introduction to corporate governance sep 17 2011
TRANSCRIPT
Corporate Governance:Role of the Board and Implications on Shareholder
Wealth Creation
Dr. Demir Yener USAID/Business Plus Initiative
Sr. Finance and Corporate Governance Advisor
CORPORATE GOVERNANCE DEVELOPMENT CENTER
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AgendaPurpose: To explain the concept and processes of corporate governance
Outline:
1. Introduction, definition for corporate governance, 2. OECD Principles of Corporate Governance3. Forms of Business Ownership 4. Separation of Ownership and Control: The Principal-Agent
Dilemma 5. Benefits of Good Corporate Governance 6. Mongolian CG Environment7. Duties of the Board: Risk Management8. Summary and Conclusions
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Learning Objectives Understand what is corporate governance and why it
matters Understand the relationship between shareholders,
management and the board Understand why corporate governance is necessary to
incentivize good business practices Appreciate how to go about implementing corporate
governance in the most effective way The relevance of good CG practices for Mongolian
Companies
Corporate Governance
INTRODUCTION, DEFINITION, AND OECD PRINCIPLES OF CG
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Working definition of Corporate Governance
Corporate Governance involves a set of relationships and the networks between a company’s management, its board of directors, its shareholders and stakeholders.
Good corporate governance practice ensures the shareholders a fair rate of return.
Stakeholders in Corporate Governance
Stakeholders of the Firm
Primary Stakeholders
Other Stakeholders
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• Shareholders• Board• Executive Management
• Managers• Employees• Customers• Suppliers• Community at large• Government• Financial Markets• Environmentalists
Corporate Governance
Corporate governance has many links
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Finance
Law
Risk Mgmt
EconomicsStrategy
Ethics
Culture
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FORMS OF BUSINESS OWNERSHIP
Corporate Governance
Implications of the Legal Form of the Firm
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Common forms of business ownership
Cooperatives
Sole Proprietorship
orPartnership
Limited Liability
Company
Joint Stock Company
Ownership Multiple members (min 9)
Single Owner or Partners
Shareholders Shareholders
Owner’s liability Limited Unlimited Limited LimitedEasy access to capital market?
No No No Yes
Is management and ownership separate?
No No Yes Yes
Are business owners exposed to double taxation?
No No Yes Yes
SEPARATION OF OWNERSHIP AND CONTROL: THE PRINCIPAL-AGENT DILEMMA
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Conflict of Interests: The heart of the matter in corporate governance
Shareholders’ InterestsManagers’ Interests
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The Board is responsible for resolving the “conflict of interest” issue between shareholders and
managers
The Principal – Agent Dilemma
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Principal-Agent Dilemma and Asymmetric Information
Principal Agent
Corporate Governance 15The main role of corporate governance is to reduce total
agency costs in order to maximize shareholder value.
Typical Agency Costs
Divergence • Management fails to
maximize SH wealth• Actual results deviate
from expected annual results
Monitoring• Developing and
implementing monitoring and control structures reduce cash flow to SH
Incentives• Share Holders need
to remunerate management with extra incentives that reduce wealth
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The Four Basic Values of Corporate Governance
TRANSPARENCY• Ensures timely,
material & accurate information is available
• Info on Finance, Performance, Ownership, Governance
• Prevents Information asymmetries
ACCOUNTABILITY• CEO
Accountable to the BOD
• BOD accountable to the S/H
RESPONSIBILITY• Recognize the
legal rights of all SHs
• Encourage cooperation between company and stakeholders
FAIR TREATMENT• Protect SH
rights• Treat all SHs
and minorities equitably
• Provide for effective redress for violations
Main governing bodies in the company
Shareholders
Provides capital
Elects or dismisses
BOD
Board
Represents SH
Sets strategy
Provides guidance to CEO
Monitors CEO
Executive Management
Helps formulate and Execute
Strategy
Provides transparent
reporting and disclosure
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The Board is the Representative of Shareholders
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The main role of the board is to monitor the management in order to reduce total agency costs, and ensure the maximization of SH’s wealth
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‘Yes-men’ Board
Different Types of Boards
‘Rubber Stamp’ Board
‘Country Club’ Board
‘Good Old Boys’ Board
‘The Real Thing’
‘Phantom’ Board
?‘Trophy’ Board
Degree of Board Involvement in Management
At the discretion of
CEOLimited Activity & Participation
Limited Accountability
Certifies to SH that CEO
meets expectations
Takes corrective
actionUnderstands
role of independent
directors
Provides insight & Support
Understands its monitoring
roleGuides and judges the
CEOHas the right
skills mix
Intensely involved in decision
making on key issues
Frequent and intense
meetings—on short notice
Makes key decision, and management implementsFills gaps in management experience.
