IFC CORPORATE GOVERNANCE METHODOLOGY Our ValueAdded Approach

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IFC CORPORATE GOVERNANCE METHODOLOGY Our
Value-Added Approach
Mike Lubrano / Peter Taylor Investor Corporate
PracticeCorporate Governance Department CEA
Department March / April 2006
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IFC / World Bank CG Department (CCG)Teresa Barger
Corporate Governance Policy Practice
Global Corporate Governance Forum Phil Armstrong
Investor and Corporate Practice Mike Lubrano

• Multi-donor trust fund
• Awareness raising
• Sponsor research
• Promotes government reform and private sector
  self-help
• Develops toolkits

• Evaluates client companies
• Uses methodology
• set of tools and practices
• Helps clients implement best practice
• Technical assistance
• Global Leadership (OECD, CIPE, National Leaders)
• Director Nominations
• Share Voting

• ROSC assessments
• IFA / OECD liaison
• Cross-support
• Operational work
• Best Practice papers
• Implementation design

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Investor and Corporate Practice (CCGCP)

• Service Unit for IOs and Clients
• Develop Tools - IFC CG Methodology
• Develop Metrics to Reinforce the Business Case
• Global Leadership
• OECD Collaboration / Roundtables
• Global Corporate Governance Forum
• Technical Assistance
• Govts Market Participants Clients
• Support to PEPs/PDFs
• IFC-Nominated Directors
• Share Voting

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Outline

• What is Corporate Governance?
• Why Care About Corporate Governance?
• What is the Right Approach for IFC?
• What CCGCP Does to Help IOs and Clients

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Definition of Corporate Governance

• Corporate governance refers to the structures
  and processes for the direction and control of
  companies.
• IFC
• Corporate governance involves a set of
  relationships between a companys management, its
  board, its shareholders and other stakeholders.
  Corporate governance also 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 Corporate Governance Principles, 2004

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What is a Workable Definition for IFC?

• OECD Principles Provide an accepted/supported
  Framework
• Financial Stakeholders (Shareholders)
• Boards of Directors (Checks and Balances)
• Control Environment (Accounting, Controls,
  Internal and External Audit)
• Transparency and Disclosure
• A Practical Investment-Driven Definition

• Distinguish from
• Corporate Citizenship
• Corporate Social Responsibility
• Socially Responsible Investing
• Other Elements of Sustainability
• Political Governance
• Business Ethics
• Anti-Corruption / AML
• (But CG does reinforce all of these!!!)

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The Business Case for Corporate Governance

• Board of Directors
• History and operations of the Board and Board
  committees
• Independence of directors, e.g., conflicts of
  interest policy
• Compensation, education, and evaluation of the
  Board
• Role in
• Vision and strategy
• Monitoring, selection and compensation of CEO,
  top management
• Major investments and transactions
• Key policies, e.g., environment, human resources
• Oversight of risk and compliance
• Internal controls
• Financial reporting
• Audit

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The Business Case for Corporate Governance

• Control Environment Processes
• Internal controls
• Design of processes to achieve (i) effectiveness
  and efficiency of operations (incl. safeguarding
  assets) (ii) reliability of reporting (iii)
  compliance with laws.
• Internal audit
• Evaluation and assurances on IC controls,
  compliance and risk management
• External audit
• Independent and competent
• Focus on relationships among
• Audit committee, management, internal and
  external auditors, regulators and supervisors

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The Business Case for Corporate Governance

• Transparency and Disclosure
• Content, quality, and dissemination of financial
  and non-financial information about the company
• Process for preparing, reviewing, and approving
  reports
• (checks and balances)
• Depth of detail (e.g., segment reporting)
• Frequency (e.g., quarterly)
• Accurate, complete, timely, fair
• Addresses
• Role of the audit committee, management and
  external auditors in disclosure
• Equal access by all shareholders (incl. minority)
• Communications with other stakeholders

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The Business Case for Corporate Governance

• Shareholder Rights
• Protection of minority shareholders in charter
  and bylaws
• History of relations with shareholders,
  securities regulators, exchanges
• Voting rights vs. economic rights
• Action requiring shareholder approval (e.g.,
  related-party transactions)
• Director elections and shareholder resolutions
• Equitable treatment of shareholders in changes of
  control (e.g., tag-along rights)
• Disclosure of beneficial ownership
• Annual meeting timetable

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Why IFC Cares About CG

• Portfolio Performance
• Poor Governance Increases Risk
• Improving Governance is a Value Proposition
  (Private Equity Funds BCR Hikma)
• Development Mission (Sustainable Development
  Along with Social, Environmental, and other
  Elements of Sustainability)
• Reputational Risk / Reputational Agent
•  Corporate governance considerations are as
  important to IFC as environmental and social
  issues  - Peter Woicke former IFC EVP

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Business Case for Good Governance (or Why Should
Companies Care About CG?)
Provides Access to, Lowers Cost of Capital
Improves Operational Efficiency Manages Risk
Value Added
Improves the Companys Reputation
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IFC Portfolio Types of Companies

