Corporate governance By Ikram Sehgal

One of the better initiatives of the State Bank of Pakistan (SBP) is to encourage financial institutions to adhere to the "Code for Corporate Governance" framed in 2002. While the SBP is mostly concerned with monitoring financial institutions, the code is applicable for all corporate entities. The most tangible step has been the establishment of the Pakistan Institute of Corporate Governance. Appointing Zahid Zaheer, a respected corporate executive as its head, shows positive intent and seriousness of purpose. Hopefully the institute will train independent directors structured corporate responsibility, and they in turn will translate this into ensuring (1) a fair return for the investors and (2) a merit-oriented professional environment for all the employees.

Zafar A Khan, a former chairman of Engro and the Karachi Stock Exchange (KSE), and presently chairman of PIA, has written a useful booklet on corporate governance in which he says: "Good corporate governance is focused on how companies should be directed and controlled so as to prevent pilferage, misrepresentation, insufficient disclosure, selective siphoning, favouritism etc. one should also address efficiency, value addition, transparency, social responsibility etc. based on high ethical behaviour. The essential prerequisite is to have an "effective board". The best positioned stakeholder to make that happen is the controlling shareholder. An enlightened controlling shareholder who values efficiency, fair play and long-term sustainability will encourage the formation of an effective board. This is particularly important in emerging countries where the controlling shareholder invariably has a dominant majority and often the influence to play above the rules.

The controlling shareholder could be the government, a multinational or a family. Zafar Khan's past performance speaks for itself. One only hopes that his basic decency as a human being will not deter him from carrying out due accountability of how PIA's scarce resources were squandered in the past.

A functioning board focuses on high-level policy decisions and is not involved in the day-to-day management of the corporate entity. Being on the boards in the corporate manufacturing sector one has as one's colleagues salaried bureaucrats, and as directors representing various development financial institutions (DFIs) which hold equity. With honourable exceptions, they may be fine human beings but as is their forte and training, bureaucrats tend to get involved in micro-management. This must be the responsibility of the senior management. The function of non-executive directors is macro-management, to oversee senior management and hold them accountable, ensuring and certifying that internal control systems are effective, that they comply with the policies and procedures approved by and as required by law or regulation.

Directors should be chosen for their skills and experience, and their potential for contributing to board discussions, and not waste the time of private sector entrepreneurs on petty details, who unlike them are putting their money where their mouth is. A clear division and delegation of authority in the relationships between the management and the board must be defined, as well as between the board and shareholders and other stakeholders. Independent directors must establish substantial weight of non-executive opinion on the board. A strong voice beyond the ranks of management and insiders. This strong, challenging and independent element will allow exercising of objective judgment and maintaining of checks and balances to equalise the influence of management and significant shareholders. Transparency and disclosure will enable stakeholders to assess financial performance and fairness in the treatment of all stakeholders. One form of blackmail of the minority bureaucrat directors is to write copious protests about micro-affairs, effectively freezing the working of the board.

Although shareholders have the right to appoint directors, the obligations of each director are owed to the bank as a whole, and not to a particular shareholder alone as the bureaucrats appointed from DFIs seem to believe. Consider this, on the one hand the government is carrying out privatisation because the public sector has no business being in business, on the other hand Pakistan is the only country in the world where public sector salaried executives with no entrepreneurial skills run riot over the majority in the board. According to the guidelines given for good corporate governance independent directors should constitute at least one-third of the membership of the board, with at least three independent, non-executive directors. Similar should be the ratio for all corporate entities.

An independent director is one whose directorship constitutes his only connection and whose judgment therefore is unlikely to be influenced by external considerations. An 'independent' director must not be the employee of any public sector corporate entity for the present or for the preceding three years, not an immediate family member of an employee or director, not receiving payment from the entity (other than as a director), not a director or owner of a company with which the entity does business, and is neither a significant shareholder (i.e. less than 5 per cent) of the entity nor affiliated with one. One salaried executive from one DFI should be enough, the other DFI representatives must be professionals selected from the market. It is useful to bring senior members of corporate management teams into the meetings of the board so that board discussions can receive the benefit of their insight and experience in increasingly technical issues.

Directors must be limited to serving on the board of not more than three public companies; some of our DFIs have their chief executives (CEs) and other senior management bureaucrats on dozens of boards in the private sector. The claim to fame of most of them is not merit but being "friends of someone in power". This is meant to avail perks from the board of tens of companies. In one case it is reported that a chairman of a DFI gets as much as Rs20 million annually under the table that is why everyone fights over the post. In any case CEs of DFIs have no business being on any board of any corporate entity.

