Current Views on Corporate Governance in Sri Lanka: Evidence from Sri Lankan Corporate Boards

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Current Views on Corporate Governance in Sri
Lanka Evidence from Sri Lankan Corporate Boards
Dr. Hareendra Dissa Bandara Director Financial
Services Academy Securities Exchange Commission
of Sri Lanka Senior Lecturer in Corporate
Governance Finance Faculty of Management
Studies Commerce University of Sri
Jayewardenepura
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Disclaimer Clause

• Views expressed herein are those of the
  presenter.  They do not necessarily reflect views
  of the Securities Exchange Commission of Sri
  Lanka or University of Sri Jayewardenepura or
  other staff members of the respective
  institutions.

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Importance
To Whom Why
Company Directors To enhance the governance level of respective companies thereby the countrys governance
Capital Market Professionals To advice clients in a broader sense
Regulators To regulate or to provide specific guidelines
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Contents

• What is corporate governance?
• Governance structures
• Need for greater corporate accountability?
• Major concerns of corporate governance
• Objectives of the study
• Methodology
• What is CGS?
• Results Adherence to the CG Essentials
• Current View

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What is Corporate Governance?

• Corporate governance is about promoting
  corporate fairness, transparency and
  accountability.
• (J. Wolfensohn, President - World bank, as quoted
  by an article in Financial Times, June 21, 1999)

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What is Corporate Governance? Contd

• Corporate governance is the system by which
  business corporations are directed and
  controlled.

The corporate governance structure specifies the
distribution of rights and responsibilities among
different participants in the corporation, such
as, the board, managers, shareholders and other
stakeholders, and spells out the rules and
procedures for making decisions on corporate
affairs.

• By doing this, it also provides the structure
  through which the company objectives are set, and
  the means of attending those objectives and
  monitoring performance.
• (Cadbury, OECD, April 1999)

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What is Corporate Governance? Contd

• Corporate governance is the mechanism by which
  companies are rationalized, directed, controlled
  and monitored. Corporate Governance coordinates
  different types of stakeholders such as
  shareholders, directors, managers, employees,
  creditors, customers, global environment and the
  rest of the society to enhance corporate
  performance and wellbeing as a common goal. Major
  considerations of a system of corporate
  governance are

• how successfully companies formulate the
  rational the reason for existence future
  direction
• how effectively corporate decisions are made
  guidelines and procedures
• how well the board on behalf of shareholders
  appraise managers decision making, and monitor
  the execution
• how fruitfully the different stakeholders are
  facilitated to achieve the goals
• (Dissa Bandara, 2006)

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Governance Structures
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US Governance Structure
Stockholder
Report
Appoint
Chairman
Board of Directors

1. Nomination Committee 2. Reward Committee
3. Inspection Committee 4. Finance Committee
5. Executive Committee
Appoint
Report
CEO
Executive Management
Source Based on Dissa Bandara (2003)
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Japanese Governance Structure
Appointment
Appointment /dismissal of Directors
Duty of Care
(Board of) Statutory Auditors at least majority
must be outside auditors in case of a large
company
Decide the administration of affairs of the
company
Supervise execution of duties of directors
Source Based on Dissa Bandara (2003)
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Sri Lankan Governance Structure
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EMPLOYEES
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Need for Greater Corporate Accountability?

• Separation of ownership and control
• Berle and Means (1932) recognise that the
  separation of ownership and control gives rise to
  a conflict of interest between insiders
  (managers) and outsiders (shareholders) with
  diffuse ownership.

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1932
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Separation of Ownership and Control
Ownership
Control
1
2
Management
Shareholder
Director

• Board of Directors leads the company and is the
  link between Owners and Managers

• 1. Determine the Future Direction Aims,
  policies strategies on behalf of the owners

• 2. Monitor the progress of Management Execution

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Separation of Ownership and Control Contd

• Agency Problem
• The greater the degree of separations, the
  greater the agency problem.
• Agency Cost
• Because of the costs of information and the
  difficulties in monitoring managers, rational
  managers undertake behaviour which shifts wealth
  from shareholders to themselves. This results in
  agency costs loss in market value relative to
  the value if no agency problems existed.

