CORPORATE GOVERNANCE IN TAIWAN 235 Corporate Governance in Taiwan: empirical evidence from Taiwanese company directors* Jill F. Solomon**, Shih Wei Lin, Simon D. Norton and Aris Solomon In this paper we present empirical evidence on the attitudes of Taiwanese company directors on the role and function of the board of directors in Taiwanese corporate governance. Our findings arise from a questionnaire survey distributed to the directors of a sample of companies listed on the Taiwanese Securities Exchange (TSE). Our findings provide a picture of the current state of corporate governance in Taiwan. The respondents indicate that the board of directors constitutes the most important instrument in Taiwanese corporate governance and our findings endorse the important role played by outside directors in the corporate governance system in Taiwan. Furthermore, the respondents endorsed the agency theory perspective on corporate governance as they considered the presence of outside directors improved corporate accountability to shareholders. There is, however, evidence that few companies have created remuneration and audit committees. We also found that Taiwanese directors are dissatisfied with the influence of families on the corporate governance of listed companies and do not consider that outside directors on boards should be related to founding families. Overall, the directors displayed an awareness of accountability issues and a desire to improve accountability and transparency. They clearly want international harmonisation of corporate governance standards and view corporate governance reform as a means of attracting foreign funds into Taiwan. This is an important finding as it endorses the work of the OECD and other international bodies in harmonising corporate governance at a global level. Keywords: Corporate governance, Taiwan, boards of directors, family control Introduction C orporate governance reform has become a global issue over the last decade. Countries around the world have been amending their legal systems and stock exchange listing requirements to reform corporate governance as well as developing new codes of best practice. There has been a growing realisation that in order for companies in countries across the world to become internationally competitive and able to attract foreign capital, they need to adopt commonly accepted standards of corporate governance. Recent scandals such as Enron and WorldCom in the US have raised global awareness of corporate governance problems. The international financial markets require a lowest common denominator of corporate governance standards which is best described in the OECD’s (1999) international corporate governance code. Greater accountability and transparency are essential if companies are going to attract foreign institutional investors. More equitable treatment of share- © Blackwell Publishing Ltd 2003. 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA. Volume 11 *This paper was presented at the 5th International Conference on Corporate Governance and Direction, 8–10 October 2002, at the Centre for Board Effectiveness, Henley Management College. ** Address for correspondence: Cardiff Business School, Cardiff University, Aberconway Building, Colum Drive, Cardiff CF10 3EU; E-mail: SOLOMONJF@cardiff.ac.uk Number 3 July 2003 CORPORATE GOVERNANCE 236 holders, greater accountability of directors and management to shareholders and stakeholders, and improved transparency of financial reporting are areas where there appears to be an international consensus. Taiwan is one country which has been focusing on corporate governance reform. Corporate governance has been acknowledged as relatively weak in many Asian countries, with companies being widely associated with creative accounting and lack of transparency in their operations, as well as notorious and frequent cases of fraud by company management (Taipei Times, 18 July 2000). Taiwanese companies have been criticised for lack of transparency and analyst bias in their financial reports (Zun, 2002). Indeed, there are growing concerns that despite substantial corporate governance reforms in East Asian countries in the aftermath of the 1997 Asian financial crisis, there may be many dormant Enron-style problems ready to erupt in the near future. Problems of transparency, especially weakness in accounting practice and company disclosures are considered significant in Asia (Taipei Times, 15 July 2002). As a result of world-wide concerns over corporate governance, Taiwan produced its first corporate governance code of practice in October 2002 (Security and Futures Commission, 2002). This takes a similar approach to that adopted by UK codes of practice as it is voluntary in nature and is based on the OECD Principles for good corporate governance. Since the Asian crisis in 1997 many countries in Asia have developed similar codes of best practice and have reformed corporate governance significantly. Indeed, some consider that from a markets perspective such reform may be seen as a positive by-product of the crisis (Taipei Times, 8 July 2002). However, this can hardly be said to compensate for the poverty and social trauma resulting from the crisis. In this paper we explore the attitudes of Taiwanese company directors towards corporate governance and towards the role and function of the board of directors in Taiwanese corporate governance. We employ an extensive postal questionnaire survey to canvas the views of Taiwanese company directors on a number of corporate governance issues in Taiwan as well as on corporate governance in an international context. The second section discusses the importance of the board of directors in corporate governance and outlines the characteristics of the Taiwanese system of corporate governance. Following this, we discuss the sample selection and research methodology, and then present the empirical evidence from the questionnaire survey. The paper concludes with a discussion. Volume 11 Number 3 July 2003 Corporate governance in Taiwan An overview of the corporate governance system in Taiwan Recent years have witnessed increasing pressure to harmonise corporate governance standards at an international level. The OECD’s (1999) global principles of “good” corporate governance were developed on the rationale that common international standards of corporate governance are essential for the expansion of international institutional investment and for the closer integration of global financial markets. Companies in countries around the world will be unable to attract foreign investment unless they adhere to basic common principles of good practice in all areas of corporate governance. Indeed, over the last few years there has been a world-wide quest for improvement in corporate accountability and transparency. The Asian crisis in 1997 and corporate scandals such as Barings, WorldCom and Enron have highlighted that need for corporate governance reform at a global level (Demirag and Solomon, 2003). In response to the call for corporate governance