CAF - Update to the study on the Effectiveness and Structure of Boards of Directors

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POLICY AND

PRODUCTIVE

TRANSFORMATION

SERIES

N°44 / 2024

UPDATE TO THE

STUDY ON THE

EFFECTIVENESS AND

STRUCTURE OF

BOARDS OF DIRECTORS

AT STATE-OWNED

COMPANIES IN LATIN

AMERICA AND

THE CARIBBEANCAPÍTULO I XXTITULO The contributions and comments of Catalina Rojas, Jose Gomez Zorrilla, Enrique Diaz, Catalina Zea, Héctor Lehuede and Jorge Echeandia are gratefully acknowledged. The ideas and proposals contained in this edition are the sole responsibility of their authors and do not compromise the official position of CAF. Graphic design Gatos Gemelos Assembly and diagramming Claudia Parra Gabaldón The digital version of this publication can be found at: scioteca.caf.com Second edition © 2024 Corporación Andina de Fomento. All rights reserved

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 2 Head of the Technical and Sectoral Analysis Division Juan Carlos Elorza Authors Andrés Bernal, Andrés Oneto, Edna Correa, Yohana Rodriguez We would like to thank the representatives of the 111 SOEs that completed the survey on which this study was based and the organizations and individuals who helped to ensure that the questionnaires reached as many companies as possible in the various countries in the region: FONAFE Corporation - Peru, Office of State Participation - Colombia, Governor’s office of Antioquia, Ministry of the Economy and Finance - Panama, Ministry of Finance - Trinidad and Tobago, Brazilian Secretariat for the Coordination of State-Owned Companies, Colombian Institute of Corporate Governance, Institute of Corporate Governance - Panama, Brazilian Institute of Corporate Governance, Association of Corporate

Antioquia, Ministry of the Economy and Finance - Panama, Ministry of Finance - Trinidad and Tobago, Brazilian Secretariat for the Coordination of State-Owned Companies, Colombian Institute of Corporate Governance, Institute of Corporate Governance - Panama, Brazilian Institute of Corporate Governance, Association of Corporate Secretaries of Latin America - ASCLA, FEPCMACPeru, Jose Antonio Felipa, Marta Viegas, Allan Binns, Paola Andrea Escobar, Eloína Diaz, Janessa Castillo, Danilo Gregorio, and Ana Lucia Pinto. Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean

PUBLIC POLICY AND PRODUCTIVE

TRANSFORMATION SERIES Public Policy and Productive Transformation consists of a series of documents focused on disseminating experiences and successful cases in Latin America as an instrument for generating knowledge for implementing best practices in business development and productive transformation. Publisher CAF This document was prepared by the Technical and Sectoral Analysis Division of the Vice Presidency for the Private Sector

ISBN Complete Work: 978-980-6810-67-9

CREDITSCAPÍTULO I

XX

TITULO

ABOUT THIS STUDY

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 3

INTRODUCTION AND

CONTEXT OF THE UPDATE

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CONTENTS

I IICAPÍTULO I

XXTITULO

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 4

CONSOLIDATED RESULTS

OF THE STUDY ANALYSIS

BY SUBJECT

HOW DOES ONE READ

THE RESULTS?

PAGE 17

1. Makeup and independence of the Boards of Directors

2. Participation of women on Boards of Directors

at State-Owned Companies in Latin America and the Caribbean 4

CONSOLIDATED RESULTS

OF THE STUDY ANALYSIS

BY SUBJECT

HOW DOES ONE READ

THE RESULTS?

