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Corporate Governance Corporate governance is about minimizing the loss of value that results from the separation of ownership

hip and control. It deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. While corporate governance has been a hot issue in recent years (Enron, Worldcomm, HIH and ne.!el" it is a problem that has been around for hundreds of years # $dam %mith (&''(". )ood corporate governance practices involve* !he corporate governance framewor+ should protect shareholders rights. !he corporate governance framewor+ should ensure the equitable treatment of all shareholders. %ta+eholders should be involved in corporate governance. Disclosure and transparency is critical. !he board of directors should be monitored and held accountable for what guidance it gives.

Internal Mechanisms ,oard of -irectors ,oard %ize . Independence Chairman/CE 0ositions ,oard Committees

E1ecutive Compensation wnership %tructure Concentrated versus -ispersed wnership Identity of wners ther ,loc+holders

External Mechanisms

E1ternal $uditors -ebt . E2uity 3ar+ets 3onitoring by debt holders $nalysts 3ergers . $c2uisitions

4egal/5egulatory %ystem Common versus Civil 4aw E1tent of 4aw Enforcement 5ecent 5egulations #)ood Corporate )overnance 0rinciples

International Differences

Board of Directors !he board of directors is responsible for overseeing management and representing shareholders6 interests. 7% and $ustralia have single8tiered boards, headed by a Chairman of the ,oard. !he CE and other e1ecutives usually also sit on the board. %ome other countries ()ermany, Indonesia" have two8tiered boards. !he roles and composition of the two boards can differ.

Board i!e ,oards should be an appropriate size # not too big not too small. -epending on the size of the company within the range of 98&9 is normal. If the board is too small, there is a lac+ of monitoring. If the board is too big, there are problems reaching a consensus for decision ma+ing.

Board Independence ,oards should have a ma:ority/high proportion of outside/independent directors. utside/independent directors should have no personal interest in the company and therefore are more effective monitors.

,ut, it is also a good idea to have some company insiders (CE , e1ecutives" on the board to provide the board with a better understanding of the company6s operations.

Chairman"CE# $ositions !he Chairman of the ,oard is responsible for overseeing the board of directors. !he CE is responsible for the day8to8day running of the company. In family8controlled companies it is common for the same person or relatives to hold both of these positions. ,ut, this concentrates power and reduces monitoring. !herefore, the positions of Chairman and CE should be separated.

Board Committees !he board of directors can delegate certain duties to board committees # this can provide increased monitoring on specific issues. $udit committee # responsible for internal audit function and appointment of e1ternal auditor. 5emuneration committee # responsible for setting appropriate compensation for directors and e1ecutives. ;omination committee # responsible for finding appropriate directors and e1ecutives.

Executive Compensation Compensation of top e1ecutives can be used to tie the interests of the e1ecutives to those of shareholders. <ariable performance pac+ages are preferred* If they perform well, they are rewarded. If they perform poorly, they are not rewarded or fired.

$lignment of interests is usually achieved through* %toc+ ownership %toc+ options

#%nership tructure $ustralian and 7% companies are usually owned by widely8dispersed shareholders and controlled by professional managers. !his means that no single party is in control of the company. However, in other nations around the world, ownership is usually concentrated in the hands of family groups or government entities. !his means that one group is in control of the company and there is very little you can do (other than sell" if you don6t li+e what they6re doing. !he identity of the controlling owner can also have corporate governance implications. =amily8controlled companies use cross8holdings and pyramidal structures to gain effective control of the company with the least cash ownership. !he mar+et recognizes this and prices the increased ris+ of e1propriation into the share price. )overnment8owned and widely8held companies are more li+ely to follow the rules. !he presence of an non8management related bloc+holder of shares can increase monitoring of the firm. $ bloc+holder usually holds at least 9> of the outstanding shares, therefore has a significant interest in the future performance of the company.

,loc+holders can be governments, financial institutions, individuals or other companies.

External &uditors toc' exchange listing requirements usually ma'e it mandatory for companies to employ an external auditor to audit their financial statements (and internal controls). External auditor should be independent of management* but +. ,enure of auditor ,enure of audit partner

Monitoring by Debt holders Debt holders provide capital to the company usually %ith conditions Debt covenants ecured on assets ,herefore debt holders actively monitor management to ensure that companies are meeting debt conditions and that they %on.t default.

&nalysts %ecurities analysts are professionals employed by investment ban+s / bro+ers / asset managers to monitor companies and provide stoc+ recommendations (buy/sell", earnings forecasts, long8term growth forecasts, target prices etc. 0rovides an e1tra level of monitoring for investors. ,ut, analysts incentives/conflicts of interest mean that not all of their output is trustworthy.

,a'eover Mar'et !he merger and ac2uisition (3.$" mar+et stands as a ?court of last resort6 for assets that are not being utilized to their full potential. If management are underperforming there is a good chance that this will be noticed by the mar+et and other players will want to ta+e control of the company. !here are active ta+eover mar+ets in $ustralia, 7%, 7@, ;ew Aealand, but few other countries.

Intervening /ariables 3easures put in place by companies that restrict shareholder rights and the effectiveness of ta+eover mar+ets* 0egal ystems Each country6s legal system has built in a certain degree of investor protection. However, there is a wide variation in protection and enforcement of these rules around the world. %taggered boards 4imits to by8law/charter changes %uperma:ority re2uirements for mergers 0oison pills )olden parachutes

Common law countries provide highest protection and =rench civil law countries provide the least protection. 4ow investor protection seems to result in concentrated ownership and underdeveloped e2uity mar+ets.

Measuring Corporate Governance 7nderstanding what good corporate governance is about is 2uite easy. However, it is difficult to measure whether companies are really committed to good governance. $ll we can do is measure if they have certain corporate governance mechanisms in place # we don6t +now if they are effective or notB rganizations such as %tandard and 0oors and Credit 4yonnais %ecurities $sia have started providing corporate governance ratings in recent years.

Benefits of Good Governance 5esearchers have shown that companies with good corporate governance practices are valued more highly and run more effectively. %o the benefits of good governance include* Higher share price 4ower cost of funds )reater international following

1hat you need to remember+ When investing it is worthwhile +eeping in mind whether a company has committed to good corporate governance or not. Cou can use the mechanisms highlighted in this lecture or corporate governance ratings as a guide. Corporate governance becomes most important during stoc+ mar+et crashes and bad economic times. ,ut, it is not a perfect science. 3anagers will always find a way to circumvent monitoring to achieve their own goalsB

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