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Commonwealth of Australia 2002 This work is copyright. Apart from any use permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Economic Analytical Unit. Requests and inquiries concerning reproduction and rights should be addressed to the Executive Director, Economic Analytical Unit, Department of Foreign Affairs and Trade, RG Casey Building, John McEwen Crescent, Barton ACT 0221. AusAID and PricewaterhouseCoopers contributed to the cost of producing this report.

National Library of Australia Cataloguing-in-Publication data: 14 February 2002 Changing corporate Asia : what business needs to know. Bibliography. ISBN 0 642 48779 0 (set) ISBN 0 642 48780 4 (volume 1) ISBN 0 642 48781 2 (volume 2) 1. Corporations - East Asia. 2. Corporations - Asia, Southeastern. 3. Corporation law - East Asia. 4. Corporation law - Asia, Southeastern. 5. Corporations - East Asia - Finance. 6. Corporations - Asia, Southeastern - Finance. 7. Competition, International. I. Australia. Dept. of Foreign Affairs and Trade. Economic Analytical Unit. 338.74905

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ACKNOWLEDGEMENTS

This report was directed by Brendan Berne, Director, Economic Analytical Unit and David Lowe, Deputy Director, ably assisted. Dr Frances Perkins, Executive Director, provided advice and oversight. Steve Scott, previously Director within the Unit, prepared the early stages of the report. Joanne Frederiksen, Michael Growder and James Hyndes provided assistance in the projects latter stages. Vanda Dei-Tos and Greg Carter provided administrative assistance. Australian diplomatic missions in the Asia region provided invaluable assistance in producing this report, coordinating Economic Analytical Unit visits to the region and providing data. In Beijing, we thank HE David Irvine, Ambassador, Michael Adams, Counsellor and Nancy Gordon, Second Secretary. At the Australian Consulate-General Shanghai, we thank David Ambrose, Consul-General, Jill Collins, Consul and Yang Yanchun, Executive Assistant. In Hong Kong, we thank Bill Tweddell, then Consul-General, John Pilbeam, Deputy Consul General and Alan Atchison, then Consul. In Manila, we thank HE John Buckley, Ambassador, Karen Gilmour, First Secretary, Jeremy Kruse, First Secretary, Dr Patricia Ludowyk, First Secretary (AusAID) and Hazel Aniceto, Research Assistant. In Tokyo, we thank HE Peter Grey, then Ambassador, Deborah Stokes, Minister, Brenda Berkley, Minister-Counsellor (Commonwealth Treasury), Walter Goode, Counsellor, Katharine Heather, First Secretary (Austrade), and Margaret Bowen, then First Secretary. In Jakarta, we thank Tony Urbansky, Counsellor and Brad Armstrong, Third Secretary. In Singapore, we thank Dominic Trindade, Deputy High Commissioner, David Holly, Counsellor (Commonwealth Treasury), Michaela Browning, Second Secretary and Vinoli Thampapillai, then Third Secretary. In Bangkok, we thank Michael Carney, Counsellor, Chulee Vo-Van, First Secretary, David Grabau, Second Secretary, Jason Mundy, Third Secretary and Pornthida Thongplengsri, Research Assistant. In Taipei, we thank Frances Adamson, Representative, ACIO. In Vietnam, we thank HE Michael Mann, Ambassador and Sybil Wishart, First Secretary. In Kuala Lumpur we thank Paul Gibbons, First Secretary. In Seoul, we thank Bill Brummitt, Counsellor. In Washington, we thank Janine Murphy, Counsellor (Commonwealth Treasury), Neil Hyden, Australian director to the World Bank and Mike Callaghan, Australian director to the IMF. Within the Department of Foreign Affairs and Trade in Canberra, we thank Pamela Fayle, Deputy Secretary; David OLeary, then Assistant Secretary, East Asia Branch, Paul Grigson, Assistant Secretary, Maritime South East Asia Branch, Lisa Filipetto, Assistant Secretary, Mainland South East and South Asia Branch, Glenda Gauci, then Assistant Secretary, North East Asia Branch, Graeme Lade, Director, and Executive Officers, Kate Duff and Elissa Dalton, Philippines/Malaysia/Singapore/ Brunei Section; Jurek Juszczyk, Director, Thailand/Vietnam/Laos Section; David Engel, Director and Jeff Roach, Executive Officer, Indonesia Section; John Langtry, Director, Hong Kong/Macau/Taiwan Section; David McGrath, Director and Shujuan Lin, Executive Officer, China Economic and Trade Section; Andrew Shearer, Director and Gayle Milnes, previously in that position and Executive Officers, Mark Bellchambers and Tim Crowe, Japan Section; and finally Arnold Jorge, Executive Officer, APEC and Regional Trade Policy Branch.

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Within AusAID, we thank Richard Moore, Assistant Director General, Tim Nicholson, Director, Dr Julie Delforce, Executive Officer, Lindsay Chan, Program Manager, and Dr Robert Christie, Program Officer. The Economic Analytical Unit wishes to acknowledge the valuable contribution made by the following consultants: Dr Suiwah Leung and Dr Patrick DeFontenay, Australian National University, Dr Helen Cabalu, Curtin University, Perth; Dr Tony Naughton, Consult Asia-Pacific Pty Ltd; within Institutional Analysis, Dr Geoff Stapledon, Jackie Cook, Dr Aris Stouraitis, Jonathan Bates and Verdun Edgtton; within Edith Cowan University, Prof Nara Srinivasan, Bernard Carmody and Timothy Houweling. From PricewaterhouseCoopers Legal, Michelle Narracott (Project Leader), Stephen Loosley, Anna Guthleben, Haidi Wilmot, Jo Lennox and Nina Ta. From PricewaterhouseCoopers, Simon Copley, Duncan Fitzgerald, Yoko Butt, Belinda Wong (in Hong Kong), Richard Moore and Gloria Warbanoff (in Thailand), Chris Cooper and Dudi Kurniawan (in Indonesia), Maurice Toyama (in Japan), Bob Graff, JeongShin Hwang and Ju-Won Jin (in Korea), Gary YK Lee, Dato Jahan Raslan, Raymond Corray and Edward Chien (in Malaysia), Ken DeWoskin, Kevin Young and Johnny Chen (in China), William Bailey, Jerry Isla, George Lavadia, Edith Tuason and Cristina Delizo (in the Philippines), Yeoh Oon Jin, Keoy Soo Earn, Keith Stephenson and Revathy Mahendra-Rajah (in Singapore), David Love and Paul Coleman (in Vietnam) and Sandra Birkensleigh (in Australia). From Puhua and Associates, correspondent law firm to PricewaterhouseCoopers Taipei, Eric Tsai, Carly Johnson and Vicky Chang (in Taiwan). Special thanks are due to the following people in Australia and Asia who gave time to be interviewed by the Economic Analytical Unit, or supplied material, information or insights. In Australia, we thank: John Hall, Chief Executive Officer, and Ian Dunlop, former Chief Executive Officer, Australian Institute of Company Directors; Alan Freshwater, Project Manager, AMP; David Holthouse AO, National Manager, and Mark Blair, Manager, Australian Stock Exchange; Rob Hogarth, Partner, David McAllister, General Manager, Richard Stone, Head of Corporate Governance and Deborah Smithers, Corporate Governance, KPMG; Martin Parkinson, Deputy Secretary, Veronique Ingram, General Manager, Terry OBrien, Specialist Adviser, Nhon Tran, Director, Ross Smith, Structural Reform Division, Godwin Greche, Financial Institutions Division, Sandra Patch, Corporate Governance Unit, Wallace Fernandes, Accounting Policy and Information Economy Unit, Andrew Sellars and Frank Donnan, Corporate Insolvency Unit, Commonwealth Treasury; Peter Moloney, Principle Business Risk Consulting, Ernst & Young; Elizabeth Johnstone, Partner, Blake Dawson Waldron; Jim Northcott AM, Managing Director, Enfour Associates Pty Ltd; Rocky Chan, President, Australia-China Business Council; Dr Peter Murphy, Executive Director, Department of Resources Development, Perth; Phillip Lipton, Associate Professor, RMIT University; Dr Grant Fleming, Department of Commerce, The Australian National University; Professor Ian Ramsay, Director, University of Melbourne; Dr Stephanie Fahey, Director, RIAP, University of Sydney; Dr Graham Bradley, Associate Dean and Vic Edwards, Director, University of New South Wales; Gitte Heij, Senior Project Manger, Murdoch University; Malcolm Rodgers, Director,

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Mark McGinness, Co-ordinator, Stephen Howell, Director and Andrew Larcos, Australian Securities & Investments Commission; Jeff Lomas, Manager, BHP Billiton; Dr Michael Briers, Director, SIRCA; and Hank Spier, Chief Executive Officer, Angela Smith, International Liaison and Elizabeth Douglass, International Liaison, Australian Competition & Consumer Commission. In China, we thank: Simon Ogus, Chief Executive Officer, DSGAsia Ltd; Stephen Cheung, Professor, City University of Hong Kong; Dr Larry Lang, Chair Professor of Finance, The Chinese University of Hong Kong; Edward Chow, Executive Chairman, China Infrastructure Group Holdings PLC; Ambassador Linda Tsao Yang, Acting Chairman, Asian Corporate Governance Association; Anthony Chung-tat Cheung, Chief Investigator, Independent Commission Against Corruption; Ryan Sai-Chiu Wong, Assistant Director of Operations, Independent Commission Against Corruption; Francis Lau, Head and Angus Chan, Manager, Hong Kong Monetary Authority; Dr Yiping Huang, Vice President, Salomon Smith Barney; Dr Feng Lei, Director, Research Fellow, Chinese Academy of Social Sciences; Liu Li Da, Research Fellow, The Peoples Bank of China; Dr Dominic Wilson, Executive Director, Goldman Sachs; Dr Hu Ru Yin, Director, Shanghai Stock Exchange; Jiyin Zhong, Associate Professor of Economics, Institute of Economics Chinese Academy of Social Sciences; Liu Xiaoxuan, Professor of Economics, Zhao Renwei, Professor of Economics, Dr Wang Guo Gang, Vice Director and Liu Rong Cang, Senior Research Fellow, Chinese Academy of Social Sciences; Fan Gang, Director, National Economic Research Institute; Fang Liufang, Professor of Law, China University of Politics and Law, Dr Chunlin Zhang, Senior Enterprise Restructuring Specialist, The World Bank Office Beijing; Andrew Godwin, Partner, Linklaters & Alliance; Lawrence Fok, Deputy Chief Operating Officer, Hong Kong Exchanges and Clearing Ltd; Thomas Wong, Chief Executive, Hong Kong Securities Institute; Esmond Lee, Principle Assistant Secretary for Financial Services, Financial Services Bureau; Gordon Jones Jr, Registrar of Companies, Companies Registry; William Liu, Deputy General Manager, Beijing Aerospace Golden Card Electronic Engineering Co., Ltd; Richard McGregor, Shanghai Correspondent, Financial Times; Francois Roy, Associate, Asian Corporate Governance Association; Renata Anna Inokomis, Sales & Marketing Director and Edward Young, Correspondent, China Economic Quarterly; Karin Finkelston, Country Manger and Cui Jian Guo, Investment Officer, International Finance Corporation; Dr Dee Bruce Sun, General Manager and Qian Wenhui, Deputy Director, China Construction Bank; Dr Huang Yuncheng, Deputy Director-General, Zuo Ding and Meng Wei, China Securities Regulatory Commission; David Stannard, Executive Director and Charles Grieve, Director of Accounting Policy, Securities and Futures Commission; Liu Wenfang, Deputy Director-General, Wu Lin and Liu Hui, China Development Bank; Jamie Allen, Secretary General, Asian Corporate Governance Association; Carlye Wai-Ling Tsui, Chief Executive Officer, The Hong Kong Institute of Directors; and Chen-Sheng Ho, Associate Research Fellow, Taiwan Institute of Economic Research Chinese Taipei APEC Study Center.

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In Indonesia, we thank: Bernie Carmody, Corporate Governance Specialist, Corporate Governance Reform/ADB Project; Eddie Gunadi, Acting Chairman, Forum for Corporate Governance in Indonesia; Dr Wahidin Herwidayatmo, Chairman, Ministry of Finance; and Mas Achmad Daniri, President Director, Jakarta Stock Exchange. In Korea, we thank: Dr Tony Mitchell, President, Euro-Asian Business Consultancy Ltd. In Malaysia, we thank: Rabindra Nathan, Partner, Shearn Delamore & Company; Tan Chun Weng, Senior Vice President, Inderjit Singh, Senior Manager and Selvarany Rasiah, Legal Advisor, Kuala Lumpur Stock Exchange; Shanthi Kandiah, Assistant Manager, Dushyanthan Vaithiyanathan, Executive and David Yap TienWei, Executive, Suruhanjaya Sekuriti; Mary Wee-Ong, Director, DBC; and Dato Megat Najmuddin Khas, President, Malaysia Institute of Corporate Governance. In the Philippines, we thank: Joven Balbosa, Economist, The World Bank; Bienvenido Oplas Jr, Economist Consultant, Think Tank Inc; Juan Miguel Luz, Managing Director, Asian Institute of Management; Erlinda Medalla, Research Fellow, Philippine Institute for Development Studies; Melito Salazar Jr, Member, Monetary Board and Francisco Dakila Jr, Bangko Sentral ng Pilipinas; Norberto Nazareno, President & Chief Executive Officer, Philippine Deposit Insurance Corp; Dr Johnny Noe Ravalo, Chief Economist, Bankers Association of the Philippines; Benito Cataran, Director, Securities and Exchange Commission; Colbert Nocom, Director, UBS Warburg; Adelardo Ables, Deputy Executive Director, Society for the Advancement of the Technology Management in the Philippines; Ramon Garcia, President, Philippine Stock Exchange; Johnny Co, Vice President and Michael La Brooy, General Manager, ANZ; Gonzalo Bongolan, Assistant Vice President, PCCI Securities Brokers Corporation; Dr Jesus Estanislao, President & Chief Executive Officer, The Institute of Corporate Directors; Soledad Emilia Cruz, Director, Department of Finance, Manila; Gloria Tan Climaco, Vice Chairperson of the Board, Equitable PCI Bank; Dr Vaughn Montes, Vice President, Cititbank; and Juzhong Zhuang, Senior Economist and Luara Walker, Governance Specialist, Asian Development Bank. In Singapore, we thank: Robinson Surendran Edward, Lead Economist, Neo Boon Sim, Assistant Director and Ng Yi Ping, Officer, Monetary Authority of Singapore; Ang Swee Tian, President, Alan Shaw, Executive Vice President, Tan Seng Hui, Vice President, Jeffrey Sim Yong Nam, Vice President and Tan Li See, Assistant Vice President, Singapore Exchange Ltd; Suinder Kathpalia, Managing Director and Cecile Saavedra, Managing Director, Standard & Poors; Ng Boon Yew, Consultant, Singapore Technologies; Ang Boon Kheng, Vice President, Eva Ho Hiu Wah, Vice President, Kenny Ong, Vice President, Chia Teck Swee, Managing Director and His Han Pin, Associate Director, Temasek Holdings; and Dr Mak Yuen Teen, Associate Professor, The National University of Singapore.

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In Thailand, we thank: Nontaphon Nimsomboon, President, The Institute of Certified Accountants and Auditors of Thailand; Andrew Gordon and Charnchai Charuvastr, President, Thai Institute of Directors; Prasarn Trairatvorakul, Secretary-General, Rapee Sucharitakul, Assistant Secretary-General and Rachamarn Suchitchon, Assistant Division Chief, Securities and Exchange Commission; Duc Nguyen, Associate Director, Grant Thornton; Mark Haines, Director, Grant Thornton; Philip Adkins, Senior Vice President, Robert McMillen, Chief Executive Officer, Seamico Securities; Hugh Mosley, Partner, Deloitte Touche Tohmatsu; Dr Warapatr Todhanakasem, President, Thai Rating and Information Services Co., Ltd; Tumnong Dasri, Director, Salinee Wangtal, Director and Amara Sriphayak, Senior Executive, Bank of Thailand; Dr Pakorn Vichyanond, Research Director, Thailand Development Research Institute Foundation; Dr Dunden Nikomborirak, Research Specialist, Thailand Development Research Institute Foundation; Weerawong Chittmittrapap, Executive Partner, White & Case Ltd; Patareeya Benjapolchai, Senior Vice Presient, The Stock Exchange of Thailand; and J. Shivakumar, Country Director and Michael Markel, Senior Financial Sector Specialist, The World Bank. In Japan, we thank: Benjamin Holt, Marketing Manger, Nakazawa Foods Co., Ltd; Koichi Togawa, General Manager and Shuichi Kameyama, Deputy General Manager, Australian Dairy Corporation; Junichi Jidou, Takenaka Corporation; Hiroo Kindaichi, Chief, Satoshi Nagano, Manager and Kimihiko Eto, Manager, Bank of Japan; Justin Ellis, Relocation Consultant, H&R Consultants; Amane Fujimoto, Senior Manager and Hiroshi Komori, Senior Manager, The Sumitomo Trust & Banking Co., Ltd; Kenichiro Yokowo, Manager and Masatsugu Mitsuishi, Keidanren; Dr Martin Schulz, Senior Economist, Fujitsu Research Institute; Shoji Matsumoto, Corporate Auditor, Komori Corporation; Tanaka Kenjirou, Chief Secretariat of Planning & Coordination Section and Masamichi Kono, Director, Financial Services Agency; Kenji Murakawa, General Manger, Maeda Corporation; Hiroshi Kurihara, Manager, The Japan Chamber of Commerce & Industry; Hiroki Kurihara, Head of Foreign Stock Group, Tokyo Stock Exchange; Hideyuki Kametani, Senior Manager, Tokyo Stock Exchange; and Kenta Seto Japan International Cooperation Agency. In Vietnam, we thank: Adam McCarty, Economist, Mekong Economics. In the United States of America, we thank: Dr Ydahlia Metzgen-Quemarez, Division Chief and Charles Enoch, Senior Advisor, International Monetary Fund; and Axel Peuker, Economic Advisor and Robert Jauncey, Executive Directors Assistant, The World Bank. Editing was by Ann Duffy. Typesetting was by Lyn Lalor.

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U n i t

ECONOMIC ANALYTICAL UNIT

The East Asia Analytical Unit was established in 1990 as the main agency within the Australian Government responsible for publishing analyses of major economic and political issues in Asia. In January 2000 it was renamed the Economic Analytical Unit to reflect its broader geographical focus. Located within the Department of Foreign Affairs and Trade, to date the EAU/EAAU have undertaken 28 studies on a major issues related to Australias trade policy interests in the region. Staffed with seven professionals, the EAU also contracts a range of consultants with specific areas of expertise. It draws on a wide range of data and information sources, including reports from Australias diplomatic and trade missions around the world. Reports and briefing papers produced by the unit are intended to assist analysts and decision makers in business, the Australian Government and the academic community. Full copies of previous reports and executive summaries now can be downloaded from the Internet. See website details below.

Contact details:
Economic Analytical Unit Department of Foreign Affairs and Trade RG Casey Building John McEwen Crescent Barton ACT 0221 Australia Telephone: +61 2 6261 2237 Facsimile: +61 2 6261 3493 Email: economic.analytical@dfat.gov.au Internet site: www.dfat.gov.au/eau Executive Director Dr Frances Perkins Directors Brendan Berne James Hyndes (a/g) Deputy Directors Joanne Frederiksen Michael Growder David Lowe Office Manager Vanda Dei-Tos

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CONTENTS

VOLUME 1

ACKNOWLEDGEMENTS ECONOMIC ANALYTICAL UNIT EXECUTIVE SUMMARY Market Forces Strengthening Regulations in Place Aid Assistance Japan Lifting Standards China in Transition Republic of Korea Pushes Reform Forward Taiwan Continues Reform Hong Kong Sets the Standard Indonesia Faces Many Challenges Thailand at the Crossroads Good Practice in Malaysia The Philippines Slowly Pursues Better Governance Vietnam Starts the Transition Singapore Aims to be the Benchmark Competition Drives Australian Companies Implications CHAPTER 1 CRISIS DRIVES CORPORATE CHANGE? Relationships Drive Asian Business East Asian Business Model under Pressure Rules Based Business Better for Growth Crisis Forces Change The New Rules of Doing Business Market Forces and Regulations Work Together Enforcement Must Improve East Asian Economies Moving at Different Speeds Implications for Australia A Different Culture Regulations to Reduce Risk to Investors Investing in Compliance Corporate and Government Asset Sales Looking Forward References

iii ix xxv xxvi xxvi xxvii xxviii xxix xxix xxx xxxi xxxi xxxii xxxii xxxiii xxxiv xxxv xxxvi xxxvi 1 3 4 6 7 7 8 9 9 10 10 10 10 11 11 12

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MARKETS GOVERNING CORPORATIONS Capital Markets Drive Change Financing Competition Limited Pre-Crisis State Owned Banks Problematic Share Markets Often Weak Bank Relationships Now Threatened Direct Financing More Important Initial Public Offers Increasing Growing Importance of Institutional Investors Family Firms Attract New Owners Major Families Still Control Corporates Corporate Ownership Likely to Diversify Product Markets Competition Increasing Impact on Corporate Governance Product Markets Lacked Competition Pre Crisis Trade Liberalising Deregulation and Competition Policies Other Barriers to Entry Foreign Investment Liberalising Mergers and Acquisitions Rising Bankruptcies Increasing Implications References

13 14 16 17 18 19 19 19 21 22 23 24 25 25 26 27 29 30 30 31 31 33 34 35 36 37 37 40 42 44 45 46 47 48 49 50 50 52 52 53 54

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REGULATING CORPORATE BEHAVIOUR Requirements for Good Governance Improving Transparency Disclosure and Financial Reporting Accounting Standards Auditing Protecting Minority Shareholders Listing Requirements Representation Board of Director Composition Directors Obligations Legal Action against Directors Protecting Creditors Bankruptcy Laws Prudential Supervision Legal systems and Enforcement Implications References

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IMPLICATIONS FOR DEVELOPMENT ASSISTANCE Aiding Corporate Governance Improving Regulations Improving Market Forces Lessons from Corporate Governance Assistance Does One Size Fit All? Recipient Government Support Recipient Government Ownership Avoiding Duplication Training and Capacity Building Multi-faceted Approach Choice of Consultants Institutional Provider Capacity Encouraging Self Assessment Private Sector Involvement Conditionality Selectivity Time Horizons Bilateral versus Multilateral Assistance Coordination Possible Areas for Australian Assistance Improving Regulations Drafting and Reviewing Legislation Building Implementation Capacity Educational and Training Programs Review of Standards and Codes Program Anti-corruption Initiatives Strengthening Markets Banking Sector Reform Developing Alternatives to Bank Financing Market Access Measures Antitrust Laws Streamlining Foreign Investment Ratings/Benchmarking Developing Civil Society Developing an Active Media Private NGO Activity Consumer and Shareholder Activism Implications References Appendix The Current Aid Agenda Multilateral Programs Bilateral Programs

57 58 58 58 59 59 59 59 60 60 60 60 61 61 61 62 62 62 63 63 63 64 64 64 65 66 66 66 66 67 68 68 68 68 68 69 69 69 69 70 72 72 72 74

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IMPLICATIONS Implications for Business Implications for Government Implications for Development Assistance Future Prospects

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VOLUME 2

ACKNOWLEDGEMENTS ECONOMIC ANALYTICAL UNIT EXECUTIVE SUMMARY Market Forces Strengthening Regulations in Place Aid Assistance Japan Lifting Standards China in Transition Republic of Korea Pushes Reform Forward Taiwan Continues Reform Hong Kong Sets the Standard Indonesia Faces Many Challenges Thailand at the Crossroads Good Practice in Malaysia The Philippines Slowly Pursues Better Governance Vietnam Starts the Transition Singapore Aims to be the Benchmark Competition Drives Australian Companies Implications CHAPTER 6 JAPAN Corporate Structure Keiretsu Dominance Deters Competition Share Markets Provide Less Discipline Market Forces Strengthening Slowly Finance Markets Increasing Bank Independence Direct Financing Increasing Institutional investors Foreign Investors More Prominent Keiretsu Links Weaken Keiretsu Forced to Compete Deregulation Foreign Investment Reforms Trade Reforms Anti-trust Reforms Bankruptcies Regulatory Reforms Transparency Corporate Reporting Accounting Standards

iii ix xxv xxvi xxvi xxvii xxviii xxix xxix xxx xxxi xxxi xxxii xxxii xxxiii xxxiv xxxv xxxvi xxxvi 1 2 2 3 4 4 4 6 7 7 8 9 9 9 11 12 12 13 13 14 14

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Auditing Shareholder Protection Listing Rules Shareholder Representation Board Structure and Duties Creditor Rights Bankruptcy Laws Prudential Supervision Enforcement Press Legal System Implications References CHAPTER 7 CHINA The Corporate sector Governance Impacts Some Markets Lack Competition Market Forces Gathering SOE Reforms Listing SOEs State Bank Reforms Achievements to Date Finance Markets Growing Rapidly China Securities Regulatory Commission Institutional Investors and Managed Funds Bond Markets WTO Accession Foreign Investors Retain Interest Stronger Regulations Transparency Corporate Reporting Accounting Standards Auditing Standards Minority Shareholders Rights Listing Rules Board Structure and Duties Creditors Rights Bankruptcy Regime Bank Supervision Compliance The Legal and Arbitration System Press Implications References Appendix

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REPUBLIC OF KOREA Corporate Sector Structure Chaebol Dominate Debt Rather than Equity Direct Financing Markets Weak Government an Important Player Chaebol Reduce Product Market Competition Markets Becoming More Competitive Chaebol Look Elsewhere for Funds Bank Reform Foreign Bank Entry Share Markets More Important Rise of Institutional Investors Chaebol under Pressure Big Deal Chaebol to Face Greater Competition Privatisation and Deregulation Trade Reforms Foreign Investment Reforms Pro-competition Action Stronger Corporate Regulations Improve Playing Field Transparency Financial Reporting Accounting Standards Auditing Minority Shareholders Rights Listing Rules Shareholder Representation Board Structure and Duties Creditors Rights Bankruptcy Laws Bank Supervision Compliance Legal System Media Implications References

43 44 44 46 46 46 46 47 47 47 48 48 51 52 53 53 53 54 54 56 56 56 56 57 57 58 58 58 58 59 59 60 60 60 60 60 61 63 64 64 64 66 66 67 67

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TAIWAN Corporate Sector Structure Families Predominantly Own Firms Deep Capital Markets Mixed Financing Market Pressures Increasing Finance Markets Capital Markets

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Institutional Investors Should Expand Bank Restructuring Product Markets Trade Reforms Foreign Direct Investment Government Ownership and Deregulation Regulations Strengthening Transparency Financial Reporting Accounting Standards Auditing Minority Shareholders Rights Listing Rules Representation Board Structure and Duties Creditors Rights Bankruptcy Laws Bank Supervision Implications References CHAPTER 10 HONG KONG Corporate Sector Structure Family Ownership High Large Diverse Conglomerates Market Forces Generally Strong Banking System Direct Finance Markets Deepen Institutional Investor Activity Effective Product Market Competition Reforms Boost Market Pressures Institutional Investment Boosted Family Ownership to Decline Regulations Excellent Transparency Corporate Reporting New Securities Laws Accounting Standards Auditing Standards Minority Shareholder Rights Listing Rules Representation Board Structure and Duties Creditors Rights Bankruptcy Proceedings Bank Supervision

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Compliance Press Implications References CHAPTER 11 INDONESIA Corporate Sector Structure Family Ownership Dominant Diverse Conglomerates the Norm Bank Debt Dominates Financing Capital Markets Immature Government Enterprises a Priority Markets Pressuring relationships Banking Reform Finance Markets Developing Slowly Corporate Restructuring Product Markets More Competitive Trade Reforms Investment Reforms Government Role to Decline Competition Policy Reform New Rules For Business Transparency Corporate Reporting Accounting Standards Auditing Minority Shareholders Rights Listing Rules Representation Board Structure and Duties Creditors Rights Bankruptcy Laws Bank Supervision Compliance Implications References CHAPTER 12 THAILAND Corporate Sector Family Owners Dominate Large Diverse Conglomerates Debt Financing Dominates Direct Financing Weak Competition Patchy Market Pressures Breaking Down Relationships Finance Markets

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Finance Sector Restructuring Opportunity to Reduce Family Ownership Direct Finance Markets Developing Institutional Investors Product Market Competition Privatisation and Deregulation Trade Reforms Foreign Direct Investment New Anti-trust Regulations Exit of Inefficient Firms New Rules For Doing Business Transparency Financial Reporting Accounting Standards Auditing Minority Shareholders Rights Listing Rules Representation Board Structure and Duties Creditors Rights Bankruptcy Bank Supervision Compliance Enforcement Press Implications References CHAPTER 13 MALAYSIA Corporate Sector Structure Deep Capital Markets Banks Independent of Corporations Family Ownership Significant Conglomerates Important Government Role Important Markets Continue to Strengthen Finance Markets Capital Markets Strengthening Institutional Investors Increasingly Active Conglomerates Under Pressure Product Markets More Competitive Privatisation and Deregulation Trade Reforms Investment Reforms Competition Policy Regulations Good and Improving Transparency

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Corporate Reporting Accounting Standards Auditing Minority Shareholders Rights Listing Rules Representation Board Structure and Duties Legal Action Against Directors Creditors Rights Bankruptcy Issuing Debentures Bank Supervision Compliance Medias Role Implications References CHAPTER 14 PHILIPPINES Corporate Sector Structure Family Ownership Dominant Conglomerates Diverse State Ownership Still Prominent Bank Financing Direct Financing Markets Immature Cartels Common Market Forces Stirring Finance Markets Slowly Improving Bank Restructuring Increasing Direct Financing Difficult Institutional Investors May Yet Develop Product Markets Deregulation Trade Reforms Foreign Direct Investment Reforms Antitrust Laws Regulations Strengthening Transparency Financial Reporting Accounting Standards Auditing Minority Shareholders Rights Listing Rules Representation Board Structure Creditors Rights Bankruptcy Bank Supervision

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Compliance Press Implications References CHAPTER 15 VIETNAM Corporate Sector Structure SOEs Dominate Most SOEs Run at a Loss Financial Sector Underdeveloped Equity Markets Weak Market Discipline Emerging SOE Reforms Finance Markets Developing Banking Sector Reforms Potential for Stock Market Development Institutional Investors Developing Product Market Competition Increasing Private Sector Developing FDI Reforms Significant International Agreements Propel Trade Reform Competition Reforms Regulations beginning Company Law Transparency Corporate Reporting Accounting Rules Auditing Standards Minority Shareholders Rights Listing Rules Board Structure and Duties Creditors Rights Bankruptcy Laws Bank Supervision Enforcement Media Implications References CHAPTER 16 SINGAPORE Corporate Structure Government Ownership Important Families Important Also Markets Working Well Direct Financing Prominent Institutional Investors Active

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Product Markets Highly Competitive Government Reviews its Role Privatising Singapore Inc Government Role as an Institutional Investor Banking Sector Reforms Regulatory Framework Strong Transparency Corporate Reporting Accounting Standards Auditing Standards Minority Shareholder Rights Listing Rules Representation Board Structure and Duties Creditors Rights Bankruptcy Laws Bank Supervision Enforcement Press Implications References CHAPTER 17 AUSTRALIA Corporate Structure Markets Discipline Corporates Financial Markets Independent and Competitive Banking System Corporate Finance Balanced, Deep Institutional Investors Mergers and Acquisitions Product Markets Competitive Trade Liberalisation Foreign Investment Liberalisation Deregulation and Competition Privatisation Well Advanced Competition Policy Anti-monopoly Legislation Corporates Well Regulated Corporate Law Reform Transparency Financial Reporting Accounting Standards Auditing Standards Minority Shareholder Protection Listing Requirements Composition of Boards of Directors Directors Obligations

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Legal Action against Directors Creditor Protection Bankruptcy Prudential Supervision Compliance Enforcement Professional Education Media Implications References INFORMATION FOR BUSINESS

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EXECUTIVE SUMMARY

Corporate governance is at a watershed in much of East Asia. Since the financial crisis, more vigorous market forces and tougher regulations are slowly transforming the East Asian corporate governance environment. In many economies, the dominant business model is changing gradually from relationship to rules based, forcing change in corporate objectives and the way firms govern themselves. Even before the crisis, many East Asian corporations and economies had become too large, complex and exposed to international competition to continue to grow robustly with businesses relying on related parties for finance, inputs and distribution. While personal relations will continue to be important, only in a reliable, rules based business environment can business access the most efficient and profitable investment opportunities, input sources and distribution options. More mature economies like Hong Kong and Singapore are well advanced in creating a rules based system; most middle income regional economies operate elements of both relationship and rules based business models, while emerging regional economies have just begun the transition from a relationship based approach. Traditionally, relationships underpinned much East Asian commercial activity; often weak legal and administrative systems made doing business with related parties the best way of ensuring contracts were honoured. In most South East Asian economies, the Republic of Korea, Hong Kong and Taiwan, family owned and run companies dominate the corporate sector and stock market listings. In some economies, a handful of families control up to 50 per cent of stock market capitalisation. In most cases, dominant family owners appoint family members to boards of directors and management positions, blurring the distinction between owners and managers. Many East Asian family owned companies form large diverse conglomerates, which include firms operating in many sectors and banks providing most group finance; many related business transactions occur between conglomerate member companies. Most other companies also have a close relationship with their bank; before the crisis, many banks undertook relationship based and collateral backed lending. Many Japanese firms also coalesce around key banks or large industrial enterprises, forming keiretsu groups that maintain long term supply and credit relationships. However, the financial crisis undermined relationship based business viability and strengthened the forces encouraging a rules based system. To complete this transition successfully, many regional governments recognise they need to strengthen market forces and enact and enforce new corporate governance laws and regulations. In the lead up to the crisis, weak corporate disclosure, limited investor and creditor protection and consequent risky corporate investments inflicted serious damage on regional economies; in some economies these factors continue to inhibit recovery. Hence, since the crisis, many regional governments commitment to improving corporate governance has grown, driving regulatory change now underway. However, commitment to change and hence progress is uneven across the region, making it important for business to know where change is occurring first. Eventually, all local and foreign businesses operating in East Asia should benefit from these changes, although as economies make this transition, risk management is important.

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MARKET FORCES STRENGTHENING


Market forces and the fallout from the crisis are forcing changes on East Asias relationship based business model. The crisis caused massive non performing loans and corporate insolvency, sparking widespread bank and corporate restructuring and severing traditional relationships between many corporates and their banks. These trends also are evident even in Japan and China, although caused more by local regulatory and corporate failings. Some conglomerates have sold less profitable affiliates introducing new, often foreign owners and breaking links within conglomerates. With fragile and cautious banks restricting lending, many family owned businesses have been forced to issue shares and bonds, requiring them to meet listing rules, obtain credit ratings and face share and bond market discipline. Increasingly in many economies, banks also must compete with share, bond and foreign financial markets for community savings; eventually this should encourage them to lend more carefully to corporates; many regional banks also are reviewing their corporate lending exposure as they seek to upgrade balance sheet quality. Tougher listing rules and market supervision protecting small shareholders eventually should make the share market a safer destination for East Asias vast savings. Fewer trade barriers and foreign ownership and investment restrictions also increase competition in East Asian markets, tightening discipline on firm management. Increasing exposure to global trade and investment is forcing firms to review relationships with traditional suppliers, distributors and banks to cut costs and maintain growth. Regional governments play an important role in encouraging stronger market forces, thereby shaping more dynamic corporate sectors. Facing fiscal pressures, many regional governments are reviewing their role in the economy, privatising state enterprises and banks, deregulating controlled sectors and boosting regulation supporting markets and corporate transparency. Other priorities include maintaining the momentum of trade and foreign investment liberalisation and corporate restructuring following the crisis. However, in some economies, powerful indebted conglomerates are opposing restructuring, often with assistance from non transparent court systems. Governments can support corporate renewal by privatising the equity they hold in banks acquired during the financial crisis; to avoid new connected lending and moral hazard, they should avoid selling to previous owners. Finally, governments can reinvigorate market forces by continuing market deregulation and privatising state enterprises. Governments owning productive enterprises in potentially competitive markets undermine private sector competition and reduce share market liquidity, hampering the shift to equity financing and impeding rules based corporate governance.

REGULATIONS IN PLACE
Most East Asian governments now provide the basic institutional framework for rules based business, but in many emerging regional markets, implementation is still weak. In many economies, new reporting, accounting and auditing standards provide for company disclosure approaching international norms. In these economies revised company laws also define outside shareholders rights to influence

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company decision making and protect outside investors from expropriation by powerful corporate insiders. Banks face greater regulation of how they use deposits, particularly when lending to businesses. In many economies, tougher bankruptcy laws give creditors more rights. However, most middle income regional economies still find it more difficult to implement effectively bankruptcy and other new commercial laws and regulations. Until regulatory frameworks are enforced efficiently and reliably many companies will not feel confident in relying on the rules based system. Lack of institutional infrastructure such as strong courts and well trained and resourced regulators, powerful vested interests and a lack of political will to prosecute non-compliers often prevent new standards being applied consistently and fairly. New bankruptcy laws require effective courts to drive rapid corporate restructuring in Indonesia, the Philippines and Thailand. In several economies, poorly enforced listing rules and corporate governance standards reduce investor confidence, inhibiting share and bond market development. Even with strong political will, these issues will take several years to resolve as solutions often require a significant shift in the current corporate culture. Despite these ongoing problems, many regional regulatory authorities and non-government professional bodies now give high priority to enforcing better corporate governance standards and most are making real progress.

AID ASSISTANCE
To help avoid another financial crisis, development assistance can contribute both to encouraging market forces and strengthening relevant regulations, to help regional developing economy governments raise corporate governance standards. In the four years since the crisis, most corporate governance development assistance in East Asia has focused on developing and implementing corporate legislation. Projects to strengthen market forces and reduce the role of relationship based lending are scarcer. Multilateral agencies provide the bulk of corporate governance assistance to East Asian governments. Few bilateral programs apart from Australias make corporate governance a priority. Since the crisis, donors have learnt much about the best ways to help build corporate governance standards in developing Asia. Ensuring local stake holders feel they own a project without reducing conditionality is important. The large number of bilateral and multilateral initiatives increases the risks of duplication. Donors also should assess the relative merits of bilateral and multilateral approaches to assisting different areas of corporate governance. Strong demand exists for ongoing Australian assistance with corporate governance reforms in East Asia. Opportunities for expanding Australian assistance exist in traditional areas of regulatory capacity building and in promoting markets forces as a means of disciplining corporate behaviour. Australia can help draft legislation for rules based business. Progressively, Indonesia, Vietnam and Thailand are developing legislation to deal with private and government owned corporations. Australian regulatory agencies, like the Australian Securities and Investments Commission and the Australian Competition and Consumer Commission have the expertise to support this type of activity. Also, in many developing economies, reasonable corporate legislation exists but authorities fail to implement

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it. For example, Indonesian securities laws, drafted in 1995, follow international best practice, but their poor implementation contributed to the financial crisis. Australian implementation experience is very relevant. Market strengthening activities are as important as regulatory reform. Australia has the capacity to assist with a range of measures, including by assisting develop direct finance markets that can compete with banks, assisting governments in privatising banks or equity in companies as a result of debt restructuring and helping open markets to trade and investment competition. Developing civil society, especially professional bodies and an effective commercial media also are needed to increase scrutiny of corporate behaviour and authorities capacity to enforce new regulations.

JAPAN LIFTING STANDARDS


More than ten years since its banking crisis began, Japan is progressing towards a rules based corporate governance environment. Before the crash, Japans traditional relationship based business model was deemed a strength, but now the Government increasingly recognises regulatory and legal system weaknesses contributed to the bubble economy and the economys failure to recover more rapidly from the late 1980s crash. Market forces and the long recession are increasing financial pressure on corporates and, with weak bank lending, have forced many firms to source investment finance from the share market, exposing them to regulations regarding financial reporting and minority shareholder treatment. Foreign firms now hold close to one quarter of listed equity, including large shares of well known companies such as Nissan and Sony. To boost shareholder value, conglomerates, especially foreign controlled ones, are shedding non-core assets and merging with firms with complementary skills. To strengthen their balance sheets, banks are reducing their stakes in corporates, weakening their incentives to lend to marginal group firms. Foreign and some domestic institutional investors are becoming more active shareholders, assisting sharemarket and corporate governance development. Trade and investment liberalisation and the long recession are sharpening goods and services market competition, reducing profits, increasing bankruptcies and forcing many firms to look beyond traditional suppliers and distributors to boost value for owners. The regulatory framework governing Japans corporates is generally sound, with recent reforms promoting a more rules based business model. However, implementing new accounting requirements and making corporate culture more transparent will take time. A new Commercial Code strengthens outside shareholder rights by permitting legal action against directors and reviewing supervisory boards roles. New laws forming part of the accounting Big Bang require consolidated reporting. Banks now must report their assets at market value, increasing their incentives to divest shares in weak companies. However, shareholders also would benefit from better representation rights at annual general meetings and clearly defined directors roles and legal obligations.

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CHINA IN TRANSITION
Chinas dynamic economy is making good progress in its transition from a centrally planned to a more market based economy, in large part because the Government recognises one of its highest priorities is to develop the legal and regulatory institutions to support a modern market economy. Over the past decade, it has strengthened listed firms accounting and disclosure requirements, tightened prudential controls on banks, passed a new law to govern the securities industry and established an effective commercial arbitration system. Increasingly, a good range of corporate laws and regulations support the corporate sector, corporate ownership is more dispersed and equity and bank finance are more accessible. Key to this strategy is reform of Chinas state owned enterprises, which still dominate large scale, capital intensive industries and infrastructure. By listing a minority of their shares on the stock exchange for sale to private investors and requiring listed firms to comply with higher accounting and corporate governance standards, the Government hopes to make state owned enterprise boards of directors and management more accountable to corporate owners, including the state. Now over 1 000 state owned enterprises are listed in China and some of the largest and most efficient state owned enterprises list on Hong Kong and international stock markets. However, state owned enterprises owe most of Chinas banks huge and growing non performing loan portfolio, estimated at 30 to 50 per cent of outstanding loans; this reflects state owned enterprises generally poor corporate governance standards and limited accountability. This serious problem makes resolving corporate governance problems in the state owned enterprises more urgent. While the Government is readying the legal and regulatory system to support a market based economy, several key elements of this framework still are missing, including an impartial and efficient legal system to enforce commercial law, a comprehensive bankruptcy law, independent state owned enterprise boards of directors that direct management to act in shareholders interests, widespread use of international accounting standards and adequate commercial bank credit analysis capacity. Until China develops these essential laws and institutions, state owned enterprise and banking sectors will continue to experience corporate governance problems, which could constrain growth.

REPUBLIC OF KOREA PUSHES REFORM FORWARD


Following the financial crisis, the Korean Government responded with stronger laws and regulations governing corporate and financial institution behaviour. With corporate and bank restructuring, old relationships between banks, massive conglomerates, chaebol and other corporates are weakening. Although the chaebol continue to dominate the Republic of Koreas corporate scene, market opening and financial restructuring have exposed them to more competition in product and finance markets, somewhat disciplining their management and levelling the playing field for new local and foreign entrants. In 1998, the Government announced several initiatives to force chaebol restructuring, curb their market power and improve corporate governance, including limiting their debt to equity ratios and restricting cross guarantees. The Governments Big Deal initiative tried to reduce chaebols
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excessive sectoral diversification, but its competition and corporate governance outcomes were mixed. Bank and corporate collapses and restructuring, as well as tighter prudential controls have made banks less willing to fund the chaebol, forcing them to seek more finance from bond and share markets. The crisis also sparked other reforms of the corporate governance framework including requiring consolidated company accounts, upgrading generally accepted accounting practices to international standards and reinforcing external auditors independence. To increase management transparency, chaebol must appoint outside directors to their boards and independent auditors to scrutinise their affiliates. In 1999, the private sector Committee on Corporate Governance issued a voluntary Code of Best Practice for Corporate Governance for listed companies; several recommendations now are law. However, chaebols continuing market power, resource constraints and cultural differences mean companies will take time to comply with the new standards.

TAIWAN CONTINUES REFORM


Taiwans relatively closed financial markets and large reserves largely protected it from the financial crisis, but this has not prevented authorities from continuing to liberalise markets and reform the corporate governance regime. Taiwans corporate structure is dominated by small and medium family owned enterprises; family owned companies often exhibit poor corporate governance. In the past, limited access to bank finance prevented the growth of family owned conglomerates and encouraged Taiwanese companies to seek share market listing more frequently. Hence, its financial markets are larger and more developed than many other East Asian economies, forcing banks to compete more for funds and imposing more market scrutiny on firms. At present, institutional investors play a relatively limited role in the share market, as high volatility reduces its attractiveness as a secure investment destination. Taiwans many small and medium sized firms already compete vigorously and increasingly liberalised trade and investment regimes expose them to global competition as well. Taiwans mature regulatory framework is robust and improving. Moreover, regulations are generally well enforced and authorities are addressing remaining deficiencies. In recent years, the authorities kept pace with regional regulatory reforms, continued liberalising the economy and deregulated key sectors, improving incentives for sound corporate behaviour. The Ministry of Finance is strengthening supervision of accountants and amending the Securities and Futures Investors Protection Act and the Securities and Exchange Law. The Securities and Futures Commission, under the Ministry of Finance, plays a key role in supervising and enforcing standards. Areas requiring further reform include introducing independent directors to boards and enforcing transparency on private companies.

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HONG KONG SETS THE STANDARD


Hong Kongs British derived legal system and efficient open markets make it, along with Singapore, an East Asian leader in establishing a rules based business environment. Most major banks are independent from other sectors and major conglomerate groups, so most firms compete for loans. Regulations governing corporations are amongst the best in the region and bank prudential control is sound and mainly disclosure based. Authorities continue to upgrade the regulatory framework to stay ahead of new developments. Authorities recently improved banking sector competition and are lifting listed company boards independence. Non-government organisations, including professional organisations, play an important role in ensuring standards keep pace with worlds best practice. However, large family companies and groups dominate the corporate scene, concentrating ownership, ensuring relationships remain important for doing business and raising minority shareholder protection concerns. Family companies prefer debt to equity finance, increasing their riskiness. Also, most conglomerate owners hold their shares closely; only around 1 per cent of the large share market is traded daily, reducing its role in disciplining listed corporations. Relatively low liquidity encourages share price manipulation, eroding market efficiency and minority shareholder confidence. However, Hong Kongs extremely liberal trade and investment regimes, competitive goods markets and to a lesser extent, service markets offset the concentrated corporate structure. Also, company ownership is likely to disperse as pension system reforms channel significant domestic savings into the share market, particularly via institutional investors. Sales of government share holdings acquired during the crisis also will disperse share ownership reducing family ownership dominance; first-time sharemarket entrants have bought most shares sold to date.

INDONESIA FACES MANY CHALLENGES


The financial crisis severely disrupted Indonesias corporate and banking sectors, undermining its relationship based business environment, but also providing an opportunity to improve generally weak corporate governance standards. The Government now owns over 50 per cent of the banking sector, including many banks formerly owned by large family controlled conglomerates. More rigorous oversight by Bank Indonesia eventually should improve corporate governance within the banking sector. Planned bank privatisations and the Governments disposal of corporate assets acquired in collateral swaps for non performing loans is an important opportunity for Indonesia to diversify its corporate sector ownership and expand the fledgling equity market. With many banks weak, increasingly corporate financing will rely on share and bond markets. However, this requires major corporate interests to relinquish insolvent company assets. While stronger laws and regulations eventually should support a rules based business environment, at present many legal and administrative weaknesses undermine their implementation. Before the crisis, many laws and regulations were not enforced adequately; since the crisis, bankruptcy laws and prudential controls are stronger, but accounting standards are not yet up to international norms

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and are enforced weakly. Despite new bankruptcy laws, the new commercial courts have made few major decisions in favour of creditors. As yet, few boards of directors are independent from family owners, and protection for minority shareholders remains limited. Delays in implementing the commercial and insolvency law framework inhibits the move to rules based business at the same time as the relationship based business approach is under threat. This failure undermines development of a more mature corporate sector and, if not addressed, could weaken medium term growth prospects.

THAILAND AT THE CROSSROADS


Family owned conglomerates dominate the Thai corporate sector, complicating corporate governance. Crisis induced bank collapses and corporate restructuring have weakened traditional relationships between banks and their corporate customers. Public and private asset management companies set up to dispose of non performing loans hold a sizeable share of corporate assets. If sold, these would introduce new owners, diluting ownership concentration. However, apart from extreme cases, banks and authorities generally prefer debt rescheduling to more thorough corporate restructuring; consequently, many insolvent owners will retain control of their assets. Nevertheless, following farreaching bank restructuring, several formerly conglomerate owned banks now belong to new, often foreign, owners and other private banks have sought foreign joint venture partners. Tighter bank capital adequacy ratios and high non performing loan levels restrict loan growth. With lending stagnant, many companies must access alternative sources of finance, especially bonds and non-voting shares. This provides competition to banks and exposes firms to listing and rating regulations. New commercial laws and regulations eventually should help guide the Thai business environment towards a more rules based business environment; however, implementing new laws and regulations remains a challenge. Since the crisis, upgraded accounting and auditing standards require listed companies to establish audit committees; many disclosure standards now match best practice. Firms now must appoint independent directors to their boards to protect outside investors rights and firms must report connected transactions. However, the minimum number of shareholders who can initiate a public meeting still is well above the international norm. While courts have had some success in protecting creditors rights, high non performing loans and shallow debt restructuring make it difficult for firms to find new creditors, threatening growth. Contract enforcement in the courts is very slow and can be problematic, slowing the transition to a more rules based business environment.

GOOD PRACTICE IN MALAYSIA


Malaysia has sound regulations and generally open, flexible goods and to a lesser extent investment markets. The financial crisis prompted additional corporate governance initiatives and Malaysia now enjoys a regulatory regime that rivals those of Hong Kong and Singapore.

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Families are an important source of ownership in Malaysia, but they use pyramid ownership structures less than elsewhere. The states proactive role in initiating and financing major private sector projects can weaken market discipline and deter small investors and new market entrants. Malaysia has a more independent banking sector than many in the region, a well-developed equity market and increasingly active institutional investors that force firms to compete for funds. Large financial markets allow a dynamic business culture; eventually this should help generate better corporate scrutiny and governance. Except in the financial and infrastructure sectors, Malaysia also enjoys relatively open trade and investment regimes, increasing discipline on the management of many companies. Malaysias long history of relatively open trade and, to a lesser extent, investment regimes provides firms in most sectors with global market discipline; the Government also is gradually privatising state owned firms. Nevertheless, regulations prevent new local entrants in some markets and foreign investment restrictions limit foreigners participation in several sectors, allowing some poorly run corporations to make high profits. Post-crisis regulations also restrict the free movement of foreign capital; this is deterring new investment and could reduce the discipline it brings. Comprehensive anti-monopoly laws still are required to boost competition levels, especially in several protected services sectors. Malaysia was well advanced in upgrading its corporate regulatory environment by the time of the crisis. In 1994, authorities required listed companies to appoint independent directors to their boards and establish audit committees. In 1995, Malaysia committed to moving from a merit based to a disclosure based regulatory regime for listed companies. Since the crisis, key reforms include incorporating the Code of Corporate Governance into listing rules and improving overall compliance. The Government is also moving to a disclosure based system of corporate governance.

THE PHILIPPINES SLOWLY PURSUES BETTER GOVERNANCE


Ownership of the Philippine corporate sector is one of the most highly concentrated in East Asia, causing significant corporate governance issues; however, authorities are attempting to move towards a rules based business environment. After 1997, the Government reviewed many aspects of the corporate regulatory framework and increased market openness, improving incentives for sound corporate behaviour. Many Philippine markets lack competition, with diverse, family controlled conglomerates operating alongside large government owned firms. Private individuals own most firms and rely almost exclusively on private and bank debt financing. Even listed firms retain close to 70 per cent of their equity in private hands and draw their finance mostly from banks. Relatively weak competition in finance, goods and services markets shelters managers from external discipline. Conglomerates form cartels, which guarantee high profit rates in many markets.

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Nevertheless, these features slowly are changing and eventually could deliver a corporate sector with more dispersed ownership facing greater competitive forces. For example, reforms allowing some foreign bank presence have increased banking industry efficiency to some extent and the merger of the two stock exchanges and prudential reforms have developed the equity market, somewhat reducing reliance on debt. Competition in goods and service markets also is more vigorous than 15 years ago when the Philippines started market opening; trade reforms are increasing manufacturing sector competition and the new administration has put privatisation and deregulation back on the reform agenda. Despite these positive steps, family conglomerates face only limited competition, especially in services markets, where foreign entry barriers remain high. For example, the Ayala Group profits from its globally competitive firms in international markets but faces limited competition in domestic markets. Also, a lack of crisis induced corporate restructuring means large families should retain their role in the Philippine corporate sector for some time. Remaining major challenges include curtailing dominant corporate families excessive market power and promoting broader corporate ownership and liquidity of share markets. On the regulatory front, following the crisis, authorities reformed regulations to strengthen corporate governance. An August 2000 Securities Regulation Code improved listing requirements and insider trading sanctions and in July 2001, the President announced the Governance Advisory Council would review corporate governance standards, reform key regulations and boost enforcement. Future challenges include closing regulatory framework gaps, formulating a best practice governance code, strengthening regulations and professional practices for accounting and improving enforcement.

VIETNAM STARTS THE TRANSITION


State owned enterprises, SOEs, dominate Vietnams corporate sector and state banks provide most finance. The weak performance of many state owned enterprises has generated high non performing loan levels, affecting the banking sector. Vietnam is slowly embarking on economic reforms, increasing the role of market forces. Growing commitment to binding international agreements, recently with the United States, and a desire to join the WTO increasingly should open markets and drive legal and institutional reforms. The stock exchange commenced operating only in July 2000; to date there have been few listings so it still has a limited influence on corporate behaviour. While Vietnam eventually may use stock exchange listings to drive corporate governance reforms, at present its strategy for achieving effective governance of SOEs is unclear. Corporate governance standards within the SOE sector remain poor. However a series of reforms recently announced, including small SOE privatisation, liquidation of insolvent companies and equitisation of others, gradually may improve incentives for better corporate behaviour. Nevertheless, the Government clearly intends to retain ownership and control of the very large SOEs, the General Corporations. Recent bank reforms, including restructuring bad debts, reforming the state owned commercial banks and improving banking and financial regulations, also are designed to complement programs to improve SOE efficiency.
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Foreign invested enterprises are playing an increasingly important role in the Vietnamese economy, boosting private sector development. An increasing share of foreign direct investment is in joint ventures and wholly foreign owned companies; these and business cooperation contracts with SOEs provide better corporate governance models for SOEs. Vietnams regulatory system is in its infancy. Separate regulatory regimes apply to enterprises with different ownership and to foreign and local firms. Minority shareholders and creditors have little legal protection and the underdeveloped court system needs assistance to effectively enforce the few laws governing corporates and debtors. Encouragingly, the newly established stock exchange is increasing public debate on corporate transparency, accounting and auditing standards and board and management accountability to shareholders. The Government is following international best practice to build institutions to establish and implement new regulations. Many new initiatives are likely in the few years remaining before WTO entry, when Vietnam must open its markets to international players.

SINGAPORE AIMS TO BE THE BENCHMARK


Singapore has one of the regions best corporate governance frameworks; its well developed financial markets and rules generally protect outside investors. A recent survey of institutional investors ranked Singapore as the second most desirable investment destination after Australia in the region. High levels of international competition mean companies face strong market forces. Singapores virtually free trade status means goods, other than alcohol and some agricultural products, attract no tariffs. Low foreign direct investment barriers mean foreigners have increased their investment in Singapore every year since 1990. Finance markets also are competitive; while local banks still significantly finance domestically oriented private corporates, Singapores direct financing markets are well developed and deep. The Government increasingly is reviewing its involvement in large pension funds and several services sectors to boost market incentives. Government linked companies, GLCs, constitute a large proportion of Singapore corporate sales and assets, possibly reducing the voice of minority shareholders and presenting barriers to new entrants in sectors they dominate. Encouragingly, the Government is partly responding to these concerns by selling its shares in some GLCs and is privately outsourcing some pension funds to develop institutional investor activity. Singapores corporate governance regulations are amongst the best in the region. Despite relatively sound pre-crisis standards, since 1997, the Government has further improved the corporate governance framework to insulate Singapore from contagion and strengthen its position as a regional financial centre. In January 2000, the Government established the Corporate Governance Committee, which recommended a new Code of Corporate Governance. New listing rules were introduced in April 2001 to require disclosure in relation to compliance with the Code. By 2003, companies must either comply with the new voluntary Corporate Governance Code, or publicly disclose in their annual reports any areas where they fail to comply.

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COMPETITION DRIVES AUSTRALIAN COMPANIES


In the last two decades, two episodes of corporate failures spurred corporate governance reforms; Australias corporate governance now largely accords with international best practice. Over the same period, Australia developed large and deep direct finance markets and highly open goods and service markets, disciplining corporations. The 2001 failure of several high profile listed corporates may test aspects of the current corporate governance framework and lead to its further evolution. These collapses and consequent shareholder and creditor losses are likely to increase market scrutiny of corporate management. Large public companies dominate Australias corporate structure; very few have significant family or government ownership. Corporates usually finance investment directly through the equity market and contract debt, producing modest debt to equity ratios by regional standards. Over recent decades, the Government has deregulated progressively; withdrawn from direct production in most sectors, increasing domestic competition; and reduced import barriers and direct assistance, exposing industries to international competitive pressure. Only auto, textile, clothing and footwear tariffs remain above 5 per cent; these are scheduled to fall to modest levels. The Government maintains pre-establishment screening of foreign investment but only limited restrictions on investment apply to a few sectors. Market conduct regulation, principally the Trade Practices Act 1974, promotes competition and fair trading. Australias robust regulatory framework represents international best practice in most areas. After corporate sector excesses in the late 1980s, successive governments implemented numerous reforms. Laws back internationally sound accounting standards and auditing standards reflect international norms. Increasingly, minority shareholders are prominent and institutional investors exercise their responsibility as large shareholders. Strong market discipline and effective regulation means most companies comply with most standards. However, recent corporate failures may provide impetus for further evolution in corporate regulation, including directors duties and maintaining auditor independence.

IMPLICATIONS
If regional governments reinforce the momentum of change under way in East Asias corporate sectors, market and regulatory reforms eventually should deliver a more predictable rules based business environment in the region. Such a system would let all business people, including existing players, new domestic entrants and foreign businesses, access the lowest cost and most efficient inputs, finance and investments, without relationships reinforcing contracts. However, if emerging regional economies cannot overcome vested interests and correct legal and regulatory system weaknesses, business may be forced to revert to the old relationship based approach. This could slow economic recovery and constrain long term growth prospects.

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This report has many implications for East Asian and Australian governments. First, economies will benefit significantly if governments strengthen market forces shaping more dynamic corporate sectors. Second, high priority attaches to governments upgrading legal and regulatory frameworks governing corporate behaviour and matching these with enforcement. Third, strong official support for prosecuting cases involving powerful interests is crucial to demonstrate government resolve to enforce change. Australias development assistance program can continue to support regional governments to upgrade and enforce corporate governance regulations and laws. Australia has a strong corporate regulatory framework and capacity to assist regional governments achieve best practice levels through long term institutional partnerships between key Australian institutions and their regional counterparts. Scholarships for promising junior staff and secondments, short courses and visits for senior personnel within regional economy regulatory agencies could assist building such links. Assisting minority shareholder groups and non-government organisations that build awareness of directors fiduciary duties would help boost corporate transparency and compliance. To increase competition in goods and services markets, development assistance can continue to support regional governments in developing and enforcing competition policy, deregulating markets and liberalising trade and investment regimes. Finally, major developments in corporate Asia significantly affect Australian business. First, accounting, auditing, legal, business consulting and training firms offer valuable skills to implement the regulation revolution under way across the region. Second, corporate rationalisation creates opportunities for consulting firms, underwriters, insolvency firms and information technology consultants. Third, new and better implemented securities market regulations gradually should protect minority investors more, reducing investment risks. Finally, as East Asian economies move from relationship to rules based business, they will remove significant entry barriers to all commerce, benefiting all Australian businesses operating in the region. Knowing which economies are making most progress in this transition is essential for Australian businesses operating in the region.

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KEY POINTS
Relationships within Japans keiretsu corporate groups are weakening somewhat, so in future market forces should have more influence on corporate behaviour. This should substantially improve the corporate environment Australian businesses face in Japan. Some keiretsu main bank relationships are under stress due to high non performing loans and banks need to defend their capital adequacy; the new requirement that banks mark corporate shareholdings to market could increase pressure to divest stocks of weaker group companies. Australian banks would be well placed to comply with these and other new bank regulations and compete successfully in this sector. Foreign investors now account for over 33 per cent of Japanese share market turnover, exerting pressure to increase the priority accorded shareholder value. Japan introduced many corporate governance reforms in the 1990s and early 2000s, including tightening company reporting requirements, increasing minority shareholder rights and introducing international accountancy standards. These reforms produce a regulatory environment more familiar to Australian investors. Since 1999, the Tokyo Stock Exchange has required listed companies to outline their corporate governance practices, but stopped short of including new corporate governance standards in listing requirements. Major internationally oriented Japanese companies are adopting smaller, more independent boards and focussing more on shareholder value. Deregulation, privatisation and foreign investment are changing business methods in major sectors like finance, autos and telecommunications, improving access for Australian producers. However, many industries continue to be characterised by a complex web of corporate, bank and bureaucratic relationships that prevent more rapid change in corporate behaviour. Minority shareholders and institutional investors still play a minor role in governing corporate behaviour, and many boards consist mainly of executive members and remain largely unaccountable to outside investors.

