Lessons from international corporate governance standards: the ethical perspective in corporate governance

Presentation by Malcolm D Knight General Manager of the BIS, at the 2nd Islamic Financial Services Board Summit, Doha, Qatar 24 May 2005.

Your Excellencies, Honoured Guests, Ladies and Gentlemen. I participated in the 1st Islamic Financial Services Board Summit in London last year, and it is a great pleasure and honour for me to be invited as a keynote speaker at this second summit in the beautiful city of Doha. It is even more of a pleasure for me to speak on the important topic of corporate governance, and particularly on its ethical perspective.

Governance and ethics
  • It is a fact of life that many of the most spectacular failures of corporate governance in recent years have been in the jurisdictions of the most advanced industrial countries. So a discussion of the principles of corporate governance can indeed yield lessons for all of us.
  • Failures of corporate governance have been at the root of recent well known cases of management defrauding the shareholders in some of the most advanced economies. This behaviour was both an example of bad governance and unethical. It disappointed stakeholders, detracted from the performance of the companies involved, and weakened the economic system generally. Where corporate governance works well, it re-enforces ethical standards; where it fails, it permits unethical practices. Good governance leads to corporate social responsibility, because a well governed corporation is expected to adhere to the values and norms of the community. But these very values of the community are not with a great deal of precision as they affect corporate behaviour, whether in the private or public sector. This is where the drafting of codes of good governance for public and private enterprises can contribute greatly.
  • Ethics, of course, refers to the shared values of the members of a community. Finding ways to give expression to these values in a financial context is a challenge. In selecting the theme of this conference as well as in its excellent work to date, the Islamic Financial Services Board has emphasised the fact that Islamic religious and ethical standards have a concrete impact on Islamic banking products and financial services.
Key elements of governance
  • There are three components of governance arrangements that apply in both private and public contexts:
  • First, it is important to understand the objectiveof an organisation, and to align incentives for managers with the preferences of stakeholders, particularly shareholders.
  • Second, it is important to benefit from transparency: stakeholders must be able to observe the actions of managers, and must have access to the information that is necessary to form an opinion on them.
  • Third, accountability is important: managers need to demonstrate that they have done their utmost to achieve the objective of the organisation.
Role of codes and best practices in achieving sound corporate governance
  • Codes and standards of corporate conduct provide a metric to guide and gauge behaviour. They are a means of giving expression to the broad ethical principles of the community in each enterprise.
  • I take governance codes to include a number of interrelated principles, for example: the mission statement of the institution; the codes of conduct for members of the board of directors, the management, and the whole staff; the ethics code; the personal account trading rules; rules on representation and gifts; procurement codes; and compliance policies.
  • If governance codes are to be accepted, they must be devised in an inclusive manner. If they incorporate the ethical standards of the community, they will be more acceptable than if they are ethically neutral.
  • Governance codes need to be backed up by effective means to ensure compliance. The incentives must be in place to make sure that they are observed. These incentives can be economic, legal and moral.
  • However, they should also be clear and simple and transparently directed towards the fundamental goals of the enterprise. Adding too many ethical objectives to governance codes may amount to imposing an additional constraint on an organisation's objective function. It is a principle of optimisation that an additional constraint means that the outcome can be no better than (and will possibly be inferior to) the outcome of optimisation without the constraint.
Making governance work
  • How can we promote good corporate governance? One important step is to consider in detail which roles can best be played by markets, by self-regulation, by governments and by regulators. As differing views about Sarbanes-Oxley demonstrate, there is no universal answer. The weight of these factors will vary from country to country, but they all have a role to play.
  • The second step is to train professionals and educate the general public. In many countries, governments and regulators have great difficulty in competing with the private sector for scarce professionals. It is also difficult to find qualified board members. Efforts are under way in the Gulf to enhance training facilities that qualify professionals for serving on shariah councils. This is similar in spirit to the creation of the Financial Stability Institute at the BIS, which has been providing high-level training to supervisory authorities worldwide for a number of years now.
Governance at the BIS
  • The BIS is celebrating its 75th anniversary this year, which makes it the oldest international financial institution in the world. Most recently, the BIS has grappled with three specific governance issues.
  • The first was the decision to buy out private shareholders, in order to reconcile the Bank's ownership structure with its public policy function. The BIS board's decision to do so was very widely supported, but implementing the decision met with a number of difficulties along the way, which are now behind us.
  • The second issue is a review of governance arrangements at the Bank. This is being carried out by a subcommittee of the board, and is intended to ensure that evolving practices and statutory arrangements remain well aligned.
  • The third was to agree on a code of conduct for the members of the Bank's board. This code, as well as the code of conduct for the Bank's staff, is available on our website.
Central bank governance
  • The BIS has cooperated with central banks for the better part of a decade now to bring together information on how central banks are governed. In our view, central banks operate in such a wide diversity of institutional, economic, political, cultural and historical settings that it would not be useful to look for a single set of best practices for their governance. However, we believe it is useful for central banks to compare notes and to learn from their peers.
  • Central bank governance and corporate governance have many common features - clear objectives, transparency and accountability are crucial in both areas. However, a number of substantial differences can be noted, to underscore that governance arrangements need to be tailored to specific types of institutions. For example:
    • In corporate governance the profit motive plays a key role, but for central banks making profits is not a primary objective.
    • Corporate governance should empower shareholders to dismiss management if they are not satisfied with its performance; by contrast, a substantial part of the typical central bank law is concerned with ensuring that the major shareholder - the government - cannot dismiss the central bank's management if it disagrees with the central bank's conduct of monetary policy.
    • In the corporate world, staggered terms for board members are seen as an impediment to shareholders' rights; but for central banks they are taken as desirable because they prevent any single government from stacking the board with its own candidates.
  • Where financial sector supervision is carried out outside the central bank, the question of governance arrangements for the supervisory authority arises. The work of the Basel Committee provides a very useful point of departure for designing appropriate governance arrangements.
Governance issues in the international arena

Governance codes are being developed on a national, regional and international level. On the international level, three of the most significant initiatives are:

  • OECD Corporate Governance Standards - recent revisions in an ongoing process designed to meet new challenges.
  • Basel Committee Core Principles - now being revised.
  • Basel Committee work on corporate governance - now in progress under the leadership of Danièle Nouy.
Conclusions

The market system is a simple, decentralised system, and has the enormous virtue of creating wealth and enhancing standards of living like no other system we know. The invisible hand that guides it is blind, just like justice. Some might contend that it is blind to ethical standards. However, ethical behaviour is as important as property rights and enforceable contracts in making markets work. Good governance gives expression to ethical norms. I believe it also adds to the prosperity of any society over the long term.