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FIN 645: International
Financial Management
Lecture 2
Exchange Rate and Corporate
Governance
Cross Exchange Rates
• The exchange rate between 2 currencies where neither
currency is the US dollar (domestic currency)
• We know the dollar rates. What if we want to know other
rates, i.e. S(€/£) ?
– Calculate cross-rates from dollar rates
– S($/€)=1.5000 and S($/£)=2.0000. What is S(€/£), i.e. the € price
of £?
$ 1 1.3333
2.0000
£ $ £ 1.5000 £1
S ( / £) 1.3333
2
Cross-Exchange Rates
• Cross-rates must be internally consistent; otherwise
arbitrage profit opportunities exist.
• Suppose that:
$
£ $ £
• A profit opportunity exists. Either S(€/£) is too high or
S(€/$) or S($/£) is too low.
• How does this work?
• Sell high and buy low.
3
Cross-Exchange Rates
Example
• Bank1: S($/¥)=0.0084; Bank2:
S($/€)=1.0500; Bank3: S(€/¥)=0.0081.
• The implied cross rate between Bank 1 and
2 is: S(€/¥)=0.0080.
• You have ¥1,250,000. What should you do?
– Go to Bank 3. Sell ¥ high!
Convert ¥1,250,000 to €10,125.00 @ 0.0081
– Go to Bank 2.
Convert €10,125 to $10,631.25 @ 1.0500. Buy ¥ low!
– Go to Bank 1.
Convert $10,631.25 to ¥1,265,625.00 @ (1/0.0084)
– The initial ¥1,250,000 becomes ¥1,265,625.
You earn a risk-free profit of ¥15,625, or
4
1.25%.
Cross Rate and Triangular
Arbitrage
• Arbitrage defined
– Riskless arbitrage is a situation in which one can lock in
a sure profit with no investment and no risk.
– Economics Professor Hal Varian and the Yankee farmer
• Triangular arbitrage
– It is the process of trading out of the domestic currency
into a second currency, then trading it for a third
currency, which is in turn is traded for domestic
currency again.
– The purpose is to earn an arbitrage profit via trading
into a second currency when the direct exchange rate
between the two is not in alignment with the cross-
exchange rate.
Triangular Arbitrage
Suppose we
$
observe these
Barclays Credit Lyonnais
banks posting
these exchange S(¥/$)=120 S(£/$)=0.60
rates.
First calculate the ¥ £
implied cross rates Credit Agricole
to see if an
arbitrage S(¥/£)=210
opportunity exists.
Triangular Arbitrage
The implied S(¥/£) cross $
rate is S(¥/£) = 200 Barclays Credit Lyonnais
S(¥/$)=120 S(£/$)=0.6
Credit Agricole has
posted a quote of
S(¥/£)=210 so there is an ¥ £
arbitrage opportunity. Credit Agricole
S(¥/£)=210
So, how can we make money?
Triangular Arbitrage
As easy as 1 – 2 – 3:
$
1. Sell our $ for £, Barclays
Credit Lyonnais
2. Sell our £ for ¥, S(¥/$)=120
S(£/$)=0.6
3. Sell those ¥ for $.
¥ £
Credit Agricole
S(¥/£)=210
Triangular Arbitrage
Sell $100,000 for £ @ S(£/$) = 0.60
receive £60,000
Sell our £ 60,000 for ¥ @ S(¥/£) = 210
receive ¥12,600,000
Sell ¥ 12,600,000 for $ @ S(¥/$) = 120
receive $105,000
profit per round trip = $ 105,000- $100,000 = $5,000
Class Exercise: Triangular
Arbitrage
Suppose we
Tk.
observe these
banks posting Prime HSBC
these exchange S(¥/Tk.)=1.76 S(£/Tk.)=.00714
rates.
First calculate the ¥ £
implied cross rates
to see if an Dhaka Bank
arbitrage S(¥/£)=250
opportunity exists.
