Viewing Asia’s Financial Markets through a New Light: Lessons from the US Corporate Governance Crisis
By Diana David
October 2002
For decades institutional investors have used an Asian
premium of several percentage points above their US counterparts to account for
the risk of Asia’s “Three “Cs”:
cronyism, collusion and corruption.
However, Enron’s crash eliminated more value than the GDP of many
smaller Asian countries. Now countries
once criticized by the US as corporate governance failures during the 1997
Asian financial crisis are gleefully returning the favor.
With the debacles of US companies such as WorldCom, Tyco
and Enron broadcast the world over, does it make sense to reduce Asia’s risk
premium? Have the criteria for
investing in Asian markets changed? A
September 25 Asia Society conference in New York City entitled, “Viewing Asia’s
Financial Markets through a New Light:
Lessons from the US Corporate Governance Crisis”, attempted to shed some
light on the subject for an elite group of pensions managers and other
interested parties.
Bill Crist, President, Board of Administration of CalPERS,
opened the event noting that CalPERS’ half a billion dollar loss on an
investment in WorldCom made their Asia deals seem far less risky. But not safe enough to reinstate several of
the South East Asian countries hurt in February when CalPERS pulled them off
their safe list for future investments.
CalPERS, with its $30 billion portfolio invested in 40 countries, is a
heavyweight investor and its decision to cease further investment in these
economies naturally made many investors follow suit.
Will Kaffenberger, CEO of AIG’s $1.7 billion Asian
Infrastructure Fund, is bullish on the area.
His thirty deals, almost half of them in China, have garnered an IRR of
45%. Despite fundraising for such funds
falling 85% this year, Kaffenberg cites GDP growth, subdued inflation, stable
exchange rates and a lack of volatility in government budgets and current
account balances, as reasons why Asia will top the list of alternative
investments in years to come. “But deal
structure can’t compensate for the reliability of people and good
intuition. The solid track record of
your partners and the countries they operate in is always your best
protection”, he said, in a world where there is diminishing reliance on
contracts.
Has the Criteria for Investing in Asia’s Markets Changed?
Crist noted that Asia will never be on an even playing
field with investors. “In the US it is our culture, our set of laws. We’re more
comfortable”, he said. As an economics
professor, Crist understands that the perfect knowledge economists and
investors would like is impossible.
“Perfect knowledge: I know that’s a reach. We just want some knowledge!”
There are some things Asian markets can do to win over US
investors. To many Asian investors,
these are not new ideas. American
investors take note; you may learn a thing or two from the efforts of your
Asian counterparts. They may win you
access to new capital, a broader investor base and more reliable shareholders.
Transparency – The Emperor’s New Clothes
Transparency is a key issue, and produces a wellspring of
complaint from investors. “Don’t give
us four hundred pages of footnotes and two lines of text and then say, ‘go find
the footnote sucker’,” complains Crist.
“A footnote, inside a footnote, three paragraphs down. You know we read
that stuff now. I read that now.”
Ernest Napier, Managing Director for Financial Service
Ratings at Standard and Poor’s, said Asian companies’ opaque ownership
structures and muddy inter-company transactions contribute to investor’s doubt
and high-risk ratings. Family or state ownership is the norm and legal
compliance tending toward, “form over substance”.
Yet, though lack of full disclosure may be a hallmark of
the Asian family-owned business, hiding behind legalese is something that
Americans have raised to an art form.
And transparency isn’t enough when the spirit of honesty and disclosure
is lacking. “In May of 2002, a briefing
paper on WorldCom indicated that the executive team appeared to offer answers
to tough questions in a forthright manner.
They were being transparent, but they were lying!” exclaims Crist.
Making the Board Pay
Boards have a responsibility to the shareholders. Although the New York Stock Exchange (NYSE)
suggests mandating independence, few investors find it reassuring. After all, fifteen of the seventeen Enron
directors at Enron were independent.
