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Corporate Governance in Asia

Corporate Governance in Asia

By Christopher Leahy, Asia Editor, Euromoney

Corporate governance has been high on the agenda for

Asian regulators in recent years with most markets having introduced comprehensive regulations. Yet as a recent independent research study shows, much work remains to be done and despite compelling evidence of the
financial benefits to companies of a good governance culture,
the ethos of corporate governance has yet to sink in.
Regulators, companies and investors all have a vital role
to play.
The well-publicized financial and corporate scandals in US
and Europe in 2001 and 2002 and the implications of the
US Sarbanes Oxley Act in 2002 have provided a source of
major impetus amongst regulators and governments in Asia.
The result has been a slew of rule and law making that has
rapidly improved the regulation of corporate governance in
key Asian markets.
With so much achieved in a relatively short period of time,
regulators now appear to be succumbing to the understandable temptation to shift their focus from rule making to rule enforcement. With rules in place goes the thinking
all that is needed to achieve corporate governance perfection is effective enforcement. That thinking is however, flawed. Despite appearances, there remain some glaring
holes in the regulatory framework in many countries in
the region that serve to hamstring the efficacy of what
has already been achieved.
To add to the challenges faced by corporate governance in
the region, although there are corporations in all markets
that consciously exceed governance standards there is also
clear evidence that the approach to the governance issue by
many Asian companies amounts to little more than box ticking
and window dressing. This fact is especially troubling since
recently published data suggest a strong linkage between good
corporate governance practice and financial returns. Asia
still has some way to go, it seems before it achieves corporate governance Nirvana.

Monitoring the monitors

Spreading the Word, the title of Corporate Governance Watch
2004, an annual collaborative study of the corporate governance landscape of Asian markets undertaken by independent
stockbroker CLSA Asia Pacific Markets (CLSA) and the Asian
Corporate Governance Association (ACGA) offers the most
comprehensive assessment of corporate governance standards
and progress for both regulators and companies within the region.
This year, CLSA and ACGA made substantial improvements
to the way in which markets were ranked for corporate governance. The key determinants behind assessing corporate
governance standards remained the same as in previous years
(namely: rules and regulations; enforcement; the political
and regulatory environment; the adoption of international
accounting standards; and the institutional landscape and
corporate governance culture). Countries were scored against
these issues and a weighting to each category applied to arrive
at an overall country score.
In addition to this standard scoring methodology, however, this
year ACGA devised a template of macro and regulatory issues
against which each country was further scored within each main
category. This additional assessment provided a further refinement and level of detail to enhance the depth of analysis of each
Markets ranked by corporate governance

2004 total score

Hong Kong


Source: CLSA Asia-Pacific Markets/Asian Corporate Governance Association


Corporate Governance in Asia

Although the top three corporate governance markets, Singapore, Hong Kong and India have not changed their position from the previous years ranking, there have been changes
further down the rankings as certain markets have improved
regulation. Most notably, Malaysia improved its ranking by
two places as a result of improved accounting standards, better
enforcement and a higher score for its political and regulatory environment, while the Philippines marginally leapfrogged China due mainly to its higher score for accounting and auditing. Indonesia remains firmly rooted at the
foot of the table.
First the good news
The CLSA/ACGA report also highlights a number of areas
of improvement across most markets. In particular, there
has been a push among regulators to improve corporate
disclosure. In Singapore, Malaysia, Indonesia and Thailand, for example, regulators now require companies to
report their annual results within two months of the fiscal
year end. Quarterly reporting is now mandatory in most
markets in Asia, with the notable exception being Hong
Kong where strong resistance to change appears to persist
among many of the territorys large companies.
Another sign of improved corporate disclosure is that all
markets except Taiwan and the Philippines now require
the disclosure of stakes in companies of 5% and more and
some markets also require the disclosure of individual director
compensation. Most markets insist on the disclosure of audit
and non-audit fees paid to external auditors too.
Other areas of improvement include enforcement, where
there is evidence in most markets of increased resources
being applied in this area, albeit far below what is necessary. Most markets have improved their accounting and
auditing standards that are now largely in line with international standards. Securities regulation in many markets
has also been updated and strengthened, especially in the
key areas of dealings in securities by directors and related
party transactions.
Now for some bad news
So much for what is good in Asian corporate governance
regulation. Despite appearances, as Spreading the Word
points out, there remain some continuing areas of weakness
among regulations in most markets in Asia. In particular,

