by Stilpon Nestor

Corporate governance concerns showed up on policy agendas as a result of four key trends that emerged in the last two decades:

• The impressive growth of equity markets as a source of corporate finance and the corresponding increase in share ownership among populations in both OECD and emerging economies.
  
• The growing role of institutional portfolio investors in the allocation of financial resources and the systemic importance of effectively managing equity risk in their global portfolios. These institutions are themselves fiduciaries of small savers/pensioners. They often have limited exit possibilities because of widespread indexing in their equity portfolios, and are thus dependent upon better corporate governance to protect their investments from expropriation.
  
• The exponential growth of cross-border portfolios and direct foreign investments along with the corresponding shrinking of official aid flows towards emerging and developing economies. This new financing pattern increased demands for more transparency, accountability and predictability on the side of capital providers (such as multinational enterprises), especially for recipients of globally mobile capital in developing countries.
  
• The growing importance of the corporation as a source of employment and growth in almost all economies as well as the resulting need for a proper legal framework and an effective social profile for this key economic institution. While in most OECD economies this translated mostly into fine-tuning the existing norms (including company laws), developing countries needed to engage in extensive institutional design and institution-building efforts in this area, often from scratch.
  

The Emergence of the OECD Principles

The Asian crisis became the catalyst in the corporate governance debate. It revealed the nefarious impact that lack of accountability has on the health of the financial markets, especially in emerging markets. In short, corporate governance was for the first time perceived as an issue of systemic financial stability.

As a response to the above concerns, the OECD ministers adopted the OECD Principles on Corporate Governance in June 1999. They are the result of the work of a Task Force comprising all 29 OECD Member governments and the European Commission, private parties, the World Bank, IMF, and other international organisations. From the start, this work also benefited from a broad exposure to public commentary on successive drafts, including through the Internet. A number of important non-OECD countries participated in repeated rounds of consultations and provided written comments on the working drafts. Thus, the Principles are multilateral and genuinely global, as they were agreed by experts from a very vast spectrum of economies with different structural characteristics, different corporate control and ownership arrangements.

Some commentators did show some scepticism as to the global applicability of the OECD Principles in the very beginning of their existence. However, these concerns were laid to rest quite early on. Most policy makers and market participants in developing countries realised that their “open architecture” and their non-binding character represent an opportunity rather than a constraint on countries. The Principles offer a transparent and straightforward way to benchmark corporate governance reform visibly and verifiably, against a standard with high substance content espoused by markets and donors alike. To achieve this, countries do not have to wear a one-size-fits-all straightjacket. That is because the Principles are, in essence, a conceptual framework for policy makers, companies, investors and others to address corporate governance in terms that are commonly understood around the world but which leave plenty of space for local solutions. Countries like China, Russia, India and Brazil have openly used them in their own reform efforts. Key development institutions such as the IMF and the World Bank are employing them as tools for their own assessments. As a result, they have been included by the Financial Stability Forum in its compendium of the 12 core global standards for financial stability.

The OECD Principles cover five main areas:

1) The protection of the rights of shareholders;
2) the equitable treatment of all shareholders;
3) the role of stakeholders;
4) transparency and disclosure; and
5) the role of boards (see box).

Cooperation between the OECD and the World Bank

The Principles would have remained a dead letter if the international community that helped produce them did not take steps for their implementation. The World Bank started a process of assessment of a number of its members on the basis of the Principles. Most importantly, the OECD and the World Bank put together a far-reaching global co-operation framework with the purposes of broadening policy dialogue and co-operation on corporate governance reform and responding to the need of individual countries to improve corporate governance.
The co-operation between the World Bank and the OECD is structured along two major initiatives: a Global Corporate Governance Forum (GCGF) and a series of Regional Policy Dialogue Round Tables.

1. The Global Corporate Governance Forum is a donor-driven mechanism that was established in March 2001. The Steering Committee of the Global Forum consists of the World Bank, OECD and all participating bilateral and multilateral donors. It is expected that the Forum will support a number of projects in developing and transition economies at national and local level.

