The equity market in the Philippines is very small and illiquid. At the end of 2003, 62% of the market capitalization of the Philippine Stock Exchange was composed of 23 family-controlled groups. This underdeveloped capital market, combined with highly concentrated ownership, results in poor corporate governance practices, as both a 2006 World Bank assessment and a 2005 Asian Development Bank report attest. Both assessments agree, however, that the Philippine regulators have undertaken significant legal and regulatory reforms over the past decade, hoping to establish the foundations for good corporate governance. In 2002, the Securities and Exchange Commission of the Philippines issued its own Code of Corporate Governance for Registered Issuers and Public Companies. In combination with the 2000 Securities Regulation Code, the adoption of International Financial Reporting Standards for financial reporting, and the establishment of new requirements for training directors, the components of a legal and regulatory framework for corporate governance can now be considered to be largely in place. Nonetheless, the implementation and enforcement of this framework still falls short, because it fails to provide incentives for a transparent and efficient market. The World Bank report highlights the importance of private and non-government initiatives in this context, to overcome the shortcomings in the promotion of a corporate governance culture and to encourage enforcement.
General Overview
The 2006 World Bank Report on the Observance of Standards and Codes (ROSC) and the 2005 Asian Development Bank assessments concur that corporate governance practices in the Philippines are slowly improving, but remain weak. This weakness has negative consequences for the development of capital markets. Both reports highlighted the high concentration of ownership in the still underdeveloped corporate sector. The resulting poor corporate governance practices prevent the development of an equity culture, thereby perpetuating the ownership concentration in the corporate sector. The ADB report concludes that "practices such as cross-holdings of equity, interlocking directorates of banks and corporations, and pyramid holding structures--quite common in the Philippines--are effective barriers to hostile takeovers and help to prevent productive assets from coming into the hands of those best positioned to manage them efficiently" (p. 6).
The 2005 ADB assessment includes the limited supervisory capacity of the Bangko Sentral ng Pilipinas (BSP) and the Securities and Exchange Commission (SEC) as one of the weak corporate governance practices that significantly inhibit the development of the financial sector as an efficient source of business funding. The report cautions that loopholes in the Corporation Code (CC) allow a company to waive the preemptive rights of shareholders in the articles of incorporation upon registration or in a subsequent amendment. The code also does not require disclosure of transactions involving potential conflicts of interests.
The 2006 World Bank ROSC supports the view that the Philippine regulators have undertaken significant reforms over the past 10 years, in an effort to establish the foundations for good corporate governance. The ROSC lists the 2000 Securities Regulation Code, the 2002 Code of Corporate Governance, the required adoption of International Financial Reporting Standards (IFRS) for financial reporting, and the establishment of new requirements for the training of directors as important components of a sound legal and regulatory framework for corporate governance. However, the ROSC cautions that the implementation and enforcement of this framework still falls short, because it fails to provide incentives for a transparent and efficient market. The World Bank report stresses the importance of private and non-government initiatives to overcome the shortcomings in corporate governance culture.
The Philippine SEC has attempted to address numerous governance deficiencies with the April 2002 Code of Corporate Governance, which aims to protect the shareholder voting rights, pre-emptive rights, rights to dividends, rights to obtain relevant information on the corporation on a timely and regular basis, and appraisal rights. The Code also empowers the SEC to protect minority stakeholders by compelling the officers of any registered corporation under SEC supervision to call meetings of stockholders. Furthermore, the 2006 ADB document states that the Philippine Capital Market Development Plan (CMDP) must be published and disseminated as the guiding policy document for capital market reforms. To guide capital market development and firmly anchor the agenda with stakeholders, the CMDP sets forth 11 objectives for capital market development and defined initiatives for 19 Government agencies, key market institutions, and other key stakeholders. The SEC will oversee reforms to enhance governance standards to increase investor confidence through improved transparency and supervision.
