Compensation & Corporate Governance in East Asia

Not to long ago Eastern Asia’s economy was lauded as a financial miracle. Foreign business leaders and academic’s admired and studied the concept of Guanxi, (cooperation through personal networking). Then came the crash, the revered guanxi revealed itself as crony capitalism. Poor credit decisions and inadequate banking supervision was seen as the root of the crisis. According to the World Bank, the crisis was a direct result of excessive borrowing to finance an unsustainable buildup of poorly performing investments. The Bank concluded that an obvious conflict of interest existed and began to speak out on the issue of corporate governance.

The guidelines that make up corporate governance are central to the on going restructuring in East Asia and are designed to protect stakeholders. One of the primary elements of good corporate governance is a compensation philosophy based on pay-for-performance. Historically, Asia has relied on low labor costs to deliver strong financial returns but with payroll costs rising dramatically, change is necessary. We believe that appropriate compensation management is vital for the region’s economic recovery. This article examines the principles of sound compensation strategy and highlights areas where abuse typically occurs.

Compensation philosophy and individual pay scales in organizations are often a result of history, hierarchy and corporate culture. In other words pay levels simply evolved. As such, pay structure can be based on outdated beliefs, inaccurate market data or the vested interests of those executives administering the compensation practices. A well conceived compensation strategy is the product of independent analysis and experienced design executed to aligning the interests of the stakeholders and executives.

To achieve this within the framework of good corporate governance recommendations it is essential that compensation philosophy is overseen by an effective independent Compensation Committee, which will assist the board of directors discharge their fiduciary responsibility to the stakeholders. This committee should be made up of independent and appropriately experienced members; their independence is vital for the committee to be able and willing to monitor and keep check on payroll excesses by non-performing executives and ensure that the compensation strategy motivates employees and executives, including the CEO towards the best interests of the company and its stakeholders.  The Compensation Committee will oversee, job and organization design, base pay, variable pay, long term incentives and management succession, along with reward strategy and performance measurement. Whether a large or small company the quality of board performance is closely linked to the quality of its outside directors, the compensation committee should be composed of these directors, care must be taken in selecting these individuals not merely for their work on the compensation committee but primarily for their role as independent directors. In the climate of crony capitalism it is not uncommon to find these appointments going to friends, paid consultants, retirees and even competitors. Ideally the appointment should be guided by appropriate experience, independence and competence. For service on the compensation committee training and education is required, members should understand the company’s key activities, strategies, organization chart, resumes and remuneration of the key people, the customers and competitors and their compensation practices. Outside advisors or experts can be invited to provide data and make contributions, but they should be engaged and compensated by the committee rather than the management, again for obvious conflict of interest reasons.

In Hong Kong a recent survey commissioned by the Hong Kong General Chamber of Commerce revealed that civil service compensation had risen to alarming levels when compared to the equivalent job in the private sector. Some reports indicated that the disparity ranged from 17 percent to as much as 229 per cent when all the benefits were taken into account; whatever the actual number the survey revealed, what many had known all along, that the disparity was unsustainable and was a result of a civil service administering their own pay adjustment mechanism over a number of years.

The message for companies is clear an effective, well functioning compensation strategy doesn’t happen by accident, it’s a result of quality design and implementation; it communicates more than words what the stakeholders can expect for it influences the behavior of the employees, the executives and the CEO and ultimately determines the future of a company.