Corporate Governance in GCC Countries and Sharia Law - Literature review Example

?Corporate Governance in GCC Countries & Sharia Law Table of Contents Table of Contents 2 Chapter 2: Literature Review 3 2.2.3 Review of Alternative Corporate Governance System 3 2.2.4 Summary: existing situation and desirable issues in Corporate Governance 6 2.3.2 Summary of Empirical Research 10 References 16 Chapter 2: Literature Review 2.2.3 Review of Alternative Corporate Governance System As observed that corporate governance system focuses on the relationship between the management of the company and stakeholders, shareholders, debtors, creditors, suppliers, board of directors and community organizations (Paton, Juleff and Schachler, 2007). The role of each participant in the corporate governance mechanism is vital. Corporate governance mechanism is largely dependent on the legal, institutional and regulatory environment. There is not a singular model framework which defines a good corporate governance system hence different countries follow different corporate governance mechanism. As mentioned before that the corporate governance mechanism differs from country to country because of varied reasons like the orientation, time zone etc. This section will help us understanding the functioning of corporate governance mechanism in different countries excluding the GCC countries. The practice of corporate governance policies has a deep influence on the managerial decision making in the UK corporations. It is regarded that the composition, size and duration of the member of the board are important factors that decide a good corporate governance mechanism (Zhang, 2012). The Corporate governance mechanism in UK is deeply influenced by the Cadbury & Green report also known as Cadbury code of best practices and Greenbury report on Director’s remuneration (FRC, 2013). The Cadbury report was framed in response to the Polly Peck and BCCI scandal and the main objective of the report was to promote effective and good corporate governance practices within the UK companies (Laing and Weir, 2002). The key elements of the report focussed on the code of duality, non executives and board of committee. The report also focuses on the leadership approach adopted by the manager of the company. It has been observed that there is a positive relationship between the leadership approach adopted by the managers and the corporate performance of the company. It also suggested that the board of directors should constitute of at least three members which are also applicable to Australian companies (EOG, 2013). The chairman, directors and the auditors are selected by the shareholders of the company at the annual general meeting. In France voluntary disclosure of financial statements has been the object of paramount importance (Lakhal, 2005). There are two kinds of financial disclosure; mandatory and voluntary disclosure (Taylor et. al., 2005). In the year 2002 a new set of corporate governance law was introduced in the winter report for the European companies which focused on tightening the corporate governance law. One of the crucial components of the report was to strengthen the role and responsibilities of the auditors. The chairman has to communicate about the internal policies to the internal and external auditors clearly. The legal laws related to French corporate governance are composed of 3 basic laws which include law of new economic regulations, law of financial security and law on financial security. However, the ownership structure of companies in France is concentrated even with the increase in the number of shareholders in the privatized companies (Charreaux and Wirtz, n.d.). The ownership structure of the French listed companies has undergone a huge change. However, the presence of increased institutional investors does not mean that their controlling the capital stakes also increases (Braendle, 2011). In the year 2002, 11.3 percent of the French companies had institutional shareholders as the main shareholders of the company compared to a 40 percent and more in USA and UK companies. According to authors Faccio and Lang (2002, cited by Charreaux and Wirtz, n.d.) 60 percent of the listed companies were under the control by the founders of the family. Therefore we can say that the ownership structure of the company varies as per the different laws prevalent in different countries (Li, 1994). However, the French Law limits the composition of board members to one third of the board seats. For example we can observe from Figure 1 that shareholders of Italian companies own a majority of the share capital compared to other countries. Table 1: Geographical Distribution of Shareholder Shareholders Proportion of Share Capital (%) Italy 66.30 Rest of the continental Europe 14.09 UK & Ireland 7.89 USA &Canada 8.77 Rest of the world 2.95 Total 100 (Source: Snam, 2013). In the year 2002 the submission of German Corporate Governance Code (GCGC) to the federal government of Germany was accepted immediately by the investors and the business companies (Von Rosen, 2007). The German corporate governance mechanism welcomes flexibility and the companies have to declare at least once in a year that they are adhering with this code (SGL, 2013). The key elements of the corporate governance code are shareholders meeting, coordination between supervisory and management board, transparency in financial and accounting activities and accurate auditing methods (Baums, n.d.). Thus we can observe that the German listed companies adopt the one tier approach and two tier approach as per their convenience. According to German Supervisory Board the number of members should not exceed 20. The corporate governance law in Netherland were formulated against the background of Dutch Corporate Law system and allows flexibility in various aspects (CGCMC, 2007). One of the major aspects of corporate governance system is that it focuses largely on stakeholder participation than shareholders participation. The Dutch corporate governance mechanism includes certain laws which can prevent the company against a hostile takeover. The corporate governance mechanism in Switzerland also known as Swiss Code of Best Practices is very flexible and is intended for the public limited companies (Swiss Business Federation, 2007). The shareholder is given authority for decision making and the company is obliged to inform the shareholders about the internal control procedure. 