Current Views on Corporate Governance in Sri Lanka:

Evidence from Sri Lankan Corporate Boards

Dr. Hareendra Dissa BandaraDirector – Financial Services Academy

Securities & Exchange Commission of Sri Lanka

&

Senior Lecturer in Corporate Governance & Finance

Faculty of Management Studies & Commerce

University of Sri Jayewardenepura

Disclaimer Clause

Views expressed herein are those of the presenter. They do not necessarily reflect views of the Securities & Exchange Commission of Sri Lanka or University of Sri Jayewardenepura or other staff members of the respective institutions.

Importance

To Whom Why

Company DirectorsTo enhance the governance level of respective companies & thereby the country’s governance

Capital Market Professionals To advice clients in a broader sense

Regulators To regulate or to provide specific guidelines

Ｃｏｎｔｅｎｔ s

1. What is corporate governance?2. Governance structures3. Need for greater corporate accountability?4. Major concerns of corporate governance5. Objectives of the study6. Methodology7. What is CGS?8. Results: Adherence to the CG Essentials9. Current View

Dissa 5

What is Corporate Governance?

• “Corporate governance is about promoting corporate fairnessfairness, , transparencytransparency and and accountabilityaccountability.”

(J. Wolfensohn, President - World bank, as quoted by an article in Financial Times, June 21, 1999)

Dissa 6

What is Corporate Governance? Contd…

“Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attending those objectives and monitoring performance.”

(Cadbury, OECD, April 1999)

Dissa 7

What is Corporate Governance? Contd…‘Corporate governance is the mechanism by which companies are rationalized, directed, controlled and monitored. Corporate Governance coordinates different types of stakeholders such as shareholders, directors, managers, employees, creditors, customers, global environment and the rest of the society to enhance corporate performance and wellbeing as a common goal. Major considerations of a system of corporate governance are:

how successfully companies formulate the rational; the

reason for existence & future directionhow effectively corporate decisions are made; guidelines

and procedures how well the board on behalf of shareholders appraise

managers’ decision making, and monitor the executionhow fruitfully the different stakeholders are facilitated to

achieve the goals’(Dissa Bandara, 2006)

Governance Structures

Dissa 9

US Governance Structure

Stockholder

Board of Directors

Executive Management

1. Nomination Committee 2. Reward Committee 3. Inspection Committee 4. Finance Committee 5. Executive Committee

Chairman

CEO

Appoint

Appoint

Report

Report

Source: Based on Dissa Bandara (2003)

Japanese Governance Structure

Decide the administration of affairs of the company

Supervise execution of duties of directors

(Board of) Statutory Auditors

at least majority must be outside auditors in case of a large company

Duty of CareAppointment /dismissal of Directors

Appointment

Source: Based on Dissa Bandara (2003)

Dissa 11

Sri Lankan Governance Structure

Shareholders

BOD Executive & Non-

Executive Directors Committees (Ind)

CEO

Employees

External Governance Mechanism

Internal Governance Mechanism:

The relationship among various components in determining the

rational, direction and performance

Foreign, Institutional, Individual Investors

External Auditors

Government

CustomersCreditors

Dissa 12

SHAREHOLDERSSHAREHOLDERS

BOARD OF DIRECTORS

Chairman

BOARD OF DIRECTORS

Chairman

Audit CommitteeAudit Committee

Remuneration

Committee

Remuneration

Committee

Nomination

Committee

Nomination

Committee

MANAGEMENTMANAGEMENT

Financial ReportingFinancial Reporting

Risk Management

Risk Management

Internal ControlsInternal Controls

Conduct of the business and

other operational

matters

Conduct of the business and

other operational

matters

Internal AuditorInternal Auditor

External AuditorExternal Auditor

Monitoring

Monitoring

Functions

Functions

Board delegates the powers to managementBoard delegates the powers to management

Shareholders delegate power to the board of directors

Shareholders delegate power to the board of directors

Non-executive DirectorsNon-executive DirectorsCEO and

Executive Directors

CEO and

Executive Directors

EMPLOYEESEMPLOYEESEMPLOYEESEMPLOYEES

Dissa 13

Separation of ownership and control– Berle and Means (1932) recognise that the

separation of ownership and control gives rise to a conflict of interest between insiders (managers) and outsiders (shareholders) with diffuse ownership.

