THREE great ideas came together to invent modern corporation. The idea of an artificial person for aggregation of capital; the idea of limited liability of subscribers to this capital (the shareholders), and the idea of the transferability of subscriptions (shares).
A corporation is therefore, first and foremost, a mechanism for solving problems encountered in raising large pools of capital. And it was invented to meet the requirements of industrial revolution, since high volume, mass production of goods, now made possible, could not be realized by the medieval style mom-and-pop shops, single family businesses, or partnerships. These are sub-optimal enterprises and ill-equipped to seize the opportunities opened up by industrial revolution.
They are even less so in meeting the challenges of globalized economy. As the national boundaries have eroded and the size of the markets has grown to global dimensions, the capital requirements to sustain economies of scale and the range and sophistication of skills needed to produce competitively for open global markets have also increased. On top of these, the old luxuries of protected national markets are evaporating as is the leverage of national governments to erect high barriers against entry of others players into the domestic market.
This is the environment that Pakistan’s corporate sector is facing. It can not afford to avoid or procrastinate on its growth. If it does not grow, it would not stay competitive for long. But it can not rely for growth on the old model of slow and protected growth. Since the distinction between the domestic and foreign markets has seized to have any significant meaning in this environment, their success in foreign markets would largely depend upon their success in holding their share in domestic market.
This then defines the challenge for corporate governance. If the markets are open as they now are; if your competitors are growing as they certainly are; if the differences between the domestic and foreign markets are eroding as they obviously are; then if your enterprise is not growing, you risk loosing your domestic market share before you hope to win any foreign markets.
And if there is no quick turnaround in its production efficiencies, the enterprise would see its cost of capital rising and its market share declining. If this persists for sometime, the enterprise may be staring at the wrong end of the market and be on the list of endangered species.
Irrespective of the corporate philosophy followed- maximizing the shareholder value; the stakeholder value; the enterprise value; or value to the society as a whole, the fundamental fact remains that corporate governance is an economic function and a value maximizing activity. Its first responsibility lies in understanding the challenges of the environment in which the enterprise as well as the industry are operating and in efficient management of its resources- capital and human- to successfully meet these challenges.
Although it is conventionally seen as managing the ‘agency problem’, corporate governance can not be reduced to merely an instrument of control. Nor can it be reduced to merely being a corporate finance function and gearing up of earnings on the stock market. And it is also more than just a legal framework of rules to regulate relationships among various players.
The business environment comprises of a variety of elements. Corporate governance can perform its functions well only when it can successfully handle these elements- both internal and external capable of influencing the range of variables in that environment.
Of course, a competent management and oversight and monitoring by a good and knowledgeable board of directors is the fundamental and critically important step towards governance of a corporation. And independent directors are meant to inject new ideas, skills and approaches into the fabric of governance.
So also are the committees for monitoring the critical functions of audit, compensation and executive search headed by independent directors. But all over the world, there are recognized limitations to what these internal instruments of governance could achieve.
The Board of Directors of a corporation is a team-management function. And independent directors could not be turned into opponent directors, nor the board rooms be turned into war rooms. That would make the whole exercise just as counterproductive as filling up the slots on the Board with near, dear or beholden ones.
Similarly, high hopes associated with institutional investors for trail blazing qualities in improving corporate governance are over pitched and unrealistic; going by the worldwide experience of involvement of institutional investors in corporate governance. To put it briefly, the ‘glass house’ characteristics of institutional investors put severe limitations upon the efficacy of one agent monitoring the performance of another agent.
That is why these instruments of governance have to be supplemented by external instruments to achieve value maximizing corporate performance. In Pakistan, some of the important external instruments like well developed and credible capital markets, a sophisticated and efficient system of corporate and securities laws as well as independent financial press are still not developed enough to make effective contributions to corporate performance.
For a number of reasons, however, the corporate sector here has largely relied upon bank credits rather than equity markets to finance growth, despite the built-in handicaps of the former against entrepreneurial drive and achievement of strategic objectives. It was understandable in the early years of industrialization in the country during 1960s, when the capital market was in its infancy. Its continuance as a dominant model of growth even after decades of development has not helped much- either in enhancing the competitiveness of corporate sector or industrialization of the country.
The graveyard of over 4000 ‘sick industries’ strewn across the country is evidence of the weaknesses of a model of corporate growth with narrow equity base and the risk being passed on to the nationalized banking. Since 1980, when the first bank loan was completely written off in the favour of a ‘sick industrial unit’, this practice, according to various reports, has eaten away over Rs250 billions of depositors’ money given as bank loans and written off, during these 25 years.
Normally, market forces are supposed to work out appropriate solutions to bad management or poor governance practices and if additional resources are needed to be pumped, these are required to be repaid when better times come or the management tides over the lean period.
Therefore, Pakistan’s own history of corporatization/ industrialization also throws up some very important lessons. A narrow equity base even when it succeeded in industrialization as it did during 1960s invited criticism and jealousies which led to radical changes in the structure and governance of corporations. Equally important, when a similar corporate structure failed as it did during the 1980s and 1990s with ‘sick industrial units’ all over the country, it invited even more criticism.
It should also be appreciated that by widening the equity base of the corporations, not only is the corporation meeting its very raison d’etre, it would also enable it to incorporate the badly needed comparative advantages of many other corporate players. Absent these two qualities, the corporate structure would find the going very tough indeed. It would not be able to create the critical mass necessary to acquire the ever expanding economies of scale necessary for meeting the global challenges. From public policy perspective, such a model of corporate growth would also help in strengthening corporate sector within the political economy and bring it rich strategic dividends.
Such a vision of the corporate sector is also important for the success of industrial revolution in Pakistan. In the globalized economy, the larger the market, the greater the range and sophistication of skills needed to succeed. Just as the medieval business model could not compete against the forces of industrial revolution, the old industrial model of protected growth within national boundaries has very little chance of succeeding in the globalized economy.
Corporate governance and corporate performance have a long way to travel in Pakistan. This would be helped by a corporate structure that turns corporation into an efficient instrument of high volume production and growth. And the full range of the objectives of corporate governance can only be achieved by developing both instruments of corporate governance - internal as well as external- and by a system of relationships for them to work in tandem with each other.
The requirements for what it takes to succeed in the globalized economy, as indicated earlier, have grown higher and become more urgent. The government must facilitate, in the growth of efficient structures of governance to help our corporations successfully face the challenges of globalized economy.
But ultimately, our corporate sector would have to do the real job itself, for they would also be its most beneficiaries.
THREE great ideas came together to invent modern corporation. The idea of an artificial person for aggregation of capital; the idea of limited liability of subscribers to this capital (the shareholders), and the idea of the transferability of subscriptions (shares).
