Corporate Governance and Organizational Behavior Review / Volume 3, Issue 2, 2019

INTERNAL AND EXTERNAL CORPORATE

GOVERNANCE MECHANISMS IN THE
CONTEXT OF THE EMERGING MARKET
Ali R. Almutairi *, Majdi A. Quttainah **
* Corresponding author, College of Business Administration, Kuwait University Kuwait
Contact details: College of Business Administration, Kuwait University PO Box: 5486, Safat 13055, Kuwait
** College of Business Administration, Kuwait University Kuwait

Abstract

How to cite this paper: Almutairi, A. R., & This review paper highlights the internal and external corporate
Quttainah, M. A. (2019). Internal and
external corporate governance
governance mechanisms in the State of Kuwait. It sheds light on the
mechanisms in the context of the emerging legal environment by which Shari’ah is a major source of legislation.
market. Corporate Governance and Since culture is influenced by religion, the ownership structure is,
Organizational Behavior Review, 3(2), 52- therefore, affecting legislation. Further, it discusses the market for
57.
http://doi.org/10.22495/cgobr_v3_i2_p5 corporate control, which is an important determinant of corporate
governance external mechanism. Due to regional geopolitical
Copyright © 2019 The Authors instability, disruption of the full implementation of corporate
This work is licensed under a Creative
governance and code of ethics is prevalent. Nevertheless, Kuwait is
Commons Attribution 4.0 International on the right path for the reinforcement of corporate governance and
License (CC BY 4.0). its code of ethics.
https://creativecommons.org/licenses/
by/4.0/ Keywords: Islamic Banks, Corporate Governance, Shari’ah Supervisory
ISSN Online: 2521-1889 Boards
ISSN Print: 2521-1870
Authors’ individual contribution: Conceptualization – A.R.A. and M. A.
Received: 20.04.2019
Accepted: 22.07.2019
Q.; Methodology – A.R.A. and M. A. Q.; Validation – A.R.A. and M. A.
Q.; Formal Analysis – A.R.A. and M. A. Q.; Resources – A.R.A. and M.
A. Q.; Data – A.R.A. and M. A. Q.; Writing Original Draft – A.R.A. and
JEL Classification: M41, G15, G21 M. A. Q.; Writing – A.R.A. and M. A. Q.; Visualization – A.R.A. and M.
DOI: 10.22495/cgobr_v3_i2_p5 A. Q.; Supervision – A.R.A. and M. A. Q.; Project Administration –
A.R.A. and M. A. Q.; Funding Acquisition – A.R.A. and M. A. Q.

1. INTRODUCTION Although Kuwait adopts capitalism as its

economy, the country is heavily relying on dual
The State of Kuwait is a country with several factors capitalism/socialism economy; two economies under
influencing policies, laws, and legislation. Shari’ah is one roof. The social-economic activities are
the main source of legislation. The Holy Quran and envisaged in the subsidies important basic food
the teachings of the Prophet Mohammed constitute items, as well as, but not limited to free healthcare,
Shari’ah, which is fundamental for all legislation, free education and free elderly care offered by the
policies, and laws. However, Shari’ah is not the only ministry of social affairs. Consequently, the oil
source of the overall commercial legislative system. revenue is a major source of government grants and
Kuwait is a member state in many different regional funding to the citizens. Despite the dual economies,
and global treaties that shape policies, legislations, Kuwait maintains an open economy with laws that
and laws. Traditionally and prior to the discovery of protect newly formed companies as well as
oil, Kuwaitis relied on primitive economic activities established national industries. Kuwait’s economy
such as glazing sheep, fishing, and diving for pearls. relies on imports, exports, investments, and most
However, the discovery of oil influenced the importantly the sovereign wealth funds. The latter is
traditional economic cycle. Such cycle switched from the government’s investment arm with diverse
basic and normative industries to sophisticated investments locally, regionally and globally. The
economic booms due to the transformation of the sovereign fund is the cornerstone for the socio-
oil production and related industries as well as economic development of Kuwait.
agricultural industries despite the desert climate. This review paper contributes to the
The latter is due to the government’s participation in understanding of the business policy and legal
economic development, which has been an environment in the State of Kuwait. Since Kuwait is
important source to foster and improve these considered a promising emerging market and its
industries and perpetuate their development. business system is almost identical to countries in

