INTERNATIONAL FINANCIAL MANAGEMENT

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INTERNATIONAL FINANCIAL MANAGEMENT

• Topic
• Corporate Governance

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What is Corporate Governance?

• Defined
• No generally accepted definition!
• Bank for International Settlements definition
• "the system of rights, processes, and controls
  established internally and externally over the
  management of a business entity with the
  objective of protecting the interest of all
  stakeholders".
• Another possible definition Corporate
  responsiveness to stakeholders.
• Central Issue How best to protect the interest
  of stakeholders!

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Why Should we be concerned about Corporate
Governance?

• Macro Implications
• Because corporations play a key role in the
  generation and allocation of a countrys
  resources.
• Micro Implications
• In the increasing world of globalization, firms
  need to practice good corporate governance so as
  to
• Continue to attract consumers and workers
• Have access to global financial markets!
• Historically, corporate governance appears to
  have been of greater concern among developed
  country corporations than developing country
  corporation!
• However, globalizations is forcing these
  developing country corporations to assess their
  corporate governance structures

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A Very Broad Definition?

• While the Bank for International Settlements
  definition may seem too broad to be practical,
  it does convey the reality that different
  stakeholder groups will focus on different
  criteria and elements in deciding what makes up
  good corporate governance as they see it.
• shareholders probably attach the greatest
  importance to maximizing the market value of
  company shares on a sustained basis.
• the general public wants to be sure the
  corporation treats customers fairly and has
  sensitivity to its impact - socially,
  environmentally, fiscally - on the local
  community.
• corporate employees want assurances the company
  will compensate them properly, provide
  opportunities for advancement, offer training and
  career development assistance, and help with
  their retirement planning

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U.S. Corporations

• All of these responses to stakeholder
  expectations or needs are examples of some kind
  of good corporate governance.
• They actually appear in some formal statements of
  corporate government policy by large U.S.
  business entities like Philip Morris and General
  Motors.
• These U.S. companies make the point that
  "corporate governance" is a fairly elastic
  concept, with a multitude of practices and
  guidelines that respond to the concerns of
  particular groups.

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What does Good Corporate Governance mean in
Practice?

• Thus, a company's commitment to good corporate
  governance probably needs to be responsive to the
  diverse concepts surrounding the term. These
  include
• A well-informed, board of directors, with a
  majority of outside (independent) with the
  information, resources and the confidence to give
  proper direction to the CEO and other senior
  company management.
• Transparent organizational structures and
  business processes, including, to the extent
  possible, transparency in the corporate
  decision-making process.
• This can be particularly important for officer
  and director selection and compensation.

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Corporate Governance in Practice

• Integrity of strategies, operating systems, and
  controls.
• A reliable process for management to detect,
  evaluate, and correct both strategic and
  operational problems, a sound risk management
  approach, and a strong internal audit program.
• Full, accurate, and timely financial disclosure.
• Which in the US would mean "in conformity with US
  Generally Accepted Accounting Principles", and
  outside the US, disclosure at least up to
  International Accounting Standards.
• A policy and record of "corporate good
  citizenship" confirming the company's ethical and
  social awareness.
• A strong corporate governance culture, probably
  formally articulated in a company statement of
  "what we stand for" and perhaps a code of
  corporate ethics.
• An appropriate level of responsiveness and
  accountability to shareholders.
• In the form of, for example, some access for
  shareholders to directors, and possibly to senior
  management, as well as opportunities for
  meaningful shareholder participation in voting on
  company policies and director/CEO selection.

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History of Corporate Governance in the U.S.

• The concept of corporate governance began in the
  U.S. early in the 20th Century when a number of
  states, most notably Delaware, passed "enabling
  statutes" known as general corporation laws.
• At that time it was recognized that there was a
  growing disparity between owners of firms and
  managers of firms.
• Issue of agency costs!
• These state statutes created a legal framework
  for stockholders investing in corporations (i.e.-
  becoming owners) who were finding themselves
  increasingly separated from the managers of those
  corporations.

