petrobras - corporate governance analysis

Corporate Governance Analysis

2015

EXECUTIVE SUMMARYPetroléo Brasileiro S.A., or Petrobras, is a multinational integrated energy corporation, ranked as the 27th largest public company worldwide in terms of sales revenue (Petrobras, 2015). Despite the company’s commercial success, its lack of a strong framework and culture of internal corporate gov-ernance led to the emergence in 2014 of the scandal colloquially known as ‘Operation Carwash’; an event that had profound financial implications for both Petrobras and the Brazilian economy at large.

This report provides an analysis of the issues within Petrobras’ corporate governance framework that contributed to ‘Operation Carwash’. We will further evaluate the opportunities available to the company to re-instill confidence not only in its shareholders, but also its consumers and the public, and exemplify what it means for a company to have effective and strong corporate governance.

The factors found most responsible for the emergence of the scandal include, in the Brazilian gov-ernance context, inadequate regulatory oversight caused by a concentration of ownership (Chavez and Silva, 2009, p. 36), and more specific to Petrobras’ governance, an entrenched culture of unethical behaviour, a lack of respect for regulatory standards among Petrobras’ top-level management and executives, and an inadequate internal governance framework. These factors culminated in encour-aging the company to exhibit low transparency, ineffective Boards, collusion and a lack of rights for minority shareholders (Silveira and Saito 2009, p. 24). Whilst actions have been taken to establish higher standards of corporate governance among Brazilian corporations, these remain largely vol-untary, rather than mandatory (Silveira and Saito, 2009, p. 27), highlighting that the Brazilian corporate environment still has a long way to go before its governance practices are aligned with international standards.

From our evaluation, we recommend the following: a redevelopment of Petrobras’ core strategy, mis-sion statement and values; a redesign of the company’s internal and external corporate governance frameworks; and the implementation and strengthening of the company’s key governance policies including: transparency, knowledge and ethics, whistle-blower protection, and relations with the Bra-zilian federal government. These recommendations are intended to leverage the role of Petrobras’ Board of Directors as a provider of strategic leadership, adjust the company’s organisational con-figuration to conform with international governance standards, and involve all stakeholders in the organisation’s governance by making ethics and transparency a part of everyday company culture.

Robert Au

President

MGMT90038 Global Corporate Governance | 3

Founded in 1953 and headquartered in Rio de Janeiro, Brazil, Petrobras (Petróleo Bra-sileiro S.A.) operates as a semi-public, multinational integrated energy corporation with a focus on oil and gas exploration, production and distribution. In total, the company oversees 135 production platforms, 15 refineries, 34,000 kilometers of pipeline and more than 8,000 service stations across 17 countries (Petrobras, 2015).

A cornerstone of Brazil’s economy, Petrobras ranked as the 27th largest public com-pany worldwide in terms of sales revenue in 2015 even despite the emergence of the Lava Jato (Operation Carwash) scandal over the past two years (Forbes, 2015). Indeed, its ranking as the 416th largest company overall would have been far higher had it not been for the publication of a 2013 Merrill Lynch report describing Petrobras as the most indebted company in the world (E&C, 2013).

OUR COMPANYOVERVIEW


JAN

2014

JULY JAN

2015

JULY TODAY

Following his arrest in March

2014, Costa and another key

informant, Alberto Youssef,

struck plea bargains with au-

thorities and delivered the

names of numerous parlia-

mentarians and construction

officials involved with ‘Opera-

tion Carwash’ (Financial Times,

2015; New York Times, 2015).

As of August 2015, “117 indictments

have been issued” against individual

company executives, “five politi-

cians have been arrested, and crimi-

nal cases have been brought against

13 companies” in association with

the scandal (New York Times, 2015).

Petrobras’ external auditor subsequently refused to sign off on the company’s quar-terly financial statements throughout the latter half of 2014, whilst police completed a series of raids on the offices of Petrobras and of construction companies linked to the scandal. These raids culminated in the ar-rest of 24 executives from Brazil’s major construction firms (Financial Times, 2015).