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 Corporate Governance and Organizational Behavior Review / Volume 3, Issue 2, 2019

its region, its uniqueness as a developing country in incentives to monitor companies and their
the world stems from the sociological dimension as management. Almutairi (2013) shows that ownership
its phenomenal economic growth. The reasons for concentration by Kuwaiti families maximizes
such uniqueness are exceptional ownership corporate value. Consequently, the legal
structure of corporations, and shareholders infrastructure of the financial sector in Kuwait is
activities. Although both said reasons are considered inefficient.
void in the absence of corporate governance Although Kuwait shares most of the
(hereafter, CG), administration in Kuwait initiated commercial characteristics of the Gulf Cooperation
important steps in the formulation and Council (GCC), the corporate governance codes in
implementation of CG. Hence, the paper is the first Kuwait are yet to be improved. The opaque nature of
to address the development and the progression of family ownership requires a highly reinforced need
the CG mechanism and the influence of religion and for corporate governance structure. This level of
culture. governance is required to address the principal-
The remainder of the paper is organized as principal and principal-agent problems that can
follows. Section 2 discusses the ownership structure arise. The former is prevalent among the controlling
of companies, and Section 3 discusses the market shareholders and minority shareholders. In some
for corporate control, the board of directors’ instances, shareholders may use the voting power
practices, and their remunerations. Section 4 sheds generated by their share ownership to manipulate
light on shareholders rights and shareholders companies’ management decisions. The latter is
activism. CG and firm performance and corporate prevalent in ownership structure known as “pyramid
social responsibility are discussed in Section 5 and ownership” in which high net worth individuals or
6, respectively. Section 7 discussed challenges and royal family members have stakes in various
limitations and Section 8 provides concluding companies in multiple holding companies and
remarks. company subsidiaries. This type of ownership
structure is prevalent in all of the GCC countries.
2. OWNERSHIP STRUCTURES OF COMPANIES IN Table 1 depicts the ownership structure of
THE COUNTRY corporations in Kuwait, the GCC, and Italy. They all
share the same characteristics of ownership
Participation in economic development has been structure. Nevertheless, Italy initiated reforms to
important to foster, flourish, and improve these ensure compliance with CG codes and ethical
industries and propagate their development. This standards. This control over companies that are
leads to exacerbated government’s ownership via listed on the Boursa Kuwait often generates
state-owned enterprises (SOE), which is hindering leadership duality where the Chairman also acts as
the enhancement of the legal system of the the CEO of the company.
