Tuesday, January 22, 2013

Corporate Governance

To all my students on Business Ethics and Corporate Governance

Read the following article. Very important!!


Asian Academy of Management Journal, Vol. 12, No. 1, 23–34, January 2007
23
CORPORATE GOVERNANCE IN MALAYSIA:
THE EFFECT OF CORPORATE REFORMS AND
STATE BUSINESS RELATION IN MALAYSIA
Nor Azizah Zainal Abidin 1 and Halimah @ Nasibah Ahmad2
1Faculty of Public Management and Law, 2Faculty of Accountancy
Universiti Utara Malaysia, 06010 Sintok, Kedah, Malaysia
ABSTRACT
The Asian Financial Crisis in 1997 not only introduced the term of corporate governance
but also drew attention of the public about the weaknesses of Malaysian corporate
governance practice. After 1998, Malaysian government decided to adopt corporate
reform that could enhance the quality of good corporate management practice. This
reform is clearly stated in the code and rules of corporate governance. The purpose of
this research is to study the significance of implementing the code and rules of corporate
governance since the public already realize the close relationship between business and
politics. Three companies were chosen as indicators for this study. As a result, it was
found that companies which are involved in corporate malpractice but have good
relationship with states will always be excluded from the legal corporate action.
Keywords: corporate governance, corporate reforms, political economy, state business
relation
INTRODUCTION
Asian Financial Crisis in 1997 not only introduced the term of corporate
governance but also drew attention of the public about the weaknesses of
Malaysian corporate governance practice. After 1998, Malaysian government
decided to adopt corporate reforms that could enhance the quality of good
corporate management practice. This included the introduction of the new
Malaysian code and rules for corporate governance. The debate of corporate
governance in Malaysia are often limited to agencies involved directly in law
enforcement such as the Ministry of Finance, Kuala Lumpur Stock Exchange
(KLSE),1 Securities Commission (SC) and Registrar of Company.
On contrary, the aim of this paper is to study the significance of implementing
the code and rules of corporate governance from the political economy
1 Recently known as Bursa Malaysia.
Nor Azizah Zainal Abidin and Halimah@Nasibah Ahmad
24
perspective.2 In Malaysia, the close relationship between the business and
politics is no longer a secret (Gomez, 1990, 1994). This is further evidenced by
firms which are wholly-owned and controlled by the ruling parties. This
phenomenon leads to a question on whether these companies will face any
corporate legal action should they fail to comply with any of the code and rules
pertaining to corporate governance.
RESEARCH METHODOLOGY
This is an exploratory study which uses qualitative research methodology. This
research extensively uses secondary data from various past researches, economic
reports, company annual reports as well as articles from journals, working papers
and books. Case study method has also been applied in this research in order to
answer the assumption made by the researcher. The focus of this research is
solely on links between state and capital. Hence, a case study was carried out on
three politically linked business companies, namely Perwaja Steel Sdn. Bhd.,
Renong Bhd. and Malaysia Airlines System Bhd. (MAS). This is the first study
of its kind in Malaysia which compares three infamous corporate malpractice
cases.
Further analyses were carried out using the Basic "Black Box" Model of
Corporation by Blair (1995), which explains how the elements of the corporate
governance function. According to Blair, a corporation is unique because there is
a substantial part of economic activity. Corporations are legal structures and their
existence is not limited in time or space. As separate legal entities, corporations
are distinct from any individuals who participate in them. They can own property
and business asset in terms of land, building, equipment and intangible assets
such as patents or brand names. Corporations can hire or contract work of
millions of individual and thousands of corporation to create more wealth. Thus,
corporations have to perform efficiently. Otherwise, their cost will be too high
and they might be out of business. If corporations default on their debt, they will
be unable to secure fresh loan or ended up paying high interest rate to
compensate credit risk. Such phenomenon will lead to a big impact on the
economic and government performance. On this note, corporate governance is
definitely needed to control various participants in corporate enterprise. But,
Blair did argue that the success of corporate governance enforcement is restricted
on how much government intervenes in the economy.
