Making Good Governance Good Business in the GulfPublished April 06, 2010 in Arabic Knowledge@Wharton
Mutlaq al-Morished reckons that Saudi Basic Industries Corporation (Sabic) -- the company where he has been the chief financial officer for the past six years -- is the exception rather than the rule. The $80 billion (market cap) conglomerate has forged ahead with top corporate governance practices far faster and thoroughly than other companies in the region, he says. Notably, all Sabic subsidiaries have audit and remuneration committees and independent directors, and it has separate CEO and board chairman posts. Sabic -- with businesses ranging from chemicals to fertilizers to steel -- not only has physical assets in the U.S., Europe and Asia, but also works with Shell, Exxon Mobil and a number of other multinationals, which expect their global partners to uphold high governance standards, he adds.
Al-Morished has a point. When held up against its local counterparts, Sabic is unusual: Not many companies in the Gulf region have pushed corporate governance to the heights that it has. According to a study of 200 publicly listed companies in the GCC by the non-profit GCC Board Directors Institute (BDI) in 2009, disclosure and transparency levels of most of the companies was low compared to standards observed in Europe, North America or Asia. For example, only 27% of the companies in the study disclose the number of board meetings they hold every year, compared with 100% of European and U.S. companies that participated in a similar study. "Let's be honest with ourselves," says al-Morished. "Corporate governance is quite recent to this part of the world."
Having been in business for more than 30 years, Sabic is now the Middle East's largest non-oil industrial company, and one that is being watched closely as companies throughout the region -- whether family or state owned, public or private -- attempt to raise their governance standards. According to Saleh Hussain, a consultant and deputy chairman of the Bahrain Association of Banks, that has been particularly true now that they have had "a very much-needed wake-up call," starting in 2008 with Saudi conglomerate AH Algosaibi & Brothers defaulting on around $1 billion of loan repayments and culminating with the implosion of Dubai World and its troubled real estate subsidiary Nakheel last year. Many blame woefully weak corporate governance at companies like those for the region's recent economic problems. As a result, there is a growing consensus in many Gulf business circles today that the pursuit of higher corporate governance standards -- including increased disclosure about decision-making and financial track records, more effective oversight and internal controls, and less reliance on personal relationships -- is a necessity.
But time isn't on the region's side. GCC BDI forecasts that the Gulf will have 1,000 public companies by 2015 from around 725 today, which will increase the external pressure to change. "A lot of [foreign] investors are coming to the stock markets in the Gulf and they expect the same standards of corporate governance, board composition, board behavior [and so on], as they do back home," says al-Morished. Upholding high governance standards at the next wave of listed companies will soon raise a number of practical issues, including how to find hundreds more business executives who have deep enough expertise to sit on boards and their specialist committees. As al-Morished notes: "Access to this kind of capable and skilled director, who is not already over-committed, is going to be a real challenge."
Al-Morished says companies like Sabic, which is 70% state owned, have a leadership role to play in inculcating best practices in governance. Others agree. "The absence of the right governance model at the government level deprives the private sector of a role model," says Hussain.
Meanwhile, hope exists in some circles that new regulations can help fill in the gaps. In the UAE, a new corporate governance law for publicly listed companies is due to come into force in April. The code will apply to public joint stock companies established in the UAE and companies listed on the Abu Dhabi Securities Exchange and Dubai Financial Market.
But some publicly owned companies haven't been waiting for the state-owned companies or the regulators to lead the way. Savola Group -- a Jeddah-based food multinational with 18 billion Saudi Arabic Riyals (US$4.8 billion) annual revenue from businesses ranging from edible oils to real estate -- started taking steps to improve its transparency back in the 1990s. That included disclosing pay packages of both the managing director and chairman in its annual reports, recalls Muhammad Ikhwan, a former vice president of mergers and acquisitions and now a senior adviser at the group. "This was unheard of at the time…. It's now become a requirement for publicly listed companies but we introduced it early on."
Since then, the Saudi-listed company -- in which the state has a 15% stake -- has been introducing other measures to improve transparency and push a new code of ethics to the fore of its day-to-day business. In 2003 and 2004, for example, senior executives and board members signed a governance charter, formally spelling out "classic issues, such as the protection of company information, policies on accepting gifts [and] the employment of relatives," says Ikhwan. Not satisfied to confine these policies to just the boardroom, however, they have been applied to further down in the company, included the marketing, sales and accounting functions.
That's no small task. Savola -- like Sabic and numerous other Gulf companies -- is a complex network of subsidiaries. As the company began growing rapidly in the 1990s, "we recognized that we had to have proper accounting and disclosure policies," he says. "This was the reality." It currently employs 12,500 people in the Gulf, North Africa and central Asia, and "we have at least 17 boards, seven or more committees, and four autonomous divisions," says Ikhwan. "We also have a regional presence in North Africa and central Asia, with different minority shareholders in Savola companies that engage in intercompany transactions.
