CEOs in Japan are already poorly paid by international standards. As the WSJ noted:
Why? Culture and history.
Yet there is already pressure on this system. Foremost, disclosure will reveal disparity among companies in Japan. For example, the aggregate pay to the top 20 officers showed that companies like Nissan and Sony paid much higher averages. Second, the disclosure will reveal higher compensation paid to non-Japanese officers, a consequence of having to compete with compensation standards in other countries. In short, disclosure will help build pressure for increases in executive compensation.
Culture will keep the numbers down to some degree but so will the strong arm of the government. This can be seen with the recent treatment of compensation at Shinsei Bank.
Shinsei is the successor to the the Long Term Credit Bank, a financial institution created in the aftermath of WWII to provide long term capital to Japanese corporations (long term credit banks had debenture issuing authority, ordinary commercial banks did not; see Brown, Japanese Banking Reform and the Occupation Legacy: Decompartmentalization, Deregulation, and Decentralization, 21 Denver J. Int'l Law 361 (1993)).
This is a particularly sensitive institution in Japan. With the economic collapse in 1989 and the demise of the compartmentalized banking system in Japan, the LTCB couldn't make the transition. It went bankrupt and was ultimately acquired by a consortium of foreign investors, making it the first Japanese bank to be acquired by foreign interests. Moreover, the government still holds a large percentage of the shares.
As the executive compensation disclosure deadline loomed, Shinsei looked likely to announce a structure that paid foreign executives substantially more than Japanese executives. In response, the WSJ reported that the FSA pressured the Bank to force the high paid executives out. According to the Journal:
In other words, the FSA did not leave matters to culture or social pressure. Those sources of restraint would likely have less impact on a financial institution with foreign ownership. As a result, the government acted as the enforcement mechanism.
The approach -- to the extent true -- shows that the current system of "cultural" limits cannot be counted on to restrain executive compensation. While banks can be pressured by the FSA, not all companies are subject to the same level of regulatory oversight. Moreover, while the FSA may be in a good position to address outliers in the compensation area, it will not be in a good position to stop compensation from creeping upward.
So, with the new disclosure requirements, we can expect an increase in executive compensation in Japan, albeit slowly. Onward and upward.
]]>This has changed. Disclosure is now required of any officer making more than Y100 million or approximately $1.09 million. The rule was promulgated by the Financial Services Agency, the successor to the old Banking Bureau within the Ministry of Finance and applied to all listed companies (approximately 3800 companies). As the regulation provides:
The change applied to fiscal years ending on or after March 31, 2010. In short, it applies now.
The change unsurprisingly drew objections from business interest, particularly from the Keidanren, Japan's Business Roundtable. In addition to learning the specifics of CEO pay, the disclosure promised to throw light on another aspect of executive compensation in Japan: The payment of foreign officers more than Japanese officers.
We will discuss the impact of these changes in the next post.
]]>Another place where converging seems to be occuring is in the area of compensation disclosure. Since 1992, the US has had robust disclosure requirements for executive compensation. After the 2006 reforms, the requirements apply to the CEO, CFO, and top three highest paid officers. Moreover, the US has moved towards a system where all benefits (including perqs) must be included in "total compensation." Total compensation does not necessarily reflect the amount actually paid to the officers but provides a basis for comparability.
Disclosure seems like an inherently good thing but there is clearly a cultural component to the requirement. In the United States, the expectation is that compensation will largely be determined and regulated by the market. To the extent excessive, unhappy shareholders can sell, depressing share prices. In order for this dynamic to work, shareholders must know the amount of compensation.
Of course, the whole approach is flawed. Shareholders do not react solely because of a single variable that makes them unhappy. Moreover, even if they sell their shares and prices fall, the board is still in a position to award excessive amounts to top officers. Indeed, most years when share prices have fallen, average executive compensation has risen.
As a result, disclosure of executive compensation has not had downward pressure on the amounts paid. Quite the reverse. Executive compensation has likely gone up as a result of disclosure. CEOs and CFOs in comparable companies can use the higher pay awarded by their competitors as a basis for arguing for a raise.
Nevertheless, pressure has increased in other countries to follow the lead of the US and require robust disclosure of executive compensation. One of the most recent converts has been Japan. Yet as public reports indicate, the impact of disclosure is likely to be very different than what occurred in the US.
]]>Part one of the Race to the Bottom’s BRIC Project: China Series seeks to illuminate the regulatory structures, agencies, and institutions that make up the Chinese system of corporate governance (“gongsi zhili”). While this discussion is not comprehensiave, it does provide sufficient detail to grasp the complexities and nuances of this blossoming market. Specifically, this post will discuss (A) the historical evolution of corporate structures in China, and (B) the corporate statutory regulation in China.
