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Watchdog, Not Bloodhound
(Interview Article to Company Secretary October 2003, vol. 13, no. 10)

Eric Li, LegCo members for the accountancy constituency and Fellow of The Institute, shares his views on the vexing role of independent non-executive directors on the boards of locally-listed companies

Recently, standing out in sharp relief against a still-festering background of global corporate malfeasance, there has been much discussion as to the specific duties, responsibilities ¡V and indeed, capabilities ¡V of non-executive directors in Hong Kong.  A report just published by The Institute outlines the difficulties faced by Hong Kong independent non-executive directors (INEDs) in performing their core function of regulatory oversight.  It is suggested in another report, the Phase II corporate governance proposals of the Standing Committee on Company Law Reform (SCCLR) that a long-term objective of one-third of the board to comprise INEDs is desirable.  Both that report and the Stock Exchange are moving in the same direction; towards strengthening and increasing the use of INEDs.  The Stock Exchange is particularly exercised that INEDs should be on a company¡¦s audit committee (now to become mandatory for Main Board issuers), the remuneration committee (recommended as minimum standards under the Listing Rules Code of Best Practice) and the nomination committee (also recommended in the Code of Best Practice).

These reports detail not only how INEDs are under-remunerated and perhaps under-utilised, but how they are also becoming implicitly loaded with larger potential legal liabilities than their executive confreres.  These disincentives create a situation that is compounded, says Eric Li, by the shallowness of the pool from which reasonably-qualified INEDs may be drawn.

Modus Operandi of an INED

What do we want from INEDs?  Eric Li has specific personal experience; this is partially derived from the fact that currently he is an independent non-executive director on the boards of eight different corporate entities in Hong Kong (see box), and it is an activity in which he has been involved for some five years.  It is not, he maintains, easy to fulfil the obligatory functions of the positions.  It requires, energy, time, resources and commitment.

Li¡¦s modus operandi appears initially to be genuinely eclectic ¡V indeed, almost experimental.  Nevertheless, as empirical techniques yield data, this activity moves towards the systematic, thus proving itself to be of use and thus becoming incorporated into his body of activity.  Anything that may reveal useful data will be prodded, scrutinized and evaluated.  He tells us how it works in practice. 

¡¥I get my information about the status of a company from many sources; news reports, analysts reports, and other types of offside activity.  However, at the end of the day, the amount of information that an independent director can collect is directly related to the number of questions that individual is prepared to ask.  I also tend to use products and services supplied by a company on occasion, and I also sometimes pay physical visits.  I have been to inspect investment in China, and I have watched products in the marketplace.  For example, I sometimes ride on KMB buses.  I do have one advantage over many independent directors in that as a legislator, I have to be in contact with a broad range of regulatory issues and this can give me further insight into public service in the interests of the consumer as well as the investor¡¦.

Training: the Key to Good Oversight

None of this comes as a natural attribute of becoming an independent director.  It is a specific discipline ¡V corporate governance oversight ¡V and it requires specific training.  Training, it appears, is a subject close to Li¡¦s heart.

¡¥Yes.  Training is the key, the lynchpin of corporate governance quality.  I believe in this strongly, and so I actually do some training myself.  Specifically, I do some lecturing for students and also for professional groups.  There are several factors involved here, but obviously from my point of view as a lecturer it is important for students to study the somewhat involved legislation, for instance.  Training can increase the pool of available talent; it can also reduce the numbers of those not fitted for the role. 

¡¥Then there are other influences that can matter.  I have spent days myself being trained in Shenzhen, where the interesting thing was to be able to quantify the differences between Hong Kong and the Mainland.  These contrasts between systems can be of great benefit in showing the way to go, and so I am an avid student of such differences.  China¡¦s evolution has been very different from that of Hong Kong, and I have to say that there has been a comparative laxness in corporate governance affairs, but the regulators have learned from their mistakes ¡V as indeed has Hong Kong.  Achieving the right kind of transparency in corporate board affairs will take longer in China, but when the mechanisms have evolved they will be more fully suited to the local circumstances.  The difference can be partly explained by the fact that corporate governance affairs of any type, including board representation, are the result of interactions between people and interest groups.  Here Hong Kong people and mainlanders tend to differ: in China bureaucrats, shareholders and directors alike seem to share a greater interest in personal power than financial affairs.

A Culture of Conscience

Once the independent director is sufficiently trained to begin distinguishing the wood from the trees, where should he seek the information that he feels he needs in order to discharge his functions and responsibilities?

¡¥Always, the company must be the prime source of information.  Corporate cultures are by their nature conservative, and although it may be unusual to find information that has been suppressed, it is not unusual to find that no one in the company has volunteered to disseminate that information.  That is not always the cases; Hang Seng Bank produces meetings for disclosures of this nature that can go on for hours ¡K on the other hands, with some companies such affairs have to be forced into existence because they may not have a tradition of volunteering disclosures.¡¦

Once in situ, does the concept of the disinterested independent director whose only remit is ensuring a higher standard of corporate governance, hold up as a arbiter of standards and a whistleblower against abuse?  In short, are these individuals the ¡¥conscience¡¦ of their companies?  Li thinks so, but says that they are not alone.

