Current Views on Corporate Governance in Sri Lanka: Evidence from Sri Lankan Corporate Boards

1. Current Views on Corporate Governance in Sri Lanka: Evidence from Sri Lankan Corporate Boards Dr. Hareendra Dissa Bandara Director – Financial Services Academy Securities & Exchange Commission of Sri Lanka & Senior Lecturer in Corporate Governance & Finance Faculty of Management Studies & Commerce University of Sri Jayewardenepura

2. Disclaimer Clause Views expressed herein are those of the presenter.  They do not necessarily reflect views of the Securities & Exchange Commission of Sri Lanka or University of Sri Jayewardenepura or other staff members of the respective institutions.

3. Importance

4. Ｃｏｎｔｅｎｔs • What is corporate governance? • Governance structures • Need for greater corporate accountability? • Major concerns of corporate governance • Objectives of the study • Methodology • What is CGS? • Results: Adherence to the CG Essentials • Current View

5. What is Corporate Governance? • “Corporate governance is about promoting corporate fairness, transparency and accountability.” (J. Wolfensohn, President - World bank, as quoted by an article in Financial Times, June 21, 1999) Dissa

6. What is Corporate Governance? Contd… “Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholdersand other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attending those objectives and monitoring performance.” (Cadbury, OECD, April 1999) Dissa

7. What is Corporate Governance? Contd… ‘Corporate governance is the mechanism by which companies arerationalized, directed, controlled and monitored. Corporate Governance coordinates different types of stakeholders such as shareholders, directors, managers, employees, creditors, customers, global environment and the rest of the society to enhance corporate performance and wellbeing as a common goal. Major considerations of a system of corporate governance are: • how successfully companies formulate the rational; the reason for existence & future direction • how effectively corporate decisions are made; guidelines and procedures • how well the board on behalf of shareholders appraise managers’ decision making, and monitor the execution • how fruitfully the different stakeholders are facilitated to achieve the goals’ (DissaBandara, 2006) Dissa

8. Governance Structures

9. US Governance Structure Stockholder Report Appoint Chairman Board of Directors 1. Nomination Committee 2. Reward Committee 3. Inspection Committee 4. Finance Committee 5. Executive Committee Appoint Report CEO ExecutiveManagement Source: Based on Dissa Bandara (2003) Dissa

10. Appointment Appointment /dismissal of Directors Duty of Care Japanese Governance Structure (Board of) Statutory Auditors at least majority must be outside auditors in case of a large company Decide the administration of affairs of the company Supervise execution of duties of directors Source: Based on Dissa Bandara (2003)

11. External Governance Mechanism Government Foreign, Institutional, Individual Investors Shareholders Internal Governance Mechanism: The relationship among various components in determining the rational, direction and performance BOD Executive & Non-Executive Directors Committees (Ind) CEO External Auditors Employees Customers Creditors Sri Lankan Governance Structure Dissa

12. SHAREHOLDERS External Auditor Shareholders delegate power to the board of directors BOARD OF DIRECTORS Chairman CEO and Executive Directors Non-executive Directors Monitoring Audit Committee Financial Reporting Functions Risk Management Remuneration Committee Internal Controls Nomination Committee Internal Auditor Conduct of the business and other operational matters Board delegates the powers to management MANAGEMENT EMPLOYEES Dissa

13. Need for Greater Corporate Accountability? Separation of ownership and control • Berle and Means (1932) recognise that the separation of ownership and control gives rise to a conflict of interest between insiders (managers) and outsiders (shareholders) with diffuse ownership. Dissa

14. 1932

15. Separation of Ownership and Control Board of Directors leads the company and is the link between ‘Owners’ and ‘Managers’ Ownership Control 1 2 Shareholder Management Director • 1. Determine the Future Direction: Aims, policies & strategies on behalf of the owners • 2. Monitor the progress of Management Execution

16. Separation of Ownership and Control Contd… • Agency Problem: The greater the degree of separations, the greater the agency problem. • Agency Cost: Because of the costs of information and the difficulties in monitoring managers, rational managers undertake behaviour which shifts wealth from shareholders to themselves. This results in agency costs: loss in market value relative to the value if no agency problems existed. Dissa

