Corporate governance: Lessons from the financial crisis

by OECD for oecd Observer at OECD,  June 30, 2009.

If there is one major lesson to draw from the financial crisis, it is that corporate governance matters.

Directors, regulators and shareholders, but also policymakers and the general public, need to pay more attention to corporate governance. This tells us how firms operate, their motives and principles, their reporting lines, who they are accountable to, and how they manage profit, remuneration and, in the case of many financial firms, other people’s money. When times were good, too many people took their eye off the ball and now we see the consequences.

The public outcry has been loud and understandable, not least in relation to executive pay. And even some top executives have now admitted the lack of relationship between pay and performance and called for a salaries shake-up. We now realise that constantly rising share prices is not necessarily a sign of good corporate governance. In fact, as recent history shows, it could actually be the opposite…(read more)

Governance Matters 2009: Learning From Over a Decade of the Worldwide Governance Indicators

by Dani Kaufmann for blog.worldbank.org, June 29, 2009.

Today we are releasing the report Governance Matters VIII, which includes the new update of the Worldwide Governance Indicators (WGI).   Now collaborating from the Brookings Institution, I continue to take part in this research project with my former World Bank colleagues Aart Kraay and Massimo Mastruzzi.

In the WGI we construct and measure six dimensions of governance, namely: Voice and Accountability, Political Stability and Absence of Violence, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption.

The new WGI is based on 35 different data sources, aggregating data from hundreds of disaggregated questions posed to tens of thousands respondents, covering 212 countries around the world…(continue reading)

Focus 6: Drivers of Corporate Governance Reforms: Take-Over and Tender Offer Experiences in Chile and Panama

by Alvaro Clarke and Carlos Barsallo, for Global Corporate Governance Forum.

PROLOGUE

By Mike Lubrano

In the wake of highly publicized scandals related to poor governance, there

followed demands for some kind of legal/regulatory response. As seen after the

East Asian crisis in 1997, the series of corporate collapses in the United States,

starting with Enron, and the Royal Ahold and Parmalat scandals in Europe,

investors and other stakeholders strongly urged governments, legislators,

and regulators to “do something about it.” But what should be done? The

circumstances surrounding each crisis were different and only rarely were there

obvious solutions at hand. Politicians, regulators, and businessmen usually

disagreed as to the underlying causes of the scandal in question and therefore

had different views regarding the recipe to avoid a repetition of the situation.

And of course, policymakers do not operate in an environment unconstrained

by political, economic, and practical constraints. When one reviews the last

10 years of corporate governance-related scandals in Asia, the Americas, and

Europe, what emerges is an impressive variety of policy outcomes. In some cases,

governments acted precipitously; in others, they acted very slowly. Some reforms

were comprehensive in scope; others more narrowly targeted. Some governments

and regulators devised responses in the framework of longer-term strategies, while

others engaged in blatant opportunism. Naturally, both the outcomes and the

reactions of the community and the market were mixed; to this day, they are the

subject of fierce criticism and intense debate.

Over the past 10 years, Latin America has had its own corporate governance

scandals, followed by public opinion reactions and reform initiatives. Shenanigans

related to non-voting shares, takeovers, and withdrawal of listings prompted

Brazil’s efforts in 2000 to reform legislation on companies and securities. The TV

Azteca case, and other instances of improper treatment of minority investors,

triggered the subsequent reform of Mexico’s stock market laws and gave rise

to the Investment Promotion Corporation (IPC), a completely new legal entity

for companies that were listed on the stock exchange and those that were not.

There were also major, albeit partial, reforms in Argentina, Colombia, and Peru.

Since 2000, the protagonists of all these public and private sector efforts have

been meeting regularly to exchange ideas and experiences at the Roundtable on

Corporate Governance of the OECD, co-organized from the start with the IFC and

supported throughout by the Global Corporate Governance Forum (GCGF).

Prologue by Mike Lubrano.

In the wake of highly publicized scandals related to poor governance, there followed demands for some kind of legal/regulatory response. As seen after the East Asian crisis in 1997, the series of corporate collapses in the United States, starting with Enron, and the Royal Ahold and Parmalat scandals in Europe, investors and other stakeholders strongly urged governments, legislators, and regulators to “do something about it.” But what should be done? The circumstances surrounding each crisis were different and only rarely were there obvious solutions at hand. Politicians, regulators, and businessmen usually disagreed as to the underlying causes of the scandal in question and therefore had different views regarding the recipe to avoid a repetition of the situation.

