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Gauging Corporate Governance Compliance

Date: 17 Sep 2015
Author: El Husseiny, Yehia
Corporate Governance has been rendered one of the most momentous topics being mooted in the aftermaths of the global financial crisis. The importance apparently amplified after the monetary shocks that had convulsed the developed economies, following strings of business scandals, which highlight serious governance weaknesses in corporations.   There has been prodigious lack of transparency and disclosure, even down to the manipulation of financial data and statements. These issues were never up to recent years expectedly to occur even in some of the budding economies.   The World Bank highlighted in its 2014 regional economic update that many countries in the Middle East and North Africa (MENA) will start to benefit from stronger external demand in the high-income economies, as the global economy was set for a rebound, however, the report also underlined the biggest risk to the outlook for an economic recovery in MENA is that overdue structural problems will remain unresolved. MENA countries share many structural problems that have been preventing their economies from moving to a higher and sustainable growth path.   In a recent global survey “Investors Debunk The Myths”, conducted in June 2015 by the CFA institute, explaining how investors view environmental, social, and governance (ESG) issues and the role ESG play in their investing process, the findings revealed that 82% of the respondents (portfolio managers and research analysts) from Europe, Middle East, and Africa (EMEA) take ESG into account in their investment analysis and decisions, where 74% are attributed to governance, 58% to environmental, and 57% to social related matters. The survey has also shown that the top three factors in terms of importance to investment analysis and decisions are; board accountability (78%), human capital (62%), and executive compensation (61%).   The Arabic Republic of Egypt, one of the leading countries in the MENA region and Arab states, and also one of the main countries affected from the Arab Spring, has just begun to establish a stable political environment with the recently elected president, and the country poised for parliamentary elections by end-2015 to establish a permanent regime; the country’s economy is finally beginning to see the benefits. The Egyptian stock market soared after presidential elections and efforts by the government to promote investment in a struggling economy trying to recover after four years of political unrest. According to Matthew Martin (2015) the benchmark EGX 30 Index climbed 11 percent in early 2015, making it the third-best performing exchange in local currency terms. The newly introduced reforms have also been praised for fostering recent economic growth in the IMF’s first assessment of the country since 2011. The 2014/2015 fiscal year growth forecasts have been raised to 3.8 percent, and an annual increase of five percent is predicted for the medium term economic growth as described by Asa Fitch and Tamer El-Ghobashy (2015).   While the outlook for the country is positive, the country ranked 135 in protecting minority investors with the indicators on strength of governance structure scoring 1.5 (on a 0-10.5 index) and shareholder governance scoring 4.2 (on a 0-10 index) according to the Doing Business Report, Workd Bank (2015).   Egypt attempted to set up and developed corporate governance code for listed companies. The National Committee of Governance formed under the Ministry of Investment, the Egyptian Capital Market Authority (now called Egyptian Financial Supervisory Authority, EFSA), and with the support of the World Bank and the International Finance Corporation (IFC), promulgated in 2005 one of the very first codes in the region for listed companies, and a revised version of the code was published in 2011 transforming the code from voluntary to comply/explain requirement. Albeit the promulgation of the code, and the recently revised listing rules and regulations of the Egyptian Stock Exchange in 2014 that included a dedicated chapter on corporate governance requirements – known as ‘chapter four’ among corporate governance practitioners and professionals – numerous challenges still remain and the road ahead appears to be rocky. There is no clear methodology to follow and there are no tools available to, or used by, the regulator to i) monitor the compliance to the governance rules and requirements, ii) incentivize companies to instill governance, iii) impose fines on non-compliant companies.   Market players (companies, regulators, etc.) need to reassure investors, both domestic and international alike, that they are equipped to weather any potential economic/political instability. Good corporate governance structures and practices help in boosting investor confidence and reassuring shareholders that their capital is protected by true systems of governance. Corporate Governance Codes encourage private sector commitment to good corporate governance and provide clearer guidance for financial and nonfinancial disclosure, foster better engagement of minority shareholders, and clarify the roles of managers and directors.   