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Corporate governance challenges in Asia
CORPORATE governance (CG) has been an enduring issue in the region, especially after the Asian financial crisis when poor CG made the crisis considerably worse as investors, local and foreign, harboured serious doubts about their fate as businesses were confronted by adverse conditions.
In spite of progress made over the years, surveys conducted by organisations such as McKinsey & Co as well as the Asian Corporate Governance Association (ACGA) show that there is much room for improvement among countries in this region compared to developed markets in North America and Western Europe; knowledgeable observers however will hasten to add that there is considerable room for improving CG in these countries too.
Two factors provide special urgency for CG "upgrading": for one, a number of Asian countries, in particular Japan, South Korea, Taiwan, and the city states of Hong Kong and Singapore, have reached a stage of economic development where "technological catching-up" cannot be relied upon for further growth.
With population increase severely limited and in some cases negative, good CG can provide a further source of economic growth.
The second factor - distinct yet related - is the looming pension problem in these societies, driven by shrinking labour forces and rapidly rising life expectancies. With the traditional Asian family-based retirement system disappearing and "pay as you go" social security systems ailing - to the extent they ever existed in the region - the only alternatives are so called "defined contribution" (DC) arrangements, illustrated by Singapore's CPF.
However, DC pension systems require the availability of assets with good returns over the long term. In practice, only equities (including real estate-related equities) can yield returns that make contributions affordable. Equity markets with good returns require high quality CG, where firms are managed for the benefit of investors.
Ultimately, CG refers to the efficient use of resources in the value creating effort of the business enterprise. Business firms consist of various "stakeholders", each pursuing its own interests - entrepreneurs/managers; providers of capital ie shareholders and creditors; employees; customers, suppliers and last but not least, the wider community where economic activities take place. CG is concerned with the alignment of interests of various parties to maximise enterprise performance.
What are the unique challenges to achieve this objective in Asia? Many. For one, CG is concerned with prioritising stakeholder rights: exactly whose property is the business enterprise?
Property rights in Asia were never very pronounced. Until not very long ago, feudal governance reigned supremely and private property rights were weak. While feudal systems were not unknown in Europe of course, property rights emerged early, as in the circumstances leading to the creation of the Magna Carta charter in England, the French Revolution and at its peak, the founding of the United States. Here, notions of private property in an "anti-feudal" system formed the core of the foundation of this new state and subsequently spread around the world. In Asia, its adoption was delayed by colonial governance which did not put a high priority on private property rights of the locals.
To boot, a fundamental institution - the "corporation" - was a concept alien to Asia. While there was no shortage of different forms of business enterprise, they were governed by custom and familial ties under notions of property quite different from western concepts of private property.
The modern joint stock company, based on the separation of "brains" (entrepreneurial management) and "money" (investors' savings) was first created by the Dutch in the 16th century (the vennootskap) and was quickly imitated by the British and later in the rest of Europe.
It brought about tremendous changes: suddenly there existed incentives for the commercialisation of innovation, rather than presenting new ideas to the feudal lord, who may or may not appreciate the impact. More importantly, the corporation and its underlying capitalist system promoted a certain degree of freedom for unconventional thinking, expression and discussion. Religion and laws were adjusted. The result was an unprecedented growth in trade, wealth, standards of living, life expectancy and last but not least, naval power, facilitating the emergence of colonialism.
History provides another clue to the difficulties faced by CG in Asia. Except for Japan, where the concept of the kaisha was quickly adopted by the reformers during the Meiji revolution, corporate business in Asia did not really start off until after the end of the colonial period and/ or concomitant wars. Thus, except for Japan and a few entities in India, virtually all Asian companies are of relatively recent origin.
Here lies one of the fundamental issues that affect CG in the region: almost all business enterprises start as family firms (or state-owned firms in socialist economies). Many of these firms have been spectacularly successful in a postwar/post colonial environment that was quite unique: there was peace, and technology and business practices were readily available from the developed world of Europe, the United States and nearby Japan for those clever enough to take advantage of the opportunities and adopt them to local markets. The growth opportunities indeed were such that internally generated resources were not sufficient: funds had to be raised from investors via the newly created stock markets in the region. The "family firm" now had to deal with external investors and it is at this point where CG challenges come to a head. It is not "my - or my father's - company" any more - the dominant shareholder/manager becomes the fiduciary of "other people's" money - a shift in perspective that creates inherent conflicts.
Indeed, observation and economic theory, buttressed by ample academic research, purport convincingly that firms with a dominant shareholder who is "minding the store" tend to perform better than firms with a widely diverse share ownership, where power reverts to managers who run the company in their own interest - not their investors' interest. This phenomenon is known as the principal (the saver/investor) vs the agent (managers) conflict. This conflict has many dimensions, excessive compensation tends to be the least.
In contrast, most firms in Asia have a dominant shareholder, usually the founding family that is "minding the store", taking credit for the tremendous value creation, reflected in the impressive economic growth of almost all countries in the region. Indeed, based on this evidence, a whole literature has developed praising the superiority of "Asian CG", especially after systemic weaknesses in western CG, particularly risk management, became evident during the global financial crisis of 2007/8. Asian companies largely escaped, not the least because many had learned the appropriate lessons 10 years earlier.
However, there is another side to the coin: the dominant shareholder does not look kindly at the passive shareholders with whom the value created is to be shared on equal terms, an outcome not considered to be equitable. Not surprisingly, dominant shareholders then tend to engage in "tunnelling", using their power to syphon resources out of the firm for their own benefit, or those close to them. Thus, minority shareholders in such firms are constantly subject to exploitation - the essence of poor CG. Given the circumstances, the dominant shareholder does not even harbour guilt feelings! To add further to this conflict is the fact that in many countries of Southern Asia, business enterprise is in the hands of an ethnic minority, the overseas Chinese, whose economic success creates precarious property rights and in turn generates defensive reactions, such as poor transparency and tunnelling.
What is the outlook for the future? Governments are under pressure to improve rules and regulations, particularly to protect minority shareholders. But regulation has limited effects - business is complex, and over-regulation has negative side-effects; indeed CG ultimately is a "state of mind" by those governing enterprises.
By the same token, as Asian business matures and G2 transits to G3, with margins squeezed by global competition requiring increased access to risk capital from third parties, self-financing corporate growth becomes impossible.
And investors have become quite sensitive to the quality of CG in an environment of lower growth, increasingly asking the question - will we be treated fairly?
- Mr Dufey is professor emeritus, University of Michigan, and faculty member at Nanyang Business School, Nanyang Technological University