In pursuit of better corporate governance: How is Hong Kong shaping up?
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Enron, WorldCom, Adelphia Communications, Tyco International... The apparently endless string of corporate scandals not only sent embattled US investors scurrying for cover but also triggered off a new round of self-examination among Asian listed corporations and market regulators, including Hong Kong . Are our listed companies well-governed? Are corporate directors and executives giving truthful pictures of their businesses? Are regulators keeping a close tab on the evolving corporate ecology to ensure an honest system and a level playing field for investors big and small? What else can and should be done in Hong Kong to raise the level of corporate governance another notch to meet the standards of good international practices?
To find out the answers to some of these questions, Bulletin spoke to Professor Ferdinand A Gul , Chair Professor of Accounting and Head of CityU's Department of Accountancy. He is also Director of the Accounting and Corporate Governance Centre (ACGC), one of three research centres in CityU's Faculty of Business. An internationally renowned scholar in accounting, Professor Gul has conducted work spanning major paradigms of research in accounting, focusing on the application of contracting and agency theories in corporate finance, as well as auditing and financial accounting.As the ACGC's Director, Professor Gul has initiated key research projects and training strategies on corporate governance in Asia, with frequent contributions to top-tier academic journals such as the Journal of Accounting and Economics, Auditing: A Journal of Theory and Practice, the Journal of Accounting Auditing and Finance and the like. Based on an integration of corporate finance theory, accounting theory and economics, his contributions range from specific governance topics to the related issues of firms' debt policies and dividend policies. In 2002, Professor Gul was the co-consultant on three projects on the Corporate Governance Review awarded by the Financial Services Bureau of the Hong Kong Special Administrative Region Government.* He is also the co-editor of the ACGC's flagship publication: the Asia-Pacific Journal of Accounting and Economics, now in its third year, which publishes top-quality research on corporate governance, accounting and finance.
Q: Let's start with the basics. Why is corporate governance needed and why does good corporate governance result in good performance?
A: In the corporate world, shareholders don't run the company, managers do. Managers are agents of the shareholders and act on behalf of the latter group. Here lies the source of all conflicts of interest. Shareholders, as a rule, want the best for the company and they don't want managers to own big cars and fancy airplanes, as in the US. Managers and directors sit on the company board and they make decisions. They naturally want rewards and perks for themselves, and the more the better. So, how do you reduce such conflicts? You need corporate governance practices and good practices in this area must come from the board of directors. Now the board of directors is made up of the directors within the company, including the managing director. This board, in theory, should monitor the managers and protect the shareholders by making sure the managers do not exploit their positions. Good corporate governance means the board is functioning in a way that protects the shareholders. That's one problem. Another is that sometimes a company has a big or majority shareholder, who makes decisions that expropriate the minority or small shareholders.
Q: How would you describe the overall situation of corporate governance in Hong Kong?
A: In Hong Kong, there have been cases where a major retailer paid bonuses worth millions of dollars to its directors even though the company was losing a lot of money. This suggests to me that something is wrong with corporate governance in Hong Kong-why else are these companies handing out huge salaries and bonuses to their directors when the companies themselves are haemorrhaging? My view is that corporate governance in Hong Kong needs to be looked at closely. To be sure, there are several regulatory authorities overseeing the conduct of corporate governance in Hong Kong: the Securities and Futures Commission and the Stock Exchange of Hong Kong. And there is legislation as well. All these are supposed to monitor the listed companies and make sure they are managed properly.
Again the laws are there to protect you and me, the average investors. And they also affect the market. Yet why is there a slump in the market right now, apart from the fact that we are under the influence of external factors like the US economy and world recovery? The slump is not as great in Singapore and Malaysia as in Hong Kong. Why? Because, I think, Hong Kong has been hit by a lack of confidence-corporate governance in Hong Kong is not as strong here as in Singapore. When the world economy and market are down, Singapore and Malaysia can handle it better than we do. One of the reasons is our relatively weak corporate governance system. Singapore has put into place several features of innovative ideas on corporate governance including remuneration and nomination committees under the board, and Hong Kong has not.
Q: What about the requirements for audit committees? How do we compare with Singapore and Malaysia in this respect?
A: They definitely have the requirement in Singapore and Malaysia but Hong Kong only introduced it in 1998. You can have audit committees and say that they are made up of independent directors. But who can judge if they are really independent? Because Hong Kong is a small place and the business community is a rich and closely-knitted circle, they may have friends or relatives sitting on the committees. How do you make sure the members are independent? What are the litmus tests? It might be better if they were willing to bring in academics. Professors like us have no vested interest. We are all well-trained and we understand the numbers. If there were no problems in corporate governance in Hong Kong we would not be experiencing such a big slump in the market.
Q: Corporate governance is, as you said, a framework made up of both statutory and non-statutory requirements. Who are pushing for reforms in the latter area?
A: There is an Asian Institute of Corporate Governance, based in Hong Kong, which functions like an advocacy group. Some demands are from the shareholders. There is a minority shareholders' group in Hong Kong, and they are pushing for timelier and better disclosure by the companies. But, unlike in the US and the UK, shareholder activism is not very strong here. The culture of greater transparency and more openness in corporate disclosures should be encouraged, though I believe some of the current policies in this area are more show than substance. All the requirements are good but I think there should be tighter controls in some areas. The groups are pushing but they do not have enough muscle. In corporate governance reform in Hong Kong we see more of a top-down, rather than a bottom-up, approach. One explanation is we have family-dominant ownership in Hong Kong's listed companies; the minority shareholders are not strong or active enough in Hong Kong.
