Introduction

Corporate governance has generated a great deal of public interest around the world. The concept, however, remains poorly defined because it covers a number of distinct areas. Basically, corporate governance is the system by which a company is directed and controlled. It is about corporate fairness, transparency and accountability.

A corporate governance structure specifies the distribution of rights and responsibilities among different participants in the company such as the board of directors, managers, shareholders, auditors and other stakeholders. It also sets out the rules and procedures for making decisions on corporate affairs and provides for the company to disclose its decisions, its performance and other information to its shareholders or investors. By so doing, it will also provide the structure through which company objectives are set and the means to meet those objectives and monitor performance. Good corporate governance helps to secure the efficient management of companies and to safeguard ways in which investors can secure a fair return on their investment.

Corporate and financial commentators often take a narrow view and suggested that corporate governance is a fancy term for the way in which directors and auditors handle their responsibilities towards shareholders; and such expression is used as if it were synonymous with shareholders democracy. Corporate governance as a topic is recently conceived, as yet ill defined and probably a bit blurred at the edges. However, good corporate governance in Hong Kong benefits shareholders, investors, employees, customers, bankers and indeed, the reputation and good standing of Hong Kong and its economy.

Will Good Corporate Governance Enhance Hong Kong’s Position as an International Financial Centre?

The short answer is ‘yes’. The long answer requires a comparison of Corporate Governance ratings with those of other financial centres. In order to provide a detailed answer we must examine our existing rules and regulations governing public corporations – including the Listing Rules, Takeover Code, the Securities and Futures Commission Ordinance (Cap24) and Companies Ordinance (Cap32) - and compare them with those of our competitors.

In the wake of corporate scandals around the world, Hong Kong companies - particularly listed companies - should arrange for corporate governance seminars and conferences to be held in Hong Kong. They should give serious thought to issues like accountability, transparency, disclosure of interests, related transactions, the protection of minority shareholders’ rights, best practices and so on.

More transparency and increased public awareness may nudge directors in the right direction over the long term. An improvement in directors’ behaviour will ultimately affect the decisions made by top management and enhance corporate fairness and the level of corporate social responsibility. Still, introducing guidelines on corporate governance would support Hong Kong’s position as an international financial centre.

Can Hong Kong attract investments from abroad?

According to recent research by the Conference Board, one major challenge for Hong Kong companies is to ‘maintain and improve competitiveness in the face of current economic difficulties, and to steer foreign direct and portfolio investment capital away from regional giants like China or Japan’. Reform on corporate governance issues can help distinguish Hong Kong from its neighbours.

The importance of corporate governance as an investment factor cannot be over-estimated. A higher standard of corporate governance provides cheaper access to capital in the same way that higher credit ratings enable companies to borrow more cheaply – whether locally or from abroad.

Hong Kong companies face many of the same problems that confront companies in North America, Europe and elsewhere. Most directors are generally aware of their fiduciary duties towards majority and minority shareholders and the goals of many companies are similar. That is to reshape the role of the board and the duties of family or nominee directors and shareholders and other insiders to protect minority shareholder rights, avoid conflicts of interest and control related party transactions that benefit only a few investors.

I believe that if Hong Kong can quickly adopt the Organization for Economic Co-Operation and Development (OECD) Principles of corporate governance (see, http://www.oecd.org/pdf/M00008000/M00008299.pdf ) with modifications applicable to local legislation and conditions, it will receive more investment from abroad.

