Corporate Governance Report Bangladesh PDF

A Comparative Analysis of Corporate Governance in South Asia:
Charting a Roadmap for Bangladesh
Edited by Farooq Sobhan and Wendy Werner
Published by Bangladesh Enterprise Institute

House 20, Road 5, Gulshan 1, Dhaka 1212, Bangladesh
Tel: (8802) 9892662-3
www.bei-bd.org; bei@bol-online.com
Acknowledgements
The authors would like to thank the UK Department for International Development (DFID),
Global Corporate Governance Forum (GCGF), and the Commonwealth Secretariat for their
support of this research and project. In particular, Bangladesh Enterprise Institute would like to
thank Frank Matsaert and Michael Gillibrand for their valuable comments and advice.
Table of Contents
Preface
Introduction
How to Contact the Authors
11
Bangladesh
12
Diagnostic Study of the Existing Corporate Governance Scenario in Bangladesh

India
130
Getting There Pretty Rapidly: The State of Corporate Governance in India

Pakistan
166
Corporate Governance in Pakistan: Ownership, Control and the Law

Sri Lanka
Corporate Governance in Sri Lanka. Fast off the Tracks: But Is The Progress
Real Progress?
266
Preface
In 2002, Bangladesh Enterprise Institute embarked on a project to examine the current state of
corporate governance norms and practices in Bangladesh, India, Sri Lanka, and Pakistan. From
the outset, we knew that Bangladesh lagged behind its South Asian neighbours with regard to
corporate governance standards and practice and hoped that a comparative analysis would
provide regional examples of initiatives that could be applied in Bangladesh to improve the
situation. This publication is the product of the first stage of the project, which comprised of four
reports on the state of corporate governance in Bangladesh, India, Sri Lanka, and Pakistan. We
were fortunate to be able to work with experts in corporate governance in each of the countries
involved.
Through the research process, the project has identified areas where reform is needed in
Bangladesh and explored successful Corporate Governance initiatives and practices in the region.
The country reports use the Organisation for Economic Cooperation and Development (OECD)
Principles of Corporate Governance as an international benchmark. Each of the reports covers:
A review or survey of literature relating to CG in the country;
Identification of the strengths and weaknesses and key institutions of the CG
landscape;
Identification and analysis of the disparities between legal and regulatory corporate
governance requirements and actual corporate governance practices;
Examination of arrangements and incentive structures in place to enable good CG;
Analysis of unsuccessful corporate governance initiatives and the causes of
continuing poor corporate governance behaviour;
Evidence of indicative improvements in company performance and investment
resulting from better corporate governance.
As is documented in this volume, in Bangladesh, failings in institutions, government agencies,
legal enforcement, and market behaviour have resulted in weak corporate governance. In many
cases, the current system in Bangladesh does not provide sufficient legal, institutional, or
economic motivations for stakeholders to encourage and enforce good corporate governance
practices. As a result, there are few rewards for companies that institute good corporate
governance practices and no penalties for failing to do so. Targeted reforms in institutions or
sectors can begin to provide the internal and external motivation for transparency and
accountability that will lead to better corporate governance.
Although Pakistan, Sri Lanka, and India have some similarities with Bangladesh in the way that
the financial sector and private sector have developed historically, Bangladeshs neighbours have
recognized the importance of corporate governance and increased transparency in the corporate
sector. Pakistan has a Code for Corporate Governance to which all listed companies are now
required to comply. India has had several high-level committees looking at corporate
governance. The Confederation of Indian Industry (CII) issued a voluntary code of desirable
corporate governance in 1998 and the Securities and Exchange Board of India (SEBI) approved
mandatory corporate governance listing requirements in the year 2000. Sri Lanka also has a Code
of Best Practice on Corporate Governance drawn up by the Institute of Chartered Accountants of
Sri Lanka. In each country, the codes have begun the process of encouraging or requiring
companies to recognize the importance of good corporate governance practices.
Comparative Analysis of Corporate Governance in South Asia
In concert with the efforts to design benchmarks for good corporate governance that are relevant
to South Asian countries, efforts are under way to harmonise and improve accounting and
auditing standards. The Accounting and Auditing Standards Monitoring Board in Sri Lanka and
the Audit Quality Control Review Committee in Pakistan are two particularly good examples that
could be emulated in Bangladesh.
The process of strengthening corporate governance in South Asia is ongoing. As the reports in
this volume point out, there are many aspects of the corporate governance regime in South Asian
countries that continues to lack strength. As Ajith Nivard Cabraal points out in his report on Sri
Lanka, there are questions regarding actual corporate governance performance compared to stated
corporate governance practices. Procedures for bankruptcy and insolvency in India are identified
as a sticking point by Omkar Goswami. Finally, Faisal Bari and Ali Cheema question whether
the requirements enshrined in the Pakistani Code of Corporate Governance will be too onerous
for small companies.
However, Bangladesh has much to learn from its South Asian neighbours and learn it must. For
Bangladesh to improve its economic performance, it must attract more investment capital both
from domestic and foreign investors. Better corporate governance is a prerequisite for investors
to entrust their funds to corporations. For Bangladesh, the first step in strengthening the role of
stakeholders in corporate governance is raising awareness regarding these issues and increase
consensus about the need for better corporate governance. In addition, there should be more
recognition that corporate governance is integral and necessary to the development of the private
sector in Bangladesh. To achieve these goals of better awareness and recognition of good
corporate governance practices, starting in August 2003, Bangladesh Enterprise Institute is
convening a Taskforce on Corporate Governance that will develop and endorse a Code of
Corporate Governance for Bangladesh. This Taskforce will begin the first step in bringing
Bangladesh up to a level equivalent with international and regional standards of corporate
governance.
This project would not have been possible without the support we received from Department for
International Development (DFID), Global Corporate Governance Forum (GCGF) and the
Commonwealth Secretariat. We were also extremely fortunate in having as our country partners
Omkar Goswami, one of Indias leading experts on Corporate Governance, Ajith Cabraal, who
chaired the very first taskforce established in Sri Lanka on Corporate Governance and Faisal Bari
and Ali Cheema two of the leading experts in Pakistan, who took a keen interest in the whole
project from the start. The seven-member BEI team on Corporate Governance consisting of Ms.
Nihad Kabir, Ms. Wendy Werner, Ms. Sheela R. Rahman, Mr. Yawar Sayeed, Mr. Monzurul
Haque, Ms. Shahnila T. Azhar and myself was a model of dedication, enthusiasm and hard work.
Though the collective effort of the team we were able to cover a lot of ground on all aspects of
Corporate Governance in Bangladesh. Throughout this period we received valuable advice and
suggestions from Michael Gillibrand (the Commonwealth Secretariat), Anne Simpson (GCGF)
and Frank Matsaert (DFID). I would like to thank all the persons mentioned above for their
support and contribution. I would also like to say how much we appreciated the encouragement
we received from the Minister of Commerce, the Minister of Law and Parliamentary Affairs, the
Governor of Bangladesh Bank, the Securities and Exchange Commission, the Institute of
Chartered Accountants and a host of other people in the government and in the private sector.
Farooq Sobhan
President, Bangladesh Enterprise Institute
August 2003
Introduction
Michael Gillibrand
Special Adviser and Head of Advisory Services
Commonwealth Secretariat
1.
Purpose and Framework for the South Asian Comparative Analysis.
This comparative analysis of the state of corporate governance in South Asia was launched by the
Bangladesh Enterprise Institute (BEI) in 2002, with the objective of laying a firm foundation of
clear strategic thinking, combined with practical experience from other countries, for the
commencement of a national programme to promote good corporate governance in Bangladesh.
This initiative of the BEI is to be highly commended, not only in terms of its academic value but
also of its practical purpose in preparing for major development policy innovations. There are
few precedents in the world where national programmes have been based on systematic research
on neighbouring countries. The research has been funded by the Department for International
Development of the British Government, with support from the Global Corporate Governance
Forum of the World Bank and the OECD, and the Commonwealth Secretariat.
The project aims to assess the development to date of corporate governance in Bangladesh, India,
Pakistan and Sri Lanka, using the OECD Principles for Corporate Governance as the common
reference. The terms of reference for the research team in each country were to:
carry out a review of the literature relating to corporate governance in each country;
identify the major features of corporate governance in each country, including the current
strengths and weaknesses;
identify the disparities between the theory and the practice of corporate governance and
assess the causes of such disparities;
examine the conditions for enabling good corporate governance, in particular through
case studies focussing on successful arrangements such as the institutions and their
underlying incentive structures, and also on unsuccessful initiatives.
This comparative analysis is part of three continuing and interlinked processes. First, by
compiling the history to date of corporate governance in Bangladesh, India, Pakistan and Sri
Lanka, it makes a significant academic contribution to the knowledge of corporate governance in
the emerging markets and developing economies of the world. This is still a relatively unknown
area, as by far the greatest amount of research on corporate governance has been done in the
advanced capital markets of North America and Europe, and a certain amount in South East Asia.
The analysis of the structures, processes and constraints of the capital markets of the subcontinent which are provided by the writers of this BEI study significantly advance our
understanding of the realities of the markets, and can therefore lead to much better informed
policies for South Asia and for other developing economies across the world. The special feature
of this comparative analysis is its diversity within its commonality: it pays equal attention to all
four countries and so encompasses the experiences of India, whose sophisticated capital markets
have over a century of experience and with a large and diversified manufacturing base which was
established prior to independence half a century ago, with the experiences of Bangladesh, one of
the poorest countries in the world with a very small capital market, a limited industrial base and a
private sector which has effectively developed only over the past quarter century. Despite these
differences, the shared heritages of these four countries of the sub-continent, together with the
similarities of their legal systems, public and private institutions and government structures,
enable valuable lessons of experience to be gained for the future development of corporate
governance in developing countries. Otherwise, the main comparative analysis has been the
review of selected emerging markets undertaken by the OECD Development Centre, and
published in July 2003 as Corporate Governance in Development - The Experiences of Brazil,
Chile, India and South Africa1.
The second process is the promotion of corporate governance in Bangladesh. On the basis of the
well proven principle that time spent on reconnaissance is seldom wasted, the publication of this
comparative analysis in August 2003, will be followed by the BEI helping to initiate a
comprehensive corporate governance programme covering all the main sectors of the economy.
It is envisaged that this will include the formation of a national taskforce on corporate
governance, with the immediate objectives of exploring the need for national codes and other key
elements for the implementation of good corporate governance practice. This study well
illustrates a critical issue which had been perceived by the BEI at the commencement of the
whole exercise that Bangladesh lags behind the other large countries of the region in the field of
corporate governance. India, Pakistan and Sri Lanka already have, for example, national codes
and one or several institutions actively implementing corporate governance programmes, while in
Bangladesh the subject has been a matter for discussion but not yet for policy or implementation,
with a few exceptions. In fact, after the completion of the research for this comparative analysis,
the Bangladesh Bank has, in mid-2003, commenced a series of banking sector reforms which
involve corporate governance systems. As part of the national programme, the results of this
comparative analysis, and the recommendations given in the report on Bangladesh, will be
presented and debated in a series of policy workshops involving all the key stakeholders. The
first such workshop was held in January 2003 to consider the preliminary findings of the report
on Bangladesh, while the next workshops will cover the comparative analysis and culminate in a
national conference which will help to set out the road map and the milestones for good corporate
governance. This study is thus the first large stride in a long road.
The third process is the building of a network of corporate governance specialists in the whole
sub-continent. This comparative analysis has been prepared by a team of multi-disciplinary
specialists, comprising professional accountants, bankers, economists, lawyers and policy
analysts, from Bangladesh, India, Pakistan and Sri Lanka who have, as part of this joint effort,
formed a regional network. This network in turn can evolve to become a platform to promote
further regional-scale corporate governance programmes to try and benefit the whole subcontinent. Whether entirely reasonable or not, it is a reality that in the world of international
investment, the reputation of one national market can influence the reputation of others in the
same region, either positively or negatively. Hence there is a need for regional cooperation to
reduce the risk of deficiencies in one country of a regional market being perceived as contagious
and also attributed to neighbouring countries a fact recognized by the South Asia Federation of
Exchanges (SAFE), consisting of the stock exchanges of Bangladesh, India, Pakistan, Sri Lanka,
Nepal and Mauritius. In this regional context, it should be noted that Mauritius had initiated
corporate governance policies in 1996, formed a national task force in 2001, and have released
their national code in 2003, which further emphasizes the need for action in Bangladesh.
2.
The Significance of Corporate Governance
Corporate Governance in Development - The Experiences of Brazil, Chile, India and South Africa. by C.
Oman, CIPE and OECD Development Centre, 2003. The chapters on India are authored by Omkar
Goswami, who is also the writer of the report on India for this BEI study.
Why is there all this attention to corporate governance, not only in South Asia but throughout the
world? This comparative analysis provides clear answers to the question. The South Asian
country studies show that the attention to corporate governance was motivated not by the East
Asian financial crisis in 1997/98 (which did not involve South Asian countries, though the whole
of Asia was effected by the fear of contagion), nor by the scandals in America, Australia,
Britain and Canada, in the late 1980s and early 1990s, which led to the high profile reports such
as from the Bosch, Cadbury and Dey committees and gave such prominence to the previously
scarcely known subject of corporate governance, but by home-grown problems in their own
financial markets.
In India there was the securities scam (involving a large number of banks) leading to the stock
market crash in 1992, followed by the consolidation of equity ownership by multinational
companies listed on the stock markets, and then by the stock market bubble in 1993 and crash of
the disappearing companies in 1994, which devastated the primary market until the end of the
century. These led to the formation by the Confederation of Indian Industry of the Bajaj
Committee on corporate governance in late 1995, well before the East Asian financial crisis. In
addition, the country report shows how the Indian capital markets had reached a crisis-point
where the accumulated distortions of decades of restrictive state policies and of corporate control
(traced back to the managing agencies in the earliest days of the stock markets in the 19th
Century) had highlighted the need for urgent capital market reform.
In Sri Lanka, the concern for corporate governance originated in the numerous company failures,
especially finance companies, in the late 1980s and early 1990s, which caused investors to lose
faith in the regulatory and semi-regulatory frameworks, as well as the standards of financial
reporting. Accordingly, the Institute of Chartered Accountants of Sri Lanka set up a task force in
1992 (about the same time as the Cadbury committee in UK) to enforce Sri Lankan accounting
standards, and then extended this initiative in 1996 (again before the East Asian financial crisis)
to set up a committee to make recommendations on the financial aspects of corporate governance.
Pakistan commenced its corporate governance programmes later, following the Securities and
Exchange Commission of Pakistan Act in 1997, the commencement of operations by the
Commission in 1999, and the introduction of the national Code for Corporate Governance in
early 2002. But despite the later start, it is evident from the country report that the initiatives in
Pakistan were driven by home-grown realities, in particular the recognition that the traditional
structures and operations of the capital market, especially lending from state-owned banks, could
no longer sustain the financing needed for growth, hence there is a critical need for reform of the
capital markets in order to mobilize domestic savings and foreign portfolio investment, as there
had been in India a decade earlier. In fact, despite the later start with formal national policies, it
could be said that Pakistan focused on corporate governance earlier than many countries in the
world, not just the region the Pakistan country report emphasizes the importance of the 1984
Companies Ordinance Act, which introduced a number of key features of good corporate
governance, at a time when the very term corporate governance had only just been coined and
was still effectively unknown outside very specialized academic circles2. Furthermore, during the
mid-1980s there were some significant policy and training programmes to strengthen corporate
control, board direction and chairmanship in both the state enterprises and the private sector,
through the Expert Advisory Cell of the Ministry of Industry and the Lahore University of
Management Sciences and Institute of Personnel, supported by USAID. Although these
The origin of the term corporate governance is generally credited to Professor Tricker in 1984.
programmes were not described as corporate governance, they could be said to form part of the
corporate governance heritage of Pakistan.
In Bangladesh, however, there have been no serious corporate scandals which have been enough
to send shock waves to undermine confidence in the financial system, nor has the country found
that it has reached the limits of conventional corporate financing mainly through bank lending.
The country report identifies that the relatively low level of international investment in
Bangladesh does not provide a sufficient motivation for improving corporate governance, nor are
there many traditional domestic motivations for improvement in corporate governance practices
in Bangladesh. Nevertheless, the report concludes that this does not mean that Bangladesh
should give low priority to corporate governance, as there are reasons other than capital market
reforms to focus on corporate governance. The Bangladesh country report notes the significance
of corporate governance for a competitive private sector in a global market as well as for
efficiently utilizing domestic investment to achieve greater economic development. Good
corporate governance practices will help develop and stimulate better business management,
strategic management, and risk management, which, in the long-term, will make Bangladeshi
businesses more competitive. In addition, the lessons from the experience of the neighbouring
countries in South Asia are such that Bangladesh can deploy good corporate governance to
prevent the problems which have afflicted other countries rather than to solve them after the
event.
The country reports go beyond describing the significance of corporate governance in theoretical
and policy terms they also provide indications of the effectiveness of corporate governance.
Perhaps the most important question for corporate governance is whether well-governed
companies perform better (in terms of growth, profitability and share price) and behave better (in
terms of corporate social and environmental responsibility and of corporate citizenship, especially
in tackling the supply side of corruption) than do badly-governed companies. Good corporate
governance is virtuous, but does it deliver results? It could be said that this question implicitly
runs like a theme through the Bangladesh country report, and explicitly emerges in conclusions
such as nor are there many traditional domestic motivations for improvement in corporate
governance practices in Bangladesh. There is a possible challenge that, unless there are
satisfactory answers to this question of the efficacy of corporate governance, Bangladesh and
other countries will, quite reasonably, not be convinced of the need to assign high priority to
corporate governance programmes. As the author of the India country report remarked on his
second page: by the middle of 2001, however, most of Asia was getting back to a concerted
growth phase, and the psyche of investors had swung from fear to greed. Not unsurprisingly,
there were incipient signs that while every country was faithfully mouthing the mantras, the spirit
of corporate governance was being prepared for a quiet burial in most. Thankfully, then came
Enron, followed by World Com, Q West, Global Crossing and the rest of their ilk. The feelings
attributed to Asia in 2001 were not new: after the sequence of the Cadbury, Greenbury and
Hampel reports in Britain in 1998, there was a general complaint of governance fatigue in the
corporate sector, and a request that a line be drawn under corporate governance. Corporate
governance was seen as a box-ticking exercise in compliance with standards designed to
prevent fraud and gross negligence, not as a tool to improve the real performance of companies
which consider themselves to be fundamentally honest and competent and the great majority of
companies consider themselves to be so, even if some might be deluded. Enron, and Marconi in
UK for different reasons, showed that corporate governance is still essential, and also
demonstrated that it must be applied in the spirit as well as the letter. But the question still
remains whether corporate governance can enhance the performance of fundamentally sound
companies, and must be answered, not by another scandal, but by consistently improved
performance by well-governed companies.
It has to be acknowledged that, globally as well as in the South Asia region, these are still early
days for the full assessment of the results which can be achieved by corporate governance, and
the task is complicated by methodological difficulties of isolating the influence of corporate
governance from other factors. Hence there is still a lack of conclusive evidence on this subject.
Nevertheless, the India country report states some firm conclusions : Indian corporations have
appreciated the fact that good corporate governance and internationally accepted standards of
accounting and disclosure can help them to access the US capital markets . . .with Infosys making
its highly successful NASDAQ issue 1 March 1998, followed by ICICI, Satyam Infoways,
Satyam, ICICI Bank, Wipro, HDFC Bank, Dr. Reddys Laboratories and others this has shown
that good governance pays off and allows companies to access the worlds largest capital market;
second, it has demonstrated that good corporate governance and disclosures are not difficult to
implement the message is now clear: it makes good business sense to be a transparent, well
governed company. It should also be noted that these benefits may be gained only with some
costs: in order to access the US capital markets ICICI Bank voluntarily recast its accounts for
1999 in terms of US accounting standards, which eroded its bottom-line by a third but gained
enormous investor confidence so that its domestic initial public offer was oversubscribed by 80%.
This case has a resonance of the experience of Siemens, which found that its impressive
profitability was turned into a loss the first time it had to present its accounts under US rather than
German accounting standards. The India country report also concludes with the benefits of
capital market reforms, of which corporate governance is an essential part. These benefits
include the phenomenal growth in market capitalization, (which) has triggered a fundamental
change in mindset from appropriating larger slices of a small pie, to doing all that is needed to let
the pie grow, even if it involves dilution of share ownership, and the increase in foreign portfolio
investors, who have voted with their feet. . .. Over the last two years they have systematically
increased their exposure in well governed firms at the expense of poorly run ones. Finally, there
has been the restructuring of the Indian corporate sector, which is a consequence not only of
corporate governance but of the whole package of reforms. The India country report highlights
that by 2002, 22 out of the top 50 Indian companies in terms of market capitalization either did
not exist or were not listed on any stock exchange in 1991, and 35 out of the top 50 companies in
2002 are now professionally managed, while the rank of the top 50 companies in 1991 fell by an
average of 88 points on the stock market. Thus, the questions which may be posed in Bangladesh
are: in 2015, which will be the top companies on the Dhaka and Chittagong stock exchanges, and
how large will they be, without corporate governance reforms, and with corporate governance
reforms?
The Sri Lanka country report also indicates the tangible benefits of good corporate governance
but, it should be noted, with some serious caveats concerning the actual practice of good
corporate governance as opposed to the pro-forma presence of the main criteria of good corporate
governance. The Sri Lanka country report included a sample survey of 21% of all the companies
listed on the Colombo Stock Exchange, and found that the average score was 45% of the total
achievable 19 criteria for good corporate governance. However, some companies scored
significantly higher with over 60%, and it was found that these companies had outperformed the
stock market index. The report therefore concludes that while there may be a number of factors
influencing the performance of a company, we believe that corporate governance disclosure and
good corporate governance practices are a significant contributory factor.
In addition to the country reports, there are external indicators that good corporate governance
generates improved performance and benefits to companies. McKinseys Global Investor Survey
has long been quoted as evidence of the advantages of corporate governance, and the 2002 survey
showed that over 80% of Asian investors ranked good corporate governance as equally or more
important as financial issues, and 78% said that they would be willing to pay a premium for
shares in a well governed company. In May 2003, the Asian Corporate Governance Association
released its annual survey of corporate governance in Asia, covering 10 countries and 380
companies across the region. Among the major findings were that companies with strong
governance outperformed their markets by an average of 35 percentage points over 5 years (19982002), while those with poor governance underperformed by 25 percentage points over the same
period. The average company score in corporate governance standards has risen by 4 percentage
points - from 58% in 2002 to 62% in 2003 - but the range in company scores remains extremely
wide and a cause for concern, so that the survey concludes like the Sri Lanka country report
that much of the improvement in CG is in form rather than substance. Nevertheless, the
indicators are that where form is indeed backed by substance there are significant gains to the
company
3.
Features and Lessons of the Comparative Analysis
The four country studies provide an immensely rich resource which can be mined for numerous
lessons of experience and critical factors for corporate governance. One special feature of the
reports are the case studies and anecdotes of the successes and failures of corporate governance,
which both bring to life the realities of what is otherwise a dry and complicated subject, and can
provide valuable training cases. Each country report contains a convenient summary or
conclusion which encapsulates the main results of the study, and demonstrates the particular
approach and focus of the research team, with similarities and differences among the countries,
and most certainly each report merits thorough attention. The reports provide an extensive
checklist of critical factors for good corporate governance, which are too extensive to summarise
in a brief introduction, but some are of particular significance as they reflect issues and factors
which have not been well highlighted in other studies, or are likely to be of particular importance
in developing practical policies for South Asia.
The first lesson which emerges from the country reports is that corporate governance cannot be
introduced in isolation from a range of other reforms (macro-economic, micro-economic,
accounting, legal, banking and institutional) nor can these other reforms achieve all their
objectives without corporate governance initiatives. The India and the Pakistan country reports
both provide outstanding analyses of the problems and market distortions which have built up
from decades of varying government policies and from strong entrenched structures and interests
of the private sector, and the complexity of picking apart the range of policies and targeting the
reforms. Reform is a cumulative process, and one set of reforms uncovers the need for other
reforms, so the challenges lie in policy management in conceptualizing and implementing a
road map of parallel and sequential reforms which constitute a comprehensive programme,
without becoming an unmanageable grand plan needing some form of philosopher-king to
enforce all the provisions in perfect synchronisation. Bitter experience shows that this cannot be
achieved, especially in vibrant democracies, but there is also the bitter experience that
liberalization reforms without effective regulatory systems and agencies may have very high
transitional costs (as India learned after 1994).
A second lesson, closely associated with the first, is the need to monitor the trends in different
sectors of the markets so as to try and avoid (or at least prepare for) a perfect storm, when there
is a confluence of several negative trends which, individually might be manageable, but together
form a crisis. Again, the India, Pakistan and Sri Lanka country reports show the dangers of
multiple fault lines in the financial and corporate sectors, such as the burden of non-performing
loans, dependency on formal and informal protection and on state development finance
institutions, structural imbalances between ownership and control and high agency costs,
outmoded laws, and lack of inflow of investment capital.
A third lesson is the need for a range of players to improve corporate governance, and the
indication that a degree of stick may be needed together with the carrots of increased
investment and performance. It is noticeable that in India the initiative for improved corporate
governance came from the Confederation of Indian Industry, who produced a voluntary code and
which they encouraged their members to follow and to demonstrate in highly advanced model
annual reports, again designed by the C.I.I. These model reports included sections of corporate
social and environmental responsibility as well as corporate governance, and set out rigorous
points of detail such as the board attendance record as well as the remuneration of individual
board members. However, only about 20 companies followed these guidelines, and it required
the intervention of the regulator (in the form of SEBI, the Securities Exchange Board of India,
and the Ministry of Company Affairs) to significantly widen the application of corporate
governance. Even then progress has been slow, and both the Indian and Sri Lankan country
reports note the significance of ratings agencies in demanding good corporate governance as well
as financial management systems for better credit ratings. Sri Lanka in particular shows the roles
of the regulators and credit agencies, combined with professional institutions such as the
chartered accountants, chartered company secretaries, institutes of directors, chambers of
commerce.
A fourth lesson is the critical importance of the company and contract laws and the efficacy of the
legal system. It is notable that all the countries have developed special commercial courts of one
sort or another to handle the commercial disputed, but the reports all generate a sense of gloom,
almost of despair, when it comes to the efficacy of the law, and of the need to modernize
bankruptcy and liquidation proceedings.
This is linked with the fifth lesson, which is the critical importance of the traditional family
ownership and control structures, and the concern that corporate governance is observed more in
form than substance. This is shown by the sub title of the Sri Lanka country report (Corporate
Governance in Sri Lanka Fast off the Tracks: But is the Progress Real Progress?) and of the
Asian Corporate Governance Association survey for 2003 (Fakin It: Board Games in Asia).
The Pakistan country paper provides an incisive view of the family control system and the
prevalence of the pyramid structures of control (higher than countries in South East Asia), while
the India country paper gives a brief but penetrating analysis of the contrasts between the agency
costs of the conventional Jensenian (Anglo-Saxon) model of the critical relationship of
separation of ownership and control in corporate governance in the US and Britain, and the
interlinked ownership and control (including pyramid corporate cross-holdings) which
characterise Asian companies. But the India report also leads towards the solution which is a
change in the mindset, with a new focus on growing the pie even if it involves dilution in share
ownership, so that families can increase and diversify their wealth by becoming investors in other
companies instead of concentrating on control of their own company.
These realities would compel a sense of caution of expectations of rapid improvement, but while
caution is an essential discipline the sixth lesson is that it should not be a reason or an excuse for
inaction and despondency. In contrast to Sri Lanka and the Asian Corporate Governance
Association, the India country report has a confident title : Getting there Pretty Rapidly : the
State of Corporate Governance in India, and its concluding sentence is by the time Beijing
hosts the 2008 Olympics, India might have the largest concentration of well governed companies
in South and South East Asia. One of the reasons for this optimism is the old 80/20 rule,
meaning in this context that if the top 20% of companies are targeted for good corporate
governance they will cover a level of 80% of the stock market capitalisation, and thus have a
powerful demonstration effect on the rest of the country. This is probably a valid strategy for all
the countries, where there is a heavy concentration of capitalisation in the top 100 companies,
though not as much as 80% due to the increased capitalisation.
This matter of the materiality of the largest companies brings to the seventh main lesson of the
comparative analysis (which is the last for this Introduction but not for the whole programme):
the significance of corporate governance for other types of enterprises which are not extensively
covered in these reports (necessarily as the terms of reference have to be confined for this initial
stages). Perhaps the most important of these other types of enterprises are the state enterprises,
which still loom very large in all these four countries. The India country report has a section
dealing with state enterprises, and notes that these account for 34% of Indias corporate paid-up
capital. The Bangladesh report alludes to the significance of the state enterprises, and the
research has also shown the need for good corporate governance practices for medium enterprises
and for Non-Governmental Organisations, which in Bangladesh and other countries often form
important trading enterprises as well as crucial social development agencies. But these matters
can at this stage be left for the next phases of the regional and national corporate governance
programmes, and for further research which will be undoubtedly required to fine-tune many of
the critical aspects of corporate governance policies.
10
How to Contact the Authors

Bangladesh
Farooq Sobhan (bei@bol-online.com)
Wendy Werner (bei@bol-online.com)
Nihad Kabir (nkabir@bol-online.com)
Sheela Rahman (sheela@bdmail.net)
Yawer Sayeed (ceo@aims-bangladesh.com)
Monzurul Haque (mhaque@global-bd.net)
Shahnila Azher (shahnila@bdcom.com)
India
Omkar Goswami (omkar.goswami@ciionline.org)
Pakistan
Faisal Bari (bari@lums.edu.pk)
Ali Cheema (cheema@lums.edu.pk)
Sri Lanka
Ajith Nivard Cabraal (nivard@eureka.lk)
Michael Gillibrand (m.gillibrand@commonweath.int)
11
Diagnostic Study of the Existing Corporate Governance Scenario

in Bangladesh
Authors and Consultants:

Farooq Sobhan
Shahnila Azher
Monzurul Haque
Nihad Kabir
Sheela Rahman
Yawer Sayeed
Wendy Werner
Table of Contents
List of Abbreviations
14
Acknowledgements
15
Project Introduction
15
Executive Summary
21
Companies, Corporate Laws and Practice
28
Financial Sector Scenario and Governance
29
Accounting Standards and Disclosures
52
Independent Regulators
55
The Judiciary
65
State Owned Enterprises
65
Existence and Role of Pressure Points
67
Conclusion
68
List of Appendices
Appendix A. Terms of Reference for Country Partners
72
Appendix B. List of Organisations Interviewed
76
12
Appendix C. List of Corporate Governance Stakeholders Interviewed
77
Appendix D. Questionnaire Corporate Sector
78
Appendix E. Questionnaire Financial Sector
84
Appendix F. Corporate Survey Findings
89
Appendix G. List of Relevant Laws and Regulations in Bangladesh
95
Appendix H. Forms to be Submitted to the RJSC and Other Bodies
98
Appendix I. Current ICAB Adoption Status of IAS
100
Appendix J. Summaries of Literature Reviewed
101
Appendix K. Financial Institutions in Bangladesh
113
Appendix L. Resources
116
Appendix M. Report on January 7, 2003 Seminar
118
13
List of Abbreviations
ADB
AGM
BAS
BB
BRPD
CA
CAG
CCI
CEO
CG
CIB
CLO
CSE
DSE
EGM
GOB
IAPC
IAS
IASC
ICAB
ICB
ICMAB
IFAC
IPO
ISA
ISA
JBC
LRA
MD
MFI
NCB
NGO
NPL
OECD
PAC
PB
PKSF
RJSC
SBC
SCB
SEC
SECA 1993
SECA 1993
SEO 1969
SER 1987
SOE
Tk.
Asian Development Bank

Annual General Meeting
Bangladesh Accounting Standards
Bangladesh Bank
Banking Regulation and Policy Division (of the Bangladesh Bank)
Chartered Accountant
Office of the Comptroller and Auditor General
Controller of Capital Issues
Chief Executive Officer
Corporate Governance
Credit Information Bureau
Collaterized Loan Obligations
Chittagong Stock Exchange
Dhaka Stock Exchange
Extraordinary General Meeting
Government of Bangladesh
International Auditing Practices Committee
International Accounting Standards
International Accounting Standards Committee
Institute of Chartered Accountants of Bangladesh
Investment Corporation of Bangladesh
Institute of Cost and Management Accountants of Bangladesh
International Federation of Accountants
Initial Public Offering
International Standards of Auditing
International Standards on Auditing
Jiban Bima Company
Lending Risk Assessment
Managing Director
Microfinance Institution
Nationalised Commercial Banks
Non-Governmental Organization
Non-Performing Loans
Organisation for Economic Cooperation and Development
Public Accounts Committee (of Parliament)
Private Banks
Palli Karma-Sahayak
Registrar of Joint Stock Companies and Firms
Sadharan Bima Company
State-owned Commercial Banks
Securities and Exchange Commission
Securities and Exchange Commission Act 1993
Securities and Exchange Commission Act, 1993
Securities and Exchange Ordinance, 1969
Securities and Exchange Rules 1987
State owned enterprise
Bangladeshi Taka (US$1 = 59 Taka)
14
Acknowledgements
Bangladesh Enterprise Institute and the authors would like to acknowledge the support of the following
organisations in funding and promoting the project A Comparative Analysis of Corporate Governance in
South Asia: Charting a Roadmap for Bangladesh:
Department for International Development, UK (DFID)
Global Corporate Governance Forum (GCGF)
We would also like to thank all the business organisations and stakeholders that generously gave their
time to complete our survey and give us interviews.
Project Introduction
This project focuses on the structures and institutions in place to support good corporate governance
practices. A valid preliminary question is, therefore, why one should focus on corporate governance in
Bangladesh. Meeting International standards is typically the first reason cited. The need to meet
international standards of corporate governance is increasingly a requirement, not an option, to attract
foreign direct and/or portfolio investment. The preamble to the OECD Principles of Corporate
Governance makes this point clear:
The degree to which corporations observe basic principles of good corporate governance
is an increasingly important factor for investment decisions. Of particular relevance is
the relation between corporate governance practices and the increasingly international
character of investment. International flows of capital enable companies to access
financing from a much larger pool of investors. If countries are to reap the full benefits
of the global capital market, and if they are to attract long-term patient capital,
corporate governance arrangements must be credible and well understood across
borders.3
This report identifies that the relatively low level of international investment in Bangladesh does not
provide a sufficient motivation for improving corporate governance (CG), nor are there many traditional
domestic motivations for improvement in corporate governance practices in Bangladesh. However, this
does not mean that one should not strive to improve corporate governance in Bangladesh; there are other
reasons to focus on corporate governance. As Bangladesh begins to focus on the development of the
private sector, strong corporate governance is a key part of increasing economic efficiency and efficiently
utilizing domestic investment to achieve greater economic development. Good corporate governance
practices will help develop and stimulate better business management, strategic management, and risk
management. In the long-term, this will make Bangladeshi businesses more competitive.
One key element in improving economic efficiency is corporate governance, which
involves a set of relationships between a companys management, its board, its
shareholders and other stakeholders. Corporate governance also provides the structure
through which the objectives of the company are set, and the means of attaining those
objectives and monitoring performance are determined. Good corporate governance . . .
should facilitate effective monitoring, thereby encouraging firms to use resources more
efficiently.4
3
4
OECD Principles of Corporate Governance, p. 12

ibid, p. 11
15
Finally, good corporate governance practices ensure that high quality information is provided to investors
as well as the general public to ensure that companies sustain the support and trust of their investors and
the public. In a country where the state has been the primary economic actor, it is important that the
burgeoning private sector prove that it has the ability to maintain high standards and operate in the best
interests of the people. Good corporate governance helps, too, to ensure that corporations take into
account the interests of a wide range of constituencies, as well as of the communities within which they
operate. . . This, in turn, helps to assure that corporations operate for the benefit of society as a whole.5
Although the impetus for improvement in corporate governance in most countries comes from investors
and the capital markets, these stakeholders are weak in Bangladesh and are unlikely to wield the influence
necessary to change corporate practices. However, there are still compelling reasons for the corporate
sector and governmental and non-governmental stakeholders to encourage better corporate governance
practices. First, Bangladesh should strive to reach international standards with regard to corporate
practices not only as a prerequisite to attracting international capital, but also to enhance the commercial
reputation of the country generally. Second, good corporate governance practices can be an important
tool in improving domestic economic efficiency, business management, and risk management, which will
assist in the development of the private sector. Finally, the corporate sector should strive to improve
corporate governance as a mechanism to demonstrate corporate responsibility and attain the trust and
support of the public.
The Objectives of the Project and Report
As the global markets have re-evaluated corporate governance practices in developed countries, the
awareness of and need for better corporate governance in developing countries has gained momentum.
This project originated from the fact that no systematic effort has been undertaken to develop and improve
the quality of corporate governance in Bangladesh. This report essentially forms the first step in an
overarching sequence of three stages and aims to deliver a diagnostic view of the existing corporate
governance (CG) landscape in Bangladesh (see Appendix A for Terms of Reference). As part of the first
stage of the project, the findings of this study and a draft of the report were presented at a national seminar
in Dhaka in January 2003. Stage 1 also includes studies of corporate governance in Pakistan, India, and
Sri Lanka. Stages 2 and 3 of the project will take the conclusions of this diagnostic work forward into
creating a concrete agenda for reform and, subsequently, intervention strategies.
Figure 1: Overarching Scheme of Project
Stage 1
Country Studies
Stage 2
Synthesis for Bangladesh
Stage 3
Design of Intervention
This project and report seeks to focus on key areas that have been identified internationally as important
to good corporate governance practices. The report does not attempt to study every aspect of the
economy or financial sector that may have some bearing on corporate governance, but instead focuses on
the most important areas in which there is greater likelihood of seeing changes come about in the near
future. In keeping with the OECD Principles of Corporate Governance, five topics were the focus of the
diagnostic study:
The Rights of Shareholders
The Equitable Treatment of Shareholders
The Role of Stakeholders in Corporate Governance
Disclosure and Transparency
Responsibilities of the Board
5
ibid, p. 7.
16
In the Terms of Reference, specific questions or subtopics were identified under each of the above-listed
topics.
First, with regard to the rights of shareholders, the report discusses to what extent the corporate
governance framework protects shareholders rights. This discussion includes the relationship between
corporate ownership structure (e.g. concentrated and family-based structure) and corporate governance
practices. In addition, requirements to protect the rights of shareholders by regulatory agencies and stock
exchanges are discussed. This topic is discussed in the Companies, Corporate Laws, and Practice section
of the report.
The second major topic is the equitable treatment of shareholders, which is defined as to what extent
shareholders of different categories are treated equitably and what mechanisms are in place for obtaining
effective redress in case of violation of shareholder rights. This topic is particularly relevant for minority
shareholders. The study evaluates the extent to which existing company laws help to define and enforce
the rights of minority shareholders in the section on Companies, Corporate Laws, and Practice.
Third, the OECD guidelines recognize the role of stakeholders in corporate governance. This is
interpreted to mean to what extent the corporate governance framework recognizes the rights of
stakeholders as established by law and encourages active cooperation between companies and
stakeholders in creating wealth, jobs, and the sustainability of sound enterprises. In the context of
Bangladesh, the major problems in this area are the role of independent regulators and creditors rights.
These issues are discussed mainly in the sections on Independent Regulators and The Banking Sector.
Fourth, requirements for disclosure and transparency are at the heart of corporate governance. The
sections on Companies, Corporate Law and Practice; Accounting Standards and Disclosures; and the
Institute of Chartered Accountants of Bangladesh (ICAB) examine the current situation in Bangladesh
with respect to audit firms, the fees they are allowed to charge, the accounting standards they actually
follow, the role of national accounting associations in prescribing audit and reporting standards, and the
adequacy of the current self-regulatory system.
Fifth, in the Companies, Corporate Laws, and Practice section the report explores the responsibilities of
the board. It identifies the legal, statutory, and practical framework that ensures the boards
accountability to shareholders and the company, the strategic guidance of the company, and the effective
monitoring of management by the board.
The authors recognize that other factors may contribute to corporate governance practices in Bangladesh,
but, in some cases, they are beyond the scope of this project. The project was guided by the OECD
Principles of Corporate Governance, which has identified the above topics and subtopics as those of
primary importance in evaluating and implementing corporate governance practices.
In addition to the focus on the OECD Principles, the report in Stage 1 has focused mainly on public and
public-listed companies. Although corporate governance principles are relevant to all corporations, the
project team found that more information was available regarding public companies and corporate
governance statutory requirements applied most to these types of companies. It would have been useful
to chalk out a split between the private and public corporate sectors in Bangladesh. However, any kind of
materiality mapping exercise turned out to be a formidable task just because of the complete lack of
relevant statistics. The RJSC cites 50,000 as the total number of entities that are incorporated in the
country and 216 are publicly listed, but the relevant share of capital of public and private companies was
not available.
17
The state-owned enterprise (SOE) sector also comprises a large sector of the country to which corporate
governance practices should be applied. The lack of reliable statistics makes it difficult to quantify the
size of the SOE sector, however the World Bank cites an asset value figure of around 35% of GDP for the
SOEs - a figure that admittedly should be used with significant caution. The application of good
corporate governance practices to the SOE sector could, therefore, have a significant effect on the
economy, but at present the concept or practice of corporate governance is almost non-existent in SOEs.
Therefore, the Diagnostic Report for Stage 1 has focused on public corporations as the sector with the
most scope for improving corporate governance practices.
Outline of the Report
To address the topics and subtopics identified above, the report is organized by the various stakeholders
and requirements that define corporate governance practices in Bangladesh. The report begins by
examining the legal framework in which corporate entities operate; the section entitled Companies,
Corporate Laws and Practice explains the requirements on a corporate organisation from various laws and
regulations and compares the requirements with practice. Evidence of observed practice comes from the
survey of corporate organizations, interviews with stakeholders, and project research. The Financial
Sector Scenario and Governance explains the market in which corporations and financial institutions
operate in Bangladesh, including their sources of financing, which plays a large part in corporate
governance practices. The report next examines Accounting Standards and Disclosures. This section
includes both the disclosures required by statutory requirements and level of disclosures observed in
everyday practice. The following section explores the function and role of the independent regulators,
which have the responsibility to ensure that practices follow regulations. The sections Judiciary and
Existence and Role of Pressure Points explore the other external actors that can enforce or encourage
good corporate governance practices. The current state of corporate governance in State-Owned
Enterprises is briefly explored. Finally, the conclusion summarises the findings and identifies sectors in
which further study is warranted.
Report Methodology
The methodology followed to prepare this report was essentially three-pronged:

1. Review of the available literature/ secondary material
2. Survey of corporate entities
3. Interviews with relevant stakeholders
As a primary step in the country study, a review of relevant literature on corporate governance in
Bangladesh was conducted. This review examined recent articles, periodicals, books, and reports, both
public and non-public. Sources included multilateral development agencies, non-governmental
organizations, government publications, and periodicals. The literature reviewed was relevant to at least
one aspect of corporate governance. At times, the focus of the literature was not corporate governance,
but contained some analysis or information relevant to the topic. The literature review summaries
contained in Appendix J provide a short summary of the more important materials reviewed. The
literature summaries cover the facts and assertions of the article and include the author(s)
recommendations or opinions that relate to corporate governance; sections of an article, for instance, that
did not relate to corporate governance were not summarized. Other resources were also used in the report
and are cited in the text and in Appendix L. As is evident from the summaries of literature reviewed, to
date limited work has been done on corporate governance in Bangladesh.
As part of the research for this report, a survey of corporate entities was completed. The survey looked at
a sample group of 30 entities (detailed list in Appendix B) comprised of eighteen public listed
18
companies, ten private companies, and two SOEs. In order to obtain a representative picture, the sample
included a mix of organisations of different performance levels across different sectors ranging from
successful multinationals to non-performing locals, from banks to leasing and insurance companies. The
basic tool used for these interviews was a questionnaire. Two qualitative questionnaires (see Appendix D
and E) were designed, following the OECD CG guidelines, to probe separately into critical issues for the
corporate and financial sectors. The interview for each organisation was conducted with the chief
executive, either the Chief Executive Officer (CEO) or Managing Director (MD). Findings have been
integrated into main text of the report, where relevant, as well as summarised in Appendix F.
Corporate governance, in the true essence of the term, is more relevant for the public listed companies in
Bangladesh than their private counterparts. Even though one-third of the corporate organisations
interviewed for this study are private companies, the results are neither extraordinary nor unexpected.
Private companies in Bangladesh are mostly closely held family businesses where the original source of
corporate governance separation of ownership and management is absent and the major issues of
insider trading, minority shareholders, or inadequate disclosure are not critical problems. For the
purposes of this report, the more important area of public listed companies has been the focus.
The stakeholders of the CG process who were interviewed for this report comprise a varied group of highlevel public and private sector officials (see Appendix C for list). These are the individuals whose
ownership of the CG concept is a necessary prerequisite for the later stages of this project to succeed.
Discussions with this select group included essentially two components: first, asking questions about the
actual practices/policies followed in their respective areas and, second, current and potential reform
initiatives.
Seminar on Strengthening Corporate Governance in Bangladesh
As part of Stage 1 of the project A Comparative Analysis of Corporate Governance in South Asia:
Charting a Roadmap for Bangladesh, Bangladesh Enterprise Institute (BEI) held a seminar on
Strengthening Corporate Governance in Bangladesh on January 7, 2003. Seminar participants,
discussants, and speakers came from a variety of stakeholder groups, including company directors,
corporate managers, chambers and business organisations, regulatory officials, and government officials.
A full report, programme, and list of attendees for the seminar are included in Appendix M.
Participants were provided with the Executive Summary of the December 30, 2002 Draft of this Report.
Discussants were provided with the full December 30, 2002 Draft.
The Honourable Minister of Law, Justice and Parliamentary Affairs, Mr. Moudud Ahmed, MP, served as
Chief Guest in the opening session of the seminar. Dr. Fakhruddin Ahmed, the Governor of the
Bangladesh Bank also addressed the seminar as Special Guest. Other distinguished discussants addressed
the seminar throughout the day.
Generally, the report was well-received by all, other than the representative from the Securities and
Exchange Commission (SEC), and the audience felt that there was important work to be done to improve
corporate governance in Bangladesh. The seminar and discussions were divided into thematic sessions as
follows:
The Role of the Directors and Shareholders
The Role of Banks and Financial Institutions
Auditing and Accounting Standards
The Regulatory and Legal Environment
For each session, knowledgeable persons were asked to serve as discussants on the report and its findings.
The audience was also given opportunities to comment and ask questions of the discussants.
19

The discussion of directors and shareholders focused on the (1) disclosures regarding the board that could
help shareholders evaluate their performance, (2) the existing difficulties regard family-dominated boards
and large boards, and (3) independent directors. First, a basic problem with regard to boards is holding
and attending board meetings. To provide shareholders with information about the boards activities, it
was recommended that required disclosures should include the dates of board meetings, the attendance
records of directors, the directors individual shareholdings, and changes in director shareholdings.
This last suggestion relates directly to a second problem identified by the discussants: boards are usually
dominated by a family group or sponsors and shareholders do not want these sponsors to reduce their
holdings. This makes it difficult to implement some good CG principles. Another problem identified by
discussants was the large size of boards in Bangladesh. It was recommended that boards be limited to ten
members.
Third, although independent directors were thought to be important there were concerns that an
independent director can easily become marginalized on a board dominated by executive directors.
Corporate participants generally thought that the number and role of independent directors should be left
up to the sponsors and shareholders. Representatives of regulatory agencies and shareholders feel that the
inclusion of independent directors should be required through some sort of proportional representation.
One example is the proposal being considered by Bangladesh Bank that they appoint a director to
represent depositors.
Throughout the discussion, the idea of director training was consistently discussed and favourably
received by most participants. There was also discussion of the blackmailing activities of certain
shareholders or shareholder groups and disruption of Annual General Meetings (AGMs). In a number of
sessions throughout the seminar, the lack of board committees was brought up. Few boards have audit
committees and almost none have nomination or remuneration committees.
Beyond the measures proposed by Bangladesh Bank that would impose and/or encourage stronger
Corporate Governance practices in financial institutions, the group discussed a number of other issues
related to the financial sector. First, there is legal uncertainty with regard to the proper jurisdiction for
financial cases. Banks often face questions of which court to take a case to, the Money Loan Court or
Bankruptcy Court. Second, internal Corporate Governance of Bangladesh Bank was discussed.
Attendees raised some issues regarding the composition of the Bangladesh Bank Board of Governors,
including the inclusion of a medical doctor on the board. Furthermore, it was emphasized that there was a
need to have some public transparency and accountability from Bangladesh Bank, particularly with regard
to the management of risk by Bangladesh Bank. Earlier in the seminar, Dr. Fakhruddin Ahmed
(Governor of Bangladesh Bank) had mentioned that Bangladesh Bank would be complying fully with
International Accounting Standards (IAS) and would be audited in compliance with International
Standards of Auditing (ISA).
Discussants and participants pointed out that certain areas of the financial sector were not discussed in the
report, particularly micro-credit and non-banking financial institutions. The report focused on the most
important areas of the financial sector with regard to Corporate Governance and rightly did not cover all
parts of the financial sector. This point will be clarified in the report.
Three main topics were discussed in the session on Auditing and Accounting. First, the seminar
discussed the need for audit committees and the difference between auditing and accounting standards.
20
Second, the process of selection of auditors by companies. Third, the changes needed for consolidated
financial reporting for group companies to take place.
First, auditors present at the seminar pointed out that all listed companies should have an audit committee
to oversee the preparation of accounts internally and to choose an auditor. They stated that adoption of
accounting standards is not enough by itself if companies do not spend the money to have properly
trained people prepare accounts. Second, companies do not look to hire high quality auditors and often
just look at which auditor will complete the audit for the lowest fee. ICAB has made audit fees an issue
of its focus. However, other participants pointed out that ICAB, as a self-regulating organisation, should
be able to control audit rates if all members agree not to quote rates below a standard. Third, the need for
consolidated accounts for group companies was discussed in some detail. Specific suggestions were
made regarding changes that would bring about consolidated financial reporting for group companies:
A change to the tax law to provide tax benefits to a group when there is a loss in one subsidiary of
which more than 51% is owned by the group. That is, a loss in a subsidiary (a member of the
group of companies) could be used to reduce taxes for the group as a whole.
A change to the Companies Law to require consolidation when a company owns 51% of the
equity of another company. Currently, consolidation is not required.
Other important comments were provided regarding ICAB and SEC. A former chair of the SEC
commented that, in his experience, ICAB punishments are too light and that ICAB should work harder at
enforcing quality requirements. In addition, a number of participants commented that there are not a
sufficient number of SEC personnel to check company accounts, nor do SEC personnel have sufficient
technical knowledge to do so thoroughly. SEC personnel may have MAs or MBAs but these are not
technical certifications, they are professional certifications. However, the representative from the SEC
did not agree to this assertion.
The discussants and participants agreed that one of the biggest problems with regards to the legal and
regulatory environment is implementation of the current laws and statues. To improve implementation,
there should be some improvement in judicial processes and also education and training. Education is
required for businesspeople and barristers regarding the proper use of the Bankruptcy Court.
Furthermore, training should be provided for judges on corporate and securities laws.
Minority shareholder rights under Section 233 were also discussed. The discussant pointed out that it is
difficult and expensive to exercise shareholder rights under Section 233 and it is difficult to prove
directors are at fault. Although the opinion was expressed that the 10% shareholding bar should not be
lowered for most companies, the discussant pointed out that Section 233 could be adjusted to require a
smaller percentage of shares for large companies.
Summary of the Seminar
In most cases the seminar participants, discussants, and guests supported the findings of the diagnostic
study. The role of audit committees and internal corporate procedures in ensuring well-prepared financial
accounts was one issue that received more emphasis in the seminar proceedings than the draft report.
After the seminar, these issues were incorporated into this final report. In addition, the seminar
highlighted the need to focus on particular areas of corporate governance where improvement is likely or
forthcoming. Without such focus, the problems of corporate governance may appear too complex and
unwieldy to change.
Executive Summary
21
This report is a diagnostic assessment of the corporate governance regulations and practices in
Bangladesh. The assessment is measured against international norms and current practices as recognized
by the OECD Guidelines on Corporate Governance. The report identifies critical areas where institutions,
regulations, or other economic factors in the corporate sector could be strengthened to improve corporate
governance (CG). As such, the authors identify strengths and weaknesses of legal requirements,
regulations, and corporate practices. To identify the current strengths and weaknesses, the authors drew
heavily on a review of laws and a survey of businesses organisations carried out by the research team as
well as a series of interviews with key stakeholders. This analysis will serve as a basis on which further
study can build. In fact, this report comprises the first stage of a three-stage project; Stage 2 will frame
detailed recommendations to strengthen corporate governance in Bangladesh and Stage 3 will formulate
implementation strategies.
Companies and Corporate Laws
To begin to understand the corporate environment in Bangladesh, a review of legal requirements relating
to corporate entities is necessary. The analysis compares statutory provisions to actual corporate
practices, as revealed by the projects survey of business organisations and stakeholders.
The Companies Act 1994 is the law which governs incorporated domestic entities in Bangladesh. It
governs the creation, functioning and dissolution of companies, the relationship of shareholders to a
company, periodic disclosure and audit requirements, the functions of the Registrar of Joint Stock
Companies, and the jurisdiction of the courts in relation to companies. Other relevant laws include:
Securities and Exchange Ordinance 1969
Bangladesh Bank Order 1972
Bank Companies Act 1991
Financial Institutions Act 1993
Bankruptcy Act 1997
The Companies Act 1994 (the Act) defines the rights of both majority and minority shareholders.
Shareholders are not intended to, and do not in practice get involved in the day-to-day management of a
company. However, the Act provides for certain supervisory functions to be undertaken by the
shareholders in the form of these rights to attend meetings, appoint and remove directors and to obtain
financial information as well as approve the balance sheet annually. The law also provides for various
mechanisms for shareholders to enforce these rights, the principal among them being a suit for minority
protection under Section 233 of the Act. The Act has some inbuilt protection for shareholders in
requiring companies to file periodic returns with the RJSC, failing which the directors and management of
the defaulting company are liable to various penalties such as fines, and in some cases, imprisonment.
The right to dividends is perhaps the right that most concerns shareholders, and has recently been in
public focus. In accordance with the law, dividends are declared by the shareholders in a general meeting
but may not exceed the amount recommended by the directors. However, in recent years the annual
general meetings of several high-profile companies have been disrupted with shareholders demanding
larger dividends than that recommended by the board of directors. The meetings have been held up until
the directors have met and resolved to recommend a higher dividend, which is then approved and
declared by the shareholders. This practice is not strictly legal. The SEC has had occasion to take action
against companies in whose meetings these events have taken place.
The Act has specific provisions targeted at protecting the interests of minority shareholders. Minority
shareholders holding at least 10% of the shares may seek remedies in Court if they feel the affairs of the
company are being conducted in a manner prejudicial to one or more of its members, or the company is
22
acting in a manner discriminatory towards any member or debenture holder. If the Court is of the opinion
that the interest of the applicant(s) are being prejudicially effected it may pass any order it deems fit
including cancelling or modifying any resolution or transaction, regulating the affairs of the company in
future as specified in the order or amending any provision of the memorandum or articles of the company.
Minority protection actions are filed in court in Bangladesh with some regularity, although a large number
of these are later found to be vexatious or not in fact relating to issues covered under the rubric of
minority protection. While Section 233 of the Companies Act and other provisions offer adequate
protection for minority shareholders, many shareholders are not aware of Section 233 and the minority
protection regime.
The primary avenue for companies to communicate with their shareholders is the annual general meeting
(AGM). A company must hold at least one general meeting of its shareholders, normally called the
AGM, in every calendar year. If an AGM is not duly called then the RJSC or the Court may authorize the
holding of the meeting out of time. In some circumstances, a number of shareholders specified in the
Articles of Association, or holders of not less than 10% of the shares of a company can require an
extraordinary general meeting to be called and held. In an AGM, the agenda must include the following
items, and may include other items as necessary:
Approval of the annual report and audited accounts of the company
Appointment of auditors
Resignation by rotation and appointment of directors (as required).
The perception of AGMs amongst the non-banking listed companies surveyed seems to be a combination
of a necessary evil and a statutory requirement. Only 38% of the non-banking listed companies see it as
an effective forum for shareholders. Generally, shareholder demands concentrate either on higher
dividends or trivial demands like better quality food and gifts at the AGM, and transportation allowances.
In the survey, banks claim to have more positive experiences at their AGMs. While one bank referred to
the usual problem of managed AGM pressures, three mentioned that this problem is not as acute as in
the corporate sector.
One function of the AGM is to elect the companies board of directors. The members of a company elect
the directors of a company from among their number in the general meeting. There are no further
requirements of law regarding the composition of the board of directors, although the Securities and
Exchange Commission (SEC) has recently been imposing a condition on public issues of shares that
directors be elected in proportion to shareholdings of institutional investors. In an overwhelming majority
(i.e. 73%) of the non-bank listed companies surveyed, the board is heavily dominated by sponsor
shareholders, usually belonging to a single family. The boards are usually actively involved in
management - in 50% of the companies, there is more than one executive director on the board.
One issue in establishing good corporate governance is the inclusion of independent directors on the
board of directors. In the context of Bangladesh, directors who would fit the definition of independent in
Bangladesh are often current or former government officials or bureaucrats. They are appointed to help
the company get licenses or as payback for previous favours. When boards need an independent opinion
they rely on employing outside consultants or advisors. Therefore, in the context of Bangladesh,
independent directors do not usually serve as an advocate for minority shareholders or as a source of new
and different ideas.
Once elected to a board, the Act imposes certain responsibilities and rights upon directors. Directors who
are interested in any contract or arrangement entered into by or on behalf of the company are required to
disclose their interest and, in some cases, to desist from voting on any such decision. However, the
penalty for contravention is a fine not exceeding Tk.5,000, a fine which cannot be considered to be a
sufficient deterrent to such actions.
23
The Board of Directors of the company are obliged to submit to shareholders a balance sheet together
with the profit and loss account at every AGM. The companys auditor must audit the financial
statements and the auditors report must be attached. The Boards report must also be included and it
should provide information regarding the companys affairs, the amount the Board proposes to reserve in
the balance sheet, the amount recommended to be paid out as dividend and any material change and
commitments which may change the financial position of the company. The information that is required
to be disclosed by a company to its shareholders and to members of the public in accordance with the law
is practically the only tool shareholders and investors have to judge the performance of a company and
monitor the activities of the directors and management. These provisions are of cardinal importance, and
should be subject to strict enforcement. Due to various reasons, including lack of knowledge on the part
of the persons responsible to maintain the records, shareholder apathy, lack of proper monitoring by the
RJSC, lack of quality auditing services, often the disclosures are not accurate or complete.
A companys auditors, as per the Companies Act, must be Chartered Accountants and are appointed in the
AGM. The auditors should have access to all books and papers whether kept at the registered office or
elsewhere. The scope of inquiry of the auditors has been elaborately spelt out in the Companies Act as well
as the nature of the certification the auditors must provide. An auditor must specifically state whether, in his
opinion and to the best of his information and according to the explanation given to him, the said accounts
provide a true and fair view of the companys affairs.
A common point of concern among stakeholders was that audit reports, except for those of multinational
companies and very reputable local companies, do not reflect a true and fair view of the state of the
companys financial affairs. Barring a few firms with international ties, audit firms do not fully know,
understand or apply the Bangladesh Standards on Auditing. It was a widely held view among
stakeholders that rigorous auditing practices would improve corporate governance in large measure
almost immediately.
Financial Sector
Financing for commercial purposes in Bangladesh is largely obtained by borrowing, mainly from banks
and financial institutions, rather than through equity or capital market products. The capital market is not
a preferred source of funds for corporations and, in any case, does not have the depth or breath necessary
to serve as an enforcer of corporate governance standards. The debt market is non-existent and insurance
market is not a major force in the financial sector. Therefore, the primary stakeholders in corporate
governance are creditors, particularly lenders.
The banking sector can serve as a motivation for better corporate governance through its requirements
and procedures for approving and monitoring loans. Unfortunately, these procedures to date have not
provided sufficient oversight of credit assessment and asset management. This can be seen most clearly
in the statistics on classified loans; classified loans as a percentage of total loans outstanding for NCBs,
PBs and foreign banks at the end of 2001 were 45%, 26%, and 4% respectively. Even these figures may
not reflect the true nature of the problem; apart from lax requirements to report on loan classification,
banks are reluctant to write-off bad debts under the misconception that they would lose rights to legally
pursue borrowers for recovery.
Beginning in the calendar year 2001, banks were required to comply with the International Accounting
Standard-30 (IAS-30). The accounting standard requires banks to disclose the classification of their loan
portfolio (as sub-standard, doubtful, or bad) based on their default activity and make a loan loss provision
specifically for classified loans, as well as make a general provision for loans that are unclassified. Full
and accurate compliance with the disclosure requirements of IAS-30 will begin to provide more
information to bank stakeholders and hopefully create a consensus for reform.
24
Bangladesh Bank (BB) is the central bank of Bangladesh and the primary regulator of banks and nonbanking financial institutions. BB has taken a number of recent steps to improve the health of the
banking sector, but the central bank still suffers from a lack of personnel possessing adequate formal
training and education in banking and central bank functions. Recently, the Governor has been a
professional from the private sector and, for the first time, an outsider and a former CEO of a foreign
bank has been appointed as a Deputy Governor. These steps are measures to inject experienced
professionals into Bangladesh Bank and gradually instil appropriate managerial skills in running what is
essentially a bank.
Although BB has introduced a Lending Risk Analysis (LRA) procedure for loans above a certain amount,
smaller loans do not require mandatory credit assessment before sanction or disbursement of credit
facilities, which is a recognised factor contributing to difficulties in recovery of defaulted loans. To
facilitate informed credit decisions by banks, a separate department was established at BB, the Credit
Information Bureau (CIB), which centralises information on borrowers and their existing credit. The
effectiveness of CIB reports is hampered by delays in updating information and disclosure only to
requesting banks. Survey results also reveal that cash incentives are often required to obtain CIB reports
in the normal course of business. Weaknesses in the CIB system often lead to delayed loan approval.
Bangladesh Bank has recently displayed increased activism in the administration of banks by exercise of
its statutory powers of removal of chairman, directors or chief executive officers of banks, which have
survived judicial review. The bank has also been steadily issuing circulars outlining the duties and
responsibilities of directors of banks. To facilitate more effective regulation, a suggestion has been made
for statutory recognition of directors' duties for all companies, with emphasis on their individual and
collective accountability.
Although there are dedicated courts for debt recovery by banks and financial institutions, Money Loan
Courts, as well as Bankruptcy Courts, the implementation of creditors rights in Bangladesh remains
weak. Money Loan Courts suffer from a shortage of judicial officers and delays in executing decisions.
The Bankruptcy Act 1997, established a further set of dedicated courts, Bankruptcy Courts, but these
courts are not a favoured option for banks. It is a common strategy for banks to prefer that borrowers
continue to remain commercially viable to generate funds for repayment rather than cripple or extinguish
their opportunities for further business by adjudication of bankruptcy. The stigma attached to being
declared bankrupt is misunderstood, and has been the primary cause of resistance to an effective
structuring and enforcement of the 1997 Act. Since the Money Loan and Bankruptcy Courts do not
provide effective means of protecting their exposure, banks often insist on blanket personal guarantees
from company directors before giving out loans. This requirement completely violates the principle of
limited liability and, in essence, acts as a barrier to enterprise development as well as a disincentive to
board membership.
In Bangladesh, the fundamental spokes of an efficient capital market wheel are not in place. The average
non-controlling shareholder in this country is an individual who does not possess sufficient level of
education, understanding and sophistication required to exert pressure on a company to change behaviour.
Institutional investors like mutual funds and pension funds are too small or disinterested to adopt a strong
activist position. As a result, a share price does not necessarily incorporate a penalty for poor corporate
practices; since market prices fail to have any kind of disciplining impact on management, companies
have no incentive to be transparent.
Due to weaknesses in the stock market, companies see few benefits in becoming a public company and
listing on the stock exchange. Capital can be more easily raised through bank financing since companies
with good reputations face few problems in obtaining adequate capital from banks. Companies that
25
cannot obtain adequate bank financing may go to the equity markets, which means, in effect, that listed
companies are often the weaker companies. Our survey revealed that equity requirements had been the
prime motivator for only 10% of the public companies interviewed - the remaining companies had cited
reasons like tax advantages and legal compulsion for going public.
At present, the capital market includes no bond, fixed-income, or other debt instruments. Government
savings schemes provide a fixed income investment vehicle, but the instruments are not traded. The high
level of interest paid on government savings schemes discourages corporate debt offerings. In spite of the
obstacles, a few organisations are attempting debt offerings. If the debt markets can develop, investors in
corporate bonds and other debt instruments could become an important pressure group for encouraging
and enforcing corporate governance principles.
Accounting practices in Bangladesh suffer from two major weaknesses. First, accounting standards are
not in compliance with international standards in a number of material aspects. Second, corporate
compliance with Bangladesh Accounting Standards (BAS) is inconsistent.
First, accounting standards are not in compliance with international standards in a number of material
aspects. The Institute of Chartered Accountants of Bangladesh (ICAB) has adopted 22 of the 41
International Accounting Standards (IAS) as BAS. However, in many cases the IAS has been adopted in
its original form and subsequent amendments have not been adopted. As a result, IAS and BAS differ in
a number of material aspects. Accounting standards in Bangladesh allow for considerable discretion by
the company and do not require disclosure of all the financial and non-financial details necessary for a
full assessment of a companys operations, financial situation, and prospects. Standards regarding
accounting for investments in subsidiaries/ associates and the lack of consolidated accounts are particular
shortcomings.
Second, a review of available literature and annual reports suggests that compliance with disclosure
requirements under the relevant laws and BAS is inconsistent. Also, the consequences for noncompliance are virtually non-existent and weak auditing and regulation allows this situation to continue
unabated. Even companies that do comply with the statutory requirements often do not provide other
relevant and material information.
Even though the elements necessary to move to full international harmonisation of accounting standards
are present in Bangladesh, there are few indicators that this will happen in the near future. Voluntary
compliance with IAS (or more stringent standards) is more likely to occur before mandatory standards are
strengthened. Voluntary IAS compliance will likely happen either through a demonstration effect or if
banks or other investors demand it. If companies which voluntarily comply with more demanding
accounting standards are seen to gain an advantage in the markets or in lending rates, others may follow
their lead.
The primary independent regulators relevant to CG in Bangladesh include government and nongovernment entities. Government regulators include the RJSC, the SEC, and Bangladesh Bank. Nongovernment regulators include ICAB, CSE, and DSE. Government regulators particularly do not provide
efficient services or easily enable companies to fulfil their regulatory or statutory requirements. As is the
case with many government agencies, government regulatory agencies do not have a sufficient number of
qualified, experienced personnel to oversee companies actions. Regulators also have expanded their
scope of authority and actions, either through regulation or practice, which companies feel has led to
misuse of their powers and to unfair harassment. Observers also point out that regulators pass arbitrary
rules and rulings and that there are few avenues for appeal. For instance, dealings of the RJSC often
26
overreach the statutory functions of the Office, though its staff openly admit that they are not trained on
company law and the role of the RJSC.
The SECs interventions have forced listed companies to be much more regular in holding annual general
meetings, declaring dividends, and disseminating price sensitive information. However, this has involved
the SEC expanding its purview by impinging on business decisions, for example SEC regulations for A,
B, and Z category companies require the payment of dividends, which is a key business decision
regarding the distribution of profits. For instance, the SEC categorizes companies on the basis of their
regularity in holding AGMs and the regularity and rate of dividends; such classification results in
particular treatment by the regulator. Further, directions issued by the SEC recently have appeared to be
targeted at specific companies, or in instant reaction to emerging situations, without bearing in mind the
overall impact of the provisions.
The ICAB is a non-governmental regulatory agency which certifies and oversees accountants and
auditors. ICAB must ensure that accountants and auditors prepare and audit financial statements that
provide full and true disclosure of a companys financial position and operations. The ability of ICAB to
carry out these functions has been seriously called into question. The auditing function in particular
would seem to represent a vicious circle. Auditors are not perceived to be independent and do not
provide quality audits. Therefore companies and shareholders are not willing to pay high fees for an
audit. The low fee structure, in turn, does not provide an incentive for auditors to provide quality
personnel and audits.
The Judiciary
As a support mechanism to enforce or impose regulations or rulings that support corporate governance,
the judiciary suffers from a large backlog of cases and a lack of specialist knowledge of financial laws
and corporate concerns. There is a Company Bench at the Supreme Court, which serves as the company
court and attends to cases under the Companies Act. There is also a Money Loan Court to hear cases of
loan default. Proposals continue to be made for a separate bench at the High Court Division level to
dispose of financial cases and their appeals. General opinion is against the transfer and vesting of such
jurisdiction to a statutory body, which may compound the bureaucratic issues with existing government
authorities and bodies involving officers with inadequate knowledge on administering financial matters.
State-owned Enterprises
In Bangladesh, state-owned enterprises (SOEs) do not see themselves as corporate enterprises and
therefore see no need for corporate governance norms. The state-owned sector is characterized by
negative net worth, high leverage, negative profit margins, and technical insolvency. Although
considered autonomous units, SOEs report to their respective sector ministries. Therefore, operations in
SOEs are primarily politically motivated and lack a commercial focus. Modern business management
and corporate governance structures have not been implemented, which makes most SOEs unable to
compete in a liberalized market. The inability to restructure SOEs and improve their management
practices makes the process of privatisation difficult.
The primary shareholder in SOEs, the government, is not an active or effective monitor on the results and
operations of SOEs. The primary agency for oversight of SOEs is the Office of the Comptroller and
Auditor General (CAG), which reports to the Public Accounts Committee (PAC) of Parliament. Neither
the CAG nor the PAC effectively completes their tasks due to lack of accountability and mismanagement.
As a result, action is rarely taken against irregularities in the state-owned sector and wrongdoers are not
penalized. Therefore, SOEs are subject to little or no financial or managerial oversight from their
majority shareholder. Without privatisation or a shift to a commercial focus, appreciation of corporate
governance is not likely to develop in the SOE sector.
27

External pressures that often demand information and more transparent corporate governance practices
are lacking in Bangladesh. First, there are few financial media outlets or knowledgeable financial
journalists. Apart from a few enterprising journalists, the financial press consists mainly of press releases
from companies. Second, shareholders do not join together in shareholder associations to demand better
company performance or to assert their shareholder rights. Third, in Bangladesh there are only a few
institutional investors, most of which are state-owned enterprises (SOEs). The few private investors do
not have enough clout to force large scale changes in the corporate sector. Fourth, most companies are
not candidates for significant foreign investment, so there is no push from the international economic
community for better corporate governance.
Conclusion
The report is a diagnostic tool from which a consensus can emerge regarding the way forward for
corporate governance in Bangladesh. At this stage, only very broad recommendations are provided,
identifying institutions or sectors that should be studied further. Specific recommendations will be
framed in subsequent stages of this project.
Further work should concentrate on the following areas to develop specific recommendations for reform:
Registrar of Joint Stock Companies
Security and Exchange Commission and the capital market environment
Institute of Chartered Accountants of Bangladesh and the auditing profession
Adoption of International Accounting Standards
Examining the requirements for and qualifications of directors, including independent directors
Shareholder education and awareness of corporate governance
Strengthening banking practices and encouraging the inclusion of corporate governance issues in
credit analysis
Each corporate governance stakeholder plays an important part to creating an environment where
transparency and accountability are encouraged, enforced, and rewarded. For Bangladesh, the first step in
strengthening the role of stakeholders in corporate governance is raising their awareness regarding these
issues. This report attempts to start that process. For companies to have sufficient motivation to disclose
information and improve governance practices, the relevant stakeholders must place a value on that
information and there must be consequences for corporate governance practices. In many cases, the
current system in Bangladesh does not provide sufficient legal, institutional, or economic motivations for
stakeholders to encourage and enforce good corporate governance practices. As a result, there are few
rewards for companies that institute good corporate governance practices and no penalties for failing to
do so. Targeted reforms in institutions or sectors can begin to provide the internal and external
motivation for transparency and accountability that will lead to better corporate governance.
Companies, corporate laws and practice
Insofar as corporate governance is a function of regulation of corporate bodies through legislation or selfregulatory mechanisms such as those of stock exchanges, a brief outline of the legal framework
surrounding corporate entities may be helpful in setting the scene for the more detailed discussion of
corporate governance in Bangladesh.
The principal laws which are relevant are:
Companies Act 1994

Bangladesh Bank Order 1972
28
Bank Companies Act 1991

Financial Institutions Act 1993
Securities and Exchange Ordinance 1969
Bankruptcy Act 1997
Companies Act 1994: This is the law under which all domestic companies in Bangladesh are
incorporated, and is the main statue governing companies, their relationship to shareholders, periodic
disclosure and audit requirements, the functions of the Registrar of Joint Stock Companies, and the
jurisdiction of the courts in relation to companies.
Bangladesh Bank Order 1972, Bank Companies Act 1991, and the Financial Institutions Act 1993:
The Bangladesh Bank Order 1972 set up the central bank (Bangladesh Bank), which regulates the
banking activities of bank companies which operate under the Bank Companies Act 1991. The provisions
of the Bank Companies Act 1991 are in addition to the provisions of the Companies Act 1994. Similarly,
non-banking financial institutions are governed by Bangladesh Bank (BB) in terms of the provisions of
the Financial Institutions Act 1993. The latter two legislations delimit the scope of activities of bank
companies and non-banking financial institutions, respectively. They provide for the regulatory steps
which may be taken by Bangladesh Bank, including powers to license and give directions to such
companies in the public interest, in the interest of monetary and/or banking policy, in order to prevent the
affairs of such companies being conducted in a manner detrimental to the interest of the companies or
depositors, and to ensure their proper management.
Securities and Exchange Ordinance 1969 and the Securities and Exchange Commission Act 1993:
These two laws form the basis of the issuance of securities and capital market regulation in Bangladesh.
The latter sets up the Securities and Exchange Commission (SEC) with broad licensing and regulatory
powers over capital market stakeholders and intermediaries such as stock exchanges, brokers and dealers,
merchant banks and portfolio managers, while the issue of securities is regulated by the provisions of the
former. The Securities and Exchange Ordinance provides the power to the SEC to make the issuance of
securities subject to any condition as it may think fit to impose, notwithstanding anything contained in the
Companies Act, 1994 or any other law in force, which is a very wide-ranging power. Much of the powers
of the SEC under these laws are aimed at proper disclosure to investors, which is at the heart of good
corporate governance.
Bankruptcy Act 1997: This law replaces the out-dated Bankruptcy Act 1920. Insofar as companies are
concerned, it makes provisions additional to the winding up provisions of the Companies Act, where the
winding up is as a result of the insolvency of the company rather than for any other reason.
In addition to these laws, there are provisions in many other laws such as the Income Tax Ordinance,
1984 which contain provisions for disclosure, audit and penalties for contravention of fiscal and revenue
matters, which relate to corporate governance. Numerous subordinate legislative instruments such as
orders, rules, regulations and circulars are issued by the Government, Bangladesh Bank, SEC, National
Board of Revenue and other agencies of the Government, stock exchanges, chambers of commerce and
industry and other self-regulatory agencies in the private sector also form a part of the legal and
regulatory framework for corporate governance.
Legal Requirements and Practice
The basic legislation governing companies is the Companies Act, 1994. Joint-stock companies in
Bangladesh were originally governed by the provisions of the Companies Act 1913. On January 1, 1995
29
the new Companies Act, 1994 came into effect. This long awaited piece of legislation was not an entirely
new piece of legislation. The Act of 1913 was subjected to major amendments in India in 1956, apart
from minor amendments from time to time, and in Pakistan in 1984 the Company Law Ordinance was
enacted. These laws were enacted to take into account the new business and corporate environments.
Similar needs were felt in Bangladesh, and the Company Law Reforms Committee was formed in 1977.
After a detailed study of the subject, the Committee handed in its Report in 1981. The 1994 Act
embodies many of the recommendations of the Committee. The recommendations were incorporated in
the Act of 1994 (referred to as the Act) to provide more accountability and openness in the management of
companies, leading to greater confidence in the corporate culture.
Formation of a Company
As in most other common law jurisdictions, the Act provides for the formation of companies with unlimited
and limited liability of shareholders. Non-profit companies may also be formed under the Act. For
incorporation a company must have a minimum of two members, with different lower and upper limits for
different types of companies. The prescribed number of persons may form an incorporated company by
subscribing their names to a memorandum of association and otherwise complying with the requirements of
this Act in respect of registration. No company can be registered with a name similar to that of a company
already in existence. The Government has been given the power to prohibit registration of undesirable
names.
Once a certificate of incorporation is given by the Registrar of Joint Stock Companies and Firms (RJSC)
it is conclusive evidence that all the requirements of the Act have been complied with and that the
association is a company authorized to be registered and duly registered under this Act.
Shareholders
It is interesting to note that while the term member is defined in the Act as a subscriber to the
memorandum of a company and every other person who agrees to become a member and whose name is
entered in the companys register of members, the term shareholder is not defined. It is accepted that a
person who holds shares of a company in his/its name is a shareholder of the company. On his name
being entered on the register of members, a shareholder acquires some specific rights on the company of
which he becomes a member. Shareholders are not intended to, and do not in practice get involved in the
day-to-day management of a company. However, the Act provides for certain supervisory functions to be
undertaken by the shareholders in the form of these rights to attend meetings, appoint and remove
directors and auditors and to obtain financial information as well as approve the balance sheet annually.
The law also provides for various mechanisms for shareholders to enforce these rights, the principal
among them being a suit for minority protection under Section 233 of the Act. The Act has some inbuilt
protection for shareholders in requiring companies to file periodic returns with the RJSC, failing which
the directors and management of the defaulting company are liable to various penalties such as fines, and
in some cases, imprisonment.
The members of a company elect the directors of a company from among their number in the general
meeting. However, this basic proposition of the Act has been eroded by the provisions of the Bank
Companies Act, 1993, the Securities and Exchange Commission Ordinance 1969 and rules and orders
issued thereunder.6 One case in example is that since October 1999 the SEC has been imposing a
condition on each and every consent on prospectus for public issue of shares as follows:
See sections on Independent Regulators and the Financial Sector.
30
Directors from sponsor group shall be proportionate to their actual shareholding in the
paid-up capital of the company. The directors shall be elected from amongst the
institutional investors proportionate to their holding of shares. If holding is more than
5% but less than 10% it will have at least one director in the Board. Representative of the
general investors who do not fall under above categories shall elect their director in the
Annual General Meeting proportionate to their shareholdings.
However, no official notification to the above effect has been issued by the SEC and the condition is
imposed under powers assumed through insertion of section 2CC in the Securities and Exchange
Commission Ordinance 1969. This requirement would appear to be in violation of the right of members
to elect directors as they see fit.
The Act provides for the removal of a shareholder-director by shareholders by extraordinary resolution
before the expiry of his period of office. The shareholders appoint the auditor(s) at each annual general
meeting of the company. Shareholders may remove an auditor before the expiry of his term only by a
special resolution taken in a general meeting.
The shareholders are given the power, acting in general meeting, to alter the memorandum of the
company; to increase, decrease, consolidate or divide all or any of its shares, to convert paid-up shares
into stock and reconvert stock into paid-up shares, as well as subdivide shares. The shareholders may
also cancel shares which have not been taken or agreed to be taken by any person.
Different classes of shares may be provided for in the articles of association of the company. Companies
may issue shares with special rights attached to them. Investors in public limited companies are able to
find out about the voting rights attached to it through the prospectus, which is published before the initial
public offering (IPO). Such rights may only be varied upon an affirmative vote by the holders of that
particular class of shares; the variation is subject to challenge in court by holders who do not agree to it.
The right to dividends is perhaps the right which most concerns shareholders, and recently has been in
public focus for many reasons. In accordance with the law, dividends are declared by the shareholders in
the general meeting but may not exceed the amount recommended by the directors. No dividend shall be
paid otherwise than out of profits of the year or any other undistributed profits. The declared dividend
must be paid within two months of such declaration. However, in recent years the annual general
meetings of several high-profile companies have been disrupted by shareholders demanding larger
dividends than that recommended by the board of directors. The meetings have been held up until the
directors have met and resolved to recommend a higher dividend, which is then approved and declared by
the shareholders. This practice is not strictly legal. The SEC has had occasion to take action against
companies in whose meetings these events have taken place.7 On the other hand, the SEC has also forced
directors to commit to personally pay dividends to shareholders when profit has failed to reach a certain
level.8 This would appear to be in violation of the requirement that dividends only be paid out of profits
and would seem to exhibit a fundamental misunderstanding of the concept of equity ownership. In either
case, the SEC is interfering in an arena that should be within the decision of company managers, not a
regulator.
General Meetings
General meetings of a company are the fora where shareholders can raise their concerns and make their
influence felt over the management of a company. A company must hold at least one general meeting of
7
8
The 2001 AGM of BEXIMCO Pharmaceuticals Ltd. is one example.