reform, many countries have changed their corporate laws or have reviewed the requirements for firms to be listed on stock exchanges. There have been detailed changes to company law in many countries following the financial crisis of 1997. Taiwan is a relatively new economic unit which continues to develop at an impressive rate. La Porta et al. (1998) studied the ownership structure of the ten largest nonfinancial corporations for a cross-section of 49 countries, including nine from East Asia. La Porta et al. (1999) studied the control structure of the largest 20 publicly traded companies in four East Asian countries (as well as 23 other countries around the world). Their evidence firmly supports the insider model for many East Asian economies characterised by a concentration of ownership resulting in control of companies being held predominantly by a small number of owners, although less so in Japan and South Korea. Taiwan is characterised by a codified style of legal system, which has influenced the development of the country’s system of corporate governance, deriving from the German legal origin (La Porta et al., 1997). According to the empirical literature, there is a significant relationship between the legal system operating in a country and a company’s ability to attract external finance. Indeed, La Porta et al. (1997) investigated the extent to which differences in the nature and effectiveness of financial systems around the world can be © Blackwell Publishing Ltd 2003 CORPORATE GOVERNANCE IN TAIWAN attributed in part to differences in the level of legal investor protection. Whereas English law (and legal systems derived from English law) is common law, established by judges and then incorporated into legislature, the legal systems based on French, German and Scandinavian models constitute the civil law tradition which involves codified legal structures. Research has shown that common law countries offer the strongest levels of investor protection, whereas countries characterised by French civil law provide the least protection for investors and legal systems of German and Scandinavian origin offer investor protection somewhere in between the two extremes. La Porta et al. (1997) found that levels of investor protection in different countries (using their own measures) capture some, but not all, of the difference between legal environments across origins. They also find that civil law countries are significantly associated with weaker investor protections and the least developed capital markets, compared with common law countries. A German origin legal system therefore places Taiwan somewhere in the middle, with mediocre investor protection and a developing capital system. As a result of the legal and cultural background of Taiwan, Taiwanese corporate governance is considered to fit more closely in the “insider-oriented” corporate governance mould, as do most East Asian countries, with ownership and control concentrated predominantly in founding families. The distinction between “insider systems” and “outsider systems” refers to two different forms of corporate governance system (Franks and Mayer, 1994). Insider systems are characterised by concentration of corporate ownership by a small number of other firms, banks and/or families. Crossshareholdings between firms are common. Alternately, in outsider systems, where ownership is dispersed among a large number of individual and institutional investors, crossshareholdings are rare. There are three levels of influence on Taiwanese corporate governance from the view of compliance. First, company law sets out the legal position with which Taiwanese companies have to comply (Company Law, 2001). Secondly, there is a series of listing requirements which applies to all companies listed on the Taiwanese stock exchange. These are therefore mandatory in nature. Third, there is the new voluntary code of practice (Security and Futures Exchange, 2002). Recently, a realisation has spread across countries that better investor protection and reformed corporate governance results in a stronger capitalist system, and attracts equity investment. As a result of this recognition, many countries with © Blackwell Publishing Ltd 2003 237 civil law systems have operationalised corporate governance reform through amendments to company law. For example, South Korea (deriving from German origin) has made a series of changes to the Korean Commercial Code with the aim of improving minority shareholder rights and improving corporate accountability to shareholders through the production of consolidated accounts which comply with International Accounting Standards (Kim, 1999, 2000). Greece (deriving from French origin) has also amended its company law to improve its system of corporate governance (Milonas et al., 2002). Although Taiwan emerged as a country with relatively weak investor protections and relatively weak equity investment in previous research (La Porta et al., 1997), there have been significant amendments to Taiwanese company law which have probably served to reduce the differences between their system and that in English law countries. Detailed study of the most recent version of the Taiwanese Articles of Incorporation (Company Law, 2001) provides a positive image of investor protection. It seems that the level of protection currently afforded investors by company law in Taiwan is comparable to that in the UK. It arises from a codified rather than a common law base. This is in part a result of recent amendments to company law. Indeed, at the margin, there is more investor protection than in the UK system, partly due to the detailed codified character of Taiwanese company law. The issues of unanimity in shareholder-related decision represents a strong element of investor protection which is not present in UK company law. There seems to be more protection of minority shareholders in Taiwan now than in the UK. One important area where investor protection is significantly different is in the area of liability. Limited liability of shareholders is entrenched in the UK company law system. In Taiwan, the Articles of Incorporation suggest substantial liabilities for shareholders. However, these are not necessarily significant for companies as the articles are amended at the individual company level to reduce shareholder liability. The Taiwan stock exchange listing requirements are very similar to those that apply in the UK both in terms of procedural requirements, informational content of circulars and remedies available to investors in respect of material misrepresentations. The Taiwan requirements arguably foster a greater awareness of corporate governance considerations and investor protection than the UK, as evidenced in, for example, Article 32. This Article provides that in respect of the provision of false or misleading information in an invest- Volume 11 Number 3 July 2003 CORPORATE GOVERNANCE 238 ment circular by the issuer, liability owed to adversely affected investors is extended to include