WHAT WILL KING IV MEAN FOR SOUTH AFRICAN INVESTORS?

There have been mixed reactions to the announcement that the King Report on Governance for South Africa (2009) (King III) is about to be updated, some welcoming it in light of recent corporate governance developments that have outpaced King III and others bemoaning “more regulation”.

Consider the following realities of the South African governance landscape: municipalities struggle to meet service delivery demands amid allegations of corruption or incompetence, or both. Questions are being raised regarding perceived irregularities with the appointment of senior officials at our public institutions, and a number of these officials being on what is seemingly a protracted suspension on full pay.

Claims of anti-competitive and collusive practices in the private sector surface with regularity, and as predictable is the controversy around the quantum of executive pay and the wage gap. The governance failures in these instances are patently obvious: deficient executive appointment processes; an inability to deal effectively with management oversight and disciplinary issues; lack of clarity on accountability and reporting lines; and the absence of constructive engagement between the company and its shareholders and other stakeholders.

Many more examples can be cited. What these realities demonstrate is that things go wrong as a result of a lack of proper governance. Organisations that regard corporate governance as a matter of grudge compliance do so at their peril. Difficult economic conditions, depressed business and a potential ratings agency downgrade are just some of the challenges facing business leaders today. Business leadership has become as much about navigating the external environment as it is about a focus on the organisation itself. Good corporate governance (and particularly the way that it is understood in the King tradition as going beyond structures, processes and procedures to encompass leadership in the context of the economy, society and the environment) is indispensable.

Good corporate governance ensures that the necessary arrangements are in place so that those charged with governance duties are poised to capture new opportunities and are more resilient to face risks in an ever-increasing complex and unpredictable environment. Seeing corporate governance in this light, it is not a barrier to enterprise but the way to successful enterprise.

AN OUTCOMES-BASED APPROACH

King IV will not constitute a significant departure from the solid foundations and philosophy set by King III and organisations need not prepare for a host of additional principles and practice recommendations.

To the contrary, in the draft King IV the number of principles are reduced from the 75 principles in King III to a mere 16 (with an additional 17th principle, which is applicable to institutional investors such as retirement funds and insurance companies).

Reducing the number of principles is a consequence of a different approach to corporate governance principles. In the draft King IV, principles are stated as aspirations and ideals that are fundamental and basic to good governance. Principles are also clearly differentiated from practice recommendations in that the practices are about what needs to be done to give effect to these aspirations and ideals. Achieving these aspirations and ideals will, according to the philosophy followed in the draft of King IV, lead to corporate governance outcomes, which include: an ethical organisational culture; performance and value creation; adequate and effective control; and trust, a good reputation and legitimacy.

This outcomes-based approach addresses box-ticking compliance, which is one of the major stumbling blocks towards achieving governance that adds value to an organisation. It is said that inflexibility is evidence of a lack of understanding. This is indeed true as far as the implementation of governance practices in a box-ticking fashion is concerned. Understanding and insight assists with mindful and judicious application, which is the opposite of taking the easier route of box-ticking. As the principle serves as the guide for what the practices should achieve, it is easier to apply judgement to what and how practices should be implemented. Simply put: practices are the means and the principles the end.

The notion of 'commander’s intent' developed by the US army illustrates the thinking behind this approach well. Chip and Dan Heath explain in their book Made to Stick that plans for military operations are very thorough, detailing the scheme of manoeuvres, equipment required, how munitions will be replaced and so forth. Despite these having become a marvel of communication and planning there is still one catch: no plan survives contact with the enemy. The unpredictable and unexpected happen, such as weather changes or a surprise move by the enemy. Articulating the commander’s intent has been devised as a way to deal with these eventualities. The idea is that generals, officers and soldiers should all understand what the intended outcome is so that they are able to improvise accordingly when plans go awry.

The principles and outcomes in King IV are meant to depict the intent, so that organisations and those charged with their governance are able to adapt practices. This way the emphasis shifts from a compliance mindset to corporate governance that achieves the intended outcomes and benefits.

