Codes and cultures

There are many parallels between Asia, Europe and other parts of the world in terms of corporate governance and risk management. The accepted general principles are shared in common. What differs often relates to interpretations of how far to go. Such interpretations may reflect cultural values, attitudes, motivations and expectations. It is not necessarily a straightforward dichotomy between, on the one hand, a robust approach in Europe, for example, and a laisser-faire approach in Asia and elsewhere.

Guiding principles

Good corporate governance seeks to protect the interests of shareholders and other stakeholders. National corporate governance codes, whether stipulated by stock exchanges or by government regulators, seek to:

- strengthen the supervisory role of the board of directors

- protect the interests of minority shareholders

- ensure transparency and prompt information to board members and others

- regulate on selection, appointment and remuneration of both executive and non-executive directors

“Around the world, the accepted generael principles of corporate governance and risk management are shared in common

- safeguard the balance and independence of the board by appointing independent and experienced non-executive directors as a check and balance on executive directors

- ensure a comprehensive and effective system of internal controls to manage the significant risks to which the enterprise may be exposed

- ensure that appropriate appraisals, audits, reviews and routine monitoring of internal controls take place at least annually.

Behind these general principles is an implicit need to protect not just finances but also corporate reputation and brand, as well as other significant risk exposures. Broad-based internal controls are clearly necessary, but particular approaches such as Sarbanes-Oxley (SOX) and Basel II are very clearly focused on finance, accountancy and counter-fraud protection. They do not deal with the vast array of other significant risk exposures typically encountered by large organisations.

SOX and quack governance

Many risks other than accounting or finance risks can be lethal to enterprises. It has been argued that the root causes of high profile collapses such as Enron, Barings and CAO lay in complex interplays between people, organisation and systems, with organisational culture and power relations at the core of both the problem and its solution. Brave attempts by the accountancy world (for example, CoSO) to address enterprise-wide non-accounting risk exposures and integrate them into SOX have been unconvincing.

There is something perverse, if not dangerous, about individuals with qualifications and experience in, say, financial derivatives, internal audit or Basel II compliance, sallying forth to render professional advice and judgment on major hazards, supply chain risks, counter-terrorism, political risks, HR risks, intellectual property and the many other kinds of significant enterprise risk exposure. In other cases, these non-financial risks just get ignored.

“There is an implicit need to protect not just finances but also corporate reputation and brand, as well as other significant risk exposures

It has also been argued that SOX is flawed in its whole approach to accounting/finance protection, let alone any consideration of wider risk exposures. Roberta Romano of Yale Law School refers to it as 'quack governance'.

In addition, so much time, money and effort is often injected by companies into feeding the SOX compliance beast, that risk management budgets are gobbled up with nothing left for the rest of ERM. Many jaundiced executives now damn enterprise risk management, because they wrongly equate it with SOX.

The Asian, US and European experience

Although corporate governance codes are often similar in content and wording, they also vary in the small print. Some, such as the UK Combined Code, are relatively comprehensive and demanding, yet rely largely on self-regulation through each organisation following additional detailed guidance on internal controls and enterprise risk management. A comprehensive view of 'all significant risks' is interpreted as meaning that ERM should not be dominated by accounting and finance interests. Other codes, such as SOX, are focused on accounting/finance and are prescriptive/compliance driven. Yet others, such as the PRC (Chinese) Code, emphasise the roles and duties of directors, remuneration, and many other important governance aspects, but barely mention internal controls and risk management. However, there was an afterthought by the PRC State-Owned Assets Supervision and Administration Committee of the State Council, in the shape of Guidelines to the Integrated Risk Management of the Central Enterprises.

Many codes have sections that are voluntary and therefore rely on the integrity and willingness of the particular board to ensure compliance. Codes that recommend a voluntary separation of CEO and chairman role-holders may result in family-owned or controlled businesses ignoring the recommendation so as to retain a dominant position. Other organisations may choose to retain a single person in the two roles because they genuinely believe that person to be the best available choice. It has been argued in relation to the issue of single joint CEO/chairmen that there is no a priori cause and effect relationship between separate post holders and company performance. However, debilitating conflicts and power struggles involving questionable decisions and possibly reputation damage and financial impact are far more likely where one individual holds too much power (see the Frou Frou Biscuits case study in this article).

