Unchanging Gears of Corporate Governance in a Changing World Ethics and Compliance

Corporate governance (CG) is a form of governance that ensures that an organization’s relations with all its stakeholders are carried out according to the principles of fairness, transparency, accountability and responsibility. We are all aware that this form of management, which we keep on talking about, is necessary for the future of organizations. Well, have you ever thought about how this necessity emerged? While understanding how this necessity is formed and what it is helps us to better understand the principles and tools used in implementing this management philosophy, it also shows us that faking it (which is the most frequent disease in our region) is not beneficial for organizations in the long run.

Let’s quickly remember how the need for corporate governance arose. Companies grew, from single-partner structures to multi-partner structures and their capital increased. As they grew, the number of employees, customers, suppliers, banks they worked with, and the lawmakers they accounted for increased too. As the number of the owners increased, in other words, as the ownership structure spread, problems began to emerge. Since it was not possible for the people who owned and managed the company to stay the same, a new position emerged – a person who did not actually own the company but acted like a boss: CEO.  The situation that I have briefly described, has been evolving in different ways in  different cultures and geographies over a long period of time and continues to evolve.

On one hand, company owners and other stakeholders and on the other hand, another party that was managing the company and having all the information about the company, emerged. Certain mechanisms were needed to prevent this asymmetric information from being used against the stakeholders. This assymetry gradually triggered the emergence of the concepts of transparency, accountability, responsibility and fairness, all of which are the main pillars of corporate governance and started to create its own tools.

While this is an important aspect, it is necessary to mention another aspect, namely that some of the companies have the structure which is not dissipated but, for some reason, they have small partners beside the dominant partner. The first aspect concerns large and international companies where the capital is deepened, while the second aspect concerns family-owned business which we are familiar with in our region and where other family members usually have the right of minority and are ruled by a dominant partner.

If you think of a scale between these two extremes, we can say that, at one end there are companies with the separation of ownership and control with the subsequent lack of audit risk, while at the other end, there are companies with majority shareholders with the risk of violation of minority rights.

Are you aware of the potential problems with varying degree of severity which could be caused by ownership and management on this scale? The cure for these potential problems is the proportionate implementation of corporate governance principles. But what do you think is the root of these problems? Before giving the answer, let’s take a brief look at what is said about “ethics and compliance“ in the OECD principles of Corporate Governance.

Board of Directors applies of high ethical standards and manage all parties’ interests

The Board of Directors has an important role not only because of its decisions but also because of its general responsibility for company’s ethical environment which it realizes through the assignment and supervision of key executives. High ethical standards which make a company more respectful and reliable are beneficial for the company not only in the sense of daily activities but also in long-term commitments. It is useful to build corporate rules based on the code of ethics and to inform the staff about these rules to make the board’s aims clearer and more understandable.

The code of ethics forms a framework for conducting business judgements on contradictory issues in companies. The code of ethics should establish, at a minimum, clear policies and procedures on how to behave when the personal interests and company interests conflict. While “compliance with law” is a requirement and a red line for every company all over the world,  the aim of “the code of ethics” is to create an environment,  beyond the compliance, where a culture of integrity in doing business is encouraged.

Reporting mechanism and non-retaliation policies
Unethical and illegal practices do not only infringe the stakeholders’ rights, but also damage the company and its shareholders from the reputation point of view and may create unexpected financial liabilities. Therefore, a retaliation mechanism and a non-retaliation policy should be established.

An environment should be created to ensure that employees and all other stakeholders can report the unethical or illegal practices they encounter to the company’s board of directors and/or the relevant public institution freely and easily.

Ethical disclosures and transparency
A strict disclosure policy which encourages real transparency is a critical element for companies which should be monitored by their shareholders and stakeholders. Inadequate, weak and non-transparent disclosure may lead to unethical behavior and, consequently, to loss of confidence in the market as well as high costs for both the company and the whole market.

Disclosure of code of ethics 
In addition to their commercial goals, companies are encouraged to publicly disclose their policies and performances related to social issues and their business ethics, environment, human rights, other public policy commitments, in case those are important for the company.  That information helps some investors and stakeholders to evaluate the relationship between companies and their business environment.

Conflicts of interest
In order to ensure proper implementation of the CG principles, all areas of conflict of interest should be managed and explained openly. The risk of conflict of interest can occur in many areas. For example, the transactions between the group companies in structures with majority shareholders are particularly susceptible to abuse. The important point here is not to ban such transactions, but rather to manage them properly, to supervise such transactions and to disclose them in a transparent manner.

Above, I have tried to touch upon the important issues that are stated in the OECD CG principles which concern ethics and compliance issues.

Now, let’s revert to the aforementioned scale indicating the problems and potential difficulties. Corporate governance requirements and practices are typically influenced by an array of legal domains, such as company law, securities regulation, accounting and auditing standards, insolvency law, contract law, labour law and tax law. Corporate governance practices of individual companies are also often influenced by human rights and environmental laws. While these laws are constantly changing due to various reasons in different markets, and while all stakeholders try to understand and adapt these laws, why do the CG principles refer to ethical conducts and underline that these conducts are initiatives that are beyond the laws?

The key to a ”good” business environment where all stakeholders want to live is the trust. Commercial success can only provide short-term happiness while trust is long-lasting. Trust stems from honest work environments where business ethics are considered important. Honesty is like a glue that hold a company together with all stakeholders, and if it is damaged, the relations will be torn apart and won’t mend easily again.

In this region, where everything changes at an unbelievable pace and where we could not give a good account of business ethics and honesty, the concepts and practices of corporate governance as well as ethics and compliance have become more important than ever.

What do you think it would be like to implement the principles of corporate governance in an environment where there is no business ethics?