the key ingredient to success: corporate governance opportunities and challenges for mfis

The Key Ingredient to Success: Corporate Governance Opportunities and Challenges for MFIs

Dr. Martin Steindl, MBA (HEC)Program ManagerInternational Finance Corporation

Tunis – May 2008

Presentation Purpose and Outline

Outline:

• What is corporate governance?

• Why does corporate governance matter; how does it add value? What can happen if you do or do not have it?

• Specific governance issues for MFIs

• Possible solutions and implementation

Purpose: To explain the concept of and business case for good corporate governance, tailored to MFIs

Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

Takeaways

• Understand what good corporate governance is

• Agree that corporate governance can add value and is indeed a key ingredient to success

• Appreciate the main issues as they pertain to MFIs, and finally

• Identify steps you may wish to undertake to implement good corporate governance in “your” MFI

By the end of this workshop, you should be able to:


Governance is governance…it is not management and it is surely not volunteering…as a board member

you have to see to it that the organization is well-managed rather than managing it yourself

Source: Ken Dayton, quoted from Consensus Statement of the Council of Microfinance Equity Funds, May 2005


What is corporate governance?What does it ‘look and feel’ like?

Why does corporate governance matter? How does it add value? What can happen if you do or do not have it?

Specific governance issues for MFIs

Possible solutions and implementation

Summary

Corporate Governance Defined

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders.

Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.”

Source: OECD Corporate Governance Principles, 2004

“Corporate governance is the system by which companies are directed and controlled.”

Source: Sir Adrian Cadbury, UK Combined Code


Founder stage: Shareholder=Director=Manager

The Overall Challenge of Aligning (Conflicting) Interests

Nom Cttee

CIA

AuditCttee

Rem Cttee

Ext.Audit

CRO CCO

RiskCttee

Act in interest

of

Elect &dismiss

Shareholders- The general assembly -

Directors- The board of directors -

Managers / Executives- CEO / mgt. team / ExCom -

Pro

vide

cap

ital

to

Report &answer to

Guide &control

Areaccountable to

Internal—Corporate—Perspective External—Stakeholder—Perspective

Stakeholders

Reputation Agents• Accounting firms

• Law firms

• Investment banks

• Credit rating agencies

• Financial analysts

• Financial media

• Research institutes

• Educational institutions

• Corporate governance institutes

• Institutes of directors

Law- & rule makers• Company, Banking,

Securities Laws• Regulations, Listing rules• National CG Codes

Civil society• CSR• HSE

Capital & Financial Markets

• Debt & equity markets• Competitive forces• Market for corporate

control

Intermediaries


But Rest Assured: One Size Does Not Fit All!

• No to cookie-cutting: corporate governance improvements should be tailored to specific institution at specific point in time in specific country!

• Focus on the following four principles:

1. Accountability2. Responsibility3. Fairness4. Transparency

• And remember: corporate governance is a journey and not a destination– Best to understand key issues, then implement on a step-by-step

basis


The ‘Look & Feel’ of Corporate Governance

Strong commitment to corporate governance reforms

Goo

d bo

ard

prac

tices

App

ropr

iate

Con

trol

en

viro

nmen

t & p

roce

sses

Stro

ng re

gim

e of

di

sclo

sure

and

tran

spar

ency

Prot

ectio

n of

(min

ority

) sh

areh

olde

r rig

hts

The five key elements ofgood corporate governance

- Role

- Duties

- Structure

- Composition

- Procedures

- Remuneration

- Evaluation

- Training

- Risk mgmt.

- Internalcontrols

- Compliance

- Internal audit

- External audit

- Audit cttee.

What:

- Financial

- Non-financial

Where:

- Annual report

- Website

When:

- Qrt, annually

By whom:

- Board vs mgt.

- Generalassembly* Cumulative voting* Information* Discussion

- Minority SH protection* Against RPT & insider deal.* Tag-along

- Dividendpolicy

- Formalization of policies and procedures

- Appointing CG leadership


Corporate governance corporate/financial management

Corporate governance corporate social responsibility or business ethics

Executive Mgmt. - Decision and Control -

Operational Mgmt.

Corporate Governance

Corporate Management

Strategic Management

Source: Robert I. Tricker, Corporate Governance, 1984

Accountability and

Supervision

Executive Mgmt. -Decision and Control-

Operational Mgmt.

