Presentation on theme: "FINANCE, LAW AND MARKETS: THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE SESSION 3."— Presentation transcript:
FINANCE, LAW AND MARKETS: THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE SESSION 3
Outline Origins and development of different corporate governance systems. The critical influence of finance, law and markets in sustaining alternative corporate governance values, structures and practices. Distinctiveness and viability of market and relationship based systems of governance. Impact of the new emerging force in corporate governance represented by the increasing vastness of the institutional investors
The Distribution of Outstanding Listed Equity Among Different Categories of Shareholders United States 1996 Japan 2001 Germany 1996 France 1994 UK 1994 Italy 1994 Sweden 1996 Australia 1996 Korea 1996 Financial sector Of which Banks + Financial Institutions Insurance + Pension Funds Investment Funds Non-Financial Sector Of which Non-financial enterprises Individuals Public Authorities Foreign Total100 Note: Due to rounding, these figures may not add up to the total. Pension Funds in Japan are managed by trust banks and Insurance companies. Division between banks and insurance companies are estimated. No data available on the extend to which mutual funds own shares. Security Australian figures are for the end of September1996. Source: OECD (2004), Corporate Governance a Survey of OECD Countries
Trends in Financial Assets of Institutional Investors ( ) US$ Trillions % of Total Financial Assets 20% 22% 27% 32% 13% 21% 18% 10 year compound Annual growth rate
The Evolution of Corporate Governance Forms and Democratic Governance (Gomez & Korine 2003) Era19 th Century – – – 21 st Century Form of capitalism Family capitalismManagerial capitalismPopular capitalism Elements of Democratic Governance Equality of rights to ownership Implementation: Creation of rights to ownership independent of social standing. Reinforcement: Strengthened by corporate law; protection for quoted corporation Reinforcement: Strengthened by new rules on the right to vote; protection of minority interests Separation of ownership / control No. Implementation: Generalization of the limited liability corporation, with general meetings, boards, executives. Reinforcement: Increasing board control over managers Representation with public debate No. Implementation: Mass ownership; stakeholder activism
Separation of Ownership and Control Almost complete ownership control Majority control Control through a legal device without majority of ownership Minority control Management control
Revised Berle and Means Model of Ownership and Control Source: Adapted from Blair M. (1995).
The Development of Law and Regulation Law influencing conduct of corporate governance: Financial markets regulation (securities law) Corporate law Labour law The US legal structure in order to achieve market liquidity and shareholder value with highly developed securities market law: The SEC regulates the capital market Corporate law is developed by the independent states
The European approach: Less emphasis on capital markets, which have traditionally been less important in this system Favours internal regulation of the firm Corporate and labour law plays a much greater role The controlling interests of majority shareholders protect management from capital market fluctuations. The Development of Law and Regulation
Bank, Majority and Market Based Finance Market for corporate control Majority group control Hostile takeovers
Number of Takeovers by Region US Ex UK EU 15 UK Total Canada Other Australia (252) Under the Thomson Financial Data (TFSD) definition a tender offer that was recommended by board of the target company to its shareholders 252 Source: Becht, Bolton and Roell (2002).
Number of Takeovers by Region EU 15 US UK Total AUST Canada Other EX UK (253) Under the TFSD definition a tender offer that was initially rejected by the board of the target company. 253 Source: Becht, Bolton and Roell (2002).
Corporate Governance Regimes Forms of Control Control by Debt Control by the Securities market Control by Shares Nature of control and basis of evaluation Solvency prime rate + bank risk premium Market for control (take- over bid; public offer of exchange) market price/private evaluation of the firms potential Financial evaluation of performance (EVA/MVA) Style of Governance and constraints on the company Long-term commitment Solvency constrain Threat to oust the controlling group Maximization of share price Charters of governance Maximization of the financial return on equity Types of capitalism CorporativePredatorShareholder value Source: Aglietta M. and Breton R. (2001).
