Shareholder and stakeholder interests: the politics of corporate governance reform in South Africa1 Stefan Andreasson, Queens University

Belfast (s.andreasson@qub.ac.uk)

Paper prepared for the 2006 British International Studies Association Annual Conference, University of Cork, Ireland, 18-20 December. FIRST DRAFT PLEASE DO NOT CITE WITHOUT PERMISSION

Introduction Detomasi (2006:225) introduces a recent study of international regimes and Western corporate governance by noting that [i]t is difficult today to avoid the topic of corporate governance. As is the case at the level of international political economy, the socio-political context of corporate governance is also becoming increasingly significant for understanding processes of regime change and transformation at the domestic level (Roe 2003; Gourevitch and Shinn 2005). This is especially the case in emerging markets, where national systems of corporate governance may not be as well institutionalised, or deeply entrenched, as they generally are in consolidated (Western) polities, and where the potential costs of corporate governance failure are also very high. For example, the economic consequences of the East Asian financial crises of the late 1990s, which were in part due to poor corporate governance, were staggering. In a recent volume on corporate governance in a global economy, Schwab (2003:x) reminds us that the five most heavily affected countries, Indonesia, Korea, Thailand, Malaysia and the Philippines, lost more than USD 600 billion in market capitalization, or around 60 percent of their combined precrisis gross domestic product. As concerns the political fallout and immense human suffering caused by the collapse of currencies and capital flight, there can be no meaningful monetary price tag applied. It is thus reasonable to assume that if global pressures for convergence affect national corporate governance regimes and reforms, then such pressures will be most acutely felt in emerging markets; the stakes, moreover, are very high for both governments and inhabitants of these countries. Emerging markets, then, constitute particularly interesting cases for investigating how changes in global governance affect national systems of corporate governance. This paper investigates the political and economic context of corporate governance reform in South Africa, an emerging market which is interesting not only as such but also given a historical context that in some aspects sets the country apart from other important emerging markets. Specifically, the paper examines how South Africas reintegration into the global economy from the early 1990s onwards has transformed preferences of both corporations and elite policy makers in government and how these reshaped preferences are producing a new South African corporate governance regime. This reform process is driven by both economic and political imperatives, the
1

Field research in Johannesburg and Tshwane (Pretoria) in August/September 2006, on which the empirical material in this paper is partly based, was made possible by an ESRC World Economy & Finance Research Programme grant (see Appendix for list of interviewees).

natures of which are local as well as global. The country-specific socio-historical context in which this reform originates is the dismantling of apartheid and the shift in political control from South Africas white minority to its black majority. As South Africas political transition has not (yet) prompted a radical economic transformation, it is now possible to observe a divergence of sorts between societal demands for propoor policies that are associated with populist pressures for socio-economic transformation on one hand and economic demands associated with business calls for market friendly policies (i.e., liberalisation and deregulation) on the other. Wishing to balance these oftentimes conflicting demands, the South African government has so far prioritised the need to pursue an internationally credible policy of business accommodation whilst delegating issues of broad-based socio-economic transformation to a future in which business friendly policies have presumably yielded a stable macroeconomic environment and sufficiently healthy public finances to then allow for a robust spending commitment on transformative issues (Andreasson 2006b). The issues examined in this paper relate to two major challenges that confront South Africas policy makers in their attempts to create a corporate governance model suitable for the twenty-first century and South Africas post-apartheid society. The first challenge revolves around the need to preserve the functionality and acceptability of an essentially Anglo-American shareholder model of governance in an environment where the stakeholder model (and stakeholder issues in general) is gaining currency and increasing appeal, most obviously among policy makers and civil society organisation in tune with the countrys developmental needs and who are seeking to represent the majority of South Africas inhabitants that remain economically deprived and socially marginalised. West (2006) suggests that a modified Anglo-American model of corporate governance is evolving in postapartheid South Africa, the result of a tension between the traditional liberal emphasis on individual property rights imbued in the Anglo-American approach to governance and the communitarianism inherent in the concept of African values (ubuntu2), values to which the government would like to anchor its policy making and thereby hopefully make its policies seem more legitimate in the eyes of the many black South Africans previously disadvantaged by, and still therefore suspicious of, the countrys traditional approach to policy making. A second challenge, beyond the tension between shareholder and stakeholder models of governance, is the importance of the US financial markets and the US approach to corporate governance which, since the enactment in the US of the Sarbanes-Oxley Act of 2002 (SOX)3, represents a legalistic, compliance-based approach to corporate governance that is more clearly distinct from the UK model than in the past. While arguing that SOX ultimately serves a symbolic purpose of attempting to bolster and reaffirm American (and global) belief in, and support for, ever more speculative and volatile financial markets, OBrien (2005:1) asserts that the legislation represents the
2

Ubuntu can best be described as an African humanism which emphasises empathy, understanding, reciprocity, harmony and cooperation. In the context of governance it can be envisioned as a guiding principle for determining how to organise African societies and how to measure the well-being of Africans (cf. Prinsloo 1998:42). Find the Act at http://www.sec.gov/about/laws/soa2002.pdf.

single most significant change to the governance of business organizations since the New Deal architecture erected in the 1930s. Within the Anglo-American sphere it is therefore now common (if more so in financial media than scholarly research) to refer to the characteristics which separate the US from the UK in particular the governance requirements and regulatory burdens for companies wishing to raise money on the New York stock exchanges rather than those which makes them similar in comparison to stakeholder models of governance in countries like Germany and Japan. The more stringent requirements of the US model represent a clear challenge to the light touch regulation in London and the principles-based approach advocated by the King Commission in South Africa.

