The CG Code for Publicly Listed Companies (PLCs) formally adopts the “comply or explain approach,” which combines voluntary compliance with mandatory disclosure, and which it defines as “Companies do not have to comply with the Code, but they must state in their annual corporate governance (CG) reports whether they comply with the Code provisions, identify any areas of non-compliance, and explain the reasons for non-compliance.” The Code therefore does not contain any penalty clause at all, and through its “comply or explain approach” relies upon the “pressure of the market” to goad PLCs to adopt its governance principles and recommended best practices. One of the outstanding features therefore of the CG Code for PLCs is its underlying belief that in the “disciplining power of the market,” thus:
• The Boards of Directors and the Management of PLCs, not the SEC, are in a better position to evolve, develop and implement within their particular industry and company culture and structures the CG principles embodied in the Code;
• That “market forces,” i.e., the negative reaction of the public investors who may dump the company’s shares when they see a grievous violation of CG principles and recommendations under the Code, have a more coercive effect on the Boards and Management of PLCs on the manner of implementation of the CG principles embodied in the Code.
The principles-based and market-disciplining features of the CG Code for PLCs provide for the following advantageous features:
(a) Principles-based governance reforms, as contrasted from “rules-based” reforms, are able to capture within its coverage all possible scenarios or situations that would confront the Boards of Directors and Management of PLCs with very little danger of loopholes that can be exploited.
(b) A principles-based system of CG has a greater tendency to change the hearts and minds of Boards and Management since in determining whether to act one way or the other in a corporate transaction, they really need to understand the meaning and coverage of the principle to determine whether the corporate act would be consistent with or contravene the covering principle.
(c) Market-disciplining feature of the CG reform would likely have a more personal effect on the exercise of business judgment of directors and senior officers since they may in fact lose their jobs against an investing public that does not approve of their non-compliance of what are recommended to be CG best-practices.
On the other hand, the principles-based and market-disciplining features of the CG Code for PLCs have a few, yet important, downsides.
Firstly, such features operate effectively only in a securities market where the ownership of PLCs are widely dispersed, and there is not a group of stockholders who control the equity and thereby be able to control the majority of the Board of Directors. In widely held public companies, the members of the Board are elected basically on the merits of their agenda presented to the voting investors at large; and are able to retain their positions in the Board over the years by being responsive to the best interests of the investing public.
This is not the case in the Philippine publicly held companies sector, where most of the listed companies are really family-owned and controlled companies, and where the public float is rather minimal. In effect, the market-disciplining force of the investing public would not be as effective a disciplining force versus the majority and controlling stockholders, who as the biggest block of equity holders are expected to run the company to maximize their returns, through the majority members of the Boards whom they are able to elect into office.
Secondly, the market-disciplining feature would be more effective where the Boards and Management of most of the PLCs are professional managers and accountable to a large investing public. The Board composition in our PLC sector, even with the system of independent directors introduced by the Securities Regulation Code, is still majority-constituted, with directors elected by the controlling family or group, and often the Chairman as head of the Board and/or CEO, as the head of Management, comes from the family or group that holds the controlling equity in the company. In effect, the market-disciplining force of the investing public (who constitute the minority stockholders) would not have a robust “coercive influence” against the Board, the majority of whom effectively represents the interest of the controlling family or group.
Thirdly, even in situations where the market-disciplining features have a strong coercive effect on the Board and Management, the legal effect is that only the stockholders of a PLC would have a real voice in goading their Boards and Management to listen to them, and thereby effectively place all other stakeholders in a nominal position to influence actions and actuations of the Boards and Management.
These varying enforcement rules between the Original and Revised CG Codes, on the one hand, and those of the CG Code for PLCs, on the other hand, are what we shall discuss vis-à-vis the mandatory governance principles provided under the Corporation Code and the Securities Regulations Code.
3. Composition of the Board of Directors of Publicly-Held Companies (PHC)
a. Size of the Board
Both the original CG Code and the Revised CG Code repeat the requirement of the Corporation Code that the Board of Directors of every PHC shall be composed of at least five (5) but not more than fifteen (15) members elected by the shareholders from among themselves, and shall have a term of one (1) year until their successors are elected and qualified.