employees, underwriters, accountants, attorneys or other professions in certain circumstances. This provision has the practical effect of extending the investigative obligations of professional advisors beyond that which currently prevails in the UK system. Under section 4 of the exchange listing rules, Article 157-1 gives indirect protection to investors against insider dealing. This Article states that if a director takes advantage of confidential information which may have a “material impact” on the price of shares of the company and makes a profit, such a director shall be accountable to the company (and in this way to the shareholders) for any profit which has been obtained in this way. Despite the fact that the legislative framework and procedural listing requirements either mirror or exceed those to be found in common law jurisdictions (such as the UK), a distinction must be drawn between legal formalism and cultural adherence. In the context of Taiwan, although corporate governance systems and structures are now in place, the question remains as to the extent to which these have become entrenched in the attitudes and cultural norms of both investors and investee companies. Until these two facets elide, and so long as a difference between the two persists, the international investor community cannot depend exclusively and indeed safely upon the formal mechanisms which have only recently been put in place. Improvements in investor protections in company law are not enough per se to ensure capital market expansion and attract foreign capital. The political risk level in Taiwan is extremely high, given the evolving political situation and this acts as a severe deterrent to foreign institutional investment in Taiwanese companies. Further, Taiwan is faced by intense competition from other East Asian Tigers such as South Korea. As suggested by La Porta et al. (1997), the legal system is not the full story. Hypothesis One: company directors want corporate governance reform in Taiwan and want to adopt internationally acceptable corporate governance standards. Family control and crony capitalism Family-owned business is an important and common phenomenon in Chinese companies. Regardless of the size, most Taiwanese companies are family owned and family controlled. The majority of companies are directly or indirectly run by founding family members, even though they may be listed on the stock Volume 11 Number 3 July 2003 market. Tightening of regulation to prevent misuse of company funds by directors is a necessary and urgent requirement if investors are to be attracted and retained (Taipei Times, 18 July 2000). Two characteristics are generally associated with Taiwanese family-owned companies: non-separation of ownership and management, and a confused organisational structure (Yeh, 1997). In a detailed study of the extent of separation and control in nine East Asian countries, Claessens et al. (2000) found extensive family control in more than half of the East Asian companies under study. They found that Taiwan was characterised by large family-controlled firms.1 However, they found that there was significant separation of ownership and control in large Taiwanese familycontrolled firms. They found that control is enhanced through pyramid structures and cross-holdings among firms in all the East Asian countries studied, so that even where control by founding families is not direct, the families have retained control through indirect shareholding networks. Further, ownership concentration in Taiwan has been found to be relatively lower than in other East Asian economies, except for Japan (Claessens et al., 2000). In Taiwan, it has been shown that about 60 per cent of companies on average do not have widely dispersed ownership with the controlling owners appointing members of top management (Claessens et al., 2000). Indeed, this study found that more than fourfifths of Taiwanese companies have managers who belong to the controlling group. Further, the proportion of family control in Taiwanese listed companies has been estimated at 20.1 per cent.2 A large concentration of family control can have a number of negative effects on the functioning of a country’s capital system including: powerful incentives and abilities to lobby government agencies and public officials for preferential treatment; a negative effect on the evolution of a country’s legal system; suppression of minority rights; the holding back of institutional development of legal and regulatory channels required to enforce minority rights; and direct participation by government officials in the control of a large part of the corporate sector leading to “crony capitalism” (Claessens et al., 2000). For example, links between family shareholders and politicians have been highlighted as a serious weakness in Taiwanese corporate governance which hinders progress in corporate governance reform (Zun, 2002). Lack of separation of ownership and management implies that agency problems seldom challenge Taiwanese family-owned companies and this can lead to abuse of power and lack of transparency. A further problem is that significant © Blackwell Publishing Ltd 2003 CORPORATE GOVERNANCE IN TAIWAN levels of family ownership and control are generally associated in Taiwanese companies with the rights of minority shareholders being ignored (Lee, 2002). Indeed, in Taiwan more than 80 per cent of firms are small and medium-sized enterprises whose shares are concentrated in the hands of just a few shareholders. Consequently, the power to run these firms tends to rest with the founding family members, such that shareholders have no sway over the companies and receive company information late, if at all (Lee, 2002). Further, the powerful influence of families on Taiwanese companies has been isolated as presenting a serious obstacle to corporate governance reform (Zun, 2002). In order to compete with foreign companies – especially in the high-technology sector – Taiwanese companies have to raise money in the capital market, which means that outside funds will flow into the traditional companies. It is unavoidable that the original owners have to share power with outside shareholders. However, in order to enhance the competitive position of companies, the owners have to hire professional managers to run companies. There is therefore a growing separation of ownership and management in Taiwanese companies, resulting in the emergence of agency problems, hitherto absent in Taiwanese companies. Hypothesis Two: company directors view the level of family control in Taiwan as a hindrance to good corporate governance and as an area where improvements and controls are necessary. The role of the board of directors, supervisors, and the auditing function in Taiwanese corporate governance According to Taiwan Company Law (2001), there are three major mechanisms operating within the Taiwanese corporate governance system – shareholders’ meetings, board of directors as well as directors, and supervisors. The major function of the shareholders’ meeting