The Internationalisation Process and Corporate Governance of Malaysia’s Government-linked Companies

Content

I Abstract

III Table

IV Abbreviations

1 Introduction

2 State-Owned Enterprises
2.1 An Introduction to State-Owned Enterprises
2.2 Types of SOEs and Motives for Nationalisation
2.3 The Government’s Regulatory Impact on GLCs
2.4 Government-linked Companies’ Performance

3 Corporate Governance
3.1 Introduction to Corporate Governance
3.2 The Agency Theory and a Countervailing Approach
3.3 Corporate Governance and Agency Theory in GLCs
3.4 Khazanah Nasional - A State-Owned Holding
3.5 The Agency Problem of Khazanah
3.6 New Government Regulations in Malaysia

4 The Internationalisation Process of Malaysian GLCs
4.1 Internationalisation Theories
4.1.1 The Eclectic Paradigm
4.1.2 Investment Development Path
4.1.3 International Product Life-Cycle Theory
4.1.4 Uppsala Theory
4.2 The Motives behind the Internationalisation of Malaysian Firms
4.3 The Malaysian Internationalisation Process - Do Government Ties constitute a Competitive Advantage?
4.4 Critical Discussion of the Applicability of Theories and the Influence of the Government in Malaysian GLCs
4.5 Combining Internationalisation and the Agency Theory for Malaysian GLCs

5 Methodology

6 Sime Darby - A Case Study
6.1 Company Profile
6.2 Ownership Structure
6.3 Governance and Government Influence
6.4 Sime Darby’s Internationalisation Process
6.5 Discussion of Sime Darby’s Internationalisation Process in view of the Theoretical Foundations
6.5.1 Ownership Advantages
6.5.2 Location Advantages
6.5.3 Internationalisation Advantages
6.5.4 Sime Darby’s Motives for Internationalisation
6.6 Summarising Thoughts in view of Internationalisation Theories

7 Conclusion and Contribution to Literature

8 References

9 Appendix

Abstract (English)

The research on the internationalisation process of Southeast Asian multinationals is limited. Especially the unique role of the government on Government-linked companies’ (GLC) corporate governance and their international development has been rarely considered. The agency theory explains an inherent governance problem but needs to be examined from a different angle for GLCs. Theories on internationalisation are based on the Western world, but the patterns are different for developing countries such as Malaysia. The analysis of a firm’s strategy requires to be viewed holistically, embedding it in its economic, cultural and politic context. Utilising a contextual approach and an in-depth case study methodology, this study describes the internationalisation process of Malaysia’s conglomerate Sime Darby and reviews it based on theoretical concepts. Considered individually, accepted theories, as, for instance, the Eclectic Paradigm, were found to be incomplete in explaining the evolving internationalisation of Sime Darby. Combined with thoughts of the Uppsala approach and the phenomenon of psychic distances the theories are complementary. The author detected that together, they can be used to explain the internationalisation process of Malaysia’s GLC. The findings, limitations of research and opportunities for further research are discussed.

Keywords: Internationalisation, Government-linked Companies, Corporate Governance

Abstract (French)

La recherche sur le processus d’internationalisation des multinationales d’Asie du Sud-Est est limitée. Le rôle unique du gouvernement sur la gouvernance d’entreprise et le développement international des entreprises publiques a rarement fait le sujet de recherche. La théorie de l’agence explique un problème de gouvernance intrinsèque mais doit être analysé sous un angle différent pour les entreprises publiques. Les théories sur l’internationalisation sont fondées sur l’Occident mais les modèles sont différents pour des pays en voie de développement comme la Malaisie. La stratégie d’une entreprise doit être appréhendée de manière globale, comme étant inscrite dans un contexte économique, culturel et politique. En s’appuyant sur une approche contextuelle et l’étude d’un cas, cette étude décrit le processus d’internationalisation du conglomérat malaisien Sime Darby et l’analyse à la lumière de concepts théoriques. Séparément, des théories reconnues, comme le Paradigme Eclectique, ont été démontrées comme étant incomplètes pour expliquer l’évolution de l’internationalisation de Sime Darby. L’auteur a découvert que, combinées aux pensées du modèle Uppsala et au phénomène des distances psychiques, ces théories sont complémentaires. Ensemble, elles peuvent être utilisées pour expliquer le processus d’internationalisation des entreprises d’Etat malaisiennes. Les conclusions, les limitations de la recherche ainsi que les ouvertures vers de plus amples recherches sont discutées.

