WHAT

IS

CORPORATE

GOVERNANCE?
Definition
Corporate governance refers to the set of systems, principles and processes by which a company is governed. They provide the guidelines as to how the company can be directed or controlled such that it can fulfill its goals and objectives in a manner that adds to the value of the company and is also beneficial for all stakeholders in the long term. Stakeholders in this case would include everyone ranging from the board of directors, management, shareholders to customers, employees and society. The management of the company hence assumes the role of a trustee for all the others. Corporate governance is a relatively new term used to describe a process, which has been practiced for as long as there have been corporate entities. This process seeks to ensure that the business and management of corporate entities is carried on in accordance with the highest prevailing standards of ethics and efficacy upon assumption that it is the best way to safeguard and promote the interests of all corporate stakeholders.

PROCESS OF CORPORATE GOVERNANCE

Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management and the board of directors. Other stakeholders include
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employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large. The process of corporate governance does not exist in isolation but draws upon basic principles and values which are expected for all human dealings, including business dealings principles such as utmost good faith, trust, competency, professionalism, transparency and accountability, and the list can go on Corporate governance builds upon these basic assumptions and demands from human dealings and adopts and refines them to the complex web of relationships and interests which make up a corporation. The body of laws, rules and practices which emerges from this synthesis is never static but constantly evolving to meet changing circumstances and re uirements in which corporations operate. !rom time to time, crisis of confidence in effective compliance with, or implementation of, prevailing corporate governance principles act as a catalyst for further refinement and enhancement of the laws, rules and practices which make up the corporate governance framework. The result is an evolving body of laws, rules and practices, which seeks to ensure that high standards of corporate governance continue to apply.

THE BENEFITS OF CORPORATE GOVERNANCE

"ood and proper corporate governance is considered imperative for the establishment of a Competitive market. There is empirical evidence to suggest that countries that have implemented good corporate governance measures have generally experienced growth of corporate sectors and higher ability to attract capital than those which have not.

IMPACT OF CORPORATE GOVERNANCE

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The positive effect of good corporate governance on different stakeholders ultimately is a strengthened economy, and hence good corporate governance is a tool for socio# economic development. $fter %ast $sian economies collapsed in the late &'th century, the (orld )ank*s president warned those countries, that for sustainable development, corporate governance has to be good. %conomic health of a nation depends substantially on how sound and ethical businesses are.

THE PAKISTANI CORPORATION

+pon independence, ,akistan inherited the -ndian Companies Consolidation $ct, ./.0. -n ./1/, this $ct was amended in certain respects, including its name, where after it was referred to as the Companies $ct, ./.0. +ntil ./21, when the Companies Ordinance, ./21 3the Companies Ordinance4 was promulgated, following lengthy debate, ,akistani companies were established and governed in accordance with the provisions of the Companies $ct, ./.0. Corporate entities in ,akistan are primarily regulated by the S%C under the Corporate entities in ,akistan are primarily regulated by the S%C under the Companies Ordinance, the Securities and %xchange Ordinance, ./5/, the Securities and %xchange Commission of ,akistan $ct, .//6, and the various rules and regulations made there under. -n addition, special companies may also be regulated under special laws and by other regulators, in addition to the S%C. -n this way, listed companies are also regulated by the stock exchange at which they are listed7 banking companies are
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also regulated by the State )ank of ,akistan7 companies engaged in the generation, transmission or distribution of electric power are also regulated by the 8ational %lectric ,ower 9egulatory $uthority7 companies engaged in providing telecommunication services are also regulated by the ,akistan Telecommunication $uthority7 and oil and gas companies are also regulated by the Oil and "as 9egulatory $uthority.

THE ORIGINS OF CORPORATE GOVERNANCE IN PAKISTAN

The S%C, since it took over the responsibilities and powers of the Corporate :aw $uthority in .///, has been acutely alive to the changes taking place in the international business environment, which directly; and indirectly impact local businesses. $s part of its multi#dimensional strategy to enable ,akistan*s corporate sector meet the challenges raised by the changing global business scenario and to build capacity, the S%C has focused, in part, on encouraging businesses to adopt good corporate governance practices. This is expected to provide transparency and accountability in the corporate sector and to safeguard the interests of stakeholders, including protection of minority shareholders* rights and strict audit compliance.