‘Operation Carwash’ has had profound financial implications both for Petrobras and the Brazil-ian economy at large. The scandal is estimated to have reduced the value of the company by around US$70 billion relative to its 2010 Initial Public Offering price (The Economist, 2014). Prior to the scandal, Petrobras’ value ac-counted for ~10% of Brazil’s gross domestic product (GDP). Consequently, the revelation of ‘Operation Carwash’ triggered a 1% con-traction in Brazil’s GDP in 2014 (Forbes, 2015).

The principal political party implicated has

been the Workers’ Party, currently led by

Brazilian President Dilma Rousseff, who was

also Petrobras’ chairman during the time

the kickback scheme was in operation (BBC,

2015). Whilst President Rousseff has thus far

avoided implication in the scandal, the pub-

lic outcry over the revelation of ‘Operation

Carwash’ has threatened her leadership and

triggered a significant drop in approval rat-

ings (International Business Times, 2015).

‘Operation Carwash’ refers to a widespread money-laundering scheme that was re-vealed in 2014 between Petrobras’ top-level management and high-ranking officials from the Brazilian Federal Government.

OPERATION CARWASHTHE SCANDAL EXPLAINED

The primary actor in the scheme was Paulo Roberto Costa, Petrobras’ Chief of Refinery between 2004 to 2012,

who was found to have unfairly leveraged his relationship with six of the largest construction firms in Brazil.

Firms that won contracts from Costa’s division were found to have overvalued their projects by as much as

three per cent, creating excess capital for the company that was then diverted into slush funds for aligned

political parties (BBC, 2015). The total value of the bribes resulting from the operation has been pegged by

Petrobras officials at $3 billion (New York Times, 2015).

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Brazilian Corporate Governance Overview

To understand the key institutional weaknesses within Petrobras that led to the emergence of ‘Operation Carwash’, it is first useful to examine corporate governance in the Brazilian context. Like most emerging economies, Brazil’s private sector is characterised by in-adequate regulatory oversight caused by a concentration of owner-ship (Chavez and Silva, 2009, p. 36). This system has its roots in Brazil’s 1976 Corporation Law, which permitted companies to issue non-voting shares to two-thirds of their equity capital (Pargendler, 2012, p. 507). As a result, family groups and single large shareholders have been able to raise equity without diffusing control, which has in turn allowed the conflation of management and ownership within the majority of Brazilian companies (Chavez and Silva, 2009, p. 36; Silveira and Saito, 2009, p. 23).

This model of corporate governance exemplifies what Berle and Means (1933, p. 70) describe as control through almost complete ownership, where an individual or majority group simultaneously serves as both owners and managers of a company. Subsequently, this lack of separation between ownership and control encourages low transparency, ineffective boards, collusion, and lack of rights for minority shareholders (Silveira and Saito 2009, p. 24). Thus in Brazil, concentration of ownership has been the underlying cause of poor standards of corporate governance.

Furthermore, the governance issues associated with the concentra-tion of ownership are particularly visible within state-owned enter-prises (SOEs), such as Petrobras. While the family control model has had a significant impact on corporate governance standards, it is the Brazilian government’s objective of protecting its interest in SOEs that has had the greatest influence on the country’s regulatory regime (Pargendler, 2012, p. 515).

In the early 1990s, like most Latin American states, Brazil enacted reforms to partially or fully privatise SOEs in order to attract for-eign direct investment (FDI) and encourage competition (Paz, 2015, p. 792). However, the Brazilian government’s ultimate objective was to increase its own revenues rather than promote dispersed ownership (Silveira and Saito, 2009, p. 22). By adjusting the Corporation Law to eliminate tag-along rights, the government sold its ownership blocks in order to maximise the capture of control premium at the expense of the rights of minority shareholders (Silveira and Saito, 2009, p. 22). As Pargendler (2012, p. 505) argues, the government’s position as both the controlling shareholder in its SOEs and the arbiter of Bra-zil’s legal and regulatory regime presents a considerable challenge to Brazil’s corporate governance standards. In addition, corporate boards in Brazil are prone to interference with government policy, which gives tacit approval to the practice of collusion between man-agers and politicians (Rabelo and Vasconcel, 2002, p. 323).

