Presentation on theme: "THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE"— Presentation transcript:
1 THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE SESSION 3FINANCE, LAW AND MARKETS:THE INSTITUTIONAL ELEMENTS OF CORPORATE GOVERNANCE
2 OutlineOrigins 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 States1996Japan2001GermanyFrance1994UKItalySwedenAustraliaKoreaFinancial sector464039868303726Of whichBanks + Financial Institutions71045112Insurance +Pension Funds28250314256Investment Funds15Non-Financial Sector54607092326374Non-financial enterprises2242581121Individuals49201934Public AuthoritiesForeign189Total100Note: 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 TotalFinancial Assets20%22%27%32%13%21%18%10 year compoundAnnual growth rate17.022.739.167.4
5 The Evolution of Corporate Governance Forms and Democratic Governance (Gomez & Korine 2003) Era19th Century – 19201920 – 19701970 – 21st CenturyForm of capitalismFamily capitalismManagerial capitalismPopular capitalismElements ofDemocraticGovernanceEquality of rights toownershipImplementation: Creation of rights to ownership independent of social standing.Reinforcement: Strengthened by corporate law; protection for quoted corporationReinforcement: Strengthened by new rules on the right to vote; protection of minority interestsSeparation ofownership / controlNo.Implementation: Generalization of the limited liability corporation, with general meetings, boards, executives.Reinforcement: Increasing board control over managersRepresentation withpublic debateImplementation: Mass ownership; stakeholder activism
6 Separation of Ownership and Control Almost complete ownership controlMajority controlControl through a legal device without majority of ownershipMinority controlManagement 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 lawLabour lawThe US legal structure in order to achieve market liquidity and shareholder value with highly developed securities market law:The SEC regulates the capital marketCorporate 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 systemFavours internal regulation of the firmCorporate and labour law plays a much greater roleThe controlling interests of majority shareholders protect management from capital market fluctuations.
10 Bank, Majority and Market Based Finance Market for corporate controlMajority group controlHostile takeovers
11 Number of Takeovers by Region 252USOtherEU 15Ex UKCanadaUK TotalAustralia(252) Under the Thomson Financial Data (TFSD) definition a tender offer that was recommended by board of the target company to its shareholdersSource: Becht, Bolton and Roell (2002).
12 Number of Takeovers by Region 253USEU 15UK TotalAUSTCanadaEX UKOther(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 ofControlControl byDebtControl by the SecuritiesmarketControl by SharesNature of controland basis ofevaluationSolvencyprime rate +bank riskpremiumMarket for control (take-over bid; public offer ofexchange) marketprice/private evaluation of the firm’s potentialFinancial evaluation of performance (EVA/MVA)Style ofGovernance andconstraints onthe companyLong-termcommitmentconstrainThreat to oust thecontrolling groupMaximization of share priceCharters of governanceMaximization of thefinancial return onequityTypes ofcapitalismCorporativePredatorShareholder valueSource: Aglietta M. and Breton R. (2001).
14 Corporate Governance Alternative Systems FeatureAnglo-SaxonGermanicLatinJapaneseOrientationMarket oriented (an active external market for corporate control)Market-oriented (relatively oligarchic, influenced by networks of shareholders, families and banks)Network-orientedRepresentative countriesUSA, UK, Canada, Australia, NZGermany, Netherlands, Switzerland, Sweden, Austria, Denmark, Norway, FinlandFrance, Italy, Spain, Belgium, Brazil, ArgentinaJapanPrevailing concept of the firmInstrumental (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)InstitutionalThe Board systemOne-tier (governance with one level of directors, making no distinction but executives and non-executivesTwo-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-tierBoard of directors, offices ofrepresentative directors, of auditors, defacto one-tierMain stakeholders toexert influence onmanagerial decision-makingShareholdersIndustrial banks (mainly in Germany; in general, oligarchic group inclusive of employees’ representatives)Financial holdings, thegovernment, families,in general oligarchicgroupsCity banks, other financialinstitutions, employees in generaloligarchic groupsImportance of stock and bond marketsHigh (requiring continued action and performance)Moderate or high (legal and regulatory bias against non-bank finance)Moderate or poorHigh (legal and regulatory bias againstnon-bank finance)Is there a market forcorporate control?YesNoOwnershipconcentrationLowModerate or high (very high in Germany)HighLow or moderateCompensation based onperformanceModerateTime horizon ofeconomic relationshipsShort-termism (management and governance myopia)Long termismStrengthsDynamic market orientation, fluidcapital, internationalization extensiveLong-term industrial strategy, very stablecapital, robust governance proceduresVery long-term industrialstrategy, stable capital, major overseasinvestmentWeaknessesVolatile, short-termism, inadequateInternationalisation more difficult, lack of flexibility, inadequate investment for new industriesFinancial speculation, secretivegovernance procedures, weakaccountability.