In the wake of the global recession, attention on corporate governance is at an all time high. Many investors lost a lot of money, particularly on investments in companies that went bankrupt due to corporate scandals, mismanagement and fraud. Many are looking for a way to prevent this happening again, and are hoping to spot the mismanaged companies before they implode.

This has resulted in a global call for a system to be developed that can measure a company’s system of corporate governance. In almost all of the systems developed so far, ‘executive compensation’ has been one of the topics used as a measure. Should governance measurement tools gain international recognition, they will play a large role in determining the structure and size of director’s compensation.

Ms Blair defines corporate governance as “the whole set of legal, cultural, and institutional arrangements that determine what public corporations can do, who controls them, how that control is exercised, and how the risks and return from the activities they undertake are allocated.” It appears that the concept of measuring a company’s corporate governance is one that is immediately fraught with problems. How can a concept so subjective be objectively measured? It is suggested that this is because however detailed a study is done on the policies within a company, it would be impossible to measure the culture accurately within a company.

This problem was demonstrated with the spectacular collapse of Enron, a former large American energy company. In terms of policies surrounding good corporate governance, the company was faultless. As Mr J. Macey pointed out, “[t]he organisation and structure of the Enron board was also a paradigm of good corporate governance”. As one commentator put it, “[T]he [Enron] board had all of the committees one would hope to see, including an executive committee, finance committee, audit and compliance committee, compensation committee, and nominating and corporate governance committee.” Despite all of these measures, Enron still went bankrupt, and has become known as ‘one of the largest frauds in business history.’

Despite these difficulties, many organisations and bodies have attempted to set up a method to measure how various entities are performing with regard to governance. On a global scale, the United Nations University drew up the World Governance Survey in 2002, in order to ‘effectively assess and analyse governance issues.’ The World Bank attempted to measure the governance of governments in 2007, using data and annual indicators from the previous ten years. More specifically focused on governance within the corporate setting, there have also been various projects undertaken to set standards by which to measure the governance of companies, commonly referred to as governance rating or index. Gompers, Ishii, and Metric’s G-Index was published in 2003, and soon after that Bebchuk, Cohen, and Ferrell’s E-Index was produced.

Another academic rating method, Brown and Caylor’s Gov-score Index, was released in 2006 as a more extensive governance index. In the UK, many researches have looked at compliance with the Cadbury Code and performance – e.g. Gompers, et al, 2003, Klapper and Love 2002, Black, Jang and Kim 2005. In order to do this, they have needed to ‘develop indices to measure a firm’s governance arrangements’.

Commercial corporate ratings governance agencies also aim to provide a measure of a company’s corporate governance policies and practices. GovernanceMetrics international (GMI), created in 2000, claims to be the first such company. The organisation produced a questionnaire with hundreds of metrics which, once answered, gave a score between one and ten for that company. Of the six research categories analysed by GMI, one of these is executive compensation.

is an organisation that offered a similar product, named for short the Governance Risk Indicators or ‘GRId’. Companies were scored against best practices in four areas, one of them being remuneration/compensation. Companies were then treated as either low, medium or high concern in each area, depending on their ratings. Indicators that decided ratings with regards to compensation included the following:

• Executive directors' ownership of shares.
• Disclosure regarding the minimum vesting periods of executive shares.
• Policy towards repricing of share options.
• Change in control agreements.

There are many benefits to such a system. Instead of a rule based system whereby companies are forced to comply with a list of regulations, companies are motivated to improve their ratings as they are linked to their business’ opportunities. The advantages of a well-established governance rating agency are easy to predict – companies would work hard to comply with the survey, and would seek to improve their corporate governance in order to obtain a favourable rating. If one thing of the influence of credit rating agencies (such as Standard and Poor’s, Moody’s or Fitch Ratings), and the effect that their opinions have on both companies and investors, it is possible to imagine the effects that a governance rating agency with the same influence would also have on entities.

However there are also disadvantages to the concept. As already discussed, it is difficult objectively and comparatively to measure a culture. Another disadvantage of such a concept is that implementing such a system is difficult, time consuming and costly. For an organisation to implement such a system, the cost of running the organisation would need to be passed on to the companies being rated. In addition to these costs, the cost within a company of complying with the regulations would also be quite substantial.

