The CEO & Corporate Governance:
The Crucial Moment of Truth
By Ricardo J. Romulo

Let us begin with four major premises.

The first is that many large Philippine corporations are family-owned and controlled, even those listed in the Philippine Stock Exchange. Second, confrontations are generally avoided and consensus is the rule in most Boards of Directors operating in the Philippines. Third, the CEO of the company is likely to be the original founder of the corporation or a close relative of the founder or, if a stranger, someone trusted by the family. And fourth, the directors typically are business associates, friends, relatives or lawyers of the family.

Thus, whether or not good governance policies are adopted and practiced is principally up to the leadership and example of the corporation’s CEO. It is not too difficult to conclude given these premises that CEOs and directors under these circumstances would view good governance strictly from a letter-of-the-law or basic compliance perspective with any doubts being resolved in favor of management. How do we alter the status quo?

The winds of change circulating around Southeast Asia for the adoption of best practices have had some effect. In fact, the Manual of Corporate Governance imposed on certain companies since September of last year by the Securities and Exchange Commission was partly influenced by developments in Malaysia, Singapore, Thailand, and Australia.

The Emergence of Rules
Since 1997, a series of consultation meetings among business groups and institutes paralleled by growing public concern over good governance in general eventually led to three key developments. The first was the adoption of a uniform manual on corporate governance based on Organisation for Economic Cooperation and Development (OECD) principles and internationally-accepted best practice. The second was the creation of a Governance Advisory Council of private sector representatives by President Gloria Macapagal Arroyo to address governance in the public sector. A third key development came about when two important government agencies took decisive action to translate theory into practice: the Bangko Sentral ng Pilipinas and the Securities and Exchange Commission.

The initial results were memorandum circulars which for the first time required certain companies to publicly adopt a manual of corporate governance. These included issuers of registered securities, public companies beyond a certain size of assets or shareholder base, corporations which were grantees of permits or licenses and secondary franchises from the SEC, publicly-listed companies (including branches of foreign corporations operating in the Philippines and listed in the SEC), and banks.

The code institutionalized principles of good corporate governance by setting the duties and responsibilities of boards of directors and executive officers; creating committees on audit compensation and remuneration, and nomination; and requiring the appointment of a compliance officer. It also listed the rights of stockholders to information, to dividends and appraisal, and mandated that directors had a duty to protect and promote these stockholders’ rights. Additionally, companies were required to have at least two independent directors.

Among banks, a “fit-and-proper” rule was applied to determine the qualifications of directors and officers of banks and expanded grounds for permanent and temporary disqualification of directors and officers were issued by the BSP. Training for directors of banks and non-bank financial institutions became mandatory.

Rules Change Behavior
In theory the adoption of a manual of corporate governance will improve accountability and transparency in the conduct of a company’s business and affairs. A compliance officer is required to monitor and report to the SEC adherence to as well as violations of the manual. Specific problems which may arise, say in the financial reporting of the company, would result in the chairman and members of the audit committee being held liable. Similarly, excessive or unreported executive compensation would have to be explained by the compensation and remuneration committee, and so on. Thus, accountability is pinpointed to individual officers, not just to the CEO or the Board.

The SEC required corporations to submit a Corporate Governance Self-Rating Form (SRF). The SRF required the evaluation of the board, management, organizational and procedural controls, independent audit mechanism, disclosure and transparency, shareholders’ benefits, and compliance system. Each major heading was to be rated by specific criteria listed in the SRF.

The SEC will make its own evaluation and recommendations based on the SRFs submitted. The SRFs and SEC evaluations will be open to public scrutiny. And, of course, for listed companies the effect of these evaluations on their share will be the ultimate sanction.

In the banking sector, the BSP has sent a very clear signal that it will hold directors responsible for bank failures. As a consequence, most of the bank boards have decided to make an assessment of its own corporate governance practices. The results of these self-assessments showed, among other things, that bank boards were deficient in the following areas: a) monitoring of performance against targets, b) consideration of strategic, long term issues, c) oversight of the risk management process, d) assessment of risk in the bank’s management process, d) assessment of risk in the bank’s portfolio, and e) diligence in reviewing audit reports. Thus, a benchmark has now been established by which the BSP can monitor the progress or lack of it, when evaluating the board’s performance.

