Category Archives: Corporate Governance

Understanding integrity

September 9, 2017 By in Corporate Governance Tags: , 3 Comments

Integrity: Constantly acting and behaving in a manner consistent with one’s values.

That is my definition of perhaps one of the most misunderstood and misused words linked to morality. The point here is that integrity is not a synonym for morality or honesty. There are words for that. This is about how we behave. It is easy to label a person as honest, or even as dishonest. But for said person to act with integrity, it has to be with respect to their values, regardless of whether you believe those values to be positive or negative.

So why is integrity deemed to be such a difficult quality to attain? It has to do with constantly acting in a manner consistent with your values. It is too easy to take shortcuts and ignore your values. In business, at work, in the corporate world, how many times have we remained silent in the face of action that violates our values, all for fear of the repercussions? When we say corporate governance failed, what we mean is that integrity failed. Continue reading →

A case study on reporting and transparency of company results

September 1, 2017 By in Corporate Governance, Analysis Tags: ,

In April of this year I talked about  some of the puzzling moves at Shuaa Capital, one of the better known investment banks in the region which is headquartered and listed in Dubai. Last month Shuaa released their H1 2017 financial results and there was quite a bit of commentary around these results. This commentary seemed to contradict the behaviour that I outlined in April. So I waited and read through the results, the press releases, the news articles and TV interviews. Now I’m ready to give a more realistic analysis of the results. My analysis will be dual, of the actual performance and of how the performance is reported. The latter is critical, as I have pointed out earlier this year on less than optimal reporting or commentary by First Abu Dhabi Bank, Abu Dhabi Commercial Bank, Emirates NBD, Mashreq Bank, Arabtec and Etisalat but stellar reporting by Dubai’s SWF ICD (all links are to my articles on reporting and transparency by these companies which were published in The National). Continue reading →

Why corporate governance fails

August 20, 2017 By in Corporate Governance Tags: 2 Comments

I am about to take my annual break from writing to refresh and energise. It reminds me of the summer holidays I used to have as a child at school. The first school I attended was The British School – Al Khubairat in Abu Dhabi, where I was one of a handful non-British students. I remember the class covering the children’s tale “The Emperor’s New Clothes” by the legendary Hans Christian Andersen. If you haven’t read it, here is Wikipedia’s summary:

[The tale is about] two weavers who promise an emperor a new suit of clothes that they say is invisible to those who are unfit for their positions, stupid, or incompetent. When the emperor parades before his subjects in his new clothes, no one dares to say that they don’t see any suit of clothes on him for fear that they will be seen as “unfit for their positions, stupid, or incompetent”. Finally, a child cries out, “But he isn’t wearing anything at all!” And everyone starts laughing and pointing at the naked emperor.

In the class discussion afterwards my British classmates focussed on the question of how people can be manipulated.

It says something that all I could think about is “What happened to the child who exposed the manipulation?”

It was decades later that I understood the relevance of this child’s tale to business. The formal theory is called the “spiral of silence theory”. It explains how boards, executive management teams and other commercial groups, which, although made of individually decent people, can act in a fraudulent or corrupt manner. Continue reading →

Your guide to handling ethical management issues

July 31, 2017 By in Management, Corporate Governance Tags: , ,

You have spent a lot of time honing your business ethics, governance and compliance skills, but time and again you find yourself in difficult situations and realise nobody taught you what to do.

If I just described you, then this article is for you.

Most of what is taught is with regards to how to act if we initiate an action and, possibly, how to react when a client initiates an action. What I have not seen taught is how to react if your manager initiates an action. In this case there are broadly two scenarios: First, it is a legal and ethical instruction; or second, it is an illegal or unethical instruction. In the first case the employee’s proscribed reaction is straightforward – execute. In the second case it is to not execute the instruction. But is that as simple as saying “no”? Of course not.

Continue reading →

Structuring formal boards and committees

July 17, 2017 By in Corporate Governance Tags: ,

A central pillar of corporate governance is to share authority. At the board level, directors have no individual authority unless the board assigns it to them. It is the board as a body that has authority. This authority is too often circumvented by the creation of an executive committee (exco) of the board. Although the existence of an exco does not mean that there will be corruption, when there is corruption it can usually be traced to the existence of an exco. The reason is that an exco effectively takes over the role of the board and the chairman of the exco becomes the de facto chairman of the board, replacing the elected chairman of the board. This is frightening.

