The Initiative for Policy Dialogue corporate governance Task Force Meeting September 25, 2003 Columbia University New York, NY Notes taken by Tomasz Michalski. Bolton: What is corporate governance? This is what I picked up from the NYT on Monday. It’s not very encouraging for us. (shows slide) Here’s our attempt to organize a few thoughts. What are the key issues for corporate governance in developing countries? We thought we’d take a mainstream approach. This is a very widespread view in the economics profession, a very simple textbook view…
Income per capita is a function of hours worked and hourly productivity… and the view is, well, what explains higher per capita income in the west, which is about $100 per hour, the difference between the US and a developing country, which is about $2, is that the US has a bigger stock of capital… You make those observations and you conclude from there that the main problem of development is really a problem of transferring capital from a rich to a poor country… a lack of social capital and trade barriers, and this is really the consensus… [Neoclassical perspective on development: income per capita is a function of hours worked and hourly productivity; higher physical or human capital increases hourly productivity; the lower the trade distortions and taxes are the higher is the marginal revenue product.
... a high school graduate. Besides the differences in incomes among the college educated ... /she can or cannot obtain. The higher a college degree is, the higher the potential income earnings are. On average, a limited ... more valuable that a high school education is correct. A person with a college education generates a higher income than that of ...
According to this, the main problem of development is thus how to transfer capital from rich to poor countries. The main obstacles to development are then lack of protection of capital income, trade barriers, rule of law etc. ]Millennium Challenge Account and US policy linking corporate governance with development aid is directly inspired by this analysis. Is protection of capital income really the panacea of economic development? How does one go about protecting capital income? What form of corporate governance, what rules should be applied? How does one solve the enforcement problem? Protecting capital income (corporate governance rules): a) ownership concentration; b) debt financing and bank supervision; c) delegation of power to boards; d) accounting standards; e) legal protections of small investors; f) regulatory agencies and tax authorities. Problems common to all solutions: who monitors the monitor? There is a possibility of potential collusion between management and the delegated monitor (block holder, auditor, director, bank) Other constituencies: in developing countries there is a relative abundance of labor and scarcity of capital; relative abundance of unskilled labor; these may not know how to manage a firm. It is not realistic to envisage the same form of worker participation as in OECD countries.
Yet employee constituency cannot be ignored altogether. There exists an interplay between politics and corporate governance. Stiglitz: Human capital is at risk when a firm is banished. We can even view it within the capital framework. Bolton: This is something to be discussed. In developing countries human capital is very important.
Stiglitz: In developing countries, there is something about having a job. You move to a place, you have a house and that is what still is destroyed even if you belong to the unskilled labor pool. Bolton: The politics of enforcement: How can better enforcement of investor protection be achieved? Should development aid finance legal enforcement? Is there a role for private enforcement? State ownership and privatization: is there a role for state ownership? How far should privatization go? What form should privatization take? Can governance of SOEs be improved? Privatization, corporate governance and competition? Bhattacharya: Corporate governance is also about intermediaries – financial intermediaries. We should also talk about issues of currency crises and the externalities there.
... corporate governance systems adopted by different countries are converging. A Comparison of Corporate Governance Factors in Four Countries 1. Introduction Corporate governance ... Min. Max. Average Registered capital of German public corporations & ... have adopted. Globalization of markets and internationalization of the ... to understand their monitoring roles. Personality, character and independence ...
What is the role of the state ownership of banks? Stiglitz: State ownership of banks in the Czech Republic was a major problem there. Van Dyck: State involvement more broadly speaking – such as monitoring. Stiglitz: In thinking about corporate governance, we have public policy focus. Why do private markets not solve the problem on their own? The Chicago school of thought is that if you don’t interfere with competition, etc.
corporate governance is fine – there are takeover markets. It says that the problems are a result of state intervention. The other view says that there are a whole variety of market failures, and there needs to be more of a role of the regulator. Bolton: You all got the survey that we wrote on corporate governance as part of your background material. Often this is not discussed but it is right. We need to ask is there a role for public policy and what is it? What should be left to contracting and how can it be supplemented? Stiglitz: It is important for developing countries, because they are different from developed countries.
How you answer the question could be different because the market might be more effective in developed countries. Zingales: I see your two points are different. The need for corporate governance is implicit in the moment you say you need firms. When firms exist where price mechanisms and contracting are not efficient, we need some authority. Once you have that you need something to monitor the authority. But you must have some market in order to have firms and to have corporate governance.
We need to find a [market] inefficiency to talk about government intervention but we do have a room to talk about corporate governance even without it. Developing markets are nonfunctioning so a call for authority is bigger and the scope of [intervention] is bigger. Corporate governance is very important if institutions are weak. OECD Corporate Governance Principles and McKinsey Opinion Surveys OECD principles of corporate governance were formulated 1999 and are under revision. It is widely seen as an international norm in corporate governance. Summary protect shareholder rights, treat shareholders equitably, protect and respect role of stakeholders; timely and accurate disclosure of all material info; boards to be effective and accountable Van Dyck: Did they talk much about the role of shareholders and the unique problems that they raise? That seems to be something missing from these principles.
... main areas which consist of Shareholder rights, Role of institutional investors, The board’s role in governance, Disclosure and transparency, Role of gatekeepers and influencers and ... .1The development of Corporate Governance in Malaysia Corporate governance has come a long way mainly due to market impacting factors such as corporate failures, corporate losses, scandals ...
Roell: There are two things that drove the policy principles. A, the scandals. Why were no appropriate steps taken? Current concern: effective implementation and enforcement of guidelines Will new regulatory frameworks be effective or just add to companies of doing business? The policy concern is the scandals: financial disclosure, audit integrity and excessive remuneration (especially for termination of contracts rewarding failure as in UK or France).
Why were no appropriate steps taken before? Market driven efforts to reestablish confidence included the inclusion of stock options as expense in income statements; use of pension funds and brokerage firms with well codified ethical standards; having institutional shareholders more energetic in voting rights; more audit committees scrutinizing non audit services by auditors. D&O insurers look more carefully at corporate governance before offering any contracts.