Mots clés : Internationalisation, Entreprises publiques, Gouvernance d ’ entreprise

III Table

Table 1: Principal-Agent Constellation with SOHs

IV Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

Government-linked Companies (GLCs) or state-owned enterprises (SOEs) are an antique phenomenon. Almost every state in the world has its own corporates or at least did so in the past. Postal services, railway or tunnel and bridge constructions in the industrial revolution or any sort of energy companies have been important vehicles in driving countries’ development (Aharoni, 1986). As a first proxy, SOEs are defined as companies where the government has a direct or an indirect majority ownership; GLCs will be used synonymously.¹ SOEs are often said to be negatively influenced by the government (Sim, 2006); but also to enjoy advantages such as a beneficial tax treatment or zero cost of financial distress. The World Bank (1995) even argues that SOEs have deficiencies of considerable impediment to economic growth. And above that, it is possible that the relationship with the government leads to serious agency problems (Zutshi & Gibbons, 1998). But in fact, the empirical evidence about whether the impact is positive or negative is ambiguous (Aharoni, 1980; Mustapha & Ahmad, 2011; Najid & Rahman, 2011; Ramirez & Tan, 2004).

Depending on the country, a SOE is a tool for the government to influence the direction of the economy, increase levels of efficiency, equally distribute income, allocate resources between the different regions and industries as well as many other social or economic objectives the state might pursue (Aharoni, 1986). The case of Malaysia shall highlight the variety of SOEs’ objectives.

Malaysia is a multi-racial but Islam-dominated country.² The natives Bumiputera (children of the land) represent about 60% of the inhabitants (Suto, 2003). In the past, one of the goals of the government was creating GLCs for the social welfare of these natives. This goes back to a movement in the 70s, which has been introduced by the New Economic Policy. The aim was to increase the number of GLCs to 30% until 1990. Though the 30%-target was not reached, some 20.3% have been achieved (Tam & Tan, 2007). In 2000, GLCs constituted for 49.5% of Malaysian listed companies (8th Malaysian Plan, 2001). 2012 seven out of Malaysia’s top ten listed companies are majority-owned by the government (Grudgings, 2013) and GLCs make up a share of 36% of total market capitalisation at the Bursa Malaysia contributing with 22% to the country’s GDP (PCG, 2012).

Besides the increasing number of GLCs, for a while, the government followed a second objective: decreasing foreign investments. This has been turned around by the liberalisation process of foreign capital inflows in the 1990s (Suto, 2003). But the same way it hampered them, the government connection helped building external networks (Ang & Ding, 2006). While firms usually internationalise for the need of resources or new markets, in many Asian economies the motive was government driven (Zutshi & Gibbons, 1998). The 1980s are characterised by a wave of foreign direct investments (FDIs) of East Asian countries and especially the four Tigers - Singapore, South Korea, Taiwan and Hong Kong (World Bank, 1995). The strong performance of those countries triggered an intra-regional direct investment-process (Sim & Pandian, 2007) transferring from Japan to the Newly Industrialised Countries (NICs) and later to also fast-growing economies such as Indonesia and Malaysia (Heng & Low, 1994). Realising the overseas-potential of an export oriented economy, the Malaysian government - within the context of its SOEs - was one of the first ASEAN³ states to foster globalising entrepreneurship (S. Z. Ahmad, 2008).

Academic research on internationalisation strategies and corporate governance has been primarily focused on the Western world. Though the Asian economic upwind is historically speaking relatively new, there is an urgent need to elaborate on their strategies. While existing literature is based on developed countries those theories are not necessarily applicable for Asia. Explicitly the active role of the government is a fairly unconsidered component, which has a tremendous impact on Asian GLC’s governance and their internationalisation process.

For clarification purposes, the author will define the underlying terms of the discussion - internationalisation, governance as well as SOEs and GLCs in more detail. Internationalisation shall be understood as the business operations spreading out beyond national borders, including the underlying strategies and characteristics (Sim, 2006). As a first approach, corporate governance is simply defined as the roles and responsibilities distributed among different participants within organisations (OECD, 2013). Besides these rather well known terms, the topic of this study contains the delicately chosen word Government-linked Company or SOE. Historically, SOEs were often part of the public sector and must therefore be governmentowned. Nowadays, that is not necessarily the case. First, SOEs are generally companies that are wholly owned by the government. The form of ownership has altered its shape in the last decades and now comprises also many firms, which are majority-owned by the state. Second, a SOE is a real firm, which implies the production and sale of goods or services.⁴ Third, the income is related to some sort of cost (Aharoni, 1986), which is why the author will not consider, for instance, a public hospital as a SOE.

But what does state-owned imply? Usually, the term own would suggest that the state has a controlling stake of more than 50%. But if the other shares are highly dispersed, a much lower ownership might be sufficient to influence the strategy of the firm. For instance, the government of Singapore defines GLCs as companies in which the state has a stake of at least 20%. This is because the actual control can still be exercised with less than 50% shareholding. Beside the dispersion, the state can assume control over a company because of the firm’s dependence on the government, might it be for funding, support with regulations, favourable distribution of government projects or simply the access to information. As elucidated, a pure percentage of government-stake will not clarify whether a company is solely linked to or owned by the government. The terms GLC and SOE shall therefore be understood as equal synonyms within this study.

