LIP SERVICE
Awareness of shareholder rights may be growing in Asia, but a new survey shows that only CFOs in China are taking it seriously.
By Tom Leander and Karen Winton

So there he was, Lawrence Fok, a leader from the team that runs Hong Kong's markets and the man most likely to calm flustered investors with tales of transparent accounting and shareholder rights. "Give Hong Kong another 50 years," he said, "and more and more of its listed companies won't have controlling shareholders." Hardly fighting words from the deputy chief operating officer of Hong Kong Exchanges and Clearing Ltd (HKEx), particularly as he was fielding questions from reporters about the HKEx's climb-down from a promise to require mandatory quarterly reporting from Hong Kong companies.

Fok's statement on November 8 was supposed to reassure, but listeners could be forgiven for squirming. Fifty years? Right now, governance is playing top bill all over Asia and it's a safe bet that global investors won't wait five years. Many of those same reporters heard the "Make no false accounts!" dictat thundered by premier Zhu Rongji to a crowd of eager accountants at the World Accounting Congress in Hong Kong 10 days after Fok's statement - and the accountants roared back with uncharacteristic brio.

When strong men praise good governance, and accountants shout back, it's fair to ask how seriously we should take them - and how far will their words be translated into action by CFOs. Don't hold your breath. Results of a survey by the Association of Certified Chartered Accountants (ACCA), in association with CFO Asia, of CFO opinion in four crucial markets show only a partial, halting advance. Institutional controls necessary to make sure investors have some measure of protection may be in place, the survey shows, but that essential connection between codes laid down by governments and enforcement of those codes has not been sealed. Companies easily comply, and very rarely explain. No Eliot Spitzer knocks at the door. Despite Zhu's thunder, most Asian regulators mew like Fok.

"Those officials who criticized the US market following the Enron scandals," says Hasung Jang, the director of the Asian Institute of Corporate Governance at Korean University in Seoul, "don't really see the importance of what's happening in the US. Rapid, serious reform is under way. Even a pro-business president like Bush had to sign something as stringent as Sarbanes-Oxley into law."

Hasung was referring to a statement by Korea's finance minister that the Enron scandal had cast a positive light on Korea's level of governance, and that Korea would be well advised to "decouple" from the US market to attract international investment. His response, however, applies to most of Asia. Jang believes that the Enron scandals have given regulators and the CFOs responsible for company financial controls an excuse to ease up on putting in place any lasting reform.

"Here in Asia, the officials talk loudly," says Hasung. "Laws have been passed. But who's really doing anything?"

Complacency

If corporate governance is tantamount to a new party line - we pretend to manage for shareholder value, they pretend to regulate us - the ACCA survey shows that Asian CFOs feel no great pressure to put real controls in place. The survey polled 200 CFO at top-listed companies by annual sales in China, Hong Kong, Malaysia and Singapore. It found a disparity between the stated case for corporate governance in companies and the CFOs' actual actions. Almost all of the CFOs said they had a "heightened awareness" of the crucial nature of corporate governance to their jobs following the parade of scandals in the US, beginning with Enron. But when asked their opinion of what needs to be done, they retorted that corporate governance was a matter of better disclosure and not a matter of placing stronger controls or allowing investors to have more of a voice.

"Half the CFOs said the main purpose was to safeguard investors," says Roger Adams, the London-based executive director of ACCA. "And ensuring accountability of management registered at only 20 percent. There is little evidence of a priority for producing effective internal checks and balances." He adds, dryly: "This suggests some complacency."

Voting With their Feet

Investors, of course, are finding ways to protect themselves from this kind of lack of vigilance. Calpers, America's largest pension fund, voted with its feet when it pulled investments from companies from Indonesia, Malaysia, Thailand and the Philippines in February 2002, citing concerns over corporate governance. The only actual enforcement in Asia seems to be occurring through such punitive measures by providers of capital. And this pressure can only increase. Where financial services reform has proved more effective, measures of accountability are being injected into the channels of access to capital. In Korea, says Hasung Jang, the painful process of clearing nonperforming loans and restructuring the nation's banks has made bankers far more wary. In late November, for example, Moody's upgraded Korea's sovereign credit rating from stable to positive, prompting a steep rise in domestic stock markets. Clearly, foreign investors took heart.