Q: In July 2001, the Standing Committee on Company Law Reform (SCCLR) recommended the minimum number of independent non-executive directors (INEDs) on company boards as an important measure to boost corporate governance. Yet the Law Society of Hong Kong said this is not feasible because Hong Kong is short of qualified INEDs. Is Hong Kong coming up with solutions that are ahead of the times?
A: No. Consider this scenari if you run a company that has no independent non-executive directors, history has shown us that you are likely to exploit the shreholders. You need to be monitored and controlled. The logical step is to make the company board more effective-let's say get two independent directors. But there are not enough of them around and they are not properly qualified. You have a choice: no independent directors at all, or have someone who is not particularly good. My choice is to go for the latter, because at least you are starting to put the mechanism in place. It's far better than not having any at all. A small step ahead is, after all, a movement forward, much better than standing still. But I think the companies and the government are not making use of academics in Hong Kong. They are knowledgeable, willing to take up the task, and, as I said, have no vested interests. The whole point of having independent non-executive directors on boards is that they will look at a problem and give another perspective. One cannot say that academics are not qualified in this respect.
Q: What sort of measures do you recommend to improve the quality of company directors and the work of the boards?
A: You have to wait for the report from the SCCLR-they are dealing with the recommendations in our consulting projects. We had to submit three reports and we are still finalizing the last one. The government will be announcing some specific recommendations on the issues of company directors and the role of boards of directors. These are in addition to what they previously announced in July 2001. I can't disclose at this stage what our recommendations are but I believe these will be announced by the end of 2002.
Q: Some people propose the idea of a chief governance officer in companies ...
A: It's a good idea but whoever takes up the post should be an outsider, not the CEO of the company. Perhaps the chairman of the board could monitor the whole situation, providing the posts of board chairman and CEO are separate. This is not implemented in Hong Kong but in Singapore they have different people for the posts.
Q: Does Enron foretell a decline in the American model of corporate governance?
A: In Hong Kong we follow the American model, whereas China favours the European model where they have a supervisory committee in the company and the banks are very much involved in the ownership of the firms. In the US, they have the Glass-Steagal Banking Act of 1933 that forbids the banks from ownership in the private sector. My view is that the world is converging into one model, when you have a global environment where people trade with each other very closely. It's my theory that one day in the future, we'll have just one currency. In the same way, all the talk of different models in corporate governance will die down because the world is getting smaller and there are a lot of transactions, trade, cross-ownership of companies and trading of shares around the world. I see, one day, the international stock exchanges coming under one roof, too, where you can go to the Hong Kong Stock Exchange and buy Intel shares and pay the same price as someone in Rio de Janeiro does. The models are historical; the differences are going to break down.
Q: In the wake of Enron and the ensuing calls for reform in accounting standards, are we seeing a convergence of accounting standards worldwide?
A: For the same reasons as above, accounting standards will converge around the world. The differences will eventually become irrelevant. Q: Do corporate scandals like Enron and WorldCom have any impact on the students and the accounting curriculum?
Of course. My first lecture in auditing this semester (September 2002) started with a discussion on Enron with my students. I told them Enron symbolizes a problem with auditors and a failure of auditing. The auditors, Arthur Andersen, could have fixed the problem but they didn't. I see students are getting more excited about auditing; previously they were bored. So, Enron has brought into focus the importance of auditing for our students. I also told them auditors are supposed to be independent and this is an ethical issue. Ethics has come to the forefront in the training of accounting professionals and I believe Enron, though disastrous in nature, can help drive home this important issue in our curriculum.
Q: What would you like to see to happen in corporate governance reforms in Hong Kong in the next two years? And what about your research? A: I'm a great believer in independent non-executive directors. We must have them on company boards. And I stress the word "independent"-there should be more independent members on audit committees. I also notice that the audit committees do not meet very often, which suggests to me the committees are not functioning properly. Audit committees should meet at least once every two months. A friend of mine told me the audit committee in his company meets during lunchtime. To me, a lunchtime meeting is not as serious in purpose and as effective as a meeting, say, between two to five. So again, we have a situation I'll call symbolism-the companies act to show compliance. I'd like to see more substantive adherence to the statutory requirements.
A: In the next two or three years, we'll go into research into these areas as well. I want to look at audit committees in Hong Kong, to find out whether committee sizes, number of meetings per year and independent directors are related to corporate performance, and in what way. I want to separate the sheep from the goats in terms of turnover, profits and other performance criteria. I have enough data already because audit committees were set up in Hong Kong in 1999. I want to see if there is such a correlation between audit committees and corporate performance. That's my main research interest.
Q: Lastly, can we say auditing is your department's unique research focus on corporate governance in Hong Kong and China?
A: Yes and no. In our China study, principally led by Dr Charles Chen and Dr Su Xijia (see article on page 76), there is certainly a definite auditing perspective, a certain expertise in the area. But I believe it is quite dangerous to study corporate governance from one single viewpoint, because governance issues affect finance, marketing and strategy. We need an interdisciplinary approach. I often try to see the issues from a financial point of view-how it affects how a company's debt is managed, to what extent a company is willing to pay back shareholders in the form of dividends. But we also have a strong corporate financial angle; at least that's where my interests lie, too. My research is across the board and interdisciplinary in approach. It's high time we equipped ourselves with different angles of accounting, finance, economics and, yes, auditing, to unravel the complex issues in corporate governance. * The three corporate governance review projects focus on: the functions of audit, nomination, and remuneration committees in connection with corporate governance review; surveying corporate governance regimes in other jurisdictions; and surveying attitudes of institutional investors towards corporate governance standards in Hong Kong.