We have a lot of laws in Pakistan mostly they are not adhered to by vested interests. One of the areas where the implementation has been excellent is the banking industry, while giving due credit to the SBP for the results that are very visible economically, the public companies also need to be brought into the ambit of corporate governance. There should be no lip-service about it! Pakistan is a land of tremendous economic opportunity and regulated through concerted corporate education we can force-multiply our potential.

The writer is a defence and political

analyst. Email: isehgal@pathfinder9.com

Why corporate sector lags behind SHADAB FARIDUDDIN

ARTICLE (May 28 2007): This article furthers the debate initiated by Mr J.M. Shaikh and printed on May 12 on the reasons behind the corporate sector's stunted growth. Any study of a society is incomplete without considering the processes of wealth creation its people adopt. Processes of economic undertakings become identities of nations, societies, people and even individuals.

America is the "consumption powerhouse" of the world, China the "manufacturing hub", India the "global IT and outsourcing giant", Nigeria the "the nation of scams and scandals", Dubai the "trading centre point", Hong Kong and Singapore the "financial services hubs". Then there are epithets like "the Asian Tigers" and "emerging economies" that paint the character of the economic evolution of these societies.

Dr Ishrat Husain, ex-governor, State Bank of Pakistan, is one of the finest economic brains in the country. In a masterly exposé, 'Pakistan: economy of an elitist state', Dr Ishrat has revealed the true character of wealth creation processes in our country.

Active ingredients of the grow-rich formula in Pakistan are tax evasion, labour exploitation, opportunism, scams, short-sightedness and silo mentality, speculation, and special favours. Sadly missing in action are fundamentals such as vision, caring and sharing, customer service, consumer care, ethics, equity and a sense of societal contribution.

One category of elites is business tycoons that grow into politics. They are of the Nawaz Sharif ilk. Originally industrialists, they were nurtured by army dictators. They reached their ultimate goals when they gained political power and became prime ministers, federal ministers and ministers of state. The second type of elite consists of politicians who become business barons such as Chaudhry Shujaat and Asif Zardari.

Essentially feudalist in character, they built their business empires on power graft, craft and cronyism. As political robber barons, they gradually achieved forward integration of landholdings with agro-based industries, thanks to easy bank loans and concessions. Their means of earning maximum profits come from hoarding, import permits, price manipulation and government tenders.

Both these corporate types inherently lack the ingredients to become global economic forces. Political corporate outfits lack the strength of business fundamentals, and hence, by definition, are like seasonal lilies, flourishing when founders are in power, floundering when they are not. Because of higher uncertainty, both corporate types have a greater business continuity risk, which makes them unattractive for collaboration in the eyes of true foreign investors and businessmen.

True business families stayed clear of politics and focused on what they do best: creating value. The Habibs, the Shirazi Group, the Adamjees, the Rafis and the Mians remained committed to the cause of business and wealth creation by risk-taking and enterprise much like their Indian counterparts such as the Tatas and Birlas. However, the economic space available to true business leaders in our country has shrunk over the years.

This is not to say that the two politico-business types don't exist in India. Our neighbour has its own fair share of examples of the scandalous nexus between politics and business. However, there is one critical difference: India's enviable continuity of democratic governments never let the Indian army become an unwieldy, fearsome business empire as in Pakistan. Democracy and constitutionalism effectively checked the army's drift into the business of business.

The huge economic space was thus filled by the expanding private sector, which learned to manage big operations needed to cater to huge internal markets. The Indian corporate sector grew organically in terms of its capacity to manage the economies of scale, which is a pre-requisite of global expansion. As against this, the army's camel entered the businessmen's tent in Pakistan. This third category is thus the elitist of all elites in Pakistan's economy.

The army business empire is immune to the vicissitudes of business cycles: when faced with recession, it can always fall back on the public exchequer to support itself. This assertion is evidenced by the fact that all businesses of the military have steadily grown, even when other actors suffered during economic recessions in the last two decades.

It can be argued that there are some industries such as defence production in which the army's involvement is justified. Yet, the military industrial complex spans retailing, real estate, banking, insurance, airline, livestock, commercial agriculture farming, information technology, infrastructure construction, lower and higher education, bottling water, leisure and recreation, fertiliser and chemicals, power generation, trading, pharmaceutical production, healthcare and many other areas of economic activity.

