Dr. Wai-Ching Poon
Economic Unit, Faculty of Management, Multimedia University

Corporate governance is a topic at the heart of business debate within most developed economies. It is defined by the OECD as the system by which business corporations are directed and controlled. Poor governance diminishes growth’s potential impact on poverty (World Bank, 1999).

It is increasingly recognised that corporate governance is a determinant of economic performance. It is about maximising value subject to meeting the corporations financial and other legal and contractual obligations. It is also about nurturing enterprise while ensuring accountability in the exercise of power and patronage by firms (Iskander and Chamlou, 2000).

Financial turmoil in some emerging markets and developing countries has put corporate governance to the forefront. Although crisis has multitude of underlying causes, corporate governance is seen as a major contributor. Political patronage is believed to have undermined the standard of corporate governance. However, the evolvement of corporate governance made things worse by the complexity of the ownership structure, interlocking relationship between government and the financial sector, weak legal and judicial system, and scarce human resource capabilities.

Following the crisis, corporate governance became a leveraging tool to attract investment before investing in emerging market. Due to global fierce competition, many developing countries are offering similar benefits such as tax subsidies, low cost, proper infrastructure etc. However, these benefits are not sufficient following globalisation and the advent of evolving information technology meant. Globalisation brings harmonisation among the different standards of corporate governance between the developing and developed countries. People are talking about undergoing significant structural transformation following privatisation, deregulation and liberalisation in various disciplines and sectors. Hence, this paper will discuss the role of the state in influencing corporate governance in Malaysia and its significance. This paper discusses the issues of corporate governance and its relationship with political ownership. The flow of the paper is as follow. Firstly, review the issues related to corporate governance. Then, discuss the corporate governance framework and how politics can influence the corporate system.

In a pure free market economy, the notion of authority does not exist because of the Adam Smith’s “invisible hand” concept that perceived the insurance efficiency and brings about market equilibrium. However in the real world, there are externalities such as asymmetric or incomplete information (Ross, 1973; Simon, 1991) that will influence the function of the market.

In a real world situation, transaction will generate a quasi-rent outcome which needs to be divided ex-post (Zingales, 1997), we commonly call it as the agency problem. Agency problem refers to the difficulties financiers have in assuring that their funds are not expropriated or wasted on unattractive projects (Shleifer and Vishny, 1997). It happens because of the inherent firm structure that separates control and ownership. Despite contracts between financiers and managers can specify the conditions of their relationship, no complete information with regards to what the manager does in all situations and how the profits are allocated. To resolve this problem, residual control rights1 must be allocated (Grossman and Hart, 1986; Hart and Moore, 1990; Hart, 1995).

Corporate governance systems are primarily shaped by politics. Bennedsen (2000) conducted a study on political involvement in resource allocation. He found that privatisation does not remove politicians’ interest in the enterprise, but it will affect the organised interest groups’ action and affect the politician’s preferred resource allocation. Thus, the interaction between the organised interest groups and the government could shape the structure of corporate governance.

For state ownership, the social welfare arguments such as monopoly power, externalities, and distributional issues are used to justify its existence. Because of these issues, bureaucrats are thought to be able to improve efficiency by controlling the decision of firms and perform better than private firms. Although in theory, the public controls the firms, the de facto control rights still belong to the bureaucrats. The bureaucrats have extremely concentrated control rights, but there is no significant cash flow right. Cash flow rights are effectively dispersed amongst the taxpayers of the country (Shleifer and Vishny, 1997). Problems arise when the bureaucrats’ objectives are not aligned with the social interests. In order to solve this problem, most countries responded by privatising their state-owned firms. Privatisation replaces political control with private control by outside investors. At the same time, it might create concentrated private cash flow ownership to go along with control.

In Malaysia, there is a link between privatisation, political ownership and corporate governance. Gomez and Jomo (1999) have indicated that in Malaysia, privatisation has led to concentrated ownership and political patronage. Privatisation is seen as an instrument to distribute rents. To accommodate the political objectives, some of the governance mechanisms have been ignored. An obvious case is the way the privatisation process was carried out. Competitive bidding or auction did not feature in transparent mode for most privatisation projects.

