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Corporate Governance in Pakistan Corporate Issues and Challenges

M. Mujahid Malik
Student of C.A & M.B.A

Zulfiqar Zahid And

Robina Iqbal
Freelance Researcher

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Economics, P. O. Box 1091, Islamabad 44000. © Pakistan Institute of Development Economics, 2010.

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Designed, composed, and finished at the Publications Division, PIDE.

Acknowledgements: The authors are Professor of Economics, Pakistan Institute of
Development Economics, Islamabad and freelance researcher respectively. The authors wish to thank Dr Rashid Amjad, Dr Tariq Javed and Dr Idrees Khawaja for their valuable comments. They are grateful to Hafeez Ahmed and Shahab-u-Din for providing assistance in compiling data and Yasir Iqbal for computer assistance. Any remaining errors and omissions are the authors’ sole responsibility.

In this paper, governance is defined as the manner in which power is exercised in the management of a country‟s economic and social resources for development. “Good Governance” is then synonymous with sound development practices. Vital reforms for public expenditure may flounder if accounting systems are so weak that budgetary policies cannot be implemented or even monitored; if poor procurement systems encourage corruption and distort public investment priorities. This only illustrates a broader point; good governance is central to creating and sustaining an environment which fosters strong and equitable development. Governments play a key role in the provision of public goods. They establish the rules that make markets work efficiently, and they correct for market failure. In order to play this role, they need revenues, and „agents‟ to collect these revenues. This in turn requires systems of accountability, adequate and reliable information, and further, efficiency in resource management and delivery of public services.

Objective of the Study

The main focus of the study is to investigate does corporate governance matters in Pakistan equity market? What are its implications for corporate valuation, corporate, ownership and corporate financing? The first dimension of this issue is measuring the corporate governance in Pakistan. Corporate governance is interpreted as mechanism–both institutional and market based, that induces the self-interested managers (controllers of the firm) to make decisions that maximise the value of the firm to its shareholders (owners of the firm) [OECD (1999)]. The aim of these mechanisms is to reduce agency costs that arise from principle agent problem; and they could be internal and/or external in nature [Klapper and Love (2002)]. Internal mechanism deals with the composition of the board of directors, such as proportion of independent outside directors, distinction of CEO and chairperson etc. another important mechanism is ownership structure, or the degree at which the ownership by managers obvious trade-off between alignment and entrenchment effects. External mechanism on the other hand rely on takeover market in addition to regulatory system, whereas the take-over market act as a treat to existing controllers in that it enable outsiders to seek control of the firm if bad corporate governance results in significant gap between potential and actual value of the firm. So given these mechanisms, it is investigated that the legal system is the only way to ensure good corporate governance. It is also examined that effective presence of these mechanisms positively associated with firm value.

Corporate governance refers to the system by which corporations are directed and
controlled. The governance structure specifies the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and specifies the rules and procedures for making decisions in corporate affairs. Governance provides the structure through which corporations set and pursue their objectives, while reflecting the context of the social, regulatory and market environment. Governance is a mechanism for monitoring the actions, policies and decisions of corporations. Governance involves the alignment of interests among the stakeholders.

Pakistan Institute of Corporate Governance (PICG) Introduction
Sound corporate governance has emerged as a crucial success factor in national and international markets. Countries all over the world are keen to encourage good corporate governance to ensure fairness, transparency and accountability in the corporate sector and safeguard the interest of all stakeholders, especially the minority shareholders. Empirical research also suggests that jurisdictions that adhere to good governance practices tend to attract more capital. Although governments play a central role in shaping the legal, institutional and regulatory climate, the major responsibility lies with the corporate sector itself. Fair participation and collective will of all major stakeholders is required to improve the corporate governance culture of any country. This requires an institutional arrangement where all major stakeholders may come collectively and discuss governance practices, identify problems and their solutions and evolve best governance practices.

Establishment of Institute
The Pakistan Institute of Corporate Governance (PICG) has been set up as a not-for-profit company, limited by guarantee and without share capital. It has been licensed under Section 42 of the Companies Ordinance, 1984. The PICG will undertake activities geared towards

achieving good corporate governance in the country and creating an enabling environment for effective implementation of the Code of Corporate Governance. The PICG anticipates becoming a leading provider of knowledge and awareness in the country related to corporate governance practices. It will strive to encourage best practices in corporate governance in public and private sectors, with focus on capacity building of board of directors, management, policy makers, investors, and other stakeholders. It shall also endeavour to cover all the issues related to corporate governance at national and international level.

The PICG has been formed through initial sponsors, which comprise a balanced representation of major stakeholders from public and private sectors. The promoters of PICG are as follows:

Corporate Regulator
 Securities and Exchange Commission of Pakistan

Banking Regulator
 State Bank of Pakistan

Corporate Sector
  Federation of Pakistan Chambers of Commerce and Industry Overseas Investors Chambers of Commerce and Industry

Non-banking Financial Sector
    Modaraba Association of Pakistan Leasing Association of Pakistan Mutual Funds Association of Pakistan Investment Banks Association of Pakistan

Banking Sector
 Pakistan Banks‟ Association

Stock Exchanges
   Karachi Stock Exchange Lahore Stock Exchange Islamabad Stock Exchange

