SHARM EL-SHEIKH, Egypt: In 1982, an informal Kuwaiti stock market known as Souq Al-Manakh collapsed. Speculators armed with vast funds from booming oil prices and from the dubious use of post-dated checks fueled share prices to unprecedented levels. Excited by their easy gains, most traders did not care to notice that many of the companies they bought and sold had no real business.
As oil prices turned so did Souq Al Manakh. The losses were enormous, and the financial system was nearly crippled with some $92 billion borrowed by investors to buy stocks.
Capital markets in the Gulf and elsewhere in the Middle East have come a long way since 1982. Today, vibrant stock exchanges with a broad range of companies, some substantial and others less so, exist throughout the region.
But despite the progress on the regulatory front, the region s stock exchanges remain susceptible to speculation and rumors, the rights of minority shareholders are often overlooked, disclosure is frequently limited to flimsy annual reports that are little more than a collection of notes and figures and good corporate governance practices are yet to take root in many listed companies.
McKinsey & Company Partner Hans-Martin Stockmeier explains that listed companies with a relatively small amount of floated shares and little transparency are more prone to rumors and speculation.
It s very difficult to move one of the real industrial companies up or a telecom up, because the free float is already too big, Stockmeier tells The Daily Star Egypt on the sidelines of the World Economic Forum on the Middle East. Typically, you have this drastic movement upwards and downwards in the smaller stocks where the free float is relatively small; and you know less about the company, that s another thing, so what they really do is less transparent; rumors can start even easier then [and] you have these drastic movements up and down.
Kito De Boer, managing director for McKinsey & Company in the Middle East, adds that corporate governance tends to be looked at in a narrow and technical way by institutions such as the OECD that promote good practice.
The issue of corporate governance needs to be seen in a broader environmental perspective, says De Boer. What you are looking for is a business ecosystem, which means the outside world is well-informed and disciplined in its approach in dealing with management. Internal corporate governance is only one mechanism for doing that.
De Boer explains that a number of mechanisms typically exist in the West to keep management on its toes but are missing or inadequate in the region. These include a critical press, creditors that encourage discipline and scrutiny from regulators.
In most parts of the world with large organizations, you have a free press that is well-informed and intrusive in its reporting of company and management performance, says De Boer. Certainly in the Gulf, business magazines look more like Vogue than they do Forbes. They re glossy magazines that have radiant stories about management heroes, but they do not have challenging articles about mismanagement in corporate affairs.
Creditors are another group that usually demands openness from companies they deal with. That tends to be blunted in the Gulf, because the bond market barely exists, so there s very little rating, says De Boer, and the debt market in many cases is very weak to the extent that bank debt is often done on a name basis, not on a company performance basis.
The dominance of strategic investors simultaneously diminishes the importance of public equity markets to management. So the management isn t forced to disclose information to the public in order to maintain a decent share price, says Stockmeier.
In many countries, taxation also creates pressure for openness and a need for scrutiny of reported financial information. Therefore the audit mechanism is taken seriously because of taxation, says De Boer. And the whole range on this side is underdeveloped, particularly in the Gulf, where taxation is really not much of an issue at all and auditing, therefore, is very sloppy.
The result is a business environment that does not encourage financial discipline and transparency. Even before we get to traditional corporate governance within the OECD parameters, even before we get started with that, the environmental conditions here are very weak, says De Boer.
Stockmeier and De Boer suggest that markets in the region should be made open to competition from foreign brokers and investment banks in order to improve the quality of public information. Such actions were taken in India in the late 1990s after a decade of severe market manipulation by speculators.
They allowed foreign investment banks and researchers to come in, says De Boer. They set up their own ratings agencies … They extended the amount of free float available on the market, so that the means and the motive for manipulation diminished. Now it s very hard to manipulate the market in India, because it’s a deep market, there s much more free float and there s much more information.
Internally, good corporate governance begins with the board of directors, which is the critical link between shareholders and management. There s a fundamental confusion amongst most boards about what it is they are meant to do, says De Boer.
The behavior of board members in the region varies from that of an absentee landlord to over-involvement in the day-to-day running of the company.
Getting that balance right between being a coach versus a disciplinarian [or] policeman is a very hard one to strike, says De Boer, and by and large, in the Middle East, most board members have not been trained, are not skilled and are ill-equipped. The board is also supported by a board secretary, whose role is usually seen as pivotal in most of the world but merely administrative in the region.
To be a board secretary, you need to be deeply steeped in bylaws of company law, explains De Boer, and they re the ones who manage the discipline around board meetings. But board secretaries here are at best a minor administrative function.