News

Sound corporate governance depends on ethical leaders – and you and me

20 January, 2020

By Levern Forley

Risk and Compliance Officer, Eskom Pension and Provident Fund

 

The concept of corporate governance has been around for hundreds of years – but it’s only in the past 50, and since the 2008 global financial crisis in particular, that it’s really taken root.

 

It is hard to imagine that the failure of one bank – Lehman Brothers – triggered the crisis, the effects of which the entire world feels even today. In other words, a total failure to abide by the basic tenets of corporate governance by a single company precipitated the financial crisis and led to hardship for billions of people. (There were certainly others that played their part, too, but Lehman was the primary catalyst.)

                                                                                                                                                                                                                                                                                                                                     

The sheer increase in shareholder activism saw a shift in the balance of powers between shareholders and Boards (notwithstanding the managers who wielded an agenda of their own). With greater economic and sustainability expectations from political leaders and the public alike, coupled with the magnification of risk that came with globalisation, there was the inevitable intervention by regulators and lawmakers globally.

 

Most surprising, however, is the emergence of a self-regulation notion and a deliberate attempt (by a select few, unfortunately) to foster good corporate governance practices, not only to attract shareholder confidence, but to play by the rules because it actually makes sense.

 

If there’s a good thing to have come out of the 2008 financial crisis, it’s that corporate governance (the good variety, that is) has taken on far greater currency and significance, and companies and other entities have embraced it like never before.

 

King iterations explained

 

In South Africa, we are led by the King Report on Corporate Governance, currently in its fourth iteration. The King report provides extensive guidelines (recommendations around practices) that governance structures of entities can either adopt voluntarily or measure themselves against.

 

Keeping pace with an ever-changing business and regulatory environment, King has been modified over time to be more inclusive and flexible. So, for example, King I and King II were almost exclusively focused on corporate entities. King III was the first to be applicable to all entities (public, private and non-profit), and championed integrated reporting standards.

 

King IV is largely similar but makes application simpler (although not easier) for non-corporate entities. Additional amendments in terms of international standards have also found a home in King IV. There might be a false sense of security for some, based on the belief that King is not legislative. However, it might be enforceable in certain instances – particularly for entities that are required to meet Johannesburg Stock Exchange listing requirements, as an example.

 

King outcomes vs conventional ‘tick-box’ compliance

 

King IV application is linked to four specific desired outcomes, against which entities can evaluate themselves. These outcomes are inextricably intertwined and reliant on each other, and cannot be measured in isolation. In order to fully comply with King IV, entities must conduct an ongoing self-evaluation on all of the outcomes:

 

1. Ethical culture – ethical leadership speaks directly to vital matters such as building an ethical culture within an organisation, as well as building trust and confidence outside of it. Organisations that are able to demonstrate a culture of ethics at the top, in between and right down to operations, have leaders who are relentless about trust and are not afraid to call each other out.

 

2. Good financial performance – financial performance is good when it is also sustainable and affects all stakeholders positively in the long run.

 

3. Legitimacy – the outcome of social relevance and legitimacy in the eyes of the public, finds its home in the Constitution, whereby juristic entities must demonstrate good corporate citizenship: doing what is right not only for the organisation, but for the society and environment within which it operates.

 

4. Effective control – the outcome of effective control speaks to an organisation’s control mechanisms and their effectiveness. Leaders must therefore have an appreciation for the importance of the various assurance functions and must be systematic in how these functions work together, to provide comprehensive coverage across all areas of the operation. For starters, do leaders understand the mandates, and do these assurance functions receive the necessary support to enable effective execution of activities?

 

Somehow, ticking all the boxes against the recommended practices within King won’t get you anywhere closer to being compliant than had you ticked off none of them. King compliance and outcomes are ultimately achieved when effective, ethical leadership is the cornerstone upon which an organisation is controlled.

Whose responsibility is it to manage ethics?

 

Ethical culture on its own is arguably the most challenging outcome to meet, because the very nature of ethics is not black and white. In the context of retirement funds, the proof is not only in the numbers, but also in the satisfaction of the members, the pensioners and the beneficiaries. The six outcomes of Treating Customers Fairly (TCF) – a regulatory approach by the Financial Sector Conduct Authority – have never been more relevant.

 

Both an organisation’s Board and executive team must lead from the front. They must call out unethical behaviour. They must nurture an ethical corporate culture. They must put in place systems and processes to ensure good corporate governance. And they must be prepared to have the hard conversations around what doing the right thing entails.

 

But this begs the question: is ethical behaviour only the responsibility of a few?

 

If one considers a rogue’s gallery of scandals just in South Africa lately, the answer is clearly “no”. The lack of an ethical culture is the common trend and it is notable that in most cases, virtually nobody has the confidence to speak out before the damage is done.

 

And that’s possibly the most difficult part of corporate governance: how exactly do you monitor and manage an ethical culture? Setting up a whistleblowing mechanism may tick that compliance box, but will people trust it? Will a fraud perception survey effectively uncover illicit behaviour? How independent is the Board, and how effective are assurance providers such as audit, risk and compliance committees?

 

Humans are responsible for all corporate governance failures, through inaction, partiality, incompetence and greed. But they represent the solution, too, as an organisation’s corporate conscience. They must feel empowered to call out corruption, declare conflicts of interest and uphold the highest ethical standards.

 

Survival of the fittest, and the righteous

 

We live in what has been termed a “VUCA world”. VUCA, an acronym for Volatile, Uncertain, Complex and Ambiguous, was coined by the United States military to describe the hitherto unknown combat conditions it was experiencing in Afghanistan and Iraq; it speaks to a fluid, unpredictable, increasingly complicated and unclear situation.

 

The only effective and ethical way to negotiate the VUCA world is with good corporate governance. The organisations that will flourish are those that choose to live and breathe corporate governance, and see it – correctly – as a business differentiator, and a moral licence to operate.

 

Honesty is still the best policy. But it is up to all of us – businesspeople, employees, investors, shareholders and members of the public, not just the few on Mahogany Row – to show ethical leadership. We need to guide and, when appropriate, check our political and business leaders. We need to point to wrongdoing when we see it – and manage upwards if we have to!

 

And we should not be satisfied with mere lip-service compliance: the true measure of good corporate governance is not that companies claim to do it, but the positive outcomes that flow from their doing it.

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