What I have tried to illustrate is the importance of devising mechanisms not only to implement good governance principles such as the manual of corporate governance but also the correlative importance of being able to check whether the principles are being effectively implemented through self-appraisals, complemented by an assessment made by outside parties or the relevant regulatory body. But the aim of these measures, like the Manual of Corporate Governance, is not so much to dock company officers and directors but moreso to show that by improving governance you improve the company’s bottom line.

These may seem to some of you as small steps, and I agree that they are; but this is one time when “little things mean a lot” because they break inbred habits. Based on my own experience, as a director of several companies, these reforms on a tentative basis are beginning to take hold and to have their effects. Directors have become a bit more active during meetings because they know that their performance as directors will be evaluated.

The Business Argument for Corporate Governance
Aside from the penalties arising from non-compliance, why should a corporation bother about its governance? There are several reasons. First, from the perspective of financial incentives, companies who exercise good corporate governance may benefit in terms of lower cost of equity and debt capital; gain access to international capital markets; enjoy better relationships with longer term investors—the so-called “patient money”; and implement better risk management and internal controls.

According to the CLSA/ACGA (Asian Corporate Governance Association) “CG Watch 2003” study, stocks of the top 25% of companies in corporate governance outperformed their markets by 35 percentage points. Conversely, the bottom 25% of companies in corporate governance saw their stocks underperform by an average of 25 percentage points. This relationship was strongest in markets known to be weak or poor in corporate governance. The Philippines was among three countries (together with Indonesia and China) perceived as riskiest from a corporate governance perspective.

The study also cited other commercial incentives. For instance, there appeared to be a relationship between good governance and being a preferred supplier or preferred partner for joint ventures, especially in dealing with multinational corporations.

Finally, from a human resource perspective, the “CG Watch 2003” study asserted that good governance can strengthen the employee-employee relationship as more transparency leads to greater trust. It also found that better governed companies are often the employer of choice for workers.

Needless to say, the incentives and benefits that apply to corporations apply to countries as well. From financial, commercial, and human resource perspectives, over the long-run, countries which are governed well will outperform countries which are not.

Rules Alone Do Not Work
It is clear that rules by themselves, even with the prospects of criminal prosecution, cannot guarantee right conduct and proper behavior at all times. Otherwise, how does one explain Enron, Adelphia Communications, Tyco, Worldcom, and, more recently, Coca-Cola’s admission of having manipulated a marketing test for frozen coke in Burger King restaurants.

However, group or societal codes of behavior, individually imbibed by its participants, can be powerful forces for good. Take the example of cyclist Jan Ullrich in the recent Tour de France. At a crucial moment, when tour leader Lance Armstrong crashed and fell when his bike’s handlebars hooked a spectator’s bag as she leaned over the race barrier, Ullrich pulled back and eased up his speed in accordance with their tradition of sportsmanship. As one journalist later wrote: “The administrators of the Tour de France could not staff their race course with enough enforcement referees to impose split-second pacing rules on a pack of speeding bikers. Jan Ullrich showed the world that only a code of behavior that can be self-administered at the crucial moment of crisis will earn virtue’s reward.”

So rules—or even the promise of benefits in the form of a better bottom line or the ability to attract better people—should not be our sole objective for pursuing and advancing the cause of good corporate governance. Corporations do not exist in a vacuum. They interact with the community in which they operate, and, in turn, they are influenced by society’s prevailing mores, ethics and culture.

Corporations, therefore, must actively participate in building a broader and proactive constituency for good governance across the board. In this regard, there are many citizens’ groups corporations can join devoted to promoting good governance, not only in the corporate sector, but also in civil society, the academe, the religious, and the public sector. To succeed, I believe there is a need to establish an overarching umbrella organization that will organize—or a vision that will guide—these disparate groups into one unified voice for good governance.

Ultimately, we need an accepted code of behavior firmly embedded in the culture of an individual, corporation, organization, and society which becomes self-fulfilling at the crucial moment of truth. The difficult question which I invite everyone to think about is how to inculcate it in every member of a corporation from CEOs to the lowest-ranking employee, just as we need to do this from our leaders down to every citizen.

Ricardo J. Romulo is Chairman of the Makati Business Club. This speech was delivered at the “Managing Corporate Governance in Asia” conference on 4-5 September 2003.