Privatisation is expected to lead managers to place greater weight on profit goals. But the changes involved are far more complex than a simple shift from ‘public interest’ objectives to profit maximisation. Under private ownership, management is directly responsible to shareholders although it may be constrained in its actions by a regulatory body. Meanwhile, for public ownership, the government monitors management, in turn acts as agents for the people.

Privatisation does not always end up with private ownership and what is expected may not be true. Political ownership could feature prominently. Political ownership is the ownership by the state, politicians or their agents. Privatisation programme that maintains political ownership is understandable because of politicians’ concerns.

The reform of state-owned enterprises (SOE) can cost a government its support base because reforms almost invariably involve eliminating jobs and cutting long established subsidies. Not surprisingly politicians carefully weigh any changes in SOE policies, naturally preferring policies that benefit their constituents and help them remain in power over policies that undermine support and may cause them to be turned out of office. While some exceptional politicians may be able to change the support base, and mobilise new constituents for reform, most are inherently responsive to supporters who put them in office. A form of compromise is to have partial privatisation. Therefore, the political ownership factor could spoil the noble objective of privatisation.

The state has been a major participant in the Malaysian economic development, particularly under the New Economic Policy (NEP). Capitalist development in Malaysia involves a series of linkages among party politics, the bureaucracy and business.

Privatisation in Malaysia is based on ethnic consideration, which was one of the objectives for NEP. It was designed to redistribute wealth and income through the allocation of 30 percent equities to the bumiputras. On the other hand, the sale of public enterprises to nonbumiputras was politically unpopular and attracted widespread protests from UMNO members (Gomez & Jomo, 1999). The only way for non-bumiputras to participate in the privatisation programme is through joint ventures with politically influential Malays. Bumiputera trust, agencies and companies have been receiving funds from the government either directly or indirectly through state administered insurance and provident funds. As a result of the complex relationship, privatisation may lead to rent-seeking behaviour amongst various power groups. According to Craig (1988), “Privatisation represents a rearrangement of ownership within already pre-existing power groups”. Gomez and Jomo (1999) added that extensive political nepotism and patronage have grown with privatisation in the absence of an independent, accountable monitoring body to ensure proper implementation of the policy.

There is widespread public concern about collusion and corruption issues in the process of privatisation. The privatisation of the North South Highway was one such case that public focused on when the Parliamentary opposition leader and other civic groups brought the case to the civil courts (Jomo, 1993). The issues being alleged was the details of the UEM’s winning bid was not transparent as UEM was virtually insolvent and yet had no track record of building highways. Transparency on government decision making has not been improved at that time. Hence, most of the privatisation projects were claimed to be assigned based on crony interests.

So, how extensive is the political ownership? The rank of market capitalisation in Kuala Lumpur Stock Exchange (KLSE) on the last trading day for the year 2000 (26 December 2000) showed that out of the top five companies, four were former public enterprises. They are Tenaga Nasional Bhd, Telekom Malaysia Bhd, Petronas Gas Bhd and Malaysia International Shipping Corporation Bhd. The former public enterprises commanded a big share of the market capital. The total market capital at the end of 2000 was RM433 billion (Investors Digest, January 2001). In other words, these companies are still fully controlled by the government as it maintains majority shareholding. The golden share that was held by the government remained high with the exception for MAS2. Political ownership in the other four selected privatised companies ranked at least 58 percent of the market capitalisation which are still with state equity ownership. This has indicated that political influence spans the state and the state is effectively the controlling shareholder. All the five companies studied show an improvement of the firms’ performance after privatisation in terms of operating efficiency and debt levels.

Politicians are motivated by their own self-interest. Since the objective of the politician is to gain votes for the next election as well as to get as much rent as possible from their position, the monitoring of these firms will be affected. The objective of corporate governance is not to shackle businesses but rather to balance the spirit of enterprise with greater accountability. It involves the balancing of internal and external factors of the firm. Within the firm, corporate governance is a set of arrangement that defines the relationship between the shareholders, directors, management and employees. This arrangement may be embed in the company law, security law, listing requirements, corporate charter, by-laws and shareholder agreements. The board of directors act as intermediary between the shareholders and the management that operates the firm. However, principal-agent problem always exists due to the inherent structure of the firm, owing to the conflict of interest between those who control the firm and those who supply the firm with external finance.

