Corporate scandals and the need for corporate governance in Pakistan

Executive Summary
Corporate governance is at the centre of attention in today’s business world. This is greatly due
to the large number of stakeholders whose wealth and interests are at stake in the business. What
has further highlighted corporate governance today has been the increasing influence and
awareness of these stake holders. With out sound corporate governance a business cannot
survive.

Corporate governance in Pakistan is still at the developing stage. The regulators mainly; the
Securities and Exchange Commission of Pakistan and the State Bank of Pakistan, are constantly
engaged in developing corporate governance in the country. The government has formed an
institute of corporate governance which promotes good corporate practices through various
means.

Cases of poor corporate governance can be found around the world. They are mostly connected
to fraudulent practices. The other major malpractices were; irregularities in accounts, non-
compliance with law, nepotism, and exploitation of minority share holders. Pakistan has also had
its share of corporate frauds and scandals however the government has taken several steps to
reduce such malpractices and their effects.

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CONTENTS
1. CORPORATE FAILURES IN PAKISTAN DUE TO LACK OF CORPORATE
GOVERNANCE PRACTICES (Page # 3)

2. EVOLUTION OF CORPORATE GOVERNANCE (Page # 5)

3. THE CORPORATE GOVERNANCE SYSTEM (Page # 6)

4. NEED FOR CORPORATE GOVERNANCE (Page # 7)

5. CORPORATE GOVERNANCE IN PAKISTAN (Page # 8)

6. BENEFITS OF CORPORATE GOVERNANCE (Page # 9)

7. CORPORATE STAKEHOLDERS (Page # 13)

8. CONCLUSSION (Page # 15)

9. REFERENCES (Page # 16)

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1. CORPORATE FAILURES IN PAKISTAN DUE TO LACK OF

CORPORATE GOVERNANCE PRACTICES

Taj Company
The Taj Company was involved in poor corporate governance practices. The company was
running a scheme through which it was able to receive huge amounts of deposits illegally. What
was far more disappointing was the religious affiliation the company had attached with its name.
Even 15 years after their fraudulent practices have been stopped; the company still owes heavy
liabilities to over 25000 people.

Crescent Bank Fraud

The entire board of directors and CEO Anjum Saleem of Crescent Standard investment bank
were legally stopped from running their offices on evidences of suspected fraud and irregular
accounting. External Auditors had predicted a missing amount of over Rs.6 Billion, apart from
illegal maintenance of parallel accounts, concealment of bank assets, un-authorized massive
funding of group companies, unlawful investments in real estate and stock market, etc. the SECP
took legal action against the companies officers, although much of the actions taken were
criticized as insufficient.

PTCL

The privatization of PTCL was also a big corporate scandal. An ex-Senior Vice President has
claimed the privatization as Pakistan’s Biggest Financial fraud. PTCL former official further
commented that the deal was closed on 2.6 billion dollars including U-fone & Paknet, however
only U-fone had enterprise value of more than 6 billion dollars which does not include assets of
U-fone. Moreover, pricing decisions were made through old records instead of determining
current market value, which means, it was like Buy One Get 2 Free offer. It has been reported
further that in September 2006, when Etisalat had refused to honor the deal, they were offered a
secret price discount of 394 million dollars along with commitment to lay off 20,000 employees
and to bear the 50% cost of layout. Supreme Court of Pakistan has already given decision against

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the privatization of PSO and Pakistan Steel and if PTCL’s privatization gets challenged on true
facts, it will bring horrifying results.

ENGRO Group of Companies

SECP was at the receiving end of immense criticism once it had allowed Fertilizer giant ENGRO
to establish its subsidiary ENGRO Foods. Critics believed that the company was associated with
the urea business and were tremendously concerned about the extent to which hygiene
requirements for the industry would be met by ENGRO foods. However SECP counter argument
was based on the fact that ENGRO has had a rich history of sound corporate governance which
satisfied SECP that ENGRO will be responsible in regards to hygiene issues associated with
ENGRO foods. Time proved that Engro’s corporate governance was in good practice and has led
to the success of ENGRO food’s with products such as Olper’s Milk.

