The Key Ingredient to Success: Corporate Governance Opportunities and Challenges for MFIs

The Key Ingredient to Success: Corporate Governance Opportunities and Challenges for MFIs Dr. Martin Steindl, MBA (HEC) Program Manager International Finance Corporation Tunis – May 2008

Presentation Purpose and Outline Purpose: To explain the concept of and business case for good corporate governance, tailored to MFIs Outline: • What is corporate governance? • Why does corporate governance matter; how does it add value? What can happen if you do or do not have it? • Specific governance issues for MFIs • Possible solutions and implementation Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

Takeaways By the end of this workshop, you should be able to: • Understand what good corporate governance is • Agree that corporate governance can add value and is indeed a key ingredient to success • Appreciate the main issues as they pertain to MFIs, and finally • Identify steps you may wish to undertake to implement good corporate governance in “your” MFI Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

Governance is governance…it is not management and it is surely not volunteering…as a board member you have to see to it that the organization is well-managed rather than managing it yourself Source: Ken Dayton, quoted from Consensus Statement of the Council of Microfinance Equity Funds, May 2005 Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

What is corporate governance?What does it ‘look and feel’ like?Why does corporate governance matter? How does it add value? What can happen if you do or do not have it?Specific governance issues for MFIsPossible solutions and implementationSummary

Corporate Governance Defined “Corporate governance is the system by which companies are directed and controlled.” “Corporate governance involves a set of relationships between a company’s 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.” Source: Sir Adrian Cadbury, UK Combined Code Source: OECD Corporate Governance Principles, 2004 Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

Internal—Corporate—Perspective External—Stakeholder—Perspective Shareholders - The general assembly - Intermediaries Stakeholders Elect &dismiss Areaccountable to Ext.Audit • Reputation Agents • Accounting firms • Law firms • Investment banks • Credit rating agencies • Financial analysts • Financial media • Research institutes • Educational institutions • Corporate governance institutes • Institutes of directors • Law- & rule makers • Company, Banking, Securities Laws • Regulations, Listing rules • National CG Codes Act in interest of Provide capital to Directors - The board of directors - AuditCttee Rem Cttee RiskCttee Nom Cttee • Capital & Financial Markets • Debt & equity markets • Competitive forces • Market for corporate control Report &answer to Guide &control Managers / Executives - CEO / mgt. team / ExCom - • Civil society • CSR • HSE CIA CRO CCO The Overall Challenge of Aligning (Conflicting) Interests Founder stage: Shareholder=Director=Manager Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

But Rest Assured: One Size Does Not Fit All! • No to cookie-cutting: corporate governance improvements should be tailored to specific institution at specific point in time in specific country! • Focus on the following four principles: • Accountability • Responsibility • Fairness • Transparency • And remember: corporate governance is a journey and not a destination • Best to understand key issues, then implement on a step-by-step basis Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

The ‘Look & Feel’ of Corporate Governance The five key elements ofgood corporate governance • Role • Duties • Structure • Composition • Procedures • Remuneration • Evaluation • Training • What: • Financial • Non-financial • Where: • Annual report • Website • When: • Qrt, annually • By whom: • Board vs mgt. • Generalassembly* Cumulative voting* Information* Discussion • Minority SH protection* Against RPT & insider deal.* Tag-along • Dividendpolicy • Risk mgmt. • Internalcontrols • Compliance • Internal audit • External audit • Audit cttee. • Strong regime of • disclosure and transparency • Protection of (minority) shareholder rights • Good board practices • Appropriate Control environment & processes Strong commitment to corporate governance reforms • Formalization of policies and procedures • Appointing CG leadership Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

Accountability and Supervision Accountability and Supervision Corporate Governance Corporate Governance Strategic Management Strategic Management Corporate Management Corporate Management Executive Mgmt. - Decision and Control - Operational Mgmt. Executive Mgmt. -Decision and Control- Operational Mgmt. Source: Robert I. Tricker, Corporate Governance, 1984 Source: Robert Tricker,Corporate Governance, 1984 Important to Distinguish Corporate Governance From Other Concepts Corporate governance  corporate/financial management Corporate governance  corporate social responsibility or business ethics If management is about running the business, corporate governance is about seeing that it is run properly. All companies need managing and governing. Intro >> Definition >> The business case >> Specific issues for MFIs >> Implementation >> Summary

