1. The Modern Corporation and Corporate Governance: An Overview
Professor Alexander Settles
Faculty of Management, State University – Higher School of Economics

2. Class Rules
Students must attend all lectures and seminars. Those students that arrive late will have to wait until the break between sessions to enter and will receive credit for attendance for the second session.
Students must be prepared for class, complete all readings, and be ready to take notes
Students may not talk during class. Students are expected to participate in class discussion but are not to interrupt the lecturer or other students
Students may not enter or leave the class during the lecture unless for emergency reasons
Students must turn off or place on silent mobile phones and may NOT use computers or other devices for entertainment purposes

3. Class Overview – Schedule Settles
17.02 – Course introduction, Corporate Governance, Globalization and BRICS
24.02 –Using Management Research, topic development and group formation
10.03 – Corporate governance overview in international context
17.03 – Valuation and Corporate Governance Ratings
IPO, mergers and acquisitions, and foreign market entry for Russian corporations
14.04 – Financial Crisis and SWF
21.04 – Compensation, and regulation
28.04 – Corporate Social Responsibility

4. Course Requirements Send me an email at asettles@hse.ru
50% - Paper - Settles
10% - Attendance to lectures - Settles
40% - Seminar Grade (Test and attendance) - Tomoradze

5. Due Dates
Proposal March 3rd
Review of literature March 31st
Draft paper due April 14th
Final paper due May 15th
Your failure to plan or act is not my problem – no action = failing grade

6. Topic Proposal Title of paper Research question Literature review
Proposed methods
Anticipated results
3 pages

7. Potential Topics
Cross-listing and IPO of emerging market firms (Russia and Brazil)
Globalization and risk
Cross-border merger and acquisitions
Cross-country comparison of management and governance: Do managers have a comparative advantage?

8. Potential Topics
Difference in business environment: Convergence or divergence in governance or management practices
Behavior of Directors and TMT in a cross cultural context
Privatization
CSR: Issues and Application across three models Russia, US, and Europe

9. Shirking and Stealing: How Corporate Governance Protects Investors

10. Learning objectives Corporate Governance and Competitiveness
Investor Protection
Role of Public Sector in Setting Framework for Good Corporate Governance
Knowledge about theory of board operation and Role of directors
Theories of board organization
Regulation concerning corporate boards
Practice in corporate boards

11. Why is Corporate Governance Important to Russia firms?

12. Corporate Governance Introduction
What is Corporate Governance?
Definition of “Governance” vs. “Administration,” “Management,” or “Control”
Corporate Governance structures
Board of Directors
Chair of the Board
Corporate Secretary
Shareholders – General Meeting of Shareholders
Why is it important to corporate finance? Cost of Capital

13. What is a Corporation?
“The business corporation is an instrument through which capital is assembled for the activities of producing and distributing goods and services and making investments. Accordingly, a basic premise of corporation law is that a business corporation should have as its objective the conduct of such activities with a view to enhancing the corporation’s profit and the gains of the corporation’s owners, that is, the shareholders.” Melvin Aaron Eisenberg

14. What is a Corporation?
“When they [the individuals composing a corporation] are consolidated and united into a corporation, they and their successors are then considered as one person in law For all the individual members that have existed from the foundation to the present time, or that shall ever hereafter exist, are but one person in law – a person that never dies: in like manner as the river Thames is still the same river, though the parts which composite are changing every instant.” Blackstone
“An ingenious device for obtaining individual profit without individual responsibility.” Ambrose Bierce, The Devil’s Dictionary

15. Corporate Form 1. limited liability for investors;
2. free transferability of investor interests;
3. legal personality (entity-attributable powers, life span, and purpose); and
4. centralized management.

16. Corporate Governance Definitions
OECD – “internal means by which a corporations are operated and controlled … which involve a set of relationships between a company’s management, its board, its shareholders and other stakeholders.”

17. IFC – Russia Corporate Governance Manual
Corporate Governance is a system of relationships, defined by structures and process. [Shareholders – Management]
These relationships may involve parties with different and sometimes contrasting interests.
All parties are involved in the direction and control of the company
All this is done to properly distribute rights and responsibilities – and thus increase long term shareholder value.