Long term changes in financial markets drive also interest in corporate governance policy. Relative decline in banking, the rapid rise of institutional investors, growth of savings for pensions and changing business circumstances are the contributors. The recent steps taken involve tight audit functions; increasing transparency and improving the role of the shareholder. Balance of legal changes / regulation /voluntary arrangements varied widely. The focus was to look at the board operation and its transparency.
The firms are voluntary to comply or explain regime but the monitoring was inadequate; less attention was paid to the role of shareholders; best practice too specific? New focus on shareholder rights includes making voting more meaningful and easier, protecting minority shareholders. Attention was put to the role of institutional investors and transparency of their voting policy Stakeholders: nearly all countries acknowledge their rights. The issues involve the enforcement of creditor rights (hard), pension claims security of current and past employers and whistle blower protection. Initiatives to improve disclosure and transparency include international controls and the role of board in approval; accounting standards; the integrity of the external audit process; financial information providers with possible conflicts of interest; nonfinancial disclosure. Operation of boards was the main priority so far. The dominant theme was to get more directors independent of management and large shareholders.
The Research paper on The only legitimate objective of any firm is Maximization of Shareholder Wealth
... performing companies attract new investors who invest money to become shareholders. These outside funds from investors are essential for growth ... on stakeholder preferences rather than maximizing value for shareholders of the firm. Companies have to find ways to attract ... N. (Autumn 2010). The Relation between Stakeholder Management, Firm Value, and CEO Compensation: A Test of Enlightened Value ...
More systematic recruiting and training; is this enough to control excessive remuneration? Zingales: Why was there so much focus on boards? Roell: I don’t know. Any one? McKinsey surveys: web to answer the question what emerging market players think. 44 professional investors, academics and policymakers were queried. Policymakers and investors agree that the changes in corporate governance in the recent years include enhanced disclosure and more equal treatment for shareholders. At a country level the focus was stronger on property rights and a pressure on corruption. Investors believe that the challenges include insolvency laws, the fiscal environment and credit information.
Policymakers on the other hand believe that the takeover market is important. Barriers to future success according to policymakers included concentrated ownership, poor enforcement, vested interests, cultural difficulties and inactive shareholders. Investors think that bad corporate governance affects the investment decision so that certain countries are avoided or face decreasing holdings. Investors would be willing to pay a premium for investment in well governed companies. Bolton: I just want to say that this is all cheap talk.
They don’t have to put their money where their mouth is. Stiglitz: How do they know if governance is good? Roell: They had list of things that capture good governance. They say things like, so many directors on the board, full disclosure… Stiglitz: Do they routinely look at that list and determine good governance? Is this really a top issue when you talk to a company or not? Or just talk to a manager they trust? Zingales: We ” re thinking about whether this lines up with the measure Alexander and I found… It lines up pretty well… Roell: Support a single global accountings standard but which one? US or international? Zingales: Everyone disagreed about naming it the American standard.
... rely on secured borrowing. 3. Key issues with Indian corporate bond market functioning The presence of corporate bond market in ... highly malformed debt market. The bond market is practically nonexistent in corporate financing. Forward-looking assessment is weak; even the biggest firms tend to ...
They don’t want to be colonized but will take the substance. Van Dyck: The footnote disclosure differs across countries. Why would institutional investors support expending stock options? The reason is that they fear small investors would be affected by that. Either the market is widely inefficient or small investors can be fooled and they don’t want that to happen. Institutional investors are unlikely to be the ones fooled and they would have a larger value of the stock. Stiglitz: Venture capitalists were strongly resistant.
Zingales: Reasoning has been so appallingly stupid as to be embarrassing. The incentive of venture capitalists is that they would unload their shares soon. Roell: Certainly in the OECD survey, there was a mention of stock options, and they said: we don’t care if it’s expense, we only care if it’s disclosed… Investor priorities include better disclosure, boards, performance related pay. They would like policymakers to strengthen shareholder rights, improve accounting standards and enforcement. Zingales: What is the bottom line of the McKinsey survey? Roell: The interesting thing is what policymakers mentioned about barriers to success – things that would stop them from reforming policy.
The usual suspects came out. Berglof: Why aren’t all of these improvements undertaken then? Von T hadden: Does this vary widely from what would be said [about corporate governance] in developed markets? Shoar: Something [should be said] about the [falling] culture of the board [and the greed]. Van Dyck: [And about the] decline in the standards of the accounting. Sudipto Bhattacharya India: a discussion of a paper by S. Douma, R.
George and R. Kabir Discussion of the Bombay Stock Exchange (5% of US market capitalization in 2000) regulations. Shareholding in India is restricted to 10% of firm capital per foreign institution, 24% altogether. FDI by nonfinancial corporations has kept increasing after the liberalization in 1991. In 1990 1991 it was $100 m but in 1999 2000 $2. 1 bn.
The Research paper on THE IMPORTANCE OF CORPORATE GOVERNANCE IN AN ORGANISATION, AND ITS IMPACT ON KEY STAKEHOLDERS
... to practice good corporate governance to effectively compete on the global market. This is being enforced through regulation such as: Companies code, 1963 (act ... Best Practices For Corporate Governance in Ghana” African Capital Markets Forum Publications, (December2002).Accra Annual Report and Accounts, 2008 Ghana Water Company Limited (2008 ...
The mergers and acquisitions law was liberalized in 1997. The licensing of entry was eased and import tariffs lowered. The question posed in the paper was about the impact of foreign ownership on performance. The innovations in methodology included the distinction between FDI vs. FII based share holdings.
Multiple performance measures the accounting ROA as well as Market Tobin’s q were considered. The problem was that different characteristics affected these measures not in the same way. The impact of owner managers and domestic institutions was studied. A distinction among domestic group and non group firms was made. A group was meant to be constituted by firms having common ownership control by a family with or without a holding company. Survey of 1000 firms in the year 1999-2000 was used.
