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Lecture on International Finance Manager

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					INTERNATIONAL
FINANCIAL
MANAGEMENT
Lecture 4:
     Topics: Corporate Governance and
     Corporate Goals/Objective Models -- A
     Global View
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.
       Another Issue: who are the relevant stakeholders that
        need protection?
Corporate Governance: Background
   Recently corporate governance 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.
           With the aim of raising capital in those markets.
   We will develop these themes throughout this
    lecture series.
Possible Stakeholders
   McDonalds: “good corporate governance is
    critical to fulfilling the Company’s obligation to
    shareholders.”
   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."
Importance of 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 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 in deciding what constitutes
    good corporate governance.
       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 for managers is what stakeholders to focus on.
       This impacts on corporate decisions, 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, the pattern of US
  ownership of corporate equities had changed from
  these entrepreneurs to an expanding group of
  individual investors.
       At that time it was also recognized that there was a growing
        disparity between owners of firms and managers of firms.
       Thus the issues of agency problems and agency costs
        became relevant.
Agency Problems and Agency Costs

   Agency problems arise when a principal (i.e.,
    owner or shareholder) hires an agent (i.e.,
    manager) to perform certain tasks, yet the
    agent does not share the principal's
    objective(s).
   Agency costs in corporations refers to the
    potential conflict of interest between
    principals (owners or shareholders) and
    agents (managers) in which agents have an
    incentive to act in their own self-interest.
State Statues to Address Corporate
Governance
   In response to the early 20th century
    changing ownership patterns of US
    corporations and the potential issue of
    agency costs 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 US corporations.
       Today, 50% of all U.S. publicly-traded companies
        and 58% of the Fortune 500 are chartered
        through the state of Delaware.
Key Element in Early 20th Century
Corporate Governance
   Boards of directors were seen as a potential solution
    to the agency cost issue.
     Thus, boards of directors were set up to exercise
       control over a company and they were seen as
       representing the interest of the stockholders.
   It was argued that these boards had fiduciary (i.e.,
    legal) duties of loyalty to owners (shareholders) 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 early boards truly independent?
The Stock Market Crash in 1929
   The stock market crash of 1929 brought the Federal
    Government into the issue corporate governance for
    the first time.
   Congress passed the Securities Acts of 1933 and
    1934 to restore confidence in the equity markets.
       1933 Act: 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 Act: 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
   In the 1980s, the focus on corporate government
    shifted.
       The decade of the 1980s was characterized by a
        wave of hostile takeovers, leveraged buyouts,
        management buyouts, junk bond financing, "poison
        pills", and a general merger frenzy.
   Within this environment, shareholder interests
    again became an issue.
       But what was different in the 1980s was the growing
        role of large institutional investors -- banks, mutual
        funds, public and private pension funds.
       These institutions were taking on an increasingly
        activist role as corporate shareholders.
The 1990s to the Present
   By 1990, the direct ownership of equities by
    households had fallen below 50% in the United
    States.
   And in the 1990s it was primarily institutional
    investors who were driving the issues of
    corporate control and accountability.
       Their focus was (and currently still is) on securing
        top performance from their investments.
   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 legislation has
    become even more focused in the United States.
   Undoubtedly corporate abuses have contributed to this:
       Waste Management and Sunbeam (1998) and Enron (2001).
   Abuses resulted in passage of Sarbanes-Oxley Act (2002)
   This act requires the certification of financial reports by
    chief executive officers and chief financial officers
       Act assumes if companies are more transparent in what they
        are doing, managers will be less tempted to act in a way
        detrimental to owners.
       There is no similar regulation in foreign countries so there is also
        the issue of applying this act to foreign companies listed in the
        U.S
Global Corporate Governance
   Globally, there are major challenges to the
    development of “good” (or at least uniform)
    corporate governance.

   These challenges stem from the fact among
    countries there is a wide diversity of laws,
    regulations, society norms, business cultures,
    attitudes towards business, ownership
    concentration, and political and market structures.

