10 Jun
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Ethiopian Share Company Law in Light of OECD Principles of Corporate Governance

This article critically analyzes the share company law provisions of the Ethiopian Commercial Code in light of the OECD (Organization for Economic Cooperation and Development) Principles of Corporate Governance. For convenience, it organizes and analyzes the share company law provisions corresponding with the structures of OECD Principles. The article identifies and demonstrates the loopholes and drawbacks of the share company law provisions that should be revisited and updated in light of the relevant OECD Principles of corporate governance.  

1.1  Enhancing the Legal and Regulatory Framework

The OECD Principles urge government policy makers should craft their legal, regulatory and institutional bases that ensure the effective and efficient corporate governance framework. It should foster market integrity and create incentives to different market players. The principles suggested three prerequisites for effective corporate governance framework. First, it should integrate effective corporate laws, regulations and voluntary codes and standards. Second, it should avoid overregulation and regulatory vacuum, as well as be to cost effective, equitably enforceable to all market players. Third, it should be supplemented by clearly allocated regulatory and supervisory powers with robust implementing institutions.

Nonetheless, as noted, the legal frameworks of some share company law provisions apparently failed to create incentives to market players and also failed to encourage transparent and efficient markets. To demonstrate these, the provisions requiring minimum capitals and memberships for the formation of share companies are inappropriate and unnecessary. These requirements not only discourage new pools of resources and investments but also contravene international best practices. Currently, several countries have abolished minimum capital requirement for two reasons. First, it is blurred and confusing because capital requirements are prone to accounting manipulation. Second, such provision neither protects shareholders nor creditors in the first place. Similarly, minimum shareholding requirement has two shortcomings. On one hand, it creates obstacles to form new share companies by less than the legal limits. On the other hand, it compels incorporated companies to winding up by the fact that company’s shareholder memberships are less than the legal limits. However, in practice companies may have less than the legal limit shareholders but may have several wholly owned subsidiary companies. Therefore, compelling to wind up such companies by mere reason of the reduction of membership to the legal limits is clearly unfeasible to the modern realities of corporate structures.

Second, the share company provisions have loopholes in the requirements of initial offering of shares to the public. The requirements of the initial offering of shares to the public provided from articles 317-323 of the Commercial Code are defective and inadequate. First, the contents of the prospectus under article 318 do not require an audit opinions of the financial information incorporated in the prospectus. Second, there are no requirements for approval and registration of the draft prospectus by regulatory authority before issued and offered to the public. In addition, the offering of additional new shares in article 469(5) or debt securities provided in articles 429-433 of the commercial failed to require financial reports to be prepared based on established accounting and auditing standards and audited by independent auditor. It also neglected to clearly articulate the liabilities of founders/issuers where the offered prospectus to the public contained untrue or misleading statements or omitted the relevant information for investors’ investment decisions. All these legal and regulatory loopholes of the share company law provisions will have potential impacts on investors’ investment decisions. This in turn not only creates loss of investors’ confidence in the Ethiopian capital markets but also results in market inefficiency, raises the cost of capitals and inefficient use of scarce resources in the country.

Third, the share company law provisions are not supplemented by other legislation. Including security laws, regulations, and voluntary codes and listing standards. Only two sets of laws regulating banking and insurance companies exist. For this reason, there are no stock exchanges or alternative trading systems for trading of shares in the capital markets. Hence, in Ethiopia company shares can be only traded by direct dealings between the shareholders and investors or informal contacts between the company and investors. Therefore, the legal and regulatory frameworks should allow the establishments of organized stock exchanges and alternative trading systems by considering the country’s business culture. The establishment of stock markets will have crucial roles for the existence of strong capital markets in Ethiopia. They will serve as markets organizer (companies share liquidity), information distributors (between investors and issuers), standard setters (setting the listing standards for companies), regulators (regulating their members based on sated standards) and as business compotators.

Forth, the share company law provides regulatory and supervisory powers solely to the Ministry of Trade. It also failed to mandate sufficient powers to the Ministry for regulating public companies from their incorporation to ongoing operations and corporate governance. The Ministry has very limited regulatory powers: registering and receiving companies’ reports; regulating share transfers between holding companies; reducing boards’ remuneration and ordering investigation of companies’ scandals based on shareholders petition. The Ministry’s supervisory roles are almost omitted in the provisions. Even after the finding of the investigation of companies’ scandals, there is no provision that allows the Ministry to take appropriate disciplinary action on failure companies. This regulatory framework is inadequate to protect investors and to avoid market inefficiencies.

