Modul ke:
BUSINESS ETHIC AND GOOD GOVERNANCE PENERAPAN GCG DI PERUSAHAAN INTERNASIONAL
Fakultas
PASCA
Program Studi
Magister Manajemen www.mercubuana.ac.id
Dr. Mirza, ST, MM
BUSINESS ETHIC & CORPORATE GOVERNANCE
International Corporate Governance
Lecture Outline
What is Corporate Governance? Internal Mechanisms External Mechanisms Convergence Measuring Corporate Governance Benefits of Good Governance What you need to remember…
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Introduction Stage 1:
Equity Voting Rights
Company founded (owned and managed) by individual, family, partnership, government or company. Stage 2:
Equity
New Equity
Voting Rights
Voting Rights
Debt
Company expands by issuing more equity and debt. New equity holders also get voting rights as to who manages the company. 4
SARBANES-OXLEY ACT
SARBANES-OXLEY ACT Di implementasikan pada tanggal 30 juli 2002, dan dijalankan oleh Securities and Exchange Commission (SEC) untuk mengatur pelaporan dan audit keuangan atas perusahaan-perusahaan yang sahamnya diperdagangkan secara public (perusahaan terbuka) di Amerika Serikat
Sarbanes-Oxley Act merupakan sebuah respons terhadap kegagalan
dalam tata kelola perusahaan, ada juga respons lainnya, seperti kepatuhan terhadap elemen dari kerangka kerja untuk pengendalian lingkungan
Sarbanes-Oxley Act berusaha keras merespons skandal-skandal dengan
cara mengatur perlindungan terhadap perilaku yang tidak etis. Karena tidak ada seorang pun yang dapat memprediksi secara pasti setiap kesalahan dalam penilaian, tidak ada “ketentuan” peraturan yang sempurna.
Ketentuan-ketentuan berikut ini memiliki dampak yang paling signifikan pada tata kelola perusahaan dan dewan direksi: Section 201: jasa di luar wewenang auditor (melarang beragam bentuk dari layanan professional yang dianggap sebagai konsultasi alih-alih mengaudit) Section 301: komite audit dari perusahaan terbuka (mengharuskan adanya independensi), Section 307: peraturan mengenai tanggung jawab professional pengacara (mengharuskan pengacara untuk melaporkan keprihatinan menyangkut kekeliruan jika tidak ditangani)
Section 404: penilaian manajemen atas pengendalian internal/ internal control
Section 406: kode etik bagi pejabat keuangan senior (diwajibkan) Section 407: pengungkapan jati diri ahli keuangan dari komite audit
Introduction Stage 1:
Equity Voting Rights
Company founded (owned and managed) by individual, family, partnership, government or company. Stage 2:
Equity
New Equity
Voting Rights
Voting Rights
Debt
Company expands by issuing more equity and debt. New equity holders also get voting rights as to who manages the company. 8
Introduction Company founder must now choose between keeping control of the company or allowing the company to be managed by professional managers. Equity
New Equity
Voting Rights
Voting Rights
Debt
If they keep control there is a potential conflict between the founders and other shareholders. If they pass management to professional managers there is a potential conflict between owners and managers. 9
What is Corporate Governance? Corporate governance is about minimizing the loss of value that results from the separation of ownership and control. It deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. While corporate governance has been a hot issue in recent years (Enron, Worldcomm, HIH and One.Tel) it is a problem that has been around for hundreds of years – Adam Smith (1776). 10
What is Corporate Governance? Good corporate governance practices involve: – The corporate governance framework should protect shareholders rights. – The corporate governance framework should ensure the equitable treatment of all shareholders. – Stakeholders should be involved in corporate governance. – Disclosure and transparency is critical. – The board of directors should be monitored and held accountable for what guidance it gives.
