Corporate governance disclosure in South Africa: theory versus practice

Transcription

1 Corporate governance disclosure in South Africa: theory versus practice Name: Affiliation: Theme: Mrs. Nadia Mans-Kemp* Prof Pierre Erasmus Prof Suzette Viviers Stellenbosch University, South Africa Public policy and regulation Contact details of corresponding author* Telephone number: +27 (0) address: Address: Nadia Mans-Kemp Department of Business Management Private Bag X1 Matieland South Africa 7602 Abstract South Africa is a pioneer in terms of the publication of corporate governance guidelines (Armstrong, Segal & Davis, 2005). Recently, a Responsible Investing (RI) code and legislation have also been published (Bertrand, 2011). Previous studies on environmental, social and corporate governance (ESG) performance within emerging markets indicated that South Africa leads the way to improved ESG disclosure and attracts international investor attention (Sinclair & Yao, 2011; Emerging Markets Disclosure Project (EMDP), 2009a). However, the focus was mainly placed on the largest firms based on market capitalisation. Consequently, the focus of this study was to determine ESG disclosure, focusing on corporate governance for a sample of South African listed and previously listed firms from 2002 to The findings indicated that despite

2 the rapid regulatory, voluntary and market-based code developments, the corporate governance reporting of some South African firms are still relatively weak. 1. Introduction The problems we have today cannot be solved by thinking the way we thought when we created them. This quote by Albert Einstein is particularly apt when considering the widespread consequences of irresponsible corporate actions. In recent years investors have come to realise that by owning a security and earning a return from it, they approve the actions of investee companies. Investors have also come to recognise that approving an immoral action is immoral (Larmer, 1997) and are increasingly resorting to a new way of thinking in terms of making their investment. The phenomenon of responsible investing (RI) provides these investors with a framework for integrating environmental, social and corporate governance (ESG) concerns into their investment decisions and ownership practices. Statistics revealed that the interest of institutional investors in RI considerably increased between 1999 and the early 2000s (International Labour Office, 2003: 71). Enhanced focus was placed on the integration of ESG considerations. Since then, the availability and quality of information on firms ESG performance has become an increasingly important consideration for global investors (Organisation for Economic Co-operation and Development (OECD), 2007; Principles for Responsible Investment (PRI), 2007). As interest in RI increased, more focus was also placed on the development of investment policies and codes. Since the early 1990s, governments in some developed countries, mainly the United States (US) and United Kingdom (UK), promoted RI by means of voluntary codes of practice, such as the Cadbury Report in the UK, and enabling legislation, such as the British Pensions Act (Aneja & Chandra, 2004). In South Africa, a developing country, emphasis was mainly placed on voluntary corporate governance codes, such as the King Reports (Mangena & Chamisa, 2008; Institute of Directors Southern Africa, 1994; 2002; 2009). 1

3 Since 2011, significant regulatory changes have taken place in South Africa. The third King Report on corporate governance (Institute of Directors Southern Africa, 2009) now makes it mandatory for firms listed on the Johannesburg Stock Exchange (JSE) to include ESG analysis (trough integrated reporting) in their annual reports from 2011 onwards (Pretorius, 2011). The first South African RI code, called the Code for Responsible Investing in South Africa (CRISA), was launched in July CRISA provides principles to institutional investors and their service providers on the integration of sustainability considerations, including ESG concerns into their investment analysis and ownership practices (Institute of Directors Southern Africa, 2011). In terms of legislation, Regulation 28 of the Pensions Fund Act (Act no 24 of 1956) was amended in March The regulation now provides a defined set of principles to institutional investors to promote RI across all asset classes in South Africa (Bertrand, 2011). In line with increased attention in RI, global investors have also become more interested in investment opportunities on the African continent (Sinclair & Yao, 2011). Investments in microfinance and infrastructure projects in particular yield social and financial returns. South Africa is a front-runner in terms of RI legislation, voluntary disclosure and regulatory codes and is therefore ideally suited to global investors who seek responsible investments. However, a lack of ESG information is often cited as a significant barrier to investing in emerging markets (Emerging Markets Disclosure Project, 2009a). Interest in RI consequently led to the development of a global RI research industry specialising in the evaluation of ESG issues and risks (Organisation for Economic Co-operation and Development, 2007). Unfortunately, ESG research and disclosure projects often only consider the top performing firms in a specific country. For example, when South Africa is included in global ESG studies, the Top 40 or Top 100 JSE-listed firms are generally observed. Small and delisted firms are mostly omitted. In light of the above, the aim of this research was to determine the extent of ESG disclosure (focusing on corporate governance) for South African firms that are/were listed on the consumer goods sector of the JSE for the period 2002 to All the listed and previously listed consumer goods firms were thus considered, not only the largest firms based on market capitalisation. This 2