A cardinal piece of the Forum’s institutional setup is the creation of advisory groups that will provide for a continuous input of key corporate governance constituencies in the process. The first of these groups, the Private Sector Advisory Group has been set up. It is chaired by Ira Millstein, one of the most well known corporate governance advocates in the U.S. It has already established task forces between key institutional investors and companies in countries such as Brazil and Russia to promote better corporate governance through private-to-private dialogue.

2. The OECD/World Bank Regional Roundtables on Corporate Governance are the second leg of the global partnership. They are organised by the OECD, in close co-operation with the World Bank Group and various regional partners – such as Securities Commissions, Stock Exchanges and Institutes of Directors – who play an active role in their preparation and in setting the agenda.

The Roundtables provide an inclusive platform for policy-dialogue, where senior policy-makers, regulators, corporations, investors, stakeholder organisations and other participants in a specific geographical region can raise concerns, exchange experiences and find solutions.
It is important to note that the Corporate Governance Roundtables are not one-off events. Rather, they consist of a cycle of meetings taking place over a 2 to 3 year period. Such a long-term presence is necessary in order to develop a regional constituency of peers who can sustain the momentum for needed reforms.

The conclusions from these discussions in each region will eventually be reflected in a “Regional White Paper on Corporate Governance”. This is a report that will be adopted by the members of each Roundtable at the end of the process. It is essentially an agenda for action and practical recommendations for reform, based on the knowledge generated by the Roundtable discussions. Hence, the White Papers’ agendas are products of the Roundtables with a real sense of regional ownership.

As of today, Roundtables have been set up in five different regions: Asia, Russia, Latin America, SouthEast Europe and Eurasia (i.e. former Soviet Union countries except Russia). They have all come to attract high-level participants, both from the public and the private side. The Asian Roundtable has the Asian Development Bank as a core co-organiser along the World Bank and the OECD. The Roundtables have become a natural point of reference in their respective regions. As an example of their presence, the APEC joint ministerial statement of September 2000:

“ ...welcome (d) the efforts of the OECD and the World
Bank to raise the awareness of, and the commitment to,
corporate governance reforms in the region
through Roundtable discussions”.

The Latin American, Russian and Asian Roundtables have already reviewed the first drafts of their respective White Papers. In the case of Latin America, the first draft was submitted in April to the Western Hemisphere Finance Ministers Forum as their key background on a corporate governance initiative they are undertaking.


Linking Corporate Governance Principles to Development and Poverty Alleviation

But how important is corporate governance in general and the
Principles in particular, for development and poverty alleviation context? In this respect, the OECD and the World Bank supported the launching of a pan-African initiative to improve corporate governance in Johannesburg in July 2001. Nevertheless, there is a clear need for a more rigorous definition of the linkages between development and aid policies – and for more analytical and policy coherence. To this end, I would like to offer a few brief thoughts for consideration:

• Corporate governance is a high priority issue for some large emerging economies with active capital markets which harbour large pockets of poverty: lowering corporate governance risks will impact directly on the cost of capital of the local corporate sector and will thus be a determining factor of growth and development. India, China, Brazil and South Africa fall within this category.
  
  
• Corporate governance also comes within the policy horizon in low-income developing or transition countries with budding but as yet not very significant capital markets. The Principles in this case have an aspirational value, showing the way ahead to designers of company laws and providers of basic education to corporate officers. In addition to equity market concerns, core company law rules and their implementation might have an impact on the behaviour of lenders and direct investors in these countries: they also face uncertainties related to the poor separation between corporate assets and the assets of shareholders, or to the overt politicisation and capture of corporate (and bank) boards by rapacious officials or ruling families.
  
