Corporate Governance, Risk Management and Corporate Social Responsibility in Emerging Markets: A Symbiotic Relationship

By Robert Adamson
Executive Director, CIBC Centre for Corporate Governance and Risk Management

As corporate governance continues to be an area of focus for most companies, regardless of whether they are involved in global operations, there are many questions and issues that firms still struggle with:  What is good corporate governance and why is it so important? Why are so many firms and governments promoting improved techniques in corporate governance? What are those techniques and best practices and is there evidence that these reforms and policies are useful for firms in promoting transparency, sustainability and the confidence of global markets and investors?

In general, corporate governance is about how companies make decisions, how they organize themselves and how they communicate with shareholders and the rest of the world. Typically, corporate governance deals with issues such as how boards and executives are chosen, what mandate and responsibilities boards and executives have,  whether shareholders have any right to participate in certain types of corporate decisions through voting and, if so, what form these shareholder rights take.

These issues are important because they promote good business practices, good decision-making and opportunities for investors to ensure the integrity of their investment. Because these issues are so important to developing good businesses and a good business environment, both companies and policy-makers are very interested in ensuring that good corporate governance is adopted widely and is effectively institutionalized throughout the firm.

So why are companies themselves so concerned and preoccupied with corporate governance, risk management and CSR? Many companies recognize that good corporate governance, risk management and CSR is good business practice, good business strategy and what many companies are focusing on to improve their business, particularly in the emerging global marketplace where companies are constantly trying to outdo each other to make their business more effective and to attract new investors. Companies, particularly those that are well-managed, want to develop good business practices, improve their decision-making and provide reasons for investors to invest in the company. While these firms are highly motivated and successful at adopting and implementing good corporate governance practices,  other companies may not acknowledge the importance and value of adopting and investing in corporate governance, risk management and CSR.

For those companies that refuse or fail to adopt good corporate practices,  this failure can have negative impacts not only for the company but for investors and the community at large. There are increasing numbers of examples where failures of corporate governance have created large liabilities for corporations and their shareholders. While not all of these problems can be linked to failures of corporate governance, many of them can. For example, the company Enron provides a well-known example of systemic problems within a corporation that could have been addressed by improved corporate governance. The recent oil spill disaster for BP also represents an example of how corporate governance problems within the company created a greater likelihood of a problem occurring. The global financial crisis is yet another example of how the failure of boards and executives to understand and manage risks led to governance failures with very serious consequences, not only for financial firms and banks, but for individuals and national economies around the world.

These are but a few illustrations of why corporate governance is important to businesses. Good corporate governance practices are an integral part of business strategy and help businesses make good decisions.

Because failures of corporate governance and risk management can have impacts that reach far beyond the company itself and lead to systemic harm for national economies, or even the global economy, policy-makers have taken a strong interest in passing rules and regulations that ensure that companies adopt good corporate governance and risk management practices. Governments increasingly do not want to take the chance on allowing firms to voluntarily adopt good corporate governance practices and policies. Governments are creating new regulatory frameworks to ensure companies improve their corporate governance.

And with the recent financial crisis as a new catalyst, policy makers have been identifying specific ways in which corporations need to do a better job of corporate governance. For example, policy makers have been passing very extensive and detailed laws on what corporations are required to do to improve the way they make decisions, manage risks, disclose information and give access to shareholders for certain types of corporate decision-making. National regulators around the world have been given extensive and detailed mandates to develop new rules and regulations that improve corporate governance. And firms themselves across all types of business sectors ranging from banking to extractive industries, are improving their own corporate governance institutions and processes, sometimes going far beyond what is required by law or what the new policies and regulations will require.

It is not only companies and policy makers that are focusing on the importance and forms of good corporate governance and risk management. Investors, particularly large institutional investors, are also focused on corporate governance issues in order to inform their investment decisions. Increasingly, institutional investors are identifying key corporate governance policies and practices that they want to see in order to attract their investment. Some institutional investors have requirements or benchmarks for corporate governance such that they are not permitted to invest in companies that do not meet those benchmarks. Paying attention to corporate governance issues is becoming an important part of investment decisions and the way that large institutional investors such as pension funds view their fiduciary responsibility when making and managing investment decisions.

Many companies around the world do not meet some of the basic requirements and benchmarks for what investors require in making their investment decisions. In some cases, companies have very few policies and practices on corporate governance and, even if they do, there is little transparency or disclosure about what those policies are. These corporate governance problems can be exacerbated in those countries where the legal environment provides very few corporate governance practices, few disclosure requirements and few shareholder rights. Together, these policies and practices create an environment where investors are unable or unwilling to invest in the firms and countries with inadequate corporate governance laws and policies.

It is not only potential investors that are constrained in their investment choices when corporations and countries have inadequate corporate governance laws and practices, the opportunities for partnerships and mergers and acquisitions are also limited. Many companies will be less interested in partnering with firms whose corporate governance is inadequate or not properly disclosed since this could expose the partnering companies to legal liability in their home jurisdiction if something were to go wrong.

These dynamics of corporate governance are global,  evolving rapidly and will continue to impact businesses around the world, including emerging markets. Companies in emerging markets should be aware of these trends and changes in corporate governance and ensure that they are keeping up with what governments, investors and businesses themselves are adopting and promoting as good corporate governance.

In fact, emerging market businesses have the potential to be leaders in promoting and adopting good corporate governance practices. With this objective in mind, it is important to identify the specific requirements and policies for how corporate governance is evolving, the policies and practices that are being adopted as best practices, and the various benefits and challenges in adopting these best practices in corporate governance.

How is corporate governance evolving: The Rules of the Game

Corporate governance is becoming more complicated, sophisticated and is providing both greater opportunities and expectations for businesses. To understand how corporate governance is evolving and changing, there are a few important ideas that are critical for businesses.

