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

Agenda
Purpose: To explain the concept and processes of corporate governance

Outline:
1. 2. 3. 4. Introduction, definition for corporate governance, OECD Principles of Corporate Governance Forms of Business Ownership Separation of Ownership and Control: The Principal-Agent Dilemma Benefits of Good Corporate Governance Mongolian CG Environment Duties of the Board: Risk Management 2 Summary and Conclusions Corporate Governance

5. 6. 7. 8.

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 3

INTRODUCTION, DEFINITION, AND OECD PRINCIPLES OF CG

Corporate Governance 4

Working definition of Corporate Governance

Corporate Governance involves a set of relationships and the networks between a companys management, its board of directors, its shareholders and stakeholders.

Good corporate governance practice ensures the shareholders a fair rate of return.
Corporate Governance 5

Stakeholders in Corporate Governance

Primary Stakeholders
Shareholders Board Executive Management

Other Stakeholders
Managers Employees Customers Suppliers Community at large Government Financial Markets Environmentalists 6

Stakeholders of the Firm

Corporate Governance

Corporate governance has many links

Finance
Culture Law

Ethics

Risk Mgmt

Economi Strategy Corporate Governance cs

Corporate Governance

FORMS OF BUSINESS OWNERSHIP

Corporate Governance 9

Implications of the Legal Form of the Firm

Corporate Form
The nature of governance implies that when an entity adopts the legal form of a corporation it has shareholders, a board, and a separate management.

Essential Attributes of a Corporation

Separate Identity Limited Liability Centralized management Ownership interests are freely transferable

Broad Application
The term corporate governance is applicable to include all types and sizes of enterprises so long as they have owners, managers, and a business interest. Corporate Governance 10

Common forms of business ownership

Cooperatives Ownership Sole Proprietorship or Partnership Limited Liability Company

Joint Stock Company

Multiple Single Owner or Shareholders Shareholders members (min 9) Partners

Owners liability
Easy access to capital market? Is management and ownership separate? Are business owners exposed to double taxation?

Limited
No No

Unlimited
No No

Limited
No Yes

Limited
Yes Yes

No

No

Yes

Yes

Corporate Governance

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SEPARATION OF OWNERSHIP AND CONTROL: THE PRINCIPAL-AGENT DILEMMA

Corporate Governance 12

Conflict of Interests:
The heart of the matter in corporate governance The Principal Agent Dilemma

Shareholders Interests

Managers Interests

The Board is responsible for resolving the conflict of interest issue between shareholders and managers
Corporate Governance 13

Principal-Agent Dilemma and Asymmetric Information Principal Agent

Corporate Governance

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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 main role of corporate governance is to reduce total Corporate Governance agency costs in order to maximize shareholder value.15

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

Corporate Governance

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Main governing bodies in the company

Shareholders

Board
Represents SH

Executive Management
Helps formulate and Execute Strategy

Provides capital Sets strategy Provides guidance to CEO

Elects or dismisses BOD

Monitors CEO
Corporate Governance

Provides transparent reporting and disclosure

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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 Corporate Governance 18 maximization of SHs wealth

Different Types of Boards

Rubber Stamp Board Yes-men Board Good Old Boys Board

The Real Thing

Phantom Board

Country Club Board

Trophy Board

?
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Degree of Board Involvement in Management

Passive

Certifying

Engaged

Intervening

Operating

At the discretion of CEO Limited Activity & Participation Limited Accountability

Certifies to SH that CEO meets expectations Takes corrective action Understands role of independent directors

Provides insight & Support Understands its monitoring role Guides and judges the CEO Has the right skills mix

Intensely involved in decision making on key issues Frequent and intense meetingson short notice

Makes key decision, and management implements Fills gaps in management experience.

