Transcript Expropriation of Minority Shareholders in East Asia

Corporate Governance and
Enforcement
By
Stijn Claessens
World Bank and University of Amsterdam
International Conference on
Corporate Governance in China and Asia
Shanghai, China, March 11-13
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Overview of presentation
• What is the enforcement problem?
• What are alternative enforcement mechanisms?
What mechanisms work?
• What is the enforcement problem in corporate
governance? What follows?
• What are corporate governance mechanisms that
can work in weak contracting environments?
• What are the policy and new research issues?
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Enforcement and development
• Problem of enforcing agreements is a long-standing part of
development agenda. North (1991): “how effectively
agreements are enforced is the single most important
determinant of economic performance”
• Enforcement particularly affects firms’ external financing
• Recent research: enforcement more important than laws
– Laws: effectiveness versus law, transition economies
– Insider trading rules: adoption versus prosecution
– LLSV: simple correlations suggestive
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Income, Antidirector Rights
and Rule of Law
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lo g o f G D P p e r c a p ita
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A n tid ire c to r R ig h ts
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A nt i di re c t or R i ght s
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What enforcement mechanisms?
Continuum of alternative tools
• Private ordering
– Exception rather than norm
– Unilateral, bilateral and multilateral, with multilateral
mechanisms especially often used in finance
• Private law enforcement
– Litigation most important tool
• Public law/regulation enforcement
– Traditional view of enforcement
• State-ownership/control
– Has many problems, but may be considered
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Private ordering
• Unilateral mechanisms
– Create valuable assets, most common reputation,
involving sunk costs, e.g., advertising, or investments
– Needs repeated dealings for it to work
• Bilateral mechanisms
– Use reputation, others’ enforcement, e.g., auditors
– Self-enforcing agreements, e.g., split of functions,
delegating of actions; joint investments, such as in JVs,
vertical integration; hostages with firm-specific assets
– Shareholder agreements: can be more specific; have
covenants of hostage nature; and rely on other courts
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Private ordering
• Multilateral mechanisms
– Financial intermediaries, e.g., banks, investment banks,
rating agencies, clearing houses
– Self-regulatory associations, e.g., industry
organizations, codes of conduct/punishments (expel),
minority shareholders associations
– Self-regulatory organizations, e.g., stock exchanges,
with listing standards and penalties
– Arbitration, e.g., as in JVs, possibly backed up
internationally, e.g., through NY convention
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Private ordering: evidence
• Unilateral and bilateral mechanisms
– Can work, e.g., voluntary adoption of CG, FDI
– Up to a limit, however, as effectiveness depends on the
overall institutional environment
• Multilateral mechanisms
– Can depend on size/number of market, scope for
entrenchment, degree of competition, multiple
equilibriums. Many practical issues, e.g., arbitration:
when to arbitrate and whom to use; which law?
– Private ordering can be the basis for public law
• Most need some form of public enforcement
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Private laws enforcement
• Either the government creates the rules, but
delegates the enforcement to others
– Delegation of public enforcement to SRO/SRAs (e.g.,
stock exchanges) can be more efficient if more
information, better tools/incentives
• Or initiation of enforcement lies with private
parties, with litigation the most important
– The norm in securities markets (LSV, 2005)
– Depends on standards set in the law, e.g., bright lines
– Depends on legal system and institutional setup, e.g.,
class action suits, role of stock exchanges depends on
competition, etc. especially with many constituencies
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Public law/regulation enforcement
• SEC, other regulator type of approach, with courts
– Seems less effective than private enforcement in
securities markets, especially when institutional
environment is weak
• Public law enforcement depends on
– Extensiveness and effectiveness of law: some laws are
easier enforced than others, affects scope for
enforcement and scope for misuse (bright line)
– Independence (financially, politically, tenure) of the
regulators and the checks and balances in the system
– Efficiency of the court system, since backup is needed
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Extensiveness of laws and origins
• What needs to be codified in the first place?
– How does codification vary with level of development,
social and economic features? How does codification
interacts with various enforcement mechanisms?
