Corporations and Corporate Governance

the historical perspective international experience

the agency theory of corporate governance managerial primacy, shareholder primacy and board

primacy International comparisons

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WHAT IS CORPORATE GOVERNANCE?

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What is corporate governance?

Corporate Governance is integrated system of internal controls and checks by which publicly traded companies are managed It provides a framework

that defines the rights, roles and responsibilities of different groups management, board, controlling shareholders and minority shareholders within an organization - CFA

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What is corporate governance

Deals with a variety of bodies on a series of purposes

Governance and management

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CREATING TRUST MECHANISMS

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Trust Mechanisms

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Product and factor markets

The bankrupcy of companies that fail to

deliver the value proposition

desired by clients

Trust Mechanisms

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Product and factor markets

Government and regulators

Organizing markets through law and

regulations

Mitigating market failure through regulation and

regulators

Trust Mechanisms

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Product and factor markets

Government and regulators

Financial markets

The scrutiny of financial institutions

when credit is granted

The scrutiny of rating agencies

Information provided

in IPOs

The pressure imposed by the threat of hostile

takeovers

Trust Mechanisms

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Product and factor markets

Government and regulators

Financial markets

Corporate Governance

Decision rights: how are rights assigned

througout the organization

Performance assessment Information

transparency and credibility

Incentive system: are

all incentives alligned?

GROWING IMPORTANCE SINCE THE 1980S

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Laws/Codes

Cadbury Report UK 1992

American Law Institute USA 1994

Events

The 1980s Restructuring corporate systems

2001 and the dotcom

bubble and burst

The banking crisis of

2008

Sarbanes-Oxley Act USA 2002

EU Green report 2011

Financial Regulation Council UK 2009

CSC and Rec CMVM Prt 2006 and 2010

UN Recommendations 2006

An increasingly present concern:

THE AGENCY THEORY OF CORPORATE GOVERNANCE

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Principal-agent problem in Corporate Governance

Separation of ownership and control

The thousands, or more, investors who own public firms could not collectively make the daily decisions needed to operate a business

Shareholders are owners of the firm

Executives control the firm

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Principal Agent models

There is a principal-agent problem when one of the parties (agent) is hired by the second one (principal) to take over tasks that affect its pay-off.

E.g., when shareholders hire a management team;

Between managers and workers

Principal Agent models

Problems in these relationships arise from: Different (separate) goals between principal and agent

Hard to observe each and every action undertaken by the agent and its information set (Asymmetry of Information)

Example 1-different goals: good buyout offers by third parties refused by management because disregard their particular interests

Example 2-asymmetry of information managers usually have access to more detailed information than shareholders (hidden action and hidden information)

there is no contract granting full protection to principals interests

Corporate Governance as a Principal-Agent problem

Principalshareholders, Agentmanagers

Principal-agent problem represents the conflict of interest between management and owners Many shareholders with small stakes may not effectively

monitor the managers behavior (fixed cost, free riding)

Managers may be tempted to use the firms assets for their own ends, at the expense of shareholders

Managers may engage in empire building

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Principal-agent problem: Solutions

Incentives Aligning executive incentives with shareholder desires

For example. stock, restricted stock, and stock options

Monitoring Setting up mechanisms for monitoring the behavior of

managers

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Monitoring the management:

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Monitoring the Management:

Within the company: Board of directors and its committees hire, compensate and

fire top management

Outside the company: Large shareholders exit (voting with their feet) or voice Creditors, commercial banks leverage disciplines Auditors, analysts, rating agencies Investment banks, consultants, attorneys Government, regulators Other stakeholders: employees, customers, suppliers,

competitors, society Market forces...

