The commercial case for improving governance could have been no better illustrated than it was by the scale of the devastation created by the near-collapse of the worldwide banking system.
The short term effect of the economic crisis at the end of 2008 was the loss of investor confidence in the capital markets which led to the drop in share prices.
Tanzania has a developing economy with a fairly small stock market and it faces the challenge of attracting foreign investors into domestic companies as well as foreign subsidiaries.
Although in the week ending June 26, 2010 foreign investors traded the most shares at the Dar es Salaam Stock Exchange accounting for 67.49 per cent of the total turnover, it is still a small market.
Good corporate governance cannot guarantee a stock market improvement but it can improve the prospects of a higher share price, especially over the longer term. It does so by reducing the possibility of scandal which would result in share price reduction by improving shareholder relationship so they are more inclined to invest.
Improving financial reporting would again increase investor confidence. Improving internal controls and risk management again would instill confidence in investors and remuneration linked to the long term success of the company as well as confidence in the market as a whole which would encourage investors.
Companies must therefore achieve a certain standard of corporate governance to attract local and foreign institutional investment funds.
Corporate governance, briefly defined, is the system by which companies are controlled and directed. It specifically focuses on public companies and how powers are exercised by the directors and the accountability of the directors to the company’s owners, and equity shareholders.
There are three theoretical frameworks to justify the needs of corporate governance structures and systems, the agency theory, the transaction cost theory and the stakeholder theory.
The agency theory is based on the separation between the ownership of the company and the control of the company’s actions. It is essentially a contract between the owners and managements who have varying interests.
Therefore the central notion of the agency theory is that owners need to have some form of monitoring or incentivising programmes for the managers.
The transaction cost theory on the other hand is based on the view that managers have bounded rationality and opportunism and their actions need to be monitored and controlled.
The stakeholder’s theory takes the view that the company’s management should have regard to the interests of all major stakeholders as well.
Based on these theories, three main approaches to corporate governance have developed: the shareholder value approach, the enlightened shareholder approach and the stakeholder (or pluralist) approach.
The shareholder value approach is based on the agency and transaction theory and states that directors should run the company and maximize the wealth of the shareholders. Although this is the best established approach, it does not take other interests into account.
The enlightened approach tries to include stakeholders’ interests but this is difficult as it is based on directors running the company with the interest of shareholders looking at the long term, but again it would need the backing of the law. The point is that directors are accountable to the shareholders and responsible to stakeholders.
The stakeholder approach is based on the stakeholder theory balancing the economic and social goals. The aim is not simply to meet the objectives of the shareholders but to have regard for other stakeholders. One problem with this approach is that the company law protects shareholders and not stakeholders. However, extensive protection in other legislations including employment, health and safety and the environmental laws may help to achieve the rights of stakeholders.
Arguably, Tanzania, being a developing economy should follow the stakeholder/pluralist approach to corporate governance rather than the shareholder approach.
The stakeholder view is concerned with achieving a balance between economic and social goals between individual and communal goals. Sound corporate governance should recognize the economic imperative companies face in competitive markets and should encourage efficient use of resources through sound investment.
Of course this would raise concerns about whether directors should take the company’s community and environment into consideration.
The recent acquisition of Cadbury by Kraft, raised questions of whether public sentiment should be taken into consideration, and although the Company Act of 2006 in the UK states that directors should take the community, environmental and employees’ interests into account, there is no real incentive for directors to consider these as ultimately they are accountable to shareholders. Similarly, under the Tanzanian Companies Act of 2002, directors are mandated to take employees’ interests into account but again it is difficult to regulate this in practice.
The new UK Corporate Governance Code was published May 28, 2010 and came into effect June 29, 2010. Although merely a guideline, it requires that company either comply or explain why they have not followed the Code.
The ‘comply and explain’ framework requires that a company must make a statement as to whether it follows the Code or not; and if not, an explanation of its alternative ownership or trading strategy should be furnished.
A company has to make a statement as to how it has applied Code principles in a manner that would enable their clients to evaluate how the principles have been applied, together with an explanation (where applicable) of non-compliance against each of the principles; or a statement as to whether the company has complied with all the relevant principles and guidance within the Code or, where it has not, an explanation of non-compliance.
The Code emphasizes key themes for the future of governance such as leadership from the chair, the need for greater diversity, the board’s role in risk management and the annual re-election of directors, all of which reflect a desire for greater accountability at the board level. Board responsibility has become a topical issue especially since the oil spill by BP in the Gulf of Mexico, strengthening the argument that corporate responsibility should no longer be optional.
Foreign investors are said to own 40 % of the shares in the UK, according to a report at the end of 2006 by the Office of National Statistics, and that number is expected to be higher now. Although it is not proposed that the Code should be a mandatory requirement on foreign investors, the Code encourages them to engage in a transparent manner with the UK companies.
Other countries, such as the Netherlands have chosen to apply international standards. Denmark now requires institutional investors to report against the UN Principles for Responsible Investment; perhaps this is a plausible option for Tanzania given that foreign investors control more than half of the stock traded at the Dar es Salaam stock exchange.The main regulatory framework for corporate governance in Tanzania is provided under the 1992 Public Corporations Act, the 1994 Capital Markets and Securities Act, and the 2002 Companies Act, which came into force on March 1 2006.
The Capital Markets and Securities Act is modeled on international standards, particularly those in the UK and are also based on the ‘comply or explain’ principle explained above.
The Capital Markets and Securities Act states that the guidelines on corporate governance practices by public listed companies have been developed, taking into account several other jurisdictions including the United Kingdom, Malaysia, South Africa, the Commonwealth Association for Corporate Governance and OECD Principles of Corporate Governance.
However, in the 2009 Doing Business Report, the World Bank reported that Tanzania was below the OECD average.
Since the very recent advent of the East African Common Market, the Securities Market is yet to be denationalised and the capital account is yet to be fully liberalised in Tanzania to enable citizens to participate in cross listing.
The air carrier Precision Air has announced plans to cross list on both the DSE and the Nairobi Stock Exchange. Kenya Airways has already cross-listed, but it is evident that this will open out cross border investment further exemplifying the need for good governance in the region to be harmonised.
Additionally, there is a need to revise the corporate government standards to bring them in line with current international standards taking into consideration the local market.
In conclusion it is evident that good corporate governance is central to economic development. In Tanzania, like a number of jurisdictions, there are guidelines for good corporate governance; however, in the midst of economic and environmental hazards, corporate governance should no longer be optional. The voluntary and self-regulatory nature of corporate governance model should be revised and harmonised across the region.
* Lotus Menezes is an associate with Ako Law in association with Clyde & Co LLP