Keynote address by Dr Madhav Mehra at the ASEAN Round Table 2004 organised by Singapore's prestigious Institute of South East Asian Studies.“Independent directors are the cornerstone of corporate governance. But excessive remunerations paid to them has made a mockery of their independence. An analysis of 2004 compensation data showed independent directors of top 200 companies are being paid £97000 for barely 7 days work in a year. Would you expect such directors to give independent and unbiased advice”

On the eve of the second birthday of the Sarbanes-Oxley Act it will be more appropriate for me, as head of a body whose raison d'etre is creating awareness of best practices in corporate governance, to talk of the successes in corporate governance effort worldwide. The report card, however, does not say so. There is no doubt that there is plenty of good news. Directors have started taking their jobs seriously. Boards are awash with independent directors. Audit committees, nomination committees, remuneration committees are all being taken seriously. Board meetings, once short briefings, now focus on indepth corporate issues, stakeholders dialogue and corporate social responsibility. Certification of financial statements on penalties of prison sentences has put a chill in the spine of Chief Executives and they are taking far deeper interest in organisation's financial reporting.

It is all hunky dory, specially for audit companies whose revenues are increasing sharply. Audit Fees for Fortune 500 companies are expected to climb 88% this year, according to a survey by the Public Accounting Report. Top accounting firms already look healthier. Ernst & Young booked a 17.4% revenue increase in its 2003 fiscal year, to $5.3 billion. Grant Thornton booked a 21% increase, to $485 million. Of course, with the bean counters cashing in, stakeholder expenses are going up. The largest U.S. companies will typically spend more than $4.6 million each to comply with just one section of the law, according to Financial Executive International. In Europe, one major energy firm listed in the U.S. market puts the annual cost of complying with Sarbanes-Oxley at over $100 million. And large companies complain that the get-tough accounting regimen is draining resources. Paul Schmidt, controller for General Motors, says GM's chairman and CFO are spending more time on accounting and certification issues, “instead of strategy”. And it could get harder, if more governments follow suit. “One of the problems two years down the road is the danger that we're going to have a proliferation of several country codes', warns Rod Armitage head of company affairs at the Confederation of British Industry. “For a company with multiple listings, this is very costly.”

On the market front things are far from satisfactory. Frauds are continuing to take place with unremitting regularity. The fraud at Ahold, the Dutch Supermarket giant, which revealed that its 2003 accounts were overstated by 500 million dollars caused its shareholders loss of more than 6 million dollars. There is little correlation between occurrence of a fraud and its detection and reporting. The fact that most of the corporate scandals are reported in the US does not necessarily mean that frauds occur in US alone and other countries are more honest. If at all it should be the other way around. Countries where no corporate frauds are reported should be the ones to be watched and avoided by investors. It is like the third truth. Truth, as we know, has several aspects. Bhagwat Geeta, the ancient scripture of India, says “Infinite truth has infinite aspects”. We deal with three aspects here. The first truth is that we tell ourselves i.e. the reality as we know it. Second truth is what we tell others: not the reality as we see it but the way, we would like others to see it. The third truth is when the reality is so distressing that we fear even acknowledging its existence. Countries which do not report corporate frauds fall into the last category. Here one must acknowledge and commend the power of US institutions to take up the frauds head on. It is always this side of the Atlantic that fraud rarely get reported. Even when they are reported the establishment closes up and soon all is forgotten.

Lot of song and dance was made of insider trading in Marks & Spencer shares. Nothing came out at the end. British do things differently. One could never think of a British icon being incarcerated the way Americans have done to Martha Stewart. These double standards in corporate governance have come into sharp relief in imposing fines on Shell by the two watchdogs. Shell has been fined a total of 151 million dollars (£ 83 million) for wrongly booking 20% of its reserves. The fine imposed by UK's Financial Services Authority is only a fraction - £17 million against £66 million imposed on it by Securities and Exchange Commission. The penalties are a flee bite as far as Shell is concerned which has just reported £2 billion of net profit in the second quarter alone, thanks to the boost in oil prices. Contrast it with over a billion dollars in fines imposed by Eliot Spitzer on three financial services giants: Citibank, Merril Lynch and CSFB even before the Sarbanes Oxley came into force. As with so many of these fines, the punishment does not seem to be particularly painful and therefore not a sufficient deterrent. By paying these fines Shell has been able to get the investigations against it closed without having to admit wrongdoing. This does not mean that the company is now over the hill. It still faces a regulatory enquiry in the Netherlands, a potential criminal investigation by the US Justice Department and a raft of class action suits. When asked about the weakness of FSA in imposing fine on Shell it was found that FSA did not even require oil and gas to make disclosures about their reserves.