Since the early 1990s, more and more countries have adopted governance codes. The pace picked up with the groundbreaking work of the Organization for Economic Co-operation and Development (OECD) in the late 1990s and became a major trend. In MENA, several initiatives resulted in the development of country corporate governance codes and in the making process numerous consultations were facilitated and corporate governance task forces were formed in many countries around MENA with the support of local and international organizations, professionals, and experts. Compliance with these codes is not always mandated by law, though companies are often required to disclose the extent of their compliance. In MENA, out of the 30 corporate governance codes, 11 are mandatory 13 are voluntary and 6 are based on comply or explain approach.   As it occurred in many parts of the world, especially in Asia, the next eventual step should be measuring how far companies, particularly the publicly listed ones, are complying with the corporate governance rules and regulations, listing requirements, code provisions, and whether the enforceability of such governance body of rules can be reflected in the performance of companies.   Corporate Governance Diagnostic Scorecards, which have been inspired by the experience of private sector investors assessing fulfillment of national codes provisions, emerged as a means to encourage compliance, assessing companies’ governance practices and providing opportunities for systematic improvement. Emerged for the first time in Germany in the late 1990s, corporate governance scorecards rapidly came out in early 2000s as one solution for investors and analysts who sought a tool to assess the quality of a company’s governance, which would guide them in making investment decisions. To date, only two countries in MENA launched their corporate governance diagnostic scorecards, namely Jordan and Palestine.   Typically, the governance scorecard criteria are tied to a national corporate governance code, the governance diagnostic tool draws the attention of the board and senior management to the value of improving the company’s corporate governance practices. For investors, the governance scorecard aids in making well-informed decisions, because it helps with monitoring adherence to good practices and determining whether any improvements have been achieved. Regulators use the scorecard to diagnose weaknesses in their country’s overall corporate governance framework and its implementation, they can determine whether to provide additional guidance, amend existing or introduce new regulations. Regulators can also target their enforcement efforts based on the governance scorecard results.   There are strong evidence in research conducted worldwide that examined the causal relationship between corporate governance compliance and financial performance of publicly listed companies. Accordingly, corporate governance scorecard, as a generally accepted tool, can help gauging governance compliance and presenting indication to what extent companies in MENA are in compliance with corporate governance rules and regulations and to what extent companies are in compliance with corporate governance international best practices beyond what is required by law.   ______________________________________________________ REFERENCES: – Asa Fitch and Tamer El-Ghobashy (2015). Reforms Produce Results for Egypt, Wall Street Journal. Retrieved from http://www.wsj.com/articles/reforms-produce-results-for-egypt-1423660800 -CFA Institute (2015). ESG Issues in Investing: Investors Debunk the Myths. Retrieved from http://www.cfainstitute.org/learning/products/publications/contributed/Pages/esg_issues_in_investing__investors_debunk_the_myths.aspx – Gillan, S. L., & Starks, L. T. (1998). A Survey of Shareholder Activism: Motivation and Empirical Evidence. Contemporary Finance Digest, 2(3), 10-34. – Gompers, P., Ishii, L and Metick, A (2003). Corporate Governance and Equity Prices. Quarterly Journal of Economics, Vol.118, pp.107-125. – International Finance Corporation (2014). Developing Corporate Governance Codes of Best Practice Toolkit, Corporate Governance Scorecard Supplement. Retrieved from http://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/corporate+governance/publications/toolkits+and+manuals/corporate+governance +scorecards – Matthew Martin (2015). Middle East M&A Activity to Increase This Year on Egypt, EY Says. Bloomberg. Retrieved from http://www.bloomberg.com/news/articles/2015-02-09/middle-east-m-a-activity-to-increase-this-year-on-egypt-ey-says – Mayer, C (1999). Corporate Governance in the UK. University of Oxford, Conference on Corporate Governance: A Comparative Perspective. – Morck, R., Shleifer, A. and Vishny, R. (1989). Alternative Mechanism for Corporate Control. American Economic Review, Vol. 79, pp.41- 56. – Mottaghi, Lili, Devarajan, Shanta. 2014. Harnessing the global recovery: a tough road ahead. MENA regional economic update. Washington, DC: World Bank Group. http://documents.worldbank.org/curated/en/2014/04/19335869/regional-economic-update-harnessing-global-recovery-tough-road-ahead – World Bank (2015). Doing Business, Measuring Business Regulations. Retrieved from http://www.doingbusiness.org

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