Above all, the analyses demonstrated that the Ethiopian legal, regulatory and institutional framework is flawed to provide incentives to market players and failed to foster market integrity and promote effective and efficient corporate governance.

 

1.2  Strengthening the Basic Rights of Shareholders

Generally, the company law provisions show the basic rights of shareholders. These are: - right to ownership registrations, right to information, right to pare take and vote in the meetings of shareholders, right to transfer or sale shares and participate in the profits or proceeds of the company.  These ownership rights of shareholders are similar to the OECD Principles. However, except the rights to share the profits of the company, the other basic ownership rights of shareholders are not properly articulated. Thus, this section analyzes each of the basic shareholders rights on by one in light of the corresponding OECD Principles.

Registrations of ownership rights in the share company law provisions are two types: registered and unregistered ownership rights. In case where the company’s shares are bearer they are not registered and holders of bearer shares will not have secured ownership rights as advocated by OECD Principle II (B). Thus, any holders of bearer shares in bona fide may exercise the ownership right no matter how he/she obtained from illegal holders. Further, allowing companies to issue bearer and unregistered shares may contribute the concentration of anonymous ownership within the company. This in turn will have two drawbacks. Firstly, it hampers company’s transparency by creating opaque companies structures. Secondly, it leads to tax evasion and misuse of the company’s assets by corporate insiders to the detriment of minority shareholders and the company. Even to participate in shareholders meeting and exercise voting rights, holders of bearer shares are compelled to deposit their shares in the company before meetings of shareholders.

Information rights are another main tool for shareholders to make informed decisions in shareholders meeting. However, as noted in the share company law provisions, the modes, materiality and accuracy of information disclosed to shareholders meeting are deficient and inadequate. The methods of disclosure prescribed in article 392 are inadequate and in terms of cost effectiveness they are burdensome for the company. Correspondingly, the means of an accessing company’s information provided under articles 392(3), 406, 417, 422 and 427 of the commercial code are expensive for shareholders; rather it should be supplemented by requiring companies to publish full and material information in their company’s website, public media and send to each shareholder via e-mails. The share company law also failed to requires the disclosure of relevant information inter alia, voting procedures, the agenda of the meeting and the issues to be decided at the meetings. Especially when the board plan to alter the basic structures of the company such as amendments of companies’ statutes, issuance of additional equity/debt securities or extraordinary transactions of the company’s assets, full and timely disclosure of such information is not explicitly provided. Unless shareholders are fully informed the voting procedures, the agenda of the meeting and the issues to be decided at the meeting, it is hardly possible for them to make informed decisions at meetings of shareholders.

Shareholders voting rights are the main tools for shareholders to influence the company by participating and voting in the meetings of shareholders. As pointed out, shareholders are entitled to appoint/remove directors and auditors; determine the amount of directors’ remuneration and review their transactions with the company; pass resolutions to institute proceedings against liable directors; vote on the amendments of company’s statutes and approve the changes made on classes of shares by class holders. However, some prerequisites for shareholders to make better decisions in the meetings are not provided. These includes, allowing shareholders the right to ask questions, to put in place issues in the agendas and with certain limitations propose resolutions in the meetings. Similarly, it cannot provide shareholders the base to participate in the board nomination process before election. This enables shareholders to identify the qualified and appropriate board nominees.  It also failed to include their voting rights to via emails in absentia.

 

The share company law provisions also impose several voting caps that limit shareholders voting rights irrespective of their shareholdings in the company contrary to “one share one vote rules”. In fact, several European countries corporate laws adopt such voting restriction rules as opposed to United States “one share one vote rules.” Since the commercial code of Ethiopia patterned from the French commercial code, it imposes several voting caps on shareholders.  In this case, the OECD Principles neither take the position of “one share one vote rules” nor voting caps. Nevertheless, two drastic disadvantages are identified in provisions that restrict the number of voting rights in shareholders’ meetings. First, they diminish and redistribute shareholders control ownership over the company in proportion to their investments. Second, they hamper their incentives to pare take in the meetings of shareholders.

Before shareholders pass resolutions, the share company law failed to require full disclosure of the rules and procedures governing the holdings of corporate assets in the capital markets inter alia, mergers and extraordinary transactions. Such transactions play pivotal roles in the capital markets where they are fully disclosed to investors, executed in transparent and efficient manner and their prices are aligned with the interest of all classes of shareholders. Institutional investors under articles 328 and 398(2) of the commercial code have voting rights through proxies. However, they may not vote in fiduciary capacity where their interests are in conflict with the company as per article 409(1) of the commercial code. On the other hand, the OECD Principles promote institutional investors to vote in meetings of shareholders with the preconditions of disclosing their corporate governance, voting policies and procedures, and how their conflicts of interests are being managed.

