity. The board also has the right to challenge management and offer direction, where needed, as to ensure that key risks are mitigated and banks’ objectives of profitability cum social responsibility are achieved. In line with this report, we argue in this chapter that banks’ boards of directors have a role to play in combating money laundering, which is widely acknowledged to occur largely via banks. With the substantial economic costs associated with money laundering, the boards should not only insist in strongly encouraging their banks to comply with AML laws so as to avoid costly fines and attendant reputational capital loss (that can come about due to money laundering offenses), but they should also insist on it, both in appearance and effect, on the grounds of corporate social responsibility (CSR), as responsible corporate citizens of the economic community within which they conduct business (Ojah 2014). To illustrate the wisdom of this position, we recall how the share value of Commonwealth Bank of Australia declined by over 10 percent immediately after AUSTRAC announced, on 2 August 2017 that it had commenced legal action on the bank over money laundering accusation.25 The risk-based approach to reporting suspicious money laundering activities often primarily depends on banks’ discretion. Boards should commit to engaging with bank management based on both cost-benefit analysis and CSR to, for instance, decide either to adopt a rule-based or a risk-based approach to reporting illegal activities. The major question to address is: should banks be fine with operating in fear and, as a consequence, incur an attendant high cost of reporting or absorb the risk of not reporting all suspected activities and supposedly keep their cost of compliance to perceived low levels (with little regard for the effective economic consequence of this myopic view)? A socially responsive board should proactively advise its firm (the bank) to choose the rule-based AML reporting approach, as a way of

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signaling integrity and probity, even if the national regulatory authorities offer latitude on the use of the discretionary reporting approach as well. The view here is that, “CSR is only effectively costly when firms adopt some public relations oriented program around CSR instead of adopting CSR as a strategic initiative that is an integral part of doing business” (Ojah 2014). An effective way for boards of banks to prudently address this need for ensuring that banks entrench a sustainable ethos of anti-unproductivebehaviors is via appropriate board committees. Unlike nonfinancial services firms, where audit, financial and remuneration and compensation committees are considered priority, banking firms must have ‘risk management’, ‘loan portfolio profile’ committees and their like ranked higher. Particularly, board members with dynamic risk management skills (e.g. financial economists, people with R&D/innovation and regulatory/ supervision backgrounds) should be appointed to bank boards and made to staff and chair the “risk management” committee. Another area where we recommend boards should get involved in the AML stance is in providing the right incentives to personnel responsible for providing information regarding untoward activities, including money laundering. For example, some firms adopt behavior-modifying mechanisms termed “claw-back policies”, where the performance bonus based on reporting accurate and reliable financial figures is withdrawn due to past period’s sub-par performance. Moreover, boards can insist on hiring qualified auditors or forensic/financial experts whose forecasts and judgment are known to be based primarily on accurate data and research, rather than on mere suspicion of transactions.26 Along the lines of boards, insisting on proper matching of personnel expertise and key tasks through effective incentive designs, periodic training on evolution of the banking landscape—e.g. contemporary surveillance technology and disruptive business models engendered by dynamism of digitization—must be part of such vital training for board members. Such periodic training will acquaint boards with the true operational environment of their firms and equip them to push for appropriately designed incentive programs for bank management and personnel. Given that money laundering indisputably thrives within a web of cross-border banking transactions, an obvious area needing boards’ oversight and/or direction is the area of banks’ external (international) engagement. Corresponding banks are generally “money center banks”, most of which are transnational firms which often have been caught up in illicit funds transfers/dealings (e.g. Barclays, HSBC, Standard Chartered and Citibank, to name a few that have been in the news recently). To signal probity and responsible corporate citizenry, proactive boards can insist on their banks’ non-association with tainted banks as correspondent banks. Implicit here is the importance

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of a board committee that would reflect “cross-border/international and corresponding banking activities”. In the same vein, boards can also insist on their banks keeping their offshore activities away from notorious tax havens (Kudrle and Eden 2003; Van Fossen 2003; Dharmapala 2008).

7. Concluding Remarks By exhaustively defining money laundering and related matters, we made the important point that money laundering comes about because of corrupt activities and the need for illicit funds to be moved around (laundered). We further observed that although other mechanisms for laundering such “soiled funds” exist,27 banks in particular and other financial institutions and markets in general, are the dominant mechanism (platform) for effecting money laundering with minimal fuss or exposure on the part of launderers. This is so primarily because banks are legitimate, ubiquitous financial services institutions whose essence of being is to financially intermediate. Expectedly, most extant anti-laundering (AML) laws and measures target banks’ compliance with these AML requirements, as paramount. Yet because of the seeming conflict between banks’ profit and CSR objectives, and the demand to demonstrate compliance, these bank-targeted AML measures appear ineffectual. This chapter, therefore, proposes that a more efficacious assistance may come from the role of banks’ boards. At a general level, we recommend that the intervention of banks’ boards must insist on: 1) the primacy of transparency and upholding of both real and perceived reputational capital of the bank, and 2) ascertaining that their banks’ relations with corresponding banks distributed across several national borders or banks domiciled in notorious tax havens are demonstrably above board. And these guiding lights, we believe, will be effective in enthroning the ethos of anti-unproductive bank activity and behavior via initiation of appropriate “financial services firm” oriented board committees.

Notes 1. Money laundering may not be nefarious but the activities or actions it sponsors, such as terrorism, human trafficking, arms dealing, etc., are clearly and increasingly becoming nefarious. 2. www.word-detective.com/2012/02/money-laundering/. Retrieved December 2017. 3. www.austrac.gov.au/typologies-and-case-studies-report-2014. Retrieved December 2017. 4. www.economist.com/news/international/21633830-blocking-rogue-statesaccess-worlds-financial-messaging-network-potent-measure. Retrieved December 2017.

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5. www.swift.com/about-us/swift-fin-traffic-figures. Retrieved December 2017. 6. www.acic.gov.au/sites/g/files/net1491/f/2017/08/oca_2017_230817_1830. pdf. Retrieved 16 December 2017. 7. https://aml-cft.net/singapore-bsi-bank-ordered-to-shut-down/ AML-CFT. 25 September 2016. Retrieved 12 December 2017. 8. https://web.archive.org/web/20140715004002/www.fbi.gov/news/ stories/2014/july/bank-guilty-of-violating-u.s.-economic-sanctions/. Retrieved 12 December 2017. 9. https://mg.co.za/article/2014-01-23-standard-bank-fined-126-million-forfailures-in-anti-laundering-controls 10. http://abcnews.go.com/US/black-market-bank-accused-laundering6b-criminal-proceeds/story?id=19275887. Retrieved 12 December 2017. 11. https://dealbook.nytimes.com/2012/12/06/standard-chartered-to-payu-s-330-million-to-settle-iran-laundering-claims/ 12. https://correctiv.org/en/investigations/mafia-africa/articles/2015/04/16/ charter-house-bank-money-laundering-machine/ 13. www.nytimes.com/2005/11/09/business/bank-settles-us-inquiry-intomoney-laundering.html 14. http://saharareporters.com/2014/03/06/how-abacha-and-associates-stolebillions-dollars-nigeria-%E2%80%94-report 15. www.newsweek.com/nigeria-switzerland-sani-abacha-corruption-434971 16. www.nytimes.com/2000/12/10/magazine/the-billion-dollar-shack.html 17. www.nydailynews.com/amp/archives/news/admits-laundering-drug-casharticle-1.716159 18. https://en.wikipedia.org/wiki/Institute_for_the_Works_of_Religion and “Vatican Bank reported to be facing money-laundering investigation” 19. Visit www.fatf-gafi.org/countries/#FATF for updates on country membership. 20. www.europarl.europa.eu/RegData/etudes/stud/2017/595371/ipol_stu(2017) 595371_en.pdf 21. https://web.archive.org/web/20120512074208/www.oecd.org/document/63/ 0,3343,en_2649_37427_30575447_1_1_1_37427,00.html 22. www.acic.gov.au/sites/g/files/net1491/f/2017/08/oca_2017_230817_1830. pdf. Retrieved 16 December 2017. 23. www.fic.gov.za/Documents/a%20new%20approach%20to%20combat%20 money%20laundering%20and%20terrorist%20financing%20(2).pdf 24. www.acams.org/wp-content/uploads/2015/08/A-Principles-BasedApproach-for-Auditing-Board-Reporting-Jeff-Houde.pdf 25. www.ft.com/content/0b75c64a-9112-11e7-a9e6-11d2f0ebb7f0 26. Commonwealth Bank of Australia recently overhauled its board of directors, on 4 September 2017, due to its recent money laundering scandal, believing that it had significantly dented their reputation and their bank’s share price. www.ft.com/content/0b75c64a-9112-11e7-a9e6-11d2f0ebb7f0 27. Transfer pricing, as the other important conduit/mechanism for money laundering, is not as amenable to scrutiny as are financial services firms because it sits between legitimate mode of business conduct and overt intent to subvert disclosure and/or tax laws; and it is carried out ‘privately’ within a firm.

References Alesina, A., and E. Ferrara. 2000. “Participation in heterogenous communities.” Quarterly Journal of Economics no. 115: 847–904. Alesina, A., S. Michalopoulos, and E. Papaioannou. 2016. “Ethnic inequality.” Journal of Political Economy no. 124 (2): 428–488.

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Aluko, Ayodeji, and Mahmood Bagheri. 2012. “The impact of money laundering on economic and financial stability and on political development in developing countries: The case of Nigeria.” Journal of Money Laundering Control no. 15 (4): 442–457. Barry-Johnston, R. 2005. “The impact of terrorism on financial markets. IMF Working Paper No. 05/60. Washington DC: International Monetary Fund. Barry-Johnston, R., and John Abbott. 2005. “Placing bankers in the front line.” Journal of Money Laundering Control no. 8 (3): 215–219. Bartlett, Brent L. 2002. “The negative effects of money laundering on economic development.” Asian Development Bank Regional Technical Assistance Project no. 5967. Bergström, Maria, Karin Svedberg Helgesson, and Ulrika Mörth. 2011. “A new role for for-profit actors? The case of anti-money laundering and risk management.” JCMS: Journal of Common Market Studies no. 49 (5): 1043–1064. Burgess, R., R. Jedwab, E. Miguel, A. Morjaria, and G. Miquel. 2011. “Ethnic favoritism.” Working Paper, National Bureau of Economic Research. Chaikin, David. 2011. “Adapting the qualifications to the banker’s common law duty of confidentiality to fight transnational crime.” Sydney Law Review no. 33: 265–849. Chaikin, David. 2017. “Money laundering and tax evasion: The assisting of the banking sector.” In The Handbook of Business and Corruption: Cross-Sectoral Experiences, 237–254. West Yorkshire: Emerald Publishing Limited. Delavallade, C. 2012. “What drives corruption? Evidence from North African firms.” Journal of African Economies no. 21: 499–547. Dev, P., B. Mberu, and R. Pongou. 2016. “Ethnic inequality: Theory and evidence from formal education in Nigeria.” Economic Development and Cultural Change no. 64 (4): 606–660. Dharmapala, Dhammika. 2008. “What problems and opportunities are created by tax havens?” Oxford Review of Economic Policy no. 24 (4): 661–679. Fenske, James, and Igor Zurimendi. 2017. “Oil and ethnic inequality in Nigeria.” Journal of Economic Growth no. 22: 397–420. Franck, R. and I. Rainer. 2012. “Does the leader’s ethnicity matter? Ethnic favoritism, education and health in Sub-Saharan Africa.” American Political Science Review no. 106 (2): 294–325. Gilmore, William C. 2004. Dirty money: The Evolution of International Measures to Counter Money Laundering and the Financing of Terrorism. Vol. 599. Strasbourg: Council of Europe. Gyimah-Brempong, K. 2002. “Corruption, economic growth, and income inequality in Africa.” Economics and Governance no. 3: 183–209. Kudrle, Robert T., and Lorraine Eden. 2003. “The campaign against tax havens: Will it last-will it work.” Stanford Journal of Law Business & Finance. no. 9: 37. Levi, Michael, and Peter Reuter. 2006. “Money laundering.” Crime and Justice no. 34 (1): 289–375. Mauro, P. 2004. “The persistence of corruption and slow economic growth.” IMF Staff Papers no. 51: 1–18. Morris-Cotterill, Nigel. 2001. “Money laundering.” Foreign Policy, 16–22. Mthanti, Thanti, and Kalu Ojah. 2017. “Institutions and corporate governance in South Africa.” In Corporate Governance in Developing and Emerging Markets,

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16 The Journey to Board Effectiveness The Case of Indonesia Sylvia Veronica Siregar

Introduction Indonesia is one of the emerging markets of the world, with impressive economic growth as shown by steadily increasing GDP per capita from $857 in the year 2000 to $3,603 in 2016 (World Bank, 2017). Indonesia is also a member of the G20. The G20 is an international forum whose membership is comprised of the world’s largest advanced and emerging economies, representing about two-thirds of the world’s population, 85  percent of global gross domestic product, and over 75 percent of global trade. Back in 1997–1998, Indonesia suffered a large economic crisis. Corporate governance (CG) weaknesses were identified as one of the major factors contributing to the economic crisis. After the crisis, many initiatives were taken to improve CG in Indonesia. In 1999, the government established the National Committee on Corporate Governance (which in 2004 was reorganised as the National Committee on Governance (NCG)). The NCG has issued several codes, including the Code of Good Corporate Governance (first issued in 1999, and later revised in 2001 and 2006) and the Code of Good Public Governance (issued in 2008). However, the application of these codes is still voluntary. Acknowledging the importance of CG for both national and international economic performance, the OECD (Organisation for Economic Co-operation and Development), in conjunction with national governments, other relevant international organisations and the private sector, developed a set of corporate governance standards and guidelines (OECD, 1999). The OECD Principles of Corporate Governance was then revised in 2004 and again in 2015. One of the principles set forth in this guideline is the responsibility of the board.

Two-Tier Board System In Indonesia, company law is regulated in Law No. 40 of 2007 concerning the limited liability company, which describes the roles and responsibilities of the board of commissioners and board of directors, as well as other

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corporate governance elements (i.e. shareholders). This law replaced the earlier Law No. 1 of 1995 and is more comprehensive in outlining governance principles of company organs comprised of the annual general meeting (AGM), board of directors and board of commissioners. Based on limited liability company law, Indonesia adopted a two-tier board system, consisting of a board of directors (BOD) and board of commissioners (BOC). The board of commissioners acts to oversee and provide advice to the board of directors, whereas the role of the board of directors is to manage company operations oriented to the best interests of the company. These two boards are appointed at the AGM. The BOC of issuers and public companies1 should have at least 30 percent independent commissioners (for financial institutions such as banks and insurance companies, at least 50 percent independent commissioners). Independent commissioners are members of the BOC originating from outside the company and are qualified to be independent commissioners as stipulated by the Financial Services Authority (Otoritas Jasa Keuangan/ OJK) regulation (POJK No. 33/POJK.04/2014).

Indonesia CG Assessment The World Bank assessed Indonesia’s corporate governance framework in 2004 and 2010, under the Reports on Observance of Standards and Codes (ROSC) (World Bank, 2004; 2010). In this report, they questioned the extent to which commissioners act independently of the controlling shareholders and exercise effective oversight (World Bank, 2004). The report also suggested that the board nomination is usually made by management (or controlling shareholders), and so the process for nomination and selection of independent commissioners needs to be strengthened. Most of these weaknesses still remain according to the recent assessment of the World Bank (2010). The ASEAN (Association of Southeast Asian Nations) CG Scorecard initiative,2 which aims to measure and improve the effectiveness of the implementation of corporate governance principles, was launched in 2011. This ASEAN CG Scorecard uses CG principles issued by the OECD as a reference for the assessment. Based on assessment results in 2012 and 2013, there have been significant improvements in the governance of issuers in Indonesia. However, there are still several aspects that need improvement, including the nomination process of members for boards of directors and boards of commissioners (ADB, 2013). The assessment results in 2013 and 2014 showed that the secondlowest score on Indonesia’s Corporate Governance Scorecard was in the principle of responsibilities of the board. The areas of improvement were mainly in the disclosure of responsibility of the board in annual reports where most companies state the responsibilities of the board, disclosure of code of ethics, and the number of BOC meetings. As required by OJK,

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the audit committee chair and members should be independent persons. There has been an improvement from previous assessments; however, BOCs have not fully exercised their fiduciary duties, and there are still concerns about commissioners’ independence in exercising these fiduciary duties. Most publicly listed companies do not have remuneration and nomination committees, and this also contributes to the ineffectiveness of BOCs. Board nomination and selection processes are also still poorly implemented. It is also not clear whether effective performance appraisals for BOCs and BODs were conducted (ADB, 2014). The results of the above assessment show that there are still several corporate governance implementation weaknesses in Indonesia, including those related to the responsibilities of the board. Extant literatures have extensively discussed factors affecting board effectiveness. Below is the detailed discussion of those factors and related regulations in Indonesia.

Board Size Recent literature on board characteristics determining board effectiveness usually focus on three categories: board size, board composition and independence and internal structure and functioning (De Andres and Vallelado, 2008). Board size is a relevant feature determining board effectiveness, as this feature is associated with board monitoring and control activity. As the number of board members increases, the ability of the board to monitor is enhanced; however, the downside is the poorer communication and decision-making associated with larger groups (Jensen, 1993; Yermack, 1996; Lipton and Lorsch, 1992). Jensen (1993: 865) argues “When boards get beyond seven or eight people they are less likely to function effectively and are easier for the CEO to control”. Lipton and Lorsch (1992: 67) believed that “the size of a board should be limited to a maximum of ten directors”. They even suggested optimal board size is eight or nine. Fernandez Alavarez et al. (1997) and Lorca et al. (2011) find a non-linear effect of board size, which suggests that from certain points the benefits of larger board size may be outweighed by the cost of communication problems and increased decision-making time. Regardless of these pros and cons, a minimum number of members should be established as this is needed for proper composition in terms of power and diversity. In Indonesia, OJK issued Regulation No. 33/ POJK.04/2014 concerning the board of directors and board of commissioners of issuers or public companies. According to this regulation, boards of directors and boards of commissioners should consist of at least two members on each board. Hence, there is already an existing regulation about minimum board size. As there are many factors affecting the optimum numbers of board members, it is hard to quantify the maximum number of board members. In Indonesia, there is no maximum threshold established in the regulation.

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Board Independence Indonesian-listed companies are dominated by concentrated ownership, particularly in the hands of controlling families. Claessens et al. (2000) find that more than two-thirds of firms are controlled by a single shareholder. The top management of about 60 percent of firms that are not widely held are related to the family of the controlling shareholder. With this type of ownership structure, the agency conflict is not between management and shareholders but between controlling shareholders and non-controlling shareholders (Ali et al., 2007). One of the ways of protecting the interests of non-controlling shareholders is the appointment of independent commissioners. Independent commissioners should make a significant contribution in decision-making, especially in evaluating executive performance, setting executive and commissioner remuneration and reviewing financial statements, as well as in resolving corporate conflicts. Their existence will also provide additional confidence to investors that the board of commissioners’ deliberations are free from bias (IFC, 2014). A board that is not predominantly independent may be more likely to make decisions that unfairly or inappropriately benefit the interests of management and controlling shareholders (Schacht et al., 2009). Due to the dominance of controlling families, the independent commissioner probably represents the interest of the controlling family, and often they are nominated and elected by the controlling shareholders (OECD, 2012), and this potentially hampers their independence in performing oversight functions. According to Nam and Nam (2004), independent directors in Indonesia have limited access to business records or books of account; they also face constraints in their access to information about board meeting agendas and obtaining outside professional services. OJK has issued regulations concerning independent boards. The specific criteria for independent commissioners based on OJK regulation No. 3/POJK.04/2014 are as follows: 1. they must not be an individual who worked or had the authority and responsibility to plan, lead, control or supervise activities of the issuer of the public company within the last six months, unless in the context of re-appointment as the independent commissioner of issuer or public company; 2. they must not directly or indirectly own shares at the issuer or public company; 3. they must not have an affiliation with the issuer or public company, members of the board of commissioners, members of the board of directors, or the main shareholders of the issuer or public company; 4. they must not have a business relationship which is directly or indirectly associated with the business activities of the issuer or public company.

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According to the regulation above, the number of independent commissioners should account for at least 30 percent of the total number of members of the board of commissioners. For banks and insurance companies, the number of independent commissioners should be at least 50 percent of the total number of board of commissioners (OJK regulation No. 55/POJK.03/2016 and No. 73/POJK.05/2016, respectively). OJK also requires issuers and public firms’ annual reports to disclose a brief biography of each board member (including independent commissioners); however, it does not require disclosure in annual reports with regard to the independence suitability criteria of independent commissioners with the applicable provisions in the annual report. With regard to the composition of the board of the directors, listing rules (issued by the Indonesia Stock Exchange/IDX) require that public companies should have at least one independent director in the BOD (Rule No. 1-A). The criteria for an independent director is as follows: 1. they must not have an affiliation with the controlling of the listed company within the last six months before appointment as independent director; 2. they must not have an affiliation with members of the board of commissioners and board of directors of the listed company; 3. they must not hold any position as director in another company; and 4. they must not be an insider of any capital market supporting institutions or professions whose services were used by the prospective listed company within the last six months before appointment as independent director. However, the OECD (2012) questions the effectiveness of this requirement above, as there is only a short cooling-off period of no more than six months. In addition, there is no requirement to disclose in the annual report whether the independent director criteria are met.

Board Directorship Previously, literature on board effectiveness has focused on two features of the board, board composition and board size. Recently, the concern over multiple directorships has received increased attention from both academics and practitioners. Recognising that a board member’s time and effort are not unlimited, holding multiple directorships will result in board members having limited attention capacities and time constraints that may affect their ability to fulfil their responsibilities (Jiraporn et al., 2009; Ahn et al., 2010). There are certain benefits of holding multiple directorships, such as enhanced board experience, the ability to provide better advice, building a business network and certification of the board’s ability (Booth and Deli, 1996; Carpenter and Westphal, 2001; Jiraporn et al., 2009; Ahn et al., 2011).

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Fich and Shivdasani (2006) find a negative association between busy boards and firm market performance. However, Ferris et al.’s (2003) findings showed that multiple directorship does not cause boards to shirk their responsibilities and that firms with busy boards are not associated with a higher probability of securities fraud litigation. Even though some empirical evidence show mixed findings, international best practice proposes limiting the number of board seats a board member can hold (Cashman et al., 2012). Regarding directorship, OJK regulation No. 33/POJK.04/2014 stipulates that members of BODs can have multiple directorships as members of BODs of not more than one other issuer or public company; members of BOCs of not more than three other issuers or public companies; and members of committees of not more than five committees at issuers or public companies where they also serve as members of the BOD or BOC. Members of BOCs can also have multiple directorships as members of BODs of not more than two other issuers or public companies and members of BOCs of not more than two other issuers or public companies. The regulation also stipulates that if a member of a board of commissioner does not have concurrent positions as a member of the board of directors, the member of the board of commissioners can concurrently serve as a member of a board of commissioners of not more than four other issuers or public companies. Members of board of commissioners can also concurrently serve as members of not more than five committees within the issuers or public companies where they function as members of the board of directors or board of commissioners. This regulation shows that OJK is aware of the benefits of having multiple directorships and at the same time shows concerns that if there are too many multiple directorships these may hinder board effectiveness. Thus OJK allows BODs and BOCs to have multiple directorships but sets the limit.

Board Meetings Directors with multiple directorships may find it difficult to attend all board meetings. Board activity is an important dimension affecting board of directors’ responsibilities to manage the company and board of commissioners’ responsibilities to oversee the board of directors. Such board activity has received intense scrutiny by regulators and shareholders/ debtholders. However, it is difficult for outsiders to observe board activity. One way to examine it is by examining the number of board meeting. Board meetings are the main vehicle for directors to collect information, make decisions and monitor the management that is important so that they can play an effective role in decision-making in the boardroom (Adams and Ferreira, 2008; Chou et al., 2013). Hence, regulators require companies to routinely report the number of board meetings in the annual report. There are several studies examining the association of board meetings and firm

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value. Vafeas (1999) and Jiraporn et al. (2009) suggest that absences in board meetings may interfere with the board’s ability to do its job effectively, and may result in lower firm value (Jiraporn et al., 2009). OJK regulation No. 33/POJK.04/2014 requires the board of directors to conduct a regular meeting of the board of directors at least once each month, and the board of commissioners must conduct a meeting at least once every two months. Both boards shall also conduct regular meetings at least once every four months. OJK (2014) shows that from 2010– 2012, there were increasing numbers of firms disclosing the frequency of meetings of BODs and BOCs, as well as joint meetings of both boards.

Board Charter (Board Manual) and Code of Ethics The BOD and BOC need to have board charters (board manuals) as their employment guidelines. These guidelines serve as a legal basis to act for the board of commissioners and board of directors in carrying out their fiduciary duties and functions and the powers and responsibilities that legally bind them (OJK, 2014). In order for corporate governance implementation to achieve long-term success, it is important for the company to have high integrity. Therefore, a code of ethics or code of conduct is vital for implementation in the company. This code serves as a reference for corporate organs and all employees in applying the values and business ethics that become part of the company’s culture (KNKG, 2006). OJK regulation No. 33/POJK.04/2014 states that the board of directors and board of commissioners should formulate a guideline (board charter) that binds every member of the board of directors and board of commissioners. According to this regulation, this guideline should consist of the legal basis, descriptions of duties, responsibilities and authorities, values, working period, and meeting policies, including attendance in the meetings, minutes of meetings and reporting and accountability. A company must disclose in its annual report that it has a guideline in place, and it must publish the guideline on its website. The same regulation also requires board of directors and board of commissioners to formulate a code of ethics for all members of the board of directors and board of commissioners, employees/staff and supporting organs of the company. Information about this code of ethics must also be disclosed in the annual report and published in full on the company’s website. Data from OJK (2014) showed that only 39 percent out of 494 public listed companies disclosed the code of conduct in their 2012 annual report.

Board Tenure With regard to independent board tenure, there are pros and cons on limiting independent board tenure. Reguera-Alvarado and Bravo (2017) as well as Bonini et al. (2017) identify the advantage of long-tenured

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board members, including the experience acquired by a director within a board by means of a long tenure. Board members will be able to build industry-specific expertise and accumulate superior information as their tenure progresses. However, there are other studies that show possible negative effect of extended board tenure. Lipton and Lorsch (1992) argued that long tenure may cause board members to become too involved in the management of the firm, which can result in potential executive conflicts. OJK regulation stipulates that members of the BOD as well as the BOC are appointed for a certain period of service and can be reappointed. There is a maximum term for one period of service which is no longer than five years. In addition to that, there are also regulations related to independent commissioner tenure. Listing rules in Indonesia, issued by IDX, set requirements of maximum tenure for independent commisioner and independent director, which is a maximum of two consecutive periods. However, this rule on maximum tenure of independent commissioner is different from that of OJK regulation. OJK regulation allows independent commissioners who have served for two consecutive terms to be reappointed, as long as they make a declaration in the relevant AGM that they will continue to be independent. To resolve this inconsistency, IDX listing rules will need to be amended. The OJK regulation that allows independent commissioners who have served for two consecutive terms to be reappointed substantially results in no limitation period for independent commissioners. International exemplary practices generally suggest that the independent commissioner has a limitation period of a maximum of nine years. OJK needs to consider limiting the maximum tenure of independent commissioners.

Board Nomination and Remuneration In its report, the World Bank (2010) states that the BOC in general companies does have a role in director nomination, but the key decisions are still to be determined by the controlling shareholders. According to Wu (2013), families often use their voting power to promote a family member to the top management position, despite the opposition of minority shareholders. The disclosure requirement by OJK for a brief biography of every board member may reduce the possibility of nepotism or cronyism in BODs and BOCs. However, the OECD (2012) questioned the effectiveness of this rule as Indonesia is still characterised by a weak institutional environment. For regulated industries (such as banks and insurance companies), the regulator conducts fit and proper person tests (OJK regulation No. 27/POJK.03/2016), but there is no equivalent regulation for nonregulated industries.

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In Indonesia, there is still no mechanism that easily allows minority shareholders to nominate board members. Company Law Article 79 (2a) provides that shareholders with at least 10 percent of shares in aggregate can call for an AGM (including an AGM for the election of their candidate); however, that rarely happens in practice. In the context of concentrated ownership in Indonesia, it is difficult for the minority candidate(s) to get elected at the AGM, as long as one share–one vote still applies for all shareholders (including for controlling shareholders). To enable shareholders (especially non-controlling shareholders) to assess the qualifications of board member candidates, it is important to disclose the background and professional experience of the candidates prior to the AGM. However, the AGM invitation does not necessarily list the names of the board member candidates, and often, there is not sufficient information regarding candidates’ qualifications. OJK regulation No. 34/POJK.04/2014 requires issuers and public companies to establish a nomination and remuneration committee, or if they do not establish such a committee, then the nomination and remuneration functions should be the responsibility of the BOC. The nomination and remuneration functions (or committee) should have a procedure in place in discharging their responsibilities, including preparing the composition and process of nomination; preparing the policies and criteria needed in the process of nomination of candidates; assisting in the performance evaluation; preparing a capacity building program; and reviewing and proposing qualified candidates to be submitted to the AGM. The committee should be chaired by an independent commissioner, however, there is no specific requirement for the majority of committee members to be independent. Giving the board of commissioners supervision functions over the board of directors in terms of nomination and remuneration, which is linked to the performance appraisal of directors, may increase the BOC’s effectiveness in discharging its supervisory function over the board of directors. The implementation of this nomination and remuneration function should be disclosed in the company’s annual report and website. However, as Varottil (2011) suggests, the nomination committee may not achieve its intended goals in firms with concentrated ownership. Even though a nomination committee selects and recommends board candidates, the election of such candidates is still within the authority of the AGM, where controlling shareholders have significant influence. Varottil (2011) also suggests that it is possible for family-controlled firms to elect independent board members that satisfy the formal definition of independence, but they may still be obligated through social ties to the controlling shareholders or management or both. Board remuneration is also an interesting issue in corporate governance. Based on agency theory (Jensen and Meckling, 1976), agency conflicts generally arise from conflicts of interest between management and shareholders in the presence of information asymmetry. The use of

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management-incentive compensation contract is considered one of the effective mechanisms to deal with agency problems. However, there are concerns over excessive management compensation. Wu (2013) suggests that if family members are entrenched in expropriating the firm’s resources, then management with family ties are predicted to be associated with excess board compensation compared to their peer firms. Setting the right remuneration should have an impact on board effectiveness. Goh and Gupta (2016) proposed that remuneration of nonexecutive board members should be associated with the likelihood of fulfilling their monitoring duties on behalf of shareholders. Hence, BOC members should receive higher remuneration because of the value that they bring to the firm through stronger monitoring. The remuneration scheme should also preserve the independence of the BOC. For example, UK governance regulations guide against the awarding of equity to nonexecutive directors (Goh and Gupta, 2016). There is no regulation with regard to board remuneration in Indonesia, except for SOEs, where the Ministry of SOE’s regulation stipulates that BOC salary is 45 percent of the BOD. OJK requires the disclosure of the following in the annual report: 1. procedures, basis of determination, structure and amount of remuneration of each member of the board of directors, as well as the relationship between remuneration and performance of the issuer or public company; 2. procedures, basis of determination, structure and amount of remuneration of each member of the board of commissioners.

Board Removal The World Bank (2010) questions the effectiveness of the BOC in discharging its oversight function. The BOC does not choose the CEO or other top management. Under Company Law (Article 94 (1) and 111 (1)), both the BOC and the BOD are chosen directly by shareholders in the AGM. The BOC may temporarily dismiss a director, but this decision must be confirmed by the AGM within 30 days. Electing directors by the AGM could limit the ability of the BOC to oversee management and hold them accountable. This requirement also means that the AGM has the technical expertise to choose the BOD directly. An extraordinary AGM can be used to remove a board member, but two-thirds of the total voting shares must be present at the AGM to do so, hence making it difficult for shareholders to remove a board member.

Board Qualification With regard to the qualifications of BOC and BOD members, company law stipulates requirements including those who in the five years before

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their appointment were not: (1) declared bankrupt, (2) members of a BOD/BOC who were declared to be at fault causing a company’s bankruptcy or (3) sentenced for crimes which caused financial losses to the state and/or which were related to the financial sector. OJK regulation No. 33/POJK.04/2014 provides more detailed requirements, including good character, morals and good integrity; legally competent; have never been declared bankrupt nor become members of a BOD and/or BOC that were convicted of causing a company being declared bankrupt within the period of five years prior to the appointment and during the tenure; and never being convicted of criminal offences resulting in state financial loss and/or related to the financial sector. They also should never become members of a BOD and/or BOC if during their tenure they failed to conduct an AGM; their accountability as members of the board of directors and/or board of commissioners was rejected by the AGM; or if they failed to provide accountability as members of the board of directors and/or board of commissioners to the AGM. In addition, they also should never caused a company that had the licence and approval from or registered by the Financial Services Authority failed to meet its obligation to submit the annual report and/or financial reports to the Financial Services Authority. Another requirement includes commitment to complying with the laws and regulations and having the knowledge and/or expertise in the field needed by the issuer or public company. However, as explained before, other than in regulated industries, there is no fit and proper test for the BOD and BOC members to ensure that they meet the above requirements. To enable shareholders to assess the qualifications of board member candidates, it is important to disclose the background and professional experience of the candidates prior to the AGM. Shareholders are expected to receive an invitation to the AGM not more than 14 days before the meeting via an advertisement in newspapers. The announcement of the AGM also shall be made at least 14 days before the invitation. The content of the invitation does not necessarily include information about the names of the candidates, neither does it include sufficient information regarding candidates’ qualifications. Thus, fundamental information about the board election is not provided before the AGM.

Board Training Increased knowledge and understanding of fiduciary duties for members of the board of commissioners and board of directors is important in ensuring that their duties and responsibilities can be carried out properly. Issuers and public companies are required to disclose in their annual report the BOD and BOC training program. OJK (2014) acknowledges the importance of board members in participating in education and training programs. One of the tasks of the nomination and remuneration committee is to provide recommendations to the BOC regarding the capacity building

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program for members of the board of directors and/or members of the board of commissioners.