• Companies must not only implement general corporate governance practice but must focus on best practices in good corporate governance
• A key element of good corporate governance is good risk management
• Another key element of good corporate governance is managing a company’s reputation and how it is perceived in the global and local community

What is Good Corporate Governance?

Most companies have structures, policies and processes that create a governance process. Whether required by law or by the necessity to create a decision-making process, companies have created boards, committees of board,  management, and reporting processes. Some companies have gone beyond these basic governance requirements and have focused on types of techniques and processes that allow them to improve the quality of their boards, management team, and relationship with shareholders. In some countries, some of these governance techniques are required by law. In other countries, these techniques are chosen and implemented by companies not because they are required to do so by law but rather because companies believe that they add value and make good business sense.

Good corporate governance extends beyond the basic minimum of what companies need to make decisions and create a governance structure. Good corporate governance includes a much more sophisticated structure for improving decision-making and creating avenues for shareholder engagement. These good corporate governance techniques may include improvements in how boards are chosen and compensated, how management is chosen and compensated, how much information is available to the investors and the community at large, how companies identify and analyse risks including the disclosure of these risks, providing for shareholder voting on board election and management compensation issues.

While good corporate governance practices vary from company to company, and from place to place, there is growing consensus on what are best practices in good corporate governance. The OECD, for example, has provided a model for good corporate governance that companies can adopt. Beyond these OECD guidelines, companies operating around the world provide useful models in good corporate governance and set the standard for other companies in respect of what is possible for corporate governance practices. These examples of good corporate governance are particularly important since many of the corporate governance practices and techniques have been adopted because companies recognize the business value and strategy in investing in good corporate governance practices.

What is the relationship between corporate governance and risk management?

Risk management is increasingly becoming a key element of good corporate governance. Some corporations have developed sophisticated and institutionalized ways to ensure that risk is identified and analysed. Other companies have little or no risk management capacity. While risk management techniques require investment of time and other resources to properly address, they are critical to all businesses, even if the firm’s risk profile is relatively benign and simple.

Risks manifest in many forms, and can appear without warning and with serious and significant consequences. The recent global financial crisis is the most recent example of how risks all of types can appear with little warning and impact companies across all business sectors. Even though the main risks during the financial crisis were created within the financial services industry, the risks reverberated though almost all business sectors, and in almost all national economies around the world.

While it is impossible to eliminate risks, companies have been developing processes and policies to improve how risks are identified and analysed. These techniques of risk management may include:

• specialized committees of the board to deal with risk separate from accounting or financial risks,
• risk officers and other forms of institutionalized risk management professionals throughout the firm,
• enterprise risk management,
• management individuals or teams to deal with reputational risk, and
• specific attention given to macroeconomic risks that often do not receive attention. These risks may include political risks, and environmental risks such as the impact of climate change on a company’s costs, business model, regulatory framework and consumer demand.

Many companies have developed sophisticated forms of risk management that they believe are a worthwhile investment. It is these techniques of risk management that are increasingly becoming a key component of good corporate governance.

Corporate Governance, Reputational Risk and Corporate Social Responsibility (CSR)

CSR has also received a lot of attention particularly from firms who have encountered reputational challenges to their brand. While CSR is quickly becoming an integral part of some companies’ business strategy and corporate governance framework, others feel that CSR is not part of their business mandate of creating profits for the business and its shareholders? It is never simple to demonstrate the business case for CSR, but those companies who have adopted CSR policies and programs have done so on the grounds that it is a good business proposition. For many companies, investing in CSR policies and programs is a way to manage a company’s reputational risk, manage relationships between the company and shareholders and other stakeholders, and preempt potential problems in how products are produced, sourced and sold.

CSR is still a controversial and somewhat amorphous area that many businesses and management either reject as bad business practices, or do not fully understand what CSR is and how it can be implemented. Many businesses still have the following questions:

• What exactly is CSR and what policies and practices can be implemented and how?
• Is CSR a costly strategy?
• How have firms implemented CSR policies and what are the successes and benefits

For the firms that have embraced CSR, they view it is an important part of their business strategy. They recognize that it requires human and financial resources to create and implement, but they believe that it is a good business proposition and good business value. For some businesses, developing CSR policies and programs is not only about good business strategy, but also about ensuring that the communities where the company produces or sells it products or services are well-served by the company. These companies view the relationship with their communities, producers and consumers as symbiotic and mutually beneficial. Furthermore, many companies view CSR as good corporate governance as it allows companies to better engage with many of their stakeholders, including investors and consumers.

These rationales have motivated companies to develop various types of CSR strategies, policies and program. CSR takes many different forms and can be rationalized in many different ways by companies whether engaged in local or global business enterprises. Some examples of CSR policies include a corporate policy on CSR, policies on human rights, policies on sourcing and suppliers to ensure that the supply chain functions according to the company’s overall CSR policy, investments in communities such as schools and infrastructure, health and safety policies for the goods and services that the company sells to ensure that the business process does not create environmental or health “externalities”.

These policies require the allocation of human and financial resources. Even more difficult can be to integrate and infuse the CSR policies and commitments into the cultural identity of the company. Despite these challenges, many companies around the world have made these investments and have argued that it is good business strategy and a necessary part of their corporate governance framework. Even if companies and their management are not convinced on the merits of CSR as a business strategy and integral practice of good corporate governance, companies should remain open to further considering and evaluating the importance and benefits of CSR. More and more academic studies and company case studies are illustrating that these CSR policies bring significant benefits for the company, and assist it in managing reputational risk, improving relationships with stakeholders and improving the company’s corporate governance procedures.