State

1
States Role In Corporate Governance In South
East Europe
Corporate Governance
Thomas Wels, Partner September 21, 2001
2
Overview

• Importance of corporate governance in SEE
• Barriers to improved governance
• State attempts to improve governance
• A pan-regional response?
• Options for the State

3
Importance of quality of board practices when
evaluating investments

In evaluating companies for potential investment
in the following regions, how important is the
quality of board practices relative to financial
issues?
Source McKinsey Investor Opinion Survey
1999/2000
4
Average premium investors would be willing to pay
for a well-governed company
Average
Over 80 of investors willing to pay a premium
30
28
Indonesia
26
Thailand
Malaysia
Greece
24
Italy
22
Germany
Taiwan
France
20
Japan
Spain
18
Switzerland
16
Continental Europe
Asia
Source McKinsey Investor Opinion Survey
1999/2000
5
Overview

• Importance of corporate governance in SEE
• Barriers to improved governance
• State attempts to improve governance
• A pan-regional response?
• Options for the State

6
The market model governance chain
Examples can be found in Australia, Canada,
U.K. and U.S. Source McKinsey
7
The control model governance chain
Examples can be found in Asia, Latin America
and many Continental and South Eastern European
countries Source McKinsey
8
Importance of institutional factors when
selecting emerging market countries in which to
invest
Average response
Irrelevant
Relevant
Highly Relevant
Enforceability of legal rights (e.g. contracts)
Quality of economic management
Independence of judiciary/quality of legal system
Level of corruption
Predictability and level of taxation system
Quality of accounting standards
Effectiveness of regulatory system
Administrative efficiency of government
Effectiveness of banking sector
Scale and liquidity of local investment market
Source McKinsey Emerging Market Investor
Opinion Survey 2001
9
Importance of corporate level factors when
selecting emerging market companies in which to
invest
Average response
Irrelevant
Relevant
Highly Relevant
Distinctions between company and family interests
Clearly defined governance arrangements
Accuracy of financial reporting
Legally enforceable minority shareholder
protection
Use of performance-related pay for top management
Timeliness of financial reporting
Coverage of financial reporting
Presence of independent (non-executive) directors
Establishment of conflicts of interests committee
Source McKinsey Emerging Market Investor
Opinion Survey 2001
10
Overview

• Importance of corporate governance in SEE
• Barriers to improved governance
• State attempts to improve governance
• A pan-regional response?
• Options for the State

11
A radical reduction in State involvement a
crisis response
COUNTRY EXAMPLE

• Financial reform . . .
• Banking sector reform
• Public, agricultural, and social security
  spending reform
• Plan to remove barriers to foreign investment
• Government asset management company to be
  established

• Economic crisis
• Large currency devaluation
• High unemployment
• Falling stock market capitalizations
• Increased non-performing bank debt
• Falling corporate profitability

Will buyers for state-owned enterprises be found?

• . . . coupled with significant corporate reform
• Privatization of Turkish Telecom, TUPRAS (oil
  refinery), POAS (petrol distribution), TEKEL
  (tobacco/alcohol), and SEKER (sugar)
• Preparations being made to facilitate further
  private investment in gas, electricity
  generation, and distribution rights, Petkim
  (petrochemicals), Turkish Airlines, and ERDEMIR
  (steel)

Source Turkish Treasury IMF clippings
12
Decreasing State ownership in corporate sector .
. .
COUNTRY EXAMPLE

• Objectives
• Attract local and foreign investors
• Boost entrepreneurship
• Encourage mergers and strategic alliances

• Challenge
• Lack of interest from international investors.
  For ex
• Prolonged negotiations for selling of Olympic
  Airways and Hellenic Shipyards
• Motor Oils disappointing IPO

• Expected results
• Over 3 billion Euros revenues
• Market consolidation
• Boost market confidence in Stock Exchange

• Measures
• Undertake large scale privatization plan, incl.
  12 major banks and companies in 2002 (e.g., OTE,
  PPC, Agricultural Bank, Postal Savings Bank)
• Introduce tax incentives to encourage more
  companies to merge
• Introduce new legal and fiscal environment to
  encourage more venture capital

Source Clippings McKinsey analysis
13
. . . and radically reduced State influence in
specific companies
COMPANY EXAMPLE
owned by state

• Other measures planned
• Revoke trade union right to appoint board
  director
• Management to be appointed by shareholders for
  5-year tenures
• Stock options introduced to be open to all
  employees over time

• External influences on telecomms sector
• Deregulation
• Competition from new market entrants

