MAIN PAGE | EVENTS & PROGRAMS | 2001 | IGM | SPEECHES | GARY BENANAV
PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | EVENTS & PROGRAMS | 2001 | IGM | SPEECHES | GARY BENANAV
Regional Vitality in the 21st Century
April 6-10, 2001 — Tokyo, Japan
Mr. Gary Benanav
REMARKS: Thank you for that kind introduction. Before I begin, I would like to say how delighted I am to be sharing the dais with such distinguished people. I think it indicates the esteem that PBEC has in both business and government circles throughout the Asia Pacific region. The title of this panel discussion is quite broad. It encompasses three very diverse topics - environmentalism, transparency and corporate responsibility - and one could go on at great length about any one of them. Rest assured that I am not going to that. In fact, I am going to invoke economist David Ricardo's 185-year old principle of comparative advantage and division of labor. I believe that my comparative advantage is in the third item on the list, corporate responsibility and the method of overseeing it through corporate governance. And so I would like to devote my time to that topic. I will mention along the way areas where corporate governance is closely related to transparency. For the most part, I will be speaking about publicly traded corporations, rather than closely held firms. I realize that family held and privately held firms are quite prevalent in Asia, much more prevalent than they are in North America. But I believe that my comments apply to all PBEC members since each economy has a growing list of securities traded on its local stock exchange. Problem of Corporate Governance More than 200 years ago, another economist, Adam Smith, articulated the challenge of corporate governance. He noted that corporate directors manage other people's capital, not their own. And he wrote that these directors "…cannot well be expected to watch over it with the same anxious vigilance with which the partners in a private company frequently watch over their own." The issue of corporate governance arises because of the separation of ownership and control. A system of corporate governance sets up the rules that define the rights and responsibilities of shareholders, managers, creditors, the government and other stakeholders. The Asian Development Bank characterizes it as a "… blend of law, regulation and voluntary practices that enable corporations to attract resources, perform efficiently, and generate long-term economic value for its shareholders." Clearly, a credible system of corporate governance is required for the development of national capital markets. At the early stages of development, countries can advance economically without stable, deep capital markets. A relatively small group of individuals can direct national savings to productive ends. But as developing countries become more sophisticated and national savings rise, a small group of individuals can no longer manage the full range of complex capital allocation decisions. Markets are the best way to make these allocations. I would submit that deep, liquid capital markets are a prerequisite for industrialization. And they cannot operate effectively over the long run and cannot achieve their full potential without a strong system of corporate governance. A system that addresses the problem Adam Smith identified. Corporate governance is a primary determinant of investor confidence, market stability and, ultimately, of competitiveness. Every nation has a vested interest in having a strong domestic system in place. But there is also an international dimension that gives one nation a genuine interest in the corporate governance system of its trading partners. When Adam Smith wrote The Wealth of Nations, the capital he had in mind traveled by wind-powered ships, which took weeks to reach their destination. Foreign exchange rates were influenced by the cost and danger of shipping gold to settle international accounts. Today, radio waves and electric current carry capital. Billions of dollars move around the globe instantly at the flick of a button, seeking the highest return possible for a given level of risk. National capital markets are interlinked and co-dependent - almost like a single global market. In the United States, this point was driven home dramatically during the 1997-1999 Asian financial crisis. Over the past 20 years, domestic participation in capital markets broadened substantially in the United States, driven by product innovation and demographic shifts. More than half of the U.S. households hold some sort of financial asset. The 1997 crisis had an immediate impact on millions of individual U.S. retirement accounts, bringing events in Asia directly into U.S. living rooms and pocket books. Corporate Governance and Financial Crises It was during this same crisis that the issue of corporate governance became a prominent topic of debate in the Asia Pacific region. A number of observers blamed the crisis on weak governance or "crony capitalism" which allowed publicly traded firms to operate in a non-transparent manner. In fact, at last year's PBEC IGM, we had a workshop on corporate governance where the first question posed was "Could the lack of corporate governance be the culprit in the Asian financial crisis?" I believe the answer to that question is "No." Certainly it may have been one of several contributing factors, but we must not exaggerate the role that poor governance played in the crisis. It is important to correct any misimpression. For if we believe that bad corporate governance alone caused the crisis, then we can be persuaded that good corporate governance will eliminate all future crises. And this is clearly not the case. An OECD roundtable last summer in Hong Kong examined the role of corporate governance in East Asia. It linked the relatively good performance of the Philippines during the crisis to prudent banking practices set up during the early 1990's. But other countries that did not have particularly strong corporate governance systems also weathered the 1997 crisis rather well. Moreover, nations that do have strong systems, including the United States, suffer nonetheless from sudden disruptions in the financial markets. Nobody believes that the current downturn in U.S. stock markets is the result of bad corporate governance of crony capitalism. On the other hand, we should not conclude that poor corporate oversight can be ignored because I believe good governance can help reduce, though not eliminate, some of the factors that lead to financial instability. Elements of a Corporate Governance System Corporate governance is a system. It has a number of components, all of which must work in harmony to make corporations accountable as well as efficient. Let me list what I see as the most important elements. First, shareholder participation. The rights of shareholders and the