17. Major Concerns of Corporate Governance • Align the interests of managers and shareholders • Prevent managers from pursuing own interests • Prevent high and excessive executive pay • Overcome agency costs associated with the separation of ownership and control • Avoid abuse of power Dissa

18. Objectives of the Study • To examine the level of compliance of Sri Lankan companieson corporate governance (CG) principles based on a proposal of Governance Research Institute of Sri Lanka (GRIS) • To understand the current views on Sri Lankan corporate boards Dissa5

19. Methodology Dissa5

20. Sample, Data & Time Period • Sample: 59 Companies Listed on the CSE • Data:BoD related Qualitative & Quantitative Data • Method of Data Collection: TRIANGULATION; Questionnaire Survey, Informal Interviews, Annual Reports & Publications, Governance Database of Governance Research Institute of Sri Lanka (GRIS) • Time Period: 2006 - 2010 Dissa5

21. Sample

22. What is CGS? Corporate Governance Score (CGS) is a measure of adherence to CG practices & policies (based on GRIS) • This CGS is; an assessment of individual companies based on their CG practices to measure the compliance with the CG standards / practices • NOT a kind of audit, a financial recommendation, credit rating nor an advice for a particular need • Again it is; NOT an indicator of financial or commercial performance Dissa5

23. Basic Strata of CGS

24. Separation of Ownership and Control Board of Directors leads the company and is the link between ‘Owners’ and ‘Managers’ Ownership Control 1 2 Shareholder Management Director • 1. Determine the Future Direction: Aims, policies & strategies on behalf of the owners • 2. Monitor the progress of Management Execution

25. Adherence to CG Principles/Practices Important Empirical Evidence Dissa5

26. Overall CGS - BOD Adherence

27. General Compliance Details

28. Top 10 CGS-BOD

29. Worst 10 CGS-BOD

30. Frequency Distribution of CGS-BOD

31. High & Low CGS-BOD Groups • High CGN Group: 9 firms with score greater than 185 • Low CGN Group: 10 firms with score less than145 Dissa5

32. High & Low CGS-BOD Groups

33. High & Low CGS Japan - 2003 1 SD = 11.2 1 SD = 11.2 Avg. 36.3 Low CGN Group 25 Firms High CGN Group 25 Firms Source: Dissa Bandara (2003) Dissa5

34. High & Low CGS Japan - 2008 1 SD = 12 1 SD = 12 Avg. 37.8 Low CGN Group 25 Firms High CGN Group 30 Firms Source: Dissa Bandara (2008) Dissa5

35. Composition of CGS-BOD

36. Composition of CGS-BOD

37. 3: Engage in Strategic Thinking and Planning

38. 1: Determining Future Direction

39. 2: Policy Formulating Practices

40. 9: Board – Staff Roles

41. 10: Monitoring & Evaluation Practices

42. 13: Stakeholders

43. Sector-wise CGS-BOD

44. Sector-wise Compliance

45. Sector-wise Compliance

46. Evidence on International Status Dissa5 Source:Based on Dissa Bandara (2008)

47. ConclusionsThe extent of Adherence to CG Principles • Actual CG practices are considerably deviated from the expected standard (AVG compliance level 56%) • A broad variation in CG practices across the firms (Max 69% & Min 39%) • A considerable variation in CG practices across the industries (48% - 61%) • Governance level is high in BFI & Diversified (high AVG score) Dissa5

48. Conclusions The extent of Adherence to CG Principles • Sri Lankan boards are good at; • Strategic planning • Determining future direction • Policy formulating practices • Sri Lankan boards are weak at; • Board-staff roles (not clearly defined and separated) • Monitoring & evaluation (split the role of Chairman &CEO) • Relationship with the stakeholders

49. Conclusions Contd… Emerging CG Characteristics • The degree of interest in the recent discussion on CG is remarkably high (over 70%) • Through their CG system they hope to enhance the performance and speed up of decision-making • There is a growing tendency of introducing new features like Independent Directors, BOD training & IR activities Dissa5

50. For Future … • Employ a multiple CGS, considering • Sri Lankan CG Principles (to be finalized) • OECD CG Principles • Other Leading Sources like, CalPers • Use Case Study & Critical Incident Method as methodological tool • External pressure should be increased to get the poor players to the track • CG practices should be familiarized among corporate level Dissa5