DIRECTORS' pay is a test case for the ability of shareholders to influence what a listed company does. Hong Kong directors continue to pay themselves whatever they feel like irrespective of what is happening at the company. Take High Fashion International. For two years the clothes retailer, specialising in washable silk garments, has been losing money. For the year ending September 30, 1995, it lost $18.14 million, down from the $41.66 million loss the year before. Presumably the directors felt this performance warranted a pay rise. They upped directors emoluments by 42 per cent to $6.96 million. The average pay of the eight directors rose 24 per cent to $870,000 a year. The highest paid director saw his pay go from up to $2 million in 1994 to up to $4 million in 1995. This state of affairs is not unusual in Hong Kong. In the past shareholders have done sweet nothing about it. Where a bonus was repaid at Sincere in 1993, the repayment followed negotiations with the Hong Kong stock exchange. No . . . the shareholders at High Fashion will probably vote through the payments, in line with other shareholders at other companies where poor corporate performance is rewarded with big pay rises. City University lecturer in law Philip Lawton says this is not good enough. Directors' remuneration is part of a wider debate raising fundamental issues of how companies should be managed and who should oversee the top managers. The ability of directors to remunerate themselves excessively is a crucial test case against which the value of theoretical models and standards of corporate good behaviour devised by various schools of thought can be assessed. If Mr Lawton is right, and directors' pay is a test case of good behaviour, then Hong Kong fails badly. Without a proper check on directors' pay in Hong Kong, the possibilities for ripping off listed companies are enormous. At present, excessive behaviour to a large extent is being kept in check on a purely voluntary basis with the stock exchange doing its best to encourage probity among directors. This is a fragile state of affairs. Listed companies remain open to abuse when it comes to directors' pay. In law, the courts can look into a company's affairs even in the absence of proof of intent to defraud. In extreme cases it has been established that excessive remuneration may amount to an illegal return of capital, fraud on a minority and unfair prejudicial conduct. It can even be used to wind up a company. In all cases, however, the evidential burden of proving the excessive nature of the remuneration is problematic, Mr Lawton says. Problems linked to influencing the behaviour of company directors are not new and are not unique to Hong Kong. There is even a growing school of thought suggesting strong corporate leadership, that does not pander to minority shareholder interests, is good and makes for profitable companies. Too much shareholder power can lead to interference in the management of companies and clouded commercial decision-making. In other countries there are internal checks and balances that have built up. In North America and Britain there is a division between the board of directors and the professional, full-time executives, who run the day-to-day operations of a company and determine strategy in consultation with the board. Germany has developed a bi-cameral structure where there is a management board and a supervisory board which co-ordinate owner, management, shareholder, employee and bank relationships. In Japan there is a main board backed by strong group company cross-holdings. The International Capital Markets Group points out in Who Holds the Reins? that many directors are promoted from the ranks of the employees. In Hong Kong, unfortunately for minority shareholders and sometimes the companies themselves, there are no similar checks and balances. Hong Kong companies have adopted the British board structure but family, ownership and management are fused. Mr Lawton quotes from author S.G. Redding saying enshrined in the Hong Kong corporate regime is the idea that power cannot really exist unless it is connected to ownership. It also enshrines a distinct style of benevolently autocratic leadership along with personalised as opposed to neutral relations. Hong Kong's bid to encourage good corporate behaviour at present focuses on more disclosure, better accounting and auditing, the used of independent directors and codes of best practice. This might not be the right approach, Mr Lawton says. Unfortunately an alternative way forward is not clear either. In any case, some way must be found to put directors' power in check to avoid abuse of power at the top. This is important for the future credibility of Hong Kong as a financial centre. Progress has been made in the past five years in encouraging good behaviour by directors. There is, however, a growing number of mainland companies listed at the exchange. Some of these companies are still learning about the benefits of developing a strong partnership with outside shareholders. Without formal checks on the power of these new corporate fiefdoms, there is a danger Hong Kong stock market regulation will become an exercise in farce. The most obvious check to put in place first is the creation of a formal mechanism for shareholders to influence what a director gets paid.