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Corporate Governance_

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									Disclosure, Corporate Governance, Competitiveness and SME Access to Finance
For Discussion at the

USAID
“Competitiveness, Anti-Corruption and Corporate Governance Conference” Budapest Marriott Hotel, March 26-28, 2002
Demir Yener, PhD. Senior Financial Sector Advisor, Corporate Governance Team Leader Office of Market Transition, USAID, Washington, D.C.

Role of Disclosure in Corporate Governance
“If investors are not confident with the level of disclosure, capital will flow elsewhere..”
Arthur Levitt, Former Chairman of US SEC

March 2002

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Purpose of the Presentation
• Discuss the term “Corporate Governance,” its implications on SME development, competitiveness and access to finance. • Discuss the economic rationale for why corporate governance is important, and its relationship with disclosure, corporate performance, economic growth, and industry structure. • Emerging international standards of effective corporate governance practices and rationale • Discuss policy conclusions.
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The Working Definition of Corporate Governance
• One of the key elements of improving economic efficiency and competitiveness is through effective corporate governance practices. • Corporate Governance involves a set of relationships and the networks between a company’s management, its board of directors, its shareholders and stakeholders.
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The Set of Relationships that Makeup Corporate Governance
• Primary Stakeholders
– Shareholders – Boards of Directors/Managing Boards – Executive Management

• Other Stakeholders
– – – – – – – Managers Employees Customers Community Suppliers Financial Markets Environmentalists

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The Analytical Framework for Corporate Governance
• Governments have now recognized the strong correlation between sound macro-economic policies and microeconomic foundations. • Effective corporate governance practice is key to improving micro-economic efficiency (i.e. competitiveness) and provides the foundation for access to finance for all firms.

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Competitiveness Is…
Sustainable Growth in Productivity Driven by: •
• •

The Quality of Business Strategy and Operations
Quality of the Business Environment MACRO Economic Environment

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Micro/Macro Linkages are KEY

Source: Dr. James E. Austin, Managing in Developing Countries, 1990
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Macroeconomic Initiatives
• Monetary Policy • Fiscal Policy Inflation Under Control Effective tax policy; Budget Deficits Restrained Tariffs Coming Down Greater Convertibility

• Foreign Trade • Foreign Exchange

• But…private investment response is not automatic…
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Microeconomic Initiatives
• Privatization • Financial Sector Restructuring • Rule of Law, Commercial Law/Judicial Recourse/Arbitration • Anti-Corruption • Trade and Investment Promotion • Small Business Facilitation • Civil Service Reform • Education Reforms • Workforce Development
March 2002

• Industrial Parks/EPZs/ Knowledge Parks • Labor Laws, Practices and Mediation Mechanisms • Private Provision of Infrastructure • Standards Bureaus • Telecom, IT and E-commerce Readiness • Intellectual Property Rights • Efficient Provision of Key Services • Sector-Specific Initiatives
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Legal Form of the Firm
• The corporate nature of governance means that the process applies when an organization adopts the corporate form. • Essential Attributes of a Corporation:
– – – – Separate identity Limited liability Centralized management Ownership interests are freely transferable
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March 2002

Models of Corporate Governance
• “Principal-Agent” or the “Agency” issue:
– the separation between ownership and control.

• Shareholders vs. Stakeholders Model • Insiders vs. Outsiders Model • Lack of Consensus

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Shareholder Model
Public Companies • asymmetric information • align the interests of managers with owners • conflicts are between entrenched managers and weak, dispersed shareholders. Closely Held Firm • Ownership concentration is prevalent (family, holding, financial institutions) • CG problem is primarily about cross shareholdings, pyramids and other mechanisms used by dominant holders at the expense of minority shareholders.
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March 2002

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Stakeholder Model
• Shareholders are not the only ones who make investments in the firm. • Competitiveness and success of the firm is ultimately due to teamwork between a wide range of stakeholders such as investors, employees, creditors, suppliers.. • CG and economic performance will be affected by the relationships between these various stakeholders of the firm. • Given the potential consequences of CG for economic performance, corporations have responsibilities to parties beyond shareholders.
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Outsider vs. Insiders Model
• Outsider systems are characterized by widely dispersed ownership: Active equity markets (US, UK Models) • Insider systems are characterized by concentrated ownership: More banking oriented financial sector (Continental European models). • Legal frameworks do matter: Civil Law vs. Common Law. • Two-way causal relationship between ownership structures and legislative environment.
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COMPARATIVE CORPORATE GOVERNANCE MODELS
Outsiders System (Capital market focus) Capital markets and external control Widely dispersed/passive shareholders Shareholders democracy and Competitive interests and contractual solutions One tier corporate boards dominated by insiders IMPORTANT ELEMENTS:  Liquidity for shareholders  Strong minority shareholder protection  Transparency, information disclosure  Creditors’ rights protected better  Self dealing prohibited  Clear Take-over rules’  Clear Bankruptcy procedures  More active securities markets Insider System (Bank focus) Universal banks and internal ownership and control Concentrated ownership/active shareholders Long term cooperation among stakeholders Two-tiered corporate boards with interlocking directors, cross shareholdings, pyramid schemes, holding company structures IMPORTANT ELEMENTS  Employee participation in management  Proxy rules  Active participation of universal banking in providing financial solutions  Active owners, closer monitoring of management, insider control  Family ownership more common