"They are demanding tighter controls themselves on the part of the companies that approach them for loans," says Hasung. The trend is also visible in Malaysia, according to Lee Leok Soon, executive director of the Malaysian Institute of Corporate Governance.

"The prudence on the part of the banks following reform is making the companies prudent themselves," says Lee. "CFOs and auditing committees have to answer to bankers. It's beginning to have an effect."

The first persuasive evidence that better corporate governance leads to a lower cost of capital is finally emerging. McKinsey, the consulting firm, rated 188 companies in Korea, Malaysia, Taiwan, India, Mexico and Turkey in the Winter 2002 McKinsey Quarterly, comparing the size of market value against a broad set of governance criteria, including board oversight, shareholder rights and transparency. It found that the highest-rated companies in corporate governance tended to have higher valuations against a national average within their industry than those that had low ratings. The highest was Korea, where 70 percent of the saints outpaced the sinners in market cap.

That competition for capital has given rise to a new class of Asian company, one that sees global capital as an alternative to local funding and understands the advantage of providing those investors systems of management accountability and a high level of disclosure. Infosys, the Bangalore information services provider, has won a number of corporate governance awards for its disclosure policies, including accolades from CLSA. Mohandas Pai, CFO of Infosys, says flatly: "Our governance policies are one of the reasons our P/E ratio is higher than our peers." Info-sys has a P/E of 20.71, compared to 12.65 at Wipro, and .48 at Satyam Infoway, two of its most frequently cited competitors by analysts. Hasung Jang cites Korea's steel giant Posco and NKT, the telecommunications companies. Both of these companies privatized and, in Hasung's view, recognized that better governance practices would differentiate them as new, publicly listed companies in their sectors.

Higher Standards

Chinese regulators have a long way to go in reforming the country's banking sector and cleaning up an estimated US$180 billion in nonperforming loans - some 25 percent of all bank loans and 15 percent of the nation's GDP. Much like Korea, however, there is a political will to do so and the government is slowly unfolding reforms that will institute tighter loan controls and foreign competition into the banking sector. That, and an intense regulatory drive to clean up publicly listed companies may be the reasons that the Chinese CFOs in the ACCA survey emerged as the least complacent. Ninety percent of these CFOs said they had reviewed corporate governance practices throughout the company in the past 12 months, in contrast to an average of 50 percent from Hong Kong, Malaysia and Singapore. "It is in mainland China that CFOs make the strongest connection between finance and best practice," says Adams.

The stronger response from China is a direct result of the PRC's recent energetic corporate governance campaign. In 1999, the government bolstered its securities laws to improve disclosure standards and to allow regulators greater scope in their investigations. It has a vested interest in reform: the government is privatising its mass of state-owned enterprises (SOEs), many of which are loss making and in dire need of investment and market discipline.

Getting these companies IPO-ready requires a lot of restructuring and preparing of books. But the biggest job is convincing markets that the SOEs are run according to best practice. Nevertheless, the PRC enterprises that do pull off international listings - thus widening their investor base, increasing their accountability and pulling themselves into the orbit of international accounting standards - have transformed themselves. China National Overseas Oil Corporation, for example, is well regarded by investment bank CLSA's annual rating of companies based on corporate governance for their transparency (Saints and Sinners, April 2001)

The respondents to the ACCA survey were asked to rate the influence of best practice on "the ability to obtain investment from institutional investors". It was the mainland respondents that drew the highest connection, assigning a score of nearly 8.5 out of a possible 10, compared to an average of 7.2 for CFOs in Hong Kong, Malaysia and Singapore.

"The Chinese leadership knows that corporate governance reform is now a necessary condition for a slew of national objectives, such as SOE reform, pension reform, competition under WTO [World Trade Organisation] and capital market development," says Francois Roy, chief analyst at the Hong Kong-based Asian Corporate Governance Association.

In a move which brought direct involvement from CFOs, the China Securities Regulatory Commission (CSRC) launched an inspection of all of China's listed companies in 2002, with the State Economic and Trade Commission. The regulators sent all listed companies a questionnaire with 110 questions in different areas of corporate governance - such as the composition of the board, frequency and preparation of board meetings, the role of independent directors, internal controls. The answers to the questionnaire had to be endorsed and certified by each full board of directors for truthfulness and accuracy.