Another basic ownership right of shareholders is the right to transfer/sale of shares or withdraws from the company. Free transferability or trading of shares in open or organized stock exchanges is the main distinct features of public companies. Free transfer of share facilitates the liquidity of public companies shares, so that investors can easily buy and sell shares in the capital markets. Contrary to this rule, article 333 of the commercial code allows the company’s statutes or resolutions of extraordinary meetings not only restrict the free transfers of sharers but also subject assignment of shares to approvals of boards. These restrictions will have two drastic shortcomings. First, it limits shareholders exercise of their key ownership rights. Second, it impedes liquidity of the company’s shares in the capital markets. Hence, the existence of this provision in the share company law is unfeasible with the distinct features of public companies.

Shareholders rights to withdraw or exit is provided under article 463 of the commercial code in cases where any changes are made in the nature or objects of the company or the company’s head office are transferred in abroad. Likewise, such rights are permitted in a narrow circumstance in others corporate laws on the assumption that greater numbers of shareholders exit may affect the capital integrity of the company. However, once the share company law allows shareholders rights to exit from the company, establishing stock exchanges and prescribing mandatory takeover bid provisions are very essential to guarantee shareholders full redress of their investments.

1.3  Improving the Equitable Treatments of Shareholders and Protections of Minority Shareholders

There are instances where boards, managements and controlling shareholders may participate and involve in activities that adversely affect the interests of the company and minority shareholders. Thus, the principle of boards’ fairness is crucial in corporate governance. It requires boards and corporate managers to equitably treat all shareholders and protect companies’ assets against misuse by corporate insiders.

As illustrated above, the share company laws prescribe some relevant provisions regarding the equitable treatments and protection of minority shareholders. The same series and classes of shareholders have the same rights and any subsequent changes require prior approval by class holders. Shareholders have right to subscribe additional new shares.  They have the right to qualified majority or unanimous vote on amendments of the company’s statues. They have the right to withdraw from the company subject to prescribed preconditions. Shareholders representing 10% of the share capitals of the company have also the right to call shareholders general meetings pursuant to article 391(2) of the commercial code. Groups of shareholders having different legal status have the right to elect at least one representative as a board member and shareholders having 20% of share capitals of the company have also the right to appoint one auditor.

The last two share company law provisions are called cumulative voting systems. They assist minority shareholders to strengthen their voice within the company by electing their representatives in board members and auditor proportion to their shareholdings. These are exceptions to ordinary voting systems which confer controlled shareholders to elect the whole board members and auditors. All the above provisions are to some extent incompliance with the standards of OECD Principles III.

However, since providing adequate basic ownership rights of shareholders are prerequisite for incentivizing boards to improve the company’s efficiency and solid financial markets, the current share company law provisions should be strengthened. It should prescribe additional ex-ante and ex-post provisions that enhance the equitable treatments of shareholders and the protection of minority shareholders. In these case, shareholders voting rights should be extended by mail, custodian or nominee of shares (OECD Principles III, A (3and5) of Annotations. The share company law under article 401 also stipulated another hindrance that compels shareholders to deposit their shares before the general meetings. This requirement has two disadvantages. First, it imposes unduly impediments to shareholders to cast votes. Second, it has the potential means for controlling shareholders to block minority shareholders from selling their shares for certain days.

 

The main challenges in public companies corporate governance is the misuse of companies’ assets by majority shareholders to the detriment of minority shareholders and the company. In this case, the share company law provisions had loopholes. It failed to adequately protect minority shareholders from corporate insiders and abusive self-dealings by or in the interests of majority shareholders directly or indirectly. Abusive self-dealings and insider trading by controlling shareholders can be exercised in the forms of electing their family or friends in board members, participating in related party transactions, pursuing personal and political agendas at shareholders meetings and extracting the profits of subsidiary companies in pyramid business structures.[xxxiv] Such activities of controlling shareholders are identified as impediments of the development of capital and financial markets.  As a result, the OECD Principles III (B) called for policy makers to prohibit such activities and fill the gaps. Hence, the share company law has to provide legal protections to minority shareholders in two ways. In one hand, impose fiduciary duties on controlling shareholders. On the other hand, require review of their transactions with the company by independent directors coupled with full disclosure and faire accounting treatments.

