CAIRO: Transparency and governance of corporations are increasingly important issues as public participation in capital markets grows. The popularity of the stock market was clearly demonstrated with several of last year s privatization offerings, including Telecom Egypt, for which numerous individuals put aside their savings to purchase shares. Furthermore, as local companies turn to foreign investors for their capital, these foreign investors require some assurance that Egypt s private sector adheres to international standards of disclosure and internal control. The principles that serve as a basis for codes of corporate governance internationally are those draw up by the OECD. OECD s principles of corporate governance outline the rights of shareholders to sufficient and timely information, the equitable treatment of minority and foreign shareholders, the responsibilities of the board and other matters relating to disclosure and oversight. The alignment of shareholder and management interests is one of the major objectives of the principles. In sole proprietorships, where the owner frequently also runs the business, this alignment is somewhat assured. But in public shareholding companies, the gap between shareholders and management widens and a structure is necessary to ensure that the board and executives serve the interests of the owners. The principles, however, are not restricted to the conduct of senior executives and the board; they also aim to promote accountability throughout a company. Transparency alone contributes to this objective. When management discloses its dividend strategy, for example, it can be held accountable for it by shareholders. Adequate oversight and control are also an important part of accountability. The internal audit function serves a critical purpose in this regard, and its independence is a decisive factor in determining its success. One method of improving the independence of the internal audit function is to have it report directly to a committee on the board, rather than to company executives. The failure to uphold principles of good corporate governance has real consequences, as demonstrated by the bankruptcy of such giants as Enron, WorldCom and Parmalat. It also affects the value of a company; a study by McKinsey in 2002 found that investors would pay a premium of 11 to 41 percent for well-governed companies. This premium varies from country to country, and amounted to 39 percent for Egypt. Moreover, the absence of corporate governance principles on a national level results in some investors excluding all companies in a country from their portfolio. This is the approach of the California Pension Fund which, due to its assessment of the general quality of corporate governance in Egypt, does not invest at all in the country. This pension fund is one of the largest investors in the United States, with assets of some $200 billion, of which 20 percent or $40 billion is invested abroad. Of all the factors relating to corporate governance, the McKinsey study found that accounting disclosure is the most important to investors. The external financial audit provides independent confirmation of financial information provided by management and is therefore an important assurance to shareholders. Dan Konigsburg, director of corporate governance at Standard & Poor s, explains that companies should choose an external auditor that has a good understanding of the industry of the company and that is well-reputed in the country, and such an auditor may not necessarily be one of the Big 4 international audit firms. The bankruptcy of American telecommunications company WorldCom is an example of the failure of the external audit. Management s continual overstatement of the company s earnings eventually resulted in the insolvency of WorldCom. One of the reasons that WorldCom s auditors failed to discover the fraud was that they were located in another city over 2,000 miles away. The bankruptcy of WorldCom demonstrates that the impact of poor corporate governance is not restricted to equity holders; creditors are also affected. For example, Konigsburg says that Standard & Poor s includes an assessment of corporate governance in its credit ratings of debt issuer, because it relates to the willingness of a company to repay its debt, which may be just as important as its ability to service debt. Good corporate governance therefore not only helps attract capital and increases the value of a company, it also reduces the financing cost for debt. A study by the ratings agency Fitch found that poor corporate governance can potentially result in an increase in the cost of borrowing by approximately 0.5 percent in absolute terms. There are various approaches to enforcement of corporate governance principles. In the United Kingdom, companies are required to either comply with the principles or explain their reasons for non-compliance. Since the collapse of Enron and the passage of the Sarbanes-Oxley Act on financial disclosure, the U.S. has taken a stricter approach, with compliance required by law and severe penalties applied to companies and managers that violate the rules. McKinsey Consultant Simon Wong says that each country should find its own approach to enforcement based on its culture and its business environment. In Egypt, corporate governance principles have been devised and promulgated by the Institute of Directors, an organization under the Ministry of Investment headed by Ashraf Gamal El-Din. Gamal El-Din explains that the principles are based on those of the OECD, and that while in Egypt those principles are voluntary, approximately 90 percent of the guidelines are in fact already included in existing legislation, particularly that relating to the listing requirements of the stock market. The institute is also in the process of formulating guidelines for state-owned companies, also based on OECD principles. This process has been delayed, explains Gamal El-Din, because of the need to reconcile certain principles with legislation due to conflicts between the two.
