Business Page – September 15, 2002


Backward Capitalism

(PART 2)

Introduction

Last week we started this article prompted by Dr. Clive Thomas’s analysis in his column in this paper in which he spoke of the “remarkable flexibility and responsiveness that capitalism, as a social mode of economic organisation so frequently displays at times of crisis”. Dr. Thomas’s discussion also noted that inherent in that system are the absence of equity and fairness and the opportunities for exploitation by “scoundrels, robbers and crooks of every possible hue and kind”. This he compared with what he describes as backward undeveloped market economies like Guyana where there is no efficiency imperative in economic performance or political performance but which also has some of the negatives and more of the more efficient system.

We noted last week that some of the symptoms of backward capitalism include weak regulations, ineffective governance, an uninformed and timid press, unresponsive governments, self-serving rather than self regulating professionals, inappropriate or poorly enforced laws and a populace that considers that the way things are is the way they will always be and corporate lawlessness which we dealt with at some length last week.

Today we look at some of these other areas.

 

Corporate Governance

Understandably, there is some overlap between corporate lawlessness and corporate governance which is about how the company is governed and managed. Progressive capitalism requires that certain institutional arrangements must be in place and must operate effectively. Some of these would include adequate laws, regulations and institutions such as functioning, active stock exchanges, an anti-monopolies commission, a strong accounting profession operating with clear rules, and competent directors. The Enron/World Com debacle showed that even in highly developed economies these bedrock institutions can and do fail for sometimes very simple reasons. Politicians became too beholden to businesses for campaign funding, the press failed to question the stratospheric p/e ratios, the accounting profession became overcome with greed, institutional investors simply forgot their roles while directors became victims of supremely powerful chief executives. The bursting of the bubble should therefore have come as no surprise.

Conceptual Conflicts

In Guyana as indeed in any backward and undeveloped economy we therefore have to find appropriate mechanisms to take us out of the backwardness. But what do we have? For over ten years we have been spending tons of money in consultancy on establishing a stock exchange which when it is established will do little to create wealth, regulate the market and win public confidence. We would have done better to look at some of the real causes of the problems contributing to weak corporate governance in the private sector including some fundamental and inherent conceptual conflicts in legislation generally and not only those in Guyana. Section 96 of our Companies’ Act places a duty of care on the directors to act in the best interest of the company and goes on to point out that in considering the “best interest of the company” directors must have regard to the interest of the employees as well as the shareholders. That duty however is owed to the company alone and it is hard to see how a shareholder benefits from such a provision.

Director Independence

Another issue is the distinction between independent and non-executive directors. The concept of the non-executive director came into vogue following the publication of the Cadbury Report on corporate governance in the UK. The USA uses the term “independent director” and for good reason. Directors owe their duty to the company of which they are a director but when they are no more than representatives of the majority shareholders, are they truly independent and indeed non-executive? It is not unusual for a chairman who holds his position on the Board because of his appointment rather than election, to welcome a worker director with a reminder that he should not see himself as representing workers but to protect the interest of the company.

Auditor Appointment

The other serious conceptual conflict relates to the auditors of the company. The law and the accounting profession hold that the auditor is independent and that he is elected by the shareholders to whom he reports. In reality however shareholders merely rubberstamp the appointment/(re-)appointment of the auditor and authorise the directors – in effect the executive – to fix the fees. He who pays the piper calls the tune is applicable to the auditing profession as well and auditors will not survive for long if they run afoul of the executive. Shareholders are also unlikely to be aware of and do not have access to one of the most important pieces of communication between the auditors and the company regarding the audit.

Closed Network

Institutional investors are supposed to have good business sense and to be able to keep the executive on their toes but they soon lose their identity and role when they become part of the group rather than remaining independent. For example, institutional investor puts up director A to represent it on the board of B. B however is a major group and appoints the same director A to look after its interest in one of its subsidiaries. This situation challenges the strict oversight role which A was expected to play in B.

Of course it will always be difficult in small societies to avoid some of these problems but it certainly does not help when the directors club is seen as a closed network “till death do I leave”. This column has referred to the reprehensible practice which takes place in Guyana of directors’ pension schemes! This should surely be outlawed. In addition there should be term and age limits for directors in public companies.

Executive Abuse

Underlying the whole concept of the joint stock company is the separation of the shareholders from the executive who of course would be answerable to the shareholders both as a group and as necessary in their individual capacity. We referred to a letter by a shareholder to a public company requesting information on governance matters in that institution but regrettably the request including follow-up telephone calls has been completely ignored. It would seem that the only option available would be to resort to the courts hut this is an expensive, time-consuming process which is surely avoidable. Perhaps the law did not make allowance for such incredible arrogance but is it not time that the law recognise shareholders’ right to information? Would the Stock Exchange make rules to prevent such executive abuse?

Public Interest Company

Another important conceptual issue relates to the status of companies. Our law allows for the incorporation of private and public companies and for the time being the principal practical difference relates to disclosure for purposes of filing with the Registrar of Companies. However, it seems to be the appropriate time for us to consider a new category called the public interest company. Let us take an example. Company A is a public company which is carrying on banking business and has total deposits of say $1Bn. Company B which is in the same business and has total deposits of $6Bn.is a private company. Should the law treat company B as less important than company A which is so much smaller? There are several companies which can come within the category “public interest company” including utilities, companies conducting financial and insurance business and the private subsidiaries of public companies. Indeed as we have noted before in these columns some jurisdictions deem any subsidiary of a public company itself a public company.

Failure of Self-Regulation

Much has been said in these columns and by Dr. Clive Thomas about that the accounting profession and few will say that the low regard which the public has for the profession is without justification. Unfortunately, the profession in Guyana as indeed the Caribbean is yet to put reform on its agenda. The profession has and continues to be self-regulated meaning that it makes its own rules, prescribes its own standards and therefore ought to ensure that its members comply with them. In practice this is a joke and accountants have shown themselves as no less hustlers than the sharp businessmen. Self-regulation has failed in every developed country.

The USA has responded to Enron by the introduction of sweeping legislation to regulate the profession through a Public Company Accounting Oversight Board with powers to register accounting firms, prescribe and enforce standards through heavy penalties. Jamaica had such a Board since the seventies but that did not prevent one of the costliest collapses of the financial system in the Caribbean. It has resuscitated and strengthened the Board which would probably be a model for Guyana. Doing nothing is not an option and the public should call for some reform of the profession.

Conclusion

It is evident that the current system of regulating business does not work and leaves the door wide open for abuses to be perpetrated by those scoundrels referred to by Dr. Thomas. We have had a number of warnings of the potential for disaster that the existing culture sustains and pre-emptive action is needed before another business scandal rocks a system that is ill prepared to withstand any major negative event, yet everyone is too busy to seriously address the situation. A good place to start would be to identify who is really responsible for ensuring effective regulation of companies in Guyana. We cannot continue to wallow in this blissful backwardness or we will never be able to provide Guyanese with the economic security that is a necessary ingredient of stability.