is to elect directors and supervisors. The board of directors is in charge of managing the company. Company Law (2001) regulates that the board of directors has the power to run the business without seeking shareholders’ agreement except in special situations. Supervisors are designed to monitor the board of directors, who are responsible for reviewing the directors’ decisions as well as the reports provided by the directors to shareholders, and solving the conflicts between shareholders and directors (Her, 1999). However, there tends to be no clear distinction between management, the board of directors © Blackwell Publishing Ltd 2003 239 and supervisors, as in most firms the directors are also managers or are closely related to management (Lee, 2002). Further, there continues to be a significant lack of independent directors in practice. There are two forms of shareholder meeting; common shareholders’ meetings and special shareholders’ meetings. Common shareholders’ meetings are called at least once a year, whereas special shareholders’ meetings are called in special circumstances. In theory, the shareholders’ meetings are important to the corporate governance function. However, in listed companies there are many shareholders and they have little influence on the company such that in practice the boards of directors exercise their power at shareholders’ meetings and are in a position to abuse their power. According to Taiwan Company Law (2001), the minimum number of directors is three and the directors are elected by shareholders in the shareholders’ meeting. Until the most recent amendment of Company Law (2001), Taiwanese directors had to hold shares in the company: very different from the qualification of directors in UK, US, German and Japanese boards. This has now been relaxed and is more consistent with UK practice. Previously, in Taiwan, it was accepted generally that if the directors did not hold shares in the company, they were not likely to protect the shareholders’ interest. Supervisors are a unique feature of Taiwanese and Japanese boards. Taiwan Company Law (2001) specifies that supervisors must be selected from shareholders in the shareholders’ meeting. In other words, the supervisors also have to be shareholders (like the directors), but the supervisors cannot be the directors and managers at the same time. These supervisors have the power to review all information disclosed by the company. Taiwanese supervisors are different from German directors in the supervisory boards. Basically, German directors in the supervisory boards must work as a group or committee, but Taiwanese supervisors have to work independently. In this way there are similarities to Japanese supervisors, who also monitor the companies and oversee management personally. In fact, the Taiwanese supervisory system is derived from the Japanese supervisory system. In practice, supervisors in Taiwan are usually under the shadow of directors; it is very common to find that the supervisors and directors belong to the same group. There are two additional differences between Taiwanese supervisors and German supervisory boards; one is that the directors in German supervisory boards have the power to elect and Volume 11 Number 3 July 2003 CORPORATE GOVERNANCE 240 dismiss the directors of management boards; the other is that German supervisory boards have a more defined hierarchy than management boards, but Taiwanese supervisors belong to the same level with the directors. To sum up, Taiwanese directors play a similar role to inside directors in the UK and US; moreover, Taiwanese supervisors also play a similar role to outside directors in the UK and US. However, in terms of corporate governance, supervisors do not tend to discuss company problems with the auditors, which weakens the function of internal control in Taiwan (Ming-Chiu, 2002). In Taiwanese listed companies, the directors are elected by the shareholders, the chairman is selected by the directors and the CEO is nominated by the chairman, and then approved by the directors. From this chain, we can see that the chairman must be responsible to the directors, the directors must be responsible to the shareholders, and the CEO must be responsible to the chairman and directors. In such a model, it is easy to see that the Taiwanese corporate governance system is built on interlocking accountability and control with the ultimate power appearing to lie with the shareholders. However, in practice, because of the family-oriented tradition, the control mechanism does not operate in this way. In many Taiwanese companies, the chairman and CEO are the same person. By contrast, Patton and Baker (1987) consider that when the chairman is also the CEO, the CEO will protect his own interest to decrease the functions of the boards. Compared with major advanced countries, although the election method of CEO in Taiwan is similar to others, the power distribution is different. For example, the dominant power in US companies belongs to the CEO; the CEO is responsible for business operations. However, in Taiwan the power belongs to the chairman. Taiwanese companies are characterised by family control with the father or the oldest one in the family usually holding the position of chairman; so even though the CEO election method is similar to that in other countries, the chairman still retains most of the power. Fama (1980) and Williamson (1963) consider that the function of the board of directors can solve agency problems. Williamson initiated the “substitution hypothesis”, which hypothesised that the mechanism of boards of directors can act as a substitute for the takeover mechanism as a means of disciplining company management and reducing agency problems. In Taiwan there are almost no cases of mergers and acquisitions, which makes the function of the board of directors extremely Volume 11 Number 3 July 2003 important to the corporate governance system. Two common problems arise in Taiwanese boards; one is the quality of directors, the other is the tenure of directors. Concerning quality of directors, in Taiwan the relationship with the owner will decide the candidate of director, not the expertise; besides, there are very few companies providing the necessary training programmes for directors; the quality of directors cannot be upgraded. The quality of directors is an important factor influencing the quality of corporate governance. The other problem is that the directors in Taiwanese companies seldom change. Although Company Law (2001) stipulates the tenure of directors and supervisors as three years, it does not limit the number of times they may be re-elected, which means that they can serve in the same companies for a very long time. In Taiwanese listed companies, the directors and supervisors hold a considerable proportion of all the shares issued – between approximately 10 and 30 per cent. According to the Taiwan Securities Transaction Code 26, the proportion of shares held by all the directors and supervisors has traditionally had to