Corporate Governance and IPO Case Study

Professor Alexander SettlesFaculty of Management, State University – Higher School of EconomicsEmail: asettles@hse.ru

Corporate Governance and Initial Public Offerings

Corporate Governance is a principle variable in evaluating risk / setting discount for IPOs

Firms reaching the market make significant CG changes to their board structure and practices to conform to market expectations

The First Wave (1996-2002)

RBC Information Systems, 2002RTS/MICEX;Ordinary shares;$ 13,28 m Raised

GoldenTelecom, 1999NASDAQ;Ordinary shares; $144,2 m Raised

LUKOIL, 2002LSE 144A; ADRs;$775 m Raised

Gazprom, 1996LSE 144A;ADRs;$ 430 m Raised

Wimm-Bill-Dann, 2002NYSE; ADRs; $207 m Raised

Tatneft, 1996London Stock Exchange 144A (LSE); Global Depository Receipts (GDRs);$ 120 m Raised

- Insufficient volumes on Russian Market;

- Perception that without US investors sufficient capital could not be raised;

- NYSE was significantly larger and more prestigious than LSE;

- Undeveloped legal regime in Russia; and

MobileTeleSystems, 2000NYSE; ADRs; $353 m Raised

VimpelCom, 1996New York Stock Exchange (NYSE); American Depository Receipts (ADRs); $110,8 m Raised.

Why?Snapshot of the Issuers

Recent History

In 2006 LSE IPO Market exceeds NYSE IPO Market 2007 IPO pipeline from Russian companies reached

$28 bln. compared with $20 bln. in 2006 “We are very concerned about corporate

governance, transparency of company financials and protection of minority shareholders and, with a number of Russian companies, these things are called into question”, Mr. Thair, the New York Stock Exchange (April, 2007; www.ft.com);

Number of US listings of Russian companies since 2004: 2 Mechel (2004) CTC Media (2006)

Number of LSE/AIM listings of Russian companies greater than $200 mln. during 2005/2006: >17

Listing Rules

NYSE – SOX/NYSE Rules LSE – UK Combined Code.

Governance Metrics International (2005) ranks UK as leading country in terms of Corporate Governance

LSE GDR/London AIM – Combined Code not required but usually insisted by underwriters as “Best Practice”

Sarbanes Oxley

Accounting regulation Public accounting oversight board Restricting consulting/auditing

Audit committee Independent financial experts

Internal control assessment Assessment by auditors and company (Section

404) Deemed costly and contested Cross-listing elsewhere…

Executive responsibility CEOs and CFOs must sign off on the company’s

quarterly and annual financial statements. If fraud causes an overstatement of earnings, these officers must return any bonuses.

Sarbanes Oxley

Many argue that SOX is hurting U.S. capital markets. SOX undermines CEO’s appetites for risk SOX is a full employment act for Accountants

(404) The Committee on Capital Markets

Regulation, set up by U.S. Treasury Secretary Hank Paulson, advocates rolling back the Sarbanes-Oxley Act.

Sarbanes Oxley

U.S. is losing out on new international listings… London is beating the U.S. in the number

of IPOs it draws. Last year, the NYSE drew 192 IPOs and

Nasdaq 126. The LSE, often cited as the example of how

SOX is chasing companies away, attracted a robust 617 IPOs, 510 of which were on the AIM, the exchanges small-cap market.

Sarbanes Oxley

However, the U.S. IPOs are larger. Of a total of $118.2 billion raised through IPOs

in 2006 $17.5 billion occurred on the LSE, $4.2 billion on

AIM $16.9 billion on the NYSE $9.4 billion on Nasdaq $0.2 billion on AMEX, according to Thomson

Financial.

NYSE Corporate Governance

Listed companies to have boards of directors with a majority of independents

The compensation, nominating, and audit committees to be entirely composed of independent directors

The publication of corporate governance guidelines and reporting of annual evaluation of the board and CEO

Cadbury Code of Best Practice

Cadbury Code Boards of directors of public companies include at

least three outside (non-executive) directors The positions of CEO and chairman of the board of

these companies be held by two different individuals Cadbury Code is not legislated into law LSE requires companies to “comply or

explain.” Empirical research suggests the code has

been effective despite not being enforceable in courts…

Role of the Board in a Public Company IPO / Listing Experience

The Board Effectiveness Talents and background of board

members Tying board remuneration closely to

performance Strategic thinking by the Board Managing risk effectively

Role of the Board in Listing - IPO

Developing a robust audit committee

Taking corporate social responsibility on board

Encouraging and active dialogue with shareholders

The Effective Board

Clear strategy aligned to capabilities Vigorous implementation of strategy Key performance drivers monitored Effective risk management Sharp focus on views of the capital

market and other key stakeholders Regular evaluation of board

performance

The audit committee’s main responsibilities

To monitor the integrity of the financial statements

To review the company’s internal financial controls, internal control and risk management systems.