And of course, policymakers do not operate in an environment unconstrained by political, economic, and practical constraints. When one reviews the last 10 years of corporate governance-related scandals in Asia, the Americas, and Europe, what emerges is an impressive variety of policy outcomes. In some cases, governments acted precipitously; in others, they acted very slowly. Some reforms were comprehensive in scope; others more narrowly targeted. Some governments and regulators devised responses in the framework of longer-term strategies, while others engaged in blatant opportunism. Naturally, both the outcomes and the reactions of the community and the market were mixed; to this day, they are the subject of fierce criticism and intense debate.

Over the past 10 years, Latin America has had its own corporate governance scandals, followed by public opinion reactions and reform initiatives. Shenanigans related to non-voting shares, takeovers, and withdrawal of listings prompted Brazil’s efforts in 2000 to reform legislation on companies and securities. The TV Azteca case, and other instances of improper treatment of minority investors, triggered the subsequent reform of Mexico’s stock market laws and gave rise to the Investment Promotion Corporation (IPC), a completely new legal entity for companies that were listed on the stock exchange and those that were not.

There were also major, albeit partial, reforms in Argentina, Colombia, and Peru. Since 2000, the protagonists of all these public and private sector efforts have been meeting regularly to exchange ideas and experiences at the Roundtable on Corporate Governance of the OECD, co-organized from the start with the IFC and supported throughout by the Global Corporate Governance Forum (GCGF)…

To download the file click here.

Also available in Spanish.

Speech by SEC Commissioner: “The American Corporation and its Shareholders: Dooryard Visits Disallowed”

by Elisse B. Walter for US Securities and Exchange Commission (SEC), June 27, 2009.

…Our thinking on corporate governance issues in this country appears divided, however. There are those who believe that the capital markets themselves will improve corporate governance. And, there are those, like me, who believe that making improvements in corporate governance will enhance the capital markets. No matter which view you ascribe to, I think we can all agree that the relationship of the capital markets to corporate governance is complex and dynamic.

We have all seen an increased focus on corporate governance at the federal level over the past year. With resignations of CEOs and mandatory Say on Pay legislation for TARP recipients, I think it is fair to say that the Obama administration and the Congress are taking the initiative to demand governance excellence in fact and not just in appearance. This theme runs throughout the Administration’s white paper, which includes a recommendation for mandatory Say on Pay votes at all public companies…(read the complete sspeech here)

Private Sector Opinion, Issue 5: Whistleblowing: Recent Developments and Implementation Issues

by  Mak Yuen Teen for Global Corporate Governance Forum.

Foreword by Stephen B. Young.

Mak Yuen Teen has raised some very important considerations for the internal governance of corporations when he argues for additional legal protections for whistleblowers. Boards of Directors should respond positively and constructively to his suggestions because his arguments go to the heart of board powers and responsibilities.

Whistleblowing occurs when there is bad news to report; news so unsettling that it is feared and covered up. That is why it often takes a “whistleblower” to bring the unsavory tidings to public attention. Normal channels for reporting and disclosure have failed.

In short, the information that is to be conveyed to responsible authorities by whistleblowers points to dangers and risks, sometimes grave dangers and high risks. One thinks of Sharon Watkins at Enron seeking to inform the CEO Ken Lay of systemic financial misreporting of actual earned income. What had been covered up and what she sought to disclose was of life and death consequence to the company. Public disclosure of her information led directly to Enron’s bankruptcy. Suffice to say a more responsible board should have prevented that event by taking early preventive action…

To download this file click here.

Foreword

Mak Yuen Teen has raised some very important considerations for the internal

governance of corporations when he argues for additional legal protections for

whistleblowers.

Boards of Directors should respond positively and constructively to his suggestions

because his arguments go to the heart of board powers and responsibilities.

Whistleblowing occurs when there is bad news to report; news so unsettling that it

is feared and covered up. That is why it often takes a “whistleblower” to bring the

unsavory tidings to public attention. Normal channels for reporting and disclosure

have failed.

In short, the information that is to be conveyed to responsible authorities by whistleblowers

points to dangers and risks, sometimes grave dangers and high risks. One

thinks of Sharon Watkins at Enron seeking to inform the CEO Ken Lay of systemic

financial misreporting of actual earned income. What had been covered up and

what she sought to disclose was of life and death consequence to the company.

Public disclosure of her information led directly to Enron’s bankruptcy. Suffice to

say a more responsible board should have prevented that event by taking early

preventive action.