The share company law prohibits directors’ loans and any business transaction with the company directly or indirectly requires a prior approval of boards and auditors notice.  However, it neglected to include the general managers.  Especially, the gaps become apparent when as per article 348(3) of the commercial code the general managers are not members of the boards. Consequently, by using this loophole, general managers may abusively transact with the company without disclosure and subject to prior approval of boards. It also missed to cover the director’s transactions with the company on behalf of third parties and their families. These loopholes are not only detrimental to minority shareholders but also to the whole shareholders and the company. Similarly, the share company law failed to provide to minority shareholders rights to derivative actions against the directors or controlling shareholders resolutions or third parties on behalf of the company once they have reasonable ground to believe that their rights are violated (OECD Principles III, A (2) Annotation). Contrarily, article 365(3) of the commercial code blocked minority shareholders right to institute proceedings against the liable directors where one fifth of share capitals of shareholders vote against the resolution.

Finally, Fekadu Petros also clearly demonstrated the inadequacies of minority shareholder protections under the share company law. He took five criteria adopted by authors La-Porta, Lopez-de, Shleifer and Vishny and six criteria adopted by author Pistor’s. After evaluated the two different criteria developed by those authors one by one corresponding with the relevant share company law provisions, he concluded that the level of minority shareholder protections under the Ethiopian share company law only comply with two of both the five and six criteria.[xxxvi]

 

1.4  Addressing the Interests and Roles of Stakeholders within the Share Company

As noted previously, corporate governance framework integrates private voluntary internal governance of the company and mandatory regulations of external governance of the company. Both internal and external governance framework intends to ensure the effective functioning of companies in the creations of wealth by minimizing costs. To attain these corporate objectives, there are two long lasting debates by legal scholars and policy makers in shaping the structure of corporate governance framework and the roles of companies. These debates are “shareholders’ primacy approach an Anglo- American model” in one hand and “stakeholders’ primacy approaches Germany and Japanese corporate governance models” on the other hand. Berle, one of the leading proponents of the first approach dictated that boards and companies managers should direct the company for the sole interests of maximizing shareholders profit by disregarding the interests of stakeholders. On the other hand, Dodd proponents of the second approach contended that boards should direct the company not only for the interests of shareholders but also for the interests of various stakeholders who make “firm specific investments” within the company. In the second models, bank creditors and employees are entitled to represent in board members and other stakeholders have also an influential voice in the governance of the company.

However, through time these two contending approaches converge into another theory called an “enlightened shareholders value” approach. According to this approach, for the long term profit maximization of shareholders and sustainability of the company, the decisions of the board should align the interest of shareholders profit maximization with the interest of stakeholders. Recently, this approach is to some extent reflected even in the “Anglo-American corporate governance model.” For instance, in United States more than 25 States enacted “constituency statutes” which permit boards to take into account the concerns of stakeholders in their decisions. Similarly, the United Kingdom Companies Act requires boards to promote the interests of stakeholders.[xli] However, in both cases their statutes failed to clearly articulate stakeholders substantive and procedural enforceable rights in the corporate governance of the company.

Similarly, the OECD Principles apparently takes the position of the “enlightened shareholders Value” approach. They recommended corporate governance frameworks should address the interests of stakeholders provided by laws and contracts.  Once national laws and contractual agreements addressed stakeholders’ interests, they should obtain all reliable and material information timely and regularly in order to proactively participate in company’s corporate governance process. In case where their rights are violated, they should be fully compensated. The principles particularly emphasised that to enhance companies’ performances, employees should be allowed to engage in the corporate governance of the company. Participation of employees may vary board member representations or consulting representatives of workers council on core company decisions or participate in the company’s shares or profits depending on national laws. The principles further advocate corporate governance frameworks are expected to have effective and efficient insolvency laws and robust enforcement of creditors’ rights.

From these analyses and discussions, the share company law provisions ostensibly adopted the traditional “Anglo- American models” of corporate governance of shareholders’ primacy approach. As a result, it entirely disregarded the interests of stakeholders within the company except rights of creditors. Only company’s creditors are permitted in certain circumstances to participate and vote in meetings called by their representative, company’s directors or by 20% of debt holders on matters related to the effective enforcement of their rights on debtor companies.[xlii] Correspondingly, companies’ directors are liable to creditors under article 366(1) when they failed to preserve the assets of the company. Under articles 362, 363 and 364 of the commercial code, directors are only accountability to the laws, shareholders and the company. These provisions entirely disregard and failed to address the interests of employees, suppliers, customers, the community and environments as a whole required by the current United Kingdom Companies Act of 2006 and OECD Principles IV. 