The case for South Africa Among emerging markets worldwide, South Africa stands out as a particularly interesting case in which to investigate how processes of corporate governance reform unfold (cf. West 2006). South Africa is Africas largest and most sophisticated economy (cf. Vaughn and Verstegen Ryan 2006), and its financial institutional structures are advanced as compared to other emerging markets. According to Mervyn King doyen of South African corporate governance and Chairman of the King Commission on Corporate Governance South Africas first world financial infrastructure, which is extraordinary for an emerging market, has resulted in foreign institutions now being the major private equity holders in the South African economy an important sign of confidence in, and approval of, South Africas capital markets and infrastructure (King 2006b). Furthermore, South Africas Anglo-oriented legacy in terms of corporate law and Board culture makes it an instructive test case in which to investigate the potential for the approximation of either an emerging USstyle corporate governance regime (rules rather than principles based), such as that manifested in SOX, or for a Continental stakeholder model to take hold.4 The country has experienced relatively comprehensive change to its corporate governance regime in the last decade (Vaughn and Verstegen Ryan 2006), and its King Reports on corporate governance, published in 1994 (King I) and 2002 (King II), have become notable examples of how emerging markets can devise their own solutions to aligning their corporate governance regimes with international best practice while at the same time considering corporate social responsibility and needs for broad-based development locally.5 Examining the South African case of corporate governance reform in a global context, the paper proceeds as follows: the traditional contrast between shareholder and stakeholder models is outlined in the context of a post-apartheid model of South African corporate governance; a more recent divergence between Anglo and American approaches to corporate governance is outlined, and South Africas interests in approximating one or the other examined; key reforms to South Africas
Although South African law is based on Roman-Dutch tradition, the difference with the UK common law tradition in corporate law is greatly diminished (Wixley 2006). Indicative of the King Reports global status, Mervyn King was in 2006 appointed chairman of a high-level United Nations (UN) steering committee on corporate governance aiming to improve corporate governance within the organisation (Business Day (Johannesburg), 24 March 2006).
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corporate governance regime following King I and, especially, King II are outlined; the significance of the US Sarbanes-Oxley Act of 2002 for corporate governance reform in South Africa is explored; an explanation of South African corporate governance reform that is based on changing preferences of business, investor, state and civil society actors is outlined. The paper concludes with a consideration of issues relating to lacking institutional capacity and skills shortages that constitute particular challenges to maintaining a good corporate governance regime in emerging markets, as well as what general lessons we may learn from corporate governance reforms in South Africa.

Shareholder v stakeholder models Theoretical debates on corporate governance generally proceed from the premise that corporate governance regimes are based on either the shareholder model that is most common in Anglo-Saxon polities, or the stakeholder model most common in social market polities, most notably Germany and Japan. The shareholder model holds that the corporation is an extension of its owners and responsible only to these owners. Key assumptions of the shareholder model include the inviolability of private ownership i.e., the shareholders and no one else own the company and therefore have exclusive rights to determine its priorities and any profits it may generate and that only market forces can achieve economic efficiency. While this model will need to resolve potential conflicts of interests between owners (principals) and managers (agents), in most cases by linking managerial rewards to corporate performance measured by share price and exercised by means of stock options, it precludes any serious consideration of market interference (such as requiring corporations to consider matters beyond the financial bottom line) in achieving the goals of the corporation (West 2006:433-34).6 The stakeholder model understands the corporation as a social entity that is responsible, and accountable, to a broader set of actors beyond those that own the corporation (its shareholders). These actors usually include suppliers, customers, employees, government and local communities that are all affected by the behaviour and performance of the corporation (West 2006:433-34). A descriptive theory of the stakeholder model simply notes that stakeholders (in addition to the owners) actually do exist, whereas an instrumental theory emphasises the need to be responsible towards stakeholders as a means to gain greater economic efficiency, and a normative theory argues that the need to take stakeholders into account is an end in itself due to moral obligation and social values that extend beyond the liberal emphasis on the individual (Donaldson and Preston 1995). In an overview of integrated sustainability reporting in South Africa, Wixley (2005:115-16) relates the increasing emphasis placed on non-financial information in annual reports of companies to, firstly, a general concern with the role of business in society [which] involves an awareness that the stakeholders in an enterprise are not merely the
6

See Pratt and Zeckhauser (1985) for a comprehensive statement on the principal-agent theory.

shareholders who provide capital, but persons contracting with the business and those with a non-contractual relationship, such as local communities nongovernmental organizations and the like [and, secondly, to] qualitative issues which influence the ability of the enterprise to create value in the future [such as] investments in human and other related intellectual capital maintenance of the reputation of the enterprise and the like. Both of these concerns are derived from the instrumental aspect of the stakeholder theory. The introduction of triple-bottom-line reporting in South Africa reporting on the sustainability environmental and social aspects of company activities in addition to traditional reporting on the economic / financial bottom line alone as recommended by King II, and the adoption of a Socially Responsible Investment (SRI) Index by the Johannesburg Stock Exchange (JSE) in 2004, the first of its kind in an emerging market, have been justified on both instrumental and normative grounds. According to Painter-Morland (2006:355), King II sets itself apart from many other governance regulations in succeeding to bridge the gap between CSR [corporate social responsibility] and good governance [by addressing] the fallacy that social and environmental issues are non-financial issues by indicating their financial bottom-line results [and by inscribing] these financial issues within the very core of its standards of good governance. In addition to a wealth of research and debates in management and related literature on the characteristics of these models (Donaldson and Preston 1995; Letza et al 2004), the different assumptions the shareholder and stakeholder models make about the nature of the corporation, and to whom it is ultimately responsible, constitute the basis for arguments about the direction in which corporate governance reform in South Africa ought to move (Institute of Directors 2002; Naidoo 2002; PricewaterhouseCoopers 2002; Wixley 2005; West 2006). In particular, the need to prioritise shareholder interests, which is the traditional concern of a country embracing the Anglo-American approach to regulation and governance, is oftentimes contrasted with the urgent need in very unevenly developed societies like South Africa to ensure that corporations contribute to socioeconomic development.