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Internal Mechanisms Board of Directors Board Size & Independence Chairman/CEO Positions Board Committees
Executive Compensation Ownership Structure Concentrated versus Dispersed Ownership Identity of Owners Other Blockholders
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External Mechanisms External Auditors Debt & Equity Markets Monitoring by debt holders Analysts Mergers & Acquisitions
Legal/Regulatory System Common versus Civil Law Extent of Law Enforcement Recent Regulations – Sarbanes Oxley Act, ASX Good Corporate Governance Principles 14
International Differences
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Board of Directors The board of directors is responsible for overseeing management and representing shareholders’ interests. US and Australia have single-tiered boards, headed by a Chairman of the Board. The CEO and other executives usually also sit on the board. Some other countries (Germany, Indonesia) have two-tiered boards. The roles and composition of the two boards can differ.
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Board Size Boards should be an appropriate size – not too big not too small. Depending on the size of the company within the range of 5-15 is normal. If the board is too small, there is a lack of monitoring. If the board is too big, there are problems reaching a consensus for decision making.
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Board Independence Boards should have a majority/high proportion of outside/independent directors. Outside/independent directors should have no personal interest in the company and therefore are more effective monitors. But, it is also a good idea to have some company insiders (CEO, executives) on the board to provide the board with a better understanding of the company’s operations.
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Chairman/CEO Positions The Chairman of the Board is responsible for overseeing the board of directors. The CEO is responsible for the day-to-day running of the company. In family-controlled companies it is common for the same person or relatives to hold both of these positions. But, this concentrates power and reduces monitoring. Therefore, the positions of Chairman and CEO should be separated. 19
Board Committees The board of directors can delegate certain duties to board committees – this can provide increased monitoring on specific issues. Audit committee – responsible for internal audit function and appointment of external auditor. Remuneration committee – responsible for setting appropriate compensation for directors and executives. Nomination committee – responsible for finding appropriate directors and executives. 20
Executive Compensation Compensation of top executives can be used to tie the interests of the executives to those of shareholders. Variable performance packages are preferred: If they perform well, they are rewarded. If they perform poorly, they are not rewarded or fired.
Alignment of interests is usually achieved through: Stock ownership Stock options
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Ownership Structure Australian and US companies are usually owned by widely-dispersed shareholders and controlled by professional managers. This means that no single party is in control of the company. However, in other nations around the world, ownership is usually concentrated in the hands of family groups or government entities. This means that one group is in control of the company and there is very little you can do (other than sell) if you don’t like what they’re doing. 22
Ownership Structure The identity of the controlling owner can also have corporate governance implications. Family-controlled companies use cross-holdings and pyramidal structures to gain effective control of the company with the least cash ownership. The market recognizes this and prices the increased risk of expropriation into the share price. Government-owned and widely-held companies are more likely to follow the rules.
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Ownership Structure The presence of an non-management related blockholder of shares can increase monitoring of the firm. A blockholder usually holds at least 5% of the outstanding shares, therefore has a significant interest in the future performance of the company. Blockholders can be governments, financial institutions, individuals or other companies.
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External Auditors Stock exchange listing requirements usually make it mandatory for companies to employ an external auditor to audit their financial statements (and internal controls). External auditor should be independent of management, but ….
Tenure of auditor Tenure of audit partner
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Monitoring by Debt holders Debt holders provide capital to the company usually with conditions:
Debt covenants Secured on assets
Therefore debt holders actively monitor management to ensure that companies are meeting debt conditions and that they won’t default.
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Analysts Securities analysts are professionals employed by investment banks / brokers / asset managers to monitor companies and provide stock recommendations (buy/sell), earnings forecasts, long-term growth forecasts, target prices etc. Provides an extra level of monitoring for investors. But, analysts incentives/conflicts of interest mean that not all of their output is trustworthy.
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Takeover Market The merger and acquisition (M&A) market stands as a ‘court of last resort’ for assets that are not being utilized to their full potential. If management are underperforming there is a good chance that this will be noticed by the market and other players will want to take control of the company. There are active takeover markets in Australia, US, UK, New Zealand, but few other countries.
