7th Issue (May 1997)

Editorial

Whilst many people regard corporate governance as primarily system reviews and procedural alignments, researchers of Price Waterhouse exposed the many other facets of it when sharing with readers the findings of two related surveys in this issue. Accounting disclosure, information to analysts and investor communications are among the soft factors of corporate governance, as pointed out in the 'Corporate Governance' article. Professor Bob TRICKER defined corporate governance as the exercise of power over corporate entities. In his article 'Wielding Corporate Power - the ethics of corporate governance', Professor TRICKER introduced to readers ethical conducts required of directors to look not only outwardly at the competitive context of a company but also inwardly at its components.

Take just a glance at this issue, readers will find that two new features viz 'Ethics at Work' and 'The Ethical Way' are included. Thanks to those who had responded to the mini-survey conducted last time, these features are in answer to their views. Those who are interested to know us more can also refer to the colourful catalogue inserted together with this issue. Any enquiries on any one of the EDC products introduced inside are most welcome.

Just don't forget to write in suggesting methods to solve ethical dilemmas outlined in 'The Ethical Way' and win a little but unique prize from the Centre.

At EDC, everything has fully geared up to achieve work targets and objectives of the 97/98 annual plan. In the coming year, the Centre will continue to promote business and related ethics among the business community and the youth population. In addition, it will also maintain close link with overseas institutions that it had contacted last year. Effective from May 1997, Mrs Bernadette COOK will replace Mrs. Helen LEE as the Deputy Executive Director.

Corporate Governance

Price Waterhouse has commissioned and published two surveys into corporate governance in Hong Kong. In January 1995 we surveyed executives from listed companies to identify how they implemented corporate governance policies and where they saw the need for further development. This was followed up by a survey of institutional investors, published in March 1996, to quantify the extent to which specific factors influenced investment decisions and to obtain their views on both corporate governance and how Hong Kong compares to other Asia Pacific countries. These surveys have helped to stimulate the discussions which are ongoing amongst the Hong Kong business community and have raised the profile of the corporate governance debate.

The comparison with its neighbours is clearly of importance given Hong Kong's continued aspiration to be a major, if not the major, commercial centre in Asia in the 21st century. In the eyes of investors surveyed, Hong Kong compared favourably with India, Indonesia, Malaysia, the Philippines and Taiwan and is broadly comparable to Australia, Japan and Singapore. Hong Kong most nearly corresponded to Singapore with 86% of respondents rating them as either about the same (41%); Hong Kong a little better (16%); or Singapore a little better (29%).

Our survey of investors sought to identify which of 23 factors investors value in their decision making process. Although we found that investment decisions are based on 'hard' quantifiable, factors are opposed to 'soft' corporate governance type issues, certain 'soft' factors are important to investors; accounting disclosure was ranked the second most important factor; information to analysis (fourth) and investor communications (eighth) were also ranked highly. The importance attached to these factors is not surprising; since investors focus on trends in EPS and absolute profit growth, the quality of earnings is critical. Adequate and accurate disclosure of company results and activities allow investors to feel more confident that informed investment decisions are being made.

Investors do seem to be more likely to invest in well run companies with high standards of both corporate governance and business ethics: more than one in three investors would be precluded from investing in a company if they were not satisfied about the existence of a code of corporate governance and business ethics; three in five investors would not invest in a company if they were dissatisfied with the level of disclosure in the company's accounts; and a significant amount of investors would not invest if they were dissatisfied with a company's relationship with its regulators (34%) or in a company that attracted negative public or press comment (25%). Furthermore both the investors and executives surveyed believed that improvements are required to Hong Kong's corporate governance regime. Overall, 87% of investors and 74% of executives believed that improvements are necessary. Of these 29% of investors and 19% of executives believed that either considerable improvement or a complete overhaul is required.

As equity markets continue to globalise, and if standards of corporate governance increase overseas, Hong Kong will need to increase its standards to maintain its status as an international market for global investors.