Triangular Arbitrage
The implied S(¥/£)cross Tk.
rate is S(¥/£)= 246.5 Prime
HSBC
S(¥/Tk.)=1.76
S(£/Tk.)=.00714
Dhaka Bank has
posted a quote of
S(¥/£)=250 so there is ¥ £
an arbitrage Dhaka
opportunity.
S(¥/£)=250
So, how can we make money?
Triangular Arbitrage
As easy as 1 – 2 – 3:
Tk.
1. Sell our Tk for £, Prime HSBC
S(£/Tk.)=.00714
2. Sell our £ for ¥, S(¥/Tk.)=1.76
3. Sell those ¥ for Tk.
¥ £
Dhaka
S(¥/£)=250
Triangular Arbitrage
Sell Tk.100,000 for £ at S(£/Tk.)=.00714
receive £714
Sell our £ 714. for ¥ at S(¥/£) = 250
receive ¥178500
Sell ¥ 178500 for Tk. at S(¥/Tk.)=1.76
receive Tk.101420
profit per round trip = Tk. Tk.101420 - Tk.100,000 =
Tk. 1420
No Arbitrage Condition for
Triangular Arbitrage
• S(j/k)*S(k/l)*S(l/j) =1, i.e. the product of
the spot rates is equal to 1, indicating zero
profit
• The no-arbitrage condition implies that
when the arbitrager starts with one unit of
a particular currency, s(he) ends up with
one unit of the same currency after
exchange
Class Exercise II:Triangular
Arbitrage
• Suppose the following exchange rates
hold:
– S($/ ¥) = $0.00960984
– S(¥/DM) = ¥ 60.750
– S(DM/$) = DM 1.7125
• See if there is an opportunity for
triangular arbitrage?
• Which rate is misaligned?
• Calculate arbitrage profit.
The Forward Market
• Forward market involves contracting today for the
future purchase or sale of foreign exchange
• Forward prices are quoted the same way as spot
prices
• Denote the forward price maturing in N days as FN
– i.e. F30($/£), F180($/€), F90(€/ ¥), etc.
– F30($/£) = 1.558
– F180($/€) =1.051
– F90(€/ ¥) = 0.0081
16
Premium and Discount
• The forward dollar price of the euro can be:
– Same as the spot price
– Higher than the spot price (euro at a premium)
– Lower than the spot price (euro at a discount)
• Examples:
– S($/ €)= 1.0051
– F30($/ €)= 1.0062
– F90($/ €)= 1.0070
– F180($/ €)=1.0075(in American terms the Euro is trading at a premium)
– S(€ /$)= .6653
– F30(€ /$)= .6645
– F90(€ /$)= .6635
– F180(€ /$)= .6630(in European terms the dollar is trading at a discount)
17
Spot Rate Quotations
Currency
W ednes day , J anuary 8, 1997 U.S. $ equiv. per U.S. $
C ountr y W ed . Tues. W ed . Tues.
EXCHANGE RATES Japan (Y en) .008639 .008681 115.75 115.20
The N ew Y ork f oreign exchange selling rates below apply to
trading am ong banks in am ounts of $1 m illion and m ore, as quoted
at 4 p.m . Eastern tim e by D ow Jones Telerate Inc. and other sources . 180-D ay Forward
Retail transactions prov ide f ewer units of f oreign currency per
30-D ay Forward
90-D ay Forward
Jord an (D inar)
.008676
.008750
.008865
1.4075
.008718
.008791
.008907
1.4075
115.26
114.28
112.80
.7105
114.71
113.76
112.28
.7105
Clearly the
K u wait (D inar) 3.3367 3.3389 .2997 .2995
market
dollar.
Currency Lebanon (Pound) .0006445 .0006445 1551.50 1551.50
U.S. $ equiv. per U.S. $ Malaysia (R inggit) .4018 .4002 2.4885 2.4990
C ountr y W ed. Tues. W ed . Tues. Malta (Lira) 2.7624 2.7701 .3620 .3610
Argentina (Peso) 1.0012 1.0012 .9988 .9988 Mexico (Peso) .... .... .... ....