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Intervening Variables Measures put in place by companies that restrict shareholder rights and the effectiveness of takeover markets:
Staggered boards Limits to by-law/charter changes Supermajority requirements for mergers Poison pills Golden parachutes
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Legal Systems Each country’s legal system has built in a certain degree of investor protection. However, there is a wide variation in protection and enforcement of these rules around the world. Common law countries provide highest protection and French civil law countries provide the least protection. Low investor protection seems to result in concentrated ownership and underdeveloped equity markets. 30
Legal Systems Country
Legal System
Protection
Rule of Law
Australia
Common law
4
10
France
French Civil law
2
8.98
Germany
German Civil law
1
9.23
India
Common law
5
4.17
Japan
German Civil law
4
8.98
Korea
German Civil law
2
5.35
Philippines
French Civil law
3
2.73
Netherlands
French Civil law
2
10
UK
Common law
5
8.57
USA
Common law
5
10 31
Recent Regulations In response to the Enron crisis in the US, the Sarbanes Oxley Act was passed in 2002. This has significantly increased governance practices and the personal liability of directors in the US. Most other nations have issued Corporate Governance Best Practice Guidelines to assist companies in improving their governance – ASX Corporate Governance Guidelines & Best Practice Guide (on OLT site). But these are voluntary! BHP website
BHP Annual report
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Convergence? Originally there were market-based, family-based, bank-based, government-affiliated systems. In recent years, most nations have started to promote US and UK best practice corporate governance guidelines. But not all companies are adopting these measures. There is evidence that family-controlled companies in particular are refusing to improve their corporate governance practices. Asian Corporate Governance Association 33
Measuring Corporate Governance Understanding what good corporate governance is about is quite easy. However, it is difficult to measure whether companies are really committed to good governance. All we can do is measure if they have certain corporate governance mechanisms in place – we don’t know if they are effective or not! Organizations such as Standard and Poors and Credit Lyonnais Securities Asia have started providing corporate governance ratings in recent years. S&P
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Benefits of Good Governance Researchers have shown that companies with good corporate governance practices are valued more highly and run more effectively. So the benefits of good governance include: Higher share price Lower cost of funds Greater international following
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What you need to remember… When investing it is worthwhile keeping in mind whether a company has committed to good corporate governance or not. You can use the mechanisms highlighted in this lecture or corporate governance ratings as a guide. Corporate governance becomes most important during stock market crashes and bad economic times. But, it is not a perfect science. Managers will always find a way to circumvent monitoring to achieve their own goals! 37
GLOBAL CORPORATE GOVERNANCE WHY DOES IT MATTER? • It is concerned with who controls what, and how well they are doing it • It is changing, and we need to understand what is happening • It affects entire economies, multinational corporations and small businesses
Global Trends: The Context • Privatization: $850 billion since 1990 • Liberalization: falling trade barriers, capital controls • Technology: mobile money, information • Globalization
Drivers of Change • Increased competition: exposing stagnant performance • Transition: roll back of the state • Decline in public funding: from aid to investment • Capital exporters: rapid growth in institutional investment • Scandals, corruption and collapse • The ‘invisible’ continent: Kenichi Ohmae
SOME SCANDALS • • • • • • •
Banks in 1990s Japan Equitable Life in the UK LTCM, Worldcom and Enron in USA Parmalat in Italy Defence contracts in France and UK The 2008-9 global banking collapse …..and they keep on coming!
