The winning paper of the Institute's Corporate Governance Paper Competition 2016 argues in favour of an inclusive stakeholder approach to corporate governance.

This submission advocates an inclusive stakeholder model for the implementation of better corporate governance. In particular, it departs from the traditional emphasis on the key internal stakeholders of a corporation. A step-by-step approach is adopted here to highlight the interdependence of our five-stage inclusive stakeholder model of corporate governance. This submission aims to unite all the internal and external stakeholders to shoulder their share of responsibility and to contribute to better corporate governance through collective action.

Defining corporate governance

It is central to our submission that the ideal state of corporate governance should be inclusive of all stakeholders. In this submission, corporate governance is defined as the relationship between the internal and external stakeholders that have influence on the operations of a corporation. The definition stated here is modified in three ways. Firstly, external non-shareholding stakeholders, such as market intermediaries and regulators, are included. Secondly, more internal stakeholders, such as management and staff, are included. Thirdly, a new arena, other than the regulatory and market spheres, should be constructed to bring together the forces of activist bodies, media and the community at large. Having adopted an inclusive stakeholder model, what are the model's implications for corporate governance? The first implication is that different stakeholders may hold varied opinions on the meaning of corporate governance. Although corporate governance as a process seeks to involve all stakeholders, corporate governance as a standard consists of universal values. The World Bank has defined corporate governance succinctly as generating 'long-term economic value for its shareholders, while respecting the interest of stakeholders and society as a whole'. As a result, achieving better corporate governance is about striking a sustainable balance between stakeholders and should not be compromised by any individual powerful stakeholder. Another implication is that corporate governance is more than corporate regulation. There is often a gap between regulatory standards and recommended practices for achieving good corporate governance – in particular, the ideals of corporate social responsibility and ethical governance cannot be provided for by legislation. What are the universal values encapsulated by the notion of corporate governance? The Organisation for Economic Co-operation and Development's (OECD) Principles of Corporate Governance 2004 identify transparency, accountability, fairness and responsibility as the four pillars of corporate governance. The OECD Principles also determine that the four pillars translate into the following elements – the rights and the equitable treatment of shareholders; timely and accurate disclosure of material matters; accountability; and the effective oversight of the board of directors. While there is wide agreement on these four pillars, there is still disagreement as to the means of implementing corporate governance through internal and external forces. This submission adopts a more inclusive approach as opposed to the traditional focus on primary stakeholders. Moreover, we suggest that the way forward is to broaden the concept of corporate governance to achieve corporate social responsibility and ethical governance through corporate governance.

The importance of corporate governance to different stakeholders

The inclusive stakeholder model we propose only makes sense if sound corporate governance brings value to all stakeholders or, alternatively, feasible incentives can be created. In this section we evaluate the value of corporate governance to internal stakeholders, shareholders, non-shareholding external stakeholders, and the community at large.

Internal stakeholders

Internal stakeholders, including directors, managers, company secretaries and employees, benefit from the improved business reputation and firm performance that results from good corporate governance. Most studies suggest a positive correlation between stock returns and the state of corporate governance in a company. Moreover, good governance provides a company with access to lower capital costs.

External stakeholders

For non-shareholding stakeholders such as creditors and suppliers, the compliance with good corporate governance practices gives a reliable indicator of the risk of default. As a result, these stakeholders value sound governance as they know that this helps to reduce due diligence costs and builds up business confidence. Good corporate governance also appeals to institutional investors. They place strong emphasis on governance indicators and companies with better governance standards often have a higher proportion of foreign ownership. This in turn relates to the value of corporate governance to Hong Kong as an international financial centre. To maintain Hong Kong's status as an IPO centre, the government should focus on the quality and not the quantity of listings. The policy direction should concentrate on attracting high-quality investors by elevating the benchmarks of corporate governance rather than watering down compliance standards to expand the market.

Core problems in Hong Kong

The existing problems of corporate governance in Hong Kong can be summarised as follows.

• imbalance of shareholding structure – concentration in shareholding, lack of minority shareholder protection and low shareholder activism
• loopholes and the obstacles in the legal/regulatory framework – particularly with regard to predominance of Hong Kong-listed companies with an overseas domicile
• insufficient disclosure and transparency
• insufficient independence of directors, and
• over-reliance on governmental regulation with little emphasis on public and market involvement.