safeguards of those rights must be well defined, and they must be effective and easy to exercise. This is particularly important for minority and outside shareholders. I stress the importance of rights that are easy to exercise. If exercising shareholder rights requires excessive diligence, shareholders become passive and skeptical about the enforceability of their rights. They lose confidence in the market. Second, transparency. Regulations must require disclosure of relevant, reliable, comprehensive, timely information about the company's performance. This information must allow the board of directors and shareholders to monitor managerial performance. Lac of transparency resulting from weak disclosure and accounting rules is a characteristic of inefficient, uncompetitive markets that hinder national economic development. Third, incentives. The company must provide a system to motivate management to perform to the best of its ability. Fourth, oversight. A board of directors or similar supervisory board must have the skills, capacity and authority to monitor and make changes in management and to intervene on behalf of shareholders. Unfortunately, in many countries the majority of the directors on a company's board also functions as executive management, reducing or even eliminating their objectivity in appraising the performance of the company and its senior manager. Even when independent, non-executive directors are represented on a board, they sometimes collude or at least have an overly cozy relationship with executive management rather than independently safeguarding the interests of shareholders. There are examples in Asia of useful rules on oversight. In Chinese Taipei, for example, boards must include at least two independent outside directors who normally sit on the audit and compensation committees. In Australia, the chairman and most of the directors are external to the firm. But I believe that more progress is needed in creating strong methods of corporate oversight so that we can eliminate, or at least reduce, one of the factors that can contribute to inefficiency and even instability in capital markets. My own belief is that a majority of the directors of public companies should be independent. Two Specific Obstacles This is a general description covering a very complex set of institutions and practices that vary from country to country. However, I'd like to mention two specific problems which, in my opinion, have created a negative impact on shareholder confidence - and shareholder confidence is a prerequisite for stable and efficient capital markets. One affects both developed and developing markets, and the other affects mainly the developing markets. The first problem is in the area of reliable data upon which to base stock buying and selling decisions. I am concerned by the declining availability of the objective investment analysis, even in well-regulated markets. In the past, professional analysts in a broker's office would wade through data, forecast a company's profit and then turn the results over to a sales force. The objectivity of that practice has recently been called into question. It's hard to explain why less than 10% of all stocks covered by Wall Street analysts have carried "sell" recommendations at a time when the stock markets dropped so much since the beginning of 2000. It's even harder to explain why certain "big name" stocks, both American and Asian, have dropped so dramatically so soon after analysts were touting their future prospects. Investment banking advice and underwriting fees are now a significant, if not the primary, source of income for all of the major international brokerage firms. And many investment banks have found themselves threatened with a loss of major corporate client's account as a result of a "sell" recommendation by one of their analysts. So it is becoming ever more difficult to maintain a true independence in rendering investment advice about a client's future prospects. The potential for a conflict of interest is clear. At the same time, large corporations have discovered that they could use analysts' results to influence investor expectations. This was especially true in media-intense countries, where analysts appear on TV business shows to forecast stock prices and short-term market moves. I believe that the traditional independent analyst played a valuable role in making markets transparent, and I would like to see their resurgence. The investment banking community needs to restore the market's confidence that stock advice and projections are independent and objective, not "hype" intended to increase investment banking fees or create more trading volume. The second problem I want to highlight is in the area of oversight, and it is particularly acute in developing markets. It concerns the dearth of candidates who are well trained to serve as outside directors on corporate boards. In most countries, there are no specific minimum requirements for education or experience of outside directors. These are examples of CEO's appointing their chauffeur to the board. A network of organizations is developing in Asia to train outside board members in their roles and responsibilities. Some exist already in Indonesia, the Philippines and Thailand. Others are in the planning and initial implementation stages. These efforts to build human capacity in the region are important components to a sound system of corporate governance, and we should support them. PBEC-PECC Cooperation Let me end on an institutional note. I mentioned earlier that we had a PBEC-APEC joint workshop on corporate governance in Honolulu last March. At about the same time, the Pacific Economic Cooperation Council - PECC - was working with World Bank and the Asian Development Bank on corporate governance. I believe we should coordinate the activities of these two efforts to the mutual advantage of both organizations and the Asia Pacific region. IF TIME PERMITS: In the United States, I happen to chair both the PBEC and the PECC national committees. I suspect that, like me, a number of you here are active in both organizations. I recently have undertaken an effort to bring the U.S. national committees closer together, including locating them in the same office space. I know that this arrangement is common with many of our national committees. Although each organization has its unique characteristics and identity, they share many common values. It is no accident that their names are so similar. It is because they have many things in common. We have to ensure that their commonalties do not become duplications. Even more important, we should exploit aggressively any synergies that exist between PBEC and PECC. We should encourage PBEC-PECC cooperation in as many areas as possible. Corporate governance is one such area.] Thank you. |
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