Summary
This article written by Nour Abi Rashed and Liwaa Taraby talk about Corporate governance (CG) refers to the framework of rules, practices, and processes by which a company is directed and controlled. As businesses grow in size and complexity and interconnect in globalized markets, Corporate Governance harmonizes the priorities and interests of different stakeholders in companies including shareholders, management, suppliers and creditors, employees, the government, the community and the environment- all components of the life of an active business upon which company law does not necessarily touch base or is incapable to address efficiently.
Analysis
Effective Corporate Governance, if achieved, has the effect of ensuring accountability, transparency and fairness in a company’ s operations. With the increasing investments through companies and financial markets, the usual framework of commercial laws no longer suffices to prevent business risks and consequently, robust governance practices become crucial to ensure sustainable performance, to mitigate risks and to foster investor confidence. This article explores the role and importance of corporate governance in modern business, while touching on its current framework in Lebanon and neighboring countries of the Gulf as well as the evolving trends shaping its mechanism. The article further suggests possible steps for Lebanese companies to enhance their governance practices amidst the current legislative framework.
- What is corporate governance?
Corporate governance is the system by which companies are directed and controlled to achieve the abovementioned goals. According to the internationally applicable G20/OECD Principles, corporate governance provides, on a fundamental level, “the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined”.
In an increasingly globalized market, big corporations can impact communities through their unilateral decision-making process. It is therefore crucial to ensure that, as contemporary corporate governance aims to, an appropriate governance structure is in place. By “appropriate” we mean a structure that considers building and maintaining long-term successful relationships with its wide range of stakeholders - all of them -, while generating profits for its shareholders. It is therefore the shareholders’ responsibility to firstly define their objectives and priorities and then ensure that the adequate governance structure is in place to achieve such objectives. The mentioned structure can be achieved through their policies, their risk management tools, the means and criteria of appointment of directors and auditors, the creation of committees, the enhancement of transparency and accountability of the directors towards the shareholders and the implementation of other CG principles as will be elaborated subsequently.
- What types of companies are invited to consider CG and why?
Listed companies
In principle, corporate governance regulations are intended to apply to listed companies. When they exist, such regulations are usually mandatorily applicable to listed companies and left optional for all the other types of companies. It is the case because corporate governance has become vital, not only for the success of a company’s business but more generally, for a powerful and fair economic system.
In fact, when it comes to investing in big/listed companies, introducing good corporate governance practices that are functional and effective is a crucial element in attracting external funding, as investors seriously consider how companies are managed. Furthermore, the enhanced transparency and accountability achieved by CG practices naturally lead to an increased investor confidence, and consequently, to an increase in shareholder returns and an improved stock performance. Such principles also ensure that investors have a say in the decision-making process of the company.
Medium to Small companies
The same beneficial influence of corporate governance has been reported on medium and small companies, notably in our region. In a report published in 2019 by the World Bank titled “Corporate Governance in MENA: Building a Framework for Competitiveness and Growth”, it has been demonstrated that corporate governance practices are positively associated with companies’ profitability in the Middle East and North Africa (MENA) region, as well as with higher levels of efficiency and an increased stringent oversight.
Additionally, small to medium companies that are looking to grow and expand are invited to invest in a solid corporate governance framework that can help them identify challenges of expansion and ensure their readiness to face them.
Family Businesses
Corporate governance practices are key solutions to many of the challenges faced by family-owned businesses, which nearly constitute 90% of the businesses in developing countries. Their major crisis of managing succession can be responded to through succession planning as well as through the anticipation and mitigation of potential conflicts via robust mechanisms of corporate governance.
All types of Companies
In addition to the corporate governance’s response to particular matters with respect to different types of companies, its advantages can be benefitted from by all companies of any type.
Indeed, all businesses, no matter their size, are invited to take risks and innovate in order to increase the profits they generate for their shareholders while ensuring a smooth balance between the interests of all the stakeholders involved in the company. In this area particularly, corporate governance plays a major role: it offers several mechanisms that will help companies assess risks more effectively, and get ready to respond to them more quickly, depending on the nature of their business. This could be achieved, inter alia, through an engaged board and an effective internal control mechanism. Additionally, all types of companies would benefit from better and more sustainable relationships with their stakeholders, as CG principles aim to achieve. The implementation of such principles can improve a company’s ability to attract and retain talent, making it a fair employer of choice. The same applies when it comes to company’s reputation and credibility vis-a-vis its creditors, as well as its wider community and environment.
- Why Corporate Governance if there is Company Law?
