A Focus on Outcomes Within an Ethical Context

The latest iteration of South Africa's King Report moves governance decisively away from structure and process to a focus on outcomes within an ethical context. Since the first King Report in 1994, South Africa has consistently pushed the boundaries of corporate governance thinking. The latest iteration of the Report in 2016, known as King IV,¹ sets out the philosophy, principles, practice, and outcomes that serve as the benchmark for corporate governance in South Africa.

One might ask why South Africa devotes so much energy to corporate governance. Three reasons spring to mind. First, and most obvious, is the desire to sanitize public life in the aftermath of apartheid. Second is the imperative to establish the country as a trusted partner in an increasingly global economy. Economic growth is a social and political necessity given the country's high unemployment rate.

A third driver is that an unintended consequence of attempts to fast-track a more equitable, post-apartheid economic order has been rampant corruption in both business and government.

Effective corporate governance is increasingly seen as a vital tool in returning the public and private sectors to health, and positioning the country to participate in the global economy.

These considerations were integral to the direction taken by the King Committees in developing this code. This article will identify the most important new elements of King IV and significance thereof in terms of embedding corporate governance into the way organizations conduct their affairs.

New Foundational Elements of King IV

Prof Mervyn King SC, the former chair (now chair emeritus) of the King Committee, says that the most unique characteristic of King IV is that it steers organizations and governing bodies away from a mindless, checklist approach. A catalyst was the alarming realization that although King III was a requisite for listing on the Johannesburg Stock Exchange, many companies simply saw it as a hurdle to be overcome, nothing more.

“The question I asked myself is, how does one make it mindful, and we went through quite a painful process and discussion [to come up with a solution],” he said. “Now directors, in adopting King IV, should be asking themselves when making a business judgment call or a decision: How will this [decision] affect those outcomes? If it is going to have a negative impact on those outcomes, well then, the probability is that the governance is not right.”²

Some of the main elements of this thinking appear in the following; while they are separated for convenience they are in reality interdependent.

King IV and Ethical Consciousness and Leadership

King IV presents corporate governance as something founded on ethical consciousness, flowing from ethical leadership. It highlights and foregrounds the notion of ethics, conceived of as the deliberate balancing of self-interest with the interests of others. Ethical considerations should guide all corporate decision making and conduct in relation to its own employees, its shareholders and stakeholders, and society as a whole.

The requirement to act ethically clearly sets the bar considerably higher than lawfulness; ethical considerations must inform everything the organization does, and mere form or “box-ticking” becomes less feasible or defensible. The Code makes it clear that the ultimate responsibility for ensuring that ethical decision making occurs starts at the top.

Accordingly, Principle 1 (see Exhibit 61.1) of King IV reads: The governing body should lead ethically and effectively. The practices recommended to give this principle life include the cultivation and display of integrity, competence, responsibility, accountability, fairness, and transparency.

Recommended Practice 2 links ethical leadership and the achievement of strategic objectives and positive outcomes while 3 speaks to the need to disclose how members of the governing body are being held to account for their “ethical and effective leadership.”

One important characteristic of King IV is the way it explicitly links ethics and effectiveness; the traditional view that the two are to some extent at least mutually exclusive is rejected. Rather, the two complement and reinforce each other:

1. Ethical leadership is exemplified by integrity, competence, responsibility, accountability, fairness, and transparency. It involves the anticipation and prevention, or otherwise amelioration, of the negative consequences of the organization's activities and outputs on the economy, society, and the environment and the capitals that it uses and affects.
2. Effective leadership is results-driven. It is about achieving strategic objectives and positive outcomes. Effective leadership includes, but goes beyond, an internal focus on effective and efficient execution.³

By linking the two, King IV recognizes that both are necessary for the organization to be well governed and sustainable.⁴ An organization that concentrated on being effective might achieve a lot, but in the wrong ways; there would be a price to pay in the end. Equally, one that was focused only on being ethical would be highly regarded but unlikely to be either profitable or to grow. Getting this right is a critical balancing act.

King IV Focuses on Conduct

Mervyn King emphasizes the concept of conduct within the context of an ethical culture and effective, ethical leadership. He says the King Committee quite consciously distinguished between ethical culture and conduct; stakeholders do not see or perceive the organization's culture; what they perceive are its characteristics as expressed in the conduct of its office bearers and employees.⁵

For that reason, he prefers to talk about code of conduct rather than code of ethics, because it is the specific actions that are the tangible fruit of the ethical culture. This approach can also make it easier for the governing body to assess whether its ethical leadership is delivering the desired results. He recommends that every two years, the governing body should discuss what the organization's characteristics are and whether they have changed. A change in characteristics would be reflective of the ethical leadership given, and could be either for the good or the bad.

