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Why Corporate Governance - A Temasek Perspective

1. I would like to take this occasion of the Asian Business Dialogue on Corporate Governance organized by ACGA to share with you Temasek Holdings’ perspective on corporate governance, and how a shareholder like Temasek can add value to its companies for the benefit of all shareholders.

Relevance of Corporate Governance

2. Companies list on the stock exchanges to raise capital from the public to fund businesses. This approach leads not only to an increase in the number of shareholders or fragmentation, but also makes the link between shareholders and management more remote. Governance issues are often seen as arising from clear separation of ownership from management. Several pertinent issues that immediately come to our mind are: To whom are the board of directors and management accountable? What are the appropriate levels of shareholder involvement? What safeguards can shareholders rely on to ensure the protection of their interest? But governance is more than a shareholder relationship issue. It is a great determinant of the actual business performance of a company.
3. Although corporate governance practices have been around for a long time, the term was hardly used until the 1980s. The subject has gained more visibility in the 1990s in Asia with the financial crisis in 1997. Such visibility has been almost exclusively focused on bringing corporate governance in Asian companies to be in line with that in USA. US corporate governance was held up as the paragon of such systems. The recent collapse of Enron, the bankruptcy of WorldCom and the accounting scandals that have hit Corporate America have now propelled corporate governance onto the centre stage. These scandals have launched a series of actions at the legislative and corporate level in America. For us in Asia it would be wise to take note of the following:
   1. Most of the causes for the current corporate scandals in USA are not due to poor corporate governance principles or systems.
   2. Not all the practices and requirements of the US system are relevant to our needs. We should pause before once again falling into the notion that the American way is the best way.
   3. With fragmented ownership, rules can only provide so much protection to shareholders. The character of the management and other service partners such as auditors and legal advisors become even more important.
4. High governance standards are important for all investors. It attests to the quality of the financial and other information on which investors make their decisions. Though there is some fragmentary evidence that institutional investors are prepared to pay a premium for companies which have good corporate governance, in my view the more important reason for good corporate governance is that it enables a company to produce better and more reliable results in its business. The effort to instill good governance practices should not be aimed only at better stock market performance. Stock performance should be only an incidental concern of a company. Its focus should be on tools that help its core business perform better.
5. We all recognize that there is no one standard approach to corporate governance. The approaches must be influenced by a number of factors such as the ownership structure, the stage of the development of a company and the legal protection afforded to shareholders. Some of the current practices and measures in the US are worth noting before I share with you Temasek’s philosophy.
6. In the US, listed companies are typically characterized by the absence of large shareholders and by dispersed ownership instead. The largest shareholder in more than half of NYSE and Nasdaq-listed companies holds less than 5% of the shares. These shareholders typically have to rely on professional managers to run the companies. Thus far, a situation where the management is freed from shareholder pressures has often been seen as the ideal model and the best way to produce results. But now, many differ as the very same situation can also unwittingly allow management who have no integrity or who are obsessed with short-term price performance to take shareholders for a ride.
7. We have ample evidence of how unscrupulous managers have been allowed to run rings around the board and shareholders.