Board Performance Assessment In order for the board to function effectively, its performance needs to be assessed on a regular basis. Regulators need to issue a regulation requiring companies to assess the performance of the board and its members and link the performance assessment results with board remuneration. OJK regulates (through Circular Letter No. 30/SEOJK.04/2016) several items related to performance assessment of the BOD and the BOC that needs to be disclosed in the annual report. Companies should disclose company policy on the BOD and BOC performance assessment. This disclosure at minimum should include matter relating to performance appraisal procedures; the performance criteria used for the assessment; and the identity of the person that conducted the assessment. The company should also disclose the relationship between remuneration and performance of the company. The nomination and remuneration committee also has a critical role in this process. It has the duty and responsibility associated with the nomination function to provide recommendations to the board of commissioners on: 1. the composition of positions of members of the board of directors and/or members of the board of commissioners; 2. the policies and criteria required in the nomination process; and 3. performance evaluation policy for members of the board of directors and/or members of the board of commissioners. The committee should also assist the board of commissioners in evaluating the performance of members of the board of directors and/or members of the board of commissioners based on the benchmarks that have been prepared.

Board Committees In order to improve the oversight function of the board of commissioners, it is required to establish certain committees. The BOC delegates some of the responsibilities to its committees (Guo and Masulis, 2015). Many important decisions of the BOC are initiated in these committees, and there is evidence that delegation of responsibilities to committees facilitates effective governance (Bilimoria and Piderit, 1994). The audit committee focuses on the appointment of independent auditors and management of internal financial performance, the nomination committee recommends the appointment of new directors to the board,

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and the compensation committee deals with compensation and benefits for executives. Directors can directly influence CEO pay, the nomination of new directors, quality of financial reporting, etc., if they serve on smaller groups with primary responsibilities for these tasks (Adams et al., 2010). In our sample, the mean tenure of directors on these committees was 4.8 years. Recent evidence suggests that the composition of board committees is important for governance. OJK regulation No. 55/POJK.04/2015 requires all issuers and public companies to have an audit committee, with a minimum membership of three independent persons (where the chair is the independent commissioner). The regulation stipulates that the audit committee should at least have the following duties and responsibilities: 1. reviewing the financial information that will be issued by the issuer or public company to the public and/or the authority, among others, the financial statements, projections and other reports related to the issuer or public company’s financial information; 2. reviewing compliance with laws and regulations relating to the activities of issuers or public companies; 3. providing an independent opinion in the event of any disagreement between management and the accountant for the services it provides; 4. providing recommendations to the board of commissioners regarding the appointment of accountants based on the independence, scope of the assignment and remuneration; 5. reviewing the conduct of audits by internal auditors and overseeing the implementation of follow up by the board of directors on the findings of internal auditors; 6. reviewing the risk management activities conducted by the board of directors if the issuer or public company does not have a risk monitoring function under the board of commissioners; 7. reviewing complaints relating to the accounting and financial reporting processes of issuers or public companies; 8. reviewing and advising the board of commissioners regarding the potential conflict of interest of the issuer or public company; and 9. maintaining the confidentiality of documents, data and information of issuers or public companies. OJK also requires firms to establish nomination and remuneration committees (or if not, then the function related to nomination and remuneration should be carry out by the board of commissioners). Regulated industries (e.g. bank and insurance companies) are required to have nomination and remuneration committees and risk management committees as well. Performance evaluation of the committees is also important to enhance board effectiveness. OJK also requires companies to disclose in annual reports the assessment of the performance of the committees that support the implementation of the duties of the board of commissioners.

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Conclusion The 1997–1998 Asian financial crisis was a major impetus for urgent reform of corporate governance in Asia, including Indonesia. After the crisis, many changes took place, including changes in relevant laws and regulation as well as many initiatives taken by regulators and other entities to improve corporate governance implementation in Indonesia, including those related to the responsibilities of the board. Several essential corporate governance requirements with regard to board mechanisms are already addressed in company law. OJK and IDX have also issued regulations (as explained above) that regulate the main substance of articles of association of listed companies in order to ensure that most of those essential requirements to enhance board effectiveness have been regulated. However, there is room for improvement. For example, OJK may stipulate more stringent rules on independent commissioners’ tenure. Enhancing board effectiveness cannot be done by simply issuing regulations; it also requires socialisation, education and training, as well as strong law and regulation enforcement. All of these require a strong commitment from all interested parties, including regulators as well as issuers and public companies. Enhancing board effectiveness is one of the important steps in the improvement of good corporate governance practices in Indonesia, which in turn will enhance Indonesian companies’ ability to compete with other companies around the world.

Notes 1. Issuers are entities conducting a public offering to sell securities to the public based on the procedures stipulated by applicable laws, whereas public companies are limited liability companies whose shares have been owned by at least 300 shareholders and have paid up capital of at least Rp3 billion or a number of shareholders and paid up capital as stipulated by government regulation. 2. In 2009, the ASEAN finance ministers endorsed the ACMF (ASEAN Capital Markets Forum) Implementation Plan to promote the development of an integrated capital market, as part of the efforts to achieve an ASEAN economic community in 2015. The ASEAN corporate governance initiative consists of the ASEAN Corporate Governance Scorecard (Scorecard) and the ranking of corporate governance of ASEAN public listed companies is one of several initiatives under the ACMF.

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Jiraporn, P., Davidson III, W. N., DaDalt, P., & Ning, Y. (2009). Too busy to show up? An analysis of directors’ absences. The Quarterly Review of Economics and Finance, 49(3), 1159–1171. Komite Nasional Kebijakan Governance (KNKG). (2006). Pedoman Umum Good Corporate Governance Indonesia (Good Corporate Governance Guidelines): Jakarta. http://www.ecgi.org/codes/documents/indonesia_cg_2006_id.pdf. Lipton, M., & Lorsch, J. W. (1992). A modest proposal for improved corporate governance. The Business Lawyer, 59–77. Lorca, C., Sánchez-Ballesta, J. P., & García-Meca, E. (2011). Board effectiveness and cost of debt. Journal of Business Ethics, 100(4), 613–631. Nam, S. W., & Nam, I. C. (2004). Corporate governance in Asia: Recent evidence from Indonesia, Republic of Korea, Malaysia, and Thailand. Working Paper, Asian Development Bank Institute. OECD. (1999). OECD Principles of Corporate Governance. www.oecd.org/ officialdocuments/publicdisplaydocumentpdf/?cote=C/MIN(99)6& docLanguage=En. OECD. (2012). Board Member Nomination and Election. www.oecd.org/daf/ca/ BoardMemberNominationElection2012.pdf. Otoritas Jasa Keuangan (OJK). (2014). Indonesia Corporate Governance Roadmap: Towards Better Governance of Issuers and Public Companies. https:// www.ifc.org/wps/wcm/connect/a476310042e2a54bbc09fc384c61d9f7/ Indonesia+CG+Roadmap.pdf?MOD=AJPERES. Reguera-Alvarado, N., & Bravo, F. (2017). The effect of independent directors’ characteristics on firm performance: Tenure and multiple directorships. Research in International Business and Finance, 41, 590–599. Schacht, K., Allen, J., & Orsagh, M. (2009). Shareowner Rights across the Markets: A Manual for Investors. CFA Institute. Vafeas, N. (1999). Board meeting frequency and firm performance. Journal of Financial Economics, 53(1), 113–142. Varottil, U. (2011). Independent directors and their constraints in China and India. Jindal Global Law Review, 2(2), 129. World Bank. (2004). Report on the Observance of Standards and Codes: corporate governance country assesment – Indonesia. http://documents.worldbank.org/ curated/en/265161468269426578/Report-on-the-observance-of-standardsand-codes-ROSC-Corporate-Governance-Country-Assessment-Indonesia. World Bank. (2010). Report on the Observance of Standards and Codes: corporate governance country assesment – Indonesia. http://documents.worldbank. org/curated/en/514561468039867553/Indonesia-Report-on-the-Observanceof-Standards-and-Codes-ROSC-corporate-governance-country-assessment. World Bank. (2017). The World Bank in Indonesia. www.worldbank.org/en/ country/indonesia/overview, last updated 19 September 2017. Wu, C. H. (2013). Family ties, board compensation and firm performance. Journal of Multinational Financial Management, 23(4), 255–271. Yermack, D. (1996). Higher market valuation of companies with a small board of directors. Journal of Financial Economics, 40(2), 185–211.

Part III

Issues in Improving the Functional Effectiveness of the Board

17 Board Roles in Business Groups and Multinational Enterprises in Emerging Markets Gül Okutan Nilsson

1. Introduction The roles, or in other words, duties and functions attributed to the board may vary according to numerous factors such as ownership structure or whether the company is listed or is a member of a group. Furthermore, the legal culture, social and political environment as well as the economic level of a country pose different challenges for companies, causing different corporate governance models to be adopted. The roles expected of the boards of parents and subsidiaries within a group of companies may also change depending on whether the group is set up in an emerging economy or whether it is part of a multinational enterprise that is also active in an emerging country among others. Emerging countries differ from developed ones not only with regard to their economic level, but also in terms of their legal and institutional environment, which affects corporate governance. The existence of a proper functioning legal and judicial system, effective enforcement of property rights and overall disclosure and transparency regime are important for good governance. Emerging countries, however, may have weaker protection and enforcement of shareholder and creditor rights and lesser transparency, as opposed to developed countries (Claessens and Yurtoglu, 2013). Furthermore, emerging countries may face problems such as bribery and corruption, and there may be impediments against free competition as markets may be controlled by insiders with connections to power elites (Kalasin et al., 2014). One explanation regarding the formation of business groups in emerging markets suggests that groups are formed as a response to such environmental factors. It is argued that market imperfections and associated transaction costs drive companies to adopt a group structure in order to pool resources, create intra-group capital facilities, diversify their portfolio in order to meet certain demands from group companies rather than unreliable external sources, or build reputation that is valuable in an institutional environment that provides only weak legal protection (Ghemawat and Khanna, 1998; Khanna and Palepu, 2000; Colpan and Hikino, 2010; Dela Rama, 2017). Indeed, family-owned and -controlled

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business groups with a diversified product portfolio are common in emerging economies (Colpan and Hikino, 2010). A business group may also be formed as a multinational enterprise operating in two or more countries covering both developed and emerging markets. Those enterprises with headquarters in developed economies and operational entities in emerging ones are exposed not only to different geographies and markets, but they also face the challenge of adapting to different legal and institutional environments (Windsor, 2009). Multinational enterprises are usually structured as corporate groups, with wholly owned or joint venture subsidiaries having independent legal entity in the countries where they are established (Windsor, 2009; Colpan and Hikino, 2010). This means that while the parent company is subject to the laws and governance principles of the country where it is located, each subsidiary has to comply with the legal requirements in its place of business (Windsor, 2009). Multinationals also have to deal with other challenges such as trying to meet short-term return expectations of financial stakeholders, maintain the long-term viability of the enterprise and face increasing pressures for corporate social responsibility all at the same time (Windsor, 2009; Kolk, 2010). Further challenges arise with respect to “implementation and monitoring of strategies, dissemination of corporate culture, management of corporate risks, corporate reporting and mitigations of potential conflicts of interests” (Latin American Companies Circle, 2014, p. 2) Coordinating such a system across national boundaries is evidently difficult and results in organisational complexity impacting the role of boards. In a business group structured as a set of separate companies, each company has its own board. However, due to demands and challenges encountered by groups, roles assumed by such boards differ as opposed to boards of stand-alone firms. The aim of this chapter is to examine how the roles expected of boards change in emerging market business groups and multinational enterprises active in emerging markets. Section 2 will begin with a discussion of the main roles of the board. Section 3 examines how the group structure affects these main roles by classifying groups under two subsections: Emerging market business groups, i.e. groups of companies which are locally established in emerging markets, and multinational groups that are active in emerging markets. Board roles in such groups will further be distinguished according to whether the board belongs to the parent or the subsidiary. The main findings will be summarised in the conclusion.

2. Roles of the Board The main roles, or functions, attributed to the board are assessed in different ways in literature depending on the theoretical perspective. According to the agency theory, the most important function of the board

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is the “control” or “monitoring” function (Fama and Jensen, 1983). It is argued that a principal-agency conflict exists between shareholders and managers, as the latter may pursue goals in their own self-interest to the detriment of shareholders. (Jensen and Meckling, 1976; Fama and Jensen, 1983; Shleifer and Vishny, 1997). In a company with a wide dispersion of shares, it will not be possible for individual shareholders to monitor the management, so the board should be exercising this function for them, especially through outside directors (Fama and Jensen, 1983; John and Senbet, 1997; Armour et al., 2017). The rise of institutional investors is thought to intensify the need for monitoring (Useem, 2017). The monitoring function involves monitoring the decisions, actions and performance of the management, reporting to shareholders and ensuring regulatory compliance (Desender, 2009). As mentioned above, the monitoring role is important for companies with diffuse ownership. In companies with large shareholders, on the other hand, shareholders have the incentives and ability to monitor management, hence the control function of the board will be less important (Shleifer and Vishny, 1997; La Porta et al., 1998). In emerging countries, diffuse ownership is rare; the majority of companies are held by large shareholders and family dominance is common (Claessens and Yurtoglu, 2013; Filatotchev and Wright, 2011). Family members are often themselves members of the board (Usdiken, 2010). In such a case, there would be no need for the board to monitor the managers on behalf of shareholders, as they can directly do this themselves. According to another stream of research based on the resource dependence theory (Pfeffer and Salancik, 2003), the board’s main roles are viewed as “strategy” and “service” (Zahra and Pearce, 1989), which some scholars combine under the heading of “provision of resources” (Hillman and Dalziel, 2003). It is claimed that the board can help the formation of the company strategy by providing counsel and advice to management through their own analysis or by suggesting alternatives, and also serve the interests of the company by linking the firm to important external stakeholders such as financers, regulators, customers or employees and by bolstering the firm’s image and providing legitimacy (Zahra and Pearce, 1989; Hillman and Dalziel, 2003). In this respect, the board is seen as a mechanism for, inter alia, managing external dependencies and reducing environmental uncertainty (Zahra and Pearce, 1989). In line with this view, it is argued that due to the increase in complexity and uncertainty in executive decision-making caused by the opening of global markets and enhanced competition, directors are being called upon by managers to give guidance as trusted advisors on key decisions (Useem, 2017). However, the content of the board’s strategic involvement and how exactly the board should contribute to the formulation of strategy is debatable (Zattoni and Pugliese, 2017; Pugliese et al., 2009).

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A question that arises based on these different theoretical views is whether the monitoring and strategy roles are mutually exclusive or compatible. Is it possible for the board to both monitor managers and to work with them on strategy? It may be argued that these two roles are conflicting, as the board needs to distance itself from managers in order to properly carry out the monitoring function, whereas working with management on strategy would bring them closer. However, recent literature proposes an integrating approach, reporting that directors actually engage in both monitoring and strategy functions, as they are both needed by the firm (Hillman and Dalziel, 2003; Zattoni and Pugliese, 2017; Useem, 2017). Based on this integrating approach, the board roles in groups are examined in terms of monitoring, strategy and service roles in this chapter. The roles expected of the board in turn affect board composition and effectiveness. In terms of the monitoring role, for example, it is argued that a higher proportion of outside directors would put the desired distance between the board and management and result in a more effective monitoring function. In the same vein, separation of the roles of CEO and chairman would enhance the monitoring role of the board (Desender, 2009). However, for companies with concentrated ownership, where the strategy and service roles of the board are more important than monitoring, maintaining a balance of insider and outsider directors and combining the CEO and chairman roles would arguably be more effective (Desender, 2009). However, in terms of effectiveness, literature reviews report that studies examining whether board composition, size or CEO/chairman duality affects firm performance produce mixed results (van Ees and van der Laan, 2017; Adams et al., 2010; Daily et al., 2003; Desender, 2009). A likely explanation is that the board processes and behaviours are more complex in real life than various theories can independently capture, and governance structures depend on the type of firm and the market and institutional order in which it operates (van Ees and van der Laan, 2017).

3. Board Roles in Business Groups The roles described above may differ in terms of their relevance, importance and scope for boards of companies in business groups, especially if it is an emerging market business group or a multinational one active in emerging markets. Emerging Market Business Groups In emerging economies, the “hierarchy type” of business group is argued to be the dominant form, as opposed to the “network type” alliancebased groups in which the independent entities preserve their autonomy

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in basic strategic decisions (Colpan and Hikino, 2010). The hierarchy type group form is characterised by “a holding company at the helm of the hierarchy [that] owns and controls legally independent operating units, which are usually organized as subsidiaries and affiliates” (Colpan and Hikino, 2010, p. 20). In other words, this type of group structure is made up of independent companies that stand in a vertical control relationship, resulting in the existence of multiple boards at various levels that need to be coordinated. As a result, in addition to the three board roles set out above, a fourth role of “coordination” can be identified for the board (Du et al., 2015). These roles may be fulfilled to different extents by boards of parent entities and by boards of subsidiaries, as examined below. Board of the Parent Entity In the group structure the parent entity will need to formulate and coordinate strategies for the whole group, bearing in mind the interests of not only the parent entity but the group as a whole (Hopt, 2015). The board of the parent entity will therefore be fulfilling the strategy and coordination roles, in addition to its other roles. The strategy role of the parent board may display differences in family business groups depending on the family culture. Some family companies prefer informal platforms such as family councils to have family-related discussions, like succession issues or concerns over balancing interests within different branches of the family (Dela Rama, 2017). If these discussions also extend to important investment decisions, the strategy role of the board may be mitigated. As for coordination, directors of the parent entity may be appointed to boards of the subsidiaries. In this way, the so-called “interlocking directors” are able to carry information between the parent and the subsidiaries enabling the parent’s board to oversee and coordinate the activities of the group (Ataay, 2016; Alpay et al., 2005). For large business groups with diverse operations, however, other structures may be necessary. For example, in large business groups with many subsidiaries, it may not be possible or desirable to have a parent director to be on the board of every subsidiary. This may necessitate the establishment of a separate committee to take over the intra-group coordination role. However, since business groups are made up of separate legal entities with separate boards, an intra-group management body across companies is not legally stipulated. This means that if interlocking directorates is not a sufficient solution, the coordination function may have to be carried out primarily by coordinators responsible for several companies of the group who report to the board or CEO of the parent entity. For example, two of the largest holding companies listed in the Turkish stock exchange Borsa Istanbul, Sabancı and Koç Holding companies, have operations in

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six different industries through numerous subsidiaries in and outside of Turkey. Operations have been grouped according to key business areas such as energy, finance, retail, automotive, etc., each of which are led by “group presidents” who are not board members of the holding company (Sabanci.com, 2018; Koc.com.tr, 2018). Finally, the monitoring role of the parent board depends on the shareholder and group structure. As mentioned above, in emerging countries, parent entities are likely to be held by large shareholders or families who have board presence and a close control on management, which diminishes the importance of monitoring through outside directors. Hence, the monitoring role of the parent board in emerging market groups may weigh more towards monitoring the management of subsidiaries, which is discussed below. Board of the Subsidiary The functions expected of the board of the subsidiary will depend on various factors, such as the level of control exercised by the parent entity, the local involvement necessitated by the subsidiary’s operations or whether the subsidiary is wholly or partially owned. Firstly, the role of the subsidiary’s board to monitor the managers may be diminished, especially if the subsidiary is wholly owned and the controlling entity’s trusted directors, such as family members, are also active in the subsidiary’s board and hence able to monitor the subsidiary’s managers directly. However, the need to monitor may differ if the subsidiary is not wholly owned, and there are minority shareholders and other stakeholders whose interests need to be protected. In companies with a controlling shareholder, the principal-agent problem is more strongly encountered between the controlling shareholder and minority shareholders rather than the shareholders and the management (La Porta et al., 2000; Hopt, 2015). Furthermore, in the group context, the controlling shareholder who has interests in other group companies would be expected to seek the well-being of the whole group rather than each individual member company. This creates the risk that the interests of one subsidiary may be sacrificed for the interests of the group, at the expense of minority shareholders and other stakeholders who do not participate in the benefits gained by other group companies (Hopt, 2015; Conac, 2013). In such a case, the board would be expected to assume a monitoring role similar to that in companies with dispersed ownership. Indeed, for listed firms with a substantial family ownership, findings suggest that outside directors help to mitigate conflicts between family owners and minority shareholders (Anderson and Reeb, 2003). In joint venture companies where the minority may be represented on the board, such monitoring would be carried out by directors appointed by the minority, rather than outside directors.

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The strategy role of the subsidiary’s board depends on the level of control exercised by the parent entity and whether the subsidiary is wholly owned. If the controlling entity chooses to directly control the subsidiary by determining its strategy at the level of the parent entity, the need for the subsidiary’s board to get involved with strategy would be reduced (Kiel et al., 2006). This may be more likely in the case of wholly owned companies (Du et al., 2015). However, if the subsidiary is a joint venture company with a strong minority stake, the minority shareholders may have board representatives, which affects the strategy role of the subsidiary board. Research findings indicate that in this case, the boards are the major forum in which majority and minority shareholders discuss strategy (Du et al., 2015). The service role of the subsidiary board would also depend on the amount of control exercised by the parent and whether the subsidiary is wholly or partially owned. The size and type of operations of the subsidiary may also play a role in this matter. For smaller, wholly owned subsidiaries that are fully controlled by the parent, the parent’s board may be exercising the service role. In other words, the subsidiary’s board may not need to form networks with stakeholders or provide legitimacy for the company as this may already be done by the parent. However, if the subsidiary can claim some independence from the parent through its nature as a joint venture company, or through its size or type of operations requiring special expertise, the board of the subsidiary may also have a service role to play. Finally, high level coordination for the whole group will be carried out by the parent entity and such a role may not be required of the subsidiary’s board, unless the subsidiary is a mid-level controlling entity. If the companies in the group are organised in several levels, then there may be mid-level companies that are themselves subsidiaries but that have control over other operational companies. Such mid-level controlling entities may also have a coordination role to fulfil. However, the operational companies that are at the bottom tier would be implementing group strategy rather than coordinating it. Nevertheless, the boards of bottom tier companies also play a role in transferring information and knowledge to and from the parent entity and thus facilitate coordination of the whole group (Du et al., 2015) Multinational Enterprises Active in Emerging Markets The complexities resulting from the group structure explained above also apply to multinational business groups. However, the latter face the additional challenge of trying to balance the demands of multinational coordination and local integration (Alpay et al., 2005). These demands can affect board roles of both the parent and the subsidiary. For multinational groups with subsidiaries in emerging countries where relationships are important for doing business, the service role of the

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subsidiary board will be important. Representatives of the parent entity on the subsidiary board may lack connections to important local stakeholders such as the state, regulators, suppliers or financiers, which may well be provided by the subsidiary’s local board members (Boyd and Hoskisson, 2010; Du et al., 2015). The strategy role of the multinational subsidiary is again closely related to the level of control exercised by the parent. In a multinational setting, if the subsidiary’s strategic decisions are taken at the level of the parent, the subsidiary board which simply exists due to national legal rules would be reduced to a mere rubber-stamping role (Boyd and Hoskisson, 2010). However, if the operations of the company are such that they require local knowledge, for example if the company’s goods or services must be adapted to local requirements, the subsidiary’s board can play a role in strategy by providing local knowledge and expertise (Du et al., 2015; Kiel et al., 2006). The monitoring role also changes character for multinational groups, where the parent entity may have difficulties in establishing control over the subsidiary’s management, due to distance, cultural differences and information asymmetries. In this case, the board of the subsidiary may play a role in the monitoring of management (Du et al., 2015). This type of monitoring, however, will have a different content then it would in companies with dispersed ownership. The subsidiary board’s role in this case will not be to monitor the managers on behalf of dispersed shareholders who lack the capacity or the incentive to carry out such monitoring themselves. Rather, they will be exercising a controlling role on behalf of a large (or sole, in the case of a wholly owned subsidiary) shareholder with the purpose of ensuring that the subsidiary does not pursue objectives that may contradict the goals of headquarters (Jaussaud and Schaaper, 2006; Du et al., 2015). To carry out this role, directors do not need to be outsiders, as they do not need to distance themselves from the management. On the contrary, they will be insiders, as agents of the controlling shareholder, supervising the management so that they perform in line with the policies of the parent entity. In this role, monitoring tasks include ratifying important decisions at the level of the subsidiary and measuring performance of the management (Du et al., 2015). For example, according to a Deloitte survey conducted among “Lead Client Service Partners” (LCSPs) serving 53 global companies with subsidiaries in India, 84 percent of the responding LCSPs indicated that parent companies of their clients have specific approval levels in place where the parent must approve actions or the spending of the subsidiary. Furthermore, interlocking directors are again a common feature employed for monitoring and coordination purposes. According to the same study, 65 percent of the LCSPs reported that boards of the significant subsidiaries of their clients have common directors with the parents’ boards (Deloitte, 2013).

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It is also important to note that the board is made up of individual members working as a team, and the individual contribution of each director in terms of roles will also be different (van Ees and van der Laan, 2017). Subsidiary boards of multinational groups frequently possess foreign directors coming from headquarters as well as directors who are nationals of the host country. While the local members of the board can contribute more in relation to tasks involving local knowledge and experience such as service roles or local aspects of strategy and coordination, foreign directors representing the parent entity may be more active in group-wide aspects of strategy and coordination as well as monitoring.

4. Conclusion The roles of the board in a stand-alone firm are in some ways different to the roles expected of the board of a company which is a member of a business group. Board roles will firstly change depending on whether the board belongs to the controlling entity or the subsidiary. In a business group, the controlling entity’s board will not only have the strategy, service and monitoring roles, but will also have to carry out a coordination role in order to be able to define and coordinate strategies for the whole group. This role is often carried out through interlocking directors or, in larger groups with a diversified business portfolio, through group presidents responsible for those companies of the group that are active in the same business area. The board of the subsidiary on the other hand, may have diminished roles in strategy, if the subsidiary is wholly owned and its operations do not require local knowledge or expertise. On the other hand, if the subsidiary is formed as a joint venture company where all joint venture partners have representatives on the board, then the board will serve as the forum where strategy is discussed. The service role of the subsidiary board may be enhanced in a multinational group, due to the existence of distance and differences in the national cultural and institutional environment where the subsidiary is active. The monitoring role of the subsidiary board will be affected firstly by shareholder structure. Wholly owned subsidiaries can be strongly controlled by the parent. Companies with a minority stake, however, will experience an agency conflict between majority and minority shareholders, in which case the board would be expected to play a monitoring role on behalf of the minority. In the case of joint venture companies with a minority representative on board, such monitoring would be carried out by the minority representative rather than an outside director. Finally, multinational groups will need a different type of monitoring, which involves the supervision of the local management to perform in line with the policies of the parent entity, for example through approval mechanisms for important decisions of the subsidiary.

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Pugliese, A., Bezemer, P., Zattoni, A., Huse, M., Van den Bosch, F. and Volberda, H. (2009). Boards of Directors’ Contribution to Strategy: A Literature Review and Research Agenda. Corporate Governance: An International Review, 17(3), pp. 292–306. Sabanci.com. (2018). Management. [online] Available at: www.sabanci.com/en/ management/ceo-strategic-business-unit-presidents [Accessed 11 Mar. 2018]. Shleifer, A. and Vishny, R. (1997). A Survey of Corporate Governance. The Journal of Finance, 52(2), pp. 737–783. Usdiken, B. (2010). The Kin and the Professional: Top Leadership in Family Business Groups. In: A. Colpan, T. Hikino and J. R. Lincoln, eds., Oxford Handbook of Business Groups, 1st ed. Oxford: Oxford University Press, pp. 696–716. Useem, M. (2017). The Ascent of Shareholder Monitoring and Strategic Partnering: The Dual Functions of the Corporate Board. In: T. Clarke and D. Branson, eds., The Sage Handbook of Corporate Governance, 1st ed. Los Angeles, London, New Delhi, Singapore, Washington, DC: Sage, pp. 136–158. Van Ees, H. and van der Laan, G. (2017). Boards and Board Effectiveness. In: T. Clarke and D. Branson, eds., The Sage Handbook of Corporate Governance, 1st ed. Los Angeles, London, New Delhi, Singapore, Washington, DC: Sage, pp. 183–195. Windsor, D. (2009). Tightening Corporate Governance. Journal of International Management, 15(3), pp. 306–316. Zahra, S. and Pearce, J. (1989). Boards of Directors and Corporate Financial Performance: A Review and Integrative Model. Journal of Management, 15(2), pp. 291–334. Zattoni, A. and Pugliese, A. (2017). Boards’ Contribution to Strategy and Innovation. In: T. Clarke and D. Branson, eds., The Sage Handbook of Corporate Governance, 1st ed. Los Angeles, London, New Delhi, Singapore, Washington, DC: Sage, pp. 217–232.

18 The Board in the Financial and Social Performance of Firms Ogechi Adeola and Eugene Ohu

Introduction Since the 1980s, the corporate board has become an increasingly popular topic in academic research as well as in corporate practice. High-profile board failures such as American Apparel, Lehman Brothers, and Enron have put the corporate board systems in modern organizations under closer scrutiny, heightening calls for improved corporate governance. Moreover, each new cycle of high-profile board failures over the years has resulted in fresh rounds of debate and board enhancements. These debates about the efficiency of corporate governance range from controversy concerning performance pressures (Zhang and Gimeno, 2016), director and CEO remuneration (Qu, Percy, Stewart and Hu, 2018) and increasing compliance (Arjoon, 2017) to calls for an increased “stakeholder approach” to governance (Cooper, 2017) and consideration for social/environmental value and impacts (Glass, Cook and Ingersoll, 2016). These activities fit the financial and social performance of firms and have increasingly attracted attention concerning how boards affect financial (e.g. shareholder value maximization) and social (e.g. CSR and sustainable development) performance of firms. The corporate board has been described as “embedding the mechanisms through which various stakeholders of an organization practice control over corporate insiders and management such that their interests are upheld” (Oludele, Oloko and Tobiah, 2016, p. 17). The board is, therefore, the platform through which the firm’s financial and social objectives are established and pursued, and through which organizational performance (both financial and social) is checked and monitored. Boards are thus presumed ultimately responsible for the long-term financial and social success of their organizations. Since the financial and social performance of firms is pivotal to stakeholders and particularly shareholders (by maintaining a going concern and maximizing shareholder wealth), it is therefore important for both academicians and practitioners to identify and analyse the impact of boards on the financial and social performance of firms (Müller, 2014). While it seems logical (though arguable) that boards have an impact on

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financial performance, it is not explicit how boards impact social performance. In the light of this debate, this chapter examines the crucial role that the board plays in the financial success of the company. It also considers the role of the board in CSR and sustainable development, two themes gaining ground in global discussions and that have been linked to good corporate governance. In the literature, many studies delve into the impact of the board on financial performance, CSR, and sustainable development, considered separately (e.g. Glass et al., 2016; Zhang and Gimeno, 2016; Arjoon, 2017). Few studies have however examined the impact of the board on financial and social performance; most dwell on the relationship between financial and corporate performance (Orlitzky, Schmidt and Rynes, 2003). This chapter, therefore, intends to fill this gap by examining the critical role of the board in the financial and social performance of firms using agency, stewardship and stakeholder theories. While the board issues discussed here are intended to apply to most parts of the world and different types of companies, the chapter draws on experiences and references from public companies in Nigeria. The chapter is organized as follows. We examine the theoretical background of boards, including the agency, stewardship and stakeholder theories, then explore the main channels through which the board can affect financial outcomes. Next, we appraise the impact of the board on CSR and sustainable development, we discuss the implications of the board in the financial and social performance of firms, and the chapter concludes with suggestions for future studies.

Theoretical Background Different theories concerning corporate governance have been employed to study the structure, role, and impact of boards in the literature. They include agency theory, stewardship theory, and stakeholder theory, each of which can be used to explain the link between board features and corporate performance. Agency Theory Agency theory is the dominant approach within finance and economics literature (Hermalin and Weisbach, 2001), concerned with the alignment of managers and owners’ interests (Jensen and Meckling, 1976; Fama and Jensen, 1983; Eisenhardt, 1989) and is based on an inherent conflict between the interests of the owners and managers (Fama and Jensen, 1983). Agency theory has led to normative recommendations that “boards should have a majority of outside and, ideally, independent directors and that the position of chairman and CEO should be held by different persons” (Kiel and Nicholson, 2003, p. 190).

