Low Chee Keong FCIS FCS, Associate Professor in Corporate Law, CUHK Business School, provides a concise overview of three inter-related questions, namely, what is corporate governance, why is it important and where may it go from here.

Academic research suggests that there is a systematic difference between countries in terms of the legal protection accorded to minority shareholders with two distinct trends emerging. First, the least protection for investors is provided in countries in which companies have the highest ownership concentration. Secondly, expropriation of outside shareholders arises most significantly where a company is affiliated to a group of companies, all of which are controlled by the same shareholder.

This evidence suggests that the common law system provides more protection for investors as the transfer of assets and profits out of firms for the benefit of their controlling shareholders is more prevalent in civil law jurisdictions and is significant for two reasons, namely:

  1. the importance of the centrality of legal protection for minority shareholders, and
  2. the assertion that legal regulation can outperform private contracting.

In short, strong legal regulation and effective enforcement are critical to sound and effective corporate governance.

Does corporate governance matter in practice?

These findings have significant policy implications as good corporate governance practices contribute towards the overall well-being of a financial system, as witnessed from both the Asian financial crisis in 1997 as well as the global financial crisis in 2008. The former brought to the foreground the common occurrence of weak corporate governance that allowed companies to engage in excessive over-leverage, some of which were aided by implicit state guarantees; while the latter exposed significant shortcomings with the laissez-faire attitude towards deregulation in the financial services industry in the US. A common thread through these crises was that the concepts of transparency, disclosure and accountability were largely ignored as investors assumed short-term outlooks to derive increasing profits from the steadily rising financial markets.

In the lead up to the Asian financial crisis, companies across the region were guilty of neglecting the principles of good corporate governance, the difference being perhaps in the degree of neglect. This is evident from instances of corporate abuse through related-party transactions, incidence of capricious decision-making, shifting of assets within the corporate group, undertaking of transactions without proper disclosure and poor financial management by directors. The repeal of the Glass-Steagall Act of 1933 – which separated the commercial and investment banking activities of financial institutions – by the Gramm-Leach-Bliley Act in the US in 1999 is often viewed as a key contributor towards the global financial crisis. With the support of the then Federal Reserve Chairman Alan Greenspan, as well as the then Treasury Secretary Professor Lawrence Summers, this reform allowed banks to use their deposits to invest in derivatives. By doing so, it allowed the larger banks to deploy their resources towards the creation of increasingly sophisticated and complex derivatives which coincide with the growth of subprime mortgages as financial institutions sought to increase their rates of returns. When the housing bubble burst, it precipitated the banking crisis in 2007 which subsequently spread to Wall Street as by 2008 a number of the major banks – with their over-reaching tentacles into the financial markets – had become ‘too big to fail’.

Defining corporate governance

The term ‘corporate governance’ was succinctly defined in The Cadbury Report as ‘the system by which companies are directed and controlled’. ‘Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place,’ the Report stated.

Although somewhat simplistic, it highlights the importance of processes that companies should institute and implement to ensure that effective practices transcend the various levels of the organisation. These were viewed as necessary responses to what was then seen as the lack of managerial oversight which led to the spectacular corporate collapses of the Bank of Credit and Commerce International, Coloroll, the Polly Peck Group and Maxwell Communication Corporation in the late 1980s and early 1990s. These collapses did not only result in substantial financial losses to shareholders, employees, creditors, investors as well as the government – they were also seen as posing considerable challenges to the integrity and reputation of the City of London as an international financial centre.

Significantly, the Cadbury Report recommended that compliance should be based on a voluntary code of best practice – designed to achieve the necessary high standards of corporate behaviour – supplemented by appropriate levels of disclosure. It must be noted that the scope of the Cadbury Report was specifically to address issues arising from the financial aspects of corporate governance, and in the circumstances the committee opined that it would be most appropriate to adopt a principles-based ‘comply or explain’ approach. In a nutshell, companies were expected to comply with the core corporate governance principles identified in the voluntary Corporate Governance Code and if they do not comply, they needed to explain why not. The underlying aims of this approach was to ensure transparency as it was hoped that market forces and pressure from investors would ensure compliance rather than explaining non-compliance.

