“Corporate Governance in Sri Lanka and Its Battle against the Pandemic in Uncertain Times”
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Charindri Jayarathna
Introduction
Exceptional times call for exceptional action. COVID -19 has taken an entire planet hostage and there is no visibility to a foreseeable end or an acclaimed remedy and is likely to imprint lasting effects on Sri Lankan society and the economy.
The pandemic has set a significant and an adverse effect on law, companies and their stakeholders. This inevitably paves the way to a new set of responsibilities and an optimized bona fide (good faith) being imposed on the Board of Directors, prominently in corporate governance. Through these harsh and increasingly complex external environment Boards are expected to rise above and beyond and ensure that the management is directed towards overcoming negative effects of the pandemic, keeping companies in business and making profits.
Background
With heavy commercial restrictions imposed due to the health crisis, Boards are now called upon to take pandemic related remedial action prior to occurrences which may adversely affect business functions and ensure continued business sustainability. The Boards are placed in a position to evaluate their duties and liabilities in ensuring that adequate long-term disaster-response and mitigation measures are available. The traditional corporate governance principles and practices together with the corporate leadership are being directed towards novel pathways in ensuring sustainable long-term values are established within their companies during this global crisis.
This, however, does not refer to an absolute deviation from the traditional corporate governance principles. Several existing key principles may be altered, and some contemporary aspects are likely to be adopted to establish efficacious corporate sustainability and achieving long-term goals.
A) The Balance of the Responsibilities of the Board and the Management
As ascribed by the Code of Best Practice on Corporate Governance the Board has a fundamental duty to;
‘provide entrepreneurial leadership of the Company within a framework of prudent and effective controls which enables risk to be assessed and managed’[1].
The management thereafter has the responsibility of creating, managing and incorporating the strategies and absorbing them to the daily operations under the oversight of the Board.
An effective Board of Directors;
‘are diligent monitors, but not managers of business operations’[2].
A Board is expected to exercise vigilant oversight of the Company and the management but refrain from micromanaging or duplicating the roles of the management. In these unprecedented times, where the Board engagement shall be premium, drawing a clear demarcation of the responsibilities of the Board and management requires intricate care. In the absence of a clear line distinguishing such, the respective duties are likely to cause friction between the two entities. Therefore, utmost consideration should be paid in engaging the Board and management to effectively establish clear demarcation of authority and avoid any clashes and confusions that may hinder the smooth execution of business functions.
Within the economic volatility created by COVID-19, both the Board and the management must ensure that they perform beyond their general expectations entailed to their roles.
B) Increased Board Engagement
Whilst the pandemic continues endangering the revamp of the economy, a high level of involvement in governance and overseeing management is required from the Board for the foreseeable future.
As the pandemic continues threaten the corporate sustainability, the Boards require directing their attention to disaster management response. Such a heightened level of engagement is unlikely to reduce in the foreseeable future considering the uncertainty of times. Until a successful vaccine has been globalized, commercial trends are likely to be unpredictable. The leadership must, therefore, rise to the occasion and play an exceptional role including managing the changes imposed by the government and the scrutiny of the stakeholders. As the long-term impact of this pandemic is thus far uncertain, the Boards require to increase their time and commitment to continuously evaluate and address the changing market needs.
C) Continued Oversight of Business Resiliency
A pivotal responsibility of the Board lies in establishing a business resilience strategy. While thus far the Boards paid attention to risks that were limited to volatile market conditions, cyber threats, supply chain deficits, etc. Pandemic related disaster response and mitigation processes were unheard of. The Board shall now require frequently review and upgrade the corporate business and management plan in recovering and creating policies and procedures to ensure business resiliency.
The Boards, among other things, should set their best foot forward in planning for the continuation of business functions to meet the same level as existed pre-pandemic. Such can be achieved by revising and appointing suitable managers to lead such efforts, obtaining the advice of external counsels and advisors, maintaining the health and safety of their workforce and effectively manage workplace pandemic outbreaks, etc,.
Engagement of long-term shareholders on issues that are significant to them as well as the Company’s long term value creation may also be beneficial for the Board in creating business resiliency.
