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Lecture 4:
     Topics: Corporate Governance and
     Corporate Goals/Objective Models -- A
     Global View
Corporate Governance: Background

   Recently has become an issue in this country
    and abroad.
   Interest has been driven by three events:
       Expanding shareholder base of corporations and
        the resulting separation of owners and manager.
       Corporate abuses.
       The globalization of companies into non-resident
        financial markets.
   We will develop these themes throughout this
    lecture series.
What is Corporate Governance?
   Bank for International Settlements definition:
       “The system of rights, processes, and controls
        established internally and externally over the
        management of a business entity with the objective of
        protecting the interest of stakeholders".

   Central Issue of corporate governance: How best to
    protect the interest of stakeholders.
       But who are the relevant stakeholders that companies
        need to protect?
Possible Stakeholders

    McDonalds: “good corporate governance is critical
     to fulfilling the Company’s obligation to
    Honda: “Our [corporate governance] aim is to
     have our customers and society, as well as our
     shareholders and investors, place even greater
     trust in us and to ensure that Honda is a company
     that society wants to exist."
Why Might We Be Concerned About
Corporate Governance?
   Macro Implications:
     Because corporations play a key role in the generation and

      allocation of a country’s resources.
   Micro Implications:
     In the increasing world of globalization, firms need to practice

      good corporate governance so as to:
          Continue to attract consumers and workers
          Have access to global financial markets!
   Historically, corporate governance appears to have been of
    greater concern among developed country corporations than
    developing country corporation!
     However, globalizations is forcing these developing country
       corporations to assess their corporate governance structures
Concerns of Different Stakeholders
   In reality, it is likely that different stakeholder groups will
    focus on different criteria and elements in deciding what
    makes up good corporate governance as they see it.
       Shareholders probably attach the greatest importance to
        maximizing the market value of the company’s shares.
       The general public wants to be sure the corporation treats
        customers fairly and has sensitivity to its impact – socially
        and environmentally -- on the local community.
       Corporate employees want assurances the company will
        compensate them properly, provide opportunities for
        advancement, offer training and career development
        assistance, and help with their retirement planning.
   The issue then for managers is what stakeholders do we
    focus on.
       This impacts on corporate goals and objectives.
       Note the difference between McDonalds and Honda.
Early 20th Century History of Corporate
Governance in the U.S.
   In the decades leading up to the 20th century, most
    US corporations were dominated and controlled by
    wealthy individuals.
       The Morgans, Rockefellers, Carnegies and du Ponts.
   However by the 1920s/1930s, pattern of US
    ownership of corporate equities had changed from
    these entrepreneurs to a wide range of investors.
       At that time it was recognized that there was a growing
        disparity between owners of firms and managers of firms.
       And thus the issues of agency problems and agency costs
        became relevant.
Agency Problems and Agency Costs

