FINS 5526

International Corporate Governance

Emma Jincheng Zhang

School of Banking & Finance
jin.zhang@unsw.edu.au

Session 1, 2017
 FINS 5526
International Corporate Governance

Week 11
Institutional Investors +
Some International Perspectives
 Institutional investors

1. Institutional investors: organizations which pool money from

individuals or other organizations and invest them in investment assets
2. These institutions are managed by investment professionals
3. Types of institutional investors
Pension funds
Mutual funds
Insurance companies
Hedge funds
Investment companies/banks, etc.

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 Institutional ownership in the US

1. In 1950, institutional investors owned 6.1% of the total market value

of equity
2. In 2009, they hold 40.4% of the total market value
Mutual funds have been especially prominent
(grew from $70bil in 1980 to $7.2tril in 2009)
3. The institutional ownership is highly concentrated
Even in the largest 25 corporations, 5 institution investors holds substantial
amount of ownership

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 Why do institutional investors exist?

1. Diversification
By pooling the large sum of money, institutional investors can diversify
their portfolio better than individual investors
(e.g., individuals buy index mutual funds to invest in the entire stock market)
2. Expertise/information advantage of professionals
By delegating investment to institutional investors, individual investors can
use the expertise of fund managers and their superior information about
investment assets
3. Benefits from blockholdings
Institutional investors tend to hold block ownership of firms, and if
necessary
they can influence management
They monitor management better than individual investors do

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Institutional Investors and Corporate
Governance
Active monitors: e.g., involvement in voting, etc.
(Threat to) exit
Activist
Any costs associated with these? Are there any factors
that could make these more difficult?

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Country-level Governance Systems

Shareholder-centric system
o Monitoring through the market forces;
o Stronger threats of takeover and shareholder activism;
o Stronger shareholder protection;
Stakeholder-centric system
o Stakeholders such as employees, and affiliated families and
other firms have relatively more influence;
o Shareholders are not necessarily the focus for protection
and/or value creation.

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Germany & Japan: Focusing on Stakeholders

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Japan: Corporate Culture

Corporate Philosophy of Asahi Breweries, Ltd.

1. Consumer Orientation
2. Quality First
3. Respect for Human Values
4. True Partnership Between Labor and Management
5. Cooperation with Business Associates
6. Social Responsibilities
We at Asahi, through securing and expanding the base of our
operations, desire to fulfill our responsibilities to stockholders and
the local communities in which we operate.

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Japan: Corporate Culture (cont.)

General Corporate Culture:

o Obligation
o Family
o Consensus
o Peer pressure
o Strict moral codes
General characteristics of governance culture:
o Well developed capital markets and regulatory systems to
protect investors and stakeholders (including shareholders)
o Shareholders are important, but not the central theme

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Japan: Toyotas Corporate Governance (2006)

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 Toyotas Return of Shareholders

Source: Allen, Franklin. "Corporate governance in emerging economies." Oxford Review of Economic
Policy, Vol. 21, No. 2, pp: 164-177, 2005.
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Toyota: What are your findings?

What are the governance-related factors that

youve chosen for Toyota Motor Corp.?
Boards, ownership, auditing, risk-management, etc.

What is your evaluation conclusion of Toyota

good/poor governance?

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Japan: Ownership Structure

Groups of companies (Keiretsu)

o Built around founding families or main banks;
o Cross-shareholdings (minority but not insignificant) are
popular;
o Cooperation instead of competition;
o Firms in financial distress may be bailed out by other
members of the same group;
o Affects the role of directors, takeovers, etc.;
o Has been at the center of criticism related to governance
issues.

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Japan: Takeover Threat

Board Structure:
o Very large number of directors;
o Dominated by employees (a kind of reward) and other long-
term investors;
o Traditionally, boards authority has been surrendered to
CEO/president.
Shareholder activism / market for corporate control:
o CEO dismissals are rare;
o Take-over bids are strongly resisted by stable stakeholders;
o AGMs are ceremonial affairs and there are very few proxy
fights.