2 The concept of political economy here refers to political business which analyses the evolving
links between politicians and large scale enterprises with emphasis given to the changing pattern
of ownership and control ties among politically well-connected companies.
Corporate governance in Malaysia
25
Based on Blair (1995), this research attempts to answer the following
assumption: "Companies, which have good relationship with states will always
be excluded from penalty under the rules and code of corporate governance."
The basis for this assumption also refers to Malaysia 's long history of close
political-business links in various forms (Gomez, 1990, 1994, 2002). In this
regard, we refer to first, ruling parties owned companies. Second, corporate
figures who have strong political networking and owned firms that once belonged
to government which eventually re-nationalized and lastly, the government
owned firms through state investment arms.
THE CONCEPT OF CORPORATE GOVERNANCE
The phrase "corporate governance" is often used but yet lacks a precise definition
(Low, 2000: 436). Most of the definitions focused on the structure and the
function of the board of directors or the rights and prerogatives of any
shareholders in boardroom decision making. The High Level Finance Committee
Report3 on Corporate Governance in Malaysia also defined corporate governance
from the same perspective. They defined corporate governance as "the process
and structure used to direct and manage the business and affairs of the company
towards enhancing business prosperity and corporate accountability with the
ultimate objective of realizing long-term shareholder value whilst taking into
account the interest of other stakeholders" (Lee, 2003: 41).
From the definition, corporate governance mainly focuses on the process used to
direct and manage the business and affairs of the company with the objectives of
striking a balance on:
· The attainment of the company's objectives.
· The alignment of corporate behavior to meet the expectations of
shareholders.
· Accountability and good stewardship, taking into consideration the
interests of shareholders, stakeholders, corporate participants and society at
large.
3 The committee comprises the Ministry of Finance, the SC, the Companies Commission of
Malaysia, the Financial Reporting Foundation, The Malaysian Accounting Standards Boards,
Bank Negara Malaysia, Association of Bank Malaysia, The Association of Merchant Banks
Malaysia, KLSE, The Association of Stock Broking Companies Malaysia, The Malaysian
Association of the Institute of Chartered Secretaries and Administration and the Federation of
Public Listed Companies.
Nor Azizah Zainal Abidin and Halimah@Nasibah Ahmad
26
Thus, corporate governance can be described as the proper procedure on how the
"government" of a company (the managers and board of directors), should be
responsible to their "voters" (the shareholders, creditors and investors). Corporate
governance emphasized on the transparency of decision making process, fairness
and trustworthiness in managing a company. However, Blair (1995) viewed the
definition and concept of corporate governance from a wider perspective but at
the same time still emphasized on the ownership and control element as
suggested by Cadbury (1992), Monks and Minow (1995) 4 and The High Level
Finance Committee Report for Blair, the degree of good enforcement of
corporate governance very much depended on the roles of the state.
THEORETICAL MODEL
Figure 1 illustrates the basic model of corporation. Corporations are organized
and run by entrepreneurs or a management team that raise funds to acquire
physical capital and to finance initial operation by borrowing from banks and
other lenders (debts) or by issuing and selling "equity" shares. The decision made
in the boardroom will directly affect the shareholders and financial institution
while indirectly affect the employees, suppliers and customers. The board of
directors has the responsibility of making the right decision that should directly
or indirectly benefit all parties involved. Meanwhile, the concepts of ownership
and control are important to ensure the company practices check and balance
system between the owner and the company's management. The owner of the
company or the shareholders has the rights to obtain accurate information which
will enable them to be comfortable with the company's operation and be sure on
return of their investment. They also have the rights to offer their opinion and
suggestion to the company's management in improving certain actions that need
to be taken by the company's management, or object upon any decis ion, which
they believe as inappropriate or unprofitable to the company. The directors of the
companies have to prove their abilities in making the right decisions especially
decision related to investment and loan in order to preserve the interest of
shareholders and other stakeholders.
