Corporate Governance Reform: Asia Experience by Stephen Yan-leung Cheung Department of Economics and Finance City University of Hong Kong

Stephen Cheung City University of Hong Kong 2 “...China Logistics Group (00217) to confess that millions of dollars has gone missing from its coffers.... The bulk of the cash is suspected to have vanished across the border.... A HK$ 200 million deposit paid out for the acquisition of Shanghai Pudong CNCC Logistics Development was missing... while the money left China logistics, it was allegedly never received by the vendor.” “...China Logistics Group (00217) to confess that millions of dollars has gone missing from its coffers.... The bulk of the cash is suspected to have vanished across the border.... A HK$ 200 million deposit paid out for the acquisition of Shanghai Pudong CNCC Logistics Development was missing... while the money left China logistics, it was allegedly never received by the vendor.” South China Morning Post, 18 September South China Morning Post, 18 September 2002.

Stephen Cheung City University of Hong Kong 3 Corporate governance in Asia Source: McKinsey, 2001 Inefficient corporate governance Reliance on family and state finance Underdeveloped and illiquid investment market Limited market for corporate control Inadequate minority protection Limited disclosure Incentives aligned with core shareholders “Insider boards” Concentrated ownership Independence and performance Capital market liquidity Transparency and accountability CORPORATE CONTEXT Shareholder environment INSTITUTIONAL CONTEXT

Stephen Cheung City University of Hong Kong 4 Introduction Companies with concentrated ownership: extract case by selling assets, goods, or services obtain loans on preferential terms assets transfer dilute the minority shareholders’ interests

Stephen Cheung City University of Hong Kong 5 Introduction A connected transaction is a) any transaction between a listed issuer or any of its subsidiaries and a connected person, whether or not it also falls within any of the other categories in 14.02; and b) an acquisition or realisation by a listed issuer or any of its subsidiaries of an interest in a company, a substantial shareholder of the listed acquiring or realising issuer or any of its subsidiaries of the listed issuer or any of its subsidiaries

Stephen Cheung City University of Hong Kong 6 Objectives 1) What are the valuation effects of different types of connected transactions? 2) What are the characteristics of firms more likely to expropriate? 3) What should be done?

Stephen Cheung City University of Hong Kong 7 Types of connected transactions 1) Asset acquisition 2) Asset sales 3) Equity sales 4) Trading relationships 5) Cash payments 6) Cash receipts 7) Subsidiary relationships 8) Takeover & joint-ventures 9) J V stake acquisition 10) Jo V stake sales

Stephen Cheung City University of Hong Kong 8 1) There were 328 connected transactions worth at least HK$116 billion during The value of the median transaction was HK$ 106 million, representing 17.5% of firm’s market capitalization. Observations

Stephen Cheung City University of Hong Kong 9Observations 2) 2 times more assets acquisition than asset sales; cash from listed companies to its controlling owners 3) 3.5 times more in providing cash assistance to third parties as opposed to receiving assistance 4) Terms are unfavorable (acquiring at a premium or selling at a discount) for most deals when information are available

Stephen Cheung City University of Hong Kong 10 Observations 5) 15% did not disclose the value of transaction in filing. 6) 2.7% did not attach a report by independent financial advisors 7) 3.4% violated a previously granted waiver 8) 7% had taken place in the past but had not disclosed to the exchange 9) 4.9% constitute an outright breach of listing rules

Stephen Cheung City University of Hong Kong 11 Results Short-term, Average of -3.4% during a period of 10 days after announcement Sales of equity stake -11.8% Sales of assets -6.4% Acquiring of assets -7.5% Trading relationships -7.5% Selling JV -6.1% Cash payment -2.5%

Stephen Cheung City University of Hong Kong 12 Long term, Average of -12.6% during a period of 12 months after announcements Sales of assets -21.9% Trading relationships -21.8% Cash payment -18.7% Takeover & JV -29.8% Selling JV -17.2%

Stephen Cheung City University of Hong Kong 13 Blue: Size & MB adjusted CARs Red: Size adjusted CARs

Stephen Cheung City University of Hong Kong 14 Returns are negatively related to percentage ownerships by the main shareholders negatively related to proxies for information disclosure – value of transaction –independent financial advisor – Big 5 as auditing firm

Stephen Cheung City University of Hong Kong 15 likelihood of undertaking connected transactions is higher –ultimate owners can be traced to mainland China likelihood of not disclosing the value of the deal and likelihood of violating the listing rules are higher for –Mainland China ownership –Concentrated ownership

Stephen Cheung City University of Hong Kong 16 Variable of Corporate governance do not have any impact –audit committee –number of independent non-executive directors –CEO duality

Stephen Cheung City University of Hong Kong 17 Discussion The quality of independent non-executive directors Information disclosure Regulatory framework

Stephen Cheung City University of Hong Kong 18 ~END~