Chapter 2 - International Corporate Governance

Question 1

Are governance systems uniform across countries?

What are the 5 factors inherent to the business environment that shape corporate governance Internationally?

What do these different factors lead to?

Answer 1

No, they are not uniform across countries.

1. Efficiency of local capital markets
2. Protections afforded by legal systems.
3. Reliability of accounting standards
4. Enforcement of regulations
5. Societal and cultural values

The different factors lead to the prevalence of agency problems and the control mechanisms needs to prevent them.

Question 2

What happens when the capital markets are efficient?

Answer 2

When they are efficient, prices (labour, capital, and natural resources) are correct which improves the decision making.

Question 3

what are the four ways that efficient capital markets discipline the corporations?

Answer 3

1. Poor decisions are punished
2. Stock prices decline
3. Cost of capital increases
4. The risk of bankruptcy or being taken over increases

Question 4

What 2 problems does efficient capital markets protect against?

Answer 4

Adverse selection - One party in a transaction has an information advantage, and uses this advantage to receive preferential pricing or risk transfer.

Moral hazard - One party does not bear the full risk of its actions and so engages in excessively risky transactions.

Question 5

What 4 entities must take its place if efficient capital markets do not exist?

Answer 5

1. Wealthy families
2. Large banking institutions
3. Other companies
4. Governments

Question 6

What do these other institutions do?

Are their interests different from other stakeholders?

Who is more effective at monitoring?

Answer 6

They also discipline corporations in order to protect their investment.

However, their interests may be different from those of other shareholders and stakeholders.

On average, private parties are less effective at monitoring companies than capital markets.

Question 7

According to research, where are the family controlled business groups more prevalent?

Why are these wealthy families needed in these situations?

What is a disadvantage of these families.

Answer 7

They are more prevalent in countries with weaker capital markets.

1. They are an important source of financing in such countries
2. They can bring risk to economy if operating with minimal external oversight.

Question 8

What is the importance of legal traditions?

What are four examples of important business laws?

Answer 8

Legal traditions has important implications on the rights afforded to the business owners

1. Protection of property against expropriation
2. Predictability of how claims will be resolved
3. Enforceability of the contracts
4. Efficiency and honesty of the judiciary

Question 9

What does a strong legal system mitigate?

Answer 9

A strong legal system will mitigate agency problems because the self interested managers know illegal actions will be punished.

Question 10

Why are accounting standards important?

What 2 issues does inaccurate information and low transparency lead too?

Answer 10

They give investors confidence that financial reports are correct and can be relied upon to evaluate the risk and rewards

Inaccurate information and low levels of transparency can lead to poor decision making and reduce the efficiency of capital markets.

Question 11

What happens if the accounting standards are compromised, manipulated, or lack transparency?

What are the three outcomes?

Answer 11

The governance quality decreases:

1. Shareholders can less effectively detect the agency problems
2. Oversight of management will suffer
3. Management incentives will be inappropriate

Question 12

What does the enforcement of regulations means in the context of corporate governance?

What does regulatory enforcement signal?

What do firms tend to do when the enforcement of securities regulations are strong?

What does the participation in equity markets do?

Answer 12

Even if the legal system is strong, officials must be willing to enforce regulations in a fair and consistent manner.

It signals that management is being monitored, which contributes to investor confidence that their interest will be protected.

They tend to use more conservative accounting policies.

In addition to equity market participation increasing when there are insider trading laws.

Question 13

What influences managerial behavior and explain.

What else does the societal values influence?

Answer 13

The society in which the company operates. It explains why the activities in one culture may be unacceptable in another culture.

Societal values also influence whether the company will be more shareholder centric or stakeholder centric

Question 14

Provide an example of how societal and cultural values affects corporate governance

Answer 14

Executives in a country that values individualism may be more likely to take self-interested actions than executives in a country that values collectivism, because they do no risk the same level of scorn for their behavior.