Here, one may argues that as long as directors are accountable to the company and the law, the interests of stakeholders are recognized under the share company law impliedly. Nevertheless, it is undeniable that with the exception of creditors, other stakeholders have no recognized substantive or procedural enforceable rights in the share company provisions. Unless stakeholders’ interests are addressed and their roles of engagement are clearly articulated, they may not claim to engage in the corporate governance of the company. In particular, employees and other stakeholders should be allowed to communicate with boards when there are malpractices within the company. It is obvious that malpractices by company managers not only detrimental to stakeholders and the company but also have potential risk to an overall country’s financial soundness and economic developments.

In contrast, article 5 of the Ethiopian National Bank Directives unequivocally prohibited bank employees from board members representation.[xliii] From this, it is reasonable to infer that the policy objective of Ethiopian corporate governance framework declines to address the interests and roles of stakeholders in the corporate governance of the company. At least the Directive should allow companies to determine whether or not employees are allowed to be represented at board members. Conversely, such clear prohibition will have disincentive for employees to apply their human capitals in the banking companies.

Since cooperation between stakeholders and companies are important to generate wealth, jobs and long run sustainability of companies in the country, the share company law should address the interest of stakeholders. More importantly, Ethiopian companies are unsophisticated, labour intensive and lacks credit access. As a result, addressing stakeholders’ interests and promoting their active cooperation with the company will be essential for the long term shareholders profit maximization and companies’ financial sustainability. On the other hand, the long term shareholders profit maximization and companies’ financial sustainability would be at risk unless the share company law provisions adequately address stakeholders’ interests within the company.

1.5  Setting Minimum Disclosure and Transparency Standards

Companies’ transparency is among the four pillars of corporate governance. It requires timely disclosures of all relevant and accurate information that reflects the “true and faire view” of the company’s financial performance and corporate governance. Disclosure requirements comprise both mandatory laws and voluntary codes. In both cases, a strong corporate disclosure regime will have three advantages. First, it enhances companies’ transparency. Second, it enables shareholders to make informed decisions and to monitor boards’ stewardship towards the company and themselves. Third, it serves as main tools for regulators to supervise and control corporate malpractices for the protection of investors and avoiding market inefficiencies. Therefore, a strong disclosure corporate governance framework assists to attract capitals and foster investors’ confidence on the capital markets whereas poor and inadequate corporate disclosure deter the proper functioning of capital markets, raise costs of capitals and result in poor allocations of resources.

In Ethiopian corporate governance framework context, disclosure and the transparency of companies are neglected and almost impossible at the current situation.[xlvi] The share company law provisions failed to clearly articulate the minimum standards of companies ‘disclosure of all relevant and reliable financial and non financial information timely and regularly. In addition, there are no other mandatory or voluntary disclosure standards in the country.

Financial and non financial disclosure requirements in the share company law provisions noted above is insufficient and defective. The financial disclosure requirements provided under 419(1), 446, 447 and 448 of the commercial code failed to comply with international financial reporting standards and best practices (OECD Principles V (B&C)). The financial reports required by these provisions only cover balance sheets and profit and loss accounts. They neglected other important components of financial reports (companies’ cash flows and income statements, and any equity changes, recognized gains or losses statement). Moreover, the share company law provisions had loopholes to require auditors to apply established accounting and auditing rules and standards. It also failed to require independently audited financial reports. Further, even company’s auditors have no established accounting and auditing rules and standards in the country to apply in their auditing functions. Unless independently audited and prepared based on established accounting and auditing rules and standards, it is hardly possible to expect that the financial statements truly and fairly represents the company’s financial position and performance.

Similarly, non financial disclosures are very limited and only included publishing the name, nature, capitals, head office and the place of the meetings in the commercial newspaper as per articles 392(1) and 396 of the commercial code. However, these disclosure requirements are not applicable when all shareholders are registered shareholders. The disclosure of shareholdings between parent and subsidiary companies as per article 344 of the commercial code and disclosure of companies directors’ civil status, professions and their directorship to other companies as per article 359 of the commercial code. These non financial disclosure provisions missed the basic elements of disclosure standards. These includes, companies’ ownership structure and voting rights, related parties’ transactions, companies’ objectives and potential risk factors, corporate governance structures, procedures and policies and how they are implemented (OECD Principles V, (A)2-8)). Such disclosures are vital for investors to decide whether or not to invest in a particular company. More severely, there is no channel of disseminating even these limited companies’ information to the public. Rather, they are kept in the companies or the registrars of the Ministry of Trade. So there is a complete information asymmetry between investors and companies in the current corporate governance framework of Ethiopia. Thus, there should be minimum mandatory and voluntary disclosure standards requirements that do not burdensome to the companies or endanger their competitiveness in the markets.  