Laura Cha, deputy head of the CSRC, says that the questionnaire was designed to identify a wide range of areas, which might be problematic. Based on the results of the questionnaires, on-site inspection was conducted on about 200 companies. "Some companies have very poor internal control," she says. "In others, the controlling shareholder and the listed company don't have sufficient segregation. Sometimes staff of the controlling shareholder of a listed company also hold positions in the listed company." Cha says that the CSRC won't launch such an extensive inspection each year, but will have routine inspection of listed companies on a rotational basis annually.

Despite such measures as the CSRC's questionnaire, some say that the way regulation has played out in China's rapid reforms has led to confusion, creating a breach between official standards and actual practice.

"When companies get listed, they disclose a lot of information. But it's bad information because they don't know what they're doing," says Larry Lang, professor of finance at the Chinese University of Hong Kong and a regional corporate governance expert. He adds that the government has failed to clarify key governance issues, such as the definition of insider trading or the criteria for the separation of ownership and management.

Cha concedes as much when she says: "We realize that the development of corporate governance is still in its early stages among Chinese companies."

Director's Cut

When it comes to the question of the role played by non-executive directors, Asian CFOs seemed clearly dissatisfied with the status quo. Nearly half the respondents - particularly from Hong Kong, Malaysia and Singapore - believe that non-executive directors don't devote enough time to their companies. More than half said they felt that board appointments were too influenced by the CEO.

The thinking in the US and Europe on the question of non-executive directors has far outpaced Asia - both by regulators and CFOs that must comply with their strictures. Independence is the main theme of the new rules proposed by the New York Stock Exchange and the NASD, which have yet to be approved by the US Securities and Exchange Commission. They mandate that all listed companies have a majority of independent directors on their boards. The rules also considerably tighten the definition of independence.

European companies already have in place a two-tier board structure - under which an independent supervisory board oversees the decisions of a management board - as a strength of continental European corporate governance. They argue that this provides a system of checks and balances that is absent when - as is often the case in the US - the chairman and the CEO are the same person, or the board is far from independent.

Asia's many markets have attacked the problem, but there is no consensus on how to act and the pressure - unlike in the US - to back away from rules that would enforce a truly independent board is enormous. Hong Kong not only shied away from quarterly reporting, but also from a measure to require that at least one-third - that's one-third, not two-thirds - of board members be independent. Singapore's efforts have been more effective. The stock exchange has held to its demand of having independents comprise at least two-thirds of the board. But in Singapore, as in Hong Kong, the concentration of family and government ownership makes it difficult to find truly qualified directors that are not connected somehow to ownership. One quarter of the 450 listed companies in Singapore are owned by 10 families, says David Gerald, the chairman of the Securities Investors Association (Singapore) (SIAS). Five shareholders own more than 50 percent of the shares.

Government-linked companies (GLCs) are involved in about 40 percent of the total number of companies. "Family owned and GLCs have been having their way for a long time," says Gerald, noting the cultural obstacles that tightly controlled companies face to having true independents.

Malaysia recently instituted a new set of listing rules through its stock exchange that demands that at least two-thirds of the board be independent. The rules require candidates for outside director to sign a statement making them liable if they have undisclosed connections with the company's ownership. In the Philippines, regulators have advised independent boards for financial institutions as a way to lay down a groundwork that might filter into companies.

In Korea, Hasung Jang says the stock exchange rules on board independence aren't being taken seriously by the chaebol sector companies. "The Federation of Korean Industries," he says, "actually has a proposal to the stock exchange regulators that would allow companies to appoint family members as outside directors."

"I don't think they get it," he adds.

CFOs in the ACCA survey may not be getting it, either. The survey results indicate Asian CFOs see non-executive directors as a mixed blessing. Their current role was seen as valuable by only 30 percent of the CFOs, and only 50 percent welcomed the role of independent directors in establishing effective corporate governance practice. "But there's also some resistance to their role and uncertainty about the value they bring," says Adams.

Most complained that it's too costly to appoint them and too tough to find qualified ones. Here, too, China's CFOs showed a concern that separates them from their south-east Asian and Hong Kong colleagues - perhaps indicating the fear of an official's peremptory knock on the door. They had no doubt that they could afford hiring a non-executive director.

