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CHAPTER 3 CORPORATE GOVERNANCE IN PUBLIC ENTITIES: A THEORETICAL OVERVIEW
INTRODUCTION
Universally, it is considered a government’s responsibility to deliver, inter alia, basic services such as education, health, policing, water, electricity and sanitation to their citizens.1 These services are offered either directly by departments and ministries or through public entities or state-owned enterprises. Public entities were incorporated in most countries to facilitate and accelerate economic and social development.2 However, increasing evidence indicates that most public entities in developing countries do not contribute strongly to this development because they perform their functions ineffectively resulting in huge losses, budgetary burdens and poor products or services.3 As a result of the poor performance by public entities, policy makers and other interested stakeholders have engaged in continuing debates. The debates were aimed at establishing the extent to which public entities contribute to economic and social development, why so many of the entities have been unsuccessful to competently deliver the services for which they were created and how their administration and governance can be improved.4
In the findings, it has been established that having an effective board is one of the key elements to a successful public entity.5 According to Frederick, in order to operate effectively, public entities should be adequately supervised by an independent board which should put in place structures and procedures that ensure that the public entities operate effectively, efficiently, accountably, and responsively in the public interest and that they are contributing to national development.6 Despite the acknowledgement of the role played by boards, empirical studies have established that the boards have not been as effective as they should be in discharging their duties.7 Greater focus has thus been on establishing the causes of the boards’ ineffectiveness and finding ways of improving their efficiency.8
In pursuance of this objective, it has been established that some of the major contributing factors to the poor performance by boards are: the scope and extent of government influence which has, in practice, been extreme;9 fewer qualified individuals available to serve as directors, appointment of people for “their political allegiance rather than business acumen and imposition of senior government or military officials who are not competent or sufficiently experienced. The other factors include individual directors sitting on too many boards thus diluting their capacity to monitor corporate events, poor board remuneration, lack of transparency10 in the face of insufficient external scrutiny and no questioning of shortfalls in board performance, among others.11 Thus the development of properly composed, focused, adequately empowered, motivated and efficient public entity boards capable of greater responsibility remains a significant challenge to corporate governance in many countries for the predictable future.12
This study attempts to establish how relevant the above findings are to Zimbabwe, and to identify any additional challenges experienced by boards of public entities in this jurisdiction. Measures taken to enhance the effectiveness of public entity boards as well as to promote good corporate governance in these entities are also examined. The ultimate goal is to recommend measures which can strengthen public entity boards’ effectiveness and promote good corporate governance in these entities so that they can significantly contribute to economic and social development. The present chapter defines corporate governance and highlights some of the benefits derived from good corporate governance practices. The chapter then gives an overview of public entities and analyses the five aspects considered critical in enabling a board to effectively discharge its duties. Lastly, the chapter examines corporate governance enforcement mechanisms and challenges from a global perspective.
OVERVIEW OF PUBLIC ENTITIES
The term “public entity” or “state-owned enterprise” refers to “enterprises where the state has significant control, through full, majority, or significant minority ownership”.13 Similarly,Shirley defines public entities to include entities that are expected to earn most of their revenue from the sale of goods and services, have a separate legal identity, and are majority-owned by government.14 Public entities provide goods and services that are not usually provided by the private sector and profit maximisation is not the sole basis for measuring their efficiency.15
Public entities have always played a critical role in the socio-economic development of many countries. According to Nellis, after independence, “most African governments inherited the notion that extensive public sector involvement in the economy was the natural, proper order of affairs”.16 He argues that efficient and effective service delivery to the public is a fundamental role of government. Thus, through public entities, governments have played a leading role in the provision of essential goods and services such as water, electricity, transportation, education and health in the urban as well as in rural areas.17 The entities have therefore, been considered as important agencies for socio-economic transformation, creation of employment and as instruments for economic empowerment.