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Relations between firms, their banks and customers are still significant in determining Japanese business behaviour. Although a relationship based corporate sector, working closely with government, successfully drove economic development for many decades, increasingly this model inhibits competition and market discipline. Relatively poor corporate governance and transparency standards, particularly in financial institutions and implicit prudential authority endorsement, contributed significantly to Japans 13 years of slow to zero growth since its so-called bubble economy burst in 1988. However, the Japanese Government now promotes more financial sector competition, including upgrading corporate governance standards and tightening regulatory controls. Bank restructuring and high non performing loans forces many keiretsu firms to compete more for finance than previously. Increased foreign ownership also should boost shareholders interests as a corporate priority. Together with new regulatory reforms, including a revised Commercial Code, these developments eventually should guide Japan towards a more rules and disclosure based corporate governance system; this is already happening in the more progressive and internationally competitive firms.

CORPORATE STRUCTURE
The keiretsu system has dominated Japans corporate scene in the post war period; longstanding banking and business relationships bind groups of firms in many sectors. Based around a large financial institution or a major manufacturer, this system appeared to serve key stakeholders well for many decades. However, the long downturn since 1988 and the banking crisis in the 1990s highlighted some of this systems inherent weaknesses. In the 1990s, reformers gradually recognised corporate governance needed to be based more on strong disclosure rules, shareholder involvement and competitive forces rather than keiretsu and bureaucratic relationships.

Keiretsu Dominance Deters Competition


Though somewhat weakened over the last decade, relationships in large keiretsu business groups still determine much Japanese corporate behaviour and governance. Banking, commercial and personal relationships and cross equity ownership vertically and horizontally link firms (Ostram, 2001). However, poor profitability during the long post 1988 recession, banking sector rationalisation, increasing import penetration and a growing foreign business presence impose significant pressures on these groups. Increasingly, member firms also look outside the group for finance, inputs and distribution channels. Keiretsu group structures protect member firms from competitive pressures, and hence can reduce market discipline on corporate behaviour. A large bank, such as Mitsubishi or Sumitomo, often is at the centre of keiretsu. In others, including Toyota and Daihatsu, manufacturing companies lead the group, holding equity in other firms up and down the production chain (Ostram, 2000). While banks

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can hold only up to 5 per cent of a firms shares, group firms often tightly hold most of the banks and each others shares. This limits market pressure on banks and group firms to provide shareholder value and minimise risk.
1

Although the main bank generally does not discount interest rates to keiretsu members, it can provide favourable repayment terms and act as a clearing house for information within the keiretsu. In times of distress, main banks can expedite assistance, ensuring a firms survival, although recently, this response is less assured. Experience of the last decade indicates this system can permit badly run and heavily indebted firms to keep operating, reducing firms caution in making investment decisions, and eventually creating weaker corporates, bad loans and failing banks (World Trade Organization, 2001). As well as easier access to bank finance, advantaging keiretsu-linked firms over potential rivals, the Japanese Fair Trade Commission identified two other keiretsu practices impeding outsiders from entering the market and reducing competition (World Trade Organization, 2001). First, manufacturing based keiretsu members often own their groups distribution channels, preventing competition from other firms goods or services (Ostram, 2000). Second, keiretsu firms often deal exclusively with each other, reducing business opportunities for new entrants. By sheltering keiretsu firms from competition in their product markets, these practices reduce keiretsu manager incentives to innovate and to act in the interests of consumers, investors and creditors (World Trade Organization, 2001). For this and other reasons, competition in Japans domestically focused industrial and service sectors is relatively weak, markedly reducing efficiency. For example, factor productivity in some sectors is as low as 63 per cent of US levels in similar industries (McKinsey Global Institute, 2000).
2

Share Markets Provide Less Discipline


As banks traditionally provided low cost, low risk financing, they reduced Japanese corporates need to raise finance directly through equity and corporate bond markets. Japanese bank deposits exceed stock market capitalisation by around 50 per cent. In contrast, US bank deposits are only around 33 per cent of stock market capitalisation (Naughton, 2001). In addition, shareholding patterns and shareholder behaviour reduce the effectiveness of the share market in disciplining firms. In 2001, banks held about 37 per cent of corporate equity and other corporates held another 26 per cent. A significant share of these holdings were keiretsu holdings and until recently, were not traded. This reduces outside investors and regulators role in scrutinising these firms. It also reduces share market liquidity, raising new firms direct financing costs, even for new ventures expected to generate high returns (Schulz, 2000). Furthermore, Japans minority

With the cross shareholding of banks and corporates limited to 5 per cent, more indirect mechanisms often provide control. Typically, keiretsu banks appoint directors to company boards and retired bank executives to management positions in keiretsu firms; this is known as the practice of amakudari, or descent from heaven (Yasui, 1999). Using former bank staff in senior management positions can improve the firms management skills and banks access to the firms financial information, protecting themselves and depositors from losses. However, this practice may disadvantage outside shareholders who want to scrutinise the firms operations (PricewaterhouseCoopers, 2001). This is known as contingent governance.

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shareholders traditionally are passive. Corporate and bank share owners rarely criticise management, at least at public shareholders meetings. While keiretsu banks typically monitor group firms management and performance, which can lift management standards, in smaller group firms, in many cases this oversight failed to discipline corporate management during the bubble economy and subsequent recession.

MARKET FORCES STRENGTHENING SLOWLY


Over the last decade, bank and corporate restructuring, trade and investment liberalisation and better prudential oversight have boosted competition in Japanese financial, goods and asset markets, slowly increasing incentives for firms and banks to break old relationships and operate in a more open, rules based environment. Deregulation and new competition policy initiatives also increase competition in final product and service markets. However, many years of transition will be necessary before Japans corporates operate on a fully transparent and competitive basis, with shareholders mainly overseeing performance.

FINANCE MARKETS
Since the late 1980s, main bank relationships in many keiretsu have weakened. Sales and mergers of distressed banks and corporates gradually are increasing bank independence and forcing firms to compete for finance including raising finance directly. Growing foreign financial institution and institutional investor presence also undermine traditional financing approaches, including main bank lending, and increase institutional pressure to maximise shareholder value and corporate transparency. Pension system deregulation and an ageing population also encourage the growth of institutional investors and fund managers, including foreign owned ones, increasing regulator and investor scrutiny of listed firms. However, all of these influences are still developing, and have not yet eclipsed the keiretsu system.

Increasing Bank Independence


Following the early 1990s banking crisis, the Governments Big Bang financial system reforms enhanced competition by allowing financial systems to restructure and merge and breaking down firewalls between financial institutions (East Asia Analytical Unit, 1999). To meet tough new capital adequacy requirements, banks sold their shares in non performing firms and many firms reciprocated by selling main bank shares. For example, in recent years, three banks belonging to the Mizuho Group sold 640 billion (US$5.8 billion) in cross held shares to offset bad lending losses. New regulations requiring banks to value their assets, including equity, at market prices should accelerate
3

In 1999, the Japanese Government recapitalised the banking system by injecting 60 trillion (US$600 billion) to restore bank balance sheets. In December 1998, it established the Financial Reconstruction Commission to facilitate financial services industry restructuring. However, often mutual unwinding of ownership takes place through a gentlemens agreement at senior levels rather than from a rationalisation program signed off at a shareholders meeting (Naughton, 2001).

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this process (Yokowo, 2001). Also, starting in 2004, banks shareholdings must not exceed 100 per cent of their capital (Yanagisawa, 2001). Amended holding company laws encourage major bank mergers, and newly formed banks, including the merged Tokyo and Mitsubishi banks often sell down their keiretsu firm shares (Kurihara et al., 2001).
5

Hence, in the year to March 2001, financial institutions holdings of domestic shares fell to 37 per cent of market capitalisation, significantly lower than their 1990 peak of 45 per cent of capitalisation (Figure 6.1) (Kurihara et al., 2001).

Figure 6.1 Banks Selling Shares in Companies Japanese Shareholder Ownership by Type
100

4.2 18.6 23.1 18

80

Per cent

60 45.2 40 36.5

20 26.9 0 1990 Foreigners


Source: Naughton, 2001.

26

2001 Individuals Financial institutions Corporations

Issuing new equity as part of corporate and bank restructuring introduces new owners, including foreigners who are unconstrained by relationship ties. For example, US investors in the Long Term Credit Bank, renamed Shinsei, suspended lending to many failing firms, contributing to the bankruptcy of the 170 year old Sogo Department Store in 2000 (South China Morning Post, www.scmp.com, 14 May 2001). Increasingly, new owners pressure banks not to waive corporate debts, increasing discipline on firms to restructure and more wisely use funds (Kurihara et al., 2001). Furthermore, the Financial Services Agency, entrusted with reforming Japans banking system, increasingly disciplines banks in which the Government holds a share. For example, in 2001, it
6

5 6

Daiichi, Fuji and IBJ also merged, under the financial Big Bang, making it one of the largest banks in the world. Of the top ten banks, a single large owner, mainly insurance or trust companies, accounts for an average of 30 per cent of total stock. Institutional investors hold a further third, and individuals hold the remainder (Bank of Japan, 2001).

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threatened to exercise its voting rights against Ashikaga Bank if it failed to pay dividends, calling the banks management to account (Far Eastern Economic Review, 13 September 2001, p. 54). The eventual sale of government bank equity to new private owners also should improve bank independence.

Direct Financing Increasing


A weaker but more independent banking sector forces firms to look elsewhere for funding, increasing the prominence of direct financing, especially from equity. Equity financing took off in the 1980s as financial markets deregulated and accelerated through the mid 1990s as bank finance became harder to secure (Figure 6.2) (Yasui, 1999). Initial public offer activity grew strongly, with 160 new firms launched across most sectors in 2000, well above the 40 to 50 average of previous years (Kurihara et al, 2001). Big Bang reforms also boosted competition between the Tokyo Stock Exchange and other securities markets, such as over-the-counter and computer based trading facilities (Tokyo Stock Exchange, 1999). This competition and regulators action against securities firms anti-competitive behaviour should reduce listing and brokerage costs, encouraging smaller new entrants to list and more people to invest in the sharemarket. Furthermore, firms increasingly worry about investor relations; by 2000, the Japan Investor Relations Association represented 500 members holding 66 per cent of market capitalisation, up from 117 members in 1993 when it began (Far Eastern Economic Review, 13 September 2001, p. 54). Despite these trends, hostile takeovers remain extremely rare, removing an important source of market discipline (Naughton, 2001).
7

Figure 6.2 Firms More Exposed to Equity Markets Sources of Corporate Financing
100

80

Per cent

60

40

20

0 1992 1993 Bank loans


Source: Bank of Japan, 2001.
7

1994

1995 Equity

1996

1997 Bonds

1998

For example, many listed firms have reduced the size of minimum blocks of tradeable shares from 1000 to 100 shares, increasing retail participation (Naughton, 2001).

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Institutional investors
Increasingly, institutional investors, holding around 10 per cent of listed stock, are influencing company management and supporting shareholder activism. For example, in June 1998, the Association of Japanese Corporate Pension Funds, Kosei Nenkin Kikin Rengokai, released its Action Guidelines for Exercising Voting Rights declaring pension funds have a duty to monitor corporate governance and urging them to utilise their votes to encourage long term strategies that maximise shareholder value (Institutional Analysis, 2001). Under recent reforms, private managers can manage more funds from state owned postal savings accounts, assisting the growth in institutional investor activism.
9 8

Institutional investors also actively use their legal rights to enhance returns on shares (Yokowo, 2001). In October 2001, defined contribution pension plans were introduced, opening up opportunities for institutional investors, although these are likely to play a secondary role to corporate pension funds for the foreseeable future. At shareholders meetings in June 2000, close to 33 per cent of attendees voted against, or abstained, on some issues and around 20 per cent now believe annual general meetings are more shareholder oriented (Schulz, 2000).

Foreign Investors More Prominent


Foreigners also increasingly participate in financing activity, accelerating the move to greater shareholder scrutiny of listed firms. By March 2000, foreign investors held over 19 per cent of Japanese market capitalisation, up from 14 in per cent in 1999 and just over 4 per cent in 1990 (Kurihara et al., 2001). Since 1998, around 50 per cent of domestic banks stock sales were to foreigners (Far Eastern Economic Review, 13 September 2001, p. 54). Furthermore, foreign investors influence the market more than these proportions suggest as many other shares are not traded actively. As early as 1998, foreign share trades reached a third of market turnover (Yasui, 1999). Foreign investors are more accustomed to imposing investor discipline on corporates; their growing presence also puts pressure on main bank relationships and interlocking shareholdings when these fail to increase shareholder value (Naughton, 2001). For example, CalPERS, a US institutional investor group, now provides guidelines for institutional investors in Japan, indicating foreign institutions continued interest in Japanese markets (Institutional Analysis, 2001). In 2001, the US based Institutional Shareholder Services opened its first office in Japan, advising institutional investors how they should vote on resolutions Japanese companies present to AGMs (Far Eastern Economic Review, 13 September 2001, p. 54). However, some foreign investors still report facing difficulties in voting effectively at annual general meetings.

The Kosei Nenkin Kikin Rengokai is pushing to draft more detailed corporate governance principles and strengthen domestic support for shareholder oversight of companies. Its 2000 manual for fund managers urged establishing proxy voting guidelines and active voting (PricewaterhouseCoopers, 2001). The postal savings system holds about 19 per cent of individuals financial assets. Under restructuring starting in April 2001, the mandatory redepositing of its savings with the Governments Fiscal Investment and Loan Program ended (World Trade Organization, 2001).

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Keiretsu Links Weaken


Since the early 1990s, many pressures accumulated, somewhat eroding keiretsu dominance of corporate behaviour. The influx of new foreign owners keen to maximise shareholder value undermines keiretsu links (Table 6.1). Also, weak demand, the strong yen and low profits increased competitive pressures from foreign imports and investment, forcing many firms to buy from the cheapest suppliers, even if they were outside the keiretsu. As the recession eroded hidden assets and costs increased many firms were forced to sell off unprofitable assets, including group shares, diversifying ownership beyond group members (PricewaterhouseCoopers, 2001).

Ta b l e 6 . 1 Foreigners Increasing Their Share Share of Foreign Ownership in Prominent Listed Companies
Company Nissan Sony Mazda Cannon Fuji
Source: Bank of Japan, 2001.

Share (per cent) 53.3 44.5 42.4 40.6 35.5

Company Nomura Securities Hitachi Fujitsu Toshiba Honda

Share (per cent) 29.0 28.9 27.5 26.5 20.4

Countering this trend, several new laws and initiatives could strengthen keiretsu. First, new laws permitting holding companies and streamlining reporting requirements for mergers and acquisitions are encouraging corporate consolidation.
10

Second, the 1999 Industrial Revitalisation Law grants

firms tax breaks and loans from government-affiliated financial institutions once the Government approves their restructuring plans; this may reduce the risks these loans become non performing and enable vulnerable firms and keiretsu to survive (South China Morning Post, www.scmp.com, 14 January, 2002). Third, 1999 amendments to the Commercial Code allow firms to swap shares without incurring transfer taxes; this is likely to encourage mergers and acquisitions, or mutual investments or disinvestments within keiretsu (Naughton, 2001). In 1999, mergers and acquisitions totalled US$36.2 billion, two and a half times more than in 1998 (Naughton, 2001). More than half these mergers and acquisitions strengthened core business competency, while less than 25 per cent expanded peripheral business activities (Schulz, 2000). Unlike banks, other corporates are maintaining their net equity holdings in other firms, suggesting many keiretsu relationships remain intact for now (Figure 6.1).

10

Toyota, Sony, NTT Communications and Japan Airlines all are moving to holding company structures. The competition authority has released guidelines concerning situations where mergers and acquisitions substantially restrain competition (World Trade Organization, 2001)

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KEIRETSU FORCED TO COMPETE


Since the early 1990s, deregulation and market opening are increasing competition in goods and services markets, tightening discipline on managers to act in their consumers and shareholders interests. Stronger competition means firms are less able to maintain non-viable business relationships without running at a loss. New, cheaper providers of many goods and services forces keiretsu to reconsider traditional supply relationships.

Deregulation
Under various reform programs since the mid 1990s, deregulation gradually increased competition and discipline on Japanese corporations. The Big Bang financial sector deregulation package was the most effective sectoral reform program, but during the 1990s the Government also relaxed entry barriers in the distribution and large scale retailing sectors, and partially liberalised electricity, petroleum and gas retail supply. By 1998, new common telecommunications carriers could enter the national long distance market, reducing the dominant incumbent carriers market share to around 50 per cent (World Trade Organization, 2001). The Government also encouraged foreign investment in key sectors, particularly financial services, and removed some informal barriers to non-agricultural trade. In December 2001, the Government announced it would abolish 19 state corporations and privatise another 45, aiming to reduce public corporations financial support by 20 per cent (South China Morning Post, www.scmp.com, 19 December 2001). However, in many areas outside the financial sector, vested private and bureaucratic interests have retained the web of regulations restricting competition, and reforms are slow and piecemeal.
11

Foreign Investment Reforms


Foreigners are investing significantly in manufacturing and key service sectors as the environment has become more welcoming. For example, foreign banks now can establish branches, agencies or subsidiaries without restrictions (World Trade Organization, 2001). The Government also eliminated foreign ownership restrictions on certain telecommunication services.
12

Nevertheless, complex

regulations and high establishment costs continue to deter foreign investment in certain sectors, especially in health and distribution, shielding those producers from competition (World Trade Organization, 2001).

11

Japan is in the third year of its latest program promoting deregulation. Initially the program covered 624 measures, such as eliminating restrictions on foreign participation in cable television, and deregulating port activity and sales of certain medicines. The 1999 revision contained 248 new measures, such as reviewing the electricity supply regime, while the 2000 revision included 351 new measures (World Trade Organization, 2001). Foreign direct investment restrictions remain on the Nippon Telegraph and Telephone Corporation.

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FOREIGNERS ACCELERATE CAR SECTOR CORPORATE CULTURE CHANGE

Foreign entry is changing corporate culture in Japans automotive sector. By 2001, Renault held around 37 per cent of Nissans shares; Daimler Chrysler held 34 per cent of Mitsubishis shares; and GM held 49 per cent of Isuzus shares, 10 per cent of Suzukis shares and 20 per cent of Subarus shares. Foreign involvement has spurred cost cutting, encouraging firms to shed non-core businesses and upgrade marketing and technological standards. For example, by 2004, Nissan and Isuzu will shed 9 700 workers. Under the stewardship of Carlos Ghosn, Nissan adopted best practice in all its operations and streamlined its business, quadrupling profits in 2000.
Source: World Trade Organization, 2001; Australian Financial Review 12 July 2001, p. 16; and Economist, 9 June, 2001, p. 67.

The reforms contributed to a dramatic increase in foreign direct investment from 1998 onwards (Figure 6.3).

Figure 6.3 Inward Direct Investment Rocketing Inward FDI as a Percentage of Total Investment, 1989-90 to 2000-01

Per cent
1 0 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00
Source: CEIC, 2002 P A G E 10

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Trade Reforms
After many decades of non-tariff barriers producing a relatively closed domestic market, Japans increasingly open trading environment complements its foreign investment reforms. At 1.7 per cent, the average tariff rate for non-agricultural products is one of the lowest in the world and over half of all tariff lines attract no tariff, the highest proportion in the world. Coupled with more gradual retail and distribution reforms, low tariffs are now increasing import penetration significantly in some areas, driving down prices and strengthening competitive discipline on competing firm managers (Figure 6.4).
13

Figure 6.4 Import Penetration Growing Share of Imports in GDP, 1993-94 to 2000-01
10

Per cent

6 1993-94
Source: CEIC, 2002

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

13

In agriculture, formal tariffs and import quotas take protection well above OECD averages. Discussions continue about moving from price to income support, but little reform has taken place thus far. Sanitary and other non-tariff barriers, particularly on food and beverages, also significantly increase trade barriers (East Asia Analytical Unit, 1997). Despite these barriers, Japan produces less than 40 per cent of its agricultural requirements, pointing to a high level of import penetration in that sector. During the 1990s, average annual subsidies to agriculture exceeded the sectors contribution to GDP, which averaged 1.5 per cent.

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Anti-trust Reforms
To increase competitive pressures in still sheltered and inefficient non-traded sectors, the Government has somewhat strengthened competition policies. In recent years it has removed exemptions under the Anti-Monopoly Act, allowed private parties to initiate cases against perceived violators and increased the Fair Trade Commissions enforcement capacity.
14

In 1999, the Fair Trade Commission monitored


15

24 sectors and prosecuted 32 firms for undesirable market performance under the Anti-Monopoly Act, up from 27 cases in 1998 (World Trade Organization, 2001).

Bankruptcies
More bankruptcies are occurring in recessed markets and the size of bankrupt firms liabilities is up sharply, as competition increases and banks are less willing to support non-viable firms (Figure 6.5). Rising bankruptcy levels undermine old relationships and increase sanctions on poorly managed firms. However, one estimate is that around 2 million more financially fragile Japanese firms may need to be liquidated (Economist, 24 March 2001). Many firms still avoid bankruptcy by merging, forebearance of their lenders or by exploiting political influence, especially in the retail, construction and banking sectors (Yokowo, 2001).

Figure 6.5 Bankruptcies Growing Number of Firms Declared Bankrupt and Value of Debt, 1986-87 to 2000-01
20 000 18 000 16 000 14 000 12 000
Number

Number of bankruptcy cases (LHS) Value of bankruptcy liabilities (RHS)

30 000

25 000

20 000
Yen billion

10 000 8 000 6 000 4 000

15 000

10 000

5 000 2 000 0 1986-87


Source: CEIC, 2002.

0 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01

14

The Government modestly increased the Fair Trade Commissions budget, by 2 per cent per year since 1997, and increased personnel from 248 to 263. The Fair Trade Commission defines undesirable market performance as a situation where entry barriers, extraordinary price increases or extremely high profit rates persist.

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REGULATORY REFORMS
Since the mid 1990s, new regulatory reforms have supported Japans gradual transition to a more rules based, arms length business environment, aiding the development of markets and the disciplines they bring. A range of reforms protect outside investors, targeting improved disclosure, accountability and minority shareholder rights. Key reforms include ongoing amendments to the Commercial Code in 2000 and 2001, and the 1997 release of the Corporate Governance Forum of Japans voluntary corporate governance code, Corporate Governance Principles a Japanese View. The Financial Services Agency, the Ministry of Justice and the Tokyo and Osaka stock exchanges implement these new corporate governance standards.
16

NEW COMMERCIAL CODE

The Ministry of Justices new draft Commercial Code is slated for implementation in sections during fiscal 2001/02. The draft code lowers the shareholders voting quorum for non-routine agenda items from one-half to one-third and introduces consolidated accounting. It also allows electronic submission of proxy votes and permits companies to issue stock options to subsidiaries directors. It will allow firms to abolish statutory auditors if they appoint committees to elect board members, audit business administration and decide salaries. These committees would need to include outside directors. However, not all aspects of the draft may survive, as some quarters have raised considerable opposition, particularly to introducing independent directors. Australian business will need to pay close attention to developments on this issue.
Source: www.japaninvestmentforum, 2001.

TRANSPARENCY
After the bubble economy burst, poor banking and corporate transparency were central to the crisis in public and foreign investor confidence in Japans financial system. Consequently, over the past decade, the Government has sought to restore public confidence, particularly by increasing transparency and reporting standards.

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Maurice Toyama, Jo Lennox and Anna Guthleben, PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section.

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NON-GOVERNMENT ORGANISATIONS PROMOTING CORPORATE GOVERNANCE

A range of non-government bodies promote improved corporate governance in Japan.


Corporate Governance Forum of Japan

Established in 1994, the Corporate Governance Forum of Japan is devoted to raising corporate governance standards. In 1998, it published a set of principles discussing traditional corporate governance systems and recommending improvements. The new Commercial Code and Listing Rules embody many of the Forums principles. One recommendation not adopted was that independent directors should comprise more than half the seats on the board of directors.
Keidanren

Keidanren, the Japan Federation of Economic Organisations, the main employer group for large industry, actively encourages wide ranging regulatory and economic reforms. It openly acknowledges Japan needs better corporate governance and more foreign involvement in the economy and opposes government attempts to support financial markets.
Source: PricewaterhouseCoopers, 2001.

Corporate Reporting
Since the late 1990s, the Government significantly tightened corporate disclosure requirements. Under the Commercial Code, each six months, all large firms must publish summary annual balance sheet and profit and loss statements.
17

Since April 2000, under the Securities and Exchange Law, all

listed companies must prepare consolidated reports and the new Commercial Code extends this to non-listed companies. Firms must disclose related party transactions, although they need not disclose the beneficial share owners. Shareholders obtaining at least 5 per cent of total issued shares in a public company must disclose their intentions and finance sources. Under stronger disclosure rules, firms also must report new developments likely to affect share prices.
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Accounting Standards
From January 2000, Japan introduced its so-called accounting Big Bang reforms to increase the compatibility of Japanese and International Accounting Standards.
19

Japanese accounting standards

now are notionally in line with international best practice; however, critics argue that operational standards are weak. Since April 2001, companies must measure all financial assets at market values, mark to market.

17

Large companies are defined as joint stock companies with either capital of over 500 million or total on-balance-sheet debt of over 20 billion. The Commercial Code provides detailed rules on recognising, measuring and reporting joint stock company assets and liabilities. Japan has a dual accounting system of company law (from nineteenth century German law) and securities law (imported from the United States after the Second World War). The two accounting standards were harmonised so they do not excessively burden companies (PricewaterhouseCoopers, 2001).

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In 2001, responsibility for setting accounting standards shifted from the Ministry of Finance to the Financial Accounting Standards Foundation, a private sector body created by a group of other organisations including Keidenren and the Japanese Institute of Certified Accounting. In 2000, nine new standards were implemented, including on interim financial statements, financial instruments and retirement benefits, modelled on International Accounting Standards (PricewaterhouseCoopers, 2001). Despite recent improvements, Japanese accounting still lacks some specific rules, and concerns persist about professional ethical standards. For example, rules do not cover segment reporting of liabilities and accounting for employee benefits other than severance indemnities (PricewaterhouseCoopers, 2001). In addition, disclosures of systematic, large scale accounting cover ups preceding surprise insolvencies in major financial institutions highlighted serious shortcomings in Japanese companies and professionals applying accounting and auditing standards.

Auditing
Auditing standards traditionally are weak; though 1995 reforms strengthened standards somewhat.
20

Since 1995, shareholders elect the statutory audit board which comprises three to four people independent of each other and management, and one outside auditor. The statutory audit board is designed to supervise management in lieu of boards of directors, which are large and comprise mainly company insiders and executives. Audit boards audit the financial documents which independent accountants prepare before they submit them to the annual shareholders meeting (American Chamber of Commerce in Japan, 2001). However, many audit boards do not effectively supervise boards of directors. Often boards of directors select corporate audit board candidates, with shareholders merely endorsing these selections; this weakens auditor boards ability to scrutinise independently board of director activities (American Chamber of Commerce in Japan, 2001). As audit boards have not proved effective supervisors of boards of directors, the new draft Commercial Code allows boards to replace the statutory audit board with various committees for deciding directors and managers remuneration, nominating directors and undertaking audits; these committees would comprise a majority of non-executive directors (Japan Investment Forum, 2001). The Ministry of Justice also intends to increase the number of outside auditors and tighten the definition of outside auditors.

SHAREHOLDER PROTECTION
Traditionally, Japans minority shareholders had limited protection with annual general meetings often short and ceremonial in nature (PricewaterhouseCoopers, 2001). However, awareness is growing of the need to improve minority shareholder rights, with the Tokyo Stock Exchange and non-government groups taking the lead.

20

Checking of accounts is done in three stages. External accounting firms prepare the raw accounts; internal auditing officers then check these; and finally the statutory audit board, kansayaku, sign off on them (Kanda, 1999).

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Listing Rules
Since March 1999, the Tokyo Stock Exchange has required listed firms to demonstrate their efforts in raising their corporate governance standards; it now requires them to report their steps to improve corporate governance in their semi-annual reports (PricewaterhouseCoopers, 2001; Kurihara et al., 2001; Tokyo Stock Exchange, 2000).
21

It also awards prizes to companies showing exemplary commitment

to corporate disclosure. Despite this progress, the Tokyo Stock Exchange is reluctant to enforce compliance with Corporate Governance Forum of Japan principles by making them part of its listing rules (Kurihara et al., 2000).

Shareholder Representation
Although the Commercial Code embodies the one share, one vote principle, current shareholder representation standards are weak. Minority shareholders may call a general shareholder meeting and ask the courts to appoint an inspector to check general meeting procedures. Amendments to improve voter participation, such as allowing proxy voting and the electronic notification of meetings, also are proposed as part of the new draft Company Code. 1993 amendments to the Commercial Code reduced the burden on shareholders wanting to initiate actions. Consequently, shareholders successfully sued Daiwa Bank for 83 billion for failing to detect illegal transactions by a futures trader working for the firm. The number of shareholder suits pending increased from 31 in 1992 to more than 280 in 1999 (Far Eastern Economic Review, 13 September 2001, p. 54).

Board Structure and Duties


Most boards of directors still comprise mostly insiders and are dysfunctionally large, but more progressive firms now are responding to outside shareholders, especially foreign investors, downsizing boards from an average of 30 directors to 12 to 15 and introducing external directors (Yokowo, 2001). If passed, the new draft Commercial Code requires independent directors be appointed to the board; a recent Tokyo Stock Exchange survey shows only half of all listed companies currently have external board members (Tokyo Stock Exchange, 2000).
22

Japanese legislation does not define clearly the concept of fiduciary duty. For example, the concept of insolvent trading by directors and legal sanctions on such trading do not exist. Instead directors are expected to exhibit bona fide loyalty and an honest managers care (PricewaterhouseCoopers, 2001). As most directors are promoted from within the firms middle ranks, board members often represent employee and management interests and give loyalty to them rather than shareholders.

21

Firms must disclose management policies on corporate governance in their preliminary financial results, including information on management goals, shareholder and investor roles in decisionmaking, and firms approaches to distributing profits. Firms also must disclose any change to management that may affect corporate governance. The Corporate Governance Forum of Japan now urges firms to ensure independent directors comprise more than half the board (Principle 8B).

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Only a minority of directors receive share options, reducing directors incentives to maximise shareholder value (Kurihara et al., 2001). Also, individuals can sit on any number of boards and directors training is not mandatory. These factors limit directors professionalism and commitment, and the time they can devote to their duties.

REFORMING JAPANS BOARDS OF DIRECTORS

Sony Corporation was one of the first major corporates to undertake corporate governance reforms. In 1997, Sony downsized its board from 38 to 10 directors, and increased its independent directors from 2 to 3, making it among the first Japanese firms to restructure its board (Yasui, 1999). Other reforms included separating director and management functions, and holding open conferences with shareholders after the annual general meeting. Following these reforms, more than 300 companies reduced their boards size, and several, including Fuji, NTT, Sanwa Bank, Sanwa Electric and Softbank, appointed independent directors.
Source: PricewaterhouseCoopers, 2001.

CREDITOR RIGHTS
Japans failure to resolve an estimated 18 trillion to 100 trillion in non performing loans after the collapse of the bubble economy in the late 1980s is partly due to bankruptcy system failure. This failure exacerbated Japans economic stagnation in the last decade. Despite recent reform attempts, these issues remain largely unresolved, undermining managers incentives to improve corporate governance and risk management, and creditors willingness to lend.

Bankruptcy Laws
In 1996, the Japanese Government embarked on a five year program to reform insolvency procedures.
23

Reflecting bankruptcys social stigma and expense, many firms in financial distress

favour informal approaches, including corporate reorganisation. However, the Government now is taking a tougher approach, as the Sogo and Hanwa collapses demonstrate. Recent reforms include the 1999 Civil Rehabilitation Law, which provides a mechanism for rehabilitating businesses in financial difficulties, similar to Chapter 11 in the United States. The Government also enacted new laws governing cross border insolvency and consumer bankruptcy. 1999 reforms allowed many firms to waive their bank obligations, as long as they provide a debt reconstruction plan to the bank and the Government.

23

Japanese insolvency laws derive from the Bankruptcy Law (Law No. 71 of 1922), the Commercial Code (Law No. 48 of 1899) for special liquidation, and the Corporate Reorganization Law (Law No. 172 of 1952).

P A G E 17

C H A N G I N G

C O R P O R A T E

A S I A W H AT B U S I N E S S N E E D S T O K N O W

Prudential Supervision
In 1998, to deal with the imploding financial system crisis, the Government upgraded prudential supervision regulations and capacity. It established the Financial Reconstruction Commission; in 2001, this became the Financial Services Agency to oversee all financial institutions and expedite financial institution restructuring (East Asia Analytical Unit, 1999).
24

Under 1998 Bank Law amendments, the Government raised bank reporting requirements. All financial institutions must disclose their financial positions to the Financial Services Agency; banks must submit a Business Performance Report twice yearly; and banks securities holdings and attendant risks for bank capitalisation are assessed each month. Also each month, banks meet with the Financial Services Agency to discuss compliance with prudential standards. The Financial Services Authority claims its standards for classifying non performing loans now are in line with world best practice. The Financial Services Agency and Bank of Japan enforce them and scrutinise bank loan quality every six months.
25

When deposit protection declines in April 2002,

pressure on banks to use their funds wisely will increase. Litigation against bank executives is increasing. For example, administrators of failed Niigata Chuo Bank filed for damages against 11 former bank staff for 2.1 billion, claiming their lending resulted in irrecoverable loans totalling billions of yen (Japan Times, www.japantimes.co.jp, 14 March 2001).

ENFORCEMENT
Previously, enforcement of the corporate framework was weak, but now stronger regulatory bodies are starting to enforce new regulations more rigorously. Other institutions which normally assist in enforcing new regulatory standards, including the press and the legal system, have played a limited role.

Press
Japans commercial press traditionally plays a very limited role in enforcing good corporate governance. However, it recently became more prominent in disclosing corporate malpractices and major scandals, including Nomura Securities kickbacks, the Yamaichi Securities insolvency cover up and prudential oversight failures.

24

Until 1998, the Ministry of Finance supervised all financial institutions. The Bank of Japan maintains on-site inspections of banks and off-site monitoring of banks which hold a current account with it (Bank of Japan, 2001). However, banks estimate that they hold around 61 trillion in bad loans, more than the official estimates of 30 trillion. The Bank of Japan interprets this as meaning banks are more stringent in their risk management than world standards demand (Bank of Japan, 2001).

25

P A G E 18

J a p a n

Legal System
During the 1990s and the early 2000s, Japans bankruptcy law and antiquated court system proved inadequate to the task of expediting corporate restructuring, resolving bankruptcies or retrieving collateral. Unfortunately little improvement has occurred in the courts to date, obstructing deeper structural reform.

IMPLICATIONS
A decade of significant change is slowly but perceptibly steering Japan towards a more open, transparent and rules based business model. The gradual weakening of the keiretsu system, the long recession, increased trade and investment openness, and prominent foreign business presence in key sectors like finance and automotives reinforce the impact of stronger prudential, accounting, competition policy and corporate governance standards. While major shifts in corporate culture take a long time and vested interests persist, Japans transition to a more modern, accountable and transparent corporate governance culture appears irreversible.

P A G E 19

C H A N G I N G

C O R P O R A T E

A S I A W H AT B U S I N E S S N E E D S T O K N O W

REFERENCES
American Chamber of Commerce in Japan, 2001, Revision of the Commercial Code, Tokyo, May. Bank of Japan, 2001, Information Supplied to Economic Analytical Unit, February. East Asia Analytical Unit, 1999, Asias Financial Markets: Capitalising on Reform, Department of Foreign Affairs and Trade, Canberra. 1997, A New Japan: Change in Asias Mega-Market, Department of Foreign Affairs and Trade, Canberra. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Japan Investment Forum, 2001, Revision of the Japanese Commercial Code (Abstract), www.japaninvestmentforum.com, accessed September. Kanda, H., 1999, Disclosure and Corporate Governance: A Japanese Perspective, paper presented at OECD conference Corporate Governance in Asia: A Comparative Perspective, Seoul, 3-5 March. Kurihara, H. and Kametani, H., 2001, Economic Analytical Unit interview with Head of Foreign Stock Group and Senior Manager, Listing Department, Tokyo Stock Exchange, Tokyo, February. McKinsey Global Institute, 2000, Why the Japanese Economy is Not Growing: Micro Barriers to Productivity Growth, Washington. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. Ostram, D., 2000, The Keiretsu System: Crackling or Crumbling?, Japan Economic Institute, no. 14, 17 April, www.jei.org, accessed September 2001. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Schulz, M., 2000, Corporate Governance in Japan, Fujitsu Research Institute, Tokyo, December. Tokyo Stock Exchange, 2000, Survey of Listed Companies Corporate Governance, Tokyo. 1999, Annual Report, Tokyo. World Trade Organization, 2001, Trade Policy Review, Japan: Report by the Secretariat, Trade Policy Review Body, Geneva. Yanagisawa, H., Minister for Financial Services, 2001, Japans Financial Sector Reform: Progress and Challenges, 3 September, www.fsa.go.jp, accessed September. Yasui, T., 1999, Corporate Governance in Japan, paper presented to OECD conference Corporate Governance in Asia: A Comparative Perspective, Seoul, 3-5 March. Yokowo, K., 2001, Economic Analytical Unit interview with Manager, Economic Policy Bureau, Keidanren, Tokyo, February.

P A G E 20

C h a p t e r

CHINA

KEY POINTS
Enforcing good corporate governance standards in Chinas state owned enterprises, SOEs, including encouraging them to operate in the interests of state and private minority shareholders, is the major corporate governance issue facing the Chinese Government. The huge and growing scale of banks non performing loans, primarily owed by SOEs, increasingly threatens Chinas financial system stability and fiscal outlook, heightening the urgency of the task of reforming SOE corporate governance. In the last five to ten years, the Government has accelerated SOE reform and rapidly is developing the legal and institutional framework to support market economy controls on SOE and private company behaviour. However, enforcing this framework in the large scale corporate sector, dominated by SOEs and state banks, presents a major challenge for regulators. Furthermore, major elements in the legal and regulatory framework still are missing, including a functioning bankruptcy act, developed commercial credit analysis capacity in the banking system and qualified, independent boards in SOEs with the power to direct management to represent shareholders interests. Recent strengthening of the securities industrys regulatory framework and market oriented listing rules eventually should help share and bond markets play a greater role in financing larger corporates, bypassing the ailing banking system.

P A G E 21

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A S I A W H AT B U S I N E S S N E E D S T O K N O W

To sustain rapid economic growth, the Chinese Government is striving to reduce its role in small and medium sized enterprises and labour intensive sectors, and increase market discipline on SOEs. While the largely state owned banking system still faces many serious challenges in improving its lending quality and assessing creditor risk, with China Securities Regulatory Commission oversight, eventually the rapidly developing stock market could become a more market based vehicle for efficiently intermediating savings. WTO accession also should increase market discipline on firms through greater trade, investment and financial sector competition.

THE CORPORATE SECTOR


The state owned sectors role in the economy is diminishing rapidly, with generally positive effects on corporate governance. SOEs share of industrial output shrank from almost 75 per cent in 1980 to only 28 per cent in 1999 (CEIC, 2002).1 The role of township and village enterprises, cooperatives, joint venture, wholly foreign owned, individually owned and other private enterprises has grown commensurately (Figure 7.1).

Figure 7.1 Non-state Ownership Dominates Industrial Sector Ownership Shares in Industrial Value Added, 2000
15% 28%

SOE Cooperative, town and village enterprises Private enterprises Foreign enterprises

19%

38%
Source: CEIC, 2002.

Here SOE refers to any firm the central, provincial and municipal governments owns outright or in which it owns a controlling interest (CEIC, 2002).

P A G E 22

C h i n a

Increasingly private individuals, cooperatives, villages or townships own small and medium sized enterprises; however, SOEs still dominate the large scale corporate sector, particularly the financial sector, heavy industry and utilities. SOEs still account for nearly half of urban employment (OECD, 2000). While the Government still holds most shares in large SOEs, it has corporatised many. By early 2002, over 1 000 SOEs were listed on the Shanghai, Shenzhen or foreign stock exchanges and the pace of new listings should accelerate under new rules based listing procedures. Though most SOEs list less than 50 per cent of shares, share sales to individuals and enterprises are diversifying SOE ownership. Private companies could list for the first time only in 1999, so SOEs dominate listed companies, accounting for over 70 per cent of market capitalisation through direct or indirect ownership (OECD 2000; CEIC, 2002).

Governance Impacts
Despite these reforms, state ownership still creates poor governance incentives. First, many SOE managers undertake investments to boost market share, generate employment or support local growth, even if proposed projects are unlikely to be profitable (Wang, 2001a). If these investments fail to generate adequate returns to repay bank loans, managers rarely are replaced or held personally responsible for losses. Second, government and workers select enterprise managers, usually Communist Party cadres, often giving insufficient weight to management expertise and commitment to enterprise profitability. Hence, party and worker concerns often are their main priority rather than the return to shareholders, including the state. Third, government appointed boards of directors also are expected to represent government, party, worker and creditor interests. Hence, as directors are not directly responsible to shareholders and even the Government has mixed motives in operating SOEs, boards have less incentive to independently scrutinise managers behaviour and maximise shareholder value (East Asia Analytical Unit, 1997). While in 2000 and the first half of 2001, SOEs increased their profitability, in 1999, about half of the 48 000 SOEs ran at a loss and SOE audits found significant irregularities (China Online, 2001a).
3 2

Some Markets Lack Competition


While non-state enterprises, including foreign enterprises, have a rapidly growing share of total output, in more capital intensive and infrastructure sectors, SOE reservations and preferential SOE access to bank credit deter new local and foreign firms from entering. Furthermore, although foreigners can own 100 per cent of manufacturing firms, authorities still restrict foreign entry in several important service sectors.4 However, Chinas WTO accession, expected in early 2002, will progressively open

2 3

For example, the party committee must approve 95 per cent of staffing decisions in most SOEs. Authorities audited 1 290 SOEs in 2000, finding irregularities in the reported assets valued at Rmb 100 billion. These included falsified accounts, off-book activities using state funds and fake value added tax receipts (South China Morning Post, www.scmp.com, 16 May 2001). Currently, foreign investment in utilities and other natural monopolies, land and air transport, retailing, telecommunications and finance are subject to restrictions.

P A G E 23

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A S I A W H AT B U S I N E S S N E E D S T O K N O W

many of these sectors to foreign competition and should consolidate and accelerate non-state sector growth and foreign firm entry, influencing all aspects of corporate behaviour (Economic Analytical Unit, 2002 forthcoming; The Economist, 20 November 1999, p. 32; Burke, 1999; Woo, 2000).

MARKET FORCES GATHERING


In the last 23 years, China has made major reforms in the course of its transition from a command to a more market driven economy, significantly increasing private ownership of enterprises and agriculture and embracing private, including foreign, participation in investment and trade (East Asia Analytical Unit, 1997; Economic Analytical Unit, 2002 forthcoming).

SOE REFORMS
Reforms started in the late 1970s increased SOEs autonomy and incentives to increase production of saleable items and make profits. In the 1990s, the Government rationalised, and in some cases closed, loss-making SOEs (Huang et al., 2000; East Asia Analytical Unit, 1997).5 In 1995, authorities also began privatising small and medium sized SOEs, further removing political influence from commercial decision making. Allowing employees to own shares in SOEs has increased incentives to generate profits (Bersani, 1993). However, evidence exists many SOEs are optimising worker and management benefits rather than profits for owners (Meng et al., 1998). In the 1990s, to further separate owners and managers, state government departments transferred responsibility for managing SOE assets from government ministries to government asset management companies. In addition, banks and their asset management companies, formed to take over banks worst performing loans, hold some SOE shares via debt for equity swaps. Large SOEs were corporatised and appointed boards of directors to represent their diverse owners. Hence, minority shareholder rights, board of directors independence and the relationship between managers, boards, owners and workers are now major issues in Chinese SOEs.

Listing SOEs
Listing SOEs is designed to increase pressure on managers to maximise shareholder value. To comply with listing rules, firms often need to restructure, shed non-profitable assets and improve management. Furthermore, private shareholders in listed SOEs can select some directors. Over the next decade, the Government plans to reduce the number of industrial SOEs to a few thousand, all of which should be large SOEs in strategic sectors and many of which will be listed (OECD, 2000; East Asia Analytical Unit, 1997). In early 2002, the Government unveiled a guide for boosting SOE competitiveness ahead of WTO accession, suggesting they list domestically and abroad to diversify their funding channels (South China Morning Post, www.scmp.com, 10 January 2002).

During the first eight months of 1999, 7 900 large and medium sized SOEs were closed and 4 million workers lost their jobs (China Online, 2001a).

P A G E 24

C h i n a

Research shows joint stock and privatised companies perform better than wholly state owned firms, reducing losses to banks and other investors (Fan, 2001). Nevertheless, authorities fear excessive privatisation may destabilise the labour market, especially in the overstaffed oil, banking, steel and rail industries; hence, at least in these sectors SOE privatisation will be gradual.

STATE BANK REFORMS


Reform of state banks is an urgently needed, but as yet incomplete complement to SOE reform. SOEs mainly finance investment with loans from government owned banks and, until 1996, the Government guaranteed both parties if the investment failed.6 Since then, banks supposedly have been responsible for all their loans. However, SOEs which cannot repay bank loans rarely are bankrupted. Although non performing loans are believed to be at record highs and have continued to grow since 1996, no major banks have failed or are likely to fail (Lardy, 2001; East Asia Analytical Unit, 1999). Hence, many SOEs treat bank borrowing as the state injecting equity, and banks rarely query firms investment plans or seek to improve their management capacity (Fan, 2001). As many SOEs do not really expect to repay loans, demand for funds often exceeds supply, and banks usually ration credit by non-market mechanisms, reducing market discipline on firms.7 These practices reduce incentives for banks to evaluate thoroughly clients credit worthiness and can also result in corrupt lending practices (Hovey et al., 2000; Far Eastern Economic Review, January 31, 2002, pp. 30-36).8

Achievements to Date
Despite serious concerns, the Government accords very high priority to overcoming banking system problems and the poor incentives they provide to SOEs.9 1996 legislation theoretically makes banks responsible for their lending, and penalises loan officers and branch managers who advance loans which become non performing.10 In early 2002, for example, authorities sacked the president of China Construction Bank for negligence and suspicious lending and authorities have charged several other senior bank officials for corruption (South China Morning Post, www.scmp.com, 16 January 2002; Far Eastern Economic Review, January 31, 2002, pp-30-36). In 1998 and 1999, the Peoples Bank of

The state owns virtually all financial institutions. The four major state owned commercial banks account for 62 per cent of loans, dominating banking. Overall, various types of state owned lending institutions provide well over 90 per cent of loans (East Asia Analytical Unit, 1999). SOE officials seeking funds often must deposit a specified proportion of loans secured with the same bank at low interest rates, effectively increasing the cost of funds (China Online, 2001b; Lardy, 2001). For example, during 1994, loss-making and profitable enterprises attracted almost the same rate of lending (Huang et al., 2000). In 1998, Zhu Rongji told the National Peoples Congress a financial sector crisis is a more serious threat to the Communist Party than unemployment. The Government also established separate policy banks responsible for non-commercial lending, particularly to agricultural and infrastructure sectors. This was intended to relieve commercial banks of directed lending responsibilities, but has only been partially effective as it has not overcome non-commercial lending to industry (Lardy, 2001).

8 9

10

P A G E 25

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A S I A W H AT B U S I N E S S N E E D S T O K N O W

China, Chinas central bank, merged and closed several financial institutions, including the Guangdong International Trade and Investment Corporation, one of Chinas largest non-bank financial institutions (East Asia Analytical Unit, 1999). In 1999, to limit the systemic risk from high levels of non performing loans, the Government recapitalised the banks and established asset management companies at the four major commercial banks.11 These are responsible for taking over and resolving a significant share of the banks non performing loans, restructuring defaulting companies and recovering collateral where possible. Now, banks and asset management companies can swap non performing loans for equity and intervene in firms in which they hold equity.12 However, while some banks made debt equity swaps with SOEs, so far, corporate restructuring or asset shedding is limited, as is asset management companies capacity to enforce better corporate performance. They usually lack sufficient authority, since they seldom have a controlling shareholding in the delinquent SOE and many large SOEs have a higher position in the bureaucratic hierarchy than the asset management companies. The latter also lack resources, as they have shareholdings in far too many SOEs for them to be able to actively monitor or intervene. Hence, asset management companies have been rather passive investors (Lardy, 2001). Banking reforms aim to increase bank independence to act as commercial entities and hence increase market discipline on SOEs. From the mid 1990s, the Government relaxed interest rate controls and allowed private bank entry. In 2000, the Peoples Bank of China broadened the discretionary band around fixed interest rates, freeing up deposit and lending rate movements (Liu et al., 2001). Nine banks now have some private ownership and discretion over their lending rates.13 Private banks, including Minsheng and Pudong Shanghai Banks, compete with the big four state banks in attracting deposits and corporate clients (Fan, 2001). In February 2002, as part of its WTO entry commitment, China loosened controls on foreign-owned and joint-venture banks and financial companies offering Yuan services, exposing domestic banks to further competition. Competition is likely to be more fierce in corporate than retail banking as some regulations would remain in the retail sector (South China Morning Post, www.scmp.com, 27, 31 December 2001). Since then, HSBC became the first foreign lender to take an equity stake in a mainland bank, purchasing 8 per cent of the Bank of Shanghai (South China Morning Post, www.scmp.com, 29 December 2001). Chinese bank executives are increasing their call for the removal of regulations separating bank, insurance and securities businesses, so they may better compete with foreign banks (South China Morning Post, www.scmp.com, 19 December 2001).

11

Officials estimate 25 per cent of loans are non performing, although private analysts estimate a much higher rate. Standard and Poors estimates Rmb 3.3 trillion in non performing loans, equivalent to 37 per cent of GDP (South China Morning Post, www.scmp.com, 5 June 2001). Other estimates are over 50 per cent (Lardy, 2001). In 2000, around 600 SOEs undertook debt to equity swaps with asset management companies, and this should rise to 1 000 by 2002 (China Online, 2001b). However, firms can buy back equity injections at some future point, undermining the authority of outside shareholders (Fan, 2001). Several companies, including Shanghai Brilliance Group and FAW Jinbei Automotive, acquired shares in private banks, including nearly 10 per cent in the Guangdong Development Bank, subject to Guangdong Bank and Peoples Bank of China approval (South China Morning Post, www.scmp.com, 15 March 2001).

12

13

P A G E 26

C h i n a

While many reforms appear to have boosted bank lending standards, they still heavily favour SOEs (OECD, 2000). Many state banks seem more reluctant to lend to poorly performing SOEs, preferring the rapidly growing consumer credit and mortgage markets.14 However, over 70 per cent of state bank lending still goes to SOEs while lending to the dynamic private sector remains minimal (Institutional Analysis, 2001). Banks can lend to foreign companies, potentially providing competition for SOE borrowers, but few have done so yet. Without the capacity to assess risk adequately or a strong bankruptcy regime, banks appear to be minimising risks, anticipating that the Government is more likely to compensate them for losses incurred in lending to SOEs, rather than stringently applying penalties for accruing more non performing loans.

FINANCE MARKETS GROWING RAPIDLY


Banks also face competition in attracting funds from the rapidly developing equity market; eventually this should increase discipline on them in lending to SOEs.
15

Equity market and other non-bank

sources of enterprise financing are booming (OECD, 2000). Stock market capitalisation has increased dramatically, approaching 60 per cent of GDP by mid 2001, or over Rmb 5 trillion (US$600 billion) (Figure 7.2).
16

In the 2000s, several major trends should accelerate stock market listings and expand firms access to equity financing, increasing discipline on corporates. First, recent listing rule reforms allow all SOEs and local private firms that meet listing requirement to list.17 Second, foreign funded joint stock companies can sell A or B shares to mainland investors on domestic exchanges and nationals can buy B shares (South China Morning Post, www.scmp.com, 12 July 2001).18 Third, the Government plans to sell equity in more SOEs to fund its massive pension liabilities and increase market discipline on SOEs.19 Finally, bank asset management companies eventually should sell some of their SOE equity.

14 15

However, SOEs in strategic sectors obtain credit easily, as they still receive strong state backing. The Government launched the Shanghai Securities Exchange and the Shenzhen Securities Exchange in December 1990 and July 1991, respectively. However, only about 70 per cent of these shares are traded. The number of firms listed on the two exchanges increased from 183 in 1993, to over 1 130 by August 2001 (Xu et al., 1997; CEIC, 2002). Previously, authorities placed strict limits on the number of newly listed firms, using non-commercial criteria to determine those allowed to list. Also, a lack of alternatives to bank deposits and limited numbers of initial public offers drove strong local investor demand for shares. Most initial public offers still are oversubscribed and authorities often impose ceilings on price rises. A shares, denominated in local currency, are only available to Chinese residents. B shares, denominated in US dollars, were previously only available to foreign nationals but are now available to local as well as foreign investors. The Government estimates pension funds debts exceed Rmb 7 trillion, representing about 33 per cent of GDP in 2000. The sale of SOE shares will contribute substantially to raising these funds (South China Morning Post, www.scmp.com, 15 May 2001).

16

17

18

19

P A G E 27

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A S I A W H AT B U S I N E S S N E E D S T O K N O W

Figure 7.2 Rapid Rise in Stock Market Capitalisation Stock Market Capitalisation to GDP
0.7 All stocks 0.6 Marketable stocks only

0.5

0.4
Ratio

0.3

0.2

0.1

0 Sep 1995
Source: CEIC, 2002

Sep 1996

Sep 1997

Sep 1998

Sep 1999

Sep 2000

China Securities Regulatory Commission


1999 legislation amalgamated provincial regulatory authorities into the China Securities Regulatory Commission, strengthening the new bodys powers over insider trading and price manipulation and significantly enhancing disclosure requirements (OECD, 2000). The Commission has considerable independence from party organs to pursue its regulatory duties vigorously, auguring well for future stock market growth and higher corporate governance standards (Zebregs et al., 2001; Far Eastern Economic Review, January 2002, p. 32). For example, in December 2001, the Commission fined Zheijiang Securities an undisclosed amount for misappropriating funds from clients margin accounts and irregularities in proprietary trading (South China Morning Post, www.scmp.com, 29 December 2001).

Institutional Investors and Managed Funds


In December 2001, the Government allowed the state run Social Security Fund to invest up to 40 per cent of its Rmb 61 billion in funds in the equity market, opening the way for large scale institutional funds management (South China Morning Post, www.scmp.com, 19 December 2001). Previously such activity was limited; in 1999, only about 12 institutional investors invested in the share market, holding under 1 per cent of market capitalisation.

P A G E 28

C h i n a

A 2001 Peoples Bank of China survey showed the burgeoning private funds market manages around Rmb 800 billion (almost US$100 billion) in private investment funds.20 Proposed new laws would allow open ended funds to enter the market.21 In addition, the Chinese and US funded China Key Enterprises Investment Fund restructures and invests in key SOEs under a joint venture arrangement, preparing them for WTO accession (China Online, 2001b).

Bond Markets
Corporate bond markets are underdeveloped and no domestic ratings agency exists, inhibiting short term growth.22 In 2001, only about ten corporate bonds were traded on the Shanghai and Shenzhen stock exchanges, although SOEs have issued many more bonds informally to their workers. In 2000, outstanding Chinese Treasury National Bond issues amounted to Rmb 400 billion (almost US$50 billion), providing a basis for pricing corporate bonds (Liu et al., 2001). The Government also recently launched municipal and city bonds and China Development Bank issued a three year bond, with demand coming mainly from other financial institutions. In early 2001, Yanzhou Coal Mining announced it might issue yuan denominated convertible bonds (South China Morning Post, www.scmp.com, 9 May 2001). In early 2002, the Peoples Bank of China allowed the large four state banks to issue long term bonds, developing the market and increasing external discipline on their management (South China Morning Post, www.scmp.com, 17 January 2002).
A SHARE BY ANY OTHER NAME

Companies may issue a range of shares: A shares are issued to nationals, comprising state held shares and legal person shares, including institutional investor shares, employee shares and those tradeable on the stock exchange. B shares can be issued to foreigners and domestic investors; these are US dollar denominated and are traded on both Chinese stock exchanges. H and N shares are traded on the Hong Kong and New York Stock Exchanges respectively. The A share market is large and liquid. Since the B share market opened to domestic investors in February 2001, liquidity and trading in that market also has increased significantly. As foreign stock exchanges impose stricter listing rules on firm management, only large and strong SOEs, such as China Mobile, list on these. In mid 2001, authorities announced plans for a second Shenzhen board for hi tech start up companies (South China Morning Post, www.scmp.com, 8 May 2001). Authorities will not merge the A and B share markets until they open Chinas capital account, but proposals exist to merge the Shanghai and Shenzhen stock exchanges; this should increase liquidity and may reduce volatility.

20

The Peoples Bank of China conducted the survey between April and June 2001, identifying 7 000 investment managers, consultants and financial advisers; previously funds under management were believed to be about Rmb 300-500 billion (South China Morning Post, www.scmp.com, 5 July 2001). A draft investment funds law, focusing on open ended funds, went to the National Peoples Congress in August 2001. The law sets broad principles for funds that raise capital privately from institutional investors and the general public. Open ended funds should channel money to the stock market once the pension system is overhauled (South China Morning Post, www.scmp.com, 30 April 2001). However, the State Development Bank provides ratings to SOEs so they can issue bonds (Liu et al., 2001).

21

22

P A G E 29

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A S I A W H AT B U S I N E S S N E E D S T O K N O W

WTO Accession
Chinas 2002 entry to the WTO will further reduce barriers to foreign investment and trade, increasing pressure on inefficient SOEs. Already, WTO entry is prompting a raft of SOE mergers and restructuring; eventually this should improve SOE profitability and may help safeguard outside investors (Far Eastern Economic Review, 28 June 2001). The expected entry of more foreign products and firms with superior management, technology and skill levels is forcing local firms to upgrade productivity and, in some cases, to exit. A recent survey of 5 075 Chinese entrepreneurs showed 72 per cent feel under tremendous pressure in preparing for WTO accession (China Online, 2001c). Pending accession also is stimulating further price liberalisation, increasing SOE autonomy in managing revenues and costs. In 2001, authorities eased price controls on another 128 categories of goods and services; markets now determine 90 per cent of retail and agricultural prices (South China Morning Post, www.scmp.com, 12 July 2001). Now, only strategic commodities like petroleum, coal, wheat and rice retain price controls, and many of these prices are close to international levels.

PRESSURE IN CAR SECTOR DRIVING MERGERS AND UPGRADES

Chinas 120 domestic car producers face significant pressure with WTO accession, as agreements pledge to remove car import quotas and reduce car import tariffs from 80 to 25 per cent over the next five years. In 2001, the Government released a five year plan to prepare the industry for this significant market opening, encouraging mergers and technological upgrades. The plan envisages three car giants, with smaller producers forced out of the market or into parts production. The Government will support remaining large firms by offering special loans and priority treatment in establishing foreign joint ventures. Many Chinese car producers, including the third largest producer, Dongfeng, seek foreign partners. The World Bank expects WTO accession could reduce the car sectors output by 4 per cent and its employment by 66 per cent by 2005, but the industry should grow thereafter.
Source: South China Morning Post, www.scmp.com, 5 July 2001.

Foreign Investors Retain Interest


In 2001, foreign direct investment actually disbursed in China increased in the lead up to WTO entry, reaching close to US$47 billion, and remained over 10 per cent of total new investment in China in 2000 (Figure 7.3). Furthermore, approved FDI in 2000 and 2001 exceeded US$60 billion, suggesting the pick up in actual foreign direct investment disbursements will continue into 2002.23

23

FDI commitments usually lead actual spending by a year or more.

P A G E 30

C h i n a

Figure 7.3 Resilient Foreign Direct Investment Foreign Investment including as a percentage of Gross Investment, 1990-2001
Actual FDI (LHS) 120 Approved FDI (LHS) Actual FDI as percentage of Gross Fixed Capital Formation (RHS) 20 18 16 14
Per cent

100

80
$US billion

12 60 10 8 40 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 0 2001

20

Source: CEIC, 2002

Foreign direct investment provides an important source of discipline on Chinese corporates, introducing significant competition in goods and services markets, encouraging them to adopt new management skills and technology and raise production efficiency. As private and joint venture firms have a greater presence on the local stock exchanges, they also should increase pressure for Chinese corporates to improve shareholder value.

STRONGER REGULATIONS
Since 1978, to support its transition to a market based economy, China has enacted numerous laws and regulations to discipline corporate behaviour, reinforce SOE reforms and promote rules based corporate governance.24 However, SOE and related corporate, legal and regulatory reform is incomplete. For example, SOE reforms increasing the autonomy of managers from owners also increases the need for corporate transparency and shareholder, including minority shareholder protection and representation in firm decision making. Similarly, increasing banks autonomy requires better prudential controls to monitor their performance and lending decisions, while increasing the role of equity financing requires tighter enforcement of listing requirements to protect shareholders. Key reforms include the 1999 Securities Law revisions to the 1995 Corporation Law and the 1995 law increasing the independence of the central bank, the Peoples Bank of China.25
24

Johnny Chen, Ken DeWoskin, Kevin Young, Nina Ta and Anna Guthleben, PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section. Key prudential reform institutions include the State Council, under Premier Zhu Rongji and Vice-Premier Wen Jiabao, the Peoples Bank of China, the Chinese Insurance Regulatory Commission and the China Securities Regulation Commission.