the report highlights the continued reluctance among many

markets not to shorten annual reporting deadlines and singles
out Hong Kong, Korea and Taiwan for particular criticism.
Only one country, notes the report, Korea, has introduced
comprehensive class action litigation (with effect from January
2005) to assist investors to fight securities violations. China
and Taiwan have systems that allow a degree of class or
representative action and Thailand has had a bill under
consideration for some time. It is noteworthy that none of
these markets is in the top quartile of the corporate governance
rankings. No market has yet introduced mandatory voting
by poll, rather than a simple show of hands, for all resolutions at shareholder meetings. Hong Kong and Taiwan are
rare examples of markets that require voting by poll for at
least some (ie, major) resolutions.
One of the most important and yet complicated areas affecting corporate governance concerns the definition of an,
independent director. Although almost all markets have
adopted a national code of best practice along international
standards, very few have defined independent director
adequately. The definitions contain loopholes that permit
people connected with management or a controlling shareholder to meet the requirements of putative independence.
It is not just in the area of independence that corporate
governance problems arise with company boards. Very few
Asian markets require directors remuneration to be disclosed on a named, individual basis. Most still permit disclosure
to be made by way of bands or in aggregate. Independent
board committees, with the exception of audit committees,
have not found strong support among regulators and no
market makes it easy for minority shareholders to nominate
independent directors. Worryingly, only Singapore, Taiwan
and, to a lesser degree, Korea, have regulations that make
it easy to remove directors convicted of fraud or another
serious corporate crime.
Talking the talk
So if some of the rules are broken, why is it that regulators
do not simply step in and fix them? According to ACGA,
regulators and governments in the region are far more
comfortable demanding high standards of accounting,
auditing and financial reporting than encouraging companies
to build strong internal controls and methodologies to

Corporate Governance in Asia

ensure accountability. In particular, notes the CLSA/ACGA

report, governments and regulators appear to be reluctant
to permit minority shareholders to exercise meaningful
influence over Asian companies, despite the irreconcilable
fact that governments regularly urge retail and institutional
investors to push for corporate governance reform. A little
like urging them to fight with one hand tied behind their
The biggest impediment to comprehensive corporate governance reform in Asia appears to be the clear vested interests that exist in each market, an issue exacerbated by
the high number of family-controlled businesses in the
region. It is one thing to increase the proportion of
independent non-executive directors on a board, for example
but if the rules that define the independence of board
candidates are fundamentally flawed, then the proper
functioning of a board can be compromised and its
independence from the controlling shareholder ironically
lessened rather than increased.
Mending the rules
Fixing these flaws, while not easy, requires an attitude shift
amongst regulators, argues ACGA, including a reassessment of some fundamental issues. Chief among these is a
review of existing regulatory and legal environments and
how these can be changed to empower and encourage market
participants, meaning principally investors, to supplement
the efforts of regulators in promoting and driving reform
within corporate governance.
Specific examples of such beneficial rule and procedural
changes include removing barriers that exist in many markets
that prevent or discourage investors to exercise their voting
rights at general meetings and changing rules that are
inherently self-defeating due to poor drafting, of which
weak definitions of independence of directors is a key
culprit. While weak rules do not necessarily prevent minority
shareholders from exercising their rights outright, says
ACGA, weak rules do influence what it is possible to achieve
and affect significantly the cost to investors of enforcing
their rights.
Despite the obvious weaknesses that exist within regulatory
regimes in Asia, the blame for weak corporate governance
practices cannot be laid at the feet of regulators and gov-

ernments alone, nor should the responsibility for implementing change in Asia rest solely on their shoulders.
Investors themselves need to take a more active role in
promoting good corporate governance practices in the region.
A top down approach from regulators will be far more
effective in achieving its aims if it is supplemented by a
bottom up approach from investors. Indeed, the promotion
of a corporate governance culture is arguably better and
more easily achieved by enforcing change through the simple
yet real threat of the withdrawal of capital, perhaps the
ultimate sanction for Asian companies, rather than the
imposition of rules that companies can find ways to
In Asia, the absence of independent investor pressure groups
remains a serious drag on achieving that bottom up pressure
on companies to change. More often than not, investors
faced with serious corporate governance issues in Asia cut
and run, simply selling investments, rather than staying
to fight abusive practices. While there are some notable
exceptions to this tendency, the ranks of corporate governance activists, especially among institutional investors,
are thin indeed.
Its the returns, stupid
While the absence of meaningful investor pressure for change
seems to suggest a bleak future for the promotion of corporate governance reform in Asia, there is some hope on
the horizon. Spreading the word has continued the work
of CLSAs and ACGAs previous annual reviews in gathering
data on the correlation between good corporate governance
and financial returns. As the report notes, there appears
to be a relationship between companies and markets with
strong corporate governance and superior returns over the
longer term. There is also a clear correlation between
investors risk appetite and market returns.
When markets are rising, says CLSA, as has been the case
in Asia in the last one to three years to mid-2004, when
the research was compiled, markets with lower corporate
governance standards tend to outperform as investors appetite for risk increases and the search for higher returns
intensifies. Correspondingly, when markets decline, as has
been the case with Asia in the last five years, the same
markets tend to under perform, while markets with higher
corporate governance standards tend to out perform.

