lan030414zxi865-2351-zxi capital markets governance of corporates: how can capital markets exert...

LAN030414ZXI865-2351-ZXI

Capital Markets Governance of Corporates: How Can Capital Markets Exert Better Governance on Corporates

5th Annual Financial Markets and Development ConferenceApril 14-16, 2003

This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

Bob Felton, McKinsey & Company, Inc.

CONFIDENTIAL

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OVERALL, GOVERNANCE REFORM IS KEY TO IMPROVED ECONOMIC CONDITIONS IN EMERGING ECONOMIES

1. Emerging economies suffer major penalties due to weak governance and other market factors

2. Important barriers inhibit movement to improved governance

3. A combination of strong legal/regulatory reform and “free market” supervision appropriate path forward

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EMERGING ECONOMIES SUFFER MAJOR PENALTY DUE TO WEAK GOVERNANCE AND OTHER MARKET FACTORS

1. Quality of governance important factor in investment decisions

2. Investor say they are willing to pay a premium for good board governance

3. This survey information is supported by financial analysis

4. This lack of robust capital markets leads to weak and unstable corporate financial structures

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GOVERNANCE REMAINS IMPORTANT COMPARED TO FINANCIALS, PARTICULARLY IN EMERGING MARKETS

*Defined as effective boards of directors; broad disclosure, and strong rights and equal treatment for shareholders

Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002

Percentage of investors

Eastern Europe/Africa

Latin America

Asia

North America

Western Europe

2002

How important is corporate governance* relative to financial issues, e.g., profit performance and growth potential, in evaluating which companies you will invest in?

15

16

18

43

44

66

61

50

41

40

18

21

7

15

45

2000

20

33

36

25

32

44

39

39

48

23

25

36

Less important

Equally important

More important

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CORPORATE GOVERNANCE IS NOW AN ESTABLISHED INVESTMENT CRITERION

Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002

Decrease/increase holdings in certain companies

Avoidance of certain companies

Avoidance of certain countries

Decrease/increase holdings in certain countries

Percentage of investors selecting this option; multiple responses possible

How does corporate governance affect your investment decision?

31

28

57

63

“Our investment group would never approve an investment in a company with bad governance”

– U.S. investment manager, $20 billion private equity fund

“‘Good governance’ is a qualitative cut-off criteria”

– Analyst, $62 billion European Asset Manager

“I simply would not buy a company with poor corporate governance”

– CFO, $ 3 billion European Private Bank

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6Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002

A SIGNIFICANT MAJORITY OF INVESTORS SAY THEY ARE WILLING TO PAY A PREMIUM FOR A WELL-GOVERNED COMPANYPercentage of investors

Western Europe

Asia

North America

Latin America

Eastern Europe/Africa

2002

78

78

76

76

73

22

22

24

24

27

2000

81

89

81

83

19

11

19

17

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THE AVERAGE PREMIUM INVESTORS WOULD BE WILLING TO PAY DIFFERS BY COUNTRY . . .Average percent

Source: McKinsey investor opinion survey

18

20

22

24

26

28

30

0Anglo-Saxon

U.S.

U.K.

Asia

Japan

Indonesia

Korea

ThailandMalaysia

Taiwan

Continental Europe

Italy

Switzerland

Germany

France

Spain

Latin America

ChileArgentina

MexicoBrazil

ColumbiaVenezuela

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245

138

106

72 65

120

42

Market cap per GDP (%)

KOREA’S EQUITY MARKET SIGNIFICANTLY UNDERDEVELOPED AND UNDERPERFORMING

Japa

n

U.K.

U.S.

Ger

man

y

Fran

ce

Korea

Significantly undersized equity market compared to leading economies

Bench

mar

k

aver

age

Source: Bloomberg; EIU; McKinsey analysis

Equity market capitalization comparison*June 2001

Underdeveloped

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COMPOSITION OF PRIVATE SECTOR LIABILITIES, 1997 Percent

Source: Bank for International Settlements; International Monetary Fund; International finance Corporation (IFC); International Federation of Stock Exchanges (FIBV); World Bank

25

44 4855 56

76 77 7787

25

5151

29

42

16 18 168

50

5 1

16

28 5 7 5

Bank loans

Bonds

Equity

U.S. Hong Kong Taiwan Malaysia Singapore Indonesia China Korea Thailand

In 2000, Korea improved to 55% bank loans, 25% bonds, and 20% equity

In 2000, U.S. changed to 50% equity, 35% bonds, and 15% bank loan

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TOTAL RETURN TO SHAREHOLDERS: S&P 500 VS. KOSPI

Source: Datastream; McKinsey analysis

0

100

200

300

400

500

600

'91 11/2001

1991-2001, percent

S&P500 : 13.0% per annum return

KOSPI : -3.8% per annum return

1991-2001

• $100 invested in the S&P500 index would be worth $340

• However, $100 invested in the KOSPI index would only be worth $68

• Korean shareholders have been seriously unrewarded for their investments

Poor performance over time

‘96

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3.48

2.48 2.382.05 2.05

2.25

0.96

MARKET-TO-BOOK COMPARISON

U.S. U.K.JapanFrance Germany Korea

June 2001, ratio*

*Sum of 2001 market cap (January-June) divided by sum of book value (2000)

Source: Bloomberg; McKinsey analysis

Bench-mark average

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PE RATIO COMPARISONJuly-Dec 2001, ratio*