Prior to 1996
June 2001
September 2001
Planned in future
Legislation passed enables changes Previous
ly, State-appointed Source Clippings
14
Investors react favorably to improved corporate
governance
COMPANY EXAMPLE
High/low points Spread of response

• Governance changes
• Strengthening of shareholder rights
• Installment of transparency and accountability
  measures
• Increased legal activity by shareholders
• Accumulation of governance knowledge and practice
• More independent boards

• Institutional changes
• Liberalisation of foreign ownership of equities
  and bonds
• Elimination of cross guarantees
• Liberalisation of the MA market
• Corporate and banking restructuring

Premiums for well-governed companiesPercent
36
34
32
30
28
26
24
22
Before changes (1998)
After changes (1999)
Source McKinsey analysis, McKinsey Investor
Opinion Surveys 1999/2000
15
Overview

• Importance of corporate governance in SEE
• Barriers to improved governance
• States attempts to improve governance
• A pan-regional response?
• Options for the State

16
Most capital markets and companies listed in
South East Europe are small
Total market cap end 2000 Millions USD
Number of companies listed (main and parallel
markets) end 2000
Average company market capitalization Millions USD
Athens
Istanbul
Sofia

Bucharest

Skopje
London
1,100
2,612,230
25 listed on the official market
and 478 on the free market
Estimates Source FiBV.com EIU ASE BSE FEAS
EBRD
17
although in relative terms, ASE is quite
successful
Selected examples Value of S.E. as a percentage
of GDP end 2000
Athens
Istanbul
Sofia
Bucharest
Skopje
London
Estimates Source FiBV.com EIU ASE BSE
FEAS EBRD
18
Yet, core shareholders dominate Greeces largest
publicly-listed companies
Shareholder structure of top 15 companies ranked
by market capitalization, end 2000
Domestic shareholders gt 5 Foreign shareholders gt
5 Shareholders lt 5
Domestic shareholders average holding 33
Foreign shareholders average holding 13
Source ASE McKinsey analysis
19
Two recent initiatives in South East Mediterranean

• Discussing increased cooperation
• Create common index comprising shares of all
  three stock exchanges
• JV is planned within 2001

• Negotiating
• Open respective markets to investors in Turkey
  and Greece via cross-membership of companies on
  both markets
• Common technical application to follow stocks on
  both markets

Source Clippings
20
A more radical solution a combined pan-regional
exchange?
Percent of total, USD millions, number of
companies
Equivalent to Brussels Stock Exchange
Equivalent Toronto Stock Exchange
Skopje
172,485
1,416
Bucharest
Bulgaria

• While combined number of companies is high,
  aggregate market capitalization is still
  relatively small
• Without more dynamic pooled equity markets,
  difficult for privatisation programs to access
  (foreign) equity financing option

Istanbul
Athens
Market capitalization
Number of companies
Source FiBV.com EIU ASE BSE FEAS EBRD
21
Requirements for pan-regional South East Europe
exchange
Requirements
Models

• Common trading platforms
• Coming listing/tracking standards
• Common corporate governance standards
• Effective market makers/traders
• Complementary, if not common, securities
  legislation

• Euronext
• Euronext
• SEC-regulated exchanges/OECD Principles
• SEC-regulated exchanges
• U.S. SEC/U.K. FSA regulations

22
Overview

• Importance of corporate governance in SEE
• Barriers to improved governance
• State attempts to improve governance
• A pan-regional response?
• Options for the State

23
Moving from control model governance chain

• Independenceand performance
• Encourage more independent boards
• Facilitate stock- related compensation

• Shareholder environment
• Attract foreign equity capital
• Reduce State ownership

OECD Principles
Corporate context
Institutional context

• Transparency and accountability
• Mandate international accounting standards
• Create and enforce shareholder rights

• Capital market liquidity
• Encourage equity-based financing
• Remove barriers to takeovers

Source McKinsey
24
Where the State can contribute to improve
Corporate Governance
Objective
Examples
Adequate regulatory frameworks

• Create an adequate Institutional and Corporate
  framework to
• attract Direct Investment
• Indirect Investment

• Internationally accepted governance rules
  (e.g.,OECD, SEC, IAS/US-GAAP)
• Create broad distribution of stock in population
• Reduce State stakes to create market for control
• Incentivise stock exchange co-operations to
  improve liquidity

Liquidity of exchanges
25

• For further information contact
• Thomas Wels 30 (1) 3672 777
• Mark Watson 1 212 446 8021

McKinsey Investor Opinion Survey 1999/2000 can be
downloaded from www.mckinsey.com Also, available
on www.mckinseyquarterly.com, Corporate reform
agenda in the developing world", an article that
includes findings from the McKinsey Emerging
Market Investor Opinion Survey