GENEVA: There are proven limitations as well as strengths in all known models of corporate governance, and progress requires practical experimentation in countries, with national policymakers being given considerable discretion as to the choices on their route to development and reform, according to Andrew Cornford, a Senior Economic Advisor in the Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development (UNCTAD).
An acknowledged specialist and expert in the financial markets and the standards being promoted by a number of institutions dealing with various facets of the markets, Cornford has given this view in a paper for the Group of 24 (developing-country group at the IMF and the World Bank).
With the existence of various international institutions - some private, some intergovermental of the major developed countries (like the Bank for International Settlements and its Basel Banking Supervisory Group that is now in the process of developing new banking capital adequacy standards), and some nominally international but controlled by the majors (such as the IMF, World Bank and WTO) - it has now become difficult for even the experts to know what each other is doing.
The standards formulated at these institutions are willy-nilly being forced on developing countries which have had no hand in setting or adopting them.
The major instrument to promote these standards, some 14 of them, Cornford says, is the International Monetary Fund and its Article IV surveillance/consultations of member countries. Such Art. IV surveillance takes place in respect of all its members, but the majors on their part just shrug off the IMF's views if these do not coincide with their own.
On the other hand, developing countries which have to raise funds in the financial markets or attract foreign capital (under the mistaken view promoted by the majors and the institutions they dominate, that foreign capital is a panacea for development) have to make sure that they receive the IMF/World Bank seal of observance of standards. Otherwise, the developing countries will pay a heavy price in terms of the margins that the foreign lenders etc apply to them.
Among the financial standards that are promoted as part of the efforts to strengthen the so-called international financial architecture, key ones relating to financial systems include the OECD's Principles of Corporate Governance, and the initiatives on International Accounting Standards and the International Standards on Auditing.
[Until the disclosures about Enron and its bankruptcy, and the roles played in it by the Andersen consulting (auditing, accounting) firm, the audit and accounting standards were being actively pushed and promoted as part of the WTO's General Agreement on Trade in Services (GATS) and its provisions on "professional standards" and harmonizing them across countries.
[The accounting-standards framework developed in GATS, under the Marrakesh Agreement, had been slated for further elaboration and promotion in the current round of GATS talks under the Doha Development Agenda. However, the Enron scandal, as well as the role played by Andersen, as a driving force under the Clinton administration, in the GATS and the accountancy-standards issues, appear to have dealt these moves a setback. However, the attempts have not been abandoned, just put on the backburner.
[WTO officials do not like to talk on record about these matters.]
Corporate-governance standards
The term "corporate governance" covers the whole gamut of relationships between a business's management and its board of directors, shareholders and lenders, as well as other stakeholders - employees, customers, suppliers and the community of which the business is a part. It concerns the framework through which business objectives are set, the manner of attaining them and how the monitoring performance is set or done.
The OECD's Principles of Corporate Governance (not a binding set of rules but a model) deal with a range of issues: protection of rights of shareholders; equitable treatment of shareholders, including full disclosure of material information and prohibition of abusive self-dealing; recognition and protection of the exercise of rights of shareholders; timely and accurate disclosure and transparency of matters material to the performance of the enterprise, ownership and governance, including annual audit conducted by an independent auditor; and a framework of corporate governance by a board of directors and their accountability to the company and shareholders.
Models of corporate governance cover a spectrum of questions not always with clear-cut breaks. The models range from the German model at one extreme, with its emphasis on multiple stakeholders and the influence exerted by banks through their shareholdings on the decisions of the firms, to the Anglo-Saxon model with its emphasis on a major role in the efficient use of resources to open financial markets and institutionalization of priority for shareholder value.
The OECD Principles had a particular application to the Enron affair, though subsequent disclosures have also brought out that other systems and models too have thrown up scandals, although many are yet to surface and be subjected to such scrutiny as Enron received.
The Cornford paper discusses extensively the lessons to be drawn from the various investigations into the Enron affair, drawing on the investigations by regulatory authorities (who mostly had been remiss at earlier stages until the collapse), as well as by the US Congress, on the various ramifications and aspects of the Enron affair (and corporate misgovernance and fraud), and the subsequent (partial?) legal reforms (including the Sarbanes-Oxley amendments).