Companies exist as a corporate vehicle for carrying on a business and are created and governed by Company Law. Consequently, the main aim of company law is to ensure that such corporate vehicle is as attractive as reasonably possible for carrying on the business, by balancing the interests of the various parties involved in, or affected by, a company’s activities.
For this reason, Company Law offers facilitative features for running a company, such as a separate legal personality of the Company, from which will result a limited liability of shareholders aiming at increasing their appetite for risk; an efficient decision-taking mechanism founded on the majority rule; a separation of ownership from the management, whereby shareholders have the opportunity to simply own and invest without being involved in running the company- leaving the management task for the directors, etc. However, each of such facilities is not implementable without any risk. Such features ensure the smooth running of the business, but do not guarantee the business won’t fail and to face nowadays increasing challenges.
Indeed, Company Law recognizes the existence of many of those risks and addresses them through different mechanisms. For instance, it provides for adequate rules such as the ‘capital maintenance’ doctrine (i.e. that a company must obtain proper consideration for shares that it issues), publicity requirements as well as the whole insolvency regime to protect creditors of a company against excessive risks taken by its shareholders.
It also provides the shareholders with several mechanisms to hold the directors accountable, such as the power of appointing and dismissing directors, addressing the risk of agency cost.
Nevertheless, it is argued that the Company Law mechanisms of addressing corporate risks are not entirely effective. Businesses still fail and third parties dealing with them (creditors, employees, etc.) often suffer the consequences. Directors still make mistakes and shareholders of the largest companies often find it difficult in practice to use any of the available company law mechanisms to hold them accountable.
This being said, Corporate Governance manifests as a means to supplement Company law’s attempts of addressing the risks created by its facilitative rules. CG principles aim at setting out a sustainable framework for running the business in a way that would protect creditors and third parties while allowing shareholders to take risks, increase their profits, and hold the management accountable if needed.
- Corporate Governance in Lebanon and the Gulf
CG in Lebanon
The corporate environment in Lebanon and the Gulf is mostly dominated by family-owned businesses, which own the largest market share of the private sector. Corporate governance in the region concerns not only listed companies and banks, but also non-listed companies, which represent the majority of companies on the market.
In Lebanon, a Code of Corporate Governance was for the first time introduced in 2006 (“CG Code 2006”) to be voluntarily applicable to companies and banks, aiming to inspire good practices to both listed and non-listed corporates. The Code introduces a number of recommendations which do not appear today as entirely aligned to best practices. It was followed by the Corporate Governance Guidelines for Listed Companies (“CG Guidelines 2010”) which serves as a mere reference for listed companies that are subjected to the Listing Regulations of the Capital Markets Authority (“Listing Rules”). The primary source of corporate governance legislation in Lebanon remains rooted in the Commercial Code of 1942 as amended recently by Law No. 126 of 29 March 2019 (“Commercial Code”).
There is no particular corporate governance code governing banks. However, the Lebanese Central Bank (Banque du Liban) has issued numerous circulars on corporate governance that serve as a guide and aims to establish general principles, allowing banks to adapt the directive according to their needs. As per the Basic Decision No. 9382 dated July 26th, 2006 (“Basic Circular 106”), banks must prepare their own CG Guides.
Based on a CG report published on Lebanon in 2021 by the European Bank for Reconstruction and Development, it was found that the institutional environment for promoting good corporate governance in Lebanon has room for improvement, with the main regulators being the Central Bank, the Banking Control Commission and the Capital Markets Authority that regulates the work of the Beirut Stock Exchange (with nearly 10 listed companies currently). In practice, the CG Code as well as the subsequent guidelines, which are both voluntary, do not seem to have been taken as a reference. Listed companies did not to pay much attention to requests by stakeholders, and international organization indicators show a framework where corruption is still perceived as a critical problem.
Indeed, the CG Code is written in a clear and concise language that makes it easy to follow. However, it lacks substance in some key areas (such as the board’s role in developing the company’s strategy and overseeing risks).
Additionally, there is no body or authority that monitors the companies’ compliance and implementation of the Code, and no evidence found of case law that refers specifically to such legislation to acknowledge rights of shareholders.
According to the World Bank “Doing Business Report” of 2019, Lebanon is ranked 143 amongst 190 economies in the ease of doing business, which is a serious call for the revision of the CG guidelines that are now outdated and unmatching with the international standards.
CG in the Gulf
Contrary to Lebanon, the last few years have been very busy for some GCC (Gulf Cooperation Council) countries legislating in the area of corporate governance, in response to the rapidly evolving business landscape across the region.
