Corporate Governance and Management Control Systems in European Co-operatives

CORPORATE GOVERNANCE AND MANAGEMENT CONTROL SYSTEMS
IN EUROPEAN CO-OPERATIVES

The following document was written by Mr. Reimer Volkers and Mrs. Moira Lees, CWS, Manchester within the framework of the ICA Europe work programme concerning "Corporate Governance and Management Systems in European Co-operatives". The text is the result of analysis and inverviews caried on in 1994-95 and of the Seminar of ICA Europe held in St.Petersburg in July 1995.
For any further information please contact the
ICA Europe Secretariat
Arsenio Invernizzi or Gabriella Sozanski
phone: 41-22-929.88.33 or 929.88.31
fax: 41-22-798.41.22
e-mail: icageneva@gn.apc.org

GENERAL TRENDS, FINDINGS AND RECOMMENDATIONS
Table of Contents
I. Reference and Working Procedures
II. Co-operative Objectives
III. Co-operatives and Membership
IV. Formal Democratic Structure
V. External Control (Auditing)
VI. Education and Information
VII. Financial Involvement
VIII.Findings and Recommendations
IX. Co-operatives in Eastern and Central Europe
I. Reference and Working Procedures
Since the beginning of 1994 the review of corporate governance and management control systems in European co-operatives has been a top priority within the work of the ICA Region Europe.
This topic came to the fore because more and more co-operatives in different sectors and different parts of Europe had experienced grave problems, which have threatened the profile and identity of the whole co-operative system. These problems include mismanagement, financial scandals, poor management control, growing distance between members and their co-operative society, failure of democracy and an unbalanced relationship between management and elected lay directors. Similar experiences appear to be common and therefore, for all co-operatives, there are valuable lessons to be learned and dangers to be avoided.
On behalf of the ICA European Council an in-depth study of the problems mentioned above was made in 1994, with particular respect to four co-operative sectors: consumer, agriculture, banking, and housing. Similar findings may be true for other co-operative sectors. The review was based on personal interviews with around 45 key persons in several European co-operatives. In addition various books, articles and published research have been considered.
After having presented a detailed analysis of the specific problems in the four sectors to the ICA European Council in Seville in May, 1994, a second summarized report was submitted to the Regional Assembly of the ICA Region Europe in Prague in October 1994. This report was also published in the Review of International Co-operation 3/94 providing co-operatives in other parts of the world with the opportunity to evaluate the findings and recommendations.
In order to discuss further some important aspects of the Corporate Governance report a seminar was held on the 11th July, 1995 in St. Petersburg. The lectures and discussions focused on Governing Bodies, balance of power between elected lay persons and management as well as on strengthening ties with members (see Annex 1). Information about the findings of the Governance project was given to the ICA Congress, October 1995 in Manchester.
This final report can only touch upon the most important trends and common problems and ends with some conclusions and recommendations which have been discussed and agreed upon during the presentations. It has not been possible to deal with the specific differences that exist from society to society. There are still a lot of societies in all sectors which are operating successfully with good governance and management control systems.
II. Co-operative Objectives
The main objective of co-operatives today, as in the past, is to promote the interests of members. This was also underlined by the statement on the Co-operative Identity adopted on the ICA Congress in Manchester October 1995 (see Annex 2). Additional objectives include: to safeguard the right of consumers, to protect the environment, to work for healthier products, to offer information and education and to pursue social activities as a form of solidarity.
Without members there exist no co-operatives. Members are the owners, goalsetters and users of their own organisation and have in this context to safeguard good governance and management control systems. That means in relation to their jointly owned and democratically-controlled enterprise.
The members expect from their co-operatives good performance including special benefits. This could be high selling prices for agri-products, accommodation of a good standard and at reasonable prices, comprehensive financial services, low prices/quality products, special offers, discounts, bonus-payments, dividends etc.
An efficient and profitable business operation is an absolute precondition to reach the economically based targets for member promotion.
III. Co-operatives and Membership
Co-operatives and their central institutions have large market shares within their respective fields of activities and employ significant work forces. The overall figures include, however, very different sizes, structures and development in each European country. Planned expansion and profit goals have not always been reached. In some countries co-operatives have stagnated or failed with heavy losses e.g. consumer co-ops, banks, agriculture co-ops.
With a membership of around 75 million, the four co-operative sectors still hold a strong position within the West European population. Continuous increases can be noted within the housing co- operatives and co-operative banks in larger towns and communities, whilst decreases can be observed within the consumer and agricultural co-operatives.
The recruitment of new members has frequently been neglected because of insufficient resources and information. Too often the members have been regarded by management as a necessary evil; as a hindrance for quick decisions and expansion. The business transacted with non-members has grown considerably. As a consequence, the interest and loyalty of members is often very low. From their role as owners and goalsetters, the members are changing to mere customers, interested in immediate benefits from the society or elsewhere. The co-operative profile has become blurred and interchangeable with that of private competitors.
At present, however, there is evidence of some change. In several co-operative organisations there is lively debate and action programmes introduced to revitalize membership. It is increasingly recognized that good economic performance is a precondition to serving the members properly and also in offering them special benefits.
In general, members of agricultural marketing societies and housing co-operatives are far more interested in the economic activities of their society than members in the consumer and banking sector where many alternatives exist in the market place.
Despite varying interests between the co-operative sectors, it can be observed that the participation of members within the formal democratic structure is low. The distance between members and societies has grown, especially in large-scale societies.
Some of the reasons are:

