The British government introduced Higgs combined code in the corporate sector for listed companies last year. One of the most important recommendations contained in that code was to ensure that the positions of Chairman and Chief Executive Officer are split in two individuals and no one individual is responsible for these two functions.
In addition to this, it was also thought in the best interest of all stakeholders that the chairman should be an independent personality and does not represent any group of shareholders so that he could apply his mind independently and act as a co-ordinating force between executive and independent non-executive directors.
It was also realised that this independence should be able to safeguard the interests of other stakeholders in case the CEO and other executive directors or any member of the senior management are not available or do not respond to the questions raised by the other stakeholders.
The Higgs Combined Code states that the appointment of chairman should meet the test of independence and the criterion set for defining independence has also been set by the code.
It further requires that he should not be a prior Chief Executive of the same company. If this arrangement is not in place, the board should designate one senior independent Director who would be available to the shareholders, should the chairman or Chief Executive Officer be unapproachable or is non-responsive.
The split of these positions should remain in place even if the position of Chairman meets the standards of independence.
In Britain splitting these two positions is very common contrary to the practice in Pakistan. It has been estimated that five out of FTSE 100 companies and 11 percent of companies outside FTSE 350 have a joint Chairman and Chief Executive as stated by Non-Executive Directors Team data analysis contained in the Higgs Review itself.
Only twenty-four FTSE 100 Chairmen were formerly Chief Executives of the same company. This is a small number if compared with the United States where the trend continues to be of combining the two roles together.
In the United States, almost 80% of the companies listed with S and P 500 have combined the roles of these two positions. The remaining 20% have split positions and the chairman remains an outsider.
Many of the split positions among these 20% were due to mergers of companies where the senior-most positions were eliminated. Now there is strong evidence that many companies listed with S and P 500 and Forbes 500 are in the process of splitting these positions due to corporate government requirements.
There is also strong indication that companies outside these two groups are also in the process of splitting these positions.
This shift seems to be the result of strong pressures being exerted by regulators, shareholders and other stakeholders to improve this area of corporate governance.
It has been estimated that in the United States almost 27 shareholders' resolutions have been presented to the companies forcing the management of these companies to split these two positions.
The objective behind this split is to provide greater accountability of management to shareholders and to provide more independent oversight of management, including CEO by board of directors.
The Securities and Exchange Commission in the United States showed a very responsive attitude towards these resolutions and favoured a separation.
According to a survey published in 'The Times of October 31, 2003, majority of directors favour a split of these two positions. 70% of 180 US directors representing 500 companies felt that the roles should be split and 72% were in favour of appointing a lead independent director.
The splitting of these two positions is being regarded as an important element of good corporate governance and that is the reason that most emphasis is being placed on this issue all over the world.
ROLE OF CHAIRMAN: The chairman and the Chief Executive collectively are responsible for leading the company. The chairman's major responsibility is towards the board and ensuring its effectiveness whilst the Chief Executive is responsible for running the company's business.
An effective chairman should spend as much time as is required to fulfil the operational requirements. He should be the one who is able to devote sufficient time to meet the demands of this position.
His major role is to bring in effectiveness of non-executive directors with proper co-ordination and understanding between the executive and non-executive management.
He has a role of leading the board in setting the values of the company, measuring its performance against the set values and objectives and to maintain a relationship of trust with all the stakeholders including the executive and non-executive management.
ROLE OF CHIEF EXECUTIVE: The chief executive acts within the authority delegated to him by the board. His specific responsibilities include ensuring that the board receives accurate, timely and clear information in order to enable the board to take informed decisions.
He leads executive directors in the day-to-day running of the company's business, including acting as chairman of the executive committee, developing and presenting to the board the strategy of the company and recommending an annual budget to the board with specific objectives to be achieved during the year.
The environmental, health, safety and risk programmes are also planned and implemented by the management committee.
These responsibilities may vary from company to company but these are the major functions that are included in the responsibilities of chief executive of companies.
IMPORTANCE AND JUSTIFICATION: This aspect of corporate governance has been regarded as so important that the current code of corporate governance suggested by Higgs requires a public justification if the two roles are not split and remain in one person.
In addition to the above requirements, it was thought prudent and essential that no individual should be appointed to this position that is already a chairman of a listed company.
It is understandable that this restriction was meant to avoid conflict of interest between the company's strategic objectives and the amount of time desired to fulfil the operational demands for this position.
In a study conducted on this issue that comprised of 22 companies, only eight companies gave their views on chief executive becoming chairman.
Of these, one considers that the practice is acceptable provided there is clear majority of independent directors; five companies were opposed to the practice and required persuasive justification.
The remaining two expressed strong opposition to this practice. One company made it clear that it would not be expected for a retiring chief executive officer to retain a seat on the board as a non-executive director.
Around 90 percent of the listed companies now separate these two positions in Britain. This was due to the recommendations made by Cadbury a decade ago. When compared with the rest of the world, the strength of British companies is due to the split of these positions.
It avoids concentration of authority in one individual and provides separation of the function of measuring the performance against the established goals.
These two positions certainly demand different skills and experiences that should compliment each other.