18. Definitions
“Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”, The Journal of Finance, Shleifer and Vishny [1997, page 737].

19. Other Definitions
"Corporate governance is about promoting corporate fairness, transparency and accountability" J. Wolfensohn, president of the Word bank, as quoted by an article in Financial Times, June 21, 1999.
“The directors of companies, being managers of other people's money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private co-partnery frequently watch over their own.” Adam Smith, The Wealth of Nations 1776

20. Corporate Governance System

22. Corporate Governance

23. Basics of Corporate Governance
By issuing corporate securities, firms sell claims to control the companies` ressources
The interests of the various securityholders differ
Separation of owership and control implies agency relationships.
Interests of agents (management) are different from those of securityholders, particulary from those of stockholders.
Monitoring the activities of agents is costly - hence, full monitoring is not optimal.
The value forgone due to imperfect optimal monitoring is an explicit agency cost.

24. Contract Theory of Corporate Governance
Contract are arranged between principles (owners) and agent (managers)
Contracts are also made between the firm and providers of capital
Problems with contracts:
Moral Hazard
Incomplete contracts
Adverse selection bias

25. Agency Problem Managerial discretion - Business judgement
Managerial opportunism – self dealing
Duty of loyalty of management to firm

26. Fiduciary Duty
The fiduciary duty is a legal relationship between two or more parties (most commonly a "fiduciary" or "trustee" and a "principal" or "beneficiary") that in English common law is arguably the most important concept within the portion of the legal system known as equity.
A fiduciary will be liable to account if it is proved that the profit, benefit, or gain was acquired by one of three means:
In circumstances of conflict of duty and interest
In circumstances of conflict of duty and duty
By taking advantage of the fiduciary position.
Therefore, it is said the fiduciary has a duty not to be in a situation where personal interests and fiduciary duty conflict, a duty not to be in a situation where their fiduciary duty conflicts with another fiduciary duty, and not to profit from their fiduciary position without express knowledge and consent. A fiduciary cannot have a conflict of interest.

27. Fiduciary Duty

28. Agency Problem Duty of loyalty of management to firm
Incentive contracts that align management interests with investors
Agency costs – monitoring and compliance
Shareholder actions- shareholder democracy, proxy fights, access to the proxy ballot, derivative lawsuits

29. Four core values of the OECD corporate governance framework
Fairness: The corporate governance framework should protect shareholder rights and ensure the equitable treatment of all shareholders, including minority and foreign shareholders.
Responsibility: The corporate governance framework should recognize the rights of stakeholders as established by law, and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

30. OECD Core Values
Transparency: The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the company, including its financial situation, performance, ownership, and governance structure.
Accountability: The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and shareholders.

31. Advantages of Good Corporate Governance
Stimulating Performance and Improving Operational Efficiency
Better oversight and accountability
Improved decision making
Better compliance and less conflict
Less self-dealing
Better informed
Avoidance of costly litigation through adherence to laws and regulations

32. Advantages of Good Corporate Governance
Improving Access to Capital Markets
Transparency, accessibility, efficiency, timeliness, completeness, and accuracy of information critical
Listing requirements
Inclusion of Corporate Governance in investment decision process

33. Accounting Scandal and Reform in the US and Western Europe

34. Crisis in Governance 1999 - 2002 Enron – fraud and oversight failure
Worldcom – accounting fraud
Adelphia – RPT securities violations, and accounting fraud
Arthur Anderson

35. More detailed list AOL Adelphia Bristol-Myers Squibb Duke Energy
Dynegy
El Paso Corporation
Enron
Freddie Mac
Global Crossing
Halliburton
Harken Energy
ImClone Systems
Kmart
Lucent Technologies
Merrill Lynch
Qwest Communications
Reliant Energy
Sunbeam
Tyco International
Waste Management, Inc.
WorldCom