¡¥Most disinterested management can be described as a company¡¦s ¡§conscience¡¨.  I feel that the concept is somewhat wider than that.  I believe it to be an aggregation of everyone in the company.  This is reasonable, because for a company to fail without obvious cause in this era of oversight and market management there has to be either a crook involved, or collusion throughout.¡¦

Blowing the Whistle

Then there is the circumstance that every individual concerned with corporate governance dreads coming across, and yet it is the circumstance that is the very reason for their existence: evidence of malfeasance.  How should the independent director react, and what does he have in his arsenal?  Eric Li ¡V an amiable man ¡V loses some of the geniality in his demeanour at this point.

¡¥First of all,¡¦ he declaims, ¡¥you take up the challenge!¡¦  That in itself is a lesson of sorts; presumably anything from intimidation to bribery may be arranged against the INED who finds out too much.  ¡¥The first thing is that you must ask for is an explanation to the anomaly you have uncovered.  At this point your support is the fact that if there is no satisfactory explanation or resolution then you are probably in the presence of a serious breach of regulation or law.  It is worth mentioning that in this type of circumstance, and despite some people¡¦s fears, liability for malfeasance does not impinge upon a whistleblower, even though that whistleblower has a part of the collective board responsibility.¡¦  Are there other courses of action that can be taken, assuming obduracy?  ¡¥Publicising a situation can also be effective: communicating with shareholders is one option.  What we call a ¡¥noisy resignation¡¦ is a fairly final action that presents itself as a last possibility?¡¦

Remuneration, Responsibilities and Liabilities

Pay is a problem.  INEDs are often poorly remunerated.  Some receive none at all.  For this meager or non-existent stipend they are expected to expend effort, spend time and incur potential liability.  Eric Li feels that much of the corporate governance infrastructure in Hong Kong is stacked against the INED.  Pay, he feels is a serious problem; then there are other grouches.

¡¥All directors carry a mutual responsibility and indeed, liability, for the quality of management¡¦s behaviour and the quality of its compliance with its regulatory requirements.  Executive directors get paid for this, but non-executive directors who are carrying the same liability, plus the extra burden of being responsible for oversight, are extremely inadequately remunerated, as well as being in the difficult position of having to react to events, rather than initiate them.  This compounds: INEDs, having no role outside of oversight and being absolutely forbidden to take part in decision-making or expenditure of any kind have less information to work with than the executive branch to begin with.  The pay problem is irritative in this regard.  There is no standard formula.  Some are paid nothing; some are paid in options.  The maximum figure paid to an INED in Hong Kong may be as little as HK$250,000 [per annum].¡¦

The Shrinking Pool

Another quandary is beginning to appear intractable.  It is suggested that all companies listed on the main board should have at least three INEDs.  For some small-cap companies that is a considerable resource problem that may in fact impact on the quality of their corporate governance in a negative manner, as the costs and requirements outstrip the ability to earn and pay for them.  More: this is not a big place, and the number of persons available who have the time and inclination to do this type of work is not great.  Eric Li sees this as a big problem.  Furthermore, he feels that there may only be 50 companies listed in Hong Kong with the resources to effectively make use of and employ three or more INEDs, even if they were available, which he fears they are not.

¡¥The system for finding non-executives is surprisingly ad hoc.  Very often it comes down to canvassing friends and acquaintances.  I was not familiar with China Resources until introduced by friends.  There is a serious requirement to increase the size of this pool.  Pay is one thing.  Another would be legislation.  I definitely feel that we require specific legislation to reduce the liability for these directors proportionately to their involvement in the affairs of the business.  This would increase the number of people coming forward.¡¦

Corporate Governance from the Wider World

What about letting others do the work?  The US Sarbanes-Oxley Act, and the UK¡¦s new Higgs corporate governance report both contain fresh thinking on oversight and regulation.  Indeed, the politically hot 2002 Sarbanes-Oxley Act has become a necessary discipline for some Hong Kong companies with significant US interests.  Can we copy wholesale from some of these recommendations?

¡¥Well, perhaps this is a problem for Hong Kong.  It is something that is so often expected of us.  There is an attitude of ¡§don¡¦t want to do different ¡V so do similar¡¨.  My thoughts on this are that other jurisdictions¡¦ legislations are a very valuable resource, but we should take their conclusions as a starting point.  It would obviously be naïve to think we could take foreign legislation on board without adapting it to our special circumstances.  The suggestion from the UK, for example, that NEDs should be foisted on companies who fail to appoint their own for example, begs the question of costs and suitability.  It takes time for an individual to grow into a company anyway.  My blanket solution here is to keep a watching brief, and to train, wait and legislate.¡¦

Some voice in the business community have been muttering that corporate governance has been taken too far; that the gains from investor-friendliness are becoming overshadowed by the costs and difficulties of complying with what has become excessive regulation.  Eric Li¡¦s answer to that is pragmatic.

¡¥We have to digest what we have already achieved and put in place.  It¡¦s all happening very fast, and the reactions have to be measured and understood by the many, rather than the very few experts who can assess the current situation.  What we need here is more time.¡¦

John Newson

Eric Li is a senior partner at the accountancy firm Li, Tang, Chen & Co, LegCo member for the accountancy functional constituency, a Fellow of The Hong Kong Institute of Company Secretaries and a member of the 10th National Committee of the Chinese People¡¦s Political Consultative Conference.  For more information, see his personal website: www.ericli.org

Eric Li¡¦s Independent Non-Executive Directorships

-         Hang Seng Bank

-         China Resources Enterprises

-         SmarTone Telecommunications Holdings

-         The Kowloon Motor Bus Holdings

-         Catic International Holdings

-         SIIC Medical Science and Technology (Group)

-         China Vanke Co

-         Wong¡¦s International (Holdings)



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