1 Corporate Management in the CIS Week 8 Corporate governance and accounting.

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Corporate Management Corporate Management in the CISin the CIS

Week 8Week 8

Corporate governance and Corporate governance and accountingaccounting

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What is Corporate Governance?What is Corporate Governance?

• The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources.

• The aim is to align as nearly as possible the interests of individuals, corporations and society

• (Sir Adrian Cadbury in ‘Global Corporate Governance Forum’, World Bank, 2000)

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What is Corporate Governance?What is Corporate Governance?

• Corporate governance is the system by which business corporations are directed and controlled.

• The corporate governance structure specifies the

• distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and

• spells out the rules and procedures for making decisions on corporate affairs.

• By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.

• OECD 1999

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Why is it necessary?Why is it necessary?

• “The directors of public companies being the managers rather of other people’s money than of their own, cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company”.

• Adam Smith The Wealth of Nations (1776)

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Why do we need Corporate Why do we need Corporate Governance?Governance?

• Loss of the role of the state

• Western style governance

• Continental Europe– Dual board– Management & Supervisory

• UK/US (Anglo)– Single tier board

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Corporate Governance CodesCorporate Governance Codes

• Non-mandatory

• Market for corporate control

• Independence of directors

• Audit functions

• Remuneration

• Transparency/Accounting

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Does it work? - EuropeDoes it work? - Europe

• Shares in media conglomerate Vivendi Universal have collapsed on reports in the French press that the company attempted to 'massage' its accounts to the tune of £1bn.

• Vivendi shares fell by a third after a report in national newspaper Le Monde alleged the company tried to flatter its 2001 accounts by as much as Euro 1.5bn (£1bn).

• It refers to an October 2001 transaction when Vivendi tried to avoid booking a Euro 1.5bn loan transaction that resulted from a deal involving the sale of BskyB shares

• Accountancy Age - 2003

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Does it work? - EuropeDoes it work? - Europe

• Although formal charges have not yet been brought, the elder Tanzi has already admitted that he secretly siphoned off at least 500 million euros ($630 million) from Parmalat to a family-owned subsidiary

• According to the charges, numerous shell companies were set up to generate fake profits for Parmalat and subsidiaries.

• In addition, Parmalat’s finance director has told interrogators that he participated in a “cut and paste” forgery, in which a document with Bank of America letterhead was scanned and then added to a document verifying a deposit account with that bank holding over $4.98 billion. The document was then passed through a fax machine several times in order to appear authentic.

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Does it work? – Europe (er, and Does it work? – Europe (er, and US)US)

• Tyco Inc• Ex-chairman Kozlowski, former finance chief

Mark Swartz and former general counsel Mark Belnick have been indicted and face criminal charges for allegedly taking $600m (£3.75m) through fraudulent stock sales and other means.

• Ahold, the Dutch-based supermarket giant, has admitted that it overstated its profits by at least $500m (£317m).

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Corporate Governance Russian Corporate Governance Russian StyleStyle

• Abuses – EBRD• Asset Stripping• Issue of new shares with preferential

conditions for insiders• Delayed dividend payments affected by

inflation• Disinformation to outsiders• Redistribution of property from bankruptcy

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History of Corporate History of Corporate GovernanceGovernance

• 3 stage model – Judge & Naoumova (2004)

• 1. In the hands of the state

• Handled property claims

• Monitored corruption

• Oversaw all financial transactions

• Private enterprise moves too fast for the state to react

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History of Corporate History of Corporate GovernanceGovernance

• 3 stage model – Judge & Naoumova (2004)• 2. Anglo-American form• Minimal state intervention• Rule of law and markets govern enterprises• Checks provided• For equity: market for corporate control• For debt: collateral and bankruptcy procedures• Few laws to establish fairness• Victory of informal rules• No easy entry/exit to market

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History of Corporate History of Corporate GovernanceGovernance

• 3 stage model – Judge & Naoumova (2004)• 3. Three choices• A) new CG code presumes Anglo approach• International markets – oil & gas• B) Continental Europe model• Bank-led FIGs• Pressure from banks• Paternalistic/hierarchical control• Participative decision making• 50% of banking capital in 5 banks• C) Develop unique method of control

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Obstacles to good Corporate Obstacles to good Corporate GovernanceGovernance

• Lack of transparency in finances

• Lack of effective enforcement in commercial law

• Low trust nation

• Skewed reward system for managers

• Maintenance of value not transparent operation

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Good Governance RatingsGood Governance Ratings

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Does it matter?Does it matter?

• Black “Does CG matter? (2001)• High correlation between governance

rating and potential market capitalisation

• 1 sd improvement in rating = X8 increase in market potential

• Better CG = lower cost of capital• Better CG = more FDI

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Governance & FDI?Governance & FDI?

