SECTION 5 - THE PRIVATE CORPORATE SECTOR IN THE RETA ECONOMIES

5.1 Introduction

One thing which is certainly common to all the RETA economies is the predominant use of the corporation as the vehicle for conducting large and medium size private enterprise. Accompanying that is a broadly similar regulatory system which prescribes the formalities to establish and thereafter operate corporations.

As a result, for example, all corporations:

• must have and are managed by directors;
• must maintain statutory records and books of account;
• must file annual financial information;
• must have a minimum amount of paid-up capital, which varies in amount from type of corporation (for example, private and public) and from economy to economy;
• are subject to regulatory control, which at a basic level requires annual filings of accounts, details of directors and so forth and at a public listed level involves a securities commission and a separate stock exchange authority.

Some divergences occur, however, which are relevant to this study. The following are relevant examples.

5.2 Accounts and accounting standards

In the context of insolvency, the proper construction and maintenance of accounts and accounting information in relation to a corporation serves three important purposes.

First, it provides a warning of the onset of financial difficulty and thus serves an important internal purpose. Secondly, it is important externally as an information system to financiers and suppliers (although one suspects that, in the case of the latter, this may be overstated). Thirdly, it can be crucial to the prospect of rescue or work-out (for example, as providing some comfort to existing investors and lenders; to determine a plan of rescue; to satisfy the inquiries of potential investors, purchasers or financiers).

A review of accounts and accounting information of large and medium sized corporations in some of the RETA economies suggests that although there is considerable importance attached to the concept and form, the reality and practice is otherwise. These following extracts from the local studies are informative.

Pakistan: "...the quality and accuracy of information [contained in the financial statements of a corporate borrower] varies". It would "probably not" be complete nor accurate.

India: "Depending upon the extent of the industrial sickness and the accumulated arrears or losses, it is likely that the records of the company would be in disarray....".

Thailand: "Auditing standards have come into question recently with the economic crisis ..... It is unlikely that the financial and other information regarding the corporate borrower is complete and accurate (particularly regarding the valuation of assets and the assessment of liabilities)".

Philippines: "....unless such financial statements come from a reputable accounting firm... they may not be giving the true state of affairs of the corporate".

Japan: "Some recent bankruptcy cases have revealed that management had made false accounting to conceal bad financial conditions of the company. Generally speaking [the] disclosure system in Japan is good but pursuit of liabilities in window dressing accounting will become more rigid in order to secure high standard transparency".

Indonesia: "In general... [there is] .. a lack of sufficient financial information. ...The completeness and accuracy of the information ...depends on the integrity of the management of the company".

Hong Kong, China: "...the frequency and standard of [financial reporting] is often less than in many Western countries".

5.3 Directors and Corporate Governance

Directors of a corporation are ultimately responsible for proper management. In some jurisdictions this responsibility has been taken to such lengths as imposing a duty on directors not to permit a corporation to engage in insolvent trading and, even, to take affirmative action once it is apparent that the corporation is insolvent or will soon become insolvent. Duties such as these become part of a "code" of corporate governance standards and can be a considerable aid toward encouraging a corporation in financial difficulty to take early affirmative action by voluntarily submitting to a formal or informal rescue process.

Attitudes toward the proper role of and standards under which directors should operate vary among the RETA economies. In many cases it seems that many "directors" are either bare nominees or certainly persons who are controlled by others. This alone suggests that standards of corporate governance responsibility are either far from developed or of not much consequence in some of the RETA economies. The Hong Kong, China local study observes that: "....it is not uncommon for listed companies in Hong Kong, China to be under (extended) family control and for there to be a lack of genuine independence even amongst non-executive members of the board of directors. ....Many local companies do not have independent managers - or if they do, have brought in the managers to raise money rather than to impose financial controls - so the controlling family often does not hear contrary views being voiced by senior managers within the company".