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Monitoring the Management: Market Forces

Market forces conditioning management behavior: Market for corporate control takeovers (corporate

raiders)

Stock market price evolution stock prices aggregate information

Product markets competition

Labor markets (for executives) executives reputation and outside option

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Board of directors composition and role: empirical evidence

Measures of board structure: Board independence

Board size

CEO is Chairman

Diversity

Relation between board structure and shareholder value and performance is weak Endogeneity: performance is both a cause and

consequence of board structure

Monitoring vs. advisory role

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Board of directors: some evidence

Yermack (1996) Firms with smaller boards have higher value

Coles, Daniel and Naveen (2008) One size does not fit all firm value increases with board

size and number of insiders for complex firms

Dahya, Dimitrov and McConnell (2008) Firm value increases with board independence in countries

with weak investor protection

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THE INTERNATIONAL PERSPECTIVE ON CORPORATE GOVERNANCE

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International perspective

There are important differences between the types of firms and capital markets that exist in US (Anglo-Saxonic countries) relative to other countries (Continental Europe and others)

This leads to differences in the fundamental problem of corporate governance. In Europe, as in other countries:

few listed firms are widely held

majority of the firms has a dominant shareholder (or a few dominant shareholders, e.g., families, funds, conglomerates)

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International perspective

Differences in ownership structure have 2 obvious consequences: Dominant shareholders have both the incentive and the

power to discipline management

Concentrated ownership creates a new agency problem, as the interests of controlling and minority shareholders are not aligned i.e. a possible conflict of interests between majority and minority

shareholders

Most existing literature handles the Anglo Saxon world (US-Canada-Australia and, to a lesser degree, the UK)

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Banco Popular

14,41%

14,15%

9,38%

7,06% 5,93% 5,50%

2,62% 2,32%

38,63%

Sociedad General Financiera, S.a. Sindicatura De Accionistas Bco. Popular Espaol, S.a.

Allianz Aktiengesellchat Holding Americo Ferreira De Amorin

Amsterdam Dresdner Holding B.v. S.a Unin Europea De Inversiones

Nicols Osuna Garcia Autocartera

Others

Telecom Italia

22,39%

5,00%

2,02%

7,79%

1,21%

61,59%

Telco, SpA Findim Group S.A.

Norges Bank Blackrock Inc. (asset management company)

Telecom Italia Group Other investors (under 2%)

Siemens

13,86%

5,75% 4,77%

4,75%

4,16% 4,08%

3,09%

6,00%

53,56%

FISHER ASSET MANAGEMENT, LLC CAPITAL INTERNATIONAL INVESTORS

BOSTON PARTNERS JENNISON ASSOCIATES LLC

WELLINGTON MANAGEMENT CO LLP VICTORY CAPITAL MANAGEMENT INC

CREDIT SUISSE AG/ Siemens Family Members

Others (less than 3%)

Arcelor Mittal

39,63%

2,58%

57,79%

HSBC Trust (C.I.) Limited (Mittal Family) Luxembourg State Others (less than 2,5%)

Fiat

30,10%

2,76% 2,64%

2,00% 62,50%

EXOR S.p.A. (Giovanni Agnelli & C. S.a.p.A) Fiat, SpA (own shares)Baillie Gifford & Co. Vanguard International Growth FundOthers (less than 2%)

Fiat Chrysler Automobiles NV will become the holding company for Fiat Chrysler Automobiles

following the reorganization of Fiat SpA and Chrysler Group LLC (to be completed by Oct,2014).

Volkswagen

50,73%

2,37%

20,00%

17,00%

9,90%

Porsche Automobil Holding SE Porsche GmbH

State of Lower Saxony Qatar Holding

Others

International perspective

There are also differences in the types of monitoring and incentives used, due to:

Bank-oriented or capital markets-oriented

Different legal environments

Different compensation contracts

Different institutional investing environments

Different, yet converging, accounting standards

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Market- vs. bank-based systems

Traditional comparisons of corporate governance systems focus on institutions financing firms (rather than on legal protection of investors)