Need for Greater Corporate Accountability?

1932

Separation of Ownership and Control

Ownership

Director

Control

ManagementShareholder 1 2

Board of Directors leads the company and is the link between ‘Owners’ and ‘Managers’

1. Determine the Future Direction: Aims, policies & strategies on behalf of the owners

2. Monitor the progress of Management Execution

Dissa 16

Separation of Ownership and Control Contd…

– Agency Problem: The greater the degree of separations, the greater the

agency problem.

– Agency Cost: Because of the costs of information and the difficulties in monitoring managers, rational managers undertake behaviour which shifts wealth from shareholders to themselves. This results in agency costs: loss in market value relative to the value if no agency problems existed.

Dissa 17

Align the interests of managers and shareholders

Prevent managers from pursuing own interestsPrevent high and excessive executive payOvercome agency costs associated with the

separation of ownership and controlAvoid abuse of power

Major Concerns of Corporate Governance

04/21/23 Dissa5 18

Objectives of the Study

• To examine the level of compliance of Sri Lankan companies on corporate governance (CG) principles based on a proposal of Governance Research Institute of Sri Lanka (GRIS)

• To understand the current views on Sri Lankan corporate boards

04/21/23 Dissa5 19

MethodologyMethodology

04/21/23 Dissa5 20

Sample, Data & Time Period

• Sample: 59 Companies Listed on the CSE

• Data: BoD related Qualitative & Quantitative Data

• Method of Data Collection: TRIANGULATION;

Questionnaire Survey, Informal Interviews, Annual Reports & Publications, Governance Database of Governance Research Institute of Sri Lanka (GRIS)

• Time Period: 2006 - 2010

SampleNo Sector No. of

CompaniesAccess

Restrictions 1st Sample Incomplete Data Final Sample

1 Bank Finance & Insurance 35 (20) 15 152 Beverage Food & Tobacco 20 (13) 7 7

3Chemicals & Pharmaceuticals 9 (9)

4Construction & Engineering 3 0 3 (3)

5 Diversified Holdings 11 (6) 5 56 Footwear and Textiles 4 (4) 7 Health care 6 (2) 4 (4) 8 Hotels & Travels 32 (23) 9 99 Information Technology 2 (2)

10 Investment Trust 9 (9) 11 Land & Property 18 (11) 7 712 Manufacturing 33 (23) 10 1013 Motors 6 (6) 14 Oil Palms 5 (5) 15 Plantations 18 (12) 6 616 Power & Energy 4 (4) 17 Services 7 (7) 18 Stores & supplies 4 (4) 19 Telecommunications 2 0 2 (2) 20 Trading 8 (5) 3 (3)

Total 236 (165) 71 (12) 59

04/21/23 Dissa5 23

What is CGS?

• This CGS is; an assessment of individual companies based on their CG

practices to measure the compliance with the CG standards / practices

• NOT a kind of audit, a financial recommendation, credit rating nor an advice for a particular need

• Again it is; NOT an indicator of financial or commercial performance

Corporate Governance Score (CGS) is a measure of adherence to CG practices & policies (based on GRIS)

Basic Strata of CGSPrinciple Areas CGS Category Principles &

Sub AreasI. Mission & Role of the BOD and

Committees CGS-BOD 14 Principles74 Sub areas

II. Rights of Shareholders & Minorities CGS-Sh 10 Principles46 Sub areas

III. Relationship with Stakeholders CGS-Stake 10 Principles40 Sub areas

IV. Role & Leadership Responsibility of CEO CGS-CEO

12 Principles44 Sub areas

V. Role of Executive Management CGS-Mgt 12 Principles40 Sub areas

VI. Disclosure and Transparency CGS-DisTrans 12 Principles42 Sub areas

Separation of Ownership and Control

Ownership

Director

Control

ManagementShareholder 1 2

Board of Directors leads the company and is the link between ‘Owners’ and ‘Managers’