APPLY AND EXPLAIN

As principles are stated as aspirations and ideals that are fundamental and basic to good governance, application thereof is assumed. For this reason, the application regime that is advocated in the draft of King IV is that of 'apply and explain', which is a departure from 'apply or explain' in King III. The rationale of assuming application becomes evident when one has regard to how the principles are phrased. There is, for instance, the principle that the governing body should set the tone and lead ethically and effectively. Another principle says that the governing body should serve as the focal point and custodian of corporate governance in the organisation. And still another that the governing body should govern technology and information in a way that supports the organisation in defining core purpose and to set and achieve strategic objectives. Due to the way, and the level at which, these principles are stated, it is difficult to contemplate a reasonable explanation of why these principles are not applied.

The 'explain' part of the application regime is an explanation in the form of a narrative of the practices that have been implemented and the progress made towards giving effect to each principle.

VOLUNTARY CODE OR LEGISLATION?

Following an 'apply and explain' and outcomes-based regime means that the flexibility of a voluntary code of corporate governance is leveraged to the full. The question is whether this flexibility will affect the efficacy of King IV. There are many who deem voluntary codes of corporate governance as not being a sufficiently strong intervention and especially one that provides for flexibility around implementation to the extent that King IV does.

Using regulation to address the cause of corporate failure and to restore confidence is not new and can, in fact, be traced back to the 17th century. A more recent example is the draconian and infamous Sarbanes-Oxley legislation that was signed into law a mere nine months after Enron had collapsed and which served as the catalyst for stricter governance regulatory measures around the world. The truth is that, notwithstanding its popularity, legislation has proved not to be the cure of bad governance. The fact that the boom-bust-regulate cycle 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 Enron in 2002, which did not prevent the global financial crisis in 2008.

It would be a mistake to conclude that voluntary codes of governance carry no sanction when contravened. The principles and practices that are recommended in these codes become the norm for behaviour as soon as they are generally and widely adopted. These adopted norms are then enforced by social and market forces and sanctions. A prerequisite for these forces and sanctions to work, though, is transparency. Society and the market can only respond to what is known to them. It is for this reason that King IV places so much emphasis on meaningful disclosure that enables stakeholders to assess the quality of corporate governance, rather than a binary account of which recommended practices have been followed and which not. More flexibility and judgement are allowed for in the implementation of King IV but in exchange the onus is on organisations to be more transparent on how that judgement has been exercised.

Another prerequisite for social and market forces to work is that shareholders and other stakeholders should be active in holding organisations accountable for good corporate governance. Institutional investors in particular have an important role to fulfil in this regard. This is addressed in King IV by virtue of the 17th principle that requires institutional investors to exercise their rights as holders of beneficial interest in the securities of companies responsibly. This includes being active owners.

GOOD CORPORATE GOVERNANCE FOR ALL ORGANISATIONS

Institutional investors are addressed in King IV, but so are other organisations beyond the traditional listed company audience. Listed companies are dependent on the infrastructure provided by the public sector. Listed companies are being held accountable by civil society for the impact of their operations on society and the natural environment.

Small and medium enterprises (SMEs) form part of the supply chain of listed companies. Retirement funds invest directly or indirectly in equities and have an interest in holding investee companies accountable for good governance. To be able to do so effectively and with credibility those retirement funds should in turn be well governed.

It should be clear that it cannot be expected of listed companies alone to follow good governance. Listed companies are part of a bigger system of interdependent relationships. For corporate governance to truly work, all of the participants in the system should adhere to good corporate governance.

Another way in which the applicability of King IV to a wide range of organisations and entities is addressed is to provide for proportionate application. Implementing corporate governance practices is not an end in itself but should be harnessed for the creation of value. This means that implementation should be appropriate to the size, nature and complexity of the organisation. Some guidance on this has been included in the King IV Report.

THE ENDGAME

Our corporate governance code should not belong only to the King Committee or the Institute of Directors in Southern Africa but to all South Africans, corporations and individuals to whom good corporate governance matters. To this end, the drafting process has been widely consultative and subjecting the draft report to the rigour of public comment is a further step in this process. The launch of the final King IV Report is planned for 1 November 2016.

Should King IV be welcomed as making the application of corporate governance accessible and understandable beyond the circle of consultants, technicians and academics, the King Committee will be able to take a bow for a job well done. Should King IV be adopted by all organisations across all sectors in a way that does not add a compliance burden but, instead, helps organisations to flourish, we can all take a bow.

AUTHOR


Ansie Ramalho
King IV Project Lead: Institute of Directors in Southern Africa

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