Corporate Governance in Hong Kong, China - HKCPEC

1 Corporate Governance in hong kong , China Rising to the Challenge of Globalization Stephen Y. L. Cheung Stephen Y. L. Cheung is Professor, Department of Economics and Finance, City University of hong kong 2 A STUDY OF FINANCIAL MARKETS. Introduction work put in place in the last 10 years have proved to .. be effective in providing an open, fair, and orderly .. Corporate Governance refers to the rules and incen- market. In the two cases where provisional liquida- .. tives by which the management of a company is di- tors had to be appointed in respect of Peregrine and .. rected and controlled to maximize the profitability CA Pacific, the failure of these companies did not .. and long-term value of the firm for shareholders while cause any substantive systemic problem, nor did they .. taking into account the interests of other legitimate lead to further volatility in the market (Financial Ser- .. stakeholders (Stone, Hurley, and Khemani 1998). vices Bureau 1998).. Corporate Governance mechanisms may be broad- This study documents the Corporate Governance .

2 Ly classified as external and internal mechanisms system in hong kong , China , to draw lessons from .. (Agrawal and Knoeber 1996). External mechanisms its strengths and weaknesses. It discusses the char- .. are determined by outsiders. These include institu- acteristics of the economy's firms, the regulatory .. tional shareholdings, outside block holdings, and take- framework, the problems encountered, and the mea- .. over activity. Internal mechanisms are decided by sures undertaken, as well as additional recommen- .. the firm's decision makers. These consist of insider dations to address them. Major cases of financial .. shareholding, board membership and characteristics collapse arising from poor Corporate Governance are .. (such as size of the board, number of outside inde- presented along with government actions to deal .. pendent directors, and remuneration committees), with them. The study provides specific policy rec- .. debt financing, and the use of outside markets for ommendations and concludes with a discussion of.

3 Managerial talent. prospects for the further enhancement of Corporate .. Good Corporate Governance , complemented by a Governance in hong kong , China .. sound business environment, can strengthen private . State of Corporate . investment, Corporate performance, and economic .. growth. A comparison of Corporate Governance Governance .. 1. among Asian economies indicated that hong kong , .. China (along with Malaysia and Singapore) main- Characteristics of Firms .. tains significantly higher standards of Corporate gov- OWNERSHIP.. ernance and at the same time has developed more In hong kong , China , most listed companies tend to .. sophisticated and adequate legal systems to protect . be controlled by families. According to a survey of .. property rights than the rest of the countries in the the ownership structure of 553 listed companies in .. region (Nam, Kang, and Kim 1999). the economy in 1995 and 1996 ( hong kong Society .. Although hong kong , China was also hard hit by of Accountants [HKSA] 1997b), 53 percent have.

4 The Asian financial turmoil, it has weathered the storm one shareholder or one family group of shareholders .. strongly and confidently. Between June 1997 and owning more than half of the entire issued capital.. March 1998, the market capitalization of the Stock Control by a single shareholder or family group ex- .. Exchange of hong kong (SEHK) shrank by 24 per- tends to more than 35 percent of issued capital in 77.. cent while that of other regional securities markets percent of the companies, and more than 25 percent . 2.. lost from 15 to 79 percent in US dollar terms. of issued capital in 88 percent of the companies. The .. hong kong , China 's trading, settlement, and risk fact that a single shareholder or family group has .. management systems continued to work well through- majority ownership in most of the listed companies .. out the period of volatility in the securities and fu- reflects the dominance of family-owned companies .. tures markets. The institutional and regulatory frame- in the economy of hong kong , China .

5 Corporate Governance IN hong kong , China : RISING TO THE CHALLENGE OF GLOBALIZATION 3. MANAGEMENT futures, and financial investment industries. All rules .. Typical of the tight control of the owner groups over made by the two exchanges (SEHK and hong kong .. the listed companies is the majority shareholder also futures Exchange [HKFE]) and the clearing houses .. serving as the chief executive officer (CEO) of the are subject to SFC approval.. company. The board of directors is also dominated SFC administers statutory requirements to ensure .. by family members. The HKSA report shows that full disclosure and fair treatment of the investing pub- .. in 9 percent of the companies, at least half of the lic. It regularly monitors trading in the securities and .. directors are family members. Among the compa- futures markets to detect possible malpractices. It .. nies in which more than 50 percent of issued capi- also conducts periodic inspection visits of registered .. tal is controlled by a single shareholder or family persons and makes inquiries in response to public.