1.6  Expand the Duties and Responsibilities of Boards and Auditors

As discussed, boards have given three broad responsibilities in the governance of the company. They are responsible to strategically directing the company, overseeing of managements and stewardship towards the shareholders and the company. In doing so, their composition and structures may be one tier, two tiers or additional statutory board structure. In terms of board member compositions, the share company law contains controversial provisions. There may be three types of board structures under the share company law. First, article 348 (3&4) of the commercial code clearly stipulated that the general manager is an employee of the company and may not be members of the boards. Therefore, in this case all board members become none-executive. Second, article 363(2) of the commercial code provides that the articles of association should determine whether all boards or one/more board member are managers of the company. In this provision, there will be two possible board structures. In one hand, in case where the articles of association assign all board members to be managers of the company, all the boards’ composition become executive directors. On the other hand, in case where the articles of association only specifies one/more directors as manager of company, the rest of board members are non executives and the composition becomes executive and non- executive boards. Thus, the two provisions seem to contradict and needs to harmony to avoid confusion. Especially, it will be more difficult for boards to make objective and independent judgement when all boards are assigned by articles of association as managers of the company pursuant to article 363(2) of the commercial code.

Accountability of boards is among the four pillars of corporate governance and hence they are required to effectively overseeing managements and accountable to shareholders and the company. As noted above, boards have two fiduciary duties while discharging their responsibilities: “duty of care and duty of loyalty.” Duty of care refers the possible best performance of boards in the discharging of their duties entrusted on them whereas “duty of loyalty and faire dealings” refers the supremacy and prevailing of the interests of shareholders over the boards. Boards of directors not only under article 364 (3) have a general duty to perform with due care in overseeing the managements of the company but also they have the responsibility to demonstrate that they are acting with due diligence and care as per article 364 (5) of the commercial code. Hence, in this case the share company law is in compliance with OECD Principle V (A). However, the relevant requirements of act in fully informed and a bona fide basis are missed. Both these to requirements are crucial for boards to discharge their duties with “due care and diligence,” especially those boards who are not executive members. In the absence of fully informed basis, it would be difficult for boards to act upon with “due care and diligence.”

As discussed, article 358 of the commercial code requires boards decisions must be taken with an absolute majority. Nonetheless, this article only provides the quantitative and missed the qualitative requirements of board decisions. Since the decisions of the board may affect different classes of shareholders, they should make objective and independent judgments which align the interests of all shareholders with the stakeholders (OECD Principles VI, (B&C)). So in this case, the share company law should make clear that board decisions must be not only absolute majority but also treat all shareholders equitably and take into account the interest of companies’ stakeholders. Act in due care and deal in fairly (loyalty) also requires boards to establish and apply ethical standards in the company. In this regard, the share company law provisions ignore to prescribe requirements of boards to adopt an appropriate ethical code of conduct to evaluate their own acts and companies managers. 

The core functions of directors discussed under article 362 (a-g) of the commercial code are more procedural and neglected substantive duties and functions of boards. This provision failed to prescribe how boards strategically direct, review companies risks policy, overseeing managements and the effective compliance of the company’s governance practices. It also failed to set out their roles in nomination and election of board members; supervising and managing conflicts of interests with the company and corporate insiders, and monitoring company’s disclosures (OECD Principles VI, D).

Even though article 361(1) of the commercial code requires boards’ balance sheet to clearly show the total amount of remuneration, it failed to align with long run interests of shareholders and the company. Unless boards’ remuneration policy shows such alignment, shareholders may not properly determine the boards’ remuneration. Similarly the share company law failed to state how managers’ remuneration is determined. Especially, as per article 348(3 and 4) of the commercial code managers are outside board members, failing clearly articulate may have potential impacts on the company’s transparency and may result in managers corporate abuse.

 

Key functions of boards to review related parties transactions other than directors are not stated in the share company law provisions. Needles to say, the accounts and books prepared under 362 (b & c) of the commercial code are not audited by independent auditor and failed to comply with the international financial reporting standards. Without accounting and auditing standards and independent auditor, it would be difficult for directors to ensure the integrity of the company’s accounts and financial reporting systems. 