In addition, the measure cannot be expected to prevent or even detect corruption or fraud. As pointed out by Mr M.A. Golden and Mr L. Picci in their study of involving the measurement of corruption, “[r]espondents directly involved in corruption may have incentives to underreport such involvement, and those not involved typically lack accurate information.

How it affects the South African business community

South Africa does not have as developed a system for measuring corporate governance as other economies. This is demonstrated by the lack of governance rating agencies that exist in the country. Ratings Africa is one organisation that has tried to implement a means to measure governance. The organisation drew up a survey that asked companies to measure their own corporate governance, but the response level in 2009 was disappointing. Of the Listed Top 40 companies, 68.3% did not respond, and 2.4% declined filling out the survey. This led the organisation to conclude that “[t]he survey cannot be considered successful in the level of response that it has generated...”

The Institute of Directors in South Africa (IoDSA) launched a similar product in February 2010, named the Governance Assessment Instrument (GAI). It consists of 300 questions relating to governance, with the results giving an “overview of the state of corporate governance in the company by category and subcategory”. The creators of the project are aware of the limitations of the product, in particular the difficulty involved in measuring an intangible item such as corporate culture.

Ms A. Romahlo, executive director of the centre of corporate governance at the Institute of Directors in South Africa said: “[a]lthough the report does not indicate the quality of governance, it does give stakeholders and all other interested parties and idea of how well positioned an organisation is for good corporate governance.” However, what matters in a charging company’s governance is ‘not the adoption of individual initiatives but the change in attitude that accompanies the use of a collection of governance measures.’ Often just the focus on the governance of a company will result in an improvement in both its practices and policies.

Whether the project receives a positive response from South African companies remains to be seen. The South African business community does not currently place the same importance levels on corporate governance that do foreign markets. It is suggested that there are two factors that could explain this fact. First, South Africa has not needed to focus urgently on its corporate governance: the country has not been rocked by public fraud scandals, such as the “Enron debacle’ in the United States of America or the collapse of Parmalat in Europe. Adding to which, South Africa’s economy has not been as affected by the global recession as other countries. One of the results of this is that investors have had less of a need to analyse or improve the country’s corporate governance.

Second, the country’s level of corporate governance is already relatively high. This could be because “[c]orporate governance in many emerging market companies is actually better than in more developed markets. It has needed to be more robust in order to attract capital.” South Africa is a country well regulated by both the King Code and Report on Governance for South Africa as well as the Companies Act No. 71 of 2008 (The Companies Act).

Recommendations

There is much room for improvement with regard to compliance with the King Code and Report on Governance for South Africa (King III) it is suggested that a possible reason for this lack of compliance is that there is little tangible motivation for companies to spend time and resources to comply with all of the report’s recommendations. A recommendation would be that, instead of merely forcing listed public companies to comply with King III, it could be helpful to create an incentive for companies to comply with King III. A corporate governance rating could supply this motivation, as companies that scored well on the rating would enhance their reputation, and open up potential investment opportunities.

For this reason it is recommended that a system for measuring corporate governance is implemented in South Africa. It can be seen from the low response levels achieved by Ratings Africa, it will need to become well known to be effective, so will need to either be government backed and compulsory for all JSE listed companies, or even legislatively enacted.

An ideal system will be one that requires companies to fill out a survey covering various corporate governance sections. These sections would be based on the recommendations of King III, and broken up into sections, with more important topics receiving a greater weighting towards the cumulative total. The survey would need to be filled out by the directors of the company, and these details would then need to be verified by an independent party – either by the rating agency itself, or by the company’s external auditors. A system would be created online hereby a company’s rating is uploaded and can be viewed by all interested parties. Details pertaining to that company’s rating (compared to peers), along with details on how to improve it, would also be easily accessible, thereby encouraging continual improvement.

It has already been pointed out that emerging markets need to have better corporate governance than more developed markets in order to attract foreign capital. While implementing a system of measuring governance will not guarantee that corporate governance will be good, the process may contribute towards improving South Africa’s global reputation, and thereby attracting overseas investments.