DCO-ZXH393-20040200-sdmPP1 The Value and Challenges of Good Corporate Governance Advanced Risk Management Workshop The World Bank Washington, DC May 2004

DCO-ZXH393-20040200-sdmPP1

The Value and Challenges of Good Corporate Governance

Advanced Risk Management WorkshopThe World Bank

Washington, DC

May 2004


2

Corporate governance codes during the last decade

Date code published (latest code)

CORPORATE GOVERNANCE REFORM IS A WORLDWIDE PHENOMENON

Source: ECGI; web sites; clippings

1999• Brazil (2002)• China, Hong

Kong (2001)• Italy (2002)• Kenya (2000)• Malaysia• Mexico• Portugal• South Korea

1997• Finland (2000)• Japan (2001)• Kyrgyz Republic• Netherlands (2003)• Sri Lanka• Thailand

Pre-1997• Australia (2002)• Canada (2004)• France (2002)• Ireland (1999)• New Zealand (2000)• South Africa (2002)• Spain (2003)• Sweden (2001)• UK (2003)• US (2003)

1998• Belgium (2000)• Greece (2001)• Germany (2003)• India (2003)

2000• Denmark (2001)• Indonesia (2001)• Philippines (2002)• Romania (2002)• Singapore (2001)

2001• Argentina• China, mainland• Czech Republic• Malta• Peru (2002)

2002• Austria• Chile• Colombia• Pakistan• Poland• Russia• Slovakia• Switzerland

2003• Cyprus• Mauritius• Oman• Turkey


3

SCOPE OF REMARKS

• Value of corporate governance to equity investors

• Value of corporate governance to creditors

• Progress and challenges in emerging markets

• Role of financial institutions in improving corporate governance


4

KEY MESSAGES

• Investors are willing to pay a premium for a well-governed company, particularly in emerging markets

• Governance is now an established investment criterion

• Investors consider corporate governance risks at three levels


5

INVESTOR OPINION SURVEY DETAILS

*Addressed to key investment decision-maker, e.g., CEO, CFO, Fund Manager**Includes investment bank with asset management activities, family offices, holding companies

Source:McKinsey Global Investor and Emerging Market Policymaker Opinion Surveys on Corporate Governance, 2002

Global Investor Opinion Survey, 2002

Type of investor

Private equity

Mutual fund

Money managerPension fund

Broker/trader

Insurance

Bank

Other**

Venture capital

20

17

11109

9

87

9

• 201 responses from professional* investors from institutions with an estimated USD 9 trillion assets under management (approximately USD 2 trillion AuM directly under their control)

• Covers 31 countries in Asia, Europe, Latin America, Middle East, Africa, and North America

• Undertaken in April/May 2002 in cooperation with the Global Corporate Governance Forum, using a questionnaire-based survey

Percent of respondents


6

A SIGNIFICANT MAJORITY OF INVESTORS SAY THEY ARE WILLING TO PAY A PREMIUM FOR A WELL-GOVERNED COMPANY

% of investors

78

78

76

76

73

22

22

24

24

27

Western Europe

Asia

North America

Latin America

Eastern Europe/Africa

Yes

No


7

PREMIUM INVESTORS WOULD PAY FOR A WELL-GOVERNED COMPANY VARIES BY COUNTRYAverage premiums of those investors willing to pay premium

Mo

roc

co

Eg

yp

t

Ru

ss

ia

Tu

rke

y

Ind

on

es

ia

Ch

ina

Arg

en

tin

a

Ve

ne

zue

la

Bra

zil

Po

lan

d

Ind

ia

Ma

lay

sia

Ph

ilip

pin

es

So

uth

Afr

ica

Ja

pa

n

Sin

ga

po

re

Co

lom

bia

So

uth

Ko

rea

Th

ail

an

d

Me

xic

o

Ta

iwa

n

Ch

ile

Ita

ly

Sw

itze

rla

nd

U.S

.

Sp

ain

Ge

rma

ny

Fra

nc

e

Sw

ed

en

U.K

.

Ca

na

da

4139 38

2725 25 24 24 24 23 23 22 22 22 21 21 21 20 20 19 19 18

16 15 14 14 13 13 13 12 11


8

THE PREMIUM INVESTORS WOULD PAY FOR A WELL GOVERNED COMPANY VARIES BY REGIONPremium in 2002

30

22

22

14

13


Latin America

Asia

Western Europe

North America


9

CORPORATE GOVERNANCE IS NOW AN ESTABLISHED INVESTMENT CRITERION

63

57

31

28

Avoidance of certain companies

Decrease/increase holdings in certain companies

Avoidance of certain countries

Decrease/increase holdings in certain countries

How does corporate governance affect your investment decision?