Corporate Governance, Norms and Practices

by Luc Laeven and Vidhi Chhaochharia, at SSRN, June 26, 2009.

Abstract:
We evaluate the impact of firm-level corporate governance provisions on the valuation of firms in a large cross-section of countries. Unlike previous work, we differentiate between minimally accepted governance attributes that are satisfied by all firms in a given country and governance attributes that are adopted at the firm level. Despite the costs associated with improving corporate governance at the firm level, we find that many firms choose to adopt governance provisions beyond those that are adopted by all firms in the country, and that these improvements in corporate governance are positively associated with firm valuation. Firms that choose not to adopt sound governance mechanisms tend to have concentrated ownership and free cash flow consistent with agency theories based on self interested managers and controlling shareholders. Our results indicate that the market rewards companies that are prepared to adopt governance attributes beyond those required by laws and common corporate practices in the home country…

To download this paper click here.

Private Sector Opinion, Issue 4: Auditors and Independence

by John Plender for Global Corporate Governance Forum.

Foreword

An old riddle loved by Abraham Lincoln asks, “How many legs does a cow have,

if you call a tail a leg?” The answer: Four. Calling a tail a leg doesn’t make it one.

And claiming an auditor is independent doesn’t make it so, either. In this essay,

excerpted from All You Need To Know About Ethics and Finance, Avinash Persaud

and John Plender correctly place independence as the foundation of the credibility

of the capital markets.

And they are correct to say that independence is particularly important when it

comes to auditors. Investors cannot be in the room when the entries are made

in the company’s books. They must believe that the auditors who check and

approve the figures are independent enough to represent their interests, instead

of being captive to the people who select them and approve payment. But

independence has been difficult to achieve and difficult to discern. Attempts, for

example, to tie the independence of directors to lower risk or greater return have

failed to show any special connection. The problem is not that independence is

not important—the problem is that independence is difficult to determine based

on the indicators required to be disclosed by the SEC and the stock exchanges.

Foreword by Nell Minow.

An old riddle loved by Abraham Lincoln asks, “How many legs does a cow have, if you call a tail a leg?” The answer: Four. Calling a tail a leg doesn’t make it one. And claiming an auditor is independent doesn’t make it so, either. In this essay, excerpted from All You Need To Know About Ethics and Finance, Avinash Persaud and John Plender correctly place independence as the foundation of the credibility of the capital markets.

And they are correct to say that independence is particularly important when it comes to auditors. Investors cannot be in the room when the entries are made in the company’s books. They must believe that the auditors who check and approve the figures are independent enough to represent their interests, instead of being captive to the people who select them and approve payment. But independence has been difficult to achieve and difficult to discern. Attempts, for example, to tie the independence of directors to lower risk or greater return have failed to show any special connection. The problem is not that independence is not important—the problem is that independence is difficult to determine based on the indicators required to be disclosed by the SEC and the stock exchanges…

To download the file click here.

Focus 5: Novo Mercado and Its Followers: Case Studies in Corporate Governance Reform

by Maria Helena Santana, Melsa Ararat, Petra Alexandru, and B. Burcin Yurtoglu for Global Corporate Governance Forum.

Foreword

by Mauro Rodrigues da Cunha

It was an interesting sight. On an August afternoon in 2000, dozens of market

participants gathered at an unlikely place, the floor of Brazil’s Chamber of Deputies.

They had come a long way to be there. They all had decided it was worth investing

their scarcest resource—time—to offer counsel on overhauling the country’s

securities laws. As they took their turns speaking at the public hearing, each

outlined reasons why it was so urgent to reform these laws.

Brazil’s securities market—especially its equities market—was becoming

increasingly irrelevant. In previous years, virtually no new companies had tapped the

equity market. No initial public offerings. No secondary offerings. In other words,

no money was flowing from private savings into the productive sector. Brazilian

Securities and Exchange Commission (Comissão de Valores Mobiliários, CVM)

data suggests close to R$10 billion was raised in equity offerings between 1995

and 1999—a low number to start with (during the same period, the US IPO market

raised US$324 billion). However, if only public offerings in reals are included, the

value of equity offerings shrinks to US$550 million. That was nothing.

The improbable visitors to Brasilia were convinced that their country could and

should have a fully functioning world-class equities market. They did not believe that

“stratospheric interest rates” were the sole culprit. They understood that demand

for shares did not meet supply because of an additional factor that is not usually

included in portfolio theory: the risk of fraud.

