Corporate governance is more art than science. Perfection will always be elusive, and rules can be dangerous. The new King 3 code on corporate governance, released last week, was produced partly in this spirit. Users should recognise that they may find imperfections in the final version, but they will also find a comprehensive set of principles and recommendations that could lift SA to world leadership in this field.
The code was produced after extensive debate, and with contributions from more than 100 people serving on subcommittees, including directors, professionals and other specialists. That, of course, is no guarantee that it will meet all expectations. It will not please everybody.
However, the context in which King 3 was produced is important. SA's company law is undergoing extensive change and modernisation. The new governance code will come into force on March 1 next year, and the new Companies Act will take effect some months later. The act will create a tougher legal regime for directors, who could be held personally liable for damages (or fines) in some circumstances.
Aside from the legal aspects, the risks companies face and stakeholders' expectations of companies have changed greatly in recent years. Governance today covers far more than financial performance. It includes risks and obligations linked to the environment, social transformation and technology.
The philosophy underlying King 3 is that good governance is about effective leadership; sustainability is the primary moral and economic imperative of the 21st century; and companies, as corporate citizens, should operate in a sustainable manner. It is difficult to argue with this thinking. It has led to a governance code that operates on principles and allows flexibility. It is also wide-ranging, including sections on sustainability, responsible investment and technology.
Two distinct approaches to corporate governance have evolved internationally in the past decade. The US, a litigious and rule-driven society (despite its record of producing entrepreneurs), chose to codify a large part of its governance in an act of congress, known as the Sarbanes-Oxley Act. This created a statutory regime, with legal sanctions for noncompliance but also with rigidities and costs for society.
The 56 countries in the Commonwealth and the 27 countries in the EU (including the UK) have opted for a code of principles and practices on a "comply or explain" basis, along with certain governance issues that are legislated.
SA took this route with the earlier versions of its governance code, known as King 1 and King 2. The latest version goes further. The principle now is "apply or explain", a reminder that the code is not simply about forced compliance. In some circumstances, judgment and discretion may be a good thing.
Some critics will argue that if governance is not enforced, it becomes irrelevant. The credit crunch and resulting crisis among leading financial institutions has been presented as a crisis of corporate governance. Mervyn King, chairman of the committee that produced the new code, points out that the US is the primary source of the financial crisis, despite Sarbanes-Oxley, with its rigorous statutory requirements.
A related issue is how to align the interests of directors with the company and its owners. Another criticism of the code is that non executive directors will not be allowed to own shares in a company whose board they sit on.
However, the new stance may encourage more independent thinking that goes beyond what may be unsustainable gains in the share price. The directors will still have a legal duty to act in the best interests of the company.
King rightly argues that in reality the ultimate compliance officer is not the company's compliance officer or a bureaucrat ensuring compliance with statutory provisions, but the stakeholders. Good corporate governance is becoming more demanding of directors, who may need to show better leadership. But it will also require more involvement from stakeholders, including the owners.
