INTRODUCTION
The corporate governance discourse has attracted global interest. At the onset, the focus was naturally on the highly developed countries, having witnessed the collapse of giant corporations such as Enron, WorldCom Inc., Aldephia, but a few (Jones & Pollitt 2003). More recently, due to its apparent significance to an organization’s strategic strength and national development, attention has been devoted to corporate systems in developing countries (Mueller 2006).
The Kenyan economy presents distinctive corporation characteristics in comparison to other developing countries in Africa. With a Gross Domestic Product (GDP) of US$ 30B in 2008, Kenya also has a long stock market tradition and the largest stock market in East Africa, thereby the best-developed economy in East Africa (WDI 2009). However, the recent spate of corporate failures in Kenya has been attributed to weak corporate systems and resulted in significant economic losses with examples like United Insurance Company, Strategies Health, Uchumi Supermarket Limited to mention a few.
Most significant, the recent 2006 Africa Peer Review Mechanism Report (APRM) recognises Kenya’s efforts to improve and create awareness of corporate governance values and principles within the country. Notably, the adoption of the Organization for Economic Co-operation and Development’s (OECD) Principles of Corporate Governance by the Kenyan Government has actively instituted a good corporate governance framework within large publicly-listed companies thereby meeting international benchmarks.
Building on Kenya’s developing economy and corporate system, this paper discusses the economic development benefits of enhanced corporate governance practices on publicly-listed companies in Kenya. While recognizing corporate relationships, contracts and ownership structures of corporations in Kenya, the first part of this paper presents the purpose, characteristics and objectives of corporations within the economy. In the second part, over a sample of companies in Kenya, we analyse the role of internal and external corporate mechanisms in achieving the corporation’s objectives. In conclusion, we consider the effect of Kenya’s corporate system mechanisms on economic development.
THE CORPORATION’S PURPOSE, OBJECTIVES AND FINDINGS FROM KENYA
The understanding of the nature of corporations has significantly influenced the purpose and objectives of corporations. In his treatise, Coase (1937:393) noted that a profitable corporation exists within a system of relationships (see Figure 1 below) managed by an entrepreneur at a lower cost. In addition, Berle & Means (1932) cited in Vives (2000) and Allen & Gale (2001) note that corporations are run by professional managers (agents) who are adversely selected by dispersed shareholders (principals). Subsequently, the shareholders are morally challenged to draw-up contracts that motivate managers to maximise their own utility (Friedman 1997)
To the contrary, Jensen & Meckling (1976:310) view the corporation as a “nexus of contracts” that guides different participants (community of human beings with different goals and interests. In addition, Fontrodona & Sison (2006:9) discredit the premise of maximising shareholders’ wealth arguing that shareholders do not own the corporation but merely “own the capital”. In agreement, (Shankman 1989:320,332) describes the shareholder theory as a “narrow form” of the stakeholder model. For this reason, the maximisation of stakeholders’ interests offers a more comprehensive view of the purpose of the corporation.
Obviously, managers may not always act in the best interest of stakeholders even when control is detached from ownership. In their treatise Barako et al (2006) highlight information asymmetry, where insiders (managers) have an information advantage as a major drawback to maximisation of stakeholder interest. In their proposal, Letza et al (2004) circumvents the agency problem by the issue of effective contracts to align management behaviour with stakeholder’s interest, while Fama & Jensen (1983) refer to the contracts as “rules of the game”. On the contrary, Demsetz & Lehn (1985:4) view that an efficient managerial labour market ought to be sufficient to monitor managerial performance. Keasey et al (1997) and Bonazzi & Sarda (2007) further support that capital market; labour and corporate markets; and market signals restrain managerial divergent behaviour.