The legislation that passed one year after their excursion was clearly not the

panacea for all the evils, as some had hoped. The “sausage factory” legislative

process inherent to democracies turned a well-intentioned project into a mixture

of good and bad reforms. Some issues were addressed appropriately. Loopholes

were closed, but many others were opened. Intense lobbying from special interests

resulted in legislation that only went half as far as was necessary.

As Vice President Marco Maciel approved the new law, market participants greeted

the event with a fraction of the enthusiasm they had originally expressed in their

testimony. Law 10.303 would not revive the market—not by itself.

Foreword by Mauro Rodrigues da Cunha.

It was an interesting sight. On an August afternoon in 2000, dozens of market participants gathered at an unlikely place, the floor of Brazil’s Chamber of Deputies. They had come a long way to be there. They all had decided it was worth investing their scarcest resource—time—to offer counsel on overhauling the country’s securities laws. As they took their turns speaking at the public hearing, each outlined reasons why it was so urgent to reform these laws. Brazil’s securities market—especially its equities market—was becoming increasingly irrelevant. In previous years, virtually no new companies had tapped the equity market. No initial public offerings. No secondary offerings. In other words, no money was flowing from private savings into the productive sector. Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários, CVM) data suggests close to R$10 billion was raised in equity offerings between 1995 and 1999—a low number to start with (during the same period, the US IPO market raised US$324 billion). However, if only public offerings in reals are included, the value of equity offerings shrinks to US$550 million. That was nothing.

The improbable visitors to Brasilia were convinced that their country could and should have a fully functioning world-class equities market. They did not believe that “stratospheric interest rates” were the sole culprit. They understood that demand for shares did not meet supply because of an additional factor that is not usually included in portfolio theory: the risk of fraud.

The legislation that passed one year after their excursion was clearly not the panacea for all the evils, as some had hoped. The “sausage factory” legislative process inherent to democracies turned a well-intentioned project into a mixture of good and bad reforms. Some issues were addressed appropriately. Loopholes were closed, but many others were opened. Intense lobbying from special interests resulted in legislation that only went half as far as was necessary.

As Vice President Marco Maciel approved the new law, market participants greeted the event with a fraction of the enthusiasm they had originally expressed in their testimony. Law 10.303 would not revive the market—not by itself…

To download the file click here.

Also available in Portuguese.

Private Sector Opinion, Issue 3: Corporate Governance: A North American Perspective

by Ira M. Millstein for Global Corporate Governance Forum.

Foreword

The recent wave of US corporate governance failures prompted a round of legal

and regulatory reform which has attracted worldwide attention. The cross border

impact of Sarbanes-Oxley has been direct as it extends the reach of US regulation

beyond home territory primarily in the case of foreign companies with US listings

and US public debt, and US companies with foreign operations. There has also

been indirect impact as reformers in other markets have been considering the

US example as a way to raise standards in corporate governance and thereby

strengthen capital markets. The debate about the proper role of law and regulation

in corporate governance reform has played out against complaints from

some sections of the business community with respect to the cost of implementing

certain reforms set forth in the legislation, and a surge in new listings on overseas

markets in comparison to US listings.

Ira Millstein’s essay puts the debate into a wider context for the US. The missing

link here is shareholder rights, which are not addressed in Sarbanes-Oxley.

Shareholders in the US have comparatively weaker rights than shareholders in

some other countries, thereby making it difficult for shareholders to hold boards to

account without prohibitive cost and effort.

While the US has drawn much of its legal governance practice from the common

law system, under the default provisions for incorporation under Delaware law,

where the bulk of large US companies are registered, shareholders can only vote

to approve directors put forward for election and cannot vote against. In addition,

shareholders in many companies may not have the right to call a general meeting

and issue a binding resolution, even if a majority of shareholders vote in favor of

the resolution. However, under shareholder pressure, more and more companies

have effectively opted out of the default plurality vote standard by adopting a

majority vote standard either through charter or bylaw amendments, or director

resignation policies. In addition, the SEC is reviewing shareholder access to the

nomination process, and proxy distribution via the internet.

Foreword by Anne Simpson.

The recent wave of US corporate governance failures prompted a round of legal and regulatory reform which has attracted worldwide attention. The cross border impact of Sarbanes-Oxley has been direct as it extends the reach of US regulation beyond home territory primarily in the case of foreign companies with US listings and US public debt, and US companies with foreign operations. There has also been indirect impact as reformers in other markets have been considering the US example as a way to raise standards in corporate governance and thereby strengthen capital markets. The debate about the proper role of law and regulation in corporate governance reform has played out against complaints from some sections of the business community with respect to the cost of implementing certain reforms set forth in the legislation, and a surge in new listings on overseas markets in comparison to US listings.