A. Historical Evolution of Corporate Structures in China
It is necessary to briefly summarize the development of Chinese corporations and the evolution of their structure in order to understand the nature of the current model for corporations, and the corporate governance and regulatory structures that evolved around them. See Cindy A. Schipani & Junhai Liu, Corporate Governance in China: Then and Now, 2002 Colum. Bus. L. Rev. 1, 1-22 (2002) (summarizing the historical evolution of corporate models in China).
The State Owned Enterprise (“SOE”) traditionally dominated the Chinese market. The SOE is the embodiment of the planned economy in China where the State exercises complete control and ownership of firms. The SOE also held special social significance for individual Chinese citizens as the organizational unit of social welfare as well as economic sufficiency.
The Traditional Model, as it has come to be known, began in the 1950’s and lasted until the mid-1980’s. After World War II, the SOE was the only legal entity available for large-scale commerce in China. The Traditional Model’s method safeguarded the “People’s” property; whereby the State exercised complete ownership and authority in commercial activity. This model, however, depressed growth, deprived SOEs of independence, and hindered productivity because all decision-making authority was concentrated in State agencies, not in the management personnel of the individual SOEs. Within the planned economy, the State gave all production and distribution requirements to the SOEs in the form of a quota, instead of letting market demand set output levels. The Party appointed all Executives, instead of the board of directors.
The Transitional Model, lasting from 1984-1993, ushered in the beginning of privatization with the enactment of the “State-Owned Industrial Enterprises Law.” Under this law, SOE reform encouraged firms to earn profits and expand production. The goal was to make SOEs responsible for their own financial viability. It marked a separation of the SOE and the State to a certain degree, but the State’s ultimate ownership remained. This Model is also referred to as the “Contracting Model,” whereby the SOE and relevant government agencies contracted to lock in the minimum amount of profit the SOE was required to pay back to the State. The SOE was allowed to keep any surplus profits, but was also required to pay back any shortfall.
The Transitional Model succeeded in making the first steps towards a market based economy by diminishing government control, but is was unsustainable for several reasons. First, accurate quota estimates and projected profits were difficult to achieve, leading to drastic under or over production. Second, SOEs were simply unable to pay back the State for any shortfalls in profits sustained. Third, SOE executive exploitation of State owned assets remained pervasive. Finally, the firms were left with no retained earnings, making expansion and capital investment nearly impossible.
In Response, the Modern Corporate Model was adopted with the passage of the “Chinese Corporate Law of 1993” (“Corporate Law”). According to Deng Xiaoping, former Chinese Paramount leader, the goal was to modernize and “set up a modern corporate system in the majority of backbone industries.” This model is still in place today. Essentially, under the Corporate Law, SOEs should be fully “corporatized,” as functioning, public, companies. A major caveat, however, remained in that the State itself persisted as the major shareholder.
B. Corporate Statutory Regulation in China
The Chinese Government saw comprehensive corporate legislation as essential to fostering and implementing the State’s plan to modernize SOEs into globally competitive market actors, as discussed specifically in the Schipani & Liu article. Schipani & Liu, Corporate Governance in China: Then and Now,” supra at 1-22. The Corporate Law, enacted by the National People’s Congress and its Standing Committee, is still in force today in an amended form. The Act sets out the fundamental features of all available business entities in China. This discussion, however, will focus solely on Publically Held Companies (“PHCs”) and SOEs. It is helpful to bear in mind that the majority of all major companies in China are still to this day owned by the state.
The Corporate Law recognizes both Closely Held (“Youxian Zeren Gonsi”) and Publically Held (“Gufen Youxian Gonsi”) Corporations. Closely Held Corporations include both Wholly State Owned and Foreign Invested Corporations, both of which pre-date the Corporate Law but were incorporated into the Act. However, as a condition of China’s inclusion into the World Trade Organization, foreign and domestic organizations are required to be governed by the same set of laws. Therefore, the distinction between Wholly State Owned and Foreign Invested Corporations has become less important.
Publically Held Corporations, on the other hand, consist of both Listed, and Non-Listed corporations defined as “corporation[s] in which the total capital shall be divided into equal shares, shareholders will assume liability towards the company to the extent of their respective shareholdings, and the corporation shall be liable for its debts to shareholders.” Corporate Law §§ 2-3. A listed company is further defined as a “Joint Stock Limited Corporation which has its issued shares listed and traded on stock exchanges with the approval of the State Council or the Department of Securities Administration.” Corporate Law § 151. These listed corporations are typically corporatized SOEs, whose shareholders are entitled to rights in proportion to their ownership position.
