Corporate Governance in Asia — Challenges and Prospects

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Executive Editor’s note: I am delighted to inform our readers that internationally known professor  Gunter Dufey has accepted our invitation to join us as  as the Director-Editor for the region of Singapore and Southeast Asia among his other activities. We are looking forward to his wise and experienced inputs. Below is a brief CV of his and the first article for our publication.

Professor Gunter Dufey, PhD or “GD” as he is known among friends and colleagues is Professor Emeritus of The University of Michigan Ross School of Business, in Ann Arbor, MI USA and Consultant on the faculty of Banking and Finance, Nanyang Business School, Singapore where he taught since 2000 to date. Parts of his academic career were spent at Stanford (USA), University of Texas, Wirtschaftsuniversität Wien (Austria), St. Gallen (Switzerland) and Universität des Saarlandes (Germany) where he was appointed Honorary Professor. His research interests focus on risk management, intl. financial markets and corporate governance. He has published widely. Parallel to his academic career, he worked for extended periods with a number of multinational companies and government agencies, such as  the US Department of the Treasury,, the Ministry of Finance ? FAIR in Tokyo and the Pacific Rim Bankers Program, Seattle, USA. He continues to serve on the Boards of Guinness/Atkinson, USA and until recently on several subsidiaries of Ally Financial (GMAC), Detroit and Toronto. He participates in managing the portfolios of several foundations. From 09/2001 to 02/2003 he was employed with McKinsey and Co. in Singapore, supporting the firm’s Corp. Governance practice in Asia. GD has been a member of the Singapore Institute of Directors, an active participant in the programs of the Asian Corporate Governance Association and currently serves part-time as Executive Director of EDUCATION EXCHANGE LTD, Singapore. Throughout his career he has been actively engaged in Executive Education.

Corporate Governance (CG) has been an enduring issue in the Region (Southeast Asia), especially after the Asian Crisis where poor CG made the crisis considerably worse as investors, local and foreign, harbored serious doubts about their fate when business firms confronted adverse conditions. In spite of progress made over the years, surveys conducted by organizations such as McKinsey & Co and well as the Asian Corporate Governance Association (ACGA) show that – while there are wide differences among countries in the Region – overall there is much room for improvement when compared to the developed markets in North America and Western Europe – although knowledgeable observers will hasten to add that there is considerable room for improving CG in these countries too.

Today, there are two factors that 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’ can not be relied upon for further growth. With population increase severely limited and in some cases negative, can provide a further source of economic growth. The second factor, distinct yet related, is the looming pension problem in all these societies, driven by shrinking labor 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, as this example shows, DC pension systems require the availability of assets with good returns over the long term. In practice only equities (incl. real estate related equities) can yield returns that make contributions affordable. And 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. On closer inspection, business firms consist of various ‘stakeholders’, each pursuing its own interests: Entrepreneurs/managers; providers of capital i.e. 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 the various parties in order to maximize enterprise performance.

What are the unique challenges to achieve this objective in Asia? Indeed, there are many. For one, CG is concerned with prioritizing 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 in such systems private property rights are weak. While feudal systems were not unknown in Europe of course, property rights emerged early, as in the circumstances creating the Magna Carta in England of 1215, the French Revolution and at its peak in the founding of the United States, where notions of private property in an ‘anti-feudal’ system were at the very core of the foundation of this new state — and were subsequently spread around the world. In Asia, the adoption of such notions were further 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, with its permanence, based on the separation of ‘brains’ (entrepreneurial management) and ‘money’ (investors’ savings) was first created by the Dutch in the 16th century (the ‘ vennootskap’), quickly imitated by the British and later in the rest of Europe. It brought about tremendous changes: suddenly there existed incentives for the commercialization of innovation, rather than presenting new ideas to the feudal lord, who may or may not appreciate the impact. Even more important, the corporation and its underlying capitalist system promoted a certain degree of freedom for unconventional thinking, expression and discussion. Religion and laws 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.

And 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 able to 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 fathers –company’ any more – the dominant shareholder/manager becomes the fiduciary of ‘other peoples’ 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 compensations 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 rightly credit for the tremendous value creation, reflected in the impressive economic growth of almost all countries in the Region. Indeed, based of 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 Crisis or 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 surprising, dominant shareholders then tend to engage in ‘tunneling’, 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 harbor 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 Oversea Chinese, whose economic success creates precarious property rights and in turn generates defensive reactions, such as poor transparency and tunneling.

What is the outlook for the future? Governments are under pressure to improve rules and regulations improving markets for equities, in particular protecting 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. And investors have become quite sensitive to the quality of CG in an environment of lower growth, asking increasingly the question: will we be treated fairly?

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