Anglo v American approaches to corporate governance South Africas colonial legacy and resultant ties with Britain have ensured that corporate law and corporate practice have been adopted mainly from the UK (West 2006:435). The South African model of corporate governance also fits the AngloAmerican approach as it is outlined by Reed (2002:230): it includes a) a single-tiered Board structure where only shareholders are represented; b) an active stock exchange (the JSE), which is a leader among emerging markets and ensures that financial markets play a dominant role; c) a banking system which plays a secondary role, in which banks are not in control of companies and avoid too close relations with clients; and d) a general commitment to a market-driven economic policy in which industrial policy plays a lesser role (manifested most clearly in the governments Growth, Employment and Redistribution (GEAR) policy). However, concessions made to labour with the 1998 Employment Equity Act and to affirmative action advocates

with the 2003 Broad-Based Black Economic Empowerment Act, as well as hints of a more active industrial policy in an evolving post-GEAR environment, suggest a more mixed picture on this final variable (cf. West 2006:434-35). Nevertheless, we may want to separate not only the Anglo-American shareholder model from the Continental (or, perhaps more accurately, German-Japanese) stakeholder model of corporate governance but, following draconian reforms to the US corporate governance regime in the wake of Enron and other high-profile corporate scandals, we may also wish to distinguish between Anglo and American approaches to corporate governance, especially in the areas of regulation, compliance and enforcement. Increasing divergence between UK and US approaches to corporate governance have come to the fore in recent months amidst speculations about a Nasdaq takeover of the London Stock Exchange. The UK government has become noticeably concerned about potentially detrimental effects of US style regulation on the light touch UK model. Ed Balls, Economic Secretary to the Treasury, thus announced in October 2006 that the government is seeking fast track legislation [to] safeguard the light touch and proportionate regulatory regime that has made London a magnet for international business (HM Treasury 2006b). Speaking in Hong Kong a month earlier, Balls noted that our system of light-touch and risk-based regulation is regularly cited alongside the Citys internationalism and the skills of those who work here as one of our chief attractions. It has provided us with a huge competitive advantage and is regarded as the best in the world [W]e have fought off proposals in Europe which would have undermined Londons standing as the leading global financial centre [W]e have resisted pressure for heavyhanded responses to US corporate scandals (HM Treasury 2006a). Given the comparatively relaxed attitude towards foreign takeovers in the UK as compared to other Western nations (most notably the US and France, where populist resistance to foreign ownership has manifested itself recently in areas of supposedly national strategic interest ranging from oil and ports in the US to yoghurt in France), the notion of fast track legislation to ward off perceived costs associated with the US approach to financial regulation is telling of the degree to which key actors in both countries perceive their regulatory systems to be different from each other. The concerns voiced in London are at least implicitly acknowledged across the Atlantic. While arguing that regulatory reform was necessary given the seriousness of Enron, WorldCom and other recent corporate malfeasance scandals, US Treasury Secretary Henry Paulsons views on the need to ease the regulatory burden on business created by SOX (in particular section 404 and its onerous reporting requirements regarding internal control and reporting) acknowledge concerns in the US, and by foreign participants in US markets, about regulatory over-stretch on part of the US government. In a recent speech to the Economic Club of New York on the competitiveness of US capital markets, Paulson notes that while US markets are the deepest, most efficient, most transparent in the world and that corporations are better governed following necessary reforms (the enactment of SOX), the new legislation has been burdensome indeed as a significant portion of the time, energy, and expense associated with implementing section 404 might have been better focused on direct

business matters that create jobs and reward shareholders (United States Department of the Treasury 2006). Since the enactment of SOX in 2002, the contrast between a prescriptive comply or else corporate regime as in the US, and a principles-based comply or explain regime as in the UK has become most instructive. South African individuals with key roles in shaping the countrys evolving corporate governance regime whether as Board Directors, leaders of private sector institutions such as the JSE or government instituted regulators such as the Financial Services Board (FSB) clearly see South Africas corporate governance regime as most closely linked, in terms of institutions and history as well as in spirit, to the UK model of corporate governance. It is (the myth or reality of) Londons gentlemans agreements and emphasis on principles and cultivation of personal relationships rather than strictly legislated compliance with rules whose effectiveness have not been demonstrated that is viewed by South African directors and executives as the proper role model for South Africa. When outlining the history of corporate governance in South Africa, King (2006a; 2006b) begins by relating South African developments to British corporate history, from Gladstone and the Limited Liability Act of 1855 to, more recently, Adrian Cadburys committee on corporate governance and its resultant 1992 Cadbury Report. King emphasises on several occasions how South African corporate governance and, more generally, corporate culture is firmly rooted in the British tradition (King 2006b; cf. Sarra 2004:29; Wixley and Everingham 2005:1). From this point of view, a move towards the US model risks causing rupture to system of corporate governance in South Africa which has evolved and responded well to the economic and political challenges associated with the transition from apartheid and re-integration into a competitive world economy, thus generating costs that far exceed the benefits of additional legislation and regulation. That these concerns are increasingly being voiced in the US as regards SOX, and that New York is perceived as losing its lustre and ability to attract international capital when compared to London, is not lost on South African observers. SOX clearly presents a challenge to the UK model of principles based corporate governance to which South African corporate governance and regulation has been historically aligned, and which constitutes, in the view of South African business generally, the prime example of international best practice. This challenge originates in the extraterritorial provisions of SOX. The rapid US response to domestic corporate failure imposed additional regulatory burden on foreign companies that sought capital in US markets and suddenly faced other regulations in addition to those imposed by their home countries (Vagts 2003) [thereby exposing] the dependency that many foreign companies have on the US capital market and [to some extent therefore rekindling] the political will to develop [their own] capital markets of similar [relative] size and liquidity (Detomasi 2006:237). The concern here is that if the SOX approach is aggressively exported by the US markets and regulators, aided by the sheer size and importance of US capital markets, governments and regulators elsewhere may feel the need to reform their own markets so as to reflect the US preference for a compliance-based approach to governance

while discounting the extra costs to less competitive and resilient markets that such an approach entails.