Floating rate .1278 .1277 7.8220 7.8330
participants
Au stralia (D ollar) .7805 .7902 1.2812 1.2655
Au stria (Schilling) .09043 .09101 11.058 10.988 N etherland (Guilder) .5655 .5699 1.7685 1.7547
B ahrain (D inar) 2.6525 2.6525 .3770 .3770 N ew Zealan d (D ollar) .7072 .7106 1.4140 1.4073
B elgium (Franc) .03080 .03105 32.470 32.205 N orway (Krone) .1540 .1548 6.4926 6.4599
B razil (R eal) .9607 .9615 1.0409 1.0401 Pakistan (R upee) .02529 .02529 39.540 39.540
B ritain (Pound) 1.6880 1.6946 .5924 .5901 Peru (new Sol) .3814 .3840 2.6218 2.6039
30-D ay Forward
90-D ay Forward
180-D ay Forward
C anada (D ollar)
1.6869
1.6843
1.6802
.7399
1.6935
1.6910
1.6867
.7370
.5928
.5937
.5905
.5914
.5952 .5929
1.3516 1.3568
Philippines (Peso)
Poland (Zloty )
Portugal (Escudo)
R ussia (R uble) (a)
.03800
.3460
.006307
.03802
.3475
.006369
26.318
2.8900
158.55
.0001787 .0001788 5595.00 5594.00
26.300
2.8780
157.02
expect that
30-D ay Forward .7414 .7386 1.3488 1.3539 Saudi Arabia (R iy al) .2666 .2667 3.7503 3.7502
90-D ay Forward
180-D ay Forward
C hile (Peso)
C hina (R enm inbi)
.7442
.7479
.002352 .002356
.1201
.7413
.7450
.1201
1.3437 1.3489
1.3370 1.3422
425.25 424.40
8.3272 8.3276
Singapore (D ollar) .7116
Slo vak R ep. (Koruna) .03259
South Africa (R and)
South K orea (W on)
.2141
.001184
.7124
.03259
.2142
.001184
1.4053
30.688
4.6705
844.75
1.4037
30.688
4.6690
844.65
the yen will
C olombia (Peso) .0009985 .0009985 1001.50 1001.50 Spain (Peseta) .007546 .007603 132.52 131.53
C zech. R ep (Krouna)
C om m ercial rate
D enmark (Krone)
Ecuador (Sucre)
....
.03662
.1663
....
....
.03677
.1677
....
....
27.307 27.194
6.0118 5.9633
....
....
....
Sweden (Krona)
Switz erland (F ranc)
30-D ay Forward
90-D ay Forward
.1431
.7334
.7357
.7401
.1435
.7387
.7411
.7454
6.9865
1.3635
1.3593
1.3511
6.9697
1.3537
1.3494
1.3416
be worth
Floating rate .0002766 .0002787 3615.00 3587.50 180-D ay Forward .7470 .7523 1.3386 1.3293
Finland (Markka)
France (Franc)
30-D ay Forward
90-D ay Forward
.2121
.1879
.1882
.1889
.2135
.1893
.1896
.1903
4.7150 4.6841
5.3220 5.2838
5.3126 5.2741
5.2935 5.2558
Taiwan (D ollar)
Thailand (Baht)
Turkey (Lira)
U nited Arab (D irham )
.03638
.03902
.00000911 .00000915109755.00109235.00
.2723
.03637
.03906
.2723
27.489
25.625
3.6720
27.493
25.605
3.6720
MORE in
180-D ay Forward .1901 .1914 5.2617 5.2243 U ruguay (N ew Peso) .... .... .... ....
