CORPORATE GOVERNANCE IN EAST ASIA

EXECUTIVE (LAW AND BUSINESS) SEMINAR

The University of Hong Kong

Saturday, 22 February 2014.

Corporate Governance Concepts and Challenges in Korea:

Principal framework. 3 LEGAL AND REGULATORY INSTRUMENTS:

Korean Commercial Code (KCC);

KCC amendments (20 times), last one in 2011;

Fair and transparent management practices: 3 POINTS TO CONSIDER.

(a) Prevention of usurpation of corporate opportunities;

(b) Self-dealing transactions;

(c) Compliance Officer system.

Usurpation of corporate opportunities:

· DUTY OF LOYALTY, need to avoid conflicts of interest;

· Obtain authorization from Board of Directors (BoD), to charge or use any corporate assets.

Self-dealing transactions:

· RESTRICTIONS, approval from the BoD;

· Amendment to KCC: transactions BETWEEN AFFILIATES constitute self-dealing.

Compliance Officer system:

· This applies to all listed corporate with capital above KRW 300 MILLION;

· Officer has to possess COMPETENT KNOWLEDGE and RELEVANT EXPERIENCE;

· Executive Officer cannot be Representative Director;

· Most Korean corporates are managed by Executive Officers, instead of BoD;

· Korean corporate structure is different from that of American (US) system.

Global Issues of Corporate Governance (CG) in East Asia:

In USA, Constituency Statutes (internal -private regulation) of the company has become the

Directors’ Guidebook;

In UK, the Companies Act (legal framework), as well as Corporate Law reforms and Case

Law are the main instruments which are to guide CG and management;

In Korea (as well as within several jurisdictions within East Asia), tendency has been more

towards legal and regulatory (external) controls, which serve as guidance framework for

Directors’ performance.

However, under the Korean jurisdiction, corporate management CONTROLS HAVE BEEN

TIGHTENED SINCE THE 2008 ECONOMIC CRISIS:

· There was no need that the BoD exercised audit functions (nowadays, the BoD must have an

Audit Committee within itself);

· After the 2008 crisis, concept of Outside Director was int roduced, especially for listed

companies.

But, who is, and what can (or should) the OUTSIDE DIRECTOR (OD) do?

Listed companies in Korea have an obligation of appointing an OD;

Duties and responsibilities of the OD are especially regulated (under specific and relevant

corporate, financial laws and ordinances);

The concept of OD has been subject of continuous controversies: surveys, evaluation (BoD

meetings, transparency, accountability), critique (formalities, red tape); however, there has

been consensus on the need to keep implementing and even improving, the figure of the

OD;

Though there have been efforts in establishing a clear and solid framework for defining its

duties and responsibilities, OD’s need empowerment (given the needs of pos sessing

sufficient qualifications, defining the scope of related persons, as well as limiting

shareholders’ influence in order to ensure impartiality, as it may happen wth the case of

chaebol issues: minority-interest companies);

Why do OD’s need empowerment and more solid protection under the law? Because, i f

they incur in breach of duties, they may be held liable before the BoD and the

shareholders: their role brings high expectations, but OD’s do not entail full -time

responsibilities, nor permanent or official appointments, as well they need the advice and

support from accountants, auditors and consultants;

In brief and concise terms: the OD ACTS AS WATCHDOG within the company (though

outside the interests of the corporate), though the principal risk, and possible weakness, of

its role underlies in its liability to minority shareholders, and its need of support by law

enforcement authorities.

Are Outside Directors Necessary in Japan?

[Reference: Kawasaki Case, an expanding shipbuilding company, lis ted in the Tokyo Stock

Exchange;

Issue: Removal of the Chairman, CEO of the Company!]

In Japan, there are generally FOUR CRUCIAL ELEMENTS for defining the Committee System

as a tool of effective CG in the local jurisdiction:

· The BoD;

· The shareholder’s meeting;

· The BoD meeting;

· The auditor’s committee of the BoD (which is conformed and operates alongside with the

nomination and compensation committees)…

However, only 3% OF ALL LISTED CORPORATES USE the COMMITTEE SYSTEM in Japan.

Under the Kawasaki Case, has CG worked or failed? TWO ASPECTS:

· Positive: BoD watches over the representative Director;

· Negative: BoD has the duty of maximizing the value of the company;

If there is failure to conciliate interests within the BoD, there is a considerable risk o f entering

into POWER STRUGGLE between the CEO and the BoD…

Then, we are getting to the point, where we can say it is recommendable to appoint an Outside

Director within the BoD of listed companies in Japan, the same way, or at least in similar terms

to the Korean way;

In Japan it is not compulsory to appoint an OD, however, in the light of recent proposals for

amendments to the Companies Act in Japan, it may be very desirable;

OD is to be appointed under companies’ discretion…

National Pension Fund in Korea:

Context nowadays:

· Inactivity in the exercise of voting rights by investors;

· Preference to sell stocks than changing corporate policies;

· National Pension Fund (NPF) has diversified investment schemes in stocks under the Capital

Markets Act.

The VOTING PROCESS within the NPF Investment Committee is defined:

On one side, by markets and regulators (GUIDELINES);

On the other side, by shareholders’ meeting (DECISION):

(a) Voting ballot (written or via e-tools),

(b) There has to be separation in the votes of the CEO and of the Chairman of the BoD.