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An important implication of agency theory for corporate governance is that control mechanisms or adequate monitoring are required to protect shareholders from management’s conflict of interest (commonly referred to as the agency costs of modern capitalism) (Fama and Jensen, 1983). The role of the board in an agency framework is “to resolve agency problems between managers and shareholders by setting compensation and replacing managers that do not create value for the shareholders. One of the key elements of an agency view of the board is that outside board members will not collude with inside directors to subvert shareholder interests because directors have incentives to build reputations as expert monitors” (Carter, Simkins and Simpson, 2003, p. 37). Stewardship Theory Firm performance is the theorized outcome of both stewardship and agency theories, though in slightly different ways, namely improved performance realized by wealth maximization in stewardship theory (Davis, Schoorman and Donaldson, 1997) and by cost minimization in agency theory (Davis et al., 1997; Fama, 1980). As developed by Donaldson and Davis (1991), the stewardship theory posits that managers, far from being opportunistic shirkers, will act as responsible stewards of corporate assets. The theory is a challenge to agency theory, in which managers are always self-interested rational maximizers at the expense of shareholders (Barney and Hesterly, 2008). According to the stewardship theory, the sole objective of the executive manager is to create and maintain a successful organization so that shareholders can prosper. The goals of the board of directors and managers are aligned, such that the latter are intrinsically motivated to act in the best interests of the organization. They thus focus more on intangible gains such as taking advantage of occasions for personal growth and achievement (Chambers, Harvey, Mannion, Bond and Marshall, 2013). Based on a human relations perspective different from the underpinnings of the agency theory, the stewardship theory argues that people are inspired to do good and to act unselfishly, as much as the necessary organizational and cultural requirements are fulfilled (Davis et al., 1997). The theory posits that owners and managers have similar agendas and work together. It emphasizes the board’s role in developing strategy rather than on monitoring performance and thus argues for many executive directors with ample access to information (Cornforth, 2003). According to proponents of stewardship theory, superior corporate performance is linked to a majority of inside directors working to maximize shareholders’ profit. The explanation is that inside directors understand and govern the business better than outside directors, and thus make superior decisions. Unlike agency theory, stewardship theorists also argue that the owners have confidence in the managers and are ready to take risks on how

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the managers run their business and provide returns on their investment. Underlying this rationale is the perspective that managers are intrinsically trustworthy and thus agency costs will be minimal (Donaldson, 1990; Donaldson and Preston, 1995). The argument is that executive managers will not disadvantage shareholders for fear of jeopardizing their reputation (Donaldson and Davis, 1994). In the literature, such studies as Anderson, Melanson and Maly (2007), which empirically studies 658 corporate directors in Australia, Canada, New Zealand, and the United States, have shown that boards of directors have evolved as active partners with management and positioned themselves as strategic assets to the organization. Consistent with the stewardship theory, this partnership role demands that the board cultivates closer ties with management. According to Chambers et al. (2013, p. 120): “This evolution of the board to strategic partner of management, combined with increased investor monitoring, offers the potential to produce a more effective governance regime”. Stakeholder Theory The stakeholder theory is an organizational theory that encourages values and morals in organizational management. With foundations in organization theory, strategic management, systems theory, corporate planning, and corporate social responsibility, stakeholder theory emphasizes the importance of various stakeholders to a specific firm. Though there are numerous studies on stakeholder theory, Freeman’s (1983) Strategic Management: A stakeholder approach is widely cited as the foundation of stakeholder theory. Freeman (1983) identifies and models the stakeholders of a corporation and recommends strategies to give regard to the various interests. Summarily, stakeholder theory argues that there are other parties involved in a company, including customers, employees, financiers, suppliers, competitors, communities, trade associations, trade unions, governmental bodies, and political groups (Miles, 2012). More recent studies on stakeholder theory include Freeman, Harrison, Wicks, Parmar and De Colle (2010), Harrison and Wicks (2013), Moriarty (2016) and Miles (2017). Most of these studies suggest that stakeholder theory emphasizes the goal of a business as creation of maximum value for stakeholders and not just shareholders. In order to therefore succeed and be sustainable over time, corporate organizations must keep the interests of customers, employees, suppliers, shareholders, and communities aligned and in the same direction. Code of Corporate Governance In many parts of the world, government regulates the practice of business and the nature and workings of the board through codes or rules.

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In Nigeria, this is achieved through a code established in April 2011 by the Security and Exchange Commission (SEC) called the Code of Corporate Governance for Public Companies (SEC, 2011). The code aims to ensure transparency, accountability, and good corporate governance, being careful not to inhibit innovation unnecessarily. Companies to be guided by the code are public businesses whose securities are listed on a “recognized securities exchange in Nigeria”, those seeking to raise funds from the capital market through the “issuance of securities”, and “all other public companies” (SEC, 2011, p. 5). To this extent, it is safe to assume that all public companies with shareholders are expected to abide by its provisions. The code stipulates minimum standards to be met by companies, investing the primary responsibility for compliance on the board, with the shareholders in the first instance, and then the SEC exercising an oversight function. It defines the responsibilities of the board and its duties, as well as makes declarations about matters such as the ideal composition and structure of the board. Board Characteristics and Effect on Firm Performance Being the primary stakeholder influencing corporate governance, the board is tasked with overseeing the overall success of the corporation and its financial performance. Various characteristics of the board affecting directors, managers, and shareholders (i.e. CEO duality, board expertise, board member tenure, board composition/diversity, and board size) have therefore been shown to influence firm performance (i.e. share returns, return on assets, and Tobin’s Q). CEO Duality One of these significant governance issues is CEO duality—the situation where the chief operating officer (CEO) is also the chairman of the board. This practice has implications for transparency, justice, remuneration packages for the single individual with these two responsibilities and company return on assets. Studies such as Van Ness, Miesing and Kang (2010) show that duality has a positive influence on return on assets. It also seems to benefit shareholders with regards to both asset utilization and profitability (Conyon and Peck, 1998). The Code of Corporate Governance in Nigeria, however, prohibits such duality, stipulating that the position of CEO and the chairman of the board should be separate and held by different persons (SEC, 2011). This is to ensure the existence of adequate checks and balances by limiting the amount of power available to a single individual. Board Expertise Van Ness et al. (2010) found that boards with academicians as members have a negative influence on revenue growth. Many academicians

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on corporate boards have limited exposure to business intricacies, and so can be decision-apprehensive and more conservative, leading to low corporate revenue expansion. Van Ness et al. (2010) found that the ratio of directors with finance expertise lessens revenue growth. Directors with finance expertise are likely to be more analytical, more sensitive to risks to stockholders’ investment, and thus less likely to be open to entrepreneurial initiatives, leading to loss of new business opportunities and revenue growth. Van Ness et al. (2010) showed that heterogeneity of director expertise has significant positive influence on revenue growth, suggesting that diverse ideas from diverse perspectives help firms to identify new opportunities for firm growth. Board Tenure This refers to the length of time a person can serve on the board. The long tenure of board members may enable better understanding of the strategy, process, and routine of the firm, as they become more familiar with their director roles and responsibilities. This understanding enables better decisions vis-à-vis the firm’s assets and greater profitability. Studies such as Van Ness et al. (2010) have found that board tenure has significant influence on financial performance. They showed that for boards with long tenures, this is positively related to return on assets. Board Composition/Diversity The racial, cultural, and gender composition of the board can significantly affect its operations and organizational and social outcomes (Carter et al., 2003). Cox and Blake (1991) and Robinson and Dechant (1997) argue in favour of board diversity as this affects an organization’s long and short-term financial values. First, the marketplace becomes more diverse, so it is important to match the diversity of a company with the diversity of potential customers and suppliers in order to penetrate markets. Second, creativity and innovation are increased by the diversity of attitudes, beliefs, and cognitive functioning. Third, diversity brings about a variety of perspectives leading to more effective problem-solving. Globalization and internationalization of businesses also call for organizational leadership that is sensitive to other cultures. In a notable study, Shrader, Blackburn and Iles (1997), examining a sample of Fortune 500 firms, found a significant negative relationship between the percentage of female board members and financial value. Zahra and Stanton (1988), using canonical analysis, found no statistically significant relationship between the percentage of ethnic minority directors and financial value. Carter et al. (2003) examined the relationship between board diversity and firm value for Fortune 1000 firms. After controlling for size, industry, and other corporate governance measures,

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the authors found significant positive association between the fraction of minorities or women on the board and firm value. They also found that the proportion of minorities and women on boards is positively related to board size but that firm size is negatively related to the number of insiders. Van Ness et al. (2010) found no significant influence on performance associated with age or gender. Another significant governance issue is the relationship between board composition and financial performance. Studies such as Rhoades, Rechner and Sundaramurthy (2000), Arosa, Iturralde and Maseda (2013) and Van Ness et al. (2010) have provided empirical evidence of the influence of board composition on financial performance. In a meta-analytic study, Rhoades et al. (2000) found that board composition (or the proportion of outside directors) has a very small positive relationship with firm performance. Kiel and Nicholson (2003) also found a positive association between the proportion of inside directors and firm performance. Arosa et al. (2013) found that the presence of outside directors does not improve firm performance. Van Ness et al. (2010) found that boards with a greater number of outside directors have no significant influence on performance. Board Size Finally, one of the significant governance issues currently facing directors, managers and shareholders of modern corporations is the size of the board of directors. Guest (2009), Arosa et al. (2013), Van Ness et al. (2010) provided empirical evidence on board size as it affects a firm’s long-term and short-term financial value. Guest (2009) examined the impact of board size on the performance of 2, 746 UK firms over the period 1981–2002 and found that board size has a strong negative effect on share returns, return on assets, and Tobin’s Q. Moreover, the inverse relationship between board size and performance was higher for larger firms with larger boards. Using a sample of 307 Spanish SMEs, Arosa et al. (2013) found that board size has negative influence on firm performance. The negative influence of board size was believed to indicate that the coordination and communication failures inside large boards superimpose the merits of better manager control by the boards. In addition, Van Ness et al. (2010) found that board size also influences financial performance in fascinating ways. As board size rises, financial leverage (measured by the debt-to-asset ratio) decreases. Since larger boards may obstruct consensus building, debt-funded projects may become subject to board indecisiveness (Forbes and Milliken, 1999; Van Ness et al., 2010). Kiel and Nicholson (2003) studied the relationship between board demographics and corporate performance in 348 of Australia’s publicly listed companies and found that board size is positively associated with firm value. Yermack (1996) and Conyon and Peck (1998)

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found an inverse relationship between board size and firm performance. In a paired sample of failed and non-failed firms, Chaganti, Mahajan and Sharma (1985) found that failed firms have smaller boards than non-failed firms. In a meta-analytic study of board size and firm performance, Dalton, Daily, Johnson and Ellstrand (1999) found a positive systematic relationship, though the relationship is stronger for smaller firms. Oludele et al. (2016) examined the influence of board size on the financial performance of 34 companies in Nigeria and found a significant positive linear relationship. Board size accounts for 16.4 percent of the variation in the return on equity, meaning that board size is a good predictor of financial performance. From an agency perspective, a larger board is likely to be more vigilant to agency problems, because a larger number of people will be appraising management actions (Kiel and Nicholson, 2003). However, proponents of agency theory recognized that there is an upper limit, beyond which higher board size interferes with group dynamics and inhibits board performance (Jensen, 1993). For example, Yermack (1996) found a mean board size of 12.3. Kiel and Nicholson (2003) argued that “an inverted ‘U’ relationship exists, whereby the addition of directors adds to the skills mix and performance of board and firm till it reaches a point where the adverse dynamics of a large board outweigh the additional benefits of a greater skills mix” (p. 7). Some further argued that it is not the board size that is critical, but rather the number of outside board members (Dalton et al., 1999), but stewardship theorists argue for the ratios of inside to outside directors, since inside directors can bring superior board decisions. The Board in CSR and Sustainable Development As aforementioned, several studies investigate the link between the board and financial performance, leading to the notion that businesses have traditionally been self-centred and profit-maximising. However, recent monumental corporate failures have redirected attention to issues of good governance, accountability, and ethics (Marsiglia and Falautano, 2005) and have led to increased objections to the pure profit maximization axiom in many policy circles. These emerging expectations have indeed led to inquiry of other aspects of corporate performance (apart from shareholder value maximization) such as maintaining the highest standards of governance internally, promoting ethics, transparency, and accountability, aligned with the interests of different stakeholders, and attuned to society’s legal, ethical, and communal aspirations (Freeman, 1984; Jamali, 2006). These activities fall within the domain of CSR, a theme which has increasingly attracted attention concerning how companies align with different stakeholders—combining shareholder value maximization with charitable activities. As a result of these activities,

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firms are increasingly inclined to broaden their performance evaluation basis from a short-term financial motivation to comprise long-term economic, social, and environmental value and impacts (Hardjono and van Marrewijk, 2001), and thus embrace CSR and sustainable development. Traditionally, governments have been solely responsible for the improvement of society. However, society’s needs have exceeded governments’ capabilities (Jamali, 2006) and have turned to focus on the role of business in the society, leading to new demands for higher corporate citizenship. Sustainable development involves “building a society in which a proper balance is created between economic, social and ecological aims”. For businesses, this involves sustaining and expanding economic growth, shareholder value, prestige, corporate reputation, customer relationships, and the quality of products and services. It also means adopting and pursuing ethical business practices, creating sustainable jobs, building value for all the company’s stakeholders, and attending to the needs of the under-served (Székely and Knirsch, 2005, p. 628). Business contribute to sustainable development by adopting an integrated decision-making process. They are also able, through local communities, to maximize the positive effects of their operations on society. (Business for Social Responsibility, 2003). Sustainable development takes place only when an active leader/manager in the company champions this approach, because it always takes an active leader to change a firm into a socially responsible and sustainable enterprise. Such a leader needs to be both a good manager who can carefully examine all the internal (managerial and organizational) or external (stakeholders’ demands) factors that determine the sustainable development performance of the company and its suppliers. The most crucial success factor for sustainable development is therefore true leadership within the firm. Székely and Knirsch (2005) argued that many companies engaged in various sustainable development initiatives to meet the expectations of society. While it is argued that these initiatives contribute to business profitability, many managers are still doubtful, because most sustainable development initiatives are not directly linked to business activity and strategy. Organizational theorists have developed a large volume of theoretically and empirically diverse literature on firm-level and macro-institutional factors affecting managerial approaches to CSR and sustainable development (e.g. van Oosterhout, 2010; Filatotchev and Nakajima, 2014). A stream of such studies is centred on the antecedents and outcomes of responsible leadership and their ethical decision-making that consider the objectives and interests of organizational stakeholders (e.g. Pless, Maak and Waldman, 2012; Voegtlin, Patzer and Scherer, 2012). However, the literature emphasizes that leaders make decisions, including CSR strategies and sustainable development initiatives, within the context of corporate governance mechanisms (Filatotchev, 2012; Filatotchev and

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Nakajima, 2014) that form the foundations of leadership accountability to shareholders and the larger body of stakeholders. However, the stakeholder theory suggests that good corporate governance requires due regard and responsibility to all stakeholders (Dunlop, 1998; Kendall, 1999; Miles, 2012). The theory considers business as responsible to a web of stakeholders that sustain and increase the value of the firm (Post, Preston and Sachs, 2002; Miles, 2012). Firms have to fulfil their moral and fiduciary responsibilities toward stakeholders, an act of accountability, transparency, and honesty crucial for businesses to earn the trust of stakeholders and financial investors (Page, 2005). Marsiglia and Falautano (2005) suggest that good corporate governance and CSR has advanced from philanthropic corporate capitalism to genuine strategies aimed at earning the trust of customers and the society at large. While corporate governance suggests “being held accountable for, ” CSR implies “taking account of” (Marsiglia and Falautano, 2005). Both mechanisms are used by businesses to regulate operations. Corporate governance and CSR define the link between organizations and their internal and external socio-political environment, both as complementarities for sustainable growth (Van den Berghe and Louche, 2005). Significant advances in the literature have revealed a gradual overlap between the corporate governance agenda, CSR initiatives, and the sustainable development agenda (Elkington, 2006; Jamali, Safieddine and Rabbath, 2008). Jamali et al. (2008) presented a review of several models that posits a relationship between corporate governance and CSR. Firstly, corporate governance is believed to be a pillar for CSR, even as CSR requires this “pillar” for integrating its initiatives. For example, Hancock (2005) identifies corporate governance as a pillar of CSR along with stakeholder capital, human capital, and the environment. These four core pillars together account for about 80 percent of a company’s true valuecreating capacity. In line with the resource-based perspective, value creation, vis-à-vis CSR, is a function of leveraging stakeholder, human and environmental capital with good corporate governance. Good corporate governance is thus the pillar of CSR, as CSR is the responsibility of corporate boards (Elkington, 2006). The interactions between corporate governance, CSR, and sustainable development have many important long-term benefits: ensuring the endurance of the business, reconciling the interests of all stakeholders, securing of long-term capital, earning the trust of financiers, and the efficient use of capital (Jamali et al., 2008). For example, Gompers, Ishii and Metrick (2003) posit that there is significant association between stock returns and firm value. Ho (2005) found that good corporate governance leads to firm competitiveness and greater financial performance. In turn, CSR increases the credibility of a firm, reinforces relations with stakeholders (Aguilera, Rupp and Ganapathi, 2007), leads to low transaction costs, and attracts investors (Hancock, 2005).

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Discussion and Implications In order for a company to be a success, it must have a well-functioning and effective board. For increased financial performance, an effective board would require a focus on elements such as duality, tenure, composition, competencies, and size of the board. Much of the debate on board structure has dwelt on the call for reduced board size. The literature overwhelmingly documents a significantly negative relationship between board size and corporate performance. The negative influence of board size is believed to indicate that the coordination and communication failures inside large boards superimpose the merits of better manager control by the boards. It is argued that, although higher board size at first expedites key functions of the board (consistent with the agency theory), a point is reached when larger boards become prone to communication and coordination failures, hampering board effectiveness and thereby firm performance (Jensen, 1993). From an agency perspective, a larger board is likely to be more vigilant to agency problems. However, there is an upper limit, beyond which higher board size interferes with group dynamics and inhibits board performance Board diversity is also important, as the diversity of attitudes, beliefs, and cognitive functioning increase creativity and innovation. Diversity produces a variety of perspectives and more effective problem-solving. Also, heterogeneity of director expertise has significant positive influence on revenue growth, suggesting that diverse ideas from diverse perspectives help firms to identify new opportunities for firm growth. The long tenure of board members may also enable a better understanding of the strategy, process, and routine of the firm, as they become more familiar with their director roles and responsibilities. This understanding enables better decisions vis-à-vis the firm’s assets and greater profitability. However, board obligations have stretched beyond financial optimization; there are certain social concerns to be prioritized. Firms are therefore no longer expected to merely increase in size and influence, and create financial value, but rather to skillfully multi-balance different bottom lines and multi-manage the interests of various stakeholders (Jamali, 2006). As such, managers, though primarily answerable to stockholders whose wealth is at stake, are also responsible to employees, customers, suppliers, and communities whose interests in the company are also important in other significant respects (Jamali et al., 2008). That is, while firms are expected to continue to generate profits, they are also expected to maintain the highest standards of governance internally, promoting ethics, transparency, and accountability, aligned with the interests of different stakeholders and attuned with society’s legal, ethical, and communal aspirations (Freeman, 1984; Jamali, 2006). Companies need to align with different stakeholders and, most importantly, combine shareholder value maximization with charitable activities. As

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a result, firms are to broaden their performance evaluation basis from a short-term financial motivation to comprise long-term economic, social, and environmental value and impacts (Hardjono and van Marrewijk, 2001), and thus embrace CSR and sustainable development. Often, the anti-CSR stance is that the only real purpose of firms is to make profits and maximize shareholder wealth. However, this view is not reflective of all major business leaders. There is no denying the fact that CSR and sustainable development are important for companies to manage their relationship with wider society (Blowfield, 2005). It is important therefore for companies to appreciate CSR and sustainable development as necessary for survival, growth, and profitability. Beyond changing the board to suit doing business responsibly, it is important for companies to revamp their decision-making processes and governance mechanisms so as to build CSR capabilities and connect to stakeholder communities easily. Similar to big corporations such as Shell, Unilever, or Coca-Cola, the boards of other companies should be concerned about maintaining the highest standards of governance internally, promoting ethics, transparency, and accountability, aligned with the interests of different stakeholders and attuned with society’s legal, ethical, and communal aspirations. Boards should have a long-term view of business success; they should become integrated throughout their decision-making processes and business operations with local communities, maximizing the positive effects of their operations on society and thereby contribute to sustainable development.

Conclusion Great strides have been made to understand the role of the board in the financial and social performance of firms through agency, stewardship and stakeholder theories. This chapter has highlighted and provided insights into the critical role of the board in the financial success of the company. It has also considered the role of the board in CSR and sustainable development. This is a value-added contribution, as most studies in the literature treat financial and social performance of firms in a dichotomous way. This chapter highlights that in order for a company to be a success, it must have a well-functioning and effective board. For increased financial performance, boards would require a focus on elements such as duality, diversity, tenure, composition, competences, and size of the board. For, example, while a larger board is likely to be more vigilant of agency problems, there is an upper limit beyond which higher board size interferes with group dynamics and inhibits board performance. This chapter also highlights that beyond financial success, boards are also expected to maintain the highest standards of governance internally, promoting transparency, accountability, and ethics aligned with the

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stakeholders, and attuned with society’s aspirations. For increased social success, boards are therefore expected to become integrated throughout their decision-making processes and business operations with local communities, maximizing the positive effects of their operations on such communities, and thereby contributing to sustainable development. Further research to inform the boards of companies, the government, and society could usefully focus on examining the aspects of the board and corporate governance most conducive to CSR and sustainable development. Further research could also focus on the nature and character of boards that contribute best to CSR and sustainable development. Such studies should look at corporate motivation, be they business, governmental, or societal, and the limitations of the board as the driver of CSR and sustainable development.

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19 Director Remuneration in Developing and Emerging Markets (DEMs) Issues, Challenges and Prospects Franklin N. Ngwu 1. Introduction With increasing competition, globalization and inter-connectedness of societies and economies through the activities of firms, the tasks of board of directors (BODs) are increasing and more demanding. While they are still required to help resolve the inherent agency problems of firms, they are also required to robustly manage the concerns and interests of other stakeholders. BODs are therefore expected to be involved in both internal and external issues that might affect the sustainable growth and performance of their firms. Of the many responsibilities of the BODs, such as director nominations, executive compensation and succession, strategic and financial controls, a central one is the task of strategy formulation. Through this task, the BODs are required to formulate effective strategy that will ensure the sustainable attainment of the vision and mission of the firm. After formulating the strategy, the BODs are also expected to properly monitor the execution of the strategy to ensure it is in line with agreed plans to achieve performance targets. The BODs are therefore expected to maintain an oversight interest in all the activities of the firm, and this they do through regular reviews of the strategy, financial accounts and operations of the firm. For BODs to effectively perform the numerous tasks expected of them, they need to be properly remunerated. Good corporate governance should provide proper incentives for the board of directors to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring (OECD 2004). One of the main reasons for remuneration of directors and other corporate incentives is to create motivation for improved job performance. An improved job performance, in the long run, contributes positively to the achievement of the firm’s objectives and general organizational growth. It is therefore necessary to formulate a proper remuneration package for directors, taking into account their time, talent and expertise as well as commitment to ethical and professional standards in modern corporate governance.

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Given the identified and demanding numerous tasks of BODs, especially in developing and emerging markets (DEMs), the aim of this chapter is to critically examine the issues in and current state of director remuneration in DEMs, and then provide suggestions that might help in achieving a better alignment of director remuneration with the long-term growth and performance of the firms. The remaining sections of the chapter will proceed as follows: while Section 2 examines the justifications for remuneration of directors, Section 3 provides an overview of directors’ remuneration in DEMs. Using the overview in Section 3, Section 4 examines the determinants of directors’ remuneration in developing and emerging markets, while emerging issues in directors’ remuneration is briefly identified in Section 5. Section 6 is the conclusion.

2. Justifications of Directors’ Remuneration A good job deserves good pay. The question then is what should be a good pay for the board of directors (BOD), given their increasing responsibility in ensuring sustainable growth and performance of firms. The main task of the board of directors can be traced back to the agency problem in firms where the principal (shareholders) employs the agent (management) to help achieve organizational objectives. The main task of the board of directors is therefore to manage the situation arising from separation of ownership and control that often results in the interest of the agent not being in sync with that of the principal (Bonazzi & Islam 2007). The basic agency problem created here is the conflict of interest between the principal and the agent. If not properly managed, the principal-agent conflict can degenerate into a serious problem, one that could threaten the existence of such corporate entity. It is the need to resolve or manage this inherent agency problem that led to the initial formation of BODs to ensure that the actions of directors will promote and not jeopardize the shareholders’ interests (Mgammal et al. 2018; Weir et al. 2002). Therefore, corporate governance through the actions of the BOD provides an avenue for reconciling the interests of managers with that of owners in order to prevent either party from pursuing their personal interests which could be detrimental to the organization’s effectiveness and growth (Desai & Dharmapala 2008). Every corporation therefore needs to put in place effective internal and external control mechanisms to reduce the potential conflict and costs associated with the agency problem. Moreover, with increasing importance of firms in socio-economic and even political development of societies and economies, the role of the BODs has expanded beyond the principalagent problem. For instance, the BOD is also responsible for managing the concerns and interests of other stakeholders of the firm, as will be further elaborated.

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The tasks of BODs can be further divided into strategic control and financial control and management, as well as advisory roles (Bainbridge 2017). These functions can be represented using the acronym SERVE— select, establish, review, voice and enforce (Rymanov 2017). More elaborately, directors are responsible for the selection of qualified management; they also establish business goals, policies, standards and procedures; they review business performance; they provide a voice for the organization by expressing their opinions and questions; just as they enforce compliance with organizational goals. To effectively perform such multi-faceted tasks, the BODs are normally involved in both strategic and operational reviews of the firm in their bid to ensure sustainable growth and performance of firms. Strategic review and operational review are means of ensuring effectiveness in an organization. While strategic review could be occasioned by circumstances such as change of ownership or the appointment of a new chief executive officer, some organizations conduct strategic reviews periodically as part of their strategic planning process (Conyon & Sadler 2010). Achieving the vision and mission of any organization requires the detailed formulation and effective execution of a well-planned strategy. Not only are the BODs involved in the strategy formulation, they are also expected to regularly vet the execution of the strategies to ensure that it is being executed according to plans and that agreed targets are being met. With such robust involvement in both formulation and execution of strategies, the BODs are able to maintain strategic control of the firm which will help them to also maintain financial control enhanced by regular operational reviews. Financial control is another core practice of directors. Directors oversee the development and implementation of adequate internal control systems of which finance is a key aspect.1 Financial control is crucial in corporate governance in order to protect the organization from the risk of bankruptcy, thereby keeping it a going concern (Kraakman & Hansmann 2017). Invariably, financial control is one of the major factors that ensures the long-term survival of a business organization, and it is one of the key objectives of the BODs (Davies 2016). Through operational reviews, both yearly firm performance and longterm firm value can be improved (Laoworapong 2018). An operational review is an in-depth and objective review of an entire organization or specific segment of an organization, assessing those factors affecting the operations of a business. Examples of such factors examined in operational review include: operational procedures, internal and external communication mechanism as well as profitability issues. In contrast to operational review, strategic review is a deliberate effort to identify new value creating opportunities within a business. For example, strategic review is essential for identifying new market opportunities.

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Since strategic and operational reviews are performed by the board of directors, an improved directors’ remuneration might be a viable means of ensuring effectiveness. Taking into account the important roles they play in providing the lead for an organization, directors must be adequately rewarded for their input. In order to prevent poor performance of directors and to keep them motivated on the job while maintaining fairness to the organization, it is expedient to ensure that directors’ remuneration reflects the sensitive functions they perform in an organization. Nevertheless, the structure of directors’ remuneration must not pose a threat to the effectiveness of the corporate entity. In other words, while maintaining adequate remuneration for directors, the company’s financial resources must not be depleted in such a way that it becomes difficult to pay dividends to shareholders and the remuneration of other stakeholders.

3. Overview of Directors Remuneration in Developing and Emerging Markets The challenge therefore is how to remunerate directors to ensure effectiveness. Pertinent questions include how the salary of directors is determined and who fixes the remuneration packages of directors in a corporate establishment? To ensure the effective performance of the tasks, it is expected that all the functions earlier examined need to be taken into consideration when making decisions on the remuneration of BODs. If the directors are underpaid, one possible outcome is that they can switch to alternatives by either joining competing organizations that might offer them higher financial rewards for the same functions. Another outcome is that directors can connive amongst themselves and work against the interest of the organization, which can result in a hostile take-over. One of the major challenges of corporate governance is how to ensure effective, efficient and sustainable remuneration packages for its directors (Agyemang & Castellini 2015; Scholtz & Engelbrecht 2015). The need to strike a balance between adequate remuneration for directors while ensuring that the interests of shareholders and other stakeholders are not jeopardized as well, constitutes a major dilemma for organizations (Laoworapong et al. 2018; Scholtz & Engelbrecht 2015). Directors must be remunerated taking into account their invaluable mental contributions to effective leadership of the organization; nevertheless the remuneration must not significantly reduce the profit of the organization such that it creates a bottleneck for paying employees’ salary, shareholders’ dividends and other stakeholders. Key challenges in the remuneration of directors in DEMs include the mechanism used in calculating what the remuneration should be and the limited disclosure of information relating to remuneration. It is argued

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that remuneration might not be in line with tasks performed and that it is determined by the company’s financial position (PWC 2017). In South Africa, the structure of directors’ remuneration package includes salary and fees, all taxable benefits, performance-related payments, awards as well as all pension-related benefits (Madlela et al. 2017). In India, whether executive or non-executive, the remuneration of a director must not exceed five percent of the net profits of the company if there is only one director, while for a company with more than one director, the total remuneration for all directors must not be greater than 10 percent of the company’s net profits (Kang & Nanda 2018). In Brazil, the emphasis is on the need for a balanced remuneration policy that combines both short and long-term incentives that are performance related. The remuneration of the executives should also be one that synergises the interests of the executives to that of the firm (OECD 2011). To ensure the alignment of remuneration to performance, there is an increasing creation of remuneration and governance committees dominated by independent directors in most DEMs, just as it in developed economies. While the committee is made up of only independent directors in Brazil, the Mexican code favours the use of an ad hoc committee to assist the BODs in setting and agreeing on the appropriate compensation for CEO and senior officials of a firm (OECD 2011). While it is mandatory in India for companies to publish information about directors’ remuneration in their periodic financial statements (Kang & Payal 2018), the fees paid to directors in many African countries are not transparently disclosed in line with good corporate governance practice. Moreover, even the availability of the disclosed information is limited. When it is disclosed, it might be as single line item in the operations income statement of the firm. There are also many instances where tribal and community leaders are appointed as directors with their remuneration and benefits not regarded as board fees (PWC 2017). So the established standards regulating remuneration disclosure in most DEMs are not in line with global best practices and can be below international standards that enhance transparency and accountability. For instance, in a comparison of UK and South Africa, it is noted that requirements for remuneration disclosure in South Africa do not meet the standards of the UK Companies Act of 2006. The board of directors of every public company in the UK is required to come up with a full report on remuneration which is to be submitted to an advisory shareholder vote during the firm’s annual general meeting (Madlela & Cassim 2017). This does not just ensure transparency and accountability in corporate governance, it goes a long way in providing adequate and up-to-date information about the board of directors’ pay packages. Since 2006, publicly traded firms in China are required by law to disclose the total compensation comprising of salary, bonus, stipends and

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other benefits for each director and top manager. Also to be disclosed are information on stock options, including total exercisable shares, exercised shares, exercising price and market price at the time of the report (CSRC 2007; Conyon & He 2011). Studies also show a more positive correlation between executive directors’ remuneration and performance for publicly traded companies. The relationship is however weak for state owned companies (Conyon & He 2011). While Brazil demands that directors’ remuneration should be disclosed, it prefers an aggregate disclosure. However, the disclosure should contain the amounts paid to the highest and lowest paid directors. The regulation also identifies the responsibilities of the board members, their dedication, competence, professional reputation and market value of their services as important factors to be considered in deciding remuneration for directors. The law also states that remuneration for directors should be based on the recommendation of the board of directors and subject to shareholders’ approval. This is similar to the situation in Indonesia where board remuneration is determined and agreed through shareholders’ meetings but can also be delegated to a supervisory board. In situations where the remuneration of directors is not covered by the by-laws of the company, then it will be determined through shareholders’ meetings. While Turkey is not yet a member of the European Union (EU), the corporate governance models including director remuneration and the disclosure requirements are in line with EU standards (OECD 2011). Non-disclosure of the information regarding director remuneration means that shareholders are not afforded the opportunity to analyse and assess directors’ remuneration viz-a-viz the companies’ performance. This information asymmetry may result in remuneration policies that only benefit the executive directors to the detriment of the shareholders who are the principals (Malak 2015). Thus, there is a need for an effective management of information regarding directors’ remuneration. One way in which the directors’ remuneration can be managed is for each company to ensure the public disclosure of directors’ remuneration packages as this would create transparency and accountability in the procedure for setting remuneration of directors (Madlela & Cassim 2017). It is therefore expedient for DEMs to adopt a mandatory and prescriptive approach in dealing with the disclosure of executive directors’ remuneration as well as creating measures to ensure enforcement and full compliance with the disclosure framework (Malak 2015).

4. Determinants of Directors’ Remuneration in Developing and Emerging Markets Questions remain on the need to maintain an increasing remuneration for directors, in spite of the financial and economic challenges of many

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DEMs, and especially when there is no clear positive relationship between the remuneration and firm performance. In examining the three major factors driving directors’ remuneration in South Africa, Bussin (2015) pointed out that most prominent is the governance structure in the organization. The two other factors are merit pay and retention strategies, thus suggesting that shareholders expect a relationship between remuneration and performance. The use of stock performance as the basis for setting directors’ pay (through the use of options and other equity awards) can help protect the interest of shareholders. The rationale behind this is that since equity is valued at the prevailing stock price, directors would therefore be motivated to pursue the shareholders’ interest in achieving improved stock prices (Yermack 2004). However, the equity option can only be used for executive and non-executive directors. It cannot be used for independent non-executive directors, as their independence might be questioned when they take part in the ownership of the company (OECD 2004). Scholtz and Engelbrecht (2015) also found that corporate governance reforms, especially those that have a bearing on institutional ownership, the number of non-executive directors on the remuneration committee, shareholder voting on the remuneration policy, as well as the number of remuneration committee meetings are major factors that determine the remuneration of executive directors in South Africa. Further empirical evidence from studies conducted to investigate the factors that drive directors’ remuneration shows that corporate growth is another important determinant of director’s remuneration (Salleh & Othman 2016; Mahtab & Islam 2015; Conyon & Sadler 2010). Contrary to a priori belief that a high salary for directors is an indication of higher profit for the organization, research has shown that directors’ remuneration is not associated with a firm’s profitability, especially in DEMs (Nahar Abdullah 2006). This connotes the existence of other significant factors that drive firm profitability in DEMs apart from director remuneration. However, the situation is not the same in some developed economies such as the UK with a positive and significant relationship between board remuneration and firm performance (Main et al. 1996; PWC, 2017). It is argued that board composition can be used to enhance the contribution of the board to a firm’s performance. Board composition, according to Goergen and Renneboog (2000) refers to the discrepancy between inside and outside directors, and it is conventionally measured as the percentage of outside directors on the board. An inside director is a board member who is also an employee, manager or stakeholder of the company, while an outside director is any board member that is not an employee, a manager or stakeholder of the company (De Andres et al. 2005). With the differences in the affiliation and stake in the company

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between inside and outside directors, it is argued that it is better for an organization to have more outside directors than inside directors (De Andres et al. 2005; Madlela and Cassim 2017). The rationale behind this is that outside directors are independent of the firm’s direct management and can therefore make effective decisions that will ensure superior performance. This notion was equally supported by Ogbechie et al. (2009) and Ruigrok et al. (2006), who in separate studies explicate the effectiveness of outside directors in making strategic decisions crucial for improving firm performance. A board that is dominated by inside directors may however be advantageous, as their vast industry experience can help improve organizational profitability (Ruigrok et al. 2006). However, given that the executive directors are subordinates of the CEO, they might not be in a strong position either to monitor or discipline the CEO (Kinsella 2017). It is therefore necessary for organizations to put in place a mechanism that ensures that the activities of the CEO and other executive directors are put in check, in order to ensure that they pursue shareholders’ interests (Weir & Laing 2001). Thus, outside directors monitor the CEO and inside directors scrutinize company strategies and challenge any suspicious deal in the organization (Ruigrok et al. 2006). Outside directors can also be used in moderating the remuneration of directors. They are able to make independent decisions without prejudice when dealing with the executive directors, and they are more interested in building their reputations as professionals in decision control (Weir & Laing 2001; Yermack 2004). Therefore, rather than conniving with inside directors to syphon the company’s financial resources, they (outside directors) can monitor the activities of inside directors and ensure that their remuneration is commensurate with stock performance. The use of outside directors in regulating the activities and remuneration packages of inside directors provides internal and external markets for decision agents such as directors (Masulis & Mobbs 2011). However, the inclusion of both outside and inside directors on the board of a company can lead to power tussles as regards who holds more power between the two classes of directors (Yermack 2004). Consequently, when lines of authority are not clearly defined, decision control can break down. Furthermore, outside directors tend to be more concerned with the acquisition of more seats on the boards of other companies, and this could affect their job performance. However, poor performance of directors in a particular organization can also have negative consequences for the directors, as it reduces the number of offers available to them for new directorships. It is therefore important to ensure that the board of directors’ remuneration packages are strictly performance-based and not fixed. If the

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other employees are being remunerated based on their output or productivity, the same should also apply to directors, to ensure fairness. In as much as an organization is expected to cater for the welfare of its directors as well as other stakeholders, outrageous salary for directors is quite inimical to the long-term survival of a corporate entity. Business organizations should also have feasible sustainability plans. One of the ways to operationalize such a plan is by maintaining a remuneration structure that could be sustained by the organization for a long period and should promote effectiveness (Conyon & Sadler 2010; Conger & Lawler 2009). Given the need to have a board that that will effectively contribute to the sustainable performance and growth of the firm, it is important that companies foster remuneration policies that attract, reward and retain highly qualified candidates for board appointment. It should ensure that the remuneration package is such that it aligns the interests of non-executive directors with the interests of the company’s long-term shareholders and provides comprehensive disclosure regarding the components of director remuneration including the philosophy behind the structure (ICGN 2016).