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INTERNAL ELEMENTS OF CORPORATE GOVERNANCE

EXTERNAL ELEMENTS OF CORPORATE GOVERNANCE

Factors of Sound Corporate Governance
   


Principal Factors
       Stakeholders Takeovers/acquisitions Bankruptcy frameworks Collateral and Foreclosure rules Enterprise Restructuring Investor and Creditors Agents: Management

Shareholders rights protection Rights and Responsibilities of Board Of Directors and Shareholders Quality of Disclosure Monitoring Effectiveness of the core management functions

       

Enabling Environment
International Accounting and Auditing Standards Securities Markets Legal and Regulatory Frameworks Financial Sector Participants: Investors, Issuers, Intermediaries Financial Market Infrastructure and Architecture Product and Factor Competitiveness Foreign Direct Investments Corporate Control Enabling, prudentially regulated business environment, with creative incentive structures

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How did we get here?
• In the wake of the 19971998 financial crises in East Asia, Russia and Latin America, Corporate Governance has become a central item on the agenda of international business and development. • Financial Stability Forum (FSF) was established in 1999 forming the genesis of the set of international standards of conduct in:
– Corporate Governance (OECD Principles) – Accounting (IAS) – Banking (BIS Standards) – Securities (IOSCO) – International Trade (WTO) – Anti-corruption
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OECD Principles of Corporate Governance
1. The rights of shareholders
2. The equitable treatment of shareholders 3. The role of stakeholders in corporate governance 4. Disclosure and transparency 5. The responsibilities of the board

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Interaction Between CG and Institutional Frameworks
• Product market competition ought to take care of CG -- But is this adequate? • External policy interventions are required to uphold the rule of law, and implement rules such as disclosure

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Assumptions
• The effective corporate governance practice is often associated with a sound legal and regulatory framework and rules of law in addition to incentive structures. • Corporate governance seeks the ethical and transparent operations of enterprises and their management.
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Good Corporate Governance Practice
• The areas most central to good corporate governance center upon:
– – – – the maximization of shareholders wealth; fair business dealings by management; ethical business judgment in oversight of operations; proper conduct of directors and controlling shareholders in corporate management with their fiduciary responsibilities to all shareholders, large or small.
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Financial Markets and SMEs
• Active equity markets encourage innovative activities, entrepreneurship, and the development of active SME sector (Venture capital, business angels etc.) • Capital markets monitoring exert more discipline on management behavior, assure more transparency, leading to wealth maximization.
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Role of External Factors
• • • • • • • Role of financial institutions Role of board of directors The role of market mechanisms Transparency, accounting and disclosure Management behavior: Short termism The role of banks The role of non-bank financial institutions
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March 2002

Access to Finance
• Cost of capital and access to finance are affected by corporate governance practice. • In insider systems, debt financing is dominant. – This is a serious problem for new firms with no credit history. • Banks are usually too conservative in lending to SMEs. • International Accounting Standards, transparency and disclosure
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Lessons Learned: Role of Regulations on CG
• Financial sector regulation can not alone ensure good-governance, • Regulation must be accompanied by a system of checks and balances, that incorporates:
– – – – Judiciary Civil Society Institutions of Higher Education Business Community (most importantly)
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March 2002

Summary: Key Functions of CG
• Good CG practice plays in both economic development and democratization of finance. • CG must be interpreted as a “holistic” approach to the rules and practices:
– about the ability of the investors/owners to exercise effective control; and, – for the financial stakeholders to have access to accurate financial disclosure and information.
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Summary(cont’d): Key Functions of CG
• CG is an effective tool for:
– promoting better business standards, regulation and transparency; – strengthening the investment environment and acting as catalyst for more deep seated reform.

• Effective CG will also respond to the process of privatization, and the desire to avoid corruption in the post privatization period.
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Summary(cont’d): Key Functions of CG
• Key institutions for preventing fraud and corruption lie within financial markets regulation and self-regulation. • For a CG system to be sustainable in the long run, an adequate professional institutional infrastructure must be developed so that it could serve as watchdog and serve in developing human capacity.
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Conclusions-1
• CG system affects the development and functioning of capital markets. • Globalization has made CG an important framework condition affecting industrial competitiveness. • CG systems may differ by country due to:
– Ownership and control mechanisms, and; – The tradeoffs between ownership and voting power concentration
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Conclusions -2
• No single model of good CG practice • Effectiveness of CG systems depend upon:
– – – – Legal and regulatory frameworks Historical and cultural factors Structure of product and factor markets Industry sectors and types of productive activity
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March 2002

Conclusions- 3
• Equity markets are important for R&D, innovative activity, entrepreneurship, and SME development.
• Effective CG practice has an underlying impact on economic performance through wealth maximization for the shareholders.
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Policy Recommendations
• Development of a CG framework necessary;
– to allow for the controlling shareholders to have direct monitoring responsibility, – while ensuring that rent seeking behavior at the expense of others is not tolerated.
March 2002

• Minority shareholder protection is critical to the development of equity markets. • Insider systems should be regulated so as not to hinder the development of active equity markets. • Product market competition must be strengthened

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Strategies for Action
• Infrastructure
– Surveys of business – Advancement of CG programs of NGOs – Business associations – Bolster NGO training programs with international best practice lessons – Facilitate finance for enterprises complying with international standards.
March 2002

• Advocacy and Education
– Advocate international standards through public and private forums – Establish relevant business education and professional certification programs – Supporting legal framework

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Role of Disclosure in Corporate Governance
“If investors are not confident with the level of disclosure, capital will flow elsewhere..”
Arthur Levitt, Former Chairman of US SEC

March 2002

Budapest Marriott Hotel

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Investor behavior is affected by fear and greed

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