“Can Corporate Governance Lead the Way to Global Competitiveness?”
YBhg Datuk Ali Abdul Kadir
Chairman, Securities Commission
International Conference on Corporate Governance in Asia:
“Corporate Governance and Global Competitiveness”
3 April 2002
Nikko Hotel, Kuala Lumpur
1. First of all, allow me to thank the organisers of the International Conference on Corporate Governance in Asia for inviting me to speak at the closing session of this conference on the topic of whether corporate governance can lead the way to global competitiveness in the context of Asian firms and Asian markets.
2. Let me begin with the basic proposition that the fundamental tenets that underlie good corporate governance, as has been expressed by the various codes and best practices of corporate governance globally – fairness, transparency, accountability and responsibility – represent management values that in fact underpin all forms of good governance or management, regardless of whether it is applied to a firm, a market or even an economy. From the perspective of management philosophy, good governance is a means to an end and not an end in itself. For firms, markets and economies alike, good governance provides a means for achieving long-term stability and sustainable growth.
3. While there are many factors that contribute to the competitiveness of a firm, a market or an economy, such as superior resources, better technology – and so on, good governance or management is a precondition to competitiveness that underlies all these other factors. This perspective provides a good explanation for the reason why, in the long term, some companies, some markets, some economies are more successful than others despite the fact that they may lack superior resources or technology – they are simply more well governed.
4. A brief review of the major trends over the past few decades that has had a profound impact on the competitiveness of firms and capital markets alike would surely include the following:
The triumph of capitalism and the rise of the market economy;
The process of globalisation, the integration financial markets and the convergence of business practices worldwide; and
The growing importance of capital markets as a source of corporate funding, and the corresponding rise in prominence of the institutional investor.
5. From the point of view of the firm, these developments have been extremely positive in that they have resulted in the freeing up of capital flows leading to greater efficiency in capital allocation hence providing greater opportunities for companies to access financing. The flip side of this is that increasingly firms, markets and economies alike are also being benchmarked against international standards. Institutional investors are increasingly demanding that international standards must be met and will not hesitate to take their money around the globe in their pursuit of quality. The constant flight of capital to quality firms and markets is itself a characteristic of the new global investment environment and reflects the impatient nature of capital today. Even the international financial institutions such as the International Monetary Fund (IMF), World Bank and the Organisation for Economic Co-operation and Development (OECD), alongside the International Organization of Securities Commissions (IOSCO), International Accounting Standards Committee (IASC), and the Basle Committee on Banking Supervision are also benchmarking economies and markets according to international standards.
6. From the point of view of the investor, corporate governance is simply a function of risk management. As investors are increasingly weighing corporate governance as a critical factor in deciding on the quality of a particular investment, the ability of firms or markets to obtain and retain a reputation for good corporate governance is in fact perhaps almost as important as the very practice of good corporate governance itself. Note that I am careful to use the term reputation, and I do so because while in a sense, the quality of corporate governance of a firm or market can be measured through objective criteria, such as for example, the quality of laws or regulations imposed by regulators or a firm’s track record in terms of its compliance to international best practices, ultimately, the decision to practise good governance is a subjective managerial decision and hence involves an element of trust on the part of the investor – trust that the firm is honest in disclosing its compliance with relevant laws and best practices and that it will continue to be committed to good governance practices. Prior to 1997, Asia had this trust, but for various reasons, it has since lost it.
7. Despite its penchant for huge domestic savings, Asia is still a net importer of capital. In this environment and for the reasons I have already described, the competition for capital between companies of the same industry has taken on regional and even global proportions. The continued survival of Asian firms hinges on their capacity to attract inexpensive financing for their investment projects and keeping high risk capital in their portfolio. If companies are to attract and retain long term capital from a large pool of investors, they need credible and recognisable corporate governance arrangements.
8. Because capital markets exist to meet the funding needs of companies through the allocation of funds from investors to issuers, a key measure of the competitiveness of a given capital market is its ability to attract capital to meet the funding needs of the private sector. In this process, price discovery, risk management and corporate governance play major roles. The trend has always been that where capital markets were perceived to have weak market or regulatory infrastructures, the risks of such weaknesses were often deemed to have carried risk management implications – the risks of which having been effectively priced into the market. Corporate governance carries a similar impact to the market – If investors feel that their investments in a particular market return poor value because of poor corporate governance, such risks will equally be priced into the market as with all other risks. Investors hate surprises, and will depart from markets with major corporate governance issues. Add to this equation the fact that institutional investors tend to move (whether strategically or otherwise) in herds, and the problem becomes far more significant.