Benefits of Implementing Corporate GovernanceEven NGOs require a return on capital to remain competitive and lend again • Streamlines business processes, leading to better operating performance & lower capital expenditures • Gompers, Ishii and Metrick, corporate governance and Equity Prices, August 2001 • Improves the company’s ROCE, with firms in the top cg quartile avg. 33% & in bottom quartile 15% • Credit Lyonnais SA, 2001 • Better share price performance, higher profitability, larger dividend payouts & lower risk levels than peers • Lawrence Brown, Georgia State University, Sept. 2003 • Global Institutional Investors managing more than 1 trillion of assets state that they will pay a premium for well governed companies. Premiums avg. 30% in Eastern Europe & Africa and 22% in Asia and Latin America  McKinsey Global Investor Opinion Survey on corporate governance, 2002 • Over 10 years, well-governed companies across a wide range of sectors have seen superior valuation multiples of more than 8% over their badly governed peers. • Metrick, Ishi and Gompers, Corporate Governance and Equity Prices, August 2001 • One standard-deviation improvement in governance brings an improvement in valuation multiples that ranges from 18% for companies in major OECD markets to 33% in emerging markets.  Clapper and Love, World Bank, 2002 • CG can make or break reputations by creating confidence, establishing goodwill andbuilding/restoring investor trust Optimizes Operational and Financial Performance Improves Access to Outside Capital (including donor funding) Sustainability & Competitiveness Improves Valuation and Lowers the Cost of Capital Builds/Improves the Company’s Reputation and Trust Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Benefits Over Long Run Thought to Outweigh Costs Corporate governance related costs: • Staff, e.g., a corporate secretary, independent directors • Structures, e.g., committees • Disclosure, e.g., annual and quarterly reporting, IFRS accounts • Control, e.g., publicly recognized external auditor, internal controller and auditor However, benefits from implementing corporate governance generally thought to outweigh costs over long run Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Specific Issues and Challenges for MFIs • A dual mission: Balancing profit-seeking with social objective of reaching poor clients • Make point to discuss right balance at highest level • Develop KPIs for social objectives • Right mix of directors • Ownership of MFIs • Informality of governance policies • Weakness of control environment • Entrepreneurial founders • Aligning interests of individual directors with interests of institution is key • Fiduciary responsibilities of MFIs • Greater than that of other corporate entities • issues to consider: i) low-income microentrepreneurs, ii) responsibility with donors, iii) threat of insolvency and its potential repercussions on national and international microfinance sector Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Specific Issues and Challenges for MFIs (cont.) • Many MFIs are incorporated as NGOs/NPOs, COOPs (and not FIs) • Principal-agent equation non-existent or shifts due to depositors • Informality of governance structures and weak oversight • Many MFIs are financial institutions, with own set of distinct issues • Strict regulation, e.g., on fit & proper, risk, and controls • Opaqueness of financial information • Relationship to regulator • Managing transformation: Developing from an NGO to a more complex organization • Risk assessment in MFIs • Extended fiduciary duties, vis-à-vis shareholders and depositors • Succession planning Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Different Board Types: The Good, Bad, and Ugly ‘Rubber Stamp’ Board ‘Yes-men’ Board ‘Good Old Boys’ Board ‘Shareholder’ Board ‘Executive’ Board ‘Hands-on’ Board ‘Country Club’ Board ‘Trophy’ Board ‘Paper’ Board Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Specific Recommendations for MFIs • Separate Ownership/oversight from control/management • For the board to better provide strategic guidance and oversight • Professionalize board • Clarify roles and responsibilities • Nominate outside and skilled directors • Ensure for appropriate mix-of-skills • Adopt appropriate working procedures • Create committees • Appoint women to board • Strengthen risk management and control frameworks • Understanding and managing risk key for financial institution • Robustness of control structure to provide assurance to board, investors • For larger MFIs: internal audit function Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

