Dr Madhav Mehra
President World Council for Corporate Governance

Courtesy of World Council for Corporate Governance

(Part 2 of this article will appear in the July - August 2008 issue)

Corporate governance has been commonly regarded as essentially an issue of statutory compliance of company law and listing requirements; at best an exercise in management of risk. Understandably, therefore, it has fostered a culture where effort is directed on “how not to get caught”. World Council for Corporate Governance founded on the core belief of shared prosperity goes beyond shareholder issues and advocates engagement with all stakeholders with a view to enhancing overall corporate value. The Council believes that shareholder returns cannot be improved if other stakeholders are not taken care of. It is the customers and employees who create most of the wealth for the company. Linking business purpose with larger societal purpose helps to align the corporation and human resource.

Rapid and accelerating advances in science and technology are transfiguring the work place as never before. New era possesses immense capabilities, tremendous increase in productivityenhancing technologies, efficiency enhancing corporate systems, innovation-spurring mechanisms and cost lowering globalisation which can work synergistically to open endless possibilities. It is empowering the customers and employees, democratising the social, economic and political institutions and creating a sustainable relationship between environment and the human kind. Social and psychological engines fired by the knowledge era are changing the way we do business.

This transformation is wreaking havoc on the institutions, creating chaos, causing disruption and disequilibrium. It is demanding a very high level of accountability from individuals and institutions specially the corporates. Directors are facing strobe-like glare of public scrutiny and have become a besieged lot. Criminal proceedings have been launched against the directors in many countries for corporate irregularities and punishment fit for Mafia dons are being awarded for corporate crimes. Directors of Enron and WorldCom have had to reimburse company losses from their own pocket. Jakarta has put Richard Ness, the President of US gold giant, Newmont Mining Corporation on trial on criminal charges of pollution of its gold mine. Bernie Ebbers, chairman of the defamed WorldCom has been awarded 25 years of prison sentence. At his age of 63 this virtually means a life sentence, the hardest sentence for any economic offence. Earlier 80 year old founder, John Rigas of Adelphia Communications Corporation received a 15 years prison sentence. His son Timothy received 20 years.

Harsh sentences meeted out to Bernie Ebbers, John Rigas and his son Timothy Rigas are reminders that public expectations of the conduct of business have risen sharply. They don’t expect boards to be simply compliant through box ticking. Boards have to be competitive and responsible. The issues of transparency, equity, integrity, accountability, inclusivity and corporate responsibility are competitive differentiators in the knowledge economy.

Economic growth cannot be sustained without embracing the vast multitudes living in abject poverty and addressing the alarming depletion of finite natural resources. With globalisation businesses have a global constituency. They cannot ignore the imperatives of social transformation. Corporate directors need to be radical and revolutionary to fulfil the competitive agendas of business, social and ecological transformation. They have to adopt a triple bottom line approach of enhancing financial, social and environmental capital by constantly spurring their organisations towards creating new competitive spaces through a spiral staircase of innovation.

The frequency and enormity of corporate frauds, sharpening inequalities, increasing poverty, deteriorating environment and rising terrorism are reminders that despite all the scientific advances, mankind is descending deeper into despair. This poses a huge challenge and an opportunity for the business to take the lead. They have to harness the technology to innovate products, services and models that satisfy the needs of all stakeholders. For the first time in human history business has the power and technology to make a difference in human lives. Corporate Governance is an instrument that can unleash the unlimited potential of the markets to realise this goal and create prosperity for all.

The role of business today is far more pervasive than ever before. Its constituency is global. Power of the … companies are not machines owned by individuals to make as much money as possible for its owner. They are living beings having their own purpose. In a millennium survey, 60% of those interviewed said they would punish companies which were not environmentally or socially responsible. This shows how social good has become a powerful competitive differentiator. MNCs has arisen enormously in the new era. There are over half a million foreign affiliate corporations in the world. The largest 100 multinationals $2000 billion in foreign assets outstrip the combined GDP of China, India, South Korea, Malaysia, Singapore and Philippines. Today, it is the economy that drives politics. It is the business that drives governments. Business is shaping the social values and also becoming a powerful cultural force. The political system has failed to address the human problems of inequity, poverty and terror. The governments of today and politicians particularly, have lost the moral authority. For the first time in human history, the business has the power to make a difference to human lives and can fill the vacuum eminently.