PARTIES TO CORPORATE GOVERNANCE

,arties involved in corporate governance include the regulatory body 3e.g. the Chief %xecutive Officer, the board of directors, management and shareholders4. Other stakeholders who take part include suppliers, employees, creditors, customers and the community at large. -n corporations, the shareholder delegates decision rights to the manager to act in the principal*s best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. ,artly as a result of this
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separation between the two parties, a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. (ith the significant increase in e uity holdings of investors, there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse. $ board of directors often plays a key role in corporate governance. -t is their responsibility to endorse the organi<ation=s strategy, develop directional policy, appoint, supervise and remunerate senior executives and to ensure accountability of the organi<ation to its owners and authorities. $ll parties to corporate governance have an interest, whether direct or indirect, in the effective performance of the organi<ation. >irectors, workers and management receive salaries, benefits and reputation, while shareholders receive capital return. Customers receive goods and services7 suppliers receive compensation for their goods or services. -n return these individuals provide value in the form of natural, human, social and other forms of capital. $ key factor in an individual*s decision to participate in an organi<ation e.g. through providing financial capital and trust that they will receive a fair share of the organi<ational returns. -f some parties are receiving more than their fair return then participants may choose to not continue participating leading to organi<ational collapse.

THE NEED FOR CORPORATE GOVERNANCE

The popularity and development of corporate governance frameworks in both the developed and developing worlds is primarily a response and an institutional means
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to meet the increasing demand of investment capital. -t is also the reali<ation and acknowledgement that weak corporate governance systems ultimately hinder investment and economic development. -n a ?c@insey survey issued in Aune &''', investors from all over the world indicated that they would pay large premiums for companies with effective corporate governance. $ number of surveys of investors in %urope and the +S support the same findings and show that investors eventually reduce their investments in a company that practices poor governance. Corporate governance serves two indispensable purposes. .. -t enhances the performance of corporations by establishing and maintaining a corporate culture that motivates directors, managers and entrepreneurs to maximi<e the company*s operational efficiency thereby ensuring returns on investment and long term productivity growth.