PAGE 17

1. Makeup and independence of the Boards of Directors

2. Participation of women on Boards of Directors

3. Nomination, election, and re-election

4. Length of tenure

5. Frequency and length of meetings

6. Focus of the Board of Directors

7. Committees

8. Induction and training

9. Evaluation of the Board of Directors

10. Remuneration

III CONCLUSIONS

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IVCAPÍTULO I

XXTITULO

GRAPH 10

Nomination process for Independent and External Directors

GRAPH 11

Consecutive terms for which reelection is allowed

GRAPH 12

Length of tenure by type of member

GRAPH 13

Frequency and length of Board of Director meetings

GRAPH 14

Level of involvement of the Boards of Directors by subject

GRAPH 15

Appointments and removals made by the Board of Directors

GRAPH 16

Percentage of Boards that have Committees

GRAPH 17

Number of members on the Committees

GRAPH 18

Committees of the Board of Directors

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 5

GRAPH 1

Participation by country

GRAPH 2

Participation by sector

GRAPH 3

Ownership structure

GRAPH 4

Ownership by type of State shareholder

GRAPH 5

Participation of SOEs in the capital market

GRAPH 6

Distribution of number of members by range

GRAPH 7

Percentage by each type of member

GRAPH 8

Period for which the Directors are elected

GRAPH 9

Responsible for electing Board members

INDEX OF GRAPHS

GRAPH 19

Committees that can make decisions

Distribution of number of members by range

GRAPH 7

Percentage by each type of member

GRAPH 8

Period for which the Directors are elected

GRAPH 9

Responsible for electing Board members

INDEX OF GRAPHS

GRAPH 19

Committees that can make decisions

GRAPH 20

Board of Directors that do induction

GRAPH 21

Induction topics

GRAPH 22

Board of Directors that do training

GRAPH 23

Emphasis during last year’s training sessions and other topics that are part of training

GRAPH 24

Frequency of training

GRAPH 25

Boards of Directors being evaluated and evaluation methodology

GRAPH 26

Evaluation methodologies and frequency of evaluation

GRAPH 27

Types of compensation received by Boards of Directors

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PAGE 53CAPÍTULO I XX The expertise generated in various projects over the last few decades has allowed CAF, Development Bank of Latin America and the Caribbean, to become a regional benchmark in the areas of competitiveness, corporate governance, local and business development, and productive inclusion. Thus, the series “Public Policy and Productive Transformation” makes documents designed to disseminate experiences and relevant cases in Latin America available to the various Latin American public and private parties as a mechanism for generating and disseminating knowledge for the implementation of best practices in business development and productive transformation. In this regard, corporate governance is one of the many instruments available to the institution to reinforce the business fabric while maintaining a long-term vision of inclusion and sustainability. CAF seeks, through its Corporate Governance Program, to contribute to responsible competitiveness

implementation of best practices in business development and productive transformation. In this regard, corporate governance is one of the many instruments available to the institution to reinforce the business fabric while maintaining a long-term vision of inclusion and sustainability. CAF seeks, through its Corporate Governance Program, to contribute to responsible competitiveness both at the individual level of State-Owned Enterprises and private companies and at the aggregate level with supervisory and regulatory bodies. To this end, the Program develops conceptual and practical tools and disseminates this knowledge in order to raise awareness of the importance this topic has for this region. Through this publication, CAF intends to continue providing guidelines and recommendations in order to have effective Boards of Directors that will enable improvements in the management of State-Owned Enterprises (SOEs), which, due to the sectors in which they operate and their size, have great relevance in the region’s development policies.

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 6 PRESENTATIONCAPÍTULO I XX Understanding the particularities of corporate governance practices of State-Owned Enterprises (SOEs) compared to companies with a private shareholder makeup is essential for identifying areas for improvement in the proper management of these institutions. Special attention should be paid to the Board of Directors, specifically to the mechanisms applied for the selection and continuity of its members as well as to how these collegial bodies operate. This report highlights the importance of strengthening corporate governance practices in SOEs in Latin America and the Caribbean, especially with respect to the structure and effectiveness of the Boards of Directors of these companies. The study is based on a survey completed by 111 SOEs and updates the 2017 study done by CAF and Governance Consultants. As is well known, SOEs face particular challenges due to potential political intervention and the high turnover of their Directors that affects their stability and sustainability. However,

companies. The study is based on a survey completed by 111 SOEs and updates the 2017 study done by CAF and Governance Consultants. As is well known, SOEs face particular challenges due to potential political intervention and the high turnover of their Directors that affects their stability and sustainability. However, there have been significant advances in recent years in the adoption of better corporate governance practices including improvements in the selection, training, and evaluation processes for Board members. These factors have led SOEs to implement more sustainable and responsible strategies and adapt their Boards of Directors to an environment of greater demands from stakeholders, investors, and regulators. The conclusions underline the need for the State to take a more active and committed role as owner and promote a clear ownership policy and effective governance practices. In particular, they need to foster more technical and independent Boards of Directors who are able to look after the long-term interests and purpose of each of these companies. In addition, SOEs are advised to continue developing their own internal mechanisms to ensure the professionalization of the Boards of Directors and to foster stability in upper management in order to minimize the effects of political changes and maximize their value in the long term.

