Why governance lapses are recurring

Published August 31, 2016

First published in Business Times on August 31, 2016

By Mak Yuen Teen

Despite extensive reform efforts and increased awareness of corporate governance issues over the last 15 years or more, there are no apparent signs of governance lapses becoming less common. Often, history seems to be repeating itself.

Consider the cases of unauthorised trading in banks. In 1995, there was the Barings Bank scandal involving unauthorised trading in futures contracts right here in Singapore that brought down the bank. This was followed by losses of A$360 million (S$370 million) from foreign currency derivatives at National Australia Bank in 2004; 4.9 billion euros (S$7.5 billion) from European stock index futures at Societe Generale in 2008; US$2.3 billion from exchange-traded funds at UBS in 2011; and US$2 billion from credit derivatives at JPMorgan in 2012.

Non-bank companies were not spared either. In 2005, China Aviation Oil here lost US$550 million from betting on oil derivatives; and in 2008, Citic Pacific in Hong Kong lost US$2 billion through foreign exchange derivatives.

Many of these cases have been detailed in four collections of Corporate Governance Case Studies which I have jointly published with CPA Australia. 2016 marks the fifth year of our collaboration, with Volume 5 due for release later this year. The 103 cases in five volumes cover Singapore, Asia and global companies.

Why do corporate governance lapses continue to occur?

In my view, there are three key factors that impose a continuing and increasing stress on the corporate governance system of companies: corporate culture, cross-border differences, and complexity of organisations.

Let’s start with corporate culture. The recently released publication by the United Kingdom Financial Reporting Council (FRC) titled Corporate Culture and the Role of Boards defines corporate culture as “a combination of the values, attitudes and behaviours manifested by a company in its operations and relations with its stakeholders”. Ethics is the basic building block of a strong corporate culture, which is like software to the corporate governance system.

Corporate governance failures often have to do with a weak corporate culture. Examples include BP’s Deepwater Horizon environmental disaster, Takata’s airbag failure, Tepco’s nuclear power plant disaster, General Motors’ ignition switch failure, Olympus’s and Toshiba’s accounting scandals, Volkwagen’s emissions scandal, and GlaxoSmithKline’s (GSK) and Leighton Holdings’ bribery scandals. The list goes on.

When Mary Barra took over as CEO of General Motors, she said that one of her immediate priorities was to change the corporate culture. The cases mentioned earlier of unauthorised trading involved corporate cultures where performance was placed before ethics.

The key takeaway here is the importance of building a strong corporate culture, with boards having a key role to play. Board and senior management must ensure that the tone at the top actually reaches people across the whole organisation.

Next is cross-border differences, be they cultural norms, business practices, or laws and regulations. The HSBC money-laundering scandal and the bribery scandals involving GSK, Leighton and Walmart have to do with a failure to appreciate (or choosing to ignore) cross-border differences.

Some other examples are Caterpillar’s troubled acquisition of a Chinese company, OSI’s tainted-meat scandal in its China operations, Nathaniel Rothschild’s dispute with the Indonesian Bakrie family in Bumi Plc, BP’s joint venture in Russia through TNK-BP, and Shell’s highly questionable dealings in its oil venture in Nigeria.

There are also many cases of companies going overseas to do business or list that have created problems for local directors, regulators, investors and other stakeholders. Here, we have cases such as China Sky and Sino-Environment as part of a rather long list of S-chip scandals. Elsewhere, we have cases like Boshiwa and Hanergy in Hong Kong, Rino in the US, and Sino-Forest in Canada.

The key takeaway here is the critical importance of gaining a deep understanding of such differences before companies enter new markets. Regulators must equally have a good understanding of these differences for companies entering the local market, for example, through a listing.

The third factor has to do with complexity of the organisation, specifically the proliferation of group entities such as subsidiaries, associates, joint ventures and special-purpose entities, often layered one on top of another. Boards of directors of group entities below the parent often have a very limited governance role, and at the same time, these entities are far from the line of sight of the group board and senior management. Today, the conversation about corporate governance should include group corporate governance.

Corporate scandals often start from a group entity, sometimes several layers below the parent company. The BP environmental disaster is a good example. More recently, OW Bunker, a company listed on the stock exchange in Denmark, collapsed due to risk management failure and unauthorised transactions in its wholly owned Singapore subsidiary.

Beyond the governance of the group entities, governance and management of other companies in the supply chain (or supply chain governance) is also important. The OSI tainted-meat scandal, the Takata airbag failure scandal and the OW Bunker collapse, for example, show how problems in one company in a supply chain can have devastating effect on other companies in that chain. The recent case of Swiber in Singapore may yet turn out to be another reminder of the domino effect on the supply chain that failure of a company can create.

The key takeaway here is the need to review the governance arrangements of the entire group, and to consider the governance and management of business partners in the supply chain.

In most of the cases in the five volumes of Corporate Governance Case Studies, deficiencies in boards of directors, financial reporting, internal audit, external audit, internal controls, risk management, remuneration policies and regulation have contributed to serious financial, environmental, social, safety or reputational consequences. However, these deficiencies often occur within the context of weak corporate cultures, cross-border differences and complexity of organisations. Future thought leadership, education and reforms for corporate governance should pay more attention to these challenges.

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