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New Look for Asian Stock Indexes

Revised Data Illustrate Family Domination of Major Firms

By Philip Bowring - International Herald Tribune


The compilers of global stock indexes - Morgan Stanley Capital International, Dow Jones & Co. and FTSE International - are at last acknowledging a fact of Asian corporate life laid bare by the regional crisis: the extent of corporate cross-holdings and pyramid structures.

Dow Jones and FTSE have been reweighting their global indexes to reflect better the actual shares available to investors, or the free float, as distinguished from those shares held by another corporate group or a government. Morgan Stanley, which publishes the most closely followed of all these indexes, has released a consultation paper indicating it will follow suit in stages.

The changes are global, giving greater weight to the United States and less to Europe and Japan. But they affect emerging Asian weightings more than any other because these have been the most distorted by the practice of family domination of listed companies. In some cases, the free float is also limited by substantial government ownership of partly privatized companies, mostly utilities and airlines.

The index changes coincide with the publication of research by two academics from the Chinese University of Hong Kong, Larry Lang and Leslie Young, detailing the extent of family domination of listed companies in Asia. This research has also focused on the way pyramid structures have persistently resulted in public companies being exploited for the benefit of family owners.

Pyramids, in this case, consist of a series of listed companies with interlocking holdings that enable a family to maintain control of a large amount of assets with a minimum of equity. They can pass profits through to the private family company and ensure that losses are concentrated in the companies in which the family's effective interest is least.

For example, the private companies sell land to the listed companies at inflated prices or use the public companies to funnel loans from related banks back to the private entities. The losers have been banks and taxpayers - through bailouts - as well as outside shareholders.

These practices have long been known in general terms, and the academics note that the stock market has long been alert to the danger of expropriation of outsiders by assigning lower valuations to closely held family companies than to their industry peers.

But what the index architects had been failing to acknowledge was the massive overweighting that pyramid structures can give to whole markets as well as to particular groups by according them a market capitalization vastly greater than if the cross-holdings were to be eliminated. Critics say market capitalization is a misleading guide to a company's importance if vast blocks of its shares never trade.

Since most institutional fund managers measure themselves against one or other of these indexes, which in turn focus on a relatively narrow selection of stocks, the impact of indexes has been greater in Asia than elsewhere. This has distorted not only market weightings within global and regional indexes but also sector weightings in country indexes.

This overconcentration in a few groups may also have a secondary effect. The more institutions feel they have to buy the major groups, the easier it becomes for the large shareholders, if they wish, to manipulate the price of the free float.

Hong Kong, supposedly the most open of all East Asian markets, has a very high level of interlocking structures. The Li Ka-shing family controls Cheung Kong, which controls Hutchison Whampoa, Hongkong Electric and Cheung Kong Infrastructure. HSBC controls Hang Seng Bank, and Swire controls Cathay Pacific. Free floats in Sun Hung Kai Properties, Wharf and Henderson Land are limited by family-dominated corporate arrangements.

According to research by Salomon Smith Barney, Hong Kong's weighting in the much-followed Morgan Stanley Far East ex-Japan index would crash to 19 percent from 27 percent if the index were fully adjusted for free float. This is an indication of just how much more tightly held Hong Kong stocks are than those elsewhere in Asia. Another big loser would be Malaysia. China would benefit, despite state control of most companies.

The biggest winner from re-weighting, according to Salomon Smith Barney, would be Taiwan, whose weighting would rise to 30 percent from 19 percent. Taiwan companies tend to be family-run, but there are few pyramid structures, and far more individuals own shares than elsewhere in Asia.

According to Mr. Lang and Ms. Young, the top 10 families control only 15 percent of stock market capitalization, the lowest in Asia. In South Korea it is 30 percent, and Hong Kong is almost as high - indeed, only the lack of family control at HSBC keeps the figure from rising to the 40 percent levels of the Philippines and Indonesia.

These figures use pre-crisis data. Things have been changing in some markets. The collapse of Daewoo Group and the partial breakup of Hyundai Group will greatly reduce family domination of the South Korean index - but it will increase the holdings of the government, which has had to rescue several listed banks. That has been a pattern throughout the region, except in Hong Kong, where official support was for the market as a whole.

In Hong Kong, the recent sale by Cable & Wireless of HK Telecom will widen ownership. In Thailand, family control of banks has been eroded by collapses and rights issues. Thailand's relative weighting is unchanged, according to both FTSE and Salomon Smith Barney.

The current recalculation of indexes has also been a reminder of how different these weightings are. FTSE has just begun including Taiwan and South Korea in its World index. Taiwan is accorded barely a third as much as Hong Kong's global weighting of 1.3 percent, and South Korea gets less than Singapore's 0.43 percent. Imperial nostalgia is evidently strong in London. The FTSE makes its new calculation on the basis of an ''investability factor'' that takes into account the free float but also aims to reflect overall investor accessibility, such as ease of transactions for foreigners and any limits on ownership or foreign-exchange remittance.

The reweighting may not have much short-term impact on Asian markets. But in the medium term, because institutional investors like to follow these weightings to avoid being out on a limb, it is likely to affect relative performance.