Corporate Governance

and Best Practices

 Corporate Governance

“Corporate governance is about promoting corporate

fairness, transparency and accountability.”
J. Wolfensohn, President - World bank, as quoted by an article in Financial Times, June 21, 1999

Corporate governance is the system by which business corporations are directed

and controlled.
The corporate governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board,
managers, shareholders and other stakeholders, and spells out the rules and
procedures for making decisions on corporate affairs.
By doing this, it also provides the structure through which the company objectives
are set, and the means of attending those objectives and monitoring
performance.”
(Cadbury, OECD, April 1999)

Source : Dr. Hareendra Dissa Bandara Director – Financial Services Academy Securities & Exchange Commission of Sri Lanka
 Corporate Governance

• Corporate governance broadly refers to the mechanisms,

processes and relations by which corporations are controlled and
directed.

• Governance structures and principles identify the distribution of

rights and responsibilities among different participants in the
corporations. (ie: Board of directors, Managers, Shareholders,
Creditors, Auditors, Regulators, and other Stakeholders)

• It defines the rules and procedures for making decisions in

corporate affairs
 Corporate Governance
History
• The roots of the modern corporate governance movement dates back to the
publication of ‘The Modern Corporation and Private Property’, by Adolf A.
Berle and Gardiner C. Means in 1932.
• However, corporate governance received much attention during the last two
decades owing to certain economic reforms in countries and accidents of
economic history such as regional market crisis and large corporate debacles.
• Becht, Bolton and Roell (2005) identify these reasons as
– World wide wave of privatization of the past two decades;
– Pension fund reform and the growth of private savings;
– The takeover wave of the 1980s;
– Deregulation and the integration of capital markets
– East Asian crisis in 1998; (Thailand , Tom Yum Goong crisis)
– Series of recent scandals and corporate failures in United States of America
(Enron…)
 Corporate Governance
Sri Lankan Context
• Sri Lanka too is not immune from these developments and
problems relating to corporate governance.

• The private sector dominated by the corporate form of entities has

become a significant economic force with introduction of open
economic policies in 1977

• On the other hand, there had been a few isolated incidents of

corporate failures , (Bankruptcy of Pramuka Bank in late 1990s and
the downfall of Vanik Incorporation)
 Corporate Governance
DEVELOPMENT OF CORPORATE GOVERNANCE BEST PRACTICES IN SRI LANKA
• The development of corporate governance structures and practices in Sri Lanka dates back to the British Colonial
rule.
• Most of the corporate entities presently listed on the CSE also have roots dating back to British era.
• Therefore, the development of corporate governance best practices in Sri Lanka has been heavily influenced by
British models and systems, which derive from the Anglo- Saxon (market based) model of corporate governance.
• Even businesses progressed after gaining independence in 1948, the traditional loyalty to this model did not fade
away mainly due to the professional biasness towards this system and development of Sri Lanka’s company law
based on the British company law.
• The development of codes on corporate governance best practices began in Sri Lanka in late 1990s based on the
developments that had taken place in this respect in United Kingdom (UK).
• The first Sri Lankan corporate governance code was introduced in 1997 by the Institute of Chartered
Accountants of Sri Lanka (ICASL) for listed companies.
• This was a blueprint of the Cadbury Code (1992) - Financial Aspects of Corporate Governance, the first code of
corporate governance introduced in UK and the first code of best practice developed based on the Anglo-Saxon
model of corporate governance.
• The Cadbury Code deals with the structure and responsibilities of the board of directors; the role of auditors; and
the rights and responsibilities of shareholders.
• The 1997 Code was replaced by the ICASL Code of Best Practice on Corporate Governance introduced in arch
2003 and it was largely based on the Hampel Report (1998).
• Its focus is much larger than of 1997 code as it covers many aspects of corporate governance covering directors,
shareholders and auditors

Source: CORPORATE GOVERNANCE DEVELOPMENT IN SRI LANKA: S. Senaratne, P. S. M. Gunaratne

 Corporate Governance
• UK had gone a long way by introducing Combined Code (2003) which superseded the Combined (Hampel) Code
(1998), by deriving from three other codes that had been developed between 1998 and 2003 to deal with several
specific aspects of corporate governance –
– Turnbull Report on Internal Controls (1999),
– Smith Report on Audit Committees (2003) and
– Higgs Report on Review of the Role and Responsibilities of Non- Executive Directors (2003).
• Sarbanes- Oxley Act was introduced in USA in 2002 aftermath of the collapse of Enron and WorldCom.
• The essential characteristic of these Sri Lankan codes is that they were voluntary codes of corporate governance.
Hence, they were only recommended to be followed by the listed companies.
• There were a number of supplementary codes to ICASL Code to deal with specific aspects or areas of corporate
governance.
– ICASL Code of Best Practice on Audit Committees 2002
– Code of Corporate Governance for Banks and Other Financial Institutions 2002 - CBSL
– Guidelines for Listed Companies in respect of Audit and Audit Committees 2004 - SEC
• The rules on corporate governance have been incorporated into the CSE Listing Rules from 2007 and made
mandatory for listed companies from April 2008.
• ICASL jointly with SEC issued a Revised Code of Best Practice in October 2008 and 2013 to be complied
voluntarily by companies in conjunction with the mandatory rules.
• Central Bank of Sri Lanka has also issued a mandatory code of corporate governance - the Banking Act Direction
No. 01 of 2008 on Corporate Governance for Licensed Commercial Banks in Sri Lanka in April 2008, which banks are
expected to comply fully by 1st January 2009.

Source: CORPORATE GOVERNANCE DEVELOPMENT IN SRI LANKA: S. Senaratne, P. S. M. Gunaratne

 Present Corporate Governance in SL
At present the corporate governance
practices of Sri Lankan listed
companies are governed by the
mandatory corporate governance
rules included in the CSE Listing
Rules.