corporate governance mechanisms due to the It is evident that corporations in Kuwait have
differences in the nature of SOE as compared to different ownership structures ranging from
privately-owned companies. The SOE dominance in government and family-owned corporations to
Kuwait provides citizens and residents with all individual and institutional investors. It is highly
required products and/or services, like water, prevalent that few shareholders control most of the
electricity, and subsidized necessary food items share ownership in Kuwait. The structure is reliant
(Boursa, 2015). Despite the fact that SOEs were upon the government and its agencies, institutional
established in Kuwait to facilitate subsidies for investors, family, and individuals (Alfaraih, 2012).
essential services and goods to contribute greatly to
the enhancement of the socio-economic conditions Table 1. Ownership structure
by providing jobs and training courses for nationals,
it is arguably by officials that attaining sound # Kuwait GCC Italy
Pyramidal √ √ √
corporate governance is by enhancing both internal Block-holding √ √ √
and external mechanisms through political, Institutional √ √ √
economic, and socioeconomic reforms (Biygautane et
al., 2018). As for public listed companies, overall, the 3. MARKET FOR CORPORATE CONTROLS (M&A)
ownership structure is characterized by pyramidal
shareholdings, large blocks, poor financial reporting, The CG Codes help in protecting the interest of the
weak transparency practices, unusual complex minority shareholders, especially when a change in
corporate structure, interlocking directorship, and corporate control is imminent. Revealing the rules
concentration of power in keyboard directors (Al- and regulations governing any possible acquisition
Musali et al., 2019). La Porta et al. (1999) and Arora of companies, as well as unusual transactions such
and Chong (2018) indicate that most of the as mergers and sell-offs of a large section of a
controlling shareholders (i.e., block-holders) of company, enables shareholders to understand the
companies in Kuwait are merchant families and the consequences and to protect their rights.
high net worth individuals who represent political Consequently, the clarity of transactions protects
figures or royal families that own dominant holding the rights of all categories of shareholders. The
and investment companies. The prevalence of board of the Boursa Kuwait pursuant to its
ownership concentration of companies is required resolution issued M&A regulations in 2015. The
by the authorities in Kuwait to disclose such regulations apply to the restricted offer or purchase
information. Additionally, it is common for non- of shares, as well as traditional or reverse takeover
merchant families to have direct, indirect or both offers. All regulations must be in conjunction with
controlling stakes in many corporations. This high the Listing Rules issued by the board of the Boursa
degree of family ownership propagates strong Kuwait (Boursa, 2015). Companies may merge with

