The financial crisis that overran much of Asia in the late 1990s prompted most of the affected countries—joined later by India—to make improved corporate governance a priority. Nearly all of them now require listed companies to have independent directors and audit committees (Exhibit 1). Agreement is growing, at least in principle, on what good governance entails, and most countries in the region have adopted explicit governance codes (see "Why codes of governance work"). Securities laws and the listing requirements of stock exchanges have been strengthened, regulatory authorities have enhanced powers, and the media are more inquisitive and probing.

Yet progress is uneven. Across Asia, too many companies remain unconvinced of the value of good governance, and change faces real-world impediments and disincentives. Moreover, the institutions needed to ensure good governance—judicial systems, capital markets, long-term institutional investors that can push for better governance—continue to be underdeveloped in most of these countries. Laws and regulations aren’t enforced rigorously; well-trained accountants and other professionals are scarce.

The starting point for reform in Asia is therefore very different from the starting point in Europe or North America. Asian governments, corporate leaders, investors, and regulators realize that corporate-governance practices won’t change overnight, so patience is needed. Getting companies to comply with new rules is a daunting prospect requiring greater transparency and better enforcement, not to mention a cultural upheaval in boardrooms.

Is best practice best for the region?

New corporate-governance laws and codes are important because they set the stage for change. But given the vast differences in ownership structures, business practices, and enforcement capabilities, merely adopting new requirements en masse from North America or Western Europe would be a mistake. Nonetheless, the temptation to do so—promoted partly by investors, foreign-aid donors, and international organizations—afflicts the region as a whole.

Consider the question of requiring CEOs or CFOs to certify the financial reports of their companies. In much of Asia, directors and officers are already liable for fraudulent financial reporting, yet some of these countries are thinking about replicating the certification requirements under the US Sarbanes-Oxley Act. In addition to being redundant, they would be hard to enforce, since under Sarbanes-Oxley standards they would require proof that a CEO or a CFO had "willfully" violated them or knew that a financial statement was false. Such a subjective yardstick would be difficult to establish, particularly with underdeveloped judicial systems.

The requirement that boards include a majority of directors who are truly independent may also be unrealistic: it is essential to have some, but a majority often might not be feasible. The pool of qualified independent directors is small in many Asian countries. In those where noncompetition and confidentiality provisions in contracts are difficult to enforce, companies may well be reluctant to give any outside director too much insight into their performance or strategy for fear that this information will be used against them. And for the many Asian corporations that have a single majority owner, such a requirement might be unfair; even the NYSE and Nasdaq don’t have one (though both require these companies to have wholly independent audit committees).

Any Asian government should therefore rank the reforms in order of priority and tailor them to the country’s needs. Ensuring that local laws and codes are consistent with the OECD Principles of Corporate Governance, promulgated by the Organisation for Economic Cooperation and Development, would be a good start. Better to enforce basic reforms vigorously than to adopt requirements that go unheeded.

Improving transparency

Without greater transparency, new laws and governance codes will do little to build investor confidence. Notwithstanding recent reforms, accounting standards in many Asian jurisdictions remain weak. Not enough professionals have an in-depth understanding of local or international accounting standards. The accounting self-regulatory organizations are lax. As a result of all this, reported earnings, cash flows, and balance sheets can be quite unreliable.

Disclosure requirements and auditing practices are improving, however, as national financial-reporting standards are gradually being harmonized with international standards. China, Malaysia, the Philippines, Singapore, and Thailand, among others, now require quarterly reporting—though whether this will really enhance corporate governance if the underlying numbers remain shaky is an open question.¹

Just as important are the innovative solutions now emerging to tackle the region’s unique disclosure issues. In South Korea, for example, de facto control of a company may be based on its identification with a particular chaebol, or conglomerate, rather than on equity ownership. In addition to the more usual consolidated financial statements, South Korea thus now requires the largest conglomerates to issue "combined" statements including all companies under their control, regardless of whether they have a direct equity interest.

The independence of external auditors is being boosted as well. The China Securities Regulatory Commission (CSRC), for instance, now forces companies to rotate their senior external auditors every five years. Other places, including Hong Kong, India, and Thailand, are also exploring such a requirement. Soon, moreover, it will apply to banks in Singapore, where external auditors of public companies also can no longer provide certain nonaudit services (for instance, bookkeeping and internal auditing) to their existing audit clients.

Regulations with bite

Although most countries are strengthening their accounting standards and adopting minimum corporate-governance rules, many are lagging behind in enforcement (Exhibit 2). Part of the problem is that business and political circles are closely intertwined, and the mechanisms for managing conflicts of interest are underdeveloped. In addition, the desire of governments to promote short-term economic growth makes them less willing to go after large corporations to protect minority shareholders.

Some regulators lack strong investigative powers and political will. Taiwan’s Securities and Futures Commission, for example, has extremely limited powers to probe corporate transgressions and must largely rely for that purpose on prosecutors and on the national bureau of investigation, both of which have limited experience pursuing them. The Securities and Futures Commission of Hong Kong has been accused of failing to pursue cases involving large, influential companies. Thailand has seen several high-profile cases of corporate misconduct in which the party under investigation, despite strong evidence of culpability, eluded prosecution because law-enforcement authorities failed to act. Often, regulators don’t have large enough staffs or budgets to conduct rigorous investigations. And with legal systems still underdeveloped, prosecuting cases is difficult.

