Corporate governance in transition economies by Korn Ferry

Case Study

Corporate governance in transition economies

Iranâ&#x20AC;&#x2122;s boards of directors and economic development.

www.kornferryinstitute.com

Introduction The Islamic Republic of Iran is one of the largest economies in the Middle East and North Africa (MENA) region, and, as part of Goldman Sachs’s “Next Eleven” group of countries, is seen as having the potential to become as important globally as the BRIC countries. Iran is a leading producer of natural energy resources, but this sector—among many others—is still owned and controlled by the state. In recent years, a massive wave of privatizations has changed the corporate landscape. But despite this, and the country’s general economic strength, Iran is still struggling to overcome its structural deficiencies while transforming itself from a centrally planned economy to a free market. Corporate governance in transition economies provides a broad view and a deep analysis of how corporate governance, and in particular the effectiveness of boards, affects national economic development and corporate growth. We took a holistic and multidisciplinary approach, with a key focus on the human capital aspect, and drew upon a wide range of sources from the international academic world, including publications from leading corporate governance experts, management scientists, sociologists and historians from Iran and other countries. In particular, we looked at the following issues: • What are the specialties of transition economies versus more established economies? What role does corporate governance play in the development of a transition economy? • Taking Iran as a case study, what factors define the state of the economy and corporations’ overall prospect of doing business from a human capital perspective? What does the national corporate governance framework look like? How does national culture influence corporate governance and the work of the board? • What steps might best improve and professionalize board effectiveness and directors’ work? Where are the best-in-class approaches, and how well will they suit non-Western cultures? On a corporate level, what are the hurdles to implementing such measures?

CORPORATE GOVERNANCE IN TRANSITION ECONOMIES

About Iran. Iran is the second largest economy in the Middle East and North Africa (MENA) region after Saudi Arabia, with an estimated Gross Domestic Product (GDP) of $366 billion in 2013-14, according to World Bank figures. The country’s area roughly equals that of the United Kingdom, France, Spain, and Germany combined, and it has the second largest population in the region after Egypt, an estimated 77.45 million in 2013. Iran is articulating its strength on the regional and world scenes as an economy of weight and a key supplier of crude oil and natural gas. Suzanne Maloney, a senior fellow at the Saban Center for Middle East Policy at the Brookings Institution, assesses the country’s potential this way: “Iran has a strong foundation for rapid growth and development, with the world’s second largest petroleum reserves, a young, welleducated population and a well-developed industrial and commercial infrastructure.” Political and economic turbulence have set the country on a rollercoaster journey: “In the last quarter of the century the economy has experienced some extraordinary times,” writes Monir Tayeb of HerlotWatt University, “an oil boom, a bloody eight-year war and international sanctions. It has been subject to large-scale nationalization, wideranging rationing and privatization and structural adjustment.” Reza Tajaddini, a researcher at Swinburne Business School, Australia adds: “In recent years Iran’s controversial nuclear program has led to the imposing of economic sanctions by both the UN Security Council and some developed countries.” “Over the past 20 years, Iran has been pursuing an isolationist approach. This is in part due to the legacy of Ayatollah Khomeini, but it is also now exemplified by the position of Iran in the global political culture,” writes Kate Hutchings, a professor at Griffith University in Australia. The Iranian state plays a key role in the economy as owner of the large public and quasi-public enterprises that dominate the manufacturing and commercial sectors, a requirement set out in Article 44 of the constitution. “The economy, although it is a capitalist one, is run on a strict protectionist and statist model,” Monir Tayeb says. “Until recently, the Iranian government controlled the majority of businesses in Iran, either directly or indirectly, and has made significant efforts to expand the capital market,” writes Bita Mashayekhi, associate professor of accounting at the University of Tehran and a member of the corporate governance committee of Tehran Stock Exchange. This has not always been beneficial, as Mohammad Chaichian, a professor in the Department of Sociology at Mount Mercy University in Iowa,

“Even though the infrastructural prerequisites for a functional capital market are in place in Iran, trading and liquidity are minimal.” – Udo Braendle American University in Dubai

