Andreas Son

7/30/2019 Andreas Son

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Shareholder and stakeholder interests: the politics of corporate governance

reform in South Africa1

Stefan Andreasson, Queens University Belfast ([email protected])

Paper prepared for the 2006 British International Studies Association Annual

Conference, University of Cork, Ireland, 18-20 December.

FIRST DRAFT PLEASE DO NOT CITE WITHOUT PERMISSION

Introduction

Detomasi (2006:225) introduces a recent study of international regimes and Westerncorporate governance by noting that [i]t is difficult today to avoid the topic of

corporate governance. As is the case at the level of international political economy,the socio-political context of corporate governance is also becoming increasinglysignificant for understanding processes of regime change and transformation at thedomestic level (Roe 2003; Gourevitch and Shinn 2005). This is especially the case inemerging markets, where national systems of corporate governance may not be aswell institutionalised, or deeply entrenched, as they generally are in consolidated(Western) polities, and where the potential costs of corporate governance failure arealso very high. For example, the economic consequences of the East Asian financialcrises of the late 1990s, which were in part due to poor corporate governance, werestaggering. In a recent volume on corporate governance in a global economy, Schwab(2003:x) reminds us that the five most heavily affected countries, Indonesia, Korea,Thailand, Malaysia and the Philippines, lost more than USD 600 billion in marketcapitalization, or around 60 percent of their combined precrisis gross domestic

product. As concerns the political fallout and immense human suffering caused bythe collapse of currencies and capital flight, there can be no meaningful monetary

price tag applied. It is thus reasonable to assume that if global pressures forconvergence affect national corporate governance regimes and reforms, then such

pressures will be most acutely felt in emerging markets; the stakes, moreover, arevery high for both governments and inhabitants of these countries. Emerging markets,then, constitute particularly interesting cases for investigating how changes in globalgovernance affect national systems of corporate governance.

This paper investigates the political and economic context of corporate governancereform in South Africa, an emerging market which is interesting not only as such butalso given a historical context that in some aspects sets the country apart from otherimportant emerging markets. Specifically, the paper examines how South Africas re-integration into the global economy from the early 1990s onwards has transformed

preferences of both corporations and elite policy makers in government and how thesereshaped preferences are producing a new South African corporate governanceregime. This reform process is driven by both economic and political imperatives, the

1 Field research in Johannesburg and Tshwane (Pretoria) in August/September 2006, on which the

empirical material in this paper is partly based, was made possible by an ESRC World Economy &Finance Research Programme grant (see Appendix for list of interviewees).


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natures of which are local as well as global. The country-specific socio-historicalcontext in which this reform originates is the dismantling ofapartheidand the shift in

political control from South Africas white minority to its black majority. As SouthAfricas political transition has not (yet) prompted a radical economic transformation,it is now possible to observe a divergence of sorts between societal demands for pro-

poor policies that are associated with populist pressures for socio-economictransformation on one hand and economic demands associated with business calls formarket friendly policies (i.e., liberalisation and deregulation) on the other. Wishingto balance these oftentimes conflicting demands, the South African government has sofar prioritised the need to pursue an internationally credible policy of businessaccommodation whilst delegating issues of broad-based socio-economictransformation to a future in which business friendly policies have presumablyyielded a stable macroeconomic environment and sufficiently healthy public financesto then allow for a robust spending commitment on transformative issues (Andreasson2006b).

The issues examined in this paper relate to two major challenges that confront SouthAfricas policy makers in their attempts to create a corporate governance modelsuitable for the twenty-first century and South Africas post-apartheid society. Thefirst challenge revolves around the need to preserve the functionality and acceptabilityof an essentially Anglo-American shareholder model of governance in anenvironment where the stakeholder model (and stakeholder issues in general) isgaining currency and increasing appeal, most obviously among policy makers andcivil society organisation in tune with the countrys developmental needs and who areseeking to represent the majority of South Africas inhabitants that remaineconomically deprived and socially marginalised. West (2006) suggests that amodified Anglo-American model of corporate governance is evolving in post-apartheidSouth Africa, the result of a tension between the traditional liberal emphasison individual property rights imbued in the Anglo-American approach to governanceand the communitarianism inherent in the concept of African values (ubuntu2),values to which the government would like to anchor its policy making and therebyhopefully make its policies seem more legitimate in the eyes of the many black SouthAfricans previously disadvantaged by, and still therefore suspicious of, the countrystraditional approach to policy making.

A second challenge, beyond the tension between shareholder and stakeholder modelsof governance, is the importance of the US financial markets and the US approach to

corporate governance which, since the enactment in the US of the Sarbanes-OxleyAct of 2002 (SOX)3, represents a legalistic, compliance-based approach to corporategovernance that is more clearly distinct from the UK model than in the past. Whilearguing that SOX ultimately serves a symbolic purpose of attempting to bolster andreaffirm American (and global) belief in, and support for, ever more speculative andvolatile financial markets, OBrien (2005:1) asserts that the legislation represents the

2Ubuntu can best be described as an African humanism which emphasises empathy, understanding,reciprocity, harmony and cooperation. In the context of governance it can be envisioned as a guiding

principle for determining how to organise African societies and how to measure the well-being ofAfricans (cf. Prinsloo 1998:42).

3 Find the Act at http://www.sec.gov/about/laws/soa2002.pdf.


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single most significant change to the governance of business organizations since theNew Deal architecture erected in the 1930s. Within the Anglo-American sphere it istherefore now common (if more so in financial media than scholarly research) to referto the characteristics which separate the US from the UK in particular thegovernance requirements and regulatory burdens for companies wishing to raise

money on the New York stock exchanges rather than those which makes themsimilar in comparison to stakeholder models of governance in countries like Germanyand Japan. The more stringent requirements of the US model represent a clearchallenge to the light touch regulation in London and the principles-based approachadvocated by the King Commission in South Africa.

