• Sun
  • Dec 21, 2014
  • Updated: 12:17pm
PUBLISHED : Tuesday, 10 December, 2013, 2:51am
UPDATED : Tuesday, 10 December, 2013, 8:55am

Tighten, not ease, governance rules to promote Hong Kong's market

Higher standards will boost valuations of listed firms, attracting both issuers and investors to the city and enhancing its financial hub status

A couple of months ago, mainland internet giant Alibaba cancelled its proposed stock offering in Hong Kong.

It pulled the deal after being told plans that would have allowed holders of 10 per cent of the company's stock to stuff the board with their own directors failed to meet the Hong Kong stock exchange's governance standards.

Inevitably, the decision prompted a chorus of complaints. By insisting on such onerous standards, the city was deterring listings from high-profile companies, grumbled local financiers. If Hong Kong is to compete successfully as an international financial centre, it must take a more flexible approach.

Even exchange chief executive Charles Li Xiaojia was swayed. In his blog, he described the existing rules as "extreme" and argued that "innovative companies" deserved special consideration when it came to governance.

If Hong Kong was not prepared to modify its stance, the city "could lose the chance to embrace the future and all the benefits it would bring", he warned.

This prevalence of controlling shareholders erodes internal controls [and destroys] value

In other words, Hong Kong should consider relaxing its governance rules to promote the city as an international financial centre.

Whether that approach would work is doubtful. On the contrary, there is strong evidence that Hong Kong's position as a financial centre would be enhanced by tightening its governance rules, not by loosening them.

The city likes to congratulate itself as a paragon of good governance. But although it performs well on some scores, like the governance components of the Global Competitiveness Report published by the World Economic Forum, specialist researchers question the city's reputation.

For example, the 2010 league table compiled by New York-based governance consultancy GMI Ratings ranked Hong Kong a lowly 26th out of 39 markets for corporate governance with a score of just four out of 10.

That placed Hong Kong only slightly above the average for emerging markets and far behind Britain, with a score of 7.6, and the United States, on 7.16 (see the first chart).

Other studies come to similar conclusions. The Asian Corporate Governance Association ranks Hong Kong-listed companies poorly for their governance rules and practices, while this year the Hong Kong Institute of Directors warned that standards of transparency and directors' responsibility were deteriorating.

These dismal ratings should be worrying because poor corporate governance means poor price performance.

According to GMI, between 2005 and 2012, shares in Asian companies that rank among the best 10 per cent in the region for accounting and governance risk outperformed those of the worst-governed by 94 per cent (see the second chart).

Bryan Michael and Say Goo at the University of Hong Kong believe many of the city's governance problems can be pinned on the abnormally high proportion of listed companies - 70 per cent - tightly controlled by dominant, often family, shareholders.

This prevalence of controlling shareholders, they argue, erodes internal controls, undermines the effectiveness of independent directors, weakens the integrity of earnings reports, suppresses innovation and leads to poor capital allocation, ultimately destroying value.

As a remedy, they propose an 18-point list of recommendations to shift the relative balance of power away from controlling interests and towards minority shareholders. That, they argue, would improve Hong Kong's corporate governance and so boost valuations.

And rising valuations will attract both issuers and investors to the city, enhancing Hong Kong as a financial centre far more effectively than racing to the bottom with looser governance standards.



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John Adams
The bar chart ranks HK only slightly better than China !
That is very worrying indeed.
But then, perhaps not so surprising given than the cronyism and nepotism within the 70% of HK listed companies "tightly controlled by dominant, often family, shareholders" is not so different from the way most Mainland companies are run (e.g. read Shirley Yam's horror-story columns) .
The only difference is that we have the ICAC (sometimes) and the rule of law ( sometimes .. but often not applied : see today's Laisee)
By reading the book ‘Unintended Consequences: Why Everything You’ve Been Told About The Economy Is Wrong’ (by Edward Conard), you may change your view towards the United States in general, and those IT internet companies (like Alibaba) in particular.
Reading Part I of the book (chapters 1-4) will be enough.
If ‘poor corporate governance means poor price performance’ is always true, then the Hang Seng Index as of today would only have been 2,374.42, not 23,744.19.
The recent relatively poor performance of the Hang Sang Index (compared to the Dow Jones Index) is partly explained by the relatively poor performance of the Shanghai Composite Index.
While the US has been printing money like crazy, China has been trying to suppress her financial repression, in two ways:
(i) ‘the central bank has engineered a gradual but relentless tightening of monetary policy, injecting less and less cash in the financial system.’
(ii) ‘Regulators have presided over a de facto liberalization of interest rates, driven in large part by wealth management products (and the shadow banking system).’
From “Soaring rates show China’s bond market is maturing” (Financial Times)
No money, no quickly rising stock market. Just that simple.
(Thanks to the easy money, the Dow Jones Index has risen so much recently.)
In recent years, the relatively sluggish performance of our stock market in general, and the share prices of China's policy banks in particular, is actually a blessing in disguise!
I always remember the English idiom ‘the pot calling the kettle black’ because there’s a similar one in Chinese.
If corporate governance in Britain and the US were that good, the subprime mortgage crisis wouldn’t have occurred in 2008.
Just read P.34-35 of the book “Saving Capitalism From Short-Termism” by Alfred Rappaport and you’ll get the point:
(Corporate boards of) directors are largely to blame for the mess because “their sole responsibility is to act as fiduciaries for the shareholders in managing risk. They not only failed to perform this task but indeed, in their approval of outrageous pay plans with perverse incentives, they all but guaranteed the current disaster.”
Hong Kong’s ‘crony’ capitalists are expected to keep a longer-term view in running their businesses, not because they are saints, but because it is in their own interests to do so --- they’ll pass their businesses onto their children, their children’s children, and so on ad infinitum (hopefully).


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