  Institute of Business Administration Lahore University of Management Sciences

Professional Institutions
Institute of Chartered Accountants of Pakistan Institute of Cost and Management Accountants of Pakistan Institute of Corporate Secretaries of Pakistan Institute of Chartered Secretaries and Managers Management Association of Pakistan

Project Background
In August 2002, the Securities and Exchange Commission of Pakistan (SECP), the United Nations Development Programme (UNDP) and the Economic Affairs Division (EAD) signed a Memorandum of Understanding. Under this umbrella agreement, UNDP provided technical and financial assistance to the SECP in encouraging good corporate governance practices and establishing a sound regulatory framework for the corporate sector in Pakistan. The primary objective of the Project on Corporate Governance is to introduce and encourage compliance with good corporate governance practices in order to revive investors‟ confidence that is

critical for sustainable economic growth, which in the long run will lead to poverty alleviation. It follows, therefore, that the Project will aim to: • develop and implement a sound corporate governance framework in Pakistan • enhance the capacity of the SECP; and • promote private institutions that encourage participation of stakeholders in ensuring good corporate governance practices.

Purpose and Objective of the Study
The SECP, in collaboration with the Institute of Chartered Accountants of Pakistan (ICAP), has developed the first Code of Corporate Governance for Pakistan. The Code is the first institutional effort of its kind in Pakistan. Pursuant to the introduction of the Code by the SECP in March 2002, it has been incorporated in the listing regulations of the three stock exchanges in the country. Accordingly, the Code is applicable to all public listed companies. It is expected that introduction of the Code will bring in transparency and efficiency within the corporate sector of the country and will create an institutional framework for protection of interests of shareholders. One of the key objectives of the Code is to give voice to minority shareholders and investors in decisions of the companies that have direct impact on investors. It is empirically tested that an effective governance structure for corporate sector improves the investment climate by raising investor confidence. Enforcing good corporate governance practices is the key to attract capital, improve efficiency of capital and financial markets and achieve sustained economic growth.

Corporate Governance Issues & Challenges

Bureaucratic Layers

Corporate governance structures are very top heavy. They require many layers of management and long lists of vice presidents and presidents for information to pass

through. This makes it very difficult for the company leaders to receive accurate, important data from the lower levels of the company, especially if managers along the way want to distort the message to make themselves sound better. Ultimately, the chain of command becomes so long that the business is unwieldy, responding slowly to change. Flat business structures with few layers of management are the goal of many corporations.


Corporate governance has earned a negative connotation in society, mostly because of the questionable practices of key executives and board members. Not all corporations commit fraud, of course, but those that do receive a lot of attention, and many executives have become used to taking questionably large bonuses even in a contracting economy. This has lead to an atmosphere of distrust among consumers and investors, which corporations fight by showing increased transparency in their work and mission.

Governance Standards

Internally, corporate governance faces a different type of struggle. A board of executives can make good decisions on company policy and propagate standards throughout the business. But what if managers prefer not to listen? Rebellious managers can ignore or subvert corporate decisions at many levels of the business, and there are often a few troublemakers in all businesses. Corporate boards need methods of enforcing standards and disciplining managers when necessary, a component of governance few boards consider.

Board Terms

Board terms are a complex issue. In a board of directors, directors typically only sit on the board for a brief term, rarely more than several years. Life-term board

members can cause problems with ingrained beliefs and concentration of power, so businesses prefer to cycle board members. But the corporation must decide how to cycle. If all directors switch around at the same time, the corporation may be left open for a hostile acquisition. If the board decides to stagger member terms, it must decide when to stagger and how to accomplish it.

Causes of Ineffectiveness of Non-executive Independent Directors in listed companies of Pakistan.
As we know that board composition and independence are fundamental issues in corporate Governance. Board independence is very important for governance mechanisms. But in Pakistan there is no concept of independent non-executive directors. Besides, non-executive directors actually are not independent. Board independence is one of the most important elements of good corporate governance. Independent directors broadly fit into the overall structure of corporate governance, and are necessary to ensure effective, balanced board. An independent non- executive director is one who is independent of management. Under the combined code the director should not have been an employee of the group within the last 5 years, should not have a material business relationship with the company, should not receive any remuneration from the company other than fees, share scheme and performance related pay, should not have close family ties with advisers, directors or senior employees, should not have significant links with other directors, should not represent a significant shareholder and should not have served on the board for more than 9 years. In Pakistan independent non-executive directors are practically absent. Here a lot of companies depict a number of their directors as non-executive and pretence them to be independent, but in reality none of them is independent. There are following reasons for INEDs being ineffective in Pakistan‟s listed companies.

Companies owned by families of closed groups
Mostly companies are owned by families or closed groups. And they usually try to stay away from such directors whom they are unable to control. Actually controlling shareholders are keen to run their company in their own way and they hate any kind of

interference from outside. They are not prepared to grant any of their powers to outsiders. It all depends on controlling shareholders whether they really want to have independent non-executive directors on their company‟s board or not.

Companies not pay remuneration
Another important cause of ineffective independent non-executive directors in Pakistan is that companies do not pay any compensation or remuneration to them. There is just a fixed fee for them for attending a meeting.

Professionals don’t have plenty of time
Good professionals are not keen to serve on the boards of listed companies just for getting only a meeting fee. In fact some of them don‟t have plenty of time to do so. To run the company successfully you need good people, and good people have no time for company matters as they are already busy with their work.

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