ICASL Code of Best Practice (2008)

will provide the basis for the
development of corporate governance
practices that are not covered in these
rules.

Companies are also required to

comply with the provisions of the
Companies Act No.07 of 2007 on the
appointment and removal of directors
and auditors.

Listed licensed commercial banks

have to comply with Central Bank
Direction on Corporate Governance
Source: CORPORATE GOVERNANCE DEVELOPMENT IN SRI LANKA: S. Senaratne, P. S. M. Gunaratne
 Corporate Governance – Cadbury Report
• The Cadbury Report, titled Financial Aspects of Corporate Governance, is a
report issued by "The Committee on the Financial Aspects of Corporate
Governance" chaired by Adrian Cadbury that sets out recommendations on the
arrangement of company boards and accounting systems to mitigate corporate
governance risks and failures. The report was published in draft version in May
1992.
• The central components of Cadbury Code, are:
– There should be a clear division of responsibilities at the top, primarily that
the position of Chairman of the Board be separated from that of Chief
Executive, or that there be a strong independent element on the board.
– The majority of the Board be comprised of outside directors.
– Remuneration committees for Board members be made up in the majority of
non-executive directors.
– The Board should appoint an Audit Committee including at least three non-
executive directors.
 Corporate Governance – Hampel Report
• The Hampel Report in 1998 was designed to be a revision of the corporate
governance system in the UK. The remit of the committee was to review the Code laid
down by the Cadbury Report (now found in the Combined Code). It asked whether the
code's original purpose was being achieved. Hampel found that there was no need for a
revolution in the UK corporate governance system. The Report aimed to combine,
harmonise and clarify the Cadbury and Greenbury recommendations.
• On the question of in whose interests companies should be run, its answer came with
clarity.
• 'The single overriding objective shared by all listed companies, whatever their size or type
of business is the preservation and the greatest practical enhancement over time of their
shareholders' investment'.[1]
• The Hampel Report relied more on broad principles and a 'common sense' approach
which was necessary to apply to different situations rather than Cadbury and Greenbury's
'box-ticking' approach.
 Corporate Governance – General Notes
Organization for Economic Co-operation and Development principles

• One of the most influential guidelines on corporate governance are the G20/OECD
Principles of Corporate Governance.
• First published as the OECD Principles in 1999.
• Endorsed by the G20 in 2015.
• The Principles often referenced by countries developing local codes or guidelines.
• Based on OECD, The United Nations Intergovernmental Working Group of Experts on
International Standards of Accounting and Reporting (ISAR) produced their Guidance on
Good Practices in Corporate Governance Disclosure., which consists of more than fifty
distinct disclosure items across five broad categories.
– Auditing
– Board and management structure and process
– Corporate responsibility and compliance in organization
– Financial transparency and information disclosure
– Ownership structure and exercise of control rights
 Corporate Governance – General Notes
• The Sarbanes-Oxley Act, is an attempt by the federal government in the United States to
legislate several of the principles recommended in the Cadbury and OECD reports
– Rights and equitable treatment of shareholders: Organizations should respect the rights of
shareholders and help shareholders to exercise those rights. They can help shareholders exercise
their rights by openly and effectively communicating information and by encouraging
shareholders to participate in general meetings.
– Interests of other stakeholders: Organizations should recognize that they have legal,
contractual, social, and market driven obligations to non-shareholder stakeholders, including
employees, investors, creditors, suppliers, local communities, customers, and policy makers.
– Role and responsibilities of the board: The board needs sufficient relevant skills and
understanding to review and challenge management performance. It also needs adequate size
and appropriate levels of independence and commitment.
– Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing
corporate officers and board members. Organizations should develop a code of conduct for their
directors and executives that promotes ethical and responsible decision making.
– Disclosure and transparency: Organizations should clarify and make publicly known the roles
and responsibilities of board and management to provide stakeholders with a level of
accountability. They should also implement procedures to independently verify and safeguard
the integrity of the company's financial reporting. Disclosure of material matters concerning the
organization should be timely and balanced to ensure that all investors have access to clear,
factual information
 Corporate Governance – General notes
• Sarbanes-Oxley Act
• The Sarbanes-Oxley Act of 2002 was enacted in the wake of a series of high-
profile corporate scandals. It established a series of requirements that affect
corporate governance in the U.S. and influenced similar laws in many other
countries. The law required, along with many other elements, that:
– The Public Company Accounting Oversight Board (PCAOB) be established to regulate the
auditing profession, which had been self-regulated prior to the law. Auditors are responsible
for reviewing the financial statements of corporations and issuing an opinion as to their
reliability.
– The Chief Executive Officer (CEO) and Chief Financial Officer (CFO) attest to the financial
statements. Prior to the law, CEO's had claimed in court they hadn't reviewed the information
as part of their defense.
– Board audit committees have members that are independent and disclose whether or not at
least one is a financial expert, or reasons why no such expert is on the audit committee.
– External audit firms cannot provide certain types of consulting services and must rotate their
lead partner every 5 years. Further, an audit firm cannot audit a company if those in specified
senior management roles worked for the auditor in the past year. Prior to the law, there was
the real or perceived conflict of interest between providing an independent opinion on the
accuracy and reliability of financial statements when the same firm was also providing
lucrative consulting services.
 Corporate Governance
• Stock exchange listing standards

• Companies listed on the New York Stock Exchange (NYSE) and other stock exchanges are
required to meet certain governance standards. For example, the NYSE Listed Company
Manual requires, among many other elements:
– Independent directors:
– Board meetings that exclude management:
– Boards organize their members into committees with specific responsibilities per
defined charters.