Prospectus of Meghna Condensed Milk Industries Limited. June 28, 2001, page 6 and the Daily Janakantha.
31
its shareholders, normally called the annual general meeting (AGM), in every calendar year. If an AGM
is not duly called, then the RJSC or the Court may authorize the holding of the meeting out of time. In
some circumstances, holders of at least 10% of the shares of a company can require an extraordinary
general meeting to be called and held.
For a general meeting (AGM or EGM) to be valid all members of the company must be served with the
notice of the meeting. The location of the meeting is decided by the directors, but should normally be at
the registered office of the company, so that all the books and records are at hand. In Bangladesh, space
constraints mean that general meetings are often held other than in the registered office of the company.
The quorum requisite is generally provided in the articles. There are usually no veto provisions regarding
company meetings. Unless otherwise specified in the Act or the articles, decisions are by a simple
majority.
In an AGM, the agenda must include the following items, and may include other items as necessary:
Approval of the annual report and audited accounts of the company
Appointment of auditors
Resignation by rotation and appointment of directors (as required)
Special majorities of three-fourths of the shareholders present and voting are required for passing special
and extraordinary resolutions. These special majorities give a measure of protection to shareholders,
particularly in widely held companies, in that there is a lower possibility of decisions being forced
through by brute majority.
A special resolution is required for the following reasons, among others:
To change provisions of the objects clause of the memorandum of the company
To alter or add to the articles of association of the company
To reduce share capital
To reserve capital
To remove a director from office
To remove an auditor before the expiry of his term
On winding up through the Court
An extraordinary resolution is required for the following reasons, among others:
For a voluntary winding up because of excess liability
To sanction all arrangements between a company and a creditor
Votes are counted by a show of hands by the Chairman of a general meeting. Shareholders present may
demand a poll on any question other than election of the Chairman of the meeting or the adjournment
thereof. If a poll is demanded the number of votes is counted on the basis of the voting shares held by
each person present and voting on the issue. This allows a single person holding a large number of shares
(or proxy) to have adequate weight in the decision-making process in proportion to his investment in the
company.
All the companies interviewed for the survey held AGMs regularly in the last three years and nearly all
public listed companies claimed that they allow non-members to be proxies at AGMs. This flexible
proxy policy more easily allows shareholders to exercise their voting rights.
Although all these provisions of the Act are intended to allow shareholders a voice in companies, most
companies in Bangladesh, whether private or public limited, and in fact many listed companies, are
closely held. Small groups of shareholders own or control the majority of shares, and by using that
32
majority, control the decision-making processes of the companies. This is no different from company law
regimes in most other countries. It has been seen recently that the SEC is keen to ensure the rights of
minority investors, but sometimes disproportionately at the cost of the majority shareholders in listed
companies.
The perception of AGMs amongst the non-banking listed companies surveyed seems to be a combination
of a necessary evil and a statutory requirement. A moderate number, i.e. 38%, see it as an effective forum
for shareholders. Generally, shareholder demands concentrate either on higher dividends or trivial
concerns like better quality food and gifts at the AGM and transportation allowances. In reaction, the
SEC has recently made any distribution other than dividend at AGMs, including food and gifts, illegal.
This, however, landed one company in trouble as their distribution of shares in specie was initially
refused consent from SEC and delayed, purportedly since it went against the rules. The main incentive
for attendance is the meal served at an attractive hotel and, surprisingly, trading activity increases prior to
AGMs to reflect that interest. There are, in reality, a very limited number of people going to AGMs who
actually understand the financial statements being presented and, consequently, have little to contribute in
terms of relevant inputs. In fact, other than one company (which received concrete recommendations
regarding accounts preparation) and one bank (which received insightful questions on branch locations
and staff benefits), none of the CEOs could recall receiving relevant feedback from their shareholders.
There is widespread justifiable suspicion that the directors or controlling shareholders of, usually, underperforming listed companies, employ hand-picked friendly shareholders, who are often stock exchange
members holding nominal shares in the companies, to intervene in the proceedings in order to manage
favourable comments and passage of resolutions. Another method of interference is by groups of
musclemen who routinely try to force companies to grant them contracts for advertisements and services
and offer to arrange peaceful AGMs in return. If the companies do not comply, these people infiltrate
AGMs, often by purchasing one share, and disrupt the proceedings. There are some common faces
sighted in almost every AGM that are quite vocal in either fomenting or suppressing dissent, as the case
may be. The SEC has now banned any distribution of food or gift item at the AGMs and made video
recording of the proceedings mandatory, but the effectiveness of these steps remains to be seen.
The banks interviewed claim to have more positive experiences at their AGMs. While one bank referred
to the usual problem of managed AGM pressures, the other three mentioned that this problem is not as
acute as in the corporate sector.
Directors
The directors of a company are entrusted by law with the management of the business of the company.
The principle of separation of ownership and management underlies this provision. However, since
companies are usually closely held in Bangladesh, most of the directors are also substantial shareholders.
This can and often does result in holders of less than 10% of the shares being left out in the cold, and
discourages small investors from investing in shares.
The members of a company elect the directors of a company from among their number in the general
meeting. There are no further rules about the election of directors in the Act. However, recent SEC rules
have required that institutional shareholders having at least 5% of shares hold a seat on the board. This
provision may have the same effect as a cumulative voting rule. Every public company and a private
company which is a subsidiary of a public company must have three directors. The law provides for
directors to hold qualification shares, and for disqualification of persons from being directors.
The Act makes it void for the articles of the company or any contract with the company to make any
provision indemnifying any director, manager or officer against any liability which by virtue of any rule
of law would otherwise attach to him in respect of any negligence, default, breach of duty or trust.
33
Moreover, the Act provides for restrictions regarding the making of any loans, guarantee or security by a
company in connection with a loan made to a third party where any director of the company is also a
director or managing agent of the third party. Exceptions are made, among others, in the case of a
banking company or a private company not being a subsidiary of a public company, or a holding
company in relation to its subsidiary, and if the loan is sanctioned by the board of directors of the
lending/guarantor company and approved by the general meeting and in the balance sheet there is a
specific mention of the loan. However, in no case shall the loan exceed 50% of the paid up value of the
shares held by such director in his own name. A fine and imprisonment are prescribed as penalties for
contravention of these provisions, and a loss of directorship may also result. But, experience would
appear to show that these are more honoured in the breach than observance.
Directors who are interested in any contract or arrangement entered into by or on behalf of the company
are required to disclose their interest and, in some cases, to desist from voting on any such decision; their
presence would not be counted towards a quorum for that purpose. However, the penalty for
contravention is a fine not exceeding Tk. 5,000. It is not clear whether such contracts would be treated as
void or not. Companies are required to keep a register in which particulars of all such contracts or
arrangements shall be entered and which shall be open to inspection by any member of the company at
the registered office of the company during business hours. Again, contravention results in a fine not
exceeding Tk. 1,000. These fines cannot be considered to be a sufficient deterrent to such conflicts of
interest.
The term managing director has been defined in this Act as a person entrusted with the main powers of
management of a company under a contract with the company, or any decision of the general meeting or
Board of the company or by the provisions of its Memorandum or Articles, which powers he would
otherwise have been unable to exercise. The appointment of managing directors is regulated for the first
time in the Act. In the case of public companies, a person cannot be appointed as a managing director if
he is the managing director of another company. Even then such appointment requires the consent of the
company in general meeting. The government, however, is empowered to relax this prohibition if it is
satisfied that the companies should for their proper working be operated as a single unit and have a
common managing director. The term of office of a managing director cannot exceed five years at a time.
The company in a general meeting may extend the term not exceeding a further five years. Stringent
provisions have been introduced prohibiting compensation to directors for loss of office, so as to prevent
collusive arrangements between companies and individuals resulting in unjust enrichment of the latter.
In an overwhelming majority (i.e. 73%) of the non-bank listed companies interviewed in the survey, the
board is heavily dominated by sponsor shareholders who generally belong to a single family the father
as the Chairman and the son as the MD is the norm. The boards are usually actively involved in
management - in 50% of the companies, there is more than one executive director on the board. Only one
of the MDs interviewed is not a voting board member. One noteworthy trend seen in the survey was that
even in companies where the MD is a sponsor shareholder, he is well educated with good qualifications.
What this reflects is an increased level of sophistication, awareness, and knowledge of sound business
practices in the second generation of business leaders.
Most of the day-to-day operational functions are delegated by the board to management the only powers
retained by the board are extraordinary decisions of write-offs, dividends, auditor selection, new
business/investment activities, etc. A majority of the companies interviewed have neither alternate
directors nor provisions for them. The board is mandated by law to hold at least one meeting every
quarter, but no legal sanctions are provided for failure to hold meetings. Companies interviewed in our
survey all claimed to hold board meetings quarterly.
34
Suggestions from survey participants as to how board performance can be improved ranged from
increasing the frequency of board meetings to holding training sessions, to imposing punitive penalties for
violation of laws to implementation of a well-defined selection process for board members. In cases
where the government or financial institutions send nominee directors, this is even more important.
Opinion was mixed on the necessity of directorship ceilings. Those favouring a ceiling recommended a
number in the range of five to ten. People who advocated against a ceiling cited reasons like companies
should themselves judge whether they want a person on the board and boards of subsidiary companies
are often symbolic so there shouldnt be any limits.
Independent Directors
In developed countries, scholars often think of good corporate governance as revolving
around such matters as subtle variations in the independence of directors, or the
constraints on the corporate control market. In developing countries, corporate
governance can be much more basic. We need honest judges and regulators before it
make sense to start worrying too much about independent directors.9
This comment perfectly summarizes the general corporate scenario in Bangladesh. In fact, there have
been several examples (including SABINCO mentioned later in this report) where independent/nonexecutive directors themselves engaged actively in underhand dealings and insider trading for personal
gains.
Of course, debate rages on what constitutes an independent director, and why any person who did not
stand to benefit from the performance of the company (a person who stands so to benefit would in all
probability no longer remain truly independent) would accept the onerous responsibilities placed upon a
director by the company law.
In the context of Bangladesh, directors who would fit the definition of independent in Bangladesh are
often current or former government officials or bureaucrats. They are appointed to help the company get
licenses or as payback for previous favours. Very few independent directors are appointed for their
expertise and the priority in appointing directors is usually their personal connections to company
management or having connections that can be used for the company in the future. When boards need an
independent opinion they rely on employing outside consultants or advisors. Therefore, in the context of
Bangladesh, independent directors do not serve as an advocate for minority shareholders or as a source of
new and different ideas. The Act also does not provide for or recognize independent directors, since a
minimum number of shares is required to be held by any director other than the MD.
Participants in BEIs seminar on Strengthening Corporate Governance also expressed concern about
defining an independent director and stated that there should be guidelines for inclusion of independent
directors on the boards of listed companies. Furthermore, as mentioned later in the Banking Sector
section of this report, it is common for banks to require personal guarantees of directors. Persons serving
as independent directors should be recognized professionals but they should not be required to provide
personal guarantees for loans. Seminar participants also thought that independent directors should be
indemnified from any civil or criminal proceedings arising out of their role as an independent director.
Chittagong Cement Clinker Company
In October 2002, the Securities and Exchange Commission (SEC) served a show cause notice on
9
Black, Bernard The Legal and Institutional Preconditions for Strong Stock Markets: The Nontriviality of
Securities Law, Corporate Governance in Asia, OECD, 2001.
35
Chittagong Cement Clinker & Grinding Company Limited on charges of violating securities law in
appointing an auditor for a publicly traded company who had been engaged in other affairs of the
company. Hoda Vasi Chowdhury, the auditor, had previously acted as the valuation consultant as well as
financial advisor to the company. In his defence, AK Chowdhury, managing partner of Hoda Vasi
Chowdhury & Co, said there is no such legal bar. "And since there is no bar, so no offence has been
committed," Chowdhury added.
Chittagong Cement has had its share of problems in the recent past. In June 2002, Chittagong Cement
informed the SEC that the company would take over Scancement International Ltd and Scancem
Bangladesh Ltd through process of amalgamation. Heidelberger Zement AG owns both Scancement
International Ltd and Scancem Bangladesh Ltd - and also has 51 per cent holding in Chittagong Cement.
The proposed amalgamation will be accepted if two third shareholders of the company approve it at the
EGM. The SEC soon after directed the company to inform its shareholders that Chittagong Cement could
be burdened with Tk 129.2 million in liabilities after this amalgamation - potentially benefiting the
controlling shareholders at the cost of minority shareholders. The SEC also launched an investigation
into the affairs of the company where the committee observed that the amalgamation of "Scancem
Bangladesh Ltd, with no assets backing [it] but with a liability equivalent to a huge negative net worth of
Tk 129.2 million, would go against the interest of the investors. Moreover, Scancem Bangladesh Ltd's
historical profitability from normal operational activities was negative."
Earlier, during January to February 2000, newspapers reported that the sponsors/directors of the company
were engaged in insider trading they had sold large amounts of their holdings driving market prices
down, and had subsequently bought back shares and resold 26% of total equity to a foreign institution
yielding a huge net gain of Tk 520 million for the sellers. A detailed, confidential enquiry report accessed
by the CG Team showed the following findings:
An MoU regarding the transfer of shares in the company by the major shareholders was not
released to the stock exchanges for five months after execution. The persons who had signed the
MoU were in the position of chief executives (Chairman / Managing Director / Director), yet had
failed to comply with the following listing regulations of both the DSE and CSE: A listed
company shall supply the Exchange with immediate effect any proposed change in the general
character or nature of business of the company or of any subsidiary thereof and particulars of any
offer or proposals for the purchase or sale of any controlling interest or any substantial part of the
assets of the company or of any subsidiary thereof and of the decisions of the Board in that
regard.
The chief executives had failed to obtain prior approval from the SEC, through the DSE/CSE,
regarding their planned share transfer as per the following regulation: All shares of public
companies listed with the Exchange shall be sold on the trading floor of the Exchange. Provided
however where the transaction of such shares are intended to take place under exceptional
circumstances in private or are to be transferred by way of gift, the broker, member, or seller shall
apply through the Exchange to the SEC for prior approval.
The stock exchanges had failed to ensure compliance of these regulations and to penalise the
contraventions.
This case highlights two key problems in the corporate governance framework. First, regulators failed to
act to protect investors, even though there would appear to be adequate evidence of wrongdoing. Second,
the auditor in this case was not independent from the company being audited, but no action was taken to
ameliorate the situation. There has been no known action by the regulators on the basis of the enquiry
report. It should be mentioned that the people involved in this case were all well respected leaders of the
36
business community.
(Source: Financial Express, Daily Star newspapers)
Prospectuses
The provisions relating to prospectuses have been streamlined in the new Act. The provisions in the body of
the Act spell out the responsibilities and liabilities of persons regarding misstatements or omissions in a
prospectus, as well as the contents in a broad outline. Under the previous law, civil and criminal liabilities for
misstatements in a prospectus were dealt with very generally, and were virtually limited to actions for fraud
which the aggrieved person had to prove. The new Act has an interpretation clause whereby a statement will
be a false statement if the manner and context in which it is included in the prospectus is misleading, and if
deliberately to mislead something is omitted from the prospectus, then the prospectus will be treated as
containing a false statement regarding the omitted matter. Criminal liabilities are specified for misleading
statements as well as for fraudulently inducing a person to invest money in a company.
Most, if not all, of the provisions as regards to issue of prospectus as appearing in the Companies Act 1994
have since been altered or made redundant through the SEC (Public Issue) Rules 1998 and various other
notifications from time to time, as well as the arbitrary imposition of other conditions on a case to case basis.
In fact the SEC Rules override the Act in many instances.
Modern Food Products Limited
Modern Food Products Limited, an herbal food producer with a poor reputation in the market, invited
public subscription during July 16-30, 2000 for Tk. 30.0 million. The issue gained SEC approval with
amazing alacrity, despite noises about the authenticity of some information furnished in the prospectus.
On July 7, a non-bank financial institution came with a claim of default loan of over Tk. 10.0 million due
from the company, which was intentionally underreported in the prospectus. The SEC seemed to have
failed to obtain a CIB report from the central bank regarding the companys default loans. After the
default situation came to light, the SEC was compelled to withhold the approval on July 12 and then
cancel it on July 30 and ask the company to reimburse the pre-IPO money to the investors. The auditors
also claimed that the company did not comply with the BAS-4 and BAS-16 regarding fixed assets. The
issue never went to the market, but some investors are yet to be reimbursed for their pre-IPO subscription
money.
Modern Food Products illustrates the inability of the regulatory authorities to fully verify and confirm
disclosures provided in a prospectus. In this case, involved parties made additional information available
to the public, but the example begs the question of how many other similar cases are not caught.
Protection of Minority Shareholders
The Act enables minority shareholders to seek remedies in Court and also enlarges the powers of the
Court to pass appropriate orders. A member or debenture holder of a company may either individually or
jointly bring to the notice of the Court by application that the affairs of the company are being conducted
in a manner prejudicial to one or more of its members. However, such an application must be brought by
members holding not less than one-tenth of the shares issued in the case of a company having a share
capital and not less than one-fifth in number in the case of a company not having a share capital. If after
hearing the parties the Court is of the opinion that the interest of the applicant(s) are being prejudicially
effected it may pass any order it deems fit including cancelling or modifying any resolution or
37
transaction, regulating the affairs of the company in future as specified in the order or amending any
provision of the memorandum or articles of the company.
The requirement of one-tenth of the shares as a threshold for bringing a minority protection action has
been much discussed. A threshold is certainly required to prevent persons with very small stakes in a
company from holding the company and larger investors to ransom by bringing vexatious actions in
court. Minority protection actions are filed in court in Bangladesh with some regularity, although a large
number of these are later found to be vexatious or not in fact relating to issues covered under the rubric of
minority protection.
In certain circumstances, a shareholder may also be able to bring an action in court to wind up the
company on the ground that it is just and equitable to do so. This, of course, is an extreme measure, and
the burden of satisfying the court is high.
It is, however, often seen that shareholders do not know all the rights provided to them by the company
law, and are unaware of the enforcement provisions. In particular, many shareholders do not know about
Section 233 and the minority protection regime.
Disclosure
The information disclosed by a company to its shareholders and to members of the public in accordance
with the disclosure requirements of the law is practically the only tool shareholders and investors have to
judge the performance of a company and monitor the activities of the directors and management.
Therefore, these provisions are of cardinal importance, and should be subject to strict enforcement. Due
to various reasons, including lack of knowledge on the part of the persons responsible to maintain the
records, shareholder apathy, lack of proper monitoring by the RJSC, lack of quality auditing services,
often the disclosures are not accurate or complete.
Every company has the obligation to keep proper books of account with respect to all sums of money
received and expended by the company, all sales and purchases of goods, the assets and liability, and
other overhead costs of the company. The books of account should be kept at the registered office of the
company and should be available for inspection during office hours for directors and any authorised
Government officials. Failure to comply with these provisions makes the relevant persons liable to
imprisonment and/or fine.
The Board of Directors of the company are obliged to lay before the company a balance sheet together
with the profit and loss account at every AGM. The balance sheet together with the profit and loss
account is to be audited by the auditor of the company and the auditors report is to be attached thereto
and read before the company in general meeting. Moreover, the Boards report is to be attached to the
balance sheet and is to provide information regarding the companys affairs, the amount the Board
proposes to reserve in such balance sheet, the amount to be paid out as dividend and any material change
and commitments which may change the financial position of the company. The balance sheet must
contain a summary of the property and assets and of the capital and liabilities of the company as at the
end of the financial year. Every balance sheet as well as the profit and loss accounts shall be signed on
behalf of the Board of Directors by its managing agents or secretary and by not less than two directors,
one of whom must be the managing director. Every member is entitled to a copy of the balance sheet
including profit and loss account, the auditors report and every other document required by law fourteen
days before the meeting free of charge.
The RJSC is empowered to call for information, explanation or to produce such books or papers, as the
Register deems necessary. The Government may also appoint inspectors to investigate into the affairs of
38
the company upon application of members holding at least 10% of the shares. These provisions are
seldom invoked.
Auditors
The Board of Directors of a company is required to appoint auditors within one month of the registration of a
company. Thereafter, auditors are appointed in general meeting. Only Chartered Accountants may be
appointed as auditors. The auditors shall have access to all books and papers. The scope of inquiry of the
auditors is elaborately spelt out in the Act, as well as the nature of the certification the auditors must provide.
Apart from the general power to audit the auditors are now required to specifically investigate the following
matters:
Whether advances or loans have been properly secured, and whether the terms on which they have
been given are harmful to the interests of the company or its shareholders;
Whether the book-transactions of the company are harmful to the interest of the company;
Whether the assets of any company other than an investment or a banking company have been sold
at a value lower than that paid through shares, debentures or other securities through which they were
purchased;
Whether loans given by the company and advance deposits made by the company have been shown
in the accounts;
Whether personal expenditure has been included in the revenue account;
Where any books of the company show that shares have been allotted for a cash consideration,
whether that consideration has in fact been received in cash, and if so whether this has been properly
reflected in the accounts and the balance sheet.
These are in line with the modern practice worldwide for certification.
The auditors now have the right to receive notices and attend all general meetings of the company and not
only the general meeting in which the accounts are placed. This is intended to allow the auditors to more
closely supervise the affairs of the company. An auditor must certifying that, to his knowledge and from the
explanations provided to him, he is satisfied that the Auditor's Report contains all the information required by
law and that the balance sheet and profit and loss accounts present a true and proper picture of the affairs of
the company as at the end of the financial year. The auditor must also state whether to his best knowledge
and belief he received all the information and explanation which were necessary for his examination, whether
in his opinion all the necessary books and records as required by the law have been properly maintained,
whether he obtained adequate information from the branches or parts of the company he did not audit, and
whether the balance sheet and profit and loss accounts audited by him bear any relation to the actual accounts
books and records of the company.
It needs to be emphasized that the auditor must now specifically state whether, in his opinion and to the best
of his information and according to the explanation given to him, the said accounts give the information
required by the Act in the manner so required and give a true and fair view in the case of the balance sheet,
of the state of the companys affairs as at the end of its financial year; and in the case of the profit and loss
account, of the profit and loss for its financial year.
While the Act prescribes that books of accounts shall be maintained by companies, and balance sheets and
profit and loss accounts prepared, there are no specific provisions in the body of the Act or the schedules
providing detailed guidelines on what information should be included in these books, and how various
incomes and expenditures should be booked. In the case of publicly listed companies, the Securities and
Exchange Rules 1987 provides in detail for the contents of the annual report and profit and loss accounts
39
required to be submitted by issuers of listed securities as required by the SEO 1969. It includes provisions on
the classification of the assets and liabilities of the company, distinction between tangible and intangible fixed
assets under several sub-heads, investments, loans, advances, current assets, capital and reserves etc. The
provision of such details and maintenance of books and records accordingly by all companies would assist
the auditors to conduct proper audits. It would also assist other persons to ascertain the actual state of affairs
of the company concerned.
Furthermore, there is no requirement under the Companies Act for boards to have an audit committee that
will oversee the external auditors. (See Role of Audit Committees and Risk Management Arrangements
under the Independent Regulators.)
Throughout the survey of the stakeholders, the common point of concern was that audit reports, except for
those of multinational companies and very reputable local companies, do not reflect a true and fair view
of the state of the companys financial affairs. The auditors, except for the very few reputed chartered
accountancy firms with tie-ups with international auditing firms (which of course after the Arthur
Andersen affair is no longer a fool-proof guarantee of quality and probity), do not fully know, understand
or apply the Bangladesh Standards on Auditing, let alone the International Standards on Auditing (ISA).
In any event, the Bangladesh Standards on Auditing, although certain ISA norms have been included over
a period of time, are not a fully satisfactory set of standards to be followed. Lawyers and accountants
carrying out due diligence of local companies for mergers, acquisitions or other purposes are more often
than not presented with unsubstantiated books of accounts (where there are any at all). It was a widely
held view among stakeholders that rigorous auditing practices would improve corporate governance in
large measure almost immediately.
Court and Government
The Court having jurisdiction under this Act is the High Court Division of the Supreme Court of
Bangladesh. The Court comes into the picture, as has been mentioned above, in the confirmation of
amendments to the object clause of the memorandum of association of a company, rectification of the
share register, confirmation of reduction of share capital, and very importantly, in the exercise of its
jurisdiction to protect the interest of the minority under Section 233 of the Act.
Other than these, the Court has extensive powers in an application for winding up a company by the
Court, which may be done in the following circumstances:
If the company has by special resolution resolved that the company be wound up by the Court;
If default is made in the filing of the statutory report or in holding the statutory meeting;
If the company does not commence its business within a year from its incorporation, or suspends
its business for a whole year;
If the number of members is reduced, in the case of a private company, below two, or in the case
of any other company, below seven;
If the company is unable to pay its debts; or
If the Court is of opinion that it is just and equitable that the company should be wound up.
The Court has a judicial discretion as to whether it will wind up a company on any of the above grounds.
The ground of a company being unable to pay its debts is a potent one invoked by creditors when all else
fails in getting a company to pay sums due and owing. The just and equitable ground give the Court a
wide discretion in winding up a company, and judicial decisions abound in identifying when it may be
just and equitable to wind up a company. The Court will consider the interests of the shareholders as well
as the creditors, and has to form an opinion as to the equity involved. Equity holders with less than 10%
40
of the equity, who would not have standing under Section 233 of the Act, may apply for winding up a
company, subject to having held shares for a specified period of time.
Petitions for winding up of a company on the ground of its inability to pay its debts are subject to extreme
scrutiny at the preliminary hearing for admission of such petitions, as such petitions are often perceived as
a method to coerce a company into paying a particular debt or debts owing to the petitioner. The first
petition for winding up a financial institution, an insurance company, was admitted for hearing in 2001
but settled out of court, and was followed by another petition for winding up of another insurance
company admitted for hearing in 2002. The admission of the two petitions reflect a significant and
welcome shift in judicial approach to petitions for winding up of inability to pay debts of financial
institutions on equal footing with other companies.
The Government has the power, under the Act, to authorize a Government officer to inspect the books of
account and other books and papers of every company. It is the duty of every director and other officer of
the company to give to the inspecting person all reasonable assistance in connection with the inspection.
The Government also has specific powers under the Act of inspection and audit; it may appoint inspectors
to investigate and report on the affairs of any company, on the application of members not having less
than 10% of the shares issued. In the case of companies without share capital, government investigation
can be triggered by the application of not less than one-fifth in number of the persons on the register of
members and, in other cases, on a report by the Registrar. The Government must be satisfied on evidence
that the applicants have good reason to ask for such inspection. The company may also, by a special
resolution, make such an application. Such an investigation and audit may lead to criminal prosecution,
winding up, proceedings for recovery of damages or property, etc. However, these powers have rarely
been invoked in Bangladesh.
Financial sector scenario and governance
This section addresses and is limited to the issues the Project Proposal. It focuses on forces within the
banking sector, capital market, and insurance sector that have the most effect on corporate governance.
An analysis of all aspects of the financial sector relating to loan disbursement, classification and recovery
is not within the scope of this study.
The Banking Sector
Financing for commercial purposes in Bangladesh is largely obtained by borrowing, mainly from banks
and financial institutions, rather than through equity or capital market products. Therefore, the primary
stakeholders in corporate governance are creditors, particularly lenders. Factors influencing the
effectiveness of regulation of lending institutions, access to finance and recovery of debts can be better
understood with an appreciation of the participants in the financial sector.
Types of Lending Institutions
Lending institutions are broadly categorised into two types: (i) banks, which conduct banking business,
and (ii) non-banking financial institutions, which conduct financing business within a more specific
domain than commercial banks. Non-banking financial institutions are prohibited from accepting
deposits payable on demand by cheque or otherwise. This category includes leasing and housing finance
companies. Banks are broadly classified as: (i) nationalised commercial banks (NCB), banks transferred
to the government upon the independence of Bangladesh; (ii) specialised banks, banks established by
statute; (iii) private commercial banks (PB), privatised NCBs and new banks established after the
independence of Bangladesh; (iv) foreign banks, which are branches of banks incorporated outside
Bangladesh; and (iv) co-operative banks. (See Appendix K for a list of financial institutions.)
41
Type of Financial Institution

Non-Bank Financial Institutions
State-owned commercial banks
Specialised and Development banks
Private commercial banks
Islamic Private commercial banks
Foreign commercial banks
Number of
Institutions
28
4
11
26
2
10
Apart from NCBs and specialised banks, lending institutions are public companies with limited liability
and a certain portion of their shares are required to be listed on a stock exchange in Bangladesh. NCBs
are burdened with outstanding debts that were existing at the time of expropriation and are also mandated
by the government to lend to specified sectors, regardless of risks involved or likelihood of recovery. PBs
are patronised by political figures, and their family members or favoured business associates compose the
boards of directors. Many PBs serve as house banks to domestic business groups of the promoters
(sponsors), and financing extended by PBs to sponsors or their preferred customers is customarily in
default for extended periods of time. Although the Bank Company Act 1991 restricts the proportion of
shareholders belonging to a "family", shares held on trust as nominee of another person ("benami") are
difficult to detect, with the result that through indirect influence the management of most banks is
effectively under the control of a few persons. Foreign banks maintain far more restrictive lending
approaches than PBs. Credit assessment at foreign banks is based on their global credit policies and
conditioned on the inadequate legal environment for debt recovery and enforcement of collateral. Such
requirements form the basis of their reluctance to extend long-term or project financing facilities.
Central Bank
Fiscal and monetary regulations and policies in Bangladesh are introduced and overseen by the Ministry
of Finance. Lending institutions are regulated by the central bank of Bangladesh, Bangladesh Bank10,
established by the Bangladesh Bank Order 1972 (P.O.127 of 1972). Although regulated by the Ministry
of Finance, Bangladesh Bank has reputedly a large measure of autonomy compared with other
government bodies. Recently, Bangladesh Bank has been granted additional autonomy, with the
Governor accountable to a parliamentary standing committee instead of the Ministry of Finance.11 The
Board of Directors of Bangladesh Bank is nominated by the Government from officials in the service of
Bangladesh Bank or other banks, and the Board is comprised of a Governor, one Deputy Governor, four
Directors nominated by the Government from the private sector with relevant experience and three
Government officials, presently of the rank of Secretary. The Governor functions as the chairman of the
Board and chief administrative officer. Recently, the Governor has been a professional appointed from
the private sector and, for the first time, an outsider and a former head of a branch of a foreign bank in
Bangladesh has been appointed as a member of the Board. These steps are measures to inject experienced
professionals into Bangladesh Bank and gradually instil appropriate managerial skills in running what is
essentially a bank. The Deputy Governor and Executive Directors are recognised as possessing abilities
to understand modern banking concepts, having attended leading western universities. The remaining
majority of officers lack adequate formal training and education in banking and central bank functions,
but exert a large measure of indirect influence in that members of the Board are reluctant to take decisions
or actions contrary to comments of these officers.
Bangladesh Bank regulates the operation of banks and financial institutions on the basis of powers vested
by the Bangladesh Bank Order 1972 and the Bank Company Act 1991 (as amended to date), and through
10
11
http://www.bangladesh-bank.org
Cabinet okays limited BB autonomy Daily Star, January 7, 2003.
42
directives, circulars and circular letters which are issued independently by its various divisions.12
However, there is a dearth of public information regarding current circulars and directives. Circulars are
distributed only among banks and financial institutions and are not published for public information.13
For instance, a compilation of guidelines for foreign exchange transactions published by Bangladesh
Bank is neither legally effective nor enforceable, and such transactions are controlled by specific
circulars.14 The result is that prospective customers are not independently informed of Bangladesh Bank
rules and banks are at times served with notices from Bangladesh Bank for violations of old circulars.
Recent proposals by the International Monetary Fund and World Bank for reforming the operations of
Bangladesh Bank, which are still under consideration by the Government, include measures such as,
requiring members of the governing board of Bangladesh Bank to be appointed by Parliament, a requisite
of ten years banking experience of the members of the governing board, and granting full autonomy to
Bangladesh Bank to counter political interference. The World Bank as part of its reform package has also
suggested downsizing the large workforce, making senior officer positions redundant and automation at
Bangladesh Bank; this has met with resistance by the unions.15
Bank Requirements, Problems, and Reforms
Although Bangladesh Bank has introduced a Lending Risk Analysis (LRA) procedure for loans above a
certain amount, smaller loans do not require mandatory credit assessment before sanction or disbursement
of credit facilities, which is a recognised factor contributing to difficulties in recovery of defaulted loans.
To facilitate informed credit decisions by banks, the Bank Company Act 1991 includes provisions for
distribution and publication of lists of loan defaulters. When the initial publications of such lists
occurred, the lists were criticised and allegations of libel made against the publishing newspapers. As an
alternative, a separate department was established at Bangladesh Bank, the Credit Information Bureau
(CIB), which centralises information on borrowers credit limits, security, and any defaults. The
effectiveness of CIB reports is hampered by delays in updating information and disclosure only to
requesting banks. This makes it difficult to discover and correct mistakes; corrections have, at times,
required judicial orders. Survey results also reveal that cash incentives are often required to obtain CIB
reports in the normal course of business. Weaknesses in the CIB system often lead to delayed loan
approval, if not outright loan rejection.
The Bank Company Act 1991 has had a measure of impact on the disbursement of loans in requiring the
approval of Bangladesh Bank for loans above a certain percentage of a bank's capital and for rescheduling
above certain amounts. But confusion continues to exist on the methodology for calculation of a bank's
capital and circulars have imposed additional conditions on the statutory lending limits, which is beyond
its powers. A popular debate is centred on the rates of interest and charges levied by banks for
transactions. Allegations of pressure tactics for pecuniary benefits for processing transactions and
sanctions are quite common. This is a factor hampering timely settlement of loan liabilities, as a fairly
good percentage of the amount disbursed may be allocated for such extra payments. The result is that
although foreign banks have higher rates and charges, borrowers prefer to pay the premium for quicker
transaction turnaround rather than spend extra time in dealing with local banks. The challenge is in the
ability to gain entrance into foreign banks which have more strict credit controls.
Furthermore, there are no statutory provisions on duties of directors of companies, bank companies or
financial institutions, nor on their qualifications other than shareholding. Bangladesh Bank has been
12
Banking Regulation and Policy Division (BRPD), Exchange Control Division (ECD)
Circulars from 1990 stated to be available at the website of Bangladesh Bank, http://www.bangladesh-bank.org,
are not readable.
14
Guidelines to Foreign Exchange Transactions as of December 31, 1996.
15
The Financial Express, October 23, 2002.
13
43
steadily issuing circulars outlining the duties and responsibilities of directors of banks, in recognition of
their fiduciary duties as directors and protection of the interests of depositors. Bangladesh Bank has
recently displayed increased activism in the administration of banks by exercise of its statutory powers of
removal of chairman, directors or chief executive officers of banks, which have survived judicial review.
To facilitate more effective regulation, a suggestion has been made for statutory recognition of directors'
duties for all companies, with emphasis on their individual and collective accountability. Bangladesh
Bank has further proposed that the number of directors be limited to eleven and that BB appoint two
independent directors to each bank board to represent depositors; amendments to implement these new
rules will be considered by Parliament in 2003. The proposals regarding bank boards have been met with
opposition from the Bangladesh Association of Banks, which considers them to be in violation of the
rights of shareholders and the Companies Act.16
Other areas in which Bangladesh Bank has been increasingly active include the selection of auditors,
accounting standards, and actions taken after investigations. First, in 1998, Bangladesh Bank required
that the auditors of banks be changed every three years, in a move appreciated by banks, to serve as a
check on auditors' performance.
Second, Bangladesh Bank has pursued investigations into bank affairs and transactions and taken action
against offending bank personnel. But investigations by Bangladesh Bank into affairs or transactions of
banks are often perceived as politically motivated. There are instances when investigations result in
junior officers being forcibly removed and statutorily barred from working in a bank again, while
executive officers with decision making powers are permitted to resign and continue to serve in the
banking sector.
Third, a significant step has been taken by Bangladesh Bank to begin to rationalize the banking sector and
improve financial reporting by banks. From December 31, 2000 banks and financial institutions were
required to comply with the International Accounting Standard-30 (IAS-30).17 The accounting standard
requires banks to disclose the classification of their loan portfolio (as sub-standard, doubtful, or bad)
based on their default activity and make a loan loss provision specifically for classified loans. Banks
must also make a general provision for loans that are unclassified. The new standard requires disclosure
of loans and advances to directors and executives, as well as more information about the various
characteristics of the institutions outstanding loans. Additional reporting is also required with regard to
banks equity, which may begin to clarify the capital situation of banks in the country. Banks and
financial institutions are now required to provide a statement of equity disclosing changes in equity
throughout the year.18 Full and accurate compliance with the disclosure requirements of IAS-30 will
begin to provide more information to bank stakeholders (including management, boards of directors,
customers, regulators, and borrowers) and hopefully create a consensus for reform.
The financial sector can serve as a motivation for better corporate governance through its requirements
and procedures for approving and monitoring loans. Unfortunately, the financial sector has not demanded
better financial performance or better corporate governance from the enterprises to which loans are
extended. This can be seen most clearly in the statistics on classified loans; classified loans as a
percentage of total loans outstanding for NCBs, PBs and foreign banks at the end of 2001 were 45%,
16
Private banks smell a rat about govt move to change rules, Financial Express, March 1, 2003.
BRPD Circular No.3, March 18, 2000.
18
Saha, Dr. Sujit and Md. Saidur Rahman. Implementation of International Accounting Standard in Banks and
Financial Institutions Step Towards Sound Governance System. Presented at the Management Forum 2002 on
Institutional Governance: Failure in Building Infrastructure for Socio-Economic Growth Organized by AMDB on
July 25-26, 2002.
17
44
26%, and 4% respectively.19 Writing off long outstanding bad loans is also not a common practice of the
commercial banks and development financial institutions and consequently such loans are carried on the
books for indefinite periods of years, ostensibly in a somewhat misconceived fear that once written off it
would eliminate all avenues of recovery. Bangladesh Bank issued a circular in January 2003 instructing
banks to write off bad debts over five years old, but clarified that banks can and should still pursue
recovery of the bad debts.20
Rescheduling of loans is another option which banks have utilized to deal with classified loans.
Bangladesh Bank has also issued guidelines on rescheduling loans, instructing banks to analyse the
reasons for default and past record of the borrower. This is attempting to avoid the common case of
habitual defaulters repeatedly rescheduling loans. BB also issued a circular in December 2002 directing
banks not to reschedule a loan of a borrower on a bilateral basis when the borrower has default loans from
multiple banks totalling at least Tk. 500 million. In such cases, decisions on rescheduling should be taken
jointly by a committee made up of all the concerned banks and based on the repayment performance of
the borrower. Bangladesh Bank has suggested a permanent committee be formed of CEOs/MDs of all
commercial banks and the Bangladesh Bank Deputy Governor to draw up guidelines for large loan
rescheduling.
Al-Baraka: Fraught with Irregularities
In late September and early October 2002 numerous allegations against Al-Baraka Bank (now Oriental
Bank Ltd) were published in the mainstream media. Headlines read Loans without risk analysis,
sanction letters in a flash and Shady shoddy deals. Al-Baraka Bank was accused of perpetuating poor
lending practices which resulted in 33% of its loan portfolio being classified loans (Tk. 3.2 billion out of
Tk. 9.9 billion). Of the classified loans, Tk. 3.1 billion was bad debt. Regular procedures of risk analysis
and document scrutiny had been bypassed in the past; loans amounting to millions of Taka had been
advanced against accounts opened with as little as Tk. 10,000 on the very same day. Proper analysis of
the capacity of the borrowers to repay was not completed. For instance, credit analysis was not
corroborated by factory visits, stock checking, or collateral verification.
In addition, credit facilities were extended to business houses with prior history of huge loan defaults.
Repeated rescheduling of loans outstanding against one renowned businessman cost the bank Tk. 1.1
billion in terms of lost income and the businessman was only paying 44% of his current liability to the
bank. Other dubious organisations got their credit limits extended from Tk. 15 million to Tk. 49 million
in two months without putting up any additional collateral. Loans were also extended to sister companies
of groups that were already in default and were in areas outside the banks supervision. As a result of
poor lending policies and mismanagement, accumulated losses of the bank amounted to Tk. 864 million
on December 31, 2001.
Uncharacteristic share transfers in early 2002, purportedly the evidence of acquisition by above
mentioned defaulter under guise of a foreign investor, also left the bank in a precarious situation. A Hong
Kong based investor bought out the shares held by the Jeddah based Al-Baraka Investment and
Development Company (34.67%) and five local companies jointly purchased another 27.16% previously
held by a major shareholder. Together, these transfers have given the loan defaulter total board control.
In spite of the grave allegations regarding Al-Baraka, the stock price of the bank actually rose over the
19
Sayeed, Yawer. Bangladesh: Strategic Issues and Potential Response Initiatives in the Finance Sector: Banking
Reform and Development (BRD), Asian Development Bank, July 22, 2002.
20
Bad for five years, write them off, Daily Star, January 14, 2003.
45
period of discussion. The newspapers expos began on September 29, 2002. In the days preceding and
following the publication of the allegations against the bank, the stock price actually increased from
Tk. 1,085 on September 25, 2002 to a high of Tk. 1,240 on October 2, 2002. Thereafter the price
declined, but by mid-October it was still higher than it had been before the newspapers allegations. This
lack of reaction to negative publicity demonstrates the problem of manipulation in the Bangladesh stock
markets. It is possible that investors already knew the facts publicized in the newspapers and that the
stock price had already incorporated the news, but in all probability some front buyers were arranged to
jack-up the price. One would expect that the shares of a bank, for which public confidence is key to
successful operations, would fall on the publication of such damaging information.
When contacted for this study, Al-Baraka Bank officials attributed these instances to genuine mistakes
made by the board and situations that arose because third-parties, like survey companies, misled the
bank. They were vehement in the fact that such mismanagement will not recur in future because
a) Bangladesh Bank is now more stringent in its monitoring and b) CEOs can now take a more firm stand
against the board (as CEOs of financial institutions cannot be removed without Bangladesh Bank
approval).
Legal Framework for Loan Recovery and Bankruptcy
A primary problem in improving the functioning of the banking system is the legal framework for
pursuing defaulters, enforcing security interests, and declaring bankruptcy. Dedicated courts for debt
recovery by banks and financial institutions, Artha Rin Adalat (Money Loan Court) were established in
1990.21 However, they have not yielded the expected accelerated results due to a shortage of judicial
officers and the requirement to enforce judgements by separate judicial (execution) proceedings. A trend
of challenging decisions of the Money Loan Court by judicial review has recently been judicially
disallowed, but appeals against such decisions to the Supreme Court are to wait in queue. The results of
the corporate survey underscore the ineffectiveness of the Money Loan Court. One private banks
managing director pointed out the discrepancy between the practice and the law, saying that the law
mandates disposal of cases in six months, but a case may even take ten years. One judge deals with too
many cases and therefore is not efficient.
Survey results revealed that there is a widespread culture of default on bank loans, and the use of the
Money Loan Court or Bankruptcy Court by banks pursuing loan defaulters does not yield satisfactory
results, particularly with respect to executing judgements against defaulters. Recent directives by the
Bangladesh Bank regarding rescheduling instalment loans also have the effect of condoning delays in
loan repayment.22 To protect their exposure, banks insist on blanket personal guarantees from company
directors before giving out loans, which disregards the separate legal personality of companies without
legislative or judicial sanction to lift the corporate veil and acts as a barrier to enterprise development.
The Securities and Exchange Commission (SEC) has followed suit, and in one instance compelled the
directors of a publicly listed limited liability company to provide an undertaking on the prospectus to the
effect that if the company fails to generate a net profit of Tk. 150 million the directors shall pay for the
shortfall from their personal sources.23 Such an approach detracts from concentration on sourcing debt
repayments from a company's revenue streams and properly evaluating a company's assets for
securitisation.
21
Artha Rin Adalat Ain (Money Loan Court) (Act No.IV of 1990)
23
Prospectus of Meghna Condensed Milk Industries Limited. June 28, 2001, Page 6 and the Daily Janakantha
22
46
The main obstacles to enforcement of security interests by banks include: inadequate expertise in
valuation of property, lack of complete and centralised public information on charges on property of all
types of debtors, maintenance of manual records at existing dispersed registries, lack of legal provisions
for immediate possession and/or sale of secured property without judicial order, delay in obtaining final
judgments for enforcement of security interests, and the enforcement of judgments by separate judicial
(execution) proceedings by controversial auctions through court. The result is protracted legal
proceedings with remote likelihood of recovery from secured property, if any is left, by the time of
enforcement of judgment. Two specialised banks possesses statutory powers of sale of mortgaged
property without judicial order24, but such proceedings are subject to the existence of valid title and
mortgage, and are often defeated for lack of verification of title and perfection or of the mortgage.
Additional factors cited for protracted legal proceedings are poor legal advice and poor documentation. It
is customary in banks to require the submission of various types of loan and security documentation,
often for different transactions or products, without proper appreciation of their significance. A trend
continues in most banks to require submission of such documents undated and to conveniently date the
same before filing legal proceedings within applicable limitation periods; such documents are often
challengeable based on later developments, such as when the signatory is no longer in office or is
deceased, stamp duty is inadequate, the signature differs, and the like.
A different strategy for debt recovery by bankruptcy was reawakened by the enactment of the Bankruptcy
Act 1997, which established a further set of dedicated courts, Bankruptcy Courts. The stigma attached to
being declared bankrupt is misunderstood, and has been the primary cause of resistance to an effective
structuring and enforcement of the 1997 Act. A draft of the 1997 Act was critically reviewed by business
bodies, which had strong political clout, and many stringent provisions were removed. This demonstrates
the failure of imposing internationally accepted standards and concepts into the Bangladesh banking
sector.
The Bankruptcy Act is applicable to both individual debtors and to companies, which creates some
overlap with the liquidation procedures of the Companies Act 1994 (for further details, see the section on
Companies, Corporate Laws and Practice of this Report). Under the Act, debtors are liable to be sent to
civil prison pending adjudication and a debt must be at least Tk. 500,000. A provision for the publication
of notices of claims of bankruptcy under the 1997 Act continues to generate claims of defamation, and
legal proceedings challenging the constitutionality of such notices are pending disposal. Overall,
proceedings under the Bankruptcy Act 1997 are not a favoured option for banks. It is a common strategy
for banks to prefer that borrowers continue to remain commercially viable to generate funds for
repayment rather than cripple or extinguish their opportunities for further business by adjudication of
bankruptcy.
Banking Sector Summary
The banking sector in Bangladesh is recognised as fairly large, but inefficient, in comparison to the size
of the economy. It has been estimated that the cost of banking inefficiency to the Bangladeshi economy
is 1.18% of GDP (using independent estimates of recapitalization requirements).25 There have been many
well-publicized examples of bank mismanagement (see box on Al-Baraka Bank), which provide concrete
examples of the problems in the banking sector. One can see from the above that the situation of the
banking sector continues to be a mixed bag. Although some promising reforms have been instituted, the
health of the banking sector is highly questionable. New reform initiatives have yet to be fully
implemented and enforced. Further advances are also required providing adequate creditors rights. The
24
Bangladesh Shilpa Bank and Bangladesh Shilpa Rin Sangstha

25
47
situation of the banks in Bangladesh clearly illustrate that they have not fulfilled their role as successful
adherents of corporate governance principles.
The Insurance Sector
The insurance sector is characterized by two state-owned companies, Sadharan Bima (SBC) and Jiban
Biman (JBC), and a proliferation of private insurance companies. Overall, there are 37 general insurance
companies and 14 life insurance companies. (See Appendix K for a full list of insurance companies
operating in Bangladesh.) Generally, private insurance companies provide a narrow range of products
and generally the service quality is low. Default amounts on unpaid insurance claims are high for both
general insurance and life insurance companies. Defaults are blamed on the delayed or erroneous survey
reports, delays from SBC in settling reinsurance claims, and funding shortfalls by the companies.
Furthermore, insurance companies have limited actuary data on which to base premiums and have limited
investment outlets for insurance funds. The Chief Controller of Insurance under the Ministry of
Commerce currently regulates insurance companies.
Section 27 of the Insurance (Amendment) Act 2000, states that at least 30% of the funds of life insurance
companies shall be invested in government securities and the balance can be utilized for any other
investment, including capital market investments. The Chief Controller of Insurance specifies a list of
eligible investments other than government securities. (Notification dated July 28, 2002) Only ICBs
unit funds, not private mutual funds, are allowed. As for share investments, insurance companies are
allowed to invest in shares and debentures of companies which are at least 25% owned by the
Government or public listed companies that have a record of dividend payments of more than 10% in at
least five out of seven years preceding the date of investment.
Reform of the insurance sector is much discussed by the both the Government of Bangladesh and
multilateral donors. The Government recently formed a Insurance Reform Committee, which has issued a
number of significant recommendations, including dissolution of the Office of the Chief Controller of
Insurance. The Committee also recommended increasing the paid-up capital of SBC, selling 49% of SBC
to the public, and limiting its business to reinsurance. Finally, the Committee recommended that private
sector companies should provide government insurance policies.
The insurance industry has recently come under focus of the World Bank and Asian Development Bank
(ADB), which has suggested measures for reform to eradicate unfair practices exercised in the sector; as
with the banking sector, political interference is the primary challenge. Such practices include inadequate
or non-existent assessments for insurable risks, issuance of policies without payment of premium,
payment against false claims, failure of payment against genuine claims, personal cash incentives
demanded for processing documentation, tax evasion on underwriting and the like. Independent
shareholder intervention in insurance companies is difficult with major shareholders controlling a
minimum of at least forty percent of equity. The Department of Insurance lacks sufficiently trained staff
and infrastructure, providing no leadership or incentive to take a more active role in monitoring and
intervention in its supervisory capacity.
To improve the situation, World Bank and ADB studies have suggested halting issuance of further
licences to insurance companies, amendment of the company law to facilitate merger or amalgamation of
the numerous and largely non-profitable insurance companies, introduction of internationally accepted
corporate governance principles and vesting the Chief Controller of Insurance, the chief regulator of the
insurance industry, with the power of enforcing the same. It has also been recommended to bring the
insurance industry under the control of the Ministry of Finance from the Ministry of Commerce, and
thereby integrating the regulation of the banking, securities markets, insurance and tax sectors under one
48
ministry. No mention has been made of the regulation of companies, which remains under the Ministry
of Commerce.
SABINCO
Saudi-Bangladesh Industrial & Agricultural Investment Company (SABINCO), a Saudi and Bangladesh
government joint venture, has been operating in the country as a private limited company since July 1985.
It obtained a license to operate as a Non-Bank Financial Institution (NBFI) from Bangladesh Bank in
February 1995. In April 2000, an inspection report prepared by a team at the Bangladesh Bank outlined a
host of irregularities including:
Investing in shares of other companies beyond the allowable limit of 25% of paid-up capital and
reserve
Paying dividends without retaining 20% of net profit as required
Continuously appointing the same person as the managing director for more than 15 years
Engaging in day-to-day management of two other companies, Bangladesh Catfish and SaudiBangla Fish Feed, beyond its normal scope of operations
The team also found that 65% of the loan portfolio was classified a situation deemed detrimental for the
future of the company.
Subsequently in July 2000, investigative reporting by a vernacular newspaper revealed that SABINCO
artificially induced a bull run in the stock market in collusion with leading brokers and causing severe
fluctuations in the prices of a few select companies. Indeed, the DSE General Index in July 2000 rose
sharply from 793 on July 2 to a high of 884 on July 29. SEC investigations unearthed collusive trading
by the company chief, his friends and some stockbroking houses for personal profiteering.
In an unprecedented move, the then SABINCO Managing Director spent a huge amount of company
funds printing out an open protest letter in all the major daily newspapers. He wrote, Through this letter,
I request the Government to institute a judicial enquiry composed of High Court Judges to investigate into
the whole thing around the capital market starting from SEC, stock exchanges, financial intermediaries
and everybody concerned and find out who play[ed] what role.
The long-reigning MD was eventually forced to resign on September 11, 2001 amidst board pressure and
the SEC filed a case against him for violation of Sections 17 and 25 of the Securities & Exchange
Ordinance 1969. It should be noted that SABINCO had three nominated directors on behalf of the
Bangladeshi government at that time: two were serving as Secretaries and the third was none other than a
Director-General of the Bureau of Anti-Corruption. Other directors were Saudi nationals appointed by its
government.
This is a classic example of all that could go wrong when the government appointed board members take
a detached and disinterested role and an all-powerful CEO is given a free hand.
The Capital Market

A Birds-Eye View
The capital market in Bangladesh is a weak link in the movement towards strengthening CG in
Bangladesh. The SEC was set up in 1993 and has enacted myriad rules and regulations to structure and
develop the capital market but the end result is still stagnation. After the surge of events in the mid
1990s starting from a general upturn in 1994 and leading to a boom that eventually crashed in 1996
49
there have been various piecemeal and ad hoc attempts to rejuvenate the market and bring back the
investors, without much success in sight.
As of the end of 2002, there are 239 listed companies on the countrys main stock exchange, the Dhaka
Stock Exchange. Market capitalization was Tk. 68,677 million (US$1,184 million) in 2002, an increase
of only 0.68% over 2001. DSE market capitalization amounted to 2.52% of GDP at the end of 2001. The
DSEs performance over the last year has been lacklustre as well: the DSE All Share Price Index gained
only 2.27% between 2001 and 2002. There were eight IPOs during 2002, a decline from eleven in the
previous year. The number of companies holding AGMs was similar over the last two years: 79% of the
total listed companies held an AGM regularly in 2002, compared to 77% holding an AGM in 2001.
During 2002, there were a number of reform measures undertaken at the DSE. The DSE included twelve
non-brokers as members of its policy-making Council, but there is no representation from investors or
issuing companies on the DSE Council. The CEO of DSE was also dismissed at the insistence of the
SEC after he installed defective on-line transaction surveillance software which generated false
information.
No. of Listed Companies

Market Capitalization ($ Mill)
Market Capitalization as % of
GDP
DSE All Share Price Index
Source: AIMS of Bangladesh
Dhaka Stock Exchange Select Statistics

Dec-99
Dec-00
Dec-01
Dec-02
221
230
231
239
01-02 change
3%
870
1,165
1,176
1,184
0.68%
2.04%
647.95
2.65%
853.75
2.52%
829.61
848.41
2.27%
Overall performance measures of the stock exchange show low trading volume, intermittent and very few
new offerings, and declining valuations. The lack of depth in equity market makes it less transparent.
When asked in the survey, sponsor shareholders of public listed companies, in several instances, admitted
to holding a significant percentage of the public shareholding under false/relatives names which means
that the companies are more closely held than what registers reveal. Pseudo names, combined with low
trading volumes, make it difficult to monitor for insider trading. The stock market scandals in 1996
further eroded investor confidence in the market. In essence, the equity markets in Bangladesh do not
react significantly to company performance and therefore do not reward firms for providing full and
accurate corporate disclosure through a higher stock valuation, neither does the market generally tend to
punish enterprises that fail to disclose material information.
50
Dhaka Stock Exchange General Index, January 1997 to December 2002
Source: AIMS of Bangladesh Limited
In Bangladesh, the fundamental spokes of an efficient capital market wheel are not in place. The average
non-controlling shareholder in this country is an individual who does not possess sufficient level of
education, understanding and sophistication required to exert pressure on a company to change behaviour.
Institutional investors like mutual funds (there are only two asset management companies in the country:
one government and one private) and pension funds are too small to adopt a strong activist position.
Takeover is also not perceived as a serious threat. Hence a share price does not necessarily incorporate a
penalty for poor corporate practices; since market prices fail to have any kind of disciplining impact on
management, companies have no incentive to be transparent.
The state-owned investment company, Investment Corporation of Bangladesh (ICB) has not been
required to publish the net asset value of its mutual funds or submit performance reports to the SEC as
private mutual funds must do by law. ICB mutual funds are run by different rules than a private mutual
fund, including rules for valuation, reporting, disclosure, borrowings and investment controls. For
instance, ICB funds regularly borrow to finance equity investments, which is not allowed for private
funds. The end result is that the largest institutional investor, ICB, has few incentives to demand good
performance from its investments and it therefore does not utilize its power as an institutional investor to
enforce changes. Furthermore, the growth of private sector institutional investors, which would be more
likely to play an activist role, is stunted due to the uneven playing field and associated high costs.
Equity Market: No Incentive to Going Public
Due to the above-mentioned weaknesses in the stock market, companies see few benefits in becoming a
public company and listing on the stock exchange. The capital market does not appear to offer adequate
incentives to become a public company and enlist on the stock exchange. On the cost side, listing
involves the expenses of filing the appropriate documents, bureaucratic obstacles, and additional
disclosure requirements. SEC requirements for proportionate board composition are a further impediment
to multinationals. As far as benefits are concerned, capital can be more easily raised through bank
financing since companies with good reputations face few problems in obtaining adequate capital from
banks. Bank financing is readily available as result of excess liquidity and extensive competition in the
banking sector due to the fact that new private bank licenses had been issued mostly on a political basis;
banks therefore are reluctant to enforce additional requirements or strict conditions in lending. This
phenomenon is substantiated by our survey which revealed that equity requirement had been the prime
motivator for only 10% of the public companies interviewed - the remaining companies had cited reasons
like tax advantages and legal compulsion, for going public. All the private companies interviewed
51
expressed their dissatisfaction with the state of the capital market and hence preferred to continue as
private companies.
Companies that cannot obtain adequate bank financing may go to the equity markets, which means, in
effect, listed companies are often the weaker companies. There is an optimum level of debt in a
companys capital structure after which point debt should become more expensive and the risk of
committing to fixed debt payments becomes too high. This equation appears not to hold true in the case
of Bangladesh. Banks do not increase lending rates for enterprises that carry high debt loads and there is
little hazard in high levels of leverage. Companies are comfortable with high fixed debt payments
because they know that the penalties for default are not necessarily severe. Banks, as consequence, end
up with high levels of non-performing loans and there is a low demand for equity financing.
Debt Market: Yet to Develop
At present, the capital market includes no bond, fixed-income, or other debt instruments of significance.
Government savings schemes provide a fixed income investment vehicle, but the instruments are not
transferable and traded. The high level of interest paid on government savings schemes discourages
corporate debt offerings. In spite of the obstacles, there is some progress being made in this sector.
BRAC, the largest non-governmental organisation in the world, is currently working with AIMS of
Bangladesh Limited to issue the first asset backed securities in Bangladesh. The securities will be backed
by BRACs outstanding micro-credit loan assets. The Credit, Bridge and Standby Facility at the Central
Bank, under the ongoing Financial Institutions Development Project of the World Bank for non-bank
financial institutions, is also contemplating issuing collaterized loan obligations (CLOs) of leasing
companies. The SEC has recently approved, in principle, a credit rating company. If the debt markets
can develop, investors in corporate bonds and other debt instruments could become an important pressure
group for encouraging and enforcing corporate governance principles.
Sources interviewed for this report believe that a market for debt and fixed-income securities is more
likely to yield results in capital market development and as a tool for improving CG. If government
savings schemes are phased out or their rates are rationalised, investors would likely prefer an investment
vehicle that matches the risk and return profile of the schemes to which they are accustomed. Bond and
other debt instruments can provide a fixed return with a low level of risk.
Outlook for Change
Within the capital market sector, there are some stakeholders that could use their power to force
companies to improve CG, but this power is often left unexercised. Large investors and financiers prefer
to complete their own analysis of a company, even if a companys CG practices are good. Non-bank
financial institutions are also large investors but usually follow bank policies and primarily lend to repeat
clients. However, multilateral donor and lending agencies appear as major power block or change agent
in almost all regards in Bangladesh. For instance, the adoption of IAS-30 was strongly advocated by the
World Bank and the ADB is financing a capital market development agenda. In addition, some such
agencies are also institutional investors and can use their ownership shares to encourage specific
companies to be leaders in CG; ADB, International Finance Corporation (IFC), the Commonwealth
Development Fund, and the Aga Khan Fund all have substantial holdings in Bangladeshi companies and
in some cases hold a seat on the board.
There are two ways of examining accounting standards: (i) the statutory, legal disclosure requirements
and (ii) the level of disclosure provided in everyday practice, or the compliance with the requirements.
Both methods of evaluating accounting standards are utilized here.
52
The Institute of Chartered Accountants of Bangladesh (ICAB) has currently adopted 23 of the 32
effective International Accounting Standards26 (IAS) as Bangladesh Accounting Standards (BAS). (See
Appendix I) However, in many cases the IAS has been adopted in its original form and subsequent
amendments by the International Accounting Standards Committee (IASC) have not been adopted by
ICAB. As a result, IAS and BAS differ in a number of material aspects. Survey results show that this
discrepancy is not an issue in the preparation of accounts for most organisations, since they do not need to
comply with IAS that have not been incorporated in BAS. A recent IAS adopted by ICAB is applicable
specifically to banks and financial institutions, which were required to comply effective December 31,
2000. IAS-30 was first adopted by ICAB and then enforced by the Bangladesh Bank by an amendment to
the Bank Company Act, 1991. Although complete adoption of IAS would be a significant step forward in
financial disclosure, the U.S. Financial Accounting Standards Board (FASB) standards require an even
higher level of disclosure. No FASB standards are in effect in Bangladesh.
Accounting standards in Bangladesh allow for considerable discretion by the company, which can lead
companies to choose the accounting conventions that show more favourable results and can prevent
investors or other stakeholders from gaining a true assessment of the companys situation. BAS do not
require disclosure of all the financial and non-financial details necessary for a full assessment of a
companys operations, financial situation, and prospects. Specifically, shortcomings exist in the
following areas:
Investments in subsidiaries are generally accounted for using the equity method or the cost
method.
Deferred tax assets and liabilities are not recognized.
The classification rules for leases allow significant scope for discretion.
Methods for foreign currency translation and depreciation are not prescribed; notes to the
financial statements are expected to explain the methods used, but do not always do so.
Outside the financial sector, segment reporting is not required and detailed classification of
revenues and expenses are not necessary.
Details about the qualifications of board members, their remuneration and their attendance record
do not need to be reported.
IAS on business combinations, accounting for investments in associates, and reporting interests in
Joint Ventures (IAS 22, 28, 31 respectively) are not in effect in Bangladesh.
Consolidated financial statements are not provided.
In spite of the adoption of IAS-27 on Consolidated Financial Statements and Accounting for Investments
in Subsidiaries, fully consolidated statements are not prepared. This stems from (i) the company
ownership practices common in Bangladesh and (ii) a lack of clarity regarding definitions in relevant laws
and accounting standards. Groups of companies in Bangladesh usually have common shareholders, but
no parent company owns shares in each of the companies of the group and therefore the group of
companies is not required to prepare consolidated statements. To achieve consolidated accounts the
Companies Act should be consistent with BAS, SEC requirements, and the Bank Companies Act.
Specifically, the definitions and requirements regarding holding companies, group companies, and
26
International Accounting Standards (IAS) are developed by the International Accounting Standards Board of the
International Accounting Standards Committee (IASC), an independent organisation made up of professional
accounting bodies from around the world. The IASC mission is (i) develop a single set of high quality global
accounting standards, (ii) promote the use of those standards, and (iii) bring about convergence of national
accounting standards and IAS.
53
consolidated financial statements should be examined. For instance, the Company Act does not require a
consolidated balance sheet for a holding company, even though this should be required under accounting
standards. This lack of consolidation in financial statements is a significant failing in the Bangladeshi
context; transfer pricing is rampant in those enterprises that are not reflected on the accounts of the group
companies. Transfer pricing is used to drain profits from a company, to the disadvantage of the common
shareholders. Both the requirements and the incentives should provide a reason for consolidation.
Observers have pointed out two changes that would encourage preparation of consolidated accounts.
First, a change to the tax law is required to provide tax benefits to a group when there is a loss in one
subsidiary of which more than 51% is owned by the group. That is, a loss in a subsidiary (a member of
the group of companies) could be used to reduce taxes for the group as a whole. Second, the Companies
Law could be changed to require consolidation when a company owns 51% of the equity of another
company. Currently, consolidation is not required.
A review of available literature and annual reports would suggest that compliance with disclosure
requirements under the relevant laws and BAS is not consistent. Statements may comply with the letter
of the laws and regulations, but not the spirit of the laws; even companies that comply with the statutory
requirements often do not provide other relevant and material information. A study in the Bangladesh
Accountant found that companies failed to comply with the Companies Act, the SEC Rules, and BAS in
the following areas, among others27:
Detailed itemization/classification of sales, revenues, production costs, investments, foreign
exchange earnings, and extraordinary items
High miscellaneous/general expense without explanation
Accounting policies for inventories, depreciation, and research and development costs
Overstated valuation of assets (especially Property, Plant, and Equipment)
Contingent liabilities and future prospects
Provision of the auditors report, a financial report in English, and timely provision of the Annual
Report prior to the AGM
The Directors Report is also an area in which disclosure could be improved. Most comply with the basic
requirements of the Companies Act, but best practices would mandate a more complete report. More
progressive companies do include additional information, including a discussion of financial and
operating results and risk factors. However, most Directors Reports fail to explain post-Balance Sheet
developments and future prospects for the companys core businesses.
While compliance with the relevant laws and regulations on disclosure is not strong, further voluntary
financial or non-financial disclosure is even less prevalent. In spite of the evidence to the contrary, an
overwhelming majority, 75%, of the companies surveyed view voluntary disclosure positively. A few
companies in the survey are still apprehensive about disclosing information that can be used by
competitors. Moreover, possible boomerang effects like fear of harassment by tax authorities act as a
major deterrent to disclosing company-specific information. The individual line-item disclosure of the
salary and allowances paid to the MD of Eastern Bank provides an interesting example of voluntary
disclosure.28 Since the salary and allowances were quite high (Tk. 1,380,000 in 2000 and Tk. 3,600,000
in 2001), shareholders complained about his compensation at the AGM. In spite of possible
repercussions, the MD is personally committed to full disclosure and plans to continue the practice.
27
28
Imam, Shahed. The Cost and Management (Journal of the ICMAB), September-October 1999
Eastern Bank Annual Report 2001. Profit and Loss Statement.
54
However, other companies looking at Eastern Banks example might conclude that the additional
voluntary disclosure would not be appreciated by shareholders or potential investors and would only
cause them problems.
In most economies, a companys motivation for complying with accounting standards and providing
quality financial disclosures comes not only from legal or regulatory requirements, but also from the
market. Firms that produce financial statements that comply with the spirit and letter of the law receive
better equity valuations, more credibility, and additional opportunities to raise capital in the equity
markets. Alternately, the market usually punishes companies that do not provide full disclosure. In
Bangladesh, companies are neither punished by the market, nor by the agencies tasked with regulating
their behaviour. Furthermore, as discussed earlier, access to equity markets is not necessary to raise
capital and a firms credibility is gained through other avenues.
The necessary elements for the corporate sector to move toward international harmonisation of
accounting standards are present in Bangladesh, but there is little momentum behind mandatory
harmonisation. Further adoption of accounting and auditing standards will likely be lead by progressive
companies taking a lead in voluntary disclosure and in adopting more rigorous accounting standards. If
these progressive companies are seen to gain an advantage from banks in their lending positions or in the
equity markets, other companies will voluntarily follow. If banks or other important investors start
demanding full IAS compliance, companies will begin to comply. The motivation for adoption of more
rigorous accounting standards must include an element of positive reinforcement along with more strict
regulatory or legal requirements.
In the financial sector, the primary regulator is the central bank of Bangladesh, Bangladesh Bank, whose
role has been discussed above. In the corporate sector and the capital market, the principal regulators are
the Registrar of Joint Stock Companies and Firms and the Securities and Exchange Commission. The
Dhaka Stock Exchange and the Chittagong Stock Exchange are two self-regulatory organisations with
key responsibilities in the capital market.
Registrar of Joint Stock Companies and Firms
The regulator dealing with company law is the companies registry, the Registrar of Joint Stock
Companies and Firms (RJSC)29, which is administered by the Ministry of Commerce. The functions of
the RJSC are governed by the Companies Act 1994 in relation to the formation of companies, filing of
statutory returns and power to call for information or explanations. Companies Rules 1941, introduced
during the time of British India, containing guidelines and forms relating to the filings with the RJSC
were not re-issued on the independence of Bangladesh. The power of investigation into the affairs of a
company is vested with the Government. The records of the RJSC are maintained manually, except for
its recent online check for the availability of names of companies for incorporation, and proposals for
computerization are pending financial sanction. Records available with the RJSC should be open for
inspection by members of the public.
Forms that must be filed at the RJSC are based on those provided in the schedules to the Act and the old
Companies Rules 1941. The forms are available for purchase through vendors sponsored by the RJSC,
but are not available at the RJSC or at its website. (See Appendix H for a list of forms to be submitted to
the RJSC and other regulatory bodies.) Dealings of the RJSC often overreach the statutory functions of
the office, though staff admits that they are not trained on company law and the role of the RJSC. For
29
http://www.registrarofcompaniesbangladesh.com
55
example, although the law provides for a company to file a satisfaction of mortgage with the RJSC and
for the RJSC to issue requisite notices to the mortgages before recording the satisfaction, the RJSC
requires counter-signature of the mortgages prior to filing the satisfaction, which is entirely without
lawful authority. This creates difficulties in that mortgages, once paid, typically have no incentive to go
through their internal procedures and provide such counter-signature.
Another example of exercise of discretion in an unfettered and uninformed manner by the RJSC relates to
the rendering of subjective opinions on the acceptance of a companys name for registration, and referrals
are made to other bodies in the absence of any requirement to this effect. An amusing instance given to
the CG Team by the erstwhile Deputy Registrar was their refusal to allow a company to be incorporated
with the name of E=MC2 without permission from the Atomic Energy Commission of Bangladesh.
Official filings fees and stamp duties for certified copies are nominal. Retrieval of the manual records at
the RJSC for inspection is time consuming and, as a result, services of consultants are used to obtain
certified copies of any particular filing, which are available at increasing premiums. Bangladesh Bank,
lending institutions and regulators require companies to submit certified copies, but in obtaining such
copies the RJSC conducts a review of the entire records of a company for acceptance by it of all filings,
including balance sheets, though there is no such power or requirement in the Act. This practice
continues, despite case law that has described the functions of the RJSC akin to a post office in that the
RJSC is for filing of statutory returns, and that members of the public may inspect the same and obtain
certified copies thereof; the RJSC has no power to accept or reject any filings. Although the RJSC is
meant to function as a depository of documents to be available to the public, it consistently overreaches
its scope and makes it difficult for companies to complete statutory requirements and difficult for the
public to access such documents.
The RJSC deals with the registration of about 2,500-3,000 new companies each year. At present, there
are about 50,000 registered companies. Exact figures are not available. The RJSC has just above 50 staff
members to handle the workload generated by these companies, which, in the absence of electronic data
management systems, is a difficult task. In addition, it was noticed during a visit to the office of the
RJSC that several staff members were engaged in activities not strictly within the purview of the office,
such as creating lists of companies classified into different fields, whereas no records exist as to how
many private and public companies are there, or how many companies are limited by shares rather than
guarantees.
The imprecise wording of the law in relation to the actual scope of authority of the RJSC, and its lack of
appreciation of such scope combine to make it a bottleneck in corporate compliance and often ineffective
as a source of notice and information.
In the early years after the end of the British Raj, the public issue of securities was controlled by the
Controller of Capital Issues (CCI) under the Capital Issues (Continuance of Control Act), 1947. The legal
regime was expanded in 1969 through the promulgation of the Securities and Exchange Ordinance, 1969
(SEO 1969). Finally, in 1993 the CCI was replaced by the Securities and Exchange Commission (SEC)
upon promulgation of the Securities and Exchange Commission Act, 1993 (SECA 1993).
SEC: The Institution
The SEC came into being in 1993 under the provisions of the SECA 1993. Initially, it had provision for a
Chairman, two full time members, and two part time members. Later, the law was amended to provide
for four full time members. Right from the beginning, the SEC suffered from a lack of an adequate
number of staff properly trained in capital market affairs. That lack still continues. The SEC does not
56
have a full time Corporate Accountant in place. The current Chairman and members are not from a
capital market background, and neither have most past chairmen and members been so; Commission
members are usually retired public servants.
The Corporate Accounts department consists of one cost accountant, two persons who have intermediate
qualifications in chartered accountancy and one person who has a degree in accountancy. This
department does not have the capacity to review the half-yearly accounts of the listed companies. The
SEC, like other regulators dealing with corporate accounts, has to depend to a large extent on the
performance of the auditors of these companies, of which much has been said elsewhere in the report.
Likewise, the Commission does not have a full time corporate lawyer on board. The surveillance and
investigations units are also not adequately staffed or trained. Therefore, the quality of the monitoring
activities of the SEC remains open to question.
A description of the powers of the SEC is given below. Since its inception, the SEC, in exercise of its
powers, has brought back a measure of discipline in the corporate sector (but, obviously, limited to listed
companies) in the holding of AGMs, declaration and issuance of dividends and disclosure of pricesensitive information. However, in doing so, it is seen as having at times overreached its authority or
exercised it in an un-evenhanded manner.
Securities and Exchange Commission Act, 1993
The SECA 1993 provides that the Commission is responsible for assuring the proper issuance of
securities, protection of the rights of the investors and the development and regulation of capital and
securities market. In pursuance of these goals, the SEC is empowered to take any or all of the following
measures, among others:
Regulation of stock exchanges and the securities market;

Regulation of stock-brokers, bankers to an issue, issue managers and trustees, underwriters,
registrars, portfolio managers, investment advisers and other intermediaries related to the
securities market;
Registration, regulation and management of mutual funds and similar joint investment
arrangements;
Prevention of fraudulent and corrupt trading in securities;
Provision of training in investment and the securities market;
Prevention of insider trading;
Acquiring shares or stocks of a company or taking control, and takeover and regulation of
companies30;
Inspection, investigation, audit, obtaining information from issuers of securities, stock exchanges
and other similar self-regulatory organizations; et cetera.
No stock broker, sub-broker, share-transfer agent, banker to an issue, portfolio manager, investment
advisor, underwriter or any other intermediary who may be connected with the securities market is
allowed to sell or carry out business in securities except in accordance with the regulations or conditions
attached to a registration certificate obtained from the SEC. The SEC is empowered to suspend or cancel
any registration certificate in accordance with regulations issued under the SECA 1993, subject to
providing the persons concerned a reasonable opportunity for hearing. In recent years this provision has
been used quite often, and some would also say it has been over-used, in an arbitrary fashion.
Numerous writ petitions are pending in the High Court Division challenging orders of suspension and
30
This may be the result of a typographical error in the Bangla text of the Act, and perhaps the correct reading
would be the regulation of takeovers of companies.
57
cancellation issued by the SEC, purportedly under this provision. In most cases the ground of contention
is that the SEC does not provide any adequate and reasonable opportunity for a hearing, and that SECs
orders are non-speaking orders, inasmuch as they merely say that the explanations provided by the
persons concerned are not acceptable, without stating why they are not acceptable. For purposes of
illustration, a translation of the relevant portions of an SEC order is quoted below31:
Whereas a complaint has been made to the Commission against [X], a member of the
Dhaka Stock Exchange for not handing over shares due to [Y], its customer, in view of
which a written explanation was called for and subsequently a personal hearing was
accorded; and whereas the written explanation of [X], and the statements made by it at
the time of hearing are not satisfactory and the complaint of the investor appears to the
Commission to be correct; and whereas it is a principal objective of the Commission
to protect the interest of the investors; Now therefore the Commission, by virtue of the
powers given under Section 20A32 of the Securities and Exchange Ordinance, 1969,
directs [X] for the above reasons to repay the dues of its customer with [Z%] interest by
[date].
It may be seen from this order that there is no discussion of why the explanations given by X were not
found to be satisfactory, and no discussion of how the complaint of Y was found to be proven. In the
notice to show cause issued to X by the SEC, which is not quoted here, X was required to show cause as
to why its registration certificate as a dealer would not be cancelled, but the penalty imposed was for
repayment of money together with interest, without stating the amount to be repaid. This example
illustrates some of the difficulties firms face in dealing with the SEC.
Under the SECA 1993, the Government reserves the power to give directions in writing to the
Commission in furtherance of the Act, which it must abide by. Any person who violates the provisions
this Act will be liable to not more that five years imprisonment or a fine of not more than Tk. 500,000.
The SECA 1993 provides for an appeal to the SEC by any person dissatisfied and aggrieved by any order
of any Member or official of the SEC, in accordance with the regulations issued in this regard. It is
interesting to note that the SEC has issued an Appeal Regulation in 1995, which provides for certain
time limits and procedures for filing such appeals. At the same time, there are other appeal provisions,
for example, the Securities and Exchange Commission (Stock Dealer, Stock Broker and Authorised
Representative) Regulations 2000 provide for different time limits and procedures, and these are
conflicting provisions which have not been rationalized or reconciled.
Powers Under the Securities and Exchange Ordinance 1969
Securities and Exchange Ordinance 1969 (SEO 1969 or the Ordinance) provides the basic set of laws
governing the capital market. SEO 1969 gives the SEC control over the issue of capital by companies in
Bangladesh. No company incorporated in Bangladesh shall, except with the consent of the SEC make an
issue of capital outside Bangladesh. Further, no company, whether incorporated in Bangladesh or not,
shall, except with the consent of the SEC make an issue of capital in Bangladesh, make any public offer
of securities for sale, or renew or postpone the maturity or repayment of any security maturing for
payment in Bangladesh. SEC has exempted certain classes of companies from the application of certain
provisions of the Ordinance
The SEO 1969 has been amended several times recently to give the SEC more and more apparently
unfettered rights to issue directions to capital market stakeholders. Two of the important provisions in
31
32
The names and figures are withheld for reasons of confidentiality

The text of Section 20A is given below.
58
this respect are Sections 2CC and 20A. By using these provisions, the SEC is creating inroads into the
company law regime contained in the Companies Act, 1994. An anomalous and potentially undesirable
situation is being created whereby a regulatory agency is in effect amending the provisions of an Act of
Parliament, without any further reference to the legislature, and often in swift reactions to emergent
situations in the capital market. Directions issued by the SEC recently have appeared to be targeted to
specific companies, or in instant reaction to extreme situations, without bearing in mind the overall
impact of the provisions.
Section 2CC of the SEO 1969 which was introduced in 1995 deserves to be quoted in full:
Notwithstanding anything contained in the Companies Act, 1994 (Act 18 of 1994), or in
any other law for the time being in force, or in any contract or any Memorandum and
Articles of Association of any company, any consent or recognition accorded under
section 2A, section 2B or section 2C, whether before or after the commencement of this
section shall be subject to such conditions, if any, whether for immediate or future
fulfilment as the commission may, from time to time, think fit to impose.
The width of this provision is almost unprecedented, and matched only by the width of Section 20A,
introduced in November 2000, which is as follows:
Power of Commission to issue directions in certain cases. Where the Commission is
satisfied that in the interest of investors or securities market or for the development of the
securities market it is necessary so to do, it may, by order in writing, issue such directions
as it deems fit to any Stock Exchange, stock broker, stock dealer, issuer or investor or any
other person associated with the capital market.
The SEC has issued a series of regulations in pursuance of its regulation-making power conferred by the
Ordinance.
Using the powers granted under the above quoted sections of the SEO 1969, during 2001 the SEC
instituted a categorization of companies on the basis of their regularity in holding AGMs and the
regularity and quantum of dividends. Stocks were classified as Category A, B, or Z. Category A stocks
are companies that held their AGM during the last year and declared dividends above 10%. Category B
companies held an AGM during the last year, but declared dividends less than 10%. Those that either did
not hold an AGM or did not declare dividends are considered Category Z companies. New issues are also
placed in categories based on earnings per share. SEC notifications declared that companies which
remain in the Z Category for over one year must reconstitute their board by holding an EGM within six
months, the MD and Chairman should be appointed with the SECs approval, and new directors must
appointed in proportion to groups of shareholders. The Bangladesh Association of Public Listed
Companies (BAPLC) has protested the Z categorization. In January 2003, the High Court issued show
cause notices, in a case brought by Shinepukur Holdings, to the SEC, DSE, and CSE questioning their
legal authority to classify companies in the Z category.33
It is unusual for a securities and exchange commission, strictly speaking, to interfere directly or indirectly
in a companys business decisions, which categorization based on dividend performance is. That is the
concern primarily of the shareholders and the stock exchanges. The reason often cited is the undeveloped
and uninformed nature of the investors in Bangladesh. However, such measures will never lead to a more
informed and developed set of investors who will be responsible for the consequences of their own
investment decisions. Ensuring transparency is certainly very important, and one of the very basic
necessary pre-conditions of a well-organized capital market. However, interference by the regulators on
an arbitrary basis will deter even good companies from entering the capital market, which can only be
detrimental to its long-term health.
33
HC issues rule upon SEC, DSE, CSE, The Independent. January 20, 2003.
59
The use of dividend payout ratio to regulate companies is an example of the SEC using performance as a
proxy for compliance. There are other such examples. For instance, SEC staff explained to researchers
that, when reviewing financial statements, they look for large negative changes in profits, revenues, or net
income. Companies with such negative results are then investigated the premise being that fraudulently
obtained results cannot be maintained indefinitely and poor performance could indicate non-compliance
with accounting standards in the past. However, there are many reasons a listed company could post poor
performance besides non-compliance. In fact, performance is more likely to be a lagging indicator of
non-compliance than a leading indicator. The focus on performance is an example of misunderstanding
the primary role of the SEC, as well as an indication of inadequate levels of qualified staff to fully check
accounts of listed companies.
If one looks back at the institutional strength, or rather the lack thereof, of the SEC, the dangers of giving
such wide powers to it become immediately apparent. One must assume that the legislature was fully
aware of the impact of these provisions, when amending the existing laws, but the measure of confidence
reposed in the SEC by the legislature may be open to discussion. There are no inbuilt safeguards against
excessive and arbitrary use of these powers, and so court cases proliferate. In many cases, however, the
persons against whom these powers are arbitrarily used capitulate rather than challenge the action, given
the powers of SEC to make their lives miserable. The SEC, rather than assisting stakeholders in
improving their record-keeping and other compliance measures (which is what Bangladesh Bank,
commendably, does with banks), reportedly uses minor lapses to impose punitive measures. This has not
been conducive to creating a healthy interrelation and any measure of predictability between the regulator
and the regulated.
The SEC also has powers to call for information and carry out investigations into the activities of market
intermediaries and listed companies. Any officer authorised by the Commission for the purpose of
inquiring into the correctness of any statement made in an application for consent or recognition to an
issue of capital may order the company to submit to him such accounts, books or other documents or to
furnish to him such information, as he may reasonably think necessary.
The Commission also regulates the stock exchanges in Bangladesh, which must be registered under the
Ordinance. The Commission has the power to inspect the books of accounts and other documents of
every stock exchange. Moreover, every stock exchange must submit to the Commission an annual report
and periodical returns relating the Stock Exchanges affairs. Where the Commission is of the opinion that
a Stock Exchange or any member, director or officer thereof has neglected or failed to comply with the
provisions of this Ordinance or any rule or regulation made thereunder, the Commission may suspend or
cancel the registration of the Stock Exchange and/or remove the person in authority concerned. Recently,
the SEC has required the Dhaka Stock Exchange to remove its Chief Executive Officer for the use of
faulty software. However, that order is under challenge in the Supreme Court, again because the SEC
apparently did not comply with the requirements of the law relating to due process, among others. An
issuer of a listed security must furnish to the Stock Exchange, to the security holders and to the
Commission an annual report of its affairs and such statements and other reports as may be prescribed.
The Commission may, on its own motion or in the case of the issuer of a listed security, on representation
of holders of not less than five percent of equity securities at any time by order in writing cause an
enquiry to be made into the affairs of any Stock Exchange or the business or any transaction in securities
by any member, director or officer of the Stock Exchange or of any issuer, or of a director or officer
thereof.
If any person fails to provide any document or information requested by the Commission it is empowered
to fine the concerned person a sum not less than Tk. 100,000. Any person who is found to be carrying out
60
fraudulent acts as specified in Section 17 of this Ordinance shall be punishable with imprisonment for a
term, which may extend to five years or with fine, which may extend to Tk. 500,000 or with both. There
have been a spate of cases recently where the SEC has started with issuing notices to stockbrokers on the
basis of complaints by investors regarding non-payment of proceeds of sale of shares or non-delivery of
share certificates, to show cause why they should not dispose of the complaints, and has ended up fining,
suspending or even cancelling the registration of the stockbroker for lapses in record keeping, without
actually ever disposing of the complaint of the investor.
It is a fact that, as mentioned earlier, the SECs interventions have forced listed companies to be much
more regular in holding annual general meetings, declaring dividends, and disseminating price sensitive
information. It is also undeniable that the weak self-governance of the stock exchanges in relation to their
members, brokers and listed companies has often forced the hands of the SEC, or provided the handle for
it to act in an apparently high-handed manner. Yet, after the stock market debacle of 1996-97, how far
these measures have succeeded in restoring investor confidence in the market remains to be seen.
Raspit Data Management and Telecommunications Limited
Raspit Data Management and Telecommunications Limited was the first IT company in the country's
capital market. It invited public subscription on September 25, 2000 with a view to expanding lines of
business by raising public money. The offering immediately sparked a wave of debate in the capital
market due to its so-called disclosure-based prospectus, which provided inadequate and vague
information on many important aspects of the company, even though the prospectus had been approved
by the SEC. In addition, information valuable to the investors was blatantly missing. Disclosure that was
provided also raised concerns; for instance, technical experts and investors were alarmed at a disclosure
that the company was spending over Tk. 3.8 million to install an undisclosed number of telephone
connections in a rented house, which would be used as an office premise for the company.
Complaints were lodged with the SEC and reported in the press claiming that the prospectus was
misleading to the investors, fabricated, ill motivated and lacked authentic information. The complaints
also cited anomalies in asset valuation, planned use of IPO proceeds, advance deposits and prepayments.
These complaints forced the SEC to postpone the IPO and ask the company to clarify its position, obtain a
report on technical feasibility verification from the Bangladesh Computer Council and re-audit their
accounts. Amazingly, instead of appointing an independent chartered accountants firm itself, the SEC
allowed the company to appoint a firm of its own choice. The newly appointed firm submitted audited
accounts similar to the one submitted earlier that had won the SEC approval. After approval of the reaudited accounts from the SEC again, subscription of the IPO came to the market on the first week of
November 2000, six weeks after the scheduled subscription opening date. As usual for DSE, the issue
was oversubscribed. At present, the scrip is traded within the range of Tk. 15-16 in both the bourses of
the country, but it is learnt that the company had already abandoned its business of Internet Service
Provider (ISP), for which the subscription was invited from the investors and the money spent on
procuring telephone lines. The example of Raspit demonstrates that even when the SEC intervenes (i.e.
requiring a new audit of the company), it may not always be carried out in a way that successfully
protects the interests of investors.
The accounting profession can be a major proponent of better corporate governance practices. Through
enforcement of accounting standards that demand further and better disclosure, investors and regulators
can gain the information they need to press for change. In Bangladesh, Chartered Accountants and
61
auditors are regulated by a self-regulatory organisation, the Institute of Chartered Accountants of

Bangladesh (ICAB). Although accountants and auditors could be better advocates for corporate
governance, currently, auditors are not considered independent or sufficiently qualified to attest to the
validity of a companys statements. As evidence, it is not difficult to find examples of audited statements
that clearly do not comply with the relevant standards.
The Securities and Exchange Rules of 1987 require that a Chartered Accountant (CA) audit the financial
statements of listed companies. The ICAB certifies Chartered Accountants and adopts and amends the
BAS. ICAB Bye-laws require compliance with BAS by Chartered Accountants. However, the
Companies Act does not require compliance with BAS. ICAB would like the Companies Act to be
amended to provide additional legal requirements and penalties to encourage compliance with BAS.
There is also an Institute of Cost and Management Accountants of Bangladesh (ICMAB), which does not
as yet have a similar compliance function.
The number of accountants in Bangladesh is lower than would be expected for the number of companies
in Bangladesh. According to ICAB, of approximately 700 members only 250 are practicing as Chartered
Accountants in Bangladesh.34 A recent World Bank critique of the accounting profession in Bangladesh
highlighted the need for better accounting training.35 The report blames the low supply of accountants on
the lack of training facilities and support for trainees and the low demand for accountants. Although the
number of trainees is in the thousands, only 20-40 Chartered Accountants obtain their certification each
year. There is also a low demand for accountants in the country because firms do not see the value in an
accountant over other types of financial professional (MBA, commerce graduate, etc.). Similarly, there is
little value placed on an audit and audit fees are quite low. Our survey supports the assertion that audit
quality is not sufficient for firms to place a higher value on their auditors.
ICAB believes a primary problem with the current audit system in Bangladesh is the low level of fees
paid to auditors. ICAB has recently issued a recommended fee schedule for audit fees based on the
category of company and the size (based on assets/turnover). The minimum recommended audit fee for a
listed company is Tk. 60,000 for a company with gross assets not exceeding Tk. 10 million. Current audit
fees can be as low as Tk. 10,000 to Tk. 15,000 for such a company. Current fees are at a level that can
barely cover an auditors costs and it would seem almost impossible that a proper audit could be
completed for such a low fee. Audit fees for a company are set by the Board of Directors and approved
by shareholders, but shareholders are usually against paying higher fees for the audit. Shareholders
believe auditors are aligned with the Board of Directors and are not representing the shareholders
interests and are therefore unwilling to pay more or consider other factors in auditor selection besides
fees. This perception is supported by our survey; CEOs and Managing Directors said that auditors are not
independent of the company they are auditing and often try to serve the interests of the person recruiting
them.
The auditing function would seem to represent a vicious circle; auditors are not perceived as independent
and do not provide quality audits, therefore companies and shareholders are not willing to pay high fees
for an audit. The low fee structure, in turn, does not provide an incentive for auditors to provide quality
personnel and audits. To improve the situation, auditors must start to provide high quality audits, but
simultaneously shareholders should be educated regarding the function of an audit and should know what
to expect from an auditor. Companies in our survey also believed that if regulators emphasize the
importance of audit, remuneration for auditors and audit standards would improve.
34
35
Institute of Chartered Accountants of Bangladesh. List of Members and Firms 2002-2003.

World Bank. Bangladesh: Financial Accountability for Good Governance, 2002
62
One way audit quality can be improved is through more stringent enforcement of audit and accounting
standards by ICAB. ICAB can discipline its members for violations of its Bye-laws and Code of Ethics,
but to date the self-regulation function has been largely ineffective. In September 2002, ICAB suspended
Haider Ahmed Khan for a period of three years for auditing violations36, but prior to this suspension
disciplinary actions have been rare. The disciplinary process is initiated when a complaint is received
against a CA. ICAB then institutes a hearing process, during which a CA may still practice but the fact of
an allegation against him or her is publicly available. As a quasi-governmental regulator, ICAB
encounters a similar problem with its enforcement mechanisms as other governmental regulators; ICAB
decisions can be appealed to the courts and the judicial process delays the implementation of a judgement.
The recent suspension of an ICAB member is currently in the courts, so the suspended member still has
the ability to practice. Overall, ICAB has not proven to be an effective body for enforcing accounting and
auditing standards on its members.
Another possible reason for the lack of compliance with BAS is a lack of training and education regarding
BAS and IAS. In 2002, ICAB began requiring members to attend at least twelve hours of Continuing
Professional Education seminars each year. The seminar topics include accounting standards, as well as
other profession topics like communication skills. In cooperation with the World Bank, a recently
completed project has focused on the application of IAS, both those adopted as BAS and those not yet
adopted. These types of seminars will hopefully improve the knowledge of CAs regarding accounting
standards, but this measure is very recent and strong enforcement will still be necessary to improve the
quality of financial statements.
The CG survey found that audit quality is a source of major discontent amongst most firms; 62% of
organizations expressed dissatisfaction with external audits. Firms cited a range of problems including:
inexperience of the auditors, a lack of professionalism and objectivity, and a mismatch between the fees
they are charging and the actual value they are adding. A new law from the SEC states that auditors must
be changed every three years but the requirement can be waived if a company has a high dividend yield.
This rule confuses the successful operation of with the auditors performance; a good audit can be
completed on a failing company and indeed a poor audit can boost a failing companys financial
performance, at least on paper.
Audit firms have recently begun to ask firms for an indemnification from liability before certifying
accounts. Indemnification is in direct conflict with the legal requirements of an audit and removes the
motivation for an audit firm to accurately and fully certify financial statements. It was a widely held view
among stakeholders that rigorous auditing practices would improve corporate governance in large
measure almost immediately.
In interviews and the literature review a number of suggestions for improvement in auditing were put
forward. First, additional classification or standardization of auditors may be a prerequisite for audits to
become a trusted tool for better CG. Regulatory bodies and investors already have their own list of
quality auditors and companies are encouraged to use those firms for their audits. For instance, additional
training and certification, beyond the CA qualification, could be required for auditors of listed companies.
Second, the World Bank has encouraged the adoption of a sub-professional accounting qualification. Sri
Lanka has successfully introduced an Accounting Technician qualification to increase the supply of
quality accounting personnel. A similar sub-professional qualification in Bangladesh could provide an
opportunity for talented individuals who do not have sufficient educational background to complete the
full Chartered Accountancy certification and could reduce the dropout rate of trainees. Significant
improvement in the perception and practices of Chartered Accountants and the accounting institutes is
needed before they will become a trusted pillar of CG in Bangladesh.
36
Institute of Chartered Accountants of Bangladesh. List of Members and Firms 2002-2003.
63
Mark Bangladesh Shilpa & Engineering Company Limited