explains: “The government’s control of almost four-fifths of Iran’s economy, economic mismanagement, and corruption at all levels of the bureaucracy further hampers the private sector’s ability to expand and create jobs.” Unclear and often changing laws and regulations keep Iranian firms off balance and disoriented, finds Vipin Gupta, a professor at California State University, San Bernardino. The capital market in Iran is relatively new and still rather inefficient, as Udo Braendle, chair of the Business and Economics Department at the American University in Dubai, notes: “Even though the infrastructural prerequisites for a functional capital market are in place in Iran, trading and liquidity are minimal and only a few Iranian companies have turned to the stock market as a source for their financial needs.” Fatemeh Mehrabani, a researcher at the Department of Management and Economic at Islamic Azad University in Tehran, states: “Iran’s capital market, whose only representative is Tehran Stock Exchange, is still unable to find its proper place in supplying and equipping financial resources and has encountered numerous problems.” It wasn’t until 2012 that plans were unveiled to create the country’s first rating agency, in partnership with the Pakistan Credit Rating Agency (“Pacra”). In 2014, Iran was ranked a rather discouraging #130 by the World Bank in its annual “ease of doing business” survey, far behind established economies such as the U.S. (#7), United Kingdom (#8), Germany (#14) or Switzerland (#20), and also considerably behind countries such as Azerbaijan (#80) or Lebanon (#104). It did, however, rank two positions higher than the previous year. Iran stands apart from the thriving Arabian Gulf states of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, and countries such as Egypt, Jordan and Morocco, which benefited from economic reform programs of the World Bank and the IMF. It belongs, instead, to a third group of countries, including Iraq, Lebanon, Syria, Algeria, Sudan, Libya and Yemen, as well as the West Bank and Gaza, that are seen as economically vulnerable either because of political instability or because they are in the very early stages of economic development, or both. Despite these conditions, Iran has seen some impressive economic developments. Alireza Omidvar, co-founder of CGR Development Center, a not-for-profit organization that promotes corporate governance and corporate social responsibility in Iran, explains: “Most of the state-owned firms are now being privatized under the general policies of Article 44 in the Iranian constitution. Under these circumstances, people are allowed to buy the shares of

CORPORATE GOVERNANCE IN TRANSITION ECONOMIES

newly privatized firms. The privatization process included some 315 companies and over $72 billion worth of assets, and was implemented most rapidly in the last six years.” Nine of the ten biggest companies on the Tehran stock exchange were listed in the past decade. Recent years have brought notable growth, Omidvar says: “Capital market value in the Tehran Stock Exchange has doubled in a mere three-year period, while a vast portion of this growth happened in 2010 alone. Even though the total capital market had mounted to some $65 billion in 2010, rising from a $3.2 billion value in March 1999, it climbed even further, peaking near $100 billion in March 2011.” This growth comes as the country works to evolve the economic environment created by the Islamic revolution of 1979. The revolution, Reza Tajaddini explains, “changed the entire structure of the country as well as that of workforces. Technocrats were replaced by ideologists, and a competent and skilled workforce was replaced with a loyal workforce. Therefore, competencies and management skills were not seen as a priority; rather, significance was paid to putting loyal and ideologically sound employees into key management and strategic positions.” Not surprisingly, about 150,000 highly qualified Iranians with tertiary education leave the country every year, according to World Bank data. “Iran has the highest level of ‘brain drain’ among 91 developing and developed nations,” comments Mohammad Chaichian. “Only 25 percent of the college educated individuals are able to find jobs.” In early 2014, a delegation of representatives from the International Monetary Fund met with the governor of the Central Bank of Iran, the minister of economy and finance and other senior public officials, as well as representatives from the private sector and academia. The IMF staff report states that “the authorities viewed as critical the need to advance reforms to improve the business environment. Staff noted that comprehensive steps would be needed to enhance the efficiency of product, financial, and labor markets, as well as to strengthen the institutional framework and effectiveness of the government. The authorities recognized that the corporate sector was facing difficult conditions. The authorities recognized that efforts to improve the business environment would require significant coordination with other state-agencies and the private sector.”

Transition economies. The overall situation in Iran is typical for a ”transition economy”— one that is moving from a centrally planned economy toward freer markets and increased entrepreneurship. “The transition countries vary considerably in history and current institutional setup, but they do share certain important features,” comments Erik Berglöf, chief economist and special adviser to the president of the European Bank for Reconstruction and Development and current board member and research fellow of the European Corporate Governance Institute. “They all have a large sector of former state-owned enterprises that need to be restructured and in many cases phased out. These countries also need new enterprises to emerge in underdeveloped parts of the economy, in particular in the service sector.” The collapse of the former Eastern Bloc and the subsequent transformation of its member states in Central and Eastern Europe is a well-known example, as is China, although there have been less prominent, but comparable, developments in Asian countries such as Cambodia, Laos and Vietnam. While many countries in transition, such as China and Russia, have experienced strong economic growth, they also encountered a number of challenges in managing that growth. There is no one template for such transitions, and countries have developed themselves in an entirely different manner from one another. Developing and implementing best-practice corporate governance frameworks is often a rather low priority in transition economies, which often struggle with more urgent matters. Emerging private companies face a simultaneous lack of market signals and managerial accountability in much of the former state-owned sector, Erik Berglöf explains: “These enterprises often require strong outside investors to execute painful restructuring, but the dominant pattern found in Central and Eastern Europe and the former Soviet Union is ‘insider control.’” Mohammedreza Abdoli, a researcher at the Islamic Azad University in Sharood, confirms: “In transition economics, the primary governance mechanisms are the state and informal networks.”