However, the performance of many public entities has been below expectation. This has been ascribed to various reasons, mainly weak corporate governance and unethical practices.18 The governance systems in some of the public entities have been found to be “characterised with role ambiguity, ineffective boards, ineffective management systems and non-adherence to statutes”.19 The other challenge cited is that of multiple and conflicting objectives set for these entities.20 Whilst governments expect public entities to operate in a commercially efficient and profitable manner, they require them to “provide goods and services at prices below cost, serve as generators of employment, receive inputs from state-sanctioned suppliers and choose plant locations based on political rather than commercial criteria”.21 The mixing of non-commercial or social with commercial objectives unavoidably leads to political interference in the public entities’ operations to the “detriment of managerial autonomy, commercial performance and economic efficiency”.22 These factors, among others, have contributed to poor performance by some of the public entities. As a result, a number of organisations and countries have come up with corporate governance principles and guidelines aimed at inculcating a culture of accountability and transparency as well as efficiency and effectiveness in the management of public entities.23
DEFINITION OF CORPORATE GOVERNANCE
Before one can critically evaluate whether or not good corporate governance makes a difference in company performance, it is essential to have a clear understanding of what corporate governance is. Corporate governance is defined in different ways.24 The Zimbabwean CGF defines corporate governance as “a set of processes, customs, value codes, policies, laws and structures governing the way a corporation is directed, controlled and held accountable”.25 Similarly, the Cadbury Report defines the term to mean “the system by which companies are directed and controlled”.26 Cadbury’s view is that corporate governance focuses almost exclusively on the internal structure and operation of the organisation’s decision-making process.27 Another view is that corporate governance relates to the inter-relationships between a company’s management, its board, its shareholders, customers and other stakeholders; provides the structure through which objectives of the company are set; and places a strong emphasis on the welfare of shareholders.28 It, therefore, encompasses matters such as directors’ duties, financial accounting and the protection of the interests of various stakeholders.29
Scholars and practitioners of corporate governance have given the term a wider variety of definitions. Some economists and social scientists have defined corporate governance largely as “the institutions that influence how business corporations allocate resources and returns”.30 John and Senbet give a more widespread definition which states that “corporate governance deals with mechanisms by which stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected”.31 According to Salacuse, these definitions focus on the informal practices that develop in the absence of effective formal rules and not only on the formal rules and institutions of corporate governance.32 Also, “they encompass not only the internal structure of the corporation but also its external environment”.
In support of the economists and social scientists’ view, the OECD34 Task Force defines corporate governance as follows:
Corporate governance … involves a set of relationships between a company’s management, its Board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the Board and management to pursue objectives that are in the interests of the company and shareholders and should facilitate effective monitoring.35
According to the OECD, corporate governance encompasses not only internal aspects of corporate governance but takes into account other stakeholders and the impact of the company on them.36 It also entails that a company, and especially its directors, abide by the provisions of relevant statutes, societal norms, standards and codes of best practices as well as manage the company reliably.37 Similarly, in support of this view, Crowther defines corporate governance as:
an environment of trust, ethics, moral values and confidence – as a synergic effort of all the constituent parts – that is the stakeholders, including government, the general public etc., professionals, service providers and the corporate sector.38
From a slightly different perspective, the Securities and Exchange Board of India (SEBI) Committee on Corporate Governance39 views corporate governance as ethical conduct in business in that it is concerned with the code of values and principles that enables a person to conduct a company’s business in line with the expectations of all stakeholders.40 According to the committee, “corporate governance is beyond the realm of law. It stems from the culture and mindset of management, and cannot be regulated by legislation alone”.41 From a public policy perspective, corporate governance concentrates more on balancing economic and social goals and individual and communal goals at the same time promoting the “efficient use of resources, accountability in the use of power and stewardship as well as aligning interest of individuals, corporations and society”.42
Judging from the above definitions, it is clear that the overall objective of corporate governance is the harmonisation of relationships and interests of key stakeholders to achieve organisational goals.43 It can also be concluded that many, if not all, of the principles of corporate governance apply to all organisations regardless of nature and size.44 Irrespective of the type of ownership and structure, the wider governance agenda advocates that all organisations should act ethically, transparently and in a socially responsible manner.45 A government organisation for instance, should be managed for the benefit of the general public and to achieve the aims of the government itself.46
A charitable organisation should be managed in the interests of the charitable activity and with regard to the interests of and concerns of providers of the funding.47 Likewise, individuals controlling an organisation should not permit self-interest to dominate their decisions but should work for the objectives of the organisation.48 Thus to deter individuals, especially directors and managers, from pursuing their own interests at the company’s expense, shareholders and other stakeholders need corporate governance mechanisms that can discipline directors’ and managers’ conduct.49
VALUE OF CORPORATE GOVERNANCE
The challenge of corporate governance is to find a way in which the interests of shareholders, directors and other interested parties can all be sufficiently satisfied.50 Thus, the majority of the guidelines in the codes of conduct for corporate governance and the codes of best practice are directed towards reducing the potential for conflict and reconciling the interests of the various stakeholder groups.51 In essence, effective corporate governance establishes a system that guides the relationship between owners, boards, managers and various stakeholders, clarifying the rules and procedures for making decisions on corporate affairs, by whom the decisions should be made and how they should be implemented.52 Corporate governance processes, accordingly, inject transparency into the decision-making process, which is valuable to shareholders, potential investors, regulators, customers, suppliers, employees and any other stakeholders who may be affected by a company’s actions.
The extent to which countries attract foreign capital is dependent on their systems of corporate governance and the degree to which companies are duty-bound to honour the legal rights of shareholders and other stakeholders.54 Arthur Levitt, the former United States’ Securities and Exchange Commissioner confirmed that: “If a country does not have a reputation for strong corporate governance practices, capital will flow elsewhere”.55 Levitt’s view is supported by Lipman who states that, good corporate governance “enhances the reputation of the organisation and makes it more attractive to customers, investors, suppliers, and in the case of non-profit organisations, contributors”.56 This means that “individual and institutional investors will refrain from providing capital or will demand a higher risk premium for their capital from enterprises in countries without effective systems of corporate governance than from similar enterprises in countries having strong corporate governance standards”.57 International investment thus not only provides corporations with expanding sources of capital, but also encourages the continued integration of sound corporate governance practices, which may help the corporations to gain the trust of investors, reduce their capital costs and induce more stable financial sources.58
Corporate governance in public entities focuses primarily on making the state an effective owner, by creating “clear and simple lines of political and social accountability, improving board selection and quality, and contributing to the development of clear corporate strategies that reward efficiency and professionalism”.59 Good corporate governance is important for public entities in that it increases their productivity and competitiveness as well as helps to ensure that public funds invested in these entities are not mismanaged and are spent effectively.60 Improving the governance of public entities thus brings substantial benefits in the form of increased productivity and profitability, improved financial position for the government, better protection and utilisation of public assets, reduced corruption,61 greater attractiveness to investors resulting in increased state income and efficient service delivery to the public.62 In addition, good corporate governance helps to increase efficiency and transparency as well as to prevent public entity failures, thus minimising adverse social effects.63
From the above, it can be concluded that countries and business entities that genuinely observe and embrace the principles of good corporate governance will derive vast benefits. Good corporate governance enables an organisation to attract investment, maximise the opportunities available to it, increase transparency and accountability, manage its risks better, boost its chances of succeeding in the market and to achieve sustainable long term growth. Every country or business entity should therefore strive to practice good corporate governance for sustainable long term growth and success.
Despite the acknowledged vast benefits of corporate governance, it has been found that, in some instances, corporate governance has not really added as much value due to the fact that in many instances directors just “box-tick”64 without substantially complying with the corporate governance principles.65 This means that, whilst good corporate governance frameworks may be valuable, they are not adequate on their own as directors may just comply with the form of corporate governance at the expense of substantive compliance. As an example, it has been found that the failure of Enron had little to do with insufficient corporate governance standards and procedures, but everything to do with the culture, environment and conduct of the people at Enron.66 Unquestionably, Enron was considered as having one of the best boards in America before its collapse and was rated highly for its commitment to corporate governance practices.67 However, its collapse may be an indication that directors just chose to box-tick without necessarily complying with good corporate governance standards.
In another study conducted in South Africa, it was shown that whilst most listed companies in South Africa view corporate governance as an important matter, full compliance with the King Corporate Governance Code is still rare and a substantial number of companies comply only with the letter and not the spirit of the Code.68 For example, many companies were found not to provide adequate information about their companies’ internal operations, such as how directors are evaluated or how much each director is remunerated.69 It therefore, follows that investors and other stakeholders must recognise that although corporate governance standards might be essential they are not sufficient on their own to compel directors to act in a manner that achieves good corporate governance.70 For corporate governance to actually add value, directors have to substantively comply with the principles and not just box-tick.
INTERNATIONAL INITIATIVES ON CORPORATE GOVERNANCE
Globally, it has become well established that, to strengthen companies, be they private or public entities, there must be continuous investment of capital and human resources as well as customer satisfaction and public confidence in the entities.71 To be able to attain these objectives, companies need to do more than just create a track record of producing goods and services and having a reasonable market share, but must have good and effective management and be perceived to be properly governed.72 Proper corporate governance is globally considered as a very important tool to achieve these aims.
The realisation of the importance of corporate governance for the socio-economic development of countries has motivated a number of initiatives, at national and at international levels, aimed at responding to the corporate governance challenges worldwide. At national level, a number of countries have come up with reforms to prevent the occurrence of further corporate collapses and improve corporate governance practices.73 Internationally, these initiatives are being spearheaded by multilateral organisations including the World Bank,74 OECD,75 CACG,76 UN77 and ICGN,78 among others.79 The World Bank regards corporate governance as an essential tool in supporting international financial structures, creating a conducive investment environment for developing countries to have access to capital and eliminating corruption in both the private and public sectors.80 In furthering efforts to promote good corporate governance practices, the World Bank partnered with the OECD to put together a far-reaching international co-operation framework.81 The co-operation between the World Bank and the OECD is structured along two major initiatives: a Global Corporate Governance Forum (GCGF)82 and a series of Regional Policy Dialogue Round Tables.
