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March 08, 2011
Will Corporate Governance Reform Become Reality?
    by Robert Kropp

A report from the United Nations Conference on Trade and Development documents corporate governance failures that led to the financial crisis and provides recommendations for reform.

That the failure of corporate governance at large financial institutions was central to the financial crisis is, by now, a widely-held insight, one which has been explored in many studies published by corporate governance experts, nongovernmental organizations (NGOs), and shareowner advocates. In many of those studies, corporate governance failures have been linked to a disregard for the long-term implications of environmental, social, and corporate governance (ESG) issues, a disregard which excluded the legitimate concerns of many key stakeholders.

A new report from the United Nations Conference on Trade and Development (UNCTAD), entitled Corporate Governance in the Wake of the Financial Crisis: Selected international views, brings together the perspectives of a number of contributors in order "to inform ongoing reform efforts and document the work of major organizations," according to UNCTAD. The report details the governance failures that led to the crisis, and provides recommendations for regulators and policymakers whose responsibility is to implement reforms.

According to the report, areas of corporate governance most in need of reform include board oversight of management, risk management as a key board responsibility, and compensation practices that balance risk and long-term performance criteria.

As Mervyn King, Chairman of both the South Africa-based Integr ated Reporting Committee (IRC) and the Global Reporting Initiative (GRI), wrote in his Foreword to the report, "One of the hallmarks of the great outside director is the ability to ask intellectually na´ve questions to test risk or the quality of a recommendation from a sub-committee in regard to taking risk for reward." Such questions, he argued, "Would have changed the risk profile of the securitized mortgage packages" whose collapse launched the crisis.

And as Anthony Miller, the Economic Affairs Officer for the Investment and Enterprise Division of UNCTAD, told, "The core of what happened in the financial crisis comes down to the oversight mechanisms of the shareholders and the boards, the compensation schemes, and risk management."

"Compensation schemes in particular were identified by G20 member states," Miller continued. "If managers are told to maximize profits without any regard for risk, then that's what they will do."

The Group of Twenty (G20) Finance Ministers and Central Bank Governors promotes discussion among nations on key issues related to global economic stability. "At their summit in Pittsburgh in 2009," the report pointed out, "Leaders of the G20 called for stricter rules for risk-taking, improved corporate governance mechanisms that align compensation with long-term performance, and greater transparency in corporate governance."

In addition to documenting the governance failures of the banking sector and providing to prevent their reoccurrence, the report observed that governance reform efforts have expanded beyond financial institutions to include corporations in other industry sectors. According to the report, "Policy makers can use the momentum created by the financial crisis to address corporate governance problems that prevail more generally."

"The banking sector stands out as an area that needs more attention than other sectors in the portfolios of pension funds," Miller said. "But when you set a new gold standard for corporate governance in the banking sector, you have to ask yourself why shareholders shouldn't have the same kind of interaction and oversight with other companies."

"If you're an investor with a large exposure to a company in any industry, how would you justify not having that oversight?" he asked.

The report also described "a recent international convergence in thinking about corporate problems and remedies," as well as "the recognition that the governance principles being promoted are applicable to corporations operating in emerging markets."

Also, "Several national corporate governance reform efforts are, for the first time, using the language of sustainability and stakeholder governance," the report continued.

King wrote in the Foreword, "Sustainability of a company means conducting operations in a manner that meets existing needs, without compromising the ability of future generations to meet their needs and has regard to the impacts that the business operations have on the life of the community in which it operates."

Miller said, "Sustainability requires a move away from a shareholder-centered focus on corporate governance to a focus on all stakeholders. Some of our ideas about corporate governance are quaint, such as the plucky investor who invests in a company and takes all the risk. But with large companies that embody so much of the economic power, many people who are not shareholders take the risk."

Referring to recent governance reform measures in Germany, Miller said, "The new corporate governance rules make explicit that good governance should focus on the stakeholder and not the shareholder."

In a report published last year, UNCTAD focused in part on the sustainable investment practices of the world's 100 largest institutional investors, finding that such practices "have become common features of the world's 100 largest pension funds."

However, "Issues of sustainability are not exclusively technical issues," the report continued, "And therefore any evaluation or analysis of the sustainability of enterprises would benefit from inputs from a range of stakeholders."

"So much of the capital markets are owned by pension funds," Miller said, referring to the earlier report. "We used the term fiduciary capitalism to describe the fiduciary duty of pension funds to all their beneficiaries."

Asked about the pace of governance reform, Miller warned, "When regulators put a priority on something, things move fast. But especially in the United States, a lot of the reforms we talk about are still ongoing and have not gone through. The biggest risks right now are no reform or watered-down reform."

"In the responsible investment community, there's always a lot of talk about ESG," Miller said. "But a lot of the discussion focuses on E and S. We have to remember that without good governance mechanisms, there is no responsible investment. Investors may have the authority to influence, but if they don't have the capability to do so their first responsibility is to get that capability. And that means corporate governance reform."


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