9. Professor Bernard Black of Stanford Law School has argued that poor corporate governance practices also carry even more significant and longer term implications for the market. He argues that this is so because in markets where the prices of securities are discounted for poor corporate governance, honest companies will not be able to receive a fair value for their securities and would have an incentive to turn either to other forms of financing or to other markets that have a more conducive environment. More worrying still, discounted prices will not discourage dishonest issuers from participating in the market. The flight of quality firms coupled with the proliferation of poor quality firms worsens the problem faced by investors. Investors in turn, rationally react to the lower quality of issuers by discounting still more the prices they will pay. This drives even more high quality issuers out of the market in what is an effectively brutal and endemic downward spiral. In the worst case scenario, liquidity will simply dry up as investors avoid the market. The good news is that the reverse is equally true – markets which have earned a reputation for good governance will enjoy a mark up in the prices of their securities, which will encourage the participation of high quality issuers, which will in turn attract liquidity – and so on. Simply put therefore, bad companies help to create bad markets, whilst high quality companies, which practice good corporate governance, help to create strong markets.
10. Historically, over the last two decades or so we have seen the decline of the East Asian and Japanese relational-management models of corporate governance. Like it or not, we have also seen an almost global convergence towards the adoption of what is essentially an Anglo-American model of corporate governance as the new benchmark of good governance. Certainly, the international financial institutions and even supra-national organisations, such as the World Bank, OECD, IMF and the Asia-Pacific Economic Cooperation (APEC) broadly tend towards this approach. But let me stress that in terms of the adoption of specific governance models or best practices for particular economies, there is no perfect one-size-fits-all solution. The fact that developed economies themselves are continually reassessing the appropriateness of key components of their respective models with the view towards major change certainly stands for this proposition – I think this fact is historically self-evident from, for example, the Guinness and the Maxwell pensions scandals in the 1980s, which provided part of the impetus for the development of the Cadbury Report in the UK, to the current Enron debacle in the US and the type of regulatory responses that this has engendered.
11. For any reform initiative to be truly genuine and effective, it must grapple with the legal, cultural and economic particularities unique to a given country. It is trite to observe that what works for one economy will not necessarily work for another. The introduction of new laws and regulations based on a governance philosophy that does not suit the cultural or environmental context of a particular economy will result in a mechanistic following of the letter rather than the spirit of those rules. Therefore, from a pragmatic point of view, what matters is not which particular model is subscribed to in the process of reform, or whether it originates in the East or the West, but rather whether it is capable of addressing the concerns and weaknesses peculiar to a given market whilst at the same time retaining the strengths already present within that market.
12. A May 1999 APEC Report on Strengthening Corporate Governance in the APEC Region which was endorsed by the Finance Ministers of member economies, and which was the product of a collaborative APEC initiative led by Malaysia, identified the following generic characteristics of Asian corporate governance, which, it said, contributed to the severity of the Asian crisis, and these are as follows:
Firstly, a key characteristic of corporate governance in Asia has been the high degree of ownership concentration typically in the hands of family groups or the state, as opposed to institutional investors.
Secondly, minority shareholders and institutional shareholders in Asia are generally passive, preferring exit over voice.
Thirdly, many boards and audit committees do not function as effective oversight mechanisms.
Fourthly, in relation to disclosure and transparency, the APEC report also highlighted that the ethic of full and timely disclosures – the cornerstone of modern capital market regulation – had yet to be fully entrenched in many Asian corporations, giving rise to the perception of a dichotomy between market ‘insiders’ and ‘outsiders’ within the investing community;
Fifthly, the report pointed out that many regional economies had weak enforcement systems, particularly in relation to its inability to respond swiftly and effectively to corporate governance violations by misbehaving corporations.
13. Insights into at least the first two of these five characteristics can be shed by reference to corporate Asia’s historical and cultural context. Reflections into Asian history reveal that modern Asian corporate growth, with the exception of a few Japanese multinationals, is a relatively recent phenomenon, emerging only after the Second World War. Contrast this to Europe, which by the 17th century already had flourishing capital markets. In this context, the Asian miracle itself was essentially founded upon the dynamic efforts of Asian entrepreneurs, who in the post-war environment, helped to build-up their domestic economies and had done so with little support other than from family or some other form help from the state.
14. In retrospect, the Asian miracle certainly makes out a strong case for Asian values, which are themselves founded on Confucionist concepts related to family values, obedience to authority, hard work and self-help in the face of adversity. Coupled with a strong entrepreneurial spirit and a relatively high degree of paternalism on the part of the state, rapid economic and industrial growth was achieved through a combination of a heavy reliance on the banking system and overt assistance from the state, which essentially prescribed export policies that strongly encouraged growth in the manufacturing sector.