Question 15

Describe the 2 parts of Canada’s capital markets

• Industry
• Corporate control

Answer 15

1. Large and diverse capital markets with a significant presence in the natural resources sector
2. An active market for corporate control with a focus on mining, energy, and financial services sectors.

Question 16

What are some of Canada’s investor protections

Answer 16

Investor interests are overseen by the provincial securities regulator such as the Ontario Securities Commission (OSC) and coordinated through the Canadian securities administrator (CSA)

Question 17

Who sets Canada’s accounting standards and what standards does Canada follow?

Answer 17

Accounting standards are set by the Accounting Standards board (AcSB) in Canada, which has adopted the International Financial Reporting Standards (IFRS) for publicly accountable enterprises

Question 18

What are the 3 governance standards in Canada?

Answer 18

1. Exchange listing requirements (TSX or the TSX Venture Exchange)
2. Audit committee is mandatory for listed companies / compensation and governance are not.
3. Provincial legislation and guidelines such as the OSC rules

Question 19

What is the orientation in Canada? What law enhances this orientation?

Answer 19

It is a stakeholder orientation, which considers the interests of various parties like the shareholder, employees, and the community.

The Canada Business Corporations Act (CBCA) which required directors to act in the best interest of the corporation, recognizing the interests of shareholders, employees, creditors, consumers, governments, and the environment.

Question 20

What is Americas Capital Markets

How are Investor Interests protected in America?

What is Americas Accounting Standards

What is the orientation?

Answer 20

1. Large and liquid capital markets, there is active market for corporate control.
2. The investors are protected by the Securities Exchange Commission (SEC)
3. Defined by the professional body (FASB)
4. America is shareholder centric

Question 21

What are Americas two governance and enforcement standards?

What does the Sarbanes Oxley act mandate? What does this group oversee?

Answer 21

Exchange listing (NYSE and NASDAQ)
Legislation (Sarbanes Oxley and Dodd Frank)

Sarbanes Oxley mandates that all listed companies must have an audit committee composed entirely of independent directors. This group will oversee the accounting and financial reporting process and audit the firms financial statements

Question 22

What does the Dodd- Frank legislation and Consumer protection act mandate?

Answer 22

Requires listed companies to have a compensation committee composed of independent directors. The committee will set and approve the compensation for the company’s executives.

Question 23

What do both of the legislations require?

Answer 23

They both require the firm to have a nominating / corporate governance committee composed of independent directors. This committee is responsible for selecting new board members and developing / implementing the company’s corporate governance guidelines.

Question 24

What is the model used in the United Kingdom?

What is the UK’s capital market structure and its corporate control (Facilitated by)?)

Answer 24

The Anglo Saxon model which is similar to the United States

Mature and highly developed capital markets, with the LSE being one of the oldest and largest

It is an active market for corporate control facilitated by both the LSE and alternative investment markets that support a diverse range of businesses.

Question 25

What are the two investor protections in the UK?

Answer 25

1. Investor are protected by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) 2. Additional oversight is provided by the UK Listing Authority (UKLA) which is part of the FCA

Question 26

Who sets the accounting standards and what is the accounting standards implemented by the UK? Who is the standard similar too and what is it applicable too?

Answer 26

The accounting standards in the UK are set by the Financial Reporting Council (FRC) which adopts and enforces the International Financial Reporting Standards (IFRS) as adopted by the EU, and applicable to the consolidate accounts of EU companies traded on a regulated market.

Question 27

What are the 2 governance standards in the UK? What are the standards set by the first governance? (BRAR) What are the standards set by the second governance standards What are the standards set by the third governance standards?

Answer 27

1. The UK Corporate Governance code, which sets standards for board leadership and effectiveness, renumeration, accountability and relationships with the stakeholders 2. Legislation including the Companies Act of 2006, which includes provisions for directors duties, 3. The UK Bribery Act of 2010, which separates the chairman and CEO roles, and has senior independent / lead directors.

