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Emerging Market Finance:
Lecture 5: Corporate Governance Issues
Separation between ownership and control
How can property rights be protected for all shareholders?
Incentive issues: how to ensure that managers will make the
“right” decisions?
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Historically Speaking
Back in 1700 or even 1800, corporate governance was not a big problem, and necessary institutions were not demanding yet
Because ……there were mostly “family businesses”
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Ownership structures of public companies:which form is the “best”?
Diverse ownership with many small shareholders: extreme separation between ownership and control
Family-controlled: some separation between ownership and control, with a family being the controlling shareholder.
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Problems with Dispersed Ownership
The Enron example
The case of “Investment Privatization Funds” (IPF) in the Czech Republic and Russia
Key reason: it may not be worth any shareholder’s efforts to mind the firm’s business, because each shareholder holds too small a stake.
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Investors: Millions
Public Corp.Stock market
Regulators (SEC)
The Court
The Press & Mkt Partic.
Auditors & Others
The Board
But, the scale and scope of modern corp. requires large financing, even arm’s-length financing. It takes “a lot” to support publicly traded corporations or stock market!
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Internal governance design issue:Positive Incentives to Resolve Conflicts between
Management & Shareholders
Design 1: performance-based bonus
Design 2: give shares to CEO and other top executives
Design 3: stock options
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In the U.S., how much did the CEO get for each $10,000 of Shareholder Value Increase?
7. 5
25
36. 6
69. 1
0
40
80
Bonus Shares owned by
CEO
Stock Options owned by CEO
In Total
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Do Executive Incentives Make any Performance Difference?
1.20%
5.70%
0%
2%
4%
6%
Diff in ROE Diff in Stock Returns
Two groups of companies used: (1) public companies for which the board required the CEO to hold a minimum level of shares and (2) firms in the same
industry but without minimum shareholding requirement for CEO
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Absent of Reliable Institutions
What can the shareholders do?
---- One way is to have large shareholders or concentrated ownership, so that someone “cares”!
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Problems with concentrated ownership: The case of Long-Fa Corp in China
On May 25, 2000, there were two Legal-Person Share transfers:
10.7 million shares from the largest shareholder to Nan-Du Group at $4.38 per share (to become 3rd largest shareholder)
12.87 million shares to another firm at $2.19 per share (to become 2nd largest shareholder)
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Question: Why Pay More on Same Day?
Nan-Du Largest Shareholder
10.7 million shares @ $4.38
Another shareholder
Past 3rd Shareholder
12.87 million shares @ $2.19
(Paid $23.43 million more)
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The first related-party asset swap: Sept. 2000
Nan-Du Long-Fa Corp.
Sell 49.5% of Nan-Du Network: @ assessed value: 117.1 million.
Book value = 63.21 million
Sell Long-Fa Ski Resort: @ assessed value: 76.1 million.
Book value = 75.43 million
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Second related-party Transaction: May 2001
Nan-Du Long-Fa Corp.
Sell 37% of Nan-Du’s Cable Company:
@ assessed value: 83.72 million.
Book value = 35.93 million
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After the Tunneling Efforts …
Long-Fa Corp’s earnings dropped 25% from 2000 to 2001
Revenues dropped 15.2%Its ROE dropped to 2.56% in 2002.
After selling its worst assets to Long-Fa Corp. Nan-Du decided to sell its holdings of Long-Fa @ $2.8 per share, in March 2002.
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Another common problem
Voting (control) rights often do not correspond to cashflow rights:
you pay the same price for a share, but do not get the same “rights” as the controlling shareholder does on a per-dollar basis
The use of pyramid holding structure to commit the least cash but hold a controlling position
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Claessens, Djankov & Lang (2000, J. of Fin. Econ.)
Case of the Ayala family in the Phillipines
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Case of the Li family in Hong Kong
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Back to Dispersed Ownership: Any mechanisms to make shareholders more active?
Class action suits: an efficient way for outside shareholders to play a more active role
Market for corporate control: hostile takeovers