Salient features of Chinese listed corporations include: the company, not the state, retains full ownership of shareholder capital; the company owns all property and capital created in the course of business; the company is authorized to pay dividends to shareholders; and shareholders are entitled to net assets in the event of liquidation. The Corporate Law defines eight legal relationships between: 1) the shareholder and corporation; 2) the shareholder and other shareholders; 3) the fiduciary relationship between the corporation and its governing bodies; 4) the corporation and its creditors; 5) the shareholders and the corporations creditors; 6) the corporation and its employees; 7) the corporation and its competitors; and 8) the corporation and consumers.
In addition to the Corporate Law’s foundational and authorizing language, listed companies in China are also subject to “The Securities Law of 1998” (“Securities Law”). The main function of the Securities Law is to regulate the shares of Chinese corporations available for sale. It utilizes a quota system whereby the Planning Commission and various provincial leaders receive a listing quota for that particular region, which constitutes a certain amount of shares of government property that may be securitized and sold. These bodies then assign their shares to Initial Public Offering (“IPO”) Candidates, which are usually SOEs. See Qiao Liu, Corporate Governance in China: Current Practices, Economic Effects, and Institutional Determinants, CESinfo Economic Studies, Oxford Journals, Volume 52, Number 2, 415-453 (2005). This system functions to mitigate the risk of bad information systemically related to IPOs in China. It also incentivizes local leaders to choose only viable SOEs for an IPO. This system has effectively regulated the emergence of the capital markets in China. The main criticism of this system is that it has led to local leaders selecting only those firms that will provide them with the most benefits locally in the form of higher rents, highest potential employment rates, etc. Schipani & Liu, Corporate Governance in China: Then and Now,” supra at 1-22.
Additionally, this system has been blamed for stalling the corporatization of China in that a firm can only sell its initial quota given at its IPO, making it difficult to raise necessary capital. Schipani & Liu, Corporate Governance in China: Then and Now,” supra. Moreover, the quota system may represent a suboptimal structure chosen to promote indefinite state control. Schipani & Liu, Corporate Governance in China: Then and Now,” supra.
A continuation of the BRIC Project’s China series is forthcoming, and discusses regulatory structures in China. Specifically, the next post will be a discussion of the Chinese Stock markets, as well as the CRSC and other voluntary regulations imposed on Chinese Listed Companies.
Part one of the blog’s BRIC Project’s China Series seeks to illuminate the regulatory structures, agencies, and institutions that make up corporate governance (gongsi zhili) in China. This continued posting on the regulatory structures in China looks at the (A) Board of Directors and the (B) Board of Supervisors in Chinese companies and their role in corporate governance, as well as (C) China’s definition of director independence.
Required Governing Bodies in Chinese Corporations
A. The Board of Directors
The Corporate Law of China requires three governing bodies within any listed corporation: the shareholder, the board of directors, and the board of supervisors. Noticeably, no other bodies or committees (such as an audit or compensation committee) are required. However, the Corporate Law was amended in 2006, and now contains strict guidelines for audit and accounting functions within listed companies. See Cindy A. Schipani & Junhai Liu, “Corporate Governance in China: Then and Now.”
In Chinese listed companies, the shareholders, however, are meant to exercise the majority of decision-making authority within the corporation via the annual shareholder meeting and any subsequent meeting of the shareholders. However, the logistics of calling a shareholder meeting for every major corporate event has proved impracticable and cumbersome. In reality, the majority of power rests with the board of directors, the senior management, and the board of supervisors.
The board of directors, much the same as the familiar model in the U.S., hires, fires, monitors and compensates management with the goal of shareholder wealth maximization. The drafters of the Corporate Law originally saw the primary duty of the board of directors to minimize the costs associated with the separation of ownership and decision making authority for the SOE from the State. See Donald Clarke, “Corporate Governance in China: An Overview.” Directors serve for a maximum term of three years. There are two enumerated fiduciary duties owed to shareholders by directors: the duty of good faith (chengxin) and the duty of diligence (qinmian).
B. The Board of Supervisors
The unique addition to the traditional governing structure is the board of supervisors, and represents the second tier of corporate management. Supervisors are charged with monitoring the directors and senior management to ensure fulfillment of their responsibilities. See Takeshi Jingu, “Corporate Governance for Listed Companies in China - Recent Moves to Improve the Quality of Listed Companies.” However, unlike Germany (which also employs a two-tier governing structure), there is no hierarchical relationship between the board of directors and board of supervisors. Indeed both are appointed and dismissed via shareholder action, and are meant to equally coexist within the management structure of the Chinese corporation.
The members of the board of supervisors consist of shareholder representatives (elected by the shareholders), and employee representatives (who work for the CEO). Some commentators, however, note that the intended supervisory role of the board of supervisors is actually quite low in most listed companies. This is because the chair of the board of supervisors is typically also the head of the labor union, who in turn is appointed by the in-house Party chief, who in turn is also often times the chairman of the board of directors. Some argue that the board of supervisors does operate as a sufficient check on the board of directors and senior management as intended.
