According to the centrepiece of our company law, the Companies Act 2001, shareholders are the ones who set out the rules, that is to maximise their profits, in the running of the public company. Abroad however, the premium is placed on the relative importance of job security versus dividends for shareholders. The question one is called upon to ask is whether, given this, the public company works with an eye to what society expects from it
If we go back to the run-up of the financial and economic crisis of 2007-08 in most advanced economies, it looks as if something has gone amiss. For, had it not been so, how could some of the world’s most important financial institutions have governed themselves so poorly as to precipitate the severe crisis whose repercussions are still being felt till today, and not only in the countries of their domicile? Questions arise as to whether the autonomy companies enjoy in their governance should be reviewed permanently and kept under closer scrutiny by the authorities, taking into account their impact – positive and negative – on wider society.
The case of Air Mauritius
Let us consider the case of Air Mauritius. Global aviation industry is exposed to international competition. Competition in the industry has kept intensifying globally since the first decade of the 21st century. Against such a backdrop, for several reasons, the national airline faced terrible headwinds during this period, severely depleting the company of its resources. The fleet of its aircrafts could not be renewed, as it should have been, due to these internal turbulences, including perhaps mismanagement. The resulting ageing aircrafts of the company carried with them additional cost implications, let alone loss of competitive edge vis-à-vis other better-equipped carriers serving the same routes. Air Mauritius’ share values plunged on the stock exchange reflecting its diminished prospects.
But the concern with the deteriorating situation was not limited to shareholders’ interests as reflected in the share price. Flight delays and cancellations due to mechanical failures shifted passengers to other more dependable airlines. When other carriers limited their service to our destination, due to their own profit-seeking on alternative routes, did we as a country not face difficulty filling up our hotels? Did this not affect recruitment in our hospitality sector? Did not the taxis which serve the tourists face difficulty? All of this happened because everything is connected in economic activity. Failure of one leads to loss for others as well. This is why limiting corporate social responsibility to funding one NGO or other having a given social objective, fails to address a much bigger societal issue as to how companies should be better governed in the wider public interest.
What corporate governance is about
When companies fail to hold together as they should, the damage done to the rest of the economic architecture needs to be also reckoned with. There is more to it than the interests of shareholders and managers of companies who may be affected. That is the reason corporate governance as a general principle of governance of companies assumes an even greater importance for companies generally. In their 2000 paper, ‘Financial Contagion’(The Journal of Political Economy), Douglas Gale of the University of New York and Franklin Allen of the University of Pennsylvania define ‘corporate governance’ as “the set of arrangements that determine a company’s objectives and how control rights, obligations and decisions are allocated among various stakeholders in the company”. Note the use of the word ‘stakeholders’.
In the general economic context of companies, stakeholders are not limited to shareholders and managers of companies. They include creditors, employees, customers and clients, government regulators and wider society.
One just needs to ponder whether the financial crisis of 2007-08 affected only the shareholders and executives of the concerned financial institutions which unleashed the catastrophe. Did not governments have to pour in enormous amounts of taxpayers’ money to salvage the systemically important failing banks? Did not huge numbers of citizens lose their jobs and houses? Are not the repairs still being done to this day, with no clear answer yet in sight? The entire world is hanging in suspense, which way the scales might tip, even today.
Improving decision-making in company boardrooms
Yet, the decisions were taken in company boardrooms and executive offices, without consulting outsiders, sometimes employing the power of lobbies to overrule financial regulators themselves. Companies made themselves even less accountable. Interest and exchange rates were rigged by their traders, having worldwide global market implications, that too, even after the international crisis had set in and damaged so many economies so deeply.
What did they undertake behind the screens of their boardrooms? Responding to short- term objectives of numerous footloose shareholders, company boards and management exacerbated the misalignment between private and social objectives by indulging in excessive risk-taking.
The finance companies unreasonably blew up their credit advances to customers, including in cases where repayment capacity was highly in doubt. They acquired artificial assets to make their books appear spick and span on the surface. On the back of all this, shareholders voted generous dividends to themselves not supported by real earned returns while executives got into exaggerated remuneration packages for themselves without identifying clear sustaining business prospects.
The need for greater interference by governments and regulators
We can only hope in Mauritius that deep holes have not been punched into the finances of our own finance companies in a similar manner, unbeknown to the wider public. If anything significant on this front, are only the financial institutions at risk or are their depositors at even greater risk? Situations like this are fraught with danger and all assurance providers – such as internal and external auditors, company audit committees, boards, regulators, et al – need to satisfy themselves that there are no dragons lying asleep which can wake up uncontrollably.
If at all it was necessary in our case to demonstrate that company decisions have much bigger implications beyond the confines of the company, we only need to refer to recent the downfall of the BAI group, which has had terrible country-wide repercussions on creditors, employees, investors, customers and insurance policy holders. And the general business environment of the country.
There has always been some amount of difficulty to reconcile private versus public interests in the running of companies. Companies would have us believe that, since they contribute to employment and earnings in the economy and it is the shareholders who risk their money, they must be allowed to “mind their own business”. On the other hand, governments and regulators have learnt that companies do not function solely at their own risk; they can often mismanage themselves to the point of threatening to bring down other companies and the entire economic edifice, not only of the countries in which they are incorporated but just as well in other places due to globalisation.
Companies have greatly evolved from their strictly unlimited liabilities status in the middle of the 19th century in England, under which shareholders risked losing their very livelihoods in a bid to pay up for all the liabilities incurred by their companies. Thereafter, the argument tilted in favour of the higher risk-taking limited liability company associated with the multiplication of companies coming in the wake of the Industrial Revolution and in the post-industrial revolution era. Unbridled accountability associated with excessive risk-taking by the latter companies led to the disaster we saw in 2007-08.
The world’s governments and regulators have learnt the lesson from leaving companies to manage their own affairs as contemplated under the Reagan- Thatcher liberal free-for-all scheme. The costs of this kind of minimum controls regime can be huge and extensive to society. It would not be surprising if the 2007-08 crisis had some roots in there. This is one reason why company regulation is becoming tougher even in the advanced economies, to bring the animal back under control.
Companies contribute no doubt to raise the level of activities and social well-being in individual economies. But, unless tightly controlled, the additional risks they keep raising for the sole interests and short-term appetites of their shareholders and executives, can spread out to the economic spectrum and it can take numerous miserable years to do the repairs.
A balance has to be struck at all times between the degrees of freedom accorded to companies to realise their full potential and the amount of prudent control they should always be subjected to in order to protect what is called the “public interest”. This is no reason to bring in an “unease” of doing business. There are parameters to safely reconcile private and public interests for the good of all without burdening companies with heavy bureaucracy. Rules must be firm and clear to contain the risks posed to society as a whole.
Anil Gujadhur, former Deputy Governor BOM & Chairperson FSC