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Japan: Ownership Structure

Concentrated ownership
Banks hold large stakes as a part of their relationship
with borrowing firms
Stable investors:
o Facilitate long-term decision-making;
o Do not publicly challenge management;
o Do not discreetly dispose shares without consultation.

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Japan: Role of Main Banks

Banks as potential good-CG keepers

o Equity holding;
o Lending relationship;
o Active intervention, should the client firm be financially
distressed.

Bear in mind, however, that main banks have the capacity

and incentive to be good-CG keepers, but it doesnt mean
that they will act actively in terms of monitoring /
governing corporate managers.

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Research Findings

1. Bankers are more likely to sit in the board of borrowing firms, if the
firm is a member of the banks Keiretsu
2. Bankers are more likely to sit in the board of group-member firms,
when the firms underperformed other rival firms in the industry
3. When bankers sit in the board of group-member firms, the firm
performance tends to be improved
4. Such a performance improvement is not found in the case where
bankers sit in the board of non-member firms

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Germany: Corporate Culture

Focusing on stakeholders (in particular

employees) rather than only shareholders
Co-operation rather than confrontation
Long-term thinking and decision-making
Delegation of authority and responsibility
Strict moral codes and self-discipline

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Germany: Corporate Boards

Two-tier board system

o Supervisory Board (Aufsichtsrat)
o Management Board (Vorstand)

Supervisory board has substantial representation by:

o Labour representatives;
o Founding family members;
o Banks (and other financial institutions).

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 Germany: Corporate Boards (cont.)

Source: www.bvdbank.com
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Germany: Ownership Structure

Ownership Structure:
o Concentrated ownership structure;
o Substantial ownership by founding families;
o One-share-one-vote, although cross-shareholdings &
pyramids exist;
o Equity ownership held by banks and insurance companies.

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Germany: Takeover Threat

Shareholder activism / market for corporate control

o Proxy contests exist but not very popular;
o Very difficult to win control from outside;
o Major hostile takeovers are very rare;
o Management proposals have to be first rejected before
counter-proposals are voted upon;
o Institutional investors are generally in coalition with
management.

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Germany: Role of Financial Institutions

Banks are a very important part of the economy

o German firms have often been highly geared;
o Substantial voting power through voting rights of
deposited shares;
o Large shareholdings by banks result from converting debt
of firms in financial distress;
o Active participation of banks into companies affairs.

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Governance in Germany & Japan

Distinct governance features

o Corporate culture
o Ownership structure
o corporate boards & compensation practices
o Role of the stock market, banks, and other institutional
investors
o Strength of company laws and shareholder protection
o Practice of disclosure and auditing
Recent trend of some convergence is the US-type
market-centered model optimal?

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Corporate Governance in Asia

Concentrated (family-based) ownership and control;

Use of pyramids and cross-shareholdings used by business
groups voting control >> ownership;
Institutional investors are not active;
Market for corporate control is not active;
Relatively poor financial disclosure quality, and weak
corporate and/or securities regulations that protect
(minority) investors.

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Insider (Family)-centered Governance System

Initially, financed by internal funds;

Then, external debt and equity finance is obtained;
But control remains with the founding family;
Family business groups could be bad, in terms of facilitating:
o Consumption of private benefits by controlling (family)
owners;
o Expropriation of minority shareholders.

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Family-centered Governance System

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Political Connections and Cronyism

Family-controlled firms in many Asian countries have

extensive political connections intangible asset;
Banks lend on the basis of political connection;
Governments are expected to bail out ailing firms that
are connected;
Few independent, outside directors, who look after
minority shareholders;
Minority shareholder rights (and those of other
stakeholders) are sometimes abused.

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Corporate Governance In South Korea

Chaebol business groups used to be very large and

powerful;
After the Asian financial crisis of 1997, Chaebol groups
have been in effect dismantled by the government
internal funds sharing and transfers are eliminated;
Regulation has also imposed designated (high-quality)
external auditors for firms that are likely to have
accounting manipulation to improve governance
quality.