25

P A G E 31

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C O R P O R A T E

A S I A W H AT B U S I N E S S N E E D S T O K N O W

Consistent legal treatment of different types of Chinese companies is needed, and not all company laws and regulations conform to international practice. For example, Chinas 1995 Corporation Law applies to limited liability and limited joint stock companies, covering most foreign owned firms and listed firms, but does not apply to other entities, including non-listed SOEs (Appendix Table 7.1). A priority issue is improving governance in firms whose boards consist of managers, and party and government officials, particularly as firms move from state to partial private ownership.

TRANSPARENCY
To attract new outside investors, listed firms will need to provide adequate information and employ transparent accounting and auditing practices; often this has not occurred.

Corporate Reporting
To address this situation, in 2000, the Ministry of Finance released new accounting and disclosure guidelines, Accounting Systems for Business Enterprises. These define the required content of financial and accounting reports, set minimum notes to the financial statements and specify regular and frequent reporting for all companies from 1 January 2001. From 2002, listed companies must provide quarterly reports which will be published in newspapers and on designated web sites. In December 1999, the China Securities Regulatory Commission increased disclosure requirements, requiring listed firms to account for all aspects of their operations. For example, companies must report how independent company management, assets and finance are from major shareholders. Listed firms also must report profit forecasts. Firms running losses and profitable firms not issuing dividends must provide reasons in their quarterly reports (China Online, 2001a). From 2001, companies must report on a consolidated basis; this is important, as many Chinese companies belong to large diverse groups, jituan.

Accounting Standards
In 1993, authorities began upgrading accounting standards to be in line with international best practice.26 Accounting Systems for Business Enterprises includes several new and revised accounting standards in line with International Accounting Standards, such as provisions requiring consolidated reporting and valuing assets. However, implementing these new standards will require time and resources; current accounting practices vary greatly. Chinese firms listed in Hong Kong or foreign stock exchanges comply with International Accounting Standards, as do large multinational joint ventures. However, a recent Ministry of Finance survey indicated wholly domestic enterprises usually employ poor accounting practices, and in some cases falsify their earnings (South China Morning Post, www.scmp.com, 28 May 2001). To overcome these problems, the Ministry of Finance is sponsoring training programs involving major foreign accounting firms, and improving the training and testing of Chinese chartered public accountants. The Government also undertakes large scale audits of SOEs to boost compliance.
26

Since then, authorities have issued ten final standards and are reviewing a further 20 standards.

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Auditing Standards
Auditing should improve compliance with new accounting standards. Under 2001 regulations, both domestic and international auditing companies must audit all financial companies listed on the Shanghai or Shenzhen stock exchanges (South China Morning Post, www.scmp.com, 25 May 2001). From April 2002, international accounting firms must audit annual reports and interim results of all firms applying for A-share initial public offerings, or making secondary issues (South China Morning Post, www.scmp.com, 4 January 2002). External audits have proven very effective in uncovering financial malpractice and fraudulent accounting (Lin, 2000). However, internal audit quality varies greatly, as CEOs define their scope. In 2001, the National Audit Office announced 14 accounting firms had written 23 gravely inaccurate auditors reports for companies listed on the Shanghai and Shenzen stock exchanges (South China Morning Post, www.scmp.com, 27 December 2001).27

MINORITY SHAREHOLDERS RIGHTS


Currently, all private shareholders in SOEs own minority shares, increasing the need for sound laws to protect them from company insiders. Also, the largest shareholder, usually a state agency, on average holds more than 40 per cent of a listed companys equity (South China Morning Post, www.scmp.com, 11 January 2002). Despite this, the Corporation Law provides little protection for minority shareholders and only allows legal action against ongoing, rather than past, unlawful conduct. Currently, the best protection for minority shareholders is to free-ride on institutional investors at annual general meetings, but these still have a small market presence. In early 2002, however, the China Securities Regulatory Commission issued guidelines prohibiting controlling shareholders from intervening in listed company decision making and preventing asset restructuring that damages minority interests (South China Morning Post, www.scmp.com, 11 January 2002).

Listing Rules
The China Securities Regulatory Commission, the 1999 Securities Law, and State Council regulations provide listing principles for companies listing domestically and abroad.28 Listing firms need equity of at least Rmb 50 million, while SOEs aspiring to list must be willing to issue shareholder capital equivalent to at least 30 per cent of total shares, and have run profitably for at least three years (China Securities Regulatory Commission, 2001). Before making an initial public offer, firms also must submit a financial report for state approval (Fang, 2001).

27

A Shanghai University of Finance and Economics survey showed 88 per cent of market participants believed most listed firms provided inaccurate financial data in the previous year (South China Morning Post, www.scmp.com, 27 December 2001). Previously, provincial regulators in Shanghai and Shenzhen formally determined listing requirements, but the Government selected firms it allowed to list, based on social and political, as well as financial and economic, criteria.

28

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NEW MARKET ORIENTED LISTING RULES

In 2001, the China Securities Regulatory Commission released new listing practices. In future, all firms meeting new listing requirements will be allowed to list and new listings complying with standards may issue unlimited equity. The Commission introduced new rules on secondary offerings, and clarified reporting rules and statements on dividend policies. In April 2001, the Commission required all listed companies to issue quarterly financial reports within a month of the end of the first and third quarters; firms issuing B shares also must summarise their interim reports in English in foreign newspapers. In 2000 and 2001, the China Securities Regulatory Commission successfully prosecuted a number of firms for failing to comply with its listing rules. For example, it forced Shanghai Narcissus, a home appliance maker, and Guangdong Kingman, to delist because of their debts (South China Morning Post, www.scmp.com, June 14 2001). The commission also disciplined or dismissed several dozen executives involved in insider trading. However, some investors have resisted the Commissions robust approach; in April 2001, nine investors took the China Securities Regulatory Commission and a Shanghai SOE to court over losses from delisting Shanghai Narcissus.

Board Structure and Duties


Authorities are acting to bolster board independence and directors understanding of their duties. The 1995 amendments to the Corporation Law specify directors fiduciary duties in limited liability and joint stock companies, including joint ventures and listed private firms. A director may be liable personally for resolutions the board passes (Fang, 2001). The Civil Procedure Law allows collective actions against directors. Recent amendments to the 1995 Corporation Law require at least one third of a listed companys directors be independent and include at least one accounting professional (Neoh, 2000). The China Securities Regulatory Commission also recently issued guidelines on shareholder representation and board directors. In 2000, the Commission released Suggestions for Standardizing Shareholders Meetings of Listed Companies, providing voluntary guidelines on strengthening shareholder representation and outlining directors duties to shareholders (China Online, 2001c). This document lays out procedures for introducing motions, voting on directors and conducting annual general meetings. Under the Corporation Law, limited joint stock companies also must appoint a supervisory board, as well as a board of directors, to supervise company finances, directors and managers. Underwriters must conduct a one year training course for key personnel in listed companies, covering the company and securities laws.

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SHAREHOLDERS NEED PROTECTING

Despite tightened requirements to uphold minority shareholder rights and ensure directors act in all shareholders interests, practice considerably lags behind these new provisions. Although shareholders should select boards at annual general meetings, the Government often appoints board members directly. The Party continues to influence SOE decisions, including selecting CEOs, and can over-rule annual general meeting resolutions via the supervisory board (Zhao, 2001). In a survey of 350 companies listed with the Shanghai stock exchange, the state owned twothirds of stock, and private investors the remainder. However, in many firms, private shareholder protection is weak. Boards of directors enjoy a close relationship with the Government and enterprise managers. In 45 per cent of firms, the Chairman of the Board and the CEO shared executive power; in 23 per cent of firms, they were the same person; and only in 35 per cent of firms, were these roles strictly separate (Zhao, 2001). Annual general meetings generally play a limited role in supervising firm behaviour, and attendance by small and medium shareholders is minimal. Only two or three legal person votes, comprising the government or another SOE owner can pass a resolution, reducing the influence of small shareholders.

CREDITORS RIGHTS
Creditors, mainly the state owned banks, are reluctant to lend to small and medium sized private enterprises and SOEs which have failed to repay loans because the bankruptcy regime is weak. However, the Government is loath to allow widespread bankruptcy of insolvent SOEs. Recent scandals indicate bank risk assessment and internal loan control procedures often are relatively weak, though new bank supervision standards eventually may increase protection for depositors (Far Eastern Economic Review, January 31, 2002, pp. 30-36.).

Bankruptcy Regime
Chinas bankruptcy regime currently provides inadequate creditor protection. SOE bankruptcy still is relatively rare given the large number of insolvent SOEs; the low risk of bankruptcy undermines the credit culture and keeps non performing loans high. The National Peoples Congress has held up passing a new bankruptcy law strengthening creditor protection. Concerns about social stability predominate and, in early 2002, a 1988 temporary bankruptcy law continues to apply. If passed, the new bankruptcy law would expedite industrial restructuring through mergers and acquisitions and firm exits. In lieu of a functioning bankruptcy system, government officials decide which firms will go bankrupt, administer the liquidation or reorganisation of assets and seek new employment for workers. In all but hopeless cases, authorities prefer SOEs to survive, meaning many trade while insolvent, further undermining creditors capacity to retrieve assets (Godwin, 2001). Even when bankruptcy is declared,

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creditors have no automatic rights to collateral. Creditor banks asset management companies generally waive most bankrupt firms debts and spread losses across all stakeholders; workers entitlements receive top priority in claims on assets. A State Economic and Trade Commission survey showed only around 1 per cent of bankrupt firms loans are repaid, suggesting bankruptcy comes too late and insolvent firms strip assets to pay workers wages and management salaries for long periods (Fang, 2001). Banks generally do not push bad debtors to declare bankruptcy, as this would force them to book non performing loans as losses, reducing their capital base and possibly bringing sanctions against bank management. Instead, banks prefer to roll debts over, deferring and concealing the problem. Authorities also prefer to consolidate non-viable firms with more viable ones, rather than declaring bankruptcy. Cases that proceed to bankruptcy hearings face inconsistent regulations in dealing with SOE assets, land use rights and obligations to employees. As well, political interference may impede local courts applying the law (Wang, 2001b). To counter problems in the local courts, in December 2001, authorities announced they would establish a new bankruptcy court in Shanghai ahead of WTO entry (South China Morning Post, www.scmp.com, 22 December 2001).

BANK SUPERVISION
The Peoples Bank of China supervises state owned commercial and policy banks, joint stock banks and some non-bank financial institutions, including credit cooperatives (East Asia Analytical Unit, 1999). All banks have a supervisory board, monitoring their management and reporting to the State Council. The Peoples Bank of China developed bank supervision criteria in conjunction with the International Monetary Fund and Moodys rating agency. In early 2002, the Peoples Bank of China intends to classify loans following international best practice (South China Morning Post, www.scmp.com, 26 December 2001). The Bank of China already includes the level of its non performing loans in its annual report and the Industrial and Commercial Bank of China has also announced it will do the same from 2002 (Lardy, 2001; South China Morning Post, www.scmp.com, 12 January 2002). The banking law governing commercial banks forces banks to take security when lending, even to major multinationals (Godwin, 2001). Also, limits on unsecured lending and securities trading constrain banks risk and treasury management capacity. However, compliance with formal requirements often is low, particularly with lending to established SOE borrowers.

COMPLIANCE
Lack of resources and weak courts undermine authorities capacity to implement prudential supervision laws and regulations. For example, when the China Securities Regulatory Commission tried to implement the new Securities Law, it found the police lacked specialised investigative skills, so it launched a new enforcement division (South China Morning Post, www.scmp.com, 29 June 2001). The commercial press also is becoming more important in exposing corporate and security industry fraud.

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The Legal and Arbitration System


The judicial systems quality, independence and authority remains a major challenge in establishing reliable commercial infrastructure and recourse for creditors, though Chinas commercial arbitration system is developing a good reputation (East Asia Analytical Unit, 1999). These issues affect all aspects of corporate governance enforcement, as well as shareholder and creditor rights. The Government recognises most judges lack commercial training and local government officials can exert significant influence over judges. Furthermore, holding cases in camera erodes confidence in the legal systems transparency (South China Morning Post, www.scmp.com, 25 May 2001). To support WTO accession, authorities have indicated they plan to develop a fair and transparent legal system and modify existing foreign trade laws and regulations to conform to international standards. The Government will establish legal consulting centres for the corporate sector and sideline local laws if they conflict with major corporate legislation. A draft bill also allows the public to witness commercial legal cases (China Online, 2001b).

Press
An active commercial press is emerging complementing official efforts to enforce new commercial laws.29 The press was very active in uncovering recent share price manipulation scandals. For example, in August 2001 after a year-long investigation, Caijing (Finance) magazine, which has earned a reputation for aggressive reporting on Chinese business activities, uncovered details of a major sharemarket scam by biotech company Guangxia Industry (Chine Online, 2001b). Caijing previously uncovered widespread insider trading abuses by Shanghai funds managers. However, as in many other economies, press owners also run non-media corporations, creating possible future conflicts of interest regarding corporate exposures.30

IMPLICATIONS
China is vigorously developing the legal and regulatory framework to enforce better corporate governance, both in state and non-state enterprises; the China Securities Regulatory Commission leads this process. However, this long and complex process is far from complete. Market forces also are pressing the corporate sector to improve efficiency and corporate governance compliance; WTO accession will reinforce this discipline.

29

Since the early 1990s, the Government has tacitly allowed domestic private capital to enter the press sector, without formally changing policy. From 1996, it allowed media companies to list stock (South China Morning Post, www.scmp.com, 30 May 2001). Official figures show media revenue growing by 25 per cent a year over the past three years, suggesting a burgeoning industry. For example, in 2001, Shanghai based company, Sanlian Group backed the launch of the weekly Economic Observer with Rmb 80 million over three years. Similarly Shanghai Bus, a bus and taxi operator, invested Rmb 50 million for a 50 per cent share of Shanghai Commercial News.

30

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The Chinese Governments main problem in raising corporate governance standards is the continued economic importance of SOEs. In operating SOEs, the Governments roles of corporate and financial regulator, corporate and bank asset owner, deposit taker, creditor and maintainer of social stability inevitably come into conflict. Conflicting objectives weaken corporate governance standards and undermine SOE manager incentives to maximise value for public and private shareholders, repay creditors and provide high quality services for consumers. Without a clear requirement to act on behalf of shareholders, many SOE managers instead optimise outcomes for themselves and their workers.

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REFERENCES
Bersani, M.D., 1993, Privatisation and the creation of stock companies in China, Columbia Business Law Review, vol. 3, pp. 301-328. Burke, M. E., 1999, Chinas stock markets and the World Trade Organization, Law and Policy in International Business, vol. 30, no. 2, pp. 321-368. CEIC, 2002, CEIC Database, Hong Kong, supplied by EconData, Canberra. China Online, 2001a, Finance Matters: As WTO accession looms, Chinas financial prospects remain limited, www.chinaonline.com, accessed on 23 May 2001. 2001b, Financial Reform in China, www.chinaonline.com, accessed on 23 May 2001. 2001c, Survey says entrepreneurs feel WTO heat, www.chinaonline.com, accessed on 23 May 2001. China Securities Regulatory Commission 2001, Information supplied to the Economic Analytical Unit, February. East Asia Analytical Unit, 1999, Asian Financial Markets: Capitalising on Reform, Chapter 12, China, Department of Foreign Affairs and Trade, Canberra. 1997, China Embraces the Market: Achievements, Challenges and Opportunities, Department of Foreign Affairs and Trade, Canberra. Economic Analytical Unit, 2002 forthcoming, China Embraces the World Market: What WTO Entry Means for Australia (working title), Department of Foreign Affairs and Trade, Canberra. Fan. G., 2001, Economic Analytical Unit interview with Director, National Economic Research Institute, Beijing, February. Fang, L., 2001, Economic Analytical Unit interview with Professor of Law, China University, Beijing, February. Godwin, A., 2001, Economic Analytical Unit interview with Partner, Linklaters and Alliance, Hong Kong, February. Hovey M., L. Li and Naughton, T., 2000, Corporate Governance Issues: A Case Study of China, in Finance Education in the New Millennium, Deakin University, Melbourne. Huang, Y. and Song L., 2000, State-owned Enterprise and Bank Reform in China: Conditions for Liberalisation of the Capital Account in Drysdale P. (ed), Reform and Recovery in East Asia: The Role of the State and Economic Enterprise, Routledge, London. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Lardy, N., 2001, Economic Analytical Unit interview with Senior Fellow, Foreign Policy Studies Department, Brookings Institute, Washington, August.

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Lin, C., 2000, Public Vices in Public Places: Challenges in Corporate Governance Development in China, Paper presented at Workshop on Corporate Governance in Developing Countries and Emerging Economies, Hong Kong, April. Liu, W., Hui, L. and Wu, L., 2001, Economic Analytical Unit interview with Deputy Director General, Investment Banking Department and members of International Finance Department, China Development Bank, February. Meng, X. and Perkins, F.C., 1998, Wage determination differences between Chinese state and non-state firms, Asian Economic Journal, vol. 12, no. 3, September, pp. 295-316. Neoh, A., 2000, Chinas Domestic Capital Markets in the New Millennium, Part II, mimeo, Hong Kong, April. OECD, 2000, Joint Meeting on Privatisation and Capital Market Development in Asia: A Comparative Perspective and Lessons from the International Experience, Denpasar, October. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Wang, Guo Gang, 2001a, Economic Analytical Unit interview with Vice Director, Finance Research Centre, Chinese Academy of Social Sciences, Beijing, February. Wang, W., 2001b, Strengthening Judicial Expertise in Bankruptcy Proceedings in China, paper presented at 2001 conference, Insolvency Reform in Asia: An Assessment of the Recent Developments and the Role of Judiciary, World Bank, Beijing, 78 February. Woo, V., 2000, The Great Call of China, Forbes Magazine, p. 172, May. Xu, X. and Wang, Y., 1997, Ownership Structure, Corporate Governance and Firms Performance, mimeo, Ahmerst College and the World Bank, May. Zebregs, H. and Blancher, N., 2001, Economic Analytical Unit interview with economists, China Desk, Asia and Pacific Department, and Surveillance Policy Division, Policy Development and Review Department, International Monetary Fund, Washington, August.

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APPENDIX
A p p e n d i x Ta b l e 7 . 1 Laws Influencing Corporate Governance
Type of Enterprise SOE Description An enterprise with assets owned by central, provincial or municipal governments An enterprise with assets owned jointly by workers and other economic entities The Government recognises three types of private enterprise: individually funded enterprises, which are funded and managed by one person partnerships which are funded, managed, and with profits and losses shared jointly limited liability company, in which the investor liability is limited to their contributions and company liability is limited to its shares Foreign enterprise Includes joint ventures, Sino-foreign cooperation enterprises and wholly owned foreign enterprises Each firm is subject to the relevant law promulgated for its firm type. If it is incorporated as a limited liability company or a joint stock company, the Corporation Law takes precedence if conflicts arise Relevant law Law on Enterprises Owned by the Whole People Law on Collectively Owned Enterprises Provisional Regulations on Private Enterprises Partnerships governed by the Partnership Law Limited liability companies governed by the Corporation Law

Collectively owned enterprise Private enterprise

Township and village enterprise

An entity owned by local governments and former commune members

Source: PricewaterhouseCoopers, 2001.

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C h a p t e r

REPUBLIC OF KOREA

KEY POINTS
Massive conglomerates, the chaebol, continue to dominate the Republic of Koreas corporate scene.1 Before the crisis, government support and favourable access to debt finance encouraged chaebol growth, leading to high debt ratios and inefficient investment. Post crisis, the Government made strong progress on financial sector reform but corporate reform remains a major challenge. However, market opening and financial restructuring have exposed the chaebol to more competition in product and finance markets, somewhat disciplining their management and levelling the playing field for Australian business. In addition, authorities now stipulate higher reporting, accounting and auditing standards and make company boards more accountable to their shareholders, so shareholders, including Australian shareholders, can make better informed investment decisions and influence companies. In 1999, the private sector Committee on Corporate Governance issued the voluntary Code of Best Practice for Corporate Governance for listed companies; several of its recommendations are becoming laws. Authorities generally enforce new laws. However, a stronger media, more independent of the chaebol could help discipline corporates and their managers. Despite post crisis reforms, minority shareholders rights remain relatively weak and most chaebol majority owners continue to run corporations in their own interests; hence Australian portfolio investors still need to exercise caution.

Hereafter, the Republic of Korea is referred to as Korea.

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The financial crisis seriously affected Koreas economy, threatening banking system stability and forcing many corporates and smaller enterprises into insolvency. The Government responded with stronger laws and regulations covering corporate and financial governance. With corporate and bank restructuring, old relationships between banks, chaebol and other corporates are weakening, and market reforms expose banks and corporates to more discipline from global competition. This should significantly change the corporate landscape Australian business faces in doing business, featuring greater market access, less local collusion and more transparent investment opportunities. However, due to the chaebols major concentration of market power and their strong capacity to resist change not in their interest, the transition to a more rules and market based system is gradual and will take some time to complete.

CORPORATE SECTOR STRUCTURE


Large diverse conglomerates, the chaebol, dominate the corporate sector and operate in nearly all sectors. Families still at least partially own and manage most chaebol. They use cross-ownership and pyramid structures, and pre-crisis, enjoyed favourable bank treatment, often with government support. Consequently, most chaebol became over-leveraged and diversified into many unrelated sectors beyond their core competencies, building up excessive foreign debt and capacity in many industrial sectors, contributing to the financial crisis.

Chaebol Dominate
The top 30 chaebol account for 46 per cent of all Koreas corporate assets, dominating the sector. Controlling families and their companies hold around 45 per cent of equity in the top 30 chaebol (Asian Development Bank, 2001). Often, families appoint relatives to management and list a minority of equity, thereby ensuring control. For example, the Hyundai Group lists only 16 of its 46 member companies (Asian Development Bank, 2001). The top 30 chaebols return on equity declined markedly from the mid 1990s and contracted even more sharply during the crisis (Asian Development Bank, 2001). Between 1988 and 1996, Korean corporate profitability was the lowest of the nine major East Asian economies, and well below that of Germany and the United States (Woo-Cummings, 2001). Declining profitability partly reflected chaebols easy access to bank finance and their belief they were too large for the government to allow them to fail; this encouraged them to over-invest and over-diversify. For example, on average, the top 30 chaebol own more than 20 subsidiaries in diverse sectors, with few complementarities (Asian Development Bank, 2001). Heavily centralised management focussed on founding family heads also reduces decision making flexibility, reducing profits.
2

Private individuals own around 40 per cent of all listed stock, and control around 30 per cent of listed companies. Corporations hold 70 per cent of controlling shares in listed companies, often through cross-ownership and pyramid structures that account for a further 20 per cent of listed equity (Asian Development Bank, 2001). In early 2002, the official definition of chaebol was in flux, so some of these groups may no longer be defined as chaebol. Corporate profitability is measured as the real return on assets in local currency. Korea does not permit holding companies.

3 4 5

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SAMSUNG CORPORATION CONTROLLED BY LEE KUN-HEE


6

The figure shows the principal shareholders in Samsung Electronics, Koreas second largest company prior to the crisis.

Samsung Electronics (Group Chairman: Lee Kun-Hee) (Chairman: Kang Jin-Ku)

Lee Kun-Hee 8.3% Samsung Co 4.3% Cheil Jedang 3.2% Shinsegae Dept Stores 1.9% Cheil Wool Textile Co 1.6%

Samsung Life 8.7%

Joang-ang Daily News 1.0%

Joang-ang Develop 0.6%

Lee Kun-Lee 15.0% Lee Kun-Lee 9.2% Samsung Life 9% Lee Kun-Lee 14.1% Lee Kun-Lee 22.7% Lee Kun-Lee 6.9%

Cheil Jedang 11.5%

Samsung Life 9.3%

49.3% Samsung Group 9.1% Lee Kun-Hee

48.3% Joang-ang Daily News 14.1% Cheil Wool Textile Co

R e p u b l i c

Lee Kun-Lee 14.1% Lee Kun-Lee 15.0% Cheil Jedang 11.5%

Lee Kun-Lee 15.0%

Cheil Jedang 11.5%

o f

Lee Kun-Lee 14.1%

Lee Kun-Lee 14.1%

K o r e a

Source: La Porta et al., 1998.

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Post-crisis corporate restructuring may have somewhat changed this structure.

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Chaebol transactions further reduced profits for small outside investors. Often, subsidiaries conducted related party transactions and off-balance sheet guarantees, without external shareholder consent (Asian Development Bank, 2001).

Debt Rather than Equity


Traditionally, chaebol have preferred debt rather than equity financing, as it minimised dilution of founding family control as the chaebol grew. Although Korean law effectively prevented cross-ownership between chaebol and banks, producing widely dispersed bank ownership, the Government pressured banks to lend to the chaebol (Nam et al., 1999). Hence, banks often ignored sound credit analysis and lent to politically well connected large firms, with implicit government guarantees (Naughton, 2001). In addition, many chaebol owned finance companies and merchant banks, providing ready access to debt finance. Hence, in 1997, the top 30 chaebols debt to equity ratios averaged 519 per cent, increasing outside investor risk. After the crisis, ratios fell to 237 per cent by April 2000; however, by international standards, debt to equity ratios remain high (Nam et al., 1999; East Asia Analytical Unit, 1999a).
7

Direct Financing Markets Weak


The corporate sectors strong bias towards debt financing inhibited Koreas share market from developing. In 2000, at 36 per cent of GDP, Koreas stock market capitalisation was the regions third smallest. Liquidity also is modest, as chaebol firms hold rather than trade their cross-held shares (Naughton, 2001).
8

Government an Important Player


The Government owns part, or all, of nearly 200 enterprises, in key infrastructure and production sectors. Laws granting public enterprises exclusive trading rights or monopoly powers deter new firms from entering these markets. Before 1997, even though all banks were privately owned, the Government appointed the major banks CEOs, effectively controlling their lending portfolios to ensure they supported national development priorities. Government financing and chaebol bail outs were designed to promote rapid industrial growth and Korean competitiveness.
9

Chaebol Reduce Product Market Competition


The scale and market power of chaebol groups present significant barriers to new players seeking to enter most markets. The four largest chaebol supply close to 60 per cent of manufacturing output in many markets, suggesting significant scope to collude to deter new entrants (Bird, 1997). Chaebol also are vertically integrated and reduce competition by owning many firms supplying their major

7 8

Consequently, banks returns on equity and assets are low compared with US and European banks. Instead of listing more shares, the chaebol accessed corporate bond markets; since the crisis, bank reluctance to lend has accelerated this trend (Naughton, 2001). However, the highly concentrated bond market means prices are volatile and investor risks high; in 1998, the five largest chaebol issued almost 80 per cent of traded bonds (Zielinski, 1999). Local authorities own and control a further 298 firms.

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R e p u b l i c

o f

K o r e a

companies with inputs and materials. For example, the LG Group diversified into the plastics industry to secure quality packaging for their cosmetics products, thereby reducing opportunities for other plastics producers (East Asia Analytical Unit, 1999a).

MARKETS BECOMING MORE COMPETITIVE


Increasingly, more open financial and product markets influence Korean corporate behaviour. Restructured and particularly foreign owned banks are more reluctant to lend at government direction, although in some cases they are still forced to comply (Truman, 2001). Developing capital markets now compete more with banks to attract funds. Corporate restructuring gradually is paring back the chaebol system, providing more opportunities for new domestic and foreign, including Australian, entrants. Foreign portfolio investment, including institutional investors participation in the share market, is rising rapidly. Meanwhile, the Government is deregulating markets, reforming competition policy and liberalising the foreign investment and trade regimes, with significant opportunities for Australia.

CHAEBOL LOOK ELSEWHERE FOR FUNDS


Since the crisis, bank and corporate collapses and restructuring, as well as tighter prudential controls have made banks less willing to fund the chaebol, forcing them to use bond and share markets for finance. The entry of institutional investors is adding depth to direct finance markets, increasing their viability for outside investors. As a result of the crisis, chaebol also lost some control over finance and trust companies, an important source of debt finance.

Bank Reform
Eventually, post crisis restructuring should produce a more market based banking sector, but in the short term, the Government is deeply involved in the banking system and some old practices continue. By December 1999, authorities had liquidated 199 financial institutions, including banks, merchant banks and leasing companies, and suspended a further 68 licences; eventually, this should increase discipline on remaining institutions. Some banks merged with stronger banks, including three major commercial banks. The Government owns close to one third of the sector after recapitalising the remaining banks, but it has announced it will sell these shares as soon as the market recovers, introducing new independent owners.
10

Although the Government allowed some major chaebol like

Daewoo to fail, it developed rescue packages for others, pressuring banks to participate. The Government recognises it eventually must withdraw from the banking system to facilitate bank independence, boost shareholder influence over management, improve depositor protection and discipline the chaebols use of funds (Nam et al., 1999).

10

However, since the crisis, under Banking Act amendments, banks can own 15 per cent or more of a corporations equity with Financial Supervisory Commission approval, instead of the previous 10 per cent (PricewaterhouseCoopers, 2001). This may strengthen bank and chaebol relationships, weakening lending quality.

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In April 2000, the Government banned the chaebol from using their finance companies as private safes; authorities also nationalised two chaebol finance sources, Korea Investment Trust Company and Daehan Investment Trust Company.

Foreign Bank Entry


Since the crisis, authorities have liberalised rules on mergers, acquisitions and foreign entry, so foreign banks can enter the market. In 1999, Newbridge Capital purchased 51 per cent of Korea First Bank, appointing the first foreigner to run a Korean bank. In 2001, Korea First refused to participate in the state driven roll over of chaebol bonds; it was the only bank to refuse. It argued the roll over was not commercially sound, and its refusal underscored its independence from government and the corporate sector (Far Eastern Economic Review, 15 February 2001, p. 54). In April 2001, Koreas two strongest banks, Kookmin and Housing and Commercial Bank, merged with combined assets of US$123 billion. Goldman Sachs, Kookmins largest shareholder, will own 16.6 per cent of the new bank. ING Barings, Housing and Commercials second largest shareholder, also will own a large share of the new bank (South China Morning Post, www.scmp.com, 16 May 2001). By January 2002, foreigners now own a total of 72 per cent of Koreas largest bank; this should markedly improve prudential standards. Increasing bank independence and foreign ownership should over time improve incentives for sound borrowing and investment by Korean corporates, though new bank shareholders will need to become more active in bank management for this to occur. However, analysts believe the Government can benefit from easing limits on bank shares strategic investors can own, privatising nationalised banks faster and withdrawing completely from bank decision making (Asian Development Bank, 2001). Australias financial institutions and services providers are well placed to pursue opportunities in this sector, both as potential investors and to provide more advanced management systems for banks upgrading their risk management capacity.

Share Markets More Important


Korean firms now prefer internal and equity financing over debt financing, although most equity issues are rights issues (Asian Development Bank, 2001). Gradually, banks share in supplying finance is decreasing (Figure 8.1). Over time, a bigger and more liquid share market should reduce the cost of equity raising and increase opportunities to impose shareholder discipline on corporates (Naughton, 2001). Between January and August 2001, the top four chaebol, Samsung, Hyundai, LG Group and SK Group, raised Won 1.9 trillion on the stock market, nearly 11 per cent more than in the same period a year earlier.

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Figure 8.1 Bank Finance Down, Direct Finance Up Shares of Alternative Corporate Fund Raising Sources

100

80

Per cent

60

40

20

0 1990 Bank
Note:

1995 Stocks

1996 Corporate bonds

1997

1998 Commercial paper

1999 Others1

1 Others includes trade credits, bills payable and borrowing from the government.

Source: Kim et al., 2000.

New regulations liberalising initial public offers, IPOs, mergers and acquisitions, and foreign portfolio investment are boosting the share market. IPOs plunged after the financial crisis, but in 2000, rebounded to a record 179 IPOs; all were issued on the KOSDAQ, Koreas equivalent of the NASDAQ (Figure 8.2) (Naughton, 2001).
11

Foreign penetration of the share market increased gradually in the lead up to the crisis (Figure 8.3); since then, it has exploded to around 35 per cent in 2001 (Naughton, 2001). Some chaebol, including Samsung and POSCO now feature foreign equity ownership in excess of 50 per cent.

11

The KOSDAQ was formed in 1996 to facilitate corporate financing for knowledge based ventures, high technology companies and small to medium sized enterprises. Since the crisis, its existence has assisted in the restructuring process. The KOSDAQs trading volume has increased 460 fold since 1998, but fell with the dot.com crash (KOSDAQ, 2001).

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Figure 8.2 Initial Public Offerings Skyrocketing IPOs, Annual, Won millions, 1990-2000
4 500 000 4 000 000 3 500 000

Won million

3 000 000 2 500 000 2 000 000 1 500 000 1 000 000 500 000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: CEIC, 2002.

Figure 8.3 Shareholdings in Korean Public Listed Companies, 1989-1998 Individuals Roles Drop, Foreigners Roles Expand
100 90 80 70
Per cent

60 50 40 30 20 10 0 1989 1990 Individuals Banking institutions 1991 1992 1993 1994 1995 1996 1997 1998 Other juridicial persons Government Other financial institutions Foreigners

Source: Institutional Analysis, 2001.

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Share market regulatory reforms should boost new local or foreign entrants capacity to contest corporate control, boosting competitive pressure on corporate management. These allow outside shareholders to challenge dominant shareholders ownership of listed companies. Since 1998, investors have not needed mandatory approval to acquire more than 10 per cent of a listed stock (Asian Development Bank, 2001). The Government also abolished the regulation forcing investors seeking 25 per cent of a listed companys shares to offer to purchase over 50 per cent of the shares; this had provided powerful protection for chaebol family owners (Naughton, 2001).

Rise of Institutional Investors


Increasingly prominent pension funds, life insurers and investment trusts should further develop capital markets. In 1999, Koreas life insurance market was Asias second largest, with 45 companies. Also in 1999, authorities allowed mutual funds to operate and several financial institutions established corporate pension fund accounts. Since the crisis, several firms have left the market and new foreign entrants are improving standards of risk management (World Trade Organization, 2000). Increasingly, civil society groups and domestic institutional investors agitate for better corporate governance. New reforms allow securities companies and investment trusts to exercise voting rights over their shares; this should strengthen their activity. Ha-sung Jang, Professor of Finance, Korea University, leads the Peoples Solidarity for Participatory Democracy that promotes minority shareholders rights, seeks board representation on listed chaebol and has launched several derivative suits against errant corporates (Black et al., 2000). Reforms allowing foreign institutional investors to access local share and bond markets also should improve corporate governance. From 1997, authorities allowed foreigners to invest in shares and, from 1998, in bonds. Foreign investors also no longer face limits on investments in financial and non-financial institutions domestic money market instrument issues (Institutional Analysis, 2001). Foreign institutions show evidence of scrutinising their investments more than Korean shareholders do. For example, US fund managers with a 10 per cent stake in SK Telecom succeeded in ending intra-group financial transfers and appointing independent directors (Ihlwan, 1998). Foreign managed funds also operate in Korea. In 2000, French owned fund manager, Indocam Asset Management Asia, opened a representative office in Seoul, planning to distribute its products to Korean investors (Naughton, 2001). In 1998, under a state led pilot program, 25 domestic financial institutions invested Won 1 trillion in three foreign managed balanced funds (Asian Development Bank, 2001). However, controls on many local institutional investors currently reduce their role in improving corporate governance. The Government has imposed limits on many large local institutional investors like public employee and teacher pension funds portfolio holdings, limiting their capacity to increase discipline on corporates (Asian Development Bank, 2001). Also, many managed funds are associated with the troubled chaebol, reducing public confidence in their security. In 2000, Daewoos collapse prompted large outflows from managed funds, reducing total funds under management to US$132 billion from US$215 billion in 1999. Distribution of managed funds is limited to securities
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companies; other channels including direct distribution, life insurance companies and financial planners are prohibited. Also, strict regulations enforce a strong degree of product homogeneity, penalising innovative providers like Australias Macquarie Bank.

CHAEBOL UNDER PRESSURE


Government and market forces are pressuring the chaebol, so they are less able to over-invest and diversify, and exploit minority shareholders. Over time, these measures also should reduce chaebol market power, increasing local and foreign companies capacity to enter Korean markets. In 1998, the Government announced several initiatives to force chaebol restructuring, curb their market power and improve corporate governance, including: requiring the largest chaebol to undertake voluntary workouts, including converting debt to equity and selling non-core subsidiaries and other assets; these sales should disperse chaebol ownership (Woo-Cummings, 2001) banning cross-guarantees of loans of chaebol group companies banning cross-ownership between companies if it restricts competition and limiting to 25 per cent companies investment in group firms removing incentives for chaebol to retain non-core businesses exempting or reducing taxes on asset transactions, encouraging merger and acquisition activity, asset sales and business asset swaps introducing new listing rules for holding companies, assisting restructuring starting a corporate restructuring fund and easing requirements for public offerings.
12

However, several of these reforms were to take effect by 1 April 2002, but due to chaebol pressure, the Government has reneged on some commitments, including waiving the 25 per cent investment limit for affiliated core businesses and easing cross equity restrictions. Also, bans on cross equity investments and debt payment guarantees only will apply to firms with assets over Won 2 trillion, reducing significantly the number of firms affected. Finally, all chaebol will be allowed to invest in SOEs as they are privatised. Nevertheless, recent chaebol failures, including Daewoo, under debts of US$80 billion in 1999, force the chaebol and their investors to accept government guarantees no longer exist. This increases incentives for other corporates to use funds wisely and forces rationalisation.

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The Won 1.5 trillion restructuring fund should support investments in small and medium companies and independent large corporations that do not belong to chaebol.

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Big Deal
The Governments Big Deal initiative aimed to reduce chaebols excessive sectoral diversification, but its competition and corporate governance outcomes are mixed. The Government encouraged chaebol to exchange non-core production facilities among themselves for assets closer to their core competence.
13

Consequently, Samsung swapped its automotive unit for Daewoos consumer

electronics unit so Samsung now holds 60 per cent of the domestic consumer electronics goods market; Daewoo took over Ssangyong; and LG Group sold its semiconductor unit to Hyundai (Woo-Cummings, 2001). However, this rationalisation is government inspired rather than market driven and the outcomes may produce dominant domestic producers, deterring new entrants. Hence, this initiative could worsen corporate governance outcomes, unless foreign producers can provide competition Korean markets now lack.

RESCUE OF HYNIX

In 2000, when Hyundai manufacturer Hynix Semiconductor lost Won 2 trillion, its debt to equity ratio rose towards the 200 per cent limit. Although the company sold non-core assets, including a basketball team and the company headquarters and raised Won 464.5 billion, in June 2001, it was unable to borrow further. Instead it issued US$1.25 billion in shares on international equity markets. Before the issue, Hynix undertook major corporate governance reforms. Majority owners, the Chung family, resigned from the board and relinquished all voting rights, although they retain their financial holdings until 2003. All ten board members now are outside directors.
Source: South China Morning Post, www.scmp.com, 16 July 2001.

CHAEBOL TO FACE GREATER COMPETITION


Since the crisis, privatisation, deregulation, trade, foreign investment and competition policy reforms have increased competition in product markets and discipline on managers.

Privatisation and Deregulation


The Government is reviewing its level of ownership and regulation of markets. By December 1999, the number of state owned enterprises had fallen to 91 from 108 in 1997. The Government also sold all but a small share of POSCO, the worlds largest steel producer; and by December 2000, its share in the communications sector was around 33 per cent, down from 100 per cent (World Trade Organization, 2000). Reforms in other sectors, including utilities, are increasing competition although government monopolies and subsidised tariffs continue. In transport, the Government has lifted several entry

13

In 1998, under combined government and market pressure, the number of Korean firms fell by 4.3 per cent and productivity increased by 13 per cent (World Trade Organization, 2000).

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restrictions on maritime services, aircraft handling and transportation (World Trade Organization, 2000). Deregulation also has improved market entry in the distribution and construction sectors, and the revised 1998 Telecommunications Business Act allows new, including foreign, entrants (World Trade Organization, 2000). The Government is reviewing energy subsidies for farmers and manufacturers.

Trade Reforms
Gradually, the Government is relaxing import restrictions, with the average applied most favoured nation tariff now 13.8 per cent, down from 14.4 per cent in 1996. Industrial tariffs average 7.5 per cent but agricultural products are high at 50.3 per cent. Average bound tariff rates also fell sharply, led by the bound tariff for motor vehicles dropping from 80 per cent to 8 per cent in December 1999, and falling tariffs on telecommunications equipment (World Trade Organization, 2000). increase competitive pressure on Korean corporates (Figure 8.4).
14

Growing imports

Foreign Investment Reforms


The 1998 Foreign Investment Promotion Act removed limits on foreign investment in Korean companies, increasing competition for the right to manage listed firms. Foreign companies no longer need permission to acquire over 33 per cent of a companys equity, allowing hostile takeovers. Hence, foreign direct investment now accounts for much more manufacturing activity than before the crisis (Figure 8.5). Foreign companies are significant in automotives, banking, insurance and the retail sector.

Figure 8.4 Imports Increasing Competition Consumer Imports as a Share of Consumer Spending, 1990-2001
13 12 11 10

Per cent

9 8 7 6 5 4 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: CEIC, 2002.

14

Beef and rice still face quantitative restrictions, but anti-dumping actions have declined markedly since 1996-97 and technical barriers now align with international best practice, improving market access.

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Figure 8.5 Foreign Investment Increasing Competition Manufacturing FDI including as a Share of Manufacturing GDP, 1995-2001
7

Per cent

0 1995
Source: CEIC, 2002.

1996

1997

1998

1999

2000

2001

However, although direct and portfolio investment is increasing strongly from a low base, the chaebol still dominate many sectors, deterring foreign entry (World Trade Organization, 2000). Also, foreign direct investment remains restricted in radio and television broadcasting, news agency activities and gambling (East Asia Analytical Unit, 1999a). Despite this, since the crisis, more domestic firms see foreign firms as the main source of competition (Korea Institute for Industrial Economics and Trade, 1999).
FOREIGNERS DRIVING DAEWOO
15

Since the Daewoo chaebol collapsed, car maker Daewoo Motor has looked for a foreign buyer. The company sacked one third of its workforce, forced its overseas businesses to be self supporting and secured more than US$2 billion in government support to prepare itself for sale to foreign investors. General Motors launched a formal bid in May 2001; however, it did not want the truck and bus factories. Following earlier sackings, the General Motors bid raised the ire of union groups. In September 2001, it signed a memorandum of understanding with Daewoos main creditor, Korea Development Bank, reportedly to inject US$400 million into a new joint venture, tentatively named GM-Daewoo Motor. Potential foreign investors are watching the outcome to see what challenges new foreign entrants in key Korean markets face. However, if Daewoos domestic market share continues to decline it may become less attractive, delaying the deal.
Source: Korea Economic Daily, english.hankyung.com, 21 September 2001.

15

In 1996, 71 per cent of firms perceived domestic producers as the main competitors; in 1998, this fell to 63 per cent.

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Pro-competition Action Stronger


While chaebol still dominate many markets, since the crisis, authorities have tried to reduce their market power by strengthening competition and anti-cartel legislation and its enforcement. For example, in 1998 and 1999, the Government revised the 1980 Monopoly and Fair Trade Act covering monopolistic market structures and extended the legislation to cover all firms.
16

Under the 1999 Omnibus Cartel

Repeal Act, authorities disbanded or investigated 20 cartels, though another 38 cartels remain active. During April 1999 alone, authorities investigated eight state enterprises for illegal activities and throughout 1999, the Fair Trade Commission identified 324 firms in 129 markets as dominant enterprises, subjecting them to regulations on the abuse of market dominance. A September 1999 probe into illegal internal trading in chaebol affiliates resulted in Won 3.7 billion in fines (World Trade Organization, 2000). Despite this concerted action, small new entrepreneurs still report it is difficult to break into markets the chaebol dominate, or even new markets, like e-business, where market positions are less established (Associated Press, www.ap.org, 12 May 2001).

CORPORATE REGULATIONS IMPROVE PLAYING FIELD


The crisis sparked aggressive government reform of Koreas corporate governance framework and increased management transparency.
17

In 1999, the private sector Committee on Corporate

Governance issued a voluntary Code of Best Practice for Corporate Governance for listed companies; several recommendations now are laws. However, the need for major business culture change and in some cases resistance from strong corporate interests mean companies will need considerable time to fully meet new standards.

TRANSPARENCY
Post crisis efforts are improving corporate transparency, albeit from a low base, and should promote better, more performance based investment.

Financial Reporting
In 1999, the Government upgraded transparency requirements under the Korean Commercial Code. Listed firms annual reports must include details of business goals and strategies, financial conditions, shareholder rights, cross-shareholdings, cross-debt guarantees and directors compensation. Firms also must report to the securities regulator any event likely to affect share prices, including dealings benefiting insiders and transactions that alter corporate control. Corporations with significant foreign

16

The Korean Fair Trade Commission enforces the legislation in all sectors except telecommunications, where the Korea Communications Commission is responsible. Bob Graff, Jeongshin Hwang, Ju-won Jin and Haidi Wilmot, PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section.

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ownership must report both in Korean and English. The top 30 chaebol must report their accounts on a consolidated basis. Under the Code of Best Practice for Corporate Governance, each quarter, corporations must disclose their compliance with the code (PricewaterhouseCoopers, 2001).

Accounting Standards
In December 1998, authorities brought the Korean Accounting Standards broadly into line with international accounting standards. The Financial Supervisory Service introduced new standards on segment reporting, valuing assets at market values, accounting for derivatives and consolidating accounts. The private sector controlled Korea Accounting Standards Board harmonises Korean standards with international ones.
18

Korean accounting standards still differ somewhat from

international standards as they do not have to disclose the fair value of financial assets and liabilities, or financial institutions liabilities by sector (PricewaterhouseCoopers, 2001). Compliance with standards generally still needs strengthening. A recent survey indicated almost half of all listed companies did not consult international accounting standards and only 10 per cent followed all international accounting standards. Despite this, auditors gave qualified opinions on only 7.4 per cent of firms. Furthermore, despite stricter auditing standards in 2000, the number of qualified opinions fell (Asian Development Bank, 2001).

Auditing
In 1999, the Securities and Futures Commission brought auditing standards into line with international ones. Traditionally, Korean company boards appointed only internal auditors; however, under the Commercial Code, corporations must establish either an audit committee or statutory internal auditor, not both (PricewaterhouseCoopers, 2001). Since December 1999, large public corporations, institutions with government ownership and financial institutions have been able to use audit committees with independent members. An audit committee must consist of at least three directors; two must be independent (Asian Development Bank, 2001). The voluntary Code of Best Practice for Corporate Governance also recommends firms establish audit committees, with two thirds of the members independent (PricewaterhouseCoopers, 2001). Since December 2000 the Financial Supervisory Service audited companies suspected of engaging in deceptive reporting; before this, it randomly audited companies. On-site inspections complement document submissions and all parties involved in deception face increased penalties. External audit firms must audit listed and registered company accounts before they are published. Since 1998, a committee comprising internal auditors, outside directors and creditors has selected the auditing firm. Almost all firms now appoint an external auditor independent of the company (Asian Development Bank, 2001).

18

In 1999, the Korean Government entered into a project with the World Bank to improve Korean standards, creating the Korea Accounting Standards Board, operating under the Korea Accounting Institute.

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MINORITY SHAREHOLDERS RIGHTS


In 1999, authorities strengthened minority rights under the Korean Commercial Code, introducing lower voting thresholds for shareholders passing resolutions and encouraging minority shareholders to participate in management. These changes offer shareholders more opportunities to influence management, although many chaebol resist shareholder activism.

Listing Rules
Since 1998, all listed companies must allocate 25 per cent of their board seats to outside, independent directors and make timely disclosure of major corporate transactions. Listed companies must disclose large transactions involving financial derivatives and major decisions including investment and debt guarantees exceeding 10 per cent of company stock (PricewaterhouseCoopers, 2001). In 2000, authorities amended the Securities and Exchange Act, applying penalties to companies disclosing inaccurate information. In August 1999, authorities suspended Daewoo Metal stock from trading because the company did not faithfully disclose details of its convertible bonds, and in November 1999, authorities suspended Sepoong stock from trading. If a company has two inaccurate disclosures in one year, it is an unfaithful disclosure company; one more incident within six months leads to delisting. In November 2000, Hansol Telecom became an unfaithful disclosure company for not disclosing a supply contract of more than 10 per cent of its sales (PricewaterhouseCoopers, 2001).

Shareholder Representation
Shareholders with 3 per cent of an unlisted companys stock or 1 per cent of a listed companys stock may call a shareholders meeting to determine major issues, including removing directors.
19

While

listing rules allow cumulative and proxy voting, companies articles of incorporation may circumvent this and currently often do. Furthermore, postal voting is not allowed (PricewaterhouseCoopers, 2001). Despite other reforms, these provisions considerably weaken minority shareholder rights.

Board Structure and Duties


Since the crisis, the Government has strengthened requirements for independent directors to sit on boards; previously this was not normal custom. The Code of Best Practice for Corporate Governance recommends half of all board directors be independent, and the Securities and Exchange Act specifies at least 25 per cent of listed company board directors be independent. From 2001, under the Security Transaction Act, half of listed company boards with capital over Won 200 billion must be independent. By June 2001, an estimated 30 per cent of listed company board directors were independent, up from 11 per cent in 1998 (PricewaterhouseCoopers, 2001). Changes to the Commercial Code allow companies with less than Won 500 million in paid-up capital to choose the number of directors, independent and otherwise.

19

If a companys capital is over Won 100 billion, 0.5 per cent of shareholders can call such a meeting.

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The Commercial Code requires directors to perform their duties under the law and provides for shareholder derivative suits. Since 1999, shareholders with only 0.01 per cent of outstanding shares have been able to file derivative lawsuits against management. Consequently, shareholder activism is growing, with outstanding suits demanding compensation for losses due to mismanagement. The Government may introduce shareholder class actions, although the business community fiercely opposes this measure.

PEOPLES SOLIDARITY FOR PARTICIPATORY DEMOCRACY

Peoples Solidarity for Participatory Democracy is a non-government group that asserts peoples authority over the chaebol. In 1997, it allied with a Korea First Bank minority shareholder group in a successful derivative law suit against the failed banks former management. The court found the Korea First Bank management lent illegally to bankrupt Hanbo Steel. In another suit, Peoples Solidarity for Participatory Democracy claim Samsung Electronics issued convertible bonds to its chairmans son, transferring company money to the family at a discount. The non-government group also attends the annual meetings of Samsung Electronics, SK Telecom, Daewoo Corporation, Hyundai Heavy Industry and LG Semiconductors, to urge corporate governance reforms, including adopting cumulative voting for electing directors.
Source: PricewaterhouseCoopers, 2001; Peoples Solidarity for Participatory Democracy, 2001.

CREDITORS RIGHTS
Pre-crisis creditors rights were relatively weak and despite stronger bankruptcy laws, slow enforcement through the courts is retarding Koreas restructuring and economic recovery.

Bankruptcy Laws
The financial crisis revealed weaknesses in Koreas bankruptcy and corporate restructuring regimes. Hence, in 1998, the Government amended bankruptcy laws simplifying legal proceedings for corporate rehabilitation and bankruptcy filing, streamlining provisions for non-viable firms to exit markets and improving creditor bank representation during resolution (PricewaterhouseCoopers, 2001). In 1998, authorities also attempted to expedite court insolvency proceedings, granting district courts exclusive authority to process cases (PricewaterhouseCoopers, 2001). However, court delays and a desire to preserve capital adequacy mean most banks negotiate with distressed debtors to restructure loans; only occasionally do banks file for receivership (Asian Development Bank, 2001). Nevertheless, by September 1998, corporate restructuring had increased firm bankruptcies to 20 000, double pre crisis levels. As well, by July 1998, bank led voluntary workouts involved 210 financial institutions under Corporate Restructuring Agreements. Threats of bankruptcy or foreclosure are
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motivating company participation. The Financial Supervisory Service drives corporate restructuring, regulating and supervising Korean financial institutions (PricewaterhouseCoopers, 2001). The Corporate Restructuring Coordination Committee arbitrates cases where agreement fails; usually, creditor bank delegations oversee defaulting firms management.

Bank Supervision
In 1998, the Financial Supervisory Service, then Commission, became responsible for supervising banks, insurance companies and security companies. It introduced a series of post crisis capital adequacy and loan loss provisioning reforms which strengthened prudential control (East Asia Analytical Unit, 1999a; East Asia Analytical Unit, 1999b).

COMPLIANCE
Increasingly active minority shareholders and prudential institutions and independent courts enforce better compliance with new standards, codes and regulations. However, long delays persist in the courts and close media and chaebol links weaken media scrutiny of chaebol behaviour.

Legal System
The rise in successful minority shareholder cases against corporates demonstrates the Korean court system is relatively independent. Importantly, in July 2001, seven former Daewoo executives were imprisoned for up to seven years and fined Won 26 trillion (about US$23 billion) for falsifying accounts and diverting company funds (South China Morning Post, www.scmp.com, 25 October 2001). These were the first custodial sentences handed out for corporate fraud and are an important indicator corporate governance should continue to improve.

Media
Chaebol directly or indirectly own much of the media, possibly weakening its willingness to scrutinise corporate behaviour; media outlets also are heavily reliant on chaebol advertising. For example, Samsung owns the daily Joongang Ilbo and Hyundai owns the daily Munhwa Ilbo. The Federation of Korean Industries, incorporating all the major chaebol, owns the Korean Economic Daily, or Hankyung, after taking it over from Hyundai in 1980 (Backman, 1999).

IMPLICATIONS
The Korean Government recognises weak corporate governance was central to Koreas severe financial crisis and since the crisis, has strengthened the regulatory environment and enforcement. Over time, new reforms, corporate restructuring, deepening capital markets, foreign bank entry and greater local and foreign market competition should weaken chaebol dominance and improving standards of corporate governance. This will be important to reduce Korea exposure to risky corporate borrowing and profligate investment at the expense of minority shareholders and hence any recurrence of the financial crisis. However, for this to happen, strong political will and institutions are vital in confronting powerful vested interests and ensuring a timely transition to a rules based business model.
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REFERENCES
Asian Development Bank, 2001, Corporate Governance and Finance in East Asia: a Study of Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand, Vol. 2, Asian Development Bank, Manila. Backman, M., 1999, Asian Eclipse, John Wiley and Sons, Singapore. Bird, K., 1997, Industry Concentration in Indonesia, mimeo, Australian National University, Canberra. Black, B., Metzger, B., OBrien, T. and Shinn, Y., 2000, Corporate Governance in Korea at the Millenium: Enhancing International Competitiveness, Stanford Law School, John M. Olin Program in Law and Economics, Working Paper No. 196, San Francisco. CEIC, 2002, CEIC database, Canberra. East Asia Analytical Unit, 1999a, Korea Rebuilds from Crisis to Opportunity, Department of Foreign Affairs and Trade, Canberra. 1999b, Asias Financial Markets: Capitalising on Reform, Department of Foreign Affairs and Trade, Canberra. Ihlwan, M., 1998, The Shareholder Revolt Comes to Korea, Business Week, No. 23, February. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Korea Institute for Industrial Economics and Trade, 1999, Country Report: Korea, Paper presented at Asian Corporate Recovery: Corporate Governance and Government Policy, 31 March-2 April, Bangkok. La Porta, R., Lopez de-Silanes, F., Shleifer, A. and Vishny, R.W., 1998, Law and Finance, Journal of Political Economy, no. 106, p. 1113-55. Nam, I.C., Kim, J.K., Kang, Y., Joh. S.W. and Kim, J., 1999, Corporate Governance in Korea, Paper presented at OECD Conference, Corporate Governance in Asia: a Comparative Perspective, 3-5 March, Seoul. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. Peoples Solidarity for Participatory Democracy, 2001, www.pspd.org, accessed December 2001. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Truman, 2001, Economic Analytical Unit interview with Senior Fellow, Institute of International Economics, Washington, August. Woo-Cumings, M., 2001, Korea: Democracy and Reforming the Corporate Sector Center for International Private Enterprise, www.cipe.org, accessed June. World Trade Organization, 2000, Trade Policy Review, Korea: Report by the Secretariat, Trade Policy Review Body, Geneva. Zielinski, R., 1999, The World Cup of Banking Reform: Its No Contest. South Korea Obliterates Japan, Time International, vol. 153, no. 2, p. 23.
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TAIWAN

KEY POINTS
The financial crisis affected Taiwan less than most other East Asian economies; however, to protect against future shocks, the Government is liberalising markets and reforming the corporate governance regime. Increasingly Taiwans corporate sector is market driven. Corporate governance standards generally are weak. Family controlled businesses, many small and medium sized, dominate the business sector. Minority shareholder rights are limited, little separation exists between owners and managers and institutional investors play a modest role. Also, some conglomerates and the state own many banks, producing connected lending. Taiwans share market is relatively large and liquid but also volatile, reducing its effectiveness as a reliable means of fund raising. Eventually, developing share markets and increasing numbers of institutional investors should deepen capital markets; eventually, this will increase corporate scrutiny. The Government is improving regulations. In 2001, it strengthened accountant supervision and amended the Company Law, and in 2002, amended the Securities Exchange Law and enacted a Merger and Acquisition Act. To further improve corporate governance, authorities have proposed introducing independent directors and enforcing transparency for private companies.

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Prior to the financial crisis, Taiwans relatively closed capital markets, broadly owned corporate sector, deep financial markets and reasonably well developed regulations helped discourage corporates borrowing excessively abroad or locally. In the future, several of these characteristics should promote better corporate governance. In recent years, the Government has kept pace with regional regulatory reforms, continued opening the economy and deregulated key sectors, improving incentives for sound corporate behaviour. However, corporate governance standards remain uneven; for some conglomerates, they have not been a high priority, while others have outstanding international reputations.

CORPORATE SECTOR STRUCTURE


Taiwans corporate sector is predominantly comprised of family controlled corporates, resembling those of Hong Kong, the Republic of Korea and many South East Asian economies. However, the Taiwan economy is dominated by SMEs, rather than the conglomerates that prevail in the other economies.

Families Predominantly Own Firms


Families control around half of companies listed on the Taiwan Stock Exchange (Claessens, 2000).
1

Typically, owner families fill most board and key management positions. However, unlike many other East Asian economies, corporations rarely cross-hold shares, and many small and medium sized family owned companies list on the share market, dispersing ownership and increasing small outside investor influence (Naughton, 2001).

Deep Capital Markets


Compared with most other East Asian economies, the Taiwan Stock Exchange is reasonably deep relative to GDP, but still quite modest given Taiwans per capital income levels (Figure 9.1) (Naughton, 1999). About 4 million people from the 22 million population hold broker accounts, and by December 2001, individuals, mainly families, held around half of market capitalisation, and accounted for around 85 per cent of share trade, amongst the highest proportions in the world. Corporations hold a further 20 per cent of share market capitalisation (Figure 9.2). In 1998, turnover was the worlds highest at 323 per cent, and in 2000 turnover remained over 300 per cent; this compares with a typical developed economys ratio of around 100 per cent (East Asia Analytical Unit, 1999; The Economist, 11 August 2001). While a high turnover ensures the market mechanism can provide incentives for good management, it also demonstrates the volatility of the market. Price manipulation also has plagued Taiwans stock market, for example through the creation of shell companies, where a conglomerate targets a particular member companys price, forcing it up through increased leveraging and shifting of group assets (Smith, 2000). Between 1980 and 2000, the average value of listed companies grew more quickly than unlisted firms, sharply increasing their share of the corporate sector (Naughton, 2001).

For this purpose, family control is defined as holdings by individual family members and by family controlled corporations using pyramid structures holding 20 per cent or more of a company. Other research suggests families control up to 75 per cent of listed companies (PricewaterhouseCoopers, 2001).

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Figure 9.1 Share Market Reasonably Deep Taiwans Share Market Capitalisation to GDP Ratio
1.4 1.3 1.2 1.1 1.0

Ratio

0.9 0.8 0.7 0.6 0.5 0.4 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: CEIC, 2001.

Figure 9.2 Families Own Large Proportion of Firms Share of Listed Companies Major Groups Own

Widely held Controlled by a family or individual Controlled by the State Controlled by a widely held financial institution Controlled by a widely held corporation

Source: Institutional Analysis, 2001.

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Despite the stock markets size, its role in enhancing corporate governance is ambiguous. Institutional investors comprise only 5 per cent of share market trading, reducing potential for informed shareholder discipline on family controlled firms. As well, government intervention through the National Stabilisation Fund can move share prices from their fair value, distorting investor signals (PricewaterhouseCoopers, 2001).
2

Due to families holding shares tightly, business culture norms and poor tender offer rules, merger and acquisition activity is minimal, weakening its role in enforcing good corporate behaviour (Naughton, 2001). In 2000, the only major domestic takeover occurred when Taiwan Semiconductor Manufacturing acquired Worldwide Semiconductor for US$6.4 billion (Asiamoney, March 2001). Banks entrenched positions and the active sharemarket limits the corporate bond markets scope; it plays only a minor role in influencing corporate behaviour compared to the share market (Naughton, 2001).

