state’s role in corporate governance in south east europe

State’s Role In Corporate Governance In South East Europe

State’s Role In Corporate Governance In South East Europe

Corporate Governance

Thomas Wels, Partner

September 21, 2001

OverviewOverview

• Importance of corporate governance in SEE

• Barriers to improved governance

• State attempts to improve governance

• A pan-regional response?

• Options for the State

Importance of quality of board practices when evaluating investmentsImportance of quality of board practices when evaluating investments%

3623 20

44

32

25 33

48

39

Europe Asia Latin America

More

Same

Less

Source:McKinsey Investor Opinion Survey 1999/2000

““In evaluating companies for potential investment in the following regions, In evaluating companies for potential investment in the following regions, how important is the quality of board practices relative to financial issues?”how important is the quality of board practices relative to financial issues?”

Average premium investors would be willing to pay for a well-governed companyAverage premium investors would be willing to pay for a well-governed companyAverage %

16

18

20

22

24

26

28

30

0Anglo-Saxon

USUK

Continental Europe

Italy

Switzerland

Germany

France

Spain

Latin America

ChileArgentinaMexico

Brazil

Columbia

Venezuela

Taiwan

Asia

Japan

Indonesia

Korea

ThailandMalaysia

Source:McKinsey Investor Opinion Survey 1999/2000

Over 80% of Over 80% of investors willing investors willing to pay a premiumto pay a premium

Greece

OverviewOverview






The market model governance chain*The market model governance chain*

*Examples can be found in Australia, Canada, U.K. and U.S.Source: McKinsey

Shareholder environment

Independenceand performance

Capital market liquidity

Corporate context

Institutionalcontext

Transparency and accountability

OECDPrinciples

Dispersedownership

Sophisticatedinstitutionalinvestment

Non-executivemajority boards

Aligned incentives

Active takeover

market

Active privateequity market

(incl. IPOs)

Shareholderequality

Highdisclosure

The control model governance chain*The control model governance chain*

*Examples can be found in Asia, Latin America and many Continental and South Eastern European countriesSource: McKinsey

Shareholder environment

Independenceand performance

Capital market liquidity

Corporate context


Transparency and accountability

OECDPrinciples

Concentrated ownership

Reliance on family, bank and

State finance

‘Insiderboards’

Incentivesaligned with

core shareholders

Limitedtakeover

market

Under-developednew issue

market

Inadequateminority

protection

Limiteddisclosure

Importance of institutional factors when selecting emerging market countries in which to investImportance of institutional factors when selecting emerging market countries in which to investAverage response

Enforceability of legal rights (e.g. contracts)

Quality of economic management

Independence of judiciary/quality of legal system

Level of corruption

Predictability and level of taxation system

Quality of accounting standards

Effectiveness of regulatory system

Effectiveness of banking sector

Administrative efficiency of government

4.5

4.3

4.0

3.9

3.9

3.8

3.8

3.5

3.3

3.3

1 2 3 4 5

Scale and liquidity of local investment market

Irrelevant RelevantHighly

Relevant

Source: McKinsey Emerging Market Investor Opinion Survey 2001

Importance of corporate level factors when selecting emerging market companies in which to investImportance of corporate level factors when selecting emerging market companies in which to investAverage response

Distinctions between company and family interests

Clearly defined governance arrangements

Accuracy of financial reporting

Legally enforceable minority shareholder protection

Use of performance-related pay for top management

Timeliness of financial reporting

Coverage of financial reporting

Presence of independent (non-executive) directors

Establishment of conflicts of interests committee

4.5

4.4

4.4

4.3

4.3

3.9

3.9

3.8

3.3

1 2 3 4 5Irrelevant Relevant

HighlyRelevant

Source: McKinsey Emerging Market Investor Opinion Survey 2001

OverviewOverview






A radical reduction in State involvement – a crisis responseA radical reduction in State involvement – a crisis response

Source:Turkish Treasury; IMF; clippings

COUNTRY EXAMPLE

Financial reform . . .Financial reform . . .• Banking sector reformBanking sector reform• Public, agricultural, and social security spending Public, agricultural, and social security spending

reformreform• Plan to remove barriers to foreign investmentPlan to remove barriers to foreign investment• Government asset management company to be Government asset management company to be

establishedestablished

. . . coupled with significant corporate reform. . . coupled with significant corporate reform• Privatization of Turkish Telecom, TUPRAS (oil Privatization of Turkish Telecom, TUPRAS (oil

refinery), POAS (petrol distribution), TEKEL refinery), POAS (petrol distribution), TEKEL (tobacco/alcohol), and SEKER (sugar)(tobacco/alcohol), and SEKER (sugar)

• Preparations being made to facilitate further Preparations being made to facilitate further private investment in gas, electricity generation, private investment in gas, electricity generation, and distribution rights, Petkim (petrochemicals), and distribution rights, Petkim (petrochemicals), Turkish Airlines, and ERDEMIR (steel)Turkish Airlines, and ERDEMIR (steel)

Will buyers for Will buyers for state-owned state-owned enterprises be enterprises be found?found?