If government ownership was > 50% then the company was excluded. Strong positive influence of foreign ownership on firm performance was found. Mixed evidence on impact of group or conglomerate affiliation The hypotheses tested were: 1) Foreign corporate ownership positively affects firm performance; 2) Foreign financial institution ownership positively associated only with q levels (they can pick better); 3) Domestic FI ownership negatively affects firm performance; 4) Domestic corporate ownership affects firm performance positively; 5) Ownership by owner managers positively affects firm performance; 6) Group affiliation negatively affects firm performance. Empirical findings: ROA improved by FDI shareholdings by 1. 3 pp with 10% of shares holdings; ROA was insignificantly improved by FII, however; Q ratio significantly improved by FDI shares; ROA significantly improved by FII shares with estimate coefficient 5. 5 times of FDI; ROA but not the q ratio significantly related to size; Size and FII ownership correlated (0.
28); Domestic financial institutions significantly affect ROA in the negative, but do not affect the q ratio; Group affiliation dummy is negatively related to ROA and q ratios; Domestic corporate (non group) share holding positively affects ROA; Stiglitz: Are the authors looking at them before they bought and after they bought? Zingales: How do you make sure it’s not a selection bias? Foreigners only invest in best firms… Stiglitz: Same study in the Czech Republic was conducted but it was all selection bias. Just the opposite if you look at change. Bhattacharya: This should bring us to the issue of what issues make the capturing of private benefits? Without further proof, it’s not clear if you want to attribute ownership in a dichotomous way to these variables [used in the paper]. Act of 1956: discourages holding companies Van Dyck: Did it reduce the pyramiding of holding companies? Less hierarchical in inter corporate world Explanations offered: There is a positive impact of FII on the q ratio due to stock picking and demonstration effects on investors not solely due to FII holding and size correlation which is similar for domestic fi shared holders ing; q and fit holding equally so The negative impact of domestic FI holdings on ROA and q ascribed to public sector nature of these intermediaries and associated with lack of incentives. Negative impact of group affiliation on ROA is attributed to diversification cum lack of firm level transparency, cross subsidies in internal capital markets and consumption of private benefits at the expense of the minority shareholders Problems with the presented methodology: Much of the FII in the studied year (2000) concentrated in the new economy which performed spectacularly in the stock market over 1998-2000.
FDI holding variable inappropriately measured. Scope for private benefits extraction less for non group domestic corporate shareholders? Some groups such as Reliance and TATA have enviable group wide professional management. Domestic FIs often are forced to carry on sick units – high correlation of holdings with firm age which is negatively correlated with q but positively with ROA. Bolton: In this paper and more broadly, what can we say in India about the link between corporate governance and FDI/FII? Bhattacharya: I believe there is something to the story that FDI improves performance. FDI tends to be concentrated in more competitive sectors.
Bolton: One of the reasons there was so little FDI was because… Bhattacharya: The legal system is slow but it basically delivers. Skeel: If you don’t have investor protection, you might want a larger stake to go in. Berglof: What is the legal structure? Is there a lot of variation for how courts work in India? When we say that they have a good well functioning legal system for the Bombay exchange, is that state or federal? Bhattacharya: Securities regulation is almost completely federal.
Schoar: But they have never prosecuted anyone. They have all these regulations in place, but they ” ve never brought anyone to court. Bhattacharya: It is a question of whether the prosecution is ever concluded. They did prosecute a former prime minister… Van Dyck: But it takes the court system 20 years to come to final judgments.
Why are private benefits so low when enforcement is slow? Bhattacharya: No, I don’t think they ” re low. ROA is reduced by 4. 5% if we have a 30% group holding. Thus it seems to be concentrated much more with group companies.
This is consistent with a legal system that is slow but not completely ineffective. It cannot prevent within group transfers. Van Dyck: What other penalties exist? Reputation al penalties? Publicizing scandals, also through the web? Bhattacharya: They are not very important. Spiegel: I think foreigners are just buying expensive stocks. There was no time series in this analysis.
Van Dyck: From other studies we know that foreigners are good for changes in ROA. Time series evidence is that their presence led to improvement. Schoar: But it is very risky. From developing capital flows are so volatile. Berglof: The conventional wisdom is that there is a large difference but we don’t really find that. Over the 10 year period, there was a tremendous change in FDI.
Michalski: Nature of FDI itself is also important. Spiegel: A lot of FDI was mergers and acquisition money. Sergei Guriev: Corporate governance in Russia Relevant features of the Russian case: mass privatization, weak judiciary system market based vs. bank based system: neither 2001-2003 corporate governance is rapidly improving, along with increasing concentration of ownership two universes: listed and non listed firms Stock market: market cap/GDP = 42% exactly at the cross country trend given the GDP per capita 80% of the valuation are oil and gas, electricity firms, to a lesser extent pulp and forests, regional telecoms A very small share of market capitalization is in free float Daily volumes are about 10 20 million formally 240 companies are listed but only 30 are traded regularly and only 10 of them every day high uncertainty to due restructuring of the electricity monopoly total number of non privatization IPO’s: 4 serious financing efforts for listing abroad rapidly growing bond market Van Dyck: How much of that 42% is in oil and gas companies? Guriev: 90%, also these are regional telecoms. Listed firms, description.
From a study by Boone and Radio nov 2002. 1995 1996 the “loans for shares” programs were in place, where the oligarchs could buy a company even at 3% of their value. The winners of the auctions were the guys who ran the auctions. 1997 2000 the expropriation / dilution of state and other outsiders took place. Consolidation of ownership happened with the major shareholder controlling a 60 90% stake.
