Download Lecture 1

The Modern Corporation and
Corporate Governance:
An Overview
Professor Alexander Settles
Faculty of Management, State University
– Higher School of Economics
Email: [email protected]
Class Rules
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Students must attend all lectures and seminars.
Those students that arrive late will have to wait
until the break between sessions to enter and
will receive credit for attendance for the second
session.
Students must be prepared for class, complete
all readings, and be ready to take notes
Students may not talk during class. Students
are expected to participate in class discussion
but are not to interrupt the lecturer or other
students
Students may not enter or leave the class
during the lecture unless for emergency reasons
Students must turn off or place on silent mobile
phones and may NOT use computers or other
devices for entertainment purposes
Class Overview – Schedule Settles
17.02 – Course introduction, Corporate Governance,
Globalization and BRICS
24.02 –Using Management Research, topic
development and group formation
10.03 – Corporate governance overview in
international context
17.03 – Valuation and Corporate Governance
Ratings
31.03 - IPO, mergers and acquisitions, and foreign
market entry for Russian corporations
14.04 – Financial Crisis and SWF
21.04 – Compensation, and regulation
28.04 – Corporate Social Responsibility
Course Requirements
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Send me an email at
[email protected]
50% - Paper - Settles
10% - Attendance to lectures Settles
40% - Seminar Grade (Test and
attendance) - Tomoradze
Due Dates
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Proposal March 3rd
Review of literature March 31st
Draft paper due April 14th
Final paper due May 15th
Your failure to plan or act is not my
problem – no action = failing grade
Topic Proposal
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Title of paper
Research question
Literature review
Proposed methods
Anticipated results
3 pages
Potential Topics
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Cross-listing and IPO of emerging
market firms (Russia and Brazil)
Globalization and risk
Cross-border merger and
acquisitions
Cross-country comparison of
management and governance: Do
managers have a comparative
advantage?
Potential Topics
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Difference in business environment:
Convergence or divergence in governance
or management practices
Behavior of Directors and TMT in a cross
cultural context
Privatization
CSR: Issues and Application across three
models Russia, US, and Europe
Shirking and Stealing: How Corporate
Governance Protects Investors
Learning objectives
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Corporate Governance and
Competitiveness
Investor Protection
Role of Public Sector in Setting
Framework for Good Corporate
Governance
Knowledge about theory of board
operation and Role of directors
Theories of board organization
Regulation concerning corporate boards
Practice in corporate boards
Why is Corporate Governance
Important to Russia firms?
Corporate Governance Introduction
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What is Corporate Governance?
Definition of “Governance” vs.
“Administration,” “Management,” or
“Control”
Corporate Governance structures
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Board of Directors
Chair of the Board
Corporate Secretary
Shareholders – General Meeting of
Shareholders
Why is it important to corporate finance?
Cost of Capital
What is a Corporation?
“The business corporation is an instrument
through which capital is assembled for the
activities of producing and distributing goods
and services and making investments.
Accordingly, a basic premise of corporation law
is that a business corporation should have as its
objective the conduct of such activities with a
view to enhancing the corporation’s profit and
the gains of the corporation’s owners, that is,
the shareholders.” Melvin Aaron Eisenberg
What is a Corporation?
“When they [the individuals composing a corporation] are
consolidated and united into a corporation, they and their
successors are then considered as one person in law . . .
For all the individual members that have existed from the
foundation to the present time, or that shall ever hereafter
exist, are but one person in law – a person that never
dies: in like manner as the river Thames is still the same
river, though the parts which composite are changing
every instant.” Blackstone
“An ingenious device for obtaining individual profit without
individual responsibility.” Ambrose Bierce, The Devil’s
Dictionary
Corporate Form
1. limited liability for investors;
2. free transferability of investor interests;
3. legal personality (entity-attributable
powers, life span, and purpose); and
4. centralized management.
Corporate Governance Definitions
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OECD – “internal means by which a
corporations are operated and
controlled … which involve a set of
relationships between a company’s
management, its board, its
shareholders and other
stakeholders.”
IFC – Russia Corporate
Governance Manual
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Corporate Governance is a system of
relationships, defined by structures and process.