Economic crisisEconomic crisis• Large currency Large currency

devaluationdevaluation• High unemploymentHigh unemployment• Falling stock market Falling stock market

capitalizationscapitalizations• Increased non-Increased non-

performing bank debtperforming bank debt• Falling corporate Falling corporate

profitabilityprofitability

Decreasing State ownership in corporate sector . . .Decreasing State ownership in corporate sector . . .

Source:Clippings; McKinsey analysis

COUNTRY EXAMPLE

ObjectivesObjectives• Attract local and foreign investorsAttract local and foreign investors• Boost entrepreneurshipBoost entrepreneurship• Encourage mergers and strategic alliancesEncourage mergers and strategic alliances

MeasuresMeasures• Undertake large scale privatization plan, incl. 12 Undertake large scale privatization plan, incl. 12

major banks and companies in 2002 (e.g., OTE, major banks and companies in 2002 (e.g., OTE, PPC, Agricultural Bank, Postal Savings Bank)PPC, Agricultural Bank, Postal Savings Bank)

• Introduce tax incentives to encourage more Introduce tax incentives to encourage more companies to mergecompanies to merge

• Introduce new legal and fiscal environment to Introduce new legal and fiscal environment to encourage more venture capitalencourage more venture capital

Expected resultsExpected results• Over 3 billion Over 3 billion

Euros revenuesEuros revenues• Market Market

consolidationconsolidation• Boost market Boost market

confidence in confidence in Stock ExchangeStock Exchange

ChallengeChallenge

Lack of interest Lack of interest from international from international investors. For ex:investors. For ex:• Prolonged Prolonged

negotiations for negotiations for selling of Olympic selling of Olympic Airways and Airways and Hellenic Hellenic Shipyards Shipyards

• Motor Oil’s Motor Oil’s disappointing IPOdisappointing IPO

. . . and radically reduced State influence in specific companies. . . and radically reduced State influence in specific companies

*Legislation passed enables changes**Previously, State-appointed

Source: Clippings

% owned by state

COMPANY EXAMPLE

External influences on External influences on telecomms sectortelecomms sector• DeregulationDeregulation• Competition from new Competition from new

market entrantsmarket entrants 33

42

51

100

Prior to 1996

June 2001

September 2001

Planned in future*

Other measures plannedOther measures planned• Revoke trade union right to Revoke trade union right to

appoint board directorappoint board director• Management to be appointed by Management to be appointed by

shareholders for 5-year tenures**shareholders for 5-year tenures**• Stock options introduced – to be Stock options introduced – to be

open to all employees over timeopen to all employees over time

Governance changesGovernance changes

• Strengthening of Strengthening of shareholder rightsshareholder rights

• Installment of Installment of transparency and transparency and accountability measuresaccountability measures

• Increased legal activity by Increased legal activity by shareholdersshareholders

• Accumulation of Accumulation of governance knowledge governance knowledge and practiceand practice

• More independent boardsMore independent boards

Investors react favorably to improved corporate governanceInvestors react favorably to improved corporate governance

Source: McKinsey analysis, McKinsey Investor Opinion Surveys 1999/2000

Institutional changesInstitutional changes

• Liberalisation of foreign Liberalisation of foreign ownership of equities and ownership of equities and bondsbonds

• Elimination of cross Elimination of cross guaranteesguarantees

• Liberalisation of the M&A Liberalisation of the M&A marketmarket

• Corporate and banking Corporate and banking restructuringrestructuring

Premiums for well-Premiums for well-governed companiesgoverned companiesPercentPercent

Before Before changes changes (1998)(1998)

After After changes changes (1999)(1999)

2222

2424

2626

2828

3030

3232

3434

3636

High/low pointsHigh/low points

Spread of responseSpread of response

COMPANY EXAMPLE

OverviewOverview



• State’s attempts to improve governance



Most capital markets – and companies listed – in South East Europe are small…Most capital markets – and companies listed – in South East Europe are small…

Total market cap – end 2000Millions USD

102,032

69,508

574

366

7

* 25 listed on the official market and 478 on the free market ** EstimatesSource:FiBV.com; EIU; ASE; BSE; FEAS; EBRD