This holds true at the executive level. The board must ensure that long-term strategic decisions are made by competent committees, not solely by the chief executive. A simple example is that you don’t want the chief executive to have sole authority over investments. That’s a one-man hedge fund. There is a balance between efficiency and governance, but that balance clearly isn’t an all-powerful chief executive.

I have seen different attempts at managing these issues. One unfortunate one that I’ve seen in this region is rejecting executives who want to be paid at the higher end of the market. The idea is that this way the executives hired are not greedy and will not commit fraud. This idea has several flaws.

The simplest flaw is that a dishonest executive is not going to care about his formal compensation as he will supplement it via the fraud. A more subtle but far more dangerous flaw is the idea that the only alternative to someone who prioritises financial compensation is one whose incentive is to do a good job. In this region I have seen that the much greater percentage are those who prioritise power and those who prioritise publicity. Both of those incentives corrupt as much as, if not more than, financial incentives. I’m not sure people stuffing their friends into jobs or people using their positions to get on the front page are any better than people who think high performance should be rewarded with high pay.

Sabah al-Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more on his Twitter feed or for deeper analysis on LinkedIn and al-binali.com.

Your guide to handling ethical management issues

July 16, 2017 By in Corporate Governance Tags:

You have spent a lot of time honing your business ethics, governance and compliance skills but time and again you find yourself in difficult situations and realise nobody taught you what to do. If I just described you, then this article is for you.

Most of what is taught is with regards to how to act if we initiate an action and, possibly, how to react when a client initiates an action. What I have not seen taught is how to react if your manager initiates an action. In this case there are broadly two scenarios: 1. It is a legal and ethical instruction, or 2. It is an illegal or unethical instruction. In the first case the employee’s proscribed reaction is straightforward – execute. In the second case it is to not execute the instruction. But is that as simple as saying “no”? Of course not.

Even in relatively flat/informal organisational structures this is difficult. When the hierarchies are formal, prized and inflexible it is next to impossible to refuse an illegal instruction. Without clear wrongful termination and whistleblower laws it becomes extremely difficult for an employee to stick to their values, especially in the current climate, as the consequences can quite easily lead to personal insolvency. For foreigners the risk is greater still, if the employee is fired in retaliation they have three months to find another job or face uprooting their entire lives, family and all. A daunting risk to doing the right thing. Continue reading →

Nigeria unit’s default poses questions for Etisalat

June 27, 2017 By in Corporate Governance, Due Diligence, Analysis

Etisalat Nigeria, a Nigerian telecoms company owned 45 per cent by Mubadala and 40 per cent by Etisalat, was reported to be effectively bankrupt over a US$1.2 billion default and was taken over last week by a syndicate of Nigerian banks. There are two broad themes that this represents that I think are instructive and they are the entry into the investment as well as its operation followed by the exit from the investment.

Let’s start with the exit. I have never seen research on the use of capital injections to support SWFs or their underlying portfolio but I was under the impression that this was usually always provided. The fact that Mubadala and Etisalat were willing to let go of egos and allow what they believe to be a bad investment to go is quite welcome. As we say in the region, they didn’t try to save face. This is the professional route. Only history will show whether this is an underlying philosophy for these companies or a one-time event.

The question on the exit would not be complete without also looking at whether standing back made commercial sense, as opposed to investing further funds. I will not do an economic analysis but suffice to say that a World Bank report states that due to the drop in oil prices (Nigeria is an oil exporter) Nigeria went into recession in 2016 and inflation reached 19 per cent. You don’t need to delve further to realise that there were sound economic decisions for Mubadala and Etisalat to back away.

I am not so optimistic about the performance of the two in entering and operating the investment. The company was established in 2008, which was the beginning of the global financial crisis. But nobody would be expected to forecast that and certainly it does not seem like it had a materially adverse effect on Etisalat Nigeria. The problems appear to stem from the collapse of the oil price in mid-2014, which subsequently led to a recession in Nigeria with high inflation. Under such circumstances it is understandable that the business environment deteriorates.