  
• Notwithstanding the point above, the priority of corporate governance in low-income countries with no capital markets is admittedly lesser than in emerging economies or OECD members. Corporations are few, mostly state-owned (SOEs) or multinationals (MNEs). What is important here is corporate responsibility on the side of the MNEs (as addressed in the OECD Guidelines for Multinational Enterprises) and privatisation -cum-new investment for the SOEs. Albeit related to corporate governance, these are areas where specific instruments, polices and implementation strategies need to be designed and pursued. From a governance perspective, it is public not corporate governance that matters the most: fighting bribery and corruption, making the state more efficient. The largest part of these economies typically consists of tiny, small and medium sized enterprises (SMEs). Boards of directors, complicated transparency systems and stakeholder relations, not to mention sophisticated minority shareholder protection systems, are largely redundant. These things are expensive; they need to be taken up only as capital markets develop. On the other hand, development of SMEs is crucial – but has more to do with micro-finance and active SME development policies. In some quarters, there is a tendency to “broaden” the concept of governance to include every type of economic issue related to commercial behaviour and activity. While this approach is driven by the good intention of capitalising on the pulling power of the corporate governance fashion, it is ultimately counter-productive. It risks leading to ill-defined standards which offer little guidance to policy makers in the developing world, are useless to capital providers and thus will have little impact on economic development. Moreover, they risk diverting resources towards new “white elephants” under the guise of better corporate governance. In short, if we want well-focused, result-oriented development policies, it is better to call things by their names.

To conclude, a lot has been achieved in the last couple of years. But there is a clear need for further deepening international co-operation and dialogue. Seattle, Washington and Prague indicate a growing concern among many that an unchecked globalisation might create disparities in the allocation of resources that will be hard to remedy. The world risks rejecting the enormous benefits of international investment and deeper capital markets if its main conduits and recipients, the corporations, are not perceived as efficient,
transparent, accountable and fair institutions.

Stilpon Nestor is is head of the Corporate Affairs Division, OECD. The opinions expressed in this article are the author’s own and do not necessarily reflect those of the OECD.

OECD Principles The Five Main Areas of the OECD Principles of Corporate Governance The protection of the rights of shareholders is a pillar of any effective corporate governance system. The ability to participate in basic decisions concerning the company, chiefly by participation in general shareholder meetings is set forth as an important right. The Principles call for full ex ante disclosure of arrangements that redistribute control over the company in ways that deviate from proportionality to equity ownership and cash flow rights. But corporate governance frameworks should also ensure equitable treatment of all shareholders, including minority and foreign shareholders. Insider trading and self-dealing should be prohibited; the latter is really the scourge of most emerging markets. Personal material interests of the board and management members in matters affecting the corporation should be disclosed. The Principles recognise that it is in the long-term self-interest of firms to encourage active participation in the governance process by stakeholders (i.e. employees, creditors, long- term suppliers and customers among others). Legal rights of stakeholders should be effectively respected. Furthermore, factors such as business ethics and corporate awareness of environmental and societal interests of the communities in which it operates can have an impact on the reputation and long term success of the corporation. The Principles call for a strong disclosure regime, acknowledging transparency as a key element of an effective corporate governance system. They call for timely and accurate information to be disclosed on matters such as the company’s financial and operating results, its objectives, major share ownership and voting rights, remuneration of key executives, and material foreseeable risk factors. This information should be prepared and audited in accordance with high quality standards. The application of high quality standards for accounting and audit, including codes of ethics for auditors, is one of the most effective ways of preserving and enhancing the quality and credibility of capital markets. In addition to their commercial objectives, companies are encouraged to disclose policies relating to business ethics, the environment and other public policy commitments as well as to the corporate governance of the company. Such information may be important to better evaluate the relationship between companies and the communities in which they operate and the steps that companies have taken to implement their objectives. Finally, the board should be the main mechanism for effective monitoring of the management and for providing strategic guidance to the corporation. The Principles make it clear that it is the duty of the board to act fairly with respect to all groups of shareholders and with stakeholders, and to assure compliance with applicable laws. Board members should be able to exercise objective judgement on corporate affairs, independent of management.