German y (Mark)
30-D ay Forward
90-D ay Forward
180-D ay Forward
.6352
.6364
.6389
.6430
.6394
.6407
.6432
.6472
1.5744 1.5639
1.5714 1.5607
1.5652 1.5547
1.5552 1.5450
Financial
Venezuela (Boliv ar)
SD R
.1145
.002098
- - -
1.4315
.1145
.002096
1.4326
8.7300
476.70
.6986
8.7300
477.12
.6980
dollars in
Greece (D rachm a) .004049 .004068 246.98 245.80 EC U 1.2308 1.2404 .....................
H ong K ong (D ollar)
H ungary (Forint)
India (R upee)
Indonesia (R upiah)
.1292
.02787
.1292
.006139 .006164
.02786
7.7390 7.7390
162.89 162.23
35.875 35.890
.0004233 .0004233 2362.15 2362.63
Special D rawing R ights (SD R ) are based on exchange rates f or
the U .S., Germ an, British, F rench, and J apanese currencies. Source:
International Monetary Fund.
six months.
Ireland (Punt) 1.6664 1.6714 .6001 .5983 European C urrency U nit (EC U ) is based on a basket of com m unity
Israel (Shekel) .3079 .3085 3.2474 3.2412 currencies.
Italy (Lira) .0006483 .0006510 1542.50 1536.00 a-f ixing, Moscow Interbank C urrency Exchange.
Forward Rate
Premium/Discount Calculation
The formula for calculating forward
Premium and discount for the currency
j in American terms is:
fN,j =[FN($/j)-S($/j)]/S($/j)x[360/days]
Class Exercise III:Forward
Rate Premium/Discount
• Consider the example from above:
for Japanese yen, the spot rate is
¥1 = $.009220
While the 180-day forward rate is
¥1 = $.009306
• Calculate the forward
premium/discount
Wrap-Up
• The foreign exchange market is by far the largest
financial market in the world.
• Currency traders trade currencies for spot and forward
delivery.
• Exchange rates are by convention quoted against the
U.S. dollar/domestic currency, but cross-rates can
easily be calculated from bilateral rates.
• Triangular arbitrage forces the cross-rates to be
internally consistent.
• The euro has enhanced trade within Europe, and the
currency has the potential of becoming a major world
currency.
21
Corporate Governance
22
Agenda
• Governance of the Public Corporation
• Agency Problem
• Law and Corporate Governance
• Corporate Governance Reform in the US
–Sarbanes Oxley
• Corporate Governance Reform in the UK
–Cadbury Code
23
Governance of the Public
Corporation
• Corporate Governance – the economic, legal, and
institutional framework in which corporate control and
cash flow rights are distributed among shareholders,
managers, and other stakeholders of the company.
• Corporate scandals: Enron, WorldCom, Global
Crossing, Daewoo Group, Parmalat, and Satyam.
• American executives “treat their companies like
automated teller machines (ATMs), awarding
themselves millions of dollars in corporate perks.”
(Harvard Business Review, 2003)
• Corporate governance failures have detrimental effects
on corporate valuations and the functioning of capital
markets.
24
25
Governance of the Public
Corporation
• Public ownership is associated with
efficient risk sharing, access to low-cost
capital, and the pursuit of risky
investment projects.
• Conflicts of interest between managers
(agents) and shareholders (principals).
– Shareholders elect the board of directors, who
in turn hire and monitor managers.
– Board composition (insiders/outsiders)
– Shareholder monitoring (free-rider)
• Conflicts of interest between controlling
26 shareholders and outside shareholders.
The Principal-Agent Problem
• Incomplete contracts
– It is impossible to foresee all future
contingencies
• Shareholders (principals) want profit
• Managers (agents) want leisure & security
• Conflicting motivations between these
groups are called agency problems.
– Professor Yunus blasts Telenor ethics in Bangladesh
– Stock brokers and investors
– Physicians and patients
– Auto mechanics and car owners
Solutions to Agency Problems
• Compensation as incentive
• Extending to all workers stock options,
bonuses, and grants of stock
– It helps to make workers act more like
owners of firm (but not always – Citibank
and Managers)
• Incentives to help the company, because that
improves the value of stock options and
bonuses
• Good legal contracts that can be effectively
enforced
The Agency Problem
• Incomplete contracts create room for agency
problems, and managers often grab the
residual control rights.
