It is often believed that the only way to get good behaviour from citizens, corporates and individuals, is to pass a law.

No amount of preaching by Securities and Exchange Commission of Pakistan (SECP) or professional bodies like ICAP (Institute of Chartered Accountants of Pakistan ) get any response from companies — yet a mere possibility of a fine does deliver.

Only the force of law make companies take steps to improve the contents of their annual reports. Only after the issuance of Code of Corporate Governance (CCG), did companies start having audit committees - although they are still far from granting true independence to these committees. The best way to prompt controlling shareholders to act more responsibly is to legislate.

The first step would be to revise the present the Code of Corporate Governance and its compliance should be mandatory and not voluntary. CCG should have specific guidelines on the constitution of boards. It is proposed that:

*The number of executive directors should not be more than one third of total number of board members. This means at least two-thirds of the board directors should be non-executive directors (NEDs). And no less than half of the NEDs should be independent non-executive directors INEDs).

* This means on average, no more than one-third of the directors would be EDs, no more than one-third would be (representative non-executive director ) RNEDs and no less than one-third INEDs. This should bring some balance of representation and power on the board.

* Specific criteria (qualification, experience, background, etc.) should be laid down for all directors, but in particular for INEDs. Similarly, roles of each class of directors (EDs, RNEDs and INEDs) be defined more elaborately.

Specific recommendations should be made for remunerating INEDs suitably, for example:

* Average remuneration for INEDs should be around 33 per cent of the average remuneration of executive directors.

* If INEDs perform any additional task like chairman/membership of special committees (e.g. audit committee, remuneration committee, nomination committee, CG Compliance committee, etc.) they should be suitably compensated.

* In addition, INEDs should be accorded some protection by the law. The current practice of treating all directors alike is unfair and devoid of natural justice.

* The possibility of allowing companies to have two-tier boards should be seriously explored. The first tier, to be called management board, may comprise entirely of executive directors plus one or two representative directors from the controlling shareholder while the second tier to be called say, supervisory board should have only NEDs, perhaps with the exception of CEO. Rules may be framed allowing:

* the shareholders to vote in the entire management board, and;

* the stakeholders (including shareholders, lenders, employees and civil society) to vote for election of directors on the supervisory board. Defining the electoral college for civil society may be difficult, but a solution can be found if there is sufficient will.

* the chairman who must be non-executive and elected by shareholders, to be common on both the boards.

While the Institute of Corporate Governance, established through assistance from IFC, is yet to produce any tangible results, another proposal could speed up the pace of improvement in the state of corporate governance.

This proposal is based on the observation that only the presence of truly independent non-executive directors supported by long-term investing companies can bring about a meaningful difference to the present sorry state of corporate governance. The proposal has two distinct steps: First step. The government should make it mandatory for all financial institutions and mutual funds having investment funds in excess of say one billion rupees to invest no less than 20 per cent of their total available funds on a long- term basis. The test should be that at any time, at least 20 per cent of their portfolio should represent holding in companies for an average of not less than three years. An incentive can also be offered to mutual funds and investment companies for holding shares for a period over three years, e.g. any dividends received from shares held by a mutual fund or investment company for over three years may be exempted from corporation tax.

This will promote institutional investors’ interest in listed companies. With presence of knowledgeable representatives from institutional investors, company boards will start acting more responsibly. Second step. NIT could play a far more active role in improving the corporate governance state of listed companies than it is currently doing. But perhaps, this is outside its present scope of responsibilities. It is proposed that the government should float a new investment company (or a mutual fund). Its equity can come from companies like NBP, NIC and State Life that are sitting on mountains of investable funds. The new investment company (IC) should have the following explicit mandate:

* It should invest primarily in listed companies on long-term basis. It must hold shares in companies for considerable duration, long enough to exert a meaningful influence on the boards of such companies.

* It should hold sufficient number of shares in companies to earn a right to get at least two directors elected on the boards of such companies. Like the NIT, the new investment company (IC) could be granted a right to purchase 10 to 15 per cent of all new issues of shares.

* It should employ a team of well -qualified, competent, experienced and honest professionals who would draw a decent salary from the IC but have no responsibility except to act as INEDs at the boards of companies in which the IC has a holding. In order to ensure proper performance from these INEDs, none of them may be made a director of more than six companies.

* The directors placed by the IC should be categorically informed that they are expected to act as independent, non-executive directors (INEDs) looking after the interests of all stakeholders, rather than representative directors protecting the interest of the IC alone. They should attend every meeting of their respective boards, take an active part in its deliberations, scrutinise every proposal put forward by the executive directors, take external professional help where needed, and to generally ensure that the controlling shareholder does not get away with any improper act.

In addition, they may act as members (or chairmen) of the various committees constituted by their respective boards. They should write periodic reports on the performance of their “ward companies” which the IC may share with the company where necessary.

* The IC can join hands with rating companies and start a system of formal rating of “boards of directors” of its investee companies. This could be confidential but its mere presence will infuse considerable responsibility into boards.

* It is hoped that presence of these INEDs on the boards of various companies will bring about a balance of representation and power on those boards. The IC could do even more. While nominating these directors on the board of various companies, the IC should also pay attention to getting a balance of attitudes and talents on those boards. This means the IC must carefully study how the board of each of its investee companies is constituted, so that it may nominate that particular talent or attitude that is missing from a particular board.

What is really important is not how much money is poured into the secondary markets (trading of already issued shares at KSE) — but how much money companies are able to get from general public for their new projects. The above proposals will go a long way in restoring the confidence of investing public in listed companies so that the bulk of public money will go to the companies — not speculators at stock exchanges.

The writer is Dean of Faculty of Management Sciences at Mohammad Ali Jinnah University, Islamabad