On the other hand, the CG Code for PLCs very sensibly does not even attempt to repeat what are obviously mandatory provisions of the Corporation Code.
In this sense, the SEC CG Codes adhere to the “CG” principle under the Corporation Code that the “optimum size” of the Board of Directors for stock and for-profit corporations should not be less than five (5), but not more than fifteen (15), members.
b. Independent Directors (IDs) in PHC Boards
While both the original and Revised CG Codes adhere to the requirement under the Securities Regulation Code (SRC) that at least two (2) of the members of the Board of Directors should be IDs or such IDs shall constitute at least 20% of the Board membership, whichever is lesser; the CG Code for PLC recommends that “the Board should have at least three  independent directors, or such number as to constitute at least one-third of the members of the Board, whichever is higher.”
The CG Code for PLCs explains its recommendation for a higher number of IDs than that required under the SRC, in the following manner:
The presence of IDs in the Board is to ensure the exercise of independent judgment on corporate affairs and proper oversight of managerial performance, including prevention of conflict of interests and balancing of competing demands of the corporation. There is increasing global recognition that more IDs in the Board lead to more objective decision-making, particularly in conflict of interest situations. In addition, experts have recognized that there are varying opinions on the optimal number of IDs in the board. However, the ideal number ranges from one-third to a substantial majority.
The merits of the rationale offered under the CG Code for PLCs for the recommended higher number of IDs, “to ensure the exercise of independent judgment on corporate affairs and proper oversight of managerial performance,” can better be appreciated from the discussions in an earlier submitted paper entitled “Revisiting the Efficacy of the Oversight Functions of Independent Directors for PLCs.”
Obviously, the “comply or explain approach” of the CG Code for PLC does not make the recommendation for a higher number of IDs contravene the mandatory provisions of the Securities Regulation Code. In fact, it makes it rather easy for the PLC Boards to explain why they cannot comply with the particular recommendation for a higher number of IDs in that it is higher than the statutorily required number of IDs, and that the only way the Board can implement the same is to amend the articles of incorporation to increase the official number of IDs. As discussed previously, in our PLC sector which is dominated by family controlled companies, the “market backlash” that may come from the minority investing public who react adversely to the refusal of the Board to adopt a higher number of IDs, cannot usually be expected to counter the primary investing interest of the majority or controlling family group who find it more important to have the Board within the majority control of their representatives.
The more important question that should be addressed is “Whether the SEC could, through the exercise of its quasi-legislative powers, make it mandatory for publicly-held companies to adopt a higher number of IDs than the number provided for under the Securities Regulation Code?” The answer would be in the negative, for the current provisions of the Securities Regulation Code on the minimum number of IDs in PHC Boards represents the current Legislative policy on the matter, and that SEC’s attempt to impose a higher minimum number of IDs would extend that policy beyond what the Legislature has set out in the SRC. Otherwise, SEC would by quasi-legislation be extending the State’s exercise of coercive police power over the proprietary rights of the majority or controlling stockholders to vote their own nominees to the Board of Directors.
On the other hand, when publicly listed companies on their own follow the recommendation under the CG Code for PLCs to increase the number of IDs above that provided for in the SRC, that would not constitute a breach of the State policy on IDs as found in the SRC, but rather a voluntary move on the part of the majority or controlling stockholders of the PLC to further erode their proprietary rights to vote for their own nominees who do not otherwise fall within the definition and qualification of IDs. In other words, the more dispersed the ownership of our PLCs become, the more effective would be the “comply or explain approach” of the CG Code for PLCs when it comes to IDs.
The intention of the CG Code for PLCs is to goad the Boards of PLCs, in the face of what may be perceived as a “market approbation,” to undertake the necessary legal process to introduce a higher number of IDs into their Board. In this sense, the recommendatory step taken by the CG Code for PLCs under its “comply or explain approach” is much better than the lame copying by the original and Revised CG Codes of just mimicking the provisions of the SRC.
The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the MAP.
Cesar L. Villanueva is Chair of the MAP Corporate Governance Committee, the Founding Partner of the Villanueva Gabionza & Dy Law Offices, and the former Chair of the Governance Commission for GOCCs (GCG).