Is Asian corporate governance fatally flawed?
In recent months, corporate Japan has been rocked by a series of extraordinary governance scandals at some of its largest listed companies. The sacking in October of Olympus Corp’s CEO, Michael Woodford, led to revelations of remarkable misconduct at the company, including improper use of company capital and enormous financial losses, which had been kept secret for several years. In the four weeks after Woodford’s dismissal, Olympus’ share price plunged more than 80%.
The saga of Olympus continues to generate headlines, as the company has narrowly escaped delisting and looks set to endure a bitter proxy fight over the selection of new management and board members. It is certainly not the only example of such behaviour that threatens shareholders’ interests in Japan.
Tokyo Electric Power (Tepco), Japan’s largest utility, which is receiving a bailout after poor board oversight and risk management contributed to the Fukushima nuclear disaster, has been filing falsified reports to nuclear safety regulators since the 1980s. The reports failed to list safety problems at eight nuclear reactors in Japan. Another utility, Kyushu Electric, is embroiled in a political influence scandal in which managers allegedly tried to manipulate public opinion about its nuclear power plants.
Meanwhile, the ex-chairman of Daio Paper was arrested in November on suspicion of using $140 million in loans from group companies for gambling.
Investors have lost $46 billion on Olympus, Daio Paper, Kyushu Electric and Tepco combined in 2011. Much has already been written about why it is that Japanese companies have been encountering these problems, with attention being drawn to systemic weakness in the company law, lack of independent directors and highly deferential corporate culture.
For investors in Asia, this gives rise to the question: if corporate governance in a highly developed country like Japan can be so poor, what hope is there for shareholders in emerging markets ?
There are structural issues in many of these markets that raise significant concerns, especially for investors outside the region. The legal and regulatory regime may be immature and disclosure is often inadequate. The quality of regulation is improving across the region, but enforcement is still a problem. Concentrated ownership of companies in Asia, where there is a family or government entity as the dominant shareholder, deters many foreign investors. Minority shareholders fear that their interests will be overlooked, especially where the board is not independent.
However, it is important not to generalise too much. Concentrated ownership is not necessarily a structural weakness, and many family-owned companies are very well governed: for example, Li & Fung in Hong Kong or Wipro in India. Indeed, if a family has a significant portion of its wealth tied up in an entity, family members have an obvious incentive to guarantee long term, shareholder value of that entity - for themselves and, thus, for the minority shareholders.
Moreover, the number of independent directors on a company’s board may not be the most important metric for measuring its performance on corporate governance. Independence is certainly important, because there need to be checks on management and as working through differences of opinion may lead to better decision making. However, independence alone is insufficient. Investors need to pay equal attention to the quality and experience of both insider and independent board members. In the case of Olympus, the company did have three independents (quite a high number for Japan), but none of them seemed to have experience in the camera or electronics industries, nor of risk management.
It is equally important to understand the commitment of time and effort by company directors. In 2009, a question was raised at DBS Group’s annual general meeting about the fact that one of the independent directors was also sitting on over 150 other company boards. This led the Singapore media to report that several prominent local businessmen were holding over 100 board places. Common sense suggests they would find it challenging to carry out their duties effectively.
When trying to gauge the governance regime of a company, investors must beware of putting form over substance. In other words, it may not be enough to see the correct structures and best practices appear to be in place, as demonstrated by the example of Satyam Computer Services, one of India’s largest outsourcing services providers. In 2009, Satyam founder and chairman, Ramalinga Raju, admitted to enormous and long-running accounting fraud: $1 billion of cash on the company’s balance sheet was fabricated, revenue was 20% lower than reported and payroll had been padded with some 13,000 imaginary people!
Satyam did apparently have governance processes in place, and the company even had an audit committee, which seemed competent and was chaired by an independent director who was a finance professor at Harvard University. However, this committee failed to act on a clear signal that the cash balance was being wrongly reported. Perhaps this was because the chairman did not, in fact, have experience of accounts or audit practice; or perhaps it was due to the fact that he lived in the US and rarely attended meetings in person. Wherever the fault really belonged, the Satyam case suggests it is necessary to get beyond the presentation, where possible, and examine the practical realities associated with company governance.
This can be extremely challenging for investors, and they may be right to err on the side of caution. However, it would not be correct to assume corporate governance in Asia is necessarily weak. There are many companies around the region which are held up as outstanding performers on disclosure and governance issues, from Shenhua Energy in China to TSMC in Taiwan to Olam International in Singapore. It is important to recognise that good governance can also have an impact on company value, which is beginning to be detected in stock performance in the region.