Transparency in Kuwaiti Corporate Governance and Stock Market

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In the wake of recent scandals associated with large and influential corporations on both sides of the globe, the issue of corporate governance is becoming more and more prevalent. Full transparency and disclosure of financial operations are necessary for the long-term survivability of large companies, as these practices prevent theft, fraud, and inefficient use of financial resources. These ideas are not new – the OECD has been underlining the necessity of transparency and disclosure as means of more effective corporate governance and stock market exchange since the release of its guidelines for private and state-owned enterprises since 2005. Disclosure and transparency are necessary for the stock market to function properly, as inappropriate practices would inadvertently lead to skewered perceptions in regards to the company and economically irrational decisions. High levels of transparency and disclosure are also necessary for businesses that want to compete on an international level.

For developing countries such as Kuwait, achieving transparency and disclosure in corporate governance and the stock market could pose certain challenges (International Monetary Fund 2012). The majority of enterprises in the country are either state-owned or belong to wealthy and powerful families, which creates a concentration of wealth and power in the hands of the few. Also, the absence of an appropriate legal framework to enforce disclosure and transparency puts additional barriers that prevent compliance with the OECD guidelines. The purpose of this paper is to review the body of literature available on the subject and evaluate the state of corporate governance in Kuwait.

Problem Statement

Many developing countries in the GCC have acknowledged the importance of corporate governance in the greater scheme of international business and stock market practices, and have introduced appropriate legal frameworks to protect shareholders and stakeholders alike. As it stands, Kuwait is currently behind its direct competitors due to having no official corporate governance code of its own (Koldertsova 2010). There are several drafts and suggestions in regards to how this code should be implemented on a statewide scale, such as the CSR’s Corporate Governance Code. However, as it stands, none of the currently available codes have any official and legal status. All of the suggestions presented in them are treated as recommendations and not as rules to follow. Kuwait can compete with other countries in the GCC due to many economic similarities between the nations located in the region. The main problems to be explored in this paper are as follows:

  • Transparency and Disclosure issues. The paper will examine the issues in Kuwait and other developing countries in the region to find a pattern of similarities between the situations.
  • Lack of a proper corporate governance legal framework. The research will examine the reasons why the Corporate Governance Code of Kuwait has not been developed or adopted yet.
  • Familial corporate practices. Since many corporations in Kuwait are in the hands of powerful and influential families, company directorship is often decided based on familial ties rather than merit or professional competence.

Literature Review

Before addressing the issue of corporate governance in Kuwait, the research requires a basic identification of what corporate governance is. Definitions vary from one scholar to another, based on the qualities of interest to their respective research. Low (2002) identifies corporate governance as an environment where the directors and top managers guide to advance the interests of all shareholders in the company. This definition does not make any differences between major and minor shareholders. However, it does not include other parties that have their interests and rights within the corporate governance model.

Spedding (2004) gives a definition that is more common to the Asia-Pacific region, which also includes the stakeholders of the company. These stakeholders include employees, customers, suppliers, and low-tier managerial personnel to the list of persons whose interests and rights should be protected under the corporate governance model. This is a popular model in Japan, which has already proven its efficiency. It indicates that stakeholders are an important part of the economy and the corporate governance code should protect their rights.

While the principles of corporate governance have been established relatively recently and reaffirmed after the global economic crisis of 2008-2009, the value of transparency and disclosure in business has been acknowledged for over a century. According to the Basle Committee on Banking Supervision (1999), disclosure and transparency are the foundation for monitoring the financial system. These factors provide accurate information for the participants of the market, which enables them to analyze the situation in a swift and timely manner. Timeliness, completeness, and accuracy of the provided information enhance the abilities of the investors to make appropriate investment decisions, which contributes to the healthiness of the economy as a whole.

The agency theory is one of the primary theories of corporate governance, upon which many modern western systems are based. It emphasizes the rights of shareholders, stating that separation of management and ownership would create problems. According to McColgan (2001, p. 33), “the directors of such joint-stock companies, however, being the managers rather of other people’s money than their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.”

In many developing countries, the idea of corporate governance is somewhat novel, as the majority of industries were, at one point or another, belonging to the government or important and powerful local clans and families. Such is the situation in Nigeria, where local businesses and corporations, as well as the government, seem to in a state of confusion as to which corporate governance model they are supposed to follow (Agelbite & Amaeshi 2010). The reason for that is that the three powerful actors operating in the region, such as the notable international organizations (IMF and OECD), local corporate governance institutions, and indigenous initiatives, are all pulling the country in different directions, which prevents the adoption of a unified corporate governance model (Agelbite & Amaeshi 2010). A similar situation can be perceived in Kuwait.

