Corporate Governance Practices of Turkey A Critical Review

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Corporate Governance Practices of Turkey: A Critical Review Metin Toprak* and Yuksel Bayraktar** Awareness about corporate governance began in 2002 and 2003, following the publications of international organizations on the same. In addition to the Capital Market Board (CMB), NGOs have had a key role to play in the development of the corporate governance system in terms of internal audit, internal control, risk management and strategic planning. The external financing of the Turkish companies was heavily based on banks (external finance) as in the continental Europe. Due to the dependence on foreign financing, development of corporate governance was relatively delayed when compared to the Anglo-Saxon countries such as the UK and the US. Reference to corporate governance appeared in a communiqué of CMB, for the first time, in 2003. Later, the banking law covered a chapter on internal systems that aimed at corporate governance. The Turkish Commercial Code, renewed in 2011, mentioned corporate governance and assigned the regulatory authority of corporate governance to CMB. Finally, the CMB law was renewed in 2012 and regulated corporate governance in detail was laid out, and it reinforced the authority of the CMB over other governmental institutions. CMB law made it mandatory for Bourse Istanbul (BIST) companies to implement corporate governance regulations. On evaluating the performance of the companies that implemented corporate governance with the non-implementing companies, it is found that the performance indexes of both the sectors do not differ significantly. It can be said that corporate governance in Turkey is still treated as a set of procedures and needs time to be internalized.

Introduction The Turkish corporate sector has experienced various changes in the commercial legal framework since the free market reform in 1980 (named January 24 Decisions). The direction of reforms has been towards free market paradigm and deregulations. Normally, the inclusion of corporate governance in these reforms must have been assumed. However, until 2002-03, it is quite hard to find sufficient footsteps of corporate governance in legal and institutional frameworks. *

Professor, Department of Economics, Istanbul University, Merkez Kampus, Beyazit, 34452 Faith, Istanbul; and is the corresponding author. E-mail: [email protected]

**

Associate Professor, Department of Economics, Istanbul University, Merkez Kampus, Beyazit, 34452 Fatih, Istanbul. E-mail: [email protected]

54 2017 IUP. All Rights Reserved. ©

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The purpose of this paper is to portray the advent of corporate governance in the Turkish economic and financial regulatory and institutional frameworks. The paper is structured as follows: it discusses the relationship of corporate governance with economic and legal structures, followed by a discussion of the historical development of regulations on corporate governance with reference to Turkey. Subsequently, the paper summarizes the corporate governance performance in Turkey, and finally, concludes presenting the main implementation fields of corporate governance in the Turkish economic environment.

Relationship of Corporate Governance with Economic and Legal Structures Corporate governance emerged firstly in the Anglo-Saxon countries such as the US and the UK, and with the globalization of trade, investment and finance, it has also spread to other developed countries in the continental Europe and Far East Asia. The last two decades have shown that corporate governance has become an international reference point like international reporting and accounting standards. The Anglo-Saxon countries provided funding for their economic development through public companies (equities). Effectiveness and sustainability of this model require accountability, responsibility, measurability, and transparency in the company activities to protect the interests of the shareholders. Taking the composition of stakeholders into account offers clues as to why corporate governance has emerged first in the countries that relied on equity-based financing model. Banking-based financing model (foreign resources) of capitalism, historically, has been common in continental Europe and Japan. The essential difference between banking-based and equity-based model has also determined the time and scope of corporate governance. It can be said that the main benefit of corporate governance is to favor the shareholders especially the small-scale ones. On the other hand, in the credit-based model, financiers of companies are banks and both sides are organized and well set up to defend their own rights against each other. Therefore, the need for state involvement to protect lenders has been felt relatively less. Since its institutionalization, corporate governance was a structural need in the Anglo-Saxon economic model, as against behavioral, cyclical or temporary in the context of continental Europe. Therefore, there is a time lag between two capitalistic traditions in terms of implementing corporate governance. The Anglo-Saxon model of corporate governance gives priority to save shareholders, while the continental Europe tradition aims at protecting various stakeholders, and shareholders are just one of them. In countries where financing model of economic development depends on banking and national economies are under dominance of family-owned companies, with the contribution of unregistered economy, structural problems are noteworthy in implementing corporate governance. It is clear that with its 40% of informal employment level, implementing corporate governance in Turkey faced important handicaps. Generally speaking, in Turkey, personality of the head of the company stands out more than identity of the company. In an environment where the boss and the company could not be Corporate Governance Practices of Turkey: A Critical Review

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considered separately, and companies have non-formal and formal accounting and reporting records on par, it is difficult to talk about an efficiently running corporate governance system in terms of transparency, accountability, responsibility and equality. In fact, during frequent intervals, the governments initiated tax amnesties to legalize and legitimize the wealth that the authorities had no knowledge of its source. Turkey has recorded great successes to attract money from abroad or assets under the mattresses. Without questioning other source of money to integrate into the system, it has run the risk of supporting illegal activities indirectly. The chairman of the umbrella organization of chambers of commerce and industry in Turkey stated that where an informal economy is pervasive, it is difficult to accomplish institutionalization and implement corporate governance. The warning remarks of the president of the Turkish business association is as follows (TOBB, 2010): “Firstly, we should encourage formal economy for the sustainability of our companies. Unfortunately, the current structure of Turkey forces companies to run informally. While encouraging working informally, it would be a luxury to talk around here about institutionalization. The more extensive informal economy means the fewer strong companies. Companies will be up to the boss”. The dominant role of banks in financing economic development has also affected financing of politics and hence democracy. Banks, as powerful institutions, have serious determinative roles in the business world and politics of the country. Without proper mechanism, this directing-capitalist model inclined towards cronyism. Due to this clientalistic business model, property rights faced serious infringements when a new government took over the reigns after elections. Implementation of corporate governance and internal systems (risk management, internal control and internal audit) in some countries where the operating model of business world and politics is not proper or designed to run into a clientalistic way, may cause some inefficiencies and crowding out effects, and may even decrease productivity and efficiency (Abdioğ lu, 2009). It should be kept in mind that performance of corporate governance and related internal systems is a result of a cultural absorption and may not produce expected results. If countries or companies are not ready mentally and intellectually, corporate governance would be only a set of procedures and may have no meaning on the transparency and accountability of governments and companies. Implementation of corporate governance necessitates a harmonious mechanism that consists of organizational structure, personnel, transportation and other supportive services and administrative expenses. Therefore, inefficient or so-called corporate governance regulations or implementations are useless and have extra costs on societies and companies. However, the worst thing after the ineffective implementation is that stakeholders would lose their faith in corporate governance. In Turkey, the following factors have had determinative influence on the implementation capability and performance of corporate governance: Shares of the public sector and private sector in the national economy, company size, trade openness, competition culture and regulations, the all-pervasive monopolistic and oligopoly markets. In terms of these criteria, 56