Nonetheless, there are reasons to be optimistic for the future : a high proportion of both the executives and investors surveyed think that further development is necessary - this is encouraging since reform is only likely to be successful if it is supported by those who have to implement change. Indeed, the very fact that corporate governance is a 'live' issue in Hong Kong is, in itself, a plus for Hong Kong.

(Article contributed by Price Waterhouse)

Wielding Corporate Power - the ethics of corporate governance

Increasingly today, public opinion is calling for boards of directors to exercise their considerable powers for good and harm with responsibility and in the interests of the many who can be affected, rather than solely in the interests of shareholders and the short term 'bottom line'.

Markets are not typically good arbiters of the public good. Yet some directors feel that their job is done if they ensure that their company is as profitable as possible year by year, whilst staying within the law. 'If society wants companies to behave in a specific way,' they argue, 'appropriate legislation must be passed.'

But in the end of the day, directorships are positions of trust, demanding absolute integrity, including the ability to make moral judgments, which recognise the broader societal interests that may be affected by board decisions. Directors also need to be able to take a longer term perspective, realising that balancing the interests of all legitimate stakeholders is the only way to ensure long term survival and success. Moreover, directors need to distinguish the company's interests from their own.

Ultimately, the success of every enterprise depends on the calibre of its directors and the effectiveness of its board. Management runs the business, but it is the directors who ensure that is being well run and in the right direction. This applies not only to large, public companies but to family firms, subsidiary and associated companies, and not-for-profit organisations. All corporate entities need to be governed as well as managed.

But what is corporate governance?

Essentially, corporate governance is about the exercise of power over corporate entities. It is concerned with the structure and processes of the governing body (often the board of directors) and of the directors' relationships with shareholders, regulators, auditors, top management and any other legitimate stakeholders. Figure 1 illustrates the scope of corporate governance in a limited company.

Despite the need to recognise the longer-term interests of all the legitimate stakeholders in a company, the directors' primary role is to act for the good of the shareholders - all of the shareholders. Similarly, in other types of corporate entity, such as charities and public associations, the members of the governing body have a duty to act in the interests of the members of their association.

What are directors' duties?

Typically two basic ideas underlie directors' duties - a duty to act with honesty, integrity and candour towards the company and a duty to exercise reasonable care, diligence and skill in their work on the board.

- a duty to act with honesty, integrity and candour

The primary duty of a director, in law, is to act honestly in good faith for the benefit of all the shareholders, giving them equal, sufficient and accurate information on all issues that could affect their interests. Directors may not treat the company as though it existed for their personal benefit. Even in the case of the 'closed' company, in which the owners, the directors and the management are the same people, the company is an independent entity and the rights of other parties, such as the creditors and the state, need to be respected by the board.

A director must not make a secret profit out of dealings with the company. Directors must disclose any personal interests to the board. For example, if a director serves on a board which is considering a tender from another company, in which the director also has an interest, that interest must be disclosed. With that knowledge, the board can decide how to act. Insider trading, that is dealing in the shares of a quoted company on the basis of information that is not in the public domain, is now a criminal offence in almost all jurisdictions including Hong Kong.

- and a duty to exercise care, diligence and skill

A further overall duty imposed on directors, by statute and case law, is the duty to exercise reasonable care, diligence and skill in their work as directors. The interpretation of what constitutes reasonable skill and care has been changing. In the past a directorship in Hong Kong was not an onerous task. An occasional meeting, perhaps a few questions and an expression of interest and support, for a fee and, maybe, a lunch was often what was required. Now all that has changed. Around the world, legal actions are being brought against companies, boards and, in some cases, individual directors alleging negligence, abuses of power or infringement of the rights of minority shareholders. There is a call for professionalism from directors. More and more is expected of them.

The board of directors is the overall decision-making body in the modern corporation. Yet most directors, and there are millions of them around the world, have never had any formal training for their work as directors. Indeed, most directors are unaware of the growing body of knowledge that is now available about the work of directors, board-level effectiveness and the exercise of power of the modern corporate entity - what is now called corporate governance. This situation is somewhat similar to the position of managers in the 1950s, before the growth of management training, management theories and business schools.

