Jurisdiction - Japan
Reports and Analysis
Asia Pacific – What is Governing Governance in Asia?

16 September, 2011


As Asia’s markets continue to mature, so does the need for good corporate governance. But there is debate as to what extent this should be regulated by formal rules.



Corporate governance can be a difficult principle to abide by, not least because it is hard to define. To some it is a philosophy, to others a formal code of practice; one person has even likened it to a hangover – recognisable but hard to put into words.


Alan Ewins, a partner of Allen & Overy in Hong Kong, defines corporate governance by asking: “If you stand back and look at how a corporate runs its business, is it doing as it would be done by? Can it justify its practices?”


For Gill Meller, legal director at MTR Corporation, corporate governance has two levels: the first relates to a company’sgovernance structure and the constitution and function of its board of directors, while the second is concerned with a much broader system of internal controls, checks and balances for the benefit of shareholders and other stakeholders.


Some countries have attempted to frame the concept of corporate governance in more detail. The UK’s 1992 Financial Aspects of Corporate Governance (better known as the Cadbury report) and the US Sarbanes-Oxley Act of 2002 are well-known sources. But perhaps the most popular source of guidance comes from the multilateral Organisation for Economic Co-operation and Development (OECD). Its Principles of Corporate Governance were first published in 1999 and revised five years later. They have now become something of an international standard.


“At the OECD we think of corporate governance as the relationship between the board, the shareholders and the management. And there are two aspects to it: the normative and behavioural,” explains Fianna Jesover, senior policy analyst in the corporate affairs division of the Organisation’s directorate for financial and enterprise affairs.


Although corporate governance concerns vital issues (the rights and treatment of shareholders, the interests of other stakeholders, the role and responsibilities of the board of directors, integrity and ethical behaviour, and disclosure and transparency), it is often not turned into black-letter law. In Hong Kong, for example, public companies come under the purview of the stock exchange’s Code on Corporate Governance Practices, which forms an appendix to the listing rules. The Code contains recommended best practices and non-binding provisions, as well as mandatory rules. Many important issues are therefore left to the discretion of companies.


So to what extent should corporate governance be a voluntary undertaking? Some countries in Asia-Pacific, including Australia and Singapore, have introduced an element of coercion through the so-called comply-or-explain regime, under which an issuer must disclose whether it is complying with corporate governance guidelines, and if not why not. In Hong Kong, the principle applies to certain binding provisions of the Code, but is only “encouraged” in relation to recommended best practices.


The bottom line


If there was a proven direct connection between a company’s corporate governance and its share price, perhaps directors would be more likely to take governance seriously. But it is not clear to what extent the two are directly linked.


“We know bad corporate governance resulting in corporate scandals will affect share value, but when it comes to attributing value to good corporate governance, it is very difficult to determine its impact,” says Richard Lam, an associate of Baker & McKenzie.Wong & Leow in Singapore.


But Lam adds that for sophisticated or institutional investors, “good corporate governance may well be a factor that is taken into consideration when assessing a company’s risk management capabilities and how strong the fundamentals of a business are.”


One piece of evidence which seems to show a connection between governance and company value comes from the US, where a number of relatively inexperienced Chinese companies have listed in recent months. Their share prices have done poorly, and this is due, say some specialists, to a lack of trust among investors as to what is really going on inside those organisations. In contrast, says Ropes & Gray partner Paul Boltz, “Chinese companies with stable management and directors, as well as more market experience, are perceived by investors as a much safer bet. Their share prices reflect this investor confidence. Building trust can go a long way.”


Academic findings reveal a more complicated picture. In his 2009 PhD thesis at Glasgow University, Ronnie Lo Hok-Leung wrote of Hong Kong public companies: “Voluntary corporate governance disclosure is positively and significantly related to market valuation for small firms, but the relationship is not significant for large or medium firms.”


Lo went on to say that firms with higher corporate governance disclosure are associated with lower dividend payout ratios, but that gaining the moral high ground may outweigh the financial disadvantage: “The evidence appears to suggest that corporate governance disclosure can substitute for dividend payout. Voluntary disclosure of corporate governance information, even under a strong legal regime for investor protection, seems to be a company attribute very much appreciated by outside investors.”