Mark Bangladesh Shilpa and Engineering Company Limited (Mark), a leather shoemaking company,
invited public subscription for Tk. 60 million during April 6-15, 1997 amid a wave of controversial press
reports and commercials claiming that a number of reputed shoemakers were regular buyers. The
claims were instantly denied by those buyers. The issue was able to gain approval from the SEC, with
amazing speed, and the company collected a subscription of over Tk. 390 million against an offer of Tk.
60 million in an overheated market. As soon it transpired that much of the information furnished in the
prospectus was not only inadequate and vague, but also materially misleading, the SEC was forced to
review the revaluation of Marks assets and found that the prospectus showed assets worth Tk. 190
million, which were actually worth no more than Tk. 50 million. There was clearly negligence in the due
diligence carried out. The Tk. 100 share (with Tk. 100 premium) now sells at Tk. 26 in the bourses. The
SEC has reportedly initiated legal action against the issue and the auditor of the company.
Role of audit committees and risk management arrangements
The problem of financial statements that accurately reflect the position of a company cannot be laid solely
at the feet of auditors, although strengthening of the auditors function could produce significant
dividends in investor confidence. Auditors are an important watchdog for investors and the general
public, but are not involved in actual process of drawing up the accounts. Internal process at companies
must also ensure that accurate accounts are presented to auditors and that accounting standards are
followed in the process. At the BEI seminar conducted in January 2003, participants commented that the
regulatory framework for corporate organisations should provide guidelines that oblige finance and
accounting personnel to follow the relevant accounting standards when drawing up accounts. One
method that the Board of Directors can use to ensure that accounts are prepared properly is an audit
committee of the Board. An audit committee oversees the internal audit process and should have enough
financial experience to evaluate the quality of internal and external audit processes. The OECD
Principles of Corporate Governance do not explicitly call for an audit committee but a key function of the
board is ensuring the integrity of the corporations accounting and financial reporting systems, including
the independent audit, and that appropriate systems of control are in place, in particular, systems for
monitoring risk, financial control, and compliance with the law.37
Audit committees are not widespread amongst public listed companies in Bangladesh and do not exist at
all in private companies. Only three companies in the survey had audit committees. Nominee and
remuneration committees are also non-existent in the companies interviewed. The check-and-balance
mechanism in 33% of the organizations is in the form of internal audit in light of the general lack of
confidence on external auditor capabilities as mentioned above. Banks have a much more stringent risk
management procedure in place audits are performed at three levels by external audit, Bangladesh
Bank, and internal audit teams. However, audit committees of bank boards of directors are still
uncommon. A draft circular requiring audit committees on bank boards has been issued by the
Bangladesh Bank; the BB is currently receiving comments on the proposal.
The Judiciary
The judiciary in Bangladesh is largely based on the structure established during the period of British India
and later formalised under the Constitution of Bangladesh 1972, as comprising of the Supreme Court of
Bangladesh, with two divisions: the High Court Division and the Appellate Division, the latter serving as
37
OECD Principles of Corporate Governance, p 43.
64
the last court of appeal, and subordinate courts. The several levels of subordinate courts possess
jurisdiction based on monetary amount of claims or subject matter. The courts adjudicating debt recovery
matters are presently ranked as Joint District Courts, which at the highest level of the lower courts.
Appeals from such courts lie to the Supreme Court of Bangladesh.
The quality of subordinate courts is the focus of numerous judicial capacity building projects. Such
projects are topic specific, and structural reforms are awaiting the long-proposed separation of the
judiciary from the executive arm of government, which is currently vested with the power to appoint
judges and perceived to thereby exert political influence.
Projects for judicial capacity building have not focused on the outdated curricula of legal education
institutions to include financial laws nor does the vocational training of lawyers include the peculiarities
of the specialised courts, such as the Artha Rin Adalat [Money Loan Court] for debt recovery by banks
and financial institutions, the Bankruptcy Court and a court of the High Court Division conventionally
referred to as the Company Court. The Company Court is vested with original jurisdiction on matters
referred under the Companies Act 1994 in addition to jurisdiction for hearing other matters, and is
consequently beleaguered with the disposal of backlog of cases on various subjects. Proposals continue
to be made for a separate court in the High Court Division to dispose of financial cases and their appeals,
including those related to debt recovery and securities laws. General opinion is against the transfer and
vesting of such jurisdiction to a statutory body, which may compound the bureaucratic issues with
existing government authorities and bodies involving officers with inadequate knowledge on
administering financial matters.
The High Court Division in the exercise of its jurisdiction for judicial review hears petitions challenging
the actions of regulators such as the SEC and Bangladesh Bank, which are considered to have been taken
without lawful authority or in improper exercise of their legal authority.
State-Owned Enterprises
The state-owned sector in Bangladesh is large and a discussion of corporate governance would not be
complete without an examination of the prospects for this sector. The non-financial enterprises owned by
the GOB are administered through 38 corporations. The 38 corporations are active in manufacturing,
utilities, transport and communication, trade and commerce, agriculture and fisheries, construction and
real estate, and various other services. In addition, there are governmental commercial agencies:
Bangladesh Railway, Bangladesh Telephone and Telegraph Board, the Post Office, Bangladesh
Television, Bangladesh Sangbad Sangstha (news organisation), Radio Bangladesh, and others. Besides
the non-financial corporations and agencies, there are a number of state-owned banks, specialized
development banks, specialized financial institutions, and insurance companies. The state-owned sector,
particularly in manufacturing, is characterized by negative net worth, negative funds flow, high leverage,
negative profit margins, and technical insolvency. Although considered autonomous units, state-owned
enterprises (SOEs) report to their respective sector ministries. Therefore, operations in SOEs are
primarily politically motivated and lack a commercial focus. Modern business management and
corporate governance structures have not been implemented, which makes most SOEs unable to compete
in a liberalized market. The inability to restructure SOEs and improve their management practices makes
the process of privatisation difficult.
The primary agency for oversight of SOEs is the Office of the Comptroller and Auditor General (CAG).
It audits all statutory corporations and commercial enterprises in which the government owns 50% or
more of the shares. CAG audit reports are passed on to the Public Accounts Committee (PAC) of
Parliament. The PAC is responsible for taking action on the basis of the CAG audit reports. Neither the
CAG nor the PAC effectively complete their tasks; both entities display a lack of properly trained
65
personnel and/or misallocation of skilled personnel, corruption, long delays, and a scope limited only to
the accounts and not to overall financial management or performance. As a result, action is rarely taken
against irregularities and wrongdoers are not penalized.38 Therefore, SOEs are subject to little or no
financial or managerial oversight from their majority shareholder, the government.
Poorly performing non-financial SOEs are also a drain on the state-owned financial sector. The stateowned banks often have to extend new loans to defaulting SOEs based on requests routed through the
Ministry of Finance. In 1999, a list of the top 20 loan defaulters included eight SOEs - the SOEs
constituted an astonishing 67% of the total default amount of the top defaulters. The situation has not
improved since.39 The burden of non-performing loans has been an obstacle to privatisation of stateowned banks, since few private buyers are interested in taking on that potential liability. Recently, there
seems to be some consensus from the government that these non-performing long-term assets cannot be
transferred to private buyers, although there has been no official decision. If the government separates the
non-performing and/or classified loans from the state-owned banks, they could be transferred to an
independent entity for collection and management.
Improvement in CG in SOEs is likely only with privatisation or closure of loss-making SOEs. There has
been some privatisation or closure SOEs, but the progress has been slow. The Privatization Board was
established in 1993 and tasked with the disposal of government shares in SOEs. Later the Privatization
Board was changed to a Privatization Commission. An analysis of the privatisation process by AIMS of
Bangladesh Limited found that individual privatisation transactions are lengthy and that tenders are often
repeated seeking satisfactory results. Sales are also bogged down in litigation concerning title to assets,
title to land and claims by the relevant ministry even after acceptance of a tender offer. The report by
AIMS identified a number of reasons for the delays in the privatisation process. First, there are
significant conflicts of interest by ministries that would like to retain control of the SOEs and ministries
often interfere in the privatisation process. Second, repeated tenders by the Privatization Commission
seeking a higher price lead to delays. Third, the PC does not carry out proper analysis of an enterprise to
prepare it for sale and valuation reports are not adequate for a realistic, independent business assessment.
Fourth, several companies have liabilities that exceed asset values and cannot be sold without debt writeoff or restructuring. Fifth, the Privatization Commission addresses issues of valuation, debt restructuring,
and identification of privatisation candidates in an ad-hoc, case-by-case manner. The Commission needs
a strategic plan for the privatisation process, which will create policies for dealing with these common
problems. Sixth, as is the case with many government agencies, the Privatization Commission is
politicised and staff do not have the skills or experience for the task.40
Our survey included interviews with two SOEs: Bangladesh Chemical Industries Corporation and
Bangladesh Textile Mills Corporation. Both were formed in 1972 as direct consequence of Presidential
Order 27 (Bangladesh Industrial Enterprises Nationalisation Order 27 of 1972). These organisations are
accountable to their respective Ministries budgets are approved by the Ministry of Finance and the
approved budget becomes the primary tool for subsequent years financial targets. The check-andbalance mechanism exists in the form of three audits: internal audit, government commercial audit, and
external audit. Performance is evaluated through preparation and discussion of monthly performance
reports showing achievement against pre-determined targets and variances.
38
Transparency International Bangladesh, Office of the Comptroller and Auditor General (CAG), Executive
Summary and Working Paper, September 2002 and Standing Committee on Public Accounts, Executive Summary
and Working Paper, September 2002.
39
Reform and Development (BRD), Asian Development Bank, July 22, 2002
40
AIMS of Bangladesh Information and Marketing Services, March 2002.
66
Senior officials in these organisations mentioned a number of significant drawbacks to better performance
in SOEs. First, there is no reward or penalty for non-performance; therefore employees have no genuine
incentive to strive for better achievement. To achieve greater accountability, managers need to have the
ability to delegate and assign full responsibility. Second, the quality of people is also a major impediment
to performance. Third, procedures are very system-based even if the system is not effective; for instance,
after conducting a tender, there is no guarantee that the option selected is the most economic one in the
long run. Finally, government interference in the form of price controls hinders the enterprise from being
commercially run.
In summary, appreciation of corporate governance is not likely to develop in traditionally run SOE
sectors, at least in the medium term without privatisation or a focus on commercial objectives. A shift
towards achieving commercial targets and improving overall financial management will make the
privatisation process easier. However, if incentives are not aligned with performance, the acceptance of
anything new by the people down the ranks will never occur.
The drive for better corporate governance can come from shareholders, investor associations, institution
investors, and the financial press. Each of these potential actors is weak in Bangladesh.
First, the financial press is weak and the constituency for detailed financial reporting is limited.
Furthermore, the numbers of journalists who have the knowledge and expertise for such reporting are
limited. Even if there were knowledgeable financial reporters and a market for their analyses, the
information provided by companies and regulatory bodies is inadequate. Apart from some high-profile
investigative reports, many of which are summarized in this report, a majority of the financial stories in
the media consist of company press releases.
Second, public shareholders do not join together in shareholder associations to demand better company
performance or to assert their shareholder rights. Even in cases where the public holds a majority of
shares, the treatment of shareholders is poor. Given that majority shareholders have not asserted their
rights, minority shareholder rights are not a priority to most public corporations.
Third, there are only a few institutional investors in the country and they often do not exercise the power
that they hold. In most capital markets, institutional investors like insurance companies, pension funds,
and mutual funds hold power over substantial sums of investment capital and demand strong performance
and transparent corporate governance. In Bangladesh, there are only a few institutional investors, most of
which are state-owned enterprises (SOEs). State-owned institutional investors have no performance
motivation to force companies to improve performance, voluntarily disclose information, or improve
corporate governance. The few private investors do not have enough clout to force large scale changes in
the corporate sector. As a corollary, the venture capital industry also does not exist.
Most companies do not think they are candidates for foreign investment, so there is no push from the
international economic community for better CG. No Bangladeshi company is listed on exchange outside
the country. Moreover, Bangladesh does not have a Sovereign Credit Rating (SCR) provided by any of
the international rating agencies; rather other international bodies that do pass judgement on Bangladeshs
creditworthiness, rate it poorly. For instance, the Economist Intelligence Unit gives Bangladesh a country
risk score of 65 out of 100 the worst rating in South Asia. An earlier approach to the finance ministry to
have the country rated by an international rating agency in 1998 was not successful.41 At that time, it was
anticipated that Bangladesh would be rated B, not a bad reflection since Pakistan and Turkey were rated
41
IDCOL Newsletter, August 24, 2001
67
CCC and B then respectively. But the government had felt that such a rating had the potential to
become a double-edged sword politically.
On a positive note, interestingly, multinational companies have emerged as a positive force in the general
business environment creating pressure for others to conform. For instance, companies like British
American Tobacco and Lever Brothers Bangladesh have proactively come forward with their own
findings and statistics on tax evasion by competitors in their respective sectors. Driven by their own selfinterests, they have succeeded though in bringing about redress at the National Board of Revenue.
Conclusion
As is documented in this report, failings in institutions, government agencies, legal enforcement, and
market behaviour have resulted in weak corporate governance in Bangladesh. The report is designed as a
diagnostic tool from which a consensus will emerge regarding the way forward for Bangladesh. The
authors hope that this report will start a dialogue amongst stakeholders about specific measures that can
be taken to improve the transparency and accountability of the corporate sector and strengthen
institutional support for good corporate governance. At this stage, only very broad recommendations are
provided, identifying institutions or sectors that should be studied further. Specific recommendations will
be framed in subsequent stages of this project.
Corporate Governance is a term that describes the interaction of government regulators, shareholders,
boards of directors, independent observers, auditors, accountants and managers to provide quality
information to shareholders, the market, and society at large. Each stakeholder plays an important part to
creating an environment where transparency and accountability are encouraged, enforced, and rewarded.
For Bangladesh, the first step in strengthening the role of stakeholders in corporate governance is raising
their awareness regarding these issues. This report attempts to start that process. For companies to have
sufficient motivation to disclose information and improve governance practices, the relevant stakeholders
must place a value on that information and there must be consequences for corporate governance
practices. In many cases, the current system in Bangladesh does not provide sufficient legal, institutional,
or economic motivations for stakeholders to encourage and enforce good corporate governance practices.
As a result, there are few rewards for companies that institute good corporate governance practices and no
penalties for failing to do so. Targeted reforms in institutions or sectors can begin to provide the internal
and external motivation for transparency and accountability that will lead to better corporate governance.
The institution or sectors that should be examined further to develop reform recommendations are
explained below.
Independent regulators in Bangladesh relevant to corporate governance consist primarily of the RJSC,
SEC, Bangladesh Bank, CSE, DSE and ICAB. The RJSC and SEC are two government agencies which
should be studied further to develop recommendations for reform. They exhibit many of the failings of
government agencies. On the whole, they lack sufficient staff and expertise to carry out their assigned
functions in a consistent and thorough manner. However, both the RJSC and the SEC often impose
requirements that are beyond their legal scope and use their power to produce arbitrary rules and rulings.
Although the SEC has been successful in forcing companies to hold AGMs and provide disclosures, it has
gained a reputation for filing unwarranted complaints against companies and also has focused on financial
indicators that are outside its purview (i.e. declaration of dividends). The RJSC is meant primarily to be
an agency in which documents are deposited and from which the public can obtain information.
However, companies and the public must often go through outside consultants to obtain forms or
documents that should be provided directly from the RJSC. Of the government regulators, the RJSC and
SEC have the most potential for strengthening and require further study.
68
ICAB and the auditing profession must also be key participants in any effort to improve corporate
governance. Both government regulators and shareholders rely on auditors to ensure the accuracy and
authenticity of financial accounts. Due in part to the accounting standards and disclosure requirements
that are behind international standards, audited financial statements in Bangladesh do not provide a clear
and true picture of a companys position. Companies do not feel that auditors provide a value-added
service and therefore do not pay high fees for an audit. To improve the situation, ICABs ability to train
accountants and auditors and enforce auditing standards should be strengthened. Also the fee structure
for auditors should be examined by companies and other stakeholders; current auditing fees are too low to
expect that quality personnel and sufficient time are allocated to complete a thorough audit.
In addition to the auditing profession, a full study of accounting standards should identify priorities for
adoption of international accounting standards. Currently ICAB has adopted about half of the
international accounting standards. The process of adoption of current IAS should be accelerated since
the lack of adoption creates loopholes for companies to hide affiliations and liabilities. One particular
accounting practice that is particularly lacking in Bangladesh is that of consolidation of accounts of
related companies.
Company Directors
As the other pillars of corporate governance begin to strengthen and provide support for better corporate
governance practices, the role of corporate boards of directors and the directors individually must play a
key role. Currently, most corporate directors do not know their legal responsibilities and therefore do not
carry out their duties with sufficient diligence, nor do they act as advocates for shareholder interests. In
fact, there is virtually no forum for directors to carry out their proper function. Board meetings are not
usually substantive and all board members are not expected to make real contributions to the running of
the company. For a variety of reasons, AGMs are not a useful forum for communication between boards
and shareholders. There are a number of roots of this weakness in the corporate boards. Part of the
problem lies in the expectations of a company regarding its board. Also, there is a lack of qualified,
independent directors. Furthermore, there are currently no professional qualification requirements or
prerequisite training for directors, although Bangladesh Bank has begun to introduce some requirements.
A common requirement by banks that all directors, not just managing directors, guarantee bank loans
provides a major disincentive to qualified persons serving on boards. In addition, there are no
requirements that boards include independent directors. Independent directors that do serve on boards
rarely serve as advocates for minority shareholders or provide an outsiders assessment of the company.
Finally, shareholders also lack information about their directors; directors qualifications, board meeting
attendance, and nomination procedures are not required to be disclosed. The issue of directors
qualifications and responsibilities and specifically whether independent directors would solve these
problems deserves further attention.
Shareholders and the Capital Markets
One of the symptoms of the weak capital market in Bangladesh is the lack of active shareholders or
institutional investors. There are only few private institutional investors, no shareholder associations, and
no equity research houses. Therefore, the population of shareholders with sufficient knowledge and skills
to understand company operations and hold management and the board of directors accountable is very
low. Shareholders can be vocal on a few issues (for instance food at an AGM), but overall do not spend
time or attention on issues of performance, business strategy, future business plans, disclosure, and
process that could give them a greater voice in the policy decisions of a company. Correspondingly, there
is very little awareness of shareholders rights and responsibilities. Generally, minority shareholder rights
are sufficient to enable them to enforce corporate governance standards, but minority shareholders do not
often exercise their rights. This institutional weakness in the capital market may slowly change as private
mutual funds and insurance companies become a larger part of the market, if and when the existing
bottlenecks are removed. However, there is some scope for immediately increasing the awareness and
69
knowledge of individual shareholders regarding corporate governance practices and shareholder rights.
For instance, shareholders could become vocal supporters of companies adopting international accounting
standards or establishing audit committees.
Banking Sector
Since the banking sector provides the primary source of capital to business organisations in Bangladesh,
any examination of corporate governance practices must examine the role that banks can play in
enforcing better corporate governance. Barring the few foreign banks, most banks do not have quality
credit analysis and asset management practices in place. This, along with inadequate enforcement of
creditors rights, has lead to high rates of classified loans and non-performing loans. There are designated
Money Loan Courts for pursuing loan defaulters, but these have been slow to provide judgements and
actual recovery rates have been low. New accounting standards and initiatives from Bangladesh Bank
may begin to improve the situation of asset quality at banks, but there is still considerable scope for banks
to include stringent financial requirements as well as corporate governance factors in their evaluation of
companies.
In addition to loan default, the combination of the bankruptcy law and its ineffective implementation
make it nearly impossible for a company to close or declare bankruptcy. Court authorities prefer to try
and salvage a sick company instead of allowing it to die and, therefore, inefficient allocation of resources
is simply perpetuated. There is a need to examine the process for winding up and bankruptcy, specifically
for reasons of overdue indebtedness.
The combination of banking practices and legal inefficiencies with regard to financial issues has put the
health of the banking sector in serious doubt. Each of the factors mentioned above should be examined
with respect to strengthening the banking sector and improving corporate governance practices.
Next Steps
In short, further work should concentrate on the following areas to develop specific recommendations for
reform:
Securities and Exchange Commission and the capital market environment
Institute of Chartered Accountants of Bangladesh and the auditing profession
Adoption of International Accounting Standards
Examining the requirements for and qualifications of directors, including independent directors
Shareholder education and awareness of corporate governance
Strengthening banking practices and encouraging the inclusion of corporate governance issues in
credit analysis
This project aims to identify the areas where reforms could improve corporate governance by examining
the experiences of companies in Bangladesh, international corporate governance guidelines, and the
examples of other South Asian countries. The ultimate impetus for better corporate governance must
come from domestic forces and institutions. Unlike some other developing countries, pressure from
international portfolio investors or the hope of accessing international equity markets is not a realistic
objective for a majority of corporate bodies in Bangladesh. Moreover, attracting international capital may
prove to be an elusive goal until the domestic investor community itself shows confidence in the
corporate sector.
70
Appendices
Appendix A. Terms of Reference for Country Partners
The Country Partner (CP) should refer to the Project Proposal as background to these ToRs.
1.
Objectives
1.1
The CPs objective in Stage 1 is to ensure that a firm foundation is provided for the work to
be carried out in Stages 2 and 3 of the Project. The Project will aim to place CG on the agenda in
Bangladesh, where it has yet to command significant attention; the Project will further aim to formulate
broad recommendations for reform and, not least of all, present strategies for intervention in 2 areas; Each
CPs work should be conducted with these considerations in mind and their objective is accordingly to
provide the necessary inputs. Regard should be maintained for the overarching scheme of the Project:
Stage 1
Country Studies
2.
Stage 2
Synthesis for Bangladesh
Stage 3
Design of Intervention
Scope of Work
The Scope of the Work is determined by considering the inputs necessary, ultimately, for the design of
intervention strategies.
2.2
The CP will undertake the following work in relation to each of the areas identified in the
Project Proposal and in the Key Issues and Areas section below, having regard to the OECD Corporate
Governance Principles:
A review or survey of literature relating to CG in each country;
a) Identification of major features of the CG landscape in each country, including existing strengths
and weaknesses; reviews of the operation of key existing institutions bearing upon the CG
climate;
b) Identification of disparities between the theory namely that to which law and institutions are
stated to aspire - and what in practice takes place and an analysis of the causes of such
disparities;
c) Examination of arrangements in place for enabling good CG; such analysis , and in particular, by
way of case studies focussing on:
i)
Successful arrangements, institutional or otherwise, and the incentive structures

underpinning the success of such arrangements, bearing in mind that the mere
existence of the right laws or legal or institutional environment is not enough: the
greater question is why such laws are adhered to; what incentives are in place or why
and how do the institutional arrangements operate to create the right incentives?
d) Unsuccessful initiatives and the causes of continuing behaviour deviating from principles of good
e) Evidence (including anecdotal and circumstantial) of indicative improvements in company
performance and increased investment resulting from better corporate governance.
f) In the case of the Bangladesh study, the CP in addition to the foregoing will further undertake a
survey of a number of companies;
71
the type of companies to be surveyed will include listed and non-listed public companies, familyowned, mixed enterprises, joint ventures and state-owned enterprises (where these are constituted as
public-limited companies and have been prioritised for privatisation) and also private limited mediumsized enterprises which will constitute approximately 20 per cent of the overall number; financial
institutions, including banks and insurance companies, will be included in the survey;
the number of companies to be surveyed will be between 50 and 60;
(ii) A detailed mapping of the key existing institutions bearing upon the CG climate,
assessing their effectiveness, assessing their susceptibility to change, identifying potential agents
of/resistance to change within those institutions, identifying impediments to reform both historically and
potentially;
(iii) A detailed mapping of the topical areas (see later) again with regard to susceptibility
to reform;
(iv) A detailed mapping of the stakeholders, identifying where stakeholders incentives are
aligned, where they are at odds and where opportunities may exist for constituency building. The task
would be approached on a practical, not theoretical level, the ultimate purpose being borne in mind,
namely to formulate a strategy for intervention;
(v) The drafting of preliminary and broadly worded recommendations for reform; here
considerable assistance may be obtained from existing codes, guidelines and principles such as the OECD
Principles of CG or the corresponding Commonwealth Secretariat guidelines.
3.
Key Issues and Areas
In approaching the problem, it will be useful to define corporate governance in terms of aspects that are
external to companies, and those that are internal to them.
3.1.1
External aspects. These deal with the corpus of corporate law and legal practices that govern
the conduct of a company, the role of independent regulators, as well as the role of civil society.
(a) General corporate laws. This would involve analyzing the corporate legislations of the four
countries, and what the legal framework has to say about the rights of shareholders, minority
shareholders, portfolio investors, various types of creditors, voting rules, conduct of shareholder
meetings, other stakeholders rights, disclosures, etc.
(b) Governance of banks and DFIs and the bankruptcy restructuring and liquidation processes. Given
that the vast bulk of South Asian companies especially the dynamically efficient SMEs
substantially rely upon funding from banks and development finance institutions (DFIs), it is critical to
have a specially section devoted to the de jure and de facto corporate governance relationship between
companies and their major debt-holders. This will involve two key areas:
(i) Procedures for sanctioning, disbursing and monitoring loans, including nonperforming loan assets. An unfortunately oft-ignored aspect of corporate governance is that of banks and
DFIs. The health of the corporate sector has much to do with the health and governance practices of
financial institutions the more so in countries that rely much more on debt financing rather than equity.
Healthy procedures and norms help corporate and financial sector growth. The experience of the Asian
crisis in 1997-98 clearly demonstrates what poor governance relations between borrowers and lenders can
do for the health of both.
72
(ii) Bankruptcy restructuring and liquidation laws and procedures. No country can
have good corporate governance standards with poor bankruptcy laws and processes. Poor recovery and
bankruptcy processes debase the ex ante disciplinary role of debt, encourage poor evaluation of risk,
misallocate capital, and eventually create a milieu of a sick financial sector which starves the needy
because of the lack of recourse to proper bankruptcy. Most South Asian nations have relatively inefficient
bankruptcy, foreclosure and securitisation processes. And it is very necessary that the study points out
such drawbacks, and suggests methods of reform.
(c) Role of independent regulators. This will examine first the existence of independent regulators in
South Asia; then evaluate their role in fostering corporate governance; and, using best practices, suggest
the reforms that need to be carried out in the future. The regulators that ought to be considered are (i) the
central bank, (ii) the capital or stock market regulator, (iii) the boards of stock exchanges, (iv) regulators
dealing with corporate law and (v) the quality of the judiciary.
(i) Pressure points: the role of civil society. Undemocratic polities (political systems)
usually tend to have poor corporate governance. Sustained corporate governance requires a strong
financial press, active shareholder associations, and consumer rights bodies. How strong and relevant are
these in the four South Asian countries? And what can be done to strengthen them? What evidence is
there of organisations introducing corporate social responsibility policies and procedures?
(d) Internal aspects. These deal with matters that are internal to companies. The key areas that the study
would need to focus on are:
(i) Role and composition of the board of directors. Directors are the chief fiduciaries
of any company. What are the legal aspects that determine the role and composition of boards. More
important, do corporate boards in South Asia do what they are expected to do?
(ii) Independent directors. The need for and the role of independent directors. What
attributes are required? Do boards have an adequate representation of such directors? Is the lack of
independence at the board level a supply-side problem (lack of enough such directors) or a preference
issue (no felt need for having such directors), or both? How trained are directors about their role,
liabilities and fiduciary responsibilities? Is there a case for intervention through focused director training
programmes? Use of corporate role models from the region.
(iii) Role of audit committees and risk management arrangements. The role and
importance of audit committees. What should such committees do? Which companies have successful and
recognized audit committees? How can one build a well performing audit committee of the board? What
arrangements exist for effective risk management?
(iv) Conduct of board meetings. The frequency of board meetings. Quality of agenda
papers. How early are the agenda papers sent to the directors? Quality of discussions on substantive
issues? Attendance record of directors. Is there a case for video and teleconferencing?
(v) Disclosures at the board level what should be the minimum, and what compares
with best practices?
(vi) Conduct of shareholder meetings. How frequent are these? Is there proxy voting? Is
there cumulative voting? Are shareholders sent notice of meeting well in advance? Do shareholders and
institutional investors get the right to speak and/or dissent?
(vii) Extent and quality of financial and non-financial disclosures. The qualifications of
board members, their remuneration and their attendance record. The quality of a companys Management
Discussion and Analysis. Distribution of shareholdings. Evaluation, quantification and explanation of
73
various risk factors. What are the accounting practices? Are the revenues properly recognised? Do
companies follow consolidation? Are related party transactions fully disclosed? Is there adequate segment
reporting? Is there provisioning for deferred tax liabilities or assets? Are contingent liabilities fully
disclosed in a comprehensible manner? Are investments in and loans to group companies clearly
highlighted? Are debt exposures highlighted with their corresponding maturities? What has been the
utilization of public funds raised in the last three years? And much more.
(viii) Accounting standards. How do the four nations rank in terms of (i) accounting
standards and (ii) quality of accounting professionals? Is there need for tighter standards? How can these
be implemented? What is the need for additional training, and who can play the role of trainers?
4.
Timing
The draft recommendations for reform will constitute a separate document from the remainder of
the work which will be supplied in the form of Report. In the cases of Bangladesh, Pakistan and Sri
Lanka, the deadline for all deliverables will be 10 October 2002. In the case of India the deadline for all
deliverables will be sixty days from the start date of the Project.
74
Appendix B. List of Organisations Interviewed

Public & Public Listed
(Non-Financial Institutions)
1. Advanced Chemical Industries
2. Apex Tannery & Footwear
3. Bangladesh Lamps
4. Bengal Fine Ceramics
5. Beximco Pharma
6. BOC Bangladesh
7. GMG Industrial Corporation
8. Rahim Textiles
9. Renata
10. Singer Bangladesh
11. Square Group
(Financial Institutions)
12. AB Bank
13. Al Baraka Bank
14. Eastern Bank
15. Industrial Development Leasing Company (IDLC)
16. Infrastructure Development Company (IDCOL)
17. Reliance Insurance
18. Southeast Bank
Private
1. Elite Garments
2. Fortuna Garments
3. Daily Star
4. Grameen Phone
5. Holcim
6. Kafco
7. Lever Brothers
8. Navana Group
9. Pacific Telecom
10. Transcom Group
State-Owned
1. Bangladesh Chemical Industries Corporation (BCIC)
2. Bangladesh Textile Mills Corporation (BTMC)
75
Appendix C. List of Corporate Governance Stakeholders Interviewed

Institution
Person Interviewed
Securities & Exchange Commission
Mr. Maniruddin Ahmad

Chairman
Bangladesh Bank
Mr. A. M. Kazmi
Executive Director
Metropolitan Chamber of Commerce & Industry
Mr. Tapan Chowdhury

President
Mr. N. M. Moniruddin Haider

Registrar
Mr. Waliul Maroof Matin

CEO
Ministry of Commerce, Government of Bangladesh
Mr. Amir Khasru M. Chowdhury

Commerce Minister
Foreign Investors Chamber of Commerce &

Industry
Mr. Wali Bhuiyan

President
Rahman, Rahman, Haque & Co. (Audit firm)
Mr. Abdul Hafiz Chowdhury

Partner
Mr. MA Baree, FCA

President
76
Appendix D. Questionnaire Corporate Sector

Name of respondent:
Designation:
Company name:
Address:
Telephone:
E-mail:
Type of company/organization:
(Public/listed/private limited/SOE):
Interview date:
Interviewed by:
Basic Information
Q1. How long has your company been in operation in this country? If listed, how long has it been
operating as a listed company?
------------ years in operation
----------------- years as listed company
Q2. Percentage of general public and sponsors shareholding:

Q3. What was the rationale behind the choice of the type of the company (i.e. private vs. public limited)
Q4. Would you classify your company as a closely held (family) or widely held company ?
Q5. Sales Turnover:
Paid-up Capital & Reserves:
Q6. Dividend pay-out ratio in last 3 years:
A.
Cash vs. stock:
Q.7. a) How was information on the process of formation of the company obtained?
b) How was the company formed, and were the services of a contractor, lawyer, accountant or
professional used?
c) Were formalities completed at a time or were requirements fulfilled after piecemeal requests from the
RJSC?
77
d) Were payments on top of the usual government fees and charges required to be paid for registration of
the company?
e) Were there difficulties in obtaining certified copies of the Memorandum & Articles of Association of
the company and other documents? What were the difficulties?
Q8. Did you encounter any difficulties in accounting for and reimbursement/payment of promotional/
initial expenses?
Q9. a) Where is the registered office of the company located? (Working premises or another place) Are
meetings held at the registered office at any time?
b) Have any complaints been received regarding access to the registered office by any
shareholder/director?
Q10. Any difficulty faced to change registered office (if applicable)?
Q11. a) As a listed company, could you kindly tell us the conditions/preconditions that you need to fulfil
with regard to share structure for listing purpose?
b) What other preconditions do you need to meet for listing with the stock exchange?
Q12. Do you think any of these preconditions is regressive, irrelevant or inappropriate?
Yes
No
(IF YES) Which of these do you think are regressive, irrelevant or inappropriate? Why do you think so?
Q13. What is the remedy in your opinion?
Q14. Has the company encountered any difficulty with any shareholder claiming ownership of the
companys property? Does any shareholder/director use any company property for personal use (e.g. car,
payment of house rent, personal travel, use of staff for personal work, others)?
Q15. Has the company encountered any difficulty in processing a transmission (after death)/transfer of
shares? If so, describe.
B.
Q16. What has your companys experiences been in handling complaints/queries of minority
shareholders?
Q17. As you may be aware, rights of the minority shareholder are at times violated. What measures do
you think can be taken to protect their rights?
Q18. Are the insider trading/information regulations in the country adequate in your opinion ? If not, what
changes do you suggest?
78
Q19. What measures would you suggest to prevent, detect and penalise insider dealings involving
controlling shareholders, directors and management officials?
Q20. Does your company allow non-members to be proxy at the AGM/EGM ?
Q21. Frequency/date of AGMs in last 3 years. Reasons for deviation (if any)
Q22. How do you view the holding of AGM : i) as a necessary evil ii) just a statutory requirement iii)
effective forum for the shareholders to give direction in charting the objectives of the company ?
C. The Role of Stakeholders in CG

Q23. How much you are aware of the bankruptcy, liquidation, and debt recovery proceedings in
Bangladesh? Are these adequate / appropriate? If not, any suggestions?
Q24. Do you think creditors rights are adequately ensured? Do the present laws lead to effective and
timely recovery of defaulted loans? If not, then what needs to be changed?
Q25. Do you have any suggestions/comments/ideas on market-based solutions that can be used to
address insolvency and debt recovery problems in Bangladesh?
Q26. Do you have any comments on the general regulatory bodies that affect your business? (Income
Tax/NBR, SEC, BOI, RJSC). Can you give two-three instances each of dealings with the Income
Tax/SEC/RJSC (satisfactory or not satisfactory)?
a) Income Tax/NBR:
b) SEC:
c) BOI:
d) RJSC:
Q27. Do the company's requests for loans from banks involve information and assessment of its board of
directors? Banks often require submission of guarantees from the company's directors have you ever
faced any problems in this regard?
D.
Q28. Does the company specify what type of company (public vs. private) it is in its corporate
documents? If not, what reference does the company use to confirm what type of company it is?
Q29. a) Are there any regulations that hinder compliance with the accounting and reporting standards or
are not appropriate? What are they?
b) Do you have any suggestions in improving these regulations or making them more appropriate and
relevant?
Q30. Do you have structured audit, nominee, and remuneration committees? Are these committees
permanent or formed ad hoc? Do you have an internal audit department?
79
Q31. As you may be aware, there are complaints about non-compliance of accounting and reporting
standards that a public limited company should achieve in our country. In this context, how would you
react to establishing a supervising agency to regulate financial reporting practices and enforce financial
reporting standards, which will be conclusive and acceptable to any government body including the tax
authorities?
Q32. How would you react to holding regular dialogues on reporting and disclosure issues amongst
government agencies that are responsible for supervising corporate reporting and national accounting
associations/auditors?
Q33. What are your views/opinion on voluntary disclosure of company-related information? Do you
prepare different sets of accounts using different accounting standards and what problems do you face?
Q34. Were you or any director of the company ever asked by any regulatory authority to explain
your/their position on corporate disclosure by your company or for any transgression of the Securities or
Companies Act ?
Q35. Are you satisfied with the capability/performance of your auditors? Why or why not? Has the
company experienced any difficulty in removing or changing its auditor?
Q36. a) Is your company part of a group of companies?
companies (e.g. holding, subsidiary, affiliate).
Describe its relationship with the other
b) What difficulties have been encountered in being part of a group of companies and what remedies
would you suggest?
c) As you are aware, there is a requirement to disclose underlying ownership of shares held by nominees
and holding companies and changes in such ownership. Do you have any comment or suggestion in this
respect?
d) Do you consolidate the accounts of the group of companies? Are the consolidated accounts distributed
to all the shareholders of the different units of the group?
Q37. a) Has your company issued any guarantee? If so, who are the beneficiaries (e.g. banks, other
companies, others) and who is the principal on whose account such guarantees are granted (e.g
employees, group company members, suppliers, others).
b) Would the company be able to meet demands under all guarantees if they were called on to pay all on
one day?
c) Does the company evaluate its ability to pay before granting such guarantees?
d) Do public companies find the requirements of section 103 functional?
Q38. How does your company maintain its registers (manually or electronically)? Any difficulties with
maintaining the registers and in maintaining the registers in the form they are?
Q39. a) How does your company calculate three-fourths vote for passing an extraordinary resolution?
b) Any difficulty encountered in passing such resolution?
80
c) Are details of the resolution provided in the notice for the meeting?
d) At what type of meeting are such resolutions passed (e.g. at any general meeting, AGM or EGM, or at
EGMs only)?
E. Responsibilities of the Board
Q40. What has been the frequency of your companys board meetings?
Q41. What are the particular functions and powers delegated by the Board to the professional
management as discretionary powers ? Does the management hold the power of hiring and firing ? Is
the Managing Director a shareholder of the company or a professionally hired expert ?
Q42. a) How is the companys board of directors comprised? What was the basis for the composition of
the board (e.g. lender requirements, group company control, others)?
b) Is any director not subject to retirement? If so, what type of directors are they (e.g. permanent,
nominee, managing director)?
c) Has the company encountered any difficulty in the composition of its board?
Q43. Does the company grant its employees/directors loans? Are they on commercial terms or
concessional terms? What kind of assessments are made on such requests? What are the experiences in
recovery of such loans, particularly from ex-employees and directors?
Q44. Does the company have any directors who conduct additional functions for the company beyond
attending board meetings (e.g. committee of directors, bank account signatory, power of attorney, others)?
Has any director acted beyond or abused such additional authority? If so, what difficulties were
encountered?
Q45. Has any director been personally charged with any liability on account of the company or personally
in relation to the companys affairs (e.g. litigation, dishonour of cheques, notice of removal as director,
others). Has the company compensated or reimbursed expenses in defending or protecting the director?
Q46. Are there any alternate directors of the company? Are there any restrictions on the appointment of
such alternates (e.g. only another director, others)? Has the company encountered difficulties in dealing
with alternates?
Q47. Has the company encountered any difficulty in obtaining recognition in the resignation of any
director (e.g. approval of Bangladesh Bank/SEC)?
Q48. How can board member performance, in general, be improved?
Q49. Should there be maximum limits on directorships? If yes, then what should that number be? What
should be the split between executive and non-executive directors and why?
Q50. Does the company feel satisfied with the type of company it is? If not, why not. Does it have any
recommendations of any other type of company it would rather convert to, which is not currently
registerable in Bangladesh?
Q51. Do you fully fund your P.F. obligations? Do you ever borrow from the P.F.?
81
Q52. Are you personally aware of all the reports that need to be filed periodically with the RJSC and/or
SEC? Who in the company is responsible for filing these records? Do you verify these for accuracy
before they are filed?
82
Appendix E. Questionnaire Financial Sector

Name of respondent:
Designation:
Company name:
Address:
Telephone:
E-mail:
Type of company/organization:
Interview date:
Interviewed by:
(Public/listed/private limited/SOE):
Basic Information
Q1. How long has your company been in operation in this country? If listed, how long has it been
operating as a listed company?
------------ years in operation
----------------- years as listed company
Q2. Percentage of general public and sponsors shareholding:
Q3. What was the rationale behind the choice of the type of the company (i.e. private vs. public limited)
Q4. Would you classify your company as a closely held (family) or widely held company ?
Q5. Sales Turnover:
Paid-up Capital & Reserves:
Q6. Dividend pay-out ratio in last 3 years:
A.
Cash vs. stock:
Q.7. a) How was information on the process of formation of the company obtained?
b) How was the company formed, and were the services of a contractor, lawyer, accountant or
professional used?
c) Were formalities completed at a time or were requirements fulfilled after piecemeal requests from the
RJSC?
d) Were payments on top of the usual government fees and charges required to be paid for registration of
the company ?
e) Were there difficulties in obtaining certified copies of the Memorandum & Articles of Association of
the company and other documents? What were the difficulties?
Q8. Did you encounter any difficulties in accounting for and reimbursement/payment of promotional/
initial expenses?
Q9. a) Where is the registered office of the company located? (Working premises or another place) Are
meetings held at the registered office at any time? (Optional question)
b) Have any complaints been received regarding access to the registered office by any
shareholder/director?
83
Q10. Any difficulty faced to change registered office (if applicable)?

Q11. a) As a listed company, could you kindly tell us the conditions/preconditions that you need to fulfil
with regard to share structure for listing purpose?
b) What other preconditions do you need to meet for listing with the stock exchange?
Q12. Do you think any of these preconditions is regressive, irrelevant or inappropriate?
Yes
1
No
2
(IF YES) Which of these do you think are regressive, irrelevant or inappropriate? Why do you think so?
Q13. What is the remedy in your opinion?
Q14. Has the company encountered any difficulty with any shareholder claiming ownership of the
companys property? Does any shareholder/director use any company property for personal use (e.g. car,
payment of house rent, personal travel, use of staff for personal work, others)?
Q15. Has the company encountered any difficulty in processing a transmission (after death)/transfer of
shares? If so, describe.
B.
Q16. What has your companys experiences been in handling complaints/queries of minority
shareholders?
Q17. As you may be aware, rights of the minority shareholder are at times violated. What measures do
you think can be taken to protect their rights?
Q18. Are the insider trading/information regulations adequate in your opinion ? If not, what changes do
you suggest?
Q19. What measures would you suggest to prevent, detect and penalise insider dealings involving
controlling shareholders, directors and management officials ?
Q20. Does your company allow non-members to be proxy at the AGM/EGM ?
Q21. Frequency/date of AGMs in last 3 years. Reasons for deviation (if any)
Q22. How do you view the holding of AGM : i) as a necessary evil ii) just a statutory requirement iii)
effective forum for the shareholders to give direction in charting the objectives of the company ?

Q23. How much you are aware of the bankruptcy, liquidation, and debt recovery proceedings in
Bangladesh? Are these adequate / appropriate? If not, any suggestions?
Q24a. Do you think the banks right as a creditor is adequately ensured? Do the present laws lead to
effective and timely recovery of defaulted loans? If not, then what needs to be changed?
Q.24b. Do you think that the depositors rights are adequately ensured? Please explain.
84
Q25. Do you have any suggestions/comments/ideas on market-based solutions that can be used to
address insolvency and debt recovery problems in Bangladesh?
Q26. Do you have any comments on the general regulatory bodies that affect your business? (Income
Tax/NBR, SEC, BOI, RJSC). Can you give two-three instances each of dealings with the Income
Tax/SEC/RJSC (satisfactory or not satisfactory)?
a) Income Tax/NBR:
b) SEC:
c) Bangladesh Bank:
d) RJSC:
Q27a. Does a company's request for loans from your banks involve information and assessment of its
board of directors? Banks often require submission of guarantees from the company's directors have
you ever faced any problems in this regard?
Q.27b. Do you think you have the freedom of rescheduling and negotiating bank loans as appropriate?
Why do you say so?
Q.27c. Lending against fake names has been a major issue with regard to some banks. How do you take
care of these problems?
Q.27d. As you are aware, BB, SEC and Companies Act require the balance sheet in three different
formats. How do you reconcile this?
Q.27e. The Companies Act says, you can not sack an auditor, BB and SEC asks to change the auditor
after every year/ three years respectively. How do you tackle this issue?
D.
Q28. Does the company specify what type of company (public vs. private) it is in its corporate
documents? If not, what reference does the company use to confirm what type of company it is?
Q29. a) Are there any regulations that hinder compliance with the accounting and reporting standards or
are not appropriate? What are they? (Optional question)
b) Do you have any suggestions in improving these regulations or making them more appropriate and
relevant? (Optional question)
Q30a. Do you have structured audit, nominee, and remuneration committees? Are these committees
permanent or formed ad hoc? Do you have an internal audit department?
Q.30b. Do you have internal auditor? How do they operate?
Q31. As you may be aware, there are complaints about non-compliance of accounting and reporting
standards that a public limited company should achieve in our country. In this context, how would you
react to establishing a supervising agency to regulate financial reporting practices and enforce financial
reporting standards, which will be conclusive and acceptable to any government body including the tax
authorities?
Q32. How would you react to holding regular dialogues on reporting and disclosure issues amongst
government agencies that are responsible for supervising corporate reporting and national accounting
associations/auditors?
85
Q33. What are your views/opinion on voluntary disclosure of company-related information? Do you
prepare different sets of accounts using different accounting standards and what problems do you face?
Q34. Were you or any director of the company ever asked by any regulatory authority to explain
your/their position on corporate disclosure by your company or for any transgression of the Securities or
Companies Act ?
Q35. Are you satisfied with the capability/performance of your auditors? Why or why not? Has the
company experienced any difficulty in removing or changing its auditor?
Q36. a) Is your company part of a group of companies? Describe its relationship with the other
companies (e.g. holding, subsidiary, affiliate).
b) What difficulties have been encountered in being part of a group of companies and what remedies
would you suggest?
c) As you are aware, there is a requirement to disclose underlying ownership of shares held by nominees
and holding companies and changes in such ownership. Do you have any comment or suggestion in this
respect?
d) Do you consolidate the accounts of the group of companies ? Are the consolidated accounts distributed
to all the shareholders of the different units of the group ?
Q37. a) Has your company issued any guarantee? If so, who are the beneficiaries (e.g. banks, other
companies, others) and who is the principal on whose account such guarantees are granted (e.g
employees, group company members, suppliers, others).
b) Would the company be able to meet demands under all guarantees if they were called on to pay all on
one day?
c) Does the company evaluate its ability to pay before granting such guarantees?
d) Do public companies find the requirements of section 103 functional?
Q38. How does your company maintain its registers (manually or electronically)? Any difficulties with
maintaining the registers and in maintaining the registers in the form they are?
Q39. a) How does your company calculate three-fourths vote for passing an extraordinary resolution?
b) Any difficulty encountered in passing such resolution?
c) Are details of the resolution provided in the notice for the meeting?
d) At what type of meeting are such resolutions passed (e.g. at any general meeting, AGM or EGM, or at
EGMs only)?

Q40. What has been the frequency of your companys board meetings?
Q41. What are the particular functions and powers delegated by the Board to the professional
management as discretionary powers ? Does the management hold the power of hiring and firing ? Is
the Managing Director a shareholder of the company or a professionally hired expert ?
86
Q42. a) How is the companys board of directors comprised? What was the basis for the composition of
the board (e.g. lender requirements, group company control, others)?
b) Is any director not subject to retirement? If so, what type of directors are they (e.g. permanent,
nominee, managing director)?
c) Has the company encountered any difficulty in the composition of its board?
Q43. Does the company grant its employees/directors loans? Are they on commercial terms or
concessional terms? What kind of assessments are made on such requests? What are the experiences in
recovery of such loans, particularly from ex-employees and directors?
Q44. Does the company have any directors that conduct additional functions for the company beyond
attending board meetings (e.g. committee of directors, bank account signatory, power of attorney, others)?
Has any director acted beyond or abused such additional authority? If so, what difficulties were
encountered?
Q45. Has any director been personally charged with any liability on account of the company or personally
in relation to the companys affairs (e.g. litigation, dishonour of cheques, notice of removal as director,
others). Has the company compensated or reimbursed expenses in defending or protecting the director?
Q46. Are there any alternate directors of the company? Are there any restrictions on the appointment of
such alternates (e.g. only another director, others)? Has the company encountered difficulties in dealing
with alternates?
Q47. Has the company encountered any difficulty in obtaining recognition in the resignation of any
director (e.g. approval of Bangladesh Bank/SEC)?
Q48. How can board member performance, in general, be improved?
Q49. Should there be maximum limits on directorships? If yes, then what should that number be? What
should be the split between executive and non-executive directors and why?
Q50. Does the company feel satisfied with the type of company it is? If not, why not. Does it have any
recommendations of any other type of company it would rather convert to, which is not currently
registerable in Bangladesh
87
Appendix F. Corporate Survey Findings

In order to find the existing level of corporate governance in the country, a representative group of 30
corporate CEOs were interviewed for this study using a qualitative questionnaire. The questionnaire was
structured to probe into issues shortlisted by the CG team as significant under the major headings
recommended by the OECD guidelines. Following is a summary of the findings received according to
the OECD guidelines.
A. The Rights of Shareholders
The questions asked in this section, i.e. questions relating to company formation and stock exchange
listing, did not yield anything of significance for the majority of the entities as either the current CEO was
not involved during formation stages or the company interviewed was part of an established group that
could work its way through the system. The group of people who did have direct start-up experience
reportedly used the RJSC, various chambers, and informal networks to acquire initial information.
Impediments related to obtaining certified copies of Articles and Memorandum of Association ranged
from the usual delays to unnecessary queries by the authority. Payments on top of the regular official
registration fees had been a pre-requisite for all companies excepting two - indicating that such practices
have become a common part of business operations. Only one company interviewed had faced problems
with fake shares and forgeries in the past. None of the CEOs were concretely aware of the stock
exchange listing requirements; this was a function regularly delegated to the finance director / company
secretary.
B. The Equitable Treatment of Shareholders
AGM Perception
The perception of AGMs amongst the non-banking listed companies surveyed seemed to be a
combination of a necessary evil and a statutory requirement. Very few, i.e. 38%, viewed it as actually an
effective forum for shareholders. Quality of shareholder profile has been on the decline since the 1996
crash and AGMs of approximately one-third of corporate houses are now hostage to a known group of
extortionists who routinely try to extort money from companies in the form of contracts (for
advertisements, services, etc.). If companies do not comply, this group creates unnecessary harassment
and chaos during actual meetings. To cite an example, one renowned company was forced to suspend its
AGM, hold an emergency board meeting and declare a higher dividend two years ago. In a well
appreciated move, SEC has asked for all AGMs to be videotaped and submitted so as to identify this
select group of agitators. Other than one person, who received concrete recommendations regarding
accounts preparation, none of the other CEOs could recall ever receiving relevant feedback from
shareholders.
The banks interviewed claimed to have more positive experiences at their AGMs. While one bank
referred to the usual problem of managed AGM pressures, the other three mentioned that this problem
is not as acute as in the corporate sector.
Minority Shareholders
Experience with minority shareholders echoes the sentiment already mentioned. Generally, shareholder
demands concentrate either on higher dividends or more basic requirements like better quality food and
gifts at the AGM and transportation allowances. (Although food and gifts have recently been made
illegal by the SEC.) The main incentive for attendance is the meal served at an attractive hotel and,
surprisingly, trading activity increases prior to AGMs to reflect that interest. There is, in reality, a very
limited number of people going to AGMs who actually understand/grasp the financial statements being
presented and, consequently, have little to contribute in terms of relevant inputs. Again, the financial
institutions interviewed revealed better experiences - with minority shareholders questioning balance
sheet specifics, staff benefits, branches and loan defaults.
88
Recommendations regarding minority shareholder protection were rare nearly all felt that the existing
laws are adequate and giving them too much of an edge will cause them to be abusive. The only two
suggestions received were awareness generation re rights and responsibilities and board representation.
Provision for Proxies
All the companies interviewed for the survey held AGMs regularly in the last three years and nearly all,
i.e. 91%, of public listed companies claimed that they allow non-members to be proxies at AGMs. This
flexible proxy policy allows shareholders to exercise their voting rights more easily.
Insider Trading
All the suggestions received from corporate entities re insider trading revolved around enforcing the laws
already in place and improving SEC surveillance. The banks interviewed were especially vocal on this
issue. One Managing Director commented, To prevent insider trading, Bank Company Act specifically
mentions that sponsors cannot hold more than 50% shares. However, what we see in practice is that
banks giving no dividends for years still continue to have high share prices this is the result of a large
number of directors trading shares amongst themselves. These particular banks have up to 30 directors
even though Bangladesh Bank sets the ceiling at 30. Only the SEC and BB can effectively check these
irregularities.
Comments on Bankruptcy, Liquidation, & Loan Recovery Procedures
Generally, awareness of the legal framework governing bankruptcy, liquidation, and loan recovery
procedures is low amongst corporate chiefs. Specific comments by the few who were knowledgeable
were:
- The system is not strong and needs major overhaul; it should provide two-way exit
- Very painful process; banks do not want to give up collateral even when the company wants
to pay back debt (this company had direct prior experience)
Comments on Creditors Rights
Comments on creditors rights currently existing in Bangladesh were:
- No legal mechanism for immediate relief other than drawn out processes
- Rights are not adequately ensured there is no bankruptcy court, no arbitration
- Problem is at enforcement level; government needs to be able to track down an individual
first through Social Security No. etc. before the rights of creditors can be ensured
- Banks are working to expedite the Corporate Debt Restructuring project whereby all banks
will jointly assess the exposure of large groups.
- A few banks are also working together to put together a list of individual defaulters (CIB
provides information at company levels)
Suggestions re possible use of market-based agencies to facilitate debt collection & insolvency
- Develop credit rating agencies
- Financially incentivise bank officials to recover bad loans
- Expedite exit of insolvent companies to partially recover debts
- Promote companies that buy bad debts and subsequently attempt to recover. Banks have
already started using small outfits for collection of bad debts. An example is Peoples
Management & Development Co. However, one company thinks this is ethically wrong
they are basically musclemen.
General Comments on Regulatory Institutions
89
Comments regarding the general nature of the regulatory authorities, not surprisingly, emphasized the
bureaucracy and corruption involved in the system. Specifically, opinion was as follows:
Agencies are corrupt to the core; honest officials have become the minority.
Negative attitude, oppressive, and inefficient; authorities only try to create problems.
Any kind of permission takes too long.
No coordination amongst government bodies for instance, SRO doesnt come out for 8 months
after government declares an incentive; 52 signatures are still needed at the customs for
clearance; VISA structure for foreign investors is dismal.
Comments re National Bureau of Revenue (NBR)
A mixed group - top people are good while rest are corrupt; a junior officer now comes in &
make reversals of crores of taka in our books.
Not set up to look after business interest; not very transparent.
Deliberately makes mistakes in SROs then companies have to pay a lot of money in bribes. This
increases the overall cost of doing business.
Creates hassles, unnecessarily checks books, tax officials can come & say that they will not
accept losses happens every year; they basically want personal shares in the taxes.
Changes in the implementation level will could have created a level field for multinational
companies vis--vis domestic ones.
Comments re SEC
Perceived as non-existent only restrictive
Tries to monitor; sends a lot of letters / queries
Comments re RJSC
Processing time depends on the whims of people involved
Slow & wont do anything without money.
The most corrupt body in the country today; every paper going in has to be helped out
Comments re BOI
Effectiveness depends on the Chairman; remittance of certain fees is a big problem even though
it's allowed without approval for say upto 6%
Has changed for better considerably this year and has become more foreign investor-friendly probably related to who is heading it
Good concept in theory but doesn't have any power; ex. we needed land once but BOI couldn't
help. Representation from concerned departments would have helped.
Major hurdle to any kind of development; you cant open a bank A/C, VISA open L/Cs without
BOI permission/registration
Comments re Bangladesh Bank
Has become more disciplined over time, Financial Sector Reform has played a key role in
bringing change.
faces interference from Ministry of Finance, BB at times gives arbitrary decisions, creates delays
when clarifications are sought, CIB report clearance takes 15 days instead of 24 hrs
calibre of people down the ranks is sub-standard
Comments on Submission of Personal Guarantees for Bank Loans
Other than large multinationals like BOC and Lever, all other companies have, at one time or another,
faced director assessment prior to bank loans. Those with significant clout refuse to give guarantees after
their reputation has been established. For companies, downsides of this pre-requisite are:
90
Unfair on the directors who are on the Board for their expertise
Deters exit
Contradicts limited liability concept
The last point is probably the strongest - unless one has limited liability, enterprise development will be
extremely difficult. Banks, on the other hand, defended their position by saying that this measure is
needed to protect their exposure since recourse against companies generally is not effective.
D. Disclosure & Transparency
Audit Committee & Internal Audit
Audit committees are not widespread amongst public listed companies (found in only 3 companies
interviewed) and do not exist at all in private companies. Nominee and remuneration committees are also
non-existent in the companies interviewed. The check-and-balance mechanism in 33% of the
organizations is in the form of internal audit in light of the general lack of confidence on external auditor
capabilities.
Banks have a much more stringent risk management procedure in place audits are performed at
three levels by external audit, Bangladesh Bank, and internal audit teams. The reaction to
establishing a supervising agency was predominantly (95%) negative on the part of the business
community. One CEO put the reason behind this feeling most succinctly when he commented, We don't
want another regulatory body because you still won't be able to get rid of the ones already existing. Too
many agencies will only cause further trouble. Other rationales included difficulties involved in
implementing this concept, creation of additional sources of corruption, and duplication of resources since
we already have ICAB and SEC with expert panels. The only comment supporting the idea specified that
this will be beneficial only if this agency belongs to the private sector.
Reaction to holding regular dialogue on reporting & disclosure issues amongst government agencies for
supervising corporate reporting
The reaction to holding regular dialogues was again predominantly negative on the part of the businesses.
Reasons cited are as follows:
This will mean another procedure and additional burden - these agencies should be cleaned up
first as they are corrupt themselves
This should be done through chambers
Outside people should not be involved; if shareholders are not satisfied, they can come back to
next year's AGM
The only interviewee supporting this idea mentioned that this should be extended to all government
institutions as they often have contradictory policies; for instance BTTB and NBR may have different
lists on which equipments qualify as capital machinery.
Views on Voluntary Disclosure of Company-related Information
General opinion among CEOs is pro voluntary disclosure with 57% favouring additional disclosure than
what is required. A bank MD has even gone to the extent of providing his salary figure in a separate line
in the banks annual report. A general look at the corporate annual reports of the country shows that
multinational entities typically have more voluntary information than local houses.
Specific noteworthy comments received from interviewees against additional disclosure were:
Existing disclosures are sufficient if auditors are correct in their work. Its already too much and
at times harassing.
Further disclosure will only help competitors.
91
This will provide the taxation authority with additional scope for harassment.
Preparation of Different Accounts Using Different Accounting Standards
This emerged to be an area of concern only for multinational companies who have to prepare two
different sets separately following BAS and IAS and hence leading to duplication of efforts. Feedback
on whether this is a critical issue was mixed and therefore difficult to determine.
Perception re External Auditors
The CG survey found that audit quality is a source of major discontent amongst most firms; 62% of
organizations expressed dissatisfaction with external audits. Firms cited a range of problems including:
inexperience of the auditors, a lack of professionalism and objectivity, and a mismatch between the fees
they are charging and the actual value they are adding. It was a widely held view among stakeholders that
rigorous auditing practices would improve corporate governance in large measure almost immediately.
Group Company Issues
64% of the public listed companies belong to other concerns through common shareholding. Comments
in this context emphasized that (a) currently, there is no incentive to creating a holding company and (b)
company law should be improved to incorporate the merger and group concept. Existing situation
involves added work in maintaining separate records for each of the entities.
Issuance of Guarantees
Guarantees are mostly extended by companies on behalf of employees to banks for loans, etc. These
guarantees are secured by the employees terminal benefits so do not pose significant exposures. Two of
the companies interviewed mentioned issuing guarantees against group companies only after appropriate
analysis.
Maintenance of Registers
Only 4 of the companies interviewed maintain their records manually. All others are electronic with
manual back-ups.
Calculation of Vote at Extraordinary Resolutions
At the CEO level, whether this calculation is based on shareholding or no. of members present is not
clear. Many have not faced EGMs yet.
All the companies selected reportedly hold regular board meetings (once every quarter) with boards
comprised of all executive directors obviously meeting more frequently. In an overwhelming majority
(i.e. 73%) of the non-bank listed companies, the board is heavily dominated by sponsor shareholders who
generally belong to a single family the father as the Chairman and the son as the MD is the usual norm.
The boards are usually actively involved in management - in 50% of the companies, there is more than
one executive director in the board. Only one of the MDs interviewed is not a voting board member.
One noteworthy trend is that even in companies where the MD is a sponsor shareholder, he is well
educated with good western qualifications - reflecting an increased level of sophistication, awareness, and
knowledge of sound business practices for a second generation of business leaders.
Most of the day-to-day operational functions are delegated by the board to management the only powers
retained by the board are extraordinary decisions of write-offs, dividends, auditor selection, new
business/investment activities, etc. Majority of the companies interviewed have neither alternate directors
nor provisions for them. Although the law provides for alternate directors in the case of the absence of a
director from Bangladesh, the survey found that only companies with foreign directors (for whom it is
difficult to travel to board meetings) have alternate director provisions.
92
Suggestions on how board performance can be improved ranged from increasing the frequency of board
meetings and holding training sessions, to imposing punitive penalties for violation of laws and
implementation of a well-defined selection process for board members (especially for nominee directors
sent by the government). Specifically, recommendations were:
Minority shareholders should be more participative, institutional shareholders should be alert in
sending right people.
Most board members dont know what to do: chambers can facilitate exchange of ideas amongst
board members.
Non-executive directors should be involved more so they know more about the company.
Shareholders should be made aware about board quality then performance would be
automatically reflected in share prices.
Regulatory bodies should make sure that at least 50% board seats go to public so that broader
interests are protected.
Recommendations relating to boards of banks included:
20% of board should be professionals; specific criteria on educational background & business
experience should be established. Including depositors in bank boards is not the answer.
Other South Asian countries have a fit and capability test for recruiting bank MDs and board
members, similar tests should be implemented here.
Restrain the board from unduly interfering into operational details.
Opinion was mixed on the necessity of directorship ceilings - with those favouring a ceiling (36%)
recommending a number within the range of 5 10. People who advocated against a ceiling cited reasons
like companies should themselves judge whether they want a person on the board and boards of
subsidiary companies are often symbolic so there shouldnt be any limits.
General Comments
Comments received from respondents regarding the overall business climate, over and beyond the
questions asked, were as follows:
A lot more issues need to be looked at first before CG; the supervising agencies need to be fixed
otherwise itll a moving target.
Required is a change in culture and mindset; government should take on defaulters so that they
are no longer respected in society
Regulatory bodies should take a tough stance against public listed companies to bring back public
confidence. They should send the right signal through exemplary punishment. Honest good
work should be positively reinforced and dishonesty punished - that should be the basic principle
of business. For instance, Saifur Rahman's initiatives to convert black money puts honest people,
who have paid their taxes so far, at a disadvantage.
Implement what we have on paper; total lack of coordination amongst agencies is frustrating.
Role of external & internal auditors is important; CG doesnt have to be solely affected by lossmaking performance, dividend limitations & stock prices.
93
Appendix G. List of Relevant Laws and Regulations in Bangladesh

Accountants
Chartered Accountants Ordinance, 1961 (Ordinance No.X of 1961)

Bangladesh Chartered Accountants Order, 1973 (P.O.42No.2 of 1973)
Cost and Management Accountants Ordinance, 1977 (Ordinance No.LIII of 1977)
SEC Order No. SEC/CFD-71/2001/Admin/08 dated 28 March 2001
SEC Order No. SEC/CFD-71/2001/Admin/02/05 dated 3 January 2002
Bangladesh Bank circular on auditors
Banks and Financial Institutions
Bangladesh Bank Order, 1972 (P.O. No.127 of 1972)

Bangladesh Banks (Nationalisation) Order, 1972 (P.O. No.26 of 1972)
as amended by Bangladesh Banks (Nationalisation) (Amendment) Ordinance, 1977 (Ordinance No.28
of 1977)
Bank Company Act, 1991 (Act No.XIV of 1991), as amended in 1991, 1993, 1995, 1997, 1999 and
2001 43
Financial Institutions Act, 1993 (Act No.XXVII of 1993) 44
Financial Institutions Regulations Rules 1994
Foreign Exchange Regulation Act, 1947 (Act No.VIII of 1947)
Money Laundering Prevention Act 2002 (Act No.VII of 2002)
Negotiable Instruments Act, 1881 (Act No.XXVI of 1881)
Negotiable Instruments (Amendment) Act, 1994 (Act No.XIX of 1994)
Bankruptcy
Bankruptcy Act, 1997 (Act No.X of 1997)

Bankruptcy Rules, 1997
Company
Companies (Foreign Interests) Act, 1918 (Act No.XX of 1918)

Undesirable Companies (Second) Ordinance, 1958 (Ordinance No.XLIX of 1958)
Companies Act, 1994 (Act No.XVIII of 1994)45
Debt Recovery Court
Artha Rin Adalat Ain [Money Loan Court Act], 1990 (Act No.IV of 1990)
Artha Rin Adalat Bidhan [Money Loan Court Rules], 1990
42
"P.O." means President's Order, which are legislation promulgated before the Constitution of Bangladesh came
into force.
43
Unofficial translations in English of the official Bengali versions of the Bank Company Act 1991 and
amendments made in 1993 and 1995 (but not those made in 1997, 1999 and 2001): http://www.sai.uniheidelberg.de/bdlaw/1991-a14.htm/.
44
Unofficial translation in English of the official Bengali version: http://www.sai.uni-heidelberg.de/bdlaw/1993a27.htm/
45
http://www.vakilno1.com/saarclaw/bangladesh/companies_act.htm
94
Insurance
Insurance Act, 1938 (Act No.IV of 1938)

as amended by Insurance (Amendment) Act, 1990 (Act No.XXVI of 1990) and Insurance
(Amendment) Act, 1993 (Act No.XII of 1993)
Insurance Rules 1958 (as amended by SRO No. 201-Law/2002 dated 22 July 2002)
Insurance Corporations Act, 1973 (Act No.IV of 1973)
as amended by Insurance Corporations (Amendment) Ordinance, 1984 (Ordinance No.LI of 1984)
and Insurance Corporations (Amendment) Act, 1990 (Act No.XXIX of 1990)
Securities 46
Securities Act, 1920 (Act No.X of 1920)

Securities and Exchange Ordinance, 1969 (Ordinance No.XVII of 1969)
Securities and Exchange Ordinance (Amendment) Act 2000 [Amendment of Ordinance No.XVII of
1969]
Securities and Exchange Commission Act, 1993 (Act No.XV of 1993)
Securities and Exchange Commission (Amendment) Act) 2000 [Amendment of Act No.XV of 1993]
Securities and Exchange Rules 1987 dated 28 Sep 1987 (SRO 237-L/87)
Securities and Exchange (Amendment) Rules 1987 dated 15 Dec 1999 (Notification
No.SEC/SMED/98-551/1560)
Securities and Exchange (Amendment) Rules 1987 dated 4 Jan 2000 (Notification
No.SEC/LSD/SER-1987/149)
Securities and Exchange Commission (Merchant Banker and Portfolio Manager) Regulations dated
24 Apr 1996 (SRO 59-Law/96)
Eligibility of Merchant Banker and Portfolio Manager (Notification) dated 24 Apr 1996 (Notification
No.SEC/Section-7/Law/94-4/115)
Capital Sufficiency of Merchant Banker and Portfolio Manager dated 24 Apr 1996 (Notification
No.SEC/Section-7/Law/94-4/1140)
Securities and Exchange Commission (Stock-Dealer, Stock-Broker and Authorised Representatives)
Rules 2000
Guidelines on Foreign Placement or Allotment of Securities dated 11 Feb 1995 (Notification
No.SEC/Section-7/95-23)
Guidelines on Initial Public Offering to Local Investors dated 8 Feb 1995 (Notification
Guidelines for Raising of Capital by Greenfield Public Companies dated 13 Jun 1995 (Notification
Credit Rating Companies Rules, 1996 dated 24 Jun 1996 (Notification No.SEC/Section-7/117) as
amended by vide Notification No. SEC/SRMID/2001-1018/Admin-03/02 dated 27 September 2001
Securities and Exchange Commission (Mutual Fund) Rules 2001
Public Issue Rules, 1998 dated 3 Jan 1999 (Notification No.SEC/Sec.7/P/R-98/140)
Rights Issue Rules, 1998 dated 27 Jul 1998 (Notification No.SEC/Section-7/RIR-98/137)
Depository Act 1999 (Act No.6 of 1999)
Depositories Regulations, 1999
Margin Rules, 1999 dated 28 Apr 1999 (Notification No.SEC/Section-5/98-542/141)
46
Copies of some of the laws and regulations in the SEC Bangladesh website, http://www.secbd.org, contain some
differences from the official versions.
95
Members Margin Regulations 2000

Listing Regulations of the Dhaka Stock Exchange, dated 18 Feb 1997 (Notification No.SEC/MemberII)
Settlement of Stock Exchange Transaction Regulations, 1998 dated 24 May 1998 (Notification
No.DSE-343/97/910), as amended from time to time
DSE Protection Fund Regulations, 1999 dated 7 Dec 1999
SEC (Acquisition of Substantial Shares, Merger & Take-over) Rules 2002
Automated Trading Regulations 1999
Investors Protection Fund Regulations 1999
SEC (Market Maker) Rules 2000
SEC (Capital Issue of Public Limited Company) Rules 2001
SEC (OTC) Rules 2001
SEC Notification No. SEC/CMRRCD/2001-14/Admin/03/06 dated August 01, 2002
SEC order of 8 October 2002 (on Lock-in on Foreign Sponsors/Placement Shares and mandatory
investing through Portfolio Accounts)
96
Appendix H. Forms to be Submitted to the RJSC and Other Bodies

Section 15: Certified copy of the order confirming the alteration of Memorandum within 90 days to the
RJSC. The alteration is of no effect till registration with the RJSC and if not dont within the time limit at
the expiration of that period the alteration becomes null and void.
Section 36 & 190: Copy of annual list of shareholders and summary of share capital within 21 days to the
RJSC. If a company is in default of this it is liable to be fined not exceeding two hundred taka for every
day.
Section 44: Notice to RJSC for rectification of register of members within 15 days.
Section 53: Notice for change in the structure of share capital to the RJSC within 15 days.
Section 54: Notice for consolidation of shares or stock to the RJSC within 15 days. Fine: not exceeding
two hundred taka.
Section 56: Notice for increase in share capital to the RJSC within 15 days. Fine: not exceeding two
hundred taka.
Section 71(5): Notice for court order on variation of shareholder rights within 15 days. Fine: not
exceeding two hundred taka.
Section 88: Return of copies of special or extraordinary resolution to the RJSC within 15 days. Fine: not
exceeding one hundred taka.
Section 92(1): Consent of directors to act as such. Cannot act as director till he has filed such a consent
with the RJSC.
Section 93(2): A person cannot act as a director unless he has filed to the RJSC a consent to act as such
within 30 days of his appointment.
Section 115(2): Return of change in directorship within 14 days of such change to the RJSC.
Section 138: Copy of prospectus signed by the directors on or before publication to the RJSC. Fine: not
exceeding five thousand taka.
Section 150: filing of verified declaration or statement in lieu of prospectus before commencement of any
borrowing powers to the RJSC. Fine: not exceeding one thousand taka.
Section 151(1)(a): where an allotment of shares is made company must within 60 days file a return of
allotments to the RJSC. Fine: not exceeding one thousand taka.
Section 159 and 160: Particulars of mortgage or charge with the instrument thereof or a verified copy to
the RJSC within 21 days. Void if not registered.
Section 161: filing of particulars in case of series of debentures being created within 21 days to the RJSC.
Section 167(1): A company has the obligation to file with the RJSC for registration of every mortgage or
charge created by the company and of the issues of debentures of a series to the RJSC.
97
Section 169: Notice for appointment of receiver within 15 days to the RJSC.
Section 170: Abstract of receipt and payments during receivers time and notice of ceasement to act as
receiver to be filed annually to the RJSC. Fine: not exceeding five hundred taka.
Section 172: Intimation for satisfaction of mortgage or charges within 21 days to the RJSC.
Section 190: Within 30 days of the annual general meeting three copies of audited and authenticated
balance sheet and profit and loss accounts to the RJSC. Fine: not exceeding one hundred taka for every
days delay.
Section 210(2): Notice of appointment to the auditor within 30 days of such appointment to the RJSC.
Section 228 & 229: Certified copy of the Courts order sanctioning the compromise agreement between
creditors and company within 14 days to the RJSC.
Section 231: Filing of prospectus or statement in lieu of prospectus on conversion of the status of any
company within 30 days to the RJSC.
Section 233(5): Notice about court order on minority shareholders right within 14 days to the RJSC.
Fine: not exceeding one thousand taka.
Section 252: Copy of winding up order made by the Court within 30 days to the RJSC.
Section 258(3): Statement of affairs to the official liquidator or the Court within 21 days. Fine: not
exceeding five hundred taka for every day.
Section 277(2): Report of the Courts order for the dissolution of company to be filed at the RJSC within
15 days of such dissolution. Fine: The official liquidator liable to a fine not exceeding one hundred taka.
Section 290: Declaration of solvency by directors to the RJSC on voluntary winding up for registration
before board meeting.
Section 296(3) & 305(3): Copy of accounts of winding up and return of general meeting of the company
within one week of the meeting to be filed with the RJSC.
Section 333: Notice of liquidator about criminal offence of directors to the RJSC. Government and
Court.
Section 379: Particulars of foreign companies to be filed with the RJSC for registration.
98
Appendix I. Current ICAB Adoption Status of IAS

IAS
Present Title
01
Presentation of Financial
Statements
Inventories
02
Effective date by IASC

original version
revised version
01 January 1975
01 July 1998
ICAB Adoption Status
01 January 1976
Adopted latest version as BAS 2
01 January 1995
07
08
Cash Flow Statements

01 January 1979
01 January 1994
Net Profit or Loss for the Period, 01 January 1979
01 January 1995
Fundamental Errors and
Changes in accounting Policies
10
Events After the Balance Sheet
01 January 1980
01 January 1995
Date
11
Construction Contracts
01 January 1980
01 January 1995
12
Income Taxes
01 January 1981
01 January 1998
14
Segment Reporting
01 January 1983
01 January 1998
15
Information Reflecting the
01 January 1983
01 January 1995
Effects of Changing Prices
16
Property, Plant and Equipment
01 January 1983
01 January 1995
17
Leases
01 January 1984
01 January 1999
18
Revenue
01 January 1984
01 January 1995
19
Employee Benefit
01 January 1985
01 January 1999
20
Accounting for Government
01 January 1984
01 January 1984
Grants & Disclosure of
Government Assistance
21
The Effects of Changes in
01 January 1985
01 January 1995
Foreign Exchange Rates
22
Business Combinations
01 January 1985
01 January 1995
23
Borrowing Costs
01 January 1986
01 January 1995
24
Related Party Disclosures
01 January 1986
01 January 1995
26
Accounting and Reporting by
01 January 1988
01 January 1995
Retirement Benefit Plans
27
Consolidated Financial
01 January 1990
01 January 1995
Statements and Accounting for
Investments in subsidiaries
28
Accounting for Investments in
01 January 1990
01 January 1995
Associates
29
Financial Reporting in
01 January 1990
01 January 1995
Hyperinflationary Economics
30
Disclosures in the Financial
01 January 1991
01 January 1995
Statements of Banks and Similar
Financial Institutions
31
Financial Reporting of Interests
01 January 1992
01 January 1995
in Joint Venture
32
Financial Instruments:
01 January 1996
Not revised
Disclosures and Presentation
33
Earnings per Share
01 January 1998
Not revised
34
Interim Financial Reporting
01 January 1999
Not revised
35
Discontinuing Operations
01 January 1999
Not revised
36
Impairment of Assets
01 July 1999
Not revised
37
Provisions, Contingent
01 July 1999
Not revised
Liabilities and Contingent
Adoption status as of October 31, 2002
(Source: ICAB National Awards 2001 for Best Published Accounts and Reports)
Adopted original version as BAS 1
Adopted original version

Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
Not Adopted
99
Appendix J. Summaries of Literature Reviewed

There has been some work done the area of corporate governance by the World Bank and ADB in
Bangladesh, but overall there is a lack of material on corporate governance issues in Bangladesh. Some
discussion regarding specific aspects of corporate governance has been undertaken by organizations like
Centre for Policy Dialogue (CPD), Institute of Chartered Accountants (ICAB), and the Institute of Bank
Management (BIBM). The brief summaries of the major articles and studies relating to CG are presented
in this appendix. The summaries explain the authors major points that relate to corporate governance.
The original articles and reports are in English, unless otherwise indicated. Other resources used in the
study are listed in the Resources Appendix.
Summaries in this Appendix
Centre for Policy Dialogue. Corporate Responsibility Practices In Bangladesh: Results from a Benchmark Study,
July 16, 2002
Mahmood, Prof. Wahiduddin. Bank Reform Committee Report (in Bangla), Government of Bangladesh,
December 1999
Saha, Dr. Sujit and Md. Saidur Rahman. Implementation of International Accounting Standard (IAS) in Banks
and Financial Institutions - A Step Towards Sound Governance System, Paper presented at the Management
Forum - 2002, on "Institutional Governance: Failure in Building Infrastructure for Socio-Economic Growth"
Organized by AMDB on July 25 - 26, 2002
World Bank. Taming Leviathan: Reforming Governance in Bangladesh
An Institutional Review, March 2002
Asian Development Bank. Capacity Building of the Securities and Exchange Commission and Selected Capital
Market Institutions, TAR:BAN 33226, November 2000
Reform and Development (BRD), Asian Development Bank
and AIMS of Bangladesh Limited, July 22, 2002
Sayeed, Yawer. Bangladesh: Strategic Issues and Potential Response Initiatives in the Finance Sector: Integrated
Financial Development (IFD), Asian Development Bank and AIMS of Bangladesh Limited, July 22, 2002
Chowdhury, Anwaruddin. Moving to International Standards, Presented at Bangladesh Moving to International
Accounting Standards, Regulation And Corporate Governance In Financial Services Opportunities and
Challenges for Financial Managers and regulators in Bangladesh March 20-21, 2001
Mahmud, Parveen. CPE Seminar on Microfinance Governance and Reporting, Institute of Chartered
Accountants of Bangladesh, November 6, 2001
Ghosh, Santi Narayan. Development of Accounting and Auditing Standards in Bangladesh IAS 18: Revenue
Recognition, Institute of Chartered Accountants of Bangladesh
Ahmad, Jamal Uddin and M.A. Baree. Corporate Governance for Transparency and Accountability, The
Bangladesh Accountant, Vol.29; No. 2, April-June 2000
100
Islam, Khan Tariqul. Annual Financial Statements of Banking Companies Are Those Serving the Purpose?,
The Bangladesh Accountant, Vol.29; No. 2, April-June 2000
Rahman, Md. Abdur and Mohammad Badrul Muttakin. Profitability of Private Sector General Insurance
Companies in Bangladesh, The Bangladesh Accountant, Vol.29; No. 2, April-June 2000
Bangladesh: Financial Accountability for Good Governance
World Bank, 2002
This report primarily discusses the current state of public sector financial accountability and makes
recommendations for reform and improvement. It deals in depth with the problems of the Comptroller
and Auditor Generals Office (CAG), internal audit, public accounts, parliamentary oversight, and public
enterprises. It also contains a section on private sector accountants and auditors, which is of primary
concern to corporate governance.
The report finds a number of failings with the structure of the accounting profession in Bangladesh. First,
the supply of accountants is low due to lack of adequate training facilities and lack of sufficient financial
support for trainees. ICAB has concentrated on increasing the quality of training and strengthening
requirements, but the self-regulation of members of both professional institutes (ICAB and ICMAB) has
been ineffective. There are three major recommendations for improvement of private sector accounting:
Professional institutes (ICAB and ICMAB) should to prepare strategic plans to expand the output
of professional accountants and auditors without sacrificing quality.
The establishment of a sub-professional accounting qualification
ICMAB should introduce a code of ethics, and both professional institutes should enforce their
codes strictly.
In general, the report concludes that the most significant failing in financial accountability in Bangladesh
is between national standards and national practices. Laws and regulations exits, but are not enforced. At
present there are few visible sanctions for wrongdoing. Recommendations focus on creating a cohesive
voice for reform by mobilizing support from beneficiaries of reform, including citizen groups, civil
society, the business community, the donor community, and reform-minded government officials.
However, as a starting point, the report recommends greater transparency of the public sector through
public dissemination of data, reports, and information. This recommendation could just as easily apply to
the corporate sector, where public disclosure is one of the cornerstones of good corporate governance.
Corporate Responsibility Practices In Bangladesh: Results from a Benchmark Study
Centre for Policy Dialogue, July 16, 2002
The Centre for Policy Dialogue (CPD) carried out a survey of 151 stakeholder groups regarding corporate
responsibility practices in Bangladesh. The stakeholder groups surveyed were civil society groups,
companies, and employees. Corporate Governance was only one aspect of corporate responsibility
included in the survey.
The general findings of the survey were:
Corporate responsibility practices in multinational companies are better compared to locally
owned companies.
101
Corporate responsibility practices in larger companies are better compared to smaller companies.
There are variations in corporate responsibility practices between different sectors.
The report shows that 66% of the civil society stakeholders are dissatisfied with corporate responsibility
practices and 82% are dissatisfied with the level of consultation and interaction with the civil society over
corporate responsibility practices. There are significant disparities in perception between different
stakeholders. For instance, 71% of the companies surveyed perceive that there is no violation of health
and safety standards, while only 16.9% workers perceives so. There is clearly dissatisfaction regarding
corporate responsibility among the workers.
The analysis of survey results concludes that improving corporate responsibility practices should provide
fiscal benefits to companies and enable them to attract more foreign investment. A number of practical
suggestions for improving corporate responsibility are discussed.
Bank Reform Committee Report (in Bangla)
GOB, Dhaka, December 1999
Prof. Wahiduddin Mahmood
Chapter V: Private Banks
The Banking Reform Committee Report (1999) observed that there is lack of good corporate governance
practices in the private banks in spite of their appointing comparatively more efficient executives and
using modern technology. In overall terms, the financial status of private banks is quite unstable, similar
to the nationalized banks. Twenty-nine percent of private bank loans were classified. Political
considerations were prevalent in the business decisions of the banks. There was also a lack of
transparency, accountability and fairness in the private banks.
Many directors were found to be misappropriating bank funds for their own advantage and neglecting the
interest of depositors. It was found that at least 152 directors took an amount of Taka 13.5 billion, which
was 20% higher than their investment in those banks. In addition to taking out loans in their own names,
the directors took loans in the name of false institution and were also taking loans in disregard to the rules
and regulations of the regulatory bodies.
Many directors were found to be associated with the irregularities in the private banks in the recent years.
At least 36 directors were reported to have been associated with irregularities such as disregarding the
Bank Company Act and circulars of the Bangladesh Bank. Many directors took monetary and other
benefits apart from being associated with irregular loans.
Instances of disciplinary actions against private bank directors are rare even though Bangladesh Bank has
the authority to remove such directors. At the time of the report, only ten directors had been ordered to be
removed. However, no penal action has ever been taken against any offender.
It is noteworthy that statutory and prudential regulations for good corporate governance have been
circulated in the private banks. However, widespread misappropriation by the directors in taking loans
and other illegal benefits from the bank is still prevalent. In considering the application for bank licenses,
it was not the qualifications and efficiency of the enterprise, but political affiliation that received
attention. The recommendations for good banking practices are enclosed in annex 5.1 of the report.
In accordance to the Bank Company Law, Bangladesh Bank is bestowed with the authority of supervising
the banking business. But it is the government, which takes the final decision on this matter by virtue of
administrative decisions. This very process is not in favour of politically neutral decision-making.
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The report points out that there is a paradox between imposing regulations on private corporations and
allowing the private sector to operate freely. It is evident that imposing restrictions on banking activities
hinders the freedom of corporate decision-making. Enhancement of the exercising authority of the
Bangladesh Bank may also lead to a more complex bureaucracy for private banks. On the other hand,
corruption and violation of the regulations cripple the total banking sector. It can be envisaged that
restrictions on private banks can be substantially withdrawn in the future once the directors operating in
the private sector can nurture a culture of good banking practices.
Implementation of International Accounting Standard (IAS) in Banks and Financial Institutions A Step Towards Sound Governance System
Dr. Sujit Saha, Professor, and Md. Saidur Rahman, Assistant Professor, BIBM
Presented at the Management Forum - 2002, on "Institutional Governance: Failure in Building
Infrastructure for Socio-Economic Growth" Organized by AMDB on July 25 - 26, 2002
This report discusses the financial disclosure practices of banks and financial institutions before adoption
of IAS-30 and the disclosure requirements now that IAS-30 has been adopted. Prior to the adoption of
IAS-30, the Bank Companies Act, 1991 (Annexure 1) governed financial disclosures of banks and
financial institutions. Compared to international standards, the requirements were lax; for example,
provisions for loan losses (specifically for bad/doubtful debt and generally for unclassified loans) were
not required. If a loan loss provision was made, it was not counted against profit and loss. In addition,
the reporting of capital adequacy was insufficient. The report includes further detail about reporting
requirements before the adoption of IAS-30.
After encouragement from the World Bank, IMF, and other international donor agencies, the Bangladesh
Bank directed banks and financial institutions to comply with the requirements of IAS-30 through BRPD
Circular No. 3/2000 dated March 18, 2000. The regulations were effective beginning December 31,
2000.
IAS-30 introduced a number of improvements in disclosure, which are detailed in the report, but will only
be briefly summarized here. There are three major, new disclosure requirements in the Profit and Loss
Account. First, categories of income and expenses must be disclosed separately. For instance, interest
income, investment income, and dividend income must be shown. Second, a specific loss provision for
individually classified bad and doubtful debts and a general provision for potential, but not specifically
classified, loans must be identified in the Profit and Loss Account. The notes should provide details on
the movement in provision for losses throughout the year. Third, BRPD Circular No. 14 (June 2001)
requires that unrealised losses on securities investments be shown in an investment loss provision
account. However, unrealised gains may not be shown in the financial statements.
With regard to Balance Sheet reporting, assets (loans, advances, and investments) must be shown by
category. Categories should include: type of asset, maturity, geographic location (domestic or
international), borrower, and classification (substandard, doubtful, etc.). IAS-30 also requires disclosure
of secured and unsecured liabilities and the type of security provided.
Under the new requirements, banks must prepare a cash flow statement, which was previously not
required. Banks and financial institutions will also have to prepare a statement showing changes in
Equity. Finally, in addition to the financial statements required, detailed notes to the financial statements
will be necessary.
103
Compliance with IAS-30 is a key step in improving the reputation of banks and financial institutions, both
domestically and internationally. The new requirements will begin to reveal the true state of affairs to
stakeholders and hopefully motivate management to make improvements. The author believes that the
positive results would come out only when the quality disclosure would take place instead of simple
compliance with the IAS-prescribed formats. To achieve this level of compliance, the author
recommends that the Bangladesh Bank issue instructive circulars and develop a training module for bank
personnel.
Taming Leviathan: Reforming Governance in Bangladesh
An Institutional Review, World Bank, March 2002
This large document mainly deals with public accountability and governance, not corporate governance.
However, given that a significant number of corporations are State-Owned Enterprises (SOEs), its
findings have some relevance here. The Review analyses the underlying causes of Bangladeshs poor
governance, the consequential weak performance of public institutions, and reasons for the governments
slowness to reform.
The Review argues that Bangladeshs development has been slow because too little attention has been
given to social and political obstacles in the design of reforms to strengthen the rule of law, reduce
corruption and arbitrary decision making and improve service delivery - which are the governments
avowed objectives. To achieve better performance from SOEs and in the privatisation process, these
same factors must be taken into account.
To succeed, reform must benefit all the stakeholders whose cooperation is needed. Because reformers
have generally adopted a technocratic approach, and largely ignored the way incentives play out, the
record of institution building is mixed with few real successes and many setbacks to learn from
effective incentives linked to real accountability are the key to better public sector performance.
Capacity Building of the Securities and Exchange Commission and Selected Capital Market
Institutions
Asian Development Bank (TAR:BAN 33226) November 2000
This document is a project document for a new technical assistance project being funded under the
auspices of the Capital Market Development Program Loan of ADB. A related technical assistance
project (Loan 1580-BAN), which started in 1997 and was ongoing at the time of the report, focused on
surveillance procedures for the SEC and other reform measures. In 1999, the GOB requested further
assistance from the ADB to strengthen the Securities and Exchange Commission (SEC), this document
details the objectives, scope, and budget of the technical assistance program (TA).
The TA will focus on the SEC, the stock exchanges (CSE and DSE), and capital market participants. It
will improve the SECs capacity to effectively regulate the markets and to audit listed companies. The
TA will help CSE and DSE become more efficient in their function as a central securities depository.
Finally, the TA will provide training for capital market participants. The focus will be on corporate
governance, financial reporting, and compliance with international accounting and auditing standards.
Some of the outputs detailed in the scope of the TA include:
Proposed amendments to existing laws to improve corporate disclosure, corporate governance,
and the protection of shareholders
A corporate governance manual
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A shareholder rights manual

A syllabus for CG training
Guidelines for governance audits
Corporate governance training sessions for listed companies
Accounting and auditing training for personnel of listed companies
SEC staff training on procedures for financial statement reporting and IAS/ISA compliance
The SEC is the executing agency for this TA. A consulting firm will implement the TA and will be
overseen by a steering committee. The TA was scheduled to start in February 2001 and was to be
completed by April 2002.
Bangladesh: Strategic Issues and Potential Response Initiatives in the Finance Sector: Banking
Reform and Development (BRD)
Yawer Sayeed, AIMS of Bangladesh Limited for the Asian Development Bank, July 22, 2002
In this working draft report prepared for the Asian Development Bank, Mr. Sayeed describes the current
banking environment and establishes a road map for future initiatives in banking reform and development.
Major failures in the banking sector identified by the report are: (i) the level of non-performing assets; (ii)
operating practices in state-owned commercial banks; (iii) ineffective oversight by the Bangladesh Bank;
and (iv) the legal and judicial framework for default loan recovery.
Overall, the report questions the health of most banks in Bangladesh. The author states, while there are
sound banks, the banking sector as a whole is technically insolvent. The primary symptom of the
problem is a very high percentage of classified loans as a percentage of total outstanding loans. In 2001,
classified loans comprised 31.3% of total outstanding bank deposits and 8.7% of GDP. A number of
operational failings are at the root of this situation. Practices of particular concern are policy lending to
loss-making state-owned enterprises, political patronage and directed lending, insider lending in private
local banks, unproductive assets, and a pervasive culture of default by borrowers.
The Bangladesh Bank, whose mandate is the oversight of the banks, does not fulfil its duties in this
respect. The Bangladesh Bank (BB) has questionable financial standing, its prudential regulations are
lax and enforcement quite ineffective. Primary obstacles to improvement of the BB are the
organizational structure, excessive union activity, and politicised appointments to the BB board and top
senior management positions. Some upcoming policy measures may improve the situation. Amendments
to the legislation governing the BB will increase its autonomy from the Ministry of Finance. Second, the
government plans to remove treasury functions from the BB, leaving it with more resources to fulfil its
regulatory and oversight functions. The BB is also concentrating on monitoring non-performing loans,
advising bank management on loan recovery, and controlling insider lending.
The final major problem identified is the lack of a legal and judicial framework for default loan recovery.
Use of Money Loan Court or Bankruptcy Court by banks pursuing loan defaulters does not yield
satisfactory results, particularly with respect to executing judgments against defaulters. Recent directives
by the BB regarding rescheduling instalment loans also have the effect of condoning delays in loan
repayment.
In short, the author suggests that reform of the banking sector must start with improved loan recovery
practices and stronger regulatory oversight. Simultaneously, banks can be relieved of their nonperforming loans by pooling them into a separate organization overseen by a private asset management
company. In addition, fast-track privatisation of the SOEs and SCBs is recommended. The final
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recommendations for a future program to improve the financial sector include detailed goals, performance
targets, monitoring mechanisms, and assumptions and risks. In addition, the author makes suggestions for
government policy initiatives and areas in which technical assistance will be required.
Bangladesh: Strategic Issues and Potential Response Initiatives in the Finance Sector: Integrated
Financial Development (IFD)
Yawer Sayeed, AIMS of Bangladesh Limited for the Asian Development Bank, July 22, 2002
Prepared for the Asian Development Bank, this report identifies ways in which the capital market can be
expanded to provide more options to enterprises and to decrease the economys vulnerability to economic
shocks. The report includes a discussion of the current capital market environment, explaining the
function of and problems with the Investment Corporation of Bangladesh (ICB), Bangladesh Shilpa Rin
Sangstha, Jiban Bima Corporation, and Sadharan Biman Corporation. Since the current capital market is
essentially equity oriented, the report primarily catalogues the impediments to the development of capital
market instruments.
The capital market outside the equity market in Bangladesh is very limited primarily because state-owned
institutions are dominant. In addition, legal and practical obstacles make it difficult for private
participants to compete with state-sponsored offerings. Current policies favor state-owned financial
institutions. For instance, the state-owned financial institutions operate in the capital market under
different rules than private players; for instance, the ICB mutual funds do not publish their net asset value
or submit performance reports, which is required of private mutual funds. Currently, the only area in
which non-bank financial institutions have been active is in leased assets, but they could expand into asset
securitisation if the current Stamp Duty is reduced. The largest impediment to the development of a fixed
income securities market is the high yield structure on government savings schemes; in comparison to the
savings schemes, any private sector fixed income offering would not be competitive. The government
recently reduced the rate paid on the savings schemes, which will likely encourage future corporate debt
securities issuances.
The Capital Market Development Program, funded by the ADB, worked to strengthen market regulation
and supervision to development capital market infrastructure. The author maintains that the program is
perceived by market participants as being regulatory-focused and has not had a direct effect on the
market. Therefore, a future capital development program should focus on capacity-building in the private
sector and removing impediments to new capital market products. Specific goals and recommendations
for a future capital market development program are discussed.
Moving to International Standards
Anwaruddin Chowdhury, President ICAB
Presented at: Bangladesh Moving to International Accounting Standards, Regulation And Corporate
Governance In Financial Services, March 20-21, 2001, Dhaka.
Hosted by The IFC, FMO, and Standard Chartered Bank Plc.
This report reviews Bangladeshs progress towards harmonization of financial reporting and auditing with
international standards, as well as provides recommendations for future steps. The author sees accounting
harmonization as a necessary step for Bangladesh to remain competitive in the face of globalisation and to
attract capital into the economy. The author explains some of the challenges involved in implementing
and monitoring IAS and ISA in Bangladesh. Some of the primary limitations to compliance are: a lack of
monitoring by regulatory agencies, the low level of compensation for auditors, and differences between
financial and tax reporting where the ICAB adopted IAS requirements are at odds with the legal
106
requirements in the Companies Act or the tax law. Furthermore, there is a lack of consistency between
the standards required and enforced by the relevant regulatory agencies (SEC, Bangladesh Bank, etc.) and
the standards adopted by profession organizations like ICAB. IAS and ISA adopted by the ICAB may be
made legally enforceable through the relevant laws (Companies Act 1994, Securities Exchange Rules
1987, Bank Company Act 1991, etc.) and/or professionally enforceable through the application of
Chartered Accountants Bye-laws 1973.
In spite of the challenges, some positive steps have been taken. ICAB voted in 2001 to amend its Byelaws so that compliance with adopted IAS and ISA is professionally enforceable for its members. In
addition, effective April 1, 2000 Bangladesh Bank required that the financial statements of banking
companies comply with IAS-30, which spells out rules on non-performing loans. Both steps provide
avenues to enforce compliance with IAS and ISA once they have been adopted for Bangladesh.
The author makes a number of recommendations for further harmonization of accounting policies. Those
of interest include:
The Companies Act should be amended to require public companies comply with IAS and ISA as
adopted by ICAB. In 1997, the SEC amended the Securities and Exchange Rules 1987 so that all
listed companies must comply with the IAS that have been adopted by ICAB. However, a further
amendment in 2000 changed the rules to bypass the ICAB adoption of IAS.
The SEC and ICAB should have a forum for regular interaction to work towards proper
implementation and monitoring of the adoption of IAS by companies.
The SEC needs additional staff qualified to monitor companies at a level consistent with
international standards.
The report includes a survey of the financial reports of 36 listed companies and four foreign companies
for compliance with IAS. The results show that, although there has been progress in ensuring
harmonization of financial accounts in Bangladesh, there is still a significant degree of non-compliance
with GAAP. Inventory cost basis, depreciation, accounting for leases, and earnings per share calculations
were all areas in which the survey found financial statements did not comply with IAS and GAAP.
An appendix to the report provides a useful table of the IAS and their ICAB adoption status. At the time
of the report, 31 IAS had been adopted by IASC for practice. The ICAB had adopted 21 IAS in their
original versions and six more were approved by the Technical and Research Committee of ICAB, but not
yet adopted by ICAB. (IASC often revises the standards after they have been issued, hence the
appellation original versions.) ICAB is reviewing the revised versions of the adopted standards. With
regards to auditing standards, the IAPC has issued more than 40 ISA, of which ICAB has adopted 22 in
their original versions.
CPE Seminar on Microfinance Governance and Reporting
Parveen Mahmud, FCA, ICAB, November 6, 2001
The article explains the regulatory structure governing microfinance institutions (MFIs) and microfinance
NGOs in Bangladesh. (In this summary, MFIs will refer to both microfinance institutions and
microfinance NGOs.) The Palli Karma-Sahayak (PKSF) is an agency set up by the Government of
Bangladesh (GOB) to oversee MFIs and to provide subsidized loans to such organizations. The PKSF has
policy and standards guidelines, which should be followed by MFIs. The guidelines relating to
governance and financial accountability include:
Standards for microfinance accounting
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Policy for loan classification and debt management reserve: Similar to banks and financial
institutions, MFI must classify their loans and account for loan loss provisions.
Financial ratio analysis: Analysis of financial ratios covering portfolio quality, operating
efficiency, and rates of return allow managers to identify strengths and weaknesses.
Guidelines for Management Audit
Guidelines for Internal Audit: The PKSF internal audit cell carries out management and
financial audits of MFIs each year.
Terms of Reference for an external auditor auditing PKSF
Terms of Reference for an external auditor of PKSF auditing MFIs: When an external audit of
PKSF takes place, the external auditor also audits the MFIs under PKSFs purview.
Terms of Reference for an external auditor auditing MFIs appointed by the MFI
If an MFI deviates from the guidelines set by PKSF, the audit report should explain the nature of each
deviation and managements reasons for not complying. PKSFs guidelines are not official accounting
standards and therefore only serve as a source of assistance to an analyst looking at the accounts of an
MFI.
Furthermore, the article outlines the PKSFs principles of good governance that discuss the composition
and function of the MFIs boards of directors.
Development of Accounting and Auditing Standards in Bangladesh, IAS 18: Revenue Recognition
Prof. Santi Narayan Ghosh, Institute of Chartered Accountants of Bangladesh
The report explains various theoretical views on the definition of revenue, the measurement of revenue,
the recognition of revenue and the timing of revenues. Revenue must be recognized in the period in
which the major economic activity leading to revenue creation takes place. Furthermore, the exchange
value of revenue must be measurable, the value of revenue be verified by a market transaction, and
revenue should be recognized concurrently with the related expenses. In addition, the business valueadding activity should be substantially complete when revenue is recognized. There are various methods
of matching the timing of revenue with value-adding activity. Depending on the type of product and the
terms of sale, the identification of substantial completion can vary; revenue can be recognized at the time
of production, completion, sale, cash collection, or some combination of those points in time. The
theoretical summary of revenue recognition provides the background for the specific application of IAS
18.
The author further details the accounting treatment of revenue under IAS 18, providing specific examples
of how various transactions would be treated under IAS 18. Identification of transactions under IAS 18
and revenue measurement is explained. The article details IAS treatment of some specific revenue
activities, including real estate sales, sale of services, franchise fees, interest, royalties, and dividends.
Finally, the article mentions the disclosure requirements for IAS 18: an enterprise complying with IAS 18
must disclose the accounting policies used for revenue recognition and the method used to determine the
stage of completion. Furthermore, an enterprise must provide the categories of revenue arising from the
various activities of the enterprise. The author states that Bangladeshi companies do not provide such
disclosures.
Corporate Governance for Transparency and Accountability
The Bangladesh Accountant, April-June 2000, Vol.29; No. 2
Jamal Uddin Ahmad, FCA and M.A. Baree, FCA
108
The authors summarize the principles and standards of corporate governance as agreed and put forth by
OECD, Cadbury Committee (UK), and other international committees. The problems of implementing
international corporate governance norms in Bangladesh are then explored. Finally, the authors make
some recommendations for reform of corporate governance in Bangladesh.
The article identifies eight characteristics of the private sector in Bangladesh as the primary obstacles to
good corporate governance in Bangladesh. They are: (1) boards and management tend to avoid
disclosure; (2) closely-held family ownership leads to limited transparency and accountability; (3) bank
finance is the primary source of financing; (4) a lack of independent directors and skilled audit committee
members; (5) a weak regulatory framework and inefficient bureaucracy; (6) low audit fees for external
auditors and a dearth of qualified internal auditors; (7) the absence of sufficient institutional investors;
and (8) a lack of active minority shareholder groups.
The article recommends three substantive actions be taken to improve corporate governance in
Bangladesh. First, a high powered committee including members from government, regulatory
agencies, companies, and ICAB should write a code for CG in Bangladesh. Second, amendments to
existing laws should be adopted to enforce CG norms. Third, academic and professional institutions
should include CG principles in their syllabi. In addition, the authors encourage institutional investors to
exercise their influence and discourage nominee directors from the GOB and financial institutions.
Annual Financial Statements of Banking Companies Are Those Serving the Purpose?
Khan Tariqul Islam, FCA
In this article from The Bangladesh Accountant, the author explains the various elements of a banks
financial statements, the importance of accurate financial statements, and the difficulties in implementing
international accounting standards in the banking sector.
Annual financial statements for banks include a balance sheet, profit and loss account, cash flow
statement, and notes to the financial statements. The article explains the major elements of each financial
statement. Of particular interest are the discussions regarding loan loss provisions and shareholders
equity. A review of the guidelines for loan classification and provision, as established by Bangladesh
Banks Circulars, is provided and the importance of accurate loan reporting is emphasized. The author
states, without true and fair reflection of loans the entire balance sheet of a bank can be misleading for its
users and any banking company can be bankrupt overnight if its loans are not truly and fairly reflected in
the balance sheet. With respect to Shareholders Equity, the article points out that the present form of
bank balance sheets make it difficult to identify and understand the amount of shareholders equity.
The article underscores the importance of making bank financial statements properly reflect the true and
fair financial position of the institution. The quality of information regarding banks is the cornerstone of
the economy. If internal or external actors in the economy lack confidence in the banks, the whole
financial system may collapse or transactions with international banks or companies may be limited. In
fact, the author believes that the lack of international-level accounting and auditing standards is a major
factor in the low level of foreign investment in the country.
The major obstacle to improving the quality of bank financial statements, as identified by the article, is
legal inconsistency between the Bank Company Act and the BAS. The implementation of BAS-30,
which is equivalent to IAS-30 and governs the treatment of loans, would bring banks closer to
international standards. However, BAS-30 is, in many cases, in conflict with the Bank Company Act,
1991. Other instances of legal inconsistencies are also mentioned in the article.
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Profitability of Private Sector General Insurance Companies in Bangladesh

Md Abdur Rahman and Mohammad Badrul Muttakin
The article summarizes the results of a survey analysing the profitability of four private sector general
insurance companies over the last five years. The results of the survey showed that for most types of
insurance, the private sector insurers earned a profit. The bulk of their profits came from marine
insurance, with fire insurance being next most profitable. All the surveyed companies showed high
Earnings Per Share and Return on Shareholders Equity results. The objective of the survey was to
demonstrate the possibilities for profitable private sector insurance.
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Appendix K. Financial Institutions in Bangladesh
State-owned commercial banks

1.
2.
3.
4.
Agrani Bank (AB)

Janata Bank (JB)
Rupali Bank Limited (RBL)
Sonali Bank (SB)
Specialised and development banks (SDBs)

1. Ansar-VDP Unnayan Bank Limited (AVUBL)
2. Bangladesh Krishi Bank (BKB)
3. Bangladesh Samabaya Bank Limited (BSBL)
4. Bangladesh Shilpa Bank (BSB)
5. Bangladesh Shilpa Rin Sangstha (BSRS)
6. BASIC Bank Limited (BBL)
7. Grameen Bank (GB)
8. House Building Finance Corporation (HBFC)
9. Investment Corporation of Bangladesh (ICB)
10. Karmasangsthan Bank Limited (KBL)
11. Rajshahi Krishi Unnayan Bank Limited (RAKUB)
Private commercial banks (PCBs)
1. Arab Bangladesh Bank Limited (ABBL)
2. Bangladesh Commerce Bank Limited (BCBL)
3. Bank Asia Limited (BAL)
4. Brac Bank Limited (BBL)
5. Dhaka Bank Limited (DBL)
6. Dutch Bangla Bank Limited (DBBL)
7. Eastern Bank Limited (EBL)
8. Exim Bank Limited (EBL)
9. First Security Bank Limited (FSBL)
10. International Finance Investment and Commerce Bank Limited (IFICBL)
11. Jamuna Bank Limited (JBL)
12. Mercantile Bank Limited (MBL)
13. Mutual Trust Bank Limited (MTBL)
14. National Bank Limited (NBL)
15. NCC Bank Limited (NCCBL)
16. One Bank Limited (OBL)
17. Premier Bank Limited (PBL)
18. Prime Bank Limited (PBL)
19. Pubali Bank Limited (PBL)
20. Shahjalal Bank Limited (SBL)
21. Southeast Bank Limited (SBL)
22. Standard Bank Limited (SBL)
23. The City Bank Limited (TCBL)
24. The Trust Bank Limited (TTBL)
25. United Commercial Bank Limited (UCBL)
26. Uttara Bank Limited (UBL)
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Foreign commercial banks

1. American Express Bank
2. Citibank NA
3. Credit Agricole Indosuez
4. Habib Bank Limited
5. National Bank of Pakistan
6. Shamil Bank of Bahrain EC (ex Faisal Bank)
7. Standard Chartered Bank
8. State Bank of India
9. The Hong Kong and Shanghai Banking Corporation Limited
10. Woori Bank Limited (ex Hanil/Hanvit Bank)
General Insurance Companies
1. Agrani Insurance Company Limited
2. Bangladesh Cooperative Insurance Limited
3. Bangladesh General Insurance Company Limited
4. Bangladesh National Insurance Company Limited
5. Central Insurance Limited
6. City General Insurance Limited
7. Continental Insurance Company Limited
8. Crystal Insurance Limited
9. Eastern Insurance Limited
10. Eastland Insurance Limited
11. Express Insurance Limited
12. Federal Insurance Limited
13. Global Insurance Limited
14. Green Delta Insurance Company Limited
15. Islami Commercial Insurance Company Limited
16. Islami Insurance Limited
17. Janata Insurance Limited
18. Karnaphuli Insurance Limited
19. Lloyds Insurance Limited
20. Meghna Insurance Limited
21. Mercantile Insurance Limited
22. Nitol Insurance Limited
23. Northern General Insurance Company Limited
24. Paramount Insurance Company Limited
25. Peoples Insurance Limited
26. Phoenix Insurance Limited
27. Pioneer Insurance Limited
28. Pragati Insurance Limited
29. Prime Insurance Company Limited
30. Purabi General Limited
31. Reliance Insurance Limited
32. Republic Insurance Limited
33. Rupali Insurance Limited
34. Sadharan Bima Corporation
35. South Asia Insurance Limited
36. Sunflower Insurance Limited
37. United Insurance Limited
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Life Insurance Companies

1. American Life Insurance Company Limited
2. Baira Life Insurance Limited
3. Delta Life Insurance Limited
4. FarEast Islami Life Insurance Company Limited
5. Homeland Life Insurance Company Limited
6. Jiban Bima Corporation
7. Meghna Life Insurance Limited
8. National Life Insurance Limited
9. Padma Life Insurance Company Limited
10. Progressive Life Insurance Company Limited
11. Provati Life Insurance Company Limited
12. Rupali Life Insurance Company Limited
13. Sandhani Life Insurance Limited
14. Sunlife Life Insurance Company Limited
Non Bank Financial Institutions
1. Bangladesh Finance & Investment Limited (BFIL)
2. Bangladesh Industrial Finance Company Limited (BIFIL)
3. Bay Leasing & Investment Limited (BLIL)
4. Delta Brac Housing Finance Company Limited (DBHFCL)
5. Fareast Finance & Investment Limited (FFIL)
6. Fidelity Assets and Securities Company Limited (FASCL)
7. First Lease International Limited (FLIL)
8. GSP Finance Company (Bangladesh) Limited (GSPFCL)
9. Industrial & Infrastructure Development Finance Company Limited (IIDFCL)
10. Industrial Development Leasing Company (IDLC) of Bangladesh Limited
11. Industrial Promotion Development Company (IPDC) of Bangladesh Limited
12. Infrastructure Development Company Limited (IDCOL)
13. International Leasing & Financial Services Limited (ILFSL)
14. Islamic Finance & Investment Limited (IFIL)
15. Midas Financing Limited (MFL)
16. National Housing Finance & Investment Limited (NHFIL)
17. Oman Bangladesh Leasing & Finance Limited (OBLFC)
18. Peoples Leasing & Financial Services Limited (PLFSL)
19. Phoenix Leasing Company Limited (PLC)
20. Premier Leasing International Limited (PLIL)
21. Prime Finance & Investment Limited (PFIL)
22. Saudi Bangladesh Industrial & Agricultural Investment Company (SABINCO) Limited
23. Self Employment Limited (SEL)
24. The UAE-Bangladesh Investment Company Limited (UBINCO)
25. Union Capital Limited (UCL)
26. United Leasing Company Limited (ULC)
27. Uttara Finance & Investment Limited (UFIL)
28. Vanik Bangladesh Limited (VBL)
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Appendix L. Resources
Ahmad, Jamal Uddin and M.A. Baree. Corporate Governance for Transparency and Accountability,
The Bangladesh Accountant, Vol.29; No. 2, April-June 2000
Ahmad, Mushtaq. Doing Business in Bangladesh, S.F.Ahmed & Co. August 1999.
Originally published by Ernst & Young International, Inc, Singapore, June 1996.
AIMS of Bangladesh. Bangladesh: Strategic Issues and Potential Response Initiatives in the
Economic Sector: Enterprise Reform and Privatization (ERP).
Asian Development Bank. Capacity Building of the Securities and Exchange Commission and
Selected Capital Market Institutions, TAR:BAN 33226, November 2000
Bangladesh: Strategic Issues and Potential Response Initiatives in the Economic Sector: Enterprise
Reform and Privatization (ERP), Working Draft for Discussion, Asian Development Bank.
Centre for Policy Dialogue. Corporate Responsibility Practices In Bangladesh: Results from a
Benchmark Study, July 16, 2002
Chowdhury, Anwaruddin. Moving to International Standards, Presented at Bangladesh Moving to
International Accounting Standards, Regulation And Corporate Governance In Financial Services
Opportunities and Challenges for Financial Managers and regulators in Bangladesh March 20-21,
2001
Commonwealth Association for Corporate Governance. Principles for Corporate Governance in the
Commonwealth, November 1999. www.cbc.to
Ghosh, Santi Narayan. Development of Accounting and Auditing Standards in Bangladesh IAS 18:
Revenue Recognition, Institute of Chartered Accountants of Bangladesh
IDCOL Newsletter, August 24, 2001
Imam, Shahed. The Cost and Management (Journal of the ICMAB), September-October 1999.
International Accounting Standards Committee. International Accounting Standards 2001, 2001.
Islam, Khan Tariqul. Annual Financial Statements of Banking Companies Are Those Serving the
Purpose?, The Bangladesh Accountant, Vol.29; No. 2, April-June 2000
Lal, Dr. T. and Ahmed Fakhrul Alam. Need for a Specialised Export Financing Institution in
Bangladesh, The Bangladesh Accountant, Vol.29; No. 2, April-June 2000
Mahmood, Prof. Wahiduddin. Bank Reform Committee Report (in Bangla), Government of
Bangladesh, December 1999
Mahmud, Parveen. CPE Seminar on Microfinance Governance and Reporting, Institute of Chartered
Accountants of Bangladesh, November 6, 2001
114
Meghna Condensed Milk Industries Limited. Prospectus, June 28, 2001

Organisation for Economic Co-operation and Development.
Governance. 1999. Available from http://www.oecd.org
Organisation for Economic Co-operation and Development.
Comparative Perspective, 2001.
OECD Principles of Corporate

Corporate Governance in Asia:
Rahman, Md. Abdur and Mohammad Badrul Muttakin. Profitability of Private Sector General
Insurance Companies in Bangladesh, The Bangladesh Accountant, Vol.29; No. 2, April-June 2000
Saha, Dr. Sujit and Md. Saidur Rahman. Implementation of International Accounting Standard (IAS)
in Banks and Financial Institutions - A Step Towards Sound Governance System, Paper presented at
the Management Forum - 2002, on "Institutional Governance: Failure in Building Infrastructure for
Socio-Economic Growth" Organized by AMDB on July 25 - 26, 2002
Sayeed, Yawer. Bangladesh: Strategic Issues and Potential Response Initiatives in the Finance Sector:
Banking Reform and Development (BRD), Asian Development Bank
and AIMS of Bangladesh Limited, July 22, 2002
Sayeed, Yawer. Bangladesh: Strategic Issues and Potential Response Initiatives in the Finance Sector:
Integrated Financial Development (IFD), Asian Development Bank and AIMS of Bangladesh Limited,
July 22, 2002
Temple, Frederick T. Country Director, World Bank, Dhaka Speech at a seminar titled Financing
Private Sector Infrastructure Projects on August 24, 2002
Transparency International Bangladesh, Office of the Comptroller and Auditor General (CAG),
Executive Summary and Working Paper, September 2002
Transparency International Bangladesh, Standing Committee on Public Accounts, Executive Summary
and Working Paper, September 2002
World Bank. Taming Leviathan: Reforming Governance in Bangladesh
An Institutional Review, March 2002
115
Appendix M. Report on January 7, 2003 Seminar

Report on Seminar: Strengthening Corporate Governance
January 7, 2003
All invitees were provided the Executive Summary of the December 30, 2002 Draft for Discussion report
A Diagnostic Study of the Existing Corporate Governance Scenario in Bangladesh. All those invited as
special/chief guests or discussants were provided the full version of the report. (Please see the attached
schedule.)
All points attributed to speakers are paraphrased from notes and the seminar transcript, unless they are
provided in quotes. A full transcript has also been prepared.
Session 1:
Farooq Sobhan inaugurated the session. Mr. Sobhan explained the basic objectives of the project and the
methods used in the research. He highlighted the survey of companies as well as interviews with key
stakeholders in the corporate governance arena. The seminar is part of the ongoing process of receiving
feedback from stakeholders. Particular thanks were given to DFID for their support of the project. In
addition, a warm welcome and thanks were extended to all the participants, but particularly the Chief
Guest, Mr. Moudud Ahmed (MP, Minister of Law, Justice and Parliamentary Affairs), and Special Guest,
Dr. Fakhruddin Ahmed (Governor, Bangladesh Bank).
After introductory remarks by Farooq Sobhan (President, Bangladesh Enterprise Institute), Wendy
Werner presented a summary of the reports findings. The floor was then opened to comments from
participants.
Mohammed Abdul Hannan Zoarder, SEC47
Through indirect regulation of listed insurance, bank, and non-bank financial institutions,
therefore, SECs scope and jurisdiction is broader than just the listed companies.
Mr. Zoarder had a number of points to refute the characterisation of the SEC in the report.
o SEC has to put rules in English and Bangla newspapers before implementation to allow
an opportunity for comments, so it is not correct that the SEC does not allow opportunity
for comments.
o The SEC tries to do something on the basis of individual events.
o Those with grievances against SEC rules or rulings can go to court. The court has not
ruled against SEC, therefore one cannot say that the SEC acts outside its legal authority.
On the point of fraud and inaccurate information in IPOs, Mr. Zoarder said the SEC cannot
examine all documents for an IPO. It is the responsibility of the auditors to ensure full disclosure.
With regard to bankruptcy, the U.S. has Ch. 11 and Ch. 7 bankruptcy. Ch. 11 bankruptcy allows
for reorganization. Bangladesh needs a similar Ch. 11 reorganization law.
The importance of an audit was also emphasized, Mr. Zoarder said good accountants are doing
bad audits.
Mohammed Aziz Khan (Managing Director, Summit Group)
Bangladesh does not yet have a critical mass of businesses to implement good Corporate
Governance (CG).
A key problem (also mentioned in the presentation and report) is the personal guarantees required
of directors. It is difficult to ensure that all directors have good credit.
47
116
This requirement is in opposition to the limited liability concept and it is a very important
problem.
A.K. Chowdhury (FCA, Hoda Vasi Chowdhury & Co.)