Another wording to be clarified is the use of state- versus government -owned firms. The author will not make any differences between these terms. Government shall not imply that the political party reigning at the time possesses a company, but it will be used synonymously with the term state, with the pure thought that it is always the state that is meant.

The paper presents a holistic view on the internationalisation process and governance of Malaysian GLCs. Its aim is to contribute to the literature by highlighting the linkage between government and business. The study will explain the influence of this connection on GLCs’ internationalisation strategies and Corporate Governance. An introduction to SOEs highlights the impact of government’s policies on GLCs and their performance. The author presents the agency theory and examines the specific application along with its problems for GLCs and for the concept of a SOH. Considering the historical recentness of Malaysia’s internationalisation process, theory is of high value to understand and explain the rise of those GLCs’ developments. Therefore, the main theories of internationalisation are introduced. The author then presents the reasons behind the internationalisation process of Malaysian GLCs and scrutinises the influence of the government. After evaluating the applicability of inter- nationalisation strategies for Malaysian GLCs in detail, the differences with existing Western theories will be stressed. By examining the particular strategy of Sime Darby, a Malaysian GLC, the author wants to draw attention to the exceptional relation between government and business and its influence on the company’s strategy development. The findings are summarised in conclusion remarks and also provide an outlook on further research.

2 State-Owned Enterprises

2.1 An Introduction to State-Owned Enterprises

The idea of setting up public enterprises can be described as an intention to minimise the gap of managerial decision-making on production activities and government long-term oriented goals and control (Zutshi & Gibbons, 1998). In the Western world, the real rise of SOEs started before and after the 2nd World War, when entrepreneurs were rare and the government actively tried to stimulate and rebuild the economy. But why did nationalisation start in Asia? Theoretically, state ownership is preferable in countries, whose economic and industrial development is lacking behind (Gerschenkorn, 1962). The government can close the development gaps and lack of entrepreneurship.⁵ Many Asian and Latin American less- developed countries started their SOEs in the 1950s-60s. The governments intended to gain complete control over particular industries and also used SOEs as a status of political and economic power. A second wave (1970s) came with the reverse investments of many developing countries. Cameron (1978) claims that in liberate economies the risk of vulnerability to external factors increases, which is why governments take precautionary measures to protect the national economy from foreign investors. The governments expropriated the local assets of foreign firms to gain control over particular industries (Aharoni, 1980). At the same time firms were nationalised to prevent a takeover of foreign investors and protect the domestic economy. Malaysia’s reverse investments in the 1980s were the country’s major step towards nationalisation (Ragayah, 1999).

In the 1990s, the business of SOEs reached its peak. Though large divestitures and privatisations took place especially in former communist countries, the share of SOEs particularly in developing countries rose (World Bank, 1995).

In Asia, Singapore serves as a role model for GLCs. The country proactively created GLCs in the 1960s while most other Asian economies followed a private-driven approach (Ramirez & Tan, 2004). Malaysia followed the example of Singapore in the 1970s (Najid & Rahman, 2011). Consequently, GLCs play a significant role and contribute a major part to Malaysia’s GDP. GLCs hold 56% of the banking assets, 67% of the communication’s business and 88% of the utilities business (Grudgings, 2013). The Malaysian government defines GLCs as companies, which it controls directly or via government-linked agencies (PCG, 2005). This is a more vague definition compared to Singapore’s mentioned 20% ownership. Malaysian GLCs are typically owned by the 1994 established state-owned holding company (SOH) Khazanah Nasional (Khazanah). Singapore, who was first to come up with such a vehicle, founded Temasek holdings already in 1975.

After gaining an understanding of the history of SOEs, the different types of SOEs and the detailed government motives for nationalisation will be scrutinised.

2.2 Types of SOEs and Motives for Nationalisation

For the purpose of this study, a simple classification of SOEs into three categories will be conducted (Kotler, Jatusripitak, & Maesincee, 1997):

1) The first group comprises enterprises wholly owned and operated by the state. Typical examples are oil and gas companies such as Malaysia’s Petronas, Mexico’s Pemex or Venezuela’s PDVSA.
2) The second category is the public services sector owned and provided by local or national governments, such as airlines, railways or the post service.
3) Finally, a more modern kind of SOEs developed through a historical privatisation or reverse investment process. Those are enterprises that are partially owned by or linked to the state: The structure and degree of ownership vary across enterprises, which are owned but not necessarily operated by the government. An example is Malaysia’s Sime Darby.

