“Trends in Corporate Governance and Its Impact on Capital Markets”

Nik Ramlah Mahmood
Director, Securities Commission

at the
International Conference on Corporate Governance –
Trends and Challenges in the Millennium

29 October 2002
Istana Hotel, Kuala Lumpur

1. First let me thank the organisers of this International Conference on corporate governance, University Kebangsaan Malaysia, Edith Cowan University, Monash University and the Malaysian Institute of Corporate Governance (MICG), for giving me the honour of delivering the keynote address for this morning’s session. Corporate governance has never been more relevant a topic for a conference as it is today, surrounded as we are, by manifestations of the consequences of its lack.
2. Corporate governance today has evolved into a practical tool of business – not regarded as a mere whimsy but rather an integral and dynamic component of a successful business, market and economy. As such, Trends and Challenges in the Millennium – is indeed a most appropriate theme for this conference, especially given the paradoxical facets of corporate governance as both the challenge and the solution to many of the concerns faced by capital markets today.


So what is corporate governance in the present context? Many definitions have been proffered, from a “combination of many elements, including sound regulation and enforcement, shareholder activism, and professional and ethical management” to “effective boards, broad disclosure, and strong rights and equal treatment for shareholder “. All the definitions are accurate to some extent but not necessarily complete. Indeed it is a fallacy to imagine that corporate governance is the invention of the modern marketplace. The principles espoused are simply principles of good governance that have long been applied by some of the most consistently successful businesses and investors in their investment.

As such, I would prefer to take a step back from the specific, to the underlying character of corporate governance that in my view, constitutes the fabric of corporate governance. For this I borrow the words of Benjamin Graham on the necessary ingredients for investing –
“What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character “.

Reasonably good intelligence, sound principles of operation, firmness of character, are all equally applicable to the basic requirements for corporate governance and a natural corollary to and source of concepts such as, effective boards, disclosure and shareholder rights.

Trends in Corporate Governance
5. A quick stocktake will clearly highlight very specific trends in corporate governance over the last five years or so. Issues of paramount importance have been that of disclosure and transparency, shareholder activism, professional and ethical management and increased enforcement efforts. Indeed directors and professionals – the accounting profession, the analysts and fund managers, the legal and other financial advisers have and are all to varying degrees being put under the corporate governance microscope to identify areas needing reinforcement.
6. An interesting dynamic of the global trend has been the changing focus and priorities in dealing with corporate governance. We have moved from one end of the spectrum that focused on a strong regulatory framework to one that places emphasis on self-regulation and market regulation. In the process of seeking the right balance, the recent massive corporate failures due in large part to the failure in corporate governance practices, have brought us back to a greater dependence and emphasis on strong and possibly onerous regulation, as is indicated by the new regulatory efforts in the USA, such as the Sarbanes-Oxley Act.
7. It is, I believe crucial for all of us to take a step back from the emotive drivers and the devastating impact of the Enrons and Worldcoms of today and examine the real issues that need to be addressed and how to address them. Whilst none of us should feel smug in our cocoon of “it won’t happen to us”, we must be objective enough to recognise the effectiveness of the mechanisms that are in place and avoid the proverbial knee jerk reaction. In fact the world over, at least, certainly in our part of the world, I think regulators were making good progress to achieving a balance that fits their respective environments when we were all forced to sit back, to absorb the implications of the cross border impact of the recent failures. In doing so, we must ensure that we do not throw the baby out with the bath water.

What does come out without doubt, is there will always be a need for a robust and relevant regulatory framework for the capital market. However it must also be a facilitative and innovative framework that provides clarity and certainty to the market and does not stymie commercial efficiency and endeavor and risk taking that is inherent in all commercial endeavors. There is therefore a need to balance the cost and benefit of regulation. This will assist policymakers to compare regulations across categories and increase the rationality of the system which will in turn lead to more reasoned policymaking and avoid unnecessary or restrictive regulation.

9. A highly prescriptive approach not only leads to the stifling of the market but also gives rise to a potential moral hazard – when there is an extensive and very specific rule book, firms may assume that if something is not explicitly covered in the rule book, there is no regulatory dimension to it. “Loophole mining” becomes not an occupation but a pre-occupation for many.
10. In Malaysia, our approach towards enhancing corporate governance has always been a holistic and proactive one. We are committed towards the development of a vigorous capital market supported by a strong and facilitative regulatory framework and our efforts to achieve the balance between statutory and self regulation are I think exemplified by the multi-pronged approach that we have adopted in enhancing corporate governance. The recommendations of the Finance Committee on Corporate Governance ranges from strengthening the regulatory framework to a voluntary Code on Corporate Governance to education and training as well as shareholder activism.
11. Of course the ever-changing contour and configuration of capital markets makes efforts at enhancing corporate governance extremely challenging. But life goes on, and so must the capital market. Our role as stakeholders of the capital market is to convert the valuable lessons from the recent corporate governance failures into an advantage of foresight, allowing us all to make a unified effort to plug the holes where necessary.
Impact on Capital Market

Let me now, briefly, examine what good corporate governance can do for the capital market and what can be done to ensure that such good practices produce the much sought after ‘CG dividend’.

