Title: Corporate Governance
1Corporate Governance
- Prof. Stephen Y.L. Cheung
- Department of Economics Finance
- City University of Hong Kong
2Corporate Governance in Asia (I)
Source McKinsey, 2001
3Corporate Governance in Asia (II)
- Some commonly repeated cliches within the region
(even in Hong Kong) - I do not need to raise any capital anytime soon.
Why should I worry about corporate governance? - I would rather have a higher cost of capital
than higher taxes that I would be forced to pay
under greater disclosure - Why should I appoint independent non-executive
directors? My company is well run. - Why should I own a bank if I cannot lend to
myself?
4Corporate Governance
- Viewed as a flow concept
- Check and balance in performance, decision-making
and monitoring processes - Establish a legal and regulatory framework
- promotes credible and effective governance
practice for the benefit of economies and society
as a whole
5Become an Important Issue.
- The Asian financial crisis
- Commenced with devaluation of Thai baht in July
1997 - Weak corporate governance excessive
over-leverage - Investors assumed a short-term outlook
- Lone rogue traders
- Barings Singapore (Nick Leeson)
- Daiwa Bank (Toshihide Iguchi)
- Sumitomo Corporation (Yasuo Hamanaka)
- The collapse of Peregrine Investment of Hong Kong
in 1998 - Other well-developed countries
- Enron and Long Term Credit Management in the US
- Morgan Grenfell in Europe
6Corporate Governance Models
- Heavy reliance on statutory provisions, e.g. US
- Promote self-regulation, e.g. U.K.
- Monitored by market participants who are aware of
their longer-term interests - Voluntary basis, market discipline and peer
pressure - Low cost
- Principle of caveat emptor - Let the buyer
beware - shift the responsibility back to investors,
enhancing their incentives to make use of
information - minimizing the moral hazard of rigid regulation
7Corporate Ownership
- Concentration of shareholding affects the cash
flow rights and control rights of shareholders
8Systems of Corporate Governance
- Outsider model
- Insider model
- Family/ state model
9Outsider Model (I)
- Features
- Strong emphasis on the protection of minority
investors in securities law and regulation - Strong requirements for disclosure
- Market-based system
- relies heavily on the capital market to influence
behaviour - Legal and regulatory approach
- build confidence among non-controlling investors
10Outsider Model (II)
- Disclosure-based
- prevent communicating and sharing information
among groups of shareholders without making known
to all - Two channels of financial intermediation
- Bank loan short-term, and maintain arms length
relationships with banks - Equity finance relatively important with low
debt equity ratios being the norm equities
represent a high share of financial assets and a
high share of GDP - Agency problem separation between ownership and
management
11Insider Model (I)
- Ownership and control are relatively closely held
- agency problem is of less importance
- Insider group
- has longer-term stable relationship with the
company - small in size
- their members are known to each other
- have some connection to the company other than
their financial investment, such as banks or
suppliers - include some combination of family interests,
allied industrial concern, banks and holding
companies - control over the company
12Insider Model (II)
- Features
- capital market is less developed
- selective information sharing
- regulatory policy only prohibit speculative
activity rather than by insisting on strong
disclosure - corporate structure pyramid structure,
cross-shareholdings - ineffective voting procedure to prevent
shareholders to vote - bank-centred
- corporate finance is highly dependent on banks
and high debt/equity ratio - banks have more complex and longer term
relationship with corporate clients
13Family/ State Model (I)
- The founding families and their allies exercise
control over an extensive network of listed and
non-listed companies - Characteristics
- Weak concept of limited liability
- The important role of a small number of
founding families of entrepreneurs in many
areas of the economy - The entire infrastructure and large parts of
heavy industry and the financial system are
usually in the hands of the state, so that the
state is able to counter concentrated power of
these giants - Family-based businesses acquire political weight
against state by branching out in many sectors - Outside financing bank-based
14Family/ State Model (II)
- Banks
- Not capable of engaging in basic credit analysis
- Inefficient credit rationing function
- Weak corporate governance systems