The external factors include external laws and institutions that provide level and competitive playing field, and discipline the behaviour of insiders. These institutions include regulatory framework such as accounting and auditing standards, laws and regulations; the financial sector such as a well-regulated banking system, transparent and efficient capital markets, contestable markets, and reputed agents that include lawyers, accountants, credit rating agencies, investment bankers and analysts, corporate governance analysts, financial media, environmentalists and consumer activists and other stakeholders.

One of the internal disciplinary mechanism systems is the board of directors. The directors stand between the shareholders and the management. They represent the shareholders by serving as a disciplinary mechanism to monitor the management. Their fiduciary duty to the shareholders is to motivate managers to enhance shareholder values.

Malaysia has a one-tier board system. There are two types of directors on this board system. The executive directors are from the management team (inside managers) and they are involved with the daily operations of the firm. While the non-executive directors are not from the management team (outside experts) that usually have good reputation in their respective fields. All directors are appointed by the controlling shareholder. It has stable shareholdings with high concentration of shareholdings and cross holdings due to family control and state ownership. In addition, firms also tend to have cozy relationships with the government.

It is clear that governance problems depend on the ownership structure of the firm. The corporate system on the other hand is shaped by the customs and legal environment. When the state intervenes directly in the corporate system, state ownership and political linkages between the various parties in the system are inevitably. Thus, the government can influence firms’ decisions and vice versa. The financial sector provides debt at cheap rates generally with the support of the government. The external markets may not function appropriately because of market barriers that are set by the government in order to fulfil its political agenda, such as the case of bailout of the financial sector by Danamodal and Danaharta. The funding for this bailout was from public savings through the sale of government guaranteed bonds to the financial institutions. The state controls the external environment by influencing the three external sectors: financial sector, regulatory sector and the markets. The state controls the financial sector through the regulatory bodies such as the Central Bank and the Securities Commission. For example in Malaysia, the regulatory structure is governed by the Companies Act 1965, the Capital Markets and Services Act 2007 and the Banking and Financial Institutions Act 1989. The Minister of Domestic Trade and Consumer Affairs enforces the Companies Act, while the Minister of Finance enforces the others.

As for the control of the market, the state being the majority shareholder can control the internal environment by controlling the board of directors. For instance, the directors are appointed by the state. The board in turn is responsible for appointing the management team. With strong political influence in the corporate system, it seems that the enforcement of laws will be very difficult. When deficient management is combined with weak banks, under-regulated capital markets and feeble law enforcement of external discipline, the whole system could implode.

The lack of competition in the product market also poses another problem. Some firms are operating as a virtual monopoly in the domestic market. These firms may not be a problem even if governance is poor because they have strong market share and they are heavily protected. Entry and exit is regulated by the state. Complications will arise when a poorly governed firm operates in a competitive market. MAS, for example, operate in a very competitive market especially on the international routes. Good governance here is crucial because MAS will be competing with highly disciplined international airlines. Deficient management would be costly to the firm. Therefore, privatisation is not an end in itself. Privatisation must be accompanied by good corporate governance in order to achieve a better outcome.

In a regulated firm, a politician can force the private sector to pay for the inefficiency. Hence, it is politically costly to subsidise privatised firms. This is one of the perils of privatisation without deregulation (Shleifer and Vishny, 1994). But after the 1997 crisis which revealed poor management and inefficiencies, investors are increasingly unwilling to pay for the inefficiencies. As such, the government had to re-nationalise the privatised projects. These include two light rail projects, MAS, a sewer system, and PROTON, amongst others.

In a nutshell, in order to possess good governance in a system of political ownership, greater transparency in governance, regulation and enforcement are necessity. To ensure transparency, it would be better to delink the political and corporate relationship to an arm’s length relationship. Politicians should concentrate on governance, not business. The regulators’ failure to impose penalties on violators has compounded the problem of weak enforcement of minority shareholder rights and the weak disclosure regime in Malaysia. Despite various rules and the reforms, which have been implemented, minority shareholders are still exposed to risk.