Mehran Bank

The National Accountability Bureau (NAB) has recovered Rs1.6 billion in the famous Mehran
Bank scandal case by selling Benami property of defunct bank’s chief Younus Habib in
Islamabad. The amount is stated to be the country’s biggest-ever single cash recovery in a wilful
loan default case. In addition, the Younus Habib Group will also pay Rs420 million.

According to the NAB, Younus Habib, former chief operating officer of the defunct bank, had
offered to settle his liability through the sale of his Benami property and accordingly entered into
a settlement agreement of Rs1.6 billion with the National Bank of Pakistan.

The Mehran Bank had been doing badly since its very beginning in January 1992, and banking
experts attributed this poor performance to Younus Habib's penchant for `extra-curricular
banking activities.

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2. EVOLUTION OF CORPORATE GOVERNANCE IN PAKISTAN

Corporate governance is at the centre of attention in today’s business world. This is greatly due
to the large number of stakeholders whose wealth and interests are at stake in the business. What
has further highlighted corporate governance today has been the increasing influence and
awareness of these stake holders. With out sound corporate governance a business cannot
survive.

Corporate governance is not just related to core business activities. Good corporate governance
caters to various other issues present in the society. Corporations today have developed a concept
of corporate social responsibility. The major components of corporate governance comprise of
company policies, Board of Directors, the role of the CEO, creditors, Stockholders, regulators,
reporting and maintaining overall transparency about the business operations.

In March 2002, the Securities and Exchange Commission of Pakistan issued the Code of
Corporate Governance to establish a framework for good governance of companies listed on
Pakistan's stock exchanges. In exercise of its powers under Section 34(4) of the Securities and
Exchange Ordinance, 1969, the SEC issued directions to the Karachi, Lahore and Islamabad
stock exchanges to incorporate the provisions of the Code in their respective listing regulations.
As a result, the listing regulations were suitably modified by the stock exchanges.

The Code is a compilation of “best practices”, designed to provide a framework by which

companies listed on Pakistan's stock exchanges are to be directed and controlled with the
objective of safeguarding the interests of stakeholders and promoting market confidence; in other
words to enhance the performance and ensure conformance of companies. In doing this, the
Code draws upon the experience of other countries in structuring corporate governance models,
in particular the experience of those countries with a common law tradition similar to Pakistan's.
The Code of Best Practice of the Cadbury Committee on the Financial Aspects of Corporate
Governance published in December 1992 (U.K.), the Report of the Hampel Committee on
Corporate Governance published in January 1998 (U.K.), the Recommendations of the King's
Report (South Africa), and the Principles of Corporate Governance published by the

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Organization for Economic Cooperation and Development in 1999 have been important
documents in this regard.

The Code is a first step in the systematic implementation of principles of The Code is a first step
in the systematic implementation of principles of good corporate governance in Pakistan. Further
measures will be required, and are contemplated by the SEC, to refine and consolidate the
principles and to educate stakeholders of the advantages of strict compliance.

Corporate governance is a relatively new term used to describe a process, which has been
practiced for as long as there have been corporate entities. This process seeks to ensure that the
business and management of corporate entities is carried on in accordance with the highest
prevailing standards of ethics and efficacy upon assumption that it is the best way to safeguard
and promote the interests of all corporate stakeholders.

3. THE CORPORATE GOVERNANCE SYSTEM

Corporate governance is the set of processes, customs, policies, laws and institutions affecting
the way a corporation is directed, administered or controlled. Corporate governance also includes
the relationships among the many stakeholders involved and the goals for which the corporation
is governed. The principal stakeholders are the shareholders, management and the board of
directors. Other stakeholders include employees, suppliers, customers, banks and other lenders,
regulators, the environment and the community at large.