remain at an amount stipulated by the authorities. This has changed with the recent amendment to Company Law (2001). This makes corporate governance reform difficult and attempts to imitate a more Anglo-Saxon style of corporate governance system may be halted by such regulation. We now turn to our research methodology and the results of our survey. Sample selection and research methodology In August 2000 we distributed a detailed postal questionnaire to the directors of listed companies on the Taiwan Security Exchange (TSE). We took a random sample of approximately half of the companies listed on the TSE. The questionnaire focused on the role and function of boards of directors in corporate governance in Taiwan. Both open and closed questions were included in the questionnaire design. The questionnaire was distributed in both English and Mandarin Chinese in order to avoid problems of comprehension and consistency. Of the 252 questionnaire distributed, 56 questionnaires were returned, providing a response rate of 22.22 per cent. We received 55 fully completed questionnaires providing a usable response rate of 21.83 per cent, which is comparable to rates from other surveys in accounting and finance. © Blackwell Publishing Ltd 2003 CORPORATE GOVERNANCE IN TAIWAN 241 Empirical evidence In this section we present the overall corporate governance views of company directors in Taiwan arising from our empirical research. First, we sketch a picture of the current state of corporate governance within Taiwanese companies from the responses to the questionnaire. Then we provide some evidence to support hypotheses one and two developed earlier. Throughout this section we make reference to a number of tables presenting the descriptive statistics. Table 1 presents the respondents’ general attitudes towards corporate governance. In Table 2 we provide descriptive statistics summarising the company directors’ views of the role of the board of directors in Taiwanese corporate governance. Table 3 presents evidence relating to board selection; data relating to board size and composition are displayed in Table 4. In Table 5 we present our findings on the role of outside directors in Taiwanese corporate governance. Table 6 displays results concerning factors affecting corporate performance and Tables 7 and 8 provide empirical evidence relating to remuneration and audit committees, respectively. (i) A picture of corporate governance in Taiwanese listed companies We asked directors a number of questions relating to the various corporate governance mechanisms in Taiwanese listed companies and their function. Our findings cover: the role of the board of directors, board structure, remuneration and corporate performance, the role of outside directors, the role of the audit function and the role of shareholders. We deal with each of these in turn. The role of the board of directors in corporate governance We can see from the survey results that company directors consider their own role to be of utmost importance to corporate governance (Table 1, statement (b); mean of 4.78, median of 5, mode of 4). Further, from our findings we can see that the ability of boards to “make things happen” is seen as extremely important by the respondents (statement (a) in Table 2; mean of 5.71; median of 6; mode of 7). We also found that one major function of Taiwanese Boards is to choose the directors’ candidate (statement (c) in Table 3). The Table 1: General attitudes towards Corporate Governance N Mean Median Mode SD Min Max 55 5.05 5 4 1.35 2 7 (b) I believe that the board of directors is the most important instrument of good corporate governance 55 4.78 5 4 1.20 2 7 (c) 53 4.04 4 3 1.22 1 7 55 2.76 3 3 1.05 1 6 (a) I believe that there should be increased international harmonisation of corporate governance standards I believe that Taiwan companies should adopt a more Anglo-Saxon model of corporate governance (d) I believe that international harmonisation of corporate governance standards will not encourage foreign investors to invest in Taiwan companies Notes: The summary statistics are associated with the scores gained where respondents were asked to indicate the importance by encircling a score from a 7-point Likert scale from 1 (strongly disagree) to 7 (strongly agree). N refers to the valid number out of 55 respondents; Mean, to mean average score; Median, to median average score; Mode, to average score; and SD, to standard deviation of scores. Min refers to the minimum score and Max refers to the maximum score. © Blackwell Publishing Ltd 2003 Volume 11 Number 3 July 2003 CORPORATE GOVERNANCE 242 Table 2: The role of the board of directors in Taiwanese corporate governance N Mean Median Mode SD Min Max I believe that the boards should be concerned about their ability to “make things happen” 55 5.71 6 7 1.13 3 7 (b) I believe we should increase the proportion of the board’s time that is focused on strategic direction 55 5.42 6 6 1.36 2 7 (c) I consider that there should be training programmes for directors 55 5.15 5 4 1.41 2 7 (d) I believe that the board should be involved directly in risk management strategy 55 4.78 5 6 1.84 1 7 (e) I believe that it is necessary to improve the method of directors’ selection in the Taiwan Company Act 53 3.34 3 3 1.37 1 7 (f) I do not believe that the board will determine the quality of corporate governance 54 3.06 3 4 1.55 1 7 (a) Notes: The summary statistics are associated with the scores gained where respondents were asked to indicate the importance by encircling a score from a 7-point Likert scale from 1 (strongly disagree) to 7 (strongly agree). N refers to the valid number out of 55 respondents; Mean, to mean average score; Median, to median average score; Mode, to average score; and SD, to standard deviation of scores. Min refers to the minimum score and Max refers to the maximum score. Table 3: Board selection Yes No Don’t know Do you think the selection of directors in your company is in accordance with the Taiwan Company Act? 76 15 9 (b) Do you think that directors are selected by family members? 