x Abu Dhabi, UAEThursday 20 July 2017

Governance is more about bottom lines

The efficiency and integrity of a firm's management are central to its prospects for being viable over the long term and maximising investor value.

The collapse of Enron Corp in 2001 led to new laws to ensure proper financial reporting by companies.
The collapse of Enron Corp in 2001 led to new laws to ensure proper financial reporting by companies.

In developed economies, private companies are spending a lot of time on "governance". This subject is also increasingly important to UAE businesses. It sounds like a word consultants and politicians dream up so they can create jobs for their friends and children. It certainly does not seem to be a major concern for managers of small companies and white-collar professionals.

Governance does matter for businesses based in the UAE. Unfortunately, too many find this out the hard way. If governance is too loose, a company can lose money, damage its reputation and go out of business before the board of directors even realises that there is a problem. Conversely when governance is too tight, costs will increase, opportunities will be missed, the best people will quit and the board of directors will be distracted from the most important issues as it deals with bureaucratic minutiae.

Perhaps your company has already found the right balance. Management is agile enough to move quickly and decisively. And there is adequate oversight to detect issues before they become major problems. Even if that is true, it may not be enough. Governance is important to other key stakeholders. Does your company need bank loans? Would you like better credit terms from foreign suppliers? Do you sell to foreign customers including large multinationals? Are you trying to attract investors? Do you plan to acquire another company? Are your local customers becoming more risk-averse? Are you prepared for tougher audits and increased regulation? Are you prepared to defend lawsuits both domestically and in foreign courts?

The world is different now. Just two years ago, governance was not considered all that important in this region. When the economy was strong, customers cared only about price, quality and service. Commercial lenders could rely on profits and increasing asset values. Investors rushed to put money into the local companies with the best potential, regardless of near-term considerations. Regulators did not have to deal with many corporate insolvencies or contract breaches.

Times have changed. Customers now want to deal with stable companies that will be around next year. Banks are slow to lend when collateral is often tied to property values. Investors have been burnt in the past and are now much more selective. GCC regulators have already begun to adopt stringent rules common in the US and EU. Everyone has been spooked by stories of hidden losses and dishonest reporting. As western firms return to the MENA region, they will be much more selective in their business dealings.

GCC companies need to further enhance their governance practices. Executives must build confidence among stakeholders by demonstrating transparency, accountability, financial strength, sound judgment and, above all, integrity. These traits cannot be developed by the marketing department. Superficial attempts at governance are doomed to fail. Reality has to support the message. The days of "check the box" governance are over. They lasted a decade.

After Enron, Arthur Andersen and Worldcom, many laws were passed in the name of good governance. In reality, many of these rules generated only superficial changes and a heap of paperwork. In response to legislation such as the Sarbanes-Oxley Act in the US, companies hired a few independent directors, compiled stacks of dusty binders, and the job was done. Governance? Check! That was a few trillion dollars ago. The scandals of the past decade were nothing like the crisis of confidence today. Back then, investors grumbled about the rules going too far. It all seemed to be an overreaction to a few bad apples committing fraud. Arthur Andersen and Enron are dead and buried. The problem was sorted - or so they thought.

A few years later, major losses surprised every global market. Banks did not realise how much risk they had on their books, and the international financial system nearly collapsed. Investors, including pension funds and governments, lost billions. Lending activity declined sharply. Private companies and indeed governments found themselves unable to borrow the funds they needed to continue operations. In the UAE's case, negative publicity around Dubai's finances affected companies across the nation. Fair or unfair, UAE companies must deal with the reality of this perception.

In this environment, trust is the new competitive advantage. Governance is the foundation on which to build that trust. Governance is not just a public relations exercise. It is the very core of a company. Who sets the priorities? How does management communicate with external stakeholders? What is the right level of top-down control versus autonomy for middle managers and front-line staff? (Coca-Cola's GCC managers can sell cans with the old pull-tabs, but they can't change the logo and paint the cans blue.)

The public relations exercise comes at the end of the process. Only then will stakeholders acknowledge a firm's credible commitment to sound business practices, transparent financial reporting and a prudent approach to risk-taking with proper oversight. But external perceptions are just one of many reasons to beef up governance. The other benefits can be even more compelling: Compliance with GCC laws, which are being strengthened each year to converge with international best practices.

Access to international markets that already have more stringent requirements. This includes prospective investors, customers, suppliers and strategic partners, as well as regulators. Better financial performance. As a company improves its governance, it will often find opportunities to increase revenues, cut costs or even reduce external debt. For example, a robust internal reporting system allows senior executives to identify middle managers guilty of "empire building". In many cases, different departments will duplicate efforts or even fight turf wars. Leaders will be able to consolidate multiple teams to cut costs, improve quality and even improve cross-selling success.

Improved risk management. Proper governance helps a company identify and address risks wherever they are found. To be effective, resources must be co-ordinated across the firm - people, policies, systems, internal and external reporting. Ultimately, governance is supposed to be about risk management. Shareholders trust executives to maximise the value of their investment. Board members are hired to ensure that executives are doing their job effectively. Executives, in turn, rely on people, processes and systems to give them comfort that their strategies are being executed properly and efficiently. Governance is what connects the front-line worker to the ultimate shareholder.

Governance also protects the individuals within an organisation. Many local board members are also executives in their own multibillion-dirham enterprises. Effective governance protects their personal reputations from potential illegal or unethical behaviour connected to one of their board affiliations. We all know that today's business climate is difficult. No company has spare cash to spend on expensive initiatives based on slick consulting presentations and long time scales. Now is a time to maximise revenue, decrease costs, reduce risk and remain in full compliance with regulations.

Proper governance should help with all of these goals. Governance is not about "best practices". It is about increasing share price, satisfying lenders, attracting customers and managing more effectively. What could be higher priorities during a recession? Steve Stanton is a managing director at Montgomery Woodrow, a management consulting firm based in the UAE and specialising in CFO and governance services, interim management and process improvement. He can be contacted at stanton@montgomerywoodrow.com