Mixed Financing
Taiwans unique financial sector history creates some differences from other East Asian economies. In the past, small and medium sized enterprises had poor access to the formal banking system, so banks are less important in financing firms in Taiwan than elsewhere in Asia. Small and medium enterprises use informal, curb-side financing mechanisms and increasingly look to the share market. Hence, Taiwans debt to equity ratios are lower than US ratios. Credit cooperatives, some run by powerful regional political figures, also provide credit to the corporate sector. Some observers estimate their non performing loans comprise around 70 per cent of total loans (Taipei Times, www.taipeitimes.com, 3 October 2001). However, increasingly conglomerate and government owned banks are involved in non-commercial, connected lending, raising non performing loan levels. For example, a cement and petrochemical conglomerate owns Chinatrust Commercial Bank, and Pan Asia Bank was caught up in the troubled Everfortune Group (East Asia Analytical Unit, 1999).
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MARKET PRESSURES INCREASING


Over the last decade, the Government has gradually opened the financial and corporate sector to international competition and investment and privatised government owned banks; eventually this should improve capital market vigilance and corporate discipline. In recent years, large internationally integrated firms, like Acer and Taiwan Semiconductor Manufacturing, have boosted their corporate governance standards to access international financial markets. However, as in the rest of East Asia, smaller family owned firms still are less convinced of the benefits of good corporate governance.

This fund, created in 2000, smooths large fluctuations in the Taipei market resulting from excessive speculation and overreaction to non-economic factors, such as the reaction to a presidential election (OECD, 2000). Non performing loans rose through the late 1990s, forcing authorities to consider funding their removal from bank balance sheets (PricewaterhouseCoopers, 2001).

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FINANCE MARKETS
New regulations, bank restructuring and privatisation and increasing foreign participation eventually should strengthen capital market development and tighten firms investment strategies.

Capital Markets
Taiwans previously government dominated banking system restricted lending to the dynamic small and medium enterprise sector, encouraging the informal financial sector, and eventually, the share market. Deepening capital markets should foster better market discipline. In 2000, 80 firms listed for the first time, Taiwans largest annual increase so far. In 2000, the Securities Exchange Commission launched the Taiwan Innovation Growing Entrepreneurs program, TIGER, with more relaxed listing rules to promote listing for smaller, particularly high technology firms on the over the counter market. In 2001, authorities lifted restrictions on foreign shareholdings; consequently, foreign shareholdings should rise from 8 per cent of market capitalisation in 2000 (Naughton, 2001). The newly amended Company Law prohibits cross-shareholding among affiliates, possibly further increasing share ownership dispersion (PricewaterhouseCoopers, 2001). Despite these developments, to maintain founding family control, many large and viable companies choose not to list, instead raising finance through internal sources, bank finance and the informal market (Naughton, 1999; East Asia Analytical Unit, 1999). In 2001, draft Company Law amendments eased regulations on firms merging and shedding noncore business units, potentially encouraging merger and acquisition activity (Taipei Times, www.taipeitimes.com, 27 October 2001). In 2002, authorities also enacted the Merger and Acquisition Act, and amended the Securities Exchange Law, the Fair Trade Law and some tax rules to increase merger and acquisition activity (PricewaterhouseCoopers, 2001).

Bond markets
Since 1999, significant new government enterprise and foreign institution bond issues have helped the bond market flourish. Issues should continue to increase in 2002, as the 2001 draft Company Law amendments simplified the regulation of small companies bond issues (Taipei Times, www.taipeitimes.com, 27 October 2001). In future, corporate bond markets could contribute to improved corporate governance (Naughton, 2001). Since the financial crisis, the Ministry of Finance has strengthened direct finance markets, including improving securities dealer supervision, enacting the Securities and Futures Investors Protection Act and amending the Securities Exchange Law (PricewaterhouseCoopers, 2001).

Institutional Investors Should Expand


Taiwans institutional investor community has been small, but recent developments should encourage its growth; if it became more active, the large share market could better realise its potential to influence firm behaviour. Since 2000, banks can invest up to 40 per cent of their paid-up capital, less cumulative losses, in securities, including in insurance and other finance-related firms. This should increase the

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number of institutional investors (PricewaterhouseCoopers, 2001). Also, the four large public pension funds increasingly allocate funds to outside managers; the latter could manage 20 to 30 per cent of public pension funds by 2005 (Taipei Times, www.taipeitimes.com, 15 October 2001). Authorities also relaxed restrictions limiting Employee Pension Fund investments in private enterprises. These trends should develop private institutional investment and reduce political pressure on public pension funds to intervene in the stock market. The 2000 Financial Institutions Merger Law and 2001 Financial Holding Company Law allow for financial institutions to merge or form holding companies, potentially increasing institutional investors influence, diversity and scale (PricewaterhouseCoopers, 2001). Taiwans domestic based mutual funds industry also is large, although it does not yet actively manage its investments. In 2000, authorities removed the 50 per cent cap on foreigners owning individual listed companies.
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Also, officially approved qualified foreign institutional investors including large banks, insurance companies, securities firms and mutual funds, can undertake portfolio investment (Asia Times, www.atimes.com, 15 December 2000). In 2000, the worlds second largest management company, UBS of Switzerland, acquired a majority stake in a local fund provider. Increasingly, foreign investors discuss corporate governance issues with management (Asian Corporate Governance Forum, 2000). However, individual foreign investors can only invest up to US$5 million in portfolio investment and non-qualifying foreign companies can only invest up to US$50 million (Asia Times, www.atimes.com, 15 December 2000). Hence, Taiwan still has one of the most restricted investment regimes in East Asia. Nevertheless, reflecting recent liberalisation, domestic and foreign institutional investors share in market trading has increased from a low base (Figure 9.3).

ADVISING TAIWANS SMALL INVESTORS

As small investors drive close to 90 per cent of share trading in Taiwan, many new firms are tapping this market, offering investment advice on stocks and corporate company information. For example in 2000, Peter Kurz, formerly head of research at Merrill Lynch in Taipei and well-known for frequent television appearances and his Mandarin and Taiwanese language skills, established www.mrtaiwan.com, catering for both small and institutional investors. The firms 40 employees focus on Taiwans large and liquid share market, especially its retail investors as foreign securities companies are less interested in these shares.
Source: Taipei Times, www.taipeitimes.com, 16 June 2001.

In July 2000, the Civil Servant Pension Fund outsourced NT$15 billion and the Postal Savings Fund outsourced NT$20 billion to nine local fund managers. The Labour Pension Fund will outsource 5 per cent of funds to private asset managers by early 2002 (Taipei Times, www.taipeitimes.com, 15 October 2001). Holding companies now can enjoy tax and other benefits, although authorities will monitor their activities closely (PricewaterhouseCoopers, 2001). In 1999, authorities capped foreign ownership at 50 per cent, up from 30 per cent for all foreign investors and 15 per cent for a single foreign investor.

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Figure 9.3 Institutional Investors More Prominent Share of Trading by Major Group, 1995-2001
100 90 80 70
Per cent

60 50 40 30 20 10 0 1995 1996 1997 1998 Domestic instituitons 1999 2000 2001

Foreign institutions
Source: CEIC, 2002.

Domestic individuals

Bank Restructuring
Ongoing privatisation, increasing foreigners presence and crisis induced restructuring force banks and corporates to compete more for funds. Since 1991, the authorities have licensed domestic private sector banks and privatised government owned banks. However, compared to many other East Asian economies, crisis induced restructuring had a limited impact on traditional bank-client relations. Most Taiwanese conglomerates have maintained their links with group banks, despite public injections into several banks. However, eventual sales of the Governments newly acquired bank equity eventually may weaken links between banks and their business groups owners. More important for bank and corporate behaviour are new reforms limiting bank ownership concentration and related party lending. October 2000 amendments to the Banking Law capped corporate or individual stakes in a bank at 25 per cent. It also limited bank lending to affiliated business groups to 40 per cent of the banks net worth (PricewaterhouseCoopers, 2001).
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However, approved holding companies stakes may exceed this.

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PRODUCT MARKETS
Taiwans many small and medium enterprises already compete vigorously and many export efficiently. Liberalised trade and investment regimes increasingly expose them to global competition, tightening discipline on managers to use investors funds wisely.

Trade Reforms
Over the late 1990s, Taiwans average nominal tariff rate fell from over 10 per cent to around 8 per cent, increasing competition for local corporates (East Asia Analytical Unit, 2000). However, substantial tariffs remain on processed food products, automotive parts and passenger vehicles. Trade licensing and import permit restrictions affect several sectors, including pharmaceuticals and agricultural products like sugar and rice.

Foreign Direct Investment


During the late 1990s, anticipating Taiwans WTO entry the Government relaxed foreign direct investment regulations, including removing restrictions on foreign banks. Authorities now restrict direct investments only in strategic and national interest sectors, including some utilities. In November 2001, Taiwan also lifted a formal 50-year ban on local companies directly investing in China, though in fact local companies had invested on the mainland for many years. Authorities also will simplify procedures for investment projects under US$20 million (South China Morning Post, www.scmp.com, 8 November 2001). With Taiwans WTO entry, several remaining restrictions, including on medical services, should end (Taipei Times, www.taipeitimes.com, 7 November 2001).

REGIONAL COMPETITION SPURS MERGERS

While still uncommon, increasing regional competition recently drove several local companies to merge to boost efficiency and potentially, shareholder profits. In March 2001, two medium sized domestic appliance firms, Teco Electric and Machinery and Samco Corp, announced their merger to better respond to strong competition from Korean and Chinese mainland firms. In the same month, in a US$1 billion deal, United Microelectronics and Acer merged their monitor manufacturing subsidiaries, creating AU Optronics, the worlds second largest flat panel display screen producer. In May 2001, United Microelectronics announced a US$300 million deal merging its four printed circuit board affiliates into Unimicron Technology Corp.
Source: Far East Economic Review, www.feer.com, 16 June 2001.

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Government Ownership and Deregulation


For over five decades, the Government was a major investor in Taiwans financial, heavy industry and infrastructure sectors, but this is changing. Now, except in some banks and utilities and the energy sector, its role in the corporate sector is relatively limited (Far Eastern Economic Review, www.feer.com, 11 February 1999). Authorities continue to privatise government owned enterprises and introduce competition in telecommunications, power generation, oil refining and distribution, however progress has slowed due to stock market weakness and volatility. However, the loss-making China Shipbuilding Corporation remains government owned, and may become Taiwans first bankrupt government owned enterprise (South China Morning Post, www.scmp.com, 7 May 2001).

REGULATIONS STRENGTHENING
Taiwans regulatory framework is mature and broadly enforced. However, the Ministry of Finance is strengthening supervision of accountants and amending the Securities and Futures Investors Protection Act and the Securities and Exchange Law. The Securities and Futures Commission supervises and enforces standards.
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TRANSPARENCY
Listed companies generally disclose more information than non-listed companies, which often lack effective reporting facilities. However, leading local companies increasingly recognise providing sound information attracts lower cost share capital.

Financial Reporting
Corporations follow a disclosure based system of reporting. Annually, bi-annually and quarterly, listed companies publicly release and register their audited and certified financial reports with the Securities and Futures Commission. Annual general meetings approve annual reports. In non-public companies with paid in capital over NT$30 million, an accountant must audit financial statements. Public companies report consolidated accounts and related party transactions (PricewaterhouseCoopers, 2001). Each month, public companies must report to the Securities and Futures Commission changes in shareholdings of people with more than 10 per cent of total shares in a listed company. In August 2000, the commission brought the Rules Governing Information Reporting by Traded Companies more into line with international standards. If a company fails to comply with a reporting standard, it is liable for an administrative fine; providing false information is a criminal act under the Securities Exchange Law (PricewaterhouseCoopers, 2001). Listed company compliance generally exceeds private company compliance.
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Eric Tsai, Carly Johnson, Vicky Chang and Nina Ta, all of Puhua and Associates, correspondent law firm to PricewaterhouseCoopers Taipei, contributed to this section. The Company Law generally governs the corporate reporting duties of non-public companies and the Securities and Exchange Law governs listed companies.

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Accounting Standards
Accounting standards generally follow United States standards, except those for reporting impaired assets and employee benefits other than pensions (Banko, 1999). The Ministry of Finance recognises standards determined by the Accounting Research and Development Foundation, an independent accounting standards board. In 2000, new standards covered disclosure of segment liabilities and cash flow statements. Furthermore, the National Federation of Certified Public Accountants can launch proceedings against accountants failing to comply with standards, improving enforcement (PricewaterhouseCoopers, 2001).

Auditing
Auditing standards also generally follow United States standards. Company law generally requires annual financial statements, and the Securities and Exchange Law further requires audit or certification of financial statements for public companies. Audits must follow the Statement of Auditing Standards and Regulations for Auditing and Certification of Financial Statements by Certified Practising Accountants (PricewaterhouseCoopers, 2001). Two or more certified public accountants must jointly audit and certify a public companys financial reports, upon application and approval from the Securities and Exchange Commission. Since 2000, the Securities and Futures Commission has been able to appoint, where necessary, a certified public accountant or other professional to examine a companys financial condition and related documents (PricewaterhouseCoopers, 2001). In February 2000, authorities increased certified public accountants inspection responsibilities. less concerned.
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Public companies now place more importance on internal audits in

satisfying shareholder concerns at annual general meetings. However, non-listed companies are

MINORITY SHAREHOLDERS RIGHTS


Despite laws granting shareholders various rights, shareholder activism is limited and minority shareholders positions generally are weak.

Listing Rules
Listing rules generally are similar to those elsewhere in East Asia. However, reflecting flagging corporate profits, in 2000, regulators eased registration requirements for listing, reduced over-the-counter stock exchange listing requirements and shortened the review period to increase capital on offer (PricewaterhouseCoopers, 2001).

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Certified public accountants and auditors assistants must pursue further education and strictly comply with professional ethics.

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Under the Securities and Exchange Law, companies violating provisions can face administrative and criminal penalties; the Taiwan Stock Exchange Commission may suspend trading in, or delist, a firms stock in the public interest. In 1999-2000, it delisted several firms, including Hung Fu Construction for not honouring its cheques payable (PricewaterhouseCoopers, 2001).

Representation
Shareholder rights are typical of the region. The chairperson of the board convenes shareholder meetings annually. In the event the chairperson fails to do so, under the Company Law, shareholders with more than 3 per cent of issued shares may request the supervisor to convene a shareholder meeting. One-share one-vote allows a simple majority of votes representing more than 50 per cent of total equity to pass resolutions. With the exception of persons engaged in trust business, shareholders may appoint proxies, although a single shareholder cannot represent more than 3 per cent of the stock. Election, though not removal, of directors is based on a mandatory cumulative voting mechanism (PricewaterhouseCoopers, 2001). Shareholders elect the board of directors and the board appoints at least one non-executive director.
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Shareholders also must appoint a supervisor, who can inspect the companys financial conditions and audit the financial statements the board proposes and submits to the annual meeting (PricewaterhouseCoopers, 2001).

COMPANIES RECOGNISE THE VALUE OF GOOD GOVERNANCE

Anecdotal evidence suggests leading corporations seeking international finance are raising their corporate governance standards. For example, Taiwans largest computer manufacturer and exporter, Acer, appointed a new non-executive board director; it also discloses financial information, the company strategy and new alliances on its Internet site. Listed companies, Giga-Byte Technology and Gordon Auto Body Parts, also have outside directors and outside supervisors. Other companies trying to take the lead in corporate governance include Taiwan Semiconductor Manufacturing and United Microelectronics.
Source: PricewaterhouseCoopers, 2001.

Board Structure and Duties


Company directors and high level managers have a duty of care as good administrators, and shareholders must approve transactions benefiting directors. Although directors do not have to be trained, those in the insurance, securities and trust management sectors need some qualifications (PricewaterhouseCoopers, 2001).

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Directors no longer need to be shareholders of the company.

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If directors breach their duties, the Company Law provides for basic shareholder derivative actions.

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However, the law does not clarify the criteria for the courts to uphold a derivative action, increasing the risk it will fail; this deters shareholder activism. Moreover, recent Company Law amendments do not provide statutory backing to the business judgement rule, a cornerstone of the Australian and US corporate governance systems, which provides statutory backing to the decision-making power of directors of a company (PricewaterhouseCoopers, 2001).

CREDITORS RIGHTS Bankruptcy Laws


Taiwans bankruptcy law is underdeveloped; at present no dedicated court deals with bankruptcy although one is planned (Taipei Times, www.taipeitimes.com, 19 October 2001). Parties seek to avoid face-losing situations, also weakening enforcement. Often, legal counsels assisting in bankruptcy matters lack financial knowledge and experience in preparing restructuring plans, and a single judge can hear more than 100 different cases a month (Taipei Times, www.taipeitimes.com, 19 October 2001). Consequently, voluntary debt restructuring often works better. Several company post crisis reorganisations revealed laws treating secured creditors need strengthening, as some deny creditors enforcement procedures. Consequently, regulators amended the Company Laws reorganisation statutory procedure. This helped the 1999 reorganisation of Tung Lung Metal Industry under a successful insolvency workout (PricewaterhouseCoopers, 2001). Despite this amendment, additional reforms are needed. Courts still take up to 270 days to approve a companys application to reorganise, compared with the international standard of 60 days, and often appoint the insolvent firms manager as its receiver, disadvantaging creditors (Taipei Times, www.taipeitimes.com, 19 October 2001).

Bank Supervision
In the early 1990s, industry deregulation significantly boosted bank numbers, increasing the need for adequate supervision. In particular, many conglomerates used liberalisation to create their own new banks, in some cases compromising lending standards (Smith, 2000). The Central Bank of China, a government owned bank, performs regulatory and central bank functions, auditing banks and financial institutions under the Banking Law. During the crisis, connected lending was behind the collapse of three out of the four financial institutions to fail in 1998 (Smith, 2000). In October 2000, penalties for violating the Banking Law increased with longer prison terms and higher fines (PricewaterhouseCoopers, 2001). In 2001, the Government proposed the Financial Supervisory Board Organisation Law which seeks to create the independent Financial Supervisory Board to execute financial regulatory policy (Taipei Times, www.taipeitimes.com, 27 March 2001). According to the proposal, the new board may order any financial institution to assist in investigating fraud or other criminal activities, imposing fines on financial institutions failing to comply.

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The amended Company Law lowers the threshold shareholding for these actions from 5 to 3 per cent.

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IMPLICATIONS
With a corporate sector dominated by family companies and previously by government owned enterprises, Taiwans corporate governance was not strong. Since the financial crisis, the Government has sought to strengthen corporate governance and related regulations to insulate Taiwan from potential contagion. On-going goods and service trade liberalisation increases pressure on domestic managers. Opening up of the financial and corporate sectors to foreign investors, on-going institutional investment and prudential regulations reforms also should promote more vigorous financial markets which eventually should increase discipline for corporates. Post crisis, authorities also addressed several corporate and bankruptcy law deficiencies, although board independence and minority shareholder protection, especially in family companies are still inadequate. Nevertheless, reforms underway and anticipated should eventually help Taiwan make the transition to a rules based business model.

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REFERENCES
Asian Corporate Governance Association, 2000, Building Stronger Boards and Companies in Asia, June, Hong Kong. Bailey, J., 2000, Economic Analytical Unit interview with Director, Corporate Rating Services, Standard and Poors, Hong Kong. Banko, P., 2001, Taipei Times interview with President of the American Chamber of Commerce in Taipei and Head of the Bank of America, 19 March . Claessens, S., Djankov, S. and Lang, L.H.P., 2000, The Separation of Ownership and Control in East Asian Corporations, Journal of Financial Economics, Vol. 58, No. 1-2, pp. 81-112. East Asia Analytical Unit, 2000, Transforming Thailand: Choices for the New Millennium, Department of Foreign Affairs and Trade, Canberra, June. 1999, Asian Financial Markets: Capitalising on Reform, Department of Foreign Affairs and Trade, Canberra. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. 1999, The role of stock markets in the Asian Pacific region, Asian Pacific Economic Literature, vol.13, No.1, pp. 22-35. OECD, 2000, Summary of Proceedings, from OECD conference, Round Table on Capital Market Reforms in Asia, Tokyo, 11-12 April, www.oecd.org, accessed December 2001. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Smith, H., 2000, The state, banking and corporate relationships in Korea and Taiwan, in Drysdale, P. (ed), Reform and Recovery in East Asia: The Role of the State and Economic Enterprise, Routledge, London.

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KEY POINTS
Hong Kongs regulatory protection for outside investors is amongst the best in the region with well regarded institutions enforcing sound rules governing business activity. The equity market is East Asias largest outside Japan, supporting active equity and bond markets, fully open to foreign investors and securities brokers. However, large family owned conglomerates dominate many sectors, raising concerns about risks to outside investors. Many large companies closely held family ownership limits turnover of listed stocks, weakening discipline on managers. Despite recent strengthening, the structure and independence of publicly listed company boards also are a potential concern; and Hong Kongs Code of Corporate Governance Best Practice is less detailed than some others. Hong Kongs goods and services markets are extremely open to foreign business, providing good discipline on firm management in traded sectors. However, competition policies are needed to allow new players to enter several less competitive non-traded sectors, particularly services.

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Hong Kong arguably leads East Asia in corporate governance standards, sharing the British common law system and offering open and competitive markets for goods and many services (Stannard et al., 2000). Several large blue chip companies set high corporate governance standards and have ready access to international capital markets (Bailey, 2000). Regulators aim to act only as a last resort, with market stakeholders expected to demand high corporate governance standards and discipline corporate activity (Jones, 2000). Nevertheless, family owned companies dominate, ownership is concentrated and relationships remain important, resulting in some corporate governance problems.

CORPORATE SECTOR STRUCTURE


Despite its modern regulatory system and deep markets, Hong Kong, like most other economies in East Asia, carries a legacy of powerful family owned conglomerates, which prefer debt over equity finance. Although the equity market is East Asias largest outside Japan, limited trading of many local stocks and concentrated ownership weakens discipline on corporate managers. While emerging institutional investors should increase shareholder discipline, the large banking sector also is highly concentrated. Hong Kongs extremely open trade and investment regimes mean family businesses confront much stronger competition in goods markets than in some financial and service markets.

Family Ownership High


Family owners dominate Hong Kong corporations. In a sample of 330 companies, individual families controlled 72 per cent of corporations by market capitalisation (Claessens et al., 1999a). Furthermore, in 53 per cent of listed companies, individual families own more than half the stock. Also, the majority shareholder often serves as CEO and family members dominate boards of directors. While some large companies, including Hong Kong Shanghai Banking Corporation, HSBC and Giordano, have dispersed ownership, these are relatively rare. Unlike elsewhere in Asia, family ownership dominates large rather than small and medium sized firms. Only 7 per cent of corporate control rights, weighted by market capitalisation, are widely held, and these mainly focus on smaller companies (Claessens et al., 1999b). Families avoid issuing equity to new investors by raising bank finance, pushing debt to equity ratios in Hong Kong far higher than in the United States and Australia, increasing the risk of insolvency and outside investor risk. In 1996, Hong Kongs average debt to equity ratio was 160 per cent. While this is well above the 110 per cent of the United States, it is still below leveraging levels in most other East Asian economies (Claessens et al., 1999a).

Large Diverse Conglomerates


Family owned firms often form part of large complex business groups, connected by cross shareholding and pyramid structures. This complex mix of listed and unlisted companies can pose risks to minority shareholders (Lang, 2000). As in many parts of Asia, businesses cover several sectors, reflecting family owners preference for maximising market share over profit. Return on assets in Hong Kong corporates traditionally is low (Claessens et al., 1999b).
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MARKET FORCES GENERALLY STRONG


With a highly globalised and competitive economy, market forces reinforce Hong Kongs strong prudential and legal framework, producing a corporate environment more familiar to Australian business.

BANKING SYSTEM
Hong Kongs large and well capitalised banking system is relatively independent of local corporates and generally efficient. However, the banking sector serving the domestic market is highly concentrated. HSBC controls more than 40 per cent of Hong Kong dollar deposits and also owns a majority of the Hang Seng Bank, the third largest bank by deposits. Despite this, both HSBC and Standard Chartered, the second largest bank, are listed on overseas stock exchanges and are widely held. Banks account for about 30 per cent of stock market capitalisation. The Bank of China Group, accounting for another 25 per cent of deposits, is 100 per cent owned by the Chinese Government. As well, several major banks, including Bank of East Asia, CITIC, Ka Wah Bank, Dao Heng Bank and Hang Seng Bank, are listed but less than half the 31 licensed banks are listed on the Hong Kong Stock Exchange. Although most banks are independently owned, large conglomerates own some banks (Asian Corporate Governance Association, 2000). For example, China Resources and the Lippo, part of Li Kai-shings Cheung Kong group jointly own Hong Kong Chinese Bank. However, DBS Group recently acquired Dao Heng Bank, the fourth largest bank, formerly owned by a large family owned conglomerate (Far Eastern Economic Review, www.feer.com, 30 August, 2001; Backman, 1999). Hong Kong is the third largest international banking centre, hosting 76 of the worlds 100 largest banks either as foreign or locally incorporated entities (Deloitte Touche Tohmatsu, 2000). As of June 2000, Hong Kong hosted 31 licensed, listed and unlisted banks. However, the operations of new foreign bank entrants are tightly controlled.
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GIORDANO, A WIDELY HELD FIRM

Giordano is a locally listed firm with wide ownership. The largest shareholder, Harris Associates, owns just under 9.5 per cent of the stock; directors hold less than 1 per cent of the companys total share capital. Among large Hong Kong companies, only Giordano and HSBC feature such dispersed ownership. Giordanos management is highly effective, producing strong profit growth each year since the financial crisis. This may reflect minority shareholder benefits from more dispersed ownership.
Source: South China Morning Post, www.scmp.com, 20 July 2001.

Foreign banks can enter the market by acquiring an existing bank or setting up a branch office as a licensed bank or a restricted licence bank. However, they face considerable restrictions on branching and the number of automatic teller machines they can operate (East Asia Analytical Unit, 1999).

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Direct Finance Markets Deepen


Hong Kongs equity market capitalisation is over three times its GDP, making it one of the deepest in the world. The total number of listed companies rose to 738 in March 2001 from 709 a year earlier and funds raised through equity finance boomed in 2000 (Figure 10.1). With increasing exposure to the stock market, ratings agencies report strong corporate demand for corporate governance ratings to reduce their financing costs (South China Morning Post, www.scmp.com, 2 January 2002). However, market capitalisation is concentrated in few companies, with the largest 50 companies accounting for close to 90 per cent of total market capitalisation as at December 2000. Also, only 10 to 15 per cent of listed stocks trade daily, resulting in only moderate liquidity. Thin trading of family company stocks weakens discipline share price movements impose on managers (Naughton, 2001).

DEMAND STRONG FOR CORPORATE GOVERNANCE SCORE CARD

Ratings agency Standard and Poors reports strong demand for its corporate governance score service in which it provides companies with an independent assessment of their management and transparency. The score covers four main areas of a corporation: ownership structure, board of director composition, shareholder relations and financial disclosure. All else being equal, a family owned company gets a lower score than one widely held. In December 2001, Hong Kong Exchanges and Clearing became the first local company to receive a score, obtaining 8.3 out of a possible 10 and other blue chip companies are showing interest in obtaining a score. Standard and Poors expect strong demand from mainland H shares, SOEs listing in Hong Kong. A company decides whether or not it will disclose its rating to the public, weakening the ratings impact.
Source: South China Morning Post, www.scmp.com, 20 July 2001.

The market also is prone to price movements unrelated to firm performance. Unlike tightly held large firms, smaller listed firms stocks often are volatile, driven by bubbles and price manipulation. Shareholding periods average only four weeks, compared to four months in the UK, suggesting much speculative trading occurs. During the crisis, the Government intervened in the share market to counter speculation against the Hong Kong dollar. Whilst this averted a price slump, it effectively subsidised credit to companies whose stock the Government bought, reducing market discipline on them. Also, insider trading remains a problem despite Securities and Futures Commission efforts to end it; in March 2001, in one example, New World Development allegedly leaked details of its earnings ahead of their publication, disadvantaging other investors (South China Morning Post, www.scmp.com, 31 December 2001).

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Figure 10.1 Equity Financing On The Rise Funds Raised Through Equity Finance, 1990-2000
500

400

HK$ billion

300

200

100

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: CEIC, 2001

Despite these limitations, Hong Kong, with Singapore and Australia, is one of only three regional portfolio investment destinations listed as suitable by the large California based institutional investor, CalPERS (Naughton, 2001). No restrictions exist on foreign investment in domestic firms. Although the numbers of mergers and hostile takeovers are low relative to market size reflecting cultural preferences, Richard Lis Pacific Century Cyberworks acquired Cable and Wireless HKT for US$35.9 billion, the largest acquisition in non-Japan Asia that year.

Growth Enterprise Market


In 2000, the Hong Kong Stock Exchange launched the Growth Enterprise Market to source finance for new technology based start-up firms. Controversy over the subsequent plunge in many dot-com company prices and perceptions tycoons exploited price movements prompted a regulatory review in early 2001 (Stannard et al., 2000). In the best known example, a well known family raised US$800 million from an initial public offer for Tom.com although the company comprised little more than a home page and a weak business model (Hopkinson, 2001). Nevertheless, the Hong Kong Stock Exchange expects the board to improve and encourages private firms to list, hoping it will increase incentives for good governance (PricewaterhouseCoopers, 2001).

Corporate bond market


In 2000, bond market capitalisation reached HK$697 billion (US$89 billion); one quarter of which were corporate bonds. Portfolio investment flows totalled HK$15.4 billion in December 2000, down

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from HK$20.2 billion a year earlier. In 1997, the Hong Kong Stock Exchange launched regional derivative warrants and convertible bonds to stimulate the regional corporate bond market and promote Hong Kong as its hub (East Asia Analytical Unit, 1999).

Institutional Investor Activity


While Hong Kongs institutional investor community is large and vibrant, many domestic securities investors are relatively passive, and inattentive to dividends; however, the recently commenced Mandatory Provident Fund should boost institutional investor presence in the local share market. Some 200 insurance companies are present in Hong Kong, more than any other economy in Asia; 104 of these are foreign owned. In addition, foreign securities firms can enter the market freely, via branching, acquiring operating companies or establishing subsidiaries (Naughton, 2001). However, few shareholders actively scrutinise their investments. Most institutional investors and managed funds invest in the Hang Seng Stock Indexs 33 stocks. Trading by insiders dominates other stock activity, often involving the owner and the company. Fund managers generally are passive about corporate governance standards; most investors vote with their feet rather than their shares (Allen, 2001; Brewer, 1997). Some institutional investors appear more interested in making short term gains than building governance infrastructure (Hopkinson, 2001); an exception is the Templeton Emerging Markets Fund (Allen, 2001).
THE HONG KONG SECURITIES INSTITUTE
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The Hong Kong Securities Institute sets standards for securities market professional conduct. Members must comply with the institutes code of conduct. A disciplinary panel cooperates with other relevant government authorities in investigating alleged professional misconduct. The Hong Kong Securities Institute has assumed responsibility for monitoring behaviour in the securities industry from the Stock Exchange.
Source: PricewaterhouseCoopers, 2001.

EFFECTIVE PRODUCT MARKET COMPETITION


Hong Kongs extremely open international trade and investment regimes, with zero tariffs on manufactured goods and few non-tariff barriers, makes goods markets very competitive. Most sectors allow foreign direct investment, with flows directed mainly into financial services, tourism and infrastructure, including ports; in these sectors, competition is high (Hopkinson, 2001). In 2001, the Heritage Foundation ranked Hong Kong the freest economy in the world, reflecting authorities lack of market interference (South China Morning Post, www.scmp.com, 13 November 2001). However, in several non-traded sectors, including property and banking, local cartels operate creating barriers to entry, discouraging foreign investors and compromising competition (Allen, 2001).
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Six of the worlds top ten insurance companies, by assets, are incorporated in Hong Kong and premium income from insurance services is the fifth highest in East Asia, after Japan, the Republic of Korea, Taiwan and China.

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With markets generally working well, the Government believes competition policy is unnecessary. Antitrust laws do not apply in services, where competition is weaker. The Hong Kong Consumer Council believes the residential property, retail, wholesale, banking, telecommunications and energy sectors need regulating to ensure greater competition (Jones, 2000).

REFORMS BOOST MARKET PRESSURES


Recent reforms gradually should lessen dominant families influence on the share market and permit institutional investors greater scrutiny.

Institutional Investment Boosted


Institutional investors investing funds from the Mandatory Provident Fund should enhance share market liquidity and disperse ownership. The Mandatory Provident Fund schemes allocate 30 per cent of fund managed assets to Hong Kong dollar-denominated securities, developing local bond and share markets. Hong Kong companies must establish defined contribution pension plans or join master trust schemes; employers and employees contribute up to 5 per cent of an employees salary. Employees can choose to place their funds in domestic and global equities, international bonds or money market funds. Contributions commenced on 1 December 2000, and should channel US$3 billion to US$4 billion per year into investment opportunities. Because 30 per cent of funds must be invested in Hong Kong assets, funds will need to scrutinise local companies as potential investment destinations. The Mandatory Provident Fund, like Australias compulsory superannuation scheme, relies on private fund managers who compete to manage assets. By late 2000, about 43 joint alliance and single entity firms had applied to manage Mandatory Provident Fund trusts. Participating institutions must follow a strict code of conduct, ensuring efficient and astute management (Allen, 2000). As institutional investors increase their profile, they increasingly will scrutinise dividends from domestic shareholdings, applying pressure to prevent unwarranted retention of dividends by dominant owners (Wong, 2000).
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Family Ownership to Decline


Sales of government shareholdings acquired during the crisis also should disperse Hong Kongs corporate ownership. These holdings totalled US$25 billion, over one quarter of total share market capitalisation. The public can buy deeply discounted units from this holding; 60 to 70 per cent of investors are new to the market. In 2000, the Hong Kong Investment Funds Association estimated
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The Mandatory Provident Fund, established in 1998, is a compulsory but privately managed pension program covering all Hong Kong workers not otherwise covered, or about two-thirds of the workforce. In August 1998, at the height of speculative attacks against the Hong Kong dollar, the Hong Kong Monetary Authority purchased substantial shares in major listed conglomerates, including Swire Pacific (12.3 per cent), Cheung Kong, (10.3 per cent) and HSBC (9 per cent). Authorities transferred these shareholdings to a new company, the Exchange Investment Fund, alleviating concerns about political interference in corporate operations. Sales are through the Tracker Fund, launched in 1999; with US$3.5 billion in assets, it is Asias largest mutual fund.

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8 per cent of the adult population owned shares, one third more than in 1999. However, this is still well below rates in the United Kingdom with 15 to 20 per cent penetration, the United States, with 40 per cent penetration and Australia (Australian Financial Review, 21 May 2001, p. 9).

REGULATIONS EXCELLENT
Hong Kongs corporate governance framework is, with Singapores, East Asias strongest, and ongoing reforms continue to update and strengthen it. Major statutory elements of the corporate governance framework include the Companies Ordinance, Securities (Disclosure of Interests) Ordinance, Securities (Insider Dealing) Ordinance and Takeover Codes. Non-statutory Listing Rules cover board structure, disclosure of connected transactions and directors remuneration. The Hong Kong Society of Accountants, the Stock Exchange of Hong Kong, the Hong Kong Monetary Authority and the Securities and Futures Commission all enforce this framework (Tsui et al., 2000). Despite recent strengthening, local experts consider listing rules on board meetings and audit committee requirements need tightening (Asian Corporate Governance Association, 2000). Furthermore, Hong Kongs Code of Corporate Governance Best Practice is not as detailed as some others, including Malaysias. Finally, the structure and independence of publicly listed company boards remain weak elements of Hong Kongs corporate governance framework.
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TRANSPARENCY
Disclosure requirements generally are good and are tighter since the financial crisis. Nevertheless, a recent Standard and Poors survey ranked Hong Kong companies disclosure standards behind those of Singapore and Australia; it placed no Hong Kong company in the top quarter of the survey (South China Morning Post, www.scmp.com, 19 November 2001).
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Corporate Reporting
Hong Kongs market regulatory regime is part disclosure and part merit based (Fok, 2000). Public issuers must inform investors and the public about all factors that may affect their interests and all companies, whether listed or not, must submit annual accounts. Additional requirements apply to banks, securities dealers and insurance companies. The Companies Ordinance describes minimum disclosure required in financial statements. Currently main-board companies must report semi-annually; authorities plan to increase this to quarterly (South China Morning Post, www.scmp.com, 22 January 2002). Under the Securities (Disclosure of Interests) Ordinance, directors, chief executives and substantial shareholders must disclose their interest in listed companies to the Hong Kong Stock Exchange.

Simon Copley, Duncan Fitzgerald, Yoko Butt, Belinda Wong and Anna Guthleben, PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section. Standard and Poors surveyed companies annual report disclosure of 98 items covering ownership structure, financial information and board and management structures.

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Shareholders holding in excess of 5 per cent of a listed company must notify the Hong Kong Stock Exchange of any acquisition or disposal of relevant shares. This ordinance also outlines how to report connected transactions. The Registry of Companies acts against companies if they fail to submit annual reports (Jones, 2001).

New Securities Laws


Several recent regulatory reforms support finance market development. These include the new Composite Securities and Futures Bill, which consolidated Hong Kongs securities laws, and demutualised and merged the stock and futures exchanges. Also the Securities and Futures Commission now can investigate extensively companies suspected of wrongdoing, and the Insider Dealing Tribunal can examine price rigging and provision of misleading information (Financial Times, 6 June 2000, p. 12). The Securities and Futures Commission also requires brokers to pass its diploma program (South China Morning Post, www.scmp.com, 16 May 2001). New insider dealing legislation reduces the level of securities ownership to be disclosed from 10 per cent to 5 per cent and covers derivatives (Stannard et al., 2000). Despite these efforts, around 60 per cent of market players do not understand the Securities and Futures Commissions role, although most rank it as one of the best in Asia (South China Morning Post, ww.scmp.com, 19 December).
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Accounting Standards
In many areas, Hong Kong accounting standards are nearly identical to International Accounting Standards. However, there are some differences between the two, with Hong Kong yet to adopt some standards. Since April 2001, companies listed on the Hong Kong Stock Exchange have been able to adopt International Accounting Standards instead of Hong Kong General Accounting and Auditing Principles.
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Overseas incorporated issuers and applicants with a secondary listing can

follow US General Accounting and Auditing Principles. Standards cover related party transactions and consolidated reporting (Tsui et al., 2000). Related party transactions that undermine shareholder value are difficult to detect; consequently, the Hong Kong Stock Exchange is pressuring the Hong Kong Society of Accountants to enforce standards better (Allen, 2001).

The Stock Exchange of Hong Kong and the Hong Kong Futures Exchange fully merged on 6 March 2000, and the Hong Kong Stock Exchange demutualised and listed its shares on 27 June 2000. The Securities and Futures Commission surveyed 345 senior executives at fund management companies, brokerages, law firms, accountants and listed companies. The Companies Ordinance outlines required accounting standards; and the Hong Kong Society of Accountants and the Listing Rules of the Stock Exchange issue interpretations. The Hong Kong Society of Accountants first issues draft updates of standards for comment, then issues the statements. By May 2001, it had issued 26 accounting standards.

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Auditing Standards
Auditing standards are issued by the Hong Kong Society of Accountants; statements on these follow closely the International Standards on Auditing. Auditors report non-compliance to the Hong Kong Stock Exchange, which can inquire into, then delist offenders (Kwong, 2000). Since 1999, listed companies also must establish audit committees, as auditors occasionally miss complex transactions between related parties. In an extreme, albeit rare example, after auditors signed off on Guang Dong Enterprises accounts, they were shown to be fraudulent, so the company directors were prosecuted (Wong, 2001).

MINORITY SHAREHOLDER RIGHTS


A major corporate governance concern is to protect minority shareholders from large family owners. Issues include the frequency of dividend payments, remuneration of directors and access to corporate information (Stannard et al., 2001).

PROPOSED LEVY TO ASSIST MINORITY SHAREHOLDERS

Investment adviser, David Webb, proposed a levy of 0.005 per cent on each securities purchase and 0.01 per cent of each sale to fund a Hong Kong Association of Minority Shareholders. The association would lobby for investors, provide corporate governance rankings for companies and initiate law suits against offenders on its members behalf. Webb also investigates company behaviour, publishing findings on his web site, Website.com. The Government remains open minded about the scheme.
Source: South China Morning Post, www.scmp.com, 13 March 2001,

Listing Rules
Many Hong Kong listed companies are incorporated offshore, limiting the reach of Hong Kongs courts. Hence, listing rules provide an alternative source of corporate governance. The Hong Kong Stock Exchanges Code of Best Practice recommends voluntary guidelines for listing companies, covering frequency and notification of board meetings, disclosure of directors remuneration and conflicts of interest. Under listing rules, an issuing company must demonstrate it meets profit requirements, maintains a stable management, possesses an open market for its securities, meets minimum size requirements and has at least two directors residing in Hong Kong. Listing rules also contain provisions to protect minority investors from abuse and provide checks and balances on directors activities. The Growth Enterprise Markets listing rules are somewhat more stringent than those for the main board, especially relating to the independence of audit committees (Tsui et al., 2000).

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In 2002, authorities proposed sweeping changes to listing rules to bring them into line with international best practice. These include tougher transparency rules and requiring listed companies to appoint different people to the chief executive and board chairman positions (South China Morning Post, www.scmp.com, 22 January 2002).

ASIAN CORPORATE GOVERNANCE ASSOCIATION

In August 1999, business leaders from across East Asia formed the Asian Corporate Governance Association, a non-profit organisation, as a private sector initiative to advocate the commercial and economic value of higher corporate governance standards in East Asia. The organisation conducts original research, disseminates its findings, runs seminars and comments on relevant matters. A founding sponsor, Lombard Asian Private Investment Company (HK), is a private equity fund management company based in Hong Kong and investing in Asia. Lombard values corporate governance highly and actively works to raise standards of transparency and accountability in its investee companies.
Source: Asian Corporate Governance Association, 2000; Allen, 2001.

Representation
Shareholders are reasonably well protected, although some small improvements are needed. Companies must notify all shareholders of upcoming meetings and provide relevant material before the annual general meeting. Shareholders have proportional voting rights and proxy voting. While a simple majority can pass members resolutions, under the Companies Ordinance, 75 per cent of equity holders present must approve certain major decisions. One or more shareholders holding 10 per cent of equity between them can call a general meeting; however, many economies including Taiwan and Republic of Korea have reduced this minimum to a cumulative 5 per cent or less. Furthermore, these meetings must conform to standard company procedures, so controlling shareholders can abort the meeting, blocking minority actions. If shareholders can provide prima facie evidence of wrongdoing, shareholders with 10 per cent of equity between them may ask Hong Kongs Financial Secretary to investigate the company.

Board Structure and Duties


All listed companies must include at least two independent non-executive directors on their boards and disclose directors remuneration in their annual reports. However, directors degree of independence often is questionable (Asian Corporate Governance Association, 2000). Individuals can hold any number of board positions. The voluntary Code of Best Practice urges directors to keep abreast of their responsibilities as directors. In 2001, authorities reviewed fiduciary duty laws, judging them to be acceptable relative to other common law countries (PricewaterhouseCoopers, 2001). However, enforcing directors fiduciary duties

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under the Companies Ordinance is difficult, as few independent directors will take on Hong Kongs powerful tycoons (Wong, 2000). Hence, authorities are reviewing whether they should adopt a statutory Code of Directors Duties (Jones, 2001). Following British tradition, courts do not entertain shareholder action against company management, except in extraordinary circumstances; this weakens remedies available to minority shareholders. However, minority shareholders can access a common law remedy if they can demonstrate their personal rights are being infringed or an act represents fraud against them. Other legal mechanisms overcome this, granting minority shareholders more power than their small shareholding normally allows.
COLLAPSE REVEALS CORPORATE LAW WEAKNESS
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In 1999, Akai Holdings Limited recorded Hong Kongs biggest ever corporate loss, US$1.72 billion and is now bankrupt. Liquidators examining the company books are unravelling a litany of misdeeds, including a directors handing over of a listed group company to another listed company, bad acquisitions, unusual deals and related party transactions. The accounts were falsified or are missing. According to the Law Reform Commissions 1999 report, this case highlighted serious weaknesses in Hong Kong corporate governance enforcement. Few regulatory provisions exist for investigating company collapses, so directors can cheat shareholders and creditors in the expectation of avoiding criminal proceedings. Furthermore, most such court proceedings are secret at present.
Source: South China Morning Post, www.scmp.com, 10 May 2001.

CREDITORS RIGHTS
Creditors rights are generally well protected, encouraging arms length lending, but bankruptcy is rare.

Bankruptcy Proceedings
Hong Kong insolvency laws are based on the British model and essentially are sound. Informal rescue processes support these laws (Harmer et al., 2001). After Law Reform Commission reviews commenced in 1990, the Government strengthened bankruptcy and liquidation law and practice; in the late 1990s, it reviewed and introduced new procedures for bankruptcy, provisional supervision and corporate rescue procedures under the Companies Ordinance (PricewaterhouseCoopers, 2001). However, as in most of East Asia, for cultural reasons, bankruptcy is uncommon; the law, most debtors and local creditors favour informal workouts. Also, directors of bankrupt companies commonly
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These are defined under Section 168A of the Companies Ordinance. A shareholder can petition the court to wind up a company under the Companies Ordinance. However, to grant such a petition, the court must feel it is just and equitable to wind up the company. The Hong Kong Association of Banks Guidelines on Corporate Difficulties also supports informal workouts (PricewaterhouseCoopers, 2001).

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destroy or misplace financial records, hampering investigations. In 2000-01, authorities made 116 convictions related to such offences, although fines averaged less than 1 per cent of the maximum penalty (South China Morning Post, www.scmp.com, 7 January 2002).

Bank Supervision
The well regarded Hong Kong Monetary Authority supervises Hong Kongs strongly capitalised and basically sound banking system. In 2000, the Hong Kong Monetary Authority released new guidelines on complying with supervisory standards; now banks must appoint three independent directors to their boards. Banks must use audit committees, and most now do so, although in some cases their independence is questionable. The authority also tightened rules on connected lending, which cannot exceed 10 per cent of a banks capital base. The Supervisory Department of the Hong Kong Monetary Authority regularly surveys banks compliance with the new guidelines. It now meets at least annually with banks boards of directors and with management, to ensure they meet statutory disclosure, risk management, capital adequacy and provisioning requirements. Prudential supervision tightening is ongoing. The Hong Kong Monetary Authoritys commercial credit reference agency should assist with bank transparency; it intends to vet senior management appointments, and all commercial bank heads of departments, and may further enhance disclosure requirements (Yeung et al., 2001). The Government also is considering establishing a deposit insurance scheme. In 2000, interest rate deregulation increased competitive pressures on the banking sector, resulting in consolidation through mergers. However, restrictions on new banks operations still protect local banks from full market competition.

COMPLIANCE
Hong Kongs strong legal and civil service institutions ensure transparency and close compliance with corporate and financial market laws and prudential regulations. The Hong Kong Monetary Authority effectively supervises banks while the Securities and Futures Commission administers statutory requirements ensuring full disclosure and fair treatment of the investing public. The Commissions disciplinary action ranges from civil and criminal sanctions to the suspension of dealer licences. It refers more serious matters to the Director of Public Prosecutions. In 2000-01, the Securities and Futures Commission concluded 352 investigations, successfully prosecuting four market manipulators and 38 entities for unregistered activities and breaches of investment, and referring four suspected insider dealers to the Financial Secretary. The emerging corporate governance environment also includes public announcements by the stock exchange. The stock exchange publicly censures directors and announces companies delinquent behaviour, allowing market forces to regulate company behaviour (Cheung, 2000). For example, in July 2000 the stock exchange publicly censured Kin Don Holdings Limited for breaching the Listing Agreement

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and Directors Undertakings. It censured four directors; two resigned in September 2000. Following a Stock Exchange Statement, the exchange can delist companies which continue to breach listing rules.

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Independent Commission Against Corruption


Hong Kong has a highly transparent civil service and provides a level playing field in business, due largely to the Independent Commission Against Corruption.
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Established in 1974, well resourced,

and independent of the police and public service, it has spearheaded the battle against corruption. The Commission has focused on changing peoples attitudes towards corruption, tackling investigation, prevention and education. It spends similar time investigating corruption allegations in the private and public sectors and its conviction rate is about 70 per cent (Wong, 2000). By eliminating official corruption, the Commission increased the public sectors capacity to enforce commercial and prudential laws and regulations.

Press
Hong Kong is home to several excellent financial media outlets, including the Asian Wall Street Journal and the Far Eastern Economic Review. While the owner of a large diversified conglomerate controls the well regarded South China Morning Post, the biggest selling English daily, editorial policy has not shifted discernibly since its takeover. For example, recently, it challenged conglomerate behaviour, criticising Li Kai-shings Cheong Kong groups covert purchase at auction of a Kowloon property at a below market price (Far Eastern Economic Review, 6 September 2001, p. 24). However, as in many other East Asian economies, large tycoons control most of Hong Kongs mainstream media, possibly compromising its role as watchdog (Cheung, 2000).

IMPLICATIONS
Hong Kong possesses one of East Asias best corporate governance regimes with its strong and transparent bureaucracy, independent judiciary and mainly open and competitive markets. Hong Kong authorities recognise the fast moving nature of the corporate and financial scene, and their oversight is constantly being refined and updated. However, Hong Kong owned corporates share many characteristics of other East Asian corporates. Large diversified conglomerates with ownership highly concentrated in founding individuals and their families hands dominate the corporate scene. These characteristics can compromise corporate incentives to protect minority shareholder rights, requiring high and continuing vigilance from authorities, and ongoing efforts to maintain regulatory standards and market discipline, so Hong Kong can to retain and build on its hard won reputation.
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In another case, on 20 June 2001, after the Listing Committee and Listing Appeals Committee of the Stock Exchange conducted hearings into the corporate behaviour of Dong Jian Tech.Com Holdings Limited, the exchange issued a public announcement warning shareholders and the investing public to exercise caution in dealing in company securities. It announced that the company failed to float at least 25 per cent of its issued shares, as listing rules require, and to use the proceeds raised from its new issue in accordance with its prospectus or to disclose this fact to the shareholders and investing public. The exchange stated retention of office by relevant directors prejudiced the interests of investors. The company failed to dispatch its annual results and report within five months of the end of the financial year. Directors responsible for the late reports were named in the public censure. Well resourced, with 1 100 staff, the Commission has adopted a zero tolerance policy towards corruption. It has made a major impact in the construction industry.

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REFERENCES
Allen, J., 2001, Economic Analytical Unit interview with Executive Director, Asian Corporate Governance Association, Hong Kong, February. Asian Corporate Governance Association, 2000, Building Stronger Boards and Companies in Asia, Hong Kong, January. Backman, M., 1999, Asian Eclipse, John Wiley & Sons, Singapore. Bailey, J., 2000, Economic Analytical Unit interview with Director, Corporate Rating Services, Standard and Poors, Hong Kong, December. Brewer, J. 1997, The State of Corporate Governance in Hong Kong, Corporate Governance Professional Papers, vol. 5, no. 2, pp. 78-82. CEIC, 2001, CEIC Database, supplied by Econdata, Canberra. Cheung, S., 2000, Economic Analytical Unit interview with Professor (Chair) of Finance, Dept of Economics and Finance, City University of Hong Kong, December. Claessens, S. and Djankov, S., 1999a, Publicly Listed East Asian Corporates: Growth, Financing and Risks, World Bank, Washington, D.C. and Lang, L., 1999b, East Asian Corporates: Growth, Financing and Risks over the Last Decade, World Bank, Washington, D.C. Deloitte Touche Tohmatsu, 2000, IAS PLUS Country Updates: Hong Kong, DTT, Hong Kong. East Asia Analytical Unit, 1999, Asian Financial Markets: Capitalising on Reform, Department of Foreign Affairs and Trade, Canberra. Fok, L., 2000, Economic Analytical Unit interview with Deputy Chief Operating Officer, Hong Kong Exchanges and Clearing Limited, Hong Kong, December. Harmer, R. and Wee. C., 2001, Recent Developments in Insolvency Reform in Asia, Hong Kong, November. Hopkinson, J., 2001, Economic Analytical Unit interview with Principal, KPMG, Hong Kong, February. Jones, G., 2000, Economic Analytical Unit interview with Registrar of Companies, Financial Services Bureau, December, Hong Kong. Kwong, K., 2000, Speech by Chief Executive to the Hong Kong Society of Accountants, 26 October, www.hksa.org.hk, accessed October, 2001. Lang, L., 2000, Economic Analytical Unit interview with Professor of Finance, Department of Finance, The Chinese University of Hong Kong, Hong Kong, December. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August.

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PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Stannard, D. and Grieve, C., 2000, Economic Analytical Unit interview, Securities and Futures Commission, Hong Kong, December. Tsui, J. and Ferdinand, A, 2000, Corporate Governance and Financial Transparencies in the Hong Kong Special Administrative Region of The Peoples Republic of China, Paper presented at the Second Roundtable on Corporate Governance, Hong Kong, May. Wong, T., 2000, Economic Analytical Unit interview with CEO, Hong Kong Securities Institute, Hong Kong, December. Yeung, R. and Chan, A., 2001, Economic Analytical Unit interview with Head and Manager of Banking Policy Department, Hong Kong Monetary Authority, Hong Kong, December.

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KEY POINTS
The financial crisis has breached relationships between many Indonesian corporates and their banks. High levels of non performing loans and banks need to retain capital adequacy and meet new regulatory requirements have prevented most new lending. Many conglomerates assets are owned by the Government and many other Indonesian corporates are trading whilst technically insolvent. The Government now owns the majority of banks, together with a large portfolio of non performing loans. If they proceed with planned public placements of bank and corporate assets and strategic sales to new entrants, including foreigners, the Government will reduce major families dominance of the corporate sector. This should encourage more unrelated transactions, increasing opportunities for an arms length business environment to develop. Many of the laws and regulations supporting a rules based business environment are in place, though accounting standards are still weak. New prudential laws and regulations passed since the crisis eventually should strengthen corporate governance and market development, but are as yet untested. For example, the Government has passed a new bankruptcy law, set up commercial courts and established an informal debt workout process. The Jakarta Stock Exchange has tightened listing rules, especially on disclosure and liquidity. However, generally weak implementation of new laws and regulations undermines their impact. In particular, the court system has yet to implement the new bankruptcy laws. Similarly, accounting and listing rules require better enforcement. Efforts to better enforce the bankruptcy laws would help accelerate the corporate restructuring and economic recovery currently underway. A few successful debt actions through the court system would make a significant contribution to encouraging more reasonable settlements through negotiation. Since the crisis, Indonesia has increased competition in goods and services markets by dismantling monopolies, reducing trade barriers on imports and relaxing foreign investment restrictions; the new Government also plans to privatise state enterprises. Eventually a more competitive economy should increase discipline on corporates.

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Serious structural weaknesses in Indonesias corporate and financial sectors, including close relationships between firms and their banks, low levels of transparency, inadequate prudential enforcement, weak outside shareholder protection and a dysfunctional insolvency regime contributed significantly to Indonesias financial crisis and retarded its recovery (PricewaterhouseCoopers, 2001). After 1997, the Government introduced legal and regulatory reforms to improve corporate and financial system operation. If these are rigorously implemented, eventually bank and corporate restructuring, the entry of new players and the enforcement of new corporate laws will create more competitive markets and better corporate governance in Indonesia, aiding economic recovery.

CORPORATE SECTOR STRUCTURE


Powerful families and the state control most of Indonesias corporate sector (Claessens et al., 1999a). Typically, a few wealthy families own and manage the dominant business groups. These family groups operate across diverse sectors, including banking, and rely on debt to finance their activities (Naughton, 2001). In the past, they used strong political connections to preserve entrenched positions in key markets. Now, many corporates are in government ownership, though some are still operated by their former family owners. Under this business model, minority shareholders, depositors with group banks and small competitors are at risk.

Family Ownership Dominant


In the lead up to the crisis, the top 15 large families controlled 62 per cent of the Indonesian share markets capitalisation (Claessens et al., 1999a). In 67 per cent of cases, owners used pyramid structures to control conglomerates, driving a wedge between voting and cash rights and in over 80 per cent of cases, owners appointed the CEO (Claessens et al., 1999a; Naughton, 2001). Consequently, controlling families could and did expropriate wealth from minority shareholders.

Diverse Conglomerates the Norm


Before the crisis, easy access to finance allowed large conglomerates to grow rapidly, entering many sectors. The top 300 conglomerates owned almost 10 000 business units across all sectors; most were unlisted; together, they accounted for about 13 per cent of GDP (Asian Development Bank, 2001). Firms in non-complementary sectors and complex relationships between listed and unlisted firms in the same group exposed banks and shareholders to considerable risk of loss.

Bank Debt Dominates Financing


Conglomerates often owned a bank that financed most of their needs. All top ten private Indonesian banks had relationships with major business groups, including the largest, Bank Central Asia, owned by the Salim Group (Asian Development Bank, 2001). State owned banks also provided low cost credit to well connected groups. The crisis forced a public bailout of the banking system, raising state ownership from around 33 per cent to close to 50 per cent (Asian Development Bank, 2001). State

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directed and relationship based lending lowered the banking sectors return on assets to well below the corporate sectors average and reduced corporate incentives to use funds efficiently (Asian Development Bank, 2001). Family conglomerates typically have higher debt-to-equity ratios than widely held firms. Conglomerates preference for debt over equity financing and readily available foreign and domestic bank lending raised debt-to-equity ratios in firms with concentrated ownership to 700 per cent by 2000; even in firms with widely dispersed ownership, debt-to-equity reached 350 per cent. High leveraging made investing in and lending to conglomerates, especially family owned ones, highly risky for minority shareholders and banks.
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Most conglomerate owners list only a small share of total equity or do not list at all, to protect controlling relationships; this retards stock market development and the stock markets potential role in disciplining corporates. Company insiders also often hold tightly a large part of listed stock. Of the 11 major East Asian economies, only Vietnams capitalisation is a smaller share of GDP than Indonesias. The crisis further undermined the role of the stock market in corporate financing, sending market capitalisation to 13 per cent of GDP at the end of 1998; despite a rally in 1999 and 2000, it was still under 20 per cent by June 2001 (Figure 11.1).

Figure 11.1 Share Market Little Impact on Corporate Behaviour Stock Market Capitalisation to GDP, 1994-2001
0.50 0.45 0.40 0.35 0.30
Ratio

0.25 0.20 0.15 0.10 0.05 0 Jun 1994 Jun 1995 Jun 1996 Jun 1997 Jun 1998 Jun 1999 Jun 2000 Jun 2001

Source : CEIC, 2002

Loose credit and prudential controls allowed listed companies average debt ratio to rise from 220 per cent in 1992 to above 300 per cent by mid 1997 (Asian Development Bank, 2001).

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Share market liquidity is also low, exceeding only the Philippines in South East Asia (Naughton, 2001). Sales by listed companies are less than 10 per cent of GDP (Asian Development Bank, 2001). Despite a substantial amount of issued public debt, the corporate bond market also is underdeveloped; issues are negligible (Naughton, 2001).

Government Enterprises a Priority


To date, post crisis commitments to privatise the large state owned sector have foundered on concerted vested interest opposition. Although state enterprises generally perform poorly, the state still controls more than 40 per cent of national assets (Jakarta Post, 30 April 2001; Naughton, 2001). Their presence reduces markets competitiveness and undermines corporate governance standards. Under the Soeharto regime, some ministers controlled state enterprises, using them to create business for connected families and cronies; in many respects they acted like family companies (Herwidayatmo, 2001). By 1995, 165 state owned companies operated in most sectors and accounted for around 8 per cent of GDP (Asian Development Bank, 2001). Despite some holding special monopoly rights and ready access to state bank lending, state enterprises have a much lower return on equity than private companies. Many state enterprise loans are non performing. Since 1998, opposition by state enterprise workers, managers, host provincial governments and the national parliament has prevented most planned state enterprise sales (East Asia Analytical Unit, 2000). Despite the current Governments commitment to an ambitious privatisation program, it has not yet made much progress. Some provincial governments are pressuring the central government to get access to state enterprise assets.
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MARKETS PRESSURING RELATIONSHIPS


Importantly, trade and investment liberalisation and dismantling of monopolies increases firms exposure to competition. Also post crisis bank and corporate restructuring eventually may separate banks from related firms, increase corporate exposure to share markets, dilute company ownership concentration and lower small investors risks; however, at present, these forces are facing resistance. Several publicly listed companies, including PT Astra and PT Indosat, plan to adopt higher corporate governance standards to protect new investors and attract new funds. Several major corporates also are seeking international business services assistance to review and upgrade their corporate governance regimes (East Asia Analytical Unit, 2000). As bank sales slow, the risk increases of state determined lending policies producing new non performing loans.
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The majority of those were once private assets nationalised after the crisis. PT Astra is one of Indonesias biggest conglomerates and PT Indosat is a major telecommunications company.

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Banking Reform
Following the crisis, massive state-led bank recapitalisation nationalised over 90 per cent of banks.
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The state plans to sell most of its recently acquired bank equity over the next five years; if this occurs, new private, including foreign, owners should make banks more independent of corporations. Already, the Government has approved a majority share sale in PT Bank Central Asia and it intends to sell PT Bank Niaga in 2002 (Naughton, 2001). However, the sale of Bank Central Asia continues to generate controversy, with parliamentary intervention aborting the initial sales plan; its sale is expected sometime in 2002 (Australian Financial Review, 9 January 2002, p. 16). Analysts and the Indonesian Bank Restructuring Agency are concerned the original owners are seeking to regain control through nominees (Reuters, www.reuters.com, 18 and 20 July 2001). The Government is also concerned; in early 2002, the Minister for State Owned Enterprises, Laksamana Sukardi, stated that the Government would not permit the Salim group to buy back a major share in Bank Central Asia. Complicating the sales process, the Parliament and Government are reluctant to sell assets at what they believe are fire sale prices, increasing market scepticism about the commitment to privatisation. Bank restructuring means many conglomerates no longer own banks. Furthermore, banks are reluctant to lend, as they need to comply with capital adequacy regulations. Major bank losses, non performing loans, restructuring and the weak corporate sector have slowed the resumption of bank lending. Many conglomerates have been forced to consider raising funds through equity or bonds, exposing them to new listing rules.