The above point is truthful for many emerging economies, such as Turkey. Aksu and Kosedag (2006) state that emerging economies are in dire need of external capital to expand into the international markets. At the same time, they possess a poor corporate governance structure and an inefficient regulatory framework to ensure the transparency and disclosure of financial activities, which are required if the country is to participate in a global market. While the Turkish companies possess a low-to-moderate transparency and disclosure rates, their capabilities and desire to participate in voluntary disclosure of financial activities remain low (Aksu & Kosedag 2006). Turkish businesses also possess numerous similarities to that of Kuwait, such as Islamic influence on the economy, strong familial businesses, and an expansive government sector.

Studying the regulations and decisions in regards to transparency and disclosure in other countries of the region provides an interesting perspective on practices and common problems among the emerging Arabic economies. According to Masry (2015), who studied the corporate governance system in Egypt, the country’s Financial Market AW number 95 and its amendments regulate the submission of financial data by the local businesses and companies within 90 days for the annual statements and 45 days for the quarterly statements. The research states that the overall disclosure rates for the Egyptian companies have reached 71.6% for the annual statements and 65.3% for the amendments in the company data. Overall disclosure rates have reached 66.5%.

An interesting case related to corporate governance and transparency is provided by Al Sawalqa (2014), who studied the implementation of corporate governance code among Jordan banks. The Central Bank of Jordan released a handbook with all the necessary instructions and regulations in regards to corporate governance in the banking sector, which included policies in regards to familial ties among the directorial board, transparency and disclosure necessities, and general governance issues. While the compliance with general governance rules was absolute (100% of banks have adopted the practices specified by the CBJ), and compliance with the board of directors rules was relatively high (90.4%), audit information compliance was at 70.5%, meaning that almost a third of banks did not comply or partially comply with transparency and disclosure demands of the CBJ. Al Sawalqa (2014) states that the reasons for such noncompliance lie in the fact that the CBJ guidelines are treated as recommendations, and Jordan banks are allowed to interpret or adapt the rulings to their specific situations and needs.

Different economies of the world employ different practices and procedures when it comes to transparency and disclosure. Since 2012, Malaysian firms have been operating under the new MFRS 7 disclosure protocols, which emphasized internal and external audit support to increase company transparency and disclosure. According to Adznan and Nelson (2014), the overall level of transparency and disclosure since the adoption of MFRS 7 has increased by 11.5%. The study shows that the implementation of mandatory disclosure and transparency protocols manages to improve the situation in the emerging markets.

Emerging economies receive a bad reputation due to various transparency and disclosure-related scandals in large businesses. Not even large countries such as China can avoid the potential consequences of scandals, as well as loss of investments and profits. However, the country makes serious efforts in counteracting corruption and improving its transparency and disclosure rates. According to Myers and Steckman (2014), China has adopted some of the OECD’s regulations and practices to improve its corporate governance, such as factual laws to ensure director independence, shareholder protection rights bulletin, and insider information regulations.

While the majority of researchers consider transparency and disclosure to be an undisputed goal with obvious benefits for the companies and stock markets in general, not everyone agrees with that assessment of the situation. Hermalin and Weisbach (2007) have found that reforms aimed at increasing transparency and disclosure can also lead to reduced firm profit, increased executive compensation, and increased turnover rates among company CEOs. The research finds that these factors could be behind the reduced levels of compliance with T&D rules in emerging economies, as the practices do not offer any short-term benefits and can potentially induce a loss of profit.

OECD is one of the international financial institutions that promote transparency and disclosure as a means of regulating the stock market. It releases guidelines for private-owned companies and state-owned enterprises alike. According to the OECD guidelines on corporate governance of state-owned enterprises, the timely and accurate disclosure of information allows the company to maintain a sound corporate governance system, as well as minimizes the risks that the company could suffer in the event of a financial crisis (OECD 2014). This is one of the reasons why corporate governance is important to Kuwait and countries of the GCC in general, as their economies are highly reliant on oil prices.

The issues of disclosure and transparency were largely ignored, as various companies operated under their own rules and regulations in regards to corporate governance, up until the economic crisis of 2008. According to Kirkpatrick (2009), the outdated and inefficient corporate governance systems did not provide enough protection from stock market-related risks. Accounting and audit systems did not provide enough feedback to facilitate a correct course of action, and due to computer systems inadequacy coupled with faulty risk-management techniques, relevant information in many cases did not reach the boards (Kirkpatrick 2009). These events have prompted many companies and financial institutions to revise their corporate governance policies and enforce transparency in the stock market to mitigate further risks.