The King Reports on Corporate Governance The King Committee on Corporate Governance was established in 1992. The Committee published its first report in 1994 (King I), which drew substantial inspiration from the 1992 UK Cadbury Committee Study (Sarra, 2004:31).7 King I also coincided with South Africas post-apartheid re-integration into a global economy following its isolation during the 1980s and the incoming democratic governments emphasis on basing economic policy at least in part on considerations of broad-based socio-economic transformation. Wishing to link corporate activity in South Africa to the new goals of transformation and development, King I went beyond the financial and regulatory aspects of corporate governance in advocating an integrated approach to good governance in the interests of a wide range of stakeholders In adopting a participative corporate governance system [The King Committee] successfully formalised the need for companies to recognise that they no longer act independently from the societies and the environment in which they operate (Institute of Directors 2002:6). That corporations indeed share an important social responsibility is acknowledged in a recent report published by South Africas leading corporate lobby organisation, the South Africa Foundation (now Business Leadership South Africa) (Schlemmer 2004:3) as well as a recent study of corporate governance in South Africa by Armstrong et al (2005:9). The King II report, published in 2002, brought together expertise representative of a wide range of organised bodies in the private sector, as well other stakeholders with various political preferences, to come up with a vision for an inclusive approach to governance in the interest of South Africa Inc (King 2006b). Task teams comprised of representatives from both public and private sectors made recommendations to the King Committee; these teams included institutional and private investors, civil society, regulators and government officials, thus ensuring a wide-ranging stakeholder input to the Committee. The King II Committee itself was composed of leading proponents of corporate governance as well as representatives of significant professional, private and public sector institutions. Local and international consultation was extensive, with the Institute of Directors in Southern Africa providing a facilitative role and secretarial support (Armstrong et al 2005:16). King II contains a Code of Corporate Practices and Conduct (the Code) and its recommendations currently apply to companies listed on the JSE, banks, financial and insurance entities and public sector enterprises falling under the Public Finance Management Act (PFMA) of 1999 and Local Government Municipal Finance
This section is based on the outline of South African corporate governance reform in Andreasson (2006a).
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Management Act of 2003. King II contains recommendations relating to six areas of corporate governance: 1) boards and directors; 2) risk management; 3) internal audit; 4) integrated sustainability reporting; 5) accounting and auditing; and 6) compliance and enforcement. The Code is considered a living document that can be updated as circumstances may demand (Wixley and Everingham 2005:8-9). King notes that it was, in retrospect, a mistake to disband the Cadbury Committee in the UK (as Cadbury himself has acknowledged), thereby denying it the opportunity to respond to and adapt its principles to changing circumstances (King 2006b). While recognising that there are some international standards that no country can escape in the era of the global investor King II displays a clear awareness of obstacles to a global convergence of international corporate governance standards: because [c]ommunities and countries differ in their culture, regulation, law and generally the way business is done there can consequently be no single generally applicable corporate governance model (emphasis added) (Institute of Directors 2002:14). This recognition of problems with one-size-fits-all approaches to corporate governance, which underestimate the importance of fitting aspirations and regulation to local conditions, has important implications for South African efforts to adopt international best practice standards, especially if that standard is to be based on the US approach embodied in SOX. In fact, the aims of King II distinguish it from SOX in several important ways: Less reliance than in SOX on heavy government intervention into corporate governance Heavy reliance on disclosure rather than compliance as a regulatory mechanism Making increased accountability and independence of company Boards a cornerstone of efficient corporate governance reform rather than narrowly emphasising the role of audit committees Involving a wider range of stakeholders, both external and internal: including workers, trade unions, consumers, suppliers, communities and the media (PricewaterhouseCoopers 2002:5-7).

It is, however, important to note that while King I and II make recommendations regarding corporate government standards in South Africa, they are not legally binding legislation as are the SOX requirements in the US. King II ultimately relies on self-governance, and it is on this point that the ability of King II make a real difference in terms of improving corporate governance in South Africa has been criticised. The South African Department of Trade and Industry, among others, has asked whether a report based on voluntary compliance really can ensure that measures are effectively implemented and sustained (Sarra 2004:47).

The Sarbanes Oxley Act of 2002 The Public Company Accounting Reform and Investor Protection Act 2002, or Sarbanes-Oxley (SOX), results from highly publicised scandals which has severely undermined public confidence in the United States system of corporate governance and