The Response • Public reform (codes, listings, company law, regulation) • Private sector response • Demand for global standards (OECD principles) • Financial stability forum • International initiatives (WB – OECD cooperation) • International standard setters • … impact felt in every region
Global Meets Local: the Variables – Legal heritage – Pattern of ownership – Exposure to international markets – Business culture and environment – … one size does not fit all (but fundamental principles apply)
COMPARING GOVERNANCE SYSTEMS • Internationally we can find four main varieties of governance system: – market-based – corporate – state-guided – “crony”-based
• Some countries have features of more than one system
STATE-GUIDED SYSTEM • Strong state, intervening systematically • Tendency to trade protection or mercantilist practices • Markets qualified by subsidy, regulation • Public/private partnership common • Possibility of large state-owned sector
“CRONY” SYSTEM • Close business-government links • Tendency to monopolistic practices • Politically-inspired subsidies, trade restrictions and interventions • Probably high income differentials and narrow distribution of wealth
International Corporate Governance
Germany
International Corporate Governance
Germany Owner and manager are often the same in private firms Public firms often have a dominant shareholder too, frequently a bank
International Corporate Governance
Germany Owner and manager are often the same in private firms Public firms often have a dominant shareholder too, frequently a bank Medium to large firms have a two-tiered board - Vorstand monitors and controls managerial decisions - Aufsichtsrat selects the Vorstand - Employees, union members and shareholders appoint members to the Aufsichtsrat
International Corporate Governance
Germany Owner and manager are often the same in private firms Public firms often have a dominant shareholder too, frequently a bank Medium to large firms have a two-tiered board - Vorstand monitors and controls managerial decisions - Aufsichtsrat selects the Vorstand - Employees, union members and shareholders appoint members to the Aufsichtsrat
Frequently there is less emphasis on shareholder value than in U.S. firms, although this may be changing
International Corporate Governance
Japan Obligation, “family” and consensus are important factors
International Corporate Governance
Japan Obligation, “family” and consensus are important factors Banks (especially “main bank”) are highly influential with firm’s managers Keiretsus are strongly interrelated groups of firms tied together by cross-shareholdings
Practice of Governance: UK • Most shares are held by pension funds, investment funds, and private individuals • Banks usually do not own shares • Almost all big companies are “listed” • Stock market performance of shares important measure of corporate success • “Hostile” takeovers fairly common
UK: Governance Assessment • Advantages:
– Fairly open and transparent – Quick rewards for success and punishment for failure – Responsiveness to business environment
• Disadvantages:
– May encourage “short-termism” – Mergers and takeovers do not always work
French Governance: Assessment • Advantages:
– Successful use of state/business partnerships – Coordinated approach to industrial strategy – Effective use long-term planning
• Disadvantages:
– Conflicts of interest between business/state – Sometimes lack of transparency – Some tolerance of underperformance
Practice of Governance: Russia • Large industrial groups, some controlled by the “oligarchs” • Some very big corporations are under strong state influence (e.g.Gazprom) • Stock market not very transparent • Many business relationships based on personal connections, sometimes crime
Russian Governance: Assessment • Advantages: – If any at all, the avoidance of disorder
• Disadvantages: – Lack of transparency – Corruption – Misallocation of resources – Excessive arbitrary state intervention
Changes in European Governance • Most corporate governance systems are tending to converge • Stock markets are becoming more important, BUT • Some shareholders becoming more activist, such as pension funds like Hermes, some unit trust companies
Practice of Governance: France • Shareholding structures more like Germany than UK • Close state-business links, and intervention by the state • Stock market has become much more important over last 20 years - state uses it as a discipline measure
French Governance: Assessment • Advantages:
– Successful use of state/business partnerships – Coordinated approach to industrial strategy – Effective use long-term planning
• Disadvantages:
– Conflicts of interest between business/state – Sometimes lack of transparency – Some tolerance of underperformance
QUESTIONS AND ISSUES • Why has Governance come to the fore in the last 25 years? • What are “good” governance and “bad” governance? • In what ways does governance differ in the private and public sectors? • How much difference does it make?
COMPARING GOVERNANCE SYSTEMS • Internationally we can find four main varieties of governance system: – market-based – corporate – state-guided – “crony”-based
• Some countries have features of more than one system
CAPITALISM: alternative taxonomies examples • Market capitalism (USA, UK, Hong Kong, New Zealand, Canada) • Corporate/institutional capitalism (Sweden, Germany, Austria, Italy,Korea) • State-guided capitalism (Japan, France, Iran, Hungary) • “Crony”capitalism (Russia, Ukraine, Thailand, Indonesia)
MARKET SYSTEM • • • • • •
Government avoids intervention Preference for low taxation/spending Preference for free trade Low levels of state asset ownership Lower levels of regulation Strong capital markets with wide share ownership; markets agents of change
CORPORATE SYSTEM • Government prepared to intervene • Banks or other institutions own much of corporate capital • Financial markets secondary, with corporate change occurring privately • Social objectives often important • Consensual policy-making
STATE-GUIDED SYSTEM • Strong state, intervening systematically • Tendency to trade protection or mercantilist practices • Markets qualified by subsidy, regulation • Public/private partnership common • Possibility of large state-owned sector
“CRONY” SYSTEM • Close business-government links • Tendency to monopolistic practices • Politically-inspired subsidies, trade restrictions and interventions • Probably high income differentials and narrow distribution of wealth
CORPORATE GOVERNANCE DI LUAR USA DAN UK •
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Kebanyakan penelitian CG diadakah dengan sampel perusahaan besar atau korporasi di USA yang pada umumnya memiliki kepemilikan yang tersebar (widely held). Untuk korporasi di luar USA dan UK, terdapat karakteristik kepemilikan yang berbeda yaitu kepemilikan saham yang terkonsentrasi atau dikuasai oleh keluarga. (Canada, Eropah kontinental, Asia Timur, India dll). Kajian Yeh dan Woidtke (2005) mencoba mengkaji korporasi di luar USA yang mempunyai struktur kepemilikan keluarga yang kental.