Key words: Corporate governance, state-owned enterprises, SOEs, Latin America and the Caribbean, Board of Directors, State ownership.

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 7 EXECUTIVE SUMMARYCAPÍTULO I XX As mentioned in the latest updates in both the “Guidelines for Good Corporate Governance of State-Owned Enterprises” (2021) https://scioteca.caf.com/handle/123456789/1791 and in the “Guidelines for a Latin American Code of Corporate Governance ”(2023) https://scioteca.caf.com/ handle/123456789/2240, the Board of Directors 1 is the main actor in the corporate governance of any company since

and in the “Guidelines for a Latin American Code of Corporate Governance ”(2023) https://scioteca.caf.com/ handle/123456789/2240, the Board of Directors 1 is the main actor in the corporate governance of any company since it is the body responsible for the management and control of the organization. In practice, the Board of Directors is an exclusive place for prospective conversations with a long-term strategic vision within the organization in addition to generating the appropriate conditions for the company’s governance system to clearly separate the areas of ownership, direction, and management for the benefit of a healthy system of checks and balances. In this respect, the suitability of the Board of Directors as a management body is based on its character as a collegial body with an appropriate combination of profiles on the effectiveness of its decision-making processes and on its ability to best represent the interests of not only the shareholders or owners, but also the various stakeholders (financiers, clients, collaborators, suppliers, regulators, civil society, etc.). The benefits that a professional, independent, and empowered Board of Directors brings to a company are manifold. For one thing, it integrates knowledge and experience into the organization. For another, it is a way to incorporate independence and objectivity into the company’s management process to benefit from the greater

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 8

SECTION I

INTRODUCTION

AND CONTEXT

OF THE UPDATE

1. The highest governing body of a company is also known as the Board of Directors, Administrative Council, or Governing Board in the different countries in this region.

In this document it will be referred to as the Board of Directors.PUBLIC

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Board of Directors, Administrative Council, or Governing Board in the different countries in this region. In this document it will be referred to as the Board of Directors.PUBLIC

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 9 Note that the Board of Directors has undergone an important change in recent decades as it has gone from being considered a body that is almost exclusively for controlling and supervising upper management to a body that is for defining strategic orientation, monitoring the company’s performance as well as ensuring a reliable and effective structure of the control model, and being the guardian of the business’ purpose. Once the company’s strategic orientation has been defined, the Board of Directors delegates the practical implementation to upper management, which they monitor while being accountable to the shareholders, the company’s true owners. Ultimately, the key functions of the Board of Directors, which should be clearly defined in the corporate documents, include:

1. The definition of the company’s strategy with a long-term vision.

2. Oversight of the organization under appropriate risk management and control systems.

3. Guidance and follow-up of senior management.

In view of the current responsibilities of the Board of Directors as well as the challenges they must manage in order to achieve a real contribution and the generation of sustainable value for the company, it is important to bear in mind that, from a corporate governance perspective, a series of good practices must be implemented, both formally and in terms of the practical workings of the collegial body to ensure that the best use is made of this governing body. professionalism in the decision-making process. Likewise, as a collegial body, the discussions are enriched through a diversity of visions, experiences, and perspectives. The latter is of particular importance considering the fact that better decisions lead to better risk management and better companies. Moreover, it is well known that the Board of Directors assists

collegial body, the discussions are enriched through a diversity of visions, experiences, and perspectives. The latter is of particular importance considering the fact that better decisions lead to better risk management and better companies. Moreover, it is well known that the Board of Directors assists upper management in working on agreements that generate value since it challenges and inspires them to find the best options for the company. The mere exercise of preparing the information and proposals for the Board of Directors makes upper management build a more solid argument or, at least, take the time to review the factors that may have an impact on the decision. Furthermore, the Board of Directors contributes to balancing the company’s longand short-term horizon while, at the same time, considering the organization’s strategic risks. It is a body that protects and ensures compliance with the business’ purpose and likewise considers the visions and expectations of the company’s stakeholders. However, today’s Boards of Directors face great challenges in carrying out their functions, considering the fact that they must meet growing responsibilities and expectations while having a limited amount of time to do so. In addition, to the extent that these bodies are made up of outside members - external to management - they must manage an asymmetry of information between this collegial body and upper management. This means they must adopt strategies to make their work more effective.Fundamental aspects that need to be adequately addressed include the structure, components, appointment, and removal of Board members, their functions and capabilities, their rights and duties as well as the dynamics of the meetings. All of this is geared towards contributing to the creation of efficient and active Boards of Directors with enough autonomy to carry out the critical tasks that correspond to the Board for the best governance of any company. In short, the goal is to avoid Boards of Directors that, due to their excessive activism, tend to co-manage and invade the areas that correspond to upper management, or Boards of Directors that, due to their passivity, may become hostages of upper management. Both