reporting. Consequently, the purpose of the Act is to restore confidence in capital markets (PricewaterhouseCoopers 2002:10). The act represents the most sweeping legislative changes to securities legislation in the US since the 1930s and, given the global prominence of the US economy, it has become a topic of public debate in financial centres, governments and regulatory bodies worldwide. According to PricewaterhouseCoopers comparison of corporate governance as mandated by SOX in the US and envisioned by King II in South Africa, SOX fundamentally changes the responsibilities of audit committees, management and external auditors, and how these actors interact with each other. Building on existing Securities and Exchange Commission (SEC) and US stock exchanges requirements, SOX increases restrictions on corporations listed in the US, expands the disclosures requirements with which corporations have to comply and toughens the penalties which company directors, auditors and others involved in the corporate governance process can incur. The most telling change may be that the Act [SOX] represents a new era of public regulation in the capital markets sector. Unlike South Africa, the United States Congress has concluded that public confidence can best be restored through greater government involvement. (PricewaterhouseCoopers 2002:1011). Consequently the response to SOX from the corporate sector has been less than enthusiastic. A recent commentary on SOX and its onerous section 404 (dubbed the section of unintended consequences) on management responsibilities for internal control and financial reporting by the American Electronics Association, the largest high-tech trade association in the US with nearly 3000 companies and 1.8 million employees represented, argues that while many reforms contained in SOX do promote better corporate governance, these reforms are being overshadowed by one section that is imposing high costs with little return in terms of fraud detection (Davern et al 2005:1). The relatively brief section 404, entitled Management Assessment of Internal Controls, makes it the responsibility of management to establish and maintain the companys internal control structure and financial reporting procedures. Management (the chief executives and chief financial officers) and the registered accounting firm (their external auditors) must furthermore assess the effectiveness of the control structure and financial reporting in annual reports and report any weaknesses within 75 days of the end of the companys fiscal year. Given the many control procedures that need to be established, compliance with 404 is expensive both in terms of financing new control systems and devoting man-hours to the actual control and reporting. Increasing costs relating to compliance with 404 requirements are especially a concern for smaller and medium-sized companies who are generally less able to divert time and money to such matters of compliance (see 404 tonnes of paper, The Economist 16 December 2004). According to Davern et al (2005:1-2) the most serious problems associated with section 404 are: High cost burden amounting to a regressive tax on small business

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Extremely burdensome and not effective in detecting corporate fraud External auditors have adopted a one size fits all approach to section 404, where small companies are being held to same standards as large companies with much more complex organisational structures Gives investors a false sense of security Expense and awkwardness hurts US competitiveness Huge increase in compliance costs has foreign companies considering withdrawing from US financial markets Implementation cost of approximately US$35 billion is more than 20 times greater than initial SEC estimates Rather than a direct correlation between extent of burden and size of reporting company, with burden increasing commensurate with company size as per the SECs prediction, the opposite has become the case.

Given this litany of woes, and the sense that the legislation may be more about responding to public outrage and insecurity rather than about effective measures to prevent fraud, it is not difficult to understand why businesses in South Africa, an emerging market with much less ability to shoulder extra cost and to compromise competitiveness than the US, as well as a South African government keen on creating a business-friendly environment which can attract foreign investments, have responded with caution, and indeed wariness, to this recent US legislative response to corporate malfeasance. According to Romano (2005:1523), SOX, which her article refers to a quack corporate governance, was was enacted in a flurry of congressional activity in the runup to the [US] midterm 2002 congressional elections after the spectacular failures of the once highly regarded firms Enron and WorldCom. Acknowledging the risk for regulatory over-stretch, noted as a concern by South African observers like Armstrong (2006) and King (2006b) when commenting on the implications of SOX for South Africa and other emerging markets, Romano begins her article on SOX by quoting US Senator Phil Gramms lamentation that its hard to argue logic in a feeding frenzy and argues further that [w]hat is perhaps most striking is how successful policy entrepreneurs were in opportunistically coupling their corporate governance proposals to Enron's collapse, offering as ostensible remedies for future Enrons reforms that had minimal or absolutely no relation to the source of that firm's demise (Romano 2005:1526). Romanos criticism of SOX echoes Kings comments on the idea of legislating honesty and ethic is general he notes that this has been attempted since the days of Moses (King 2006b), generally with rather poor results. Implications for South Africa The potential influence of SOX on South Africas corporate governance regime poses a challenge not only in terms of difficulties and costs associated with implementation for South African companies listed in New York, but to South Africas culture of regulation and governance in general. King and other senior representatives of South African corporations have been sceptical, oftentimes scathing, in their criticism of the 11

recent US government response to corporate scandals that have resulted in the enactment of SOX. However, while South African corporations that are listed in the US are directly affected by the legal requirements of SOX is not clear that the additional requirements and expectations placed on these companies are feeding back to operations and management in South Africa. Nick Holland, Chief Financial Officer at Gold Fields, a major South African multinational listed in Johannesburg and New York and one of only two emerging market companies recently noted in a major global survey by GovernanceMetrics International for its high quality corporate governance8, suggests that SOX has not produced any knock on effect on companies governance procedures in South Africa. According to Holland (2006), SOX is unique to New York and is a good example of over-regulation in a country which tends to one extreme or the other on regulation (in the words of King (2006b), SOX was the result of a knee-jerk reaction typical of the American mindset). Holland (2006) also recognises the emerging disjuncture between the UK and US approaches by noting that SOX has had no real effect on practices in the UK and that the view among CFOs in Europe has, generally, been that SOX amounts to a huge waste of time (which he considers somewhat surprising given that SOX has had a partly positive outcome in terms of forcing major corporations worldwide to think carefully about the quality of their control and reporting procedures). South Africas regulators and policymakers must therefore consider carefully the merits of SOX and whether the ability of South Africa to claim adherence to best practice internationally, which is very important given its African location (and its attendant associations with risk) and its urgent need to attract foreign investment, depends on South Africa assimilating aspects of the SOX approach into its own corporate governance regime. On this matter the jury is still out. There are no immediate indications of SOX-style legislation emerging in South Africa. However, [SOX] is definitely on the regulators minds according to Philip Armstrong, Head of the Global Corporate Governance Forum in Europe and the International Finance Corporation in Washington, and an expert on South African corporate governance. If the South African government comes to believe that businesses operating in South Africa will not willingly comply with the voluntary recommendations of King II, or if very big corporate scandals emerge (such as the LeisureNet and MacMed corporate governance scandals of the 1990s), then the government could well decide to move beyond the selective implementation of King II in the PFMA, local government legislation and the JSE listing requirements by making the King II recommendations fully enshrined in statutory law. In this sense South Africa is displaying what Armstrong calls a typical emerging market syndrome: because it is difficult for government agencies to enforce voluntary disclosure and regulation, there is often an attempt by government to mitigate this difficulty with mandatory legislation. Indeed, Finance Minster Trevor Manuel has noted that if businesses do not get their act together on financial reporting and disclosure, then government would consider more stringent legislation (Armstrong 2006). Complicating the picture further, the idea that corporate governance works best in a self-regulating environment (which is the underlying principle of the King reports, given Kings opposition to an overly prescriptive approach to corporate governance)
8

See http://www.gmiratings.com/(xf2ek4v4dpvabgnxhervgc45)/news/reuters_09_18_06.htm.