13. What does good corporate governance translate Into? Firstly, better firm performance. Good corporate governance provides the company with a stable base from which to operate with the necessary checks and balances to better withstand economic vagaries and market movements. There is no doubt that the level of awareness and understanding of corporate governance issues not just as concepts but as practical tools of good management and shareholder value enhancement has increased at an accelerated pace. In essence it has become an integral part of the risk management tool kit.
14. Better firm performance in turn, leads to better returns on investments. In a recent study of 398 firms from Indonesia, Korea, Malaysia, the Philippines, and Thailand it was found that differences in variables related to corporate governance had a strong impact on firm performance during the East Asian financial crisis of 1997¯1998. The study showed significantly better stock price performance was associated with firms that had indicators of higher disclosure quality, had higher outside ownership concentration, and firms that were focused rather than diversified.
15. Particularly relevant for Malaysia is the CLSA’s CG Watch Report published in February 2002, which has moved Malaysia up in its ratings, highlighting in particular, the revamped listing requirements, increased emphasis on minority shareholders, government efforts to separate ownership from management and increased enforcement efforts. Of particular interest, is their finding that high corporate governance stocks have outperformed the Kuala Lumpur Composite Index (KLCI) by 60.4% over five years to end 2001. The report finds such stocks command “premium valuations for good corporate governance, well-managed operations and entrenched market positions” .
16. This adds to the increasing body of evidence that companies demonstrating good governance practices are becoming more attractive to investors and the concept of the ‘corporate governance dividend’ is becoming a reality. For investors, it is fundamental; it means a more transparent and accountable market with higher standards of disclosure on which they may base their investment decisions.
17. Better corporate governance as such, can translate into a willingness to pay a corporate governance premium. Surveys such as the McKinsey “Investor Opinion Survey 2000″, indicate that investors have begun to place significant emphasis on corporate governance in making their investment decisions. This was confirmed more recently in the McKinsey “Global Investor Opinion Survey” in July this year. Both surveys found, inter alia, that an overwhelming majority of investors were prepared to pay a premium for companies exhibiting high governance standards. It is interesting to note that the premiums that they were willing to pay with regards to investments in well governed companies in Asia, was as high as 20 -25%.
18. Globalisation and the integration of markets have resulted in global competition for both capital and products. Companies are competing for increased market share either directly or through strategic partnerships and mergers and the ability to raise capital at costs relatively lower than their competitors. As such, competition from global players is manifest not just in the international but in domestic markets as well. Hence, domestic companies and markets are increasingly being benchmarked against global standards, including global standards of corporate governance. There is also an increasing pool of evidence that corporate failures involving corporate governance transgressions can have an effect on markets both within and across national boundaries.
19. The fundamental lesson that comes out of the recent examples of corporate governance failures is that, however sound and facilitative a regulatory framework is, if it is not complemented by the necessary ingredients of market discipline through effective self-regulation and on an individual level – self- discipline, together with a commitment to the spirit of corporate governance principles – all the regulation in the world cannot prevent corporate failures.

While it is very important to note that good corporate governance is certainly not a panacea for all the economic woes of a company and indeed the capital market, it provides a strong and stable infrastructure to support the activities of a company and the market place. Somewhat akin to a trampoline that with the necessary strength and tension, acts as a safety net that gets one going back up with every fall. Similarly with corporate governance, it provides companies with the ability at the worst, to survive the various challenges facing them.

Walk the Talk, Talk the Walk
21. Not surprisingly therefore, corporate governance is now an established investment criterion. 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 has become as fundamental as the very practice of good corporate governance itself. When institutional investors pull out of a market, the impact can be significant. As such, we must ourselves take the initiative in providing information to the investors – particularly institutional investors, analysts and the like, so that their opinions and analysis are based on an accurate and complete picture. We must walk our talk, and indeed we have. But it is also crucial that we talk our walk as well, as often, the very many significant measures that we have taken are not known beyond our shores.
22. It is also not sufficient that corporate governance principles are practiced but as in the case of ‘justice’, it ‘must be seen to be done’. Market sentiment often has analysts running in circles trying to explain the sudden dips and highs. Phrases such as ‘bulls and bears’ derive from market sentiment and as such should never be under estimated. Analysts are providing corporate governance rating services based on their perception of and the responses and disclosures made by, the companies concerned. Their methodology is usually based on the extent to which a company adopts and complies with codes and guidelines of good governance practices.
23. Therefore, we must all play our part in ensuring proper dissemination, understanding and appreciation of our efforts and their effectiveness in enhancing corporate governance. To this end, in acknowledgement of the importance of perception, companies are increasingly engaging their shareholders and other stakeholders, by way of dialogues, seminars, publications, investor relation units and the like. Indeed the establishment of investor relation units is in itself an important aspect of efforts to enhance shareholder rights.