[Shareholders – Management]
These relationships may involve parties with
different and sometimes contrasting interests.
All parties are involved in the direction and
control of the company
All this is done to properly distribute rights and
responsibilities – and thus increase long term
shareholder value.
Definitions
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“Corporate governance deals with
the ways in which suppliers of
finance to corporations assure
themselves of getting a return on
their investment”, The Journal of
Finance, Shleifer and Vishny [1997,
page 737].
Other Definitions
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"Corporate governance is about promoting
corporate fairness, transparency and
accountability" J. Wolfensohn, president of the
Word bank, as quoted by an article in Financial
Times, June 21, 1999.
“The directors of companies, being managers of
other people's money than their own, it cannot
well be expected that they should watch over it
with the same anxious vigilance with which the
partners in a private co-partnery frequently watch
over their own.” Adam Smith, The Wealth of
Nations 1776
Corporate Governance System
Corporate Governance
Basics of Corporate Governance
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By issuing corporate securities, firms sell claims
to control the companies` ressources
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The interests of the various securityholders differ
Separation of owership and control implies agency
relationships.
Interests of agents (management) are different
from those of securityholders, particulary from
those of stockholders.
Monitoring the activities of agents is costly - hence,
full monitoring is not optimal.
The value forgone due to imperfect optimal
monitoring is an explicit agency cost.
Contract Theory of Corporate
Governance
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Contract are arranged between
principles (owners) and agent
(managers)
Contracts are also made between
the firm and providers of capital
Problems with contracts:
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Moral Hazard
Incomplete contracts
Adverse selection bias
Agency Problem
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Managerial discretion - Business
judgement
Managerial opportunism – self
dealing
Duty of loyalty of management to
firm
Fiduciary Duty
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The fiduciary duty is a legal relationship between two
or more parties (most commonly a "fiduciary" or
"trustee" and a "principal" or "beneficiary") that in
English common law is arguably the most important
concept within the portion of the legal system known
as equity.
A fiduciary will be liable to account if it is proved that
the profit, benefit, or gain was acquired by one of three
means:
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In circumstances of conflict of duty and interest
In circumstances of conflict of duty and duty
By taking advantage of the fiduciary position.
Therefore, it is said the fiduciary has a duty not to be
in a situation where personal interests and fiduciary
duty conflict, a duty not to be in a situation where their
fiduciary duty conflicts with another fiduciary duty, and
not to profit from their fiduciary position without
express knowledge and consent. A fiduciary cannot
have a conflict of interest.
Fiduciary Duty
Agency Problem Duty of loyalty of
management to firm
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Incentive contracts that align
management interests with
investors
Agency costs – monitoring and
compliance
Shareholder actions- shareholder
democracy, proxy fights, access to
the proxy ballot, derivative lawsuits
Four core values of the OECD
corporate governance framework
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Fairness: The corporate governance
framework should protect shareholder
rights and ensure the equitable treatment
of all shareholders, including minority and
foreign shareholders.
Responsibility: The corporate governance
framework should recognize the rights of
stakeholders as established by law, and
encourage active co-operation between
corporations and stakeholders in creating
wealth, jobs, and the sustainability of
financially sound enterprises.
OECD Core Values
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Transparency: The corporate governance
framework should ensure that timely and
accurate disclosure is made on all
material matters regarding the company,
including its financial situation,
performance, ownership, and governance
structure.
Accountability: The corporate governance
framework should ensure the strategic
guidance of the company, the effective
monitoring of management by the board,
and the board’s accountability to the
company and shareholders.