C. Defining “Independent Director” in China
Chapter IV, Section 5 of the Corporate Law was amended in 2004 to require listed Chinese companies to have some proportion of independent directors. This amendment was added in response to the “State Council’s 2004 Several Opinions on Promoting the Reform, Opening Up, and Stable Development of Capital Markets” (a.k.a. “The Nine Opinions”). The CSRC implemented this initiative via the codes it promulgates to require that, by 2003, one-third of all directors sitting on the boards of directors should be independent. See “Code of Corporate Governance for Listed Companies in China (2001),” and the “Provisional Code of Corporate Governance for Security Companies (2004)”). Another code revision requires that as directors’ terms expire, non-independent directors should not exceed one-half of the entire board. See Larry Li, Tony Naughton & Martin T. Hovey, “A Review of Corporate Governance in China.”
The regulatory laws of China define independence as not having a position within the company (i.e. the CEO). Further qualifications for independent directors include: (1) subjectively meeting honesty and credibility standards, (2) knowledge of securities markets, (3) familiarity with all laws and regulations pertaining to listed companies, (4) five years of relevant experience, and (5) possessing sufficient time to review and having access to all corporate material necessary to do the job. The CSRC requires that the views and attitudes of all independent directors should be explicitly stated in any board resolution, and related transactions may not close until they are approved by a majority independent of the directors. Further, two or more independent directors can propose a special shareholder meeting, and can individually report directly to shareholders or regulatory agencies. Independent directors are, in theory, to be on par with non-independent directors.
However, all of the requirements imposed by the CSRC apply only to overseas-listed corporations. Domestically listed corporations are not bound by any requirement to have any independent directors on their boards. They may, however, adopt a discretionary provision in the Memorandum of Associations (which is similar to a combination of the Articles of Incorproation and Bylaws in U.S. corporations) whereby “the listed corporation may appoint independent directors when it deems necessary.” This leaves most independent directors in domestically listed corporatized SOE’s with a limited role.
The final installment of Part one of the BRIC Project’s China Series is forthcoming, and discusses the ability of a shareholder in China to bring a lawsuit against a listed company, the legal system in China as it relates to shareholder actions and the perceived difficulty of shareholders in China to seek redress for breaches of fiduciary duties by management.
Part one of the blog’s BRIC Project’s China Series seeks to illuminate the regulatory structures, agencies, and institutions that make up corporate governance (gongsi zhili) in China. This continued posting on the regulatory structures in China looks at the (A) Stock Exchanges and Agency Regulation in China, and (B) Voluntary Regulations in China.
A. Stock Exchanges and Agency Regulation in China
The regulatory body created to administer the Chinese stock exchanges is the China Securities Regulatory Commission (CSRC). This agency has promulgated two codes: the “Code of Corporate Governance for Listed Companies in China (2001),” and the “Provisional Code of Corporate Governance for Security Companies (2004).” These codes apply equally to all listed companies, and represent an attempt on the part of the CSCR to standardize operating procedures and promote healthy corporate governance.
Investors see the level of compliance by Chinese companies with both codes as the best metric for the health of the corporate governance system for a given listed company in China, as discussed in an article by Larry Li, Tony Naughton & Martin T. Hovey. Li, Larry, Naughton, Tony and Hovey, Martin T., A Review of Corporate Governance in China (August 18, 2008).
The codes flesh out the details of the ideal corporate governance system. The codes also enumerate the basic behavior, rules and moral standards for members of the governing bodies of the corporation. Specifically, some of the more important features include: (1) Shareholders and the Annual Shareholder Meeting, (2) Controlling Shareholders, (3) Memorandum of Associations, (4) Board of Directors, (5) Board of Supervisors, and (6) Disclosure.
The codes promote cohesive treatment of shareholders under all of the corporate and securities laws in China and stress that shareholders are to be treated fairly. The codes also outline the requirements of shareholder communications, and reiterate that corporate management is to bear the burden of compensating shareholders in the event that management breach their fiduciary duties leading to loss on the part of shareholders. The codes also require that related-party transactions should be undertaken at market value. Further, qualification standards for management are outlined, and there is a notification requirement where the CSCR must be told of any major changes in the composition of the management team in any listed company.
In addition, the codes reiterate the notion, contained in both the Corporate Law and Securities Law, that the shareholder annual meeting is to be the powerhouse and primary forum for corporate decision-making. In actual practice, however, Chinese listed companies face the same difficulties with annual meetings that U.S. corporations do; expense, low turn out and lack of dissent.
The codes also lay out the proper relationship of the controlling shareholders to the company itself. Controlling members must obey all laws in exercising their rights as investors, and they may not harm the company or the interests of a minority shareholder.
