[Note: A transcript of this meeting is unavailable. The discussion is summarized below.]
November 15, 2001
Project Director: James Shinn
Thanks for your interest in the Corporate Governance Roundtable. This memo has a few nuggets of wisdom from the November 15 meeting that Peter and I culled from your discussion, several excellent points made by Participants in subsequent emails and notes (which we gratefully acknowledge), unanswered questions that loom over our effort to make sense of this policy question, and another call for your wisdom.
- Key Points from Session 2
Q1: What are the preferences of institutional investors with regard to governance institutions? What premium (or discount) will they pay? How much of the premium is firm-based versus country-based? Do these preferences vary by type of institutional investor, between mutual funds, hedge funds, and pension funds, for example?
- Institutional investors are expanding their shares of foreign equity markets dramatically, and they care about minority shareholder protections, though these are just one of several variables in valuation.
- There is fairly strong empirical evidence that the governance premium is sizeable, at least in emerging markets. It is less clear whether this premium holds in developed markets in Europe and in Japan.
- The country-based governance premium or discount appears to "wash out" the firm-based premium or discount, though there is some controversy over this notion.
- The governance premium (or discount) may come into play only when firms find themselves in financial distress.
- As countries have widely varying constellations of governance institutions and regulatory practices, it is not clear precisely which governance institutions are most valued (or most discounted).
- Long term (or "patient") investors care more about good governance than short term investors. The spreading use of indexing may also serve to "lock in" investors to country markets and thereby enhance their concerns for corporate governance, since they can't simply "walk".
- Doubts were expressed whether majority shareholders ("private blockholders") have been responsive to these good governance premia and discounts. Some evidence was cited that private blockholders largely prefer the private benefits of control to the valuation gains from prospective good governance. It was pointed out that governments may have been more proactive than private blockholders in making this "good governance deal", as governments have depended on the proceeds of share offerings in former state owned firms in order to plug their budget gaps.
Q2: Do pension funds such as TIAA/CREF or CalPERS have unique preferences for governance? Why do they behave differently than other pension funds with regard to governance? What happened to so-called institutional activism, and what effect (if any) has it had on governance convergence abroad? Will this be renewed by improvements in proxy voting procedures and services?
- The pension funds which exhibit the most activism in pressing for good governance are those which have a large customer base independent of corporate retirement funds, or which are large enough to resist corporate lobbying pressure. In contrast, many pension fund managers step carefully on governance lest they antagonize corporate customers. There was little mention of changes in proxy voting procedures.
- Private equity funds may play a bigger role in corporate governance reforms abroad that we have assumed. Private equity funds can buy out private blockholders, restructure firms, and then liquidate this majority position by means of public offerings, either on local or international exchanges, adopting governance reforms in exchange for higher valuation by institutional investors.
Q3: Are the preferences of Anglo-American investors mirrored by those of institutional investors in France, Germany, and Japan? What accounts for the difference, if any?
We did not shed much light on this question.
Q4: What role did the Pension and Welfare Benefits Administration (PWBA) in the U.S. Department of Labor play in supporting governance reforms? Is this role being emulated by pension supervision agencies abroad?
- PWBA has had some effect in strengthening the governance role of investors by emphasizing their fiduciary duty to exercise voting power in the interests of their beneficiaries, which broadly translates into support for better corporate governance. It was noted that this effect was due to a decade old, very limited poll by PWBA.
- However, this discussion did lead to the hypothesis that the key to broader corporate governance reforms may lie in the governance of pension funds and other institutional investors.
- Key Points from Subsequent Commentary
- Not only are the US and UK (improperly commingled as the "Anglo-American" model) systems of corporate governance different in several respects, the UK may be superior in providing minority shareholder protections. One possible reason for this superiority is greater regulatory pressure on institutional investors in the UK to vote their shares, as imposed by the Company Law Reform and the Myners Report, and rules that make it easier to call a special meeting or otherwise depose incumbent boards. The prospect of convergence on the Anglo-American model may well involve the U.S. converging on the U.K. model in order to remedy current deficiencies in U.S. domestic practices.
