BANK OF UGANDA
Remarks by
Louis Kasekende (PhD)
Deputy Governor, Bank of Uganda
At the 2017 Financial Reporting (FiRe) Awards
Kampala Serena Hotel; November 09, 2017
CEO of Capital Markets Authority,
President of the Institute of Public Accountants of Uganda
All captains of industry, and sponsors of the FiRe Awards,
Ladies and Gentlemen
Good evening!
I would like to begin by thanking the CEO of the Institute of Certified
Public Accountants in Uganda for inviting me to be chief guest at this
wards dinner and to commend the Institute and the other organisers and
sponsors - the Capital Markets Authority, the Uganda Securities
Exchange and the New Vision - for this very commendable initiative.
I hope it will lead to a greater understanding among the business
community in Uganda of the benefits which firms can derive by
preparing financial accounts that comply with best practise and global
reporting standards.
I want to reflect in these remarks on the contribution which financial
reporting makes to a developing economy and in particular the growth of
a modern business sector. The business sector in Uganda is dominated
by small and medium scale enterprises (SMEs); the most recent
comprehensive data which are available from the Census of Business
Establishments indicates that the average number of employees of a
registered business is only 2.3. As is the case elsewhere in Africa, SMEs
in Uganda struggle to expand. The vast majority of them never expand
enough to become large firms. Of the approximately 460,000 registered
businesses in Uganda, less than 1,000 have more than 50 employees.
One of the reasons why SMEs struggle to expand is the nature of these
firms. The majority are owned by a single proprietor or by a group of
related family members. The proprietor of the firm is often the manager.
The governance of these firms, including financial governance, tends to
be informal, without transparent rules, records and procedures. This
type of informal governance may be adequate for small companies but it
is a major barrier to their growth and expansion.
Firms cannot expand without mobilising capital for investment. Beyond
a relatively small size, the investment needs of a firm outstrip the
financial resources of a sole proprietor or a single family. Hence finance
must be mobilised from outside sources; i.e. from outside of the firm's
immediate ownership. From a business perspective, the ideal form of
finance for firm expansion is equity capital, because this is long term
finance and its returns are linked to the performance of the firm. Equity
capital from outside sources can be mobilised through private equity
placements or by selling shares on the stock market.
But to mobilise equity capital from outside sources, the existing
proprietor or proprietors must be prepared to share ownership of the
firm with new, probably minority shareholders. For their part, new
investors will only purchase equity in a firm if they are confident that
they will, as non-controlling shareholders, be treated equitably by those
who control the firm.
Some SMEs try to avoid bringing in outside shareholders to fund their
expansion by relying on debt finance instead of equity. But this often
leads to the failure of the firm. The maturity of debt finance is often
much shorter than the payback period of capital investments. Thinly
capitalised firms often have to devote a large share of their revenues to
servicing their debt and so are very vulnerable to adverse shocks to their
revenues or to the costs of debt servicing.
A second fundamental change which firms must make if they are to
expand successfully is the separation of ownership and management. As
a firm grows larger, its management becomes more complex and
demanding of professional and technical expertise. As such, a
professional manager or management team becomes essential. This
means that the micro-management of the firm by a sole proprietor is no
longer a tenable business practise. The proprietor or proprietors of the
firm must be prepared to step back from its everyday management and
instead focus on playing an oversight role as board directors of the firm.
These two types of changes which are essential for firm expansion - the
diversification of share ownership and the separation of ownership and
management - require fundamental changes in the governance of a firm.
The type of informal, non-transparent governance which characterises
small firms managed by a sole proprietor is no longer adequate for larger
and more complex firms with multiple shareholders and professional
managers. The governance structures of the latter must be much more
formal and transparent, so that all of the different types of stakeholders
in a firm can be confident that their own legitimate interests are properly
taken into account in the management of the firm.
One of the reasons why formal and transparent corporate governance
structures are necessary in larger firms is that complex organisations are
often vulnerable to what economists call "principal agent problems". An
agent is someone endowed with executive authority by a principal to
serve the interests of the latter. For example a chief executive officer is
appointed by the shareholders of a firm to serve their interests; in this
case the CEO is the agent and the shareholders the principals.
Principal agent problems usually arise when agents have incentives to
act in ways which are not in the interests of their principals and when the
latter lack the means to properly monitor and control the actions of the
former. Three main types of principal agent problems can occur in the
management of firms: between managers and owners, between
controlling and non-controlling shareholders and between a firm and its
creditors.
Proper corporate governance structures are a means to mitigate
principal agent problems and thus ensure that a firm can be managed
efficiently for the mutual benefit of all of its stakeholders. Because the
operations of a large complex firm involve a host of non-controlling
stakeholders, without effective corporate governance structures to
mitigate principal agent problems, modern business would not be
possible.
One of the most important components of effective corporate
governance structures are accurate and reliable financial reports. Other
key aspects are a clear legal framework which delineates the rights and
obligations of all of the different stakeholders and which can be enforced
effectively in the courts, and appropriate management and oversight
structures within the firm, with clear responsibilities for the firm's board
of directors. Financial reports provide a window into the operations of a
firm which can give all of its stakeholders the information that they need
to conduct transactions with confidence that they are not being taken
advantage of in any way.
For example, without accurate financial reports, minority shareholders
cannot be certain that the firm in which they have invested their wealth
is being managed in the best interests of all shareholders and not just
those who control the firm's management. Financial reports are essential
to enable a firm's board of directors to evaluate the managers they have
appointed. They are an essential tool for a firm's board of directors,
which is why a firm's internal auditor usually reports directly to the
board and not to the management, so that the board can be confident in
the veracity of the financial reports.
The requirements of modern firms for credit cannot be accommodated
satisfactorily by lenders unless the latter have confidence that a firm can
service its debts from its future revenues as a going concern, but such
confidence is only possible if lenders have access to reliable financial
information with which to evaluate the firm's business prospects. For
those firms seeking to mobilise capital by issuing equity or corporate
bonds on the capital market, a history of financial reports is a
prerequisite, because the institutional investors who are the main
customers for corporate stocks and bonds rely heavily on financial
reports to evaluate prospective investments.
To maximise the benefit of financial reports for all stakeholders, it is
essential that they be prepared according to international best practise,
such as the IFRS 9, which will become mandatory in Uganda, as in the
rest of the world, from the beginning of 2018. A common set of
internationally recognised standards for financial reports allows
everyone to understand precisely what the information contained in
them means. We also require high calibre professional accountants with
the requisite expertise to prepare financial accounts to the highest
standards. In this regard, I would like to commend the Institute of
Certified Public Accountants of Uganda for their efforts to uphold the
highest standards of accountancy and financial reporting in this country.
Finally, let me conclude by congratulating all the companies which have
won Financial Reporting Awards this year.
Thank you for listening.