introduction to corporate governance sep 17 2011

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

Corporate Governance2

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

Corporate Governance 3

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

4


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


• Shareholders• Board• Executive Management

• Managers• Employees• Customers• Suppliers• Community at large• Government• Financial Markets• Environmentalists


Corporate governance has many links

7

Finance

Law

Risk Mgmt

EconomicsStrategy

Ethics

Culture


FORMS OF BUSINESS OWNERSHIP


Implications of the Legal Form of the Firm

10


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


Conflict of Interests: The heart of the matter in corporate governance

Shareholders’ InterestsManagers’ Interests


The Board is responsible for resolving the “conflict of interest” issue between shareholders and

managers

The Principal – Agent Dilemma


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


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


The Board is the Representative of Shareholders


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


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



The Separation of Ownership and Control


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


Discrimination Human rights New technology Product environmental

impact

Dividends Risk management

Health and safety

Social benefits/taxes

Socially responsible investments

Dividends/financial

performance


Growth, prestige and reputation

Protection of rights/

dividends

Standard of living

Environment and safety standards


Growth, prestige and reputation

Safety standards

BENEFITS OF GOOD CG


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


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


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



Lowering the cost of capital and raising the value of the firm

39

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 %


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



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



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


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



Corporate Governance is the Antidote to Corruption

Corporate Governanc

e

Anti-corruption

40

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.


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

http://www.oecd.org/

http://www.worldbank.org/

http://www.gcgf.org/

http://www.bis.org/

http://www.iif.com/

http://www.fsf.org/

http://www.iosco.org/

OECD Principles of Corporate Governance www.oecd.org/daf/corporateaffairs/principles/text


http://www.oecd.org/daf/corporateaffairs/principles/text


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



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)


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

Corporate Governance49

Mongolian Legal and Regulatory Frameworks supporting Corporate Governance


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


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



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?



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


• 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


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.


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


Determinants of Risk Appetite

Risk Appetite

Capital at Risk

StrategyInternal Constraints

59

• Market Risk• Credit Risk• Operational

Risk• “What if”

Scenarios

• Organizational Structure

• HR• Systems (IT)

• Markets• Stakeholders• Shareholders


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

61

SUMMARY AND CONCLUSIONS



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


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


Investor behavior is shaped by greed and fear

Bayarlalaa

Thank you