CORPORATE GOVERNANCEANALYSIS


CORPORATE GOVERNACEANALYSIS (CONT.)In light of the disadvantaged position of minority sharehold-ers in the Brazilian business environment, a number of vol-untary corporate governance codes have been established to increase the confidence of foreign investors. In 2000, the Sao Paulo Stock Exchange, known locally as Bovespa, cre-ated a listing segment designed for companies seeking to adopt higher standards of corporate governance practices and transparency requirements not required under the Bra-zilian Corporation Law (BM&F Bovespa, 2015). Consisting of three listings, Level 1 requirements incorporate improved methods of disclosure and ownership dispersion rules, while Level 2 includes tag-along rights for minority share-holders (BM&F Bovespa, 2015). The most stringent listing is Novo Mercado, which involves the adoption of both Levels 1 and 2 as well requiring companies to issue voting shares only (BM&F Bovespa, 2015). SOEs including Petrobras were among the first to go public on Novo Mercado during the privatisation process (Pargendler, 2012, p. 2940).

The two other main corporate governance codes in Bra-zil are the Instituto Brasileiro de Governança Corporativa (IBGC - Brazilian Institute of Corporate Governance) and the Comissão de Valores Mobiliarios (CVM - Brazilian Securi-ties and Exchange Commission). Created in 1995, the IBGC code applies the four basic principles of transparency, fair-ness, accountability, and corporate responsibility to six sec-tions of governance including ownership, board of directors,

management, independent auditing, fiscal council, and con-duct and conflict of interests (IBGC, 1995). The CVM code promotes protection of investors through transparency, ac-countability, and monitoring (Securities and Exchange Com-mission of Brazil, 2015).

While the above mentioned codes represent a move toward promoting improved corporate governance practices, they remain voluntary rather than mandatory (Silveira and Saito, 2009, p. 27). With the exception of Novo Mercado, which is based on a contractual framework wherein companies can be issued with warnings, fines, suspension of trading, or can-cellation of registration for violating the terms of their listing title, none of the codes include enforcement mechanisms (Silveira and Saito, 2009, p. 31). Furthermore, as Pargendler (2014, pp. 7-8) points out, Novo Mercado stipulations can be amended for SOEs under the Corporations Law, which au-thorises the government to “direct the activities of the com-pany so as to attend to the public interest that justified its creation.” While an improvement to the Corporation Law in 2001 adjusted the ratio of non-voting shares that corpora-tions can issue from two-thirds to 50 percent, the new re-quirement is only applicable to companies established after 31 October 2001 (Silveira and Saito 2009, p. 26). In all, this highlights that the Brazilian corporate environment still has a long way to go before its governance practices are aligned with international standards.

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CORPORATE GOVERNACEANALYSIS (CONT.)Two primary issues within Petrobras’ corporate governance framework ultimately led to the development of ‘Op-eration Carwash’: (1) an entrenched culture of unethical behaviour and lack of respect for regulatory standards among Petrobras’ top-level management and executives; and (2) an inadequate internal governance framework

Corporate Governance Issues at Petrobras

As mentioned above, the primary issue of corruption and unethical corporate behaviour is by no means isolated to Petro-bras. Such practices are prevalent across numerous public and private corporations in Brazil and are reflective of a nation-wide absence of sound regulatory frameworks. Scholars believe that a voluntary self-regulated system in Brazil has failed to raise corporate governance practices to international standards (Silveira and Saito, 2009, p. 27-32).

Whilst this culture of corruption is widely acknowledged at a macro level, lax internal governance standards at Petrobras engendered an environment that fostered corrupt activities among individuals in management positions. The ability of man-agers such as Paulo Costa to leverage pre-existing relationships with construction firms through Petrobras for both personal benefit and the benefit of aligned political parties is emblematic of a corporate structure that lacks respect for regulatory norms.

