ࡱ> npmq` DbjbjqPqP .t::;0%  84..2" "6 B . . . . . . .$/h92D.P%  P%P%D.4Y.'''P%.'P%.''** pk(&* ,o.0.*,3&3*3*<J H!'|"8#J J J D.D.0'jJ J J .P%P%P%P%~D~ The Macroeconomic Benefits of Good Corporate Governance Nii K. Sowa( Introduction Mr. Chairman, ladies and gentlemen, I thank you for inviting to share ideas with you in this all important subject. In recent times closer attention is being paid to corporate governance issues at both the micro and macro levels of the economic structure. This interest may have been engendered by events at the close of the last millennium which were brought to the attention of the corporate world. In one instance, poor corporate governance is said to be the root cause of the East Asian financial crisis and its contagion. At the micro level, the corporate malfeasance by Enron and WorldCom undermined the corporate sector and sent shockwaves through stock markets all over the world. Since then, new best practices paradigms are being evolved by regulators of all sorts and nation states to forestall a major recurrence of such financial debacle. The International Monetary Fund, for example, has now included corporate governance issues as part of its surveillance activities, as has the World Bank and the OECD. In Africa, corporate governance issues have been made an integral part of the African Peer Review Mechanism (APRM). What is Corporate Governance? Corporate governance refers to the structures and processes for the direction and control of companies. It concerns the relationships among the management, Board of Directors, controlling shareholders, minority shareholders and other stakeholders. In general, Governance is the exercise of authority, direction and control of an organization in order to ensure its purpose is achieved. It refers to who is in charge of what; who sets the direction and the parameters within which the direction is to be pursued; who makes decisions about what; who sets performance indicators, monitors progress and evaluates results; and, who is accountable to whom for what. Corporate governance is generally seen as the systems or processes by which entities are managed and controlled. These are usually summarized in the rules and regulations governing the entity. But corporate governance is more than just rules and regulations. In his address to the 23rd Conference on Bank Structure and Competition, held in Chicago, Illinois, the Governor of the Federal Reserve, Alan Greenspan observed rules cannot substitute for character. In virtually all transactions, whether with customers or colleagues, we rely on the word of those with whom we do business. If we do not do so, goods and services could not be exchanged efficiently. Even when we followed to the letter, rules guide only a small number of day-to-day decisions required of corporate management. The rest are governed by whatever personal code of values corporate managers bring to the table. Mr. Greenspans observation is rooted in economic theory. Nobel laureate George Akerloff in his seminal paper in 1970 showed that a failure of markets arises when the seller does not share honest and complete information about the quality of a product. Akerloff showed that such asymmetry in information and opportunistic behaviour will ultimately drive honest dealings out of the market unless it is overcome by new institutional structures. Invariably, the new institutional structures are just new form of regulations. Thus, unscrupulous behaviours in the market usually get countered with new regulations which just increase the cost of doing business. Good corporate governance calls for honest reputation and trust. In a system of liberalized markets, a reputation for honest dealings is a valued asset. Trust is a sine qua non in any financial dealing. Indeed, without trust there would be no banking as we know it today. It is the honest reputation created by the earlier goldsmiths and the trust such reputation engendered in the early merchants that led to the creation of paper money as we know it today. It is only honest reputation and unalloyed trust that cause them to issue and accept uncollateralized receipts which were later exchanged for specie. Those were the elements of true corporate governance - without rule or regulation; simply innate reputation and earned trust. Consequences of Poor Corporate Governance Before getting to the benefits of good corporate governance let us take a peep at some of the consequences of poor corporate governance. Although the near collapse of the financial system in Ghana in the 1970s and the early 1980s could in general be attributed to economic-wide mismanagement, much of it bears the traits of poor corporate governance. Unqualified people were employed in most of the banks. The banking industry in Ghana was too slow in insisting on training and qualification before placement. In the army, the best in military tactics could not become an officer without attending an officers course; similarly, the best mechanical fitter could never be taken as an engineer without a formal training as such; yet, in Ghanaian banks, until quite recently, it was possible for one to enter the