Many “independent” directors are long-time friends and colleagues of top
executive brass. James Shapiro, Vice
President, International, of the NYSE said suggestions have been made to
preclude a CEO from also being the Chairman of the Board, and allowing
independent directors to meet without top management. But foreign companies are exempt and need only explain their own
rules. Still, companies who comply with
standards appear safer to investors.
“In Asia, a culture of conformity exists that makes it
[independence] especially hard,” said Simon Wong, corporate governance
consultant to the World Bank. Investors
should make sure that they are aware of the nominating process and who appoints
the board. Investors should also
request nominating their own board members.
Kaffenberger takes it a step further, suggesting that board members be
held individually accountable for their mistakes.
The Private Sector – An Ocean of Advocacy
In an era where individual investors are suing companies
and banks for failed investments, Americans take for granted that shareholders
should be involved, share ideas and criteria, and put pressure on those who
govern to be responsible.
But it wasn’t until the late 1970s that CalPERS started to
pay attention to proxies. The
investment committee was concerned by the increase in greenmail -- investors
demanding a buyout in return for keeping quite on management flaws. CalPERS began to vote its proxies. “When we voted ‘no’ to egregious management
benefits, the company called us up to ask, ‘did you check the wrong box?’ It was unheard of for pension investors to
be so involved and pay attention to proxies,” said Ambassador Linda Tsao Yang,
Chairman of the Asian Corporate Governance Association and one of the five
people on the investment committee at the time.
CalPERS now makes sure independent audit committees
exist. Programs to encourage
innovations are scrutinized for abuses like expensing options or re-pricing
executive options to limit downside.
They request CEO income be determined by shareholders. Not like Tyco’s “I’m going to get me a
whatever. It’s only $2 billion; I think I’ll get two of them. Put it in a footnote”, said Crist.
Shareholder passivity is a problem especially in countries where maximizing
shareholder wealth is not the beacon it is in the US, according to John Pritchard,
Vice Chairman of Pillsbury Winthrop.
“The private sector has got to take the lead”, said Yang. “The ocean is made up of tiny drops of
water. One government official in China
explained it to me this way. There are
65 million individual investors in China.
I don’t want even one-tenth of one percent blocking the door to my
office.”
I Fought The Law and The Law Won
Investors in Asian companies often put the blame for risk
on governments’ inability to enforce laws that protect minority investors. Asian governments have responded by cracking
down, demanding quarterly reporting and auditor rotations. Korea’s Securities
and Futures Commission fined a local chapter of PricewaterhouseCoopers and
China recently shut down a small brokerage firm. Korea, Taiwan and Thailand are all investigating the feasibility
of class-action lawsuits on behalf of investors.
But the United States isn’t much healthier. “Two years ago we ditched the Glass Steagal
act and I cheered from the sidelines because it had put US financial
institutions at a commercial disadvantage.
But now there is nothing to replace it.
The Chinese wall is made out of paper,” Yang said.
The US recently passed the Sarbanes Oxley Act in response
to US corporate meltdowns. While, “that
act is chock full of stuff. I don’t
think we can count on the law”, said Crist.
“It is important to have an international accounting standard for
uniformity. Laws enforced by the
courts, parliaments, diets, etc. They
follow different politics and are made by different politicians”. Napier agreed, “Universality is hard.”
What Can the US and Asia Learn from Each Other’s Reform
Efforts?
The consensus among the speakers was that ethics can and
will contribute to financial success.
As the Depression of the 1930’s led to the formation of the SEC and new
regulations, so now ethics and laws return to favor. “Not just to limit legal liabilities but to comply with the
spirit of the law,” Yang said. “Maybe
the margins will not be as high margins, but with no surprises”
Napier noted that S&P ratings for Asia were not back
to pre-crisis levels so, “it’s not time to take off your seatbelt yet”. But as one Wall Street Journal editor noted,
“The bumps we can handle, it’s the crashes we worry about!”
Diana
David is a private equity specialist with a focus on Asia. She has worked for
Henry Kissinger at Kissinger Associates, PriceWaterhouseCoopers and various
American media companies around the world. She can be reached at chinafinanceyenta@yahoo.com with
questions, comments and suggestions.
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