© Prof. Thomas Clarke

SESSION 1Introduction

CYCLES OF CORPORATE GOVERNANCE

Outline

‣Introduction

“Why governance? Why Now?”

‣Cycles of Governance

“Will we ever learn? Or are disasters inevitable?”

‣Theoretical Perspectives

Definitions

‣ “Corporate Governance is the system by which companies are directed and controlled…” (Cadbury Report, UK, 1992)

‣ “Involves a set or relationships between a company’s management, its board, its shareholders, and other stakeholders… provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” (OECD, Principles of Corporate Governance, 1999; 2004)

A Greater Purpose?

In its broadest sense,

“Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals”.

The governance framework is there to ‘encourage the efficient use of resources and equally to require accountability for the stewardship of those resources’. The aim is to align as nearly as possible the interests of individuals, of corporations, and of society. (Cadbury 2004)

Epoch Making Challenges

‣19th C Entrepreneurship

‣20th C Management

‣21st C Governance

(R.I. Tricker circa 1992)

Why governance?, Why now?

“Why Governance?, Why now?”

‣International deregulation of financial markets

‣Increasing scale and activity of corporations

‣Growth of investment institutions

‣Effective monitoring necessary for security of investments

‣Recognition that governance matters for accountability, performance and attracting capital.

‣A general trend in society towards openness, transparency and disclosure.

CYCLES OF GOVERNANCE

Cycles of Governance

‣“Corporate Governance crisis and reform is essentially cyclical”.

‣“Waves of corporate governance reform and increased regulation occur during periods of recession, corporate collapse and re-examination of the viability of regulatory systems”.

‣“During long periods of expansion, active interest in governance diminishes, as companies and shareholders become again more concerned with the generation of wealth, than in its retention”.

(Clarke, T. (2004).

East Asia : Most affected countries by the 1997 Financial

Crisis

Stock Market Bubbles in US( Dow Jones 1997-2009)

97 98 99 00 01 02 03 04 05 06 07 08 09

14,000

12,000

10,000

8,000

Source: Yahoo Finance 5 March 2009

Forms of Business Association

Sole Trader Unincorporated Associations Corporations

PartnershipsLimited

partnershipsJoint ventures Syndicates Trusts

(Including property and unit trusts)

UnincorporatedNon- profit

organisations

AssociationsIncorporated

under associationsIncorporations Acts

Co-operatives Chartered Corporations

Corporations created by

special Act of Parliament

Banks andInsurance companies

Credit unions,

Permanent Building Socs, Friendly Socs.

Companies under The

Corporations Act

Public companiesLimited by

shares

Public Companies limited by guarantee

ProprietaryCompaniesLimited by

shares

Public unlimited companies

ProprietaryUnlimited companies

No liability companies

Source: Redmond P. (2005:99)

Determining Factors Influencing to Decision to Incorporate

‣ Limited Liability

‣ Perpetual Succession

‣ Financing

‣ Cost, Formality and Continuing Obligations

‣ Taxation

Corporate Governance Lifecycle

Maturity Governance challenges

Growth Governance challenges:

Launch Governance Challenges:

• Maintain alertness• Board assessment•Advance value commitments

•Risk management •Develop board directors.• Engage stakeholders.

• Raise capital• Recruit board of directors• Establish accountability

Time

Co

rpo

rate

De

vel

op

me

nt

FoundingEntrepreneurs

PrivateCompany

IPO(Initial Public Offering)

Public Corporation(Majority Shareholders)

Public Corporation(Diffuse Shareholders)

Source: Clarke T. (2006)

Diversity in Corporate Governance

‣ National, regional and cultural differences

‣ Ownership structure and dispersion

‣ Industry and market environment

‣ Firm size and structure

‣ Life cycle variations : origin & development, technology & periodic crisis and new directions

OUTSIDER SYSTEMS INSIDER SYSTEMSPROPERTIESOwnership Dispersed ownership Concentrated ownership

ControlSeparation of ownership and controlLittle incentive for outside investors to participate in corporate control

Association of ownership with controlControl by interested parties (banks, related firms, and employees)

FinanceLow debt/equity ratio and low ratio of bank credits to total liabilitiesHighly sophisticated and diversified financial markets

High debt/equity ratio and high ratio of bank credits to total liabilitiesLow level of sophistication and low opportunities for diversification of financial markets

Growth Merger and acquisition Organic growthTakeovers Hostile takeovers that are costly and

antagonisticAbsence of hostile takeovers

Orientation Short term Long termManagement Mission

Performance of assets to release shareholder value

Stewardship of business institution to achieve long term stakeholder values

Business Strategy

Low commitment of outsider investors to long-term strategies of firmsCompetitive strategy, marketing and profitability priorities

Interested parties contribute to strategy, intervention by outside investors limited to periods of clear financial failureProduction strategy, operations, quality and sales volume priorities

Stakeholders Interests of other stakeholders are not represented

Other stakeholders are represented

Weaknesses Takeovers may create monopoliesManagers may become self-interested

Insider systems may encourage collusionSocial obligations may slow necessary restructuring

Domestic Market Capitalization (WFE 2009)

0 2000 2001 2002 2003 2004 2005 2006 2007 2008

25 000

20 000

40 000

5 000

10 000

USD bn

WFE total (USD

bn)30,956 26,595 22,833 30,627 36,848 40,888 50,650 60,854 32,551

Value of Share Trading (WFE 2009)

70 000

60 000

50 000

40 000

30 000

20 000

10 000

0 2000 2001 2002 2003 2004 2005 2006 2007 2008

USD bn

WFE total

(USD bn)56,491 41,834 33,115 33,331 42,267 54,765 70,035 112,969 113,602

CRISIS

QUIS CUSTODIET IPSOS CUSTODES?