Cornford adds: "Complex corporate structures and complex financial transactions (such as those exemplified in the case of Enron) demand high levels of skill on the part of those responsible for supervision and oversight. Shortages of people possessing such skills are a commonplace feature of developing countries (and to some extent of developed countries as well). The availability of the required levels of capacity for oversight and supervision should be given appropriate weight in development or reform of a country's regime for conglomerate firms."
The OECD principles are only one of the 12 key financial standards that have been identified as essential to the soundness and stability of financial systems, and as having a key role to play in the international financial architecture. Observance of these standards has been added as a subject to be covered in the IMF's Art. IV consultations. A "positive assessment" by the IMF in these consultations is one of the conditions for a country's eligibility for financing under the IMF's Contingency Credit Line.
There are also other roles envisaged for the key financial standards, Cornford notes.
One role is their incorporation in the decision-making of international lenders and investors. But another, which has been proposed in the Doha round of multilateral negotiations (in respect of GATS), would link the discretion of countries with regard to taking prudential measures under certain provisions of GATS, in ways not yet defined, to progress under the heading of key financial standards.
Prudential regulations under GATS
WTO officials and those providing technical assistance to developing countries encourage them to liberalize their financial services sectors under GATS or bind the liberalization measures they have already undertaken autonomously (under the IMF/World Bank structural adjustment programmes and conditional lending), while making some reassuring noises that their ability now or in the future to put in place prudential regulations is safeguarded.
Cornford notes that under paragraph 2(a) of the GATS Annex on Financial Services, a country "shall not be prevented from taking measures for prudential reasons, including for the protection of investors, depositors, policy-holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system."
"However," points out Cornford, "this freedom is qualified by the provision that 'where such measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Members' commitments or obligations under the Agreement'."
[Whether or not a prudential regulation conforms with GATS and its financial services annex will be determined, when a dispute arises, by a dispute panel of the WTO (and its appellate body) and their interpretations (which depend on the panellists and the AB, and their ideological orientations).
[At the WTO, there is no time limitation for such challenges, which thus creates many uncertainties in an area where both the public and market participants need some certainty.
[Already, the developing countries are being asked to negotiate and enter into new commitments under GATS without any data to guide governments about the implications of the commitments. In such a crucial sector as the financial sector, a misjudgement could cost the public of a country (and the government treasury) in terms of enormous outflows.
[The 'prudential regulations' and safeguards, as a result, seem likely to prove a mere lollipop for the present generation at the expense of a walloping cost in the future.]
Developing countries targeted
On the standards issue itself, Cornford notes that the recent financial scandals will inevitably affect the political climate within which work on implementation and further development of the standards will take place. The scandals have already led to efforts to strengthen the OECD corporate governance principles.
However, they raise questions about a basic assumption of international initiatives on the subject. Although the regimes in various industrial countries could be improved by further work on particular subjects of corporate governance, many covered by ongoing work on financial standards, these regimes have reached a level of development satisfactory enough for the major targets of future reform to be the emerging markets and other developing countries.
The relatively underdeveloped conditions of regimes in most of the latter group of countries are not disputed. A lesson that many will draw from the current corporate scandals (in advanced countries) is that corporate governance in industrial countries is being importantly weakened by the capacity of firms to get around major features of legal regimes and regulations through opportunities furnished by innovations involving financial transactions and institutional structures as well as by the access to multiple jurisdictions which has accompanied the internationalization of business.
From the first, there were queries as to the suitability of corporate governance as a subject for application of incentives and sanctions as part of global promotion of key financial standards. The grounds for the queries included the summary nature of the OECD Principles, the complexity of the subject, the potential intrusiveness of international initiatives, and the non-representative character of the body (the OECD) which had enunciated the principles.
To these doubts and queries will now be added others reflecting the acknowledgement that in important respects the state of the art in regimes considered the most developed has recently demonstrated shortcomings hitherto unrecognized or only partially recognized.
"Corporate governance has in fact so far been one of the less scrutinized subjects in the reports (ROSC, reports on standards and codes) of the IMF and World Bank assessing progress of countries regarding key financial standards." This seems understandable, given the difficulties of the subject. Much good can eventually result from a patient process of development and reform in this area, in which international cooperation through exchange of experience and technical assistance can play a significant part.
"But this process should also incorporate acknowledgement of the proven limitations as well as the strengths of all known models of corporate governance. Progress regarding such governance requires practical experimentation, and this experimentation in turn can only take place if national policymakers are left considerable discretion as to choices regarding their route to development and reform," Cornford says. (SUNS5338)