Mr. Chowdhury pointed out that the DSE, insurance, and mutual fund sectors were not mentioned
in the Executive Summary and that these are also key institutions/sectors. (Editors note: DSE,
insurance, and mutual fund sectors are discussed in the full report. Mr. Chowdhury had only
received the Executive Summary.)
He also believes that there is a strong need for emphasizing audit committees in companies.
Board of Investment (BOI) also plays a key role in attracting investment.
Before good CG, we need good public governance.
M.A. Malik (former Secretary)
There is a need for a post-privatization programme for State-owned Enterprises (SOEs) and a need to look
specifically at CG at privatised SOEs.
Sultan-uz Zaman Khan (former Chairman, SEC)
There is a need to improve general governance and adherence to the rule of law in addition or
before looking at CG.
Insurance funds can play an important role in CG, particularly the Chief Controller of Insurance.
BOI and Bangladesh Export Processing Zone Authority (BEPZA) are also important to attracting
foreign direct investment (FDI).
He asked the writers to substantiate the claim that SEC impinges on business decisions regarding
distribution of profits.
There is a need to close and/or privatise more SOEs.
Special Guest, Dr. Fakhruddin Ahmed (Governor, Bangladesh Bank) was then asked to make his
comments.
Dr. Fakhruddin Ahmed (Governor, Bangladesh Bank)
In order to improve CG, we have to break it down into pieces and operationalize it. We need good
governance as well, but can start on the pieces of CG first. If the pieces of CG are identified, we can
begin to do something on each one of those pieces. The BEI study is a start and it provides a menu of the
current problems.
With regard to directors and management, outsiders should understand the role of directors and
management. Bangladesh Bank (BB) has issued a circular on the role and responsibilities of boards in
nationalised banks. We [BB] are also thinking about requirements for directors for private banks.
Another organisation that could play a part is Bangladesh Institute of Bank Managers (BIBM). What is
their role? An amendment to the Bank Control Act is also being considered to allow for directors
representing depositors to be appointed by BB. This could be the beginning of real independent directors.
BB has recently been working to strengthen regulations. We recently increased the capital adequacy of
banks. Loan approval limits are now 50% of a banks capital. There are also new limits on total
exposure.
With regard to audits, financial statements should require more disclosures. There is also a need to
improve audit standards. BB has now required banks to comply with IAS-30 and BB itself will be
complying with IAS and will be audited according to ISA.
All BB regulations should now be available on our website.
117
The issue of impediments to the capital markets is an important one. Banks should not be 97% of
the financial sector.
Bank rates should also increase to move closer to the national savings certificate rates. BB is
working on a primary auction market.
The one thing that will truly determine the improvement in CG is the quality of boardroom
discussions, which no one can regulate. How will we know if the directors behave as they
should? Perhaps training for directors (as mentioned by Farooq Sobhan) is a good solution.
A question was posed by the SEC representative.
Mr. Zoarder: You have limited the size of the bank boards to 9 to 11 directors.
Dr. Ahmed: Yes, we have circulated a proposal on limitation of the size of boards for everyones views.
Its not yet been officially released. We are also considering a fit and proper test for directors similar to
the fit and proper test for CEOs that we already issued.
The Law Minister was then given the floor.
Moudud Ahmed (MP, Minister of Law, Justice and Parliamentary Affairs)
The BEI study provides a base for improving CG in Bangladesh. Our primary problem is a lack of
professionalism, meaning a lack of efficiency and also a lack of good governance. So far, the country has
not been able to develop a corporate culture, but we are a new country and were previously not
independent.
Two important laws that have not been mentioned that encourage foreign investors are the
intellectual property rights and the Arbitration Act.
We have recently decided, just last night, that the government will have to be devolved and BB
will be completely independent.
The Registrar of Joint Stock Companies (RJSC) is in a dismal condition. One cant get
documents that should be available. It can take 6 months or more to get documents and some
documents are just not there. Certified copies also take time. The RJSC needs to be modernized
and computerized. They also do some things that are just not in the law. For instance, the RJSC
requires a no objection certificate to change a registered office, but this appears nowhere in the
law.
There is also a high default rate because borrowers dont use money for the reasons the money
was provided.
Banks also are half-hearted in their filing in the Money Loan Court. They file at the last minute
so that they can tell their boards they have done so. Once the suit is filed, they do not pursue the
case.
Execution of Money Loan Court decisions is also a problem; execution usually takes several
years. We will recast the law on loan recovery to deal with this problem.
Extensive training of judges regarding arbitration and mediation procedures that could take place
outside the court.
The current Bankruptcy Act is inadequate. There has been no case in the Supreme Court yet, so
the courts have a lack of understanding regarding the law. There is a need for education
regarding the proper use of the Bankruptcy Act.
Implementation recommendations for this project should include training to increase awareness
of CG. Also, we should recognize good CG, perhaps through national awards and the
establishment of a national standard.
Session 2: The Role of the Directors and Shareholders
Prof. Abu Ahmed (Dept. of Economics, University of Dhaka)
118
I have some relevant experience to share here as I have been on boards of directors as the lone outsider.
Mostly management and the board have been family owned. In the case of one board that was familydominated, they didnt even want to hold board meetings and AGMs did not take place on time. Finally,
I quit the board because I didnt feel I was representing shareholders adequately.
There should be a regulation by the SEC that the number of board meetings and the attendance at
board meetings should be reported.
Usually on boards non-executive directors are dominated by executive directors
In banking companies, I think there should be proportional board representation to the
contributors of capital.
Prof. Ahmed is Chair of the board for a development financial institution (govt). He finds generally that
the board does not have time to even read the agenda before the meeting and executive directors and
management control what is put on the agenda. So the directors do not have much real input to the board
meeting. Furthermore, when, as Chair, he asks for borrowers to provide more information (i.e. tax
information), they question why the information is being requested and do not like to provide the
information.
On shareholders, AGMs dont last more than 3-4 hours, with good food and therefore are not long enough
to spend time on the substantive issues. Shareholders in Bangladesh are not educated to analyse financial
statements.
Disclosures are an area in which things could be improved for shareholders. First, salaries and
allowances of CEOs should be a required disclosure. Second, one can notice many differences in Annual
Reports due to voluntary disclosure. For instance, some companies disclose the individual shareholdings
by each director and show the changes over time. This is a piece of information a shareholder can
understand and it should be a required disclosure.
Z category companies: One third of the companies on the DSE are categorized as Z category.
They start declaring 2-3% dividends in order to graduate from the Z category even though there is
no change in operations.
With regard to the SEC requirement for institutional shareholders to have a board seat, he is in
favor of the requirement.
The report asserts there are few incentives to going public. He agreed; the current tax advantage
(5%) is not enough to provide an incentive to go public. The tax advantage should be at least
10%
Syed Manzoor Elahi (Chair, Apex Group; President, Bangladesh Association of Banks; Vice President,
Bangladesh Association of Public Listed Companies)
Private companies see no reasons for disclosure or to go public. When a company has a big
project, it then goes to the public because financing only with debt is too expensive. So the
assertion of the report that there are few reasons to become a public company is correct.
With regard to the Companies Act, the Companies Act should clearly define the rights and
responsibilities of shareholders.
Boards of directors with too many directors are very difficult to run. I would limit the number of
directors to 10. A good way to limit the number of directors is to require that all directors hold
qualification shares of 5-10% of the company.
With regard to family holdings, the thinking of shareholders here is that larger family holdings (at
least 60%) is better. If the familys shareholding is diluted shareholders complain because they
feel the family managers-owners are no longer interested in the company.
Therefore, it is difficult to implement many CG governance principles in Bangladesh when the
board is dominated by family and thats exactly what the shareholders want.
119
On shareholders and the AGM: Most activist shareholders are professional hecklers that try to
extort money prior to the AGM in exchange for their silence at the AGM. Even with stronger
SEC rules, this AGM mafia continue to blackmail companies.
Rights and responsibilities of shareholders and directors should be in the Companies Act.
Companies Act should also not conflict with Articles of Association. It is the task of the RJSC to
point out violations of the Companies Act that appear in Articles of Association. For instance,
the Companies Act does not allow the renting out of company property (?), but many Articles of
Association allow it.
Independent directors are a double-edged sword and their inclusion should be left up to the
sponsors.
The floor was opened to discussion and questions.
Sultan-uz Zaman Khan (former Chairman, SEC) suggested merging the offices of the SEC and RJSC.
Haroonur Rashid (former Chairman, SEC)
A merger of the SEC and RJSC may not solve the problem if they are not provided with proper
pay, equipment, logistics, etc.
The rights and responsibilities of directors and shareholders are adequately addressed in the laws,
but are not enforced properly.
It is also difficult and expensive to utilise minority shareholder protections under Section 233.
Mohammed Abdul Hannan Zoarder (SEC)
The SEC cannot monitor all board meetings and minutes; that would be micro-managing
companies. There is no circular yet on individual board shareholdings.
The SEC is understaffed and the benefits are inadequate. In Pakistan, the SEC and RJSC have
been merged and extra compensation is offered to SEC officers.
There are incentives to going public:
1. A public company gains respect and esteem.
2. They can raise more money and can grow bigger.
3. A publicly listed company receives a 10% tax rebate.
The SEC has required videotapes of AGMs but has not yet reviewed them all. Videos will be
used to make a case before a court, but they have not yet gathered sufficient evidence to prosecute
anyone yet.
On the issue of CG principles being voluntary or required: The SEC has tried to encourage
voluntary compliance with good CG principles. We sent the OECD guidelines on CG to the
chamber bodies, but the chambers dont do anything to encourage them. Further, 95% of the
requirements for global CG are in the law, but they are not enforced.
Farooq Sobhan posed the question of why IPOs in Bangladesh are declining. Mr. Zoarder replied
that other countries have also seen a decline in IPOs. He cited examples of Pakistan and Thailand
which have had one and zero IPOs, respectively.
Yawer Sayeed (CEO, AIMS of Bangladesh Ltd. and BEI CG Team)
In response to Mr. Zoarder of the SEC, Mr. Sayeed highlighted that the diagnostic study revealed the state
of corporate governance in the country through the impressions of entrepreneurs as well as regulators.
The study highlights that there is considerable scope for improvement in the regulatory agencies. It
recognizes that the SEC has a difficult situation to manage and that the pay scale and capacity at the SEC
is in need of improvement. The exercise here is not to pass the buck or blame other groups or agencies,
but to begin to work together to improve the situation.
Session 3: Banks and Financial Institutions
120
Dr. Debapriya Bhattacharya (Executive Director, Centre for Policy Dialogue)

The financial sector section of the report does not cover the full financial sector. It doesnt look
at non-banking financial institutions and micro-credit. The focus of the report should be
qualified.
As for the organization of the report, the sub-headings should identify the areas of major
problems.
Other areas that should be mentioned in the report include: (i) corporate management and
incentive failures/moral hazard problems, (ii) banking wing of the Ministry of Finance, (iii) more
on the indigenous committees and reports that have been prepared on banking (Money and
Banking Reform 1985, Mahmuds Commission 1991)
In the capital markets section, there should be a discussion of governance issues with the
DSE/CSE and computerization. For instance, the central depository system didnt work for the
stock exchange.
The survey is not completely reflected in the paper. The data from the survey should be provided
in a tabular form.
The judiciary is not discussed in the financial sector. Banks often face questions of which court
to take a case to, the Money Loan Court or Bankruptcy Court. The Supreme Court also identifies
defaulters.
M.A. Malik (former Secretary)
The importance of CG is not confined to the commercial banking sector. The CG situation at Bangladesh
Bank should also be included. We need to see if the risk is being managed properly at Bangladesh Bank.
I would suggest you take a look at the Basel Committee guidelines on banking supervision.
Sultan-uz Zaman Khan (former Chairman, SEC)
I agree the report should include more discussion of the DSE/CSE. The performance of the capital
markets could also be expanded. There were a number of SEC reports after the 1996 situation that could
be helpful.
Habibullah Bahar (Economic Advisor, Bangladesh Bank)
There is some inaccuracy in the report regarding the composition of the BB Board of Directors; there are
currently 9 members.
Dr. Debapriya Bhattacharya (Executive Director, Centre for Policy Dialogue)
There is a problem of the BB board. Right now theres an MD (medical doctor) on the board,
which should not be allowed.
NCBs are also not under the purview of the BB, which is a major shortcoming.
Session 4: Auditing and Accounting
M.A. Baree (former president, Institute of Chartered Accountants of Bangladesh)
Ive just returned from India and the group will be glad to hear that a Bangladeshi company
received an award for the quality of its accounts.
Adoption of accounting standards is not enough by itself. In Bangladesh, companies do not want
to spend money and time to have proper accounts prepared. Even if adopt all International
Accounting Standards (IAS), companies will select the worst auditor.
The basic problem is very low audit fees.
The SEC does not have sufficient technical knowledge to check accounts.
121
I propose that all listed companies should have an audit committee of the board of directors,
which must include directors with financial knowledge. The audit committee should select the
auditors.
I believe that having non-executive directors without family connections is important. Director
training is also a good idea.
A major problem in Bangladesh is that group companies dont have to be consolidated. We do
not have a fiscal incentive to consolidate. Most places have a provision in the tax law that allows
a company with greater than 51% of a holding in a subsidiary to apply any loss from that
subsidiary to the overall accounts of the group (and therefore reduce taxes). We do not have this
in our tax law.
Comments were taken from the floor.
A.K. Chowdhury (FCA, Hoda Vasi Chowdhury & Co.)
Accounting standards and auditing standards are often mixed up. Accounting standards apply to
the internal workings of preparing accountings. There are no regulations on who will prepare
accounts.
No one in the SEC properly evaluate the accounts prepared by companies.
ICAB only has 700 members and they have very little money, the contributions from members
are very low.
Hafizuddin Khan (former CAG)
Mr. Khan made extensive comments regarding the preparation and treatment of public accounts and the
CAG. The full remarks will be taken from the transcript.
The floor was opened to questions.
Wendy Werner (BEI)
Ms. Werner asked Mr. Baree about his opinion regarding the role of ICAB in informing shareholders
about the role and value of an auditor and about what further steps should be taken to encourage or
enforce consolidation.
M.A. Baree
ICAB has many limitations in raising awareness among shareholders. The SEC or stock
exchanges should make shareholders more aware.
On consolidation, the Companies Act should allow/require consolidation when a company has
51% of the equity of another enterprise.
Haroonur Rashid (former Chairman, SEC)
ICAB maintains that audit quality is not maintained because fees are too low. However, the fees
should be controlled by the self-regulating organisation (SRO). If all members agree not to quote
rates below a standard, the level of rates will be maintained.
In his experience, ICAB punishments are too light. ICAB should work harder at enforcing
quality requirements.
Mr. Zoarder also defending the capabilities of the officers at the SEC saying they all had MBAs or MAs
in Accounting. Mr. Baree pointed out that an MBA is a professional degree but a Chartered Accountant
is a technical qualification. The SEC needs this type of technical expertise.
Session 5: Regulatory and Legal Environment
122
Dr. M. Zahir (Senior Advocate, Supreme Court)

The legal environment for CG is poor. The particular problem is implementation.
There should be further training for judges on corporate and securities law.
The SEC is trying, but sometimes there is some overkill. SEC comes up with lots of regulations,
every Friday they are introduced and I dont know who has the time to read them all.
There is also a lack of knowledge of the law and its requirements on the part of managers.
Accountants and auditors should act as watchdogs, not bloodhounds, but also should not give up
after sniffing the air just once. Auditors must clearly point out the problems so others can solve
them. In 1993, Justice Donovan in a Canadian case said yes, yes he may be a watchdog, but it is
no good if after one howl, he retires to the barn and goes to sleep.
Liability of auditors: If auditors are not up to the mark, what remedy do shareholders have?
There is nothing in the law protecting shareholders, there is only some case law. In the U.S. for
instance, there must be direct causation of financial liability from the auditors statements or
actions.
With regard to application of Section 233, a case can only go forward with 10% of the shares,
which is quite a lot in the case of a large company. It is also difficult to prove directors are at
fault. In response to questions, Dr. Zahir pointed out that the 10% requirement could be sensitive
to the size of a company i.e. large companies could only require 5% of the stock, or similar.
The High Court does not have direct jurisdiction over SEC cases.
Ms. Sheela Rahman (Advocate and BEI CG team)
There is a significant lack of prompt information regarding rules, regulations and laws with
regard to companies and securities. This creates difficulties for companies trying to comply with
the laws as well as for professionals trying to advise companies whether to go for listing or stay a
listed company.
One result of the report was that there is a lack of awareness regarding the rights of shareholders.
This is true in many instances of law so what we would like to do is to raise awareness before
going on to law reform.
The question of shareholder rights also brings up the 10% floor for minority protection. There
has been recommendations regarding lowering the floor for minority shareholder action; this
would open a floodgate of actions.
There is a significant need for additional training in the areas of commercial law, securities law
and the role of specialized courts.
Dr. Zahir
On the issue of the 10% floor for minority shareholding, a formula could be used that relates the
percentage requirement to the size of the company.
After some further discussion with Dr. Zahir, the meeting was adjourned by Farooq Sobhan, with thanks
particularly to the participants and the discussants.
Particular thanks are extended to Mr. Mohammed Abdul Hannan Zoarder of the SEC and Mr. A.K.
Chowdhury of Hoda Vasi Chowdhury & Co. who provided written comments to the draft report. In all
possible cases, the written comments were incorporated into this final report.
123
List of participants in the Seminar on Strengthening Corporate Governance held on

7 January 2003 at BEI
Sl No
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
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29.
30.
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32.
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34.
35.
Name
Organization
Ms. Wendy Werner

Mr. Haroonur Rashid
Mr.K. Mahmood Sattar
BEI
Former Chairman, SEC
Managing Director & CEO
Eastern Bank Ltd
Mr. Zia U. Ahmed
SEDF, 10 Gulshan Ave
Mr. Anil Sinha
SEDF, 10 Gulshan Ave
Mr. Anton de Wilde
SEDF
Mr. Aminul Islam
Former Ambassador
Mr. Mostafa Faruque Mohammed
Sr. Research Fellow, BEI
Mr. Sultan-uz Zaman Khan
Ex-Chairman, SEC
Mr. M.A. Malik
Former Secretary
Mr. M. Afsarul Qader
Former Ambassador
Mr. Frank Matsaert
DFID, British High Comm
Mr. Monzurul Haque
ORG-MARG-QUEST
Mr. Yawer Sayeed
AIMS of Bangladesh Ltd
Mr. A.K. Chowdhury
HODA VASI Chowdhury & Co.
Mr. Wali-ul-Maroof Matin
Mr. AKM Ziauddin
P.B.TL
Mr. Mohammad Tipu Sultan
P.B.TL
Mr. Abu Ahmed
Dhaka University
Mr. Mohammed Abdul Hannan Zoarder
SEC
Mr. Zahid Hossain
Mr. Mohammed Aziz Khan
Summit Group
Mr. M. Shafiullah
Iqbal U Ahmed
A.B. Bank Ltd, Head Office
Mr. SM Abdul Mannan
Member, BEI Board of Governors
Mr. Mollah Shahidul Haque
Consultant DCCI
Syed Mazur Elahi
Chairman, Apex Group; Vice President,
Bangladesh Association of Public Listed Companies
Mr. Habibullah Bahar
Bangladesh Bank
Mr. Debapriya Bhattacharya
Executive Director, CPD
Mr. M.A. Bari
Institute of Chartered Accountants of
Bangladesh
Ms. Sheela R. Rahman
Bar-at-Law, Rokunuddin Mahmud
and Associates
Dr. M. Zahir
Sr. Advocate, Supreme Court
Mr. Hafizuddin Khan
Former CAG
Mr. Altaf Hossain Sarkar
Member, BEI Board of Governors
Mr. Farooq Sobhan
President, BEI
124
Programme for National Seminar on

Strengthening Corporate Governance in Bangladesh
January 7, 2003
Bangladesh Enterprise Institute
House 20, Road 5, Gulshan-1, Dhaka
Session 1:
9:30 am to 11:00 am
Introductory Remarks:
Farooq Sobhan
Presentation of the Draft Report Diagnostic Study of the Existing
Corporate Scenario in Bangladesh
BEI Corporate Governance Team
Special Guest:
Dr. Fakhruddin Ahmed
Governor, Bangladesh Bank
Chief Guest:
Moudud Ahmed, MP
Minister of Law, Justice and Parliamentary Affairs
Tea Break:
11:00 am to 11:30 am
Session 2:
11:30 am to 1:00 pm

Discussants:
Prof. Abu Ahmed, Dhaka University
Syed Manzoor Elahi, Apex Group
Lunch:
1:00 pm to 2:00 pm
Hosted by Bangladesh Enterprise Institute
Session 3:
2:00 pm to 3:00 pm

Discussants:
Allah Malik Kazemi, Deputy Governor, Bangladesh Bank
Mahmud Sattar, MD, Eastern Bank
Dr. Debapriya Bhattacharya, Executive Director, CPD
Session 4:
3:00 pm to 4:00 pm

Discussants:
MA Baree, President, ICAB
M Hafiz Uddin Khan, Chairman, Public Expenditure Review
Commission
Tea Break:
125
4:00 pm to 4:15 pm
Session 5:
4:15 pm to 5:15 pm

Discussants:
Manir Uddin Ahmad, Chairman, SEC
Dr. Muhammad Zahir, Senior Advocate, Supreme Court
Closing Session:
5:15 pm to 6:00pm
Chief Guest:
Amir Khosru Mahmud Chowdhury, MP
Commerce Minister
Closing Remarks:
Farooq Sobhan
126
Getting There Pretty Rapidly

The State of Corporate Governance in India
Omkar Goswami48
Chief Economist
Confederation of Indian Industry
New Delhi, India
It would be accurate to say that corporate governance was a relatively unknown phrase throughout most
of Asia until the Thai baht spun out of control in July 1997, and started the financial crisis throughout the
region. No doubt there were occasional international seminars on the subject where a handful of activists
made powerful, often emotional, cases for greater corporate transparency, disclosure and protection of
minority rights; and some enlightened managers and policy-makers had read the Cadbury Committee
Report and believed in the desirability of having better boards with more independent directors.
However, in the main, corporate governance was generally unheard of, and considered an alien occidental
fad that was ill suited to Asian values and time-tested ways of doing business.
Superficially, South-East and East Asian corporations, banks, stock markets and governments seemed to
have every reason to be unconcerned about corporate governance. From the mid-1980s right up to 1996,
the region as a whole had consistently clocked extremely impressive growth rates among the highest in
the world. The countries followed prudent fiscal policies. Indeed, most of them notched budget
surpluses, and none that were crippled by the Asian contagion racked up deficits like the ones seen in
Latin America, Turkey, India, or even some of the western European nations. Most enjoyed a booming
export trade. These countries had high savings as well as investment rates, and relatively good
infrastructure. Banks as well as foreign and domestic investors bent over backwards to offer all manner
of debt and equity. Sure, many of the conglomerates were heavily leveraged with short term dollar
denominated debt, and were riddled with complex cross-holdings. But, there were projects to be had,
profits to be made, and so long as the boom continued, debts would be paid. Stock markets were
booming like never before, giving equity investors handsome capital gains. The system worked like a
well oiled machine. There was absolutely no felt need to impose concepts like better accounting
practices, greater disclosure, and independent board oversight.
The crisis of 1997-98 changed all that. This was no classical Latin American debt crisis. Here were
fiscally responsible, healthy, rapidly growing, export driven economies that went into crippling financial
crisis. Slowly, companies, banks, governments as well as international multilateral institutions began to
understand that severe structural flaws in the realms of microeconomics could trigger region-wide
macroeconomic financial collapse. There was a gradual realisation that the devil lay in the institutional
details the nitty-gritty of transactions between companies, banks, financial institutions and capital
markets; of the design of corporate laws; of bankruptcy procedures and practices; of the structure of
ownership and crony capitalism; of stock market practices; of poor boards of directors with scant
fiduciary responsibilities; of disclosures and transparency; and of inadequate accounting and auditing
48
For comments and queries, please E-Mail omkar.goswami@ciionline.org. No part of this article may be quoted or
reproduced without permission of the author or the Confederation of Indian Industry.
127
standards. Suddenly, corporate governance was dusted out of academic and activist closets and given
centre stage.
The corporate governance movement began in most of Asia in 1998 and continued at varying paces right
up to 2001. By the middle of 2001, however, most of Asia was getting back to a concerted growth phase,
and the psyche of investors had swung from fear to greed. Not unsurprisingly, there were incipient signs
that while every country was faithfully mouthing the mantras, the spirit of corporate governance was
being prepared for a quiet burial in most. Thankfully, then came Enron, followed by World Com, QWest,
Global Crossing and the rest of their ilk. And, in the words of Nell Minnow, a corporate governance
activist in the US, What couldnt be got for decades is now being achieved in days. All tea leaves
suggest that corporate governance is here to stay at least for a fair while.
Strangely, in this Asian scheme of things, India has been an unpublicised outlier. First, unlike South-East
and East Asia, the corporate governance movement did not occur due to a national or region-wide
macroeconomic and financial collapse.49 Indeed, the Asian crisis barely touched India. As we shall see
later in this paper, the need for having international standards of corporate governance and better financial
and non-financial disclosures became prominent well before the Thai baht began to nosedive in June
1997. Second, again unlike all other Asian countries, the initial formalised drive for having higher
standards of corporate governance and disclosure came from an all-India industry and business
association and not the stock markets, regulators, investor associations or government.50 Third, at the
risk of pre-empting a conclusion, it will be fair to say that listed companies in India follow the most
stringent guidelines for corporate governance throughout Asia, which rank among some of the best in the
world. This is not to claim that India cant do better corporate governance; but that it is definitely in the
vanguard and that the pace of Indias corporate governance reforms far outstrip that of other economic
reforms.
This article attempts to interlink some business history and economic theory with considerable empirical
evidence to delineate the story of corporate governance in India how the country stands today, and
what could be the future direction. Section 1 gives a brief historical overview, if only to understand the
structure of corporate India and why corporate governance meant so little until the late 1990s. Section 2
describes the existing structure of corporate India, and its legal and regulatory agencies. It gives details of
49
Governance issues came to the fore due to a spate of corporate scandals that occurred during the first flush of
economic liberalisation. The first was a major securities scam that was uncovered in April 1992, which involved a
large number of banks, and resulted in the stock market nose-diving for the first time since the advent of reforms in
1991. The second was a sudden growth of cases where multinational companies, aided by an obscure provision in
Companies Act, 1956, started consolidating their ownership by issuing preferential equity allotments to their
controlling group at steep discounts to their market price. The third scandal involved disappearing companies of
1993-94. Between July 1993 and September 1994, the stock index shot up by 120%. During this boom, hundreds
of obscure companies made public issues at large share premia, buttressed by sales pitch of obscure investment
banks and misleading prospectuses. The management of most of these companies siphoned off the funds, and a vast
number of small investors were saddled with illiquid stocks of dud companies. This shattered investor confidence,
and resulted in the virtual destruction of the primary market for the next six years. These three episodes led to the
prominence of corporate governance within the financial press, banks and financial institutions, mutual funds,
shareholders, the more enlightened business associations, the regulatory agencies and the government.
50
In December 1995, the Confederation of Indian Industry (CII) set up a high-powered committee under the
chairmanship of Rahul Bajaj to prepare a comprehensive voluntary code of corporate governance for the listed
companies. The author was a member of the committee. After several committee meetings and hearings, the final
draft report was prepared by April 1997, whose almost unedited version was released in April 1998 as a booklet,
Desirable Corporate Governance: A Code. Until the end of 2000, the CII code was the only guideline for corporate
governance in India. Since 2001, it has been supplemented by Clause 41 of the Listing Agreement of all stock
exchanges where most of the requirements derive from the initial CII code.
128
the number of companies, the percentage that is listed, the size of stock exchanges and so on, plus the
corpus of corporate laws and agencies that monitor these laws and regulations. Section 3 looks at the
legal and procedural linchpins of good corporate governance. These are divided into two categories
those that deal with debt-holders and others with equity-holders. Thus, the section examines bankruptcy
restructuring, liquidation and loan recovery on the one hand, and the market for takeovers and corporate
control on the other. Section 4 examines corporate financial disclosures, and how these match up with the
best international practices. Section 5 describes recent corporate governance initiatives, and how have
these have positively affected governance, disclosure, fairness and transparency. In doing so, it analyses
the new roles and duties of the Board of Directors, including the Audit Committee. It also takes a peep at
the corporate governance initiatives that can be expected in the near future. Section 6 discusses corporate
governance of state-owned enterprises (SOEs), which account for a significant share of secondary and
services sector GDP. Section 7 concludes the article.
1.
Historical Overview
In some ways, India was unlike other de-colonised nations of Asia and Africa. At the time of
independence in 1947, India was one of the poorest nations in the world with a per capita income of less
than $30. Yet, manufacturing accounted for almost a fifth of the countrys national product, and half of
that (10% of GDP) was produced by the modern factory sector, which included cotton textile mills, jute
mills and collieries, iron and steel mills, nascent engineering units and foundries, cement, sugar and
paper.51
From the last quarter of the 19th century, the organisational structure of the large- and medium-scale
factories was along corporate lines through the vehicle of widely-held, joint-stock limited liability
companies most of which were floated in India and listed on local stock exchanges.52 The Bombay
Stock Exchange (BSE) was formed in 1875 under the name of Native Share and Stockholders
Association, and began trading three years before the Tokyo Stock Exchange. At the beginning of the
20th Century, India had four fully functioning stock exchanges in Bombay (now called Mumbai),
Calcutta, Madras and Ahmedabad, with reasonably well-defined listing, trading and settlement rules. By
independence, there were over 800 listed rupee companies, with many having sizeable floating stock.
The dominant corporate organisation form was the so-called managing agency system. It worked
something like this. Every major corporate group had a closely held company or partnership called a
managing agency. De facto, these functioned like holding companies. Managing agencies would float (or
promote) companies, and their prestige, past performance and signature sufficed to ensure massive oversubscription of shares.53 Given excess demand, most of these companies could split shareholdings into
small enough allotments to ensure that nobody barring the managing agency had sufficiently large
stocks to ensure their presence in the board of directors. Dispersed ownership, thus, facilitated managing
agencies to retain corporate control with relatively low equity ownership a trend that continued right
up to the mid-1980s and early 1990s. From the corporate governance point of view, therefore, the
51
For detailed expositions on the growth of Indian industry since the early 20th. century, see Bagchi (1972), Ray
(1979) and Morris (1983). For national income estimates during the period 1900-47, see Sivasubramonian (1965,
1977) and Heston (1983).
52
Carr-Tagore and Company, the first joint-stock limited liability company in India was incorporated as early as
1848; and one of the promoters of this company was an Indian Dwarkanath Tagore. For details of this
company, see Kling (1976).
53
Those who promoted companies were called promoters a term that exists in ordinary and legal lexicon until
this day. Promoters invariably managed the companies they floated.
129
tendency for management in India to enjoy control rights that significantly exceed ownership or residual
cash flow rights goes back to the early years of the 20th century. 54
On the positive side, however, because much of corporate growth in pre-independent India was financed
through equity, Indias urban investors developed a fairly sophisticated equity culture by the time of
independence. Furthermore, banks ware surprisingly well developed for a country as poor as India. Most
of the major banks that exist in India today were operating before independence. Until the late 1960s,
these were privately owned, typically advanced working capital against the collateral of inventories (as
distinct from long- and medium-term loans secured against plant and machinery), maintained fairly
prudential lending norms, and were backed up by reasonably sound recovery processes.
Given that the company was a key organisational form of industrial development, it is not surprising that
colonial India put in place a substantive body of corporate law. For instance, the present Companies Act,
1956 which, with periodic amendments, substantially governs the legal and regulatory aspects of
public and private limited companies derives from the Indian Companies Acts of 1866, 1882 and
1913. Similarly, most of todays legal jurisdiction for corporate matters and disputes pre-date
independence. The Indian Trusts Act was passed in 1882 to regulate the functioning of all public and
private trust funds. Legislation aimed at prudent regulation of banks began with the Reserve Bank of
India Act, 1934 and was extended by the Banking Regulation Act, 1949.
To re-cap, India in 1947 had a sizeable corporate sector accounting for some 10% of GDP; it had
reasonably functioning stock markets and a fairly well developed (if not extensive) banking system; it had
a substantial body of corporate and banking laws; and it had developed a nascent but vibrant equity
culture among a section of the urban populace.
In hindsight, therefore, India was probably the de-colonised country that was best equipped to use the
corporate vehicle to trigger rapid industrial and service sector growth, and simultaneously practice good
corporate governance that could have maximised long term corporate value while protecting stakeholder
rights. But it didnt. To understand why and how India squandered its early advantages, it is necessary to
examine the post-independent regulatory regime.
The first barrier to investments came with the Industries (Development and Regulation) Act, 1951
(IDRA), continued for four decades before being dismantled in June 1991. The IDRA required all
existing and proposed industrial units to obtain licences from the central government. This all-pervasive
licensing regime quickly fostered entry barriers through pre-emption of industrial licences which, in turn,
allowed for widespread rent seeking. Entrepreneurial families and business houses that had built their
fortune in textile, coal, iron and steel and jute now used licences to secure monopolistic and oligopolistic
privileges in new industries such as aluminium, paper, cement and engineering. Over the years, licensing
became increasingly stringent and was accompanied by multiple procedures that required clearances from
a large number of uncoordinated ministries. For instance, a typical private sector manufacturing company
in between the late-1970s and the mid-1980s needed government permission to establish a new plant,
54
Occasionally, this strategy had its dangers. In some industries, Indian merchants who were long term corporate
vendors or purchasers also happened to be stockholders. Given the rudimentary nature of technology and low
barriers to entry, some of these traders began to accumulate shares in the secondary market and then demand seats
on the boards. This happened in a significant way in the jute and coal industry even during the colonial era.
Goswami (1985, 1988, 1990) chronicles the market for takeovers in the jute industry and collieries during 19201950. Even so, it would be fair to say that low equity ownership coupled with complex cross-holdings allowed most
promoters to control listed companies with relatively low ownership.
130
manufacture a new article, expand capacity, change location, import capital goods and do many other
things that fell under the rubric of normal corporate activity.55
A more serious barrier to entry occurred in 1956, when the Industrial Policy Resolution (IPR) adopted the
maxim of a socialist pattern of society and prescribed that the public sector would occupy the
commanding heights of the economy. Schedule A of the IPR listed 17 industries whose future
development would be the exclusive responsibility of the State and 12 Schedule B industries where the
State will increasingly establish new undertakings.56 In one stroke, India succeeded in creating another
barrier to private investment. With it, the government also created a legislative and executive milieu to
build a massive, all-pervasive state-owned industrial and services sector which, over time, created its own
dysfunctionalities, inefficiencies, cost disadvantages and governance problems. These are discussed in
Section 6.
The late-1960s and early-1970s witnessed a more intensified trend to limit private investment and foster
inefficient manufacturing scales. The Monopolies and Restrictive Trade Practices Act, 1969 (popularly
known as MRTP) linked industrial licensing with an asset-based classification of monopoly.57 With the
passing of MRTP, private sector businesses whose assets exceeded a paltry amount varying from Rs.10
million to Rs.1 billion had to apply for additional licences to increase capacities. More often than not,
such applications were rejected. MRTP was followed by widespread nationalisation, which began in
1969 with the insurance companies and banks and, in 1970 encompassed petroleum companies and
collieries. Among other things, nationalisation made employment preservation a political objective. The
1970s and early 1980s saw the second wave of nationalisation, with the government taking over
financially distressed private sector textile mills and engineering companies thus converting private
bankruptcy to high cost public debt.
In addition, the government made a fetish out of small is beautiful. This occurred in two ways. First,
successive governments sponsored the setting up of mini-plants. For instance, the 1980s saw a
mushrooming of technologically non-viable mini-steel, mini-cement and mini-paper units whose
profitability hinged upon heavy tax concessions, high initial leveraging, subsidised long term finance,
high tariffs and import quotas and the munificence of government orders. Second, governments actively
encouraged small-scale industries. While this is not necessarily a bad thing small and medium
enterprises are often more efficient and flexible compared to larger firms the small-scale sector was
fostered through artificial means such as tax concessions and product reservations. Even today, there are
over 800 product lines reserved for the small scale sector, of which more than 600 arent even
manufactured in India!
These distortions could not have existed as long as they did in an outward-oriented, open economy. In the
final analysis, they were eventually supported by a regime of high tariffs and import quotas. Despite
preferential tariffs for Britain and the Empire countries, there were no major barriers to trade during the
colonial era. Consequently, the major industries that existed prior to independence cotton textiles and
yarn, jute, tea and coal were internationally competitive, and two of them (jute and tea) were driven by
exports. Things began to change from the mid-1960s, intensifying with the import substituting regime of
the 1970s and early 1980s. Import substitution made it incumbent upon a company to demonstrate to
55
Today, it seems odd almost funny to recall that India had something called a Carry On Business (CoB)
licence, which was needed to expand capacity and output by even 5% under normal course of business.
56
The genesis, growth and problems of Indias state owned enterprises is discussed by Mohan and Aggarwal (1990)
and Bhandari and Goswami (2000).
57
Interestingly, MRTP did not apply to state owned enterprises on a wishful assumption that public monopolies
were not inimical to either the nations or the consumers interest.
131
bureaucrats the essentiality of any import, and the doctrine of indigenous availability ensured the
purchase of Indian inputs even at higher price-lower quality configurations.
Import substitution was sustained by quantitative restrictions and high tariffs. Quotas came in the form of
various types of import licences. Among them were Actual Users (Industrial) Licenses, Actual Users
(Non-industrial) Licenses, Capital Goods Licenses, Customs Clearance Permits, Supplementary Licenses,
Import Replenishment Licenses, Special Import Licenses, Additional Licenses, canalisation of imports
and Open General Licenses. Over the years industrial tariffs continued to be raised until the peak rate
exceeded 300%. By 1985, the mean tariff rate for intermediate goods was 146% (standard deviation
56%); and for capital goods it was 107% (standard deviation 48%).58
To be sure, some of the policies helped setting up industrial capacities, especially in iron and steel,
engineering, cement, pharmaceuticals, chemicals, fertilisers and petrochemicals. But these also created
highly protected markets, fostered an uncompetitive regime and promoted large scale rent-seeking
through a nexus between companies and bureaucrats and politicians.
Adding fuel to fire was the corporate and personal income tax structure. At its peak, the corporate tax
rate was as high as 55%, and the maximum marginal personal income tax rate was an astronomical
98.75%. Such rates created widespread incentives for cheating which took many forms undeclared
cash perquisites, private expenses footed on company account, complicated emolument structures and
complex cross-holdings of shares to confound calculations regarding dividend and wealth tax.
The message was simple and profoundly negative. What mattered was how to expropriate larger slices of
a small pie, and do so in ways that escaped the tax net. There were absolutely no incentives to grow the
pie, create wealth and share it among stakeholders in transparent and equitable ways.
Curiously, the instrument that the government used to foster widespread industrial growth subsidised
long term loans as development finance for creating fixed assets militated against good corporate
governance. In many ways, the story is similar to that of South Korea and requires some elaboration.
After independence, the Government of India set up three all-India development finance institutions
(DFIs). These were the Industrial Finance Corporation of India (IFCI), the Industrial Development Bank
of India (IDBI) and the Industrial Credit and Investment Corporation of India (ICICI). In addition, state
governments set up their State Financial Corporations. From their inception up to the early 1990s, the
raison dtre of these public sector DFIs was to foster industrialisation by advancing subsidised, low
priced, long term loans for setting up plant and machinery.
Arguably, there may be nothing wrong with a fiscally surplus government using subsidised long term
funds to create competitive industrial capacities. South Koreas huge industrial base is a testimony to
such a policy. However, when careful project appraisal is abandoned for loan pushing DFIs were
judged on the amount of loans sanctioned and disbursed, and not by their asset quality and when this
occurs in a tightly controlled, rigidly licensed, highly protected, import substituting milieu, it invariably
results in crony capitalism, rent seeking, setting up of inefficient capacities, and corporate misgovernance
with public funds. In more ways than one, this is what occurred in India in the 1970s and 1980s.
There are two strands to the DFI-induced corporate misgovernance story. The first has to do with excess
leveraging, and the second with the role of DFIs as shareholders. By the early 1980s, many term loans for
industrial projects were sanctioned with a long term debt-to-equity ratio that exceeded 2.5:1, and a total
58
At that point of time, Chinas mean tariff rates were 79% for intermediates and 63% for capital goods. See Kelkar,
Kumar and Nangia (1990).
132
debt-to-equity ratio that went over 4:1. This kind of gearing allowed the promoters to start projects with a
relatively low equity base, and an even lower promoters contribution. During the industrial expansion of
the 1970s and 1980s, average share ownership of the controlling groups was less than 15% of total equity.
Thus, promoters could commission a Rs.500 million project with only Rs.100 million of equity, of which
a mere Rs.15 million came from their pockets and yet retain full management control.
To understand the extent of leveraging, one needs to take a look at corporate data for the financial year
ended 31 March 1991 just before the beginning of economic reforms. In that year, 528 listed
manufacturing and non-banking services companies posted sales in excess of Rs.500 million. Some 65%
of their total capital employed of Rs.1,145 billion (or $64 billion at the prevailing exchange rate) was
accounted for by borrowed funds. Almost 20% of borrowings were supplied by the three all-India DFIs.
The mean gearing (ratio of total borrowing to net worth) was 1.25, the median was 1.44 and a third of the
sample were leveraged in excess of 2.50.59
The stage was thus set for enacting the moral hazard of limited liability. Given subsidised loan funds and
various tax incentives to set up industries, most promoters recovered their relatively meagre equity within
a year or two of operation, if not earlier. Thereafter, in good states, DFIs could count on the loans being
repaid. In bad states, debt took a hit while equity had already recouped its outlay. The nexus between
business groups and politicians ensured that debts would be invariably rescheduled even after successive
defaults, all in the name of rehabilitating financially sick industrial companies. Played out in the
backdrop of inefficient implementation of bankruptcy laws, this created widespread corporate
misgovernance, and contributed to systematic diversion of taxpayer financed, government subsidised DFI
funds for other ventures.
The other aspect of poor governance had much to do with the shareholding of government owned
financial institutions. Even today, 11 years after the advent of economic liberalisation, a substantial
proportion of the equity of Indias private sector companies is held by the DFIs, the nationalised insurance
companies, and the government owned mutual fund, the Unit Trust of India, or UTI. Consider, for
instance, a sample of 144 listed private sector companies which, as of June 2002, accounted for almost a
fifth of Indias market capitalisation. For these companies, the median shareholding of governmentowned DFIs, banks and mutual funds stood at 17%; while the median borrowing from government owned
banks and financial institutions was 58% of total borrowing. Thus, even in this day and age, government
indirectly supplies not only over half the debt of private sector companies accounting for 20% of market
cap, but also owns close to a fifth of their equity.
There is a small body of corporate governance literature which argues without sufficiently conclusive
evidence that concentrating debt and equity in the hands of banks facilitates better corporate
governance of the borrowing companies. It is believed that such bundling automatically increases the
quality of monitoring which, in turn, reduces the agency costs associated with debt as well as dispersed
equity holdings. Unfortunately, this literature has staked its empirical claim partly based on German
companies in the 1980s, and largely on Japanese and Korean companies in the 1970s and 1980s. As we
now know, Japan and Korea were engulfed in a banking crisis in 1998 with massive amounts of nonperforming loans and Japan still struggles with the problem. Equally, most conglomerates both
countries can hardly be described as paradigms of good corporate governance. Therefore, the empirical
basis for staking the benefits of banks and DFIs holding large chunks of equity as well as debt is quite
questionable.
Indeed, the Indian data suggest quite the opposite. In theory, the three all-India DFIs could have played
the role of corporate governance watchdogs in the 1970s and 1980s. But they didnt. The DFIs insisted
59
Unless stated otherwise, data are computed from Prowess.
133
on nominating their directors on corporate boards. Given their shareholdings, nobody could argue with
that. However, at best, most of these nominee directors were incompetent; at worst, they were tacitly
induced to support the incumbent management irrespective of performance. Soon, promoters knew that
they had the unstated support of anything between a fifth and a third of the voting stock. Not surprisingly,
their control rights vastly exceeded their cash flow rights
Such significant errors of omission cannot be fully explained by the nexus between industrialists,
bureaucrats and politicians. Much of it has to do state ownership of these DFIs where nobody was
rewarded for profit-making or punished for adverse wealth and income consequences of inaction. On the
equity side, the failure had to do with distorted incentives of government ownership and management of
the DFIs, and the statebusiness nexus that induced nominee directors to invariably vote with the
promoters. On the debt side, it had much to do with inadequate income recognition and provisioning
norms, as well as poor processes for bankruptcy and debt recovery.60
Thus, by the time India embarked on economic liberalisation, the waters had got very muddied. On the
one hand, the country had an equity base which was substantially greater than most developing countries;
laws that regulated companies and protected the rights of shareholders; and a large and active industrial
sector ranging from complex petrochemicals to simple manufacturing. On the other, a combination of
licensing, protection, quotas, high gearing and poor board-level accountability had created an
environment that didnt punish poor corporate governance.
How have reforms changed this picture? Before going into this, it is useful to give a snapshot of the
corporate sector in India.
2.
Structure of Corporate India
Indias corporate sector consists of closely held (private limited) as well as publicly held (public limited)
companies. Among the latter are those listed in one or more stock exchanges. Table 1 gives the data for
1997-2000. 61
Table 1: Basic statistics of Indias corporate sector, 1997-2000
1997 Share
1998 Share
1999 Share
2000 Share
Number of companies
Closely held (Private limited)
386,841 86% 415,954 86% 440,997 86% 487,111 86%
Widely held (Public limited including listed) 64,109 14% 68,546 14% 71,064 14% 76,029 14%
60
Right up to the late 1980s, banks and DFIs were allowed to book interest income on an accrual basis irrespective
of actual payment, and rare was the case when a loan asset was properly written down. Thus, most accounts were
never non-performing. Not surprisingly, all banks and FIs made profits. India took 1993-96 to gradually introduce
proper income recognition, asset classification and provisioning according to the Basle standards. When it did, the
profits of most banks and financial institutions nosedived, and the government had to spend in excess of $5 billion to
recapitalise impaired banks. Bankruptcy is discussed in section 4. For non-performing loan assets and problems in
the banking system, see CII, Report on Non-Performing Assets in the Indian Financial System: An Agenda for
Change (December 1999).
61
There is no category called listed company in The Companies Act, 1956. That is defined in the Securities Contract
(Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992. Unfortunately, the Department of
Company Affairs has not been able to compile the data for 2001 which says something about its ability to
monitor the hundreds of thousands of companies under its regulatory purview.
134
All companies
450,950 100% 484,500 100% 512,061 100% 563,140 100%
Paid-up capital (Rs. Billion)

Closely held (Private limited)
588 32%
718 34%
790 34%
1,013 33%
Widely held (Public limited including listed)
1,257 68%
1,409 66%
1,503 66%
2,063 67%
All companies
1,845 100%
2,127 100%
2,293 100%
3,076 100%
1,220 0.30%
1,223 0.30%
1,240 0.24%
1,256 0.22%
797 43%
824 39%
890 39%
982 32%
Government companies
Number of companies
Paid-up capital (Rs. billion)
Source: Ministry of Law and Justice, Department of Company Affairs, Government of India
As expected, the number of closely held companies vastly outnumber the publicly held ones, and
constitute the bulk of small-scale enterprises. However, public limited companies, including the listed
ones, account for almost two-thirds of the book-value of equity. The other point worth noting from Table
1 is the sheer size of the government corporate sector: while it accounts for a mere 0.22% of the number
of companies, it speaks for 34% of corporate Indias paid-up capital. A silver lining of economic
liberalisation is the gradual reduction of the relative size of the state-owned sector. As the table shows, its
share in total paid-up capital has fallen from 43% as on 31 March 1997 to 32% on 31 March 2000.
Today, there are well over 13,500 listed companies in India. While there are 23 registered stock
exchanges in India, many are moribund and exist only because the law insists that any listed company
must at least register with the stock exchange that is located nearest to the companys registered address.62
Only two stock exchanges matter in terms of size, efficiency and liquidity. These are the Bombay Stock
Exchange (BSE) and the National Stock Exchange (NSE), which came into being in the late 1980s. Any
company worth its reputation in corporate India is listed in either BSE or NSE, or both.
Despite a long bear market phase, the market capitalisation of companies listed on the BSE at the end of
September 2002 stood at Rs.6.3 trillion, or US $130 billion at prevailing exchange rates. In other words,
at the trough of the bear hug, the market cap of Indias listed companies accounts for almost 23% of the
countrys GDP.63 At current levels, Indias market cap ranks seventh in Asia-Pacific league table.
A remarkable feature of listed Indian companies is the relatively large weight of SOEs in overall market
capitalisation. For example, the BSE lists only 75 SOEs, which translates to less than 1% of the listed
companies on the exchange. Yet, despite the hammering received because of the present governments
lack of appetite for consistent disinvestments and privatisation, these stocks still account for almost 15%
of market capitalisation. It reflects the fact that most listed SOEs are larger in size, sales and value than
their private sector counterparts. This has serious policy implications for corporate governance, which are
discussed in section 6.
Given Indias pre-eminence in information technology (IT), it is hardly surprising that IT stocks are at the
top of the market capitalisation table. However, every conceivable major industry or service have their
place in the sun among listed companies. Computer software, computer hardware, diversified companies,
62
In fact, many of these regional stock exchanges see no active trade whatsoever, and survive only on the basis of
the annual listing fees of the companies located in its region.
63
At its peak, market cap accounted for almost 60% of GDP.
135
crude oil, petroleum, natural gas, banks and DFIs, pharmaceuticals, telecom service providers, trading
firms, commercial vehicles, cars, two- and three-wheelers, communication equipment, cement, steel,
aluminium, cosmetics and toiletries, and electricity utilities, to name a few all account for anything
between 18% and 1% of total market cap.
How wide and deep are the two main stock markets? Not enough by the standards of most developed
countries. The free float of any company should account for shares owned by individual investors,
mutual funds, insurance companies and DFIs. In India, DFIs and, to a lesser extent, the state-owned
insurance companies hardly trade their portfolio in the market. Hence, a more realistic concept of freely
tradeable shares should be limited to the holdings of individual investors and the mutual funds. This
Chart A: Frequency distribution of freely

tradeable shareholdings
35%
30%
% of companies in a class
Me
29.1%
24.0%
25%
18.6%
20%
14.2%
15%
10%
5%
6.0%
3.8%
0.0%
2.8%
0.8% 0.6%
0.0%
0%
0
10
20
30
40
50
60
Shareholding class (%)
70
80
90
100
share varies considerably across listed companies.

As Chart a shows, something like 30% of the shares of a typical listed company can be theoretically
treated as freely tradable. The average trading volume is far less. For liquid, pivotal stocks, no more than
20% of the freely tradable shares are actually traded on highly active days. Thus, while the market cap of
Indian companies is impressive given Indias per capita income of $510 the actual trading market is
quite thin even in active exchanges like the BSE and the NSE. That explains the relatively high volatility
of share prices, especially narrow-based share indices such the BSE Sensitivity Index (or Sensex) or the
NSE-50 (popularly called Nifty).
At this stage, it is useful to briefly describe the laws that govern corporations in India. If an entity is
incorporated as a company which accounts for the vast majority of corporate India it is primarily
governed by the provisions of the Companies Act, 1956. Based largely on its British counterpart, many
sections of the Companies Act have been amended from time to time.64 Table 2 describes the more
substantive parts of Act.
64
In fact, there have been so many disjointed amendments that the Act has now become unwieldy and, in many
instances, unrepresentative of the times.
136
Table 2: Abridged subject content of the Companies Act, 1956

Parts
Description
Part I
Preliminaries, including definitions, and administration of the Company Law Board

(CLB), a quasi-judicial body that has the powers to hear cases dealing with
provisions of the Act. The CLBs decisions can be appealed to at the High Courts
and, thereafter, the Supreme Court.
Part II
Rules and procedures regarding the incorporation of a company memorandum

and articles of association, definition of a member and the membership of
companies, registration.
Part III
Prospectus and allotment of ordinary and preference shares and debentures
Part IV
Kinds of share capital (ordinary and preference), numbering and certificate of

shares, transfer of shares and debentures and reduction in share capital.
Part V
Registration of various types of charges
Part VI
Management and administration of a company: registered office, register of

shareholders and debenture-holders, annual returns, frequency and conduct of
shareholders meetings and proceedings, managerial remuneration, the nature and
payment of dividend, maintenance of accounts, statutory audit, the board of
directors, disqualification of directors, meetings of the board, register of directors
and their shareholdings, remuneration of directors, role of the Company Secretary,
prevention of mismanagement and oppression of minority shareholders rights,
provident funds, and the power of investigation by the government, including
powers of the CLB.
Part VII
Winding up, or liquidation of companies
Schedules
The important ones: the minimum that needs to be given in the memorandum and
articles of association, who constitute relatives, the form of the annual report
including balance sheet and profit and loss account along with its schedules, and
rates of permissible depreciation.
Three other pieces of legislation are also important from the point of view of corporate governance.
These are:
Securities Contracts (Regulation) Act, 1956. It covers all types of tradable government paper,
shares, stocks, bonds, debentures and any other form of marketable securities issued by companies,
including the rights and interest in securities thus effectively allowing for options. The SCRA
defines the parameters of conduct of stock exchanges as well as its powers.
137
Securities and Exchange Board of India (SEBI) Act, 1992. It established the independent capital
market regulatory authority, SEBI, with the objective to protect the interests of investors in securities
and to promote and regulate the securities markets.
Sick Industrial Companies (Special Provisions) Act, 1985. This Act, popularly known as SICA,
lays down the framework for bankruptcy restructuring of financially distressed companies. SICA will
be critiqued in section 4.
To conclude this section:
India has a sizeable corporate sector registered as closely- or widely-held companies under the
Companies Act.
Although widely held firms speak for only 14% of the number of registered companies, these account
for 67% of corporate Indias book value of paid-up capital.
SOEs play a significant part among the widely held public limited companies. While government
companies constitute only 0.22% of the number of companies, these account for 32% of paid-up
capital.
There are over 13,500 listed companies, of which the larger ones are listed on the Bombay Stock
Exchange (BSE) and the National Stock Exchange (NSE). As of end-September 2002, market cap of
the BSE stood at $130 billion, or 23% of Indias GDP.
Private sector listed companies account for almost 85% of BSEs market cap; the remaining 15% is
made up of listed SOEs.
Listed companies represent all possible commercial activity, covering every major branch of
manufacturing and services.
As in most stock exchanges, a large number of companies constitute a very small proportion of the
market cap, while relatively few make up for the bulk. For instance, the top 10% of private sector
companies (450 corporates) account for over 95% of private sectors market cap.
Freely tradable shares account for roughly 30% of the equity of listed companies. However, even on
very active days, no more than 20% of this stock is traded and even this estimate is on the high
side. Thus, despite the size of corporate Indias market cap, trading volumes are quite thin.
3.
Agency Costs and the Rights of Debt and Equity
In corporate governance literature, the discussion of agency costs has mostly focused on efficiency.
Thats not surprising given the disproportionate role which US corporations have played to empirically
validate agency costs arguments. Following Jensen and Meckling (1976), and a series of Michael
Jensens articles [Jensen (1986, 1988, 1989, 1993)], there has been a widespread view in the Anglo-Saxon
world that the dominant aspect of poor corporate governance is erosion of corporate value due to
dispersed shareholding and the separation of ownership from control.65
65
Well before Jensen, Adam Smith had highlighted the efficiency aspect of agency costs. Speaking of managers of
joint-stock companies, Smith wrote, The directors [managers] of such companies, however, being managers of
other peoples money than their own, it cannot well be expected that they should watch over it with the same
anxious vigilance with which the partners in a private co-partnery frequently watch over their own Negligence
138
3.1
Agency Costs
The model is as follows. Modern US (and British) corporations are characterised by almost complete
separation of ownership and control. Managers of vast corporations used to run their empires with little
or no shareholding. Therefore, they had no incentive to align their managerial behaviour and decisions in
line with those desired by the shareholders. Until the mid-1980s, this was facilitated by widely dispersed
share ownership, and the absence of powerful pension and mutual funds which could have used their
concentrated stockholdings to demand greater shareholder value. According to Jensen and his followers,
this was the prime cause for erosion of corporate value, which triggered the spate of junk-bond financed
takeovers and leveraged buyouts from the mid-1970s to the mid-1980s.
Jensens description fits US corporations of the 1970s and early 1980s like a glove. But here lies the rub.
Intense competition after second oil price shock, technological discontinuities leading to the growth of
new corporations and the demise or radical re-engineering of the older ones, the warning bells pealed by
leveraged buy-outs during 1975-85, and the rapidly increasing power of large pension funds like
CalPERS and TIAA-CREF in the USA have changed the Jensenian model of corporate America. More
important, the Jensen description doesnt seem to fit the story of corporate control in most parts of Asia.
There are three dominant themes that characterise corporate ownership and control in most parts of Asia.
First, relative to their size, most Asian companies have low equity. This has been traditionally facilitated
by highly geared, credit-driven growth. Second, given the low equity base, promoters have found it
relatively cheap to own majority shares. This is true for many companies in Hong Kong, Indonesia,
Malaysia, Philippines, Thailand and China. In many instances, the entrepreneur and his family own up to
75% of the equity, which thwarts all possibilities of equity-triggered takeovers. Third, as in the case of
Korea and Japan, equity ownership is invariably camouflaged through complex corporate cross-holdings.
None of this conforms to the model of the modern US corporation with its large equity base, dispersed
shareholding and profound separation of ownership from management. However, that doesnt reduce the
importance of agency costs. Unlike Jensens model, the corporate governance structure of Asian
companies these did not affect corporate efficiency as much as minority shareholder rights.
A promoter who controls management and directly or beneficially owns over 75% of a companys equity
is not expected to perform in a value-destroying manner like many US corporate managers and boards did
up to the mid-1980s. However, he can do a large number of things that deprive minority shareholders of
their de jure ownership rights, without adversely affecting pre- or post-tax profits. These involve fixing
the election of board members, packing boards with crony directors, ensuring that key shareholder
resolutions are vaguely worded and inadequately discussed at shareholders meetings, fobbing off
minority shareholder complaints, issuing preferential equity allotments to the promoters and their allies at
discounts, transferring shares through private bought-out deals at prices well below those prevailing in the
secondary markets, and the like.
In most parts of Asia, such acts did not necessarily destroy corporate value, and until the Asian crash of
1997-98 most listed companies of South-east Asia enjoyed consistently good valuations. Much of that
may be because of thin and inefficient capital markets, greedy investors, and corporate governance
structures that placed no value on proper financial and non-financial disclosures. Thus, from the late
1980s right up to the crash, poorly governed Asian companies did very well for themselves. They earned
large profits, bagged greater and greater debt, grew in scale and scope and, most important, managed to
maintain high valuations. The tycoons were honoured citizens who were admired for creating national
and profusion, therefore, must always prevail more or less in the management of the affairs of such a company.
Adam Smith, An Inquiry into The Nature and Causes of The Wealth of Nations, 31
139
wealth not reviled as inefficient perquisite-grabbing managers and directors of the Jensenian
corporations of the US in the mid-1980s.
It will take considerably more research before anyone can definitively apportion agency cost effects
between efficiency and expropriation for the Asian corporations. However, the point to recognise is that
poor corporate governance is not only about destroying shareholder value through managerial inefficiency
arising out of the disjunction between share ownership and corporate control. Efficiently run firms that
consistently outperform the market and earn returns that exceed the opportunity cost of capital can have
poor corporate governance. And this can manifest itself in a steady expropriation of minority shareholder
rights. Indeed, the attitude of minority shareholders in most parts of Asia has facilitated this process. For
most part, they have not questioned corporate policies of their companies, and felt satisfied by their
dividends and capital appreciation.66
Until the mid-1990s, India had the worst of both types of agency costs. Dysfunctional economic and
trade policies combined with low equity ownership to allow companies to thrive in uncompetitive ways
which began to have their denouement when the economy started opening up to international
competition. There was a major erosion of corporate value, measured in terms of economic value added
(EVA), which is difference between the return on capital employed and the opportunity cost of capital. A
CII study shows that, during the four-year period between 1995 and 1998, the top 363 listed Indian
companies ranked by sales lost EVA to the tune of Rs.564 billion ($13 billion), which amounted to almost
6% of the aggregate value of sales.67
Added to this value destruction was the expropriation of minority shareholder rights. In part, this was
facilitated by the nominee directors of banks, financial institutions and DFIs who invariably voted with
management. But laws did their bit as well. Until nine years ago, there were provisions in the
Companies Act which put restrictions on acquisition and transfer of shares.68
Thankfully, such provisions are things of the past and, as we shall see in this section, there is now a
transparent legal framework for facilitating the market for equity-driven corporate control. Besides, the
introduction of paperless trading through dematerialisation of shares has drastically reduced transactions
costs and allowed minority shareholders to enter and exit at will. Moreover, the market has begun to
severely punish under-performing companies as well as those that have disregarded minority shareholder
interests. For instance, the CII study mentioned above shows that, in the last four years, markets have
consistently punished poorly governed under-performers and rewarded the more transparent firms.
66
An example suffices to emphasise the difference in attitudes of small shareholders in the US and Great Britain and
most parts of Asia. Until a couple of years ago, most individual Indian shareholders (who in the aggregate often hold
more equity than mutual funds) were happy when their companies incessantly increased free reserves. It was
considered a sign of good management and financial prudence where the company put back a large chunk of its
post-tax profits for future investments or for a rainy day. Such managerial behaviour will not be tolerated by
shareholders in the US or Britain.
67
Omkar Goswami, M. Karthikeyan and G. Srivastava, Are Indian Companies Losing Shareholder Value?, CII
Corporate Research Series, 1(1), 1999. It is, however, difficult to ascertain how much of this value destruction was
due to poor corporate governance, and how much due to these companies inertia and historical inability to deal with
increasing competition.
68
Section 108B stated that if the government was satisfied that any share transfer might result in a change in the
board of directors, and if it considered this prejudicial to the interest of the company or to the public interest, it
could prevent such a transfer. Section 108D allowed government to restrict share transfer if it could lead to a change
in the controlling interest that might be prejudicial to the company or public interest. These provisions were tested in
1983, when Swraj Paul, a British citizen of Indian origin, launched a takeover bid for two major companies, Escorts
and DCM. In both companies, the promoters controlled corporate affairs despite owning less than 5% of the equity.
Paul might have succeeded in getting on to their boards, if not wresting control, had not the government used these
provisions to prevent the share transfers.
140
Curiously, while the market for corporate control has greatly improved on the equity side with a welldefined takeover code, the debt side remains as bad as before. It is not a coincidence that countries with
ineffective bankruptcy laws and procedures have widespread corporate misgovernance. Poor protection
of creditors rights gives enormous and ultimately value destroying discretionary space to
inefficient management. It allows companies to reallocate funds to highly risky investments (since
management fears neither attachment nor bankruptcy); it needlessly raises the cost of credit; it debases the
ex ante disciplining role of debt; and it eventually ruins the health of a countrys financial sector.
Unfortunately, India has very poor bankruptcy reorganisation laws and procedures, and the liquidation
procedures are worse still.
3.2
Bankruptcy restructuring
While a new Insolvency Bill has been awaiting Parliamentary assent for the last two years, bankruptcy
reorganisation of large industrial companies still continues to be governed by Sick Industrial Companies
(Special Provisions) Act, 1985 or SICA, and the process is directed and supervised by the Board for
Financial and Industrial Reconstruction (BIFR). A quick look at the law and BIFR will demonstrate the
flaws of poorly designed and inadequately implemented bankruptcy procedures.
There are five fundamental flaws with the SICA-BIFR process. These are:
a) Late detection. The law defines financial distress as erosion of net worth. This is much worse than
bankruptcy which is basically debt default. When a company loses so much as to erode its net
worth, the probability of a successful turnaround becomes very low. Not surprisingly, between July
1987 and November 1998, only 11% of the 1954 cases that BIFR has considered maintainable are
no longer sick. A losing record of 89% reflects both late detection and time consuming procedures.
b) Cumbersome and time consuming procedures. Between 1987 and 1992 the mean delay in arriving at
a decision in BIFR was 851 days. That was bad enough. It has worsened since then. Between
January 1997 and March 1998, the mean delay for cases that were sanctioned restructuring schemes
was almost double at 1664 days; while those that were recommended liquidation took 1,468 days.
Such delays are caused by tedious quasi-judicial procedures where cases continue to go through
multiple loops before a final decision is taken. In the process, the delays confer additional bargaining
power to the management of the bankrupt company at the expense of secured and senior creditors.
c) Indefinite stay on all claims of creditors. From the time the company is registered and until the case
is disposed, BIFR will not allow creditors to exercise any claims. All reasonable restructuring
processes confer time-bound stays. This is based on the assumption that the value of the whole is
greater than the sum of its parts, and that a company must get some breathing space to reorganise
itself and offer a viable restructuring plan. In BIFR, however, delays exceed four years. That makes
the legal stay a strategic device for the promoters of debtor firms. All they need to do is to get the
case registered, and then secure protection from creditors claims for years on end.
d) Debtor in possession. Neither SICA nor BIFR recognises that incumbent management always has
great informational advantage compared to outside creditors. Therefore, a procedure that allows
existing management to control and run a bankrupt company during the period when it is being
reorganised invariably results in secured creditors having to take big hits on their exposures at the
expense of existing shareholders and management. Studies clearly show that secured creditors of
141
BIFR companies had to make large write-offs on their exposure, while management and shareholders
did not.69
e) Violation of absolute priority rule. This says that in any bankruptcy restructuring or liquidation,
senior creditors have to be settled in full before junior creditors are entertained at all. BIFR
procedures violate this principal by often rewarding incumbent management and old shareholders
(despite net worth being negative) at the expense of fully secured creditors.
It is not difficult to design a far better bankruptcy reorganisation system. The key features of an
expeditious, market-driven and incentive compatible procedure must incorporate the following features.
The definition of bankruptcy should be altered to debt default. That will detect financial distress
much earlier than net worth erosion and, all else being equal, increase the probability of a successful
turnaround.
Up to a point, bankruptcy restructuring should be voluntary for the company. The onus must be on
the company to convince its secured and senior creditors with a satisfactory rescheduling and cash
flow plan. This should be outside bankruptcy court.
Only if negotiations break down between the company and senior creditors should the case be taken
to the bankruptcy court, which can give one extra time-bound chance to renegotiate. If that does not
succeed, the court must appoint an independent administrator with the mandate to advertise for the
sale of the company. During the advertising and sale period, the court should impose a strictly time
bound stay on creditors claims on the companys assets. In the meanwhile, an independent financial
professional can determine the liquidation value of the company. That will serve as the confidential
reserve price.
The sealed bid offers must be submitted within the given time period. During this period, subject to a
confidentiality bond, all prospective bidders should be permitted to conduct due diligence. Existing
promoter(s) can also bid.
The bids should be in two parts: (a) the post-restructuring profit and loss account, balance sheet and
cash flow projections, and (b) the financial bid, which can be in cash or in recognised securities.
Secured and senior creditors should vote within their class on (a). Those bids that secure the assent of
75% of secured and senior credit should be short-listed. The best financial bid of the shortlist is the
winning bid.
If the winning bid happens to be less than the liquidation value, then the company should go for
liquidation. If it is greater than the liquidation value but less than the secured debt, then the proceeds
should be pro-rated across secured creditors (including wage dues), with unsecured creditors getting
nothing. If the bid is high enough to meet the outstanding of unsecured creditors, then all claimants
get their dues. And if it was higher still, then old equity obtains the residual value.
In this scheme of things, the bankruptcy court will act like a facilitator. All cases are designed to get
cleared within a specified time period, and in a market-driven manner. Such a time-bound scheme was
enunciated in the Companies Amendment Bill, 2000, and placed in Parliament for consultative committee
debate and legislation. Unfortunately, two years have passed without the bill being enacted as law.
69
See, for instance, the Committee on Industrial Sickness and Corporate Restructuring (Goswami Committee, July
1993), Anant, Datta Chaudhuri, Gangopadhyay and Goswami (1994), Anant and Goswami (1995) and Goswami
(1996).
142
3.3
Bankruptcy liquidation or winding up
If bankruptcy restructuring under BIFR is tedious, liquidation under the Companies Act is virtually
impossible. Table 3 gives data as of 1992-93 for 1,859 companies which were under winding up in
courts. Not much has changed up to now.
Table 3: Delays in Winding Up in Courts
0-10
10-20
20-30
30-40
40-50
>50
yrs
yrs
yrs
yrs
yrs
yrs
774
506
346
186
44
3
(41%)
(27%)
(19%)
(10%)
(2%)
(1%)
Note: ( ) indicates % of total. Source: Ajeet N. Mathur, Industrial restructuring and the National
Renewal Fund, ADB, 1993.
These delays reflect two factors of the law and legal administration:
Lack of appreciation that it is of prime importance to preserve the value of the assets of a company
that is being wound up which is best achieved by ensuring that these assets are quickly re-allocated
to productive use by more efficient entrepreneurs;
Failure to realise that the parties worst affected by delays in winding up are employees and secured
creditors.
An attempt to reform the laws governing liquidation was made in 1996-97 by the Working Group on the
Companies Act. The group recognised international best practices in corporate bankruptcy: sell assets as
quickly as possible; adjudicate and distribute later. It recommended an entirely new and time-bound
approach to winding up, whose key features are:
Encouraging voluntary winding-up, which is generally a more cost and time efficient manner of
liquidation.
Distinctly separating the two aspects of liquidation: (i) first, asset sale and (ii) then, distribution of the
proceeds.
Clarity in winding-up order which should coherently describe the steps that have to be taken along
with time frames for each action.
Clear enunciation of the manner in which the Act would catalyze rapid, transparent, marketdetermined sale of assets.
Well-defined and non-subjective norms to ascertain whether a companys assets should be sold in
totality as a going concern, or in parts as individual asset sale.
Permitting professionals such as chartered accountants, lawyers or company secretaries to be

empanelled by the High Court as Company Liquidators.
Indeed, these recommendations found their place in the Companies Amendment Bill, 2000, popularly
referred to as the Insolvency Bill. But, as mentioned earlier, the bill still awaits legislative sanction.
By law, creditors have prior claims over shareholders. When their contractual obligations are not adhered
to, creditors can do one of three things demand bankruptcy reorganisation under SICA/BIFR, or file
for winding up of the company, or apply for receivership. As discussed, BIFR leaves much to be desired,
143
and filing for winding up is losing proposition. Therefore, these are hardly credible threats. The speed
with which creditors can obtain a receivership decree varies according to High Courts. It is quite efficient
in Mumbai, extremely inefficient (bordering on impossible) in Kolkata, and somewhere in between in
other High Courts.
Since 1993, banks and DFIs have recourse to a third alternative that of filing for recovery of dues at
the Debt Recovery Tribunals (DRTs). These quasi-judicial bodies were set up in response to inordinate
delays in the basic judicial system. However, the last six years have shown that the DRTs are riddled
with their own problems. For one, many of them have not yet been set up because of either
administrative delays in finding an appropriate presiding officer, or because injunctions have been filed
against the appointment of such officers. For another, the DRTs have also got clogged up, and they have
no infrastructural support to decongest their traffic.
In June 2002, frustrated by delays in the legislative process, the government promulgated an ordinance
that permits banks and DFIs to go through an abbreviated, summary procedure to attach assets and
foreclose on loans of debt defaulters who are classified as non-performing assets (NPAs). It is too early
to comment on how this ordinance will play out. At the time of writing, industrial lobbies especially
those close to huge debt-defaulting promoters have already decried this NPA ordinance as draconian.
And moves are afoot to dilute the provisions so as to render them ineffective. Given Indian industrys
innate ability to use the levers of power to delay bankruptcy reforms, it seems unlikely that this ordinance
will be effectively executed by banks and DFIs.
On balance, therefore, creditors have very little protection in reality. A consequence is extreme risk
aversion, especially in a milieu where public sector bank managers have to stop pushing loans and focus
on their bottom-line. As a result, banks are in a peculiar situation. On the one hand, they are flush with
depositors funds. On the other, they avoid lending to anyone other than blue chip companies. The
remainder they invest in treasury bills which are risk free, dont impair capital adequacy and, most
important, require no effort at project appraisal. This pervasive debasing of debt is choking off funds to
small and medium enterprises which, unless rectified by better implementation of creditors rights, will
have serious negative implications for the future structure and sustainability of industrial growth.
3.4
Market for equity-driven takeovers
Thankfully, the equity side of the market for corporate control has been reformed in substantive ways.
Credit for this goes entirely to the capital market regulatory body, the Securities and Exchange Board of
India or SEBI, which came into being under the Securities and Exchange Board of India (SEBI) Act,
1992.70
Until February 1997, companies could structure quietly negotiated takeover deals, which more often than
not, left minority shareholders in the lurch. This changed with the SEBI (Substantial Acquisition of
Shares and Takeovers) Regulation, 1997, which is popularly known as the Takeover Code. The major
provisions are:
70
The Board consists of a chairman and five other members, two of whom are from the central government and one
from the central bank, the Reserve Bank of India (RBI). Among other things, SEBI is empowered to (i) regulate
stock exchanges and any other securities markets, (ii) register and regulate brokers and sub-brokers, share transfer
agents, bankers and registrars to an issue, underwriters, domestic and foreign portfolio managers, investors in
securities, independent financial advisers, trustees of trust deeds, mutual funds and venture capital funds, credit
rating agencies, depositories and custodians of securities, and self-regulatory securities market organisations, (iii)
prohibit fraudulent and unfair trading practices, including insider trading; (iv) regulate public offers for the takeover
of companies; and obtain information from all securities market institutions and intermediaries and conduct
inspections, inquiries and audits.
144
Disclosure. Any person or body corporate whose shareholding crosses the 5% threshold has to
publicly disclose this to the relevant stock exchange and to SEBI.
Trigger. SEBI initially specified a 15% trigger. If an acquirers shareholding crossed 15%, he
(person or body corporate) has to make an open offer for at least an extra 20% of the shares. In other
words, if the acquirer crosses the 15% threshold, he must purchase at least 35%. Given the structure of
share ownership in corporate India, SEBI believes and rightly so that 35% generally suffices to give
controlling interest.
Minimum offer price. Any such public offer must carry a minimum price which is the average of the
market price for the last six months.
Creeping acquisition. Existing management is allowed to consolidate its holdings through the
secondary market so long as such acquisition does not annually exceed 5% of the shares. This creeping
acquisition provision is aimed to allow management to gradually consolidate its ownership without
detriment to minority shareholders.
Escrow. To ensure that the takeover bids are serious, there has to be an escrow account to which the
acquirer has to deposit 25% of the value of his total bid. He loses this in the event of his winning the bid
but reneging on timely payment.
The SEBI regulation has had two beneficial effects. First, it has created a transparent market for
takeovers. Second, by legislating in favour of open offers, it has ensured that minority shareholders will
have the right to obtain a market driven price in any takeover. Moreover, while friendly takeovers are
still the norm, hostile takeovers have begun. And the SEBI Takeover Code has been already tested in at
least half-a-dozen hostile bids, and has come out more robust than before.
4.
Financial Disclosures
This section deals with financial disclosures mandated by law, as well as their strengths and weaknesses.
All companies have to submit their statutorily audited annual accounts first to the Audit Committee of the
Board of Directors for discussion and approval. The Audit Committee then recommends the results to the
full Board for assent. Thereafter, the annual accounts are sent to all shareholders, and their adoption is
sought in the annual shareholders meeting. After this, copies of the accounts are lodged with the
Registrar of Companies. Listed companies have three other requirements. First, the annual accounts have
to be submitted to every stock exchange where the companies are listed. Second, they have to prepare
abridged un-audited financial summaries for every quarter. Third, in addition to all the disclosure
requirements mandated under the Companies Act for public limited companies, listed firms have to
submit a detailed cash flow statement.
As far as incorporated companies go, the quality of financial disclosure in the annual accounts is
determined by three agencies: (i) The Department of Company Affairs, which administers the Companies
Act, (ii) SEBI, which mandates special disclosure requirements for listed companies, and (iii) the Institute
of Chartered Accountants of India (ICAI) the body which lays down the parameters of Indian
accounting standards.
The most substantive financial disclosures of companies are to be found in their annual reports
particularly the balance sheet, profit and loss account and their relevant schedules. All these have to give
the data for the current and the previous financial year. The gist of such disclosures is discussed below.
4.1
Balance Sheet
145
SOURCES OF FUNDS
Capital: This gives the share capital of the company, backed up by a schedule that gives details of the
number of equity shares authorised, issued and paid-up. Taken together, these are sufficiently
transparent.
Reserves and surplus. The summarised version is supported by a detailed schedule that classifies the
reserves under various heads. The mandated items are (i) capital reserve, (ii) share premium reserve, (iii)
debenture redemption reserve (iv) investment allowance reserve, (v) general reserves less the debit
balance in the profit and loss account, and (vi) the surplus, i.e. balance in profit and loss account after
providing for dividends, bonus or reserves. Again, this is up to international standards.
Secured loans. The accompanying schedule gives full line-by-line disclosure of debentures. The data on
loans and advances from term lending institutions and banks is also quite detailed, and includes the
description and extent of charge on each loan, with separate disclosure on foreign currency loans. These,
too, are exhaustive by international norms.
Unsecured loans. All heads of unsecured loans have to be listed.
APPLICATION OF FUNDS
Fixed assets. Although the listing of fixed assets in the schedule is quite exhaustive, it suffers from two
types of problems. First, gross block is valued at historical cost. A more realistic approach will be to
value all the elements at either market prices or replacement cost. Second, the depreciation schedules
used in annual accounts have no bearing with that which is permitted for computing the corporate income
tax liability. This is a historical anomaly which has been rectified in 2001-02, by mandating the
accounting deferred tax liability and/or assets in the balance sheet and its provisioning in the profit and
loss account.
Investments. These are split between long and short term, with the latter covering a period of a year or
less. Investments in quoted securities have to be marked to market, while those in unquoted instruments
are evaluated at cost. While the disclosures look tight on paper, this is the area of opaqueness, especially
because companies still have the option of not consolidating their accounts. The best solution is to
mandate consolidation according to US-GAAP or Internationally Accepted Accounting Standards
(IAAS), and insist of full disclosure of all related party transactions. The latter has been made mandatory
from 2001-02. At the time of writing, the ICAI is actively considering making consolidation compulsory.
When that happens, these disclosures will become much more transparent.
Loans, advances and deposits. In the absence of consolidation, entries on this account can be opaque.
However, since the terms of each such loan have to be stringently disclosed, these are more transparent
than inter-corporate investments evaluated at cost.
Inventories are normally well captured, especially for medium and large scale manufacturing companies.
Smaller companies tend to play around a bit with work-in-progress, but that is quite minor.
Sundry debtors can occasionally be used to artificially push up sales in the profit and loss account. It
works as follows. Companies book extra sales in the last month or two before the end of the financial
year, knowing that the revenue is not intended to be received by the year end. The top line on the profit
and loss account gets inflated and, all else being equal, the bottom line as well. Fully anticipated unpaid
dues get booked as receivable under sundry debtors. Sometimes this gets a bit more sinister. Output is
siphoned out to a host of subsidiary or front dealer companies through dummy sales. No payment is
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intended to take place. The amount languishes receivable for a few years and is then written down
first as doubtful, and then as bad debt.
Cash and bank balances. Usually reflects the true picture.
4.2
Profit and loss account
By and large, the disclosures required in the profit and loss account are quite exhaustive and up to
international standards. The Companies Act requires detailed schedules for:
Other income, i.e. income other than what the company earned from its sale of goods and services.
Expenditure on raw materials and intermediate goods.
Wages and employee costs.
Other expenses, which includes consumables, energy charges, repairs and maintenance, rents, rates
and local taxes, advertising and selling costs, R&D expenses, travelling expenses, directors fees and
commissions, and other heads.
Inventories, including work-in-progress and finished goods.
Interest, which includes interest on fixed term loans and debentures and on other loans, less interest
received.
There are two areas for fiddling the books. The first relates to manufacturing expenses, which can be
inflated up to a point. Beyond that it requires collusion with the governments sales tax and excise duty
officials. The second has to do with selling, distribution, administration and other expenses. However,
the scope for mis-reporting on these two heads is far less than for investments on the balance sheet. And,
by and large, most of the records in the profit and loss account tend to reflect the true and fair picture of a
company.
4.3
Cash flow statement
Listed companies have to submit a three-part cash flow statement consisting of cash flows from (i)
operating activities, (ii) investing activities, and (iii) financing activities. This statement is quite detailed
and any reasonably well equipped financial analyst should be able to arrive at a companys free cash
flows for a given year.
4.4
New accounting initiatives
In 2001-02, the ICAI announced four major initiatives that have played a significant role in aligning
Indian financial disclosures with international best practices. These are:
Segment reporting. All multi-product or multi-industry or multi-segment companies have to give a
detailed audited report of annual segmental incomes. A segment is defined as a distinct area of
business which accounts for at least 10% of revenue. These involve: (i) segmental revenues, (ii)
segmental operation costs, (iii) segmental operational profits, and (iv) segmental allocation of capital.
Today, the segment report is very much in line indeed, goes beyond with best practices; and
any financial analyst should be able to read that report to ascertain which division of the company is
gaining shareholder value (earning a return in excess of the opportunity cost of capital) and which
isnt.
Related party transactions. The ICAI has mandated exhaustive disclosure on any materially
significant related party transaction. Again, if followed in letter and spirit, the accounting standard
for disclosing related party transactions is in line with the best in the world.
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Accounting for deferred taxation. As mentioned earlier, 2001-02 saw the introduction of
internationally defined procedures to account for deferred tax liabilities and assets. Until 2001-02,
law allowed two sets of audited accounts to be prepared one for the shareholders, and another for
income tax purposes. The difference lay in differential deprecation provisions and in specific income
and indirect tax incentives. For instance, the accounts presented to shareholders generally used lower
depreciation rules and, thus, created higher net profits and, hence, dividends; while those prepared for
the tax authorities used higher fiscally permissible depreciation provisions and all the relevant tax
shields to legally reduce the pre-tax profit and, therefore, the tax liability. Today, the aggregate value
of the timing difference between the two has to be reported in the balance sheet (as deferred tax
liability or asset) and annually provisioned for in the profit and loss account. Over time, accounting
for deferred taxation will help harmonise the two accounts and give the same picture to the
shareholders as well as the tax authorities.
Consolidation of accounts. As of now, it is recommended by ICAI, but not made compulsory.

