corporate governance developments and implications for europe prof. florencio lópez-de-silanes yale...

Corporate Governance Developments and Implications for Europe

Prof. Florencio López-de-Silanes

Yale University

International Institute for Corporate Governance

Paris, France

October 21st, 2003. © Florencio Lopez-de-Silanes

2

© Florencio Lopez-de-Silanes

Conflicts of Interest all Over

Recent experiences (e.g. Ahold in the Netherlands, ABB in Switzerland, Vivendi in France, Sibneft in Russia, SK Telecom in Korea, Enron in the US, or Toyota in Japan) show the need for a better understanding of related-party / self-interested transactions if we are to understand minority shareholder’s protection.

Conflicts of interest arise all over the world and are not exclusive of certain countries.

3


Outline

I. The Impact of US Corporate Governance scandals on Europe

II. What do we know about Corporate Governance that can help?

1. What aspects should we concentrate on?

2. What about Judicial Enforcement?

III. Challenges ahead

4


Common Failures of Corporate Governace

Causes of recent Corporate Governance scandals:

1. Bridge of fiduciary duties (duty of loyalty and duty of care)

a. Lack of independence

b. Conflict of interests

2. Insuficient information on accounting and related transactions

a. High rik accounting practices

b. Off-the-books activities

Consequences:

1. Related transactions benefitting directors and controlling shareholders.

2. Excesive diretors’ compensation.

3. Auditors, lawyers, analists and financial intermediaries with divided loyalties.

5


The Impact of US Scandals

US scandals generated a large regulatory reaction from all sides (Sarbanes-Oxley Act, NYSE & Nasdaq Regulations, etc..)

The new set of rules has 2 main impacts on Europe:

1. Raised the awareness of the relevance of Corporate Governance: Shown that CG needs to be a continuous reform Lifted the standards in many areas Focused energy in two areas:

Accounting and Auditing Conflicts of Interest, particularly relevant for countries with

concentrated ownership and groups

So, European initiatives have been revitalized or accelerated

6



The new set of rules has 2 main impacts on Europe:

2. De facto Exported regulation for foreign listings in the US markets:

Applies to: Firms with ADRs Firms that file reports under SEC Act (including European

firms filling Form 20-F)

So, close to 1000 non-US firms are affected: 469 non-US firms (185 European) list on NYSE 451 non-US firms (149 European) list on NASDAQ ½ of UK’s FTSE 100 has a secondary listing

7



Regulatory spill-over is increasingly common in transatlantic arena:

European & US economies are so interwoven that it is difficult for the impact of the law to come to a complete halt at either border

Europe started its own process of reform in 1999 with the Financial Services Action plan towards the integration of EU capital markets:

1. International Accounting Standards Regulation by 2005

2. Prospectus Directive

3. Transparency Obligations Directive

4. Investment Services Directive

5. Market Abuse Directive

6. Takeover Directive

These, as European competition policy has, will also impact US firms

8


Outline

I. The Impact of US Corporate Governance scandals on Europe.





9


The Legal Approach to Corporate Governance

The law and its enforcement are key mechanisms of investor protection.

When investors finance firms, they receive rights or powers in exchange. Without an ability to enforce rights, investors might end up with nothing.

Implication: Strong investor protection leads to deeper financial markets & better financing terms for firms.

•Company law•Bankruptcy law•Securities law•Takeover law•Courts & Regulators

•Protect Shareholders & Creditors

•Force timely disclosure of accurate information

10


Two Views On How Securities Laws May Matter

Two complementary views on why securities laws are beneficial for the development of securities markets.

Private enforcement view. Financial contracts are too costly to enforce when regulated only by contract and tort law.

o Key contribution to standardize contracts (e.g., mandatory disclosure rules) and simplify private litigation (e.g., describing obligations and liabilities of various parties and establishing the burden of the proof).

Public enforcement view. Private incentives to enforce contracts are insufficient (e.g., free-rider problems, development of precedents).

o Key contribution is to create a public enforcer.o Focused and independent from political interference; with powers to

obtain information and impose sanctions on issuers and market participants.