Finance Markets Developing Slowly


Indonesian financial markets are developing gradually from a low base. Already, the share market may motivate better governance, granting an average equity premium of 27 per cent for firms practising sound corporate governance (Naughton, 2001). Although relatively few companies are listed, the eventual sale of government owned bank and corporate equity will expand the supply of equity, boosting market capitalisation. The number of listed firms on the Jakarta Stock Exchange increased gradually from 122 in 1990 to 291 in 2000. In 2001, around 30 new firms listed, 9 more than in 2000. Market turnover remains well below 1997s peak. Foreign investors total annual trading peaked in 1993 at US$157.5 million or 20.7 per cent of total trading. However, by 2000, it had tumbled to US$9.2 million or 1.3 per cent of the market. The corporate bond market is underdeveloped and reviving only gradually from the crisis. By December 2000, only Rp92 billion (US$9.52 million) worth of convertible bonds were outstanding. A local ratings agency, Pefindo, with close links to Standard and Poors, provides local firm ratings, aiding bond market transparency (Institutional Analysis, 2001). Since the crisis, large government debt issues have provided a benchmark yield curve, but could crowd out private sector borrowing as demand grows for funding.

The Government reduced the number of banks from 240 to around 160. Five state owned banks now hold 33 per cent of deposits. The state owns 95 per cent of private commercial banks; these hold around 65 per cent of deposits.

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Institutional investors are growing gradually from a low base. The Government is committed to developing the pension fund sector; employer managed funds are growing rapidly; and life and non-life insurance activity surged after the crisis. Foreign insurance companies can enter the Indonesian market without restrictions, boosting insurance sector growth (East Asia Analytical Unit, 2000). The 1995 Capital Market Law regulates listed securities and market participants. The legislation defines financial reporting, auditing and disclosure requirements, cross shareholding and insider trading regulation and shareholder standards. Indonesias Capital Market Supervisory Agency, Bapepam, and the Jakarta Stock Exchange gradually are improving their enforcement of this law, exposing non-compliers to tougher penalties and fines (Herwidayatmo, 2001). However, prior to the crisis, enforcement was limited. Delistings for non-compliance remain rare.

Corporate Restructuring
Corporate restructuring eventually should weaken relationships between firms in conglomerates, reducing the dominance of original owners and increasing their exposure to direct financing markets and market regulators. Bank conversion of non performing loans into equity or secured convertible bonds theoretically has transferred ownership from families to the state and banks. Analysts estimate a majority of Indonesias corporate sector is technically insolvent. Most domestic debts are owed to troubled domestic banks and have been transferred to the Government as part of the bank restructuring program (East Asia Analytical Unit, 2000). If sold, this equity should disperse ownership and reduce dominant shareholders power. However, under the Indonesian Bank Restructuring Agencys Master Settlement and Acquisitions Agreement, and many agreed restructuring schemes, original owners can retain operational control and ownership of recapitalised firms (Far Eastern Economic Review, 19 October 2000, p. 43). Furthermore, original owners have illegally tried to use front companies to buy back their assets at low prices, at minority shareholders and taxpayers expense (Patrick, 2001). Such practices create a moral hazard and limit new investors scope to dilute family control. The Government is working hard to avoid these actions succeeding. The bulk of debt workouts being undertaken under the Jakarta Initiative largely favour debt rescheduling agreements over more thoroughgoing management and asset restructuring. Hence, many distressed assets are likely to remain in original owners hands, lessening the long term viability and productivity of these assets, and weakening the potentially positive impact of more thorough restructuring on corporate governance.

PRODUCT MARKETS MORE COMPETITIVE


In the long term, post crisis trade and investment reforms should force conglomerates to adopt international best practice management, technology and corporate governance if they wish to survive international competition and generate high profits. After the onset of the crisis, the Government abolished several private and government monopolies, notably import licensing requirements on

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commodities that the national logistic agency, BULOG, controlled. Now, imports and distribution of wheat, flour, sugar, soy beans and garlic are competitive (East Asia Analytical Unit, 2000). It also abolished monopolies in the car, plywood and clove industries.

Trade Reforms
After the financial crisis began, the Government accelerated trade reform; Indonesias trade regime now is moving towards that of Singapore or Hong Kong in the 1960s and 1970s. By mid 2000, 60 per cent of Indonesian tariff lines had duties of 0 to 5 per cent and over 70 per cent had tariffs of 10 per cent or less. The unweighted average tariff rate is below 9 per cent. The Government also removed many non-tariff barriers on agricultural imports.

Investment Reforms
Indonesias foreign investment regime also is now more open; as economic stability returns, resumed inflows eventually should encourage greater corporate competition. Foreigners now can: own 100 per cent of manufacturing and plantation operations, existing banks and most other financial institutions; operate retail outlets; distribute goods produced locally; and apply to import and distribute other products. Foreign banks can purchase banks or bank equity from the Indonesian Bank Restructuring Agencys sizeable holdings. Foreign investors also can form holding companies to facilitate local business debt restructuring and enter joint ventures for medical services and telecommunications. Only a few sectors restrict foreign investment; foreigners cannot invest in property unrelated to productive investments or own land in Indonesia, although they can take out long term leases. Despite reforms opening most sectors to foreign investment, due to political uncertainty and cautious government asset sales, foreign direct investment flows have been negative since 1997. Net outflows reached US$4 billion in the first half of 2001, compared to net inflows of US$6 billion in 1996 (CEIC, 2002). If the current administration sells state enterprises and nationalised assets and the weak rupiah keeps export oriented and import substitution sectors competitive, foreign investment inflows should recover. This would not only boost growth but corporate governance prospects.

Government Role to Decline


The Minister for State Owned Enterprises, Laksamana Sukardi, has committed to a vigorous program of privatisation. Selling inefficient state firms should boost economic efficiency and competition and benefit consumers. If this succeeds it will make an important contribution to moving to a rules based business environment. In 1999, sales of three state owned enterprises raised US$850 million and in 2000, the part sale of PT Telkom raised a further US$406 million (World Bank, 2001). However, in 2001, the privatisation process stalled. The thwarted sale of Semen Gresik and its subsidiaries, Semen Padang and Semen Tonasa, to Mexican company Cemex, reflected the competing interests opposing privatisation. The only significant privatisation achievement in 2001 was the 11 per cent sale of shares in PT Telkom, which mostly went to institutional investors. In 2002, the Government

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aims to accelerate sales, including majority shares in profitable telco Indosat and pharmaceutical firm Indofarma, and a minority share in property firm Wisma Nusantara (South China Morning Post, www.scmp.com, 15 January 2002).

Competition Policy Reform


In 1999, the Government passed the Prohibition of Monopolistic Practices and Unfair Business Competition Law. Authorities also plan to establish a Fair Competition Commission (Asia Foundation, 1999). However, implementing this legislation is very challenging in the current business and bureaucratic environment.

NEW RULES FOR BUSINESS


Many of the prudential and market reinforcing laws and regulations supporting arms length business dealings are in place and several have been strengthened since the crisis, but their weak implementation undermines their impact on corporate governance and market development. As market discipline increases, firms should be more motivated to adhere to these regulations. However, regulations still do not protect minority shareholders or require directors to meet fiduciary duties. Further, despite reasonably sound laws, weak enforcement still results in regulatory failure. The major challenges are to improve regulatory implementation and strengthen corporate recognition of the need for good corporate governance for firms survival and recovery.
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TRANSPARENCY
Better and more timely information on companies is needed to make arms length investing safe; institutional investors and market analysts rate Indonesias transparency and disclosure as poor and deteriorating. Indonesia is near the bottom of the scale of Transparency Internationals Corruption Perceptions Index, scoring 2.7 out of 10 in 2000 and only 1.9 in 2001 (Naughton, 2001). The Indonesian accounting standards, the Capital Market Supervisory Agency, Bapepam, rules and the stock exchange, regulate corporate disclosure. Since the crisis, most disclosure requirements are tighter and enforcement is improving, although from a low base.
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Corporate Reporting
Since 1999, all companies seeking funds from the public, issuing debt instruments and controlling total or net assets over Rp25 billion must provide annual reports, including audited and annotated financial statements and a company profile. Reports must be available on the Internet and at local registries. Consolidated reporting is mandatory.

Chris Cooper, Dudi Kurniawan and Michelle Narracott, PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section. Bapepam produces a publication Presentation and Disclosure of Financial Statements, a Guideline for Publicly Listed Companies.

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NON-GOVERNMENT CORPORATE GOVERNANCE INITIATIVES

Since the crisis, several public and private initiatives have sought to boost corporate governance standards. In October 1999, the National Committee on Corporate Governance, which included eminent official and private sector representatives, presented the Government with a draft Code for Good Governance to guide corporate governance reforms. The committees recommendations have influenced several new and planned reforms. In June 2001, the National Committee on Corporate Governance set up an Indonesian Institute of Directors and Commissioners to train company directors in good corporate governance. The Corporate Leadership Development Institute also trains directors. State enterprises allocate 5 per cent of their training budget to fund the Institute. The Institute runs workshops and major conferences on corporate governance; a mid 2001 conference had 500 attendees. At present, professionals from companies like PricewaterhouseCoopers give their time voluntarily to speak at these conferences and run training seminars. Indonesias Forum for Corporate Governance initially had five professional associations; this has doubled and includes the Publicly Listed Companies Association, the Indonesian Financial Executives Association, the Indonesian Accountancy Institute and the Transparency Institute of Indonesia. The Forum raises awareness of corporate governance issues among company directors, helps produce position papers for the National Committee on Corporate Governance, provides inputs into the code on corporate governance, runs workshops and conferences, and publishes and distributes corporate governance materials. In cooperation with PricewaterhouseCoopers and the Asian Development Bank, the Forum launched a self-assessment questionnaire for firms regarding their corporate governance standards, available at www.fcgi.or.id. Since August 1998, the Indonesian Society for Transparency has promoted good governance in the public and private sectors, publishing a newsletter and conducting seminars and research led by prominent private and public sector members, including former Ministers (Asian Corporate Governance Association, 2000). These initiatives provide an important positive impetus, but all these bodies recognise the existing corporate culture will be slow to change.
Source: Carmody, 2001; Cooper, 2001; Gunadi, 2001.

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Accounting Standards
The reform program for Indonesian accounting standards started in the early 1990s, but was given a higher priority as a result of the crisis; it aims for the profession to attain IAS implementation within five years. Indonesian law requires all companies, listed and private, to comply with accounting standards issued by Indonesias standard setting body, the Committee on Financial Accounting Standards and endorsed by the Indonesian Accountants Institute. The Financial Accounting Standards Advisory Council, representing regulators, public accounting firms, businesses and state owned enterprises, advises the Accounting Standards Board on which standards should be developed or revised. Listed firms do not have to use international accounting standards, but can employ a mix of international and Indonesian standards. Currently, only about 50 per cent of Indonesian accounting standards refer to international accounting standards with some adjustments for local conditions, laws and regulations. Around a quarter of Indonesian standards are completely local, relating to Indonesian laws or conditions. Since the crisis, accounting standards have improved, due largely to the efforts of the Indonesian Accountancy Institute, the professions supervisory body; however, enforcement remains weak and practices could take five to ten years to improve significantly. Education on accounting standards takes place through the institutes continuing professional education program and its journal, Media Akuntansi (Kurniawan, 2000). The institutes judiciary process seeks to enforce standards. Since 1998, the Indonesian Accountancy Institute has overseen all accountants exams and issued licences. In cases of malpractice, it can withdraw an accountants licence. In the last three years, fewer than ten public accountants have lost their licences, but this is considerably more than before the crisis (Gunadi, 2001). Most major firms only use accountants from the big five accounting firms, which usually have local partners (Gunadi, 2001).
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Auditing
Formal auditing standards are good but not properly enforced. Under the 1995 Corporate Law, independent auditors must audit companies annual accounts. Company shareholders should appoint independent auditors, usually an international audit company. The National Committee on Corporate Governance also recommends the company board of commissioners establish an audit committee, independent of the Board of Directors, with the external auditors solely reporting to the board of commissioners. In mid 2001, the Jakarta Stock Exchange required listed companies to establish audit committees, appoint independent commissioners comprising at least 20 per cent of the board
8

The Accounting Standards Board, created in 1998 to supersede the Indonesian Accounting Standards Committee develops and maintains accounting standards. The Board has formalised processes for identifying and developing accounting standards and makes draft standards available to ensure informed public comment. Indonesian companies have a board of directors consisting mainly of executives and company insiders, and a board of commissioners overseeing the board of directors.

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of commissioners and strengthen the company secretarys function. In 2000, fewer than 25 per cent of Indonesian companies had audit committees (Asian Development Bank, 2001). In 1999, Bank Indonesia also required commercial banks to appoint a compliance director to audit their activities.
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The Indonesian Accountancy Institutes Professional Standards for Public Accountants defines auditing standards based on International Standards of Auditing. Despite this, their implementation has been limited. For instance, during the financial crisis, many auditors failed to warn the public about companies true financial positions. To improve standards, the Indonesian Accountancy Institute conducts reviews of professional conduct through the Judiciary Council for Public Accountants. The institute has prosecuted several auditors for failing to maintain independence and objectivity, observe ethical conduct or provide sufficient working papers to support an audit (Kurniawan, 2000).

MINORITY SHAREHOLDERS RIGHTS


In most Indonesian listed companies, the dominance of large shareholders, typically founding family members, weakens outside shareholders positions and increases their need for protection. Beneficial transactions, expropriation of minority shareholders wealth and asset stripping are commonplace (Patrick, 2001). Addressing these problems is essential to develop equity markets for arms length financing of companies.

Listing Rules
Since the crisis, the Jakarta Stock Exchange has tightened listing rules, especially disclosure and liquidity rules (Jakarta Stock Exchange, 2001). For main board listing, companies need a minimum of 200 shareholders, Rp300 billion in assets and two years of making profits. Development board listing conditions are more lenient (Daniri, 2001).
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If companies fail to comply with listing rules, the exchange now more often publicly exposes and sanctions them. However, analysts believe the Jakarta and Surabaya stock exchanges often defer difficult decisions, especially delisting insolvent or distressed companies; this may hamper corporate governance improvements (Patrick, 2001). Since the crisis, Bapepam also has issued numerous rules and regulations to strengthen corporate governance. Bapepam requires public companies to appoint independent directors and commissioners, and imposes sanctions against related party lending. Enforcement is strengthening slowly but major improvements will take a long time (Herwidayatmo, 2001).
11

Overlapping corporate governance jurisdictions create confusion. For example, an earlier Bapepam regulation says audit committees are voluntary, while in 1999, Bank Indonesia said audit committees are no longer required. To list on the development board, companies need 500 shareholders, Rp10 billion in assets and to have operated profitably for at least the last 6 months (Jakarta Stock Exchange, 2001). In 2000, 21 new companies listed and, in the 6 months to June 2001, ten new companies listed, most on the development board. The exchange recognises that if it had not eased its listing rules virtually no new companies could have listed as virtually no company has been profitable in the last three years (Daniri, 2001). In 2000, the exchange publicly exposed 40 companies compared to six in 1999.

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Representation
The company and capital market laws regulate shareholder meetings, providing most shareholder protection; however, Indonesian minority shareholders are positioned weakly. Corporate law measures to protect minority shareholders include proxy and cumulative voting, the right to call an emergency meeting, mandatory shareholder approval of important transactions and mandatory disclosure of transactions benefiting insiders. Compliance is low, particularly on proxy and cumulative voting (Asian Development Bank, 2001). Under the law, a simple majority vote of shareholders can approve company charter amendments, mergers and acquisitions, and bankruptcy declarations. Mostly this ensures dominant owners views prevail, providing little effective voice for minority shareholders (Asian Development Bank, 2001).

FORMAL SHAREHOLDER PROTECTION GOOD

Indonesian company law formally protects shareholders rights including: access to reliable information free of charge proxy voting, including by mail cumulative voting for directors pre-emptive rights on new share issues one share one vote procedures to call emergency shareholders meetings ability to make proposals at shareholders meetings mandatory shareholders approval of interested transactions and major transactions mandatory disclosure of transactions of significant shareholders, connected interests of non-financial information and inter-company affiliation, such as affiliated lending or guarantees mechanisms for resolving disputes between the company and shareholders severe penalties for insider trading.

However, the Government recognises considerable effort is needed to lift implementation.


Source: PricewaterhouseCoopers, 2001.

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From March 2000, Bapepam required public companies to hold special shareholders meetings to approve all material transactions that could affect the private economic interests or commissions of directors.
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Company management and boards of directors must release information justifying the

transaction, explore alternatives that achieve the same result without a conflict of interest and have an independent expert evaluate the proposal before any meeting. Notwithstanding this provision, controlling shareholder dominance can undermine efforts to improve minority shareholder representation. For example, from 1998 to 2000, shareholders rejected only one management proposal at an annual general meeting (Asian Development Bank, 2001).

Board Structure and Duties


Indonesias two tier board structure, comprising the Board of Directors and the Board of Commissioners essentially requires directors to represent management, and commissioners to oversee and guide board directors to protect the owners interests. However, in general this system does not operate well. Boards of Commissioners usually exert limited control over directors and the roles of the two boards are unclear, impairing decision making and good corporate governance (Asian Development Bank, 2001). The new Corporate Governance code defines board members fiduciary duties and urges them to conduct their roles faithfully and responsibly in the companys interest; they also should disclose all shareholdings (Forum for Corporate Governance in Indonesia, 2000). Board members may be personally liable for the boards actions with the burden of proof on the board member to address any allegation (Kurniawan, 2000). However, directors who fail to meet their fiduciary duties are not subject to any criminal sanctions, weakening the impact of these requirements (Gunadi, 2001). In mid 2000, the Jakarta Stock Exchange required companies to appoint independent commissioners in proportion to the shares owned by non-controlling shareholders, and to a minimum of 20 per cent of board positions. However, of 40 recently surveyed companies, 29 did not have independent commissioners and 30 did not have independent directors (Asian Development Bank, 2001). The Government is trying to improve directors and commissioners credentials, who must now undergo fit and proper tests. In one example, 5 per cent of a companys directors failed this test and had to resign (Kurniawan, 2000).

CREDITORS RIGHTS
Pre-crisis, relationship driven lending and a weak bankruptcy regime resulted in high non performing loan rates. After the financial crisis, the Government raised creditor protection by amending bankruptcy laws, establishing a new Commercial Court and introducing an out-of-court framework for restructuring non performing loans. However, problems with a weak and opaque court system and political resistance to bankrupting well connected debtors thwarts the effectiveness of these new laws.
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Material transactions are acquisitions or disposals of assets, or changes in the line of business, of amounts exceeding 10 per cent of company revenues or 20 per cent of the equity.

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Bankruptcy Laws
Theoretically, the bankruptcy laws provide good protection but failure to implement them undermines incentives for good corporate governance and risk management. The 1998 bankruptcy law allows unsecured creditors to proceed against defaulting debtors in the commercial courts (Asian Development Bank, 2001). The court can declare a firm bankrupt if at least two creditors request it or if default occurs on a single loan. In 2000, the Government also passed the Company Bankruptcy and Debt Restructuring and/or Rehabilitation Act, modelled on US Chapter 11 laws. The Jakarta Initiative complements these legal procedures, providing a voluntary work out facility allowing parties to bypass the courts.
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In 2000, the Government increased sanctions on uncooperative debtors and empowered

the Attorney General to deal directly with cases, improving the incentives for debtor participation (World Bank, 2000). Since the crisis, commercial courts have declared only a handful of companies bankrupt (Asian Development Bank, 2001). Most distressed companies continue to trade while insolvent, weakening protection for creditors (World Bank, 2000; International Monetary Fund, 2000a). The Habibie and Wahid administrations also drew criticism by refinancing and exempting from bankruptcy proceedings some well connected corporates.

Bank Supervision
Strengthening bank supervision is key to restoring depositors confidence in the banking system and increasing market discipline. The 1998 Banking Amendment Law introduced stricter prudential controls on banks and more liberal foreign ownership rules.
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The Indonesian Bank Restructuring Agency

supervises problem banks and requires external audits by international firms.

COMPLIANCE
Throughout Indonesia, weak regulatory institution capacity and the courts impede the potential of new laws to strengthen corporate governance standards. Better enforcement is essential to increase the credibility of regulations and motivate higher corporate governance standards. The Government openly acknowledges the legal systems shortcomings; the judiciarys skills and independence urgently need improving. The Asian Development Bank is assisting the National Corporate Governance Committee in developing a corporate governance legal reform master plan, proposing changes in listing and company laws, minority shareholders rights and directors responsibilities (Carmody, 2001).

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In January 2001, companies with a combined debt over US$17 billion were registered with the Jakarta Initiative program. It also introduced elements of Islamic, syariah, law.

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IMPLICATIONS
Difficulties in fostering arms length financing for firms via the largely dysfunctional banking system and the under developed share and bond markets, failure to enforce bankruptcy laws and unwillingness to thoroughly restructure insolvent corporates retards Indonesias recovery. Since the crisis, the Government has introduced many new laws and regulations, and many committed regulators and non-government organisations have sought to improve corporate governance standards. If these laws are rigorously implemented and responsible agencies adequately resourced, corporate behaviour should improve and levels of economic activity increase.

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REFERENCES
Asia Foundation, 1999, Indonesias Anti-Monopoly Law and its Impact on Small and Medium Enterprises, Jakarta. Asian Development Bank, 2001, Corporate Governance and Financing in East Asia, Volume Two, ADB, Manila, Philippines. Asian Corporate Governance Association, 2000, Building Stronger Boards and Companies in Asia, mimeo, Hong Kong, January. Basisfield, 1999, BA tests Indonesian appetite, www.basisfield.com/bfnews/ infomain.htm, accessed February 2000, Basis Point Publishing Ltd, Hong Kong. Carmody, B., 2001, Economic Analytical Unit interview with Team Leader, Asian Development Bank Corporate Government Reform project, Jakarta, June. Claessens, S. and Djankov, S., 1999a, Who Controls East Asian Corporations and the Implications for Legal Reform, World Bank, Washington. Cooper, C., 2001, Economic Analytical Unit interview with Senior Partner, PricewaterhouseCoopers, Jakarta, June. Daniri, M.A., 2001, Economic Analytical Unit interview with Chairman, Jakarta Stock Exchange, Jakarta, June. East Asia Analytical Unit, 2000, Indonesia: Facing the Challenge, Department of Foreign Affairs and Trade, Canberra. Forum for Corporate Governance in Indonesia, 2000, The Roles of the Board of Commissioners and the Audit Committee in Corporate Governance, Jakarta, June. Gunadi, E. M., 2001, Economic Analytical Unit interview with Acting Chairman, Forum for Corporate Government in Indonesia, Jakarta, June. Herwidayatmo, 2001, Economic Analytical Unit interview with Chairman, Capital Market Supervisory Committee, Bapepam, Jakarta, June. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. International Monetary Fund, 2000, Selected Issues, Jakarta, August. Jakarta Stock Exchange, 2001, Listing Rules, www.jsx.co.id, accessed August. Kurniawan, D. M., 2000, Corporate Governance in Indonesia, Paper presented at Second Asian Roundtable on Corporate Governance, OECD, Singapore, June. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. Patrick, H., 2001, Corporate Governance and the Indonesian Financial System: a Comparative Perspective, Paper prepared for the Columbia University CSIS program, Indonesian Economic Institution Building in a Global Economy, New York. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. World Bank, 2001, Indonesias Road to recovery, http://www.worldbank.org, accessed August. 2000, Accelerating Recovery in Uncertain Times: Brief for the Consultative group on Indonesia, Jakarta, October.
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THAILAND

KEY POINTS
Relationships between many Thai corporates and their banks are strained due to high non performing loans, and banks need to retain capital adequacy and meet new regulatory requirements; hence new lending is limited. The Thai corporate sector is emerging from the crisis dominated somewhat less by family ownership and featuring more government and foreign ownership. After 1997, authorities made significant progress in strengthening the formal business environment, requiring listed firms to establish audit committees, tightening listed firms disclosure and accountancy standards and issuing best practice guidelines on protecting outside investors, audit committee operation, directors performance and shareholder meeting proceedings. In 2000, the Government initiated Committee on Good Corporate Governance Practices recommended non-mandatory guidelines on good corporate governance which the Stock Exchange of Thailand released and endorsed. After the crisis, Thailand increased competition in some goods and services markets, reducing trade barriers on imports and relaxing some foreign investment restrictions, somewhat improving the competitive environment. However, since 2000 this process has slowed and even partially reversed. To strengthen corporate governance, Thailand needs to take its foreign direct investment reforms forward and make clear its intention to expand further recent corporate governance initiatives.

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C O R P O R A T E

A S I A W H AT B U S I N E S S N E E D S T O K N O W

The 1997 financial crisis originated in Thailand, profoundly affecting South East Asias and particularly Thailands corporate environment. First, a high proportion of Thai corporates and financial institutions became insolvent, requiring restructuring and in some cases foreign entry; this undermined some old relationships and exposed more local firms to market forces (East Asia Analytical Unit, 2000). Second, regulators started reviewing and upgrading corporate and prudential regulation supporting transactions between unrelated parties; if this process is continued, eventually it should increase minority shareholder and creditor protection and management accountability. Finally, the crisis markedly raised awareness about corporate governance shortcomings, spawning new non-government organisations promoting corporate governance reform. However, the Government has yet to announce its strategy for policies promoting and extending recent corporate governance initiatives. Despite this, the Thai economys opening to global trade and investment probably is irreversible; eventually this should enforce stronger corporate governance.

CORPORATE SECTOR
Thailands corporate sector is typical of many South East Asian economies, with mainly large and diverse family owned conglomerates, mostly financed by banks that often have close relationships with borrowing firms. The crisis exposed minority shareholders and bank depositors to significant losses; the Government was forced to guarantee bank deposits, at a major cost to taxpayers (East Asia Analytical Unit, 2000). Listed companies performance deteriorated sharply in the lead up to the crisis, with corporate sector returns on equity declining to a low 5 per cent in 1996, compared with an average of 9 per cent in the late 1980s; few have returned to profitability (Asian Development Bank, 2001).

Family Owners Dominate


Rules based models of corporate governance are very difficult to impose when founding families or individuals majority own most listed companies. Large corporates family owners control 52 per cent of Thailands share market capitalisation, with the largest ten families alone controlling half of all corporate assets (Figure 2.6) (Claessens et al., 1999). Thai corporates use pyramid and cross holdings to secure control less than other South East Asian corporates. Instead, many business groups originate from informal alliances among families, with one family often assuming control (Suehiro, 1993). Also some holding companies are unlisted whilst subsidiary or associated entities in the group may be listed. In most cases, family members manage these firms, appointing relatives and friends to boards, ensuring they vote along family lines (Claessens et al., 1999).
1

The 100 or so powerful Thai corporate families which essentially control corporate Thailand include the Sophonpanich family (Bangkok Bank), the Lam Sam family (Thai Farmers Bank), the Techapaiboon family (previous owners of Nakornthon Bank) the Chearavnont family (Chareon Phokaphand conglomerate) and the Chirativat family (The Central department store and a hotel chain).

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T h a i l a n d

Large Diverse Conglomerates


In the search for prestige, growth and profit, family owned conglomerates operate in many sectors, including property, finance, agribusiness and manufacturing, but transparency often is low (Naughton, 2001). Holding companies house the bulk of a typical groups companies, including both listed and non-listed ventures. This mix of ownership makes outside investors vulnerable to losses related to undisclosed related party transactions and poor transparency (Naughton, 2001). These diverse business groups often centre on banks. For example, Thailands largest bank, Bangkok Bank, belongs to a group active in property, infrastructure and rice trading. This bank holds 10 per cent of shares in 30 non-financial companies in sectors including textiles, food trading and chemicals (Backman, 1999). Prior to the crisis, enforcement of connected lending prohibitions was weak, so such related banks often provided finance for conglomerate investments; group ties and close informal relations with borrowers reduced commitment to proper credit assessment processes. Firms within the same group also financially assist each other, providing a buffer for struggling firms and insulating poor managers from market discipline.
2

Debt Financing Dominates


Debt, mostly via bank loans, provides around two thirds of Thai corporate financing needs, with equity providing the remainder (Nikomborirak et al., 1999). With many business groups owning their own banks and finance companies, finance was readily available before the crisis, causing debt-toequity ratios to soar (Figure 2.7) (Alba et al., 1998). Debt financing also allowed family controlled companies to expand without issuing equity to new owners, thereby retaining control and preserving relationships between companies within the conglomerate. Hence, few significant outside shareholders discipline large Thai corporates.
3

Direct Financing Weak


With firms avoiding equity issues and, prior to the crisis, banks offering cheap finance, direct finance markets were small. Family controlled firms often list only to gain tax concessions, with listed companies offering as little as 7 per cent of their total capitalisation to the public. Furthermore, domestic institutional investors hold only 10 per cent of market capitalisation, shielding managers from active investors (Naughton, 2001). Only the stocks of 50 out of 420 listed firms, mainly big banks and a few large corporates, trade actively, reducing liquidity and making portfolio investment risky. The demand side of the market also is weak; only 1 per cent of Thai household savings are invested in stocks and formal pension schemes cover under 15 per cent of Thai employees (Naughton, 2001). Hence, institutional investors play a small role. In many sectors, foreign ownership is restricted to 49 per cent of domestic firms, also reducing demand for Thai shares.

Non-bank financial institutions also feature prominently in these diverse business groups, as bank holdings of non-financial firm equity are unlimited. About half of listed Thai companies have a non-bank financial institution amongst their top five shareholders (Asian Development Bank, 2001). This equity is rarely traded, so group cross-shareholdings weaken corporate discipline. Statistical analysis confirms the link between family ownership and high debt-to-equity ratios (Asian Development Bank, 2001).

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Figure 12.1

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Minority Shareholders out of the Loop

C H A N G I N G

Organisational Chart of a Typical Thai Conglomerate

Foreign Market Government

Domestic Market

C O R P O R A T E

Hedging Forex

Hedging Interest Rate

Contact

Debtholders Big Equity Owners

Help Debt Financing

Small Equity Owners

A S I A

Over-expanding by Debt Financing

Discipline Management
Conglomerate

Monitoring
Non-Finance Issues

W H AT

Domestic CORE Input

Domestic Import

Output

B U S I N E S S

Export

N E E D S

Hedging

M&A, Direct Investment & Project Finance

Hedging

Segment 1

Segment N

T O

Mutual Guarantee of Debt Financing

K N O W

Source: Institutional Analysis, 2001.

T h a i l a n d

Since the financial crisis, Thai stock market performance has been the regions poorest. Market capitalisation fell from US$100 billion in 1996 to US$37 billion in 2001, and closely held shares keep market liquidity low (Naughton, 2001). In 2001, monthly market turnover averaged about 7.5 per cent of market capitalisation (CEIC, 2002). This has limited any expansion of direct financing, and the discipline it can bring to corporate governance, to a few large blue chip firms.

Competition Patchy
Barriers to foreign entry reduce competition in agribusiness, manufacturing and many service sectors, especially real estate and financial and business services. Individual private ownership of companies is extremely high in the property and finance industries, sectors the crisis affected most (Nikomborirak, 2001). Close relationships between large business groups can reduce competition in those markets and excessive expansion by incumbent firms deters new entrants (World Trade Organization, 2000). Benefiting from preferential treatment and restrictions on entry into certain sectors, state enterprises contributed around 20 per cent of GDP in 2000 (Naughton, 2001). Many large state enterprises operate as monopolies; for example, three state owned trading enterprises, the Public Warehouse Organisation, the Liquor Distillery Organisation and the Thailand Tobacco monopoly, have strong market positions. Due to state directed lending and weak risk management strategies, since the crisis, state owned banks have suffered much higher non performing loan ratios than private banks. In 2000, when overall non performing loans averaged about 40 per cent of total loans, state banks non performing loans averaged about 60 per cent and the largest state bank, Krung Thai, still had non performing loans of over 63 per cent in early 2001. Since 2001, the Thai Asset Management Company has purchased many non performing loans, including a large share of state banks loans (East Asia Analytical Unit, 2000; CEIC, 2002).

MARKET PRESSURES BREAKING DOWN RELATIONSHIPS


Despite the Thai corporate sectors serious structural problems, market forces unleashed by the crisis and recent corporate restructuring are undermining some old relationships. If supported by enforced commercial regulations and laws, such forces could eventually provide sufficient discipline to generate a culture of shareholder value and facilitate the growth of a more rules based business environment.

FINANCE MARKETS
While still heavily family owned, since the crisis, the Thai corporate sector has experienced more government and foreign ownership. The Government now owns a large minority of the banking industry. Recent bank sales to foreigners and planned public placements should reduce families former dominance and allow more transactions between hitherto unrelated parties, increasing opportunities for new business entrants. However, earlier Alien Business Act reforms appear under review, possibly hindering foreign investor and professional service suppliers contributing to improved corporate governance standards.
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Finance Sector Restructuring


The 1997 financial crisis forced the Government to take over seven of the major 15 banks, notionally putting most of the banking system in government hands and undermining ties with some former corporate customers (Table 12.1). Subsequently, the Government sold three of these banks to foreigners, two others merged into Krung Thai Bank and two more are preparing for public offers (East Asia Analytical Unit, 2000). Sales of the two nationalised banks, Nakornthon and UOB Radanasin banks, to foreign banks, Standard Chartered Bank and Singapores United Development Bank, and the partial sale of two private banks, Bank of Asia and Thai Danu Bank, also to foreign banks, is boosting competition in the sector.

Ta b l e 1 2 . 1 Bank Ownership Changing Ownership of Major Banks Pre and Post Crisis
Share of bank sector deposits (per cent) Bangkok Bank Thai Farmers Bank Siam Commercial Bank Bank of Ayudhaya Siam City Bank Bangkok Metropolitan Bank 21.5 12.5 12.3 8.5 5.3 4.1 Ownership before crisis Majority family Majority family Controlled by Crown Property Company Majority family Over 20 per cent family owned Majority family owned and related business Ownership after crisis Family 10-15 per cent/ FDI 49 per cent Family 7-8 per cent/ FDI 49 per cent Government owned under Tier 1 Family 35-40 per cent Government owned under Tier 1 Government owned under Tier 1

Source: Khan, 1999.

Opportunity to Reduce Family Ownership


While many family owned corporates are hanging on to non-core assets despite high leveraging and low cash flows, more enlightened entrepreneurs are restoring their companies through restructuring. If the global downturn makes asset sales more widespread, they will reduce corporate ownership concentration and increase competition in key sectors. This trend is already evident; in 1999 foreign banks were among the top five shareholders in banking, finance, securities, energy, telecommunications and electronic sectors (Nikomborirak et al., 1999).

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LEADING TYCOON TAKES PROACTIVE APPROACH

In some cases, family heads have voluntarily restructured their business groups, listed their companies and sought external managers and directors to attract new finance. For example, before the crisis, Dhanin Chearavanonts corporate empire, Charoen Pokphand, typified many Thai family owned businesses, operating in many sectors including food, telecommunications, insurance, retailing, pharmaceuticals and petrochemicals. It was financed by a mix of bank borrowing and equity, but favoured borrowing. Following the crisis, the group shed non-core businesses, including supermarkets, a brewery and a motor cycle manufacturer, and turned down offers to expand into airports, motorways and power plants. The group also became more transparent, by placing the entire conglomerate in a public holding company. Dhanin recognised the business had to deleverage to remain viable, had outgrown his family, and needed new equity owners and capital to thrive.
Source: Economist, 6 June 2001.

In mid 2001, the Government established the Thai Asset Management Corporation to buy a proportion of banks non performing loans. Already, the Government controls a large portfolio of corporate assets through debts owed to state owned and nationalised banks; Thai Asset Management Company purchases will expand this portfolio. The sale of these assets would open significantly the Thai corporate sector to new entrants and boost the equity markets size and liquidity. However, except in the case of severely insolvent companies, the Thai Asset Management Company generally will seek debt and corporate restructuring, rather than precipitate bankruptcy cases (Tumnong, 2001). Many private bank asset management companies also are holding on to assets, generally opting for superficial debt rescheduling rather than more thorough government restructuring, raising concerns about powerful corporates influence on asset disposal outcomes. Many analysts believe strong commitment is needed to avoid lenient debt restructuring, allowing insolvent original owners to retain control of their assets. Instead, the market needs viable enterprises and contestable markets (Markels et al., 2001).
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Non performing loans fell from over 30 per cent to 12 per cent in the 12 months to September 2001 (CEIC, 2001), due mainly to banks transferring non performing loans to their asset management companies. Most of these loans have not been restructured thoroughly and few assets realised, nor are they realisable, so some of this steep fall is cosmetic rather than actual.

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CORPORATE RESTRUCTURING AT THE CROSSROADS

Despite several families making early progress in rationalising their business groups, indecisive outcomes in key bankruptcy cases encouraged others to retain non-core business, maintaining highly leveraged balance sheets. For example, in 1998, Thailands largest industrial conglomerate, Siam Cement, which produces cement, chemicals and electronics, committed to shedding several non-core businesses to reduce its debts from US$5.4 billion. Through 1999, the business sold nearly half the promised assets. Banks previously supplying lending were less willing or able to lend, so the company also raised finance by issuing equity. However, with more court decisions running against creditors after 1999, Siam Cement did not sell any more assets in 2000. Businesses scheduled for sale returned to the companys fold and, by mid 2000, the groups debt-to-equity ratio was once more increasing. Over the first half of 2000, security analysts sold down the companys equity by 20 per cent, anxious about high leveraging and opacity in the firms accounts; this made it difficult to decipher which group businesses owed debts.
Source: Far Eastern Economic Review, 12 June 2000.

Direct Finance Markets Developing


Since the crisis, with banks unable to lend or preferring to hold government bonds, several blue chip Thai corporates have turned to the equity and bond markets (Kawai et al., 1999). Most banks are unlikely to resume past lending levels rapidly, so as the economy recovers, corporates will have a strong incentive to seek direct finance. Outstanding bonds in the corporate bond market almost trebled between 1998 and 2000, exceeding Baht 500 billion (US$11.4) in 2000. Foreign private banks hold about half this corporate debt (Naughton, 2001, CEIC, 2002). Several big companies, including Siam Cement and many banks, successfully issued bonds after the crisis (Sucharitakul, 2001). By contrast, despite a modest rally and several large banks successfully issuing non-voting shares in 1998-99, the share market remained relatively flat after prices collapsed in 1996-97 (Figure 12.2). No new listings occurred in 1999, two in 2000 and three in the six months to June 2001. However, some firms placed equity privately with strategic partners; for example, Society Generale injected capital into Bangkok Bank. Such activity fuelled a boom in new equity raisings in 1998 and 1999, but this was not maintained in 2000 and 2001 (Figure 12.3). In late 2001, strong demand for initial public offerings of INET, Thailands largest internet provider, and Thai Petroleum, both as part of the privatisation program, boosted the share market.
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Government bond issues helped establish a yield curve for pricing corporate bonds, and secondary market liquidity, although small, is increasing steadily (Sucharitakul, 2001).

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Figure 12.2 Share Market Flat Stock Market Capitalisation to GDP, 1994-2001
0.5

0.4

0.3

Ratio
0.2 0.1 0 Mar 94
Source: CEIC, 2002

Mar 95

Mar 96

Mar 97

Mar 98

Mar 99

Mar 00

Mar 01

Figure 12.3 Strategic Placements Succeed till 2000 New Capital Raised through Equity Issues by Listed Companies, 1993-2001
300

250

200

Baht Billion

150

100

50

0 1993
Source: CEIC, 2002

1994

1995

1996

1997

1998

1999

2000

2001

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As the economy recovers, corporate bond and share market growth could encourage better corporate governance, as companies with sound standards can access cheaper capital, and bond and share issuers must meet listing rules and have ratings. The Thai Ratings and Information Services, the first and, until recently, only Thai credit rating service, incorporates some corporate governance indicators in their rating process and publishes corporate governance guidelines. The service now has 45 clients, mainly large companies; 90 per cent of these are issuing debentures (Todhanakasen, 2001).
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Institutional Investors
Institutional investors are important because they allocate funds to firms on commercial grounds, bypassing the traditional firm-bank funding relationship. Thailand has few large institutional investors to develop markets for direct finance and represent minority investors; PTT is an example. A formal pension fund covers only 15 per cent of Thais and only 1.5 per cent of companies operate provident funds providing employee pension benefits (Werner, 2001). However, the largest institutional investor, the Governments Thai Pension Fund, already leads in encouraging better corporate governance. With Baht 140 billion in assets, it plans to invest in blue chip listed companies which meet the Stock Exchange of Thailands corporate governance guidelines (Charuvastr, 2001). The fund also rates companies (Benjapolchai, 2001). While the number of fund managers, provident funds, and private and public service pension schemes is growing, obstacles hamper these funds from investing more in the local share market. First, state pension funds presently can invest a limit of 25 per cent of their funds in shares. Second, government guarantees on bank deposits deter broader savings and community interest in shares. Third, foreign institutional investors face a 50 per cent limit on foreign equity holdings in many sectors.
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PRODUCT MARKET COMPETITION


After the crisis, Thailand increased competition in some goods and services markets, reducing trade barriers on many imports and relaxing some foreign investment restrictions. However, in 2000, this process slowed; Thai trade restrictions remain some of the highest in the region. Hence, more reforms would ensure Thai corporate managers face competitive discipline when investing and producing, especially through privatising state enterprises, dismantling public and government supported private monopolies, easing visa restrictions on foreign professionals and reducing barriers to trade and foreign investment, including in services. This is particularly the case given the added impact from the global economic downturn in 2001/02.

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Fitch-IBA set up a new ratings company in May 2001 (Benjapolchai, 2001). The Government is launching a foreign share market board to attract foreigners into stocks that reach the 50 per cent foreign ownership limit, but shares will not have voting rights (Financial Times, www.globalarchive.ft.com, 16 May 2001).

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Privatisation and Deregulation


Since the crisis, successive administrations have committed to privatising most of the remaining 50 state enterprises (East Asia Analytical Unit, 2000). Widespread privatisation in competitive market environments would boost product and service market contestability, raising incentives for protecting investors (Naughton, 2001). While public sector managers and unions slowed privatisation in 1999 and 2000, the newly elected administration announced in 2001 it would prioritise privatisation, commencing in late 2001 partial sales of Thai Petroleum, PTT and INET (Dow Jones International News, 10 July 2001). State enterprises generally exhibit poor corporate governance standards and political factors can influence their operation. The Government previously attempted to improve their corporate governance by introducing audit committees and considered requiring half the boards members be non-political (Todhanakasen et al., 2001). However, government controlled and supported monopolies still remain in some sectors, reducing competition, and corporatisation and privatisation has faced considerable resistance.

Trade Reforms
Since the mid 1970s, Thailand progressively opened its markets to international trade, but in the late 1990s, reforms slowed. While the simple average tariff rate fell from 44 per cent in 1991 to 17 per cent in 1999, compared to many other emerging East Asian economies, Thailands tariffs remain relatively high for East Asia. In 1999, Thailand and China had the regions highest simple average tariff rates, double Malaysias rate, 60 to 70 per cent higher than Philippine and Indonesian rates, and over triple Australias average rate of 5 per cent (East Asia Analytical Unit, 2000). Moreover, strong support for import substitution amongst senior ministerial and bureaucratic quarters is re-emerging. While at this stage the Government does not have a specific timetable for lowering tariffs over the short to medium term, trade liberalisation achieved to date has produced a steady climb in import penetration (Figure 12.4). Notably, imports jumped suddenly as a share of GDP from 0.46 in 1999 to 0.58 in 2000. While this to some extent reflects the increasing openness of the Thai economy, and should impose more competitive discipline on firms, the boom in export processing zones producing autos in part explains this jump.
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However, because of the large share of duty free imports, Thailands effective tariff rate, measured as the ratio of customs revenue to merchandise imports, was only 3.8 per cent in 1999 (CEIC, 2001; World Trade Organization, 1999). This low rate reflects Thailands complex system of duty exemptions.

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Figure 12.4 Imports Imply Competition Imports as a Share of GDP, 1985-2000


60 55 50 45
Per cent

40 35 30 25 20 1985 1987 1989 1991 1993 1995 1997 1999 2001

Source: CEIC, 2001.

Foreign Direct Investment


Foreign direct investment, FDI, has risen strongly since the crisis as the Government relaxed sectoral and ownership limit controls. In the financial sector, new FDI is increasing risk and prudential management standards, with four of the 13 banks and 27 of the pre-crisis 53 securities companies now wholly or partially foreign owned (McMillan et al., 2001; East Asia Analytical Unit, 2000). The 1999 Alien Business Law review reduced sectors restricting FDI from 63 to 43. Key reforms include allowing 100 per cent foreign ownership of large retail chains with foreign equity over Baht 100 million, banks, finance companies, security houses and manufacturing enterprises outside Bangkok. Nevertheless, in many activities, FDI remains restricted, reducing its potential to boost competition and corporate governance standards.
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Foreign investment is banned in the media, farming, livestock

raising, forestry, fishing and real estate sectors. Cabinet must approve foreign participation in water and air transport, natural resource exploitation, sugar, salt farming and mining, and locals must control a minimum of 40 per cent of any venture in these sectors. Foreigners also must obtain Ministry of Commerce approval before entering many professions, including accounting and law. Recent decisions not to extend visas for professionals may indicate a more restrictive trend.

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An alien company now is defined as any legal entity in which foreigners hold 50 per cent or more of the share value. In banking, foreigners may hold up to 100 per cent of shares in commercial banks for up to ten years before divesting 51 per cent of the stock. For foreign banks, the number of foreign bank branches, use of automatic teller machines and the number of personnel each branch may hire remain restricted.

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FOREIGN RETAIL GIANTS BOOST COMPETITION

The entry of foreign hypermarket operators is increasing retail sector competition. Britains Tesco, Frances Carrefour and Dutch Siam Makro are recent entrants, opening several new stores and pumping millions of dollars into the sector. Many of these foreign retailers favour joint ventures. Casino, a French discounter, has employed a Thai chairman and invested Baht 4 billion opening several new Big C stores selling products that are 95 per cent locally made. Local operators, feeling the threat from foreign competition, have improved their services to Thai consumers. For example, the Mall, a wholly owned Thai retailer, is stepping up its battle against foreign entrants by targeting low income earners. Its strategies include competitive prices and service. Its sales increased 15 per cent in the March quarter 2001 and similar growth was forecast for the second quarter.
Source: Far Eastern Economic Review, 5 June 2001, p. 34.

New Anti-trust Regulations


The Government also reviewed competition policy in 1999, introducing the Business Competition Act; this aims to prevent abuses of market power and ensure new firms can enter most sectors. This law focuses on large firms, prohibiting them from limiting supply and setting unfair prices and outlawing collusion. The Committee on Business Competition must approve all mergers; though this law does not apply to state enterprises. Finally, authorities are dismantling some regulations differentiating firms with foreign participation from local firms.

Exit of Inefficient Firms


High levels of indebtedness and collapsed demand led to the number of insolvent firms and non performing loans skyrocketing immediately after the crisis. New bankruptcy laws passed in 1999 provided a better framework for adjudicating whether a firm should be wound up, and a new commercial court was supposed to expedite hearings. This finally produced a jump in the rate of firm exits in 2000, although lenient debt restructuring deals and debtor oriented decisions on some key cases including the benchmark Thai Petrochemical Industry Case, ensure many marginal firms survive. In 2001, bankruptcies slowed to a trickle (Figure 12.5).

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Figure 12.5 Bankruptcies Slow to a Trickle Capital of Bankrupt Firms, 1996-2001


5 000 4 500 4 000 3 500

Baht million

3 000 2 500 2 000 1 500 1 000 500 0 1996 1997 1998 1999 2000 2001

Source: CEIC, 2002.

NEW RULES FOR DOING BUSINESS


Despite considerable post crisis government efforts to build new institutions, tighten regulations and raise consciousness to establish a more rules based system of doing business, Thailand is still working towards this ideal. Since 1997, authorities have issued best practice guidelines on protecting outside investors, including audit committee operation, directors performance and shareholder meeting proceedings and tightened listed firms disclosure and accountancy standards. Importantly, the Stock Exchange of Thailand established the Committee on Good Corporate Governance Practices which, in 2000, released non-mandatory guidelines on good corporate governance.
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TRANSPARENCY
Before the crisis, outside investors in listed Thai companies had little access to accurate information on majority shareholder activities affecting the firms value. Company directors generally were, and in many cases still are, friends and relatives of company majority shareholders; traditionally, business was based on connections and relationships, so most firm owners and directors came from 300 to 400 elite Thai families. Preference for relationship based business was due to the relatively

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Richard Moore, Gloria Warbanoff, Michelle Narracott and Anna Guthleben, from PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section.

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weak legal and court system, and cultural and historical reasons. Connected deals were a normal part of business life and conflict of interest was a little known concept (Charuvastr, 2001; Chittmittrapap, 2001). However, new government and non-government efforts seek to upgrade transparency for outside investors and depositors.

Financial Reporting
The 1992 Securities and Exchange Act requires companies to submit periodic and non-periodic reports following the Stock Exchange of Thailands Disclosure Manual standards. Firms must disclose and distribute information correctly and quickly to all investors. Listed companies must disclose all relevant information that may affect shareholder rights and investments. Listed company directors must constantly report their holdings and purchases or sales of company securities. Since 1999, directors also must disclose any non-compliance with the Directors Code on Corporate Governance in their companies annual reports. The Stock Exchange of Thailand and Securities and Exchange Commission are enforcing disclosure requirements more strictly, demanding related party transactions, such as real estate sales and mergers and acquisitions, are disclosed fully (McMillan, 2001).

Accounting Standards
Thai accounting standard upgrades commenced in 1997.
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Now, 95 per cent of auditing standards


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and 90 per cent of accounting standards comply with International Standards.

The Stock Exchange

of Thailand and Securities and Exchange Commission enforce standards. The May 2000 Accountancy Law makes company management, not the auditor or accountant, responsible for legal behaviour (Nimsomboon, 2001). Consequently, accounting standards have improved (McMillan, 2001). However, many companies still run multiple sets of books, depending on the audience and poor accounting and auditing continue to undermine the quality of financial reports. A survey of listed companies compliance showed only 25 out of 46 respondents adhered to International Accounting Standards, although a further 19 observed some of these standards (Asian Development Bank, 2001). In traditional Thai corporates, junior staff, including accountants and auditors, often will not challenge their superiors, even when irregularities occur. A proposed Accounting Profession Act should introduce self regulation for the profession, which would accredit accountants. At present, the Institute of Certified Accountants and Auditors of Thailand can issue professional standards but cannot legally enforce them. The Ministry of Commerce dispenses licences to accountants who have a university degree in accountancy, 2 000 hours of practice, and pass five tests (Nimsomboon, 2001).

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National accounting standards are derived from standards the Institute of Chartered Accountants and Auditors issue and the Securities and Exchange Commissions ministerial regulations. Two of the most important ways Thai accounting standards differ from International Accounting Standards are in accounting for employee benefits and revalued assets.

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Auditing
Since July 1999, listed companies have had to establish an audit committee to review company financial reports to ensure they are accurate and provide shareholders sufficient information; they also examine internal financial controls and supervise internal audits. Boards of directors appoint audit committees, which must include at least three independent directors.
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By 2001, 88 per cent of Thailands 380 listed companies had established audit committees; most of the rest were in rehabilitation (Benjapolchai, 2001). While most companies have complied, as audit committees are a new concept, many committees are not yet clear about their role and some still have difficulty asking hard questions of managers (Moore, 2001). Audit committee members are legally liable for their actions, but since none have yet been prosecuted, legal action may not appear a credible threat. Internal and external auditor standards still are relatively weak; improvement is not as great as for accountants. However, local companies increasingly use the big five international accounting companies as auditors. The Securities and Exchange Commission also lists approved auditors, pressuring locals to maintain standards; verified complaints about auditors result in those auditors being struck off. Hence, auditors reputations are becoming more important (McMillan, 2001).

MINORITY SHAREHOLDERS RIGHTS


Thai minority shareholders traditionally are rather passive and their interests often are not a priority for majority shareholders, who mostly are family owners. Majority shareholders can issue warrants to themselves, rather than pay dividends to all shareholders, and many listed companies borrow money and on-lend to unlisted subsidiaries. A Thai company, Alphatex, did this in a Baht 5 billion transaction, which is under investigation (Haines, 2001). However, the Securities and Exchange Commission is seeking to strengthen minority shareholders rights (Sucharitakul, 2001).

Listing Rules
Since the crisis, the Government has tightened listing rules, requiring listed companies to establish audit committees and appoint outside directors to at least one quarter of board positions (or two directors, whichever is greater). However, as initial public offers have dried up since the crisis, the Government passed a new law in mid 2000 weakening listing rules, allowing more companies to list. Now, companies need to have had profits for one year, not three (Charuvastr, 2001); listed companies attract a lower 25 per cent tax rate, not the normal 30 per cent. Despite these relaxed rules, only three companies made new initial public offers in the 12 months to June 2001. The Government also opened a second bourse for small and medium sized enterprises, with an even lower tax rate, but no companies have listed on this yet (Benjapolchai, 2001).

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The Stock Exchange of Thailands Best Practice Guidelines for Audit Committees requires members to meet four times a year, inform board directors of all decisions and report on company activities and any other relevant information. Clear rules also govern the relationship between audit committee members and management and members interests in affiliated companies.

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The Securities and Exchange Commission and Stock Exchange of Thailand are being strengthened, providing more effective monitoring and enforcement of listing standards and other regulations. The increasing amount and frequency of fines reflects this (McMillan, 2001).

Representation
In 1999, to improve representation of shareholders rights, the Stock Exchange of Thailand issued a Code of Practice for listed companies organising and operating shareholders meetings. The Code states that listed companies should provide all relevant information at shareholders meetings and encourage shareholders to comment or object. However, the code is voluntary, minimising its effect to date in protecting minority shareholders. A new company law was intended to increase minority shareholders rights, including lowering the proportion of shareholders who could precipitate a general meeting. The previous government delayed these amendments and the new government has not yet indicated whether it will back them. Although proxy voting is allowed, absent shareholders often are not sufficiently informed of a meetings agenda (Asian Development Bank, 2001).
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Shareholders may call an emergency meeting and must approve

major transactions, although the quorum is set at a high 20 per cent of shareholders. However, minority shareholder approval is not needed to approve connected transactions and issue warrants to majority shareholders; dominant shareholders can use this provision to reduce minority shareholders wealth. On average, only 8 per cent of shareholders attend meetings (Asian Development Bank, 2001).
THAI INSTITUTE OF DIRECTORS PROMOTES BEST PRACTICE

Established in 1999 through Corporate Governance Committee reforms, the Thai Institute of Directors helps implement the Stock Exchange of Thailands 60 dos and donts for listed company directors. The Institute of Directors seeks to upgrade corporate governance standards by providing training and seminars for company directors. Its curriculum is based on an Australian Institute of Company Directors training package; so far, 200 directors from listed and major unlisted companies have studied fiduciary duties and good corporate governance. The institute can train 250 directors per year, but more funding could double or triple this. Its targets are the 3 800 listed company directors, of which it hopes to train 1 300 or so. The institutes course focuses on directors responsibilities and issues raised in financial accounts. Most directors trained to date are from blue chip companies, but some unlisted family companies also have trained directors. Company annual reports show which directors have graduated from the course. The Thai Institute of Directors also has graduated 36 top CEOs and Board Chairmen from its Chairmans class. This one-day course covers conflict of interest, responsibilities of directors, managers and shareholders, disclosure, fiduciary duties and directors legal responsibilities. The Institute also has engaged McKinsey to benchmark firms corporate governance standards.
Source: Charuvastr, 2001.

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An Asian Development Bank survey in 2001 showed 44 out of 46 firms offered proxy voting (Asian Development Bank, 2001).

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The Securities and Exchange Commission sends staff to attend shareholders meetings to help secure fair conduct and shareholders rights; with the Stock Exchange of Thailand, it also may establish a shareholders watchdog group (Sucharitakul, 2001).

Board Structure and Duties


After a 1997 Stock Exchange of Thailand survey indicated most directors knew little about good corporate governance, in 1998, the exchange issued company directors with a company directors manual. This outlined relevant laws, regulations, fiduciary duties and best practice approaches to corporate governance (Benjapolchai, 2001). Subsequent changes to listing rules required outside directors to comprise one quarter of the total board. Of 382 listed companies in 2000, about 60 per cent of boards had two or fewer independent directors, 38 per cent had three to four and 2 per cent had five or more (Charuvastr, 2001). With an average board size of 12 directors, compliance is still reasonably low (Asian Development Bank, 2001). A person can hold unlimited board positions, except in the financial services sector, but can be managing director of only one company.
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Cumulative voting for directors is permitted, and a proposed amendment to the Public Company Act may make it compulsory. Shareholders may dismiss directors through a simple majority vote, although highly concentrated ownership allows dominant family shareholders to carry the vote (Nikomborirak et al., 1999). Legal sanctions apply to a directors failure to perform some but not all fiduciary duties. For example, directors can engage in business activities that may affect the company, with board approval; this could leave minority shareholders vulnerable. Previously, few legal provisions controlled disclosure of related party transactions, although now these are monitored more closely. Still, a majority vote at an annual general meeting can pardon directors for violating fiduciary duties (Asian Development Bank, 2001). Authorities currently are drafting new regulations to address these inadequacies. Under the Best Practice Code, directors must disclose the degree of compliance with the code in company annual reports, but compliance with the code is not compulsory. Shareholders can sue directors for misconduct leading to loss, although fiduciary duty is defined vaguely (Nikomborirak et al., 1999).
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CREDITORS RIGHTS
Despite new laws, and positive early court decisions, in 2001, the courts failed to resolve quickly the steep rise in corporate insolvencies the crisis caused, suggesting inadequacies in creditor rights protection. Consequently, very few foreign banks currently are prepared to lend to Thai corporates, and local bank lending also is declining (CEIC, 2001). Failure to protect creditors rights, enforce reasonable and fair restructuring or secure collateral from severely insolvent companies may create a serious moral hazard and weak credit culture. Analysts believe many non performing loans are strategic (Haines, 2001).

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This is slightly higher for companies in the financial services sector. However, as in most economies, court rulings better clarify this issue.

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Bankruptcy
The financial crisis forced the Government to establish new bankruptcy laws strengthening creditor rights, but their implementation strongly emphasises financially rehabilitating insolvent companies. Insolvent firms have an automatic stay, protecting them from foreclosure for five years while they restructure. In 1999, creditors gained the right to claim repayment for new loans to a debtor business, enabling restructuring firms to gain finance. Shortcomings of the new legislation include adopting a balance sheet rather than a cash-flow test of insolvency, increasing the burden of proving insolvency and debtors leverage. Directors who fail to act when they become aware of insolvency face no personal liability and creditors cannot force a company into bankruptcy or restructuring until it declares itself insolvent (PricewaterhouseCoopers, 2001). The new Bankruptcy Court initially won creditors confidence with landmark rulings against the largest and most notorious Thai corporate debtor, Thai Petrochemical Industry. However, in 2001, the court allowed an appeal against a previous ruling in this case, precipitating a flood of similar appeals, further slowing restructuring (Chittmittrapap, 2001). Most cases can take up to 10 years, so creditors receive little net value from collateral, even if eventually it is realised. The Corporate Debt Restructuring Advisory Committee facilitates formal out-of-court debt workouts to complement court activity.
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This program has restructured about 81 per cent of signatory cases

(Tumnong, 2001). The recently established Thai Asset Management Company is designed to take more non performing loans off banks books and dispose of collateral backing these loans. However, analysts are as yet unclear whether this will expedite or slow the restructuring process. To date restructuring has often entailed only debt rescheduling with long grace periods and lower interest rates; thorough corporate restructuring, imposing write-offs on banks and forcing companies to shed non-core assets is more rare. Hence a significant proportion, up to 20 per cent, of restructured non performing loans already are non performing again. Many banks resist more restructuring, as this avoids admitting greater losses and forcing recapitalisation (Chittmittrapap, 2001; Markels et al., 2001). In the long term, the bankruptcy systems weakness could well undermine Thai credit culture and reduce effective sanctions on corporate managers. This could undermine Thai corporates adopting good risk management and corporate governance standards.

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The court appointed administrator, Australian company Ferrier Hodgson, was also remanded in custody in 2001, raising concerns about legal and police bias. Chaired by the Governor of the Bank of Thailand, the Corporate Debt Restructuring Advisory Committee issued guidelines on restructuring debt and valuing collateral. Its methods follow the London Approach featuring inapplicability of legal court procedures, automatic stays, the appointment of a bank or committee to steer the process and discussion, and new loan extension.

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Bank Supervision
After the crisis, the Bank of Thailand, the Securities and Exchange Commission and the Stock Exchange of Thailand worked to strengthen financial institution prudential control. The Financial Institutions Law modernised prudential supervision of deposit-taking institutions and the Deposit Insurance Law superseded the blanket guarantee of the financial system. The new Central Bank Law enhanced the Bank of Thailands authority and independence, and the Bank of Thailand has increased disclosure and transparency pressure on financial institution CEOs and board members. However, in 2001, the replacement of the Bank of Thailands Governor raised market questions about its independence.

