In this article, I have highlighted examples of failures of corporate governance, analysed the factors that are more likely to be responsible, and have outlined the requirement for an appropriate code to remedy this situation.
The ECC committee of the cabinet has formulated a ten billion rupees bail out plan for Pakistan Steel Mills (PSM) to take out the company out of its financial troubles. The plan consists of a five year loan and a running overdraft against a sovereign guarantee by a consortium of banks under the lead of National Bank of Pakistan (NBP). The company incurred almost over 25 billion rupees losses during the past year. This is a company whose chairman was sacked few months ago due to alleged frauds and misappropriations. It remains arguable who was the appointing authority of the chairman? Where was the chief executive and the board during the period it incurred huge financial losses and why there were no whistle blowers within the board itself?
We have seen major fraud in the bank owned by the Punjab government, where almost 12 billion rupees were borrowed without proper securities through an alleged connivance between management and the borrowers. Amazingly, no senior staff member or any director of the bank could detect this fraud during normal course of events. Senior management and board of directors remained exempt from any responsibility so far.
National Bank of Pakistan (NBP) has earned a reputation of a lender of the last resort to loss-making and corrupt organisations. It provides loans generously to government-controlled entities that are virtually insolvent. It has been in the forefront to finance controversial Rental Power Plants (RPPS), where other private banks hesitated to be the part of consortium. It has also provided loan facilities to Pakistan International Airlines (PIA) that has incurred a total loss of 75.26 billion rupees till September 2009 against its paid-up capital of rupees 21.42 billion.
Its total liabilities outstanding amounts to 160.87 billion rupees.Its equity have been eroded completely with a negative net worth of rupees 53.84 billion. A government-owned corporation that has liabilities to the tune of eight times of its paid-up capital has no reason to survive and should have been liquidated long ago. NBP still kept on lending money to this corporation to support the lavish style of its senior management, its staff and to keep on its corrupt practices.
The long outstanding loan to Pakistan Telephone industries is another example of generous lending by NBP. It was restructured recently on the government's sovereign guarantee. The performance of two gas distribution companies SSGC and SNGPL speak for itself. Government's interference is visible from the recent induction of almost 850 ex-employees that were laid off twelve years ago on the instruction of the minister. It is questionable if the minister had any legal authority to do so. Its financial impact upon the performance of SSGC should have been examined. Has any objection risen from any board member, who is the ultimate decision-making authority for the company?
National Logistic Company (NLC) incurred losses of rupees 1.5 billion rupees on its investment portfolio during the last one year. Similarly, OBI also suffered huge losses of similar nature in the equity markets. The decisions to invest in capital markets by the senior management of these two organisations raises questions of their integrity and white-collar corruption. No investigation has so far been made in these cases. These are just the few examples of mismanagement in public sector companies. In addition to the above, Ministry of Finance has recently clarified that the government exchequer is incurring a financial burden of rupees 250 billion annually to keep the twelve loss-making government-managed institutions alive.
The above examples indicate that there is something seriously wrong with the public sector companies. There is no single authority to act as a watchdog that should be responsible to oversee the performance of state owned companies to ensure that white-collar crimes are not committed. Therefore, the present state of affairs has eroded public confidence in government's capability to improve the governance of these companies.
A similar situation arose in western countries where serious corporate disasters occurred and some of the major corporate giants went bust. In both cases, there were several things in common. Firstly, there was gross negligence by directors; secondly, there were serious defects in the appointment of directors and senior management of companies and thirdly, the shortcoming within those organisations could not be detected by the boards on timely basis. However, all the corporate collapses in western regimes were investigated according to the laws of those regimes and severe actions were taken against those who were responsible for negligence. In the cases of Enron and WorldCom, the directors paid huge damages out of their own pockets for being negligent in the performance of their duties, but no such investigations took place in case of the Pakistani state owned companies.
As it is visible, cases of poor corporate governance in public sector organisations are largely due to appointments made on political and party affiliations basis. The concept of "independent non-executive directors" had been grossly misused in these cases. Therefore, the concept of true independent judgement on those positions never existed and the quality of decision-making was severely affected. Those who contributed towards poor corporate governance were simply transferred out to other institutions, thereby providing them an additional opportunity to carry on their corrupt practices elsewhere. This is visible in almost all cases in state owned companies.