4 paper forms part of a larger PhD study where the corporate governance disclosure of firms listed on the other JSE sectors are also considered. The paper is structured as follows: firstly, a literature review of RI codes and legislation within the South African context and various corporate governance measures is provided. Thereafter, the research design and methodology adopted in this study are presented followed by the empirical findings. Finally, the conclusion and recommendations for future research are indicated. 2. Literature review In this section attention will be given to South African RI codes and legislation, as well as various measures that can be used to determine firms corporate governance disclosure. 2.1 RI codes and legislation in South Africa South Africa is the biggest institutional investment market on the African continent (Pretorius, 2011). In a 2009 report on corporate sustainability disclosure in emerging markets, it was indicated that few countries offer comprehensive ESG reporting (Emerging Markets Disclosure Project, 2009b). The results were based on ESG data reported by the Top 10 firms of ten emerging markets, ranked in terms of market capitalisation. South Africa was noted as an exception. Firms based in South Africa exhibited the best overall transparency practices, reporting some form of ESG data. The highest reporting rate was for issues relating to corporate governance. Of the three ESG categories, environmental data were the least likely to be reported on. Corporate governance is generally the first level of ESG engagement for investors and issuers (World Federation of Exchanges, 2010: 2). In South Africa, focus is also placed on corporate governance. A possible reason for this tendency is the well-developed corporate framework within the country, based on the King reports on corporate governance. Amongst developing countries, South Africa pioneered the publication of corporate governance guidelines and codes 3

5 with the King Report I in 1994, provoking unprecedented international interest in corporate governance (Armstrong, Segal & Davis, 2005; Rossouw, van der Watt & Malan, 2002; Institute of Directors Southern Africa, 1994). This report took an inclusive approach to corporate governance according to which the firm should consider the wider community including shareholders and stakeholders when conducting its operations (Mallin, 2007). Extensive legislative changes occurred in South Africa between 1994 and Consequently, the King Report I was revised and the King Report II was published in 2002 (Mallin, 2007: 248). This report provided information concerning integrated sustainability reporting as well as accounting and auditing of publicly listed firms (Institute of Directors Southern Africa, 2002). Compliance with the King Report II was voluntary for firms. However, the JSE Listing Requirements (2005) obliged JSE-listed firms to disclose the extent of compliance/noncompliance with the King Report II. In the case of non-compliance, reasons were required (Mangena & Chamisa, 2008). Following the publication of the King Report II, the first Socially Responsible Investment (SRI) index in an emerging market was launched by the JSE in May The JSE SRI index provides guidelines on good practices relating to triple bottom line reporting. The index is used to measure the performance of firms listed in the FTSE/JSE All Share Index and can be used as a sustainability benchmark for investment decision-making (Johannesburg Stock Exchange, 2012). The JSE SRI index does not only consider large market capitalisation firms. Since the establishment of the index, the number of small and medium capitalisation constituents increased significantly. In 2011, 36 Top 40 firms, 31 middle capitalisation and 7 small capitalisation firms formed part of the index (Le Roux, 2011). The publication of the King Report III in 2009 became necessary due to the promulgation of a new Companies Act (Number 71 of 2008) and changes in international governance trends. This report highlighted, among other topics, the importance of integrated corporate reporting (Institute of Directors Southern Africa, 2009). Where the first two King reports followed a voluntary comply or explain approach, the King Report III follows an apply or explain approach. The focus is therefore now on how the principles and recommendations of the report are applied 4