The US had a head start in legislation on corporate governance having passed the Sarbanes- Oxley legislation on 31 July 2002. There was more dithering on this side of the Atlantic. Even though Sir Derek Higgs had submitted his report not very long after Sarbanes, the combined code on corporate governance incorporating his recommendations came into force only on the 1 November last year. According to the research conducted by Manifest, commissioned by the Financial Times of UK, only a slim majority of leading companies are on track to meet corporate governance standards as outlined by Sir Derek. Smaller companies have actually scaled down the number of non Executives on the key board room committees taking advantage of the exemption given by Sir Derek. The data shows that while 86% of small CAP companies boasted at least 3 non executives at the audit committee in July 2003, 12 months later the figure dropped to just 70%. Sir Derek came down heavily against the combined role of chief executives and chairmen. There is a good news here. While last year 20 of the biggest 350 companies had chairmen and chief executives rolled into one the figure has now gone down to 13. Also the number of FTSE 100 companies that had designated a senior independent director has increased from 73% to 83%. The biggest rub however is only on remunerations paid to the non executives. These have risen sharply. HSBC pays its non-executives £35,000 a year with plans to increase that to £55,000. Audit committee members get an extra £15,000 while the chairman pockets £40,000 more. By contrast, the chairman of the bank's remuneration committee received an extra £20,000. At Diageo, the drinks company, non-executives receive a base £50,000, an increase of £15,000 in 2002. Its audit committee chairman gets an extra £20,000, double the amount of the year before. At Reuters, non-executives get a base £50,000, an increase of £15,000 on the year before; the audit committee chairman is paid an extra amount equivalent to triple that of his counterpart on the nominations committee.

The worst fall out of these corporate governance reforms is that non-executive directors are no longer independent thus defeating the purpose of the exercise. Their salaries have soared so much that they rate alongside the executive directors raising the same issue of conflict of interest. An analy­sis of 2004 compensation data shows average remuneration for so-called “non-employee” directors of the top 200 US companies rose 13.4 per cent to $177,000 (£97,000). Fees paid for attending committee meetings jumped by more than a third. The most important issue facing the companies today is of transparency. Edward Archer, managing director of Pearl Meyer & Part­ners, the New York compensa­tion consultant that carried out the analysis, said: “It is like haz­ardous duty pay. They are wor­ried about the risk to their repu­tations as well as legal liability from the fact that they have to put their name on the dotted line.” Pearl Meyer says most compa­nies now choose to issue shares to directors plus fixed annual retainers because of criticism of past reliance on variable atten­dance fees, share options and other perks such as pensions. For some companies, share awards now make up the bulk of director compensation. At Gold­man Sachs, for example, new arrangements mean directors are offered restricted stock worth $280,000 a year plus a retainer of up to $100,000.

One of the issues that came into the forefront in Philip Green's takeover battle with Marks & Spencer is the degree of opacity still maintained even by star companies in their financial statements. Philip Green merely wanted to carry out a programme of due diligence on Marks & Spencer before buying it. How his attempt was foiled is now history. The story is instructive to the extent it brings into fore the difficulties experienced by a typical private equity investor. The World Council for Corporate Governance has always believed that the focus of corporate governance should not be simply compliance to regulation but making boards more competitive. Competitiveness can improve only if companies are open about sharing information. Philip Green had to sweat and bleed even to get information on Marks & Spencer pension funds. Investors who wish to hold significant stakes in businesses want those companies to be more competitive and naturally want a lot more information than is currently available as per statutory requirements.

According to Charles Cary-Elwes who set up RREV, the corporate governance joint-venture between the National Association of Pension Funds and the Institution of Shareholder Services, “the debacle such as at Sainsbury - where Sir Peter Davis, the chairman, was awarded a substantial bonus despite poor performance would not have happened had private equity investors been serving on the board. The big difference is that when pension funds and other institutional shareholders talk of engaging with companies, they usually mean Corporate Governance; whereas, when private equity investors talk of engagement, they tend to mean something different, namely “Enterprise” Governance.” We believe that corporate governance without “enterprise” governance is an almond without a kernel.

There are a lot of lessons for developing and emerging economies like India in the way corporate governance has been practiced in the west. While these markets are highly sophisticated their governance systems are far from satisfactory. They cannot serve as role models for Asian and African economies but their scandals such as Enron, Anderson, Worldcom, Parmalat, Scandia, Vivendi, Equitable Life, Computer Associates, Ahold and Shell offer great lessons. They make us wonder that if companies such as Shell whose slogan was “Judge us not by what we say but what we do,” can lie through their teeth to their biggest shareholders, would they have any qualms in doing so to Nigerian or Indian villagers?

While corporate triumphs a la Microsoft or General Electric are narratives fashioned by the triumphant to suit their agenda, corporate failures and disasters that go through dissection and analysis at various levels provide us rich and wide ranging inputs for reforms. In this we must give the US its due as its reports on such scandals are far more penetrating with learning points for everyone.

In the end we have to recognise that corporate governance practices cannot be imposed by legislation alone - least of all ticking boxes. Issues of corporate governance are the issues of the heart. Do you pride yourself in being transparent and honest and have the conviction to own your mistakes or do you continue to do business as usual using all the techniques, skill and technology to ensure you don't get caught?

As long as markets are driven by crass greed, codes will have little power to remove the practice of double standards. Only investors can - by punishing those at the helm of companies that get caught. It is in fact the investors who should adopt double standards – forgive companies who admit to having made genuine mistakes and promise to learn, and incarcerate those who use corporate governance simply as a cover up for their “business as usual” approach.

* Dr Madhav Mehra, President, World Council for Corporate Governance