COMPLIANCE
Enforcing a more rules based system of corporate governance will take time. Compliance with many standards, including audit committees and directors duties, requires more technical skill than many corporates presently have. Many directors continue to adopt a tick the box approach to compliance (Moore, 2001). Many directors and audit committee members are unaware of their legal obligations (Charuvastr, 2001). However, training by the Institute of Directors should slowly build directors capacity and awareness of their fiduciary duties, so long as the Government maintains its commitment to stronger corporate governance.

Enforcement
Authorities increasingly enforce new tighter accounting, disclosure and corporate governance requirements, like audit committees, although as yet most companies see this as a burden rather than essential for their businesses (Nikomborirak et al., 1999; Sucharitakul, 2001). Both listed and non-listed companies must conform with Thai Accounting Standards, including for consolidated reporting. If auditors issue a verdict of non-compliance, the Securities and Exchange Commission can reject the companys annual report, fine the company or delist it.
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The May 2000 Accountancy Act provides criminal and civil penalties for directors and managers of companies if they provide false information to auditors and accountants (Nimsomboon, 2001).21 However, very few company or bank directors or executives have been prosecuted, despite the many corporate scandals before and since the crisis. Analysts consider a high profile prosecution is needed to make directors take their responsibilities seriously.22

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In the 12 months to June 2001, the Securities and Exchange Commission sent about ten companies accounts back to them for clarification. If accounts are not corrected satisfactorily in one month, the Stock Exchange of Thailand publicises the case; this happens from time to time (Benjapolchai, 2001). Smaller registered partnerships are exempted from certified public accountant audits, although tax auditors can inspect them, as the Taxation Office believes compliance at this level is a problem. In October 2001, a former CEO of one of the defunct financial institutions was convicted.

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Press
In 2000 and 2001, investigative journalism uncovered several large corporate frauds. For example, Thai journalists uncovered dubious lending by the Bangkok Bank of Commerce, which fell as a result of their investigations (Far Eastern Economic Review, 1 March, 2001). Also, the television show Transparency 360 Degrees provides an excellent forum for raising issues relating to corporate governance. However, large corporates own most of the Thai press, so the press is relatively passive in scrutinising corporate behaviour. As generally, the financial press does not act as a whistleblower on corporate wrong doers, the onus falls on regulators to enforce standards (Sucharitakul, 2001).

IMPLICATIONS
Only since the crisis have most Thai authorities and corporates focused on the need for stronger corporate governance standards. The Securities and Exchange Commission, Stock Exchange of Thailand, Bank of Thailand and Institute of Directors include skilled personnel committed to helping corporates strengthen their compliance. They have made substantial progress in strengthening corporate governance standards, including upgrading financial reporting standards, tightening listing rules and promoting adherence to judiciary duties among company directors. However, the dominance of family owned companies, a shortage of major institutional investors, weaker bankruptcy and corporate restructuring outcomes and delays in proposed new legislation seem set to slow improvements in corporate governance standards. Nevertheless, most market analysts recognise significant progress in these all areas is crucial to the corporate sector restoring business confidence and Thailand resuming strong and sustainable economic growth.

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REFERENCES
Alba, P., Claessens, S. and Djankov, D., 1998, Thailands Corporate Financing and Governance Structures: Impact on Firms Competitiveness, World Bank, Washington, May. Asian Development Bank, 2001, Corporate Governance and Financing in East Asia: Volume Two, Manila, Philippines. Backman, M., 1999, Asian Eclipse, John Wiley & Sons, Singapore. Benjapolchai, P., 2001, Economic Analytical Unit interview with Senior Vice President, Stock Exchange of Thailand, Bangkok, June. CEIC, 2001, CEIC Database, supplied by Econdata, Canberra. Charuvastr, C., 2001, Economic Analytical Unit interview with President, Thai Institute of Directors, Bangkok, June. Chittmittrapap, W., 2001, Economic Analytical Unit interview with Executive Partner, White and Case, law firm, Bangkok, June. Claessens, S. and Djankov, S., 1999, Who Controls East Asian Corporations and the Implications for Legal Reform, World Bank, Washington. East Asia Analytical Unit, 2000, Transforming Thailand Choices for the New Millennium, Department of Foreign Affairs and Trade, Canberra, June. Haines, M., 2001, Economic Analytical Unit interview with Director, Grant Thornton (certified public accountants and business consultants), Bangkok, June. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Kawai, M. and Takayasu, K., 1999, The Economic Crisis and Banking Sector Restructuring in Thailand. Rising to the Challenge in Asia: A Study of Financial Markets: Volume 11, Asian Development Bank, Bangkok. Khan, H., 1999, Corporate Governance of Family Businesses in Asia: Whats Right and Whats Wrong?, ADB Institute Working Paper, Tokyo, August. Markels, M. and Shivakumar, J., 2001, Economic Analytical Unit interview with Senior Financial Sector Specialist and Country Director, World Bank, Bangkok, June. McMillan, R. and Adkins, P., 2001, Economic Analytical Unit interview with CEO and Senior Vice President Investment Banking, Seamico Securities, Bangkok, June. Moore, R., 2001, Economic Analytical Unit interview with Partner, PricewaterhouseCoopers Thailand, Bangkok, June. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August.

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Nikomborirak, D., 2001, Economic Analytical Unit interview with Senior Researcher, Thailand Development Research Institute, Bangkok, June. and Tangkitvanich, S., 1999, Corporate Governance: The Challenge Facing the Thai Economy, Paper presented at conference Corporate Governance in Asia: A Comparative Perspective, OECD, Seoul, March. Nimsomboon, N., 2001, Economic Analytical Unit interview with the President of the Institute of Chartered Accountants and Auditors of Thailand, Bangkok, June PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Shinawatra, T., 2001, Opening Address of the Prime Minister to Asian Development Bank Forum, Bangkok, June. Sucharitakul, R., 2001, Economic Analytical Unit interview with Assistant Director General, Securities and Exchange Commission, Bangkok, June. Suehiro, A., 1993, Family Business Reassessed: Corporate Structure and Late-Starting Industrialization in Thailand, Developing Economies, vol. 31, no. 4, pp. 378-407. Todhanakasen, W., 2001, Economic Analytical Unit interview with President, Thai Ratings and Information Service, Bangkok, June. Tumnong, D., 2001, Economic Analytical Unit interview with Director, Office 5, Corporate Debt Reconstructing Advisory Committee, Bank of Thailand, Bangkok, June. Werner, R. A., 2001, Capital Market in Thailand: Issues and Opportunities, Rising to the Challenge in Asia: A Study of Financial Markets: Volume 11 Thailand, Asian Development Bank, Manila. World Trade Organization, 2000, Trade Policy Review, Geneva.

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MALAYSIA

KEY POINTS
Before the crisis, Malaysian corporate governance standards exceeded practices in most regional economies; Malaysia continues to lead much of the region. The Malaysian Government takes a very proactive role in initiating and financing major private sector corporations, driving industrial development. This may shelter some corporations from market discipline and incentives and in some cases, make regulatory enforcement more difficult. Government support for large corporate players also can discourage small investors and new market entrants. The Government is gradually reducing its role in the corporate sector, especially by re-privatising banks and outsourcing pension fund management, furthering Malaysias progress in moving to a rules and disclosure based system of doing business. The financial crisis also prompted new corporate governance initiatives. Malaysian regulations now rival those of Hong Kong and Singapore; the Government revamped Kuala Lumpur Stock Exchange listing rules, strengthened financial reporting and insider trading laws, and revised the Securities Commission Act. Unlike many other economies in the region, Malaysias banking sector is independent of other business interests; its equity market is well developed; and increasingly active institutional investors force firms to compete for funds. Except in the financial and infrastructure sectors, trade and investment regimes are relatively open, increasing corporate discipline.

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After Singapore, Malaysia leads South East Asia in corporate governance, with excellent regulations, open, flexible markets and an active community of relevant non-government organisations. The financial crisis prompted new corporate governance initiatives and Malaysia now enjoys regulations rivalling those of Hong Kong and Singapore; the Government revamped Kuala Lumpur Stock Exchange Listing Rules, strengthened accounting standards and insider trading laws and revised the Securities Commission Act. Large financial markets promote a dynamic business culture; eventually, this should reduce relationship based lending that produced poor pre-crisis investments. However, the Governments leadership in the corporate sector, both as investor and producer, may weaken the market incentives managers face, reducing investment quality.
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CORPORATE SECTOR STRUCTURE


Unlike many other regional economies, Malaysias independent banking sector and well developed equity market make firms compete for funds. Although families are an important source of ownership, their reliance on pyramid ownership structures to concentrate control is less than elsewhere (Naughton, 2001). Nevertheless, family owned conglomerates built on extensive crossshareholdings, and the Governments large corporate presence, can discourage small investors and new market entrants.

Deep Capital Markets


Malaysias equity markets are more developed than in most other East Asian economies. In 2000, the total market capitalisation of the 809 listed companies equalled 124 per cent of GDP (CEIC, 2002). However, market liquidity is modest, even by regional standards, possibly because families and the state prefer to hold, rather than trade, shares (Claessens et al., 1999). With a relatively large share market, firms rely less on bank lending; at around 1.3, the average debt-to-equity ratio resembles many developed countries ratios (Naughton, 2001). Hence, outside equity owners discipline management more than in most regional economies and investor risks generally are somewhat lower. Despite a thriving government bond market, the Malaysian corporate bond market remains underdeveloped (Naughton, 2001).
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These include the Malaysian Institute of Corporate Governance, the Malaysian Institute of Accountants and the Federation of Public Listed Companies. In April 2001, a survey of East Asian corporate governance, Saints and SinnersWhos Got Religion? scored Malaysia highly on its rules and regulations. In June 2001, a survey of expatriate business people ranked Malaysia first amongst East Asian economies, scoring 3 on a scale of zero to 10, with zero being the best grade (CLSA Emerging Markets, 2001; PricewaterhouseCoopers, 2001). The long term market, excluding bank issues, includes securities ranging from straight bonds to bonds with warrants, convertibles and Islamic bonds.

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Banks Independent of Corporations


Strict central bank rules cover bank ownership, so Malaysias banking sector is relatively independent, with most bank shareholders holding few other interests (Backman, 1999). Furthermore, banks cannot hold controlling shares in other companies or sit on their boards of directors (Institutional Analysis, 2001). Hence, banks generally hold little equity, usually not over 10 per cent, in any one company (Institutional Analysis, 2001). This may reduce firms ability to use bank relationships to obtain finance.
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Family Ownership Significant


Although outside investors are prominent, families still control over 40 per cent of Malaysias publicly listed companies (Claessens et al., 1999). However, the top ten families control only around 25 per cent of market capitalisation, well below that of Thailand, Indonesia and the Philippines. Malaysian family owners commonly appoint relatives to management and use cross-shareholdings to enhance control, making less use of multi-layered pyramid structures and reducing outside investor risk (Claessens et al., 1999).
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Conglomerates Important
Many Malaysian conglomerates have close links with the Government through their national service obligations. These conglomerates can access low cost finance, often through state development bodies and pension funds, have exclusive business relationships with state owned enterprises, SOEs, and enjoy preferential access to major government contracts (Far Eastern Economic Review, www.feer.com, 9 August 2001). However, many conglomerates amassed substantial non performing loans from the financial crisis, often owed to the state. For example, Malaysian Resources now owes loans of Ringgit 600 million to Ringgit 700 million (US$158 million to US$184 million) mainly to the Employees Provident Fund. Following the crisis, government financial assistance to some struggling privately owned conglomerates, including Malaysia Airlines and Renong, highlighted their special position in the corporate sector; the Government has since moved away from this strategy (Far Eastern Economic Review, www.feer.com, 23 August 2001).

Government Role Important


With a significant presence in corporate Malaysia, the Government holds 35 per cent of total market capitalisation, and SOEs produce about 10 per cent of total national output (Claessens et al., 1999).
4

However, exceptions include the Hong Leong and Ban Hin Lee banks, which are part of the large Hong Leong Group conglomerate (Backman, 1999). Commercial banks cannot obtain a share in other commercial banks, but may do so in merchant banks, and vice versa. Investors cannot acquire 5 or more per cent of a bank if they already hold shares in another licensed financial institution (Institutional Analysis, 2001). Most private companies also are family owned. The Government holds at least 10 per cent of the equity in 18 per cent of Malaysian public companies (World Trade Organization, 1999).

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Furthermore, the state invests directly in publicly listed private companies through its investment trust, Khazanah Nasional, various pension funds and the state owned oil company, Petronas.
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Excluding China and Vietnam, after Singapore, Malaysia has the second highest number of government-controlled listed firms of economies surveyed (Claessens et al., 2000). Post-crisis restructuring has given government bodies, including Danaharta and Danamodal, equity in various banks and corporations (Danamodal, 2001; East Asian Analytical Unit, 1999). Government ownership can have negative effects on market disciplines. First, SOEs often must buy from other state firms, regardless of price or quality. Second, in the past, government affiliated business groups readily obtained loans from government-controlled banks (Asian Development Bank, 2001). Third, state ownership protects many SOEs from insolvency, weakening the penalties on managers using funds poorly (World Trade Organization, 2000). Finally, corporate governance, particularly transparency, needs improving in many SOEs. For example, Petronas releases only abbreviated financial reports to the public, although this is regarded as superior to many other SOEs (Far Eastern Economic Review, www.feer.com, 12 August 2001).
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MARKETS CONTINUE TO STRENGTHEN


Since the crisis, capital market reforms, trade and investment liberalisation, and market opening due to bank and corporate restructuring have strengthened incentives for sound corporate behaviour. Market reforms support the Governments goal of moving to disclosure based corporate governance. The Government is reviewing its role in the corporate sector and this may help lower barriers to new market entrants and increase outside investor confidence.

FINANCE MARKETS
The crisis provided an opportunity to further develop financial markets and boost incentives for better corporate behaviour. Sales of government equity in restructured banks, particularly to strategic investors, should improve lending quality and preserve bank independence. Furthermore, sales of substantial government equity in listed companies would increase share market liquidity and turnover, reducing price volatility and investor risk. Finally, the Governments positive steps to gradually privatise government pension funds and outsource their management will help develop institutional investor activism, boosting compliance with new corporate regulations.

Two major funds are the Employees Provident Fund and the public service pension fund Kumpulan Wang Amanah Pencen (Institutional Analysis, 2001). These public procurement requirements extend to 58 statutory bodies and the three largest non-farm public enterprises, Petronas, Tenaga Nasional and Telekom Malaysia Berhad (World Trade Organization, 1999).

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Capital Markets Strengthening


Since the crisis, with Malaysian banks lending capacity weaker, more firms have sought direct financing. In the share and bond markets, new capital market strengthening rules expose companies to stronger corporate governance standards. Given remaining problems in the banking sector, firms increasingly may use equity finance to fund new investment, boosting market size and liquidity. Far reaching banking sector reforms should improve bank lending quality, so well connected businesses will find it more difficult to obtain banking finance, also encouraging them to use the equity market. However, reduced liquidity due to foreign capital flow controls and controversy about the Time.Dot.Com initial public offer in early 2001 probably deterred new issues; in 2000, new floats remained well below pre-crisis levels (Figure 13.1) (Naughton, 2001).
10

Government support for post-crisis financial market restructuring has left state owned Danaharta, established to manage banks bad assets and collateral, holding equity of around Ringgit 11 billion in various listed companies. Sales of this equity, including to new owners, should boost investor participation and share market capitalisation (Danaharta, 2001).
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Figure 13.1 Initial Public Offers Yet to Recover Initial Public Offerings, Ringgit millions, 1990-2000
6 000

5 000

4 000

RM million

3 000

2 000

1 000

0 1990
Source: Naughton, 2001.

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

10

The Time.dot.com initial public offer was 74 per cent undersubscribed, and the share price dropped 40 per cent soon after listing. However, most of the Ringgit 32 billion in assets it has disposed of so far have returned to their original owners.

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Danamodal, established to dispose of bank assets, is selling its equity in banks it acquired in post-crisis bank restructuring. By September 2001, through initial public offers and strategic sales, Danamodal halved its initial investment in banks; now it holds equity in only three banks (Table 13.1).
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These

sales, some to new owners, also bolster banking sector independence from family owned conglomerates. In addition, Bank Negara Malaysia intends to reduce to ten the number of domestically controlled banks, to improve their commercial viability.

Ta b l e 1 3 . 1 State Ownership of Banks Unwinding Danamodals Equity Holdings in Key Banks, Ringgit Million
Original Investment MBF Finance Berhad RHB Bank Berhad Arab-Malaysian Bank Berhad Oriental Bank BSN Commercial Bank Arab-Malaysian Finance Arab-Malaysian Merchant Sabah Bank United Merchant Finance Perdana Merchant Total
Source: Danaharta, 2001.

Investment at 30 September 2001 2 280 1 000 460 0 0 0 0 0 0 0 3 740

2 280 1 500 800 700 420 500 400 140 800 50 7 590

Despite Malaysias deep share market, mergers and acquisitions are rare, removing an important source of corporate discipline. Since the crisis, most new acquisitions have involved government led bank and corporate restructuring rather than hostile takeovers (Naughton, 2001). However, a new takeover code provides minority shareholders an opportunity to consider takeover offers, possibly boosting activity. From 2001, improved regulation of insider trading and market manipulation, requiring directors and CEOs to disclose interests in listed companies securities, also should assist in building market confidence.

Institutional Investors Increasingly Active


More active institutional investors scrutinise firm behaviour, increasing share market effectiveness in disciplining corporates. Large government pension funds invest in companies, then press them to improve their corporate governance standards. The Employees Provident Fund, EPF, manages

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Danamodal agreed to dispose of its holdings, in line with Malaysias WTO commitment to liberalise the banking sector.

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90 per cent of Malaysias pension funds and holds 5 per cent of market capitalisation in almost 70 companies; it leads institutional investor activism (Figure 13.2). The fund is active in company annual general meetings, sometimes imposing better management practices. The EPF holds shares in about 300 companies, with equity of more than 5 per cent in 100 of these. The EPF established a Corporate Surveillance Unit to scrutinise firm behaviour in which it is invested (Bushon, 2002). However, the fund can invest only up to 25 per cent of its assets in equities, limiting its role. Other state run institutional investors lobby for better corporate governance. These include Permodalan Nasional Bhd, which holds considerable stakes in listed companies for the bumiputera, indigenous Malays, the Ministry of Finance, Khazanah Holdings and Danaharta.
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When it rehabilitates indebted

firms, Danaharta replaces their board and management with special administrators (Shimomoto, 1999). Furthermore, large pension funds formed a minority shareholders watchdog group, providing institutional investors with research and direction on governance issues. The group, led by the Employees Provident Fund and involving all Malaysias main unit trust and superannuation organisations, has approached several major companies, including Malaysia Airlines, and in some cases, improved management practices (Institutional Analysis, 2001).
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Figure 13.2 Employee Provident Funds Increasing EPF Funds under Management, Ringgit billions
180

160

140

RM billion

120

100

80

60

1995

1996

1997

1998

1999

2000

Source: CEIC, 2002.

13

Bumiputera is also the broad term for Malaysias indigenous people. Government plans to allocate 30 per cent of corporate ownership to the bumiputera by 1990 largely succeeded, although the crisis partially unwound this. Bumiputera now hold around 20 per cent of corporate assets, but critics argue a handful of families own these. The Ministry of Finance agreed to this group in June 2000. Participating funds include EPF, PNB, LTAT, LUTH and PERKESO.

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Over time, as large state owned institutional investors are privatised, a more independent institutional investor community may focus on investor returns. Until then, private institutional investors probably will remain weak, with 34 companies managing less than 8 per cent of market capitalisation in 2001, well below Singaporean, Japanese and US private participation levels of 20 to 40 per cent (Far Eastern Economic Review, www.feer.com, 1 March 2001). Encouragingly, from 2003, authorities will allow foreign equity participation in domestic stockbroking companies beyond 49 per cent, possibly boosting funds management (Far Eastern Economic Review, www.feer.com, 1 March 2001).
CAPITAL MARKET MASTERPLAN

In 2001, authorities released its Capital Market Masterplan to develop comprehensively Malaysias capital markets, under the auspices of the Securities Commission. The plan sequences further market liberalisation and identifies Malaysias potential as a regional financial centre. Its implementation over ten years should: promote an effective investment management industry and a more conducive environment for investors enhance the competitive position and efficiency of market institutions develop a strong and competitive environment for intermediation services ensure a stronger and more facilitative regulatory regime establish Malaysia as an international Islamic capital market centre liberalise the foreign shareholding limit in stages from 2003.

Authorities also released their Financial Sector Masterplan to prepare domestic financial institutions for financial services sector liberalisation and a Code of Conduct for Market Institutions to introduce best practice in corporate governance and accountability.
Source: Institutional Analysis, 2001.

Conglomerates under Pressure


The Governments Corporate Debt Restructuring Committee, CDRC presses large conglomerates to reduce debt and sell non-core businesses; already it is restructuring Malaysian Resources, United Engineers and Renong. This may boost equity issues and financial market development. Although these conglomerates received some public capital injections during restructuring, shareholders and creditors also incurred major losses, reducing the potential for moral hazard.
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For example, the

Government purchased shares in Renong at a price lower than expected, alleviating concerns of a

15

In August 2001, the CDRC announced new guidelines to accelerate the restructuring of Ringgit 29 billion in debts 32 firms owe, stressing management overhauls and operation rationalisation (Far Eastern Economic Review, www.feer.com, 23 August 2001). Moral hazard refers to a situation where efforts to protect a firm or individual from the consequences of their actions weakens their incentive for cautious behaviour in future.

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bailout (Far Eastern Economic Review, www.feer.com, 18 October 2001). Selling this equity should disperse ownership and increase share market size and liquidity. In addition, the committee replaces family management with private sector professionals, improving corporate behaviour; for example, Malaysian Resources controlling shareholder had to resign as CEO. In Malaysia Airlines, the original owners lost their assets, diluting market concentration and the influence of major family interests (Far Eastern Economic Review, www.feer.com, 23 August 2001). Many conglomerates also had to sell non-core businesses; for example, Renong expects to retain only its core businesses, including infrastructure activities, and sell the remainder on the share market (Far Eastern Economic Review, www.feer.com, 18 October 2001). Corporate bankruptcy escalated after the financial crisis, presumably increasing discipline on remaining firms (Figure 13.3). Nevertheless, government equity injections forestalling bankruptcy may reduce incentives for corporates to restructure or liquidate and more efficiently use invested funds.

Figure 13.3 Threat of Bankruptcy Increases Firm Discipline Number of Malaysian Corporations Declaring Bankruptcy
7 000

6 000

5 000

Number

4 000

3 000

2 000

1 000

0 1995
Source: CEIC, 2002.

1996

1997

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June 2001

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PRODUCT MARKETS MORE COMPETITIVE


Malaysias long history of relatively open trade, and to a lesser extent, investment regimes exposes firms in most sectors to global market discipline; the Government also is gradually privatising state owned firms. Nevertheless, in some markets, regulations prevent new local entrants and in several sectors, foreign investment restrictions limit participation. Furthermore, to boost competition, especially in protected services sectors, comprehensive anti-monopoly laws would be beneficial.

Privatisation and Deregulation


While SOE privatisation has slowed in recent years, the Government gradually is selling off substantial SOEs (Naughton, 2001).
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Investment in public non-farm enterprises fell from an average of almost

18 per cent of gross domestic product in the early 1990s to 11.5 per cent in the late 1990s (World Trade Organization, 1999). The Government also is easing barriers to firms entering many previously reserved public sector areas, boosting competition.
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Foreigners often invest in privatisations, despite the 25 per cent ceiling

on their ownership of former SOEs (World Trade Organization, 1999). Records indicate foreigners invested in five of the 15 companies sold between 1993 and 1997 for which records are available, although generally, they acquired well below 10 per cent of stock. The Government also is improving SOE corporate governance standards by separating the CEO and chairman positions, including in Telekom and Tenaga (Hadzar, 2000). The Ministry of Finance also encourages board members to undertake regular training.

Trade Reforms
During the last decade, Malaysian trade has opened with its average applied most favoured nation tariff rate falling from 15.2 per cent in 1993 to 9.7 per cent in 1999. In 1993, only 13 per cent of all items attracted zero tariffs; now more than 50 per cent do (World Trade Organization, 1999).
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Import

licensing affects under 25 per cent of tariff lines, and authorities generally grant licences within three days. The only remaining state trading enterprise, BERNAS, procures, mills and trades rice; however, over the next few years, authorities plan to phase out its role. While local content requirements outside the auto industry do not exist formally, manufacturers using local inputs can receive government investment incentives.
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Privatisation proceeds reached US$2.5 billion in 1995, but dwindled to US$130 million by 1999. For example, under the 1994 National Telecommunications Policy, the Malaysian Telecommunications Department should encourage competition and ensure orderly and efficient development of the telecoms industry. In the transport sector, all airports are scheduled for privatisation, although foreign ownership of airlines is restricted to 30 per cent. Malaysia ratified WTO Agreements on 6 September 1994, and was a founding WTO member in 1995. The Government also promotes locally produced goods and service inputs through the Industrial Linkage Program which supports small and medium enterprises.

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Investment Reforms
Although foreign ownership caps are common, in recent decades, relatively open foreign direct investment has boosted Malaysias industrial growth. All manufacturing sectors are open to FDI, but caps depend on the firms export output, regional location and technological sophistication of the sector in which it operates. For example, full foreign ownership occurs in totally export-oriented and high technology manufacturing, such as in the Multimedia Super Corridor, and in mining. However, all investments must comply with national and social objectives (World Trade Organization, 1999).
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Foreign investors in the services sector require a licence and investment limits vary by sector, but generally investment is capped at 30 per cent. The Government offers foreign investors considerable incentives, including lower direct and indirect tax rates and government sponsored loans. Foreigners may hold only up to 30 per cent equity in banks. (World Trade Organization, 1999).
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However, the insurance sector is open

to foreigners, with six foreign firms accounting for around 55 per cent of all life premium business

Competition Policy
Although no comprehensive competition law exists, in some key sectors, regulations attempt to control prices in uncompetitive markets. For example, price controls on refined sugar, wheat flour, rice, bread, chicken, petroleum and some cement products inhibit large producers exploiting their dominant market position. Nevertheless, cartels are not formally monitored (World Trade Organization, 1999).

REGULATIONS GOOD AND IMPROVING


Malaysia was well advanced in upgrading its corporate regulatory environment when the crisis hit. In the 1980s, authorities required listed companies to appoint independent directors to their boards and establish audit committees. In 1996, Malaysia committed to move from a merit based to a disclosure based regulatory regime for listed companies. (PricewaterhouseCoopers, 2001).
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Since the crisis, key reforms include incorporating

the Code of Corporate Governance into listing rules, and improving overall compliance

20

Companies must apply for a manufacturing licence unless the investment is less than Ringgit 2.5 million or employs fewer than 75 full time workers. Foreign banks seeking to acquire more than 5 per cent of a Malaysian bank must contribute to Malaysias financial and economic development, and the country of origin must have significant trade and investment interests in Malaysia. Gary Yk Lee, DatoJahan Raslan, Raymond Corray, Edward Chien and Anna Guthleben, PricewaterhouseCoopers and Pricewaterhouse Coopers Legal, contributed to this section. A merit based disclosure system allows authorities to regulate securities offerings by assessing the investment merits and pricing of the offering.

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TRANSPARENCY
Since the crisis, authorities introduced several measures, building on an already sound corporate reporting framework. These include strengthening accounting standards, enhancing disclosure of related party transactions and beneficial ownership of shares, and refining the role of the audit committee (PricewaterhouseCoopers, 2001).

Corporate Reporting
In 1996, authorities began moving to a disclosure-based system of regulation for all firms offering securities to the public. In 1997, the Government established the Financial Reporting Foundation with regulatory, corporation and accounting profession representatives, to oversee corporate reporting standards (PricewaterhouseCoopers, 2001). In 1998, the amended Securities Industry Central Depositories Act required beneficial owners of securities to declare their status.
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In 1999, amended

listing rules required quarterly reporting of financial information. Also, annual reports to shareholders must include the directors report, income statement, balance sheet, cash flow statement and detail equity changes. Companies must report shareholder approval of all related party transactions to the Kuala Lumpur Stock Exchange, KLSE.
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In July 2000, new laws imposed stringent disclosure standards for prospectuses and heavy sanctions for false or misleading statements or material omission. However, these are the only statutory provisions against poor disclosure, weakening adherence (International Monetary Fund, 2000).

Accounting Standards
Malaysian accounting standards are among the highest in East Asia, and some exceed US standards. (See Figure 3.1.) Once the Malaysian Accounting Standards Board, MASB, approves them, Malaysian accounting standards automatically become law, unlike in many other economies (Zain, 2000). The MASB reviews international standards to ensure they suit local conditions, modifying them if necessary.
27

KLSE listing requirements also have been refined to ensure listed companies prepare

their annual audited accounts in line with MASB standards. The Securities Commission is responsible for enforcing compliance with Malaysias accountancy standards, Bank Negara Malaysia is responsible for public listed companies and licensed financial institutions, and the Register of Companies is responsible for all other public and private companies (PricewaterhouseCoopers, 2001). Each institutions task force investigates compliance with board standards (PricewaterhouseCoopers, 2001).

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The Government also introduced laws to name beneficial owners of a companys 20 largest shareholders below the nominees name; compliance is high (PricewaterhouseCoopers, 2001). Annual reports must also include an audit committee report, a statement on corporate governance and internal control and other items. Section 132E of the Companies Act forbids substantial property transactions between the company and its directors or people connected with directors without prior shareholder approval. Malaysian Accounting Standards 17 and 18 are examples of standards issued in the absence of international standards.

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Auditing
Auditing standards comply with international standards. Before the crisis, the KLSE required all listed companies audit committees to include an independent chair and at least one member of the Malaysian Institute of Accountants, MIA.
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All committee members must undertake formal training on the


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Malaysian Code of Corporate Governance. audit and name the audit committee.
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Listed firms annual reports should detail the internal

MINORITY SHAREHOLDERS RIGHTS


Since the financial crisis, Malaysian authorities also have sought to strengthen minority shareholder rights.

Listing Rules
In January 2001, the Kuala Lumpur Stock Exchange became the regions first to require disclosure of compliance with the Corporate Governance Code via its listing requirements, enhancing the protection of minority shareholders (PricewaterhouseCoopers, 2001). Listing requirements are amongst the best in East Asia, and similar to London Stock Exchange rules. For example, all listed companies must report on corporate governance in their annual reports.
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Company directors also must report

separately on internal control in the annual report (PricewaterhouseCoopers, 2001). The Kuala Lumpur Stock Exchange can act against individual directors, as well as the listed company, for not complying with listing rules. As at 30 June 2001, the Exchange had a total of 481 investigations, and of these had taken 119 enforcement actions, including 26 public reprimands and 37 fines.

Representation
Under Malaysian law, shareholders have a proprietary right to vote, with one vote per share. Shareholders can register ownership to convey or transfer shares, participate and vote at general shareholder meetings and elect members of the board (PricewaterhouseCoopers, 2001). Under the Companies Act the appointment of voting proxies overrides articles of association provisions and shareholders, who together hold at least 10 per cent of equity, may call a meeting.
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Shareholders also may submit proposals to the general meeting (PricewaterhouseCoopers, 2001). rights (Rasiah et al., 2000).
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Finally, the Securities Commission is examining ways to allow shareholders cumulative voting

Or, if not a member of the MIA, the person shall normally have at least 3 years experience and have passed examinations the Accountants Act 1967 defines; or, be a member of one of the associations specified in the Act. A listed companys finance director and head of internal audit must attend audit committee meetings. Audit committees should meet with external auditors at least annually, without the executive being present. To achieve a quorum, the majority of audit committee members present must be independent. Companies such as Tanjong Plc, Commerce Asset Holdings Berhad, Malayan Banking Berhad and Utama Banking Group Berhad, voluntarily reported on their corporate governance before the amendments. If the directors decline to convene a meeting within 21 days after receiving such a request, those requesting a meeting may convene it themselves. However, in practice, as shareholders must bear the cost of circulating shareholder resolutions, these are rare.

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Board Structure and Duties


Under new listing rules, one third of listed companies directors or two directors, whichever is higher, must be independent. A 1998 survey showed Malaysian companies average eight directors: 2.6 are independent; 2.6 are non-executives; and 2.9 are executive directors. Only 20 per cent of companies formally selected independent non-executive directors. Also, in many small companies, non-executive directors are not independent (World Bank, 2000). Directors can sit on up to ten listed company boards or 15 non-listed company boards. All directors must attend a Research Institute of Investment Analysts, Malaysia accreditation program (Rasiah et al., 2000). While shareholders may appoint directors at the annual general meeting, in practice, boards select directors, except where a significant shareholder controls the company.
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Shareholders may remove

directors at any time. Under the Companies Act, directors must discharge their duties honestly and diligently. The Kuala Lumpur Stock Exchange may sanction companies for failing to appoint independent directors, although this has yet to occur (PricewaterhouseCoopers, 2001).

Legal Action against Directors


The 1965 Companies Act and Securities Commission Act provide several statutory remedies for dissatisfied shareholders. Investors may sue companies including false or misleading statements in their prospectus, and class actions are allowed (Rasiah et al., 2000). High costs and procedural complexities deter derivative actions. Hence, the Securities Commission may introduce derivative actions similar to those in Australia (Rasiah et al., 2000).
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CREDITORS RIGHTS
By regional standards, Malaysias creditor protection is reasonably good.

Bankruptcy
Even before the financial crisis, Malaysian bankruptcy laws were sound by international standards, and since the crisis, three reforms should expedite the resolution of banking system non performing loans. The first post crisis reform allows Danaharta to sell non performing loans it acquired from distressed banks and appoint special administrators to manage and restructure these assets; Danahartas out-of-court approaches achieve an average recovery rate of 60 per cent of loans face value. Second, authorities reduced companies ability to impose restraining orders on creditors under

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The revamped rules further require directors remuneration and backgrounds to be disclosed and the audit committee to summarise the discharging of its duties. Under best practice, a nominations committee comprising a majority of independent non-executive directors selects nonexecutive directors. A derivative action usually involves a person, often a shareholder, suing company directors or its subsidiarys directors for wrongdoing.

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Section 176 of the Bankruptcy Act.

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Third, the Government introduced informal debt workouts. The

Corporate Debt Restructuring Committee uses out-of-court approaches to restructure debts over Ringgit 50 million viable companies owe (PricewaterhouseCoopers, 2001). Despite reforms, under Section 176 creditors cannot take action against debtors for up to two years (Nathan, 2000). In addition, moves are underway to increase the judiciarys commercial expertise to appropriately adjudicate complex cases (PricewtarehouseCoopers, 2001).

Issuing Debentures
Under Guidelines on the Offering of Private Debt Securities issued in July 2000, corporate bond issuers must disclose accurately all information relevant to investors. However, the new guidelines do not require debtors to have a minimum credit rating; they assume markets will accurately price securities given available information.

Bank Supervision
Since the crisis, Bank Negara Malaysia has tightened already high standards of bank supervision. It gave domestic banks until December 2001 to comply with increased minimum capital requirements. Insurance companies also had to raise their paid up capital to Ringgit 100 million by 30 June 2001, forcing some firms to merge or exit (Institutional Analysis, 2001). Bank Negara liaises closely with banks, ensuring proper internal risk management systems are in place once mergers occur (Yunus, 2001). Bank Negara also requires at least two thirds of bank board members be non-executive directors, approved by Bank Negara. Bank officers must be trained in prudential standards and banks must spend 2.5 per cent of their salary budget on training (Yunus, 2001).

COMPLIANCE
Malaysias Securities Commission is the main regulator governing fundraising activities, registering prospectuses issued for all securities. The Securities Commission meets with boards of directors wanting to issue securities to ensure compliance. Since the financial crisis, the commission has issued significantly more fines and reprimands (PricewaterhouseCoopers, 2001). The Kuala Lumpur Stock Exchange also enforces listing rules, systematically reviewing financial reports, providing avenues for investors to request actions and observing selected annual general meetings. In 1998, the Securities Commission and Kuala Lumpur Stock Exchange set up a Financial Review and Surveillance Department to ensure listed companies meet disclosure standards (Rasiah et al., 2000). The Registrar of Companies monitors unlisted companies (Asian Development Bank, 2001). Companies cautioned or fined over Ringgit 1 million for failing to comply with listing rules must disclose this in their annual reports.

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S176 follows Chapter 11 in the United States.

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In the first half of 2001, the Securities Commission charged ten people for listing offences, including seven company directors and two ex-chairmen. The Kuala Lumpur Stock Exchange also publicly reprimanded several listed companies for failing to observe listing requirements. Several non-government bodies also support corporate governance enforcement. The Malaysia Institute of Corporate Governance runs extensive awareness programs targeting directors, and discourages companies from adopting a tick-box approach to complying with new corporate governance laws (Khas et al., 2000). As in many Asian economies, strengthening the legal system is key to improving regulatory enforcement. The appointment of a new, highly regarded Chief Justice should help achieve this.

Medias Role
Malaysias financial and commercial media often uncover examples of corporate misconduct. With government controls relaxed since the crisis, new entrants can enter the media sector. Large conglomerates own some newspapers, raising concerns about press independence when reporting on related commercial cases. For example, the Malaysian Resources group owns the New Straits Times, Business Times and Malay Mail (Backman, 1999).

IMPLICATIONS
Malaysias generally strong laws and regulations can support highly developed markets. The Government increasingly is reviewing its large and active presence in the corporate sector and how this may affect incentives facing business. Malaysias new corporate governance regulations provide a rules and market based framework for its corporate sector; government efforts to review its role in the economy would assist this process.

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REFERENCES
Asian Development Bank, 2001, Corporate Governance and Financing in East Asia: Volume2, Manila. Backman, M., 1999, Asian Eclipse, John Wiley and Sons, Singapore. Bushon, R. B., 2002, Information supplied to the Economic Analytical Unit by Staff Member, Employee Provident Fund, Kuala Lumpur. CEIC, 2001, CEIC database, Canberra. Claessens, S., Djankov, S. and Lang, L., 2000, The Separation of Ownership and Control in East Asian Corporations, Journal of Financial Economics, Vol. 58, No. 1,2, pp. 81-112. Claessens, S., Djankov, S. and Lang, L., 1999, Who Controls East Asian Corporationsand the Implications for Legal Reform, World Bank, Washington DC. CLSA Emerging Markets, 2001, Saint and SinnersWhos Got Religion?, June, Hong Kong. Danaharta, 2001, Operational Report, 30 June 2001, www.danaharta.com.my, accessed 16 October 2001. Danamodal, 2001, Frequently asked questions, www.bnm.gov.my/danamodal, accessed October 2001. East Asian Analytical Unit, 1999, Asias Financial Markets: Capitalising on Reform, Department of Foreign Affairs and Trade, Canberra. Hadzar, S., 2000, Economic Analytical Unit interview with Secretary, Economic and International Division, Ministry of Finance, Kuala Lumpur, December. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. International Monetary Fund, 2000, Review of Standards and Codes: Malaysia, www.imf.org, accessed July 2001. Khas, D.M.N., Soon, L.L. and Kamal bin Ismail, I., 2000, Economic Analytical Unit interview with President, Executive Director and Senior Member, Malaysian Institute of Corporate Governance, Kuala Lumpur, December. Nathan, R.S., 2000, Economic Analytical Unit interview with Partner, Shearn Delamore and Co., Kuala Lumpur, December. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Rasiah, S.,Weng, T.C. and Singh, I. N., 2000, Economic Analytical Unit interview with Legal Advisor, Listing Group, and Senior Manager, Listing Operations, Kuala Lumpur Stock Exchange, Kuala Lumpur, December. Shimomoto, Y., 1999, The Capital Market in Malaysia. Rising to the Challenge in Asia: A Study of Financial Markets: Volume 8Malaysia, Asian Development Bank, Manila, pp. 80-112.

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World Trade Organization, 1999, Trade Policy Review, World Trade Organization, Geneva. Yunus, N.S., 2000, Economic Analytical Unit interview with Director, Bank Regulation Department, Bank Negara Malaysia, Kuala Lumpur, December. Zain, N.M., 2000, Economic Analytical Unit interview with Executive Director, Malaysian Accounting Standards Board, Kuala Lumpur, December.

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PHILIPPINES

KEY POINTS
Following the crisis, authorities initiated several useful reforms, introducing the new Securities Code and establishing a Governance Advisory Council to review corporate governance. Since the early 1990s, significantly reduced trade barriers, a freer foreign investment environment, privatisation and deregulation, increasingly disciplined Philippine corporate managers. However, regulatory reform and increased enforcement would alleviate the risks which concentrated firm ownership and markets impose on small investors. Diverse mainly family controlled conglomerates dominate the corporate sector. The Philippines top five families account for a higher proportion of share market capitalisation than do the same sized group in any other East Asian economy. Cartel arrangements and concentrated ownership guarantee a few firms high profit rates in many markets and weaken commercial discipline. To retain control, firms favour debt finance and concessional official lending over equity, inhibiting sharemarket development. Boosting equity financing and the role of institutional investors would improve significantly corporate governance. Sales of government shares in some important banks could introduce new owners who are independent of conglomerates, improving lending quality.

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While the Philippine corporate sector exhibits many of the same characteristics of other East Asian economies, authorities are attempting to move towards a rules based business environment. After 1997, the Government reviewed many aspects of the corporate regulatory framework and increased market openness, improving incentives for sound corporate behaviour. Remaining major challenges include curtailing dominant corporate families market power, promoting broader corporate ownership and liquidity of share markets, closing regulatory framework gaps, formulating best practice governance codes, strengthening regulations and professional practices for accounting and improving enforcement.

CORPORATE SECTOR STRUCTURE


Many Philippine markets lack competition, with diverse, family controlled conglomerates operating alongside large government owned firms. Private individuals own most firms and rely almost exclusively on private and bank debt financing. Even listed firms retain close to 70 per cent of their equity in private hands and draw their finance mostly from banks. Relatively weak competition in finance, goods and services markets shelters managers from external discipline. Conglomerates form cartels, which guarantee high profit rates in many markets, despite often poor management.

Family Ownership Dominant


The Philippines top five families control almost 43 per cent of total listed corporate assets, the highest proportion in East Asia (Claessens et al,1999) (Figure 2.6). In total, families control 48 per cent of publicly listed firms, where control is defined as 20 per cent of equity; this is the second highest rate of family ownership in East Asia after Hong Kong (Figure 14.1). Families tightly control most boards, minimising outside minority shareholders influence. Business groups often comprise a complex mix of listed and private companies, producing opaque ownership structures (Naughton, 2001). Of the major banks, only Far East Bank is not owned by a family, a single firm or the Government (Montes, 2001).

Conglomerates Diverse
Philippine corporates cross-hold more equity, creating larger conglomerates, than do corporates in any other East Asian economy except Japan (Naughton, 2001). They operate in a wide range of sectors, including real estate, services, banking, infrastructure supply, manufacturing, retail, telecommunications and mass media. While this can often reduce their economies of scale and raise costs, entry barriers maintain high profits at consumers expense. Corporate groups with affiliated banks and finance companies can access cheap finance, reducing their need for direct financing (De Ocampo, 2000).

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Figure 14.1 Family Ownership Significant Share of Listed Companies Key Groups Own, 1999, Per cent 1

Widely held corporation Widely held financial State Family Widely held

Notes: 1 Widely held refers to firms whose shares are held by many individuals and companies; Widely Held Corporation and Widely Held Financial refer to firms whose stock is held by a company or financial institution whose stock is widely held. Source: Institutional Analysis, 2001.

AYALA GROUP OPERATES ACROSS THE ECONOMY

The Ayala family, through a web of complex structures, owns the Philippines largest conglomerate, the Ayala Group. The Ayala Groups 48 companies control local telecommunications companies, real estate, food, agribusiness and industrial interests, and own the Bank of the Philippine Islands, one of the countrys largest banks. The family wholly owns Mermac, which owns 59 per cent of Ayala Corporation, a conglomerate member and second largest listed company in the Philippines. Ayala Corporation effectively controls Ayala Land, AYC Overseas, Ayala Foundation, IMicro Electronics, Pure Foods and Globe Telecom. Those companies then own substantial proportions of other firms in the group. Despite this, Ayala Group is relatively more exposed to international competition, and therefore greater management discipline, than other large family owned conglomerates.
Source: Claessens et al., 2000.

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State Ownership Still Prominent


Despite a decade of privatisation, the Government still owns and manages 179 state owned enterprises in the power, agriculture, railways, water, high technology and financial sectors. The government owned Development Bank of the Philippines is a significant source of concessional finance. The government pension fund also holds equity in private banks and other firms, potentially influencing their lending decisions and other outcomes affecting outside investors (Cruz, 2001). The Government can direct private banks to lend to state owned firms, providing implicit guarantees for state firms to borrow, increasing the risk of unviable investment.

Bank Financing
Commercial banks largely finance firms, especially those belonging to the same industrial group. However, banks roles in corporate governance are much less clear than, for example, in Japan, under the main bank system. Philippine banks are not represented in management positions, nor do they monitor corporate activity in the way Japanese main banks do (Naughton, 2001). Like elsewhere in East Asia, corporates prefer bank financing to equity financing, as it does not dilute ownership. Close bank-corporate connections remove the need for managers to compete for equity market finance; only 80 of the Philippines top 1 000 companies are publicly listed. Bank ownership also is concentrated amongst powerful family shareholders, hindering prudential supervisors regulatory capacity (De Ocampo, 2000).

Direct Financing Markets Immature


Banks and corporates are reluctant to dilute ownership by issuing equity; this inhibits share market development. Companies often issue minimal shares to secure a listing (De Ocampo, 2001). Large blocs of controlling shareholders hold tightly most shares in most Philippine companies and often dominate decision making in public companies. Regulations require firms to list a certain minimum of their equity in initial public offers, deterring private companies from listing. Central bank regulations also deter securitisation, with reserve requirements preventing banks from selling commercial paper. On the demand side, the middle class mostly prefers to hold US dollar deposits, which represent 60 per cent of all bank deposits, rather than local shares, also inhibiting the share market developing. Hence, share market capitalisation is a relatively modest 60 per cent of GDP; furthermore low share market turnover increases price volatility and deters investors. Outside the banking sector, mergers and acquisitions, hostile takeovers and corporate raiders are rare, limiting discipline on management by protecting managers from the consequences of poor decisions. When corporates change owners, they normally do so behind closed doors (Wells, 1999). In 2000, no cross-border acquisitions of Philippine companies occurred and an investor groups acquisition of Coca-Cola Bottlers Philippines, for a modest US$1.27 billion, was the sole domestic takeover (Naughton, 2001).

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Cartels Common
Competition in some sectors is weak, featuring a small number of firms. Within industries, companies price movements are similar, suggesting cartels prevail, especially regionally (Zhuang, 2001). For example, monopolies dominate telecommunications, and the top five banks control 50 per cent of total assets (Far Eastern Economic Review, www.feer.com, 13 May 1999).

MARKET FORCES STIRRING


Despite this rather closed corporate culture, trade and investment opening in the late 1980s and 1990s increasingly expose Philippine corporates to market forces. Reforms allowing some foreign bank presence have somewhat increased banking industry efficiency, and merger of the two stock exchanges and prudential reforms have developed the equity market, somewhat reducing reliance on debt. However, many areas would benefit from further market and regulatory reform. Equity financing and institutional investors roles remain underdeveloped. Also, while large tariff reductions boosted goods and service market competition, cartels and foreign direct investment restrictions keep competitive pressures in many sectors relatively weak.

FINANCE MARKETS SLOWLY IMPROVING


The IMFs involvement in the economy after financial crises in the 1980s, and lower growth due to limited reforms helped Philippine authorities protect the financial sector from the worst of East Asias mid 1990s excesses. However, more prudential reforms are needed to develop financial markets so they are more active in corporate financing and disciplining corporates. Although the Philippine banking sector needed less restructuring than elsewhere in the region after the crisis, since then, bank led restructuring has converted many non performing loans to equity. Sales of these shares could diversify corporate ownership and increase share market liquidity. The Securities and Exchange Commission has proposed four financial market development bills: the Corporate Recovery Act to fast track the rehabilitation of distressed companies, the Special Purpose Vehicles Act to create asset management companies and to provide them incentives to buy banks non performing loans, the Revised Investment Companies Act to stimulate mutual fund industry development, and the Securitisation Act to encourage public and private companies to borrow against a pool of existing assets and/or receivables. However, there is concern over how long these laws will remain stalled in Congress. Furthermore, the taxation system currently favours debt over equity finance.

Bank Restructuring
Although post crisis bank restructuring was less aggressive than elsewhere in East Asia, its role in corporate sector reform was important. After the crisis, several banks merged, with some large corporate shareholders divesting their shares in local banks (De Ocampo, 2000). However, some
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Three banks, Orient, Prime Bank and Monte de Piedad, failed during the crisis.

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mergers may prove risky in the long run because acquisitions were done in haste and without parties undertaking a due diligence study. Although most banks had relatively healthy balance sheets in the lead up to the crisis, after the crisis, the Government took up shares in several banks. Selling these to new entrants would increase bank independence. A further deterioration of banks balance sheets in 2002 may lead to the need for further injections of public capital and eventual sale of this equity to new owners. In 2001, banks non performing loans reached 19 per cent, and those of the third largest bank, Philippine National Bank, reached over 50 per cent.
2

Foreign bank entry


Since the 1990s, ten foreign banks have received joint venture licences for wholesale banking, joining long established banks like Citibank which have operated in the Philippines since Independence. Citibank has had an important influence on Philippine banking, training many of the chief executives of local banks. Other foreign banks gradually may help lift competition and standards, but onerous branching restrictions limit their capacity to compete with local retail banks. Foreign banks in the wholesale market cater mainly to foreign companies, but with domestic bank balance sheets weak, they eventually may seek a greater share of domestic business, increasing competition for funds. Foreign banks provided capital for some failing banks during the crisis. For example, Keppel Bank of Singapore acquired the failed Monte de Piedad Bank. The market share of foreign banks branches and subsidiaries comprised 14.7 per cent of total assets of the banking sector in 2000, up substantially from pre crisis levels (Securities and Exchange Commission, 2001).

Increasing Direct Financing Difficult


The weak state of bank balance sheets may force corporates to seek finance from direct markets. However, families desire to preserve corporate control, government financial institution lending at concessional rates and deposit guarantees discourage increased use of equity finance. As in many East Asian economies, total share market capitalisation is modest as a ratio to GDP and remains below pre-crisis levels (Figure 14.2). Since the crisis, the number of listed firms has risen only slightly; in August 2001, 231 firms were listed, up from 216 at the end of 1996. No major new private or state company has listed in recent years, inhibiting market capitalisation growth (Figure 14.3) (Naughton, 2001). The Securities and Exchange Commission has set a target of 24 initial public offers for 2002, based on the expectation that oil companies will list as mandated by the Oil Deregulation Law and that Board of Investments registered firms will go public (Philippines Daily Inquirer, 7 January 2002).

For example, the Government owns around 15 per cent of Philippine National Bank and has committed to sell its stake (Far Eastern Economic Review, www.feer.com, 12 October 2000).

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Figure 14.2 Share Market Recovering, but below Pre-crisis Highs Market Capitalisation to GDP, Ratio, 1990-2000
1.2

1.0

0.8

Ratio

0.6

0.4

0.2

0 1990
Source: CEIC, 2002.

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Figure 14.3 Initial Public Offers Remain Weak Initial Public Offers, Pesos millions, Annual, 1990-2000
40 000 35 000 30 000
Pesos millions

25 000 20 000 15 000 10 000 5 000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: CEIC, 2002.

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Corporate bonds can raise funds without diluting control, but floating rate instruments and macroeconomic instability increase their cost. The small bond market also reduces liquidity and increases costs relative to bank financing (Wells, 1999). In addition, lack of adequate ratings and investor protection and concerns about corporate governance standards reduce investors demand. Hence, few companies tap publicly-issued debt market instruments, including commercial paper; the number of commercial papers on the market declined from 50 in 1996 to only 29 in 2000.

Institutional Investors May Yet Develop


Over the medium term, institutional fund managers provide the best means of developing financial markets; already the Philippine analyst and broker community imposes discipline on large listed firms (Asian Corporate Governance Association, 2000). However, the Government owns many institutional investors, possibly inhibiting the growth of a private funds management industry. Government pension funds, including the Government Service Insurance System and the Social Security System, control 20 to 40 per cent of the bank sector. Also equity investment limits restrict public institutional investors role in encouraging improved corporate governance. Instead pension funds invest mainly in bank deposits, housing loans and government bonds (Wells, 1999). Privatising government institutions and liberalising controls on their portfolio holdings would boost share market liquidity and private institutional investor activity in it. At present, no regulatory framework exists for private pension funds. Nevertheless, private insurance companies investing in listed and private companies exert some direct control over management. Large holdings, usually 10 to 25 per cent of equity, guarantee the funds representation on boards and allow close monitoring of management. Interestingly, companies once partly owned by a private insurance company are more likely to list (Wells, 1999).
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PRODUCT MARKETS
Competition in goods and service markets is more vigorous than 15 years ago when the Philippines started market opening; however, some family conglomerates face only limited competition, especially in services markets, where foreign entry barriers remain high. For example, the Ayala Group profits from its globally competitive firms in international markets but faces limited competition in domestic markets. Nevertheless, trade reforms are increasing manufacturing sector competition and the new administration has put privatisation and deregulation on the reform agenda.

Deregulation
In the 1990s, significant deregulation reduced entry barriers to shipping, banking and retailing. Slowly, the large state owned sector is being privatised, often involving strategic foreign partners, such as in National Steels sale to a Malaysian group. The Government intends to sell around half of its 180 state enterprises including in the power, agricultural, railway and water sectors. Furthermore, WTO induced reforms eliminated monopoly licences in many sectors including telecommunications.

Companies operating retirement schemes use banks common trust funds.

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However, vested interests frustrate deregulation. Family owned monopolies in power distribution and telecommunications are difficult to break and powerful commercial interests can influence regulatory bodies.

Trade Reforms
Since the crisis, Uruguay Round commitments and the Governments unilateral tariff reform program reduced Philippine tariffs more than any other East Asian economy (World Trade Organization, 1999). When the peso depreciated sharply in 1997 and 1998, the Philippines took the opportunity to progressively reduce tariffs to under 5 per cent, except for sensitive agricultural products, by 2004. By 2001, the simple average nominal tariff rate was 7.7 per cent, down from 13.4 per cent in 1997 (Philippine Tariff Commission, 2001). These reforms increase competition in goods markets, curb the market power of large conglomerates and reduce costs for consumers and producers inputs. However, significant non-tariff barriers remain for agricultural products. For example, sensitive agricultural products are subject to minimum access volume tariff-rate quotas until at least 2005. Products covered include live animals, fresh, chilled or frozen beef, pork, poultry and goat meat, potatoes, coffee, corn and sugar. The National Food Authority retains its exclusive authority to import rice and issue import quotas and permits for rice and corn. The Government currently is moving to privatise rice importation, but indications exist the authority will retain significant administrative control even after the privatisation. Although the application of sanitary and phytosanitary rules has become more predictable, difficulties in obtaining import permits persist (World Trade Organization, 1999).

Foreign Direct Investment Reforms


Since the early 1990s, foreign direct investment reforms have opened Philippine manufacturing to foreign investment, but restrictions remain in many other key sectors including mining and infrastructure (East Asia Analytical Unit, 1998). In 1996, further reforms increased foreign participation in the economy; remaining restrictions include the media, various professional services, some infrastructure sectors and small scale mining. Since the 2000 passage of the Retail Trade Liberalisation Act, several foreign companies have entered the retail sector (PricewaterhouseCoopers, 2001). However, the Philippine constitution still limits foreign ownership of land, mining and infrastructure projects and a majority of Philippine residents must sit on listed company boards, deterring foreign investment.
JOLLIBEE RESPONDS TO FOREIGN ENTRY

In 1980, McDonalds entered the local fast food market, increasing competition for local firm, Jollibee. Jollibee responded by heavily investing in staff training and new capacity. In 1993, it listed on the stock exchange to finance more outlets and rebuilt its image. Jollibee introduced several external directors to the board and lifted corporate governance standards, satisfying minority shareholder needs. Jollibees market share now is sizeable, acquiring related firms Greenwich Pizza in 1994 and Chowking in 1999.
Source: Lim, 2001.

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Antitrust Laws
Philippine anti-trust laws need upgrading; no agency implements the laws or prosecutes firms (World Trade Organization, 1999). In mid 2001, in an example of collusion, the two largest mobile phone companies, Globe Telecoms of the Ayala group and Smart Communications of the Metro Pacific group, almost simultaneously announced a reduction in free short messaging services by 60 per cent. The National Telecommunications Commission lodged a temporary restraining order questioning its legality, but it was lifted almost immediately due to lack of sufficient evidence. Since the crisis, the Government has initiated moves to formulate a national competition policy framework, reviewing existing competition laws and statutes (Asia Pacific Economic Cooperation, 2000).

REGULATIONS STRENGTHENING
After the crisis, authorities reformed regulations to strengthen corporate governance. An August 2000 Securities Regulation Code improves listing requirements and insider trading sanctions, and the government Securities and Exchange Commission regulates corporations. In July 2001, the President announced the Governance Advisory Council would review corporate governance standards, reforming key regulations and boosting enforcement. This poses a major challenge to regulators.
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TRANSPARENCY
Although formal regulations ensuring transparency broadly are adequate, enforcement proves difficult.

Financial Reporting
Philippine financial reporting requirements are reasonable by regional standards, but do not conform to international best practice levels. Listed companies must provide annual reports with balance sheets and profit and loss statements to the Securities and Exchange Commission. They also must report any event affecting investors (PricewaterhouseCoopers, 2001). The Bureau of Internal Revenue also requires all companies with gross revenues over Pesos 150 000 (US$2 800) to submit audited financial statements with their income tax returns. In 2001, the Securities and Exchange Commission began implementing a new regulatory framework based on international standards. The commission also is developing IT software so analysts, investors and others can access data on firms financial performance (Manila Bulletin, www.mb.com.ph, 29 July 2001). The Corporation Code sets corporates legal framework, specifying company registration and shareholder rights. Companies must detail all transactions and provide the minutes of meetings to directors and shareholders. At regular or special shareholders meetings, shareholders representing at least a majority of the outstanding capital stock must approve transactions that benefit directors (PricewaterhouseCoopers, 2001). The code is unchanged since its inception in 1980.
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William Bailey, Jerry Isla, George Lavadia, Edith Tuason, Cristina Delizo, Jo Lennox and Michelle Narracott, PricewaterhouseCoopers and PricewaterhouseCoopers Legal, contributed to this section.

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Consolidated reporting is not mandatory, but when companies merge or acquire assets, both parties must provide the Securities and Exchange Commission with annual reports.

Accounting Standards
In 1997, the Government announced it would gradually adopt international accounting standards by 2004; since then Philippine accounting standards have moved closer to international norms.
5

Areas most affected include the preparation and presentation of financial statements, reporting by sector and interim financial reporting. However, disclosing the fair value of financial assets and liabilities, treatment of impaired assets and accounting for issuers financial instruments still need reforming. Draft standards awaiting Board of Accountancy approval cover consolidating financial statements and reporting related party disclosures. At present, compliance with standards generally is weak; many firms maintain up to three sets of books, for banks, regulators and owners. Weak penalties and certified public accountants lack of a stringent code of ethics hinders compliance. The Securities and Exchange Commission and the Philippine Institute of Certified Public Accountants recognise the need to penalise independent auditors for poorly prepared audited financial statements (Asian Development Bank, 2001).

Auditing
Audit requirements are generally sound and follow the US system, although enforcement is weak. In addition, where the US system is not specific, Philippine firms often prepare inadequate investment information. Where resources permit, the Securities and Exchange Commission supervises listed companies independent audits. Audit boards are not compulsory and rarely used (PricewaterhouseCoopers, 2001).

MINORITY SHAREHOLDERS RIGHTS


New rules related to listing, shareholder representation, board structure and legal action against directors offer minority shareholders increasing protection. However, enforcement remains a concern.

Listing Rules
Recent changes under the new Securities Regulations Code may offer better protection to minority shareholders through mandatory tender offers and deter market abuses and fraud through prohibiting insider trading, affiliated broker and dealer transactions and segregating broker and dealer functions (PricewaterhouseCoopers, 2001). Listing companies must demonstrate their financial stability, ongoing viability and sustainable projected earnings. Applicants also must assure the Securities and Exchange Commission of the integrity of key personnel. Before a company makes an initial public offer, a licensed underwriter must conduct due diligence on the prospectus.
5

Philippine accounting standards are based on the Statements of Financial Accounting Standards the Accounting Standards Council issue, and Rule 68 (Special Accounting Rules) of the Securities Regulation Code. The Securities and Exchange Commission and the Philippine central bank, Bangko Sentral ng Pilipinas, recognise new accounting standards that become mandatory after the Professional Regulation Commission approves them (PricewaterhouseCoopers, 2001).

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The Securities Regulation Code defines listing rules for public companies and the Securities and Exchange Commission implements them. Although adequate in numbers, Securities and Exchange Commission staff sometimes lack resources. Exchange membership requirements are not particularly stringent; many local brokers are small and under-capitalised and a few large foreign firms dominate the market (Institutional Analysis, 2001).