As a general proposition, the standard of professionalism expected of directors is significantly higher than a few years ago and rising. Of course, business decision-making involves making judgments and taking risks. It is not the role of the courts to second guess commercial judgements made by directors, even though by hind-sight they turn out to have been misguided.

What should directors do?

Essentially, directors need to look outwards, beyond the company, seeing the business in its competitive, commercial context. They must also look inwards at the component parts of the company. They need to be able to focus on the future of the business in both the medium and the long-term; and they must concentrate on the present position and recent performance.

In contributing to strategy formulation and policy making, directors are adding their abilities to the performance of the company. In monitoring and supervising executive actions and providing accountability, the directors are ensuring compliance and conformance to corporate values and the achievement of the overall corporate mission. In this way every director has a personal stake in the ethical standing of the enterprise and its relations with all whose interests it might affect.

It is every director's responsibility to ensure the business decisions are in line with the policies, procedures and plans that have been sanctioned. In this way directors ensure that appropriate ethical standards have been identified, understood and are being pursued throughout the company from top to bottom. Directors have the ultimate responsibility to monitor the activities of the top management and to act if not satisfied.

Being a director calls for the highest levels of personal integrity and the ability to act in a non-adversarial yet tough minded way, ensuring that every issue of concern is explored to its heart. As one director commented : 'personally, I have no problem with ethical issues, I merely ask myself whether I would mind if my old father read in the local paper about what I have been doing.'

Having spent fourteen years in Hong Kong, Bob Tricker is now based in the UK, with Honorary Professorships of the Universities of Hong Kong and Warwick. He edits the quarterly journal Corporate Governance - an international review, and is the author of the Economist Pocket Director, from which this article has been taken. He continues to consult, write and teach around the world on board level topics and can be contacted through the Quicksilver organisation in Hong Kong.

Ethics At Work

In order to let each and every staff understand the meaning of the Code and the Programme and their importance to Lamex in building up an ethical culture, a series of training seminars were organized. Staff of the ICAC and Training Department of Lamex worked closely in tailoring the content of the seminars for different levels of staff, ranging from top management to front-line staff. For instance, managerial staff discussed the ways to manage staff integrity and how to detect early signs of corruption; sales staff were asked to resolve ethical dilemmas that would be encountered in their workplace. In each seminar, the Training Manager of Lamex, Miss Jade CHAN explained the implications of the Code and the Programme to all staff. This provided a good opportunity for questions, clarifications and comments.

Through this series of training seminars, staff's acceptance and commitment to the Code and the Compliance Programme were enhanced and they could work more efficiently with a set of clear standard and guidelines.

Seminars

In view of the overwhelming response towards the past seminars for finance and accounting managers and a considerable number of applicants were turned down due to space constraints of the venue, the Centre and the Hong Kong Society of Accountants will join hands again in organizing the fourth seminar in June. Apart from corruption and fraud prevention, the seminar will also focus on problems relating to China trade. Participants will hold discussion on hypothetical cases. Call 2587 9812 for details.

Video

The Ethical Way

(Please send your name, address, contact phone and answers to the Editor, 'Ethics in Practice', 1/F, Tung Wah Mansion, 199-203, Hennessy Road, Wanchai, HK or by fax (2924 9766); E-mail (hkedc@chevalier.net)

After returning from a regional meeting, Sally's department heads filed their expense vouchers. Nothing was out of the ordinary except that one new department head, Cain, turned in a voucher for $3,000 less than any of the others. Someone in accounting thought this was strange because everyone used the same transportation and stayed at the same hotel. Sally had been in the company long enough to know that padding travel expenses was not uncommon. Some of the vice-presidents joke about it as being an added fringe benefit. But official company policy states that these cases were prohibited and that violators face demotion or termination. It's Sally's job to decide how to enforce the policy.

What should Sally do?

extracted from Ethics in Management -
A Resource Portfolio for Hong Kong Universities
published by HKEDC