The codes and Corporate Law specify the nature and content of this organizational and governing document. The Memorandum is similar to a combination of both the Articles of Incorporation and Bylaws in an American corporation.
The codes provide that election of directors is to be transparent; the identity and qualifications of director candidates are to be disclosed before the annual meeting.
The codes encourage shareholders to appoint members to this unique governing body from the professions of law and accounting, or candidates who possess extensive experience in business or finance. Their identity and qualifications should likewise be disclosed prior to the annual meeting.
The codes ask for extensive disclosure of major events facing the corporation. They require the disclosure of information to be widely accessible to the public.
B. Voluntary Regulation in China
The Chinese corporate governance regulatory structure is sometimes characterized as a Control Model, meaning that affirmative acts on the part of the State, via regulation and investigation, are meant to enforce compliance. Chi Guotai, Yang Zhongyuan, Zhao Guzngjun, Li Gang, The Trends of Transparency, Laws and Regulations on Chinese Corporate Governance, Dalian University of Technology (China), School of Management. In other emerging markets, however, compliance with corporate governance principles is merely voluntary.
Disclosure is one aspect of corporate governance in China that may deviate from the Control Model. It could be categorized as voluntary, despite extensive disclosure obligations imposed by both the Corporate Law and the CSRC. For instance, some commentators note that the level of information disclosed by listed companies is far behind that of most international public companies. See Guotai, Zhongyuan, Guzngjun & Gang, “The Trends of Transparency, Laws and Regulations on Chinese Corporate Governance,” supra. Much of the disclosure requirements are discretionary, and companies vigorously exercise their discretion not to release important information. When companies do disclose, some complain that the information is untimely, the necessary information is incomplete, and the public lacks easy points of access to this information. Interestingly, in China, disclosure is done through appointed print newspapers. A typical trick is to publish the disclosure in a provincial, instead of the nationally appointed, newspaper to bury the disclosure.
One commentator illustrates the differences between the CSRC and the functional equivalent in the United States; the Securities and Exchange Commission (“SEC”). Where the SEC is primarily occupied with the enforcement of disclosure rules, the CSRC affirmatively enforces merit requirements in a public company to ensure investment quality. Clarke, Donald C., Corporate Governance in China: An Overview (July 15, 2003). However, the CSRC, unlike the SEC, is engaged in only limited disciplinary actions to enforce compliance with the codes it promulgates.
A continuation of the BRIC Project’s China series is forthcoming, and discusses regulatory structures in China. Specifically, the next post will be a discussion of the Board of Directors and the second tier of management of Chinese corporations; the Board of Supervisors. The next post also examines what “independent director” means in China and the associated difficulties of corporate governance reform from the perspective of the boardroom.
]]>A more detailed description of board membership can be found in The White Paper on Corporate Governance, published by the Tokyo Stock Exchange.
Companies such as Toyota lack any directors who meet the requirements of the NYSE. As the auto company reported in its most recent report filed on Form 20-F:
As the TSE statistics suggest, the Toyota board structure is not unusual. Insular boards are the practice. Yet the current set of scandals surrounding Toyota indicate the need to revisit this board structure.
The slow acceptance of independent directors may have a cultural explanation. After all, the purpose of independent directors is to provide a sometimes discordant voice in the board room, an approach inconsistent with a culture that places considerable weight on communal values and consensus. The problem, of course, is that these values are not shared globally. Large Japanese companies need a board that meets global rather than exclusively Japanese needs.
]]>Through most of the post-war period, Japan relied for corporate governance primarily on the main bank system (for a bit of history on the securities markets in the post war period, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets). Boards consisted mostly of former employees, with the position largely ceremonial. Real control was exercised by main banks, both because of ownership control (indirectly through the keiretsu) and because it was a critical if not the critical source of financing. The system was also used by the government, particularly the doyens in the Ministry of Finance, to guide industrial policy. This is discussed at greater length in J. Robert Brown, Jr., Industrial Policy and the Dangers of Emulating Japan, 27 GW J. Int'l L. & Econ. 1 (1993).
Government influence has wained and so has the main bank system. In the aftermath of the bubble economy of the 1980s, Japanese banks have begun to unwind their holdings in corporate clients. Moreover, large companies are no longer dependent upon main banks for their financing, at least for those companies capable of tapping bond markets and international markets. As a result, corporate governance in Japan has been in transition.
Consistent with the global trend, Japan has increasingly turned to independent directors as the solution. In 2009, the TSE adopted Rule 436-2 which required listed companies to have at least one independent director. The definition of independent mostly screened for material financial and employment relationships with the company (or its affiliates), not for relationships with management or controlling shareholders. See Guidelines, at III.5(3)-2. Independent directors were charged with acting in the best interests of shareholders.