King IV Promotes an Outcomes-Based View

Specifically, it promotes corporate governance as integral to running an organization and delivering governance outcomes such as an ethical culture, good performance, effective control, and legitimacy.

Mervyn King argues that King IV's emphasis on integrated reporting, inherited from King III, and its corollary, integrated thinking, led to the outcomes-based approach that, perhaps more than any other, defines King IV.⁶ The previous King III Code listed governance principles and practices which, in practice, tended to be followed blindly, as if their mere implementation would result in good governance. It was thus easier to treat governance as a compliance exercise, in which following certain “rules” was in and of itself the goal.

Ansie Ramalho, the IoDSA's former King IV Project Lead, likens the process to throwing darts at random, and then painting the target later around where the darts have landed. By contrast, the outcomes-based approach begins by specifying the desired target; this means the recommended practices are used only to advance the organization toward the target. It also avoids the wasted effort of implementing practices that, for a specific organization or set of circumstances, will not deliver the desired results.

What are the outcomes to which King IV directs organizations? The Code defines corporate governance as “the exercise of ethical and effective leadership by the governing body toward the achievement of the following governance outcomes:

• Ethical culture
• Good performance
• Effective control
• Legitimacy.”⁷

A further advance in King IV is that governance practices are clearly linked to the board's role, thus integrating governance into the fabric of what the board does:

The governing body's primary governance role and responsibilities are … part of the dynamic of the organization's business cycle … [and] replicated and incorporated as the structural basis for the recommended practices under each of the governance areas … covered by the Code … By organizing the recommended practices in accordance with the governance role and responsibilities as explained above, King IV provides governing bodies with a model for the way in which any area that is subject to their governance should be approached.⁸

An important word here is “model” because it emphasizes the move away from the mindless application of “rules” to the mindful, selective use of recommended practices and principles to achieve a goal.

The “Apply-and-Explain” Regime

The “apply-and-explain” regime within King IV encourages transparent and meaningful reporting to stakeholders that reveals the intent behind the board's actions.

The move from apply-or-explain in King III to apply-and-explain is the logical corollary of the outcomes-based approach adopted in King IV. This move should be seen as a progression indicating the maturing of corporate governance codes, from the “comply-or-explain” of the Cadbury Report in 1992 through the “comply-or-else” approach implicit in Sarbanes-Oxley, to the “apply-or-explain” first adopted in the Netherlands in 2004. The last-mentioned was adopted by King III, which also introduced the concept that corporate governance is the product of ethical and effective leadership.

One important element of this progression has been the move away from comply, introducing greater flexibility into the application of the Code, but more significant still is the move from or to and. This decisively shifts the focus away from compliance to mindful application of principles or practices in order to achieve a certain goal.

Apply-and-explain also introduces a great degree of flexibility because it gives directors the freedom to decide that certain principles or practices would not be appropriate for their organizations, or would not advance the goals of corporate governance, and then to put forward their reasoning to stakeholders. By insisting that an explanation be supplied for each principle, King IV clearly seeks to make boards think more deeply about how to apply that principle in a way that is appropriate to current realities in order to achieve certain outcomes.

The concept of proportionality, discussed ahead, is also germane here.

As part of its move from the exception reporting of apply-or-explain to apply-and-explain, King IV reduced King III's 75 principles to 16. The reasoning behind this winnowing was that many of the “principles” of King III were, strictly speaking, important practices. In the world of King IV, the distinction between principles and recommended practices needed to be crystal clear to drive home the message that actions were only important in terms of the outcomes they enabled. This reduction in the number of principles makes the apply-and-explain regime of King IV practical.

Mervyn King emphasizes that the explanation (or disclosure, to use the more technical term), does not have to be either formal or extremely detailed. It could appear on the corporate website if the governing body felt that was the best channel.

“Just explain what your practices were in striving to achieve those principles and that's it,” he has said.⁹

Broad Applicability of King IV

King IV broadens the applicability of the Code to a variety of sectors and organizational types.

As noted earlier, King IV reduced the number of principles from 75 to 16. It also took care to draft these principles to apply to all organization types in a variety of sectors. The King Committee saw this as a critical element of King IV, as previous King Codes (and most international corporate governance codes) focus on larger companies, be they listed or just big enough to be designated of public interest. But because King IV so explicitly links corporate governance and organizational performance, it is important to make it available to all types of organizations, including nonprofit organizations (NPOs), smaller enterprises, state-owned enterprises (SOEs), and other public sector entities like municipalities.