36. SOX reforms to US Corporate Governance
Auditor independence
Corporate Officer Responsibility for financial statements
Internal Control Sections 404 and 302
Significant increase in monitoring costs for PLCs

37. Market Size

38. Anglo-Saxon Model US, UK, Canada, Australia, New Zealand
Shareholder value maximization
“outsider” model – arms length investor
Internal governance mechanisms
board of directors
employee compensation
External mechanisms
market for corporate control
monitoring by financial institutions
competition in product and input market
Reliance on legal mechanisms to protect shareholder rights
Short term financial performance key
Sha

39. Market for Corporate Control
“Friendly Takeover”
When a bidder makes an offer for another, it will usually inform the board of the target beforehand. If the board feels that the value that the shareholders will get will be greatest by accepting the offer, it will recommend the offer be accepted by the shareholders.
A takeover would be considered "hostile" if
1) the board rejects the offer, but the bidder continues to pursue it, or
2) if the bidder makes the offer without informing the board beforehand.

40. German (Continental) Model
Co-determination - partnership between capital and labor
Social cooperation
The two-tier board structure that consists of a supervisory board and executive board – greater efficiency in separation of supervision and management
Cross–shareholding in financial – industrial groups
Role of banks as major shareholders
Primary sources of capital – retained earnings and loans

41. Japanese Model
Formal role of large and almost entirely executive boards – single tier board
Historical roots of the Keiretsu network interlocking business relationships
Existence of significant cross holdings and interlocking-directorships,
Lifetime employment system plays in corporate policy
Role of banks
Market share maximization over shareholder value maximization
Long term perspective

42. Corporate Governance Framework in Russia
Concentrated Ownership
Little separation between ownership and control
Unwieldy holding structures used to hide beneficial ownership, avoid taxes, or steal from minority owners
Reorganizations to dilute minority stakes
Inexperienced Supervisory Board (Boards of Directors)

43. Theory
Berle and Means (1932) – separation of ownership and control through modern corporation structures
Agency Problem

44. Control Mechanisms

45. Conventional Wisdom
The business literature describing the classical functions of boards of directors typically includes three important roles: (1) establishing basic objectives, corporate strategies, and board policies: (2) asking discerning questions; and (3) selecting the president.

46. Some Early Research (Manne 1971)
First classical role
Found that boards of directors of most large and medium-sized companies do not establish objectives, strategies, and policies however defined
These roles are performed by company management
Presidents and outside directors generally agreed that only management can and should have these responsibilities.

47. Some Early Research (Manne 1971)
A second classical role assigned to boards of directors is that of asking discerning questions - inside and outside the board meetings. Again it was found that directors do not, in fact, do this. Board meetings are not regarded as proper forums for discussions arising out of questions asked by board members.
A third classical role usually regarded as a responsibility of the board of directors is the selection of the president. Yet it was found that in most companies directors do not in fact select the president, except in the two crisis situations cited earlier.

48. Stewardship theory
Stewardship theory, the alternative perspective, takes an altogether broader frame of reference, being based on the original and legal view of the corporation in which directors have a fiduciary duty to their shareholders to be stewards for their interests.

49. Stewardship Theory
Muth and Donaldson (1997) challenged agency theory, which underpin conventional assumptions about the benefits of checks and balances –
Boards with well connected, executive directors perform better than those that meet the paradigms of conventional governance thinking
Also research has shown that increasing governance conformance and compliance may not add to corporate performance - it can actually detract - Donaldson and Davies (1994)

50. Introduction to Corporate Governance Structures
Supervisory Board (Board of Directors)
Central role in Corporate Governance framework
Sets strategy, business priorities, annual financial and business plan, and oversees managerial performance
Oversees the work of the General Director (CEO) and the Executive Board

51. Role of Supervisory Board
Protecting the interests of the company and its shareholders
Defining the Boards role and priorities
Setting the company’s governance framework
Organizing the General Meeting of Shareholders,
Protection of company assets
Resolution of conflicts
Supervision of internal controls and risk management

53. Types of Directors a) Executive Directors
Executive directors can be defined as those that also hold an executive position in the company, namely that of:
The General Director;
An Executive Board member; or
A manager of the company who is not an Executive Board member.