5. Emerging Issues in Directors Remuneration Given the increasing globalization and competition among firms, the need to have very competent boards to guide firms through the competitive challenges is not in doubt. What is in doubt is the ability of firms to attract board members that are capable and effective in having a robust understanding of emerging factors that will affect the firms, and as such board and firm performance. The emerging factors will require very skilled and knowledgeable boards that DEMs will need to contend with. First, there is an increasing awareness and demand that firms should take into proper consideration environmental, social and governance (ESG) issues in their strategy and plans for profit and other objectives. Firms are now required to act responsibly by taking into good consideration labour and ESG issues in managing their commercial realities and needs. Achieving a balance between the ESG factors and profitability for instance will require the recruitment of board members that are conversant and skilled with the issues and their link to the sustained profitability of the firm. Second is the increasing utilization of artificial intelligence and cyber-security factors which require a new set of knowledge and skill. Third is the changing global population with over half of the world population now women. This implies that future boards might be women dominated. All these emerging factors expectedly connote new challenges and risks that require proper understanding and management. Probably

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related or independent of the identified factors, customer behaviour and needs are changing; new regulatory frameworks are being developed and implemented to contend with the multi-faceted challenges. In the face of such a rapidly changing and complex business environment, organizations are expectedly also to undergo changes in order to remain agile and flexible to adapt to the emerging situation. Undoubtedly, having a board with all the necessary skills and knowledge to manage the rapid changes and their complexities will not be an easy task, especially in DEMs with a dearth of the relevant skills. Since to remain competitive will require the appointment of such a competent board, it means that the remuneration of directors will likely increase. What is therefore required of firms in DEMs is to properly appreciate the emerging issues and to be proactive in managing them. This will include the recruitment and development of members that can possibly be supported to enhance their skills and knowledge.

6. Conclusions This chapter has examined the need for proper remuneration of directors in developing and emerging markets. Good corporate governance should provide proper incentives for the board of directors, in order to enable them to pursue objectives that are in the interests of the company and its shareholders. Board composition can greatly influence organizational performance as the number of outside directors in an organization is positively related to the profitability of the corporate entity. The rationale behind this is that outside directors are independent of the firm’s direct management and can therefore make effective decisions that will ensure superior performance. Directors are involved in the strategic management and administrative planning, as well as financial controlling of the organization. Hence, it is pertinent to ensure that they are adequately remunerated to prevent hostile take-over. Contrary to what holds in developed markets where there is strong advocacy for public disclosure of directors’ remuneration to enhance transparency and accountability, the established standards regulating remuneration disclosure in most developing and emerging economies are not in line with global best practices and can be below international standards. Consequently, DEMs need to derive other measures of ensuring transparency and accountability, apart from publicly disclosing directors’ pay. Directors should be remunerated to facilitate corporate effectiveness as it provides an avenue for reconciling the interests of managers with that of owners in order to prevent either party from pursuing their personal interest which could be detrimental to the organization’s corporate effectiveness. Improved directors’ remuneration is therefore sacrosanct to board and corporate effectiveness.

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Note 1. International Financial Corporation, www.ifc.org/wps/wcm/connect/c8cf61 00468133e58da7bd9916182e35/Session+4+-+Control+Environment.pdf? MOD=AJPERES

References Agyemang, O. S., & Castellini, M. (2015). Corporate governance in an emergent economy: A case of Ghana. Corporate Governance, 15(1), 52–84. Bainbridge, S. M. (2017). Corporate directors in the United Kingdom. William and Mary; Law Review. Bonazzi, L., & Islam, S. M. (2007). Agency theory and corporate governance: A study of the effectiveness of board in their monitoring of the CEO. Journal of Modelling in Management, 2(1), 7–23. Bussin, M. (2015). Factors driving changes to remuneration policies in South Africa. South African Journal of Labour Relations, 39(2), 43–63. Conger, J., & Lawler, E. E. (2009). Sharing leadership on corporate boards: A critical requirement for teamwork at the top, Marshall School of Business. Working paper, pg 1–39. Conyon, M. J., & Gregg, P. (1994). Pay at the top: A study of the sensitivity of top director remuneration to company specific shocks. National Institute Economic Review, 149(1), 83–92. Conyon, M. J., & Sadler, G. (2010). Shareholder voting and directors’ remuneration report legislation: Say on pay in the UK. Corporate Governance: An International Review, 18(4), 296–312. CRCS (2007). China Securities Regulatory Commission Annual Report: http:// www.csrc.gov.cn Davies, A. (2016). Best practice in corporate governance: Building reputation and sustainable success. Abingdon, UK: Routledge. De Andres, P., Azofra, V., & Lopez, F. (2005). Corporate boards in OECD countries: Size, composition, functioning and effectiveness. Corporate Governance: An International Review, 13(2), 197–210. Desai, M. A., & Dharmapala, D. (2008). Tax and corporate governance: An economic approach. In Tax and corporate governance (pp. 13–30). Berlin, Heidelberg: Springer. Goergen, M., & Renneboog, L. (2000). Insider control by large investor groups and managerial disciplining in listed Belgian companies. Managerial Finance, 26(10), 22–41. International Corporate Governance Network. (2016). ICGN guidance on nonexecutive director remuneration: For ICGN member approval at the annual general meeting taking place on 27th June 2016. Internet file retrieved on 18th April 2018, from file:///C:/Users/User/Downloads/_ICGN%20Non-Execu tive%20Director%20Guidelines%20(1).pdf: ICGN AGM in London. Kang, L. S., & Nanda, P. (2018). What determines the disclosure of managerial remuneration in India? Journal of Financial Reporting and Accounting, (justaccepted), Vol. 16 Issue 1 p. 2–23. Kang, L. S., & Payal, N. (2018). Managerial remuneration in India: Analysing trends before and during the economic slowdown. Management and Labour Studies, 0258042X18763417. http://oi.org/10/1177

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Kinsella, M. (2017). Hostile takeovers: An analysis through just war theory. Journal of Business Ethics, 146(4), 771–786. Kraakman, R., & Hansmann, H. (2017). The end of history for corporate law. In Corporate Governance (pp. 49–78). Gower. Taylor and Francis. Laoworapong, M., Supattarakul, S., & Swierczek, F. W. (2018). Corporate governance, board effectiveness, and performance of Thai listed firms. AU Journal of Management, 13(1), 25–40. Madlela, V., & Cassim, R. (2017). Disclosure of directors’ remuneration under South African company law: Is it adequate? South African Law Journal, 134(2), 383–414. Mahtab, N., & Islam, M. N. (2015). Corporate governance: A preliminary study on current situation in Bangladeshi companies and the need for corporate governance. Corporate Governance, 6(6). Main, B. G., Bruce, A., & Buck, T. (1996). Total board remuneration and company performance. The Economic Journal, 1627–1644. Malak, S. S. D. A. (2015). The Malaysian disclosure framework on executive directors’ remuneration: A critical review and closing its loops. Mediterranean Journal of Social Sciences, 6(6), 410. Masulis, R. W., & Mobbs, S. (2011). Are all inside directors the same? Evidence from the external directorship market. The Journal of Finance, 66(3), 823–872. Mgammal, M. H., Bardai, B., & Ku Ismail, K. N. I. (2018). Corporate governance and tax disclosure phenomenon in the Malaysian listed companies. Corporate Governance: The International Journal of Business in Society, vol. 18 issue 5, 779–808. Nahar Abdullah, S. (2006). Directors’ remuneration, firm’s performance and corporate governance in Malaysia among distressed companies. Corporate Governance: The International Journal of Business in Society, 6(2), 162–174. OECD. (2004). The OECD principles of corporate governance. Contaduríay Administración, (216). Ogbechie, C., Koufopoulos, D. N., & Argyropoulou, M. (2009). Board characteristics and involvement in strategic decision making: The Nigerian perspective. Management Research News, 32(2), 169–184. PWC. (2017). Non-executive directors practices and remuneration trends report. Internet file retrieved on 18th April 2018, from file:///C:/Users/User/Down loads/PWC%20NED-report-2017%20(1).pdf Ruigrok, W., Peck, S. I., & Keller, H. (2006). Board characteristics and involvement in strategic decision making: Evidence from Swiss companies. Journal of Management Studies, 43(5), 1201–1226. Rymanov, A and Karpovich A (2017): Board of Directors: The case of Emerging Banking System: SSRN 2916560; doi.org/10.2139 Salleh, S. M., & Othman, R. (2016). Board of director’s attributes as deterrence to corporate fraud. Procedia Economics and Finance, 35, 82–91. Scholtz, H. E., & Engelbrecht, W. A. (2015). The effect of remuneration committees, directors’ shareholding and institutional ownership on the remuneration of directors in the top 100 companies in South Africa. Southern African Business Review, 19(Special edition 2), 22–51.

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Weir, C., & Laing, D. (2001). Governance structures, director independence and corporate performance in the UK. European Business Review, 13(2), 86–95. Weir, C., Laing, D., & McKnight, P. J. (2002). Internal and external governance mechanisms: Their impact on the performance of large UK public companies. Journal of Business Finance & Accounting, 29(5–6), 579–611. Yermack, D (2004): Remuneration, Retention and Reputation Incentives for Outside Directors: The Journal of Finance/ vol 59, Issue,

20 Board Composition and Diversity in Developing and Emerging Markets Enase Okonedo

Introduction The board of directors of every organization is instituted to ensure that managers and executives act in the best interest of the organization and that their objectives are aligned to enhance the overall effectiveness of the organization. In addition to its responsibility of ensuring the proper functioning of the organization and providing strategic and other direction for the company, the board of directors in every organization is meant to be the custodian of corporate governance. Effective corporate governance depends on factors such as the codes of corporate governance in existence in respective countries; the processes and mechanisms within companies to ensure proper governance; and most importantly, the effectiveness of the board of directors. Codes of corporate governance which stipulate governance mechanisms and board composition are all established to ensure that boards function effectively; ensuring a clear delineation of roles, duties and responsibilities; and enable the board to maintain control over the business activities of the company. For instance, in Nigeria, the Companies and Allied Matters Act (1990), the Securities and Exchange Commission (SEC) Code of Corporate Governance for Public Companies (2014), the Central Bank of Nigeria (CBN) Code of Corporate Governance (2006) state the requirement, composition, structure, duties and responsibilities, and roles of the board of directors of companies operating in Nigeria. In South Africa, the King (III) Code of Corporate Governance (2009) as well as the King (IV) Code of Corporate Governance (2016) stipulate the composition and responsibilities of the board of directors and require every board to recognize the size, diversity and demographics of its members for greater effectiveness. In Kenya, the Capital Market Authority (2015) Code of Corporate Governance Practices for issuers of securities to the public stipulates principles, guidelines, and recommendations including board composition that all listed and unlisted companies should adopt in order to ensure improved corporate governance practices. The composition of the board must be such as to ensure sound

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judgment, independence of thought and different perspectives, all of which contribute to board efficiency and effectiveness, and enhance good corporate governance. The chapter begins with a brief description of board effectiveness and factors that influence it. It then discusses board composition and its effect on board effectiveness, showing how membership and independence of the board contributes to its effectiveness. In addition, the chapter examines diversity: gender, age, qualification, and how they influence board effectiveness. It also considers the roles of boards as well as those of the chairman and chief executive officer. In doing this, it examines board compositions of public companies in three African countries—Nigeria, Kenya, and South Africa.

Board Effectiveness Board effectiveness can be viewed from different perspectives and remains an important aspect of corporate governance (John & Senbet, 1998). Factors such as board composition, board independence, gender diversity, age, experience, and qualifications individually and collectively affect the effectiveness and performance of the board. Board effectiveness considers how well a board executes its key functions of control, service, and strategy as identified by Zahra & Pearce (1989), Jonnergård, Kärreman, & Svensson (1997), Maassen (1999); Garg & Eisenhardt (2017); Concannon & Nordberg (2018) and carries out its responsibilities. The service function is sometimes referred to as the advisory function of boards. It is greatly influenced by the composition of the members of the board with diverse demographics who bring different qualities to the board and render advice. The control function which focuses on the decision control attribute of the board focuses on the examination and evaluation of organizational performance to ensure consistent improvement in corporate growth, as well as monitoring and appraising the CEO’s performance. The strategic function remains a combination of both the service and control function. It combines the overall decision management and control activities of the corporate board. It includes the establishment of corporate and broad strategies, shared direction, and a responsibility to pursue it (Ingley & Van der Walt, 2001).

Board Composition and Its Effect on Board Effectiveness For effectiveness to be achieved there is a need to establish mechanisms and structures for executing each of the aforementioned roles and functions. The board has this responsibility and board members must have a shared sense of purpose, of values, and a commitment to work towards a coherent goal. Members can be categorized as executive, non-executive

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or independent non-executive directors (Singh & Kumar, 2017; Chughtai, Naseer, & Hassan, 2017). These classifications usually denote the relationship each individual director has with the organization. Executive directors are members of the board who sit on the board by virtue of their responsibilities within the organizations. They are employees who hold executive roles within these organizations. Non-executive directors are members of the board who do not have any executive or managerial responsibility within the organization but may have other relationships. For example, they may have a managerial relationship in a holding company—such as in the case of a holding company structure— or be representative of a group of shareholders or other stakeholder groups. Independent directors are non-executive directors who are completely independent and have no formal, material, or pecuniary relationship with the organization or other members of management. Other categorizations of board memberships exist such as affiliated, inside and outside directors (Baysinger & Butler, 1985; Gupta, Hothi, & Gupta, 2011). This categorization is based on the degree of involvement in the affairs of the company. Affiliated non-executive directors are those that have a business relationship with the company but are non-employees of that company. Inside directors are those members of the board who hold an executive position or belong to the management of that company, while outside directors do not serve in any official employment capacity within an organization or have any form of economic dependence on the company’s management. It is important to understand the ways by which boards can enhance their effectiveness (Zahra & Pearce, 1989). Nicholson & Kiel (2004) asserts that the effectiveness of the board depends on the adequate combination of the board’s intellectual capability and an in-depth understanding of its role in the company’s affairs. He went further to assert that an organization will be said to have performed well based on the efficiency and effectiveness of its board of directors. Levrau & Van den Berghe (2009) identifies the key determinants of an effective board to be board structure, board culture, and board diversity. The independence of the board is a critical factor for board effectiveness (Muth & Donaldson, 1998; Hermalin & Weisbach, 2003; Corten, Steijvers, & Lybaert, 2017) and in ensuring that the board carries out the functions entrusted to it. Board members, regardless of their categorization, must act in the best interest of the company and not in their personal interest or that of any affiliations. Typically, judgments on the independence of the board are made examining the proportion of independent to non-independent or executive directors. A dominance of independent non-executive directors on boards is expected to ensure that boards act independently. The Cadbury Report (1992)1 advocates the adoption of more independent non-executive directors, free from any relationship that could materially impede objectivity and independent judgment on

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boards. A higher percentage of outside directors will enhance board independence (Ogbechie, 2012). Within the context of developing and emerging markets such as Nigeria and South Africa, the respective codes of corporate governance stipulate that the number of non-executive directors should be more than executive directors on the board. This is because of the expected unbiased nature of their judgments and not subject to the influence of top management. However, a preponderance of outside directors on the board does not always guarantee independence and in certain circumstances, independence could be compromised. For instance, situations where individual directors are beholden to influential people who nominated them to the board. This could impair independence.

Board Diversity—Gender, Age and Qualifications Wellner (2000) describes diversity as a multiplicity of differences and similarities in people and comprises different characteristics such as age, gender, religion, ethnicity, experience, etc. Kang, Cheng, & Gray (2007) stated that diversity considers the numerous characteristics of the board of directors which can be seen from both observable and less observable dimensions. The observable dimensions are the various demographic compositions such as ethnicity, religion, nationality, age, and gender, while the less observable dimensions are the functional background and experiences of the individuals on the board (Coffey & Wang, 1998; Erhardt, Werbel, & Shrader, 2003). Carter, Simkins, & Simpson (2003) in their study on diversity within corporate boards, found that greater board diversity promotes increased understanding of the market, enhances innovation by the board, leads to better decision-making, improved relationship management, and ensures independence. Furthermore, Ararat, Aksu, & Tansel Cetin (2015), as well as Abdullah, Ismail, & Nachum, (2016) in their studies examining board diversity and firm performance in emerging markets, support the view that board diversity positively influences organizational performance. Board diversity which refers to the different characteristics that individual members or groups of members bring to the board will shape the policies and the future direction of the company. It is therefore essential to have qualified individuals with diverse attributes on the board in order to enhance board effectiveness and company performance. Gender An effectively functioning board welcomes a multiplicity of ideas and different perspectives that promote robust discussion of internal and external issues that may affect an organization. Previous researchers have

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sought to study the effect of female representation on boards on company performance (Du Plessis, Saenger, & Foster, 2012; Buchwald & Hottenrott, 2015; Terjesen, Couto, & Francisco, 2016). In examining female representation on boards and its effect on firm performance, studies have found in some instances that there is a positive relationship between the presence of females on boards and performance levels. Campbell, & Mínguez-Vera (2008) established from their study on Spanish companies, that a positive relationship existed between gender diversity on boards and company value added. Dang & Vo (2012) assert that females are found to improve decision-making as a result of their cognitive difference from men; increase the level of knowledge brought to the table; and generally improve external communications. Also, research from the Credit Suisse Research Institute (2012) indicates that from 2006 to 2012, companies with women represented on the board performed better than the ones without adequate female representation on their boards. Terjesen, Couto, & Francisco (2016) also found that the presence of females on boards increases the effectiveness of the control function performed by the board. Given the traditional role of women in African society where they are the primary homemakers making decisions regarding the purchase of goods and services, it is essential that they have a voice in corporate boardrooms, as they bring unique perspectives different from males. As in the case of all board members, due attention has to be given to ensuring the individual has the requisite experience and attributes which will enhance the effectiveness of the board. Since about half of the global population are female, boards will gradually mover towards the same balance in the near future (PWC, 2017). However, female representation on boards should be on account of the realization of the unique qualities they bring to the board rather than as a symbolic gesture, tokenism, or to comply with legislation. Again, in traditional African culture, males are considered the leaders in any entity—family or organizational, while women are perceived as subordinate to their male counterparts. This may account for why in the African countries studied here, there is a dominance of males on boards we find from our analysis contained in Figures 20.1, 20.4, and 20.7 that board composition in Nigeria, South Africa, and Kenya is mainly male dominated with an average of 80 percent males on boards. Given this, these countries and others in African countries have imposed requirements to increase female board membership in specific sectors. In South Africa, the Broad-Based Black Economic Empowerment (BBBEE) Act and Codes of Good Practices (2016) as amended require listed companies in the marketing, advertising and communications sector to have a policy on promoting gender diversity on corporate boards. For this sector, the amended act sets a specific target of 25 percent for black female directors and executives on boards of listed companies. In

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the Circular titled “Nigerian Sustainable Banking Principle (NSBP”, the Central Bank of Nigeria (2012) stipulates a quota representation in order to improve the representation of females on boards and top management in the banking sector, requiring that these be 30 percent and 40 percent respectively by the end of 2014. In Kenya, the government enacted a legislative quota representation of 33 percent for state-owned enterprises. The Constitution of the Republic of Kenya 2010 stipulates a two-thirds gender rule stating that “not more than two-thirds of the members of elective or appointive bodies shall be of the same gender”. Elective or appointive bodies in this regard include boards of state-owned companies. Age A few studies have been conducted examining the relationship between age and organizational performance with varying results. According to Houle (1990), most boards should have an adequate spread of age groups. He opines that the older members would provide the relevant experience and guidance needed as well as wisdom and economic resources while the younger members will contribute the vibrancy, intellect, and innovative capabilities. Selvaraj (2015) studying workforce diversity on employee’s performance found that a blend of both young and older directors leads to increased organizational growth. Likewise, Ararat, Aksu, & Tansel (2010) in their study reported a positive association between age, board diversity, and company performance. On the contrary, Randøy, Thomsen, &Oxelheim (2006) studying Perspectives on Corporate Boards Diversity in 500 largest companies in Denmark, Sweden and Norway found no significant influence of boards’ age diversity on company performance. Consistent with the need to ensure the board as a whole is efficient and effective, all board members must be able to contribute positively to the discussions and decisions regardless of their age. Age should not be a necessary qualifying criterion for board membership. However, given the need for adequate planning and succession of board members to ensure continuity, it may be expedient to have a mix of young and older members. A board should strive to have a mix of board members of varying ages in order to have the benefit of youthful enthusiasm and innovative thinking that characterizes younger minds, as well as wisdom and experience garnered through the ages by older members. However, age in itself should not be a predominant consideration in selecting board members. Experience and Qualification The qualifications and experiences of board members is also an important factor in board effectiveness. Board members ought to have the relevant

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corporate governance knowledge, and adequate industry knowledge to perform more effectively. Where directors are brought on board because of specific technical, industry, or other skills, there has to be adequate training given on good corporate governance to ensure they are knowledgeable and prepared to carry out their responsibilities.

The Roles and Qualifications of the Board’s Chair The chair of a board is a preeminent member of the board, providing leadership to both the board and the company, tasked with ensuring that the board carries out its responsibilities. As a key board responsibility is corporate governance that prescribes how the organizations should be directed, monitored, and controlled, the chair being responsible and accountable to the board, ought to be the principal driver for corporate governance of the organization. The contemporary roles of the chairman are board leadership, information dissemination, board relationship management, and other functions such as overseeing, instilling, and initiating standards of corporate governance, as well as directing the affairs of the board in the best interest of the shareholders (Ajogwu, 2009).

CEO Duality: Nature and Role of the Chief Executive Officer (CEO) The CEO, in conjunction with the board as a whole, is responsible for the formulation and implementation of the company’s strategic goals and objectives with a view to protecting stakeholders’ interest. The CEO performs a leadership role that entails overall day-to-day management of strategic, tactical, and operational decisions. He acts as an intermediary between the board of directors and management of the company; communicates with other stakeholders of the company such as employees, suppliers, customers, the government, and the public in general; and acts as the link between the company and the rest of the society. CEO duality refers to the practice of one individual combining the roles of both CEO and chairman. Kesner & Dalton (1986) opine that the combination of the role of chairman and CEO will create a potential threat to the independence of the board of directors. They state that a separation of ownership from control is central to effective corporate governance within entities. On the contrary, Donaldson & Davis (1991) are of the view that the combined role of the board’s chair and the CEO will create an institutional structure which would enable improved performance to the extent that the CEO has an unchallenged authority to navigate the affairs of the firm. The fusion of the legal right and authority will create a clear and unified corporate leadership for the organization. This will, therefore, show a positive outlook in the productivity and overall performance of the firm.

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Within the context of emerging markets, companies adopt different strategies with regards to a combination or separation of the role of CEO and chairman. For example, the Code of Corporate Governance for Banks in Nigeria Post Consolidation (2006) and the CBN (2014) guidelines stipulate that the functions, roles, and duties of the CEO of a bank should be separated from that of the chairman such that the two positions are held by different individuals. In addition, it disallows members of the same extended family to hold the position of chairman, CEO, or executive director at the same time. South African King IV (2016) Report on Corporate Governance categorically states that the CEO should not serve as the chair of the governing body. The CEO’s role is more operational but with a strategic orientation, whereas the role of the chairman is more strategic than operational, leading the members of the board to determine the direction of the organization in both the short as well as long-term. Good governance, therefore, demands that both roles be distinct and managed by two different individuals.

Board Composition in Publicly Listed Companies in Africa In studying board composition in Africa, three countries representative of the major regions of Sub-Saharan Africa were selected: Nigeria in West Africa, South Africa in Southern Africa, and Kenya in East Africa. These countries have active stock exchanges with information on listed companies publicly available. Nigeria The membership of boards of 40 of the 172 listed companies on the Nigerian Stock Exchange (NSE) as at March 2018, for which data was obtained, indicates board sizes ranging from 5 to 17 members with a low representation of females. Figure 20.1 shows female representation on the boards of these 40 companies is low. 46% of the total boards studied have between 0-10% females on their boards, 24% have 11-20% females, 15% have between 20-30% and 15% have above 30%. Figure 20.2 shows percentage distribution of the number of non-executive directors on the boards of the same 40 companies and indicates that about 13 percent have between two to four non-executive directors on their boards; 43 percent have five to seven; 20 percent have eight to nine, and 24 percent have a total of ten and above. The presence of at least one independent director on every board is expected to enhance the independence of the board. Figure 20.3 shows that the percentage of independent directors on the boards of Nigerian Companies is low. Eighty-two percent of the companies studied have less than 30 percent independent directors, 10 percent have between 31–50

15% 46%

15%

24%

0–10%

11–20%

20–30%

30% and Above

Figure 20.1 Board Composition: Female Representation on Boards in Nigeria Source: Bloomberg (2018).

13% 24%

10 and Above 8&9 5 to 7 43%

20%

2 to 4

Figure 20.2 Board Composition: Non-executive Directors (NEDs) on Boards in Nigeria Source: Bloomberg (2018).

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10%

335

8%

82%

0–30%

31–50%

51 and Above%

Figure 20.3 Board Composition: Independent Directors on Boards in Nigeria Source: Bloomberg (2018).

percent, and 8 percent have above 51 percent. As this number is an indication of the independence of the board, it is important that companies in Nigeria aim to increase these numbers. South Africa In examining the board composition of listed companies on the Johannesburg Stock Exchange, data gathered from the Bloomberg terminal reveals that board size ranges from five to twenty board members as at March 2018. As shown in Figure 20.4, compared to other African stock exchanges, the JSE has a significant number of women represented on their boards. Twenty-one percent of the companies studied have between 0 and 10 percent females on boards; 35 percent have 11–20 percent; 23 percent have 21–30 percent; 21 percent have 21–30 percent; while 21 percent have 30 percent and above. Of the 117 companies studied, the number of non-executive directors on board is quite significant. Figure 20.5 reveals that 34 percent have between four and seven non-executive directors on their boards; 31 percent between eight and nine; 25 percent between ten to twelve; and 10 percent have thirteen and above.

21%

21%

23% 35%

0-10%

11 to 20%

21-30 %

30 and above%

Figure 20.4 Board Composition: Female Representation on Boards in South Africa Source: Bloomberg (2018).

10%

34% 4 to 7

25%

8&9 10 to 12 13 & Above

31%

Figure 20.5 Board Composition: Non-executive Directors (NEDs) on Boards in South Africa Source: Bloomberg (2018).

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2% 19%

79%

0–30%

31–50%

51% and Above

Figure 20.6 Board Composition: Independent Directors on Boards in South Africa Source: Bloomberg (2018).

Figure 20.6 indicates that 79 percent of the 117 companies studied have above 50 percent independent directors, 19 percent have between 30–50 percent and 2 percent have 30 percent.

Kenya Listed companies on the Nigerian Stock Exchange and the Nairobi Stock Exchange share some similarities and differences in terms of board composition. As in the case of the Nigerian Stock Exchange, Figure  20.7 shows that of the nine companies in Kenya for which data were obtained, female representation on boards is significantly higher with 56 percent having between 21–30 percent females, 33 percent between 11–20 percent, and 11 percent have 0–10 percent females. This reveals that Kenyan boards are more gender diverse than Nigerian boards. Despite the effort to improve women’s participation on the boards of companies through the legislative quota of 33 percent and the two-thirds gender rule stipulated by the Kenyan government, some companies are yet to comply with this requirement as of December 2017.

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11% 33%

56%

0–10

11 to 20

21–30

Figure 20.7 Board Composition: Female Representation on Boards in Kenya Source: Bloomberg (2018).

33%

6 to 8

9 and Above 67%

Figure 20.8 Board Composition: Non-executive Directors (NEDs) on Boards in Kenya Source: Bloomberg (2018).

The Nairobi Stock Exchange has a significant presence of non-executive directors with 33 percent having between six to eight non-executive members and 67 percent having more than eight. This is shown in Figure 20.8. It is important to note however, that Kenyan boards have an adequate representation of independent directors. As shown in Figure 20.9, all the companies used for this study have above 50 percent representation of independent directors on corporate boards. This is expected to have a positive influence on board independence.

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0%

100%

0–30

31–50

50 and Above

Figure 20.9 Board Composition: Independent Directors on Boards in Kenya Source: Bloomberg (2018).

Conclusion The composition of a board is critical in instituting good corporate governance in any organization. Due care has to be taken to ensure that the board is composed of individuals who are able to contribute positively to discussions on strategy, governance, accountability, and the duty of care that every company owes to its stakeholders. In composing a board, attention has to be paid to qualities that specific individuals bring, such as experience from not only the sector the organization plays in, but from other sectors, as well as specific technical skills that may be useful in formulating the organization’s strategy. In African countries such as Nigeria, Kenya, and South Africa, even though increasing attention is being paid to the inclusion of a significant percentage of women on boards of public companies, the proportion is still considered low in Nigeria as compared to South Africa and Kenya. Our analysis indicates that female representation on Nigerian boards is less than 10 percent in about half of the companies studied. In South Africa, over 40 percent of the boards of listed companies have greater than 20 percent female representation on boards, whilst in Kenya over half of the boards studied have greater than 20 percent females on their boards. Boards require different perspectives from a diverse group to

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ensure robust discussions and effectiveness. Increasing female representation on boards contributes to this. With regards to age, individuals are often selected to serve on boards because of a history of successful careers as executives over a long period of time. One therefore, sees boards with a higher proportion of retired or serving executives who are well able to contribute, but less of young individuals brought on account of innovative, creative, and critical thinking. Youth represent a growing proportion of the African population and over 60 percent are below 25 years (World Economic Forum, 2017). Given this, companies will be well served by considering the inclusion of younger people in boards for these qualities, as well as to ensure adequate succession planning for board membership. Independent directors on the boards of 82 percent of the Nigerian companies studied constitute less than 30 percent of board membership. This is considered low in comparison with South Africa where 79 percent of companies listed on the JSE have above 50 percent and Kenya where all the companies studied have over 50 percent independent directors on boards. This suggests that boards in South Africa and Kenya are better able to carry out their functions effectively with a higher degree of independent thinking. In appointing independent board members, the company must look beyond selecting individuals principally on account of their having no formal relationship with the company. To ensure greater effectiveness, companies should seek individuals with objectivity in judgment regardless of any formal or informal relationships with the company’s stakeholders. Effort should be put into determining this at the point of nomination and selection to the board. In ensuring the board effectively carries out its functions as expected, there is a need for a clear division of the responsibilities of chairman and CEO. Whilst there are related roles such as the CEO’s involvement in strategy formulation and the chairman ensuring that the operations of the company are such as to minimize risks, a clear separation is necessary for good corporate governance. Furthermore, board committees are necessary for effective functioning of the board. There are statutory requirements in the codes of corporate governance in the three countries studied that require specific committees. Nevertheless, this does not preclude boards from instituting additional committees as deemed fit to ensure that issues within specific areas are suitably discussed in depth and proposals made on these to the full board for approval. The specific codes of corporate governance appear robust and have requirements to ensure good corporate governance. Nevertheless, companies may go beyond these requirements in order to ensure that care is taken and adequate attention given in composing boards to ensure continuity, enhanced company performance, and effective corporate governance.

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Future Research Given the indications revealed by this study, it may be necessary for further research to be carried out on specific effects of gender diversity on company performance in the regions covered, Nigeria, South Africa, and Kenya. Considering the fact that corporate governance principles, codes and practices in these countries differ slightly, future studies could be carried out to identify how the prevailing corporate governance principles in each region affects board performance and financial performance.

Note 1. The Cadbury Report (1992), titled “The Financial Aspect of Corporate Governance” and published in December 1992 by the Sir Adrian Cadbury Committee on the Financial Aspect of Corporate Governance in the UK, made recommendations on the composition of company boards, accounting and auditing processes/systems and disclosures.