“Good governance is something that applies to all organizations—NPOs, SMEs [small-to-medium enterprises], private, big, listed, nonlisted, SOEs, whatever—and it's a question of proportionality as to how you apply the practices to achieve the principles,” in Mervyn King's words.

King IV's overall concept of identifying a limited number of principles with clearly identified goals obviously lends itself to this broader, more flexible application. Sector supplements were created to help guide the application of the Code in the following sectors and/or categories:

• Municipalities
• Nonprofit organizations
• Retirement funds
• Small and medium enterprises
• State-owned entities

These supplements provide high-level guidance on how the King IV Code should be interpreted and applied by these sectors. In line with King IV's overall normative rather than prescriptive approach, the supplements aim to provide a demonstration of how King IV's principles should be adapted, interpreted, and then applied in different contexts. The hope is that these demonstrations will enable those charged with governance duties to adapt the practices to their particular governance challenges, including those challenges not addressed in the supplements, while still giving effect to the aspirations expressed in the principles. The examples in the supplements are designed to demonstrate the manner in which governing bodies should apply their minds to King IV, and do not replace the exercise of judgment by providing detailed solutions for all situations.

Organization types or sectors for which no supplements were provided should identify the supplement most closely aligned with their particular circumstances and adapt accordingly, always bearing in mind that it is the governance outcome that is important, not the means for achieving it.

Because King IV attempts to apply to all organizations, it was felt necessary to adopt more neutral terminology. Thus, the Code uses “governing body” in preference to “board,” “member of the governing body” in preference to “director,” and “organization” instead of “company.”

Greater Clarity Is Obtained

Greater clarity in King IV is obtained by clearly distinguishing between principles and practices, and restricting the number of principles and prescriptive practices.

In King III, and in many international governance codes, really important practices were often given the status of principles. For example, this is why King III had 75 principles. Moving to an outcomes-based approach necessitated a clear distinction between principles, which are truly aspirational, and practices, which are suggested actions that could help the board achieve the goals identified by the principle.

In King IV, therefore, a greatly reduced number of principles “embody the aspirations of the journey towards good corporate governance” while practices “are recommended at the level of leading practice … [and] … should be applied so that they support and give effect to the aspiration as expressed in that principle.”¹⁰

Thanks to careful phrasing, the principles are now also more easily applicable to all types of entities in all sectors. For example, Principle 1—The governing body should lead ethically and effectively—is clearly applicable to any organization.

Proportionality Is an Important Concept

Proportionality allows governing bodies to apply the recommended practices in line with the organization's size and resources, and the extent and complexity of its activities.

If the Code is to be applicable to every organization regardless of its size or the sector in which it operates, it must be flexible. As the discussion so far has made clear, this flexibility is inherent in the use of aspirational principles to guide the journey toward identified outcomes, rather than compliance for its own sake. Proportionality supplies the missing piece because it enables members of a governing body to adapt, discard, or even introduce new practices as appropriate to help them achieve the outcome.

In short, King IV attempts to instill a qualitative approach in which recommended practices are implemented only to realize the principles and the governance outcomes.

Even where not expressly stated in the Code, practices are meant to be scaled in accordance with the following proportionality:

• Size of turnover and workforce
• Resources
• Extent and complexity of activities, including impact on the triple context¹¹ in which it operates

Naturally, applying any recommended practices on a proportional basis must take into account any relevant legal provisions, and always with the aim of giving effect to the associated principle.

The following examples illustrate how recommended practices could be scaled in accordance with proportionality considerations.

Where it is recommended in the Code that certain functions should be established—for example, finance, risk, technology and information, compliance or internal audit functions—in a small organization, such functions could consist of a senior employee instead of a team of people. If proportionality considerations warrant it, further downscaling could be achieved by allocating part-time responsibility for the function to such an employee. Outsourcing of functions is another alternative, and so is sharing functions and resources with affiliated organizations.

Similarly, a recommendation that a committee of the governing body should be formed could, if justified by proportionality considerations, be honored by having the governing body carry out the functions normally fulfilled by such committee. Alternatively, the governing body could formally delegate one of its members to investigate, consider, and prepare submissions for recommendation and consideration by the full governing body, but without abdicating its own accountability.