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is often misunderstood in emerging markets. For example, Armstrong argues that the Combined Code has worked well in the UK because it is a leading, wellfunctioning financial centre and business environment. There is an active media and shareholders, pension funds that are informed, have clear mandates and understand their fiduciary duties, and so on. Active engagement, information, proper and effective facilitative regulation are all key components of such a well-functioning financial centre. All these components are necessary for a self-regulative environment to work, and the self-disclosed information has to be actively and effectively questioned and examined. But Johannesburg is not London and the fact that all of these components may not be present or working sufficiently well in South Africa, nor in other emerging markets, must be taken into account when legislation is considered (Armstrong 2006). A key question, in addition to whether SOX is having an impact on corporate governance reforms unfolding in South Africa, is what actors are promoting reform of one kind or another i.e., what actors are promoting the compliance-based approach la SOX and which ones are resisting it? The corporate sector, which feels very comfortable with the UK model of doing business, prefers reform based on the King reports and which maintains a clear alignment with the UK model, while regulators and politicians who are concerned about the public perception of capitalism and the role of corporations in South African society (especially with regard to transformation issues) are more likely to find legislation in the spirit of SOX, or at least additional legislation of King II principles, appealing. As in the US, government in South Africa may wish to be seen as taking a hard line on corrupt practices in the corporate sector and thus prefer to enact rather strict legal requirements in terms of how corporations are to be governed and held to account. However, in order to understand what drives corporate governance reform in South Africa we must not simply understand what may be the preferences of various actors involved (e.g., business, investors, government, civil society) but also which of these actors are best positioned to promote their preferences. In an emerging market like South Africa, where uneven development has created serious skills shortages, it is especially important to consider not only preferences, but also capabilities to act on these preferences. Skills shortages are felt most acutely in government and the public sector as the private sector is able to poach the best talent, oftentimes from key positions in the public sector, by offering superior wages and status (Southall 2004:538-39). Government is thus somewhat weakly positioned in terms of being able to promote, manage and implement more advanced forms of corporate governance regulation, where the requirements in terms of oversight, investigation and prosecution of malfeasance are particularly demanding. This situation has allowed the corporate sector to seize an opportunity in attempting to frame and drive the national debate on corporate governance and what it ought to look like in a democratic, market-oriented South Africa. The King Committee is the paradigmatic example of how an organised interest group in this case South Africas private business sector takes initiative by pooling its expertise (forming an epistemic community of sorts), advancing a plan for action and then setting in motion the process of turning advocacy into policy and practice. In terms of the King Code recommendations, this was done most concretely by incorporating aspects of the Code into the JSE listing requirements. In a typical comply or explain section, the JSE

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listing requirements mandate that issuers on the exchange must disclose the following information relating to the King Code in their annual reports: a narrative statement of how [the company] has applied the principles [of the] Code, providing explanation(s) that enable(s) its shareholders to evaluate how the principles have been applied; and a statement addressing the extent of the companys compliance with the King Code and the reasons for [any instances of] non-compliance.

According to the CEO of the JSE, Russell Loubser (2006), and JSE Executive Director of Issuer Services, John Burke (2006), it was the JSE itself, rather than government, that took the lead on bringing listing requirements up to the standard advocated by King II. The JSE and the financial industry considers the King II benchmark important for the ability of South Africas stock exchange, and South Africas corporations and financial industry in general, to distinguish themselves as part of an emerging market of the highest international standard and sophistication. Clearly in this case, a key market actor (the JSE) perceives that additional requirements, in terms of regulation, are in its own interest. It is therefore somewhat ironic that governments subsequent decision to legislate based on the King II principles, incorporating some of Kings provisions into the PFMA and local government legislation, which presumably would have been understood as a clear endorsement of Kings principles on what constitutes best practice corporate governance, was in fact criticised by King himself for turning principles into legal requirements (the tick box approach, which King opposes).9 Worse, from Kings point of view and that of others sceptical to the prescriptive, compliance-based approach, the PFMA is legislation for the public sector where the ability to effectively implement more sophisticated and demanding legislation is certainly a more acute concern than are related issues of capacity and implementation in the private sector. When King and his colleagues on the Commission and elsewhere speak of the importance of a South African corporate governance regime to be principles based, they really mean that such principles ought not to be turned into legal requirements tout court.

Explaining reform: diffusion from above or pressure from below The 1990s prompted comprehensive revision to the South Africas regulatory framework which is still based on the 1973 Companies Act. Consultations about, and representations on public drafts of, a new Companies Act are ongoing. The new Act will presumably incorporate aspects of the recommendations in King II is expected to be finalised in the near future. According to South Africa Reserve Bank (SARB) consultant Hans Falkena, [t]he speed of institutional change has been so rapid in South Africa, that the regulatory and supervisory authorities at times had difficulties in keeping up with appropriate regulatory changes (Falkena et al 2001).
9

King has repeatedly stated his opposition to an overly prescriptive approach, what he calls a tick box approach to corporate governance, in recent interviews. See Moneyweb audio interview by Alec Hogg, 22March 2006, at http://www.moneyweb.co.za/moneyweb_radio/mny_power_hour/984777.htm.