Eventhough the corporate governance recognized the rights and power of the
shareholders and director as the shareholder's proxy, the rights and power are still
subjected to the law regulated by the government (Blair, 1995). This means that
the actual rights and power of the principal and its agent in the company's
4 The concept of ownership and control is to establish an internal management system in a
company to avoid misuse of resources and fraud. The boards of directors and shareholders of
company play an important role in determining the company's direction. At the same time, the
balance of interest of all individual, company and society were done to encourage and develop
investment opportunities, which benefit all parties involved. See Nor Azizah (2004: 32–37).
Corporate governance in Malaysia
27
management is very much dependent on how much the state intervenes in the
economy. In this case, Blair concluded that the state is the actual company
controller compared to policy or law regulated under the rules and code of
corporate governance. Financial institutions also play an important role in the
enforcement of the corporate governance. The stability of the financial institution
will also lead to company's stability. However, the problem arises when the
financial institution is also owned by the state. As the owner, the state is enabled
to control the company through the financial policy besides the rules and
corporate laws.
Figure 1. Basic "Black Box"Model of Corporation
Source: Blair (1995: 21)
RESEARCH ANALYSIS
Corporate Reforms and Achievements
The Asian Financial Cris is led government to adopt corporate reforms. Since
1998, government and private sector had chosen to enhance the corporate la w in
order to improve the level of corporate governance in the country. In 1999, under
the Ministry of Finance, a High Level Financial Committee on Corporate
Suppliers
Customers
Shareholders
Board of Directors
Corporation
(Management and physical capital)
Employees
Voting power
Supervisory power
Dividents Equity capital
Lenders
Wages
Labour
Debt capital
Interest payments
(market rate)
Market price Goods & Market price
Sercives
Input
Nor Azizah Zainal Abidin and Halimah@Nasibah Ahmad
28
Governance was formed. The committee was given the responsibility to review
the corporate framework and make recommendations to improve the level of
corporate governance in the country. The committee felt that there were serious
corporate governance weaknesses particularly in the following areas –
transparency and disclosure requirement, corporate monitoring responsibilities
and accountability of company directors including the rights of minority
shareholders (Das, 2000: 19). Therefore, the code of corporate governance, which
included the principles and best practices in the corporate governance, were
established for the corporate participants. This code essentially aimed to
encourage transparency management of a company besides providing relevant
information to the investors to enable them to guide the company's direction. This
code can also serve as guidelines to the board of directors on how to manage the
company based on their roles and responsibilities (Low, 2000: 438).
The Bursa Malaysia and SC had gazetted new rules for the public listed
companies. They were required to disclose their financial status, shareholders
structure and loan position on a quarterly basis. A company's manager is
subjected to penalty or jail sentence if they fail to comply with the rules. The
government had granted a warrant amounting to US$100,000 to Malaysia
Institute of Corporate Governance (MICG) to conduct research and training
program in order to improve the corporate governance standard and quality (Das,
2000: 19).
In August 2000, Minority Shareholder Watchdog Group was established to
encourage the company to comply with the principles of corporate governance
and to improve the awareness among the minority shareholder about their rights
and the appropriate methods to enforce their rights. Members of this committee
were from the government fund institutions such as Employees Provident Funds
(EPF), Armed Forces Fund Authority (LTAT), Pilgrims Fund Board (LUTH),
Social Security Organization (SOCSO) and Permodalan Nasional Berhad (PNB)
(Yusof Abu Othman, 2000).
The undertaken reformation illustrated that the government and the private sector
had put much effort in order to enhance the standard of Malaysian corporate
governance. An investment bank, CLSA Emerging Market in collaboration with
Asian Corporate Governance Association (ACGA) through their research
regarding the Asian Corporate Governance, reported that Malaysia has achieved
the highest score of 9.0 compared to other Asian countries in reforming their
corporate rules and regulation (Halim, 2003). However, the same research also
showed that the score for the enforcement of corporate rules and regulation was
among the lowest (refer to Table 1). With a score of only 3.5, Malaysia was
ranked 4th lowest position ahead of Indonesia, Philippines and Thailand. This
scenario tells us that the law reforms and implementation are inconsistent.