Where the Code recommends that a formal policy be established, it could be accomplished by formalizing in writing a few guiding criteria and processes, and by continually developing the document as learning evolves. The benefits of being intentional and devoting the necessary consideration to putting policies and structures in place should not be underestimated. Doing so clarifies intention and ensures alignment among those affected by the policy on the nature and extent of responsibilities, functions, and authority delegated.

In summary, the King Committee felt that proportionality was important to overcome the one-size-fits-all approach to governance, one that does not accommodate the size, nature, and/or resources of an organization. If corporate governance codes are drafted with only the largest and best-resourced companies in mind, the benefits of corporate governance are effectively put out of the reach of smaller organizations, or those whose structures or purposes do not correlate exactly with those of the classic for-profit corporation. Proportionality now gives governing body members the license to adapt the recommended practices as needed in pursuit of the principles, so long as they can justify their thinking to their stakeholders as envisaged in the apply-and-explain regime.

Specific Content Shifts in King IV

The preceding discussion touched on the main structural ways in which King IV builds on King III. They concerned the fundamentals underlying the latest iteration of the King Code, although surely not the last. Alongside them, there are a number of more technical changes to the content of the Code, most of them influenced by the conceptual changes already noted. It may be helpful to outline the most important of these.

Conclusion

To conclude, King IV's decisive move toward an outcomes-based approach founded on the application of principles rather than the implementation of a set of practices should be seen as an important development in corporate governance. It is equally clear, though, that it must be seen as a milestone on the journey toward an economic and organizational dispensation that is both ethical and successful, not a destination. In the nature of things, we will continue to see further developments in corporate governance in South Africa and globally.

About the Authors

Parmi Natesan is the chief executive officer of the Institute of Directors in Southern Africa (IoDSA).

Parmi has been with the IoDSA for eight years, first as senior governance specialist and then executive of the Centre for Corporate Governance, overseeing governance thought leadership, director training, and certifications. She is a leading corporate governance specialist in the country who has authored numerous articles and papers and has spoken at various conferences and events.

She has served as an executive director on the board of the IoDSA for four years. She also serves on the boards of PPS Holdings Trust and Alviva Holdings as a nonexecutive director.

Parmi represents the IoDSA on a number of forums and committees, including the King Committee of South Africa, the Integrated Reporting Committee of South Africa, the Anti-Intimidation and Ethical Practices Forum, the 30% Club (which advocates gender diversity on boards), and the Global Network of Director Institutes.

She has received numerous accolades over her career, including a Rising Star alumni award from the Nelson Mandela University, and was named one of Destiny magazine's top-40 African women under the age of 40.

Parmi is a qualified chartered accountant, registered with the South African Institute of Chartered Accountants, and holds BCom (cum laude) and BCom Honors degrees.

With more than three decades' experience in global economic and investment, finance, insurance, and investment management, Dr. Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. He is chairman of Plexus Holdings, a business widely respected for its innovative approach to investments, which he founded in 1995.

Du Plessis also serves as nonexecutive director of Distell Group (chair of Risk Committee, member of Audit Committee and Social and Ethics Committee), trustee of the Professional Provident Society (PPS) Holdings Trust, nonexecutive director of PPS Insurance Company (chair of Remuneration Committee and member of Risk Committee), nonexecutive director of PPS Investments (chair of Audit and Risk Committee), member of the Investment Committee of the Law Practitioners Insurance Indemnity Fund, and is the immediate past nonexecutive chairperson of the Institute of Directors (South Africa).

Furthermore, Du Plessis is a member of the advisory board of the University of Stellenbosch Business School (USB), chair of the Audit and Risk Committee, and member of the Investment Committee of Stellenbosch University. Additionally, he is professor extraordinaire at USB, honorary consul general of Slovenia for South Africa, and deputy dean of the Consular Corps of Cape Town.

He has vast experience of serving as chairman of and director on boards and board committees of public and private companies. Du Plessis has a solid background in corporate governance, including being one of the few holders of the Chartered Director (South Africa) designation and a recipient of the Certificate in Corporate Governance (International Directors Programme) (INSEAD, France), having completed the Risk Management for Corporate Leaders course at Harvard Business School. He is the author of an e-book on company directorship and a newspaper columnist on corporate governance.

He holds the following degrees: BSc (Quantity Surveying) (University of Cape Town), MBA (cum laude) (Stellenbosch University), and DBA (Doctor of Business Administration—Finance) (Stellenbosch University).

Prieur is 64 years old and lives with his wife and two children in Stellenbosch, Cape Town. His recreational activities include running, reading, traveling, and horology.