poor performance, no benefits from the society.
members do not know very much about the special characteristics of co-operation in general, and about their society specifically, due to lack of information, Management is not really interested in membership.
members do not feel at ease with the growing size and complexity of the business operations.
members do not want to take responsibility or offer their spare time. They want to use the services and obtain the economic benefits, but do not want any other involvement.
genuine membership rights are transferred to delegates who are often not known to the ordinary members.
active members are disappointed about the real opportunity for influencing and controlling the operations of the society and consequently they resign from the Governing Bodies.
rotation within elected delegates and members of the Boardrooms is low, giving interested members very limited chances to participate.

IV. Formal Democratic Structure
The formal democratic structure is similar in all countries and co-operative sectors, with some variations in detail. Within this structure both the monist and the dualist systems are used: Shareholders' Meetings, Board of Directors/ Shareholders' Meetings, Supervisory Board, Executive Board.
Annual Shareholders' Meetings are either open to all members (in small and medium sized societies and most British consumer co-ops) or only to delegates. Delegates are elected for between two and four year terms at district meetings or on tickets (lists) voted upon in special election offices or by letter. On average, participation in elections is low. Elections are rarely contested. Often it is difficult to find a sufficient number of candidates.
The duties for Shareholders' Meetings are almost the same in each country and co-operative sector. These include the approval of the annual accounts and balance sheet, elections of Board members, change of rules, decision about mergers, election of auditors.
Critical comments and questions to the Senior Management (CEO) about the current situation and development of the society are rarely heard in many Shareholders' Meetings.
The Board of Directors/Supervisory Board is elected for a two to four year term. Except for being a loyal member, no formal qualifications for candidates are required. In many co- operatives, elections are not often contested but this has increased somewhat during recent times. It is known and generally accepted, that candidates are often preselected and proposed by the sitting Board and chief officials. Re-election is possible and frequent.
In the monist system, it is the Board which legally exercises the ultimate power and responsibility in all matters of the society but it delegates the running of the daily operations to the chief official (CEO) and his management team who are appointed/approved by the Board. In some countries and societies, the chief official is member of the Board e.g. in Sweden, or its President e.g. holding the office of PDG in many French and Italian societies, thus putting him in a very strong position.
In the dualist system, e.g. in Germany and Austria the exact responsibilities of the Supervisory Board and the Executive Board are laid down in the co-op laws and/or rules of the society.
The Supervisory Board monitors closely the development of the operation and performance of the management, examines the financial statements and balance sheets, follows up the results of the auditors and, most importantly, appoints and removes the Executive Board. The Executive Board runs the business in its own right and in the framework of given guidelines and limitations set by the law and the statute of the society. In large societies, the Executive Board consists increasingly of full time salaried executives only.
Employee representation in the Boardrooms i.e. elected by the employees, is governed by workers' participation laws or by voluntary agreements. Representation ranges from nil to 50 per cent. Severe conflicts of interests between employee representatives and the general interests of members were not reported but, realistically must occur in case of crisis, staff reductions and closures. Urgent changes and decision making may be slowed down because of such conflict of interest. On the other hand, there are also examples e. g. Sweden) where employee representation helped to implement necessary changes.
In Great Britain, most consumer co-ops have some directors who are employees but who are elected by members. This can cause conflicts as mentioned. The Registrar of Friendly Societies is limiting numbers of employees to below quorum level.
The frequency of Board meetings varies between six and twelve times a year, with dates set beforehand e.g. up to one year. In general the attendance is high, up to 90 to 100 per cent. A varying degree of sophisticated information is sent out before the meetings, supplemented by further documentation and reports by senior management at the meeting.
To a varying extent the Boards, especially of larger societies, work with sub-committees on specific areas, such as finance and financial accounts (auditing), investments, membership, personnel, loans etc. A special committee chaired by the President is often responsible for preparing the appointment of chief officials and senior management and determining their remuneration package.
Only a few women are represented on the Boards, which means that they do not necessarily represent the interests of all members, especially in those societies with a large share of women within the membership.
In all West European co-operative sectors and societies strengths and weaknesses in the functioning of the formal democratic structures and in the collaboration between Boards and management are to be found. In successful societies there are normally few problems in the Boardroom and there is confidence in the ability of the management to run the business in a proper way promoting the interests of members. But there is a warning voice from Sweden which has to be taken into account - that continuous success creates inaction and lack of drive for new initiatives and innovations with the danger of future failure.
The following weaknesses and problems in the Boardroom and in the collaboration with management have occurred in one way or another:

The elected directors have not been strong enough to exert the authority and power given to them by the law and rules in relation to management. In the case of continuously failing to meet budgets and excessive losses, the Boards did not take, or only hesitantly took, the necessary measures e.g. the removal of the executives.
Some of the Board members did not have the background and ability (and/or time and commitment) to lead and monitor large complex business operations thus failing to recognise wrong developments, mismanagement and heavy losses in time. Matters became worse by gaps in vital information provided by management.
The balance of power is sometimes inappropriate. The real power lies with chief officials. Only they have detailed knowledge of the business. They have more or less an information monopoly and may decide, to a large extent, the information to be given and the topics to be dealt with on the agendas of the Boards.
The Board appointed inadequately qualified management who lost control of a growing, complex business in an increasingly competitive environment, thus leading to disaster.
Management is not generally interested in membership nor in responding to a questioning Board but in pursuing own priorities in relation to rapid expansion and own careers.
Boards have grown too close to management, leaving too little room for critical questioning and unpopular decisions.
Board rotation is too low, giving younger active members very little chance to participate.

V. External Control (Auditing)
The important external control and supervision role is executed by external auditing. As a rule, co-operatives are audited every year under law e.g. in Austria and Germany and/or in accordance with the rules of the societies. These services are provided by external professional auditing companies elected by the Shareholders' Meetings or by the co-operative federations. In several organisations, additional auditors from the membership, are appointed by the Shareholders' Meetings. Their role is to monitor the professional audits and to ensure that the results and decisions are in accordance with the interests of members.
The audit reports are given to the Governing Bodies for discussion and for taking necessary action. At the annual Shareholders' Meetings, it is normal for a short summary of the audit to be presented, including a statement on the accuracy of the balance sheet and accounts. The audit reports help the Boards to carry out the control duties, despite the fact that the information about the performance of the society is historical. In reality, Shareholders and elected directors do not always recognise the importance of the auditors' role.
VI. Education and Information
To a varying degree, most co-op organisations offer their elected directors introductory seminars and/or educational programmes on commercial and co-operative matters. In general the interest in participating is high. Training seminars for elected delegates and ordinary members are only available in exceptional cases, e.g. in Denmark, Norway, France or Germany. In some organisations e.g. in Great Britain, Germany and Norway, Board members are provided with a detailed handbook about the background and structure of their co-op society and the rights and duties of the elected lay-persons. These are well received.
As a rule, management and staff training has a high priority in most societies and is carried out internally by own educational facilities, and externally using outside training schools and seminars. The training concentrates largely on commercial matters and on improving professional skills. Employee knowledge about co-operation is generally low and is often not seen as important by management.
In large societies it is inevitable that only a small number of members are able to be directly involved in the formal democratic structure. In varying extent, societies are trying to explore new ways of providing information and improving information and consultation with members, especially within consumer co-op organisations but also in some agricultural co-operatives e.g. in Denmark and housing co-ops. Examples given include members' meetings around shops or housing complexes, district meetings, shop committees, study circles, debate evenings, cultural and leisure time arrangements, consumer forums, women's guilds etc.
However, generally these are not sufficient to improve the often poor knowledge of members about co-operation or to revitalize the interest of members in the affairs of their society. Important and additional activities include the giving of regular information via member magazines, newsletters, press releases, films and TV spots, short annual reports, social balances etc. These information channels are known but used insufficiently. High costs are mentioned by management as a reason for doing little or nothing.
VII. Financial Involvement
It was underlined by many of those interviewed that a substantial financial involvement is able to contribute to stronger loyalty and commitment by members in the affairs of their society and this involved paying them an attractive dividend or interest rate.
In most countries members invest one or more shares in their co-op society, with a minimum and maximum amount. As the amounts are widely different, anything from 1 pound to 20,000 pounds, members play a varying role in financing and risk bearing in their society. In addition to the member shares, parts of the profits are retained and transferred to the equity capital, especially important in Denmark, Holland and Denmark, where member shares are not required.
For improving the level of risk bearing equity capital, new financial instruments for attracting more capital have been developed. Some German societies e.g. consumer Co-op Dortmund - Kassel have issued "participation certificates" (Genuss-scheine) via the Stock Exchange and banks. In France and Italy new legal regulations provide the possibility of placing preferred non-voting shares with "investor members" or to float co-operative investment certificates. The envisaged European Co-operative Statute includes similar regulations.
Several European consumer and housing co-operatives collect savings from members, which are shown as liabilities in the balance sheet, but add to liquidity and financing of the societies (but are withdrawable on short notice). Members of housing co-operatives have to make a substantial extra contribution in shares and loans, when moving into a new co-operative home.
Limited liability companies and stock holding companies are widely used at secondary levels (central co-operative institutions) for large scale business operations, subsidiaries, daughter companies and takeovers. In Germany, several co-operatives were changed into stock holding companies trying to maintain the co-operative character by corresponding regulations in the new statutes e. g. voting rights, auditing. That proved to be a failure in the case of the consumer co-ops and in the end the majority of shares were taken over by large competitors.
VIII. Findings and Recommendations