Writing for the KWR Advisor in 2002, Benitez and Rosarion reported that, in October 2001, the Philippine government adopted the Guidelines for Good Corporate Governance Practices endorsed by the Asia-Pacific Economic Cooperation (APEC). These guidelines, drafted by the Pacific Economic Cooperation Council, stress the importance of fairness, transparency, and accountability. These three principles have been incorporated in the SEC's Code of Corporate Governance through the SEC's Memorandum Circular No. 2. The Code also requires each corporation to document its corporate governance rules and principles in a manual and submit it to the SEC.
The 2006 World Bank ROSC focuses its recommendations on the issues of enforcement and implementation in order to achieve a more transparent, accountable, and efficient corporate sector and a more robust stock market. It calls for strengthening the SEC and PSE's enforcement of existing laws and regulations, particularly those involving insider trading, tender offer rules, and disclosure, and seeks enhanced protection of minority shareholder rights through better enforcement. It argues for better monitoring of compliance with International Accounting and International Financial Reporting Standards, and for requiring additional disclosure of internal controls and governance issues by listed firms. The ROSC also recommends enhancing the Philippines Stock Exchange's surveillance system to deal with unusual trading activities, and encourages the development of advocacy institutions to promote minority shareholders rights. It suggests that the minimum 10 percent requirement of total registered shares offered to the public be raised in order to increase the investor base. It calls for greater independence of the SEC board and management, and for the separation of the positions of the Chairman and the CEO, to avoid conflicts of interests.
Regarding the size, scope, and composition of Philippine capital markets, the ADB 2005 assessment reports that "the equity market in the Philippines is very small and not liquid". (p. 7) In 2002, only five new issues were listed, raising a total of $3.5 million. While there is a "Small and Medium Enterprise" (SME) board, it has only five listings and is also somewhat illiquid. The ADB report asserts that the weak equity market deters the development of a venture capital industry, further reducing the sources of finance available to small firms.
The 2005 ADB report asserts that the corporate sector is still relatively small, accounting for only 26-29% of GDP during 1990-2001, but it is highly concentrated. The sector is dominated by large, family-owned businesses operating in diversified sectors: At the end of 2003, 62% of the market capitalization of the Philippine Stock Exchange (PSE) was composed of 23 family-controlled groups. The ADB report states that these companies are typically closely held, with the top five shareholders owning more than 50% of the total outstanding shares. Less than 20% of the largest 1,000 corporations are listed on the PSE. Although high levels of ownership concentration are common in East Asia, the ADB report finds most notable the degree of concentration across firms. The report makes the further point that Philippine conglomerates exhibit many characteristics similar to pre-crisis Korean chaebols and Japanese zaibatsus.
The 2006 World Bank ROSC argued that, to promote good governance practices, a number of institutions and advocacy groups have been established. These include the Institute of Corporate Directors (ICD), the Corporate Governance Institute of the Philippines (CGIP), and the AIM-Hills Governance Center. According to the ROSC, "the SEC requires training of directors if requirement for such training is stated in the Corporate Governance Manuals submitted by SEC-covered companies" (p. 1) In 2005, the Institute for Corporate Development (ICD) began issuing a scorecard for corporate governance, starting with the assessment of 49 listed companies, or 90% the PSE market capitalization.
The 2001 World Bank ROSC discloses that the leading domestic institutional investors in the Philippines are the pension funds of private sector employees (Social Security System), government employees (Government Service Insurance System or GSIS), and the armed forces (Armed Forces of the Philippines Retirement Service and Benefit System). The report added that minority shareholders were not organized or represented by a separate organization. Prior to 1998, investments in equities were small, in the case of GSIS totaling less than 2% of its portfolio. According to the 2001 ROSC, foreign equity did not play an important role, in part because board membership of investment companies and funds was restricted to Philippine nationals.
The Investor Protection Index, a subcomponent of the World Bank's 2007 Doing Business Indicators, consists of three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index) and shareholders' ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index). The index range is from 0 to 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection. The Philippines scores 1 in the Disclosure Index, against a regional average of 5.2 and an OECD average of 6.3. It scores 2 in the Director Liability Index, against a regional average of 4.4 and an OECD average of 5.0; and 7 in the Shareholder Suits Index, against a regional average of 6.1 and an OECD average of 6.6.