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Sarra (2004:6) and Armstrong et al (2005:15) identify several pieces of government legislation that have directly impacted corporate governance in South Africa (as amended): the Companies Act (1973), the Labour Relations Act (1995), the Basic Conditions of Employment Act (1997), the Employment Equity Act (1998), the National Environmental Management Act (1998), the Insider Trading Act (1998), the Public Finance Management Act (1999), the Promotion of Access to Information Act (2002) and the Securities Services Act (2004). The Constitution of the Republic of South Africa (1996), which enshrines environmental protection rights for South African citizens, may also have a profound impact on corporate governance standards since companies considered in breach of such constitutional rights become open to class action suits (Sarra 2004:6). The Securities Services Act combines and supersedes much of the previous legislation on corporate governance in an attempt to align South Africa with international best practice by aiming to increase confidence in South African financial markets, promote the protection of regulated persons and clients, reduce systemic risk and promote the international competitiveness of securities services in South Africa. The Act also increases criminal penalties for malfeasance significantly, both in terms of potential fines and custodial sentences (Mller 2005). A 2003 World Bank Report on the Observance of Standards and Codes (ROSC), an assessment of corporate governance in South Africa undertaken by Philip Armstrong in extensive consultation with the King Commission, the JSE, key regulatory and professional bodies and leading experts in South Africa, was published following the 2001 release of King II for comment and declares that King I and the forthcoming King II set out international best practice (World Bank 2003:1). The South Africa ROSC concludes that legislative reforms, especially the Security Services Act and revised Companies Act currently in preparation, are addressing issues of corporate governance and will provide greater clarity, responsibility, accountability and transparency. According to the ROSC, the most important challenge is enforcement of existing laws, rules and regulations and to strengthen the FSBs sanction and enforcement powers (World Bank 2003:14-15). Overall, the ROSC deems South Africa to be largely in observance of OECD Corporate Governance Principles, covering 1) the rights of shareholders; 2) equitable treatment of shareholders; 3) the role of stakeholders in corporate governance; 4) disclosure and transparency; and 5) responsibilities of the Board (World Bank 2003:Annex A). Changes to any particular corporate governance regime do not occur in a vacuum; indeed, it is reasonable to expect that (major) change to corporate governance in one country will be influenced by practices elsewhere and will, potentially, have consequences beyond its own legal borders. Although they draw different conclusions regarding the potential for global convergence of corporate governance regimes (and financial regulation in general), OSullivan (2003), Erturk et al (2004), Baker (2005) and Detomasi (2006) examine various hypotheses about the pressures for convergence at the international level that they all agree do exist to some degree.10 It has also been hypothesised that the nature of corporate governance reforms in a dominant market,
10

At the domestic level, Roe (2003) and Gourevitch and Shinn (2005) provide politically grounded explanations for varieties in corporate governance regimes, and the political and economic processes that produce these different types of regimes.

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like the US, will impact corporate governance reforms in emerging markets, like South Africa. OBrien (forthcoming 2007) argues that the corporate scandals which prompted SOX in the US in 2002 are likely to have wide-ranging implications for corporate governance reform elsewhere given the global importance of the US as a market where corporations from all over the world can raise large amounts of capital with relative ease and speed. The view from South Africa is, however, somewhat different, as the previously highlighted concerns about additional regulatory burdens associated with SOX demonstrate. Just as research on the transition from apartheid to democracy in South Africa has focused on the difficult choices to be made by government in terms of balancing demands by local and international corporate interests (and their governmental and institutional allies) for business friendly policies with domestic populist demands for redistribution and pro-poor development policies, the issue of corporate governance presents the government with a similar, if somewhat more complex, set of choices. Rossouw et al (2002:298-300) links the process of corporate governance reform in South Africa to the convening of the King Commission and subsequent publication of King I in 1994 and sees this reform process as being driven internationally by pressures from international governance standards and institutional investors and domestically by pressures emanating from the (social and economic) transformation of South African society and a deeper sense of cultural shift associated with the notion of what President Mbeki calls an African Renaissance.11 The international pressures are largely understood as being technocratic in nature, relating to issues of defining and complying with best practice in the pursuit of better performing corporations. The domestic pressures are largely perceived as political in nature, such as determining the responsibility of corporations beyond its owners and the degree to which they are obliged to contribute to socioeconomic transformation. South African corporations have in media and interactions with government and regulators promoted light touch regulation of corporate governance as appropriate for South Africa, arguing that government intervention in the shape of burdensome legislation is an additional cost that corporations (especially local ones) cannot bear and therefore a particularly ill-advised course of action in an emerging market that can ill-afford to raise the costs of business in a competitive global environment.12 At the same time, Western governments and international institutions (the IMF, the World Bank, the OECD) are pushing for reform of corporate governance in emerging markets, to bring them up to international best practice, which generally entails more sophisticated accounting, monitoring and reporting. These pressures are
11

A 1997 ANC discussion document entitled Developing Strategic Perspective on South African Foreign Policy identifies the following key elements of the African Renaissance: recovery of the African continent as a whole; establishment of democracy in Africa; breaking neo-colonial relations between Africa and global economic power; mobilising Africans to enable them taking their destiny into their own hands by preventing Africa being a place for the attainment of geostrategic interests of global powers; and speeding up the development of people driven and centred economic growth and development to meet basic needs of Africans (see Maloka 2001 and Bongma 2004).

12

However, large South African corporations have largely accepted the logic and demands of Black Economic Empowerment (BEE) which, in its aim to promote black capitalism and socio-economic transformation, places an additional burden on corporations in terms of complying with BEE legislation mandating promotion of black employees at all levels and transfer of equity from white to black ownership (Andreasson 2006c).