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Turkey had a promising scenario. Half of the BIST-30 companies are family-owned. At the end of June 2013, while openness ratio of BIST-30 companies was 34%, that ratio for all publiclyheld corporations was 29% (TUYID, 2013).

Corporate Governance: Organization and Management Institutions may be affected directly by various factors in the environment in which they operate: Property rights, diversification of public funds, public confidence in politicians, unforeseen payments and bribery, judicial independence, favoritism in decisions of government officials, wasting in government spending, burden of government regulation, the effectiveness of the legal framework for resolving disputes, the effectiveness of the legal framework for making the necessary changes in regulations (Harvard Business Review, 2000). Therefore, the quality of activity within the environment affects institutionalization and determines the quality of corporate governance. In terms of companies, major stakeholders are listed as follows: shareholders, the board, managers, employees, suppliers, customers, tax authorities, lenders and the settlement areas in which the company operates. The mechanism foreseen to formulate optimum protection of the role of the stakeholders— those who are in the company’s decision-making and enforcement mechanism and those who are not effective in these decision and enforcement mechanism—is considered for corporate governance. The necessity of corporate governance may show urgency and public nature in several ways: publicly-held corporations, the public goods nature of products and services, the number of shareholders and other stakeholders who are not represented on the board, public health, environmental protection, competition, tax concerns, informal sector, differences between private and social costs or benefits, i.e., externalities. Corporate governance is neither a guarantee for a company’s high performance nor a prescription for preventing bankruptcy of a company. Corporate governance is an approach that should not be related directly to the success or failure. Adoption of corporate governance is to ensure development of mechanisms aiming at preventing abuse and realizing justice. Corporate governance does not mean that all public-private companies and other organizations should wear the same type of dresses. It is clear that many factors such as sector, public-private ownership, the public goods, nature of goods and services, and monopolistic nature of the activities require unique structures and operations. Factors such as type of ownership of companies, principal-agent relationships in terms of stakeholders, accounting and auditing standards and legal structure are important in corporate governance. Differences in the structure and functioning of corporate governance systems have raised the problem of: How to control a company effectively? Who should control the firm? What should be the composition of the board of directors? What should be the role of the board of directors in its relation to the management? Due to the differences in motivations of stakeholders who have direct relations with the company, it is the responsibility of the board of directors to ensure compliance with the optimum benefit (Koçer, 2005). As a result, the main problem to be solved here is the principalagent problem. Corporate sector and political environment interact to a certain extent. Corporate Governance Practices of Turkey: A Critical Review

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Comparing corporate governance and democracy can give a useful simile. While the solution to the principal-agent (Fama and Jensen, 1983) problem for companies is corporate governance, the most effective instrument that has ever been developed for the problem in a democracy is the separation of powers in the world of politics. Internationalization of trade, portfolio and direct investments has led to internationalization of accounting and reporting standards and made it a necessity to develop a universal language for accounting and auditing. A time lag between developing and developed countries has been gradually shortened and even simultaneous regulations in many countries have become a trend. Speaking the same language in the fields of accounting and auditing is crucially important for accountability and responsibility dimensions of corporate governance. Company scandals are the driving factor behind the development of the principles of corporate governance as well as standards for accounting, finance and auditing at international level (The Cadbury Report, 1992). Corporate scandals, such as Enron and WorldCom in the US, Parmalat in Italy, HIH and One Tel in Australia, Ahold in the Netherlands, Yanguangxia in China and Imar Bank, Interbank, Çukurova Elektrik, leading football clubs, ÝSKÝ, and public banks in Turkey, forced governments to give priority to the management and control of companies. La Porta, Lopez, Shleifer and Vishny (LLSV hereafter, 1998) categorized 49 countries into four general groups: common law countries, the French Civil Law countries, the German Civil Law countries and the Scandinavian Civil Law countries. It could be said that while the strongest protection of shareholders is assured by the common law, the weakest protection belongs to the French civil law. The German and the Scandinavian Civil Law countries are stronger to operate laws than the common law countries. However, the French Civil Law countries are the weakest to operate the laws effectively. According to LLSV’s findings, Turkey’s performance in the fields of effectiveness of the judicial system, the rule of law, corruption and accounting standards are below the sample average. In the remaining two fields (risk of expropriation and risk of a breach of contract), Turkey has the sample average. Klapper and Love (2004) found that Turkey is under the sample average in three new fields, the effectiveness of the judicial process, the rights restricting the board of directors, and lawfulness.

