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Asian Business Dialogue on Corporate Governance 2003 Thinking Strategically about Governance October 16, 2003 The Ritz-Carlton, Hong Kong Conference Report Editors: Jamie Allen, Helen Wong 2 © ACGA Ltd, 2003-2004 "Asian Business Dialogue on Corporate Governance 2003" Contents 1. Acknowledgements 5 2. Opening Keynote Speech: “Corporate Governance and Private Sector Development in Asia” 7-11 3. Session 1: Asia Progress Report 13-27 4. Session 2: Shareowner Activism 29-40 5. Luncheon Keynote: “The Critical Role of Company Courts in Fostering Good Corporate Governance” 41-51 6. Session 3: Stakeholder Imperatives 53-66 7. Session 4: Thinking Strategically about Governance 67-80 8. Conference Summary 81-85 9. Speaker biographies 87-109 Copyright provision For permission to reprint or reproduce parts of this report, please contact the Asian Corporate Governance Association (www.acga-asia.org). © ACGA Ltd, 2003-2004 3 "Asian Business Dialogue on Corporate Governance 2003" 4 © ACGA Ltd, 2003-2004 "Asian Business Dialogue on Corporate Governance 2003" Acknowledgements ACGA would like to thank the following organisations and individuals for their generous support for and assistance to the “Asian Business Dialogue on Corporate Governance 2003”: Principal Sponsors: Chubb Insurance CLSA Asia-Pacific Markets Lombard Asian Private Investment Company Supporting Sponsor: Oracle Corporation Luncheon Sponsor: Sun Life Financial Asia Regional Media Partner: Asian Wall Street Journal Supporting Organisation: International Chamber of Commerce Conference Programme Advisors: Lawrence S. Schaner, Jenner & Block, LLC, Chicago Takeshi Kadota, Mitsubishi Corporation, Tokyo Conference Event Manager: Interaction Events Management, Hong Kong Speakers Our sincere thanks also goes to our keynote speakers—Mr. Jin Liqun and Justice Jack B. Jacobs— and to all our moderators and speakers for giving so generously of their time and sharing their knowledge and insights. © ACGA Ltd, 2003-2004 5 "Asian Business Dialogue on Corporate Governance 2003" 6 © ACGA Ltd, 2003-2004 "Asian Business Dialogue on Corporate Governance 2003" Opening Keynote Speech “Corporate Governance and Private Sector Development in Asia” Jin Liqun Vice President (Operations 1) Asian Development Bank, Manila Mr Jin argued that corporate governance can minimise the costs and tensions inherent in relationships between managers, shareholders and regulators, hence improving bottom-line value. He concluded by urging delegates to think of corporate governance as a “vitamin” (something you want to take) not a “medicine” (something you need to take). Introduction It is my honour to address the “Asian Business Dialogue on Corporate Governance 2003” on behalf of the Asian Development Bank (ADB). I am delighted to be here today to share and learn with you where we are in the development of corporate governance in Asia. Between the mid-1960s and the mid-1990s, Asia—particularly East Asia—grew faster than any other region in the world. Contributing to this success were pro-growth public policies, declining income inequality, rapid growth of exports, high investment and saving rates, and superior accumulation of physical and human capital, among other factors. Unfortunately, all this was not able to prevent the Asian financial crisis. In the post-crisis period, there was a lot of finger pointing at a host of problems in the crisis countries. It is certainly important to identify the root causes of the crisis, and it is gratifying to see that these countries are serious about getting things right. One of the priorities is to improve governance, both at the government and the corporate level. It is the right approach to fix the problems and ensure sustained, healthy development of this region. The Chinese have an old admonition against complacency that goes: “Those who do not prepare for troubles far ahead will definitely find their hands full of problems soon.” In other words, one should feel the worst when one feels the best. The nature of Asian business is changing. The demands of Asian markets are increasing. The role of government vis-à-vis the private sector is evolving. In short, the status quo dictating the relationship among firms, investors, and government is being challenged. We must understand WHAT is corporate governance, WHY it is valuable, and HOW to implement it. So today I would like to touch on two topics. First, I will briefly talk about the academic theories behind the need for corporate governance. Second, I want to share with you the results of some recent research that demonstrates the bottom-line value for good corporate governance. Throughout I will try to place an Asian-filter on these topics. © ACGA Ltd, 2003-2004 7 "Asian Business Dialogue on