6 (Malan, 2010a). From 2011, the King III Report makes it mandatory for JSE-listed firms to include an ESG analysis (trough integrated reporting) in their annual reports (Pretorius, 2011). As noted, the quality and availability of ESG information is an important consideration for emerging market investment. Improved ESG disclosure by firms is thus likely to enhance the development of RI in South Africa. In an attempt to ensure the stability of global economies, especially in the light of the 2008 global financial crisis, there is a need for greater oversight of financial markets through government regulation (Hebb, 2012). In many OECD countries, pension fund regulation authorities have taken a relatively passive regulatory stance (Organisation for Economic Cooperation and Development, 2007). In South Africa, corporate governance voluntary guidelines existed since However, there was a lack of RI enabling legislation. In 2011 the situation changed with the introduction of both an RI code and amendment to pension fund legislation. With regard to the former, the Code for Responsible Investing in South Africa (CRISA) was launched in July The aim of this code is to provide investors with the necessary guidance to give effect to the King Report III as well as the PRI initiative. CRISA is not legislation and merely encourages service providers and institutional investors to practice its recommendations on an apply or explain basis. One of the code s main recommendations is that institutional investor should incorporate sustainability considerations (including ESG) into investment activities (Association for Savings and Investments SA, 2012). Pension funds are major role players in the investment industry (Organisation for Economic Cooperation and Development, 2011). In March 2011, a fundamental shift took place in the South African investment industry with the amendment of Regulation 28 of the Pension Funds Act. Regulation 28 states that prudent investing should consider all factors that could materially affect an investment, including ESG considerations (Pension Funds Act, 1956: Amendment of Regulation 28 of the Regulations made under section ; Pretorius 2011). The biggest pension fund in South Africa, the Government Employees Pension Fund (GEPF), is taking a leading role in RI by allocating more resources towards ESG research. The research findings are carefully considered to ensure that ESG considerations are meaningfully integrated 5

7 into the GEPF s long-term investment strategies. The GEPF is also a founding South African signatory to the PRI (Government Employees Pension Fund, 2009). Most of the GEPF s assets are managed by the Public Investment Corporation Limited (PIC), an asset-management company that is wholly-owned by the South African government (Public Investment Corporation, 2012). More stringent regulation and pressure from investors are important drivers of RI in South Africa, while important enablers are RI benchmarks such as the JSE SRI Index (Eccles, Nicholls & de Jongh, 2007). In order to do RI benchmarking and compare firms, measures are required to determine the firms ESG disclosure. The following section indicates the available measures that can be used to determine the corporate governance disclosure of South African firms. 2.2 Corporate governance measures As indicated earlier, the focus is often placed on corporate governance in South Africa. There is limited reporting on environmental issues (Antonites & de Villiers, 2003). There is also a lack of measuring tools to evaluate the environmental and social impact of firms. In 2011, Next Generation Consultants developed South Africa s first tool to measure the environmental, social and economic value created by firms (Next Generation, 2012). Given the advent of integrated reporting and the establishment of ESG consultancies, a time-series study considering ESG data for all JSE-listed South African firms (not only the largest firms) will most likely become possible within a few years. At present, most studies, including this one, only focus on corporate governance disclosure. In order to determine the appropriate corporate governance evaluation measure to use in this study, various measures employed by previous corporate governance researchers (Vafeas & Theodorou, 1998; Daily, Dalton & Cannella, 2003; Hermalin & Weisbach, 2003; Brown & Caylor, 2004) were considered. A summary metric called Gov-Score was used by Brown and Caylor (2004) to examine the corporate governance disclosure for a sample of US firms. Gov- Score is a composite measure consisting of 51 factors encompassing eight corporate governance 6