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others that share the identical legal structure by governance system that has the capability to allow
which the merger is by either amalgamation and the transformation of control from inefficient to
consolidation or division and amalgamation. In efficient management teams. Furthermore, it
addition, members of the board of the company encourages a convergence of interest between
involved in the merger process have no rights to cast corporate management and shareholders.
their votes before the board meeting,
subcommittees, or the general assembly of the Table 2. M&A
company.
Nevertheless, board members may cast their # Kuwait GCC Italy
vote if their ownership in “a merger holds less than Antitakeover law X X √
5% of the shares that have voting rights in the Poison pill X X √
general assembly meetings” (Boursa, 2015). Boursa
(2018) states that companies who have an initial 3.1. Board of directors’ practices
agreement regarding a merger should be followed by
disclosure so that the authority has initial approval In Kuwait, corporate governance significantly
of the memorandum of the merger. When the influences and sustains a professional, healthy, and
authority approves the memorandum of the merger, safe environment for corporations in the process of
the authority officially announces the merger engaging and becoming effective members of the
resolution for the relevant parties involved in the world trade organization (Al-Wasmi, 2011). Hence,
mergers, “the Authority’s approval of the Draft such mechanisms of corporate governance enhance
Merger Contract shall be announced in at least two public firms’ financial performance, liquidity ratios,
daily newspapers, in addition to the other means set and on top of all the abilities to achieve financial
out herein” (Bourse, 2018). goals efficiently (Al-Wasmi, 2011). Consequently,
Disclosure is mandatory during an acquisition Kuwait’s corporate law is crucial to maintain
whether or not parties successfully finalized an excellent stakeholder relations. The responsibility of
initial acquisition offer agreement, and when the the board of directors is to raise corporate interest
offered company notices a crucially important offer first, even if this interest affects the (short-term)
via submitting an unconditional offer. Further, the interest of shareholders (Boursa, 2015). The board of
disclosure is mandatory when the responsible directors must generate a formalized strategy that
authority approves the offering document and when will be ingrained in all of the firm’s business
the offered company recommends addition or practices. This strategy must be in writing so that it
deletion of certain terms and conditions to the is readily available for review by all shareholders,
company that submitted the offer. It is as well particularly those who have significant holdings (i.e.,
mandatory to disclose the percentage and time block-holders). In addition, the board of directors is
period of the shares collected. Further to the latter,
responsible for creating policies relating to risk
the disclosure is required when all procedures for
management of the firm’s activities (Dawd &
the execution of the acquisition offers are
Charfeddine, 2019).
completed, including any crucial disclosure
A continuing process of review, revision,
requirement by the authority (Boursa, 2015).
improvement, and mandatory implementation is
If a conflict arises from shareholders or block-
central to this function. Further, the board of
holders due to the merger decision, the block-
directors is required to appoint a Compliance Officer
holders have the right to object by providing the
authority with official required documentation data under the company’s legal department to ensure
or documents deemed necessary to decide on the that the policies are not circumvented (Al-Wasmi,
grievance. Upon providing the necessary official 2011). Additionally, the board of directors’ roles
documentation, an irrevocable decision will be made include monitoring and controlling the behaviors of
by the officials of the authority within a twenty-day management and the implementation of their
period. If the plaintiff fails to hear from the business functions in order to ensure efficiency.
authority within a twenty-day period, it indicates Moreover, the board of directors must approve a
that the authority disapproved the complaint. This written CG policy for the company, oversee the
could be challenged before the judicial system in policy’s implementation, and monitor the level of
Kuwait within sixty days from the date notifying the compliance with the policy on an annual basis.
concerned parties (Boursa, 2015). The characteristics Further, the board of directors must draft a written
of the Kuwaiti capital market have significant code of business conduct, which states professional
governance implications. Table 2 depicts the and business ethical standards that serve to regulate
comparison of the antitakeover laws in Kuwait in the relationship of the company with its
comparison with the GCC and Italy. Table 2 shows stakeholders for protecting their respective rights
that Kuwait and other GCC have not yet adopted the (AlHaris et al., 2019). Despite the possibility of
antitakeover law or the poison pill. Nevertheless, agency problems and the considerable evolution of
Kuwait has addressed an important issue that the legislation relating to CG, a higher proportion of
proper disclosure is of importance during an listed companies have engaged in the process of
acquisition whether or not parties successfully adopting the recommendations of the CG Code.
finalized an initial acquisition offer agreement, and Due to the growing alignment between CG
when the offered company notices a crucially Codes, the characteristics of Kuwait’s board of
important offer via submitting an unconditional directors are increasingly similar to the best
offer. Consequently, the market for corporate practices at the international level. However, the
control is less prominent in Kuwait since takeover impact of insider shareholders on the board of
mechanisms are widely used. Therefore, the market directors remains a specific characteristic of many
for corporate control constitutes an important boards of listed companies in the Kuwait stock