In large part, the issue of inadequate internal governance frameworks is attributable to the role of government in shaping Petrobras’ Board. Petrobras’ Board currently has “ten members, seven of whom are appointed by the Federal Government (including the Chairman of the Board), one by the minority holders of common shares, one by the holders of preferred shares, excluding the controlling shareholder, and one by the employees” (Petrobras, 2014, p. 14). With distinct ties to the governing political party, this board structure allows for potentially unethical collusion between government and Petrobras officials, including the type seen in ‘Operation Carwash’. Furthermore, it serves to increase the degree of discretion enjoyed by the Federal Government as controlling shareholder, a position that can and has been taken advantage of by unscrupulous politi-cal figures (Pargendler 2014, p. 8).


Importantly, both of Petrobras’ key governance failings highlight the importance of a strong and independent Board of Direc-tors, as the primary role of such a body is to supervise the company on behalf of the shareholders (Australian Institute of Company Directors, 2015) and to set the strategic guidance of the company (the Strategic Role) (OECD, 2015).

We therefore recommend the following changes in order to prevent and overcome further governance issues:

1. Redevelopment of Petrobras’ core strategy, mission statement and values;

2. Redesign of the company’s internal and external corporate governance frameworks;

3. Implementation or strengthening of the following key governance policies within the company:

o Transparency, knowledge and ethics;

o Whistle-blower protection;

o Relations with the Federal Government.

Each of these recommendations will be outlined in further detail below.

With reference to the corporate governance issues pertaining to Petrobras and the wider Brazilian economy, we have pro-

posed a holistic set of recommendations that offer a comprehensive means of overcoming the scandal.

MOVING FORWARDRECOMMENDATIONS

10

Firstly, we recommend that Petrobras redevelop its core strategy, mission statement

and values to emphasise ethics, transparency and integrity at all levels of its operations.

This recommendation is intended to leverage the role of Petrobras’ Board of Directors

as a provider of strategic leadership: a new vision and values promoted by the Board

has the potential to stamp out the poor internal culture at Petrobras that both fostered

and enabled ‘Operation Carwash’, replacing it with one of integrity and ethical behaviour.

IMPORTANCE OF OUR

CORPORATE MISSION

STATEMENT & VALUES STABLE FOUNDATION

Core values offer a stable foundation

for decision-makers to turn to in the

face of uncertainty and change, an is-

sue of growing significance in today’s

unpredictable business environment.

OFFERS INSPIRATION

Core values offer inspiration and

the potential to unite and motivate

employees.

DEFINED BOUNDARIES

Core values provide overarching

constraints on strategic decisions by

defining the boundaries within which

employees, including managers, are

given the freedom to innovate. In turn,

this discourages individuals from act-

ing unethically.

CLEAR OUTLINE

Core values provide a clear outline of

what the company, stakeholders and

shareholders will and will not accept.

Specifically, we recommend that Petrobras adopt an or-ganisation-wide mission statement of “Leadership through clarity and knowledge,” demonstrated through the follow-ing core values:

1. Ethics & transparency across all operations;

2. Pride in being Petrobras;

3. Sustainable development;

4. Results and readiness for change; and

5. Stakeholder integration.

These values acknowledge Petrobras’ position as a glob-al leader in the integrated energy industry, whilst striving toward transparency and ethical behaviour. By placing these values at the core of Petrobras’ operations, the Board intrinsically emphasises the importance of ethical and sustainable behaviour at every level of the organi-

sation – and that development and profit should not be sought at their expense. Additionally, prioritising these goals will reinforce adherence to and support for the stricter governance controls and policies outlined in rec-ommendations (2) and (3).

We also recommend that Petrobras adopt a values-based vision statement outlining what the company hopes to achieve in the near future. Collins & Porras have outlined the benefit of what they term a “Big, Hairy, Audacious Goal that requires significant change to be achieved as a driv-ing force for [an] organisation” (1996, p. 66). As Petrobras’ “BHAG”, we would recommend working toward an ideal of being “Corruption-free by 2020.” The concept is to pro-vide a unifying goal for employees and to assist in key decisions by management and the Board.

Finally, in implementing these changes, individual busi-ness units will be encouraged to develop subsets of these statements and values to further support and develop the required change within the organisation.