65 33 2 (c) 82 15 3 (a) Does your nominating committee rather than the CEO direct the search for new board members and invite candidates to stand for election? respondents seemed to have confidence in the role they play in corporate governance since, in response to a “yes/no” question asking the company directors whether or not they considered that their company’s board added value as much as it should, 64 per cent of the respondents agreed that it did. However this does beg the question, what about the other 36 per cent? Perhaps they consider that with more training their role and function could be Volume 11 Number 3 July 2003 improved. Indeed, the respondents agreed that there should be training programmes to strengthen the directors’ professional abilities (statement (c) in Table 2; mean of 5.15; median of 5; mode of 4). The respondents agreed strongly that the board of directors should increase the amount of time focused on strategic direction (statement (b) in Table 2; mean of 5.43, median and mode of 6) placing corporate strategy at the top of the list of directors’ duties. © Blackwell Publishing Ltd 2003 CORPORATE GOVERNANCE IN TAIWAN 243 Table 4: Board size and composition (a) I believe that the size of the board influences company performance. (b) I believe that it is necessary to limit the number of outside directors (c) I believe that employee representatives should have seats on the board. N Mean Median Mode SD Min Max 55 5.24 5 4 1.35 2 7 54 4.52 4 4 1.63 2 7 55 4.25 4 4 1.82 1 7 Notes: The summary statistics are associated with the scores gained where respondents were asked to indicate the importance by encircling a score from a 7-point Likert scale from 1 (strongly disagree) to 7 (strongly agree). N refers to the valid number out of 55 respondents; Mean, to mean average score; Median, to median average score; Mode, to average score; and SD, to standard deviation of scores. Min refers to the minimum score and Max refers to the maximum score. Table 5: The role of outside directors in Taiwanese corporate governance (a) (b) (c) (d) (e) (f) (g) (h) Outside directors should formally evaluate our CEO’s strengths, weaknesses, objectives, personal plans, and performance annually. Outside directors should annually review succession plans for senior management. The presence of outside directors improves accountability to shareholders. The presence of outside directors slows down management decisionmaking. From my experience outside directors are unnecessary. Outside directors perform no real function because all major decisions are in fact taken by inside directors. Outside directors should meet without management on a regular basis. Outside directors should have family ties to other directors, chairman, and CEO. N Mean Median Mode SD Min Max 55 4.89 4 4 1.33 3 7 55 4.35 4 4 1.51 1 7 55 4.20 4 4 1.25 1 7 55 3.33 3 3 1.35 1 6 55 3.29 4 4 1.15 1 6 54 2.96 3 2 1.2 1 7 54 2.24 2 1 1.26 1 7 55 2.11 2 1 1.21 1 7 Notes: The summary statistics are associated with the scores gained where respondents were asked to indicate the importance by encircling a score from a 7-point Likert scale from 1 (strongly disagree) to 7 (strongly agree). N refers to the valid number out of 55 respondents; Mean, to mean average score; Median, to median average score; Mode, to average score; and SD, to standard deviation of scores. Min refers to the minimum score and Max refers to the maximum score. © Blackwell Publishing Ltd 2003 Volume 11 Number 3 July 2003 CORPORATE GOVERNANCE 244 Table 6: Factors affecting corporate performance N Mean Median Mode SD Min Max 55 4.60 4 4 1.34 2 7 (b) The board needs outside directors to conduct an annual evaluation of the CEO. 54 4.33 4 4 1.45 1 7 (c) The success of companies does not depend on directors’ performance. 55 3.20 3 2 1.39 1 6 (d) Directors’ remuneration should be linked to share price performance. 55 2.38 2 2 1.19 1 6 (a) The structure of the board is related to corporate performance. Notes: The summary statistics are associated with the scores gained where respondents were asked to indicate the importance by encircling a score from a 7-point Likert scale from 1 (strongly disagree) to 7 (strongly agree). N refers to the valid number out of 55 respondents; Mean, to mean average score; Median, to median average score; Mode, to average score; and SD, to standard deviation of scores. Min refers to the minimum score and Max refers to the maximum score. Table 7: The remuneration committee Yes No Don’t know 8 92 0 63 37 0 Yes No Don’t know 24 76 0 (b) Does your audit committee, rather than management, have the authority to approve the partner in charge of auditing the company? 87 13 0 (c) 100 0 0 (a) Does your company have a remuneration committee? If the respondent answered “yes” to (h) they proceeded to answer (b) otherwise they proceeded to the next question (b) Has your remuneration committee established formulae for CEO remuneration based on long-term results? Table 8: The audit committee (a) Does your company have an audit committee? If the respondent answered “yes” to (a) they proceeded to (b) and (c), otherwise they proceeded straight to the following question. Does your audit committee routinely review high-exposure areas? Board structure and composition In relation to board structure, the directors were asked to indicate how many inside and outside directors were on their board of Volume 11 Number 3 July 2003 directors. The respondents indicated that, on average, the board included nine directors of whom there were an average of four inside directors and five outside directors. This suggests that in Taiwan the number of inside © Blackwell Publishing Ltd 2003 CORPORATE GOVERNANCE IN TAIWAN directors on the board is approximately equal to the number of outside directors, indicating that there is a balance of power between managers and owners. An interesting finding is that whereas codes of corporate governance in many countries focus on increasing the number of outside directors in order to improve the monitoring function of the boards, the respondents did not follow this trend. Instead, they agreed that it is necessary to limit the number of outside directors (statement (b) in Table 4; mean of 4.52, median of 4 and mode of 4). However, the relationship between these parties is not necessarily productive. We asked the directors whether or not there was mutual trust and understanding between the inside and outside directors and 85 per cent of the respondents stated that there was. Although this is a high percentage, it implies there are a substantial number of directors who do not consider mutual trust exists between these parties, and this is worrying in terms of corporate governance. In relation to dynamism within Taiwanese company boards, the company directors were asked whether or not their companies regularly reviewed their size and composition, and 64 per cent of the respondents stated that it did. This is an encouraging finding, but one that suggests more companies should adopt a more dynamic approach to corporate governance in this area. Overall, our findings suggest that the priority for Taiwanese boards is to keep a small, simple and efficient board so as to avoid conflict. The role of outside directors We can see that the respondents agreed quite strongly with the suggestion that outside directors should formally evaluate the strengths, weaknesses, objectives, personal plans and performance of the CEOs on an annual basis (statement (a) in Table 5; mean of 4.89; median and mode of 4). The results appear to indicate a reasonably developed and sophisticated system for outside directors. The function of outside directors may be interpreted as a means of lessening the agency problem by aligning the interests of management with those of shareholders. This perspective is supported by the respondents’ agreement with the suggestion that the presence of outside directors improves accountability to shareholders (statement (c) in Table 5; mean of 4.20; median and mode of 