Ready-made solutions to improve corporate governance and management-control systems are not available. It is recommended that the individual societies and their Boards carefully consider their own situation and, if necessary draw up and implement the necessary measures. Against the background of the Corporate Governance report and experience of members, the ICA could act as a catalyst for information and recommendations.
In theory, the message and corporate identity of co-operation is very clear but in practice not very well recognized by members, customers and public. It has become blurred and interchangeable with that of private competitors. Weaknesses in detail can easily be detected by each society by member interviews and feedback.
A radical change can only be made if both Boards and top management really want it and implement the necessary action programmes. The policy and strategies of the society have to be redefined with priorities set for member orientation and member promotion, but which will in no way harm or hamper the efficiency and profitability of the business operations. They are, on the contrary, preconditions to reach the necessary economically based targets for member promotion.
At present profile programmes have been introduced e.g. in Italy, Sweden, Norway, France and Denmark. The success story of the consumer co-operatives in Norway was presented at the seminar in St. Petersburg (see Annex 3), which is worth studying in more detail.
It is mostly recognised that an active and involved membership remains the motor of each society. On the basis of an agreed Board policy, strong efforts have to be made to revitalise the interests of members and to recruit new members. Appropriate financial and management resources have to be budgeted for. It is recommended that responsibility for membership should be placed with the top management with the obligation to report regularly to the Board about the development and measures taken.
Furthermore, membership lists should be updated from time to time, allowing a realistic review and launching of action programmes aimed at existing members loyal to the society.
With the revitalisation of member interests it should be possible to encourage qualified members to become candidates for elected delegates to annual meetings or directors of the Boards. Whilst it seems to be legitimate and in order for elected delegates, Board members and/or administration to identify and propose suitable candidates it should be normal practice that candidates are nominated by grassroot members either in writing or spontaneously at the election meetings. An election committee chaired by the President could be of great help. For a healthy democracy it is of great advantage if elections are contested. Direct elections at election meetings are to be preferred but participation could be improved by more attractive arrangements at these meetings. If list votings are used, information on all candidates should be added to the lists to allow informed voting. New methods of voting should be examined e.g. postal ballots, ballots in election localities in easy reach (shops, banking branches).
To be a loyal and active member should still be the only formal qualification for the elected member representatives to the Governing Bodies. Further formal qualification conditions, even if desirable, would limit the rights of members to nominate and elect a candidate of their own choice and reduce further the grassroots interest. As many examples show, it is possible, especially in societies with large membership, to find member representatives with the appropriate skills, strength and qualifications. More important is that these elected delegates and directors are willing and able to offer sufficient time and commitment for their new office, to become acquainted with the business and to fully involve themselves in the demanding duties of the Governing Bodies, not least in the Boardrooms, and to attend ongoing training programmes.
In order to improve the knowledge and skills of the elected Governing Bodies it should be the obligation of all co-op societies to offer introduction courses and comprehensive training programmes on commercial and co-operative matters. At the same time it should be an obligation for the elected directors, to attend any training that is provided. In addition, handbooks and other written documentation could be of great help in explaining the co-op structures and targets as well as the duties of the Governing Bodies.
In co-operative societies, especially with a large share of females in membership it should be an objective to elect more women to the Governing Bodies and, within the staff, employ at all levels. A corresponding resolution was unanimously adopted by the ICA Congress in Manchester, October 1995 (see Annex 4).
There should be a clear cut division of legally binding responsibilities between the Board of Directors and chief officials, (and the respective Supervisory Board and Executive Board) written down in the society's rules and/or standing orders where the law does not provide for it.
The advantages and disadvantages of the monist and of the dualist system were presented and discussed at the previously mentioned seminar in St. Petersburg (see Annex 5). Further research is recommended, also in connection with the role of the chief official (CEO) including the question of whether the CEO should be a member or even President of the Board. Another important topic could be employee representation in the Board rooms and possible conflicts.
An age limit for elected member representatives, introduced already by several co-op organisations, is one example which other societies may wish to consider. The purpose of age limits is to improve rotation, giving interested members the possibility to participate within the Governing Bodies.
For their important, responsible and time-consuming work the Board members should be paid a realistic financial compensation. The level of this fee could be fixed in collaboration with the co-op federations or in accordance with guidelines provided by the federations and should be carefully balanced. In the comments to the financial statements presented to the Shareholders' Meetings, information about the total sums paid to elected directors and top executives should be given as a sign of full openness to members.
