Examples/lessons learned in Bulgaria and
transition countries
Todor Yalamov
Boyan Belev
Center for the Study of Democracy, Bulgaria
The phenomenon referred to as corruption comprises
the sundry forms of abuse of power (economic, political and
administrative) which all result in obtaining personal or
collective benefits to the detriment of the rights and lawful
interests of an individual, groups or the whole society. Corruption
hinders development virtually everywhere, thus harming the social,
political, and economic life of any society. It distorts choice,
increases costs of products and services, promotes unproductive
investment, contributes to decline of living standards and
undermines democracy and societal integrity.
Corruption is not solely a disease; it is rather a
symptom. It indicates poor governance - both in public
administration and business. Lack of transparency, discretionary
power and low accountability are considered as the three main
causes for corruption worldwide. Corruption in transitional context
is also a response to the institutional gaps that meets new demands
of people and firms.
Existing corruption in business-to-business
relationships is a symptom of poor corporate governance. A full
range of examples of corporate governance failures that are
associated with corruption, fraud and cronyism in support of the
hypothesis outline above could be found in the Asian and the
Russian economic crises of the late 1990s.
Corporate governance problems in the context of
transitional or developing countries go beyond the classical
problems that result from the separation of ownership and control.
Following the new institutional economics approach, the
effectiveness of a particular corporate governance system is
interdependent with the set of institutions (regulations, contracts
and norms) which create self-governing firms in the economy. Among
the core issues to address in the attempts to build sound corporate
governance in transition countries we should mention transparency
of financial and performance information, conflicts of interest,
procedures for bankruptcy, property rights, contract enforcement,
etc. It is also absolutely necessary that the public and private
sector cooperate in order to develop a set of rules which would
establish the ways in which companies govern themselves.
Good corporate governance is a counterbalance to
corrupt practices in the private business. Sound corporate
governance practices attack the supply side of corrupt
relationships by raising transparency, reducing discretionary
power, and holding decision-makers accountable. In the course of
corporate governance reform new norms, trust and integrity are
built which limit the space for corrupt activities.
On the basis of the Bulgarian experience, we
could say that good corporate governance can provide effective
instruments in the fight against corruption - instruments which are
equally applicable in other countries within the context of
transition to a competitive market economy and increased importance
of civil society in political and social affairs. The numbers used
in it are courtesy of Vitosha Research (www.online.bg/vr) - a major Bulgarian
polling agency which has conducted multiple surveys on corruption
and corporate governance.
1. Transparency Reduces Fraud and
Corruption
In addition to creating direct obstacles to
legitimate actions, shortcomings in transparency have indirect
adverse effects by providing room for unjustified discretional
behavior. Lack of adequate disclosure has been widely regarded as a
major factor which brought about the Asian crisis a few years ago.
The following examples demonstrate that low disclosure standards
induce or permit fraud and corruption regardless of the time and
place: A small shareholder of a Bulgarian company was informed of
facts showing that the management was not trying to maximize
shareholders value - it was targeting private gain instead. This
shareholder wanted to convene a general assembly meeting (GAM) to
discuss the evidences she had, to obtain further information and
eventually undertake remedy measures together with the other
shareholders. The law provides that someone holding at least 5% of
the capital could litigate a case against the management. The
company management, however, rejected the idea of convening a GAM
claiming that only shareholders of more than 10% have the formal
right to convene a meeting; on the top of that it refused to make
available the list of all shareholders on record. In addition, the
Central Depository, which has all this information, was not willing
to cooperate. Thus, the small shareholder had either to bribe the
Central Depository or leave the corrupt behavior with no
reaction.
In another case a GAM of a company was held at a
hotel. The announcement, however, did not include detailed
information about the exact place of the meeting at the hotel, so
representatives of the holders of more than 34% of the capital
couldn t attend in spite of being on the premises of the hotel. As
a result, capital increase was voted in their absence, their
holdings were diluted and they lost blocking power.
Another case which attracted public attention was
holding a GAM of state-owned enterprises in the course of the
privatization process which increased the number of shares owned
required to elect members of the board. This decision was not
disclosed properly and made it impossible even if a private
investor acquired more than 50% (in some cases up to 66%) to make
changes in the board of directors and the management of the company
against the will of the government. Further appointments of new
board members were possible only after extensive negotiations
involving corrupt practices. After a strong negative public
response to this the government was forced to pull back.
Disclosure of information exerts a disciplining
effect in corporate governance provided that the information
disclosed is available to investors in a fast, easy and inexpensive
manner. Unfortunately, most of the public companies in Bulgaria do
not comply with the transparency requirements (This conclusion was
reached by Vitosha Research on the basis of a study in 2000 of 268
listed companies with authorized capital over BGN 200,000 (response
rate of 59%).
Serious problems exist with the disclosure of
management and board members remuneration - only a few companies do
this properly. Virtually no disclosures of conflict of interest
exist. In a broader context, even the statutory requirement of
publishing annual financial statements (balance sheets, income
statements and cash flow statements) is often violated. Access to
disclosed information is rendered difficult for to a number of
reasons: information is not consolidated; much of it is not
submitted in an electronic version; low awareness of the
requirements for access to public information in general, etc.
2. Discretionary Power Creates Incentives for
Corruption
Discretionary power is manifested in all areas of
corporate actions: convening general assembly, capital increase,
nominating board members, contracts, etc.
