Thai Institute of Directors

Corporate Governance 4.0 ...What We’ve Been Through So Far

Corporate Governance 4.0 ...What We’ve Been Through So Far

CG in the Transition Era... What Do We Expect from Directors?

As directors, we probably are familiar with the term “Corporate Governance”. It works as a mechanism that connects shareholders, Board, and management to perform their respective roles and duties in unified direction to drive the organization towards pre-determined purposes.

Some of you may assume that “Corporate Governance” is classic and timeless knowledge while it actually is rather dynamic and everchanging. This article will depict the “Evolution of Corporate Governance” over the past century or so, which can be divided roughly into four eras.

Corporate Governance 1.0 may date back to 1930’s in the U.S. when a number of business enterprises started to transform into listed companies and sold shares to the general public. Obviously, “Boards” of companies at that time were mere grouping of “acquaintances”, friends, and relatives (Crony Board). They did not have clear roles and responsibilities but to “observe from a distance” and mostly “approve” management proposals. This type of Board is usually branded as “Rubber Stamp”.

What’s wrong with being the “Rubber Stamp” Board?…The best way to answer this question and give you a “clear picture” is to discuss the collapse of Enron in 2001.

The fall of Enron some 20 years ago is considered one of many moral hazard incidents that reflect the most explicit “failure of corporate governance” and “the Board’s oversight role in corporate governance” in history and is still remembered through this day.

Enron went bust because its executives like Kenneth Lay and Jeffrey Skilling attempted to conceal the company’s massive debt and dumped shares for their personal gains. They also colluded with Arthur Andersen, renowned external auditor at the time, to “manipulate” financial figures and make people misunderstood that the company still “went well” and remain “profitable”. Eventually, karma took its toll and brought the company down to the ground. Dozens of executives were put behind bars while massive number of losses and damages were absorbed by stakeholders and the society as a whole.

The fall of Enron is considered the bitter ending of Corporate Governance 1.0 era. It made us reconsider “what have we missed?” and this very question led us to officially enter Corporate Governance 2.0 era.

Corporate Governance 2.0 is considered the era of “learning” (that the Board is still reckless in oversight role regarding the management’s performance) and “recognizing mistakes” (that the organization’s system/financial controls remain imprudence). There were noticeable attempts to use lessons learned (from Enron/Worldcom incidents) and seek ways to prevent the history from repeating itself. One of the highlights is the enactment of Sarbanes Oxley (SOX) Act with U.S. listed companies to prevent investors from accounting fraud and extend responsible scope of the management and the Board toward accuracy and sufficient disclosure of financial reports.

An explicit observation for the 2.0 era is the attempt to “reform” the Board’s roles with deeper Board engagement. The Board is encouraged to perform “oversight role” by probing challenging questions and act as “conscious” element for both the CEO and management, not easily persuaded by the management. This era is the origin of various Board practices that eventually turned into Best Practice these days, such as Executive Session for non-executive directors to consider issues/concerns freely without management presence, etc. Such efforts are ultimately meant to generate growth and solid performance to maximize the wealth of shareholders, “genuine owner” of the organization.

Shareholder Centric concept then gained popularity and become “Corporate Purpose” adhered by numerous enterprises. This concept has eventually been “challenged”, especially after the Sub-Prime crisis in 2008. It is undeniable that the crisis is partly caused by profit-maximization mindset. While “financial institutions” only emphasized on nominal growth but neglected prudent credit policy, “financial advisors” focused on polishing quality of financial instruments until it failed to reflect inherent risks. Therefore, it probably will not be wrong to say that the late 2.0 era left directors with several “lessons” and “key questions” such as:

· Have we considered wide enough interpretation of the “true meaning of the Board’s Fiduciary Duty toward shareholders”?

· Can “value” creation reflected through “stock price” turn into “cost” of other stakeholders?

Corporate Governance 3.0 emerged from serious attempts to “find the right answers” to aforementioned questions. It brought an “end” to the governance concept of wealth maximization for shareholders (alone) and “start” emphasizing on interests of both major and minor stakeholders surrounding the organization.

One of the most concrete movements in the 3.0 era was the Business Roundtable’s pledge in 2019 which clearly expressed their stances that from then on, U.S. enterprises will not only focus on maximizing return to shareholders but will also emphasize on interests of four other key stakeholders, including employees, customers, suppliers, and community. It was the shift of corporate governance “focus” from “shareholder centric” to “stakeholder centric”, with (new) beliefs that “business cannot succeed in societies and environment that fail”. Under the new paradigm, sustainability requires more than just governance (G) to ensure competitive corporate strategies that respond to customers’ demand. The business must also take part in driving social advancement and good quality of living (S) as well as preserve environment (E).

The ESG (Environmental, Social, Governance) framework gained popularity worldwide and became “philosophy” adopted by modern businesses as it helps “mitigates risk” and at the same time “creates opportunity” for the company. As investors emphasized more and shifted investment toward companies that seriously complied with the ESG, the framework seemed to have transformed from “Nice to have” into “License to Operate”.

While “COVID-19 pandemic” generated hectic impact on businesses of all sizes and types, we started to see all kinds of New Normal including...

· New working patterns like “Work from Home” (or even “Work from Anywhere”, which has now become “permanent policy” of some organizations.)

· Emphasis of employee’s wellness (both physically and mentally) beyond just workplace safety.

· Business Transformation to achieve new business model or new products through deployment of new technology or digital system to ensure continuous accessibility and value/experience delivery to consumers when “meeting in person” is still rather difficult.

· Emphasis of “safety” and “data privacy” when almost anyone on earth can access and has cyber “identity”.

The aforementioned phenomena sent similar “signals” that “technology” will soon become “core” driver for businesses to stay relevant, competitive and grow. Thus, the path of “corporate governance” must be adjusted accordingly and this is the official prelude to “the fourth era”.

Corporate Governance 4.0 is the real “era of challenges” for directors. Besides overseeing and monitoring performances of management (which has now become issue of the “past” and “present”), the Board is required to have farsightedness, see risks ahead (issues of the future), and collaborate closely with the management to drive business toward desirable goals.

Since businesses in 4.0 era is driven by technology, the Board must be equipped with “knowledge-understanding” in this matter (albeit not being expertise). Therefore, digital literacy gradually becomes one of core competencies that all directors must possess. At the very least, directors should understand or able to “visualize” how technology deployed by the organization (1) support corporate strategies? (2) encourage new innovation or enhance competitiveness? And (3) can deliver unique value to customers or stakeholders?

Therefore, the Board in Corporate Governance 4.0 era must be “modern” and “eager to learn”. Not only knowing which technologies are “about to come”, the Board also needs to know how to develop internal “personnel” to be compatible with those new technologies. It also needs to recognize “preferences” and “behaviors” of consumers to actually “win” their hearts.

Given unprecedented velocity of change, key roles of today’s Board are not to generate growth with “excess fat” but to ensure the organization is “lean” and “agile” enough to tackle future uncertainties.

Anyway, “which era” your Board is currently in?

P.S. Thai Institute of Directors (IOD) has completed the “Guideline for Board’s Oversight Role in Corporate Governance” to help directors perform their duties and determine key policies in accordance with ever-changing corporate governance trend. The guideline can be downloaded free of charge at https://forms.gle/QhLZin9QofTrAkML9