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Major Concerns of Corporate Governance

• Align the interests of managers and shareholders
• Prevent managers from pursuing own interests
• Prevent high and excessive executive pay
• Overcome agency costs associated with the
  separation of ownership and control
• Avoid abuse of power

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Objectives of the Study

• To examine the level of compliance of Sri Lankan
  companies on corporate governance (CG) principles
  based on a proposal of Governance Research
  Institute of Sri Lanka (GRIS)
• To understand the current views on Sri Lankan
  corporate boards

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Methodology
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Sample, Data Time Period

• Sample 59 Companies Listed on the CSE
• Data BoD related Qualitative Quantitative Data
• Method of Data Collection TRIANGULATION
• Questionnaire Survey, Informal Interviews,
  Annual Reports Publications, Governance
  Database of Governance Research Institute of Sri
  Lanka (GRIS)
• Time Period 2006 - 2010

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Sample
No Sector No. of Companies Access Restrictions 1st Sample Incomplete Data Final Sample
1 Bank Finance Insurance 35 (20) 15   15
2 Beverage Food Tobacco 20 (13) 7   7
3 Chemicals Pharmaceuticals 9 (9)      
4 Construction Engineering 3 0 3 (3)  
5 Diversified Holdings 11 (6) 5   5
6 Footwear and Textiles 4 (4)      
7 Health care 6 (2) 4 (4)  
8 Hotels Travels 32 (23) 9   9
9 Information Technology 2 (2)      
10 Investment Trust 9 (9)      
11 Land Property 18 (11) 7   7
12 Manufacturing 33 (23) 10   10
13 Motors 6 (6)      
14 Oil Palms 5 (5)      
15 Plantations 18 (12) 6   6
16 Power Energy 4 (4)      
17 Services 7 (7)      
18 Stores supplies 4 (4)      
19 Telecommunications 2 0 2 (2)  
20 Trading 8 (5) 3 (3)  
  Total 236 (165) 71 (12) 59
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Analysis and Tools

• 1. Formulating a Quantifiable Tool
• - Corporate Governance Score - BOD (CGSB)
• 2. Quantitative Analysis
• 3. Descriptive Analysis

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What is CGS?
Corporate Governance Score (CGS) is a measure
of adherence to CG practices policies (based on
GRIS)

• This CGS is
• an assessment of individual companies based on
  their CG practices to measure the compliance with
  the CG standards / practices
• NOT a kind of audit, a financial recommendation,
  credit rating nor an advice for a particular need
• Again it is
• NOT an indicator of financial or commercial
  performance

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Basic Strata of CGS
Principle Areas CGS Category Principles Sub Areas
I. Mission Role of the BOD and Committees CGS-BOD 14 Principles
I. Mission Role of the BOD and Committees CGS-BOD 74 Sub areas
II. Rights of Shareholders Minorities CGS-Sh 10 Principles
II. Rights of Shareholders Minorities CGS-Sh 46 Sub areas
III. Relationship with Stakeholders CGS-Stake 10 Principles
III. Relationship with Stakeholders CGS-Stake 40 Sub areas
IV. Role Leadership Responsibility of CEO CGS-CEO 12 Principles
IV. Role Leadership Responsibility of CEO CGS-CEO 44 Sub areas
V. Role of Executive Management CGS-Mgt 12 Principles
V. Role of Executive Management CGS-Mgt 40 Sub areas
VI. Disclosure and Transparency CGS-DisTrans 12 Principles
VI. Disclosure and Transparency CGS-DisTrans 42 Sub areas
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Separation of Ownership and Control
Ownership
Control
1
2
Management
Shareholder
Director