Corporate governance in Malaysia
29
Table 1
Rank of Countries Based on Corporate Reforms and Enforcement
Countries Laws and rules reforms Enforcement
Singapore 8.5 7.5
Hong Kong 8.0 6.5
India 8.0 6.0
Taiwan 7.0 5.0
Korea 7.0 3.5
Malaysia 9.0 3.5
Thailand 7.5 3.0
China 5.0 4.0
Philippines 6.5 2.0
Indonesia 4.5 1.5
Source: Amended from CLSA Emerging Market in Halim Wahab (2003)
In Malaysia, it can be seen that the state intervention in the economy began in
1970 when the government initiated the positive discrimination policy, i.e. the
New Economic Policy (NEP).5 Under the NEP, government tried to groom
Bumiputera entrepreneur groups in modern economic sector.6 Therefore, the
trustee system7 was created to achieve NEP's overall mission. Public enterprise
was among the first method introduced by the government to increase
Bumiputera participation in the commercial trading sector. However, this method
had actually initiated the relationship between business and politics. Initially, the
state involvement was merely to act as the shareholder for the Bumiputera, but
eventually become owners of companies or shareholders or investment proxy
through companies owned by the ruling parties.
5 NEP was introduced with an objective to obtain national integration through poverty elimination
and society restructuring to eliminate economic trademark by race.
6 Government tried to achieve 30% Bumiputera ownership of the corporate sector.
7 The trusteeship system refers to trusted individual or organization in implementing certain
policy. According to Jomo et al. (1986: 5), there are two basic criteria in trustee strategy in
Malaysia. Firstly, decision on budget allocation and resources and preferred investment were
done according to rules and method determine by the trustee. Secondly, the power on economic
resources is with the trustee and separated from the parties who owned it. There are two level of
trusteeship. The first level is that small group of individuals who makes political decision. The
second level is those superior officers and government servants who serve as the middlemen in
implementing and controlling multiples projects and programs under the trustee system. Under
the system, the level of poverty or wealth is very much dependent on decision made by the
trustee and how the decision is derived. If the decision making process were done with efficiency
and fairness, proper production and distribution can be obtained effectively compared to
capitalism system and socialism system. See Gomez (1990) and Nor Azizah (2004).
Nor Azizah Zainal Abidin and Halimah@Nasibah Ahmad
30
Three companies were selected as indicators in this research. They are Perwaja,
Renong and MAS. The context of discussion focuses on ownership and control as
well as discordance rules and regulation governing these companies. Hence, this
paper tries to demonstrate how the government and business work hand in hand
to conceal the evidence of wrongdoing and malpractice.
Perwaja was established in 1982 by HICOM Bhd., a company owned by the
government in collaboration with a Japanese company, Nippon Steel Corporation
to fulfill the government's mission in implementing the heavy industrial policy.
This is an example where the government had direct interest, as shareholders in a
company. On the other hand, Renong8 was known as United Malays National
Organization (UMNO)'s investment company in the corporate sector. Renong
became a successful conglomerate after Halim Saat,9 Daim's protégé took over its
management. Halim has spurred UMNO's move in business (Yong, Wong,
Chong, Lim, & Chan, 1991). Renong was awarded with many infrastructure
development contracts by the state.10 Another similar case involved MAS, whose
establishment and ownership are also related to the state. MAS which started off
as an airline company wholly owned by the government, was later sold to Bank
Negara as a private entity. However, despite the transfer of ownership, the
government still owned the "golden share",11 which bundles together with the
veto power to influence MAS's decision making process. In 1993, Bank Negara
sold MAS to Naluri Bhd. As the case of Renong, Naluri's owner, Tajudin Ramli
was also Daim's protégé. The veto power of the government remained
unchanged.