% of investors selecting this option; multiple responses possible

"Our investment group would never approve an investment in a company with bad governance"

– US Investment Manager, US$2 billion Private Equity Fund

"Good governance is a qualitative cut-off criterion"

– Analyst, US$62 billon European Asset Manager

"I simply would not buy a company with poor corporate governance"

– CFO, US$3 billon European Private Bank


10

GOVERNANCE OFTEN AS IMPORTANT AS FINANCIALS, PARTICULARLY IN EMERGING MARKETS

How important is corporate governance relative to financial issues – e.g., profit performance and growth potential – in evaluating the companies in which you invest?% of investors, 2002

15

16

18

43

44

45

66

61

50

41

40

18

21

7

15


Latin America

Asia

North America

Western Europe

Less important

Equally important

More important


11

INVESTORS IDENTIFY RISKS AT THREE LEVELS THAT IMPACT ON THEIR INVESTMENT DECISIONS% of investors who think that factor is very important for investment decision; top ten factors listed

71

47

43

42

37

46

32

32

31

30

Accounting disclosure

Shareholder equality

Market regulation and infrastructure

International accounting standards

Market liquidity

Property rights

Pressure on corruption

Insolvency and bankruptcy regulation

Fiscal environment

Banking system

Corporate factors

Capital market factors

Broad country level factors


12

SCOPE OF REMARKS






13

CORPORATE GOVERNANCE ANALYSIS IN CREDIT RATINGS

“The combination of aggressive management culture and weak board oversight has the potential to constrain or impair creditworthiness. Alternatively, evidence of strong corporate governance could mitigate perceived risk in management culture, thereby contributing to ratings stability.”

• Risk-based approach, focus on:– Aggressiveness of business

model/growth strategy– Complexity/transparency of legal,

financial and tax structure– Aggressiveness of accounting practices– Absence of succession plan– Litigation/government actions

• Outputs include CG commentary in credit rating report and separate Governance Assessment report

“Research on the impact of corporate governance practices on credit risk is limited. Moody’s will be undertaking research to clarify these issues. The core objective of undertaking the Corporate Governance Assessment is to improve rating quality and help investors assess the credit risk of issuers.”

• Qualitative discussions of key governance issues; no quantitative ratings or scores

• Identify significant deviations from generally accepted best practices, including: – Composition and quality of the board of

directors– Audit committee and key

audit/accountability functions– Conflicts of interest– Executive compensation– Shareholder rights– Governance transparency


14

SCOPE OF REMARKS






15

POLICYMAKER OPINION SURVEY DETAILS

Source:McKinsey Global Investor and Emerging Market Policymaker Opinion Surveys on Corporate Governance, 2002

Emerging Market Policymaker Opinion Survey, 2002

Market regulator

Stock exchange official

Academic

Business representative body

Government official

Type of policymaker

32

2222

195

• 44 responses from leading policymakers and academics

• Covers 20 countries in Asia, Eastern Europe, and Latin America

• Undertaken in April/May 2002, using a questionnaire-based survey

Percent of respondents


16Source:McKinsey Emerging Market Policymaker Opinion Survey on Corporate Governance, 2002

POLICYMAKERS HIGHLIGHT SIGNIFICANT CORPORATE GOVERNANCE CHANGES IN RECENT YEARS

44

38

35

29

26

4. Strengthened shareholder rights and enforced activism

2. Adoption of best practice code

3. Improved corporate legislation

1. Enhanced disclosure

5. Improved and enforced capital market regulation

"Enhanced enforcement powers of regulators and the penalties applicable for breaches of securities law"

– Director, Asian Market Regulator

"The comprehensive review of the legal framework and its specific recommendations"

– Law Reform Manager, Asian Market Regulator

"Increased protection, and board and general meeting representation, for minority shareholders"

– Chief Advisor, Latin American Market Regulator

% of respondents; Top 5 changes


17

POLICYMAKERS BELIEVE IMPLEMENTATION HAS BEEN RELATIVELY SUCCESSFUL, BUT WITH ROOM FOR IMPROVEMENT

Source: McKinsey Emerging Market Policymaker Opinion Survey on Corporate Governance, 2002

How successful has your country been in implementing corporate governance reform?