Writing for the Asian Corporate Governance Association in 2006, Jaime Allen and Oliver Jones published an inaugural report on Proxy Voting in Asia. covering five broad categories of corporate governance: rules and regulations; enforcement; political and regulatory institutions; international accounting and auditing standards; and "corporate governance culture." For the year 2005, they ranked the Philippines as eighth out of ten Asian markets, with a score of 46%, compared to Singapore, which led with a score of 70%. In the September 2006 Proxy Survey, the Philippines ranked fifth out of ten Asian markets with a score of 56%, compared to leading Hong Kong which received a score of 67%.
The Principles
Principle I: Ensuring the Basis for an Effective Corporate Governance Framework
In its 2006 Corporate Governance Country Assessment of the Philippines, the World Bank rates the Philippines performance on all four of the sub-principles of Principle I as "Partially Observed." While the legal and regulatory framework complied with the Principle, practices and enforcement diverged.
The SEC administers both the Corporation Code and SRC, and has supervisory responsibilities for all corporations, including unlisted companies. It is the primary regulator of the capital market with powers to supervise and regulate the exchanges; regulate securities transactions under the principle of full disclosure; license stockbrokers, dealers, and sale of securities; and promulgate rules and regulations on securities trading. The ADB 2005 assessment adds that the limited supervisory capacity of the Bangko Sentral ng Pilipinas (BSP) and the Securities and Exchange Commission (SEC), combined with the weak corporate governance practices, play a major role in inhibiting the development of the financial sector as an efficient source of business funding. The 2001 World Bank ROSC notes that "a comprehensive set of corporate law and capital market regulations are enforced by relatively weak institutions that are undergoing restructuring reforms" (p. 1). Furthermore, the PSE supervises and regulates the stock market. It is a self-regulatory corporate organization that independently finances its operations through capital from and fees collected for listing and continuing membership. Its Compliance and Surveillance Group conducts legal audit and monitoring of member-brokers, and is responsible for monitoring the daily automated trading activity.
The World Bank, in its 2006 assessment, prioritizes a number of recommendations aimed at institutional strengthening. First is the SEC and PSE enforcement of laws and regulations related to insider trading and tender offers. Next, information enforcement actions should be posted on the SEC website. The scale of penalties should be reconsidered, to better incentivize market players to follow the rules. The World Bank found that the laws and regulations on corporate governance are relatively strong in the Philippines, so it suggested that the SEC and PSE should concentrate on effective enforcement. It also called for enhancing the PSE's surveillance system by providing additional resources for high-tech market surveillance that could more effectively monitor compliance and detect any unusual trading activities at PSE. Regulation of shareholders' agreements should be enhanced, and monitoring of compliance with IAS and IFRS should be strengthened. Disclosure of internal control systems and other governance matters in annual reports of listed companies should be required. The Code of Corporate Governance should be strengthened by ensuring greater independence of the SEC board and management. The quality and timeliness of information posted on SEC's website should be improved. Finally, the SEC should receive adequate budgetary support to help strengthen its operating capacity and its data on-line capabilities.
Principle II: The Rights of Shareholders and Key Ownership Function
In its 2006 Corporate Governance Country Assessment of the Philippines, the World Bank found the Philippines to largely observe the following sub-principles of Principle II. "Basic shareholder rights," "Rights to participate in fundamental decisions," and "Shareholders' right to consult with each other." On the other hand, the Philippines only partially observed the following sub-principles: "Shareholder's Annual General Meeting rights," "Disproportionate control disclosure," "The functioning of control arrangements," and "The facilitation of ownership rights." This suggests that, while the legal and regulatory framework complies with the Principle, practices and enforcement diverge.