Bank-centered systems (e.g., Germany and Japan) Relationship-based corporate governance a main bank

provides a significant share of finance and governance

Market-centered systems (e.g., US and UK) Governance is provided by large numbers of investors and

in which takeovers play a key governance role

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CORPORATE GOVERNANCE IN LAWMAKERS AGENDA

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Corporate Governance Codes

1980s

Cadburys report (UK 1992)

American law institute (US 1994)

2000s: Dotcom bubble and corporate scandals

Sarbanes-Oxley Act (US 2002)

2007-2009 financial crisis

Financial regulation coucil (UK 2010)

EU green report (2011)

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Legal origin and investors+ creditors protection

Legal origin and protection of investors is able to better explain economic and financial development patterns La Porta, Lopez-de-Silanes, Shleifer and Vishny (LLSV 1997, 1998)

4 legal origins: Common law (formed by judges resolving specific

disputes) - English origin

Civil law (originates in Roman law, using statutes & codes) French origin (written under Napoleon in 1807)

German origin (written in 1897)

Scandinavian origin

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Legal origin and investors+ creditors protection

Sample of 49 countries

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Legal origin and investors+ creditors protection

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Results

Results show that common-law countries generally have the strongest, and French civil-law countries the weakest legal protection of investors;

German and Scandinavian civil-law systems in the middle;

Concentration of ownership of shares in the largest public companies is negativelly related (not causality) to investors protection;

This is consistent that hipothesis that small diversified shareholders will move away from systems where their rights obtain less protection.

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NORTH AMERICA VS WORLD

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Summary of Differences in Corporate Governance Systems

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US Japan Germany

Ownership Mostly widely held High Corporations; High Banks; Low Management

High Banks; High Family; Concentrated

Problem Separation of ownership and control

Transactional efficiency Transactional efficiency

Goal Maximize shareholder value Long-term commercial relationships

Long-term commercial relationships

Contracts Explicit; legalistic system Implicit contracts; non-legal incentives and dispute solution

Implicit contracts

Market for corporate control

Yes Almost non-existent Almost non-existent

Board of directors Outside dominated; 7-10 members

Insider dominated; 20-40 members

Two-tiered system (Auf-sichtsrat and Vorstand)

Incentive Contracts (CEO) as of 2001

Yes, high pay

2.2m; fix ~700k

400k, fix 300k 1m, fix 350k

Labor market; CEO firer after bad performance?

Active; CEO twice as likely fired with 50% drop in stock price.

Active; similar to US for firms with large bank ownership

similar to US for firms with large bank ownership

Differences in Corporate Governance US vs. World

Firm-level index of corporate governance by country Aggarwal, Erel, Stulz and Williamson (2011) RiskMetrics data: Only 13% of non-US firms have higher index than US matching

firm Underinvestment in firm-level governance due to poor institutions (firm

and country governance are complements)

Firms with negative governance gap vs. US matching firm have lower shareholder value Investment in firm-level governance benefit minority shareholders at

the expenses of controlling shareholders

More valuable to invest in governance for firms with more growth opportunities and external finance needs

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Differences in Corporate Governance US vs. World

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Differences in Corporate Governance US vs. World

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Differences in Corporate Governance US vs. World

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U.S. Cross listing premium

Firms can voluntary committ to US corporate governance and capital market regulations (SEC) by cross-listing in the US

Legal bonding; Doidge, Karolyi and Stulz (2004)

Exchange listings (level 2 and 3 ADRs) or ordinary listings increase shareholder value by about 16%

Reduces expropriation by controllinh shareholders

US OTC much smaller effect

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Differences in Corporate Governance US vs. World

Evidence also suggests that firm-level governance attributes are complementary (not substitutes) to country-level protection;

Also supports that minority shareholders of a typical foreign firm would benefit from na increase in investment and governance (but firms controlling shareholder would not).

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Corporations and Corporate Governance

the historical perspective international experience

the agency theory of corporate governance managerial primacy, shareholder primacy and board

primacy International comparisons

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