International Corporate Governance

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International Corporate Governance

• Reading Chapter 1 (pages 3-21)

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Lecture Outline

• What is Corporate Governance?
• Internal Mechanisms
• External Mechanisms
• Convergence
• Measuring Corporate Governance
• Benefits of Good Governance
• What you need to remember

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Introduction
Stage 1
Company founded (owned and managed) by
individual, family, partnership, government or
company.
Stage 2
Voting Rights
Voting Rights
Company expands by issuing more equity and debt.
New equity holders also get voting rights as to
who manages the company.
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Introduction
Company founder must now choose between keeping
control of the company or allowing the company to
be managed by professional managers.
Voting Rights
Voting Rights
If they keep control there is a potential
conflict between the founders and other
shareholders. If they pass management to
professional managers there is a potential
conflict between owners and managers.
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What is Corporate Governance?

• Corporate governance is about minimizing the loss
  of value that results from the separation of
  ownership and control.
• It deals with the ways in which suppliers of
  finance to corporations assure themselves of
  getting a return on their investment.
• While corporate governance has been a hot issue
  in recent years (Enron, Worldcomm, HIH and
  One.Tel) it is a problem that has been around for
  hundreds of years Adam Smith (1776).

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What is Corporate Governance?

• Good corporate governance practices involve
• The corporate governance framework should protect
  shareholders rights.
• The corporate governance framework should ensure
  the equitable treatment of all shareholders.
• Stakeholders should be involved in corporate
  governance.
• Disclosure and transparency is critical.
• The board of directors should be monitored and
  held accountable for what guidance it gives.

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Internal Mechanisms

• Board of Directors
• Board Size Independence
• Chairman/CEO Positions
• Board Committees
• Executive Compensation
• Ownership Structure
• Concentrated versus Dispersed Ownership
• Identity of Owners
• Other Blockholders

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External Mechanisms

• External Auditors
• Debt Equity Markets
• Monitoring by debt holders
• Analysts
• Mergers Acquisitions
• Legal/Regulatory System
• Common versus Civil Law
• Extent of Law Enforcement
• Recent Regulations Sarbanes Oxley Act, ASX Good
  Corporate Governance Principles

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International Differences
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Board of Directors

• The board of directors is responsible for
  overseeing management and representing
  shareholders interests.
• US and Australia have single-tiered boards,
  headed by a Chairman of the Board. The CEO and
  other executives usually also sit on the board.
• Some other countries (Germany, Indonesia) have
  two-tiered boards. The roles and composition of
  the two boards can differ.

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Board Size

• Boards should be an appropriate size not too
  big not too small.
• Depending on the size of the company within the
  range of 5-15 is normal.
• If the board is too small, there is a lack of
  monitoring.
• If the board is too big, there are problems
  reaching a consensus for decision making.

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Board Independence

• Boards should have a majority/high proportion of
  outside/independent directors.
• Outside/independent directors should have no
  personal interest in the company and therefore
  are more effective monitors.
• But, it is also a good idea to have some company
  insiders (CEO, executives) on the board to
  provide the board with a better understanding of
  the companys operations.

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Chairman/CEO Positions

• The Chairman of the Board is responsible for
  overseeing the board of directors.
• The CEO is responsible for the day-to-day running
  of the company.
• In family-controlled companies it is common for
  the same person or relatives to hold both of
  these positions. But, this concentrates power and
  reduces monitoring.
• Therefore, the positions of Chairman and CEO
  should be separated.

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Board Committees

• The board of directors can delegate certain
  duties to board committees this can provide
  increased monitoring on specific issues.
• Audit committee responsible for internal audit
  function and appointment of external auditor.
• Remuneration committee responsible for setting
  appropriate compensation for directors and
  executives.
• Nomination committee responsible for finding
  appropriate directors and executives.

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Executive Compensation

• Compensation of top executives can be used to tie
  the interests of the executives to those of
  shareholders.
• Variable performance packages are preferred
• If they perform well, they are rewarded.
• If they perform poorly, they are not rewarded or
  fired.
• Alignment of interests is usually achieved
  through
• Stock ownership
• Stock options

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Ownership Structure

• Australian and US companies are usually owned by
  widely-dispersed shareholders and controlled by
  professional managers. This means that no single
  party is in control of the company.
• However, in other nations around the world,
  ownership is usually concentrated in the hands of
  family groups or government entities. This means
  that one group is in control of the company and
  there is very little you can do (other than sell)
  if you dont like what theyre doing.