This principles-based self-regulatory approach rapidly gained favour across global capital markets. The idea of a voluntary code on corporate governance that focuses on structures, processes and practices has been actively promoted since the publication of the Cadbury Report in 1992 and the present UK Corporate Governance Code, which was published in September 2014, now sits at the forefront having being followed in almost every sophisticated corporate law system in the world.

Different models for corporate governance

The evolution of the ‘comply or explain’ model has continued over the years, assisted by the publication of the Principles of Corporate Governance by the Organisation for Economic Co-operation and Development (the OECD Principles) in 1999, providing a sound template upon which the various codes of corporate governance across jurisdictions could be harmonised. Recognising that good corporate governance is not an end in itself and in response to various developments in the financial markets, as well as with the global economy, the OECD Principles were updated and revised in 2004 and 2015 respectively.

While most countries have adopted the principles-based approach, it is not the only model as some jurisdictions such as the US practices a rules-based approach. The latter has enshrined its applicable standards of corporate governance in the Sarbanes-Oxley Act thereby making compliance mandatory. A key objective of passing this legislation was to restore public confidence in the markets following the scandals which surfaced from the collapse and subsequent bankruptcies of Enron, WorldCom, Adelphia, Tyco and Global Crossing in the preceding two years which resulted in billions of dollars in financial losses, as well as the loss of thousands of jobs.

However, the irony is that it was with this almost draconian legislation firmly in place when its shortcomings were glaringly exposed with the collapse of Lehman Brothers in the US, triggering the global financial crisis of 2008 with its well-known impact on the American and world economies. Another knee-jerk reaction followed with more draconian legislation passed in the form of the Dodd-Frank Act of 2010 as the black letter law approach, with its severe sanctions for contraventions of the rules, was perpetuated.

Did the self-regulatory and principles-based approach on the other side of the Atlantic fare any better? That is very hard to conclude as was crudely illustrated by the collapse of the Royal Bank of Scotland which necessitated the biggest bank bail-out ever by the British government.

So, what are the choices if any? Despite the differences in approach, both the principles-based as well as the rules-based models share a common objective, namely, to enhance the quality of the processes that support the practice of good corporate governance through lessons learnt from the corporate collapses from the late 1980s through to early 2002. However, is one model to be preferred over the other?

In his speech at the 2003 Washington Economic Policy Conference, William Donaldson, the then Chairman of the Securities and Exchange Commission, noted that ‘corporate scandals have exacerbated the roughly US$7 trillion collapse in the aggregate market value of US corporations over the past few years’ and opined that – ‘a “check the box” approach to good corporate governance will not inspire a true sense of ethical obligation. It could merely lead to an array of inhibiting, “politically correct” dictates. If this was the case, ultimately corporations would not strive to meet higher standards, they would only strain under new costs associated with fulfilling a mandated process that could produce little of the desired effect. They would lose the freedom to make innovative decisions that an ethically sound entrepreneurial culture requires.’

Donaldson goes on to recommend that board members should define the culture of ethics that they expect all aspects of the company to embrace, and that this must apply ‘to the very DNA of the corporate body itself – from top to bottom and from bottom to top’.

Just simply checking the box is not enough and it is trite that the foundations of good corporate governance must rest upon an effective system of checks and balances as highlighted succinctly by Monks and Minow in their book Corporate Governance. ‘In essence, corporate governance is the structure that is intended:

  1. to make sure that the right questions get asked, and
  2. that checks and balances are in place to make sure that the answers reflect what is best for the creation of long-term, sustainable, renewable value.’

With moral hazard appearing to increase on the part of investors, especially with government intervention following the global financial crisis, how do we effectively respond to the cultural and structural challenges that are raised above? How do we get corporate boards to move away from the ‘shareholder primacy’ model – where only profits matter as charity has no seat at the board – to one that encompasses a more diverse range of interests which include shareholders, employees, consumers, the community and the environment? Should we – and would it be too onerous – to impose upon boards of directors a duty to consider, and to implement, robust standards for good corporate social responsibility as a safeguard against reputational risks?