The state ownership in all the three companies created close relationship between
business and politics. According to Gomez (1990), this relationship can no longer
split the business and politics as two different entities, but make them
indispensable and dependable on each other.12 In our point of view, this
relationship can easily cause fraud and corruption in the trustee system and offer
much freedom to the businessman to act above the corporate law.
8 It started when Renong (after being taken over by Halim Saat) bought all Fleet Group assets
from Fleet Holding (UMNO's investment company – refer Yong, Wong, Chong, Lim, & Chan
(1991) via reverse takeover with RM1.226 billion shares issuance. Halim Saat admitted that he
is an UMNO proxy in the business. See Gomez (1994: 117).
9 Halim Saat was the director in several governments owned companies, i.e. Landmark Holdings
and Paremba. He was also the director for several listed public companies where Daim's (the
Minister of Finance at the time) family members were among the shareholders, i.e. Roxy, D&C
Bank and Clod Storage (Gomez, 1990: 49–50).
10 See Gomez & Jomo (1999: 97–98).
11 See Lennane (1997: 26–30).
12 Businessman needs politician's support for ease of being awarded with resources owned by the
government. While politicians need businessmen support to fund their political campaigns
during the election season to enable them to be reelected as representative in the government.
Corporate governance in Malaysia
31
Since incorporated, Perwaja had not only failed to gain any profit but was
involved in endless scandals and corruption.13 Within six years, it was knocking
on bankruptcy's door. Perwaja suffered losses of RM2.95 billion and at the same
time owed banks another RM7 billion. Perwaja was also facing colligations of
corruption and mismanagement in tender and contract awarding. For example,
Mah Sun Company and its related companies were awarded with RM967 billion
worth of contracts without any authorization from the board of directors.
Another RM103 billion worth of contract were also awarded to the same
company with no documents traced. Furthermore, doubtful trading transactions
and payments were carried out to non-existing company, i.e. Frilsham
Enterprise.14 Datuk Seri Anwar Ibrahim (Minister of Finance at that time)
informed Parliament that Perwaja was insolvent. However, no legal actions were
taken against Perwaja until Eric Chia was arrested in Mac 2004. Today, Perwaja
is still in operation with fresh funds being injected by the government (Netto,
2004).
In another case, the problems happened in Renong has revealed the malpractice
of corporate governance in Malaysia. The Asian Financial Crisis which led to
Ringgit depreciation has further caused serious financial problem. Apart from
this, it has also increased the amount of Renong accumulated debt between
RM20–28 billion which constituted more than 5% of loans by Malaysian banking
systems (Gomez, 2002: 102; Thomas, 2002: 154). Many economists were
puzzled wit h this situation. The main issue was how did the company obtain such
a large fund as their corporate loans? Did the board of directors and shareholders
play a part in executing their rights to enable Renong to obtain such a big
amount? Had the loan process and procedure been simplified? According to
Gomez (2002), those figures indicated that a significant amount of bank loans
had been channeled to a selected minority. During the crisis, Halim, who owned
not more than 78% of the company's equity tried to save it via restructuring
process. He used his subsidiaries to pay Renong's debt15 but the minority
shareholders were not pleased with his act as it was against their rights and
interest and was a felony pertaining to corporate governance rules.16 Majority of
13 In 1986, Perwaja reported a loss exceeding RM131 million, due to internal management
problems and currencies movement as a result of economic crisis, where Japanese Yen
appreciated against Ringgit Malaysia. See Financial Times (April 1, 2002).
14 See Nor Azizah (2004).
15 Halim bought Renong's shares via UEM, while PLUS issued RM17 billion of bonds at coupon
rate of not less than 10% per annum, in order to settle Renong's debt amounting to RM8 billion
in seven years. See Jayasankaran (2003).