Representation
On paper, laws ensure minority shareholders can influence company decisions, but often implementation is weak. Proxy and cumulative voting is allowed and a two thirds majority vote must pass resolutions, but concentrated ownership generally makes it easy for the board to obtain the majority needed to approve deals (Asian Development Bank, 2001). In theory, if large related transactions occur, dissenting shareholders may demand payment of the fair value of shares. Also, regulations specify minority shareholders may examine all business transactions and minutes of meetings, voice concerns at the annual general meeting without needing a minimum quorum and call a shareholders meeting when directors act against their interests. However, these events are rare. Non-voting shares are not permitted except preferred or redeemable ones, although these offer voting rights in key decisions (PricewaterhouseCoopers, 2001). Rules require tender offers to minority shareholders following any third-party offer to buy in excess of 15 per cent of stock (Manila Bulletin, www.mb.com.ph, 7 August 2001). In January 2002, Unitrust Development Bank failed, reportedly as a result of conflict of interest between dominant and minority stockholders. The bank suffered heavy withdrawals in 2001 after a change in ownership when shareholders accused the new owner of using the bank as a financing arm of a sister company that also was closed.

Board Structure
A board must have between five and 15 directors and, even for wholly foreign owned firms, a majority must be Philippine residents. For listed companies, at least two directors or 20 per cent of the board, whichever is greatest, must be independent (PricewaterhouseCoopers, 2001). Interlocking directorships are common and legal, although shareholders must approve transactions between directors within the same group. Representatives of minority stockholders cannot be removed without cause. The Securities Regulations Code prohibits insider trading and applies strict liability for director violations (PricewaterhouseCoopers, 2001). However enforcing insider trading laws proves difficult. For example, the Philippine Stock Exchange and the Securities Exchange Commission are investigating several cases of insider trading, including the case of BW Resources. While investigations are ongoing, to date, no one has been prosecuted for insider trading. Failure to resolve this case has delayed the return of investor confidence in the Philippine stock market. The Corporate Code holds directors who act negligently or in bad faith liable for damages and shareholders can launch a class action or file a derivative suit against company directors, although not on behalf of the corporation. However, such cases are lengthy, costly and rare (PricewaterhouseCoopers, 2001).

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CREDITORS RIGHTS
Creditors rights, including bankruptcy laws and banking system supervision, are improving. However, lack of enforcement resources, some inadequate provisions and weak enforcement in the courts undermine outcomes.

Bankruptcy
Bankruptcy laws are sound but application is weak. The Insolvency Law establishes procedures for temporarily suspended payments, voluntary and involuntary liquidation. Post crisis reforms empower the Department of Justice to administer insolvency and simplify its administration. A new specialised commercial court system encourages stakeholder activism by canvassing insolvency alternatives and developing substantial insolvency procedures (PricewaterhouseCoopers, 2001). In 2001, the Supreme Court promulgated a resolution designating regional trial courts to sit as special courts to handle corporate rehabilitation cases. However, grey areas exist regarding which agency should accept petitions for involuntary and voluntary dissolutions where creditors are affected (Business World, 4 January 2001). Nevertheless, the number of corporate rehabilitation cases has risen sharply (PricewaterhouseCoopers, 2001). Under Presidential Decree 902-A, authorities can replace corporate management in rehabilitating corporates. Despite these reforms, lack of court resources and training hinder insolvency proceedings, undermining creditor protection. Creditors cannot vote on rehabilitation programs developed under new reforms and sometimes the legislation is contradictory (PricewaterhouseCoopers, 2001).

Bank Supervision
Prior to the crisis, significant reforms and IMF involvement since the 1983 banking crisis gave the Philippines a higher level of prudential standards than in many other East Asian economies; however, implementation of bank supervision is still lacking in some areas. The General Banking Law passed in May 2000 clarifies the central banks prudential responsibilities and imposes tough criteria on bank auditors. It also institutes consolidated banking supervision, formally adopts risk-based capital requirements, increases allowable foreign bank ownership of local banks to 100 per cent, clarifies the legal basis for determining unsafe banking practices and increases bank transparency and disclosure standards. This puts the Philippines at the forefront of prudential standards. In the early 1990s, prudential caps and sectoral qualifications on foreign borrowing limited corporate and bank access to foreign debt markets and their exposure during the financial crisis (Asian Development Bank, 2000). After the Asian financial crisis, the central bank raised capital adequacy ratios, tightened provisioning requirements and adopted stricter loan classifications (Gochoco-Bautista, 1999). However, retail banking remains relatively closed to new foreign bank entrants. Freer foreign financial institution entry could strengthen banking industry prudential standards, competition and corporate governance. Promoting mergers and acquisitions of the many smaller local banks and privatising and public listing of government banks would help promote efficiency and disperse bank holdings (Gochoco-Bautista, 1999).
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COMPLIANCE
The Government is aware compliance and enforcement of corporate governance and prudential standards need improving. Some judges lack training in corporation law and court transparency remains a concern. Accounting standards are improving but as yet are implemented poorly and often audits are weak. In addition, public ombudsmen face many obstacles in pursuing justice.

Press
Although the media have the freedom to scrutinise corporations independently, powerful politically connected families can influence reporting. Family groups frequently own media outlets, creating conflicts of interest. For example, industrial conglomerates own the Manila Chronicle, Manila Times, Manila Bulletin and Manila Standard.

IMPLICATIONS
Despite concerted official attempts to improve and enforce the Philippines reasonably good corporate governance legislation, checking the market power of large well connected family owned conglomerates and enforcing corporate laws is proving difficult. Regulators need more financial and human resources and training to build institutional capacity. Australian development assistance projects have assisted in many of these areas and have the capacity to continue institutional strengthening in future. The new Arroyo administration is less willing than its predecessor to tolerate cronies and more serious about strengthening market forces. Such reforms are needed urgently to boost the Philippines lagging economic prospects. At the National Economic Summit in December 2001, good governance was identified as a major area needing reform. However, this will be a lengthy process, requiring strong political will, private sector cooperation and vigilance from public interest groups.

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REFERENCES
Asia Pacific Economic Cooperation, 2000, Philippines Individual Action Plan 2000, www.apecsec.org.sg, accessed October 2001. Asian Corporate Governance Association, 2000, Building Stronger Boards and Companies in Asia, Hong Kong. Asian Development Bank, 2001, Corporate Governance and Finance in East Asia: A Study of Indonesia, Republic of Korea, Malaysia, Philippines and Thailand, vol 2, Asian Development Bank, Manila. Cataran, B., 2001, Economic Analytical Unit interview with Director, Company Registration and Monitoring Department, Securities and Exchange Commission, Manila, February. CEIC, 2001, CEIC database, Hong Kong, supplied by DX Data, Canberra. Claessens, S., Djankov, S. and Lang, L.H.P., 2000, East Asian Corporations: Heroes or Villains?, World Bank Discussion Paper No 409, World Bank, Washington DC. Claessens, S. and Djankov, S., 1999, Who Controls East Asian Corporationsand the Implications for Legal Reform, World Bank, Washington DC. Cruz, S., 2001, Economic Analytical Unit interview with Director, Corporate Affairs, Department of Finance, Manila, February. De Ocampo, R.F., 2000, Corporate Ownership and Corporate Governance: Issues and Concerns in the Philippines, paper presented at Asian Development BankOECD-World Bank 2nd Asian Roundtable on Corporate Governance, Hong Kong, 31 May-2 June. East Asia Analytical Unit, 1998, The Philippines - Beyond the Crisis, Department of Foreign Affairs and Trade, Canberra. Gochoco-Bautista, M.S., 1999, The Past Performance of the Philippines Banking Sector and Challenges in the Post-crisis Period, in Rising to the Challenge in Asia: A Study of Financial Markets, Philippines, Asian Development Bank, Vol 10, Manila. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Lim, B., 2001, Economic Analytical Unit interview with Professor, Asian Institute of Management, Manila, February. Montes, V., 2001, Economic Analytical Unit interview with Manager, Citibank, Manila, February. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. Philippine Tariff Commission, 2001, Primer on new developments in trade and tariff policy, Philippine Tariff Commission, Manila.

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PricewaterhouseCoopers, 2000, Consultancy prepared for the Economic Analytical Unit, August. Securities and Exchange Commission, 2001, Philippines 5000, Manila Wells, S., 1999, Solid Crust with Soft Center: a Problem of Enforcement in the Philippine Capital Market, in Rising to the Challenge in Asia: A Study of Financial Markets: Philippines, Asian Development Bank, Vol 10, Manila. World Trade Organization, 1999, Trade Policy Review, Philippines: Report by the Secretariat, Trade Policy Review Body, Geneva. Zhuang, J., 2001, Economic Analytical Unit interview with Senior Economist, Asian Development Bank, Manila, February.

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VIETNAM

KEY POINTS
State owned enterprises, SOEs, dominate Vietnams corporate sector; most exhibit quite weak corporate governance standards. State banks dominate corporate financing; state owned enterprises poor investment performance has generated relatively high non performing loan levels, weakening the banking sector. The stock exchange commenced operating only in July 2000; to date few companies have listed so it still has a limited influence on corporate behaviour. While Vietnam could use stock exchange listings to drive corporate governance reforms, at present its strategy for achieving effective governance of SOEs remains unclear. Vietnams increasing commitment to binding international agreements, recently with the United States, and its desire to join the WTO, increasingly should drive legal and institutional reforms. Foreign invested enterprises are playing an increasingly important role in the Vietnamese economy, boosting private sector development. Wholly foreign invested enterprises, joint ventures and foreign business cooperation contracts with state owned enterprises, offer SOEs better corporate governance examples. Regulations governing corporate behaviour are at an early stage of development.

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Since 1989, Vietnam has undergone significant structural change in moving towards a market-based economy. Nevertheless, the Government faces a considerable task in implementing the institutional framework required to support a viable private sector. Vietnamese economic growth and FDI inflows peaked in 1996, prior to the Asian financial crisis, signalling the economy would benefit from renewed market opening, prudential and monopoly regulation and corporate governance reforms (Leung, 2001). By increasing competition for export markets and FDI, the Asian financial crisis heightened the urgency of further reform.

CORPORATE SECTOR STRUCTURE


Despite over a decade during which private enterprises were allowed in many sectors, state bank financed SOEs continue to dominate the corporate sector. The underdeveloped share market imposes little discipline on SOEs or competitive pressure on banks, and is unlikely to do so for many years.

SOEs Dominate
SOEs continue to account for a large proportion of the Vietnamese economy. The constitution did not formally recognise private land-use rights until 1992. Wholly domestically owned SOEs are concentrated in capital intensive industries; net of joint ventures with foreign investment components they account for about 30 per cent of GDP, 42 per cent of industrial output and 50 per cent of exports but employ only 1.6 million workers, about 5 per cent of the workforce (Leung, 2001). Administrative barriers to private enterprise entering many capital intensive manufacturing and utilities sectors, the high costs of land use rights and, until recently, limited access to bank credit, also restrict private corporate sector development (Asian Development Bank, 1999; Riedel, 1999; Leung et al., 2000).

Most SOEs Run at a Loss


At the end of 1997, about 60 per cent of SOEs made losses or were only marginally profitable (World Bank, 2000a). These losses directly affected state banks balance sheets. The situation has not improved since then. While Vietnamese SOEs are less of a drain on the government budget than in China, few SOEs are forced into bankruptcy, even if they have been running losses for many years. Most do not really expect to repay loans to state banks, implying SOEs are subjected to limited fiscal and managerial discipline.
1

Due to the weak accounting and auditing environment, some profitable SOEs also may report losses or marginal profits, and may also negotiate the profits they declare and taxes they pay with the relevant authorities.

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Financial Sector Underdeveloped


State banks face little competition from private banks, non bank financial institutions or capital markets when seeking household and enterprise savings and most corporations have little choice but to borrow from the state banks. Most banks are government owned; in 1998, the six state owned commercial banks accounted for up to 75 per cent of the total banking sector assets (Leung et al., 1998). The 1 044 largest SOEs are highly indebted, with an average debt to asset ratio of 1.64 (Asian Development Bank, 1999).
4 3 2

In 1998, banks non performing loans stood at 30 to 35 per cent of total bank lending, based on estimates using internationally recognised classifications of non performing loans (Leung, 2001).
5

While financing most SOE investment, state banks contribute relatively little to their corporate governance. Despite ending formal directed lending, various levels of government continue to impose direct and indirect pressure on state owned banks to lend for favoured state owned enterprise projects. Furthermore, the perception exists that lending to SOEs is safer as the government will ultimately underwrite those debts.

Equity Markets Weak


Vietnams financial markets are the least developed of any economy surveyed in this report, with only a handful of firms able to directly raise capital from the market. The capitalisation of the Ho Chi Minh City Securities Trading Centre, established in July 2000 is tiny. Although the number of listed stocks is rising, by January 2002, it listed only eleven stocks, five government bonds and two corporate bonds (Vietnam Economy, www.vneconomy.com.vn, 2002). The market opens for only three days a week, with each session restricted to one hour of trading. Market activity is heavily restricted, with the State Securities Commission imposing a maximum daily price change of 2 per cent; previously the permissible trading band was higher. The limited number of stocks contributes to market volatility; the index rocketed to a high of 571 on 25 June 2001 back to a low of 235 on in December 2001 (Figure 15.1) (The Financial Times, 6 November, 2001).
6

However, in recent years foreign banks, including ANZ, which has a significant foreign bank presence in Vietnam, have lent to large SOEs like Air Vietnam and port operators in Ho Chi Minh City. State owned commercial banks account for 80 per cent of banking system liabilities (World Bank, 2001). Joint stock banks account for 15 per cent of liabilities, with a small number of foreign and joint venture banks accounting for 5 per cent (World Bank, 2001). There are virtually no non-bank financial institutions except rural credit cooperatives (Leung, 2001). Inconsistent methods of asset valuation mean this figure should be treated as a guide only. Vietnams definition of non performing loan is much narrower than the internationally-accepted definition. Hence the official government estimate of non performing loans is considerably lower than the estimate made by the International Monetary Fund (International Monetary Fund, 1999). These levels are equivalent to the official estimates of non performing loans in China at that time, but are less than unofficial Chinese estimates at present (Lardy, 2002). The State Securities Commission is planning to extend this to five trading days a week from March 2002.

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Figure 15.1 Thin Listings Make Stock Index Volatile Ho Chi Min City Stock Trade Index, 2001
600

500

400
Index

300

200

100

0 Dec 00 Jan 01 Feb 01 Mar 01 Apr 01 May 01 Jun 01 Jul 01 Aug 01 Sep 01 Oct 01 Nov 01 Dec 01
Source, CEIC, 2002

Since its launch, trading volumes have grown only slowly to a daily average of Dong 6 billion (US$400 000) in 2001, and no private sector IPO has taken place. Authorities have so far failed to attract the larger, more successful enterprises, some of them newly privatised, to the market. Many Vietnamese companies are small and financially weak, with only 60 registering capital over Dong 10 billion (US$650 000) making them unsuitable to list. Furthermore, the listing process is not always transparent. In 2001, the lack of tradable shares and restricted price movements imposed large losses on the six licensed securities firms (Tran, 2000). With the perceived high costs and little visible benefits from listing, many public companies are choosing to raise capital and have their shares traded on the informal share market (Saigon Economic Times, 5 October 2001). This market comprises principally of groups of middlemen meeting with clients in local cafes and restaurants. In the absence of a developed share market, there is little room for active institutional investors to play a role in improving corporate governance. No ratings agency exists.
7

Company assets may be undervalued and shares can be allocated to officials, managers, workers and related persons, who then often hold shares tightly. Opaque accounting and asset valuation methods provide little information to potential buyers or sellers.

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MARKET DISCIPLINE EMERGING


While reforms to trade and investment regimes, SOEs, banks and other financing mechanisms are at an early stage, initiatives in some areas could boost discipline on corporate behaviour.

SOE REFORMS
SOE reform began in 1989 as part of Vietnams major economic renewal program, Doi Moi, and after stalling in the mid 1990s, accelerated once more from mid 1998 (Leung, 2001). The Asian financial crisis and growing SOE losses increased government determination to accelerate reform. The National Enterprise Reform Committee, set up in June 1998 and chaired by a Deputy Prime Minister solely responsible for SOE reform, restarted the equitisation process begun in the mid 1990s (Leung, 2001). The Committee also strengthened a push to liquidate non-viable state enterprises. In 1999, to reduce social impediments to restructuring, the state formed the Assistance Fund for Restructuring and Equitising SOEs to finance severance payments for redundancies (World Bank, 2000b). Authorities also devolved control of the equitisation process of provincial SOEs to provincial governments. Other initiatives restructured large state enterprises, restricted state owned enterprise access to credit, increased transparency and introduced diagnostic audits of enterprises. Since 1999, the Government has equitised more than 700 SOEs, resulting in a total capital raising of some Dong 3 000 billion (about US$200 million) from the public. These firms have since increased turnover by 40 per cent, doubled their profits, and increased their tax contributions and workers wages by 20 per cent (Labour, 4 December 2001). By 2004, the Government plans to divest a further 1 800 small SOEs, either through equitisation or outright privatisation (World Bank, 2001). It is quite clear, however, that the government is insistent on retaining ownership and control of the General Corporations, large SOE conglomerates. Authorities plan new reforms to the ownership, regulation and management of SOEs to bring them under the ambit of the 2000 Enterprise Law, governing private companies (Leung, 2001). Despite this, the Ten-year Socio-Economic Plan the Ninth Party Congress approved in April 2001 indicated that for the foreseeable future the Government will retain ownership and control of very large or strategic General Corporations, particularly utilities. In February 2002, Deputy Prime Minister Nyuen Tan Dung announced most large and medium sized SOEs would be converted into limited liability companies, those which did not need to be 100 per cent state owned would be equitised; those too small to list would be sold or leased. Loss making SOEs would be dissolved, merged with other firms or declared bankrupt (Reuters, Feb 2-8, 2002).
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Under equitisation, limited amounts of SOEs shares were sold to selected buyers (Leung, 2001).

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FINANCE MARKETS DEVELOPING


As in most regional economies, particularly formerly centrally planned ones, the banking system dominates corporate lending and has a complex relationship with SOEs.

Banking Sector Reforms


Recent bank reforms are designed to complement programs improving the efficiency of SOEs. The Government developed a plan for restructuring banks non performing loans, reforming the state owned commercial banks and improving banking and financial regulations. In 1999, authorities established the National Development Support Fund, providing direct finance, interest subsidies and explicit guarantees for government directed lending, relieving state owned banks of some of the burden of policy driven lending. In March 2001, authorities introduced commercial lending criteria for the banks to follow; in theory this eventually should reduce SOEs preferential access to bank credit. The Government also has completed diagnostic audits of the four major state owned banks, and authorities are considering introducing an asset management company to take over and manage the state banks non performing loans (Leung, 2001). Looking ahead, the Government plans to recapitalise some state owned banks using government revenue and international aid, while the World Banks International Financial Corporation also may invest in some (Reuters, 3 December 2001).
10 9

Under a scheme designed to subject private banks to greater prudential oversight, banks must purchase deposit insurance from the State Deposit Insurance Company, established in early 2000. However, the company currently lacks the personnel and expertise to assess risk premiums accurately, and the scheme risks the Government assuming the credit risk of joint stock banks if they fail (Leung, 2001).

Private banks
Banks outside the state sector play a minor role; four joint venture banks and 26 branches of foreign banks, including ANZ and Vietnamese Malaysia Bank, have licences to offer a limited range of services. Authorities will soon permit these joint venture and foreign banks to compete fully with domestic banks by removing restrictions on branching and on dong deposit taking and loans.
11

In addition, 44 joint stock banks provide some banking services; many are part owned by SOEs and ethnic Chinese families; the latter are concentrated in Ho Chi Minh City. However, concerns over low capital adequacy ratios of the joint stock banks sector prompted the state to commence a consolidated program, with a view to reducing their numbers to 25 through forced mergers and liquidations (Leung, 2001).

9 10

Many of these reforms mirror those undertaken in Chinas banking sector over the last decade. The Private Sector Forum, a multi-sectoral working group, is working with the State Bank of Vietnam on improving the banking sector. Decision by State Bank of Vietnam on 17 November 2001.

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THE ASIAN COMMERCIAL BANK

The Asian Commercial Bank, headquartered in Ho Chi Minh City, is one of Vietnams largest joint stock banks, with loans of Dong 2 235 billion (US$150 million) and deposits of Dong 5 833 billion (US$390 million) in 2000. Its capital base of Dong 341 billion (US$23 million) is nearly five times the required minimum of Dong 70 billion, giving it a capital deposit ratio of about 6 per cent. However, as deposits grew very rapidly during 2000, its lending also should grow strongly. Currently, the bank is 30 per cent foreign owned and 4.3 per cent owned by an SOE, with the remaining 65.7 per cent of capital from the domestic private sector. The bank eventually must increase its SOE share contribution to 10 per cent of total capital. The Asian Commercial Bank has a 14 member board of directors, including one director from the SOE which has capital in the bank, two directors from its foreign partners (Jardine and the Vietnam Fund) and the rest come from the Vietnamese private sector. All six bank executives are from the Vietnamese private sector. For the past four years, Ernst and Young or PricewaterhouseCoopers have audited the banks accounts. The banks major activities include deposit taking, lending, credit cards, money transfers, foreign exchange, securities, real estate and other investment.
Source: Trieu, 2001

Potential for Stock Market Development


A range of recent and planned reforms should develop the stock market. First, the governments sale of SOE equity eventually should increase the stockmarkets size. By the end of 2002, the Government plans to transform at least seven to ten SOEs into joint stock companies for potential listing (Vietnam Economy, www.vneconomy.com.vn, 26 March 2001). To support this, authorities are improving transparency of the SOE tender process. In 1999, the Government allowed foreign organisations and individuals to buy up to 30 per cent of listed joint stock companies, but foreigners can only purchase such shares in local companies if the Prime Minister gives the company permission to sell them.
12

As well, foreigners cannot buy more

than 20 per cent of companies listed on the stock exchange. Foreigners have not yet invested in the Vietnamese stock market, due to low transparency and high volatility (Phan-Le, 2001). Authorities plan to remove limits on the size of foreigners shareholdings to increase demand, but the market and its regulatory framework are likely to need wider reforms before major foreign investors will enter it. The authorities recognise the increasing need for technical and institutional support to develop the stock market and tackle the frequent cases of fraud relating to false information and failure to complete transactions (Intellasia, 8 June 2001). Using their experience in running the Securities Trading Centre,

12

To date only equitised SOEs have been given such permission. Decision 145/TTg of 28 June 1999.

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the State Securities Commission intends to extend the basic securities markets legislation, first issued in 1998.
13

Regulators also are aware that rules covering foreign participation lack clarity, deterring

foreign investor interest and reducing liquidity (Vietnam Business Forum, 2001). With the support of the Korean Government and stock exchange, authorities plan to establish another Trading Centre for Hanoi in 2002 (Voice of Vietnam, 29 November 2001).

Institutional Investors Developing


Currently, institutional investors role is minor, as insurance companies and banks mostly place surplus funds in government bonds or foreign banks (Leung, 2001). However, banks and insurers, the major institutional investors, appear to be considering a wider range of investments, including securities (Vietnam Chamber of Commerce and Industry, 2001a, 2001b). Banks and insurance companies already can invest in other enterprises equity, and may purchase shares and bonds.
14

In 2001, the

State Bank of Vietnam issued guidelines on capital investment by credit organisations. Institutional investment is showing some promise. The insurance industry is growing at over 20 per cent a year and diversifying its services; eventually these investors could have influence on the corporations in which they invest.
15

PRODUCT MARKET COMPETITION INCREASING


Starting from a fully centrally planned and largely closed economy in 1989, trade liberalisation, increasing foreign participation in the Vietnamese economy and incremental domestic reform gradually is strengthening market forces.
16

Private Sector Developing


In absolute terms, the domestic private sector grew rapidly over the decade to 2001, though the even faster growth of foreign invested enterprises reduced its share of industrial output (Figure 15.2). While foreign joint venture companies drove private sector expansion over the last decade, in 2000, local private sector industrial growth kept pace with foreign invested sector industrial output for the first time (Central Institute for Economic Management, 2001). SOEs relative contribution to industrial output fell continuously over the last decade.

13 14 15

Decree 48/1998/ND-CP, 11 July 1998, outlines procedures on securities and securities markets. Under the Insurance Law and the Credit Organisations Law. Institutional investors now have more diversified ownership and offer more services. Of 15 operating insurers in early 2001, four were state-owned, three were joint stock, four were joint ventures and four were wholly foreign invested companies. Bao Viet, Vietnams largest insurer, now offers 90 services, compared to only 20 in 1994. At the beginning of December 2001, the National Assembly approved a constitutional amendment aimed at levelling the playing field for the domestic private sector by stating that all economic sectors are important integral parts of the socialistoriented market economy. However, as yet, this concepts practical importance for private sector development is unclear (Leung, 2001).

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Figure 15.2 Foreign Companies Production Share Growing, SOEs Shrinking Share of Industrial Output by Ownership, Selected Years
70 SOE 60 50 Domestic Private Foreign Invested

Per cent

40 30

20 10

0 1990 1995 1999 2000

Source: World Bank, 2000a

About 30 000 non-state business entities, including shareholding companies, limited liability companies, private enterprises and close to 1 million households now undertake business activities, operating mainly in trading, handicraft goods, small scale food production and light industries, including clothing, assembly and primitive transport. As in the other East Asian economies, family ownership and relationship based methods of doing business characterise Vietnams private sector (Leung, 2001).

FDI Reforms Significant


Until the mid 1990s, market opening reforms generated strong inward FDI flows and expanding trade. However, FDI inflows dropped sharply after the mid 1990s, due to the Asian financial crisis, slowing reform and increasing transparency issues (Figure 15.3).
17

In May 2000, responding to this

decline, authorities amended the Foreign Investment Law, offering preferential corporate tax treatment for foreign invested enterprises located in industrial parks that export over 50 per cent of their output. In addition, some types of foreign investment now achieve automatic registration, foreign enterprises have improved access to foreign exchange and foreign bank branches can offer mortgages on land. Authorities also granted tax incentives for foreign private entry in the healthcare, education and scientific research sectors.

17

More recent estimates of FDI indicate it is continuing to recover, albeit gradually, improving from 2.7 per cent of GDP in 1998-2000 to 3.2 per cent in 2001 (International Monetary Fund, 2002a).

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Figure 15.3 FDI Peaked in 1995 FDI Disbursement, 1990-2000


2 500

2 000

$US million

1 500

1 000

500

0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: International Monetary Fund staff estimates; International Monetary Fund, 1999a, 2000 and 2002b.

Despite recent reforms, SOEs continue to receive more favourable treatment than the private corporate sector, so to date over half of FDI is in joint ventures with SOEs and another 25 per cent is in business cooperation contracts (Figure 15.4). However, latest FDI trends show commitments are picking up, many joint ventures have moved to become wholly foreign owned and a much larger share of new FDI is now 100 per cent foreign owned.

Figure 15.4 Joint Ventures and Business Cooperation Contracts Dominate FDI Foreign Investment by Type, 1991-98

Business cooperation contracts 23.8%

100% foreign owned 22.4%

BOT 0.1%

JVC with private sector 1.5%

JVC with SOE 52.2%


Source: International Monetary Fund, 1999a

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International Agreements Propel Trade Reform


During the 1990s, much of Vietnams trade liberalisation was unilateral, but more recently, binding international agreements have become the major driver (Warner et al., 2001). Authorities are implementing a trade and investment agreement with the EU and in December 2001 the National Assembly ratified the United States Bilateral Trade Agreement (Leung, 2001).
18

In 2001, Vietnam

completed the transparency phase of its planned accession to the World Trade Organization, and since then it has been negotiating market access with major members. Regionally, the government is committed to liberalising trade and investment under the ASEAN free trade agreement and, on a more voluntary basis, via APEC. These international agreements also are spurring renewed reforms opening many markets to foreign competition. For example, under the US Bilateral Trade Agreement, Vietnam committed to open its banking, insurance and telecommunications markets to partially US owned joint ventures, and in some cases to fully US owned firms. Deadlines vary from two to 10 years (US Vietnam Business Center, 2001). While the agreement applies to the United States only, negotiations are underway for similar agreements with the EU and others. Such market opening should further encourage FDI into Vietnam, supporting the developing private sector and hastening the regulatory reform process. However, until Vietnam achieves World Trade Organization entry, which analysts predict will not be before 2005, trade barriers will continue in many areas, limiting the role of foreign imports in boosting competition.
19

Competition Reforms
The strong SOE presence in particular sectors prevents new firms entering these markets, reducing competition. Authorities are drafting competition laws including market dominance measures, fair trading rules and consumer protection to improve competition. However, implementing these laws will take at least two years and probably longer. Other government reforms encourage private entry into new markets, boosting competition. First, authorities have simplified application procedures for establishing private enterprises. Second, the Enterprise Law of 2000 and subsequent amendments removed requirements for 240 sectoral operating licenses, reducing entry barriers for new firms. Third, provisions under the US bilateral trade agreement improve access in a number of sectors, albeit for US firms only. Authorities also plan to develop a competition policy framework that facilitates mergers and acquisitions of SOEs, superseding current restrictions on SOE and joint stock company ownership.
20

18

The United States BTA provides Vietnam with access to the US market on an MFN basis, equivalent to a reduction in tariffs from about 40 per cent to about 4 per cent (Leung, 2001). Substituting non-tariff barriers for tariffs also limits the impact of foreign competition (McCarty, 1999). However, the Governments announced policy of merging most SOEs into a few very large general corporations could undermine objectives of increasing market competition.

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However, implementing these measures will be gradual. The Government has not yet established an institution to monitor and deter monopoly power, or enabled the court system to hear appeals against government decisions.

REGULATIONS BEGINNING
Vietnams regulatory system is in its infancy. Separate regulatory regimes apply to enterprises with different ownership and to foreign and local firms. Minority shareholders and creditors have little legal protection. The underdeveloped court system does not effectively enforce the few laws governing corporates and debtors, and the bureaucracy struggles to reconcile overlapping and sometimes contradictory laws, decrees and ordinances from different arms of government. Encouragingly, the newly established stock exchange is increasing public debates on corporate transparency, accounting and auditing standards and the accountability of management and boards to shareholders (Leung, 2001). The Government is following international best practice to build institutions to establish and implement new regulations. However, much remains to be done in the few years remaining before WTO entry when Vietnam must open its markets to international players.
21

COMPANY LAW
Authorities gradually are reconciling differences in company laws application to private and SOE firms.
22

For example, in January 2000, the Enterprise Law 2000 substantially reformed company
23

law, applying it to all forms of domestically owned private enterprise.

In the first nine months after its

introduction, 15 000 firms registered under the law, 25 per cent of all private firms registered since 1990; many more would have registered by early 2002 (Clowes, 2002). Once they convert to joint stock companies, SOEs and foreign firms fall under the law (Leung, 2001).

21

David Love, Paul Coleman, Nina Ta and Anna Guthleben, Pricewaterhouse Coopers and PricewaterhouseCoopers Legal, contributed to this section. The other major type of company is the limited liability company, whose liabilities are limited to paid up capital of the company, as with the joint stock company, but the number of owners is limited to a maximum of 50 and they cannot issues shares. The State-owned Enterprise Law 1995 governs SOEs, the Enterprise Law 2000 governs local enterprises, including limited liability companies, joint stock companies, private enterprises, partnerships and sole proprietor companies, the Foreign Investment Law 1996 governs foreign invested enterprises and the Co-operatives Law governs co-operatives.

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SOE GOVERNANCE STRUCTURE

Vietnams major SOEs in were formed in the early 1990s through mergers and liquidations of smaller SOEs. Amalgamations produced two types of large SOE, General Corporations and State Corporations. The major difference between the two is control; the Prime Ministers Office controls General Corporations, while the respective line ministries or local Peoples Committees control State Corporations (Table 15.1). As line ministries also are responsible for technical guidance and regulation, State Corporations in particular suffer from blurred responsibilities, which can detract from good governance. The Government hopes to resolve this conflict of interest through the corporatisation process under the Enterprise Law 2000 (Leung, 2001). In addition, the General Department for the Management of State Assets and Enterprises, part of the Ministry of Finance, exerts financial control over all SOEs. The ministry implemented this system following mismanagement that arose in the mid 1990s. The drawback is that it can compromise autonomy of the SOEs, which is important for their flexibility and competitiveness in the marketplace (Leung, 2001).

Ta b l e 1 5 . 1 SOEs Responsibility Demarcation Complex Governance of Major SOEs


General Corporations State Corporations Central government Organisation and management Technical matters and regulation Financial matters Prime Minister Line ministry Line ministry Line ministry Provincial government Peoples Committee Line ministry
a

General Department for the Management of State Assets and Enterprises

Note: a equivalent to local government. Source: Leung, 2001; Vu, 2001

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TRANSPARENCY
While improvements are likely as part of SOE reforms, corporate transparency standards generally are low, except in larger foreign firms.

Corporate Reporting
SOE reporting standards are low, with much SOE financial information, including annual reports, not available to the public (Narayen et al., 2000b).
24

Private local and foreign invested enterprises


25

companies must submit balance sheets, income statements, cash flow statements and explanations of financial reporting statements to authorities quarterly; SOEs need only do this on an annual basis. The small number of listed firms must comply with enhanced disclosure requirements. Authorities currently do not require reporting on a consolidated basis and of related party transactions, although new standards may correct this. Over time, SOE reforms should improve reporting standards. As authorities encourage SOEs to equitise and list, investors and regulators should demand better levels of disclosure.

Accounting Rules
Accounting laws and practices are in transition towards a more internationally applied system. The 1988 Ordinance on Accounting and Statistics governs accounting and auditing standards, but the accounting system is a set of principles rather than standards, and allows for a variety of treatments and based on a mix of accounting traditions from French, Russian and Chinese standards. Since 1995, a European Union project, EUROTAPVIET, has introduced International Accounting Standards to Vietnamese corporates to gradually replace the Vietnamese Accounting System (Narayan et al., 2000b). In 1999, the Ministry of Finance set up the Accounting Standards Board, responsible for establishing and monitoring accounting standards. The government will enact a new Accounting and Auditing Law and the Ministry of Finance plans to have a complete set of uniform standards, based on international standards, in place by 2003 (Leung, 2001). Foreign companies usually follow international standards, using the big five accounting firms, but local accounting practices of smaller local firms and SOEs are not transparent. The Government is assisting developing professional oversight of accountants. With Ministry of Finance assistance, the Chief Accountants Club formed the Vietnam Accounting Association. Representing the accounting fraternity, this body now has about 5 000 members (Narayan et al., 2000b). As authorities face a raft of problems in the accounting system, including a lack of qualified Vietnamese accountants, strengthening the Vietnam Accounting Association is seen as important. Analysts also believe Vietnam would benefit from establishing a Public Sector Accounting Standards Board based on the International Federation of Accountants.

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See McCarty, 2001 for an overview of accountability in Vietnam. SOEs and foreign invested enterprises have to report to financial bodies, tax authorities, statistical bodies, and licensing body, while private enterprises need only report to the tax authorities and the licensing body.

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Making the transition from existing accounting standards to international ones will be difficult. Time and qualified accountants familiar with both systems are in short supply, given the impending opening of Vietnamese markets to US competition. However, the European Union has set up an accounting institute training local auditing companies in new standards. PricewaterhouseCoopers also runs a program for young Vietnamese accountants, putting them through the UK system (PricewaterhouseCoopers, 2001).

Auditing Standards
As with accounting standards, auditing standards are currently being upgraded. The authorities expect new Accounting and Auditing Law and standards based on international norms will be in place by 2003 (Leung, 2001). By December 2000, authorities had issued ten Vietnamese Standards on Auditing, covering the principles governing the audit of financial statements. Authorities expect to complete a full set of auditing standards by the end of 2002 (Narayan et al., 2000a). Compulsory audit requirements apply only to foreign invested enterprises and some large SOEs. In 2000, the State Audit Department audited 100 large SOEs uncovering evidence of significant fraud (PricewaterhouseCoopers, 2001). No requirement for internal or external auditing of financial statements exists under the Enterprise Law (Leung, 2001). While tax authorities usually scrutinise enterprises financial reports, they focus only on incomes and expenditures for tax purposes. The lack of centralised and accessible database of corporate information makes due diligence and auditing difficult.

MANAGING QUALIFIED AUDIT REPORTS

A culture of corporate governance is still not ingrained among major Vietnamese corporations. Short term expediency can take precedence over long effects on corporate reputation. For example, a large local institution published financial statements in its annual report bearing no resemblance to its audited financial statements signed off by one of the major international auditors firm and presented to an international funding agency. The annual report also quoted very selectively from the auditors report, which only referred to favourable remarks and omitting qualifications. As a result of the auditors strenuous objection, the Vietnamese corporation withdrew the annual report and published a public apology. However, directors and the institution appeared to suffer no serious consequences to their reputations and financial standing, indicating corporate governance concerns are still in their early stage of development.

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MINORITY SHAREHOLDERS RIGHTS


The relevant legislation, the Enterprise Law, provides inadequate protection of minority shareholders (Leung, 2001). Provisions exist for proxy voting and certain critical decisions require 65 per cent of shareholders to vote, but no provisions exist for cumulative voting, class action suits against management, one share-one vote or insider trading rules. Several cases of insider trading and disclosure avoidance have gone unpunished, simply because currently such behaviour is not illegal (Vietnam News Agency, 22 November 2001). Company charters can often work against minority shareholders. In one case, the company charter stipulated shareholders must hold a minimum number of shares to attend the annual general meeting; in another case, a company decreed only shareholders holding shares valued over Dong 100 million (about US$7 000) would receive annual reports (Vietnam Economic Times, 7 February 2001; Securities, 19 May 2001). Legal provisions for mergers and acquisitions also remain undeveloped. The enterprise law does not cover interlocking shareholdings acquisition limits, or outlaw management practices like poison pills or green mail.
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Listing Rules
At present, listing rules have negligible impact on corporate governance standards, but the number of listed companies is rising and listing rules may become more relevant as the stock exchanges role expands. The stock exchange, effectively the business arm of the State Securities Commission, issues the permits for listing, which for practical purposes act as listing rules. As at January 2002, more than 60 companies met the eligibility criteria to list, but due to the limited functionality of the stock exchange, only 11 had actually listed. Under State Securities Commission rules, listed companies must register capital of at least Dong 10 billion, run profits for two successive years, possess a feasible business plan and have experienced directors. Over 100 outside shareholders must hold 20 per cent of the capital. rules also provide for outside investors and require auditing of accounts. To list on the Ho Chi Minh City Securities Trading Center, an SOE must equitise and transform into a joint stock company. After equitisation, the enterprise comes under the Enterprise Law 2000 and the State becomes a normal shareholder of the enterprise.
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Founding shareholders must control at least 20 per cent of the capital for the first three years. Listing

26

A poison pill occurs when, to avoid a takeover, management issues existing shareholders rights to buy more shares at bargain prices. Green mail occurs when management repurchases shares from a subset of shareholders, normally potential raiders, at a premium (Leung, 2001). Both practices typically are illegal in most economies. Article 22, State Securities Commission, 27 March 1999. For those with capital of Dong 100 billion or more, the proportion is 15 per cent.

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Board Structure and Duties


Under the 2000 Enterprise Law, the annual general meeting of joint stock companies appoints a supervisory board and supervises management and the board of directors. It has the power to call a special general meeting to remove directors or managers if they violate the law, the company charter or resolutions of the annual general meeting. Oversight of accounting practices is another board duty. One area where the law is deficient is in the role of the supervisory board, which only the company charter, not legislation, determines. Also, the Enterprise Law contains no statutory penalties for directors who fail to fulfil their fiduciary duties (Leung, 2001). A Board of Management and a general director, or general manager manage large SOEs. A single director, or general manager, manages small and medium sized SOEs. The State appoints members of the board and general managers. The enterprise Charter defines the powers of the board and managers. To some extent, the board functions as a state representative, reducing its ability to provide independent scrutiny of management. The relationship between the general manager and the board often is unclear. Although the general manager is the legal representative of the SOE, some transactions require approval by both the general manager and the board.

CREDITORS RIGHTS
Creditors currently have very limited rights.

Bankruptcy Laws
Vietnam currently lacks a functioning bankruptcy law to allow debtors and creditors to restructure financial obligations, secure collateral and force insolvent firms to close operation. The current law, introduced in 1993, also includes inconsistencies and ambiguities. In addition, the underdeveloped court and judicial system make these laws difficult to implement effectively. Since 1993, only 22 bankruptcy cases have been brought to Ho Chi Minh Citys Commercial Court, and of those only three eventually were declared bankrupt; the remainder were dismissed or are still pending (Leung, 2001). This compares to 300 companies which disappeared without formal liquidation in the first nine months of 2001 (Youth, 16 November 2001). One case which caused a scandal was the inability of the bankruptcy law to liquidate the Minh Phung Company, one of Vietnams biggest business scams in the late 1990s. Even though the entire board of directors and many of its executives have been sentenced either to death or imprisonment due to misappropriation of the companys assets, the company was not subject to bankruptcy proceedings (Youth, 2 November 2001). The Government recognises further development of the financial and private corporate sector requires bankruptcy law upgrading. In the 2001 Memorandum on Economic and Financial Policies, the Government stated it aims to strengthen creditor rights relating to the foreclosure of collateral, liquidation of assets on a market basis, and transfer of land use rights. With Asian Development Bank support, authorities are attempting to develop an effective, modern bankruptcy law for Vietnam. However, the

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weak legal system and a shortage of bureaucrats skilled in this area hamper this process. Many regulatory institutions currently have limited the capacity to implement new laws fully (International Monetary Fund, 1999b).

Bank Supervision
Several reforms to the banking sector are well under way, including reducing directed credit, allowing freer foreign bank operation and restructuring joint-stock banks. The 2001 Memorandum on Economic and Financial Policies outlined new efforts to strengthen banks regulatory framework and supervisory oversight in line with international best practice. These reforms will build on earlier measures, including of legislation improving banking system regulation.
29

Historically, banks poor accounting practices made credit evaluation problematic, while the bank supervisors lacked necessary human and physical resources to enforce prudential standards. Many state banks still do not declare the true level of their non performing loans. The World Bank is providing technical assistance to Vietcombank, has drafted restructuring plans for another three banks and has funded international accounting standard audits of the largest banks.

ENFORCEMENT
The still developing role of civil society and a free media places greater onus on the legal and regulatory systems to ensure corporations comply with regulations and protect outside investors. However, the legal system currently cannot adequately undertake this role, and further work is needed in reviewing, consolidating and translating relevant laws. Several legislative inconsistencies make implementing laws difficult. One of the main barriers to creating a functioning system of commercial law is the lack of an independent judiciary and courts system with sufficient commercial knowledge to interpret and enforce laws. According to a 1999 survey, 91 per cent of Vietnamese private sector managers doubted the courts enforcement power, compared to 58 per cent in Russia and 55 per cent in the Ukraine (McMillan et al., 1999). This lack of public confidence in the judiciary and the courts system exacerbates the ineffectiveness of many commercial laws. The bilateral agreement with the United States may encourage authorities to overhaul the judicial system. Improved corporate governance can only occur if those in breach of the law are brought to court and convicted (Leung, 2001). However, it is yet too early to determine whether and when the Government will respond to this challenge.

29

These include the State Bank Law, the Credit Organisations Law, the Decree on the organisation and operation of foreign bank branches and representative offices of foreign bank branches, the Decree on securities and securities exchange, the new Decree on foreign exchange control, and the Decree on security transactions.

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Media
Vietnam has a high level of literacy and education; this provides the media with an informed readership and encourages improving media quality. While editorial independence is still limited, the number and range of the financial press is impressive. Hence, the ingredients exist for developing a well-informed public, capable of applying market discipline to corporate behaviour.

IMPLICATIONS
While new laws and other reforms are occurring quickly, Vietnams current corporate structure, market conditions and regulatory and legal framework do not yet promote good corporate governance. Most business continues to be undertaken on the basis of relationships. Considerable time and effort are needed to develop and particularly enforce a robust rules based corporate governance environment capable of protecting outside investors and creditors. For this to happen, corporate, government and legal cultures need to develop in parallel with legal reforms to ensure laws and regulations are implemented and become effective and functional. Given the short timeframe Vietnam has until it is obliged to open many of its key markets to international competition, the authorities need to move with some urgency if Vietnam is to avoid being exposed to the consequences of risky corporate behaviour exhibited in neighbouring East Asian economies prior to the Asian financial crisis.

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REFERENCES
Asian Development Bank, 1999, Report and Recommendation of the President to the Board of Directors on Proposed Loans and Technical Grants to the Socialist Republic of Vietnam for the State-Owned Enterprise Reform and Corporate Governance Program, Asian Development Bank, Manila. Central Institute for Economic Management, 2001, The Economy of Vietnam, April, 2001, Hanoi. Clowes, D., 2002, Advice to the Economic Analytical Unit from senior partner PWC Vietnam, Ho Chi Minh City, February. International Monetary Fund, 2002a, IMF Survey, vol. 31, no. 2, www.imf.org, accessed February. 2002b, Vietnam: Selected Issues and Statistical Appendix, www.imf.org, accessed February. 2000, Vietnam: Statistical Appendix, www.imf.org, accessed June 2001. 1999a, Vietnam: Statistical Appendix, www.imf.org, accessed June 2001. 1999b, Vietnam: Selected Issues - Chapter V, Summary of Vietnam Governance Assessment. Basic Parameters of Governance. Key Governance Issues in Cambodia, Lao PDR, Thailand, and Vietnam. Lardy, N., 2002, Integrating China into the Global Economy, Brookings Institution, Washington D.C. Leung, S., 2001, Consultancy prepared for the Economic Analytical Unit, December. and Doanh, Le Dang, 1998, Vietnam in McLeod, R. H. and Garnaut, R. (eds), East Asia in Crisis, Edward Elgar Ltd, United Kingdom. Leung, S. and Riedel, J., 2000, The Role of the State in Vietnams Economic Transition, paper presented at Conference on Achieving High Growth: Experiences of Transitional Economies in East Asia, Australian National University, September. McCarty, A., 2001, Governance institutions and incentive structures in Vietnam, Paper presented at Building Institutional Capacity in Asia conference, Jakarta, www.riap.usyd.edu.au/bica, accessed February 2002 1999, Vietnams Integration with ASEAN: Survey of non-tariff measures affecting trade, UNDP project VIE 95/015, www.undp.org.vn/projects, United Nations Development Programme, Hanoi, accessed February 2002. McMillan, J. and Woodruff, C., 1999, Inter-firm Relationships and Informal Credit in Vietnam, Quarterly Journal of Economics, vol. 114, no. 4, pp. 1285-1320. Narayan, F.B. and Godden T., 2000a, Financial Management and Governance Issues in Vietnam, vol. 1, Asian Development Bank and World Bank.

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Narayan, F.B., Godden, T., Reid, B. and Ortega, M. R. P., 2000b, Financial Management and Governance Issues in Selected Developing Member Countries, Asian Development Bank. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Riedel, J., 1999, Needed: a Strategic Vision for Setting Reform Priorities in Vietnam, in Leung, S. (ed.), Vietnam and the East Asian Crisis, Edward Elgar, United Kingdom. Trieu Hong Cam, 2001, Mimeo, Economics University, Ho Chi Minh City, December. US Vietnam Business Center, 2001, Vietnam Trade Agreement: Summary of Key Provisions, www.usvietnam.com, accessed February 2002. Vietnam Chamber of Commerce and Industry, 2001a, Life insurers search for investments, www.vcci.com.vn/English/BusinessNews/, accessed July. 2001b, Insurers warned on payments ability, www.vcci.com.vn/English/BusinessNews/, accessed July 2001. Vu Quoc Ngu, 2001, State owned Enterprises Reform in Vietnam, draft PhD thesis, Australian National University, Canberra. Warner, R., Vu Q.M., Nguyen V.C. and Nguyen Q.T., 2001, Economic Integration and Vietnams Development Strategy, Project VIE/99/002, Ministry of Planning and Investment and UNDP, Hanoi. World Bank, 2000a, Vietnam 2010: Entering the 21st Century, World Bank, Washington. 2000b, Vietnam: Taking Stock, World Bank, Washington. 2001, Vietnam Economic Monitor, World Bank. Spring 2001.

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SINGAPORE

KEY POINTS
Singapore has one of the regions best corporate governance frameworks; its well developed financial markets and rules generally protect outside investors. A recent survey of institutional investors ranked Singapore as the second most desirable investment destination after Australia in the region. Low trade and investment barriers expose Singapores corporates to international competition, so goods markets are very open and efficient. However, the Government increasingly recognises its involvement in several services sectors may shelter some firms from international competition. Government linked companies, GLCs, also constitute a large proportion of Singapore corporate sales and assets, possibly weakening outside investor protection and contributing to barriers new market entrants face. Encouragingly, the Government is partly responding to these concerns by selling its shares in some GLCs. Since the crisis, the Government has further improved the formal corporate governance framework, moving to a disclosure based system with strong market incentives supporting self-compliance. In January 2000, the Government established the Corporate Governance Committee and subsequently adopted many of its recommendations. As part of new listing rules, companies must comply with the new voluntary Corporate Governance Code or publicly disclose any failure to do so. Regulators key priorities include improving corporate disclosure, clarifying the roles of the chairman and CEO and better defining the relationship between boards and management.

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Singapores well developed corporate governance and financial market regulatory framework generally protects outside investors. Its sound prudential and corporate governance framework helped Singapore largely avoid the crisis and since 1997, the Government has upgraded the business regulatory framework and started to reduce its role in corporate and financial sectors (Teen, 2000). While institutional investors rank Singapore highly as an investment destination, the top 20 corporates are GLCs and operate within a different incentive structure to privately owned corporates (PricewaterhouseCoopers, 2001).

CORPORATE STRUCTURE
Singapore has an unusually high level of government involvement in its corporate sector for a market economy, the heritage of the Governments proactive role in Singapores post-Independence economic development. The private sector is typical of East Asia, with a high proportion of family owned and managed firms.

Government Ownership Important


Some analysts see the GLCs dominant market position and level of government support as Singapores major corporate governance issue. Of Singapores largest 500 firms, GLCs account for 12 per cent of total sales, 19.5 per cent of profits and 23 per cent of assets. Temasek Holdings, the state investment vehicle, controls state investments valued at S$47 billion, including Singtel and Singapore Airlines, but it does not detail its entire holdings (Claessens et al., 1999). Temasek companies operate in transport, media, financial services, property development and leisure sectors. The Government also owns a significant share of the largest bank, Development Bank of Singapore (South China Morning Post, www.scmp.com, 27 June 2001). While the Government remains a relatively passive shareholder and GLCs operate like other major companies, GLCs have public duty obligations which may expose them to sub-optimal investments (Ong et al., 2001). As well, many GLCs have close, non-transparent relationships with regulators; regulators sit on GLC boards, potentially providing them with advantages over private corporates. No large and few small GLCs have been declared bankrupt, despite some incurring serious losses; consequently, GLC managers may face moral hazard issues in determining investments. GLCs have ready access to low cost finance, including in the past from the Development Bank of Singapore and the compulsory national pension fund, raising questions about the extent of market discipline these companies face.

Families Important Also


Private sector corporates are highly concentrated; the top ten families control 25 per cent of Singapores corporate sector. Families also control three of the four large listed banks including several that are part of large non-financial conglomerates. Unlike many other Asian family corporates, Singaporean ones often appoint outside managers, increasing distance between managers and owners and possibly boosting minority investor protection (Naughton, 2001). However, more than elsewhere in the region, owners use pyramid structures to ensure control, reducing transparency and increasing outside investors risk (Claessens et al., 1999).
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MARKETS WORKING WELL


Despite Singapores unusual corporate structure, open trade and foreign direct investment make most domestic markets competitive and efficient, although some service sectors have some protection. Singapores large and deep share market also generally disciplines corporate behaviour.

DIRECT FINANCING PROMINENT


While local banks still significantly finance domestically oriented private corporates, Singapores direct financing markets are well developed and deep. In 1999, its share market capitalisation peaked at US$198 billion or over 250 per cent of GDP, second only to Hong Kongs in East Asia (Figure 16.1) (Naughton, 2001). In 2000, 390 companies were listed, up sharply from 266 in 1996, including 43 foreign companies. Since 1999, each year an average of 13 foreign firms have listed, highlighting the markets quality and appeal (Naughton, 2001). Singapore is one of only three East Asian economies CalPERS includes in its Equity Permissible Country List. The Australian Stock Exchange also crosslists Singaporean firms (Shaw, 2001). However, with a few large family companies and the state tightly holding a high proportion of listed equity, market liquidity and turnover is not high by regional standards, reducing the share markets potential to discipline corporates (Naughton, 2001). Furthermore, debt to equity ratios for construction sector firms are five times greater than those in the manufacturing sector, reflecting their family owners preference for bank over equity finance (CEIC, 2002).
1

Figure 16.1 Share Market Large and Increasing Share Market Capitalisation to GDP, 1990-2000
3.5

3.0

2.5

Ratio

2.0

1.5

1.0

0.5 1990
Source: CEIC, 2002.
1

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

By regional standards, Singapores market turnover ratio of 67 per cent is modest (Naughton, 2001).

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In 2000, the Singapore Stock Exchanges new guidelines granted companies greater freedom in issuing initial public offers. After the financial crisis, initial public offers collapsed but since 1999, they have grown strongly (Figure 16.2). Singapores share market regulations now encourage acquisition and merger activity; this should increase management discipline. In November 2000, the Securities Industry Council modified the takeover code so a company or individual investor can bid for more than 50 per cent of another company without having to bid for all the outstanding shares (Ing Barings, 2000). Also, to increase transparency, now a bid for 25 per cent or more of a companys stock triggers a takeover; this is below the regional norm of 30 to 35 per cent (Naughton, 2001). Since the crisis, banking sector merger activity in particular has increased and foreign acquisitions have more than tripled (Hale, 2001). For example, in June 2001, Overseas Chinese Banking Corporation launched a hostile bid for Keppel TatLee Bank, and Development Bank of Singapore bid for Overseas Union Bank (South China Morning Post, www.scmp.com, 27 June 2001). A friendly bid from United Overseas Bank countered Development Bank of Singapore Banks bid; United Overseas Bank prevailed in August 2001 (Far Eastern Economic Review, www.feer.com, 13 September 2001).
2

Figure 16.2 Initial Public Offerings Recovering IPOs, 1990-2000


8 000 7 000 6 000 5 000

S$ million

4 000 3 000 2 000 1 000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: CEIC, 2002.

No individual investor can take up more than 5 per cent of an offering without a waiver from the exchange, although waivers are given frequently.

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The new Securities and Futures Act consolidates the existing Securities Industry Act, the Futures Trading Act and Companies Act provisions on capital raising. The draft introduces a single regime for licensing securities and futures intermediaries (Shanmugaratnam, 2001); it should further strengthen enforcement of listed firms corporate governance standards.
COMPETITION SHAKES OUT STOCKBROKING BUSINESS

Regional competition and declining margins are forcing family owned stockbroking firms to merge and rationalise. In October 2000, Singapores ongoing financial liberalisation freed up stockbroker commissions. Opening the market to foreign rivals and online trading ensures tough competition for commissions. In 1998, 51 per cent Goh family owned stockbroker, GK Goh Holdings, merged with family owned Lee and Company. In 2000, 40 per cent family owned stockbroker, Ong Asia, reported its earnings fell 60 per cent; it may partner various other stockbrokers. Some analysts predict the number of brokerages could decline from 25 in mid 2001 to five or six by the end of 2002.
Source: Far Eastern Economic Review, www.feer.com, 7 June 2001.

The bond market also has developed strongly in recent years, achieving record issues in 2000 (Figure 16.3). Government run statutory boards like the Land Transport Authority and Jurong Town Corporation issue bonds, creating a sovereign yield curve as a benchmark for private issue prices (Far Eastern Economic Review, www.feer.com, 10 August 2001).

Figure 16.3 Bond Market Surging Corporate Debt Issues, 1995-2000


16 14 12 10
S$ billion

8 6 4 2 0 1995 1996 1997 1998 1999 2000

Source: CEIC, 2002.

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INSTITUTIONAL INVESTORS ACTIVE


Government plays an important role in managing Singapores significant institutional investment funds. The Central Provident Fund, the state run pension fund, manages S$80 billion in investments from all Singaporean wage and salary earners compulsory contributions (Financial Times, www.ft.com, 30 April 2001). In addition, the Singapore Government Investment Corporation invests around US$100 billion of Singapores foreign reserves and GLC profits in bond and equity markets, GLCs and some start-up firms. Private institutional investors actively influence corporate governance; 55 per cent of large investors believe the investment community drives improvements in governance (Institutional Analysis, 2001). large firms corporate governance although no corporates publish them as yet (Saavedra, 2001).
4 3

In June 2000, foreign portfolio investment stood at US$3.3 billion. Some ratings agencies grade

INITIAL PUBLIC OFFERINGS RULES ENFORCED STRICTLY

The Singapore Exchange insists on inclusive and transparent IPOs. For example, in 1998, after local oil-drilling equipment maker, Mid-Continent Equipment, offered 90 per cent of its shares to five individuals, the exchange discovered the transactions. For eight days, stock prices gyrated wildly until the exchange forced the float manager to buy back shares from burned investors at a high price and delisted the stock, forcing losses on the five original buyers. In January 1999, the Commercial Affairs Department raided the offices of Kim Eng Securities, seizing documents related to an Internet companys IPO. In addition, under new insider trading laws, the Government can sue stock manipulators for the assessed amount those on the other side of the trades lose.
Source: Far Eastern Economic Review, www.feer.com, 3 February 2000.

PRODUCT MARKETS HIGHLY COMPETITIVE


Under Singapores liberal trade and investment regimes, except in some service sectors, local firms face high levels of competition. Since 1990, each year foreigners have increased their investment in Singapore (Figure 16.4) (World Trade Organization, 1999). However, in some service and utility sectors, foreign investment remains restricted. In 1999, authorities lifted the 40 per cent investment limit in locally incorporated banks. Now foreigners can own up to 74 per cent of telecommunications firms. Restrictions remain in some electricity and water services, and on property acquisitions. No limits exist on portfolio investment.
3 4

However, traditionally, most of this has been invested in government bonds. In October 1999, PricewaterhouseCoopers and the Singapore Stock Exchange surveyed 47 corporate investors, including security dealers and brokers, asset management firms, banks and insurance companies; 55 per cent of these large investors came to this conclusion.

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Figure 16.4 FDI Important and Rising Inward FDI Flows, 1990-1999
160 140 120 100

S$ billion

80 60 40 20 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Source: CEIC, 2002.

Singapores virtually free trade status means goods, other than alcohol and some agricultural products, attract no tariffs. Import prohibitions and licensing measures comply with international safety standards, apart from a few items for reasons of food security (World Trade Organization, 1999). With tariffs low, import penetration is high, so manufacturing sector managers face global discipline in their investment decisions. Like Hong Kong, Singapore has no competition law, believing its free markets make this unnecessary.
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However, GLCs powerful positions in many sectors raise concerns about entry barriers new firms face (World Trade Organization, 1999). Traditionally, many GLCs often monopolised their market, blocking new entrants and competition. In addition, Temasek firms may subsidise each other and crowd out smaller private firms (World Trade Organization, 1999). Most GLCs are large, especially in the service sector, where competition generally is lower. Major GLCs rarely, if ever, fail; instead, they restructure or merge. By contrast, private firms often fail, disciplining remaining firms (Figure 16.5). Although GLCs generally appoint outside directors, the Government influences these appointments and companies operation. Nevertheless, most directors merit their appointments and separating ownership and management produces good governance.

The Government has established regulatory frameworks in service sectors undergoing liberalisation, including telecommunications and energy (World Trade Organization, 1999).

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Figure 16.5 Bankruptcies Discipline Firms Number of Companies Wound Up, 1990-2000
400 350 300 250 Number 200 150 100 50 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: CEIC, 2001.

GOVERNMENT REVIEWS ITS ROLE


The Government is responding to investor and WTO concerns about the GLCs potential impact on competition and governance standards and reducing its presence in finance, goods and service markets. It also is increasing banking sector competition through mergers and more relaxed foreign entry.

Privatising Singapore Inc


The Government recognises reducing the role of GLCs is important to increasing Singapores dynamism, by encouraging new private firms to enter Singaporean markets. In May 2000, the Government reiterated it would continue to sell down its holdings in large firms, gradually floating many large GLCs (South China Morning Post, www.scmp.com, 17 May 2001). In 2001, it reduced its stake in Singtel, surrendered its veto power over important corporate decisions and removed Singtels monopoly. Singtel, Singapore Airlines and Development Bank of Singapore are all listed on the stock exchange, exposing them to listing rules (Lee, 2001). Before it sells them, the Government encourages larger GLCs to operate in overseas markets, so they compete internationally and foreign shareholders can scrutinise them (Far Eastern Economic Review, www.feer.com, 4 October 2001). In 2001, Singtel acquired Cable and Wireless Optus and Development Bank of Singapore took control of Hong Kongs Dao Heng Bank. The Government

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stresses these firms have full commercial freedom when investing abroad and all GLCs answer to their private shareholders (South China Morning Post, www.scmp.com, 17 May 2001; Ong et al., 2001). Foreigners can invest in most GLCs, although limits remain on Singapore Airlines and Singapore Press Holdings.