While voluntary compliance with good corporate governance practices based on the principle of ‘comply or explain’ has gained wide recognition as possibly one of the best and most comprehensive examples of ‘self-regulation’, questions have nonetheless arisen with respect to whether it is the most effective way of ensuring that corporations act responsibly. ‘Soft’ law is beneficial only where there is active compliance by business elites, diligent monitoring by capital market actors, and effective control by regulatory elites. On a critical analysis, have codes of corporate governance contributed significantly to improved corporate governance practices? If they have not, is it time – at least in certain areas – to rethink and re-evaluate the case for enhanced reliance on ‘hard law’ so as to provide clearer expectations to ensure compliance? In short, should corporate governance be by rule or by principle or indeed by some hybrid of the two?

What’s next?

Amongst the key causes of the global financial crisis are the failures of ethical and effective leadership of corporations, characteristics of which make them difficult to regulate let alone ponder over the impossibility of legislating on such issues. Principles of corporate governance need to be more carefully contextualised and diversified, especially in the transnational domain. Simultaneously,
the status of and relations between citizenship, states, transnational corporations and non-governmental organisations in a transnational regulatory domain needs much closer consideration. Only with these issues addressed can a more balanced and fruitful discussion of corporate governance mechanisms take place, especially when it comes to assessing the merits of ‘soft’ versus ‘hard’ law in a given political economy.

In the circumstances, despite the complexities, the appeal of the flexibility of Codes which encompasses both ‘soft’ and ‘hard’ law becomes increasingly evident. Guidance on this vexed issue may be obtained from the recently released King IV Report which lays emphasis on the outcomes that good governance should achieve – namely the exercise of ethical and effective leadership by the governing body towards the achievement of an ethical culture, good performance, effective control and legitimacy. King IV also moved from ‘apply or explain’ to ‘apply and explain’.

Taking cognisance of the paradigm shifts in the corporate world, the foundation stones upon which King IV are built include ethical leadership, the organisation in society, corporate citizenship, sustainable development, stakeholder inclusivity, integrated thinking and integrated reporting. The appeal of King IV lies substantially in its universal applicability stating as it does that ‘good leadership, which is underpinned by the principles of good governance, is equally valuable in all types of organisations’.


Codes of corporate governance have come a long way since the publication of the Cadbury Report about a quarter of a century ago. It must be remembered that the committee chaired by Sir Adrian Cadbury was tasked simply to deal with the financial aspects of corporate governance and that we have in the intervening period since then expanded considerably on the scope of such codes. On the other hand, the US adopts a ‘black letter law’ approach with a legislative framework setting out the requirements and resulting penalties for non-compliance. It is trite that there is no ‘one size fits all’ as regards ‘soft’ or ‘hard’ law since market development and maturity may differ across jurisdictions compounded by cultural and/or socio-economic considerations. Accordingly what may work well in one country may not necessarily produce similar results in another.

That said, what is clear is that there must be adherence to some basic common sensical practices which transcends national boundaries especially since there is a common denominator in the corporate governance debate namely that companies always involve the use of ‘other people’s money’ for which there is a legitimate right to expect that this will be applied responsibly by those empowered to do so. As the tentacles of the modern corporation reach further outwards so too must there be a commensurate level of corporate behaviour that meets the expectations of the various stakeholders which continue to evolve.

The practice of corporate governance – together with its associated codes as well as legislation – have evolved over the past 25 years during which time numerous corporate excesses have been witnessed, leading to the Asian financial crisis in 1997 as well as the global financial crisis in 2008. Although a number of fora has been set up to raise and discuss some of the issues, as well as to propose changes, it must be expressly recognised that, despite all best intentions, we must recognise the fragilities of humans which have invariably been the dominant or root cause of the crises that we have experienced to date.

Low Chee Keong FCIS FCS
Associate Professor in Corporate Law CUHK Business School

This article draws from and expands upon the chapter titled ‘Corporate Governance Codes Under the Spotlight’ in du Plessis JJ & Low CK (eds), Corporate Governance Codes for the 21st Century: International Perspectives and Critical Analyses, Springer (2017) available at: www.springer.com/gp/book/9783319518671.
The author can be reached at: cklow@cuhk.edu.hk.