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Business & Economics
Review
Vol. 10 No. 1
1998-1999
Corporate Governance, Philippine Style:
WHO CONTROLS THE BALL?
Michael John Sullivan & Angelo Unite
INTRODUCTION
Corporate governance can be viewed as the relationship between corporate
stakeholders and managers and how these participants determine the direction and
of the corporation. How corporate governance is manifested varies among
performance
economies, depending on how the role and importance of corporate participants are
affected by the type of corporate governance system in place and by the evolution and
maturity of the system. Influential corporate participants typically include shareholders
of directors, and in some cases may include
of common stock, managers, and the board
creditors, the government, employees, suppliers, and customers.
Three models of corporate governance are discussed in the literature: (1) the
capital market model, (2) the industrial group model, and (3) the entrepreneurial corporate
model (Prowse 1992, Garvey and Swan 1994, Megginson 1997). In discussing the
effectiveness of these alternative forms of corporate governance it is important to answer
the basic question of how suppliers of capital are able to assure themselves of receiving
a return on their investment; or more importantly, how common stockholders, who are
the legal owners of the corporation, are able to assure themselves that the corporation
is managed with their interests in mind.
The intent of this research is to investigate and analyze the corporate governance
system of an emerging market economy and determine whether the Anglo-ll.merican or
Japanese-German form, or some alternative form has evolved. The particular country
analyzed is the Philippines. The Philippines has many similarities with its emerging
Southeast Asian neighbors due to proximity, and some differences, as well, due to its
unique history and culture. First, we describe each of these corporate governance models
(see Megginson 1997 for a detailed description). Then we discuss which of these
alternative models best describes the Philippine economy. We conclude by discussing
the strengths and weaknesses of the Philippine system of corporate governance.
MODELS OF CORPORATE GOVERNANCE
Tile Capital Market Model
Economies based on the capital market model rely on the marketplace to allocate
resources and to determine asset values. These economies are characterized by having
a large number of independent, publicly traded companies where freely transferable
32 CORPORATE GOVERNANCE, PHILIPPINE STYLE
ownership rights are traded in liquid markets. Corporations in these markets rely on
public markets for external financing and use professional managers to make important
corporate decisions. Since ownership is characteristically highly diffuse, managers run
the company and often exert significant influence on the board of directors. Therefore,
as a method of preventing managers from acting disproportionately
in their own interests,
laws and regulations are developed to protect small investors and mandate reliable
information disclosure.
Vast amounts of corporate information are available and corporate
activities and corporate financial positions are transparent to market participants. There
are two primary methods of assuring that managers perform with stakeholders' interests
in mind. First, managerial compensation packages are designed to motivate managers
to act in a manner that will maximize shareholder wealth. Second, an active market for
corporate control acts as the ultimate means of disciplining managers who act contrary
to interests of shareholders. This corporate governance model is found in the United
States, the United Kingdom, and Canada.
The capital market model has many advantages in this modern world of
international markets. Corporations in these economies are able to raise large sums of
money, comparatively quickly, and at minimal costs (typically the costs of gathering
information, monitoring, and trading are lower). The strong enforcement of regulations
which requires that information be made public, promotes transparency and allows
investors to make informed decisions. This transparency also promotes the creation of
risk-tolerant markets that promote growth firms and venture funds, and together with
market liquidity gives rise to the increased development of large public and private
pension funds. In addition, the presence of professional managers and a relatively large
market of managerial talent, together with an active takeover market, allow for the efficient
allocation of management talent.
One weakness of this system is the disproportionate concentration on short-
term goals by management in order to satisfy investors' short-term interests. Also. the
presence of agency problems created by the separation in goals between professional
managers and owners, and the high costs of disciplining these managers, allow
managers some latitude to act
in their own interests and contrary to the goals of owners.
Finally, the mandatory information disclosure to financial markets results in the greater
difficulty of protecting proprietary information.
The Industrial Group Model
The industrial group model is a system where a country's economy is dominated
by industrial groups. These large industrial groups are composed of a close alliance of
large manufacturing, marketing, and banking companies, and are typically headed by a
large commercial bank. Company groups control all aspects of product flow, from
acquisition of raw materials to production, marketing, and distribution. These groups
are held together by a combination of interlocking directorships, cross-shareholding,
joint ventures, and product development agreements.
As a result, the domestic economy
is dominated by a small number of immensely large and economically powerful corporate
groups that also act as the country's leading exporters. Consequently, equity markets
are underdeveloped and small shareholders have no avenue in which to exert their
ownership rights since legal protections are inadequate and the takeover market is
virtually nonexistent.
The primary advantage of this system, as present
in Japan and South Korea, is
that it has acted as the vehicle for rapid economic development without reliance on
foreign markets.' Product development and export growth have been fueled by
MICHAEL JOHN SULLIVAN & ANGELO UNITE 33
competition between groups. Centralized control of decisions emanating from the main
bank promotes monitoring and information transfer, and allows
for rapid dissemination
of corporate decisions. This focus permits these groups to concentrate on long-term
decisions when appropriate, allowing focused growth and development.
One weakness of this system is the necessity for groups to be competitive and
to grow at similar rates. Otherwise, a few groups will dominate the economy resulting in
diminished competition, and therefore, greater economic inefficiency. There is little market
of available reliable information. In addition, the reliance on
discipline because of lack
company groups imposes high costs on domestic consumers, since the industrial groups
focus on remaining competitive in export markets.