governance of any company. In short, the goal is to avoid Boards of Directors that, due to their excessive activism, tend to co-manage and invade the areas that correspond to upper management, or Boards of Directors that, due to their passivity, may become hostages of upper management. Both situations are pernicious since they dilute the value that this body should effectively generate. The point is that the Board of Directors should always act in a responsible, autonomous, professional and independent manner. Note that all of the above is valid for the Board of Directors of any type of company, whether privately owned or state-owned (both at the central and sub-national government level). However, there are particularities with respect to State-Owned Enterprises (SOEs) that differentiate them from private companies in that the Boards of Directors of SOEs are exposed to changes due to the dynamics and potential political interference of the State. In the exercise of its ownership rights, either as full owner or controlling shareholder, the State elects and removes the members of the Board of Directors of its companies. This fact, although inherent and legitimate, is affected specifically by the political cycle, which generally results in shorter tenure for Directors compared to companies with other ownership structures, or in the election of Directors based on political rather than technical criteria. In practice, this implies that, given the dynamics of political cycles, changes in the ownership representative (minister, governor, mayor, etc.) every 4-5 years, if not sooner, often imply changes in the Board of Directors and upper management. This could affect not only the direction of the company, but also its sustainability. In addition to this high turnover, there is also the risk that the Board of Directors’ agenda will focus on short-term objectives that may undermine the fulfillment of the purpose for which the organization was created, due to the dynamics of the SOE’s relationship with the government in power. A good corporate governance structure seeks to reduce these impacts and ensure an empowered Board of Directors and

agenda will focus on short-term objectives that may undermine the fulfillment of the purpose for which the organization was created, due to the dynamics of the SOE’s relationship with the government in power. A good corporate governance structure seeks to reduce these impacts and ensure an empowered Board of Directors and an appropriate selection of its members in order to enhance the stability of the Board and thus the long-term vision of the organization. Therefore, it is a challenge at the level of State-ownership policy to have mechanisms and selection processes focused on promoting the continuity of Directors and stability in the upper management of the company, regardless of changes in the political/electoral system. In this way, it will be possible to maintain an efficient SOE that fulfills the mandate for which it was created and is not limited to the interests of the political player of the day.

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 10It is with this reality in mind that the first edition of this document was published in 2017 (https://scioteca.caf.com/ handle/123456789/1025) with the objective of providing a first approach to knowing and understanding how the governance models of SOE Boards work in Latin America and the Caribbean and to identify opportunities for improvement. It must be noted that the study was done under a theoretical-practical perspective that sought to present and analyze best practices in corporate governance to strengthen the role and governance of the Boards of Directors of SOEs in the region, so as to compare these practices later with the results obtained in a survey answered by a total of 50 State-Owned Enterprises in Latin America and the Caribbean and thus propose concrete recommendations. This update does not seek to deepen the theoretical component of the original document, since they are still valid. Therefore, in order to understand the role of the Board of Directors in SOE corporate governance, we recommend

State-Owned Enterprises in Latin America and the Caribbean and thus propose concrete recommendations. This update does not seek to deepen the theoretical component of the original document, since they are still valid. Therefore, in order to understand the role of the Board of Directors in SOE corporate governance, we recommend reviewing Chapter 1 of the first edition of this study. That being said, it should be recognized that, in the seven years since the original publication, global events have occurred that have had an impact on the way in which companies are governed as well as changed what is expected of them in relation not only to their shareholders, but also to their stakeholders in general. Obviously, this has an impact on the composition and functions of the Board of Directors.