References Abdullah, S. N., Ismail, K. N. I. K., & Nachum, L. (2016). Does having women on boards create value? The impact of societal perceptions and corporate governance in emerging markets. Strategic Management Journal, 37(3), 466–476. Ajogwu, F. (2009). The role of the chairman of the board. Journal of Corporate Governance, 1(1), 1–66. Ararat, M., Aksu, M. H., & Tansel Cetin, A. (2010). The impact of board diversity on boards’ monitoring intensity and firm performance: Evidence from the Istanbul Stock Exchange. Retreived from https://papers.ssrn.com/sol3/papers. cfm?abstract_id=1572283 Ararat, M., Aksu, M., & Tansel Cetin, A. (2015). How board diversity affects firm performance in emerging markets: Evidence on channels in controlled firms. Corporate Governance: An International Review, 23(2), 83–103. Baysinger, B. D., & Butler, H. N. (1985). Corporate governance and the board of directors: Performance effects of changes in board composition. Journal of Law, Economics, & Organization, 1(1), 101–124. Buchwald, Achim; Hottenrott, Hanna (2015) : Women on the board and executive duration: Evidence for European listed firms, DICE Discussion Paper, No. 178, ISBN 978-3-86304-177-9, Düsseldorf Institute for Competition Economics (DICE), Düsseldorf Campbell, K., & Mínguez-Vera, A. (2008). Gender diversity in the boardroom and firm financial performance. Journal of Business Ethics, 83(3), 435–451. Capital Markets Authority. (2015). The Code of Corporate Governance Practices for the Issuers of Securities to the Public. Kenya. Carter, D. A., Simkins, B. J., & Simpson, W. G. (2003). Corporate governance, board diversity, and firm value. Financial Review, 38(1), 33–53. Central Bank of Nigeria. (2006). Code of Corporate Governance for Banks in Nigeria Post Consolidation (Effective Date: April 3, 2006).

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Central Bank of Nigeria. (2014). Code of Corporate Governance for Banks and Discount Houses in Nigeria and Guidelines for Whistle Blowing in the Nigerian Banking Industry. Central Bank of Nigeria (2012). Nigerian Sustainable Banking Principle (NSBP). Abuja, Nigeria: Central Bank of Nigeria. Chughtai, A. R., Naseer, A., & Hassan, A. (2017). Relationship between Code of Corporate Governance and corporate financial performance (An empirical study of food companies listed on KSE). International Journal of Financial Management, 7(1). Coffey, B. S., & Wang, J. (1998). Board diversity and managerial control as predictors of corporate social performance. Journal of Business Ethics, 17(14), 1595–1603. The Committee on the Financial Aspects of Corporate Governance. (1992). The Financial Aspect of Corporate Governance (Cadbury Report). London. Companies and Allied Matters Act. (1990). Nigeria: Enacted by the Federal Republic of Nigeria. Concannon, M., & Nordberg, D. (2018). Boards strategizing in liminal spaces: Process and practice, formal and informal. European Management Journal, 36(1), 71-82. Corten, M., Steijvers, T., & Lybaert, N. (2017). The effect of intrafamily agency conflicts on audit demand in private family firms: The moderating role of the board of directors. Journal of Family Business Strategy, 8(1), 13–28. Dang, R., & Vo, L. C. (2012). Women on corporate boards of directors: Theories, facts and analysis. In Board directors and corporate social responsibility (pp. 3–21). Palgrave Macmillan, London. Donaldson, L., & Davis, J. H. (1991). Stewardship theory or agency theory: CEO governance and shareholder returns. Australian Journal of Management, 16(1), 49–64. Du Plessis, J. J., Saenger, I., & Foster, R. (2012). Board diversity or gender diversity: Perspectives from Europe, Australia and South Africa. Deakin Law Review, 17, 207. Erhardt, N. L., Werbel, J. D., & Shrader, C. B. (2003). Board of director diversity and firm financial performance. Corporate Governance: An International Review, 11(2), 102–111. Garg, S., & Eisenhardt, K. M. (2017). Unpacking the CEO-Board relationship: How strategy making happens in entrepreneurial firms. Academy of Management Journal, 60(5), 1828–1858. Gupta, M. A., Hothi, B. S., & Gupta, S. L. (2011). Corporate: Independent directors in the board. Global Journal of Management and Business Research, 11(1). Hermalin, B. E., & Weisbach, M. S. (2003). Boards of directors as an endogenously determined institution: A survey of the economic literature. Economic Policy Review, 9, 7-26. Houle, C. O. (1990). Who should be on your board? Nonprofit World, 8, 33–35. Ingley, C. B., & Van der Walt, N. T. (2001). The strategic board: The changing role of directors in developing and maintaining corporate capability. Corporate Governance: An International Review, 9(3), 174–185. The Institute of Directors in South Africa. (2009). King Code of Governance Principles for South Africa (King III). South Africa. The Institute of Directors in South Africa. (2016). King Code of Governance Principles for South Africa (King IV). South Africa.

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John, K., & Senbet, L. W. (1998). Corporate governance and board effectiveness. Journal of Banking & Finance, 22(4), 371–403. Jonnergård, K., Kärreman, M., & Svensson, C. (1997). Opening up the black box: Lines of reasoning in the work of corporate boards, Working Paper Series 1997/1. Institute of Economic Research, Lund. Kang, H., Cheng, M., & Gray, S. J. (2007). Corporate governance and board composition: Diversity and independence of Australian boards. Corporate Governance: An International Review, 15(2), 194–207. The Kenya, the Code of Corporate Governance Practices for Issuers of Securities to the Public. (2015). Kesner, I. F., & Dalton, D. R. (1986). Boards of directors and the checks and (im) balances of corporate governance. Business Horizons, 29(5), 17–23. Levrau, A., & Van den Berghe, L. (2009). Identifying key determinants of effective boards of directors. In Global Boards (pp. 9–44). Palgrave Macmillan, London. Maassen, G. F. (1999). An international comparison of corporate governance models: A study on the formal independence and convergence of one-tier and two-tier corporate boards of directors in the United States of America, the United Kingdom and the Netherlands (No. 31). Amsterdam: Spencer Stuart Amsterdam. Muth, M., & Donaldson, L. (1998). Stewardship theory and board structure: A contingency approach. Corporate Governance: An International Review, 6(1), 5–28. Nicholson, G. J., & Kiel, G. C. (2004). A framework for diagnosing board effectiveness. Corporate Governance: An International Review, 12(4), 442–460. Ogbechie, C. I. (2012). Key determinants of effective board of directors-evidence from Nigeria. Brunel University, Brunel Business School, PhD Thesis. PWC. (2017). Executive Directors’ Remuneration: Practices and Trends Report. June. Randøy, T., Thomsen, S., & Oxelheim, L. (2006). A Nordic perspective on corporate board diversity. Age, 390(0.5428). Securities and Exchange Commission. (2014). Code of Corporate Governance for Public Companies in Nigeria. Selvaraj, P. C. (2015). The effects of work force diversity on employee performance in Singapore organisations. International Journal of Business Administration, 6(2), 17. Singh, D., & Kumar, V. (2017). Types of directors and other managerial personnel in a company. Retrieved from https://dx.doi.org/10.2139/ssrn.2972430 Suisse, C. (2012). Gender diversity and corporate performance. Credit Suisse Research Institute. Retrieved from https://publications.credit-suisse.com/tasks/ render/file/index.cfm?fileid=88EC32A9-83E8-EB92-9D5A40FF69E66808 Terjesen, S., Couto, E. B., & Francisco, P. M. (2016). Does the presence of independent and female directors impact firm performance? A multi-country study of board diversity. Journal of Management & Governance, 20(3), 447–483. Wellner, A. (2000). How do you spell diversity? Training, 37(4). World Economic Forum. (2017). The Future of Jobs and Skills in Africa, Preparing the Region for the Fourth Industrial Revolution. Retrieved from http:// www3.weforum.org/docs/WEF_EGW_FOJ_Africa.pdf Zahra, S. A., & Pearce, J. A. (1989). Boards of directors and corporate financial performance: A review and integrative model. Journal of Management, 15(2), 291–334.

21 Shareholders and Institutional Investment Kalu Ojah and Chris van der Hoven

Introduction Agency problems, as a feature of publicly traded firms, will remain an important concern for scholars and policymakers so long as we continue to organize production in the “corporation” legal form of business. Similarly, efforts at mitigating the attendant problems of the principal-agent relationship will also remain a preoccupation (Manne, 1965; Jensen & Meckling, 1976; Berle & Means, 1991).1 And it is for these efforts that “corporate governance” exists.2 Among others, La Porta et al. (2000), Denis (2001), Estrin and Revezer (2011), and most recently Ngwu et al. (2017), have examined the nature, evolution and context of corporate governance. And what is prominently commonplace in these diversely motivated works is the need to achieve corporate governance effectiveness in support of efficient production notwithstanding what form it takes, e.g. mandated versus voluntary disclosure (Frankel et al., 1995; Klein, 1998; Ho & Wong, 2001), dominant model type (Ojah & Mokoaleli-Mokoteli, 2012; Ojah & GodspowerAkpomiemie, 2017), board composition (Donaldson & Davis, 1994; Rediker & Seth, 1995; Ho et al., 2012), board effectiveness (John & Senbet, 1998), and so on. The focus of this book, which also subsumes that of this chapter, sits within the intersection of board effectiveness and a distinct and evolving emerging economy corporate governance context. To ascertain the extent to which board effectiveness can be fruitful in emerging economies, one has to, among other factors, consider the business ownership pattern in these countries. By that we mean the extent of individual shareholders’ ownership stake in corporations vis-à-vis the ownership stake of institutional investors.3 Incidentally, as contractual savings such as pension funds, retirement accounts, and insurance activity, grow in popularity in a given country, such a country experiences a shift in ownership pattern in favor of institutional investors (Emerson, 1955; Oyarzún, 2011; Bebchuk et al., 2017).4 While we naturally highlight why such shift in ownership patterns takes place, the overarching questions of this chapter are: (1) How does

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such a shift enhance corporate governance in general and particularly via board constitution and/or effectiveness? (2) Is such institutional investor oriented “board effectiveness” equally achievable in emerging economies, especially in light of the relatively less efficient institutional infrastructures and/or dominance of culture-based informal arrangements of these economies vis-à-vis those of advanced economies? (3) And are there ways to strengthen the corporate governance usefulness of institutional investment in the emerging market context than is inherent in the institutional investment ownership slant? The remainder of the chapter unfolds along the lines of attempts at answering these key questions, and concludes with a summary of useful lessons for ownership mix-based enhancement of board effectiveness in emerging economies.

Evolution of Ownership Mix Between Individual and Institutional Investors As far back as the 1950s, research showed that institutional investors (by way of investment companies, insurance companies, pension funds, and similar block-holders of firms) are parts of the largest holders of ownership shares in the US (Emerson, 1955). Institutional investors held 471 million ownership shares then, accounting for 13 percent of total common shares in the US in 1951, 24.2 percent by 1980, 50 percent in 1994, and now about 63 percent (Bebchuk et al., 2017), with this steady increment attributed to growth of pension assets (Sias & Starks, 1998). Similarly, due to the rise of institutional investors, shareholding by individuals in the UK has decreased over the last 30 years, while ownership by institutional investors has relatively increased (Oyarzún, 2011). This rise of institutional investors is traceable to investors’ recognition of the value of low-cost diversification, institutions’ wealth management sophistication,5 and favorable regulatory treatments of institutional investment (Bebchuk et al., 2017). For example, institutional investors in the US are eligible to purchase privately placed financial security issues as accredited investors under Rule 506 of Regulation D. They also have rights to purchase certain securities unavailable to individual investors.6 The rise of institutional investors has, in fact, transformed the corporate governance landscapes of modern corporations. With large proportion of shares held by institutional investors, individual shareholders who are less equipped to engage managers, now have a voice via institutional investors. However, remnants of agency problems between these institutions and individuals that they represent still impede realization of full benefits from high shareholdings by institutional investors (Bebchuk et al., 2017). Although institutional investors have not played as prominent a role in emerging economies as they demonstrably have played in advanced economies, some emerging economies have witnessed growth of pension funds, which are classic institutional investors. Pension funds reform has

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begun to impact the pattern of ownership of publicly held firms, as well as the capital markets in some emerging economies (Acuña & Iglesias, 2001; Gillan & Starks, 2003). For instance, in Chile, domestic pension funds have become a major source of debt financing to publicly held firms. Pension funds grew from approximately 0 percent in the 1980s to 60 percent of GDP as at 2002, accounting for 65 percent of government debt holdings, 12 percent of time deposits and bank bonds, 56 percent of mortgage bonds, 40 percent of corporate bonds, and 7 percent of outstanding equity market capitalization (Walker & Lefort, 2002). Based on the foregoing review, there is a marked shift globally in the ownership pattern of corporations from the dominance of individual shareholders to the importance of institutional investors. Figure 21.1 illustrates this clear trend graphically. Note that because of the paucity of data on ownership patterns in emerging economies, growth of pension fund investments is used as proxy for the evolving relative importance of institutional investments in emerging economies. As is evident from the figure, this evolving ownership pattern is similar across countries of differing income/development levels. Corporate Governance Importance of Institutional Investors Versus Individual Shareholders Is holding wealth in firms’ assets independently as an individual shareholder a more effective way of ensuring wealth enhancement than holding wealth collectively with like-minded investors via institutional investment? Shareholders have certain rights in their firm, including the right to vote for the board of directors, whose responsibilities, in turn, include monitoring and evaluating mangers’ performance. Should shareholders be displeased with their firm’s performance, they have three kinds of recourse: sell off their holdings in the firm; voice out their dissatisfaction while holding their shares; or hold their shares and do nothing (Gillan & Starks, 2003). The question that therefore follows is: what motivates investors to engage in monitoring managers? Firms with a large number of atomistic dispersed shareholders are characterized by high levels of agency problems between shareholders and managers (Roe, 1990). In such a structure, there is no incentive for one owner to monitor corporate managers, because that shareholder would bear the entire monitoring cost, while the other shareholders benefit freely from it. Thus, agency problems are directly related to the ownership structure of firms, and they are less in economies where ownership patterns favor institutional investors (especially block-holding foreign investors). In fact, it has long been observed that agency problems are reduced when institutional investors are involved in monitoring firms (Shleifer &

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A. Pension Fund as % of GDP in some Emerging Markets Bolivia Chile

70%

Colombia El Salvador

Costa Rica Mexico

60%

% of GDP

50%

40%

30%

20%

10%

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

0%

B. Growth of Instititonal Investors in United States 70% 63%

60% 50%

50% 40% 30% 24%

20% 10%

13%

0% 1951

1980

1994

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Figure 21.1 Trends of Ownership Patterns and Pension Fund Growth across Countries Source: Authors’ compilation.

Vishny, 1986; Admati et al., 1994; Maug, 1998; Noe, 2002). Institutional investors also have additional incentives to monitor managers because they earn management fees and performance bonuses, which are substantial relative to the value of ownership shares, were they to be held independently by individual investors. In line with the monitoring role of institutional investors, Agrawal and Mandelker (1990) find that firms with higher institutional ownership

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have larger stock price reactions to take-over news. Brickley et al. (1988), however, argue that the incentive to monitor and its effectiveness depend on the community of institutional investors. Grouping institutional investors into “pressure-sensitive” (e.g. banks and insurance firms) and “pressureinsensitive” (e.g. pension and mutual funds) they find that “pressure sensitive” investors may hold back from effectively monitoring managers, because they may have business interests in the firm which they are afraid to endanger. Further, lending institutions may have a comparative advantage in monitoring due to their access to insider information and superior intermediation capabilities relative to arm’s-length lenders (Fama, 1985), but this advantage applies differently across countries with different governance models. While regulations prohibit US banks from holding shares in firms, Japanese banks hold firms’ shares, including those to which they provide credits (Gillan & Starks, 2003), and this is because the US operates under a shareholder-based governance model while Japan operates under a stakeholder-based model. However, because banks’ loan positions are far larger than their equity positions in firms, they also hold ownership stakes; it is unclear whether their insider position is used entirely for shareholders’ interests or in a self-serving manner (Morck & Nakamura, 1999). Van Nuys (1993) examined shareholders’ voting patterns in Honeywell Inc during a proxy fight and found that banks and insurance firms support management decisions more than other institutional investors. Moreover, Payne et al. (1996) found that when income and directorrelated relationships exist [do not exist] between institutional investors (mostly banks) and firms, banks tend to vote in favor of [against] management decisions. To sum up, there are conditional corporate governance benefits from the involvement of institutional investors in board roles, and these benefits seem quite nuanced and largely studied in the context of advanced economies. Therefore, given what we know and the kinds of institutions involved, how are these relationships likely to pan out in the emerging economy space? Shareholder Activism via Institutional Investment Shareholder activism has evolved to become an important part of corporate governance, and thus attracted increased research attention, especially in terms of institutional investor activism (Gillan & Starks, 2000; Hadani et al., 2011; Prevost et al., 2016; Denes et al., 2017). Its essence is to identify poorly performing firms and pressurize their management team to improve performance and the attendant shareholder value. As institutional investment has increased, the institutional investors’ role has also evolved from that of just being part-owners of firms to involvement

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in corporate governance matters by, for example, making specific performance demands of boards of directors. Corporate governance debates have stressed the need for institutional investors’ participation, especially as members of boards and strategic exercising of voting rights. In the UK and US, reports/committees, e.g. the Cadbury Committee,7 have not only lauded the activist role of institutions’ in enhancing board effectiveness but have also advocated that they take on greater roles in improving the quality of corporate governance (Cadbury, 1992). In turn, institutional investors’ expert investing (allocation) of pooled funds from vast array of investors has impacted the economy by enhancing firm productivity and economic growth in the UK (Myners, 2001). For example, institutional investors in the UK have formed the Institutional Shareholders Committee (ISC) to evolve guidelines to enable its members to monitor their firms and advise them productively (Oyarzún, 2011). Some proponents of shareholder activism posit that increased activism elicits a number of positive influences in target firms (Gillan & Starks, 2000). For instance, Prevost et al. (2016) confirm that activism increases stock price informativeness and thus, reduces information asymmetry between diverse kinds of investors/stakeholders of the firm. Given that the increase in institutional investors’ equity holding is significantly attributable to increases in pension assets, some opponents of institutional activism (Murphy & Van Nuys, 1994; Monks, 1997) argue that pension funds managers may not be interested in advising managers of firms, and view activism as a distraction from their asset management function. Contrarily, Hadani et al. (2011) show that while activism of individual shareholders induces managers to deploy earnings management, institutional activism is negatively related to earnings management. Moreover, Denes et al. (2017) document that activism in recent years, led largely by institutions, is more positively associated with share value than that of the 1980s to 1990s. There are, arguably, some differences between management of firms in the UK and US, versus those of firms in emerging economies (e.g. China, India and Korea). Firms in the UK and US are mostly run by professional managers, who may not have direct ownership interest in the firms. In China, India and Korea, families and government appointees manage corporations, which are known to engender weak corporate governance. Consequently, the potential role of institutions in boards of emerging market firms appear quite critical, and primarily because of what Young et al. (2008) term “principal-principal agency complications in emerging economies” vis-à-vis the often studied principal-agent relations that are prevalent in advanced economies (see the next section for elaboration). Based on the above review, we surmise that shareholder activism exists predominantly in developed countries, e.g. the US and UK, where established, elaborate shareholders’ committees coordinate serious activism

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in the interest of all shareholders. Institutions are thus able to exercise their important ownership rights. And with such a collective voice, activism in turn contributes to firm value enhancement and overall welfare of countries. From the emerging market perspective, there seems to be only limited institutional activism where, for instance, in India, there is still contestation about the wisdom of appointing institutional investors as important as banks, to boards of firms to which they have extended credit (Patil, 2001). Importantly, there is the pervasive dominance of control rights by family groups or government owners of corporations at the expense of minority interests, especially in circumstances where informal arrangements appear to supplant weak formal institutional infrastructures (Claessens et al., 2000; Peng, 2004; Young et al., 2008; Wright et al., 2005; Gwatidzo & Ojah, 2014; Mthanti & Ojah, 2017).

Institutional Environment and Board Effectiveness The literature has amply documented that the institutional environment of a country determines the dominant corporate governance architecture firms under which the country operates with this reality further complicated by a lack of or weakness of institutional infrastructures in emerging economies vis-à-vis advanced economies (Young et al., 2004, 2008; Estrin & Revezer, 2010; Mthanti & Ojah, 2017; Ngwu et al., 2017; Dato et al., 2018). Therefore, the resultant corporate governance landscapes prevalent in emerging economies do not lend themselves to the prototypical principal-agent articulation as the basis of corporate governance problems, and many of the almost standard mechanisms for resolving agency problems in a principal-agent context, such as boards and markets for corporate control, may be ineffectual in emerging economies. Per Ngwu et al.’s (2017) exposition of how institutional environments influence prevailing governance models in emerging economies, the inadequacy of relevant formal institutions affect the efficacy of what little presence of corporate governance that exists (Spisto, 2002; Judge et al., 2008; Steier, 2009; Chen et al., 2010; Mthanti & Ojah, 2017; Ojah & Godspower-Akpomiemie, 2017). For example Ojah & GodspowerAkpomiemie mapped emerging economies’ governance types on a continuum of global corporate governance forms with two prototypical types at each end and argued that the “market for corporate control” could be productively deployed in these economies as well to extract effective governance benefits, but only if a requisite “highly independent and effective organized financial markets” is first put in place. Importantly, the key reason for which Ojah and Godspower-Akpomiemie point out this proviso is elaborately detailed by Young et al. (2008) around corporate governance conditions they dub the “principal-principal perspective”. Young and company describe the principal-principal agency conflicts to be between controlling shareholders8 and minority shareholders, and

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that is traceable to the prevalence of concentrated ownership (Filatotchev et al., 2001; Zahra & Filatotchev, 2004), extensive family ownership and control (Schulze et al., 2003; Filatotchev et al., 2005), business group structures (Chang, 2003; Chung, 2006; Muristama, 2006), state ownership (Filatotchev et al., 2001; Ho et al., 2012), and glaringly weak legal protection of minority shareholders (Hoskisson et al., 2000; La Porta et al., 2000; Reese & Weisbach, 2002). More tellingly, Mthanti and Ojah (2017) provide an exposition of a complicated corporate governance outcome in an emerging economy that is widely acclaimed to boast financial markets and other institutional infrastructures comparable to those of advanced economies, i.e. South Africa; yet they conclude that interaction of informal institutions with a fully visible formal institution, curiously perverts the expected benefits of governance resolutions tailor-made for the principal-agent context. They attribute this outcome mainly to the government’s lack of appreciation for the fact that the South African economy is starkly bifurcated into advanced and developing economies, a reality that requires a yet-to-beevolved appropriately corrective and overtly inclusive corporate governance model. From the foregoing, it is clear, as Young et al. (2008) note, that these kinds of peculiar emerging economy-oriented agency complications “alter the dynamics of corporate governance processes and, in turn, require different agency-resolution arrangements”.9 In the following concluding section, we attempt to point to such workable arrangements for the emerging economy context.

Possible Ways Forward Based on these highlighted problems that impede effectiveness of corporate governance broadly, and of boards specifically, in the emerging economy context, it seems apparent that relevant solutions must have at their core: (1) recognition of the need to counter-balance the value-decreasing and/or unproductive dominance of owner-manager (control interests) over minority interests in board influence in the principal-principal (p-p) conflict, and (2) the need for proactive internally originated trust to counter lack of it in an internal mechanism, which in the course of making up for inadequacies of external governance reinforcing mechanisms (of formal institutions), subsists on control via concentration and its attendant self-interestedness (Young et al., 2008; Chen & Young, 2010). These critical bases for possible effective resolution of the p-p problem suggest that sensible solutions most likely emerge from undoing unintended consequences of internal mechanisms considered “formal institutions weakness augmenting”, such as ownership concentration. One such creative possibility is inspired by the leveraging of insights from the institutional investor role in the principal-agent context (a la Cadbury,

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1992; Oyarzún, 2011; and much of the second section of this chapter). We suggest that a coalition of otherwise minority interests across a country, which when combined constitute competitive holdings of 10 to 20 percent of individual firms under an “association of institutional investors”, would provide a credible counter-balance to owner-managers’ usually high holdings of 10 to 50 percent in individual firms in emerging economies, where they as a result of such high holdings dominate company boards and associated board decisions (Fried et al., 1998; Young et al., 2008; Dato et al., 2018). Not only would this kind of “virtual significant institutional investor” garner similar benefits that are characteristics of institutional investors in a principal-agent context, but the common cause of protecting their collective ownership interests will also galvanize and motivate “the coalition” as one that truly has “skin in the game”. Importantly, this kind of endogenously originated solution, appears to us to be more practicable and likely to be more readily received by owner-managers than the kind of exogenously oriented two-tier board (stakeholder model) recommendation of Spisto (2002), which would require that owner-managers accommodate sharing their “earned control rights” with “outside and less legitimate monitors” such as civil society representatives. For this reason, the coalition solution would be amenable to emerging economies with common law legal origin, whose evolving national corporate governance model tilts towards the market-based governance model, such as South Africa and India (Ojah & Godspower-Akpomiemie, 2017). Along similar lines as the coalition idea, meaningful holdings (of 5 to 10 percent) by foreign investors from shores characterized by effective corporate governance practices and/or the listing of emerging market corporations across national borders (in shores also characterized by effective corporate governance practices), are said and documented, to foster high-level corporate governance discipline akin to a combination of both internal and external governance reinforcing mechanisms (Reese & Weisbach, 2002; Young et al., 2008; Chen & Young, 2010). Even when such cross-border importation of corporate governance best practice has taken place intra-regionally, anecdotal evidence appears to support its efficacy, as in the case of “good corporate governance seeking Nigerian corporations” admiring and copying good corporate governance practices of MTN-Nigeria (a South African import), especially in respect of the caliber of persons appointed to boards and the matching of such appointees’ skills to appropriate board committees. Turning to a potential solution that addresses the “trust issue” in the p-p conflicts, the owner-managers must proactively play a “bonding role”. This goal can be pursued by reserving critical board committee roles (e.g. audit, remuneration, and financing committees) for minority shareholders (Fried et al., 1998; Klein, 1998, 2002; Dato et al., 2018). This solution, which should originate proactively from owner-managers who seek

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to check and minimize the unintended consequences of a governance mechanism evolved to mitigate lack of or inadequacies of formal institutions in the emerging market space (ownership concentration), is best suited to economies characterized by relationship-based national governance models, with weakly independent financial markets such as Russia, Turkey, and the Philippines. And as Filatotchev et al. (2005) and Young et al. (2008) note, this kind of internally originated bonding mechanism has been deployed by some East Asian (e.g. Taiwanese) firms that are particularly seeking to transcend the “threshold enterprise stage”10 of public enterprise evolution onto truly large, publicly held firms, capable of being trusted as independent that can be ran by professional managers. Responding to the kind of “twisted” p-p outcome highlighted by Mthanti and Ojah (2017) and Spisto (2002), Spisto recommends a two-tier board solution for a “new” South Africa. The idea is that a stakeholder-based governance model would accommodate boards that include shareholders’ representatives and those of stakeholders such as employees, civil society, governments, and so on. This resolution holds some promise for an environment that boasts relatively independent financial markets, but because of pervasiveness of racial fractionalization (a sad legacy of apartheid); boards that are independently selected by white-dominated shareholders still protect white interests primarily resulting in untransformed production ownership. In such a situation, an exogenous nonmarket resolution seems sensible.

Concluding Remarks In this chapter, we set out to examine how the relation between shareholders and institutional investment could be harnessed to strengthen board effectiveness as an expression of effective corporate governance, especially in the emerging economy context. To that effect, we noted the global evolution of corporate ownership patterns from individual shareholder dominance to the increasing importance of institutional holdings. In the process, we highlighted the economics of institutional investment versus those of individual ownership, including the incredibly effective governance impacts of institutional shareholder activism and its attendant enhanced productivity and economic growth effects. Importantly, we noted how these recorded gains have occurred largely in advanced economies under a principal-agent context of corporate governance architecture, and particularly flag how stark differences between institutional infrastructures of advanced and emerging economies means that it would be erroneous for us to rely on the almost standard corporate governance mechanisms tailored for the principal-agent context for the principal-principal agency context of emerging economies. By carefully delineating the reasons for the agency context prevalent in emerging economies, we are able to proffer reasonable solutions that are

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underpinned by efforts at counter-balancing the effects of concentration on boards of firms and attempts at bridging the trust deficit (gap) between controlling owner-managers and minority interests. Guided by these flagged preconditions, we are confident that a few other agencyresolution ideas for the emerging economy context are possible.

Notes 1. Agency problems arise when corporation managers, take decisions deemed not to be in shareholders’ best interest. 2. “One can view corporate governance as a set of guiding rules and principles that enables managers to conduct the affairs of corporations in ways that ensure the primacy of owners’ interest and overall objectives of the firm, without harm to the economic community within which the firm operates” (Ojah & Godspower-Akpomiemie, 2017). 3. The pooling of various individual investors, depending on common reasons for holding wealth in ownership claims and/or debt obligations of distributed firms, constitutes institutional investment. E.g., individuals who seek ownership in a diversified set of financial assets for some return, but cannot afford to buy the constituent assets that would yield that level of return because of high unit prices of those assets, traditionally accomplish their objective by purchasing “mutual fund shares” which are typically priced affordably in small units (denomination intermediation) that entitle holders to pro-rata ownership in the pooled investment. Other examples of institutional investor are pension funds, hedge funds and insurance firms. 4. Such a shift in ownership pattern has been amply argued and shown to be a reflection of incremental advantages traceable to participation of institutional investors in firms they hold significant ownership stake. 5. Institutional investors are said to be sophisticated due to their rich knowledge and experience in business and investment matters, with the ability to evaluate risks, costs and benefits of prospective financial assets. 6. www.sec.gov/fast-answers/answers-regdhtm.html 7. The Cadbury Report was produced in 1992 in response to several business failures in the UK. The main aim of the report was to restore investor confidence and, as much as is possible, forestall corporate failures (Cadbury, 1992). 8. In whatever form controlling owners manifest, they tend to expropriate the wealth of minority interests by: employing unqualified family and friends in important positions, yielding suboptimal outcomes; through transfer pricing; lowering expenditure for innovation as to keep cash flow rights of controlling interests high, etc. (Young et al., 2008). 9. At this juncture, it is important to note that effective corporate governance is an ensemble of reinforcing sets of internal mechanisms (chiefly represented by boards) and external ones (reflected by markets for corporate control, strong property rights and credible courts, and effective independent financial markets). 10. The “threshold stage” of enterprise evolution is that trust hurdle which a family-, business group- or government-dominated publicly held firm must jump in order to assure minority shareholders that their interests will no longer be subordinated to owner-managers’ whim or have owner-managers continue to expropriate minority shareholders’ rights with impunity, especially in an environment devoid of markets for corporate control (Chang, 2003; Zahra & Filatotchev, 2004; Young et al., 2008).

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References Acuña, R. and A. Iglesias. 2001. Chile’s pension reform after 20 years. World Bank Social Protection Discussion Paper (0129). Admati, A., P. Pfleiderer and J. Zechner. 1994. Large shareholder activism, risk sharing, and financial market equilibrium. Journal of Political Economy 102 (6): 1097–1130. Agrawal, A. and G. Mandelker. 1990. Large shareholders and the monitoring of managers: The case of antitakeover charter amendments. Journal of Financial and Quantitative Analysis 25 (2): 143–161. Bebchuk, L., A. Cohen and S. Hirst. 2017. The agency problems of institutional investors. Journal of Economic Perspectives 31 (3): 89–102. Berle, A. and G. Means. 1991. The modern corporation and private property. Transaction Publishers. New Brunswick: Taylor and Francis. Brickley, J., R. Lease and C. Smith. 1988. Ownership structure and voting on antitakeover amendments. Journal of Financial Economics 20: 267–291. Cadbury, A. 1992. Cadbury report: The financial aspects of corporate governance. Tech Report, HMG, London. Chang, S. 2003. Ownership structure, expropriation, and performance of groupaffiliated companies in Korea. Academy of Management Journal 46: 238–254. Chen, Y. and M. Young. 2010. Cross-border mergers and acquisitions by Chinese listed companies: A principal-principal perspective. Asia-Pacific Journal of Management 27 (3): 523–539. Chung, H. 2006. Managerial ties, control, and deregulation: And investigation of business groups entering the deregulated banking industry in Taiwan. AsiaPacific Journal of Management 23: 505–520. Claessens, S., S. Djankov and L. Lang. 2000. The separation of ownership and control in East Asian corporations. Journal of Financial Economics 58: 81–112. Dato, M., R. Mersland and N. Mori. 2018. Board committees and performance in microfinance institutions: Evidence from Ethiopia. International Journal of Emerging Markets 13 (2): 350–370. Denes, M. R., J. M. Karpoff and V. B. McWilliams. 2017. Thirty years of shareholder activism: A survey of empirical research. Journal of Corporate Finance 44: 405–424. Denis, D. 2001. Twenty-five years of corporate governance research .  .  . and counting. Review of Financial Economics 10: 191–212. Donaldson, L. and J. Davis. 1994. Boards and company performance-research challenges the conventional wisdom. Corporate Governance: An International Review 2 (3): 151–160. Emerson, F. 1955. Institutional and individual participation under the SEC’s shareholder proposal rule. Financial Analysts Journal 11 (5): 59–64. Estrin, S. and M. Revezer. 2010. A survey on institutions and new firm entry: How and why do entry rates differ in emerging markets? Economic Systems 34 (3): 289–308. Estrin, S. and M. Revezer. 2011. The role of informational institutions in corporate governance: Brazil, Russia, India and China. Asia-Pacific Journal of Management 54 (4): S105–S130. Fama, E. 1985. What’s different about banks? Journal of Monetary Economics 15 (1): 29–39.