The Entrepreneurial Corporate Model
Entrepreneurial corporate systems are found in Western Europe, East Asia, and
generally in most
of the developing world. These systems vary greatly among countries
an earlier, less-developed version of the capital
and in many ways resemble being either
market or industrial group systems. A common feature is that corporations are controlled
by their founding families, where ownership is extremely concentrated, and in the rare
case where the firm is publicly-traded, many shares are
closely-held and rarely traded.
Consequently, capital markets are mostly undeveloped and companies rely on internally
generated funds or bank financing to fund operations and growth. Due to having
underdeveloped stock and bond markets, a small number of very large, strong
commercial banks with inordinate power in lending and underwriting typically emerge.
With top management positions, there is minimal reliance on professional managers.
In
addition, the use of stock-based compensation is rare; there is very little mandated
information disclosure; and the market for corporate control is inactive, except in extreme
cases.
The strength of this entrepreneurial corporate system depends on the strength
and functioning of the country's intermediaries, most importantly the large commercial
banks. In this system intermediaries act as the source of the majority of corporate funds,
and are therefore, in a natural position to act as corporate monitor. This role means
intermediaries raise and allocate resources.
Also, intermediaries can better build long-
term relationships and are in better position to assist firms in financial distress.
The inherent
problem with this system lies in the conflict-of-interest arising from
the intermediaries' role as the primary creditor to the country's largest firms and the
ownership position these same firms often have in the lending intermediaries. This
creates an atmosphere of self-dealing, with little information transparency on which
regulators can rely to assure the safety of the banking system. In addition, high levels
of sell-dealing diminishes efficiency in the banking system, which in turn results in
higher transaction costs lor banking customers.
SYSTEM FOR THE PHILIPPINES
The system currently in place in the Philippines most closely resembles the
entrepreneurial corporate
model.ln the Philippines the economy is dominated by large
family groups through their holding companies [e.g. Sy Group with SM Investments
Corporation, the Gokongwei Group with JG Summit Holdings, Inc., and the Lopez Group
with Benpres Holdings Corporation], many of which have significant holdings in large
commercial banks [e.g. the Gokongwei Group with 28% and the Lopez Group with 26%
of Philippine Commercial International Bank (PCIB), and the Ayala Group with 46% of
34 CORPORATE GOVERNANCE, PHILIPPINE STYLE
the Bank of Philippine Islands (BPI)] (Philippine Stock Exchange 1997). This association
between large firm groups and banks allows lor the rapid growth of group companies
and the increasing concentration of economic wealth on these groups. How effociently
the purchased assets are employed depends on how well these family-dominated groups
are managed by the founders or their offspring.
To determine how well this Filipino system of corporate governance functions, it
is essential to evaluate the regulatory environment, the monitoring system, and the
presence of moral hazard.
Regulation
An important feature of the Philippine regulatory environment affecting the
corporate governance system lies in the enforcement of government regulations that
are meant to promote the transparency of information and create a sound banking
system. Adequate regulation and its enforcement can take the place of markets, in the
case of the capital market system, and main banks, in the industrial group system, to
ensure the adequate monitoring of corporate activity and to reduce moral hazard
problems. The Philippine system of corporate governance can be broken down in three
areas, namely, (1) monitoring bank lending, (2) financial reporting, and (3) assuring
fairness for investors trading in public equity markets.
Monitoring Bank Lending
In the Philippines, one way in which bank lending practices are monitored through
government regulation is via Republic Act 337, Chapter IX, Section 83. This statute
regulates loans and other credit accommodations to Directors, Officers, Stockholders,
and their Related Interests, otherwise known as
DOSRI rules. The general policy states
that "Dealings of a bank with any of its directors, officers or stockholders and their
related interests should be in the regular course of business and upon terms not less
favorable to the bank than those offered to others".2 DOSRIIoan limits are defined in
general terms as (a) the individual limit to an amount not to exceed their outstanding
deposits and book value of their paid-in capital contributions in the lending bank (provided
that unsecured credit does not exceed 30% to any DOSRI), and being constrained to
(b) an overall limit of loans to all DOSRI of 15% of the total loan portfolio or 100% of
combined capital accounts net of deferred income tax and other capital adjustments as
may be required by the Bangko Sentral ng Pilipinas (BSP).
The central question is how well these regulations are enforced. Many argue
that commercial banks associated with firm groups often lend to group companies at
favored terms, regardless of risk and without proper disclosure to regulators (Prowse
1992, Krugman 1998). Oftentimes a major purpose of a group bank is to act as a conduit
transferring savers funds to group companies for the purpose of supporting company
growth. An example that puts the enforcement of
DOSRI regulations into question is the
case of the failure of Orient Bank in early 1998. Orient Bank seriously viofated DOSRI
rules, but these violations only became known after the bank failed as a result of liquidity
problems. Before its failure in 1998,
Orient Bank was controlled by the Go family. The
amount of loans made by Orient Bank to other Go Family companies was in violation of
DOSRI limits. At the time of failure it was discovered that of the bank's 6.1 billion peso
loan portfolio, 5.8 billion pesos in loans (95.1%} were to DOSRI parties, which were
well in excess of the limits (Business World, March 9, 1998). At the time of bank failure,
Orient Bank had only reported DOSRIIoans of 365 million pesos (less than 6.0%). This
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