Its ambitious aim is to continuously push for greater transparency. That's why Savola's financial reports disclose the overall performance of their individual companies, as well as that of subsidiaries, even though the law does not require them to do so. "It is not enough for plastics to say, for example, that it has improved profitability by 20%," he says. They have to tell the public which of the three plastics subsidiaries contributed to this, which is over-performing and which is under-performing and why, so we can see each performance clearly. If sales have gone down in one, here are the reasons. This gives investors more visibility into what constitutes Savola, the company," says Ikhwan. "Each business unit is now out in the open."
To skeptics in the region who say that such transparency doesn't ultimately benefit the top or bottom line of a company, Ikhwan points out that it's all part of a virtuous circle. For example, "the business heads become keener to improve the performance of each sub-unit because they know it will get a public rendering in the annual report. This has a positive impact on business performance and hence on investor confidence," he says. "As far as our share price is concerned, for the last eight months, we have slightly outperformed the index."
'It Could Happen to Them'
Even with the prospect of such benefits, other GCC companies are nonetheless resisting taking the route Savola has. Governance experts say that's especially the case with traditional family-owned companies, which account for some 90% of the region's trade.
According to Hussain of the Bahrain Association of Banks, "To separate ownership from management is a huge hurdle." Indeed, family owners are firmly entrenched in the running of their companies. In Saudi Arabia, for example, one-third of listed firms have more than two directors from the same family.
Part of the reason for the resistance is that there has been little incentive to change. "The pressure on traditional Gulf family businesses stems from the fact that they were not really encouraged or requested by regulators to do something about their corporate governance structures," he says.
But cases such as Algosaibi & Brothers are helping to change attitudes. "It reinforces the point for others who are not committed to [good governance] that it could happen to them," says Sabic's al-Morished.
Whatever the ownership structure, GCC companies have more external reasons to change. First, there are the banks. "The incidents with the family businesses last year certainly have triggered interest, especially among banks, in improving corporate governance," says Said al-Shaikh, a senior Saudi economist and member of the kingdom's Majlis al-Shura, the consultative council. "They want more clarity on where this borrowed money would be used and in what line of business and they want more disclosure as far as their financial statements."
But what about the regulators? If more GCC companies do go public as GCC BDI's research suggests, some experts hope stock exchange regulators will use their powers to modernize corporate governance in the region. In Saudi Arabia, for example, a new corporate law, which is under review in the Majlis al-Shura, will impose further governance rules on listed companies and joint stock companies, including a requirement to establish audit committees.
"The authorities have seen [the Saudi stock exchange] listings as one important way of improving corporate governance standards in Saudi Arabia by essentially forcing companies to become more transparent," notes Jarmo Kotilaine, chief economist at Saudi Arabian investment bank NCB Capital. One problem, however, is that the Saudi bourse, like other Gulf stock exchanges, is a retail-driven, closed market with investors who tend not to base their investment decisions on research or dispassionate analysis of the market. In this kind of environment, says Kotilaine, it can be difficult to have market-led enforcement of these rules.
Business leaders, meanwhile, are calling for more far-reaching reforms. "I would ask the regulators to make it a requirement for [limited liability companies] of a certain size to publish their audited accounts," says Savola's Ikhwan. "Currently, they only require publicly listed companies to do that. But we have LLCs that are now very sizeable, employing thousands of people. The public has an interest in knowing the performance of these companies, regardless of the ownership."
The way al-Morished sees it: "We need rules and regulations, we need best practice, we need procedures."
Firefighting or Focusing Minds?
Despite the growing interest in reform, the necessity of dealing with the immediate financial crisis is obstructing governance progress, say some experts. "The reality is that we have spent most of the past year and arguably even more in firefighting mode, where people understand that systemic reform is necessary, but on the whole they've been more focused on immediate day-to-day challenges," says Kotilaine.
Others, however, say the global financial crisis is helping focus minds, according to Hawkamah, a UAE-based governance think tank whose latest GCC transparency rankings show an increasing level of disclosure. Its 2009 Behavioral Assessment Score for Investors and Corporations rankings reveal a significant improvement year on year in GCC corporate communication and disclosure. Overall, the average score improved 8.3%, while the corporate communication and disclosure categories improved 7.7% and 12.6%, respectively.
Law firms specializing in corporate governance also note increased interest from companies in changing corporate structures. One UAE-based lawyer notes, "We have seen several private firms warming to the idea that they have to put some compliance issues in place, things like the independence of directors and setting up charters. They are recognizing that they have to comply with these kinds of things if they want to play in the big wide world."
But experts hope that GCC companies are able to resist turning governance compliance into the "box-ticking" exercises so prevalent in other parts of the world. The long-term challenge is to infuse corporate governance into business life in the region. "Corporate governance isn't about rules," says Ikhwan. It's about a culture of openness that has to become prevalent inside the corporation so that it is reflected naturally in business decisions." In other words, it's a matter of understanding that "good governance is definitely good business."
And while some bemoan the glacial pace of change in the region, Sabic's al-Morished advises patience. "We are getting there, but we are a young emerging economy," he says. "We are not mature and that's a fact of life. We have to learn as we go."