• Approx. 250 New Deals Per Year / 1500 in
  Portfolio
• Existing Publicly-Listed / Unlisted Companies
  Commercial Companies
• Financial Institutions
• Unlisted Founder / Family Controlled Enterprises
  (Board Shareholders Managers)
• Privatizations and Newly-Privatized
• Greenfields Three-way Joint Ventures (Board
  Shareholders Meeting)

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Developing a Workable Methodology

• Create a Common Definition / Vocabulary
• Be Consistent with the IFC Mission
  Sustainability / Value Added
• Tailored to IFCs Unique and Diverse Portfolio
• Fit with Existing Operating Procedures (Project
  Prep and Decision Meetings)
• Usable and Accessible to IOs (website)
• Training (Basic and Advanced)
• Avoid Formalism / Box Ticking

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Fit with the Appraisal / Supervision Process

• How should staff evaluate client companies and
  work with them to add value to their governance?
• By following a series of steps -- from first
  impressions to follow-up -- that fit into
  existing appraisal / supervision patterns
• The time and effort involved in each step varies
  in nature depending on the type of enterprise
  listed companies, family/founder firms, financial
  institutions, and companies in Transition
  economies (the paradigms).
• The intensity of project team effort depends on
  risk and opportunity.

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When to Focus on Corporate Governance

• Risks and/or Opportunities Financial Return and
  Development Impact
• Risks may be
• attitudinal (little or no commitment to
  governance)
• financial/operational (weak controls)
• legal (weak compliance)
• reputational (negative image)
• Opportunities (to add value) may be
• attitudinal (strong commitment to governance)
• financial (access to capital/better valuations)
• legal (model codes/compliance/documentation)
• reputational (fulfilling IFCs mission)

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CG Throughout the IFC Deal Process
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Making the Methodology Useable

• Break Governance Into Digestible Bits
• Company paradigms (non-exclusive)
• Listed companies
• Family- or Founder-Owned Unlisted Companies
• Financial Institutions
• Transition Economy Companies
• Five attributes of effectiveness.
• Four levels, from acceptable to leadership.
  We call this our Progression Matrix. This
  approach parallels the approach taken in the
  other areas of sustainability (social and
  environmental).

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Core Tool Simple Progression Matrices

• A Self-Assessment and Client Orientation Tool

LEVELS
PROGRESSION
ATTRIBUTES
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How IOs Work with Clients1) Use the IO Tools

• CG Progression Matrices
• Instruction Sheets
• CG Information Request Lists
• Why Corporate Governance?
• Model CG Improvement Programs
• Indicative Independent Director Definition
• Supervision Checklist

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How IOs Work with Clients2) Step-by-Step
Approach

• Step 1 First Impressions
• Step 2 Client Self-Assessment
• Step 3 Corporate Governance Review
• Step 4 CG Improvement Program
• Step 5 Documentation and Implementation
• Step 6 Supervision

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(Some) Corporate Governance Problems

• Developed Markets
• Dispersed ownership agency problems between
  shareholders and managers
• Empire building of CEOs
• Excessive remuneration (stock options)
• Insider trading
• Defense mechanisms (poison pills, staggered
  boards)
• Non-disclosure of information (manipulation with
  SPEs)
• Internal control problems (independence of
  auditor)

• Emerging/Transition Economies
• Concentrated ownership agency problems between
  controlling and minority shareholders
• Ineffective Boards
• Poor Capacity
• Passive Approach
• Low independence
• Conflicts of Interest RPTs
• Minority Shareholder mistreatment, especially in
  change of control situations
• Succession / Family Business Issues
• Transparency / Internal Controls / Audit Function

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Sample Responses

• Clearly Articulate Shareholder Treatment Policies
• Strengthen Boards (e.g., composition and
  procedures)
• Introduce Board Committees and Other Mechanisms
  to Handle Conflicts
• Introduce Audit Committees
• Internal Audit
• Financial Professionals
• Stregthen Internal Controls and Risk Management
• Improve Accounting and Auditing

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CCG Services to Investment Depts.
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Conclusions

• Corporate governance adds value to IFC and its
  clients
• Corporate governance considerations are an
  integral part of all investment deals (explicitly
  or implicitly)
• IOs - Be Diligent, Conscientious and Skeptical
  about Promises
• Our motto United Front Against Window Dressing
  
• Not You lie and Ill swear to it

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Thank you for your attention!Questions?www.ifc
.org/corporategovernance
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Special Challenges for Family Companies

• Need to Distinguish Family Relationships and
  Company Relationships (True Separation is
  Impossible)
• Especially financial relationships and accounts
• Informality of governance policies
• Common understandings may not be so universally
  held or understood
• Weakness of control environment
• Challenges only increase as the family grows More
  Complex with Succeeding Generations

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Specific Issues for Family Companies

• Succession Planning
• Family Employment
• Family Salary-Earners vs. Dividend-Receivers
• Incentivating Non-Family Managers
• Treatment of Outside Financial Stakeholders
• Formalities They Do Matter
• Familys Long-Term Role as Shareholder (Share
  Retention/Voting)