These outfits are so sacred that they can't be "privatised", that is, sold to more efficient private sectors in Pakistan or abroad. They crowd out the private sector when it comes to getting public procurement. As a result, private enterprises do not learn to manage the economies of scale.

Military businesses enjoy special concessions in terms of taxes and duties that helps them outdo the others. They collude among themselves to keep rivals out. In this scenario, private corporations in Pakistan are unlikely to grow big enough to become global outfits.

Will we, instead, see internationalisation of our army's businesses to compete with the Indian global giants? Unlikely. The only legitimate area of international cooperation, and thus globalisation, is where the army's core capability lies: defence production. We may see a global corporation emerge.

Two assumptions underlie the desire: the looming diplomatic sanctions over the A.Q. Khan fiasco don't come into force and competitors like Sweden, France, the US, Russia, China and Ukraine let us play fairly in the global market!

The government-business relationship shaped two different types of economic behaviour in India and Pakistan. In India, the corrupting nexus did not come about as in Pakistan. The government was either not supportive of businesses or was indifferent. It did not resort to selective use of public policy. Public resources were not directed towards private gains. Tax evasion, debt write-offs, special concessions to political cronies did not become widespread in India. There were well-laid-out rules, howsoever restrictive and cumbersome, by which the businesses learned to play.

The swadeshi (self-sufficiency) movement was integral to India's independence struggle. It protected indigenous industries, helped them grow organically and created pride in the "made in India" label. Successive governments and political leaders lived and breathed the swadeshi movement, demonstrating their commitment to the principle by using Indian products and produce. The political leadership shaped the consumption and production behaviour of its people.

We were about 40 years late in realising the vibrancy of indigenous business. When the 'be Pakistani, buy Pakistani' slogan was raised in the late 1980s, two things happened. First, the slogan did not sink in well with the masses because the leader who raised it did not live it.

Second, the nation's negative attitude towards Pakistani goods had already been shaped. Preferences for foreign labels meant that local goods would not generate enough demand to justify investment in plant expansion. Manufacturers became traders. Phony foreign goods flooded the markets. Bara markets sprang up. Economic incentives for investment dwindled. All this meant that even genuine local manufacturers could not grow large enough to prepare for global expansion.

Government-business ties in Pakistan have always been politically motivated. Politicians used power to further their own business interests. Power in the hands of politicians meant punishment for business competitors. The world's second largest ship-breaking industry was ruined so that Ittefaq Foundries could prosper. Ships carrying scrap for Ittefaq were not allowed to unload their cargo at the port.

Not to be left behind, army rulers have used fiscal policy and public infrastructure expenditure to build and strengthen their own business constituencies. The Frontier Works Organisation is awarded contracts to build virtually all mega projects announced by General Musharraf. Knowing fully well that it cannot execute them all, it has sub-contracted them to private construction companies!

Patterns and types of labour exported from the two countries also explain why Indian companies are now global while ours remain stunted. Apart from the numbers going abroad for jobs and other reasons, the qualitative difference stems from the nature of skills that went abroad and became part of the expatriate communities of the two countries.

For historical and demographic reasons, more Indians now live abroad than Pakistanis. However, a critical difference lies in the composition of the two expatriate communities and the economic roles played by them. India exported brains; Pakistan sent out brawn.

Educated well, Indians sought white-collar jobs in the fiercely competitive corporate world of Europe and the US. Their skills and competence carried a much higher price tag compared to those of Pakistani labourers. Indians progressed more rapidly up the socio-economic ladder as compared to the blue-collar Pakistani workers.

With the advent of knowledge economy, the mind, as the source of value generation, commanded premium. The Indians benefited. Emphasis on good education paid off. Many rose to become CEOs of Fortune 500 companies. The linkages they developed, the competence they nurtured, the respect they commanded and the wealth they accumulated spilled over back home and came in handy in the globalisation of Indian corporations.

Remittances by the Indian labour class were used more judiciously than those by Pakistanis. By nature, Indians are more mature in money matters than Pakistanis who are given to conspicuous consumption. A higher portion of remittances went into building up the national savings rate and thus ploughed into the productive investment in India. The Indian government also strictly discouraged the import of consumer durables, garments and electronics.

Pakistan suffered on both counts. Being a new nation, Pakistan lagged behind in producing enough professionals. Nevertheless, the way we squandered billions of dollars sent home in the last four decades by toiling Pakistani expatriates is criminal. Assuming a plausible average of one billion dollars a year, we may well have received over 30 billion dollars since 1975, when work-force exports really picked up thanks to Zulfikar Ali Bhutto's vision and diplomacy.