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Low High
Passive Certifying Engaged Intervening Operating
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The Chairman of the Board and Directors
Role of Stakeholders
Stakeholders cannot have claims on the firms except those specified by
laws
Firms have a social responsibility to fulfill so they must act in
the broad interests of the society at large
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The Separation of Ownership and Control
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The Stakeholders of the FirmEmployees Shareholders Community Government Environmental
GroupsManagement Customers
SuppliersWage equity Financial returns Political
corruptionRegulatory compliance
Pollution Financial returns
Product safety (for people and
the environment)
Workplace health and
safety
Accurate and timely disclosure
of operations and performance
Local employment
Pollution and other
environmental issues
Biodiversity Stock options Customer satisfaction
Workforce diversity
Corporate governance,
including executive
compensation
Living environment/
Workplace health and
safety
Regulatory compliance
Executive remuneration
Product performance
Job security and
regulatory compliance
Increase in share prices
Environmental standards
Employment Sustainability Increase share value
Responsible advertising practices
Salary increase
Shareholder proxies
Regulatory compliance
Discrimination Human rights New technology Product environmental
impact
Dividends Risk management
Health and safety
Social benefits/taxes
Socially responsible investments
Dividends/financial
performance
Regulatory compliance
Growth, prestige and reputation
Protection of rights/
dividends
Standard of living
Environment and safety standards
Regulatory compliance
Growth, prestige and reputation
Safety standards
BENEFITS OF GOOD CG
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Good Corporate Governance Attracts Capital
• Good corporate governance helps improve access to capital investment and finance with better terms and lowers cost of capital for good firms
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Benefits of Good Corporate Governance
5. Shareholder wealth creation assured
4. Improved operational efficiency increases
competitiveness
3. Public recognition results in better access to finance
2. Improved CG structure lowers the cost of capital
1. Basic legal compliance improves company
reputation
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Good CG ensures better access to capital
Good
board
guidance
& oversight
Material and
timely disclos
ure
SH rights protected
Investor friendly
company
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Access to finance facilitated
Good CG Practices Stimulate Firm Performance
Efficiency •Streamlining business process•Improves operating performance•Lowers costs and capital expenditures
ROE •Improving ROE•Increase profitability•Improves the chances that SHs will receive sustainable dividends
Higher Share Price •Profitability improves share price performance•Firms gets better recognition as a good performing stock•Attracts investor confidence, and new capital
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Lowering the cost of capital and raising the value of the firm
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2523
1413
24
0 10 20 30 40 50
Russia
China
Brazil
Poland
USA
Germany
Source: McKinsey, Global Investor Opinion Survey on Corporate Governance, 2002
73% would consider a premium for better governed firms-depending on region Average premium of investors are ready to pay for well-governed companies, in %
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Average premium investors would be willing to pay differs by country and regions
Latin America Asia Western Europe Northern America
Columbia
Argentina
Chile
Thailand Italy
United Kingdom
USAGermany
50
40
30
20
10
0
%
E Europe/Africa
Morocco41%
Egypt
Russia
Turkey 24%
25% China
Poland23%Philippines
22% Mexico19%
18%12%
11%
South Africa
Canada
Taiwan19%
Average 30%
Average 22%
Average 22%
Average 14%
Average 13%
Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
14%13%
27%
Good Corporate Governance Increases Long Term Performance
Building the Business Case for Good CG• Transparent• Responsible• Accountable• Fair investment
environment
• Investors are protected under the law
• Prudential regulation
• Transparency improves market price discovery mechanism
• Increasing investor confidence attract investments to the market
Open Market
Rule of Law
Lower Systemic
Risk
Investor Confidenc
e
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The Analytical Framework for CG CG is a Public Policy Concern: Governments
have now recognized the strong correlation between sound macro-economic policies and microeconomic foundations.