CORPORATE GOVERNANCE IN TRANSITION ECONOMIES

The impact of corporate governance. Much current research has found that good corporate governance practices bring a number of benefits for transition economies and their corporations: • Gianni De Nicolo, Kenichi Ueda, and Luc Laeven showed in a study for the International Monetary Fund that improvements in corporate governance quality are connected with real economic activity (GDP growth, productivity growth, and the ratio of investment to GDP), both for developed and emerging market countries. • Abdussalam Mahmoud Abu-Tapanjeh, chairman of the Accounting Department at Mutah University in Jordan, has found that countries that have implemented good corporategovernance measures generally experience robust growth of corporate sectors and higher ability to attract capital. • Fatemeh Mehrabani finds that improved corporate governance increases both the market value and the efficiency of affected enterprises in the stock exchange market. These shifts attract local and foreign investors, which in turn drives economic growth. • Lawrence Brown and Marcus Caylor of Georgia State University found a strong positive correlation between good corporate governance and firm performance when they analyzed a sample of more than 2,300 companies. • Franklin Allen of The Wharton School of the University of Pennsylvania finds that good corporate governance practices lead to increased access to external financing under more favorable conditions, an increase in entrepreneurial activities, especially the founding of new firms, and an improvement in companies’ overall operational performance. A few studies on Iran’s corporate governance situation have already been conducted: • Saeed Ghorbani and Seyed Tabaie Zavareh of the University of Economic Sciences, Tehran, have constructed a corporate governance index based on 13 attributes. Looking at 141 Tehran Stock Exchange listed companies, they separately correlated each of the 13 governance attributes with the companies’ performance over a period of six years and found a significantly high correlation between a firm’s performance and its governance index rating.

Countries with good corporategovernance measures generally experience robust growth and higher ability to attract capital.

â&#x20AC;˘ Bita Mashayekhi has conducted multi-year research on 150 Iranian publicly listed companies and found strong correlations between earnings quality and a number of good corporate governance practices. â&#x20AC;˘ In a survey in which he analyses the status quo of corporate governance in Iranian companies, Udo Braendle finds positive outcomes for good governance practices on a more operational level: improved brand and credibility, improved risk management systems, compliance with legal and judicial requirements, defending shareholder rights, improved strategic decision-making process and better access to capital and foreign partners.

CORPORATE GOVERNANCE IN TRANSITION ECONOMIES

The role of the board and it’s directors. If good corporate governance is a key driver for strong performance, what is the role of the board of directors in this context, and how is its impact affected by its composition and the profiles of its members? Amir Licht, dean of the Interdisciplinary Center Herzliya, believes that “the board of directors is the epicenter of power relations in the corporation. It is therefore a key component in firms’ corporate governance.” There is substantial evidence to prove this. Lawrence Brown and Marcus Caylor surveyed more than 2,300 corporations and found nine board characteristics that appear to be drivers for strong performance, which they define as producing higher returns on equity, higher profit margins, larger dividend yields, and larger stock repurchases: • More than 50% of the board consists of independent outside directors. • The ideal board size is between six and 15 directors. • CEO and Chairman roles are separate. • The attendance rate at board meetings exceeds 75%. • The company has a nominating committee solely made up of independent outside directors. • The board has a governance committee that meets at least annually. • There is a mandatory retirement age for directors • The performance of the board is reviewed regularly. • The board has its own “board” with outside advisors.

The corporate governance framework in Iran. That ideal framework is almost non-existent in Iranian corporations. “Corporate governance and its importance is a relatively new subject in Iran, having come to public attention with the first attempt by the Tehran Stock Exchange to develop the first draft of a code of corporate governance in 2004,” says Udo Braendle. The overall concept still in its “infancy,” according to Akram Bodaghi of Mazandaran University of Science and Technology, Iran. Dr. Hassan Ghalibaf Asl, Tehran Stock Exchange’s CEO, concurs. “In global financial markets, corporate governance has been a common issue for some years,” he stated in a press release, but, he added, there is much work to do in Iran. Udo Braendle analyzed 26 Iranian companies from all sectors, including listed companies, multinational companies, and private sector and family-owned companies, finding that only “18% of the respondents are familiar or knowledgeable with the concept of corporate governance and its principles,” compared with 52% in Turkey, 59% in Pakistan, and 60% in the overall MENA region. All in all, “Iranian companies have weak corporate governance practices compared to those in industrialized economies,” concludes Alizera Omidvar. Though they may have a corporate governance framework imposed them by a third party, only 63% have formalized and self-imposed codes of conduct and ethics. In a study conducted by the Islamic Parliamentary Research Centre in Iran, Seyed Mohammad Aarabi, Rahim Zareh, and Masoud Moghaddas concluded that “the corporate governance principles of trade law are insufficient in following areas: the failure and the lack of effective framework for the protection of small shareholders’ rights, lack of an effective framework for internal control and efficient inspection, no separation of board chairman and CEO roles, no separation of auditor and inspector legal of the corporation, lack of proper disclosure and transparency measures taken, and other shareholders’ rights aren’t observed.” Valuable insight into the evolution of Iran’s corporate governance system can come from looking at the country’s legal traditions, researchers suggest. Bita Mashayekhi explains that, “Iranian civil law, which is a synthesis of French and Belgian civil law, provided relatively weak legal protection for shareholders and creditors. The process of instituting and controlling firms is briefly addressed in the Iranian Trade Law, particularly in its April 1968 amendment.” The French antecedents may be particularly significant. A group of researchers, Rafael La Porta, Florencio Lopez de Silanes, Andrei Shleifer and Robert W. Vishny—often referred to as “LLSV”—find a