The World Bank 2006 ROSC notes that the Corporate Code and Securities Regulation Code (with amended rules) set forth the formal for an annual general meeting (AGM). The SEC Code of Corporate Governance protects stockholder rights by providing for the right of minority stockholders to propose a meeting and the agenda for the meeting. The Corporate Code calls for "one share/one vote." Corporations are not permitted to set caps on the number of votes per stockholder. In addition, corporations may issue different classes or series of shares, but common shares always have full voting rights. The issuance of shares with multiple voting rights and non-voting shares is prohibited. Stockholders of a corporation may create a voting trust agreement, giving the right to vote and other rights pertaining to the shares to the trust. The Corporate Code prohibits voting trust agreements from circumventing the law. The SEC requires extensive disclosure of voting trust holders of 5 percent or more in the company's annual report. Both in law and practice, acquisition of controlling interest in a public company can only be done through a mandatory tender offer. Finally, the ROSC notes that, "under the CC, major corporate actions involving fundamental changes in the corporate structure, such as an increase / decrease of capital stock, the creation or increase of bonded indebtedness, and sale / disposition of all or substantially all corporate assets, requires approval of two-thirds of the outstanding capital stock" (p. 4)
Principle III: The Equitable Treatment of Shareholders
In its 2006 Corporate Governance Country Assessment of the Philippines, the World Bank rates the Philippines as largely observant of all three sub-principles of Principle III, indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. The 2005 ADB report confirms that the problems with minority shareholder rights protection are related to the effective implementation of protective provisions, difficulties which are related to the generally high ownership concentration in Philippine companies. The report states that "shareholders' rights, in particular those of minority shareholders, are not effectively protected in the Philippines. While existing laws contain standard provisions for protecting minority shareholders, the presence of dominant shareholders in so many Filipino companies makes these provisions more difficult to uphold" (p. 16). The 2006 World Bank encourages the establishment of an association to promote minority shareholder rights. This effort, according to the assessment, could be supported by government institutions such as the Government Service Insurance System (GSIS) and Social Security System (SSS).
Principle IV: The Role of Stakeholders in Corporate Governance
In its 2006 Corporate Governance Country Assessment of the Philippines, the World Bank rates the Philippines as largely observant of the sub-principle of "Legal Rights of stakeholder are respected," indicating that there are only minor shortcomings that do not raise questions about the authorities' ability and intent to achieve full observance in the short term. "Stakeholder Redress," "Performance-enhancing mechanisms," and "Stakeholder Disclosure," are rated as "Partially Observed," indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. "Whistleblower protection" and "Creditor Rights and Law enforcement" are rated as "Materially Not Observed," indicating that, despite progress, shortcomings are sufficient to raise doubts about the authorities' ability to achieve observance. The World Bank recommends the enactment of long-awaited legislation, "such as the proposed Credit Information Act, which should mandate the credit rating of all fund-taking institutions; and the Corporate Reform Act (locally known as the Lapus Bill after its sponsor, which is a reform patterned after the U.S. Sarbanes-Oxley Act)" (p. 7) to improve creditor rights and access to information.
In its 2006 Corporate Governance Country Assessment of the Philippines, the World Bank rates the Philippines as largely observant of standards of accounting and audit, indicating that it found only minor shortcomings that do not raise questions about the authorities' ability and intent to achieve full observance in the short term. On the sub-principles of "Disclosure standards," "Independent audit annually," "External auditors should be accountable," "Fair and timely dissemination," and " Disclosure of conflicts of interest by analysts, brokers, rating agencies" as "Partially Observed," were rated as partially observed, indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. In this report, the World Bank notes that, "in line with the development of corporate governance, SEC and PSE have enforced the policy of 'Full Disclosure Approach' on matters regarding the corporations" (p. 4). The report noted that PSE Revised Disclosure Rules set standards of timeliness, accuracy, and transparency in matters affecting the capital market, both for financial and non-financial information. The 2003 launch of the Online Disclosure System enabled electronic filing and data retrieval. The PSE website makes it possible for the public to access all reports. The disclosure procedures of the SEC and PSE are set forth in the Securities Regulation Code.
The World Bank also evaluated the Philippines compliance with International Financial Reporting Standards (IFRSs) in 2001, in a specialized ROSC dealing with the accounting and auditing framework. IFRSs and (ISAs were used as the benchmarks for assessing national standards. The World Bank's 2006 Update reported that most of the shortcomings identified in the 2001 assessment have been addressed. The World Bank commended the Philippine authorities for the progress achieved; but noted that there were certain problems with the actual implementation of the accounting requirements. It recommended that an oversight board for quality control be created, and the technical strength and resources of the Philippine Institute of Certified Public Accountants (PICPA) built up to improve compliance with the accounting requirements.
