Corporate governance—or CG—is the new buzz word in the region as banks and financial institutions scramble to adopt anti-money laundering and counter terrorism financing laws, implement due diligence, and abide by the Basel II accords to effectively compete in our globalized world.

Since 2001, the US has been at the forefront of pushing this new corporate diligence ideology, and the region, particularly the oil-rich GCC, is wising up to the new mindset—not only to attract investment but also when investing in other markets. Foreign companies, particularly from the West, are looking for effective CG before investing. But the spanner in the works is that the implementation of CG in the Middle East is moving at a snail’s pace.

Out of 10 major banking and financial institutions contacted by Executive to discuss the implementation of CG, only one could talk with authority on the subject. And this is with four of the 10 in the top 20 of The Middle East magazine’s top 100 Arab companies.

This is somewhat surprising, as CG is about improving performance, transparency, management and communication. In a nutshell, CG is about the way in which board members oversee the running of a company by its managers, and how board members are accountable to shareholders and the company itself.

CG involves improving performance across the board—the “governance” in “CG”—and in company behavior toward shareholders, clients and employees. And rather than have management governed centrally, CG is about de-centralization and distributing the workload more effectively, freeing up, rather than overloading, upper management’s time, for instance—hence the need for corporate officers, PR spokespeople, compliance managers, and so on.

But the attitude of financial institutions contacted could not be further from even moderate aspirations of CG implementation.

One leading bank said that they had implemented CG in Lebanon, but for authorization would have to speak to their headquarters in Jordan, as that was where CG decisions were made.

Elsewhere, asking to speak to an administrator concerned with CG at a financial institution the response was: “I really don’t know what you are talking about.” Likewise, one of the top banks in the GCC said: “You need to liaise with the corporate … what do you call him?” After being shunted from one person to another and innumerable emails with promises to reply, there was nothing to report.

At a different bank, the caller was directed to the head of PR, but on getting through was informed by voice mail that the person was away for the week. No one had been deputized to take over.

Comparison of corporate governance frameworks in the GCC with IIF guidelines

(On scale of 1-5 with 5 being fully compliant)

Few can define CG, much less institute it

Judging by this small sample, it would seem as if some of these institutions do not fully understand what effective CG means.

This is something that the Dubai-based Hawkamah Institute for Corporate Governance, set up to encourage CG in the region and headed by the former economy minister and vice-governor of Lebanon’s central bank, Nasser Saidi, is only too well aware of.

In a recent Institute of International Finance (IIF)-Hawkamah survey on the GCC, 59.2% of respondents were unable to define CG, while only 59.3% of respondent cited CG as important or very important. 

The survey, evaluating CG standards across 56 criteria in five broad categories—minority shareholders’ rights; responsibilities of board of directors; accounting and auditing standards; transparency and ownership; and regulatory environment—found that the average for compliance with international best practices was almost 50%. Considering the GCC is ahead of other Arab countries, the region’s adoption of CG is far lower than other emerging markets such as India with 75% and China with 65%.

Taking these results into account, it is perhaps not very surprising that so many banks and financial institutions were mute in their ability to discuss CG.

Stephen Vink, head of group risk management at Global Investment House in Kuwait, said it didn’t come as a surprise that so few companies responded.

“I went to an inaugural conference on CG in Dubai about one month ago. There was a huge turn out but because of specific methodology there is a fear CG will impact on business—profits, disclosure and transparency,” he said.

“I think there’s a fear, a misunderstanding, of what CG is about, so people are shy. To say companies have not implement CG is not correct, but to say they have 100% is not true either,” Vink added.

Indeed, the IIF-Hawkamah survey found that the top three barriers to CG cited by respondents were a lack of qualified specialists to help with implementation (53.6%), lack of information or know-how (37.7%), and low priority of CG in relation to other tasks (24.6%). It is the latter statistic that is perhaps of most concern to proponents of rolling out CG in the Middle East.

“The region is still at very early stages of corporate governance implementation. While there are a number of companies that are implementing good corporate governance practices, they are few and far between,” said Nikolai Nadal, director at Hawkamah.

Nadal said that banks, primarily because of Basel II requirements, are the most responsive in implementing CG. “Listed companies, primarily because of listing requirements on CG, are also responsive, but their responsiveness depends on the degree that capital market authorities and stock exchanges enforce the corporate governance frameworks,” he said.

“The corporate governance legal and regulatory environments, except for Oman where it is quite advanced, are starting to take shape with some countries looking at modernizing their company laws to include adoption of key CG principles,” he added.

In a comparative survey of CG frameworks in GCC countries that abide by IIF guidelines, rated from 1-5, (5 being fully compliant), Oman scored highest with a 3.5, Saudi Arabia and Kuwait got a 3, and Bahrain, Qatar and the UAE received a 2.

