Interview: Professor Mervyn King – Corporate Governance Guru
Private arbitration by sitting judges: “I think that there is a conflict of interest there”
IRS: “As long as it is done in a controlled manner, which I understand is indeed the case, I think it’s alright”
Professor Mervyn King is perhaps as illustrious a person in the field of Corporate Governance as his namesake at the Bank of England is for his authoritative Governorship of the Central Bank of England. Coming from a legal and judicial background, Prof King has earned a global reputation as an eminent Guru of Corporate Governance. His track record covers as extensive an area as occupying high academic positions in the best known universities of South Africa to advising the World Bank on governance, let alone his incursions in social work.
He has been closely associated with Mauritius ever since we introduced corporate governance as a worthwhile objective to pursue in the early 2000s. His background in consulting with various governments and close contact with businesses make him highly pragmatic when dealing with matters of concern to corporations. It is this pragmatism and lucidity that we see reflected in the interview he has accorded to Mauritius Times (at the close of a workshop organised by the Mauritius Institute of Directors, this week) in what follows…
Mauritius Times: It is said that good corporate governance makes good business sense. Now another dimension has been added to it: integrated reporting, that is reporting on governance, long-term strategy and sustainability. What’s the evidence that this is indeed the case? That both make the case for good business sense?
Professor Mervyn E. King: For more than a hundred years we have had corporate reporting which is focussed on financial reporting, which by definition is historical, it relates to something that has happened already — so you are thus looking at a rear-view mirror at information as if there were no road ahead. Of course, there is a road ahead for every company.
Moreover every company does not operate only in a financial context, it operates in the triple context of the society in which it carries out its business (because it is part of society and it is not apart from society); it also impacts on the environment (because it is using natural assets such as water, air, wood, oil, etc., on a daily basis so that the natural assets of planet earth are very important); the third relates to the financial context.
This means that you have to report on how the business model of your company, its operations are impacting on these three; otherwise, the trustee of your pension fund, for example, investing your money in the equity of a company, say a beverage manufacturer, will not be able to make an informed assessment as to whether this business is going to sustain itself on a long-term basis. That’s because the financial statements of the company contain historical information; now we know that for a beverage manufacturer water is a critical factor, and water is the scarcest commodity on earth. This should be made clear in the beverage manufacturer’s report that he is going to conserve water, recycle it and re-use it. The conclusion that could otherwise be drawn is that this business is not going to be sustainable and might go out of business within the next couple of years.
So you need to provide information in a clear and understandable language. Financial reports have become very complicated because financial reporting standards have become more complicated. And you, who are the provider of capital to companies these days, would not understand reading a financial report. Remember that the greatest shareholders today is becoming the pension fund institutions that are investing your money. The interesting thing is the man walking in the streets in Port Louis is the consumer and the capitalist.
* But what’s the evidence that integrated reporting makes good business sense and enhances wealth creation?
Absolutely. There are two things always happening inside every company. First, it’s how you make your decisions – that’s what governance is about because it sets out guidelines as to how you direct the company and manage it. Second, you make a business judgement call to change the way you are doing business. You are not going to make the right business judgement calls ten out of ten; you are going to make mistakes from time to time because you are dealing with uncertain future events. You actually learn from it and but when you get that wrong and you practise poor governance, that’s when you get corporate failure. But if you practise good governance and make a wrong business judgement call, society will still say you are nice directors, who have applied their minds honestly, and it will continue to support your company. But if you are dishonest or practise corporate governance and make the wrong judgement call, that’s when you get failures. In that sense good corporate governance is essentially about good business.
* Would good corporate governance be also part of the explanation behind the economic success of most of the Nordic countries and Singapore as well as of those that are coming up like Indonesia, Vietnam, etc?
It does not follow now because it is an amalgam of good governance, which is about quality not quantity, and intellectual honesty, that is the honest application of your mind as a director to make a business judgement decision in the best interests of the company — that is good governance. Singapore has applied both: it has been making good judgement decisions and it has also been practising good governance. Some companies have not done either and they have gone out of business.
* The rules of good corporate governance have been in place in the West and different other parts of the world since nearly two decades now. This has not prevented some the world’s most systemically important banks from failing in droves in the financial sector crash of 2007. Who could have been paying lip service to those rules?
Good governance is a process, it relates to guidelines as to how to make decisions and how to manage the operations of the company. That is what they are; you cannot legislate for honesty and you cannot give guidelines for honesty. If I were the President of Mauritius and were to pass an Act of Parliament that everybody should henceforth act honestly, will everybody act honestly? The answer is no. Will I be able to enforce that law? The answer is no. Governance does not mean that it causes systematic failure; it means that you have not applied your mind honestly in the best interests of the company or the entity. You have not applied good governance decisions and/or you made wrong business judgement calls.
* Do companies have to be incentivised for them to act honestly?
Companies are inanimate objects, and the directors are human beings who suffer from frailty. None of us is perfect, so you have got to manage it. As a director you, who are the heart, mind and soul of the company, have got to be conscious of these things when you are acting in that capacity for the best interests of this incapacitated person that is the company.
* Good governance practices do not imply absence of government or less government as canvassed by promoters of neo liberalism, isn’t it? You need to have a strong government to act as regulator and arbiter to ensure that the rules are abided by?
