This article is relevant to Paper F4 (ZAF)
This article briefly deals with the following:
- The definition and meaning of corporate governance
- The regulation of corporate governance in South Africa:
- The King III Report on Corporate Governance (2009), and
- The Companies Act 71 2008.
Since 2001, corporate governance has received renewed interest internationally due to high-profile collapses. Enron and WorldCom in the US and Saambou Bank and Fidentia in South Africa are examples of prominent corporate collapses. Directors are expected to act in a socially responsible manner. Corporate social responsible conduct relates to important social, safety, health and environmental factors to which company management must have adequate regard.
In an article in the Harvard Business Review, McKinsey & Company MD Dominic Barton makes a few interesting points (1).
First, he states that the ways in which directors govern, manage and lead corporations should change. The focus of directors should be on long-term value. Secondly, directors must realise that serving the interests of all major stakeholders will not have a negative effect on the maximisation of corporate value. And, lastly, boards should govern a company like owners.
One can therefore ask the question: what is 'corporate governance' precisely and is it regulated at all? And, if so, to what extent?
Corporate governance is often described as a vague concept, with loose definitions giving rise to different understandings of what it involves. Various documents, reports and codes of best practice define corporate governance. A definition often used is the one drafted by the Cadbury Committee in the UK in 1992. It defined corporate governance as 'a system by which companies are directed and controlled'. (The name changed to the UK Corporate Governance Code in 2009. It was previously called the Combined Code (2).)
In the 2007 ASX’s Principles of Good Corporate Governance and Best Practice Recommendations, corporate governance is defined as 'the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations.' (3)
In essence, corporate governance therefore relates to the manner in which corporations are regulated and managed.
Although South Africa is not a member state, the Organisation for Economic Co-Operation and Development's Principles of Corporate Governance are pertinent when interpreting principles of corporate governance. The aim of these principles is to assist governments in their efforts to evaluate and improve the legal, institutional and regulatory framework concerning corporate governance.
Corporate Governance in South Africa
The King III Report
Principles of good governance are not only regulated in terms of legislation and the common law. Important recommendations are contained in Codes of Best Practice. The King II Report on Corporate Governance of 2002 (hereafter referred to as 'King II') was applicable to South African enterprises until the end of February 2010.
In view of the anticipated new Companies Act 2008, it became necessary to draft a new King Report on Corporate Governance. The King III Committee consisted of 11 subcommittees, namely:
- boards and directors
- accounting and auditing
- risk management
- internal audit
- integrated sustainability reporting
- compliance and stakeholder relationships
- business rescue
- fundamental and affected transactions
- IT governance
- alternative dispute resolutions
The King III Report deals with more or less the same issues as dealt with in King II. It provides general principles regarding ethical leadership and corporate governance (chapter 1), as well as principles of good governance relating to the board and directors (chapter 2), audit committees (chapter 3), the governance of risk and information technology (chapter 4 and 5), compliance with laws, codes, rules and standards (chapter 6), internal audit (chapter 7), governing stakeholder relationships (chapter 8) and integrated reporting and disclosure (chapter 9).
The King III Report applies to all entities regardless of the manner and form of incorporation or establishment and whether in the public, private or non-profit sectors (para 13 of the introduction and background part in the report).
Chapter 5 contains principles that were not part of King II (4). Recommendations were also added dealing with fundamental transactions as directors need to be aware of their duties in regard to mergers, acquisitions and amalgamations (this is dealt with in the practice notes). King III also refers to business rescue proceedings (principle 2.15) as provided for in the new Companies Act 2008 (5). This is, however, not dealt with in detail in King III. The King III Report operates on an 'apply and explain' basis. This is similar to the 'comply and explain' basis that King II operated on. The King III committee found the word 'apply' more appropriate than 'comply'.
The key principles of the King III Report are leadership, sustainability and corporate citizenship (para 8 of the introduction and background part in the report). Good governance is essentially about effective leadership. It is stated that effective leaders are characterised by the values of responsibility, accountability, fairness and transparency (para 8.1).
Sustainability is also very important as nature, society and business are interrelated and directors need to understand this. Sustainability reporting is one of the core aspects of good corporate governance, but has to be cost effective (6). Corporate citizenship (para 8.3 of the introduction and background part in the report) refers to the fact that a company is a person that has to operate in a sustainable manner. The responsibilities placed on individuals and juristic persons in terms of the constitution are relevant in this regard.
