Presentation on theme: "The Modern Corporation and Corporate Governance: An Overview"— Presentation transcript:
1 The Modern Corporation and Corporate Governance: An Overview Professor Alexander SettlesFaculty of Management, State University – Higher School of Economics
2 Class RulesStudents 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 notesStudents may not talk during class. Students are expected to participate in class discussion but are not to interrupt the lecturer or other studentsStudents may not enter or leave the class during the lecture unless for emergency reasonsStudents 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 BRICS24.02 –Using Management Research, topic development and group formation10.03 – Corporate governance overview in international context17.03 – Valuation and Corporate Governance RatingsIPO, mergers and acquisitions, and foreign market entry for Russian corporations14.04 – Financial Crisis and SWF21.04 – Compensation, and regulation28.04 – Corporate Social Responsibility
4 Course Requirements Send me an email at firstname.lastname@example.org 50% - Paper - Settles10% - Attendance to lectures - Settles40% - Seminar Grade (Test and attendance) - Tomoradze
5 Due DatesProposal March 3rdReview of literature March 31stDraft paper due April 14thFinal paper due May 15thYour failure to plan or act is not my problem – no action = failing grade
6 Topic Proposal Title of paper Research question Literature review Proposed methodsAnticipated results3 pages
7 Potential TopicsCross-listing and IPO of emerging market firms (Russia and Brazil)Globalization and riskCross-border merger and acquisitionsCross-country comparison of management and governance: Do managers have a comparative advantage?
8 Potential TopicsDifference in business environment: Convergence or divergence in governance or management practicesBehavior of Directors and TMT in a cross cultural contextPrivatizationCSR: 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 ProtectionRole of Public Sector in Setting Framework for Good Corporate GovernanceKnowledge about theory of board operation and Role of directorsTheories of board organizationRegulation concerning corporate boardsPractice 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 structuresBoard of DirectorsChair of the BoardCorporate SecretaryShareholders – General Meeting of ShareholdersWhy 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); and4. 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 companyAll 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
23 Basics of Corporate Governance By issuing corporate securities, firms sell claims to control the companies` ressourcesThe interests of the various securityholders differSeparation 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 capitalProblems with contracts:Moral HazardIncomplete contractsAdverse selection bias
25 Agency Problem Managerial discretion - Business judgement Managerial opportunism – self dealingDuty of loyalty of management to firm
26 Fiduciary DutyThe 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 interestIn circumstances of conflict of duty and dutyBy 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.
28 Agency Problem Duty of loyalty of management to firm Incentive contracts that align management interests with investorsAgency costs – monitoring and complianceShareholder 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 ValuesTransparency: 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 EfficiencyBetter oversight and accountabilityImproved decision makingBetter compliance and less conflictLess self-dealingBetter informedAvoidance of costly litigation through adherence to laws and regulations
32 Advantages of Good Corporate Governance Improving Access to Capital MarketsTransparency, accessibility, efficiency, timeliness, completeness, and accuracy of information criticalListing requirementsInclusion 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 fraudAdelphia – RPT securities violations, and accounting fraudArthur Anderson
35 More detailed list AOL Adelphia Bristol-Myers Squibb Duke Energy DynegyEl Paso CorporationEnronFreddie MacGlobal CrossingHalliburtonHarken EnergyImClone SystemsKmartLucent TechnologiesMerrill LynchQwest CommunicationsReliant EnergySunbeamTyco InternationalWaste Management, Inc.WorldCom
36 SOX reforms to US Corporate Governance Auditor independenceCorporate Officer Responsibility for financial statementsInternal Control Sections 404 and 302Significant increase in monitoring costs for PLCs
38 Anglo-Saxon Model US, UK, Canada, Australia, New Zealand Shareholder value maximization“outsider” model – arms length investorInternal governance mechanismsboard of directorsemployee compensationExternal mechanismsmarket for corporate controlmonitoring by financial institutionscompetition in product and input marketReliance on legal mechanisms to protect shareholder rightsShort term financial performance keySha
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" if1) the board rejects the offer, but the bidder continues to pursue it, or2) if the bidder makes the offer without informing the board beforehand.