Low

High
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The Chairman of the Board and Directors

Corporate Governance

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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
Corporate Governance 22

The Separation of Ownership and Control

Corporate Governance

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The Stakeholders of the Firm

Employees
Wage equity

Shareholders
Financial returns

Community
Political corruption

Government
Regulatory compliance

Environmental Groups
Pollution

Management
Financial returns

Customers Suppliers
Product safety (for people and the environment) Customer satisfaction

Workplace health and safety

Accurate and timely disclosure of operations and performance

Local employment

Pollution and other environmental issues

Biodiversity

Stock options

Workforce diversity

Corporate governance, including executive compensation

Increase in share prices

Living environment/

Workplace health and safety

Regulatory compliance

Executive remuneration

Product performance

Job security and regulatory compliance Salary increase Dividends

Environmental standards

Employment

Sustainability

Increase share value

Responsible advertising practices Product environmental impact Regulatory compliance Safety standards

Shareholder proxies Risk management Protection of rights/ dividends

Regulatory compliance Health and safety Standard of living

Discrimination

Human rights

New technology

Social benefits/taxes Environment Corporate Governance

Socially responsible investments Regulatory compliance

Dividends/ financial performance Growth, prestige and reputation

Growth, prestige and reputation

and safety standards

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BENEFITS OF GOOD CG

Corporate Governance

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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

Corporate Governance

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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 disclosure

SH rights protected

Investor friendly company

Access to finance facilitated

Corporate Governance 28

Good CG Practices Stimulate Firm Performance

Streamlining business process Improves operating performance Lowers costs and capital expenditures

Efficiency

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
Corporate Governance 29

Lowering the cost of capital and raising the value of the firm
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 %
13
Germany

14

USA

23

Poland

24

Brazil

25

China

39

Russia

10

Corporate Governance

20

30

40

50

30

Source: McKinsey, Global Investor Opinion Survey on Corporate Governance, 2002

Good Corporate Governance Increases Long Term Performance

%
50 Average 30% 41% 40 Egypt Average 22% Russia 30 27% 20 22% Average 22% 25% China Average 13% Average 14% Morocco

Average premium investors would be willing to pay differs by country and regions

Turkey

24%

Argentina
Columbia 19%

Philippines 23%
Thailand Taiwan 13% 12%

Poland
Italy Germany 19% 14% Mexico USA Canada

South Africa

18% 10

Chile

11% United Kingdom

E Europe/Africa

Latin America

Asia

Western Europe

Northern America

Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 Corporate Governance 31

Building the Business Case for Good CG

Transparent Responsible Accountable Fair investment environment Investors are protected under the law Prudential regulation

Open Market

Rule of Law

Increasing investor confidence attract investments to the market

Investor Confiden ce

Lower Systemic Risk

Transparency improves market price discovery mechanism

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Corporate Governance

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.
Corporate Governance 33

THE PROPER ENVIRONMENT FOR CORPORATE GOVERNANCE

Corporate Governance 34

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

Corporate Governance 35

Impact Points on Micro and Macro Policies

Policy*
Category Monetary Fiscal Credit (O) Tax Rates (L) Investment Credit (L) Government Sales (O) Government Purchases (O) Incomes Trade Price Controls (A) Wage controls (A) Tariffs (A) X X X X X X X X X X X X X X X X X X X X Instrument Interest Rates (A) Finance X X X X X X

Company Impact Points**

Marketing Production Organization

Import Quotas (A)

Export Incentives (L) Exchange rates (A) Foreign Investment Ownership Requirements (L) Repatriation Limit (L) Personnel Regulations (A) Sectoral Technology Licensing (A) Production Licensing (A) SOE Operations (O)

X
X X

Corporate Governance *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 affected Source: J.E. Austin Associates. Managing in Developing Countries, 1990

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Macroeconomic Initiatives

Monetary Policy
Inflation Under Control (Stability & Predictability) Interest Rates

Fiscal Policy
Effective tax policy Budget Deficits Restrained

Foreign Trade
Balance of Payments Tariffs Coming Down Greater Convertibility of Currency 37