One of the main reasons for Kuwait’s financial vulnerability during crises is the increased value of executive remuneration. Improper business practices in many Kuwait companies favor large and non-transparent sums of executive remuneration, which sets the bar low when it comes to profits and opportunities. According to Moore (2004), a focus on immediate value rather than a long-term perspective is the sole motivation behind avoiding transparency and disclosure in the majority of the companies in the emerging economic sectors such as Kuwait and Jordan.

In the absence of an official corporate governance code, Kuwait operates under the rules and regulations of the KSE (Kuwait Stock Exchange), which provides a list of rules and regulations towards corporate transparency and disclosure. However, it is not a very efficient system to use as a corporate governance tool, because many of its responsibilities are overlapping with the Central Bank of Kuwait and the Ministry of Commerce and Industry. According to the International Monetary Fund report (2010), KSE is ineffective due to numerous reasons, one of which being that senior managers and corporate executives are appointed by most companies and banks through a simple shareholder vote.

One of the shortcomings of the Kuwait corporate government system in the state-owned business sector is that the regulations are very loose and control mechanisms are underdeveloped. This factor, coupled with the issue of nearly infinite funding for the government sector, results in managers and directors taking advantage of the lack of transparency and disclosure by looting the company. As a result, foreign investors express reluctance to participate in the Kuwait economy until the issues of theft and corruption are dealt with (Center for International Private Enterprise 2002).

In 2004, the Central Bank of Kuwait had provided a list of corporate governance principles to be imposed upon the Banks of Kuwait. These recommendations include the protection of shareholder interests, provides instructions and regulation to the role of stakeholders, establishes a demand for disclosure and transparency, lists the election procedure for the board of directors as well as managerial responsibilities, and states the rules on audit processes (The Central Bank of Kuwait 2004). While these regulations are based on the OECD recommendations, Kuwait still lacks an effective enforcement mechanism that would ensure these rules are followed.

According to the Institute of International Finance (2007), many countries and economies in the GCC share similar problems in regards to transparency and corporate governance. Based on the numerous findings and observations, they have proposed several key elements that the corporate governance systems should have to ensure increased transparency and disclosure. These are (Institute of International Finance 2007):

  • Strong regulatory structure with a clear separation of responsibilities between the regulators and the stock exchange.
  • Regulators must be made fully independent of the government.
  • Compliance with corporate governance codes must be mandatory.
  • Appropriate institutions must be given the capabilities to supervise and ensure compliance.

Governments around the world implement both mandatory and voluntary transparency and disclosure procedures. Each system has its pros and cons. According to Black (2000), voluntary disclosure is efficient when the government provides positive reinforcement for complying with the procedure, such as refunds and tax returns. However, it does not work for smaller businesses, and companies that feel not disclosing their financial activities would provide a greater short-term benefit when compared to the incentives. Compulsory disclosure, on the other hand, is considered more efficient, but its efficiency is related to the efficiency of the enforcement and supervisory agencies. Black (2000) states that in a corrupt government, these instruments are used to force unfavorable conditions upon the potential competitors.

Some banks and financial facilities in Kuwait are operating under the rules and regulations of Islamic finance. According to Henry and Wilson (2006), the roots of Islamic influence on Kuwait’s financial system go back to 1977 and the foundation of the First Islamic Bank. Right now, three major banks in Kuwait operate under Islamic rules and regulations. The structure of the Islamic banks differs from that of standard banks, and all decisions and conflicts between shareholders are first regulated by the SSB, provided their decisions do not break Kuwait law. This structure of overarching authority over shareholders creates difficulties related to corporate governance and transparency (Henry and Wilson 2006).

Family businesses in Kuwait make up for the majority of enterprises. According to Schumpeter (2016), more than 110,000 individual enterprises in Kuwait are owned by families. This trend repeats itself in different parts of the world, particularly in Asia and the Middle East. However, Kuwait corporate governance is currently suffering from succession failure, with many conflicts emerging from the fact that most businesses are now in or past the third generation, meaning that governance-related issues emerge from disputes between various members of the families over positions and directorship, which is harmful to the Kuwait business (Schumpeter 2016).

Corporate governance is often seen to be a separate subject in state-owned enterprises. Khan and Kumar (1997) state that while some researchers see that the government controls its enterprises in a way costly to the overall efficiency and proper economic performance, the success of such an enterprise relies largely on a balance between control and economic performance, which is the ultimate goal of any efficient corporate governance structure. Khan and Kumar (1997) also underline the importance of proper and quality leadership in government enterprises, as that would enhance the organization’s accountability and transparency.