In principle, any of the approaches could work. However, both highly prescriptive accounting approaches and laisser-faire voluntary approaches have inherent weaknesses. The proof of the pudding will be in the eating.

Family business case studies

“It has been argued that the root causes of high profile collapses such as Enron, Barings and CAO lay in complex interplays between people, organisation and systems, with organisational culture and power relations at the core of both the problem and its solution.

Alan Waring, chief executive of risk management consultants Asia Risk

Frou-Frou Biscuits (Cyprus - EU)

Alkis Hajikyriakou (Frou-Frou) Biscuits Public Co Ltd (also known as FBI) is a major food manufacturer in the Republic of Cyprus. The company is listed on the Cyprus Stock Exchange (CSE) Alternative Market and is therefore subject to the Cyprus Corporate Governance Code, which is voluntary for this market. Section A.2.4 of the latter requires a clear division of responsibility between the roles of CEO and chairman. Further, if the two posts are not separated, the code requires that a justification should be given in part 2 of the board's annual report to shareholders.

The company's major shareholder is the joint CEO and executive chairman, Alkis Hajikyriakou, who is reported to hold 52% of the share capital. The second main shareholder is the executive vice-chairman, his sister Elena (Nora) Dikaiou with 17%.

The vice-chairman has been seeking to get the board to adopt the code and demonstrate transparency and accountability to shareholders, but apparently met resistance from the CEO and executive chairman. In response to her attempt to get the topic on the AGM agenda, she alleges that her brother sacked her. The company's annual report for 2006 cites 10 reasons in justification for not adopting the code. In a scathing critique of the Frou-Frou CEO/chairman's actions, Michael Olympios, a leading business consultant, states that: 'these explanations not only lack substance but in reality are almost an exact copy of other family firms in the CSE, revealing that this is a symptom of a wider problem of family firms'. He notes that despite corporate reforms, many family firms that are now publicly listed are unable to accept that public companies are accountable to the public. Having executives report to themselves at the board and without the presence of any robust independent NEDs is ‘like having students grading their own exam papers’.

The Institute of Directors of Cyprus has now weighed into the Frou-Frou battle by publicly demanding in June 2007 that the CSE and SEC should make the Corporate Governance Code mandatory for companies listed on the Alternative Market, as it is already for the main market.

Heavenly Homes (Cyprus - EU)

Heavenly Homes (not its real name) began in the 1990s as a small house builder, typically with small projects of up to six houses at a time. Owned by the Papacostas brothers (not their real name), the company developed a good reputation within Cyprus for quality and price.

“So much time, money and effort is often injected by companies into feeding the SOX compliance beast, that risk management budgets are gobbled up with nothing left for the rest of ERM

Alan Waring, chief executive of risk management consultants Asia Risk

Around 2000, Cyprus started to enjoy a new residential property boom, centred primarily on the growing holiday homes and ex-pat relocation market, some 75% of which involves buyers from Britain. The Papacostas brothers saw the opportunity to grow Heavenly Homes exponentially by building a series of apartment blocks, typically three to six blocks with 15-30 units per block, in up-and-coming villages in tourist areas. Alongside the apartments, they planned for detached houses, typically 50 per site. Large areas of land were bought, licences obtained and plans drawn up. As marketing accelerated, many people bought off-plan at a discount. Delivery times were typically quoted as 18 months. The expansion plan got under way.