STRATEGY & VALUESRECOMMENDATIONS

Whilst a company’s vision and values can at times seem tangential to business objectives, stud-

ies show that companies that enjoy enduring success most often possess core values and a core

purpose (i.e., a ‘mission’) that remain fixed, while their business strategies and practices “endlessly

adapt to a changing world” (Collins & Porras, 1996, p. 65).


[OUR] VALUES ACKNOWLEDGE PETROBRAS’ POSITION AS A GLOBAL

LEADER, WHILST STRIVING TOWARDS TRANSPARENCY AND ETHICAL

BEHAVIOUR

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Having thus addressed the symbolic role that the Board plays in corporate governance, it is equally imperative to address structural issues within Petrobras’ corporate governance frame-work. Significant adjustment to Petrobras’ organisational configuration is inhibited as much of the company’s structure is determined by law (Petrobras, 2015); however, we have worked within these limitations to develop a set of recommendations that strengthen Petrobras’ govern-ance while adhering to legal requirements.

Structure

As seen in Fig. 1, Petrobras currently has an Executive Board that sits below a supervisory Board of Direc-tors, further overseen by an external Audit Committee.

CG FRAMEWORKSRECOMMENDATIONS

Fig. 1:

Petrobras organisational

structure. Source: ‘Or-

ganization Chart,’ Petrobras,

retrieved 15 October 2015,

www.petrobras.br/en

The Board of Directors is comprised of independent directors appointed by Petrobras’ stakeholder groups, including the Federal Government, labour unions, and preferred and minority shareholder groups; while the Executive Board is comprised of the President of the company and the Vice-Presidents of the re-spective divisions of the company. The Executive Board’s activities are audited by the company’s Internal Auditing department, whose report is delivered alongside the Executive Board’s to the Board of Directors.

We recommend the following changes to the current structure:

1. The creation of a new Appointment and Remuneration Committee to sit alongside the Audit Committee, in order to address issues of conflict of interest associated with the appointment of previous Directors (discussed further in recommendation (3)).

2. The addition of a Chief Knowledge Officer, a Chief Transparency Officer and a Chief Audit Officer to the Executive Board, emphasising the increased importance of these measures within the organisation. These officers, and other members of the Executive Board, will be subject to the same additional appoint-ment and remuneration criteria outlined in recommendation (3).

Membership

As well as their structure, the membership of Petrobras’ Board of Directors and Executive Board will determine the effectiveness of these Boards (Ryan & Wiggins, 2004). Like many domestic legal systems, Brazil’s corporate legislation places minimal constraints on who can be a Director of a private or public company (Brazilian Federal Law no. 6,404). Thus, the responsibility for setting and enforcing standards for Directors falls upon individual companies as a means of self-regulation. We recommend that Petrobras apply the following standards in order to ensure that the members of each of its Boards are adequately qualified to hold their positions.


Board of Directors

1. Members of the Board of Directors should be rec-ommended to relevant stakeholders by the Appointment and Remuneration Committee, rather than being chosen by the controlling shareholder.

2. Directors cannot have been a ‘Related Party’ of the organisation within the 24 months before their appointment.

3. Directors must have sufficient experience in an industry relevant to the position in which they will serve, aiming for representation from a broad range of industries including legal, engineering, business, social services, gov-ernment relations and the sciences.

4. Directors must have academic qualifications at a level appropriate to the position in which they will serve, and if not, must be prepared to undergo “on-boarding” via a relevant management course from a qualified independent organisation.

5. Directors must be an existing member of a relevant industry body, relating either to the position in which they will serve or to management at a Board level.

Executive Board

1. As with the Board of Directors, members of the Executive Board should be recommended to the Board of Directors by the Appointment and Remuneration Committee rather than selected by the majority shareholder.

2. Members of the Executive Board must possess key knowledge contacts within the organisation.

3. Members of the Executive Board must meet a transparent set of key selection criteria based on merit, per-formance, industry knowledge and expertise.

4. Members of the Executive Board must undergo significant training as part of the “on-boarding” process to gain familiarity with the requirements and responsibilities of an executive position (including ethics and governance train-ing).