Advantages of Good Corporate
Governance
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Stimulating Performance and Improving
Operational Efficiency
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Better oversight and accountability
Improved decision making
Better compliance and less conflict
Less self-dealing
Better informed
Avoidance of costly litigation through
adherence to laws and regulations
Advantages of Good Corporate
Governance
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Improving Access to Capital Markets
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Transparency, accessibility, efficiency,
timeliness, completeness, and accuracy
of information critical
Listing requirements
Inclusion of Corporate Governance in
investment decision process
Accounting Scandal and Reform in the
US and Western Europe
Crisis in Governance 1999 - 2002
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Enron – fraud and
oversight failure
Worldcom –
accounting fraud
Adelphia – RPT
securities
violations, and
accounting fraud
Arthur Anderson
More detailed list
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AOL
Adelphia
Bristol-Myers Squibb
Duke Energy
Dynegy
El Paso Corporation
Enron
Freddie Mac
Global Crossing
Halliburton
Harken Energy
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ImClone Systems
Kmart
Lucent Technologies
Merrill Lynch
Qwest
Communications
Reliant Energy
Sunbeam
Tyco International
Waste Management,
Inc.
WorldCom
SOX reforms to US Corporate
Governance
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Auditor independence
Corporate Officer Responsibility for
financial statements
Internal Control Sections 404 and
302
Significant increase in monitoring
costs for PLCs
Market Size
Anglo-Saxon Model
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US, UK, Canada, Australia, New Zealand
Shareholder value maximization
“outsider” model – arms length investor
Internal governance mechanisms
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External mechanisms
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board of directors
employee compensation
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
Market for Corporate Control
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“Friendly Takeover”
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When a bidder makes an offer for another, it
will usually inform the board of the target
beforehand. If the board feels that the value
that the shareholders will get will be greatest
by accepting the offer, it will recommend the
offer be accepted by the shareholders.
A takeover would be considered "hostile"
if
1) the board rejects the offer, but the bidder
continues to pursue it, or
2) if the bidder makes the offer without
informing the board beforehand.
German (Continental) Model
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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
Japanese Model
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Formal role of large and almost entirely executive
boards – single tier board
Historical roots of the Keiretsu network
interlocking business relationships
Existence of significant cross holdings and
interlocking-directorships,
Lifetime employment system plays in corporate
policy
Role of banks
Market share maximization over shareholder
value maximization
Long term perspective
Corporate Governance Framework
in Russia
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Concentrated Ownership
Little separation between ownership and
control
Unwieldy holding structures used to hide
beneficial ownership, avoid taxes, or steal
from minority owners
Reorganizations to dilute minority stakes
Inexperienced Supervisory Board (Boards
of Directors)
Theory
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Berle and Means (1932) –
separation of ownership and control
through modern corporation
structures
Agency Problem
Control Mechanisms
Conventional Wisdom
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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.
Some Early Research (Manne 1971)
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First classical role
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Found that boards of directors of most large
and medium-sized companies do not
establish objectives, strategies, and policies
however defined
These roles are performed by company
management
Presidents and outside directors generally
agreed that only management can and
should have these responsibilities.
Some Early Research (Manne 1971)
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A second classical role assigned to boards of
directors is that of asking discerning questions inside and outside the board meetings. Again it
was found that directors do not, in fact, do this.
Board meetings are not regarded as proper
forums for discussions arising out of questions
asked by board members.
A third classical role usually regarded as a
responsibility of the board of directors is the
selection of the president. Yet it was found that
in most companies directors do not in fact
select the president, except in the two crisis
situations cited earlier.
Stewardship theory
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Stewardship theory, the alternative
perspective, takes an altogether
broader frame of reference, being
based on the original and legal view
of the corporation in which directors
have a fiduciary duty to their
shareholders to be stewards for
their interests.
Stewardship Theory
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Muth and Donaldson (1997) challenged
agency theory, which underpin
conventional assumptions about the
benefits of checks and balances –
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Boards with well connected, executive
directors perform better than those that meet
the paradigms of conventional governance
thinking
Also research has shown that increasing
governance conformance and compliance
may not add to corporate performance - it
can actually detract - Donaldson and
Davies (1994)
Introduction to Corporate
Governance Structures
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Supervisory Board (Board of
Directors)
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Central role in Corporate Governance
framework
Sets strategy, business priorities,
annual financial and business plan, and
oversees managerial performance
Oversees the work of the General
Director (CEO) and the Executive Board
Role of Supervisory Board
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Protecting the interests of the company and
its shareholders
Defining the Boards role and priorities
Setting the company’s governance
framework
Organizing the General Meeting of
Shareholders,
Protection of company assets
Resolution of conflicts
Supervision of internal controls and risk
management
Types of Directors
a) Executive Directors
Executive directors can be defined as
those that also hold an executive
position in the company, namely
that of:
The General Director;
An Executive Board member; or
A manager of the company who is not an
Executive Board member.