But how do SOEs evolve? What are the government’s patterns, reasons and motives for building its own company? The main process to create SOEs is nationalisation. Nationalisation usually comes with a certain negative taste, mainly due to examples like Libya, Venezuela or Argentina, which are often referred to as corrupt ⁶ governments (Toninelli, 2000). At the risk of overgeneralisation the author will try to structure the motives for nationalisation into five categories (Aharoni, 1986; Toninelli, 2000):

1) Political power

In many cases the establishment of GLCs was politically motivated. Especially in countries that are composed of coalitions, different ministers tried to build SOEs to diminish the power of the ministry of finance (Aharoni, 1986). As such, individual ministers could control the resources in their resort via the GLC and also use it as a vehicle to reach to the public, for instance, to gain votes.⁷

2) Ideology

Supporters of nationalisation can be divided into socialists and liberals. To socialists, nationalisation is a matter of principle and vaguely argued. The motive is a rumour around social welfare.⁸ For the liberals, the approach has to be reasoned by economic efficiency (Becham, 1950). The arguments given are obviously not a complete analysis of the differentiation between social and liberal supporters of nationalisation. But for the purpose of understanding that ideology is a motive for nationalisation, they are meant to be extensive enough to prove that a socialist’s mind-set is not a monopoly on nationalisation. Even ground-laying economists such as Adam Smith offer views supporting public enterprises (MacGregor, 1949).

3) Social motives

The government has to fulfil a variety of social reasons for which the possession of a SOE would be useful. Among others, it could support the guarantee of full employment, ensure better working conditions and foster industrial relations, such as the collaboration with any trade unions.

4) Economic reasons

The primary reason here is the promotion of economic growth and development. While states generally aim for welfare, economic development is an integral part of the same. Only literature often argues that economic reasons are merely for the purpose of superior goals like the social transformation in underdeveloped countries or regions (Jones, 1982). The argument is that the government’s decisions are based on long-term objectives, which cannot be profit-oriented, e.g. the exploitation of natural resources. Contrary to private companies, governments might sometimes be inclined to stabilise or even reduce certain prices to ensure a fair distribution of income especially for the lower-income-part of the population (Bös, 1986).

A very recent trend or economic motive is the industrial bailout. The state rescues private companies affected by a crisis. For example, in the most recent financial crisis, the UK government was the first to announce the bailout of Royal Bank of Scotland, until then the second largest bank of Europe and an important figure for the stability not only of the British but the European financial market.

5) Other reasons

Though a number of reasons could be used to extend the list, the one most commonly discussed is market failure. Governments proclaim a necessity of interference in the free market when Adam Smith’s invisible hand is unsatisfactory (Nove, 1973). A typical example is the natural monopoly. Since unregulated private companies could lead to exploitation, the state needs to intervene to guarantee the welfare. The idea behind is the state’s ability to guarantee fair prices, tariffs and secure supply.

As shown, GLCs can be established on the basis of a variety of reasons. But explaining why GLCs actually arise is even more complex. One also needs to take into account the history of a country, the stage of development⁹ and the respective economic environment including its crises.

2.3 The Government’s Regulatory Impact on GLCs

GLCs and other multinational enterprises (MNEs) operate in an environment where states often follow their own national interests. In Argentina, for example, the protectionist policies including fixing national currencies, exchange rates and trade balances or immobilising factors of production are examples of the government’s influence on the market environment. Above that, the author mentioned several motives of the state, which are similar to its objectives, such as social welfare. However, the realisation of national interests is not necessarily the main objective of the corporation itself (Graham, 1996).

It appears inevitable that the government influences GLCs. But what does influence actually mean? According to Murtha and Lenway (1994) a government’s industrial strategy only influences GLCs’ strategies when it alters any pre-established choices or strategic directions. There are many company decisions that seem to be altered by government actions but actually did not change the fundamental strategic direction. They further argue that managers already discount government influence, e.g. incentives to base the business in a certain location. Hence, even if the company decides for one of the government’s preferred locations, this choice would already have been within the basket of possibilities the company was considering anyway (Murtha & Lenway, 1994).

When on the other hand a government export incentive programme leads a company to inter- nationally diversify its business, despite an on-going cost cutting, this is altering the strategy.

At one extreme, the government-link can be very beneficial. Literature generally assumes that GLCs have advantages regarding their access to capital markets and especially to participate in government projects. Just monitoring the share price movements of Malaysian companies, it can be concluded that only the announcement of new government projects has an instant effect on the share prices of the respective GLCs (Sulong & Nor, 2008). Depending on the country’s image, the link with the government also gives the company credibility in the market (Ang & Ding, 2006). As Boddewyn & Brewer (1994) contend: Working with government decision-makers firms can leverage their bargaining power as they improve the state’s competitiveness. The government then can support the firm (Luo, Xue, & Han, 2010):

- Provide fiscal incentives (e.g. tax incentives or cheap funding)
- Organise the coverage of political risk
- Pass treaties to shield overseas investment
- Create multilateral framework for liberalising investments in the host country or
- Build a network and make deals with the host country via government institutions

At the other extreme, the government-link may pose a threat. For example imposing fixed exchange rates or trade barriers hinders a firm’s growth (Graham, 1996). Yi and Wang (2012) view SOEs along with the main body of literature as less competitive in international markets, because of their ambiguous political and social objectives. Murtha and Lenway (1994) confirm that the state can negatively impact a firm’s international competitiveness and even lead to bad investment decisions (Sulong & Nor, 2008).