Board meetings, with set agendas, should be held at regular periods, with timetables fixed well in advance. An absolute minimum seems to be six meetings a year. The notices for meetings are sent out by the society but in the name of the Board's President, who is also responsible for setting up the agenda. The topics on the agenda should be well documented. The Board (Supervisory Board) has to instruct the chief officials (Executive Board) which information and key figures are to be supplied to directors on a regular basis between meetings and before and at the meetings. The information has to be comprehensive, but short and to the point, and easily understandable. At any time, the Board has the right to full information about the affairs of the society. On the basis of an agreed Board policy and guidelines Board members should have the right to seek independent advice if special problems, developments and proposals have to be clarified in more detail. For such requests, the elected auditors or the auditing departments of the co-op federation should be available.
Dependent on the size of the Board, it is advisable to employ sub-committees for special areas, which are able to consider the subjects in question in more detail and inform the Board as a whole accordingly. Such sub-committees are used for example for finance and financial statements (auditing), investments, loans, personnel, membership.
One of the most important duties of the Boards is to appoint a qualified management, This duty implies that Boards must also be prepared to issue management with warnings, and even removal, if objectives are not achieved. In many cases, a special Board committee for senior management has the responsibility of preparing for the appointment of the chief official and his management team, deciding service contracts with remuneration and terms of office. The appointment of the top management (Executive Board) is often made for a four to five year term. Re-appointment is possible and common but gives the directors the possibility of reconsidering the qualifications and achievements of the management in question.
The important role of the President/chairperson of the society should be fully recognized. The election of a suitable person with ability, power and commitment has to be considered very carefully as he or she has to guide and organize the work of the Board, agree the agenda of Board meetings, initiate and monitor strategic decisions and oversee and collaborate with the top management.
As with the functioning of the formal democratic structures and management within primary co-operatives, the collaboration between the primary societies and their central organisations is of great importance for the progress of the whole group. Due to weaknesses and flaws e.g. lack of confidence, much time, energy and resources have been wasted during recent years. As shown by successful examples, it is important to have a clear division of work and responsibility on all sides and on different levels. In this context, the election of qualified member representatives into the Governing Bodies of the central organisations is highly desirable, giving them influence in protecting the overall membership interests.
The reports of external audits, either by elected independent professional auditing companies or by auditing departments of the co-op federations, can be of great assistance for the control of the business operations of the society. They support the supervising duties of the Governing Bodies. Furthermore the auditors are available if special audits are required.
The results of the audits should be thoroughly evaluated by the Board. In this context the sub-committee for Finance and Financial Statements (sometimes called the Audit Committee) should examine the audit report together with the auditors and formulate, if necessary, critical questions to be put to the management.
In order to guarantee, from the outset, the necessary distance between the auditors and the administration of the society it is advisable to change the auditors from time to time.
In large co-operatives only a small number of members are able to participate actively within the Governing Bodies. Therefore, it is of the utmost importance that societies develop and introduce new ways for consultation and information as already adopted by consumer co-ops and societies in some other sectors. Among other methods mentioned are district meetings, shop committees, study circles, debate evenings, consumer forums, cultural and leisure activities etc.
In addition, members should receive by right, on a regular basis, information about their own society and other co-operative and consumer related matters. Only informed members are loyal members and therefore providing information must be a priority. The existing information channels are known, and to a varying degree used, e.g. member magazines, news letters, press releases, films and TV spots, short annual report, social report etc.
Co-operative aims and targets can only be reached if the employees at all levels are motivated and encouraged to achieve these targets. They need a high standard of professional skills which are mostly obtained through training provided internally in own schools and externally at seminars. It is also important that the employees identify themselves with co-operative philosophy and with the special profile of co-operatives in order to understand the significance of the economically based targets of member promotion in their daily work. In this context, staff education in co-operative matters should be intensified.
In many societies, financing and increasing the risk-bearing own capital are a high priority. Besides the traditional form of member shares, new financial instruments are available or under consideration. It is recommended that the Co-op Banks of the EU in Brussels keep ICA members informed of the latest developments.
As demonstrated above, Corporate Governance and Management Control systems include many aspects of membership and membership involvement. In some countries (Great Britain and France) Co-op organisations are trying to identify the most important aspects in Codes of Behaviour or Codes of Best Practice. It should be of great interest for the European co-op organisations to follow the working of these codes and the future experiences. The British Co-op Code of Best Practice was presented at the seminar in St. Petersburg and attracted great interest from the participants. It is suggested that a code similar to the British Consumer code be prepared on an European level which should cover, if possible, all co-operative sectors.

