International Financial Management

honeydewscreenManagement

Nov 9, 2013 (7 years and 10 months ago)

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Corporate Governance

International Financial Management

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Corporate Governance….

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Home Depot’s chief executive, Robert Nardelli,

was removed after shareholders protested his pay.

Home De(s)pot

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Home De(s)pot


Bob
Nardelli

took the helm at Home Depot in 2000, and sales
soared from $46 billion in 2000 to $81.5 billion in 2005.


Profits more than doubled…


Stock price has lagged the market, and especially Lowes…


Bob
Nardelli

was paid $38.1 million from his last yearly contract.


He refused to accept even a reduction in his current stock
package, and only agreed to give up a guarantee that he would
receive a minimum $3 million bonus each year.


Board members asked him to more closely tie his future stock
awards to shareholder gains, but he refused.


Nardelli

claims that he cannot control the stock price, so his
compensation should not be tied to it…


Shareholders threatened to riot at annual meeting in May, 2007.


Nardelli

was asked to leave on January 2, 2007, with a $210
million retirement package!!!


4

Home De(s)pot

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Home De(s)pot

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Agenda


Governance of the Public Corporation


Agency Problem


Law and Corporate Governance


Corporate Governance Reform


Sarbanes Oxley


Cadbury Code

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Governance of the Public Corporation


Corporate Governance


the economic, legal, and institutional
framework in which corporate control and cash flow rights are
distributed among shareholders, managers, and other stakeholders of
the company.


Corporate scandals: Enron, WorldCom, Global Crossing,
Daewoo Group, Parmalat, and HIH.


American executives “treat their companies like ATMs,
awarding themselves millions of dollars in corporate perks.”
(Harvard Business Review, 2003)


Corporate governance failures have detrimental effects on
corporate valuations and the functioning of capital markets.


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9

Governance of the Public Corporation


Public ownership is associated with efficient risk sharing,
access to low
-
cost capital, and the pursuit of risky investment
projects.


Conflicts of interest between managers (agents) and
shareholders (principals).


Shareholders elect the board of directors, who in turn hire and
monitor managers.


Board composition (insiders/outsiders)


Shareholder monitoring (free
-
rider)


Conflicts of interest between controlling shareholders and
outside shareholders.

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The Agency Problem


Incomplete contracts create room for agency problems, and
managers often grab the residual control rights.


Perquisites


Steal funds


Divert funds


Waste funds


Managerial entrenchment


Free cash flows, Payout problems


Retain cash to avoid future capital raising


Size


Higher compensation


Size


Higher prestige

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Remedies for Agency Problem


Board of directors


Outside directors on board


CEO and chairman of board different people


Europe


union representation, two
-
tier boards


Incentive contracts


Stocks and stock options


Independent compensation committee


Concentrated ownership


Germany, France, Japan, China, Latin America


Morck, Shleifer, and Vishny (1988): Effect of managerial
ownership (%) on firm value is likely non
-
linear and
entrenchment dominates in 5
-
25% range for the US.

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Morck, Shleifer, and Vishny (1988)

x

y

Manager Ownership (%)

Firm Value

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Morck, Shleifer, and Vishny (1988)

x

y

Manager Ownership (%)

Firm Value

Alignment

Entrenchment

Alignment

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Remedies for Agency Problem


Accounting Transparency


Accurate accounting information in a timely fashion


Debt


Less managerial discretion wrt payouts


Less flexibility for financing investment projects


Overseas Stock Listings


Credible bond to provide better investor protection (Doidge,
Karolyi, and Stulz (2002))


Market for Corporate Control


Disciplinary effect on managers and enhance company
efficiency (US and UK)


Developing also in Germany, Japan, etc.

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Law and Corporate Governance


La
Porta
, Lopez
-
de
-
Silanes
,
Shleifer
, and
Vishny

(LLSV)


Sharp differences among countries with respect to:


Corporate ownership structure


Depth and breadth of capital markets


Access of firms to external financing


Dividend policies


Explained by how well investors are protected from expropriation
by managers and controlling shareholders and the origin of the
country’s legal system.


