Ever since the 1997 financial crisis there has been plenty of talk about corporate governance in Asia. In some important respects there has also been substantial progress. Almost every market in the region now has a basic governance regulatory framework in place. While loopholes persist - regulators still have their work to do - the focus now is increasingly on institutional investors and how they can promote better standards among companies in which they invest.
An institutional investor’s role in the corporate governance of a company ought generally to take three forms. First and foremost, the fund manager should examine the governance of a company in the context of the investment analysis that leads to the decision to buy or sell a stock. Second, the firm should exercise the right to vote the shares that they hold. Third, institutional investors can go further by engaging directly and more proactively with company management and boards.
The most basic interaction of an investor with a company is the decision to buy or sell the company’s shares. Consequently, the first responsibility in terms of corporate governance is to make governance a part of traditional securities analysis. That means looking more closely at areas such as who owns the company, transactions with any related companies, whether the independent directors add any real value and the clarity of the financial and non-financial disclosures. Of these, the most crucial question is who controls the company and what track record they have in treating minorities. Here institutional memory and knowing who’s who in every market are more important than any laborious governance checklist. And there is no substitute for face-to-face visits with management.
At our firm, we evaluate govern-ance as part of a broader quality check. Only if a company passes this filter do we look at value. While it is conceivable that a company could have good quality management but weak governance, this is rarely the case. So although we do not have any explicit minimum governance criteria, a company that has poor governance would not pass our quality test.
But why does governance matter? Beyond the safety-first aspects of due diligence - making sure managers will manage in shareholders’ common interests - investors should realise the potential for a governance premium (and, conversely, discount) that should work in their interest. For by buying companies with good governance, the investor bids up the price of the stock, rewarding the company with a lower cost of equity. And by selling or not buying companies with weak governance, the stock price is bid downwards. The problem is that when too few investors apply governance to their investment decisions, the effectiveness of the governance carrot and stick is diminished.
Few institutional investors would admit to not caring about these issues, so why do more not apply themselves? One reason may be that they are taking the wrong approach - for example, trying to reduce governance issues into a simple checklist or quantitative scorecard. Certainly, if carefully written, checklists can provide a useful list of issues for closer inspection and scorecards can raise public awareness of governance issues. But corporate governance frequently requires qualitative judgements based on human factors - chief among them trust.
If there is no substitute for discrete decision-making based on first-hand research (which is always time-consuming), the other reason for the apparent gap between the good intentions of investors and their application may be due to the time-frame of investing. A fund manager with an investment style that focuses on short-term price movements or market momentum has less reason to concern himself with a company’s governance shortcomings. In contrast, investors that tend to hold companies for longer periods will have more reason to look at governance and will also be better equipped to make subjective judgements since they probably know the companies and their track records better.
The second level of investor interaction with a company is through voting at the annual general meetings (AGMs) and extraordinary general meetings (EGMs). In recent years an increasing number of institutional investors have been voting the shares for which they have voting rights. Apart from the growing realisation that voting of shares may be a straightforward way to influence company management, there is also an emerging consensus that institutional investors have a duty to vote. In the UK, there is increasing pressure on institutional investors from underlying clients (such as pension trustees) and regulators to vote the shares they hold and then disclose how they voted and why. This pressure to vote has not yet materialised in any market in Asia, but it seems inevitable in the longer term.
To vote responsibly requires careful consideration of the motions put before the shareholders. In most cases, this is not difficult since many motions, such as the approval of the annual accounts and the appointment of the external auditors, should be routine. However, contentious issues do occur, both as one-off and repeat actions. It is useful therefore to have internal guidelines on how to vote. For example, in both Singapore and Hong Kong, most companies normally request a general mandate from shareholders to issue up to 20% of the company’s share capital, without any pre-emption right and potentially at a substantial discount to the market price. Although most companies would never use this clause, there is always the potential for dilution or abuse. Our policy is to vote against any general mandate that allows more than 10% share issuance – as a matter of principle. Other issues that we face too often are independent directors who do not seem genuinely independent and motions where not enough information is provided for us to make an informed decision.