Effective corporate governance practice is key to improving micro-economic efficiency through competitiveness and provides the foundation for access to finance for all firms.
THE PROPER ENVIRONMENT FOR CORPORATE GOVERNANCE
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The Environment for Good Corporate Governance
Good CG helps make the company Competitive Competitiveness requires:
• Quality of the Business Environment
• MACRO Economic Environment
• The Quality of Business Strategy and Operations
• Ensuring sustainable productivity growth
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Impact Points on Micro and Macro PoliciesPolicy* Company Impact Points**
Category Instrument Finance Marketing Production Organization
Monetary Interest Rates (A) X
Credit (O) X
Fiscal Tax Rates (L) X
Investment Credit (L) X X
Government Sales (O) X
Government Purchases (O) X
Incomes Price Controls (A) X
Wage controls (A) X X
Trade Tariffs (A) X X
Import Quotas (A) X X
Export Incentives (L) X X
Exchange rates (A) X X
Foreign Investment Ownership Requirements (L) X X
Repatriation Limit (L) X
Personnel Regulations (A) X
Sectoral Technology Licensing (A) X X X
Production Licensing (A) X X
SOE Operations (O) X X X X
*Types of policy instruments: A = Administrative; L= Legal; O= Direct market operations** Management control aspects of each of the fours functional areas could also be affectedSource: J.E. Austin Associates. Managing in Developing Countries, 1990
Macroeconomic Initiatives
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Microeconomic Initiatives Privatization Financial Sector
Restructuring Rule of Law, Commercial
Law/Judicial Recourse/Arbitration
Anti-Corruption Trade and Investment
Promotion Small Business Facilitation Civil Service Reform Education Reforms Workforce Development
Industrial Parks/EPZs/ Techno/Knowledge Parks Labor Laws, Practices and
Mediation Mechanisms Private Provision of
Infrastructure Standards Bureaus Telecom, IT and E-commerce
Readiness Intellectual Property Rights Efficient Provision of Key
Services Sector-Specific Initiatives
Relationship between Investment and Economics
Economic Growth
CapitalInvestme
ntQuality of Business
EnvironmentRule of law
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Corporate Governance
Corporate Governance is the Antidote to Corruption
Corporate Governanc
e
Anti-corruption
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Seeking Balance between the Interests of Stakeholders
Proper legal and regulatory frameworks will provide an equilibrium between the shareholders, other stakeholders and the firm that is sustainable over time.
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International Institutions Providing Guidance on Corporate Governance
Organization for Economic Cooperation and Development (OECD) www.oecd.org
The World Bank Group: IBRD/IMF/IFC www.worldbank.org Global Corporate Governance Forum (IFC/OECD)
www.gcgf.org Basel Committee on Banking Supervision (BIS) www.bis.org Institute of International Finance (IIF) www.iif.com Financial Stability Forum (FSF) www.fsf.org International Organization for Securities Commissions
(IOSCO) www.iosco.org Governments and financial sector regulators around the
world Corporate Governance 42
OECD Principles of Corporate Governance www.oecd.org/daf/corporateaffairs/principles/text
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OECD Principles of Corporate Governance (2004)www.oecd.org
1. Ensuring the Basis for an Effective Corporate Governance Framework
2. The Rights of Shareholders and Key Ownership Functions
3. The Equitable Treatment of Shareholders4. The Role of Stakeholders 5. Disclosure and transparency6. The responsibilities of the board
Corporate Governance 45Source: Foreign Affairs, September-October 2002.
CG ENVIRONMENT IN MONGOLIA
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Leading Mongolian Institutions Supporting Corporate Governance
Governmental Financial Regulatory Commission (FRC) Central Bank of Mongolia (BOM) State Property Commission (SPC)Non-Governmental Mongolian National Chamber of Commerce and
Industry (MNCCI) Mongolian Employers Federation (MONEF)
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Mongolian Corporate Governance CodeResolution no. 210 of the Financial Regulatory Commission,
December 26, 2007
1- Principles of corporate governance2- Meetings of shareholders3- The role of the board of directors4-The role of the executive management5- Open and transparent information6- The Stakeholders -- Participating entities7- Supervision of operations8- Dividend Policy9- Settlement of disputes
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Mongolian Legal and Regulatory Frameworks supporting Corporate Governance
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Legal and Regulatory Reforms in Mongolia Mongolia pursued legal reforms during the 1990s
The judiciary is the backbone of a strong enforcement system.
