By Michael Backman

The Asian economic crisis was not caused by George Soros, conspiratorial international bankers and not even by the CIA as some in Asia have claimed, but rather the Asian crisis was caused by Asia.

Many Asian currencies were linked to the US dollar which brought them some measure of stability.  But the link also meant that a group of economies with some of the worst records on the rule of law and corporate governance in the world had the value of their currencies determined by that of the US – an economy that performs strongly on the rule of law and corporate governance. 

This mismatch meant that Asia’s currencies became overvalued relative to the underlying value of their assets – assets that became increasingly marred by corruption, cronyism and poor corporate governance. 

Unless there are significant improvements in the rule of law and corporate governance in Asia then there is little reason why the Asian economic crisis will not happen again.  Certainly, several of Asia’s stock markets have doubled in price from the lows of last year.  The money that has gone in during the last few months is as hot as ever and could easily leave as quickly as it did in 1997, thus triggering another crisis.

Many of the constraints on companies to ensure that they do the right thing work poorly in Asia.  Regulation, the threat of bankruptcy, minority shareholder rights, and the threat of exposure in the media, are all of a low standard in much of Asia.

Regulation

The two main problems with regulation in Asia are:
1. poorly drafted laws; and 
2. bribery and corruption

The first feeds into the other.  Vague laws that allow bureaucrats to exercise a fair degree of discretion inevitably lead to corruption particularly if they are poorly paid.

It is not the Soeharto-level corruption that is so damaging to an economy but more petty bribery on the part of lower level bureaucrats that render practically any law inoperable.

This applies as much to bribing environmental protection agencies to say that environmental laws have been adhered to, to bribing labour regulation bodies to say that worker protection laws have been complied with, to bribing the finance ministry to say that all taxes have been paid.  Also, in those countries where there is a high degree of public ownership of power, water and other utilities such as in Indonesia, China and Thailand, bribes routinely are paid to the staff of these utilities to have power and water rates artificially reduced.
 
 

Another important area rendered practically useless by corruption in many Asian countries is the judiciary.  Take Indonesia for example.  The average judge in a first instance court in Indonesia is paid around US$200 per month.  Now, it should be fairly obvious that if you pay a judge as little as that, you don’t end up with a court case – you end up with an auction.

In 1997, a retiring judge in Indonesia’s Supreme Court claimed that half of Indonesia’s judges were corrupt.  It was an extraordinary admission but it was publicly disputed by the then chairman of the Indonesian Barristers Association who claimed the actual figure was more like 90%.

And it is not just judges who are bribed but everyone associated with the courts including the court clerks who have the power to schedule cases, or with sufficient incentive, not to schedule cases.

Paying civil servants decently I believe is the most fundamental reform that Asia needs to make.  But unfortunately, some Asian governments went the other way in response to the Asian economic crisis.  Korea, for example, announced an across the board cut in salaries for its government workers of 20%.
 

It is not just South-East Asia that is corrupt or has inadequate judicial systems.  Corruption in Japan has at times reached extraordinary levels particularly in the construction and infrastructure sectors.  The LDP faction associated with former Prime Minister Tanaka routinely took a 3% commission on all major infrastructure projects throughout the 1980s.  Tanaka himself also ably demonstrated the inadequacy of the Japanese court system.  He was charged in 1976 for taking bribes from the American Lockheed Corporation, but he still had not exhausted the appeals process by the time he died in 1993 – some 18 years after he was first charged.  Japan’s courts may not be corrupt but they can move with the speed of a glacier.

In many respects, Japan has first world wealth but it has been built on a third world framework of law and corporate governance.  Hence the country’s economic slowdown now.

Another aspect of business in Asia is nepotism and favour giving.  Again, the worst example of this is to be found in Indonesia, where my research for Asian Eclipse found no less than 66 major American, Australian, European, Japanese and Korean companies that set up joint ventures with the Soeharto family.  Many of the shares held by the Soehartos were in the form of a ‘carried interest’, whereby equity in joint ventures was given to the Soehartos as a loan with their share of the profits being kept back by the foreign partner to repay that loan.  In reality, these were just deals to get around the US Foreign Corrupt Practices Act.

And of course it is not just the Soeharto family that had to be cut in on many major joint ventures.  So too were and are the families of cabinet ministers, senior civil servants and senior military figures as well as the pension funds attached to these various sources of influence.

Another threat to the rule of law in Asia is the lack of separation between business and government.  Typically regulators are stakeholders in the regulated.  Nowhere is this more apparent than in China, where the commercial arms of many Chinese ministries still own companies that operate in the sectors in which the parent ministry is the regulator.  China’s key airline regulator, for example, also happens to have awarded its business arm monopoly rights over the importing and retailing of computerised reservation systems which it then forced each airline to buy.

In Thailand, the Board of Investment is responsible for doling out huge tax holidays and other concessions to local companies notwithstanding the fact that even the Board’s secretary general and other senior staff sit as directors on the boards of companies that receive the benefits.  This lack of separation between business and government is common across Asia.

Of course, in Asia these sorts of practices are thought of as part of a consensual approach - part of the ‘Asian’ way - but the trouble is they also represent clear conflicts of interest – conflicts that inevitably lead to poor checks and balances and poor accountability, the very things needed to build strong economies be they Asian or not.