   Agency problems arise when a principal
    (owner) hires an agent (manager) to perform
    certain tasks, yet the agent does not share
    the principal's objective.
   Issue of agency costs in corporations:
       Refers to the potential conflict of interest between
        principals (shareholders) and agents (managers)
        in which agents have an incentive to act in their
        own self-interest because they bear less than the
        total costs of their actions.
State Statues to Address Corporate
   Because of the changing ownership of US
    corporations and the issue of agency costs.
       The concept of corporate governance was
        addressed when a number of states, most notably
        Delaware, passed "enabling statutes" known as
        general corporation laws.
       These state statutes created a legal framework for
        stockholders investing in corporations who were
        finding themselves increasingly separated from
        the managers of those corporations.
Key Element in Early 20th Century
Corporate Governance
   Boards of directors were seen as important to the
    agency cost issue.
     Boards were set up to exercise control and
       management over the company; thus they were
       seen as representatives of the stockholders
   It was argued that these boards had fiduciary (legal)
    duties of loyalty to owners and they should ensure
    the “wise management of the corporation in the best
    interests of its owners.”
       A key element in this process was the “independence of
        directors” from undue influence by interested parties
        (including managers).
       But were these boards truly independent?
The Stock Market Crash in 1929
   The stock market crash of 1929 brought the federal
    government into the regulation of corporate
    governance for the first time.
   Congress passed the Securities Acts of 1933 and
    1934 to restore confidence in the equity markets.
       1933: Established the Securities and Exchange
        Commission (SEC); requires registration with the SEC of
        securities offered for public sale and outlaws fraud in the
        sale of securities.
       1934: Regulates stock exchanges and requires corporate
        officers to report their trading in securities.
       These acts also require that public companies undergo an
        annual independent audit of their financial statements.
The 1980s
   The decade of the 1980s was characterized by
    a wave of hostile takeovers, leveraged buyouts,
    management buyouts, junk bond financing,
    "poison pills", and the general merger frenzy of
    those days.
   Within this environment, shareholder interests
    again became an issue.
       The corporate governance debate was revived.
       But what was different now was the role and voice
        of large institutional investors as these institutions
        played an increasingly activist role as corporate
The 1990s to the Present
   In the United States, by 1990, the direct ownership of
    equities by households had fallen below 50%.
   Thus, by the 1990s, it was primarily these institutional
    investors (e.g., banks, mutual funds, public and private
    pension funds) who were driving the issues of corporate
    control and accountability.
     Their focus was (and currently is) on securing top
       performance from their investments.
       Critical to this is the role of the “independent” board of
   Today, these institutional investors hold about 60% of all
    listed corporate stock in the United States (about 70% in
    the largest 1,000 corporations).
Impact of Corporate Abuses in the US
on Corporate Governance
   In recent years corporate governance has become (relatively)
    well defined in the United States.
     Undoubtedly recent corporate abuses have contributed to
        Waste Management and Sunbeam (1998) and Enron
        Abuses resulted in passage of Sarbanes-Oxley Act (2002)
            Among other requirements is the certification of financial reports by
             chief executive officers and chief financial officers
               Assumes if companies are more transparent in what they are
                doing, managers will be less tempted to act in a way detrimental
                to owners.
            But there is no similar regulation in foreign countries.
            Issue of applying this act to foreign companies listed in the U.S
Global Corporate Governance
   Globally, there are two major challenges to the
    development of “good” corporate governance.
   First, there is a great diversity of national practices,
    traditions, laws, regulations, and political and market
       For example, common law versus civil law and differences
        in ownership patterns
   Second, the possibilities for implementing "good
    corporate governance" are often constrained in a
    given country by legal, cultural, and/or economic
       For example, differences management models
Global Variations in Ownership
   Separation of ownership and management (i.e.,
    potential control):
       Varies widely among countries.
       When measured by ownership concentration:

    Country            Average ownership of 3 largest shareholders
    United States      20%
    United Kingdom     19%
    Italy              58%
    Germany            48%
    Brazil             57%
    Mexico             64%

   United States and U.K. have a “diverse shareholder
    base.” In other countries, often founding families control
    the companies!
Ownership Impacts
   If ownership is concentrated, it is likely that a small
    number of owners will find it easy and
    advantageous to monitor managers.
       This may be the case of countries like Italy, Brazil
        and Mexico, but not the U.S. and the U.K. (see
        previous slide).
       Agency cost may be reduced as owners and
        managers become better aligned due to ownership
           Thus large shareholders may play a role in corporate
           Studies also suggest that concentration of ownership
            may have a positive impact on a company’s
            performance and value.
               Japan (1995) and Germany (2000)
Legal Variations
   Currently we can identify 4 main legal systems on a
    global basis:
       English common law
       French civil law
       German civil law
       Scandinavian civil law
   Studies have suggested that variations in corporate
    governance from country to country can be
    attributed to differences in legal systems.
       Why: Legal systems determine how well investors are
Common Versus Civil Law
   Common Law
       Based on precedent, formed by the rulings of independent
        judges regarding specific disputes.
       Originated in U.K. and spread throughout the world through
        British colonization (as well as independent adoption):
         United States, Australia, Canada, India, South Africa,
           Singapore, New Zealand.
   Civil Law
       Codification of legal rulings.
       Dominates legal systems globally.
         France, Germany, Japan, Mexico, China, Latin America,
Shareholder Rights and the Legal
   Historically, in civil law countries, the “state” has
    played a greater role in regulating economic activity
    but a less active role in individual (e.g., private
    property) rights.
   On the other hand, English common law appears to
    be more protective of private property and investor
       Conclusion for investors: English common law tends to
        offer the strongest protection for investors.
       Studies also suggest that countries with strong shareholder
        protection have more company listings on stock markets
        and more value stock markets (capitalization of
Law and Ownership Concentration