The case for South Africa

Among emerging markets worldwide, South Africa stands out as a particularlyinteresting case in which to investigate how processes of corporate governance reform

unfold (cf. West 2006). South Africa is Africas largest and most sophisticatedeconomy (cf. Vaughn and Verstegen Ryan 2006), and its financial institutionalstructures are advanced as compared to other emerging markets. According to MervynKing doyen of South African corporate governance and Chairman of the KingCommission on Corporate Governance South Africas first world financialinfrastructure, which is extraordinary for an emerging market, has resulted inforeign institutions now being the major private equity holders in the South Africaneconomy an important sign of confidence in, and approval of, South Africas capitalmarkets and infrastructure (King 2006b). Furthermore, South Africas Anglo-orientedlegacy in terms of corporate law and Board culture makes it an instructive test casein which to investigate the potential for the approximation of either an emerging US-style corporate governance regime (rules rather than principles based), such as thatmanifested in SOX, or for a Continental stakeholder model to take hold.4 Thecountry has experienced relatively comprehensive change to its corporate governanceregime in the last decade (Vaughn and Verstegen Ryan 2006), and its King Reportson corporate governance, published in 1994 (King I) and 2002 (King II), have becomenotable examples of how emerging markets can devise their own solutions to aligningtheir corporate governance regimes with international best practice while at the sametime considering corporate social responsibility and needs for broad-baseddevelopment locally.5

Examining the South African case of corporate governance reform in a global context,the paper proceeds as follows: the traditional contrast between shareholder andstakeholder models is outlined in the context of a post-apartheid model of SouthAfrican corporate governance; a more recent divergence between Anglo andAmerican approaches to corporate governance is outlined, and South Africasinterests in approximating one or the other examined; key reforms to South Africas

4 Although South African law is based on Roman-Dutch tradition, the difference with the UK commonlaw tradition in corporate law is greatly diminished (Wixley 2006).

5 Indicative of the King Reports global status, Mervyn King was in 2006 appointed chairman of a

high-level United Nations (UN) steering committee on corporate governance aiming to improvecorporate governance within the organisation (Business Day (Johannesburg), 24 March 2006).


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corporate governance regime following King I and, especially, King II are outlined;the significance of the US Sarbanes-Oxley Act of 2002 for corporate governancereform in South Africa is explored; an explanation of South African corporategovernance reform that is based on changing preferences of business, investor, stateand civil society actors is outlined. The paper concludes with a consideration of issues

relating to lacking institutional capacity and skills shortages that constitute particularchallenges to maintaining a good corporate governance regime in emerging markets,as well as what general lessons we may learn from corporate governance reforms inSouth Africa.

Shareholder v stakeholder models

Theoretical debates on corporate governance generally proceed from the premise thatcorporate governance regimes are based on either the shareholder model that is mostcommon in Anglo-Saxon polities, or the stakeholder model most common in social

market polities, most notably Germany and Japan. The shareholder model holds thatthe corporation is an extension of its owners and responsible only to these owners.Key assumptions of the shareholder model include the inviolability of privateownership i.e., the shareholders and no one else own the company and thereforehave exclusive rights to determine its priorities and any profits it may generate andthat only market forces can achieve economic efficiency. While this model will needto resolve potential conflicts of interests between owners (principals) and managers(agents), in most cases by linking managerial rewards to corporate performancemeasured by share price and exercised by means of stock options, it precludes anyserious consideration of market interference (such as requiring corporations toconsider matters beyond the financial bottom line) in achieving the goals of thecorporation (West 2006:433-34).6

The stakeholder model understands the corporation as a social entity that isresponsible, and accountable, to a broader set of actors beyond those that own thecorporation (its shareholders). These actors usually include suppliers, customers,employees, government and local communities that are all affected by the behaviourand performance of the corporation (West 2006:433-34). A descriptive theory of thestakeholder model simply notes that stakeholders (in addition to the owners) actuallydo exist, whereas an instrumental theory emphasises the need to be responsibletowards stakeholders as a means to gain greater economic efficiency, and a normative

theory argues that the need to take stakeholders into account is an end in itself due tomoral obligation and social values that extend beyond the liberal emphasis on theindividual (Donaldson and Preston 1995).

In an overview of integrated sustainability reporting in South Africa, Wixley(2005:115-16) relates the increasing emphasis placed on non-financial information inannual reports of companies to, firstly,

a general concern with the role of business in society [which] involves anawareness that the stakeholders in an enterprise are not merely the

6 See Pratt and Zeckhauser (1985) for a comprehensive statement on the principal-agent theory.


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shareholders who provide capital, but persons contracting with the business and those with a non-contractual relationship, such as local communities non-governmental organizations and the like [and, secondly, to] qualitative issueswhich influence the ability of the enterprise to create value in the future [such as] investments in human and other related intellectual capital

maintenance of the reputation of the enterprise and the like.

Both of these concerns are derived from the instrumental aspect of the stakeholdertheory. The introduction of triple-bottom-line reporting in South Africa reportingon the sustainability environmental and social aspects of company activities inaddition to traditional reporting on the economic / financial bottom line alone asrecommended by King II, and the adoption of a Socially Responsible Investment(SRI) Index by the Johannesburg Stock Exchange (JSE) in 2004, the first of its kind inan emerging market, have been justified on both instrumental and normative grounds.According to Painter-Morland (2006:355), King II

sets itself apart from many other governance regulations in succeeding tobridge the gap between CSR [corporate social responsibility] and goodgovernance [by addressing] the fallacy that social and environmental issuesare non-financial issues by indicating their financial bottom-line results [and by inscribing] these financial issues within the very core of its standardsof good governance.

In addition to a wealth of research and debates in management and related literatureon the characteristics of these models (Donaldson and Preston 1995; Letza et al2004), the different assumptions the shareholder and stakeholder models make aboutthe nature of the corporation, and to whom it is ultimately responsible, constitute the

basis for arguments about the direction in which corporate governance reform inSouth Africa ought to move (Institute of Directors 2002; Naidoo 2002;PricewaterhouseCoopers 2002; Wixley 2005; West 2006). In particular, the need to

prioritise shareholder interests, which is the traditional concern of a countryembracing the Anglo-American approach to regulation and governance, isoftentimes contrasted with the urgent need in very unevenly developed societies likeSouth Africa to ensure that corporations contribute to socioeconomic development.

