CorporateGovernance:AnOverview

ProfessorJohnC.Coates

December2016

IOSCO/PIFS-HLS

GlobalCerGficateProgramforRegulatorsofSecuriGesMarkets

Whatiscorporategovernance?

VerydifferentdefiniGons

•  ThewayssuppliersoffinancetocorporaGonsassurethemselvesofgeUngareturnoninvestment.

–  Shleifer&VishnyJF1997

•  ThereconciliaGonofconflictsofinterestamongcorporateclaimholders.

–  ClaessensandYurtogluIFCForum2012

•  Theconstraintsthatshapeexpostbargainingoverprofitsgeneratedbyfirms.

–  ZingalesNewPalgraveDicGonaryofEconomics1998

•  Thesystembywhichcompaniesaredirectedandcontrolled.–  CadburyCommi`ee1992

Financial/shareholderPOVdominant(inUS,spreading),butconsider...

•  “Thevastmajorityofcapitalexpenditures[atlargeUSfirms]areinternallyfunded.”

–  JonathanBerkandPeterDeMarzo,CorporateFinance(ThirdEdiGon2014),at525

•  “Morethan75%ofcapitalexpendituresarefundedfromretainedearnings.”–  Id.at570

CurrentRangeofMeanings

Control DisclosureClear ReliableFlexible Consistent

Enforceable Relevant

Accountability LegiGmacyFinancial Rent-seekingCompliance Self-aggrandizement

Resilience (Sustainable) Socialvalue

CurrentRangeofMeaningMakers

BoardsMostlyCEOsAudit/financial

VarietyofotherSMEsLobbyists+LawyersTradeorganizaGons

UnionsInsGtuGonalowneragentsEntrepreneurs

RegulatorsandjudgesStockexchangesStandardse`ers(egFASB)

AcademicsLaw,finance,ethics,Economics,accounGng

AcGvistsShareholder+social

PoliGcians

HowisCGchanging?

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

UK

US

Linear (UK)

Linear (US)

Data sources: Federal Reserve Board (US); Office for National Statistics (UK)

“Owners” are concentrating in “owner-agents”: conventional institutions in US and UK

1 in 5 have > 30%!Held by 1 owner!

Conventional vs. New Institutions in US

0%

5%

10%

15%

20%

25%

30%

1980 1990 2000 2010 2013

As % of US Corporate Equity

Pension funds

Insurance Cos.

RICs

Conventional vs. New Institutions in US

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

As % of US Corporate Equity

Hedge Funds

Purely passive

0%

5%

10%

15%

20%

25%

30%

1980 1990 2000 2010 2013

As % of US Corporate Equity

Pension funds

Insurance Cos.

RICs

OldShareholder“Levers”

•  WallStreetwalk•  Pushingfor“bestpracGce”changes

–  Currentfocus:board“renewal”(evaluaGons,limits)

•  Directcontacts•  Embarrassment•  Lobbying(SOX,Dodd-Frank)•  Sayonpayvotes•  Shareholderproposals

–  Currentfocus:proxyaccess(1-3shhrepsonboard)•  Proxyprocess(hosGletakeovers)

NewShareholder“Levers”

•  WallStreetwalk•  Pushingfor“bestpracGce”changes

–  Currentfocus:board“renewal”(evaluaGons,limits)

•  Directcontacts(“engagement”)•  Embarrassment–

–  “Withhold”votes–  Sayonpayvotes

•  Shareholderproposals(e.g.,majorityvotebylaws)–  Currentfocus:proxyaccess(1-3shhrepsonboard)

•  Lobbying(SOX,Dodd-Frank,JOBSAct)•  Proxyprocess(hosGletakeovers)

Casestudy:Allergan

•  Overseveralyears•  ISS+convenGonalinsGtuGonspushed

•  Grudgingacquiescence–  Declassifiedboard–  SpecialmeeGngs

•  Valeant&PershingSquareTeamup

•  HosGlebid+acGvistHF

•  Valeant–  “Inverted”forlowtaxrate–  Raisedprices,cutR&D–  EPSgrowth->moreM&A

•  ForcedAto:–  Buybackshares–  CutR&D–  SelltoWhiteKnight

•  Inalower-taxjurisdicGon

•  Thencollapsedinscandal

Yetmoreshareholder“levers”

