Apr 17, 2016

When the Capital Markets Authority, “CMA” published a “Code of Corporate Governance Practices” last month, we did a focus note on Corporate Governance in Kenya . In that focus note, we highlighted instances where potential corporate governance malpractices may have contributed to significant loses to the investing public to the tune of approximately Kshs. 257.0 bn. We then made suggestions on how to improve corporate governance. In this note, we update the count of recent losses due to corporate governance, we then review how we can improve corporate governance in this market and highlight our upcoming Corporate Governance Index.

Since the March 2016 article, we have had two more instances of significant investor loses that are primarily about corporate governance and ethics - the collapse of Chase Bank and the management changes at National Bank of Kenya (NBK). Not even considering any potential depositor losses, Chase Bank bond holders currently have Kshs. 4.8 bn at risk and NBK shareholders have lost Kshs. 2.0 bn in total value since the recent peak of Kshs 16.0 per share in November 2015 to the current Kshs 9.20 per share.

Total number of companies that have incurred investor loses relating to corporate governance now comes to 8: previously we had CMC, Imperial, Uchumi, Mumias, Kenya Airways and TransCentury, and now Chase Bank and NBK. The estimated potential losses to the investing public now amounts to roughly Kshs. 263.0 bn. This trend threatens the health of our financial and capital markets, which are essential to the wealth and livelihoods of many Kenyans invested in these markets, and also threatens businesses that depend on these markets for funding. As seen in the most recent occurrence, isolated cases such as Chase caused a crisis of confidence in the entire banking industry, stopped access to Kshs 94.3 bn of deposits and has cut funding and services to enterprises that relied on Chase for running their business.

In an economy with a GDP growth rate of about 6.0% per annum, investors should not be experiencing such significant widespread losses, and the prevalence of corporate governance issues that is affecting almost 10% of listed securities should worry us. All market participants including investors, regulators and corporates need to do their part in addressing the crisis of corporate governance in our private sector.

Corporate governance constitutes the mechanisms, processes, and relations through which companies are controlled and governed. Corporate governance is founded on the pillars that businesses have to practice accountability to stakeholders, fairness, have transparency in business activities and exhibit independence in decision making of the board. The benefits of good corporate governance are numerous as (i) it protects the interest of the investing public, (ii) improves access to funding at better costs, (iii) reduces risks of corporate crisis, (iv) improves firm valuation and share price performance, and (v) generally improves the performance of the entire firm and enhances sustainability.

There are numerous aspects to good corporate governance, including equitable treatment of shareholders, balancing the interest of all stakeholders, a competent and diverse board, ethical standards, disclosure and transparency, conflict of interest policy, firm but fair regulatory environment, etc. While all these aspects are important, we find the following five to be key to quickly enhancing good corporate governance in Kenya:

1. First and foremost, is integrity and ethical behavior of all market participants. Most of the corporate malpractices in Kenya are not due to poor judgement or mere underperformance by boards and management. They can be traced to ethical issues and conflicts of interest where the board and management made decisions that are selfishly focused on benefitting themselves rather than prudently running the company. Specifically, boards and management should never do business with their company, such as supplies and tenders. Top management should never engage in any business that competes with their company and should always declare all other businesses they are engaged in while occupying the position of executive management.
2. Professional ethics: All cases of unethical practices, such as irregular loans to shareholders and insiders, unsecured loans to influential borrowers, kickbacks to managers allocating to banks corporate deposits could not have happened without the knowledge of key professionals within organizations. Beyond boards and CEOs, senior management around them need to take their professional obligations seriously.
3. Regulatory independence coupled by firm but fair enforcement. There is a market perception that some market participants are not playing by the rules given their connections with regulators and law enforcement agencies. We have heard allegations of Imperial Bank management having compromised regulatory staff and regulators in some instances are also market participants. Regulators are the referees in the public investments game hence, we cannot have a vibrant financial market without an independent, firm, fair and transparent regulatory framework.
4. Investors have to take governance seriously and factor it as part of their investment decision process. Investors have to ask themselves questions such as, is the board competent? Is the board and management diversified? Is there a strong management team around the CEO? What is the track record of the board and the management? What is the tenure of the CEO - are they changing too quickly, on the other hand, have they stayed in office too long? For example, the tenure of the Imperial Bank CEO, for 22 years, and the lack of diversity on TransCentury’s board, could have raised red flags that should have invited investors to further scrutiny.
5. Board oversight and competency: Boards need to ask themselves whether they truly understand what is going on in the company and practice healthy skepticism of what management is telling them. In the case of Imperial, the board itself claims that they were not aware of the malpractices in the company. In the case of Kenya Airways, one wonders whether the board truly understood the implications of the aggressive expansion strategy that management was pursuing. The case at Chase bank, where the board was full of sophisticated global markets private equity investors, is puzzling because one would have expected them to have detected the issues early. Each board member needs to seriously ask themselves this question: “Do I really understand what is going on in this company for me to be able to effectively play an oversight? Can I explain all the key changes in the financial statements?”

Following the recent developments that are largely driven by failures in corporate governance, we have constructed an index to rank companies according to the effectiveness of their corporate governance framework. We rank companies using 25 metrics that monitor a company’s operations in the aspects of (i) strategy execution, (ii) risk management, (iii) director and management discipline monitored through evaluations, (iv) transparency, (v) independence of board members, (vi) responsibility and accountability of management and directors, (vii) fairness towards shareholders and other stakeholders, and (viii) participation in social responsibility activities. The components of the index and the respective scores are currently undergoing review and discussions with the participants prior to release.

Good corporate governance is essential to well-functioning and vibrant financial markets, and vibrant financial markets are essential to funding economic growth, which in turn creates jobs and raises the standards of living for Kenyans. Consequently, good corporate governance is a national imperative and we have a choice: we either focus on it and get it right for the benefit of all Kenyans, or give it lip service for the benefit of a few unscrupulous players.

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.