16 In November 1997, Halim sold 32.6% of Renong shares to UEM at RM3.24 per share, 35%
higher than cost price of RM2.40 per share (Ranawana, 2000). According to Gomez (2001), this
acquisition implemented partly through a RM800 million loan provided by government-owned
and politically well-connected banks, upset UEM minority shareholder. Later, PLUS, a Renong
subsidiary, was used by Halim to fund Renong's debts. See Nor Azizah (2004: 59–64).
Nor Azizah Zainal Abidin and Halimah@Nasibah Ahmad
32
analysts were of the view that this type of funding was ridiculous, as subsidiaries
fund was not supposed to be utilized to bail out its parent's debt.
Last but not least, MAS was also faced with internal management problems. Prior
to the Asian Financial Crisis, MAS had already suffered huge debts caused by the
new management under Tajudin Ramli. This had put MAS at risk during the
crisis as all their transactions were done in US dollars. At the same time, Tajudin
also had huge personal debts.17 However, the veto power of the government in
MAS's management had limited plan for MAS to expand and revise funding
strategies for its debts, i.e. decision on airlines destinations were subjected to
government's decision and endorsement. At the time, the destinations decided by
the government were not popular destinations or less concentrated areas, but
MAS had to oblige and extend its services to comply with Malaysian foreign
policy. This type of veto decision contributed to lower return for MAS compared
to other air lines. Consequently, the Asian Financial Crisis affected both MAS and
Tajudin badly due to the significant increase in debts. MAS had sold nine of
their aircrafts costing RM10 billion at a price of RM14 billion to pay Tajudin's
personal debts (MASSA, April 17, 1999). By December 1999, Naluri's loans were
RM888.25 billion causing the company to be deemed as unqualified to be in
charge of MAS's operation anymore (Fauziah, 2000).
CONCLUSION
At this point, we can see that the states involvement in business had changed and
therefore increased the roles of state in many different ways. First, the state at its
capacity as the shareholders had the right to be informed about the business
operation and plan of the company. They can accept or reject any proposals and
plans as well as instruct the management of the company to pursue according to
government's needs. Second, the state as the owner of the financial institutions18
controlled the financial institutions that provided funds and working capitals.
Third, the state as a ruler, can instruct any agency and government offices to
process applications for contracts, loan tender, etc. from its wholly owned
companies. The state , in the ruler's capacity is also the enforcer of any rules and
legislation gazetted by the government.
17 Tajudin obtained personal loans amounting to RM1.8 billion from four banks to enable him to
buy Bank Negara's share in MAS (Jayasankaran, 1999).
18 Malayan Banking Berhad (MBB) and Bumiputra Commerce Berhad (BCB) are examples of
financial institutions owned by the government. The government through Permodalan Nasional
Berhad (PNB), chaired by the Prime Minister, controls MBB. Commerce-Asset Holdings,
subsidiary of Renong Berhad, controls BCB.
Corporate governance in Malaysia
33
These roles, which are conflicting with each other, had caused interruptions in the
appropriate ownership and control practice. This situation le d to an imbalance
condition between the owner and controller of the company, perhaps causing the
misuse of government and financial institutions in the event where
"check and balance" system was neglected.19 This scenario also showed that the
balance of power within the state had shifted in favor of increasingly centralized
executives. Hence, this sit uation conforms to Blair's (1995) model, which
strongly emphasized the rights and power of the principle and its agent in
company's management are still subjected to the degree of government
intervention.
Even though the Asian Financial Crisis is over and we had successfully overcome
the situation, we can never let it happen again as such crisis will lead to a great
loss of our resources in the long term. We learn from history that government's
intervention in economy is essential as free market had faile d to build up the
conducive economic environment. However, the degree of government's
intervention should be limited to certain extent, or else it could jeopardize the
level of democratic practice by the key market players. The politics and business
interest should be aligned in order to prevent any corporate misconduct, hence
avoiding selected legal phenomena, which will eventually affect the government's
credibility as the ruler.
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