- Problems in the prudential supervision of banks
- Shortcomings of foreign lenders
- Deficient market exit arrangements
- Benefit of the model
- stability of ownership
- high degrees of reinvestment of earnings
- long-term commitment
- firm-specific investment by stakeholders
15Examples of Corporate Governance Initiatives (I)
- The Organization for Economic Co-operation and
Development Principles of Corporate Governance
(OCED Principles) - Key factors that transcend both legal and
national boundaries - Objectives, transparency, benchmarks,
accountability, timely and readily accessible
information - Adopted by the International Corporate Governance
Network - Founded in 1995, whose members collectively
manage assets estimated to be in excess of US10
trillion - Commonwealth Association for Corporate Governance
(CACG) - Established in April 1998
- Aims at establishing self-sustaining
institutional capacities for corporate governance
in 53 Commonwealth countries within a five-year
period
16Examples of Corporate Governance Initiatives (II)
- Corporate Governance Core Principles Guidelines
by CalPERS in April 1998 - the California Public Employees Retirement
System, with assets in excess of US110 billion - The PECC Guidelines
- Guidelines for Good Corporate Governance Practice
by Pacific Economic Cooperation Council - Endorsed by the ministers represented at APEC
meeting in Shanghai in October 2001 - Implementing on a voluntary basis
- 10 key elements the board, the chairman, the
members of the board, independent non-executive
directors, executive directors, board meetings,
board committees, board issues, stakeholders and
ethics
17Elements of Corporate Governance (I)
- Purpose
- Clearly thought through, well-defined and
understood, solid and not changing, clear
financial aspects - Constitution
- Well-conceived appropriate, clear, legal,
autonomous - Board
- An appropriate mix- owners, independents and
full-time executives to approve strategies, adopt
plans, monitor performance, make appropriate
decisions and hire top executives
18Elements of Corporate Governance (II)
- Board (contd)
- 4 sub-categories
- Codes of best practice
- Reduce market risk, minimum standards of
accountability, governance and control - Board independence
- Board members truly independent, appropriate
skills and access to key corporate information - Split chairman/ chief executive
- First enshrined in Britains Cadbury Committee
Report (1992) - Co-ordinate the ouster of management
- Protect the interests of all shareholders
- Board committees
- nominate directors and officers
- oversee accounting procedures and the outside
audit - decide the pay of corporate executives
19Elements of Corporate Governance (III)
- Executive
- Develop strategies to meet the purpose
- plan to achieve the strategies
- recommend or make key decisions
- demonstrate mutual respect in operating
interdependence - Chief financial officer
- Steer towards sound financial purpose, strategy,
objectives and criteria - Judge plans and decisions from a financial
viewpoint and from the perspective of other key
functional directors
20Elements of Corporate Governance (IV)
- Criteria
- Measuring tools for all elements of the business
against which plan and performance can be
objectively set to achieve desired success - Plans
- judge against purpose and strategies
- Contain objective criteria a high probability of
achievement with sensitively test ? plan and
identify the consequences of various scenarios - Decisions
- Whether the consequent decision propels the
organization forward
21Elements of Corporate Governance (V)
- Reporting
- A regular stream of relevant, clearly absorbed
information for monitoring - True, fair, comprehensive, transparent and
meaningful - Shareholder relations
- Well-defined purpose and independent
- Autonomous structure allows accountability to
pursue a defined purpose and a defined
performance - Integrity
- Meet ethical standards and progress the entity
- Do not say yes when answer should clearly be
no
22Elements of Corporate Governance (VI)
- Commercial/ financial/ price determination
- Carefully conceived pricing policies
- Sufficient revenue to cover all costs, service
and retire appropriate levels of debt and reward
the investors - High prudent commercial principles
- Spell high reward on investment, high return on
assets invested ? secure borrowing, higher
gearing, higher shareholder return - Elements
- Maximize return to shareholder, dividend, retain
earnings - Optimize return on project, asset, revenue
- Max min financing, loan, equity
23Global Corporate Governance
- Corporate governance
- a process which is concerned about how
corporations are managed, how managers are