The report once again opted for the inclusive stakeholder value approach (7). The board should consider the interests of all legitimate stakeholders and not just those of the shareholders. Two approaches are referred to – namely the enlightened shareholder value approach, where stakeholders are only considered in so far as it would benefit the shareholders collectively, and the stakeholder inclusive approach, where the board would consider the interest of the stakeholders on the basis that it is in the best interests of the company. In the stakeholder inclusive model, recognised in the report, the legitimate interests of all stakeholders are considered when determining what is in the best interest of the company. The various interests of different stakeholders are determined on a case-by-case basis to act in the best interests of the company. A certain stakeholder may receive preferential treatment if that serves the interests of the company best.
Integrated sustainability performance and integrated reporting is also recommended in the report to enable stakeholders to make informed assessments on the economic value of a company (8).
Emerging governance trends like alternative dispute resolutions, risk-based internal auditing and policies on remuneration were also included in the report (9). In short, the board should ensure that disputes are resolved effectively, efficiently and expeditiously as possible. Internal audit should be risk-based and the auditors should provide the board with an assessment on an annual basis regarding the systems of internal control and also to the audit committee on the effectiveness of internal financial controls. Companies should remunerate directors and executives fairly and responsibly.
The Code is available online to download. (10)
The Companies Act 71 of 2008
When reading the Companies Act 2008, it is clear that corporate governance issues are not just regulated in Codes of Best Practice, it is now also dealt with in legislation.
Corporate social responsibility issues enjoy more prominence in the Companies Act 2008 than in any previous company legislation in South Africa. Section 7(d) confirms that one of the purposes of the new Act is to reaffirm the concept of the company as a means of achieving economic and social benefits. Stakeholder protection is addressed in section 76(3)(b). Section 72(4) furthermore provides for the establishment of a social and ethics committee.
Various other sections also deal with corporate governance issues. See, for example:
- Chapter 2, Part C dealing with general transparency and accountability requirements. Enhanced requirements are furthermore listed in chapter 3. This is, however, only applicable to certain companies.
- Chapter 2, Part 7 concerns general governance of companies. Directors’ duties are, for example, partially codified in sections 75 and 76. This includes the business judgment rule.
These sections will not be discussed here, but it is important to note that some issues are no longer just dealt with in King III, which is self-regulatory as explained above, but are now part of South African legislation.
Corporate governance is regulated in South Africa. Most of the companies that had corporate governance failures did subscribe to principles of good corporate governance and had certain measures in place. This raises the question: does the drafting of codes of good governance really make companies healthier and more sustainable, and will they reduce the likelihood of corporate collapses? This question is linked to the concept of 'box-ticking', referring to the practice of ticking off certain areas/boxes to indicate that there was compliance with specific aspects. To merely tick boxes is clearly not ideal as there must be compliance with the rule and not just with the form.
Written by a member of the Paper F4 examining team
- See Dominic Barton, ‘Capitalism for the Long Term’, Harvard Business Review, March 2011, pp3–9
- See www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance.aspx
- These principles (with the 2010 amendments) are available at www.asxgroup.com.au/media/PDFs/cg_principles_recommendations_with_2010_
amendments.pdf and issued by the Australian Securities Exchange
- See para 11 of the introduction and background part in the report
- See sections 128ff
- See para 8.2 and 9 of the introduction and background part in the report
- See para 9 of the introduction and background part in the report, as well as chapter 8
- See para 9 of the introduction and background part in the report, as well as chapter 9
- See principle 8.6 for alternative dispute resolutions, principle 3.5 regarding internal auditing, as well as chapter 7 in general and principle 2.25 regarding remuneration policies
- See www.iodsa.co.za. Copyright of the code and the report rests with the Institute of Directors in Southern Africa. The report is also available at www.iodsa.co.za, but only to read and not to download. For a copy of the report, one has to purchase it from the Institute directly
After reading this article, you should be able to:
- define corporate governance
- understand the general nature and operation of the King III Report
- have a general overview of the contents of the King III Report
- understand and explain the inclusive stakeholder value approach
- know that corporate governance issues are now also dealt with in legislation and be able to explain this.
See R Naidoo, Corporate Governance: An Essential Guide for South African Companies (2nd ed), (2009), LexisNexis Publishers, for further additional/recommended reading on this topic.