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strong correlation between the origin of a country’s legal system and the country’s institutions and financial and economic “outcomes,” particularly economic growth. Their research shows that English common-law countries generally have the strongest legal protections for investors and produce better institutions, including less corrupt governments and more informative accounting standards, whereas French-civil-law countries score much worse in these areas. The revolution in 1979 brought Sharia law to the country, but interestingly, many components of the civil law were retained. Bita Mashayekhi continues: “The Asian financial crisis in 1997-1998 significantly changed the landscape of corporate governance in many affected countries, including Iran.” Iran’s first step towards reform came in 2000, when the management of the TSE, the Islamic Parliament Research Centre and the Economic and Finance Ministry jointly started an initiative to develop a code of corporate governance for the country. In 2004, a first edition of this code was published by the TSE Research and Development Centre. This code was based mainly on the guidelines of the Organization for Economic Co-operation and Development (OECD) and was also benchmarked with the Code of Corporate Governance in the Malaysian Stock Market. A newly revised Securities Market Law followed in 2005. In 2010, the Securities and Exchange Organization (SEO), which was created in 2003 to separate market regulation and governance from transaction execution, finalized and formally adopted the Iranian Code of Corporate Governance, It is still not compulsory for companies to implement the code. However, according to the new Securities Market Law and TSE listing requirements, public companies are required to indicate their degree of compliance with several of its provisions. In 2013, TSE took another step to encourage compliance, launching a corporate governance index to rate companies listed in the exchange. The average score was a disappointing 57 out of 100. The corporate governance code has blind spots. Remarks Fatemeh Mehrabani: The edition issued by TSE authorities at the end of 2007 “concentrates only on internal frameworks like ownership concentration, board and board remuneration while it pays no attention to external framework.”

“Iranian civil law, which is a synthesis of French and Belgian civil law, provided relatively weak legal protection for shareholders and creditors.” - Bita Mashayekhi University of Tehran

The Iranian board of directors. The Iranian system is based on a one-tier board structure, although some of the Iranian semi-government companies have a two-tier board structure: a trustee board and a management board. An SEO bylaw obliges all listed companies to separate the CEO and chairman roles. It is still uncommon for boards to have sub-committees, and only 17% of the listed companies have audit committees. Mohammed Reza Abdoli notes that “despite the fact that Iran’s corporate governance law has put emphasis on employing at least one financial member on the board, half of the firms fail to abide by it.”

Figure 1 The board of directors in Iran

Percentage of ownership required to invite the general assembly

Only holders of shares above 20% can call an extraordinary shareholder meeting.

Board system

One-tier board.

Disclosure of information about board and managers

In listed firms, records and qualifications of board and CEO should be reported.

Compensation for board services

Board’s fees and remuneration will not be reported in detail, broken down per director, but rather only as a total sum for the whole board of directors.

Ownership disclosure

Yes—but understanding the ownership structure and identifying the ultimate owner is difficult.

Independent board members

Uncommon in Iran.

Board committees

Uncommon in Iran.

Source: Udo Braendle.

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The role of the board in Iranian companies is rather “poorly defined,” as Udo Braendle says. “Traditionally and also based on the Iranian commercial law, the board is responsible for executive and strategic duties. However, the power structure in Iranian companies is very centralized, with little delegation of authority to lower management levels.” Adds Alireza Omidvar: “There are no published guidelines or booklets explaining the roles, responsibilities, operation, qualifications or structure of boards in Iran. In practice, boards have not assumed an independent oversight function for themselves, and are considered to play a relatively minor role in providing strategic guidance for companies.” Figure 2 To what degree are international corporate governance standards followed?

Separation of chairman from CEO

68%

Developing procedures governing deals with related parties and preventing conflicts of interest

40%

Developing compensation and remuneration mechanisms for board of directors and executives

31%

Independent and non-executive board members

27%

Nomination procedure

22%

Mechanisms on board selection criteria

13%

Board evaluation instructions

13%

Board committees (internal audit committee, risk management, nomination and selection committee, etc.)

Instructions for protecting shareholder and stakeholder rights

Source: Udo Braendle.