After this, there was an incentive in 2001 2003 to improve corporate governance (increasing transparency, boards etc. ) and allow for growth in market capitalization and liquidity. Zingales: How many of the voucher privatization companies are traded today? Guriev: Pretty much none, and I’ll talk about them. Zingales: So why are none of those traded? Guriev: Privatization pretty much went through insiders, directors and workers pretty much got the shares. These are medium-sized companies, and the stock market doesn’t really reach out to medium-sized companies. There are exceptions…
Shoar: I thought one of the problems is that workers sold their vouchers at huge discounts. Bolton: This was all predictable… What they did in the Czech Republic, they sold vouchers, for a nominal fee, and no one came out and bought them. Then, the Harvard Fund came in and said we ” ll pay 10 times more when you ” re allowed to resell them, and that brought people in. That saved the voucher program. Why is corporate governance improving? Access to global capital market? Why now when the oil price is so high? One can use cash to buy industrial assets at bargain price (the oligarchs have a comparative advantage over others of doing so).
Why investors believe that current corporate governance improvement is irreversible? Many are optimistic about shareholder activism. Why some oligarchs are still grabbing assets (“squeezing” shares so that the old shareholders are unable to lay out cash to buy new issues at the margin) while others are already restructuring the assets and improving corporate governance? Incentives for value maximization and for sharing the value pro rata: If there is a weak government, then corporate governance can only be based on incentives for controlling shareholders (corporate governance codes are strictly voluntary; corporate governance provides an exit strategy for controlling shareholders: value maximization and sharing the value with outsiders are complementary, the goals are internal restructuring and then sale to foreigners; hence improved corporate governance).
Anecdotal evidence points that improvement of outside investor protection is correlated with high TFP. Controlling shareholders’ incentives are undermined by insecure property rights – there is a wide view of illegitimacy of privatization (the median voter supports expropriation).
In order to protect property the oligarchs want to invest in the political process and bring in foreign investors. 77% of Russians believe oligarchs should be prosecuted.
Therefore an improved corporate governance offers an exit strategy. Van Dyck: Are they buying parties or just individual politicians? Guriev: They buy both. They buy parties, and actually put managers on the party lists. Sometimes, they run really high up on the party list. So this story can actually imply, the better corporate governance, the higher the market carries them. Schoar: In a way your story says that because your market capitalization is high now, they need to get good corporate governance now.
Guriev: Yes, but corporate governance also leads to improvements in the exit option. It is very hard to distinguish these two stories. There are huge returns to corporate governance improvements especially among disperse ly owned firms and state owned ones. Still important part of the economy is outside the stock market (non listed companies 80-90% of employment).
Ongoing tunneling and asset stripping, especially in favor of the top or middle management. Attempts of the federal government to re appropriate fail.
Huge internal arise relative to private / consolidated counterparts. What happens in non listed firms? Dearth of investment – cyclical growth is over; Lack of cash; Formally incorporated but not listed or not traded; Mass privatization legacies – substantial ownership dispersion. Corporate governance in non listed firms is out of conventional corporate governance mechanisms. Ownership concentration where there is no market for corporate control. Corporate governance depends on ownership structure Van Dyck: Do you also mean bankruptcy? Guriev: Yes, but less so in recent years. Now they know bankruptcy is too risky so you’d better get shares and become an equity owner.
Corporate control market in Russia Takeovers from red directors by more efficient owners. Who are the bidders? There is no financial intermediation, FDI are not welcome, resource exporters invest cash flows (oligarchs are the real buyers).
Effect of regulation: corruption converts regulatory barriers into pecuniary costs; politically connected Stakeholders play a role – labor is not unionized but regional governors import “corporate citizenship”; this is because of segmented labor markets. Vertical integration: lack of competition in upstream and downstream markets. You need to buy out your own suppliers; otherwise you might be denied supplies by competitors. Zingales: Where there is no government, there is more need for authority.
There should be anti trust regulation. Skeel: What is the threat where companies control regional governments? Why do they give in to labor in that context? Guriev: The public outrage is not violent, but there have been cases where you buy a company and you physically cannot enter your office. It’s physical. Now it’s more efficient, but the threat is always there. Berglof: Also, I was there this summer.
There was an advertisement campaign in Moscow, and there was a perfectly groomed hand in handcuffs, and it said all the privatizations should be returned. 2002 survey findings: ownership of Russian industrial firms is concentrated but minority shareholders are still present corporate governance varies significantly across firms ownership concentration Corporate governance is a device to protect yourself from takeovers. You want to make sure outside shareholders know their shares are not worthless so they won’t sell to a very low bidder. Most firms finance investments out of internal funds. Ownership concentration has a positive effect on investment.
The corporate governance effect on investment is insignificant on average but increasing with minority shareholders’s take. There is a low awareness of the code of corporate conduct. Van Dyck: If you ” re selling a 10% stake, how is that done? Through intermediaries? Guriev: Yes, there are investment funds in Moscow. For unlisted companies, it would involve the regional government, local mafia bosses and the federal government.
So, the interesting part is that even without liquid markets, without good courts and regulators, there is corporate governance. There are many anti-takeover devices, but people circumvent them. Many people understand now that if you pay cash, your property rights will be more legitimate. The concentration of ownership has lots of market failures within that. The only people who have cash are the people who sell oil and aluminum in global markets, so ownership becomes concentrated.
The “Who owns Russia project”: in the absence of financial markets and FDI, who controls Russia? 25 groups of owners. China: Wei Xiong: Corporate Governance in China in Public Firms The basic structure of a listed firm the state, investors, manager. 3 types of shares: state shares, non tradable, held by central and local government legal person shares, non tradable held by domestic institutions such as industrial enterprises, , securities firms tradable shares domestic and foreign investors Each of these account for 1/3 of all shares. 95% of listed shares is directly or indirectly in state control. 47%, non tradable shares accounted for 70 90% of all shares 41%, non tradable shares accounted for 50 69%In only 8% of cases tradable shares represent more than 50% of total shares of a company. Ownership is relatively highly concentrated few have contestable control.
Board of directors state has absolute control Manager vs. the state: state as the controlling shareholder: the problem in China is efficiency rather than stealing as in Russia. Government can exert power over many appointments and incentives and thereby over company behavior. Most corporate managers still aspire for a civil rank and are judged by their superiors in the political and administrative hierarchy based on profits, political correctness and discharge of social obligations. Local governments have incentives not aligned with the plans of companies that operate on national or international scale. Conflict between listed firms and parent companies (often are in the same business sector and may compete with each other, have business transactions with each other or share resources and functions).