– Perquisites
– Steal funds
– Divert funds
– Waste funds
– Managerial entrenchment
• Free cash flows, Payout problems
– Retain cash to avoid future capital raising
– Size Higher compensation
– Size Higher prestige
29
Remedies for Agency
Problem
• Board of directors
– Outside directors on board
– CEO and chairman of board different people
– Europe – union representation, two-tier boards
• Incentive contracts
– Stocks and stock options
– Independent compensation committee
• Concentrated ownership
– Strong incentives to monitor management
– Germany, France, Japan, China, Latin America
– Morck, Shleifer, and Vishny (1988): Effect of managerial
ownership (%) on firm value is likely non-linear and
entrenchment dominates in 5-25% range for the US.
30
Morck, Shleifer, and Vishny
Firm Value(1988)
Alignment Entrenchment Alignment
x y Manager Ownership (%)
31
Remedies for Agency
Problem
• Accounting Transparency
– Accurate accounting information in a timely
fashion
• Debt
– Less managerial discretion with respect to
payouts
– Less flexibility for financing investment projects
• Overseas Stock Listings
– Credible bond to provide better investor
protection (Doidge, Karolyi, and Stulz (2002))
• Market for Corporate Control
– Threats of takeover
– Disciplinary effect on managers and enhance
32 company efficiency (US and UK)
– Developing also in Germany, Japan, etc.
Law and Corporate
Governance
• La Porta, Lopez-de-Silanes, Shleifer, and Vishny (LLSV)
• Sharp differences among countries with respect to:
– Corporate ownership structure
– Depth and breadth of capital markets
– Access of firms to external financing
– Dividend policies
• Explained by how well investors are protected from
expropriation by managers and controlling shareholders and
the origin of the country’s legal system.
– English common law – discrete rulings, judicial precedent
– French civil law – codification of legal rules (Roman)
– German civil law – codification of legal rules (Roman)
– Scandinavian civil law – codification/precedent
33
Law and Corporate
Governance
• LLSV (1998) Invented the: Shareholder Rights Index
and the Rule of Law Index
• English common law countries rank highest on
shareholder rights, while Scandinavian and German
civil law countries rank highest on enforcement.
• Why are they so different?
• Glaesser and Shleifer (2002) argue the explanation
dates back to the Middle Ages.
– France – power of adjudication to the center (King)
– England - power of adjudication to a local jury
34
Consequences of Law
• LLSV (1998) find that corporate ownership
tends to be more concentrated in countries with
weaker investor protection.
Legal Origin Ownership External Domestic
Concentration Cap/GNP Firms/Population
English 0.43 0.60 35.45
common law
French civil law 0.54 0.21 10.00
German civil 0.34 0.46 16.79
law
Scandinavian 0.37 0.30 27.26
civil law
35
Consequences of Law
• Dominant investor may seek to acquire control
rights in excess of cash flow rights
– Shares with superior voting rights
– Pyramidal ownership structure
• Li Ka-Shing Family (Hutchison Whampoa)
• Lee Keun-Hee (Samsung Electronics)
• Robert Bosch GmbH (Daimler-Benz)
– Interfirm cross-holdings
• Private Benefits of Control that are not shared by
other shareholders or pro rata basis
– Nenova (2001) premium for voting shares: US
2.0%, Canada 2.8%, Brazil 23%, Germany
9.5%, Italy and Korea 29% and Mexico 36%...
– Dyck and Zingales (2003) block premium:
Canada US and UK 1%, Australia and Finland
2%, Brazil 65%, Czech Republic 58%, Israel
36 27%, Italy 37%, Korea 16%, and Mexico 34%.