How has the approach worked? We address that in the next post.
]]>
The Indian corporate sector witnessed numerous changes in law and regulations as a result of increased globalization efforts since the 1990’s. SEBI’s origination was one of the most important developments in India’s corporate governance initiatives. Moreover, corporate scandals during this liberalization period triggered a need for investigative practices and spreading awareness of ideal governance practices to compete in the global market. The MCA and SEBI, through subcommittees and regulations, had maximum impact on changing the corporate governance in Indian companies.
Ministry of Corporate Affairs:
The Ministry of Corporate Affairs (“MCA”) is the main authority responsible for regulating and promoting efficiency, transparency, and accountability in the Indian corporate sector. The MCA is specifically responsible for the administration of the Companies Act, 1956, and other allied legislation.
In addition, the MCA supervises three professional regulatory bodies, namely, Institute of Chartered Accountants of India (“ICAI”), Institute of Company Secretaries of India (“ICSI”) and the Institute of Cost and Works Accountants of India (“ICWAI”).
The Indian Companies Act, provided by the Central Government, is the key legislation for corporations in India. It has elaborate provisions, including those that deal with accountants and audits, director remuneration, financial and nonfinancial disclosures, corporate democracy, powers of inspection, and prevention of mismanagement among others. More specifically, through numerous committees, the central government has power to take independent actions, which can include inspection of a company’s book accounts, directing special audits, investigating company affairs and prosecuting for violating provisions of the Companies Act. The inspections are designed to ensure compliance with provisions under the Act, to identify practices that are detrimental to public interest, and to detect mismanagement that adversely affects interests of shareholders, creditors, and employees. Overall, the Act provides important basic guidelines for operating corporate entities with a single, comprehensive, and centrally administered framework. The basic objectives for the Companies Act, 1956 can be found here.
In 2009, the Ministry submitted the Companies Bill 2009 to parliament. It emphasizes increased shareholder democracy with less intervention by governing bodies. Further, the proposed regulation encourages self-regulation with adequate disclosures and accountability. At the same time, the new legislation imposes less control over internal procedures.
While the MCA is the primary governing body responsible for administering the Companies Act of 1956, the Securities & Exchange Board of India (“SEBI”) functions as the securities market regulator.
Securities and Exchange Board of India:
The central government of India set up regulatory control over the stock markets through SEBI in 1992. Although SEBI was originally established in 1988 as an advisory body, the SEBI Act of 1992 (the “Act”) granted it authority to regulate the entire securities market. Through the adoption of the Act, parliament established SEBI as an independent statutory authority but still required it to submit annual reports to the legislature.
The stated purpose of SEBI as an agency is to “protect the interests of investors in securities and to promote the development of, and to regulate, the securities market.”
The extent of SEBI’s authority is unclear. This agency’s principal tasks according to Chapter IV of the SEBI Act include “regulating the business in stock exchanges and other securities markets… prohibiting fraudulent and unfair trade practices relating to securities markets…prohibiting insider trading in securities…regulating substantial acquisition of shares and take-over of companies…” In carrying out these tasks, however, SEBI frequently amended the Act and expanded its powers with respect to inspection, investigation, and enforcement. The remaining powers and functions of the board are available here.
One of SEBI’s significant powers is its rule-making authority. It has made several significant amendments to the Listing Agreement, which greatly increases responsibility of publically listed companies. In the article, Corporate Governance Convergence: Lessons from the Indian Experience, Afra Afsharipour argues that it is unclear whether SEBI was explicitly granted the authority to impose such corporate governance rules in the Listing Agreement. The article adds that SEBI justifies such actions by considering the scope of its authority under Section 11A to “specify, by regulations, …matters relating to issue of capital, transfer of securities and other matters incidental thereto… and the manner in which such matters shall be disclosed by the companies.” The extent of SEBI’s power is unclear to such an extent that it has constantly been in tension with the MCA, the major regulatory body.
Power conflicts between the MCA and SEBI began with SEBI’s formation in 1992. A major reason for this tension is that many regulatory responsibilities stemming from legislation are carried out simultaneously by multiple agencies. This results in separate charges being filed by different agencies. Moreover, SEBI is looked upon as an agency that continuously expands its powers under the Act.
The Companies Act, 1956 prescribes that MCA is responsible for regulating all registered companies. Similarly, the Act imposes responsibility for listed companies on SEBI. This results in overlapping jurisdiction and often, regulatory gaps. Therefore, there is a need to bring about coordination in the role and action of various regulatory agencies to enable effective regulation and protection for investors.
Listing Agreement:
India has two national stock exchanges, the Bombay Stock Exchange and the National Stock Exchange. Companies that wish to be listed on either must comply with the requirements of the respective exchanges’ Listing Agreement. These stock exchanges are self-regulating organizations that are registered with and regulated by SEBI. SEBI Act of 1992 grants SEBI the authority to regulate the stock exchanges, including power to inspect them.