• Extensiveness of law affects enforcement problem
– With imprecise laws, private ordering and private
enforcement may be costly or uncertain, and the
benefits for parties to deviate may be too big
– But, broader laws allow for more evolution
• Transplanting of laws/systems leads to less effective
formal institutions, higher legality with voluntary adoption
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State control
• State ownership
– Can be justified to deal with market failures,
externalities, public goods, coordination issues, etc
• Golden share
– A more targeted approach to certain concerns
• Regulations covering various areas have also corporate
governance functions, especially with other stakeholders
• Full control, through ownership or centrally planned
economy/lack of market economy
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Choice of enforcement technologies
• Overall environment
– Social and other norms, civic capital, general political
• Costs and benefits of each technology/issues
– Outside options vary; Multistage issues, need several
technologies; Public to back up
• Path dependence, certain technology can stick
– Technological progress can change choices
• Mix of technologies will always be used
– Vary by country, issue to be enforced
• Rules and political economy
– Tollbooth view: rules can create rent-seeking
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Corporate governance and
enforcement
• CG and enforcement: intimately linked
• Firms: nexus of contracts require enforcement
– Corporate governance is about firms’ ability to commit
towards their stakeholders, in particular towards
external investors (shareholders and creditors)
– The enforcement environment can help with
commitment problem, i.e., lower cost, overcome timeinconsistency
– But corporate governance is also about balancing
multiple stakeholders’ interests, so perfect enforcement
of every contract is not necessarily always first best
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Corporate governance mechanisms
• Facilitate collective action of dispersed investors
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Concentrated shareholdings
Hostile takeovers
Proxy fights
Board activity
Executive compensation schemes
Litigation through courts
Bank monitoring
Public opinion and media
Other stakeholders
• Vary in their need for enforcement and use of
enforcement tools, e.g, exit, collateral, bankruptcy, etc.
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With weak enforcement
• In many developing and transition countries, general
enforcement environment is weak and few traditional
corporate governance mechanisms are effective
• Predominant form of corporate governance is then large
blockholders and high ownership/control concentration
• But this mechanism has important costs
– Main corporate governance conflict for public firms:
controlling owners vs. minority shareholders
– But also corporate governance weaknesses impact
SMEs’ ability to raise financing and to grow
– Overall adverse impact on corporate governance
environment, institutional development
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Large blockholders dominate, with costs
though and limited scope for policy
Corporate governance
mechanism
Private ordering
Private law enforcement
Public enforcement
Relative importance in
developing and transition
countries
Scope for policy intervention
Large blockholders
Natural Outcome
Shareholders suits
Governance codes evolving
into corporate and securities
law
Likely to be the most
important governance
mechanism
Strengthen rules protecting
minority investors without
removing incentives to hold
controlling blocks
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What is scope for other corporate
governance mechanisms?
• Most mechanisms need some enforcement technology and
tools, e.g, exit, collateral, bankruptcy, etc. Will not work
well. Ownership concentration the outcome, yet has costs.
• What to do in weak contracting environment? What to
expect from private ordering, private law enforcement,
public enforcement? What is their relative importance in
developing/transition countries, for which mechanisms?
• What policy interventions can help reduce costs and
reinforce specific mechanisms?
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Scope for policy interventions for other
corporate governance mechanisms
Corporate governance
mechanism
Large blockholders
Market for corporate
control
Proxy fights
Board activity
Scope for policy intervention
Strengthen rules protecting minority investors without removing
incentives to hold controlling blocks
Remove some managerial defenses; disclosure of ownership and
control; develop banking system
Technology improvements for communicating with and among
shareholders; disclosure of ownership and control
Introduce elements of independence of directors; training of
directors; disclosure of voting; cumulative voting possibly
Executive
compensation
Disclosure of compensation schemes, conflicts of interest rules
Bank monitoring
Strengthen banking regulation and institutions; encourage
accumulation of information on credit histories; develop supporting
credit bureaus and other information intermediaries;
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Scope for policy interventions for other
corporate governance mechanisms
Corporate governance
mechanism
Shareholder Activism
Scope for policy intervention
Encourage interaction among shareholders. Strengthen minority
Disclosure of information to employees; possibly require board
Employee monitoring
representation; assure flexible labor markets
Facilitate communication among shareholders; encourage classLitigation
action suits with safeguards against excessive litigation
Media and social Encourage competition in and diverse control of media; active public
control
campaigns can empower public
Reputation and self
Depend on growth opportunities and scope for rent seeking.
enforcement
Encourage competition in factor markets
Bilateral private
enforcement
Requiring functioning civil/commercial courts
mechanisms
Arbitration, auditors,
Facilitate the formation of private third party mechanisms
other multilateral
(sometimes avoid forming public alternatives); deal with conflicts of
mechanisms
interest; ensure competition
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Have to consider the political
economy of enforcement
• Laws and enforcement evolve in response to
economic and other pressures
– Can be vested clear interests blocking progress
– Wealth concentration hinders reform
• Capacity building is a difficult investment
– Long-term payoffs, many bodies, subject to many
parties, low political payoff
• Enforcement is a public good, with few champions
– Can be indirect effects of financial sector development,
changes in ownership structures, real sector reform on
desires for enforcement and institutional reform
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Possible research topics on enforcement
• Balance between private enforcement of public standards
and public enforcement in corporate governance
• Tradeoffs between the extensiveness of the law and its
effectiveness in different contexts
• Effectiveness of self-regulatory agencies and organizations
in encouraging better standards and greater enforcement
• Role of competition in improving the environment for
enforcement
• Both case studies and cross-country research can help clarify
what is best suited to needs of different countries
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