However, if a reporting company chooses to consolidate its accounts, it must do so only according to
internationally acceptable accounting standards.
4.5
Credit rating
Since the early 1990s, the law prescribes that companies have to be rated by approved credit rating
agencies before issuing any commercial paper, bonds and debentures. At present there are five rating
agencies, of which four CRISIL, CARE, ICRA and Duff and Phelps are well established. Each of
these agencies have a set of ratings from very safe to poorer than junk bond status. The rating has to be
made public, and must be accompanied by the rating agencies perceptions of risk factors that can affect
payment of interest and repayment of the principal. Company management also exercises its right to
comment on these risk factors.
In the past there was a tendency to do rating shopping namely, to approach more than one rating
agency, and then publish the one which is most beneficial to the company. As early as 1998, the
Confederation of Indian Industry (CII) commented on this practice, and recommended that:
If any company goes to more than one credit rating agency, then it must divulge in the prospectus
and issue document the rating of all the agencies that did such an exercise. It is not enough to
blandly state the ratings. These must be given in a tabular format that shows where the company
stands relative to higher and lower ranking. It makes considerable difference to an investor to
know whether the rating agency or agencies placed the company in the top slots, or in the middle,
or in the bottom. [CII, Desirable Corporate Governance: A Code, April 1998, Recommendation
15, pp.9-10]
Today, CIIs recommendation has been adopted by SEBI. All ratings have to be fully disclosed.
4.6
Insider trading
Clause (g) of sub-section (2) of section 11 of the SEBI Act, 1992, clearly states that one of the functions
of the capital market regulator is prohibiting insider trading in securities. The law also defines insider
trading quite explicitly:
Insider trading takes place when insiders or other persons who, by virtue of their position in
office or otherwise, have access to unpublished price sensitive information relating to the affairs
of a company and deal in the securities of such company or cause the trading of securities while
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in possession of such information or communicate such information to others who use it in

connection with the purchase or sale of securities.
Moreover, the annual report of every listed company has to statutorily list its guidelines that ban insider
trading.
However, as in most countries, the problem with insider trading lies in implementation. The example of
SEC shows that, even with sophisticated detection devices, it is very difficult to pin-point insider trades.
In the US, less than 1% of the trades that are initially identified as potential cases of insider trading are
actually investigated; lesser still are charged and convicted. In India there are three sets of problems. The
first, despite the BSE and NSE having full-fledged screen based trading, it is still difficult to flag a trade
as a possible case of insider trading. Second, given the number of brokers and middle-men who operate
in the market, it is possible for a person who has insider information to create enough fire-walls between
himself and the traders which militates against identifying the real insiders. Third, and most
important, SEBI does not have judicial powers like courts. It can conduct an investigation, prepare a
report and even suggest a penalty; but it cannot inflict that penalty. The act of implementing the
punishment vests upon courts. Given the judicial delays in India, such penalties dont account for much.
Despite SEBIs handicap, it has initiated several cases of insider trading.
4.7
Financial disclosures of banks and DFIs
Although Indian banks and DFIs disclose more than their counterparts in East and South-east Asia and,
indeed, Switzerland, these fall short of what is desirable. In particular, neither banks nor DFIs need to
disclose the structure and extent of their asset-liability mismatch something that says a great deal about
their future financial health. Moreover, while they follow the Basle standards for recognition of nonperforming assets, this does not take into account some of the institutional realities of India. To give an
example, a case that is referred to BIFR should not be expected to be resolved in anything less than four
years. Therefore, prudential accounting should treat that loan as bad, and write it off the books to be
added back as profits if and when something is recovered. Similarly, any case going for winding-up
under court should be written off. More often than not, such practices are followed 71in the breach.
In this context, ICICI Bank has taken a lead. Driven by the objective of becoming Indias first truly
universal bank, ICICI decided to tap the US capital market via an American Depository Security Receipt
that was launched in late September 1999. To access the US market, ICICI voluntarily re-cast its
accounts for the year ended 31 March 1999 in terms of US-GAAP. The exercise eroded ICICIs bottomline by a third. But it has also created investor confidence arising from the comfort that a large DFI in
the process of becoming a universal bank is not afraid of using the toughest accounting standards. Not
surprisingly, ICICIs domestic IPO (concluded on 13 September 1999) was over-subscribed by 80%. On
28 March 2000, ICICI Bank, then a subsidiary of ICICI, also got listed on the NYSE and thus conformed
to all SEC disclosure standards.
While the Companies Act specifies punishments for non-compliance of financial disclosures, these are
extremely light and, in most instances, the penalties are disproportionately less than the extent of the
infringement. Moreover, huge judicial delays further diminish the minimal deterrence that such penalties
are supposed to inflict. At the time of writing, the Department of Company Affairs has appointed a
committee to recommend more realistically deterring penalties. Hopefully, the recommendations of the
committee will be quickly enshrined in the rule book.
71
From April 2002, ICICI has merged into ICICI Bank, and the entity is an NYSE-listed company, following all
disclosure standards mandated by the SEC and the NYSE.
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If anything, stock markets are doing their own enforcement. Increasingly, companies are enjoying market
premium for best-in-class corporate disclosures, which has increased the demand for hiring the services of
internationally respected and independent audit firms. The search of international capital at competitive
rates has resulted in an increasing use of international auditing firms. And, the experience of the last few
years suggests that the better companies are voluntarily following the maxim: When in doubt, disclose.
To be sure, India can do even better in its financial disclosures. However, it is important to emphasise
that Indian accounting and financial disclosure standards today are significantly better than those that
prevail throughout most of Asia (excepting perhaps Singapore), Latin America, and continental Europe.
This point needs emphasising and advertising much more vigorously.
5.
Recent Corporate Governance Initiatives
There have been two major corporate governance initiative launched in India since the mid-1990s. The
first has been by the Confederation of Indian Industry (CII), which is Indias largest industry and business
association. The second is by the SEBI.
5.1
The CII Code
More than a year before the onset of the Asian crisis, CII set up a committee to examine corporate
governance issues, and recommend a voluntary code of best practices. The committee was driven by the
conviction that good corporate governance was essential for Indian companies to access domestic as well
as global capital at competitive rates. The first draft of the code was prepared by April 1997, and the final
document (Desirable Corporate Governance: A Code), was publicly released in April 1998. The code
focuses on listed companies. Given below are excerpts that highlight the rationale of the exercise, and
summarise the key recommendations.
First, there is no unique structure of corporate governance Thus, one cannot design a
code of corporate governance for Indian companies by mechanically importing one form
or another. Second, Indian companies, banks and financial institutions (FIs) can no
longer afford to ignore better corporate practices. As India gets integrated in the world
market, Indian as well as international investors will demand greater disclosure, more
transparent explanation for major decisions and better shareholder value. Third,
corporate governance goes far beyond company law.
The objective of good corporate governance [is] maximising long-term shareholder
value. Since shareholders are residual claimants, this objective follows from a premise
that, in well performing capital and financial markets, whatever maximises shareholder
value must necessarily maximise corporate prosperity, and best satisfy the claims of
creditors, employees, shareholders and the State.
Board of Directors
The key to good corporate governance is a well functioning, informed board of directors. The board
should have a core group of excellent, professionally acclaimed non-executive directors.
The full board should meet a minimum of six times a year, preferably at an interval of two months.
Any listed company with a turnover of Rs.1 billion and above should have professionally competent,
independent, non-executive directors, who should constitute at least 30% of the board if the Chairman
of the company is a non-executive director, or at least 50% of the board if the Chairman and
Managing Director is the same person.
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No single person should hold directorships in more than 10 listed companies.

To secure better effort from non-executive directors, companies should:
Pay a commission over and above the sitting fees for the use of the professional inputs.
Consider offering stock options, so as to relate rewards to performance.
While re-appointing members of the board, companies should give the attendance record of the
concerned directors. If a director has not been present for 50% or more meetings, then this should be
explicitly stated in the resolution that is put to vote. As a general practice, one should not re-appoint
any director who has not had the time to attend even one half of the meetings.
Key information that must be reported to, and placed before, the board must contain:
Annual operating plans and budgets, together with up-dated long term plans.
Capital budgets, manpower and overhead budgets.
Quarterly results for the company as a whole and its operating divisions or business segments.
Internal audit reports, including cases of theft and dishonesty of a material nature.
Show cause, demand and prosecution notices received from revenue authorities which are
considered to be materially important. (Material nature if any exposure that exceeds 1 percent of
the company's net worth).
Fatal or serious accidents, dangerous occurrences, and any effluent or pollution problems.
Default in payment of interest or non-payment of the principal on any public deposit, and/or to
any secured creditor or financial institution.
Defaults such as non-payment of inter-corporate deposits by or to the company, or materially
substantial non-payment for goods sold by the company.
Any issue which involves possible public or product liability claims of a substantial nature,
including any judgement or order which may have either passed strictures on the conduct of the
company, or taken an adverse view regarding another enterprise that can have negative
implications for the company.
Details of any joint venture or collaboration agreement.
Transactions that involve substantial payment towards goodwill, brand equity, or intellectual
property.
Recruitment and remuneration of senior officers just below the board level, including
appointment or removal of the Chief Financial Officer and the Company Secretary.
Labour problems and their proposed solutions.
Quarterly details of foreign exchange exposure and the steps taken by management to limit the
risks of adverse exchange rate movement, if material.
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Listed companies with either a turnover of over Rs.1 billion or a paid-up capital of Rs.200 million
should set up Audit Committees within two years. Audit Committees should consist of at least three
members, all drawn from a company's non-executive directors, who should have adequate knowledge
of finance, accounts and basic elements of company law. Audit Committees should assist the board
in fulfilling its functions relating to corporate accounting and reporting practices, financial and
accounting controls, and financial statements and proposals that accompany the public issue of any
security and thus provide effective supervision of the financial reporting process. They should
periodically interact with the statutory auditors and the internal auditors to ascertain the quality and
veracity of the company's accounts as well as the capability of the auditors themselves.
Desirable disclosure
Listed companies should give data on: high and low monthly averages of share prices in a major
stock exchange where the company is listed; greater detail on business segments, up to 10% of turnover,
giving share in sales revenue, review of operations, analysis of markets and future prospects.
Major Indian stock exchanges should gradually insist upon a corporate governance compliance
certificate, signed by the CEO and the CFO.
If any company goes to more than one credit rating agency, then it must divulge in the prospectus
and issue document the rating of all the agencies that did such an exercise. These must be given in a
tabular format that shows where the company stands relative to higher and lower ranking.
Companies which are making foreign debt issues cannot have two sets of disclosure norms: an
exhaustive one for the foreigners, and a relatively minuscule one for Indian investors.
Companies that default on fixed deposits should not be permitted to accept further deposits and
make inter-corporate loans or investments or declare dividends until the default is made good.
The CII code is voluntary. Between 1998 and 2000, CII induced over 20 companies to disclose much
greater information in line with the code. Consequently, annual reports of such companies reflected much
greater disclosure with better qualitative and quantitative information. Even before SEBI mandated a
corporate governance code for financial year 2001 and thereafter, companies that voluntarily adhered to
the CII code disclosed information on:
The composition of the board: executive, non-executive and independent directors. An independent
director is (i) not a formal executive and has no professional relationship with the company, (ii) not a
large customer and/or vendor to the company, (iii) not a close relative of the promoter and/or any
executive directors, (iv) not holding a significant stake, and (v) not a nominee of any large
shareholder/creditor.
The number of outside directorships held.
Family relationship with other directors.
Business relationship with the company, other than being a director.
Loans and advances taken from the company.
Remuneration consisting of salaries and perquisites, sitting fees, commission and stock options, if
any.
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Attendance of directors at board meetings, including those of special committees of the board. These
have to be tabulated as number of meetings held versus those attended.
Details about their monthly high and low share prices in various stock exchanges, and compare these
with the market indices;
Data on the distribution of shares across various types of shareholders and according to size classes;
Classes of complaints received from shareholders regarding share transfers, and how these have
been addressed;
Economic value added (EVA), return on capital employed (ROCE) and return on net worth (RONW);
Details on risk factors, especially foreign exchange and derivative risks;
Details on contingent liabilities;
Data on outstanding warrants and their effect on dilution of equity, when converted;
Segment-wise information, wherever appropriate, in a chapter on management discussion and

analysis.
For the financial year ended 31 March 1999, 23 large listed companies accounting for 19% of
Indias market capitalization have fully or partly adopted the CII disclosure norms. For the year ended 31
March 2000, 36 companies joined the ranks. Indeed, companies such as Infosys or Dr. Reddys
Laboratories systematically overshot such norms. A more subtle, effect of the CII initiative was to create
a trend among larger listed companies to look positively towards corporate governance, instead of
discounting it as the flavour of the month.
5.2
SEBIs Initiative
The other major and mandatory corporate governance initiative was by SEBI. In early 1999, it set
up a committee under Kumar Mangalam Birla. By late 2000, the SEBI board accepted and ratified key
recommendation of this committee and informed all stock exchanges accordingly. SEBIs key
recommendations are mandatory. These apply to listed companies and are enforced at the level of stock
exchanges through listing agreements. The main recommendations are:
Independent directors are defined as those who, apart from receiving directors remuneration, do not
have any other material pecuniary relationship or transactions with the company, its promoters, its
management or its subsidiaries, which in the judgement of the board may affect their independence of
judgement.
Not less than 50% of the board should comprise of non-executive directors. The number of
independent directors would depend on the nature of the chairman of the board. In case a company
has a non-executive chairman, at least one-third of board should comprise of independent directors
and in case a company has an executive chairman, at least half of board should be independent.
Every listed company must, according to their size and a three year time-table, set up a qualified and
independent audit committee at its board level. The audit committee should have minimum three
members, all being non executive directors, with the majority being independent, and with at least
one director having financial and accounting knowledge; the chairman of the committee should be an
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independent director, who should be present at Annual General Meeting to answer shareholder
queries; the Company Secretary should act as the secretary to the committee. To begin with the audit
committee should meet at least thrice a year. One meeting must be held before finalisation of annual
accounts and one necessarily every six months. The audit committee should have powers to (i)
investigate any activity within its terms of reference, (ii) seek information from any employee, (iii)
obtain outside legal or other professional advice, and (iv) secure attendance of outsiders with relevant
expertise, if necessary.
Among other things, the audit committee should (i) oversee a companys financial reporting process
and quality of disclosure of financial information, (ii) recommend the appointment and removal of
external auditor, (iii) review with management, external and internal auditors the adequacy of internal
audit function and the annual financial statements before submission to the board, including financial
risks and risk management policies.
The board of directors should decide the remuneration of non-executive directors.
The following disclosures should be made in the section on corporate governance of the annual
report: (i) all elements of remuneration package of all the directors i.e. salary, benefits, bonuses, stock
options, pension etc. (ii) details of fixed component and performance linked incentives, along with the
performance criteria, (iii) service contracts, notice period, severance fees, and (iv) stock option
details, and whether issued at a discount as well as the period over which accrued and over which
exercisable.
Board meetings should be held at least four times in a year, with a maximum time gap of four months
between any two meetings.
To ensure that directors give due importance and commitment to their fiduciary responsibilities, no
director should be a member in more than 10 board-level committees or act as chairman of more than
five committees across all companies in which he is a director.
In every companys annual report, there should be a detailed chapter on Management Discussion and
Analysis. This should include discussion on industry structure and developments, opportunities and
threats, segment-wise or product-wise performance, outlook, risks and concerns, internal control
systems and their adequacy, relating financial performance with operational performance, and issues
relating to human resource development.
For appointment or re-appointment of a director, shareholders must be provided with the following
information: (i) a brief resume of the director, (ii) nature of his expertise in specific functional areas,
and (iii) companies in which he holds directorships.
Information like quarterly results, presentation made by companies to analysts should be put on the
companys web-site and sent in such a form so as to enable the stock exchange on which the
company is listed to put it on its own web-site.
A board committee under the chairmanship of a non-executive director should be formed to

specifically look into the redressing of shareholder complaints like transfer of shares, non-receipt of
balance sheet, non-receipt of declared dividends etc.
There should be a separate section on corporate governance in the annual reports of companies. Noncompliance of any mandatory recommendation with their reasons should be specifically highlighted.
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This will enable the shareholders and the securities market to assess for themselves the standards of
corporate governance followed by a company.
SEBI set a clear timetable for ushering in mandated corporate governance. The recommendations had to
be followed at the time of listing for all companies that are listing for the first time. For already listed
companies, the larger ones that fall under Group A of the BSE or in the S&P CNX 50 index (the Nifty),
had to adhere to the guidelines no later than 31 March 2001. That covered more than 80% of market cap.
For most of the rest, the guidelines came into effect by 31 March 2002. Today, listed companies
accounting for over 95% of Indias market capitalisation have to follow SEBIs corporate governance
guidelines.
While most of SEBIs recommendations follow from the CII code, there is no question that the
regulators mandate has much more teeth. CIIs code is, by its very nature, voluntary. In contrast, the
substantive aspects of the SEBI code are mandatory. And there is a need to put in place certain mandated
aspects of corporate governance.
5.3
Even more recent initiatives
After the collapse of Enron followed by the scandals of WorldCom, Global Crossing, QWest and
others, India, like the US, has decided to tighten corporate governance standards in several areas.
The Ministry of Finance, SEBI and Department of Company Affairs have set up several highpowered committees to recommend improvements in the follow areas:
Review of relationship between companies and auditors. This committee, which is expected to
submit its report in early November 2002, is examining the auditor-client relationship, the issue of
auditor independence, rotation of audit firms or principal auditors, restrictions on non-audit work,
audit versus non-audit fees and methods to strengthen Audit Committees of Boards.
Accounting for stock options. Although there are stringent caps of the percentage of a companys
shares that could be earmarked for stock options, the US scandals have raised the issue of expensing
of such options. A committee under the SEBI has been set up to review the issue and submit its
recommendations by mid-November 2002.
Additional corporate financial and non-financial disclosures. Set up to examine whether the
existing corpus of mandated disclosures suffice, or whether there is need to tighten some standards as
well as introduce some new disclosures. This committee is also expected to submit its report by the
second half of November 2002.
Penalties and fines for non-compliance and infringement. To recommend substantially greater
fines and penalties, so that these are more in line with the size of the crime. The committee will
submit its report by late November 2002.
Thus, by December 2002 or early 2003, India, most likely, will have several more disclosures and
accounting standards that align the country even more in line with international best practices.
There are, however, a couple of questions. The first relates to policing and punishment. SEBI envisages
that all these corporate governance norms will be enforced through listing agreements between companies
and the stock exchanges. A little reflection suggests that for companies with very little floating stock
which account for more than 85% of the listed companies de-listing because of non-compliance is
hardly a credible threat. SEBI can, of course, counter that by stating that it is first focusing on the big
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fish, namely the Group A and S&P CNX 50 companies. Here, the reputation effect of de-listing can
induce compliance and, hence, better corporate governance.
If SEBIs policing mechanism are not considered credible enough, then the Department of Company
Affairs (DCAs) is worse still. For one, it deals with over 76,000 public limited companies, while
SEBIs mandate is limited to 13,500 listed corporates. For another, the DCA staffing is much poorer in
quality compared to SEBIs. More important, unlike the SEBI, the DCA is not an independent regulatory
body. It is a department of government and, therefore, a servant of the whims and fashions of its
ministers.
The second issue is more problematic, and it has to do with form versus substance. There is a fear that by
legally mandating several aspects of corporate governance, SEBI might unintentionally encourage the
practice of companies ticking checklists, instead of focusing on the spirit of good governance. The fear is
not unfounded. Take, for instance, the case of Korea. After the crash of 1998, a part of the IMF bailout
package was that a fourth of the board of every listed Korean company must consist of independent
directors. They do, but the directors are hardly independent by any stretch of imagination. For most part,
they are retired executives of the chaebols, friends of business groups and politicians that have supported
the business in the past. And, in any event, they dont do what was intended namely, to speak for
shareholders and ensure that management does what is necessary to maximise long term shareholder
value.
This raises a question of how to trace the line that divides voluntary from mandatory. In an ideal world
with efficient capital markets, such a question need not arise because the markets would recognise
which companies are well governed and which are not, and reward and punish accordingly.
Unfortunately, ideal capital markets exist only in theory. The reality is quite different. Markets are often
thin and shallow and operate on the basis of ebbs and flows of pivotal stocks; informational requirements
are lax; and regulatory and policing devices leave much to be desired.
Thus, it could be argued is that the need of the hour is a relatively small corpus of legally mandated rules,
buttressed by a much larger body of self-regulation and voluntary compliance. This will surely happen in
India. When all listed companies as well as public limited companies are forced to follow increasingly
stringent SEBI and DCA guidelines, the better ones will voluntarily raise the bar so as to be measured
according to best international practices. That will occur because of the desire of the high performers to
be separated from the chaff and to emphasise this separation to attract international funds.
6.
State Owned Enterprises
Given the size of state owned enterprises (SOEs) among listed companies which account for 15% of
market capitalisation it necessary to touch upon their governance structures. These are companies
which can be best described by a phrase: Agents without principals. Shareholders (or principals) of
private sector companies are direct beneficiaries of profitable performance. Therefore, in theory, they
have an incentive to monitor management so that it maximises corporate value. In contrast, most
government companies, especially the unlisted ones, do not have a substantial body of informed private
shareholders whose income depends upon the performance of these companies.
If anything, the major shareholder of SOEs has distinctly different objectives. Commercial viability,
profitability, quality, cost minimisation, optimal investment decisions and corporate value creation rarely
figure among the concerns of a typical Member of Parliament or a minister. Next in the hierarchy of
shareholders representatives comes the civil servants. By their very training, bureaucrats specialise in
slavishly adhering to laid-down procedures, irrespective of their relevance. This training creates an
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inconsistency between the organisational forms of governments and those of modern financial and
industrial entities: governments and their agents are process oriented, whereas firms have to result
oriented. The mismatch gets exacerbated by a civil servants aversion to risk taking. Thus, when a civil
servant serves on the board of an SOE, he typically tows the ministrys line, ensures that the SOE follows
proper procedures, and avoids any risky decision that may have harmful consequences for his ministry.
Given the non-commercial objectives of the principal, most chief executives of SOEs quickly adopt the
line of least resistance, develop the dont rock the boat syndrome and avoid changes that may alienate
any powerful element among the shifting and fuzzy coalition of interests. Thus, important organisational
changes are not made, erring staff remain undisciplined, loss-making plants are neither downsized nor
closed, wages are not linked to productivity, and redundant workers are not retrenched.
Above all this sits Article 12 of the Constitution of India, which defines the State as the Government
and Parliament of India and the Government and Legislature of each of the States and all local or other
authorities within the territory of India or under the control of the Government of India. Since most
SOEs have more than 50% government ownership, they fall under the ambit of the State. This has
affected SOEs in several adverse ways.
All SOEs are expected to achieve a wide variety of non-commercial objectives which are imposed by
the ministries and the Parliament.
One of the most difficult one to maintain is employment reservation. Every SOE must adhere to the
affirmative action norms, and ensure that the share of employment under reserved categories
(scheduled castes, scheduled tribes, other backward castes, physically handicapped persons, and exmilitary or dependants of those killed in military or para-military action) is identical to the central
government ministries. Employment reservation is monitored at five levels: by the administrative
ministries, the Department of Public Enterprises under the Ministry of Industry, the Departments of
Personnel and Training under the Ministry of Labour, the Parliamentary Committee on the Welfare of
Scheduled Castes and Scheduled Tribes, and the National Commission for the Scheduled Castes and
Scheduled Tribes. The chief executive of an SOE has to ensure that the reserved quota is maintained
not just on incremental employment, but increasingly on the average and deviations, particularly in
the higher paid categories, invite immediate Parliamentary questions and show-cause notices.72
The annual audit by the Comptroller and Accountant General (CAG) in addition to the audit by the
statutory auditor. The area where CAG audits inflict the greatest ex ante damage is in purchases and
tenders. SOE managers and board members invariably veer towards selecting the lowest bid, even
when they know that the quality is poorer. Innumerable CAG allegations of financial impropriety
adduced only on the basis of rejecting the lowest bid have taught SOE executives and directors that
propriety dominates profitability.
Constraints on appointment of senior management personnel, which can only be done through the
Public Enterprise Selection Board (PESB) and, thereafter, clearance from the Department of
Personnel, the Home Ministry, and, in many instances, by the Office of the Prime Minister. This has
led to delays, non-appointment of CEOs and executive directors and excessive emphasis on seniority.
In such a milieu, biding time dominates corporate accomplishment. A study sponsored by the
Standing Committee on Public Enterprises (SCOPE) in 1992 found that only 64 companies of a
72
Presently, for all state agencies the minimal reservation quotas are 15% for Scheduled Castes, 7.5% for Scheduled
Tribes, and 27% for Other Backward Classes making it 49.5% of total employment. For the relatively lower paid,
lower skill jobs, there is an additional quota of 3% for the physically disabled, and 14.5% to 24.5% for ex-military
and dependants of those killed in military or para-military action. These quotas are particularly restrictive in
selecting people for technically specialised jobs.
157
sample of 101 central SOEs had full-time chairmen or executive chairman-cum-managing directors;
and the post of 30 chief executives and 66 executive directors were lying vacant [Kaw (1994), 360].
The study also found that only 13% of the chief executives and 5% of the functional directors
remained in employment for the full five-year contract period; they reached the mandatory retirement
age in an average of 18 months. Matters have not improved since.
Since SOEs are parts of the State, they are subject to writ petitions to the Supreme Court under
Articles 32, and High Courts under Article 226 of the Constitution.
Again by virtue of being considered as servants of the State, managers as well as directors of SOEs
are, in principle, subject to criminal investigation by the Chief Vigilance Commissioner and the
Central Bureau of Investigation.
State status limits managers from downsizing plants, retrenching or re-deploying employees.
Finally, the directors of SOEs have little autonomy in finalising investment decisions.
What do SOE managers have to say about these restrictions? A survey published in January 1997
emphasises their frustrations in no uncertain terms, as seen in Table 4.
Table 4: Responses of Senior SOE Managers
Issues
Percentage of
respondents
Accountability
Oppose Interference from political quarters
Oppose Interference from bureaucracy
Oppose multiple reporting
Oppose multiple accountability (Ministries, vigilance,
Parliament)
Bureaucrat Directors
Oppose increase in number of government officers as
directors
Restructuring
Favour financial restructuring
Favour business restructuring
Favour privatisation
Note: 114 senior executives from 83 SOEs responded to the questionnaire.
Survey of Public Sector Chief Executives: Executive Summary, January 1997.
62
75
65
82
82
77
74
71
Source: SCOPE, Opinion
In the final analysis, there can be no real solution to SOEs without systematic and transparent
privatisation. This has been recognised by the present government and clearly enunciated in its policies.
However, progress has been poor partly because of resistance from entrenched, rent-seeking
bureaucracy, and partly due to the lack of sufficient political will. In the meanwhile, even the better run
SOEs are suffering on two counts. First, there has been a major fall in corporate value, measured in terms
of EVA. For the four year period between 1995 and 1998, a sample of 109 SOEs in the aggregate lost
EVA worth Rs.9.1 billion, which amounted to almost 9% of their capital employed.73 Second, there has
been a far more important loss that of skilled and trained managers leaving for the private sector.
73
Bhandari and Goswami (2000), Chapter 3.
158
Unless these companies get privatised, and managers realise that they will be rewarded for performance
and risk-taking, this exodus will continue. And with it, the deterioration of SOEs will exacerbate.
7.
Conclusion
It is fair to say that, in the last five years, India has made much more rapid strides in corporate governance
than most, if not all, its Asian counterparts. It is also certain that the next few years will see an even
greater flurry of activity. This will be driven by several factors.
First, and most important, is the force of competition. With the dismantling of licenses and controls,
reduction of import tariffs and quotas, virtual elimination of public sector reservations, and a much more
liberalised regime for foreign direct and portfolio investments, Indian companies have faced more
competition in the second half of the 1990s than they did since independence. Competition has forced
companies to drastically restructure their ways of doing business. Underutilised assets are being sold,
capital is being utilised like never before, and companies are focusing on the top and bottom line with a
hitherto unknown degree of intensity. Moreover, while there have been losers in liberalisation,
competition has led to greater over all profits. Thus, the aggregate financial impact of competition has
been positive the more so for those who went through the pains of restructuring in the relatively early
days of liberalisation. And there is every indication that while many companies will fall by the wayside,
many more will earn greater profits than before.
Second, economic reforms of the last 11 years however glacial the process of change has definitely
contributed to a great churning in corporate India. Nothing emphasises this more than two simple
comparisons the fall from grace of yesterdays corporate giants, and the rise of the new kids on the
block.
Consider the top 100 companies ranked according to market capitalisation as on 1 April 1991. How have
these been treated by the market 11 years after liberalisation? Very poorly, as the following statistics
indicate:
The rank of the top 10 companies on 1 April 1991 fell by an average of 38 points as on 30 September
2002.
The rank of the top 25 companies fell by an average of 67 points.
The rank of the top 50 companies fell by an average of 88 points.
For the top 100, the average fall in rank was 157 points.
In relative terms, therefore, yesterdays giants have been dwarfed by the forces of change. What about the
new kings of the bourse? When did these companies come into being? That data is even more revealing,
and shows how economic liberalisation, competitiveness and dismantling of controls have reduced entry
barriers and permitted new entrepreneurs to race to the top of the market capitalisation table.
Four of the top 10 companies ranked by market cap as on 30 September 2002 either did not exist or
were not listed on any stock exchange.
Twenty-two of the top 50 companies were in identical circumstances.
The dominant characteristic of todays top 50 companies is the preponderance of first generation
enterprise or professionally run businesses. In 1991, 22 out of the top 50 companies were controlled by
family groups that held their sway during the licence-control regime. By February 2002, the roles were
159
reversed: 35 were professionally managed, of which 14 were first generation businesses; only 4 out of the
50 were run by older business families. By and large, these are companies managed by relatively young,
modern, outward-oriented professionals who place a great deal of value on corporate governance and
transparency if not for themselves, then as instruments for facilitating access to international and
domestic capital. Therefore, they are more than willing to have professional boards and voluntarily
follow disclosure standards that measure up to the best in the world.
Third, there has been a phenomenal growth in market capitalisation. This has triggered a fundamental
change in mindset from the earlier one of appropriating larger slices of a small pie, to doing all that is
needed to let the pie grow, even if it involves dilution in share ownership. Creating and distributing
wealth have become more popular maxims than ever before the more so when these tenets are
validated by growing market cap.
Fourth, one cannot exaggerate the impact of well focused, well researched foreign portfolio investors.
These investors have steadily raised their demands for better corporate governance, more transparency
and greater disclosure. And given their clout in the secondary market they account for over 25% of the
average daily volume of trade foreign portfolio investors have voted with their feet. Over the last two
years, they have systematically increased their exposure in well governed firms at the expense of poorly
run ones.
Fifth, the pressure on corporate governance will intensify with the entry of foreign pension funds. Indian
equity offers attractive dollar-denominated rates of return on capital, which should make international
pension funds begin to look at selected Indian stocks. These funds hold on to their investments much
longer than mutual funds; and their managers will be looking even more closely at corporate governance
before making their investments. Indeed, it is fair to predict that in the next five years, the biggest
pension funds will invest in India, and some of them will put Indian companies on their corporate
governance watch.
Sixth, India has a strong financial press, which gets stronger with the years. In the last five years, the
press and financial analysts have induced a level of disclosure that was inconceivable a decade ago. This
will increase and force companies to become more transparentnot just in their financial statements but
also in matters relating to internal governance.
Seventh, despite serious lacunae in Indian bankruptcy provisions, neither banks nor DFIs have the
appetite to support management irrespective of performance. Already, the more aggressive and market
oriented DFIs have started converting some of their outstanding debt to equity, and have set up mergers
and acquisition subsidiaries to sell their shares in under-performing companies to more dynamic
entrepreneurs and managerial groups. This will intensify over time, especially with the advent of
universal banking.
Penultimately, Indian corporations have appreciated the fact that good corporate governance and
internationally accepted standards of accounting and disclosure can help them to access the US capital
markets. Until 1998, this premise exited only in theory. It changed with Infosys making its highly
successful Nasdaq issue in March 1998. This was followed ICICI, Satyam Infoways, Satyam, ICICI
Bank, Wipro, HDFC Bank, Dr. Reddys Laboratories and others (most of whom are listed on the NYSE).
At this point, there at least ten companies gearing up to issue US depository receipts in 2003. This trend
has had two major beneficial effects. First, it has shown that good governance pays off, and allows
companies to access the worlds largest capital market. Second, it has demonstrated that good corporate
governance and disclosures are not difficult to implement and that Indian companies can do all that is
needed to satisfy US investors and the SEC. The message is now clear: it makes good business sense to
be a transparent, well governed company incorporating internally acceptable accounting standards.
160
Finally, within the next five years or so, India will move to full capital account convertibility. When that
happens, an Indian investor will seriously consider whether to put his funds in an Indian company or to
place it with a foreign mutual or pension fund. That kind of freedom will be the ultimate weapon in
favour of good corporate governance. Thankfully for India, the companies that matter have already seen
the writing on the wall. Thus, it may not wrong to predict that, by the time Beijing hosts the 2008
Olympics, India might have the largest concentration of well governed companies in South and Southeast Asia.
161
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163
Corporate Governance in Pakistan: Ownership, Control and the Law

By
Ali Cheema
Faisal Bari
Osama Siddique74
Table of Contents
Introduction
165
1. Industrial Policy and Corporate Finance in Pakistan: A Historical Overview
167
2. Pakistans Corporate Governance System
170
3. Capital Markets
180
4. SECPs Recent CG Reform Effort
182
5. Financial Reporting and Disclosure
192
6. Financial Sector and Corporate Governance
200
7. Judicial System
206
8. Conclusions
207
9. Bibliography
209
List of Appendices
Appendix 1. Sample Description
211
Appendix 2. Relevant Excerpts from the SECP Annual Report 2002
216
Appendix 3. Case Study Evidence on Corporate Structures
219
Appendix 4. The Code of Corporate Governance
223
Appendix 5. The Legal Aspects of Corporate Governance in Pakistan
236
74
Faculty at the Lahore University of Management Sciences. We would like to thank Ms. Ghazia Aslam and Mr.
Ali Zahid Rahim for providing valuable research assistance. We would like to thank Mr. Bilal Minto, Mirza
Mehmood Ahmed and Ms. Wendy Werner for their comments on earlier drafts. Finally, we owe a very deep
gratitude to Khadim Ali Shah Bukhari, ICAP and SECP Pakistan, in particular, Mr. Haroon, Sharif for their help
with data.
164
Introduction
Corporate governance (CG) reform has dominated policy agendas in both developed and developing
countries during the nineties. Policy making interest in CG gained momentum in the wake of the East
Asian financial crisis and as a result of scandalous revelations about corporate practices in leading U.S
corporates like Enron. Governments, stock exchanges and business associations across the world are
competing to produce CG guidelines. These reforms are thought to be of great significance for
developing countries that are making a sustained effort to attract Foreign Direct Investment (FDI) and to
mobilize greater savings through capital markets.
In Pakistan, CG reforms initiated during the last few years, by the Securities and Exchange Commission
of Pakistan (SECP), are argued to be an important component of the Government of Pakistans (GOP)
growth revival strategy. The concern for growth revival in Pakistan is underscored by Table 1, which
reveals the extent of the growth slowdown during the last decade.
Table 1. South Asian GDP per Capita Growth Rates
Growth Rate of GDP per capita
Country Name
60's 70's 80's 90's
4.29 2.11 3.82 1.47
Pakistan
1.52 0.75 3.70 3.73
India
1.40 -0.52 1.98 3.15
Bangladesh
0.48 -0.32 1.49 2.25
Nepal
2.15 2.63 2.84 3.98
Sri Lanka
Source: World Development Indicators, 2002.
Pakistans growth response stands in sharp contrast to the positive response of other South Asian
economies that have adopted similar policies of structural adjustment and liberalization during the
nineties. The relative slowdown in Pakistans growth during the nineties can be attributed to falling rates
of capital accumulation and total factor productivity growth (Table 2).
Table 2. Comparison of Factors Contributing to Growth in South Asia75
Growth of
Output per
worker
Bangladesh
90's
1960-90
India
90's
1960-90
Pakistan
90's
1960-90
Sri Lanka
75
Physical
Capital
Per worker
Education
Per worker
Total Factor
Productivity
2.08
0.06
0.88
-0.07
0.16
0.31
1.03
-0.18
3.40
2.31
1.45
1.05
0.33
0.38
1.61
0.87
1.39
2.45
0.61
1.48
1.75
0.79
-0.97
0.17
The methodology for these estimates is given in Basudeb and Bari (2002).
165
90's
2.51
1960-90
2.32
Source: Basudeb and Bari (2000).
1.02
1.19
0.16
0.28
1.33
0.84
There is a concern that low rates of capital accumulation reflect Pakistans inability to mobilize domestic
savings (Table 3) and Foreign Direct Investment (Table 4).
Table 3. Gross Domestic Savings
(Percentage of GDP)
Country
1980-90
South Asian Economies
Bangladesh
7.84
1990-2000
14.60
India
20.09
20.98
Nepal
10.70
12.20
Pakistan
8.31
12.08
Sri Lanka
12.78
16.08
Source: World Development Indicators (2002).
World
Developing
Countries
Asia
SAARC
Country
1980-90
East Asian Economies
South
30.59
Korea
Thailand
26.46
Singapore
41.78
Malaysia
33.09
Indonesia
31.60
Table 4. Foreign Direct Investment Inflows

(US $ million)
1980-85
1990
1995
49,813
203,341
331,189
12,634
31,345
105,511
1990-2000
35.10
35.16
48.68
40.63
32.29
1998
643,879
165,936
5,043
18,948
67,386
84,880
178
458
2,753
3,433
(3.5%)
(2.4%)
(4.08%)
(4.04%)
Bangladesh
-0.1
3.0
2.0
317.0
(0%)
(0.01%)
(0.002%)
(0.37%)
India
62
162
1,964
2,258
(1.2%)
(0.85%)
(2.9%)
(2.7%)
Pakistan
75
244
719
497
(1.5%)
(1.3%)
(1.07%)
(0.6%)
Sri Lanka
42
43
53
345
(0.8%)
(0.2%)
(0.7%)
(0.4%)
Source: UNCTAD, World Investment Report, various years, taken from Institute of Policy Studies
Note: Parenthesis gives country FDI as a percentage of Asian FDI.
In order to address these growth-financing concerns the SECP has placed considerable emphasis on the
reform of capital markets. The objective of capital market reform is to increase the depth and efficiency of
capital markets with an aim to mobilize domestic savings and foreign portfolio investment. As pointed
out earlier, an important component of this reform is the improvement in Pakistans Corporate
Governance (CG) system. The measures proposed to fulfill these objectives include: minority shareholder
representation in the board of directors; requiring directors to discharge their fiduciary responsibility in
the larger interest of all stakeholders; and improved disclosure through better regulation of audit activity
and through the adoption of international standards. SECP recognizes that growth creation in global
166
capitalism requires a corporate governance system that has the ability to efficiently raise external equity
capital, to increase corporate competitiveness and to stimulate corporate growth.
This chapter assesses the constraints imposed by Pakistans corporate governance structure, laws
and regulatory institutions on the development of external investor financing. Section 1 provides a
historical analysis of Pakistans corporate growth and corporate finance experience. Its main
purpose is to illuminate the reasons for the underdevelopment of capital markets in Pakistan.
Section 2 provides detailed empirical analysis of Pakistans structure of corporate ownership and
control. We show that family based corporates represent an important potential source of
corporate growth in Pakistans existing economic environment. However, we also argue that the
control maximization objective of family based corporates may be inimical to the development of
Pakistans capital markets. Section 3 argues that opaque information disclosure and other
inefficiencies in Pakistans capital markets tend to make them unattractive avenues for both
mobilization of funds and investment. Sections 4 and 5 detail the recent Corporate Governance
reforms brought about by the SECP. We argue that while the reforms have brought Pakistans
corporate law in line with international best practice, its implementation may be limited by the
countrys structure of ownership and control. We also show that an underdeveloped corporate
sector creates negative externalities, which reduce incentives for the improvement in the quality of
the audit market. However, we acknowledge the SECPs recent reforms have had a positive effect
on the consolidation of a quality segment in the accounting profession. Sections 6 and 7 analyze the
causes for inefficiencies in credit allocation and the rise of non-performing loans (NPLs) in
Pakistans financial sector. We identify poor judicial enforcement and historical weaknesses in the
structure of financial markets and their regulatory agencies as important causes for this
phenomenon. We also argue that recent financial sector reforms have made financial institutions
excessively risk averse in their practices, which will raise the cost of debt financing for Pakistani
corporates. This suggests that there may be a need for capital market reforms. Section 8
concludes.
1. Industrial Policy and Corporate Finance in Pakistan: A Historical Overview
The Pakistani States policy involvement with the corporate sector dates back to the fifties. The private
sector was identified as the main agent for industrialization during the first two decades after partition.
During the fifties, the state intervened through heavy protection and it provided the manufacturing sector
with generous fiscal incentives, cheap imports of capital goods and subsidized credit. An overvalued
exchange rate was used to reduce the domestic prices of jute and cotton, the two main sources of
industrial raw material. Quantitative import restrictions created acute scarcities in the domestic market,
which together with an overvalued exchange rate allowed windfall profits76 to be made by importers and
import substituting industrialists. Generous state incentives combined with a large domestic market and
cheap industrial raw material created the first wave of accumulation in Pakistani industry.
Pakistans industrial policy during the sixties witnessed a number of important departures, although it
kept intact quantitative barriers and tariffs on imports of manufacturing goods. The state introduced the
export bonus scheme, which was in effect a multiple exchange rate system favouring manufacturing
exports (Noman 1992). Government policy continued to insure the availability of subsidized raw
material as well as the availability of subsidized credit and cheap foreign exchange. In addition, the
government instituted policies that kept the price of machinery close to the international level and
maintained an overvalued exchange rate for agricultural exports.
76
Papanecks (1967) estimates suggest that many import-substituting industrialists made over a hundred percent
profit during this phase of Pakistans industrialization.
167
The state also created policy transfers through the financial sector. It did this by providing foreign
exchange and domestic currency loans on favourable terms to Pakistans corporate sector. The rate of
interest charged on these loans was 30% of the scarcity value of capital (Amjad 1982). This considerably
influenced the profitability and financial position of Pakistans industrialists. Easy access to these
subsidies was provided by disbursing foreign exchange loans and grants provided by multilateral agencies
through state-run financial institutions namely, the Pakistan Industrial Credit and Investment Corporation
(PICIC) and the Industrial Development Bank of Pakistan (IDBP). These schemes covered over 65% of
investment financing during the sixties. Amjads (1982) estimates clearly show that access to subsidized
foreign exchange loans explains, in large part, the differences in corporate growth in Pakistan during the
sixties.
The main beneficiaries of the states financing policy were Pakistans monopoly houses. Amjad (1982)
defines monopoly houses as being characterized by family ownership under a centralized decision making
authority, usually the patriarch of the family, and consisting of several legally separate companies
engaged in highly diversified activities. Furthermore, he argues that there is no separation of ownership
from control in these houses. Not only did these houses have access to subsidized loans they also had
considerable institutional access to the boards of state-run financial institutions, which were the main
disbursers of long-term loans to the manufacturing sector. A third of directors of important state-run
financial institutions such as the Pakistan Industrial Credit and Investment Corporation (PICIC), the
Investment Corporation of Pakistan (ICP) and the National Investment Trust (NIT) were from these
houses77. An outcome of this corporate structure was the concentration of industrial assets in the hands of
44 monopoly houses that controlled 48% of gross fixed assets of the large-scale manufacturing sector in
1970 (Amjad 1982). These houses were also the main beneficiaries of loans disbursed by the two major
Development Finance Institutions (DFIs) run by the state, PICIC and Industrial Development Bank of
Pakistan (IDBP).
The formation of the Pakistan Peoples Party (PPP) government in the seventies (which had pledged a
manifesto commitment to reduce industrial concentration), the creation of Bangladesh78 and the
nationalization of the economic assets of the monopoly houses crushed their economic power. Amjads
(1983) study shows that 11 out of the top 26 houses lost more than 50% of their assets in this period. The
private sector was no longer considered the main agent of industrialization and the emphasis of the states
industrial policy shifted towards developing public sector industries. The new beneficiary of state policy
was the public sector, as a result the share of the public sector in large-scale manufacturing investment
increased from 13% in 1972-73 to 78% by 1976-77.
The Bhutto (PPP) government also nationalized Pakistans banking sector during the seventies. Banking
nationalization extended political control over the entire financial sector and with minor modifications
this structure persisted until the late nineties. Political control over the banking sector was strengthened by
weakening State Bank of Pakistans (SBP) regulatory and supervisory role through the creation of the
Pakistan Banking Council (PBC), which became the operational controller of banks (section 6). The
Federal government retained the right to select the members of the PBC, and through the PBC it retained
effective control over the appointments of boards of individual banks. This change heightened political
control over credit transfers to industry.
General Zia-ul-Haq and subsequent democratically elected governments sought to revive the role of the
private sector during the eighties and early nineties. During the eighties, government policy attempted to
stimulate and direct industrialization by boosting profitability through measures such as, tax holidays,
tax credits, accelerated depreciation allowance, concessions in import duty on machinery and equipment
77
78
Amjad (1982).
Monopoly houses lost both private assets and a large internal market as a result of the creation of Bangladesh.
168
and raw materials, exemption of sales and excise taxes and tariff protection given to the manufacturing
sector (Hamid 1992). In addition, the government provided an additional incentive to industry in the form
of the availability of raw materials (cotton and hides and skins) at below world prices by placing
restrictions or duties on their exports.
Subsidized credit79 continued to provide essential state-created incentives for corporate growth during the
eighties-nineties. However, the conduit for credit transfers was no longer only the state-run financial
institutions but also commercial banks that had been nationalized under Bhutto (1971-77). The aid
dividend from the Soviet-Afghan war had created significant foreign exchange liquidity for the state to
make liberal transfers to industry. An important consequence of this intervention was increased
leveraging in Pakistans corporate sector (Table 1.1). Availability of cheap state-provided credit and
inflated profits due to other state-created incentives significantly diluted the Pakistani corporations need
to mobilize equity finance through capital markets.
Table 1.1. Leveraging in Pakistans Private Manufacturing Sectors
1980
1985
1990
1995
1998
0.7
5.4
1.1
1.1
1.0
Textiles
0.3
0.9
1.2
2.5
0.2
Others
Source: State Bank of Pakistan (2001).
Note: The textile data is separately reported as textile companies dominate the listed companys sector in
terms of numbers.
By the early nineties, the state lowered entry barriers into the industrial sector, which had been in place
during the past two decades. Liberal provision of cheap state-provided credit combined with liberal entry
control resulted in a number of important consequences, which are illuminated by Cheemas (1999) case
study of the spinning sector80. First, the availability of cheap state credit resulted in rapid new entry into
key manufacturing sectors, like spinning, during the nineties (Table 1.2, column 2).
Table 1.2. Entry Rates and Credit Access in Pakistans Spinning Sector
Gross Entry
Market Share
Rate (per
of Incumbent
Period
annum)
Companies
(1)
(2)
(3)
1981-85
1.8%
95%
1986-90
4.5%
77%
1990-94
11%
63%
Source: Cheema (forthcoming)
Market Share
of New
Companies
(4)
5%
23%
37%
Incumbent
Companies
Share in State
Credit
(5)
97%
79%
53%
New
Companies
Share in State
Credit
(6)
3%
21%
47%
Second, column (4) shows that the entry of new companies grew at an increasing rate during the mid-tolate eighties and the early nineties. Columns (3) and (4) show that not only did new companies enter the
sector they were also able to wrestle away market shares from incumbent companies. Third, columns (5)
and (6) show that access to state credit provided an important means to underwrite the entry of new
79
Cheema (1999) shows that during the 1980s and early 1990s the rate of interest on long-term loans was only 40%
of the open market price of capital, which constituted a significant subsidy for the industrial sector.
80
We rely on this case study, as there is a paucity of rigourous material analyzing the impact of state policy on
industrialization during the eighties and nineties.
169
companies in Pakistans corporate sector. The proportionate disbursement of state credit to new entrants
more than doubled during the early nineties.
Fourth, Table 1.3 shows that the main beneficiaries of changes in the ownership pattern were not only the
established monopoly houses, as had been the case during the sixties. Instead it shows that by 1994
single-company entrepreneurs had doubled their share of spinning capacity from 27% in 1981 to 45% in
1994, or from 66 companies in 1981 to 234 companies in 1994. These new entrants were much smaller in
size; the average size of a single-company mill was 14,500 spindles in 1994, while an Industrial Group
mill averaged 24,000 spindles. Cheemas (1999) estimates show that these new entrants on average
tended to be low-productivity companies, many of whom ended up as major loan defaulters by the mid to
late nineties, which points to, among other things, the existence of poor project selection, political
corruption, and weak lending practices in the state-run banking sector.
Table 1.3. Ownership Profile of Spinning Entrepreneurs
Percentage of Installed Capacity Owned by Different
Groups
1981
1990
1994
47%
56%
39%
26%
13%
17%
Monopoly Houses Established Before 1979

Monopoly Houses Established During the
Eighties
Single-Company Entrepreneurs
27%
31%
45%
Source: Cheema (1999)
Note: All companies belonging to an Industrial Group or to one of its family members have been
consolidated as Industrial Group Ownership. If a family has split up into different groups then this has
been taken into account.
An analysis of Pakistans industrialization experience shows that state provided incentives, given in
various forms over the decades, have helped to inflate internal profits of industry. An important subsidy
given by the state to the private sector in all decades, barring the seventies, has been cheap credit.
Evidence, however, suggests that unlike the sixties state-provided credit disbursements are no longer
monopolized by a handful of business groups. Protection profits and access to cheap credit has
determined the nature of corporate finance in Pakistan, which has historically been debt and internal
finance dependent. In turn, this pattern of corporate finance has reduced the corporates incentive to
mobilize capital through equity markets, which has undoubtedly contributed to the underdevelopment of
capital markets in Pakistan (see section 3 for a detailed discussion of Pakistans capital markets).
Mounting non-performing loans in Pakistans banking sector, tighter regulation of the banking sector,
liberalization of interest rates and the adoption of more market-based lending practices, by the midnineties, had made state-credit an unattractive means to finance corporate growth (see section 6). This
resulted in a downward trend in leveraging ratios, especially in sectors other than textiles (Table 1.1).
The reversal in the easy availability of state credit leaves the corporates with two options, either they rely
on internal financing for growth or they will have to raise equity through the capital markets. There are
limitations on the former option because of the liberalization of product and factor markets in Pakistan,
which will reduce protection profits for industry. Therefore, capital market development has acquired a
premium in the current context of Pakistans growth history.
2. Pakistans Corporate Governance System
170
A historical analysis of Pakistans corporate growth experience gives many clues into the state of
underdevelopment of the countrys capital markets. In this section, we argue that Pakistans existing
corporate governance structure provides another important reason for the underdevelopment of capital
markets in Pakistan.
Recent literature has emphasized the relationship between corporate governance systems and capital
market development. It is received wisdom that corporate governance reforms are an important prerequisite for capital market development as they provide essential protections for external investors.
Shleifer and Vishny (1997) pose the governance question as one of how external investors could ensure
that managers or majority controllers would provide them with ample return and would not expropriate
their investment. The issue of corporate governance arises because of the separation of ownership from
control in corporations. The agency costs that arise due to a disjuncture between ownership and control
could exist not just between shareholders and managers, but also between controlling and minority
shareholders and between shareholders and creditors (Berglof and Von Thadden 2000). These agency
costs raise the expropriation risk for investors and make them shy of investing in companies.
Zhuang et. al (2000) define a corporate governance system as consisting of (i) a set of rules that define
the relationships between shareholders, managers, creditors and the government and (ii) a set of
mechanisms that help directly or indirectly to enforce theses rules (pg. 5). A well-designed corporate
governance system will not only protect investors investment, but will also help reduce market risk and
maintain financial stability. By doing this, a corporate governance system helps create the environment
for capital market development and for the growth of the corporate sector. The next two sections raise the
simple, but essential, question, that is, whether Pakistans current corporate governance system is
compatible with the requirements of capital market development?
2.1 An Overview of Pakistans Corporate Sector
Pakistans manufacturing sector can be used as a first approximation to measure the importance of the
corporate sector in Pakistans economy. Table 2.1 reveals four interesting features about Pakistans
manufacturing sector81. First, it shows the dominance of the private sector in both Pakistans large and
small and medium manufacturing industries. Second, it reveals the small presence of foreign controlled
units in terms of numbers. Third, and for our purpose, most importantly, it highlights the relative
underdevelopment of the corporate sector in Pakistans private large-scale manufacturing industry.
Finally, it shows the lack of development of the widely held companies sector in Pakistan.
Table 2.1. Legal Status of Pakistans Manufacturing Units, 1988
Large82
(% of large units)
Foreign Controlled Units
Private Sector Units
Individual Proprietorship
Partnership
Private Limited
Public Limited
0.04%
42.0%
13.2%
7.06%
18.4%
2.6%
Small & Medium83

(% of small and medium
units)
85.8%
82.8%
2.5%
0.3%
0.13%
81
This exercise could not be conducted for other sectors and for recent years because of the paucity of data.
100 or more workers.
83
Less than 100 workers.
82
171
Others
Source: Census of Establishments (1988)
0.09%
0.01%
These findings are reinforced by Table 2.2, which underscores the relative dominance of the closely held
sector in terms of numbers. However, as in India, publicly listed companies become more prominent if
importance is estimated in terms of the book value of equity. We also find that Pakistan trails India in
terms of the contribution of the widely held sector, when measured as a share of paid-up capital. This
discussion suggests a two-pronged conclusion. First, Pakistan is clearly under performing in the area of
corporate development. Second, capital market development clearly requires growth in the widely held
sector.
Table 2.2. A Comparative Overview of Pakistans Corporate Sector 2001
Private
Limited
(Closely held)
Public
Limited
(Widely held)
All
Companies
Paid-up
Capital
Pakistan
Number
Percent
2173
75%
India
Number
487,111
Percent
86%
723
25%
76,029
14%
2896
100%
563,140
100%
Share
42%
Indian
Rupees
(Billion)
1,013
Share
33%
Pak Rupees
(Billion)
190
Private
Limited
(Closely held)
Public
261
58%
2,063
67%
Limited
(Widely held)
All
451
100%
3,076
100%
Companies
Source: SECP For Pakistan. Goswami (this volume) for India.
Note: (1) The Pakistani data does not control for non-operational publicly listed corporations. In effect,
the share of the listed sector will be smaller in Pakistan once we decontaminate the listed companies
register. (2) The Pak rupee is 58 to a U.S dollar, while the Indian rupee is 48 to a U.S dollar.
2.2 The Listed Companies Sector in Pakistan
The ownership composition of Pakistans top 40 publicly listed companies84 gives important insights into
the salient characteristics of widely held corporates in the country. Table 2.3 highlights the importance of
government and semi-government ownership in Pakistans top listed corporations. Equally importantly,
it emphasizes the significance of local private companies both in terms of numbers and as a percentage of
the top 40 companies market capitalization. Interestingly, the share of MNCs as a percentage of the
market capitalization of the top 40 companies is, contrary to popular opinion, not that high.
84
We use the top 40 companies as a benchmark because they account for over 80% of market capitalization.
172
Table 2.3. Ownership Composition of Pakistans Top 40 Listed Companies

Percent of top 40 Companies
Percent of top 40 Market

Capitalization
All
Non-Financial
Ownership
All
Non-Financial
Type
Local Private
52.5
59.0
30.2
29.8
Government
12.5
12.0
36.5
36.8
Semi22.5
14.0
16.3
15.6
Government
MNCs
12.5
15.0
17.0
18.0
Source: Authors calculation based on information gathered from the Karachi Stock Exchange website.
Note: All companies that are not controlled by either MNCs or by government are classified as Local
private companies.
An analysis of investor composition in listed companies reveals interesting variations across ownership
type (Tables 2.4 (a) and (b)). The major investors in MNCs are management followed by financial
institutions; together they own 76% of an average MNCs equity capital. Banks and financial institutions
also emerge as important investors in government corporations; where they own 40% equity in an average
government listed company, which is second only to the direct ownership of government. While direct
individual ownership is not insignificant in government corporations and MNCs, it does not appear to
dominate equity ownership in these corporations. This data suggests that multinational and government
listed companies may not be extremely widely held and appear to be dominated by concentrated
ownership in the hands of management and government, respectively.
Table 2.4. (a) Investor Composition in Listed Government Companies and MNCs
(percentage shares owned by an investor type)
Investor Type
Government
40.1
Banks/Financial Institutions
1.3
Corporations
0.01
Employees
1.6
Foreigners
0.2
Affiliated Companies
44.4
Government
11.5
Individuals
0.5
Management
0.2
Modaraba85 and Leasing
Companies
0.1
Others
Source: Authors calculation with data obtained from the SECP.
Note: Details of the sample are given in Appendix 1.
MNCs
16.9
2.5
0.04
2.8
1.1
4.1
12.3
58.8
0.6
1.1
The dominance of the family is apparent in listed local private companies (Table 2.4 (b)). The family as a
unit controls approximately half of the equity of an average listed Textile Company either through direct
ownership or by virtue of ownership through associated companies. Family dominance is also evident in
85
Modaraba is trust financing: one party provides 100 percent of the capital, the other provides management. Profits
are distributed in a pre-agreed ratio. Losses are borne only by the provider of capital.
173
sectors other than textiles, Pakistans largest manufacturing sector86, where the family directly and
indirectly controls approximately one-third of the equity of an average company.
Table 2.4 (b) Investor Composition in Listed Local Private Companies
(percentage shares owned by an investor type)
Investor Type
Textile
Non-Textile
29.3
9.1
Direct Holding by Family
Members
8.4
11.1
NIT/ICP
5.1
8.2
Financial Institutions
1.9
14.3
Foreign Investors
23.2
16.9
Joint Stock Companies
17.4
21.4
Associated Companies of the
controlling family
Source: Authors calculation from 2002 Annual Reports of the sample companies.
Note: Details of the sample are given in Appendix 1. The textile sample is separately reported as textile
companies dominate the listed companys sector in terms of numbers. The non-textile sample reflects
randomly drawn family companies from other sectors.
The significant presence of family-based local private companies in Pakistans listed sector (Table 2.3), in
terms of both numbers and market capitalization, clearly reveals the potential of these entities as future
providers of growth in the publicly listed corporate sector. Given the significance of family-based
corporates it is instructive to question whether their current ownership and control structure is compatible
with capital market development and with the attainment of corporate efficiency. An adequate answer to
this question can only be provided after analyzing the family-based corporate model in Pakistan.
2.3. Features of Pakistans Family Based Corporate Sector
One of the benefits of CG reforms in Pakistan is information disclosure, regarding family ownership of
stocks in publicly listed companies, that has recently been mandated by the SECP. This data allows
analysts to document Pakistans family-controlled corporate model. The findings of this section are based
on an analysis of this data.
The most fundamental characteristic revealed by our sample data is that the control of the owning family
over the company is absolute and all-important decisions are taken by members of the family. Table 2.5
reveals the extent of family control that persists in Pakistans privately owned domestic publicly limited
companies. We define family control as the percentage of an average companys shares under the control
of a family at different thresholds of control. A family can control shares in a target company either by
owning shares directly or indirectly through associated companies, which are under their control.
Interestingly, Table 2.5 shows that the concentration of family control in Pakistan, at any given threshold
level, is much higher than in many East Asian economies, which are known for excessive family control.
Table 2.5. Family Control in Asian Corporates
(Percentage of the sample companies)
Percent of
Family
86
Pakistan
(Textiles)
Pakistan
(Non-
Indonesi
a
Korea
Malaysia
Taiwan
Thailand
The textile sector accounts for approximately one-third of large-scale manufacturing production.
174
Control
Textiles)
87
10% cut
92.9 %
88.9%
67.1%
67.9%
57.7%
65.6%
50.8%
off
30% cut
85.888%
55.5%
58.7%
20.1%
45.6%
18.4%
54.8%
off
%
> 40%
50.089%
38.9%
35.4%
3.5%
14.7%
5.0%
38.9%
Source: Claessens, Djankov and Lang (1999) for East Asia. Authors calculation for Pakistan.
Note: The sample size of the Pakistani data is 32 domestically owned listed companies. The sample does
not include MNCs or government corporations. Proxy holding bias has not been removed for either East
Asia or Pakistan. Similarly, family control data for all countries includes control through associated
companies.
In addition, table 2.6 shows that in Pakistan ownership is not as concentrated as is the case in most East
Asian economies.
Table 2.6. Ownership Concentration in Asian Corporates
Country
Concentration Ratio (%) of Top Five

Shareholders
Pakistan
37.090%
Indonesia
67.5%
Korea
38.5%
Malaysia
58.8%
Philippines
60.2%
Thailand
56.6%
Source: Zhuang et. al. (1999) for East Asia. Authors calculation for Pakistan.
Note: The sample size of the Pakistani data is 32 domestically owned listed companies. Proxy holding
bias has not been removed for either East Asia or Pakistan.
Table 2.6 read together with table 2.5 shows that while concentration of control is much higher in
Pakistan than in East Asia, ownership concentration is not as high. This could partly be a consequence of
the quality of data, which does not control for ownership by individuals who act as proxies for the family.
However, the finding that ownership is not as concentrated as control is in line with findings for other
South Asian economies such as India (Bagchi 1999, Bertrand et. al. 2000). It is also consistent with
findings from earlier periods of Indian and Pakistani corporate history (Amjad 1982, Lokanathan 1935,
Hazari 1966). This data once put together suggests that there is evidence supporting the notion that a
separation of ownership from control may exist in Pakistans publicly listed corporations.
2.4. Separation of Ownership from Control and Private Benefit Seeking in Pakistan
Why should the separation of ownership from control be a matter of concern? This is an extremely
important issue that requires some analytical clarification. At a conceptual level a separation of
ownership from control in a publicly limited company implies that the controller (a family-based owner
87
The figure implies that in 92.9% of our sample companies the family controls equal to or more than 10% of the
total share capital.
88
The figure implies that in 85.8% of our sample companies the family controls equal to or more than 30% of the
total share capital.
89
The figure implies that in 50% of our sample companies the family controls more than 40% of the total share
capital
90
Implies that the top five shareholders of an average company in Pakistan own 37% of the share capital.
175
manager in the Pakistani case) retains effective decision-making control over capital that has been
invested by external investors (banks and minority shareholders). This allows the controller considerable
discretion over the use and allocation of the external investors capital. In developing countries this
discretion is strengthened by weak disclosures and a poorly regulated auditing infrastructure that
continues to plague these economies91. Among other things, this discretion allows the family controller to
seek private benefits, which are attained by tunneling external investors capital to associated companies
(for Indian evidence see Bertrand et.al. 2000) and by allocating profits to expenditures that benefit the
controller. The types of expenditures that typically represent private benefits in developing countries
include; political lobbying investment, expenditures on posh cars and offices; travel; and provision of
expensive personal housing, lavish expense accounts, etc. The insets provide some recent evidence
collated by the SECP regarding private rent seeking by Pakistani corporate controllers.
Box 1. Case Study Leasing Sector
An inspection of Company A revealed that investments in Musharika92 Finance were disbursed to eight
fictitious parties to transfer the funds to an associated company. Furthermore, lease financing to related,
associated and favored parties, that had become non-performing, constituted about 60% of the total
portfolio.
In addition to this, the directors and management of the company not only increased salaries and benefits,
but also created final settlements for themselves on account of excessive claim of gratuity, leave
encashment and commissions before handing over possession to a new management.
As a consequence of these activities, the equity of the company was reduced to approximately Rs. 21
million as compared to a paid up capital of some Rs. 110 million.
Several reasons can be pointed out that led to this outcome. First, there was a lack of professional
management and of internal checks and balances in the company. Secondly, about 150 fake National
Identity Cards were recovered that had been used for showing fake morahaba financing to these
individuals or as shareholders in the company. Third, the ownership and management had been
concentrated in a single person, who had been the main sponsor and this individual had appointed
company drivers and other staff as Directors of an associated company!
Source: SECP Audit Reports.
Box 2. Case Study Leasing Sector
Inspection of a Company D revealed that about 168% of the equity of the company had been invested into
its associated companies and concerns even though the financial condition of the latter was questionable
and deteriorating. Furthermore, the company maintained deposits of Rs. 43 million with an associated
undertaking. Despite the fact that the mark-up on this investment had been suspended, the company went
on to place an additional Rs. 20 million with the same undertaking.
As a result, the Companys viability as a going concern is doubtful and the break up value per share
stands at a negative Rs. 2.15.
The main reason behind this has been the lack of foresight and prudence in the decisions taken by the
director. Additionally, the main concern had been to finance and support the associated companies with
91
A detailed discussion regarding the Pakistani context is given in section 5.

Musharika is profit and loss sharing agreement. Both parties provide capital, both provide management, and then
share profits in a pre-arranged ratio.
92
176
no regard for their continuously deteriorating financial position. Finally, the Chief Accounting Officer of
the company did not possess the requisite qualifications to hold the office.
Box 3. Case Study Modaraba Sector
In a Special Audit of Company X, it was found that an amount of Rs. 76.9 million had been
misappropriated by granting finance facilities to a number of fictitious parties. In defiance of Prudential
Regulations, the Company failed to make provisions of Rs. 91.6 million against morahaba/musharika
financing. Finally, again in violation of the law, the company invested Rs. 49 million in unquoted shares
of group companies.
As a consequence, the financial statements issued by the management presented misleading information
to certificate and other stakeholders. Furthermore, the funds of the modaraba were eroded to the tune of
Rs. 100 million.
The factors leading up to this outcome included the fact that the company was primarily concerned with
providing benefits to the associated firms at the expense of the certificate holders. These facilities had
been renewed/rescheduled by the directors without recovery of any mark-up and principal amount.
Additionally, the ownership and management of the modaraba was concentrated in a single person,
namely the Chairman/sponsor director. The directors had never applied collective wisdom and
discharged their statutory and fiduciary duties while approving the transactions.
Finally, no internal checks existed to safeguard the assets of the modaraba.
Understandably, the concern for external investors is that excessive private benefit seeking by controllers
often comes at the expense of their profits and dividends. This concept is simple to understand. Consider
a company that has declared a profit of $100, in which the controller owns only 10% of total ownership.
Therefore, for every dollar of profit that is reallocated, by the controller, to private benefits (say towards a
wholly owned private limited company) he loses only 10 cents (given his 10% ownership) of profits.
That is, the cost of a dollar of private benefit is very low for controllers being only 10 cents in this
particular example. However, the cost of a dollar of private benefits is a dollar of profits for the company.
Therefore, external investors who do not gain from these private benefits would much rather take this
money in the form of declared profits or dividends. However, the problem is that they do not have
effective control to veto the reallocation of capital towards private benefits.
In countries like Pakistan external investors lack effective means to control private benefit seeking by
family controllers for two reasons. First, as pointed out in the last section, external investors in general do
not share in the control of local corporations in Pakistan. Second, external investor control is further
diluted as the family retains majority votes and as a result has complete dominance over the Board of
Directors93. Therefore, concentrated control in the hands of the family increases the controllers
discretion to create private benefits.
Furthermore, private benefit seeking sets incentives for family controllers to establish corporate structures
that ensure and reinforce majority control. There are indications that many corporates in Pakistan use
cross-shareholdings and interlocking directorships to fulfill the objective of retaining majority control.
93
This is discussed at length for the Pakistani case in section 4.
177
Similarly, data suggests that Pakistani corporates may be using pyramid structures to retain majority
control. Berle and Means (1932) define pyramid structures as owning a majority of the stock of one
corporation which in turn holds a majority stock of another - a process that can be repeated a number of
times. The control of an operating company routed through the ownership and control of a holding (or
trading) company has the advantage of ensuring majority control without commensurate concentration of
ownership. For example, if a family owns 51% of the stock of publicly listed company A, which in turn
owns 51% of company B, the family retains majority control in company B (51% of votes). However, in
this example majority control is retained despite the fact that the family does not own a commensurate
amount of shares (only 26%) in company B Cross-shareholdings, pyramid structures and interlocking
directorships are advantageous for family controllers as they allow them to make cash transfers across
family companies. Cash transfers are made through various means: companies give each other high (or
low) interest loans, manipulate transfer prices, sell assets to each other at above or below market prices
etc. The SECP Annual Report 2002 lists a range of rich stories regarding the nature of these transfer
payments in Pakistan (see Appendix 2).
How prevalent are these structures in a country like Pakistan? Amjad (1982) has documented the
extensive use of interlocking directorships in Pakistans corporate structure during the sixties (see
Appendix 3 figure A.3.1). Cheema (1999) confirms the persistence of this structure among monopoly
group companies in the textile sector during the eighties.
Table 2.7 shows that the use of pyramids is pervasive in our sample companies and the incidence of
pyramiding is much higher in Pakistan than in most East Asian economies. Case study evidence also
suggests the existence of pyramiding and cross-shareholdings in Pakistani corporate groups (see
Appendix 3 figures A.3.2 and A.3.394). The figures show a significant use of inter-corporate holdings by
corporate groups in Pakistan.
Table 2.7. Incidence of Pyramiding in Asia
(Percentage of the sample)
Incidence of pyramiding
Incidence of pyramiding
with greater than 10%
ownership
Pakistan (textiles)
66.7%
47.6%
Pakistan (non-textiles)
78.3%
56.5%
Indonesia
66.9%
n.a.
Korea
42.6%
n.a.
Malaysia
39.3%
n.a.
Philippines
40.2%
n.a.
Thailand
12.7%
n.a.
Source: Claessens, Djankov and Lang (1999) for East Asia. Authors calculation for Pakistan.
Note: Pyramiding is equal to one if the controlling owner exercises control through at least one publicly
limited company. Sample size is 32 companies.
This discussion suggests that concentrated control in Pakistan, which is buttressed by interlocking
directorships, cross-shareholdings and pyramid structures, may strengthen incentives for excessive private
benefit seeking in Pakistan.
94
In both figures we show that apart from direct family holdings, families also control companies through crossholding using associated private and public companies.
178
2.5. Potential consequences of Private Benefit Seeking in Pakistan

Concentrated control that is a defining feature of Pakistani CG has a number of consequences for the
development of the corporate sector and capital markets in Pakistan.
As pointed out above, a first consequence of concentrated control is the opaqueness in the use of public
money, which may lead to excessive private benefit seeking. This is the conclusion suggested by SECP
audits discussed in the last section. Although, it is important to point out that further work is needed to
rigourously estimate the magnitude of these transfers, whose size cannot be established on the basis of our
small sample. Furthermore, it needs to be pointed out that family reputation with external investors
operates as an effective constraint on private benefit seeking. In fact, South Asian economies, including
Pakistan, have seen the emergence of a number of family controlled corporations that have created
transparent CG structures in order to protect their reputation with external international investors. In this
regard, it is interesting to point out that in India it was the Confederation of Indian Industries (CII) that
took the lead in drawing up Indias draft CG code. Nonetheless, such corporates remain small in numbers
and as yet have not come to dominate the corporate sector in the region. While, it is true that excessive
and opaque control by families over companies will dampen capital market reforms, nonetheless, it
should be appreciated that private benefits, which result from concentrated control, set strong incentives
for these families to maximize the generation of operating surpluses.
The second consequence is that family controllers seldom trade their companies shares. This increases
the cost of takeovers and protects family controllers from the potential loss of control, thereby, diluting
the effectiveness of an important mechanism to penalize inefficiency. This expectation is confirmed for
Pakistan. Table 2.8 shows that the incidence of share trading is extremely low in family controlled
corporates in Pakistan. The protection of family control is an important reason why share turnover is
extremely low in most family-based listed companies. The result is illiquid stock markets in Pakistan (see
section 3), which reduce the value of the exit option for minority shareholders and end up raising their
risks.
Table 2.8 Annual Share Turnover in a Sample of Pakistans Listed Companies, 2000
Turnover in an Average Company
(as a percentage of total annual
Ownership Type
turnover of the entire sample)
S.D
Family-based
0.91%
0.9
Government
4.6%
8.6
MNCs
9.3%
16.1
Source: Authors calculation based on data provided by Dr. A. Mian. Details of the data and sample are
given in Appendix 1.
The third consequence is that family based controllers are reluctant to declare dividends and would prefer
to reallocate profits to obtain private benefits. Tables 2.9 confirms this expectation, it shows that more
than 50% of Pakistani corporates do not declare dividends. Although there is an increased trend in favour
of declaring dividends, nonetheless, the number of companies not declaring dividends remains quite high.
Table 2.9. Dividend Declaration Performance in Pakistans Listed Companies
1999
% of Companies not declaring dividends in each

Sector
67.5%
179
2000
2001
2002
Source: SECP (2002).
59.1%
52.5%
59.7%
The fourth consequence is that family based controllers tend to oppose reforms that dilute their control
over listed companies and that increase disclosure requirements95. In our view, these reforms are opposed
in part because they are expected to curtail low cost access to private benefits. The incentive to retain
control also explains why local companies are reluctant to use capital markets to raise funds. The
objective of retaining control by families is an important reason behind shallow capital markets in
Pakistan (see section 3).
These reasons give good cause to doubt the expectation that local corporates will be enthusiastic partners
in Pakistans CG reform effort. In fact, it comes as no surprise that most corporates are lukewarm about
CG reform in Pakistan and continue to informally threaten the SECP with de-listing96. This tendency
persists despite the fact that without CG reform both the corporate sector and the country may end up
paying a heavy price in the form of underdeveloped capital markets and the reluctance of external equity
investors to finance corporate growth in Pakistan. However, it is the rationale of retaining majority
control that continues to motivate the politics of a large number of Pakistani corporations, although there
are notable exceptions to this general tendency. The objective of maximizing majority control, in turn,
results in inadequate demand for capital market reform.
3. Capital Markets
While, there appears to be a demand side constraint for capital market reform there is also a concern that
Pakistans capital markets are not adequately structured to supply the large-scale mobilization of external
investor capital. In this section, we describe some supply side constraints on capital market development
that stem from inefficiencies in Pakistans existing structure of market trading. However, we start by
giving an overview of Pakistans stock markets and their regulator the SECP.
3.1 An Overview of the Stock Market and the SECP
The Karachi Stock Exchange (KSE), established soon after independence in 1947, continues to be the
main stock market in Pakistan. In 2001, KSE captured 74% of the overall trading volume in Pakistan.
The Lahore Stock Exchange (LSE) was commissioned during the 1970s and is the second largest stock
exchange. The Islamabad Stock Exchange, commissioned in 1992, is the third stock exchange in
Pakistan, capturing 4% of the trading volume. In 2002, SECP gave a license for the first electronic stock
exchange; however, it has not started operations as yet.
The Securities and Exchange Commission of Pakistan (SECP) was established under the Securities and
Exchange Commission of Pakistan Act, which was passed and promulgated by the Parliament in 1997.
Unlike its predecessor the Corporate Law Authority (CLA), which was an attached department of the
Ministry of Finance, the SECP is an autonomous body. SECP started operations from January 1999, and
CLA stood dissolved from that date.
The 1997 Act gives the SECP the responsibility for: 1) regulating the issue of securities; 2) regulating the
business of stock exchanges and other security markets; 3) supervising depository and clearing houses; 4)
95
This tendency clearly came out in interviews with owners of family based corporates.
Another reason for delisting is the initial reduction and the eventual elimination in the tax differential between
public and private limited companies, which GoP is committed to bring about by 2007.
96
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registering stock brokers and sub-brokers; 5) regulating investment schemes and funds; 6) preventing
fraud in securities markets; 7) regulating share acquisition and mergers/takeovers of companies; and 8)
regulating the issues of securities. The Act thus makes SECP the apex body for regulating the corporate
and equity markets. The State Bank of Pakistan (SBP) and SECP jointly announced that, from July 1,
2002, SECP would perform supervisory functions for most Non-Bank Financial Institutions (NBFIs),
including investment banks, discount houses and housing finance companies. So, other than commercial
banks and DFIs, all companies come under the supervision of the SECP.
SECP is organized into six divisions:
Securities market division
Specialized companies division (including NBFIs but not insurance)
Company law administration division
Enforcement Division
Insurance division
Support services division
Each division has an executive director at the apex, who in turn reports to the Commissioners, although
usually a particular Commissioner is asked to take care of a division. There are currently five
Commissioners at the SECP, including the chairperson. The chairperson amongst the Commissioners is
the chief executive of the SECP. The tenure of the Commissioners is for a period of three years,
extendable by another three. No Commissioner can serve uninterrupted at the Commission for more than
six years at a stretch. The Commissioners are appointments made by the Ministry of Finance, but they are
usually experts from the field of capital markets.
3.2. Market Performance
Table 3.1 allows us to track some of the performance measures for the Karachi Stock Exchange (KSE),
the biggest stock market in Pakistan. Although the Karachi Stock Exchange has grown over the 1990s
(Table 3.1) additional data shows that the number of listed companies still form only about 2% of
registered companies, there were only 6 new equity issues in 2001-2002, and for the financial year 2000
only four companies97 accounted for 80 to 85% of the total trading volume in KSE. Khwaja and Mian
(2003) highlight the small size of the KSE (in terms of market-capitalization/GDP) in comparison to other
stock markets around the world. The shallowness of the market notwithstanding, KSE does have high
turnover (dollar-volume/market-capitalization) when compared to other developing country markets
across the world. The high turnover is coupled with high price volatility of KSE. Over the 1997-2002
period, Khwaja and Mian (2003) show that the highest price of the KSE-100 price index98 was about three
times the lowest prices. This is also the period when Pakistan has been going through a low GDP growth
phase, and not many new issues have been offered on the market. There has not been any growth in
listing of companies since 1995, although for the last year or so the market capitalization has increased
significantly, and in June 2003 the KSE-100 index stood at 3,200. Finally it is not only the case that the
distribution of firms is highly skewed in terms of turnover (top 25 firms account for more than 85% of the
overall turnover), it is highly skewed in terms of size-distribution as well and the top 25 firms account for
75% of the overall market capitalization (see Appendix 3 figure A.3.4).
Table 3.1. Performance of Karachi Stock Exchange
(Amount in billion Rupees)
97
98
Pakistan Telecommunication Corporation Limited, Hubco, Pakistan State Oil and ICI.
A weighted price index of the top 100 firms listed on the stock market.
181
End period
FY91
497
No. of listed companies
31.1
Listed capital
90.0
Market capitalization
1,855
KSE-100 index
361
Yearly trade volume (million)
Source: State Bank of Pakistan. Various Publications.
FY95
746
118.8
293.3
1,612
2,293
FY00
762
229.0
391.9
1,521
48,109
Dec. 2002
711
588.4
2,701
-
The equity market in Pakistan, after 50 years of development, is still very small, shallow, and highly
skewed, in terms of both capitalization and turnover, in favor of the larger players. Khwaja and Mian
(2003) also show that the market is not transparent either. In fact, they show that some insiders (brokers)
make substantially higher returns compared to others. This is partly due to the shallow and volatile
nature of the market and partly due to the poor information revelation mechanism available to the
participants. More importantly, the perception and reality of manipulation a) discourages outside
investors from investing in the market, and b) implies large participation costs for rational and
sophisticated agents trying to raise or invest capital in equity markets99.
Reforms are consequently required in the equity markets, and the introduction of CG reform, introduced
by the SECP for corporations as well as stock exchanges in Pakistan, is an important part of the overall
capital market reform programme. But implementation of these reforms, even where the right reforms
can be identified easily, is not going to be straightforward. One implication of the analysis of Khwaja and
Mian (2003) is that since brokers and insiders in general stand to gain from the current structure, they are
going to resist change and are not going to be willing partners in creating the impetus and pressure for
change. The political economy story tells us that if rents earned by a small number of individuals are
large enough then even these small number of people can prevent reforms that may be beneficial to the
economy at large100. SECP will thus have to design ways of eliciting cooperation from these groups in
addition to coming up with rules and regulations that improve governance. The development of capital
markets in Pakistan might significantly depend on the ability of the SECP to motivate the changes in the
governance structure by buying in the more powerful and organized stakeholders in a skillful manner.
4. SECPs Recent CG Reform Effort
The SECP has come up with an ambitious set of recommendations to regulate the existing structure of the
corporate sector in Pakistan. A Code for Corporate Governance was introduced by the SECP in early
2002 for the stated purpose of establishing a framework of good Corporate Governance, whereby a listed
company can be managed in compliance with international best practices. The Code has been prepared
after a review of the leading international reports prescribing best practices for Corporate Governance101.
It is the result of joint efforts of the commission and Institute of Chartered Accountants Pakistan (ICAP).
The Code has been adopted by all the stock exchanges of the country by way of its incorporation in their
respective listing regulations. As a result all listed companies in Pakistan are now required to comply
with the provisions of the Code. The introduction of the code has been followed by amendments to the
Companies Ordinance 1984, which are aimed to strengthen corporate governance in Pakistan.
The major thrust of the code is to restructure the board of directors in order to make it accountable to all
shareholders; to strengthen internal control systems of corporations; to foster better disclosure and to
99
Khwaja and Mian (2003), pg. 29.