Overseas Pakistanis don't have shareholding in local businesses; they do not have businesses of their own either. The industrial landscape of Pakistan lacks meaningful participation by overseas Pakistanis. No wonder our businesses remain stunted and don't have a global face to show.

__________________
Time is like a river.
You cannot touch the same water twice,
because the flow that has passed will never pass again.
Enjoy every moment of life.

I have learnt silence from the talkative, toleration from the intolerant, and kindness from the unkind; yet strange, I am ungrateful to these teachers.

Building corporate sector

By Shahid Javed Burki

MY article in Dawn (‘A stunted corporate sector’, February 13, 2007) on the reasons why the corporate sector in Pakistan had not developed to the point where it could play a part in the global economy provoked some debate in the columns of some newspapers. This is heartening since the subject needs to be looked at carefully and policymakers need to address some of the obstacles the corporations face that affects their healthy development.

Public policy has a major role to play in the development of the corporate sector in the country. Without the creation of a supportive environment, Pakistani companies will continue to languish in the margins of the global corporate business.

The subject is of interest at this time not only because of its history but because some members of the corporate community have begun to walk the corridors of power once again in order to seek protection from international competition. This is particularly the case with the textile industry, the country’s largest industrial sub-sector.

Should the state intervene to prop textiles or should it be left to face the winds of foreign competition? What is the role the exchange rate policy should play in aiding the sectors that rely on foreign markets for a good part of their sales?

These are important questions and they may be taken up in the budget for 2007-08. But the current travails of the textile sector were not the reason for me to write on the subject of corporate Pakistan.

I was prompted to write the article after watching the recent developments of large corporations across the border in India. Some of them have become global in scope, acquiring assets in both the old (steel) and new (information technology and pharmaceuticals) sectors in the developed world. Why were Pakistani companies totally absent from the global field, was the question I raised in the article.

There are several reasons why the corporate sector in Pakistan has failed to develop world class companies. Among the two that are most important was the nationalisation of large industries and financial companies in the early 1970s and corporate dependence on the government for support particularly during their lean periods.

I held the nationalisation programme carried out by the administration of Zulfikar Ali Bhutto to be an important reason for the stunted growth of the corporate sector. I suggested that the banking sector in particular would have done well had it been allowed to continue in the private sector.

In 1974, when the banks were nationalised some of them had developed to the point from where they were looking to move to Europe, the Middle East and other parts of the developing world. Penetrating the Middle Eastern market at that time would have been an extremely fortunate development since, in the early 1970s, the countries in this region were about to launch a massive programme aimed at economic development and modernisation.

Had the Pakistani banks been present at the start of the process that saw the economic transformation of the Middle East, they would have gone on to become global players in the world of finance.

I singled out the United Bank Limited as one institution that had developed a large Pakistani presence on account of the exceptional entrepreneurship of some of its managers. In the early 1970s it was poised to go global but then the Bhutto administration struck. Some of the bankers who had grown with the UBL went on to play significant roles in the banking world.

Most notable among these was Agha Hasan Abedi who founded the Bank for Credit and Commerce International, the BCCI. While the BCCI had an unhappy ending it launched many banking careers for bankers from Pakistan. It also laid the foundations for the development of the banking sector in the countries of the Gulf. Some of these banks entered Pakistan once the banking sector was reformed and the process of privatisation was launched.

The banks, once in the public sector following their nationalisation, lost the dynamism they had acquired during the period of Ayub Khan. They were used to favour the friends and supporters of whichever regime happened to be in power. As was the case with other public sector corporations, they were forced to hire staff they did not need. Little attention was paid to the examination of loan applications that were received; much of the lending was done without due diligence.

Consequently by the end of the 1990s, most public sector banks were groaning under the weight of non-performing loans. Some of them have still to fully recover.

My singling out the nationalisation of industry and finance as the single most important factor for setting back the development of the corporate sector was not appreciated by Tariq Islam, a nephew of Zulfikar Ali Bhutto, who contributed a spirited article to the pages of this newspaper in April.

The article was meant to honour the late prime minister on his death anniversary. “ZAB has been much maligned for his economic policies and nationalisation programme,” he wrote, “Pakistan was ruled by the famous 22 families who held complete monopolistic sway over the economy. Together they owned industries and the banks, disbursed loans to each other and controlled the means of production and supply. The poor were becoming poorer, they were without a voice, without hope, without a future.”

