Corporate Governance and IPO Case Study

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Corporate Governance and IPO Case Study

• Professor Alexander Settles
• Faculty of Management, State University Higher
  School of Economics
• Email asettles_at_hse.ru

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Corporate Governance and Initial Public Offerings

• Corporate Governance is a principle variable in
  evaluating risk / setting discount for IPOs
• Firms reaching the market make significant CG
  changes to their board structure and practices to
  conform to market expectations

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The First Wave (1996-2002)
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Recent History

• In 2006 LSE IPO Market exceeds NYSE IPO Market
• 2007 IPO pipeline from Russian companies reached
  28 bln. compared with 20 bln. in 2006
• We are very concerned about corporate
  governance, transparency of company financials
  and protection of minority shareholders and, with
  a number of Russian companies, these things are
  called into question, Mr. Thair, the New York
  Stock Exchange (April, 2007 www.ft.com)
• Number of US listings of Russian companies since
  2004 2
• Mechel (2004)
• CTC Media (2006)
• Number of LSE/AIM listings of Russian companies
  greater than 200 mln. during 2005/2006 gt17

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Listing Rules

• NYSE SOX/NYSE Rules
• LSE UK Combined Code. Governance Metrics
  International (2005) ranks UK as leading country
  in terms of Corporate Governance
• LSE GDR/London AIM Combined Code not required
  but usually insisted by underwriters as Best
  Practice

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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 companys
  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 CEOs 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.

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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.

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Sarbanes Oxley

• 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

• 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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Role of the Board in a Public Company IPO /
Listing Experience

• The Board
• Effectiveness
• Talents and background of board members
• Tying board remuneration closely to performance
• Strategic thinking by the Board
• Managing risk effectively

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Role of the Board in Listing - IPO

• Developing a robust audit committee
• Taking corporate social responsibility on board
• Encouraging and active dialogue with shareholders

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The Effective Board

• Clear strategy aligned to capabilities
• Vigorous implementation of strategy
• Key performance drivers monitored
• Effective risk management
• Sharp focus on views of the capital market and
  other key stakeholders
• Regular evaluation of board performance

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The audit committees main responsibilities

• To monitor the integrity of the financial
  statements
• To review the companys internal financial
  controls, internal control and risk management
  systems.
• To monitor/review the effectiveness of the
  internal audit function.
• To make recommendations to the board on the
  appointment/removal of the external auditor

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The audit committees main responsibilities

• To monitor/review the external auditors
  independence/objectivity and the effectiveness of
  the audit process.
• To develop/implement policy on the engagement of
  the external auditor to supply non-audit services
• To review arrangements by which staff may raise
  concerns about possible improprieties
  (whistleblowing)

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Stakeholders in the IPO Process

• Owners employees
• Stock Exchange
• Government (SEC, FSFM, etc.)
• Institutional shareholder
• Public Investors

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Google Time to Cash Out?

• Reports valued Googles IPO at 16 billion
• Estimated 2003 revenue 1 billion, profit 300
  million
• In order to compete with the giants (Yahoo! and
  Microsoft), it would be in Googles best interest
  to raise more money

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Googles naïve attempts to stay private

• Why stay private?
• Eric Schmidt Were generating cash. We dont
  ever need to go public.
• Google didnt want to become a short-sighted
  company
• However, Google was bound to become publicly
  traded
• SEC regulation forcing them to report because of
  stock options offered to employees
• Companies funded by venture capitalists almost
  always result in IPOs
• During 2003, they unsuccessfully toyed with
  different strategies to remain private

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Googles IPO Process

• Decision to become public in early 2004
• Debate over filing for public offering
• Using investment bank vs. auction method
• Ended up using a Dutch auction
• Proposed S1 (formal public offering document)
• Sell 2,718,281,828 worth of shares

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S1 An Owners Manual for Googles Shareholders

• Outlined how Brin/Page planned on running the
  company
• Claimed Google was different, so it would not act
  as a traditional public company
• Proposed corporate structure that protected
  Googles ability to innovate and retain its
  distinctive characteristics
• Dual class shareholding structure Founders and
  executives have far more control than common
  shareholder (common in media companies)

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Googles IPO Process

• Google IPO did not follow Wall Street practices
• S1 represented a destruction of the traditional
  share selling, corporate governance, investor
  communications, and management structure of
  public companies
• However, it showed tremendous numbers in the
  income statement
• Profits, Cash, Operating Margins

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Googles Struggle to IPO

• Bad Reputation
• Google increased Secrecy
• Slow amendments to S1 and entire process
• Playboy Interview
• Relentless scrutiny (SEC)
• Companies uneven management of overwhelming
  growth
• Reporting requirements would require a great deal
  of restructuring (e.g. Advertising)
• Founders reluctance about the public path

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Initial Public Offering (Finally)

• Auction on August 12, 2004
• Revealed market price range 85 to 108
• Public on August 19, 2004
• Price was 85/share

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Post-IPO steps?

• Created Tablets (declaration of what makes
  Google itself)
• Post-IPO Organization (core groups)
• Core search
• Advertising Products
• 20 Percent (Gmail, Google News, Orkut)
• 10 Percent (Google Keyhole, Picasa)
• Could now execute on its two core businesses,
  while other groups could pursue projects that
  could potentially turn into core businesses or
  useful products

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Brin and Page Still in Power

• Brian Reid (former senior manager) sued Google
  for age discrimination
• Google is a monarchy with two kings
• Culture youth obsessed
• However, somehow they have succeeded
• 5 year revenue growth is 400,000
• Fastest growing company ever

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Russian IPO Examples - VTB
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VTB Overview

• The Group has three principal areas of business
• Corporate banking
• Retail banking
• Investment banking

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Offering Size

• 1,399,835,420,000 shares or 20.82 of the capital
  of VTB was offered as GDRs
• 79.15 was retained by the Federal Property
  Administration

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Investment Banks

• Joint Global Coordinators
• Citi
• Deutsche Bank
• Goldman Sachs
• International Joint Bookrunners
• Citi
• Deutsche Bank
• Goldman Sachs International
• Renaissance Capital

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Corporate Governance Issues

• The interests of VTBs principal shareholder may
  conflict with those of other shareholders
• VTBs management has recognised a material
  weakness in the Groups internal controls
• Some interested party transactions of Russian
  banks in the Group require the approval of
  disinterested directors or disinterested
  shareholders
• Shareholder liability under Russian law could
  cause the Group to be liable for the obligations
  of its subsidiaries
• There are weaknesses in legal protections for
  minority shareholders and in corporate governance
  standards under Russian law

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Corporate Governance Issues

• Of the eleven seats on VTBs Supervisory Council,
  six are held by representatives of various
  Government ministries and agencies, one is held
  by representatives of each of the CBR and the
  Russian President, one is held by VTBs
  President-Chairman, and two are held by
  independent directors.

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IPO Process

• Global Offering
• Russian securities legislation does not permit
  VTB to sell more than70 of the total number of
  ordinary shares authorised in the Global Offering
  in the form of GDRs.
• Retail Offering - retail investors in Russia
  Peoples IPO
• The Institutional Offering
• 13.60 Kopecks or 0.00528 per Share and 10.56
  per GDR.
• Dec 2, 2008 share price is 2.05

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Good deal announced bad deal delivered?