Too many recent business disasters - some fatal and others that, not so much, caused tremendous economic and social value destruction - have shown serious problems of corporate governance in Portugal. And they also showed that the first deficiency in this matter lies within the corporate culture and the indifference with which society considers this issue.
As a result of several vicissitudes, among which careless macroeconomic management, Portugal shows an extreme deficit of its own capital and, for this reason, it became very dependent on foreign capital. This vulnerability has especially attracted capital from political geographies with less acceptance in global markets, and opportunistic capital that seeks to take advantage of assets undervalued by the country's situation. Such capital should not be discouraged, on the contrary, but the effects of reputational contagion should be prevented from an excessive predominance that it may assume in the control of the main national companies, with the consequent devaluation of national assets.
In this context, a good corporate governance system, keeping shareholders at arm's length from management, and with adequate mechanisms for supervising and controlling executive management, is the best antidote to these risks. For this reason, and in addition to the general reasons that recommend it in any circumstance, the requirement for such a system should become a strategic goal for the country.
In order to contribute to this goal, this essay seeks to reason why good governance is needed and what specific concerns it must address. From this reasoning, practical corollaries are then drawn for any regulations that aim at good corporate governance. Without any surprises, the text points out that the most important in good governance are the people involved and the values that guide them.
Actions aimed at good corporate governance must focus on changing the dominant culture. Hence, imposing principles, rules, and procedures in the careful and transparent selection of people involved in this governance. A transformation that will only be achieved if led by regulatory means.
René Descartes began his Method Speach by writing that “common sense is the best distributed thing in the world, as everyone thinks that it is so well provided for.” Also concerning good governance, it does not seem that any of our great companies feel or have ever felt, insufficiently provided. However…
There are already too many business disasters, and economic and social value disasters, led by examples of bad governance, so that self-content in this area can be reassuring and can be passively accepted by public authorities and civil society.
There is no tradition of good corporate governance in Portugal, which is partly due to the prevailing income culture. Indeed, it would be an interesting exercise to assess how many PSI 20 companies would, for example, be currently accepted on the London Stock Exchange.
António Horta Osório, inserted in an environment where corporate governance is seen and treated with great demand, both by regulators and by the capital market itself, recently touched a sensitive spot on our bad practices. In a conference held by the Jornal de Negócios, on April 17th, 2015, he said, according to the online version of the newspaper that same day, that:
In Portugal "we don't have a governance system, in general terms, at the level of what is best practiced in international terms, as in England or the United States". There must be, he added, "checks and balances". In Portugal, in his opinion, "we give excessive power to the executive president, devaluing the role of the chairman and non-executive directors". And he gives an example: in Portugal, a regulator never, as in England, has meetings with chairmen or non-executives or even with committee chairmen.
The Directors Board must represent the shareholders in the management inspection. Companies "must have high-level Directors Board, with a chairman responsible for appointing the CEO (Chief Executive Officer) and ensuring good governance".
Proving the accuracy of this diagnosis, as well as the cultural deficit in this matter, I recall that a Parliamentary Committee of Inquiry recently worked to assess the events surrounding the fall of BES (Banco Espírito Santo). Among the large dozens of people that the Parliament considered listening to on the subject, no one considered it necessary or convenient to include the Chairman of the Directors Board or other non-executive directors of the company. And no one, inside or outside Parliament, seemed to find such an omission strange. In the same way that when a former non-executive director of the same bank stated, in an interview to a newspaper, that during the six years he was a director, he went mute and left silent, no one from the economic and political elites showed any strangeness.
Both cases clearly demonstrate the irrelevance that our corporate culture, political society, and even qualified opinion, attribute to those positions in corporate governance. This reveals that it is at this level that the main deficiency that hovers over it is located.
Because it is in this deficiency that the bad practices, unfortunately too widespread, that led to the referred business disasters take root (although not all of them would have been fatal to the companies involved, at least in the immediate future). It is also on this same deficiency that much distributive asymmetry of the value of companies is based, and that the persistent resistance to change is founded.
I do not propose to do a detailed analysis of corporate governance in Portugal, nor an inventory of bad practices, although I understand that this could be a very useful exercise to be carried out by some institution, regulatory or self-regulatory, with the means to do so. I rather propose to approach the subject from the constructive perspective of justifying the need for good corporate governance and identifying essential elements that it must address.
