HomeAnalysisGreed and ignorance at the heart of corporate failures

Greed and ignorance at the heart of corporate failures

A few days ago, I had a discussion with two respectable corporate directors at a local hotel regarding the shame that is brought to the corporate world by shareholders who decide not to respect the roles of management and directors by bulldozing their way and drawing money from the business.

Daniel Ngwira,Chartered Accountant

Invariably, these businesses fold because they would have been hamstrung by the siphoning of working capital which is needed to support the existing business and generate more. Essentially, it means that wrong directors were appointed. Directors have a duty to uphold the interests of the company.

In many cases, these drawings are accounted for as related party loans despite the fact that there will not be any documentation to regularise the loans. Where the shareholders draw capital from the business, which ends up failing to pay creditors and statutory obligations such as taxes, these cases should be treated as corporate fraud. Both shareholders and directors should be charged.

The directors would be accomplices as they would have facilitated such irregular drawings by their shareholders.
There have been cases where such shareholders follow the daily takings so that they can siphon them out of the business. This is irregular in that shareholders are supposed to be paid by dividends where it is declared by the directors as they deem fit provided it is out of the profits of the company. Accountants who facilitate the false recording of these transactions so that they do not reflect that related parties have taken money out of the businesses, should also be held accountable.

The Companies Act obligates directors to cause proper books of accounts to be kept for a body corporate. The books of accounts are required to record transactions involving receipts and expenditure of the business, a record of all sales and purchases of goods and services and the assets and liabilities of the company.

A close look at this requirement shows that the Companies Act insinuates that a company should, ultimately have a statement of income, a statement of financial position and a statement of cash flows of the business, all of which are principal statements in financial reporting. It is subtle on the statement of changes in equity.

The Act goes on to say that “proper books shall not be deemed to be kept if there are not kept such books of account as are necessary to give a true and fair view of the state of the company’s affairs and to explain its transactions”. This suggests that a company should prepare its books of accounts in accordance with the International Financial Reporting Standards (IFRS) (previously International Accounting Standards) or the Generally Accepted Accounting Practice as applicable.

When books of accounts give a true and fair view of the state of the company’s affairs, it means that the financial statements must be factual. In addition, they must be a true depiction of the commercial substance of the reporting entity. Moreover, the financial statements must be free from any bias. The Companies Act suggests that there must be notes to explain the transactions of the reporting entity.

As a consequence of the pronunciation of the Act, it is evident that the directors, whose burden it is to cause proper books of accounts to be kept, should hire accountants to enable the proper books of accounts to be kept in such a manner that they reflect the true substance of economic transactions. In cases where proper books of accounts are not kept, the burden of responsibility falls upon the directors, who are also charged with governance.

There have been cases where companies, forced into liquidation by shareholders who draw from the business more than they have invested and more than the company has made, have declared that they cannot find the books of accounts as another tenant would have moved into the rented premises, thus perhaps either misplacing the books or throwing them away. This is inexcusable as the directors have a duty to keep the accounts. What happened in these cases is that the directors and shareholders would be trying to avoid the scrutiny that comes with liquidation. This is an unfair benefit of the shareholders at the expense of the creditors who would have advanced money in form of goods and services to the business in good faith.

In recent times, the country has been ceased with shareholders who do not respect the separation of roles of the shareholders, directors and management. This has created a lot of pandemonium in the corporate world with extreme cases of corporate failure. When one is running a tuck shop, it is theirs and they can do whatever they desire. They can draw money at any given point in time and use it the way they desire.
Many failed companies have been run using what I call the “tuck shop model”. Here there is very little accountability and in most cases the shareholder is fully in charge of the business. There is little distinction between the business and the individual. We have seen this model being used in many sectors of the economy, including banks and insurance companies.

A company cannot be run using this model. It will almost certainly fail. Shareholders are members to the company and they appoint directors to run the company for them. These directors appoint management to run the day-to-day affairs of the business. The ultimate responsibility to run the company will rest with the directors who will communicate performance of the company at a general meeting. The directors are ordinarily paid board sitting allowances which, depending on the company’s policy, could cover any reimbursement for mileage and any other costs incidental to the attendance of the board meetings. Except for executive directors, the directors are not employees of the company and as such are not entitled to salary or option based remuneration or bonuses. Their role is to exercise oversight of the company.

On one hand, shareholders or members are the owners of the company. The definition of ownership here differs with that entailed where one owns a tuck shop. A shareholder who is not an executive director of the company cannot be paid a salary. Their remuneration is in form of dividends. The term dividends comes from the word divide in that a share of profits will literally be divided among the members of the company according to how they have contributed to it as defined by share capital.

