Templates by BIGtheme NET
Home » Business Monthly » Unpacking the new corporate governance code

Unpacking the new corporate governance code

In the past two years, there have been several high profile cases of poor governance in Kenya’s corporate scene. Some of these cases have been in private companies while others, sadly, in list-ed firms. Although poor corporate governance requires a blanket con-demnation, it merits a particularly harsh admonition in listed firms as it discourages foreign and even local participation in the capital markets. This can have devastating effects for the economy. high profile cases in 2015 of listed firms such as retailer Uchumi, where staff were allegedly involved in the systematic pilferage of merchandize from supermarket shelves. There was also concern that books had been manipulated to the tune of Sh1.04 billion, according to a forensic report by KPMG. Uchumi chief executive at the time, Jonathan Ciano, was later dismissed. Cigarette maker BAT also announced in January that Ciano left the board, where he was a non-exec-utive director, for “personal reasons.”
The degree of malpractice was even more acute in sugar processor Mumias, where top managers were accused of colluding with illegal sugar importers to import cheap sugar and later repackage and sell as Mumias Sugar.
These cases point to the huge corporate governance gaps in Kenya. Corporate governance best practices demand that the board of a compa-ny should act in the best interest of shareholders. This means that the board, even though not criminally liable in cases of grand malpractice orchestrated by management, can never really absolve itself of respon-sibility. The board should have the capacity as well as the tools to pre-vent issues before they occur. This means that an updated and strict corporate governance code is not only encouraged, but necessary.
The CMA, which is primarily concerned with the efficient regu-lation of the capital markets, has always identified the institution of sound corporate governance prin-ciples as integral to Kenya’s efforts to become an international financial center. This is why the gazettement of the CMA’s new code marks a critical milestone in the Authority’s continued implementation of its Capital Markets Master Plan, a 10 year blueprint outlining the path that Kenya must take to become the “heart of African financial markets.”Corporate Governance Practices for Issuers of Securities to the Public 2016 was developed as part of wider corporate governance reforms. The reforms were informed by the need to respond to the changing busi-ness environment and the desire to align local standards to global best practice to promote institutional strengthening for listed companies’, said Mr. Paul Muthaura, acting chief executive officer of the CMA.
Tough but practical
There are a lot of new measures that stand out in the new code. For instance, companies listed on the Nairobi bourse will now have to disclose the reasons behind the exit of their board members and top managers such as chief executives and chief finance officers.
About a dozen top executives have exited NSE-listed firms after facing allegations of professional misconduct ranging from falsifying books and poor management deci-sions. Firms, however, have made a practice of sugar-coating the reasons for executive and board member exits, throwing around terms such as “for personal reasons” rather than telling it as it is.
When professional misconduct is the reason for the exit of a top execu-tive or board members’ exit, it needs to be stated explicitly and as bluntly as possible. This minimizes systemic risks in the markets in the event that the rogue executive or director move to other listed firms.
“The Capital Markets Authority shall be notified immediately the resignation takes place and such notification shall include detailed circumstances necessitating the res-ignation,” said CMA’s Paul Muthaura in a notice published in the Kenya Gazette dated March 4 2016. “The board shall disclose resignation of a serving board member in two news-papers with national reach imme-diately it happens; and in the GOVERNANCE
Special Feature
company’s website immediately it happens,” he added.
Another novel measure in the CMA’s code of corporate governance for listed firms is the rule that ties executives’ pay to profitability. The regulations require publicly traded companies to adopt a pay-for-per-formance formula for remunerating board members and top manag-ers such as chief executive officers (CEOs) and chief finance officers (CFOs).The remuneration of execu-tive directors shall also include an element that is linked to corporate performance so as to ensure maxi-mization of the shareholders’ value.
This new law means that top executives and directors will now work harder to ensure consistent profit growth, especially considering that the law comes on the back of profit warnings from 18 listed firms on the NSE.
Another key measure introduced in the new code is that directors of publicly listed companies will need to disclose their pay to the pub-lic. Executive directors will also be required to have some shareholding in the companies they serve.
The new code has also placed age restrictions on members, with the maximum age being 70 years. Board members that are past the upper age limit now have to seek fresh shareholder approval at their next AGMs to continue serving. The move is meant to strike a balance between having long-serving, experi-enced directors and the need to inject fresh blood and ideas into the listed companies.
Despite the hard demands that this new code makes on listed firms, it is also practical in that it has made a fundamental departure from the “comply or explain” approach to the new “apply or explain” approach.
The “apply or explain” approach recognizes that no single set of rules can be applicable to all types of com-panies. This Code allows for flexibil-ity in the decision-making process by the Boards of listed companies with a focus on ensuring corporate decisions result in the application of the highest standards of governance with the benefit of the guidance of the standards recommended in the new Corporate Governance Code.
Where decision-making produc-es a lower standard than that which is prescribed in the Code, listed com-panies will be required to explain non-application of the recommended standards to shareholders and the Authority through relevant channels such as annual reports and Annual General Meetings.
In a nutshell, the “apply or explain” approach introduces a mea-sure of flexibility that ensures the new code of corporate governance is facilitative and not restrictive. Limitations
There is no denying that there are some limitations to implement-ing this new code. First, performance related pay for executives may not be practical, especially in the finan-cial service sector; that is, insur-ance and banking. This is because high pay has typically been used to attract top talent in the financial sector, especially in insurance.
Talent is scarce and insurance firms are willing to pay a premi-um for it. “Companies are offering higher pay as a key talent retention strategy,” said Kuria Muchiru, PwC’s human resource leader for Central and Southern Africa. This is a trend not only restricted to insurance but, increasingly, also to banking.
There is stiff competition for good executives. This is what has been pushing executive and CEO remuneration through the roof, especially in the financial services industry. Financial services is rapidly expanding and any executive with good experience is likely to receive multiple offers from top firms as there is scarcity of talent.
If you cut the pay of your chief executive by 25 percent because profits fell—especially due to uncon-trollable macro-factors such as high interest rates or a falling curren-cy—a competitor will give him a better deal and pay him even double what he made before the pay cut.
Moreover, as the economy grows, more top executives and directors are needed to oversee this growth and manage companies. Unfortunately, corporates do not want to appoint fresh CEO’s who will acquire skills in the job. They want a CEO with the skills, expertise, experience and networks who will hit the ground running and bring results in record time. They are looking for quick results in order to retain sharehold-ers’ trust.
This means that high pay for top executives and directors will remain a key talent attraction and retention strategy in corporate Kenya, intro-ducing insurmountable difficulties in the implementation of CMA’s new code of corporate governance, which calls for performance related pay.
It is also instructive to note that even if performance related pay is implemented, it does not lessen the risk of manipulating books but rath-er provides incentives for it. This is something that cannot be over-looked, considering manipulation of books is something that has hit listed firms in the recent past. The aforementioned example of Uchumi is a strong case in point.
Another area that raises ques-tions is the restriction on those above 70 from serving on boards. The rule could affect about 27 serving direc-tors on NSE listed companies. This rule is not entirely in line with global best practices, considering some of the world’s most efficient directors such as Warren Buffet are also the world’s oldest. Warren Buffet is 86 but he still oversees a company with one of the most spectacular and consistent investment track records in the world.
In business nothing beats prac-tical experience, and this is what experienced board members bring to the table. They say foresight is important, but hindsight is equally, if not more, important. This is espe-cially true in cyclical industries.
Ethical demands
In the final analysis, the new corporate governance code places considerable ethical demands on listed firms. This is because in addi-tion to pushing for sound corporate governance, it also advocates for reliable frameworks to tackle money laundering and terrorist financing.
Although legislation may go a long way in restricting money laun-dering and terrorist financing, ethi-cal practice in businesses go a longer way. “Law and ethics are not the same thing. Both exist to influence behavior, but complying with the law is mandatory, while adhering to an ethical code is voluntary,” says Dr. Hanningtone Gaya, a published academician with vast experience in the field of corporate governance and corporate responsibility. “Laws define what is permissible, while ethics speak to what is right, good and just,” he adds.
The reason why it is hard to enforce anti-money laundering and terrorist financing is that sometimes perpetrators of these vices will use the correct channels, which techni-cally means that they will be operat-ing under the law. It therefore boils down to a question of individual responsibility, which is never easy to legislate.
Vetting of directors is also anoth-er area where ethical demands will increase. In the past when directors are vetted, we have seen a clear pat-tern where those with outstanding and publicly known integrity issues are cleared on so-called “technicalities”. This is a sharp illustration of how hard it is to legislate eth-ics. From a legal standpoint, these directors make the cut. But from an ethical standpoint, their suitability is highly debatable. It will be inter-esting to see whether the new code addresses this.
The new code of corporate gover-nance therefore carries a lot of impli-cations for corporate Kenya. For listed firms, it is clear that the law is slowly catching up with the demands of today’s corporate world. It is also clear that each employee has an individual responsibility to ensure ethical standards are maintained. For other private firms, it is a cue to introduce best governance practices.
For Kenya, the new code is an admittedly a step in the right direc-tion. It comes at a time when the country’s image has been tarnished due to endemic corruption. It will help salvage the country’s image on a global level, especially considering that it coincided with international recognition of CMA’s acting CEO Paul Muthaura.
Muthaura has been elected the Vice Chair of the Africa Middle East Regional Committee (AMERC) of the International Organization of Securities Commissions (IOSCO) for a two-year term, starting May 2016. He will further continue to serve on the IOSCO Board, to which he was elected in September 2014. The elec-tion, coupled with the new code, will help cement Kenya’s positon as a key voice in articulating policy concerns unique to emerging markets.
The CMA notes that sound corporate governance, reliable and transparent financial reporting and effective frameworks to tackle money laundering and combat terrorist financing are pre-conditions to the development of the capital markets in Kenya as well as the realization of the Vision 2030 goal of establishing Nairobi as an international financial center.