Corporate Governance

Corporate Management

Strategic Management

Source: Robert Tricker,Corporate Governance, 1984

Accountability and

Supervision

Important to Distinguish Corporate Governance From Other Concepts

If management is about running the business, corporate governance is about seeing that it is run properly. All companies need managing and governing.






Summary

Sustainability &

Com

petitiveness

Improves Access to Outside Capital (including donor funding)

Improves Valuation and Lowers the Cost of Capital

Builds/Improves the Company’s Reputation and Trust

Optimizes Operational and Financial Performance

Benefits of Implementing Corporate GovernanceEven NGOs require a return on capital to remain competitive and lend again

• Streamlines business processes, leading to better operating performance & lower capital expenditures Gompers, Ishii and Metrick, corporate governance and Equity Prices, August 2001

• Improves the company’s ROCE, with firms in the top cg quartile avg. 33% & in bottom quartile 15% Credit Lyonnais SA, 2001

• Better share price performance, higher profitability, larger dividend payouts & lower risk levels than peers

Lawrence Brown, Georgia State University, Sept. 2003

• Over 10 years, well-governed companies across a wide range of sectors have seen superior valuation multiples of more than 8% over their badly governed peers.

Metrick, Ishi and Gompers, Corporate Governance and Equity Prices, August 2001• One standard-deviation improvement in governance brings an improvement in valuation multiples that

ranges from 18% for companies in major OECD markets to 33% in emerging markets. Clapper and Love, World Bank, 2002

• Global Institutional Investors managing more than 1 trillion of assets state that they will pay a premium for well governed companies. Premiums avg. 30% in Eastern Europe & Africa and 22% in Asia and Latin America

McKinsey Global Investor Opinion Survey on corporate governance, 2002

• CG can make or break reputations by creating confidence, establishing goodwill and building/restoring investor trust


Benefits Over Long Run Thought to Outweigh Costs

Corporate governance related costs: Staff, e.g., a corporate secretary, independent directors

Structures, e.g., committees

Disclosure, e.g., annual and quarterly reporting, IFRS accounts

Control, e.g., publicly recognized external auditor, internal controller and auditor

However, benefits from implementing corporate governance generally thought

to outweigh costs over long run






Summary

Specific Issues and Challenges for MFIs

• A dual mission: Balancing profit-seeking with social objective of reaching poor clients

– Make point to discuss right balance at highest level– Develop KPIs for social objectives– Right mix of directors

• Ownership of MFIs– Informality of governance policies– Weakness of control environment– Entrepreneurial founders– Aligning interests of individual directors with interests of institution is key

• Fiduciary responsibilities of MFIs– Greater than that of other corporate entities– issues to consider: i) low-income microentrepreneurs, ii) responsibility with donors,

iii) threat of insolvency and its potential repercussions on national and international microfinance sector


• Many MFIs are incorporated as NGOs/NPOs, COOPs (and not FIs)

– Principal-agent equation non-existent or shifts due to depositors– Informality of governance structures and weak oversight

• Many MFIs are financial institutions, with own set of distinct issues

– Strict regulation, e.g., on fit & proper, risk, and controls– Opaqueness of financial information– Relationship to regulator

• Managing transformation: Developing from an NGO to a more complex organization

– Risk assessment in MFIs– Extended fiduciary duties, vis-à-vis shareholders and depositors– Succession planning


Specific Issues and Challenges for MFIs (cont.)

‘Yes-men’ Board

Different Board Types: The Good, Bad, and Ugly

‘Rubber Stamp’ Board

‘Country Club’ Board

‘Good Old Boys’ Board

‘Paper’ Board

‘Trophy’ Board

‘Shareholder’ Board

‘Executive’ Board


‘Hands-on’ Board





Summary

Specific Recommendations for MFIs

• Separate Ownership/oversight from control/management– For the board to better provide strategic guidance and oversight

• Professionalize board– Clarify roles and responsibilities– Nominate outside and skilled directors– Ensure for appropriate mix-of-skills– Adopt appropriate working procedures– Create committees– Appoint women to board

• Strengthen risk management and control frameworks– Understanding and managing risk key for financial institution – Robustness of control structure to provide assurance to board,

investors– For larger MFIs: internal audit function


How Involved is the Board?