1. Determine the Future Direction: Aims, policies & strategies on behalf of the owners

2. Monitor the progress of Management Execution

04/21/23 Dissa5 26

Adherence to CG Principles/PracticesAdherence to CG Principles/Practices

Important Empirical EvidenceImportant Empirical Evidence

Overall CGS - BOD Adherence

General Compliance Details

Top 10 CGS-BOD

Rank Order Company Sector Score

1 AAA BFI 2032 BBB DIV 1993 CCC BFI 1984 DDD BFI 1975 EEE BFI 1926 FFF DIV 1917 GGG Hotels 1888 HHH Manu 1879 III Manu 186

10 JJJ Manu 185

Worst 10 CGS-BOD

Rank Order Company Sector Score

1 ZZZ Manu 1152 YYY Manu 119

3 XXX Land & Pro 120

4 WWW BFI 132

5 VVV Manu 139

6 UUU Land & Pro 140

7 TTT Manu 140

8 SSS Land & Pro 143

9 RRR Plantation 143

10 QQQ Land & Pro 144

Frequency Distribution of CGS-BOD

04/21/23 Dissa5 32

High & Low CGS-BOD Groups

1. High CGN Group: 9 firms with score greater than 185

2. Low CGN Group: 10 firms with score less than145

High & Low CGS-BOD Groups

04/21/23 Dissa5 34

High & Low CGS Japan - 2003

0

510

1520

25

3035

40

10 15 20 25 30 35 40 45 50 55 60 65 70 75

CGN

No

. o

f F

irm

s

1 SD =

11.2

1 SD =

11.2

Avg.

36.

3

Low CGN Group 25 Firms High CGN Group 25 Firms

Source: Dissa Bandara (2003)

04/21/23 Dissa5 35

High & Low CGS Japan - 2008

0

5

10

15

20

25

30

35

40

10 15 20 25 30 35 40 45 50 55 60 65 70 75

No

.of

Fir

ms

CGS

1 SD =

12

1 SD =

12

Avg.

37.

8

Low CGN Group 25 Firms High CGN Group 30 Firms

Source: Dissa Bandara (2008)

Composition of CGS-BODSpecific Areas Point Allocation Score Obtained Compliance Level

1: Determining Future Direction 20 13.33 67%2: Policy Formulating Practices 20 12.88 64%

3: Engage in Strategic Thinking and Planning

20 13.38 67%

4: Board Structure & Practices 25 14.28 57%

5: Board Membership & Orientation

16 8.52 53%

6: Board Meetings 25 14.49 58%7: Board Committees 45 24.39 54%

8: Board-CEO & Senior Management Relationship

20 9.93 50%

9: Board – Staff Roles 20 9.17 46%

10: Monitoring & Evaluation Practices

25 11.68 47%

11: Legal & Ethical Compliance 12 7.72 64%12: The Entity 12 7.11 59%13: Stakeholders 16 7.76 48%14: External Relations Practices 20 10.44 52%

OVERALL 296 165 56%

Composition of CGS-BOD

Specific AreasPoint

AllocationScore

ObtainedCompliance

Level

3: Engage in Strategic Thinking and Planning 20 13.38 67%

1: Determining Future Direction 20 13.33 67%

2: Policy Formulating Practices 20 12.88 64%

11: Legal & Ethical Compliance 12 7.72 64%

12: The Entity 12 7.11 59%

6: Board Meetings 25 14.49 58%

4: Board Structure & Practices 25 14.28 57%

7: Board Committees 45 24.39 54%

5: Board Membership & Orientation 16 8.52 53%

14: External Relations Practices 20 10.44 52%

8: Board-CEO & Senior Management Relationship 20 9.93 50%

13: Stakeholders 16 7.76 48%

10: Monitoring & Evaluation Practices 25 11.68 47%

9: Board – Staff Roles 20 9.17 46%

OVERALL 296 165 56%

3: Engage in Strategic Thinking and Planning

  Specific Areas

1The organization’s corporate plan & annual budget is fully discussed by the board prior to its approval.

2The financial status of our organization is regularly reviewed and needed board actions are taken thoughtfully but quickly.

3Board leadership takes steps to ensure that financial reports are thoroughly understood by board members.

4The annual report of the organization and independent auditor is reviewed and needed actions are taken in a timely way.

5Board members are well aware of their legal responsibilities for the organization’s financial management.