“Independent directors have not been permitted in law, and such a concept has not been popular or even known in Iran.” – Udo Braendle American University in Dubai

A major issue is the lack of truly independent directors. Udo Braendle notes: “Board members are appointed not on the basis of their expertise and merits, but because of their political connections and influence. Independent directors have not been permitted in law, and such a concept has not been popular or even known in Iran. The commercial law of Iran does not accept such directors on the board,” he says, because every board member has to be both a shareholder and a representative of the shareholders. The first problem, at least, can be technically circumvented, adds Alireza Omidvar, “by granting one share to an elected independent director.” Still, the concept remains so novel in Iran that Braendle’s research took unexpected turns: “Even though the definition of independent director was given in the questionnaire and explained during the process of interview, a majority of respondents did not understand the definition. For them, a non-executive director who did not work full time for a company was an independent director. A majority of the respondents expressed that it is difficult to find any non-executive directors and impossible to find independent non-executive directors.”

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An approach to a solution. Given this context, how can participants in this transitional economy best develop and implement measures to improve corporate governance and board work? Will it suffice to take a proven solution from the Western world, notably the U.S., as a one-size-fits-all measure? Ruth Aguilera of the University of Illinois and Gregory Jackson of the Free University of Berlin find: “Corporate governance is often understood in relation to the publicly traded firm, and implicitly takes for granted the context of Anglo-American corporate governance— characterized by little direct state involvement, minimal legal rights for stakeholders, and so on. This model is often treated as a baseline of ‘good’ corporate governance.” But Thomas Clarke and Marie dela Rama, researchers at the University of Technology in Sydney, remind us: “Just as the OECD, World Bank and IMF were increasingly confidently projecting the Anglo-American, market-based outsider system of governance as the preeminent model from which all other countries might learn, the Enron disaster occurred.” And most research is looking only at the micro-economic perspective of corporate governance and the board’s impact, which “neglects the institutional, legal, and cultural environment in which organizations and decisions are embedded,” as Ruth Aguilera and Gregory Jackson point out in their research. Amir Licht believes that national culture plays a strong role in shaping corporate governance, up to the functioning and structure of the board. Including this dimension in corporate governance is new, he says. “In the beginning, references to culture—when they were made—tended to be intuitive and impressionistic.” But now there is data from a fundamental study of the impact of national cultural on the structure and work of the board of directors. Jiatao Li and J. Richard Harrison from the Hong Kong University of Science & Technology conducted a study based on a sample of 399 large, multinational manufacturing companies in 15 industrial countries including Australia, Japan, and countries in North America and Western Europe. When they examined national culture variables, board composition, and CEO/chair consolidation, controlling for company size, performance, capital structure, ownership structure, and country-level economic development, they found that national social and cultural characteristics have a significant influence on corporate governance frameworks, board composition and leadership structure. Before making any more specific recommendations, then, let us first look at the cultural issues specific to Iran.

History and identity in Iran. There is no simple way to summarize the characteristics of this nation. As Orkideh Behrouzan, a researcher at King’s College London, says simply: “The question of the Iranian identity is not an easy one.” Comparing Iran to its neighbours in the region, Reza Tajaddini finds that “due to its unique historical, linguistic and racial identities, it has a different and unique culture.” The Simorgh Foundation, an Iranian think-tank based in Vienna, recently conducted a study titled, “In search of identity—what does it mean to be an Iranian?” polling Iranians both inside and outside the country. Sixty-six percent of the respondents were between 20 and 34, and interestingly, they showed a strong degree of national pride—“culture” and “history” were the most frequent keywords they used to underline their feelings. Iran is home to one of the world’s oldest continuous major civilizations. The country became an Islamic republic in 1979 after the ruling Pahlavi dynasty was overthrown. Today, it has the world’s first and only clerically ruled government. The president, who heads the government, is democratically elected, while the divine leader, who is elected by a body of Islamic theologians, the Majles-e Khobregan, oversees the military, the judiciary and the state broadcasting services. In Iran, religion and politics are inseparable, with the Shi’a branch of Islam forming the framework for a theocracy. Ayatollah Ruhollah Khomeini, the leader of the 1979 Islamic revolution, created a system that tried not only to assign ultimate authority to the clerics, but also to make sure that their actions were responsive to and expressive of popular will, although the 1979 constitution mentions the word “democracy” only once—in the preamble. Political scientist Francis Fukuyama of Stanford University calls the constitution “a curious hybrid of authoritarian, theocratic and democratic elements.” It officially recognises three minority religions—Christianity, Judaism and Zoroastrianism—along with the State religion, and they all have reserved seats in the Iranian Parliament, Majles-e Shorâ-ye Eslami. According to the CIA Factbook, Persians are Iran’s largest ethnic group, but nearly a third of the population belongs to a variety of other ethnicities. They are Azeris, Kurds, Arabs, Baluchis, Lors, Turkomen, Qashqais, Mazandaranis, Talysh and Gilakis. Monir Tayeb explains: “Iranian culture is a mixture of three different cultures which have co-existed for centuries: Ancient Persian culture, with about 6,000 years of history; Islamic culture, with about 1,400 years of history; and Western culture, with over 200 years of history.” The latter is not to be underestimated. “Western—especially American—culture, political rhetoric, and lifestyles have been part of the Iranian psyche since World War II,” writes Nilou Mostofi of the University of Chicago. The more conservative circles in the