Most governments, however, are augmenting their resources to monitor companies² and enhancing the authority of their regulators, some of which are now getting tougher. In 2002, South Korea’s Securities and Futures Commission took the unprecedented step of punishing the local affiliate of a global accounting firm for negligence by reducing the number of companies it can serve as external auditor. In Hong Kong, regulators and the police are cooperating to combat financial crime. In China, the CSRC has shut down China Southern Securities, the country’s fifth-largest brokerage, in a continuing effort to improve corporate governance and stamp out improprieties.

A few places, including China, South Korea, Taiwan, and Thailand, have introduced or are contemplating the introduction of class action lawsuits or similar measures to empower investors—an important first step. But to achieve the intended objective of raising management’s accountability, it must become easier to bring lawsuits. At the top of the list of impediments are court-filing fees (which must be paid in advance) that are based on the amount of the claims, a backlog of cases, "loser pays" rules, limited access to the defendants’ records in noncriminal cases, and a shortage of judges with experience in business litigation.

The power of investors

In principle, investors and creditors could pressure companies to comply with new governance requirements (Exhibit 3). In practice, most of the region’s investors—domestic and foreign—are reluctant to get involved. They invest in a company if they believe that its growth prospects and risk premium outweigh all other factors and tend to sell their holdings rather than challenge management when governance problems arise. And as a Bank of Korea official recently lamented, local institutional investors largely bet on short-term price movements rather than long-term growth prospects.

Investors must become more vocal in support of reform and more willing to engage management. Improved financial reporting and broader disclosure will help. Also useful would be reforms making it easier for minority shareholders to vote by proxy, to nominate and elect directors, and to raise questions at annual meetings. In hopes of promoting participation by investors, China is thinking about allowing them to vote online on major proposals—to issue shares, for example.

Meanwhile, some investors actually are doing their bit to improve corporate governance. A number of local Thai funds, asset-management firms, and life insurance companies that collectively manage $23 billion in assets, for instance, have formed the Institutional Investor Alliance to promote better corporate governance in Thailand. The Securities Investors Association of Singapore works with companies to nominate independent directors and hopes to collaborate with fund managers to improve corporate governance in the companies in which they invest.

Creditors too are playing a role: Kookmin Bank, in South Korea, now rewards midsize corporate borrowers with lower interest rates for meeting specified governance standards. Moreover, the region’s media are becoming noticeably more willing to probe management practices. In China, for instance, unprecedented exposés of corporate malfeasance in the financial magazine Caijing have earned it widespread praise. Malaysia’s business weekly The Edge regularly features corporate-governance issues and warns its readers about questionable conduct in local companies.

Embracing change

Since corporate governance is a new concept in most parts of Asia, raising awareness is a vital element of any reform effort. Many directors, for example, are unaware of their fiduciary obligations and view their directorships as sinecures, without real responsibility, so the institutes of directors in Hong Kong, Singapore, South Korea, and Thailand now offer seminars and training programs for directors and officers. Region-wide organizations, such as the Asian Corporate Governance Association, have been formed to promote understanding and reform. What’s more, several regional groups, including CLSA³ Emerging Markets (a regional brokerage firm), Thai Rating and Information Services, and India’s ICRA,⁴ publicly rate the governance practices of listed companies.

Some Asian companies themselves have heartily embraced reform. India’s Infosys Technologies discloses the extent of its compliance with ten corporate-governance codes, reconciles its financial statements with eight accounting standards (including the US and UK generally accepted accounting principles), and has a board with a majority of independent directors as well as wholly independent audit, nominations, and compensation committees. Exemplary companies can also be found in other parts of Asia. CLP⁵ (Hong Kong), POSCO (South Korea), Public Bank (Malaysia), Siam Cement (Thailand), and Singapore Telecommunications (Singapore), to name a few, have been recognized by publications and organizations for their good corporate-governance practices.

More common, however, are companies that have in place basic governancestructures—such as boards of reasonable size, with some independent directors—but lag behind in their actual board governance. Many boards that look good on paper follow the letter rather than the spirit of reform: they have yet to fully embrace such duties as looking after minority shareholders, providing rigorous management oversight, and holding a two-way dialogue with investors. To move to the next level, these boards must behave very differently by asking management tough questions, actively helping to set corporate strategy, monitoring risk management, contributing to CEO succession plans, and ensuring that companies set and meet their financial and operating-performance targets. The new forms of behavior will undoubtedly take time to become ingrained. Some companies, hoping to speed up the process, have recruited experienced foreign directors to help overhaul board practices.⁶

Corporate governance has undoubtedly improved in Asia. Some countries—Singapore in particular—have made significant progress. The next step is to instill the new behavior, and that will take time. Many corporate leaders, investors, and regulators in Asia articulate the benefits of more effective corporate governance. But they understand that enduring reform won’t be achieved overnight and that, in the short term, many practical impediments and disincentives block the necessary changes.

To move ahead, both governments and companies in Asia must do their part. Companies should create stronger and more purposeful boards; enhance the scope, accuracy, and timeliness of financial reporting; and pay more regard to the rights and interests of minority shareholders. Governments should provide a strong legal and regulatory framework to underpin the reforms. While specific provisions will differ from one country to the next, any reform effort must include elements such as robust corporate and securities laws, tough accounting standards, strong regulators, efficient judicial systems, and determined efforts to clamp down on corruption. Without sustained progress in these foundations of corporate governance, any improvement at individual companies will fall far short of its potential.