In Korea something similar is evident. There is a requirement that a corporation has a minimum of 3 directors. There is nothing particularly extraordinary about that. However, when that requirement is coupled with the fact that private ownership or proprietorship or control of a corporation is culturally and commercially important in Korea, it emerges that, in many cases, two of the three directors will be mere employees of the corporation. The third will be the owner or proprietor. The two employed directors will rarely, if ever, play any real part in management of the corporation. Yet it will often be a requirement of a lender that all directors guarantee the borrowings of the corporation. This can produce some unhappy consequences for the employee directors.

In India the concept of a "nominee" director is recognised, both at a commercial and a legal level. As a result, it is not uncommon for a lender or lenders to be represented on the board of directors of a borrower corporation, through nominee directors. This enables the lender to become reasonably well informed about the financial condition and to exert some influence or control over transactions proposed by the corporation. It should be added, however, that this involvement would not extend to day-to-day management of the corporation.

In Japan it is not at all uncommon for a "main" bank to be represented on the board of directors of a corporate borrower. Sometimes this is a result of the fact that the bank owns equity in the corporate borrower.

In some of the other RETA economies a bank is strictly prohibited from having any relationship or association with a corporate borrower other than the relationship of lender.

5.4 Banks as equity holders in borrower corporations

The treatment of bank lenders as shareholders in a borrowing corporation varies in the RETA economies. For example, in India a lending bank is permitted to hold up to thirty (30) per cent of the issued shares of a borrower corporation. In Japan it is five (5) per cent. In Taipei,China, unless there is some special permission, a lending bank is not permitted to hold equity in the corporate borrower. In Pakistan there is no limit on the amount of equity that a lending bank may hold in a corporate borrower. In Korea it is permissible for a lending bank to own up to fifteen (15) per cent of the issued shares in a corporate borrower.

This can have some effect and some consequence concerning the insolvency of a corporate borrower. It might be anticipated, for example, that a "main" or housebank to a corporate borrower in Japan would normally own equity in the corporate borrower and would more than likely occupy a position on the board of directors of the corporate borrower. It is likely, therefore, that such a "main" bank would obtain early warnings of any financial difficulty or instability.

In an insolvency rescue or work-out situation, the prospect of converting debt to equity on the part of a bank might be more facilitated in, for example, Korea and India than in Taipei,China.

5.5 Family control of corporations

In many of the RETA economies it is apparent that powerful family ownership or control of both large and medium sized corporations is quite common. This is consistent with that which occurred in more fully developed countries some decades ago when it was common for large and powerful corporates to be dominated by the interests of a family. With the greater growth of most of these corporates (and a lessening of the cultural importance of "family" empires), the extent of powerful family influence, control or dominance in the more fully developed countries has lessened.

The extent of "family" control or influence can have an appreciable effect if the corporation becomes insolvent because of the type of cultural factors mentioned in the preceding section.

5.6 Conglomerates of corporations

In some of the RETA economies the private corporate sector is sometimes dominated by large conglomerates. These are often a group of companies which are industrially linked, even though some of them might be independently owned. This is a relatively common feature of the private corporate sector of, for example, Japan, Korea and Thailand. This can present some complexity if some one or more of the members of a conglomerate become insolvent or suffer financial difficulty. It poses a problem, not only for the creditors but also for the group which constitutes the conglomerate. It could mean, for example, that additional factors have to be taken into account before a possible solution for rescue or otherwise will emerge. As mentioned in the local study of Thailand: "The inter-relationship between companies in a conglomerate is often very complex and a purely legal analysis will not reveal their true nature".

5.7 Political/Government associations

In many of the RETA economies there is either a direct political involvement in or strong relationship between political forces and corporations. These associations may be expected to be of some considerable influence in the event that financial difficulty affects a corporation. Some of the local studies place considerable emphasis on this factor as, for example:

Thailand: "The union between big business and government for mutual benefit is well established in Thailand. Politicians and bureaucrats are frequently board members and shareholders, and may have multiple business interests that in other jurisdictions would be perceived to represent a conflict of interest ....".

Philippines: "Politicians are perceived to be the most powerful sector as they can influence, to a significant extent, the granting of loans by government controlled financial institutions .... and even, at times, the bailing out of a soon-to-be bankrupt enterprise".

Taipei,China: "....a number of conglomerates are owned or controlled by powerful families or political parties".