Who knows what CG means? (Nearly 60% don’t)

Oman on top when it comes to CG

Oman tops the league, said Nadal, as the Oman Capital Market Authority adopted a corporate governance framework as early as 2002.

Spurred on by the IIF-Hawkamah findings, the financial hubs of the UAE are scrambling to get up to par.

Khaled Deeb, Head of Internal Audit at the Abu Dhabi Chamber of Commerce, said some companies in the emirate had implemented CG and the government was fully behind such initiatives, kicking off a program this year to encourage companies to do the same.

“CG is very important. It is not new, but new in the market, in this country, and this region,” he asserted.

Regarding family businesses, of which there are 200 in Abu Dhabi, he said the chamber was working closely with Hawkamah to encourage family run enterprises to adopt a certain CG code. “But it is not easy to implement, you need to believe in CG first. You can get a consultant, but companies need to see the value of implementing CG,” Deeb said.

To encourage companies, Deeb said the chamber is thinking of implementing GC free of charge at a private company or family business as a pilot case to highlight the benefits to other companies in the emirate.

The Union of Arab Banks (UAB) on the other hand has been working for the past five years with the OECD, and now Hawkamah, to implement CG in the region.

 “CG is essential for economic reform and attracting investment, for without CG there can be no reform,” said Fouad Shaker, the UAB’s Secretary-General.

Shaker said he was pleased with the adoption of CG in the region, particularly in Jordan, the first country to implement CG regulations, in Lebanon, which has adopted a Manager Institute, and in Egypt, which has also established an institute.

“As for the central banks, most—if not all—have set rules to apply CG,” he added.

However, Vink believes that central banks could be doing a lot more to regulate CG, such as introducing spot inspections.

“A lot of reliance is placed on returnees ticking a certain box. If you look at the growth of CG in the West, inspections are part of the process. Very soon the next process here to kick in will be the fear factor: ‘I’m from the central bank, you are regulated by us and I’m here to inspect for two days.’ This is not happening here, but to be taken seriously the region is going to have to do this,” Vink said.

Other factors of good CG also need to be taken seriously. Compliance, risk management and internal audits are the backbone of CG, but in Kuwait, Vink said, there is no requirement to have a risk management department.  “But any investment company that doesn’t is probably committing suicide,” he stated.

Other regulations also need to be tightened and standardized as there are differing regulations for retail banking and investment houses, with CG regulations a lot less stringent for retail banks.

“You need to level the playing field, and more or less have the same requirements to apply because both are dealing with clients’ money and customers,” said Vink.

Local peculiarities are also hindering CG growth, with traditionally more trust between companies in the Arab world than elsewhere, few corporate failures, and minimal white-collar crime or fraud. “I don’t think we should wait until that happens,” Vink asserted.

Indeed, the IIF-Hawkamah survey found that due to high liquidity in the region, with easy access to capital, there was little incentive to change at the company level. Excessive liquidity is also creating high volatility in stock markets with too much money chasing too few stocks, which Hawkamah attributes to a lack of sophisticated investors and poor equity culture.

Despite such economic complacency, Vink said that all it would take is for a major scandal, such as the collapse of a large bank, to send a shockwave through the region that would have seriously negative repercussions, particularly on the outlook of Western investors.

With an international tendency to lump Arab countries together and refer to businesses as “Middle Eastern,” rather than country-specific as in Europe or the States, the relative interdependency  of Arab markets would suffer from a major scandal. And some 99% of corporate scandals, according to Vink, happen due to a breakdown of CG.

Vink said he based his benchmark for good CG on his native South Africa, which has adopted similarly strict rules as the UK. But he said institutions are perhaps overregulated in South Africa, such as the dual listing of the Johannesburg Stock Exchange and the London Stock Exchange. Equally, some countries have responded to corporate scandals such as Enron in the US and Parmalat in Italy in a reactive way, often implementing excessive CG regulation. The Sarbanes-Oxley Act of 2002 for instance, implemented in the US in the wake of the Enron scandal, has been criticized by financial institutions in recent years for hindering the decision making process—a view shared, incidentally, by former US Chairman of the Federal Reserve Alan Greenspan.

Is combining the positions of CEO and chairman against best practices?

As a result the region should learn from the experience of other countries in the implementation of CG and get the right regulatory balance.

The ultimate question however, as the IIF-Hawkamah survey highlighted, is why companies should implement CG.

Vink’s Global Invest is applying a risk management framework based on best practices. The reasons for that are two fold, he explained: “It’s prudent business to be proactive and have risk management for the organization. Secondly, as a result of methodologies, organizations will be a lot more efficient.”

As CG is a long-term view and essentially a bottom line cost, companies should not be looking for immediate short-term benefits. “There is a price to be paid for sustainability,” said Vink. “From a scientific and mathematical perspective, CG does make sense. Investors are prepared to pay a 30% premium to have CG, but there is no way CG will cost 30% to implement, so that’s the value.”