54. Types of Directors b) Non-Executive Directors c) Independent Directors
Non-executive directors are Supervisory Board members that do not hold an executive position in the company.
c) Independent Directors
Russian law does not define the concept of independent directors. The Company Law does, however, refer to independent directors under specific circumstances to determine the position of individuals engaged in related party transactions and to prevent possible conflicts of interests.

55. Independent Director
In this respect, an independent director is defined as an individual who has not been in any of the following positions at the time of the approval of a business transaction, or during one year immediately preceding the approval of such a transaction:
The General Director, the External Manager, an Executive Board member or a member of the governing bodies (Supervisory Board, General Director and Executive Board) of the External Manager; or
A person whose spouse, parents, children, brothers, and sisters by one or both parents are the External Manager or hold a position in the governing bodies of the External Manager; or
A person whose adoptive parents or adopted children are the External Manager or hold a position in the governing bodies or the External Manager; or
An affiliated person other than a director of the company.

56. What is Independence?
Independence of a Director: a Director must always act in a manner independent of management and never be conflicted by any relationship to management (i.e., financial, familial, or social). Independence measurements include: Relatedness of the Director:   - Employee (in last three years);   - Professional advisor (in last three years);   - Executive of any affiliated company;   - Other income from company;   - Kinship or social ties; • Interlocks with other Directors; • Number of Boards on which Director serves.

57. The Election of Directors
All directors must be elected with cumulative voting.
Cumulative voting is a system that helps minority shareholders pool their votes to elect a representative for the Supervisory Board. The election of directors cannot be done if a GMS is held by written consent.
How Cumulative Voting Works:
Candidates for the Supervisory Board are voted on collectively, i.e. as a group;
Each shareholder has a maximum number of votes equal to the number of directors that must be elected (according to the charter or a decision of the GMS) multiplied by the number of voting shares held;
Shareholders can allocate their votes to one candidate or divide them among several candidates as they please;
The top X candidates with the most votes are considered elected, whereby X equals the number of Supervisory Board members to be elected as specified by the charter or the decision of the GMS.

58. Cumulative Voting: Minimum number of votes to elect one director
where D — the number of directors to be elected, S — the number of outstanding voting
shares and n — the total number of directors the majority shareholder wants to elect

59. Company Practices in Russia
Representatives of major shareholders (35%),management and employees (30%) are the most common types of directors,
Independent directors (18%) and minority shareholder representatives (9%) still constitute a minority on most Supervisory Boards.
A positive correlation exists between the number of shareholders in a company and the number of representatives of majority shareholders on the Supervisory Board. Hence, Supervisory Boards of large companies with many shareholders tend to include more representatives of large shareholders.

60. Governance is Different from Management

61. Governance and Management
Management runs the business
the board ensures that the business is well run and run in the right direction

62. Functions of the board Strategy Formulation Outward looking Providing
Accountability
Approve and work
through the CEO
Inward
Looking
Monitoring and
Supervising
Policy Making and
Revising
Past and present focused
Future Focused

63. All Executive Board Governance O O O O O O - executive directors
Management

64. Majority – executive board
Governance N N N O O O O
O - executive directors
N – non executive
directors
Management

65. Majority – non executive board
Governance N N N N O O O
O - executive directors
N – non executive
directors
Management

66. Two – tier board Governance N N N N N N N N N O - executive directors
N – non executive
directors O O O
Management O O

67. Wimm-Bill-Dann Board of Directors
One tier board in the US / UK model
Members
David Iakobachvili Chairman - non-excutive & dependent (owns 9.46%)
Sergei A. Plastinin Director, Chairman of Management Board and Head of Dairy Business Unit - Executive (owns 12.16%)
Guy de Selliers Director - non-executive and indepedent
Mikhail V. Dubinin Director - executive (owns 6.83%)
Michael A. O'Neil Director - non-executive and independent (?)
Alexander S. Orlov Director - executive (owns 4.39%)
Vladimir N. Sherbak Director - non-excutive and dependent
Victor A. Tutelyan Director - non-executive and indepedent
Earnest Linwood Tipton Director - non-excutive and indepedent
Evgeny G. Yasin Director - non-excutive and independent
Gavril A. Yushvaev Director - non-excutive and depedent (owns 18.80%)

