Corporate Governance Code and the Role of Regulators

David A. Brown, C.M., Q.C.

May 5, 2009

Bahrain

Role of the Regulator Best Practices Implementation Process

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Overview

• Policy makers and thought leaders are turning their attention to corporate governance issues

• For three reasons Good governance works! Investors expect good governance Government social agendas

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Good Governance Works!

• Institutional investors recognize that good governance contributes positively to corporate performance Example – Canadian Coalition for Good Governance –

41 pension funds holding $1.4 trillion assets of Canadian public companies “good governance practices contribute to a

company’s ability to create value for its shareholders”

Corporate activist

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Investors Expect Good Governance

• Confidence in fairness has been shaken by recent events Corporate failures (Enron, etc) Global financial crisis

• Perception that inadequate governance contributed to the destruction of shareholder values

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Government Social Agendas

• Governments seeking to foster economic development Create jobs Create opportunities for wealth creation for

their populations

• Recognize advantages of a viable capital market Good corporate governance a cornerstone

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Particularly Important for Bahrain

• Relative infancy of capital markets• Historical and cultural background - survey

Companies owned by families or closely held Boards reflect ownership structures

More representative than strategic• Boards must evolve to align more with structures in

developed markets Fulfill several functions including oversight of

management, strategy setting, risk management• Assist establishment of a viable capital market

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Why is a Corporate Governance Code Necessary?

• To compete for issuers and investors, must have a viable capital market

• Issuers and investors must have confidence in the integrity of the market Fair and efficient access for issuers Safe environment; level playing field for

investors• Market reputation is critical

Must be seen as a fair place for investors to invest

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A Viable Capital Market

• Major determinant of a marketplace’s reputation for fairness will be the principles by which listed companies conduct themselves

• Compliance with a robust governance code is essential

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A Viable Capital Market

• Draft Bahrain Code captures the best practices that have been developed since the failures of Enron, Parmalat, etc.

• Adapts internationally accepted principles to the environment here in Bahrain

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A Viable Capital Market

• If the new Code is embraced and enforced by all of the principal players, Bahrain will be a viable competitor for investors and listings among competing marketplaces

• There will be tangible improvements in the businesses that adopt them

• Economic development will be enhanced

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Role of Regulators

• Pressure on regulators to provide marketplaces with a competitive edge From politicians

Benefits in fostering social change From market participants

Convenience – burden with complying with foreign regulations

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Role of Regulators

• Difficult role for regulators Very least – ensure regulatory systems not a

drag Probably pressured to go further – create a

favourable regulatory climate

• Not an impossible job Effective regulation and competitive markets

have common roots Both require fair treatment of investors

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Role of Regulators

• Must have investors who want to invest Climate in which investors confident of protection

against fraud, manipulation, unfairness Wide choice of listed companies

• Must have listed companies Efficient and fair marketplaces

Will be attracted by presence of investors Not if rules designed to attract investors place

unreasonably high regulatory burdens• Need an environment attractive to both sides• Real challenge is to maintain a proper balance

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Global Context

• Useful to examine your draft Code in the context of global corporate governance developments Explain why some principles evolved Discuss objectives sought to be achieved Underscore the desirability of implementing and

enforcing the Code

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Global Context

• Global pressures for governance reform Enron etc. collapses attributed, in part, to failures of

corporate governance Failure by boards of directors to provide

independent oversight of management Failure to ensure that external auditors provided

independent, objective review of financial reports Failure by companies to provide timely and

accurate information Rules and practices evolved to rectify these failures

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Core Principles of Bahrain Code

• Examine the principles of your draft Code against the background of this global evolution

• Focus on four key areas Empowering the board Role of the audit committee Protection of minority shareholders Compensation and incentives

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Empowering the Board

• Enron and other failures exposed serious issues about board effectiveness Boards had been comprised of competent,

experienced people; some with high profiles Yet, management wasn’t challenged Necessary stewardship wasn’t provided

• No one was protecting the best interests of the corporation and its investors

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Empowering the Board

• Global response to board shortcomings Require some degree of board independence from

management Clearly articulate the board’s accountabilities, duties

of loyalty Many countries have gone further

separate the roles of the chair of the board and the CEO

Require CEO and CFO certification of financial statements

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Empowering the Board

• Result Public companies are recruiting

knowledgeable, independent directors Legitimized conduct by directors

Questioning, probing management Holding management accountable

Now widely accepted as part of board culture

• Draft Bahrain Code incorporates these best practices

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Role of the Audit Committee

• External auditors had become too aligned with management Audit not a reliable independent, professional

review of management’s financial statements Auditors looked to management as their client