1: Determining Future Direction

  Specific Areas

1Organization’s mission and purpose are clearly understood and accepted by the board.

2The members of the board have reached consensus on a vision that indicates where the organization will be headed over the next 3-5 years.

3The full board collaboratively reviews and updates the organization’s strategic plan at least every two years.

4Staff develops and carry out annual plans based on the board’s approved strategic plan.

5The board is well-briefed by the management on annual plans/action plans developed by staff.

2: Policy Formulating Practices

  Specific Areas

1If a new policy is needed for the board or the organization as a whole, the issue is clearly presented to and discussed by the board.

2The full board approves all new organizational policies before they are implemented.

3Policies exist for key areas such as finance, personnel, safety, and ethics, and all functions unique to our organization’s work.

4Our organization’s policies are effectively communicated to all board members.

5The Board reviews policies at least annually and updates them as needed.

9: Board – Staff Roles  Specific Areas

1The role and responsibilities of the board are clearly defined and separate from those of the management & staff (Monitoring vs Controlling).

2The board takes the primary responsibility for developing the organization’s policies.

3Board members never assume roles and responsibilities that belong to staff.

4The board delegates to the organization’s Chief Executive sufficient authority to lead the staff and carry out the organization’s mission.

5When a problem or conflict arises between board and staff, parties move quickly and effectively to resolve it.

10: Monitoring & Evaluation Practices  Specific Areas

1Board members are adequately knowledgeable about the organization’s programs/projects and services.

2Periodically review with the CEO the possibilities of adding new programs/projects and services, and modifying or discontinuing current programs/projects and services.

3The board keeps itself informed of the organization’s performance against predetermined plans and goals.

4The effectiveness of the board and committee structure is assessed every year.

5Annually assess the individual members’ satisfaction with their participation on the board.

6 Regularly evaluate the effectiveness of the board meetings.

13: Stakeholders  Specific Areas

1 Has the Board identified key stakeholders?

2 What is the state of the relationship with the key stakeholders?

3How well do entity's objectives reflect stakeholders’ expectations?

4Is there a policy determining how the entity will relate with stakeholders?