Somewhat unsuccessful

Very successful

Somewhat successful

78

14

8

% of respondents


18

POLICYMAKERS IDENTIFY SIGNIFICANT BARRIERS TO FUTURE CORPORATE GOVERNANCE SUCCESS

*Including lack of trained personnel

Source:McKinsey Emerging Market Policymaker Opinion Survey on Corporate Governance, 2002

% of respondents

Core owners/ concentrated ownership

Poor enforcement*

Other vested interests, e.g., political interference

Cultural difficulties

Inactive shareholders

32

24

30

27

22

"No strong local institutional investment industry"

– Head of Listings, Latin American Stock Exchange

"Successful lobbying by effected and influential people"

– Vice Chairman, Latin American Market Regulator

"Change in corporate culture is evolutionary in nature"

– Deputy President, Asian Stock Exchange

"Mindset that the company belongs to me (as the dominant shareholders) even though there are many other shareholders"

– Head of Regulation, Asian Ministry of Finance


19

EXAMPLE: THE ASIA REGION

Many reforms since 1997–1998

• Government led initiatives– Enhanced authority for regulators– Strengthened board

independence– Improved disclosure standards– Stopping auditing/consulting

linkage

• Private sector activities– Thailand: Institutional Investor

Alliance– Singapore: Securities Investors

Association– Individual companies: Infosys

and others

… but

• Compliance with letter not spirit of law

• Focus on structure/process; less attention paid to changing behaviour

• Enforcement lagging

• Shareholders sell rather than challenge

• Lack of qualified professionals

• Uneven progress across the region


20

PROGRESS ACROSS THE REGION ON SOME ISSUESIndependent director and audit committee requirements

Independent directors? Audit committees?

1997

Independent directors? Audit committees?

2003

China

Hong Kong

India

Indonesia

Malaysia

Philippines

Singapore

South Korea

Taiwan

Thailand

Source: Asian Corporate Governance Association


21

A NUMBER OF EXEMPLARY COMPANIES

Other leaders of the pack in Asia

• Complies with 10 corporate governance codes

• Reconciles financial statement to 8 accounting standards

• Board with majority of independent directors, with wholly independent committees

• Received numerous corporate governance awards

Hong Kong Korea Malaysia Thailand Singapore


22

ENFORCEMENT LAGS FORMAL RULES

1 = lowest, 100 = highest

Source: Asian Corporate Governance Association

Singapore

Hong Kong

Malaysia

India

South Korea

Taiwan

Thailand

Philippines

China

Indonesia

1 20 40 60 80 100

Enforcement

Rules, regulations/ adoption of IGAAP


23

KEY CHALLENGE IN MANY EMERGING MARKETS IS BUILDING EFFECTIVE SUPPORTING INFRASTRUCTURE

When …

• Regulators do not have sufficient human and financial resources

• Contracts are difficult to enforce

• Corruption is rife

• Judicial system not working

How can you pursue …

• Greater disclosure and transparency

• More independent directors

• Long-term outlook

• Foreign investment


24

GOVERNMENTS AND COMPANIES MUST MOVE FORWARD SIMULTANEOUSLY

Mindset change

Basic governance structure and processes

World-class corporate governance

Stability and predictability

Quality of rules and enforcement

Market discipline

• Realize importance of good corporate governance

• Secure adequate board independence

• Create independent board committees

• Embrace strict accounting norms

• Institute risk management structures

• Build a strategic, value-added board

• Constructive engagement with investors and stakeholders

• High quality of financial and non-financial disclosure

• Rule of law• Corporate and

securities legislation• Check on corruption

• Disclosure/listing requirements

• Strong regulators and vigorous enforcement

• Protection of minority shareholders

• Well-developed equity and bond markets

• Takeover market• Enhanced remedies

for shareholders

Companies

Governments


25

SCOPE OF REMARKS






26

SETTING THE CONTEXT: PRACTICES OF BANKS CONTRIBUTED TO 1997-1998 ASIAN FINANCIAL CRISIS

• Family or state ownership of banks led to excessive lending to related parties or politically-motivated lending decisions

• Weak credit assessment mechanisms

• Poor monitoring of borrowers


27

THE CHALLENGE TO FINANCIAL INSTITUTIONS

Financial institutions can play an important role in improving corporate governance if they:

Lead by example: Adopt good corporate governance practices themselves

Adopt disciplined approach: Engage in rigorous pre-lending evaluation and post-lending monitoring

Reward good behaviour: Insist that borrowers undertake reform and lower the borrowing rates for those that do


The Value and Challenges of Good Corporate Governance

Advanced Risk Management WorkshopThe World Bank

Washington, DC

May 2004

Documents

DCO-ZXH393-20040200-sdmPP1 The Value and Challenges of Good Corporate Governance Advanced Risk Management Workshop The World Bank Washington, DC May 2004