Untitled Document

Scandals and corporate governance
By Professor Willie Mendis, Senior Professor, University of Moratuwa
The economic reforms in Sri Lanka originally initiated in 1977, dramatically shifted the lever of reliance for growth in favour of the private sector. This thrust even labelled the latter as the ‘engine of growth‘. Its subsequent expansion became accepted by the major political parties. Its overall impact has now matured to the stage where public policy has become strongly focused on competitiveness and on financial reforms necessary for such achievement.

In the above setting, the experience of other countries which have traversed on this road map indicate that with private sector expansion there will be an increase in the number of stakeholders. The latter being driven by higher returns that can be potentially earned with diminishing risks over the traditional investments in bank deposits. It is a visible transformation in the process of capital mobilisation in private sector-led growth.

The aim of public policy in the development of the capital market is thus to promote listed public companies. Its bed-rock comprises the twin bodies of the Securities and Exchange Commission (SEC) and the Colombo Stock Exchange (CSE). They are actively involved with the listed corporate sector on which will grow public savings, inclusive of its retirement funds. The barometer of the latter will be reflected in the indices computed by the CSE, such as the ASPI and MILANKA. In turn, these have the opportunity to be contrasted with the indices of the international capital markets. Its outcome will be the derivative of global competitiveness of our economy.

In the aforesaid manner the sensitivity of the nation’s economic health will need to be inevitably integrated with good corporate governance. The vulnerability of the latter to ‘crashes‘ became more than evident with the collapse of the giants of the corporate world such as Enron Corp. and WorldCom. The huge damage it caused was immeasurable to the US economy as a whole and to the shareholders who had faith in the corporate sector to be their safety nets, especially in retirement. Their collapse destroyed billions of dollars in investor equity and thousands of jobs ushering in a crisis of confidence among US investors.

At the heart of a company are its key financial executives. They are the experts at crunching the numbers which drive the wheels of corporate governance. Their successes will lead to massive gains in its share values in the barometer of the stock exchange. Their failures will wipe out the company and its shareholders. Consequently, the vulnerability of the corporate governance will lie somewhere between success and failure. It arises from manipulative practices which masks the true financial status of the company to make it look rosy in the stock market.

It is further driven by equally suspect practices of those who are key players in the provision of financial services such as brokers and even the research arms of the brokerage houses. The most shocking is the involvement of the auditors in accounting scandals, either directly or indirectly through its consulting associates.
Recently, some of the high profile names of the corporate world were exposed in remarkable accounting scandals. The most notable was that of Arthur Andersen, a leader in the audit world. It was further reported in the media that US regulators fined five brokerage houses including Goldman Sachs, Morgan Stanley and Soloman Smith Barney for violations of securities legislation and stock market regulations.

On a previous occasion an aide of Merryl Lynch pleaded guilty to providing insider information related to transactions involving the top-rung US firm, Martha Stewart. In addition, Goldman Sachs was also cited for IPO favouritism in stock picks.
Despite the recent bad publicity, it was nevertheless found that in the second quarter of 2002, forty-eight Fortune 500 companies practiced reporting rules that departed from nationally recognized standards. The US SEC also announced that a substantial majority of Fortune 500 companies whose financial statements were reviewed by it “have raised questions”.

The corresponding state in corporate Asia has been identified by a prominent Asian watcher “as needing to air its corporate dirty linen in public, even if that means losing face, if it wants to clean up the standard of its business practices.” He has cited the advantages of the transparency that prevailed in the US in the Enron and WorldCom scandals. Accordingly, he encourages corporate Asia to look at the US corporate model wherein there was a Senate enquiry to enable regulators to improve their handling of corporate accounting scandals.

On the other hand, he concluded that “… a willingness to expose fraud was seriously lacking in Asia wherein the tendency was to sweep it under the carpet and pretend it didn’t happen because they don’t want people to lose face”. It is relevant to note that in the US, the prestigious Washington Post newspaper carried a cartoon which ridiculed its SEC of “sweeping problems under the carpet”.

In Sri Lanka the local media commented recently that this is an era of so called transparency and good governance where the trend in more mature markets, driven by corporate scandals, is towards more openness, not less. It added that “the media has a duty to report both the good news as well as the bad. A free market economy cannot thrive without a free media and watchful financial news media which must provide the investing public the information they require to make informed decisions about where and how to invest their money”.

It further argued that “if investors feel companies are not maintaining proper accounts and that they cannot be trusted to do so, and the auditors also cannot be relied on, they are unlikely to have much faith in the stock market from which corporates raise cheap funds. Their concerns have therefore to be considered, especially if it is the government’s and the business community’s aim to make the island a share-owing democracy as we have repeatedly been told.”

Consequently, Sri Lanka is moving in the right direction. It must now expeditiously balance between the need to protect the interests of the investing public while ensuring that companies and key players of the market are not scared away with excessive regulation. In such a context, public policy in promoting the growth of small investors who do not have access to information that sophisticated market players would undoubtedly have, or of access to high-powered research, requires urgent review to capture their confidence.

A significant responsibility for enabling the above situation lies with the watchdog of corporate governance, the Securities and Exchange Commission. It is complemented by the professional accounting institutes which obligates its members to comply with proper accounting standards and best practices. The monitoring of the same by the Sri Lanka Accounting Standards and Monitoring Board facilitates further accountability of the corporates.

Yet, greater oversight seems essential in the light of the US experience where companies and executives who were held in high esteem in a mature market were found to be downright crooked. The latter has shown that bad corporate governance is probably person- driven rather than profession-driven. Consequently, the protective net for safeguarding public interest and in restoring investor confidence, compel the intervention of governments to enact investor protection legislation, similar to what happened in the US following the Enron saga. This will be the way to initiate measures for greater disclosure. The US equivalent of the Public Company

Accounting Oversight Panel might be worthy of emulation. Meanwhile, it is relevant to mention that the findings of a study undertaken on the contrasts in the Corporate Governance Statements provided in the Annual Reports of a reputed Sri Lankan listed company and that of a high-profile overseas company listed in its own market, indicate the latter disclosing more information, especially of its practices on Executive Compensation and Internal Controls to ensure the integrity of its reporting, the process of Risk Assessment and Management inclusive of quarterly Corporate Review, and of policies on Ethical Standards on matters such as the environment.

The latter is significant as the Johannesburg Declaration on Sustainable Development adopted by the global community at the World Summit in September 2002, affirmed that “there is a need for private sector corporations to enforce corporate accountability. This should take place within a transparent and stable regulatory environment”.

Consequently, it is satisfying to note that such corporate efforts are already in practice in a more mature market, which our own Institute of Chartered Accountants of Sri Lanka (ICASL) is proposing to encourage by launching an award scheme for the Best Corporate Governance Disclosure.The creation of the enabling environment to promote a share-owning democracy is timely with the emergence of hope for the dawn of peace in Sri Lanka.

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