These standards will ensure that Board members not only have sufficient skillsets to occupy their nominated positions, but will also bring with them significant reputations in their fields that they will fear losing – this imperative, called the management of reputation capital, has been shown to re-inforce good corporate behaviour (Klewes & Wreschniok, 2004).

Finally, as described above, we recommend giving significant care to the “on-boarding” and ongoing training of new Direc-tors. Studies show that extremely high-performing compa-nies pay extraordinary attention to managing what might be called the socialisation process for their employees and management – the development of a strong organisational culture mutually reinforces the development of strong gov-ernance standards within a corporation (Nadler, 2004).

Membership criteria

Notably, the membership criteria outlined above place a sig-nificant emphasis on demonstrated industry experience and skills. Whilst this may limit the pool of available Directors to a certain extent, we believe that given the size, scope, and complexity of Petrobras’ operations, demonstrated knowl-edge and performance across the company’s technical ar-eas of operation are a crucial indicator of a Director’s future performance in the role (Carter, Simkins and Simpson, 2003).

We also emphasise appointing Directors with a diverse range of experience - both geographical, cultural, and across industries - as it has been demonstrated that when a Board demonstrates a significant diversity of experience, company performance improves along both business and governance metrics (Carter, Simkins and Simpson, 2003). Boards with a diversity of experience are also negatively correlated with corruption (Upadhyay, 2014; Rhode and Packel, n.d.). Finally, a diverse Board provides strategic benefits by allowing ac-cess to a broader range of markets and networks and by boosting reputation (Brammer, Millington and Pavelin, 2009).

Finally, we emphasise that Board members should be able to demonstrate a commitment to activist directorship (Millstein and MacAvoy, 1998). Referring to Nadler’s discussion of es-sential Board “types”, the “activist” Board might sit some-where between the “engaging” and the “intervening” Board: while frequently involved in decision-making and quick to provide operational guidance to management, it nonethe-less does not interfere with management’s capacity to make independent business decisions (Nadler, 2004; Millstein and MacAvoy, 1998). We believe that given the challenges Petro-bras faces at present, and the significant changes it will need to undertake in order to mitigate the impacts of ‘Operation Carwash’, the company requires strong, active and participa-tory leadership. An activist Board, when designed well and comprised of qualified individuals, can be a significant tool for successfully implementing organisational change (Beer & Eisenstat, 2000).

CG FRAMEWORKSRECOMMENDATIONS (CONTINUED)

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Implementation or strengthening of key governance policies

As mentioned above, we recommend that Petrobras implement or strengthen native policies in the following areas:

1. Transparency, knowledge and ethics;

2. Whistleblower protection;

3. Relations with the Federal Government.

Details of each of these policies are outlined below.

A key component of these new policies is that they involve the imposition of new requirements upon all of Petrobras’ stakeholders to various extents, from the executive to the operational level. As one of the world’s largest public companies, Petrobras already possesses relatively comprehensive risk management and governance policies administered through its Governance, Risk and Compliance department (Fig. 1). However, these policies were not enough to counter the widespread and significant unethical practices that occurred during ‘Operation Carwash’. Therefore, we recommend strengthening these policies by making them a contractual obligation to engagement with Petrobras: adherence to each policy would be a pre-requisite to doing business with Petrobras on any level, whether as a Director, executive, employee or contractor. These obligations would also apply to all suppliers, partners and resellers within the Petrobras network. Not only would this allow for stronger enforcement of Petrobras’ governance policies, it would also serve to involve all stakeholders in the organisa-tion’s governance by making ethics and transparency a part of their everyday induction and training, thus assisting in the elimination of bribery and corruption within the organisation (Rose-Ackerman, 1999). Similar efforts by other companies have been shown to have a high efficacy rate in minimising both the opportunity for and prevalence of corruption within organisa-tions (Rose-Ackerman, 1999).

Further, we recommend that all Petrobras stakeholders are required to undertake new training and initiation programmes that address and explain the new policies as part of their implementation. Ongoing integration and communication are shown to be significant components of enacting cultural change within a corporation and maintaining a strong corporate culture (Martin, Frost and O’Neill, 2006).

