(First of two parts)
Introduction
Corporate governance has gained prominence in our country mainly as a result of the financial crisis in East Asia in the late nineties. This crisis has shown that opening up economies on the macro-level (i.e., no capital/exchange controls) should be complemented by strong microeconomic fundamentals at the corporate level. Otherwise, distortions in capital flows can happen. Capital that comes in easily can go out just as fast in a massive way thereby causing instability in a country’s financial system (as what happened in the Asian financial crisis).
In addition, there were the corporate scandals both here and abroad. I’m sure you’ve heard of Enron, Worldcom, Parmalat, etc. The Philippine capital market also had its own share of scandals.
Those two reasons have highlighted the need for fairness, accountability and transparency which are the basic principles of Corporate Governance. These principles are principally needed for publicly-accountable entities such as listed companies and regulated entities imbued with public interest such as banks, insurance and utility companies.
Corporate governance principles
Fairness involves the respect for the rights of all stakeholders, especially the minority shareholders whose access to information is not the same as that of the majority shareholders.
Accountability is assured by assigning authority and responsibility for running the affairs of the corporation to the Board of Directors, not just to one person, such as the CEO or the controlling shareholder. The Board sets the strategy, formulates policies and delegates the execution thereof to management. The Board establishes the mechanisms to monitor the performance of management to ensure that shareholder value is maximized.
Transparency is achieved when the Board takes responsibility for ensuring the adequacy and accuracy of all corporate reports. The accounting polices followed and disclosures made should be in conformity with internationally accepted standards and best practices.
To ensure that these principles are followed, the regulators have prescribed that the Board include enough independent, outside directors. The hope is that with these directors, the decisions of the Board will be more objective.
Corporate governance therefore involves the separation of powers. Ownership belongs to the stockholders, governance is with the Board and management is with the CEO and the officers. A system of checks and balances must be set up to ensure that everybody is in the same direction, ensuring that the objectives of corporation are achieved and that shareholder value is enhanced. This means that the Board which has the power of governance must exercise such power with due regard for the interest of all stakeholders.
In practice, there will be conflicts between the interests of different stakeholders. Resolving these conflicts is a difficult task, especially when one of the parties involved is the one who appointed the directors to the Board. The Board ultimately has to make compromises and strike the appropriate balance between competing interests. This is the reason why it is best practice to have a Board composed of directors with varied disciplines and have broad experience. To be effective, the Board must have full access to information, and work as a team. No one person or group should dominate the discussions and an open, participatory system of decision-making must be encouraged in the boardroom.
The Board works through various committees. Foremost among these Board committees is the Audit Committee as enunciated in the Code of Corporate Governance issued by the Securities & Exchange Commission (SEC). Those who have read the Code will note that it stresses accountability and proper reporting which are the responsibility of the Audit Committee. In a publication of KPMG’s Audit Committee Institute, the agenda of Audit Committees in 2008 should include the following:
1. Be a catalyst for improving risk management and oversight. This gains further importance in light of the SocGen debacle and the subprime crisis in the US.
2. Closely monitor disclosures made by management.
3. Be up to speed on International Financial Reporting Standards and other key financial reporting issues and developments. Given the complexity of reporting issues involved, the committee should require management and the external auditor to discuss the implications of those issues (including key assumptions and estimates).
4. Assess the tone at the top and throughout the organization.
5. Encourage frequent communications with the internal and external auditors. (To be concluded)
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(Roberto G. Manabat is the Chief Executive Officer and Chairman of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email manila@kpmg.com.ph or rgmanabat@kpmg.com).