Porter (1990) argues instead that a government should pursue policies to maximise economic benefits within the country’s borders. But alongside political objectives such as creating employment, states might fall towards what Porter describes a simple global strategy. This strategy requires establishing a decent part of the value chain in the home country and is observing the world as a unified market served from the nation’s home (Porter, 1986). For Porter, the home-market is a source of strength or weakness and explicitly important. But this might similarly imply that the state hampers any decisions towards internationalisation.

Another very simple idea shall emphasise the government’s influence: Its effect on the most important person in a company, the Chief Executive Officer (CEO). The CEO is said to be the most powerful person in a company due to the abilities to distribute rewards, set salaries, hire and fire and the special as well as broad knowledge about the whole firm (Aharoni, 1986). The scarcest resource of a CEO is time. Within the context of a SOE the CEO is required to spend time on government audits, parliament sessions, cultivating political support and maybe on his new own objective of gathering political influence. This time will be missing for the economic decision-making, which is the core activity of a CEO. Government-ownership has therefore inevitably an influence on the company’s decision-making process even if only considering this very plain effect. The following paragraph clarifies how this influence affects the government firms’ performance.

2.4 Government-linked Companies’ Performance

It is important to emphasise the importance of the performance issue, since many of the following discussions about governance and internationalisation will have an impact on it.

Literature lays a special focus on the GLCs’ performance. Titles such as “Do Government- linked Companies underperform? ” , “ Government ownership and the performance of GLCs ” or “ The performance in SOEs ” are prevailing in literature (Aharoni, 2000; Ang & Ding, 2006; Feng, Sun, & Tong, 2004). Acknowledging the existing literature and given the significance of the topic, the following paragraph will touch upon the ambiguity of different studies’ results on performance. It shall nonetheless not be the focus of this very study itself.

Judging performance implies generally a deductive measurement of efficiency, which is defined as the ratio of output to input. The problem when analysing the performance of SOEs is the ambiguous company’s purpose, which is not necessarily the economic efficiency but also social welfare (Aharoni, 2000).

Overall, literature perceives the performance of GLCs as inferior compared to private organisations. The World Bank (1995) observes that a greater participation of private owners leads to a better performance. This can possibly be explained by the incentives that private agents have. While their pay or additional benefits are usually linked to performance they respond to those incentives with better work. This is supported by various other studies who have no doubt about the mediocre financial performance of GLCs (Aharoni, 2000).

However, results are inconsistent. There are several studies, which start with similar stereotypes about the inferior performance of GLCs but conclude with opposite results. Feng, Sun, & Tong (2004) did not observe any evidence that Singaporean GLCs are not comparable to private enterprises in terms of efficiency. Contrary to any inferior performance, Ang and Ding (2006) results even show that Singaporean GLCs outperform non-GLCs regarding its financial and market performance and also have higher valuation. The Tobin’s q¹⁰ of GLCs was about 10% higher on average (Ramirez & Tan, 2004). The same has been observed for Malaysia’s GLCs (Sulong & Nor, 2008). Further, a lower expense to asset-ratio implies or at least supports the theory of lower agency costs for SOEs (Ang & Ding, 2006).¹¹ An alternative mode of monitoring can be named as one reason why governance and ownership are adding to the firm value (Sulong & Nor, 2008). By managing GLCs via SOHs and the state allowing foreign ownership, the government assures different modes of monitoring, enhancing the firm’s credibility and ultimately its performance (Ang & Ding, 2006).

Maybe the discussion about whether government-ownership has a positive or negative effect on performance can be put on hold with the following argument: It is not necessarily the ownership that is crucial but the kind of the competitive state in which the firm operates (Singh, 2003). That comprises the country’s particularities, the state’s policy and the specific enterprise strategy (Castro de & Uhlenbruck, 1997).

Due to the high coverage in literature and the interesting dispute about the results of performance it was inevitable to cover the topic. Nevertheless, given the uncompromised focus of this paper, it will not be further examined throughout this study.

3 Corporate Governance

3.1 Introduction to Corporate Governance

The various crises in less-developed countries during the 1990s, like the Asian crisis in 1997/98 as well as the most recent one in 2007 have one thing in common. One of the main reasons for the crises is the lack of corporate governance (Mustapha & Ahmad, 2011). Therefore, the improvement of guidelines of corporate governance is fundamental not only for the corporation’s principals but also for the economic system. It is, hence, inevitable to study problems arising with corporate governance in SOEs.