   Thus, the ability for implementing what we in the US
    might view as "good corporate governance" is often
    constrained by these differences.
Differences in Ownership Concentrations
   Globally, ownership concentration varies widely.
    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.
   Question: Does concentration have an impact on control
    and oversight of managers (agents)?
Ownership Impacts
   If ownership is concentrated, it is more likely that a
    small number of owners will find it relatively easy
    and advantageous to be involved in the direct
    monitoring of managers.
       Thus, in countries like Italy, Brazil and Mexico, a few
        large shareholders may play a significant role in
        corporate governance; but this is not necessarily
        the case in the U.S. and the U.K. (see previous
        slide).
       Therefore, in high concentration countries, agency
        cost may be reduced as owners and managers
        become better aligned.
Differences in Legal Systems
   Currently, it is possible to identify 2 major legal
    systems:
   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,
Legal Variations and Corporate
Governance
   Studies have suggested that differences in
    legal systems may have in impact in
    variations in corporate governance.
   Reason: Legal systems vary in how well
    investors are protected.
Shareholder Rights and the Legal
System
   In civil law countries, the “state” has
    historically played a greater role in regulating
    economic activity but a less active role in
    protecting individual (e.g., private property)
    rights.
   On the other hand, English common law is
    more protective of private property and
    investor rights.
       Conclusion for investors: English common law
        offers the strongest protection for investors.
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 these higher concentration ratios are a
    response to relatively weaker investor protection laws
    in civil law countries?
   Or perhaps of the high concentration ratios are seen
    as alleviating the need for strong investor protection
    laws?
Corporate Goals
   Corporate goals are specified targets which a
    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
   American company focus on financial goals is
    undoubtedly driven by the corporate model
    used in this country.
    Differences in “Corporate Model”
   There are 2 major corporate models in use 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
                shareholders.
   Within this model, there is a general acceptance of
    “hostile” takeovers to ensure appropriate financial
    performance.
       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
        interests, including employees, the community, the
        country, shareholders, lenders...
   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 in search of a “Third-
    Way” – a middle ground between capitalism and
    socialism).
Corporate Wealth Model
   In Continental Europe and Asia we the corporate wealth
    model includes:
       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.
           Payback analysis preferred.
   Friendly takeovers are the rule in corporate wealth countries.
       Although this is changing somewhat, e.g., in Japan and in Europe
        we are beginning to see hostile takeovers.
Mergers and Acquisitions in Japan and
Germany: Historical Data
   Japan: Between 1985 and 1989, mergers and
    acquisitions accounted for just over 3% of the total
    market capitalization, and all were friendly
    transactions.
   Germany: Between 1985 and 1989, only 2.3% of the
    market value of listed stocks were involved in
    mergers and acquisitions, compared with more than
    40% in the U.S.
   Historically, in both Japan and Germany mergers
    have tended to be friendly, arranged deals, rather
    than hostile takeovers.
“Equity” Cultural Differences
   Shareholder Wealth countries (U.S., U.K.,
    Australia, Canada)
       Have a well developed equity culture:
           There is an understanding and acceptance of ownership and,
            especially, equity capital risk.
       Thus, equity capital is an important source of funds for
        corporate financing in these countries.
       But, perhaps, the equity culture also affects corporate
        goals and management decisions.
       Management tends to focus on shareholders.
“Equity” Cultural Differences
   Corporate Wealth countries (Continental Europe
    and many Asian countries)
       Historically, relatively less developed equity culture.
           In Japan and Germany the percent of households holding
            common stock (in direct form) is roughly half that of the US.
           Risk is not as well understood or tolerated.
       Thus in these countries there has historically been a
        reliance on debt and bank financing.
           Bond financing important in Japan and commercial bank
            financing in Germany.
       These countries also tend to develop interlocking
        relationships.
           Banks own approximately 14% of shares of German corporations,
            while roughly 40% are owned by other German corporations.
           Keiretsu in Japan and Chaebol in South Korea
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.
     In 1999, Nissan hired a Frenchman, Carlos Ghosn (known as the

      “cost cutter”) as their CEO 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.
       In 2005, Sony hired an American, Howard Stringer as their CEO.
           He has set an operating profit margin goal of 5% for the company by
            2008.
Governance and Transparency Among
the World’s Central Banks
   Financial markets and financial organizations (e.g.,
    central banks) around the world are also working to
    become more transparent.
     All central banks now publish their web sites in

      English.
         http://www.bis.org/cbanks.htm

				
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