• Board of Directors leads the company and is the
  link between Owners and Managers

• 1. Determine the Future Direction Aims,
  policies strategies on behalf of the owners

• 2. Monitor the progress of Management Execution

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Adherence to CG Principles/Practices
Important Empirical Evidence
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Overall CGS - BOD Adherence
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General Compliance Details
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Top 10 CGS-BOD
Rank Order Company Sector Score
1 AAA BFI 203
2 BBB DIV 199
3 CCC BFI 198
4 DDD BFI 197
5 EEE BFI 192
6 FFF DIV 191
7 GGG Hotels 188
8 HHH Manu 187
9 III Manu 186
10 JJJ Manu 185
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Worst 10 CGS-BOD
Rank Order Company Sector Score
1 ZZZ Manu 115
2 YYY Manu 119
3 XXX Land Pro 120
4 WWW BFI 132
5 VVV Manu 139
6 UUU Land Pro 140
7 TTT Manu 140
8 SSS Land Pro 143
9 RRR Plantation 143
10 QQQ Land Pro 144
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Frequency Distribution of CGS-BOD
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High Low CGS-BOD Groups

• High CGN Group
  9
  firms with score greater than 185
  
  
• Low CGN Group
  
• 10 firms with score less than145

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High Low CGS-BOD Groups
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High Low CGS Japan - 2003
1 SD 11.2
1 SD 11.2
Avg. 36.3
Low CGN Group 25 Firms
High CGN Group 25 Firms
Source Dissa Bandara (2003)
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High Low CGS Japan - 2008
1 SD 12
1 SD 12
Avg. 37.8
Low CGN Group 25 Firms
High CGN Group 30 Firms
Source Dissa Bandara (2008)
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Composition of CGS-BOD
Specific Areas Point Allocation Score Obtained Compliance Level
1 Determining Future Direction 20 13.33 67
2 Policy Formulating Practices 20 12.88 64
3 Engage in Strategic Thinking and Planning 20 13.38 67
4 Board Structure Practices 25 14.28 57
5 Board Membership Orientation 16 8.52 53
6 Board Meetings 25 14.49 58
7 Board Committees 45 24.39 54
8 Board-CEO Senior Management Relationship 20 9.93 50
9 Board Staff Roles 20 9.17 46
10 Monitoring Evaluation Practices 25 11.68 47
11 Legal Ethical Compliance 12 7.72 64
12 The Entity 12 7.11 59
13 Stakeholders 16 7.76 48
14 External Relations Practices 20 10.44 52
OVERALL 296 165 56
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Composition of CGS-BOD
Specific Areas Point Allocation Score Obtained Compliance Level
3 Engage in Strategic Thinking and Planning 20 13.38 67
1 Determining Future Direction 20 13.33 67
2 Policy Formulating Practices 20 12.88 64
11 Legal Ethical Compliance 12 7.72 64
12 The Entity 12 7.11 59
6 Board Meetings 25 14.49 58
4 Board Structure Practices 25 14.28 57
7 Board Committees 45 24.39 54
5 Board Membership Orientation 16 8.52 53
14 External Relations Practices 20 10.44 52
8 Board-CEO Senior Management Relationship 20 9.93 50
13 Stakeholders 16 7.76 48
10 Monitoring Evaluation Practices 25 11.68 47
9 Board Staff Roles 20 9.17 46
OVERALL 296 165 56
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3 Engage in Strategic Thinking and Planning
  Specific Areas
1 The organizations corporate plan annual budget is fully discussed by the board prior to its approval.
2 The financial status of our organization is regularly reviewed and needed board actions are taken thoughtfully but quickly.
3 Board leadership takes steps to ensure that financial reports are thoroughly understood by board members.
4 The annual report of the organization and independent auditor is reviewed and needed actions are taken in a timely way.
5 Board members are well aware of their legal responsibilities for the organizations financial management.