D) Enterprise Risk Management (ERM)
Lessons learnt through the global economic crisis (1998, 2008), Enron (2001) and Worldcom (2002) scandals were used for the initial establishment of ERM plans and processes. They are, however, unlikely to address the geo-economics brought out by COVID-19.
The risk tolerance of the Company has been put to test and it is likely that the risk appetite of the company is inept in managing these new circumstances. Boards should focus on forming ERM committees to have a broader oversight of catalytic occurrences that may hinder their business functions in the future.
The ERM committee shall thereafter provide perspective to the Board of primarily; application of ERM, nature, scope and foreseeable future of the pandemic, the foreseeable evolution of ERM processes in comparison to previous years, contingency plans, etc,.
E) Technology Planning
Among the many requisites of commerce, the pandemic has made technology an absolute necessity. For the foreseeable future, the Boards shall have to place effective emergency technology plans which shall continue to keep a business afloat despite mobility restrictions. Such plans should ideally comprise updated technology, equipment and professionals. Considering variations of possible catastrophes or in the absence of any of the above mentioned three, a map of possibilities should be drawn and made aware of, including the use of external technology, technical support and backup/replacement technology. Based on such map the Boards shall retain oversight of the longevity of the business functions in face of another calamity, including the forecasted costs and timelines.
This scenario-based technology mapping may be assigned to the management. However, the Board should frequently ensure that the organization remains ‘tech-savvy’ to meet the volatility of technological needs and shall at no point face ‘tech-outages’.
F) New Compliance Functions
An exponential increase of risks requires the Boards to reevaluate and redraft the existing compliance functions within their company. Taking into consideration the increasing number of regulatory and industry-specific local and international compliance requirements the Board shall face the challenge of establishing an effective compliance framework to address all such requirements and the consequences of the pandemic.
Under the prevailing conditions, new concerns have been raised with respect to antitrust matters, cyber security threats, health and safety precautions, national emergency processes etc. Each of these require to be addressed through a cost-efficient and effective compliance framework. The primary responsibility lies within the existing legal, risk and compliance personnel within the organization, who shall be proactive in their subject matter and collaborate with each other in the functions and reporting lines as opposed to the traditional singular and separate functions and reporting lines.
With the recognition that a wide variation of compliances is spread among varied businesses and related regulatory regimes, the Boards will have the opportunity to recognize that there is no right approach for all and opt for the most suited approach for their company. The Board should provide their support and oversight on the new compliance functions and ensure the collaboration is given a higher level of responsibility and accountability.
G) Employee Appraisals and Compensation
The new work from home concept has taken employees away from the traditional office space and into the virtual office setting. Similarly, the leadership roles too must be modeled to be of virtual leadership and ensure that performance and productivity are maintained within agreed parameters. Employees who performed exceptionally during these times are likely to be rewarded well by the Board with incentives to further enhance their productivity.
Among the many lessons the lockdown has taught businesses, is the need to reassess and evaluate the executive structure and payment schemes. Based on a careful evaluation a new balance has to be distinguished between salary and performance. The Board should refer to their remuneration committees to investigate this matter and establish a new executive compensation philosophy to adopt and oversee the implantation that fits the long-term values of the Company. Considering the turbulent economic conditions the new structure should be built with meaningful goals for performance-based compensation together with flexibility so that when a crisis strikes payment can be halted, delayed or be paid in some other agreed form. The existing compensation schemes require to be revised to be affordable on the long term for a company to sustain during these times. The discretion of suspending benefits in times of crisis should also be in consideration.
While many crisis inflicted industries have already opted for revoked benefits, pay cuts and layoffs, the Board should ensure that value and recognition is given where required and further ensure that valuable human capital is not sacrificed for this pandemic. The compensation committee and the Board are likely to be conflicted in drawing a definite line in recognizing certain parameters; however, it shall be advantageous for the long term sustainability of the organization.