6 Group, 73 percent have boards where 50 percent or complaints about misconduct by intermediaries and .. more of the directors are family members. In 30 market malpractice.. percent of the companies surveyed, family mem- SFC is empowered to inspect a listed company's .. bers hold 50 percent or more of the executive di- books and records if its directors and officers are .. rector positions.. suspected of impropriety in the management of a company's affairs. Disciplinary actions and civil and . Regulatory Framework . criminal sanctions range from private or public cen- .. The current framework of Corporate Governance sure to suspension or revocation of a license. Re- .. in hong kong , China includes both statutory and garding criminal actions, SFC is responsible for the .. nonstatutory requirements. Statutory requirements investigation of various criminal offenses and while .. consist of the Companies Ordinance, Securities (Dis- it prosecutes minor offenses, serious matters are.)

7 Closure of Interests) Ordinance, Securities (Insider prosecuted at the independent discretion of the Di- .. Dealing) Ordinance, and Takeover Codes. Nonstatu- rector of Public Prosecutions.. tory requirements are those specified under the List- SFC also has frontline regulatory responsibility for .. ing Rules covering the number of independent non- takeovers and mergers, offers of investment prod- .. executive directors, disclosures of connected trans- ucts, and financial intermediaries other than SEHK.. actions, and disclosures of the different components and HKFE members. Executive rulings at the re- .. of directors' remuneration. quest of any dissatisfied party and disciplinary mat- .. ters are heard by the Takeovers and Mergers Panel, .. REGULATORY BODIES a committee established by SFC. The panel consists .. The Stock Exchange of hong kong is the primary of representatives of SFC, SEHK, financial institu- .. front-line regulatory organization responsible for the tions, and other constituencies with an interest in take.

8 Day-to-day supervision and regulation of listed com- overs and mergers.. panies, their directors and controlling shareholders, hong kong , China 's securities market regula- .. and market users generally in respect of all listing- tions fully comply with the principles of the Interna- .. related matters. It performs a self-regulatory func- tional Organization of Securities Commission .. tion, overseeing the conduct of its members, and op- (IOSCO).. erates a stock market providing a wide variety of .. products ranging from ordinary shares to options, war- ORDINANCES.. rants, unit trusts, and debt securities. To ensure that listed companies are properly run and .. The Securities and Futures Commission (SFC) the rights of minority shareholders are protected, .. exercises prudential supervision over the securities, hong kong , China has various rules and codes for . 4 A STUDY OF FINANCIAL MARKETS. specific areas of abuse. The following are the statu- The Securities (Disclosure of Interests) Ordinance.

9 Tory requirements relating to Corporate Governance . (SDIO) requires directors (including their spouses .. SEHK's Listing Rules are the main instrument for and children) and substantial shareholders (those .. strengthening the principles and practice of corpo- holding at least 10 percent of the company's relevant .. rate Governance in listed companies. The rules state share capital) to disclose their interest in the listed .. that directors are responsible for the management companies to SEHK. The aim is to provide a fair, .. and operations of the listed companies, and are ex- orderly, transparent, and efficient market for listed .. pected to fulfill their fiduciary duties (both collec- securities. Substantial shareholders are required to .. tively and individually) with as much skill, care, and notify SEHK of any additional acquisition or disposal .. diligence as commensurate at least with the stan- of relevant shares.. dards set by the laws of hong kong , China . At least SDIO also provides a regulatory framework and.

10 Two nonexecutive directors must sit on the board of disclosure requirements for connected transactions.. a company to ensure its independence and to mini- The Listing Rules define a connected transaction as .. mize the influence of majority shareholders. Impor- a transaction between a listed issuer or its subsidiary .. tant amendments to the Listing Rules require the dis- and a connected person. If the transaction primarily .. closure of directors' emoluments and other informa- involves financial assistance by a connected person .. tion, and a statement of directors' interests in the to a listed issuer, the shareholders' interests must be .. companies' five largest suppliers or customers. How- protected. SEHK normally requires connected trans- .. ever, the Listing Rules have no legal effect, the most actions to be approved by the shareholders in a gen- .. severe form of punishment being public censure and eral meeting, and restrains the connected person from .. a period of cold shouldering.