Two decades ago, within the blink of an eye, the Asian Financial Crisis pushed many of Asia’s miracle economies to the brink of collapse. In the post-mortem, the proclivity of Asia’s controlling shareholders to engage in wealth tunnelling through related party transactions (RPTs) was identified as a seminal cause of the Crisis. Although Asia has since recovered and emerged as the engine of global economic growth, the corporate governance norms and mechanisms developed in the years following the Crisis – including prominently the regulation of RPTs – have come to define global corporate governance.
The World Bank’s influential Doing Business Report (DBR) has been a key platform for the American-driven dissemination of global norms of good corporate governance. A prominent part of the DBR is the RPT Index, which ranks 190 jurisdictions from around the world on the quality of their laws regulating RPTs. By this measure, Commonwealth Asia appears to be a corporate governance utopia. According to the RPT index, the regulation of RPTs in Commonwealth Asia’s most important economies is stellar. In the latest RPT Index, Singapore ranked 1st, Hong Kong 3rd, Malaysia 5th, and India 20th out of 190 jurisdictions.
Against this backdrop, our in-depth analysis of the actual function and regulation of RPTs in Commonwealth Asia’s most important economies presents an intriguing puzzle. Despite the uniformly high RPT Index scores in all of Commonwealth Asia’s most important economies, empirical, case-study, and anecdotal evidence overwhelmingly suggests that there are in practice significant inter-jurisdictional and intra-jurisdictional differences in the actual function and regulation of RPTs in Commonwealth Asia. In short, there is a conspicuous gap between what the RPT Index suggests should be occurring and what is actually occurring in practice.
In a working paper titled ‘Related Party Transactions in Commonwealth Asia: Complexity Revealed’, we assert that such a yawning gap exists because it fails to capture the complexity of RPTs in three respects, which we term: (1) regulatory complexity; (2) shareholder complexity; and (3) normative complexity. First, it appears that the RPT Index overly emphasizes the role played by a jurisdiction’s formal corporate and securities laws in determining the effectiveness of its RPT regulation. Our detailed comparative analysis of RPTs in Commonwealth Asia’s leading economies demonstrates that while a jurisdiction’s corporate and securities law are no doubt important, its corporate culture and rule of law norms may be as important – if not more important – in determining the efficiency of its RPT regulation. In turn, we suggest that the regulatory complexity of RPTs must be properly appreciated to accurately understand the actual function and role of RPTs in Commonwealth Asia (and, we suspect, elsewhere).
Second, the RPT Index erroneously assumes that controlling shareholders are a homogeneous group driven by similar incentives. The RPT Index proposes common solutions for regulating RPTs in jurisdictions with distinct shareholder ownership landscapes and in different companies within a single jurisdiction that have different types of controlling shareholders (ie, the state, family members, or a controlling shareholder from another jurisdiction). However, our comparative analysis of RPTs in Commonwealth Asia suggests that RPTs function differently depending on a jurisdiction’s specific shareholder landscape – particularly on the characteristics of its most significant controlling shareholders. In turn, we suggest that appreciating each jurisdiction’s internal shareholder complexity is essential for properly understanding RPTs in Commonwealth Asia (and, we suspect, elsewhere).
Third, the general assumption that RPTs per se are evidence of defective corporate governance and that stricter regulation of RPTs consequently equates to ‘good law’ is erroneous. The simplistic perception that permissive regulations on RPTs are ‘bad law’ glosses over an important body of research which convincingly demonstrates and explains why RPTs may promote good corporate governance and efficient equity markets. In fact, there is an emerging consensus that even when RPTs provide a vehicle for controlling shareholders to extract private benefits of control, they may, in certain circumstances, promote corporate governance efficiency. We argue that a proper understanding of the normative complexity of RPTs is necessary to understand the actual function and role of RPTs in Commonwealth Asia (and, we suspect, elsewhere).
Demonstrating the frailties of the RPT Index is important in practice because jurisdictions – especially developing ones – commonly look to the DBR and its indices when reforming their laws. In addition, the intellectual foundation of the RPT Index also makes the findings in our paper academically significant.
Dan W. Puchniak is Associate Professor at the Faculty of Law of the National University of Singapore (NUS), and Director at the NUS Centre for Asian Legal Studies (CALS).
Umakanth Varottil is Associate Professor at the Faculty of Law of the National University of Singapore.