Corporate Governance at a Crossroads

Outsiders could be forgiven for wondering just how well Chile, a member of the Organization for Economic Co-operation and Development (OECD) since 2010, complies with its benchmark corporate governance standards. Listed companies can, after all, be divided into two basic types – those where ownership is dispersed among a multitude of small shareholders and those controlled by a single shareholder through either a majority stake or a shareholders’ agreement – and, in both, Chile has recently had important mishaps.

First, in mid-2011, shareholders in one of its few examples of a dispersed ownership structure – the La Polar department store chain – saw the value of their assets plummet after it emerged that the company had been misrepresenting its results. Essentially – pending the result of ongoing lawsuits – it seems that its management had been taking bad debts off the company’s books by the simple expedient of “renegotiating” them behind the debtors’ backs.

Then, in July this year, the Enersis electricity holding company in which Spain’s Endesa holds over a 60% stake upset its minority shareholders and triggered a sharp drop in its share price when it unveiled plans for an US$8 billion capital increase. The catch was that Endesa – in turn, controlled by Italy’s Enel – would put up its part not in fresh money but existing assets with a disputed valuation and, with close to a two-thirds stake, was legally in a strong position to push the deal through.  

On corporate governance, Chile certainly has challenges. Corporate governance is, after all, a relatively new concept, points out Arturo Platt, a partner at Deloitte Chile, and has become important only over the past 30 or so years and, particularly, since the collapse of Enron in 2001.

It is, moreover, a concept that is Anglo-Saxon in origin and does not necessarily sit readily in a country like Chile where, traditionally, anything not forbidden by law has been permitted and there isn’t a word for “accountability”. But, beyond the obvious argument that accidents can happen in the best families, there is broad consensus that, on corporate governance, Chile has been doing reasonably well.

A dispersed ownership structure is very rare in Chile and may explain in part what happened at La Polar, suggests Héctor Lehuedé, a Chilean lawyer and currently senior policy analyst at the OECD’s Corporate Affairs Division. As in other Latin American countries and Asia, most companies in Chile have an active controlling group, with powerful incentives for keeping a close eye on management, so directors and analysts are less attuned to the risk of management misbehavior, he says.

And, he adds, the recent debate about the Enersis capital increase, in fact, illustrates one of the strengths of the Chilean market as compared to others with concentrated property structures – its powerful private pension funds (AFPs). As institutional investors, they have made a key contribution to the development of corporate governance in Chile, he points out, and it is, indeed, largely due to their vociferous complaints that the proposed capital increase is being treated as a related-party transaction  and, for now, remains on hold. 

Defining corporate governance

The crux of corporate governance is the so-called “agency dilemma” or how to manage the divergence of interests and asymmetrical access to information that exist between majority and minority shareholders in closely controlled companies or, in those with dispersed ownership, between shareholders and a company’s management.

These divergences are not easy to regulate. It is not only a matter of preventing abuse – majority shareholders usurping value from minority shareholders or indulging in improper related-party transactions or, for example, managers giving priority to year-end bonuses rather than the company’s long-term interests – but also of balancing legitimately different interests, points out Matías Zegers, director of the Corporate Governance Center of Santiago’s Catholic University.

Over the last 20 years, numerous laws and codes of conduct or best practices have been devised in a bid to address this dilemma. In 1992, for example, following the report of the so-called Cadbury Committee, the United Kingdom introduced its first Corporate Governance Code while, in 1999, the OECD published the first version of its Principles of Corporate Governance. And, in the United States, the Sarbanes-Oxley Act was introduced in the wake of the Enron scandal.   

But, at the same time, the concept of corporate governance has expanded, points out Deloitte’s Arturo Platt. Today, at least in academic circles, it is considered to encompass not only a company’s shareholders and their rights but also other stakeholders or, in other words, anyone affected by the decisions of its board, thereby implicitly extending directors’ responsibilities beyond the legal and financial spheres to areas such as a company’s sustainability plan. 

The task of directors today is far more complex than it was 20 or 30 years ago, agrees Carlos Cáceres, president of the board of the local subsidiary of UK-based British American Tobacco. One reason, he says, is globalization but another is the entry of institutional investors – principally the AFPs – making directors’ responsibilities very different from the time when companies were financed just out of their owners’ resources or by reinvesting earnings.

Another new ingredient, he adds, is risk analysis. Increasingly viewed as a board responsibility – and with its importance highlighted by the La Polar and Enersis cases – this represents a radical change for directors, says Cáceres, that calls for detailed assessment of a company’s strategic, financial, operational, environmental, reputational and other risks and the measures it should take to mitigate them.  

Platt says that, in his experience, this is an area in which corporate governance in Chile still lacks maturity as compared to, say, the United States. Companies’ annual reports there include whole sections on the risks that investors would run by investing in them, he points out, while many companies in Chile still baulk at such public confession of what could be considered weaknesses.

But new responsibilities for directors call for new skills. And, at odds with the traditional idea that being a director – rather like being a parent – is something that comes naturally to right-minded people, that implies training.

