By the late 1980s, many of South Africa's corporations were bloated, unfocused and run by entrenched and complacent managers. These firms were sustained and tolerated by a very different environment from that in advanced economies and capital markets. The mainstay of the South African environment was isolation. Tariffs and political isolation shielded firms from foreign product competition, while financial sanctions kept international institutions out of the domestic capital market, and South African firms out of international capital markets. Corporate practices fell behind international norms, as did laws and regulations.
In 2001, little of that comfortable, introverted world remains. With political reform, engagement and change have replaced isolation and stasis. South African corporations, their managers and domestic shareholders have been exposed, in succession, to a new political system, rapid trade liberalisation, demanding international investors, an emerging markets crisis and rapid-fire regulatory reform.
Corporate structure has changed irrevocably. A decade ago, the six mining finance houses - corporate structures peculiar to South Africa, though reminiscent of the Japanese pre-War Zaibatsu, and formed in similar circumstances - dominated the economy. Today the mining finance house no longer exists. Along with the demise of the mining finance house, two of its widely imitated characteristics - diversified holdings and the entrenchment of control through pyramid structures - have fallen from favour. Conglomerates have been unbundled, and elaborate control structures dismantled. At the same time legislation, regulations, listing rules and accounting standards are converging to international norms.
The rapid changes are explained by the development path chosen by South Africa since becoming a democracy. Upon taking power in 1994, the government chose to eschew confiscation of property, and instead to seek growth, which, among other things, could fund expanded social services and more employment. To attain higher growth, South Africa will need to increase mobilisation of both domestic and foreign capital, as well as use that capital more efficiently. Hence the central role of the capital market and private firms in the government's plans - a surprising policy choice that came at considerable political cost. Seen in this light, corporate governance, by which we mean the quality of corporate monitoring and decision-making, impacts both stability and growth prospects.
Stability. Modest debt-equity ratios and conservative banking practices enabled South African firms to avoid liquidity and solvency problems during the emerging markets crisis. A number of historic factors lie behind these sound balance sheets. But in future, proper disclosure, governance and market oversight will be the most important check on corporate gearing and bank lending. Also, by reducing investor risk, sound governance should increase the use of equity and bond markets as capital-raising alternatives to the highly leveraged balance sheets of banks. The future resilience of South African corporations and banks to macroeconomic shocks is to some extent a governance issue.
Growth. Over the last five years, corporations have mobilised more than three-quarters of South Africa's domestic savings, allocated and planned 85 percent of all investment, and currently own and manage three-quarters of the country's capital stock. The better firms are at allocating and managing these resources, the higher the output growth that can be squeezed from South Africa's modest accretion of capital stock. A knock-on effect of improved performance would be more attractive capital markets, and larger capital inflows. Conversely, misallocating resources to improve returns for control blocs, and shielding poor managements from the market for corporate control, will, if pervasive, reduce growth.
A deep equity culture. More than one-third of the assets of non-financial listed firms in South Africa was funded by the proceeds of equity issues, and more than half of recent asset growth in technology, media and telecommunications companies has been funded by fresh equity issues. However, the robustness of the primary market in equities has declined in the last two years, with new equity issuance virtually drying up, particularly for small and medium firms. Misgivings about the governance and leadership of smaller companies have played a role.
Forces for change. The most important force for corporate governance reform in South Africa has been the market. Market discipline imposed through falling equity prices has led to radical changes in corporate structure and conduct, among others the dismantling of the mining finance houses. Undoubtedly one element of South Africa's equity culture, widespread executive share compensation, brought home the impact of market disenchantment. But the leading role was played by foreign institutional investors, who robustly criticised corporate structure, governance and performance upon their return to South African markets in 1994.
The government, regulatory agencies, the accountants' profession and the stock exchange have also been forces for change, motivated largely by the desire to apply international standards in South Africa. New legislation against insider trading led to a palpable change in market attitudes and conduct, while improved listing requirements and accounting standards have eliminated some of the backlog of South African levels of disclosure compared to international practice.
Areas of poor performance. Disappointing progress has been made in the areas of director independence, director disclosure and the market for corporate control. A major factor has been opposition from among control blocs and family-owners of mid-sized companies on the Johannesburg bourse. However, in all three areas progress is imminent.
- The need for truly independent directors. While the influential (and voluntary) King code of corporate governance, released in 1994, stipulates that boards include non-executive directors, they are not required to be independent of management or control blocs. In addition, board chairmen are not required to be non-executive. An updated version of the King Code, to be released later this year, is expected to reverse both these genuflections to family-owned companies.
- A robust market for corporate control. The rarity of hostile takeovers in South Africa is a legacy of the clubby world of the mining finance house. Listed companies have used pyramid structures and differential voting shares to entrench the control of founding blocs with a minority stake. While market pressure has led to the dismantling of some of these arrangements, many remain. In an important move, the JSE will henceforth prohibit further listing of low-voting shares and shares of pyramid companies. But, establishing a vibrant market for corporate control will require more action. The regulations and institutions that monitor take-overs have to be strengthened, and boards, particularly independent directors, have to be trained as to their obligations and roles during take-overs.
- Disclosure of director remuneration. The new listing requirements of the JSE require disclosure of remuneration per director. Opposition from listed companies has led to a postponement of the introduction of this requirement until 2002. The strength of opposition has been surprising, and careful monitoring will be needed to ensure that the requirement is not effectively evaded.
Two dynamics that will influence the future shape of corporate structure and conduct, and of capital markets generally, in South Africa need to be mentioned.
- Institutions, tentatively, to the fore. As in other emerging markets, the regulators and business media in South Africa are under-resourced. It is also difficult for retail investors to monitor firms effectively. Institutions will need to take the lead. However, South Africa's otherwise well-developed and sophisticated domestic institutions have not actively and publicly monitored corporate governance. There are also no collective investor boards such as those in the US and Britain. There may be some obstacles to this, not least of which close relations between the institutions and large corporates. Sound corporate governance is unlikely to take hold in South Africa, and in emerging economies generally, without institutional investors playing the key role. Particularly important is the participation of domestic funds invested in a large number of locally listed firms.
- Whither capital markets on the periphery? Since 1997, South Africa has seen five of its eight largest publicly traded corporations shift their domicile and primary listing to the United Kingdom. The migration has markedly reduced the aggregate market capitalisation of primarylisted JSE firms, but trading volumes have not yet suffered. The moves were motivated by the need to raise large amounts of off-shore capital, and more than $5.1 billion has been raised by these firms since shifting. The objective for government policy-makers and the JSE is to maintain an effective equity market in South Africa for those firms that cannot or do not wish to raise capital in the international markets. At the same time, the advantages of a London listing need to analysed. One difference, certainly, is in the respective levels of corporate governance and take-over regulation and enforcement. From the perspective of the domestic capital market, convergence is now a matter of survival.