Corporate Governance Issues & Challenges

Bureaucratic Layers

Corporate governance structures are very top heavy. They require many layers of management
and long lists of vice presidents and presidents for information to pass through. This makes it very
difficult for the company leaders to receive accurate, important data from the lower levels of the
company, especially if managers along the way want to distort the message to make themselves
sound better. Ultimately, the chain of command becomes so long that the business is unwieldy,
responding slowly to change. Flat business structures with few layers of management are the goal
of many corporations.
Accountability

Corporate governance has earned a negative connotation in society, mostly because of the
questionable practices of key executives and board members. Not all corporations commit fraud, of
course, but those that do receive a lot of attention, and many executives have become used to
taking questionably large bonuses even in a contracting economy. This has lead to an atmosphere of
distrust among consumers and investors, which corporations fight by showing increased
transparency in their work and mission.

Governance Standards

Internally, corporate governance faces a different type of struggle. A board of executives can make
good decisions on company policy and propagate standards throughout the business. But what if
managers prefer not to listen? Rebellious managers can ignore or subvert corporate decisions at
many levels of the business, and there are often a few troublemakers in all businesses. Corporate
boards need methods of enforcing standards and disciplining managers when necessary, a
component of governance few boards consider.

Board Terms

Board terms are a complex issue. In a board of directors, directors typically only sit on the board
for a brief term, rarely more than several years. Life-term board members can cause problems with
ingrained beliefs and concentration of power, so businesses prefer to cycle board members. But the
corporation must decide how to cycle. If all directors switch around at the same time, the
corporation may be left open for a hostile acquisition. If the board decides to stagger member
terms, it must decide when to stagger and how to accomplish it.

Causes of Ineffectiveness of Non-executive Independent Directors in listed

companies of Pakistan.

As we know that board composition and independence are fundamental issues in corporate
Governance. Board independence is very important for governance mechanisms. But in Pakistan
there is no concept of independent non-executive directors. Besides, non-executive directors
actually are not independent. Board independence is one of the most important elements of good
corporate governance. Independent directors broadly fit into the overall structure of corporate
governance, and are necessary to ensure effective, balanced board. An independent non- executive
director is one who is independent of management. Under the combined code the director should
not have been an employee of the group within the last 5 years, should not have a material business
relationship with the company, should not receive any remuneration from the company other than
fees, share scheme and performance related pay, should not have close family
ties with advisers, directors or senior employees, should not have significant links with other
directors, should not represent a significant shareholder and should not have served on the board
for more than 9 years.

In Pakistan independent non-executive directors are practically absent. Here a lot of companies
depict a number of their directors as non-executive and pretence them to be independent, but in
reality none of them is independent. There are following reasons for INEDs being ineffective in
Pakistan‟s listed companies.
Companies owned by families of closed groups

Mostly companies are owned by families or closed groups. And they usually try to stay away from
such directors whom they are unable to control. Actually controlling shareholders are keen to run
their company in their own way and they hate any kind of interference from outside. They are not
prepared to grant any of their powers to outsiders. It all depends on controlling shareholders
whether they really want to have independent non-executive directors on their company‟s board or
not.

Companies not pay remuneration

Another important cause of ineffective independent non-executive directors in Pakistan is that

companies do not pay any compensation or remuneration to them. There is just a fixed fee for them
for attending a meeting.

Professionals don’t have plenty of time

Good professionals are not keen to serve on the boards of listed companies just for getting only a
meeting fee. In fact some of them don‟t have plenty of time to do so. To run the company
successfully you need good people, and good people have no time for company matters as they are
already busy with their work.

Satyam case

Question 6 : Explain the theories of corporate governance with reference to the Satyam case.

As a worldwide scandal, the Satyam case emphasis the most common corporate governance
theories, such as the agency theory. Agency theory illustrates the relative between a primary person,
who assigns task, and the mediator who executes that task. Agency theory concerns solving two
kinds of problems that can come up in this relationship. In this theory, it is crystal clear to see the
agent is playing a 3 Corporate Governance Failure at Satyam most vital part in determining the
status of an organization. Another theory is the transaction cost theory. When companies want to
exploit a firm-specific asset abroad they will more likely invest in own facilities rather than through,
for example licensing if transaction costs are high. The more intangible the firm-specific asset is, the
greater the incentive for internalisation will be. Organising transactions may be carried out through
two methods, the price system or hierarchy. The problem with the price system may be that some
market participants take advantage of measurement difficulties to overprice and/or underperform.
To avoid this 'cheating' behaviour companies internalise and integrate transactions.

Redrafting corporate governance law 2

Regulation is a key instrument through which governments achieve their social and economic policy
objectives.
The Securities and Exchange Commission of Pakistan (SECP) notified on 31 August for public comments
a draft Listed Companies (Code of Corporate Governance) 2017, under the newly promulgated Companies
Act, 2017.

Through these regulations, the regulator has attempted to align the code with emerging challenges;
however, the proposed draft compromises the principles of Code of Corporate Governance, 2012 and
maintains the status quo in the area of corporate governance.

