The McKinsey Quarterly 2004 Number 2 54 Asias governance challenge 55

The McKinsey Quarterly 2004 Number 2 54 Asias governance challenge 55

The financial crisis that overran much of Asia in the late 1990s prompted
most of the affected countriesjoined later by Indiato make improved
corporate governance a priority. Nearly all of them now require listed com-
panies to have independent directors and audit committees (Exhibit 1, on
the next page). Agreement is growing, at least in principle, on what good
governance entails, and most countries in the region have adopted explicit
governance codes (see Why codes of governance work, in the current issue).
Securities laws and the listing requirements of stock exchanges have been
strengthened, regulatory authorities have enhanced powers, and the media
are more inquisitive and probing.
Yet progress is uneven. Across Asia, too many companies remain uncon-
vinced of the value of good governance, and change faces real-world
impediments and disincentives. Moreover, the institutions needed to ensure
good governancejudicial systems, capital markets, long-term institu-
tional investors that can push for better governancecontinue to be under-
developed in most of these countries. Laws and regulations arent enforced
rigorously; well-trained accountants and other professionals are scarce.
The starting point for reform in Asia is therefore very different from the
starting point in Europe or North America. Asian governments, corporate
leaders, investors, and regulators realize that corporate-governance
Asias governance
challenge
Corporate governance in Asia has improved, but implanting new
forms of behavior will take time.
Dominic Barton, Paul Coombes,
and Simon Chiu-Yin Wong
The McKinsey Quarterly 2004 Number 2 56 Asias governance challenge 57
practices wont change overnight,
so patience is needed. Getting
companies to comply with new
rules is a daunting prospect
requiring greater transparency
and better enforcement, not
to mention a cultural upheaval in
boardrooms.
Is best practice best for
the region?
New corporate-governance laws
and codes are important because
they set the stage for change.
But given the vast differences in
ownership structures, business
practices, and enforcement capa-
bilities, merely adopting new
requirements en masse from North America or Western Europe would be
a mistake. Nonetheless, the temptation to do sopromoted partly by
investors, foreign-aid donors, and international organizationsafficts the
region as a whole.
Consider the question of requiring CEOs or CFOs to certify the fnancial
reports of their companies. In much of Asia, directors and offcers are
already liable for fraudulent fnancial reporting, yet some of these countries
are thinking about replicating the certifcation requirements under the US
Sarbanes-Oxley Act. In addition to being redundant, they would be hard
to enforce, since under Sarbanes-Oxley standards they would require
proof that a CEO or a CFO had willfully violated them or knew that
a fnancial statement was false. Such a subjective yardstick would be
diffcult to establish, particularly with underdeveloped judicial systems.
The requirement that boards include a majority of directors who are truly
independent may also be unrealistic: it is essential to have some, but a
majority often might not be feasible. The pool of qualifed independent
directors is small in many Asian countries. In those where noncompeti-
tion and confdentiality provisions in contracts are diffcult to enforce,
companies may well be reluctant to give any outside director too much
insight into their performance or strategy for fear that this information will
be used against them. And for the many Asian corporations that have a
single majority owner, such a requirement might be unfair; even the NYSE
and Nasdaq dont have one (though both require these companies to have
wholly independent audit committees).