In addition to the induction that companies provide for new directors and the legal advice provided in-house or by a director’s own counsel, there are a number of organizations that now offer formal training for incumbent or prospective directors. They include the Catholic University’s Corporate Governance Center – with a Director’s College that has an alliance with Stanford University – as well as the University of Chile’s Center for Corporate Governance and Capital Markets and the BOARD Institute for Corporate Governance and Strategy, created by the Adolfo Ibáñez and Diego Portales Universities and Ernst & Young.

But, although there is a clear trend towards more professional directors, the anecdotal evidence still suggests a certain reluctance on the part of incumbent directors to admit to a need for training. “I still see directors who privately ask me for help in understanding their company’s financial statements but wouldn’t be seen dead going to a course,” reported one company advisor.

Another concern that has gained ground internationally in recent years, points out the OECD’s Héctor Lehuedé, is the diversity as well as quality and independence of a company’s directors. And, although Chilean companies are getting better at selecting a mix of directors that adds value and more independent directors are chosen every year, this is an area in which, by international standards, they are still lagging as reflected, for example, in the very small number of women occupying board seats.

From discipline to self-discipline

As the demands placed on corporate governance have increased – or, in practice, as holes have appeared – Chile has incrementally improved its legal framework, points out Álvaro Clarke, president of the University of Chile’s Corporate Governance Center and a former head of the Securities and Insurance Superintendency (SVS), the market regulator. That has not only brought Chilean legislation on corporate governance ever closer into line with best international practices but also means that it is today considered among the best in Latin America. 

It is, indeed, the best in the region, asserts Matías Zegers. “It has provided a framework for the sustained growth enjoyed by Chilean companies in recent decades,” he notes. 

The process began with the Law on Public Tender Offers, passed in 2000 after the so-called Chispas scandal surrounding the acquisition of Enersis by Spain’s Endesa. It not only sought to protect the rights of minority shareholders in a take-over situation but also required companies to establish Directors’ Committees on the lines of the Audit Committees of US companies.

It was followed in 2009 by a new Corporate Governance Law, establishing increased transparency standards and introducing new mechanisms for addressing use of privileged information, related-party transactions and conflicts of interest. In addition, it strengthened the role of the Directors’ Committee and defined more clearly the criteria with which independent directors must comply (although exempting companies with a free float of less than 12.5% from some of these requirements).  

As a result, an OECD report on corporate governance in Chile, prepared as part of the country’s accession process and published in early 2011, concluded that, “overall, Chile has a framework in place that broadly provides for the existence and enforcement of shareholder rights and the equitable treatment of shareholders”.   

And that view seems to hold despite the La Polar and Enersis cases. “It appears that both events in La Polar and debate about the Enersis capital increase have been well managed and should be properly resolved under existing regulation,” says Lehuedé.

There is, however, a growing view locally that the SVS requires greater autonomy from the incumbent government, a recommendation also put forward by the OECD in its 2011 report. This would be addressed by a bill, which the government has promised to present to Congress towards the end of this year, under which both the SVS and the Superintendency of Banks and Financial Institutions (SBIF) would be transformed into Commissions with a structure of councilors, appointed across different governments, similar to that of the Central Bank.

But corporate governance is not only about keeping on the right side of the law or the regulator. According to best international practices, it also involves self-regulation and, there, Chile has been dragging its feet.

As Carlos Cáceres points out, few Chilean companies have the detailed codes of conduct that govern the boards of companies like British American Tobacco. Moreover, Chile – unlike Brazil, Colombia and Peru – does not have a national code of best practices on the lines of, for example, the UK Corporate Governance Code.

There are many explanations for this lag. One, suggests Álvaro Clarke, is a stricter legal framework as compared to, for example, Brazil where protection of minority shareholders is weaker than in Chile and the code of conduct serves to complement these more lax legal controls. Another is that the private sector – including the stock exchange, typically a driver of the development of voluntary codes in other countries – has simply been too passive.

In July, however, the SVS took the bull by the horns, unveiling a proposed code of conduct that has raised a storm of protest from the private sector. Part of the problem is a suspicion that it would be “voluntary” in name only since companies not complying with it would be obliged to explain why not and could, moreover, be ranked publicly according to their performance.

Other complaints include the inclusion of obligations such as risk analysis that exceed legal requirements. Critics also complain of a lack of the flexibility required to take account of the diversity of economic activities and, therefore, the nature of the companies that exercise them.

“My concern is that Chile could be moving towards increased regulation rather than self-regulation,” says Cáceres. “That would mean greater bureaucracy and corporate governance is about managing third-party resources efficiently as well as correctly.”

There is, however, an underlying consensus that the SVS may have been right, if not in the terms of its proposal, at least in pitching a ball that it is time for the private sector to pick up. Whether it reacts appropriately will determine not only the future shape of corporate governance in Chile but potentially also the extent of companies’ ability to continue generating value for shareholders and the country.    

Ruth Bradley is a freelance journalist based in Santiago and a former editor of bUSiness CHILE.