Sunday, 4 December 2011

Corporate Governance Blueprint 2011, What are we to do?

Very interesting article in The Star from Tan Sri Lin See-Yan.

I don't full agree with some remarks, I am actually (slightly) in favour of limiting directorships to nine years. One reason is "Long stretches of service may prejudice a director's ability to act independently and in the best interest of the company". Another reason is that in companies with less good CG standards where independent directors have been toeing the line, the CEO/Majority shareholder would like to retain the same set of independent directors, exactly when "fresh blood" would be beneficial.

The same more or less for separation in the roles of CEO and Chairman, I would prefer that exactly in the companies with less good standards.

On the other hand, in those cases the majority shareholders probably can find other persons who toe the line, so I don't expect miracles of these rules.

"SC should practise what it preaches. Stop imposing more and more rules."
I would even promote giving bonuses to SC and BM employees who can simplify and reduce the current number of rules, the amount is quite mind blowing at the moment. I can speak from practice, I fought some cases tooth and nail and had to go through most of the rules (BM, SC and SSM), it is really too much.

"The corporate community needs breathing space and time to build its own culture."
I hope the writer means in combination with increased enforcement from SC and/or BM, without fear or favour. The CG culture is simply disappointing in Malaysia, many companies have had it too easy for too long time. It will improve over time, I am confident about that, but increased enforcement and more attention for CG issues in the press will help to speed this process up.

In Singapore there is for instance a lively discussion about REIT's: a related party transaction which is hotly debated and managers whose interests are not alligned with those of shareholders and therefore initiate freqent rights issues. I simply miss these kind of healthy discussions in Malaysia.

From my personal experience: as an "angel" investor I work mostly with young founders (majority from Malaysia and Singapore) of startup companies, and their behavior is exemplary. They very quickly learn about CG and the long-term beneficial effects, for all involved (founders, angels, other shareholders, employees). There might be something of a generation gap, which might have to do with international exposure and changing culture. But I am hopeful things will continue to improve, otherwise I would not be investing in Malaysia.


The maturity of the capital market is reflected in the quality of its corporate governance (CG). Most observers say CG in Malaysia has much to improve.

On the surface, we appear to have complied (with the myriad of regulations to provide for good CG) and have a good record on paper in meeting international benchmark “good practices.” But in substance, we don't do so good. Indeed, there is much to be desired. Still, we are told often enough, we need more rules to remain relevant.

So it's not surprising that we now have another Corporate Governance Blueprint 2011 a “major review and recalibration of controls is necessary” says the Securities Commission (SC). This Blueprint contains 35 new recommendations “to move from the normative tendency which regards corporate governance as a matter of compliance with rules, to one that more fittingly captures the essence of good governance”
The SC chairman further emphasised that the blueprint “outlines strategic initiatives aimed at strengthening self and market discipline” (highlighting is mine); yet its recommendation introduces more rules in the name of intending “to reinforce self and market disciplinary mechanisms.”

It's quite clear what we need is time to build our own corporate culture. It's also strange SC doesn't practise what it preaches away from normative rules to greater reliance on self regulation. The essence of good CG involves a state of mind. Human behaviour is unpredictable. Just can't legislate good morals.

Since then, the SC issued on Nov 15, a public consultation paper seeking comments on two issues: whether or not the chairman of a public-listed company should be independent, and whether or not poll voting should be extended to all resolutions requiring shareholders' approval.

Both the July blueprint and the recent paper raise important issues of wide public interest and concern. They deserve careful study and a frank public response in the hope that the SC will take them seriously enough to promote the best interest of companies and stakeholders. In this context, my July 2010 column, On corporate governance and doing it right, remains relevant. Frankly, we don't need more rules. Just more time to build our own corporate culture.

Independent directors
The SC is right in saying independence is “inherently situational and is, more than anything, a state of mind.” It's in short supply. In this regard, the existing seven criteria for independent directors (Indies) still make sense: “Needs to be independent of management and free from any business and other relationship which could interfere with the exercise of independent judgement or the ability to act in the best interest of the company.”

Ultimately, the qualitative evaluation, on a case-by-case basis, is made by the collective board. The listing requirements advise that “boards have to give effect to the spirit, intention and purpose of the independence definition.” In the end, judgement rules the day as it should be.

The blueprint states from its survey that in 2009, 37.3% of companies had Indies whose tenure on the board exceeded nine years and concluded: “Long stretches of service may prejudice a director's ability to act independently and in the best interest of the company.” This is only an impression not backed by empirical evidence.

The finding is not alarming. It cuts both ways. It then refers to other jurisdictions' tenure limits (nine years on average). “Given the potential adverse effects of tenure on independence,” the SC recommends that a limit of up to nine years be imposed. This is, at best, a flimsy basis. It reflects “group think” this safety in numbers is quite inconsistent with good culture.

Indeed “group think” is dangerous. It fails to consider our short historical CG evolution, imperatives of our Asian culture, our close-knit corporate community, the company's business cycle, supply and demand of experienced director expertise, increasing turnover of top management staff, inherent practical problems arising from frequent “sneaking-in” of AOB (any other business) items at meetings, and important decisions via circular resolutions.

In the end, it's arbitrary and mechanical (okay at eight years, but gone the next). It's just a line in the sand (not even a straight line). Agreed, everyone has a limit. But it should not be set arbitrarily it could lead to “musical chairs.”

This is a contentious area since it involves the individual's mindset. Setting a quantitative limit on an issue that is largely subjective should be avoided. Ultimately let the collective board decide on how to balance the company's needs with the individual's capacity to add value, but ensure transparency.