Anglo v American approaches to corporate governance

South Africas colonial legacy and resultant ties with Britain have ensured thatcorporate law and corporate practice have been adopted mainly from the UK (West2006:435). The South African model of corporate governance also fits the Anglo-American approach as it is outlined by Reed (2002:230): it includes a) a single-tieredBoard structure where only shareholders are represented; b) an active stock exchange(the JSE), which is a leader among emerging markets and ensures that financialmarkets play a dominant role; c) a banking system which plays a secondary role, inwhich banks are not in control of companies and avoid too close relations with clients;and d) a general commitment to a market-driven economic policy in which industrial

policy plays a lesser role (manifested most clearly in the governments Growth,

Employment and Redistribution (GEAR) policy). However, concessions made tolabour with the 1998 Employment Equity Act and to affirmative action advocates


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with the 2003 Broad-Based Black Economic Empowerment Act, as well as hints of amore active industrial policy in an evolving post-GEAR environment, suggest amore mixed picture on this final variable (cf. West 2006:434-35). Nevertheless, wemay want to separate not only the Anglo-American shareholder model from theContinental (or, perhaps more accurately, German-Japanese) stakeholder model of

corporate governance but, following draconian reforms to the US corporategovernance regime in the wake of Enron and other high-profile corporate scandals,we may also wish to distinguish between Anglo and American approaches tocorporate governance, especially in the areas of regulation, compliance andenforcement.

Increasing divergence between UK and US approaches to corporate governance havecome to the fore in recent months amidst speculations about a Nasdaq takeover of theLondon Stock Exchange. The UK government has become noticeably concernedabout potentially detrimental effects of US style regulation on the light touch UKmodel. Ed Balls, Economic Secretary to the Treasury, thus announced in October

2006 that the government is seeking fast track legislation [to] safeguard the lighttouch and proportionate regulatory regime that has made London a magnet forinternational business (HM Treasury 2006b). Speaking in Hong Kong a monthearlier, Balls noted that

our system of light-touch and risk-based regulation is regularly cited -alongside the Citys internationalism and the skills of those who work here -as one of our chief attractions. It has provided us with a huge competitiveadvantage and is regarded as the best in the world [W]e have fought off

proposals in Europe which would have undermined Londons standing as theleading global financial centre [W]e have resisted pressure for heavy-handed responses to US corporate scandals (HM Treasury 2006a).

Given the comparatively relaxed attitude towards foreign takeovers in the UK ascompared to other Western nations (most notably the US and France, where populistresistance to foreign ownership has manifested itself recently in areas of supposedlynational strategic interest ranging from oil and ports in the US to yoghurt in France),the notion of fast track legislation to ward off perceived costs associated with the USapproach to financial regulation is telling of the degree to which key actors in bothcountries perceive their regulatory systems to be different from each other.

The concerns voiced in London are at least implicitly acknowledged across theAtlantic. While arguing that regulatory reform was necessary given the seriousness ofEnron, WorldCom and other recent corporate malfeasance scandals, US TreasurySecretary Henry Paulsons views on the need to ease the regulatory burden on

business created by SOX (in particular section 404 and its onerous reportingrequirements regarding internal control and reporting) acknowledge concerns in theUS, and by foreign participants in US markets, about regulatory over-stretch on partof the US government. In a recent speech to the Economic Club of New York on thecompetitiveness of US capital markets, Paulson notes that while US markets are thedeepest, most efficient, most transparent in the world and that corporations are bettergoverned following necessary reforms (the enactment of SOX), the new legislation

has been burdensome indeed as a significant portion of the time, energy, and expenseassociated with implementing section 404 might have been better focused on direct


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business matters that create jobs and reward shareholders (United States Departmentof the Treasury 2006).

Since the enactment of SOX in 2002, the contrast between a prescriptive comply orelse corporate regime as in the US, and a principles-based comply or explain

regime as in the UK has become most instructive. South African individuals with keyroles in shaping the countrys evolving corporate governance regime whether asBoard Directors, leaders of private sector institutions such as the JSE or governmentinstituted regulators such as the Financial Services Board (FSB) clearly see SouthAfricas corporate governance regime as most closely linked, in terms of institutionsand history as well as in spirit, to the UK model of corporate governance. It is (themyth or reality of) Londons gentlemans agreements and emphasis on principles andcultivation of personal relationships rather than strictly legislated compliance withrules whose effectiveness have not been demonstrated that is viewed by South Africandirectors and executives as the proper role model for South Africa. When outliningthe history of corporate governance in South Africa, King (2006a; 2006b) begins by

relating South African developments to British corporate history, from Gladstone andthe Limited Liability Act of 1855 to, more recently, Adrian Cadburys committee oncorporate governance and its resultant 1992 Cadbury Report. King emphasises onseveral occasions how South African corporate governance and, more generally,corporate culture is firmly rooted in the British tradition (King 2006b; cf. Sarra2004:29; Wixley and Everingham 2005:1).

From this point of view, a move towards the US model risks causing rupture tosystem of corporate governance in South Africa which has evolved and respondedwell to the economic and political challenges associated with the transition fromapartheidand re-integration into a competitive world economy, thus generating coststhat far exceed the benefits of additional legislation and regulation. That theseconcerns are increasingly being voiced in the US as regards SOX, and that New Yorkis perceived as losing its lustre and ability to attract international capital whencompared to London, is not lost on South African observers.

SOX clearly presents a challenge to the UK model of principles based corporategovernance to which South African corporate governance and regulation has beenhistorically aligned, and which constitutes, in the view of South African businessgenerally, the prime example of international best practice. This challenge originatesin the extraterritorial provisions of SOX.

The rapid US response to domestic corporate failure imposed additionalregulatory burden on foreign companies that sought capital in US markets andsuddenly faced other regulations in addition to those imposed by their homecountries (Vagts 2003) [thereby exposing] the dependency that manyforeign companies have on the US capital market and [to some extenttherefore rekindling] the political will to develop [their own] capital marketsof similar [relative] size and liquidity (Detomasi 2006:237).