   Civil law countries generally have greater ownership
    concentration ratios.
    Legal System     Average ownership of 3 largest shareholders

    English Common   43%
    French Civil     54%

   Perhaps higher concentration ratios are a response
    to relatively weak investor protection laws in civil law
    countries? Or perhaps of the high concentration
    ratios are seen as reducing the need for strong
    investor protection laws?
Corporate Goals

   Corporate Goals: Specified targets which the
    company desires to achieve.
   In the United States, companies tend to
    produce rather well defined financial goals.
       For Example, FedEx Corporation
           Grow revenue by 10% per year
           Increase EPS by 10%-15% per year
   The American company focus on these types
    of financial goals is driven by the corporate
    model which we use.
    Differences in “Corporate Model”
   We can identify 2 different corporate models in the
    world today:
   Shareholder Wealth Structure (aka, Anglo-American
    or Anglo-Saxon) Model:
       Believes that a firm’s objective should be to maximize
        shareholder wealth.
         “Shareholder Wealth” countries include the US,
          Canada, Australia, United Kingdom.
   Corporate Wealth Structure (aka, Non-Anglo-
    American) Model:
       Believe that a firm’s objective should be to maximize
        corporate wealth (which includes all stakeholders; e.g.,
        employees, community, banks, owners)
         “Corporate Wealth” countries include the EU, Japan
          and Latin American countries.
Shareholder Wealth Model
   This model focuses on the importance of
    shareholders to the corporate structure.
   Wealth is seen as strictly “financial.”
       Within this context, management tools measure impact of
        their decisions on equity (common stock) values.
       Shareholder Wealth capital budgeting techniques include:
           Net Present Value
           Internal Rates of Return
               These are aimed at securing returns greater than the firm’s
                cost of capital and thereby increasing returns to
   Within this model, there is a general acceptance of
    “hostile” takeovers to ensure appropriate financial
       Again this is seen as benefiting shareholders.
Corporate Wealth Model
   The focus of the corporate wealth model is much
    broader than the Shareholder Wealth viewpoint.
      Under the Corporate Wealth Model,
       consideration of corporate decisions is given
       to a wider range of parties, including human
       resources, community, state, shareholders,
   The Corporate Wealth model came about
    because of distrust of unrestricted capitalism
    especially in Latin America and post World War
    II Europe (thus, the phrase a search for the
Corporate Wealth Model
   In Continental Europe and Asia we see this
    model manifested in:
       Advisory Committees (with labor representation):
        important in Europe as part of corporate structures
        and involved by law in corporate decisions.
       Strict labor laws (e.g., on firing employees) in Europe.
       Life time employment concept in Japan in early post
        war years.
           Weakened substantially in Japan in the 1990s.
       Less attention in Japan of Anglo Saxon capital
        budgeting techniques; especially equity cost of capital.
   Friendly takeovers are the rule (although this is
    changing as well, in Japan and in Europe).
“Equity” Cultural Differences
   Shareholder Wealth countries (U.S., U.K.,
       Historically have had a well developed equity culture
           Within these countries there is an understanding and
            acceptance of ownership and, especially, equity capital risk.
       Thus, this sector is an important source of funds for
        corporate financing.
       But, perhaps, it also affects corporate goals.
   Management tends to focus on shareholders.
“Equity” Cultural Differences
   Corporate Wealth countries (Continental Europe
    and many Asian countries)
       Historically, relatively less developed equity culture
         Risk is not as well understood or tolerated.

       Thus in these countries there has historically been a
        reliance on debt and bank financing.
       Globalization is changing this!
The Future: Are the Two Models
Finding a Middle Ground?
   Starbucks, Corporate Social Responsibility: “…
    conducting business in ways that produces social,
    environmental, and economic benefits for the
    communities in which we operate.”
   Many Japanese companies are now concern with
    Anglo-American financial performance.
     Nissan hired “cost-cutter” Carlos Ghosn as their CEO
      in 1999 to turn the company around.
           One year after he arrived, Nissan's net profit climbed to $2.7
            billion from a loss of $6.1 billion in the previous year.
       Sony hired an American, Howard Stringer as their
        CEO in 2005.
           He has set operating profit margin goal of 5% for the company
            by 2008.
The Future: Are the Two Models
Finding a Middle Ground?
   Financial markets and financial organizations (e.g.,
    central banks) around the world are working to
    become more transparent.
     All central banks now publishes their web sites in

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