2.2.4 Summary: existing situation and desirable issues in Corporate Governance It is observed that the corporate governance mechanism of different countries is developed for the best interest for the companies. It was also observed that apart from the composition of the board and structure for corporate governance mechanism, the code of best practices of different countries laid emphasis on the corporate performance of the company (Rao, Tilt and Lester, 2012). The corporate governance mechanism of UK and USA has gone through major transformations which have led to increased corporate performance (Deloitte, 2012). The corporate governance practices are stringent in UK and require continuous regulation from the government. In Netherlands the formation of the supervisory board is not compulsory for the medium sized and small corporations (Bekkum et. al., 2010). Although the supervisory board are monitored continuously by the Dutch government there is a possibility of legal changes to occur in the future. The topic of composition of the board is a heated debate among various theorists and there is no defined proposition that claims that large number of board contributes to the corporate performance (Kim, 2011). We can observe the different corporate governance structure of different countries as per the legal laws of different countries. Country Structure USA One Tier UK One Tier Germany One & Two Tier France Companies are free to choose between one and second tier model and government do not impose (Goyer, 2003). Switzerland Free to choose any corporate governance model The main reason of German companies to choose between one and two tier model is to combine the executive and monitoring functions of the company and delegate the responsibilities to one board. The US companies are adopting the one tier model whereas the German companies are adopting the two tier model. (Von Rosen, 2007). We will now observe the impact of one tier and two tier boards on managerial decision making in companies operating in UK, USA and Germany. The structure of the board and the size of the board have a significant impact on the accounting and managerial decision making. The companies having a one tier board model have clearly distinguished the separation of the roles and responsibilities of the chairman and the CEO. The chairman monitors the performance of the CEO stringently which can bring clarity in decision making. In two tier boards the combination of roles and responsibilities of the chairman and CEO may lead to rationalization in decision making. However, it is found that both the models have their limitations. The companies following a one tier model are usually negatively associated with shareholders wealth and two tier model leads to confusion and irrational decision making among the board members. The legal laws and government interference also influences the corporate governance structure to a large extent. Country Government Interference UK Non Interference Germany Minimal Interference Japan Excessive Government Interference Netherlands Government Interference to a extent France Government Interference to a extent USA The government assists in decision making with the coordination with the management for the best interests of the company. In UK the corporate governance structure is regarded as a classic example due to the contribution of several significant inputs from the Cadbury & Green report. The one tier model provides rationale decision making and ensures the removal of confusion and chaos among the board (Maassen, 2002). However, shareholders casting their vote through telephonic and electronic mode should be discouraged because the physical presence provides relevance to the meeting. The management should discover new means of shareholder engagement. The independent board of directors should be clearly mentioned in the annual report. A transparent and formal procedure should be implemented for the appointment of the directors. The appointed remuneration committee should monitor and judge the remuneration received by the directors. The companies in Germany and France follow the two tier board structure Switzerland need to adopt the one tier model which provides opportunity to the managers to adopt a strong and unambiguous leadership approach which can improve the unity of command among the employees, managers and the board members. It also avoids the perplexity of having two spokesperson of the company which can lead to potential conflicts. The German companies should ensure that the major events are recorded and published in the financial calendar. The company should publish the financial details in English language for the convenience of foreign investors. The company should list all the names of the participants who have share ownership of more than 10 percent. The vesting period should also be increased to at least 3 years. The French companies should clearly mention the remuneration package of the directors and stock option plans in the financial reports. The annual report should highlight details like executive position, age, and the terms of appointment of the directors. The number of meetings and content of the meetings should be clearly mentioned in the annual report. The Dutch companies should allow the holders of the depositary receipts to vote and