Global corporations today are facing enormous geopolitical challenges. As the businesses expand and their operations extend beyond their borders they have to transcend their parochial mentalities. Of the 100 biggest economies in the world 51 are transnational corporations. What sets them apart is that their constituency is global which enables them to capitalise on the inherent advantages of knowledge economy and constructively engaging with diverse stakeholders.

One of the greatest debates is on what is the purpose of the company. Arie de Geus in his book, “The Living Company” argues that companies are not machines owned by individuals to make as much money as possible for its owner. They are living beings having their own purpose. Companies are not controllable but influencable through complex interactive processes which are just as likely to alter the influence as the influence. He defines a living company as one that exists primarily for its own survival and improvement in order to fulfil its potential and become as great as it can be.

Charles Handy has discussed the changing “meaning of business”. A business, he writes, “is no longer just an economic instrument.” Part of the reason can be found in its purpose. “The principal purpose of a company is not to make profit, full stop. It is to make profit in order to continue to do things or make things, and to do so even better and more abundantly. To say that profit is a means to another end and not an end in itself is not a semantic quibble; it is a serious moral point.” The simplistic view that prevailed in the 1990s that business leaders need to focus exclusively on shareholder value as determined by the share price and that financial analysts are the best judge of business strategy simply cannot hold ground today. In a millennium survey 60% of those interviewed said they would punish companies, which were not environmentally or socially responsible. This shows how social good has become a powerful competitive differentiator. Business run on true principles of transparency, equity, accountability, integrity and responsibility can make a difference that could give enormous pride to executives and provide the true incentive for driving the corporations.

Once corporations internalise that their profitability depends on the public perception of the difference they make to the society, governance of corporations will become easier. Boards will rise up to meet the expectations of all stakeholders. Only then will our focus shift from rhetoric to implementation and we will realise that what we need most urgently is not more codes but training to change our beliefs, ideas and attitudes of how things will work in the new era. This is why there is an urgent need to change governance strategies and get directors truly on board. The wrenching change taking place all around cannot allow directors to remain aloof and leave the job to management. Boards today have to be proactive and not pliant, intrusive and not quiet, radical and not staid, innovative and not incremental.

The dean of Oxford University’s School of Management Studies, John Kay argues in his book “Foundation of Corporate Governance” that a firm’s network of social and business relationship can provide it with a competitive advantage over other companies. One recent poll found 95% of the Americans agreeing with a sentiment long shared in Europe and Asia: Corporations owe a larger debt to society than simply making profits. One reason why this is true is the growing recognition of an independent, networked society in which business plays a key role. James Moore’s “business ecosystem” model, for example, along with such concepts as industrial ecology, stress that corporations are not narrow institutions distinct from the social contexts in which they are embedded. The recognition among business leaders that they cannot thrive if their surrounding ecology is perishing is already leading many companies to broaden the scope of their activities. “Ten years from now, I am firmly convinced,” Moore has concluded, “business leaders will be actively and daily addressing social and environmental issues.” This insight will help corporations find innovative ways to contribute to broader needs of society by collaborative problem solving. Businesses have to find new models of constructive engagement involving all stakeholders to bring about change in the society. The question no longer is whether the business has a role in social change but how it should play this role.

Our corporate attitudes can change only by making the boards diverse. Diversity is the wellspring of creativity. It is the diversity that generates a clash of ideas that in turn fosters innovation. It is the innovation that provides the grist to company’s mill. Innovation cannot be nurtured unless the corporations consciously encourage dissent. The value today is created not by conformity but diversity; not by deference but difference. Darwin told us in 1859 that growing a variety of crops improves the yield. We have still not applied this to humans. What the 21st century boards need is training to harness the differences.

Diversity is vital for the knowledge economy. When knowledge is shared the resultant gain to the parties depends on their diversity. Greater the diversity, more is the aggregate value of knowledge. Knowledge societies have no role for yes-men and thinkalikes. This has transformational value for the societies and nations hitherto clinging to their own race, caste, region, religion. Realisation that the value increases not by cloning of same but cooperating with the opposites will begin the end of the hatred spurred by the accidents of birth and mark a new era of ethnic integration.

New economy has seen massive transition to private economies. There is a considerable rise in the volunteerism and the social sector. America today has 1.5 million nonprofit organisations that employ over 10 million peoples and account for 7% of its GDP. UK has over 300,000 charities. More and more young graduates are moving to voluntary work. NGOs in China have grown from 100 in 1950 to 200,000 today. Social consciousness among young has become so heightened that 40% of MBAs in a survey said they would refuse to work for an irresponsible business. 80% said they would accept a lower pay for a company that was “very socially responsible”. The generational divide is obvious.