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Key Element in Early 20th Century Corporate
Governance

• Boards of directors were important to this
  process.
• It was argued that these boards had fiduciary
  duties of loyalty and care in the wise
  management of the corporation in the best
  interests of its owners.
• A key element in this was the independence of
  directors from undue influence by interested
  parties (including managers) at the expense of
  the corporation's welfare.

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The Stock Market Crash 1929

• In the aftermath of the stock market crash in
  1929, there was a public debate over the
  inability of shareholders to assure that boards
  and their appointed managers were in fact
  operating in the best interests of owners.
• Shareholders were seen as widely dispersed in
  the United States.
• Most financial market regulation from this time,
  however, involved improving public disclosure.

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1980s

• The decade of the 1980s was characterized by a
  wave of hostile takeovers, leveraged buyouts,
  management buyouts, junk bond financing, "poison
  pills", and the general merger frenzy of those
  days.
• Within this environment, shareholder interests
  again became an issue.
• the corporate governance debate was revived and
  large institutional investors began to be heard.
• Reflected the growing importance of these
  institutions.

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1990s

• In the 1990s, it was primarily these
  institutional investors in the form of pension
  and retirement funds - along with the legal,
  accounting, and consulting professions - who
  drove the development of concepts of corporate
  control and accountability.
• Their main focus was (and continues to be) on the
  role of the independent board of directors.
• Key concept here is independent.
• Was not always the case, even in the 1990s.

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Today

• We are currently living through a tidal wave of
  interest in the concept and forces of corporate
  governance.
• In the United States, this has much to do with
  the prominent and increasingly activist role of
  institutional fund investors as corporate
  shareholders.
• Focus on securing top performance from their
  investments.
• Globally, this aggressive shareholder demand for
  corporate responsiveness is spilling over into
  other countries.
• American fund managers have diversified their
  portfolios internationally and set an example for
  local investors.

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Global Corporate Governance

• However, internationally active financial
  institutions find themselves particularly
  challenged by the need to promote corporate
  governance.
• First, they must work hard to understand, and
  adapt strategies and operations to a great
  diversity of national practices, traditions,
  laws, regulations, and political and market
  structures.
• Second, their possibilities for implementing an
  American style of "good corporate governance" are
  often constrained in a given context or a given
  country by legal, cultural, economic, or even
  purely logistical factors.

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Global Variations

• Separation of ownership and management (control)
• Varies widely among countries.
• Measured by ownership concentration
• Country Average ownership of 3 largest
  shareholders
• United States 20
• United Kingdom 19
• Italy 58
• Germany 48
• Brazil 57
• Mexico 64
• United States and U.K. have a diverse
  shareholder base. In other countries, often
  founding families control the companies!

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Concentration of Ownership

• If ownership is concentrated, a small number of
  owners will find it advantageous to monitor
  managers.
• This may be the case of countries other than the
  U.S. and the U.K. (see previous slide).
• Previous studies suggest that concentration of
  ownership has a positive impact on a companys
  performance.
• Agency cost may be reduced as owners and managers
  become better aligned!

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Legal Variations

• Studies have suggested that many variations in
  corporate governance from country to country can
  be attributed to differences in legal systems.
• Legal systems determine how well investors are
  protected.
• Four main legal systems to consider
• English common law
• French civil law
• German civil law
• Scandinavian civil law

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Common Versus Civil Law

• Common Law
• Based on precedent, formed by the rulings of
  independent judges regarding specific disputes.
• Originated in U.K. and spread throughout the
  world through British colonization (as well as
  independent adoption)
• United States, Australia, Canada, India, South
  Africa, Singapore, New Zealand.
• Civil Law
• Codification of legal rulings.
• Dominates legal systems globally.
• France, Germany, Japan, Mexico, China, Latin
  America,

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Shareholder Rights

• English common law appears to be more protective
  of private property and investor rights.
• Conclusion English common law tends to offer the
  strongest protection for investors.
• Why?
• Historically the state has played a greater
  role in regulating economic activity in civil law
  countries but a less active role in individual
  (e.g., private property) rights.

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Law and Ownership Concentration

• Another Issue Civil law countries generally
  have greater ownership concentration ratios.
• Legal System Average ownership of 3 largest
  shareholders
• English Common 43
• French Civil 54
• Question Are concentration ratios a response to
  relatively weak investor protection laws?