While considering a measure for the performance of managers, Li (1964) presents the corporation’s objectives to include the corporation’s survival and growth. He (ibid) critiques the corporation’s profit maximisation objective arguing that it does not financially support nor motivate managers. Nevertheless, the existing legal and governance system (market oriented or relations-based) also influences the survival and growth of corporations (La Porta et al 1997; La Porta et al 1998). In conclusion, Vives (2000) affirms that corporate governance augments the corporation’s survival and growth and is most effective while balancing the corporation’s internal and external controls.
a)An overview of the corporate governance system in Kenya
In light of the above discussion, this section interrogates the existing corporate governance system in Kenya. As a developing economy, the nature of corporations is characterised by small and medium-sized enterprises of which most are not listed on the Nairobi Stock Exchange (NSE). In 2000, it was estimated that only 30% of businesses operated in the formal sector with less than 1% listed on the NSE (Gatamah 2005).
More recently, at the beginning of 2010, only 47 corporations were publicly-held and almost 99% of formally registered enterprises operated outside the capital market authority regulation (NSE 2010). This peculiar organization of factors of production gives room for undemanding governance structures and an almost nonexistent market for corporate control.
Majority of listed corporations are controlled by East African institutions (74.16%), East African individuals (15.90%) and foreign investors (9.93%) with presence of cross-holding structures and pyramid structures. On the other hand, a selected review of listed corporations in the agricultural sector identifies that all corporations are foreign owned. For example, Rea Vipingo Plantations Limited (RVPL) is primarily owned by Richard Robinow, a British nationality. In addition to his individual shareholding of 26,786 shares, companies controlled by the Robinow family and their subsidiary and associated companies own at least 57% shareholding in RVPL. In their research, Nganga et al (2003) highlight that the concentrated ownership structures – mainly multinationals and family interests – have side-stepped the agency theory by acquiring a controlling stake in listed businesses. For example, figure 3 below analyses the Aga Khan for Economic Development’s (AKFED) cross holding in listed corporations.
The Standard Report (2009) also observes that a large number of companies in Kenya have majority shareholding. The concentrated ownership structures in Kenya support Reed (2002:233) as cited in Gustavson et al (2005) and Shleifer and Vishny (1996:38) views that for developing economies a conflict of interest is more evident between majority and minority shareholders and not between the shareholders and managers. On the other hand, La Porta et al (1998) argues that the presence of a common law system should result in stronger shareholder protection regulation. Notwithstanding the presence of common law in Kenya, Nganga et al (2003) comparative study of shareholder rights report the lack of minority shareholder rights where unsatisfied shareholders have two options: sell their shares or sue the company (see Figure 4 below).
Nevertheless, majority of the corporations in Kenya are limited liability companies thereby governed by the existing corporate common law and the market-oriented (Anglo-American model) governance system. Like most former British colonies, the country’s corporate common law is embodied in the Companies Act 1962 (Chapter 486, Laws of Kenya) which is significantly similar to the England’s Companies Act of 1948 (Musikali 2008). While the Companies Act presents the minimum financial accounting and reporting requirements, various independent regulating bodies such as the Institute of Certified Public Accountants Kenya (ICPAK), Central Bank of Kenya, and the Capital Markets Authority (CMA) supplement and enforce adherence of corporations to regulation.
While the Anglo-American governance model is significantly supported by a strong market for corporate control, the lack of hostile takeovers in Kenya limits the efficiency of managers. In addition, the pre-existing “directing and managing” overlap as discussed in Gustavson (2005:11) compromise the maximisation of the corporation’s utility and growth. Supportively, the Corporate Governance Bulletin (2004:1) cited in Gustavson et al (2005) raise fundamental weakness in the controlled ownership structures. For instance, the high incidence of board members overriding management in particular corporations while others cases managers have a lot of control at the board level overshadowing other directors.
In addition, Musikali (2008) bemoans the efficiency of the existing legal system. The paper (ibid) considers the current business laws outdated. The legal process is also lengthy and regulators are constrained in resolving complex commercial disputes. In addition, the political interference within the corporate system of public corporations incapacitates the regulation power. In summary, the World Economic Forum’s Africa Competitiveness Report 2000/2001 ranks the Kenyan legal system almost not effective.