governed, what questions face boards of directors
and the accountability a corporation has to
shareholders. - Increase efficiency and effectiveness of
companies - Elements of forming a trust on a company
- accountability and transparency
24Minority Shareholders
- The interests, not the rights, of minority
shareholders should be stressed - Controlling shareholders and management bodies
treat the company and its resources as their own - Inadequate legal protection for the interests of
shareholders
25 Control Management Opportunism
- Four crucial pillars
- Accountability
- Transparency
- Minority investor protection measures
- Enforced regulations
26Accountability (I)
- Sense of responsibility to work towards the
mission of the company and all shareholders - Credit Lyonnais Securities Asia (CLSA) report on
corporate governance in emerging markets - The degree of accountability can be measured by
- Independence and non-executive nature of board
members - Presence of more than half non-executive board
members - Presence of foreign nationals on the boards
- Occurrence of regular full-board meetings
- Opportunity for the members to exercise effective
scrutiny - Presence of audit committees
27Accountability (II)
- CLSA report (contd)
- Very important issues
- Keep track of any mismanagement and take
effective steps against those responsible - Have measures to protect the rights of minority
shareholders - Ensure transparent share trading by board members
- Maintain a board size that is effective and
efficient
28Transparency (I)
- Two essential criteria of a fair market
- Timely information to all players
- The rules that govern the market are known to all
- Conditions for good transparency
- Full and prompt disclosure of information
relating to the company - Timely disclosure of information
- Disclosure of conflicts of interest of directors
or majority shareholders - Adequate advance notice of meetings
- High quality accounting standards of financial
disclosure
29Transparency (II)
- Complete information
- operating results
- remuneration of the board and key executives
- material foreseeable risk factors
- material issues regarding employees and other
shareholders - Transparency and accountability will not be
effective if the information generated by markets
is not adequate.
30Minority Investor Protection Measures (I)
- Tools
- Voting rights one-share, one-vote principle
- Strategy involved in decisions regarding
fundamental corporate changes - Access to the vote
- Anti-takeover devices
- Independent board members
- Pre-emptive rights for all existing shareholders
to buy new shares at an equal price - For the related party transactions by controlling
shareholders, only the minority shareholders
should be allowed to vote - Minimum notice period of at least 30 days to call
a shareholders meeting
31Minority Investor Protection Measures (II)
- Low shareholder activism in most countries
- High costs of litigation
- The legal systems may be riddled with corruption
and inefficiency - Investors invest on a shorter-term basis
- Key mechanism legal protection
- Gang of Four comprising Prof. La Porta,
Lopez-de-Silanes, Shleifer and Vishny - high concentration of ownership ? poor legal
protection of investors ? smaller and narrower
capital markets - Top ten families in each of the East Asian
countries (excluding Japan) controlled 15-58
percent of the total listed corporate assets
32Enforced Regulations
- Ensure implementation and enforcement with
effective penalties for non-compliance - Ensure managers cannot overstep the powers given
to them/ ignore the rights and interests of
minority shareholders
33Western vs. Eastern Firms
- Western companies
- A diverse mix of investors
- Greater focus on the share performance, capital
acquisition at a lower cost - Fear of litigation and criminal prosecution keeps
boards and managers on their toes - Eastern companies
- Family or state-owned, and directors have
controlling shares - Concern corporate governance only when raising
capital, and the company may return to bad
governance practices afterward. - The HAMS Initiative Empowering Hong Kong
Minority Shareholders by David Webb - Key point Honesty and fairness have no cultural,
ethnic or national boundaries
34Benefits of Good Corporate Governance (I)
- To individual stocks
- Better management
- ? more prudent allocation of the companys
resources - ? enhanced corporate performance
- ? higher share price
- ? increase the value of a shareholders holdings
and increase the attractiveness of investing in a
company - Facilitate to make investment decisions
- Corporate governance premium
- additional amount paid by investors for shares in