Proposed Reform

I propose that Hong Kong adopt reforms in the following areas:

(i) Independence of Non-Executive Directors. The Hong Kong Stock Exchange Listing Rules regarding non-executive directors should be revised to provide minimum requirements for the quantity and quality of independent directors. In due course, many companies will need to appoint independent and qualified non-executive directors such as solicitors and chartered accountants and provide Continuing Practical Guidance (CPG) courses;

(ii) Increase Non-Executive Director Fees. The remuneration of non-executive directors in Hong Kong is too low to attract suitably qualified candidates who can perform the tasks expected of them. Directors' fees should be substantially increased;

(iii) Directors' Liability. Although Hong Kong is not yet prone to shareholder litigation, listed companies should insure directors against liability;

(iv) Audit Committee. With the ongoing Asian crisis, the Enron and other scandals there is an urgent need to establish independent audit committees. Such committees should consist only of non-executive directors and be authorised to hire and fire outside auditors in order to comply with international accounting standards and best practices;

(v) Independence of Auditors. Audit committees should have full control over external auditors who should be independent of the management and of any other consulting services rendered, including internal audit services;

(vi) Internal Auditors' Certification. Public listed companies should appoint a qualified internal auditor to prepare and sign quarterly written statements certifying that there are no irregularities on the accounts etc.;

(vii)Remuneration of Executive. The remuneration of executives should be linked to their job performance;

(viii) CEO Succession. Global investors are concerned with the succession planning process beyond the senior management level;

(ix) Selection Committee. A selection committee should be formed and comprised of a majority of non-executive directors and an internal auditor to nominate directors to the shareholders for election and to evaluate the performance of the directors and the effectiveness of the board in carrying out its duties;

(x) Protection of Minority Shareholders. The procedures for appointing proxies to attend general meetings should be simplified. Voting by way of poll should be allowed;

(xi) Communications with Investors. It is important to manage relationships with shareholders and investors and regular communication with management should be facilitated.