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supported not only by global institutional investors (e.g., large Western pension funds that are increasingly investing in South Africa and other emerging markets) but by corporations, banks and other market actors that are concerned about investing in what are considered relatively high-risk markets. Finally, various domestic actors from politicians and labour unions to civil society activists and non-governmental organisations (NGOs) are concerned about the nature of South Africas postapartheid capitalism. In particular, they are concerned with the social costs of an increasingly mobile and therefore potentially volatile market-based society and the degree to which corporations with global aspirations are willing to contribute to the general democratic aspiration of broad-based transformation. In other words, they wish to clarify and determine the extent to which corporations should be accountable beyond their shareholders, and how these corporations can best be held accountable without being alienated and shirking their responsibilities to society. Given recent concerns about an investment strike by South African corporations worried about their future relations with the ANC government and their ability to operate freely in South Africa, these issues are highly salient, politically as well as economically (Andreasson 2006c). The range of actors and their main priorities can be summarised as follows: Actor Business (global and local) Investors (global and local) Governance bodies (global and local) Government Priority Market friendly policy environment; economic, political and social predictability and stability Evidence of international best practice governance standards and effective risk control Reforms adopting international best practice and evidence of ability to monitor and enforce Appropriate policy arsenal to accommodate various pressure groups (business, investors, governance bodies and civil society) Socioeconomic transformation; accountability of corporations (including Black Economic Empowerment)

Civil society

Concluding comments This paper has provided an overview of contemporary corporate governance reforms in South Africa in the context of economic and political changes associated with the transition from apartheid to democracy. It has examined how traditional debates on shareholder and stakeholder models of corporate governance, and an emerging debate on the increasing distinction between light touch UK and regulation-heavy US approaches to governance, inform ongoing corporate governance reforms in South Africa. South African reforms have been examined primarily via the prism of the King II report and Code of corporate governance, as well as the Sarbanes-Oxley Act

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in the US and the views taken in both private and public sectors in South Africa to these two competing visions what constitutes good corporate governance. The debates on both the shareholder versus stakeholder models and the UK versus US approaches to corporate governance are highly relevant South Africa and other emerging markets. As emerging markets like South Africa generally have to contend with serious problems of underdevelopment, governments much carefully balance the interests and rights of shareholders with the needs and demands of a wider range of stakeholders in society. While thinking on corporate governance in South Africa is for historical reasons naturally aligned with principles of good governance and business conduct in the UK, the size and importance of US markets to companies and policymakers worldwide means that changes to governance in the US must be closely monitored and considered by multinational corporations as well as policy makers in South Africa as in countries worldwide. The issue of lacking institutional capacity, primarily in the public sector, plays an important role in considerations of what constitutes an appropriate corporate governance regime for South Africa in the twenty-first century and the for the needs of a society pursuing a broad-based societal transformation with the aim to once and for all leave the debilitating legacy of apartheid behind. South Africas general skills shortage is the result of substandard apartheid era education for the countrys majority black population, as well as a significant out-migration of (primarily white) skilled professionals over the last two decades that has been exacerbated by a Home Affairs immigration policy much criticised for its (now somewhat relaxed) restrictions and narrow view on the economic need for more skilled professionals contributing to economic growth and capacity building. Given this context, the ability of institutions to cope with more sophisticated and demanding regulation must always be assessed and evaluated in the context of these structural (if not necessarily permanent) shortcomings. Decisions on what aspects of the King Code ought to be enshrined in law and practice must be based on a clear sense of how institutions will be able to facilitate and monitor compliance with any new and more demanding corporate governance regime. In terms of enforcing laws and regulations against corporate malfeasance it is, according to Rob Barrow (Executive Officer at the FSB which oversees the non-banking financial services industry in South Africa), far from clear that the already under-resourced and over-stretched National Prosecuting Authority is able to handle cases of corporate crime that often involve highly complex technological and legal issues (Barrow 2006). South Africa has therefore with the Insider Trading Act made it possible to deal with corporate malfeasance via civil liability where the burden of proof is less demanding (Malherbe and Segal 2001:5657). The Act makes it possible for the Insider Trading Directorate to withdraw further litigation in return for a payment by the party under investigation (payments subsequently redistributed to shareholders that have potentially suffered loss). Investigations and settlements are announced in the South African media, constituting a policy of naming and shaming which has, according to the JSE (Loubser 20006), been very effective in reducing the problem of insider trading. Options for South African policy makers in pursuit of an optimal corporate governance strategy aligned with established international best practice will for the foreseeable future remain restricted by the problems associated with a lack of institutional capacity. A better, more nuanced understanding of how to align goals for

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improving corporate governance with the reality of weak (governmental) institutional capabilities and policy demands relating to the maintenance of a business friendly environment, as well as the pursuit of socio-economic transformation and broad-based development, is necessary for South Africa to retain, and improve upon, its deserved reputation as an emerging market with an innovative and exemplary approach to corporate governance.

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Appendix Interviews conducted August September 2006 Mr Philip Armstrong Head, Global Corporate Governance Forum, International Finance Corporation, Washington Mr Rob Barrow Executive Officer, Financial Services Board, Pretoria Mr Colin Brayshaw Chairperson, Coronation Investments and Trading, Sandown Mr John Burke Executive Director, Issuer Services, The JSE Stock Exchange, Sandown Mr Ian Cockerill CEO, Gold Fields, Parktown Mr Tony Dixon Executive Director, Institute of Directors Southern Africa, Parktown Mr Nick Holland Chief Financial Officer and Executive Director, Gold Fields, Parktown Professor Derick de Jongh Director, Centre for Corporate Citizenship, University of South Africa, Pretoria Mr Mervyn King Senior Chairman, Brait, Sandton Dr Len Konar Consultant, Fisher Hoffman PKF, Parktown Mr Russell Loubser CEO, The JSE Stock Exchange, Sandown Mr Higgo du Toit Director, Corporate Governance, National Treasury, Pretoria Mr Dube Tshidi Deputy Executive Officer, Investment Institutions, Financial Services Board, Pretoria Mr Tom Wixley Non-Executive Director, Johnnic, Johannesburg

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