Juvenal (A.A. 60-130) Satires vi, 347.

(“Who is to guard the guards themselves?”)

Influences of Corporate Governance on Performance

‣Effects the development & functioning of capital markets and exerts a strong influence on resource allocation.

‣Can impinge upon the development of equity markets, R & D, innovative activity, entrepreneurship, and the development of an active SME sector, and thus impinge on economic growth.

‣In transition economies, privatization has raised questions about the way in which private enterprises should be governed.

“It is thought that poor corporate governance mechanisms in these countries have proved, in part, to be a major impediment to improving the competitiveness of firms.” (Maher & Andersson, OECD, 1999)

-40 -20 0 20 40 60 80

WorldCom ( Down 86%)

Enron Corp (Down 99%)

Tyco (Down 65%)

Parmalat (Down (96%)

-2 Months -1 Month 1 Month 2 Months 3 Months 4 Months

TRADING DAYS

0

10

20

30

40

50

60

70

80

90

100

110

120

Six Months in the Life of WorldCom, Enron, Tyco and Parmalat

Continuing Crisis in Corporate Governance

‣ CEO pay

‣ Earnings Misstatements

‣ Agency and double agency dilemmas

EXECUTIVE REWARD

US Top Ten Highest Paid CEOs in 2008

Rank Company CEO Pay (USD ) MarketCapitalization

(USD Bn)

1 Oracle Lawrence J. Ellison 557 000 000 105.35

2 Occidental Capital Ray Irani 222 640 000 51.29

3 Hess John B. Hess 154 580 000 16.24

4 Ultra Petroleum Michael D. Watford 117 000 000 5.61

5 Chesapeake Energy Corp Aubrey McClendon 112 460 000 11.70

6 Motorola Inc Jha Sanjay 91 490 000 14.19

7 EOG Resources Mark G. Papa 90 470 000 16.08

8 WR Berkley William R. Berkley 87 480 000 2.02

9 Burlington Santa Fe Matthew K. Rose 68 620 000 24.61

10 Allegheny Energy Paul J. Evanson 67 290 000 4.23

Source: Data compiled from Forbes CEO Compensation Report (2008); Yahoo News Executive Compensation 2008. Yahoo Finance 2009

Rest of the World Highest paid CEOs in 2004

Rank Company CEO Pay(millions)

MarketCapitalization

(USD Bn)

1 (UK) Man Group Peter Clarke GBP 7.2 437.25

2 (UK) Royal Bank of Scotland Fred Goodwin GBP 7.06 2186.25

3 (FR) Alcatel-Lucent Patricia Russo EU 6 3.85

4 (SW) Roche Holding Franz Humer SW Fr 11.3 102.93

5 (SP) Banco Santander Central Alfred Saenz EU 8.34 69.81

6 (GE) Volkswagen Martin Winterkorn EU 6.14 69.12

7 (UK) Royal Dutch Shell Jeroen Van-der veer EU 8.78 86.62

8 (FR) Loreal Jean Paul Agon EU 3.5 32.29

9 (ITA) FiatSpA Sergio Marchionne EU 3.05 9.45

10 (DE) Adidas Herbert Hainer EU 3.44 5.13

Source: Compiled from Wall Street Journal: Market Watch “Notable Executive Pay Deals in Europe’, May 2009. and Yahoo Finance 2009

Average CEO Pay in US and Europe 2008 (US$ millions)

Source: Forbes (2009):CEO Compensation Special Report (2009), Wall Street Journal : Market Watch ‘Notable Executive Pay Deals in Europe’, May 2009; Institute for Policy Studies: Executive Excess Report 2008.

Top Five US CEOs vs Five US Fund Managers CEOs 2008 (US$ millions)

Chesapeake

Energy

Ultra Petroleum

Hess Occidental Petroleum

Oracle Citadel Investment

Group

Harbinger Partners

Reinaissance Technologies

Soros Fund Mgmt

Paulson & Co

Source: Compilation from Forbes CEO Compensation 2008 Report; Institute of Policy Studies: Executive Excess 2008.