What is difficult to understand is why companies already based in an economy with a high exposure to oil prices would increase their exposure to oil. Especially since they each independently had already increased their exposure to oil – Mubadala via direct investments in the sector globally and Etisalat via operations in countries such as Saudi Arabia, which is even more dependent on oil.

I tried to get some insight by looking at Etisalat’s 2016 annual report. The problem is that since Etisalat owns such a large percentage of the company the financials are consolidated, ie combined with all the other operations of the group. To its credit, Etisalat does talk about each subsidiary separately. The annual report begins the Etisalat Nigeria section with “in 2016, the Nigerian telecommunications sector was confronted with considerable challenges, as the country’s economy slipped into recession and regulatory constraints persisted”. After those 22 words the next 490 words of the review are optimistic about the Nigeria operations. There is no direct warning that Etisalat would lose the company due to a default in a mere six months.

Remember, Etisalat is a listed company and has reporting standards as part of its fiduciary duty to it public shareholders. Mubadala of course has no such reporting duty to the public. Now, I said that there was no direct warning, but there certainly is at least one indirect warning. Etisalat, using large icons and large font in the margins, disclose the revenue, Ebitda and capex of Etisalat Nigeria. Here’s the warning: for its Morocco operation, reported right before Nigeria, and Pakistan, reported right after Nigeria, Etisalat additionally reports the P/L and the Ebitda margin. Why did Etisalat withhold these important numbers from the public? How can Etisalat not have known that within six months its subsidiary would default? Was it incompetence? Was it neglect? Was it an ethical issue? It is important to understand the answer.

One clue is what happened with Saudi unit Etihad Etisalat, also known as Mobily, in which in addition to holding a sizeable equity stake it also had a management contract with. A restatement of the financials at the firm for 2014 led to about Dh1.7 billion in profits subsequently being cut. This led, at least in part, to Deloitte, one of the big four audit firms, being banned by regulators from auditing listed companies in Saudi for two years. Etisalat’s management contract for Mobily was not renewed.

Given the public information available there seem to be operational weaknesses within Etisalat, at least in terms of its international operations. If a unit misstating Dh1.7bn in profit is reported as a scandal, then what do you call losing a whole ­subsidiary in a default? Worse, what do you call it when you don’t warn your shareholders?

Earlier this year, Sheikh Mohammed bin Rashid, Vice President and Ruler of Dubai, spoke at the World Government Summit and of the many points that he emphasised two relevant ones here are “We don’t tolerate corruption. We have zero tolerance here” and “Arab leaders are surrounded by officials who keep saying everything is fine”. I agree. I would, however, respectfully and humbly add one more point.

Incompetence costs us far more than corruption. We should also have zero tolerance for incompetence and when managers say everything is fine, they need to be challenged as to whether the issue is exogenous events or incompetence.

This article was originally published in The National.

Board drama, and crunching the numbers on oil

May 9, 2017 By in Investments, Finance, Corporate Governance, Oil Tags: , ,

A few weeks ago I pointed out that Etisalat generated earnings of Dh0.97 per share and paid out Dh0.80 per share, which is a payout ratio of 82 per cent. I further pointed out that paying out such a high percentage of profits was consistent with a status quo strategy and inconsistent with an expansion strategy, which would need to use the earnings to expand. Last week Etisalat bid for Oman’s third mobile operator license.

The question is, is it rational to pay your shareholders nearly all of your profits and then to go on to expand? Etisalat saw its revenue drop in the first quarter although it managed to grow profit by cutting expenses. Still, with revenue falling, earnings being paid out and an expansion strategy, one is walking a tight rope.

I also recently analysed the 2016 financial performance of Gulf Finance House (GFH), a financial services group, in particular with respect to announced discussions with Shuaa Capital for a merger. The analysis showed a large loss from normal operations of about US$230 million masked by a one-time litigation award to show a profit. I was curious to see why Shuaa would be interested in GFH and so reviewed GFH’s Q1 2017 financials that were recently released. Perhaps GFH could engineer a miraculous turn around in normal operations.

The report showed that GFH has indeed achieved a profit of $33.5m for the quarter. An astounding achievement. I dug deeper. Financial services can have notoriously volatile earnings but one thing caught my eye: a profit of $25.6m from the sale of a subsidiary.