Concluding the above discussion (presence of concentrated ownership structures, prevalence of family ownership, incidences of pyramid control structures, a poor market for corporate control) it is not surprising that Gustavson et al (2005) question the appropriateness of the existing Anglo-American governance system in Kenya.
b)Corporate governance and it’s mechanisms: how corporation’s in Kenya achieve their objectives
The corporate governance discussion builds from the thesis “The Modern Corporation and Private Property” by Berle and Means (1932). Therefore, from the above discussion the standard Bearle and Means’ (1936) firm characterized by dispersed ownership is a rare phenomenon in Kenya. Most corporations in Kenya are significantly influenced directly or indirectly by an economic group that owns a large percent of the corporation’s shareholding thereby exercising tight control over the corporation.
In a broad sense, corporate governance mechanisms that support the corporations overall objectives of survival and growth may be distinguished between internal and external governance mechanisms. In this section we focus on three mechanisms – two internal mechanisms (board attributes and ownership structure) and one external mechanism (the regulation system) – as implemented in Kenya.
1)Board attributes and CEO duality
The concern of corporate governance has been the accountability and effectiveness of the board toward achieving the corporation’s objectives (Cadbury 1997). As argued above, the independence of board members and management is important in achieving the corporation’s objectives. Further Hampel (1998) argues that a board is more independent if non-executive directors (outside directors) dominate the board and the chairman and CEO position is separated. This argument is supported in Daynton (1984:35) cited in Abdullah (2004), if one person is wearing two hats, “it is always the governance hat that is doffed.” However, Fosberg’s (1989) laments that non-executive directors may adversely affect board performance as they neither have sufficient institutional knowledge nor hold significant number of shares (Conyon and Peck 1998). Nevertheless, Abdullah (2004) citing (Reay 1994:74) concludes that non-executive directors support the corporation’s performance as they are expected to be independent of management and appointed for their industry experience.
Additionally, as illustrated in Box 2 the governance code in Kenya advocates that “appropriate committees” should be established within the board (Nganga et al 2003). In their review, Gustavson et al (2005) also note that the guidelines overemphasize the monitoring role of the board at the expense of the strategic role. On the other hand, directors of multinational companies are perceived as mere “rubberstamps” for the parent company while the lack of diversity in the pool of potential directors limits the strategic and monitoring role of the board (Nganga et al 2003; Gustavson et al 2005). In her conclusion (Musikali 2008:17) recommends that a dual standard responsibility be implemented to ensure that directors act in the best interest of shareholders who are tasked to contract them to maximise their returns.
2)Ownership structures and the role of shareholders
In their treatise, Demsetz & Villalonga (2001:231) argue that the market succeeds in bringing forth ownership structures that eliminate any systematic relation between firm performance and ownership structure. However, in developing markets such as Kenya which are:heavily relationship-based rather than effective market rule based; characterized by widespread smaller firms that are not listed on the NSE or large family owned, state owned and foreign owned that are listed on the NSE; and exposed to expropriation by corporate insiders and vested interest groups, it is not surprising that ownership structures have a great influence toward the survival and growth of the corporation (Oman et al 2003).
More specific, the relationship between ownership structures in corporations and the corporation’s survival and growth is discussed in Barako (2007). The study indicates that the corporation disclosure is influenced by the corporation’s concentrated ownership structure. Therefore, building on the premise that the level of voluntary disclosure influences investor confidence in a corporation, the study concludes that the size and value of companies is significantly associated with the ownership structure and subsequent voluntary disclosure of information. In conclusion, Vives (2000) confirms that the concentration of ownership improves the control of management.
3)Regulation and other linkages
In the absence of a market for corporate control, the existing regulation and other linkages such as the Private Sector Corporate Governance Trust (PSCGT), CMA, NSE and ICPAK support the corporation’s objectives. These external mechanisms ensure consistent monitoring of corporate performance, provoking public scrutiny therefore management work hard to avoid poor performance. On the other hand, executive pay packages for management positively influence the corporation’s growth as management seek a better return for the investors (Gustavson 2005). However, in their conclusion, the 2006 NEPAD report recommends for improved enforcement and updating of laws and regulation, enhanced supervisory capacities for the supervisory institutions and proper assessment of corporation boards.
