The changing corporate governance landscape

The expression “change is the only constant” rings true when applied to the ever shifting landscape of corporate governance today. Looking back over the past few years, vast progress in and changes have been made to corporate governance in South Africa – from the development of the King Code on Corporate Practices and Conduct (King I) in 1994, to the legislation of the Public Finance Management Act in 1999 and the Corporate Laws Amendment Act at the end of 2007 to the pending King III Report and Companies Bill expected to be gazetted this year.

In response to this changing landscape, companies have moved from a voluntary application of corporate governance principles on a ‘comply or explain’ basis, to a hybrid system where some previously voluntary corporate governance principles are now required by law or industry regulations.

New developments
Of the more current corporate governance changes, the Companies Act as amended by the Corporate Laws Amendment Act (CLAA), and the changes to the JSE Listing Requirements, are perhaps the most pressing.

The CLAA has legislated a requirement for widely-held companies to have an audit committee comprised of at least two directors, with all members being independent non-executive directors. The CLAA also stipulates various tasks for which the audit committee of a widely-held company is responsible. Although many of these tasks cover those recommended in King II, for example, the nomination of independent registered auditors and approval of audit fees and terms of engagement, the CLAA introduces new responsibilities for audit committees of widely-held companies. Chief amongst these are:

· The need for the audit committee to pre-approve any non-audit services performed by the independent registered auditor
· The need to and receive and deal appropriately with complaints relating to accounting practices, internal audit, content or auditing of the company’s financial statements or to any other related matters.

The recent amendment to the JSE Listing Requirements, which came into effect on 1 September 2008, requires all listed companies to have a financial director. Furthermore, the amendment requires audit committees of listed companies to confirm and report to the JSE their satisfaction as to the appropriateness of the expertise and experience of the financial director. Please note: Existing listed companies have until 30 June 2009 to appoint a financial director if they have not done so.

The introduction of these requirements has meant that audit committees of widely held companies have had to re-examine their composition, make the necessary changes to their terms of reference and ensure that these new responsibilities are adequately handled.

The current draft of the Companies Bill, expected to be gazetted this year and likely to be effective from 2010, has also legislated various corporate governance requirements, ranging from the composition and duties of audit committees, to the appointment and dismissal of directors, to the conduct of directors. The current draft of the Companies Bill also codifies the responsibility of directors to act with good faith, care, skill and due diligence.

King III to close the gap
The prevailing Code of Corporate Governance in South Africa, King II, is voluntary and is applied by companies on a ‘comply or explain’ basis. However, the King II Report is in the process of being revised under the chairmanship of Mervyn King, with a draft of King III anticipated to be released in January 2009. This revision is being driven as a response to the changes in legislation, some of which are mentioned above, the introduction of the Broad-based Black Economic Empowerment Codes of Good Practice, the Prevention and Combating of Corrupt Activities Act, the Auditing Profession Act and continued instances of corporate failures and fraud. Global developments in governance and legislation which have left South Africa behind in what is considered leading practice, is also driving this revision.

King III is expected to be more detailed and comprehensive than King II and will contain certain sections of the CLAA and new Companies Bill. This is logical, because, as noted, the CLAA and new Companies Bill legislate various corporate governance principles. The revision will also, however, take international best practice into account.

Various subcommittees have been formed to investigate potential improvements and additions to the existing King II report. A key focus will be the accountability and responsibility of boards of directors and their resultant personal and collective liability to the company and its shareholders. One of the other main areas of increased emphasis is sustainable development. According to Lindy Engelbrecht, CEO of the Institute of Directors and editor of King III, “The main principle of King III is that you cannot separate strategy, sustainability and governance. We’re also bringing in the concept of good corporate citizenship – where it is becoming less important how companies have spent their money, and more important as to how companies actually make their money.”

Business rescue and alternative dispute resolution are two new topics that will be addressed in King III. According to Engelbrecht, “Business rescue is being brought in specifically in reaction to what is in the Companies Bill. The whole process of business rescue and judicial management in South Africa is going to change. This particular chapter in King III will deal with the new legislation, and then how companies need to react to the legislation, what the board of directors’ responsibilities are, and how they need to incorporate that into their risk management processes.”

The change in South Africa (and in many parts of the world) from a voluntary system of corporate governance to either a legislated or hybrid system of corporate governance, has attracted both support and criticism.

Voluntary vs legislated systems of corporate governance
Detractors of legislating corporate governance principles maintain that legislation may have good intentions for improving corporate governance but can result in unnecessary and burdensome costs, especially for smaller companies. This expenditure includes the costs of implementing the legislation, monitoring and assessing compliance therewith and the process of reporting on compliance.

Voluntary codes of corporate governance provide greater flexibility. Corporate governance cannot be a ‘one size fits all’ approach; different companies operating under different circumstances require different corporate governance structures and processes. Just because a company does not comply with a corporate governance principle does not necessarily mean it is not a well governed company. Forcing a company to comply with principles that have been legislated may actually result in more harm than good, as the company is forced to adopt structures and processes that are not meaningful to its circumstances.

Supporters of voluntary codes of corporate governance are also of the opinion that companies are predisposed to complying with voluntary codes where these voluntary codes are in place. The driving force behind this predisposition is said to be the value that investors place on good corporate governance. By complying with a voluntary code of corporate governance, a company can boost its reputation and improve its access to capital markets on the back of this investor confidence.

Those who do not support voluntary systems of corporate governance state that the difficulty with voluntary systems is just that: they are voluntary – companies can merely choose principles they want to comply with and explain away those to which they do not wish to adhere to.

Supporters of legislated and/or hybrid regimes maintain that if there are minimum standards of corporate governance to which companies have to comply, it will build confidence in capital markets and protect investors.

Conclusion
It is clear that South Africa has moved and will continue to move towards a hybrid system of corporate governance and that boards and directors will be obliged to comply with certain corporate governance principles, whether they want to or not.

What is also clear is that issues such as broad-based transformation, alternative dispute resolution, business rescue and sustainable development are going to move to the forefront of the corporate governance agenda in the near future.

These changes in the corporate governance landscape present a challenge to boards and directors to remain focused and aware of the implications of these changes on the companies they lead. Boards and directors will have to institute strategies and plans for their companies to adapt to this changing landscape in order to ensure the continued sustainability of the business.

Failure to do so may result in penalties and/or a loss of investor and consumer confidence in the company. As Charles Darwin said, “It is neither the strongest species that survives, nor the most intelligent, it is the one that is most adaptable to change.”