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) DisclosureSecurities laws on full disclosure of financial results and self-dealing transactionsOwnership disclosure rulesOne-share, one-vote rule. In general, rules to prevent or restrict pyramid ownership structuresStrong publicly enforced civil and criminal sanctions against insiders for violating the disclosure and self-dealing rulesCivil liability risk for insidersHonest, 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 efficientlyBoard of DirectorsIndependent directors who can control self-dealing transactionsProcedural controls on self-dealing transactions with review by independent directors, non- interested shareholders, or bothCivil liability risk for independent directors who approve gross self-dealing transactions.Independent directors on auditing and compensations committeesMarket EnvironmentMarket transparency rules (time, quantity and price of trades promptly disclosed to investors)Investor property rights protectionStock exchange with reliable listing standards and active surveillance of insider trading to fine or de-list trespassers.Enforced ban on market manipulationA culture of disclosure (“concealing bad news is a recipe for trouble”)Active financial press and securities analysts professionReliable judiciary system and widespread law enforcement
16 Reputational Intermediaries for Sound Corporate Governance Good accounting and auditing rulesAccounting review of self dealing transactionsCivil liability risk for accountantsAn institution with competence and independence to write accounting rulesSophisticated accounting professionAccountantsSecurities lawyers to ensure issuers abide by the law and rules of disclosureCivil discovery rules and class action procedure to protect minority rightsLiability riskLawyers review of self-dealing transactionsLawyersInvestment bankersSophisticated banking profession to investigate the issuers of securitiesCivil liability risk for investment bankersRating agencies that furnish not only credit-risk rating but also country-risk ratingsworldwideVenture capital funds that allow new enterprises to be financed and monitored,and also provide them with reputational capitalPublic regulators like central banks and securities exchange commissionsSelf regulatory organizations (SRO), either voluntary or mandatory, subject toregulatory oversightCorporate monitoring firms (Latham, 1999)Other ReputationalIntermediaries
17 How Efficient are the various Methods of Controlling Managers? DeviceRationaleLimitsIncentive PayIndexing wage on performanceAligning managers’ and rank-and-file workers’ interestsPossible manipulation of performance by managersBonus linked to profitAligning managers’ interests and firm strategyStock optionsAligning CEO interest with shareholders’ wealthStill a major gap between CEOand shareholders’ interestsAttribution of stock of the companyLoosely correlated with CEO strategy and large benefits during financial bubbleTransparencyPublic disclosure of CEO’s remunerationTrigger outrage from shareholders and institutional investorsCamouflage tactic by managers in spite of statements in favor of transparencyRemuneration settingCreation of an independent remuneration committeePrevent self-determination of remuneration by CEOsThe CEO may largely control the committeeLarge number of independent members of the boardPrevent excessive remuneration by the detriment of shareholdersThe income of members may depend on their generosity to the managerSurvey by consultant firms of CEO remunerationSet an objective benchmarkThe reference to average or median remuneration induces spill-over and excessive pay increasesMarket for corporate governanceFiring of CEOsIncentive to commitmentExceptional configuration in the pastThreat of takeoverPuts a limit on CEO opportunismGolden parachute for losers CEO income may increase even if shareholders suffer value destructionSource: 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).
20 Institutional Investor Concern for CG HighLife AssurersPensionFundsCorporate GovernanceImportance ofLowMutualFundsPrivateinvestorsHedge FundsNoneTime HorizonsYEARSSource: 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’ CorporateGovernance (2006).
25 The Complex Governance and Regulatory Relationships of the Institutional Investors AFAAPRAASICAISTASAASFAAIMRFPAIAAAFMAIFSACMSFSIAASXInstitutionsInvestorsTrusteesMasterTrustsInsuranceCompaniesFinancialMarketsRegulatoryATOAssetConsultantsSource: UTS Centre for Corporate Governance 2002