Although several GCC member nations have been active in this regard, it appears that the UAE and Kingdom of Saudi Arabia (KSA) regions are leading the way toward establishing a world-class corporate governance system. These two countries are witnessing in particular a strong wave of companies going public, which calls for a significant undertaking in terms of establishing a robust CG system. Additionally, the growing institutional investment in the business landscape of the region urges medium enterprises to achieve world-class status.
In the UAE, rigorous new CG standards were adopted in 2020 for public joint-stock companies in alignment with international best practices, promoting accountability, fairness, gender diversity and transparency. For instance, amongst these standards is found the requirement for the majority of the board to be independent and non-executive, the requirement of a minimum 20% representation on the board and the elaboration of policies on gender diversity, and so on.
In April 2022, the Dubai International Financial Center (DIFC), Abu Dhabi Global Market (ADGM), and Financial Action Task Force (FATF) all issued new regulations pertaining to decision-making frameworks and procedures across the region. Subsequently in March 2023, the Dubai Financial Services Authority (DFSA) published a new set of CG regulations for regulated entities in DIFC to ensure high standards of CG are maintained. These regulations provide updates on conflicts of interest management, board diversity, board composition and executive remuneration.
In KSA, both the Ministry of Commerce and Investment and the Saudi Capital Market authority (CMA) have been collaborating to develop and modify CG standards for listed and non-listed companies. Inspired by the UK CG regulations, they have issued six separate CG resolutions in the past decades aiming at better matching the Saudi Arabian setting to international best practices. The most important measures tackled, inter alia, remuneration and compensation reforms, executive compensation disclosure, shareholder rights and assemblies, development of strategy and training programs for board members, conflicts of interests resolution and strict disclosures, audit, nominations and responsibilities of risk management committees. For companies seeking to list on Tadawul, the CMA in KSA released new rules that establish high standards for CG practices (including board roles and responsibilities, shareholder rights protection, reporting obligations, risk management and internal control framework) seeking to strengthen investors’ confidence and attract foreign investments.
- Increasing CG trends
The adoption of international CG standards is itself a significant trend in the region. Firms in the Middle East, no matter their size, are seeking an increase of their transparency and sustainability which will potentially allow them to access capital markets more easily and build trust with investors. Among the most common trends in terms of CG principles, we notice the following:
- An increased tendency towards independent boards of directors: whereby firms are now appointing independent directors (non-shareholders, and not related to shareholders) to strengthen CG practices. Efficient and independent decision-making is achieved when shareholders, who are entitled to hold the board members accountable for their mismanagement, put their accountability tools into practice.
- The two-tier board structure: This structure can manifest in the separation of the role of Chairman from the manager’s role, as a distinction of the management and operations from decision making and strategic thinking. It is further reflected when the board of directors include both executive and non-executive directors (supervisory board), manifesting in a two-tier structure to guarantee the compliance of the board’s operations with the company’s strategy. This practice ensures that such compliance is enforced from within the board itself. Yet, it is worth noting that although the two-tier board structure is being popularized by large organizations and giant multinational corporations, the one-tier structure remains the most common in the Middle East often comprising in average 6 to 11 board members, depending on the size of the firm and the nature of business, especially among family-owned businesses.
- Committee structures within the Board: it is increasingly desirable to create separate Board Committees for different preoccupation of the board, notably relating to corporate responsibility, risk management, audit and remuneration committees. This trend is recommended and was motivated by the remarkable achievements of board members who have a certain matter expertise as well as specialized experience and a specific industry knowledge. Additionally, it has been observed that extensive and targeted work happens in board committees who can cover regulatory matters and progressive agendas, such as community awareness, employees’ well-being and the importance of generating value for shareholders, in depth.
- An increased use of technology to enhance the CG practices: such as CG software, cloud computing, artificial intelligence and other technology tools that are put in place to strengthen the internal processes and ensure regulatory compliance.
- An enhanced all-level diversity: although gender-diversity has become a self-imposed requirement in many markets, if not through government regulators, somehow through social pressure, diversity on all levels lies at the core of corporate governance. It is therefore an increased trend of firms to look, further than gender diversity, at the diversity of skills, experience, leadership preferences and geographical diversity. Members are sought for their experience but also for their specific expertise in fulfilling their role and their trustworthiness that should remain a top priority.
- An increased attention to defining a Culture: the corporate practice manifested as a crucial element of the company, specially in times of crisis and pandemics where proactive leadership of board members played a significant role.