- Some of the participants employed needlessly restrictive definitions of "corporate governance." This is a misleading name, and some better rubric ('Investment relations?' 'Economic relations?' 'Corporate diplomacy?') would better capture the various diplomatic and legal functions usually meant by the phrase. I would propose that for purposes of future discussion the term encompass any issue for an investor which is not a quantifiable investment issue: i.e., not profitability, not growth, not strategy, not market timing, and not choice of financial structure. This is the sort of definition Jon Lukomnik was using when he spoke of "risk factors," as opposed to "performance factors," and this is the kind of definition most of us who have been active in this field have been using. To define "corporate governance" as the structure and functioning of boards, and exclude issues relating to e.g., public policy and attitudes toward other stakeholders, neuters the discussion from the outset, and renders it utterly useless in a foreign policy context.
- Most of the corporate governance reforms discussed at the Roundtable, at least in respect to emerging markets, have related to the corporate sector. An even more profound set of reforms has taken place in corporate governance practices in the financial sector. This can be seen particularly dramatically in Asia, where sweeping corporate governance reforms were insisted upon by governments as they recapitalized banks and non-bank financial institutions following the onset of the Asian financial crisis. Financial institutions with more transparent and accountable corporate governance practices can have a significant impact on corporate governance practices in the corporate sector, both through such institutions' role(s) as equity investors and/or as lenders. In Japan and Korea some of the most notable changes in corporate governance practice in the corporate sector in the past two years have taken place as a result of the changed relationship between corporates and their bankers, including a significantly reduced willingness of directors (particularly at financial institutions with foreign investors) to engage in "policy" or "relationship" lending to corporate customers. Some of the first cases of directors' liability for breach of fiduciary duty have arisen, again in Korea and Japan, from the financial sector, where the former directors of failed banks have been held personally liable for approving loans to insolvent corporate customers.
- During Ira Millstein's presentation at the first meeting of the Roundtable, he argued strongly for U.S. government financial support for private sector corporate governance reform efforts. Yet most of the progress which has been made to date in emerging markets has come from private initiatives of institutional investors such as the Russell 20-20 and CalPERS support for the Asian Corporate Governance Association, from modestly funded efforts by the World Bank and OECD (such as the Private Sector Advisory Group which Millstein chairs) and through multilateral institution technical assistance to particular governments (World Bank, ADB, EBRD, etc.). If, as has so convincingly been demonstrated by so many empirical studies, institutional shareholders benefit from better (more transparent and accountable) corporate governance, why should U.S. government assistance be required, rather than leaving these initiatives to the self-interest of private sector investors and to the activities of multilateral institutions working with their member governments in support of those initiatives?
- Unanswered Questions
- Can the minority shareholder model work where effective regulatory systems on the SEC (or FSA) model do not exist? How long does it take to create these systems?
- What are the strengths and weakness of the concentrated private blockholder model, which apparently can operate for years with positive economic performance in the absence of good governance? Are there things it can do well, at certain stages of economic development, and other things it cannot? For example, is good governance largely irrelevant at labor intensive or capital intensive activities, but crucial to technology-intensive activities?
- What is the sequencing of governance changes that can be effective? Are some of them reform-generating? What are the risks involved in a sequence of change? For example, the United State's S & L crisis is often said to involve deregulation without the placement of adequate supervisory structures. Is the Japanese case another example?
- What are the political requirements of a regulatory process? If there are effective codes, will they be enforced? Can good rules work in authoritarian systems?
- Call for Your Wisdom
The Roundtable website has been slowed down by a system upgrade at the CFR, but will soon be fully operational. We repeat our request to Participants to submit memos and other materials relevant to our discussion for posting. If you have longer works you would like us to add to the background documentation, by all means send them as well, to the attention of Robert Knake (email@example.com) at the Studies Department.