English common law


discrete rulings, judicial precedent


French civil law


codification of legal rules (Roman)


German civil law


codification of legal rules (Roman)


Scandinavian civil law


codification/precedent


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Law and Corporate Governance


LLSV (1998) Invented the: Shareholder Rights Index and the
Rule of Law Index


English common law countries rank highest on shareholder
rights, while Scandinavian and German civil law countries
rank highest on enforcement.


Why are they so different?


Glaesser and Shleifer (2002) argue the explanation dates back
to the Middle Ages.


France


power of adjudication to the center (King)


England
-

power of adjudication to a local jury

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Consequences of Law


LLSV (1998) find that corporate ownership tends to be more concentrated in
countries with weaker investor protection.


Legal Origin

Ownership
Concentration

External
Cap/GNP

Domestic
Firms/Population

English
common law

0.43

0.60

35.45

French civil law

0.54

0.21

10.00

German civil
law

0.34

0.46

16.79

Scandinavian
civil law

0.37

0.30

27.26

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Consequences of Law


Dominant investor may seek to acquire control rights in excess of
cash flow rights


Shares with superior voting rights


Pyramidal ownership structure


Li Ka
-
Shing

Family (Hutchison Whampoa)


Lee
Keun
-
Hee

(Samsung Electronics)


Robert Bosch GmbH (Daimler
-
Benz)


Interfirm

cross
-
holdings


Private Benefits of Control


Nenova

(2001) premium for voting shares: US 2.0%, Canada
2.8%, Brazil 23%, Germany 9.5%, Italy and Korea 29% and
Mexico 36%...


Dyck

and
Zingales

(2003) block premium: Canada US and UK
1%, Australia and Finland 2%, Brazil 65%, Czech Republic
58%, Israel 27%, Italy 37%, Korea 16%, and Mexico 34%.


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Consequences of Law


Capital Markets and Valuation


LLSV (1997) find that countries with strong shareholder
protection tend to have more valuable stock markets and more
companies listed on stock exchanges per capital than countries
with weak protection.


Studies (e.g., Lins (2002)) show that higher insider cash flow
rights are associated with higher valuations, while higher insider
control rights are associated with lower valuations.


Johnson, Boon, Breach and Friedman (2000) find that stock
markets declined more in countries with weaker investor
protection during the Asian financial crisis 1997
-
1998.


Lemmon and Lins (2003) find that crisis period returns of firms
in which managers have high levels of control rights, but have
separated their control and cash flow ownership, are 10
-
20
percentage points lower than those of other firms.


Financial market development also promotes growth.

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Consequences of Law


Doidge, Karolyi, and Stulz (2004)


Almost all of the variation in governance ratings across firms in
less developed countries is attributable to country
characteristics rather than firm characteristics typically used to
explain governance choices.


Firm characteristics explain more of the variation in governance
ratings in more developed countries.


Access to global capital markets sharpens firm incentives for
better governance, but decreases the importance of home
-
country legal protections of minority investors.

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Corporate Governance Reform


Late 1990s


Internal corporate governance mechanisms,
auditors, regulators, banks, and institutional investors
failed…


Strengthen the protection of outside shareholders against
expropriation of managers and controling shareholders


Strengthening the independence of boards of directors with
more outsiders


Enhancing the transparency and disclosure standard of financial
statements


Energize the regulatory monitoring role of the stock market
regulator and the exchanges


Modernize the legal framework

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Sarbanes Oxley


Accounting regulation


Public accounting oversight board


Restricting consulting/auditing


Audit committee


Independent financial experts


Internal control assessment


Assessment by auditors and company (Section 404)


Deemed costly and contested


Cross
-
listing elsewhere…


Executive responsibility


CEOs and CFOs must sign off on the company’s quarterly and
annual financial statements. If fraud causes an overstatement of
earnings, these officers must return any bonuses.

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Sarbanes Oxley


Many argue that SOX is hurting U.S. capital markets.


SOX undermines CEO’s appetites for risk


SOX is a full employment act for Accountants (404)


The Committee on Capital Markets Regulation, set up by
U.S. Treasury Secretary Hank Paulson, advocates rolling back
the Sarbanes
-
Oxley Act.


New York Governor
-
elect Eliot Spitzer, New York City Mayor
Michael Bloomberg and U.S. Sen. Charles Schumer of New
York have weighed in too, saying SOX is wrecking New
York’s standing as the world’s financial markets.