P P
P P P

P P
P P

P P P P
P P

P P P P
P P

P P
P P
The McKinsey Quarterly 2004 Number 2 56 Asias governance challenge 57
Any Asian government should therefore rank the reforms in order of priority
and tailor them to the countrys needs. Ensuring that local laws and codes
are consistent with the OECD Principles of Corporate Governance, promul-
gated by the Organisation for Economic Co-operation and Development,
would be a good start. Better to enforce basic reforms vigorously than to
adopt requirements that go unheeded.
Improving transparency
Without greater transparency, new laws and governance codes will do
little to build investor confdence. Notwithstanding recent reforms,
accounting standards in many Asian jurisdictions remain weak. Not enough
professionals have an in-depth understanding of local or international
accounting standards. The accounting self-regulatory organizations are lax.
As a result of all this, reported earnings, cash fows, and balance sheets
can be quite unreliable.
Disclosure requirements and auditing practices are improving, however, as
national fnancial-reporting standards are gradually being harmonized
with international standards. China, Malaysia, the Philippines, Singapore,
and Thailand, among others, now require quarterly reportingthough
whether this will really enhance corporate governance if the underlying
numbers remain shaky is an open question.
1
Just as important are the innovative solutions now emerging to tackle the
regions unique disclosure issues. In South Korea, for example, de facto
control of a company may be based on its identifcation with a particular
chaebol, or conglomerate, rather than on equity ownership. In addition
to the more usual consolidated fnancial statements, South Korea thus
now requires the largest conglomerates to issue combined statements
including all companies under their control, regardless of whether they have
a direct equity interest.
The independence of external auditors is being boosted as well. The China
Securities Regulatory Commission (CSRC), for instance, now forces
companies to rotate their senior external auditors every fve years. Other
places, including Hong Kong, India, and Thailand, are also exploring
such a requirement. Soon, moreover, it will apply to banks in Singapore,
where external auditors of public companies also can no longer provide
certain nonaudit services (for instance, bookkeeping and internal auditing)
to their existing audit clients.
1
In certain jurisdictions, many observers argue that quarterly reporting leads to an excessive short-term
focus on the part of management. In Asia, where there has often been too little disclosure, we believe that the
benefts of having more information outweigh the potential costs.
The McKinsey Quarterly 2004 Number 2 58 Asias governance challenge 59
Regulations with bite
Although most countries are
strengthening their accounting
standards and adopting mini-
mum corporate-governance
rules, many are lagging behind
in enforcement (Exhibit 2). Part
of the problem is that business
and political circles are closely
intertwined, and the mechanisms
for managing conficts of interest
are underdeveloped. In addition,
the desire of governments to
promote short-term economic
growth makes them less willing
to go after large corporations to
protect minority shareholders.
Some regulators lack strong
investigative powers and political
will. Taiwans Securities and
Futures Commission, for example,
has extremely limited powers to probe corporate transgressions and must
largely rely for that purpose on prosecutors and on the national bureau of
investigation, both of which have limited experience pursuing them.
The Securities and Futures Commission of Hong Kong has been accused
of failing to pursue cases involving large, infuential companies. Thailand
has seen several high-profle cases of corporate misconduct in which the party
under investigation, despite strong evidence of culpability, eluded prose-
cution because law-enforcement authorities failed to act. Often, regulators
dont have large enough staffs or budgets to conduct rigorous investigations.
And with legal systems still underdeveloped, prosecuting cases is diffcult.
Most governments, however, are augmenting their resources to monitor
companies
2
and enhancing the authority of their regulators, some of
which are now getting tougher. In 2002, South Koreas Securities and
Futures Commission took the unprecedented step of punishing the local
affliate of a global accounting frm for negligence by reducing the number
of companies it can serve as external auditor. In Hong Kong, regulators
and the police are cooperating to combat fnancial crime. In China, the CSRC
has shut down China Southern Securities, the countrys ffth-largest