The Performance of the Board of Directors and Corporate Governance The greatest responsibility with regard to the implementation of corporate governance belongs to the board of directors. Therefore, the composition of the board of directors, qualitatively and quantitatively, and distribution of tasks between members are important indicators to show the performance level of corporate governance. Presence of independent members on the board of directors is quite an unusual thing at traditional family-owned companies. Independent members of the board of directors are not faced with conflict of interest with shareholders and activities of the company, so they can evaluate the company more objectively. Independent members can be appointed by general shareholder meeting of the company, but before this step, pre-approval of independent 58

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members by Capital Market Board (CMB) is needed (for a theoretical critique, see, Alpar Lošonc, 2007, 359-362; TTK, 2011; and SPK, 2012). The conditions CMB (Turkish abbreviation is SPK) is seeking for independent members are focused on knowledge and experience, and absence of conflict of interest. Independent members of the board cannot be attached directly to the general director, because they evaluate the operations of the company. Besides, independent members should not have supplier or buyer relationships with the company, because in that case they cannot act independently. In addition to the independent board members, the separation of Chief Executive Officer (CEO) and chairman of the board is another crucially important issue. A CEO is responsible for the operations and reports to the board. In order to evaluate the performance of the personnel and the company objectively, to prevent conflicts of interests, and to ensure independent opinion on the activities, the separation of the roles of the chairman and the CEO is a necessity.

Corporate Governance Mechanisms The regulations related to corporate governance are carried out under the patronage of the CMB (SPK, 2012). In fact, corporate governance is not just a collection of principles. If the principles of transparency, accountability, equality (fairness), and responsibility are not concretized for the whole administrative process and instruments, it will not go beyond rhetoric. Moreover, only procedural establishment of the mechanisms may not be meaningful, so an independent evaluation is needed to show that the established mechanisms and administrative structure work effectively. In countries where (i) the business world is dominated by families; (ii) companies are experiencing serious problems while being transferred to the next generation; (iii) the informal economy is widespread; (iv) property rights are not protected like in the developed countries; and (v) the identity or personality of the boss is standing out more than that of the company, corporate governance performance of companies is interestingly in line with the performance of democracy in the country. Stability or instability of the governments goes parallel with the private sector. Clientalistic relationships between the government and the companies are very determinative for proprietorship and competitiveness of companies. The principle of equality can be defined as equidistant from all stakeholders, and protection of their rights in terms of regulations and ethical rules (Rezaee, 2009). An extra problematic issue for Turkey is that the companies are short-lived and the company and the boss are very much intertwined. Only 4% of the family-owned companies are transferred to the fourth generation (Alacaklıoğ lu, 2010). Although these rates are low all over the world, Turkey’s rate is lower than the world average. The principle of transparency necessitates disclosure of all information about the company—timely, accurately and easily accessible. International accounting standards and international financial reporting standards have important functions in this respect. Turkey is in full compliance with these standards. However, it needs time to absorb those standards for both the public and private sectors. The principle of accountability expresses the accountability of the board and directors towards the company, shareholders and other stakeholders. Corporate Governance Practices of Turkey: A Critical Review

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Notable problems and violations may occur in the companies where the separation of functions of decision, implementation and evaluation (control) are not clearly disassociated from each other. A very convenient example for this violation is the Turkish case of 2001 financial crisis. Regulation and supervision of public authorities on banks and companies turned to supervision fiascos due to the clientalistic patterns. The principle of responsibility aims at compliance of company’s operations, organization and functioning of management with the in-house regulations and the main statute, and independent evaluation of this compliance.

The Relationship Between Corporate Governance, Internal Control, Internal Audit and Risk Management When corporate governance is implemented besides risk management, internal control and internal audit systems, outcomes such as an increase in the credibility of the company, a decrease in the cost of capital, a rise in credit facilities, a rise in the performance of the company, minimization of conflicts of interest, a rising trend in mergers and acquisitions, and an increase in the sustainability of the company are expected. Capital Market Board and Banking Regulation and Supervision Agency (BRSA, Turkish abbreviation is BDDK) have primary and secondary regulations in terms of internal systems and corporate governance for the companies under their regulatory and supervisory responsibilities. These regulations are updated on a par with the developments in the world. Since corporate governance requires transparent, accountable, and compatible procedures, it is clear that the internal systems of a company will make the most contribution. Otherwise, without effective internal systems, corporate governance will not be successful. While internal control is performed during the execution of activities and is the basis of quality assurance, internal audit is performed mainly after the operations and tries to eliminate production losses or evaluate the whole system more systematically. Risk management prioritizes the company’s risky activities by considering their risk levels and volumes. Thus, the administrative measures (corporate governance) as well as business measures (internal systems) are vital for the sustainability of the companies. Turkey’s regulations relating to the internal systems are in line with international approaches developed from an international perspective (see, Rachdi, 2010).

Regulations for Corporate Governance in Turkey The CMB is the authorized public institution for the corporate governance framework. Other sectoral organizations can make their own sectoral regulations on corporate governance only after taking consent of CMB (Doğ an, 2005). The law-level regulations on corporate governance are as follows: the Capital Market Law, the Banking law and the Turkish Commercial Code (TCC). Especially, CMB and BRSA circulated various decrees aimed at incorporating corporate governance. In addition to these sector-specific laws, nation-level 5-year development plans include corporate governance understanding that the public sector should make it concrete at institutional level (The Ministry of Development, 2013). 60

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It is mandatory to apply corporate governance for public institutions. The legal basis for this obligation depends on the law titled “Law on Public Fiscal Management and Control”. Based on this law, “The Internal Audit Coordination Board” was established in 2004. The corporate governance approach developed here is in line with the regulations of CMB and the TCC. Besides governmental institutions, NGOs and other Non-Profit Organizations (NPOs) such as Association of Corporate Governance in Turkey (TKYD) and Institute of Internal Auditors (IIA) have also contributed to raising awareness about corporate governance (Ararat and Ugur, 2003). TUSIAD, an umbrella association for the largest companies in Turkey, published a guide in 2002 titled, “Corporate Governance Best Practice Code: Structure and Functioning of the Board of Directors” (TUSIAD, 2002). This guide entrusts the main responsibility of implementation of corporate governance to the board of directors. Therefore, the guide focuses on the formation, independence and agendas of the board of directors.