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exchange. The ownership structure of the Kuwaiti decisions to be made without the approval of
listed companies is still very concentrated. shareholders and grant more and broader access to
Combined with an absence of active and pertinent information. Further, provisions include
independent institutional investors, the board is appointments and dismissal of managers as well as
selected by major or controlling shareholders. the board of directors and auditors. They also
contain more requirements on disclosure of
3.2. Directors' remuneration practices interests, mandatory takeovers, insider trading, and
related party transactions. Although these two
In compliance with regulatory requirements, chairs legislations still lack some elements, they definitely
of the board of directors are not allowed to chair embody a number of corporate governance-related
any committee unless they are appointed as provisions and provide more protections to
independent directors. Moreover, the chairman of shareholders’ rights.
each committee should be elected from among
independent members of the board and the majority 4.2. Shareholder activism
of the committee members should be of
nonexecutive members. The remuneration Shareholder activism refers to the extent that
committee recommends a numeration policy to the shareholders can influence firm policies and
board of directors, which includes all forms of practices through their ownership position. Activism
numeration schemes, including salary performance- can be defensive and offensive. In Kuwait, defensive
related schemes, pension schemes, share-based investor activism is common because of family
numeration, and severance pay. It also evaluates the entrenchment. However, offensive investor activism
CEO’s performance based on the company’s goals tends to be very limited. For example, in early 1997,
and objectives, as well as the company’s Al-Khurafi family group, one of the major
performance relative to comparable companies. shareholders in the KSE market built up a coalition
The remuneration best practices and policies of with other shareholders to acquire Al-Sahel Co.,
specific directors are aligned with the organization’s which was owned and controlled by Jasem M. Al-
long-term performance and risk as well as regulatory Saqr, an influential stakeholder in many KSE-listed
requirements. Such practices and policies are companies. After the acquisition, the coalition
reflective of the organization’s objectives and goals, removed Al-Saqr and his board of directors in April
considering the uniqueness and the soundness of 1997 due to poor performance and several law
the corporation’s operations and financial position. violations. In addition, in 2013, another coalition led
In addition, directors’ qualifications and by several family groups (e.g., Al-Marzouq, Al-
contributions to the success of the company Ghanem, Al-Nefisi, Al-Saqr, Al-Nisf, and Al-Khurafi)
constitute a major component in setting directors’ acquired Kuwait Finance House (KFH), one of the
remunerations. Most public companies in Kuwait major Islamic banks in Kuwait and MENA, and
disclose information about the total amount and nominated a new board of directors.
form of the compensation of top management and The limitation of offensive shareholder
directors, as well as the number of shares that each activism in Kuwait, especially from small
hold, in their annual reports or in the section of the shareholders, is attributed to many reasons such as
CG of their companies’ websites (CSR, 2010). All ownership concentration, restrictions on
public companies are required to provide the Capital shareholders’ rights, high threshold percentages
Markets Authority with detailed records of required for other shareholders’ rights, and major
management and directors’ compensations. shareholder being the manager of the company in
Concealing any personal benefits leads to serious most KSE-listed companies. Kuwait authorities and
legal consequences. The board can engage outside media still need to promote and encourage more
consultants or internal auditors of the organization responsible shareholder activism by domestic and
to identify the gaps within the remuneration process foreign shareholders.
and equity-based plans.
5. CORPORATE GOVERNANCE AND FIRM
4. SHAREHOLDER'S RIGHTS PROTECTION & PERFORMANCE
ACTIVISM
Corporate governance in Kuwait has become one of
4.1. Shareholder's rights protection the major concerns for investors since the 1982
crisis of Souk Al-Manakh stock market (unofficial
The 2004 International Monetary Fund (hereafter, stock market). Weak corporate governance was
IMF) report indicates critical concerns of Kuwait’s widely seen as contributing to this crisis. While
overall corporate governance and shareholder rights public companies in Kuwait have improved their
protections, in particular, minority shareholder corporate governance practices due to the
rights protections. At the time of the IMF report, enforcement of corporate governance laws, large
Kuwait had only one provision of minority private companies voluntarily have made serious
shareholder protection. To address the IMF changes to their corporate governance practices as
concerns, Kuwait has passed two legislations. The well (e.g., increasing financial transparency,
first legislation is a comprehensive Capital Market introducing structure to the board of directors).
Law (Law 15/1960) enacted in 2010, and the second These changes are attributed to the new guidelines
one is a major amendment of the Commercial of the Central Bank of Kuwait (e.g., Basel
Companies Law (Law 25/2012) (Boursa, 2015). These requirements), the requirements of the OECD
two legislations reserve certain decisions to corporate governance, the adoption of IFRS and the
shareholder meetings, prevent some executive greater level of globalization of Kuwaiti firms.