KEY GOVERNANCE POLICIESRECOMMENDATIONS


Transparency, Knowledge and Ethics

The Transparency, Knowledge and Ethics policy emphasises the obligation of Petrobras and individuals within Petrobras to act in an open and transparent manner across all operations. Given the industries that Petrobras operates across, and given the Brazilian Federal Government’s status as both a ma-jority shareholder and a significant stakeholder, there are some limits to the extent of information that Petrobras can legally divulge. Still, in order to foster accountability and help develop confidence in the organisation among inves-tors and the public, we recommend that Petrobras adopt the continuous dis-closure obligations of the Australian Stock Exchange (ASX), recognised by the OECD as one of the most stringent reporting regimes in the world (Interna-tional Monetary Fund, 2015). This will ensure that if Petrobras “is or becomes aware of any information ... that a reasonable person would expect to have a material effect on the price or value of [its] securities, [it] must immediately tell ASX that information” (ASX, 2015). This ensures that all information that should be publicly available is available.

In addition to strengthening the company’s disclosure and information-sharing obligations, we recommend that employees and, where applicable, contrac-tors of Petrobras should be required to abide by the same ethical standards that are imposed on the Board and executives. These include:

1. Duty of good faith;

2. Duty to act in the best interest of the company;

3. Duty to avoid conflicts between the interests of the company and the employee’s own interests (related party transactions); and

4. Duty to act honestly, and to exercise the requisite care and dili-gence in all operations.

These duties would be integrated into Petrobras’ native employment policies, such that if they are violated the employee in question would be liable in a civil context as well as facing potential criminal liabilities.

Whistleblower Protection

A whistleblower is defined as an individual that exposes any kind of information or activity that is deemed illegal, dishonest, unethical, or otherwise improper within a public or private organisation (Johnson, 2003). Whilst a whistleblower is often typecast as someone who exposes poor internal practices to an ex-ternal regulator, an effective internal whistleblower policy is largely agreed to be an integral piece of a company’s corporate governance framework, as it enables the company to foster a culture of effective due diligence regarding corrupt or illegal practices (Johnson, 2003). We therefore recommend that Petrobras strengthen its existing whistleblower policy by installing whistle-blower officers at all levels of the company, who are readily available and responsible for receiving reports of illegal or unethical behaviour.

KEY GOVERNANCEPOLICIESRECOMMENDATIONS (CONT.)

16

THE TRANSPARENCY, KNOWLEDGE AND ETHICS POLICY EMPHASISES THE OBLIGATION OF PETROBRAS TO ACT IN AN OPEN AND TRANSPARENT MANNER

ACROSS ALL OPERATIONS


KEY GOVERNANCE POLICIESRECOMMENDATIONS (CONTINUED)

An effective whistleblower policy should possess the following features:

1. Reporting responsibility - individuals have a duty to report any illegal or unethical behaviour by or involving a Petrobras employee, contractor or other stakeholder that they may observe or otherwise become aware of;

2. No retaliation - individuals must be able to expect that a report to the whistleblower officer will not be met with retaliation or punishment, either directly or indirectly, at any level of the company;

3. Reporting procedure - clear procedures must be followed in the reporting of all incidents to the whistleblower of-ficer;

4. Good faith - all reports to the whistleblower officer must be made in good faith, i.e. the individual who makes the report must have every reason to believe the information s/he is reporting is true;

5. Confidentiality - all reports to the whistleblower officer are made in complete confidence and should be kept in complete confidence.

This policy is designed to encourage individuals within Petrobras’ network to report incidences of illegal or unethical be-haviour that have a reasonable basis for claim; to ensure that the reporting individuals are not retaliated against; and to establish policies that ensure all allegations receive sufficient follow-up. Importantly, there is an obligation of confidentiality on all parties involved in the process, as well as a requirement that both the reporting and investigation parties act in good faith (Near, Dworkin and Miceli, 1990). We believe these requirements sufficiently facilitate reporting and follow-up whilst addressing the risk that allegations will be made against individuals as a form of personal retribution.

