1. THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE
SESSION 3
FINANCE, LAW AND MARKETS:
THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE

2. 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

3. The Distribution of Outstanding Listed Equity Among Different Categories of Shareholders
United States
1996
Japan
2001
Germany
France
1994 UK
Italy
Sweden
Australia
Korea
Financial sector 46 40 39 8 68 30 37 26
Of which
Banks + Financial Institutions 7 10 4 5 1 12
Insurance +
Pension Funds 28 2 50 3 14 25 6
Investment Funds 15
Non-Financial Sector 54 60 70 92 32 63 74
Non-financial enterprises 22 42 58 11 21
Individuals 49 20 19 34
Public Authorities
Foreign 18 9
Total
100
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”

4. Trends in Financial Assets of Institutional Investors (1998-2007)
US$ Trillions
% of Total
Financial Assets
20%
22%
27%
32%
13%
21%
18%
10 year compound
Annual growth rate
17.0
22.7
39.1
67.4

5. The Evolution of Corporate Governance Forms and Democratic Governance (Gomez & Korine 2003)
Era
19th Century – 1920
1920 – 1970
1970 – 21st Century
Form of capitalism
Family capitalism
Managerial capitalism
Popular 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
Implementation: Mass ownership; stakeholder activism

6. Separation of Ownership and Control
Almost complete ownership control
Majority control
Control through a legal device without majority of ownership
Minority control
Management control

7. Revised Berle and Means Model of Ownership and Control
Source: Adapted from Blair M. (1995).

8. 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

9. The Development of Law and Regulation
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.

10. Bank, Majority and Market Based Finance
Market for corporate control
Majority group control
Hostile takeovers

11. Number of Takeovers by Region
252 US
Other
EU 15
Ex UK
Canada
UK Total
Australia
(252) Under the Thomson Financial Data (TFSD) definition a tender offer that was recommended by board of the target company to its shareholders
Source: Becht, Bolton and Roell (2002).

12. Number of Takeovers by Region
253 US
EU 15
UK Total
AUST
Canada
EX UK
Other
(253) Under the TFSD definition a tender offer that was initially rejected by the board of the target company.
Source: Becht, Bolton and Roell (2002).

13. 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 firm’s potential
Financial evaluation of performance (EVA/MVA)
Style of
Governance and
constraints on
the company
Long-term
commitment
constrain
Threat to oust the
controlling group
Maximization of share price
Charters of governance
Maximization of the
financial return on
equity
Types of
capitalism
Corporative
Predator
Shareholder value
Source: Aglietta M. and Breton R. (2001).

14. Corporate Governance Alternative Systems
Feature
Anglo-Saxon
Germanic
Latin
Japanese
Orientation
Market oriented (an active external market for corporate control)
Market-oriented (relatively oligarchic, influenced by networks of shareholders, families and banks)
Network-oriented
Representative countries
USA, UK, Canada, Australia, NZ
Germany, 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 system
One-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
Shareholders
Industrial 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 poor
High (legal and regulatory bias against
non-bank finance)
Is there a market for
corporate control?
Yes No
Ownership
concentration
Low
Moderate or high (very high in Germany)
High
Low or moderate
Compensation based on
performance
Moderate
Time horizon of
economic relationships
Short-termism (management and governance myopia)
Long termism
Strengths
Dynamic 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
Weaknesses
Volatile, short-termism, inadequate
Internationalisation 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)

15. 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

16. Reputational Intermediaries for Sound Corporate Governance
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
Accountants
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
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)
Other Reputational
Intermediaries

17. How Efficient are the various Methods of Controlling Managers?
Device
Rationale
Limits
Incentive Pay
Indexing wage on performance
Aligning managers’ and rank-and-file workers’ interests
Possible manipulation of performance by managers
Bonus linked to profit
Aligning managers’ interests and firm strategy
Stock options
Aligning CEO interest with shareholders’ wealth
Still a major gap between CEO
and shareholders’ interests
Attribution of stock of the company
Loosely correlated with CEO strategy and large benefits during financial bubble
Transparency
Public disclosure of CEO’s remuneration
Trigger 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 benchmark
The reference to average or median remuneration induces spill-over and excessive pay increases
Market for corporate governance
Firing of CEOs
Incentive to commitment
Exceptional configuration in the past
Threat of takeover
Puts a limit on CEO opportunism
Golden parachute for losers CEO income may increase even if shareholders suffer value destruction
Source: Inspired by Bebchuk & Fried (2003)

18. Pension Funds and Life Insurance Assets (selected OECD Economies 2003-2004)
Source: OECD Recent Trends in Institutional Investors Statistics: Gonnard,et.al. (2008).

19. Pension Fund Allocation Around the World

20. Institutional Investor Concern for CG
High
Life Assurers
Pension
Funds
Corporate Governance
Importance of
Low
Mutual
Funds
Private
investors
Hedge Funds
None
Time Horizons
YEARS
Source: Morley Fund Management (2003).

21. Monitoring Activities by Institutional Investors
Source: ACGA 2005

22. Investment Fund Managers Role in Corporate Governance
Source: The Mays Report (2003).

23. Number of CG Proposals per year
Source: Monks, R et al (2004).

24. Resolutions Not Supported By AMP Capital Investors July –December 2005
Source: AMP Capital Investors’ Corporate
Governance (2006).

25. The Complex Governance and Regulatory Relationships of the Institutional Investors
AFA
APRA
ASIC
AIST
ASA
ASFA
AIMR
FPA
IAA
AFMA
IFSA
CMSF
SIA
ASX
Institutions
Investors
Trustees
Master
Trusts
Insurance
Companies
Financial
Markets
Regulatory
ATO
Asset
Consultants
Source: UTS Centre for Corporate Governance 2002