Corporate Abuses and Dysfunctional Board, Dispute Resolution:

Current situation:

Under Anglo-American law, Directors’ duty is to act in the interest of the Company;

Shareholder Supremacy doctrine: They are bosses;

Companies shall (and need to) reduce transaction costs;

Drectors’ incentives are tied to profit maximization;

Creation of STAKEHOLDERS’ BOARDS (SHB);

Adam Smith’s INVISIBLE HAND…

Nowadays, we have 3 INNOVATION MODELS in Asia:

· Stakeholders’ theory;

· Corporate Social Responsibility;

· Confucian Values applied to CG…

However, it is also important to mention there are 3 MAIN CHALLENGES:

· Determine percentages of BoD and SHB interest representations: 50-50? Majority? Co-

determination?;

· How to represent the consumer and the community?;

· Longer decision-making, more complicated, slower to respond to a shifting environment and

constantly-changing markets.

Then, WHAT CAN BE DONE?

The idea of maximizing profits is main cause for corporate abuses, such as misallocation of

resources, or macro-inefficiency;

There also comes a NEED TO REFORM the unitary shareholders’ representative board

system (shareholders represented by the BoD);

For the case of MNC’s IN DEVELOPING COUNTRIES, where there is history of abuses or

neglection of stakeholders, they NEED TO CREATE SHB’s as well…

Public vs. Private Enforcement:

US vs. China (PRC) transaction models:

US system is litigation-friendly, mainly adopting a post-conflict settlement approach;

PRC system is prevention-friendly, mainly adopting a regulatory and conciliatory

approach…

However, we can say that the Hong Kong experience (where the system may be considered

“hybrid”), may bring us light for innovating in New Dispute Resolution (or better said, Alternate

Dispute Resolution, ADR) schemes. This is mainly because:

· Common-law institutions provide us more flexibility for ADR means;

· Equity principles are relevant…

BUT THE MAIN DISADVANTAGE IN THE COMMON-LAW JURISDICTIONS is that rulings

must be coherent (not contradict each other).

ARBITRATION or LITIGATION?, In order to solve disputes:

Arbitration, can be considered more as a “consented” resolution procedure, shareholders

are entitled to choose arbitration in case of imminent or incoming dispute (as long as

permitted);

Arbitration is useful, as it helps to protect the interests of minority shareholders.

Litigation, on the other hand, is compulsory by law;

The main problem with Litigation is that, despite it can be more effectively enforced, it

leaves a very narrow or reduced margin for ending Dispute Resolution process with a

friendly resolution that protects interests of both the shareholders and stakeholders; the

outcome can be uncertain…

Confucianism in Corporate Governance:

Agency Theory and Stewardship as Schools of Confucianism in East-Asian CG;

In the PRC we are facing two relevant challenges:

· Systemic problems;

· Quality of individuals;

These two aspects can be noticed in issues, such as: inside control gaps, fraudulent trading,

bribery, corruption and certainly recurrent malpractices in transaction processes, etc…

Consider the roles and intentions of CG participants:

· Agents and principals are UTILITY MAXIMIZERS;

· Basic assumption in economics: self-interest;

Collectivism vs. Individualism?,

· Constant challenge: reduce costs, using the stewardship and agency theories.

RULE BY LAW vs. RULE OF LAW?;

Prosecution vs. Equity;

AGENCY (contention, enforcement) vs. STEWARDSHIP (trust-building)…

Evil (XUNZI), Agency vs. Good Faith (HANFEI), Stewardship:

Xunzi: Presumed evil nature, goodness is false, COERCIVE ENFORCEMENT IS

NECESSARY to suppress malbehavior;

Hanfei: Law should act as an instrument to maintain order, however on a GOOD FAITH

APPROACH (self-regulation), the legal system should trust the representatives…

Which approach is better? Consider the CONTEXT AND CHALLENGES:

· Independent and transparent system is important, otherwise rules will be paper without effects;

· Under the stewardship theory, Directors are stewards (acting in good faith for the interests of

the company);

· Question: How to align personal needs to those of the corporation?…

In line with the stewardship theory, we can think about the principles of Mencius (vs. those of

Confucius, which go more in line with the agency teory): Human nature is good and beautiful;

Then, we need to trust our colleagues and representatives. PEOPLE CAN SELF-REGULATE

THEMSELVES.

· Education of business ethics will be more influential in the long run…

Final Questions and Remarks:

Question 1.

Can the figure of the Outside Director apply to the CG framework in Hong Kong (even with its

limitations and liabilities)?

It may be a sensible idea to bring the figure of the OD to Hong Kong, but there is a real

need to keep promoting diligence in the exercise of duties of Directors (generally), even

when the liabilities of the OD are limited (in Korea and Japan, Directors enjoy an average

remuneration threefold that of HK);

It is also very important to work in making compatible the figure of the OD with the

Common-law framework of HK, in comparison with the Civil-law frameworks of Korea and

Japan…

Question 2.

Are stakeholders’ interest advocacy, similar to that of workers’ unions interest advocacy?

This remains as an open question: stakeholders’ advocates do not have a vote in

stakeholders’ decisions, even though they represent the interests of stakeholders;

Enforcement remains as a crucial issue, even when there are extensive legal and

regulatory frameworks in East Asia, including within HK;

Directors have a duty of balancing interests (those of companies’ shareholders with those

of stakeholders)…