And the value of CG goes far beyond profit margins. Implemented effectively from the top-down, good CG will improve a company’s performance, attract more investment and help it get taken more seriously by international investors.

“Any big organization outside the Middle East will not put money in an organization without transparency,” asserted Vink. “Regional organizations need to be proactive; there needs to be a new mindset” to implement CG, he added.

It’s 8.15 a.m. and Dr Abou Bahlawan (he has an unfinished doctoral thesis from the University of Fun and Games, San Antonio, CA) makes his entry at Bank al Nile, Dajla wal Litani (BNDL). You see, Dr. Abou Bahlawan is the chairman and general manager and the majority shareholder of BNDL. His grandfather founded the bank 60 years earlier to provide full-time jobs for his descendants. The rest of the shareholders are former ministers, MPs, prime ministers and a former president, all of whom have been brought in at minimal cost.

These minority shareholders generally attend one board meeting every three years and take the opportunity to reminisce about the good old days. At some point, a director—whoever is in favor with the chairman at that time—is invited to brief, in less than five minutes, the effect of the external “situation” on the financial health of the bank.

Micro-managing run amok

But back to the daily grind. For the first three hours, Dr. Abou Bahlawan obsessively goes through the employee attendance sheets, checking on tellers, office boys, tea ladies and the like. He notices that one young lad has been arriving fifteen minutes late but staying on an extra hour.  Dr. Abou Bahlawan is furious and scolds the culprit vigorously for forty five minutes. This puts the chairman-CEO-CFO-etc. in a bad mood and he takes out his frustration on the team of external advisors and consultants he has hired to build up internal systems and procedures by firing them before the expiration of their contract. Naturally, Dr. Abou Bahlawan is not concerned about ensuing law suits.

For the rest of the day (and the week), Dr. Abou Bahlawan fulfills very important functions. These include long working sessions with his accountant (who should be the CFO but who’s had his wings clipped in order to not pose a threat to the Chairman-CEO) to massage the financial figures and present a “nice” image to the central bank and the public. He will also do his utter best to philosophically dismiss as a “bloody nuisance” and “irrelevant” any new and decisive banking laws (e.g. Basel II). He will place family members in strategic positions. He will wine and dine the judges and lawyers representing parties filing law suits against BNDL and will accept significant cash deposits from dubious people that he calls “friends” and “allies.” He rewards handsomely all managers and directors that have been “nice” to him throughout the year and will think nothing about going on a one-day “business” trip to Venice at the bank’s expense. In essence, he makes all the decisions necessary for the running of the bank, even down to the ordering of paper clips.

Sound familiar? Although a grotesque picture of absolute no-nos in management and board memberships, our pastiche nevertheless represents almost all the basic mistakes of lousy corporate governance.

Corporate governance becoming hot topic

The corporate governance (CG) dragon is stirring. Throughout the region CG has become the latest buzz word—Hawkamah, headed by former Lebanese Economy Minister Dr. Nasser Saidi, is the region’s first organization whose sole purpose is to promote CG—and is seen as the next step in the corporate evolution ladder if regional companies are to maximize efficiency and play (and behave) on a level (and transparent) playing field with Western companies.

Regional managers, shareholders and directors are all aware that good CG is the key for developing a successful business characterized by financial performance and where everybody is protected, respected and motivated. However, the majority of institutions are still not truly aware of the importance of CG and what it means. There is an endemic lack of ability and capacity to implement and enforce proper CG regulations, and there is little willingness from family or single individual owners of businesses (the vast majority of Lebanon’s private sector is family- or individual-owned and run) to go into the CG route. They regard it to be a threat to their dominance and fear the more staff and management become aware of their rights and of the need of better governance, the more uncomfortable family and single individual owners will feel, as their managerial weaknesses are gradually exposed.

The key elements of good CG principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect and commitment to the cause. The most commonly accepted principles of CG include respecting the rights of shareholders and helping these shareholders exercise those rights. Although this aspect of CG is a hotter issue in developed markets, it is worth the consideration of some of the larger Lebanese institutions, such as Solidere; the larger banks, which are all listed companies and have a diversified shareholder base; and some of the larger family companies, which have many family members as shareholders. The main right of shareholders is to have the management (when it is not comprised of family members or of some shareholders themselves) communicate information that is understandable and accessible and encourage shareholders to participate in general meetings.

Companies should realize that they have legal obligations towards all corporate participants—managers, employees, directors, shareholders, external consultants, and so on. In Lebanon and other countries in the Arab world, many people are employed on a contract with a fixed duration. It is not unusual to see employers terminating these contracts for no obvious reasons prior to their end date with no compensation. In this case, the firm is failing on its CG.