But, before that, I would like to explain why I believe that it is, at this moment, strategic for Portugal to ensure the conditions for good corporate governance and why this goal, more than a business one, must be political.
The successive increase of high external deficits between 1995 and 2011, not only corroded the savings base accumulated by Portugal but left the economy heavily indebted abroad. In fact, the accumulated national savings represented, until 1995, more than 80% of the economy's physical capital stock; since then, this strategic autonomy indicator has been steadily waning and currently corresponds to just over 50%.
This indicator is quite elucidating the strong erosion of the national savings-capital base and the huge dependence on foreign capital in which this erosion has placed the country and its companies. Therefore, when the recent international financial crisis emerged, almost half of the country's physical capital stock was already directly owned by foreigners or was mortgaged abroad (debt). This provides a macroeconomic perspective to better understand some business disasters of recent times, as well as the foreign control that the main national companies have been passing through (in some cases at “occasion prices”).
Each case will have a microeconomic explanation, that is, a business case, but the set of all cases is only duly explainable if one understands the macroeconomic environment, which means, the erosion of the national savings base caused by the accumulation of almost a decade and a half of high external deficits. Thus, it can be described what the country has been witnessing in this field as a process triggered by the international crisis, of resolution (in some cases uncontrolled) of the “mortgages” to which national property was subject.
It is also important to mention that one cannot fail to take into account that, for the notorious scarcity of national capital savings that the country faces, and which has made it so dependent, the destruction of private capital savings has also contributed a lot that the State acted twice, in the space of a generation: first, when it nationalized almost the entire economy, without compensating the owners; and, later, when he threw away the revenues obtained from the reprivatization of the companies he had nationalized.
In any case, what matters for the topic that I set out to address - the strategic imperative of good corporate governance - is that the country has become deeply dependent on foreign capital, not only for boosting the economy - productive investment - but for the very support and development of companies - financial investment.
In the face of this dependency, the country needs to remain attractive to international investors, especially those susceptible to making a long-term commitment to it and to become a lever for economic development and competitiveness; and to ensure a reasonable geographical distribution of that investment's origins, in order to avoid economic dependencies that condition the country's political freedom and control over its own development. In these circumstances ensuring the conditions of attractiveness for investment, while preserving the fair value of its assets, cannot fail to be considered strategic for the development of Portugal.
The financial vulnerability, however, has made Portugal particularly attractive for capital coming from political geographies that are not well regarded in global markets and for “opportunistic capital”, that is, funds that seek undervalued assets, to realize quick gains, but without having a long-term development project for the acquired companies.
Portugal cannot and should not refuse these capitals. In the first case, because political and friendship ties with the countries of origin are important for the country and, as such, reciprocal relations should be encouraged and not discouraged. In the second, because they are agents that are part of the “natural ecology” of the capital market, whose hostility would negatively impact the perception of investment conditions in Portugal.
However, the excessive dependence on these capitals and their eventual predominance in the control of national companies, especially in the governance practices context referred to in the introduction to this article, can devalue the country reputationally, narrowing its attractiveness and undervaluing national assets. All the more so as some indications are already mentioned as being able to repeat paths similar to those that led to the aforementioned disasters caused by national investors.
As it is not desirable, as already mentioned, to discourage such investments, that risk can be greatly mitigated by ensuring that Portuguese companies adopt the best practices of good governance, protecting the direct management of companies from undue interference by some shareholders (keeping both, shareholders and direct management, at arms length, in the most appropriate English expression) and ensuring that the rights of all other interested parties, and other potential investors, will be fully respected.
That is why, in the circumstances in which the country finds itself, I consider the strategic objective of ensuring the generalized practice of good governance in national companies to be absolutely strategic, so that Portugal is not disregarded from the institutional investors' route, nor the strategic investors' radar in a wider geography.
The achievement of such a goal also has the collateral advantage of providing shareholders from the political geographies concerned with the not-negligible benefit of their own credibility in global markets, whose access may be facilitated by this means.
I do not believe, however, that the achievement of this goal can come from within the business environment or even from civil society. The latter, as I highlighted above, has no sensitivity to the subject and the corporate culture is comfortable with the status quo and the asymmetries it provides. Only public authorities will be able to lead the achievement of such a goal. But time is a crucial variable if we don't want to let possible reputational damage solidify.