Relations with the Federal Government

As a state-owned enterprise (SOE), Petrobras is required by law to maintain the Brazilian Federal Government as its con-trolling shareholder. This means that the Federal Government holds the majority of the company’s voting shares and, under current policies, has the power to elect a majority of the members of its Board of Directors. Further to this, Petrobras dis-closes in its 2014 Management Report that the Federal Government “has license to enact macroeconomic and social poli-cies through [Petrobras],” that Petrobras “can carry out activities that prioritise the Federal Government’s policies, instead of [its] own economic and business objectives,” and, of most concern, that Petrobras “can perform sales on terms that may adversely affect [the company’s] operating results and financial condition” (Petrobras, 2014, p. 14).

This legally unavoidable situation represents a significant risk factor for the development of corruption within Petrobras’ company culture, particularly at the top levels (Transparency International, 2013, p. 2). Indeed, the relationship between Petrobras and the Brazilian Federal Government was almost certainly a facilitating factor in the political kickbacks that oc-curred during ‘Operation Carwash’: the government’s control over the membership of Petrobras’ Board would have allowed it to keep renewing the mandate of officials like Paulo Roberto Costa for years on end.

That said, SOEs are not necessarily condemned to problems with corruption and cronyism. Insights from consultancies Mc-Kinsey & Company and PwC show that well-governed SOEs can perform as well or better than private companies, in some cases even cracking the Fortune Global 50 (McKinsey, 2009; PwC, 2015). However, appropriate layers of checks and balances must be implemented between persons in office and persons in key positions at SOEs; and transparent disclosure of all deals, contracts and other transactions between SOEs and current state officials is crucial (OECD, 2010; 2009).

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Thus, while Petrobras is required under current law to maintain a structure that includes ownership by and partnership with the Brazilian Federal Government, we recommend the following changes to Petrobras’ fiduciary and business relationship with the government:

1. Government shares placed in a statutory body. This will serve as a means of establishing “a clear separation be-tween the state’s role as market regulator and owner of the company,” which is “an essential requirement to ensure [good] corporate governance in SOEs” (Transparency International, 2013, p. 3). Placing government shares in an independently managed statutory body will help ensure that the state’s “ownership functions [are] separated from the responsibility for industrial policy”; i.e., that Petrobras is no longer obliged to act as agent of macroeconomic policy for the Brazilian Federal Government at the expense of its own operations or objectives (Transparency International, 2013, p. 3).

2. External audit of government appointees to the Board of Directors to ensure they comply with the standards for appointment and remuneration outlined in recommendation (2).

3. Increase the proportion of “shared value” projects in Petrobras’ relationship with public sector. PwC (2015) notes that since SOEs are inherently hindered from operating on a purely profit-oriented model, they are best served by leverag-ing the policy-oriented aspect of their mandate to pursue shared value projects in collaboration with public and third-sector organisations (p. 7). In the case of Petrobras, taking on an increased number of shared value or development projects in partnership with the government could recast the perception of Petrobras’ relationship with the public sector from one of cronyism to one of collaboration toward broader social and economic goals.

4. Lobby the Federal Government to alter legislation to move toward privatisation of SOEs. Though unlikely to see results in the short term, it is worthwhile for Petrobras to lay the groundwork for a policy of lobbying for the privatisation of SOEs in Brazil, as the nation’s increasing participation and influence in international economic organisations may eventually see the government adjust its policies to fall in line with the liberal capitalist model favoured by the West. This will have to be done tactfully and incrementally so as to avoid coming into direct conflict with the state, as occurred when the CEO of the Brazilian mining firm Vale was forced by the government to depart his position for being too “independent-minded” (The Economist, 2012).

KEY GOVERNANCE POLICIESRECOMMENDATIONS (CONT.)


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All stock images provided by www.istockphoto.com

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Melbourne Business School, 2015MGMT90038 Global Corporate Governance5,455 words

Robert Au

Danna Diaz

Lennard Iosif

Marisa Pensky

Hunter Santamaria

Jedd Watmore

FOR PETER VERHEZEN

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