Multiple directorships
As in the case of Indies, the blueprint's rationale for limiting directorships to five is rushed. Bursa data show the number of persons holding more than five directorships are “extremely small” and concluded the issue is therefore “not about multiplicity of directorships held, but of capacity and commitment by directors.” The logic gets simplistic from here on: “Taking both these points into account, we believe ” the maximum directorships held should be five.

Agreed, directorships represent significant time commitment. But it must be recognised that an individual's capacity for work varies depending on the individual and his mental capacity to multitask; whether he is a full-time director; his work and leisure balance; within his work schedule, time committed to being an Indie; the company's circumstance, its business, size and state of finances; tasks entrusted on him; and the amount of time he needs to spend to add value to the company.

All these point to his own assessment of the degree of care and diligence required of him, against the skills and experience he brings to the table, recognising the practical reality of collective effort in making, and the responsibility for, board decisions.

In essence, it is only fair that this be left to the individual to decide, rather than being determined remotely by the SC. Real Indies will not accept a role they can't fulfil. Others merrily do so on paper but care little about their role. It's widely practised in audit firms, for example, that the number an audit partner signs off varies depending on the complexity of the companies and the individual capacity of the partner. In the final analysis, it should be based on the capacity of the individual to perform.

The existing system of ultimately letting the collective board make the qualitative judgement and make the final call continues to make sense. The SC should not dictate what should indeed be left to the individual he knows best about his legal and fiduciary responsibilities. Current data show this is not a problem. If it ain't broke, why fix it. Putting a limit on multiple directorships deprives companies of scarce board talent.

Separating chairman and CEO
The SC makes a compelling case for separation and independence. Data presented shows the underlying problem. Although 72.5% of listed companies on Bursa Malaysia in 2008 have separate chairmen and chief executive officers, in substance 15% of them do not practise it, reflecting the impact of strong family ties.
This is not surprising. After all, the practice of separation is not universal. In the United Kingdom, 95% of the companies in the FTSE 350 have an outside chairmen. In the United States, 53% of S&P's Top 1,500 companies combine the two jobs. The case for separation is based on the simple principle of balance of powers.

Empirically, there is no solid evidence that splitting the job does good. The past 20 years of research had ended with inconclusive results. Enron and Worldcom both split the jobs; so did Royal Bank of Scotland and Northern Rock.

Splitting the job brought also undesirable consequences: CEOs find it harder to make quick decisions; ego-driven chairmen and CEOs squabble over who is really in charge; and shortage of first-class CEO talent may mean bosses are often second guessed by a chairman who usually has less knowledge of the business. The US solution: 90% of S&P 500 companies now have “lead” or “presiding” directors to act as counterweight to the executive chairmen.

In the end, there is just no one-size-fits-all solution.

After all, separating the jobs is only one aspect of CG. As I see it, the best solution is evolutionary, given our short CG history. In 1992, Sir Adrian Cadbury (Cadbury Report) introduced the “comply or explain” solution: if you can't comply (i.e. split), explain why. Seems like a sensible solution.

We should avoid “group think” just because the United Kingdom, South Africa, Australia and Thailand have split. Singapore's compromise also sounds workable: where the jobs are combined, ensure the majority of the board members are Indies. In the event a split is needed in the best interest of the company, an independent chairman makes more sense.

Mandatory poll voting
In this digital age, it makes sense for voting to go electronic. Poll voting accurately underlies the principle of one share, one vote.Because of the large number of diverse shareholders, poll voting can get cumbersome and time consuming, just as voting by show of hands is antiquated and inaccurate.

The technology is here to implement poll voting; it's just a matter of cost. Mandatory poll voting should be implemented once a credible electronic voting platform that is cost effective is found. This should not be an issue of concern.

Board diversity is good, including gender representation to harness diverse insights and perspectives. But the notion of “the goal is for woman participation on boards to reach 30% by 2016 and the progress towards this goal will be monitored and assessed in 2013” is discriminatory and bad policy. It's the wrong way to promote woman. Granted woman account for one-half of the population, but they make up only 15% of the board members in big US firms, and 10% in Europe.

Empirical evidence shows mixed boards make better decisions. But quotas are a blunt tool and insult woman with calibre. But I do understand why they are used: (i) men dominate boards and are incorrigible sexists; (ii) talented executives are mentored by men, preferring males for fear of being misunderstood; and (iii) globalisation demands mobility which disrupts families.

A recent study shows quotas place inexperienced women on boards, seriously damaging the firm's performance. Here again, no shortcuts. Companies need to start by helping more women: (a) gain the right experience up the ladder; and (b) balance their family lives with the demands of the workplace. This is a slower process but likely to be more meaningful, and upholds the dignity of woman.

Continuing education (CE)
The growing complexities of modern business make it difficult for most directors to catch up. Professional directors need to be intellectually honest and robust; they need more than a fleeting acquaintance with new management techniques, including skills in risk management, strategic and business methods, and human psychology.

It's good that CE programmes will be made mandatory. But in order not to encourage and entrench vested interests, the SC and Bursa should not be involved in providing them. Let the private sector compete for the business operating under strict SC guidance stressing quality and international exposure.
It is important to get the best and brightest on board (here and from abroad) to teach. Otherwise, forget it. Directors are smart and intellectually curious need to get for them the best there is to make it worth their while.

SC should practise what it preaches. Stop imposing more and more rules. The corporate community needs breathing space and time to build its own culture.

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