The process of corporate governance does not exist in isolation but draws upon basic principles
and values which are expected to permeate all human dealings, including business dealings
principles such as utmost good faith, trust, competency, professionalism, transparency and
accountability, and the list can go on Corporate governance builds upon these basic assumptions
and demands from human dealings and adopts and refines them to the complex web of
relationships and interests which make up a corporation. The body of laws, rules and practices
which emerges from this synthesis is never static but constantly evolving to meet changing
circumstances and requirements in which corporations operate. From time to time, crisis of
confidence in effective compliance with, or implementation of, prevailing corporate governance
principles act as a catalyst for further refinement and enhancement of the laws, rules and
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practices which make up the corporate governance framework. The result is an evolving body of
laws, rules and practices, which seeks to ensure that high standards of corporate governance
continue to apply.

Some examples of corporate governance issues arising are the circumstances surrounding the
collapse of the South Sea Company (frequently referred to as the “South Sea Bubble”) in
England in 1720. The famous Enron case in 2002 and more recent examples are the Taj
Company Scandal in Pakistan.

4. NEED FOR CORPORATE GOVERNANCE

Good and proper corporate governance is considered imperative for the establishment of a
Competitive market. There is empirical evidence to suggest that countries that have implemented
good corporate governance measures have generally experienced robust growth of corporate
sectors and higher ability to attract capital than those which have not.

The positive effect of good corporate governance on different stakeholders ultimately is a

strengthened economy, and hence good corporate governance is a tool for socio-economic
development. After East Asian economies collapsed in the late 20th century, the World Bank's
president warned those countries, that for sustainable development, corporate governance has to
be good. Economic health of a nation depends substantially on how sound and ethical businesses
are.

Upon independence, Pakistan inherited the Indian Companies Consolidation Act, 1913. In 1949,
this Act was amended in certain respects, including its name, where after it was referred to as the
Companies Act, 1913. Until 1984, when the Companies Ordinance, 1984 (the Companies
Ordinance) was promulgated, following lengthy debate, Pakistani companies were established
and governed in accordance with the provisions of the Companies Act, 1913.

Corporate entities in Pakistan are primarily regulated by the SEC under the Corporate entities in
Pakistan are primarily regulated by the SEC under the Companies Ordinance, the Securities and
Exchange Ordinance, 1969, the Securities and Exchange Commission of Pakistan Act, 1997, and
the various rules and regulations made there under. In addition, special companies may also be
regulated under special laws and by other regulators, in addition to the SEC. In this way, listed

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companies are also regulated by the stock exchange at which they are listed; banking companies
are also regulated by the State Bank of Pakistan; companies engaged in the generation,
transmission or distribution of electric power are also regulated by the National Electric Power
Regulatory Authority; companies engaged in providing telecommunication services are also
regulated by the Pakistan Telecommunication Authority; and oil and gas companies are also
regulated by the Oil and Gas Regulatory Authority.

5. CORPORATE GOVERNANCE IN PAKISTAN

The SEC, since it took over the responsibilities and powers of the Corporate Law Authority in
1999, has been acutely alive to the changes taking place in the international business
environment, which directly: and indirectly impact local businesses. As part of its multi-
dimensional strategy to enable Pakistan's corporate sector meet the challenges raised by the
changing global business scenario and to build capacity, the SEC has focused, in part, on
encouraging businesses to adopt good corporate governance practices. This is expected to
provide transparency and accountability in the corporate sector and to safeguard the interests of
stakeholders, including protection of minority shareholders' rights and strict audit compliance.

Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive
Officer, the board of directors, management and shareholders). Other stakeholders who take part
include suppliers, employees, creditors, customers and the community at large.

In corporations, the shareholder delegates decision rights to the manager to act in the principal's
best interests. This separation of ownership from control implies a loss of effective control by
shareholders over managerial decisions. Partly as a result of this separation between the two
parties, a system of corporate governance controls is implemented to assist in aligning the
incentives of managers with those of shareholders. With the significant increase in equity
holdings of investors, there has been an opportunity for a reversal of the separation of ownership
and control problems because ownership is not so diffuse.