Corporate control mechanisms and shareholder activism can do little to alleviate such agency problems under the existing ownership structure. Schoar: Is it fair to say that the problem is one of efficiency? Sergei described the stealing problem. Does a strong government prevent the stealing problem? Bai: There is some stealing between the parent companies and distant companies. Bolton: But not managers stealing for themselves? Bai: Parent companies taking advantage. For example, the sales and personnel departments are often the same. Guriev: How do local governments affect decisions? Xiong: The managers are appointed by regional government.
These companies are really governed by state. It is very difficult to think about investors’ protection with the ownership structure as it is. Pistor: But we have much more turnover and much more trading than in Russia. Xiong: The behavior in the stock market is very different from Russia. The role of stock markets: an efficient market rewards better corporate governance. The listing process is strictly controlled by the state with tight quotas; listing is viewed as a privilege and a fundraising mechanism for ailing SOE’s.
So not necessarily the better companies are listed as in “normal” markets. Investors believe that they are protected, since either the government is likely to provide direct support or the firm will find a “white knight”; market participants have little incentive to care for the firm fundamentals, including corporate governance. Van Dyck: But the other option is to put funds into bank with 0% interest so they ” re looking effectively for any investment instrument. Xiong: Yes, this is important as well. There are quotas on how many IPOs can be done in a year, the privileges of listing are given out during party meetings. Even if you cannot get an IPO, you can buy out a listed company and use it as a shell.
There has never been a bankruptcy in the last 10 years. Schoar: But there’s huge volatility. Somebody must be losing money. Xiong: Foreign and domestic investors trade separately. Speculative trading is an important determinant of “A” share prices that is available to domestic buyers in Shanghai and Shenzhen. “B” shares are traded by foreigners in foreign currency only.
“H” shares in Hong Kong. The relative valuation of A/B shares was recently studied. The “A” shares have a 500% of turnover to value while the “B” shares only 120%. Share turnovers can explain 25% of cross-sectional deviation of A-B shares premium after controlling for other fundamental / liquidity factors. Governance is totally unimportant so stock market is basically a casino (however, no short sales are legally possible).
Institutional investors have a very small presence (5%), mostly individuals trade.
Insurance companies can only buy mutual funds and have only 9% of their assets in stocks. Only recently have open-end funds have been allowed to trade. The valuation is not really based about fundamentals. Delisting would never happen b / c local government wouldn’t let it happen. They would grant tax rebates etc.
before that happened. Van Dyck: What about CRSC – the stock regulator commission? How important are they? Xiong: The listing process it self is very political. Bai: For a company to get listed an approval from CRSC is needed but it is basically determined on the regional level. From 1997 to 2002 the CSRC has taken 200+ actions against companies. As for mass litigation / class actions suits – the government has dismissed these as incompetent – but they are now revisiting. The listing process is not market determined.
Managerial compensation and stock performance: it is impractical to tie compensation with performance due to the speculative nature of prices: there is a small float but high volatility de listing is not very possible nobody went bankrupt IPO prices are fixed at low levels. No necessity for analysts. Market for corporate control: successful hostile takeovers are unlikely Hundreds of mergers and acquisitions did take place each year – transfer of non tradable “A” shares through private agreements; largest shareholder in 28% of listed firms has changed since IPO Reason for M&A: sell assets to meet profit targets set by government or to generate exceptional gains to meet the 10% return on equity required to issue new shares, forced asset foreclosure when debtors cannot repay The number of M/A’s too small for consolidations to be possible. Bai: 1978-1992: incentive contracts within the firm. From planning to semi-autonomy. Incentive contracts based on profit, sales or investment.
Was not effective, because it was hard to measure performance, the incentives were too weak, not credible (when the performance was bad, the managers were not penalized).
Diversion of assets to private firms also occurred. 1992: ownership changes First wave of privatization: selling firm to employees. The effects: employee job security, high decision making cost, little control over manager. Only one candidate for a manager was voted on. Employees could sell their shares to insiders only (illiquid assets).
Employee-owned firms paid out a lot of dividends. When a foreign company wanted to buy out such a company, it had to deal about employment contracts. Second wave: selling the firms to managers. There were liquidity constraint; land use right often not sold together (a lot of assets could not be used for collateral in the future); expropriation; managerial entrenchment; no competition. Selling to outside investors recently: poor protection of creditor and employee interests restrictions on private equity funds (limited partnership restricted by law; restriction on type of securities; venture capital is viewed exclusive as a tool to fund high tech startups; limited means of exit) restrictions on foreign investors have been relaxed large firms as investors Why privatize? government wants to get rid of burdens surplus workers (that way government won’t have to pay for these workers) improve performance increase competition increase openness (FDI/exports) Banks play very little role in corporate governance: policy loans weak protection of creditor rights weak debt covenants little say in liquidation process little info sharing about credit worthiness of borrowers (forced to do so now, but are not very cooperative poor governance of banks themselves Sources of financing of non-listed firms: FDI (20-30%) Township-village enterprises (10-15%) Leakage from SOEs Informal credit market (coastal region) Equity from big firms Corporate governance and firm valuation (listed firms): correlations with q, market price/BV: concentration of 2-9 large shareholders positive cross listing in HK, NY positive largest shareholder being the sate negative CEO being chair of board negative other factors not significant: outside directors, managerial incentives, parent company Market for corporate control When a company lost money in the last 2 years it is labeled “special treatment.” It is subject to certain restrictions: it needs to issue quarterly reports; daily volatility cannot be more than 5%.
If they don’t improve after two years, they will be de listed. But the local government won’t let that happen and will find other companies to become the largest shareholder. Find other “saviors” and ask how much they can contribute to firm; contribute certain assets and get control rights. More than 50% of such firms had their investors changed within the two next years after receiving the status. Policy issues: state shares political economy of regulation institutional investors shareholder activism Small shareholders do not support the CSRC. The CSRC is very unpopular with people when it moves to enforce government rules.