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country have long objected to what they call gharbzadegi (literally: “Westoxification,” the title of a book written by Jalal Al-e-Ahmad, a prominent Iranian social and political critic in the 1960s). In their dayto-day lives, Iranians are surrounded by Western consumer goods and cultural products, and feel the West’s influence on gender roles, political ideas and many other parts of life. Tellingly, for the estimated 150,000 well-educated emigrants who leave the country every year, the prime destination is the United States. According to the Office of Immigration Statistics (OIS), from 1970 to 2004, more than 350,000 Iranian-born immigrants were admitted to the United States, and more than half of them live in the state of California. Today the United States contains the highest number of Iranians outside of Iran—and they are doing well, as Orkideh Behrouzan found: “Iran is ranked the first among the 68 immigrant groups in the U.S. in terms of educational achievements as well as financial success.” A study of 2000 U.S. Cenusus data conducted by Ali Mostashari of the Iranian Studies Group (ISG) at the Massachusetts Institute of Technology provides substantial evidence: “Iranian-Americans have founded and served in senior leadership positions of many major U.S. companies, many of them in the Fortune 500,” he wrote. Pierre Omidyar, the founder and current chairman of Ebay, is the most prominent example, but today’s ranks of entrepreneurs and C-level executives are crowded with names such as Isaac Larian (MGA Entertainment), Omid Kordestani (Google, Vodafone), Manny Mashouf (bebe stores), Arash Ferdowsi (Dropbox), Ali Rowghani (Twitter, Pixar), Farzad Nazem (Yahoo), Dara Khosrowshahi (Expedia), Shaygan Kheradpir (Juniper Networks), Hossein Eslambolchi (AT&T), and Cyma Zarghami (Viacom). Many more have come to the United States to get an education: President Hassan Rouhani’s current cabinet has more members with Ph.D.s from American universities than the US cabinet itself, according to The Economist.

“Iran is ranked the first among the 68 immigrant groups in the U.S. in terms of educational achievements as well as financial success.” – Orkideh Behrouzan Researcher, King’s College

Characteristics of Iran’s culture. Iran’s culture has been assessed in an empirical and structured way by the “Global Leadership and Organizational Behaviour Effectiveness” (“GLOBE”) Research Program, conceived in 1991 by Robert House of the Wharton School of Business. The program, a large-scale study of leadership and culture in 62 nations, looked at the interrelationships among societal culture, organizational culture, and organizational leadership. It established nine cultural dimensions that make it possible to capture the similarities and/or differences in norms, values, beliefs and practices among societies. Researchers Ali Dastmalchian, Mansour Javidan and Kamran Alam worked on the Iranian sub-project of GLOBE. When placing societies into culture clusters, they found that Iran, despite its geographical location, shares more cultural traits with South Asian countries such as India, Thailand and Malaysia than with its direct neighbors. Its unique characteristics stood out in its individual scores in several categories. Strong group identity, with limits. In the GLOBE survey, Iran has the third-highest score in in-group collectivism. “A prominent feature of the Iranian societal culture is the extent to which they demonstrate loyalty, express pride and cohesiveness toward family, organizations and other in-group collectives,” explains Ali Dastmalchian. That in-group orientation “is one of the distinguishing features of the Iranian culture, which suggests loyalty and cohesiveness toward small groups such as family and close friends,” Reza Tajaddini confirms. In a corporate context, the concept of family is often replicated by creating in-groups within the firm, sometimes narrowed down to the team of an executive, and often excluding or alienating anyone outside that circle. “This influence of local culture on personnel practices, with its focus on nepotism and pre-existing relationships that take precedence over skills and competencies, can be seen especially in recruitment and selection, performance management and compensation,” says Tajaddini. Iranians’ rather low score on institutional collectivism shows that loyalty and a sense of belonging to a larger group, on an abstract level, is unusual. “The workplace does not belong to their in-group, as it is the case, for example, in Japan,” Monir Tayeb finds. “Their commitment to the company is at best shaky and at worst open to negotiation.”