The “sway” of the 22 families over the country’s industry and finance is exaggerated. There was a serious analytical flaw in the conclusion that Mahbubul Haq drew from the numbers at his disposal when he delivered his famous “22 families speech”. His data referred to the distribution of assets among the companies listed on the Karachi stock market.

It was a bit of a stretch to extend that conclusion to the entire economy which is what he did for the sake of a greater political impact of his limited finding. This is also what Tariq Islam did in his article. However, it is not my intention to relive that controversy.

What I would like to stress though is that nationalisation is not the right remedy for correcting the concentration of economic power, in particular concentration in the sectors of industry and finance. What is required is intelligent public policy aimed at creating regulatory mechanisms that would not only check concentration but also encourage competition.

The debate on the working of the corporate sector has been joined by several other contributors who have enriched the discourse which, I hope, will also begin to interest the makers of public policy in Islamabad. In his thoughtful article published in Dawn on May 12, J.M. Sheikh, questioned my focus on the 1972-74 nationalisation as the turning point in the development of the corporate sector.

“No, nationalisation was not the unmitigated disaster that Mr Burki and others make it out to be,” he wrote. Instead he assigns much higher significance to the way the sector was being managed and believes that nationalisation, while it may not have been the ultimate solution, gave the system the shock it deserved. He suggests that Prime Minister Bhutto’s policies introduced many reforms in the corporate sector. This was particularly the case in bringing in and encouraging the introduction of professional managers into the nationalised industries.

“The demand for professional management increased with nationalisation and this was met with both thorough in-house training as well as by public service institutions”, writes Mr Sheikh. I suppose by “public service” institutions, he means the civil and later the military bureaucracy that supplied the nationalised industries a great deal of manpower.

In his contribution to Dawn on May 19, Shadab Fariduddin focuses on the negative role being played by the military’s growing economic interests in the country. “It can be argued that there are some industries such as defence production in which the army’s involvement is justified,” he writes. But the military has gone much beyond and penetrated the sectors in which it does not have any comparative advantage. It “spans retailing, real estate, banking, insurance, airlines, livestock, commercial agriculture, information technology, infrastructure construction, lower and higher education, bottling water, leisure and recreation, fertiliser and chemicals, power generation, trading, pharmaceuticals production, healthcare and many other areas of economic activity.”

The military’s involvement in the economy is not unique to Pakistan. It happens in both developed and developing countries. In the United States, for instance, the Corp of Engineers has a significant role in the development of infrastructure. Much of the intricate levee system along the Mississippi River was built by the American army. The Chinese People’s Liberation Army, the PLA, has extensive business interests in several sectors of the economy. The military is deeply involved in the economies of Argentina, Chile, Egypt, and Turkey.

What creates problems is when the military “unlevels” the playing field. That appears to be happening in Pakistan and is the subject of a recent book length study by Ayesha Siddiqa. To quote once again from Mr Fariduddin, “military businesses enjoy special concessions in terms of taxes and duties that help them outdo the others. They collude among themselves to keep rivals out. In this scenario, private corporations in Pakistan are unlikely to grow big enough to become global outfits.”

Public policy has also given the state the role of the nurse for the private corporate sector with the government stepping in to provide support when the companies should have been left to fend for themselves. To extend the medical metaphor a bit, the industrial policy pursued by the country in the first three decades of independence made the state become the midwife, watching and helping the birth of private sector companies. This created what economists call “path dependence” which has survived to this date.

Path dependence happens when economic matters continue to pursue the course of action that have produced satisfactory results in the past. According to this line of thinking, what has succeeded in the past should also work in the future. There are currently demands emanating from the textile sector for support since it has failed to deal with the competitive environment created by the end of the Multi-Fibre Arrangement that had provided protective space to the exporters in the markets of major importers.

Public policy needs to address these issues. It needs to balance the demands of the citizenry for the provision of goods and services it needs at affordable prices as well as the requirement that the corporations in both the public and private sectors can face external competition. I am sure the discourse on the subject will continue and would contribute to the formulation of intelligent public policy aimed at developing an efficient corporate sector that can become global. Such policy must also protect public interest.

__________________
Time is like a river.
You cannot touch the same water twice,
because the flow that has passed will never pass again.
Enjoy every moment of life.

I have learnt silence from the talkative, toleration from the intolerant, and kindness from the unkind; yet strange, I am ungrateful to these teachers.