Government doesn’t want share prices to go up too sharply – because then the cost to bailout companies becomes much higher. The view is that when price starts to burst the government has to step in. Right now, the only loser is the government. South Korea: Antoinette Schoar ” Does corporate governance affect firm value?” Corporate governance and performance in Korea Use specific regulatory environment to identify the role of governance.
Who benefits from better governance? How to measure the corporate governance effect on performance? Firms that have a higher governance index have higher performance. The index construction follows an outline that is very informed by the debate in the US. The items considered are shareholder rights, board of directors, outside directors, auditors, disclosure to investors. What is the link between governance and performance? An improvement in governance causes better performance. Good firms tend to have good governance systems in place: omitted variable bias these firms have unobservable higher quality and thus they do everything right; signaling good firms put good governance in place to signal their higher quality to the outside market (instrumental for firm in fundraising).
They might want to look like a US firm.
Governance requirements vary for small and large firms Firms with book value of assets above 2 trillion KRW need to have more than 50% outside directors on the board; establish independent audit and nomination committees. Firms below 2 trillion KRW need to have 25% outside directors on board; and do not need to establish independent committees The size distribution of firms: Size affects performance not only through changes in governance (firms are larger b / c they are better on potentially many unobservable dimensions. The threshold is, however, exogenous. We can use firms only of the size around KRW 2 trillion as in regression discontinuity analysis. If firms are right around the threshold, and they can manipulate their book value, can we observe a peak in the size distribution just above or below 2 trillion? Perhaps firms try to stay smaller artificially to prevent disclosure. You would expect a bump just before 2 trillion.
Interaction of what companies think about governance Why do in Korea oppose more governance reforms if good governance leads to higher performance? Redistribution from large to minority shareholders? Insiders lose private benefits of control Fear of taxation and greater regulation? Union bargaining? Entrenchment of existing capitalHasung Yang: overall corporate governance structure in Korea The corporate governance issue was brought into attention only after 1997 crisis. Before that there was no public debate. After the crisis the government introduced regulation and structures new to the market. Series of bankruptcies of large companies also contributed to new view of corporate governance. It was felt that many numbers that were given by the companies were unreliable. Opening of capital market to foreign investors also helped.
Before, only up to 14% of the stock could be owned by outsiders. As an example, after the opening 60% of Samsung shares were held by foreign investors with the price going 10 times up. The unique feature of Korea is shareholder activism that has increased since 1997. Groups of civil activists – mostly lawyers and accountants targeted leading Korean companies that dealt badly with minority shareholders. Limited legal cases but strong enough to send clear signals to management and the controlling families. Bolton: These are important changes.
Has there been a change in the direction of breaking up the? In terms of reducing their size? Diversification? Yang: The government agency called the fair trade commission which regulates these conglomerates. There has been a consistent effort by government to shake up these groups. But it was not successful. Stiglitz: They did pass law restricting cross holdings. But government actually did not actually weaken the big companies – just moved things around. Due to IMF policies, interest rates increased, which actually helped such as Samsung to bolster their market dominance more than before.
In fact, regulation has made them less transparent in places! Yang: Market dominance is stronger than before. They are creating more circuitous liaisons. And are less transparent now. Zingales: But did not the 1997 crisis happen b / c of failure of corporate governance? Has it been proven, and if so, then on what basis? Stiglitz: No! Yang: I don’t think it initiated the crisis but since the sector was very weak and not strong enough to register shocks, the big ones got the first hit. Poor corporate governance contributed to speeding up the magnitude of the crisis. Stiglitz: The price of chips also had an effect.
High debt / equity ratios helped. It was a natural consequence of a government running the banking system as a lender with cyclical banking. That role of banks reversed in this crisis The role of banks was reversed in this crisis, and it is fair to say that big firms misjudged the rules of the game. In terms of standard corporate governance problems, Korean firms are not standard. They were so majority-controlled that the majority wasn’t ripping off minority… If Samsung would own all the shares they would make the same mistake.
The perception was there that size matters. Zingales: I disagree. Stiglitz: Weren’t the central problems responsible? Yang: The fundamental problem was ownership. Control 40% on average. Banks weren’t functioning in terms of properly lending money. During the crisis, big companies are forced to come to the financial market.
Stiglitz: Overall investment wasn’t terrible. Evidence shows that resources were well allocated, with the possible exception of Samsung, which made too many cars. Plus, firms had very high savings rates. Zingales: Was there over investment? Bolton: There was over investment and problems with corporate governance. This is a link sometimes drawn with the US crisis. Equally one could say there was over investment because people got carried away believing in dreams.
Like with NASDAQ, the “new economy”, despite warnings that the stock exchange was overvalued… Stiglitz: But you can say there was more of an element of corporate governance [in the US] because of stock options. Stock options gave firms a built-in incentive to misrepresent numbers – MCI Worldcom’s accounting was distorted so that the CEO could make more money. Distorted numbers misled investors. Just to have Embers making money. Schoar: The Neuer Markt in Germany was actually a model of corporate governance…
Yang: Price earning ratio across the country – Korea always came last even among emerging market countries. Some companies had a stock market value lower than their cash. One of the financial firms tried to take control of a failed firm, SK. Net asset value was three times the market capitalization, and SK Telecom alone was twice the market capitalization. Schoar: So there is no market for corporate control? Is that something these big families have lobbied for? Yang: Cash value is not the concern. Size is important and they don’t want to lose control.
Stiglitz: Most resistant to class action suit reform. They looked at US and were worried that would happen. They did not want cumulative voting either – they just didn’t want minority shareholders to get large votes. Yang: Cumulative voting we got but at last moment they inserted one condition. Over 70% have opted out of cumulative voting. Pistor: Are shareholder activists a way around this problem? Yang: The resources of activists are limited and they have very little practical means to bring changes.
Stiglitz: But there is now more focus on corporate governance in Korea than anywhere else. Van Dyck: Aren’t there also more minority shareholders? Stiglitz: Also the resistance has to do with rhetoric. There was a pressure from the IMF for the fire-sale of assets. It all got mixed in with nationalism and rightly so in some ways.