40 German (Continental) Model Co-determination - partnership between capital and laborSocial cooperationThe two-tier board structure that consists of a supervisory board and executive board – greater efficiency in separation of supervision and managementCross–shareholding in financial – industrial groupsRole of banks as major shareholdersPrimary sources of capital – retained earnings and loans
41 Japanese ModelFormal role of large and almost entirely executive boards – single tier boardHistorical roots of the Keiretsu network interlocking business relationshipsExistence of significant cross holdings and interlocking-directorships,Lifetime employment system plays in corporate policyRole of banksMarket share maximization over shareholder value maximizationLong term perspective
42 Corporate Governance Framework in Russia Concentrated OwnershipLittle separation between ownership and controlUnwieldy holding structures used to hide beneficial ownership, avoid taxes, or steal from minority ownersReorganizations to dilute minority stakesInexperienced Supervisory Board (Boards of Directors)
43 TheoryBerle and Means (1932) – separation of ownership and control through modern corporation structuresAgency Problem
45 Conventional WisdomThe 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 roleFound that boards of directors of most large and medium-sized companies do not establish objectives, strategies, and policies however definedThese roles are performed by company managementPresidents 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 theoryStewardship 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 TheoryMuth 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 thinkingAlso 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 frameworkSets strategy, business priorities, annual financial and business plan, and oversees managerial performanceOversees the work of the General Director (CEO) and the Executive Board
51 Role of Supervisory Board Protecting the interests of the company and its shareholdersDefining the Boards role and prioritiesSetting the company’s governance frameworkOrganizing the General Meeting of Shareholders,Protection of company assetsResolution of conflictsSupervision 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; orA 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 DirectorsRussian 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 DirectorIn 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; orA 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; orA person whose adoptive parents or adopted children are the External Manager or hold a position in the governing bodies or the External Manager; orAn 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 votingshares 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.
61 Governance and Management Management runs the businessthe board ensures that the business is well run and run in the right direction
62 Functions of the board Strategy Formulation Outward looking Providing AccountabilityApprove and workthrough the CEOInwardLookingMonitoring andSupervisingPolicy Making andRevisingPast and present focusedFuture Focused
63 All Executive Board Governance O O O O O O - executive directors Management
65 Majority – non executive board GovernanceNNNNOOOO - executive directorsN – non executivedirectorsManagement
66 Two – tier board Governance N N N N N N N N N O - executive directors N – non executivedirectorsOOOManagementOO
67 Wimm-Bill-Dann Board of Directors One tier board in the US / UK modelMembersDavid 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 indepedentMikhail 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 dependentVictor A. Tutelyan Director - non-executive and indepedentEarnest Linwood Tipton Director - non-excutive and indepedentEvgeny G. Yasin Director - non-excutive and independentGavril A. Yushvaev Director - non-excutive and depedent (owns 18.80%)
68 OwnershipParty 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 OwnersParex Bank JSC (owns 5.29%)Templeton Strategic Emerging Markets Fund LDC (owns 1.18%)Others own 4.74% of Russian traded sharesAmerican 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 directorsN/I – non executive directors/independentN/O – non executive directors/ ownersN/D – non executive directors/dependentN/DN/IE/ON/IE/OE/OManagement
70 Wimm – Bill – Dann Committees Audit Committee – 3 independent directorsThe Committee for Investment and Strategic Planning – 1 independent & 2 dependent directorsCommittee 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 expensesChairman of the Board is compensated $300,000Members 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 & managersMajority of ownership is controlled through a shareholder agreementNo threat of takeover without owner-manager consentBoard 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 IPOsFirms 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 EffectivenessTalents and background of board membersTying board remuneration closely to performanceStrategic thinking by the BoardManaging risk effectively
75 Role of the Board in Listing - IPO Developing a robust audit committeeTaking corporate social responsibility on boardEncouraging and active dialogue with shareholders
76 The Effective Board Clear strategy aligned to capabilities Vigorous implementation of strategyKey performance drivers monitoredEffective risk managementSharp focus on views of the capital market and other key stakeholdersRegular evaluation of board performance
77 What does the market look for in a board member? Asks the difficult questionsWorks well with othersHas industry awarenessProvides valuable inputIs available when neededIs alert and inquisitive
78 What does the market look for in a board member? Has business knowledgeContributes to committee workAttends meetingsSpeaks out appropriately at board meetingsPrepares for meetingsMakes long-range planning contributionProvides overall contribution
79 Implementing effective strategy and change programs The blueprint for the strategyThe business caseThe transformation programA mobilized organizationA ‘transformation map’What would happen if there were no change? What is the value that will be created by the newstrategy? When, and how, can that be tracked?
80 The audit committee’s main responsibilities To monitor the integrity of the financial statementsTo 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 servicesTo review arrangements by which staff may raise concerns about possible improprieties (‘whistleblowing’)