11


Public Enforcement and Financial Markets

coef = .25253782, (robust) se = .20541086, t = 1.23

Mar

ket

Cap

ital

izat

ion

/ GN

P(a

ll e

lse

equa

l)

Public Enforcement (all else equal)-.534415 .3508

-.530406

.86197

JPN

ZAF

IRL

NGA

PAK

AUT

LKAESP

CHE

NZL

NOR

KOR

CHIEGY

DNK

FIN

MEXZWE

ARG

DEUGRC

BEL

TWA

SWE

ECU

NID

COL

PRTBRAIND

ITA

GBR

URY

IDN

KENTUR

VEN

JORTHA

PERCAN

HKG

USAMYSPHL

ISR

FRA

SGP

AUS

12


Laws that Facilitate Private Enforcement Deeper Financial Markets

coef = .71131062, (robust) se = .15351288, t = 4.63

Mar

ket

Cap

ital

izat

ion

/ GN

P(a

ll e

lse

equa

l)

Private Enforcement (all else equal)-.383308 .433087

-.530406

.86197

URY

AUT

ECU

ARG

CHI

COL

BRADEU

NOR

VENPAK

SWE

NZL

FRAGRC

EGY

IRLESP

TURZWE

PER

GBR

KEN

FIN

MEX

PRT

HKG

JPN

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CHE

NGAITA

ISR

LKA

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IND

BEL

MYS

SGP

TWA

DNKCAN

IDNUSA

THA

NID

KOR

PHL

13


More Disclosure about Conflicts of Interest Deeper Financial Markets

coef = .58127359, (robust) se = .1376864, t = 4.22

Mar

ket

Cap

ital

izat

ion

/ GN

P(a

ll e

lse

equa

l)

Disclosure Requirements (all else equal)-.49042 .479462

-.530406

.86197

URY

ECU

BRA

AUT

PERVEN

CHI

ESP

GRC

COL

ARG

PRT

NOR

PAK

FIN

ZWE

NZL

SWE

KEN

NID

IRL

DEU

GBR

EGY

JPN

AUS

ISR

DNK

TURBEL

IDNZAF

NGA

HKG

CAN

CHE

FRA

IND

TWA

LKA

USA

MEX

MYSJOR

ITA

KORSGP

PHL THA

14


15


Shifting the Burden of Proof to the Accused Deeper Financial Markets

coef = .40931822, (robust) se = .13112176, t = 3.12

Mar

ket

Cap

ital

izat

ion

/ GN

P(a

ll e

lse

equa

l)

Burden of Proof (all else equal)-.351049 .576335

-.530406

.86197

ARG

COLDEU

CHI

AUT

FRA

URY

SWE

NOR

MEX

NZL

PAK

TUREGY

BRA

ECUITAVEN

IRL

HKG

GBR

JOR

CHE

THA

LKA

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ZAF

NGA

JPN

KEN

GRC

SGP

AUSIND

ESP

MYSFIN

ISR

TWA

PRT

BEL

PER

KOR

USA

CAN

DNK

IDNNID

PHL

16


17


Outline






18


Higher Levels of Court Formalism Longer Duration of Judicial Processes

coef = .31096164, (robust) se = .05177885, t = 6.01

Log

of

Du

rati

on

Formalism (all else equal)-2.41689 2.46151

-3.26529

1.75909

HKGBLZ

ZMB

ZAF

TTO

NZLTCA

UGA

AIA

AUS

GHA

BMU

JAM

MWIMYS

CAN

TURBRB

KEN

MLT

NGATWNZWEGEO

GIBBGD

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IDNFIN

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CYP

TUN

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DOM

COL

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ARE

PRTURY

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BGR

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MAR

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ECU

PHL

MEX

LBN

BOLCRIPER

GTM

ESP

ARG

PRYPAN

VEN

(all

els

e eq

ual)

19


Higher Levels of Court Formalism Lower Levels of Legal Fairness and Impartiality in the System

coef = -.41804976, (robust) se = .06001672, t = -6.97

Leg

al S

yste

m is

Fai

r an

d Im

part

ial

-2.38021 2.21613

-1.64229

1.84195

BLZ

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TUR

UGA

GBRGHA

USA

MWI

SWE

KEN

GEO

BRA

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HUNDEU

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Formalism (all else equal)

(all

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ual)

20


Outline





III. Challenges Ahead

21


Challenges Ahead

The impact of the US Corporate Governance reforms will spill-over to impact the future of European markets.

The real problem is the fact that capital markets in US and Europe have become global institutions and thus act as transmission belts.

The challenge for Europe is complicated as it is in the middle of transformation, enlargement, and integration of its capital markets.

