ZimCode Secretariat
Key messages:

  • Apply or explain approach
  • Application of the mind in governance process
  • Role of outsiders in governance
  • Personal Integrity and Ethical leadership

Chapter 7 of the ZimCode talks about compliance and enforcement of the code. In our first chapter (series 1), we established that the ZimCode takes the “apply or explain” approach to corporate governance. We explained that it is a soft regulation which encourages individuals and corporates to take responsibility and ownership of corporate governance.Entities are given a set of standards to follow, but they’re not mandated to comply with everything. They have the liberty to choose principles that apply to their entities. However, they are expected to explain and be able to justify the reasons behind their choices. This gives flexibility to companies to apply corporate governance principles with the understanding that “one size does not always fit all”.

Going a step further, it has to be understood that companies should not just be content with the quantitative application of corporate codes, but should be able to analyse if these applications are resulting in meaningful benefits to their entities and stakeholders, which is the ultimate reason for having these codes.

The benefits to a company of practising good corporate governance are well known. It can raise capital more cheaply in a world where capital is a scarce resource; when it has a downturn it will have support from its stakeholders in its turnaround attempt; its business will be more sustainable, it is better equipped to manage risk; its reputation is enhanced, the list is endless.

But the question remains, does every company that applies corporate codes enjoy these benefits?

Does it follow that a company which religiously follows the guidelines of corporate governance code is practising good governance? Unfortunately, the answer to both questions is a big no. There might not be a straight forward answer to these questions because circumstances vary but here are some important insights.

Some companies can be so obsessed with the application of the guidelines of the code and forget to define what they really want to achieve through its application. The company can even appoint compliance officers to tick off the company’s compliance with the guidelines.

The compliance officer goes on to report to the board that there has been compliance. Yet without application of the mind by the board as to whether it is governing in an acceptable manner this will just be another mindless occupation.

It does not follow that if there has been a pure quantitative compliance with a code’s guidelines, the company is being well governed. Of course there are certain basics which have become necessary in the governance of companies such as outside directorship, committees of the board and so forth.

Apart from these basic principles, other things can be altered depending on the needs of the company. What is essential for good governance is that directors apply their minds as to which governance processes are in the best interests of the business of the company.

Apart from the Board, outsiders looking into the company can assess whether the company is being well governed or not hence their views should not be ignored. At times these outsiders, i.e. the market, investors and stakeholders can be the ultimate compliance officers who determine whether a company is being well governed or not.

When directors who are duty bound to apply their minds as to the guidelines which are most suited for the business of the company believe that non-compliance with a guideline is in the interest of the company and they explain it, the ultimate test should be how the outsiders receive their decision. If investors and other stakeholders continue to support the company then the question answers itself.

However, there are certain instances where the outsiders can be fooled. We can take for example, what Enron did for a while with all its superfluities of good governance yet it was dysfunctional.

Over a long period of time Enron used this facade of good corporate governance to create a stable basis for more corruption. Its financial condition was sustained by institutionalised, systematic, and creatively planned accounting fraud https://en.wikipedia.org/wiki/Accounting_scandals. There was scepticism in the market about Enron’s profitability and its cash position. Suspicions grew that Enron’s earnings had been manipulated and it emerged that its chief finance officer had privately made himself rich at Enron’s expense through the off-balance sheet vehicles.

Enron’s share price then rapidly declined, triggering repayment clauses in the financing vehicles which Enron couldn’t handle. Banks refused further finance, suppliers refused to supply and customers stopped buying and Enron had to file for bankruptcy.

Enron’s experience showed that outsiders cannot be fooled all the time. In the end it is the evaluation of the quality of the governance by the company’s ultimate compliance officer, the outsiders, that is important. Once they second guess your company, then it’s done for good.

The Enron scandal also brings out the ethical issues in corporate governance that every company has to take cognisant of. The behaviour of top management at Enron who rewarded themselves with high incentives and developed an amoral and unethical culture in which customers, suppliers and even colleagues were misled and exploited to achieve targets shows that simply applying the guidelines of corporate codes is not enough.

There is need to focus on cultivating a culture of good people, in which personal values are aligned with the principles of the code and embedded in the mind of the people, instead of focusing on corporate governance codes only. Personal integrity and ethical leadership is not something that a company will achieve by implementing the code but it is the individuals within that company who must actively cultivate these from within themselves. It must be their way of life such that corporate governance rules, regulations and guidelines are simply reinforcing principles that are already embedded in their minds.

 

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