2
The Offce of the Securities and Exchange Commission, Thailand, for example, is devoting additional
resources to monitoring disclosures by listed companies and has announced that it will step up its investigations
of internal fraud and insider trading by executives.
The McKinsey Quarterly 2004 Number 2 58 Asias governance challenge 59
brokerage, in a continuing effort to improve corporate governance and
stamp out improprieties.
A few places, including China, South Korea, Taiwan, and Thailand, have
introduced or are contemplating the introduction of class action lawsuits
or similar measures to empower investorsan important frst step. But to
achieve the intended objective of raising managements accountability, it
must become easier to bring lawsuits. At the top of the list of impediments
are court-fling fees (which must be paid in advance) that are based on the
amount of the claims, a backlog of cases, loser pays rules, limited access
to the defendants records in noncriminal cases, and a shortage of judges
with experience in business litigation.
The power of investors
In principle, investors and creditors could pressure companies to comply
with new governance requirements (Exhibit 3, on the next page). In
practice, most of the regions investorsdomestic and foreignare reluctant
to get involved. They invest in a company if they believe that its growth
prospects and risk premium outweigh all other factors and tend to sell their
holdings rather than challenge management when governance problems
arise. And as a Bank of Korea offcial recently lamented, local institutional
investors largely bet on short-term price movements rather than long-term
growth prospects.
Investors must become more vocal in support of reform and more willing
to engage management. Improved fnancial reporting and broader disclosure
will help. Also useful would be reforms making it easier for minority
shareholders to vote by proxy, to nominate and elect directors, and to raise
questions at annual meetings. In hopes of promoting participation by
investors, China is thinking about allowing them to vote online on major
proposalsto issue shares, for example.
Meanwhile, some investors actually are doing their bit to improve corporate
governance. A number of local Thai funds, asset-management frms, and
life insurance companies that collectively manage $23 billion in assets, for
instance, have formed the Institutional Investor Alliance to promote better
corporate governance in Thailand. The Securities Investors Association of
Singapore works with companies to nominate independent directors and
hopes to collaborate with fund managers to improve corporate governance
in the companies in which they invest.
Creditors too are playing a role: Kookmin Bank, in South Korea, now
rewards midsize corporate borrowers with lower interest rates for meeting
specifed governance standards. Moreover, the regions media are becoming
noticeably more willing to probe management practices. In China, for
The McKinsey Quarterly 2004 Number 2 60 Asias governance challenge 61
instance, unprecedented exposs of corporate malfeasance in the fnancial
magazine Caijing have earned it widespread praise. Malaysias business
weekly The Edge regularly features corporate-governance issues and warns
its readers about questionable conduct in local companies.
Embracing change
Since corporate governance is a
new concept in most parts of
Asia, raising awareness is a vital
element of any reform effort.
Many directors, for example, are
unaware of their fduciary obliga-
tions and view their directorships
as sinecures, without real respon-
sibility, so the institutes of directors
in Hong Kong, Singapore, South
Korea, and Thailand now offer
seminars and training programs
for directors and offcers. Region-
wide organizations, such as the
Asian Corporate Governance
Association, have been formed to
promote understanding and reform.
Whats more, several regional groups, including CLSA
3
Emerging Markets
(a regional brokerage frm), Thai Rating and Information Services, and
Indias ICRA,
4
publicly rate the governance practices of listed companies.
Some Asian companies themselves have heartily embraced reform. Indias
Infosys Technologies discloses the extent of its compliance with ten corporate-
governance codes, reconciles its fnancial statements with eight accounting
standards (including the US and UK generally accepted accounting principles),
and has a board with a majority of independent directors as well as wholly
independent audit, nominations, and compensation committees. Exemplary
companies can also be found in other parts of Asia. CLP
5
(Hong Kong),
POSCO (South Korea), Public Bank (Malaysia), Siam Cement (Thailand),
and Singapore Telecommunications (Singapore), to name a few, have been
recognized by publications and organizations for their good corporate-
governance practices.
More common, however, are companies that have in place basic governance
structuressuch as boards of reasonable size, with some independent
3
Formerly Crdit Lyonnais Securities Asia.
4
Formerly the Investment Information and Credit Rating Agency.
5
Formerly China Light & Power.

The McKinsey Quarterly 2004 Number 2 60 Asias governance challenge 61
directorsbut lag behind in their actual board governance. Many boards
that look good on paper follow the letter rather than the spirit of reform:
they have yet to fully embrace such duties as looking after minority share-
holders, providing rigorous management oversight, and holding a two-way
dialogue with investors. To move to the next level, these boards must behave
very differently by asking management tough questions, actively helping
to set corporate strategy, monitoring risk management, contributing to CEO
succession plans, and ensuring that companies set and meet their fnancial
and operating-performance targets. The new forms of behavior will undoubt-
edly take time to become ingrained. Some companies, hoping to speed
up the process, have recruited experienced foreign directors to help overhaul
board practices.
6
Corporate governance has undoubtedly improved in Asia. Some countries
Singapore in particularhave made signifcant progress. The next step
is to instill the new behavior, and that will take time. Many corporate
leaders, investors, and regulators in Asia articulate the benefts of more
effective corporate governance. But they understand that enduring reform
wont be achieved overnight and that, in the short term, many practical
impediments and disincentives block the necessary changes.
To move ahead, both governments and companies in Asia must do their part.
Companies should create stronger and more purposeful boards; enhance
the scope, accuracy, and timeliness of fnancial reporting; and pay more
regard to the rights and interests of minority shareholders. Governments
should provide a strong legal and regulatory framework to underpin the
reforms. While specifc provisions will differ from one country to the
next, any reform effort must include elements such as robust corporate and
securities laws, tough accounting standards, strong regulators, effcient
judicial systems, and determined efforts to clamp down on corruption.
Without sustained progress in these foundations of corporate governance,
any improvement at individual companies will fall far short of its potential.
Dominic Barton is a director in McKinseys Shanghai offce;
Paul Coombes, formerly a director in the London offce, is now an adviser to the frm;
Simon Wong is a consultant in the London offce.
Copyright 2004 McKinsey & Company. All rights reserved.
6
For insights on how governance and other practices have evolved at the Philippine company Ayala, see Ken
Gibson, A case for the family-owned conglomerate, The McKinsey Quarterly, 2002 Number 4, pp. 12637
(www.mckinseyquarterly.com/links/12116).
Q