15. However, while the close relationships between Asian firms with the state or with family groups have given rise to strong synergies which have helped in the past, it also gave rise to governance concerns that such relationships create the opportunity for serious conflicts of interest and may engender excessive or imprudent risk-taking at the expense of both the public and minority shareholders. The Asian crisis highlighted the fact that these were very real concerns.
16. As Asia moves towards greater global competition – competing against global competitors who subscribe to global standards of corporate governance and management – many aspects of the old Asian paradigm will certainly require rethinking. A key competitive distinction between Asian firms and Western firms is that that Western firms have had a big head start in developing and leveraging on superior financial and managerial expertise. The Malaysian Code on Corporate Governance sums up this contention in the form of a challenge for Malaysia. It states, (and I quote) “[There is a] need to reinvent the corporate enterprise, so as to efficiently meet emerging global competition. The world’s economies are tending toward market orientation. In market-orientated economies, companies are less protected by traditional and prescriptive legal rules and regulations. … Hence there is a need for companies to be more efficient and more well managed than ever before to meet existing and anticipated world-wide competition”.
17. Going forward, I believe there is no one universal solution that can be applied equally to all economies to resolve this challenge. I think that the way forward, at least for developing Asian economies, is in the more pragmatic approach of learning from the varied models and experiences of other economies which broadly bear similar legal or cultural heritages, and building a domestic model based on relevant lessons learnt. In the development of a domestic governance framework for each Asian economy, there is certainly a need to address the concerns I have already highlighted, in addition to addressing other governance concerns specific to that particular economy. But there is an equally crucial need to ensure that the existing strengths which are unique to our firms and markets – such as the legendary Asian spirit of entrepreneurship and hard work that has been the hallmark of Asian firms and markets – are retained and not sacrificed in the process of imposing governance reforms.
18. In Malaysia, the Finance Committee Report on Corporate Governance and the Capital Market Masterplan collectively provides us with a comprehensive blueprint for corporate governance reform agenda over the period of the next 10 years. Essentially, the approach adopted has been to effect legal reform alongside the introduction of voluntary codes whilst taking strong measures to facilitate the training of directors, as well as inculcating investor activism. In Malaysia, it is fundamentally believed that the appropriate mix between self-regulation by the market and regulatory discipline by the regulators is essential in the development of a strong and effective framework for corporate governance regulation.
19. In essence, the key thrusts of the Malaysian corporate governance reform agenda seek to address the concerns I have highlighted and accordingly focus on achieving the following broad objectives:
Fair treatment of all shareholders and protection of minority shareholder rights, with particular emphasis on enhancing the rights and remedies of minority shareholders;
Transparency – through the timely disclosure of adequate, clear and comparable information concerning corporate financial performance, corporate governance and corporate ownership;
Accountability and independence of the board of directors;
The promotion of training and education at levels to ensure that the framework for corporate governance is supported by the necessary human and institutional capital; and
The strengthening of regulatory enforcement
20. Malaysia undertook a major review early in 1998, of the then existing state of corporate governance regulation in the through the high level Finance Committee on Corporate Governance. The Committee, which was comprised of both government and industry identified the weaknesses exposed by the crisis in the then existing governance framework and recommended sweeping changes. An Implementation Project Team (IPT), subsequently formed and tasked to lead and oversee the implementation of the recommendations of the Report, is currently working towards the completion of the implementation process. Among the first fruits of the work of the Finance Committee was the release of the Malaysian Code of Corporate Governance in March 2000.
21. Since then, significant progress has been made. In respect of primary market disclosures, amendments to securities legislation, effective 1 July 2000, have effectively delineated and streamlined the responsibilities of the SC and the Registrar of Companies with regards to prospectuses, resulting in greater legal and regulatory certainty in the area of public offerings of securities.
22. The revamped Kuala Lumpur Stock Exchange (KLSE) Listing Requirements, released on 22 January last year represents the successful implementation of a significant component of recommendations contained in the Finance Committee Report. This was chiefly aimed at enhancing standards of corporate governance by enhancing board-level and shareholder-level controls on the conduct of listed companies. This has principally taken the form of amendments to the Listing Requirements in the areas relating to disclosure and reporting, internal controls, board composition and board committees, mandatory directors’ training, related party transactions as well as other measures to enhance the protection of minority shareholders.
23. The Finance Committee Report also recommended further changes to securities and company law, including the requirement for auditors to report suspected breaches of securities laws, the codification of key duties of directors and provisions to curb a controlling shareholder’s right to vote in cases involving related party transactions. Implementation of these measures is currently underway.
