VII. International Corporate Governance

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VII. International Corporate Governance
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• ltKesi, Sherri, Juliagt
• The Revolution in Corporate Finance Stern Chew

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Agenda

• Overview of Corporate Governance
• Kesi the American Financial System
• Sherri the Asian Financial System
• Julia the European Financial System
• Questions and Answers
• Case Study

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Corporate Governance

• To take advantage of technological progress and
  scale economies, modern corporations take the
  form of large organizations requiring heavy
  capital investment. The amount of capital
  required often can be raised only by pooling the
  savings of a multitude of investors, who must
  rely on others to manage their investments and
  run the enterprise. The institutions (the
  particular set of legal rules, incentives, and
  behaviors) that support and underlie that
  reliance by investors constitute the system of
  corporate governance.
• Therefore, corporate governance is a set of
  processes by which investors attempt to minimize
  the transactions costs and agency costs
  associated with doing business within a firm.

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Goals of Corporate Governance

• To fill in the gaps in the incomplete corporate
  contracts
• To control the managerial tendency to pursue
  interests and objectives that conflict with those
  of maximizing efficiency and value

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How to Measure Corporate Governance (Jonathan R.
Macey)

• On the basis of how effective the systems are in
  limiting managers ability to divert firm
  resources to their own, private uses (the size of
  the premium at which voting shares trade in to
  relation to non-voting shares)
• On the basis of how willing entrepreneurs are to
  make initial public offerings of stock (the
  relative proclivity of firms under rival
  governance schemes to go public)
• On the basis of the speed with which management
  is replaced for sustained poor performance (the
  functioning of internal and external markets for
  corporate control)

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Is the USs mechanism for monitoring and
controlling corporate managers inferior to that
of Germany and Japan?

• Corporate Governance in the US
• Japan and the Keiretsu
• Germany

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The role of COMMERCIAL BANKS

• The US and COMMERCIAL BANKS
• Banks as FIXED CLAIMANTS
• The great EQUILIBRIUM
• Manager vs. Shareholder

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Costs? Practices? Problems? Risk?

• What are the COSTS of the German/Japan bank
  dominated systems?
• Is excessive risk taking a common PRACTICE in the
  US?
• What is the PROBLEM with Americas corporate
  governance and the advantages?
• Why does corporate diversification reduce the
  RISK of managers at the expense of shareholders?

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Asian Corporate Governance System

• Keiretsu Chaebols
• Parent company (main banks) act as administrator
  intervene in cases of financial distress
• Banks allowed to hold equity positions in
  companies
• Largely self-governing
• High opacity and resistant to change
• Perform best when there are little capital
  relative to opportunities and when
  contractibility is low

• Pros
• Reduce corporate agency costs
• Ensure returns to banks
• Easier for firm to obtain funds
• Below-market lending rates
• Cons
• No price signal to guide decisions
• Potential conflicts of interest
• Costly misallocation of resources

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Relationship Vs Arm Length

• Differences
• Financing firms ( banks) protected by contracts
• Prompt unbiased enforcement of contract by the
  market system
• High transparency
• Works best when there is high contractibility
  high capital opportunity

• Similarities
• Well-developed legal institutions and laws
  establishing voting control rights for
  shareholders
• Combination of economic and control rights into
  large blocks to control ineffectualness of
  fragmented voting power

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Asian Economic Crisis

• Causes
• Clash of two system
• Who is responsible?

• Reform
• Return to relationship system in short run
• Problems with reforming
• Attention to state of legal protection from
  potentially conflicting transactions
• Examine banks incentives to act
• Shareholders protection
• Governments role

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Costs? Practices? Problems? Risk?

• What are the pros and cons of external equity
  finance?
• Ultimately, should the Asian economies involved
  continue using the Relationship system or should
  they enforce a change to Arms Length system?

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Continental Financial System

• Separation of ownership and control in outsider
  systems of US and UK vs. convergence of ownership
  and control in insider systems of France and
  Germany
• Main Features
• Large number of shareholders with no effect on
  control
• Institutional owners play a prominent role
  (highly dispersed in the UK, highly concentrated
  in France and Germany)
• Insignificant role of outside shareholders in
  France and Germany (controlling shareholding
  resides with other companies)
• Large shareholdings by families
• Markets for corporate control are little in
  evidence or seriously restricted
• Bank control
• Little association of the market for corporate
  control with poor past performance (or ex poste
  failure)

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UK France

• United Kingdom
• 2,000 companies quoted on the stock market out of
  a total population of around 500,000 firms
• 80 of the largest 800 companies are quoted on
  the stock market, with 81 value of GDP
• Two-thirds of the equity quoted UK companies is
  held by institutions
• France
• The single largest group of shareholders is the
  corporate sector itself, then families, trusts,
  institutional investors, foreign companies,
  banks, and state

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Germany

• AG German Aktiemgesellschaft two-tier board
  structure a management and executive committee
  (Vorstand) and a supervisory board of directors
  (Aufsichtsrat)
• Equity holdings by firms in a related or the same
  industry
• The other corporate owners are not trading
  partners
• Banks and insurance companies often emerge higher
  up in the ownership tree
• Large block shareholders that take an active role
  in management to reduce managerial shirking and
  misconduct
• Banks own a modest percentage of the shares in
  the firms to which they lend money, but they
  exercise a degree of control significantly out of
  proportion to the amount of their shareholdings
• German banks vote bearer shares that they hold as
  custodians on behalf of the beneficial owners who
  are small shareholder-clients of the banks
  brokerage operations
• German companies often limit voting rights of any
  single shareholder to 5-15 of total votes
• Banks voting power is enhanced beyond their
  actually ownership position by the banks
  operation of mutual funds and right to vote the
  shares held by mutual funds

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Costs? Practices? Problems? Risk?

• What is the difference between the bank-based
  and market-based national financial systems?
• What are the benefits of the vertical/joint
  corporate control?
• What are the market place alternatives to
  traditional corporate governance?

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Disney vs. Comcast
Sources The Economist, Financial Times

• Walt Disneys board of directors on
• Monday night unanimously rejected
• Comcasts 60bn hostile offer and
• backed Michael Eisner, its chairman
• and chief executive, after concluding
• that the cable operators all-share
• offer undervalued the iconic media group.
• Last week, Comcast launched a hostile takeover
  bid for the Walt Disney Company. Comcast took
  advantage of a particular weak point in Disney
  history. Last month Disneys most important
  business partner, Pixar, abandoned it. At the end
  of last year, two board members, Roy Disney and
  Stanley Gold, resigned and started a campaign to
  oust Michael Eisner, Disneys boss.

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Bad Corporate Governance?
Sources The Economist, Financial Times

• Disney Under Disneys current management, the
  groups profits are now a third lower than they
  were in 1998, and its share price is at the level
  it was in 1997. In his first 13 years in charge
  Mr. Eisner raised revenues from 1.65bn to 22bn,
  and market value from 2bn to 67bn.
• Comcast After buying ATT Broadband, Comcast is
  considered to be Americas largest and best-run
  cable operator with 21m cable subscribers.

A Perfect, brilliant combination? A merger
between Comcast and Disney would create by far
the biggest vertically-integrated entertainment
giant, with a market capitalization of over
120bn, compared with Time Warners current
78bn. Cost savings could be 300-500m a year,
bringing a total cash-flow boost from the merger
of as much as 1bn annually. Since Comcast
launched its bid, Disney has been named a
possible partner or target for several groups,
including Microsoft, Barry Dillers
InterActiveCorp and Viacom. Whats to be done?
Reforms? Takeover? Value maximization?