THE KENYAN CORPORATE SYSTEM, ITS IMPACT ON ECONOMIC DEVELOPMENT AND RESULTS
Cadbury (1992) identifies the positive influence of a sound and effective corporate system on a nation’s economic drive and competitive advantage. In addition, Klapper & Love (2004) also presents a positive relationship between corporate governance and firm performance in developing countries. While several arguments have indicated that a strong governance system leads to improved corporation performance, enhanced supervisory and protection of stakeholders’ interest; this section considers the impact of the Kenya’s corporate system on the country’s economic development.
a)Building investor confidence
One may question why shareholder rights are so important while the corporation’s purpose has been concluded as the maximisation of stakeholders’ utility. According to (Paredes 2005:34) shareholder protection encourages investment, development of capital markets, and ultimately economic growth. In the recent years, there is substantial increase in trading activities at NSE.
Strong investor protection is associated with an effective corporate governance system and the presence of greater security of property rights as proposed in (La Porta et al 2000). In addition Claessens et al (2003) cited in Kyereboah-Coleman & Biekpe (2006) mentions that a better corporate governance system benefits corporations through greater access to financing, lower cost of capital, increased market liquidity and more favourable treatment of all stakeholders. In Kenya, while appreciating other factors (among them enhanced corporate system) generates investor goodwill and confidence in the capital market thereby facilitating economic growth – to the extent that recent bond issues have been oversubscribed and foreign direct investment has significantly increased .
b)Mitigates corporation failures: prevention of fraud and ensuring the effective allocation and usage of resources
Developing economy provides much scope for corporate frauds, ineffective allocation and usage of resources resulting in non-optimal economic results. In fact Chen at al (2006:445) report that controlling stakeholders and management are faced with opportunities to increase personal wealth and expropriate assets for the benefit of controlling stockholders. Most significant, corporate governance provides a mechanism for influencing the accountability and fiduciary role of management and board and advocating for stakeholder protection (Otero 1998; Paredes 2005).
The enforcement of the governance code by the CCG, CMA, NSE, CBK and KPSCGT empower the judiciary and legal system to investigate and penalize fraud. This contributes to the long-term sustainable growth of corporations while supporting economic development. For instance, the immediate compensation to stakeholders’ of Nyaga Stockbrokers’ (now in receivership) upholds enforcement of corporation sustainability and economic growth CMA (2009). In addition, the implementation of the governance code in public institution shall significantly contribute toward efficient allocation of resources within companies where the government has a controlling stake. As highlighted in Nganga et al (2003), the Kenya Power & Lighting Company (KPLC) and the National Bank of Kenya (NBK) were often mentioned as cases where government involvement had perpetuated questionable accounting practices. In all, improved accountability by public institutions shall significantly reduce public expenditure and contribute toward efficient allocation of resources and national development.
In conclusion, while the impact of an enhanced corporate system is evident, the question for the Kenya corporate system would be: does the country have an optimal corporate governance system to enhance economic development?
CONCLUSION
The above discussion presents a case for enhanced corporate governance in developing countries. A review of the corporate system in Kenya presents a relationship between corporate governance and economic development. More specific, increased investor confidence and mitigation of corporate frauds boost economic development. While considering effective mechanisms supporting the corporation’s objective: survival and growth the corporation shall achieve its comprehensive purpose of stakeholder interest maximisation.
However, if the corporations are to effectively monitor management by protecting stakeholders’ interest from the abuses and mismanagement of directors and managers while also protect minority shareholders from selfish controlling shareholders, developing countries generally should turn to a mandatory model of corporate law instead of a market-oriented corporate governance system (Paredes 2005:34). In addition, the peculiar characteristics of corporations in the country present the need for small and micro enterprises to gain access to cost effective capital to fund growth and expansion of the economy.
Most significant, the review has highlighted a salient weakness in the legal system. The presence of an inefficient legal system and out dated laws presents a barrier toward the optimal implementation of corporate guidelines. The lengthy legal processes marred with political interference limits the practicability of instituting the governance guidelines. Musikali (2008) recommends for improved enforcement and adequate monitoring of corporate compliance. In conclusion, the business laws, legal and regulatory framework should be updated to optimize the benefits of corporate governance.