The Capital Market Law CMB publicized a guide on corporate governance in 2003. This is the first public regulation on corporate governance in Turkey. The guide was in the form of principles and emphasized that compliance with these principles are discretionary. However, many publicly-traded companies renewed their organizational architectures in line with these principles (SPK, 2004). Turkey’s corporate governance regulation is going parallel with its EU membership agenda and its relations with international organizations and initiatives. Turkey is an active member of the OECD, IMF, BIS, IASCO, UNDP, G-20 and the World Bank. Since the early 2000s, in addition to traditional bureaucratic structures, independent sectoral regulators have begun to emerge in Turkey. With these independent regulatory authorities, international developments have been monitored more closely and compliance with international regulations accelerated (OECD, 2004). There is a remarkable parallelism between the Turkish corporate governance regulations and Sarbanes-Oxley Act (The Sarbanes-Oxley Act, 2002). In addition, the BIS and the Basel Committee on Banking Supervision play a leading role in guiding the banks by developing principles and rules on corporate governance and internal systems of banks. The first international regulation on corporate governance issued by the OECD in 1999 was titled “OECD Principles of Corporate Governance”. A few years later, CMB issued a parallel set of principles titled “Capital Market Corporate Governance Principles” in 2003. Then, this guide was updated in 2005 and 2011 in parallel with updates in the international understanding. In the 2011 update, that guide was converted into a communiqué, and corporate governance thus has had a stronger base, because until that time it was only a decision of CMB. In order to help investors to make healthy decisions, some obligations related to the timing and content of advertisements of general assembly meetings have been put into effect. Moreover, a mechanism of independent board member has been regulated to ensure representation of small investors more effectively and effective functioning of the board of directors away from conflicts of interest. Corporate Governance Practices of Turkey: A Critical Review

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In October 2011, a decree-law changed the capital market law (No. 2499) and added an article on corporate governance. With this new amendment, the phenomenon of corporate governance has become a legal necessity for publicly-held corporations. Law article on corporate governance is regulated as follows: “In publicly-held corporations, the procedures and the principles regarding corporate governance principles, the content and publication of corporate governance compliance reports, the rating of compliance of corporations with corporate governance principles and the independent memberships of board of directors shall be determined by the Board. The Board shall use this authority in a manner that would not result in unfair competition among publicly-held corporations and by considering the principle of applying equal rules to equivalent corporations.” All publicly-held corporations, listed by BIST with the last amendment in December 2011, except the traded corporations, are in the watch list companies market and the developing corporations market. However, after taking the feedback of markets and other related stakeholders, CMB added three new principles and made amendments to the existing four in February 2012. A measurement has been developed by classifying corporations into three groups in terms of their market values. Based on the market value of a company, some principles may be obligatory or discretionary. As mentioned above, an update made in capital market law in December 2012 and corporate governance has been arranged as a separate article. Publiclyheld corporations have to prepare and publicize a report about corporate governance compliance. The compliance report should follow the approach of “apply or explain” in terms of each principle and main part. Corporate governance compliance report is prepared on the basis of CMB communiqué. A decision of CMB in 2004 arranged that the compliance report may be a part of annual activity report and should clarify the implementation degree of each principle. The Communiqué of CMB organizes corporate governance principles into four main sections: (i) shareholders (facilitate using of shareholders’ rights, information and inspection rights, right to participate in the general meeting, voting rights, minority rights, dividend rights, transfer of shares); (ii) public disclosure and transparency (public disclosure principles and tools, website, annual activity report); (iii) stakeholders (the company’s policy towards stakeholders, promoting the participation of stakeholders in the management of the company, the company’s human resources policy; and (iv) the board of directors (management function of the board, the board’s operating principles, the structure of the board, the structure of the board meetings, committees established within the board). BIST has established corporate governance rating and a corporate governance index. The corporations which prefer to be included in this index would save an annual listing fee of up to 50% for the first two years, 25% for the next two years, and 10% for the following years.

The Banking Law Corporate governance implementation in the banking sector depends on the decisions of Basel Committee on Banking Supervision. After the Asian and the Russian crises in 1997-98, the 62

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Committee prepared various documents on interest risk management, internal control systems, transparency and credit risk management. The Banking Law arranges corporate governance in a separate section under four headings (BDDK, 2006). These headings are management (corporate governance principles, the board of directors, audit committee, managers), internal systems (internal control, risk management, internal audit), the authorized institutions (independent audit firms, valuation and rating agencies, supporting services organizations) and financial reporting. According to the Banking Law (No. 5411), BRSA has to consult CMB and associations of institutions which are under its regulatory and supervisory responsibility about corporate governance implementation (Baskıcı, 2012). Based on the banking law, BRSA declared and put into force a communiqué titled “Communiqué on corporate governance principles for banks” in November 2006. In that communiqué, corporate governance is described as follows: “Corporate governance means the bank’s administration by its top management in compliance with the goals set, the Law, the regulations published pursuant to the said Law as well as other related legislation, the bank’s articles of association, the in-bank regulations and the ethical banking rules in a manner to protect interests and rights of all stakeholders and shareholders as well as the owners of the accounts held.” This regulation is binding on all banks. Corporate governance principles for banks in the banking law are developed exclusively for banks and general principles of corporate governance declared by CMB are also binding on the banks. Therefore, corporate governance principles for banks can be an example for sectorspecific principles, and this set of principles is neither general nor binding on other corporations.1