The events in western regimes triggered widespread concerns over these lapses. Those regimes acted swiftly to improve the situation. In the United Kingdom, the new Combined Code on Corporate Governance of 2003 mainly addressed the "role and effectiveness of non-executive directors" on the principle of "comply or explain". The new Code emphasised on an increased number of "independent directors" in the composition of listed Boards compared with the previous Code. Recently, public confidence in listed company's, especially financial and banking sector boards, started slackening due to widespread defaults because of toxic loans.
The eroding confidence prompted the Treasury Committee of UK, to suggest its post-Northern Rock recommendation in July 2009 that senior bankers should possess a relevant qualification or, if they do not, that the onus be on them to prove that they have relevant compensatory experience. This was done to improve the performance of financial and banking sector companies to restore public confidence over these institutions. Similarly in the United States, the Sarbanes-Oxley Act (SOX) introduced new standards of accountability on the board of directors for U.S. companies or companies listed on U.S. stock exchanges. The European Commission has also formally invited Member States, through its non binding Recommendation, to reinforce the presence and role of "independent non-executive directors" on listed companies' boards
The above codes of governance have been constantly under review and the objective of the reviews seems to be to put more emphasis on the "non-executive directors", who should be "independent directors" in the true sense, to enhance the quality of the decision-making process and to improve the process of overseeing the operations of the listed companies through an independent process. Has that objective been achieved? No reliable statistics or surveys are available to establish the achievement of this objective. In fact, the perception seems to be emerging that it is because of this additional emphasis of inducting additional number of "non-executive directors" that the corporate governance has, in fact, deteriorated.
It has been argued that NEDs have limited time available to attend to the companies business and that they rely too much on the executive directors and other senior management in the decision making process that their independent judgement is compromised due to these shortcomings. This seems to be true in cases where government has to rely mostly upon non-executive directors. This leads us to conclude that the nomination process of directors in public sector undertakings seems to be seriously flawed.
This perception seems to be confirmed In the recent past, where on the revelation of intelligence agencies, the government removed several members of the board of directors of OGDCL and PSO that were appointed by it on the pretext of existence of conflict of interest between the directors and the management of the said companies. The names appearing on the two boards are reflection of cronies and friends and confirm the carelessness and the arbitrary use of power in their appointment.
It is also alleged that in majority cases the appointments as directors has been one of the major reason that, encourages rampant corruption and results in bad decision-making. The perception of too much reliance on the expertise of executive directors by the non-executive directors is more relevant in Pakistani corporate governance where there is clear evidence that the NEDs are inexperienced, are unwilling to learn the issues facing these companies, and are only interested in their perks as "non-executive directors." They are unaware of their legal responsibilities as director.
Though there is no definitive single statement of directors' general duties under the Companies Ordinance 1984, yet their duties are set out in case law developed in other regimes eg UK and India, much of which dates back to the 19th century. English case law is highly persuasive and English common law principles relating to directors' fiduciary duties are somewhat precise and can be summarised. In Re Barings Plc (No 5) [2000] the English Court of Appeal approved the summary as "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..."
In recent years, various Reports on Corporate Governance recommended more accountability for directors of companies. These recommendations were incorporated into the new UK Companies Act which was signed in April 2009. It will be easier for shareholders now to claim against directors for negligence and breach of directors' duties. A director who is found liable can be fined, imprisoned, and ordered to pay damages or repay the value of any opportunity lost by the company as a result of the director's conduct. But that is not the case in Pakistan.
Conclusion:
We see that as a response to poor corporate governance a key factor that was introduced in the western regimes was the accountability factor for directors whether they be "executive" or "non-executive." Thus there is a need to implement a code that ensures that right type of persons are appointed directors, revisit our corporate laws to ensure that there are stringent rules in place for negligent directors, and there is in place an autonomous Financial Authority that has the mandate of overseeing white-collar crimes to minimise the waste in our corporate resources.
The legislature should enact laws that should make it difficult to commit white collar crimes and there should be a forum to try these cases on a fast track basis. The shareholders especially, the institutional investors should be willing to litigate for their rights and take a lead to sue the negligent directors and their appointing authorities for damages and compensations as has been the practice in western countries.
(The writer is LLM (corporate law) Northumbria University UK and a fellow member of Institute of Chartered Management Accountant's of UK)