There is yet another reason for the political leadership of the process. The reason that is timeless in its essence, was also made pressing by the current economic circumstances - competitiveness. The Cadbury Report - which remains a prime reference for good governance, despite having more than 20 years, - emphasized, right at the opening and focusing on its own country, that:
“The country's economy depends on the energy and efficiency of its companies. Thus, the effectiveness with which their administrations fulfill their responsibilities determines Britain's competitive position” [see note 2].
In order to properly understand what good corporate governance must do, it is necessary to start by understanding what a company is and what interests it involves because it is in this perception that many of the misconceptions on governance are rooted.
A company - and I look only at public limited companies - is not only its shareholders, nor do they represent the only legitimate interests on which a company rests its existence and on which its operation depends. A company is a much broader set of combined interests. It is an articulation of contractual agreements between several parties - some explicit, others implicit -, aiming to achieve their own goals, commonly coordinated through their operation [see note 3]. Those parties, legitimately interested in the company and its operation, include, in particular, shareholders, managers, employees, suppliers, customers, creditors, authorities, and the company where it operates.
Consequently, the key duties of good corporate governance are, on one hand, to promote their overall good performance in creating value and, on the other, to ensure the effective and fair articulation of the interests of the different parties involved in the contractual relations on which its existence.
And if the value creation can be easily identified as a common interest to all parties - and, as such, easily articulated - the distribution of this value among the interested parties is likely to involve interests and goals, not only diverse but often conflicting so it should be rightly arbitrated.
It follows, then, that since it is easy for interests to converge in terms of value creation, it is reasonable to delegate to shareholders the free choice of executive management, since being the hierarchically residual recipients in the distribution chain, they are the most important part. interested in that goal. However, for the distribution of the created value, the delegation to shareholders must already be conditioned, since the interests to be served are diverse and potentially conflicting. Not only can the interests of shareholders not prevail at all over other interests, but the interests of some shareholders - especially the majority shareholders - cannot prevail over those of others - especially minority shareholders.
Good governance is thus responsible for ensuring the fair distribution of the created value, providing each one with what is due to him by right [see note 4]. This includes, among other things, treating employees, customers, and suppliers with loyalty, respecting social norms, preventing the imposition of negative externalities on third parties and contributing to the enhancement of the society in which the company operates.
That said, it may seem like an easy task. But it isn't. Just look at the example of some recent business disasters and how they resulted from the appropriation, or attempted appropriation, of a disproportionate and undue share of the companies' value by one or a few shareholders, at the expense of others and other interested parties. And how, because of that, some parties ended up being totally robbed of what their right would be or be subject to paying a disproportionate share of charges resulting from the disaster.
Or the cases of companies with polluting activity, or sanitary deficiency, and which pass on to society the costs of remedying their damage, while appropriating results exclusively. Or, if one wishes to attend to more recent examples of the international financial crisis, the cases of financial institutions which, having privately appropriated for their shareholders and earnings managers - often artificially created at the expense of sophisticated accounting and financial gymnastics -, ended up make their survival dependent - and, therefore, the safeguard of all other associated interests - on the assumption of heavy costs by taxpayers.
Therefore, and to be more precise, good governance must ensure that no shareholder, minority or majority, captures the management of the company in its favor, at the expense of the rest (especially minority shareholders) and other interested parties.
Thus, how should you ensure that shareholders do not misappropriate - in direct or indirect ways - the value that would be due to other stakeholders. Not forgetting that one of the forms of “deviation” of a company's value, by one or more shareholders, is through the realization of that value, due to the company, in other companies or organizations, of its property, where it is easier for them to capture it exclusively.
On the other hand, it should be noted that when it comes to value, this doesn't just mean directly financial value; it also involves intangible, private or social values, such as, for example, the environment or the social order, that is, respect for norms and ethically correct behaviors.
But there are other forms of undue and disproportionate distribution of company value that good governance must protect. One is the possible appropriation by the executive management, overlapping the interests of the shareholders it is supposed to represent. This problem is profusely treated in the economic literature as the agency problem and the associated risk of the agent overlapping his function in preference to that of the principal, that is, in this case, the shareholders. And, I add, of the other legitimately interested parties.
Another is its intertemporal distribution when the future (and sometimes the company's sustainability itself) is sacrificed to force the achievement of immediate results. This usually involves taking excessive risks or reducing the ability to create future value.