Comparison of Corporate Governance Practices in Public Companies

1. Shareholders’ Rights
	Hong Kong	Japan	South Korea	France	Germany	Italy
a. Can shares have unequal voting rights?	Same class of shares must have same voting rights. Non-voting shares are allowed. 1 share, 1 vote rule.	Same class of shares must have same voting rights. Non-voting or limited voting shares are allowed. 1 share, 1 vote rule.	Same class of shares must have same voting rights. 1 share, 1 vote rule. Preferred stock generally has no voting rights.	Same class of shares must have same voting rights. 1 share, 1 vote rule. Preferred shares may have double or no voting rights. Articles may limit the number of votes of a class shareholder.	Same class of shares must have same voting rights. 1 share, 1 vote rule. Only preferred stock is permitted to be non-voting.	Same class of shares must have same voting rights. 1 share, 1 vote rule. Preferred stock and other classes of shares are permitted to be non-voting.
b. Can non-voting shareholders vote? What are the requirements for calling a meeting of non-voting shares?	Non-voting shares may not vote. In some cases, non-voting shares may have a limited right to vote on certain resolutions, if rights of non-voting shareholders would be affected. Company’s Articles may set requirements for calling meetings of non-voting shares.	Non-voting shares have the right to vote if (1) the preferential dividend will not be paid; (2) the articles will be amended to require board approval for the transfer of shares; (3) the company will be changed into a private company; or (4) if the rights of the shares are affected. Company’s articles set out requirements for calling a meeting of non-voting shares, but the quorum is 50% of the affected class shareholders.	Non-voting preferred shares are entitled to vote following a resolution by shareholders not to pay preferred shareholders dividend.	Preferred non-voting shares may acquire voting rights if preferential dividends due for the past 3 fiscal years have not been paid or if certain rights of the shares are affected. The quorum is 50% of the preferred non-voting shares for a meeting held on 1^st call and 25% for a meeting held on 2^nd call. The meeting may be called by the Board, the statutory auditors, or an agent appointed by the Court at the request 1/10 of the preferred non-voting shares.	Non-voting preferred shares have voting rights if (1)the preference dividend is not fully paid; (2) the preferential rights of the shares are cancelled or (3) new shares will be issued that have priority over the shares. Only Managing Directors can call a meeting of non-voting shares and there is no quorum requirement. In the event of non-payment of dividend, the voting right ends when the short fall is paid.	Non-voting shares, such as preferred shares and savings shares, have voting rights if certain rights of the shares are affected. The quorum for a special meeting is normally 20% of the preferred or savings shares held on the 1^st call, or 10% for the 2^nd call, and no requirement for the 3^rd call.
c. Is cumulative voting permissible?	No.	Yes.	Yes. (for the election of directors)	No.	No.	Yes.
d. What notice of general meeting is required to be given?	Notice must be published in 1 English and 1 Chinese language newspaper and must be mailed to each shareholder.	Notice must be delivered to each shareholder, unless all shareholders consent to waive the notice requirement.	Notice must be delivered to each shareholder by mail, but in some instances, notice by publication is allowed.	For a listed company, notice must be published in a legal journal. For an unlisted company, notice is sent to shareholders who have asked to receive it.	Notice of shareholders’ Meetings must be published in the official Government Gazette.	Notice of shareholders’ Meetings must be published in the Government Gazette. For non-listed companies, notice may also be given to each shareholder. For listed companies, notice is also published in a newspaper with national distribution.
e. Are there any general or special requirements for giving notice?	At least 21 days notice must be given to shareholders for AGM and 14 days notice for EGM.	At least 14 days notice must be given to shareholders.	At least 14 days notice must be given to shareholders.	At least 30 days notice by publication must be given to shareholders of listed companies, and at least 35 days notice by mail to shareholders of unlisted companies.	At least 30 days notice must be given to shareholders.	For non-listed companies, notice must be given at least 15 days before the meeting. For listed companies, notice must be given at least 30 days before the meeting.
f. Can a shareholder propose to nominate a candidate to the Board of Directors or remove a Director?	Yes. Shareholders holding 5% or more of the shares are entitled to propose the nomination, or the removal, of a director.	Yes. Shareholders can propose to nominate or to remove a director.	Yes. Shareholders may propose the nomination or removal of a director by submitting a proposal or calling special meetings.	Yes. Shareholders owning a specialized percentage of the voting shares may propose the nomination or removal of a director.	Yes. Any shareholder can propose the nomination or removal of a director from the supervisory board. However, shareholders can indirectly influence the composition of the management board, which is appointed by the supervisory board.	Yes. Any shareholder can propose the nomination or removal of a director. The company’s by laws may impose requirements on this process.
g. What rights does a minority shareholder have in a corporate transaction (eg, a takeover, merger or privatisation)?	Shareholders who have an interest in the transaction are precluded from voting. 75% of the shareholders must approve a company’s withdrawal from listing in the stock exchange. In case of buy-back by the company, shareholders are not obliged to sell their shares.	2/3 majority shareholders are required to approve the transaction. A dissenting shareholder can force the company to redeem its shares at fair value.	Dissenting shareholders have appraisal rights for certain matters subject to special resolution.	Dissenting shareholders have appraisal rights for certain transactions. During a takeover bid, certain regulations protect minority shareholder, who may also bring a derivative action against the directors of the company.	Most major corporate transactions require approval of 75% of the shareholders, where the transaction affects the value of the shares, the shareholders have the right to fair and reasonable compensation from the purchaser. Shareholders can also file a lawsuit in Court to enforce their rights.	For certain corporate transactions, a dissenting shareholder has a right to be cashed out at a price based on the share price during the past 6 months. Dissenting shareholders must make their request within 3 days of the meeting, or 15 days of the registration of the minutes in the company register, if the dissenting shareholders did not attend the meeting.

2. Dividends
a. Do companies publicly announce the payment of a dividend?	Yes. Companies must announce the payment of a dividend in an English and Chinese newspaper.	No. Except for listed company.	Yes. The dividend record date must be publicly announced at least 2 weeks in advance, unless specified by the articles.	Yes. Listed companies must publish the announcement in a legal journal. All companies must also file reports, which include information on dividends, annually with the Commercial Court.	Yes. Listed companies must announce the payment of a dividend, usually in a German newspaper.	Yes. Listed companies must announce the payment of dividend in a newspaper and send notice to the Italian Stock Exchange. Non-listed companies also must announce the payment of a dividend.
b. Are dividend distributions mandatory or discretionary?	Discretionary, subject to the articles.	Discretionary, subject to approval at shareholders’ Meeting.	Discretionary.	Discretionary, subject to the articles, which may provide for payment of certain ‘guaranteed dividends’	Discretionary. To be declared by shareholder resolution based on proposal by the management board.	Discretionary. To be declared by board resolution and approved by shareholders’ meeting.
c. Are dividends payable only in local currency?	Yes.	Yes.	No.	No.	Yes. Payment in Euros is becoming more common.	No. Payment in Euros is becoming more common.

