Preventing Board of Directors from Imprudent or Irresponsible Borrowing

In Pakistan majority of listed companies are managed by controlling shareholders who are close family members. Other investors in these companies are in minority. According to section 196(2) of Companies Ordinance 1984, directors can exercise borrowing powers of the company by means of a resolution at a board of directors meeting. Code of Corporate Governance also allows directors to exercise all powers on behalf of the company and only binds them morally to do this “with a sense of objective judgment and independence in the best interests of the listed company.”

Further, it asks to maintain “a complete record of particulars of the significant policies, as may be determined, along with the dates on which they were approved or amended by the Board of Directors.” Practically, there is no check on the directors regarding imprudent decisions.

Following are the key steps to redress this condition:

• There should be a maximum limit on the borrowing powers of directors such as a certain percentage of net equity. That limit should be prescribed in the Company Law.

• There should be a provision in the Articles of Association of every listed company that sets a maximum limit on the borrowing powers of directors such as a certain percentage of net equity or total assets.

• There should be a system of internal controls that plug the loop holes and strengthen the decision making procedures thereby reducing the chance of imprudent borrowing.

• The board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the board’s decision-making.

• There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. This procedure should be reported along with the compliance report of the Code of Corporate Governance.

• The board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.

• The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the company’s auditors.