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Emerging Market Finance: Lecture 5: Corporate Governance Issues

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?. Historically Speaking.

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Emerging Market Finance: Lecture 5: Corporate Governance Issues

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  1. 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?

  2. 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”

  3. 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.

  4. 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.

  5. 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! Regulators (SEC) The Court Public Corp. Investors: Millions Stock market The Board The Press & Mkt Partic. Auditors & Others

  6. 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

  7. In the U.S., how much did the CEO get for each $10,000 of Shareholder Value Increase? Shares owned by CEO Bonus Stock Options owned by CEO In Total

  8. Do Executive Incentives Make any Performance Difference? 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

  9. Absent of Reliable Institutions • What can the shareholders do?---- One way is to have large shareholders or concentrated ownership, so that someone “cares”!

  10. 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)

  11. Question: Why Pay More on Same Day? 10.7 million shares @ $4.38 Largest Shareholder Nan-Du (Paid $23.43 million more) 12.87 million shares @ $2.19 Another shareholder Past 3rd Shareholder

  12. The first related-party asset swap: Sept. 2000 Sell 49.5% of Nan-Du Network: @ assessed value: 117.1 million. Book value = 63.21 million Nan-Du Long-Fa Corp. Sell Long-Fa Ski Resort: @ assessed value: 76.1 million. Book value = 75.43 million

  13. Second related-party Transaction: May 2001 Sell 37% of Nan-Du’s Cable Company: @ assessed value: 83.72 million. Book value = 35.93 million Long-Fa Corp. Nan-Du

  14. 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.

  15. 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

  16. Case of the Ayala family in the Phillipines Claessens, Djankov & Lang (2000, J. of Fin. Econ.)

  17. Case of the Li family in Hong Kong

  18. 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

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