THE CORPORATE EFFECT

The development of transparent and equal governance for business organisations has been a key trend in the world economy over the past five decades. Called 'corporate governance standards', this regime has been adopted by virtually all leading corporate companies and banks. In January of this year national corporate governance standards were endorsed in our country, too. They were drawn up by the Azerbaijani government and have been put into effect over the past five years by specialists of the International Finance Corporation (IFC).

From sole ownership to collectivization

In the 1990s, in the initial stages of the great privatization period, when the first banks, insurance companies, holding and other companies appeared in Azerbaijan's market economy, the introduction of corporate governance was difficult for a number of reasons. Firstly, in most cases the forms of governance of the new joint-stock companies, whether they were industrial enterprises or financial structures, were not of a collective nature - their main shareholders combined the functions of ownership and management. In other words, even though they were public joint-stock companies, these structures were run as virtually individual private firms.

In considering the capitalization of these new joint-stock companies, it should be pointed out that they were also far from collective in nature. However, the reason was entirely practical: the securities market had only just emerged, was underdeveloped and the lack of liquid financial instruments did not allow the first joint-stock companies opportunities to attract free flows of cash from the market. And so, at first the main means of capitalization for the country's joint-stock companies was for the main shareholders to invest their own money or borrow from banks. In order to attract market funding by other means, local joint-stock companies had to trade their shares on the stock exchange. To do so they had to go through a procedure of listing - obtaining an expert's assessment and entering the company's shares on a list of securities quoted at the exchange. This was a routine procedure on the stock markets of developed countries, but quite rare for our market. The reason was very simple: most local companies, including over 1,600 joint-stock companies, had serious problems regarding the transparency of their financial activities and the introduction of corporate governance. Quite a few joint-stock companies did not always pay dividends to small investors, alluding to a lack of profit and sometimes they even 'forgot' to hold meetings of shareholders. It was clearly rather difficult in such conditions to assess the reliability of securities issued by some joint-stock companies. 

With the opening of the new century, the situation in Azerbaijan gradually began to change - small companies were transformed into joint-stock companies and merged into major multi-industrial holdings. In recent years a number of state-owned enterprises in the water, gas and electricity sectors, highway construction, rail and air transport and so on, have gradually embraced the corporatization process. These processes have had a huge influence on Azerbaijan's securities market in the last few years. There has been speedy development of the primary and secondary corporate bonds markets, which are now 2.6 times larger, and bonds denominated in foreign currency are three times the number they were. Thus, based on last year's results alone, the average growth of operations in corporate securities has increased by 25 per cent in the overall volume of the securities market. New issuers of corporate bonds appear on the market every year, and a distinct group of about 100,000 shareholders, up to 15 per cent of them active investors, has formed in this sector today, and last year companies invested in the main to increase their capitalization. An increase in the volume of bonds from the Azerbaijani mortgage fund also had a positive effect on growth in the corporate securities sector.

Naturally, demand from expanding Azerbaijani companies required new forms of management and more effective administrative structures. These positive processes have become noticeably stronger in the past 5-6 years: some local corporate structures have gradually evolved, departing from the negative 'insider' model of governance, which was based on combining the rights of ownership with management and preferring the interests of major shareholders and management to the detriment of other investors. The first to depart from the 'insider' model towards corporate standards were Azerbaijani banks and a number of leading industrial and service companies and holdings.

Leading the introduction of standards of corporate governance in the country was the banking sector, which has substantially increased the size of its operations over the past decade by spreading branch networks and bringing greater sophistication to its organizational structure. A big incentive in introducing corporate standards was the banks' demand for long-term, low-interest credit limits, as well as the need for small investments in their own capital. This process was linked to the demand from foreign banks and international donor structures for the compulsory introduction of the corporate code by their beneficiaries. Thus it was precisely the demand of our banking sector for investment and preferential credit that was the locomotive hauling the introduction of corporate standards into the country.

The corporate code

Over the past five or six years, the introduction of a corporate code has been transformed from abstract idea to conscious need. This created a vital necessity to institutionalize and legalize this market trend. National standards of corporate governance began to develop spontaneously in 2005. This was when the Azerbaijan Corporate Governance Project (ACGP) was set up on the initiative of the Ministry of Economic Development, the Central Bank, the Ministry of Justice, the State Securities Committee and the Azerbaijan Investment Company. The International Finance Corporation, with financial support from the Swiss State Secretariat for Economic Affairs (SECO), was engaged to prepare the corporate code. The first phase of the project was due to last three years, with a budget of 2.6m US dollars. The main areas of activity from 2005-2007 were in developing the experience of corporate governance in the country's private joint-stock companies and assisting them to improve management and to enhance opportunities for attracting foreign investment. This work was carried out in five basic areas - liabilities, experience, the controlled environment, transparency and publicity (the disclosure of information) and protecting the rights of shareholders. As part of the first stage, consultations on the introduction of corporate governance standards were accorded to six Azerbaijani banks and a number of companies, enabling them to attract investments of 100m US dollars.