shareholder should be allowed to contribute significant inputs to the managerial decision making. The investors who represent 1 percent of the issued capital should be able to help in decision making for the agenda 30 days prior to the annual general meeting. The annual report should clearly mention the details of each member of the supervisory board committee. The member should be appointed for a limited duration and reappointment of these members should be done cautiously. The Switzerland companies should focus on improving the quality and composition of the board and impose important duties on the board (Schneider and Chan, 2001). Care should be taken to increase the liability of monitoring and conduct regular audits. A suitable organizational structure should be adopted which will help in effective monitoring of the internal control system (Schneider and Chan, 2001). The monitoring function should be regular and effective which extends to the activities carried out by the management, board and audit committee, employees and the chairman. 2.3.2 Summary of Empirical Research The empiric research was conducted on ten countries with relevant data collection instruments and the research methodology. The first study conducted by investigator laid emphasis on the relationship between the corporate governance system and corporate performance. One of the main objectives was to investigate the direct relationship between good corporate governance and shareholder’s value. As per the results of the statistical analysis it was observed that there is no direct relationship between the corporate governance system and corporate performance. The statistical analysis was conducted through qualitative methodology. There were certain limitations in the study like the inability of the investigator to provide rationale for the selection of direct and indirect variables. The second study was conducted in Egypt and laid emphasis on the impact of the corporate governance practices and the auditor’s decisions. As per the results derived from quantitative analysis it was observed that the active participation of the shareholders and stakeholders improved the quality of corporate governance reporting method. It was also observed that accurate financial reporting and shareholder participation was directly linked. This is to note that a quantitative matrix model was used by the investigator to evaluate the relationship between the variables. The study served purposeful to the investigator as it helped in studying the importance and role of audit committee in the corporate governance practices especially in countries where corporate governance is voluntary. The investigator faced certain challenges while conducting the study like the impact of shareholder’s expectation, remuneration package of the board and the market value of the company on the corporate governance practices which could have improved the quality of the investigation. The third study was conducted in Thailand to understand the effectiveness of corporate governance in the state owned enterprises of Thailand. The results derived from the qualitative and quantitative analysis were that good corporate governance practices in strategic human department of the state owned enterprises had a pivotal role while corporate governance practices in state owned enterprises had no impact on the internal auditing. It was also derived from the result that the ability of the state owned enterprise to handle risk management decided the corporate governance practice of the firm. However it was observed that the non strategic department of the state owned enterprises required good corporate governance practice in order to improve the decision making ability and decrease fraud accounting. The investigator was successful in determination of relationship between corporate governance practices and corporate performance. However limitations like lack of ontological and axiological perspective, geographical dimensions, non parametric nature of data analysis etc decreased the quality of the project to a certain extent. The study would act as guideline for other researchers to measure the corporate performance using traditional corporate governance theories and models. The fourth study was conducted to understand the relationship between the corporate governance behaviour, corporate governance environment and corporate performance with respect to the telecommunication industry of China. A quantitative analysis was conducted to understand the impact of corporate governance environment, practice and corporate performance on the chine telecom firms and companies. As per the results derived from the quantitative and qualitative analysis it was observed that there is lack of proper equilibrium between the three interdependent variables and weak relationship between corporate governance environment and corporate performance. It was suggested by the investigator that a strong juxtaposition between these three interdependent variables can improve the corporate governance behaviour. However, the investigator faced several limitations while conducting the research study like misrepresentation of fact and subjectivity. The limitation of the study had decreased the empirical value of the study to a slight extent. The fifth study was conducted to understand the determinant of good corporate governance in companies of USA (United States of America). A quantitative analysis was conducted on 624 listed financial companies to understand the impact of the variables board committee, audit committee and board of directors on corporate governance of the companies. As per the results derived from the quantitative analysis it was found out that there is a strong association between performance of board committee, directors and audit committee but corporate performance also depends upon the internal activities of the firm. It was