Mar 13, 2016

This week the Capital Markets Authority published the “Code of Corporate Governance Practices” for public listed companies in Kenya, which were Gazetted on 4th March, 2016. The new Corporate Governance Code replaces the Guidelines on Corporate Governance, and listed companies will have a transition period of one year from the date of gazettement to come into compliance.

The new code of governance is based on “apply or explain” principle, a paradigm shift from the “comply or explain” approach of their previous guidelines, which have been in place since 2002. The “comply or explain” approach lets individual companies to decide whether to follow set codes or not but the “apply or explain” approach requires companies to actually follow the set out corporate governance codes.

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.

The rules could not have come at a better time given the recent corporate malpractices that have been very costly to the public investors, for example:

1. CMC: The directors of the company were accused of maintaining a secret overseas slush fund account in the island of Jersey that received commissions related to the company’s operations, totalling Kshs 1.2 bn between 1977 and 2013, costing shareholders the said amount
2. Imperial Bank: The bank’s management is alleged to have been committing fraud over a period of 13 years between 2002 and 2015, and could have lost approximately Kshs. 34 bn. Including the potential Kshs. 2 bn bond issued just before it went under receivership, the potential losses to depositors and investors could well be over Kshs. 36 bn
3. Uchumi: The bank’s management is alleged to have caused the financial collapse of the retailer primarily due to insider dealings and conflicts of interest. The potential loss to investors from the market peak in 2013 at a share price of Kshs 23 to the current Kshs 5.4 is Kshs 4.7 bn.
4. Mumias: The miller is alleged to have collapsed due to poor management. The potential loss to investors from the market peak in 2006 at a share price of Kshs 19 to the current Kshs 1.6 is Kshs 26.7 bn.
5. Kenya Airways: The airline is alleged to have run into seriously financial solvency issues due to poor financial management and an unsustainable expansion strategy. The potential loss to investors from the market peak in 2006 at a share price of Kshs 124 to the current Kshs 4.5 is Kshs 179.3 bn.
6. Transcentury: The investment firm is in dire financial straits given unsustainable debt levels and questionable investment decisions into such like RVR. The potential loss to investors from the market peak in 2013 at a share price of Kshs 36 to the current Kshs 5.6 is Kshs 8.5 bn.

For a market with about 60 listed companies to have significant issues with at least 6 companies equates to about 10% of listed companies with corporate governance issues. That is a worryingly high statistic that should call into question our regulatory frameworks and their effectiveness. Collectively, investors in just these six companies have lost at least Kshs. 256.4 bn from their peak. The move to attend to corporate governance is crucial to the sustainability of our capital markets. Investors will not provide capital to a market where they believe that the rules are rigged against them. However, we are sceptical that the new code will have a material impact in enhancing the levels of corporate governance in the market unless we collectively address 4 areas:

1. First and foremost, is integrity and ethical behaviour 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 focussed on benefitting themselves rather than prudently running the company. Specifically, boards and management should never do business with their company, such as supplying and tenders. And 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. 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. 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, we cannot have a vibrant financial market without an independent, firm, fair and transparent regulatory framework.
3. 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 management? What is the tenure of the CEO – are they changing too quickly, on the other hand, have they staying too long? For example, the tenure of the Imperial Bank CEO, for 22 years, and the lack of diversity on Trancentury’s board, could have raised red flags that should have invited investors to further scrutiny.
4. Board oversight and competency: Boards need to ask themselves whether they truly understand what is going on in the company and practice healthy scepticism 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. We think that 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 or I am just seated here for the recognition and perks?”

In addition to the above four areas, where we think there is urgent need for address, we would also benefit from the traditional areas of governance such as:

• Good Board Practices: This would entail clearly defined roles, director remuneration procedures that are in line with the performance of the company, appropriate composition of board in terms of age, gender, ethnicity, global market experience and non-executive mix
• Effective Control Environment: A company needs to have risk management frameworks in place, disaster recovery systems, independent audit committee, media management policies and business continuity procedures which speak to how well the company is prepared for any eventualities
• Transparency Disclosures: The importance of companies disclosing both financial and non-financial information pertaining to leadership provides shareholders with tangible evidence to gauge how well their investment is being put into use as well as hold management accountable. This should also follow in line with up to date fillings, compliance with international standards and web-based disclosures
• Shareholder Rights: Being the recipient of all decisions that are made, companies should be diligent in how they treat their shareholders by ensuring clearly defined dividend policies, having well organized meeting structures and ensuring minority shareholders are represented in the overall decision making process
• Board Commitment: Boards are only as good as how much the leadership is invested in the success of the company. This come to play not only in the management having shareholding to improve their motivation to see the company succeed but also in how they place the company to be a corporate governance leader and the resources they allocate to implement corporate governance initiatives

We have a long way to go in terms of corporate governance but the frameworks that are being put in place are a good starting point to establish ourselves as a regional leader in corporate governance and its role in company performance. Kenya can borrow from a leaf from South Africa that have gone the extra mile and created a corporate governance index to track companies on their behaviour aside from good financials since 2004 with 82 companies currently being evaluated under the index.

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 right for the benefit of all Kenyans, or give it lip service for the benefit of a few unscrupulous players.