Governance by directors, for directors
King 3's woolly definitions are letdown for shareholders
April 20, 2009
 By Ann Crotty
Brian Molefe, the chief executive of the Public Investment Corporation (PIC), describes the draft of the King 3 report as bland.
Theo Botha, the shareholder activist, says it does nothing to promote the interests of stakeholders. David Couldridge of Frater Asset Management notes that it lacks statutory obligation and therefore is problematic in terms of requiring ineffective boards to apply the principles.
Jonathan de Pasquallie of Avior Research says the draft "was formed by directors, for directors and there is clearly a risk of bias".
It does seem that anybody in the broader South African investment community who has an expressed interest in promoting corporate governance has significant concerns with the draft Code of Governance Principles for South Africa.
Botha seems most exercised by the fact that the code makes absolutely no effort to hold anyone accountable for adhering to the principles. In this regard he notes that King 3 follows the non-rigorous approach adopted by the two earlier codes. He notes that no board has ever been held to account for its lack of adherence to either of the earlier codes.
The King 2 report stressed in its introduction: "Monitoring and supervision across the entire spectrum of economic and commercial enterprises is impossible by any measure, and thus the recommendations contained in this report remain self-regulatory."
Some, but only some, King 2 recommendations have been incorporated into the listings requirements for the JSE.
Despite the failure of this sort of self-regulation, which is evident in the current global financial crisis, King 3 persists with this approach.
It defends the non-statutory, "apply or explain" approach to governance on the grounds that a "comply or else" approach to firms of varying sizes "cannot logically be suitable because the scales of business carried out by companies vary to such a large degree".
In addition, the cost of compliance "is burdensome both in time and money" and in a "comply or else" environment the board and management "become focused on compliance rather than the business of the enterprise".
King 3 refers to the estimated $264 billion (R2.4 trillion) that compliance to Sarbanes-Oxley has cost US companies since those regulations were introduced in 2002 following the controversial collapse of high-profile companies such as Enron and WorldCom.
Botha counters that this sort of expense is to be expected in the initial period of implementation, but that as companies become accustomed to the tougher compliance requirements and as the requirements become part of the way of doing business, the costs will diminish.
What Botha and some other corporate governance practitioners find particularly disturbing is the additional flexibility King 3 provides to the "apply or explain" approach.
In terms of the latest draft code, a board can adopt a practice different from that recommended, and is merely required to explain the different practice. "This is just like saying, 'I have these principles but if you don't like them, I have others,'" said Botha.
In its discussion of the link between governance principles and law, King 3 does hold out some hope that failure to meet a recognised standard of governance, although it is not legislated, "may render a board or individual director liable at law".
This is because when it assesses the standard of appropriate conduct, "a court will take into account all relevant circumstances, including what is regarded as the normal or usual practice in the particular situation".
King 3's requirement that an independent director "does not receive remuneration contingent upon the performance of the company" is long overdue.
This is designed to ensure that independent directors are not issued with share options. Two notable examples of this are Steinhoff and JD Group: the latter issued share options to independent directors Mervyn King of the King report and Len Konar, a long-serving member of the King committee.
Strangely, King 3 has removed two independence requirements contained in King 2: that an independent director is "not a significant supplier to, or customer of, the company or group" and that the director "has no significant contractual relationship with the company or group" have been dropped.
But the greatest concern on this front is that King 3 applies no time restriction to the definition of independence.
It states that independent non-executive directors should be "independent in fact and in the perception of a reasonably informed outsider", then goes on to make the concept of independence even woollier by emphasising "independence is … more a state of mind than an objective fact and perception".
This statement, contained in annex 1.3, represents the report's greatest lost opportunity. It is without doubt the most powerful evidence that this report was written by directors, for directors, with little concern for the views of other stakeholders.
As Botha explains: "The independent directors are the foundation of corporate governance. If there are any concerns about their independence, then the whole corporate governance structure is considerably weakened."
De Pasquallie says: "Independence is a topical issue for South African boards and requires an unambiguous definition due to its subjective nature."
Molefe points out that the King 3 treatment of independence is contrary to the UK's Combined Code of Corporate Governance, which states that after sitting on a board for 10 years, a director can no longer be deemed to be independent.
"This report does not move us forward," says Molefe.
The report's approach to the vexed issue of directors sitting on multiple boards is also disappointing.
It notes that because of the time and dedication required to fulfil their obligations properly, "it is important that non-executive directors do not hold any more directorships than is reasonably considered appropriate in order for them to provide the care, skill and diligence that is required from a board member".
It then merely suggests directors "honestly apply their minds to their workloads and abilities to discharge their duties".
The weaknesses of the King 3 draft are compounded by the absence of a tradition of shareholder activism in this country.
A report written by directors for directors will wholly determine the corporate governance environment because there is an absence of any other stakeholder group to counter that influence.
Institutional fund managers, who manage hundreds of billions of rands invested in equities on behalf of investors, savers and pension funds, are largely self-regulating.
As a result, the ultimate beneficial shareholders in our public companies, namely the members of the public, have little or no idea whether directors are adhering to even minimal standards of corporate governance.
Although there are 18 South African signatories to the UN's Principles of Responsible Investment, the PIC and Frater's are the only asset managers providing the public with details of the companies in which they are invested.
They are also the only asset managers that publicly disclose their proxy policies, which outline their approach to corporate governance and detail the way they vote at shareholder meetings.
Given the general absence of this type of shareholder activism, corporate governance, as presented by King 3, has little to offer the broad body of stakeholders and most of the true beneficial shareholders of corporate South Africa.
It is destined to be like one hand clapping.
The public has been invited to submit written comments on the report and the code by Saturday
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