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Ownership Structure
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Ownership Structure

• The identity of the controlling owner can also
  have corporate governance implications.
• Family-controlled companies use cross-holdings
  and pyramidal structures to gain effective
  control of the company with the least cash
  ownership. The market recognizes this and prices
  the increased risk of expropriation into the
  share price.
• Government-owned and widely-held companies are
  more likely to follow the rules.

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Ownership Structure

• The presence of an non-management related
  blockholder of shares can increase monitoring of
  the firm.
• A blockholder usually holds at least 5 of the
  outstanding shares, therefore has a significant
  interest in the future performance of the
  company.
• Blockholders can be governments, financial
  institutions, individuals or other companies.

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External Auditors

• Stock exchange listing requirements usually make
  it mandatory for companies to employ an external
  auditor to audit their financial statements (and
  internal controls).
• External auditor should be independent of
  management, but .
• Tenure of auditor
• Tenure of audit partner

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Monitoring by Debt holders

• Debt holders provide capital to the company
  usually with conditions
• Debt covenants
• Secured on assets
• Therefore debt holders actively monitor
  management to ensure that companies are meeting
  debt conditions and that they wont default.

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Analysts

• Securities analysts are professionals employed by
  investment banks / brokers / asset managers to
  monitor companies and provide stock
  recommendations (buy/sell), earnings forecasts,
  long-term growth forecasts, target prices etc.
• Provides an extra level of monitoring for
  investors.
• But, analysts incentives/conflicts of interest
  mean that not all of their output is trustworthy.

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Takeover Market

• The merger and acquisition (MA) market stands as
  a court of last resort for assets that are not
  being utilized to their full potential.
• If management are underperforming there is a good
  chance that this will be noticed by the market
  and other players will want to take control of
  the company.
• There are active takeover markets in Australia,
  US, UK, New Zealand, but few other countries.

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Intervening Variables

• Measures put in place by companies that restrict
  shareholder rights and the effectiveness of
  takeover markets
• Staggered boards
• Limits to by-law/charter changes
• Supermajority requirements for mergers
• Poison pills
• Golden parachutes

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Legal Systems

• Each countrys legal system has built in a
  certain degree of investor protection. However,
  there is a wide variation in protection and
  enforcement of these rules around the world.
• Common law countries provide highest protection
  and French civil law countries provide the least
  protection.
• Low investor protection seems to result in
  concentrated ownership and underdeveloped equity
  markets.

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Legal Systems
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Recent Regulations

• In response to the Enron crisis in the US, the
  Sarbanes Oxley Act was passed in 2002. This has
  significantly increased governance practices and
  the personal liability of directors in the US.
• Most other nations have issued Corporate
  Governance Best Practice Guidelines to assist
  companies in improving their governance ASX
  Corporate Governance Guidelines Best Practice
  Guide (on OLT site). But these are voluntary!
• BHP website BHP Annual report

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Convergence?

• Originally there were market-based, family-based,
  bank-based, government-affiliated systems.
• In recent years, most nations have started to
  promote US and UK best practice corporate
  governance guidelines. But not all companies are
  adopting these measures.
• There is evidence that family-controlled
  companies in particular are refusing to improve
  their corporate governance practices.
• Asian Corporate Governance Association

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Measuring Corporate Governance

• Understanding what good corporate governance is
  about is quite easy. However, it is difficult to
  measure whether companies are really committed to
  good governance.
• All we can do is measure if they have certain
  corporate governance mechanisms in place we
  dont know if they are effective or not!
• Organizations such as Standard and Poors and
  Credit Lyonnais Securities Asia have started
  providing corporate governance ratings in recent
  years.
• SP

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Benefits of Good Governance

• Researchers have shown that companies with good
  corporate governance practices are valued more
  highly and run more effectively.
• So the benefits of good governance include
• Higher share price
• Lower cost of funds
• Greater international following

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What you need to remember

• When investing it is worthwhile keeping in mind
  whether a company has committed to good corporate
  governance or not. You can use the mechanisms
  highlighted in this lecture or corporate
  governance ratings as a guide.
• Corporate governance becomes most important
  during stock market crashes and bad economic
  times.
• But, it is not a perfect science. Managers will
  always find a way to circumvent monitoring to
  achieve their own goals!