Some Kuwait corporations are implementing self-appointed codes of corporate governance that promote values of transparency and financial disclosure. One such corporation is the Kuwait Petroleum Corporation, which came up with its own grassroots initiative to apply the best practices of corporate governance into its code of conduct. The important principles adopted by the KPC are ethical business conduct, good citizenship, HSE policy commitment, and confidentiality. Such initiatives could be used as a base for the formulation of an official corporate governance code for Kuwait enterprises (Kuwait Petroleum Corporation 2010).

Kuwaiti Law No: 1/1993 Regarding the Protection of Public Funds is one of the primary laws that could help establish proper corporate governance in the Kuwaiti state business sector. This law is relevant to all state-owned enterprises, including the oil industry. It states that strategic resources belong to every individual citizen in Kuwait, and as such, any money embezzlement, theft, or other crime of similar nature committed by a worker or a manager within a state-owned enterprise is subjected to strict punishments and incarceration. The application of said laws by any surveillance government bodies would ensure proper conduct and organizational transparency (Almelhem 1995).

State-owned enterprises (SOE) in Kuwait operate under two standard laws

One of these laws is the Companies Law 1960/15, and the other law is the Establishment Law for every enterprise. According to Roy (2015), these laws are insufficient, as they do not provide enough regulations for the establishment of the board of directors, governing laws and regulations, and do not highlight the differences in objectives and goals between state-owned and private enterprises.

Institutionalization of shareholders in Kuwait enterprises has the potential to improve the quality of corporate governance and increase transparency on all levels of operations. According to OECD (2010, p. 10), “the exercise of ownership rights by all shareholders, including institutional investors, should be facilitated. Institutional investors acting in a fiduciary capacity should disclose their overall corporate governance and voting policy concerning their investments, including the procedures that they have in place for deciding on the use of their voting rights. Institutional investors acting in a fiduciary capacity should disclose how they manage material conflict of interest that may affect the exercise of ownership rights regarding their investments.”

The legal mechanisms of corporate governance are used to protect the rights and safety of investors. They can be implemented in Kuwait, but only after the laws and regulations are provided with sufficient enforcement. According to La Porta et al. (2000), a well-established regulatory framework would restore investor confidence and attract foreign money flow into the country. They will be assured that their funds would be spent on economic development and would not be expropriated by the market participants. A good example of this trend would be China, which has made several important changes in its corporate governance policies to attract additional investment (La Porta et al. 2000).

As it stands, the rest of the GCC countries have already adopted their codes of corporate governance, with Kuwait being the only country that did not. As such, Kuwait can learn from the experiences of countries that have similar economic and legislative systems. According to Samaha (2010), one such country is Saudi Arabia. Its governance code was introduced in 206 and received provisions in 2009. They also have specific agencies tasked with enforcing the code of corporate governance, something that Kuwait did not develop or even discuss yet. The trend of preferring mandatory compliance to the code is a recurring theme among the countries of the GCC (Samaha 2010).

Kuwait did commit to increasing its transparency and disclosure, however, following the example of Saudi Arabia and transforming its stock exchange by establishing a Capital Markets Authority. Kuwait’s CMA issues rulings and guidelines that are intended to increase corporate transparency, disclosure, and providing a series of guidelines for businesses to follow (CMA 2015a). The difference between CMA’s guidelines and recommendations provided by the Central Bank of Kuwait, however, lies in the fact that CMA is authorized to initiate legal action against enterprises that do not comply with the major established rulings and regulations. In the case with Saudi Arabia, who was known for its soft requirements towards transparency and disclosure, the introduction of CMA managed to improve not only its transparency values but also the protection of customers and investors, which managed to attract foreign investors into the country. While these measures do not equate to the adoption of the official corporate governance codes and policies, they are enough to bring Kuwait’s legal system to the minimum standard acceptable in the world stock exchange (CMA 2015a).

The corporate governance recommendations established by the CMA in 2015 contain a list of instructions, responsibilities, and requirements that banks, corporations, and other financial entities are expected to follow. In terms of content, these instructions are very similar to the OECD guidelines, which were adapted to Kuwait’s realities. The recommendations and guidelines utilized by CMA cover all the important topics related to corporate governance, such as board composition, executive officer remuneration, protection of shareholder and stakeholder rights, financial code of conduct, transparency and disclosure, and corporate social responsibility (CMA 2015b). However, this code has more legal value and stronger support because CMA has a modicum of power to enforce compliance with the major regulations (CMA 2015b).

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