Economic Analytical Unit - Department of Foreign Affairs and Trade

Changing Corporate Asia -
What Business Needs to Know

Presentation on report, 7 March 2002.

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How often do Australian business people return from a trip to Asia feeling they missed out on a contract, not because they had the wrong product, service, project or price, but because they lacked the vital insider relationships? Is this key aspect of the Asian business scene likely to change, and if so, where is change occurring first and fastest?

This report aims to answer these questions. It finds the pace of change varies considerably around the region, but overall East Asia is making a gradual but discernible shift from a relationship to a more rules based business model. However, in some emerging regional economies, the pace of change risks being too slow to help restore growth.

Asia’s Old Business Model Failing

Relationship based business is a natural response to a lack of effective laws and institutions to enforce contracts. In the past, developed economies also did business in much the same way, but as these economies became larger and more complex, effectively enforced rules and laws became increasingly necessary to let business operate efficiently. 

However, regional governments and analysts now increasingly recognise relationship based business contributed to the crisis and is failing to deliver growth. They resulted in East Asian markets being dominated by a few family owned corporates, reducing competition, inflating profit margins and often generating poor corporate governance and minority shareholder protection.

Since the Crisis

Forces Driving Change

In this environment, at least four major forces are driving East Asia away from relationships towards a rules based business model.

Slide 1 – Forces driving change

• Relationships are under strain
• Domestic and global competition is strengthening
• Corporates need new finance sources
• Governments are tightening disclosure regulations and insolvency laws.

Relationships under Strain

• Throughout East Asia, key corporate and financial institution relationships are under strain. The crisis made many major banks and companies insolvent; many companies are not repaying creditors or suppliers; so many regional businesses can no longer rely on relationships to do business.

Slide 2 – This is reflected in high non performing loans levels

Slide 3 - Bank lending is still contracting

five years after the crisis commenced, in part because banks are unwilling to lend to corporates,

Anecdote; For example, in 2000, the new foreign owners of the Long Term Credit Bank of Japan, renamed Shinsei Bank ended the bank’s long relationship with the insolvent Sogo department store, finally bankrupting the 170 year old retailer.

Benefit to Australia: reducing the importance of relationships will increase opportunities for Australian goods and service exporters to supply into the region on a more level playing field. For example, weakening Japanese main bank and keiretsu group relationships is increasing opportunities for foreign financial institutions, including Australian companies, to meet corporate financing needs and exporters to supply group firm input needs.

Increasing Competition

Slide 6; Tariffs have continued to fall

Slide 7 Foreign direct investment increasing

However, most regional economies would benefit from further deregulation, privatisation and market opening to reinforce regulators’ efforts to boost corporate governance standards.

Anecdote: Foreign entry is changing corporate culture in Japan’s automotive sector. By 2001, Renault, Daimler Chrysler and GM held 20-50 per cent of Nissan’s; Isuzu’s, Mitsubishi’s and Subaru’s shares. Foreign involvement spurred cost cutting, encouraging firms to shed non-core businesses and upgrade marketing and technological standards. For example, Nissan quadrupled its profits in 2000.

In the Thai financial sector, four of the 13 banks and 27 of the pre-crisis 53 securities companies now wholly or partially foreign owned, increasing pressure on local banks to lift service and risk and prudential management standards. Banks like Thai Farmers Bank and Bangkok Bank are making significant efforts, including using foreign professionals to help them to reach international banking standards.

Australian benefit: Many Australian accounting and banking professionals are assisting companies responding to growing competitive pressures throughout the region.

New Sources of Finance Sought

With banks less willing to lend to corporates, they are seeking new sources of finance, including from equity and bond markets, increasing market scrutiny.

deepening sharemarkets, eventually this will increase competition for banks and impose more market discipline on corporates who must comply with listing rules and respond to more active shareholders.

Anecdote: For example, in 2000, Korean manufacturer Hynix Semiconductor’s sold non-core assets but remained too highly leveraged to borrow and instead it issued over US$1 billion in shares on international equity markets. But before doing so it undertook major corporate governance reforms. Its majority owners, the Chung family, resigned from the board and relinquished all voting rights, although they retain their financial holdings until 2003. All ten board members now are outside directors.

Benefit to Australia: Australian securities firms are now operating throughout the region assisting firms with IPOs and such corporate governance reforms should make regional security markets a safer destination for Australian investors.

Tighter New Regulations

Across the region, governments responded to the financial crisis by tightening accounting, disclosure and listing regulations, strengthening insolvency and other corporate laws and boosting enforcement capacity to protect shareholders and creditors. In many regional economies including Hong Kong, Singapore, Malaysia, the Republic of Korea, Japan and Taiwan, new company reporting, accounting, auditing and disclosure standards approach international norms. Eventually these reforms should make regional share markets and banks a safer destination for East Asia’s vast savings.

Slide 7 -- Checklist of reporting requirements in East Asia

Slide 8 -  Formal accounting standards also are improving

Benefit for Australia: Tighter disclosure and accounting rules and improved minority shareholder rights also will help make such markets a safer for Australian portfolio investors.

Pace of Reform, Progress in Transition Varies

Slide 9 – Regional Map – Best corporate governance economies

Hong Kong’s British derived legal system and efficient open markets make it an East Asian leader in establishing a rules based business environment. A recent survey of institutional investors ranked Singapore as the second most desirable investment destination after Australia in the region, in terms of its legal and regulatory framework. The Singapore Government also is listing Government linked companies and increasing corporate disclosure.

Slide 10 – Regional Map – Middle income economies and China progressing

Anecdote. For example, Sony Corporation was one of the first major Japanese corporates to undertake corporate governance reforms, downsizing its board from 38 to 10 directors, and increasing its independent directors from 2 to 3. Following these reforms, more than 300 companies reduced their boards’ size, and several, including Fuji, NTT, Sanwa Bank, Sanwa Electric and Softbank, appointed independent directors.

Slide 11 – Regional Map – Emerging economies’ progress slower

Anecdotes: In Thailand, leading corporate Charoen Pokphand deleveraged, shed non-core businesses and became more transparent, placing the entire conglomerate in a public holding company to attract new equity owners. On the other hand, other major  conglomerate like Siam Cement are resisting restructuring. For example, in 1998, it` committed to shedding several non-core businesses to reduce debts of over US$5 billion. Through 1999, the business sold nearly half the promised assets and raised finance by issuing equity. However, in the lead up to the 2000 elections, businesses scheduled for sale returned to the company’s fold and by mid 2000, the group’s debt-to-equity ratio was rising again. Over the first half of 2000, security analysts sold down the company’s equity by 20 per cent, anxious about high leveraging and opacity in the firms’ accounts.

This picture is repeated in Indonesia, where corporate restructuring is generally shallow and major conglomerates are resisting asset sales. The report finds that unless governments act quickly, several regional emerging economies risk being caught in limbo, with neither a relationship nor a rules based system functioning effectively. This will undermine their medium to long term growth prospects.

Business Implications

Hence the report draws three major implications for Australian business:

Summing Up

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