•  WallStreetwalk•  Pushingfor“bestpracGce”changes

–  Currentfocus:board“renewal”(evaluaGons,limits)•  Directcontacts(“engagement”)•  Embarrassment–

–  “Withhold”votes–  Sayonpayvotes

•  Shareholderproposals–  Currentfocus:proxyaccess(1-3shhrepsonboard)

•  Lobbying(SOX,Dodd-Frank,JOBSAct)•  Proxyprocess(hosGletakeovers)

Anotherway“owners”havego`enmorepower

•  Fewer(iflarger)publiccompanies

•  Morefirmsownedbyprivateequity

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

3/1/80

3/1/81

3/1/82

3/1/83

3/1/84

3/1/85

3/1/86

3/1/87

3/1/88

3/1/89

3/1/90

3/1/91

3/1/92

3/1/93

3/1/94

3/1/95

3/1/96

3/1/97

3/1/98

3/1/99

3/1/00

3/1/01

3/1/02

3/1/03

3/1/04

3/1/05

3/1/06

3/1/07

3/1/08

3/1/09

3/1/10

3/1/11

3/1/12

3/1/13

3/1/14

3/1/15

Num

berofCom

panies

Date

NumberofUS-listedForeignandDomes9cCompanies

n_foreign

n_domesGc

Note:OperaGngcompaniesonly(i.e.,nolimitedpartnerships,closed-endfunds,REITs,ETFs)listedonNasdaq,NYSE,andAmex(nowNYSEMKT)

Source:ProfessorJayRi`er’sIPOwebsite

But that doesn’t mean US equity markets have been shrinking – they’ve been growing, in fact

60%

65%

70%

75%

80%

85%

90%

0

5000

10000

15000

20000

25000

30000

35000

40000

1980 1990 2000 2010 2013

Market cap of US public companies

MC as % of CE

But all corporate equity has been growing faster

60%

65%

70%

75%

80%

85%

90%

0

5000

10000

15000

20000

25000

30000

35000

40000

1980 1990 2000 2010 2013

Corporate equity

Market cap of US public companies

MC as % of CE

Public equity has thus been declining in relative importance

60%

65%

70%

75%

80%

85%

90%

0

5000

10000

15000

20000

25000

30000

35000

40000

1980 1990 2000 2010 2013

Corporate equity

Market cap of US public companies

MC as % of CE

But“private”equityisamisnomer

Whoowns“private”equityfunds?

•  Pensionfunds•  Banks•  Insurancecompanies

•  Endowments

•  Sovereignwealthfunds•  ETFs•  Inotherwords,thesameinsGtuGonsthatownpubliccompanies

LessonsforRegulatorsfromTrend1

•  Knowtheinvestors SECCorpFin+IM

•  Goals,constraints,trends•  Recognizemostdecisionmakersarealsoagents

•  AnalyzegovernancereformsatmulGplelevels

•  What’stheeffectoncompanies?

•  Managers?Boards?Employees?

•  What’stheeffectonulGmateinvestors?

•  Bytypes? Beneficiaries?•  Moneymanagers?Governanceprofessionals?

Alsonew:agovernanceindustry

•  Aninterestgroup–  Publicpensionfunds–  Unionpensionfunds–  Proxyadvisors(ISS)–  Academics–  Assetmanagers

•  BlackRock•  SSgA•  Vanguard•  Allianz

•  WithininsGtuGons:–  Goalsmayconflictwithporxoliomanagers

•  AcrossinsGtuGons:–  Goalsmayconflictwitheachother,e.g.,

•  SSgApolicy2016:– Maywithholdvotes

–  Ifdirectorsse`le– WithhedgefundsatexpenseofLTinvestors

Shareholder“Levers”

•  WallStreetwalk•  Pushingfor“bestprac9ce”changes

–  Currentfocus:board“renewal”(evalua9ons,limits)•  Directcontacts(“engagement”)•  Embarrassment–

–  “Withhold”votes–  Sayonpayvotes

•  Shareholderproposals–  Currentfocus:proxyaccess(1-3shhrepsonboard)

•  Lobbying(SOX,Dodd-Frank,JOBSAct)•  Proxyprocess(hosGletakeovers)

Foreignownershipisgrowing,too

GlobalizaGon’srisks

•  “BestpracGces”ingovernancespreadthroughmulGlateralorganizaGons

•  Oyenwithoutenoughregardtorelevantownershiporothercountry-specificdifferences

•  WhatisroleofNEDsatacompanywithacontrolshareholder?–  UScorporatelawdefersonlylightlytosuchNEDs

•  Increasingshareholderpoweroverall(vsboard)canworsenintra-shareholderconflict

LoomingChoices

•  IPOsvs.othertriggersforCGlawsornorms?