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22 Board Effectiveness and Regulation Explaining the Deficit Gary Lynch-Wood and David Williamson

Introduction It is almost beyond question that in the present market economy firms have become highly influential and, in some cases, powerful political and social entities. Firms have become essential to the creation of wealth and employment opportunities (see Lodge and Wilson 2006). They provide important private and public goods and services, and they create a great many innovations and discoveries in important areas like technologies and medicine. This explains why policies that encourage and support a thriving private sector are important for improving lives and tackling deep issues, such as poverty and exclusion (see OECD 2006; DfID 2011; European Commission 2011). The significance and presence of the firm has recently been confirmed by the democratic social justice organization, Global Justice Now (formerly the World Development Movement), which reported that in 2015 some corporations had increased their wealth to such an extent that 69 of the world’s top economic entities were corporations, rather than countries.1 The world’s top ten firms, including household names such as Shell and Apple, had combined revenues of more than the 180 “poorest” countries combined in the list—a list including Indonesia, Colombia, Greece, South Africa, Iraq and Vietnam.2 Given this, it is hardly surprising that the activities, strategies, objectives and decisions of firms are a matter of importance to politicians, scholars, non-governmental organizations, and more. It is seen as important that firms act within an effective framework of rules that set out what is and is not appropriate and acceptable forms of behavior (Lynch-Wood and Williamson 2011). The regulatory framework designed to incentivise and regulate the decisions of firms is a matter of importance, and provides the context for this chapter. The chapter looks at issues around corporate governance and the Board of Directors (BoDs), and the regulatory framework that underpins this. We need to point out at this juncture, that we regard to BoD as the manifestation of the firm, although it obviously cannot control each and every action that the firm takes. When we use the term

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firm or board, we tend here to be referring to the same thing. Our particular context for exploring corporate governance is the UK. The UK framework comprises a complex network of mandatory laws, governance codes, and economic measures. It is, so to speak, a regulatory mix. The UK has a framework that is not only well-documented in areas of legislation, regulation and codes, but is one that is widely regarded as an effective model that has influenced other jurisdictions (Calkoen 2017; Grant Thornton 2017; FRC 2017; Arcot et al. 2010). That said, what seems less clear is whether the importance of the UK model is justified when gauged against the effectiveness of the BoDs and corporate decision-making. This is an important and on-going matter, particularly when we observe examples of irresponsible behavior in business, as recently exemplified by the failure of BHS and employee issues at Sports Direct (see Gordon 2016). How is the regulatory framework performing, and how effective is it, when we witness problems such as accounting irregularities and inflated profits at the supermarket giant, Tesco, the charging of its (former) executives, and the firm’s subsequent announcement of “an extensive programme of change”?3 And why is it, if our corporate governance framework is a model of good practice, that evidence suggests not all UK businesses meet their corporate governance requirements?4 In trying to unpack these issues, this brief chapter looks at the effectiveness of the regulatory framework for corporate governance. Its main focus is the UK Corporate Governance Code. The code is a self-regulatory mechanism that has become a core feature of a mix of regulatory tools, and it is seen as contributing to this mix due to its design around notions of flexibility and risk management. The chapter explores why “compliance” with the code, though improving, is less than complete. While there have been other analyses of the reasons for corporate governance weaknesses (see Lipman and Lorsch 1992; Arcot et al. 2010), and there are alternative theories that can explain governance problems (e.g. agency theory, see Daily et al. 2003; Donaldson and Davis 1991; Clarke 2004), we adopt an alternative and novel view by arguing that it is differences across “situated firms” that shape responses to regulation, including selfregulation and codes. These differences explain corporate governance weaknesses. Associated with this, the chapter goes on to consider how regulation functions on the basis of regulatee “conditions”, and suggests that the presence or absence of these conditions will either support or undermine the effectiveness of particular regulatory tools and initiatives. This provides the basis for understanding how and why the governance code will or will not work, and might indicate ways of improving its performance. The chapter helps us to appreciate why there is a regulation deficit, and what we may need to do to close it. While the chapter adopts a largely Western, market economy viewpoint, it offers some comments on how the issues raised might be equally relevant for other jurisdictions.

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The chapter begins by outlining the nature of BoDs. It then explains in broad terms the overall regulatory framework, but looks in a little more detail at the governance code. The chapter then looks at organizational differences, and the way differences shape how firms respond to regulation. It ends with some comments on why the governance code might be underperforming and on what this might mean more broadly.

The Board of Directors To start, and for a proper context, it is worth considering briefly what we mean by a BoDs and outlining why the BoDs is important. A BoDs, in simple terms, is a group of individuals who are elected by the firm’s owners (stockholders or shareholders) to take care of firm and ensure that the managers act in the firm’s best interests. The directors are critical to the firm’s running, and thus have a fiduciary duty, deriving from a relationship involving the utmost trust and confidence, to the shareholders. The BoDs has overall responsibility for making critical decisions affecting the firm, and for settling on the firm’s longer-term strategy and objectives so that, at least in theory, it serves the best interests of its owners (e.g., stakeholders) primarily and, to a lesser extent, other stakeholders (e.g. customers, suppliers, those providing long-term finance, communities). The BoDs is charged with assessing the performance of management. It is the BoDs that makes important decisions on matters relating to acquisitions and sales as well as executive compensation packages. In endorsing the importance of the BoDs, the Financial Reporting Council (FRC 2016: 7), the body responsible for ensuring high standards of corporate governance, says the role of the BoDs is to: “provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed”. It is important to recognize that although specific members of the BoDs might not be involved in the daily business of firms, it is the entire Board that is liable for the consequences of the actions or omissions of the firm. This is the doctrine of collective responsibility. Our context for this chapter is those firms, such as with very large PLCs, where directors tend to be separated from ownership (i.e. directors are not the major owners of the firm). The typical situation we are referring to is where directors are elected by the subscribers or stockholders to preside over the firm, and watch over the stockholders’ interests. Important and fascinating though it is, and a subject that is in need of further analysis, our concern is not with those situations where the directors of the firm may also be the owners, as is typically the case with very small (e.g. micro) firms. As indicated previously, the BoD does not operate with impunity. It is subject to a complex legal and regulatory framework. Its powers, duties

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and responsibilities are not only determined by its own structure, constitution and by-laws, but also by the regulatory framework that comprises legislation, the common law, and codes of practice. We will now consider briefly what this framework entails.

The Regulatory Framework: An Overview If the overall purpose of the BoDs is to look at after the interests of the firm and to ensure that management acts in the interests of shareholders, and if we accept that modern corporations are powerful and influential entities, then it is not difficult to see why the activities of the BoD goes to the heart of corporate governance and the way firms should perform. It is also not difficult to see why the governance of firms has become subject to an increasing range of external (e.g. regulatory) controls and influences. As mentioned previously, the UK regulatory framework, our focus here, is one that is regarded as robust. It is seen as a regime that businesses and investors are able to trust. Space prevents us from considering all components of the extensive system of provisions that shape how firms interact with their external world. We will briefly outline several important legislative provisions before providing an outline of the Corporate Governance Code. The UK statutory framework is complex. The most appropriate starting point is the Companies Act 2006, as amended. Indeed, no account of the responsibilities and obligations of directors would be complete without some consideration of the directors’ duties under this important statutory framework. The Companies Act, together with statutory instruments and supporting case law, establishes the basic framework through which companies are governed (Dewing and Russell 2004), and it sets out a number of important legal duties for directors. We should note that directors have long held duties towards the companies that they are tasked with overseeing. This has been an enduring feature of company law, but the duties were not always set out in statutory form. They evolved through the decisions of the courts, which in several landmark cases had held that directors, for example, had a duty to exercise skill and care or to avoid conflicts of interests. The current provisions, set out in the Companies Act 2006, are the outcome of an extensive process of reform that started towards the end of the 1990s. The initiative for reform derived from the government’s commitment to creating a legislative framework that, amongst other things, promoted and encouraged enterprise, investment and job creation. The resulting act is a lengthy and complex statute that stretches for around 700 pages, and which has 47 parts and around 1300 provisions. The directors’ duties are found in Part 10, Chapter 2. The statutory duties have not precisely codified the existing common law duties, and so they have altered the scope of the existing judicial principles. The Act thus introduced new aspects of

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the law on directors’ duties. The duties include, but are not limited to: the declaration of interests in a proposed transaction; acting within powers; promoting the company’s success; and exercising reasonable care, skill and diligence. Directors owe these duties to the firm. This means it is only the firm that can bring an action for breach of duty. Alongside directors’ duties under the Companies Act, it is important not to disregard several legislative provisions that regulate how firms interact with society and that are likely to shape, in some form, corporate decisionmaking and the decisions of directors. Of note is the Equality Act 2010, for example, which provides legal protection for people from discrimination in the workplace as well as in wider society. The area of corruption and bribery is another important area that has resonated in corporate boards and which has an impact on firms’ decisions. The Bribery Act 2010 came into force 2011. The act extends the crime of bribery to cover private sector transactions (see Engle 2010) and not just transactions that relate to public officials. There are several offenses (e.g. promising or giving a bribe), and if a firm is convicted the directors can be liable if it can be demonstrated that they in some way consented or connived. Another important measure is the Manslaughter and Corporate Homicide Act 2007. This landmark act meant firms could be found guilty of corporate manslaughter. For this to happen, it must be shown that there was a serious management failure leading to a gross breach of a duty of care. Finally, the Modern Slavery Act 2015 obligates firms that are of a particular size to disclose annually the actions taken to ensure there is no modern slavery either within their firms or their supply chains. Each of these Acts has potentially important implications for the decisions of firms. The Corporate Governance Code is one of the most important components of the regulatory framework. It was first established in 1992. In 1991, the Committee on the Financial Aspects of Corporate Governance was set up to consider issues and standards of financial reporting and accountability. This was prompted by events such as the Maxwell pensions scandal and the collapse of Polly Peck. The subsequent report, published in 1992, was known as the Cadbury Report, after the Committee Chair, Sir Adrian Cadbury. The report established a suite of principles that were incorporated into the Listing Rules for the London Stock Exchange.5 Under the listing rules, companies with a Premium Listing of equity shares in the UK must report in their annual report and accounts how they apply the Code. Perhaps most importantly, the report recommended a “comply or explain” model of governance. This approach was adopted. The “comply or explain” model has become the hallmark of the UK framework. The code has been amended on several occasions since its introduction, and the latest version was published recently in 2016.6 This version, which followed a consultation on changes needed to implement the EU Audit Regulation and Directive, applies to financial years commencing on or after 17 June 2016.7

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Thus, from a regulatory perspective, the code is a different approach to that found in the legislation. The code does not set out legislative rules. It specifies important principles—main principles and supporting principles—and provisions. These standards, which cover issues such as the relationship between the chairman and chief executive, the role of non-executive directors, nominations to the board, executive remuneration, risk and auditing, are principles that firms are expected to comply with. That said, since the code is not prescriptive or dogmatic, and since firms can choose how to comply, it is thought to have the advantage of flexibility. It is also thought to provide valuable insights into how firms propose to advance their governance performance, and is said to ensure that risk is managed effectively and appropriately. The control feature, so to speak, which is the heart of its regulatory function and effectiveness, is the disclosure feature of the code. It is a disclosure or information tool. It is important to note that the code requires firms to report to shareholders, and not regulators. It therefore allows an appraisal by those who own the firm to actually gauge whether the company’s governance is adequate or effective. Since companies are obliged to explain if they decide or fail to comply with any of the standards or provisions, they are thought to provide a comprehensive framework for safeguarding interests of the owners. Thus, the code, in many respects, presupposes a degree of shareholder activism. Shareholder activism presupposes that directors cannot be trusted (i.e. the agent-principal problem) and requires a willingness to engage in corporate governance matters as well as the resources to be able to engage in those matters. There are many ways of looking at the governance framework. We could, for instance, explore it from the perspective of legitimacy or stakeholder theory. Our concern is how the code functions as a regulatory tool. We need to better understand why, particularly given the stature of the firms targeted and the institutional weight underpinning the code, not all UK businesses meet their corporate governance requirements?8 In a 2017 report (FRC 2017), it was said that compliance was high and full compliance had risen from 57 to 62 percent in that year. Yet, importantly, it has also been stated that while compliance with the code generally increases annually, there were still firms, based on the quality of disclosures, that have not embraced the principles of good governance even when there seems to be compliance.9 Amongst other things, there is often minimal disclosure around how firms review the effectiveness of internal controls and there is problem with the use of “boilerplating” and generic disclosure. Why, then, is compliance questionable? What is it about the regulatory framework that means firms fail to fully comply or properly embrace what is required? It is our view that the regulatory framework, like any other regulatory framework, struggles to cope with organization

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differences. It is these differences, and what they mean for regulation, to which we now turn.

The “Situated” Firm and Differences One of the central features of our claim, regarding the weaknesses of the current regulatory framework, is that firms differ. This is based on the important view that rule-following is learned in the act of living our lives. Bourdieu (1984), for example, argues that “knowledge” is a practical ability embodied in skilful behavior. Social codes are therefore acquired as part of a taken-for-granted background to everyday life. Regularities of behavior as manifested in gang crime or religious devotion, for instance, can be explained in terms of their respective codes of masculinity and deliverance. This behavior is generally implicit, for it is acquired in practice, and is a practical ability as it is learned through familiarization or “habituation”. Bourdieu thus refers to the learning context as a “habitus” and uses it to explain, among other things, judgments on taste and educational success. A habitus can thus be considered a system of dispositions acquired through practice. The world is made up of many different types of habitus, and these produce different practices, which are the basis for the drawing of distinctions, whether on taste, or, for current purposes, firms’ interpretations of, and relationships with, regulatory frameworks and codes of practice. The firm is thus the setting where skilful behavior is learned, and where, by inference, distinctions on responses to regulation materialize themselves. These differences in behavior, which can constitute deep-seated and unconscious beliefs and positions, operate in a structured domain of activity that Bourdieu calls a “field” (e.g. economy, family, education, law). And since they are relatively autonomous, the different fields have distinct views on what constitutes legitimate opinion and what are appropriate power relations—they have, so to speak, their own particular logic and judgment. The habitus, in other words, provides the practical skills to navigate a field. In very simple terms, for example, a university lecturer would presumably possess the practical skills to navigate the field of higher education, and because of this his or her view on higher education may likely be different than, say, a plumber’s view. And since the lecturer may share and agree this with other lecturers, the habitus of the field that is higher education will constitute those shared beliefs and practices. The rules and resources relating to the reproduction of learned practices are diverse. Giddens (1984) argues that rules range from those that are intensive/shallow, tacit/discursive, informal/formalized, and weakly sanctioned/strongly sanctioned. Resources have to do with power and legitimation, about control over goods and materials, and the capacity to have command over individuals. Situated human agents operate within and determine these structural factors, and for this reason any

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investigation of social systems—and as argued here, the corporate governance regulatory framework and the Corporate Governance Code— has to accommodate both structure and system dimensions. Structure, in this context, refers to those varied arrangements of social institutions (e.g. politics and religion) which influence the choices that limit behavior, while system refers to how those institutions are configured to provide for stable arrangements, and therefore for how individuals and firms collectively interact with one another. And since structure and system dimensions vary, we can see why the practices in relation to the Corporate Governance Code are likely to differ. It is essentially because differences that accrue from social origin and power relations have their origin and basis in the control of physical and human resources. This has implications for how regulation is carried out, with the immediate and overarching implication being that, if it is to be effective in changing behaviors, regulation should be aligned with rule-following practices. In other words, you do not want to hinder beyond compliance behavior, just as you would not want to encourage noncompliance by applying the wrong regulatory fix or mechanism. The points that we have raised converge to suggest that responses to regulation can only properly be understood by examining the practices of regulated entities. Likewise, the appropriateness of regulation can only be properly understood by looking at the practice produced by that regulation, since different settings are going to produce different practices. Indeed, one should expect that different settings will embody different constraints and empowerments (e.g. willingness to engage with effective corporate governance) as a result of different types of habitus and fields. One would also expect many of these learned practices to be difficult to change, for a learned consciousness develops over time and can be difficult to undo (e.g. Aoki 2007; Greif 2006). It is thus important for regulators and rule-makers to appreciate a feature they may have always been aware of: it is very difficult to change a learned practice since the regulatory instruments are having to overcome the constraints that result from differences in, say, class, power, function, resources, views and so forth. The immediate implication from this is that regulation, including corporate governance regulation, will underperform, unless of course it is able to address the constraints, and leverage the empowerments, across different types of firms that have different worldviews and pressures etc. We thus need to better understand how differences influence the way regulations work. Thus, one of the reasons the regulation may underperform is that it often assumes a common form of regulatory response, which, given differences in rule-following behavior and practice within and across firms, is unlikely. In general terms, differences, when looking at firms, are evident in many areas. They are reflected in the way firms are likely to belong to industries with different technologies and logistic chains, and how this

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then affects their views and behavior toward technology and logistics. Firms will also likely vary in size, and this will have a bearing on how they view and tailor their provision to suit the different types of customers they service. Some firms will also be more entrepreneurial than others, with their behaviors similarly being affected by factors such as ownership structure (e.g. family-run, shareholder-led businesses), geographic scope (e.g. global, local) and rates of change (e.g. static, dynamic). Alongside the differences highlighted, firms will try to differentiate themselves from their competitors, with the basis of that distinction again affecting and embodying behavior. This can follow on from competition on internal dimensions (e.g. supply chain expertise, ability to develop brands, use of information technology) and through aspects that are market-based and internal to the firm (e.g. a firm in a market that is homogeneous and low-cost, where it has to compete on cost, will have little choice but to leverage factors that are internal to the firm if it is to maintain its position with, or outperform, other players in the sector (Porter 1985). It also makes sense for firms that have a competitive advantage to seek to protect that benefit by making the resources that underpin the advantage difficult to copy. This can be generalized to the form that firms are competitively distinctive due to firms being unequal in their ability to acquire and utilize resources (e.g. Peteraf 1993). The situated behavior-regulation link can also be affected by the structure of the firm. As Chandler (1962) has observed, as firms grow they develop different organizational structures. These structures are associated with different behaviors (see Mintzberg 1979). In fact they affect the tone and direction of the strategy-making processes, and might therefore influence the preferences of the firm. It corresponds with the view that firms have bounded rationalities and cultures and these guide their decision-making processes (Prahalad and Bettis 1986). This suggests that firms do not always act in a rationally optimum way due to the constraints on their decision-making (e.g. they do not have the time or resources to gather all the information they need to make an optimal decision), with them instead simplifying their world by choosing the first alternative that is satisfactory (Simon 1982). It corresponds with firms sticking with what has worked for them in the past (other explanations include reinforcement-expectancy learning, the efficiency of maintaining proven competences over developing new ones, performance exceeding aspirations, and difficult-to-change organizational structures). The history of the firm therefore matters, with the conditions that give rise to self-reinforcing feedback (to help maintain existing structures) being attributed to the historically embedded nature of cognitive selections, sunk costs making it difficult to switch to alternatives, complex interrelatedness (social, institutional and technical), and increasing returns when using a common method (David 1985; Arthur 1989).

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A further factor affecting the behavior of firms, by virtue of the way that it shapes the allocation and use of resources across firms, is the institutional environment. This is because institutions provide the rules of the game, and these guide and restrain the behavior of the firm (North 1990, 2005). Rules can be formal or informal (e.g. norms, routines, political processes, contracts, incentives, authority, laws), and the weight given to these vary by firm. The institutional environment therefore helps to produce and sustain different behaviors. It influences the acquisition of organizational knowledge, and hence the building blocks of organizational behavior (see Granovetter 1985). These examples support the case that persistent differences in behavior are inescapable. In fact the wider literature reveals that the factors behind divergence in organizational behavior comes from many sources and provides a compelling case for different forms of firm-level knowledge. On that basis, there is a need to consider how these differences are matched in regulatory practices and approaches. Specifically, there is a need to investigate how these differences are constituted in the “conditions” upon which any regulatory framework must operate. The consequent question is thus as follows: what conditions are required for a regulatory mechanism, such as the UK Corporate Governance Code, to be effective, and how do differences across firms affect these conditions? This will make it possible to see if and how the code could be configured so as to make it more amenable to different situated contexts.

Conditions of Regulation Another critical and related feature of our claim is that, in order to be effective, a particular regulatory mechanism or approach requires the existence of conditions; conditions relating to firms’ characteristics and behaviors. Since an instrument relies on the existence of different conditions, then the instrument will be more effective if the conditions it assumes are—or need to be—present do in fact exist, or closely fit the social and economic conditions that shape regulated entities themselves. If those conditions are absent or poorly aligned, there will be a regulation deficit and the instrument will not achieve its full potential. Here, a condition refers to a situation, state of affairs, or factor that must be present before something else is possible, permissible, or likely to occur. It could be declared, for example, that condition “X” must be present or in place before thing “Y” can take place, or thing “Y” will occur only if condition “X” exists. So how does this inform our views on regulation and how it functions in practice? It is posited that firms (e.g. their features, capacities, interactions with market and social contexts) provide some of those necessary conditions. That is, the characteristics of regulatees provide the conditions that determine whether regulations perform or fall short. Taking the firm as the unit of analysis,

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key questions are: “What are the conditions on the part of the regulatee that mean a particular instrument will perform, or that mean it is less or not likely to perform?”, “What is it about firms’ resources, behaviors, institutional settings, and circumstances that provide the conditions for successful regulatory implementation?”, and “Are those institutional and organizational conditions in place, in relation to given instruments or approaches?” So far as it could be argued here, the idea of regulatee conditions has not been discussed in any explicit sense. It is recognized partly by Baldwin and Black’s (2007) model of “really responsive regulation”, which acknowledges the importance of taking account of the attitudinal settings of firms, their operative and cognitive frameworks, and their institutional frameworks. Yet the chapter takes this further by trying to identify those conditions that enable regulation to deliver its outcomes. Moreover, it considers a broad spectrum of research to identify three broad conditions that determine whether and how firms will respond. These are (1) their understanding of the regulated situation, (2) their capacities to respond, and (3) their willingness or acceptance of a need to take action. These conditions are referred to as follows: the knowledge condition, the substantive compliance resources condition, and the agreement condition. Firms, for example, have different levels of resources that can affect their ability to act, which is evidenced by the general observation that a critical factor affecting the compliance behavior of smaller firms is their limited competence level and capacity to adopt approaches of environmentally sustainable industrial development (OECD 2007). In other words, resources affect compliance positions. There is also evidence of a corporate “attitude” toward compliance (Gray and Deily 1996), suggesting that the way firms view the principles of a regulatory regime will be an important feature of the compliance process. Each condition has variability (e.g. different levels of knowledge), the implications of which are itemized for the Corporate Governance Code in Table 22.1. It is suggested that these are the essential conditions that apply to all forms of regulation, and that the way they interact will determine how different regulations perform. Importantly, it is only when all three conditions are present that there will be no regulation deficit (see Figure 22.1). By looking at regulation and its relationship with regulatee conditions, it is possible to get a more sophisticated view of how measures such as the Corporate Governance Code may work in practice and why such instruments may underperform. For example, what, if any, knowledge deficits need to be addressed? How do you improve firms’ willingness to comply? Thus, having introduced what conditions mean for our understanding of regulation, a brief look at differences and conditions in the context of the Corporate Governance Code can be taken. It requires, given the differences across firms, that we consider the knowledge requirements on firms, the resource requirements on firms, and the willingness on firms to engage and comply.

Meaning

Understanding that the regulation exists and what its demands are

Capacity and capability (resources to meet the demands and requirements of regulation)

Willingness, desire, or pressure to meet the demands and requirements of regulation

Condition

Knowledge

Substantive compliance resources

Agreement

Table 22.1 Regulation Conditions

• Are all firms aware of its existence? • Is it promoted to all firms? • Are all firms part of the Corporate Governance Code setting? • Are the knowledge demands of the corporate governance aligned to the knowledge capacities of all firms? • Are the regulatory requirements of the Corporate Governance Code aligned to the resource capacities of all firms? • Are the timeframes for compliance with the Corporate Governance Code aligned to the resource capacities of all firms? • What is the setting that promotes engagement? • Are the pressures to engage with, and to comply with, the Corporate Governance Code the same for all firms?

The regulatee must have a measure of regulatory knowledge and understanding. The regulatee needs to be aware of the existence of a regulatory measure and requires a reasonable and working knowledge of its requirements.

There is a need for commitment to the regulatory cause—or a level of agreement or consensus on the part of the regulatee. Specifically, the regulatee needs to “agree” to compliance, or to acquiesce to the compliance process, and then respond in the right way. The term “agree” is used broadly, in that agreement to comply can be “voluntary”, “desired”, or “preferred”, as well as “forced” through appropriate enforcement or pressurized through appropriate social pressure or norms.

Regulation requires firms to have the necessary resources that enable them to achieve actual or substantive compliance. That is, the effectiveness of regulation is dependent on regulatees having the necessary resources to know what the regulations require and to then put that knowledge into practical activities.

Implications

Explanation

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Knowledge Condion

Agreement Condion

Substanve Compliance Resources Condion

Figure 22.1 Conditions and Deficits

Final Comments The ideas that we have outlined in this brief account have important implications for both regulation in general as well as for mechanisms such as the Corporate Governance Code. We have tried to suggest that concepts such as habituation explain the process by which we learn to behave and follow rules, and it can explain why firms (and BoDs) behave differently. Moreover, demonstrating that firms differ, and that these differences manifest themselves as variable conditions that determine the effectiveness of particular regulatory instruments, has serious implications for how regulation performs and for what might be done for it to be improved. In addition, it perhaps enables us to identify and appreciate why there might be regulation deficits, what causes these deficits, and how they may be reduced. In relation to the Corporate Governance Code, we have asked what we believe to be a series of important questions. Are firms aware of the measure’s existence? Are firms part of the code’s context, and are demands in terms of knowledge appropriately aligned to the capacities of the firm? We considered whether there is the right setting to promote engagement. Are the pressures to engage with, and to comply with, the code, the same for all firms? It is questions that relate to engagement that, for us, raise key issues and problems. The code, in many respects, presupposes a degree of shareholder activism. As we have suggested, shareholder activism presupposes that directors cannot be trusted and requires investors and shareholders to have a genuine willingness to properly engage in corporate governance matters and the activities of their directors and their firms. One of the key features, it seems, is that irrespective of the content of the code, there

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has to be an active and interested audience for the information, and that the active audience must have the avenues to then hold the BoDs to account. Finally, we suggested that the chapter adopts a largely Western, market economy viewpoint. We nevertheless feel that the issues raised in relation to firms’ differences, and the way these differences influence the performance of corporate governance regulations, will have implications more generally. More analysis is required in this area to see whether differences in alternative contexts and jurisdictions are exacerbated or moderated. And the key to this endeavour is to realise that differences cannot be eliminated: it is their extent which is important and which will duly determine the workability of corporate governance regulation in developing and emerging markets.

Notes 1. www.globaljustice.org.uk/news/2016/sep/12/10-biggest-corporations-makemore-money-most-countries-world-combined (accessed 26 March 2018) 2. Ibid. 3. www.bbc.co.uk/news/business-37316125 (accessed 26 March 2018) 4. www.ft.com/content/c56c86a0-a80c-11e6-8898-79a99e2a4de6 (accessed 19 March 2018) 5. Under the code, firms are required to ‘comply’ with UK Listing Authority (UKLA) requirements. These are administered through the Financial Conduct Authority (FCA). It involves compliance with the FCA Disclosure and Transparency Rules, FCA Prospectus Rules, and FCA Listing Rules (see FCA Handbook 2016). A feature of the FCA Disclosure and Transparency Rules are the linked corporate governance standards set out in the UK Corporate Governance Code. 6. www.frc.org.uk/directors/corporate-governance-and-stewardship/uk-corpo rate-governance-code/history-of-the-uk-corporate-governance-code (accessed 22 March 2018) 7. Ibid. 8. www.ft.com/content/c56c86a0-a80c-11e6-8898-79a99e2a4de6 (accessed on 19 March 2018) 9. www.frc.org.uk/directors/corporate-governance-and-stewardship/uk-corpo rate-governance-code/25th-anniversary-of-the-uk-corporate-governanceco/a-code-review-is-not-enough-companies-must-take-o (accessed 22 March 2018)

References Aoki, M. (2007). Endogenizing institutions and institutional changes. Journal of Institutional Economics, 3(1), 1–31. Arcot, S., Bruno, V. and Faure-Grimaud, A. (2010). Corporate governance in the UK: Is the comply or explain approach working? International Review of Law and Economics, 30, 193–201. Arthur, B. (1989). Competing technologies, increasing returns, and lock-in by historical events. Economic Journal, 99, 116–131. Baldwin, R. and Black, J. (2007). Really responsive regulation. Modern Law Review, 71(1), 59–94.

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Bourdieu, P. (1984). Distinction: A Social Critique of the Judgement of Taste. Cambridge, MA: Harvard University Press. Calkoen, W. (2017). The Corporate Governance Review. The Law Reviews. London. Chandler, A.D., Jr. (1962). Strategy and Structure: Chapters in the History of the American Industrial Enterprise. Boston: MIT Press (1969 paperback edition). Clarke, T. (2004). Theories of Corporate Governance. Abingdon, UK: Routledge. Daily, C., Dalton, D. and Cannella, A. (2003). Corporate governance: Decades of dialogue and data. Academy of Management Review, 28(3), 371–382. David, P.A. (1985). Clio and the economics of Qwerty. American Economic Review, 75, 332–337. Dewing, I. and Russell, P. (2004). Regulation of UK Corporate governance: Lessons from accounting, audit and financial services. Corporate Governance: An International Review, 12(1), 107–115. DfID. (2011). The Engine of Development: The Private Sector and Prosperity for Poor People. Department for International Development. London. Donaldson, L. and Davis, J. (1991) Stewardship theory or agency theory: CEO governance and shareholder returns. Australian Journal of Management, 16(1), 49–64. Engle, E. (2010, Winter). I get by with a little help from my friends? Understanding the U.K. Anti-Bribery Statute, by reference to the OECD Convention and the Foreign Corrupt Practices Act. The International Lawyer, 44(4), 1173–1188. European Commission. (2011). Increasing the Impact of EU Development Policy: An Agenda for Change. Brussels, COM(2011) 637 final. Financial Reporting Council. (2016, April). The UK Corporate Governance Code. Financial Reporting Council. (2017, January). Developments in Corporate Governance and Stewardship 2016. Giddens, A. (1984). The Constitution of Society. Cambridge: Polity Press. Gordon, S. (2016). Third of UK Businesses Do Not Meet Corporate Governance Requirements (November 13, ). Granovetter, M. (1985). Economic action and social structure: The problem of embeddedness. American Journal of Sociology, 91, 481–510. Grant Thornton. (2017). Corporate Governance Review. Grant Thornton UK LLP. See https://www.grantthornton.co.uk/globalassets/1.-member-firms/united-king dom/pdf/publication/corporate-governance-review-2017.pdf Gray, W. and Deily, M. (1996). Compliance and enforcement: Air pollution regulation in the U.S. steel industry. Journal of Environmental Economics and Management, 31, 96–111. Greif, A. (2006). Institutions and the Path to the Modern Economy. Cambridge: Cambridge University Press. Lipman, M. and Lorsch. J. (1992, November). A modest proposal for improved corporate governance. The Business Lawyer, 48(1), 59–77. Lodge, G. and Wilson, C. (2006). Multinational corporations and global poverty reduction. Challenge, 49(3), 17–25. Lynch-Wood, G. and Williamson, D. (2011). The receptive capacity of firms: Why differences. Journal of Environmental Law, 23(3), 383–413. Mintzberg, H. (1979). The Structuring of Organisations. Englewood Cliffs, NJ: Prentice Hall.

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North, D.C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. North, D.C. (2005). Understanding the Process of Economic Change. Princeton, NJ: Princeton University Press. OECD. (2006). Promoting Pro-Poor Growth: Private Sector Development. OECD Publications. Paris. OECD. (2007). Small Businesses and Environmental Compliance: Review and Possible Application of International Experience in Georgia. Paris. Peteraf, M.A. (1993). The cornerstones of competitive advantage: A resourcebased view. Strategic Management Journal, 14, 179–191. Prahalad, C.K. and Bettis, R.A. (1986). The dominant logic: A new linkage between diversity and performance. Strategic Management Journal, 7(6), 485–501. Porter, M.E. (1985). Competitive Advantage: Creating and Sustaining Superior Performance. New York: The Free Press. Simon, H.A. (1982). Models of Bounded Rationality (2 vols.). Cambridge, MA: MIT Press.

23 Effective Boards in Developing and Emerging Markets Looking Ahead David Williamson, Chris Ogbechie, Onyeka K. Osuji and Franklin N. Ngwu Introduction A consequence that arises from the work presented in the preceding chapters, either directly or by implication, is the need to be cognizant of the range of issues that will have to be considered when investigating board effectiveness in developing and emerging markets. There is certainly no apparent, or readily available, ‘quick fix’ solution to how board effectiveness can be improved. Rather, the factors affecting boards have been shown to be diverse and collectively complex, and, as a result, the remedies proposed have been similarly multifaceted and complex. The reason for this, as we will attempt to show when we consider each of the chapters in turn, is that no two developing or emerging markets are the same. They each have their own unique characteristics. Moreover, if we consider this a strength rather than a weakness then each market has the potential to realize improvements in board effectiveness on its own terms, and in corporate governance, by not having to follow in any rigid sense what everyone else is doing. Indeed, the issue of convergence in corporate governance seems to be a sterile debate when confronted with the diversity exhibited in the contributions to this text. We could go even further, and posit that even if there are increasing similarities across different markets, there is no possibility, as the penultimate chapter has indicated, that differences across firms can ever be fully accommodated in regulation. The key is to recognize the world as it is, and to seek to accommodate this in how we understand and address the issue of board effectiveness in developing and emerging markets. To see what this potentially looks like we will now turn to implications arising from the chapters themselves.