If we come back to the first case mentioned,
shareholders ultimately managed to get together and demanded to
convene a general assembly meeting. If the management does not
respond positively within a month, then the court can convene this
meeting. At the time of the case it was not specified in the law
within what timeframe the GAM had to be held and the management
convened the meeting with a delay of one year, thus preventing
earlier resolution of the issue in spite of the court decision.
A few privatization funds exercised their
discretionary power provided by the Commercial Code to convene
general assembly meetings at locations difficult to reach (for
example villages in the mountains where no public transportation
exists) or even abroad. These meetings usually resulted in dilution
of shareholder value for those who could not attend as a result of
the capital increase voted at the meetings. In this respect 11.6%
of the public companies in Bulgaria admit to have increased their
capital at least once in disregard of proportional participation of
all shareholders.
One privatization fund, known among investors and
the public for the worst corporate governance record in Bulgaria,
used the provision for allowing a shareholder with 5% of the
capital to file a court case against a company solely for blackmail
of the management and the controlling shareholders. It also used
the lack of clarity in terms of holding general meetings to take
over the management by not allowing the majority shareholder to
attend the meeting. Further, it obtained that these illegitimate
decisions were registered with the court with the help of insiders
and started siphoning off the company. The problem was ultimately
resolved after the diplomatic involvement of a foreign government
(the majority shareholder was a foreign investor) and the media
putting pressure on the judicial system.
Presently, a number of Bulgarian public companies
suffer because controlling shareholders siphon off funds to their
own private companies. For example, a public company strikes a
sweetheart deal (often regarding advertising, consulting or even
supply of raw materials or distribution of goods) with a company
wholly-owned by controlling shareholders. Under the present law
this is not totally illegal. The only regulation concerning
conflict of interests is included in the Commercial Code and
relates to the exercise of the voting rights at the general
assembly meeting. Thus, shareholders or their representatives are
prevented from voting on resolutions for claims against the major
actors in such practices or initiating actions for enforcement of
these actors liability to the company. Another important area where
discretionary power exists is the nomination of board members. It
often results in nepotism, cronyism and low representativeness. At
present, there are no rules or criteria concerning who should serve
on boards, nor the balance between internal and external directors.
For example, participation of government representatives at boards
where the government has no shares is an indicator of (possible)
corrupt practices or unnecessary politicizing of purely economic
decisions.
In a number of cases representatives of the
government which was holding shares in the company voted explicitly
in favor of a private majority shareholder, against the interests
of their principal and the mandate they had received. In most cases
these people have not been held accountable for their actions.
3. Low accountability and responsibilities feed
corruption
Even when decisions, relevant information and
behavior are transparent corruption would still widely exist if the
people involved are not accountable for their actions.
Accountability is shaped by the legislation and enforced by the
judicial system. The judicial system in Bulgaria, however, is
usually slow to act. Still a missing element of the puzzle is the
self-control of private business exercised, for example, through
companies regulations of their management and employees
conduct.
The Commercial Code and the Law on Public Offering
of Securities do not spell out the responsibilities of the
governing bodies and fail in this respect to draw a distinction
between public and private joint-stock companies. Presently, the
liability of the members of governing boards is limited to three
month compensation. Sanctions are possible only in cases of failure
to comply with the reporting requirements with regard to the
commercial register and the requirements of the State Securities
and Exchanges Commission.
Internal control is a valuable tool to prevent
corrupt behavior. There is a clear lack of understanding of how
boards should be structured and different committees (on
compensation, appointments, etc.) should be formed. To date, 75.8%
of the public companies in Bulgaria have no auxiliary committees in
their managing bodies; if such committees exist, their efficiency
is assessed as low. Moreover, the institution of outside directors
has not yet been established.
The capital market usually plays the role of an
external disciplining mechanism for managers and directors, but as
it is underdeveloped in Bulgaria it cannot adequately perform this
role. Self-regulation within the private sector (for instance,
through Codes of Best Practices) can probably be a substitute for
the lack of an effective checks and balances system.
4. Building trust and new institutions can curbs
corruption
Corruption has flourished in the transition context
and due to the inefficiency of the existing institutions. It is the
lack of trust in these institutions and their inadequacy to the new
needs of individuals and firms what accounts for the existing
situation; for this, effective strategies to curb corruption should
work toward improving the existing institutions and building new
one ones which could be up to the challenge. These new
institutional forms can be country-specific - the Corporate
Governance Initiative (CGI) (www.csd.bg/cgi) in Bulgaria represents a
good example of effective strategy of public-private partnership in
combating corruption, a coalition in which the Center for the Study
of Democracy has played a key role.
CGI adopted a strategy of assisting in the
elaboration and the implementation of practical and policy
instruments which would bring trust, accountability, transparency
and sound business practice in a transition economy, promoting
public awareness of best corporate governance standards and their
practical importance for economic growth and social progress,
setting up a framework for policy dialogue between private and
public sector institutions with the goal of introducing sound
corporate governance structures and procedures.
CGI proposed a number of institutional innovations
as tools in combating corruption. They include:
- Endorsement by private business of a Best
Practices Code. This Code would address the public expectations of
equal treatment of shareholders, including protection of minority
shareholder interest; design a clear mechanism for management and
control focusing on the responsibilities and motivation of
governing bodies (boards); set clear standards on disclosure and
dealing with conflict of interest; adequately address the issue of
transparency of business activities and disclosure of corporate
information.
- Establishment of an institution for intermediation
and non-judicial settlement of corporate governance disputes. This
institution would ensure confidentiality, free access, speed,
quality and cost efficiency.
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