Introduction
Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation is directed, administered or controlled. It also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. Good corporate governance (GCG) is a mandatory requirement in today's complex and dynamic business environment to ensure equity and transparency to every stakeholder and enhance the required values to different stakeholder groups. GCG is, however, not only relevant to sizable or listed companies but covers all sizes of businesses. Corporations that demonstrate a commitment to high standards of corporate governance will benefit from the availability and lower cost of capital; improved competitiveness and financial performance; and truly sustainable long-term growth. The proliferation of scandals and crises arising from poor corporate governance strengthen strong demand of GCG to ensure long-term sustainability of corporations. So, GCG should be cultivated and practiced regularly within the current structure of the business.
Implications for Corporate Governance Regulation
Corporate governance has been seen at the forefront of establishing standards of corporate ethics aimed at reducing unscrupulous corporate practices while preserving a fair business environment. Equally important, GCG instills the core values of transparency, fairness, accountability, and responsibility. Corporations may devise their own codes on corporate governance practices on the terms as they may consider appropriate. Proper governance programs must educate corporate directors in fundamental corporate governance principles; educate shareholders on their rights and responsibilities; and raise public awareness of the need for effective corporate governance practices. Moreover, GCG practices reinforce investors' confidence by building transparency and trust through greater disclosure and better accountability and responsibility thereby bringing in stability and growth of corporation. Thus, investors are demanding better financial reporting and greater transparency and also demanding more GCG practices. GCG is a way towards healthy and sustainable business growth, adapting to good practices in governance can ensure responsible and accountable leadership and management are in place to further drive the business forward on quality and reputation.
Hong Kong Regulatory Environment
Fundamental corporate governance in Hong Kong is currently governed by laws and regulations - listed companies regulated by Securities and Futures Commission (SFC) and Hong Kong Exchanges and Clearing Ltd (HKEx) and core legal rules contained in the Companies Ordinance. The regulatory framework of corporate governance includes both statutory and non-statutory requirements:
- Statutory provisions - the Companies Ordinance, Securities Ordinance (Insider Dealing), Future Ordinance (Disclosure of Interest) and Takeover Codes; and
- Non-statutory regulations - those provisions specified under the Listing Rules covering the composition of the board, the number of independent nonexecutive directors, disclosures of connected transactions, and disclosures of the different components of directors' remuneration.
NB: Rule 3.25 of Main Board Listing Rules and Rule 5.34 of Growth Enterprise Market Listing Rules in which a corporate governance report must be included in the annual and interim financial report by the boards. Companies are required to apply the principles and adhere to the code provisions in the Code on Corporate Governance Practices (the "CG Code") set out in Appendix 14 to the Rules Governing the Listing of Securities on the Hong Kong Stock Exchange as amended from time to time (the "Listing Rules").
Developing Corporate Governance Framework
In any establishment, GCG starts with the owners and percolates down through the board and different management levels to the employees. No matter what the ownership is, there is a need for transparency and accountability in its relationship with other stakeholders. In this context, all rules that define the governance responsibilities, incentives and sanctions facing the board, management and staff must be well articulated. Board members must be held accountable and liable for their decisions and actions that have impact on the interests of other stakeholders.
The guiding principles of corporate governance are threefold:
- Transparency;
- Accountability; and
- Corporate control.
Figure 1: Corporate Governance Framework
Corporate governance concerns the control of a corporation, vested in the board of directors who play a crucial coordinating role to balance the interests of various stakeholders (both internal and external) and achieve sustainable profits. Therefore, corporate governance may consist of relational as well as structural system of management control, improving the governance process.
In general, corporate governance highlights the important principles of oversight and control over the executive management's performance and strategic directions; and their accountability to the shareholders. A code of ethics, which clarifies and stipulates adherence to some of more abstract ideals of trust and accountability, is essential for GCG. Effective codes of ethics might spell out who must adhere to the rules, division of power between management and its board of directors, etc.
Transparency is one of the key steps to corporate governance. A key element of 'good' governance is "transparency" (projected through a code of governance), which incorporates a system of checks and balances among the board of directors, senior level management, auditors and other stakeholders. All in all, disclosure and transparency enhance the control and behavior that support effective accountability for performance outcomes. An entity is more likely to achieve better result when corporate governance practices of disclosure and transparency are given prominence within the organization. Conversely, firms with poor corporate governance strategies are more likely to underperform in the long term.
Mechanisms and Controls
Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and managers' opportunistic behavior. Corporate governance plays a significant role for many corporations as it spells out governance rules and guidelines which could assist all parties to know how to manage the corporation. GCG practices should assist and encourage their governing boards, councils and management to establish and maintain a clear focus on performance, transparency and accountability. Moreover, GCG leads to improved internal control systems which result in more accountability. As a result, internal conflicts would be better managed and more attention given to achieve the corporation's growth objectives and support profitability.