The separate role should provide an encouragement to independent non-executive directors, as CEO would not be defending the executive team unnecessarily regarding the achievement standards.
The chairman should not seek executive responsibility and should let the chief executive take credit for the operational achievements.
Therefore, there should be clear division of responsibilities between these two roles.
APPOINTMENT OF CHAIRMAN: It is essential that nomination committee for the chairman's position should prepare a proper job description. It has been argued that the chief executive should not be appointed as the chairman of the same company due to the reason that it would be very difficult for the Chairman who had been the CEO of the same company to encourage the new CEO to make effective changes to improve the existing organisational structure or make difficult strategic decisions that were not previously made.
Under these circumstances, it is felt that the Chairman may not be co-operative with the new CEO and that may result in stagnation and wasteful resources.
CURRENT PRACTICE IN PAKISTAN: Looking at the listed companies in Pakistan, the concept of splitting these two positions has never been practised. No importance or any requirement is required by the Companies Ordinance 1984 or by the newly enforced corporate governance code.
The Chief Executive of a company always regarded it as a right to hold both these position. If we look at the annual reports of the listed companies, this is evident that in almost 90% of the companies, these two positions are combined and held by one individual.
This practice is strengthened by the lenient attitude of Pakistani code of corporate governance that states in Para (ix) that, " the Chairman of a listed company shall preferably be elected from among the non-executive directors.
The board of directors shall define the role of the Chairman and Chief Executive whether or not these two positions are held by separate individuals or the same individual."
It may be argued from the above wording that there is no compulsion to appoint an independent non-executive Chairman and that the role and responsibilities of these positions shall be determined by the board of directors composed of non-executive and executive directors.
This is contrary to the recent codes of corporate governance implemented in other European countries, Britain and the OECD countries.
These recommendations are meant to improve efficiency, reduce corruption, fraud and nepotism and meet the world standards of corporate governance to encourage trust and confidence among investors that was eroded during the multinational corporation's collapses.
COMPOSITION OF BOARDS: The non-executive directors in most of the cases are disinterested individuals who act as rubber stamp of what the chief executive says.
The executive directors are normally employees of the company who in majority of case do not oppose the senior boss as their entire career progression depends upon his pleasure.
Under this unique composition of the board structure, how the two roles exercised by one individual could be successful and effective for the company.
Even if these two roles are separated in some of the companies and a separate Chairman is appointed, it is interesting to see that the Chairman is an executive member of the board and is not an independent non-executive director and it may be argued that an executive Chairman may not be as effective as an independent non-executive Chairman and that is an important prerequisite of good corporate governance.
Under the present corporate culture, it seems more desirable that these two important roles be split between two individuals, and one of them is an independent non-executive director who should be appointed as Chairman.
This change may bring in more efficient attitudes towards complex corporate issues especially when the companies may have to operate under WTO regime.
The splitting of these two roles may have a positive impact upon the foreign investor who may be glancing at the composition of the board of directors and observes that one individual is holding the combined role contrary to the modern concept of good corporate governance.
STATE-CONTROLLED CORPORATIONS: It is irony that if we analyse the composition of board of directors of the state owned corporations, we observe that in most of the large companies that are listed on the stock exchanges of Pakistan lack these essential elements of code of corporate governance.
These companies represent substantial capitalisation and form a substantial weight in the composition of KSE 100 Index.
The notable companies among these are Pakistan Telecommunication Company Ltd and National bank of Pakistan.
In these institutions, one person holds both the top roles of chairman and chief executive. This is not an exhaustive list of companies that are organised on this pattern. We should also mention the case of National Investment Trust that manages an investment portfolio of approximately over 50 billion rupees and the same individual is managing the two roles of chairman and chief executive.
Is it not a defective organisational structure that lacks internal controls and checks over the authority of these two roles?
This type of organisation is grossly flawed and must be corrected either through amending the code of corporate governance or through positive actions by those authorities that are responsible to make appointments of this nature.
There must be check and balances on these roles and it is considered that the best acceptable checks and balances are separation of these two roles that is acknowledged universally.
SHORTCOMINGS OF STATE OWNED CORPORATIONS: Majority of the shareholding of these institutions remains with the government, but no effort has ever been made to ensure that the code of corporate governance framed by the Securities and Exchange Commission of Pakistan, that is part of the government itself, is being violated.
The government should have set a good example by implementing the code of corporate governance that is mandatory for others. Violation of rules of good corporate governance by the government-controlled institutions encourages corruption, nepotism and inefficiencies that are costly to the organisation and the previous history of National Investment Trust is a live example of defective decision-making process by this institution in the past when this institution was not able to honour its commitment regarding the redemption of NIT units and that forced the federal Government to issue Letters of Comforts to the major Unit holders.
Under the present organisational structure, are we sure that the history will not be repeated again and once these appointees complete their tenure, these would not come under investigation by the National Accountability Board?
Therefore it is in the best interest of the companies themselves to reorganise them to meet the future challenges.
In case, this reorganisation is not done voluntarily, then the Securities and Exchange Commission of Pakistan must step in and make the required changes in the Code of Corporate governance to achieve the objectives and bring the code in line with other regional and international codes of corporate governance.