Bankruptcy

The Asian economic crisis has not been accompanied by the flood of assets onto the marketplace for cashed-up Western investors to buy that many had expected.  Why not?  Largely because of the inadequacy of bankruptcy procedures.  But the problem is not so much due to inadequately drafted laws, but more with their enforcement.

Indonesia’s banking laws were very similar to those of Holland that successfully saw the Dutch companies DAF Trucks and Fokker wound up.  But in Indonesia in the 10 years to 1994, there were just 13 bankruptcies in the entire country and then only four of these were in relation to companies.  By way of contrast, there were almost 300 company bankruptcies last year alone in Singapore and here in Australia we’ve been averaging around 200 a month.  Why the disparity?  It has a lot to do with enforcement of the law rather than the law itself, and as usual the problem is the bribery of court officials.

Bankruptcies need to be seen as a positive sign of an economy’s prospects rather than as an overt negative.  Bankruptcies are key to removing capital and assets from the hands of poor managers and allocating them to those with better managerial capabilities.  But in many parts of Asia this just doesn’t happen.  Today, South-East Asia is full of business families who can’t or won’t pay perhaps 70% of their debts but who still have full control of their companies.  Capital is thus inefficiently allocated from Japan to Indonesia and Asian economic growth rates over the next decade or so will suffer accordingly.
 

Minority Shareholder Rights

Practically all companies listed on stock exchanges in Hong Kong, China, and South-East Asia are controlled by a majority shareholder, and certainly in Hong Kong and SE Asia, that shareholder is typically an ethnic Chinese business family.

In Asia, listing on a stock market is designed to achieve one of three things:
1. to get rid of the company because it is no longer so profitable; or
2. to float a small part of the company so that the majority owner can achieve a market valuation for its entire stock and then use it as collateral for a bank loan; or
3. to bring in other shareholders in a minority capacity who can then be regularly fleeced with rights issues to raise cash - cash which is then often spirited from the company to the majority shareholders’ other interests via unfavourable related-party transactions

Clearly, none of these reasons is about benefiting minority shareholders.  Accordingly, activism on the part of minority shareholders is curbed in many ways.  Many of Asia’s stock markets now have rules that require that major transactions between a company and its majority shareholders be approved by the minority shareholders.  But what many majority shareholders do is hold stock in nominee arrangements to give them the appearance of being minority shareholders so that they can vote in ballots reserved for minorities.

Another trick is to coordinate annual general meetings so that as many as possible are held on the same day thereby limiting the number of meetings that investors who hold stock in several or more companies can attend.  The practice in Japan has reached absurd lengths.  In 1996, more than 94% of all the companies that closed their books in March of that year (there were 1,864 such listed companies) held their annual general meetings (AGMs) on just one day – the 27th June.  Not only that but the average length of an AGM on that day was just 26 minutes.

Media

Another constraint on business that is largely ineffective in much of Asia, is what I like to call the ‘Sixty Minutes’ effect, whereby companies in say America or Australia choose not to behave improperly or unethically if for no other reason than for fear of finding themselves exposed on television on a Sunday night.

The same risk of exposure via the media is not present for many companies in Asia simply because many belong to diversified conglomerates that include the media outlets that would otherwise expose them.

Clearly, a business newspaper or television station that belongs to the same conglomerate as a bank will not expose fraud or corruption at that bank with quite the same vigour if there was no such relationship.

Serious though these sorts of conflicts of interest are, an even bigger problem is that journalists in many Asian countries are simply so poorly paid that they readily accept bribes from companies not to write stories that might cause them embarrassment.  This is a huge problem in Thailand, Indonesia and China. 

It is said that in those countries some journalists actually make more money by not writing than by actually writing.  It also means that the business media in those countries cannot be relied upon to accurately report what is really happening in the local corporate sector. 

Banking

Asia’s banks are another area that must be reformed.  Too many banks are part of diversified conglomerates and have indulged in improper and usually illegal lending to affiliated companies.  And as usual, banking supervision has been subverted by the banks bribing their relevant supervisory central bank to look the other way.  Also, in Korea and China, lending has been at the direction of government and with little regard for appropriate risk analysis.  Accordingly, there is little reason why banks across Asia are now so best with non-performing loans.

In Summary

The rule of law and corporate governance are and will remain enormous issues for Asia for a long time to come.  They have yet to be resolved satisfactorily.  Capital is shifting back to Asia and giving positive reinforcement for insufficient reform.

The highlighting of corporate Asia’s problems as has been done in Asian Eclipse is designed to help both people in Asia as much as it is to inform those outside the region.  Before a problem must be fixed it must first be defined and this is what Asian Eclipse does.  The process may not always be flattering, particularly for those versed in traditional Asian culture, which is not always welcoming of criticism.  But at the end of the day, poor corporate practice in Asia has led to severe economic recession, job losses and wealth destruction not for Westerners especially, but for people in Asia.  The main beneficiaries of better corporate practice in Asia – a move away from traditional ways of doing things and towards more open and modern cooperate practice – will be Asia and the people who live there.

Asian Eclipse: Exposing the Dark Side of Business in Asia by Michael Backman is available from (or can be ordered from) leading bookshops, worldwide.