Rigorous corporate governance should include proper supervision over the management. Management control is that critical aspect for maximizing corporation effectiveness, as it helps obtain results in line with expectations of the shareholders. The highest management level in the corporation is the board, where the directors have to "run the show". But in reality it is often the management which runs the show. A fair control of these management members by the board (see Table 1 below) is therefore one of the essential aspects of corporate governance.
| Table 1: Internal Governance Controls Mechanisms Ownership Concentration
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Important focus should be given on balancing power of the board and the management. Board independence from management continues to be affected by directors who have limited accountability to shareholders, and are ill-equipped in exercising management oversight. It is important to have directors in the board who have the necessary expertise and experience to contribute effectively to management oversight.
A board should not only run the daily affairs of the company, but it must have a good knowledge of the sector of the company's strategic position and competitive edge in order to appraise its operations and decisions. A competent, informed board supports the chief executive in defining the strategic direction. Thus, corporate governance tends to strive for a decent, fair and reliable direction: "to do the right (good) things and to do things right (well) and achieves quality of governance. All in all, the aim of corporate governance is to give management sufficient latitude to use its expertise whilst ensuring it recognizes its responsibility to the owners.
Guiding Principles of Good Corporate Governance
Corporate governance has attracted considerable attention over the past decades, leading to recommended codes of practice, conceptual models, and empirical studies. A growing number of empirical studies have demonstrated that GCG contributes to better investor protection, lower costs of capital, reduced earnings manipulations, increased company market value, improved stock returns, and even economic growth. In essence, GCG practice is about achieving the stakeholders' goal and delivering success in an ethical way. Thus, it must entail a holistic application of best management practice.
It is important to take a wide perspective when considering GCG because we cannot emphasize that common management practices, as described below, will ensure GCG. On the other hand, the proper implementation of GCG does not necessarily guarantee success of the corporation. Moreover, a bad corporate governance practice is certainly a common syndrome causing failure in many corporations.
Composition of the Board
Corporate power is vested in the hands of the board of directors and senior management who are appointed by the shareholders to act in a way so as to maximize shareholders' value. The board should be made up of directors who have the necessary knowledge, judgment and experience to perform their tasks effectively. Moreover, the composition of the board constitutes a key issue of corporate governance in many enterprises for the purpose of accountability. In Hong Kong, the Chairman of the board is commonly the Chief Executive Officer (CEO) of the company, which means that the incumbent becomes accountable to himself/herself. This will create the potential issue of abuse of power by the Chairman and CEO and also issues in effective corporate governance since accountability forms a critical part of regulations for corporations. Thus, the positions of the Chairman and the CEO should be held by different persons. An effective board should consist of executive directors and a number of independent non-executive directors who contribute special expertise to the company. The independent board majority is a key mechanism to fulfill its objective oversight role and holds management accountable to shareholders.
Cultivation of Corporate Culture
As corporations grow in size and increase in complexity, implementing GCG becomes increasingly difficult and important. In managing change for growth, corporations need to cultivate a new corporate culture in support of reforms and innovations. The core values of transparency and accountability would be embedded in their corporate culture should corporate governance be applied. This culture of transparency and accountability would also indicate professional management and GCG is a key foundation for successful and well organized corporations. However, many entrepreneurs still manage their businesses with traditional modes of operation and are not ready for change. Some entrepreneurs lack a good understanding of the concept of corporate governance and therefore fail to apply modern management skills and introduce timely reforms to their mode of governance. As the new governance culture is likely to be incompatible with the existing culture, it is impossible for changes to take place overnight. Nor can it expect the changes to occur naturally. Instead, the changes must be top down, complemented with appropriate training and support with a view to building a new corporate culture to reform the corporate governance in order to meet the challenges of the corporation.
Integrity of Financial Reporting
Accounting can play a vital role for ensuring and continuing with GCG. As accounting is an important discipline and the practice of accounting is harmonized and aligned with the varied needs of stakeholders, it can be used as a tool for ensuring and enhancing GCG within a corporation. Management is responsible for the integrity of the corporation's financial reporting system. It is management's responsibility to put in place and supervise the financial reporting system that allows the corporation to produce financial statements that fairly present the corporation's financial position and thus allow investors to understand the business and financial risk of the corporation. Since corporate governance is a significant component of equity risk, it must be measured and taken into consideration by the investors. A corporation should have effective internal control systems ensuing that the corporation's books and records are accurate, that its assets are safeguarded and that it complies with applicable laws.
Conclusion
In Hong Kong, the issue of GCG is an imperative for ensuing successful corporate performance. The corporate governance principles of the corporation emphasize an effective board, prudent internal control, transparency and accountability to its shareholders. A high standard of GCG practices and procedures are essential for effective management to enhancing shareholders' value. Building GCG is a shared responsibility among all stakeholders, each of whom may exert pressure to move forward a corporation. It is reasonable to expect that managers of the modern corporations must satisfy a larger range of stakeholders than shareholders alone and accept the need for strong corporate governance. It is strongly believed that corporations that exercise GCG will deliver good returns for their shareholders over the long term. The use of corporate governance as a management technique is crucial to its long term sustainability.
About the Author
Dr Fung is currently Senior Lecturer of Caritas Francis Hsu College teaching Accounting and Corporate Management courses. Dr Fung has over 20 years' working experience in corporate banking and has expertise in corporate governance, internal control and risk management.
Email: wmfung2010@gmail.com