Effective Corporate Governance in Asia

Panelist: Joseph P.H. Fan

Professor of Accountancy and FinanceDeputy Director, Center for Institutions and Governance

Chinese University of Hong Kong

Prepared for panel discussion at the APEC High Level Conference on Structural Reform, September 8-9, 2004,

Tokyo

2

Outline

Why some Asian companies failed to produce reliable financial information?Auditor, audit committee, and audit supervisory agencySelf-enforcement: the importance of reputation building in weak institutional environmentsUltimate solution: institutional reforms

3

Why some Asian companies failed to produce reliable financial information?

Complex organizational and ownership structuresCovering up: difficulties of putting investors’ interests before family interestRelationship-based business dealings, rent seeking, or even corruptionPrevent predation and expropriation (sometimes by governments) in weak property rights systemsIf these institutional constraints cannot be relieved, it would be difficult to improve corporate transparency even with new accounting standards, laws, and regulations

4

C h e n g Y u T u n g

C h o w T a i F o o k E n te rp r is e s L td

A s e a n R e s o u rc e sH o ld in g L im ite d *

(0 0 2 2 )3 4 %

IM C H o ld in g L td . *( 0 1 5 8 )

2 7 %

N e w W o r ld D e v e lo p m e n tC o m p a n y L td . *

( 0 0 1 7 )3 7 .8 %

L e e H u n gD e v e lo p m e n t *

( 0 0 6 8 )6 %

P a u l Y . IT C C o n s t ru c t io nH o ld in g s L td . *

( 0 4 9 8 )2 0 .2 %

« n µ Ø § ë ¸ ê ª Ñ

F e r g u rs o n H o te lH o ld in g s L td .

4 7 .3 %

Q u e e n s w a y H o te lL td .

2 4 .8 %

N e w W o r ld C h in aL a n d L td . *

( 0 9 1 7 )7 2 .0 5 %

N W D ( H o te ls ) In v .L td .6 4 %

N e w W o r ldT e le p h o n e

H o ld in g s L td .9 5 %

N e w W o r ldS e rv ic e s L td .

5 0 %

N e w W o r ldC y b e r B a s e *

( 0 2 7 6 )3 4 .7 4 *

N e w W o r ld In f r a s t ru c tu reL td .*

(0 3 0 1 )6 0 .6 4 %

P a u l Y . P ro p e r t ie sM a n a g e m e n t L td

1 0 0 %

A s ia In fo rm a t io nR e s o u rc e s (H o ld in g s )

L td .*(8 0 2 5 )

1 3 .8 8 %

B e i j in g B e id a J a d e B irdU n iv e rs a l S c i- T e c h C o . L td .*

(8 0 9 5 )7 .2 6 %

P a u l Y . R e a lE s ta te A g e n c y

L td1 0 0 %

A irC o m m u n ic a t io n s

(A s ia ) L td .

D y n a m ic W inA s s e ts L td .

C y b e r Q u e s t L td .

N e w W o r ld F ir s tF e r r y S e rv ic e s

( M a c a u ) L td .1 0 0 %

V a s t E a r n g ro u pL td (a s u b s id ia r y

o f N e w W o r ldD e v . C o . L td )

K w o o n C h u n gB u s H o ld in g s

L td .*(0 3 0 6 )

2 1 .0 3 %

N e w W o r ld R is kM a n a g e m e n t

8 5 %

W a i K e e H o ld in g s L td .*(0 6 1 0 )

1 6 .5 4 %

N e w W o r ld F ir s tH o ld in g L td .

1 0 0 %

T a i F o o k S e c u r i tyG ro u p L td . *

( 0 6 6 5 )2 0 %

K w o o n C h u n gC y b e r L td .

1 0 0 %

N e w W o r ld F ir s t F e r r yS e rv ic e s L td .

1 0 0 %

N e w W o r ld F ir s t B u s S e rv ic e sL td .

1 0 0 %

C h o n g q in gT o u r is m (G ro u p )

C o . L td .6 0 %

T a i F u n g C o a c h &T ra d e T ra v e l

1 0 0 %

N e w L a n ta o B u sC o . ( 1 9 7 3 ) L td .

9 9 .9 %

S u n d a r t T im b e rP ro d u c ts C o . L td .

6 5 %

N g o K e eC o n s tru c t io n C o .

L td .1 0 0 %

G ra n d e u r B u ild in gM a te r ia l

(H o ld in g s ) L td .1 0 0 %

Z e n P a c if icC o n s t ru c t io n L td .

1 0 0 %

R o a d K in gIn f ra s tru c tu re L td .*

(1 0 9 8 )4 9 .1 9 %

C h o n g q in g I r o n &S te e l C o . L td .*

(1 0 5 3 )3 %

P a c i f ic P o r ts C o .L td .*

(0 6 5 9 )2 5 %

S h e n y a n g P u b licU ti l i ty C o . L td . *

( 0 7 4 7 )9 %

C S X W o r ldT e rm in a ls H o n g

K o n g L td .3 3 .3 4 %

A s ia C o n ta in e rT e rm in a ls L td .

3 6 .3 3 %

A T L L o g is t ic sC e n tre H o n g

K o n g L td .3 9 %

S h e n y a n g S h a n h a iH o t E le c t r ic ity C o .

L td .1 1 .1 1 %

Q in g h u a Z ig u a n gT e c h n o lo g y V e n tu re

In v . C o . L td .2 2 .5 %

S h e n y a n gD e v e lo p m e n t R e a l

E s ta te C o . L td .9 9 %

S h e n y a n g W a te rC o . L td .9 9 .3 7 %

U n ith a i S h ip y a rd& E n g in e e r in g

L td .2 5 %

W a n B o n g C o .L td .