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Research Question • Yeh dan Woidtke (2005) mengajukan pertanyaan penelitian: – Apakah struktur Board (BOD/BOC) dapat menjadi indikator baik buruknya Corporate Governance pada perusahaan yang kepemilikannya terkonsentrasi? – Apakah konsentrasi kepemilikan saham membuat “controlling shareholder” memilih BOD/BOC yang profesional atau justru memilih orang-orang dapat membantu mereka melakukan eksproprasi terhadap pemegang saham minoritas? – Apakah independensi Board amat penting dalam suatu perusahaan yang kepemilikannya terkonsentrasi
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Concentrated Ownership •
Keunggulan dari struktur kepemilikan yang terkonsentrasi adalah untuk mengatasi agency problem, khususnya di negara yang lemah investor protection nya, sebab pemegang saham pengendali mempunyai kekuasaan untuk mendisiplinkan manajemen.
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Kelemahan : struktur kepemilikan yang terkonsentrasi dapat menciptakan peluang atau kondisi untuk munculnya agency problem yang lain yaitu ekspropriasi, sebab kepentingan pemegang saham mayoritas tidak selalu seiring dengan kepentingan pemegang saham minoritas terutama bila terdapat divergensi antara besarnya kontrol terhadap perusahaan dengan jumlah kepemilikan saham.
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Concentrated Ownership • Bila kondisi divergensi ini terjadi, maka diharapkan Boards akan berperan untuk membatasi kecenderungan ekspropriasi pemegang saham mayoritas terhadap pemegang saham minoritas (Fama dan Jensen, 1983).
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Concentrated Ownership • Namun demikian, komposisi Boards kemungkinan akan dipengaruhi oleh pemegang saham pengendali. • Oleh karena itu, struktur Boards dapat menjadi indikator baik buruknya kondisi CG di sebuah perusahaan: apakah pemegang saham pengendali berkomitmen terhadap good corporate governance atau entrenched.
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Concentrated Ownership Karakteristik Perusahaan Taiwan • • • • • • •
Perlindungan terhadap pemegang saham minoritas relatif lemah Konsentrasi kepemilikan yang tinggi Dominasi kontrol keluarga pemilik (family control) Banyaknya perusahaan dengan struktur pyramidal groups dan crossholding Sedikitnya kepemilikan perusahaan oleh institusi Inactive market for corporate control Hak-hak pemegang saham lebih terbatas (dibatasi) dibandingkan dengan U.S.
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Concentrated Ownership Karakteristik seperti itu merupakan kondisi yang baik untuk menguji pengaruh dari Positive Incentive dan Negative Entrenchment Effects dari Komposisi Board.
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Findings and Conclusion •Anggota Board yang terafiliasi dengan pemegang saham utama (keluarga pemilik) akan berjumlah lebih banyak apabila pemegang saham utamanya: – Mempunyai excess control (divergensi CFR dengan CR) yang besar – Adalah bagian dari controlling family – Adalah CEO dan chairman BOS •Komposisi Board yang terafiliasi berkorelasi positif dengan Excess Control dan berkorelasi negatif dengan ratio CFR/CR.