The Companies Act expresses that “the company in general meeting may declare dividends, but no dividend shall exceed the amount recommended by the directors. The directors may from time to time pay to the members such interim dividends as appear to the directors to be justified by the profits of the company. No dividend shall be paid otherwise than out of profits.

“The directors may, before recommending any dividend, set aside out of the profits of the company such sums as they think proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for any purpose to which the profits of the company may be properly applied and, pending such application, may, at the like discretion, either be employed in the business of the company or be invested in such investments, other than shares of the company, as the directors may from time to time think fit. The directors may also without placing the same to reserve carry forward any profits which they may think prudent not to divide”.

This entails that the moment people become members of a company, they delegate their remuneration affairs to directors of the company. In declaring dividends, directors are guided by the performance of the company as well as the future outlook of the business. Shareholders cannot challenge directors on the extent of dividends they would have proposed.

It is a fact that everyone needs money to survive. The main motive of shareholders violating the Companies Act by going after daily takings and not waiting for their turn to be paid a dividend is survival which then turns into greed. To resolve this problem, a shareholder, where permissible, could be employed by their own companies so that they can draw a defined amount called a salary. In Zimbabwe, we have an example of Patterson Timba who became the executive chairman of First ReNaissance Corporation Limited (Afre). This means that he was involved in the day-to-day operations of the business, which is not common of any board chairman.

Sadly, in most of the cases of high-profile corporate failure in Zimbabwe, it is evident that shareholders and directors violated the Companies Act by “declaring dividends” when the companies did not make profits. Focussing on banks, by accessing preferential unsecured loans which they dared not pay, the shareholders essentially received a dividend. Because shareholders, cannot, under normal circumstances execute transactions without the aid of directors, it entails that directors were accomplices in this regard.

While in some cases ignorance has played a role in corporate failures, in other cases the underlying reason for failure could be either greed or arrogance.

In many of the high-profile cases of corporate failure, the shareholders are either qualified accountants or business professionals who, ordinarily are expected to know the essence of good corporate governance. Such people have used their skills and expertise to circumvent the provisions of the Companies Act by taking dividends in loss making companies through “borrowing” from the companies in which they have been shareholders.

To avoid self-inflicted corporate failure, shareholders must establish alternative forms of income-generating projects which will form the core of their remuneration. In a number of cases shareholders realise that they have invested all they had in their company and because they do not have any alternative source of income, they end up cannibalising the company and withdrawing the required working capital from the company. This, inevitably, results in corporate failure.

As a pre-emptive strategy, perhaps government needs to educate citizens what company ownership entails in light of the indigenisation laws to avoid corporate failure of the magnitude we have seen in the financial services sector.

When indigenous people own 51% of a given company, the shareholding structure could change due to the performance of the company. Where the company is not performing, the directors can go back to the shareholder and request for more capital. This could result in a rights issue which could result in some shareholders not following their rights resulting in shareholder changes.

To preserve the 51% ownership, it entails that the underwriters of transactions should equally be indigenous. Yet in the event where there is a deficit of capital by the indigenous people, the 51% ownership can temporarily be upset otherwise businesses would close due to shortage of capital. Further, for as long as a company is not performing well and not generating profits, it entails that the shareholders of a business will go unpaid. This in essence will be tantamount to disenfranchising those whom the indigenisation law seeks to protect and to promote.

It is clear that the equity model of indigenisation has serious flaws. Empowering indigenous people by giving them shares in Old Mutual could be an irony in that for as long as the directors do not declare dividends, the easier way by which the shareholders could create a dividend and pay themselves will be through the sale of the shares on the stock market. In the long run, this will work against the spirit of indigenisation.

Better empowerment would come in the form of locals supplying the big entities targeted for indigenisation. This will enable them to have a more reliable source of income unlike where they own shares. At de-mutualisation, hundreds of people became shareholders in Old Mutual, but sooner rather than later a great number of people offloaded the shares on the market as people thought of profiting from capital appreciation and the attractive share price that Old Mutual carried at the time.

The law restricts shareholders who own a certain percentage deemed significant from being executives of a bank. The reason is that owner-managed banks have a higher chance of failure due to shareholders accessing loans at will in addition to other governance matters. Despite the existence of this law, we have seen the shareholders become shadow directors and having more influence in their companies than the full boards and the chief executive officer.

This is deplorable. In some instances,such shareholders have appointed CEs and directors whom they can manipulate.

Such schemes are well-orchestrated for self-aggrandisement.

Ngwira is a chartered accountant, former bank treasurer and former university lecturer. He holds finance and business qualifications. — daniel.ngwira@gmail.com/ cell: +267 73 113 161.

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