The principles formulated by the OECD, CACG, UN and ICGN have provided a broad framework for a large number of countries to develop their own specific principles of corporate governance.84 The broad membership of the OECD, CACG, UN and ICGN suggest that these principles reflect the views of a large number of countries with respect to the correct approach for addressing the challenge of corporate governance. The principles recommended by the OECD, CACG, UN and ICGN are minimum benchmarks against which member countries can compare their systems and carry out country-specific initiatives.85
To complement the efforts of international organisations like the OECD, CACG, UN and ICGN, African leaders and policy makers have also come up with initiatives to, among other things; promote good corporate governance practices in the continent. Examples of the initiatives are the New Partnership for Africa’s Development (NEPAD),86 African Peer Review Mechanism (APRM),87 Africa Governance Forum (AGF),88 Africa Governance Inventory (AGI).89 In the same spirit, a number of organisations have spearheaded the promotion and facilitation of high standards of corporate governance, business ethics and social responsibility for the economic development and social transformation of Africa. Examples are the African Development Bank (AfDB)90 and Centre for Corporate Governance (CCG).91 In addition, the Institutes of Directors from twelve African countries launched the African Corporate Governance Network (ACGN) whose main objective is to strengthen “national corporate governance standards through shared learning, experience exchanges and dissemination of best practices aimed at addressing on-going corporate governance challenges in Africa”.
TABLE OF CONTENTS
DEDICATION
ACKNOWLEDGEMENTS
DECLARATION
ABSTRACT
LIST OF ABBREVIATIONS
CHAPTER 1 INTRODUCTION
1.1 CORPORATE GOVERNANCE AND PUBLIC ENTITIES
1.2 PROBLEM STATEMENT
1.3 SIGNIFICANCE OF THE STUDY
1.4 RESEARCH METHODS
1.5 SCOPE OF THE RESEARCH
1.6 POINTS OF DEPARTURE AND ASSUMPTIONS
1.7 FRAMEWORK OF THE THESIS
1.8 REFERENCE TECHNIQUES
CHAPTER 2 RESEARCH METHODOLOGY
2.1 INTRODUCTION
2.2 RESEARCH PROBLEM
2.3 RESEARCH APPROACH
2.4 LIMITATIONS OF THE RESEARCH METHODS
2.5 PRELIMINARY CONCLUSIONS
CHAPTER 3 CORPORATE GOVERNANCE IN PUBLIC ENTITIES: A THEORETICAL OVERVIEW
3.1 INTRODUCTION
3.2 OVERVIEW OF PUBLIC ENTITIES
3.3 DEFINITION OF CORPORATE GOVERNANCE
3.4 VALUE OF CORPORATE GOVERNANCE
3.5 INTERNATIONAL INITIATIVES ON CORPORATE GOVERNANCE
3.6 FUNDAMENTALS OF AN EFFECTIVE BOARD
3.7 PRELIMINARY CONCLUSIONS
CHAPTER 4 ZIMBABWE’S CORPORATE GOVERNANCE FRAMEWORK
4.1 INTRODUCTION
4.2 ZIMBABWE’S CORPORATE GOVERNANCE FRAMEWORK
4.3 PRELIMINARY CONCLUSIONS
CHAPTER 5 COMPARISON OF SOUTH AFRICA AND ZIMBABWE’S CORPORATE GOVERNANCE FRAMEWORKS
5.1 INTRODUCTION
5.2 COMPARISON OF SOUTH AFRICA AND ZIMBABWE’S CORPORATE GOVERNANCE FRAMEWORKS
5.3 PRELIMINARY CONCLUSIONS
CHAPTER 6 COMPARATIVE ANALYSIS OF THE ZIMBABWEAN AND AUSTRALIAN CORPORATE GOVERNANCE FRAMEWORKS
6.1 INTRODUCTION
6.2 COMPARISON BETWEEN THE ZIMBABWEAN AND AUSTRALIAN CORPORATE GOVERNANCE FRAMEWORKS
6.3 PRELIMINARY CONCLUSIONS
CHAPTER 7 ANALYSIS OF RESULTS AND DISCUSSION
7.1 INTRODUCTION
7.2 RESULTS
7.3 PRELIMINARY CONCLUSIONS
CHAPTER 8 SUMMARY, CONCLUSION AND RECOMMENDATIONS
8.1 INTRODUCTION
8.2 SUMMARY OF FINDINGS
8.3 CONCLUSIONS
8.4 RECOMMENDATIONS
8.5 FURTHER RESEARCH
BIBLIOGRAPHY
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