Speech following the adoption of the 2004 Review of the OECD Principles of Corporate Governance
By agreeing on these Principles, OECD governments have set the broad foundations for high standards of corporate governance. Looking ahead, the governments of OECD countries are committed to maintaining an open dialogue with all the parties involved so that everyone can learn and benefit from the shared experiences of putting these Principles of Corporate Governance into practice. This is vital to ensuring that the Principles remain relevant and effective, evolving as new issues arise.
Corporate governance is about the way in which boards oversee the running of a company by its managers, and how board members are in turn accountable to shareholders and the company. This has implications for company behaviour towards employees, shareholders, customers and banks. Good corporate governance plays a vital role in underpinning the integrity and efficiency of financial markets. Poor corporate governance weakens a company’s potential and at worst can pave the way for financial difficulties and even fraud. If companies are well governed, they will usually outperform other companies and will be able to attract investors whose support can help to finance further growth.
Work on corporate governance has been going on at the OECD for a number of years. The OECD is an ideal forum for such discussions, as it brings together representatives of 30 OECD member countries as well as numerous other countries that participate in the Organisation’s work. Together, these countries account for more than 90 percent of world stock market capitalisation. Their governments have a vested interest in working on behalf of their citizens to ensure good practice in corporate governance, as an essential element in the promotion of prosperity and economic growth.
In 1999, the OECD published its Principles of Corporate Governance, the first international code of good corporate governance approved by governments. These Principles focus on publicly traded companies and are intended to assist governments in improving the legal, institutional and regulatory framework that underpins corporate governance. They also provide practical guidance and suggestions for stock exchanges, investors, corporations, and other parties that have a role in the process of developing good corporate governance. Corporate governance arrangements and institutions vary from one country to another, and experience in both developed and emerging economies has shown that there is no single framework that is appropriate for all markets, so the Principles are not prescriptive or binding, but rather take the form of recommendations that each country can respond to as best befits its own traditions and market conditions. Since 1999, they have been widely adopted as a benchmark for good practice in corporate governance: they are used as one of 12 key standards by the Financial Stability Forum for ensuring international financial stability and by the World Bank in its work to improve corporate governance in emerging markets.
Since the Principles were first published, however, a spate of corporate scandals has undermined the confidence of investors in financial markets and company boards. In 2002, OECD governments called for a review of the Principles to take account of these developments. On April 22 2004, OECD governments approved a revised version of the OECD Principles of Corporate Governance , adding a series of new recommendations and modifying others. The revised text is the product of a consultation process involving OECD members and representatives from the OECD and non-OECD areas including businesses and professional bodies, trade unions, civil society organisations and international standard-setting bodies. They are designed to assist policy makers in both developed and emerging markets in improving corporate governance in their jurisdictions, as a vital step in rebuilding public trust in companies and financial markets.
The new Principles call for a stronger role for shareholders in a number of important areas, including executive remuneration and the appointment of board members. They call on companies to make sure that they have mechanisms to address possible conflicts of interest, to recognise and safeguard the rights of stakeholders and a framework in which internal complaints can be heard, with adequate protection for individual whistleblowers. They stress the responsibilities of auditors to shareholders and the need for institutional investors acting in a fiduciary capacity such as pension funds and collective investment schemes to be transparent and open about how they exercise their ownership rights. And they call on company boards to be truly accountable to shareholders and to take ultimate responsibility for their firm’s adherence to a high standard of corporate behaviour and ethics.
For board members, this means fostering the best interests of the company and the shareholders who have invested their money in the company which they oversee. But it also involves establishing productive relationships with other stakeholders such as employees and balancing their interests with others. Recent history shows that boards in some cases have failed to play this role, condoning remuneration packages that have no true link to performance, for example, and approving excessively ambitious expansion projects that have undermined a company’s stability. To guard against such practices, the OECD Principles of Corporate Governance call for directors “capable of exercising independent judgement” and for boards able to “exercise objective independent judgement on corporate affairs”, independent, in particular from management and in many cases from controlling shareholders and others in a position to control the company.
In almost all developed economies, investors have fairly extensive legal rights. In practice, however, their ability to exercise them is often restricted. Company by-laws and corporate practices can impose restrictions on investors’ ability to submit questions to company boards. Investors’ ability to propose or oppose individual members of the board is often limited to the point of being non-existent. More open board elections would enable shareholders to exercise their ownership rights in an effective manner. Shareholders need to be able to pose questions to the board and to put forward proposals to the general meeting of shareholders. Resolutions passed by shareholders should be taken into account by boards. The revised OECD Principles contain recommendations on these points.