companies which consistently display management
competence and practise sound disclosure and
accountability
35Benefits of Good Corporate Governance (II)
- Corporate governance premium is evidenced by
- CLSA study Corporate governance in emerging
markets Saints and Sinners - Strong correlations between higher corporate
governance rankings and superior financial return
ratios, as well as price-to-book ratio, higher
valuation and medium-term share price
outperformance. - National impact Flight to quality and
price-earnings discount - Company impact A strong correlation between
corporate governance and price performance of the
largest stocks. - Across emerging markets Companies in the lowest
corporate governance had a lower return on
capital employed
36Benefits of Good Corporate Governance (III)
- Corporate governance premium is evidenced by
(contd) - McKinsey Companys Investor Opinion Survey on
Corporate Governance in June 2000 - Survey on attitudes towards investing in Asia,
Europe, US, and Latin America from September 1999
to April 2000 - 75 of respondents rated board practices as
important as financial performance, especially in
emerging markets - more than 80 are willing to pay more for the
well-governed company - Similar results generated by a study of Russell
Reynolds Associates
37Benefits of Good Corporate Governance (IV)
- To the market
- Ensure the market are fair, efficient and
transparent ? reduce systematic risks - Overall market confidence
- International investors feel safer in terms of
security for minority shareholders, quality
management and even investment returns - Increase the supply of investment capital seeking
to enter that market - Efficiency of international capital allocation
- The renewal of countries industrial bases
- Ultimately nationals overall wealth and welfare
- Contribute positively to the development of
financial markets - Barrier
- social, cultural and economic diversity between
countries
38Effects of Poor Corporate Governance
- Microeconomic view
- If an investor is not satisfied, they simply sell
out the stock, resulting in lower marketable
price and liquidity - Macroeconomic view
- A lack of core value of corporate governance does
have a negative impact globally - The chain reaction that repels investment capital
- Poor corporate governance ? Hurt the reputation
of the whole market ? reduce investor confidence
? Investment becomes far less attractive ? reduce
the investments price and liquidity ? those
seeking investment capital have to pay more for
it, i.e. higher cost of capital
39Corporate Governance Practices in Emerging Markets
- Only aware of the concept but ineffective
implementation and removing the inertia - Little incentive to improve family-controlled
businesses - Implementation
- take into account the family-based nature of
corporation - transform in a gradual and flexible manner
- key not to take drastic steps and provide a
supportive environment - The reforms needed are as follows
- A change in attitude by governments and their
officials - Full and complete disclosure of all corporate
activity affecting the value of shareholders
equity - The establishment of equal rights for all
shareholders. - The rights of all shareholders need to be
enforced rigorously.
40Causes of Convergence of Corporate Governance
Systems
- The globalization of markets
- Path dependency and the politics of governance
- Legal convergence
41The Globalization of Markets
- Investment by institutional investor
- have expectations about shareholder value
- require firms to establish profit targets and to
produce competitive returns - insist that companies respect international norms
of governance - companies adapt in order to be tap global capital
market - New financial instruments, e.g. ADRs and GDRs
- Deeper integration of markets
- Stronger, international competition
- Radical change in corporate finance landscape in
a global way - A more propitious environment for international
co-operation
42Path Dependency and the Politics of Governance
- Path dependent
- Convergence is unlikely to be done in the medium
term - Dont overestimated political and institutional
resistance to alien concept - Citizens are increasingly open to foreign ideas
- Acquisition of major industrial companies by
foreign competitors does not caused any political
problems - Top-down convergence
- Increasing exposure of policy makers to regional
and global policy fora - Ready availability of other countries experience
and the wish to be part of an open world
43Policy Maker
- Balance between mandatory law and contract in
each jurisdiction - Optimum mix between flexibility and
predictability
44END