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Trade and Industry Department The Government of the Hong Kong Special Administrative Region
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Speeches

Speech by the Director-General of Trade and Industry
Tuesday, April 10, 2001

The Hong Kong Institute of Directors Luncheon Meeting
Corporate Governance and SMEs

Moses, members of HKID, ladies and gentlemen,

Thank you, Moses, for inviting me to address today's luncheon meeting of the Hong Kong Institute of Directors.

2. As the premier body representing professional Directors in Hong Kong, the Hong Kong Institute of Directors has been a major driving force in raising the community's awareness of the significance of good corporate governance for our companies and upgrading the professionalism of company directors. The Institute has been and, I'm sure will continue to be, a valuable partner to our corporate sector in spreading good corporate governance practices among Hong Kong enterprises.

3. By and large, the concept of "corporate governance" is more familiar to large private corporations, publicly-listed companies and public organizations. But I would argue that the concept is equally relevant for small and medium enterprises (SMEs). I would like to spend a few minutes discussing why I believe small and medium enterprises (SMEs) should also embrace and practice "corporate governance" and cultivate corporate culture. And how it would benefit SMEs in their strive to take full advantage of the business opportunities arising from China's accession to WTO, to further develop and prosper in their respective industries/sectors, and to co-exist with large corporations in an increasingly competitive and globalised market.

4. According to the preamble to the OECD Principles of Corporate Governance (1999), corporate governance is about the institutionalisation of "a set of relationship between a company's management, its board, its shareholders and other stakeholders". Corporate governance is concerned about such values as openness, integrity, accountability and transparency. These are not terribly complicated technical jargons. They are straight forward descriptions of a healthy state of affair. They have become the lynchpin of all well-organised and successful companies and indeed the hallmark of professional management. More importantly, good governance is fundamental to attracting investments, building corporate image and furthering Hong Kong's status as an international financial centre. It is no wonder that large corporations, publicly-listed companies and public organizations in Hong Kong have placed great emphasis on fostering good governance standards. Indeed I am proud to note that the corporate governance standards in Hong Kong are regarded to be among the highest in the Region.

5. Of course, setting high corporate governance standards is not enough. To ensure lasting effects, there is the need to inculcate strong corporate culture. Corporate culture is a set of vision, mission and values that is commonly shared by members of a corporation, ranging from the owners and the top managers to the rank and file staff. Again, I am aware that our large corporations have been more active in cultivating corporate culture, as they realise that proper corporate culture would help to foster team work, enhance staff morale, motivate resources, minimise staff wastage and could have positive effect on a corporation's long-term economic performance.

6. In fact, the positive effects of good corporate culture on corporations' long term economic performance have long been the subject of academic researches.

7. In their book "Corporate Culture and Performanc" published some 9 years ago, Professor John Kotter and James Heskett - both from the Harvard Business School - presented an analysis of the financial performance of 207 U.S. companies over a period of eleven years from 1977 to 1988. Using a survey questionnaire, the two professors constructed an index measuring the relative cultural strengths of these companies. Then, they evaluated these companies' 1977-1988 financial performance using three different measures, namely average yearly increase in income, average yearly return on investment and average yearly increase in stock price. Correlations tested the assertion that companies with strong cultures performed better than their weaker counterparts. Their book concluded that corporate culture could have a significant impact on a firm's long term economic performance and that corporate culture would probably be an even more important factor in determining the success or failure of firms in future.

8. The correlation between corporate cultures and economic performance was further illustrated by the results of the re-analysis work undertaken by Terrence Deal and Allan Kennedy, the joint authors of the book "Corporate Cultures: The Rites and Rituals of Corporate Life". They calculated the average performance of the top twenty culturally robust companies and compared these to ratings for the bottom twenty. The remarkable results showed that the culturally strong companies averaged 571% higher gains in operating earnings, 417% higher returns on investment and 363% increase in stock prices respectively than their culturally deprived counterparts over the eleven years.

9. In so far as SMEs in Hong Kong are concerned, I am afraid that the concepts of "corporate governance" and corporate culture are still somewhat foreign to the majority of them. Few are aware of their importance. Still less have actual experience of implementing good corporate governance standards or cultivating strong, consistent corporate culture in their own firm.

10. This is not surprising at all if we understand how the majority of our SMEs operate. As you are well aware, the main thrust of corporate governance is to enhance transparency and accountability in the relationship and interaction among the various stakeholders of a company. These stakeholders include Board of Directors, top management, owners and others interested in the affairs of the company, such as creditors, debt financiers, investors, analysts, auditors and corporate regulators. As regards corporate culture, it aims to spearhead efforts towards common objectives and goals. Most of our SMEs have rather simple organizational or hierarchical structures. An SME may comprise only the owner, who may also be the sole proprietor and manager of the company, plus a few employees, some of whom may be his immediate family members or relatives. The main preoccupation of the owner is to sell certain goods or services to his customers. He would argue that as a small firm he can hardly afford the energy to focus on other things. He probably would not envisage the scenario of being accountable to any third party. He may well have bankers to work along with, but probably their relationship is nothing more than that of a borrower and a lender. He would not expect his part-time accountant or auditor to perform functions other than those required to fulfill the bare minimum requirements. He probably does not see his suppliers and customers as strategic partners. Nor does he envisage the need to set long term goals with his staff, as more often than not, he is the motivator in the company whereas the rest would merely take instructions from him. In such a somewhat "closed" system, there will not be much incentives for an SME to look beyond his day-to-day preoccupations to think about seemingly philosophical concepts like corporate governance.