Part I: Board of Directors, Effectiveness, and Corporate Governance In setting the scene, Chapter 2 by Ashiru, Nakpodia and Adegbite reminded us that boards, since they monitor, control and supervise the ongoing

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performance and direction of the firm, are essential to good corporate governance. This is evident when firms unnecessarily underperform and fail in developing and emerging markets. The backdrop to this is not that firms should never fail, as this goes against the tenets of a competitive market system, but rather, why is it that firms underperform when all other things are equal. It begs the question of what can be put in place to encourage and support more effective boards? In commencing the chapters which seek to address this question, Williamson and Lynch-Wood (Chapter 3) considered the use of codes of behaviour and codes of conduct as mechanisms for improved board effectiveness. Their use of what constitutes an inner morality of law, conditions of regulation and firm differences, provided them with the tools to say that codes, while important for some firms, have insufficient legal empowerment (and directive power) to affect the behaviour of all firms. Looking ahead, the obvious need is therefore to create the environment for code success more generally. However, there is also the need to identify what can be achieved, even where conditions are favourable, given the inherent weakness of codes if they are purely voluntary in character. Also, and this is particularly relevant in developing and emerging markets, there is a need to identify where and when codes can be a useful addition to regulation, or even when they can be used to compensate for a lack of regulation. This raises a further and more general question, which pertains to what other mechanisms can induce increased board effectiveness in the absence of regulation. Chapter 4 by Ogbechie highlighted the distinctive character of boards in developing and emerging markets and that existing research has largely failed to accommodate this in prescriptive solutions. Hence, when dominant ownership prevails, what is the potential solution? A remedy put forward was that such firms can go public, so then they would have to comply with governance codes and so forth. However, this would also be unrealistic for many firms since they would not wish to go public. It would likely raise a wide spectra of other problems if this is required to happen. What then is the potential solution? From our perspective it requires that the solution retains the distinctive character of the developing and emerging market where going public can accommodate the essential character of family ownership. Evidence from China in Chapter 5 by Liu, Uddin, Chowdhury and Muganhu showed that concentrated ownership, through the state, can likewise undermine board effectiveness, and again, that this needed to be addressed if economic progress was to be sustained. On the basis of our discussion so far, this needs to be duly cognizant of the particular environment in China, such that the solution may be very different in character to the solution in another developing and emerging market. For the use of committees to improve board effectiveness in the developing and emerging market of Turkey, Chapter 6 by Çolgar provided an indication of how law needed to change. Thus, it was

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addressing a specific contextual situation and specific contextual remedy. Yet, there is also a need to understand the limits to a specific contextual remedy since it can be anticipated that the character of the differences across firms in Turkey will have a limiting effect on any proposed remedy. As such, future research must also identify the limits of proposed remedies. Taking a different approach, Chapter 7 by van der Hoven and Ojah shows that differences operate at different levels, by illustrating how board effectiveness has been affected by a movement from collectivism to individualism. The extent to which this translates across developing and emerging markets is an open question and demands further investigation. This is also evident in Chapter 8 by Arjoon, where the tone at the top is seen to affect organizational culture. Since cultures differ across developing and emerging markets, as well as within those markets, what is the extent and significance of this movement? That is, does it affect all developing and emerging markets equally, or even at all? Likewise, would the remedy be the same or different across developing and emerging markets?

Part II: Institutions, Regulations, and Corporate Governance An implication from the contributions so far discussed is that institutional and regulatory differences across developing and emerging markets do matter. In Part II this is centre stage, with Chapter 9 by Okanigbuan Jr. showing that while the UK, US and Nigeria share aspects of ‘world best practice’, it is the local context which determines their success. This raises the question, as the author does, of how the localized context can be accommodated in regulatory frameworks. This, as we have tried to illustrate, is an important question. Indeed, we can anticipate that the answer, whether it is affirmative or otherwise, will have important consequences for corporate governance in developing and emerging markets. At a more theoretical level, Chapter 10 by Osuji posited that enforced self-evaluation by ‘clubs’ would improve board effectiveness. The issue of how this would work across different institutional settings is therefore an important theoretical and empirical question. In particular, the potential for bespoke clubs across developing and emerging markets offers a tantalizing vision of what may be possible when confronted with contextual differences. When doing so, the research must therefore also account for how the institutional framework is able, or not able, to support clubs. The potential for bespoke solutions is developed further in Chapter 11 by Ajai. In showing that corporate governance codes should differ between public companies, SMEs, not-for-profit and public sector organizations, the analysis brings to light the need for different approaches to facilitate good corporate governance and board effectiveness.

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That being the case, it is interesting that Dube and Rahim, in Chapter 12, argued for a global style of company reporting. This seems to be at odds with much of what we have said so far. In short, how can the need for an overarching style of company reporting to provide accountability be aligned to and made compatible with bespoke approaches to good corporate governance, when what constitutes good corporate governance can take different forms? In many ways, the same was true in Chapter 13 by Ogbechie, where issues relating to director selection, on-boarding and disqualification were discussed. Is good practice in these areas common to all developing and emerging markets, and should it be if the concept of good practice is itself contested? Furthermore, if it is up to the board to ensure that appropriate mechanisms and procedures are put in place such that it fits the needs of the local situation, how do we then compare practices to assess efficiency and effectiveness? This also illustrates the need for a consideration of the trade-offs involved, when we are faced with the need for local level solutions as well as macro-level assurance to sustain cross jurisdictional trust. The same appears in the consideration of director duties in Chapter 14 by Okoye, as the need for their determination in law also invites the question as to why they need to be the same in all markets. In Chapter 15 by Godspower-Akpomiemie and Ojah, it was pointed out that boards in banks need to be transparent, if they are to create reputational capital to counter mistrust around money laundering. A followon question, which is in line with the overall theme we wish to develop, is how do you achieve transparency and trust when the conditions for transparency to operate successfully differ in developing and emerging markets, when there is a reduced civil society to make transparency a vehicle for trust? Therefore, if transparency and scrutiny go hand-inhand, it is important that researchers explore the different ways in which this can operate in developing and emerging markets. The final chapter in Part II, Chapter 16 by Siregar, chronicled the corporate governance changes that have taken place in Indonesia following the financial crisis in 1997–1998. It illustrated the specific nature of the changes by showing that this is a continuing process and that the remedies put in place are both detailed and collectively complex. If this is the case in Indonesia can we infer that it will be equally detailed and complex in all developing and emerging markets? To assess this further we must consider the questions raised in chapters in Part III.

Part III: Issues in Improving the Functional Effectiveness of the Board Chapter 17 by Nilsson considered the importance of subsidiary firms having the same powers as their multinational parents. Having the same

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powers so that they can act on their local knowledge seems to be a very important question and certainly one that needs to followed up through additional empirical investigation. More particularly, is the symmetry of being able to draw upon parent guidance and expertise and at the same time having the power to act locally, reconcilable with their different expectations as a consequence of different knowledge at the micro and macro levels? Is it always a race to the top, by which we mean compliance to the standards demanded of the parent firm, or is possible and desirable (or viable) to have compliance to other world views? A similar line of enquiry was evident in Chapter 18 by Adeola and Ohu, when they posited that financial and social performance can be improved when the board is integrated into the local community. How this can be achieved, as with subsidiary boards when they likewise have to be integrated into the parent firm, and when there are differing degrees of trust in developing and emerging markets, is an issue worthy of further research. Specifically, research is needed to identify the facilitators and barriers to boards, of all types, being integrated into local communities. Looking at the issue of director remuneration in Chapter 19, Ngwu noted that the remuneration of directors in developing and emerging markets is frequently undisclosed and thus there is limited scope for linking remuneration to firm performance in order to discipline and motivate directors. In advocating reform to address this problem they also noted the need for both hard and soft law approaches. Again, we would anticipate that the ability to use as well as benefit from the use of hard law or soft law, and combinations of both, will vary across developing and emerging markets. The question for researchers is therefore one of trying to understand what will work and where will it work, rather than one of providing a justification for shoehorning a common approach into different contexts. The same line of argument can be applied to Chapter 20 by Okonedo, where diversity and independence of boards was considered by looking at practices in Nigeria, Kenya and South Africa. In particular, it seems necessary to also understand what would constitute an appropriate level of diversity and independence in different developing and emerging markets, and how these variations in practice can be made acceptable to international stakeholders. Perhaps this is where international codes and other mechanisms have to likewise change, by focusing more on bespoke rather than parity of practice, to show that what constitutes excellent practice will have different benchmarks in different developing and emerging market contexts. In Chapter 21, Ojah and van der Hoven focus on the potential of institutional shareholders to protect minority rights in developing and emerging markets and raised important questions for future research. In advocating ownership mix and a grouping of institutional shareholders

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as ways of protecting minority rights, there is a concomitant need to now see how this would work, and what it would look like, in different developing and emerging market contexts. Also, what should be done to make-up the difference if ownership mix and grouping of institutional shareholders is weak? These types of issues are taken up directly in Chapter 22 by LynchWood and Williamson, the penultimate chapter, where it was argued that all regulations, no matter the form that they take, have conditions that have to be satisfied in order for the regulation to work, and that differences affecting the ability of states and firms to meet those conditions will always make compliance problematic. This is precisely the reason why the valuable contributions presented in this text need to be tested and extended, since they can only be tested and extended when they are contextualized in individual developing and emerging market contexts.

Conclusion Bringing these considerations together, and looking ahead, it is clear that there is much to do if we are to fully understand how board effectiveness can be improved in developing and emerging markets. It is clearly a multifaceted issue and one that defies simple one-size-fits-all solutions. That said, the contributions presented in this text indicate that there are likely to be benefits when we improve our knowledge on the following issues: •

• • • •

•

• •

The extent to which mechanisms, whether they be hard or soft in character, can operate successfully in different developing and emerging market contexts. The extent to which different mechanisms compete and distract from one another when applied in developing and emerging markets. The extent of the change, on issues such as the movement from collectivism to individualism, in developing and emerging markets. The extent to which global best practice can be localized (and the trade-offs involved, including the ability to benchmark practices). The extent to which we can have bespoke solutions while retaining wider accountability and trust—and thus provide transparency and trust. The extent to which ‘good practice’ can be contextually dependent without it losing value within, and external to, its developing and emerging market context. The extent to which we can integrate boards into local communities. The extent to which we can enforce prescriptive solutions in different developing and emerging markets, and if it makes any sense to try to do so.

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This list is indicative of many other questions that need to be asked and pursued, and it is hoped that they will spur further research in developing and emerging markets. The answers to these types of questions will not only provide a better theoretical understanding of boards in developing and emerging markets, and how this should be conceptualized in general theories on corporate governance, but ultimately also on practice itself.

Contributors

Emmanuel Adegbite, PhD, is a professor of Accounting and Corporate Governance at Nottingham University Business School. His published works on management accounting, corporate governance, corporate social responsibility and corporate finance have been widely cited and has, in collaboration, secured around £500,000 in funding. He received a Durham University award for Excellence in Research in 2014; the ‘Celebrated Nigerian Award UK’ in 2016; and the ‘International Business Review Best Journal Paper of the Year Award’ in 2016. Emmanuel is a visiting professor at James Cook University, Singapore, and works closely with business leaders and policy influencers in implementing good corporate governance standards, and in developing strategies for instrumental corporate social responsibility. Ogechi Adeola, DBA, teaches marketing management at the Lagos Business School (LBS), Pan-Atlantic University, Nigeria, and currently serves as the academic director, LBS Sales and Marketing Academy. Her research interests include financial inclusion, tourism and hospitality marketing, strategic marketing, and export marketing strategies in sub-Saharan Africa. She has published academic papers in top scholarly journals. Her co-authored papers won Best Paper Awards at conferences in 2016 and 2017. She holds a doctorate in business administration (DBA) from Manchester Business School, UK, and started her career at Citibank Nigeria, spending approximately 14 years in the financial sector before moving into academia. Olawale Ajai, PhD, is a professor of legal, social and political environment of business at the Lagos Business School, Pan-Atlantic University, Lagos, Nigeria. He holds a PhD in law and facilitates sessions on the social and political environments of business and business law. His research focuses on corporate sustainability, corporate political activity, financial inclusion, digital law and economy, and business and environmental law. He successively held roles as group company secretary/legal adviser, executive director, human capital and executive director, marketing and strategy at Dunlop Nigeria Plc. He is a legal

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practitioner of the Supreme Court of Nigeria. His consulting activities include assignments in public policy reform, legislative drafting, and strategic management training. He is an alumnus of Lagos Business School, IESE Business School, and Harvard Kennedy School of Government. He is a member of the Nigerian Bar Association, IUCN World Commission on Environmental Law, Chartered Institute of Taxation of Nigeria, Institute of Directors, Chartered Institute of Personnel Management of Nigeria, and a fellow of LEAD International. Surendra Arjoon, PhD, is a professor of business and professional ethics, department of management studies/Arthur Lok Jack Graduate School of Business, the University of the West Indies (UWI), St Augustine Campus, Trinidad and Tobago. He has a PhD in business ethics (corporate governance and ethical decision-making). He served as head, department of management studies (2011–2014, 2002–2005) and as deputy dean in the faculty of social sciences (1996–2002, 2015–2018). In 2015, he received the UWI Vice-Chancellor’s Award for All-round Excellence Performance for his teaching and research accomplishments. In 2012, he was the recipient of the UWI/Guardian Life Premium Teaching Award. He also served as the vice-president of the Trinidad and Tobago Economics Association (2000–2010). He is currently serving as a member of the Salaries Review Commission (2016–2019), the Board of Directors of the Central Bank of Trinidad and Tobago (2016–2019), and is the chairman of the St Augustine Campus Research Ethics Committee (2017–2020). He is internationally recognized as one of the leading scholars in business ethics with over 850 citations of his work. Folajimi Ashiru is currently a PhD student researcher at Durham University, UK, where he teaches strategic management seminars to third-year undergraduates. A seasoned financial expert with extensive financial industry working experience, Folajimi has over 13 years of banking experience spanning international funding, NGOs, MDGs and multilaterals, public-private partnerships, commercial banking, operations and treasury. In 2009, he obtained an MBA from Aston University, UK, following which he established his own entrepreneurial ventures in the entertainment industry (TV shows and documentary production), as well as in the transportation industry. Emek Toraman Çolgar, PhD, is an assistant professor in the commercial law department Koç University Law School, Turkey. She completed her BA in Law at Istanbul Bilgi University Faculty of Law in 2004 and after graduation worked as an intern lawyer for one year in Cerrahoğlu Law Firm. She obtained her LLM degree from Istanbul Bilgi University Business Law program in 2008 and received her PhD from Istanbul University in 2015, specializing in corporate law. During

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her doctoral research she spent 13 months at the Max Planck Institute for Comparative and International Private Law, Hamburg, as a guest researcher. Her areas of research and specialization include corporate law, commercial law, intellectual property law, and capital markets law. She has been a consultant for corporate law in different law firms since 2012. She is also a board member of the Dr. Nüsret Semahat Arsel International Business Law Implementation and Research Center and a member of the Istanbul Bar Association. Indrajit Dube, PhD, is an associate professor at Rajiv Gandhi School of Intellectual Property Law, Indian Institute of Technology Kharagpur, India. His areas of specialization include corporate law and corporate governance. He has numerous publications in refereed journals published in India and abroad. His writings are mainly focused on independent directors, directors’ liability, integrated reporting, corporate social responsibility, and corporate governance in the energy sector. He has several books to his credit. He has conducted about 20 funded projects from agencies, both national as well as international. He has also been invited as visiting faculty at the University of Western Ontario, Ontario, Canada (January 2010) and the University of British Columbia, British Columbia, Canada (December 2011). He has the distinction of being invited to deliver the Kirby Lecture Series at the School of Law, University of New England, Australia (February 2016). He has been invited to participate in multi-stakeholder expert consultations at Osgood Hall Law School, York University, Toronto, organised in support of the mandate of Prof John G. Ruggie, United Nations Special Representative on Business and Human Rights (November 2009). He was awarded the School of Taxation and Business Law 2018 Fellowship. Euphemia Godspower-Akpomiemie is a PhD candidate and a postdoctoral fellow in finance at the University of Witwatersrand Business School, South Africa. She also holds a master’s of management in finance and investment from Witswatersrand, a postgraduate diploma in business management, and an HND in accounting and finance from Nigeria. She worked in the banking industry for several years. Her research interests include banking and financial regulations/supervision and financial development in emerging markets, behavioral finance, and corporate governance. She is a member of Golden Key International Honor Society and a holder of the PhD Bradlow Scholarship and Postgraduate Merit Award, both of the University of the Witwatersrand. She has published chapters on corporate governance and peer-review works in the African Finance Journal. She volunteers to tutor students and women’s organizations on financial literacy and personal hygiene.

Contributors

385

Jia Liu, PhD, is a professor in finance at the University of Salford, UK. She holds a PhD in economics from the University of Birmingham, UK. Her research interests focus on corporate finance, corporate governance, asset pricing, capital market, and economic sustainability and growth. She has widely published in international, SSCI-indexed economics, business, and finance journals, such as the International Review of Financial Analysis, European Journal of Finance, Journal of Business Finance and Accounting, British Accounting Review, International Business Review, and others. Her research publications have decisively influenced corporate finance, corporate governance, capital markets, and the development of related public policy. Her research has won prestigious awards, including the British Academy of Management and European Management Journal Best Paper Prizes. She is associate editor and editorial board member of several ABS-3 and 4-rated journals, including the British Journal of Management and British Accounting Review. An active committee member of the British Accounting and Finance Association and the British Academy of Management, she helps formulate public policy and vigorously stimulates debates, encouraging new thinking and innovation in the accounting, finance, and business management communities. She has been frequently invited as visiting professor by universities in Europe, Africa, and Asia. Gary Lynch-Wood is a senior lecturer in law at the University of Manchester, UK. He is the LLB programme director, the course director for legal methods and systems (compulsory first-year undergraduate unit), and a contributor to teaching on contract law. He is also the course director for a postgraduate course in law, the corporation, and social responsibility. In recognition of Gary’s contribution to teaching, in August 2012 he was presented with an award through the university’s Recognising and Rewarding Exceptional Performance programme, and in May 2013, he received an award from the students at the Manchester University Law Society in recognition of his work on student learning and student experience. Gary’s research focuses mainly on corporate social responsibility and the law, and he has published widely on this issue in leading journals (e.g. Journal of Law and Society, Journal of Environmental Law, Journal of Business Ethics). Gary is regarded as a leading authority on the legal and regulatory issues facing firms, particularly smaller firms. The main focus of his current research is rule-following and the impact this has on regulatory compliance and culture. He is also considering issues relating to age discrimination, which builds on his previous work on aspects of corporate social responsibility. Gary has also conducted funded research on behalf of bodies such as the Scotland and Northern Ireland Forum for Environmental Research, the Environment Agency of England and Wales, and the Engineering Employers Federation.

386

Contributors

Christopher Muganhu, PhD, is an Assistant Lecturer in Finance at Coventry University School of Economics, Finance and Accounting. He is also a Visiting Lecturer in Accounting and Finance at Salford Business School, University of Salford. He holds a PhD in Finance awarded by the University of Salford in 2017. Currently, he is conducting two projects on corporate governance and M&As in China. His paper on corporate governance was awarded the Best Corporate Governance Paper at the 2017 British Academy of Management Conference, held at Warwick Business School. He also acts as an academic reviewer for journals and conferences. He has strong methodological knowledge and data analysis skills. Franklin Nakpodia, PhD, is a lecturer in accounting and finance at Leeds University Business School, University of Leeds, UK. He has a master’s degree from the University of York, and a PhD in accounting from Northumbria University, both in the UK. He has published articles in journals such as Journal of Business Ethics, Accounting Forum, Journal of Business Research, and Business & Society, amongst others. He is research active in the areas of corporate governance, corporate regulation, corporate social responsibility, religion & spirituality, and knowledge sharing. Franklin N. Ngwu, PhD, is a senior lecturer in strategy, finance and risk management, Lagos Business School, Pan-Atlantic University, Nigeria. He has a PhD in law and economics of banking regulation, MSc in economics, and post-graduate diploma in development economics from the University of Manchester, UK. In addition, he also has an MSc in comparative political economy from Cardiff University, UK, and a BSc in sociology from the University of Lagos, Nigeria. He has over 15 years of experience in teaching, private sector, policy research, and consulting, both in Nigeria and the UK. He has consulted for both local and international organisations and worked in Barclays Bank UK for over five years. He has lectured at the Glasgow School of Business and Society, Glasgow Caledonian University; School of Built Environment and Business, University of Salford; and Department of Economics and School of Law, University of Manchester. He has multi-disciplinary teaching and research interests including business strategy and management, risk management in financial institutions, bank management and financial services regulation, law and finance in emerging markets, corporate governance and corporate social responsibility, law and development economics. He is the author/editor of a corporate governance handbook titled Corporate Governance in Developing and Emerging Markets (Routledge, 2016). He is working on his third and fourth books to be published by Cambridge University Press. He is a member of several bodies, including the Society of

Contributors

387

Corporate Governance Nigeria, British Academy of Management, and Risk Managers Association of Nigeria (RIMAN). Gül Okutan Nilsson, PhD, is a professor of law and a member of the company law department of the Istanbul Bilgi University Faculty of Law, Turkey. She is the director of Istanbul Bilgi University Intellectual Property Law Research Center. She graduated from the Istanbul University Faculty of Law and completed her LLM at the Amsterdam School of International Relations in the field of European and international trade law as a Jean Monnet Scholar. She obtained her PhD in the field of private law at Istanbul University. During her PhD studies she conducted research at the Hamburg Max-Planck Institute of Foreign and International Private Law as a Max Planck Scholar and at the Institute of Comparative Law in Lausanne, Switzerland, as a scholar of the Swiss Confederation. She was a visiting fellow at the London school of economics and social sciences, guest lecturer at Vanderbilt University Law School, and visiting scholar of the Institute of Advanced Legal Studies, University of London. She has published books on shareholders’ agreements, corporate group law and SPACs, and numerous articles on corporate and intellectual property law. She is advising companies and law firms in Turkey on corporate law. Chris Ogbechie, PhD, is a professor of strategic management at Lagos Business School (LBS), Pan-Atlantic University, Nigeria. He is also a visiting professor at Strathmore Business School, Nairobi, Kenya. Professor Ogbechie has a first-class honours degree in mechanical engineering from Manchester University, an MBA from Manchester Business School, and a PhD in business administration from Brunel Business School in the UK. He has vast experience in marketing, strategy, and corporate governance derived from his work as head of marketing/sales at Nestle Nigeria and from his consulting work with Nigerian, Ghanaian, and Kenyan firms over the years. While at Nestle, he held international positions in Malaysia, Singapore, and Switzerland. Professor Ogbechie teaches strategy, sustainability, and corporate governance and he is also the founding director of the LBS Sustainability Centre. His research interests are in strategy in turbulent environments, strategic leadership, board effectiveness, and corporate sustainability. He has been involved with several start-ups and on the boards of several private and public companies including Red Star Express Plc (FedEx), National Salt Company of Nigeria Plc (NASCON), Health Partners, and Palton Morgan Holdings. He has several publications in financial services marketing, strategic planning, corporate social responsibility, and corporate governance and has presented various papers on corporate governance at international conferences. His first book, Strategic Marketing of Financial Services

388

Contributors

in Nigeria (2011), provides essential information for marketing practitioners, especially in the financial services sector, for improving the effectiveness of their marketing. His second book, Re-engineering the Nigerian Society through Social Marketing (2012), is his contribution towards changing societal values in a positive way. Eugene Ohu, PhD, is a full-time faculty member in the department of organizational behaviour/human resource Management AT The Lagos Business School, Nigeria, where he currently serves as the head of department. He has a PhD in institutional social communications from the Pontifical University of the Holy Cross, Rome, Italy. Dr. Ohu’s teaching areas include human behaviour in organizations, management communication, human resource management, and digital marketing. His research interests converge on the study of human behaviour in ICT usage, in both work and non-work environments. He also researches in work-life interactions. Kalu Ojah, PhD, is a professor of financial economics and deputy head of school and director of the master in finance and investment at University of the Witwatersrand Business School (WBS), Johannesburg, South Africa. He has garnered invaluable socio-cultural experiences by living, studying, and working in several regions of the world including North America, Europe, the Middle East, and Africa. He holds both a PhD and MFn in Finance (Saint Louis, USA) and a BSc in management/economics (Oral Roberts University, USA). Kalu has also taught and researched at major business schools in America, Spain, the United Arab Emirates, and South Africa and was a visiting scholar at NYU’s Stern School of Business. Kalu is a very active researcher and has published many peer-reviewed articles in leading international journals, many of which have been cited and awarded, e.g. Journal of Banking & Finance, International Review of Economics & Finance, Journal of International Business Studies, and Research Policy. Kalu fulfils several editorial and reviewer roles, including editing Africa’s major finance journal, the African Finance Journal. Kalu also serves in advisory roles as independent non-executive director of multinational corporations such as Consolidated Infrastructure Group, Limited; advised/consulted Coca Cola International; the World Bank; the African Capacity Building Foundation; and the Government of Swaziland, among others. He is frequently invited by the media to provide expert views on contemporary financial economics issues and often engages in thought leadership debates and presentations. Francis A. Okanigbuan, Jr., is a lecturer in the School of Law, Liverpool John Moores University. He was a post-doctoral research fellow on the Arts and Humanities Research Council funded project, Business Judgment and the Courts in the Centre for Business Law and Practice, School of Law, University of Leeds. He was a teaching assistant at the

Contributors

389

University of Manchester and tutor at the Manchester Metropolitan University. He is a graduate-member of the Institute of Chartered Secretaries and Administrators. He is also a member of the London Court of International Arbitration (Young International Arbitration Group). His research interests include corporate law, corporate governance, takeovers (the market for corporate control) the law, and economics of regulation and comparative law. Enase Okonedo, DBA, is a senior fellow and dean, Lagos Business School, Nigeria, and leads sessions in corporate financial management, decision-making, and problem-solving. She holds a bachelor’s degree in Accounting, an MBA from IESE Business School, Barcelona, and a doctorate in business administration from the International School of Management (ISM), Paris. She is a fellow of the Institute of Chartered Accountants of Nigeria (FCA) as well as the Society of Corporate Governance of Nigeria. Her research interests include corporate governance dynamics, executive decision-making, and management education in Africa and emerging economies. An accomplished professional with more than 30 years’ experience in the financial services and management education sectors, Enase serves on the board of several indigenous and international organizations. Ngozi Okoye, PhD, is a senior lecturer in law, Lincoln Law School, University of Lincoln, UK. She undertook a PhD in corporate governance, examining behavioural issues in relation to directors of UK public listed companies and suggesting the adoption of regulatory reforms as a solution to the problems created by these issues. She researches and publishes in the areas of corporate governance, company law, and international commercial law. She is particularly interested in undertaking the evaluation of regulatory mechanisms in the areas of her research interest. Her knowledge and experience enable a broad and effective engagement with corporate governance and commercial law issues, with the aim of contributing to the discourse and solutions required in that regard. Her background and education also enable the exploration of problems and issues regarding regulation as it relates to her research interests in developing countries and emerging markets. Onyeka K. Osuji, PhD, is a reader in law and coordinator of the commercial law research cluster at the School of Law, University of Essex, UK. He is also the director of the Commercial Law Postgraduate Taught Programme at the institution. Dr Osuji obtained a PhD from the University of Manchester and a BCL from the University of Oxford. He has an LLB from the University of Nigeria and a barrister-at-law diploma from the Nigerian Law School. Dr Osuji previously practised in corporate and commercial law before becoming an academic. He is qualified as a barrister and solicitor of Nigeria and a (non-practising) solicitor of England and Wales and has advised individuals, corporations, and

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Contributors

national and international governmental and non-governmental organizations. He has presented papers at several international conferences and has published extensively in books and reputable international journals in the areas of corporate governance, corporate social responsibility, globalization, regulation, consumer protection, social and nonfinancial reporting, and multinational enterprises. Dr Osuji’s current teaching responsibilities include consumer contract law, commercial contract law, and international commercial and business law. He is a fellow of the Higher Education Academy. Mia Mahmudur Rahim, PhD, is a senior lecturer in law at the University of South Australia. Previously he worked at the Queensland University of Technology and the Bangladesh Judiciary. He completed a bachelor of laws with honours and a masters of laws from Dhaka University, a masters in international economic law from Warwick University, a masters in public administration from the National University of Singapore, and a PhD from the school of law at Macquarie University. His research interests lie in different forms of legal regulation, the nexus between corporate self-regulation and CSR, legal issues in corporate governance, and accountability. Dimitrios Stafylas, PhD, is a Lecturer (Assistant Professor) in Finance at Aston University since 2016. Prior this he was working as an Associate Lecturer at the University of York where he completed also his PhD in Finance. He has an MBA and an MSc in Net-Centric Systems from ALBA and University of Piraeus, respectively. His research interests are in the areas of alternative investments, financial markets and behavioural finance. He has published in journals such as International Review of Financial Analysis, Applied Economics, and Global Finance Journal. His work has been appeared in International academic conferences such as Financial Engineering and Banking Society, Multinational Finance Society, and INFINITI conference. He has worked as a referee to various conference and journal papers. He has worked for several years in the industry in various consulting and management positions. Sylvia Veronica Siregar, PhD, currently holds the position as director of the graduate program in accounting, faculty of economics and business, University of Indonesia. She is a lecturer and researcher at the faculty of economics and business, University of Indonesia. She holds a doctoral degree from the faculty of economics and business, University of Indonesia, majoring in accounting. She currently serves as a member of the Financial Accounting Standards Implementation Team of the Indonesian Institute of Accountants (Tim Implementasi Standar Akuntansi Keuangan Ikatan Akuntan Indonesia/TISAK IAI) and was previously a member of the Indonesian Accounting Standards Accounting Standards Board (Dewan Standar Akuntansi Keuangan

Contributors

391

Ikatan Akuntan Indonesia/DSAK IAI). She also serves as a member of several audit committees in publicly listed companies. She also has presented papers at many international conferences and has published papers in several reputable international journals. She is also the co-author of several financial accounting books and author of a corporate governance book chapter. Chris van der Hoven, PhD, is a professor and academic director at the University of Witwatersrand (WBS), Johannesburg, South Africa. Before joining WBS he was a senior fellow at Cambridge University working within the Centre for Technology Management. Prior to that, he spent over a decade at Cranfield School of Management, also in the UK. In both institutions the bulk of his work was in executive education and working with top teams. He is focused on the intersection of strategy, innovation, technology, and R&D in his academic and corporate work. He has been a visiting faculty member at ten different business schools, including in China, France, Germany, Holland, Sweden, and the United States. He also worked on a master’s in defence administration at the Royal Military College (now the Defence Academy) in the UK. His corporate work covers diverse industries such as air traffic control, construction, energy, engineering, gaming, logistics, hightech manufacturing, medical devices, and telecoms. Among others, he worked on projects for Barclays Capital (UK), DP World (Brazil), Royal Hoskoning (Holland), Shell, Seagram (across the EU), Imerys (France), Morgan Advanced Materials (USA), and Cable & Wireless (globally). Professor van der Hoven has worked in more than 40 countries and with leaders from all over the world. He has a BSc from UCT, an MBA from Cranfield, and a PhD from Cambridge University. David Williamson is an honorary senior research fellow, School of Law, University of Manchester, UK. He was a professor of regulation and governance and associate dean for scholarship, enterprise and research, Staffordshire University, UK. After leaving university with a geography degree, David worked in manufacturing for 13 years, mainly as a production manager. During this period he studied part time for an MSc in management sciences. David then joined Staffordshire University as a lecturer. After many years of senior course management responsibility he set up and ran the Centre for Research into Corporate Responsibility and the Environment and became director of the Institute for Environment and Sustainability Research. These responsibilities coincided with an interest in how firms should be regulated. This eventually led him to join the school of law, University of Manchester as a Senior Research Fellow in 2006. The interest in regulation has continued, and he helped set up ManReg: Manchester Centre for Regulation, Governance and Security. David is currently working on a monograph which explains the way we regulate firms’ matters. He is also investigating

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how institutional investors regulate the firms they invest in, and the implications that this has for regulatory theory and practice. Junjie Wu, Ph.D, is Reader in Finance at Leeds Business School, Leeds Beckett University, where she has worked since 2004. She has been employed by three universities in the UK and China since 1981. She obtained a Master’s degree from Zhongnan Economics and Law University in 1990, China, and a Doctoral degree from the University of Huddersfield, UK, in 2003. Her multidisciplinary research areas span accounting, finance, economics, energy, international business and education, using diversified research methods, such as quantitative, qualitative, narrative and case studies. Her ongoing research areas include formal and informal lending, socially responsible investment, behavioural finance, and government debt issues. She has been widely published in leading national and international journals, including International Journal of Accounting, Energy Policy, Economic Modelling and Managerial and Decision Economics, and is the author of almost 60 scholarly articles as well as editing two textbooks. She is a Visiting Professor and has been invited to deliver guest lectures at several Chinese universities. She is currently collaborating with overseas scholars, based in China, USA, Vietnam, Thailand and Ghana, on various projects.