Meanwhile, in a paper published in the Quarterly Journal of Economics (‘Corporate governance and equity prices’, February 2003, pp 107-155), Paul Gompers, Joy Ishii and Andrew Metrick found that firms with stronger shareholder rights “had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions.”


Aptitude and attitude


Considerations of corporate governance clearly require a careful balancing of the rights of the various stakeholders involved, but how and to what extent this can be done depends on a country’s business culture.


“In Hong Kong … a lot of big companies are still majority family-owned which means that different corporate governance systems may be required,” says Meller. (According to Forbes, companies owned by Li Ka Shing and his family alone make up 15% of the market capacity of issuers on the Hong Kong stock exchange.)


On this point Lo wrote: “Past research suggests that concentration of control in a few families creates powerful incentives and abilities to lobby government officials for preferential contracts, non-market-based financing, and may lead to crony capitalism, suppressing minority investors’ rights.”


Although Asia may be starting at a position of disadvantage when it comes to governance and transparency, since the 1997 Asian financial crisis there has been a shift away from focusing only on making money. Companies and investors are gradually appreciating the significance of corporate governance, a change in attitudes which mirrors what is happening on a global scale. Ewins notes that the G20 has consistently expressed a general desire to improve corporate governance practices internationally, with a marked increase in pushing for things to be done because they are “the right thing to do”.


The OECD has been closely involved with governments and regulators in the region since 1999, through its Asian Roundtable on Corporate Governance, and is now seeing more activity across Asia.


“We’ve been working with the region in this forum … to improve corporate governance frameworks and practices in Asia, using international standards,” Jesover says. “In 2003, we came up with recommendations and priorities for reform – this was done collectively. There was already a good group dedicated to try to improve things; they worked with us to come up with recommendations and to try to achieve them.”


“We’re now revising and setting an even higher standard for Asia in a paper that’s coming out in October [2011] in Indonesia,” she continues. “A lot has improved – the legal and regulatory framework has been strengthened, institutions to support corporate governance reform have developed, and there are improvements in convergence with international accounting standards.”


In Hong Kong, recent controversy concerning the misuse of personal data, the continued fallout from the mis-selling of Lehman Brothers mini-bonds, and the general downturn in the economy have made governance an important issue for the general public. Meanwhile, corporate governance is now “firmly in the sights” of the Hong Kong regulators, according to Ewins. The stock exchange, for example, is now in the latter stages of a review of the Code on Corporate Governance Practices. Conclusions from the consultation period are pending, but initial proposals were for many of the existing best practices and guidelines to be upgraded to binding rules.


In Singapore, too, there are plans to tighten up the country’s corporate governance structure as part of changes to the Companies Act. (The new rules would require the majority of a company’s board to be made up of independent directors, and give the board responsibility for risk management and internal controls). In mainland China, meanwhile, the banking regulator has just finished a public consultation on draft corporate governance guidelines for commercial banks, which aim to consolidate various existing regulations and introduce more sophisticated governance measures.


Asian regulators clearly feel the time is ripe for an upgrade of corporate governance rules. But would this produce any meaningful improvement? There is evidence to suggest that the answer is no. The CG Watch 2010 report on corporate governance in Asia, published by CLSA Asia-Pacific Markets in collaboration with the Asian Corporate Governance Association (ACGA) contains some worrying reading:


“Corporate governance standards have improved over the past decade, but even the best Asian markets remain far from international best practice. Regulators make it too easy for companies to get away with box-ticking. Markets still lack effective rules on fundamentals such as independent directors and audit committees. Not enough has been invested to make best practices work. Meanwhile, most institutional investors are yet to invest sufficiently in voting, engagement or stewardship. Rather than use the global financial crisis as a platform to push reform forward, governments have taken a complacent view, happy that the crisis this time did not start in Asia.”


The report goes on to say that Singapore and Hong Kong “should be performing at a much higher level for financial centres that aspire to follow international standards”. Whatever the reason behind their lag, some feel that increased pressure from regulators is not the whole solution.


“There is desire from regulators wanting change, but we are not seeing a similar change in attitude among companies,” says Hayden Flinn, a partner of Mallesons Stephen Jaques. “Many Asian companies look at corporate governance as … a compliance exercise rather than with any genuine belief that anything is being added to the organisation.”


As Tanner De Witt partner Tim Drew says: “You can pass legislation to provide for greater corporate governance, but there’s got to be a willingness to embrace it.”