Malaysia’s Corporate Governance Reform : Agenda and Achievements


Currently, the Malaysian corporate governance reform agenda is essentially encapsulated in the Finance Committee Report on Corporate Governance released in February 1999 and the Capital Market Masterplan which was released in February 2001. They collectively provide Malaysia with a comprehensive blueprint for corporate governance reform over a period of 10 years from 2001. I will not go into too much detail of progress made in Malaysia with regards to corporate governance reforms and initiatives thus far – it has been well documented and will I am sure be discussed through the course of the conference. Essentially, however, the approach adopted in Malaysia, has been to effect legal reform alongside the introduction of voluntary codes, facilitating investor education and training and inculcating shareholder activism. Our efforts are an ongoing process and started well before the crisis. Examples of these efforts would include:

  • The Malaysian Accounting Standards Board (MASB) which was established under the Financial Reporting Act in 1997. It was the first accounting standard setting body in Asia. Additionally, compliance to the MASB standards are mandated by law and enforced by the relevant agencies.
  • The requirement since 1994, for all boards of public listed companies (PLCs) to have audit committees. The requirements on the composition and functions of audit committees have since been significantly enhanced.
  • The ‘true and fair certification’ by directors of company accounts since 1965.

Additionally, a very significant proportion of the recommendations of the Finance Committee on Corporate Governance have also been implemented. Others are well underway. These and other measures include:

  • The Malaysian Code on Corporate Governance, which sets out principles and best practices.
  • The amendment of the Kuala Lumpur Stock Exchange (KLSE) listing requirements to require,

    • quarterly reporting of financial information, keeping pace with the greater need for financial transparency;
    • a third of the composition of the board of PLCs to comprise of independent directors;
    • directors of PLCs to undergo a Mandatory Accreditation Programme; and
    • disclosure on the extent of a company’s compliance with Code on Corporate governance.

  • The formation of a Minority Shareholder Watchdog Group, led by major institutional investors.
  • The Malaysian Code on Take-overs and Mergers was revamped in 1999 based on international best practice, requiring higher standards of disclosure and corporate behaviour from those involved in mergers and acquisitions. It seeks to provide minority shareholders, fair opportunity to consider the merits and demerits of an offer to enable them to decide whether they should retain or dispose of their shares.
26. Other efforts include the release of guidelines on the internal audit function for PLCs in July this year, revisions to securities laws, rules and guidelines that inter alia enhance laws on insider dealing and require enhanced disclosure in prospectuses.
27. We have also enhanced enforcement efforts, some of which, given the high profile have been reported on. These have been supported by the enhanced supervisory and enforcement capabilities of regulators. These include our civil enforcement powers in relation to insider trading provisions, powers to impose civil penalties and the enhancement of our compounding powers. Since 1999 to date, we have prosecuted 59 individuals, of which, 28 were for corporate governance related offences. In so far as our compounding powers are concerned, 21% of our compounding actions were in relation to corporate governance related offences.
28. Together with this and of paramount importance to the capital market, are our ongoing efforts to increase awareness through our engagement with our constituents and other regulators in regular dialogues and consultation sessions, and our various education and awareness programmes. In this respect, bodies such as the MICG, industry associations and the universities are highly valued partners.
29. A significant point that ought to be highlighted in respect of Malaysia’s corporate governance reform agenda, is that the government is a strong catalyst, sometimes driver, and always advocate and strong supporter of our efforts in corporate governance, and have demonstrated their leadership and commitment in many instances.
30. The government has for instance, taken the lead by separating the posts of the Chairman and the CEO in many government controlled corporations. The government has also been proactive in appointing professional managers to companies in which the government has a controlling stake. This move is to ensure there is a clear separation of ownership from management, with professional mangers being appointed to manage the companies.

A Collaborative Cohesive Approach

31. The successful development of a strong and credible corporate governance environment must be premised on hybrid vigour – a dynamic synthesis of the efforts of both the regulators and the market – each must fully discharge their respective roles and responsibilities. Every player is an integral cog in the wheel of corporate governance that holds the market forces in balance and must fully bear their responsibility in setting and implementing the corporate governance standards within their own environment. It only requires one to fail in this responsibility for the structural integrity of the wheel as a whole to be affected. Whilst sound regulation may exist, it is in the implementation and application of the principles on which the regulations are based that determines their effectiveness. The beneficiaries of such a market place must as such, play their part in ensuring an environment that is facilitative and conducive to good corporate governance practice. Rules and regulations cannot and should not displace the proper role of the market in self-discipline, self-regulation and in the proper exercise of its business judgment.
32. Let me conclude by saying that there is always a silver lining to our trials and tribulations. The silver lining to corporate governance failures is that it makes us all sit up and examine the issues and our own performance. It demonstrates our vulnerabilities and hopefully will accelerate the mind-set change that regulators are constantly striving to achieve. As the saying goes, ‘within our biggest challenges lie our greatest opportunities’.
33. We have progressed well on the corporate governance journey, but we still have some way to go – the most challenging part of the journey is the acceptance of personal responsibility by each and everyone of us in demonstrating reasonably good intelligence, sound principles of operation and firmness of character in all that we do. Thank You.