4). This finding also indicates some degree of awareness of accountability issues. Further support for the presence of outside directors and the usefulness of their function arises from the © Blackwell Publishing Ltd 2003 245 respondents’ disagreement with statements (d), (e) and (f) in Table 5. Factors affecting corporate performance We can see from our results that the directors believe that board size is related to corporate performance (statement (a) in Table 6; mean of 5.24, median of 5 and mode of 4). Further, the respondents agreed that the structure of the board is related to corporate performance (statement (a) in Table 6; mean of 4.60; median and mode of 4) and that the success of companies depends on directors’ performance (statement (c) in Table 6; mean of 3.20; median of 3; mode of 2). These findings reveal that the respondents believe the board and directors are the key indicators of the success of the company. Board remuneration In relation to remuneration of members of the board of directors, only 8 per cent of the responding companies stated that they had remuneration committees (statement (a) in Table 7). There is an obvious and interesting apparent contradiction between the respondents’ answers to two “yes/no” questions. First, when asked whether or not directors’ pay is linked to corporate performance, 67.3 per cent of the directors who responded stated that it was. However, when asked whether or not the performance of each of their directors was reviewed periodically, 78.2 per cent of the respondents stated that it was not. This begs the question, how can directors’ pay be related to performance when their performance is not reviewed? If directors’ performance is not reviewed, how can pay represent changes in performance? At this point there is no answer to these questions. As for directors’ remuneration, the respondents do not agree that it should be linked to stock performance (statement (d) in Table 7; mean of 2.38; median and mode of 2). This indicates that Taiwanese companies do not have a sophisticated remuneration policy. The role of the audit function and internal control Our findings indicate that there are few boards (24 per cent) with audit committees (statement (a) in Table 8). However, these are not formal audit committees comparable to those established in UK companies. They are, rather, informal precursors to a formalised system. The first formal audit committee in a Taiwanese company was not established until July 2002 by Taiwan Semiconductor Manufac- Volume 11 Number 3 July 2003 CORPORATE GOVERNANCE 246 turing Company (TSMC) (Chang and Chan, 2002). This is perhaps due to the two-tier style of Taiwanese boards, where the supervisors are encouraged to engage closely with the audit function. In Taiwan, there is no supervisory board such that the supervisors act individually. The supervisors have the right to check any detail of the company any time and must monitor the board of directors. Any financial report entering the public domain must first be agreed by supervisors. In other words, Taiwanese supervisors replace the role of the audit committee. (ii) A desire for corporate governance reform and internationally acceptable standards Our empirical results provide support for hypothesis one that Taiwanese company directors want corporate governance reform in Taiwan and want to adopt internationally acceptable corporate governance standards. Indeed, our findings provide strong support for the growing international harmonisation of corporate governance standards (statement (a) in Table 1; mean of 5.05; median of 5; mode of 4). However, the form which an eventual harmonised system would take is less clear, as the respondents were quite neutral concerning whether or not Taiwanese companies should adopt a more Anglo-Saxon style of corporate governance (statement (c) in Table 1 with a mean of 4.04 and median with 4 and mode with 3). One reason for the company directors’ desire to reform corporate governance seems to be founded in a desire to attract foreign investment, as the respondents disagreed strongly with the suggestion that the international harmonisation of corporate governance will not encourage foreign investors to invest in Taiwan companies (statement (d) in Table 1; mean of 2.76; median of 3; mode of 3). (iii) Family control and crony capitalism need to be curbed We also provide some support for hypothesis two that company directors view the level of family control in Taiwan as a hindrance to good corporate governance and as an area where improvements and controls are necessary. We can see that the respondents view excessive family control in a negative light from their strong disagreement with the suggestion that outside directors should have family ties to other directors, chairman and CEO (statement (h) in Table 5, mean of 2.11; median of 2, mode of 1). This clearly shows that they favour some independence of decision-making from their Volume 11 Number 3 July 2003 outside directors and see this as a means of controlling the negative effects of excessive family control. Interestingly, the respondents stated that 65 per cent of the respondents believe that directors are selected by family members (statement (b) in Table 3). However, this response provides no direct indication of whether or not the respondents see this as a positive or negative issue. It is, nevertheless likely that many company directors in Taiwan are uncomfortable with high levels of family control, as although they themselves are often selected by family members, they may not be related. They may therefore feel their position and decision-making ability is hindered by family interference. Concluding discussion and policy recommendations From our empirical research, we have found that Taiwanese company directors are extremely interested in corporate governance reform and consider that the board of directors is an essential mechanism in corporate governance. Specifically, the respondents indicated that outside directors play an important role in corporate governance and that their presence helps to align the interests of management and shareholders. This is particularly important in Taiwan given the relatively recent emergence of an agency problem. Only recently has there been an increasing separation of ownership and control in Taiwanese companies. Another salient issue is that of family influence. The directors who responded to our questionnaire indicated that they were not at all in favour of the continuing dominance of founding families over Taiwanese company management. They considered that outside directors should not be board members and that by reducing family control over Taiwanese companies corporate governance would improve. The results clearly indicated a desire to reform the system of corporate governance in Taiwan. However, in the area of director remuneration, our findings suggested that remuneration policies were not sophisticated. This is an area where attention could be focused in the future. The links between firm performance