The most cited definition of corporate governance is probably also the simplest: Cadbury (1992)¹² defines corporate governance as the system by which business corporations are directed and controlled. The definition of the OECD (2013)¹³ is heading into the same direction, but formulates it even more precisely as the roles and responsibilities distributed among different participants in the organisation - such as board, managers and stakeholders. A main responsibility is formulating a firm’s vision and its objectives. The firm owner usually sets those. Although private companies may be owned by a number of different individuals, generally speaking they should follow only one goal: Long-term shareholder value maximisation. In contrast to private companies, SOE owners are the citizens of a country. This group has not just numerous but also ambiguous and sometimes conflicting objectives.

Defining the government’s objectives and deciding between social or economic goals is a complex task. This is further complicated by a conflict of interest between the government’s agent and its individual goals. While the government as a principal and agent should be presented as an institution, it finally comes down to the individual actors with its own personal ambitions. One should assume that a manager of a government agency follows either the economic profit-maximising goals or other social ones. However, managerial behaviour theories hold true, which reject this rational argument (Simon, 1959), because in reality they often follow both.

Even if only looking at the several ministers of a country, they cannot be considered a single principal. And if we consider the populace as the principal, there are then many agents (ministers and managers) acting on its behalf. Consequently, no perfect match between agent (manager) and principal can be achieved (Aharoni, 1986).

This has implications on the governance of a corporation. As an obvious result, the clear statement of a GLC’s goals should be a primary objective. A SOH might be one way to solve this problem. In the following, the underlying theory of the principal agent problem will be presented. The stewardship theory will challenge it as an alternative explanation. We will then examine the specific applicability of the theory for GLCs and finally consider Malaysia’s SOH Khazanah.

3.2 The Agency Theory and a Countervailing Approach

The Agency Theory scrutinises the problems that occur when one party (the principal) delegates work to another (the agent) who performs the work on the principals behalf (Eisenhardt, 1989). It is the separation of ownership and control that creates principals (ownership) and agents (control). A problem emerges, when those two parties follow diverse objectives (Jensen & Meckling, 1976). Under uncertainty or incomplete information, of which both are common in business practice, adverse selection and moral hazard arise (Eisenhardt, 1989). Moral hazard describes a situation where the principal is unsure if the agent gives his maximal effort. Adverse selection is the principal not knowing whether or not the agent actually has the ability to represent his interests the way the principal expects him to. This can be caused by asymmetric information. In real (imperfect) markets information is not fully available and theory suggests that the available information is distributed asymmetrically between principals and agents (Jensen & Meckling, 1976).

In business context, the theory deals with the conflicts of interest between shareholders and directors, and between the Chairman and the CEO, whose unified role is also known as duality. Agency theory claims that non-duality decreases agency costs. It also tries to answer the question how to align interests. The principal can align the agent’s objectives by providing adequate incentives or even providing the agent with actual ownership.¹⁴ Further, theory lays out concepts of different controlling mechanisms. Assuming agents have a different individual agenda than their principals, those in return need to monitor their agent’s actions which imposes costs (Jensen & Meckling, 1976).

The drawback of the agency theory is that it mainly focuses on the top executives. Other stakeholders such as employees or the government in this specific environment are basically neglected (Liew, 2007). Furthermore, it assumes a fundamental mistrust towards the agent.

A countervailing theory was developed by Donaldson and Davids (1989). The Stewardship Theory contradicts the agency theory with a simple basic assumption that managers are good stewards of a company. In contrast to the distrust in the agency theory this theory believes in goal alignment since manager’s intrinsic motivation is to perform well and because they are team players (Donaldson, 1990). The differences between the two theories can be summarised in three aspects:

1) Stewardship assumes trustworthy managers that will act in the company’s best interest versus rational, self-interested managers under the agency theory.
2) The main consequences of the agency theory are arising from monitoring and control costs. The stewardship theory proposes ways to build the relationship between the agent and principal instead.
3) While the main focus of the agency theory is on the various goals of different stakeholders within an organisation the stewardship theory rather draws attention on recognising and aligning them.

With respect to subsequent discussions on duality, Donaldson and Davis reverse the view on duality. They suggest that combining the CEO and Chairman’s position will remove the ambiguity and the accompanying conflicts. They even predict higher financial performance as a consequence and refer to some empirical evidence that has been found (Donaldson, 1990).