Consequences of Law
• Capital Markets and Valuation
– LLSV (1997) find that countries with strong shareholder
protection tend to have more valuable stock markets and more
companies listed on stock exchanges per capita than countries
with weak protection.
– Studies (e.g., Lins (2002)) show that higher insider cash flow
rights are associated with higher valuations, while higher insider
control rights are associated with lower valuations.
– Johnson, Boon, Breach and Friedman (2000) find that stock
markets declined more in countries with weaker investor
protection during the Asian financial crisis 1997-1998.
– Lemmon and Lins (2003) find that crisis period returns of firms
in which managers have high levels of control rights, but have
separated their control and cash flow ownership, are 10-20
percentage points lower than those of other firms.
– Financial market development also promotes growth.
37
Consequences of Law
• Doidge, Karolyi, and Stulz (2004)
– Almost all of the variation in governance ratings
across firms in less developed countries is
attributable to country characteristics rather
than firm characteristics typically used to
explain governance choices.
– Firm characteristics explain more of the
variation in governance ratings in more
developed countries.
– Access to global capital markets sharpens firm
incentives for better governance, but decreases
the importance of home-country legal
38 protections of minority investors.
Corporate Governance
Reform
• Late 1990s – Internal corporate governance
mechanisms, auditors, regulators, banks, and
institutional investors failed…
• Strengthen the protection of outside
shareholders against expropriation of
managers and controlling shareholders
– Strengthening the independence of boards of
directors with more outsiders
– Enhancing the transparency and disclosure
standard of financial statements
– Energize the regulatory monitoring role of the
stock market regulator and the exchanges
39
– Modernize the legal framework
Sarbanes Oxley
• Accounting regulation
– Public accounting oversight board
– Restricting consulting/auditing
• Audit committee
– Independent financial experts
• Internal control assessment
– Assessment by auditors and company (Section 404)
– Deemed costly and contested
– Cross-listing elsewhere…
• Executive responsibility
– CEOs and CFOs must sign off on the company’s quarterly
and annual financial statements. If fraud causes an
overstatement of earnings, these officers must return any
bonuses.
40
Sarbanes Oxley
• Many argue that SOX is hurting U.S. capital markets.
– SOX undermines CEO’s appetites for risk
– SOX is a full employment act for Accountants (404)
• The Committee on Capital Markets Regulation, set up
by U.S. Treasury Secretary Hank Paulson, advocates
rolling back the Sarbanes-Oxley Act.
• New York Governor-elect Eliot Spitzer, New York City
Mayor Michael Bloomberg and U.S. Sen. Charles
Schumer of New York have weighed in too, saying
SOX is wrecking New York’s standing as the world’s
financial markets.
41
Sarbanes Oxley
• Many propose:
– Section 404 attestation provisions should be rolled back
for small companies, with an internal control review every
two years.
– The bar should be raised on what constitutes a “material
weakness” in internal controls.
– It is particularly foreign companies that are balking at
SOX.
• New markets are appearing…
– Chi-X a London-based joint venture that claims it will offer
cheaper trading in European stocks
– Equiduct, and all-electronic, Pan-European exchange
based in Belgium
– Goldman Sachs, Merrill Lynch, Morgan Stanley, Citigroup,
Credit Suisse, UBS, and Deutsche Bank reportedly will
form a consortium to trade equities across Europe
(already announced the same for US…)
42
Sarbanes Oxley
• U.S. is losing out on new international listings…
– London is beating the U.S. in the number of IPOs it draws.
– Last year, the NYSE drew 192 IPOs and Nasdaq 126.
– The LSE, often cited as the example of how SOX is
chasing companies away, attracted a robust 617 IPOs,
510 of which were on the AIM, the exchanges small-cap
market.
– However, the U.S. IPOs are larger.
• Of a total of $118.2 billion raised through IPOs in 2006
– $17.5 billion occurred on the LSE, $4.2 billion on AIM
– $16.9 billion on the NYSE
– $9.4 billion on Nasdaq
– $0.2 billion on AMEX, according to Thomson Financial.