8 categories, namely audit, board of directors, charter/bylaw, director education, executive and director compensation, ownership, progressive practices and state of incorporation. In a South African study, Abdo and Fisher (2007) studied the impact of reported corporate governance disclosure on the financial performance of 97 firms listed on the JSE from 2003 to They developed a corporate governance disclosure scorecard called G-score. The scorecard consisted of 29 governance disclosure factors, encompassing seven corporate governance categories, namely board effectiveness, remuneration, audit and accounting, internal audit, risk management, sustainability and ethics. The scorecard was based on the recommendations of the King Report II and the Standard and Poors International CGS Index. However, the study only focused on listed firms. The Unit for Corporate Governance in Africa at the University of Stellenbosch Business School developed the PIC Corporate Governance Rating Matrix. This matrix is a developmental tool aimed to assist firms to improve their corporate governance performance and reporting. The matrix includes ESG focus areas, with the main focus on corporate governance. Variables under consideration include the board, individual directors, remuneration, auditing and accounting, corporate behaviour, transformation, environmental behaviour, health and safety, corporate responsibility and corporate culture (Malan, 2010b). The different available measures were compared and the PIC matrix was identified as the best-tested and most comprehensive matrix. The Unit has agreed that an adjusted version of their matrix can be used to measure corporate governance for this study. Previous research conducted on the disclosure of corporate governance issues by South African companies mainly centred on disclosure by the largest firms based on market capitalisation. Another shortcoming of prior studies is that ESG data were collected over limited time periods. The aim of this study was consequently to determine the level of disclosure on corporate governance issues for a sample of firms that are/were listed on the JSE for a nine year study period. 7

9 3. Research design and methodology In order to collect comparative corporate governance data, the study period 2002 (the year that the King Report II became active) to 2010 was considered. Only the requirements of the King Report II were considered. Although the King Report III became effective from 1 March 2010, it only became mandatory for JSE-listed firms to incorporate ESG analysis in their annual reporting from For consistency purposes, the recommendations of the King Report II were applied for the entire study period. The JSE consists of 10 sectors, namely oil and gas, basic materials, industrials, consumer goods, health care, consumer services, telecommunications, utilities, financials and technology (Johannesburg Stock Exchange, 2011). In this study, only a sample of JSE-listed firms was considered. Firms were included in the sample based on four criteria, namely: sector description; availability of the company s financial statements on the McGregor BFA database (2011); being listed for the entire calendar year (January to December); availability of data for at least two consecutive years during the study period. The listing information published in Die Burger local newspaper on the last trading day of each year was considered for this purpose. The sample for this study consisted of all the firms that complied with the relevant criteria and that were listed on the consumer goods sector of the JSE during the research period. The consumer goods sector was selected since it contains Top 40 firms, medium and small capitalisation firms as well as number of delisted firms. The final sample contained 42 firms (262 annual observations) of which 27 were listed (204 annual observations) and 15 delisted (58 annual observations). The published annual reports for the listed and delisted firms were obtained from the McGregor BFA database (2011). A corporate governance score (CGS) is then compiled for each firm. The CGS consists of two dimensions namely disclosure and acceptability. The emphasis of the disclosure dimension is on whether the firm mentioned or indicated information regarding the 8

10 variable under consideration. Specific guidelines are set for acceptability, based on the King Report II and recommendations by the PIC. The maximum CGS that a firm can obtain is consequently 74, stemming from nine corporate governance categories, namely board, board committees, individual directors, remuneration, shareholder treatment, accounting and auditing, risk disclosure and reporting, corporate culture and behaviour and sustainability report. The CGS for all the firms was calculated for the nine year study period. The most important findings will be discussed next. 4. Empirical findings Table 1 contains the descriptive statistics for all the firms in the sample, broken down in terms of their status as listed or delisted. Table 1: Descriptive statistics: CGS for listed and delisted consumer goods companies ( ) CGS Valid N Mean Median Minimum value Maximum value Lower quartile Upper quartile Standard deviation Skewness Kurtosis All observed firms Listed firms Delisted firms From Table 1 it can be seen that the mean CGS of all the observed firms over the nine year study period was and the median CGS was 49. Relative to the highest possible score of 74, the mean value entails 63.05% and the median value 66.22% in terms of compliance and disclosure. The mean and median values of listed firms were considerably higher than the mean and median values of delisted firms. In relation to the total CGS, the mean and median values of the delisted firms entail a score of less than 50%. 9