also observed that there is strong and positive association between the company’s requirement of capital and institutional ownership model. This means that increase in shareholder’s ownership and participation can increase the corporate governance behaviour of the company. However, the limitations of the study decreased the empirical value of research there was no valid reasoning behind the selection of interdependent variables and the investigator was unable to identify the underlying relationship between the corporate governance problems and corporate governance quality. The investigator had ignored the impact of external variables like the economic structure, financial system, political scenario, legal system and societal impact on good corporate governance. The sixth study was conducted to analyze the interdependency of internal and external corporate governance mechanism and to measure the impact of the corporate governance practices on capital structure of the securities companies of UAE (United Arab Emirates). As per the results derived by the investigator through quantitative analysis it was observed that capital structure of the securities company of UAE did not get affected by the improvement in the quality of the work of external auditors . It was also observed that engagement of these companies with leading audit firms like KPMG, Ernst &Young could not contribute significantly in increased capital structure of the company. It was also noted that there is a negative relationship between the composition of the board and the capital structure of the companies. It was also observed that the institutional investors were discouraged to practice their voting rights to protect the rights of the shareholders. There were minor limitations in the study because the investigator worked in cooperation with scholar who had thorough knowledge regarding the corporate governance practices in UAE securities companies. Limitations like the manager’s lack of awareness of the benefits of the corporate governance practices on corporate performance had minor impact on the research study. The seventh study was conducted on the two hundred firms listed on ASX to understand the impact of the corporate governance practice on the earnings of the company. As per the results derived from the quantitative analysis it was observed that there is a strong and positive relationship between the independence of board and audit committee and the discretionary accrual earnings of the company (Ayers, Jiang and Yeung, 2006). There is also a positive relationship between the share ownership of the executive director and earnings of the company (Ayers, Jiang and Yeung, 2006). Minuscule limitations like data of two years were used by the investigators hence a generalized opinion could not be formed and moreover the proxy method was used to compensate the delisted companies of ASX during the tenure 2000 to 2005. The eight research study was conducted to understand the relationship between the role of the internal auditor and corporate governance of the company. As per the results derived from the qualitative and quantitative analysis it was observed that there is significant association with internal audit function and increased corporate governance. However, limitations like inability to provide justifications which are not in synchronization with the actual practices and relationship between the role of internal auditing and internal control functions has insignificant impact on the research study. The ninth research study was conducted to identify the relationship between the corporate governance system and the strategic management dynamics of the company. As per the results derived from the qualitative research model it was observed that the parameters which define corporate governance have a direct link with the life cycle of the companies. There is a significant contribution of the corporate governance policies on the lifecycle of the company. However, it was observed that there were several limitations which reduced the empirical value of the research. The investigator had utilized simple descriptive statistics to identify the relationship between the strategic life cycle of the company and corporate governance policies. The investigator did not utilize any hypothesis to test the viability of the relationship between the two variables. The final research study was conducted to understand the nature of corporate governance practices in the companies of Uganda. As per the findings it was observed that stakeholders in the companies in Uganda are concerned of the legal impact on corporate governance. The investigator observed that the stakeholders were concerned with the legal practices which impacted the corporate governance issues. Thus we can observe that awareness and benefits about corporate governance is prevalent in most of the countries. We have also observed that corporate governance either has or does not have a significant impact on the companies. As per the analysis of the corporate governance practices on the companies in GCC countries it was observed that lack of well defined and clear corporate governance policies has made potential investors reluctant to invest in the companies of GCC countries. The secondary reason behind the reluctance of the potential investor would be the stagnant growth of the economy of GCC countries. The lack of well defined corporate governance mechanism in the region is one of the prime contributors of the stagnant economy. Islamic principles play a vital role in deciding the corporate governance mechanism of the country hence curbing down the power of the board and shareholder (Abu-Tapanjeh, 2009). However, Sharia law focuses on increasing the moral conduct among the employees which could have a direct influence on the corporate performance of the company. 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