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Another researcher, Mirahmad Amirshahi of Alzahra University, Iran, surveyed a sample of more than 700 Iranian executives to identify the value systems and decision-making styles of Iranian managers. Among his findings: • A conformist orientation is the dominant value system of Iranian executives, with egocentric values the least dominant. • More than half of Iranian executives (55%) practice consultative means of decision-making. Delegative, autocratic and pseudoconsultative decision styles are the least preferred in Iran. Vipin Gupta confirms this often-found behaviour: “Mid-level managers rarely make decisions without seeking the approval of the managing director, who in turn consults with various boards and committees,” he says. High power distance, low assertiveness. In Iranian culture, the extent to which the less powerful members of organizations and institutions accept and expect that power will be distributed unequally, is very high, according to GLOBE data. “Iranians’ respect for authority is evident in most business dealings. The relationship between subordinates and their superiors, for example, is distinct and highly official,” comments Reza Tajaddini. “People accept a hierarchical order in which everybody has a place and which needs no further justification,” finds the Simorgh Foundation in its survey. Resources are available only to a few, and information is localized and hoarded. As Jiatao Li explains: “High power distance is associated with strong authority and steep hierarchies.” John Zinkin, deputy chairman of the Institute of Corporate Responsibility in Malaysia, elaborates: “People do not question their superiors, by virtue of their position rank and title. Thus even though the board director has the freedom to question, in practice, this goes against cultural norms.” The acceptance of high hierarchical distance, Reza Tajaddini explains, is “deeply rooted in many aspects of Iranian mythology, history, politics, religion and family structure.” That makes it difficult to implement rules and regulations to which everyone feels bound to adhere. As Kate Hutchings finds: “Rules may be subverted for those who have the right connection.”

“Even though the board director has the freedom to question, in practice, this goes against cultural norms.” – John Zinkin Deputy Chairman Institute of Corporate Responsibility

When it comes to social relationships, Iranians are far less confrontational and aggressive than others, says Ali Dastmalchian. “Iran appeared to have the lowest score on assertiveness,” whereas the US, for example, ranks toward the top (10th-highest). This means that in Iranian social interactions, communication will be rather indirect and much emphasis will be put upon “saving face.” But that can be misleading to people who do not know how to read this cultural trait. Iranian-American journalist and writer Azadeh Moaveni notes wryly that it is “unfortunate we have no word for passiveaggressive in Farsi, since it is half our culture.” Outspokenness and open criticism are unlikely, and subordinates will be expected to be loyal to their superior. The “tough on the issue, tough on the person” leadership approach found in the German business world would not work there.

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How to drive change and make it happen. Cultural understanding will play an important role in translating these findings into a development plan with individual milestones that can be effectively executed. “In traditional, hierarchical, and collectivistic societies like Iran,” Mirahmad Amirshahi argues, “change should start from the very top.” Alireza Omidvar says that “the cultural demand for compliance or initiatives to voluntarily go beyond legislation is not strong in Iran. This is also one of the issues that had strong effects on weak growth of corporate responsibility in Iran.” He recommends an approach that “must go beyond simple enforcement activities and employ a multi-layer policy to reflect cultural, economic and financial structures, habits and assumptions.” The culture of strong in-group collectivism will make it difficult to implement measures if change is driven by outside institutions. A corporate governance leitmotif? The first step is to look for an overall role model for the economic system and its corporate governance framework. Since the Islamic revolution in 1979, Iran’s social and business activities have been based on fundamentalist religious laws and regulations. Abdussalam Mahmoud Abu-Tapanjeh says: “The Islamic religion directly relates to all spheres of life, including how to conduct trade and commerce.” The preamble to the constitution of the Islamic Republic of Iran states very clearly that: “The Economy is a Means, Not an End.” As Abbas Ali Daryaei, a researcher at the Islamic Azad University, Iran, explains: “The aim of the Islamic economic system is to allow people to earn their living in a fair and profitable way without exploitation of others, so that the whole society may benefit.” This does not change the need for a corporate governance system that puts controls in place to help corporations meet their overall objectives, but it changes the way such a system is executed. In particular, it leads to a very specific definition of the role of the corporation, as it is not “seen as a device to create shareholder value. Rather, it is considered to be an autonomous economic entity constituting a coalition of various participants, such as shareholders, corporate management, employees, suppliers of goods and services, suppliers of debt and customers, striving for the continuity of the firm as a whole.” Bita Mashayekhi confirms: “Corporate governance in Iran is expected to optimize the interests of a broader group of stakeholders.” Not surprisingly, the “shareholder value” approach typically found in the US and Anglo-Saxon economies, and often taken as default model for corporate governance in the Western world, is seen in a rather critical light, especially by the conservative