But the biggest challenge to effective share voting is not the substantive question of which way to vote, but rather the host of obstacles standing in the way of the right to exercise the vote in the first place! A recent investor survey by the Asian Corporate Governance Association (ACGA) identified 10 key impediments1:
n Insufficient notice of shareholder meetings;
n Insufficient time to vote before meetings;
n Inadequate information to vote;
n Non-availability of translated material;
n No confirmation that vote has been received;
n Voting by show of hands, not by poll;
n Clustering of meeting dates;
n Bundling of resolutions;
n Non-publication of vote results;
n No independent audit of vote results.
Even in sophisticated financial centres, share voting is surprisingly difficult: in Singapore, almost all companies still vote by a show of hands and few release vote results; in Japan, nearly all the AGMs are clustered on the same few days.
As with most other parts of the world, with the exception of the UK and the US, most companies in Asia have a controlling shareholder. Some people question the purpose of voting in an election where the outcome is beyond doubt because the controlling shareholder can out-vote the minority shareholders. However, there are an increasing number of cases where the mathematics of voting are a little more complicated and the minority shareholders may have more power than many of them realise.
For a growing list of situations, such as executive stock options and major transactions with the controlling shareholder, the majority shareholder is often barred from voting, so a vote may be passed or rejected by the majority of the minority. There are also many companies where the controlling shareholders exert their control despite having only a plurality, not a majority, of the shares. Even in those situations where the minority shareholders can be sure that they will lose the vote, it is still useful to send a public signal to the controlling shareholders and management.
Beyond buying and selling and share voting, the third form of governance interaction with companies is direct shareholder engagement, including meeting with management, writing letters to the board, threatening the sale of shares (as opposed to exiting quietly), asking questions at shareholder meetings (in addition to voting) and building coalitions with like-minded minority shareholders for more proactive use of voting rights. However, fund managers should be careful not to go beyond their rightful area to start second-guessing the business decisions of company management.
Although there is some interesting work being done in South Korea and Japan, there is very little shareholder engagement with companies in the other Asian markets. But given the wide gap between the standards of the best and the worst companies in each market in the region, there must be considerable potential to unlock value (reducing the governance discount or increasing the governance premium) by engaging with companies that are willing to listen.
That said, before launching a shareholder engagement programme, there are some challenges that an institutional investor should take into account. The chances of success depend not just on the specifics of the investor and the company, but also on the regulatory framework in which the company operates. Weak rules (and enforcement) will not give the minority shareholders the bargaining power they need. Yet support is critical because of the ubiquity of single, controlling shareholders across Asia.
There is also the classic free-rider problem, where the benefits of the governance improvement are felt by all shareholders in the company, but the costs - in terms of time and resources - are borne only by the investor that undertook the shareholder engagement. Finally, there is the issue of reputational risk; in corporate Asia nobody wants to be branded as anti-establishment or an opportunist corporate raider.
As with governance analysis and share voting, the decision about whether to undertake shareholder engagement is likely to come back again to the investor’s time frame. Consider the so-called ‘Wall Street rule’ - that when faced with problems at a company, investors should sell rather than try to make the situation better. This dictum might make sense to short-term investors and prevent them from wasting time and effort on companies that they will probably not even own a few months later. For their part, longer-term investors now realise that the short-term governance efforts are necessary in order to extract long-term investment gains. Provided they emphasise carrots as much as sticks.
Peter Taylor is head of corporate governance for Aberdeen Asset Management Asia. He joined the firm’s Singapore office in February 2007, having previously worked for the International Finance Corporation in Hong Kong.
1Allen, Jamie, and Oliver Jones, ACGA Proxy Voting Survey 2006, Asian Corporate Governance Association, 2006
Allen, Jamie, and Oliver Jones,
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