Corporate Governance 2003" The theoretical rationale First, the theories. There has long been academic rationale that explains the tense, costly, and necessary relationship among investors, managers, and regulators. In particular, “agency theory” and “asymmetric information theory” underpin the inherent costs involved in a capitalistic environment where investors provide the money, management controls its usage, and regulators keep watch over this relationship. In agency theory, the cost of the relationship between investors and the managers is threefold. First, “divergence cost” arises from the fact that shareholders and managers have different goals and incentives. For shareholders, the goal is to maximise shareholder value. For managers, although it is their fiduciary duty to also maximise shareholder value, the goal for some may simply be to maximise their own compensation. This potential conflict of interest leads to the second cost, “monitoring cost”, which shareholders bear in order to make sure that divergence cost is minimised. Finally, despite recent bad news, management is NOT the enemy. Shareholders know that management skills are necessary. And so the last cost in this relationship is “incentive cost”, which is basically negotiating the right balance between compensation and performance. The second theory behind the WHY of corporate governance is information asymmetry, or the fact that insiders (the founders and managers) generally know more about the company’s value, potential and risks than outsiders (the shareholders and regulators). This gap in knowledge about the firm is a double-edged sword. On the one hand, that’s exactly why shareholders entrust their money to managers, because managers know more about the business. On the other hand, this gap in knowledge can lead to three kinds of costs. First, “information cost” arises from poor (or fraudulent) disclosure of a firm’s structure and performance by management. Consequently, this leads to higher risk perception by investors and higher funding costs for the firm. Other costs that can arise from information asymmetry are “mispricing cost”, especially when firms go public, and “management cost”, which occurs when managers interested in protecting their jobs employ anti-takeover provisions that are value-destroying. Finally, related to management cost is the practice of “self-dealing”—which is somewhat common in Asia—when firms engage in related-party transactions that could result in management selling goods or assets at below market prices to other firms owned by or related to management. The bottom-line value But so what? What does this mean to investors who want to see their stock rise in value? What does this mean to managers who seek lower costs and better performance for their firms? What does this mean to regulators who strive for strong and sustainable economies that provide fair opportunities for all? What’s in it for them? Why should investors, managers and policymakers care about good corporate governance? To start, good corporate governance minimises the costs laid out in the theories we’ve just mentioned. And so the logic is that if these costs are reduced, the firm’s bottom-line—its shareholder value—should increase. So does it? Absolutely. 8 © ACGA Ltd, 2003-2004 "Asian Business Dialogue on Corporate Governance 2003" In the last two years, numerous studies clearly demonstrate that companies are more valuable when they are well governed. From McKinsey and CLSA to the S&P 500 and the World Bank, the data shows clear evidence that good governance is rewarded with a higher market valuation. Let me provide some examples. From 2000 to 2002, the global consultancy McKinsey analysed almost 200 emerging market firms, scoring them along 15 metrics of corporate governance. What it found was that firms with higher scores enjoy a valuation premium of up to 30%. Interestingly, the force behind much of this premium came from institutional investors who are the leaders in recognising the bottom- line value of good corporate governance. Moreover, for companies improving from the worst to best in any of the 15 governance metrics, they enjoyed a 10% to 12% premium gain in their stock price. Finally, well-governed companies are found to be relatively more competitive. The McKinsey study showed that firms with higher corporate governance practices beat their respective local market indices by at least 20%. In another detailed study conducted in 2001, S&P 500 joined with McKinsey to look at 90% of the firms in the S&P 500 index. These firms, with available data, showed a consistent relationship between corporate governance and performance. For example, well-governed firms consistently demonstrated (i) higher market-to-book ratios, (ii) higher return on capital employed, and (iii)