Government Role as an Institutional Investor


Singapores aged population increases by 6 per cent per year, boosting demand for a competitive institutional investor sector. With Central Provident Fund real returns low, averaging only 0.07 per cent per year between 1987 and 1998, many Singaporeans will need additional retirement funds. For example, 24 per cent of retiring fund members hold less than S$16 000 in their accounts (Far Eastern Economic Review, www.feer.com, 25 May 2001). In 2000, the Government began outsourcing part of the funds management of its Central Provident Fund, providing opportunities for private asset managers. This has the potential to increase institutional investors role in improving local listed companies corporate governance. New regulations also should allow independent financial advisers to become intermediaries for retail investors (Far Eastern Economic Review, www.feer.com, 1 March 2001).
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Other government and private institutional investors also have a growing role. Since 2001, workers also can voluntarily place additional retirement savings with private firms through the Supplementary Retirement Scheme (South China Morning Post, www.scmp.com, 9 February 2001). American International Assurance controls more than half of the Singaporean life insurance market, although in June 2000, Citibank entered the insurance market, aiming to gain a 20 to 25 per cent market share within five years (Far Eastern Economic Review, www.feer.com, 25 May 2000). Government increasingly uses its position as a large investor to increase governance standards. In 1999, Temasek Holdings introduced separate chairman and CEO functions, director rotations and limited board member tenure in GLCs (Asian Corporate Governance Association, 2000). Many GLCs have audit and remuneration committees and by 2003, all must comply with Singapores new code of corporate governance (Sim, 2001). The code encourages companies to focus on shareholder value and protect minority shareholders (Ong et al., 2001).

Banking Sector Reforms


More liberal rules allowing foreign entry also increases discipline local banks face. In October 1999, four foreign banks, ABN Amro, Banque National de Paris, Citibank and Standard Chartered Bank, received Qualifying Full Bank privileges and several more received restricted bank licences (Business

Since 1994, fund members have been able to invest in private unit trusts and with foreign fund managers, although they must retain S$60 000 in the fund, including applicable housing assets. By December 1998, only around 16.5 per cent of members used these accounts (Sim, 2001; Far Eastern Economic Review, www.feer.com, 25 May 2000). In recent years, the Singapore Government Investment Corporation has allocated S$30 billion of its overseas invested funds to private fund managers including Dresdner RCM, JP Morgan and Alliance Capital (South China Morning Post, www.scmp.com, 24 May 2001).

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Times Asia, www.business-times.asia1.com.sg, 30 October 2001; South China Morning Post, www.scmp.com, 9 May 2001). In December 2001, Malayan Banking Berhad and HSBC also received Qualifying Full Bank privileges. Other recent Monetary Authority of Singapore measures also should increase competition local banks face, boost lending efficiency and raise corporate governance scrutiny. It encouraged the previous top five banks to merge, reducing the number of commercial banks to three in preparation for foreign entry. Under new regulations, banks must separate their financial and non-financial holdings. The Government also has dropped restrictions on foreign bank branching and ATMs (Sim, 2001).

COMPETITION IMPROVES BANKS GOVERNANCE

With growing international competition, many Singaporean banks have replaced family managers with foreign professionals and reviewed their internal management. In 1999, family owned Overseas Chinese Banking Corp appointed Hong Kong based Alex Wu as CEO. In 2000, many elderly board directors retired and the bank appointed over 100 foreigners to senior management positions. The bank also is divesting non-core assets, including property, to streamline operations. Recently, Development Bank of Singapore appointed a French national as CEO and took over several regional banks to prepare it for tough regional competition.
Source: Far Eastern Economic Review, www.feer.com, 8 March 2001.

REGULATORY FRAMEWORK STRONG


Despite relatively sound pre-crisis standards, since 1997, the Government has further improved the corporate governance framework to insulate Singapore from contagion and strengthen its position as a regional financial centre.
89

In January 2000, the Government established the Corporate

Governance Committee, which recommended a new Code of Corporate Governance. New listing rules were introduced in April 2001 to require disclosure in relation to compliance with the Code. By 2003, companies must either comply with the new voluntary Corporate Governance Code, or publicly disclose in their annual reports any areas where they fail to comply (PricewaterhouseCoopers, 2001). In the late 1990s, three committees examined disclosure and accounting standards, company legislation and the regulatory framework. Their recommendations should bring Singapores corporate governance framework to a best practice disclosure based model, with strong market incentives encouraging regulatory compliance (Asian Corporate Governance Association, 2000). However, while
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Yeoh Oon Jin, Keoy Soo Earn, Keith Stephenson, Revathy Mahendra-Rajah and Haidi Wilmot, PricewaterhouseCoopers and PricewaterhouseCoopers Legal contributed to this section. The Monetary Authority of Singapore, Registry of Companies and Businesses, Securities Industry Council and Singapore Stock Exchange formally regulate corporate governance. These were the Disclosure and Accounting Standards Committee, Corporate Governance Committee and Committee on Company Legislation and Regulatory Framework, which is yet to report.

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transition is underway, the Monetary Authority of Singapore still regulates banks using a strongly merit based approach, rather than insisting on a high level of disclosure and leaving discipline to the market. For regulators, key priorities include improving corporate disclosure, and clarifying the role of chairman and CEO, and the relationship between board and management (Asian Corporate Governance Association, 2000).

TRANSPARENCY
While reporting requirements are world best practice, at least until recently disclosure was not outstanding. For example, in an October 1999 survey, most of the 47 corporate investor respondents were concerned about local financial reporting standards (PricewaterhouseCoopers, 2001). In August 2001, the Disclosure and Accounting Standards Committee suggested improving transparency through better enforcing of accounting standards (Sim, 2001). The Government now presses GLCs to improve their transparency standards (Saavedra et al., 2001).

Corporate Reporting
Before the October 2001 Securities and Futures Act existed, corporates faced limited disclosure requirements, mainly relying on voluntary compliance (PricewaterhouseCoopers, 2001).
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The

Singapore Stock Exchanges reporting guidelines, included in its voluntary Best Practices Guide, contained few specific details, so many companies disclosed the minimum information the Companies Act required (Teen et al., 2000). However, the new law significantly increases disclosure obligations by giving statutory backing to the listing requirements regarding disclosure, which are now at world best practice levels (Shaw, 2001). In 2001, stronger prospectus requirements ensure prospectuses include all the information investors reasonably expect, although enforcement lags. Under the new law, companies must report annually, within five months of financial year end, and disclose all information likely to affect securities prices, including changes in directors and senior management and key transactions. Companies must disclose substantial shareholders direct and deemed interests and the names and holdings of the companys top 20 shareholders. directors need not disclose dealings with related parties (Teen et al., 2000). Despite stricter regulations, surveys indicate companies often report too little, too late; 246 of the 291 local companies posting interim results for the six months to 30 June 2001 did not pass the Business Times Corporate Transparency Index.
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However,

However, since the crisis, GLCs have lifted their

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Post crisis reviews of corporate reporting recommended strengthening disclosure requirements. The Corporate Finance Committee of the Financial Sector Review Group recommended imposing a statutory obligation on companies to disclose information, like the UK, United States, Australian and Canadian approaches (PricewaterhouseCoopers, 2001). The Corporate Governance Committee also recommended making disclosure about companies level of compliance with the corporate governance Code compulsory under listing rules (Shaw, 2001). However, the law identifies direct interests, who often include nominee shareholders, rather than actual beneficial shareholders. The Corporate Transparency Index score is based on what a companys interim report contains and how it is conveyed.

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reporting standards. For example, the survey ranked partially state owned Development Bank of Singapore as having the second best corporate governance amongst Singapores five banks (Business Times Asia, www.business-times.asia1.com.sg, 30 October 2001).

Accounting Standards
Singapores sound accounting standards are based on International Accounting Standards. The Accounting Standards Committee of the Institute of Certified Public Accountants of Singapore develops and maintains Statements of Accounting Standards, and ensures accountants and companies comply with accounting standards (PricewaterhouseCoopers, 2001; Shaw, 2001). Professional accounting standards are in line with developed countries, but are not backed by law, so accounting professionals monitor standards when auditing companies. However, enforcing accounting standards is less effective than in other developed countries (Teen et al., 2000). Consequently, the Disclosure and Accounting Standards Committee advocates legislation to enforce accounting standards (PricewaterhouseCoopers, 2001).

Auditing Standards
Generally, Singapores auditing standards are sound; the Companies Act requires all companies be audited and the Registry of Companies and Businesses enforces this (Shaw, 2001). Although they lack legal backing, the Singapore Standards on Auditing, based on the International Guidelines on Auditing, define the form and content of audit reports. Companies usually conduct internal audits to complement mandatory external audits. The Best Practices Guide referred to in the Singapore Exchanges Listing Manual recommends that the audit committee comprise at least 3 directors, all non-executive, the majority of whom, including the chairman, should be independent. Under the Companies Act and Listing Rules, all companies must set up audit committees, though some analysts indicate they play little role at present. However, as skill sets increase they may be expected to have more impact.
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MINORITY SHAREHOLDER RIGHTS


Minority shareholder protection is reasonable, although cross-holdings and pyramiding can obscure company control. Under the Companies Act, Articles of Association grant shareholders generally sound formal rights. Increasing institutional investor activism boosts the relevance of new regulations protecting minority shareholders. Companies take the Singapore Exchanges concerns about minority shareholder treatment very seriously. For example, in the Serial System takeover attempt, the executive involved offered to compensate those disadvantaged. The Securities Industries Council hears cases of alleged wrong doing, evaluates the evidence and combines legal action and suasion to ensure compliance. Sanctions include private reprimand, public censure or action designed to deprive the offender temporarily or permanently of securities market facilities (Shaw, 2001).

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The internal auditor usually reports solely to the audit committee. The Public Accountants Board regulates external auditors.

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Listing Rules
Singapores exchange employs both voluntary and mandatory listing standards, including the Listing Manual, the Best Practices Guide and the Corporate Governance Committees Code of Corporate Governance (Sucharitakul, 2001). Since April 2001, listed companies have disclosed corporate governance practices, including deviations from the Corporate Governance Committees Code of Corporate Governance. From 1 January 2003, companies must comply with the Code for Annual General Meetings. The new Securities and Futures Act resembles the Australian Financial Sector Reform Act; it upgrades listing rules to international standards, requires listed companies to adopt continual disclosure and makes directors civilly and criminally liable for misdemeanours (Shaw, 2001; Shanmugaratnam, 2001). The securities exchange rarely delists or suspends companies for failing to comply with listing rules (Sucharitakul, 2001).
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Instead, it releases a press statement naming companies which fail to comply

with disclosure or other rules. In the case of disclosure breaches, authorities believe this sanction injures directors reputations but does not hurt shareholders as much as suspending trading would (Shaw, 2001). In April 2001, the Singapore exchange announced it would review the Listing Manual and in August, released a consultation paper for public comment (Shaw, 2001). When enacted, proposed amendments, based on International Organisation of Securities Companies listing requirements, should ensure listing rules meet the changing needs of the market. Some amendments were proposed to reflect the enactment of the Securities and Futures Act. Some proposed amendments would reduce the minimum number of public shareholders from 1 000 to 500, remove prescriptive quantitative initial public offer distribution guidelines, require continuous disclosure of material information, clarify reporting requirements and better define the exchanges powers to suspend trading in listed securities.

Representation
Minority shareholder representation is reasonable. The Companies Act bans cumulative voting for directors, weakening minority shareholders representation (PricewaterhouseCoopers, 2001). Authorities allow proxy voting, but not by post. In specific circumstances, companies may issue shares with different voting rights.

Board Structure and Duties


The Code of Corporate Governance recommends companies boards should include a majority of non-executive members, two finance and accounting professionals and a human resource expert, and have at least one third of the board independent. It also suggests companies establish

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The Singapore Stock Exchange believes this minimises shareholder punishment; often they are innocent parties.

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remuneration, audit and nomination committees, the latter to appoint new directors (PricewaterhouseCoopers, 2001). Listed companies must appoint at least two non-executive directors to their boards. Finally, the Companies Act defines the boards role in overseeing the company. Although a director can hold any number of board positions, the code indicates directors holding multiple board positions must give sufficient time and attention to each companys affairs (PricewaterhouseCoopers, 2001). In 1999, the Institute of Directors released the Code of Professional Conduct for Directors; directors may be untrained but can be certified through institute programs. By law, directors must act honestly and demonstrate diligence in discharging their duties. conviction, lowering the burden of proof (PricewaterhouseCoopers, 2001).
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Since

2001, shareholders have been able to file civil actions for damages without first securing a criminal

CREDITORS RIGHTS
These are generally well protected, minimising the need for post crisis changes.

Bankruptcy Laws
While formal insolvency proceedings, based on British laws, generally are effective and efficient, the Official Receiver actively oversees and reviews corporate insolvency law.
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Post crisis reforms prevent

undischarged bankrupts from acting as directors or taking a management role. The Companies Act regulates corporate insolvency and the judiciary reviews pre-insolvency court applications. Courts faithfully apply legislation in most cases, although insolvent GLCs tend to merge with healthier GLCs rather than face bankruptcy (Saavedra, 2001).

Bank Supervision
Although banks weathered the crisis well, the Monetary Authority of Singapore has strengthened some controls and is introducing risk based capital standards across the financial sector, in line with best practice (Shanmugaratnam, 2001; Sim, 2001). Under this new framework, banks must report on internal controls and compliance. Local banks corporate governance standards often exceed the Corporate Governance Committees Code of Corporate Governance recommendations. Most banks appoint additional independent board members and report related party transactions, directors remuneration and risk management practices (Shanmugaratnam, 2001). Rigorous annual Monetary Authority of Singapore inspections and mandatory external audits ensure a high level of compliance with standards.

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They must uphold fiduciary, skill, care and diligence, and statutory duties. The High Court and Official Receiver supervise private liquidators who act as officers of the court. The Official Receiver monitors private liquidators conduct, investigates complaints, and undertakes criminal prosecutions and civil actions against company directors (PricewaterhouseCoopers, 2001).

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ENFORCEMENT
Overall, transparent and efficient regulatory institutions ensure compliance is high. While strong politicalcommercial links may complicate enforcement in GLCs, most now are keen to be at the forefront of improving corporate governance standards. Older directors indifference and lack of skills may deter compliance in some more traditional family owned companies (PricewaterhouseCoopers, 2001). Some analysts consider only the top firms practise high corporate governance standards; others adopt a tick-box approach (Saavedra, 2001).

Press
Despite some useful initiatives, like the Business Times Corporate Transparency Index, the local media does not impose much discipline on companies. The medias approach to corporate governance issues is more gung ho than most other developed economys media. For example, it criticises lengthy trading suspensions before major announcements; whereas, the western financial media would demand it. The government linked Singapore Press Holdings has almost monopoly ownership of all local newspapers. However, the first private business weekly, The Edge, should start operating in 2002. Its owner, former banker Tong Kooi Ong, holds few interests outside media, suggesting the paper could independently scrutinize Singaporean corporates (Far Eastern Economic Review, www.feer.com, 29 October 2001). The Today newspaper also is an independent daily in Singapore.

IMPLICATIONS
Competitive and well governed markets protected Singapore from the financial crisis; they continue to ensure generally good corporate governance standards and drive local investment in an otherwise troubled region. Nevertheless, the Government recognises it needs to reduce its corporate sector involvement to continue to realise the full potential of its open markets and best practice regulations.

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REFERENCES
Asian Corporate Governance Association, 2000, Building Stronger Boards and Companies in Asia, Hong Kong. Claessens, S., Djankov, S. and Lang, L., 1999, Who Controls East Asian Corporations?, World Bank, Washington DC. Hale, D., 2001, Corporate Restructuring After the East Asian Crisis, Paper presented at East Asia Pacific Executive Forum, Honolulu, 17 January. Ing Barings, 2000, Regional Strategy, Singapore. Institutional Analysis, 2001, Consultancy prepared for the Economic Analytical Unit, August. Lee, G., 2001, Economic Analytical Unit interview with Partner, PricewaterhouseCoopers, Singapore, June. Naughton, T., 2001, Consultancy prepared for the Economic Analytical Unit, August. Ong, K. and Kheng, A.B., 2001, Economic Analytical Unit interview with Vice Predsidents Corporate Planning and Corporate Finance/Corporate Governance, Temasek Holdings, Singapore, June. PricewaterhouseCoopers, 2001, Consultancy prepared for the Economic Analytical Unit, August. Saavedra, C. and Kathpalia, S., 2002, Economic Analytical Unit interview with Managing Directors, Asia Pacific Ratings, Standard and Poors, Singapore, June. Shanmugaratnam, T., 2001, Update on the Singaporean Economy: Statement delivered at the Monetary Authority of Singapore Annual Report 2000/01 Media Conference, 12 July, Singapore, www.bis.org, accessed October 2001. Shaw, A. and Tan, L.S., 2001, Economic Analytical Unit interview with Executive Vice President and Assistant Executive Vice President, Singapore Exchange Limited, Singapore, June. Sim, N.B., 2001, Economic Analytical Unit interview with Assistant Director Corporate Finance, Monetary Authority of Singapore, Singapore, June. Sucharitakul, R., 2001, Economic Analytical Unit interview with Director, Market Intermediaries Supervision Department, Securities and Exchange Commission, Singapore, June. Teen, M.Y. and Kiong, C.C., 2000, Corporate Governance Practices and Disclosures in Singapore: an Update, Paper presented at OECD/World Bank Second Roundtable, Corporate Governance on The Role of Disclosure in Strengthening Corporate Governance and Accountability, Hong Kong, 31 May2 June. World Trade Organization, 1999, Trade Policy Review, WTO, Geneva.

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AUSTRALIA

KEY POINTS
Over the past two decades, major trade and microeconomic reforms have exposed Australian firms to more competitive markets, disciplining their behaviour. A major recession, related corporate collapses and moves to keep abreast of world best practice encouraged on-going regulatory reform, creating a sound corporate governance environment. Corporates balance debt and equity financing, encouraging direct financing markets. Strong household demand for shares supports capital raising on the share market, exposing firms to regulatory and shareholder activism. Banks are highly independent and competitive, lowering interest margins for debt finance. Minority shareholders are increasingly prominent and institutional investors generally exercise their rights as large shareholders. Recent corporate failures may provide an impetus to further finetune the role of directors and auditors and further prioritise corporate ethical standards. The press closely scrutinises corporate behaviour, including financial performance.

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In the last two decades, two waves of corporate failures spurred Australian corporate governance reforms; corporate governance now largely accords with international best practice. Over the same period, Australia developed large and deep direct finance markets and very open goods and service markets, disciplining corporations. The 2001 failure of several high profile corporates may test aspects of the current corporate governance framework and lead to its further evolution. These collapses and consequent shareholder and creditor losses will increase their financial and corporate governance scrutiny of corporates.

CORPORATE STRUCTURE
Large public companies dominate Australias corporate structure, resulting in managerial autonomy; very few have significant family or government ownership. Shareholders actively trade on markets, strongly influencing management behaviour. In 2000, 52 per cent of Australias adult population owned shares, 40 percentage points of whom owned them directly, up from just 22 per cent in 1991. This gives Australia one of the highest levels of share ownership in the world (Australian Stock Exchange, 2001). The Government used public floats to privatise, fully or partially, several public corporations, including Telstra, Commonwealth Bank and Qantas and several mutual societies, including AMP, the largest insurance company, demutualised, boosting ownership growth.
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MARKETS DISCIPLINE CORPORATES


Australian goods, services and financial markets are generally very competitive and have few barriers to new entrants. Corporates usually finance investment directly through the equity and bond markets, producing modest debt to equity ratios. Over recent decades, the Government progressively deregulated goods and financial markets and withdrew from direct production in most sectors, increasing domestic competition. It also reduced import barriers and direct industry assistance, exposing industries more to international competition. Significant tariffs remain only in the auto, footwear, clothing and textile industries and in some agricultural industries; all these also have declined steeply in the last decade and are scheduled to fall to modest levels in future years. While the Government maintains pre-establishment screening of foreign investment, few sectoral restrictions apply to foreign direct investment. Market conduct regulation, principally the 1974 Trade Practices Act, is designed to promote competition and fair trading.

FINANCIAL MARKETS
Financial markets discipline Australian firms; managers closely attend to share price movements and increasingly to shareholder concerns. Vigorous banking system competition eliminates incentives for corporates to deal with only one bank and direct financing increases market scrutiny of firm behaviour.

This could well be higher than the ownership levels in the United States, where, in 1998, 49 per cent of families, not individuals, owned stock equity (Kennickell et al., 2000).

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Independent and Competitive Banking System


Australias big four banks are listed publicly and feature dispersed shareholders; the last significant state owned bank was sold in the 1990s. Australias highly competitive banking system is not regulated excessively and relies mainly on a disclosure based approach. The mergers and acquisitions market is active; recent takeovers include the privatised and widely held Commonwealth Banks 2000 acquisition of Colonial, a bank and insurance company. Deregulating financial markets encourages greater competition for equity and credit. In the 1970s and 1980s, the Government removed interest rate controls, floated the exchange rate and opened the financial sector to foreign competition. Deregulation in mortgage finance and deposit taking markets allowed new entrants to challenge the banks; since then, margins have contracted by about 40 per cent (Battellino, 2000). Australias 33 foreign banks operate without branching or other restrictions (Australian Prudential Regulation Authority, 2001).
FINANCIAL DEREGULATION PRECURSOR TO EXCESSES OF THE 1980S

As occurred in East Asia in the mid 1990s, significant deregulation of the banking sector from 1983 removed interest rate caps and prudential controls on asset holding, encouraging some Australian banks and corporates to undertake risky lending and investment. Financial market deregulation allowed new banks to enter the market for the first time in many decades. Competition for market share was intense and some lenders relaxed lending standards. These factors, combined with overall global economic conditions, contributed to an explosion in bank lending and private debt, which grew at an average rate of 17 per cent per year during the 1980s (Lavarch, 1994). Subsequent company disclosures reveal some banks made poor business decisions, including lending to unscrupulous borrowers. Several major corporates collapsed, many revealing illegal and unethical behaviour by their major owner managers; one major bank, Westpac, came close to collapse due to high non performing loans. Regulators, corporates and banks learnt many valuable lessons from this salutary experience; in part these helped protect Australia from corporate excesses in the mid 1990s. Partly stimulated by a banking crisis in the late 1980s and early 1990s, Australian banks now are highly focused on risk measurement and management. For example, Australian banks have long maintained credit bureaus to separate credit management from credit origination and manage credit risk at the group level. More recently, banks have established independent risk management groups to assess all risks that bank groups face (Gruen et al., 1998).

Corporate Finance Balanced, Deep


Australian firms balance their funding sources, prudently mixing debt and equity finance. After the late 1980s debt excesses, listed companies reduced their debt to equity ratios and banks closely scrutinised these ratios, encouraging equity financing. By regional standards, Australias debt to equity ratio for private non-financial firms is low, at just under 100 per cent (Figure 17.1). Over the past two decades, authorities removed tax and regulatory biases against equity financing, including removing double taxation of company income and dividends through introducing dividend imputation.

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Figure 17.1 Low Debt to Equity Ratio Continues Debt to Equity Ratio, 1989-2001
1.20

1.10

Ratio

1.00

0.90

0.80

Mar 89

Mar 90

Mar 91

Mar 92

Mar 93

Mar 94

Mar 95

Mar 96

Mar 97

Mar 98

Mar 99

Mar 00

Source: Australian Bureau of Statistics, unpublished data.

Reflecting corporates balanced approach to financing, bond, equity and foreign exchange markets have expanded at broadly similar rates since banking sector deregulation (Battellino, 2000). By December 2000, the market capitalisation of domestic equities was A$671 billion, after growing at an average 17 per cent per year in the previous decade. Bond market capitalisation also grew, peaking at A$118 billion in December 1996 but dropping back to A$106 billion by December 2000 (Australian Stock Exchange, 2001). International analysts consider Australias capital markets to be strong. In 1998, Global Securities Consulting Services rated Australia one of the worlds top three equities markets for settlement services and operational risk (Lee-Tulliss, 1998). Australia is building on its well established domestic government bond market, with rapidly growing markets for corporate bonds and for foreigners who raise funds in Australias domestic debt markets.
2

Hence, direct financing has grown strongly; in 2000, firms raised A$31.5 billion in equity capital on the Australian Stock Exchange, up from A$7.4 billion in 1990. New floats increased dramatically, particularly from large privatisations or demutualisations (Figure 17.2).

In 1998 and 1999, issuers included the Asian Development Bank, the German Development Bank, German Development Agency and Nordic Investment Bank (Asiamoney Supplement, July/August 1999, pp. 14-19).

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Figure 17.2 Big Rise in Direct Financing Australian Equity Capital Raisings, 1990-2000
35 Other capital raisings 30 New floats 25
A$ billion

20 15 10 5 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Source: Australian Stock Exchange, 2001.

Hybrid equity securities, combining the positive aspects of debt and equity, also are increasingly popular (Asiamoney, November 2001, p. 35). Reset preference shares, income securities and convertible notes and bonds offer companies more repayment flexibility than debt, without the performance demands associated with equity. They also tap into demand for income earning securities when continuing budget surpluses reduce the supply of government securities. Of the Australian Stock Exchanges top 50 companies, 20 issue hybrid securities and more plan to. Hybrid security issues peaked at A$5.9 billion in 1999, up from A$100 million in 1995 and exceeded A$3.1 billion in 2001.

Institutional Investors
Over the past decade, Australian institutional investors numbers and activism increased dramatically. In the 1980s, the Government introduced mandatory superannuation contributions to privately operated, competing pension funds. This policy, combined with the populations gradual aging, boosted superannuation funds size and their power as large shareholders. In June 2001, funds under management stood at A$650 billion, of which A$160 billion was invested in domestic equities (Investment and Financial Services Association of Australia, 2001). At that time, pension funds and insurance companies owned 24 per cent of total domestic equity market capitalisation; households owned 24 per cent; and foreign investors owned 36 per cent (Figure 17.3).

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Figure 17.3 Institutional Investors and Households Have Strong Presence Australian Listed Equity by Ownership, 1995-2001
900 800 700 600
A$ billion

Rest of world Pension funds Life and other insurance companies Banks and financial intermediaries Private non-financial corporations Households General government

500 400 300 200 100 0 Jun 1995 Jun 1998 Jun 2001

Source: Australian Bureau of Statistics, various years.

Vigorous competition between fund managers lowers management fees and pressures managers to achieve high returns. Independent ratings firms, such as CANNEX and ASSIRT, publish performance ratings and grade individual funds. In addition, in the investment fund market, indexed funds like Vanguard offer reduced management fees, providing added competition.

MERGERS AND ACQUISITIONS


An active merger and acquisition market disciplines firm managers, protecting outside investors and eliminating inefficient business models. By 2000, over one third of 1990s top 100 companies had merged, been acquired or restructured (The Australian, 15 August 2001, p. 44). Mergers and acquisitions far outweigh bankruptcy as a reason for delisting. Due mainly to strong economic growth, the rate of business bankruptcy fell from 10.4 failures per 1000 enterprises in 1991-92 to 3.6 in 1999-2000 (Bickerdyke et al., 2000). Nevertheless, the recent collapse of prominent Australian companies such as HIH Insurance, Ansett and One.Tel has focussed Australias attention on its system of company regulation, insolvency and prudential supervision.

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PRODUCT MARKETS COMPETITIVE


Competition in Australian product markets is generally high, with few entry barriers and legislation guaranteeing third party access. Competition authorities also actively promote competition to increase market efficiency. These factors and high exposure to international markets create competitive product markets.

Trade Liberalisation
Since the mid 1970s, Australia has instituted wide ranging trade liberalisation. Average effective rates of manufacturing assistance fell from 22 per cent in 1984-85 to 5 per cent in 2000-01 (Industry Commission, 1995; Productivity Commission, 2001a). Rates of assistance remain significant only in the car and textiles, clothing and footwear industries; outside these two sectors, average levels of manufacturing assistance are very low. Exposing Australian industries to international competition has encouraged more efficient corporate leadership.
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Foreign Investment Liberalisation


Over the past two decades, foreign investment liberalisation has created one of the regions most liberal investment regimes, resulting in strong competition in goods and service markets. Limited restrictions remain in aviation, media and established residential real estate. The Foreign Acquisitions and Takeovers Act 1975 empowers the Government to examine investment proposals on a pre-establishment basis. Proposals may only be rejected where they are found to be contrary to the national interest. However, since 1975, only two major foreign investment proposals have not met this criterion.
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TREASURER BLOCKS SHELLS BID FOR WOODSIDE PETROLEUM

In late 2000, Royal Dutch Shell bid for a controlling stake in Woodside Petroleum, which is the operator and a major shareholder in Australias largest resource development project, the North West Shelf natural gas fields. Following the standard procedure for planned acquisitions of substantial foreign investments interests in Australian businesses valued over A$50 million, Shell notified the Foreign Investment Review Board, which advises the Treasurer, of the bid. In April 2001, the Government blocked the bid, notwithstanding Shells claims it would operate the North West Shelf project in line with Australias national interest, rather than the global Shell groups interest.
Source: Costello, 2001.

Effective rates of assistance measures include trade barriers, budgetary assistance and other measures that raise the return to producers. In 2000-01, effective rates of assistance (the percentage increase in returns that assistance delivers) for cars was 14 per cent and textiles, clothing and footwear was 23 per cent, down from 165 per cent and 68 per cent respectively in 198485. For all other manufacturing, effective rates of protection were between -1 and 6 per cent. These were proposals to demolish and redevelop the historic, inner Sydney harbour side suburb of Woolloomooloo and Shells bid to take over Woodside Petroleum.

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DEREGULATION AND COMPETITION


During the 1980s and 1990s, wide ranging Australian economic reforms included financial market deregulation in 1983, labour market and taxation reforms and National Competition Policy reforms from 1995. These reforms significantly improved the incentive structures managers face.

Privatisation Well Advanced


Australia has undertaken one of the worlds largest privatisation programs, so now government plays a relatively low direct role in production; this increases access for new market players and competition. Historically, Australias economy included both federal and state government-owned enterprises, some operating natural monopoly infrastructure and others operating alongside private enterprises in markets including banking, insurance and air transport. Over the last decade, governments at all levels have corporatised and privatised state owned firms. Governments also have opened a range of sectors previously reserved for state enterprises to competition, including utilities, railways, telecommunications networks and off-course betting. They have separated, corporatised and in many cases privatised former monopoly enterprises. However, this process is still on-going; while states like Victoria have privatised their power industry, due to union and electoral resistance other states like New South Wales have not.

Competition Policy
The Australian Competition and Consumer Commission can pursue companies undertaking anti-competitive conduct, such as predatory pricing, which companies may use to sustain market power in industries without natural entry barriers. The national competition statute, the Trade Practices Act 1974, prohibits certain firms conduct which would prevent or deter market entry. In particular, the Act prohibits horizontal and vertical arrangements between firms which result in a substantial lessening of competition and prohibits individual firms with substantial market power from taking advantage of that power. In industries where insurmountable entry barriers create a natural monopoly, Australia now has a national access regime promoting competition in service provision that uses this monopoly network infrastructure. Electricity transmission now operates within a national code and telecommunications service providers have guaranteed access to the national fixed line grid.

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NATIONAL ACCESS REGIME

The Government introduced the National Access Regime as part of the 1995 National Competition Policy reforms. It facilitates third party access to certain infrastructure on reasonable terms and conditions, where replicating the infrastructure is not economically feasible. The regime seeks to enhance incentives for negotiation and provide a means of access if negotiations fail. Such access is particularly important for electricity, gas, rail and telecommunication networks. Both regimes promote efficient pricing in upstream or downstream markets which benefits the broader economy.
Source: Productivity Commission, 2001b.
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Anti-monopoly Legislation
The Trade Practices Act neither prohibits monopolies nor provides for them to be broken up. Rather, it seeks to regulate monopolies either by preventing them being created (by prohibiting mergers or acquisitions which result in a substantial lessening of competition) or by preventing a monopolist from misusing its market power. The independent regulator established under the Act, the Australian Competition and Consumer Commission, plays a significant role in relation to merger and acquisition enforcement and, if it would result in a net public benefit, also may grant authorisation under the Act to allow a merger or acquisition which would otherwise be prohibited by the Act. Private litigants have often succeeded in courts prohibiting misuse of market power, but the commission recently has become more active in taking court actions (Australian Competition and Consumer Commission, 2000).

CORPORATES WELL REGULATED


Australias robust regulatory framework represents international best practice in virtually all areas. After corporate sector excesses in the late 1980s, successive governments implemented numerous corporate governance and prudential reforms. Laws back internationally sound accounting standards and auditing standards reflect international norms. Increasingly, minority shareholders are prominent and institutional investors exercise their responsibility as large shareholders. Recent corporate failures may provide impetus for further evolution in corporate regulation, including regarding directors duties and accounting for workers entitlements.

There is a separate sector-specific access regime for telecommunications.

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AUSTRALIAS CORPORATE GOVERNANCE FRAMEWORK

Australias corporate governance framework consists of a matrix of legislation, accounting standards which have the force of law, Australian Stock Exchange Listing Rules and voluntary self-regulatory codes of practice. For example, protection of shareholders basic rights and descriptions of directors duties are contained in both legislation, the Corporations Act and common law. Financial reporting requirements are contained in the Corporations Act, in enforceable accounting standards and in the Listing Rules. Non-financial reporting requirements are contained in the Corporations Act and in the Listing Rules. Self-regulatory codes of practice also cover aspects of the internal management of companies, including the structure and operation of boards. Overseeing this matrix of regulation is an independent statutory authority, the Australian Securities and Investments Commission; it has a wide-ranging role in regulating companies, including: investigating and enforcing alleged breaches of the Corporations Act setting and enforcing standards for investment advice and managed investments, prospectuses, takeover documents and financial reporting applying standards described in the law to business problems, explaining how the law works and contributing to law reform guiding companies on the interface between legal requirements and corporate practice publishing reports on investigations where the commission considers it desirable, or where the Minister directs. Private action by market participants also enforces the Corporations Act. Listing Rules ensure timely dissemination of price sensitive information to the market, which can act to discipline listed companies. Various professional organisations also enforce corporate governance standards and publish guidance on corporate governance. In 1999, the Governments Corporate Law Economic Reform Program reviewed business regulation policy with the aim of facilitating a more efficient and competitive business environment. The resulting Corporate Law Economic Reform Program Act 2000 clarified directors duties, introduced a statutory form of business judgement rule and a statutory derivative action. Other areas of reform in the Act involved takeovers, fundraising and accounting standards. The recent Financial Services Reform Act 2001 introduced a harmonised regulatory framework for consumer protection and market integrity in the financial services industry.

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CORPORATE LAW REFORM


Since the early 1990s, corporate law reform increasingly strengthened Australias investment environment. Establishing a national enforcement body, the Australian Securities and Investments Commission, and developing corporations legislation to improve disclosure of all relevant matters was the main approach taken. The Corporate Law Economic Reform Program and its predecessors drove these changes, overcoming legal inconsistencies and limitations arising from Australias federal system of government and closely aligning business regulation with international best practice. The program mainly aimed to modernise regulation of financial reporting and financial markets, corporate governance, takeovers, directors duties, fundraising and investment products to enhance transparency and accountability (Australian Treasury, 1999).

TRANSPARENCY
Australian financial reporting provisions and accounting and auditing standards align with international standards. Through successive reforms the chief corporate regulator, the Australian Securities and Investments Commission, has improved transparency by gaining more powers to enforce standards.

Financial Reporting
Australia now legally prescribes full market disclosure; authorities require larger companies to: provide annual and half-yearly reports to shareholders disclose promptly and continuously events that may affect the companys share price notify investors of specific information relating to obtaining shareholder approval for related party transactions disclose directors remuneration and their attendance at board meetings.

The Australian Securities and Investments Commission surveys companies financial reports, targeting weaknesses. The commission selectively examines companies according to its intelligence, complaints received and matters its staff note during other activities. During the 1990s, federal governments amended the Corporations Law to further improve the information companies disclose, including: removing the true and fair override, so companies could not avoid applicable accounting standards enhancing disclosure requirements for economically important entities, usually listed corporations transferring detailed disclosure requirements from the Corporations Law and the Corporations Regulations to accounting standards, so the environment for making any necessary changes to disclosure and reporting requirements became more flexible.

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Accounting Standards
The Australian Accounting Standards Board, established under the Australian Securities and Investments Commission Act 1989, specifies accounting standards companies use to report under the Corporations Act. Accounting standards have legal backing. Currently, the board is harmonising Australian accounting standards with International Accounting Standards and working with the International Accounting Standards Board and other national standard setters to develop a single set of high quality accounting standards for world-wide use. Overall, Australian standards differ little from international standards and some exceed international requirements. The Australian Securities and Investments Commission ensures companies comply with legal disclosure requirements, including accounting standards. If a company does not comply, the commission revises the financial statements with the company or if necessary, formally investigates and prosecutes it. The Financial Reporting Council provides broad oversight of Australias accounting standard setting arrangements.

Auditing Standards
The Auditing and Assurance Standards Board of the Australian Accounting Research Foundation develops standards and guidance on audits and related functions. These benchmark appropriate professional conduct for members of the Institute of Chartered Accountants in Australia and CPA Australia. However, they do not have the force of law. The Auditing and Assurance Standards Board implements International Auditing Practices Committee statements; Australian Auditing Standards align with international standards.
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While auditing standards do not have force of law, ethical standards apply. In addition, the Australian Securities and Investments Commission registers company auditors; it may refer auditors who do not carry out their duties adequately and properly to the Companies Auditors and Liquidators Disciplinary Board for appropriate action. The Business Councils Bosch Report recommended establishing an audit committee with a majority of non-executive directors on it. A survey of the top 100 listed companies in 1995 found that a 98 per cent had audit committees (Business Council of Australia, 1991; Ernst & Young, 1999). The Government is currently considering a report on audit independence in Australia prepared by Professor Ian Ramsay of Melbourne University and a survey by the Australian Securities and

This is because auditing standards tend to require auditors to form more qualitative judgements on a wide range of matters than accounting standards do. Most differences reflect the boards consistent application of a more general approach to setting a standard, establishing a basic principle and providing guidance on relevant procedures in the standard and allowing auditors to exercise their judgement. International standards often prescribe detailed procedures that apply in certain situations (Australian Treasury, 1999).

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Investments Commission, which both found that as auditors frequently provide non-audit services to their Australian clients, processes for dealing with potential conflicts of interest require attention (Australian Securities and Investments Commission, 2002).

MINORITY SHAREHOLDER PROTECTION


The Australian Securities and Investments Commission recognises institutional shareholders play a key role in monitoring company performance. The commission encourages active institutional shareholders to improve corporate governance. In recent years, the commission lifted various restrictions, enabling discussion and cooperative voting agreements between institutional and other minority investors on governance issues; it now allows shareholders holding more than 20 per cent of the voting shares to associate (Australian Securities and Investments Commission, 1998). However, some observers question whether institutional investors sufficiently exercise their voting power. For example, some institutions were concerned BHPs merger with Billiton would be counter to BHP shareholders interests, yet did not oppose it. BHPs Chairman and CEO promised to resign if the merger failed, contributing to investor reluctance. Some press observers also allege institutions simultaneously advising and investing in BHP faced conflicts of interest, weakening their ability to oppose the merger (Ethical Investor, www.ethicalinvestor.com.au, 2001). Proxy advisers also actively encourage good corporate governance; Computershare Analytics and Institutional Shareholder Services Australia offer services soliciting proxy votes from institutional investors and rating corporates corporate governance standards (OECD, 2000).

LISTING REQUIREMENTS
The Australian Stock Exchange requires extensive listed company disclosure and disciplines companies breaching listing rules, including suspending or de-listing them. Companies must outline their main corporate governance practices during the reporting period. Most companies comply as it promotes high quality and consistent disclosure. If companies selectively disclose price sensitive information to market analysts prior to public disclosure, as AMP was alleged to have done in mid 2001, the Australian Securities and Investments Commission acts against them. It also issues guidelines encouraging companies to develop disclosure policies on distributing company information and conducting analysts briefings.

Composition of Boards of Directors


Australian authorities take a disclosure approach rather than prescribe board structure. Companies can decide many matters about board composition, including the ratio of executive to non-executive directors, whether the chairperson is a non-executive director and if appropriate committees and procedures deal with conflicts of interest, dissent and resignation. Companies must detail these practices in their annual statement of corporate governance practices.

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The Bosch Report recommended boards comprise a majority non-executive directors. A survey of the practices of 90 of 1993s top 500 listed companies found Australian companies already complied broadly with recommended practice, on average having twice as many non-executive directors as executive directors (Business Council of Australia, 1991; Clifford et al., 1995). In addition, 70 per cent of companies had an independent non-executive chair and another 14 per cent had a separate CEO and chair.

Directors Obligations
The Corporations Law specifies directors basic duties, which are largely unchanged from the original UK common law. In 2000, the Governments statutory business judgement rule clarified shareholders reasonable expectations of company officers and ensured company officers personal liability did not deter management from responsibly taking risk. Also in 2000, the Australian Securities and Investments Commission campaigned to ensure listed company directors inform the market when they traded their companies shares. Compliance has increased significantly since.

Legal Action against Directors


The Australian Securities and Investments Commission and a range of other parties may bring criminal or civil proceedings against directors failing to comply with their Corporations Law duties, causing damage to the company, its creditors or shareholders. The Government recently changed the law to provide individual shareholders with the statutory right to bring an action against a company for its wrongdoings.
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CREDITOR PROTECTION
Australias insolvency framework is generally sound and efficient. It is known as relatively creditor friendly, although restructuring and reorganisation provisions are very often successful. However, a small number of recent high profile corporate collapses raised questions about the efficacy of regulatory oversight, directors ethics and the protection hierarchy of some creditors, including workers. The recent collapses of prominent Australian companies such as HIH Insurance, Ansett and One.Tel were significant, highlighting in particular the importance of effective disclosure provisions and insolvency laws and practices. In 1999, the Australian Government announced it would commission a wide ranging review of the framework for liquidation, voluntary administration and reconstruction of companies (Hockey, 1999).

Authorities act against directors who transfer assets belonging to a company either to themselves or another company, depriving creditors of access to assets. This conduct occurred both in small private unlisted companies and, particularly during the late 1980s, in some major listed companies. Other common criminal cases involve people acting as directors or in company management when they were disqualified, either because they carried past convictions involving fraud or were bankrupt.

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Bankruptcy
Australian corporate law provides four ways to administer insolvent corporations: liquidation, receivership, voluntary administration and schemes of arrangement. 1992 Corporations Law amendments included voluntary administration provisions, offering companies greater scope to trade out of difficulty when they faced insolvency.

THE IMPACT OF CORPORATE FAILURES

Over the past 15 years, several waves of corporate failure have prompted changes, including regulatory reform. The first failures came after Australias 1980s bubble burst, producing a spate of non performing loans and corporate collapses; this sparked revised banking practices and accounting standard reforms. Later, in 2001, HIH, One.Tel, Ansett and many other smaller companies, particularly in the information, communication and technology industries, collapsed. HIH went into provisional liquidation in March 2001. In the previous three to four years, it had made several major acquisitions and a number of directors had resigned from its board. Speculation about HIHs solvency arose in late 2000 as commentators questioned the adequacy of its reserves. With around one million general insurance policy holders affected by the companys collapse, the Government announced a royal commission into HIH in June 2001. The commission will examine whether directors, officers or associated advisers decisions or actions contributed to the companys failure and whether they were involved in any undesirable or illegal corporate governance practices. The commission will report and recommend changes to the regulatory system by 30 June 2002. In May 2001, telecommunications company One.Tel went under administration and the Australian Securities and Investments Commission launched an investigation into its collapse. Ansett went under administration in September 2001 and also is under investigation. Both investigations will examine whether the companies continued to trade while insolvent and whether the directors breached their fiduciary duties. These failures reflect primarily sectoral and company specific factors as well as failures of aspects of corporate governance. The investigations may provoke a review of directors duties, particularly of independent directors and certain accounting and auditing standards. In particular, the inquiries are likely to examine how auditors can be kept independent when many corporates contract the same auditing companies for management consultancies. Reform of the insurance supervisory framework was underway prior to the failure of HIH, but that failure provides more impetus to this process.
Source: CCH Australia, 2001.

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Laws require directors to cease trading when a company becomes insolvent; failing to do so makes them personally liable for the companys debts. The Australian Securities and Investments Commission licenses specialised accounting professionals to conduct external corporate administrations and administer corporate insolvency. Some administration types entail a significant supervisory role for the court, while others, notably voluntary administration, require a smaller role. In all cases, the commission has an overall supervisory role. The objective of the corporate insolvency system is to balance the public interest in preserving enterprises wherever possible with the need for efficiency, certainty and predictability for creditors.

PRUDENTIAL SUPERVISION
Following several decades of ongoing reform, Australias financial sector prudential framework is close to international best practice. In 1997, the Government accepted the recommendations of its second major Financial System Inquiry, consolidating prudential regulation of all deposit taking institutions, including banks, building societies, credit unions, life and general insurance companies and superannuation funds, under a single new institution, the Australian Prudential Regulation Authority.
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The authoritys supervisory approach is forward looking, primarily risk based and
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consultative.

The authority is in the process of developing standards relating to the supervision of

financial conglomerates, to prudentially accommodate the changing nature of the financial system. Australia is among the first group of countries to tackle issues of financial conglomerate supervision and has issued several papers outlining a proposed policy, which is in future expected to apply to all financial and mixed conglomerate groups. The other major reform resulting from the 1997 Financial System Inquiry was to consolidate responsibility for securities market supervision into a single regulator, the Australian Securities and Investments Commission.
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This initiative overcame regulatory gaps under previous arrangements

and also ensures Australian financial markets will remain well regulated as corporate fund raising shifts from financial sector intermediaries to capital markets, where disclosure regulation is critical.

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The Financial System Inquiry, headed by Stan Wallis, with a Secretariat provided by the Australian Treasury, was the first major inquiry into the Australian financial system since the Campbell Committee Inquiry in 1981. At the forefront of developing innovative supervisory techniques, the authority actively encourages agencies to monitor their own risks and ensure adequate capitalisation occurs. These techniques are designed to reduce the regulatory burden on the sector, while maintaining a secure environment for depositors. The expected application of the draft proposals of the Basel Capital Accord, released in 2001 by the Basel Committee on Banking and Supervision, will increase flexibility in the financial sector by ensuring that capital requirements are more responsive to the underlying risk profile of each regulated institution. Consolidation facilitates coherent regulation of financial institutions with activities in many financial markets and sectors. State based institutions came under its consolidated regulatory umbrella on 1 July 1999. These changes have produced a more effective regulatory framework for dealing with financial conglomerates, providing scope for greater regulatory consistency across institutions undertaking similar activities and provides a better focussed, more accountable structure for addressing community expectations regarding issues of consumer protection.

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These two agencies were granted substantial autonomy and clear charters of objectives with a mechanism instituted to ensure effective coordination between the agencies.
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Regulations aim to

minimise the risk of depositors losing their funds and to be consistent with international standards. Prudential standards are as far as possible reinforced through encouraging financial institutions to increase the public disclosure of their risk and management systems.

COMPLIANCE
Strong market discipline and effective regulation means most companies comply with most standards. Key regulators, major accounting firms and universities run relevant training courses, while private professional groups, other non-government organisations and a highly effective commercial media encourage generally sound practices and scrutinise corporate behaviour.

Enforcement
The Australian Securities and Investments Commission ensures compliance with corporations law disclosure requirements, accounting standards and auditing practices. It enforces mostly through negotiation, but can apply legal sanctions. Individuals also can access legal redress; for example, in November 2001, liquidators of the Bond group of companies acted against Arthur Anderson, auditors of the companies 1987-88 accounts, alleging an incompetent audit (ABC, 21 November 2001, abc.net.au).

Professional Education
Regulatory authorities and professional associations, including the Australian Securities and Investments Commission and the Australian Institute of Company Directors, run training and education programs to improve corporate governance practices. The commission also publishes The Watchdogs Guide, a plain language explanation of small company directors and secretaries legal responsibilities. Commission officers also regularly speak on directors duties and good governance at small business seminars.

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The Reserve Bank of Australia also has responsibility for ensuring overall systemic stability of the financial system.

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PROMOTION OF GOOD PRACTICE

Industry and professional groups sponsor initiatives to support regulatory reform and compliance. The first was in 1991, when the Business Council of Australia produced the Bosch Report to encourage company boards and their chairs to follow sound practices; define the roles of audit committees, non-executive directors, company accountants and auditors; detail codes of ethics and introduce guidelines for directors conduct regarding conflict of interest, confidentiality and insider trading. Many other reports followed, including Strictly Boardroom in 1993. It outlines guidelines for good corporate governance and reminds reformers that legislative reforms should aim to encourage good corporate behaviour but be sensitive to the compliance costs (Hilmer, 1993). Increasingly, governments share the view society must shift the corporate governance focus from conformance to performance, encouraging good practice, rather than coercing companies. Various private sector organisations also produced documents providing guidance on corporate governance, including the Australian Investment Managers Associations Guide for Investment Managers and Corporations and the Australian Institute of Company Directors General Protocol for Company Directors. Such guidelines provide examples of best practice in the context of globalised capital markets and emerging international best practice, helping companies determine the best corporate governance model for their own circumstances.

Media
Australia generally is well served by the financial media; the high quality Australian Financial Review focuses mainly on financial and corporate developments. With The Australian and The Age, the Australian Financial Review leads press scrutiny of corporate behaviour.

IMPLICATIONS
Australias competitive economy has diverse ownership and a mature and robust corporate governance regime. It could act as a model for regional economies that seek to improve their regimes. However, Australias corporate governance system could improve further, with several recent corporate failures highlighting the role of directors and auditors in ensuring good governance.

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REFERENCES
Australian Bureau of Statistics, various years, Financial Accounts, Catalogue No. 5232.0, ABS, Canberra. Australian Competition and Consumer Commission, 2000, Annual Report 1999-2000, AusInfo, Canberra. Australian Prudential Regulation Authority, 2001, List of Authorised Deposit-Taking Institutions, www.apra.gov.au, accessed December 2001. Australian Securities and Investments Commission, 2002, ASIC Announces Findings of Auditor Independence Survey, Media Release, 16 January, www.asic.gov.au, accessed January. 1998, Collective Action by Institutional Investors, Policy Statement 128, www.cpd.com.au/asic, accessed November 2001. Australian Stock Exchange, 2001, Fact Book 2001, Sydney. Australian Treasury, 1999, Making Transparency Transparent: an Australian Assessment, www.treasury.gov.au, accessed April 2001. Battellino, R., 2000, Australian Financial Markets: Looking Back and Looking Ahead, Address to Australian Finance and Capital Markets Conference, Sydney, 24-25 February. Bickerdyke, I., Lattimore, R. and Madge, A., 2000, Business Failure and Change: an Australian Perspective, Productivity Commission Staff Research Paper, AusInfo, Canberra. Business Council of Australia (Bosch Report), 1991, Corporate Practices and Conduct, Information Australia, Melbourne. CCH Australia, 2001, Collapse Incorporated: Tales, Safeguards and Responsibilities of Corporate Australia, CCH Australia, Sydney. Clifford, P. and Evans, R., 1995, Corporate Governance: an Investigation into the Practices of Australian Companies, Institute for Research into International Competitiveness Discussion Paper 95.01, Curtin University. Costello, P., 2001, Transcript of Press Conference, Canberra, 23 April, www.treasury.gov.au, accessed November 2001. Dunlop, I.T., 2000, The Importance of Independent Active Directors on Corporate Boardsan Australian View, Speech given to Open Conference on Corporate Governance and Related Reforms, Manila, 29 May. Ernst and Young, 1999, Corporate Governance Survey, Corporate Governance Series: A Guide for Directors, July. Gruen, D., Gray, B. and Stevens, G., 1998, Australia in McLeod, R. and Garnaut, R. (eds), East Asia in Crisis: from Being a Miracle to Needing One, Routledge, London, pp. 207-26. Hilmer, F.G., 1993, Strictly Boardroom, Information Australia, Melbourne.

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Hockey, J., 1999, Speech to Conference on Insolvency Systems in Asia: An Efficiency Perspective, Minister for Financial Services and Regulation, Sydney, 30 November. Industry Commission, 1995, Assistance to Agricultural and Manufacturing Industries, Information Paper, AGPS, Canberra. Investment and Financial Services Association Ltd, 2001, Shareholder Activism among Fund Managers: Policy and Practice, www.ifsa.com.au, accessed November 2001. Kennickell, A.B., Starr-McCluer, M. and Surette, B.J., 2000, Recent Changes in US Family Finances: Results from the 1998 Survey of Consumer Finances, Federal Reserve Bulletin, Vol. 86, No. 1, January, pp. 1-29, www.federalreserve.gov, accessed November 2001. Lavarch, M., 1994, The Governments Approach to Corporate Law Reform, Australian Journal of Corporate Law, Vol. 4, No. 1, pp. 1-19. Lee-Tullis, J., 1998, The 1998 Review of Emerging Markets, Global Securities Consulting Services, London. OECD, 2000, Corporate Governance in OECD Member Countries: Recent Developments and Trends, www.oecd.org, accessed November 2001. Productivity Commission, 2001a, Trade and Assistance Review 1999-2000, Annual Report Series 1999-2000, AusInfo, Canberra. 2001b, Review of the National Access Regime, Position Paper, Canberra.

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INFORMATION FOR BUSINESS

LEGAL CONTACT DETAILS


HONG KONG
PricewaterhouseCoopers 33/F, Cheung Kong Center 2 Queens Road Central Hong Kong GPO Box 690 Hong Kong Phone: (852) 2289 8888 Primary contact: Duncan Fitzgerald (2289 1190) Simon Copley (2289 2988) duncan.fitzgerald@hk.pwcglobal.com simon.copley@hk.pwcglobal.com

JAPAN
ChuoAoyama Audit Corporation 32nd Floor Kasumigaseki Building 2-5 Kasumigaseki 3chome Chiyoda-Ku, Tokyo 100-6088 Phone: 81 3 5532 2100 Primary contact: Maurice Toyama

KOREA
Samil Accounting Corporation Kukje Center Building 21st Floor 191 Hangangro 2 ga Yongsanku Seoul 140-702, Korea CPO Box 2170 Seoul 100-621 Korea Phone: 82-2-709-0320 Primary contact: Bob Graff bob.graff@kr.pwcglobal.com

THAILAND
PricewaterhouseCoopers 15th Floor Bangkok City Tower, 179/74-80 South Sathorn Rd, Bangkok 10110 GPO Box 800 Bangkok 10501 Thailand Phone: 66 2 3441354 Primary contact: Richard Moore richard.g.moore@th.pwcglobal.com

MALAYSIA
PricewaterhouseCoopers 11th Floor Wisma Sime Darby Jalan Raja Laut 50350 Kuala Lumpur Malaysia PO Box 10192 50706 Kuala Lumpur Malaysia Phone: +603-2693 1077 Primary contact: Raja Datuk Arshad Raja Tun Uda (Executive Chairman) Chin Kwai Fatt (Managing Director) arshad.uda@my.pwcglobal.com kwai.fatt.chin@my.pwcglobal.com

INDONESIA
PricewaterhouseCoopers 5th Floor JI HR Rasuna Said Kav C- 3 Kuningan, Jakarta 12920 PO Box 2473 JKP 10001 Jakarta Indonesia Phone: 62 21 521 2901 Primary contact: Chris Cooper chris.cooper@id.pwcglobal.com

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PRCHINA
Beiking/PricewaterhouseCoopers #1Guang Hua Road 18th Floor North Tower Beijing Kerry Center Choa Yang District Beijing 100040 Phone: 86-10-6561 2233 Primary contact: Johnny Chen Johnny.chen@cn.pwcglobal.com

VIETNAM
PricewaterhouseCoopers 3rd Floor Saigon Tower 29 Le Duan Boulevard District 1 Ho Chi Minh City Phone: 84 8823 0796 Primary contact: Damian Clowes Damian.Clowes@vn.pwcglobal.com

PHILIPPINES
PricewaterhouseCoopers/ Joaquin Cunanan & Co. 29/F Philamlife Tower 8767 Paseo de Roxas Makati City Philippines PO Box 2288 1099 Manila Philippines Phone: (632) 845-2728 Primary contact: Jerry Isla jerry.s.isla@ph.pwcglobal.com

AUSTRALIA
PricewaterhouseCoopers Legal Darling Park 201 Sussex Street SYDNEY, NSW 1171 AUSTRALIA Phone: 61 2 82666807 Primary contact: Andrew Bristow andrew.Bristow@pwclegal.com.au PricewaterhouseCoopers Darling Park 201 Sussex Street SYDNEY, NSW 1171 AUSTRALIA Phone: 61 2 8266 0000 Primary contact: Sandra Birkensleigh sandra.birkensleigh@au.pwcglobal.com

SINGAPORE
PricewaterhouseCoopers 8 Cross Street #17-00 PWC Building Singapore 048424 Phone: +65 236 3108 Primary contact: Yeoh Oon Jin oon.jin.yeoh@sg.pwcglobal.com

TAIWAN
Puhua & Associates, a correspondent law firm of PriceWaterhouse 12 F 460 Hsin Yi Rd Sect 4 Taipei, Taiwan Phone: 886-2-2729-6666 Ext. 3833 Primary contact: Carly Johnson Carly.Johnson@tw.pwcglobal.com

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ALSO BY THE ECONOMIC ANALYTICAL UNIT

India: New Economy, Old Economy Published November 2001 (ISBN 0 642 56583), A$39 Investing in Latin American Growth: Unlocking Opportunities in Brazil, Mexico, Argentina and Chile Published August 2001 (ISBN 0 642 51879 3), A$39 Indonesia: Facing the Challenge Published December 2000 (ISBN 0 642 70501 1), A$30 Accessing Middle East Growth: Business Opportunities in the Arabian Peninsula and Iran Published September 2000 (ISBN 0 642 47659 4), 160 pages, A$30 Transforming Thailand: Choices for the New Millennium Published June 2000 (ISBN 0 642 70469 4), 228 pages, A$30 Asias Financial Markets: Capitalising on Reform Published November 1999 (ISBN 0 642 56561 9), 376 pages, A$30 Korea Rebuilds: From Crisis to Opportunity Published May 1999 (ISBN 0 642 47624 1), 272 pages, A$20 Asias Infrastructure in the Crisis: Harnessing Private Enterprise Published December 1998 (ISBN 0 642 50149 1), 250 pages, A$20 The Philippines: Beyond the Crisis Published May 1998 (ISBN 0 642 30521 8), 328 pages, A$20 The New ASEANs - Vietnam, Burma, Cambodia and Laos Published June 1997 (ISBN 0642 27148 8), 380 pages, A$15 A New Japan? Change in Asias Megamarket Published June 1997 (ISBN 0 642 27131 3), 512 pages, A$15 China Embraces the Market: Achievements, Constraints and Opportunities Published April 1997 (ISBN 0 642 26952 1), 448 pages, A$15 Asias Global Powers: China-Japan Relations in the 21st Century Published April 1996 (ISBN 0 642 24525 8), 158 pages, A$15 Pacific Russia: Risks and Rewards Published April 1996 (ISBN 0 642 24521 5), 119 pages, A$15 Iron and Steel in China and Australia Published November 1995 (ISBN 0 642 24404 9), 110 pages, A$15 Growth Triangles of South East Asia Published November 1995 (ISBN 0 642 23571 6), 136 pages, only available online. Overseas Chinese Business Networks in Asia Published August 1995 (ISBN 0 642 22960 0), 372 pages, A$20

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Subsistence to Supermarket: Food and Agricultural Transformation in South-East Asia Published August 1994 (ISBN 0 644 35093 8), 390 pages, A$15 Expanding Horizons: Australia and Indonesia into the 21st Century Published June 1994 (ISBN 0 644 33514 9), 364 pages, A$15 Indias Economy at the Midnight Hour: Australias India Strategy Published April 1994 (ISBN 0 644 33328 6), 260 pages, A$15 ASEAN Free Trade Area: Trading Bloc or Building Block? Published April 1994 (ISBN 0 644 33325 1), 180 pages, A$15 Changing Tack: Australian Investment in South-East Asia Published March 1994 (ISBN 0 644 33075 9), 110 pages, A$10 Australias Business Challenge: South-East Asia in the 1990s Published December 1992 (ISBN 0 644 25852 7), 380 pages, A$15 Southern China in Transition Published December 1992 (ISBN 0 644 25814 4), 150 pages, A$10 Grain in China Published December 1992 (ISBN 0 644 25813 6), 150 pages, A$10 Korea to the Year 2000: Implications for Australia Published November 1992 (ISBN 0 644 27819 5), 150 pages, A$10 Australia and North-East Asia in the 1990s: Accelerating Change Published February 1992 (ISBN 0 644 24376 7), 318 pages, A$15 Prices cited are current discounted prices inclusive of GST.

Forthcoming Reports (working titles only)


Asian Regional and Subregional Free Trade Arrangements: Implications, Costs and Opportunities for Australia, May 2002. East Asian Opportunities in New Technologies, June 2002 China Embraces the World Market: WTO Implications for Australia, July 2002 Keeping the Gains of Globalisation, September 2002 Changing Production Chains in North East Asia, October 2002

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P u b l i c a t i o n s

Reports and full publications catalogues can be obtained from: Jane Monico Market Information and Analysis Unit Department of Foreign Affairs and Trade RG Casey Building, John McEwen Crescent Barton ACT 0221, Australia Telephone: +61 2 6261 3114 Facsimile: +61 2 6261 3321 Email: jane.monico@dfat.gov.au Internet: www.dfat.gov.au/eau gives access to executive summaries, tables of contents, many full reports, details of briefing papers and order forms

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