Independent and objective judgements in corporate affairs are essential elements for boards’ stewardship towards shareholders and the company. To deliver independent and objective judgements and avoid conflicts of interests, the existence of non-executive and independent board members in the company is crucial. In this case, the separation of chairman man of boards and manager pursuant to 348(1&3)) of the commercial code is one step. However, as illustrated in the above paragraph, there is the possibility that all board members are executive directors as per article 363(2) of the commercial code. In such case, there will be apparent conflicts of interests when executive boards review their own transactions with the company pursuant to article 356 of the commercial code. Board members are collectively responsible to exercise their duties and responsibilities according to the law, the company’s statutes and resolutions of shareholders meeting under article 364(1) of the commercial code. This provision imposes on boards’ cumulative responsibility though they may act individually.

In the case of auditors, the share company law has two drastic loopholes. First, it failed to require auditors to carry out their accounting and auditing functions based on established rules of accounting and auditing standards. Second, it failed to require minimum qualification to be eligible an auditor or holding a practicing license issued in accordance with the regulations of the country’s accountancy professions. Finally, the share company law also failed to provide boards and auditors liability of failures to observe the sated accounting, auditing and financial reporting

Conclusion and Recommendations

It is undeniable that formulating and establishing appropriate and effective legal, regulatory and institutional framework are a prerequisite for good corporate governance in Ethiopia. The existence of good corporate governance framework within the country will not only foster market integrity, improves economic efficiency and development but also builds investor confidence. As the share company law is one of the major components of corporate structure of the country, this article critically analyzed whether the Ethiopian share company law envisaged such outcomes or not in light of the six minimum standards of OECD Principles of corporate governance. The findings of this article demonstrated that the Ethiopian share company law legal and regulatory framework apparently failed to intend to achieve these outcomes. Rather, the legal and regulatory framework of the share company law provisions lagged far behind from the new markets development and concerns of complex corporate governance issues. The government of Ethiopia has also already recognized the inadequacy of the entire commercial code and committed to draft a new one.

Hence, formulating an appropriate and efficient share company law that reflects the modern business realities and accommodates the demands of different market players in the country is very importance. As noted above, the OECD Principles of corporate governance will have relevancy to improve the legal, regulatory and institutional framework of Ethiopian corporate governance by taking into account its national legal, economic and business practices. Therefore, to update the share company law provisions with the modern markets development and concerns of complex corporate governance issues, this article advocated that consulting the relevant OECD Principles of corporate governance as a reference and benchmark is worthwhile. It also recommends that the identified gaps and shortcomings of the share company law provisions should be rectified during the drafting of the new commercial code.

 

This article depicted that the requirements of minimum capitals and shareholders membership to form share companies have no relevance to protect shareholders or creditors. Rather, they will discourage pools of new capital investments; consequently these two provisions should be revised. It also identified that the requirements to incorporate or increase the capital of share companies through the offering of equity or debt securities to the public have three major loopholes. First, the financial reports incorporated in the initial prospectus offered to the public neither incorporate auditor’s opinions nor approved and registered by Ministry of Trade. Secondly, in the offering of additional equity or debt securities, the provisions failed to require the prospectus to include independently audited financial reports. Thirdly, there is no provision that makes founders or issuers liable when the prospectus offered to the public contained misleading or inaccurate statements or omitted the relevant information. Thus, to protect investors and avoid markets inefficiencies all these gaps should be filled.

In addition, the share company law legal framework should also require supplementary laws and regulations, including voluntary codes and standards. Illiquidity of shares and lacks of credit accesses in the capital markets are the main challenge for Ethiopian share companies. In this regard, allowing the establishment of stock exchanges and alternative trading systems will have crucial roles. Without stock exchanges and alternative trading systems, there will not be strong capital markets within the country. The share company law should also allocate adequate and sufficient regulatory and supervisory powers to regulators. Thus, besides to the Ministry of Trade, there should be clear allocation of regulatory and supervisory powers among government and private agencies subject to avoiding over regulation and conflict of powers.  