68. Ownership
Party to the Amended and Restated Partnership and Cooperation Agreement.
Mikhail I Vishyakov (owns 2.59%)
Evgeny L. Yaroslavsky (owns 1.43%)
Vicktor E. Evdokimov (owns 0.42%)
Other Owners
Parex Bank JSC (owns 5.29%)
Templeton Strategic Emerging Markets Fund LDC (owns 1.18%)
Others own 4.74% of Russian traded shares
American Depositary Receipt Holders own 32.70%

69. Wimm – Bill – Dann Governance N/O N/I N/I N/D N/I
E/O - executive /owners directors
N/I – non executive directors/independent
N/O – non executive directors/ owners
N/D – non executive directors/dependent
N/D
N/I
E/O
N/I
E/O
E/O
Management

70. Wimm – Bill – Dann Committees
Audit Committee – 3 independent directors
The Committee for Investment and Strategic Planning – 1 independent & 2 dependent directors
Committee for Personnel and Remuneration – 1 independent director & 1 dependent director

71. Compensation of Board Members
Board member receive $50,000 annually plus transportation and lodging expenses incurred in connection with board meeting attendance, and up to $2,000 per year for other expenses
Chairman of the Board is compensated $300,000
Members of the Personnel and Compensation Committee & Investment and Strategic Planning Committee receive $3,000 and each member of the Audit Committee receive $5,000 for participation in each planned direct Committee meeting.

72. What does the Wimm – Bill – Dann Case Indicate?
Outside investors should know the following:
Board members are directors, executives & managers
Majority of ownership is controlled through a shareholder agreement
No threat of takeover without owner-manager consent
Board and committees are structured to meet NYSE requirements for CG

73. Corporate Governance and Initial Public Offerings
Corporate Governance is a principle variable in evaluating risk / setting discount for IPOs
Firms reaching the market make significant CG changes to their board structure and practices to conform to market expectations

74. Role of the Board in a Public Company IPO / Listing Experience
Effectiveness
Talents and background of board members
Tying board remuneration closely to performance
Strategic thinking by the Board
Managing risk effectively

75. Role of the Board in Listing - IPO
Developing a robust audit committee
Taking corporate social responsibility on board
Encouraging and active dialogue with shareholders

76. The Effective Board Clear strategy aligned to capabilities
Vigorous implementation of strategy
Key performance drivers monitored
Effective risk management
Sharp focus on views of the capital market and other key stakeholders
Regular evaluation of board performance

77. What does the market look for in a board member?
Asks the difficult questions
Works well with others
Has industry awareness
Provides valuable input
Is available when needed
Is alert and inquisitive

78. What does the market look for in a board member?
Has business knowledge
Contributes to committee work
Attends meetings
Speaks out appropriately at board meetings
Prepares for meetings
Makes long-range planning contribution
Provides overall contribution

79. Implementing effective strategy and change programs
The blueprint for the strategy
The business case
The transformation program
A mobilized organization
A ‘transformation map’
What would happen if there were no change? What is the value that will be created by the new
strategy? When, and how, can that be tracked?

80. The audit committee’s main responsibilities
To monitor the integrity of the financial statements
To review the company’s internal financial controls, internal control and risk management systems.
To monitor/review the effectiveness of the internal audit function.
To make recommendations to the board on the appointment/removal of the external auditor

81. The audit committee’s main responsibilities
To monitor/review the external auditor’s independence/objectivity and the effectiveness of the audit process.
To develop/implement policy on the engagement of the external auditor to supply non-audit services
To review arrangements by which staff may raise concerns about possible improprieties (‘whistleblowing’)

82. Flotation – who ends up steering the boat?