The problem of the under-representation of public interest and limited public discussion of governance issues is prevalent in Hong Kong. A public activist group is the most cost-effective way to represent the interests of minority shareholders. In Hong Kong, the minimum public float is only 25% for listed companies; this limits the room for minority shareholders to exercise their rights and powers. Given the predominance of controlling shareholders and prevalence of family cross-shareholdings in Hong Kong, there is surprisingly no minority shareholder activist group. Also, there is no institutionalised public lobbying – just one vocal activist, David Webb. Furthermore, in spite of a relatively sound regime of shareholders’ remedies as in the availability of derivative action and other remedies, minority shareholders cannot afford to resort to legal action because of the costs and time delay. The Minority Shareholder's Watchdog Group in Malaysia is a successful example of a developing public watchdog group. The functions of the watchdog group are to make inquiries into the company about market misconduct and to demand reasonable explanations. To achieve minority shareholder protection, a cost-effective and time-efficient protection is needed to tackle the problems of limited resources and insufficient bargaining power. The failure of companies to give adequate reasons for non-compliance or simply no response is a powerful weapon that may attract public scrutiny and investors’ suspicion. It is also likely that a public watchdog group could gain bargaining power following active enquiries.

The inclusive stakeholder model

Our inclusive stakeholder model of corporate governance adopts a step-by-step approach by dividing corporate governance into five stages (see the graphic 'Inclusive stakeholder model’ above). The five stages – standard setting, compliance, monitoring, enforcement and engagement – are interrelated and mutually reinforcing. The graphic above highlights the key internal and external stakeholders for each stage, although each of the five stages are designed to be as inclusive as possible. In this first part of the article, we look at the first standard setting stage of the model. This first stage means the construction of a legal and voluntary framework that consists of benchmarks and the standards for compliance. As corporate governance has to balance the interests of stakeholders and society, in order to elicit compliance from all stakeholders, the corollary is that the opinion of all stakeholders should be welcomed and respected in the process. In other words, the relatively dominant stakeholder should not marginalise the voices of others. An inclusive stakeholder model is desirable for the standard setting stage because effective corporate governance requires the collaboration of both internal and external forces. The notion of corporate governance concerns not only the must-dos, but also the should-dos. In this respect, external stakeholders play a key role in elevating and broadening the standard and expectations of corporate governance. External stakeholders bridge the gap between the minimum standards prescribed by the law and best practice. It is argued that the unbalanced representation of various stakeholders is the root cause for the core problems in standard setting. Specifically, the interest of minority shareholders and the general public are given disproportionately low representation as compared to that of vested interests.

Standards of independence

The presence of independent non-executive directors (INEDs) forms an integral part of corporate governance in a company. The INEDs should play the role of a 'watchdog’ to safeguard the interests of the minority shareholders. Their importance is highlighted in the requirement that each board of directors must include at least three INEDs. In order to further ensure the authority of the INEDs, they must represent at least one-third of the entire board. This practice averts the possibility of the power of the executive directors going unchecked. There have been concerns that, where independent directors serve several companies simultaneously, questions should be raised as to whether they can spare sufficient time to oversee the corporate governance of the company. Another issue regarding the board is that some companies employ INEDs just to meet the statutory requirements and even elect INEDs without adequate financial or management knowledge to serve on the audit committee. Every member of the audit committee should possess the required standard of knowledge on auditing and management.

Standards of disclosure and transparency

Audits, whether by the internal or external auditors, or by the audit committee, can play a significant role in monitoring corporate disclosures. Their primary role is to ensure the corporate information released is relevant, reliable, timely and accurate. Establishing pertinent standards of disclosure are of vital importance for auditors in executing a fair audit of organisations. Although there are existing standards from external regulatory bodies such as the Securities and Futures Commission, those standards usually merely satisfy the minimum legal requirement.

‘SMART’ standards

When there is a gap between legal requirements and ethical standards, a company should establish its own disclosure standard that is above the legal requirements. The standard should be 'SMART’ as set out below. Specific – the standard should specifically state what information has to be disclosed other than the minimum legal requirements. Measurable – the standard should be measurable so that the company can constantly measure its progress and improve its disclosure. Attainable – the standard should be reasonable so that the company has room to keep certain business information private. Relevant – the company should disclose relevant information that affects the public interest. Time-framed – the disclosure should be released in a timely manner. A bottom-up approach is suggested so as to enable the minority stakeholders to have a say on the standards. This can help resolve the problem of unbalanced representation and minimise the gap between legal requirements and ethical standards.

Publicly initiated standards

Besides relying on the company's self-discipline, public activists can also help to push the development of information disclosure and for the better corporate governance. They can publish some recommended standards for the company's reference. As outsiders, they can probably suggest fairer standards without being driven by private interests. Therefore, the company could refer to publicly initiated standards and improve their own standards as well, which could be a possible external force for better corporate governance. Chan Sze Wai, Chiu Wai Hung and Wong Ho Wai The University of Hong Kong