With regard to the basic ownership rights of shareholders, allowing companies to issue bearer shares have three identified disadvantages. First, it failed to confer secured shareholders ownership rights. Second, it deters companies’ transparency. Third, this may lead to evasion of government taxes and abuse of company’s assets by mangers. Thus, article 325 of the commercial code needs to be rectified. This article also suggested that shareholders right to information provided in the share company law is inadequate and should to be revised. Especially, shareholders should have the right to be informed about the voting procedure, the agenda and the issues to be decided before they participate and vote at the meeting. Similarly, article 397(2) of the commercial code that prohibits shareholders to put in place items in the agenda at shareholders meetings should be avoided. Instead, they should be promoted to ask questions, forward issues to put in place on the agenda and propose resolutions subject to certain limitations to prevent abuses. Shareholders right to vote in proxy should also include voting via E-mail. Since voting restrictions of shareholders diminish control ownership and disincentive to participate in shareholders meetings, such provisions should be liberalized as much as possible. It would be advisable not to impose restrictions more than half of the share capitals of the company. Therefore, make it clear that at least half of the capitals of the company’s shares should be ordinary shares. Moreover, restricting free transfers of shares in public company impedes liquidity of the company’s shares in the capital markets. As a result, article 333 of the commercial code should be deleted. To make enforceable shareholders right to exit provided in article 364 of the commercial code, introducing stock markets and prescribing additional mandatory takeover provisions would be very crucial.

To protect minority shareholders from corporate insiders, the share company law should clearly prohibit direct or indirect insider trading and abusive self-dealings within the company, including controlling shareholders. In this case, two mechanisms can be devised.  First, transactions between controlling shareholders or/and managers and the company should be reviewed by non-executive boards. Second, provisions can be made that impose a fiduciary duty on controlling shareholders. Cumulative voting rights of minority shareholders provided under article 352 of the commercial code is vague and unclear; consequently it should explicitly refer each class of shareholders. Compelling shareholders to deposit their shares before the meetings of shareholders has the potential to block minority shareholders from selling their shares for certain days. Hence, article 401 of the commercial code should be relaxed to the extent possible. Likewise, article 365(3) of the commercial code that restricts minority shareholders right to institute proceedings against liable directors should be avoided. Rather, minority shareholders should be allowed the right to derivative actions when they have a reasonable ground that their rights are violated. Nonetheless, devising appropriate mechanisms should be made to prevent using of such rights for abusive purpose.

Since stakeholders are an integral parts of company’s capital resource, clearly addressing their interests and roles within the company will improve the financial sustainability of the company and the development of the economy. In this regard, the share company law should at least require the accountability of boards to the interests of employees, creditors, suppliers, customers, the community and the environment as a whole. To the extent possible, provisions may also be made that permit companies employees to engage in the corporate governance of the company. 

Regarding companies disclosure and transparency, poor disclosure regime deters effective functioning of capital markets, raises costs of capital and result in poor allocations of resources. As a result, the financial disclosure provided in the share company law should include companies’ cash flows and income statements, and statements of any equity changes and recognized gains or losses. The financial reports should also be prepared based on established accounting and auditing standards and be audited by independent auditor. Equally, minimum mandatory and voluntary non-financial public disclosures should be provided. Especially, companies’ ownership structures and voting rights, related parties’ transactions, companies’ objectives and potential risk factors, and the company’s corporate governance structure are very importance.

With regard to boards, the contradicted provisions of articles 348(3&4) and 362(2) of the commercial code that prescribe the compositions of boards should be harmonized. Since allowing companies’ statutes to assign all board members as managers of the company will make boards incompetent to deliver independent and objective judgments, it should be rectified. Boards decisions provided under article 358 of the commercial code should also qualify objective and independent judgments for equal treatments of all classes of shareholders. The provisions of boards’ duties, functions and liabilities set out in articles 362, 363 and 364 of the commercial code should clearly articulate how boards strategically direct and review companies risk policy; supervise managements and controls conflict of interests. It should also provide how companies’ managers are remunerated and compensated.

Boards’ review of related parties’ transaction with the company should extend to managers and controlling shareholders. For this, boards should be required to apply an appropriate ethical code of conduct to evaluate their own acts and control managements. The boards’ books and accounts should also clearly show that the financial reports are prepared according to established accounting and auditing standards and audited by independent auditor.

 

Regarding auditors, the share company law should require auditors to carry out their auditing functions based on established accounting and auditing rules and standards. It should also prescribe the minimum qualification to be eligible an auditor or holding a practicing license issued according to the regulations of country’s accountancy professions. Finally, the share company law should stipulate applicable penalties on boards and auditors who failed to observe accounting, auditing and financial reporting standards.

Gebeyaw Simachew

The blogger has acquired his LLB from Haramaya University in 2007 and in 2012 he acquired LLM on International Corporate Governance, Financial Regulation and Economic Law form University of London. The blogger has special interest on corporate governance, commercial code and financial regulation.