Question 28

What is the UK's orientation and when was it set? What approach does the UK take for enforcing the setting the standards?

Answer 28

The stakeholder orientation (Act in 2006), They use the comply or explain approach, the companies are required to disclose reasons for non compliance with the standards.

Question 29

What is Germany's board structure? What does the Germany Corporate Governance code mandate? What are the two boards in Germany? What are their duties?

Answer 29

It is a two tiered structure, it is a system that balances employee and shareholder interests thus it is co-determination. It mandates that a firm with greater than equal to 500 employees must allocate 1/3 of its supervisor board seats to labour representatives. Management board - They run the company Supervisory Board - Oversees the company

Question 30

What are the three activities that the supervisory board does? - Who do they appoint - What is the maximum amount of labor representatives permitted? - Who are the 3 examples of the party that it includes? (FIR) What is the role of banks? Do public shareholders have lots of voting rights?

Answer 30

1. Appoint members to the management board 2. Up to 50% of the labour representatives (co determination) 3. Includes the founding family members, financial institutions, and retired management Exercise significant power as a source of financing for the firms. The concentration of ownership is strong. No, their voting rights are somewhat limited.

Question 31

What is Keiretsu in Japan? What are the two parts of keiretsu?

Answer 31

It is a history of strong interconnections among the firms. 1. Cross ownership among customers, suppliers, affiliates, and financiers. 2. System encourages business relations and cooperation towards a shared objective.

Question 32

What is Japan's orientation? What are the three ways that Japan shows this orientation? Who mostly consists on Japan's large boards?

Answer 32

Stakeholder centric. 1. Maintain healthy employment 2. Preserve rage hostile interactions among the firms The executive directors

Question 33

What change did Japan make in 2002?

Answer 33

The Japanese Minister of Justice modified the law to adopt a more Western governance system. The revised code allows companies to choose between Keiretsu board structure and one with the majority independent audit, nomination, compensation committees.

Question 34

What is China's board structure?Who is the primary owner? What do they protect?

Answer 34

It is a partial transition from communism to capitalism. The government is the primary owner. The protect the societal concerns such as (maintaining employment, protecting key industries from foreign competition.

Question 35

What are the three types of shares issued by China?

Answer 35

1. Those held by the state 2. Those held by the founders and employees 3. Those held by the public.

Question 36

What are the three categories of public shares?

Answer 36

A Shares (Domestic investors in renminbi) B Shares (Domestic investors in foreign Fx) H Shares (Foreign investors in Hong Kong dollars)

Question 37

What is China's two tiered board? Who is comprised on these boards? Do the individual shareholders have lots of power? Is there a lot of foreign ownership?

Answer 37

1. Board of directors - Most company executives 2. Board of supervisors - 33% employee representation No they are minority owners with minimal voting power. Also no, it is very minimal.

Question 38

Who dominates in South Koreas economy? Who is in the Chaebol? What power do they have?

Answer 38

Conglomerate organizations known as chaebol or the financial house. They are not a single company but groups of affiliated companies that are controlled by a powerful group chairman who holds the ultimate decision making authority on all investments and activities

Question 39

What are the 3 weaknesses of the Chaebol?

Answer 39

1. Insulated from market forces because of their unequal voting rights 2. Reliance on internal debt financing sources 3. Lack of transparency that Chaebol were not subject to disciplinary forces of external institutional intergroup guarantees and debt holders - They could not pay their debts

Question 40

What were the four responses the government of South Korea had towards the Chaebol? What happened as a result of the change?

Answer 40

1. The practice of transferring the funds between Chaebol affiliates are eliminated 2. Boosted board independence 3. Eliminated intergroup guarantees 4. Granted greater minority shareholder rights The reforms resulted in superior stock performance when adopted, and those companies that exceeded the regulatory disclosure standards trade at higher valuations.

Question 41

What is the history of India's corporate governance? 3 negative aspects?