A board of directors often plays a key role in corporate governance. It is their responsibility to
endorse the organization’s strategy, develop directional policy, appoint, supervise and

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remunerate senior executives and to ensure accountability of the organization to its owners and
authorities.

All parties to corporate governance have an interest, whether direct or indirect, in the effective
performance of the organization. Directors, workers and management receive salaries, benefits
and reputation, while shareholders receive capital return. Customers receive goods and services;
suppliers receive compensation for their goods or services. In return these individuals provide
value in the form of natural, human, social and other forms of capital.

A key factor in an individual's decision to participate in an organization e.g. through providing

financial capital and trust that they will receive a fair share of the organizational returns. If some
parties are receiving more than their fair return then participants may choose to not continue
participating leading to organizational collapse.

6. BENEFITS OF CORPORATE GOVERNANCE

The popularity and development of corporate governance frameworks in both the developed and
developing worlds is primarily a response and an institutional means to meet the increasing
demand of investment capital. It is also the realization and acknowledgement that weak corporate
governance systems ultimately hinder investment and economic development. In a McKinsey
survey issued in June 2000, investors from all over the world indicated that they would pay large
premiums for companies with effective corporate governance. A number of surveys of investors
in Europe and the US support the same findings and show that investors eventually reduce their
investments in a company that practices poor governance.

Corporate governance serves two indispensable purposes.

 It enhances the performance of corporations by establishing and maintaining a

corporate culture that motivates directors, managers and entrepreneurs to
maximize the company's operational efficiency thereby ensuring returns on
investment and long term productivity growth.
 Moreover, it ensures the conformance of corporations to laws, rules and practices,
which provide mechanisms to monitor directors' and managers' behavior through
corporate accountability that in turn safeguards the investor interest. It is

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fundamental that managers exercise their discretion with due diligence and in the
best interest of the company and the shareholders. This can be better achieved
through independent monitoring of management, transparency as to corporate
performance, ownership and control, and participation in certain fundamental
decisions by shareholders.

Dramatic changes have occurred in the capital markets throughout the past decade. There has
been a move away from traditional forms of financing and a collapse of many of the barriers to
globalization. Companies all over the world are now competing against each other for new
capital. Added to this is the changing role of institutional investors. In many countries corporate
ownership is becoming increasingly concentrated in institutions, which are able to exercise
greater influence as the predominant source of future capital. Corporate governance has become
the means by which companies seek to improve competitiveness and access to capital and
borrowing in a local and global market.

Effective corporate governance allows for the mobilization of capital annexed with the
promotion of efficient use of resources both within the company and the larger economy. It
assists in attracting lower cost investment capital by improving domestic as well as international
investor confidence that the capital will be invested in the most efficient manner for the
production of goods and services most in demand and with the highest rate of return. Good
corporate governance ensures the accountability of the management and the Board in use of such
capital. The Board of directors will also ensure legal compliance and their decisions will not be
based on political or public relations considerations. It is understood that efficient corporate
governance will make it difficult for corrupt practices to develop and take root, though it may not
eradicate them immediately. In addition, it will also assist companies in responding to changes in
the business environment, crisis and the inevitable periods of decline.

Corporate governance is the market mechanism designed to protect investors' rights and enhance
confidence. Throughout the world, institutions are awakening to the opportunities presented by
governance activism. As a result, Boards and management are voluntarily and proactively taking
steps to improve their own accountability. Simply put, the corporations, including Pakistani
corporations, have begun to recognize the need for change for positive gain. Along with
traditional financial criteria, the governance profile of a corporation is now an essential factor

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that investors and lenders take into consideration when deciding how to allocate their capital.
The more obscure the information, the less likely that investors and lenders would be attracted
and persuaded to invest or lend. The lack of transparency, unreliable disclosure, unaccountable
management and the lack of supervision of financial institutions (all of which are the
consequences of inadequate corporate governance) combine to infringe investors' rights. Poor
corporate governance has a tendency to inflate uncertainty and hamper the application of
appropriate remedies.

