Lecture 4 and 5
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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
Advantages of Good Corporate Governance
Benefits from corporate 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”
The Role of Stakeholders
•
•
–
–
–
–
–
–
–
•
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
• 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
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
– Banks have very large shareholdings in major corporations
•
•
•
•
•
•
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
– US, UK, Canada, Australia, New Zealand
– Shareholder value maximization
–
–
–
•
•
•
•
•
•
•
“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?
Compare between corporate governance in developed and developing countries?
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
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
Advantages of Good Corporate Governance
Benefits from corporate 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”
The Role of Stakeholders
•
•
–
–
–
–
–
–
–
•
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
• 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
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
– Banks have very large shareholdings in major corporations
•
•
•
•
•
•
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
– US, UK, Canada, Australia, New Zealand
– Shareholder value maximization
–
–
–
•
•
•
•
•
•
•
“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?
Compare between corporate governance in developed and developing countries?