Answer 41

India has had a managed economy with burdensome regulations, nationalized financed sector, and weak corporate governance.

Question 42

What happened in 1998 in India? What happened in 1999?

Answer 42

The confederation of Indian Industries created a voluntary Corporate Governance code. One year later, the Securities and Exchange Board of India incorporated clause 49 which set governance standards for all companies listed on the Indian stock exchange

Question 43

What are the 5 requirements of clause 49?

Answer 43

1. A majority non executive directors 2. Chair requirements 3. Directors can serve on no more than 10 board committees 4. An audit committees is required 5. CEO and CFO must certify financials and restrictions on related party transactions / disclosure requirements

Question 44

What are the 3 results of these changes? - What type of capital market - How much foreign investment - What % held by wealthy families

Answer 44

India still has an inefficient capital market Restrictions on foreign investments Wealthy families dominate the economy owning approximately 45% of the equity value of all Indian companies

Question 45

What are the 3 characteristics of Brazil's corporate governance environment? What is the typical composition of the board? Who do the non executives typically represent? What % typically have majority independent directors?

Answer 45

1. Excessive influence by insiders 2. Controlling shareholders 3. Low levels of transparency and disclosure The boards are typically majority executive directors, with non executive directors usually representing a controlling shareholder group. Only about 20% have the majority independent directors.

Question 46

Why do shareholders not know whether a director is independent? What are the two classes of shares in Brazil? Who owns most of the voting shares in almost all cases

Answer 46

The disclosure rules prevent them from knowing. 1. Common shares with voting rights 2. Preferred shares with no voting rights The controlling shareholders / groups

Question 47

What is the name of the exchange in Brazil? How many equity exchanges does it have and what are their names? Which of the 3 equity exchanges has the most stringent listing requirements? What are its 5 strict requirements? What have studies highlighted?

Answer 47

São Paulo Stock Exchange (Bovespa) It has 3 equity exchanges being the Nivel 1, Nivel 2, and Novo Mercado. The Novo Mercado has the strictest. 1. Issue only voting shares 2. Maintain a 25% free float 3. Board must have at least 5 members and 20% independent 4. Financial reports in US GAAP or IFRS 5. Minority shareholders have tag along rights Studies have highlighted how stock migrated to the Novo Mercado outperformed the index.

Question 48

What are the 6 characteristics of corporate governance in Russia? (CIWMIH) Who do the boards members mostly consist of? What are the 4 ways that controlling shareholders use their influence (IBMP)

Answer 48

1. Concentrated ownership interests 2. Insider control 3. Weak legal protection for minority shareholders 4. Modest disclosure 5. Inefficient capital markets 6. Heavy government control. They mostly consist of insiders. Controlling shareholders use their influence to 1. Increase their claim on corporate assets 2. Bribe the registrar to lose ownership records 3. Manipulate transfer pricing to siphon off profits 4. Private equity offerings to controlling shareholders to dilute minority shareholders.

Question 49

What is another source of governance abuse? What do regional government corruption prevent? What restricts the influence of shareholders? What does the Russia war on Ukraine represent?

Answer 49

The Russian government by intervening in businesses to promote its own interests, usually by making dubious claims about unpaid taxes. It prevents competition from foreign competitors Lack of transparency it represents the Russian Corporate governance test.

Question 50

What is the role of globalization? What are the three pressures from globalization? What are 3 examples of hostile markets for corporate control?

Answer 50

Governance systems vary greatly around the world, and the formerly closed economies are facing the pressure of globalization. 1. Capital market financing 2. International investors demanding rights and returns 3. Hostile market for corporate control (activist investors, hedge funds, and private equity)

Question 51

What does globalization converge too? Is it likely that a standard system will work every where? What is this main challenge?

Answer 51

It converges towards the international standards of governance No it is unlikely that a standard system will work well in all countries. The main challenge is adapting to the international standards while trying to stay true to your societal values