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1 Determining Future Direction
  Specific Areas
1 Organizations mission and purpose are clearly understood and accepted by the board.
2 The members of the board have reached consensus on a vision that indicates where the organization will be headed over the next 3-5 years.
3 The full board collaboratively reviews and updates the organizations strategic plan at least every two years.
4 Staff develops and carry out annual plans based on the boards approved strategic plan.
5 The board is well-briefed by the management on annual plans/action plans developed by staff.
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2 Policy Formulating Practices
  Specific Areas
1 If a new policy is needed for the board or the organization as a whole, the issue is clearly presented to and discussed by the board.
2 The full board approves all new organizational policies before they are implemented.
3 Policies exist for key areas such as finance, personnel, safety, and ethics, and all functions unique to our organizations work.
4 Our organizations policies are effectively communicated to all board members.
5 The Board reviews policies at least annually and updates them as needed.
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9 Board Staff Roles
  Specific Areas
1 The role and responsibilities of the board are clearly defined and separate from those of the management staff (Monitoring vs Controlling).
2 The board takes the primary responsibility for developing the organizations policies.
3 Board members never assume roles and responsibilities that belong to staff.
4 The board delegates to the organizations Chief Executive sufficient authority to lead the staff and carry out the organizations mission.
5 When a problem or conflict arises between board and staff, parties move quickly and effectively to resolve it.
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10 Monitoring Evaluation Practices
  Specific Areas
1 Board members are adequately knowledgeable about the organizations programs/projects and services.
2 Periodically review with the CEO the possibilities of adding new programs/projects and services, and modifying or discontinuing current programs/projects and services.
3 The board keeps itself informed of the organizations performance against predetermined plans and goals.
4 The effectiveness of the board and committee structure is assessed every year.
5 Annually assess the individual members satisfaction with their participation on the board.
6 Regularly evaluate the effectiveness of the board meetings.
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13 Stakeholders
  Specific Areas
1 Has the Board identified key stakeholders?
2 What is the state of the relationship with the key stakeholders?
3 How well do entity's objectives reflect stakeholders expectations?
4 Is there a policy determining how the entity will relate with stakeholders?
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Sector-wise CGS-BOD
CGS-BOD Components Point Allocation BFI BFT Diversified Hotel Trav Land Property Manufact Plantation Overall Compliance
1 Future Direction 20 16 13 13 14 11 12 13 13
2 Policy Formulating 20 14 13 13 13 11 12 14 13
3 Strategic Thinking 20 15 13 14 13 12 13 14 13
4 Board Structure 25 15 14 16 14 12 14 14 14
5 Board Membership 16 9 8 10 9 7 8 9 9
6 Board Meetings 25 15 14 16 14 13 14 15 14
7 Board Committees 45 26 24 27 24 21 23 25 24
8 Board-CEO Mgt 20 10 10 11 10 9 10 10 10
9 Board Staff 20 10 9 9 10 8 9 9 9
10 Monitoring 25 12 13 12 11 11 11 11 12
11 Legal compliance 12 10 7 8 7 6 7 7 8
12 The Entity 12 7 7 8 7 6 7 7 7
13 Stakeholders 16 6 8 10 8 6 8 8 8
14 External Relations 20 11 11 12 10 9 10 10 10
CGS-BOD Components 296 178 165 180 164 143 160 166 165