It may be noted that draft CCG regulations were to become effective within 14 days from date of
notification; however the SECP extended the deadline up to September 30. Sufficient time was not
provided by the SECP to elicit the views of all stakeholders, especially the professional accounting bodies.

The draft rules seemed ambiguous and unclear in many places. Proper references of the Companies Act,
2017— the main source of corporate law — were also not provided. It contained provisions against the
interests of stakeholders, including minority shareholders.

Specifically, Section 24 of the said regulation is quite adverse through which foreign qualified accountants
have been allowed to become the head of internal audit of listed companies in Pakistan. Such a provision
limits employment opportunities for qualified Pakistan professionals.

Let us analyse some of the major provisions of the draft regulations which require a revisit by the regulator
in terms of its relevancy, rephrasing, referencing and applicability.

Chapter II of draft CCG Regulations deals with the composition of the board. The number of directors is
confined to five, whereas the Companies Act, 2017 under Section 154 says that a listed company shall
have not less than seven Directors. This is a flaw and needs to be reconciled with Companies Act, 2017.

Further, the provision related to listed subsidiaries must be deleted. If a Director is on the Board of a listed
company, he has to attend at least two meetings in general on a quarterly and three meetings per quarter, if
he is a member of the HR Committee as well. This comes to 15 meetings per quarter (5 Committees x 3)
for a director.

If we exclude listed subsidiaries from the count then this figure will be on the higher side, and one may not
be able to concentrate on agenda and working papers of meetings as required by the Code under directors’
role and responsibilities.

The inclusion of two Independent directors on the board is a welcome step; however, it needs to be
referenced with Section 166 of Companies Act, 2017 which outlines the selection criteria and maintenance
of data bank of independent directors.

Until the databank is notified by SECP, listed companies may be allowed to appoint those professionals as
independent directors who are ‘Certified Directors’ under any SECP-approved directors training
programme. The procedure to fill up casual vacancy of independent directors needs to be provided.

The mandatory provision for having one female director on boards of listed companies is also an
appreciable initiative to synchronise with global practice of gender diversity on boards. However, there is
an element of concern that companies will comply by appointing female relatives of incumbent board
members. It is suggested that qualification criteria and appointment procedure for female directors should
be defined in draft regulations.

In line with CG Code 2012, the Section 20 of Listed Companies CCG Regulations, 2017 also requires for
all directors of listed companies to have certification by June 30, 2020 under any director training
programme offered by any local or foreign institution.

Through Section 23 of draft regulations, in addition to qualified professional accountants, post-graduate

degree holders with five years’ experience have been allowed to become the CFO of listed companies. It is
suggested that since the position of CFO is of a specialised nature, only those persons having professional
qualification like CAs and CMAs from any recognised body of professional accountants in Pakistan should
be allowed to hold it.

Foreign qualified accountants may be considered if they have completed their qualification through
Pakistan Tax and corporate laws. In case of any code of conduct issue, they should be subject to Pakistani
legal framework for disciplinary action as per applicable code of conduct.

Another flaw in draft legislation is that under Section 24 the experience requirement for an Internal
Auditor has been proposed to be three years, whereas for CFO the required experience is five years. As
such, the experience requirement for Head of Internal Audit should be increased to at least 5 years.

The draft rules, in Chapter VIII, do not define the required qualification for a ‘Company Secretary’,
whereas the required qualifications of CFO and Head of Internal Audit have been duly mentioned. This
omission needs to be addressed.

It is proposed that a Company Secretary should be a person holding the qualification from any recognised
body of professional accountants or the Institute of Corporate Secretaries of Pakistan (ICSP) with
minimum 3 years’ experience as a Company Secretary of any other company. The Company Secretary
should also be made responsible for Corporate Compliance of the listed company.

It is further proposed that a Risk Management Committee and Procurement Committee may also be
formed by the Board in view of its significance for the listed companies. Accordingly, a new Section on
Procurement Committee may be added in Chapter X of the said Regulations.

One important provision is External Audit under Section 32 which says that every listed company shall
appoint only those audit firms which have satisfactory QCR rating from ICAP and registered with Audit
Oversight Board (AOB) of Pakistan.

The conventional rights of statutory audit need to be reviewed in a more transparent manner and equal
opportunity may be provided to professionals from other recognised professional accounting bodies who
study audit and assurance.

In the perspective of external audit provision, it is to be pointed out that the existing Audit Oversight Board
lacks independence. An Independent Financial Reporting Council (FRC) may be established in its place, as
per global practice, having representation from all recognised bodies of professional accountants,
academia, law, industry and other stakeholders.

Section 33 under Chapter XII on External Audit is missing. It needs to be clarified by the Commission if
this is a typographical error or omission of a complete Section, which inadvertently is not part of circulated
draft.

Section 34 refers to the rotation of external auditors after every five years in all listed companies in the
financial sector. In proviso to this section it is stated that all inter-related companies/ institutions, engaged
in business of providing financial services shall appoint the same firm of auditors to conduct the audit of
their account.

As per Internal Control principles, rotation of five years is on the higher side and it must be lowered to
three years to provide opportunity to other firm to review/ audit financial statements from different aspects.