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Transparency, Corporate Governance, and Capital Markets

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The Subject is Summarized in Three Simple Statements Equity investment requires good corporate governance. – PowerPoint PPT presentation

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Title: Transparency, Corporate Governance, and Capital Markets


1
Transparency, Corporate Governance, and Capital
Markets
  • Ronald J. Gilson
  • Stanford Columbia Universities
  • Latin American Corporate Governance Roundtable
  • São Paulo Brazil, April 26-28, 2000

2
The Subject is Summarized in Three Simple
Statements
  • Equity investment requires good corporate
    governance.
  • Good corporate governance requires credible
    disclosure by the issuer.
  • The absence of credible disclosure by issuers
    will have macroeconomic effects bank financing
    and conglomerate internal capital markets will
    not support the development of economically
    significant new industries.

3
Step One Corporate Governance is the Equity
Contract
  • We are all familiar with the debt contract a
    detailed document specifies the interest rate,
    the repayment date, the debtors covenants, and
    the events of default.
  • What is the equity contract?
  • The corporate governance system specifies the
    rights of an equity holder and the steps
    available if management breaches its
    responsibilities
  • Gilsons rule of value you pay for what you get!

4
Step Two Good Governance Requires Credible
Disclosure
  • The corollary to Gilsons rule of value
  • You get what you can measure.
  • The algebra of governance and disclosure
  • You pay for what you get you get what you can
    measure
  • Canceling yields
  • You pay for what you get you get what you
    can measure
  • You pay for what you can measure!
  • The difference between disclosure and credible
    disclosure.

5
Step Three The Effect of a Bad Equity Contract
  • A bad equity contract an issuers inability or
    unwillingness to make credible disclosure makes
    it difficult for the market to distinguish good
    risks from bad.
  • The increased cost of capital shifts financing
    and the capital market toward debt.
  • Consequences
  • Debt is ineffective at financing high risk, high
    return early stage investment.
  • The capital market will not support cutting edge
    industries.

6
The Institutions Necessary to Support Credible
Disclosure
  • Legally Mandated Disclosure Requirements.
  • Good Accounting Standards.
  • Independent Auditors.
  • Effective Enforcement.

7
Legally Mandated Disclosure Requirements
  • Problem
  • How do we distinguish between those who disclose
    accurately and those who do not?
  • Absent effective private intermediaries, a
    reputation model will not work.
  • By imposing penalties on false disclosure, a
    legal mandate allows honest companies to
    distinguish themselves.

8
Good Accounting Standards
  • The critical characteristic is not the particular
    standard the metaphysics of accounting but
    that the form of disclosure allow users to
    rearrange the information to their own use.
  • Good rule of thumb an accounting system that has
    no use for the adjective hidden. Examples
  • German hidden reserves.
  • U.S. debate over charging the value of employee
    stock options to earnings.
  • U.S. pooling vs. purchase accounting for
    acquisitions.

9
Independent Auditors
  • Credible disclosure requires honest, competent,
    and independent auditors.
  • The annual audit process is more effective than a
    government agency.
  • The problem is independence.
  • What is the impact on auditor independence of the
    consolidation of the profession into 5
    multi-national, multi-disciplinary professional
    service firms.
  • What happens to independence when non-audit fees
    climb?
  • Current focus of the U.S. Securities and Exchange
    Commission.

10
Enforcement
  • Mandatory disclosure is no more effective that
    the expectation that the rules will be enforced.
    We need
  • A politically insulated regulatory agency with
    the independence to impose significant sanctions
    on the countrys largest economic actors.
  • An independent, effective judiciary.
  • Effective private enforcement.

11
A Piggybacking Strategy
  • How does a high quality firm establish its
    credibility while local disclosure institutions
    are developing?
  • Foreign stock listing.
  • E.g., NYSE listing imposes on a foreign company
  • Governance standards imposed by contract.
  • U.S. regulatory standards triggered by listing.
  • Israeli companies going public on NASDAQ.
  • Strategy limited to larger companies.

12
Summary
  • Equity investment requires good corporate
    governance.
  • Good corporate governance the equity contract
    requires credible disclosure by the issuer.
  • The absence of credible disclosure by the issuer
    will have macroeconomic effects bank financing
    and conglomerate internal capital markets will
    not support the development of economically
    significant new industries.
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