and remuneration of directors did not appear to be fully appreciated by the respondents. In relation to international developments in corporate governance, the respondents agreed that further international harmonisation of corporate governance standards represented an important development and they endorsed corporate governance reform at a global level. They also agreed that the need to attract inter- © Blackwell Publishing Ltd 2003 CORPORATE GOVERNANCE IN TAIWAN national capital was a main driver of international corporate governance harmonisation. Claessens et al. (2000) consider that crony capitalism arising from excessive family control of corporations can lead to a vicious circle where family groups lobby government, leading in turn to increasing family control and an increasing interdependence of politicians and tycoons. Indeed, they conclude that where wealth is concentrated in the hands of a few corporate families, this may have negatively affected the evolution of the legal and other institutional frameworks for corporate governance and may in fact present a barrier to future policy reform. It is therefore clear that the extent of family control in Taiwan needs to diminish. This is also the view of our questionnaire respondents. If family control is slowing down corporate governance reform in Taiwan and choking the free operation of the capital market system, then perhaps legislation is required to minimise the continuance of family control in Taiwanese companies in the future. Overall, our findings endorse the work of the OECD and other bodies who are encouraging countries around the world to improve and harmonise their corporate governance in line with internationally acceptable standards of corporate governance. Acknowledgements We are grateful to delegates attending the Fifth international conference on Corporate Governance and Direction, Henley Management College, October 2002, who provided helpful comments and suggestions on an earlier draft of this paper. We are also grateful to Brenda Thompson for editing and commenting on the paper. Thanks also to the many members of company boards in Taiwanese listed companies who were kind enough to participate in this research. Notes 1. The countries studied were Hong Kong, Indonesia, Japan, South Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand. 2. This is the proportion of total value of listed corporate assets that the Top 15 families control in 1996 and is reported in Claessens et al. (2000). References Chang, C. Z. and Chan, L. S. (2002) TSMC Establishes First Audit Committee, Economy Daily, 26 July (only available in Mandarin Chinese). © Blackwell Publishing Ltd 2003 247 Claessens, S., Djanklov, S. and Lang, L. H. P. (2000) The Separation of Ownership and Control in East Asian Corporations, Journal of Financial Economics, 58, 81–112. Company Law (2001) Company Law. Amended on 12 November 2001, translated into English by Lee & Li, Attorneys-at-Law, Taipei, Taiwan. Demirag, I. S. and Solomon, J. F. (2003) International Developments in Corporate Governance, Guest Editorial, Corporate Governance: An International Review, forthcoming. Fama, E. F. (1980) Agency Problems and the Theory of the Firm, Journal of Political Economy, 88, 288–307. Franks, J. and Mayer, C. (1994) The Ownership and Control of German Corporations, manuscript, London Business School. Her, M. M. (1999) Corporate Governance of FamilyControlled Publicly-Traded Firms: The Case of Taiwanese Listed Firms, PhD Dissertation, Texas A & M University. Kim, Y. (1999) The Meaning and Future Direction of the Establishment of Best Practices for Korean Corporate Governance, Sang-Jang-Hyup, 39, 1–29. Kim, J. (2000) Recent Amendments to the Korean Commercial Code and their Effects on International Competition, University of Pennsylvania Journal of International Economic Law, 21, 273–330. La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R. W. (1997) Legal Determinants of External Finance, Journal of Finance, 52(3), 1131–1150. La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R. (1998) Law and Finance, Journal of Political Economy, 106, 1113–1155. La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. (1999) Corporate Ownership Around the World, Journal of Finance, 54, 471–518. Lee, L. (2002) Time for Taiwan to Act on NonPerforming Loans, Taipei Times, 23 August. Milonas, N., Solomon, A., Solomon, J. F. and Travlos, N. (2002) Controlling the Growing Agency Problem: Should there be Further Mandatory Corporate Governance Reform in Greece? Paper presented at the Multinational Finance Conference, Paphos, Cyprus, July. Ming-Chiu, Y. (2002) Negligence Makes It Easy for Fraud, Taipei Times, 23 September. Organisation for Economic Co-operation and Development (OECD) (1999) OECD Principles of Corporate Governance. OECD, Paris, France. Patton, A. and Baker, J. C. (1987) Why Don’t Directors Rock the Boat, Harvard Business Review, November/December, 10–18. Security and Futures Commission (2002) Practical Guidance on Corporate Governance for Listed and OTC Companies. Securities and Futures Commission, Taiwan Stock Exchange and OTC, 15 October. Taipei Times (18 July 2000) Corporate Scandal Old Hat in Asia. Taipei Times (8 July 2002) Reforms Help Asia Endure Downturn. Taipei Times (15 July 2002) Asia Can Learn from Trials in the US. Williamson, O. E. (1963) Managerial Discretion and Business Behaviour, American Economic Review, 53, 1032–1057. Volume 11 Number 3 July 2003 CORPORATE GOVERNANCE 248 Yeh, K. S. (1997) Board Network Structural Change before and after Initial Public Offerings in Taiwan, Sun Yat-sen Management Review, 1997 International Issue, 93–114. Zun, W. M. (2002) The Difficulties of Improving Taiwanese Corporate Governance, Economy Daily, 2 September (only available in Mandarin Chinese). Jill F. Solomon is a lecturer in Finance at Cardiff University Business School. She has published widely in the areas of corporate governance and socially responsible investment, focusing on corporate governance reform in the UK and in East Asian countries. She is an associate member of BRASS, the ESRC-funded research centre at Cardiff University. Shih Wei Lin is currently preparing his PhD thesis at Cardiff Business School. He is inves- Volume 11 Number 3 July 2003 tigating the evolution of corporate governance in Taiwan, focusing specifically on the role of institutional investors. This paper derives from a survey conducted by Shih Wei in researching his MBA dissertation, while he was studying at Sheffield University. Simon D. Norton is a lecturer in Law at Cardiff Business School. His research interests lie mainly in the area of company law, financial institutions and corporate governance reform in East Asian countries. Aris Solomon is a lecturer in Accounting at Cardiff Business School. He has published widely in the areas of corporate environmental reporting, corporate governance and socially responsible investment. He is an associate member of BRASS, the ESRC-funded research centre at Cardiff University. © Blackwell Publishing Ltd 2003