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Findings and Conclusion •
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Nilai perusahaan akan lebih rendah jika jumlah anggota Board yang terafiliasi dengan keluarga pemilik lebih banyak. Sebab, komposisi Board yang terkait dengan controlling family akan disertai dengan kuatnya pengaruh negative entrenchment, yang akibatnya perusahaan akan dinilai rendah oleh investor. Sebaliknya, komposisi Board yang independen dari keluarga pemilik akan disertai dengan kuatnya pengaruh positive incentive, dan perusahaan ini akan dinilai tinggi oleh investor.
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Findings and Conclusion •
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Controlling shareholder mempunyai pilihan untuk menentukan apakah komposisi Board akan dibuat independen dan profesional guna meningkatkan nilai sahamnya (positif incentive effects) atau menyusun komposisi Board yang terafiliasi untuk mempertahankan kendalinya atas perusahaan guna melakukan ekspropriasi terhadap pemegang saham minoritas (negative entrenchment effects). Komposisi Board, oleh karenanya, dapat dijadikan indikator baik buruknya Corporate Governance.
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Findings and Conclusion •
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Nilai perusahaan akan lebih rendah jika jumlah anggota Board yang terafiliasi dengan keluarga pemilik lebih banyak. Sebab, komposisi Board yang terkait dengan controlling family akan disertai dengan kuatnya pengaruh negative entrenchment, yang akibatnya perusahaan akan dinilai rendah oleh investor. Sebaliknya, komposisi Board yang independen dari keluarga pemilik akan disertai dengan kuatnya pengaruh positive incentive, dan perusahaan ini akan dinilai tinggi oleh investor.
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The Agency Problem • Shareholders allocate decision-making authority to the managers. • That’s why the managers are hired in the first place. • Many shareholders are not qualified to make complex business decisions. • A shareholder with a diversified portfolio would not have the time to devote to making the numerous decisions at each of his many companies anyway. 4-79
The Agency Problem • Having the short-term control of the firm’s assets, managers might be tempted to act in the manager’s short-term best interest instead of the shareholder’s long-term best interest. – Consumption of lavish perquisites is one example. – Outright stealing is another example. • Some Russian oil companies are known to sell oil to manager-owned trading companies at below market prices. • Even at that, they don’t always bother to collect the bills!
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•Agency Theory = implies that entrepreneurs, shareholders, and managers should always find ways to minimize the loss value that arises from the separation of ownership = is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. •Two Main Problems that are Concerns by the Agency Theory1. The first is the agency problem that arises when: a. The desires or goals of the principal and agent conflict b. It is difficult or expensive for the principal to verify that the agent has behave appropriately2. Risk-sharing problem that arises when the principal and agent have different attitudes toward risk •Corporate Governance in Publicly TradedMNCs generally contains related Tiers: 1. Parent-level corporate governance - how the parent company’s rights, power and responsibilities are divided and monitored. 2. Subsidiary-level corporate governance – how foreign subsidiaries that have their own board of directors deal with their shareholders and other local stakeholders while simultaneously answering to and integrating with the parent firm.
Governance and the Public Corporation: Key Issues • A key weakness is the conflict of interest between managers and shareholders. • In principle, shareholders elect a board of directors, who in turn hire and fire the managers who actually run the company. • In reality, management-friendly insiders often dominate the board of directors, with relatively few outside directors who can independently monitor the management. 4-82
Governance and the Public Corporation: Key Issues • In the case of Enron and other dysfunctional corporations, the boards of directors grossly failed to safeguard shareholder interests. • Furthermore, with diffused ownership, most shareholders have strong enough incentive to incur the costs of monitoring management themselves. – It’s easier to just sell your shares a.k.a. “The Wall Street Walk”.
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Corporate Boards • The structure and legal charge of corporate boards vary greatly across counties. – In Germany the board is not legally charged with representing the interests of shareholders, but is rather charged with representing the interests of stakeholders (e.g. workers, creditors, etc.) as well as shareholders.
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Corporate Boards • The structure and legal charge of corporate boards vary greatly across counties. – In England, the majority of public companies voluntarily abide by the Code of Best Practice on corporate governance. – It recommends there should be at least three outside directors and the board chairman and the CEO should be different individuals.
