Understanding the Second Wave of Corporate Governance in the Middle East

Understanding the Second Wave of Corporate Governance in the Middle East

  • Over the past few years, awareness about- and adoption of- corporate governance has picked up pace worldwide, including the Middle East.
  • The need to attract foreign investors and improve access to capital resulted in the first wave of corporate governance awareness in the region in early 21st century.
  • The second, and the current, wave of corporate governance adoption is being driven by the need for family-owned businesses to diversify their boards to improve strategy and decision making, in wake of increased competition from global organizations entering the Middle East. 

Over the past few years, awareness about- and adoption of- corporate governance has picked up pace worldwide, including the Middle East. In this first article of a two part series, we will talk about the meaning of corporate governance and the reasons driving the implementing of corporate governance reforms in the Middle East. In the second article, we will look at the progress made on actual implementation of corporate governance practices by the Middle East companies.

Before we analyze the factors driving corporate governance in the Middle East, let’s understand what the term really means. The Cadbury Report in 1992 offered the simplest and most concise definition of the term: “Corporate governance is the system by which companies are directed and controlled”. It essentially means balancing the interests of all stakeholders in an organization – shareholders, management, customers, suppliers, financiers, government and the community.

Now, let’s understand the business conditions in the Middle East that have created the need for improved corporate governance in the region.

The need to attract foreign investors and improve access to capital resulted in the first wave of corporate governance awareness in the region in early 21st century. Middle East was faced difficulty in attracting foreign investors due to a perceived lack of transparency and accountability among businesses in the region, which hampered FDI inflow and corporate partnerships from investors and corporates in the US and the UK. In fact, the first wave of corporate governance awareness occurred in the Middle East about a decade ago (early 21st century), primarily fuelled by the drive to garner foreign funds particularly by countries having no petrochemical resources and requiring substantial funds for developing their infrastructure. The fact that businesses which lacked corporate governance practices had to face higher funding costs and enjoyed a limited access to capital markets compelled the local companies to adopt corporate governance reforms.

However, Transparency International’s 2013 Corruption Perceptions Index, that ranks 177 countries and territories on a scale from 0 (highly corrupt) to 100 (very clean) based on how corrupt their public sector seems to be, lists five Arab countries in the bottom ten of the list. Also, according to PwC’s 2014 Global Economic Crime Survey, 21% of Middle East companies have been the victims of some form of economic crime.  Therefore, corporate governance reforms are far from complete and there is still a lot that needs to be done to improve the attractiveness of the region for foreign investors.

Understanding the Second Wave of Corporate Governance in the Middle East 1

Transparency International’s Corruption Perceptions Index 2013 

Source: Transparency International

The second, and the current, wave of corporate governance adoption is being driven by the need for family-owned businesses to diversify their boards to improve strategy and decision making, in wake of increased competition from global organizations entering the Middle East.

The presence of a large number of state-owned and family businesses in the region, especially in the Gulf Cooperation Countries (GCC), is characterized by extreme ownership concentrations. With 90% of Middle East companies being family-owned, they tend to be run by a single person or group of persons (appointed by the family). Even majority of the non-listed companies (also SMEs) are controlled by family business founders or their descendants. However, while the family-owned structure results in greater control, it creates challenges as the business passes from one generation to another, and faces hurdles in the form of increased competition from big multinationals entering the region.

As per S&P, “Government-related entities tend to make decisions that serve the interest of state policies rather than minority shareholders or creditors. Similarly, in the case of family-owned businesses, one person often holds both the chairman and CEO position, which combined with a strong appetite for investments, risks creating diversified companies ‘that are based more on opportunism than a clearly articulated strategy’”

Understanding the Second Wave of Corporate Governance in the Middle East 2

Family-owned Businesses & the Need for Corporate Governance in the Middle East 

Source: EY Family Business Yearbook 2014

As a result, governance challenges have multiplied, and leaders have come under public pressure to professionalize their boards and management. The above factors have created a compelling case for companies in the Middle East to restructure their boards and adopt advanced corporate governance principles. According to research conducted by the Pearl Initiative (GCC-based organization into corporate governance) and PwC in 2013, there is growing appreciation amongst family-owned companies in the region about the importance of a strong well-functioning independent Board. About 55% of the surveyed GCC-based family firms had Board members from outside the family, and 42% of firms had at least one non-family non-executive director on the Board.

Visionary companies across the region have adopted corporate governance practices as a strategic advantage in their search for growth and profitability. We will look at the progress made by the region’s countries as well as companies in the next part of our article. Watch this space!

The article was originally published at: Arab Business Review

 To read more thought-leadership stuff by leaders from Arab Region, please visit Arab Business Review

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