Stock Options

8.  Stock options scheme as a key driver of management performance is a feature of many US companies. In start-up technology companies, stock options as the main form of payments have an important role. The case for stock options is not so persuasive with respect to established companies – what can be termed main Board companies. In the last 2-3 decades an unhealthy management culture has grown which focuses on stock price performance rather than the business of the company. As shareholders rely increasingly on stock performance rather than dividend yields for their returns, the idea has grown that in order to align the interests of management with shareholders, management should also be shareholders with a deep vested interest in the stock price of the company. In the US, for various reasons (tax, accounting etc which are not relevant to the point I want to make), stock options have become the favoured way of compensating in order to align the interests of management with shareholders.
9. The fact that no shareholder approval is required for stock options issue and that no cost is attributed to stock options have also helped popularise this form of incentive.
10. Listed companies in the US are allowed to issue stock options to employees without seeking shareholders’ approval if the plans are broad-based i.e. plans in which at least a majority of the participants are not officers or directors. But as we know, in light of the excesses, the New York Stock Exchange and Nasdaq are currently in the process of changing their rules to subject all stock option plans to shareholders’ approval. I see this as an attempt to return to fundamentals ie. to focus management’s attention on running the underlying business.
11. Current accounting treatment for the different forms of stock options is not uniform. The granting of fixed price options with the exercise price equal to the fair market value on the date of grant does not result in an expense in the financial statements. Therefore, even though there is potentially a dilution cost to shareholders, issuing fixed price options is virtually cost free from the management’s perspective.
12. As a consequence, senior executives have been granted a large number of options dominated by fixed price options. According to Standard & Poor’s data, the 79% rise in the median CEO compensation from 1992 to 2000 was due to the growth in long-term incentives, mainly stock options. Stock options were 27% of median CEO compensation in 1992 compared to 60% in 2000. As the executives’ personal wealth was so closely tied to their companies’ share prices, not surprisingly, they had a keen interest in share prices and became very obsessed with maintaining stockmarket performance even in the short term.
13. At first glance, there is no question that aligning the interests of management and shareholders is the right thing to do. But it is increasingly clear that very few investors are interested in the medium and long-term growth of the companies that they invest in or in good dividend yields. They look to share price appreciation for their main returns which is entirely proper if they have a medium or long-term view. But there is increasing evidence that many investors including institutional investors and pension funds manage their investments according to stock price movements in the short term. There is clear evidence that institutional investors are decreasing their holding periods. With individuals, one study showed that the average holding period in 2001 was 11 months compared with 8 years in 1960. Another study showed that average holding period by shareholders of a blue chip US company is less than one month. With management also having an increasing part of its fortunes tied to the stock price, the obsession with short-term price movements is compounded. The temptation to dress up results to ensure that the stock continues to perform is almost irresistible.
14. Because of this short-term horizon, many investors demand information and systems that feed this requirement. One such requirement is quarterly reporting. I am dismayed that we in Singapore have decided to impose this practice on listed companies. We seem to have tilted in favour of traders in stocks rather than investors in stocks. I am not in favour of quarterly reporting not because of the cost. Any good company must have at least monthly figures of its performance. But having a system that encourages the market to set quarterly targets and that beats the stock up or down according to penny variations from the target does not seem to me to encourage investment.
15. A worst case collateral consequence of short-term measures is that it has contributed to executives adopting a short-term approach to managing corporate performance, to play the earnings game by managing market expectations. When taken to extreme proportions, management will succumb to temptations to engage in creative accounting or simply, fraudulent practices as the examples in the Enrons, Tycos and WorldComs of today show.

Lessons Learnt

16. The corporate governance crisis in Corporate America shows us that although its corporate governance system generally functions well, it is not foolproof. In fact, no amount of legislation or imposition of rules can prevent wilful fraud or impropriety. It also shows that the imbalance of power and influence between shareholders and the board of directors and management, can give rise to the opportunity for wrongdoing.
17. To help prevent similar occurrences in the future, one way, though I must stress that it is by no means the only way, is for shareholders, particularly the major shareholder if there is one, to proactively monitor the companies in which it is invested.