The concern here is that if the SOX approach is aggressively exported by the USmarkets and regulators, aided by the sheer size and importance of US capital markets,

governments and regulators elsewhere may feel the need to reform their own marketsso as to reflect the US preference for a compliance-based approach to governance


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while discounting the extra costs to less competitive and resilient markets that such anapproach entails.

The King Reports on Corporate Governance

The King Committee on Corporate Governance was established in 1992. TheCommittee published its first report in 1994 (King I), which drew substantialinspiration from the 1992 UK Cadbury Committee Study (Sarra, 2004:31).7 King Ialso coincided with South Africas post-apartheid re-integration into a globaleconomy following its isolation during the 1980s and the incoming democraticgovernments emphasis on basing economic policy at least in part on considerationsof broad-based socio-economic transformation. Wishing to link corporate activity inSouth Africa to the new goals of transformation and development, King I

went beyond the financial and regulatory aspects of corporate governance in

advocating an integrated approach to good governance in the interests of awide range of stakeholders In adopting a participative corporate governancesystem [The King Committee] successfully formalised the need forcompanies to recognise that they no longer act independently from thesocieties and the environment in which they operate (Institute of Directors2002:6).

That corporations indeed share an important social responsibility is acknowledged ina recent report published by South Africas leading corporate lobby organisation, theSouth Africa Foundation (now Business Leadership South Africa) (Schlemmer2004:3) as well as a recent study of corporate governance in South Africa byArmstrong et al (2005:9).

The King II report, published in 2002, brought together expertise representative of awide range of organised bodies in the private sector, as well other stakeholders withvarious political preferences, to come up with a vision for an inclusive approach togovernance in the interest of South Africa Inc (King 2006b). Task teamscomprised of representatives from both public and private sectors maderecommendations to the King Committee; these teams included institutional and

private investors, civil society, regulators and government officials, thus ensuring awide-ranging stakeholder input to the Committee. The King II Committee itself was

composed of leading proponents of corporate governance as well as representativesof significant professional, private and public sector institutions. Local andinternational consultation was extensive, with the Institute of Directors in SouthernAfrica providing a facilitative role and secretarial support (Armstrong et al2005:16).

King II contains a Code of Corporate Practices and Conduct (the Code) and itsrecommendations currently apply to companies listed on the JSE, banks, financial andinsurance entities and public sector enterprises falling under the Public FinanceManagement Act (PFMA) of 1999 and Local Government Municipal Finance

7

This section is based on the outline of South African corporate governance reform in Andreasson(2006a).


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Management Act of 2003. King II contains recommendations relating to six areas ofcorporate governance: 1) boards and directors; 2) risk management; 3) internal audit;4) integrated sustainability reporting; 5) accounting and auditing; and 6) complianceand enforcement. The Code is considered a living document that can be updated ascircumstances may demand (Wixley and Everingham 2005:8-9). King notes that it

was, in retrospect, a mistake to disband the Cadbury Committee in the UK (asCadbury himself has acknowledged), thereby denying it the opportunity to respond toand adapt its principles to changing circumstances (King 2006b).

While recognising that there are some international standards that no country canescape in the era of the global investor King II displays a clear awareness ofobstacles to a global convergence of international corporate governance standards:

because [c]ommunities and countries differ in their culture, regulation, law andgenerally the way business is done there can consequently be no single generallyapplicable corporate governance model (emphasis added) (Institute of Directors2002:14). This recognition of problems with one-size-fits-all approaches to

corporate governance, which underestimate the importance of fitting aspirations andregulation to local conditions, has important implications for South African efforts toadopt international best practice standards, especially if that standard is to be basedon the US approach embodied in SOX. In fact, the aims of King II distinguish it fromSOX in several important ways:

Less reliance than in SOX on heavy government intervention into corporategovernance

Heavy reliance on disclosure rather than compliance as a regulatorymechanism

Making increased accountability and independence of company Boards acornerstone of efficient corporate governance reform rather than narrowlyemphasising the role of audit committees

Involving a wider range of stakeholders, both external and internal: includingworkers, trade unions, consumers, suppliers, communities and the media(PricewaterhouseCoopers 2002:5-7).

It is, however, important to note that while King I and II make recommendationsregarding corporate government standards in South Africa, they are not legally

binding legislation as are the SOX requirements in the US. King II ultimately relieson self-governance, and it is on this point that the ability of King II make a real

difference in terms of improving corporate governance in South Africa has beencriticised. The South African Department of Trade and Industry, among others, hasasked whether a report based on voluntary compliance really can ensure that measuresare effectively implemented and sustained (Sarra 2004:47).

The Sarbanes Oxley Act of 2002

The Public Company Accounting Reform and Investor Protection Act 2002, orSarbanes-Oxley (SOX),

results from highly publicised scandals which has severely underminedpublic confidence in the United States system of corporate governance and


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reporting. Consequently, the purpose of the Act is to restore confidence incapital markets (PricewaterhouseCoopers 2002:10).

The act represents the most sweeping legislative changes to securities legislation inthe US since the 1930s and, given the global prominence of the US economy, it has

become a topic of public debate in financial centres, governments and regulatorybodies worldwide. According to PricewaterhouseCoopers comparison of corporategovernance as mandated by SOX in the US and envisioned by King II in SouthAfrica, SOX fundamentally changes the responsibilities of audit committees,management and external auditors, and how these actors interact with each other.Building on existing Securities and Exchange Commission (SEC) and US stockexchanges requirements, SOX increases restrictions on corporations listed in the US,expands the disclosures requirements with which corporations have to comply andtoughens the penalties which company directors, auditors and others involved in thecorporate governance process can incur.

The most telling change may be that the Act [SOX] represents a new era ofpublic regulation in the capital markets sector. Unlike South Africa, the UnitedStates Congress has concluded that public confidence can best be restoredthrough greater government involvement. (PricewaterhouseCoopers 2002:10-11).