The Turkish Commercial Code (TCC) The concept of corporate governance was adopted for the first time in the renovated TCC (No. 6102) in 2011 (TTK, 2011). The law consists of corporate governance regulations which are binding not only on publicly-held corporations but also on some kinds of non-public corporations. By these regulations, it is aimed to concretize corporate governance principles 1

BRSA has determined 7 principles about corporate governance. Under each principle there are explanatory rules that banks should obey (Regulation on the Banks’ Corporate Governance Principles, BRSA, 2006): Principle 1: Corporate values and strategic goals shall be established within the Bank. Principle 2: Authorities and responsibilities within the bank shall be clearly specified and implemented. Principle 3: Members of board of directors shall have the qualifications required to fulfil their tasks effectively, be conscious of their roles they have undertaken within the corporate management and be capable of making independent assessments on the bank’s activities. Principle 4: The higher management shall be equipped with qualifications to fulfil its duties effectively and be conscious of its role undertaken in the corporate governance. Principle 5: The bank shall make the best use of the works carried out by its auditors as well as the independent auditors effectively. Principle 6: The compliance of the wages policy with the bank’s ethical values, strategic goals and internal balances shall be provided. Principle 7: Transparency shall be ensured in the corporate governance.

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to operate effectively. After legalization of corporate governance principles, all criticisms about absence of legal base for corporate governance have been met. With the new TCC, CMB has become the national authority for developing a framework of corporate governance. Other regulatory bodies can only develop corporate governance principles for their operational fields and have to take consent of CMB. The new TCC differentiates the corporate governance principles between publicly-held corporations and nonpublic corporations as expected. Because these two types of corporations have different stakeholders whose members, qualifications and motivations differ. The corporations which prefer to enter the CMB umbrella have to implement CMB corporate governance principles besides TCC corporate governance rules. The new TCC determined the inalienable duties and powers of the board of directors. The law assigns the board to establish committees and commissions related to the processes and set up internal systems. According to the law, publicly-held companies should carry out their internal systems by setting up expert committees. The law determines that the board of directors has to prepare an annual activity report and present it to the general meeting of the company and these duties or authorities cannot be transferred to other bodies in the company.

Corporate Governance Practices of State-Owned Companies The government had initiated steps on corporate governance in State-Owned Enterprises (SOEs) in order to strengthen accountability and transparency. However, there was no progress until 2006, except the feedback from public institutions on the request. The Technical Committee on Corporate Governance relaunched the works on corporate governance in 2006 in collaboration with state planning organization, Directorate of Privatization Administration and CMB. The works have been carried out within the context of the “Application of the Principles of Corporate Governance in SOEs” project (YOIKK, 2007).2 It was aimed to make necessary regulatory arrangement based on the results of these studies and develop an appropriate model for Turkey. Since there is no confirmation of the project, it appears the works under this project are still underway. As mentioned earlier, based on the law (Public Fiscal Management and Control Law), the Internal Audit Coordination Board was established and the main duty of this body is to identify if resources in the economy are managed according to the principles of effectiveness, efficiency and productivity. Turkey has launched an initiative for SOEs during the 2001 crisis with the technical and advisory support of the World Bank. The initiative, Coordination Council for the Improvement of the Investment Environment (YOIKK) aims at eliminating administrative and bureaucratic barriers for international and national investors, establishing a more favorable environment for 2

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The project consists of the following steps: (i) To stocktaking and classification of public enterprises; (ii) To examine international practices and identify good practices; (iii) To identify differences between Turkish case and well-functioning models; (iv) To prepare a draft model and presenting it to the view of the government; (v) To prepare a draft legislation; (vi) To present the draft legislation to the view of the government; (vii) To discuss the draft legislation with stakeholders to exchange ideas; and (viii) To finalize the draft legislation. http://www.yoikk.gov.tr/upload/komiteler/kurumsalyonetim/kamukurumsal.pdf. Accessed on August 14, 2013. The IUP Journal of Corporate Governance, Vol. XVI, No. 2, 2017

investments, increasing productivity and competitiveness of the country (for a country case study, see, Savic, 2012). Secretary services of the YOIKK are carried out by the Treasury. The first YOIKK meeting was held on March 22, 2002. There are 12 technical committees working under YOIKK. One of these is “Corporate Governance Technical Committee”. Chaired by CMB, this committee aimed at having all publicly-held companies incorporate corporate governance, and today this has been fully accomplished. In addition, the duty of monitoring the implementation of corporate governance in SOEs was also given to this committee. Most of the 18 SOEs operate in uncompetitive markets, and produce mostly monopolistic goods and services. Therefore, accountability, responsibility and equality are the main concerns in terms of corporate governance. However, there is no difference between domestic and foreign or public and private companies; all are subject to the same regulations as far as corporate governance is concerned. This is an important motivation and a leverage for domestic public and private corporations to follow international understanding.