Distortion

Something of the same distortion emerges in CFOs' views of how to improve governance in the region. Southeast Asian and Hong Kong CFOs roundly landed on a high degree of self-regulation, seemed unperturbed by government intervention, but were fiercely against the meddling of investors. Almost 50 percent of the total respondents believed that investors should have no role in improving corporate governance standards. This is hardly a shocker. No CFO welcomes crusading gadflies any more than they do a visit from the taxman. Yet the results show that only half of the companies polled outside of China have even taken the initiative to launch reviews of corporate governance practices in the past six months, implying a low degree of vigilance that might doom self-regulation from the start.

Further, self-regulation already seems to be failing. Disclosure regulation in the four markets in the survey as well as South Korea follows a global principal of compliance, called "comply or explain." The practice allows for companies to choose between complying to the letter or giving a detailed explanation where they have deviated from strict compliance. Comply or explain in theory puts more onus on the companies themselves. It also allows regulators a legal wedge. If companies complied to the letter, but not the spirit, of a regulation, regulators can reasonably ask: "Why, then, didn't you explain?" In the wake of the Enron scandals, the New York Stock Exchange is mulling a proposal to introduce the practice to US-listed companies.

But if the Asian experience can be taken as an example, comply or explain is failing. "Typically, what most companies in Asia do is comply because it's easier for them to comply than think through the issues and come up with their own answers and explain why they do or don't follow the code," says Jamie Allen, secretary general of the ACGA.

Adding to the complacency is the fact that Asian governments have demonstrated little interest in strictly enforcing disclosure rules. Until regulators get a new set of teeth, there's little incentive to make the effort at setting up an internal review and giving a detailed explanation of governance procedures. In Hong Kong, for example, the last time the Securities and Futures Commission (SFC), the body responsible for pursuing financial wrongdoers, intervened to protect the rights of minority shareholders was in the Mandarin Resources case in 1996.

David Webb, a former investment banker turned shareholder activist, says that the SFC has had the firepower to act, but not the government support. "In the last few years the SFC has lacked a government mandate to spend the money needed on major intervention in corporate abuses, either in being able to wind up a company or implement alternative measures," he says.

Singapore's record of enforcement has been equally weak. In the UOB case in 1999, the last major investor rights case in Singapore, the government levied a fine of only S$400,000. The previous major lawsuit was a high-profile case in 1979, when the chairman of Haw Par Brothers International was sentenced to six years in jail, charged with non-disclosure violations.

Not surprisingly, China has bared more fangs than its neighbors, but only lately. Recent actions against corporate executives who have allegedly falsified their company's accounts include the indictment for tax evasion of chairman Yang Bin of Euro-Asia, a conglomerate that made its original money in orchids, and the removal by shareholders of chairman Yang Rong of Brilliance China, an automotive company.

Fifty Up

While a few companies scattered about Asia's economically diverse markets don't amount to a movement for better corporate governance, they do indicate that some see an advantage. For now, it means little more than some competition for the still-flourishing family owned business empires in Asia. For so long, tightly held, family-owned businesses that had direct relationships with their bankers - very often cross-shareholding relationships - could enact financial transactions without accountability. As the channels of capital change, companies that demonstrate best practices in governance will find an advantage.

But it's easy to overplay this point. The ACCA survey shows a high degree of complacency among the stewards of finance in three of four of the region's major markets. And recent evidence in Hong Kong shows just how possible backsliding can be. Thirty-two of 33 of the listed companies on the Hang Seng Index are companies owned and controlled by a tightly held majority. There is little real incentive for these companies to attend to minority shareholder rights.

"Give Hong Kong another 50 years," said Lawrence Fok in November. For a moment, take his suggestion to heart. Asia 50 years from now could provide many wonders. Bangalore designers may build a pocket supercomputer. Skiers may shussh the slopes of Tibet. But one possibility seems most likely of all: the capital markets of the world will be funding China's development, and if Chinese companies succeed in placing better emphasis on corporate governance practices, Hong Kong's primacy as a regional business center will wither away to become a footnote to the history of modern China.

Tom Leander is Editor in Chief, and Karen Winton is a Senior Writer at CFO Asia.