The diffused benefits to the society-at-large prevent effective organization of the larger group to counter the
pressure from the smaller but more organized group.
101
It appears to be particularly influenced by the Cadbury Report and the Combined Code, which seem to have had a
strong influence on its eventual shape and its exhaustive scope.
100
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strengthen internal and external audit requirements of listed companies (SECP 2002). In addition, the
Companies Ordinance 1984 has been amended to strengthen minority shareholder rights. However, at
present the requirements suggested by the Code have not been extended to non-listed companies nor have
they been enacted as part of the Companies Ordinance. This section describes the salient features of the
Code and the company law provisions that impinge on corporate governance in Pakistan. We concentrate
on the proposed reform of the board of directors and minority shareholder protection, reforms related to
disclosure and audit are described in section 5. In order to maintain analytical tightness we have chosen
to highlight the key features of the law rather than conduct an exhaustive review, which is detailed in
Appendix 5. The section also assesses the effectiveness of Pakistans current legal provisions as a means
to create an environment of improved corporate governance and external investor protection. An analysis
of these provisions is important because, as pointed out in section 2, concentrated control in Pakistans
corporations appears to be antithetical to external investor protection.
4.1 Strengthening the Board of Directors (BOD)
SECP (2002) points out that the Code primarily aims to establish a system whereby a company is
directed and controlled by its directors in compliance with best practices so as to safeguard the interests
of a diverse range of stakeholders(pg. 114, emphasis added). The two underlying objectives of the
reform of the BOD are to:
(a) Introduce representation by minority shareholders.
(b) To set incentives for directors to discharge their fiduciary responsibilities in the larger interest of all
shareholders and not just in the sectional interest of controlling shareholders.
(c) To make the BOD a more structured and efficient forum of shareholder monitoring.
The following sub-sections describe the proposed reforms that have been laid down to meet these stated
objectives.
4.1.1 The Role of Non-Executive Directors (NEDs)
The Code attaches special importance to the role of NEDs. It visualizes the NEDs as performing two
significant functions, namely:
(1) A careful independent review of the performance of the Board and of the Chief Executive; and
(2) Taking the lead where potential conflicts of interest arise. In effect the Code is using NEDs to provide
a check in situations when the specific interests of the executive management and the wider interests of
minority shareholders diverge e.g. over takeovers, boardroom succession, or directors pay.
Clause (i-a) of the Code takes some progressive and highly significant steps in this direction by
encouraging listed companies to ensure effective representation of independent102 NEDs, including those
representing minority interests, on their Boards of Directors. The Code visualizes and lays out certain
102
An independent director in this context is defined to mean a director who is not connected with the listed
company or its promoters or directors on the basis of family relationship and who does not have any other
relationship, whether pecuniary or otherwise, with the listed company, its associated companies, directors,
executives or related parties. Such an independent director is to be selected by such investors through a resolution of
its Board of Directors and the policy for election on the Board of Directors of the investee company is to be
disclosed in the Directors Report of the investor company.
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helpful procedural steps to ensure that minority shareholders as a class are facilitated to contest election of
directors by proxy solicitation.
Additionally, Clause (i-b) of the Code recommends that the Boards of Directors of listed companies
include at least one NED representing institutional equity interest of a banking company, Development
Financial Institution, Non-Banking Financial Institutions (including a modaraba, leasing company or
investment bank), mutual funds and insurance companies. It is further recommended by Clause (i-c), that
for listed companies, the executive directors (working or whole-time directors) as a group should not
constitute more than 75% of the elected directors (including the Chief Executive).
Therefore, the Code takes a number of important steps that bring CG regulations in Pakistan in line with
international best practice. It is also important to point out that the introduction of the concept of NEDs in
Pakistans CG regulations is an important additionality brought about by the code, as the Companies
Ordinance (1984) visualizes no such provision. However, at this juncture the Code does not require
companies to appoint NEDs, it merely recommends this as a practice.
4.1.2 The Role of the Chairman and the CEO
The Code makes a bold attempt at giving some definite shape and direction to the role of the Chairman of
the BODs in Pakistans Corporate Governance environment. Clause (ix) lays down that the Chairman of
a listed company is to be preferably elected from among the NEDs. It also requires that the Board of
Directors is to clearly define the respective roles and responsibilities of the Chairman and CEO, whether
or not these offices are held by separate individuals or the same individual.
Likewise, Clause ix requires the Board of Directors to clearly define the role and responsibilities of the
Chief Executive. It further requires (Clause viii-e) that the appointment, remuneration and other terms
and conditions of employment of the CEO and other executive directors should be determined and
approved by the Board of Directors. This provision is expected to increase the accountability of
management to the BODs.
Again, it appears that the Code represents additionality to the current law, which does not lay down a
well-defined and distinct role for both the Chairman of the BODs and the Office of the CEO. This
essentially means that two important Corporate Offices had not received any detailed attention in the
Companies Ordinance. In fact, Section 160 (3) of the Companies Ordinance 1984 proposes an extremely
vague definition of the Chairmans role:
The Chairman of the Board of Directors, if any, shall preside as Chairman at every
general meeting of the company, but if there is no such Chairman, or if at any meeting he
is not present within fifteen minutes after the time appointed for holding the meeting, or
is unwilling to act as Chairman, any one of the directors present may be elected to be
Chairman, and if none of the directors are present or are unwilling to act as Chairman, the
members present shall choose one of their numbers to be Chairman.
However, at present the provisions detailed above are recommended and are neither part of the statute nor
are they mandatory requirements for listed companies. Furthermore, at present neither the Code nor the
Companies Ordinance specifically precludes the possibility of the same person holding the office of the
Chairman and the CEO.
4.1.3 Strengthening Decision Making at the Level of the BODs
The Code aims to strengthen decision making at the level of the BOD by stipulating the frequency of its
meetings; by defining the tenure of office of the directors; and by proposing a list of significant issues that
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should be put before the BODs for consideration and decision. Again, in most of these areas the Code
provides additionality to the Companies Ordinance.
Clause (xi) of the Code says that the Board of Directors of a listed company is to meet at least once in
every quarter of the financial year. This provision has been made part of the Companies Ordinance
through an amendment to Section 193. This provision takes a significant step forward in strictly
mandating an active role for the BOD as a decision making body.
Clause (VI) affirms the existing tenure limit in the Companies Ordinance (Section 180) by stating that the
tenure of office of directors is to be three years. This provides a good balance in allowing directors to
develop a strategic long-term vision, while not getting too entrenched in a companys governance
structure.
Further, the Code (Clause xiii) proposes a list of significant issues which should be put before the Board
of Directors for information, consideration and decision, in order to strengthen and formalize the
corporate decision making process (see Appendix 4). Again, the code represents additionality, as
previously there was no requirement for the BOD to specifically perform these functions.
4.1.4 Increasing Accountability at the Level of the BODs
4.1.4.1 Statement of Ethics and Business Practices
In order to strengthen accountability at the level of directors the Code (Clause viii-a) requires that every
listed company prepare and circulate a Statement of Ethics and Business Practices on an annual basis.
The objective of publishing this statement is to establish a standard of conduct for directors and
employees by requiring each of them to sign the statement and acknowledge his (her) acceptance and
understanding of the standard of conduct. Again the Code has taken a step that is not provided in the
existing provisions of the Companies Ordinance 1984.
4.1.4.2 Disclosure by Directors and Management
The Code has come up with some important disclosure requirements and limitations on the actions of
directors and management that will help increase their accountability to external investors:
(a) For listed companies, the Code (Clause xxvi) has come up with the further requirement that any
director, chief executive, executive or their spouses selling, buying or taking any position, whether
directly or indirectly, in the shares of a listed company of which s/he is director, chief executive or
executive, as the case may be, is to immediately notify the Company Secretary of such intentions and
deliver a written record of the price, number of shares, form of share certificates and nature of the
transaction. Such notice has to be presented by the Company Secretary at the meeting of the board of
directors immediately subsequent to such transaction.
(b) Clause xxvi requires that each company determine a closed period prior to the announcement of
interim/final results and any business decision, which may materially affect the market price of its shares.
It also requires that no director, chief executive or executive shall, directly or indirectly, deal in the shares
of that company in any manner during the closed period.
The Companies Ordinance 1984 contains some important restrictions that form part of the governing
ethical regime of companies and are meant to promote the above-mentioned initiatives by the Code.
185
(a) Section 195 of the Ordinance provides an extensive ban on the direct or indirect extension by a
company of any loans to, or the provision of any guarantee or security in connection with a loan made by
any other person to, or to any other person by, a director of the company or his relatives.
(b) Section 197 of the Ordinance prohibits a company from contributing any amount to any political party
or for any political purpose to any individual or body, or else face penalties.
(c) Section 197-A of the Ordinance prohibits the distribution of gifts by a company in any form to its
members at its meetings, or face penalties.
(d) Section 191 of the Ordinance says that the remuneration of a director, for performing extra services,
including holding the office of the chairman, shall be determined by the directors or the company in
general meeting in accordance with the provisions in the companys articles. The remuneration to be paid
to any director for attending the meetings of the directors or a committee of directors shall not exceed the
scale approved by the company or the directors, as the case may be, in accordance with the provisions of
the articles.
The Companies Ordinance 1984, also stipulates disclosure requirements and limitations on the part of
directors, which help further the accountability of directors to shareholders. The following are the main
requirements found in the Companies Ordinance:
(a) Directors and Officers are mandated by Sections 214 and 215 of the Companies Ordinance 1984
respectively, to disclose the nature of their direct or indirect concerns or interests in any contract or
arrangement entered into or to be entered into by or on behalf of the company.
(b) Section 216 of the Companies Ordinance precludes discussion of or voting on any contract or
arrangement in which the said director is, directly or indirectly, concerned or interested.
(c) A violation of the above sections can (apart from a financial penalty) lead to a court, declaring a
director as lacking fiduciary behaviour, under Section 217 of the Ordinance.
(d) Section 218 of the Ordinance mandates disclosure to members of a directors interest in contracts;
appointing the chief executive, managing agent, whole-time director or secretary. Again, non-compliance
leads to a pecuniary fine.
(e) Section 224 of the Companies Ordinance prohibits trading of listed equity securities within six months
of appointment on part of any director, Chief Executive, managing agent, chief accountant, secretary or
auditor of a listed company or any person owning at least 10% beneficial interest in listed equity
securities, either directly or indirectly.
(f) Section 203 of the Ordinance mandates that the Chief Executive cannot engage, directly or indirectly,
in a business competing with the companys business. The Section further requires that the Chief
Executive disclose to the company in writing, the nature of such business and his interest therein.
4.1.4.3 Disclosure With Regard to Associated Companies
Section 2 pointed out the incidence of pyramiding and cross-shareholdings in Pakistans listed companies.
In this sub-section we analyze the state of the law with regard to inter-corporate transfers and disclosures
related to these transfers. An implication of our analysis in section 2 is that controlling shareholders need
to be made accountable to external investors with regard to these transfers.
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An amendment to Section 208 of the Companies Ordinance (1984) aims to raise the cost of tunneling for
private controllers and to make inter-corporate transfers more accountable to the shareholders. The
amended section reads as follows, A company shall not make any investment in any of its associated
companies or associated undertakings except under the authority of a special resolution... The section
has also stipulated strong penalties in the event of non-compliance with the law.
4.1.4.4 Summing Up
The analysis in section 4.1 shows that Pakistani corporate law provides a significant number of
limitations and disclosure requirements that should help make corporate controllers accountable to
external investors. This suggests that the problem of weak corporate accountability of controllers to
shareholders is not on account of inadequate legal rules. Instead, we will show in section 4.3 that the
problem lies in the enforceability of these rules.
4.2 Minority Shareholder Protection
In corporate structures, with concentrated promoter control the rights of minority shareholders play an
essential part in protecting the interest of external investors. The stronger these rights the higher the
probability that rogue controllers can be held accountable and penalized for excessive private benefit
seeking. Basic shareholder rights, usually specified in company laws, include the right to (i) participate
and vote in Annual General Meetings (AGMs) and special general meetings (SGMs), including electing
members of the board and participating in making key decisions, such as amendments to the articles of
association; (ii) low cost judicial recourse on behalf of the company; (iii) share in the residual profits of
the company; (iv) appoint directors; and (v) convey or transfer shares.
The strength of shareholder rights depends upon voting procedures as well as the structure of ownership
and control. The proxy-voting rule, allows shareholders not in attendance to exercise voting rights, which
increases shareholder participation. Similarly, cumulative voting103 strengthens the position of minority
shareholders under concentrated ownership structures. An important consideration regarding voting rules
is whether or not they tilt the balance of power away from family controllers and in favour of external and
minority shareholders. This section details the substantive provisions regarding minority shareholder
protection found in the Pakistani law.
4.2.1 Right to Attend and Call Annual General Meeting (AGMs) and Special General Meetings (SGMs)
Again, the rights described in this section appear to be in line with modern Anglo-Saxon company law.
4.2.1.1 Annual General Meetings
Section 158 of the Companies Ordinance mandates that every company is to hold, in addition to any other
meetings, a general meeting, as its annual general meeting, within 18 months of its incorporation and
thereafter once at least in every calendar year. The AGM has to be held within a period of six months
following the close of the companys financial year and not more than 15 months after the holding of its
last preceding annual general meeting. For listed companies, the SECP, and for other companies, the
Registrar may for any special reason extend the time within which any annual meeting is to be held.
103
Zhuang et. al. (2000, pg. 9) define cumulative voting as a procedure that allows shareholder to cumulate their
votes, e.g. for directors, by multiplying the number of votes the shareholder is entitled to cast by the number of
directors for whom they are entitled to vote and casting the product for a single candidate or by distributing the
product among two or more candidates.
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4.2.1.2. Extraordinary General Meetings

Section 159 of the Ordinance allows the directors to call an extraordinary general meeting to consider any
matter that requires the approval of the company in a general meeting. However, at least one-tenth of the
votes are required to call an extraordinary general meeting. The requisitionists, or a majority of them in
value, may themselves call a meeting, if the directors do not proceed to call the meeting within 21 days
from the date of requisition. Any default entails penalties.
4.2.1.3 Power of the Registrar to call Meetings
Section 170 of the Ordinance gives the Registrar the power to call, inter alia, any annual general meeting
or extraordinary general meeting, if there has been a default in the holding of any such meetings. The
meeting can be called either on the motion of the registrar or on the application of any director or member
of the company. Furthermore, there is a penalty for any default in complying with the Registrars
directions.
4.2.1.4 Minority Shareholders Right to Pass Special Resolutions
Section 164(2) of the Ordinance gives members with at least 10% voting power in the company the right
to give notice of a resolution, which they want considered at a general meeting. Similarly, Section 167(c)
and (d) of the Ordinance require the Chairman to order a poll upon the demand of, inter alia, any member
or members present in person or by proxy having at least one-tenth of the total voting power in respect of
the resolution.
However, Section 28 of the Ordinance requires a special resolution passed by three-fourths of the
members of a company for it to alter any of its articles of association. In the event that the alteration
affects the substantive rights or liabilities of a class of members then at least three-fourths of this class
need to vote in favour of the alteration, for it to take effect.
4.2.2 Voting Rules
4.2.2.1 One Share-One Vote
Section 160(4) of the Ordinance allows every member to have votes proportionate to the paid-up value of
the shares or other securities carrying voting rights held by him according to the entitlement of the class
of such shares or securities, as the case may be. Similarly, Section 160(5) of the Ordinance states that no
member carrying shares or other securities carrying voting rights shall be debarred from casting his vote,
nor shall anything contained in the articles have the effect of so debarring him. Therefore, Pakistani law
allows the possibility of offerings share with non-voting rights, which may weaken the power of minority
shareholders, especially as the capital market in Pakistan is fairly inefficient.
4.2.2.2 Proxy and Cumulative Voting
The Pakistani law allows for proxy voting thereby strengthening the rights of minority shareholders.
Section 160(7) of the Ordinance says that on a poll, votes may be given either personally or by proxy.
However, the Ordinance dilutes this right by denying members the right to cast proxy votes by mail.
The Ordinance also appears to allow a form of cumulative voting. Section 178(5)(b) says that a a
member may give all his votes to a single candidate or divide them between more than one of the
188
candidates in such manner as he may choose. Again, this provision goes some way in strengthening
minority shareholder rights.
4.2.3 Right to Claim Dividend
The Ordinance does not mandate any consequential compulsory payment of dividends. All that Section
248 mandates is that no dividend can exceed the amount recommended by the directors.
However, the Ordinance does place a time limitation within which dividend once announced has to be
paid. Section 251 of the Ordinance requires that when a dividend has been declared, it has to be paid
within forty-five days of the declaration. A default on this provision exposes the CEO for a prison term
of up to two years and fines up to a million rupees. The Pakistani law makes the BOD the relevant forum
for deciding on dividends.
4.2.4 Judicial Recourse Available to Minority Shareholders
Section 108 of the Ordinance provides that if ten percent or more of the class of shareholders have been
aggrieved by any such variation of their rights, they may, within thirty days of the date of the resolution
varying their rights, apply to the Court for an order cancelling the resolution. The Court is thus entrusted
with the task of ensuring that these shareholders are not the victims of any unfair prejudice.
4.2.5. Minority Shareholder Rights Related to Divesture and Transfer of Shares
The Code strengthens minority shareholder protection through Clause xxix. It states that in the event of a
divesture of not less than 75% of the total shareholding of a listed company, the directors are allowed
such a transfer only after it has been ascertained that an offer in writing has been made to the minority
shareholders for acquisition of their shares at the same price at which divesture of majority shares was
contemplated.
Section 289 of the Ordinance provides for minority shareholder protection in the event of transfer of
shares between companies. It binds the transferring company to acquire the shares of dissenting
shareholders on the same terms as the ones on which shares of the approving shareholders are being
acquired. It also states that for a transfer of shares between companies to take place requires the approval
of at least 9/10th of the holders of the companys shares in terms of value.
Finally, Section 86 of the Ordinance states that where directors decide to increase capital by issuance of
further shares, such shares are to be issued to each existing member strictly in proportion to his present
shareholding, irrespective of the class of shares held.
4.3 Analyzing Pakistans Legal Provisions Related to BODs and Minority Shareholders - The
Ground Realities
The last two sections have detailed the substantive regulatory and legal provisions that strengthen the
BOD structure and give effective protection to minority shareholders. The reader would have noticed that
many of these provisions are compatible with the standards provided by the Anglo-Saxon legal
framework. Therefore, while one can venture a prima facie conclusion that Pakistans corporate law
provisions appear fairly adequate as a means to govern corporations - nonetheless -it is important to ask
whether these provisions provide an effective means to protect external shareholders in a de facto sense.
This question gains added importance when it is recognized that many of the legal provisions in the
Companies Ordinance, and additions made by the Code, are influenced by Anglo-Saxon thinking,
189
whereas these provisions are being applied to a corporate structure that is extremely different from the
Anglo-Saxon one.
4.3.1 Analyzing the Effectiveness of Provisions of the Code Related to the BOD
We have pointed out that the Code has provided an emphasis on restructuring the BOD with an aim to
increase minority shareholder representation. The main vehicle chosen for this representation is the
induction of NEDs in the BOD. In addition, a number of limitations have been placed on directors
actions that are meant to make the BOD accountable to the shareholder. The Code has also redefined and
increased the decision-making role of the BOD by placing before it certain key decisions, which have
traditionally been the prerogative of management. Finally, the Code has indicated a preference for the
separation of the office of the Chairman from the CEO. These measures, while immensely important,
may not be sufficient to create an environment of external investor protection for the following reasons.
First, as mentioned earlier, Pakistans local private corporations tend to be family dominated. A feature
of these corporations is that there is collusion between BODs and management, not because the latter
dominates the former in terms of positions on the board, but because the family as a unit controls both the
BOD and management. Table 4.1 shows the extent to which the family dominates the BOD of an average
local private company in Pakistan. While interpreting these numbers it should be kept in mind that these
numbers are understatements as it was not possible to identify non-family proxy directors appointed by a
family on the BOD of companies controlled by them. Therefore, even with the best legal provisions it is
difficult to visualize the BOD not being a representative body of the majority owners in Pakistans local
private companies. It also means that the separation of the office of the Chairman from the CEO really
does not matter in Pakistans current corporate structure. This suggests that there are limitations to using
the BOD as a body that is accountable to all shareholders.
Table 4.1 Constitution of the BOD of Local Private Companies in Pakistan
Average No. of Directors on
Average No. of Family
Sectors
the BOD
Directors on the BOD
7.3
4.0
Textiles
7.0
3.0
Non-Textiles
Source: Authors calculation from 2002 Annual Reports of the sample companies.
Note: (1) Details of the sample are given in Appendix 1. (2) The textile sample is separately reported as
textile companies dominate the listed companys sector in terms of numbers. The non-textile sample
reflects randomly drawn family companies from other sectors. (3) This data does not control for the
presence of non-family BOD members who are de facto appointees of the family.
However, we would expect CG reforms to be more effective in MNCs and in companies that tend to be
widely held. Even though presently there appears to be a paucity of the latter corporate type, nonetheless,
the Code has taken an important first step in defining an environment that has the potential to make the
BOD structure more streamlined and accountable when and if there is a growth of widely-held companies
on the stock markets.
Second, there are limitations in using NEDs as a means of minority shareholder representation. A
preliminary analysis of data suggests a bi-modal distribution of shareholding, with family and
management controllers, in the case of local private companies and MNCs respectively, having majority
ownership, and the remaining shareholders having considerably diluted ownership. Hart (1995) has
already raised the issue of NEDs, with small shareholdings, and independent directors, with no
shareholdings, having sub-optimal incentives to put in monitoring effort. We have pointed out earlier that
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the Code does not have any recommendations regarding NEDs compensation. Until the issue of NED
incentives is sorted out there cannot be much expectation that these directors, who either have small or no
ownership, will put in the requisite effort on behalf of external investors. Alternatively, NEDs could be
drawn from high profile professionals whose incentive to perform may be a function of protecting their
reputation rather than being contingent on monetary incentives. However, again the issue of
remuneration for these directors needs to be worked out by corporates in order to make the system
effective.
It is also important at this juncture to be cognizant of some recent developments in Pakistani law, which
may have an adverse impact on the functioning of the NEDs, as visualized by the Code. The National
Accountability Bureau Ordinance (1999) (NAB Ordinance) is a recent law, which furnishes a new regime
of anti-corruption and accountability measures, including, inter alia, the issue of willful default.
According to the NAB Ordinance, a person is said to commit Willful default if he does not pay, or
continues not to pay, or return or repay the amount to any bank, financial institution, cooperative society,
or a Government department or a statutory body or an authority established or controlled by a
Government on the date that it became due as per agreement containing the obligation to pay. For
purposes of this Section and the rest of the NAB Ordinance, a Person includes in the case of a corporate
body, the sponsors, Chairman, Chief Executive, Managing director, elected directors, by whatever name
called, and the guarantors of the company or anyone exercising direction or control of the affairs of such
corporate body. This definition of Person seems to be wide enough to encompass the NEDs
proposed by the Code. This means that potential candidates for the position of NEDs may be highly
reluctant to act as directors as they may be risking large potential liabilities. Furthermore, as mentioned
above, there seems to be a legislative trend currently en vogue in Pakistan, which is generally extending
the ambit of accountability to company directors. If this trend continues, very few people may be willing
to act as NEDs, and this would then force a reconsideration of the role of the NEDs in the regulatory
mechanism being visualized by the Code.
4.3.2 Analyzing the Effectiveness of Provisions of the Code Related to Minority Shareholder Rights
In Pakistan, there is significant compliance with regard to the holding of AGMs, which is an important
means to make shareholder rights effective. Not only is the level of compliance high with regard to the
timely holding of AGMs, it appears to indicate an improving trend (Table.4.2).
Table 4.2. Compliance with Timely Holding of the AGM
Year
Total Listed
Companies
617
2002
635
2001
Source: SECP Annual Report (2002)
Number of
Compliant
Companies
548
534
% Compliance
89
84
The effectiveness of legal provisions related to minority shareholder rights needs to be examined in the
context of Pakistans ownership and control structure. We have pointed out in section 2, that in Pakistan,
controllers of MNCs, Government Corporations and Local Private companies tend to have majority
ownership, while case study evidence suggests the existence of diluted ownership amongst external
investors. This suggests that the provisions related to minority shareholder/external investor protection
may be too demanding thereby compromising their effectiveness in Pakistans current corporate
governance structure. For example, it appears that the requirements for action by minority shareholders
are relatively stringent: the representation requirement for judicial recourse is ten percent; a call for an
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extraordinary shareholder meeting is ten percent; and calls for special resolution ten percent. These
provisions appear onerous in the context of diluted shareholding by external investors.
As pointed out in section 4.2, current legal provisions appear to dilute the effectiveness of proxy voting.
Furthermore, the right to issue non-voting shares in the context of Pakistans inefficient capital markets
may end up making external investor protection even weaker. Finally, the BOD is the empowered forum
to declare dividends. However, the extent of family dominance over the BOD raises fears that it may not
be a judicious forum for the protection of cash-flow rights of external shareholders. These reasons
suggest that under the current structure of ownership and control external investor and minority
shareholder rights may not be as strong as they appear on paper.
5. Financial Reporting and Disclosure
The quality of transparency and disclosure depends crucially on accounting and auditing standards.
Independence of auditing is the key to ensuring that the information is disseminated reliably and credibly.
The adoption of internationally acceptable accounting standards will certainly help to improve the quality
of transparency. Good financial reporting systems facilitate easy access to reliable and credible
information by external investors and help develop confidence in capital markets. It is also important to
assess the prevailing incentives in the market for auditors and accountants, in order to ascertain incentivecompatibility with the requirements of better disclosure and adoption of standards.
5.1. Financial Disclosure and Audits
The basic idea behind the emphasis on disclosure and reporting is the advantage to investors, analysts,
and other users and ultimately to the company itself of financial reporting rules which limit the scope for
uncertainty and manipulation. Information is the lifeblood of markets and barriers to the flow of relevant
information represent imperfections in the market. What shareholders (and others) need from the report
and accounts is a coherent narrative, supported by the companys performance and prospects. The
cardinal principle of financial reporting is that the view presented should be true and fair. Boards should
aim for the highest level of disclosure consonant with presenting reports, which are understandable, while
avoiding damage to their competitive position. Boards should also aim to ensure the integrity and
consistency of their reports and they should meet the spirit as well as the letter of reporting standards.
5.1.1 Nature, Quality and Frequency of Financial Reporting
The Code (Clause xxiv) tightens and augments the existing provisions by requiring that a listed company
cannot circulate its financial statements unless the Chief Executive and the CFO present such statements,
endorsed under their signatures, for consideration and approval by the board of directors and the board,
after such consideration and approval, authorizes their issuance and circulation. In addition to this, the
Company Secretary is required to furnish a secretarial compliance certificate to the Registrar to certify
that the secretarial and corporate requirements of the Companies Ordinance 1984 have been duly
complied with. The Code (Clause xix) further bolsters the categories of information to be provided under
a Directors Report under Section 236 of the Companies Ordinance by requiring that it provide statements
to the effect that:
(a)
(b)
(c)
(d)
(e)
(f)
the financial statements of the company present a fair picture

proper books of account have been maintained
appropriate accounting policies have been consistently applied
international accounting standards, as applicable in Pakistan, have been followed
a sound internal control system has been effectively implemented and monitored
the listed company can continue as a going concern, beyond significant doubt
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(g) there has been no departure from the best practices of Corporate Governance, as detailed in the
amended listing regulations of the stock exchanges after the introduction of the Code.
The Code further requires additional disclosures, where necessary, which pertain to diverse areas such as:
key operating and financial information and deviations; dividends; taxes; corporate plans and decisions;
investments; director attendance at board meetings; pattern of shareholding; and trading in shares of
company by directors, chief executive, other executives and their spouses and minor children. The Code
(Clauses xx, xxi, xxii and xxiii) takes disclosure requirements a step further by requiring, inter alia, (a) the
publication and circulation of quarterly un-audited financial statements along with directors report; (b) a
limited scope review of half-yearly financial statements by statutory auditors in a manner approved by the
SECP; (c) immediate dissemination to the SECP and stock exchanges, of all such material information
relating to business and other affairs of company that will affect its market price (the Code lists the
potential areas such information may relate to).
The Companies Ordinance also provides a regime of detailed financial disclosure requirements on part of
a company. Section 233 of the Ordinance mandates the presentation by directors of a balance sheet and a
profit and loss account at every annual general meeting. These reports are to be accompanied by a proper
auditors report and a directors report which is then required to be sent to every member of the company
and a specified number of copies are required to be sent to the SECP, the stock exchange and the
Registrar.
The Ordinance also addresses the quality of information to be disclosed. Section 234 of the Ordinance
states that the contents of the balance sheet should give a true and fair view of the affairs of the company
and the profit and loss account/income and expenditure statement should give a true and fair view of the
profit and loss/income and expenditure of the company for the financial year. Detailed standard
schedules are required to be followed in the preparation of these financial statements. In the case of listed
companies, International Accounting Standards notified by the SECP in the Official Gazette are to be
followed. Furthermore, a statement of changes in the financial position or statement of sources and
application of funds is to form part of the balance sheet and profit and loss account. Accounting policies
are required to be stated and if there is any change in such policies, auditors are to report whether they
agree with such a change.
The Companies Ordinance also mandates the preparation of Directors Reports. Section 236 of the
Ordinance requires such reports for public companies or private companies which are subsidiaries of a
public company, to disclose, inter alia, (while stating the companys affairs, recommended dividends
etc.,) (i) any material changes and commitments affecting the financial position of the company; (ii) any
material changes that have occurred during the financial year concerning the nature of the business of the
company or in the classes of business in which the company has interest; (iii) full information and
explanation as regards any reservation, observation, qualification or adverse remark contained in the
auditors report; (iv) information about the pattern of holding of shares; (v) earning per share information;
(vi) reasons for incurring loss and reasonable indication of future profit prospects; and (vii) information
about defaults in payment of debts, if any, and reasons thereof.
Section 246 of the Ordinance gives SECP the authority to require companies to prepare and send to
members, Registrar, etc; such other periodical statements of accounts, information or other reports in such
form and manner and within such time as may be specified by it.
It can be seen from the above analysis that existing law mandates many disclosure requirements, which
are further supplemented and tightened by the requirements introduced by the Code. There are areas of
overlap as far as some statutory regimes are concerned. One potential issue though is whether some of
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the additional requirements introduced by the Code may prove to be too onerous for the smaller listed
companies in Pakistan.
5.1.2 Additional Rights of Shareholders to get Information from the Company
The following are some other disclosure requirements under the Companies Ordinance, which give
specific rights to the members of a company to have access to information. All these are tools for
shareholders and creditors (when applicable) to remain informed as to how the company is being run and
to protect their respective rights.
Sections 35 and 36 of the Ordinance require the Company to provide copies of updated memorandum and
articles of the company, upon request, within fourteen days of such a request. Section 136 of the
Ordinance provides the right to inspect copies of instruments creating mortgages and charges and the
companys register of mortgages to members, creditors and other persons during prescribed times and a
defaulting company faces penalties. Sections 147 and 149 of the Ordinance require a company to
maintain a register of members and a register of debenture holders in the prescribed form. Section 150 of
the Ordinance mandates that these registers be open to inspection at prescribed times and default entails
penalties. Section 156 mandates that a company file an annual list of members with the Registrar.
Section 173 of the Ordinance mandates the maintenance of books containing minutes of proceedings of
general meetings and meetings of directors, which are open to the inspection of members at prescribed
times. The Companies Amendment Ordinance also introduces additional language here, which is A
copy of the minutes of meeting of the board of directors shall be furnished to every director within
fourteen days of the date of the meeting. Section 205 of the Ordinance mandates the maintenance by
companies of a regularly updated register of their directors and officers, at its registered office, which is
to be open to inspection of members and other persons at prescribed times.
Permissible investments under Section 209 of the Ordinance are required to be recorded and open to the
inspection of members, debenture-holders and creditors, during prescribed times. Section 219 of the
Ordinance mandates the maintenance of a register of contracts, arrangements and appointments in which
directors, etc are interested, and this register is to be open to inspection of members of the company
during prescribed times. Section 220 of the Ordinance requires every listed company to maintain a
register as respects each director, chief executive, managing agent, chief accountant, secretary or auditor
of the company and every person holding at least 10% of the beneficial interest in the company, the
number, description and amounts of any shares in or debentures of the company and other related entities,
which are held by him or in trust for him etc. Such register is to be open to inspection during prescribed
times. It is the duty of directors to make disclosures to the company under Section 221 of the Ordinance
for it to comply with the requirements of Section 220 of the Ordinance.
The above analysis supplements the analysis of the disclosure requirements under Pakistani law
conducted in Section 5.1.1. It is meant to visualize the existing regime of access to meaningful
information on part of shareholders in order to exercise better control over the running of the company.
The additional disclosure provisions in the Code have to be gauged in this context and once again the
issue as to whether some of the additional requirements introduced by the Code may prove to be too
onerous for the smaller listed companies in Pakistan becomes relevant.
5.2 The Role of Audit Committees, and Internal & External Auditors
5.2.1
Audit Committees
The audit functions supply an important safeguard against fraud. Audit committees provide a forum for
discussing issues related to reporting in detail, and can identify gaps in internal reporting and ensure that
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legal requirements are fully met. The UKs Cadbury report states that audit committees should be
formally constituted, and should have more than three members, and they should mostly be NonExecutive Directors (NEDs). It also states that external auditor and the finance director should also attend
the meetings of the committee. It also recommends that the audit committee should have the power to
investigate all relevant matters.
The Code (Clauses xxx, xxxi, xxxii, xxxiii and xxxiv) comes up with detailed requirements for listed
companies in the areas of audit committees with provisions as to their composition, frequency of
meetings, attendance at meetings, terms of reference and reporting procedure.
Listed companies are required to establish audit committees comprising of not less than three members
(including the Chairman, with the majority of the members coming from the NEDs of the company and
the chairman of the audit committee preferably being an NED). The audit committee is required to meet
once every quarter of a financial year and also whenever requested by the external auditor or head of
internal audit. The CFO, head of internal audit and a representative of the external auditors are required
to attend meetings of the audit committee, at which issues relating to account and audit are discussed. At
least, once a year, the audit committee is required to meet the external auditors without the CFO and head
of internal audit. The board of directors of a listed company are required to determine the terms of
reference of the audit committee and they shall, among other things, recommend the appointment of
external auditors to the board of directors as well as provide direction in other related matters such as
resignation/removal of external auditors, their audit fees and the provision of additional services by
external auditors.
The Code actually lays out several ingredients, which the terms of reference of the audit committee
should contain. The terms of reference include, inter alia, measures to safeguard companys assets,
review of periodic financial statements with a focus on important stated areas, facilitation of the external
audit, coordination of the internal and external audit functions, review of the scope and extent of internal
audit, consideration of various major findings of internal investigations, internal financial and operational
controls, accounting systems, reporting structures, compliance with statutory requirements, institution of
special projects/value for money studies, monitoring compliance with the Code and other issues or
matters assigned by board of directors. The audit committee is required to appoint a secretary of the
committee responsible for circulating minutes of meetings of audit committee.
Audit Committees are a new concept being introduced and formalized through the Code and serve as an
additional tier of audit control in a company. While one can see its obvious positives, the question again
arises whether it is too much to ask and really necessary for a small listed company to maintain three tiers
of audit. An analysis of disclosures of a sample of 32 family-based domestic private listed companies
reveals that more than 45% of the annual reports checked had not reported the creation of an audit
committee. Furthermore, the data suggests that the audit committees that have been created tend to be
dominated by family members. This once again suggests that there is some time to go before the audit
committees can start playing the role of an independent monitor in Pakistans corporate governance
structure.
5.2.2
Internal Audit
The Cadbury Report propounds it as a good practice for companies to establish internal audit functions to
undertake regular monitoring of key controls and procedures. Heads of internal audit should have
unrestricted access to the chairman of the audit committee in order to ensure the independence of their
position. Directors should report on the effectiveness of their system of internal control, and the auditors
should report on their statement.
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The Code (Clauses xxxv and xxxvi) also requires that there be an internal audit function in every listed
company whose head has access to the person chairing the audit committee. All listed companies are
required to ensure that internal audit reports are provided for the review of external auditors and that
auditors discuss any major findings in relation to the report with the audit committee, which shall report
matters of significance to the board of directors.
Once again the same comments as those for audit committees made above apply here too. Internal audit
too is a relatively new concept for Pakistan, and it too can be onerous for the smaller firms on the stock
markets.
5.2.3
External Audit
The Cadbury Report emphasizes the annual audit as one of the cornerstones of Corporate Governance.
The audit provides an external and objective check on the way in which the financial statements are
prepared and presented, and it is an essential part of the checks and balances required. The question is not
whether there should be an audit, but how to ensure its objectivity and effectiveness. Audits are a
reassurance to all who have a financial interest in a company, quite apart from their value to boards of
directors. The most direct method of ensuring that companies are accountable for their actions is through
open disclosure by boards and through audits carried out against strict accounting standards.
One central requirement of the entire process is to ensure that an appropriate relationship exists between
the auditors and the management whose financial statements they are auditing. Shareholders require
auditors to work with and not against management, while always remaining professionally objective that
is to say, applying their professional skills impartially and retaining a critical detachment and a
consciousness of their accountability to those who formally appoint them. Another important requirement
is that there is a full disclosure of fees paid to audit firms for non-audit work. The essential principle is
that disclosure must enable the relative significance of the companys audit and non-audit fees to the audit
firm to be assessed. It is also a good practice for audit committees to keep under review the non-audit
fees paid to the auditor both in relation to their significance to the auditor and in relation to the companys
total expenditure on consultancy. For listed companies, a periodic change of audit partners should be
arranged to bring a fresh approach to the audit. The Cadbury Report clarifies that the auditors role is to
report whether the financial statements give a true and fair view. The auditors role is not to prepare the
financial statements, nor to provide absolute assurance that the figures in the financial statements are
correct, nor to provide a guarantee that the company will continue in existence. The audit is essentially
designed to provide a reasonable assurance that the financial statements are free of material
misstatements. The external auditors should be present at board meetings when the annual reports and
accounts are approved and preferably when the half-yearly report is considered as well.
The Code (Clauses xxxvii to xliv) bolsters and supplements existing law by reemphasizing and requiring,
inter alia, that only those firms are appointed as external auditors; (a) which have been given a
satisfactory rating by the Quality Control Review Program of Institute of Chartered Accountants of
Pakistan (ICAP) and (b) which are compliant with International Federation of Accountants (IFAC)
guidelines on Code of Ethics, as adopted by ICAP.
Additionally, listed companies are now required to change their auditors every five years and if for any
reason this is impractical then as a minimum they are required to rotate the partner in charge of its audit
engagement after obtaining the consent of the SECP. The Code further requires that no listed company
shall appoint as CEO, CFO, an internal auditor or a director someone who was a partner of the firm of its
external auditors (or an employee involved in the audit of the listed company) at any time during the two
years preceding such appointment. The Code also requires that a partner of the firm of the external
196
auditors shall be required to attend the Annual General Meeting at which audited accounts are placed for
consideration and approval of shareholders.
All listed companies are required by the Code (Clause xxvii) to ensure that the firm of external auditors or
any partner in that firm and his spouse and minor children do not at any time, hold, purchase, sell or take
any position in shares of the listed company or any of its associated companies or undertakings.
Section 252 of the Companies Ordinance states that external auditors have to be appointed at every
Annual General Meeting to serve till the next general meeting (in case of the appointment of the first
auditors, the appointment is made by the directors) and where the company fails to appoint auditors at the
stated time or there is a vacancy for any other reason, SECP can appoint a person to fill the vacancy. The
remuneration of auditors is fixed by the directors or the SECP or the company in a general meeting or in
such a manner as the general meeting may determine, depending on who makes the appointment.
Companies Amendment Ordinance now further provides that auditor or auditors appointed in a general
meeting may be removed before conclusion of the next annual general meeting through a special
resolution, and that they may not be removed during their tenure in any other manner.
Section 254 of the Ordinance mandates that the auditor for a public company or a private company which
is the subsidiary of a public company or a private company having a paid up capital of three million
rupees or more, has to be a Chartered Accountant within the meaning of the Chartered Accountant
Ordinance of 1961. A person cannot be appointed as an auditor if; (a) he was, at any time during the
preceding three years, a director, other officer or employee of the company; (b) he/she is a partner of, or
in the employment of a director, officer or employee of the company; (c) he/she is the spouse of a director
of the company; (d) he/she is indebted to the company; and (e) it is a body corporate.
5.2.4
Summing Up
The additional provisions introduced by the Code can help create a more effective external auditing
environment for companies. It must be noted that the Code empowers audit committees by saying that
they shall, among other things, recommend the appointment of external auditors to the board of directors
as well as provide direction in other related matters such as resignation/removal of external auditors, their
audit fees and the provision of additional services by external auditors. Therefore, audit committees in
that sense are a sine qua non for the Codes regime of external auditors. However, as we have pointed out
that in the Pakistani case family members may end up dominating audit committees in which case their
role as impartial monitors of the companies affairs may get compromised.
5.3 The Market for Auditors and Accountants in Pakistan
The last section shows that many of the provisions stipulated by the Code regarding the audit function are
in line with international best practice. However, it is important to assess whether the market for
Chartered Accountants provides them with adequate incentives for conducting high quality and impartial
disclosures. This section provides an answer to this question by analyzing the organization and incentive
structure regulating the profession in Pakistan.
The Institute of Chartered Accountants of Pakistan (ICAP) is the regulator of the Chartered Accountancy
profession. It is a statutory autonomous body established under the Chartered Accountants Ordinance
1961. Its many functions include the function of maintaining high standards of professional conduct and
ethics by all its members. The strength of ICAP membership was 3,036 as of June 30, 2002. However,
only 17% of its members were working as full time Chartered Accountants in Pakistans domestic market.
The bulk of ICAP membership was employed in commerce and industry with some presence in finance
and banking.
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ICAP certifies Chartered Accountants and adopts and amends the Accounting Standards applicable in
Pakistan. ICAP Bye-laws require compliance with prescribed Accounting Standards by Chartered
Accountants. During the last decade, ICAP has set up a Quality Control Review Committee with the
explicit purpose of auditing the auditors. As a result, ICAP has two tools, at its disposal, to ensure better
disclosure and transparency of information by the accounting profession.
ICAP has taken bold steps in the adoption of International Accounting Standards. It has adopted 37 out
of 41 International Accounting Standards. It has also institutionalized some bold steps for ensuring
compliance with these standards by the profession. The Council of ICAP formed the Quality Control
Review (QCR) Committee in 1987. Initially, the QCR was a peer review process, where peers in practice
conducted reviews of other practicing members. However, the process never gained legitimacy among
members, who were hesitant to share information with competitors. In order to address this concern the
Council decided to form a separate department in 1998, called the Professional Standards Compliance
Department (PSC), which is manned by full time chartered accountants to carry out QCRs. Currently two
reviewers are based in Karachi (Southern region) while the other is in Lahore (Northern region). The
Executive Director of the Institute has overall responsibility for the programme. Furthermore, the
Institute is presently bearing all costs for the QCR programme, and the firms are not charged for this
service.
The QCR process followed by PSC selects audit working paper files from an audit practices list of
clients, which are reviewed to ensure that they conform to the benchmark set in the International
Standards on Auditing and conform to local laws and regulations. QCR is applicable to all firms engaged
in professional practice who audit companies or other large entities. Management consultancy, taxation
and corporate services, and internal audit are currently not included in QCR.
However, the QCR is at present not mandatory, as according to the Chartered Accounts Ordinance (1961,
Schedule II, Part I clause (1)), working paper files of a client cannot be disclosed to any other person
without the consent of the client, which implies that ICAP cannot require auditing firms to submit
working paper files for QCR. Therefore, QCRs are conducted for only those firms that obtain
authorization from their clients to submit working paper files for review, if such authorization is not
forthcoming than a review is not possible. However, all firms submitting themselves for QCR are
required to undergo the process at least once in two years.
For those firms who submit for QCR, the PSC selects a sample of five to six clients from the annual audit
list of the firm. Preference is given to audits of Publicly Listed Companies. A review is scheduled at the
premises of the audit practice. A QCR checklist is used to record weaknesses in the working paper files.
All identified issues are first discussed with the partner/manager of the practicing firm for comments. In
the event that the reviewers are not satisfied with the comments a formal review report is prepared along
with recommendations for improvement. Therefore, the QCR ends up not only being an audit of auditors,
it also contributes to auditor training and education.
If a QCR reports no issues or issues of a minor nature then the review report declares the firm to be inaccordance with International Standards on Auditing. In the event that the performance of the firm is not
satisfactory, a not-in accordance with International Standards on Auditing conclusion is expressed. In
this case a period of six months is given to the firm to improve its performance. A revisit is scheduled
after 6 months to ensure compliance with the recommendations for improvement. In the event that the
QCR gives a gross negligence conclusion, the work of the reviewer is reconfirmed by another reviewer,
and after deliberations in the QCR committee, the matter is sent to ICAPs Investigation Committee for
appropriate action.
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There are two major impediments in the QCR process taking root. First, as stated earlier, under the
current law ICAP cannot require all of its member firms to undergo QCR. This limits the scope and
effectiveness of the process. This limitation has been removed in the case of listed companies, by a recent
SECP directive, which requires these companies to appoint only those auditors who have a satisfactory
QCR rating (see section 5.2). This directive has helped create a demand for QCR in Pakistan.
Second, firms auditing non-listed companies have not been shy in using the court to limit ICAPs
attempts to mandate QCR for its entire membership. A group of Lahore based practices has already taken
the ICAP to court, and won, based on the argument that the law does not allow auditors to disclose
privileged client information without authorization. This suggests that there is resistance to the general
application of the QCR requirement. This is understandable as there is no incentive for either non-listed
firms or their auditors to comply with QCR in the current system. There is also the fear that QCR will
end up raising compliance costs for smaller companies. However, the opposition is also possibly due to
the companies and the auditors protecting private rents.
Table 5.1. Market Segmentation in the Adoption of QCR, 2002
Auditors for
Listed
Companies
Total Number
Consented to
Review
Yet to be
Reviewed
Review
Rating for
Listed
Company
Auditors
InAccordance
Not-in
Accordance
Source: ICAP
Numbers
86
78
Percentage
100%
91%
9%
Numbers
% of Firms
Submitting
to Review
62
79%
16
21%
Other
Auditors
Total Number
Consented to
Review
Yet to be
Reviewed
Review
Rating for
Other
Auditors
InAccordance
Not-in
Accordance
Numbers
217
28
Percentage
100%
13%
189
87%
Numbers
% of Firms
Submitting
to Review
15
53%
13
47%
Table 5.1 clearly shows that there is a segmented application of the QCR function. There are a much
larger proportion of listed companies auditors, 91% as opposed to13% for other auditors, who are
submitting themselves for QCR. As stated earlier, this is largely driven by the SECP directive requiring
auditors of listed companies to go through QCR. Furthermore, compliance, measured by the number of
auditors in-accordance with ISA as percentage of the total number submitting for review, is much
higher in listed companies auditors, at 79%, as opposed to other auditors at merely 53%. Compliance
appears to be high in firms with foreign affiliations. Data suggests that 80% of Pakistani auditing firms
with foreign affiliations have received an in-accordance rating.104
104
Of course we cannot determine the direction of causality by the correlation alone, i.e., it is not obvious whether
better quality firms are opting for foreign affiliations or whether foreign affiliation status sets the necessary
incentives for quality improvement.
199
However, with regard to other auditors the data suggests that not only have the bulk of these auditors not
gone through the QCR process, but a large proportion of those reviewed are currently not in-accordance
with ISA. This evidence clearly points towards market segmentation. On the one hand are listed
companies auditors who have much better compliance with ISA but are small in number. On the other
hand are the non-listed companies auditors who constitute a very large proportion of the overall
accounting market and many of whom are currently non-compliant with ISA. Therefore, while the SECP
directive and the changes in the structure of the accounting profession have set incentives for the
consolidation of a high quality segment within the profession, a major proportion of the profession
remains locked into the medium to low quality segments. This segmentation equilibrium can, in large
part, be explained by the small size of the listed companies sector, which creates insufficient demand for
high quality auditors. Unless the demand for high quality auditors and consultants emerges, which will
have to await the growth of the listed companies sector, changes in the law mandating QCR on all firms,
while an important step, will possibly have limited effect in improving the quality of the profession.
6. Financial Sector and Corporate Governance
This section shows that Pakistans concentrated and largely state-owned financial sector resulted in
distortions and inefficiencies, during the eighties to mid-nineties, which resulted in mounting nonperforming loans that threatened the viability of Pakistans financial sector. In response to this crisis
GOP has instituted reforms of the market structure, regulatory regime and prices, which are expected to
create high-powered incentives and more prudent dealings between creditors and debtors. We argue that
while these reforms have had a number of positive effects, the financial sector continues to be plagued by
weak contractual rights, which has made it excessively risk-averse and unwilling to take on term lending.
Therefore, urgent changes are needed in strengthening efficient judicial processes that strengthen
creditors rights.
6.1. Pre-Reform Structure in 1990
6.1.1 Financial Sector Institutions
Pakistans banking sector was dominated by the public sector as late as the early nineties (Table 6.1).
This was largely the result of policy initiatives that had been undertaken during the 1970s, which
persisted throughout the 1980s. These initiatives substantially increased the role of government in the
banking sector through nationalizations and through restrictions on private sector entry in deposit
mobilization and credit allocation.
Table 6.1. Structure of Pakistans Financial Sector in 1990
(Amount in Rs. billion, share in percent)
Banks
State-owned
Private
Foreign
NBFIs
State-owned
Private
Number
s
24
7
17
36
13
23
Assets
Amoun
Share
t
425.6
61.6
392.3
56.7
33.4
4.8
133.9
19.4
124.3
18
9.6
1.4
Advances
Amount
Share
218.5
201.2
17.3
98.3
94.7
3.6
48.7
44.8
3.9
21.9
21.1
0.8
Investment
Amoun Share
t
111.3
89.0
104.1
83.2
7.3
5.8
13.7
11
13.3
10.6
0.4
0.3
200
1
131.9
19.1
131.9
29.4
CDNS
2
90
Equity
markets105
63
691.5
100
448.7
100
125.1
100
Total
NBFI: Non-Bank Financial Institution, CDNS: Central Directorate of National Savings
Source: Pakistan: Financial Sector Assessment 1990-2000. State Bank of Pakistan (SBP).
The public sector also dominated the Non-Bank Financial Institutions (NBFIs) during the 1980s despite
an easing of entry regulations that allowed greater private investment into the sector (Table 6.1).
Although the number of private Non-Bank Financial Institutions was 23 out of a total of 36, their asset
base, as well as their share in advances and investment remained extremely small. Within the NBFIs, it
was the state-owned Development Finance Institutions (DFIs), twelve in number, which dominated the
share of assets (78.6%) and advances (80.4%). The Central Directorate of National Savings, again a
public sector institution, had a network of 300 plus branches, and had mobilized a total of Rs. 131.9
billion until 1991.
Therefore, the structure of Pakistans financial sector that emerged during the eighties and nineties was
characterized by significant and concentrated state ownership with restrictions on competition from the
private sector. We will show that this structure had a considerable impact, not only, on corporate
financing but also on the efficiency with which external finance was used.
6.1.2. Supervisory Structure
In 1990, three bodies were playing a supervisory/regulatory role vis--vis Pakistans financial sector. The
State Bank of Pakistan (SBP) dispensed its functions under the SBP Act (1956); the Pakistan Banking
Council (PBC) monitored the performance of nationalized banks under the Banks (Nationalization) Act
(1974), and the Corporate Law Authority (CLA) regulated the equity market under the Securities and
Exchange Ordinance (1969).
The SBP, the apex regulatory institution of the country, had the responsibility for: conducting the
monetary policy of the country; managing the exchange rate; and performing banking supervision. The
PBC operated as a holding company for the government, and was responsible for, among other things,
ensuring that directed credit policies were properly implemented in state-owned banks. The PBC
reported to the Ministry of Finance and was placed below direct political control. The PBC had the same
regulatory role as the SBP, but its additional responsibilities and its exposure to political control created
substantial distortions in the banking sector. Furthermore, the regulatory structure that emerged was
fragmented and the overlapping jurisdiction of different supervisory bodies made the structure inefficient.
6.1.3 Consequences
Concentrated state control over credit disbursement and a fragmented and polticized regulatory structure
led to a number of distortions in the system. The first consequence was the accumulation of a large
portfolio of Non-Performing Loans (NPLs) that nationalized banks became (and still are to an extent)
burdened with. Second, direct mobilization of funds through CDNS, at high interest rates, lowered the
ability of the financial sector to raise deposits. CDNS was offering tax incentives and high interest rates
(up to 15%) for deposits that were risk-free, while banks could only give a 7-9% interest on their deposits.
These factors led to not only low returns on bank portfolios, but also to dis-intermediation in the banking
system.
105
Market capitalization of KSE is not included in the total.
201
Third, absolute credit ceilings and sectoral credit allocation targets limited the banks ability to benefit
from de-centralized decision-making and sectoral profit-making opportunities. Administered interest
rates further limited the scope for responding to risk differentials. Finally implicit deposit risk insurance,
offered by the state, implied significant moral hazard for state-owned banks and DFIs. Entry restrictions
on private domestic and foreign banks limited competition for state-owned institutions, which resulted in
the creation of service related inefficiencies as well as the creation of rents for distribution on the basis of
patronage. As mentioned earlier, one consequence of these practices has been the large portfolio of nonperforming loans (NPLs) that the financial institutions, especially state-owned ones, have been burdened
with (Table 6.3).
6.2. Financial Sector Reforms During the 1990s
The aim of financial sector reforms instituted by the Government of Pakistan (GoP) during the 1990s is to
create efficiencies in the financial market. The reforms attempt to achieve these objectives through a
series of interventions that are detailed and analyzed in this section.
6.2.1 Institutional Reform
GOP took a number of reform measures during the 1990s. In order increase competition the government
started privatizing the nationalized banks and other financial institutions through amendments to the
Banks (Nationalization) Act (1974). Three large nationalized banks, Muslim Commercial Bank, Allied
Bank and United Bank, have so far been privatized. Further amendments to the 1974 act lowered entry
barriers for the private sector to enter the banking industry. As a result, some 13 private domestic banks
have been commissioned to start commercial banking.
The reforms have taken a number of steps to streamline and increase the efficacy of financial sector
practices and regulations. The Banking Companies Ordinance (1962) has been amended to allow
stronger self-governance by banks. Furthermore the state has also introduced strong restructuring
programmes in all banks and DFIs that continue to operate in the state sector. These restructuring plans
include initiatives like branch and employee rationalization, and voluntary early retirement plans. In two
years (up to December 1999) state-owned banks had reduced their workforce from 99,954 to 81,079, and
had reduced the number of branches by 718 (by June 2000).
GOP has also made significant changes to Prudential Regulations in order to increase the sustainability of
banking institutions. The changes include an increase in the capital adequacy ratio and the minimum
paid-up capital requirement. Furthermore, SBP has mandated NBFIs to obtain credit ratings.
The SBP has streamlined the loan recovery process by requiring disclosure of substandard and doubtful
loans; by establishing quarterly recovery targets; and by increasing the number of banking tribunals to
process recovery cases. Furthermore, the Banking Companies (Recovery of Loans, Advances, Credits,
and Finances) Act (1997) has been instituted to allow for the establishment of banking courts to further
facilitate and expedite the recovery process. These changes allow for quicker decisions for foreclosure
and sale, and takeover of property (where warranted) without filing a suit. Finally, in order to create
powerful market incentives targeted lending schemes have been reduced and SBP has dismantled the
regime of administered interest rates.
6.2.2. Banking Supervision Reform106
106
More detailed account of the legal changes is given in Appendix 5.
202
The most important steps taken by GOP are: to amend the SBP Act (1956) to make SBP autonomous; to
prohibit any government body from issuing any directive to banks (and NBFIs) regulated by the SBP; and
to ensure that the SBP has the requisite powers for formulating and implementing the countrys monetary
policy. Furthermore, GOP amended the Banks (Nationalization) Act (1974) in 1997 and consolidated all
regulatory functions pertaining to banks under the SBP, abolished the PBC, and gave SBP the right to
regulate the affairs of the state-owned banks as well. GOP has placed limitations on the political control
of financial institutions by placing them under the supervision of an autonomous central bank, as opposed
to a politically controlled PBC.
Reforms in the Banking Companies Ordinance have also strengthened the SBPs role as a regulator of
financial institutions. Section 40A gives SBP the power to ensure that banks comply with all statutory
requirements and banking rules and regulations, and in case of non-compliance SBP can take remedial
action. Section 41D empowers SBP to direct prosecution of a director or CEO, who has caused loss to
depositors money or income of the bank.
6.3 Impact of Financial Sector Reforms
This section assesses whether the reforms have, indeed, been successful in creating a competitive, marketdriven environment that sets incentives for prudent lending and efficient investment allocation. We also
analyze the constraints that continue to persist in Pakistans financial sector despite these reforms.
6.3.1. Impact on the Financial Structure
The reforms of the 1990s have transformed the structure of the financial sector in Pakistan. The asset
share of banking institutions in the private sector has increased from 7.8% in 1990 to about 55% in
2002.107 Furthermore, the compound annual growth rate of assets and deposits was almost fourfold in the
private sector as compared to the public sector. Consequently, in terms of GDP, the share of private
banking institutions jumped from 3.9% in 1990 to more than 27% in 2002. The same trend was visible in
the NBFIs as well. This suggests that the reforms have been successful in engendering greater
competition in Pakistans financial sector.
The reforms have also stressed the objective of dismantling of the role of the government in credit
allocation. As a result, concessionary credit, as a percentage of total credit, decreased from 44.2% in
1990 to 31.4% in 2000. This has ensured that bank allocations are driven increasingly by profit motives
and not by state policy.
6.3.2 Impact on Banking Supervision
As pointed out earlier, SBP introduced stronger Prudential Regulations after the 1997 amendments in its
powers. Most banks have complied fairly thoroughly with the new regulations. By 2000 only three, out
of 39, banks had a lower than 8% capital to risk-weighted asset ratio. By June 2001, out of 80 financial
institutions, credit ratings of fifty institutions had been completed.
SBP has also improved its regulatory capacity by investing in change management. As a result, in many
cases it has been able to identify problems early and to take early remedial action. Board and
management of Bankers Equity Limited (BEL) were removed by SBP in August 1999 when it was clear
that the bank was in trouble. SBP was able to payback most account holders by February 2000.
Similarly, the license for Indus Bank Limited was cancelled after early warnings in 2000, and SBP has
now almost finished the liquidation process. SBP has recently created a subsidiary State Bank of Pakistan
107
The figure includes the estimated changes from recent privatization of United Bank Ltd.
203
Banking Services Corporation (SBPBSC) that will look after banking services exclusively. This will
allow SBP to offer even better regulation and monitoring.
6.3.3. Performance Evaluation Post-Reform
First, compared to some its regional competitors and countries that are at a roughly comparable level of
development, Pakistan still has a long way to go in terms of financial sector development (Table 6.2). On
the whole Pakistani indicators are poorer than the East Asian countries and Turkey, and some indicators
are weaker than other South Asian countries as well. This just shows that Pakistan still has a long way to
go before it can claim to have a deep, entrenched, fairly efficient and extensive financial sector.
Table 6.2. Indicators of Financial Depth and Efficiency
(Percent)
Sri
2000
Pakistan India Bangladesh Lanka Philippines Malaysia
46.5
56.9
43.3
38.2
62.5
102.6
M2/GDP
27.8
17.5
14.2
13
9.3
6.4
Currency/M2
12.9
9.9
6.2
5
5.8
6.6
Currency/GDP
3.2
4.1
4.6
4.7
4.7
4.1
Money
Multiplier
43.2
14.9
14.5
13.3
10.6
17.4
Demand Deposit
56.8
85.1
85.5
86.7
89.4
82.6
Time Deposit
41.8
44.5
22.2
27.8
23.4
-2.2
Credit to
Government
Turkey
44.6
5.6
2.5
5.6
12
88
52.7
Second, Non-performing loans (NPLs) of financial institutions have continued to grow throughout the
1990s (Table 6.3). However, the average rate of growth did slow down from 17.4% to 10.1% after 1997.
In December 2002, NPLs of banks stood at Rs. 244.2 billion up from the 2000 figure of Rs. 173.6 billion.
Public sector banks accounted for 50% of NPLs, which was much higher than the figure for private and
foreign banks (Table 6.3). In December 2002, the NPLs to total loans ratio stood at 23.7% for all banks
and at 37.1% for public sector banks.
Table 6.3. Volume and Concentration of NPLs
(Amount in billion Rs., shares in percent)
All banks and NBFIs (Amount)
All banks
State-owned banks
Private banks
Foreign banks
1990
66.1
41.1
39.0
2.1
1995
142.6
94.9
89.3
2.4
3.2
2000
271.4
173.6
153.0
13.6
7.0
NBFIs
DFIs
HFC
Others
25.0
22.8
0.6
1.6
47.7
39.6
4.3
3.7
97.8
83.4
9.3
3.0
204
Share in NPLs (percent)

All banks and NBFIs
All banks
State-owned banks
Private banks
Foreign banks
NBFIs
DFIs
HFC
Others
100
62.1
59.0
3.1
100
66.5
62.6
1.7
2.3
100
64.0
56.4
5.0
2.6
37.9
34.6
1.0
2.4
33.5
27.8
3.0
2.7
36.0
30.7
3.4
1.9
State-owned institutions
96.9
96.0
91.6
The poor recovery process of NPLs is partly a consequence of policy but partly it is explained by weak
creditors rights. There are several important issues to note here. As the section on Pakistans corporate
governance structure shows, Pakistani corporations, even listed ones, tend not reveal sufficient credible
information, and tend not maintain credible and transparent governance structures. In addition, even
though creditors rights as judged on the basis of five widely accepted international best practices (La
Porta et al 1998 and 1999)108 are well protected in the Companies Ordinance 1984, banks do not have
confidence in the judicial system enforcing their rights effectively (see Table 7.1 and section 7 for
details). Given this constraint banks have either become reluctant to fund long-term projects, or have
started asking for more than 100% collateral. Both these effects have helped to lower the flow of debt to
the corporate sector.
GOP has responded to this situation of weak creditors rights in two ways. First, amendments have been
made to the Banking Companies (Recovery of Loans, Advances, Credits, and Finances) Act, in 1997 and
2001, which try to address these concerns about creditors rights109. These changes aim at not only
providing summary proceedings for recovery, but for the first time, they have also introduced the idea that
the bank can sell mortgaged property without intervention from the courts. Sections 10 and 11 of the
Recovery of Finances Ordinance 2001 allow for summary hearing and quick decree if no substantial point
of law is present on the side of the defendant. Section 15 allows for the creditor to sell mortgaged
property, in case of default, and after due notices have been given, through public auction and without
intervention from the court. Section 16 allows for recovery of moveable property from the defaulter
without intervention of the court if such a provision had been made in the initial agreement. Section 23
restricts debtors from alienating disputed property until the decision of the court. These reforms have
been instituted to expedite the loan recovery process by bypassing the court system. Second, as pointed
out in Section 4.3.1, the NAB Ordinance (1999) has instituted a regime of more or less unlimited liability
for directors of companies, which is again meant to expedite recovery. However, the attempt to pierce
limited liability has reduced the demand for debt among corporates (section 1).
Third, as a result of higher risks and weak creditors rights banks have become reluctant to provide longterm finance to the corporate sector. As has been shown, the corporate sector has traditionally relied on
DFIs and other specialized institutions to acquire term financing. This has not only created the
aforementioned problems of NPLs, due to poor governance and politicised incentive structures in DFIs
108
These are 1) restrictions for going into reorganization, 2) no automatic stay on secured assets, 3) secured creditors
first, 4) management does not stay, 5) legal reserve. These are discussed in detail, for Pakistan, in Appendix 5.
109
The issue of implementation and the effectiveness of judiciary are discussed separately in section 7.
205
and public sector banks, it has also created rents that were distributed to insiders or firms that were able
to tap into the existing patronage network. However, the reform environment has marginalized the DFIs
and NBFIs. Their marginalization is a consequence of their inability to mobilize funds; a drastic squeeze
in their foreign funding lines; and structural weaknesses that burdened them with significantly infected
portfolios and high levels of NPLs. Sharp increases in NPLs have, in turn, restricted their lending
operations. As a result, their role in the overall financial industry has become quite small (Table 6.4).
This analysis suggests that the future of the DFI model is weak in Pakistans current financial sector
environment. This means that the old model of corporate financing has come under strain and corporates
will have to look elsewhere to obtain external finance.
Table 6.4. Sanctions and Disbursements by Selected DFIs and Specialized Banks
(million Rupees)
Financial Year 1990
Deposit Sanctions Disbursed
12,422
5,123
2,272
NDFC
128
459
239
RDFC
1,771
4,152
1,462
BEL
1,191
8,591
1,239
PICIC
Source: Pakistan: Financial Sector Assessment 1990-2000.
Financial Year 2000

Deposit Sanctions Disbursed
28,338
127
225
601
3,895
15
3,263
988
193
State Bank of Pakistan (SBP).
The key question is that as DFIs and specialized institutions are scaled down, will these legal provisions
be enough to allow banks and NBFIs to enter term financing market, and finance the development of the
corporate sector in the country? A lot will depend on the efficacy of the legal system in enforcing the
protections that have been given to creditors. This is discussed in detail in the next section.
7. Judicial System
Governments are supposed to define the legal framework within which individuals and organizations are
to function and set up mechanisms and institutional arrangements for ensuring rule compliance and
conflict resolution in a fair manner. Deficiencies in both design of the legal framework and in the way it
works affects the performance of the economy. Laws and regulations in Pakistan tend to be complicated,
cumbersome and at times defective (Bari et al 2003). Incentives for strict and fair implementation are
weak and widespread bureaucratic and political interference make matters much worse.
Consequently inadequate knowledge of the relevant laws, and more importantly, the high cost (in terms of
time and resources) of seeking and securing redress partly explain why those adversely affected do not
take recourse to legal remedies or exert pressure on the enforcement agencies to take appropriate
corrective action. It also implies that in both cases when the right laws are not there, or when
enforcement is weak, parties to a transaction will try to either avoid the transaction, design second best
solutions to cover their downside, or just bear the higher transaction cost. But in all of the above the cost
of transaction will go up and efficiency, compared to the optimal, will be much lower. One poignant
example of this has been the reluctance of banks and NBFIs to go into term financing. La Porta et. al.s
(1999) estimates show that in Pakistan the issue is not the legal structure of credit protection but judicial
enforcement, a point we have emphasized throughout this chapter (Table 7.1). It is because of the
weaknesses in judicial enforcement that banks have over-collateralized loans, or have used other means to
manage risks. The same is the case with enforcement, through courts, of minority shareholder rights as
well. Corporate governance reforms, if they are going to work, will need to rely on strong reforms in the
judicial system.
Table 7.1 Investor Protection in Asia and Latin America
206
Creditor Protection1
Judicial Enforcement2
4
4.3
Pakistan
4
6.1
India
3
5
Sri Lanka
4
7.7
Malaysia
0
4.1
Philippines
4
4.4
Indonesia
3
5.9
Thailand
1
5.6
Argentina
1
6.5
Brazil
2
6.8
Chile
0
5.7
Colombia
0
6
Mexico
Source: La Porta et. al. (1998 and 1999)
Note: 1) An index of how well the legal framework protects secured creditors. It will equal four (best)
when: (a) there are minimum restrictions e.g. creditors consent for firms to file reorganization; (b) there
is no automatic stay on collateral; (c) debtor loses control of the firm during reorganisation; and (d)
secured creditors are given priority during reorganisation.
2) An index measuring the quality of judicial enforcement ranging from 1 (worst) to 10 (best) equal to the
average of five sub-indexes measuring: (a) efficiency of the judicial system; (b) rule of law; (c)
corruption; (d) risk of expropriation; and (e) risk of contract repudiation.
The main weaknesses of the judicial system stem from the very low disposal rates of cases. Parties to a
dispute can take recourse to three appellate forums: District Courts, the High Court and the Supreme
Court, and since interim orders can be subjected to the three forums as well, delays become endemic and
weaken property rights and contract enforcement. Parties can rely on delays in the judicial system since
they have become quite predictable. The low salary structure of the civil judiciary, coupled with the
possibility of delaying decision-making, lead to significant opportunities for corruption.
Historically, civil courts that applied ordinary civil and procedural laws, handled the process of debt
recovery as well (enforcing creditor rights). The problems posed by lack of judges trained in commercial,
corporate, banking and tax laws are compounded by the procedural and legal complications (mentioned
above) in liquidating collateral. Procedural loopholes alone could delay action for years reducing the
value of the collateral significantly apart from imposing direct costs on the creditor. Furthermore,
corruption makes the outcome even more unpredictable. This adversely impacts upon the availability of
debt. Financial institutions are reluctant to advance loans to parties that are not blue chip as the value of
collateral is undermined by procedural and legal complications. The above circumstances also encourage
financial institutions to become excessively stringent in requiring collateral.
In February 1997 the federal government established 34 banking courts across the country to admit cases
of loan defaulters below Rs. 30 million. For cases above Rs. 30 million, two judges from the Lahore
High Court and one judge each from Sindh and Baluchistan High Courts were nominated to deal
exclusively with such cases. Though more banking courts have been added to the judicial system, and the
judicial process for recoveries has been improved, the general problems that have been identified above
still hamper the working of the judiciary and continue to impose significant transaction costs on the
companies and providers of finance. These need to be addressed quickly, and on a priority basis.
8. Conclusions
207
In this chapter we have argued that Pakistan has entered a new phase in its corporate growth history. The
government is phasing out the old model of corporate growth that relied on state-disbursed credit and
inflated internal finance through protectionist policies. Furthermore, recent reforms in the financial sector
appear to have made financial institutions excessively risk-averse when it comes to corporate lending
practices. The risk-aversion of financial institutions is also a consequence of weak creditors rights that
arise on account of inefficiencies in the judicial enforcement structure. This means that future financing
for corporate growth will either come from internal profitability or from external equity capital.
However, we have also argued that currently Pakistans capital markets are prone to inefficiencies
because of their shallowness and because they remain extremely skewed in terms of both market
capitalization and turnover. Opaque information and a distorted market structure appear to create many
opportunities for making profits through market manipulation rather than efficient portfolio investment.
This suggests that if Pakistan is to achieve large-scale corporate growth it must reform its capital markets.
An important question that needs to be addressed is the source of future growth of the corporate sector.
At first glance it appears that in Pakistans current economic environment family-based corporates offer
the greatest potential source for corporate growth. However, we have shown that the ownership and
control structure of the family-based corporates is such that their main objective becomes one of
maximizing family control. We have also argued that the control maximization objective is inimical to
capital market development. Furthermore, concentrated control leads to a number of inefficiencies, which
include:
1.
2.
3.
4.
Opaqueness in the use of public money

Excessive private benefit seeking through tunneling and other means
Low share trading which reduces market liquidity
Lack of incentives to declare dividends
Many of these practices lower external investor protection and are contrary to the requirements of capital
market development. However, we have also pointed out that private benefits, which result from
concentrated control, set strong incentives for these families to maximize the generation of operating
surpluses. This suggests that there may be a trade-off between profit maximization and the development
of capital markets in Pakistan.
It is this structure that the SECP is attempting to regulate through the prescription of a bold Code for
Corporate Governance. The Code has taken a number of important steps that are in line with international
best practices. These include: a greater role for Non-Executive Directors on the BODs; strengthening
minority shareholder rights; and improving the audit and disclosure mechanisms in Pakistan. These steps
have laid down a framework that will help define tomorrows corporate environment. However, we have
argued that in the current structure many of these provisions will not be as effective as they would have
been in a more developed capital market. For example, the dominance of the family on the BOD and on
audit committees will make these forums partial to majority controllers and it cannot be expected that
these forums will end up playing the role that is envisaged of them. We have also argued that
concentrated control of votes in the hands of the family tends to make the actual enforcement of minority
shareholder rights difficult and onerous. Again, this means that the de facto force of these rights will be
much less than their de jure force.
Where the SECPs new Code has made a perceptible difference is in the consolidation of a higher quality
segment in the audit market. The Codes requirement of a quality control review for listed companies
auditors combined with ICAPs role in adopting ISA and enforcing their compliance has helped to
maintain a high-quality market segment. However, we have shown that this high-quality market segment
is small and there is much room for upgrading the quality of other auditors in the market. The resistance
to this change amongst auditors is partly because the small size of the corporate sector reduces the
208
premium that can be obtained from moving up into the high quality segment and partly because opaque
corporate practices create rents not only for corporates but also for complementary professions.
Given this situation, where are capital market development and the growth of the widely held sector going
to come from? In our opinion there are two potential sources of this growth. The first is an increase in
the liquidity of Pakistans stock market through greater participation by foreign portfolio investors.
Large-scale inflow of funds brought in by institutional investors may help create the necessary carrot for
local corporates to bite on. Along side this institutional investors with concentrated control over
investment may have the needed ability to discipline local corporates and make them bargain away some
control in exchange for the large-scale availability of reasonably priced risk-sharing capital. However,
this scenario is contingent upon how foreign investors react to the improvement in Pakistans macro
situation that has emerged partly by virtue of the September 11th dividends and partly on account of
government policy.
Alternatively, growth in Pakistans corporate sector will have to wait for the emergence of Pakistani
corporations that are striving to grow in the global market. This has already happened in Indias IT
sector. However, this would mean a major change in the entrepreneurial vision of the Pakistani corporate
controller, who is currently locked into making profits either on the basis of processing domestically
available raw material or on the basis of high protection rents in the domestic capital-intensive sectors.
9. Bibliography
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Bagchi, A.K (eds.) (1999). Economy and Organization. Sage.
Bari, F. Cheema, A. & S.H. Kardar (2003). Private Sector Development Strategy for Pakistan. Asian
Development Bank, March.
Basudeb, G.K and F. Bari (2000). Sources of Growth in South Asian Countries. Global Development
Network.
Bergloff, E. and E.L. von Thadden (2002). The Changing Corporate Governance Paradigm: Implications
for Developing and Transition Economies in B. Pleskovic and J.E. Stiglitz (eds.) The Annual World Bank
Conference on Development Economics, 1999. World Bank, Washington.
Berle, A. and G. Means (1932). The Modern Corporation and Private Property. Macmillan.
Bertrand, M., P. Mehta and S. Mullainathan (2000). Ferreting out Tunneling: An Application to Indian
Business Groups. MIT working paper.
Cheema, A. (1999). Rent-Seeking, Institutional Change and Industrial Performance: The Effect of State
Regulation on the Productivity Growth Performance of Pakistans Spinning Sector, 1981-1994.
Dissertation submitted to the University of Cambridge, UK.
Cheema, A (forthcoming). State and Capital in Pakistan: The Changing Politics of Accumulation in A.
Mukherjee-Reid (eds.) Corporate Capitalism in Contemporary South Asia. Macmillan.
Claessens, S., S. Djankov and L. Lang (1999). Who Controls East Asian Corporations? Manuscript.
Financial Economics Unit, Financial Sector Practice Department, World Bank.
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Goswami, O. (this volume). Getting There --- Pretty Rapidly: The State of Corporate Governance in
India.
Hamid, N. (1992). Industrial Incentive Structure: A Need for Reform, in A. Nasim (eds.) Financing
Pakistans Development in the Nineties. Lahore, OUP.
Hart, O. (1995). Corporate Governance: Some Theory and Implications, Economic Journal, Vol. 105,
Issue 430.
Hazari R. K. (1966). The Structure of the Corporate Private Sector: A Study of Concentration, Ownership
and Control. Asia Publishing House.
Khwaja, A.I. & A. Mian (2003) Price Manipulation and Phantom Markets: An In-depth Exploration of
a Stock Market. Draft paper, February.
La Porta, Rafael, F. Lopez-de-Silanis, A. Shliefer and R. Vishny (1998). Law and Finance, Journal of
Political Economy 106.
La Porta, Rafael, F. Lopez-de-Silanis, A. Shliefer and R. Vishny (1999). Corporate Ownership Around
the World, Journal of Finance 54.
Lokanathan, P.S (1935). Industrial Organization in India. Allen Unwin.
Noman, A. (1992). Liberalization of Foreign Trade and International Competitiveness, in A. Nasim (eds.)
Financing Pakistans Development in the Nineties. Lahore, OUP.
Papaneck, G. (1967). Pakistans Development: Social Goals and Private Incentives. Harvard University
Press.
Securities and Exchange Commission of Pakistan (2002). Annual Report 2002. Islamabad.
Shleifer, A, and R. Vishny (1997). A Survey of Corporate Governance, Journal of Finance 52.
State Bank of Pakistan (2003). Quarterly Performance Review of the Banking System, Quarter Ended
December 2002. Banking Supervision Department.
State Bank of Pakistan (2002). Quarterly Reports on the State of the Economy. Various Issues.
State Bank of Pakistan (2002). Pakistan: Financial Sector Assessment 1990-2000. Research Department.
State Bank of Pakistan (2002). Balance Sheet Analysis of Joint Stock Companies (various issues).
Karachi.
World Bank (2002). World Development Indicators. World Bank Washington.
Zhang, J, D. Edwards, D. Webb and M.V. Capulong (1999). Corporate Governance and Finance in East
Asia. Asian Development Bank.
210
Appendix 1. Sample Description

1. Table 2.4 (a) Sample:
The sample included 7 companies; 4 of which were MNCs and 3 were government enterprises. Data for
calculation was obtained from the SECP Securities. Names of the companies included in the sample are
as follows:
Multi-Nationals
Hubco
ICI Pakistan
Lever Brothers
Shell Pakistan
Government Enterprises
SNGPL
SSGC
PSO
2. Table 2.4 (b) Sample
Total companies included in the sample were 43. The sample included 21 textile companies and 22 nontextile companies. Name of the companies are as follows:
Textile Companies
Alhamd Textile Mills
Bilal Fibres
Brothers
Burewala
Ellcot Spinning Mills
Ghazi Fabrics
Ibrahim Fibres
Ideal Spinning Mills
Idrees Textile Mills
Ishaq Textile Mills
Khalid Siraj
Muhammad Farooq Textile Mills
Nagina Cotton Mills
Prosperity Weaving Mills
Ruby Textile Mills
Shaheen Cotton Mills
Shahtaj Textile mills
Shahzid Textile mills
Tata Textile Mills
Tritex Cotton
Zaman Textiles
Non-Textiles
211
Allwin Eng
Atlas Battery
Baluchistan Glass
Chakwal Cement
Crescent Boards
Crescent Jute
Crescent Steel and Allied Products
Dandot Cement Company
Data Agro
Dewan Salman
DG Cement
Dynea (Dyno Pak)
General Tyre
Indus Motor Company
Kohinoor Genertek
Maple Leaf Cement Factory
Pakistan Synthetics Ltd
Pel Appliances
Shabbir Tiles and Ceramics
Suhail Jute Mills
Transpak Corporation Ltd
United distributors
3. Table 2.5 (Data for Pakistan)
The sample consisted of 32 total companies; 14 of which were textile companies and
18 were non-textile companies. Data was acquired from the company reports of these
companies
Names of the companies are given as follows:
Non-Textiles
Indus Motor company
Dyno Pak
Shabbir tiles and ceramics limited
Crescent Boards
Crescent Steel and allied products
Pakistan Synthetics Ltd
DG Cement
Maple leaf cement factory
Crescent Jute
Allwin Engineering Industries ltd
Transpak Corporation Ltd
Pel Appliances Ltd
Dandot Cement Company ltd
Kohinoor Genertek ltd
Atlas Battery (Atlas Group)
212
United Distributors Pakistan ltd

Dewan
Sohail Jute Mills Limited
Textile Mills
Zaman Textile mills
Brothers
Idrees TM
Kohinoor textile mills
Bilal Fibres Limited
Muhammand Farooq Textile Mills
Ideal spinning mills
Tata Textiles
Ghazi Fabrics
Ibrahim Fibres limited
Ellcot Spinning Mills
Tritex cotton
Nagina Cotton
Prosperity Weaving mills
4. Table 2.6 (Data for Pakistan) Sample:
Same sample is used as in Table 2.5
5. Table 2.7 Sample:
The sample consisted of 33 companies. Of these, 18 companies were family based, 12
were government and 3 were multi-national companies. The relevant data was provided
by Dr. A. Mian of the University of Chicago.
Names of the companies are as follows:
Family Based
Bolan Bank
Chakwal Cement
D.G.Cement
Dewan Salman
Engro Chem.
Fauji Cement
Faysal Bank
IbrahimFibres
Japan Power
Kohinoor Energy
Lucky Cement
M. C. B.
Maple Leaf Cement
Nishat Mills
Prime Bank
213
Soneri Bank
Union Bank
World Call Payphones
Government
K. E. S. C.
P.I.A.C. (A)
P.N.S.C.
P.T.C.L.A
Askari Bank
B.O.Punjab
Fauji Fert
FFC JORDAN
P.I.C.I.C.
P.S.O.
Sui Northern
Sui South Gas
MNCs
Hub Power
Nimir Ind. Chem
Pak Tobacco
6. Table 4.1 Sample:
The sample included 34 total companies. Of these 16 were textile companies and 18
were non-textile companies. The required data was acquired form the company reports
of these companies.
Names of the companies are given as follows:
Non-Textiles
Allwin Engineering
Atlas Hodna
Crescent boards
Crescent Jute
Crescent steel and allied products
Dandot Cement
Dewan Salman
DG cement
Dyno Pak
Indus Motor Company
Kohinoor Gertek
Malpe leaf cement factory
Pakistan Synthetics
Pel Appliances
Shabir tiles and ceramincs
Suhail Jute mills
214
transpak corporation
United Distributers
Textiles
Amin Textiles
Apollo Textile Mills
Burewala Textiles
Chakwal Spinning
Colony Sarhad
Colony Thal
CresKnit
Globe Textile
Ibrahim Filbres
Kohinoor textile mills
Lawrencepur
Nishat Mills
Sapphire Textile Mills
Shams Textile Mills
Tritex cotton mills
Zaman Textiles
215
Appendix 2. Relevant Excerpts from the SECP Annual Report 2002

4.3.11 Inter-corporate Financing
While inter-corporate financing constitutes a major source of funding for productive investment and
capital formation, this avenue has been greatly abused by managements and sponsors for transfer of funds
to their own companies. In order to curb this misuse of funds, the Companies Ordinance, 1984 has placed
certain restrictions on investments in associated companies. During the year under review, efforts were
made by the EMD to deter unlawful inter-corporate financing. As a result of its proactive monitoring, the
EMD was able to detect material deficiencies in the information provided by certain companies in the
proposed resolutions and statements of material facts annexed to notices of general meetings. Timely
interference by the EMD caused four companies to withdraw the proposed resolutions for making
investments aggregating Rs. 120 million in their associated companies. In another case, a company was
prevented from selling its investment in a subsidiary at a throw away price. Another company was
restricted to pass a resolution for making advances to associated undertakings without any return thereon.
A number of cases were also identified where investments were either made in associated companies
without approval of shareholders or in excess of the prescribed limit or free of any return. Proceedings
were initiated against 15 companies for violation of the mandatory provisions of the Companies
Ordinance. Of these, five cases were disposed of during the year while others were pending adjudication
as of June 30, 2002. As a result of actions taken by the EMD, more than Rs. 1.1 million, along with
return thereon at not less than the borrowing cost of the investing companies, would be returned to these
companies. The details of cases disposed of during the year are given in the table below.
TABLE 20 Cases of Unlawful Inter-corporate Financing Disposed of During the Year
S. No. Company
Amount Invested Action Taken
(Rs. In Million)
1
Spencer and company 504.697
Penalty of Rs. I million imposed on the CEO
(Pakistan) Limited
and direction given to recover the investment
along with return.
2
Gharibwal
cement 510.841
Penalty of Rs. 1.5 million imposed on the CEO
Limited
and directors and direction given to recover the
investments.
3
Mandviwalla Mauser
18.000
Penalty of Rs. 200,000 imposed on the CEO and
direction given to recover the investment and
return thereon.
4
Yousaf Textile Mills 5.626
Penalty of Rs. 10,000 imposed on the CEO.
Limited
5
Ghani Glass Limited
49.935
Penalty of Rs. 135,000 imposed on the CEO and
directors and direction given to recover the
return on investments.
Total
1,089.099
Further to the orders made by the Executive Director, EMD, appeals were filed before the Appellate
Bench of the Commission in the matter of Spencer and Company (Pakistan) Limited and Gharibwal
Cement Limited. While the decision of the Executive Director was upheld by the Appellate Bench in the
case of Spencer and Company (Pakistan) Limited, the penalty, in the case of Gharibwal Cement Limited,
was reduced from Rs. 1.5 million to Rs. 600,000. The case of Spencer and Company (Pakistan) Limited
is now pending before the Honorable Sindh High Court. In another case, the Honorable Sindh High
Court has stayed the show cause proceedings initiated by the EMD against a listed company for making
216
unlawful investments in its associated companies.

4.3.12 Sale of Substantial Assets at a Loss to Minority Shareholders
During the year under review, the EMD also took note of situations where sale proceeds of assets of
companies were used to settle their outstanding debts, including the amounts borrowed from sponsors.
Effectively, this practice results in a loss in the value of investment of minority shareholders. The EMD
took a number of remedial measures to discourage this practice. Based on a review of notices published
in newspapers regarding sale of assets by companies, appropriate directions were issued to concerned
companies to ensure that minority shareholders were adequately compensated. This policy was adopted
in the case of companies in which either there was no chance of revival of operations or the future returns
to shareholders were considered negligible. During the year, two companies were directed not to sell a
sizable part of their assets without the approval of the Commission. Accordingly, these companies were
unable to undertake business that was prejudicial to the interest of minority shareholders.
4.3.13 Proper Exercise of Powers by Directors
Provisions of the Companies Ordinance, 1984 place certain restrictions on exercise of powers by
directors. During the year under review, two cases were identified where directors had exceeded their
powers in violation of statutory provisions and had, in each case, disposed of a sizeable part of the
undertaking without seeking the consent of shareholders in general meetings. Taking cognizance of these
violations, the EMD issued show cause notices to the directors of these companies. While one of the
cases was pending adjudication at the end of financial year 2002, the directors of the other company have
obtained the stay order of the Court in respect of proceedings initiated by the EMD.
4.3.14 Loans to Directors
Section 195 of the Companies Ordinance, 1984 prohibits public companies and private companies, which
are subsidiaries of public companies, to provide loans, or give guarantees in connection with loans, to
their directors. These restrictions equally apply to loans or guarantees to relatives of directors and private
companies or firms in which such directors have substantial interest. During the year under review, the
EMD issued directives to the following companies whose funds had been transferred in contravention of
the statutory requirements.
(i)
The CEO and directors of Associated Industries Limited were directed to recover an amount of Rs.
18.3 million, along with mark-up, from its associated company, Quality Food Products (Private)
Limited. This amount was unlawfully advanced to the associated company and no interest was
being charged under the pretext of non-trading transactions. The company, on the directions of the
Commission, recovered an amount of Rs. 46.1 million on account of principal and mark-up.
(ii)
The CEO and directors of United Distributors Pakistan Limited were directed to recover the amount
of interest-free loan of Rs. 34.7 million from its associated company, International Brands (Private)
Limited. The full amount of the loan has been recovered by the company on the directions of the
Commission.
(iii) The directors of Brothers Textile Mills Limited were directed to cancel the guarantee provided to a
bank in connection with a loan given by the said bank to one of its associated undertakings. The
company has complied with the direction of the Commission and consequential proceedings have
been dropped accordingly.
Section 195 allows that a company, subject to the approval of the Commission, can extend a loan to a
217
whole time working director for the purpose of construction or acquisition of a house or other purposes
enumerated in the said Section. During the year, only one application was received from a company to
seek approval for giving a house-building loan to its director. The application was suitably processed and
disposed of.
4.3.15 Irregularities in Holding of Election of Directors
In case of 22 listed companies, the EMD took cognizance of lack of disclosure in notices of general
meetings regarding proposed resolutions for election of directors. Explanations were called and remedial
actions were taken by the EMD. However, on a complaint by NIT that election of directors in a company
was held through show of hands and not in compliance with the procedure prescribed in Section 178 of
the Companies Ordinance, 1984, necessary proceedings were initiated against the company. As a result,
the CEO of the company was fined for violating mandatory provisions of the Companies Ordinance,
1984.
218
Appendix 3. Case Study Evidence on Corporate Structures

Figure A 3.1 Interlocking directorates 1970
Premier
Arag
Hoti
Khanzada
Ferozesons
Dada
Nishat
Zafarul Ahsan
Valika
Colony (F)
Saigol
Crescent
Reyaz-oKhalid
Shahnawaz
Hyesons
Colony (N)
Rahimtoola
Wazir Ali
Amins
Bawany
Habib
R
a
n
g
o
o
n
wala
D
a
w
o
o
d
A
d
a
m
j
e
e
A.
K.
K
h
a
n
Haroon
Husein
Faruque
Dadabhoy
Represents at least one directorship by a family
member of a monopoly house in a firm under
the control of another monopoly house.
A. Khaleeli
219
Isphani
Figure A 3.2 Pyramiding in a Prominent Pakistani Business Group 1
Familys Direct
Holding
6.93 (% of total share value)
0.27
Post-Privatization
Acquisition
19.28
Flagship
Company
0.63
0.04
30
0.24
Associated Public
Ltd. Operating Co.
Associated Public
Company
Associated Pvt.
Ltd. Co. holding
Inter-Corporate Holding
220
31.66
Figure A 3.3 Pyramiding in a Prominent Pakistani Business Group 2
Familys Direct Holding

73.82
Flagship Co. 1
16.10
0.77 (% of total share value)
0.67
60.28
Flagship Co. 2
Flagship Co. 3
0.11
5.72
Associated
Pvt. Co. 1
19.86
1.91
Associated
Pvt. Co. 2
1.60
50.01
4.68
5.06
0.24
19.52
Associated
Pvt. Co. 3
Associated
Pvt. Co. 4
Associated
Pvt. Co. 5
Inter-Corporate Holding
221
Associated
Pvt. Co. 6
Figure A 3.4 Cumulative Share of Market Capitalization and Turnover by Firm$
222
Securities and Exchange Commission of Pakistan
Appendix 4. The Code of Corporate Governance

March 28, 2002
BOARD OF DIRECTORS
(i)
All listed companies shall encourage effective representation of independent non-executive

directors, including those representing minority interests, on their Boards of Directors so that the
Board as a group includes core competencies considered relevant in the context of each listed
company. For the purpose, listed companies may take necessary steps such that:
(a) minority shareholders as a class are facilitated to contest election of directors by proxy
solicitation, for which purpose the listed companies may:
annex to the notice of general meeting at which directors are to be elected, a statement by
a candidate(s) from among the minority shareholders who seeks to contest election to the
Board of Directors, which statement may include a profile of the candidate(s);
provide information regarding shareholding structure and copies of register of members
to the candidate(s) representing minority shareholders; and
on a request by the candidate(s) representing minority shareholders and at the cost of the
company, annex to the notice of general meeting at which directors are to be elected an
additional copy of proxy form duly filled in by such candidate(s) and transmit the same to
all shareholders in terms of section 178 (4) of the Companies Ordinance, 1984;
(b) the Board of Directors of each listed company includes at least one independent director
representing institutional equity interest of a banking company, Development Financial
Institution, Non-Banking Financial Institution (including a modaraba, leasing company or
investment bank), mutual fund or insurance company; and
Explanation: For the purpose of this clause, the expression "independent director" means a
director who is not connected with the listed company or its promoters or directors on the
basis of family relationship and who does not have any other relationship, whether pecuniary
or otherwise, with the listed company, its associated companies, directors, executives or
related parties. The test of independence principally emanates from the fact whether such
person can be reasonably perceived as being able to exercise independent business judgment
without being subservient to any apparent form of interference.
Any person nominated as a director under sections 182 and 183 of the Companies Ordinance,
1984 shall not be taken to be an "independent director" for the above said purposes.
The independent director representing an institutional investor shall be selected by such
investor through a resolution of its Board of Directors and the policy with regard to selection
of such person for election on the Board of Directors of the investee company shall be
disclosed in the Directors' Report of the investor company.
(c) executive directors, i.e. working or whole time directors, are not more than 75% of the
elected directors including the Chief Executive:
Provided that in special circumstances, this condition may be relaxed by the Securities and
Exchange Commission of Pakistan.
223
Provided further that nothing contained in this clause shall apply to banking companies,
which are required by Prudential Regulation No.9 for Banks to have not more than 25% of
the directors as paid executives of the banks.
(ii)
The directors of listed companies shall, at the time of filing their consent to act as such, give a
declaration in such consent that they are aware of their duties and powers under the relevant
law(s) and the listed companies Memorandum and Articles of Association and the listing
regulations of stock exchanges in Pakistan.
QUALIFICATION AND ELIGIBILITY TO ACT AS A DIRECTOR

(iii)
No listed company shall have as a director, a person who is serving as a director of ten other
listed companies.
(iv)
No person shall be elected or nominated as a director of a listed company if:

(a) his name is not borne on the register of National Tax Payers except where such person is a
non-resident; and
(v)
(b) he has been convicted by a court of competent jurisdiction as a defaulter in payment of any
loan to a banking company, a Development Financial Institution or a Non-Banking Financial
Institution or he, being a member of a stock exchange, has been declared as a defaulter by
such the stock exchange; and
A listed company shall endeavour that no person is elected or nominated as a director if he or his
spouse is engaged in the business of stock brokerage (unless specifically exempted by the
Securities and Exchange Commission of Pakistan).
TENURE OF OFFICE OF DIRECTORS

(vi)
The tenure of office of Directors shall be three years. Any casual vacancy in the Board of
Directors of a listed company shall be filled up by the directors within 30 days thereof.
RESPONSIBILITIES, POWERS AND FUNCTIONS OF BOARD OF DIRECTORS

(vii)
The directors of listed companies shall exercise their powers and carry out their fiduciary duties
with a sense of objective judgment and independence in the best interests of the listed company.
(viii)
Every listed company shall ensure that:

(a) a Statement of Ethics and Business Practices is prepared and circulated annually by its
Board of Directors to establish a standard of conduct for directors and employees, which
Statement shall be signed by each director and employee in acknowledgement of his
understanding and acceptance of the standard of conduct;
(b) the Board of Directors adopt a vision/ mission statement and overall corporate strategy for the
listed company and also formulate significant policies, having regard to the level of
materiality, as may be determined it;
Explanation:
Significant policies for this purpose may include:
224
risk management;
human resource management including preparation of a succession plan;
procurement of goods and services;
marketing;
determination of terms of credit and discount to customers;
write-off of bad/ doubtful debts, advances and receivables;
acquisition/ disposal of fixed assets;
investments;
borrowing of moneys and the amount in excess of which borrowings shall be sanctioned/
ratified by a general meeting of shareholders;
donations, charities, contributions and other payments of a similar nature;
determination and delegation of financial powers;
transactions or contracts with associated companies and related parties; and
health, safety and environment
A complete record of particulars of the significant policies, as may be determined, along

with the dates on which they were approved or amended by the Board of Directors shall be
maintained.
The Board of Directors shall define the level of materiality, keeping in view the specific
circumstances of the listed company and the recommendations of any technical or executive
sub-committee of the Board that may be set up for the purpose;
(c)
the Board of Directors establish a system of sound internal control, which is effectively
implemented at all levels within the listed company;
(d)
the following powers are exercised by the Board of Directors on behalf of the listed company and
decisions on material transactions or significant matters are documented by a resolution passed at
a meeting of the Board:
(e)
investment and disinvestment of funds where the maturity period of such investments is six
months or more, except in the case of banking companies, Non-Banking Financial
Institutions, trusts and insurance companies;
determination of the nature of loans and advances made by the listed company and fixing a
monetary limit thereof;
write-off of bad debts, advances and receivables and determination of a reasonable provision
for doubtful debts;
write-off of inventories and other assets; and
determination of the terms of and the circumstances in which a law suit may be compromised
and a claim/ right in favour of the listed company may be waived, released, extinguished or
relinquished;
appointment, remuneration and terms and conditions of employment of the Chief Executive
Officer (CEO) and other executive directors of the listed company are determined and approved
by the Board of Directors; and
225
(f)
in the case of a modaraba or a Non-Banking Financial Institution, whose main business is

investment in listed securities, the Board of Directors approve and adopt an investment policy,
which is stated in each annual report of the modaraba/ Non-Banking Financial Institution.
Explanation:
The investment policy shall inter alia state:
that the modaraba/ Non-Banking Financial Institution shall not invest in a connected person,
as defined in the Asset Management Companies Rules, 1995, and shall provide a list of all
such connected persons;
that the modaraba/ Non-Banking Financial Institution shall not invest in shares of unlisted
companies; and
the criteria for investment in listed securities.
The Net Asset Value of each modaraba/ Non-Banking Financial Institution shall be provided
for publication on a monthly basis to the stock exchange on which its shares/ certificates are
listed.
(ix)
The Chairman of a listed company shall preferably be elected from among the non-executive
directors of the listed company. The Board of Directors shall clearly define the respective roles
and responsibilities of the Chairman and Chief Executive, whether or not these offices are held by
separate individuals or the same individual.
MEETINGS OF THE BOARD

(x)
The Chairman of a listed company, if present, shall preside over meetings of the Board of
Directors.
(xi)
The Board of Directors of a listed company shall meet at least once in every quarter of the
financial year. Written notices (including agenda) of meetings shall be circulated not less than
seven days before the meetings, except in the case of emergency meetings, where the notice
period may be reduced or waived.
(xii)
The Chairman of a listed company shall ensure that minutes of meetings of the Board of Directors
are appropriately recorded. The minutes of meetings shall be circulated to directors and officers
entitled to attend Board meetings not later than 30 days thereof, unless a shorter period is
provided in the listed companys Articles of Association.
In the event that a director of a listed company is of the view that his dissenting note has not been
satisfactorily recorded in the minutes of a meeting of the Board of Directors, he may refer the
matter to the Company Secretary. The director may require the note to be appended to the
minutes, failing which he may file an objection with the Securities and Exchange Commission of
Pakistan in the form of a statement to that effect.
SIGNIFICANT ISSUES TO BE PLACED FOR DECISION BY THE BOARD OF DIRECTORS

(xiii)
In order to strengthen and formalize corporate decision-making process, significant issues shall
be placed for the information, consideration and decision of the Boards of Directors of listed
companies.
226
Significant issues for this purpose may include:
annual business plans, cash flow projections, forecasts and long term plans;
budgets including capital, manpower and overhead budgets, along with variance analyses;
quarterly operating results of the listed company as a whole and in terms of its operating
divisions or business segments;
internal audit reports, including cases of fraud or irregularities of a material nature;
management letter issued by the external auditors;
details of joint venture or collaboration agreements or agreements with distributors, agents,
etc;
promulgation or amendment of a law, rule or regulation, enforcement of an accounting
standard and such other matters as may affect the listed company;
status and implications of any law suit or proceedings of material nature, filed by or against
the listed company;
any show cause, demand or prosecution notice received from revenue or regulatory
authorities, which may be material;
default in payment of principal and/or interest, including penalties on late payments and other
dues, to a creditor, bank or financial institution or default in payment of public deposit;
failure to recover material amounts of loans, advances, and deposits made by the listed
company, including trade debts and inter-corporate finances;
any significant accidents, dangerous occurrences and instances of pollution and
environmental problems involving the listed company;
significant public or product liability claims likely to be made against the listed company,
including any adverse judgment or order made on the conduct of the listed company or of
another company that may bear negatively on the listed company;
disputes with labour and their proposed solutions, any agreement with the labour union or
Collective Bargaining Agent and any charter of demands on the listed company; and
payment for goodwill, brand equity or intellectual property.
ORIENTATION COURSES
(xiv)
All listed companies shall make appropriate arrangements to carry out orientation courses for
their directors to acquaint them with their duties and responsibilities and enable them to manage
the affairs of the listed companies on behalf of shareholders.
CHIEF FINANCIAL OFFICER (CFO) AND COMPANY SECRETARY

APPOINTMENT AND APPROVAL
(xv)
The appointment, remuneration and terms and conditions of employment of the Chief Financial
Officer (CFO), the Company Secretary and the head of internal audit of listed companies shall be
determined by the CEO with the approval of the Board of Directors. The CFO or the Company
Secretary of listed companies shall not be removed except by the CEO with the approval of the
Board of Directors.
QUALIFICATION OF CFO AND COMPANY SECRETARY

(xvi)
No person shall be appointed as the CFO of a listed company unless:
227
(xvii)
(a) he is a member of a recognized body of professional accountants; or

(b) he is a graduate from a recognized university or equivalent, having at least five years
experience in handling financial or corporate affairs of a listed public company or a bank or a
financial institution.
No person shall be appointed as the Company Secretary of a listed company unless he is:
(a) a member of a recognized body of professional accountants; or
(b) a member of a recognized body of corporate/ chartered secretaries; or
(c) a lawyer; or
(d) a graduate from a recognized university or equivalent, having at least five years
experience of handling corporate affairs of a listed public company or corporation.
REQUIREMENT TO ATTEND BOARD MEETINGS

