Company directors’ self-dealing: A legal/economic perspective Part I

By Julius Chikomwe
RECENT events in some of Zimbabwe’s companies — listed, government-owned and even unlisted, in which the public invests – have called into question the effectiveness of our corporate governance frameworks in general, and specifically, the ability of our corporate governance systems to deal with the problem of company directors’ self-dealing. Indeed, statistics to date do show that there has been persistent increase in the reported number of directors’ self-dealing cases. What is self-dealing and why might it be of concern? This article, the first of a three-part series will discuss the subject of self-dealing by company directors. The first instalment will discuss self-dealing in terms of its origins and characteristics. The second instalment will discuss the circumstances under which self-dealing transactions are harmful to companies and their shareholders. It will also analyse how the law attempts to regulate directors’ self dealing.
The third and final instalment explores the range of legal remedies are available to companies and their shareholders in self-dealing cases and explain why these have not been as effective as they ought to be in constraining value-reducing opportunism by company directors.
What is Self-Dealing?
Self-dealing is a particular instance of part of a set of problems that economists may refer to as “agency problems”. Agency problems arise when the controllers or management of a company use their authority to benefit themselves at the expense of the company and its shareholders. Self-dealing, like all other agency problems, has its origins in the separation of ownership and control which, as a matter of legal and economic necessity, inherently requires the deployment of human agents as company controllers to co-ordinate productive activity. Centralized, delegated management is therefore an integral feature of all large business enterprises.
Self-dealing is defined as a transaction, other than that concerning a director’s compensation, between the company and a director; or between the company and another person, wherever the director has a personal interest in the welfare of the other person involved in the transaction, or in certain collateral consequences of the transactions (third party transaction) or between another entity whose welfare affects that of the company (Lucas Enriques, 2000).
Self-dealing is therefore a subject that cannot be fully understood outside the regular context of corporate governance. Why is corporate governance in general and self-dealing in particular of concern to corporate law and Zimbabwe’s economy?
The Role of Corporate Governance
As in other economies, both developed and developing, the standards of corporate governance, of which the regulation of self-dealing is an integral part, plays a very critical role in the development of an economy. But what is corporate governance?
According to the International Finance Corporation (IFC), corporate governance refers to “the structures and processeses for the direction and control of companies. Corporate governance concerns the relationships among the management, board of directors, controlling shareholders, minority shareholders and other stakeholders. Good corporate governance contributes to sustainable economic development by enhancing the performance of companies and increasing their access to outside capital”.
From the above definition of corporate governance, it is clear that good corporate governance is a matter that is of interest to governments, employees, shareholders, management and indeed, the rest of society: First, customers — they ask for high quality products at competitive prices; second, employees — they insist on good income and secure jobs; third, investors — they expect the invested capital to be maintained and for it to yield a steady flow of income; fourth, the state and the rest of society — they expect companies to contribute towards the fiscus and towards the solution of national problems.
Clearly, a corporate governance framework under which the predatory appropriation of corporate assets by corporate insiders seems to be thriving will do little to advance society’s expectations in this regard.
Crucially, there are additional reasons that point to the need for a more robust and more vigilant corporate governance framework in our economy.
Zimbabwe is currently experiencing serious scarcity of capital. The country’s annualised cost of borrowing presently stands at upwards of 60% per annum, while the regional average is below 15%. The cost of borrowing is a function of the interplay between supply and demand.
The huge gap between the regional average cost of borrowing and Zimbabwe’s figure of upwards of 60% is a useful indicator of the severity of capital shortages in Zimbabwe today.
As part of the whole strategy of overcoming the scarcity of capital in our economy, it is crucial that we upgrade our corporate governance standards so as to capture an increased percentage of the world’s annual foreign direct investment. For example, China towards the late 70s opened up its economy to foreign direct investment and now ranks top in average global foreign direct investment rankings.
Failure to respond appropriately to successive corporate governance related failures not only undermines our global competitiveness as an investment destination; it erodes the confidence of existing investors. And this, in turn, leads to capital flight, thereby worsening the present shortage of capital.
Lastly, there is evidence that there is growing income inequality between company directors and the generality of the company’s workers. Indeed, while many ordinary workers are struggling to make ends meet, many directors are living lavishly and yet this cannot be linked to their official income. There are logical reasons, therefore, for believing that directors could be making significant amounts of money through self-dealing, and that this additional income may account for ever widening gulf between directors’ incomes and those of the company’s workers. Why would this be of concern?
Growing income inequality could slow down economic growth through strikes and resultant skills flight. Growing income inequality therefore threatens the future of industrial peace in this country. Effective corporate governance has a role to play in keeping matters in this regard in check.
To sum up, better corporate governance would lead to more efficient and optimal allocation of resources. This should enhance our country’s standing on the Corporate Governance Perception index. An improved standing on the Corporate Governance Perception index would in turn catalyse Foreign Direct (FDI) inflows into Zimbabwe. Increased foreign direct inflows would lead to output expansion, employment creation and increased consumer demand. Is this not what we need to do to regain our rightful place in the world?

  • Julius Chikomwe is a Harare Attorney. This article was written in his personal capacity. His email address is jc@wsc.co.zw N.B. This article is for informational purposes only and is not intended as basis for decisions in specific situations. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship.