The 2001 collapse of Enron gave companies, stock exchanges and legislators across the world the opportunity to revisit the corporate governance landscape. Weak areas should have been addressed and rectified so as to prevent another disaster that could have severe implications for stakeholders, particularly the vulnerable ones such as pensioners – The Sarbanes-Oxley Act is one direct action taken.
But has enough been done to address the risks of corporate collapse and have we learned any lessons over the past few years? How far have we come, and the frightening question is – have we perhaps even regressed in some areas?
PricewaterhouseCoopers partner Rob Newsome published an article “Corporate Governance in South Africa – what is the likelihood of an Enron here?” that appeared in several publications over the period 2002 – 2004. The Enron key governance indicators were assessed and evaluated in terms of the South African context. Rob has now reviewed the current corporate governance landscape against these indicators. He concludes that while South Africa has made some commendable progress, the overall result is a mixed bag. In some aspects of governance, we have actually become worse.
On the contentious issue of corporate greed, Newsome says the rating has regrettably dropped down to poor, in both private and public sectors. “We have deteriorated significantly in a number of areas – corruption is becoming endemic, executive remuneration is often not understood in terms of the contribution made to corporate performance by the executives, accountability is not consistent where an executive gets a light slap on the wrist for accepting bribes and lesser employees are summarily dismissed, and the number of instant millionaires made through BEE deals where the value or risks taken on are not clear. These have contributed to an overall decline in business morality and ethics, in both the public and private sectors.”
Newsome says that investment banks and fund managers should share in some of the blame for this decline, as their priorities are not always the same as the investors they represent. “Their time horizons are shorter and they obsess on quarterly performance, which aligns with executive motivation – to push the share price and their bonuses and the value of the executive share options etc. It could be time for them to start sharing in some of the investment losses they create for their clients. This would align their performance with those of the investors they represent.”
On the highly charged concept of ethics, Newsome says this is inseparable from corporate greed and has also been rated as poor. “Ethics are slipping, partly due to the pitiful success rate of prosecutions and low chances of being caught out. Victims of white collar crime often don’t lay charges as they know the chance of a successful conviction is slim. Executives set bad examples and have no qualms about lavish entertainment and highly visible excesses. The tone is not being set from the top and values are being neglected or even forgotten. The public sector is notably visible here due to the media attention it receives.”
Newsome does credit corporate South Africa with improving the structure of the board of company directors. “There is a better balance of nonexecutive and independent directors, but risks still remain. The pool of available (and quality) talent is improving, with initiatives such The Institute of Directors’ Director Training starting to show results. However, many of the same faces from both the old and new guards sit everywhere. There are frequent suggestions that directors are holding too many positions and this could impact on how effective they are. Nomination committees need to seriously consider the abilities of directors who sit on several boards and whether they are competently fulfilling their appointment responsibilities.”
On the accounting and financial reporting side, far more attention is being paid to the concept of substance over form, thereby limiting the scope for creative accounting and manipulations. But Newsome says despite this positive development, the flip side is that the complexities and sheer volume of accounting standards are becoming overwhelming. “We may be admirably IFRS-compliant but the usefulness of the detail of information disclosed to users is questionable. The value of information that companies are compelled to disclose needs to be more aggressively challenged at an earlier stage, before it effectively becomes a formal requirement, and there should be a stronger culture of questioning the usefulness of required disclosures and policies. With the proliferation of standards and disclosure requirements, are we any closer to achieving the ultimate goal - being the fair presentation of the affairs of a business? Unfortunately the progress in financial reporting made by moving closer to the substance over form concept could become lost in the mass of detail.”
One area of significant improvement in SA is the liquidity in our financial markets, and Newsome says this had made for better pricing mechanisms. “We decided to join the global financial market and are playing by its rules in terms of disclosure and regulation. Foreign investment flows are up and this in turn creates fewer concentrations of shareholdings. Companies have actively engaged in disinvestment of noncore holdings and unbundled pyramid and holding company structures.”
But a remaining concern for Newsome is the retention of foreign exchange controls that limit scope for offshore investment and restrain the options for local investment alternatives. “This containment of funds looking for a home in turn pushes up market prices, sometimes to unrealistic levels.”
The position of the auditor has become more clearly defined in both the private and public sectors. Newsome says that corporations now take auditors far more seriously and the auditors are less vulnerable to pressures such as more favourable disclosures and lower fees, and there are fewer changes in appointments. “The auditors' position has also been strengthened by the audit committee role and by the accounting firms addressing problems of independence arising when the same firm offers both audit and consulting services.”
But Newsome remains unhappy on the remaining undeserved negative focus on the auditor, who is unduly blamed for corporate failures. “The auditor cannot uncover or catch everything and is not responsible for financial disasters – management is and always will be. There is sometimes an unrealistic expectation that the auditor is the whistleblower and will uncover all irregularities in a business. The recent requirement for auditors to report irregularities is one such expectation.”
Newsome says it may be surprising to learn that public sector organisations are taking the concept of risk management far more seriously than their private sector counterparts. “Several departments and public sector organisations have moved to an integrated approach to risk management, whereas the private sector focus remains narrowly concerned with internal financial reporting risks and insurance-related risks. The banking sector has adopted risk management practices following the implementation of the Basel II requirements.”
He says that the private sector tends to pay lip service to the concept of integrated risk management and rely on the performance management practices to manage risk. “The current performance management approaches focus on what has been defined and what can be measured. With a more integrated approach to the management of risk, better quality and more relevant information will reach the board of directors and equip them for more informed decision making.”
There has been a great improvement in communications and disclosures to analysts and the broader markets, especially with regard to issues such as sustainability reporting. But Newsome says there is still scope for some improvements, for example company cautionary announcements and reasons for the resignations of directors.
Shareholder activism is seeing a lot of engagement and talk between parties but Newsome is hesitant on just how effective these interactions are and how they translate into practice. “The Public Investment Corporation (PIC) has issued guidance on its investments, but the concern is the extent to which there are political motivations behind the investment strategies, rather than considering the investors on whose behalf they act.”
In the institutional shareholding sector, Newsome says there is probably more scope for activism and shareholders should not be afraid of expressing dissent, even when their votes are too small to make a difference. “Shareholders should also be bold enough to confront executive management when they are dissatisfied, rather than taking a less confrontational way out by selling their interests and exiting from an unpleasant situation.”
On the broader front, politics is infiltrating business at an increasing rate and engagements and interactions are biased and politically motivated. “The issue of BEE complicates and clouds the business landscape. There is a lack of transparency regarding business and political connections and less than desired transactions are not being adequately exposed.”
“To put it bluntly”, says Newsome, “We have not come far enough since the days of Enron and the possibility of a corporate collapse in SA remains highly probable and has happened – Leisure Net and Fidentia are examples. The imminent release of King 3 on Corporate Governance will hopefully address some of these remaining, disappointing and malignant concerns.”
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