Corporate Governance
Around the World

Law and Corporate Governance

Corporate Governance Reform

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Political Dynamics

The Sarbanes-Oxley Act

The Cadbury Code of Best Practice

The Dodd-Frank Act

Consequense of Law

Protection of investors’ rights has major economic consequences

Pattern of corporate ownership and valuation

Component

The Agency Problem

Shareholders

Shareholders allocate decision-making
authority to the managers

Residual control rights refer to the right to make discretionary decisions under those contingencies that are not specifically covered by a contract

Managers

May allow themselves to consumer exorbitant perquisites

may also steal investors’ funds

Self-interested managers may also waste funds by undertaking
unprofitable projects that benefit themselves but not investors

Managers may also adopt antitakeover measures to ensure personal job security

E.g., private jets worth tens of millions of dollars

E.g., transfer pricing scheme

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Managers can exercise substantial discretion over the disposition and allocation of investors’ capital

Investors are no longer assured of receiving fair returns on their funds

Remedies for the Agency Problem

1. Independent board of directors

2. Incentive contracts

3. Concentrated ownership

4. Accounting transparency

5. Debt

6. Shareholder activism

7. Overseas stock listings

8. Market for corporate control

Definition

Advantages

Disadvantages

An independent director is a member of the board of directors who

(1) do not have a material relationship with the company,

(2) is not part of the company’s executive team, and

(3) is not involved with the day-to-day operations of the company.

Is the key to good corporate governance

An independent board with a majority would be better suited to oversee the Chief Executive Officer (CEO) rather than a board consisting of dependent directors

Appointing more independent directors often brings more third-party advice and expertise

The risk of information asymmetry as independent directors are generally less informed about the company than the management team

In addition, they may not have the requisite skills and knowledge to be an effective board member

Advantages

The contract types that is an owner to make an additional compensation to a contractor based on the contractor’s execution performance of cost, schedule, quality, and safety,..

Offered managers incentive contracts

such as shares and stock options

to reduce arbitrage and better align their interests managers with the interests of investors.

managers can be motivated to run the company in a way that enhances shareholder wealth as well as their own

Disadvantages

Losses to the company if supervisory shareholders are not careful

managers can artificially manipulating accounting numbers

sometimes with the involvement of auditors, or by changing investment policies

they can reap great profits in terms of personal interests

The case where majority of shares are held by few owners.

Disadvantages

Advantages

Concentrated ownership is an effective way to reduce the agency problem

Thereby reducing the situation of mistakes or frauds in management and administration

They will favor decisions that enhance long-term performance over decisions with short-term benefits.

When the executives are large shareholders or have large voting rights, they can use their power to influence the decisions of the Board of Directors for personal gain

The financial reporting process of accounting where companies report their financials to the public.

Advantages

Disadvantage

The scandal about accounting transparency
"the collapse of Enron"

To achieve greater transparency.

(i) Countries to reform the accounting rules

(ii) Companies to have an active and qualified audit committee.

Creating products whose sole purpose was to help companies transform their debt into capital or revenue through the use of accounting loopholes, special purpose entities, and poor financial reporting.

A dividend to pay to shareholders

Disadvantages

Borrowing and the subsequent obligation to make interest payments on time

Debt can be a stronger mechanism than stocks for credibly bonding managers to release cash flows to investors

In turbulent economic conditions, managers do not have such flexibility and the company’s survival can be threatened

The risk-averse managers to forgo profitable but risky investment projects, causing an underinvestment problem

Debt may not be such a desirable governance mechanism for young companies with few cash reserves or tangible assets

"Activist investors”
Who invest in stocks of a company for the explicit purpose of influencing the company’s management, started to play an important role in promoting shareholders’ interests.

Activist shareholders also pursue their social and political agenda

The companies to make commitments to corporate social responsibilities

Increase gender and ethnic diversity on the board of directors

Get involved in target firms’ strategic, operational, and financial decisions, these firms experience significant share price appreciations

A company that is constantly underperforming and all its internal governance mechanisms can't fix the problem.

Another company or investor makes a takeover bid.

The bidder typically makes a tender offer to the target shareholders at a price substantially exceeding the prevailing share price.

Companies based in countries with weak investor protection regimes, such as Italy, South Korea, and Russia

They may choose another way to provide better investor protection by listing their shares in countries with strong investor protection regimes, such as the United States and the United Kingdom.

Foreign companies with weak governance may choose to outsource a potential existing corporate governance arrangement in the United States through cross-listing.