3.3 Corporate Governance and Agency Theory in GLCs

The first step when considering governance issues for GLCs is to define whether the public or the government represents the principal. Both can take on this role while the ultimate identification of the goals becomes very difficult (Wicaksono, 2009). It is possible that the relationship with the government leads to serious agency problems for shareholders. Bureaucrats loyal to the country, who are simultaneously in charge of a GLC may encounter conflicts of interest. This overvaluation of loyalty or national pride and the distrust of markets are prevalent for managers of GLCs (Yi & Wang, 2012). The applicability of the stewardship theory shall therefore be questioned. Considering an ownership control of the government or solely inner control via board positions assigned to government officials, the enterprise may not always take decisions in favour of their shareholders, as the agency theory contends.

But what is actually so different between private enterprise and SOE’s governance? The differences can be presented as three simplified categories (S. Wong, 2004):

1) Principal-Agent problem

Within the public sector the principal-agent problem can occur between citizen (principal) and bureaucrat (agent) as well as between the government (principal) and the manager (agent) (Anwar & Sam, 2006).

2) Objectives

Governments might focus on specific objectives such as low output prices or employment (Boycko, Shleifer, & Vishny, 1996). Though managers have an interest in public welfare within their role as bureaucrats and shareholder maximisation within their role as managers of the company, their personal interests might be even different.

3) Transparency

The cost of monitoring for this additional conflict of interest is high. While agency cost can be mitigated by managing owners (Jensen & Meckling, 1976) this is different for GLCs. State firms have the highest ownership concentration among companies in Malaysia (Tam & Tan, 2007). And though the state can establish bureaucrats in the management of its enterprises there is ultimately no single controlling owner who would be able to absorb the monitoring cost. Especially since the dispute between public and government often leads to sullenness of the public to actually monitor.

If the government though is involved in monitoring its investments by assuming responsibilities, e.g. in the board of those GLCs, this risk can be mitigated (Najid & Rahman, 2011). Yet, assigning board members alone does not solve the problem. As in general business practice a long-term oriented performance-linkage can be an incentive against the agency problem. Without the possibility to also influence the performance base of those managers, the solely numeration of board members does not serve the government’s interests. Also the problem of information asymmetry can be mitigated by the government, which should have easier access to information compared to the usual owner.

But why would managers in SOEs not follow their principal’s interests? First, one should assume that a manager of a government agency follows either the profit-maximising goals or other social ones. But in the end it all comes down to managerial behaviour theories reject this rational argument (Simon, 1959). Second, managers of any kind can usually afford to have a separate agenda since it is difficult to measure performance. Third, in the case of SOEs it happens that a manager feels to be as much a trustee of the state as any of his government superiors¹⁵ and hence, thinks he can make the best decisions for the country on his own. As the manager (agent) of a SOE knows about the duality of goals, he feels a need to make a decision on the specific goal, may it be the shareholder value maximisation or the government’s goal. The last argument is the pure selfishness of a human being, by taking his own decisions the agent can build its individual brand of political power (Aharoni, 1986).

When finally the goals are stated, a control system will be established to monitor their implementation. Control shall be defined as the regulation of actions to ensure the efficient goal achievement. Due to the urgency of decision-making in the corporate world, controls cannot be carried out on a single-activity basis but the aggregated actions are subject to control. In a SOH, such as Khazanah in Malaysia or Temasek in Singapore, the control can be centralised. Amongst acknowledging the importance of the sector, a holding allows to monitor and control all SOEs with a similar mechanism. The conflict of interest between the different ministries can be solved easier at the same time by directly assigning the funds to the holding rather than to a certain ministry (Aharoni, 1986).

The following paragraphs will therefore examine the governance problems and possible solutions for Malaysia and lay a focus on the interesting concept of the SOH Khazanah.

3.4 Khazanah Nasional - A State-Owned Holding

Considering the performance issues of several SOEs some governments tend to move from a direct state involvement via ownership towards a pure regulatory setting. The state can operate either as a pure financial investor (state ownership) or intervene in the evolution of the economy by taking significant risk of structural change (Bellini, 2000). According to Bellini (2000) the objectives of the state are unchanged but the design and implementation is shared among a wider group.

An interesting aspect about the Malaysian model of governance ownership is that many entities are owned and controlled via one single vehicle, the SOH Khazanah Nasional ¹⁶ . Different to other SOEs the government usually owns the majority of cash flow rights using this financial holding but does not necessarily exercise operational control (Ang & Ding, 2006). On the one hand, this has the advantage of avoiding inter-agency problems between different governmental organisations or ministries. On the other hand, Malaysia bears the risk that the holding becomes too big and powerful. This may impact the efficiency of the decision-making process and the ability to pursue multiple interests.