Transparency also has to be viewed as a competitive differentiator because it enables the company to access capital. One of the greatest benefits of globalisation is the instant accessibility to global capital. The biggest owners of capital in the world today are not cigar smoking Monaco based capitalists. They are state employees and ordinary insurance policy holders. The largest single pool of capital in the world is the $ 144 billion California Employees Pension Fund called CALPERS. The second largest is the $130 billion pension fund of Dutch civil servants & teachers, ABP of Netherlands. Worldwide pension funds and general insurance companies between them own assets which are ten times the entire value of the UK stock market and about one and a half times the value of the US stock market. They invest as much as $2.7 trillion, almost twice the entire value of UK equity investment, on socially responsible companies. The criteria for these investments are employment practices, transparency, environmental, social responsibility, sustainable material, no animal testing, human rights etc. India does well in all these areas yet does not receive even a fraction of this investment. This investment has increased 10 fold in the last four years i.e., from $ 30 billion to $ 326 billion in UK alone. Even if 5% of this investment is diverted to India our FDI would increase seven fold, thus having a transformational effect on our economy.

FAO’s latest hunger report says starvation, humankind’s oldest enemy, still lurks in large parts of the world. Well after a decade of globalisation, hunger is actually on the increase. According to UNDP’s latest Human Development Report 799 million Indians are still below the poverty line earning less than $2 a day. The great IT revolution has not touched the poor. Even US, the world’s strongest economy is amidst a poverty trap. According to the latest Census Bureau figures 37 million people in US are living below the poverty line, up 1.1 million from 2003. The bottom fifth of US householders receive only 4% of the national income while top fifth receive about half of it. 82% of the expanding export trade is enjoyed by the top fifth quintile of world wealth. Bottom fifth enjoys only 1% of its expanding export trade.

FAO’s report links hunger with AIDS. It shows that countries with a high prevalence of chronically hungry people are also afflicted by high rates of HIV / AIDS. World’s AIDS graph shows a steady increase of the number of deaths on account of AIDS. The figure last year went up by 3 million. After infecting 28 million people in Sub Saharan Africa, AIDS is advancing steadily towards Asia and East Europe. 1.8 million people are living with AIDS in the countries of Eastern Europe and Central Europe. Total number of people living with AIDS has increased to 40 million.

All this shows that the maxim of capitalism, on which the globalisation was based, that the free markets would lead to universal growth through free competition has been proved wrong. The levelling that was expected due to the great trickle-down effect has not materialised. In fact the inequalities have sharpened both in the developed and developing countries. They have increased by 2% since the Uruguay Round in developing countries. The world is witnessing a new phenomenon called “jobless growth”. In 2001-2002 the monthly per capita consumption expenditure in rural areas of India rose a mere 0.7% over that in 2000-2001, while consumer price index for agricultural labourers, a measure of their cost of living, went up 2.23% pushing more people below the poverty line. Poverty means powerlessness, voicelessness, vulnerability, disease, fear.

Large parts of the world are being increasingly disenfranchised. It is purposeless waste to have 40% of world population in abject poverty with unused capacity in 20% of it. Test of the progress is not whether we add more to the abundance of those who already have too much, it is whether we provide enough to those who have little. It is the disparity that drives people to desperation. People can live in poverty but cannot stand injustice. These disparities are a time bomb waiting to explode and pose the greatest threat to the security of business. This is especially true in India where 54% of the population is under 25. Most of the unemployed are under 30. The business should have vested interest in thinking of revolutionary ways to remove the widening gap. It was John F. Kennedy who said in his inaugural address back in 1961: “If we do not make a peaceful revolution possible we will only make a violent revolution inevitable”.

Throughout 2004 World Council For Corporate Governance has drawn corporate attention to the widening gap between rich and poor and the governance strategies required for bridging it. We have repeatedly argued that the socioeconomic disparities are a serious threat to the security and sustainability of business. The business should have a vested interest in thinking of radical ways to draw the poor in to the market economy and reassure them that globalisation will equally work for them.

We are living in a world characterised by gruelling poverty and unused capacity. Large parts of the world are being increasingly disenfranchised. 40% of the world is in abject poverty whereas 20% owns hugely excessive resources. Such disparities amount purposeless waste and owe its origin to outmoded business models, short term approach and grass greed. This is an outcome of bankruptcy of imagination and lethargy of innovation. There is an urgent need, therefore, for a fundamental rethinking of our business paradigms, and overhaul of its structure and reward system to align it with the requirements of knowledge economy.