It is commonly agreed that the 1997 Asian financial crisis was mainly caused by a lack of effective corporate governance and transparency in many Asian financial markets. It is also found that the impact of this financial crisis is more severe for less transparent markets. Thus a solution to restore international investors' confidence is to strengthen their corporate governance.

The recent collapse of the Enron Corporation in the US and similar incidents in Hong Kong and the Mainland China have provided evidence indicating that even large corporations may also suffer seriously from poor corporate governance. Disclosures of misleading information and other market misconducts by these individuals have led international policy makers worldwide to conclude that a substantial review and overhaul of corporate governance (CG) processes is critical to restoring confidence and balance in the international marketplace.

International financial markets' performance and private investment decisions are all considerably affected by institutional and governance arrangement. Corporate governance is defined as a system that delineates the rights and responsibilities of each primary stakeholder (shareholders, directors and management) of a company and the design of institutions and mechanisms that induce or control entrusted board directors and management to serve the best interests of all types of shareholders and other stakeholders of the company.

The board of directors is the 'soul' of a company—the foundation of all business decisions and the origin of corporate culture of the whole entity. The essence of corporate governance includes ownership structure, managerial discipline, integrity, independence, fairness, transparency, responsibility, accountability, and social awareness. These attributes are usually used to measure the standard or quality of corporate governance of an organization.

In East Asian markets with concentrated ownership by controlling families, unchecked insider or connected party transactions are frequent and the main conflict is between the board/management (dominated by controlling shareholders) and minority shareholders. Therefore, the protection of the rights of minority shareholders is one of the key concerns in East Asia countries.

There are four layers of CG or sources of forces shaping a company's CG:

1. individual ethics and corporate cultures,
2. internal ownership, control and incentive mechanisms,
3. external monitoring mechanisms, and
4. law and regulations.

Recent studies by McKinsey and CLSA have shown that firms practicing good CG enjoy lower cost of capital and higher share value. Companies with poor corporate governance are high-risk investments. Markets and stocks with poor corporate governance are punished. Research by Standard and Poor's indicates that investors are willing to pay a premium for shares of a well-governed company. There is empirical evidence that bad corporate governance is a good early warning of deeper trouble. The overall CG quality of an economy also affects its international competitiveness.

In recent years, both the Chinese and the HKSAR Governments have recognized the importance of corporate governance and put much attention to it. The former Financial Secretary Donald Tsang of the HKSAR Government said in his 1999 Budget Speech that high corporate standards were the hallmark of a first-class financial centre. He added that "our aim is to establish Hong Kong as a paragon of corporate governance, ensuring that those investments in Hong Kong are afforded the best protection and that our listed companies are managed with excellence, complying with the highest international standards including those related to risk management and disclosure of information".

Amongst 10 East-Asian countries, Hong Kong was always ranked second in terms of the quality of corporate governance over the last several years, just after Singapore. These two economies benefit from a colonial legacy of common law institutions, relatively strong judiciaries, good ethical standards and low corruption. On the other hand, China has been ranked among the second last in the list, although there has been visible improvement in the aspect of transparency. However, while Asian CG standards were improving, they still had a long way to go. At the corporate level, Hong Kong actually contains few companies that practise world-class corporate governance.

Given this importance and complexity, improving corporate governance is the key for the healthy development of a financial market and the economy as a whole. Many CG and financial policy issues are inter-related. Any changes in such rules and/or policies would significantly affect the operations and behaviour of many participants in the financial market. Thus, in-depth academic and policy research is essential for enhancing the quality and effectiveness of CG and financial policies in Hong Kong and the region.

For example, the Hong Kong Stock Exchange's proposals for de-listing firms and lengthening of trading hours in 2002 met with severe market reactions and resistance from market participants. Its recent increase in the required number of independent non-executive directors for each corporate board is not backed by any empirical research. Contrary to the universal CG standard practice, until very recently, Hong Kong has not required a listed company to set up an audit committee or to disclose executive compensations by individual names.

Indeed, in the 2004 Policy Address by the HKSAR Chief Executive, his called for more vigorous public policy research within the community, in order to better realize the objectives of effective governance. With the strong academic staff within the School of Business and their dedicated research interest in corporate governance and financial policy issues, the "Centre for Corporate Governance and Financial Policy" was set up in late 2004, with policy research as one of the main objectives.