Corporate Governance Alternative Systems FeatureAnglo-SaxonGermanicLatinJapanese OrientationMarket oriented (an active external market for corporate control) Market-oriented (relatively oligarchic, influenced by networks of shareholders, families and banks) Network-oriented Representative countriesUSA, UK, Canada, Australia, NZGermany, Netherlands, Switzerland, Sweden, Austria, Denmark, Norway, Finland France, Italy, Spain, Belgium, Brazil, Argentina Japan Prevailing concept of the firm Instrumental (as a means for creative shareholder value) Institutional (autonomous economic units coming out of a coalition of shareholders, corporate managers, suppliers of goods and debts, and customers) Institutional The Board systemOne-tier (governance with one level of directors, making no distinction but executives and non-executives Two-tier (executive and supervisory board, the latter monitoring, appointing or dismissing managers; large shareholders on the Board and high pressure from banks) Optional (France) in general one-tier Board of directors, offices of representative directors, of auditors, de facto one-tier Main stakeholders to exert influence on managerial decision- making ShareholdersIndustrial banks (mainly in Germany; in general, oligarchic group inclusive of employees representatives) Financial holdings, the government, families, in general oligarchic groups City banks, other financial institutions, employees in general oligarchic groups Importance of stock and bond markets High (requiring continued action and performance) Moderate or high (legal and regulatory bias against non-bank finance) Moderate or poorHigh (legal and regulatory bias against non-bank finance) Is there a market for corporate control? YesNo Ownership concentration LowModerate or high (very high in Germany)HighLow or moderate Compensation based on performance HighLowModerateLow Time horizon of economic relationships Short-termism (management and governance myopia) Long termism StrengthsDynamic market orientation, fluid capital, internationalization extensive Long-term industrial strategy, very stable capital, robust governance procedures Very long-term industrial strategy, stable capital, major overseas investment WeaknessesVolatile, short-termism, inadequateInternationalisation more difficult, lack of flexibility, inadequate investment for new industries Financial speculation, secretive governance procedures, weak accountability. Sources: Adapted from Keenan J. and Aggestam M.(2001); and Clarke T. and Bostock R. (1994)
Reputational Intermediaries for Sound Corporate Governance (Apreda 2003) Disclosure Securities laws on full disclosure of financial results and self-dealing transactions Ownership disclosure rules One-share, one-vote rule. In general, rules to prevent or restrict pyramid ownership structures Strong publicly enforced civil and criminal sanctions against insiders for violating the disclosure and self-dealing rules Civil liability risk for insiders Honest, sophisticated and well-functioning courts. Honest, sophisticated securities agency and prosecutors for criminal cases both furnished with staff, skills and budget to accomplish their tasks efficiently Board of Directors Independent directors who can control self-dealing transactions Procedural controls on self-dealing transactions with review by independent directors, non- interested shareholders, or both Civil liability risk for independent directors who approve gross self-dealing transactions. Independent directors on auditing and compensations committees Market Environment Market transparency rules (time, quantity and price of trades promptly disclosed to investors) Investor property rights protection Stock exchange with reliable listing standards and active surveillance of insider trading to fine or de-list trespassers. Enforced ban on market manipulation A culture of disclosure (concealing bad news is a recipe for trouble) Active financial press and securities analysts profession Reliable judiciary system and widespread law enforcement
Reputational Intermediaries for Sound Corporate Governance Accountants Good accounting and auditing rules Accounting review of self dealing transactions Civil liability risk for accountants An institution with competence and independence to write accounting rules Sophisticated accounting profession Securities lawyers to ensure issuers abide by the law and rules of disclosure Civil discovery rules and class action procedure to protect minority rights Liability risk Lawyers review of self-dealing transactions Lawyers Investment bankers Sophisticated banking profession to investigate the issuers of securities Civil liability risk for investment bankers Other Reputational Intermediaries Rating agencies that furnish not only credit-risk rating but also country-risk ratings worldwide Venture capital funds that allow new enterprises to be financed and monitored, and also provide them with reputational capital Public regulators like central banks and securities exchange commissions Self regulatory organizations (SRO), either voluntary or mandatory, subject to regulatory oversight Corporate monitoring firms (Latham, 1999)
How Efficient are the various Methods of Controlling Managers? Source: Inspired by Bebchuk & Fried (2003) DeviceRationaleLimits Incentive Pay Indexing wage on performanceAligning managers and rank-and-file workers interests Possible manipulation of performance by managers Bonus linked to profitAligning managers interests and firm strategy Stock optionsAligning CEO interest with shareholders wealth Still a major gap between CEO and shareholders interests Attribution of stock of the companyAligning CEO interest with shareholders wealth Loosely correlated with CEO strategy and large benefits during financial bubble Transparency Public disclosure of CEOs remunerationTrigger outrage from shareholders and institutional investors Camouflage tactic by managers in spite of statements in favor of transparency Remuneration setting Creation of an independent remuneration committee Prevent self-determination of remuneration by CEOs The CEO may largely control the committee Large number of independent members of the board Prevent excessive remuneration by the detriment of shareholders The income of members may depend on their generosity to the manager Survey by consultant firms of CEO remuneration Set an objective benchmarkThe reference to average or median remuneration induces spill-over and excessive pay increases Market for corporate governance Firing of CEOsIncentive to commitmentExceptional configuration in the past Threat of takeoverPuts a limit on CEO opportunismGolden parachute for losers CEO income may increase even if shareholders suffer value destruction
Pension Funds and Life Insurance Assets ( selected OECD Economies ) Source: OECD Recent Trends in Institutional Investors Statistics: Gonnard,et.al. (2008).
Pension Fund Allocation Around the World
High Low None YEARS Importance of Corporate Governance Hedge Funds Mutual Funds Private investors Life Assurers Pension Funds Time Horizons Source: Morley Fund Management (2003). Institutional Investor Concern for CG
Monitoring Activities by Institutional Investors Source: ACGA 2005
Investment Fund Managers Role in Corporate Governance Source: The Mays Report (2003).
Number of CG Proposals per year Source: Monks, R et al (2004).
Resolutions Not Supported By AMP Capital Investors July –December 2005 Source: AMP Capital Investors Corporate Governance (2006).
Source: UTS Centre for Corporate Governance 2002 The Complex Governance and Regulatory Relationships of the Institutional Investors