The Corporate Governance Performance of Turkey In this section, the findings of various studies on the Turkish corporations are summarized. Turkey has been taking structural steps, each passing year, in the field of corporate governance. In addition, awareness has been turning towards more powerful applications. Therefore, it can be said that these researches may underestimate the current situation because they are leaning on the past. However, this positive trend is experienced all over the world, so the relative position of Turkey may not change in spite of improvement in corporate governance implementation. The most common medium of visibility of corporate governance to the general public is Istanbul Stock Exchange (BIST, formerly ISE or IMKB), where publicly-held corporations trade. The BIST corporate governance index (XKURY) is composed of companies which implement corporate governance principles. The purpose of the BIST corporate governance index is to measure price and yield performance of corporations having minimum grades of 7 out of 10 on an average and minimum grades of 6.5 for each chapter. Corporations are encouraged to be ranked on the basis of grades obtained from compliance with the corporate governance principles (BIST, 2014). Compliance grade is given by the rating agencies authorized by CMB. Evaluation is based on compliance of implementation by a company of all corporate governance principles. The corporate governance index calculation started on August 31, 2007. As of August 16, 2013, only 43 corporations traded in BIST out of the 424 included in the index. It is easy to reach corporate governance indices of companies via public disclosure platform on the BIST website. As mentioned earlier, there is a financial advantage for corporations. Analyses of economic performances of corporations, which implement corporate governance, give inconclusive findings (K iy ilar and Belen, 2006). Therefore, there is not a significant difference between corporations inside and outside the index. Some argue that early Corporate Governance Practices of Turkey: A Critical Review

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stages of implementing corporate governance may have resulted in this finding. However, in the near future, when all publicly-held corporations have to be included in that index, then it will be almost impossible to differentiate the performance. As a result, the necessity of corporate governance principles should not be evaluated with the performance of corporations such as price and yield. Connecting a direct link between corporate governance and performance is out of context. Taking direct and indirect shares of families together, it seems that 68 of 94 biggest corporations belong to families in Turkey. 37 of 68 corporations are controlled by families via pyramid structures. The chain of voting rights gives this opportunity and at least one of the corporations in the pyramid is publicly-held. Families controlled the remaining 31 corporations directly without using an intermediary corporation or via their other non-publicly traded corporations. The average share of ownership in the companies that families control is 52.05% which is about twice the share of direct ownership (23.60%). Besides, the average voting rights of families is 65.75%. Families use the pyramid structure to raise their level of control. Yurtoğlu used 2001-end data of the BIST corporations and found that in 242 of 305 corporations, 67.03% of control belongs to families as ultimate owners and families’ share in cash flow is 50.56% (Yurtoğlu, 2003). Saraç examined the period of 1997-2001 with a sample representing the industry sector and found that family control had a rising trend at the expense of managerial control. These findings indicate that the Turkish industry sector had a concentrated ownership structure during that period. Corporations which belong to the group or holding corporations are the major shareholders in most corporations (Saraç, 2002). Demirağ and Serter studied the largest 100 corporations considering their market value at the end of 1999. They assumed that if the total of direct and indirect voting rights exceed 30%, then that company belonged to that shareholder. The findings showed that ownership was concentrated intensively. In 100 corporations, the biggest shareholder’s share was 45.10%. There is one shareholder with at least 50% in 38 corporations. The share of the biggest 5 shareholders is 64.5% on an average. Almost 5 shareholders controlled at least 50% of shares in 83 corporations (Demirag and Serter, 2003). CMB conducted a study on 248 corporations, quoted in the BIST, in order to identify their corporate governance practices (SPK, 2004). A chapter in the survey was dedicated to corporate governance principles on the board of directors. According to the responses received, the following conclusions were obtained. Only 50% of companies traded on the BIST had mission/ vision statements approved and declared by the board of directors. This ratio was up to 69% in the BIST-30 corporations. In most corporations (87%), the board of directors approved strategic goals which had been prepared by managers. This ratio was up to 96% for BIST-30. Boards of directors reviewed the degree of achievement of the objectives of the corporation in every three or six month period. 52% of corporations had risk management and internal audit mechanisms that were established by the board of directors, and this ratio was up to 69% for BIST-30 corporations. Authorities and responsibilities of the board of directors were clearly laid out in 79% of corporations in BIST-All in the main statute. This ratio rose to 88% for BIST-30. 77% of 66

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corporations determined the authority and responsibility of the board of directors and reported it in annual reports. That ratio is same for BIST-all and BIST-30 corporations. 77% of BIST-all corporations and 85% of BIST-30 corporations had mechanisms to inform the board of directors timely and correctly for extraordinary developments affecting the company. The ratio of corporations having ethical rules for corporations and employees is 56% for BIST-all corporations and 65% for BIST-30. However, the proportion of corporations that explains the rules was 11% for BIST-all companies and 19% for BIST-30 (SPK, 2004). Approximately, 50% of corporations prohibited their managers to compete with the corporation. There were equal voting rights for each member of the board of directors in almost all companies. 24% of all corporations had a veto mechanism. This ratio was 35% for BIST-30. 31% of all corporations and 12% of BIST-30 corporations had regulations in their main statutes about calling the board of directors for a board meeting. Only 15% of corporations had an arrangement in the main statute for seeking certain features for the members of the board of the directors in terms of knowledge, skills, experience and education. Most corporations had executive and non-executive members (78 % of BIST-All and 88% of BIST-30). However, only 26% of BIST-all corporations and 42% of BIST-30 corporations had independent board members. None of corporations had a cumulative voting system in its main statute (SPK, 2004). The majority of BIST-all corporations did not apply performance-based remuneration for the board of directors (96% of BIST-All and 92% of BIST-30 corporations). Only 9% of BIST-all and 23% of BIST-30 corporations had procedures that specify the route the corporate governance committee would follow while executing its authority. Only 18% of corporations had arrangements and sanctions for managers who had plans to resign to prohibit them from working for competing corporations. Evaluation of corporate governance compliance reports of BIST corporations gives similar results to the findings of CMB field research. “Iyiş irket” Consulting company conducted a research (Iyiş irket, 2006) on BIST-100 corporations to evaluate implementation of CMB corporate governance principles. The findings related to the level of corporate governance from that research (BIST-100 Corporations Corporate Governance Research) are as follows: 1. Corporations at very good levels (score range 86-80)