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In spite of the new wave of laws enacted to There are very few studies on CSR in Kuwait.
improve corporate governance standards, companies For example, based on a sample of 211 firms listed
in Kuwait have the lowest standards of corporate on Kuwait stock exchange in 2012, Al-Ajmi et al.
governance in the GCC (Gulf Countries Council) (2015) show that 49 percent of these companies
(Hawkamah, 2009). Statistics show that Kuwait, out disclose their corporate social practices. They also
of the GCC countries in the year 2009, ranked as one report that the level of social responsibility
of lowest GCC countries on “Competitiveness Index” disclosures is positively related to firm size and
(published by the World Economic Forum) and “Ease profitability and negatively related to government
of Doing Business Index,” (published by the World ownership. In Al-Shammari (2008), the disclosure of
Bank). Although the concept of corporate CSR is greater in firm size. Kamla (2007) indicates
governance is well known in Kuwait, some current that the quality of CSR disclosures in Kuwait, among
corporate governance regulations are irrelevant, and other Arab countries, is similar to the quality of CSR
some corporate governance mechanisms are either reporting in European countries.
weak or not well organized (Al-Saidi & Al-Shammari,
2014). Empirical evidence in general shows that 7. CHALLENGES AND LIMITATIONS
corporate governance practices, for example, lead to
poor corporate performance (e.g., Alfaraih et al., To further improve the CG and CG Codes, the
2012), or has no influence on firm value (Al-Saidi, legislature in the country should ensure sound and
2010). agree upon adopting the best CG practice.
Nevertheless, there might be a slight hindrance,
6. CORPORATE SOCIAL RESPONSIBILITY especially that higher proportion of the legislatures;
the members of parliament, are themselves
Although there is no mandatory CSR in Kuwait, merchants engaging in business transactions. Thus,
many public and private companies voluntarily reforms of laws will be unsuccessful without
disclose their CSR practices. The annual report of reforming the legislative body of the country. With
multinational and local companies in Kuwait such reforms, soundness and transparency will
highlights to what extent these companies engage in improve the overall environment. Leading to the
CSR. The incorporation of CSR in these companies implementation and embracing the best CG Codes
has shown a positive outlook on social activities. In and practice.
Kuwait, an annual CSR conference is held to A major limitation is the conflicting data
promote the incorporation of CSR within businesses between government organizations/agencies. Hence,
and to offer companies suggestions and data could have provided a clearer picture of the
recommendations on how to enhance performance. existing internal and external CG mechanisms.
The CSR conference honors companies that
contribute to communities with annual awards. 8. CONCLUSION
Healthcare, education and financing aid and
charitable trust are the major domains that local It is evident that the State of Kuwait is one of the
companies contribute to communities. Within the few last countries that enforced CG regulations.
first domain, companies fund construction projects Prior to the enactment of the CG law in 2016, Only
of hospitals, medical centers as well as purchasing the banking sector in Kuwait exhibited more CG
medical equipment and tools. For example, Zain, a practices. However, post-June 30th, 2016, nationwide
multinational telecommunication company, enforcement of the CG law subjected all companies
sponsored and supervised the construction of Zain to abide and adhere to the new CG law. The
hospital for Ear, Nose and Throat. In addition, increasing significance of the role played by banks
Kuwaiti Projects Company (KIPCO) sponsored a and investment companies in Kuwait toward
campaign on dyslexia to increase the awareness developing the country as a regional financial hub
among students and professionals, and Kuwait emphasizes strengthening the principles of CG. The
Finance House (KFH) donated KD 1.250 million for regulation and oversight of investment companies
the construction project of 15 motorway ambulance have shifted from the Central Bank of Kuwait to the
centers. Capital Markets Authority as of September 13th,
As for the education domain, local companies 2011.
reach out to students and educational institutes to Although the regulators in the State of Kuwait
educate on environment pollution, provide training initiated the reforms during the 1990s; specifically,
workshops and internships and develop discipline in 1997, via many different programs such as
and personal skills. For instance, EQUITE, a privatizations and liquidating government’s
multinational petrochemical company, sponsored ownership whether, in SOE or Semi State-Owned
educational and research programs and provided Enterprises, it is evident that the geopolitical
scholarships and awards for higher education. influences disrupted the fulfilment of the CG
In the financing aid and charitable trust regulations and code of ethics. Furthermore, to
domain, companies donate money from their foster CG practices in banks, the Central Bank of
accounts to official trusts and charitable Kuwait applied Basel II capital standards on
organizations. Some companies allocate a fixed December 31, 2005, and then Basel III capital
percentage of their annual sales to charities such as standards in 2014 with full implementation in 2016.
Kuwait Red Crescent and Kuwait Zakat House. For As for the investment sector, many companies
example, Kuwait Foreign Petroleum Exploration voluntarily adopted numerous principles of
Company (KUFPEC), donate to the devastating corporate governance.
drought crisis in Somalia and Pakistan flood victims.

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