• Required a knowledgeable body, independent of management, to direct external auditors

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Role of the Audit Committee

• Global response was to mandate and empower an audit committee of the board Independent of management Members financially literate Audit committee rather than management

would become the external auditor’s “client”

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Role of the Audit Committee

• Result Audit committees are part of virtually every public

company External and internal auditors report to the audit

committee Boards are now allocating additional responsibilities to

the audit committee Danger that they will become over burdened

• Draft Companies Law and Code mandate and empower an audit committee

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Protection of Minority Shareholders

• Regulators recognize the importance to markets and economies of the entrepreneurial drive of family groups and other controlling shareholders

• For the most part, interests of controlling shareholders are aligned with the minority

• Corporate scandals exposed areas where controlling shareholders can use their position to advantage

• Need to find a proper balance

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Protection of Minority Shareholders

• Responses to these issues vary depending on local environment Universal requirement – all directors owe their duties

to the corporation and all of its shareholders All shareholders are equal

In many countries there are further protections Nominees of controlling shareholders are not

classified as independent directors Dealings with controlling shareholders must be

approved by independent directors• Draft Companies Law and Code adopt these provisions

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Compensation and Incentives

• Following Enron and other failures – recognized that form of management compensation could create perverse incentives

• Stock options seen as fostering short term outlooks Interests not aligned with shareholders

Particularly when awarded to directors Share ownership better aligns interests with

shareholders Many companies require directors to own shares

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Compensation and Incentives

• Still, properly designed compensation plans can be an effective tool for motivating management Some forms of incentive plans are here to stay

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Compensation and Incentives

• Global response in the post-Enron period Governments generally reluctant to legislate the form

or amount of compensation Instead required compensation committees of the

boards All or a majority independent of management

Required extensive public disclosure of management compensation Amounts and components Factors considered in designing compensation

• Draft Bahrain Code adopts these approaches

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Compensation and Incentives

• Recent economic crisis has exposed instances of compensation excesses Particularly in some financial institutions Incentivizing excessive risk-taking

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Compensation and Incentives

• Responses are still being formulated In the U.S., caps are put on executive pay in

corporations receiving government monetary support

“Say on pay” votes by shareholders

• Bahrain draft Company Law and Code require shareholder approval of executive compensation

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Comply or Explain Approach

• Rationale Alternative to US-based “rules” approach Principles based, flexible Allows companies to phase in, adapt to

specific circumstances

• Canada adopted a code and a comply or explain approach in response to Sarbanes Oxley

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Comply or Explain Approach

• Properly administered, comply or explain can be very effective

• Theory is that market forces will determine whether a company is following appropriate governance practices

• In Canada – market and peer pressure have prompted uniformity of adoption of all aspects of the code

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Comply or Explain Approach

• Success depends on effective, constant oversight by regulators Failure to address disclosure items “Boilerplate” disclosure

• Guidance; assistance to help issuers make appropriate disclosure available precedent

• After initial start up phase Regulators can issue public report highlighting

deficient areas of disclosure

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Comply or Explain Approach

• Targeted reviews of problem areas of disclosure

• Enforcement Require delinquent companies to republish correct

disclosure Fines, sanctions of directors and/or officers Delisting last resort punishes shareholders, not those responsible for the

failure

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Comply or Explain Approach

• Challenges Be wary of relying on the stock exchange to

police disclosure Possible confusion of responsibilities under the

Code Ministry of Industry and Commerce (MOIC) Central Bank of Bahrain (CBB) Bahrain Stock Exchange (BSE)

Should be a single authoritative voice

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Summary

• Compliance with a robust governance code is essential to a financial market’s reputation for fairness

• Draft Bahrain Code captures best practices that have been accepted by investors, listed companies and regulators around the world

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Summary

• As regulators you play an important part in ensuring that the Code is complied with

• If listed companies embrace the Code and you enforce it Bahrain will be a viable competitor for investors and

listings among competing financial markets There will be tangible improvements in the businesses

that adopt them Economic development will be enhanced

• Thank you

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Dialogue, Questions

• Dialogue

• Discussion

• Questions?

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Implementation Process

• Discussion of some of the provisions of the Code Some issues to watch for

• Review and discussion of precedent materials

• Dialogue and discussion