establishment as a clerk and simply by years of service rise to the level of senior management without any formal training in banking. Was it surprising that loans were given without proper documentation or collateral? Was it surprising that a facility could be granted to someone whose address was near the big tree, Koforidua? Improper appraisal of projects was also prevalent. Facilities were granted more on the basis of whom you know and how much you are willing to share with the bank official. These elements of poor governance structures introduced into the financial system problems of adverse selection and moral hazard, leading to poor allocation of resources. In other words, because of the poor governance structure, resources did not go to those with the best use. Kalabule and corruption were the order of the day. Credit was poorly allocated, productive processes suffered and the economy as a whole declined. Such were the consequences of poor corporate governance. The Structural Adjustment Programme (SAP) and the Financial Sector Adjustment Programme (FINSAP) which were initiated in the 1980s helped to clean up the balance sheets of the banks and instituted elements of proper corporate governance in them. The corporate restructuring was helped in no small way by the improvements in the macro economy also. Macroeconomic Benefits of Good Corporate Governance A good system of corporate governance contributes to sustainable economic development by enhancing the performance of companies and increasing their access to outside capital. Good corporate governance has both a stabilizing impact as well as a growth impact on the macro economy. In terms of growth, the argument is straight forward. Good governance encourages confidence in the financial system leading to increased mobilization and investment. All things being equal the increased invest will lead to increased growth in the economy. It is important to note that because good governance ensures that resources are allocated to those that use it best, productivity would be enhanced and consequently growth is enhanced. Good corporate governance would also lead to a stable macroeconomic situation. This requires an all embracing interpretation of good corporate governance. Imagine a situation in which government is the largest shareholder in most of the banks. Government then selects both senior management and members of the board of directors. If the selection is not based on qualification and competence, but rather political cronyism and nepotism, then there is a strong possibility for the emergence of poor corporate governance. In such situations, Government is more likely to finance its deficits through bank borrowing with all its attendant problems of high inflation and crowding out of the private sector. In other words, a poor corporate governance structure is more likely to lead to an unstable macroeconomic system than a good one. Basic Indicators of Economic Performance (Annual Average Growth Rates, %)1960-701970-831984-891990-2003Real GDP 2.2-0.85.04.3 Agriculture0.8*-0.53.63.2 Industry5.4*-3.59.34.7 Services3.1*1.17.45.7Gross Domestic Investment -3.1-5.916.546.4Exports 0.1-4.411.79.1Imports -1.5-7.213.59.2Terms of Trade 1.1-1.31.415.3Population 2.32.43.53.1* Average growth rates for 1966-1970 Source: 1960-70: World Bank, Toward Sustained Development in Sub-Saharan Africa (Statistical Annex), Washington, 1984; 1970-83: World Bank (1990), World Tables and World Development Indicators (1995); 1984-89 and 1990-2003 computed from Ghana Statistical Service and International Financial Statistics (IFS), International Monetary Fund (IMF) The table summarizes the performance of the economy over the years, gives a verdict of a very successful stabilization and growth period of 1984-1989 under the Structural Adjustment Programme, which was characterized by good corporate governance. Growth in output, which in the decade before the adjustment declined at an annual average of about 1 percent per annum, started showing positive growth rates averaging almost 5 percent per annum between 1984 and 1989. In 1990, output growth slowed down to 3.3 percent and although good rains in 1991 and a good harvest boosted output growth in 1991, this could not be sustained in subsequent years as growth in output for 1992, 1994 and 1995 were below 5 percent. Sectoral decomposition of the output growth reveals that the reforms which took place in the trade sector and the subsequent liberalization of the exchange rate had boosted performance in the service sector while the external competition it engendered and the high rates of interest in the country hurt the manufacturing sector. Throughout the adjustment period, agriculture remained just dependent on the weather, and hence performed poorly. Like output, inflation saw a remarkable turn-around in the adjustment period. Good harvests in 1984/85 coupled with good macroeconomic policies and substantial inflow of foreign aid led to the rate of inflation falling from 123 percent in 1983 to 10 percent in 1985 and averaged 30 percent per annum for the rest of the decade. The 1990s began with low rates of inflation