Total Number of US Corporation Earnings Re-Statements (1997-

2005)

92 102

174201 225

330

514

613

1195

0

92 102

174201 225

330

514

613

1195

01997 1998 1999 2000 2001 2002 2003 2004 2005

Source: Adapted from Coffee J. (2002) Source: Adapted from Coffee J. (2002)

Source: Adapted from Coffee J. (2002), Glass, Lewis and Co (2006)Full source: Adapted from Coffee Jr J.C. (2002). “Racing Towards the Top: The Impact of Cross-Listings and Stock MarketCompetition on International Corporate Governance”. Columbia Law Review 107(7):1757-1831; Glass Lewis &Co (2006) Company website.

THEORIES OF CORPORATE GOVERNANCE

From Owner Entrepreneur to double Agency Dilemma

Double Agency Dilemma

Owner Entrepreneur

PUBLICCOMPANY

MANAGEMENT

Shareholders Delegate Power to the Board of Directors

SHAREHOLDERS

Board Delegates Power to Management

BOARD OF DIRECTORS

OWNER

PRIVATECOMPANY

Source: Adapted from Blake (1999).

Double Agency Dilemma

COMPANY SHAREHOLDERS

BOARD OFDIRECTORS

MANAGEMENT

Shareholders Delegate Power to the Board of Directors

Board Delegates Power to Management

Source: Adapted from Blake (1999)

‣ A multi-theoretical approach is needed for recognizing the many mechanisms and structures that might reasonably enhance organizational functioning

‣ From narrow focus of agency theory and transaction cost theory inspired by financial economics, through approaches including stewardship, resource dependency, stakeholder and managerialist

Theoretical Perspectives on Boards and Governance

Theoretical Perspectives: CG and Board Role

Source: Adapted from Corbet and Mayer (1991); Charkham 1992; Ebster-Grusz and Pugh 1992; and Nunnenkamp (1995)

AGENCY TRANSACTION COSTS ECONOMICS

STEWARDSHIP RESOURCEDEPENDENCY

STAKEHOLDERMANAGERIAL HEGEMONY

CLASS HEGEMONY

CORPORATE GOVERNANCE AND BOARD ROLE

Self-interestedutility maximizingmotivationof individual actors

Ensure match Between managers (‘agents’) and shareholders. (‘principals’)

Focus on governance needs of exchange relations

Concerned with mechanisms which reduce costsassociated with contractual hazards

Ensure the Stewardshipof corporate assets

No inherent conflict of Interestbetween Managers/owners, andthat optimum governance structures allow coordination of the enterprise to be achieved

Reduce uncertainty; boundary spanning; highlights the Interdependenceof firms rather than viewing them simply interms of management intentions

Connecting firm with external resources help to reduce Uncertainty

Defines firms as inclusive multilateral agreements between the enterprise and multipleStakeholders

These relation-ships constrain and create the strategic possibilities of the company.

The board asa ‘legal fiction’; Managerial control

Need to understand the relationship Betweenowners, Managersand The board of Directors

Perpetuate elite & classpower; Corporationsas exploitativevehicle for Accumulation of wealth and power

AGENCY TRANSACTION COSTS ECONOMICS

STEWARDSHIPRESOURCEDEPENDENCY STAKEHOLDER

MANAGERIAL HEGEMONY

CLASS HEGEMONY

THEORETICAL ORIGIN

Self-interestedutility maximizingmotivationof individual actors

Ensure match Between managers (‘agents’) and shareholders. (‘principals’)

Focus on governance needs of exchange relations

Concerned with mechanisms which reduce costsassociated with contractual hazards

Ensure the Stewardshipof corporate assets

No inherent conflict of Interestbetween Managers/owners, andthat optimum governance structures allow coordination of the enterprise to be achieved

Reduce uncertainty; boundary spanning; highlights the Interdependence

of firms rather than viewing themsimply in termterms of management intentions

Connecting firm with external resources help to reduce uncertainty

Defines firms as inclusive multilateral agreements between the enterprise and multipleStakeholders

These relation-ships constrain and create the strategic possibilities of the company.

The board as

a ‘legal fiction’; Managerial control

Need to understand the relationship Betweenowners, Managersand The board of Directors

Perpetuate elite and classpower; Corporationsas exploitativevehicle for Accumulation

of wealth and

power

Theoretical Perspectives: Origin

Source: Adapted from Corbet and Mayer (1991); Charkham 1992; Ebster-Grusz and Pugh 1992; and Nunnenkamp (1995)

AGENCY TRANSACTION COSTS ECONOMICS

STEWARDSHIPRESOURCEDEPENDENCY STAKEHOLDER

MANAGERIAL HEGEMONY

CLASS HEGEMONY

ORIGIN

Economics and Finance

Economics and

Finance

Organization Studies

Organization Studies

Politics, Law, & managementorganization studies

Management OrganizationalStudies

Sociology & Politics

ANALYSIS

Individual Transaction Coordination Resources Stakeholders Management Corporations

FOCUS

Agency costs Asset Specificity

Stewardship Interdependence Relationships Control Exploitation

Theoretical Perspectives: Origin, Analysis, Focus

Source: Adapted from Corbet and Mayer (1991); Charkham 1992; Ebster-Grusz and Pugh 1992; and Nunnenkamp (1995) Stiles and Taylor 2002