In its 2006 Corporate Governance Country Assessment of the Philippines, the World Bank rates the Philippines as largely observant of Principle VI's sub-principle of "Access to information," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. For the sub-principles of "Acting with due diligence and care," "Fair treatment of all shareholders," "Apply high ethical standards," "The board should fulfill certain key functions," and "Exercise objective judgment" the Philippines are rated as partially observant, indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge.
The World Bank report further notes that, the board is unitary in structure. The Corporation Code permits corporations to create an executive committee that is board-appointed and which may act by majority vote of the board as may be delegated in the by-laws, except with respect to approval of actions for which shareholders' approval is also required. Further, the report asserts that the SRC and the Code of Corporate Governance require publicly listed companies and those with registered securities, to appoint a minimum of two independent directors or 20 percent of the board, whichever is more. The SEC also requires the establishment of an audit committee for all regulated entities. This should be composed of at least three board members, with accounting and finance expertise. One of the audit committee members should be an independent director. In addition, the World Bank assessment reports that the Corporation Code and the Corporate Governance Code clearly define the fiduciary duties of the board. "The adoption of the latter in 2002 by the SEC has brought into focus the duties of care, diligence, and loyalty of each director. Therefore, any director who commits unlawful acts or is guilty of gross negligence or bad faith, and acquires any personal interest, shall be liable jointly and severally for all damages" (p. 6).
Asian Development Bank, "Private Sector Assessment for Philippines," Manila: ADB, 2005. Available from Asian Development Bank website. Accessed on August 6, 2007. (ADB 2005)
Allen, J., and Jones, O., "Voting for Change, Bringing Proxy Voting Systems in Asia into the 21st Century - ACGA Asian Proxy Voting Survey 2006," September 2006. Available from ACGA website. Accessed on August 6, 2007. (Allen and Jones 2006)
Asian Development Bank, "Proposed Program Cluster, Loan, and Technical Assistance Grant Republic of the Philippines: Financial Market Regulation and Intermediation Program," Project Number 38276, November 2006. Available from Asian Development Bank website. Accessed on website. Accessed on July 20, 2007. (ADB 2006)
Bautista, L., "The OECD Roundtable Report on Capital Market Reform: Country Report on the Philippines," Fifth Round Table on Capital Market Reform in Asia, ADB Institute, November 2003. Available from Organization for Economic Cooperation and Development website. Accessed on December 11, 2006. (Bautista 2003)
Benitez, Rene B., and Rosario, Juan Carlos, "Global Problem of Corporate Governance: The Philippines' Response," KWR Advisor, 2002. Available from KWR International website. Accessed on December 11, 2006. (Benitez and Rosario 2002)
Organization For Economic Cooperation and Development, "White Paper on Corporate Governance in Asia," June 2003. Available from Organization for Economic Cooperation and Development website. Accessed on December 11, 2006. (OECD 2003)
Securities and Exchange Commission, "SEC Memorandum Circular No. 16, Series 2002," November 2002. Available from Securities and Exchange Commission website. Accessed on December 11, 2006. (SEC 2002)
World Bank, "Republic Of The Philippines: Report On The Observance Of Standards And Codes, Corporate Governance Country Assessment," September 2001. Available from World Bank website. Accessed on August 6, 2007. (WB 2001a)
World Bank, "The Philippines: Report on the Observance of Standards and Codes, Accounting and Auditing," December 2001. Available from World Bank website. Accessed on July 19, 2007. (WB 2001b)
World Bank, "Republic of the Philippines: Report on the Observance of Standards and Codes, Accounting and Auditing Update," March 15, 2006. Available from World Bank website. Accessed on July 19, 2007. (WB 2006b)
World Bank, "Doing Business: Snapshot of Business Environment, The Philippines," 2007. Available from World Bank website. Accessed on August 9, 2007. (WB 2007)
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