As a result, and although board’s responsibilities are mostly supervisory in nature, the company’s culture is highly influenced by the board’s actions and decisions. The culture begins at the top, and therefore, board members are expected to be the first to adopt and practice the cultural traits that they consider would best benefit the organization, in compliance with the vision and strategy they draw for the company. This calls for the establishment of a long-term strategy and a corporate purpose for the organization, with which all the practices, activities and decisions must be aligned. In addition to all the above, firms that implement consistent levels of good governance were noticed to have emphasis on their Human capital management, compensation discussion and analysis, shareholder and stakeholder engagement as well as sustainability and risk management challenges.
- Opportunities of enhancing CG in Lebanon
As previously mentioned, the framework of corporate governance in Lebanon drawn within the limits of an old commercial law (1942) and some superficial recommendations (2006) and guidelines (2010) of CG principles that became obsolete. The guidelines provided are no longer aligned with the current international CG practice, in addition to the fact that no legal body or authority exists to ensure the compliance of companies with CG practice, due to their fluidity and non-mandatory aspect.
Nevertheless, Lebanese corporations are still invited to assess their compliance with good governance practices, and to enhance it accordingly. In a small developing market such as Lebanon, where the rule of law is breached on a daily basis and compliance instruments are shy, businesses have an increased interest to procure their own transparency and compliance process, and enhance their governance frameworks to attract more investors in a sustainable way.
New tools for achieving a better corporate governance were made available following the 2019 amendments of the commercial code, notably:
- The election of board members who are non-shareholders is now possible for the first time. This will open the door for more specialized boards that focus on management and operations, independently from the shareholders who own the company and invest in it. Such shareholders will consequently be able to exercise their role of overviewing the board effectively, and hopefully, to enable their powers of holding board members accountable for their management errors and breaches through the means available to them. This separation will create room for more specialized and expert members to sit on the board of directors, beyond family members and founders of the business. Additionally, the independence of board members from shareholders is strengthened by eliminating the requirement for each board member to hold guarantee shares. This mechanism is inefficient and could potentially lead to conflicts of interest.
- One third of the board members must be Lebanese nationals, shifting from a previous requirement where the majority of members had to hold Lebanese nationality, which improves diversity in boards composition.
- The same advantages are further enhanced through the new possibility of separation between the Chairman of the board, who will merely preside the BoD, and the general manager who will be responsible for the actual operations and management of the business.
- The transparency and disclosure pertaining to a company’s activities were enhanced through the current obligation of board members to submit their annual reports, financial statements and annual accounts every fiscal year to the general assembly of shareholders, who shall assess them and take the decision of their ratification (or not) depending on the case. The said decision of the ordinary general assembly should then be registered and published before the commercial registrar. This obligation is applicable to joint-stock companies. Disclosure and publishing obligations have the effect of allowing better access to shareholders into a business’ management and financial accounts, which in turn will allow shareholders to better exercise their role of supervision and accountability. Additionally, it will offer enhanced visibility and information to third parties, and therefore, a further layer of protection.
- The abolishing of the necessity for the Chairman of the Board to obtain a work permit if they are a non-Lebanese resident outside of Lebanon. This allows the participation of qualified chairmen in boards of Lebanese joint-stock companies, which is in alignment with the diversity objective, as set out above.
- The external auditor of the company, who must maintain independence, is not allowed to remain in its position for more than one year and its tenure is capped at five years. This helps prevent potential conflicts of interest, minimizes the auditors' influence over the company's governing bodies, and holds the former accountable, to some extent, to the latter.
- The broadening of the scope of regulated agreements to cover not only agreements made with Board members, general manager, etc., but also any shareholder who directly or indirectly holds voting rights amounting to five percent (5%) of the company's capital, who shall be subject to prior approval from the board of directors for any contract, agreement, or commitment intended to be made with the company. This encourages transparency and avoids conflicts of interest.
Nevertheless, although the 2019 amendments brought to the Lebanese commercial code held some advancement in terms of better governance, the corporate governance framework of Lebanon remains missing extremely essential practices. Audit and risk committees were only recommended in the guidelines issued for banks, whereas committees in general, notably relating to audit, risk management, remuneration of directors (and control of such remuneration) and other important topics in the life of a company, are highly advised for better practices of growing businesses but missed out by the 2019 amendments. This was a lost opportunity for improvement in terms of CG.
Additionally, as the international standards of corporate governance are now directed towards further diversity and inclusion, as well as attention to sustainability, environment, the outer community and other stakeholders of the company (such as its employees, creditors, etc.), Lebanon remains far from international trends of corporate governance. No current Lebanese law includes any provision relating to the abovementioned topics of diversity, environment or sustainability. Written by Nour Abi Rashed and Liwaa Taraby