4%

2. Corporations at good levels (score range 70-79)

5%

3. Corporations at modest levels (score range 60-69)

5%

4. Corporations that strive (score range 50-59)

14%

5. Corporations at low levels (score range 0-49)

72%

These results indicate that the publicly-held corporations in Turkey need significant progress to comply with the corporate governance principles. In a research on BIST corporations, for the period of 2007-2009, on the relationship between the performances of corporate governance and risk-return, the findings did not give Corporate Governance Practices of Turkey: A Critical Review

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any significant differences in terms of additional income to investors between covered and uncovered corporations. Thus, being listed in the corporate governance index had no positive improvements on investors. However, it has been concluded that to invest in those corporations covered by the corporate governance index was found less risky (Dağlı et al., 2010). Results of a survey (OECD, 2006) conducted by the OECD on the largest and most liquid 52 BIST corporations showed that corporate governance performance of the group was found moderate in terms of financial transparency and disclosure, ownership structure and investor relations, board of directors, and management structure processes. In another study (Karamustafa et al., 2009), positive correlation between corporation performance and corporate governance for BIST corporations was found. After being listed in BIST corporate index, performances of companies showed a statistically significant increase. A field study (TKYD and Boston Consulting Group Research Summary, 2005) aimed to evaluate compliance and performance of corporate governance that was applied to 123 corporations and 15 face-to-face interviews were conducted. Size of corporations differed in terms of number of employees (between 9-19 thousands) and turnover (from $300 thousand to $1.3 bn). Approaches to corporate governance are naturally parallel between the OECD and CMB. Therefore, there is full compliance in terms of written principles. However, it was identified that the corporations studied needed an improvement for each principle of corporate governance, in practice. The term of shareholders rights was understood as rights of major shareholders (Kula, 2006). Although respondents accepted that rights of other stakeholders were also important for a good company, the arrangements related to the rights of other stakeholders had no room in corporation policies and public disclosure and transparency related to those stakeholders were insufficient. In spite of the critical role of the board of directors as the most important body in a company, election criteria of its members were not defined very well. 91% of respondents thought that it was difficult to apply corporate governance effectively in Turkey. The Turkish experience showed that the board of directors operates both as a decisionmaking body and as an execution body in many corporations. Respondents of the survey (Ibid., 2005) thought that the executive role of the board restricted its regulatory and supervisory functions. The board of directors was formed primarily on demand by the major shareholders. Respondents believed that processes, functions and structures of the board were satisfactory, but the level of effectiveness was totally dependent on the behaviors of major shareholders. Comparing Turkish case to the findings of Boston Consulting Group (BCG) research that covered 132 interviews with 132 CEOs, across the world, showed a significant parallelism between them. Association of Institutional Investment Managers of Turkey (TKYD) conducted a research (TKYD and Istanbul Bilgi University, 2006) in partnership with Istanbul Bilgi University to determine the compliance level of corporate governance and evaluate effectiveness of implementation. 119 corporations were covered in the research and also compliance reports (July-August 2006) of the corporations listed in BIST-30 were evaluated qualitatively. Summary phrase of the research is “better than nothing”! 68

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According to the findings in this study, non-quoted corporations tended to see corporate governance as “good management” and also emphasized that it was still early to implement corporate governance in Turkey. In addition, respondents argued that instead of top-down approach, a bottom-up approach would be more effective in Turkey’s conditions. They also thought that cultural, institutional and legal environment of the Turkish business world needed to mature. Evaluating the place of stakeholders in the corporation, most of the professional managers, SMEs and BIST-30 corporations had parallel views. However, BIST-30 corporations gave relatively low significance to the suppliers, while employees had relatively low importance in the eyes of SMEs (TKYD and Istanbul Bilgi University, 2006). In terms of portfolio investors, corporations listed in corporate governance index have relatively temporary externalities. K il iç conducted a study (K il iç, 2011) using stock exchange data of corporations listed in BIST corporate governance index. Data of 28 corporations was analyzed as of December 31, 2010. The date when corporations took the passing scores and declared they would be listed in BIST corporate governance index and the following five days were examined to identify if extraordinary earnings occurred. As a result, only about 60% of the corporations listed in the index provided positive returns to their investors for the first few days. However, the amount of returns could be negligible except for two corporations. Besides, after a few days of being covered by the corporate governance index, almost all increases in shares disappeared. Therefore, it is concluded that investors were not mainly interested in the covering of corporations in the index. A study was conducted for the municipal enterprises in the Marmara Region and investigated the effectiveness of internal control systems in the formation of corporate governance. For this purpose, face-to-face interviews were conducted with accounting managers of municipal enterprises. The sample was selected randomly. Aiming to measure the effectiveness of the internal control systems in municipal economic enterprises, this study examined enterprise activities under six chapters and developed hypotheses for each one (Usul et al., 2011). The researchers concluded that internal control system was not effective in maintaining cash and cash equivalents, the universal principles on accounting and internal control systems were not arranged and implemented, and there was not an effective internal control system for sales. In addition, it was identified that there was no effective internal control system for inventory, fixed assets and wage payments. The researchers argued that there were no preventive and identifying measures, effective internal control systems, neither understanding nor principles of corporate governance.