Low Involvement High Involvement

The PassiveBoard

At discretion of the CEO

Limited activity & participation

Limited accountability

Ratifies mgmt. preferences

The CertifyingBoard

Certifies to SHs that CEO meets expectations

Takes corrective action only as very last resort

Understands role of independent directors

Informed about CEO’s performance

Establishes a succession plan

The EngagedBoard

Provides insight, advice & support to mgmt.

Understands its responsibility to oversee mgmt.

Guides & judges the CEO

Has right skills mix to add value

Define roles and responsibility of Board vs. management

The InterveningBoard

Intensely involved in decision-making around key issues

Frequent & intense meetings, often on short notice

The OperatingBoard

Makes key decisions that mgmt. then implements

Fills gaps in mgmt. experience

Source: HBR, David A. Nadler, Building Better Boards


Executive, Non-Executive & Independent DirectorsDefinition & Role

The role of executive, non-executive and independent directorsExecutive directors

Definition: Executive directors hold an operational position in the company Role: Executives are responsible for the day-to-day operations and results;

best placed to develop, set and implement strategy

Non-executive directors

Definition: Non-executive directors (NEDs) do not hold an executive position in the company. A NED may or may not be independent

Role: NEDs contribute (i) an outside perspective and greater impartiality in their judgments; (ii) additional external experience and knowledge; (iii) useful contacts

Independent directors

Definition: An independent director (ID) is a director who has no material relationship with the company beyond his or her directorship

Role: Ensure that the board includes individuals who can effectively exercise objective judgment for the exclusive benefit of the company and its shareholders


‘There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.’

• The leadership of the board, setting its agenda and ensuring effective contribution of all its members acting in the best interest of the bank’s shareholders

Board Chairperson and the CEO

Source: UK Combined Code 2003

• The day to day running of the bank within the risk parameters defined by the board and delivering the bank’s strategy endorsed by the board

The chairpersonis responsible for

The CEOis responsible for


Example of a Board’s Composition

Non-executive Chairperson

Non-executive / independent Director






General ManagerRetail Services

General ManagerBusiness/Corporate

Chief Executive OfficerExecutive Directors

Non-executive/ independent Directors

Chief Financial OfficerCompany Secretary

In attendance


Corporate Governance & Audit Committee

General Assembly(Shareholders)

Board of DirectorsBoard Committees

Audit Committee Risk Committee Exec Committee

Remuneration Other Committees

Bank Infrastructure

Internal Audit Risk Management

Business And Support Units

ReportingElection Feedback

Senior Management

StrategyPolicies

Risk AppetitePerformance

AdviceConcerns

External Audit

Capital MarketsAuthority

Central Bank

Rating Agencies

Investment Analysts

International FinancialServices Industry

Tran

spar

ency

Pro

fess

iona

lism

Dyn

amis

m

TrustR

espect

Press

Customers

Institutional Investors

External S

takeholders

Bank

Compliance


The audit committee: Reviews integrity of the financial statements, and endorses and

reviews accounting policies in use Reviews the bank’s systems of internal control Reviews the effectiveness of internal audit Oversees external audit independence, work, and engagement Reviews legal and regulatory compliance Acts as central coordination point for investigation of complaints

relating to financial statements, compliance & internal controlsIt then: Provides regular updates to the board Alerts the board to problems Pursues and resolves areas of concern

Audit Committee – Terms of Reference


How Risk Aware is Your Board?Red Flags for Directors!

As a board member you should ask the following questions:

Does your board ever discuss current and future risks as an agenda item?

Do you receive intuitive reportage which enables you to understand and be comfortable with your bank’s risks?

Are you sure your bank is being properly rewarded for the risks it takes?

Is your bank on track with delivering its strategy?

What are the serious challenges it is facing at the moment?






Summary

Summary and Conclusions

Put most simply, corporate governance is defined as a series of structures and processes for the direction & control of a company; it must not to be confused with public governance, CSR or business ethics

Corporate governance improvement planning is a journey and not a destination

There are a number of behaviors and practices that will need to change, in addition to the company’s framework, policies, and procedures

In general, MFIs can improve their governance by (i) professionalizing their board of directors, i.e., creating a committee structure, separating the role of the board chair and managing director, etc., and (ii) strengthening risk management and control frameworks

Intro >> Definition >> The business case >> Implementation for MFIs >> IFC Methodology >> Summary

Thank you for your attention

the key ingredient to success: corporate governance opportunities and challenges for mfis

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