Athens

Istanbul

Bucharest

Skopje

Sofia

London

Number of companies listed (main and parallel markets) – end 2000

342

315

503

115

141

2,3742,612,230

Average company market capitalizationMillions USD

1

3

221

>1

298

WIP

1,100

**

*

…although in relative terms, ASE is quite successful…although in relative terms, ASE is quite successful

Selected examplesValue of S.E. as a percentage of GDP – end 2000

Athens

Istanbul

Bucharest

Skopje

Sofia

London

34

2

5

93

185

<1 *

*EstimatesSource:FiBV.com; EIU; ASE; BSE; FEAS; EBRD

InterAmerican

Panafon

ETVA

DOL

HBC

Viohalko

Intracom

EFG

CBG

OTE

Titan

Alpha

NBG

Bank of Cyprus

Piraeus

Yet, core shareholders dominate Greece’s largest publicly-listed companiesYet, core shareholders dominate Greece’s largest publicly-listed companies

Source:ASE; McKinsey analysis

Shareholder structure of top 15 companies ranked by market capitalization, end 2000

Foreign shareholder’sForeign shareholder’s average holding ~13%average holding ~13%

Domestic shareholder’sDomestic shareholder’s average holding ~33%average holding ~33%

Domestic shareholders > 5%

Foreign shareholders > 5%

Shareholders < 5%

Two recent initiatives in South East MediterraneanTwo recent initiatives in South East Mediterranean

Source:Clippings

Discussing increased cooperation:• Create common

index comprising shares of all three

stock exchanges• JV is planned

within 2001

Negotiating:• Open respective

markets to investors in Turkey and Greece via cross-membership of companies on both markets

• Common technical application to follow stocks on both markets

A more radical solution – a combined pan-regional exchange?A more radical solution – a combined pan-regional exchange?Percent of total, USD millions, number of companies

Market capitalization

Bulgaria

Istanbul

Athens

Source:FiBV.com; EIU; ASE; BSE; FEAS; EBRD

59

24

22

36

40

>1

8

>1

10

>1BucharestSkopje

• While combined number of companies is high, aggregate market capitalization is still relatively small

• Without more dynamic pooled equity markets, difficult for privatisation programs to access (foreign) equity financing option

172,485 1,416

Equivalent to Brussels Equivalent to Brussels Stock ExchangeStock Exchange

Equivalent Toronto Equivalent Toronto Stock ExchangeStock Exchange

Number of companies

Requirements for pan-regional South East Europe exchangeRequirements for pan-regional South East Europe exchange

ILLUSTRATIVE

Requirements Models

•Common trading platforms

•Coming listing/tracking standards

•Common corporate governance standards

•Effective market makers/traders

•Complementary, if not common, securities legislation

•Euronext

•Euronext

•SEC-regulated exchanges/OECD Principles

•SEC-regulated exchanges

•U.S. SEC/U.K. FSA regulations

OverviewOverview






Moving from control model governance chainMoving from control model governance chain

Source: McKinsey

Corporate context


OECDPrinciples

Concentrated ownership

Reliance on family, bank and

State finance

‘Insiderboards’

Incentivesaligned with

core shareholders

Limitedtakeover

market

Under-developednew issue

market

Inadequateminority

protection

Limiteddisclosure

Capital market liquidity• Encourage equity-

based financing• Remove barriers to

takeovers

Transparency and accountability-Mandate international

accounting standards- Create and enforce

shareholder rights

Independenceand performance- Encourage more

independent boards- Facilitate stock-

related compensation

Shareholder environment- Attract foreign equity

capital- Reduce State ownership

Where the State can contribute to improve Corporate GovernanceWhere the State can contribute to improve Corporate Governance

Objective Examples

•Create an adequate Institutional and Corporate framework to

– attract Direct Investment

– Indirect Investment

• Internationally accepted governance rules (e.g.,OECD, SEC, IAS/US-GAAP)

•Create broad distribution of stock in population

•Reduce State stakes to create market for control

• Incentivise stock exchange co-operations to improve liquidity

Alternatives to state share- holdings

Liquidity of exchanges

Adequate regulatory frameworks

250401LNZXC483TSMW-P1

25

For further information contact:For further information contact:Thomas Wels: +30 (1) 3672 777Thomas Wels: +30 (1) 3672 777Mark Watson: +1 212 446 8021Mark Watson: +1 212 446 8021

McKinsey Investor Opinion Survey 1999/2000 can be downloaded from

www.mckinsey.com

Also, available on www.mckinseyquarterly.com, “Corporate reform agenda in the developing

world", an article that includes findings from the McKinsey Emerging Market Investor Opinion

Survey