Speeches

Corporate Governance in the Knowledge Economy

In 1966 Lester Thurow wrote in the "Future of Capitalism" : "Paradoxically at precisely the time when capitalism finds itself without any serious competitor, its former competitor socialism and communism having died, it will have to undergo a profound metamorphosis". That profound metamorphosis has now begun in the form of developing an effective framework for corporate governance.

The role of corporate governance has never been more vital. Transparency, accountability, integrity, equity and responsibility in the governance of corporations can have a transformational effect on our entire economic and social performance. Yet high profile corporate failures such as ENRON, MARCONI and Swissair continue to take place even in the west where we are led to believe that principles of corporate governance have a strong base. Indeed analysts will find little to distinguish between the reasons of the collapse of ENRON in US and UTI in India. Both fell prey to the same political patronage. It is time, therefore, that we reflect why even 7 years after the Cadbury Report we continue to face situations, which continue to reveal the enormous cleavage between the rhetoric and reality of corporate governance.

Most of the work on corporate governance in the past has been done keeping shareholders as the focal point. In the knowledge economy of today when 1.2 billion people or a fifth of the world population still lives below the poverty line our aspirations of globalization of trade would sound hollow if they do not involve the poor. Once we have adopted market economy as a vehicle for economic growth there has to be a gradual weaning away of the state's role and a corresponding enlargement of the role of the corporations. In this new equation shareholders are not the only owners who matter. Employees, customers, suppliers also make investments which are no less at risk than the equity capital. Corporate Governance, therefore, is much wider than disclosures and compliance and calls for a paradigm change in the role of the board and corporate directors. Directors are no longer required to be passive and pliant. They need to be radicals and revolutionaries constantly spurring their companies towards creating new competitive spaces through a spiraling staircase of innovations. There is an explosion of stakeholder aspirations. At the same time the gap between what can be imagined and what can be achieved has never been smaller.

Morphing of industrial economy into knowledge economy has created a tectonic shift in public values. Companies can ignore this shift only at their own peril. Public hostility faced by Shell, Nike, Reebok, Ikea and Monsanto should provide lessons to corporations who violate the social license and show lack of environmental responsibility. In today's market, successful companies will be those that recognize they have responsibilities to the society, community and the planet that go beyond compliance with law. In a study carried out by Wheeler and Silanpaa quoted in their book called "The Stakeholder Corporation: A blue print for Maximizing Stakeholders Values (1997)", they asserted that during most of the 20th century in the UK and USA, stakeholder inclusive enterprises fared better than "shareholders - first" companies. Stakeholder inclusive corporations invariably lead to better long term business performance.
Harnessing the full potential of knowledge economy requires understanding of how knowledge works. Sharing of capital or physical assets does not increase the total value to society. Sharing of knowledge, on the other hand, adds value to both sides. Knowledge behaves entirely differently from capital. Capital consists of tangible assets (buildings, plant, land etc.) that are limited and can be used for only one purpose. But knowledge is a fluid, intangible asset that can be transferred at little cost. Its value increases when shared. This insight explains why collaboration between the corporation and its stakeholders can be beneficial to both sides. The end result is not one plus one equals two, but much more.
Corporate governance has become an issue of worldwide importance. The corporation has a key role to play in providing employment, public and private services, goods and infrastructure. The efficiency and accountability of the corporation is now a matter of both private and public interest, and governance, therefore, comes at the top of the international agenda. Whether the corporation is state or privately owned, needing local or international capital, governance is critical. Corporate Governance is concerned with the systems of laws, regulations, and practices which will promote enterprise, ensure accountability and accelerate trigger performance.

Globalization has brought in its wake the need for international coordination of effort to ensure that growth is sustained and shared: sustained in that it is robust and can withstand shocks. It should be shared in that it brings prosperity to the many, rather than the few. Good governance is a powerful competitive differentiator and critical to economic and social progress. In an increasingly globalized economy, firms need to tap domestic and international capital markets for investment. But capital providers have choice. The quality of corporate governance is increasingly becoming a criterion for investment and lending. Expanding and deepening the capital pool for developing and emerging economies requires full attention to corporate governance standards. This sets the crying imperative for reform.

There is a complex interplay of factors which contribute to an effective corporate governance system. This includes both internal and external factors. Factors internal to the firm are the board of directors, providers of capital, stakeholders, and management. Factors external to the corporation which ensure effective governance are legal and regulatory requirements, competitive markets, the media, transparency and high standards of reporting on accounting, firm ownership and owner's interests. Governance failures seriously affect corporation's credibility.

Just what constitutes corporate governance is still the subject of lively debate. It is an emerging discipline, and one in which little to date has been written specially from the perspective of developing and transition economies.

Corporate Governance is concerned with empowering people, spurring and pursuing innovation and improving efficiency. It also addresses conflicts of interest which can impose burdens on the enterprise. Ensuring transparency and probity in corporate affairs can make a major contribution to improving business standards, public accountability and consequently increase its market capitalization.

From the corporation's perspective, the emerging consensus is that the purpose of high standards of governance is to increase the firm's value by effectively meeting the corporation's financial, legal and statutory obligations. This inclusive definition stresses the need for boards of directors to balance the interests of capital providers with sweat providers. This highlights the need to involve all stakeholders in order to achieve long term sustained market success. From a public policy perspective, the purpose of corporate governance is to nurture the spirit of enterprise whilst ensuring accountability for the exercise of power and patronage by firms. The role of public policy is to provide firms with the incentives and discipline to minimize the divergence between private and social returns, and to optimise the interests of all stakeholders, the environment and the community at large.

Recent years have witnessed a spate of reports and legislative action, which casts specific responsibility on company directors to ensure accountability, integrity, probity and transparency. Starting with the Cadbury Report in the UK in 1992, Greenbury Report of 1995 and Hampel Report of 1998, there have been numerous codes on corporate governance issued by among others Business Round Table of USA, Australia's Investment Managers Association, OECD Principles of Corporate Governance, Blue Ribbon Commission of US and Commonwealth Association of Corporate Governance.

India too has witnessed 3 reports - Desirable Corporate Governance by CII, Kumar Mangalam Birla's report of SEBI and the latest Corporate Excellence Report issued by Department of Company Affairs. Before the close of the year the Centre for Corporate Governance has brought its own guidelines on corporate governance, which also take into account the disclosure of environmental and social reports. All these reports tend to focus primarily on the "conformance" role of the directors. Quality of Governance is much wider than transparency and disclosures to shareholders. It is being increasingly recognized that in the fiercely competitive world of today, where the markets, products, customers and even rules of business are changing on hourly basis, no board can add value through the conformance role alone. There is need to broaden the role of corporate governance to make it a powerful instrument of national resurgence.

Issue of corporate governance has assumed even greater relevance in the post 11 September world. The corporations today have a vested interest in making the world safe for the business. They need to pause and think what contribution they are making to human welfare, to eliminate inequalities, to reduce poverty, to remove disease and improve ecology.

Good governance needs to ensure that the corporations take into account the interests of all constituencies in which they operate. A business enterprise's corporate actions must be compatible with long term societal needs such as the quality of environment and welfare of local community. Ultimate competitiveness and corporate success is dependent as much on investors, employees, customers, creditors and suppliers as on shareholders.

The rampant corruption and corporate mis-governance are alienating the civil society from the corporations. This is the last thing that we can afford in the era of globalization. This lends an urgency to implementation of good governance practices. It's importance in India is even greater because of the recent scams in India's financial and corporate sector. The crisis of confidence created by this has severely jeopardized our ability to attract investment, in particular the foreign investment, so vital to bring about India's economic transformation.

*******