Application Areas of Corporate Governance The implications of corporate governance go well beyond the corporate sector; the judiciary, the legislature, charity organizations, non-governmental organizations can find useful principles to implement the corporate governance approach. Turkey had witnessed scandals within the charity organizations in the last decade. These organizations cheated the faith and confidence of philanthropists, and invested the collected Corporate Governance Practices of Turkey: A Critical Review

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money into their own businesses. Their misuse of funds crossed the frontiers of Turkey and extended mainly to the Western Europe where many Turks lived. The exploitation was not limited to personal misuse of funds, but ideological misuse of those funds via primarily media investment and supporting alleged suspicious activities in other countries. The Turkish public opinion wasted significant amount of time on those discussions. “Public Fiscal Management and Control Law” is binding for public institutions to set up internal systems and implement corporate governance. The law is compatible with corporate governance understanding. However, very little progress has been made. Implementing corporate governance effectively can be a problem-solving approach in the design of the relationship between sectoral regulatory governmental bodies. Sectoral authorities in the fields of energy, telecommunications, media, banking, capital markets, strategic agricultural and industrial products are active besides the traditional ministerial institutions. Sectoral authorities have been criticized less when compared to the traditional public institutions. Interested parties believe that sectoral authorities operate substantially independently and due to this opinion, sectoral authorities have more positive image. However, as discussed widely in the literature, sectoral authorities have a risk to behave like the authority of the sector! This incorrect behavior is called regulatory capture. In this case, it may be difficult to understand the main duty of sectoral authorities—if it is protection of customers or protection of interests of the sector. There is no doubt that a sectoral regulator should compromise the interests of all stakeholders but this is related closely to the democratic culture and accountability experience of that institution specifically, and of the country, in general. Independent sectoral authorities have more positive reputation in the eyes of the judiciary when compared to other traditional ministerial institutions. These bodies are seen as specialized agencies and by employing overqualified personnel, their decisions are more respected. However, because of the organized and powerful actors of the sectors, there is a risk for sectoral authorities to be confused with regard to their positioning: on the side of government and consumers or on the side of the sector. Independent sectoral authorities are equipped with “special powers” compared to the traditional ministerial institutions. Therefore, it is important that they should always be kept under periodical surveillance. Due to the various responsibilities wielded by the public institutions with regard to abuse of dominant position, advertising, unfair competition, state aids, and consumer protection and market surveillance activities, coordination gaps, coordination failures and overlapping of authorities have occurred from time to time. As in the case of the Turkey Football Federation, sometimes some nongovernmental professional organizations are equipped not only with executive powers but also strangely enough have regulatory and supervisory powers. Thus, regulation and supervision authority of the government has been transferred to private hands. Moreover, functioning as a quasi-judicial body, the Turkish Competition Authority has conflicts with sectoral regulatory agencies from time to time. Some sectoral regulations may violate the universal principles of competition and the Turkish competition law. Undoubtedly, the sector-specific exceptional arrangements are 70

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possible. However, protectionist and clientalistic arbitrary regulations may also be observed in sectoral regulations. In this respect, Turkey’s EU membership process has a critical function to force regulatory institutions to comply with international norms. If the sectoral authorities and the competition authority, as well as courts implement corporate governance effectively, it can be said that infringements of competition and problem of regulatory capture will be minimized. Another important application field of corporate governance is SOEs. Compared to the private sector, the public economic enterprises could not benefit from protectionism or extra incentives, because all public and private enterprises are subject to the same regulatory framework. In addition, SOEs are also subject to extra red tapism. Regulatory and supervisory burdens on SOEs are heavier than those on the private sector. Thus, it can be said that equality (fairness) principle of corporate governance is not violated by SOEs.

Conclusion Awareness of corporate governance in Turkey dates back to 2002 and 2003, just after the publications of international organizations. In addition to CMB, NGOs have also played a major role in developing corporate governance and internal systems. The first public regulation on corporate governance was CMB communiqué in 2003. Then the Banking Law in 2005, and later the TCC in 2011 and finally, the Capital Market Law in 2012 provided strong legal bases. The umbrella institution for corporate governance is CMB. In other words, developing general framework of corporate governance is under the patronage of CMB. The TCC has given regulatory authority to CMB. In addition, authority related to corporate governance principles for publicly-held corporations, principles of public disclosure of decisions of the board of the directors, the authority related to rating of corporations are given to CMB. CMB has made corporate governance mandatory for publicly-held companies trading at BIST (Tuzcu, 2003). All other institutions can make their sectoral regulations on corporate governance after taking the consent of CMB. There is no uncertainty regarding authorized regulatory body in Turkey. Corporate governance emerged in Anglo-Saxon economies first, since financing of economic development depended on the stock exchange in those economies. In that model, small or large various shareholders are protected against management and dominant shareholders. Corporate governance then spread to continental Europe and the far Asia. In this second group of countries, financing development depended on banks. Turkey is classified in the second model. As a result, equality-based financing model necessitates more corporate governance than credit-based financing model. Adaptation of continental European model is mostly due to the long-lasting candidacy of Turkey in the EU. Since corporate governance has come to Turkey quite late, it is still at the stage of initial development. Turkey has experienced many crises due to lack of corporate governance. As of today, state aids and state-owned enterprises are seen as the main problematic areas in terms of corporate governance. There is no direct positive or negative correlation between the performance of a company and level of corporate governance. Many studies have shown that there is no significant difference between performance of implementing and non-implementing corporations. Corporate governance is still seen as a set of procedures and needs time to be Corporate Governance Practices of Turkey: A Critical Review

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internalized. If regulation of corporate governance is not taken as an integral part of the whole economic, legal and institutional framework, there is no easy way to be successful by mere legislation. Corporate governance can be initiated not only in the corporate sector but also in the government institutions, nongovernmental organizations, non-profit organizations and charity organizations that may benefit by implementing corporate governance principles. Indeed, Turkey has witnessed discussions of corruption that engaged the public for a long time in these areas. Therefore, development of corporate governance in the business sector is parallel to the development of democracy. Turkey is one of the good examples of this phenomenon. o

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