Consequently the response to SOX from the corporate sector has been less thanenthusiastic. A recent commentary on SOX and its onerous section 404 (dubbed thesection of unintended consequences) on management responsibilities for internalcontrol and financial reporting by the American Electronics Association, the largesthigh-tech trade association in the US with nearly 3000 companies and 1.8 millionemployees represented, argues that while many reforms contained in SOX do promote

better corporate governance, these reforms are being overshadowed by one sectionthat is imposing high costs with little return in terms of fraud detection (Davern et al2005:1).

The relatively brief section 404, entitled Management Assessment of InternalControls, makes it the responsibility of management to establish and maintain thecompanys internal control structure and financial reporting procedures. Management(the chief executives and chief financial officers) and the registered accounting firm(their external auditors) must furthermore assess the effectiveness of the control

structure and financial reporting in annual reports and report any weaknesses within75 days of the end of the companys fiscal year. Given the many control proceduresthat need to be established, compliance with 404 is expensive both in terms offinancing new control systems and devoting man-hours to the actual control andreporting. Increasing costs relating to compliance with 404 requirements areespecially a concern for smaller and medium-sized companies who are generally lessable to divert time and money to such matters of compliance (see 404 tonnes of

paper, The Economist16 December 2004).

According to Davern et al (2005:1-2) the most serious problems associated withsection 404 are:

High cost burden amounting to a regressive tax on small business


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Extremely burdensome and not effective in detecting corporate fraud External auditors have adopted a one size fits all approach to section 404, where

small companies are being held to same standards as large companies with muchmore complex organisational structures

Gives investors a false sense of security Expense and awkwardness hurts US competitiveness Huge increase in compliance costs has foreign companies considering

withdrawing from US financial markets

Implementation cost of approximately US$35 billion is more than 20 times greaterthan initial SEC estimates

Rather than a direct correlation between extent of burden and size of reportingcompany, with burden increasing commensurate with company size as per theSECs prediction, the opposite has become the case.

Given this litany of woes, and the sense that the legislation may be more about

responding to public outrage and insecurity rather than about effective measures toprevent fraud, it is not difficult to understand why businesses in South Africa, anemerging market with much less ability to shoulder extra cost and to compromisecompetitiveness than the US, as well as a South African government keen on creatinga business-friendly environment which can attract foreign investments, haveresponded with caution, and indeed wariness, to this recent US legislative response tocorporate malfeasance.

According to Romano (2005:1523), SOX, which her article refers to a quackcorporate governance, was was enacted in a flurry of congressional activity in therunup to the [US] midterm 2002 congressional elections after the spectacular failures

of the once highly regarded firms Enron and WorldCom. Acknowledging the risk forregulatory over-stretch, noted as a concern by South African observers like Armstrong(2006) and King (2006b) when commenting on the implications of SOX for SouthAfrica and other emerging markets, Romano begins her article on SOX by quoting USSenator Phil Gramms lamentation that its hard to argue logic in a feeding frenzyand argues further that

[w]hat is perhaps most striking is how successful policy entrepreneurs were inopportunistically coupling their corporate governance proposals to Enron'scollapse, offering as ostensible remedies for future Enrons reforms that hadminimal or absolutely no relation to the source of that firm's demise (Romano

2005:1526).

Romanos criticism of SOX echoes Kings comments on the idea of legislatinghonesty and ethic is general he notes that this has been attempted since the days ofMoses (King 2006b), generally with rather poor results.

Implications for South Africa

The potential influence of SOX on South Africas corporate governance regime posesa challenge not only in terms of difficulties and costs associated with implementationfor South African companies listed in New York, but to South Africas culture of

regulation and governance in general. King and other senior representatives of SouthAfrican corporations have been sceptical, oftentimes scathing, in their criticism of the


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recent US government response to corporate scandals that have resulted in theenactment of SOX. However, while South African corporations that are listed in theUS are directly affected by the legal requirements of SOX is not clear that theadditional requirements and expectations placed on these companies are feeding

back to operations and management in South Africa. Nick Holland, Chief Financial

Officer at Gold Fields, a major South African multinational listed in Johannesburgand New York and one of only two emerging market companies recently noted in amajor global survey by GovernanceMetrics International for its high quality corporategovernance8, suggests that SOX has not produced any knock on effect oncompanies governance procedures in South Africa. According to Holland (2006),SOX is unique to New York and is a good example of over-regulation in a countrywhich tends to one extreme or the other on regulation (in the words of King (2006b),SOX was the result of a knee-jerk reaction typical of the American mindset).Holland (2006) also recognises the emerging disjuncture between the UK and USapproaches by noting that SOX has had no real effect on practices in the UK and thatthe view among CFOs in Europe has, generally, been that SOX amounts to a huge

waste of time (which he considers somewhat surprising given that SOX has had apartly positive outcome in terms of forcing major corporations worldwide to thinkcarefully about the quality of their control and reporting procedures).

South Africas regulators and policymakers must therefore consider carefully themerits of SOX and whether the ability of South Africa to claim adherence to best

practice internationally, which is very important given its African location (and itsattendant associations with risk) and its urgent need to attract foreign investment,depends on South Africa assimilating aspects of the SOX approach into its owncorporate governance regime. On this matter the jury is still out. There are noimmediate indications of SOX-style legislation emerging in South Africa. However,[SOX] is definitely on the regulators minds according to Philip Armstrong, Head ofthe Global Corporate Governance Forum in Europe and the International FinanceCorporation in Washington, and an expert on South African corporate governance. Ifthe South African government comes to believe that businesses operating in SouthAfrica will not willingly comply with the voluntary recommendations of King II, or ifvery big corporate scandals emerge (such as the LeisureNet and MacMed corporategovernance scandals of the 1990s), then the government could well decide to move

beyond the selective implementation of King II in the PFMA, local governmentlegislation and the JSE listing requirements by making the King II recommendationsfully enshrined in statutory law. In this sense South Africa is displaying what

Armstrong calls a typical emerging market syndrome: because it is difficult forgovernment agencies to enforce voluntary disclosure and regulation, there is often anattempt by government to mitigate this difficulty with mandatory legislation. Indeed,Finance Minster Trevor Manuel has noted that if businesses do not get their acttogether on financial reporting and disclosure, then government would consider morestringent legislation (Armstrong 2006).