The board should have de facto a range of skills and capabilities to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. This means that there must be a balance between non-executive and executive directors and that the CEO (or general manager, as he is often called) and the Chairman should not be the same person, particularly in banks. Furthermore, the board should have a clue as to how the business of the company should be run. Too often they involve family members who barely challenge their senior managers, either because the same senior managers are other family members, or because they have been politically appointed.

Organizations must develop a code of conduct for their directors, executives and employees. Rare are those companies that make their staff sign a document on a code of conduct at the time of recruitment. When these documents exist, they are generally not read and after a while are not respected. In other words, there is no proper CG that dictates staff, at senior and junior level, behave professionally and efficiently—a tall order for some private sector firms and virtually impossible for the dinosaur-like public sector, especially in countries like Lebanon.

Disclosure and transparency are desperately needed

Last but not least is the hot subject of disclosure and transparency. In principle, all organizations should clarify and make publicly known the roles and responsibilities of the board and the management to provide shareholders with a level of accountability. Independent procedures to verify and safeguard the integrity of the company’s financial reporting should also be implemented. The disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors and the public (in some cases) have access to clear, factual information. In Lebanon, disclosure and transparency is virtually non-existent in the corporate sector, with the exception of the few listed companies on the Beirut Stock Exchange. The banking sector is the most transparent, although the level of accountability of the board and the management is relatively low. Some senior managers are employed for life, no matter how many mistakes they make, and have a tendency to cloud their activities to such an extent that it is very difficult to hire experienced newcomers. This behavior has contributed and still contributes to the departure of young professionals to greener pastures, and prevents the return of many experienced and highly skilled Lebanese.

Other issues of CG include the oversight of the preparation of a company’s financial statements, internal controls and the independence of the company’s auditors, a review of compensation arrangements for the CEO and other senior executives and the procedure through which individuals are nominated for board positions. Then there is the issue of what resources are available to directors in carrying out their duties (a problem transformed into art form in Lebanon), oversight and management of risk (non-existent except in some banks that are trying to adopt Basel II) and dividend policy (a case of the sky’s the limit if shareholders and senior management are the same persons and to hell with organic growth).

So what are the benefits? Good CG contributes to sustainable economic development by enhancing the performance of companies and increasing their access to outside capital. Improved governance structures and processes help ensure quality decision-making, encourage effective succession planning for senior management and enhance the long-term prosperity of any company and its sources of funding. Well-governed companies also receive higher market valuations, particularly in emerging markets such as Lebanon, where companies are assessed principally by the experience and quality of their management, board and core shareholders. Improving corporate governance should improve capital flows to companies in countries such as Lebanon from domestic and global capital, equity and debt, and from public securities markets and private capital sources. A company that is seeking to expand internationally or regionally cannot achieve sustainable, recurrent earnings, assets and capital growth without the trust of the markets, be they international, regional or local. Only good and consistent governance can help build such trust.

The key is to try to gradually change the behavior of corporate fat cats over time. For the moment, shareholders and senior directors are gauging each other to see who is going to go the CG route first. What most concerned people in Lebanon still do not understand is that good governance implies corporate performance. With proper CG, companies and banks can enter the globalization process with comfort and confidence, can become more competitive, can attract investors, and above all boost productivity, as staff become more motivated.

What, then, must be done?

Most urgent in the region is the need to separate the roles of chairman, general manager (or CEO) and the board of directors. This holds true in banks and corporations and is not going to be achieved in the near future, as long as ownership is not institutionalized. Another task is to set up supervision, reporting and management information systems, and with more stringent internal audit and compliance controls and functions. While this has been carried out, more or less, within the larger segment of the banking sector, it remains a weak spot for most other companies. A third objective is to increase awareness among shareholders and senior management that human capital is key for the long-term financial and qualitative performance of an organization. Training is an absolute necessity, and while little is being spent by companies on training and professional courses, the regulators must make an effort to push for these aspects to be reinforced.

It is also vital is for board members to meet on a regular basis and to participate in setting up business plans and strategies for their organization. Involving as many competent managers as possible is also more important, as many board members are usually members of the same family and make their decisions alone. There is little dilution of decision-making in the region; and despite efforts by some banks to tackle this issue, the problem is still far from being sorted.

While recruitment strategies have to be changed, and staff (at all levels) must be chosen according to ability and what they can bring to the board and the company, creativity and innovation are also aspects that can clearly benefit from good CG. Regional firms in Lebanon must create an atmosphere that is conducive to creativity and innovation, by setting up reward schemes and proper staff quality assessment systems. In the latter’s absence, motivation can hardly be developed and the willingness to perform will dwindle over time. The absence of a long-term vision in most family and single-individual owned companies—and the existing lack of decision-dilution and sharing—can kill off creativity among all staff. And people wonder why there is a youth and brain drain, even in times of relative economic and political stability!