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Mr. Chairman, Ladies and Gentlemen:
It is a great pleasure and honor to speak before your annual conference. I have chosen to address the question of “What is the right model for corporate governance in Asia?” To be absolutely frank, I do not think that there is an adequate answer yet. As I became The General Counsel of the ADB less than six months ago, I cannot claim to have in-depth knowledge of the actual circumstances surrounding capital markets in the developing countries in the region. On the other hand, I am very familiar with the United States and Japan. Both countries have successfully developed yet, historically their approaches have been quite different. Although it can be argued that their systems are converging, I would like to examine in some detail what went wrong on both countries. Perhaps, there are some lessons that other countries can learn from those experiences.
During most of the 1990s, American’s economy and its capital market delivered an outstanding performance. So, it was quite natural for some to argue that we should expect that the American model would become the global standard by which all economic systems would be judged. Critics of that argument called it “market fundamentalism” or worse yet – “American triumphalism”.
This model stands in stark contrast to the brand of stakeholder capitalism that has been practiced in Japan since the Keizai Doyukai came up with its basic blueprint in 1947. The stakeholder paradigm has generated high growth in both post-World War II, Germany and Japan but serious doubts were raised when this system of corporate governance, together with the bank-centric financial model, failed to produce the results that were occurring in America in the 1990s.
But the debate over the merits of shareholder capitalism versus stakeholder capitalism does not really help us to understand the problems. The interests of customers, employees, retirees and investors are important in both America and Japan.
It should be clear to all of us that the way in which the engines of wealth – that is our corporations – are governed, is of paramount importance.
Over the last 24 months, the Enron and other scandals have raised some serious doubts about the American shareholder-capital market-centric – model, as well.
Even Paul Volker, who was shocked by the explosion of corporate greed that occurred in the 1990s, has been quoted as saying: “Traditional norms didn’t exist. You had this whole culture where the only sign of worth was how much money you made”.
But greed alone does not explain what happened in America. And certainly none of us here would argue that advanced countries such as Japan and America should become less wealthy in order to make things better.
Corporate governance is critical to all of us in one way or another because our standard of living is tied to the future prospects of our corporations and the feasibility of creating new businesses and jobs.
Simply put, if our companies are uncompetitive, unproductive and wasteful – all of the stakeholders will lose. If only a few at the top are permitted to loot the wealth of the companies, those companies are likely to go bankrupt.
I think that it is useful to look at corporate governance in terms of three components:
When these factors work in balance, the “greater good” has a chance of being achieved. But like many things in life, that is easier said than done because good corporate governance involves politics, economics, management, accounting, ethics and law.
The first factor – accountability, transparency, and disclosure – the sum of accounting standards and practices and legal rules and regulations that allow investors to feel that it is safe to part with their money.
The relative lack of this factor in the past in Japan accounts for many of the many corporate scandals, the low profitability of its companies and the lack of high levels of investment in new businesses.
Through the Big Bang financial reforms, the updating of accounting standards and amendment of the Commercial Code, Japan has made tremendous progress over the past five years. For example, with effect from this year, the Commercial Code has been amended to provide an opportunity for large corporations to adopt a corporate governance system that will permit and encourage the appointment of independent directors and the establishment of audit, nominating and compensation committees of the board.
One of the lessons of the Enron-type scandals is that independent directors and audit committees by themselves will not ensure that there is good corporate governance.
As we in America address the Enron-type problems, we must remember that there is a real danger that we may go too far if we create an adversarial relationship between the shareholders, manager and the outside directors. We need to strike a balance.
In the 1990s, stock options became the favorite tool to provide incentives to management and employees as well (at some companies). The argument was made that shareholder value will be increased if the interests of management are properly aligned with the interests of shareholders in achieving a higher stock price.
No distinction was made between the managers of Silicon Valley-type start-ups (where the managers were taking great personal risks) and the managers of Fortune 500 companies (where the managers took very little personal risk). All were awarded stock options whose ultimate value was based on the price of the stock.
In 1997, the Commercial Code in Japan was amended to allow companies to issue stock options to directors and employees and amended again this year to allow a broader group of people to receive options with fewer conditions. But relatively few Japanese companies have experimented with this device and, in any event, the price of stocks has been declining for the past ten years – so it’s not much of a problem for the moment.
Options are very much at the center of the problems in corporate America. There has been a tremendous amount of debate over some rather arcane accounting rules concerning whether options should be shown as an expense in the corporate accounts or merely mentioned in the footnotes to the financial statements and how options should be valued and how they should be taxed.
The heart of the problem is that too many executives and their enablers – that is the accountants like Arthur Andersen and others, certain lawyers, investment bankers and stock analysts – were either engaging in or overlooking accounting practices that encouraged stock prices to rise so that the options would become more valuable.
It looks like expensing options will become a standard practice but the real issue remains – how to properly compensate managers – and this will continue to exist.
Finally, the issue of corporate discipline must be addressed. In America, there is no longer a debate about the legality or feasibility of hostile takeovers. Many consider the threat to remove entrenched or unsuitable management teams as a potent check on prerogatives of management. Certainly no one can force shareholders to sell their shares but the “control premium” would have to be set at a very high level before shareholders would dump management that they were really satisfied with.
Hostile takeovers through proxy fights and TOBs have not been very popular to date in Japan but the idea that Japanese management must be disciplined by the market is catching on. While Japan does have legal rules on proxy fights and tender offers that are similar to those in the United States, it does not have a Takeover Code like the U.K. or even rudimentary rules governing hostile takeovers. Indeed, the Commercial Code, in effect, ties the hands of management following a TOB by making most defensive tactics unworkable.
As the cross-shareholding and stable shareholding ratios continue to decline, the degree of nakedness and vulnerability of Japanese companies to hostile takeovers only increases.
Some of my Japanese lawyer colleagues and I have invented a poison pill suitable for use under the provisions of the Commercial Code but for the moment, there has been very little interest in this device. But again, the lessons of the American experience may be instructive. We have a long history of using staggered boards and poison pills but if the economic conditions are right and the control premium is sufficient; there is really very little that will prevent shareholders from selling to a hostile bidder.
Following the Enron and other American scandals, we in the U.S. are asking
The U.S. Congress has addressed the problem by passing the Sarbanes-Oxley Act, which makes corporate executives more accountable to their public shareholders, expands criminal and civil liability in the securities area and creates a new regulatory regime for public accountants.
Over the last five years, Japan has earnestly reformed its legal and regulatory system by introducing amendments or new legislation that permit holding companies (1997), stock-for-stock exchanges (1999), a Chapter 11-type Civil Rehabilitation Law (2000), a corporate spin-off law (2001), a broader range of corporate stock options (2002) and a new emphasis on the protection of intellectual property. But the Japanese economy and the state of its banks and corporations are not better than it was five years ago. Proper rules and regulations alone will not suffice.
The rules and traditional norms that Mr. Volker mentioned did not prevent Enron from happening. In reality, Enron and the Other American corporate scandals represent a perversion of the shareholder value model. While paying lip service to the goal of satisfying stockholder interests, these managers merely enriched themselves, committed fraud or outright stole corporate assets.
The Japanese corporate scandals over the last ten years too represent a kind of perversion of the stakeholder model, where management, in the name of protecting employees and other stakeholders, diverted corporate assets to pet projects, hid losses in subsidiaries and destroyed corporate value.
At the extreme side of both ends of the spectrum – in a very perverted way – both the American and the Japanese systems of corporate governance converged into a kind of managerial capitalism – or capitalism for the benefit of those who control the corporation.
__________
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URL: http://www.asianlii.org/asia/other/ADBLPRes/2003/3.html