H) Capital Allocation
During this time of crisis, balance sheets are under duress as companies incur major unexpected costs. Boards are likely to focus on both short and long-term use of capital to be consistent with the Company’s business goals and strategy. Companies also need to maintain their workforce, invest in new resources such as technology and security. The management thereby becomes obligated to ensure that employee welfare is simultaneously upheld, and the morale of the employees are maintained.
With this unexpected expenditure companies can no longer opt to buy back their own shares, as often seen pre-pandemic in the stock market. Dividend distributions are therefore, likely to be affected. With the rising expenditure, the Boards should dedicate themselves to taking necessary action in retaining existing capital and utilizing emergency capital allocations. If need be, Boards are likely to raise capital through existing institutional shareholders which may prove to be valuable assets to the Company, specifically in providing advice, services etc,.
I) Virtual Annual General Meetings (AGMs)
Large physical gatherings impose a serious health hazard. To remedy this situation many Boards opted hold virtual AGMs. Many obstacles lie in holding a virtual AGM. Primarily, shareholders giving their consent to join virtually and having adequate technological resources were of significance. Another critical obstacle was ensuring that the articles of the company provides flexibility to hold a virtual AGM.
Generally, physical AGMs are promoted to create a dialogue between the shareholders and the Board with respect to the performance of the company and the long-term goals. Virtual meetings now being a necessity the Boards must, however, ensure that the shareholder concerns are sufficiently addressed to.
J) Organizational culture
A positive and valued organizational culture is a corporate asset. Setting up a good ‘tone at the top’ has always been a priority of the Board of Directors.
In the increasingly demanding role the Board has to play, oversight of the changing organizational culture is mandatory, specially in terms of maintaining the health and safety of the employees While the traditional checks and balances of a positive organizational culture shall remain, novel aspects require to be introduced in terms of securing a healthy and safe workspace. Such novel aspects are likely to be crucial to the Boards’ post-pandemic business model as well.
K) Organizational Succession Plan
In Sri Lanka, succession planning is very much limited to the senior management of a company. However, during this time the Board may also require changes as they play the leadership role in shaping the Corporate Governance of the Company and therefore shall strive to build an engaged and diverse Board. The new Board composition shall be focused on catering necessary pandemic appropriate expertise, the Company’s needs and strategy.
In terms of senior management, the Board is likely to engage with former CEOs and Board directors to provide mentorship and guidance in managing crisis situations together with attention to the mental and physical well-being of the overworked workforce.
Having moved on to the virtual office space the Board should be more focused on escalating the succession plan to the executive level as well. The Board should be inclined to advice senior management to groom junior employees to take over leadership positions. Multiple candidates are prone to be given shared responsibilities and groomed to take over vacant positions, emergency responsibilities and tasks.
Conclusion
These perilous times have brought out a series of obstacles to be resolved at the virtual Board room. The pandemic caused significant issues to businesses including disrupted supply chain functions, credit management, insufficient capital, lack of customers etc,. The vexing circumstances proved how ill-prepared companies are for certain crisis events. The dividend distribution is another aspect that has been significantly affected in Sri Lanka. Both the banking[3] and insurance[4] sectors have been mandated to withhold dividend payments by their respective regulators to maintain the liquidity and the appropriate cash flows. This inadvertently led majority of foreign investors to be rid of their shares at the Colombo Stock Exchange. Many AGMs were held virtually for the first time in Sri Lanka. Virtual AGMs have proven cost and time efficient for companies, even though they might not be popular with shareholders. Another aspect was where the Boards recognized the importance of all stakeholders, over the customarily prioritized shareholders. The existence of customers and the safety of employees are now valued more than before.
Hence the Boards now have a heightened level of responsibility in their oversight of the Company. More frequent and short virtual meetings are held to discuss matters in comparison to the traditional lengthy physical meetings. Boards should work closely with the management and create efficient reporting lines to ensure that accurate information reaches them in a timely manner to address new concerns and risks to the company. The ERM committee will have a premium role for the foreseeable future in evaluating and adopting necessary preventive measures that may impact the company’s performance. The Boards should also focus on disaster management within the company including employee deficits, the continuation of IT functions, cyber threats, disruptions in reporting lines and regulatory compliances. The Board should frequently evaluate the measures set forth and update disaster management processes to face any crisis situations.