Complicating the picture further, the idea that corporate governance works best in aself-regulating environment (which is the underlying principle of the King reports,given Kings opposition to an overly prescriptive approach to corporate governance)

8 See http://www.gmiratings.com/(xf2ek4v4dpvabgnxhervgc45)/news/reuters_09_18_06.htm.


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is often misunderstood in emerging markets. For example, Armstrong argues thatthe Combined Code has worked well in the UK because it is a leading, well-functioning financial centre and business environment. There is an active media andshareholders, pension funds that are informed, have clear mandates and understandtheir fiduciary duties, and so on. Active engagement, information, proper and

effective facilitative regulation are all key components of such a well-functioningfinancial centre. All these components are necessary for a self-regulative environmentto work, and the self-disclosed information has to be actively and effectivelyquestioned and examined. But Johannesburg is not London and the fact that all ofthese components may not be present or working sufficiently well in South Africa,nor in other emerging markets, must be taken into account when legislation isconsidered (Armstrong 2006).

A key question, in addition to whether SOX is having an impact on corporategovernance reforms unfolding in South Africa, is what actors are promoting reform ofone kind or another i.e., what actors are promoting the compliance-based approach

la SOX and which ones are resisting it? The corporate sector, which feels verycomfortable with the UK model of doing business, prefers reform based on the Kingreports and which maintains a clear alignment with the UK model, while regulatorsand politicians who are concerned about the public perception of capitalism and therole of corporations in South African society (especially with regard to transformationissues) are more likely to find legislation in the spirit of SOX, or at least additionallegislation of King II principles, appealing. As in the US, government in South Africamay wish to be seen as taking a hard line on corrupt practices in the corporate sectorand thus prefer to enact rather strict legal requirements in terms of how corporationsare to be governed and held to account.

However, in order to understand what drives corporate governance reform in SouthAfrica we must not simply understand what may be the preferences of various actorsinvolved (e.g., business, investors, government, civil society) but also which of theseactors are best positioned to promote their preferences. In an emerging market likeSouth Africa, where uneven development has created serious skills shortages, it isespecially important to consider not only preferences, but also capabilities to act onthese preferences. Skills shortages are felt most acutely in government and the publicsector as the private sector is able to poach the best talent, oftentimes from key

positions in the public sector, by offering superior wages and status (Southall2004:538-39). Government is thus somewhat weakly positioned in terms of being able

to promote, manage and implement more advanced forms of corporate governanceregulation, where the requirements in terms of oversight, investigation andprosecution of malfeasance are particularly demanding.

This situation has allowed the corporate sector to seize an opportunity in attempting toframe and drive the national debate on corporate governance and what it ought to looklike in a democratic, market-oriented South Africa. The King Committee is the

paradigmatic example of how an organised interest group in this case South Africasprivate business sector takes initiative by pooling its expertise (forming an epistemiccommunity of sorts), advancing a plan for action and then setting in motion the

process of turning advocacy into policy and practice. In terms of the King Code

recommendations, this was done most concretely by incorporating aspects of the Codeinto the JSE listing requirements. In a typical comply or explain section, the JSE


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listing requirements mandate that issuers on the exchange must disclose the followinginformation relating to the King Code in their annual reports:

a narrative statement of how [the company] has applied the principles [ofthe] Code, providing explanation(s) that enable(s) its shareholders to

evaluate how the principles have been applied; and a statement addressing the extent of the companys compliance with the

King Code and the reasons for [any instances of] non-compliance.

According to the CEO of the JSE, Russell Loubser (2006), and JSE ExecutiveDirector of Issuer Services, John Burke (2006), it was the JSE itself, rather thangovernment, that took the lead on bringing listing requirements up to the standardadvocated by King II. The JSE and the financial industry considers the King II

benchmark important for the ability of South Africas stock exchange, and SouthAfricas corporations and financial industry in general, to distinguish themselves as

part of an emerging market of the highest international standard and sophistication.

Clearly in this case, a key market actor (the JSE) perceives that additionalrequirements, in terms of regulation, are in its own interest. It is therefore somewhatironic that governments subsequent decision to legislate based on the King II

principles, incorporating some of Kings provisions into the PFMA and localgovernment legislation, which presumably would have been understood as a clearendorsement of Kings principles on what constitutes best practice corporategovernance, was in fact criticised by King himself for turning principles into legalrequirements (the tick box approach, which King opposes).9 Worse, from Kings

point of view and that of others sceptical to the prescriptive, compliance-basedapproach, the PFMA is legislation for the public sector where the ability to effectively

implement more sophisticated and demanding legislation is certainly a more acuteconcern than are related issues of capacity and implementation in the private sector.When King and his colleagues on the Commission and elsewhere speak of theimportance of a South African corporate governance regime to be principles based,they really mean that such principles ought not to be turned into legal requirementstout court.

Explaining reform: diffusion from above or pressure from below

The 1990s prompted comprehensive revision to the South Africas regulatory

framework which is still based on the 1973 Companies Act. Consultations about, andrepresentations on public drafts of, a new Companies Act are ongoing. The new Actwill presumably incorporate aspects of the recommendations in King II is expected to

be finalised in the near future. According to South Africa Reserve Bank (SARB)consultant Hans Falkena,

[t]he speed of institutional change has been so rapid in South Africa, that theregulatory and supervisory authorities at times had difficulties in keeping upwith appropriate regulatory changes (Falkena et al 2001).

9 King has repeatedly stated his opposition to an overly prescriptive approach, what he calls a tick box

approach to corporate governance, in recent interviews. See Moneyweb audio interview by AlecHogg, 22March 2006, at http://www.moneyweb.co.za/moneyweb_radio/mny_power_hour/984777.htm.


