Board Independence within State Owned Enterprises THE PREMIER CONFERENCE ON CORPORATE GOVERNANCE: September 2009, Sandton Convention Centre

Table of Contents 1.What is the challenge? ◦ Separation of ownership and management control to increase efficiencies & lower agency costs 2.How do SOEs handle the challenge vs the Private Sector? SOEs ◦ Complex ownership models ◦ Unclear performance expectations Private Sector ◦ Market orientated Disciplines  Insolvency & Takeovers  Empowered boards of directors 3.What should SOEs do to rectify their shortcomings? ◦ Empower their boards (Board Independence) 3(a)What are the Impediments to board Independence? Nomination of Directors ◦ Appointment / Dismissal of CEO ◦ Government Representatives on SOE boards ◦ Usurpation of Board powers by shareholder ◦ Poor SOE objectives/mandates ◦ Lack of Performance Assessments 4. How do we address these Impediments ◦ Nomination - Structured & Transparent nomination process ◦ Appointment of CEO – Board to lead not shareholder ◦ Government Representatives – Why should they be on the board? ◦ Usurpation of board powers – shareholder (mandate); board (strategy); CEO/SOE (implementation) ◦ Clear Objectives – Shareholder Compacts ◦ Performance Assessments – Board by Shareholder, CEO by board, Executive Management by CEO 5.Conclusion 2

What is the Challenge? 3

The Governance Challenge The separation of ownership and management control to increase efficiencies & lower agency costs is as old as the corporate structure itself Private Sector – shareholders elect directors who in turn appoint managers Public Sector - Government as an Owner – Shareholder concerned with return on investment – Policymaker concerned with service delivery – Regulator concerned with industry practice and interests of consumers Complex Model of State Ownership – Multiplicity of Shareholder Representatives with Competing Objectives The Executive (Cabinet), Executive Authority, Line Department, Policy Department, NT, Regulator The Setting & measuring of performance indicators of SOEs – No clear articulation of performance expectations from relevant Government department (do shareholder compacts add value?) Lack of clarity of which role it is playing at any time 4

How do SOEs handle the challenge vs the Private Sector? 5

Mechanism for Monitoring Management Conduct Private Sector The market for corporate control Insolvency & Takeover Public Sector – SOEs insulated from market forces due to implicit Government guarantee leading to complacency within SOE boards The Board of Directors The board is a mechanism to monitor and oversee management conduct to ensure alignment with shareholders’ interest – To achieve this the board should be empowered, properly mandated and have the appropriate structures. 6

What should SOEs do to rectify their shortcomings? 7

Empowering SOE Boards: Board Structure & Independence The central prerequisite in empowering SOE boards is to structure them in a way that they can effectively exercise objective & independent judgement (OECD Guidelines) “Independence is the ability to make impartial decisions without fear or favour.” (King III) Independence of judgment – is an important contribution of a director to the board requiring that the aspect be taken into consideration in the structuring of the board Independent director - is a non-executive director who has not been employed by the SOE, does not represent and/or is not affiliated with the shareholder or any other major stakeholder, has no business dealings or contracts with the SOE Independent Board comprises of a majority of independent directors who have the ability to exercise independent judgement. 8

What are the Impediments to Independence of SOE Boards? 9

1. Nomination processes to SOE Boards Strong political input and appointment of politically affiliated persons at the expense of professionalism There is lack of transparency Lack of defined processes and criteria of selection Lack of proper due diligence to determine whether the director is fit & proper Board positions are offered as rewards for political patronage 10

2. Appointment and dismissal of the Chief Executive In most SOEs appointment & Dismissal of CEO and other key executives are the prerogative of the Minister & Cabinet (power reserved to shareholder through founding legislation of SOEs) The power to hire and fire the CEO is a key board competence & a prerequisite to board effectiveness. It is therefore contradictory to charge the board with responsibility for SOE performance with no power to hire and fire executive management 11

Government Representatives on SOE Boards The appointment of ‘Super Directors’ on the board influence pursuit of political policy at the expense of interests of the SOE They exert direct and undue political interference on the board Senior government officials on the board upset board dynamics They Lack the incentive to attend and participate in board meetings as they are not remunerated Primary Duty to company & Secondary duty to shareholders Duty of Confidentiality Personal liability for reckless decisions 12

Usurpation of Board Powers by Shareholder The shareholder sets and drives the strategy of the SOE The Shareholder exercises oversight and monitors management The shareholder appoints & dismisses the CEO The Shareholder approves Financial & major Capital expenditure projects of the SOE With management dealing with the day to day activities of the SOE The role of the board is severely constrained There is little accountability on the part of management to the board – board discussions are a formality Limited power by board to police and prevent abuses by management The role of the board is severely constrained There is little accountability on the part of management to the board – board discussions are a formality Limited power by board to police and prevent abuses by management 13

Poor clarification of objectives of the SOE by the shareholder Affords managers discretion to run the SOE in their own interests; and Allows abuse of discretion by Government to meddle in the affairs of the SOE for political gain The question that resurfaces is – ‘are shareholder compacts being utilised to their full potential? 14

No Performance assessment of the Board by Shareholders Shareholder activism (who is monitoring the monitor?) Ineffective board self-assessment Ineffective or no individual director assessment & not linked to performance incentives or director rotation. No evaluation of the board by the shareholder or evaluation conducted solely from a policy perspective Assessment of ‘super directors’? E.g. Turkey – body in charge of auditing SOEs also evaluates the boards of the SOEs 15

How Do We Address These Impediments? 16

Addressing SOE Governance Challenges Nomination Process – implement structured nomination process that includes appraisals of board members which will ensure that the ultimate selection criteria is ‘competency based’. Appointment of CEO – power to appoint and dismiss the CEO and senior management is a key function of the board not the shareholder. 17

Addressing SOE Governance Challenges Appointing Shareholder Representatives – Limit appointment of shareholder representatives Independent boards require a sufficient number of independent directors free of conflict of interest who should predominantly be drawn from the private sector to make SOEs more business orientated. Directors selected should have relevant competency and experience to the SOE’s specific policy objectives Explicit prohibition of senior members of Government or political parties from sitting on SOE boards. Appointing specialised board committees with a majority of independent non-executive directors with specialised skills can off- set influence of the ‘super director’ on the main board Develop guidelines to help civil servants and executive directors on boards to maintain independent judgement. 18

Addressing SOE Governance Challenges Delineation of roles and responsibilities ◦ Shareholder should define the mandate of the SOE, the board should define, review & guide corporate strategy to achieve the mandate; and the CEO should implement the strategy. ◦ A clear delineation of roles & responsibilities Poor clarification of objectives of the SOE by the shareholder ◦ Objectives should be clearly defined in performance agreements/shareholder compacts ◦ If SOE board members have special duties beyond their private sector counterparts, they should be transparent and clearly defined 19

Addressing SOE Governance Challenges Performance assessment of the Board by Shareholders ◦ Enforcement and proper monitoring of shareholder compacts & corporate plans. ◦ Proper scrutiny of annual reports 20

Conclusion Is there a place for shareholder representatives on SOE boards? Should the power to appoint and dismiss the CEO continue to be a shareholder prerogative? Should we consider the OECD model and appoint central ownership agencies? 21

THANK YOU 22