Upon closer examination, the profit came from selling a stake in a school.

The shares were received as part of the litigation settlement in 2016 and GFH valued this part of the stake at $29.4m. A year, or less, later they sold the stake for $55m for a profit of $25.6m. That is a return on investment of 87 per cent in at most one year. Did GFH generate a fantastic 87 per cent return in one year by its skill in operating the school?

Perhaps the whole market went up 87 per cent? Possibly the buyer and their advisers are clueless and overpaid by nearly double?

This one-off extraordinary transaction explains 76 per cent of the profit. I considered analysing if the other 24 per cent was one-off or normal recurring business, but why bother?

Union Properties last week announced that three of the directors of the board had resigned right after an AGM that appointed them. The three directors publicly denied resigning. There could be some chance that this is just a big misunderstanding. The more likely scenarios are less than salubrious.

Board drama is a red flag suggesting serious internal issues at a company. The number of such incidents in the market, along with going concern warning, capital injections at loss making companies, and law suits, will be a gauge of how much the oil price drop from 2014 is affecting our economy.

On Thursday, the price of oil dropped to its lowest level in five months. The main benchmark Brent fell below US$50 a barrel, followed by a modest comeback on Friday to about $49; as of Monday afternoon it was still at that level.

One reason for the drop was reported in a Financial Times article that quoted Jamie Webster, a fellow at the Center on Global Energy Policy at Columbia University: “Opec extension is baked into market expectations, but roaring shale growth makes the sizeable but too small a cut completely lose its potency.” A separate FT article stated that although the agreed Opec production cuts amount to 1.4 million barrels per day (bpd) the actual cut to exports might be as little as 800,000 bpd.

It is a little worrisome that Opec cuts production and oil prices pop up for only a short while. We keep hearing how oil prices will go up because of a lack of investment in oil infrastructure. Oil prices might pop up, but they keep dropping back down. If what you are hearing is different than what you are seeing, which should you believe?

In the investment world we have a phrase, “talking one’s book”. This describes the natural human trait of speaking positively about something beneficial to you, in this case the investments an investor has made. As investors and individuals who must make a myriad decisions based on the economy we should ask ourselves: if doing the same thing but expecting different results is a sign of insanity, then what is listening to the same thing and expecting different results a sign of?

This article was originally published in The National.

Q1 results in the UAE mask less than stellar fundamentals

May 2, 2017 By in Corporate Governance, Finance Tags: , 1 Comment

We have recently seen a flurry of reports regarding the financials for the first quarter of this year.

Despite happy headlines, the fundamentals are not good. I will use some examples to show how to dig under the rosy announcements to get a better idea of the situation.

Let’s start with the banking sector, the blood flow of the economy. In their publicly presented financials there is a wealth of information from the two largest domestic banks in the UAE, First Abu Dhabi Bank (FAB), the merged FGB-NBAD, and from Emirates NBD.

Consolidated FAB net interest and financing income was year-on-year (y-o-y) for Q1 4.9 per cent lower – ie, Q1 2017 showed a decline of 4.9 per cent over Q1 2016. This is the income predominantly generated from the core business of a bank – lending and borrowing.

Continue reading →

Some listed firms need a sensible talk on governance

April 18, 2017 By in Corporate Governance Tags: 1 Comment

In shocking news, this month Bahrain introduced common law for limited liability partnerships without having to create a free zone.
All the legal protection without artificial costs. What a concept.

Meanwhile, there are some decisions being made in listed companies – firms in which the public are investors – that do not seem to be in line with the best standards of corporate governance.

I will cover three – Shuaa, Arabtec and Drake & Scull – and then discuss what this means to our economy.

For Shuaa, the corporate governance journey started with the announcement last month that it was acquiring two companies from a major shareholder. This created a possible conflict of interest and as a listed company regulated by the Central Bank of the UAE and the SCA, the market regulator, you would expect that as part of the announcement a plan to mitigate any possible conflict of interest would be released so that small shareholders can decide if it is fair. The chief executive of the seller is the chairman of the buyer, Shuaa. Will he and other board members appointed by the major shareholder, Abu Dhabi Financial Group, recuse themselves from voting? How will the deals be priced? Who decided that this was a good deal for Shuaa?

Continue reading →