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Sarra (2004:6) and Armstrong et al (2005:15) identify several pieces of governmentlegislation that have directly impacted corporate governance in South Africa (asamended): the Companies Act (1973), the Labour Relations Act (1995), the BasicConditions of Employment Act (1997), the Employment Equity Act (1998), the

National Environmental Management Act (1998), the Insider Trading Act (1998), thePublic Finance Management Act (1999), the Promotion of Access to Information Act(2002) and the Securities Services Act (2004). The Constitution of the Republic ofSouth Africa (1996), which enshrines environmental protection rights for SouthAfrican citizens, may also have a profound impact on corporate governancestandards since companies considered in breach of such constitutional rights becomeopen to class action suits (Sarra 2004:6). The Securities Services Act combines andsupersedes much of the previous legislation on corporate governance in an attempt toalign South Africa with international best practice by aiming to increase confidencein South African financial markets, promote the protection of regulated persons andclients, reduce systemic risk and promote the international competitiveness of

securities services in South Africa. The Act also increases criminal penalties formalfeasance significantly, both in terms of potential fines and custodial sentences(Mller 2005).

A 2003 World Bank Report on the Observance of Standards and Codes (ROSC), anassessment of corporate governance in South Africa undertaken by Philip Armstrongin extensive consultation with the King Commission, the JSE, key regulatory and

professional bodies and leading experts in South Africa, was published following the2001 release of King II for comment and declares that King I and the forthcomingKing II set out international best practice (World Bank 2003:1). The South AfricaROSC concludes that legislative reforms, especially the Security Services Act andrevised Companies Act currently in preparation, are addressing issues of corporategovernance and will provide greater clarity, responsibility, accountability andtransparency. According to the ROSC, the most important challenge is enforcementof existing laws, rules and regulations and to strengthen the FSBs sanction andenforcement powers (World Bank 2003:14-15). Overall, the ROSC deems SouthAfrica to be largely in observance of OECD Corporate Governance Principles,covering 1) the rights of shareholders; 2) equitable treatment of shareholders; 3) therole of stakeholders in corporate governance; 4) disclosure and transparency; and 5)responsibilities of the Board (World Bank 2003:Annex A).

Changes to any particular corporate governance regime do not occur in a vacuum;indeed, it is reasonable to expect that (major) change to corporate governance in onecountry will be influenced by practices elsewhere and will, potentially, haveconsequences beyond its own legal borders. Although they draw different conclusionsregarding the potential for global convergence of corporate governance regimes (andfinancial regulation in general), OSullivan (2003), Erturket al (2004), Baker (2005)and Detomasi (2006) examine various hypotheses about the pressures for convergenceat the international level that they all agree do exist to some degree.10 It has also beenhypothesised that the nature of corporate governance reforms in a dominant market,

10 At the domestic level, Roe (2003) and Gourevitch and Shinn (2005) provide politically grounded

explanations for varieties in corporate governance regimes, and the political and economic processesthat produce these different types of regimes.


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like the US, will impact corporate governance reforms in emerging markets, likeSouth Africa. OBrien (forthcoming 2007) argues that the corporate scandals which

prompted SOX in the US in 2002 are likely to have wide-ranging implications forcorporate governance reform elsewhere given the global importance of the US as amarket where corporations from all over the world can raise large amounts of capital

with relative ease and speed. The view from South Africa is, however, somewhatdifferent, as the previously highlighted concerns about additional regulatory burdensassociated with SOX demonstrate.

Just as research on the transition from apartheid to democracy in South Africa hasfocused on the difficult choices to be made by government in terms of balancingdemands by local and international corporate interests (and their governmental andinstitutional allies) for business friendly policies with domestic populist demands forredistribution and pro-poor development policies, the issue of corporate governance

presents the government with a similar, if somewhat more complex, set of choices.Rossouw et al (2002:298-300) links the process of corporate governance reform in

South Africa to the convening of the King Commission and subsequent publication ofKing I in 1994 and sees this reform process as being driven internationally by

pressures from international governance standards and institutional investors anddomestically by pressures emanating from the (social and economic) transformationof South African society and a deeper sense of cultural shift associated with the notionof what President Mbeki calls an African Renaissance.11 The international pressuresare largely understood as being technocratic in nature, relating to issues of definingand complying with best practice in the pursuit of better performing corporations. Thedomestic pressures are largely perceived as political in nature, such as determining theresponsibility of corporations beyond its owners and the degree to which they areobliged to contribute to socioeconomic transformation.

South African corporations have in media and interactions with government andregulators promoted light touch regulation of corporate governance as appropriatefor South Africa, arguing that government intervention in the shape of burdensomelegislation is an additional cost that corporations (especially local ones) cannot bearand therefore a particularly ill-advised course of action in an emerging market thatcan ill-afford to raise the costs of business in a competitive global environment.12 Atthe same time, Western governments and international institutions (the IMF, theWorld Bank, the OECD) are pushing for reform of corporate governance in emergingmarkets, to bring them up to international best practice, which generally entails

more sophisticated accounting, monitoring and reporting. These pressures are

11 A 1997 ANC discussion document entitled Developing Strategic Perspective on South AfricanForeign Policy identifies the following key elements of the African Renaissance: recovery of theAfrican continent as a whole; establishment of democracy in Africa; breaking neo-colonial relations

between Africa and global economic power; mobilising Africans to enable them taking their destinyinto their own hands by preventing Africa being a place for the attainment of geostrategic interests ofglobal powers; and speeding up the development of people driven and centred economic growth anddevelopment to meet basic needs of Africans (see Maloka 2001 and Bongma 2004).

12 However, large South African corporations have largely accepted the logic and demands of BlackEconomic Empowerment (BEE) which, in its aim to promote black capitalism and socio-economic

transformation, places an additional burden on corporations in terms of complying with BEElegislation mandating promotion of black employees at all levels and transfer of equity from white to

black ownership (Andreasson 2006c).