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
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Corporate Governance

Relationship between Investment and Economics

Investment Quality of Business Environment

Capital

Rule of law

Economic Growth

Corporate Governance

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Corporate Governance is the Antidote to Corruption

Corporate Governance Anticorruption

Corporate Governance

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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.
Corporate Governance 41

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

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

Corporate Governance

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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 Shareholders 4. The Role of Stakeholders 5. Disclosure and transparency 6. The responsibilities of the board
Corporate Governance 44

Source: Foreign Affairs, September-October 2002.

Corporate Governance

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CG ENVIRONMENT IN MONGOLIA
Corporate Governance 46

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)
Corporate Governance 47

Mongolian Corporate Governance Code

Resolution no. 210 of the Financial Regulatory Commission, December 26, 2007

1- Principles of corporate governance 2- Meetings of shareholders 3- The role of the board of directors 4-The role of the executive management 5- Open and transparent information 6- The Stakeholders -- Participating entities 7- Supervision of operations 8- Dividend Policy Corporate Governance 9- Settlement of disputes

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Mongolian Legal and Regulatory Frameworks supporting Corporate Governance

Civil Code (2002)
Competition Law (2000)

Company Law (1999)

Banking Law (1996, 1999, 2010)

Securities Law (2002)

Dispute Resolution (Mongolian NCCI) & Courts

Law on NBFIs (2002)

FRC Law (2005)

Taxation Law (2006)

Corporate Governance Code (2007)

Bankruptcy and Insolvency Law (1997)

49 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

Corporate Governance

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BOM CG Principles for Banks

The Constituents

Accountabilities and Authorities of the Board

Functions of Senior Management

Audit Committee and the Functions of Internal Audit

Functions of External Audit

Transparency
Corporate Governance 51

THE ROLE OF THE BOARD IN RISK MANAGEMENT

Corporate Governance 52

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.

Corporate Governance

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Risk Appetite: Living Dangerously, Speculation, or Calculated Risk?

Corporate Governance

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Effective Risk Management Strategies Help By:

Being proactive in dealing with possible unanticipated losses; Protecting the firms 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;
Corporate Governance 55

Types of Risk
EXTERNAL FACTOR RISKS INTERNAL FACTOR RISKS LEGAL & REGULATORY RISK MARKET RISK PROCESS RISKS COMPLIANCE RISKS PEOPLE RISKS

STRATE-GIC RISKS

OPERATIONS RISKS

FINANCE RISKS
TREASURY RISKS CREDIT RISKS TRADING RISKS TAX RISK

INFORMATION RISKS
FINANCIAL RISKS OPERATIONAL RISKS TECHNOLOGY RISKS

Corporate Governance

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Risk Management is Board Responsibility

Key board functions

Source: OECD Principles of Corporate Governance, 2004.

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.

BOD shall be a unit defining the strategic policy of corporate activities and imposing supervision on activities of the executive management.
Source Corporate : Mongolian Governance Code of Corporate Governance, December 2007 57

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
Corporate Governance 58

Determinants of Risk Appetite

Markets Stakeholders Shareholders

Strategy
Market Risk Credit Risk Operational Risk What if Scenarios

Capital at Risk

Internal Constraints

Organizational Structure HR Systems (IT)

Risk Appetite
Corporate Governance 59

The Level of Boards Risk Awareness

The right kind of risk

The right amount of risk

Adequate risk management

Corporate Governance 60

What does it take to implement good governance?

Board Commitment

Disclosure & Transparency

Board Leadership

Shareholder Rights Protection

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SUMMARY AND CONCLUSIONS

Corporate Governance 62

Summary and Conclusion

Private sector corporations are the most important business form, they generate most of the countrys 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
Corporate Governance 63

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

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Investor behavior is shaped by greed and fear

Corporate Governance

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Corporate Governance

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