Index

Note: Page numbers in italics indicate figures, those in bold indicate tables, and those with n indicate notes. Aberdeen Railway Co v Blaikie Bros 235 abilities, of board members 107–108; communicating essence 107–108; creating shared contexts 107; grasping essence 107; judging goodness 107; political power 108; practical wisdom in others 108 accountability: agency problems in 234–235; of board 18; in performance evaluation, promoting 163–165 ACMF (ASEAN Capital Markets Forum) Implementation Plan 280n2 acquirers’ characteristics 64, 65, 66, 69, 70, 72, 74, 75 acquisition experience 67, 69, 72, 75 Adams v Cape Industries Plc 240 Adelphia Communications Corp 140n5, 145n65 ad hoc committees 90 advisory function of boards 327 Afribank 128 African countries; see also Kenya; Nigeria; South Africa: CG codes and 196; publicly listed companies in 333–339 African model 24–25 age, board composition/diversity and 331 agency costs of modern capitalism 299 agency framework 299 agency problems: in accountability and liability 234–235; in board effectiveness, in Indonesia 276; board size and 304, 307; in CG

and theory 17, 187; in CG in China 63, 74, 77; in institutions and board effectiveness 129, 136, 137, 144–145n59; role of board in 299; between shareholders and institutions 344, 345–347, 350, 354n1 agency theory 17, 298–299 all cash 67, 69, 72 all stock 67, 69, 72 Alternative Investment Management Association (AIMA) 152 American Apparel 297 Anglo-American model 20–22 annual general meeting (AGM) 268, 274–277 Annunzio-Wylie AML Act 257 anti-money laundering (AML) measures 253–263; compliance with 258–261; customer due diligence 259–260; examples of 256–257; reporting requirements 260; role for BoD of banks 261–263; sanctions 260–261; supervision 260 Anti-terrorism, Crime and Security Act 257 artificial intelligence 321 ASEAN (Association of Southeast Asian Nations) 268, 280n2 ASEAN Corporate Governance Scorecard 268, 280n2 Asian model 23–24 Association of Certified AML Specialists (ACAMS) 261–263 audit committee 87–88 Audit Committee Leadership Summit 118

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Australia, board director’s duties in 236–237 Australian Crime Commission (ACC) 253 Australian Criminal Intelligence Commission (ACIC) 259 Australian Securities and Investments Commission (ASIC) 132 Australian Transaction Reports and Analysis Centre (AUSTRAC) 248, 251, 256 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame 244n9 background checks, for recruitment 224 Bank for International Settlement 159 Bank of Credit and Commerce International (BCCI) 127, 140n5, 145n63 Bank of New York 254, 258 Bank PHB 128 Bank Secrecy Act 257 Barclays Bank Libor 140n5 Barings Bank 41, 140n5, 145n63 Basel Committee on Banking Supervision 168, 259–260 Basle Accord on Capital Adequacy 159 Bell Pottinger 97 benchmarking through voluntary clubs, regulatory 173–175 Better Regulation Commission 158, 168, 169 BIST companies 82, 85, 86, 93 Black Economic Empowerment (BEE) policy 195 BNP Paribas 254 board capital 155 board characteristics: in DEM boards 47–48; firm performance affected by 301; integrity 18 board charter (board manual) and code of ethics 273 board composition: age and 331; board effectiveness and 269, 271, 327–329; CEO, nature and role of 332–333; chair of board, roles and qualifications of 332; defined 319; in DEMs 46; diversity and 302–303, 326–341; experience/ qualification and 331–332; gender and 329–331; independent directors

and DEMs 328, 333, 335, 335, 337, 338, 339, 340; in Indonesia 269, 271, 288; introduction 326–327; organizational performance and 319; in publicly listed companies in Africa 333–339; roles of boards and 288; roles of directors and 220; skills and 53–54; structural issues 46; tenure limits and 220 board diversity 46–47, 192, 307, 328; age and 331; board composition and 302–303, 326–341; defined 329; ethnicity 53–54; experience/ qualification and 276–277, 331–332; gender 53–54, 329–331; professions 53–54; skills 53–54 board dynamics and diversity 46–47 board effectiveness: agency problems in 276; approaches to, in US, UK and Nigeria 135–138; background and introduction 127–129; board committees and firm value, correlation between 92–93; board committees in general 83–90; board composition and 269, 271, 327–329; board diversity and 329–332; board members and firm value, correlation between 92–93; BoDs in general 82–83; collectivism and 106–107, 377; committees and 81–93; in DEMs 48–50, 375–380; determinants of 133–135; director and 155–156, 157, 271–272; of directors 134–139; enhancing, introduction to 1–12; framework for institutional development of 129–131; FRC guidance on 133–134; good CG and firm value, correlation between 90–92; of independent directors 134–139; in Indonesia 267–280; in institutional environments 127–139, 350–351; levels of institutional development and change 131–133; minority shareholders and 83, 90, 92, 350–351, 352; in Nigeria 135–138; regulations and 81–82, 359–372; Tone at the Top and 111–121; in Turkey 81–93; in US, UK and Nigeria, approaches to 135–138 board independence 46, 270–271 board leadership 18, 106–108, 218, 332; see also board of directors (BoDs); director

Index board meetings: defined 98; directors’ role in 219; in Indonesia 272–273; informal connections outside of, value of 121; in Turkey 82 board nomination and remuneration 274–276 board of commissioners (BOC) 268–269 board of directors (BoDs) 30, 112, 268–269; AML measures for BoD of banks 261–263; in board effectiveness 82–83; good practice 30, 106, 360, 378; individualism in 97–109 board of parent entity 289–290 board of subsidiary 290–291 board qualification 276–277, 331–332 board removal 276 board role 17–20, 285–293; agency problems 299; board of parent entity 289–290; board of subsidiary 290–291; business groups 288–293; CG codes 187; chair of board 332; committees 220–221; in DEMs 42–44; director 19–20, 46, 155–156, 157; emerging market business groups 288–289; introduction 285–286; multinational enterprises in emerging markets 291–293; strategic 191 boards in DEMs 41–56; assessment of board effectiveness 48–50, 375–380; board characteristics 47–48; contemporary roles and duties of 42–44; diversity (skills, gender, professions and ethnicity) 53–54; emerging issues 50–54; features of 44–45, 45; governance structural issues 50–52; peculiarities and nuances of 45–50; risk and strategy, linking 52–53; structural issues 45–47 board size 66, 269 board system, two-tier 267–268 board tenure 273–274 board training 277–278 BoDs see board of directors (BoDs) Brazil, CG code provisions in 188 breach of duties 245n35, 363; lifting the veil of incorporation and directors’ liabilities 239–242; personal and collective liability for 238–239 Bribery Act 363 BRICS countries 50, 195–196

395

British Lawn Tennis Association’s Code of Conduct 30 Broad-Based Black Economic Empowerment (BBBEE) Act and Codes of Good Practices 330 BSI 254 business groups, board roles in 288–293; board of parent entity 289–290; board of subsidiary 290–291; emerging market business groups 288–289; multinational enterprises in emerging markets 291–293 Business Judgement Rule 235, 244n17, 345 Cadbury, Sir Adrian 341n1, 363 Cadbury Committee 341n1, 349, 363 Cadbury Nigeria Plc 128, 137 Cadbury Report 35, 140n8, 328–329, 341n1, 354n7, 363 candidates, for recruitment 224 Carbon Disclosure Project 171 carbon emissions 171, 214n3 Central Bank of Nigeria (CBN) 49–50, 56, 141–142n22, 220, 223, 230, 326, 331, 333 Centre for International Governance Innovation 60 CEO duality 66, 332–333 certification provisions 162 CG see corporate governance (CG) chair of board, roles and qualifications of 332 Chandler v Cape Plc 241 change, board members and 99–100 characteristics of boards in DEMs 47–48 Charter House Bank 254 chief executive officer (CEO) 46, 332–333 chief financial officer (CFO) 46 chief risk officer (CRO) 46 China, business growth and CG in 59–78; see also mergers and acquisitions (M&A); agency problems 63, 74, 77; CG code provisions in 188; CG mechanism 60–64; conclusions and policy implications 75–78; external CG environment 62–64; internal CG environment 60; political connections 61; state ownership and ownership concentration 60–61; system of CG 62; weak internal CG 62

396

Index

China, mergers and acquisitions in 64–75; cross-sectional regression model 65; data and sampling 64–65; descriptive statistics 68–70; distribution of M&A deals by calendar year 68; empirical modelling 65; empirical results and discussions 70–75; regression results 70–75, 72–73; summary statistics 69; theoretical background and research questions 64; variable definitions 65, 66–67 China Securities Regulation Commission (CSRC) 60, 62, 67, 69 China State-owned Assets Management Bureaucracy 61 City Code on Takeovers and Mergers 173 CIVITS countries 50 claw-back policies 262 Clinton, Bill 253 club membership disclosure 170–171 club theory 153–155; see also voluntary clubs Code of Best Practices for Corporate Governance in Nigeria 137 Code of Corporate Governance for Banks 50 Code of Corporate Governance for Banks and Discount Houses 141n18 Code of Corporate Governance for Banks in Nigeria PostConsolidation 141n18, 333 Code of Corporate Governance for Pension Operators 51 Code of Corporate Governance for Public Companies in Nigeria 43, 50, 141n18, 301, 326 code of ethics see ethics and conduct Code of Good Corporate Governance 267 Code of Good Public Governance 267 codes for boards of directors (BoDs) 30–37; see also ethics and conduct cognitive biases 102–105, 104 collective liability 238–239 collectivism: board effectiveness affected by 106–107, 377; defined 98; individualism compared to 99 Committee on the Financial Aspects of Corporate Governance 127, 363 committees 83–90, 278–279; ad hoc committees 90; audit committee

87–88; CG committee 88; of early detection of risk 89; firm value and, correlation between 92–93; formation of 84–87; nomination committee 89; remuneration committee 89–90; roles of 220–221; special purpose committees 90 committees, board effectiveness and 81–93; board committees in general 83–90; board members and firm value, correlation between 92–93; board of directors in general 82–83; good CG and firm value, correlation between 90–92; legal regulations 81–82 commonality corollary 103 communiqués 81–88 Companies Act 134, 139n1, 140n3, 163, 164, 236, 238, 243, 244n7, 317, 362–363 Companies and Allied Matters Act (CAMA) 46, 139n1, 219, 229, 230, 231, 237 Company Directors Disqualification Act 238 compensation committee 84, 164, 262, 279 competitive industry 65, 67, 69, 70, 73, 75 compliance, to CG codes 190–191 Compliance Committee 113 ‘comply or explain’ approach 3, 20–21, 31, 81–82, 84, 85, 89, 93, 136, 141n16, 146n79, 188, 189, 190, 193, 205, 214n2, 363 conditions of regulation 368–369, 370, 371 conduct see ethics and conduct conflict of interest 16, 54, 88, 120, 191, 218, 221, 230, 238, 279, 299, 314 construction corollary 103 contemporary roles and duties of boards in DEMs 42–44 contexts, board members creating shared 107 Continental European two-tier model 22–23 Cook v Deeks 238 corollaries 103 corporate directorships 244n7 corporate governance (CG): board effectiveness and committees 81–93; boards in DEMs, nature

Index of 41–56; business growth and 59–78; codes for BoDs 30–37; defined 41; directors’ performance evaluation and 151–175; firm value and, correlation between 90–92; individualism in BoDs 97–109; institutional investors versus individual shareholders, importance of 346–348; introduction 15–16; models of, in different CG systems 20–26; principles of 15–26; role of board in 17–20; theory and 16–17 corporate governance (CG) codes 184–197; advice and council 191; African countries 196; assessing efficacy of 34–36; board role and 187; for BoDs 30–37; BRICS countries 195–196; compliance to 190–191; in DEMs 187, 188–189; design dynamics of 192–193; development of 141n18; factors affecting efficacy of 32–34; introduction 184; monitoring and compliance 190–191; in Nigeria 141n18; NPOs 194; performance evaluation and 192; public sector organizations 194–195; resource provisions 191; role of board in 187; SMEs 193–194; strategy role 191; theoretical approaches to 185–187 corporate governance (CG) committee 88 Corporate Governance Index 65, 66, 71, 72, 83, 91 corporate personality 171–172 corporate scandals 1, 4, 41, 127–128, 130–132, 135–136, 138, 140n5, 152, 192–193 corporate social responsibility (CSR): in Africa 54; anti-CSR stance 308; CG compared to 51–52; corporate board in 297–298, 304–306, 308; defined 51; money laundering and 261, 262; reporting 203, 214n1; stakeholder theory and 192 Corporations Act 236–237 Counter-Terrorism Financing Act 256 credit crunch 77 cross-sectional regression model 65 CSMAR database 59, 65 CSR see corporate social responsibility (CSR) cultural evolution 132, 143n42

397

culture: individualism and 98–99; organizational 2, 112, 114, 115, 117–119, 191, 377 customer due diligence, in AML measures 259–260 cyber-security factors 321 data, in mergers and acquisitions 64–65 deal characteristics 64, 65, 67, 69, 70, 72, 74, 75 deal value 67, 68, 69, 72 Deloitte Report 48, 49, 84, 120, 220 Deloitte’s Director Alert 52 Deloitte survey conducted among LCSPs 292 DEMs see developing and emerging markets (DEMs) design dynamics, of CG codes 192–193 developing and emerging markets (DEMs): board characteristics 47–48; board composition 46; board duties 43–44; board dynamics and diversity 46–47; board effectiveness 48–50, 375–380; board structural issues 45–47; CG codes and 187, 188–189; contemporary roles and duties of 42–44; diversity (skills, gender professions and ethnicity) 53–54; emerging issues 50–54; ethics and conduct 36–37; features of 44–45; governance structural issues 50–52; issues, emerging 50–54; key economic/institutional differences between developed markets and 45; nature of 41–56; peculiarities and nuances of 45–50; risk and strategy, linking 52–53 DHN Food Distributors Ltd v Tower Hamlets 240 dichotomy corollary 103 director; see also corporate governance (CG) codes; independent directors: duties of 234–243; effectiveness of, determining 271–272; effectiveness of, regulation and 155–156, 157; interlocking directors 23, 289, 292; performance evaluation 151–175; role of 19–20, 46; selection by 217–232 Director’s Day 229 director’s selection 217–232; disengagement process and 226–231;

398

Index

induction process 225–226; introduction 217–218; need for boards and 218–219; on-boarding process 225–226; recruitment process and 221–225, 222; role of board committees 220–221; role of director in 219–220 disclosure in performance evaluation, limitations of 161–163; certification provisions and 162; eco-labels and 162; peer review and 161, 161–162 descriptive statistics, in mergers and acquisitions 68–70 disengagement process 226–231 disqualification 221 distribution of M&A deals by calendar year 68 diversification: deals 70; individualism and 99–100; low-cost, value of 345 diversifying acquisitions 67, 69, 72, 75 diversity see board diversity Dodd-Frank Act 214n3 do it yourself (DIY) questions 228 dominant logic, board members and 99–100 duties of director 234–243; breach of, liability for 238–239; introduction 234–236; lifting the veil of incorporation, directors’ liability and 239–242; recommendations and conclusions 242–243; in UK, US, Australia, South Africa, Germany, and Nigeria 236–237 dynamic managerial capabilities 100–101 EAGLE countries 50 early detection of risk, committee of 89 eco-labels 162 economic conditions, in DEMs versus developed markets 45 Egypt, CG code provisions in 189 emerging issues of boards in DEMs 50–54; board characteristics, peculiarities and nuances of 47–48; diversity (skills, gender, professions and ethnicity) 53–54; governance structural issues 50–52; risk and strategy, linking 52–53 emerging market business groups 288–289 empirical modelling 65 enforcement, in performance evaluation 172–173

Enron Corporation 41, 77, 97, 127–128, 136, 140n5, 140n7, 141n19, 145n63, 145n65, 184, 217, 297 enterprise-wide risk management (EWRM) 53 environmental, social and governance (ESG) issues 321 Equality Act 363 Equitable Life 97, 145n66 essence, board members and: communicating 107–108; grasping 107 ethics and conduct 30–36; assessing efficacy of 34–36; code of 273; in DEMs 36–37; factors affecting efficacy of 32–34; individualism in BoDs and 101–102 ethnicity, diversity and 53–54 European Banking Federation (EBF) 152 European Commission 168, 359 European Union (EU) 22, 32, 193, 249, 318, 363 European Union Eco-Management and Audit Scheme 209 executive shares 66, 69, 72 family-owned businesses (FOBs) 5, 44, 54 FCA Disclosure and Transparency Rules 372n5 FCA Prospectus Rules 372n5 features of boards in DEMs 44–45, 45 federal character principle in appointment 54 female representation on boards: effect of 330; in Kenya 337–338, 338; in Nigeria 333, 334, 339; in South Africa 336, 339 Ferguson v Wilson 243–244n7 fiduciary duty 167, 220, 238, 361 Financial Action Task Force (FATF) 249, 251, 253 financial and social performance of firms 297–309; agency theory 298–299; board characteristics and effect on firm performance 301; board composition/diversity 302–303; board expertise 301–302; board in CSR and sustainable development 304–306; board size 303–304; CEO duality 301; code of corporate governance 300–301; discussion and

Index implications 307–308; introduction 297–298; stakeholder theory 300; stewardship theory 299–300 Financial Conduct Authority (FCA) 257, 372n5 financial crime see money laundering Financial Intelligence Centre Act (FICA) 248, 257, 260 financial intelligent unit (FIU) 248, 256, 257, 260 Financial Reporting Council (FRC) 3, 52, 127, 132–133, 134, 137, 140n6–7, 190, 192, 360, 361, 364 Financial Services Authority 268 Financial Transactions & Reports Analysis Center of Afghanistan (FinTRACA) 256 Financial Transactions & Reports Analysis Centre of Canada (FINTRAC) 256 Finbank 128 firm size 65, 66, 69, 72, 74, 303 firm value: committees and, correlation between 92–93; good CG and, correlation between 90–92; transmission of, voluntary clubs and 158–160 Football Association 170 Forensic Services Fraud, Corruption, and Business Ethics 113–114 formation of committees 84–87 France, CG code provisions in 189 Futures and Options Association 152 gender, board composition/diversity and 53–54, 329–331 geographical focus 65, 67, 69, 72 German Civil Code (BGB) 237 German Commercial Code (HGB) 237 Germany, board director’s duties in 236–237 Gilford Motor Co Ltd v Horne 240 global financial crisis, 2007–2008 1, 52, 55, 140n4, 159, 227 Global Financial Markets Association 152 Global Reporting Initiative (GRI) 208–209 goodness, judging 107 good practice 30, 106, 360, 378 Governance and Remuneration committee 220 governance structural issues, in DEMs boards 50–52

399

Gramophone and Typewriter Ltd v Stanley 244n9 Greenhouse Gas Rules 214n3 Group of Thirty 152 groupthink 105–106, 191 grundnums 143n45 G20 267 G20/OECD Principles of Corporate Governance (OECD) 151, 152, 158, 161, 164–165, 170, 174 Guidance on Board Effectiveness (Hogg) 3 Guideline on Establishment of Independent Director System in Listed Companies (CSRC) 62 habituation 365 habitus 365, 366 Haude, Jeffrey 261 HBOS 145n69 headquarters havens 258 hedge funds 354n HIH Insurance Company 128 HIH Royal Commission 141n11 Hippocratic Oath 30 ‘History of the UK Corporate Governance Code’ (Financial Reporting Council) 140n6 Hogg, Baroness 3 human capital 47, 75, 155, 160, 306 human interactions 129, 143n43 illusion of control bias 103–104 İMKB 88, 91, 93 impunity 354n10, 361 independence in Japan, concept of 193 independent body 115 independent directors: agency theory 298; board composition and DEMs 328, 333, 335, 335, 337, 338, 339, 340; board effectiveness 134–139; board models 21, 23–24; Chinese system of corporate governance 62, 66, 69, 71, 74; code provisions 188–189, 190–191, 190–193; defined 66; Guideline on Establishment of Independent Director System in Listed Companies (CSRC) 62; Indonesia 270, 271, 274; remuneration in DEMs 317; selection, on-boarding, and disqualification 218–222; theoretical approach to CG 185–186; Tone at the Top 120;

400

Index

Turkish system of corporate governance 83; voluntary clubs 160 Independent Directors Council (IDC) 220, 221–225 India, CG code provisions in 188 individualism, in BoDs 97–109; abilities and 107–108; change and 99–100; cognitive biases and 102–105, 104; collectivism compared to 99; culture and 98–99; definitions, overview of 98; diversification and 99–100; dominant logic and 99–100; dynamic managerial capabilities and 100–101; ethical considerations and 101–102; future of board leadership and 106–108; groupthink and 105–106 individuality corollary 103 individual responsibility 171–172 Indonesia: board charter (board manual) and code of ethics 273; board committees 278–279; board directorship 271–272; board effectiveness in 267–280; board independence 270–271; board meetings 272–273; board meetings in 272–273; board nomination and remuneration 274–276; board performance assessment 278; board qualification 276–277; board removal 276; board size 269; board tenure 273–274; board training 277–278; CG assessment 268–269; introduction 267; two-tier board system 267–268 Indonesian Financial Transaction Reports and Analysis Center (INTRAC) 256 Indonesia Stock Exchange (IDX) 9, 271, 274, 280 induction process 225–226 Institute for Works Religion (IOR) 255 institutional conditions, in DEMs versus developed markets 45 institutional economics: new 130–131, 133, 137, 142n27, 154; old 130–131, 142n27 institutional investment: agency problems 344, 345–347, 350, 354n1; CG importance of institutional investors versus individual shareholders 346–348; institutional environment and board

effectiveness 350–351; introduction 344–345; ownership mix between individual and institutional investors 345–350; shareholder activism via institutional investment 348–350; trends of ownership patterns and pension fund growth across countries 347; ways forward 351–353 Institutional Shareholders Committee (ISC) 349 institutional shares 66, 69, 71, 72 institutions, board effectiveness and 127–139; approaches to, in US, UK and Nigeria 135–138; background and introduction 127–129; determinants of 133–135; framework for institutional development of 129–131; FRC guidance on 133–134; levels of institutional development and change 131–133 insurance firms 344, 348, 354n3 integrated corporate governance report (ICGR) 208 integrated reporting (IR) 210–212 integration stage of money laundering 252 integrity, of board 18 Intelligent Reform and Terrorism Prevention Act 257 Intercontinental Bank 128 interlocking directors 23, 289, 292 international best practices 135, 142n25, 160, 193, 196, 272 International Ethics Standards Board of Accountants 30 International Financial Reporting Standard (IFRS) 206, 208 International Integrated Reporting Council (IIRC) 209–212 International Netball Federation AntiCorruption Code 30 International Organisation for Standardisation (ISO) 155, 162, 209 international reporting initiatives and challenges 208–212 International Swaps and Derivatives Association (ISDA) 152 interviews, for recruitment 224 Investment Management Association 152 issuers 268–272, 275–277, 279, 280n1, 326

Index Jones v Lipman 240 judging goodness, board members and 107 Jurado-Rodriguez, Franklin 255 keiretsu 20, 23, 24 Kenya: female representation on boards in 337–338, 338; independent directors on boards in 339; non-executive directors on boards in 338; publicly listed companies in 337–338, 338 King (III) Code of Corporate Governance 211, 326 King (IV) Code of Corporate Governance 143n55, 326 King Reports on Corporate Governance 196; King III report 214n2; King IV report 42, 43–44, 48, 49, 54, 143n55, 217, 333 know your customer (KYC) policy 259–260 layering stage of money laundering 251 Lead Client Service Partners (LCSPs) 292 leadership see board leadership; board of directors (BoDs); director Lehman Brothers 145n63, 297 leverage 65, 66, 69, 70, 72, 74, 185, 303, 366–367 Leveson Inquiry 165 Lexi Holdings Plc (in administration) v Luqman & Ors 238 liability: agency problems and 234–235; breach of 238–239; cases on 238–239; collective 238–239; lifting the veil of incorporation 239–242; limited 9, 81, 171–172, 234, 242, 243n3, 267–268, 280n1; personal 238–239 Liberty Reserve 254 licensing 169, 170 lifting the veil of incorporation 239–242 limited liability 9, 81, 171–172, 234, 242, 243n3, 267–268, 280n1 Limited Liability Act 243n3 Listing Rules 363, 372n5 Littlewoods Mail Order Stores v IRC 240 Lloyds Group 145n69 Local State-owned Assets Management Bureau (LSAMB) 61

401

London Club 153 London Energy Brokers’ Association 152 M&A see mergers and acquisitions (M&A) Manslaughter and Corporate Homicide Act 363 Marcos, Ferdinand 255 market-book ratio 65, 66 Mauritius, CG code provisions in 189 Maxwell, Robert 166 Maxwell Communication Corporation Plc 127, 140n5, 145n63, 363 MB ratio 67n1, 68, 69, 74, 75 MCA Records Inc v Charly Records Ltd (No 5) 242 mergers and acquisitions (M&A) 64–75; cross-sectional regression model 65; data and sampling 64–65; descriptive statistics 68–70; distribution of deals by calendar year 68; empirical modelling 65; empirical results and discussions 70–75; regression results 70–75, 72–73; summary statistics 69; theoretical background and research questions 64; variable definitions 65, 66–67 minority shareholders 16, 25; in CG and business growth 62–63, 74; on committees, board effectiveness and 83, 90, 92; in DEMs 48, 51; in Indonesia 274–275; in institutional environment, board effectiveness and 350–351, 352; multinational 290–291 MINTS countries 50 Model Articles 243–244n7 models of CG 20–26; African model 24–25; Anglo-American model 20–22; Asian model 23–24; conclusions and areas for further research 25–26; Continental European two-tier model 22–23 Modern Slavery Act 363 money laundering 249–263; see also anti-money laundering (AML) measures; consequences of 253; financial institution roles in, possible remedies and 259; integration stage of 252; layering stage of 251; notable case of 254–255; origin and

402

Index

underlying theories of 249–251; placement stage of 251; regulations 257; sources of soiled money needing laundering 252–253; twintrack or twin-pillar approach 259 Money Laundering and Financial Crimes Strategy Act 257 Money Laundering Control Act 257 monitoring, of CG codes 190–191 MTN-Nigeria 97, 352 multinational enterprises in emerging markets 291–293 mutual fund shares 254n3 National Code of Corporate Governance for the Private Sector in Nigeria 141n18, 143n55 National Committee on Governance (NCG) 267 National Insurance Commission (NAICOM) 50 neo-classical economics 130–131, 142n28 new institutional economics 130–131, 133, 137, 142n27, 154 Nigeria: board director’s duties in 236–237; board effectiveness in 135–138; CG code provisions in 189; codes of CG in 141n18; corporate regulation in 141n17; female representation on boards in 333, 334, 339; independent directors on boards in 333–335, 335; non-executive directors on boards in 333, 334; publicly listed companies in 333–335, 334–335 Nigerian Pension Commission (PENCOM) 51 Nigerian Stock Exchange (NSE) 333 Nixon, Richard 249 Noel v Poland 242 nomination committee 89 non-executive directors (NEDs) 219, 334, 336, 338 non-for-profit organizations (NPOs) 194 Obaze, Jim 52 Oceanic Bank 128–129 O’Donnell v Shanahan 238 OECD Principles of Corporate Governance 267 offshore shell banks 255

old institutional economics 130–131, 142n27 on-boarding process 225–226 ordinary least squares (OLS) regression analysis with clusters 65 organizational culture 2, 112, 114, 115, 191, 377; defined 6, 117; Tone at the Top and 117–119 organizational performance 319 Otoritas Jasa Keuangan (OJK) 9, 268–280; see also Indonesia Owen, Neville 141n11 ownership pattern, shift in 344–345, 354n4 ownership structure 59, 61, 63, 69, 69, 71, 72, 76 Parmalat 140n5 Patriot Act 248 peculiarities and nuances of boards in DEMs 45–50; assessment of board effectiveness 48–50; board characteristics 47–48; board structural issues 45–47 peer review 161, 161–162 pension funds 344, 345–346, 347, 349, 354n3 performance evaluation 151–175; accountability in, promoting 163–165; board directorship and 156–158, 157; certification provisions and 162; CG codes and 192; club membership disclosure 170–171; directors’ 151–175; disclosure in, limitations of 161–163; disengagement process and 226–229; eco-labels and 162; enforced components of 165–173, 169; individual responsibility 171 – 172; in Indonesia 278; introduction 151–153; licensing 169, 170; peer review and 161, 161–162; voluntary clubs and 156–158, 157 personal and collective liability 238–239 placement stage of money laundering 251 Policy Framework for Investment (OECD) 152 political power, of board members 108 Polly Peck International 77, 140n5, 145n63, 363

Index PPATK 256 pre-nuptial agreements 231 Press Complaints Commission 165 Prest v Petrodel Resources Ltd 241 Prevention of Money Laundering Act (PMLA) 256 preventive track 259 PricewaterhouseCoopers LLP (PWC) 114 principal–principal agency problem 16, 25, 349 Principles of Corporate Governance VI 143–144n55 Private Limited Companies Act (GmbHG) 237 private target 65, 67, 69, 70, 72 Proceeds of Crime Act 256, 257 Proceeds of Crime (Money Laundering) Act (PCMLA) 256 Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) 256 productive havens 258 product market competition 65, 67, 69, 70–71, 73, 75 professions, diversity in 53–54 pro-rata ownership 254n3 publicly listed companies in Africa 333–339; Kenya 337–338, 338; Nigeria 333–335, 334–335; South Africa 335–337, 336 public sector organizations 194–195 Re AG (Manchester) Ltd Official Receiver v Watson & anor 239 Re Bugle Press 240 recruitment process criteria 221–225, 222; conduct background checks 224; create shortlist 224; define search criteria 222; find the right “fit” 224; identify candidates 224; interviews 224; taking time in 224–225 Re Emerging Communications Inc. Shareholders Litigation 245n35 Regal (Hastings) Ltd v Gulliver 238 regression results, in mergers and acquisitions 70–75, 72–73 regulations: board effectiveness and 81–82, 359–372; BoDs 361–362; conditions of regulation 368–369, 370, 371; directors’ role in 155–156, 157; introduction

403

359–361; money laundering 257; regulatory framework, overview of 362–365; reporting companies and 203–204; situated firm and differences 365–368 related party transactions 24, 65, 67, 69, 70, 72, 74, 82 remuneration committee 89–90 reporting by companies 202–214; in AML measures 260; development of 203–206; international reporting initiatives and challenges 208–212; introduction 202–203; legal regulations 203–204; styles in 206–208 Reports on Observance of Standards and Codes (ROSC) 268 repressive or enforcement track 259 research questions, in mergers and acquisitions 64 resource dependence theory 155, 287 resource provisions, CG codes and 191 retirement accounts 344 return on assets 65, 66, 69, 70, 72, 74, 301, 302, 303 right “fit,” for recruitment 224 risk: capacity 53; committee of early detection of risk 89; exposures 121; management system 121; profile 53, 121; strategy and, linking 52–53; tolerance 53, 121 Russia, CG code provisions in 188 sales growth 65, 66, 69, 72 Salomon v Salomon & Co Ltd 240, 243n3 sampling, in mergers and acquisitions 64–65 sanctions, AML measures and 260–261 Sani Abacha 255 Sarbanes-Oxley Act 21, 136, 140n9, 193, 214n3 SEC Code of Corporate Governance for Public Companies 43, 50, 141n18, 301, 326 secrecy havens 258 Secretary of State for Business, Innovation and Skills v Drummond 238–239 Securities and Exchange Commission (SEC): Nigeria 43, 50, 141n18, 301, 326; US 21

404

Index

Securities Exchange Act, US 136, 140n9, 143n55, 145n66 self-assessment questions 228 self-regulatory measures 161, 167 separation of ownership and control 15, 16, 134, 144–145n59, 237, 242, 314 service function of boards 327 sham havens 258 shareholders; see also minority shareholders: agency problems 344, 345–347, 350, 354n1; CG importance of institutional investors versus individual shareholders 346–348; institutional environment and board effectiveness 350–351; institutional investment and 344–354; introduction 344–345; ownership mix between individual and institutional investors 345–350; shareholder activism via institutional investment 348–350; trends of ownership patterns and pension fund growth across countries 347; ways forward 351–353 shift in ownership pattern 344–345, 354n4 shortlist, for recruitment 224 Sir Adrian Cadbury Committee 341n1, 349, 363 skills, board composition/diversity and 53–54 small and medium enterprises (SMEs) 193–194 Smith v Van Gorkom 239 sociality corollary 103 South Africa: board director’s duties in 236–237; CG code provisions in 189; female representation on boards in 336, 339; independent directors on boards in 335, 337; non-executive directors on boards in 336; publicly listed companies in 335, 336 South Africa Companies Act 237 South African King IV Code on Corporate Governance 143n55 special purpose committees 90 Spring Bank 128 stakeholder capital 306 stakeholder theory 17, 192, 300 Standard Bank 254 Standard Chartered 254, 262 Standards Relating to Audit Committees 140n9

State Economic and Trade Commission 60 State of Delaware Code, Title 8 244n7 state-owned businesses (SOEs) 5, 44, 54 state shares 66, 69, 71, 72 Steinhoff International 97 stewardship theory 17, 299–300 Stock Corporation Act (AktG) 237 stock price run-up 65, 66, 69, 72, 74 strongmen/women 25 structural issues, in boards of DEMs 45–47 structural issues in boards 45–47; board composition 46; board dynamics and diversity 46–47 structure, defined 366 summary statistics, in mergers and acquisitions 69 Supreme Court of Nigeria 128–129 sustainability, of board 18 sustainable development: corporate board in 298, 304–306, 308; governance structural issues and 51–52; NPOs in 194 sustainable investing 51 SWIFT 251 system, defined 366 Takeover Panel 166, 173 tax havens 258 term limits 223 Terrorism Act 257 Tesco Plc 146–147n87 theoretical approaches to CG 16–17, 298–301; agency theory 17, 298–299; club theory 153–155; codes 185–187; in mergers and acquisitions 64; of personal constructs 102–103; of process of money laundering 251–252; stakeholder theory 17, 192, 300; stewardship theory 17, 299–300 Tone at the Top 111–121; board effectiveness and 114–117; conceptual framework 115; defined 112; improving, strategies and recommendations for 119–121; organizational culture and 117–119 Towcester Racecourse Co Ltd v Racecourse Association Ltd 244n9 Towers v Premier Waste Management Ltd 235, 238 Transnational Auditors Committee 111 transparency 258

Index

405

United States (US): board director’s duties in 236–237; board effectiveness in 135–138; statutory approach to CG 141n16 United States Securities Exchange Act 136, 140n9, 143n55, 145n66

Transparency Corruption Perception Index 55 triple bottom line 206 Trustor AB v Smallbone 240–241 Turkey, board effectiveness and 81–93; board committees and firm value, correlation between 92–93; board committees in general 83–90; BoDs in general 82–83; committees and 81–93; good CG and firm value, correlation between 90–92; introduction 81; legal regulations 81–82 Turkish Commercial Code (TCC) 81–90, 92 twin-track or twin-pillar approach 259 two-tier board system 267–268 Tyco Int’l Ltd 140n5

variable definitions, in mergers and acquisitions 65, 66–67 Volkswagen car emissions scandal 171 voluntary clubs 151–175; see also performance evaluation; benchmarking through, regulatory 173–175; club theory and 153–155; directors’ effectiveness, regulation and 155–156, 157; introduction 151–153; self-regulatory measures and 161, 167; transmission of CG values and 158–160

UK Border Agency 170 UK Corporate Governance Code 3, 11, 30–36, 136, 140n8, 143–144n55, 172, 244n26, 360, 363, 368, 372n5 UK Listing Authority (UKLA) 372n5 UK Model Articles 243–244n7 UK Takeover Panel 166, 173 UN Global Compact 155, 160, 161, 170, 208, 209 Union Bank 128 unique industry 65, 67, 69, 70, 73, 75 United Kingdom (UK): board director’s duties in 236–237; board effectiveness in 135–138; CG code provisions in 189; ‘comply or explain’ approach to CG 141n16

Watergate scandal 249 Wholesale Market Brokers’ Association 152 Williams v Natural Life Health Foods Ltd 241–242 wisdom in others, board members and 108 Wolfensohn, James D. 52 World Bank GDP Ranking 141n17 World Bank Governance Indicator (WGI) 55 WorldCom 41, 97, 140n5, 140n7, 145n63, 145n65, 217 Worldwide Interbank Financial Telecommunication (SWIFT) apparatus 251