To monitor/review the effectiveness of the internal audit function.

To make recommendations to the board on the appointment/removal of the external auditor

The audit committee’s main responsibilities

To monitor/review the external auditor’s independence/objectivity and the effectiveness of the audit process.

To develop/implement policy on the engagement of the external auditor to supply non-audit services

To review arrangements by which staff may raise concerns about possible improprieties (‘whistleblowing’)

Stakeholders in the IPO Process

Owners & employees Stock Exchange Government (SEC, FSFM, etc.) Institutional shareholder Public Investors

Google: Time to Cash Out?

Reports valued Google’s IPO at $16 billion

Estimated 2003 revenue: $1 billion, profit: $300 million

In order to compete with the giants (Yahoo! and Microsoft), it would be in Google’s best interest to raise more money

Google’s naïve attempts to stay private

Why stay private? Eric Schmidt: “We’re generating cash. We don’t

ever need to go public.” Google didn’t want to become a “short-sighted”

company However, Google was bound to become

publicly traded SEC regulation forcing them to report because of

stock options offered to employees Companies funded by venture capitalists almost

always result in IPOs During 2003, they unsuccessfully toyed with

different strategies to remain private

Google’s IPO Process

Decision to become public in early 2004

Debate over filing for public offering Using investment bank vs. auction

method Ended up using a Dutch auction

Proposed S1 (formal public offering document) Sell $2,718,281,828 worth of shares

S1 “An Owner’s Manual for Google’s Shareholders”

Outlined how Brin/Page planned on running the company

Claimed Google was different, so it would not act as a traditional public company

Proposed corporate structure that protected Google’s ability to “innovate and retain its distinctive characteristics” “Dual class shareholding structure”: Founders

and executives have far more control than common shareholder (common in media companies)

Google’s IPO Process

Google IPO did not follow Wall Street practices: S1 represented a destruction of the

traditional share selling, corporate governance, investor communications, and management structure of public companies

However, it showed tremendous numbers in the income statement Profits, Cash, Operating Margins

Google’s Struggle to IPO Bad Reputation

Google increased Secrecy Slow amendments to S1 and entire process Playboy Interview

Relentless scrutiny (SEC) Companies uneven management of

overwhelming growth Reporting requirements would require a great deal

of restructuring (e.g. Advertising) Founders’ reluctance about the public path

Initial Public Offering (Finally)

Auction on August 12, 2004 Revealed market price range: $85 to

$108 Public on August 19, 2004

Price was $85/share

Post-IPO steps?

Created “Tablets” (declaration of what makes Google itself)

Post-IPO Organization (core groups) Core search Advertising Products “20 Percent” (Gmail, Google News, Orkut) “10 Percent” (Google Keyhole, Picasa)

Could now execute on its two core businesses, while other groups could pursue projects that could potentially turn into core businesses or useful products

Brin and Page: Still in Power

Brian Reid (former senior manager) sued Google for age discrimination “Google is a monarchy with two kings” Culture: “youth obsessed”

However, somehow they have succeeded 5 year revenue growth is 400,000% Fastest growing company ever

Russian IPO Examples - VTB

VTB Overview

The Group has three principal areas of business: Corporate banking Retail banking Investment banking

Offering Size

1,399,835,420,000 shares or 20.82% of the capital of VTB was offered as GDRs

79.15% was retained by the Federal Property Administration

Investment Banks

Joint Global Coordinators Citi Deutsche Bank Goldman Sachs International Joint Bookrunners Citi Deutsche Bank Goldman Sachs International Renaissance Capital

Corporate Governance Issues

The interests of VTB’s principal shareholder may conflict with those of other shareholders;

VTB’s management has recognised a material weakness in the Group’s internal controls;

Some interested party transactions of Russian banks in the Group require the approval of disinterested directors or disinterested shareholders;

Shareholder liability under Russian law could cause the Group to be liable for the obligations of its subsidiaries;

There are weaknesses in legal protections for minority shareholders and in corporate governance standards under Russian law;

Corporate Governance Issues

Of the eleven seats on VTB’s Supervisory Council, six are held by representatives of various Government ministries and agencies, one is held by representatives of each of the CBR and the Russian President, one is held by VTB’s President-Chairman, and two are held by independent directors.

IPO Process

Global Offering: Russian securities legislation does not permit

VTB to sell more than70% of the total number of ordinary shares authorised in the Global Offering in the form of GDRs.

Retail Offering - retail investors in Russia “People’s IPO”

The Institutional Offering 13.60 Kopecks or $0.00528 per Share and

$10.56 per GDR. Dec 2, 2008 share price is $2.05

Good deal announced – bad deal delivered?

Source: Factset

VTB GDR price

reba

sed

to

10

0

Jun 2007 Aug 2007 Oct 2007 Dec 2007 Feb 2008

70

80

90

100

110

120

130

140

Russia RTS VTB Bank