Khazanah is basically a copycat of Singapore’s role model Temasek. The holding structure, which manages Malaysia’s financial resources has been set up in September 1993 and began operations in 1994. In March 2005, Khazanah managed assets worth USD 16.8 billion and throughout the following years experienced an increase of 11% p.a. to eventually manage a portfolio of USD 40 billion in December 2012 (Khazanah Nasional, 2013a). The continuing growth does not only represent economic growth but also continuous new acquisitions as well as new incorporations. The portfolio comprises over 50 companies, such as Malaysian Airlines, Iskandar Malaysia (southern development corridor) , UEM (Infrastructure- Engineering conglomerate) or IHH Healthcare (incorporated 2010 with Khazanah as the main shareholder), most of which located in the public service sector. Besides those directly and often completely state-owned enterprises there are numerous companies that fulfil the respective government requirements to be named a GLC. The government defines GLCs as firms, which it controls directly or via government-linked agencies.¹⁷

As the investment arm of the government, Khazanah focuses primarily on maximising value and shaping the national competitiveness. The holding is separated from other government roles such as the regulator (law enforcement) as well as provider of public infrastructure. Still it may arise the question how strict these differentiation and separation of goals can be, especially taking into consideration that the Prime Minister also serves as the Chairman of Khazanah. Additionally, of the current eight members of the Board, three are active Ministers (Khazanah Nasional, 2013b). The management board though is merely assigned with executives from the private economy.

Khazanah states shareholder value creation to be the primary measure. Nevertheless, it points out that all stakeholders’ - namely customers, labour, suppliers, and the government - need to be fairly addressed (Mokhtar, CEO of Khazanah, 2005).

The following paragraph will investigate the specific agency problems of a SOH and highlight to what extent they deviate.

3.5 The Agency Problem of Khazanah

Malaysia’s economy is characterised by a very different ownership structure compared with the Western world. However, the Western world conditions implicitly form the underlying assumptions of the agency theory. In Malaysia though, the high number of GLCs in industries such as transportation, energy, telecommunications and financial services form the backbone of economic and social development. Corporate governance for GLCs is hence to be understood as a matter of national interest (Najid & Rahman, 2011). Those interests can go along or interfere with basic business principles.

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¹ The reader will find a more profound description later within this and in Chapter 2.1 State-Owned Enterprises.

² The author’s particular interest for Malaysia aroused representing this very country in the World Model United Nations in Vancouver in 2012 (WorldMUN). The internationalisation process of GLCs and the government’s influence under such multi-ethnic circumstances have been part of an inspiring talk with the Malaysian High Commissioner Datuk Zakaria Sulon in London, March 2012.

³ ASEAN stands for Association of Southeast Asian Nations.

⁴ The army for example is no such SOE as their services are not for sale.

⁵ As Singapore’s past Prime Minister, Lee Kuan Yew stated: ‘ The only reason the government moved in was that no entrepreneur had the guts and the gumption and the capital to go in on his own. So we went in and got it going, using government officials who had the drive and the flair. And we were prepared to go into more high- risk areas where Singaporean entrepreneurs are unable to carry that risk, either for lack of daring or for lack of capital. ’ (Zutshi & Gibbons, 1998)

⁶ The author does not intend to discuss corruptness. The term shall hence be understood as in its colloquial use.

⁷ Imagine for example the minister of agriculture might utilise his proper SOE - and the respective government funds - to grant cheaper loans to farmers in order to nurture his political image.

⁸ It is not necessary to deep-dive into any distinction between socialists, collectivists or communists. The basic principles of the social ownership of the production factors as well as the fundamental position of central planning are crucial to any of these possibly distinctive positions. Perhaps, because both aim for economic profit, but prioritise it differently.

⁹ See Chapter 4.1.2 Investment Development Path.

¹⁰ Tobin’s q is a market-based measure for firm valuations.

¹¹ See Chapter 3.3 Corporate Governance and Agency Theory in Asian SOEs for a detailed explanation.

¹² Cadbury was the Chairman of the Committee and sometimes referred to as the actual author of the presented thoughts.

¹³ Quoted first in the introduction.

¹⁴ The strong concentration of ownership leads to another agency cost, which can be described as the expropriation of minority shareholders by the controlling shareholder (Maury, 2006). This specific agency cost type II shall not be further discussed in this study but is inherent in a vast number of especially family-owned businesses in Malaysia. The emergence of agency cost type II by GLCs could be subject to further research.

¹⁵ The same can apply to MNEs.

¹⁶ Throughout this study the terms ‚Khazanah Nasional’ and ‚Khazanah’ both refer to Malaysia’s SOH. 18

¹⁷ According to the Putrajaya Committee on GLC High Performance (PCG), those agencies can be the Ministry of Finance (MOF), Kumpulan Wang Amanah Pencen (KWAP) and Bank Negara Malaysia (BNM). They might also be owned by Government-linked Investment Companies (GLICs) such as Permodalan Nasional Berhad (PNB), Employees Provident Fund (EPF) or Tabung Haji. Apart from a direct ownership stake, PCG also refers to the government’s ability to appoint board members and make major decisions for GLCs either directly or through GLICs. See Appendix 1 for a historical overview of the original ‘G20’ GLCs held by GLICs.