wing of corporate governance theorists in the Middle East, whereas the “stakeholder” or “inside” models found in some European countries such as Germany or France are much more favorably viewed. The third way: Germany’s triple-bottom-line. Germany is a good example of an economy that has developed its own version of corporate governance. That system “has long emphasized cooperative relationships among banks, shareholders, boards, managers, and employees in the interests of labor peace and corporate efficiency,” says Jiatao Li. “A relatively strong emphasis on collectivism and avoiding uncertainty underlies the system.” Franklin Allen adds: “In Germany the legal system is quite explicit that firms do not have a sole duty to pursue the interests of shareholders,” Indeed, Article 14 of the German constitution fosters certain demands: “Property entails obligations. Its use shall also serve the public good,” which echoes the preamble to the Iranian constitution. Mervyn K. Lewis, adjunct professor at the University of South Australia Business School, calls this a “triple-bottom-line agenda, with its economic, social and environmental dimensions.” During the first 10 years after World War II, when the country was in a “vulnerable stage of its history,” according to Trevor Buck, it withstood the temptation to overly “Americanize” its corporate governance system, which shows the resilience of national culture. “Although the financial system and its role in corporate governance has evolved in an AngloAmerican direction, labor has maintained its strong influence within the company through works councils and board representation,” explains Sigurt Vitols, research fellow at the Berlin Social Science Centre. “The strong role of labor in Germany did not prevent the adoption of managerial practices oriented toward shareholder value, but conversely shareholder value did not undermine the strong role of employee influence and commitment to long-term employment practices,” says Ruth Aguilera. Germany’s “third way” is last but not least reflected in its unique terminology, Sigurt Vitols says. “Many German companies have taken pains to avoid using either the English term (“shareholder value”) or its direct translation into German, for example, with the phrase ‘wertorientierte Unternehmensführung.’” Empower the stock exchanges. In their research, Lawrence Brown and Marcus Caylor provide a good example of how empowering stock exchanges as regulators can enforce compliance with corporate governance guidelines. They describe how in 2003, the SEC approved several reform propositions for corporate governance improvement that were put forward by the American Stock Exchange (AMEX), the New York Stock Exchange (NYSE), and the

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Nasdaq Stock Market (NASDAQ). Companies are required to have a board with a majority of outside independent directors. Furthermore, processes for nominating directors and defining directors’ compensation need to be executed by independent committees. Failure to comply with these rules can lead to severe consequences, ranging from public “shaming” (by so-called “Public Reprimand Letters”) to de-listing. Develop professional board directors. As research shows, the concept of the “outside independent director” is unfamiliar in Iran and will take time to develop. “Good boards do not just appear overnight,” says Gholamhossein Davani, the Iranian managing partner of the global accounting firm RSM and a former member of the high council of the Iranian Institute of Certified Accountants. “They are conceived, nurtured, trained, instructed, advised, and rewarded over a period of years so they will be there when they are most urgently needed.” Availability is an important issue, finds Udo Braendle. Non-executive directors often hold middle-level positions in other companies and this, coupled with a busy board-meeting calendar, may leave them with very little time to devote to the essential day-today work of their boards. Gholamhossein Davani believes in directors who are not afraid to work hands-on: “Increased board involvement is a positive development in company management. If a board nominee is not prepared to be an active, inquiring, participating director, he or she should decline the offer to serve.” Given the non-assertiveness of Iranian culture, he calls for a quite challenging and unusual director profile. “The position requires an ability to learn what it is important to know about a business, and a willingness to study hard, ask questions, and form opinions. A director must have the intellectual curiosity to analyze a situation, must know how to raise concerns without being argumentative, and must relate well to fellow board members. The most helpful directors I have seen are those who study the company, ask questions because they really want answers, and provide supportive criticism.” Finding executives who can implement best-practice approaches from more mature economies while simultaneously navigating the complex cultural frameworks will be a challenge. One solution could be to target the Iranian diaspora—which might work, as long as candidates have not become too “Westernized” to understand the cultural codes of Iran. Another tack could be to nurture potential board directors from within the country.

“The most helpful directors I have seen are those who study the company, ask questions because they really want answers, and provide supportive criticism.” – Gholamhossein Davani Managing partner RSM

Create a corporate governance ecosystem. Once there is a critical mass of professional board directors, they should be encouraged to form networks by being on the board of more than one company. Amir Licht found that “more extensively connected, and hence more powerful, independent directors are economically and statistically positively correlated with shareholder valuations.” Again, the cultural dimension plays an important role, given the strong in-group collectivism of the country. “Outside board members with multiple directorships may not be able to provide valuable information because nobody will supply them with such information, which is reserved for in-group members,” says Licht. “A significant barrier in implementing good corporate governance was the unavailability of qualified staff,” says Udo Braendle. To diffuse the existing knowledge on corporate governance as well as to encourage discussion on the subject and the exchange of ideas, experts recommend conducting more research on board behavior and board effectiveness, not only on national level but with the inclusion of international participants to help develop best-in-class practices. We’ve seen movement in that direction. In May 2013, Iran’s first national Corporate Governance Conference was held in Tehran, with lectures and seminars on retail shareholders’ rights, board independence and accountability, investor relations, and internal auditing and control systems. Participants were drawn from the ministry of economic affairs, the financial services industry and the academic world. It was a small, but significant, first step.

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About the author Hagen Schweinitz Senior Client Partner hagen.schweinitz@kornferry.com +49 69 71670 251

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