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Sarbanes Oxley


Many propose:


Section 404 attestation provisions should be rolled back for
small companies, with an internal control review every two
years.


The bar should be raised on what constitutes a “material
weakness” in internal controls.


It is particularly foreign companies that are balking at SOX.


New markets are appearing…


Chi
-
X a London
-
based joint venture that claims it will offer
cheaper trading in European stocks


Equiduct, and all
-
electronic, Pan
-
European exchange based in
Belgium


Goldman Sachs, Merrill Lynch, Morgan Stanley, Citigroup,
Credit Suisse, UBS, and Deutsche Bank reportedly will form a
consortium to trade equities across Europe (already announced
the same for US…)

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Sarbanes Oxley


U.S. is losing out on new international listings…


London is beating the U.S. in the number of IPOs it draws.


Last year, the NYSE drew 192 IPOs and Nasdaq 126.


The LSE, often cited as the example of how SOX is chasing
companies away, attracted a robust 617 IPOs, 510 of which
were on the AIM, the exchanges small
-
cap market.


However, the U.S. IPOs are larger.


Of a total of $118.2 billion raised through IPOs in 2006


$17.5 billion occurred on the LSE, $4.2 billion on AIM


$16.9 billion on the NYSE


$9.4 billion on Nasdaq


$0.2 billion on AMEX, according to Thomson Financial.

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NYSE Corporate Governance


Listed companies to have boards of directors with a majority
of independents


The compensation, nominating, and audit committees to be
entirely composed of independent directors


The publication of corporate governance guidelines and
reporting of annual evaluation of the board and CEO


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Cadbury Code of Best Practice


Ferranti, Colorol Group, BCCI, and Maxwell Group…


Cadbury Code


Boards of directors of public companies include at least three
outside (non
-
executive) directors


The positions of CEO and chairman of the board of these
companies be held by two different individuals


Cadbury Code is not legislated into law


LSE requires companies to “comply or explain.”


Empirical research suggests the code has been effective
despite not being enforceable in courts…

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Corporate Governance Indices


FTSE ISS Corporate Governance Index Series (CGI)


Quantifying the risk of corporate governance across
international markets has posed a challenge for investors
trying to deal with the increased recognition of the issue.


The new FTSE ISS Corporate Governance Index (CGI)
Series assists you with company analysis, portfolio
management and stock selection against selected companies
with a proven standard in corporate governance.


The series is the result of a collaboration between FTSE and
corporate governance experts ISS, two market leaders in
their respective fields. The design incorporates

ISS corporate
governance ratings

into a financial index.


You will now be able to track the financial performance of
companies against the universal themes in corporate
governance practice of:


Compensation systems for Executive and Non
Executive Directors


Executive and Non
-
Executive stock ownership


Equity Structure


Structure and independence of the Board


Independence and integrity of the audit process


The series consists of six regional and country equity
indices covering 24 developed countries as defined by
the FTSE Global Equity Index Series.

http://www.issproxy.com/institutional/cgi/index.jsp

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FTSE ISS CGI

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Corporate Governance Around the World


European Corporate Governance Institute


http://www.ecgi.org/codes/all_codes.php


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Parmalat


Let’s discuss Parmalat, p. 101
-
102, at the beginning of next
class.


How was it possible for Parmalat managers to “cook the
books” and hide it for so long?


Investigate and discuss the role that international banks and
auditors might have played in Parmalat’s collapse.


Study and discuss Italy’s corporate governance regime and its
role in the failure of Parmalat.

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Conclusions


Agency conflicts may arise between managers and controlling shareholders on
the one hand and outside shareholders on the other hand.


Corporate governance: protecting shareholders against expropriation by
managers and controlling shareholders.


Mechanisms to control agency problems: strengthening the independence of
boards of directors, providing managers with incentive contracts, concentrating
ownership, using debt, cross
-
listing to bond to better investor protection, and
facilitating the market for corporate control.


The legal origin influences shareholder protection and enforcement of laws, and
this in turn has consequences for corporate valuations.


Tradeoff concentrated ownership and lack of investor protection.


Corporate governance reform is an uphill battle…

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