Lecture 4 & 5: Outline
• What is corporate governance? • Definition of “Governance” • Corporate Governance participants • Why is it important?
• Who are the boards?
• Theories of corporate governance. • OECD corporate governance principles. • Global trends in corporate governance.
– Driver for change.
– European system (e.g. UK system). – Anglo American system.
• Forms of Business Ownership – A sole proprietorship – A partnership – Corporation
• Separation of Ownership and Control
• There is a problem with the separation of ownership and control
• In academic terms, this situation is known as the principal-agent problem or the agency problem
• Corporate Governance Definitions • How to measure Corporate Governance
1. On the basis of how effective the systems are in limiting managers’ to divert firm resources to their own private uses
2. On the basis of how willing entrepreneurs are to make initial public offerings of stock
3. On the basis of the speed with which management is replaced for sustained poor performance
• Four core values of the OECD corporate governance framework − Fairness
− Responsibility − Transparency − Accountability
• The fundamental values of good governance • The Legal Directorial Appointment Sequence • Governance is Different from Management • Basics of Corporate Governance
• Related issues to Corporate Governance – The duties of directors.
– Methods of financing the corporation. – Managerial compensation.
– Acquisitions and divestments.
– Monitoring of decision making at the strategic and operating level. • Corporate Governance Goals
• What is Good Governance • What is Poor Governance
• The Board of Directors
– What is a “GOOD BOARD”?
• Members have relevant experience.
• Members who has worked in the same or similar industry for many years. • Members have different backgrounds.
• The most common board committees are the following: • Audit committee
• Compensation committee • Nomination committee • Who can be a director?
• Types of Directors
a) Executive Directors b) Non-Executive Directors c) Independent Directors What is Independence?
• Interlocks with other Directors; • The Election of Directors
– All directors must be elected with cumulative voting.
• Cumulative voting is a system that helps minority shareholders pool their votes to elect a representative for the Supervisory Board.
• Theories of Corporate governance
– Berle and Means (1932) – separation of ownership and control through modern corporation structures.
– Agency Problem. – Agency Theory.
– Theoretical Challenges to Agency Theory (Stewardship theory).
– The business literature describing the classical functions of boards of directors typically includes three important roles: (1) establishing basic objectives, corporate strategies, and board policies: (2) asking discerning questions; and (3) selecting the president. – Stewardship Theory
– Resource Dependency Theory
• Who watches the executives?
– If executives have the temptations , and if the executives are not watched by engaged owners; then the organization has serious problem
– Solution to this problem :
• The incentive solution :is to tie the wealth of the executives to the wealth of shareholders
• The second solution : is to set up mechanisms for monitoring the behavior of managers
– Types of executives compensation – Base Salary:
– Stock Options: – Other Compensation:
• When shareholders are active monitors of the firm they own stocks in , their activism is referred to as “Shareholder Activism”
– Shareholders – by exercising shareholder rights
– Depositors and other customers – by avoiding business with unsound banks
– Auditors – through an established and qualified audit profession, audit standards and communication to boards and supervisors
– Governments – through laws, regulations, enforcement and an effective judicial framework
– Credit rating agencies – through review and assessment of the impact of corporate governance practices on a bank’s risk profile
– Securities regulators, stock exchanges and other self-regulatory organizations – through disclosure and listing requirements
– Employees – through communication of concerns regarding illegal or unethical practices or other corporate governance weaknesses
• Corporate Governance and International Business
– Globalization and its consequences on international capital flows means growing pressure for international standards
– International agencies such as OECD, World Bank, IMF, European Union are advocating more effective ‘Corporate Governance’
Lecture 2: TRENDS IN GLOBAL CORPORATE GOVERNANCE
WHY DOES IT MATTER?
• Privatisation
– Liberalisation: falling trade barriers, capital controls – Technology: mobile money, information
– Globalisation • 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
• Demand for global standards (OECD principles) • International initiatives (WB – OECD cooperation) • 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
• 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 • 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. • Practice of Governance: Germany
– Long-term (cosy?) relationships
– Other shareholders are proportionately less important
– Hostile takeovers virtually unknown (exception: Vodafone/Mannesman) • German Governance: Assessment
– Advantages:
• Long-term business relationships • Stability of employment and production • Social cohesion?
– Disadvantages:
• Lack of transparency and openness • Sometimes tolerant of poor performance • May be unresponsive to global change • 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 • 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
• Anglo-Saxon Model
– “outsider” model – arms length investor – Internal governance mechanisms
• board of directors • employee compensation – External mechanisms
• market for corporate control • monitoring by financial institutions • competition in product and input market
– Reliance on legal mechanisms to protect shareholder rights – Short term financial performance key
• German (Continental) Model
– Co-determination - partnership between capital and labor • Social cooperation
• The two-tier board structure that consists of a supervisory board and executive board – greater efficiency in separation of supervision and management
• Cross–shareholding in financial – industrial groups • Role of banks as major shareholders
• Primary sources of capital – retained earnings and loans • Market for Corporate Control
• “Friendly Takeover”
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?