Corporate governance is, after all, all about what is “right”. So is it possible for such a fuzzy concept to be properly regulated by a system of compulsory rules?


“There is no one-size-fits-all model to corporate governance,” says Baker & McKenzie.Wong & Leow associate principal Lan Hing Liew. “What may work in the US or UK may not work in Asia given the different market conditions, cultural differences, or even the way companies conduct business.”


With less direct pressure from regulators and a largely voluntary system of corporate governance, it would be left to external factors to provide sufficient incentives for companies to comply.


“Many multinationals need to take corporate governance into account not just in terms of whether they could be vulnerable to regulatory action, but also in areas such as risk management, particularly having a clean record in the public eye,” says Ewins.


This could work reasonably well in places like Hong Kong, which enjoys a free press, independent awards for voluntary corporate governance disclosure (such as those given by the Hong Kong Institute of Certified Public Accountants), and a high level of interest in share dealing among the general public. But it may not be such a significant part of the equation everywhere in the region, meaning that some company bosses may acknowledge the existence of corporate governance, but dismiss it as irrelevant to the way they have traditionally done business in the region. With no class-actions possible for shareholders, there would be little redress. Moreover Boltz points out that when companies are planning to list, they generally look to see what the requirements are – whether customary practices which are expected by institutional investors at the launch of an IPO, or mandatory listing rules – and rarely go further than this.


“You don’t often see companies bending over backwards to go further than what they are required to do,” he says.


Given these factors, the arguments for more legally-binding rules begin to look more attractive again. Flinn uses Australia as an example of how stricter rules can influence the behaviour of directors.


“In Australia, people are hesitant to be appointed as directors because they know there is a genuine responsibility which goes with being a director of public company. Directors are reluctant to sign anything which gives them personal liability,” he says, pointing to a recent case in which directors and officers of the Centro group of companies were found to have breached duties of care and diligence under the Corporations Act.  According to a Mallesons briefing, the decision “suggests that directors’ duties have special application in the context of financial reporting obligations … So much so, that directors cannot delegate their responsibilities to make these declarations.”


Flinn contrasts the decision with the situation in Asia.


“There is not a history of personal sanctions on directors if they don’t comply with their duties,” he says. “The only way change can happen [in Asia] is if individuals are held accountable.”


The voice of reason


Amid all this stands the in-house lawyer, but most codes on corporate governance do not mention their role at all. The proposed changes to the Singapore code, for example, adopt the view that the board will have oversight of risk, and that the management would then work with the directors to implement the framework of the system. But the in-house counsel should be playing a significant part in corporate governance. As lawyers, they are (or should be) constantly aware of compliance issues, and ought to be well placed to influence a company’s policies. Meller says that in a Hong Kong listed company, the in-house lawyer must make sure the directors and senior managers are aware of continuing obligations at the start of the company’s listing career. From then on, there is a complex set of requirements and obligations to bear in mind, and it makes most sense for the in-house counsel to be at the forefront of compliance. Assuming their company has put them in a position to be able to exercise sufficient influence (“Without a seat on the executive team or board, it’s a much more difficult job,” says Meller), the in-house counsel has the ear of senior figures and can sound appropriate notes of caution where necessary. They can also help ensure that systems and policies are set up correctly and act as a bridge to external counsel should additional legal advice or training be necessary.


“We have a dual role,” says Meller. “We to some degree act as corporate guardians in terms of advising on listing rule impact and the legal impact of transactions the company is entering into. There’s also a broader role of educating the business as to what the rules and regulations are all about.”


Flinn, however, cautions against over-reliance on procedures and policies.


“The difficulty is that it’s up to individuals and culture; counsel can add value by setting up frameworks and procedures, and policing them, but a culture of good governance has to come from the top.”


The issue comes back to one of strong leadership, and a good understanding of what corporate governance means – for the company in question, and for the country and region in which it is operating. Investors may be willing to accept lower returns if they are assured of good, stable governance, but no amount of rules or penalties can achieve this outcome. And nor can goodwill alone. Promoting good corporate governance is a balancing act in which organisations such as the OECD and ACGA, along with governments, regulators, public companies and lawyers all have a vital part to play.



By Phil Taylor



Further reading


Leave a Reply

You must be logged in to post a comment.