Of course, there is always the case for the government to act as an arbiter… You cannot carry out business in the absence of a legal framework anyway; otherwise, you cannot operate. As for less government, I think that’s calling for less legislation. I believe that America’s idea of passing the Sarbanes-Oxley Act (that set new or enhanced standards for all U.S. public company boards, management and public accounting firms – it is in essence a piece of legislation that directs directors or executives or even auditors as to how to do things in their respective capacities) helps in making honest directors in the sense of intellectual honesty.
* What is it that helps then?
The honest application of mind and appreciation that you are acting for an incapacitated person. If you are asked to take care of a young person who has been injured in a car accident and will remain incapacitated for the rest of his life, would you contemplate stealing from that person or act in a manner that would not be in the best interests of that person? The obvious answer is no. You’ll put in good care, good faith, skill and diligence, won’t you? Same thing for a company, which after all is an incapacitated person.
* OK. But we have seen this very week that a young trader of the reputed Swiss bank, UBS, was found guilty in Britain of having fraudulently exceeded his permitted limits, with the bank incurring a loss of $2.3 billion in unhedged trades. He risks facing seven years in jail. But what about those at the top whose job it should have been to implement the necessary controls to prevent such liberties being taken by someone at the junior level?
That is a question of fact… Were they carrying out their job of oversight over him or not? Were there functions in place to have oversight over whatever he was doing? I do not know the facts. If they never had, then maybe they were failing in their duty of care to the company…
* Isn’t it that this kind of failure in the duty of care to their respective companies by senior managers and the relaxation of financial sector regulation rules under pressure from Wall Street that could explain the financial crash of 2007?
I do not agree. In my view, the financial crisis of 2007 started with President Clinton when he said to the banks that American citizens are entitled to own homes: “you can’t redline a district”. So, he applied political pressure on the banks to advance money to those areas. That’s how it all started.
* What explains that, years after 2007, governments are still deciding about reinforcing banking regulation when it should have been a priority on their agenda?
The question is: do you go for more legislation in the face of a problem? Or is the answer to that problem a rethink of whether you are doing things properly or not?
Legislation is not always the answer. You know the old Roman saying: ‘Which God guards the guardians?”… So, if legislation is not the answer to all this, then it’s obviously the honest application of mind, and if you have a dishonest application of mind, you will never be able to overcome the problem facing you…
* An honest application of the mind has proved to be a tall order for many, and it’s going to be so in future, isn’t it?
Of course it’s going to be a tall order, because none of us is perfect. But if you are going to accept the job of a director, you’ll have to honestly apply your mind in the same manner as looking after an 18-year-old man incapacitated for life as a result of a car accident. Wouldn’t you be ashamed if your friends were to know that you are fetching some benefit for yourself and that you are not honestly applying your mind for that young person? Same thing for a director… it’s even worse because when you are a director of a company like Enron that goes on to collapse, that impacts on the lives of 70 million of people. The collapse of Lehman Brothers impacted on the lives of two billion people.
* After so many years of advocating corporate governance the world over, can it be said that irreversible progress has been made in this field and that the law of the jungle will not come back with force from time to time, depending on who is in power?
Absolutely, it is a huge progress because it has led to the fact and the acceptance by the Who’s Who of corporate reporting that corporate reporting as we have known it for a hundred years, is no longer fit for purpose. We have to start reporting on how companies impact on society and the environment as well.
* The onus of good governance should fall on the government as the leader of society. If it does not show itself to be bound by its own rules, what authority can it use to make corporations and individuals abide by the rules of good governance?
What you are saying is that governments must legislate about governance for companies. Good governance culture is not about rules, it is about guidelines; you either apply them or you explain why you are not doing it. If you don’t apply them and you give explanations which are not acceptable to the stakeholders, they are going to reject your company. Your stakeholders are your ultimate compliance officers.
* We have in Mauritius a Committee of Corporate Governance since 2004. Have you formed an opinion on what it has been able to achieve so far?
I was the adviser to the National Committee on Corporate Governance, so I know your governance code well. I have discussed this matter with your Prime Minister, and he has accepted that the Code needs updating. Every governance code falls behind because governance is an evolutionary process; it alters as the world changes. At the moment the norm is in favour of integrated reporting, which you do not have in your Code, so you need to bring your Code up to date.
* How do you react to the issue of private arbitration by sitting judges? That a State should allow this to take place does not speak well about its understanding of good governance, isn’t it?
I would not like to comment on whether your State is acting properly or not, but I think that there is a conflict of interest in a situation where a sitting judge, who is being paid a salary by the government, is getting paid as an arbitrator in a corporate dispute.
* At your talk at the University of Mauritius, you mentioned that Mauritius should seize the opportunity to show the world that it is a good example of leadership, sustainability and corporate citizenship in managing its open spaces, especially for the sustainability of its tourism sector. But with the adoption of our IRS strategy that is converting these open paces into concrete jungles are we not going off-track?
I said that Mauritius has a lot of open space and that it has an opportunity to correct that which it has done wrong by creating polluted areas in your island. You still have an opportunity to make Mauritius a beautiful, eco-friendly island which will attract a lot of foreign investment and tourism… If the ‘Maurice Ile Durable’ programme is implemented, you stand a chance of rehabilitating those areas that have been polluted.
* What about this question of selling land to foreigners, the IRS scheme?
As long as it is done in a controlled manner, which I understand is indeed the case, I think it’s alright…
* Published in print edition on 30 November 2012