11. But, I would urge SMEs with such mindset to ask themselves this question: how long would they expect to be able to continue to function and operate in such an "old fashioned manner" before they are overtaken by their competitors, be they visionary local SMEs, expanding large corporations and overseas competitors? And, how long could they remain competitive to meet the new opportunities and challenges lying ahead without paying attention to values such as transparency, disclosure, accountability and openness?

12. I think for many SMEs, the answer is: "I don't know." And let me say this, the correct answer is: "probably not very long". The increasingly globalised world economy, the advent of the knowledge-based economy, the changes that are brought about by the advancement in information technology, and the opening up of the Mainland market as a result of the Mainland's accession to the WTO have created tremendous pressure on corporations. Whether they are SMEs or large corporations, they need to change their way of doing business, to enhance their capabilities in all aspects, and to reposition themselves in order to remain competitive and take full advantage of new business opportunities.

13. First, the advent of information technology, particularly e-commerce and Internet, has cut cross all national boundaries. This means greater and easier access to new markets and new customers almost anywhere in the world at very low cost. In the past, only multinational corporations (MNCs) could afford to establish market presence in places away from their home grounds. However, with internet and e-commerce, even an SME could be transformed overnight into an MNC, in terms of market coverage if not in terms of company size or turnover. While SMEs which are adaptive to these technological changes could successfully ride on the IT superhighway and expand their markets, those that fail to take advantage of what IT can offer would not just be left behind, but would find their markets contracting.

14. If you ask me what distinguishes a visionary and aggressive SME from a non-performing one in an era of rapid and constant changes, I would say it is the mindset of the management. And SMEs that are well-run and have the right corporate culture would, I believe, stand a much better chance of having the right mindset to cope with such changes.

15. Another point to note is China's accession to the WTO. It will lead to the further opening up of the Mainland market and hence greater business opportunities to SMEs. First, SMEs in the import and export sector, which account for 99% of the import and export firms in Hong Kong, would certainly benefit from the relaxation of export and distribution rights of the Mainland. Secondly, SMEs in the services and professional sectors would benefit as there would be strong demand for imported professional services in the Mainland to fill up the emerging demand/supply gaps. But opportunities do not stop here.

16. More important still, the further opening up of the Mainland market would not only attract overseas SMEs to enter the Mainland market. I believe many Mainland SMEs would also be tempted to explore new opportunities in overseas markets. For SMEs in the Mainland or overseas, the markets they are going to explore could be entirely strangers to them. It would therefore make sense for them to look for strategic partners who know the markets well, to mimimise risks and to avoid beating about the bush. Given the profound knowledge of Hong Kong SMEs on both the Mainland and overseas markets, and the business network they have built up in both places over the years, Hong Kong SMEs would naturally be the preferred strategic partners to both Mainland and overseas SMEs. So ample opportunities are awaiting Hong Kong SMEs now and in the years to come.

17. But some SMEs may ask : to what extent would corporate governance and corporate culture impact on their abilities to embrace these challenges and opportunities. I would say "to a very great extent". First, SMEs would need to expand in order to leverage on these opportunities. And to expand, they most probably need additional funding. Be they banks, individual investors or venture capitalists from whom SMEs are seeking financing, all these parties would be more inclined to provide lending to or to invest in well-run SMEs. This is because bankers, investors and venture capitalists know too well that SMEs that are not well managed tend to be more risky entities, as they often lack clear and proper financial accounts and bookkeeping records and are therefore high risk business partners or borrowers. They would rather choose not to form strategic partners or do business with risky SMEs.

18. Not only bankers and investors look for properly run SMEs for business and investment, so would overseas and Mainland SMEs who are looking for strategic partners with Hong Kong SMEs. Overseas SMEs in particular are likely to be very demanding on the background of their strategic partners. Without any experiences in collaborating with Hong Kong SMEs, they would naturally assess a Hong Kong SME in terms of its corporate governance standards and corporate culture, as these are more easily observable indicators of the extent of openness, integrity, accountability, trustworthiness and capabilities of a corporation.

19. In sum, my message to our SMEs is this: "corporate governance" is not an exclusive label or luxury reserved for big boys. It has become a necessity for small and medium firms. The importance of practicing good corporate governance and cultivating strong corporate culture can no longer be ignored. To help them to come to this awakening, the Trade and Industry Department will be working closely with your Institute to bring home the message to our SMEs. In this regard, I have pleasure to inform you that a seminar to raise the awareness of SMEs on the importance of corporate governance and the proper roles of a company director will be jointly organised by my Department and your Institute on 5 May. The seminar will only be the first move of both of us in this direction. I look forward to many more opportunities of cooperating with your Institute to pursue such worthwhile cause together in future.

20. Thank you.