The Eun and Huang study

B-shares and H-shares, is subject to much more stringent disclosure and listing standards.
Institutional investors, may provide more rigorous monitoring of the management.

"Ceteris paribus"

English common law

Has considerable power to interpret law based on the unique circumstances of each individual case, including other business and commercial dispute situations

Follow the practice and legal precedent set by national courts.

Affects decision-making in extraordinary cases

Outcome cannot be determined based on applicable statutes or written rules of law

French civil law

Derived from the legal system of France and the laws of some continental European countries

French law is the most important and has great influence on the laws of other countries

Based on concepts, categories, and rules derived from Roman law, with some canonical influence, sometimes supplemented or modified largely according to local custom or culture

Civil law describe law concerning people and things and the relationships that develop between them

Comprehensive system of rules and principles that are usually organised by rule and easily accessible to citizens and jurists

Favours cooperation, order, and predictability

Based on a logical and dynamic taxonomy developed from Roman law and reflected in the structure of the codes

Avoid excessive detail, and contains general provisions that allow adaptation to change

Primarily legislative, but still leaves room for the judiciary to adapt the rules to social change and new needs

Capital Markets and Valuation

Private Benefits of Control

Development of capital markets

Economic growth

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Ownership and Control Pattern

Large shareholders can control and monitor managers effectively and solve the agency problem

No conflicts between large shareholders and small shareholders

Dominant investors may acquire control through various schemes

Shares with superior voting rights

Pyramidal ownership structure

Interfirm cross-holdings

Accumulating superior voting shares, investors can acquire control rights exceeding cash flow rights

Control a holding company that owns a controlling block of another company

Concentrate and leverage voting rights to acquire control

Not shared by other shareholders on a pro-rata basis

The voting premium

The total vote value as a proportion of the firm’s equity market value

Dominant shareholders extract substantial private benefits
of control

Block premium

Difference between the price per share paid for the control block and the exchange price after
the announcement of the control transaction, divided by the exchange price after the control transaction

Large shareholders tend to extract significant private benefits of control in those countries

Investor protection promotes the development of external capital markets

Strong investor protection will be conducive to large capital markets

Weak investor protection can be a factor in sharp market declines

Accelerated expropriation can induce sharp declines in security prices

Well-developed financial markets may stimulate economic growth by making funds readily available for investment at low cost

Enhances savings

Channels savings toward real investments in productive capacities, thereby fostering the capital accumulation

Enhances efficiency of investment allocation through monitoring and signaling functions of capital markets

More than these companies’

failed

auditors

regulators

banks

institutional investors

will damage investor
confidence

stunt the development of capital markets

raise the cost
of capital

distort capital allocation

shake confidence in
capitalism itself

It is not easy to change historical legacies

Objectives of Reform

strengthening the independence

enhancing the transparency

disclosure standard

energising the regulatory

monitoring functions of the SEC

stock exchanges.

parties

vested interests

resist any attempt to change the status

should

understand the political dynamics surrounding
governance issues

seek help

the media

public opinion

nongovernmental organisations (NGOs)

The Sarbanes-Oxley Act of 2002

help protect investors

fraudulent financial statements by companies

required strict reform of existing securities regulations

introduced tough new penalties

who broke the law

address

financial scandals in the early 2000s involving publicly traded companies

The primary goal

to protect investors

improving the accuracy

reliability of corporate disclosures

restoring public confidence

the integrity of reporting. business Finance

Accounting Regulations

The establishment

overseeing the audit public companies

limit the consulting services

Audit committee

The company

appoint independent

“financial experts”

to its audit committee

Evaluation of Internal Controls:

Public companies

evaluate the effectiveness

preventing fraud

Take the main responsibility

The CEO and finance officials (CEO and CFO)

sign
quarterly

annual financial reports.

The British government

appointed

the Cadbury Commission in 1991

addressing corporate governance

The Cadbury Rules

'Code of Best Practice'

The UK's Cadbury

financial reporting

auditing

recommends

at least three (non-consecutive) external directors.

CEO and COB

two different individuals.

called the Dodd-Frank Wall Street Reform and Consumer Protection Act

regulations

the financial industry

created programs

stop mortgage companies

lenders from taking advantage

Volker rule

Deposit-taking banks

be banned

proprietary trading

from owning

more than a small fraction

hedge funds

private equity firms

Resolution authority

Government

seize

dismantle a large bank

orderly manner

Cadbury Code

The board of directors

meet regularly

retain complete

effective control over the company

oversee management

The head of the company

clearly accepted division

responsibility

The board of directors

include non-executive directors

considerable size

number so that their views carry considerable weight in board decisions.