Class actions and other litigation on the part of shareholders can play a positive role in bringing discipline to company boards, but mechanisms also need to be considered to avoid abuse and disruption. Strengthening the rights of shareholders, however, should not undermine the ability of a company to carry out its day to day activities and should not allow them to try and second-guess the business judgements of board members. The revised Principles call on policy makers to consider the need for mechanisms to avoid excesses in this area.
An important feature of modern financial markets is the increased weight of institutional investors. Some, such as mutual funds and pension funds, act in a fiduciary capacity on behalf of individual investors. Others, including insurance companies and investment banks, act in their own right. The importance of institutional investors as owners of corporate equity has grown enormously over the past few years, to the point where they have become the principal players in many markets. In 1999, the value of assets owned by insurance companies, pension funds and collective investment schemes or mutual funds amounted to the equivalent of 144% of the GDP of OECD countries, compared with only 38% in 1980. Institutions acting in a fiduciary capacity, such as pension funds, mutual funds and other collective investment schemes, own shares on behalf of millions of investors.
The revised Principles emphasise the important role that institutional investors can play in monitoring company performance and in conveying their concerns to the board of a company. They can challenge or support the board through voting at the general meetings of shareholders and they are well placed to take their concerns directly to the board and to propose a course of action. An increasing number of institutional investors are actively exercising their ownership roles in this way.
However, the exercise of informed ownership through monitoring is costly and institutional investors are also subject to possible conflicts of interest, for example in cases where other commercial relations with the firm in question may take precedence over what might be a desirable course of action from an ownership perspective. Nor do all institutional investors have the same incentive for exercising ownership rights. As a result the Principles focus on those acting in a fiduciary capacity. Such institutions, either for prudential or other regulatory reasons or as a result of their investment strategy, may hold only small stakes in individual companies and so have little incentive to monitor these firms closely. In such cases, these institutional investors’ role as owner could be enhanced by exchanging information and plans with other shareholders, leading to coordinated action. This is now happening in some countries, with institutional shareholders pooling their shares in order to attain the thresholds needed for them to be able to take specific action. However, barriers do remain in part related to concern that such coordination could be either anti-competitive or subvert takeover law. The revised Principles contain recommendations to governments for policy action in these areas.
For investors to exercise their shareholder rights, they need to be properly informed. This calls for a minimum level of transparency and disclosure on the part of companies. The revised OECD Principles address a range of aspects of this requirement, from the internal preparation of financial reports and internal controls through to the role of the board in approving the disclosure, the accounting standards being used and the integrity of the external audit process. A number of countries have introduced public oversight of the setting of accounting and audit standards. A growing number of countries also restrict the non-audit services that auditors can offer their clients, so as to avoid creating business interests that might undermine the independence of the audit process. These are areas covered by recommendations in the revised Principles.
Markets work best when information is available to all. Companies have a responsibility in this area, but other intermediaries, such as brokers, analysts and rating agencies, also play an important role. Here, too, the revised OECD Principles call for measures to ensure independence and transparency and to counter possible conflicts of interest.
The revised Principles emphasise the need for effective regulatory systems that ensure that the potential for damaging conflicts of interest remains limited and that there is a level playing field among the major participants in corporate governance, for example, through protection of minority shareholders. Effective implementation and enforcement require that laws and regulations are designed in a way that makes them possible to implement and enforce in an efficient and credible fashion. Supervisory, regulatory and enforcement authorities should have the power, integrity and resources to act professionally and objectively. The division of authority between agencies and supervisory bodies should be well defined and they should pursue their function in an unbiased and even-handed manner without serious conflicts of interest.
By agreeing on these Principles, OECD governments have set the broad foundations for high standards of corporate governance. The legislation needed to enforce these standards is the responsibility of individual governments, and in enacting it, governments and policy makers need to find a balance between rules and regulations on one hand and flexibility on the other. Looking ahead, the governments of OECD countries are committed to maintaining an open dialogue with all the parties involved so that everyone can learn and benefit from the shared experiences of putting these Principles of Corporate Governance into practice. This is vital to ensuring that the Principles remain relevant and effective, evolving as new issues arise.