Can the financial crisis help corporate governance?

At the recent annual conference of the Hawkamah Institute of Corporate Governance in Doha, a recurring theme was the issue of the recent financial crisis and corporate governance. Among the participants, there was consensus that the meltdown offers an opportunity for renewed focus on corporate governance. Investors have now been burned twice in the last decade—the first being the dot.com bust—and will demand greater corporate governance compliance as the basis for investment decisions. As confidence has been weakened, better risk management is necessary.

Rainer Geiger, OECD Regional Advisor for the Middle East, commented that “corporate governance deficiencies may not have been causal, but rather they facilitated or did not prevent practices that resulted in poor performance”. In other words, it’s time to get back to the basics. The key, however, is not just the right rules and regulations on the books, but rather the actual practice of corporate governance standards.

At the Doha conference, Mr. Hilton McCann, Senior Vice President for Abraaj Capital, went straight to the heart of the issue when he noted that “corporate governance merely reflects how a company behaves when no one is looking.” The application of corporate governance principles rests on senior leadership creating a corporate culture that values and adheres to ethical standards. Without this commitment from the top, very little will change other than the proverbial box-ticking.

Another topic that generated keen interest is the link between private equity funds and the demand for corporate governance. In an excellent presentation, Milica Boksovic, Managing Director of the Millstein Center at Yale University, outlined how private equity investment can be a powerful impetus for stronger corporate governance practices. When private equity funds take undervalued companies and work to increase the value over the long term, they are playing a new, dominant role on boards, which can drive better corporate governance practices.

At their best, private equity funds will lend greater efficiency, more oversight over management, industry-specific insight and a commitment to a long-term investment, rather than quick turnarounds and takeovers. Their presence on boards means, potentially, that a more stable approach can be taken and the agency problem is minimized. On the flip side, private equity is critiqued because there may be a lack of transparency, high level of risk, a blurring of the line between owner and manager and potential layoffs.

Zia Hashemi, regional general counsel of ESG-Hermes, notes that private equity seeks high returns by investing in businesses that cannot raise (or prefers not to seek) other types of finance. In order to manage higher risk, there is an imperative for even greater due diligence, including an assessment of corporate governance practices. If private equity fund managers walk away from an investment if corporate governance is weak, then they will play an important role in motivating better practices. Despite possible negative effects, the increasing presence of private equity funds in the MENA region can and should be a positive engine for greater corporate governance compliance.

Published Date: November 24, 2008