Van Dyck and Zingales Why do we have corporate governance? There is a role for authority even in a market economy How is that authority created and allocated? Corporate governance answers these questions, related to the boundaries of firms. Property rights might not be well defined. Lets start thinking about corporate governance in terms of fostering human capital investment. Schleifer and Vishnu 1997: Corporate governance is about how suppliers of finance protect themselves.
Becht/Bolton/Roell: Concerned with the resolution of collective action problems among dispersed investors Zingales: CG is ex-post bargaining over quasi-rents generated by a firm. What are the welfare implications? CG fosters more investment in general and in human capital specifically. It minimizes inefficiency. Stiglitz: The multiple stakeholder view of corporate governance is very useful. Becht/Bolton/Roell: Mechanisms: the board, takeovers, block holders’ monitoring, incentive contracts, fiduciary duties / shareholders suits Shortcomings: Who monitors the monitors? Who designs the contracts? Heavily rely on courts.
Missing elements: emphasis on the role of contracts / law and not enough on other institutional constraints; Product market competition: reduces the need for corporate governance, reduces the cost of corporate governance inefficiencies. Reputation: Why has Grasso been forced to resign? Why do business schools respond to “Business Week”? To function it needs reliable disclosure and effective dissemination; Role of taxes: the state is de facto the largest minority shareholder in almost all corporations. The way it exercises its rights has an effect on the value of other minority claims (think about punishment for corrupted managers in China).
Developing countries characteristics: Low income per capita: issue of how much is invested is more important than where to invest (comment from the audience: but still marginal returns should count – there is an opportunity of allocating funds in a bad sector); Low institutional development: courts slow and corrupt; lack of fair competition; Low social capital development: different social norms; lack of trust; lack of reliable institutions; Less functioning democracy. Bolton: Why don’t we put a legal system like America’s in the Congo for example? Will you get back your investment? Zingales: Yes, you would. I don’t know why we can’t do it.
Doesn’t it pay to have a functioning legal system? Bolton: Central question: why isn’t this taking place? Pistor: But we don’t know how to do it also. It’s creating both demand and supply and agreeing that legal framework is now the dominant order in place. Bolton: Legal protections are very important in creating an environment. Can development aid be channeled into legal infrastructure? How do you do it? How do you enforce? Pistor: Some experience in free economic zones but devoid of rest of political system. Extremely hard. Export processing zones (Eps) have their own dispute settlement mechanisms.
And in Bosnia and Croatia, the courts are fully protected by Americans. Zingales: Functioning democracy: no political will to make it work. Corporate governance in developing countries More about how to get the money than how to invest it More concerned with stealing than mismanagement; Competition and legal system is of little help Can reputation work? Then we need disclosure, reliable dissemination, some form of punishment (legal, social) Can developing countries do it alone? Public disclosure: may be Reliable dissemination: no Punishment: neither either legal nor social Importance of capital mobility: When developing countries need to attract foreign capital then they care about reputation of foreign investors. For these investors there are institutions that diffuse information reliably. With more disclosure developing countries can piggyback on developed countries social institutions to achieve better corporate governance. Problem: cultural colonialism.
Pistor: Doesn’t that assume that foreign investors still behave like American investor in America? This relates to the Kaufman paper: “Far Away from Home.” Guriev: But they pay taxes. Berglof: The evidence is that there is no difference between local and foreign companies. They take all local standards and don’t bring anything along. Guriev: But when the US makes bribery illegal, then US firms shape up. Berglof: If you are very severely punished at home then it makes somewhat of a difference. Bhattacharya: Even in developing countries where norms differ, there are still elites who care about maintenance of local norms, since they feel threatened by international legal intervention.
Using the elites to strengthen movements. Should we emphasize that more? Rather than just relying on foreign investors? Political elites should coordinate. Bolton: OECD principles can be seen as initiative in that direction. The effort was led by Larry Summers, who chose to do it through OECD and not through the US Treasury. A contingent of US lawyers pushed US-style principles of CG, but Germany and Sweden blocked it. (Enactment requires unanimous support.
) Pistor: But there is no evidence that the OECD principles really make a difference. Is any company putting them into action? I’m not sure that harmonizing at the international level will have any real impact. Van Dyck: But there are reputation motives. International press is an effective mechanism in affecting the actions of business elites in developing countries to invoke reputation al penalties. Need these to work very effectively when there are no courts, etc. so that this is an instrument that will affect actions.
Some people always care about how they will be perceived. For example: Putin. Bhattacharya: In India, there are a lot of people that care in the local area. Should be used in broader context. Zingales: There is a much larger system of accountability, since international reputation also affects political elites (i. e.
friends of the US and to IFIs).
Schoar: Germany chancellor won because of an Anti-American stance. For very big cases Dyck is correct – it is very effective but you couldn’t have had little companies appear in the front page of the WSJ. The attention span of public is only for large companies. Not a fine grained mechanism. Zingales: Yes, but it can trickle down to some extent.
Yang: In East Asia there is sensitivity about these issues at government level. Van Dyck: When you do activist campaigns, do you embarrass specific people? Yang: Yes, in front of an international audience. Van Dyck: Even if there are high-profile individual cases, it still depends on whether there will be a spill-over effect that encourages politicians to enact legislation affecting everyone (like a public hanging).
For Khodorkovsky, a listing on NYSE or corporate governance is a commitment device to have accountability. Bai: Source of foreign investment can affect media you pay attention to.
Example: Hong Kong and Taiwan newspapers are important in China. Role played by taxes: Lack of verifiable information makes corporate governance problem worse. Incentives are determined by the tax system affect the degree of verifiability: higher taxes, more incentive to hide. 1909 1% corporate excise tax which was well enforced caused accounting law to be enforced.
Political economy: in a low functioning or not functioning democracy the political economy of reforms is more difficult. There is a higher overlap between business and politicians. There is an importance of capital mobility to promote reforms. Bolton: Word of caution. But the countries we looked at today – maybe Russia fits the bill but others don’t. Zingales: There is more business elite capture of political power in developing countries.