11 The top firm in terms of the CGS received an outstanding maximum value of 70 (very close to a 100%). In contrast, the minimum value was 9, revealing considerable variation in the data. Given that that the data set contained firms that forms part of the FTSE/JSE Top 40 index, as well as firms that delisted within two years from their listing date, the results are not entirely unexpected. The skewness and kurtosis values indicated that the data set does not have a normal distribution. The total data set was divided into listed and delisted firms and compared on an annual basis in order to evaluate possible differences between the two sub-sets and also over time. Table 2 indicates the descriptive statistics for all listed firms from 2002 to Table 2: Descriptive statistics for all listed firms from CGS listed firms Valid N Mean Median Minimum value Maximum value Lower quartile Upper quartile Standard deviation From Table 2 it can be seen that the mean and median CGS values increased over time. A possible explanation is that firms became more aware of the guidelines of the King Report II as well as international RI trends. Since 2005, the JSE Listing Requirements (2005) obliged listed firms to disclose the extent of compliance with the King Report II. When examining annual reports, an increasing trend was also seen in the number of firms that employed a compliance officer or established an internal compliance function during the study period. 10

12 When the minimum and maximum values are compared, it is evident that there are still firms that do not embrace the recommendations of the King Report II. The low minimum value of 29 in 2010 is challenging, since the King Report III was already introduced, which entails mandatory integrated reporting from The introduction of pro-ri legislation is expected to guide firms towards improved disclosure and compliance with environmental, social and corporate governance considerations within future. On the other hand, the consistent maximum CGS value of 70 observed for listed firms during the period 2008 to 2010 indicates that some firms have excellent corporate governance compliance. When considering the firms reports, those that obtained a high CGS, often also reported comprehensive social and environmental information. The CGS was furthermore compared over time for delisted firms. Table 3 indicates the CGS for all delisted firms from 2002 to There were no delisted firms in the consumer goods sector for 2009 and Table 3: Descriptive statistics for all delisted firms from CGS delisted firms Valid N Mean Median Minimum value Maximum value Lower quartile Upper quartile Standard deviation When considering the information provided in Table 3, it can be seen that the CGS of delisted firms differed considerably from those of the listed firms summarised in Table 2. Although the mean and median values of delisted firms increased over the period 2002 to 2008, they only improved by a score of approximately 10. The 2008 mean CGS value for the delisted firms is almost the same value than the 2002 mean CGS value for the listed firms. The minimum value 11

13 over the study period of 9 is very low in relation to the total CGS of 74. The highest CGS that delisted firms obtained was 58 in It should be noted that not all firms that delisted from the JSE over the research period necessarily went out of business. Strict reporting guidelines (and hence higher auditing costs) can make listing less attractive for firms. Some firms consequently delist to avoid red tape and potential penalties (Gingrich, Haley & Tyler, 2009). Delisted firms often do not have the financial capacity to immediately incorporate non-core codes and guidelines. When considering annual reports, a decrease in the CGS of a firm was often observed just before it delisted. 5. Conclusion Global investors have shown increased interest in both listed and unlisted Sub-Saharan African investments. South Africa attracts the most investors compared to other countries in the region (Sinclair & Yao, 2011). Previous research indicated that asset owners and investment managers seek standardised ESG reporting that can be used for investment decision-making (PRI, 2007). Consequently, the demand for publicly available ESG information and reliable impact measurements have increased. Previously, critics argued that the lack of enforcement mechanisms can prevent ESG guidelines to provide clear direction to institutional investors. The guidelines were also criticised for not incorporating enough social and environmental issues (Organisation for Economic Co-operation and Development, 2007). The Emerging Markets Investor Survey Report (Ethical Investment Research Service, 2009) indicated that a lack of ESG disclosure by firms is seen as an important challenge to investing in emerging markets. Despite improvements in corporate reporting in recent years, the findings of this study show that corporate governance reporting was still relatively low in one of the major economic sectors of the country during the nine years after the introduction of the King Report II. There is also a lack of available tools to assess the impact of firms ESG performance. The first assessment tool that focuses on environmental and social 12

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