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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 ...

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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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...Business economics review vol no corporate governance philippine style who controls the ball michael john sullivan angelo unite introduction can be viewed as relationship between stakeholders and managers how these participants determine direction of corporation is manifested varies among performance economies depending on role importance are affected by type system in place evolution maturity influential typically include shareholders directors some cases may common stock board creditors government employees suppliers customers three models discussed literature capital market model industrial group entrepreneurial prowse garvey swan megginson discussing effectiveness alternative forms it important to answer basic question able assure themselves receiving a return their investment or more importantly stockholders legal owners that managed with interests mind intent this research investigate analyze an emerging economy whether anglo ll merican japanese german form has evolved particular...

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