Revisiting Corporate Governance Principles

Written by YRK Reddy | Updated: Oct 18 2003, 05:30am hrs
The OECD principles were endorsed in May 1999 by its 29 member governments. Since then, the principles have made a unique impact in influencing the thinking of all countries and multilateral organisations like the IMF, World Bank, IOSCO and created a new value system in this area. While most countries have followed these very important principles in designing their respective codes, best practices, regulations, and legislations, the IMF has included them even as a condition for eligibility under its contingency credit line. The principles are now one of the twelve financial standards considered essential for the soundness and stability of the financial system and have emerged as de facto global standards. It is evident that they were made chiefly for their member countries - all from the developed world, some of whom are yet to fully adopt them. The OECD is currently reviewing the principles and has rightly initiated a global consultative process ahead of the revision scheduled in 2004 to gather wider participation and perspective than earlier.

Developing countries like India should be able to analyse the fundamental assumptions in these principles and their implications instead of staid adoption through local committees, which reflect the same perspective albeit derived from the US/UK recommendations, codes and principles. Such an analysis will enable the country to frame its thinking and pro-actively generate a debate that can shape the revision to meet the needs of the developing world.

The OECD principles focus on the governance problems that result from the separation of ownership and control arising from the historic Berle and Means arguments about the modern corporation. Yet, research shows that the widely held corporation is indeed a rare species except in the UK and to a lesser extent, the USA, if control is defined as 10 percent of equity. Relatedly, the principles appear to promote the so called outsider model despite the increasing evidence from Germany and Japan, and the developing world that family controlled business groups and insider models have not necessarily contributed to crony capitalism but may have supported economic growth. In the case of the developing countries like India, such insider models have laid the foundation for industrial growth that was delayed for several colonial, political and economic reasons. Further, the underlying theme for the principles obviously has been to improve the shareholder value as determined by the markets. This is understandable given that the principles were evolved at the height of the romance with the capital market.

The focus on shareholder value is a relatively recent phenomenon - notably of the 90s that have seen growth in capital markets in many countries. During these years there has been a change from the earlier efforts at retaining and re-investing to that of squeezing the companies through downsizing and distribution of the juice to the shareholders who can dynamically exit, invest, or reinvest. The assumption about shareholder value, as against sustainable efficiency, higher residual income or welfare, is deeply connected with the aspiration to create free capital markets and an equity culture in the economy. Belying this hope, several stock exchanges opened around the world, after the cold war during the 90s, have either collapsed or contracted especially in the developing and transitional economies. We, in India, are also experiencing the spate of de-listing for reasons that include the high transaction cost involved in the governance frame-work we now have. An additional point in this context is that, in the developing countries, the amount of money that drives corporate growth is predominantly from internal accruals and debt. Fresh equity contributes to about 11-16 per cent only. Further, the number of publicly traded companies as a percen- tage of all companies is a mere 0.16 per cent in the developing countries even though they may account for a significant portion of output. In effect, the OECD principles, as they are now, explicitly address a microcosm of developing countries under assumptions that can at best be aspirational than realistic. The main issue before developing countries, such as India, is not so much the quality of governance of the corporates in terms of shareholder rights, their equitable treatment, or the Board compositions.

The concern is more of reforming and strengthening important institutions and their governance. The OECD principles, do mention, though in passing, that they may be useful not only for companies but also for other organisations including the State enterprises. Yet, because of the core assumption about capital markets, the principles cannot be used meaningfully in strengthening the governance of important institutions such as the regulators, State controlled banks, development financial institutions, and State-owned enterprises. Consequently, the challenge in revisiting the principles would be to make them universally applicable or to limit them to narrowly defined corporates. The worry for developing countries should be that such principles can become painful conditionality and generate misplaced expectations. In effect, ill-crafted principles may demand that the feet be cut to size to fit the shoes! The principles as they are now and their derivatives in the shape of new codes, recommendations, listing rules and rating bench-marks may indeed improve box-ticking and house-keeping in a limited number of publicly traded corporates.

But they may not impact significantly either the content of corporate governance nor support the developmental concerns of the country. The expectation that they may at least attract significant international finances may also remain unfulfilled as growth investors are known to be averse to paying a premium for corporate governance relative to the value investor - this indeed is evident from Mc Kinseys much cited study itself.

And money seems to be pouring into opaque China than into Russia, where several companies subjected themselves to corporate governance rating by Standard & Poor based on the OECD model.

It would thus be important for policy makers to delve deeper into the rationale and implications of the current set of OECD principles and the revisions required in keeping with the developmental concerns of our country.

The OECD by its consultative process has indeed shown its desire to make the principles more inclusive than earlier. The opportunity must be availed of proactively and sensitively lest they become de jure global standards without much change, on approval by the Global Financial Stabilisation Committee in 2004.

(Prof. YRK Reddy is Founder Trustee, Academy of Corporate Governance and Consultant to Commonwealth Secretariat on revision of OECD Principles and Coordinator, Advisory Team of CACG for Review of OECD Principles.

He can be reached at yrk@yagaconsulting.com)