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Sector-wise Compliance
CGS-BOD Components Point Allocation BFI BFT Diversified Hotel Trav Land Property Manufact Plantation Overall Compliance
1 Future Direction 20 81 67 66 69 56 62 66 67
2 Policy Formulating 20 72 63 66 63 55 62 69 64
3 Strategic Thinking 20 74 65 70 64 59 66 69 67
4 Board Structure 25 61 57 65 57 49 55 57 57
5 Board Membership 16 55 53 62 53 44 52 54 53
6 Board Meetings 25 60 58 64 57 50 56 60 58
7 Board Committees 45 58 54 60 54 48 52 55 54
8 Board-CEO Mgt 20 52 50 54 49 43 49 51 50
9 Board Staff 20 52 44 46 50 39 45 44 46
10 Monitoring 25 48 52 50 44 44 45 44 47
11 Legal compliance 12 83 61 70 62 53 60 61 64
12 The Entity 12 62 61 68 58 51 57 59 59
13 Stakeholders 16 41 51 60 48 39 49 51 48
14 External Relations 20 55 53 59 51 45 50 52 52
OVERALL 296 61 56 61 56 48 54 57 56
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Sector-wise Compliance
CGS-BOD Components Point Allocation BFI BFT Diversified Hotel Trav Land Property Manufac Plantation Overall Compliance
1 20 81 67 66 69 56 62 66 67
2 20 72 63 66 63 55 62 69 64
3 20 74 65 70 64 59 66 69 67
4 25 61 57 65 57 49 55 57 57
5 16 55 53 62 53 44 52 54 53
6 25 60 58 64 57 50 56 60 58
7 45 58 54 60 54 48 52 55 54
8 20 52 50 54 49 43 49 51 50
9 20 52 44 46 50 39 45 44 46
10 25 48 52 50 44 44 45 44 47
11 12 83 61 70 62 53 60 61 64
12 12 62 61 68 58 51 57 59 59
13 16 41 51 60 48 39 49 51 48
14 20 55 53 59 51 45 50 52 52
OVERALL 296 61 56 61 56 48 54 57 56
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Evidence on International Status
Indicator Belgium France Germany Japan Nethlnds Port UK US
1.1 Best Practice Codes 5 9 6 3 4 4 9 9
1.2 Non-executive Directors 8 9 5 1 10 3 6 8
1.3 Board Independence 2 3 2 0 1 0 4 7
1.4 Split Chairman/CEO 6 2 5 0 5 2 6 1
1.5 Board Committees 3 4 1 0 3 3 6 8
21 Voting Rights 10 6 9 10 6 6 10 9
2.2 Voting Issues 8 8 5 4 5 7 7 3
3.1 Accounting Standards 2 3 7 0 6 2 9 10
3.2 Executive Pay 3 10 2 2 8 2 10 10
4.1 Takeover Barriers 3 4 3 0 1 2 10 7
Overall Score 5.0 5.8 4.5 2.0 4.9 3.1 7.7 7.2
Country Rank 4 3 6 8 5 7 1 2
SourceBased on Dissa Bandara (2008)
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ConclusionsThe extent of Adherence to CG
Principles

• Actual CG practices are considerably deviated
  from the expected standard (AVG compliance level
  56)
• A broad variation in CG practices across the
  firms (Max 69 Min 39)
• A considerable variation in CG practices across
  the industries (48 - 61)
• Governance level is high in BFI Diversified
  (high AVG score)

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Conclusions The extent of Adherence to CG
Principles

• Sri Lankan boards are good at
• Strategic planning
• Determining future direction
• Policy formulating practices
• Sri Lankan boards are weak at
• Board-staff roles (not clearly defined and
  separated)
• Monitoring evaluation (split the role of
  Chairman CEO)
• Relationship with the stakeholders

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Conclusions Contd Emerging CG Characteristics

• The degree of interest in the recent discussion
  on CG is remarkably high (over 70)
• Through their CG system they hope to enhance the
  performance and speed up of decision-making
• There is a growing tendency of introducing new
  features like Independent Directors, BOD training
  IR activities

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For Future

• Employ a multiple CGS, considering
• Sri Lankan CG Principles (to be finalized)
• OECD CG Principles
• Other Leading Sources like, CalPers
• Use Case Study Critical Incident Method as
  methodological tool
• External pressure should be increased to get the
  poor players to the track
• CG practices should be familiarized among
  corporate level