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Corporate Boards • The structure and legal charge of corporate boards vary greatly across counties. – In Japan, most corporate boards are insiderdominated and primarily concerned with the welfare of the keiretsu to which the company belongs.
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Incentive Contracts • It is difficult to design a compensation scheme that gives executives an incentive to work hard at increasing shareholder wealth. • Accounting-based schemes are subject to manipulation. – Arthur Andersen’s involvement with the Enron debacle is an egregious example.
• Executive stock options are an increasingly popular form of incentive compatible compensation. 4-87
Executive Stock Options • Executive Stock Options exist to align the interests of shareholders and managers. • Executive Stock Options are call options (technically warrants) on the employer’s shares. – Inalienable: the option can’t be sold. – Typical maturity is 10 years. – Typical vesting period is 3 years.
• Executive Stock Options give executives an important tax break: grants of at-the-money options are not considered taxable income. (Taxes are due if the option is exercised.) 4-88
Concentrated Ownership • Another way to alleviate the agency problem is to concentrate shareholdings. • In the United States and the United Kingdom, concentrated ownership is relatively rare. • Elsewhere in the world, however, concentrated ownership is the norm.
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Debt • If managers fail to pay interest and principal to creditors, the company can be forced into bankruptcy and managers may lose their jobs. • Borrowing can have a major disciplinary effect on managers, motivating them to curb private perquisites and wasteful investments and trim bloated organizations. • Excessive debt creates its own agency problems, however. 4-90
Overseas Stock Listing • Companies domiciled in countries with weak investor protection can bond themselves credibly to better investor protection by listing their stocks in countries with strong investor protection.
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Law and Corporate Governance • Commercial legal systems of most countries derive from a relatively few legal origins. – – – –
English common law French civil law German civil law Scandinavian civil law
• Thus the content of law protecting investors’ rights varies a great deal across countries. • It should also be noted that the quality of law enforcement varies a great deal across countries. 4-92
Consequences of Law • Protection of investors’ rights has major economic consequences. • These consequences include – The pattern of corporate ownership and valuation. – Development of capital markets. – Economic growth.
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Capital Markets and Valuation • Investor protection promotes the development of external capital markets. • When investors are assured of receiving fair returns on their funds, they will be willing to pay more for securities. • Thus strong investor protection will be conducive to large capital markets. • Weak investor protection can be a factor in sharp market declines during a financial crisis. 4-94
Economic Growth • The existence of well-developed financial markets, promoted by strong investor protection, may stimulate economic growth by making funds readily available for investment at low cost. • Several studies document this link. • Financial development can contribute to economic growth in three ways: – It enhances savings. – It channels savings toward real investments in productive capacities. – It enhances the efficiency of investment allocation.
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Corporate Governance Reform • Scandal-weary investors around the world are demanding corporate governance reform. • It’s not just the companies’ internal governance mechanisms that failed; auditors, regulators, banks, and institutional investors also failed in their respective roles. • Failure to reform corporate governance will damage investor confidence, stunt the development of capital markets, raise the cost of capital, distort capital allocation, and even shake confidence in the capitalist system itself. 4-96
The Sarbanes-Oxley Act • Major components: – Accounting regulation – Audit committee – Internal control assessment – Executive responsibility
• Many companies find compliance onerous, costing millions of dollars. • Some foreign firms have chosen to list their shares on the London Stock Exchange instead of U.S. exchanges to avoid costly compliance. 4-97
CFA Institute Ethical and Professional Standards of Corporate Governance Quality of Corporate Governance • The Board: – Is it largely independent? Are they cozy with Mgt? – Are the directors qualified? – Do they have access to outside resources? – How are they elected? – Do any directors have cross-company relationships? • Management: – Do they have a code of ethics? Are they vendors or customers? – Are there lots of perquisites? – How is their compensation structured?
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Key Board Committees • Audit Committee: – Oversees financial reporting. Should watch out for Accounting shenanigans
• Executive Compensation Committee: – Approves compensation packages including bonuses, stock options, severance, loans, etc. What incentives are being created?
• Nominations Committee: – Recruits and proposes new board members. Are they “stacking” the board? 4-99
