Emerging markets have seen capital inflows increase since the tapering of the global finance crisis, with particular focus on Asia. However, concerns remain over corporate governance with views frequently heard from many on what is needed to improve and enhance the region. Over the past decade, several myths have evolved into popular narrative, serving to skew understandings and detract from real issues. There is a lot of excellent discussion on corporate governance in Asia; this article aims not to detract from that discussion, but rather seeks to address several preconceptions that seem to reappear when Asian corporate governance is discussed. By focusing on popularized myths and preconceptions, real underlying issues in Asia will not be addressed, and corporate governance risk will remain material.
Myth #1 – Family/State ownership is A Bad Thing
Discussions on Asian corporate governance, and on Asian business, begin (and often end) with debate about ownership models. Whilst Anglo-American corporate governance typically sees atomized ownership structures and professional managers, Asian corporate governance typically sees a large shareholder owning a major portion of the company’s shares. In some cases, that shareholder engages professional managers to manage the company, in others it retains control. These ownership structures are often cited as a structural weakness of corporate governance in the region. Yet, ask any investor to namethe best managed companies across Asia, and the list tends to be dominated by companies with a substantial central shareholder, either a family or the state. This may be coincidence, maybe not. But discussions around ownership need to be more nuanced than on the issue of absolute level of ownership. Where a family or state has a significant portion of their wealth tied up in an entity, they have a motivation to ensure the long-term survival of that entity. Families are an interesting case. If a family has control over ten entities there may be potential for value-destroying corporate actions (including acquisitions, diversifications, and related party transactions). If one entity fails, then nine more remain. But if a family controls only one entity, in which most family wealth is tied up (and may have been for multiple generations), then that family has an incentive to guarantee long-term sustainable shareholder value creation (and hence represents an attractive investment for minority shareholders). In short, shareholders need to look at the nature of the owner (and their track record of treatment of non-family, minority shareholders) rather than the absolute level of ownership.
Myth #2 – Independent directors will save the day
Much discussion has, rightly, focused on boards in Asian companies. Much progress has been made in Asia over the past ten years since the Asian Financial Crisis. Yet, concern still focuses on whether a company has a certain
proportion of independent directors on its board. Independence is important – robust debate leads to better decision-making – and a line needs to be drawn somewhere. However, emphasis on levels of independence alone is insufficient. First, while there are some excellent independent directors in Asia, any director appointed by a major shareholder serves at the pleasure of that shareholder. Rules to ban that shareholder from voting do not (and arguably should not) exist, and as such the major shareholder acts as recruitment consultant, nominating committee, and swing vote all at once. Minority shareholders should enter into discussions around independent directors, and questions of independence, with eyes wide open. Second, the focus on independence potentially detracts from a focus on quality of directors. What skill-set does this director bring to the board? Does this candidate possess suitable accounting expertise? Industry expertise? A track-record of defending shareholder interests and growing shareholder wealth? All are questions that should be asked in addition to enquiries over independence. Here, the risk is that investors become focused on absolute measures of quantity, as opposed to focusing on quality. Looking at the skills of directors as opposed to a focus purely on independence (or dependence, where fees are substantial) as a sole measure of suitability will lead to more rounded, more involved boards.
Myth #3 – More regulation is a panacea
Often, a corporate scandal or blowup is closely followed by calls for more regulation. In some cases, these calls are justified – calls to strengthen related party transaction rules around Asia are important and timely. However,drawing up new rules and regulations is one area where Asia excels. To many, a first look at company laws, listing rules and codes of corporate governance around Asia may prove surprising – for the most part (save for a few notable exceptions), these documents are well thought out, well written, and well maintained. However, where Asia falls down is on enforcement of rules and regulations. Enforcement has always been a weakness in Asia, and it is here that the debate should perhaps focus. A recent OECD paper on related party transactions in Asia commented on: “an insufficient number of independent and qualified (external) auditors capable of effectively monitoring related party transactions in many jurisdictions; and an insufficient number of experienced, independent, and qualified judges, lawyers and securities market regulators in some jurisdictions.” Indeed, more rules and regulations are not what are needed; better enforcement of existing rules, more independent and qualified judges, auditors, lawyers, and regulators are. The former are perhaps most important, ensuring that judiciaries around Asia have sufficient experience in handling complex securities cases is paramount. Even if shareholders are sophisticated enough to bring a case to court, the outcome rests on the judge being sufficiently qualified and experienced to pass judgment.
Myth #4 – Investors in Asia are neither aware of the problems, nor are they engaged
One final myth – investors in Asia are not seeking to manage issues of corporate governance. For the most part, this is inaccurate. Large numbers of fund managers in Asia do engage in significant corporate governance and sustainability-related due diligence prior to investing, do carry out material engagements on ESG
issues, and do have a keen understanding of corporate governance. They don’t call it ‘corporate governance’, just ‘sensible investing’. That’s not to say that all is positive – many fund managers are still devotees of the ‘Wall Street walk’, particularly where regulation does not support engagement or enforcement. Voting at AGMs and EGMs is under developed (again, in some cases because regulation is a hindrance), whilst co-operative engagements as seen in the US or Europe are less prevalent. But fund managers are aware of the issues faced, and are seeking to work out solutions. Indeed, US- or Europe-based fund managers may benefit themselves from sustained engagements with Asian fund managers, tapping their experiences and expertise on issues of corporate governance and sustainability in Asia.A dogmatic focus on common topics of independence and regulation will not address the core issues in Asia, and will serve to perpetuate the real risks to investing in Asia – a systemic lack of quality directors in some jurisdictions, overly independent (yet under-qualified) boards, a paucity of well qualified and suitably experienced judges, lawyers, and accountants & auditors, and an emphasis on regulation over enforcement. By addressing these issues, investors can succeed in effecting material improvements in corporate governance in the region.
David Smith, is based in Singapore and is head of Asia corporate governance research at RiskMetrics Group.
This commentary expresses the views of the author alone and does not purport to represent the views of RiskMetrics Group or its clients.