The King 3 report will set new benchmarks of acceptable practice for South African companies.
The global credit crunch, stock market collapse and recession bring into clear focus the reality of economic cycles and the fact that the good times do not run on forever. Whenever things go pear-shaped and the man in the street loses money, there is a witch-hunt to identify the culprits. Somebody must take the blame; it cannot, surely, just be an economic cycle playing itself out!
The easiest place to rest the blame is regulation. This is too simplistic because the role of regulation is to create a level and predictable playing field and to institute acceptable levels of investor protection. The primary objective is not to prevent financial disasters - it would be wonderful if it could, but the reality is that financial meltdowns are triggered by events that regulators are in no position to control.
South Africa has been fortunate in having great visionaries of corporate governance and regulation. This is evidenced by the fact that the Institute of Directors has produced the King 3 corporate governance report, which is due to come into effect on March 1 next year. This report continues the work that has been going on for 17 years; it was given greater urgency by the fact that we are on the brink of enacting a new Companies Act.
The King Report committee was formed in 1992 and led by former High Court judge Mervin King. In 1994, the committee released the King Report, which set levels of acceptable corporate behaviour. This was novel at that time.
As was anticipated, the King process was evolutionary and, as a result of practice and experience, it was hardly astonishing that, in 2002, King 2 was published. The code set out in King 1 had already become standard, and all JSE-listed companies, financial institutions and public sector enterprises governed by the Public Finance Management Act fell under the regiment of the code, as did many other entities.
King 2 reaffirmed much of the original report but went far beyond the strictly financial and regulatory aspects of corporate governance. It took into account a wider range of stakeholders and included the social, ethical and environmental impact of company practice. King 2 identified seven primary characteristics of good corporate governance, namely discipline, transparency, independence, accountability, responsibility, fairness and social responsibility.
King 3 adds to the two previous reports by highlighting corporate citizenship across the board, leadership and innovation. Sustainability has become a focal point of our age of global warming and has been emphasised in the report.
The new report goes further than its predecessors in that it stipulates that a company must have risk and nomination committees in addition to the audit and remuneration committees previously required. It also introduces information technology governance.
A company board should have a majority of non-executive directors and a minimum of two executive directors, including the chief executive officer and the chief financial officer. Non-executive directors must be rotated on the basis that one-third retires each year.
Remuneration policies should be clear and should state the mix between fixed and variable pay, which should be clearly agreed on by the committee. Shareholders should approve non-executive fees in advance, and the committee should periodically evaluate incentive schemes to ensure they add value.
A controversial stipulation is that non-executive directors should not receive share options because this may create a conflict of interest in terms of their duties to shareholders.
Each section of the report clearly outlines what aspects should be regarded as necessary (or prescriptive) and recommended (optional). The report "will apply to all entities regardless of the manner and form, incorporation or establishment". King 3 invites companies to "comply or explain". So they have the option not to comply with the report but should provide well-considered explanations for not doing so.
The report is a vibrant response to changing times in a world that has witnessed financial chaos that can be partially attributed to misaligned interests, mismanagement, poor implementation of corporate governance and unimaginable greed. On balance, it is a positive report and it will be generally welcomed by the investing community. With change taking place at such a pace nowadays, it seems likely that King 4 will be in the pipeline soon.
- David Sylvester is the chairman of the Shareholders' Association, telephone 021 686 7567.
This article was first published in Personal Finance magazine, 3rd Quarter 2009. See what's in our latest issue