Corporate Governance in Asia

there is a much stronger

correlation between companies practising good corporate
governance and long term
shareholder returns over three
year and particularly five year
periods. Over the last five years,
for example, the top quartile
of corporate governance stocks
outperformed their country
sample in eight out of ten
markets, notes CLSA
Good management: good

In the 12 months to mid-2004, Asian markets have performed

well. MSCI Asia ex-Japan, the key benchmark index for nonJapan Asia, rose 27% in the 12 months to June 30 2004.
During the same period, the bottom five ranked corporate
governance markets provided an average return of 32%, while
the markets ranked in the top half of Asia returned 27%. In
the last three years, the MSCI Asia ex-Japan rose 26%, the
bottom five markets gained on average 50% while the top
five gained 36% and the top three, just 19%.
Over the last five years, the
regional benchmark index fell
16.5%, the weakest corporate
governance markets performed
badly, falling an average of
36%. In contrast, the top half
markets for corporate
governance rose 3% over the
period, a solid performance
against the regional index.
The same relationship applies
within the markets themselves,
notes CLSA. While in the short
term, a variety of factors affect
returns from individual stocks
and it is difficult to establish
a clear relationship between
performance and governance,

In seeking to explain this

relationship between longerterm returns and good
corporate governance, CLSA
points to a number of reasons. First, good corporate governance
is a reflection of quality management, with the highest caliber
management understanding the role that high corporate governance standards plays in maintaining checks and balances
within the organization, increasing transparency, and preventing
corporate abuse and mismanagement. Management of good
corporate governance companies also understands the importance
to investors of long-term, sustained operating performance
and tends to be inherently performance-driven.

Corporate Governance in Asia

Another factor that explains the returns-governance correlation, is the shift away from dedicated country funds
that often found it difficult to avoid investing in poorer
corporate governance markets and stocks simply by virtue
of their limited investment objects, into global institutional
funds that have the financial muscle and the universe of
opportunities to reject poor governance stocks and even
entire markets. This globalization of the possible investment
universe has led to large investors being able to employ
corporate governance standards as a key measurement tool
in assessing market, sector and company risks.
The role of promoting corporate governance standards is
especially apparent in the longer-term focused funds, where
solid corporate governance principles play a more fundamental role in stock and market selection in driving investment philosophy than for institutional investors that
rely on momentum investing or mis-pricing opportunities
to drive policy, such as hedge funds or country-focused
Pushing the envelope
It is not just governments and investors playing a role in raising corporate governance standards in the region, however.
Despite a high degree of form over substance and ritualized
box ticking on the part of many companies in Asia, a small
but growing band of companies in the region is increasingly
setting its own corporate governance agenda and standards.
While these are often not the largest or most obvious companies, they do tend to share certain common characteristics. Businesses in banking and finance, technology and
with strong brand-dependent businesses (retail, fashion
etc.) almost irrespective of which market in Asia they operate,
often display a strong corporate governance culture and
many of these have adopted ethical and governance principles
that they practice far in excess of the rules and regulations
laid down in their home markets. The precise reason for
this corporate governance out performance by specific com-

panies is a matter of some debate but certainly, the fact

that they tend to operate in sectors that face strong global
competition and that many are not family-controlled
businesses are likely to be major influencing factors.
While the ranks of corporate governance over achievers
does appear to be growing, albeit slowly, perhaps as the
empirical evidence of the correlation between good
governance and financial returns strengthens, there is still
much work to be done to raise corporate governance
standards across the region. Considerable progress in
installing regulatory regimes and structures has indeed
been made but regulators and governments need to guard
against complacency and simply relying on enforcement
efforts to raise standards.
Corporate governance in Asia remains at best a work in
progress. Before meaningful further improvements can
be forthcoming, most Asian companies will need to change
fundamentally their attitudes to corporate governance from
one of often begrudging compliance with what is regarded
as a regulatory issue, to one that embraces the ethos and
spirit behind corporate governance. That approach is really
much more about the way in which a company is managed
and it is by definition, almost impossible to regulate or
legislate for what is essentially an ethical issue.
In that context, companies and investors both have a vital
role to play: good corporate governance companies by continually improving performance that supports the governance-return correlation and investors by applying practical
and concerted pressure to raise standards by exercising
their rights rather than simply walking away and also by
threatening the withdrawal of capital. Regulators and governments can only achieve so much in the battle for corporate
governance. To mark a permanent shift in standards, companies need to want to embrace corporate governance standards and investors need to demand that they do.

Christopher Leahy is Asian Editor, Euromoney, a leading international financial magazine, and a contributing editor for Asiamoney.
Prior to embarking on a journalistic career, Mr Leahy enjoyed a successful business career as a stockbroker, CFO and investment
banker both in the UK and Asia with a number of leading financial institutions, including Warburg Securities (now UBS), BNP
Paribas Peregrine and Crosby. He has lived in Hong Kong for the past eight years.