To protect against these problems, it is necessary that executive management be subject to permanent and committed supervision by agents, not only disconnected from this management but independent of it. And to protect against other forms of value misappropriation by some parties, ensuring the fair distribution of that value, it is necessary that all, or a substantial part of these agents, be truly independent of all parties interested in the value distribution, and so on, capable of exercising a disinterested judgment in the executive management supervision.
What I have just stated is, from my point of view, the analytical foundation of the need for good corporate governance and the concerns that it must address. And that, I believe, will also help to realize that the governance of private companies is associated with a social value, which is beyond private interests directly at stake in the life of the company, since, not only does it interact with society, leaving brands, such as the articulation of interests on which its operation is based, involves moral values, such as distributive justice, which are part of the social order.
In this way, and with important social values at stake, the foundation is also established for society to have the right, through its political representation, to regulate corporate governance, conditioning the choices and the room for maneuver of its owners.
Moving from theoretical conceptualization to the practical field, and as governance is embodied in a series of structures and processes, it is important to start by retaining some practical corollaries of that conceptualization. Therefore:
Governance should, as is generally accepted, contain two clearly separate roles: an executive and a supervisory and control role;
The supervisory and control role must have the capacity - members and powers - that guarantee practical effectiveness to the role, allowing it, in particular, to prevent undue or objectionable actions;
In order to guarantee the protection against the unfair distribution of value, or the capture of management by shareholder parties, the members of the supervisory and control function must be mostly independent of the parties involved and offer guarantees of autonomy of judgment and opinion;
To prevent catches, and the interests of the agent - executive management - from overlapping those of the principal - shareholder body -, the executive leadership must be directly accountable to the supervisory and control role (remember, in this regard, António Horta Osório's criticism referred to in the introduction to this article);
For the same reasons, the leadership of the supervisory and control role should not be combined with the leadership of the executive function and should preferably be performed by an independent member of the parties directly concerned.
Respecting the corollaries explained before, good governance can be achieved in practice through three fundamental pillars:
The first pillar is the easiest to implement, at least in its statement, as it only requires good regulatory rhetoric. The failure that is often associated with it, however, is related to the (lack of effectiveness in) adherence of the practice to the statements, which results from the failure of the other two pillars.
The second pillar is the most important because people, with their technical and ethical skills, are the crucial component of good governance. For this reason, and in order for this pillar to be truly effective, not only remaining due to formalities, it requires, among other things, a transparent process of rigorous selection and scrutiny, and external certification of the conditions of independence for the places where it is.
The “Cadbury Report” was very peremptory on this subject:
“Given the importance of their distinctive contribution, non-executive directors must be selected with the same impartiality and care as senior executives. We recommend that their appointment should be a matter for the management as a whole and that there should be a formal selection process, which will reinforce the independence of non-executive directors and make it clear that they will have been appointed on merit rather than through sponsorship ”[see note 5].
The third pillar is crucial for the effectiveness of the second because it contains the values that guide, or are expected to guide, the actions of those involved in governance. And it is known that it is in the mismatch of these values - between what should be and what is - that much of bad governance is based. Its effectiveness, however, depends not only on what can be undertaken at the company level, but on social morality (i.e. the values, and their graduation, prevalent in the society where the company has its social roots). Hence it is the most difficult to modify.
And, if this pillar is not established on a healthy basis, it is unlikely that the second can guarantee its expected effectiveness, because people with more demanding values, and who try in isolation to counter socially dominant morality, will more easily be centrifuged from the system than they can impose. up to that morality. For this reason, the Basel Committee on Banking Supervision, in the Corporate Governance Principles for Banks, recently released (July 2015), recognizes that:
"A major component of good governance is a corporate culture of reinforcing the appropriate standards for responsible and ethical behavior".
It isn't easy to change the social culture. It is very difficult for change to occur spontaneously, except in a very long period. That is why relying on self-regulation to achieve such a result seems to me to be unwise. Faster changes, at least in the effects produced, are usually only achieved with systems of incentives and penalties that become effective inducers of behavioral changes. For example, the uncontrolled parking on top of the sidewalks in Lisbon, which until recently was not the general norm in the city, was only effectively contained when the council placed impediment bollards in many places and the inspection of irregular parking, turned into a business, became widespread. Few will doubt that if these two instruments are removed, uncontrolled parking will become the norm again.