Deficiencies in enforcement is persistent
Enhanced mandate and capacity of Financial Regulatory Commission/Bank of Mongolia is needed
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BOM CG Principles for BanksThe Constituents
Accountabilities and Authorities of the Board
Functions of Senior Management
Audit Committee and the Functions of Internal Audit
Functions of External Audit
Transparency
THE ROLE OF THE BOARD IN RISK MANAGEMENT
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What is Risk?• The English word “Risk” derives from the Latin
“Periclum” that infers taking daring actions. • In this sense, “risk” represents a conscientious
choices made by a firm, – as the consequence of the actions taken or strategies
pursued, – rather than “fate” that befalls upon an entity by an act of
nature that was unanticipated– even though that is also a possibility in life.
Risk Appetite: Living Dangerously, Speculation, or Calculated Risk?
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Effective Risk Management Strategies Help By: Being proactive in dealing with possible
unanticipated losses; Protecting the firm’s credit rating; Ensuring growth and profitability of the firm; Contributing to creating positive public image and/or
reputation; Increasing customer and stakeholder interest in firm; Making company attractive for recruiting good talent
and better management compensation and contracts;
Improving parameters in planning and budgeting;
Types of Risk
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• EXTERNAL FACTOR RISKS
• INTERNAL FACTOR RISKS
• LEGAL & REGULATORY RISK
• MARKET RISK• PROCESS RISKS• COMPLIANCE RISKS• PEOPLE RISKS
• FINANCIAL RISKS• OPERATIONAL RISKS• TECHNOLOGY RISKS
• TREASURY RISKS• CREDIT RISKS• TRADING RISKS• TAX RISK
STRATE-GIC RISKS
OPERA-TIONS RISKS
INFORMA-TION RISKS
FINANCE RISKS
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Risk Management is Board Responsibility
Key board functions
Review and guide corporate strategy, plans of action, risk policy, budget & business plans.
Set performance objectives.
Monitor implementation and corporate performance.
Oversight and guidance on major capital expenditures, acquisitions and divestitures.
Source: OECD Principles of Corporate Governance, 2004.
Source: Mongolian Code of Corporate Governance, December 2007
BOD shall be a unit defining the strategic policy of corporate activities and imposing supervision on activities of the executive management.
Corporate Governance
Risk Tolerance and Risk Appetite
Risk Tolerance
• “The willingness of the board to take risk in order to achieve a predefined objective”
Risk Appetite
• “The amount of risk an entity is willing to accept in pursuit of shareholder value creation” 58
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Determinants of Risk Appetite
Risk Appetite
Capital at Risk
StrategyInternal Constraints
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• Market Risk• Credit Risk• Operational
Risk• “What if”
Scenarios
• Organizational Structure
• HR• Systems (IT)
• Markets• Stakeholders• Shareholders
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The “right” kind of risk
The “right” amount of risk
“Adequate” risk management
The Level of Board’s Risk Awareness
What does it take to implement good governance?
BoardCommitment
Board Leadership
Shareholder Rights
Protection
Disclosure & Transparency
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SUMMARY AND CONCLUSIONS
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Summary and Conclusion Private sector corporations are the most important business form, they
generate most of the country’s GDP Separation of ownership and control causes the agency problem known as
the “principal-agent problem” are that can be resolved by adequate incentives and monitoring
OECD Principles of CG provides the template for many codes globally. Corporate governance is the set of internal and external mechanisms which
allows for the resolution of principal-agent problem In addition to the shareholders, stakeholders also play an important role in
corporate governance Good CG ensures operational efficiencies, access to finance at a lower cost
of capital, higher shareholder value and higher reputational benefits. CG is better understood if internal and external perspectives are considered
but the different systems are increasingly converging as financial markets continue to globalize
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The Role of Disclosure
“If investors are not confident with the level of disclosure, capital will flow elsewhere..”
Arthur Levitt, Former Chairman of US SEC
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Investor behavior is shaped by greed and fear
Bayarlalaa
Thank you
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