Sector-wise CGS-BODCGS-BOD Components

Point Allocation

BFI BFTDiversif

iedHotel & Trav Land & Property Manufact Plantation

Overall Compliance

1: Future Direction 20 16 13 13 14 11 12 13 13

2: Policy Formulating 20 14 13 13 13 11 12 14 13

3: Strategic Thinking 20 15 13 14 13 12 13 14 13

4: Board Structure 25 15 14 16 14 12 14 14 14

5: Board Membership 16 9 8 10 9 7 8 9 9

6: Board Meetings 25 15 14 16 14 13 14 15 14

7: Board Committees 45 26 24 27 24 21 23 25 24

8: Board-CEO & Mgt 20 10 10 11 10 9 10 10 10

9: Board – Staff 20 10 9 9 10 8 9 9 9

10: Monitoring 25 12 13 12 11 11 11 11 12

11: Legal compliance 12 10 7 8 7 6 7 7 8

12: The Entity 12 7 7 8 7 6 7 7 7

13: Stakeholders 16 6 8 10 8 6 8 8 8

14: External Relations 20 11 11 12 10 9 10 10 10

CGS-BOD Components 296 178 165 180 164 143 160 166 165

Sector-wise Compliance

CGS-BOD ComponentsPoint

Allocation BFI BFT Diversified Hotel & TravLand &

PropertyManufact Plantation

Overall Compliance

1: Future Direction 20 81% 67% 66% 69% 56% 62% 66% 67%

2: Policy Formulating 20 72% 63% 66% 63% 55% 62% 69% 64%3: Strategic Thinking

20 74% 65% 70% 64% 59% 66% 69% 67%

4: Board Structure 25 61% 57% 65% 57% 49% 55% 57% 57%

5: Board Membership 16 55% 53% 62% 53% 44% 52% 54% 53%

6: Board Meetings 25 60% 58% 64% 57% 50% 56% 60% 58%

7: Board Committees 45 58% 54% 60% 54% 48% 52% 55% 54%

8: Board-CEO & Mgt 20 52% 50% 54% 49% 43% 49% 51% 50%

9: Board – Staff 20 52% 44% 46% 50% 39% 45% 44% 46%

10: Monitoring 25 48% 52% 50% 44% 44% 45% 44% 47%

11: Legal compliance 12 83% 61% 70% 62% 53% 60% 61% 64%

12: The Entity 12 62% 61% 68% 58% 51% 57% 59% 59%

13: Stakeholders 16 41% 51% 60% 48% 39% 49% 51% 48%

14: External Relations 20 55% 53% 59% 51% 45% 50% 52% 52%

OVERALL 296 61% 56% 61% 56% 48% 54% 57% 56%

Sector-wise ComplianceCGS-BOD

ComponentsPoint Allocation BFI BFT Diversified

Hotel & Trav

Land & Property

Manufac PlantationOverall

Compliance

1 20 81% 67% 66% 69% 56% 62% 66% 67%

2 20 72% 63% 66% 63% 55% 62% 69% 64%

3 20 74% 65% 70% 64% 59% 66% 69% 67%

4 25 61% 57% 65% 57% 49% 55% 57% 57%

5 16 55% 53% 62% 53% 44% 52% 54% 53%

6 25 60% 58% 64% 57% 50% 56% 60% 58%

7 45 58% 54% 60% 54% 48% 52% 55% 54%

8 20 52% 50% 54% 49% 43% 49% 51% 50%

9 20 52% 44% 46% 50% 39% 45% 44% 46%

10 25 48% 52% 50% 44% 44% 45% 44% 47%

11 12 83% 61% 70% 62% 53% 60% 61% 64%

12 12 62% 61% 68% 58% 51% 57% 59% 59%

13 16 41% 51% 60% 48% 39% 49% 51% 48%

14 20 55% 53% 59% 51% 45% 50% 52% 52%

OVERALL 296 61% 56% 61% 56% 48% 54% 57% 56%

04/21/23 Dissa5 47

Evidence on International StatusIndicator Belgiu

mFrance Germany Japan

Nethlnds

Port UK US

1.1 Best Practice Codes

5 9 6 3 4 4 9 9

1.2 Non-executive Directors

8 9 5 1 10 3 6 8

1.3 Board Independence

2 3 2 0 1 0 4 7

1.4 Split Chairman/CEO

6 2 5 0 5 2 6 1

1.5 Board Committees

3 4 1 0 3 3 6 8

21 Voting Rights 10 6 9 10 6 6 10 9

2.2 Voting Issues 8 8 5 4 5 7 7 3

3.1 Accounting Standards

2 3 7 0 6 2 9 10

3.2 Executive Pay 3 10 2 2 8 2 10 10

4.1 Takeover Barriers

3 4 3 0 1 2 10 7

Overall Score 5.0 5.8 4.5 2.0 4.9 3.1 7.7 7.2

Country Rank 4 3 6 8 5 7 1 2

Source:Based on Dissa Bandara (2008)

04/21/23 Dissa5 48

ConclusionsThe extent of Adherence to CG Principles

• Actual CG practices are considerably deviated from the expected standard (AVG compliance level 56%)

• A broad variation in CG practices across the firms (Max 69% & Min 39%)

• A considerable variation in CG practices across the industries (48% - 61%)

• Governance level is high in BFI & Diversified (high AVG score)

Conclusions The extent of Adherence to CG Principles• Sri Lankan boards are good at;

– Strategic planning– Determining future direction – Policy formulating practices

• Sri Lankan boards are weak at;– Board-staff roles (not clearly defined and separated)– Monitoring & evaluation (split the role of Chairman

&CEO)– Relationship with the stakeholders

04/21/23 Dissa5 50

Conclusions Contd… Emerging CG Characteristics

• The degree of interest in the recent discussion on CG is remarkably high (over 70%)

• Through their CG system they hope to enhance the performance and speed up of decision-making

• There is a growing tendency of introducing new features like Independent Directors, BOD training & IR activities

04/21/23 Dissa5 51

For Future …

• Employ a multiple CGS, considering• Sri Lankan CG Principles (to be finalized)• OECD CG Principles• Other Leading Sources like, CalPers

• Use Case Study & Critical Incident Method as methodological tool

• External pressure should be increased to get the poor players to the track

• CG practices should be familiarized among corporate level