Types of Directors
b) Non-Executive Directors
Non-executive directors are Supervisory Board
members that do not hold an executive
position in the company.
c) Independent Directors
Russian law does not define the concept of
independent directors. The Company Law
does, however, refer to independent directors
under specific circumstances to determine the
position of individuals engaged in related party
transactions and to prevent possible conflicts
of interests.
Independent Director
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In this respect, an independent director is defined as
an individual who has not been in any of the following
positions at the time of the approval of a business
transaction, or during one year immediately preceding
the approval of such a transaction:
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The General Director, the External Manager, an
Executive Board member or a member of the
governing bodies (Supervisory Board, General Director
and Executive Board) of the External Manager; or
A person whose spouse, parents, children, brothers,
and sisters by one or both parents are the External
Manager or hold a position in the governing bodies of
the External Manager; or
A person whose adoptive parents or adopted children
are the External Manager or hold a position in the
governing bodies or the External Manager; or
An affiliated person other than a director of the
company.
What is Independence?
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Independence of a Director: a Director must
always act in a manner independent of
management and never be conflicted by any
relationship to management (i.e., financial,
familial, or social). Independence measurements
include:
Relatedness of the Director:
- Employee (in last three years);
- Professional advisor (in last three years);
- Executive of any affiliated company;
- Other income from company;
- Kinship or social ties;
• Interlocks with other Directors;
• Number of Boards on which Director serves.
The Election of Directors
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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. The election of directors
cannot be done if a GMS is held by written consent.
How Cumulative Voting Works:
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Candidates for the Supervisory Board are voted on
collectively, i.e. as a group;
Each shareholder has a maximum number of votes equal to
the number of directors that must be elected (according to
the charter or a decision of the GMS) multiplied by the
number of voting shares held;
Shareholders can allocate their votes to one candidate or
divide them among several candidates as they please;
The top X candidates with the most votes are considered
elected, whereby X equals the number of Supervisory Board
members to be elected as specified by the charter or the
decision of the GMS.
Cumulative Voting: Minimum number of
votes to elect one director
where D — the number of directors to be
elected, S — the number of outstanding voting
shares and n — the total number of directors the
majority shareholder wants to elect
Company Practices in Russia
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Representatives of major shareholders
(35%),management and employees (30%) are
the most common types of directors,
Independent directors (18%) and minority
shareholder representatives (9%) still constitute a
minority on most Supervisory Boards.
A positive correlation exists between the number
of shareholders in a company and the number of
representatives of majority shareholders on the
Supervisory Board. Hence, Supervisory Boards of
large companies with many shareholders tend to
include more representatives of large
shareholders.
Governance is Different from
Management
Governance
Management
Governance and Management
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Management runs the business
the board ensures that the business
is well run and run in the right
direction
Functions of the board
Outward
looking
Providing
Accountability
Strategy Formulation
Approve and work
through the CEO
Inward
Looking
Monitoring and
Supervising
Past and present focused
Policy Making and
Revising
Future Focused
All Executive Board
Governance
O
O
O
O
O
O - executive directors
Management
Majority – executive board
Governance
N
N
N
O
O
O
O - executive directors
N – non executive
directors
O
Management
Majority – non executive board
Governance
N
N
N
O
O - executive directors
N – non executive
directors
N
O
O
Management
Two – tier board
N
N
Governance
N
N
N
N
N
N
N
O
O
O
O
O - executive directors
N – non executive
directors
O
Management
Wimm-Bill-Dann Board of Directors
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One tier board in the US / UK model
Members
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David Iakobachvili Chairman - non-excutive & dependent
(owns 9.46%)
Sergei A. Plastinin Director, Chairman of Management Board
and Head of Dairy Business Unit - Executive (owns 12.16%)
Guy de Selliers Director - non-executive and indepedent
Mikhail V. Dubinin Director - executive (owns 6.83%)
Michael A. O'Neil Director - non-executive and independent
(?)