3. Financial Information & Auditors
a. Are there any regulations governing the preparation of financial reports?	Yes.	Yes. All joint stock companies must prepare annual financial reports and periodic financial reports are also required under the securities laws for listed companies.	Yes.	Yes.	Yes.	Yes.
b. Are the financial reports publicly available?	Yes. Annual report and audited accounts must be published in newspapers.	Yes. After AGM, public notice of the balance sheet of the company is published.	Yes.	Yes.	Yes, but shareholder has to request it.	Yes.
c. Can a shareholder ask for the reports?	Yes.	Yes.	Yes.	Yes.	Yes.	No. Shareholders can view annual financial statement at the company’s offices.
d. Are there any rules concerning the qualification of auditors?	Yes. Auditors must be qualified under the professional accounting Ordinance and may not be an officer of the company.	Yes. Shareholders elect a statutory auditor annually. The auditor cannot be an officer of the company or any of its subsidiaries. For larger companies, there must be an independent certified public accountant.	Yes. A qualified accounting firm should be appointed to perform the company’s external audit. Internal auditors are required to submit their audit reports to the Securities Futures Commission and the Korean Institute of Certified Public Accountants.	Yes.	Yes. Auditors must be independent from management and are elected by shareholders annually.	Yes. Auditors must be independent and appointed by the shareholders.

4. Corporate Governance Codes
Has the Government or local Stock Exchange adopted Corporate Governance Code?	No. But the Hong Kong Listing Rules contains a code of best practices for conducting board meetings.	No.	Yes. The Korea Stock Exchange, the Korea Security depositary, the Korea Security Dealers Association, and the Financial Supervisory Committee have adopted codes of conduct.	No. But the committee on Corporate Governance has issued recommend- ations.	Yes. The German Corporate Governance Code is applicable to Stock-Exchange Listed companies.	Yes. The Italian Stock Exchange has adopted a code of conduct for listed companies.

Conclusion

According to the President of the World Bank, Dr JD Wolfensohn, the proper governance of companies will soon become as crucial to the world economy as the proper governing of countries.

One of the root causes of the Asian financial crisis was poor corporate governance. Opaque and complicated relationships between companies, their owners and their finance providers diminished investors’ confidence in the region. Economies that took early steps to improve corporate governance have been recovering from the crisis at a more rapid pace than those who have failed to address the issue. The Asian financial crisis showed that good corporate governance is important not only for an individual company to raise capital but also for an economy to achieve sustainable growth.

Hong Kong’s laissez-faire attitude towards minority shareholders, corporate governance, and securities fraud may be changing. Indeed, the securities laws have now been revised for the first time in more than a decade. The changes make insider trading a criminal offence and executives now face the possibility of going to jail instead of paying a fine. Substantial shareholders must now disclose sales or purchases that affects 5% or more of the shares of a company, instead of the previous threshold of 10%. Such changes, together with the reforms proposed above and the recommendations of the Standing Committee on Company Law Reform will eventually improve Hong Kong’s competitiveness and promote Hong Kong as one of the best international financial centres in the World.

George YC Mok

Senior Partner

George YC Mok & Co

CORPORATE GOVERNANCE – A PRACTITIONER’S VIEW

GYC Mok considers whether good corporate governance can increase Hong Kong’s competitiveness and improve its economy

Introduction

Proposed Reform

Comparison of Corporate Governance Practices in Public Companies

Conclusion

CORPORATE GOVERNANCE –
A PRACTITIONER’S VIEW