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supported not only by global institutional investors (e.g., large Western pension fundsthat are increasingly investing in South Africa and other emerging markets) but bycorporations, banks and other market actors that are concerned about investing inwhat are considered relatively high-risk markets. Finally, various domestic actors from politicians and labour unions to civil society activists and non-governmental

organisations (NGOs) are concerned about the nature of South Africas post-apartheid capitalism. In particular, they are concerned with the social costs of anincreasingly mobile and therefore potentially volatile market-based society and thedegree to which corporations with global aspirations are willing to contribute to thegeneral democratic aspiration of broad-based transformation. In other words, theywish to clarify and determine the extent to which corporations should be accountable

beyond their shareholders, and how these corporations can best be held accountablewithout being alienated and shirking their responsibilities to society. Given recentconcerns about an investment strike by South African corporations worried abouttheir future relations with the ANC government and their ability to operate freely inSouth Africa, these issues are highly salient, politically as well as economically

(Andreasson 2006c).

The range of actors and their main priorities can be summarised as follows:

Actor Priority

Business(global and local)

Market friendly policy environment;economic, political and social

predictability and stability

Investors(global and local)

Evidence of international best practicegovernance standards and effective riskcontrol

Governance bodies(global and local)

Reforms adopting international bestpractice and evidence of ability tomonitor and enforce

Government Appropriate policy arsenal toaccommodate various pressure groups(business, investors, governance bodiesand civil society)

Civil society Socioeconomic transformation;accountability of corporations (includingBlack Economic Empowerment)

Concluding comments

This paper has provided an overview of contemporary corporate governance reformsin South Africa in the context of economic and political changes associated with thetransition from apartheidto democracy. It has examined how traditional debates onshareholder and stakeholder models of corporate governance, and an emerging debateon the increasing distinction between light touch UK and regulation-heavy USapproaches to governance, inform ongoing corporate governance reforms in SouthAfrica. South African reforms have been examined primarily via the prism of the

King II report and Code of corporate governance, as well as the Sarbanes-Oxley Act


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in the US and the views taken in both private and public sectors in South Africa tothese two competing visions what constitutes good corporate governance.

The debates on both the shareholder versus stakeholder models and the UK versus USapproaches to corporate governance are highly relevant South Africa and other

emerging markets. As emerging markets like South Africa generally have to contendwith serious problems of underdevelopment, governments much carefully balance theinterests and rights of shareholders with the needs and demands of a wider range ofstakeholders in society. While thinking on corporate governance in South Africa is forhistorical reasons naturally aligned with principles of good governance and businessconduct in the UK, the size and importance of US markets to companies and

policymakers worldwide means that changes to governance in the US must be closelymonitored and considered by multinational corporations as well as policy makers inSouth Africa as in countries worldwide.

The issue of lacking institutional capacity, primarily in the public sector, plays an

important role in considerations of what constitutes an appropriate corporategovernance regime for South Africa in the twenty-first century and the for the needsof a society pursuing a broad-based societal transformation with the aim to once andfor all leave the debilitating legacy ofapartheidbehind. South Africas general skillsshortage is the result of substandard apartheid era education for the countrysmajority black population, as well as a significant out-migration of (primarily white)skilled professionals over the last two decades that has been exacerbated by a HomeAffairs immigration policy much criticised for its (now somewhat relaxed) restrictionsand narrow view on the economic need for more skilled professionals contributing toeconomic growth and capacity building. Given this context, the ability of institutionsto cope with more sophisticated and demanding regulation must always be assessedand evaluated in the context of these structural (if not necessarily permanent)shortcomings. Decisions on what aspects of the King Code ought to be enshrined inlaw and practice must be based on a clear sense of how institutions will be able tofacilitate and monitor compliance with any new and more demanding corporategovernance regime. In terms of enforcing laws and regulations against corporatemalfeasance it is, according to Rob Barrow (Executive Officer at the FSB whichoversees the non-banking financial services industry in South Africa), far from clearthat the already under-resourced and over-stretched National Prosecuting Authority isable to handle cases of corporate crime that often involve highly complextechnological and legal issues (Barrow 2006). South Africa has therefore with the

Insider Trading Act made it possible to deal with corporate malfeasance via civilliability where the burden of proof is less demanding (Malherbe and Segal 2001:56-57). The Act makes it possible for the Insider Trading Directorate to withdraw furtherlitigation in return for a payment by the party under investigation (paymentssubsequently redistributed to shareholders that have potentially suffered loss).Investigations and settlements are announced in the South African media, constitutinga policy of naming and shaming which has, according to the JSE (Loubser 20006),

been very effective in reducing the problem of insider trading.

Options for South African policy makers in pursuit of an optimal corporategovernance strategy aligned with established international best practice will for the

foreseeable future remain restricted by the problems associated with a lack ofinstitutional capacity. A better, more nuanced understanding of how to align goals for


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improving corporate governance with the reality of weak (governmental) institutionalcapabilities and policy demands relating to the maintenance of a business friendlyenvironment, as well as the pursuit of socio-economic transformation and broad-baseddevelopment, is necessary for South Africa to retain, and improve upon, its deservedreputation as an emerging market with an innovative and exemplary approach to

corporate governance.


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Appendix

Interviews conducted August September 2006

Mr Philip Armstrong

Head, Global Corporate GovernanceForum, International FinanceCorporation, Washington

Mr Rob Barrow

Executive Officer, Financial ServicesBoard, Pretoria

Mr Colin Brayshaw

Chairperson, Coronation Investments andTrading, Sandown

Mr John BurkeExecutive Director, Issuer Services, TheJSE Stock Exchange, Sandown

Mr Ian Cockerill

CEO, Gold Fields, Parktown

Mr Tony Dixon

Executive Director, Institute of DirectorsSouthern Africa, Parktown

Mr Nick HollandChief Financial Officer and ExecutiveDirector, Gold Fields, Parktown

Professor Derick de Jongh

Director, Centre for CorporateCitizenship, University of South Africa,Pretoria

Mr Mervyn King

Senior Chairman, Brait, Sandton

Dr Len Konar

Consultant, Fisher Hoffman PKF,Parktown

Mr Russell LoubserCEO, The JSE Stock Exchange, Sandown

Mr Higgo du ToitDirector, Corporate Governance, NationalTreasury, Pretoria

Mr Dube Tshidi

Deputy Executive Officer, InvestmentInstitutions, Financial Services Board,Pretoria

Mr Tom Wixley

Non-Executive Director, Johnnic,Johannesburg


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Andreas Son

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