IX. Co-operatives in Eastern and Central Europe
A separate section on co-operatives in Eastern and Central Europe is required because of the very different circumstances which affect them. These co-operatives are heavily engaged in adopting and streamlining their operations to the conditions of the free market economy. Despite the difficulties they have made remarkable progress and are still holding significant market shares in their respective fields of activities. But they are aware of the fact that the growing competition from private companies and the needs of members make it necessary to improve further the efficiency and profitability of their operational units. This means high investments in reconstruction, modernizing and closing down of unprofitable units. As a consequence this requires large investment in education and training thus improving the professional skills at all levels.
In addition one of the most important tasks seems to be to revitalize membership and the functioning of the formal democratic systems. In the past members were not accustomed to (nor permitted to) influence and control the affairs of their society. At present, most of them are not interested in doing so, leaving the affairs of the society more or less without guidance and control by members. In this context many problems are similar to those in West European co-operatives meaning that similar solutions have to be found.
A continuous close collaboration between the member organisations of the ICA Region Europe and with the ICA headquarters in Geneva is of great importance to supporting the ongoing process of reconstruction and modernisation.

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CORPORATE GOVERNANCE AND MANAGEMENT CONTROL SYSTEMS IN EUROPEAN CO-OPERATIVES

I. Reference and Working Procedures

CORPORATE GOVERNANCE AND MANAGEMENT CONTROL SYSTEMS
IN EUROPEAN CO-OPERATIVES