For this reason, cultural change in corporate governance will only be effective within a reasonable time if certain behaviors are imposed by regulatory means, through principles and rules, processes and procedures, sanctions and possible preferential treatment in regulatory and institutional relations for the complainants.
And it is not worth too much effort to try to invent what has been invented a long time ago. The subject is more than studied and there is enough experience of good practices so that it is enough to simply copy these experiences, as in a trivial benchmarking exercise. The United Kingdom, with simple codes in the statements, but vast in the scope of the contents, and contemplating different situations - from large companies to small and medium-sized companies, as well as unlisted ones - is, perhaps, the experience from which it will be most profitable enjoy, especially if you are aware that time is running out. For my part, and without prejudice to further investigation, I would recommend the immediate adoption of the following documents from the UK's Financial Reporting Council: The UK Corporate Governance Code and Guidance on Board Effectiveness.
In any case, the quality of corporate governance will certainly be much better if:
Become the supervisory role (non-executive management) truly effective, through its formal empowerment;
If, in the Directors Board, the Chairman is of central importance, who must be independent and whose recruitment must be particularly careful and bearing in mind that he must “demonstrate the highest standards of integrity and probity, and establish expectations clear regarding the company's culture, values and behaviors ”[see note 6];
Not being the independent chairman, institute the role of “leading independent director” to lead and coordinate the independent directors;
Establish formal mechanisms for the demanding and transparent selection of members of non-executive management.
Even so, it is reasonable to ask the following question: once all the assumptions and conditions stated for good governance are meticulous, is it possible to ensure that it guarantees the success of the company and prevents its eventual failure? No of course not. Good governance is a necessary condition for success, as it provides a favorable environment for this, but it's not enough.
The business activity involves risks, since:
“Risk is to a certain extent at the heart of any business. Risks are taken in the search for return. No governance system can prevent mistakes or protect companies and their stakeholders from the consequences of mistakes” [see note 7].
In fact, governance is a job done by people, and people make mistakes. Opportunities to make mistakes can be minimized, but there is no guarantee that they will never make mistakes. On the other hand, good governance can minimize the risks of choosing the wrong business strategies, but cannot guarantee their elimination; and wrong choices can have very adverse consequences.
This vulnerability, intrinsic to the human nature of institutions, can be an inspiring source of false arguments that are adverse to change and improved governance, maintaining that there are no perfect systems and that all are fallible. But this type of argumentation, which is inherently reactionary, neglects a fundamental point (from which its fallacy arises). Since all human works are imperfect and insecure, there is an abysmal difference between those that provide a security level of 80% and those that provide a level of 20%. And in this, as in many other things, the amount of good and bad results defines the quality of the system.
Once again, the seminal work of the committee led by Adrian Cadbury was already enlightening:
“No corporate governance system can be fully proof against fraud and incompetence. The test is how much these aberrations can be discouraged and how quickly they can be brought to light. Crucial safeguards are properly constituted administrations, separation of the roles of chairman and executive chairman, audit committees, supervisory shareholders and financial reports and audit systems that provide complete and timely information” [see note 8].
1- The companies underlying this analysis are those formed in the form of public limited companies.
2- Report of the Committee on The Financial Aspects of Good Governance (Cadbury Report), December 1992 (paragraph 1.1)
3- Definition inspired by this, taken from http://www.succurro.com.au/articles/49-governance/85-what-isgood- corporate-governance-.html: “The most fundamental definition for corporate governance is based on the idea that an organization is essentially a nexus of contractual agreements between many parties to achieve the organization's goals. These parties include shareholders, directors, managers, suppliers, employees, customers, financiers, government authorities, other stakeholders and the society in which the company operates. Whilst some of these contractual agreements are formal written ones, many are implicit. Likewise, some of these contractual agreements are financially based but many are not ”.
4- Note that the “right” referred to here is not necessarily the positive right, but the philosophical concept of what exactly is due to each one.
5- Cadbury Report (paragraph 4.15)
6- Financial Reporting Council, Guidance On Board Effectiveness (Chapter “The Role of the Chairman”, paragraph 1.5)
7- Judge Owen, in “The HIH Royal Commission”, Canberra, 2003
8- Cadbury Report (paragraph 7.2)