The second phase of the project, which began in June 2008, was fully funded by the SECO, which allocated over 4m US dollars. As part of this second phase of the ACGP, a working group in the Ministry of Economic Development focused its main attention on the country's financial institutions, especially the banks that were given assistance in assessing corporate governance and reducing financial risks. Similar consultative services were accorded to micro-finance organizations, insurance companies and pension funds, this included training and seminars at a number of higher educational colleges.

What were the basic principles of the system of corporate governance and what did they hope to achieve? To all intents and purposes, the corporate code is a mechanism for inter-action between the shareholders and a company's top management. Therefore the use of various forms of standards is aimed, first and foremost, at guaranteeing the rights and interests of shareholders, enabling them to control all corporate activity. Behind the need to develop such standards was the fact that, from the second half of the last century, the larger companies or banks in most countries became the property of groups of investors owning shares or share participation. The joint-stock structures were governed directly by hired management which, as a rule, did not own the business. This led to a number of significant overheads in the development of a business and created a conflict of interests between the shareholder-owners (supervisory council) and the hired management (board or council of directors). The members of the board, who run the business directly, by definition possess significantly greater information and the potential to carry out various operations which are not aimed at meeting the interests of the owners.

Another set of problems is linked with differences between the interests of the owners of large packages of shares (majority shareholders) and minority shareholders.  A failure to implement a corporate code infringes upon the interests of the latter, for example in the payment of dividends because, if there is no transparency of control a company's profits could be appropriated by its management or major shareholders. In short, corporate governance standards help to ensure responsibility of governance to shareholders, of management to the board of directors, of owners of major packages of shares to those with minority shares and of the corporation as a whole to rank-and-file employees and clients and, if we are talking about a state-run company, then the fulfilment of obligations to the state and the public as a whole. Corporate governance is based on the fact that all these groups and institutions fulfil their obligations, preserving a balance of interests in the best possible way.

The second stage of the ACGP was completed at the end of last year and, in January 2011, the Ministry of Economic Development endorsed a final version of the corporate code drawn up by the working group with the support of specialists from the IFC. This document consists of six chapters devoted to the functions of the supervisory council, management, financial accountability, shareholders and other matters.

Useful standards

"The introduction of national standards of corporate governance in Azerbaijan is aimed at developing private enterprise and organizing the optimal and transparent activity of companies. Applying these standards will help to prevent infringements of the law linked to corruption and to create conditions for transparent activity of bodies of management and responsible individuals", said Samir Veliyev, head of the office of the Ministry of Economic Development, at a recent conference on the completion of the ACGP. He said that the ministry also plans to hold presentations of the standards in different parts of the country and, later, with the support of international organizations, it will monitor the practical application of these standards.

In recent years the private sector in Azerbaijan has achieved great success in the development of corporate governance and now, thanks to the implementation of this international document, the government will have a useful tool to speed up changes in the governance system of the state sector, so says Anar Gadzhizade, head of a working group to develop national corporate governance standards and head of a sector of the Ministry of Economic Development. He says that the introduction of these new standards in state-run joint-stock companies will have a positive impact on their strategic and operational control and will improve their financial and social performance.

At the same time, experts from the IFC point out that the application of these standards will be of a purely voluntary nature and the code itself will be as close as possible to local conditions and requirements, containing the necessary mechanisms for resolving problems encountered by local companies that are frequently not regulated by existing legislation.

"The introduction of corporate standards will be of considerable assistance in supporting the rapidly developing financial sector and the securities market" stressed Ilhar Muradov, deputy chairman of the State Securities Committee (SSC). The SSC has completed a draft of changes and additions to the Civil Code and the Code of Administrative Violations - these amendments are in full harmony with the recently endorsed national corporate governance standards.

The code will serve the rights of minority shareholders to no less an extent, it will ensure transparency in conducting business and also help to introduce advanced experience. According to Sabine Ullmann, the Swiss ambassador to Azerbaijan, the broad circulation of corporate governance standards through the country will help to integrate the country's business into the world economic community.

It is significant that this message has been heard more than once in recent speeches by Azerbaijani President Ilham Aliyev, who was given the tasks of building up exports of non-petroleum products and integrating our country into the world market as a strategic objective of the country's development over the next few decades. Corporate governance standards will be an effective tool in implementing this task.