24. The successful and effective implementation of these reforms has only been possible because the latent legal and institutional building blocks to support the development of a sound corporate governance framework has already been present in Malaysia. Because Malaysia’s securities and company law are based on sound common law traditions, laws relating to governance issues such as directors duties, conduct of general meetings, insider trading, have been in existence for a long time. Regulators too have been vigilant in the periodic review of laws and regulations to ensure their continued effectiveness and in this sense our corporate governance reform initiatives started long before the publication of the Finance Committee Report, having been implemented prior to, and during the crisis. Allow me to point out a few key examples:
In 1997, the Malaysian Accounting Standards Board was established as the sole authority to issue, approve and review accounting standards as a measure to enhance accounting standards in the country.
In 1998, strong measures were taken to strengthen insider trading laws and to enhance transparency of share ownership. The new law on insider trading introduces a more stringent definition of “insiders” and empowers investors or the SC (on behalf of investors) to claim compensation for loss suffered up to three times the insiders gain or loss avoided. Amendments were made to the securities legislation in October 1998 to achieve transparency of share ownership. The amendments now prohibit a person from hiding behind their nominees in the reporting of the structure of corporate shareholding.
1999 saw the introduction of quarterly reporting of corporate financial information in Malaysia. In 1999, a new Malaysian Code on Take-overs and Mergers was introduced. The new Code requires higher standards of disclosure and corporate behaviour from those involved in mergers and acquisitions and is based on international best practice and enhances minority shareholder protection.
25. In recognition of the fact that genuine reform in corporate governance practices require efforts beyond mere legal and policy reform – and entails instead cultural and attitudinal changes to be imbibed amongst corporate constituents – strong measures have been taken to step up the training and education of corporate governance agents at all levels. Firstly, novel amendments to the KLSE Listing Requirements described above have introduced a new rule requiring the mandatory accreditation and training of directors of listed companies as a prerequisite to listing. Additionally, the Malaysian Institute of Corporate Governance (MICG) and other professional bodies have also been proactively supporting and complementing the training and education efforts of the exchanges and regulators in respect of the training of other corporate and capital market constituents.
26. As a measure to harness the ability of large albeit minority institutional investors, a Minority Shareholder Watchdog Group has been established, comprising of the largest institutional funds in the country. The Watchdog Group appointed its first CEO, En. Yusof Abu Othman, in July 2001 and I am pleased to announce that it has recently obtained its Investment Adviser’s license from the SC on the 4th of March 2002.
27. Looking beyond what has already been achieved, the Malaysian Capital Market Masterplan, which was released in February 2001 seeks to comprehensively chart the strategic positioning of the Malaysian capital market over the next 10 years, the broad vision of which targets the development of a highly efficient and internationally competitive capital market which would have the fundamental ability to meet the country’s basic capital and investment needs. The Masterplan itself is premised upon the achievement of 6 key objectives, expressed in 152 recommendations, 10 of which relate directly to corporate governance. The Masterplan builds on the recommendations of the Finance Committee Report and further develops the corporate governance reform agenda in a number of key areas. In line with the need for the adoption of a market-based approach to regulation in the capital market, the Masterplan stresses the importance of developing the role of the active exercise of market discipline and market-based enforcement mechanisms in the area of corporate governance regulation. You will find that this strategy is clearly evident in the 10 recommendations in the Masterplan relating to corporate governance, which may be summarised as follows:
Firstly, the Masterplan expresses the commitment of the SC towards ensuring the timely and effective implementation of the Finance Committee Report on Corporate Governance;
Secondly, to further enhance the awareness and accountability of company directors, financial controllers and management, and strengthening the role of auditors of public listed companies with respect to discharging their fiduciary duties to shareholders;
Thirdly, to enhance company-shareholder communications at all levels to ensure high standards of financial reporting and the continuous disclosure of timely, relevant and accurate corporate information to the shareholder to facilitate market discipline and informed investor decision making; and
Finally, to improve shareholder activism by improving avenues for minority shareholders to enforce their rights and to further encourage greater institutional investor participation in corporate governance through the introduction of industry guidelines for institutional investors to enhance their role as effective corporate governance agents.
28. Over the past decade, we have seen how corporate governance has played a major role in determining the competitive survival of our firms and markets. I would like conclude by stressing that if Asian firms and markets are to continue to thrive and succeed in the 21st century, then real commitment towards raising domestic corporate governance standards and towards aligning these with international standards, will surely be required of all parties in our respective markets, most of all the corporate captains themselves. Ultimately however, I believe that Asian firms will continue to change and compete, not merely because Asian regulators are prescribing stronger and more effective frameworks for corporate governance regulation for them to comply with, but because they themselves want to change, in order to remain competitive in an increasingly globalised environment.