How to stop boards going all crooked

Voluntary codes with investor input work better than state regulation

IT HAS often been said that the problem with corporate wrongdoing is not that directors are crooks, but rather that some crooks become directors.

In this respect, directors as a collective merely mirror any other cross-section of society. The difference is that directors wield significant power and when corporations fail, regulators draw blood by increasing directors’ liability — the theory being that escalating the sanctions will improve the behaviour of boards and consequently restore confidence in the market.

If lack of confidence is an indicator for more regulation, then certainly South African businesses are ripe to be regulated to the hilt.

The 2015 Edelman Trust Barometer indicates a dramatic fall of 11% from the previous year of trust in CEOs and boards and directors by the general South African public. Trust now stands at 58% and 54% for CEOs and boards respectively.

Put another way, this means that almost half of the South African population does not have confidence in business — something that should worry us all.

Using regulation to address the cause of corporate failure and to restore confidence is not new, and has its roots as far back as the 17th century.

An example is the draconian and infamous Sarbanes-Oxley legislation that was signed into law in the US a mere nine months after Enron collapsed. Unfortunately, Sarbanes-Oxley served as the catalyst for stricter governance regulatory measures across the globe.

With the fourth iteration of South Africa’s own governance code in the works, the efficacy of the King tradition’s compliance regime is in the limelight.

What sets corporate governance codes apart from other forms of regulation is that rather than being applied by corporations on the basis of “comply or else”, they follow a voluntary “comply or explain” approach which is articulated in King 3 as “apply or explain”.

Many critics don’t see this as sufficiently strong intervention. But then, if half of the country believes directors are crooks, this thinking isn’t that surprising.

Notwithstanding its popularity, legislation has not proved to be the elixir that cures crooks of their base desires.

The fact that the cycle of “boom, bust, regulate” has been repeating itself for centuries is enough reason to question its value — not to mention its cost. A case in point is the swift and decisive action taken after the Enron debacle in 2002, which, as we all know, did nothing to prevent the global financial crisis in 2008.

Voluntary codes of conduct are not as toothless as many believe, however.

While rules that are imposed externally have been found to offer a challenge to cheaters to find ways around them, governance operates primarily at the level of corporate culture, values, beliefs and ethos.

Extrapolating that reasoning, governance principles and practices function optimally if they are rooted in norms institutionalised within the business community.

Once institutionalisation has happened, contravention of these norms invokes third-party sanctions administered by the market. And because market efficiencies are leveraged, a normative approach is more flexible and less costly than legislation.

There is some discomfort from doing it this way, mainly because people believe boards and directors are self-interested actors — which leads us back to the directors are crooks argument.

Behavioural studies have found, though, that humans are likely to be as motivated by achievement, altruism and the commitment to meaningful work as they are by selfinterest. Man is predictably irrational, as behaviour economist and professor Dan Ariely says.

So if this is a 50-50 game, what

Almost half the SA population does not have confidence in business

would tip the scales in favour of achieving actual governance application on a voluntary basis? I suggest that it be done by adding the weight of accountability to the voluntary end of the scale.

Accountability, though, is dependent on a system of checks and balances.

This is made up of various parts — including transparent disclosure by boards (which is where the “or explain” part of governance codes features), shareholders and other stakeholders being active protectors of sound governance, and, lastly, pension fund members questioning institutional investors about how their contributions are invested.

The road ahead has a number of forks: we could keep looking to the government to keep CEOs and boards on the straight and narrow with more regulation, or we could shape our environment ourselves.

Personally, I am all for selfsufficiency.

Ramalho is the project leader for the Institute of Directors in Southern Africa on the King IV project