Khairunnisa Rahinaningtyas Corporate Governance

16/397035/EK/20991

External Governance Mechanisms: Systemic Accountability

Outside a corporation, there is another contrasting key forces that greatly influence the mechanisms of
a corporate. From a financial markets perspective, a proper system permits efficient mobilization of
capital, management of risks, identification of investment opportunities, and exchange of assets. From
a structural perspective, a proper system creates authorities that enforce rules and regulations.

Regulatory Oversight

Although companies may have internal control process that is already effective, it is still important to
have regulatory oversight. Because there is a risk companies not designing proper checks and
balances, regulatory oversight is essential for the economy to run smoothly. This is usually developed
by legislators, and promulgated by financial supervisors & listing exchanges. Other than to protect a
wide range of stakeholders, regulatory oversight also has a purpose to protect broader macro
economic mechanisms that requires continuous enhancements. Areas of regulatory oversight includes:
1. Financial soundness and stability
2. Operating and financial risk control process
3. Accounting and disclosure standards
4. Legal compliance standards
5. Code of conduct/ethics

Legal / Bankruptcy Regimes

Legal regimes is usually not specific, but it provides a very important set of safeguards. The duties
are: (1) create & support mechanisms of firms, (2) enforce key enterprise tenets, (3) define & support
contracts in business, (4) insolvency, reorganization and liquidation. At first, companies only need to
pay attention to legal compliance in establishing the company, the process is often “off the shelf”.
After that, the compliance shifts to the activities of collaboration, cooperation and regular transactions
with long-term customers that usually involve written contracts. In developing countries, these
regimes lack strength & key areas in property rights, etc. For short-term concern, it is advisable to put
greater emphasis on relationships between supervisors, companies, and large shareholders.

Capital Markets Access

It is a marketplace for public, private issuance and trading of debt and equity capital. The duties are
to: (1) raise capital for deserving companies, (2) assign appropriate cost of capital to companies, (3)
create proper process for scrutinizing corporate issues, (4) supply funds for corporate control
activities. Transparent and regulated capital market is essential for three major reasons. First, it
supplies capital for deserving companies. Second, it successfully differentiates various strength of
companies, “worse” and “better”. Third, it provides another layer of corporate scrutiny & discipline
by performing in-depth ​due diligence. ​This strength can be a signal for “worse” companies for room
of improvement.

Corporate Control Activity

This activity put greater operating efficiencies, but it do not ensure that the capital is used by
management for corporate gains only. Critics said that corporate control activity can impose
undesirable rigidity or skew corporate behavior.
Khairunnisa Rahinaningtyas Corporate Governance
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1. Open market purchases - purchase block of shares

2. Tender offers - purchase offer directly to shareholders
3. Negotiated swaps - exchange of assets
4. Proxy contests - acquisition through proxy voting
5. Friendly takeover - agreed upon acquisition
6. Hostile takeover - unsolicited acquisition. Not popular anymore
7. LBOs/MBOs - companies taken private
8. Recapitilization - giving more or less voting power to each shareholders
9. Spinoffs - initial public offering

Mergers, acquisitions, and spinoffs - ​in 1970s to 1980s in USA, there was an ongoing rigid antitrust
laws that prohibit corporates to acquire other companies in specific industry, this led to corporations
following the strategy of diversification. Several problems arose, including​ moral hazard​ risks,
inefficient assignment of capital and assets, etc. Because the trend was to be privately financed, the
problems occurred due to this strategy could not be identified for long. After sometime, because there
was a decline in financial self-sufficiency in early 1980s, external corporate market took turn.
Specialization is therefore still the better option instead of diversification.

LBOs and MBOs - ​the critics said that buyout advocates focus only on short-time cash out, but the
advocate said that it will lead to long-term growth. Properly priced and executed LBOs to be popular
among corporations.

Antitakeover defenses - t​ o protect shareholder from potentially unfair behavior by would-be acquirers.
An example is fair price provisions, in which it provides protection against two-tier acquisition offer.
Board of directors sometimes need to know ​omnipresent specter, ​to ensure shareholders’ welfare.

Block Holder Monitoring - ​duties:

1. Monitor management and take action if necessary

2. Evaluate decisions made
3. Nominate or appoint board of directors
4. Exert influence through voting pressures
5. Promote long-term value creation by de-emphasizing short-term metrics

Activist Institutional Investor Monitoring - ​duties:

1. Monitor the activities of management and directors in order to help advance corporate goals
and shareholder interests.
2. Evaluate the decisions being taken by management more directly.
3. Exert influence through direct communication with directors, AGM and lawsuits.

External Audits - ​duties:

1. Verify the strength and integrity of internal financial controls.

2. Test a sample of transactions impacting the income statement, statement of cash flows and
balance sheet.
Khairunnisa Rahinaningtyas Corporate Governance
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3. Review off-balance-sheet structures and transactions (for example, special purpose entities,
derivatives, commitments, contingencies).
4. Test a sample of asset and liability valuations (for example, historical valuations,
mark-to-market or mark-to-model valuations).
5. Review reserving and expensing policies and test transactions.
6. Ensure compliance with relevant accounting standards and principles
7. Make certain financials meet regulatory reporting requirements/ standards.
8. Review interim and/or annual statements.
9. Prepare management letter with audit opinion.

Credit Rating Agency Review

Credit rating agencies can play an important role in the external governance process by adding another
layer of scrutiny to companies seeking to access the public debt capital markets. Rating agencies rate
the creditworthiness, or financial strength, of individual companies to determine their capacity to
repay obligations.