Transparency can be achieved through three key market elements:

1. Openness
2. Accounting standards
3. Compliance reporting.

Efficient markets depend upon investor confidence in the accuracy and openness of information
provided to the public. Also, compliance with internationally recognized accounting standards is
necessary to ensure that investors can effectively analyze and compare company data. With
incorporation of the Code in the listing regulations of the Pakistan's stock exchanges, listed
companies are now under an obligation to act transparently.

Initially, principles of corporate governance were more specifically framed to facilitate the so
called “agency problems” that were a consequence of the separation of ownership and
management in publicly owned corporations. As the ownership of corporations is widely
dispersed, management of the corporation is vested in directors who act as agents for the owners,
(the shareholders). From this stems the theory that the interest of the shareholder is not
determined or protected by any formal instrument, unlike the interest of most stakeholders and
investors which can generally and adequately be protected through contractual rights and
obligations with the company. It is, for this reason, that corporate governance is primarily
directed at the effective protection of shareholder interests.

The corporate governance system specifies the rights of the shareholder and the steps available if
management breaches its responsibilities established on equitable principles from this springs
the “equity contract”. In addition to the applicable general law, the equity contract is created
under Section 31 of the Companies Ordinance.

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The inability or unwillingness to make credible disclosure constitutes a bad equity contract
which potentially makes it difficult for the market to distinguish good risk from bad resulting in
an inability to attract investors. The long term consequences of such inabilities prove to have a
crippling effect, not only on corporations, but also on the stock market as it blocks crucial
liquidity of the stock market, with the resultant weakening of the entire financial system.
Consequently, the increased cost of capital reallocates financing and the capital market towards
debt. A distinctive characteristic of the Pakistani corporate culture, however, is the pyramidal
ownership structure and corporations with concentrated ownership enabling large shareholders to
directly control managers and corporate assets. Thus the need for corporate governance should
not, perhaps, arise under the prevailing structure as the conflict of interest that emerges gives rise
to the “expropriation problem” as opposed to the “agency problem”. It is imperative, however, at
this stage, to acknowledge the rapid developments that are taking place within the Pakistan
corporate culture and the fading out of the traditional and more conventional corporate
formation. Furthermore, a good governance system is required for such institutions as the
success of any institution is a combined effort comprising of contributions from a range of
resource providers including employees and creditors. It is for this reason that the role of the
various stakeholders cannot go ignored and their rights and the corporations' obligations must be
determined. Financing of any kind, whether for publicly traded companies or privately held and
state owned companies, can only be made possible through the exercise of good corporate
governance.

7. CORPORATE STAKEHOLDERS

A corporation enjoys the status of a separate legal entity; however, the formation of a public
listed company is such that its success is dependant upon the performance of a contribution of
factors encompassing a number of stakeholders. A “stakeholder” is a person (including an entity

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or group) that has an interest or concern in a business or enterprise though not necessarily as an
owner. The ownership of listed companies is comprised of a large number of shareholders drawn
from institutional investors to members of public and thus it is impossible for it to be managed
and controlled by such a large number of diversified minds. Hence, management and control is
delegated by the shareholders to agents called the Board of directors. In order to achieve
maximum success, the Board of directors is further assisted by managers, employees,
contractors, creditors, etc. Therefore it is imperative to recognize the importance of stakeholders
and their rights.

Communication with stakeholders is considered to be an important feature of corporate

governance as cooperation between stakeholders and corporations allows for the creation of
wealth, jobs and sustain ability of financially sound enterprises. It is the Board's duty to present a
balanced assessment of the company's position when reporting to stakeholders. Both positive and
negative aspects of the activities of the company should be presented to give an open and
transparent account thereof.