43
NYSE Corporate Governance
• Listed companies to have boards of
directors with a majority of
independents
• The compensation, nominating, and
audit committees to be entirely
composed of independent directors
• The publication of corporate governance
guidelines and reporting of annual
evaluation of the board and CEO
44
Cadbury Code of Best
Practice
• Corporate scandals in the 1980s and 1990s
– Bankruptcy of Ferranti, Colorol Group, BCCI, and Maxwell
Group
• Cadbury Code
– Boards of directors of public companies include at least
three outside (non-executive) directors
– The positions of CEO and chairman of the board of these
companies be held by two different individuals
• Cadbury Code is not legislated into law
• LSE requires companies to “comply or explain.”
• Empirical research suggests the code has been
effective despite not being enforceable in courts…
45
Corporate Governance
Indices
• FTSE ISS Corporate Governance Index
Series (CGI)
• Quantifying the risk of corporate governance
across international markets has posed a
challenge for investors trying to deal with the
increased recognition of the issue.
• The new FTSE ISS Corporate Governance
Index (CGI) Series assists you with company
analysis, portfolio management and stock
selection against selected companies with a
proven standard in corporate governance.
• The series is the result of a collaboration
between FTSE and corporate governance
experts ISS, two market leaders in their
respective fields. The design incorporates ISS
corporate governance ratings into a financial
index.
• You will now be able to track the financial
performance of companies against the
universal themes in corporate governance
practice of:
– Compensation systems for Executive and Non
Executive Directors
– Executive and Non-Executive stock ownership
– Equity Structure
– Structure and independence of the Board
– Independence and integrity of the audit
process
– The series consists of six regional and country
equity indices covering 24 developed countries
as defined by the FTSE Global Equity Index
Series.
http://www.issproxy.com/institutional/cgi/index.jsp
46
FTSE ISS CGI
47
Corporate Governance Around the
World
• European Corporate Governance
Institute
• http://www.ecgi.org/codes/all_codes.ph
p
48
Parmalat
• How was it possible for Parmalat managers to
“cook the books” and hide it for so long?
• Investigate and discuss the role that
international banks and auditors might have
played in Parmalat’s collapse.
• Study and discuss Italy’s corporate
governance regime and its role in the failure
of Parmalat.
49
Satyam Systems
• A global IT company based in India
• Satyam's CEO, Ramalingam Raju, took
responsibility for broad accounting improprieties
that overstated the company's revenues and
profits and reported a cash holding of
approximately $1.04 billion that simply did not
exist.
• They usually start by fudging the number a little-
-and then it grows
• What started as a marginal gap between actual
operating profits and ones reflected in the books
of accounts continued to grow over the years.
Satyam Systems
• World Council for Corporate Governance awarded
Satyam its Golden Peacock Award for Corporate
Governance in 2008
• When an accounting fraud involves reporting cash
that is not there, it is typically the result of adding
fraudulent transactions, such as cash sales, to
customers that never happened. These types of
transactions should have been audited to assure
their legitimacy. In the case of Satyam, the
auditors signed off on the financial reports
• We also need stiffer penalties. Simply put, "white
collar" crime cannot be viewed as less of an evil
than any other form of crime
• If there isn't sufficient belief in the notion that
business will act in good faith, then the capitalist
system is itself at risk.
Conclusions
• Agency conflicts may arise between managers and
controlling shareholders on the one hand and outside
shareholders on the other hand.
• Corporate governance: protecting shareholders against
expropriation by managers and controlling shareholders.
• Mechanisms to control agency problems: strengthening the
independence of boards of directors, providing managers
with incentive contracts, concentrating ownership, using
debt, cross-listing to bond to better investor protection, and
facilitating the market for corporate control.
• The legal origin influences shareholder protection and
enforcement of laws, and this in turn has consequences for
corporate valuations.
• Tradeoff concentrated ownership and lack of investor
protection.
• Corporate governance reform is an uphill battle…
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