Ira Millstein’s essay puts the debate into a wider context for the US. The missing link here is shareholder rights, which are not addressed in Sarbanes-Oxley. Shareholders in the US have comparatively weaker rights than shareholders in some other countries, thereby making it difficult for shareholders to hold boards to account without prohibitive cost and effort.

While the US has drawn much of its legal governance practice from the common law system, under the default provisions for incorporation under Delaware law, where the bulk of large US companies are registered, shareholders can only vote to approve directors put forward for election and cannot vote against. In addition, shareholders in many companies may not have the right to call a general meeting and issue a binding resolution, even if a majority of shareholders vote in favor of the resolution. However, under shareholder pressure, more and more companies have effectively opted out of the default plurality vote standard by adopting a majority vote standard either through charter or bylaw amendments, or director resignation policies. In addition, the SEC is reviewing shareholder access to the nomination process, and proxy distribution via the internet…

To download the file click here.

Focus 4: Mediating Corporate Governance Conflicts and Dispute

by Eric M. Runesson and Marie-Laurence Guy for Global Corporate Governance Forum.

FOREWORD

By Mervyn E. King SC

A company is as integral to society today as the family unit is. Many of us spend

the greater part of our lives in companies that provide our livelihood. We establish

friendships and relationships through our work. Our children become friends of our

colleagues’ children, and our companies at times help us educate our children.

Many of us, too, have become equity holders of the world’s greatest companies,

either directly or indirectly through investments of our pension funds. By pooling

together human and capital resources efficiently and effectively, companies help

economies achieve prosperity.

In modern governance, the board remains accountable to the company as the

principal, but a board must make decisions that take into account the legitimate

expectations of the company’s stakeholders. A board must do so to be seen as a

decent citizen in the community in which it operates.

Corporate governance concerns not only how a board steers or directs a company

and monitors management, but also how managers manage. As Sir Adrian

Cadbury explained, corporate governance is simply defined as how companies are

directed and controlled. Corporate governance provides principles and practices

to aid directors and managers in discharging their responsibilities. They must make

business judgment calls on issues in which no one can be right all the time because

one is dealing with uncertain future events and risks. But the decisions and conduct

of directors and managers have a huge impact on society because companies

today are so integral to society. Better companies mean better societies.

When a dispute arises, what is in the best interests of the company? The answer

is to resolve it effectively, expeditiously, and efficiently. It is thus an important

governance issue for the board to ask: Do we have an adequate mechanism to

resolve disputes which may arise? If mediation is a tool to resolve conflict, why

can it not be used to manage relationships? In corporations, the human resource

director, for example, has become that manager of conflict between employer and

employee. Mediation can become a management tool and thereby strive for conflict

prevention rather than conflict resolution.

Foreword by Mervyn E. King SC.

A company is as integral to society today as the family unit is. Many of us spend the greater part of our lives in companies that provide our livelihood. We establish friendships and relationships through our work. Our children become friends of our colleagues’ children, and our companies at times help us educate our children.

Many of us, too, have become equity holders of the world’s greatest companies, either directly or indirectly through investments of our pension funds. By pooling together human and capital resources efficiently and effectively, companies help economies achieve prosperity.

In modern governance, the board remains accountable to the company as the principal, but a board must make decisions that take into account the legitimate expectations of the company’s stakeholders. A board must do so to be seen as a decent citizen in the community in which it operates.

Corporate governance concerns not only how a board steers or directs a company and monitors management, but also how managers manage. As Sir Adrian Cadbury explained, corporate governance is simply defined as how companies are directed and controlled. Corporate governance provides principles and practices to aid directors and managers in discharging their responsibilities. They must make business judgment calls on issues in which no one can be right all the time because one is dealing with uncertain future events and risks. But the decisions and conduct of directors and managers have a huge impact on society because companies today are so integral to society. Better companies mean better societies.

When a dispute arises, what is in the best interests of the company? The answer is to resolve it effectively, expeditiously, and efficiently. It is thus an important governance issue for the board to ask: Do we have an adequate mechanism to resolve disputes which may arise? If mediation is a tool to resolve conflict, why can it not be used to manage relationships? In corporations, the human resource director, for example, has become that manager of conflict between employer and employee. Mediation can become a management tool and thereby strive for conflict prevention rather than conflict resolution…

To download the file click here.