Diversity of Shareholder Stewardship in Asia: Faux Convergence

Gen Goto is Professor of Law at the University of Tokyo; Alan K. Koh is Assistant Professor of Law at Nanyang Business School; and Dan W. Puchniak is Associate Professor at the National University of Singapore Faculty of Law. This post is based on their recent paper, forthcoming in the Vanderbilt Journal of Transnational Law. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here) and Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here).

In 2010, when the United Kingdom enacted the world’s first stewardship code (UK Code), the impetus behind it was clear. Institutional investors had come to hold a substantial majority of the shares in UK listed companies. However, most institutional investors lacked the incentive to use their shareholder power to monitor management. In turn, they were branded as “rationally passive” shareholders. As the theory goes, when left unmonitored by institutional investors who collectively controlled the UK’s shareholder float, the management of UK listed companies engaged in excessive risk-taking and short-termism behaviors which were identified as significant contributors to the 2008 Global Financial Crisis (GFC). Thus, the original objective, or intended function, of the UK Code was to motivate institutional investors to become responsible and engaged shareholders. Specifically, its aim was to incentivize them, through the use of soft law, to act as “good stewards” by exercising their control over listed companies through their collective voting rights. The ultimate goal was to mitigate the excessive risk-taking and short-termism by corporate management that might have otherwise led to another financial crisis.

Since the adoption of the UK Code in 2010, stewardship codes and similar initiatives have proliferated throughout Asia. Asia’s largest developed economy (Japan), Asia’s tiger economies (Hong Kong, Singapore, South Korea, and Taiwan), and two of Asia’s most important high-growth economies (Malaysia and Thailand) have all adopted stewardship codes. Asia’s largest economy (China) recently inserted provisions into its revised corporate governance code to promote shareholder stewardship among institutional investors. In addition, several of Asia’s most important developing economies (including India and the Philippines) have placed the creation of a stewardship code on their corporate governance agendas.

Given the UK Code’s prominence, it is tempting to assume that the stewardship codes in Asia perform the same function as the UK Code. This assumption belies the truth: all these codes—regardless of whether they have in fact drawn inspiration from the UK Code—have taken different trajectories due to each adopting jurisdiction’s distinctive institutional and legal context.

Using empirical evidence and in-depth case studies of stewardship in Japan and Singapore, our forthcoming paper in the Vanderbilt Journal of Transnational Law—Diversity of Shareholder Stewardship in Asia: Faux Convergence—reveals how any reception of UK-style stewardship concepts is only skin-deep. Even where the text of stewardship codes in Asia resemble the UK Code in form, their functional impact on corporate governance significantly depart from, or even run counter to, the intended functions of the UK Code. As explained in our paper, the Japanese government adopted a stewardship code with the aim of reforming its traditional lifetime employee and stakeholder-oriented, risk-averse governance system towards a more shareholder-oriented, profit maximizing, and less risk-averse governance system. In Singapore, its stewardship codes appear to be designed to entrench its successful state-controlled and family-controlled system of corporate governance. These functions would have been beyond the contemplation of the original drafters of the UK Code.

The fact that stewardship fulfills different functions in Asia than in the UK should not surprise. Throughout most of Asia controlling shareholders—often families, the state, or other affiliated or group corporations—have actual or de facto control over the corporate governance of most listed companies through their voting rights. Asia’s corporate controllers are similar to the UK’s institutional investors in that they control the shareholder float in virtually all listed companies in their jurisdictions. However, the nature of Asia’s corporate controllers is diametrically opposed to the UK’s institutional investors with respect to the feature most relevant to shareholder stewardship: Asia’s corporate controllers are “rationally engaged” shareholders whereas the UK’s institutional investors are “rationally passive”. From this perspective, Asia does not lack “shareholder stewards” whereas the UK does. A related important observation is that although institutional investor ownership has been on the rise in most Asian jurisdictions, family and state controlling shareholders continue to dominate public listed companies generally. Accordingly, in most jurisdictions in Asia institutional investors do not have the ability to control—or, perhaps more importantly, to threaten to force a change in control—in most listed companies.

From an agency cost perspective, it is also well recognized that in most Asian jurisdictions the primary corporate governance problem is not the lack of engagement or managerial monitoring by those who control the shareholder float. Rather, the problem is that the controlling shareholder is engaged and monitors management for his own interests, and not necessarily as a “good steward” for the benefit of minority shareholders, the environment, or society. Consequently, the problems that spawned the UK Code (i.e., excessive risk taking and short-termism by unmonitored management) and the solution provided by the UK Code (i.e., to incentivize institutional investors to collectively make use of their control over the shareholder float) are both largely absent in Asia. Instead, entrenched management backed by controlling or affiliated shareholders is the norm, and institutional shareholders (whether passive or active) most often lack the voting power to seize control.

This makes the purported meteoric rise of stewardship codes in Asia puzzling. Why has a UK corporate governance mechanism—notwithstanding that it was designed for a problem that largely does not exist in Asia, and which provides for a solution that is largely unavailable in Asia—been implemented throughout Asia? The short answer is that stewardship codes in Asia have been used as a convenient vehicle for local governments and/or market players to achieve their own particular interests through an inexpensive, non-binding, and malleable tool, the formal adoption of which sends a signal of “good corporate governance” to the rest of the world. While such practices explain and contextualize the widespread adoption of stewardship codes in Asia, they also compound the challenge of drawing positive or normative conclusions from this development. This observation is important as leading corporate governance scholars, prominent international organizations, and market participants alike have appeared content to draw such conclusions unaware that stewardship codes generally do not fulfill a similar function to the UK Code in Asia.

Our paper concludes by explaining how adopting globally recognized mechanisms of “good corporate governance” at a superficial formal level, and then altering their function to serve local purposes, appears to be a rising trend in corporate governance in Asia (and, we suspect, elsewhere, too). This phenomenon, which we coin “faux convergence”, calls for the re-examination of important and impactful theories about corporate governance convergence. As an initial foray, this paper develops an expanded taxonomy of corporate governance convergence and lays the foundation for future research on “faux convergence”.

The research for this paper forms part of the broader, and comparative EGCI-supported Global Shareholder Stewardship Project led by Dionysia Katelouzou and supported by Dan W. Puchniak. For further work on stewardship on Japan and Singapore, see respectively the article by Gen Goto and the forthcoming paper by Dan Puchniak and Samantha Tang.

The complete paper is available here.

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