?oreover, it ensures the conformance of corporations to laws, rules and practices, which provide mechanisms to monitor directors* and managers* behavior through corporate accountability that in turn safeguards the investor interest. -t is fundamental that managers exercise their discretion with due diligence and in the best interest of the company and the shareholders. This can be better achieved through independent monitoring of management, transparency as to corporate performance, ownership and control, and participation in certain fundamental decisions by shareholders. >ramatic changes have occurred in the capital markets throughout the past decade. There has been a move away from traditional forms of financing and a collapse of many of the barriers to globali<ation. Companies all over the world are now competing against each other for new capital. $dded to this is the changing role of institutional investors. -n many countries corporate ownership is becoming increasingly concentrated in institutions, which are able to exercise greater influence as the predominant source of future capital. Corporate governance has become the means by which companies seek to improve competitiveness and access to capital and borrowing in a local and global market. %ffective corporate governance allows for the mobili<ation of capital annexed with the promotion of efficient use of resources both within the company and the larger economy. -t assists in attracting lower cost investment capital by improving domestic as well as international investor confidence that the capital will be invested in the most efficient manner for the production of goods and services most in demand and with the highest rate of return. "ood corporate governance ensures the accountability of the management and the )oard in use of such capital. The )oard of directors will also ensure legal compliance and their decisions will not be based on political or public relations considerations. -t is understood that efficient corporate governance will make it difficult for corrupt practices to develop and take root, though it may not eradicate them immediately. -n addition, it will also assist companies in responding to changes in the business environment, crisis and the inevitable periods of decline. Corporate governance is the market mechanism designed to protect investors* rights
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and enhance confidence. Throughout the world, institutions are awakening to the opportunities presented by governance activism. $s a result, )oards and management are voluntarily and proactively taking steps to improve their own accountability. Simply put, the corporations, including ,akistani corporations, have begun to recogni<e the need for change for positive gain. $long with traditional financial criteria, the governance profile of a corporation is now an essential factor that investors and lenders take into consideration when deciding how to allocate their capital. The more obscure the information, the less likely that investors and lenders would be attracted and persuaded to invest or lend. The lack of transparency, unreliable disclosure, unaccountable management and the lack of supervision of financial institutions 3all of which are the conse uences of inade uate corporate governance4 combine to infringe investors* rights. ,oor corporate governance has a tendency to inflate uncertainty and hamper the application of appropriate remedies. Transparency can be achieved through three key market elements; .. Openness &. $ccounting standards 0. Compliance reporting. %fficient markets depend upon investor confidence in the accuracy and openness of information provided to the public. $lso, compliance with internationally recogni<ed accounting standards is necessary to ensure that investors can effectively analy<e and compare company data. (ith incorporation of the Code in the listing regulations of the ,akistan*s stock exchanges, listed companies are now under an obligation to act transparently. The inability or unwillingness to make credible disclosure constitutes a bad e uity contract which potentially makes it difficult for the market to distinguish good risk from bad resulting in an inability to attract investors. The long term conse uences of
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such inabilities prove to have a crippling effect, not only on corporations, but also on the stock market as it blocks crucial li uidity of the stock market, with the resultant weakening of the entire financial system. Conse uently, the increased cost of capital reallocates financing and the capital market towards debt. $ distinctive characteristic of the ,akistani corporate culture, however, is the pyramidal ownership structure and corporations with concentrated ownership enabling large shareholders to directly control managers and corporate assets. Thus the need for corporate governance should not, perhaps, arise under the prevailing structure as the conflict of interest that emerges gives rise to the Bexpropriation problemC as opposed to the Bagency problemC. -t is imperative, however, at this stage, to acknowledge the rapid developments that are taking place within the ,akistan corporate culture and the fading out of the traditional and more conventional corporate formation. !urthermore, a good governance system is re uired for such institutions as the success of any institution is a combined effort comprising of contributions from a range of resource providers including employees and creditors. -t is for this reason that the role of the various stakeholders cannot go ignored and their rights and the corporations* obligations must be determined. !inancing of any kind, whether for publicly traded companies or privately held and state owned companies, can only be made possible through the exercise of good corporate governance. THE STAKEHOLDERS $ corporation enjoys the status of a separate legal entity7 however the formation of a public listed company is such that its success is dependent upon the performance of a contribution of factors encompassing a number of stakeholders. $ stakeholder is a person that has an interest or concern in a business or enterprise though not necessarily as an owner. The ownership of listed companies is comprised of a large number of shareholders drawn from institutional investors to members of public and thus it is impossible for it to be managed and controlled by such a large number of
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diversified minds. Dence, management and control is delegated by the shareholders to agents called the )oard of directors. -n order to achieve maximum success, the )oard of directors is further assisted by managers, employees, contractors, creditors, etc. Therefore it is imperative to recogni<e the importance of stakeholders and their rights. Communication with stakeholders is considered to be an important feature of corporate governance as cooperation between stakeholders and corporations allows for the creation of wealth, jobs and sustain ability of financially sound enterprises. -t is the )oard*s duty to present a balanced assessment of the company*s position when reporting to stakeholders. )oth positive and negative aspects of the activities of the company should be presented to give an open and transparent account thereof. The annual report is a vital link and, in most instances, the only link between the company and its stakeholders. The Companies Ordinance re uires directors to attach in the annual report director report on certain specific matters. The Code expands the content of the directors* report and re uires greater disclosure on a number of matters that traditionally were not reported on. The aim is for the directors to discuss and interpret the financial statements to give a meaningful overview of the enterprise*s activities to stakeholders and to give users a better foundation on which to base decisions. Specific emphasis has been placed upon the fiduciary obligations of directors and hence the need to understand the implications of such obligations also arises.

PRINCIPLES OF CORPORATE GOVERNANCE Commonly accepted principles of corporate governance include; 1: Rig t! of t e !t"#e o$%e&! Organi<ations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively
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communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. ': Inte&e!t! of ot e& !t"#e o$%e&! Organi<ations should recogni<e that they have legal and other obligations to all legitimate stakeholders. (: Ro$e "n% &e!)on!i*i$itie! of t e *o"&% The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. -t needs to be of sufficient si<e and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non#executive directors. The key roles of chairperson and C%O should not be held by the same person.

+: Integ&it, "n% et i-"$ *e ".io& %thical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organi<ations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. -t is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. )ecause of this, many organi<ations establish Compliance and %thics ,rograms to minimi<e the risk that the firm steps outside of ethical and legal boundaries.
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/: Di!-$o!0&e "n% t&"n!)"&en-, Organi<ations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company*s financial reporting. >isclosure of material matters concerning the organi<ation should be timely and balanced to ensure that all investors have access to clear, factual information. CONCL1SION Corporate governance is the mechanism by which the agency problems of corporation stakeholders, including the shareholders, creditors, management, employees, consumers and the public at large are framed and sought to be resolved.

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