By 2005, Heavenly Homes had at least six major sites at various stages of build and with further projects planned. However, from 2002 onwards there were growing customer complaints about major defects, poor quality, (very) late delivery and reluctance to close-out snagging lists and deal with complaints. Heavenly Homes soon acquired the tag 'Hellish Homes' among dissatisfied buyers. George Papacostas, the CEO and chairman, candidly admitted in 2005 that the company had suffered huge damage to its reputation that would take a long time to recover. Nevertheless, major new capital projects, including properties at golf complexes, are in hand that will dwarf the company's previous experience. As one of the largest privately owned land developers in Cyprus, Heavenly Homes may well apply for CSE listing despite their continuing problems.

The root cause of the company's problem lies in a combination of greed fuelled by the property boom, the inexperience of the owners in running major capital projects, their lack of knowledge of basic management methods, their tendency to cut corners and their unwillingness to buy in the necessary expertise. The board of directors lacks both numbers and expertise, including strong independent NEDs. The lack of professionalism, coupled with a fear of accepting new expertise and a reluctance to let go, typifies many family-run businesses of all sizes in Cyprus and many other countries.

The Cyprus property boom has slowed down sharply over the past 18 months, with over-supply, over-pricing and under-demand. Whereas in 2004 properties were snapped up off-plan, now many built properties remain unsold after more than 12 months. Despite all the warning signs, many developers (Heavenly Homes included) continue to gamble on an upturn and continue to build relentlessly. If the property bubble bursts, their survival is in doubt.

Asian conglomerate

The Triple A Asia Group (not its real name) is a privately owned conglomerate employing over 10,000 people across Asia in activities including finance, insurance, manufacturing and distribution. It has a solid reputation and, in some areas, it is the market leader. It has been operating for approximately 100 years.

Although family-owned, Triple A Asia took the decision some 20 years ago to recruit professional managers, specialists and technocrats to ensure that all the existing businesses had the necessary skill resources to adapt and grow in the global marketplace. Further, long-term strategic planning ensures that new businesses are started, that will become significant revenue generators in the years to come. A considerable amount of time, effort and money is invested in selecting the best human resources.

“Codes that recommend a voluntary separation of CEO and chairman role-holders may result in family-owned or controlled businesses ignoring the recommendation so as to retain a dominant position.

Alan Waring, chief executive of risk management consultants Asia Risk

The various group company boards are required to show transparency and accountability and appoint independent NEDs. This policy is regarded as a necessary part of protecting the interests of all shareholders and stakeholders. Protection of corporate reputation is regarded as an imperative. This policy position presages a recent study of the Hong Kong family firm Hutchison Whampoa Limited, which concurs with previous studies that good practice in corporate governance and social responsibility is not an optional extra for any family firm wishing to put themselves at a competitive advantage both inside and outside Asia.

Key issues

These examples show that the key issues for success in protection of shareholder and stakeholder interests, and especially for family-controlled businesses, appear to be:

- Whether relevant corporate governance codes (CGCs) are mandatory or voluntary

- Whether CGCs are strict or laisser-faire

- Whether CGCs are comprehensive or narrow

- The CEO/chairman split and how this affects board decision-making

“The company's major shareholder is the joint CEO and executive chairman, Alkis Hajikyriakou, who is reported to hold 52% of the share capital. The second main shareholder is the executive vice-chairman, his sister Elena (Nora) Dikaiou with 17%.

Alan Waring, chief executive of risk management consultants Asia Risk

- Knowledge, experience, quality, integrity and risk appetite/aversion of board directors

- Independence and authority of INEDs and ED/INED balance

- Ownership structure, including significant institutional investors

- Boardroom culture and power relations

A matter of interpretation

Around the world, the accepted general principles of corporate governance and risk management are shared in common. What differs often relates to interpretations of how far to go. Such interpretations may reflect cultural values, attitudes, motivations and expectations. Many common issues arise both in small EU countries such as Cyprus and in larger Asian countries. Publicly listed businesses need to consider the benefits to corporate reputation, brand, shareholder protection and public confidence from implementing corporate governance codes and the damage that may result from ignoring them. Implementation should not be dominated by feeding the beast of compliance with particular codes, such as SOX. Such tunnel vision may create an illusion of protection when it comes to the full array of enterprise risk exposures.