Spiegel: But what about recent events in the US? Are they not an indicator of business power within the political process here? Zingales: Developing countries have a high degree of overlap between business elites and political elites. (see study by Marla Fach a) Pistor: Just look at the percentage of total jobs that reside in the public sector. Spiegel: These reforms are not being pushed on developed countries, since they went through these reforms already. It suffices to say that political economy matters in developing countries, not so much that it matters more or less than in developed countries. Schoar: It is important to know if democracy promotes change. Autocratic systems administer change: for example Chile.
Democracy is slower, but it seems to work better. Zingales: If you pick the right leader it’s good but on an ex ante basis you don’t know that. Pistor: The data is inconclusive on short-term vs. long-term leadership. Van Dyck: Are we overemphasizing the importance of reputation mechanisms? Yang: Corporate governance and transparency. Activists are definitely a strong force in South Korea.
Big families are also fearful of them in Hong Kong. They control the major media, but there are still independent and alternative media. If the story gets big enough, the “” have to run the story. Schoar: If you think reputation is such an important mechanism, how does it work? What hurts you when reputation is hurt? Bai: The biggest fear of the Chinese government is mass protest.
It is a big constraint on the government. They do not want to shoot at people. Guriev: I talked to top Koreans but they said lots of changes had happened since 1997 because the government felt public outrage against conglomerates. Russians didn’t insist on change though. The political economy is different. Van Dyck: Is reputation a substitute or a complement? The presence of the law allows newspapers to report on a lawsuit, even if the law will not be enforced.
This triggers existing institutions to do their jobs better. Individuals who care about their reputations do not want to be on the cover of Fortune and Business Week… The media can be a straight jacket. Yang: If there is a reasonably clear violation of law or regulation, as well as a public outcry, it will affect the reputation of the regulator, the prosecutor, and the government (in addition to the accused business leader).
There is also a cultural dimension, since smeared reputation can hurt family prospects. Powerful families will review newspapers the night before, and the accused will sometimes bribe the paper not to publish the story.
Zingales: Swiss bankers refused to do business with the Russian oligarchs. It must be bad if you have the money but you cannot use it! Erik Berglof: Millennium challenge account Development aid and corporate governance. Innovative way to allocate foreign aid by applying objective measure of performance incorporating a composite measure of governing justly (providing the rule of law – World Bank Institute indicator), investing in people, promoting economic freedom (regulatory quality, days to start a business – World Bank Institute, Freedom House) Better performer would have to score above the median on half of the indicators in each of the 3 policy areas. Since scores are correlated with income, separate competitions will be run for countries with different income thresholds.
World Bank and IMF adopted OECD guidelines. Used in country assessments: Report on Observance of Standards and Codes. Some issues: What are the correct institutions? Fine tuning may be secondary to enforcement – but could it be useful? Institution building vs. transplantation? Looking for the wrong institutions? (too narrow view on what is important – if you go to Mobutu, should it matter how many days it takes to start a business? ) In implementation of these policies, how well is it going to work in practice? Ex.
Russia looks great on books but clearly is not, China looks bad but has a better corporate governance environment (severe punishment for disclosed wrongdoers) Bolton: Why is Russia not fulfilling performance criteria? How well do these criteria hold up in practice? It is something for this task force to look at. Bhattacharya: Why cannot corporate governance be a part of a multilateral forum like trade is? Labor solutions are also wanting (child labor).
Should there be a link of corporate governance to WTO? WTO is trying to discipline, f. ex. bankruptcy and bank regulation. Spiegel: But this is dangerous, could become another political platform to ignore developing countries concerns and push through one version of corporate governance.
Could be a mistake just like capital liberalization. There could be a tremendous pressure – with competition banks need to have cleaned balance sheets. Russia delayed WTO membership because there would be more outward competition for assets. Schoar: What are the limitations of competitive forces? Russia: there was a big blow to “capitalism” because of the mass privatization failure.
There is a conflict between liberal values (private property rights) and democratic values in Russia. Privatization was illegitimate from the median voter point of view. Pistor: External conditionalities undermine democracy. Privatization of 1990 s is still haunting us today. Berglof: This is true but in the EU accession that is less the case.
Pistor: Environmental agenda undermined by new criteria of the EU; damage happened by imposing them from outside. There was a take it or leave it approach. Bolton: Move in IMF towards people’s own agenda because conditionality shot them in the foot. Yang: Imposed conditionality is like invading armies. In Korea, World Bank invited local experts to give advice whereas IMF did not.
Bhattacharya: I mean why WTO is not as bad. Trade has a more bilateral aspect to it. Van Dyck: We need to look at both conditions and outcome. We need to check to see if there really is high correlation between these institutions and good outcomes (ie.
Bolton: We are building a policy on current knowledge about corporate governance but knowledge is evolving very fast and what’s the updating procedure for these policies? How do we adapt and update them? In 20 years it might be a total failure. The McKinsey survey used the US model of corporate governance: disclosure, board members, etc. Van Dyck: The Malaysia study showed that investors are very concerned about press and regulatory pressures, but they do not come up so much in the US. Bhattacharya: Formal interaction with NGOs could be helpful.
Political legitimacy as well. There could be more interactions between the World Bank and the IMF. US firms are very adept at incorporating local culture into marketing, so why not into corporate governance? Pistor: The American model came out of competition at the state level and here we are thinking this is going to come about from harmonization. Does that really makes sense? Bolton: What do we want to see unified? And what do we want to see done at the local level? Bhattacharya: There is a learning process involved in perceiving the trade offs of different regulatory regimes. There could be an “infant industry” argument used for countries to protect their companies. Pistor: It looks like countries don’t keep transplanted institutions well.
There is little evolution and I think that indicates that they aren’t really used. Just imposing these laws doesn’t mean it’s going to really stick. Next steps: Another meeting with full group where we prepare concrete agenda on what sort of report we want to write Circulate that in terms of next meeting Next meeting in January / early spring.