*Sum of market cap divided by sum of forecasted earnings

**Companies whose market cap combines to account for 80% of total country market cap; excludes outliers (companies whose PE ratios were 3 standard deviations away from country average)

Source: Bloomberg; McKinsey analysis; I/D/E/C

Korea’s PE ratio is significantly lower than that of other countries

2826

2422

19

24

9

Japan U.K.U.S.Germany France KoreaBench-mark average

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June 2001, PE ratio INDUSTRY PE COMPARISON*

*Only compared for those industries in which Korean companies operate

Source: Bloomberg; McKinsey analysis

Tel

eco

mm

un

icat

ion

s

Div

ersi

fied

Fin

anci

al

Ser

vice

Tra

nsp

ort

atio

n

Ele

ctri

cal C

om

po

n &

E

qu

ip

En

erg

y

Iro

n/s

teel

/bas

ic

mat

eria

lF

oo

d &

Bev

erag

eP

har

mac

euti

cals

&

Bio

tech

Ret

ail

Ch

emic

als

Au

to &

Co

mp

on

ents

Insu

ran

ce

Ban

kin

g

34

16

25

20

29

20

29 29 28

19

25

16

24

9 8 8 7 7 7 6 5 5 5 52

20

Benchmark

Korea

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MARKET VOLATILITY* OF KEY INDICES OVER THE PAST 5 YEARS (1997-2001)

*The relative rate at which the price of a security/index moves up and down, found by calculating the annualized standard deviation of day-over-day differences in daily price charge

**KOSDAQ 50 was developed on Jan. 4, 1999; thus only the last 3 years have been provided for this index

***Hang Seng Composite Index was developed on Jan. 3, 2000; thus only the last 2 years have been provided for this index

Source: Bloomberg

Percent

3835

29 29 28

21

57

41

KOS-DAQ**

KOSPI S&P 500

Kuala Lumpur

NAS-DAQ

Hang Seng***

Singa-pore Straits Times

Taiwan

The KOSPI and KOSDAQ have been most volatile, when compared to their peers in South East Asia and the United States

Highly volatile

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ENTREPRENEURS ACCESS TO CAPITAL

United States

United Kingdom

Luxembourg

Hong Kong

Netherlands

Switzerland

Singapore

Canada

New Zealand

Ireland

Germany

Australia

Finland

Sweden

Taiwan

Spain

Japan

France

Belgium

Denmark

Austria

Israel

Portugal

Chile

South Korea

Malaysia

Norway

Iceland

Thailand

Italy

Score

5.72

5.63

5.59

5.58

5.49

5.46

5.36

5.25

5.14

5.10

5.09

5.08

5.04

5.02

5.00

Rank

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

Score

4.90

4.85

4.81

4.79

4.78

4.77

4.74

4.74

4.72

4.64

4.63

4.62

4.56

4.56

4.54

Rank

16

17

18

19

20

21

22

23

24

25

26

27

28

28

30

Source: Milken Institute

Country Country

Ranking, 2001

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TOTAL STOCK VALUE CONTROLLED BY INSTITUTIONAL INVESTORS

Source: KSE; GAI; National Accounts; NYSE

13

29

37

51

Korea France Germany U.S.

Presence of institutional investors is a sign of an advanced equity market

2001, percent

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1. Complicated ownership structures with heavy cross-ownership

2. Weak minority shareholder rights

3. Conflicted boards of directors

4. Weak and intransparent financial reports and limited reporting to international standards

5. Impediments to takeover activity

6. Weak investor relations practices

WHILE THESE FINANCIAL PENALTIES RESULT FROM MANY FACTORS, WEAK GOVERNANCE IS A MAJOR CONCERN

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PYRAMIDAL EQUITY OWNERSHIP

SamsungElectronics

SamsungCorpSamsung

Life Ins

Samsung Foundations

SamsungSDI

SamsungCard

Samsung Mech. Elec

Samsung Heavy Ind.

SamsungCapital

CheilTextile

HotelShilla

SamsungEverland

CheilComm.

SamsungSecurity

SamsungTechwin

SamsungF&M Ins

SamsungEngineering

SamsungPrec.Chem

S-one

Samsung group

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A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD

1. Important legal projections necessary–Clean up ownership structure, probably by establishing legal

framework for holding company–Strengthen minority shareholder rights–Remove barriers to hostile takeovers, including foreign

investors–Regulate third-party transactions–Hold management and directors accountable for

illegal/inappropriate activities

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A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD (CONTINUED)

2. Improve regulatory activities–Require majority of directors to be independent,

especially on audit committee–Mandate that financial reporting complies with

international standards; demand transparency and periodic reporting

– Install consistent, aggressive, and effective regulatory enforcement

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3. Encourage companies to improve investor relations for all shareholders*

–More transparency–More open about risks/challenges–Encourage Q&A–More CEO-led discussions–Give investors advance notification about meeting dates– If listed globally, make announcements after markets open– Install information-rich Web sites

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4. Work to improve quality of director pool–Director pool often weak in emerging markets– Important to establish training/recruiting

programs to develop adequate supply of strong directors

–Consider non-executive certification program

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HOWEVER, GOVERNMENTS SHOULD RESIST TEMPTATION TO MICROMANAGE PRIVATE SECTOR

1. Establish limited, focused legal/regulatory framework . . . and enforce aggressively

2. Ensure transparency of financials and independence of boards

3. And let free market provide disciple and “regulation”

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