(xviii) The CFO and the Company Secretary of a listed company shall attend meetings of the Board of
Directors.
Provided that unless elected as a director, the CFO or the Company Secretary shall not be deemed
to be a director or entitled to cast a vote at meetings of the Board of Directors for the purpose of
this clause. Provided further that the CFO and/ or the Company Secretary shall not attend such
part of a meeting of the Board of Directors, which involves consideration of an agenda item
relating to the CFO, Company Secretary, CEO or any director.
CORPORATE AND FINANCIAL REPORTING FRAMEWORK
THE DIRECTORS REPORT TO SHAREHOLDERS
(xix)
The directors of listed companies shall include statements to the following effect in the Directors
Report, prepared under section 236 of the Companies Ordinance, 1984:
(a) The financial statements, prepared by the management of the listed company, present fairly its
state of affairs, the result of its operations, cash flows and changes in equity.
(b) Proper books of account of the listed company have been maintained.
(c) Appropriate accounting policies have been consistently applied in preparation of financial
statements and accounting estimates are based on reasonable and prudent judgment.
(d) International Accounting Standards, as applicable in Pakistan, have been followed in
preparation of financial statements and any departure therefrom has been adequately
disclosed.
(e) The system of internal control is sound in design and has been effectively implemented and
monitored.
(f) There are no significant doubts upon the listed companys ability to continue as a going
concern.
(g) There has been no material departure from the best practices of corporate governance, as
detailed in the listing regulations.
The Directors Reports of listed companies shall also include the following, where necessary:
(a) If the listed company is not considered to be a going concern, the fact along with reasons shall
be disclosed.
(b) Significant deviations from last year in operating results of the listed company shall be
highlighted and reasons thereof shall be explained.
228
(c) Key operating and financial data of last six years shall be summarised.
(d) If the listed company has not declared dividend or issued bonus shares for any year, the
reasons thereof shall be given.
(e) Where any statutory payment on account of taxes, duties, levies and charges is outstanding,
the amount together with a brief description and reasons for the same shall be disclosed.
(f) Significant plans and decisions, such as corporate restructuring, business expansion and
discontinuance of operations, shall be outlined along with future prospects, risks and
uncertainties surrounding the listed company.
(g) A statement as to the value of investments of provident, gratuity and pension funds, based on
their respective audited accounts, shall be included.
(h) The number of Board meetings held during the year and attendance by each director shall be
disclosed.
(i) The pattern of shareholding shall be reported to disclose the aggregate number of shares (along
with name wise details where stated below) held by:
associated companies, undertakings and related parties (name wise details);
NIT and ICP (name wise details);
directors, CEO and their spouse and minor children (name wise details);
executives;
public sector companies and corporations;
banks, Development Finance Institutions, Non-Banking Finance Institutions, insurance
companies, modarabas and mutual funds; and
shareholders holding ten percent or more voting interest in the listed company (name
wise details).
Explanation: For the purpose of this clause, clause (b) of direction (i) and direction (xxiii),
the expression executive means an employee of a listed company other than the CEO and
directors whose basic salary exceeds five hundred thousand rupees in a financial year.
(j) All trades in the shares of the listed company, carried out by its directors, CEO, CFO,
Company Secretary and their spouses and minor children shall also be disclosed.
FREQUENCY OF FINANCIAL REPORTING
(xx)
The quarterly unaudited financial statements of listed companies shall be published and circulated
along with directors review on the affairs of the listed company for the quarter.
(xxi)
All listed companies shall ensure that half-yearly financial statements are subjected to a limited
scope review by the statutory auditors in such manner and according to such Securities and
Exchange Commission of Pakistan terms and conditions as may be determined by the Institute of
Chartered Accountants of Pakistan and approved by the Securities and Exchange Commission of
Pakistan.
(xxii) All listed companies shall ensure that the annual audited financial statements are circulated not
later than four months from the close of the financial year.
(xxiii) Every listed company shall immediately disseminate to the Securities and Exchange Commission
of Pakistan and the stock exchange on which its shares are listed all material information relating
to the business and other affairs of the listed company that will affect the market price of its
shares. Mode of dissemination of information shall be prescribed by the stock exchange on which
shares of the company are listed.
229
This information may include but shall not be restricted to information regarding a joint venture,
merger or acquisition or loss of any material contract; purchase or sale of significant assets; any
unforeseen or undisclosed impairment of assets due to technological obsolescence, etc.; delay/
loss of production due to strike, fire, natural calamities, major breakdown, etc.; issue or
redemption of any securities; a major change in borrowings including any default in repayment or
rescheduling of loans; and change in directors, Chairman or CEO of the listed company.
RESPONSIBILITY FOR FINANCIAL REPORTING AND CORPORATE COMPLIANCE
(xxiv) No listed company shall circulate its financial statements unless the CEO and the CFO present the
financial statements, duly endorsed under their respective signatures, for consideration and
approval of the Board of Directors and the Board, after consideration and approval, authorize the
signing of financial statements for issuance and circulation.
(xxv)
The Company Secretary of a listed company shall furnish a Secretarial Compliance Certificate, in
the prescribed form, as part of the annual return filed with the Registrar of Companies to certify
that the secretarial and corporate requirements of the Companies Ordinance, 1984 have been duly
complied with.
DISCLOSURE OF INTEREST BY A DIRECTOR HOLDING COMPANYS SHARES

(xxvi) Where any director, CEO or executive of a listed company or their spouses sell, buy or take any
position, whether directly or indirectly, in shares of the listed company of which he is a director,
CEO or executive, as the case may be, he shall immediately notify in writing the Company
Secretary of his intentions. Such director, CEO or executive, as the case may be, shall also deliver
a written record of the price, number of shares, form of share certificates (i.e. whether physical or
electronic within the Central Depository System) and nature of transaction to the Company
Secretary within four days of effecting the transaction. The notice of the director, CEO or
executive, as the case may be, shall be presented by the Company Secretary at the meeting of the
Board of Directors immediately subsequent to such transaction. In the event of default by a
director, CEO or executive to give a written notice or deliver a written record, the Company
Secretary shall place the matter before the Board of Directors in its immediate next meeting:
Provided that each listed company shall determine a closed period prior to the announcement of
interim/ final results and any business decision, which may materially affect the market price of
its shares. No director, CEO or executive shall, directly or indirectly, deal in the shares of the
listed company in any manner during the closed period.
AUDITORS NOT TO HOLD SHARES
(xxvii) All listed companies shall ensure that the firm of external auditors or any partner in the firm of
external auditors and his spouse and minor children do not at any time hold, purchase, sell or take
any position in shares of the listed company or any of its associated companies or undertakings:
Provided that where a firm or a partner or his spouse or minor child owns shares in a listed
company, being the audit client, prior to the appointment as auditors, such listed company shall
take measures to ensure that the auditors disclose the interest to the listed Securities company
within 14 days of appointment and divest themselves of such interest not later than 90 days
thereof.
230
CORPORATE OWNERSHIP STRUCTURE

(xxviii) Every company which is proposed to be listed shall, at the time of public offering, offer not less
than Rs. 100 million or 20% of the share capital of the company, whichever is higher, to the
general public unless the limit is relaxed by the stock exchange with the approval of the Securities
and Exchange Commission of Pakistan.
DIVESTITURE OF SHARES BY SPONSORS/CONTROLLING INTEREST
(xxix) In the event of divestiture of not less than 75% of the total shareholding of a listed company,
other than a divestiture by non-resident shareholder(s) in favour of other nonresident
shareholder(s) or a disinvestment through the process of privatization by the Federal or Provincial
Government, at a price higher than the market value ruling at the time of divestiture, it shall be
desirable and expected of the directors of the listed company to allow the transfer of shares after
it has been ascertained that an offer in writing has been made to the minority shareholders for
acquisition of their shares at the same price at which the divestiture of majority shares was
contemplated. Where the offer price to minority shareholders is lower than the price offered for
acquisition of controlling interest, such offer price shall be subject to the approval of the
Securities and Exchange Commission of Pakistan.
AUDIT COMMITTEE
COMPOSITION
(xxx)
The Board of Directors of every listed company shall establish an Audit Committee, which shall
comprise not less than three members, including the chairman. Majority of the members of the
Committee shall be from among the non-executive directors of the listed company and the
chairman of the Audit Committee shall preferably be a non-Securities and Exchange Commission
of Pakistan executive director. The names of members of the Audit Committee shall be disclosed
in ach annual report of the listed company.
FREQUENCY OF MEETINGS
(xxxi) The Audit Committee of a listed company shall meet at least once every quarter of the financial
year. These meetings shall be held prior to the approval of interim results of the listed company
by its Board of Directors and before and after completion of external audit. A meeting of the
Audit Committee shall also be held, if requested by the external auditors or the head of internal
audit.
ATTENDANCE AT MEETINGS
(xxxii) The CFO, the head of internal audit and a representative of the external auditors shall attend
meetings of the Audit Committee at which issues relating to accounts and audit are discussed.
Provided that at least once a year, the Audit Committee shall meet the external auditors without
the CFO and the head of internal audit being present.
Provided further that at least once a year, the Audit Committee shall meet the head of internal
audit and other members of the internal audit function without the CFO and the external auditors
being present.
231
TERMS OF REFERENCE
(xxxiii) The Board of Directors of every listed company shall determine the terms of reference of the
Audit Committee. The Audit Committee shall, among other things, be responsible for
recommending to the Board of Directors the appointment of external auditors by the listed
companys shareholders and shall consider any questions of resignation or removal of external
auditors, audit fees and provision by external auditors of any service to the listed company in
addition to audit of its financial statements. In the absence of strong grounds to proceed
otherwise, the Board of Directors shall act in accordance with the recommendations of the Audit
Committee in all these matters.
The terms of reference of the Audit Committee shall also include the following:
(a) determination of appropriate measures to safeguard the listed companys assets;
(b) review of preliminary announcements of results prior to publication;
(c) review of quarterly, half-yearly and annual financial statements of the listed company, prior to
their approval by the Board of Directors, focusing on:
major judgmental areas;
significant adjustments resulting from the audit;
the going-concern assumption;
any changes in accounting policies and practices;
compliance with applicable accounting standards; and
compliance with listing regulations and other statutory and regulatory requirements.
(d) facilitating the external audit and discussion with external auditors of major observations
arising from interim and final audits and any matter that the auditors may wish to highlight (in
the absence of management, where necessary);
(e) review of management letter issued by external auditors and managements response thereto;
(f) ensuring coordination between the internal and external auditors of the listed company;
(g) review of the scope and extent of internal audit and ensuring that the internal audit function
has adequate resources and is appropriately placed within the listed company;
(h) consideration of major findings of internal investigations and management's response thereto;
(i) ascertaining that the internal control system including financial and operational controls,
accounting system and reporting structure are adequate and effective;
(j) review of the listed companys statement on internal control systems prior to endorsement by
the Board of Directors;
(k) instituting special projects, value for money studies or other investigations on any matter
specified by the Board of Directors, in consultation with the Chief Executive and to consider
remittance of any matter to the external auditors or to any other external body;
(l) determination of compliance with relevant statutory requirements;
(m) monitoring compliance with the best practices of corporate governance and identification of
significant violations thereof; and
(n) consideration of any other issue or matter as may be assigned by the Board of Directors.
REPORTING PROCEDURE
232
(xxxiv) The Audit Committee of a listed company shall appoint a secretary of the Committee. The
secretary shall circulate minutes of meetings of the Audit Committee to all members, directors
and the CFO within a fortnight.
INTERNAL AUDIT
(xxxv) There shall be an internal audit function in every listed company. The head of internal audit shall
have access to the chair of the Audit Committee.
(xxxvi) All listed companies shall ensure that internal audit reports are provided for the review of external
auditors. The auditors shall discuss any major findings in relation to the reports with the Audit
Committee, which shall report matters of significance to the Board of Directors.
EXTERNAL AUDITORS
(xxxvii)No listed company shall appoint as external auditors a firm of auditors which has not been given a
satisfactory rating under the Quality Control Review programme of the Institute of Chartered
Accountants of Pakistan.
(xxxviii)No listed company shall appoint as external auditors a firm of auditors which firm or a partner of
which firm is non-compliant with the International Federation of Accountants' (IFAC) Guidelines
on Code of Ethics, as adopted by the Institute of Chartered Accountants of Pakistan.
(xxxix) The Board of Directors of a listed company shall recommend appointment of external auditors for
a year, as suggested by the Audit Committee. The recommendations of the Audit Committee for
appointment of retiring auditors or otherwise shall be included in the Directors Report. In case of
a recommendation for change of external auditors before the elapse of three consecutive financial
years, the reasons for the same shall be included in the Directors Report.
(xl)
No listed company shall appoint its auditors to provide services in addition to audit except in
accordance with the regulations and shall require the auditors to observe applicable IFAC
guidelines in this regard and shall ensure that the auditors do not perform management functions
or make management decisions, responsibility for which remains with the Board of Directors and
management of the listed company.
(xli)
All listed companies are required to change their external auditors every five years. If for any
reason this is impractical, a listed company may at a minimum, rotate the partner in charge of its
audit engagement after obtaining the consent of the Securities and Exchange Commission of
Pakistan.
(xlii)
No listed company shall appoint a person as the CEO, the CFO, an internal auditor or a director
of the listed company who was a partner of the firm of its external auditors (or an employee
involved in the audit of the listed company) at any time during the two years preceding such
appointment or is a close relative, i.e. spouse, parents, dependents and non-dependent children, of
such partner (or employee).
(xliii) Every listed company shall require external auditors to furnish a Management Letter to its Board
of Directors not later than 30 days from the date of audit report.
(xliv)
Every listed company shall require a partner of the firm of its external auditors to attend the
Annual General Meeting at which audited accounts are placed for consideration and approval of
shareholders.
233
COMPLIANCE WITH THE CODE OF CORPORATE GOVERNANCE

(xlv)
All listed companies shall publish and circulate a statement along with their annual reports to set
out the status of their compliance with the best practices of corporate governance set out above.
(xlvi) All listed companies shall ensure that the statement of compliance with the best practices of
corporate governance is reviewed and certified by statutory auditors, where such compliance can
be objectively verified, before publication by listed companies.
(xlvii) Where the Securities and Exchange Commission of Pakistan is satisfied that it is not practicable
to comply with any of the best practices of corporate governance in a particular case, the
Commission may, for reasons to be recorded, relax the same subject to such conditions as it may
deem fit.
Clause Reference
Brief Description
(i)
Representation of independent non-executive directors,

including those representing minority interests, on the Board
of Directors of listed companies
(ii)
(iii) and (iv)
(v)
(vi)
(vii), (viii)and (ix)
(x), (xi)and (xii)
(xiii)
Manner of
Enforcement
Voluntary
Effective
Date
When next election is due
Filing of consent by directors

Qualification and eligibility to act as a director
Election/ nomination of a broker on the Board of Directors
Mandatory
Mandatory
Voluntary

Tenure of office of directors

Responsibilities, powers and functions of the Board of
Directors
Mandatory
Mandatory
Immediate
July 1, 2002
Mandatory
Mandatory
Immediate
July 1, 2002
Mandatory
Mandatory
July 1, 2002
July 1, 2002
Mandatory
Immediately for new

appointments
Mandatory
Immediate
Mandatory
For accounting periods

ending on or after June 30,
2002
2002
2002
Meetings of the Board of Directors

Significant issues to be placed for decision by the Board of
Directors
(xiv)
(xv)
Orientation courses
Appointment and removal of CFO and Company Secretary
(xvi) and(xvii)
Qualification of CFO and Company Secretary
(xviii)
Requirement for CFO and Company Secretary to attend
Board meetings
(xix)
The directors' report to shareholders
(xx), (xxi),(xxii) and
(xxiii)
Mandatory
Frequency of financial reporting
(xxiv) and(xxv)
Mandatory
Responsibility for financial reporting and corporate
compliance
(xxvi)
Mandatory
Immediate
Disclosure of interest by a director holding company's
234

(xxvii)
(xxviii)
(xxix)
(xxx),(xxxi),(xxxii),
(xxxiii) and(xxxiv)
(xxxv) and (xxxvi)
(xxxvii), (xxxviii),
(xxxix) and (xl)
(xli)
shares
Auditors not to hold shares
Corporate ownership structure
Divestiture of shares by sponsors/ controlling interest
Audit Committee
Internal Audit
Appointment of external auditors
Mandatory
Mandatory
Mandatory
Mandatory
Immediate
July 1, 2002
July 1, 2002
July 1, 2002
Mandatory
Mandatory
July 1, 2002
When next appointment of
auditors is due
When next appointment of
auditors is due
Mandatory
Rotation of external auditors

(xlii)
(xliii)
Appointment of a partner or employee of the external

auditors in a key position within the listed company
Mandatory
Immediately for new

appointments
Mandatory

2002
2002
2002
Management letter issued by external auditors

(xliv)
Mandatory
Attendance of external auditors at Annual General Meeting
(xlv) and (xlvi)
Mandatory
Compliance with the Code of Corporate Governance
235
Appendix 5
The Legal Aspects of Corporate Governance in Pakistan
By Osama Siddique
Introduction
Recent years have seen a spate of activity in and tremendous emphasis on the area of corporate
governance all over the world. This development has been for a variety of reasons, ranging from a
downturn in economic performance exposing otherwise undisclosed corporate governance weaknesses to
downright corruption in the uppermost echelons of global corporations. The reasons why this area has
been comparatively less studied in Pakistan have more to do with the level of development of its
corporate sector. The past few years, however, have been very significant in terms of legal developments
in the corporate governance area and some recently introduced laws and regulations are progressive and
up to speed with the latest global trends. There is growing awareness in the legal and corporate circles in
Pakistan that corporate governance is not just a sophisticated buzzword but is profoundly important to the
sound functioning of a corporate system and fundamental to the establishment of investor and creditor
confidence
The following overview of the fast evolving legal regime governing corporate governance in Pakistan has
been prepared, keeping in view certain internationally accepted standards and principles of good
corporate governance. While there is a wealth of contemporary literature on the subject, these
benchmarks for best practices of corporate governance have been gleaned primarily from the report of a
committee set up in the United Kingdom to look into the financial aspects of corporate governance, which
was submitted under the chairmanship of Sir Adrian Cadbury on 1st December, 1992110. This seminal
report (now widely known as and hereinafter referred to as the Cadbury Report) is regarded as one of
the most penetrative and exhaustive contemporary studies of the issues of modern corporate governance
and puts forward detailed findings and recommendations. The output of the Cadbury Report has been
widely discussed in recent years and forms the basis of several subsequent reports on corporate
governance and codes of best practices, including a code for corporate governance, which has been
recently introduced in Pakistan.
One significant area of corporate governance, which was not within the ambit of the Cadbury Report, is
creditors rights. Partially to fill this gap and partially to supplement the Cadbury Report with another
more recent study in the area, additional standards and principles, especially for the creditors rights
area have been obtained from a paper by La Porta, Lopez-de-Silanes, Shleifer and Vishny111 (the La
Porta Report, the Cadbury Report and the La Porta Report are hereinafter collectively referred to as the
International Corporate Governance Reports). The La Porta Report conducts an analysis of the
corporate governance rules pertaining to the protection of the rights of shareholder and creditors in 49
countries, the origin of these rules and the quality and effectiveness of their enforcement. The La Porta
Report thus offers standards with a very international appeal and applicability.
This appendix states the corporate governance best practices from the International Corporate Governance
Reports and then compares the best practice with Pakistani legal and regulatory provisions.
The Corporate Governance Law Regime in Pakistan
110
Report of the Committee on the Financial Aspects of Corporate Governance. 1st December, 1992.
Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer -- Harvard University. Robert W. Vishny,
University of Chicago. The Journal of Political Economy, Volume 106, Issue 6 (Dec, 1998), 1113-1155.
111
236
The following is a brief description of the main laws and primary agencies, which oversee and regulate
corporate governance in Pakistan.
Companies Ordinance, 1984 (Ordinance). This is the main overarching law in Pakistan relating
to the governance and regulation of entities incorporated as companies and certain other
associations. The Ordinance consolidates and amends the earlier laws relating to this area. The
Ordinance also lays out the powers and functions of the Corporate Law Authority. The Corporate
Law Authority is now replaced by the Securities and Exchange Commission of Pakistan (SECP)
which inherited all the powers of the Corporate Law Authority under the Ordinance. The
Ordinance further establishes the office of the Registrar who supervises the registration of
companies and related documents and the corporate disclosure requirements and performs other
related tasks. The Registrar is also equipped under the Ordinance with certain important
investigative and fact-finding powers.
Securities and Exchange Ordinance, 1969 (SE Ordinance). The Ordinance has been
promulgated for the stated purpose of providing for the protection of investors, regulation of
markets and dealings in securities and related matters and includes important provisions for the
prevention of fraud and insider trading.
Securities and Exchange Commission of Pakistan Act, 1997 (SECP Act). The SECP Act has
established the SECP for the beneficial regulation of the capital markets and the superintendence
and control of corporate entities. The SECP enjoys wide powers in this regard under the SECP
Act. The SECP Act also lays out important provisions defining fraudulent and unfair trade
practices as well as provisions defining powers of the SECP relating to the protection of minority
shareholders, creditors, the regulation of the board of directors of listed companies and the
internal management of the SECP.
Financial Institutions (Recovery of Finances) Ordinance, 2001 (Recovery of Finances
Ordinance). This Ordinance has been promulgated with the stated objective of safeguarding the
interests of creditors/financial institutions. It prescribes a summary procedure for the facilitation
of a swift recovery of defaulted loans.
Provincial Insolvency Act, 1920. The Provincial Insolvency Act consolidates and amends the
laws relating to insolvency.
Apart from the above main laws described above (Ordinance and related laws), the following recently
introduced regulatory codes are playing an increasingly important role in contemporary corporate
governance regulation in Pakistan.
Code of Corporate Governance, 2002 (Code). The Code was introduced by the SECP in early
2002 for the stated purpose of establishing a framework of good corporate governance whereby a
listed company can be managed in compliance with best practices. The Code has been prepared
after a review of the leading international reports prescribing best practices for corporate
governance, (including the Cadbury Report, which seems to have had a strong influence on its
eventual shape) and is exhaustive in scope. (Please see Appendix A for the detailed text of the
Code). The Code has been adopted by all the stock exchanges of the country by way of its
incorporation in their respective listing regulations, so that all the listed companies in Pakistan are
now required to comply with the provisions of the Code, according to a timeframe stated in the
Code itself. The SECP plans to supervise such compliance by requiring that:
(i)
All listed companies are to publish and circulate a statement along with their
annual reports to set out the status of their compliance with the best practices of
corporate governance;
(ii)
All listed companies are to ensure that the statement of compliance with the best
practices of corporate governance is reviewed and certified by statutory auditors,
237
where such compliance can be objectively verified, before publication by listed

companies; and
(iii)
Where the SECP is satisfied that it is not practicable to comply with any of the
best practices of corporate governance in a particular case, SECP may, for
reasons to be recorded, relax the same subject to such conditions as it may deem
fit.
Listed Companies (Prohibition of Insiders Trading) Guidelines, 2002 (Insider Trading
Guidelines). The Insider Trading Guidelines deal extensively with the insider trading
phenomenon and are a significant advancement in its regulation in Pakistan.
The Trichotomy of Shareholder/Creditor Rights protection in Pakistan

It would be useful to compartmentalize the protection of the rights of the shareholders and creditors
under Pakistani law under the following three heads.
1. Statutory Rights and Best Practice Guidelines. These are rights, which are already enshrined
in the Ordinance and related laws and hence there are in-built protections in the laws. For
example, the various rights and protections, which can be invoked by shareholders holding at
least 10% of the value of the total shareholding can be put in this category because these are
established rights which can be invoked whenever the requisite number of shareholders get
together and decide to invoke them. To this list can be added the additional protections
introduced by the Code and the Insider Trading Guidelines, which are of increasing
importance.
2. Protection through the Regulatory Agencies. The SECP and the Registrar have special
powers, which they can use on application of a shareholder or creditor or on their own
initiative, to ensure that companies are not doing anything which can lead to fraudulent or
negligent behaviour, resulting in a violation of the rights of shareholders and creditors.
3. Protection through the Courts. The Ordinance and related laws have special provisions,
which provide shareholders and creditors with recourse to the courts under special
circumstances. Over the years, the courts have made some significant contributions to the
existing statutory protection for the rights of shareholders and creditors, by way of a further
enhancement of and broadening of these rights.
The following is a synopsis of the laws, legal processes and guidelines, which currently exist in Pakistan,
presented and structured under the standards derived from the International Corporate Governance
Reports. These standards are laid out under the following broad categories:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
The structure and responsibilities of the Board of Directors

Powers and duties of Executive Directors
Role of the Non-Executive Directors (NEDs) and other executives
Financial disclosure and reporting requirements of the Company
The role of Internal and External Auditors
Prevention of Minority Shareholder oppression
Other Shareholder rights
Creditors rights
It is important to note here that the International Corporate Governance Reports provide relatively few
generic benchmarks for creditors rights protection. This is owing to the primary emphasis of these
reports on the relationship between boards of directors and shareholders as well as the diversity in the
kinds and types of creditors and hence their rights, which make such rights less amenable to be reduced to
some basic standards. For this reason, Creditors rights under the Pakistani legal system have been
238
discussed only to a limited extent in comparison with a set of internationally recognized standards and
more as a self-contained, detailed analysis of the existing legal regime and its significant features.
1.
Statutory Rights and Best Practice Guidelines
(i) The structure and responsibilities of the Board of Directors

The basic idea being propounded by the International Corporate Governance Reports is that every public
company should be headed by an effective board (with a Chairman of the Board of Directors, the
Executive and Non-Executive directors, etc.), which can both lead and control the business. The board
should meet regularly, retain full and effective control over the company and monitor the executive
management. Furthermore, there should be a clearly accepted division of responsibilities at the head of
the company, in order to ensure a balance of power and authority, such that no one individual has
unfettered powers of decisions. Given the importance and particular nature of the Chairmans role, it
should in principle be separate from that of the Chief Executive. Where the Chairman is also the Chief
Executive, it is essential that there should be a strong and independent element on the board, with a
recognized senior member. The board is to collectively ensure, regardless of the particular
responsibilities of certain directors, that it is meeting its obligations.
Standard: Prevention of domination of Boards by one individual. Shareholders should properly constitute
boards and to ensure that any one individual does not dominate the boards of their companies. To prevent
any such domination, separate individuals should hold the offices of Chairman and Chief Executive.
Standard: Responsibilities of Chairman. Chairman of the board is primarily responsible for the working
of the board, for its balance of membership (subject to board and shareholder approval), for ensuring that
all relevant issues are on the agenda, and for further ensuring that all directors (executive and nonexecutive alike) are enabled and encouraged to play their full part in its activities. The Chairman should
be able to stand sufficiently back from the day-to-day running of the business to ensure that the board is
in full control of the companys affairs and alert to its obligations to the shareholders.
Standard: Chairmans nexus with the Non-Executive Directors (NEDs) and the Executive Directors. It
is for the Chairman to make certain that the NEDs receive timely, relevant information tailored to their
needs, that they are properly briefed on the issues arising at board meetings and that they make an
effective contribution as board members in practice. It is equally for the Chairman to ensure that
Executive Directors look beyond their executive duties and accept their full share of the responsibilities of
governance.
The above standards have been listed together because they are various facets of the same underlying
idea, which is the vital importance of an effectively functioning and independent board. The following
description essentially relates to all of the above standards. At the very outset it should be stated that the
Ordinance and the related laws do not lay down a well-defined and distinct role for the Chairman of the
board of directors. This essentially means that an essential component of the above standards, the role of
the Chairman, has not received any detailed attention by the Ordinance and related laws. Therefore, it can
be said that there is at least no statutory framework to ensure that the Chairman is actually required to
meet the above-listed standards.
Role of the Chairman
Section 160 of the Ordinance deals with provisions as to general meetings and votes. Clause (3) of the
section says The chairman of the board of directors, if any, shall preside as chairman at every general
meeting of the company, but if there is no such chairman, or if at any meeting he is not present within
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fifteen minutes after the time appointed for holding the meeting, or is unwilling to act as chairman, any
one of the directors present may be elected to be chairman, and if none of the directors are present or are
unwilling to act as chairman, the members present shall choose one of their numbers to be chairman.
This shows that the Ordinance does not visualize a distinct individual performing a definite, continuing
role as the Chairman along the lines of international standards. Furthermore, the Ordinance does not
specifically preclude the possibility of the same person holding the office of Chairman and Chief
Executive, thus leaving that possibility open.
The Code, however, makes an attempt at giving some definite shape and direction to the role of the
Chairman. The Code lays down that the Chairman of a listed company is to be preferably elected from
among the NEDs of the listed company and that the board of directors is to clearly define the respective
roles and responsibilities of the Chairman and the Chief Executive, whether or not these offices are held
by separate individuals or the same individual (once again the possibility of a single person holding both
these offices has not been precluded).
The Code makes further attempts to formalize the role of the Chairman by requiring that, inter alia, (i) the
Chairman, if present, preside over meetings of board of directors (which are required to meet at least once
in every quarter of the financial year), and (ii) the Chairman ensure that the minutes of meetings of the
board of directors are appropriately recorded and circulated.
Role of the Chief Executive
The Ordinance does provide certain checks on the powers of the Chief Executive. Section 203 of the
Ordinance mandates that the Chief Executive cannot engage, directly or indirectly, in a business
competing with the companys business. The section further requires that the Chief Executive disclose to
the company, in writing, the nature of such business and the interest therein.
The mechanism for removing a Chief Executive who entrenches himself against the wishes of the
directors is provided under Section 202 of the Ordinance which allows such a removal through a special
resolution (passed by at least three fourths of the total number of directors at the time).
The Code also requires that the appointment, remuneration and other terms and conditions of employment
of the Chief Executive and other executive directors of the listed company are determined and approved
by the board of directors.
Standard: Board meetings and general functioning. Boards should meet regularly, with due notice of the
issues to be discussed, supported by necessary paperwork, and should record its conclusions.
Standard: Appointment of committees by boards. The effectiveness of a board is buttressed by its
structure and procedures. One aspect of the structure is the appointment of committees of the board, such
as the audit, remuneration and nomination committees. Boards should recognize the importance of the
finance function by making it the designated responsibility of a director, who should be a signatory to the
accounts on behalf of the board and should have the right of access to the Audit Committee.
Standard: Formal schedule of matters for Boards. Boards should have a formal schedule of matters
specifically reserved for them for their collective decision, to ensure that the direction and control of the
company remains firmly in their hands and as a safeguard against misjudgments and possible illegal
practices.
Quorum and frequency of Board meetings
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Section 193 of the Ordinance lays down the quorum for a meeting of directors of a listed company as not
less than one third of their number or four, whichever is greater. The directors of a public company are
required to meet at least twice a year. In case of any default regarding the above there are financial
penalties for the Chairman and the directors.
Appointment of Committees by Boards
The Ordinance and related laws do not elaborate upon the appointment of board committees. The Code
has some important provisions relating to the appointment and functioning of audit committees, which are
discusses under the role of Internal and External Auditors, later in this report. The Code generally
visualizes and mentions the role of technical and executive subcommittees of the board, but does not
elaborate much upon their exact duties and role.
The decision making process of the board.
The Ordinance and related laws do not shed any light on board decision making. However, the Code
contains some important provisions to formalize and structure the decision making process of the board.
One way that it tries to achieve this objective is through requiring more and better quality information so
that the decisions of the board are informed. The other way is through laying out a fairly exhaustive list
of areas that should be analyzed under the purview of strategic decision making. The following is a
summary of these provisions:
Key information to be placed for decision by the board of directors. In order to strengthen and formalize
corporate decision making processes, the Code requires that significant issues be placed before the board
for their information, consideration and decision of the directors of listed companies. The Code attaches
an exhaustive list for this purpose.
Vision/Mission statement and overall corporate strategy of the company. The Code requires that every
listed companys board of directors adopt a vision/mission statement and overall corporate strategy for the
company. The Code lays out an extensive list of areas for which such significant policies may be made.
It further requires that a complete record of the particulars of any such policies should be maintained by
the company along with the dates on which they were approved or amended by the board of directors.
The boards of directors are required further to define the level of materiality, keeping in view the specific
circumstances of the company and the recommendations of any technical or executive subcommittee of
the board that may be set up for the purpose.
System of sound internal control. The Code further requires that the boards of directors of listed
companies establish a system for sound internal control, which is effectively implemented at all levels
within the company. It then lays out certain areas of decisions which should be taken by the boards of
directors and documented through board resolutions, which include (with stated exceptions) (i)
investment and disinvestments of funds; (ii) nature and limit of the loans advanced by the company; (iii)
write-off of bad debts etc; (iv) write-off of inventories; and (v) compromise/waiver of lawsuits.
Standard: Internal Codes of Ethics and Statement of Business Practice. It a good practice for boards of
directors to draw up codes of ethics or statements of business practice and to publish them both internally
and externally so that all employees know what standards of conduct are expected of them.
Statement of Ethics and Business Practices. The Ordinance does not require the preparation of any such
statement but once again the Code has tried to take an initiative in the area by requiring that every listed
company is to prepare and circulate a Statement of Ethics and Business Practices on an annual basis to
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establish a standard of conduct for directors and employees, which statement is to be signed by each
director and employee in acknowledgement of his acceptance and understanding of the standard of
conduct.
Restrictions under the Ordinance. The Ordinance does contain some important restrictions on certain
practices, which form part of the governing ethical regime of companies.
For instance, Section 195 of the Ordinance provides an extensive ban on the direct or indirect extension
by a company of any loans to, or the provision of any guarantee or security in connection with a loan
made by any other person to, or to any other person by, a director of the company or his relatives.
Section 197 of the Ordinance prohibits a company from contributing any amount to any political party or
for any political purpose to any individual or body, or else face penalties.
Section 197-A of the Ordinance prohibits the distribution of gifts by a Company in any form to its
members at its meetings, or face penalties.
Standard: Board Remuneration. Shareholders are entitled to a full and clear statement of a directors
present and future benefits for their service and how they have been determined. Boards should appoint
remuneration committees, consisting wholly or mainly of NEDs and chaired by a NED, to recommend to
the board the remuneration of the executive directors in all its forms. Executive Directors should play no
part in decisions on their own remuneration. Shareholders require that the remuneration of directors
should be both fair and competitive.
Section 191 of the Ordinance says that the remuneration of a director, for performing extra services,
including holding the office of the chairman, shall be determined by the directors or the company in
general meeting in accordance with the provisions in the companys articles. The remuneration to be paid
to any director for attending the meetings of the directors or a committee of directors shall not exceed the
scale approved by the company or the directors, as the case may be, in accordance with the provisions of
the articles. The process of setting remuneration, disclosure of such information and the appointment of
remuneration committees are not mentioned in the Ordinance and related laws.
Standard: Boards responsibility towards prevention of fraud. The prime responsibility for the prevention
and detection of fraud (and other illegal acts) is that of the board, as part of its fiduciary responsibility for
protecting the assets of the company. Directors are responsible for maintaining a system of internal
controls for the minimization of the risk of fraud.
Once again the Ordinance and related laws do not dwell upon any mandatory mechanisms, which the
directors are required to employ for the prevention of the commission of fraud. The preventive measures
for detection and prevention of fraud can be analyzed, however, under four heads, namely:
(i)
Statutory provisions. Under Pakistani law, these exists in the form of penalties which
are expected to act as a deterrent against fraud, which are described below;
(ii)
The control by creditors and shareholders through information made available to

them. The next section, which deals with directors duties, and the one after which
deals with disclosure and reporting requirements on part of the company, contain
important disclosure requirements, which are the primary mechanism for shareholders
and creditors to scrutinize the board and to detect the commission of any fraud.
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(iii)
The role of auditors. Both the internal and external audit functions of a company play
a cardinal role in the detection and prevention of fraud. These are discussed in the
separate section dealing with audits.
(iv)
Insider Trading. This is a specific kind of fraudulent activity, which has become
increasingly important to manage in recent years and is dealt with in detail below.
As mentioned above, the Ordinance does contain some specific penalties for fraudulent acts, which are as
follows.
Penalties for certain fraudulent acts
Penalty for fraudulently inducing persons to invest money. Section 66 of the Ordinance carries a penalty
of up to three years imprisonment and up to a fine of Rs. 20,000 for anyone making any statement,
promise or forecast which is untrue to induce other persons to acquire or dispose of shares. Section 153
lays down imprisonment of up to one year as a penalty for fraudulent entries or omissions from register of
company.
Prevention of insider trading
The main objective of the Insider Trading Guidelines, a very recent legal initiative in this area, is to curb
insider trading in the security markets. The Insider Trading Guidelines prohibit the use of unpublished
price sensitive information by any person who at any time during the preceding six months has been
associated with the concerned company either on his own or on behalf of someone else by dealing in such
securities, disclosing such information to someone else or aiding him to deal in securities on the basis of
such information. The Insider Trading Guidelines define unpublished price sensitive information as the
information concerning a company, which is not generally known or published by that company and is
likely to materially affect the price of its securities. Any person found guilty of insider trading is liable
to penal action under section 15-B of the SE Ordinance.
The Insider Trading Guidelines further provide that a person, dealing with the securities on the basis of
unpublished price sensitive information shall be liable to compensate the person/entity suffering any loss
or damage as a result of such transaction. If the issuer of a security fails to obtain prosecution of an action
commenced against a person guilty of insider trading then the SECP or the person affected by such
insider trading may obtain sanction of the court to enforce the liability. Under Para 7, the SECP may, on
an application or suo moto, undertake to investigate into the books of accounts of an insider to check
insider trading. The SECP may appoint an enquiry officer, who may be an auditor, for carrying out such
investigation and the insider shall be under obligation to allow such officer access to his books and
records, etc. Before taking any action on the basis of any enquiry, the SECP is bound to give the insider
an opportunity of being heard and also to consider the explanations, if any, given by him. After receiving
such explanation the SECP may, in order to protect the interest of investors and security markets and for
due compliance of the SE Ordinance, restrain the insider from dealing in securities in any particular
manner, or prohibit the insider from disposing of any of the securities acquired in violation of these
regulations, or restrain the insider from communicating or providing counsel to any person in relation to
dealing with the securities.
The SE Ordinance also has sections relating to insider trading. Section 15-A of the SE Ordinance defines
an insider and the act of insider trading in more or less the same terms as the guidelines, discussed above.
Under Section 15-B of the SE Ordinance, the SECP may ask a person accused of insider trading to show
cause as to why he should not be required to compensate any person who has suffered loss as a result of
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insider trading. If the explanation given by the insider is not found satisfactory by the SECP then such
person, in addition to his liability to compensate the sufferer, shall be punishable with the imprisonment
for a term which may extend to three years or with a fine which may extend to three times the amount
gained or loss avoided by such person.
(ii) Directors powers and duties
Standard: Qualifications and eligibility to act as a Director. Level and nature of checks on the Directors
powers.
(a) Qualifications and eligibility to act as a Director
The basic qualification requirements for directors are an important first check to ensure that inappropriate
people are not entrusted with the fiduciary position of a director. Section 187 of the Ordinance lays out
some basic requirements for eligibility. These requirements pertain to requisite age, soundness of mind,
solvency, absence of any conviction by a court for an offence involving moral turpitude, absence of an
earlier debar from holding such office under the Ordinance and absence of any betrayal of lack of
fiduciary behaviour with a declaration to that effect by a court and membership of company.
The Code supplements these basic eligibility criteria with some additional mandatory requirements for
listed companies, non-observance of which lead to disqualification of an ineligible nominee or director.
These requirements are briefly as follows: In order to be eligible to become a director, a person should (i)
have his name present on the register of National Tax Payers, except where such person is a non-resident;
and (ii) such a person should have no prior conviction by a court as a defaulter in payment of any loan.
Additionally, the Code says that listed companies are to endeavour that no person is elected or nominated
as director if he or his spouse are engaged in the business of stock exchange brokerage (unless
specifically exempted by the SECP). These additional requirements are self-explanatory in terms of the
kind of people they want to preclude from directorships of listed companies and the reasons for doing so.
(b) Level and nature of checks on the Directors powers
Duties to disclose information on part of directors serve as the main mechanism for shareholders and
creditors to remain abreast of the exact functioning and the performance of the directors. Furthermore,
the quantity and quality of information disclosed determines their chances of detecting any foul play or
conflict of interest, which may cloud the judgment and commitment to the welfare of the company of the
directors. The quantity and quality of information which directors are obliged to communicate and the
kind of activities they are precluded by law from engaging in are thus two important indications of the
level of accountability control which the shareholders and creditors exercise over them. As to disclosure
requirements on part of directors, the Ordinance provides various important checks and balances. The
following are the main requirements.
Directors and Officers are mandated by Sections 214 and 215 of the Ordinance to disclose the nature of
their direct or indirect concerns or interests in any contract or arrangement entered into or to be entered
into by or on behalf of the company. Section 216 of the Ordinance precludes discussion of or voting on
any contract or arrangement in which the said director is, directly or indirectly, concerned or interested.
A violation of the above sections can (apart from a financial penalty) lead to a court declaring a director
as lacking fiduciary behaviour, under Section 217 of the Ordinance. There is also provision for disclosure
of a directors interest in contracts appointing chief executive, managing agent, full-time director or
secretary, with non-compliance leading to a fine.
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In addition to the provisions of the Ordinance, the Code has come up with some important disclosure
requirements.
Disclosure requirement for transactions in shares of the company. For listed companies, the Code has
come up with the further requirement that any director, chief executive, executive or their spouses selling,
buying or taking any position, whether directly or indirectly, in the shares of a listed company of which he
is director, chief executive or executive, as the case may be, is to immediately notify the Company
Secretary of such intentions and deliver a written record of the price, number of shares, form of share
certificates and nature of the transaction. Such notice will be presented by the Company Secretary at the
meeting of the board of directors immediately subsequent to such transaction.
There is also a further provision requiring that each company determine a closed period prior to the
announcement of interim/final results and any business decision, which may materially affect the market
price of its shares, and no director, chief executive or executive shall, directly or indirectly, deal in the
shares of that company in any manner during the closed period.
There are prohibitions under Section 223 of the Ordinance on short selling and under Section 224 of the
Ordinance on trading (in listed companies) of listed equity securities within six months on part of any
director, chief executive, managing agent, chief accountant, secretary or auditor of a listed company or
any person owing at least 10% beneficial interest in listed equity securities, either directly or indirectly.
Standard: Training of Directors. Given the varying backgrounds, qualifications and experience of
directors, it is highly desirable that they should all undertake some form of internal or external training;
this is particularly important for directors, whether executive or non-executive, with no previous board
experience.
The Ordinance and related laws do not mandate that companies ensure any such compulsory training. The
Code, however, has addressed this issue by requiring that all listed companies are to make appropriate
arrangements to carry out orientation courses for their directors to acquaint them with their duties and
responsibilities and to enable them to manage the affairs of the company on behalf of shareholders.
Standard: Duration of Directors service contracts. Directors service contracts should not exceed three
years without shareholders approval.
This is an area where the Ordinance gives a specific mandatory direction. Section 180 of the Ordinance
states that a director elected under the provisions of the Ordinance shall hold office for a period of three
years unless he resigns earlier, becomes disqualified from being a director or otherwise ceases to hold
office. The Code further affirms this by saying that the tenure of office of directors is to be three years.
Standard: Access to professional advice by Directors. Directors should always be able to consult the
companys advisers for legal and financial advice in the furtherance of their duties. However, in this
regard, if the directors consider it necessary to take independent legal or financial advice, they should be
entitled to do so at the companys expense through an agreed procedure.
While the Ordinance and related laws provide mechanisms to ensure that directors have constant recourse
to legal and financial advice from the companys advisers, they do not provide the directors with a right to
seek independent legal and financial advice. The Code has also not addressed this question
(iii) Role of Non-Executive Directors (NEDs) and the Corporate Secretary
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The Cadbury Report attaches special importance to the role of the NEDs. It visualizes the NEDs as
performing two significant functions. First, NEDs will provide an independent review of the performance
of the board and of the Chief Executive and an insurance that the Chairman (if the Chairman is also the
Chief Executive, then a senior non-executive director) is aware of their views addressed to him regarding
any concerns that they may have. Second, NEDs will take the lead where potential conflicts of interest
arise with the recognition that the specific interests of the executive management and the wider interests
of the company may at times diverge, e.g. over takeovers, boardroom succession, or directors pay.
According to the Cadbury Report, the caliber of the non-executive members of the board is of special
importance in setting and maintaining standards of corporate governance. NEDs are expected to bring an
independent judgement to bear on issues of strategy, performance, resources, including key appointments,
and standards of conduct.
Standard: All boards should have a minimum of three non-executive directors, one of whom may be the
Chairman of the company, provided he or she is not also its executive head. The majority of nonexecutives on a board should be independent of the company, which means that apart from their directors
fees and shareholdings, they should be independent of management and free from any business or other
relationship, which could materially interfere with the exercise of their independent judgment.
The Ordinance and related laws do not visualize and provide a role for NEDs. The Code, however, takes
some progressive and highly significant step in this direction by encouraging listed companies to ensure
effective representation of independent NEDs, including those representing minority interests, on their
boards of directors. The Code visualizes and lays out certain helpful procedural steps to ensure that
minority shareholders as a class are facilitated to contest election of directors by proxy solicitation.
Additionally, the Code recommends that the boards of directors of listed companies include at least one
independent director representing institutional equity interest of a banking company, Development
Financial Institution, Non-Banking Financial Institutions (including a modaraba, leasing company or
investment bank), mutual funds and insurance companies. An independent director in this context is
defined to mean a director who is not connected with the listed company or its promoters or directors on
the basis of family relationship and who does not have any other relationship, whether pecuniary or
otherwise, with the listed company, its associated companies, directors, executives or related parties. Such
an independent director is to be selected by such investor through a resolution of its board of directors and
the policy for such selection for election on the board of directors of the investee company is to be
disclosed in the Directors Report of the investor company.
It is further recommended by the Code, that for listed companies, the executive directors (working or fulltime directors) be not more than 75% of the elected directors including the Chief Executive. It must be
noted that unlike all the other requirements in the Code, which are mandatory, the provisions pertaining to
having NEDs on boards of directors of listed companies are on a voluntary adoption basis and just a
recommended best practice. It remains to be seen whether these provisions will also become mandatory
requirements in the fast changing corporate governance environment in Pakistan. Since the idea of
introducing NEDs in Pakistani companies is still in relative infancy, the Code does not at this stage go
into the further details pertaining to NEDS, which the Cadbury Report discusses.
Standard: The role of the Company Secretary. The Company Secretary has a key role to play in ensuring
that board procedures are both followed and regularly reviewed. All directors should have access to the
advice and services of the Company Secretary and should recognize that the Chairman is entitled to the
strong and positive support of the Company Secretary in ensuring the effective functioning of the board.
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While Company Secretaries exist in the Pakistani corporate environment, the Ordinance and related laws
do not specifically deal with the appointment and duties of the Company Secretary. The Code, however,
takes an important step in this direction, as discussed below.
Standard: Capability of the Secretary. The responsibility for appointment of a capable secretary and of
ensuring that the secretary remains capable, and any question of the secretarys removal, should be a
matter for the board as a whole.
Formalization of appointment of the Company Secretary and the CFO.
The Code takes initiative in this area by formalizing the appointment and qualification requirements of
both the Company Secretary as well as the Chief Financial Officer (CFO), two offices, which it considers
important and which should be occupied by separate individuals. The Code requires that the Company
Secretary and the CFO be appointed and their remuneration, terms and conditions of employment as well
as removal be determined by the Chief Executive with the approval of the board of directors. Both the
CFO and the Company Secretary are required by the Code to attend meetings of the board of directors.
The Code requires that a Company Secretary be (a) a member of a recognized body of professional
accountants; or (b) a member of a recognized body of corporate/chartered secretaries; or (c) a lawyer; or
(d) a graduate from a recognized university or equivalent, having at least five years experience of
handling corporate affairs of a listed public company or corporation.
The Company Secretary is required to play an additional specific and important role, which is that in the
event the director of a listed company is of the view that his dissenting note has not been satisfactorily
recorded in the minutes of a meeting of the board of directors, he may refer it to the Company Secretary,
requiring that the note be appended to such minutes (failing which he may file an objection with the
SECP).
As to the qualifications of the CFO, the Code requires that he be either, (a) a member of a recognized
body of professional accountants; or (b) a graduate from a recognized university or equivalent, having at
least five years experience in handling financial or corporate affairs of a listed public company or a bank
or a financial institution.
(iv) Financial Reporting and Disclosure Requirements
The International Corporate Governance Reports underline the advantages to investors, analysts, other
users and ultimately to the company itself of financial reporting rules which limit the scope for
uncertainty and manipulation. They emphasize that the lifeblood of markets is information and barriers to
the flow of relevant information represent imperfections in the market. What shareholders (and others)
need from the report and accounts is a coherent narrative, supported by the companys performance and
prospects. The cardinal principle of financial reporting is that the view presented should be true and fair.
Boards should aim for the highest level of disclosure consonant with presenting reports, which are
understandable, while avoiding damage to their competitive position. Boards should also aim to ensure
the integrity and consistency of their reports and they should meet the spirit as well as the letter of
reporting standards.
Standard: Yearly and Half-Yearly reporting. Listed companies must publish full financial statements
annually and half-yearly reports in the interim. In between these major announcements, boards need to
keep shareholders and the market in touch with their companys progress. The guiding principle is
openness and boards should aim for any intervening statements to be widely circulated, in fairness to
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individual shareholders and to minimize the possibility of insider trading. Interim reports should be
reviewed by auditors. Accounting rules for preparation of such interim reports should be clarified.
The Ordinance provides a regime of detailed financial disclosure requirements on part of a company. The
following are the main requirements.
Annual accounts and balance sheet. Section 233 of the Ordinance mandates the presentation by directors
of a balance sheet and a profit and loss account at every annual general meeting. These reports are to be
accompanied by a proper auditors report and a directors report which is then required to be sent to every
member of the company and specified number of copies are required to be sent to the SECP, the stock
exchange and the Registrar.
Contents and preparation of balance sheet and profit and loss statements. Section 234 of the Ordinance
states that the contents of the balance sheet should give a true and fair view of the affairs of the company
and the profit and loss account/income and expenditure statement should give a true and fair view of the
profit and loss/income and expenditure of the company for the financial year. Detailed standard
schedules (provided in the Ordinance) are required to be followed in the preparation of these financial
statements. In the case of listed companies, International Accounting Standards notified by the SECP in
the Official Gazette are to be followed. Furthermore, a statement of changes in the financial position or
statement of sources and application of funds is to form part of the balance sheet and profit and loss
account. Accounting policies must be stated and if there is any change in such policies, auditors are to
report whether they agree with such a change.
Further formalization of the issuance of financial statements. The Code further tightens and augments
the above provisions by requiring that a listed company cannot circulate its financial statements unless the
Chief Executive and the CFO present such statements, endorsed under their signatures, for consideration
and approval by the board of directors and the board after such consideration and approval, authorizes
their issuance and circulation. In addition to this, the Company Secretary is required to furnish a
secretarial compliance certificate with the Registrar to certify that the secretarial and corporate
requirements of the Ordinance have been duly complied with.
Directors Report. Section 236 of the Ordinance requires such reports for public companies or private
companies which are subsidiaries of a public company, to disclose, inter alia, (while stating the
companys affairs, recommended dividends, etc.) (i) any material changes and commitments affecting the
financial position of the company; (ii) any material changes that have occurred during the financial year
concerning the nature of the business of the company or in the classes of business in which the company
has interest; (iii) full information and explanation as regards any reservation, observation, qualification or
adverse remark contained in the auditors report; (iv) information about the pattern of holding of shares;
(v) earning per share information; (vi) reasons for incurring loss and reasonable indication of future profit
prospects; and (vii) information about defaults in payment of debts, if any, and reasons thereof.
The Code further bolsters the extent/categories of information to be provided under a Directors Report
under Section 236 of the Ordinance by requiring that it provide statements to the effects that (a) the
financial statements of the company present a fair picture; (b) proper books of account have been
maintained; (c) appropriate accounting policies have been consistently applied; (d) international
accounting standards, as applicable in Pakistan, have been followed; (e) a sound internal control system
has been effectively implemented and monitored; (f) the listed company can continue as a going
concern, beyond significant doubt; and (g) there has been no departure from the best practices of
corporate governance, as detailed in the amended listing regulations of the stock exchanges after the
introduction of the Code.
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The Code further requires additional disclosures, where necessary, which pertain to diverse areas such
key operating and financial information and deviations, dividends, taxes, corporate plans and decisions,
investments, director attendance at board meetings, pattern of shareholding and trading in shares of
company by directors, chief executive, other executives and their spouses and minor children.
Preparation of Half-Yearly Statements. Section 245 of the Ordinance mandates listed companies to
prepare (audited or otherwise) half-yearly profit and loss accounts as well as balance sheets.
Authority of SECP to require additional information from companies. Section 246 of the Ordinance gives
SECP the authority to require companies to prepare and send to members, Registrar, etc.; such other
periodical statements of accounts, information or other reports in such form and manner and within such
time as may be specified by it.
Additional requirements including submission of quarterly reports. The Code takes the disclosure
requirements a huge step further by requiring, inter alia, (a) publication and circulation of quarterly
unaudited financial statements along with directors report; (b) limited scope review of half-yearly
financial statements by statutory auditors in a manner approved by the SECP; (c) immediate
dissemination to SECP and stock exchanges, of all such material information relating to business and
other affairs of company that will affect its market price (the Code lists potential areas of such
information).
The following are some other disclosure requirements under the Ordinance, which give certain specific
rights to the members of a company to have access to information. All these are tools for shareholders
and creditors (when applicable) to remain informed as to how the company is being run and to protect
their respective rights.
Copies of updated memorandum and articles of the company. Sections 35 and 36 of the Ordinance
require the Company to provide the same, upon request, within fourteen days of such a request.
Right to inspect copies of instruments creating mortgages and charges and the companys register of
mortgages. Section 136 of the Ordinance provides this right to members, creditors and other persons
during prescribed times and a defaulting company faces penalties.
Register of Members and Debenture Holders. Sections 147 and 149 of the Ordinance require a company
to maintain a register of members and a register of debenture holders in the prescribed form. Section 150
of the Ordinance mandates that these registers be open to inspection at prescribed times and default
entails penalties.
Requirement on part of a company to file annual list of members with the Registrar. Section 156 of the
Ordinance mandates this and default carries a penalty.
Minutes of proceedings of general meetings and meetings of directors. Section 173 of the Ordinance
mandates the maintenance of books containing this information, which are open to the inspection of
members at prescribed times.
Register of directors and other officers. Section 205 of the Ordinance mandates the maintenance by
companies of a regularly updated register of their directors and officers, at its registered office, which is
to be open to inspection of members and other persons at prescribed times.
All investment made by a company on its own behalf to be held in its own name. Record to be maintained
of shares and securities invested in by a Company. Permissible investments under Section 209 of the
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Ordinance are required to be recorded and open to the inspection of members, debenture-holders and
creditors, during prescribed times.
Maintenance of Register of contracts, arrangements and appointments in which directors, etc are
interested. Section 219 of the Ordinance mandates the maintenance of such a register, open to inspection
of members of the company during prescribed times.
Register of directors shareholdings. Section 220 of the Ordinance requires every listed company to
maintain a register as respects each director, chief executive, managing agent, chief accountant, secretary
or auditor of the company and every person holding at least ten percent of the beneficial interest in the
company, the number, description and amounts of any shares in or debentures of the company and other
related entities, which are held by him or in trust for him etc. Such register is to be open to inspection
during prescribed times. It is the duty of directors etc to make disclosures to the company under Section
221 of the Ordinance for it to comply with the requirements of Section 220 of the Ordinance.
Maintenance of proper book of accounts by the Company. Section 230 of the Ordinance requires that the
books give a true and fair view of the state of affairs of the Company in order to qualify as proper.
These are to be open to inspection by directors during business hours.
The right of every member of a company to acquire from the company, on payment of a prescribed
maximum sum, copies of balance sheet, income statement, directors and auditors reports. Section 243
of the Ordinance gives this right to the members and Section 247 of the Ordinance gives the same right to
debenture holders.
(v) The Role of Internal and External Auditors
The Cadbury Report attaches great importance to the audit dimension of corporate governance. In this
direction, it essentially gives recommendations for the audit function to be strengthened at three different
levels, namely (i) audit committees; (ii) internal audit function; and (iii) external auditors.
It would be useful to give a brief synopsis of these recommendations in order to better gauge the legal
regime pertaining to auditing in Pakistan.
(i) Audit Committees. The Cadbury Report regards audit committees as an important safeguard against
the commission of fraud in a company. According to it, the audit committees have an important role to
play in considering whether any extra work should be undertaken in addition to the normal audit
procedures to investigate defenses against fraud, and in reviewing reports on the adequacy of internal
control systems. The audit committee also provides a forum in which auditors can discuss at board level
any concern they may have about the possibility of fraud by senior management. It is the responsibility
of boards to establish what their legal duties are and to ensure that they monitor compliance with them.
This would be enhanced if the auditors role were to check that boards had established their legal
requirements and that a working system for monitoring compliance was in place.
The Cadbury Report goes into great detail as to their creation and functioning. It states that (a) audit
committees should be formally constituted to ensure that they have a clear relationship with the board to
whom they are answerable and to whom they should report regularly. They should be given written terms
of reference which deal adequately with their membership, authority and duties, and they should normally
meet at least twice a year; (b) audit committees should comprise of a minimum of three members.
Membership should be confined to the NEDs of the company and a majority of the non-executives
serving on the committee should be independent; (c) The external auditor should normally attend audit
committee meetings, as should the finance director. Because the board as a whole is responsible for the
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financial statements, other board members should also have the right to attend. The audit committee
should have a discussion with the external auditors, at least once a year, without executive board members
present, to ensure that there are no unresolved issues of concern; (d) The audit committee should have
explicit authority to investigate any matters within its terms of reference, the resources which it needs to
do so, and full access to information. The audit committee should be able to obtain external professional
advice and to invite outsiders with relevant experience to attend if necessary.
Standard: Composition and functioning of audit committees.
While the Ordinance does not contain any relevant provisions, the Code comes up with detailed
requirements for listed companies in the areas of audit committees with provisions as to their
composition, frequency of meetings, attendance at meetings, terms of reference and reporting procedure.
These provisions are forward-looking and closely tally with the recommendations of the Cadbury Report.
The following is a synopsis of these requirements under the Code.
Composition of audit committee. Listed companies are required to establish such committees comprising
of not less than three members (including the Chairman, and with the majority of the members coming
from the NEDs of the company and the chairman of the audit committee preferably being an NED).
Meetings of audit committee. The audit committee is required to meet once every quarter of a financial
year and also whenever requested by the external auditor or head of internal audit.
Attendance at meetings of audit committee. The CFO, head of internal audit and a representative of the
external auditors are required to attend meetings of the audit committee, at which issues relating to
accounts and audit are discussed. At least once a year, the audit committee is required to meet the
external auditors without the CFO and head of internal audit and once a year the audit committee should
meet with the head of internal audit without the CFO and external auditors.
Terms of reference of audit committees. The board of directors of a listed company are required to
determine the terms of reference of the audit committee and they shall, among other things, recommend
the appointment of external auditors to the board of directors as well as provide direction in other related
matters such as resignation/removal of external auditors, their audit fees and the provision of additional
services by external auditors. The Code actually lays out several ingredients, which the terms of
reference of the audit committee should contain, which include, inter alia, measures to safeguard
companys assets, review of periodic financial statements with a focus on important stated areas,
facilitation of the external audit, coordination of the internal and external audit functions, review of the
scope and extent of internal audit, consideration of various major findings of internal investigations,
internal financial and operational controls, accounting systems, reporting structures, compliance with
statutory requirements, institution of special projects/value for money studies, monitoring compliance
with the code and other issues or matters assigned by board of directors.
(ii) Internal audit functions. The Cadbury Report propounds it as a good practice for companies to
establish internal audit functions to undertake regular monitoring of key controls and procedures. Heads
of internal audit should have unrestricted access to the chairman of the audit committee in order to ensure
the independence of their position. Directors should report on the effectiveness of their system of internal
control, and the auditors should report on their statement. An effective internal control system is an
essential part of the efficient management of a company.
Standard: Provision and efficacy of the internal audit function.
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The Code also requires that there be an internal audit function in every listed company whose head has
access to the person chairing the audit committee. All listed companies are required to ensure that
internal audit reports are provided for the review of external auditors and that auditors discuss any major
findings in relation to the report with the audit committee, which shall report matters of significance to the
board of directors.
(iii) External auditors.
The Cadbury Report emphasizes the annual external audit as one of the cornerstones of corporate
governance. Given the separation of ownership from management, the directors are required to report on
their stewardship by means of the annual report and financial statements sent to the shareholders. The
audit provides an external and objective check on the way in which the financial statements are prepared
and presented, and it is an essential part of the checks and balances required. The question is not whether
there should be an audit, but how to ensure its objectivity and effectiveness. Audits are a reassurance to
all who have a financial interest in companies, quite apart from their value to boards of directors. The
most direct method of ensuring that companies are accountable for their actions is through open
disclosure by boards and through audits carried out against strict accounting standards.
One central requirement of the entire process is to ensure that an appropriate relationship exists between
the auditors and the management whose financial statements they are auditing. Shareholders require
auditors to work with and not against management, while always remaining professionally objective
that is to say, applying their professional skills impartially and retaining a critical detachment and a
consciousness of their accountability to those who formally appoint them. Another important requirement
is that there be full disclosure of fees paid to audit firms for non-audit work. The essential principle is
that disclosure must enable the relative significance of the companys audit and non-audit fees to the audit
firm to be assessed. It as also a good practice for audit committees to keep under review the non-audit
fees paid to the auditor both in relation to their significance to the auditor and in relation to the companys
total expenditure on consultancy. For listed companies, a periodic change of audit partners should be
arranged to bring a fresh approach to the audit. The Cadbury report clarifies that the auditors role is to
report whether the financial statements give a true and fair view. The auditors role is not to prepare the
financial statements, nor to provide absolute assurance that the figures in the financial statements are
correct, nor to provide a guarantee that the company will continue in existence. The audit is essentially
designed to provide a reasonable assurance that the financial statements are free of material
misstatements. The external auditors should be present at board meetings when the annual reports and
accounts are approved and preferably when the half-yearly report is considered as well.
Standard: Appointment, quality and independence of external auditors.
The Ordinance lays out a mechanism for the appointment and functioning of external auditors. Section
252 of the Ordinance states that external auditors have to be appointed at every annual general meeting to
serve till the next general meeting (in case of the appointment of the first auditors, the appointment is
made by the directors) and where the company fails to appoint auditors at the stated time or there is a
vacancy for any other reason, SECP can appoint a person to fill the vacancy. The remuneration of
auditors is fixed by the directors or the SECP or the company in a general meeting or in such a manner as
the general meeting may determine, depending on who makes the appointment.
Professional qualification requirements for external auditors. Section 254 of the Ordinance mandates
that the auditor for a public company or a private company which is the subsidiary of a public company or
a private company having a paid up capital of three million rupees or more, has to be a Chartered
Accountant within the meaning of the Chartered Accountant Ordinance of 1961. A person cannot be
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appointed as an auditor if; (a) he was, at any time during the preceding three years, a director, other
officer or employee of the company; (b) he/she is a partner of, or in the employment of a director, officer
or employee of the company; (c) he/she is the spouse of a director of the company; (d) he/she is indebted
to the company; or (e) it is a body corporate.
Auditors right of access to company records/information. Section 255 of the Ordinance gives auditors
the right of access at all times to books, papers, accounts and vouchers of the company and all
information and explanation which he thinks necessary for performance of duties. Auditors are mandated
to make a detailed report to members on the accounts and all related documents with their analysis and
conclusions as to whether they meet the requirements of the Ordinance, and inter alia; (a) whether or not
they have obtained all the information and explanations which to the best of their knowledge and belief
were necessary for the audit; (b) whether proper books of accounts have been kept; (c) the balance sheet
and profit and loss account have been drawn up in conformity with the Ordinance and are in agreement
with the books of accounts; and (d) whether the said accounts give the information required by the
Ordinance and give a true and fair view. Where the auditors answer in the negative as to any of the
aforementioned matters or with a qualification, the report shall state the reasons for such an answer along
with the factual position to the best of the auditors information.
Right to attend meetings. Auditors are entitled to attend any general meeting and to be heard at such a
meeting. For listed companies, the auditors are required to be present in the general meeting in which the
balance sheet and profit and loss account and auditors report are to be considered.
The Code, bolsters and supplement the above by reemphasizing and requiring, inter alia, that only those
firms are appointed as external auditors; (a) which have been given a satisfactory rating by the Quality
Control Review Program of Institute of Chartered Accountants of Pakistan (ICAP) and (b) which are
compliant with International Federation of Accountants (IFAC) guidelines on Code of Ethics, as adopted
by ICAP; Furthermore, the Code states that auditors will be required to only provide services in relation
to audit except in accordance with the regulations and will be further required to observe applicable IFAC
guidelines and it shall be ensured that they do not perform management functions or make management
decisions. Additionally, listed companies are now required to change their auditors every five years and
if for any reason this is impractical then as a minimum they will rotate the partner in charge of its audit
engagement after obtaining the consent of the SECP. The Code further requires that no listed company
shall appoint as CEO, CFO, an internal auditor or a director someone who was a partner of the firm of its
external auditors (or an employee involved in the audit of the listed company) at any time during the two
years preceding such appointment or someone who is a close relative, i.e. spouse, parents, dependent and
non-dependent children, of such partner (or employee). The Code also requires that a partner of the firm
of the external auditors shall be required to attend the Annual general Meeting at which audited accounts
are placed for consideration and approval of shareholders.
Auditors not to hold shares. All listed companies are required by the Code to ensure that the firm of
external auditors or any partner in that firm and his spouse and minor children do not at any time, hold,
purchase, sell or take any position in shares of the listed company or any of its associated companies or
undertakings.
(vi) Prevention of minority shareholder oppression
Standard: The right to protection mechanisms for minority shareholders. Also, it is considered good
practice if the minority shareholders (minority shareholders are defined as those shareholders who own
10% of share capital or less) are granted either a judicial venue to challenge the decisions of management
or the right to step out of the company by requiring the company to purchase their shares when they
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object to certain fundamental changes, such as mergers, asset dispositions, and changes in the articles of
incorporation.
The Ordinance and related laws and the Code contain several provisions, which provide special protection
to minority shareholders and other special interest groups. There can be several acts of a company, which
can fundamentally alter the rights of the minority shareholders. Some key protections in such areas under
the Ordinance are as follows.
Alteration to the Memorandum of Association. According to Section 21 of the Ordinance, a Company
cannot make any alteration (which requires a special resolution passed by three fourths of its members)
to its Memorandum of Association without seeking the confirmation of the SECP.
SECPs duty to safeguard minority rights/rights of creditors. According to Section 23 of the Ordinance,
while exercising its authority in terms of an alteration under Section 21 of the Ordinance, the SECP is to
have regard to the rights and interests of members or any class of members of the company as well as the
rights and interests of the creditors and may allow time by adjourning its proceedings to facilitate
arrangements for the purchase of the interests of dissident members and may also give such
orders/directions as are necessary to carry such arrangements into effect.
Alteration to Articles of Association. Section 28 of the Ordinance requires a special resolution passed
by three fourths of the members of a company for it to alter any of its articles of association. However, if
such alteration affects the substantive rights or liabilities of members or of a class of members then at
least three fourths of such members or class of members to be affected need to vote for such alteration for
it to take affect.
Effect of alteration in memorandum/articles. Section 34 of the Ordinance mandates that no member of a
company is bound by such an alteration which requires him to take, or subscribe for more shares than the
number he holds or which increases his liability to contribute to the share capital of, or otherwise to pay
money to the company unless he agrees in writing to be bound by such alteration.
Judicial recourse for minority shareholders
The following is an important rights protection in the form of judicial recourse to the court by the
minority shareholders.
Variation of rights of Shareholders of a class. Section 108 of the Ordinance provides that while the
variation of the rights of shareholders of any class shall be effected only in the manner laid down in
Section 28 of the Ordinance (above), 10% or more of the class of shareholders who are aggrieved by any
such variation of their rights may, within thirty days of the date of the resolution varying their rights,
apply to the Court for an order canceling the resolution. The Court is thus entrusted with the task of
ensuring that these shareholders are not the victims of any unfair prejudice or a decision based on not all
the relevant information.
Petition to declare a general meeting invalid. Section 161(8) of the Ordinance allows members having at
least ten percent voting power to petition to the court, within thirty days of the impugned meeting, that
proceedings of a general meeting be declared invalid by reason of a material defect or omission in the
notice or irregularity in the proceedings of the meeting, which prevented members from effectively using
their rights.
Resolution by Minority Shareholders. Section 164(2) of the Ordinance allows members with at least ten
percent voting power in the company to give notice of a resolution and such resolution together with the
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supporting statement, if any, which they propose to be considered at the meeting, shall be forwarded so as
to reach the company and the company shall forthwith circulate such resolution to all members.
Demand for polls by Minority Shareholders. Section 167(c) and (d) of the Ordinance require the
Chairman to, before or on the declaration of the result of the voting on any resolution on a show of hands,
order a poll upon the demand of, inter alia, any member or members present in person or by proxy having
at least one-tenth of the total voting power in respect of the resolution as well any member or members
present in person or by proxy and holding shares in the company conferring a right to vote on the
resolution, being shares on which an aggregate sum has bee paid up which is not less than one-tenth of the
total sum paid up on all the shares conferring that right.
The following section contains an important protection for minority shareholders in a situation where
scheme of transfer of shares is being implemented. According to Section 289 of the Ordinance, if within
120 days of such an offer by transferee company, it has been approved by holders of at least nine-tenths in
value of shares whose transfer is involved (other than shares already held at the date of the offer by, or by
a nominee for, the transferee company or its subsidiary) the transferee company may at any time, within
60 days after expiry of said 120 days, give notice to any dissenting shareholders of its desire to acquire his
shares. After such a notice (unless dissenting shareholders make an application within 30 days of the
notice and court thinks it fit to order otherwise) the transferring company will be entitled and bound to
acquire these shares on the same terms as the ones on which shares of the approving share-holders are
being acquired.
The Code provides protection to minority shareholders in a scenario where a company is divesting its
shares.
Divesture of shares by sponsors/controlling interest. The Code provides a minority shareholder
protection by stating that in the event of a divesture of not less than 75% of the total shareholding of a
listed company (with some exceptions), at a price higher than the market value at that time, it shall be
desirable and expected of the directors to allow such transfer after it has been ascertained that an offer in
writing has been made to the minority shareholders for acquisition of their shares at the same price at
which divesture of majority shares was contemplated (where the price is lower, such offer price will be
subject to the approval of the SECP).
(vii) Other Shareholder rights
The International Corporate Governance Reports emphasize the accountability of boards to shareholders.
The formal relationship between the shareholders and the board of directors is that the shareholders elect
the directors, the directors report on their stewardship to the shareholders and the shareholders appoint
the auditors to provide an external check on the directors financial statements. Thus the shareholders as
owners of the company elect the directors to run the business on their behalf and hold them accountable
for its progress. The issue for corporate governance is how to strengthen the accountability of boards of
directors to shareholders. While we have already discussed various dimensions of this relationship, the
following are some additional internationally recognized rights of shareholders.
Standard: One share-one vote. Ordinary shares should carry one vote per share. It is desirable to
have prohibition on the existence of both multiple-voting and nonvoting ordinary shares. Also, it is
desirable if firms are not allowed to set a maximum number of votes per shareholder irrespective of
the number of shares owned.
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The one share-one vote standard is ensured under Pakistani law by the following provisions. These
provisions underline the prohibition of the undesirable practices mentioned in the statement of the
standard above.
Section 160(4) of the Ordinance states that in every company having share capital, every member shall
have votes proportionate to the paid-up value of the shares or other securities carrying voting rights held
by him according to the entitlement of the class of such shares or securities, as the case may be.
Section 160(5) of the Ordinance states that no member carrying shares or other securities carrying voting
rights shall be debarred from casting his vote, nor shall anything contained in the articles have the effect
of so debarring him.
Section 160(6) of the Ordinance states that for companies limited by guarantee and having no share
capital, every member thereof shall have one vote.
Standard: Proxy by mail. It is considered good practice if shareholders are allowed to mail their proxy
vote to the firm.
The Ordinance and related laws as well as the Code do not allow for mailing a proxy vote. The following
is a synopsis of the law relating to ordinary and proxy voting.
Section 160(7) of the Ordinance says that on a poll, votes may be given either personally or by proxy.
There is no provision here for proxy by mail and the proxy has to be through another person.
Section 168 of the Ordinance says that any proxy appointed by a member shall have such rights as
respects speaking and voting at the meeting as available to a member but a member shall not be entitled to
appoint more than one proxy to attend the meeting and a proxy must also be a member unless the articles
of the company permit appointment of a non-member as proxy.
Standard: Shares not blocked before meeting. It is considered good practice if firms are not allowed to
require that shareholders deposit their shares prior to a general shareholders meeting, thus preventing
them from selling those shares for a number of days.
The Ordinance and related laws as well as the Code make no provision for such a practice, neither do they
disallow it.
Standard: Cumulative voting or proportional representation. It is considered good practice if the
shareholders are allowed to cast all their votes for one candidate standing for election to the board of
directors (cumulative voting) or if a mechanism of proportional representation in the board is allowed by
which minority interests may name a proportional number of directors to the board.
The Ordinance and related laws as well as the Code make no provision for such practices.
Standard: Preemptive rights. It is considered good practice that shareholders are granted the first
opportunity to buy new issues of stock, and this right can be waived only by a shareholders vote.
The Ordinance provides for this right of the shareholders.
Further issuance of Capital. Section 86 of the Ordinance states that where directors decide to increase
capital by issuance of further shares, such shares are to be issued to each existing member strictly in
proportion to his present shareholding, irrespective of class, and such offer to be made by notice,
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specifying the number of shares to which the member is entitled and stating the time within which the
offer is to be accepted, otherwise deemed declined. However, the Federal Government may, on an
application made by a public company on the basis of a special resolution passed by it, allow such a
company to raise its further capital without issue of right shares.
Standard: Percentage of share capital to call an extraordinary shareholders meeting. The minimum
percentage of ownership of share capital that entitles a shareholder to call for an extraordinary
shareholders meeting is less than or equal to 10%.
This right is enshrined in the Ordinance in the following terms.
Section 159 of the Ordinance requires the directors of a company to call an extraordinary general meeting
of the company to consider any matter which requires the approval of a company in a general meeting and
the company is to, on the requisition of members representing at least 1/10th in value of the voting power
on the date of the deposit of the requisition, forthwith proceed to call an extraordinary general meeting.
The requisitionists, or a majority of them in value, may themselves call a meeting, if the directors do not
proceed within twenty-one days from the date of the requisition being so deposited to cause a meeting to
be called. Any default entails penalties.
Standard: Mandatory dividend. It is a good practice for a company to declare a dividend once it reaches
the target of a given percentage growth in net income.
While the Ordinance does not mandate any such given percentage and a consequential compulsory
payment of dividend, it has some other important provisions covering this area that provide protection to
the shareholders.
The amount and source of dividends. Section 248 of the Ordinance mandates that no dividend can exceed
the amount recommended by the directors and cannot be paid out of any profits made through sale or
disposal of immovable property or assets of a capital nature (unless such transactions wholly or partly
form the business of the company). Section 249 of the Ordinance mandates that Dividends can only be
paid out of the profits of the Company and Section 250 of the Ordinance says that such dividends can
only be paid out to registered shareholders or to their order or to their bankers.
Time limit within which to pay announced dividends. Section 251 of the Ordinance requires that when a
dividend has been declared, it has to be paid within forty-five days of the declaration, in case of listed
company, and within thirty days of declaration, for other companies (unless a listed defense can be
invoked). Defaulting chief executive may be imprisoned for up to two years and fines up to a million
rupees.
Standard: Mandatory Annual General Meeting. Reports and accounts are presented to shareholders at the
Annual General Meeting, when they have the opportunity to comment on them and to put their questions.
In particular, the Annual General Meeting gives all shareholders, whatever the size of their shareholding,
direct and public access to their boards. In the Committees view, both shareholders and boards of
directors should consider how the effectiveness of general meetings could be increased and as a result the
accountability of boards to all their shareholders strengthened.
The Ordinance contains the following provisions relating to this area.
Annual General Meetings. Section 158 of the Ordinance mandates that every company is to hold, in
addition to any other meetings, a general meeting, as its annual general meeting, within eighteen months
of its incorporation and thereafter once at least in every calendar year within a period of six months
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following the close of its financial year and not more than fifteen months after the holding of its last
preceding annual general meeting. For listed companies, the SECP, and for other companies, the
Registrar may for any special reason extend the time within which any annual meeting, not being the first
such meeting, shall be held by a period not exceeding ninety days.
Extraordinary general meetings. Section 159 of the Ordinance, as more briefly described above, allows
the directors to at any time call such a meeting to consider any matter which requires the approval of the
company in a general meeting and on the on the requisition of members representing at least one-tenth of
the voting power on the date of the deposit of the requisition, they are required to forthwith proceed to
call an extraordinary general meeting. The requisitionists, or a majority of them in value, may themselves
call a meeting, if the directors do not proceed within twenty-one days from the date of the requisition
being so deposited to cause a meeting to be called. Any default entails penalties.
Power of Registrar to call meetings. Section 170 gives the Registrar the power to call, inter alia, any
annual general meeting or extraordinary general meeting, if there has been a default in the holding of any
such meetings, either of his own motion or on the application of any director or member of the company
and there is a penalty for any default in complying with the Registrars directions.
Institutional shareholders largely hold shares on behalf of individuals, as members of pension funds,
holders of insurance policies and the like. As a result, there is an important degree of common interest
between individual and institutional shareholders. In particular, both have the same stake in the standards
of financial reporting and of governance in the companies in which they invest. Given the weight of their
votes, the way in which institutional shareholders use their power to influence the standards of corporate
governance is of fundamental importance. Institutional investors should encourage regular, systematic
contact at senior executive level to exchange views and information on strategy, performance, board
membership and quality of management. Institutional investors should make positive use of their voting
rights, unless they have good reason for doing otherwise. They should register their votes wherever
possible on a regular basis. Institutional investors should take a positive interest in the composition of
boards of directors.
Protection through the Regulatory Agencies
Powers of Registrar and SECP under the Ordinance
The Registrar and the SECP play an increasingly important regulatory role in the Pakistani
corporate governance environment. The following is an overview of some of their more important
powers under the Ordinance in the context of the protection of the rights of shareholders and
creditors.
The Registrar has important and significant powers to require companies to divulge information, if he
thinks it is important for any reason for him have access to such information while looking into a matter.
This serves as an important weapon against a company not coming clean with information.
Power of Registrar to call for information or explanation. Section 261 of the Ordinance provides that if
the Registrar thinks that any information, explanation or document is necessary, he may in writing call for
it (within a specified time frame not less than 14 days). If no information furnished within specified time
or inadequate information provided, the Registrar may through a written order call for production of any
books or papers which he considers necessary and it will be duty of company and such persons to provide
the same within the specified time frame. If still a default, then apart from financial penalty and the
penalty that every defaulting officer punishable with imprisonment for up to one year, the Authority
trying the offence may, on the Registrars application make an order, directing the Company to produce
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such books or papers as in its opinion may reasonably be required by Registrar. If still no information,
explanation, book or paper furnished, as required by the Registrar or such a submission shows an
unsatisfactory state of affairs or does not disclose a full and fair statement of the matter, the Registrar may
report in writing the circumstances to the SECP.
An extension of the above power of the Registrar is the power to take even more direct attention and size
documents from the company under certain scenarios.
Seizure of documents by Registrar. Section 262 of the Ordinance provides that where the Registrar has
reasonable grounds to believe that books or papers of or relating to any company or any chief executive or
officer of such company or any associate of such person, may be destroyed, mutilated, altered, falsified or
secreted, then after obtaining permission from magistrate of the first class or Court, he can search and
seize such books and papers. Documents are to be returned within thirty days after seizure unless SECP
gives another thirty-day grace period. The Criminal Procedure Code is to be followed during searches.
The SECP has wide-ranging investigative powers into the affairs of a company, which are as follows.
Investigation of affairs of company on application by members or report by Registrar. Section 263 of the
Ordinance provides that SECP inspectors may investigate on: (a) in case of company with share capital,
on application of members holding no less than one-tenth of total voting power; (b) in case of company
with no share capital, on application of no less than one-tenth of persons on companys register as
members; and (c) in case of any company, on receipt of a report under Section 231(5) of the Ordinance (a
report by an officer of SECP when inspecting accounts under this section) or the Registrars report under
Section 261(6) of the Ordinance.
SECP has further powers to initiate investigations into the affairs of a company under the following
scenarios, either due to a board resolution requesting such an investigation or a court order directing one
or under certain special circumstances.
Investigation of companys affairs in other cases. Section 265 of the Ordinance says that the SECP may
appoint inspectors for investigation if; (a) the company, by a resolution in general meeting or, (b) the
court, by order declares that the affairs of the company ought to be investigated. SECP may also
investigate (after giving Company show cause notice) if in the opinion of SECP certain circumstances
exist which suggest that (i) business being conducted with intent to defraud or unlawful purpose; (ii)
framers of company guilty of fraud, misfeasance, breach of trust, misconduct towards company or any of
its members or have been carrying unauthorized business; (iii) affairs of company so conducted so as to
deprive members of reasonable return; (iv) members not given all information which they might
reasonably expect; (v) any shares of company allotted for inadequate consideration; or (vi) affairs of
company not being managed in accordance with sound business principles or prudent commercial
practices.
Inspector to be a Court for certain purposes. This declaration is provided by Section 266 of the
Ordinance and applies to an inspector under Sections 263 and 265 of the Ordinance. Every proceeding
before such inspector will be a judicial proceeding. Non-compliance or contravention with any orders,
directions or requirement of the Inspector will have the same consequences, liabilities and penalties as
provided for such in the civil and criminal procedures.
Duty of officers to assist inspector. Section 268 of the Ordinance states that it is the duty of officers to
assist the inspector and any default in this regard is punishable with imprisonment and fine.
259
Inspectors report. Section 269 says that inspectors may, and if so directed by SECP, make interim
reports and on conclusion of investigation, a final report. SECP will forward a copy to company and
may, on request, give a copy to a member of the company or other body corporate or anyone interested in
affairs of the company or whose interest as creditor of company or other body corporate appear to SECP
to be affected. Also copies should be forwarded to the court, Registrar, and shareholders under given
situations.
SECP power of Prosecution. Section 270 of the Ordinance allows SECP (on the basis of a report under
Section 269 of the Ordinance) to prosecute that any person whose affairs have been investigated under
Section 267 of the Ordinance and who has been guilty of an offence for which he is criminally liable, and
it shall be duty of all officers, employees, agents of company and body corporate (other than the accused)
to give all reasonable assistance in this process.
Power of SECP to initiate action against management. Section 271 says that if the SECP is of the
opinion that (on the basis of a report under Section 269 of the Ordinance) that: (i) the business of the
company is being conducted with intent to defraud or unlawful purpose; (ii) framers of the company are
guilty of fraud, misfeasance, breach of trust, misconduct towards company or any of its members or have
been carrying unauthorized business; (iii) affairs of company so conducted so as to deprive members of
reasonable return; (iv) members were not given all information which they might reasonably expect; (v)
any shares of company allotted for inadequate consideration; (vi) affairs of company not being managed
in accordance with sound business principles or prudent commercial practices; or (vii) the financial
position of the company is such as to endanger its solvency, then SECP may apply to court. The court
may order (a) removal from office of director, officer, managing agent or chief executive (not unless court
specifies a lower period, disqualified for five years from holding such a position), (b) that directors should
carry out specified changes in management or accounting policies, (c) a meeting of members to consider
specified matters and take appropriate remedial action, or (d) annulment of any existing contract which is
to detriment of company or members or to benefit of any officer or director.
Sections 273 and 274 of the Ordinance state that no compensation to be paid for annulment or
modification of contract and no right of compensation for loss of office.
SECPs powers to initiate proceedings for recovery of damages or property
Under Section 278 of the Ordinance, the SECP may, if from a report under Section 269, it appears to it
that in the public interest, proceedings should be brought by company or body corporate (whose affairs
are being investigated) for recovery of damages (in respect of fraud, misfeasance, breach of trust or other
misconduct) or any property, which has been misapplied or wrongfully retained, bring proceedings in the
name of such entity (which will indemnify SECP for any costs and expenses).
SECPs powers of Imposition of restrictions on shares and debentures and prohibition of transfer of
shares and debentures in certain cases
Section 279 of the Ordinance states that where it appears to SECP that in connection with any
investigation, it is important for fact finding about shares to impose certain specified restrictions, but
SECP may impose such restrictions for not more than a year. SECP is to provide an opportunity for
showing cause before imposing any such restriction. Detailed list of restrictions are specified under the
section. SECP can also block for up to year a change in directors of a company through an already
completed transfer of shares or a future transfer of shares, if SECP thinks that such change is prejudicial
to public interest. SECP can rescind any of its orders. Otherwise, relief against such an order lies in court
(which will first hear SECP). Default is punishable with imprisonment or fine or both.
260
Powers of SECP under the SE Ordinance and the SECP Act

SECP draws its basic powers of registering and regulating stock exchanges as well as regulating issuers
under the SE Ordinance. The SE Ordinance is significant for its detailed treatment under Section 15-A of
prohibited insider trading and under Section 17 of prohibited fraudulent acts, which it defines in great
detail. If further provides the procedure for enquiries, the penalties and appeals pertaining to the same.
Section 20 of the SE Ordinance allows the SECP to issue prohibitory orders for preventing, through any
commission or omission, a contravention of any provision of the SE Ordinance or any rules made
thereunder. Section 21 gives the Federal Government the power, suo moto or on an application, to
appoint any person to inquire into (i) the affairs of any stock exchange, or (ii) the dealing/trading being
conducted by any broker, member, director or officer of a stock exchange.
The SECP Act dwells in greater detail on the structure, functioning and powers of the SECP. Some of the
significant stated powers of the SECP under Section 20 of the SECP Act include, inter alia:
1. prohibiting fraudulent and unfair trade practices relating to the securities market;
2. conducting investigations in respect of matters relating to the SECP Act and the SECP ordinance
and in particular for the purpose of investigating insider trading in securities and prosecuting
offenders;
3. regulating substantial acquisition of shares and the merger and take-over of companies;
4. considering and suggesting reforms of the law relating to companies and bodies corporate,
securities markets, including changes to the constitution, rules and regulations of companies and
bodies corporate, Stock Exchanges or clearing houses;
5. promoting investors education and training of intermediaries of securities market; and
6. encouraging organized development of the capital market and the corporate sector in Pakistan.
Even a cursory glance at the above reveals the wide ambit of powers, which the SECP enjoys and the
many hats that it wears. It acts as a developer and educator as well as a regulator with wide investigative
powers. The regulatory power of the SECP, especially in the acquisition, take-over and merger area has
been effectively used recently for the protection of the interest of minority shareholders and creditors.
Adjudicative powers. Section 22 of the SECP Act also gives the SECP adjudicative powers to adjudicate
upon the rights of any person whose application on any matter it is required to consider in the exercise of
any power or function under the SECP Act and some very important case law has emerged from this
process over the last couple of years which has clarified the rights and duties of various components of
the corporate sector in Pakistan. Section 29 of the SECP Act empowers the SECP to conduct
investigations in respect of any matter that is an offence under the SECP Act.
Protection through the Courts
The primary power of the courts to intervene to prevent oppression of shareholders and mismanagement
of the affairs of the country is through Section 290 of the Ordinance. This has been demonstrated through
recent case law.
According to Section 290 of the Ordinance, if any member/members holding not less than 20% of issued
share capital of a company or creditor/creditors having an interest not less than 20% of the paid up
capital, complain(s), or the Registrar is of the opinion, that the affairs of the company are being conducted
or are likely to be conducted in a manner, that is unlawful or fraudulent, or in a manner not provided for
in its memorandum, or in a manner oppressive to the members/creditors/ or any of the members/creditors
or in a manner prejudicial to the public interest, such person(s) or Registrar may make an application to
the Court by petition for an order under this section. The Court, on such petition (if it is of the opinion
261
that any of the above is taking place and that to wind up the company would unfairly prejudice the
members of creditors), may make such order as it thinks fit to bring an end to the matters complained of
(whether an order for regulating the companys conduct in future or for the purchase of shares of any
members of the company by other members of the company or by the company and in case of purchase
by company, for the reduction accordingly of the companys capital or otherwise). The company cannot
(unless Court allows) make an addition or further alteration to its memorandum or articles, which is
inconsistent with any addition or alteration to its memorandum or articles by the Court under this section
(which will be as if duly made by a company resolution). Section 291 of the Ordinance lays out further
specific powers of the Court in connection with the exercise of its general powers under Section 290 of
the Ordinance.
The courts have been active in recent years in the development of jurisprudence in the various important
areas of corporate governance. Some illustrative instances are as follows.
The High Court observed that the Auditors are the ultimate watchdogs of the shareholders interests.
According to the set practice, the Auditors are required to give a report, which is either clean or
qualified. By issuing a clean report, the Auditors certifies that the financial statement reflects a true
and fair view of the companys affair and a qualified report subjects such opinion to some observation
of irregularity or inconsistency. The High Court highlighted and denounced the practice adopted by the
managements of some large companies, which are dependant on public confidence, frenziedly trying to
secure a clean audit report from their auditors. The High Court pointed out that since the auditors are
recommended (and virtually appointed) by the board of directors, some of them are made to condescend
to the managements demand and declared that it caused a devastating effect if the auditors put a seal of
approval on the misleading accounts of a company. 112
The High Court has emphasized in a 2002 case, that the SECP should consider the advisability of issuing
instructions for guidance of companies to ensure that shareholders attending general body meetings with
the object of considering special business receive full disclosure of facts necessary for making an
informed decision. Furthermore, that the SECP should also consider issuing guidelines for determining
the fair value of shares by companies. 113
In the above stated case, the High Court made another very significant addition to minority shareholder
rights protection by underlining the fundamental importance and duty of the courts to the protection of
minority shareholder rights. It was observed by the High Court, that the court is not a bystander obliged
to grant approval to all schemes of arrangements approved by special majority of shareholders specified
in Section 284 of the Ordinance (dealing with a compromise of the company with its creditors and
members). The court can review the proposed scheme and decline approval, even though scheme
approved by requisite majority, in a situation where the majority shareholders of a company had voted in
a manner coercive or oppressive to the minority or where the majority shareholders had not voted in the
interest of shareholders as a class. The High Court further observed that wherever the court reaches the
conclusion that a scheme is unfair and conscionable, and to which material objections have been raised by
any shareholder either in a general meeting or before the court, it would become a duty of the court not to
approve the scheme. The fact that the objecting shareholder constitutes a small minority in proportion to
the majority will be wholly irrelevant in such circumstances. Elaborating further on the Section 284
provision, it said that Section 284 of the Ordinance which required the sanction of the Court to any
scheme of arrangement is meant for the protection of the rights of powerless small minorities who can be
outvoted at general meetings and cannot, therefore, adequately safeguard their interests on the strength of
their voting rights alone. It is, therefore, open to these minorities to show to the Court that the proposed
112
113
Institute of Chartered Accountants of Pakistan v. Messers Hyderali Bhimji & Co. 2002 CLD 1207.
Kohinoor Raiwind Mills Limited v. Kohinoor Gujar Khan. 2002 CLD 1314.
262
scheme of arrangement is unfair, unreasonable and prejudicial to their interest, or to the interests of the
shareholders generally. 114
The above three examples are all from the year 2002 and indicative of the growing role of the judiciary in
elaborating upon and further enhancing the protections for shareholders and creditors under the law.
Some concluding remarks. In conclusion, the Ordinance and related laws are perhaps not as up to date
with the growing consensus on best practices, which are now being introduced globally for more effective
corporate governance. However the Code and the growing role of the SECP are clear illustrations of a
very progressive and modern approach to this area in Pakistan in recent years. It has to be emphasized
that the Code has only just been introduced and it remains to be seen as to how much impact it will
eventually have. Furthermore, it only applies to listed companies at the moment and rather than that
contributing to the negative trend of companies de-listing, the ambit of the Code should be extended to all
companies through statute. Another area, which may need revision, is the current level of penalties
attached to a violation of the various above-discussed provisions of the Ordinance. In order to have real
deterrent effect, these penalties need to be reexamined.
114
Ibid.
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Corporate Governance in Sri Lanka

Fast off the Tracks:
But is the Progress Real Progress?
By
Ajith Nivard Cabraal
FCA, FCMA, FSCMA
Cabraal Consulting Group (Pvt) Ltd
Everywhere shareholders are re-examining their relationships with company bosses what is
known as their system of corporate governance. Every country has its own, distinct brand of
corporate governance, reflecting its legal, regulatory and tax regimes The problem of how to
make bosses accountable has been around ever since the public limited company was invented in
the 19th century, for the first time separating the owners of firms from the managers who run
them
Corporate Governance: Watching the Boss, The Economist (Jan.29, 1994)
Table of Contents
Preamble
265
Executive Summary
265
1. The Evolution of Corporate Governance in Sri Lanka
267
2. How does Sri Lankas CG practices compare with best international standards?
275
3. The Emerging International and national issues How has Sri Lanka responded?
278
4. The Way Forward.. is good corporate governance the panacea for all business
ills?
293
Abbreviations used in Report
292
Annex 1: Report of Survey of Corporate Governance Practices in Sri Lanka
293
Annex 2: Comparison of Sri Lankas CG Practices with OECD Principles
304
264
Preamble
This comparative analysis is undertaken to assist South Asian countries, especially Bangladesh in
understanding corporate governance practices with a view to adopting best practices and significantly
improving the quality of corporate governance in the private sector. The project is designed to finally
respond to the governance needs of the private sector in Bangladesh.
The project aims to identify major features of the corporate governance landscape using the OECD
guidelines as the major reference document in Bangladesh, India, Pakistan and Sri Lanka. The project is
also expected to highlight existing strengths and weaknesses in these countries, as well as identify any
disparities between theory and practice, and the arrangements which are in place for enabling better
The ultimate goal of the project is to design strategies for intervention, after identifying areas bearing
upon the climate of corporate governance in which such interventions could be made. In that context, this
Report attempts to codify and set out the practices prevailing as at date rather than a detailed account of
the evolution of the process. Of course, a brief history of some practices and institutions is included in
the Report as background to certain issues, but the general thrust of the Report has been to identify future
needs and the possible future courses of action.
Stage 1 of the project consists of each country partner undertaking essentially the same exercise (although
in the case of Bangladesh, there will be certain differences), which exercise is to consist of:
a.
b.
c.
d.
A review or survey of literature relating to CG in each country;