The dynamics between the Board and the management requires to be more open and engaging. The relationship must evolve specifically around business risks, resiliency and workplace health and safety measures. Updated legal and regulatory compliances must be reviewed frequently and the Board must provide clear instructions to the management on their responsibilities. The effect of the pandemic on the suppliers, service providers, key customers, creditors and lenders must be investigated to identify issues that may arise in contracts, specifically relating to force majeure (any act beyond the reasonable control of man), defaults, warranties, indemnities and termination. The Board should also pay attention to the adequacy of the insurance policies of the Company.
As waves of contamination are grappling the society the Board must create an emergency succession plan in the event key personnel are incapacitated by the virus. The Board must ensure that replacements are capable of being accountable for their new responsibilities. The Board should set up a committee to establish such transitions and evaluate such processes. Consequently, the Board will also have to revisit the long-term goals and strategy of the Company and together with the steering committee, ensure that the company is prepared and resilient given the dramatic volatility of the economy. Another aspect is employee compensation. Rewards must be proportional to the time and commitment of the employees, but keeping in mind the financial status of the Company. Performance targets and metrics are likely to set with certain flexibility to address the current market conditions.
Among the very many concerns of the Board, the most significant is the company’s liquidity and capital considerations. The impact on the cash flow, outstanding debts and further financial constraints should be given significant focus. Share prices of many listed companies fell dramatically subsequent to March 2020. Such companies are vulnerable to hostile takeovers in the present condition. While a Board is generally prepared for such instances, reviewing the existing processes and seeking advice from external parties such as investment banks and financial consultants is prudent. The Boards should at all times be prepared with market intelligence and be aware of market trends to act diligently. Even in the event of friendly takeovers, the Board must be prepared with necessary responses.
With the series of challenges that continues to affect companies’ excessive amount of responsibilities and liabilities are laid on the Board. It is pertinent that the Board is well informed and prepared to face such challenges. While many Board Directors sit in several board rooms special focus must be placed with respect to conflict of interests.
The new role of the Board demands an excessive time commitment and a diligent oversight. The corporate governance structures established to facilitate good governance, therefore, requires to reviewed and updated with the above propositions to successfully and effectively battle the consequences of the pandemic and to ensure that the company’s long-term goals and sustainability are retained in the post-pandemic business plan.
As previously mentioned, not all principles of Corporate Governance fit the needs of all the Companies, and it is at the discretion of the Board to utilize them as seen fit. Until the global crisis is successfully contained Boards are likely to heavily rely on their Corporate Governance structures and maintain uberrima fides (utmost good faith) to their companies and the stakeholders.
- Charindri Jayarathna
LL.M (Distinction) Staffordshire
LL.B (Hons) Staffordshire
Attorney-at-Law
Visiting Lecturer
Nawaloka College of Higher Education
[1] The Institute of Chartered Accountants of Sri Lanka, ‘Code of best practice on corporate governance 2017’ , <https://www.casrilanka.com/casl/images/stories/2017/2017_pdfs/code_of_best_practice_on_corporate_governance_2017_final_for_web.pdf >, accessed on 09th November 2020
[2] Michael W. Peregrine, Ralph DeJong and Sandy DiVarco, ‘Principles of Corporate Governance’, Harvard Law School Forum on Corporate Governance, <https://corpgov.law.harvard.edu/>, accessed on 9th November 2020
[3] Duruthu E Chandrasekera, ‘Foreign Investors Flee Sri Lankan Bank Stocks Amid Dividend Ban’, (Regulation Asia, 26 May 2020),< https://www.regulationasia.com/foreign-investors-flee-sri-lankan-bank-stocks-amid-dividend-ban/ >, accessed 13 November 2020
[4] ‘Regulator suspends shareholder dividend payments by insurance firms’ Daily Mirror Online, (13 November 2020), < http://www.dailymirror.lk/business-news/Regulator-suspends-shareholder-dividend-payments-by-insurance-firms/273-195097>, accessed on 13 November 2020