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Corporate Governance In China

Transitioning from planned economy to market-

based economy;
Developing but relatively poor regulatory
environment to protect investors;
Developing capital markets;
Government ownership & board representation
in many publicly listed companies;
Institutional investors and market for corporate
control are not effective.

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Corporate Governance In China (cont.)

Government ownership in many publicly listed companies

social agenda (e.g. job creations & social stability);
State ownership is gradually decreasing over time,
especially after 2005-06 Split Reform which allows non-
tradable government shares to become tradable over time;
Government has visible (dominating) representation on
corporate boards political connection in a
relationship-based market, become profitable intangible
asset for connected firms;
Board system: board of directors, and board of supervisors
(or, supervisory committee).
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Corporate Governance In India

Transitioning to more market-based

economy;
Developing but relatively poor regulatory
environment to protect investors;
Developing capital markets;
Dominance of family ownership and control
in many publicly listed corporations;

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Corporate Governance In India (cont.)

Boards are required to have majority

independence;
Audit committees are also required to have
majority independence;
Improving financial disclosure requirements;
Institutional investors and market for corporate
control are not effective;

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Satyam Computers Ltd.

Satyam Computers Ltd., founded by Ramalinga Raju

and his brother, became a publicly listed company in
1992. The company expanded into foreign countries in
1996, and Satyam has been cross-listed in the U.S (as
ADR) since 1999.
The company had some (foreign) institutional investors.
The company had a board with majority independence,
and Raju brothers were the only promoter
shareholders sitting on the board. The audit and
remuneration committees were entirely independent.

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Satyam Computers Ltd. (Cont.)

In 2008, ranked as the 4th-largest software development

and information technology consulting company in India,

Winner of Golden Peacock Award for Excellence in

Corporate Governance

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Satyam Computers Ltd. (Cont.)

Failed Maytas acquisition -> Ramalinga Raju (founder,

CEO and the chairman) resigned and admitted fraud

The entire episode became a mockery of corporate

governance, sparking issues such as the lack of
transparency, conflicts of interests, and the inefficiency of
several governance mechanisms.

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Governance and the Asian Financial Crisis

In countries like the U.S. and UK, greater

managerial ownership has been advocated by
some as a good governance tool to align interest
of managers and shareholder;
In other parts of the world such as South East
Asia, concentrated ownership has been quoted
as one of the impediments to better corporate
governance, in particular after the 1997 Asian
crisis. Does poor corporate governance
contribute to the Asian financial crisis?

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The Asian Financial Crisis
Before the crisis:
o Expansion of firms into property market;
o Heavy reliance on debt market/overseas borrowing;
o Commercial banks do not meet capital reserve
requirements set by central banks;
o Transfer-pricing across associated/related firms;
o Firms withholding vital information from regulators;
o Funds are diverted for political/personal purposes instead of
real investments;

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The Asian Financial Crisis (cont.)

During the crisis:

Expropriation of minority shareholders:
Bailing-out of associate firms;
Fund diverted to off-shore accounts;
Moving profitable business to associated firms, and equity raised
by one firm is used to capitalize another associated firm;
Expropriation of creditors:
Assets pledged as collateral disappearing;
Creditors with connection being repaid first.

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What Have We Learned?

While corporate governance problems did not trigger

the Asian Financial Crisis, they made the crisis
substantially worse.
Aspects for reform:
o Governments intervention / participation;
o Disclosure, accountability, protection of shareholder and
creditor rights;
o Corporate ownership and control;
o Independence & role of corporate directors.

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What Have We Learned? (Cont.)

While corporate governance problems did not trigger

the recent Global Financial Crisis (GFC), they also
contributed to the severity of the crisis.
Aspects for reform:
o Role of the board & executive compensation corporate
risk-taking behavior;
o Role of institutional investors as active governance
participants.

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Going into the future
For next weeks class
Information about the final exam
Group presentation

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