Alexander S. Orlov Director - executive (owns 4.39%)
Vladimir N. Sherbak Director - non-excutive and dependent
Victor A. Tutelyan Director - non-executive and indepedent
Earnest Linwood Tipton Director - non-excutive and
indepedent
Evgeny G. Yasin Director - non-excutive and independent
Gavril A. Yushvaev Director - non-excutive and depedent
(owns 18.80%)
Ownership
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Party to the Amended and Restated
Partnership and Cooperation Agreement.
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Mikhail I Vishyakov (owns 2.59%)
Evgeny L. Yaroslavsky (owns 1.43%)
Vicktor E. Evdokimov (owns 0.42%)
Other Owners
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Parex Bank JSC (owns 5.29%)
Templeton Strategic Emerging Markets Fund
LDC (owns 1.18%)
Others own 4.74% of Russian traded shares
American Depositary Receipt Holders own
32.70%
Wimm – Bill – Dann
Governance
N/O
N/I
N/I
N/I
N/D
N/D
N/I
E/O
N/I
E/O
E/O - executive /owners directors
N/I – non executive directors/independent
N/O – non executive directors/ owners
N/D – non executive directors/dependent
E/O
Management
Wimm – Bill – Dann Committees
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Audit Committee – 3 independent
directors
The Committee for Investment and
Strategic Planning – 1 independent
& 2 dependent directors
Committee for Personnel and
Remuneration – 1 independent
director & 1 dependent director
Compensation of Board Members
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Board member receive $50,000 annually
plus transportation and lodging expenses
incurred in connection with board meeting
attendance, and up to $2,000 per year for
other expenses
Chairman of the Board is compensated
$300,000
Members of the Personnel and
Compensation Committee & Investment
and Strategic Planning Committee
receive $3,000 and each member of the
Audit Committee receive $5,000 for
participation in each planned direct
Committee meeting.
What does the Wimm – Bill – Dann
Case Indicate?
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Outside investors should know the
following:
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Board members are directors,
executives & managers
Majority of ownership is controlled
through a shareholder agreement
No threat of takeover without ownermanager consent
Board and committees are structured
to meet NYSE requirements for CG
Corporate Governance and
Initial Public Offerings
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Corporate Governance is a principle
variable in evaluating risk / setting
discount for IPOs
Firms reaching the market make
significant CG changes to their
board structure and practices to
conform to market expectations
Role of the Board in a Public Company
IPO / Listing Experience
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The Board
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Effectiveness
Talents and background of board
members
Tying board remuneration closely to
performance
Strategic thinking by the Board
Managing risk effectively
Role of the Board in Listing - IPO
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Developing a robust audit
committee
Taking corporate social
responsibility on board
Encouraging and active dialogue
with shareholders
The Effective Board
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Clear strategy aligned to capabilities
Vigorous implementation of strategy
Key performance drivers monitored
Effective risk management
Sharp focus on views of the capital
market and other key stakeholders
Regular evaluation of board
performance
What does the market look for in a
board member?
Asks the difficult questions
 Works well with others
 Has industry awareness
 Provides valuable input
 Is available when needed
 Is alert and inquisitive
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What does the market look for in a
board member?
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Has business knowledge
Contributes to committee work
Attends meetings
Speaks out appropriately at board
meetings
Prepares for meetings
Makes long-range planning contribution
Provides overall contribution
Implementing effective strategy and
change programs
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The blueprint for the strategy
The business case
The transformation program
A mobilized organization
A ‘transformation map’
The audit committee’s main
responsibilities
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To monitor the integrity of the financial
statements
To review the company’s internal
financial controls, internal control and
risk management systems.
To monitor/review the effectiveness of
the internal audit function.
To make recommendations to the board
on the appointment/removal of the
external auditor
The audit committee’s main
responsibilities
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To monitor/review the external auditor’s
independence/objectivity and the
effectiveness of the audit process.
To develop/implement policy on the
engagement of the external auditor to
supply non-audit services
To review arrangements by which staff
may raise concerns about possible
improprieties (‘whistleblowing’)
Flotation – who ends up steering the
boat?