How Involved is the Board? High Involvement Low Involvement The PassiveBoard The CertifyingBoard The EngagedBoard The InterveningBoard The OperatingBoard • At discretion of the CEO • Limited activity & participation • Limited accountability • Ratifies mgmt. preferences • Certifies to SHs that CEO meets expectations • Takes corrective action only as very last resort • Understands role of independent directors • Informed about CEO’s performance • Establishes a succession plan • Provides insight, advice & support to mgmt. • Understands its responsibility to oversee mgmt. • Guides & judges the CEO • Has right skills mix to add value • Define roles and responsibility of Board vs. management • Intensely involved in decision-making around key issues • Frequent & intense meetings, often on short notice • Makes key decisions that mgmt. then implements • Fills gaps in mgmt. experience Source: HBR, David A. Nadler, Building Better Boards Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Executive, Non-Executive & Independent DirectorsDefinition & Role Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Board Chairperson and the CEO ‘There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.’ Source: UK Combined Code 2003 The chairpersonis responsible for The CEOis responsible for • The leadership of the board, setting its agenda and ensuring effective contribution of all its members acting in the best interest of the bank’s shareholders • The day to day running of the bank within the risk parameters defined by the board and delivering the bank’s strategy endorsed by the board Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Example of a Board’s Composition Non-executive Chairperson Non-executive / independent Director Non-executive / independent Director Non-executive / independent Director Non-executive / independent Director Non-executive / independent Director Non-executive / independent Director General Manager Retail Services General Manager Business/Corporate Company Secretary Chief Financial Officer In attendance Chief Executive Officer Executive Directors Non-executive/ independent Directors Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Corporate Governance & Audit Committee Central Bank General Assembly (Shareholders) Reporting Capital Markets Authority Election Feedback Board of Directors Transparency Professionalism Dynamism External Audit Board Committees Audit Committee Risk Committee Exec Committee Rating Agencies Remuneration Other Committees Investment Analysts External Stakeholders Bank Performance Advice Concerns Strategy Policies Risk Appetite International Financial Services Industry Senior Management Trust Respect Press Bank Infrastructure Customers Internal Audit Risk Management Compliance Institutional Investors Business And Support Units Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Audit Committee – Terms of Reference The audit committee: • Reviews integrity of the financial statements, and endorses and reviews accounting policies in use • Reviews the bank’s systems of internal control • Reviews the effectiveness of internal audit • Oversees external audit independence, work, and engagement • Reviews legal and regulatory compliance • Acts as central coordination point for investigation of complaints relating to financial statements, compliance & internal controls It then: • Provides regular updates to the board • Alerts the board to problems • Pursues and resolves areas of concern Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

How Risk Aware is Your Board?Red Flags for Directors! As a board member you should ask the following questions: • Does your board ever discuss current and future risks as an agenda item? • Do you receive intuitive reportage which enables you to understand and be comfortable with your bank’s risks? • Are you sure your bank is being properly rewarded for the risks it takes? • Is your bank on track with delivering its strategy? • What are the serious challenges it is facing at the moment? Intro >> Definition>> The business case >> Specific issues for MFIs >> Implementation >> Summary

Summary and Conclusions • Put most simply, corporate governance is defined as a series of structures and processes for the direction & control of a company; it must not to be confused with public governance, CSR or business ethics • Corporate governance improvement planning is a journey and not a destination • There are a number of behaviors and practices that will need to change, in addition to the company’s framework, policies, and procedures • In general, MFIs can improve their governance by (i) professionalizing their board of directors, i.e., creating a committee structure, separating the role of the board chair and managing director, etc., and (ii) strengthening risk management and control frameworks Intro >> Definition >> The business case>> Implementation for MFIs >> IFC Methodology >> Summary

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The Key Ingredient to Success: Corporate Governance Opportunities and Challenges for MFIs