•  AnGtrustvs.CG?

•  Dualclassornot?

Triggers•  TradiGonalUStrigger:IPO,lisGng,or#ofRHs

–  IncreasingdeviaGonsfromsingle-model

–  JOBSAct•  PermanentexempGonforsmallcapsfromSOX

•  Emerginggrowthcompanies

•  Upto2000accreditedinvestors–  Firm-specificCGdeviaGonspre-IPO(dualclass)

•  Otherpossibletriggers–  Industry(SIFIs,largeextracGveundertakings)–  Size(largeundertakings)–  Employment(Germanco-determinaGon)–  Numberofeconomic(notlegal)owners(PE)

Triggers•  TradiGonalUStrigger:IPO,lisGng,or#ofRHs

–  IncreasingdeviaGonsfromsingle-model

–  JOBSAct•  PermanentexempGonforsmallcapsfromSOX

•  Emerginggrowthcompanies

•  Upto2000accreditedinvestors–  Firm-specificCGdeviaGonspre-IPO(dualclass)

•  Otherpossibletriggers–  Industry(SIFIs,largeextracGveundertakings)–  Size(largeundertakings)–  Employment(Germanco-determinaGon)–  Numberofeconomic(notlegal)owners(PE)

AnGtrust

•  TradiGonalanGtrustsharplydisGnguishedfirmsfromowners,absent“control”

•  Concentrated(non-controlling)ownership– PossiblygoodforCG– BadforanGtrust:reducedincenGvestocompete

Source:Azaretal.2015,forthcomingJournalofFinance

AnGtrust

•  TradiGonalanGtrustsharplydisGnguishedfirmsfromowners,absent“control”

•  Mayalsoworseninequality(Elhauge2016)

•  SoluGons?

– Watchthisspace!

Short-Termvs.Long-Term

•  OneresultofincreasedshareholderpoweratUSfirmshasbeenreducedmanagerpower– Manyentrepreneursarepost-IPOmanagers

– Asaresult,theuseofnon-contestablecontrolstructureshasbeenincreasing

Source:ProfessorJayRi`er’sIPOwebsite

Difficultpolicyissues•  PermitdualclasslisGngatall?

–  AlibabacametoUSbecauseHongKongwouldnot•  “Morethantwo-thirdsofthemarketcapitalisaGonofChinesecompanieslistedinNewYorkusedual-classshares,includingBaiduandJD.com.”

•  Permit“breakthrough”?–  Topermitcross-borderM&A?

•  EU’sTakeoverDirecGvewouldhavedonethis–  Notclearlygoodpolicy,except...

•  OverGme,suchstructureserodevalue

–  Ayersetperiodofyearsunlessre-authorized?–  Ayerfounderdies?

Difficultpolicyissues•  PermitdualclasslisGngatall?

–  AlibabacametoUSbecauseHongKongwouldnot•  “Morethantwo-thirdsofthemarketcapitalisaGonofChinesecompanieslistedinNewYorkusedual-classshares,includingBaiduandJD.com.”

•  Permit“breakthrough”?–  Topermitcross-borderM&A?

•  EU’sTakeoverDirecGvewouldhavedonethis–  Notclearlygoodpolicy,except...

•  OverGme,suchstructureserodevalue

–  Ayersetperiodofyearsunlessre-authorized?–  Ayerfounderdies?

Conclusion•  Corporategovernance’smeaningiscontested•  Threetrends

– “Owner-agent”powerisgrowing– A“governanceindustry”isgrowing– Governanceisglobalizing

•  Threehard,near-termchoices– TriggersforregulaGon,norms– AnGtrust– Dualclass

Thankyou!