1 0 0 %

* - P u b l ic i ty l is te d C o . in H o n g K o n g

C h o w T a i F o o kN o m in e e

5

Percentage of listed Asian companies affiliated with business groups(Source: Claessens, Fan, Lang, 2002)

0

10

20

30

40

50

60

70

80Hong KongIndonesiaJapanSouth KoreaMalaysiaThe PhilippinesSingaporeTaiwan ThailandAll economies

6

Percentage of listed companies that are diversified (with multiple segments)

0

10

20

30

40

50

60

70

80Hong KongIndonesiaJapanSouth KoreaMalaysiaThe PhilippinesSingaporeTaiwanThailandAll Economies

7

The Formosa Group (Taiwan) of the Wang’s Family

Nan Ya Plastics

37.20%2.15%

4.93%

4.75%

4.08%

Wang’s family

Investment Companies and other entities

FormosaPlastics

Formosa Chemicals and Fiber

Formosa Taffeta

8.41%12.97% 18.66%

3.57%

36.44%13.13% 13.12%

4.44%

8

Why some Asian companies failed to produce reliable financial information?

Complex organizational and ownership structuresCovering up: difficulties of putting investors’ interests before family interestRelationship-based business dealings, rent seeking, or even corruptionPrevent predation and expropriation (sometimes by governments) in weak property rights systemsIf these institutional constraints cannot be relieved, it would be difficult to improve corporate transparency even with new accounting standards, laws, and regulations

9

Family control

0

10

20

30

40

50

60

70

80

Percentage of firms controlled by families

HKIndonesiaS. KoreaMalaysiaSingaporeTaiwanThailandEast AsiaJapanAll

10

Asia’s corporate governance problems are often induced by country level institutional constraints

Weak disciplinary market forceHostile takeovers are rare in AsiaIn china, state shares are not freely transferableProduct markets are heavily regulated in some economies

Weak laws and public enforcementSignificant increase in the quantity of laws, but enforcement is weak

Corruption and weak public governance in many Asian economiesThese country institutional factors affect the nature of business dealings in Asia and shape corporate governance practices

11

Corruption and corporate transparency

Why corporate transparency in Asia is low, despite new laws and regulations requiring more disclosure? Why do Asian investors seldom read financial reports?Disclosure of proprietary information can be costly, even investors agreeFan and Wong, Journal of Accounting and Economics, 2002

12

Opacity Premium in AsiaSource: PricewaterhouseCoopers

0

2

4

6

8

10

12

14

Economy

ChinaTaiwanHong KongIndonesiaJapanKorea (South)SingaporeThailand

13

Corruption in Asian Economies(Source: Transparency International: mean Corruption Perception Index 1992-2000)

0123456789

Economy

ChinaTaiwanHong KongIndonesiaJapanKorea (South)SingaporeThailand

14

Corporate governance roles of external auditors in Asia

ImportantAcademic research (Fan and Wong, Journal of Accounting Research) has found that high quality auditors improve the credibility of accounting information to investors and help strengthening corporate governance in East Asia

15

Market Share of Big-Five and Big-Five Affiliated Auditors in Asia, US, and UK

0102030405060708090

100

Economy

TaiwanHong KongIndonesiaJapanKorea (South)MalaysiaPhilippinesSingaporeThailandUnited StateUnited Kingdom

16

Auditor oversight agency and audit committee

Audit oversight bodyAgree that creating an audit oversight body is important. Does the agency have strong disciplinary power?Will Asian governments and courts respect and help enforce the disciplinary actions recommended by the audit overseeing agency?It may be unrealistic to rely on auditors as gatekeepers

Will an audit committee help in Asia?Yes if one can bypass institutional constraints

17

Boards of directors are weak in governance: the case of China (Chen, Fan, Wong, 2004)

Board size 9.22 (range 5 to 19)Manager directors 34%Largest shareholder 53%Minority shareholders 0%Politicians 32%

Central govt 4%Local govt 19%Others 9%

18

Boards of directors are weak in governance: the case of China (Chen, Fan, Wong, 2004)

Directors from unaffiliated firms(“expert” directors) 18%

Professionals 5%Academics 14%Woman directors 5%Age 47Education Between Junior college

and university

19

Corruption and board professionalismShougang Group in ChinaPercentage of Directors that Are Professionals –

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Corruption CaseCorruption Case

20

Corporate governance in weak institutional environments: what work?

Reputation building, in my view, is the most important self-enforcing mechanism of corporate governance

Reputation of profitabilityReputation of accountabilityThe two do not always go hand in hand

21

How do Asia’s public corporations build reputation?

Repeated transactions that show good results and reliabilityBonding (borrowing someone else’s reputation)

Foreign partners in joint ventures or strategic allianceForeign listingsInformation intermediaries, such as rating agencies, financial analysts, and external auditors

22

Reputation ratings

Corporate Reputation Rating

http://www.ratingresearch.com/

23

Where else do we find reputation at work?

24

The CEO that holds a bible – does it work?

He is the CEO of a listed micro-electronic company in TaiwanHe always holds a bible in front of media and prays before company meetingsHe was recently married to a daughter of Mr. Wang Young-Ching, the chairman of Formosa Group, and the “god of management” in TaiwanHis company has been involved in various law suits involving stealing trade secrets from competitors. He and his wife are prosecuted by the Taiwan court for 4 years in prison and monetary penaltiesBorrowing the reputation from the two gods, will he and his company prevail?

25

ConclusionsSustainable growth of corporations and economy as a whole is the ultimate reward of effective corporate governanceReputation is the most important corporate governance mechanism in Asia that all corporations should seek to establish with their stakeholdersBut there is a limitation of the self-enforcing solution. The ultimate solution is institutional reform that improve public governance and law enforcement