Emerging Capital Markets AG907 M.Sc. Investment & Finance M.Sc. International Banking & Finance Lecture 2 – Corporate Governance in Emerging Capital Markets I g n a c i o R e q u e j o – G l a s g o w , 2 0 1 0 / 2 0 1 1
Overview of Lecture 1. Introduction 2. Definition of Corporate Governance 3. Importance of CG for Emerging Economies 4. Basic Principles of Corporate Governance 5. Who benefits from Corporate Governance? 6. Types of Corporate Governance Mechanisms Empirical Evidence – CG: A Case Study of India E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 1
1. Introduction • Corporate governance (CG) for long-term development in emerging economies ⇒ Move from relationship- based to rules-based institutions • Beginnings: East Asian financial crisis of 1997-1998, followed by those in Russia and Brazil ⇒ Problems of “crony capitalism” & poor CG in emerging economies • Importance of CG for Emerging economies Economic Transformation Rules-based system Political E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 2
“Crony capitalism” Capitalist economy in which success in business depends on close relationships between business people & government officials It may be exhibited by favouritism in the distribution of legal permits, government grants, special tax breaks and so forth E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 3
2. Definition of CG A country’s private and public institutions (formal & informal) which govern relationship between “corporate insiders” & other stakeholders Includes corporate laws, securities laws, accounting rules, generally accepted business practices, etc. E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 4
Purpose of CG 1. Facilitate performance of corporations 2. Limit insiders’ abuse of power (“agency problems”) 3. Provide means to monitor managers’ behaviour E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 5
3. Importance of CG for EMs • CG long thought to be unimportant for emerging countries ⇒ Different corporate ownership structures Unlisted companies Publicly listed (family-, state- or vs. corporations foreign-owned) • CG helps alleviate agency problems in firms from emerging markets ⇒ Expropriation & Entrenchment • Importance of CG also to achieve long-term economic growth in emerging economies E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 6
3.1. The expropriation problem • Focus of CG on owner–manager conflicts; other stakeholders protected contractually (US & UK) • But in emerging economies Weak laws & Concentrated Complex control enforcement ownership structures Different agency problem ⇒ controlling shareholder– • minority investors • Use of complex ownership structures as substitute for development of financial markets E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 7
3.2. The entrenchment problem Entrenchment can occur in family firm successions ⇒ • Incompetent heirs cannot be easily removed • Incompetent CEO can potentially damage firm value • In many emerging economies, few wealthy families or other entities (e.g., individuals, state) control large parts of the economy ⇒ Macroeconomic implications Corporate entrenchment ⇒ Economic entrenchment • (less innovation & less long-term economic growth) E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 8
4. Basic Principles of CG • Effective CG system: Internal External & discipline discipline • To maximize performance • To minimize risk • To protect stakeholders’ interests • The 2004 OECD Principles of Corporate Governance E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 9
I. Basis for an effective CG framework Sets the important context for the other principles • Transparent & efficient markets • Rule of law • Clear division of responsibilities among authorities E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 10
II. Rights of shareholders Corporate governance framework should protect and facilitate exercise of shareholders’ rights • Secure ownership • Information • Participation • Voting • Share of profits E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 11
III. Equitable treatment of shareholders Corporate governance framework should ensure the equitable treatment of all shareholders • Equal voting rights • Protection of minority & foreign shareholders • No insider trading or self-dealing • Voting • Redress for violation of rights E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 12
IV. Role of stakeholders Recognize the rights of stakeholders • Respect for legal rights & agreements • Co-operation between corporations & stakeholders • Access to information • Communication & redress for violations E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 13
V. Disclosure & transparency Disclosure & transparency on all material matters • Timely & accurate disclosure of material information • Financial status, performance, ownership, governance • Accounting standards • Audits of financial statements E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 14
VI. Responsibilities of the Board The responsibilities of the board include • Strategic guidance • Monitoring of management • Accountability to the company & shareholders • Duty of care • Duty of loyalty E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 15
Concerns of special importance to EMs OECD principles first adopted in 1999 ⇒ Problem of ownership–control separation within corporations Revision of OECD principles in 2004 ⇒ Two concerns Institutional framework for markets ⇒ appropriate • regulations & enforcement Protection of minority shareholders ⇒ to attract new • investors & allow sustainable growth E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 16
The institutional environment Source : Adapted from La Porta et al. (1998) Accounting Judicial Risk of Rule of law Corruption system expropriation standards Developed 72.50 9.63 10.00 9.32 9.83 North America 64.60 8.77 9.10 8.82 9.48 Europe 69.83 9.33 8.52 8.18 9.09 Asia Pacific 64.00 10.00 4.82 8.33 8.25 Mid East & Africa 66.54 All 25 9.02 8.86 8.69 9.37 Emerging 49.83 6.46 5.04 5.33 6.77 Latin America 51.00 4.00 5.18 5.18 7.00 Europe 5.89 4.90 4.87 7.24 65.40 Asia Pacific 6.53 4.02 4.85 6.03 51.00 Mid East & Africa 55.33 6.17 4.71 5.03 6.73 All 21 Developed: Canada, US, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, UK, Australia, Hong Kong, Japan, New Zealand, Singapore, South Korea, Israel Emerging: Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Turkey, India, Indonesia, Malaysia, Philippines, Sri Lanka, Taiwan, Thailand, Egypt, Jordan, Kenya, Nigeria, Pakistan, South Africa E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 17
5. Who benefits from CG? Companies ⇒ Relationships with stakeholders, firm • performance, cost of capital Shareholders ⇒ Protection of their rights, higher • liquidity, transparency Stakeholders & society ⇒ Employees, customers, • creditors, suppliers & communities E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 18
6. Types of CG Mechanisms Internal governance of firms Board of directors ⇒ independent directors • Shareholders’ rights ⇒ self-dealing, insider trading, • related party transactions Reporting & internal controls ⇒ transparency, audits • E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 19
6. Types of CG Mechanisms External governance of firms Factor & product markets ⇒ efficient allocation of • resources Stock markets ⇒ efficiency & liquidity • Markets for corporate control ⇒ mergers & acquisitions • E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 20
‘The relation between firm-level corporate governance and market value: A case study of India’ Balasubramanian, N., Black, B.S. and Khanna, V. Emerging Markets Review 11 (2010) 319–340 E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 21
Main objectives • Provide overview of CG practices of publicly traded firms in India • Identify areas where governance practices are strong or weak • Develop an Indian Corporate Governance Index (ICGI) • Analyze relation between CG & firm value E m e r g i n g C a p i t a l M a r k e t s – I g n a c i o R e q u e j o 22
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