A Listing Agreement lays out rules and procedures to which companies must comply if they wish to remain listed on an Indian stock exchange. Actions prescribed on the Listing Agreement include payment of listing fees and numerous governance standards that companies must adopt. Specifically, the Listing Agreement on the exchanges require disclosures of financial statements, adherence to requirements concerning independent directors, and compliance with any additional rule that SEBI or another governmental agency may put forth.
Listing departments monitor compliance with provisions outlined in the Listing Agreement. They have the authority to impose disciplinary measures for erring companies, up to and including delisting.
Overall, primary reforms in India’s corporate governance have been introduced through amendments to the Listing Agreement. A prime example is the creation of Clause 49. This regulation set up basic governance practices for listed companies in India. It evolved to strengthen board practices by requiring a minimum number of independent directors to sit on boards, formation of audit committees and shareholder grievance committees, among other things. A large portion of companies, including large public-sector corporations, have failed to comply with the existing requirements. However, such companies have not been penalized for noncompliance and continue to be exonerated by SEBI. A post by Umakanth V. on the Indian Corporate Law Blog reports that more than 1,000 companies failed to file corporate governance reports in 2008, thus indicating a need for strengthened enforcement measures ensuring compliance.
Historically, mandatory guidelines governed listed corporations in India. While many public companies have been successful in turning their knowledge of corporate governance practices into company norms, there are still numerous entities that are not in compliance. The Satyam scandal highlighted the failure of current corporate governance norms and the need for a new approach in regulation. As a response, the Ministry of Corporate Affairs submitted a draft of voluntary guidelines to parliament for consideration. These guidelines would be enforced under a “comply or explain” basis where companies would be expected to comply with regulatory provisions or issue an explanation to shareholders detailing reasons for noncompliance.
]]>It is important to frame the importance of the discussion by recognizing the following:
• China’s GDP, year over year, grew by 11.4% in 2007
• China’s economy is the second largest in world measured in purchasing power parity
• 9 automobiles to every 1,000 Chinese’s, vs. 1,000 automobiles to every 1,000 U.S. citizens
• The Shanghai and Shenzhen exchanges together are the 8th largest in the world
• There are over 70 million investor accounts in China, representing 300 million Chinese citizens
• 70% of the listed companies in China do not meet international corporate governance standards
• Within the next decade, China’s share of the global market should equal the U.S.’s share
• Within the next three decades, China will likely be the largest market in the world
While China copes with the stress of rapid growth and corporate governance reform, it is making concerted, substantial efforts to establish standards that bring health to its capital markets. Lingering in the background, however, is the fundamental problem of China’s pervasive State ownership and control of private and public corporations. Instituting meaningful, incentive based reform in China, therefore, is important to fill the regulatory gap as the State withdraws and investors move in as dominant shareholders of Chinese companies.
Over the following weeks and months, the blog will post a four-part series analyzing the bourgeoning corporate governance régimes in China. Part I will address the regulatory structures currently in place in China, and the nature of the corporate forms they authorize. Part II will address the issue of executive compensation in China, and analyze its approach to controlling abuse. Part III will address the nature of shareholder rights in China, and recent reforms. Finally, Part IV will summarize current literature’s perceived strengths and weaknesses of corporate governance in China.
]]>That nearly 20% of the market capitalization of Brazil’s largest stock exchange is now comprised of corporations that voluntarily comply with strict standards of corporate governance that increase dispersed ownership and shareholders’ rights is impressive. Also, corporations listed on the Novo Mercado’s strictest tier have been shown to receive higher prices for their securities. Id. at 453. Such data exists as encouraging evidence that even when compliance is voluntary, the pursuit of meaningful transparency, dispersed ownership, and shareholders’ rights allows firms to more easily attain financing, to become more competitive, and ultimately to create increased value to investors. This is exactly the ideal upon which the Novo Mercado’s creation was based.
However, further analysis of the Novo Mercado, its more lenient tiers, and Bovespa’s traditional market listings has suggested that it may be too soon to conclude that the Novo Mercado is actually changing patterns of corporate governance or ownership in Brazil. Id. at 448. Gorga’s empirical research showed that a mere 15.2% of companies listed on the Novo Mercado came from the traditional market, and that the vast majority of such firms were “new entrants,” with approximately 85% having been closely held corporations that went public and listed directly onto the Novo Mercado. Id. Furthermore, the vast majority of publicly listed firms that actually migrated from the traditional market to the Novo Mercado, migrated to the scheme’s most lenient tier, Level 1. Id. These statistics highlight the rarity and reluctance of Brazil’s larger and traditional firms that existed before the creation of the Novo Mercado, to evolve, to reform their practices, and to embrace more progressive standards of corporate governance.