22


Challenges Ahead

But more importantly, the evidence raised here suggests that there are 3 essential ingredients for the system to work in the long run:

1. Better investor rights in corporate laws, strong regulation on disclosure and accounting standards.

2. Regulations and laws that facilitate shareholder actions and private enforcement.

3. A well functioning judicial system which allows the functioning of financial markets and business transactions in general.

23


Appendix

24


The Rigas of Adelphia

Over $2.5 BillionOver $2.5 Billion co-borrowed by family entities. co-borrowed by family entities. $1.4 B used to buy shares in Adelphia.$1.4 B used to buy shares in Adelphia. $200 M to fund margin call payments on loans

secured by Adelphia securities.

Guaranteed $120 M to Rigas entity controlling Buffalo Sabres hockey team.

$3.5 M in unsecured loans made to Rigas family. $12 M to build golf course next to Rigas’ estate

Use of Adelphia-owned aircraft and apartments without charge for personal purposes.

Adelphia services provided free of charge to Rigas entities, e.g. advertising.

25


Main Sarbanes-Oxley Requirements Applicable to Foreign Companies Listing in the US

I. Directors and Executive Officers

1. CEO and CFO certification requirements

2. Prohibition on personal loans to executives

3. Code of ethics for senior financial officers

4. Forfeiture of bonuses and profits if accounting restatements

5. Prohibition of Improper influence on Auditor

6. May be barred from serving as officer or director if conduct is unfit

II. Audit Committee

Have an audit committee comprised of independent directors and with someone with financial expertise, etc..

Audit committee hires, oversees & discharges independent auditors Procedure for handling whistle blowers.

26


Main Sarbanes-Oxley Requirements Applicable to Foreign Companies Listing in the US

III. Auditors1. Prohibition of Audit services if officer worked there 1 year before2. Rotation of audit partner every 5 years certification requirements3. Prohibition to give non-auditing services to the firm4. Public Company Accounting Oversight Board: firms to register / be

subject

IV. Expanded Company Disclosures:

Restrictions on use of pro-forma financial information Disclose all material off-balance sheet transaction Management and Auditor assessment of Internal Controls Real time disclosures

V. Counsel’s Responsibility to report material violations

VI. Criminalization of Misconduct for participants

27



SOX was created to protect US investors, so presumption is for no omission for foreign firms issuing in the US.

This has created a virulent European reaction: 61% European CEOs say they will turn their back to US markets

Porsche did decide not to cross-list in the US Auditing and Legal firms are not pleased “These are US solutions for US problems”

SEC has conceded some ground: Concessions on independence of audit committees Exemption to explain financial information not conforming to

US-GAAP But unlikely SEC will give in much more

28


Challenges Ahead

The impact of the US Corporate Governance reforms will spill-over to impact the future of the European Union markets.

The real problem is the fact that capital markets in US and Europe have become global institutions and thus act as transmission belts.

The challenges for the EU are more complicated as it is in the middle of the transformation, enlargement, and integration of its capital markets.

The road to an integrated EU capital market by 2006 will require: Agreement on a definition of a public offering for EU EU “passport” for EU issuers across EU markets Unique EU clearing and settlement system Transparency and comparability of financial reporting

29


coef = 4.7998059, (robust) se = 1.668115, t = 2.88

IPO

s / P

opul

atio

n(a

ll e

lse

equa

l)


-4.74683

6.34918

URY

ECU

AUTCOL

ARGCHIBRA

VEN

DEU

FRANOR

SWE

PAK

PER

NZL

TUR

AUS

GRC

HKG

KEN

GBR

EGYZWE

ESPPRT

ISR

IRL

FIN

MEXJOR

ITA

SGP

MYS

IND

CHE

NGA

BEL

LKA

CAN

ZAFJPNUSA

TWA

THA

IDN

DNK

NID

KOR

PHL

Private Enforcement More IPOs (Controlling for Public Enforcement)

30


coef = 2.5366363, (robust) se = .6580322, t = 3.85

Acc

ess

to E

qui

ty(a

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-1.96349

1.2934

ECUARG

AUT

COL

BRA

CHI

VEN

FRA

DEU

NOR

SWE

TUR

PER

AUS

GRC

NZL

HKG

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JPN

DNK

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Private Enforcement Greater Access to Equity (Controlling for Public Enforcement)

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