The annual report is a vital link and, in most instances, the only link between the company and
its stakeholders. The Companies Ordinance requires directors to attach in the annual report a
directors' report on certain specific matters. The Code expands the content of the directors' report
and requires greater disclosure on a number of matters that traditionally were not reported on.
The aim is for the directors to discuss and interpret the financial statements to give a meaningful
overview of the enterprise's activities to stakeholders and to give users a better foundation on
which to base decisions. Specific emphasis has been placed upon the fiduciary obligations of
directors and hence the need to understand the implications of such obligations also arises.

Apart from the above, stakeholder communication should consist of a discussion and
interpretation of the business including:

 Its main features;

 Uncertainties in its environment;
 Its financial structure and the factors relevant to an assessment of future prospects
 Other significant items which may be relevant to a full appreciation of the business.

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WHAT ARE THE RULES OF CORPORATE GOVERNANCE?

Commonly accepted principles of corporate governance include:

 Rights and equitable treatment of shareholders: Organizations should respect the rights of
shareholders and help shareholders to exercise those rights. They can help shareholders
exercise their rights by effectively communicating information that is understandable and
accessible and encouraging shareholders to participate in general meetings.

 Interests of other stakeholders: Organizations should recognize that they have legal and
other obligations to all legitimate stakeholders.

 Role and responsibilities of the board: The board needs a range of skills and
understanding to be able to deal with various business issues and have the ability to
review and challenge management performance. It needs to be of sufficient size and have
an appropriate level of commitment to fulfill its responsibilities and duties. There are
issues about the appropriate mix of executive and non-executive directors. The key roles
of chairperson and CEO should not be held by the same person.

 Integrity and ethical behaviour: Ethical and responsible decision making is not only
important for public relations, but it is also a necessary element in risk management and
avoiding lawsuits. Organizations should develop a code of conduct for their directors and
executives that promotes ethical and responsible decision making. It is important to
understand, though, that reliance by a company on the integrity and ethics of individuals
is bound to eventual failure. Because of this, many organizations establish Compliance
and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal
boundaries.

 Disclosure and transparency: Organizations should clarify and make publicly known the
roles and responsibilities of board and management to provide shareholders with a level
of accountability. They should also implement procedures to independently verify and

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safeguard the integrity of the company's financial reporting. Disclosure of material

matters concerning the organization should be timely and balanced to ensure that all
investors have access to clear, factual information.

8. CONCLUSION

Corporate governance is the mechanism by which the agency problems of corporation

stakeholders, including the shareholders, creditors, management, employees, consumers and the
public at large are framed and sought to be resolved.

Corporate governance is an inevitable phenomenon of corporate businesses. Whether it is good

or bad is determined by the performance of the components. Good corporate governance is being
promoted in almost all parts of the world.

Corporate governance is at the evolutionary stage in developing countries. However that does not
mean that poor corporate governance is not present in the developed world. With cases such as
the Enron bankruptcy, it is quite evident that corporate governance mal-practices are present
everywhere. Major issues in corporate governance are Ethical dilemmas, Window Dressing,
Board Composition, and interaction with minority shareholders.

The following of corporate governance principles is not that common in Pakistan and it is still
ignored by companies because the market is not aware of it. But the short benefits should not be
given more importance than long term benefits that Corporate Governance brings with it. If a
company wants to establish a long term loyalty base relationship with stakeholders than there is
no other way but to adopt good Corporate Governance ideals.

9. References:

 http://telecompk.net/2007/09/04/ptcl%E2%80%99s-privatization-the-biggest-
financial-scam-in-pakistan%E2%80%99s-history/

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 http://www.nation.com.pk/pakistan-news-newspaper-daily-english-
online/Business/10-Feb-2009/Corporate-Governance-ensures-management-
accountability

 www.wikipedia.com

 www.picg.org.pk

 www.defencejournal.com/dec99/open-letter.htm

 http://www.dhalahore.biz/ads/index.php?
command=searchnamepostsandcomments&searchstr=SM&entry=0

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