Role for a major shareholder – Temasek Holdings

18.  Unlike in the US, the ownership structures of listed companies in some Asian countries e.g. Hong Kong, Malaysia and Singapore, are more concentrated than dispersed. Major shareholders are typically families. A public listed company with one major or controlling shareholder has its own set of problems and dangers. Minority shareholders in many family-owned companies have discovered this to their cost. The governance systems and procedures must ensure that the major shareholder influences and drives management in the interest of all shareholders. Here the character issue as it relates to the major or controlling shareholder is a key issue. An unscrupulous, dishonest controlling shareholder of a publicly listed company can be worse than unscrupulous, dishonest management.
19. In Singapore, Temasek is a major shareholder in a number of Temasek-Linked Companies (or TLCs). Formed in 1974, Temasek is a Singapore Government investment holding company. Temasek has substantial shareholdings in a number of listed companies such as Singapore Airlines, Singapore Telecommunications, SMRT Corporation, Neptune Orient Lines, Keppel Corp and SembCorp Industries as well as non-listed companies such as PSA Corporation and Singapore Power. These companies are involved in a wide range of industries ranging from transportation and logistics to finance, telecommunications, engineering, utilities and property.
20. As a major shareholder in the TLCs, Temasek firmly believes that ownership comes with the usual rights as well as a moral responsibility. The character of Temasek derives from the character of the political leadership in Singapore with the qualities of honesty, probity, meritocracy, focus on the right rather than the popular decision and transparency being the main features. Temasek has defined for itself a proactive stewardship role. Being an involved, interested and informed owner, and with enough clout, it can help prevent the types of excesses seen in the US. Over the years, it has exercised its due influence as a major shareholder over its companies in a number of different areas, namely:
    1. the nomination of suitable persons for appointment as directors onto the TLC boards;
    2. the establishment of employee compensation schemes (including stock options), and succession and development plans. Listed companies in Singapore require shareholders’ approval for stock option plans;
    3. the scrutiny of material transactions e.g. mergers and acquisitions that require shareholders’ approval; and
    4. the institutionalising of corporate governance and disclosure practices.
21. Temasek behaves no differently from any institutional investor ie. it seeks to maximise shareholder value. There is no divergence between Temasek’s interests and those of other shareholders since its aim is to ensure that TLCs are well managed and create value for the benefit of all shareholders. Furthermore, it also continuously strives to institutionalize good corporate governance practices in TLCs to enhance their transparency and accountability.
22. In terms of its companies’ corporate governance standards, third parties’ studies and awards, listed-TLCs generally have been shown to have good to outstanding corporate governance standings. Let me share with you some of the accolades received by the companies.
    1. In the CLSA corporate governance ranking of Singaporean companies published in 2002, 11 out of the top 15 listed companies are TLCs;
    2. At the 27th Annual Reports Award competition in 2001, Keppel Land, Singapore Airlines and ST Engineering won the top three prizes for main board listed companies; and
    3. In the Standard & Poor’s inaugural Transparency and Disclosure Survey published in November 2001, ST Engineering was rated as one of Singapore’s companies with the highest level of corporate transparency and disclosure in Asia Pacific.
23. So far, I have spoken about why Temasek, as a major shareholder, needs to take a proactive shareholder role in driving the governance of its companies and why it can do so without reducing the wealth of other shareholders. Next, I will share with you how Temasek seeks to value add to its companies.

The Temasek Model

24. Some of you probably know that Temasek has recently released its charter. Its new mission is to build a future for Singapore through nurturing successful and vibrant international enterprises so as to help broaden and deepen Singapore’s economic base.
25. Temasek’s strategies are to leverage on the brands and market positions to globalise existing businesses, and from time to time, to also very selectively invest in new businesses in order to nurture new industry clusters in Singapore. As for those businesses that are no longer strategic and have no international potential, it will divest them.
26. The character, values and competence of the people who lead the company at Board and management level are the most important requirements for the success of a company. Temasek puts paramount emphasis on this.
27. In carrying out its new mission, it will work closely with the TLCs to focus on the following five areas:
    1. Values: It will promote and maintain a strong culture of integrity, meritocracy, excellence and innovation;
    2. Focus: It will require its companies to focus on core competence, value creation, customer fulfillment and shareholder return so as to maximize the long-term shareholder value;
    3. Human capital: As the quality of the human capital is an important asset towards achieving the new mission, it will work with TLCs to nurture a group of internationally competitive cadre of board and management as well as outstanding employees;
    4. Sustainable growth: To achieve this, it will support and institutionalize high standards of business leadership, financial discipline, operational excellence and corporate governance; and
    5. Strategic developments: To build regional or international businesses, it will assist the TLCs to shape their strategic developments that include consolidations, mergers, acquisitions, rationalization or collaborations as appropriate.
28. The role played by Temasek is one of a strategic catalyst. It does not micro-manage or control the TLCs. The day-to-day management of the businesses is left to the respective companies’ management and supervised by their boards.

Quality Boards are all-important

29. However, as the TLCs enter into their next phase of growth, they will all the more need quality and independent boards. To establish quality and independent TLC boards, Temasek works closely with its companies to compose effective boards. In composing effective boards, Temasek helps TLCs source widely for potential directors and ensure that there are complementary skill sets and experience to meet the diverse needs of companies. Temasek places emphasis on the importance of board independence. As at June 2002, about half of the 600 odd key directorships is held by independent directors.

Conclusion

30. I would like to conclude my speech by reiterating that there are benefits in having a major shareholder, like Temasek, to drive the governance of its investee companies. It is for this reason that when Temasek divests its companies in line with its privatization plans, it will not exit from the more significant companies without first ensuring that major reputable shareholders are put in place to drive the companies forward.
31. Thank you.