Identification of major features of the CG landscape in each country, including existing
strengths and weaknesses;
Identification of disparities between the theory-namely that to which law and institutions are
stated to aspire- and the practice or reality, and the causes of such disparities;
Examination of arrangements in place for enabling good CG, and in particular, by way of
case studies focussing on:
i.
Successful arrangements, institutional or otherwise, and the incentive structures
underpinning the success of such arrangements, bearing in mind that the mere
existence of the right laws or legal or institutional environment is not enough: the
greater question is why such laws are adhered to; what incentives are in place or why
and how do the institutional arrangements operate to create the right incentives?
ii.
Unsuccessful initiatives and the causes of continuing behaviour deviating from
principles of good corporate governance.
Executive Summary
The study and practice of Corporate Governance has evolved rapidly over the past decade or so to a level
where the objective pursued today is a governance system which assures corporate decisions that are
efficient and effective. This has resulted in a paradigm shift from the earlier managed corporation to
the more modern model of the governed corporation. Over the past few years, the Organization for
Economic Co-operation and Development (OECD) has set out extensive principles and practices which
are today used as guidelines by many Corporate Governance regimes all over the world.
In Sri Lanka the focus on Corporate Governance was led by the Institute of Chartered Accountants of Sri
Lanka who developed the Code of Best Practice on Corporate Governance in 1997. The setting up of the
Sri Lanka Accounting and Auditing Standards Board in 1995, the initiatives of the Securities Exchange
265
Commission as well as the Colombo Stock Exchange to develop the standards of financial reporting and
the stock market operations help to generate interest in the subject of governance further.
Developments over the past few years have given rise to many vexed and complicated issues in relation to
corporate governance. The suggestion that corporate influence is disproportionate to responsibility
and that society as a whole may not be best served if corporations are operated for the benefit of
shareholders only, has been repeatedly raised in the recent past. In that connection, a corporate entitys
responsibility towards the environment, national and local communities, shareholders, employees,
customers, suppliers and contractors, is now being stressed and attempts are being made to include these
stakeholders too, in future frameworks of corporate governance practices.
It is now clear that Institutional investors who exercise control over massive funds are ideally positioned
to demand that corporate entities in which they invest in, act, function and behave in a certain
professional and ethical manner. In that context, institutional investors have a responsibility to drive good
governance practices to ensure board independence, proper board processes, effective evaluations of
boards and CEOs, ensuring a proper mix of different skills within boards, etc.
The new demands made on directors may appear to some as being too onerous, and some may even
contend that these demands result in skilled persons being un-willing to take up appointments as
Directors. In a similar manner, there are also some auditors who tend to think that audits are becoming to
onerous with new rules and regulations having to be adhered to. Although such reactions may be
justifiable to some extent, investors seem to be appreciative of the pressure that is mounting on directors
and auditors to deliver better shareholder value through such new responsibilities.
A survey of CG practices in Sri Lanka has revealed that companies do not actually do what they say they
do in relation to corporate governance. This is probably true in most other countries as well. In order to
address this concern, it may be necessary to increase awareness about CG practices within business
communities and to institutionalize a mechanism for the independent assessment of the actual degree of
physical compliance with CG practices and policies by companies. The fact that many directors are not
conversant with CG practices to be implemented seems to be another serious issue that needs attention.
The deficiencies of regulators; the risks run by whistle-blowers; and the greed and impatience of
shareholders who are indirectly driving corrupt and/or aggressive CEOs towards attempting to maximize
shareholder value through risky and dubious means, are also some of the major issues of the present day
and age. The fact that CEOs are often hired on social connections and supposed-to-be-independent
advisors are having serious conflicts of interest have also been matters of concern to the CG community.
In addition, the many new initiatives suggested over the past few years which have raised boardroom
costs considerably is yet another issue that is causing tension in the CG landscape.
Global and national surveys indicate that the investors of today rely heavily on corporate governance
practices in making their investment decisions. It has also led some persons to mistakenly believe that
good CG is a kind of a guarantee against business risk. This feeling and attitude is likely to damage the
overall credibility of the CG process in the longer term, and needs to be immediately addressed.
A clear nexus exists between sound business ethics and good corporate governance practices and sound
ethical behaviour can be considered an integral function of corporate governance. The ethical values and
practices of market participants in the corporate scene will probably determine whether a particular
corporation is a well governed one creating shareholder value or one which provides an opportunity for
management to enrich themselves at the expense of other stakeholders.
The fundamental challenge to the emerging science of corporate governance is to move consistently
forward notwithstanding the many difficulties and issues it would face over the ensuring years. The
266
success or failure of the corporate world and capital markets of the future may finally depend on the
manner in which this challenge is met by the market participants.
1.
The Evolution of Corporate Governance In Sri Lanka
1.1
Corporate Governance the Buzzword

When at first Corporate Governance started becoming a buzz word in the early to mid 90s in Sri
Lanka, it was popularly understood as the system by which companies were to be directed and
controlled. As done in many countries, Sri Lanka too, through its corporate networks and
regulatory regimes began to respond to the need to develop good governance processes in a
formal manner by developing a Code of Best Practice on Corporate Governance for the guidance
of their corporate sectors in 1977. As is well known, the impact of globalization shaped and
forced the various issues pertaining to corporate governance in Sri Lanka to take an international
flavour, and as of today the Sri Lankan corporate sector also voluntarily follows the guidelines of
many worldwide and regional bodies which are actively promoting corporate governance
globally, regionally and in individual countries, in addition to the various guidelines prevailing in
Sri Lanka.
1.2
Sri Lankas interest in Corporate Governance

At this stage, it is worthy to note that The Global Corporate Governance Forum has, as its
mission, the objective of helping countries improve the standards of governance for their
corporations by fostering the spirit of enterprise and accountability, promoting fairness,
transparency and responsibility. In that light, it would be seen that good Corporate Governance is
today a desired outcome of international concern for corporations and countries all over the
world, since good corporate governance would undoubtedly contribute immensely to economic
development. In that context, it is perhaps no surprise that Sri Lanka is showing a keen interest in
embracing the state-of-the-art corporate governance principles, given its commitment to a
liberalized economic policy and growth through private/public sector partnerships.
1.3
Fuelling the need for good CG practices

In a globalized economy, where there is a rapid rise in the size and number of institutional
investors and global funds, the focus on good corporate practices increases correspondingly,
almost as a reflex action. At the same time, the number and sophistication of investment
managers, intermediaries and specialists, has also been rising dramatically. All these factors have
further fuelled the need for good Corporate Governance practices and hence it could now be said
that the concept has really come of age and almost certainly, to stay.
1.4
The Sri Lanka Code of Best Practice on Corporate Governance
1.4.1
In Sri Lanka, the first real effort at codifying the principles of Corporate Governance in a
structured manner was in 1996 when the Council of the Institute of Chartered Accountants of Sri
Lanka decided to set up a Committee to make Recommendations on matters relating to Financial
Aspects of Corporate Governance.
1.4.2
This report was undertaken at a time when Sri Lankas own stock market was showing signs of
maturity and growth, although the issues relating to Corporate Governance in Sri Lanka had by
that time not progressed too far. In that context, the initiative taken by the Institute of Chartered
Accountants of Sri Lanka (ICASL) to set up a Committee was a laudable effort. The Committee
267
comprised of eminent and senior persons who were from the many organizations and bodies
which had a significant impact and influence on the development of Sri Lankas stock market,
and they also represented a wide cross section of the interested parties in the subject of Corporate
Governance.
1.4.3
The Committee categorized their final recommendations for implementation through the
following mechanisms:
a)
Possible amendments to the Securities and Exchange Commission Act
b)
Possible amendments to the rules and regulations of the Colombo Stock Exchange.
c)
Possible amendments to the Companies Act
d)
Possible amendments to the ICASL Act
e)
A Code of Best Practice, as applicable to all listed companies
1.4.4
In addition, the Committee Report made a useful observation that the corporate regulatory system
in Sri Lanka had many involved regulatory and semi-regulatory organizations, sometimes
working in rather rigid, water-tight compartments. These authorities, e.g. the Securities and
Exchange Commission of Sri Lanka, (SEC), the Colombo Stock Exchange (CSE), the Registrar
of Companies (ROC), the Sri Lanka Accounting and Auditing Standards Monitoring Board
(SLAASMB), the Accounting Standards Committee (ASC) of the ICASL, the Auditing Standards
Committee (AuSC) of the ICASL, the Urgent Issues Task Force (UITF) of the ICASL were often
seen to be performing overlapping functions and therefore an attempt to infuse an element of
congruence within their respective activities seemed also to be necessary. The ICASL Committee
has been hopeful that the setting out of the Code of Best Practice would lead to a greater degree
of congruence and understanding within the above stated organizations as well.
1.4.5
This Code of Best Practice could, in retrospect, be considered as the key initiative which laid the
foundation for the healthy evolution of Corporate Governance principles and practices in Sri
Lanka. Thereafter, many initiatives have followed, and these are described in this chapter of the
Report. The empirical study made in September 2002, shows that the results are somewhat
mixed, and a summary of the findings is set out in Annex 1.
1.5
The Sri Lanka Accounting and Auditing Standards Monitoring Board and Urgent Issues
Task Force of the ICASL
1.5.1
In the late 80s and early 90s, Sri Lanka witnessed many failures of Companies, especially
Finance Companies. In the light of such failures, the general public perception was that there was
no one prepared to take responsibility for these debacles. Many reasons were attributed for the
crashes, but whatever these were, these resulted in many investors losing faith in the regulatory
and semi-regulatory frame-works, as well as the standards of financial reporting. This situation
almost reached crisis proportions at a certain point in time, in the late 80s and early 90s, but
fortunately some interventions by the concerned regulatory and semi-regulatory authorities, even
through somewhat late in being introduced, resulted in the storm being weathered. But the
underlying causes for the failures including the weak financial reporting and auditing structures
needed to be addressed on a fundamental basis, urgently and decisively.
1.5.2
As a response to this particular aspect of this wide issue, the ICASL in 1992 took the preliminary
steps to institutionalize a scheme whereby the application of Sri Lanka Accounting Standards
could be monitored and enforced. To implement such scheme, the ICASL set up a Task Force to
look into all aspects relating to the enforcement of the Sri Lanka Accounting Standards, and such
Task Force recommended the setting up of an Accounting Standards Monitoring Unit. This
proposal was formally forwarded to the Government in 1993, and was referred to the Financial
268
Sector Reform Committee, which accepted same. This finally resulted in the Government
enacting the present Sri Lanka Accounting and Auditing Standards Act No. 15 of 1995. This Act
empowered the ICASL to adopt Sri Lanka Accounting Standards (SLAS) and Sri Lanka Auditing
Standards (SLAuS) and provided for the setting up of an independent Sri Lanka Accounting and
Auditing Standards Monitoring Board (SLAASMB). The Act also required all specified business
enterprises (defined in terms of criteria based on turnover, share capital, net assets, number of
employees, and loans taken from the banking system), to prepare their financial statements in
accordance with SLAS and have their accounts audited in accordance with SLAuS. The Sri
Lanka Accounting and Auditing Standards Monitoring Board was to monitor the compliance of
Sri Lanka Accounting and Auditing Standards promulgated by the ICASL for specified
enterprises as set out in the Act.
1.5.3
This initiative was a significant development in the field of financial reporting and no doubt went
a long way in instilling confidence in investors and stock market intermediaries in the
enhancement of the quality of financial reporting in Sri Lanka. As of today, a considerable
amount of work has been done by the SLAASMB and their reports are being taken seriously by
companies and the business community alike. Further, the fact that the SLAASMB is actively
examining the financial statements of the specified business entities (SBEs) has placed these
SBEs on guard, and has had a useful deterrent effect on them. Consequently it could be said that
the standards of financial reporting with the attendant impact on good corporate governance, has
received a boost from this initiative.
Another significant initiative that was taken by the ICASL was the setting up of an Urgent Issues
Task Force, (UITF) in 1993 with a mandate to provide clarifications and interpretation of the Sri
Lanka Accounting and Auditing Standards. Today, the UITF makes regular rulings at the request
of corporates, auditors, and interested parties, and is perceived by the business and financial
community as a useful body in promoting the understanding and application of the Sri Lanka
Accounting and Auditing Standards. Its rulings are readily accepted as quasi-Standards,
particularly where the Standard itself is not clear on a particular issue.
1.6
Ceylon Chamber of Commerce

In 2001/02, the Ceylon Chamber of Commerce (CCC) prepared and issued a booklet titled
Corporate Governance. This effort codifies the key Corporate Governance initiatives which are
considered desirable for Sri Lanka and has been useful in promoting Corporate Governance in Sri
Lanka. In addition to this publication, the CCC has consistently promoted good corporate
governance among its members, and has been instrumental in promoting CG principles amongst
its wide membership.
1.7
Institute of Chartered Secretaries and Administrators of Sri Lanka

In the year 2000/01, the Institute of Chartered Secretaries and Administrators in Sri Lanka also
published a Hand book on Corporate Governance. This hand book contained detailed principles
and guide lines to best practices in Sri Lanka. Although not quoted extensively, this booklet
serves as a useful explanatory note to those who are involved in promoting and practising
1.8
National Task Force on Corporate Governance

In December 2001, a Task Force on Corporate Governance in Sri Lanka was set up under the
facilitation and auspices of the Institute of Chartered Secretaries and Administrators of Sri Lanka.
This Task Force which is comprised of many eminent persons in the business, professional,
269
banking, marketing and regulatory fields has been driving Corporate Governance forward in Sri
Lanka since their formation. They have also been in close contact with the Commonwealth
Association of Corporate Governance and this alliance has helped to further focus on Corporate
Governance initiatives that are necessary for Sri Lanka. This group plays an important role in
creating awareness as well as promoting good governance practices in the country.
1.9
Sri Lanka Institute of Directors (SLID)

The formation of the Sri Lanka Institute of Directors is a recent initiative which has brought
together a large number of Company Directors who have been actively focusing on
administration and Governance issues. The Institute holds regular meetings at which directors
discuss methods of improving Governance in their own organizations. These awareness
campaigns of SLID have helped to focus attention on the subject of governance as well as keep
the membership alive to the developments taking place world wide.
1.10
Provisions under the Companies Act that promote good governance

The Companys Act of Sri Lanka although having been enacted in 1982 has many provisions that
encourage good governance practices. Extensive sections of the Companies Act deal with
disclosures in the annual financial statements of Companies, conduct of board proceedings,
conduct of shareholders meetings, particulars re. proxies, directors reports, responsibilities of
directors, auditors functions, etc. etc., The Companies Act also sets out the provisions relating to
the winding up of companies, consolidation procedures and certain procedures and processes
connected to borrowings by Companies etc. There provisions may not be the most modern of
provisions, but nevertheless they serve as a useful framework which is reasonably formal and
practical.
1.11
Securities and Exchange Commission of Sri Lanka
1.11.1 The Securities and Exchange Commission of Sri Lanka was established through an Act of
Parliament No:36 of 1987. The Commission become quite active from the early 1990s and since
then, has been playing a dynamic role in financial reporting issues and the development and
regulation of the capital market in Sri Lanka. The Commission was instrumental in initiating
many innovations such as the setting up of the Central Depository System, the formulation of the
Mergers and Takeovers Code, the implementation of laws relating to Insider Trading, etc. Today,
the Securities Exchange Commission possesses a team of highly skilled professionals who have
been trained in gathering and analysing market information, keeping abreast of worldwide
developments and enforcing the implementation of the provisions contained in the SEC Act and
Regulations.
1.11.2 While the infrastructure is in place for the SEC to play a highly dynamic role in the capital market
development effort and improvement of governance practices in the country, the actual work of
the Commission seems to have fallen short of expectations. This is mainly because of issues such
as conflicts of interest and certain apparently biased decisions of some of the SEC members.
These conflicts have rocked the corporate sector and have served to erode the level of public
confidence in the capital market of Sri Lanka in general and the SEC in particular. Various
attempts have been made by several governmental agencies to deal with this declining confidence
levels but it appears that the process is slow and painstaking. As is seen, the SEC would have to
play a very significant role in the overall enhancement of governance in the country, and any
deficiency in the discharge of its duty would be reflected as a major blow to the maintenance and
enhancement of the Corporate Governance levels of the country. In that context, it is imperative
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that urgent steps be taken to re-infuse credibility into the SEC as soon as possible so that the SEC
could play, and also be seen as playing, an impartial and professional role.
1.12
Colombo Stock Exchange

The Colombo Stock Exchange is an institution which has a history of over a century and is the
only market that is available for the trading of listed securities in Sri Lanka. Some of its key
functions and services are described below:
1.12.1 Initial Public Offerings

The Colombo Stock Exchange has set out extensive procedures with regard to initial public
offerings. Although in the recent past, the number of IPOs has been few, the procedures have
been tried and tested during the first part of 1990s during which period there were many large
scale IPOs. Even during the recent past, some of the privatizations were carried out through the
Colombo Stock Exchange and the public offerings connected to such privatizations evoked
considerable interest in the Colombo Stock Exchange. The IPO procedures have been well
structured and are contained in the CSEs handbook of procedures as a special chapter and the
provisions are carefully adhered to by all sponsoring brokers, companies issuing shares, and all
other parties.
1.12.2 Listing Requirements Initial and Continuing
The Colombo Stock Exchange has published a comprehensive booklet setting out the Continuing
Listing Requirements which have to be adhered to by all Companies that are listed in the
Colombo Stock Exchange. These are monitored carefully by a professional team of enforcement
officers of the CSE which ensures that the integrity of the Listing procedure is maintained.
1.12.3 Disclosure Practices
The Colombo Stock Exchange has also enumerated the corporate disclosures that need to be
made by the Companies that are listed in the Colombo Stock Exchange. Here again, the
enforcement officers of Colombo Stock Exchange are expected to ensure the integrity of the
process by constant and consistent monitoring of transactions, accuracy of disclosed information,
assessment of a companys financial and other statements, etc.
1.12.4 Mergers and Takeovers Code
For a considerable period of time, mergers and acquisitions in Sri Lanka were not regulated in
any way. There was no Code to set out guidelines about the procedures to be followed if and
when a merger or take over was contemplated or attempted. With the issue of the Mergers and
Takeovers Code by the SEC under the Securities and Exchange Commission Act, this situation
has been rectified and today there is an orderly process that governs this activity in Sri Lanka.
1.12.5 Insider Trading
The laws and regulations in relation to insider trading are contained in the Securities and
Exchange Commission Act. These provisions are very stringent and are designed to reduce malpractices that arise as a result of insider trading by market players. The processes set out in the
Act however, does not seem to have had the desired effect, and the general perception in the
market circles is that there are many instances of insider trading which are continuing. The
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Central Depository System and the market tracking features contained in the system has helped a
great deal to overcome and deter some of the mal-practices but much needs to be still done,
especially in the timely implementation of the provisions of the code in the true spirit of the
Code.
1.12.6 Related Parties
The transactions between related parties which affect companies have often created major
controversies in the Sri Lankan corporate scenario. The Companies Act of Sri Lanka requires
that disclosures be made of all transactions where the parties to the transaction are connected in
certain ways. Notwithstanding such provisions there have been allegations of impropriety which
have disturbed the Sri Lankan corporate world many times. As of now, the Auditors Opinion
contains a special paragraph where they are expected to report upon the related party transactions
and this requirement has had a useful impact on this issue. At the same time, the Sri Lanka
Accounting and Auditing Standards Monitoring Board Act also deals with the manner of
reporting and disclosure of transactions pertaining to related parties through the empowerment of
the Accounting Standards Committee and the Auditing Standards Committee of the ICASL to
promulgate Sri Lankan Accounting and Auditing Standards as quasi-laws. This initiative has
helped to maintain a certain consistency in this regard and it has proved useful in the overall
achievement of better governance and accountability in the corporate sector in Sri Lanka.
1.12.7 Credit Rating
Credit Rating in Sri Lanka is a comparatively recent development. Over the past few years
several firms with international connections have set up credit rating firms which rate firms as
well as various financial and debt instruments. These rating institutions fulfil a very important
need since rating was a function that was neglected for a long time, in Sri Lanka, although it
has been considered extremely useful, worldwide. Even though credit rating has been in
existence for a short period only, credit rating firms of Sri Lanka today play a useful role in the
stock market and debt market operations in Sri Lanka and the trend appears to be that they would
continue to expand their influence and scope of operations in the country. The type of evaluation
carried out by credit rating agencies and the reports issued by them naturally enhances the
governance in those target companies directly and indirectly. Such outcomes are important for
the overall improvement of Corporate Governance Systems in the Country and it could be
positively stated that this development has helped to improve governance in general, in Sri Lanka.
1.12.8 Central Depository System
The Central Depository System was introduced into Sri Lanka in 1992/ 1993 as a joint initiative
of the Securities and Exchange Commission and the Colombo Stock Exchange. Since then, it has
played a very useful role in the Sri Lankan capital market. The transactions at the CSE have
become accurate, faster and complete with very useful information being generated and being
available which makes it possible for the convenient and speedy tracking of market activities,
trends and transactions. The CDS has also made the trading process quite transparent with its
obvious attendant advantages. This outcome has helped to infuse a greater degree of discipline
and control into the capital market which necessarily enhances the overall governance levels in
the country.
1.13
Registrar of Companies
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The Registrar of Companies (ROC) in Sri Lanka has been traditionally an institution which had
been perceived as a typical governmental bureaucratic institution which is almost totally
unresponsive to public needs, with archaic systems and reeking with corruption and
mismanagement. However, the ROC of today appears to be an institution which has undergone a
considerable re-organization and is generally considered as a somewhat responsive governmental
institution. Most records at the ROC have been computerized and information retrieval systems
have been improved considerably, leading to a reduction in the turnaround time for the supply of
information and with regard to various other activities of the institution. The procedures involved
in the formation of companies, name approvals, filing of records, searches, etc., have all been
organized on an interactive basis, and many of the functions of the ROC could now be carried out
on-line.
These developments have improved ROCs function as a quasi-judicial institution and have had
the impact of enhancing the overall governance in the corporate sector.
1.14
Central Bank of Sri Lanka and Banking Sector
1.14.1 In addition to the traditional functions of the Central Bank of Sri Lanka, the Bank also performs
many other regulatory functions. One such function is the CB role to supervise Banks and other
Financial Institutions and this function has assumed an extremely important level today. This
function naturally extends to assisting Banks and Financial Institutions to improve their
governance systems and their credit delivery systems, as well. In that context, the Central Bank
by its supervisory function helps to improve the overall Corporate Governance procedures and
practices in a key and important sector which has a tremendous impact upon the economy of the
nation.
1.14.2 In the late 1990s, a spate of finance company failures led to adverse public reactions against the
Central Bank, which culminated in several reforms being initiated. Some of these reforms were to
tighten the doubtful debt provisioning methods and the more effective supervision and regulation
of the conduct of Directors, especially in relation to related party transactions. The Central Bank
also initiated the CRIB, i.e. the Credit Information Bureau, which today provides up-to-date
information about customers who have defaulted to any one of the member banks. Through such
pooling of vital credit information via the access to a centralized information network, the Banks
in general have been able to improve their own credit delivery systems significantly.
1.14.3 Since of late, a few concerns have been expressed that the Central Bank has been somewhat lax in
its supervision of the banking and finance company sectors, and this has resulted in some
expressions of dissatisfaction within the corporate community. It is hoped that such situation
would be temporary, and that the Central Bank would respond more positively towards enhancing
the overall governance in the banking sector.
1.15
Judicial Review including function of the Commercial High Court
1.15.1 For a considerable period of time, there has been grave concern in the minds of many that the
administration of justice in general, and the judicial process in relation to corporate matters in
particular, has been extremely unsatisfactory. It would be readily conceded that there are many
laws in the statute books covering almost every issue, together with very elaborate procedures to
implement such laws. However, there have been major bottlenecks and inordinate delays which
have, almost always negated the effect and impact of these laws. Consequently, the general
consensus has been that many commercial establishments have been inconvenienced
tremendously without any useful redress being received in a timely manner as a result of litigation.
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1.15.2 To address this issue, a Commercial High Court was set up a few years ago to deal with
commercial matters and disputes so that such issues could be dealt with expeditiously and the long
suffering business community given an opportunity to obtain redress faster and more
conveniently. This initiative has, to some degree served to reduce the litigation time in relation to
commercial disputes, but nevertheless the problem of delayed justice has yet not been adequately
or effectively addressed. The issue of training the judges on business practices and commercial
transactions also need to be carefully considered since the quality of justice and the judicial orders
often hinge upon the knowledge and understanding of the judges viewing and dealing with
commercial issues from a sound business angle as well.
1.16
Role of Media Business Newspapers, Business TV Shows/News,
1.16.1 Over the past decade or so, the media in Sri Lanka has been very active in highlighting business
and commercial issues. At present, it has evolved to a reasonably sophisticated level and many
national newspapers of today carry separate features and sections in their daily and weekly
editions which are entirely dedicated to business news.
1.16.2 Since of late, press reports have extended to vibrantly exposing matters and issues of concern and
this type of reporting has had a very useful impact on the business world. In addition to the print
media, the electronic media too has kept pace and at present, almost all television channels in the
country beam business programmes at least once every week and in fact the daily news bulletins
of all TV networks carry a segment devoted to business news. Such developments have assisted
to keep the corporate sector and the general public informed and conscious of responsibilities
toward shareholders and varied groups of stakeholders, and these have contribute immensely to
the improvement of governance procedures in the country.
1.17
Role of Analysts and Fund Managers

One of the major developments that have been taking place since the early 1990s in the Sri
Lankan financial sector has been the proliferation of analysts and fund managers and those
functions becoming more professional. At the same time, extensive overseas expertise and
experiences have been channelled into the Sri Lankan business environment and those inputs have
helped to develop these services extensively. As of now, almost all the Broking firms and Banks
have set up well organized research units which are providing very useful information for
investors. These efforts and outputs of the analysts and fund managers have resulted in a greater
demand for accountability within the corporate community, both directly and indirectly and that
has led to an improvement in the governance practices in the country.
1.18
Civil Society and Investor Associations

In relation with any major law reform or development of a regulatory process, it is essential that
civil society plays a dynamic role. In that context, in the development of a capital market, Sri
Lankas civil society has been reasonably active in their reactions towards the capital market
development effort. A few watch-dog groups have actively pursued several corporate issues
which have resulted in greater awareness being created in governance. At the same time, several
investor associations have also been formed, which are dedicated towards safeguarding the
interests of investors, and these associations mainly consist of groups of smaller investors who are
seeking greater rights for minorities as well as the promotion of good governance practices in
general.
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1.19
Political will and commitment of Government and State Agencies towards CG
1.19.1 In all initiatives connected to the development of capital markets, enhancement of governance
systems, a Governments commitment and involvement towards such effort would be of special
significance. The enactment of laws, framing of regulations, empowerment of regulatory
authorities and establishment of the necessary key institutions would require the support and
commitment of the government.
1.19.2 Fortunately for Sri Lanka, successive governments from the late 1980s up to now have shown a
firm commitment towards this process. At the same time, a special feature in the corporate
governance landscape of Sri Lanka has been that several quasi-governmental organisations have
contributed their efforts towards good governance practices in Sri Lanka, sometimes even
venturing much further than what could be normally expected from them as their routine
functions. All these efforts have resulted in a steady improvement in corporate governance
practices in Sri Lanka notwithstanding a few complications at various intervals.
2.
How Do Sri Lankas Corporate Governance Practices Compare With Best International
Standards?
2.1
Todays definition of CG
2.1.1
Today, Corporate Governance has evolved to a level where the outcome pursued internationally
appears to be a system which assures corporate decisions that are efficient and effective. At the
same time, the foundation for the practices seem to be resting on the philosophy that corporate
decisions need to be internally challenged in an effective manner in order to assure and establish
its validity and long term sustainability.
2.1.2
Accordingly, present day good governance systems often provide for senior managers and boards
to collaborate amongst each other and for them to seek the input of institutional shareholders in a
participatory relationship, rather than in a detached mode. Perhaps therefore, it could be said that
there is almost a paradigm shift from the previous concept of managed corporations to the more
modern model of governed corporations. This shift is based on the fact that managed
corporation boards hired, monitored and fired management, while todays governed corporation
boards are expected to promote and foster efficient and effective decision-making. Hence, in a
way, corporate governance is no longer pre-occupied only with structures and procedures such as
Audit Committees, Remuneration Committees, Internal Control systems, etc; but more
importantly, concerned with governance processes which attempt to decrease the possibility of
corporate mistakes, and if mistakes are made, increase the speed at which corrective action is
taken.
2.1.3
Since the initial initiatives in the early 90s, Sri Lanka has continued to progress in developing
new initiatives at enhancing Corporate Governance practices in the country. In that context, the
Institute of Chartered Accountants of Sri Lanka, Ceylon Chamber of Commerce, the Securities
and Exchange Commission of Sri Lanka, the Colombo Stock Exchange and the Institute of
Chartered Secretaries and Administrators of Sri Lanka have played, and are continuing to play
significant roles and those have been described in this Report.
2.2
The Benchmark
When carrying out an overview of corporate governance practices in any particular CG regime, it
would be useful to examine such provisions against governance practices which are considered to
275
be best international practices. Hence, it would perhaps be useful to firstly study the corporate
governance practices as set out by the Organisation for Economic Co-operation and Development
(OECD), which are generally considered to be the benchmark for many CG studies taking place
today.
2.3
Background to international practices
2.3.1
In considering such best international practices, the background to such practices is also
important to be considered, and OECDs own comments in this connection may be of relevance:
2.3.2
The degree to which corporations observe basic principles of good corporate governance is an
increasingly important factor for investment decisions. Of particular relevance is the relation
between corporate governance practices and the increasingly international character of
investment. International flows of capital enable companies to access financing from a much
larger pool of investors. If countries are to reap the full benefits of the global capital market, and
if they are to attract long-term patient capital, corporate governance arrangements must be
credible and well understood across borders. Even if corporations do not rely primarily on
foreign sources of capital, adherence to good corporate governance practices will help improve
the confidence of domestic investors, may reduce the cost of capital, and ultimately induce more
stable sources of financing.
2.3.3
Corporate governance is affected by the relationships among participants in the governance

system. Controlling shareholders, which may be individuals, family holdings, bloc alliances, or
other corporations acting through a holding company or cross shareholdings, can significantly
influence corporate behaviour. As owners of equity, institutional investors are increasingly
demanding a voice in corporate governance in some markets. Individual shareholders usually do
not seek to exercise governance rights but may be highly concerned about obtaining fair
treatment from controlling shareholders and management. Creditors play an important role in
some governance systems and have the potential to serve as external monitors over corporate
performance. Employees and other stakeholders play an important role in contributing to the
long-term success and performance of the corporation, while governments establish the overall
institutional and legal framework for corporate governance. The role of each of these
participants and their interactions vary widely among OECD countries and among non Members as well. These relationships are subject, in part, to law and regulation and, in part, to
voluntary adaptation and market forces.
2.3.4
As stated earlier, over the past 10-12 years Corporate Governance has been constantly and
continuously evolving, developing, responding, reacting, and pro-acting. While several reactions
and principles could be described as responses to the rapidly evolving commercial and business
developments world-wide, some initiatives could be termed as proactive responses to achieve
certain desired goals. The evolution has been steady and almost always the principles, local and
international, have been instrumental in enhancing the manner in which corporate entities take
decisions as well as ensuring that shareholders have a voice in the governance structures and
systems of corporations.
2.3.5
In this regard, the Preamble to the OECD Principles of Corporate Governance

comprehensively sets out what could be identified as the stage on which corporate governance is
established internationally today, and such extract is set out below:
There is no single model of good corporate governance. At the same time, work carried out in
Member countries and within the OECD has identified some common elements that underlie good
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corporate governance. The principles build on these common elements and are formulated to
embrace the different models that exist.
The Principles are non-binding and do not aim at detailed prescriptions for national
legislation. Their purpose is to serve as a reference point. They can be used by policy makers, as
they examine and develop their legal and regulatory frameworks for corporate governance that
reflect their own economic, social, legal and cultural circumstances, and by market participants as
they develop their own practices.
The Principles are evolutionary in nature and should be reviewed in the light of significant
changes in circumstances. To remain competitive in a changing world, corporations must
innovate and adapt their corporate governance practices so that they can meet new demands and
grasp new opportunities. Similarly, governments have an important responsibility for shaping an
effective regulatory framework that provides for sufficient flexibility to allow markets to function
effectively and to respond to expectations of shareholders and other stakeholders. It is up to
governments and market participants to decide how to apply these Principles in developing their
own frameworks for corporate governance, taking into account the costs and benefits of
regulation.
2.4
The OECD Principles:

These are set out below:
2.4.1
The rights of shareholders

The corporate governance framework should protect shareholders rights.
2.4.2
The equitable treatment of shareholders

The corporate governance framework should ensure the equitable treatment of all shareholders,
including minority and foreign shareholders. All shareholders should have the opportunity to
obtain effective redress for violation of their rights.
2.4.3
The role of stakeholders in corporate governance

The corporate governance framework should recognise the rights of stakeholders in creating
wealth, jobs, and the sustainability of financially sound enterprises.
2.4.4
Disclosure and transparency

The corporate governance framework should ensure that timely and accurate disclosure is made
on all material matters regarding the corporation, including the financial situation, performance,
ownership, and governance of the company.
2.4.5
The responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the company, the
effective monitoring of management by the board, and the boards accountability to the company
and the shareholders.
2.5
How does Sri Lankas CG practices compare with OECD Principles?

Annex 2 compares the Sri Lankan state of corporate governance with that of the OECD
Principles.
2.6
The continuing conflict between freedom and regulation
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2.6.1
All in all, the OECD Principles as well as the Principles followed by many countries in general,
are designed to enhance confidence in the system of governance. It therefore follows that an
effective enforcement of such systems requires that the relevant laws, rules, and standards are
implemented effectively in the financial, legal and regulatory systems. If it is so done, the system
itself would greatly benefit and thrive and consequently most countries are today moving towards
such regulatory and legal regimes.
2.6.2
At the same time, there is also a growing feeling, especially among emerging economies, that a
countrys business environment must be maintained and operated in a manner that is conducive
for growth and sustainability. Hence, the corporate governance practices should also be regularly
tested and/or analysed so as to ascertain whether those processes constitute a frame work within
which businesses can prosper and grow. It is no secret that some persons view certain corporate
governance practices as irritants to the quick growth of businesses because of the increasing
requirements and minimum standards being imposed. On the other hand, there are also the others
who argue, and perhaps successfully, that long term investors are more likely to invest in
economies which have strong corporate governance practices that are well regulated and
implemented. As the Sri Lanka Code of Best Practice on Corporate Governance sets outs: the
challenge is to strike a balance between the two propositions and to have a satisfactory mix of
freedom and regulation which encourages both the steady growth of companies as well as
the steady build up of confidence of investors.
2.6.3
In summary, it may be stated that the fundamental platform on which corporate governance
practices and principles have been developed over the years has been on the basis that the
practices must not stifle business, but stimulate it.
3.
The Emerging International And National Issues. How Has Sri Lanka Responded?
3.1
The Emergence of Issues

The comprehensive study of any subject, especially one that is evolving
rapidly and having a
significant impact continuously, will naturally produce many issues. In that sense, the subject of
Corporate Governance is bound to be a prime candidate to generate many key issues. In its
comparatively short history, corporate governance has had more than its fair share of issues,
controversies, developments, scandals and more are emerging regularly, and more will probably
emerge in the future. Over the past few years Sri Lanka too has had its share of controversies and
the study of the Sri Lankan CG landscape provides some interesting insights into the manner in
which SL has responded to, and tackled these issues.
3.2
Is corporate influence disproportionate to responsibility?
3.2.1
Robert Monks and Nell Minow, with perhaps a little exaggeration have claimed that:
Corporations determine far more than any other institution, the air we breathe, the quality of
the water we drink, even where we live. Yet they are not accountable to anyone, (Power and
Accountability)
This comment aptly describes the issue that the overall influence wielded by corporate entities far
out-weighs the responsibility that society casts upon them. This issue has been probably raised
on numerous occasions at different fora, and discussed and debated by many experts and
practitioners. But yet an acceptable formula to proportionately link influence and responsibility is
eluding the international business and corporate community.
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3.2.2
In Sri Lanka this situation is no different and it is observed that many companies are today
influencing the overall lifestyles of millions of people. Nevertheless it is noted with some
concern that there are very few governance policies or practices which addresses those concerns.
While many practices are designed from the point of view of safeguarding corporate stakeholders,
there appears to be few which are to protect the environmental, national and local communities,
employers, customers, suppliers and contractors. This wide gap is being felt by many and today
several civil groups are questioning the validity of the governance practices as existing today, in
that they are not wide enough to cover the host of other stakeholders as well.
3.3
Beyond Corporate Governance.
3.3.1
This growing view is that the corporate sector should not confine themselves to corporate issues
only as stated in statements of Corporate Governance Principles, but venture beyond the obvious
corporate issues. The proponents of this view suggest that the corporate sector should act in a
more responsible manner and be concerned with the wider community as well. Society as a
whole may not be best served if Corporations are run for shareholders only. For many kinds of
Corporations, the community, employees and other stakeholders have as much claim to being
owners of the corporations as do the shareholders, and perhaps even more so. Dr. Margaret M.
Blair, Corporate Governance expert attached to The Brookings Institution, USA.
3.3.2
These new issues have given rise to new responsibilities for corporate entities being enumerated
across the world. The following concepts of social and corporate accountability and
responsibility towards other stakeholders are based on the recommendations of the Investor
Responsibility Research Centre of the USA which has suggested a series of Corporate
Responsibility Principles.
[a]
The corporate entitys responsibility towards the environment

Generally Desired outcomes:
Careful attention must be paid to ensure that the corporate entitys actions do not
damage the environment. Issues such as climate change, bio-diversity and pollution
prevention are central to this.
A corporate entity should adopt high environmental standards and ensure that these
are implemented universally, regardless of any legal enforcement or lack thereof, and
should continually seek to improve its performance.
While there are laws to protect the environment in Sri Lanka, and these are being enforced by
statutory authorities and local bodies, there are very few companies who voluntarily disclose
their corporate policies
vis a vis the environment. There is also a general perception that corporations are responsible
for polluting the environment in many ways and in that context, a demand from the investor
community that corporations should disclose their policies and practices to safeguard the
environment in this connection as a part of their overall CG practices, may be a step that
would be of great benefit to the community.
[b]
The corporate entitys responsibility towards the national communities

Generally desired outcomes:
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The corporate entity should strive to be a good corporate citizen in all its locations and
hold it to be the responsibility of every employee to ensure that there is full compliance
with all labour, health and safety standards.
The corporate entity should strive to, in a responsible and transparent way, to contribute
to the countrys efforts to promote full human development for all its citizens.
The corporate entity should respect the political jurisdiction of national communities.
The corporate entity shall be committed to fully respect internationally recognized human
rights standards.
The corporate entity should not use the mobility of capital and the relative immobility of
labour as a tool against workers.
Here too, there are many laws in Sri Lanka which are supposed to ensure that many of the above
outcomes are achieved. However, it is common knowledge that most corporations are in breach
of many of these standards and requirements. In that context, a positive statement by corporates
to the effect that they voluntarily conform to such standards and practices may be a useful first
step it such an outcome is to be pursued in the future.
[c]
The corporate entitys responsibility towards the local communities

A corporate entity should recognise its political and economic impact on local
communities, especially where it is the principal employer. Its programmes, policies and
practices should reflect this recognition.
The employees should be encouraged to participate in local community activities and

organizations.
The corporate entity should take account of local cultures in its decision making
processes while not condoning cultural practices which denigrate human beings on the
basis of gender, caste, class, culture or race.
The corporate entity should strive to contribute to the long-term sustainability of the local
communities in which it operates.
In Sri Lanka, corporates are generally sensitive to local concerns, possibly driven by the need
to maintain good relationships in its area of operations. It is also seen that some companies
reach out to the local communities more than the others, and consequently are held in high
esteem in their locations of business. However, as with the other areas of responsibility
described above, in this regard too, there is no structured system to achieve this outcome, and
it is perhaps very desirable if the corporate and investing community were to address this
need.
[d]
The corporate entitys responsibility towards the shareholders:
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The corporate entitys corporate governance policies should balance the interests of
managers, employees, shareholders and other stakeholders.
The corporate entity should ensure shareholders participation and rights to information
while protecting the interest of other stakeholders.
The corporate entity should respect the right of shareholders to submit proposals for vote
and to ask questions at the annual meeting.
The corporate entity should observe a code of best practice or should have its own
comprehensive corporate code to cover company directors and employee behaviour.
These needs of course seem to be addressed through a host of laws and practices. In addition,
corporates in Sri Lanka are also expected to publicly affirm their commitment to such
practices, and hence it could be said that this issue is reasonably well addressed.
[e]
The corporate entitys responsibility towards the employees

The corporate entity should have a set standard governing its employment practices and
industrial relations. This standard should include genuine respect for employees rights
to freedom of association, labour organisation and free collective bargaining and should
be non-discriminatory in employment.
The corporate entity should value its employees and their contributions in every sector of
its operations.
The corporate entity should pay sustainable community wages, which enable employees,
especially women, to meet both the basic needs of themselves and their families as well
as to invest in the ongoing development of sustainability in local communities through
the use of discretionary income.
The corporate entity should recognize the need for supporting and/or providing the
essential social infrastructure of child care, elder care and community services which
allows workers, especially women who have traditionally done this work as unpaid
labour, to participate as employees.
Very few companies in Sri Lanka follow any of the above practices in a structured way. While
there is a regular lament within the corporate community about the very low productivity in the
country and general labour unrest and inefficiencies, little has been done to address these issues in
a positive and practical manner. It should perhaps be realized that corporations can only be as
effective and efficient as its employees, and therefore steps should be taken to implement such
reforms in a pro-active manner, rather than merely attempting to comply with the many labour
laws that prevail in the country. This is probably one area where good governance practices
could make a significant impact on the countrys business environment.
[f]
The corporate entitys responsibility towards customers, suppliers and contractors.
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The corporate entity should ensure that its products and services meet customer
requirements and product specification.
The corporate entity should be committed to marketing practices, which protect

consumers, and ensures the safety of all its products.
The corporate entity should not market it products to consumers for whom they are not
appropriate.
The corporate entity should have a commitment to fair trading practices.
The corporate entity should use its purchasing power to encourage good corporate
citizenship among its suppliers.
In Sri Lanka, many companies seem to operate on the basis that customers, suppliers and
contractors are groups that need to be exploited to the maximum. Very few companies
function on the basis that the long term health of each of those groups is vital to its own long
term sustainable development and growth. It is essential that this issue be addressed fairly
and openly and corporations encouraged to reconsider their relationships in a more long term
manner. In that context, new initiatives regarding disclosure of policies towards customers,
suppliers and customers by corporations may be the first step in achieving this outcome and
new initiatives in this regard would be very welcome.
3.3.3
It appears that the above mentioned aspects of good governance is almost completely ignored in
Sri Lanka and it is perhaps time that special efforts be taken to include such practices into the
range of practices that should be recommended for adherence by corporate entities.
3.4
Are Institutional Investors demanding enough from corporate entities?
3.4.1
There has been a phenomenal increase in the growth of pension and retirement funds all over the
world. As of the year 2000, American workers are said to have saved and invested approximately
$ 6 trillion in retirement assets such as pensions and stock plans savings funds. The growth of
those funds gives rise to several issues. In a globalised economic system, it would be possible to
invest such funds in corporations across the world. In such a scenario, who should control these
assets, and what type of safeguards should be in place if funds are to be so invested across the
globe? Who should execute voting rights?
These fundamental questions may require that such institutional investors should insist that
corporations that they directly and indirectly invest in should act responsibly. Towards that end,
new mechanisms of transparency and accountability will also have to be constantly developed.
3.4.2
These issues have gradually compelled passive investors of the past to become more active. In
that context, it is interesting as to what one of the largest funds in the world, the California Public
Employees Retirement Systems (CalPERS) has to say about what they have learned.
What have we learned during these past dozen years? We have learned that:
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(a) company managers want to perform well, in both an absolute sense and as compared
to their peers;
(b) company managers want to adopt long-term strategies and vision, but often do not
feel that their shareowners are patient enough; and
(c) all companies whether governed under a structure of full accountability or not
will inevitably experience both ascents and descents along the path of profitability.
We have also learned, and firmly embrace, the belief that good corporate governance
that is, accountable governance means the difference between wallowing for long (and
perhaps fatal) periods in the depths of the performance cycle, and responding quickly to
correct the corporate course.
3.4.3
In Sri Lanka too, institutional investors are today playing a significant role in capital market
activity. At the same time however, their influence over corporation activity and in implementing
good corporate governance practices unfortunately, has not been correspondingly proportionate
or encouraging. Other than a few institutional investors and mutual funds which have been
somewhat insistent about good governance practices, many have passively watched the emerging
scenario without taking a pro-active role to drive companies towards better governance practices.
Surprisingly but fortunately, the initiatives towards good CG practices have been driven in Sri
Lanka mainly by the regulators and quasi-regulators, (such as the ICASL), almost at the
exception of the direct beneficiaries of good governance practices. It is only during the past one
or two years that the investor community has been showing some interest on these issues and that
is certainly a step in the right direction. Hopefully if this trend continues, the applicability and
quality of CG practices in Sri Lanka is bound to improve significantly.
3.4.4
It is a well-known maxim that no one passionately calls for accountability and good
governance when the market keeps going up. And, it would be readily acknowledged that the
demand for such twin virtues would increase rapidly during bear runs in markets. Therefore, it
is perhaps time that the corporate community realises that instead of indulging in knee-jerk
reactions to such sentiments based on market conditions, it would be wiser and more appropriate
if funds, especially the indexed pension funds were to insist on some kind of active good
governance programmes from corporate entities because there would then be some degree of
accountability as demanded by the beneficiaries. It may also be kept in mind that if any
disgruntled beneficiaries were to sue for alleged mismanagement of funds, a fund with a track
record of investing in corporations with good governance programmes may be able to point out
that they (the institutional investors) did whatever they could to take the necessary steps to
safeguard their investors, and thereby repudiate liability, at least to some extent.
3.4.5
Perhaps to meet the above stated needs and requirements, many large and influential institutional
investors have been slowly but surely moving towards persuading the corporations they intend
investing to embrace good CG practices and make changes in the manner in which they govern
their corporations. The benchmarks that CalPERS desire have been set out in the Corporate
Governance Core Principles and Guidelines of CalPERS. For purposes of comparison, this report
attempts to use the CalPERS principles as a benchmark and examine the literature in Sri Lanka
against such norm.
3.4.6
How can board independence and leadership be ensured?
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CalPERS says:
Independence is the cornerstone of accountability. It is now widely recognised
throughout the USA that Independent Boards are essential to a sound governance
structure. But the emerging issue is that it has been found that independence of a
majority of the board is not enough. The requirement is that the leadership of the
board should embrace independence, and it must ultimately change the way in
which directors interact with management. The issue is eloquently summed up
in the following quotation: In the past, the CEO was clearly more powerful than
the board. In the future, both will share influence. In a sense, directors and the
CEO will act as peers. Significant change must occur in the future if boards are
to be effective monitors and stimulators of strategic change. Directors and their
CEOs must develop a new kind of relationship, which is more complex than has
existed in the past..
Jay W. Lorsch, The Board as a Change Agent, THE CORPORATE BOARD
(July/Aug, 1996)
In this context, a further key issue in the achievement of independence, as per CalPERS, is a
lack of conflict between the directors personal, financial, or professional interests, and the
interests of the shareholders. This issue too is yet simmering, and quite possibly would not go
away in the near future. The following comment places the issue in perspective.
A directors greatest virtue is the independence which allows him or her to
challenge management decisions and evaluate corporate performance from a
completely free and objective perspective. A director should not be beholden to
management in any way. If an outside director performs paid consulting work,
be becomes a player in the management decisions which he oversees as a
representative of the shareholder.
Robert H. Rock, Chairman NACD, DIRECTORS & BOARDS (Summer 1996)
In Sri Lanka, an Exposure Draft (ED) on Board Room Governance was issued by the Institute of
Chartered Accountants of Sri Lanka in the year 2001. Although this ED has not yet been
finalized and issued as a Code of Best Practice, it has several features which are designed to
improve the Boards independence as well as ensure board leadership. Needless to say, if these
practices as described are followed, the outcomes as described by CalPERS would be
comfortably achieved. The question however would be as to how effectively these practices
could be and would be followed at some stage when those are issued as a Code and companies
are encouraged to follow such practices on a voluntary basis.
3.4.7
Board processes and evaluation is enough being done?

CalPERS says: No board can truly perform its overriding functions of establishing a companys
strategic direction and then monitoring managements success without a system of evaluating
itself.
To achieve the above outcome of self-evaluation, there is a growing need for boards to adopt
written statements about their own governance principles; have an appropriate mix of director
characteristics; set out performance criteria for itself together with review processes; and to
establish performance criteria and compensation incentives for the CEO.
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It has been generally found that self-evaluations are not too successful and the processes
employed to do so, often do not foster too much credibility in the minds of those who are
watching the process. However, perhaps for want of a better alternative, self-evaluation is
resorted to but it is obvious that it needs to be greatly improved, if greater confidence is to be
instilled in the process. A possible response to this situation is discussed in Paragraph 3.7 of this
Report.
The ICASL ED on Board Room Governance has provided for Board Processes and Evaluation as
per the paragraphs A9-Appriasal of Boardroom Performance and A10- Appraisal of Chief
Executive Officer and hence the Sri Lankan literature could be said to cover these aspects to some
degree. As the survey results show however, the physical practices and application of these
processes seem to be woefully inadequate.
3.4.8
Individual director characteristics is there sufficient quality and quantity available?

In CalPERS view, Each director should add something unique and valuable to the board as a
whole. Each director should fit within the skill sets identified by the board. No director,
however, can fulfil his or her potential as an effective board member without personal dedication
of time and energy and an ability to bring new and different perspectives to the board.
The above benchmark requires a high degree of competence and commitment on the part of the
directors. In emerging economies such as Sri Lanka, corporate entities face a severe dearth of
qualified and competent persons who may be able to undertake such responsibilities. In Sri
Lanka, it is observed that the Code of Best Practice suggests that non-executive directors should
bring expertise in the different fields to the board. It is also suggested in the Code that persons
with wide knowledge on a variety of disciplines, as well as honest persons with integrity should
constitute the boards of companies. Whilst these suggestions are laudable, it remains to be seen
as to whether there are sufficient number of persons who could fit these characteristics in the Sri
Lankan business sector. This then raises the important issue of providing intense training to those
who are already in the field to meet the individual director characteristics that are necessary for
the effective implementation of good CG practices.
3.5
Are non-executive directorships becoming too onerous?
3.5.1
In the past and even at present, in the case of certain companies, non-executive directors were
usually retired eminent persons who were either ceremoniously adorning boards, or persons
who were being rewarded with directorships because of some past favour he or she had rendered
to the CEO. Perhaps rather unkindly, some non-executive directors were even referred to as
being fat, dumb and comfortable. Board meetings were usually cakes and tea affairs with
board members usually jostling amongst themselves to endorse whatever decisions the Chairman
or CEO wishes to take, as fast as possible.
3.5.2
Fortunately, events and initiatives of the recent past have changed this situation to some extent.
Todays shareholders, especially some of the institutional shareholders and some rather
vociferous minority shareholders, are more alert to the directors contributions to management,
and they are now demanding that non-executive directors really earn their fees. The nonexecutive directors are not spared flak when companies decline. Many are in fact, being held
liable for all of the companys actions. Judges and regulators are also tough on them. These
developments have resulted in creating a marked change in the overall functioning of nonexecutive directors. So much so, that some persons are now nervous about taking positions as
directors and are even shying away from being directors. Some others may however say, it is a
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case of when the going gets tough, the not-so-tough running away, and not hence contend that
one should be too uncomfortable about such an outcome.
3.5.3
The general perception however, seems to be that this attitudinal shift has been a good one for
the corporate world, and should be sustained and further encouraged. At the same time, because
of CG provisions of this nature, more persons are likely to specialise in the duties of directors as
well as opt to serve as directors with their eyes open. Accordingly the benefits that
corporations would derive in the future from non-executive directors are bound to improve.
3.6
With pressure on auditors mounting, are audits becoming too onerous?
3.6.1
Up until about the 70s, corporate audits were somewhat mundane exercises, and may have even
been perceived as yet another ceremonial function, which had to done just for the sake of doing it.
A greater part of the attention of the auditor was very often on the arithmetical accuracy of the
books and as to whether the principles of double entry book keeping had been adhered to.
However, over the past two decades or so, there has been a growing concern building up in the
minds of investors about the quality and independence of the services rendered by auditors and
many auditors have been sued large sums of money for negligence, connivance, fraud, etc. These
reactions have compelled auditors to take their duties and responsibilities a lot more seriously,
and as a result the quality of the audits has certainly improved over the years.
3.6.2
The advent of Audit Committees also helped, at least on paper to improve the quality of the audit.
Sri Lankas Code of Best Practice, followed by a new Code of Best Practice on Audit
Committees issued by the ICASL in May 2002 certainly were initiatives that focussed on the
need to improve the quality of the audit.
3.6.3
However the issue also surfaces as to whether audits are becoming so onerous today that many
practitioners are gradually moving away from such services. If that happens, the corporate world
would face a complex factor, i.e., the non-availability of competent auditors, which may be
another hindrance to achieving good corporate governance. In the face of these two conflicting
positions, the corporate sector may have to develop a suitable compromise or a healthy balance to
deal with this complex issue.
3.6.4
At the same time, the old story that auditors are getting too cozy with their clients is also
surfacing again and again. A survey conducted by the Investor Responsibility Research Centre
revealed that 72% of the $5.7 billion in fees paid by 1,200 public companies to their auditors in
2000 was for non-audit services. Similar findings would probably surface in emerging economies
as well. Everyone knows this is an old story. But somehow or another, not much seems to have
been done to address this issue, all over the world. To some extent perhaps, Sri Lanka may be at
least slightly different.
3.6.5
In Sri Lanka, the introduction of the Sri Lanka Accounting and Auditing Standards Monitoring
Board Act in 1995 added a new dimension to this vexed issue about ensuring compliance with Sri
Lanka Accounting and Auditing Standards in the preparation and audit of financial statements by
specified business entities. As would be seen, the Act requires SBEs to prepare their financial
statements in accordance with Sri Lanka Accounting Standards. In a way, such a provision
facilitates the work of the auditor in a certain manner and degree. At the same time however, the
work of the auditor too may have become more onerous as a result of the added requirement that
the audit too should be conducted in accordance with Sri Lanka Auditing Standards. The Act
empowers the Monitoring Board to take various measures to ensure compliance and penalties
specified for defaulters include heavy fines and even imprisonment. These rather stringent
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provisions have certainly had an effect and impact on the financial reporting standards and audit
quality, and this initiative of the SLAASMB could perhaps be described as one of the high points
in the Sri Lankan CG landscape
3.7
In relation to Corporate Governance, do companies actually do what they say they do?
3.7.1
Over the past three or four years, it would have been observed by the Sri Lankan business
community that many corporate entities proudly state in their annual reports that they are
complying with a wide variety of corporate governance practices. They also state very diligently
that, as good corporate citizens, they adhere to some Code of Best Practice or another. These
statements are obviously very comforting to the shareholders and the community of investors,
who are naturally interested as to how efficiently and effectively their companies are being
managed, operated and governed.
3.7.2
Notwithstanding such good feelings, there is today a growing and nagging concern among
many investors who have some insight into the manner in which many Sri Lankan companies
actually operate, that companies do not, in actual fact, follow the Corporate Governance practices
in spirit and form, although they say they do so.
3.7.3
In the course of the empirical study on Corporate Governance (CG) Practices in Sri Lanka carried
out in September 2002, one of the stunning findings was that sufficient evidence was not
available to even weakly confirm that many of the corporate governance practices that corporate
entities said publicly that they were following, were in fact being practiced professionally and
diligently. Nevertheless, probably in order to show a good picture in their Annual Reports and to
appear as a good corporate citizens, practicing state of the art corporate practices, such claims
seemed to have been made quite nonchalantly or perhaps even casually. Maybe, in many
instances, these statements were not entirely or totally untrue or inaccurate. But in general, it
seemed that the statements were grossly exaggerated and/or largely unsubstantiated.
3.7.4
But, as practices prevail today, whatever may be the actual ground position, how is anyone to
know? As per the current practices that prevail in Sri Lanka, the corporate community is only
able to know what companies do as far as corporate governance practices are concerned, is from
what the companies say they do. There is no suggestion or requirement, legal or otherwise, that
such self claims of good behaviour by companies should be independently verified and
reported upon. In the absence of such an independent and professional review of the company
claims, no disbeliever could state with any certainty or conviction, that some practice or another
was not carried out or that the adherence to some other practice was overstated or exaggerated.
This outcome therefore, raises a very significant issue. When corporate entities are technically
given the opportunity, or even coaxed and encouraged into making price sensitive statements,
(there is enough evidence to show that corporate governance compliance statements are price
sensitive) and such claims are not subjected to any review as to its veracity, is the corporate
community inadvertently exposing itself to a dangerous abuse of the system? Could it be said that
they may even be tacitly encouraging and/or promoting such abuse? In that context, an extract
from the Annual Report (2000) of Enron Corporation which was responsible for one of the largest
bankruptcies in US history and caused a highly publicised financial scandal, is worthy of note.
The adequacy of Enrons financial controls and accounting principles employed in financial
reporting are under the general oversight of the Audit Committee of Enron Corporations Board
of Directors. No member of this Committee is an officer or employee of Enron. Technically
true? Ethically false?
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3.7.5
During the Sri Lankan survey, it was quite patent that a number of Sri Lankan companies
assessed during the survey were merely setting out certain selected extracts from the Institute of
Chartered Accountants of Sri Lanka (ICASL) Code of Best Practice or the Cadbury Guidelines
without a clear link or reference to the rest of those Reports. There was no clear disclosure as to
how those guidelines were actually being followed. A number of relatively smaller companies
also seemed to have reported on certain aspects of CG within their CG reports or Directors'
reports on an ad hoc basis, and it seemed that they were merely mimicking the reports of others.
Some of the larger companies which appeared to be getting conceptual inputs from specialized
Annual Report production firms seemed to be following a set template with a pre-configured
checklist of reporting topics. All in all, it looked as if it was a case of many companies blindly
following a Framework or Code on CG without clearly comprehending the spirit in which it had
been established. It followed therefore that it is very unlikely that those companies would
actually be reaping the benefits for which the CG practices were recommended to be followed, in
the first instance.
3.7.6
This unsatisfactory situation is further compounded by the fact that an established mechanism of
independently verifying the actual degree of compliance by different companies with the various
Best Practice recommendations, is not in place in Sri Lanka, or for that matter in other CG
regimes as well. For example, a company that has an Audit Committee that meets once a year for
15 minutes (perhaps just for the sake of meeting), and a company that has an Audit Committee
with a number of non-executive directors, meeting once a month for a comprehensive review,
would both be able to technically and truthfully, disclose as having working Audit Committees.
It is even possible that this wide latitude available in describing its practices has led some
companies to even have a somewhat lacklustre attitude towards CG disclosures, and maybe even
consider it as a bit of a farce. As one company quite casually remarked in their annual report, it
is not mandatory to disclose corporate governance practices. However This kind of feeling is
obviously not surprising because in actual practice, there is no real onus on the companies to
disclose their CG practices in a credible environment, and even it they were to do so, they know it
could be done by using a varied number of measures which results in it being difficult or even
impossible for any one to make useful inferences and comparisons.
3.7.7
Although not sufficiently highlighted in the past, this issue is a very serious one and needs a
response from the world-wide corporate community soon. It could perhaps be identified as an
issue which is deeply rooted in an information-expectation-awareness-understanding gap
between corporations and investors/other stakeholders, coupled with an acute misunderstanding
on the part of many company directors and investors about the true nature of CG. In that context,
the appropriate response to deal with this issue could possibly be through a two-pronged strategy
which addresses the underlying and fundamental reasons for this problem.
3.7.8
The first part of such strategy would be to create awareness in the business community of the
need to ensure that companies actually do what companies say they do. For this to happen, there
should be an active and concerted drive towards enhancing awareness about this issue among all
companies and investors and make them appreciate the vast benefits and opportunities that could
be derived from the adherence to good CG practices. The second part of the strategy would be to
set up an institutionalized mechanism for Independent Assessments to be done on the actual
degree of physical compliance with CG practices and policies by companies. It is obvious that all
aspects of a companys CG practices including the activities of various board committees,
disclosures of information, composition of non-executive directors, implementation of
Board/CEO evaluation criteria and evaluation of performance etc. should be scrutinised,
evaluated and reported upon, if it is to be credible. In that background, the investment
community should essentially drive the demand for such independent monitoring, since their
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investment decisions are to some extent, based on such claims. Just as investors require credit
ratings of corporates from independent credit rating firms before making decisions on certain
investments and debt instruments, investors should also require independent reviews and
evaluation of corporates CG practices from CG rating firms, if they are to confidently rely
upon such claims.
3.7.9
Many surveys across the world have shown that investors pay more for shares of companies who
have good CG practices. The Global Investor Opinion Survey, 2002 released by McKinsey &
Company clearly showed the importance todays investors place on good corporate governance.
63% of investors said they would avoid certain companies with unreliable CG, while 57% stated
that they would increase or decrease their holdings based on the companys CG practices. Over
80% of Asian investors ranked good CG as equally or more important, relative to financial issues.
A significant percentage of investors (78%) said they would be willing to pay a premium for a
well-governed company. A new stock market, the STAR exchange, launched in April 2001 by
Italys Borsa Italiana for companies that follow a strict set of governance requirements also
provides more evidence. Listed companies in the STAR exchange must have a minimum number
of independent, non-executive directors; ensure that the compensation of managers and directors
reflects their performance; and adhere to rigorous disclosure requirements. Studies have revealed
that Companies on the STAR exchange out-performed those on the main boards by 16.5% and
had a weighted average market-to-book ratio of 3.8, compared with 2.1 on the main exchange.
(The McKinsey Quarterly, 2002 Number 3). These findings confirm the price-sensitive nature
of perceived adherence to corporate governance practices. Sri Lanka is no different. The
September/October 2002 survey findings clearly revealed that several companies which ranked
higher with regard to their stated adherence to CG practices, displayed higher PE ratios than their
counterparts whose stated CG practices ranked lower. It could therefore be said with some
authority that investors of today are prepared to pay a premium for companies with good CG
practices. In that background it would not be too difficult to implement an independent review
scheme as suggested, since it would greatly enhance the credibility of the process. Further, it is
very likely that when such a scheme is set in motion, the companies themselves would opt for
independent assessment of their CG practices in order to show themselves off to the investor
community as model corporate citizens. In this context, CG champions should in the very near
future, identify the key assessment criteria along with the skills required by Independent
Assessors, and such initiatives should be translated into a comprehensive strategic framework
with an implementation arm as well. It is indeed surprising that this issue has not received
sufficient attention from the global CG community as yet, but it is now certainly time that it be
viewed with serious concern, and responses implemented before some horrendous scandal
surfaces to direct the public and media searchlight towards it.
3.8
How can CG practices be implemented when many directors do not even know how to do
so?
3.8.1
It may also be opportune to acknowledge another ground reality in that many company directors
do not know how to effectively implement good governance practices in their companies. It is no
secret among many in the investing community that the knowledge and appreciation of
governance practices is very limited amongst many directors. Unfortunately, there are very few
who could train such directors either! For example, in the case of the implementation of practices
such as Independent Board appraisals, CEO appraisals, CEO succession, Nominating Committee
processes, Remuneration Committee processes, etc., many directors are not sure as to how those
processes could be worked or even how they should work!
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3.8.2
It is therefore very necessary that experts in these fields start to offer specialized services to assist
boards to carry out such appraisals as well as to develop functional and practical methods and
models for the successful implementation of various governance procedures, processes, etc.
While it is noted that there are some ad hoc type of initiatives in the form of director training
courses carried out in this regard, many of these do not address the real needs as set out above. It
is therefore important that a sufficient number of structured courses are organised to impart these
special knowledge and skills to Directors and Chairmen. If this does not happen soon, the wellspelled out governance processes will remain processes on paper only.
3.9 What about Whistleblowers?

A study by the National Whistleblowers Centre in the USA has revealed that about a half of the
whistle-blowers who exposed workplace wrongdoing, have been fired, harassed, or been unfairly
disciplined. The question then may be posed as to in that if this situation continues, who will tell?
Who is to safeguard the whistle-blowers?
In emerging economies, especially in South Asia, whistle-blowing could be a somewhat risky
enterprise, and it is quite likely that if members of the staff or top executives were to expose
wrong-doing, they would almost certainly be subjected to harassment and/or penalized in some
way. In Sri Lanka, there have been very few cases where whistleblowers have been successful in
exposing instances of wrong doing, but more often than not, the reverse would be true; and it is
unlikely that any material change would take place in this regard in the near future. This is
perhaps an issue that needs careful attention soon.
3.10 Are regulators really independent?
3.10.1 An issue that it is also quite pertinent is the quality, integrity and independence of regulators.
Especially in smaller economies, old boys clubs have taken root where persons with obvious
conflicts of interest sit on judgement on many corporate issues, as Members of Commissions,
Members of Supervisory Bodies and other Regulatory authorities. Such blatant disregard of good
governance principles hardly promotes confidence, and should be exposed and discouraged at
every turn.
3.10.2 In Sri Lanka there is a plethora of regulators in many forms. These institutions and the work
done by them are described in Paragraph 1 of this Report. Any person looking at these
institutions from outside is bound to convince themselves that these organizations are all working
satisfactorily, supporting each other effectively and are all part of a framework which results in
promoting and ensuring a very high quality of governance in the country. Unfortunately
however, although all these institutions have been established to fulfil some major need, it is sad
that not all are playing such dynamic and/or useful roles. There are many instances which are
surfacing again and again with regard to conflict of interest, arrogant or arbitrary behaviour, poor
understanding of issues, obvious bias, painful bureaucratic procedures, etc. These shortcomings
very often make those institutions less credible and effective. Therefore not only is it necessary
to head-hunt outstanding persons to fill regulatory roles and invite them to carry out the tasks
ahead with integrity and efficiency, but also restore confidence in the regulatory system by
ensuring that there is consistency in the decision making processes.
3.11
CG is a vibrant and dynamic process

The above mentioned emerging issues as well as many others contribute to the vibrancy and
dynamism of the subject of corporate governance. While obvious benefits would follow if the
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above mentioned issues are satisfactorily resolved, or managed, it must be kept in mind that fresh
issues would also emerge as time goes on. The necessity therefore would be to strike the
optimum balance when faced with contradictory issues, as well as develop a global community
of CG professionals who will watch over this new science. That then would probably be one of
the main challenges that are facing the business and corporate sector today.
4.
The Way ForwardIs Good Corporate Governance, The Panacea For All Business Ills?
4.1
CG at the centre of investment decisions

It is very clear that Corporate Governance is of great concern and interest for institutional
investors, according to the July 2002 Global Investor Opinion Survey released by McKinsey &
Company. The survey has also revealed that the strengthening of the quality of accounting
disclosure has also been identified as a top priority by the investing community. From all
accounts, therefore it could be safely stated that Corporate Governance is obviously at the centre
of all investment decisions. In fact, as per the McKinsey findings:
4.2
Investors state that they place corporate governance on par with financial indicators when
evaluating investment decisions.
An overwhelming majority of investors have stated that they are prepared to pay a premium
for companies exhibiting high governance standards. [Premiums averaged 12-14% in North
America and Western Europe; 20-25% in Asia and Latin America; and over 30% in Eastern
Europe and Africa].
The relative significance of governance seems to have decreased slightly since 2000. This
is probably due to the fact that:
(a) many countries have implemented governance-related reforms in their corporate sectors,
and
that
has
been
welcomed
by
investors,
and
(b) more than 60% of institutional investors have been guided by policies that make them to
avoid individual companies with poor governance, as well as avoid countries with poor
governance.
Is CG the new miracle drug?

Does all this mean therefore that Corporate Governance is the new miracle drug that could be
prescribed to treat all corporate ills?
Over the past few years the awareness about corporate governance principles has been growing
worldwide. Together with such awareness, the expectations of corporate entities and investors
about its validity and usefulness have also been growing. Investors have begun to have more
faith in corporate entities that practice good corporate governance processes rather than those
which do not do so.
4.3
Will good CG eliminate business risk?
4.3.1
On the downside however, this situation has also perhaps in an indirect manner, led to many
investors tending to perceive and believe that corporations which follow good corporate
governance practices are risk free and that the good governance practices offer some kind of a
guarantee against business risk and the uncertainty of business as well. The disappointments
being expressed about CG practices when corporate failures take place is probably a
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manifestation of this growing, genuine belief. This is a dangerous and misleading trend and can
quite effectively damage the positive build-up about the concept that is prevailing today.
4.3.2
It is therefore vital for these who are involved in promoting good corporate governance practices
to also publicise the limitations of corporate governance and address this growing expectation
gap. Good corporate governance practices however soundly applied, does not eliminate business
risk. The fact that such practices could certainly help to manage and control risk and to bring a
corporate entity back to profitability and stability faster, should not be mistaken for the
elimination of business risk. Emerging economies such as Sri Lanka are greatly susceptible to
expectations of this nature and hence it is vital that good CG is shown in its true light with all its
strengths and weaknesses.
We wanted a system which stops reasonable men being fooled, not to protect fools from their
own folly. White Paper on Investor Protection, January 1985 in England
Abbreviations used in this Report

CBSL
CCC
CDS
CEO
CSE
ED
ICASL
IPO
OECD
ROC
SBE
SEC
SLAASMB
SLAS
SLAuS
SLID
TOR
UITF
- Central Bank of Sri Lanka

- Ceylon Chamber of Commerce
- Central Depository System
- Chief Executive Officer
- Colombo Stock Exchange
- Exposure Draft
- Institute of Chartered Accountants of Sri Lanka
- Initial Public Offering
- Organisation for Economic Co-operation and Development
- Registrar of Companies
- Specified Business Enterprise
- Securities and Exchange Commission of Sri Lanka
- Sri Lanka Accounting and Auditing Standards Monitoring Board
- Sri Lanka Accounting Standards
- Sri Lanka Auditing Standards
- Sri Lanka Institute of Directors
- Terms of Reference
- Urgent Issues Task Forces
292
Annex 1
Survey of Corporate Governance Practices in Sri Lanka
1.0
Introduction
Good Corporate Governance (CG) is an extremely complex issue. The issues and complexities involved
are shared alike in developing countries, transition economies and the developed world. Therefore, it is
necessary to gain a clear understanding of these issues at a grass-roots level in order to devise practical
frameworks and processes to contribute to good CG and economic expansion.
2.0
CG Survey
The survey was conducted on a random sample of 50 Public Listed Limited Liability companies
representing 21% of all listed companies in the Colombo Stock Exchange (CSE). The sample covered
most of the major sectors in the CSE.
The sample companies recorded a combined turnover of LKR 141.2 billion (US$ 1.5 billion) within the
period of review.
The latest available Annual Reports of the sample companies were analysed based the following criteria:
Statement of Compliance to ICASL guidelines
Separation of the Chairman and the CEO
Composition of the Board of Directors with respect to Non-Executive Directors
Provision of training to directors
Disclosure of a Nomination Committee
Disclosure of an Audit Committee
Disclosure of a Remuneration Committee
Having a Director in charge of finance
Statement of internal control
Disclosure of audit fees as a separate item
Directors responsibility statement
Statement of going concern
Payment of all Statutory Payments
Qualified Company Secretary
Statement of a Code of Ethics in business practices
Chairmans review addressing future prospects
Method for CEO succession
Method for CEO evaluation
Method for Board evaluation
Each Company was given 1 point for fulfilling each of the above criteria (apart from the percentage
composition of the Board) for a maximum of 18 points.
3.0
Analysis
The Sample obtained an average of 8 points or 45% of the total achievable score with a median of 9.
Notable high-scorers include National Development Bank (72%), Commercial Bank (67%), John Keells
Holdings (67%), Ceylon Tobacco Company (67%) and Hayleys (61%).
293
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Statement of
Compliance
Audit
Committee
Remuneration
Committee
Internal
Control
Statement
Fig. 1.0
44% of the Sample Companies disclosed a Statement of Compliance with the ICASL Best Practices
Guidelines. However, non-of the companies stated the degree of compliance. There was a significant
number of companies that extracted verbatim the definition of Corporate Governance from the ICASL
guidelines or from the Cadbury Report on Corporate Governance without any clear linkage to the
remainder of their CG report. The purpose of this exercise is unclear apart from giving the reader a
definition of CG. There were also a number of companies that stated that they agreed fully with the
guidelines set by the ICASL, but did not state whether they were complying with the guidelines.
Over two thirds of the Sample Companies issued a Statement of Internal Control. Most of the larger
companies had a specific report on the subject while some smaller companies included it within the
Directors Report.
Just over half of the Sample Companies reported an Audit Committee. Some of the larger companies
accompanied the disclosure with a separate Audit Committee Report. The smaller companies usually
disclosed the presence of an Audit Committee within its CG report, but did not disclose the functions and
responsibilities of the Committee or its activities within the reporting period.
The Remuneration Committee was generally reported only by the larger and more established companies.
It has to be noted that all the companies within the Diversified Holdings sector reported a Remuneration
Committee.
294
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Responsibility
Statement
Directors
Training
Going Concern
Statutory
Payment
Fig. 2.0
A significant majority (78%) of the Sample Companies reported a Directors Responsibility Statement.
The Statements generally conformed to the ICASL guidelines identified that the Directors responsibility
is different from the responsibilities of the Auditors. They also referred to the relevant sections of the
Companies Act and Sri Lanka Accounting Standards (SLAS).
64% of the Sample Companies reported a Statement of Going Concern while half of the Sample
Companies disclosed that their statutory payments were up-to-date. It was notable that a leading bank
that had omitted to report a going concern statement in the preceding reporting period had disclosed such
a statement within the current period.
However, a very dismal 14% reported any kind of training programs for their Directors. Moreover, none
disclosed the type of training and skills development available.
Nearly two thirds of the Sample Companies reported a separation of duties between the Chairman and the
Chief Executive Officer. Many companies referred to the ICASL guidelines as a prime motivator for this
separation. A few of the larger companies also referred to the OECD guidelines115. However, there were
a nominal number of companies, including a large Bank and Diversified Holdings Company, which had
an executive Chairman and a CEO. While these companies reported faithfully following Guidelines, they
do not necessarily adhere to the spirit of such Guidelines.
The OECD Guidelines for the separation of the roles between Chairman and CEO is to ensure an
"appropriate balance of power, increasing accountability and increasing the capacity of the board for
independent decision making116. However, it is unclear how this can be achieved by having an executive
Chairman and a CEO.
115
116
OECD Principles of Corporate Governance (1999), OECD

OECD Principles of Corporate Governance (1999), OECD, pp. 24
295
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Chairman &
CEO
Finance
Director
Future
Prospects
Ethical
Standards
Fig. 3.0
It was only 18% of the Sample Companies that had a Director in-charge of finance in their Boards.
Considering that it is the responsibility of the Directors to ensure (sic) the integrity of the corporations
accounting and financial reporting and reviewingannual budgetsand setting performance
objectives and monitoringperformance117 it is essential to have representation of a financially qualified
person within the Board.
80% of the Sample Companies referred to their future prospects and strategies in their respective
Chairmans Reviews. A few companies reported their future plans within the Directors Review or
Management Discussion.
Only one fifth of the Sample Companies referred to any code of ethical practices. Some companies stated
that they expect their employees to act in the highest ethical standards, but failed to refer to any
standard or code.
One fourth of the Sample Companies had a composition of over 80% non-executive directors within their
Boards.
Nearly 75% of the Sample Companies had a composition of over 41% non-executive directors within
their Boards.
Many companies referred to the ICASL Code and the OECD Code as a motivating factor in deciding
Board Compositions. A number of Companies stated that the experience and calibre of non-executive
directors will contribute significantly to the performance of their companies and will look after the
interests of external stakeholders.
All the Sample Companies showed audit fees as a separate cost item in their notes to accounts.
117
OECD Principles of Corporate Governance (1999), OECD, pp. 9
296
48 of the Sample Companies reported qualified Company Secretaries. While most companies used a
corporate services firm to provide secretarial services few companies used in-house corporate secretaries.
Their qualifications were disclosed.
Only one company-a bank- reported procedures for CEO succession and CEO evaluation. Two other
companies had procedures for Board Evaluation.
4.0
Case Study
N/A
14%
0<20 %
12%
21<40 %
6%
81<100 %
26%
41<60 %
20%
61<80 %
22%
There were a few companies that

were way ahead of the others
with respect to disclosure.
Therefore, we sought to establish
whether there was any distinct
advantage with respect to the
company by a high rate of
disclosure.
A test was undertaken to
measure the performance of the
Company
against
the
performance of the overall
market during the reporting
period.
The Company Price
Earnings Ration (PER) was
plotted against the Colombo
Stock Exchange Market PER.
While there may be a number of
Fig. 4.0: Non Executive Director
Composition
factors influencing the performance of a company, we believe that corporate governance disclosure and
good CG practices are a significant contributory factor.
4.1
John Keells Holdings Ltd.
297
18
16
14
PER X
12
10
8
6
4
2
JKH
Market
12/2/01
11/2/01
10/2/01
9/2/01
8/2/01
7/2/01
6/2/01
5/2/01
4/2/01
3/2/01
2/2/01
1/2/01
Fig. 4.0: JKH PER performance
John Keels Holdings Ltd. (JKH) is a Diversified Holdings company involved in Leisure, Food &
Beverage, IT, Infrastructure Development, Plantations and Financial Services Sectors.
JKH had a 67% disclosure rate in the CG survey. Moreover, the Company was one of the first corporates
to adopt the ICASL guidelines and have consistently made a high degree of disclosure.
The Company has constantly over performed the market during the reporting period.
4.2
Commercial Bank
Commercial Bank (CB) is one of the largest private sector banks in Sri Lanka. It was the first bank to
reach the LKR 1 billion mark in its profit.
298
10
9
8
7
PER X
6
5
4
3
2
1
Commercial Bank
Market
12/2/01
11/2/01
10/2/01
9/2/01
8/2/01
7/2/01
6/2/01
5/2/01
4/2/01
3/2/01
2/2/01
1/2/01
Fig. 5.0: CB PER performance based on

EPS of voting shares
The Bank has won the prestigious Best Bank in Sri Lanka award from the Global Finance Magazine for
three consecutive years from 1999-2001. Moreover, CB has won the Bank of the Year 2001 Sri Lanka
award from the Banker Magazine.
CB was the only company to disclose procedures for CEO succession and evaluation.
CB has over performed or performed at par with the Market in what was essentially a depressed year for
financial services.
4.3
Richard Pieris & Co. Ltd
299
18
16
14
PER X
12
10
8
6
4
2
RPC
12/11/01
11/11/01
10/11/01
9/11/01
8/11/01
7/11/01
6/11/01
5/11/01
4/11/01
3/11/01
2/11/01
1/11/01
Market
Fig. 6.0: RPC PER performance
Richard Pieris & Co. Ltd. (RPC) is a large manufacturing company with interests in real estate
development and retail services.
The Company has shown a significant year on year growth in its CG reporting.
RPC has incrementally disclosed the addition of a Director of Finance, Audit Committee and a Statement
of Statutory Payments within the review period applicable to the Survey.
RPC has consistently over performed the market within the same period.
4.4
Hayleys Ltd.
Hayleys Ltd. (HL) is a large Diversified Holdings company involved in Manufacturing, Agriculture,
Plantations, Transportation, Leisure and Textiles.
HL had a disclosure rate of 61%. The Company was one of the few in the Survey that disclosed training
for Directors.
300
10
9
8
7
PER X
6
5
4
3
2
1
Hayleys
12/2/01
11/2/01
10/2/01
9/2/01
8/2/01
7/2/01
6/2/01
5/2/01
4/2/01
3/2/01
2/2/01
1/2/01
Market
Fig. 6.0: RPC PER performance
The Company has been winning the ICASL Annual Report

Competition consistently for the last 2 years in the Diversified Holdings Sector.
disclosure is a key criterion for winning the Annual Report Competition.
The measure of
The Company has performed generally at par with the market in a depressed year for a number of its core
sectors.
5.0
On the Ground
The Global Investor Opinion Survey, 2002118 released by McKinsey & Company clearly shows the
importance todays investors place on good corporate governance. 63% of investors said they would
avoid certain companies with unreliable CG, while 57% stated that they would increase or decrease their
holdings based on the companys CG practices.
Over 80% of Asian investors ranked good CG as equally or more important relative to financial issues. A
significant percentage of investors (78%) said they would be willing to pay a premium for a wellgoverned company.
5.1
The Sri Lankan Case
Our survey on the Sri Lankan CG practices show that most companies are following a framework based
on theoretical principles. However, there is no clear indication as to how these principles are really put
into practice.
We came across a number of companies during the Survey that merely printed extracts from the ICASL
guidelines or the Cadbury Guidelines without any clear link or relevance to the rest of the report. These
118
Global Investor Opinion Survey on Corporate Governance (2002), McKinsey & Company
301
extracts were used more as a definition of CG while there was no disclosure as to whether these
guidelines were being actually followed.
5.2
The Pied Piper Effect
A number of smaller companies reported on certain aspects of CG within their CG reports or Directors'
report on an ad hoc basis. There was no clear indication as to whether these companies were aware of the
ICASL guidelines or whether they were merely mimicking reports of others.
Some of the larger companies were getting conceptual inputs from specialised Annual Report Production
firms. Most of these firms follow a set template with a pre-configured checklist of reporting topics.
Therefore, there seems to be a blind following of the Framework without clearly comprehending the spirit
of which it was established. Just as the mice of Hamelin blindly followed the Pied Piper and his flute,
many companies seem to be following the Framework without actually reaping or passing on its benefits
for which it was devised. Such a reality might lead some companies over the cliff of investor confidencejust like the mice of Hamelin- to their eventual demise.
This situation is further compounded by the fact that there is no way of independently verifying the actual
degrees of compliance of the various Best Practice recommendations of different companies. For
example, a company that has an Audit Committee that meets once a year for 15 minutes and a company
that has an Audit Committee with a number of non-executive directors and meet once a month for a
comprehensive review would both be able to disclose as having a working Audit Committee within their
respective Annual Reports.
Some companies have a lacklustre attitude towards CG disclosure. As one company put it it is not
mandatory to disclose corporate governance. However This shows that there is no real onus on the
Companies to disclose their CG practices and even when they do it is done by using a varied number of
base measures that no useful inferences can be made.
Another case to point: An extract from the Annual Report (2000) of Enron Corporation- which was
responsible for one of the largest bankruptcies in US history and caused a highly publicised financial
scandal.
The adequacy of Enrons financial controls and accounting principles employed in financial reporting
are under the general oversight of the Audit Committee of Enron Corp.s Board of Directors. No member
of this committee is an officer or employee of Enron. 119
This clearly shows that having the tools for good CG is by itself not enough. They have to be used
knowledgably and with a clear idea of what needs to be achieved.
6.0
A Solution
We believe that any solution to this information gap between the corporation and investor (and other
stakeholders) along with the attitude deficit of the corporation needs to be addressed through a twopronged strategy.
6.1
119
Awareness
Annual Report (2000), Enron Corporation
302
It should be the responsibility of the persons who are championing good Corporate Governance to ensure
that companies are actually doing what they say they are doing within the true spirit of the frameworks
and concepts.
There should be an active drive towards enhancing awareness among the smaller companies and to make
them realise the opportunities that can be derived from good CG.
6.2
Independent Assessment
Although Latham (1999)120 calls for independent Corporate Monitoring Firms to nominate director
candidates for a companys Board, we believe independent assessment of a companys CG practices
should be much more far reaching.
All aspects of a companys CG practices including the activities of various Board committees, disclosure
of information, composition of non-executive directors, Board/CEO evaluation criteria and evaluation
performance etc. should be scrutinised and reported.
The investment community should essentially drive the demand for independent monitoring. Just as
investors require credit ratings of corporates from independent credit rating firms before making any
decisions on an investment instrument, investors should require an independent audit of a corporates
CG practices.
With many investors prepared to pay a premium for companies with good CG121 it should also be the
responsibility of the corporates themselves to opt for independent assessment.
CG champions such as the ICASL and the international CG institutions should identify the key
assessment criteria along with the skill set required by the Independent Assessors, which should be
translated into a comprehensive strategic framework.
7.0
Conclusion
While the Sri Lankan CG landscape is yet a long way off from ideal there has been significant
improvements year on year. As the case studies show some companies are already reaping dividends
from their CG practices.
One of the principal problems in Sri Lanka and indeed the rest of the world is that there is no reliable way
of assessing the CG practices of individual companies. Therefore, independent assessment backed by a
strategic framework from CG champions and driven by the investment community would be a step in the
right direction to enhance the utility of CG in the investment environment.
120
121
Latham, M.(1999) The Corporate Monitoring Firm, Corporate Governance- An International Review, Vol. 7, No. 1
Global Investor Opinion Survey on Corporate Governance (2002), McKinsey & Company
303
Annex 2
Comparison of Sri Lankas CG Practices with OECD Principles
Responsibilities of the Board
Act fully informed, due diligence, best interests of the Company and the
shareholders
Seeking legal and financial advice with the Company to bear the cost
Formal and basic training for Directors
Short "in-house" courses organised by Institutions
Treat shareholders fairly
Draft: Statement of equitable treatment of shareholders
Ensure compliance with applicable laws and take into account the
interests of the shareholders
Issue compliance report setting out the extent statutory payments have been
made.
I: Responsibility of Board to look after interests of stakeholders
Reviewing and guiding corporate strategy, plans, annual budgets,
performance objectives, implementation, cap ex, acquisitions and
divestitures
Draft: Board should meet regularly with board meetings at least once every
quarter
Draft: Board should have a formal schedule of matters for decision
Selecting, compensating, monitoring, replacing key executives and
overseeing succession planning
Appointment of Remuneration Committee
Appointment of Non-Ex Directors should be a matter for the Board as a
whole
Draft: Nomination Committee for Board Appointments
I: Reviewing and appraising the performance of the Board annually
Draft: Appraisal of CEO
Monitoring and managing potential conflicts of interest

Appointment of Audit Committee
Internal Control Statement
Draw up a Code of Ethics and Statements of Business Practices
Draft: Declaration of all material contracts involving the Company and
refrain for voting in materially interested matters
Ensuring the integrity of the corporation's accounting and
financial reporting systems
Finance function should be the responsibility of a specific
board director
Statement of Directors' Responsibility for Financial Statements
Fees paid for audit and non audit work to be shown separately
Periodical rotation of audit partners and staff
Statement of Going Concern
I: Business Risks undertaken after due consideration by both
management and board
Monitoring the effectiveness of governance practices
Draft: CG Report
Key:
Supporting recommendations of the OECD Principles
Supporting recommendations of ICASL and other documents
I: Supporting recommendations of ICSA
Draft: Supporting recommendations of Exposure Draft ICASL
304
Responsibilities of the Board (cont.)

Overseeing the process of disclosure and
communications
I: Annual Report of the Board should give concise
and informative statements that give insight to the company's
underlying governance approach
Key:
Exercise objective judgement of corporate affairs

independent of management
Separation of Chairman and CEO
Appointment of independent non- ex board members
Have access to accurate, relevant and timely information

I: Company secretary to provide information to the Board
Draft: Board must be supplied information in a timely manner
in sufficient quality to discharge its duties
305

Disclosure should include, but not limited to:
The financial and operating results of the company
I: Annual Report- financial statements of the company prepared
in terms of the Companies Act No. 17, 1982 and SLAS
Company objectives
I: Concise statements should be provided for company plans and strategies
Major Share ownership and voting rights

Members of the board and key executives, and their
remuneration
Draft: The company's Annual Report should contain statement of
remuneration policy
Draft: Disclose all elements of remunerationof the board as
a whole
I: Identification of chairman and CEO and also non-ex and
Information should be prepared, audited and disclosed

in accordance with high quality standards of
accounting and audit
Confirmation that applicable Sri Lanka Accounting Standards
have been followed.
Annual audit should be conducted by an independent
auditor
External Auditaccording to SLAS would lead to expression
of objective, independent and effective opinion on the
Financial Statement
Channels for disseminating information should
provide for fair, timely and cost efficient access to
relevant information by users
independent directors
Material foreseeable risk factors
I: Concise statements should be provided for company risk
management
Material issues regarding employees and other
stakeholders
Governance structures and policies
Directors should state the extent of compliance with the
Code of Best Practice
Key:
306
Role of Stakeholders in CG
CG framework should assure the rights of

stakeholders that are protected by law are respected
Where stakeholder interests are protected by law,

stakeholders should have the opportunity to obtain
effective redress for violation of their rights
CG framework should permit performance-enhancing

mechanisms for stakeholder participation
Where stakeholders participate in CG they should

have access to relevant information
Equitable Treatment of Shareholders
All shareholders of the same class should be

treated equally
Within the same class, all shareholders should have
the same voting rights
Votes should be cast by custodians and nominees in a
manner agreed upon with the beneficial owner of the
shares
Draft: Companies should count all proxy votes
Processes and procedures for general shareholder

meetings should allow for equitable treatment of
shareholders
Key:
307

Basic shareholder rights:
Secure method of ownership registration
Convey or transfer shares
Obtain relevant information
Participate and vote in general shareholder meetings
The Company should use its AGM to communicate effectively
with its shareholders
Elect members of the Board
The Directors should stand for re-election at an AGM at
regular intervals
Share in the profits of the corporation
Opportunity for shareholders to ask questions of the board and

place items on the agenda
Able to vote in person or absentia
Capital structures and arrangements that enable certain

shareholders to obtain a degree of control disproportionate to
their equity ownership should be disclosed
Markets for corporate control should be allowed to function in

an efficient and transparent manner
Right to participate in and sufficiently informed on
Amendments to statutes, AA or similar governing
documents of the company
Authorisation of additional shares
Extraordinary Transaction
Draft: Directors should disclose to shareholders all proposed
corporate transactions, which if entered into, would materially
alter/vary the companys net asset base
Should be furnished with sufficient and timely information

concerning the date, location and agenda of general meetings
as well as full and timely information
I: Send notice of AGM and all connected documents at least
28 calendar days before the day of the meeting
Should consider the costs and benefits of exercising their voting

rights
Key:
308

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A Comparative Analysis of Corporate Governance in South Asia:

Charting a Roadmap for Bangladesh

Edited by Farooq Sobhan and Wendy Werner

Published by Bangladesh Enterprise Institute

How to Contact the Authors

Diagnostic Study of the Existing Corporate Governance Scenario in Bangladesh

Getting There Pretty Rapidly: The State of Corporate Governance in India

Corporate Governance in Pakistan: Ownership, Control and the Law

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

Purpose and Framework for the South Asian Comparative Analysis.

Comparative Analysis of Corporate Governance in South Asia

The Significance of Corporate Governance

Comparative Analysis of Corporate Governance in South Asia

Features and Lessons of the Comparative Analysis

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

How to Contact the Authors

Comparative Analysis of Corporate Governance in South Asia

Diagnostic Study of the Existing Corporate Governance Scenario

Authors and Consultants:

Companies, Corporate Laws and Practice

Financial Sector Scenario and Governance

Accounting Standards and Disclosures

State Owned Enterprises

Existence and Role of Pressure Points

Appendix B. List of Organisations Interviewed

Comparative Analysis of Corporate Governance in South Asia

Appendix C. List of Corporate Governance Stakeholders Interviewed

Appendix D. Questionnaire Corporate Sector

Appendix E. Questionnaire Financial Sector

Appendix F. Corporate Survey Findings

Appendix G. List of Relevant Laws and Regulations in Bangladesh

Appendix H. Forms to be Submitted to the RJSC and Other Bodies

Appendix I. Current ICAB Adoption Status of IAS

Appendix J. Summaries of Literature Reviewed

Appendix K. Financial Institutions in Bangladesh

Appendix M. Report on January 7, 2003 Seminar

Comparative Analysis of Corporate Governance in South Asia

Asian Development Bank

Comparative Analysis of Corporate Governance in South Asia

OECD Principles of Corporate Governance, p. 12

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

The methodology followed to prepare this report was essentially three-pronged:

Comparative Analysis of Corporate Governance in South Asia

The Role of the Directors and Shareholders

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

Existence and Role of Pressure Points

Companies Act 1994

Comparative Analysis of Corporate Governance in South Asia

Bank Companies Act 1991

Comparative Analysis of Corporate Governance in South Asia

See sections on Independent Regulators and the Financial Sector.

Comparative Analysis of Corporate Governance in South Asia

The 2001 AGM of BEXIMCO Pharmaceuticals Ltd. is one example.

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia

Comparative Analysis of Corporate Governance in South Asia