with rates of 18 and 10 percent for 1991 and 1992 respectively. Good weather and abundant agricultural output seemed to have accounted for the low rates for those two years. By 1993 weaknesses in macro fundamentals and poor harvest sent inflation into high gear. Frantic attempts in 1995 to bring inflation under control through greater tax collection by the introduction of a value added tax system and petrol price increases to close the ever widening fiscal gap led to inflation galloping to 70 percent by the close of 1995. Best Practices As intimated earlier, best practices now abound for good corporate governance. The Sarbanes-Oxley Act in the United States, the Code of Best Practices issued by the Brazilian Institute of Corporate Directors and the Code of Corporate Governance issued by the Corporate Governance Committee of Mexican Business Coordinating Counsel, the Confederation of India Industry Code and the Stock Exchange of Thailand Code are all designed to build awareness within the corporate sector of governance best practices. However, care should be taken in importing any of these best practices into Ghana. Governance needs must be tailored to the specific conditions of the country law, politics, culture, and resource endowments. As one economist warns - business practices and laws are part of a system and may not work as expected when transferred piecemeal from one economy to another. Corporate structures differ from one country to another. In most western economies corporate power is left in the hands of the board of directors and senior management who are appointed by the shareholders to act in a way so as to maximize shareholders value. This structure referred to as the Anglo-American system contrasts with the stakeholder system, as is practiced in places like Germany and Japan. In the stakeholder or relational system, shareholding is more concentrated, with large blocs held by banks, other corporations, and families. These blocs tend not to be actively traded. They have greater reliance on debt financing and a governance role for banks. Banks hold equity either in direct or depositary form, and may be represented on the board of directors. Shares also are held by key customers, suppliers, and allied corporations, often on a reciprocal basis. Concentrated, dedicated holdings make it difficult to establish a market for corporate control. Finally, employees play a role in corporate governance in the stakeholder system. Thus, under the stake holder system creditors control the company while in the Anglo-American system the Board of Directors and the top management acts agents for the shareholders in maximizing their value. The macro impact of corporate governance differs under the different scenarios. Imagine a situation of excessive capital expenditure leading to excess aggregate supply in the economy. Simple Keynesian remedy would suggest increasing aggregate demand through tax cuts, public works projects, and the like. While under both systems the Keynesian demands can be satisfied, the low risk profile of creditor controlled firms will lead them to more increased market-share objectives than pragmatic but risky ventures likely to get the economy out of the doldrums. Conclusion Good corporate governance is essential to the development of any economy. Permit me to quote extensively from a speech delivered by Paul Kagame, President of Rwanda, at the 9th COMESA Summit: For Africa to develop and attract quality business, building business confidence is an absolute necessity. And let me say that for a continent like ours that needs to attract more investment and see business as a key solution to the welfare of our people, the importance of good corporate governance cannot be over-emphasized. I believe that in Africa today, embracing and practicing good corporate governance is of both strategic importance and a matter of survival. We all know that a state that applies rules and policies predictably and fairly, a state that ensures order and the rule of law, and protects property rights will generate confidence and attract more domestic and foreign investment. Because of the importance of economic and political institutions in good corporate governance, the state of corporate governance is linked in many ways to the state of economic and political governance in a given countrys economy. For example, an unaccountable and non-transparent economic and political governance can cause the blurring of the lines between public and private sectors, leading to government interference or even government takeover of private interests. The other benefits of committing to corporate governance mechanisms are less corruption, a healthier private sector, fairer markets and greater institutional development, all of which support economic growth. ( Dr. Nii Sowa is an Economic Consultant and the Acting Director General of the Securities and Exchange Commission, Accra, Ghana. This papered is prepared for presentation at a Roundtable Discussion on Corporate Governance and Ethics in Banks on the 14-15th November, at the Banking College, Accra.     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