Among the most relevant aspects, the following are particularly noteworthy: (i) the implications of the Covid-19 health crisis on company management,(ii) the impacts generated by Environmental, Social, Governance (ESG) and Climate Change issues, and (iii) the progress made in the implementation of corporate governance practices in SOEs in the countries in the region. With respect to the first factor, the Covid-19 pandemic has led SOEs, like any other company, to adjust the way they operate, make use of new technologies, identify new types of risks, and adapt the vision and requirements of the Board of Directors to unprecedented conditions. Regarding the second factor, greater regulation and the presence of stakeholders such as institutional investors or multilateral financing providers as well as other stakeholders, who more vehemently demand more robust corporate governance standards, and a clearer position on the part of companies regarding their environmental and social policies and strategies, has encouraged Boards of Directors to apply an ESG agenda within SOEs and their own collegial bodies, under a Corporate Sustainability vision that meets the expectations of the various groups of stakeholders. Finally, with respect to the specific progress made by the SOEs in the region, the following considerations should be taken into account:

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under a Corporate Sustainability vision that meets the expectations of the various groups of stakeholders. Finally, with respect to the specific progress made by the SOEs in the region, the following considerations should be taken into account:

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111. Broadly speaking, there is greater interest and commitment on the part of the State as owner, which has made it possible to better address some of the major challenges faced by the SOE Boards. As a result of this, laws have been enacted at the national level in countries in the region that target SOEs and which, along with other things, define minimum conditions for compliance at the Board level. Moreover, entities with centralized ownership have been strengthened and mandatory corporate governance codes that are issued by these institutions have been implemented.

2. The SOEs and their Boards of Directors have, on their own, promoted and applied a series of practices that will have a high impact on the management of the SOE itself without the need to modify laws or statutes that require the involvement of mayors, governors, ministers or even the country’s Parliament. The implementation of practices such as the induction and training of its members, the more efficient management of Board meetings, and the evaluation of the collegial body are within the scope of action of the institution itself and to make them effective only requires the involvement of the Board of Directors and upper management.

Taking the above into account, the decision was made to do this update, specifically with regard to the surveys, and incorporate new questions or refine the existing ones in order to incorporate the factors mentioned above as well as to expand the sample. Thus, a better understanding of the progress made in the region and the identification of recurring or new issues that should be promoted was sought. This report consists of four chapters. The first corresponds to this section “Introduction and context of the update”; the

to incorporate the factors mentioned above as well as to expand the sample. Thus, a better understanding of the progress made in the region and the identification of recurring or new issues that should be promoted was sought. This report consists of four chapters. The first corresponds to this section “Introduction and context of the update”; the second, describes the scope and methodology used to collect information and a general description of the participating companies; the third presents the results obtained in the study as well as an analysis of the information and recommendations for SOE Boards, considering best practices and corporate governance standards; and finally, the fourth presents the main conclusions.

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 12CAPÍTULO I XX This document is prepared on the basis of the consolidated results of the survey “Effectiveness and Structure of Boards of Directors at State-Owned Enterprises (SOEs), Latin America and the Caribbean.” Its objective has been to analyze the effectiveness and structure of SOE Boards of Directors in Latin American and Caribbean countries that are members of CAF in order to generate public policy recommendations as well as to identify best practices that can be replicated in other SOEs. As noted in the previous section, the contents of the first edition of the study (2017) have been updated and include the incorporation of questions related to the responsibility of the Board of Directors regarding ESG issues and the structure and makeup of the collegial body itself while considering the best practices related to corporate sustainability issues. The sample was also expanded from 50 to more than 100 companies that voluntarily responded to the questionnaire. Considering the above, to the extent that the sample universes of the two studies are different, it has not been feasible to do a comparative analysis between the 2017 and 2024 samples.

Methodology As an information gathering instrument, a survey was designed to cover the main areas of analysis relevant to the

studies are different, it has not been feasible to do a comparative analysis between the 2017 and 2024 samples.

Methodology As an information gathering instrument, a survey was designed to cover the main areas of analysis relevant to the effectiveness and structure of the Boards of Directors in State-Owned Enterprises. The questions were framed to obtain detailed and objective information on key aspects of the Boards’ operations and ensure comprehensive coverage of critical governance issues. These areas of analysis include:

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TRANSFORMATION SERIES Update to the study on the Effectiveness and Structure of Boards of Directors at State-Owned Companies in Latin America and the Caribbean 13 SECTION II ABOUT THIS STUDYi. Description of the company. ii. Makeup and size of the Board of Directors. iii. Profile of the Directors. iv. Fulfillment of the role of the Board of Directors and participation in decision making.

1. Board of Directors’ support committees. vi. How well the Board of Directors’ meetings operate. vii. Role o