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Drivers of Governance reformDrivers of Governance reform

• Global rating system• Outside institutional investors• Putin administration & need to actively

involve in global economy• Approach to “criminals” in private sector• PWC estimate hard line could generate extra

$10 billion annual foreign investment• Russian firms sell for $54 bn less as result of

poor governance (Troika Dialog)

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Wimm-Bill-Dann – the right wayWimm-Bill-Dann – the right way

• Dairy plant founded in 1992• Now employs 15,000• 20 manufacturing plants• 2002 sales = US$675 million• Growth = 40% per annum• Committed to transparency & good

governance• Standard & Poor’s rate in top Russian firms

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Wimm-Bill-Dann – the right wayWimm-Bill-Dann – the right way

• In its initial public offering for the New York Stock Exchange, WBD’s prospectus revealed that one of its principal investors had spent nine years in prison for committing a violent crime, and that this could hurt investors in the future.

• According the New York Times, this revelation was startling and unexpected.

• Perhaps because of its words and deeds to be “squeaky clean”, along with its considerably upside potential, the public offering on 8 February 2002 was a huge success and its stock value continues to rise

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Corporate Governance Code – Corporate Governance Code – April 2002April 2002

• Will it be any good?

• Brunswick UBS Warburg suggest aims

• Educational providing firms with clear checklist of what initiatives investors would like

• Sets out mechanism to attain these

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Corporate Governance Code – Corporate Governance Code – April 2002April 2002

• Not actual Law• So no binding force• Government suggest could become law• UBS argue companies with state in

majority control (eg Gazprom/Sperbank) will conform

• Should/could have cascade effect

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Structure of codeStructure of code

• Chapter 1. Principles of Corporate Governance• Chapter 2. General Shareholders Meetings• Chapter 3. Board of Directors• Chapter 4. Executive Bodies• Chapter 5. Company Secretary• Chapter 6. Essential Corporate Activities• Chapter 7. Information Disclosure• Chapter 8. Monitoring Operational• Chapter 9. Dividends• Chapter 10. Resolving Corporate Conflicts

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Content of the CodeContent of the Code

• Principles of Corporate Governance• Rights of shareholders• Reliable registration of ownership• Participation in management• Receipt of full information• General Shareholders Meetings• AGM/EGM right to full information/right to

participate• Board of Directors• Roles/elections/regular meetings/not to disclose

sensitive information

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Content of the CodeContent of the Code

• Executive Bodies• Law currently allows all executive power to be with

CEO• Should set up supervisory board• 2 tier system• Company Secretary• New post• Intermediary between board and shareholders• Essential Corporate Activities• Large transactions (25% asset base) to be approved

by board or EGM before finalisation & evaluated by independent auditor

• Rules on takeover – information & protection

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Content of the CodeContent of the Code

• Information Disclosure• What information to be disclosed and when• Monitoring Operational• 3 layers of control• Internal audit/control and revision committee

reporting to AGM/external audit• Dividends• Clear rules on calculation and payment• Resolving Corporate Conflicts• Role and powers of company secretary in conflict

resolution

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Is it working?Is it working?

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Ownership & ControlOwnership & Control

• Highly concentrated• Largely non-transparent• Examples• Gazprom ignores legal requirement for

independent audit• Lukoil issues financial statements well

beyond deadlines & often unaudited 6 monthly reports

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Current problemsCurrent problems

• Preobragenskaya & McGee (summer 2004)• Lack of clear & transparent professional

standards• Slow progress in internal control• Lack of criteria in establishing board

remuneration• Weak procedures to settle conflicts of interest• Low effectiveness of audit work• Low level of disclosure of main beneficial

owners

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An Investor PerspectiveAn Investor Perspective

• Corporate governance in Russia remains weak despite progress since the Task Force visit two years ago. Moreover, the Yukos affair and other recent government actions to reassert control over the energy sector have underscored the weaknesses and fragility of Russia’s institutional framework that underpins corporate governance practices. President Putin’s assurances during the past year that the government places great value on property rights and the rule of law have not been confirmed by realities of the marketplace and investors have been increasingly disturbed by the government’s heavy-handed action to seize Yukos assets for non-payment of taxes. As a consequence, investor confidence has been shaken on a scale not seen since the Russian 1998 financial crisis.

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Failure of policy?Failure of policy?

• Rise of political risk (US Banker Jan 2004)

• Politics has a huge effect even when market fundamental look good

• Khodorkovsky case• Raises all the red flags• Selective enforcement of laws• Crisis of democracy – political rivalry

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Elsewhere….Elsewhere….

• Ukraine – see yesterday’s crisis of democracy• Also Kostyuk (2003)• Market for corporate control• Corporate ownership structures getting more

concentrated• Corresponding drop in market performance• Most active players are FIGs• Companies do not have systems of financial

reporting which meet international standards• Buying in Ukraine like “cat in a sack”• Weak informational transparency deters foreign

investors