Therefore, given that Bovespa’s traditional, laissez-faire, market listings account for approximately 40% of the market capitalization of the stock exchange, and the most lenient Level 1 tier of the Novo Mercado comprises 38% of market capitalization, some 78% corporations listed on the exchange operate according to weak, or non-existent, standards of corporate governance. Among Level 1 and Level 2 firms, controlling shareholders account for an average of 63.14% and 64.79% of the ownership of their firms respectively, suggesting that outside the strictest Novo Mercado tier, concentrated ownership by Brazil’s political and financial elite remains a serious issue. Id. at 447-8.
Ultimately, nearly one-fifth of the market capitalization of Brazil’s largest stock exchange is now comprised of corporations that are attempting to conduct business according to more modern standards of corporate governance. This is an important first step, both for Brazil and for South America. This is a particularly noteworthy shift in a nation that just ten years ago existed as a jurisdiction without a discernable approach to corporate governance.
However, despite the definite benefits that the creation and climb of the Novo Mercado have yielded, compliance with meaningful standards of corporate governance remains overwhelmingly voluntary in Brazil. While the Novo Mercado’s voluntary soft-model of regulation is certainly preferable to no regulation at all, Brazil and Bovespa face real challenges to expanding the reach and sharpening the teeth of meaningful corporate governance in Brazil. It is important to remember that while Bovespa is Brazil’s largest stock exchange, it is not a government agency. Therefore, Bovespa’s Novo Mercado scheme does not apply to Brazilian corporations that fail to list and its enforcement capabilities are limited to deciding on which tiers it will allow certain corporations to list.
Bovespa’s three-tiered Novo Mercado scheme of listing rules undoubtedly represents an important first step for corporate governance in Brazil. However, this is likely a first step on the very long path to Brazil’s emergence as a jurisdiction with progressive, comprehensive, and enforceable standards of corporate governance.
The Novo Mercado (New Market) is the strictest tier of the São Paulo Stock Exchange’s (BOVESPA) three-tiered scheme of corporate governance listing requirements. (See, Novo Mercado Listing Rules) Compliance with the Novo Mercado is entirely voluntary, as is compliance with lower tiers, Level 1 and Level 2. According to Bovespa’s website, compliance with the Novo Mercado is premised on the idea that “stock valuation and liquidity are positively impacted and assured by shareholders’ rights and by the quality of companies’ information.” As of March 2010, 107 companies were listed on the Novo Mercado. (See, list). Companies that wish to list on the Novo Mercado must fully comply with all the requirements of Bovespa’s Corporate Governance Level 1 and Level 2.The Novo Mercado is distinguished from the two more lenient tiers by two paramount listing requirements. First, companies’ capital stock must be entirely comprised of common, voting shares. (§3.1(vi)). In other words, all shares which make-up a company’s capital stock must conform with a one-share-one-vote rule. Preferred and founding shares, which receive special voting privileges, are forbidden on the Novo Mercado. (§3.1(vii)). Secondly, regarding any disposal of control via the sale of capital stock holdings, any “public tender offer must comply with the law and with these Listing Rules and the other shareholders must be given the same treatment as the Selling Controlling Shareholder.” (§8.1). While all three tiers of Bovespa’s corporate governance listing requirements encourage dispersed ownership, transparency, and broader access to investors, the Novo Mercado is the only tier that requires the one-share-one-vote rule which best enables dispersed ownership. Gorga, Érica, 29 Nw. J. Int'l L. & Bus. 439, 446 (2009), Changing the Paradigm of Stock Ownership From Concentrated Towards Dispersed Ownership? Evidence From Brazil and Consequences for Emerging Countries.
These strict listing standards are comparable to many of the standards enforced by the American Securities and Exchange Commission. However, it is important to remember that compliance with these stricter listing standards is completely voluntary, and thus far applies only to public companies that both decide to list with Bovespa and agree to conduct business in accordance with the aforementioned principles.
In the following post, we will present a broader assessment of the impact that the Novo Mercado has had in Brazil and the challenges that the advance of modern and meaningful standards of corporate governance continues to face in Brazil.
]]>As noted on Bovespa’s corporate governance website, the Brazilian Institute of Corporate Governance (IBGC) defines “corporate governance” as the “system by which companies are directed and monitored, concerning Shareholders, the Board, Directors, Independent Audit and Fiscal Council.” The website also notes that “[g]ood practices of corporate governance aim to increase the value of the company, facilitate its access to capital and contribute to its sustainability,” and that “the adherence to Bovespa’s ‘Special Corporate Governance Levels’ better advertises the efforts of the company to improve the relation with its investors and increases the potential for appreciation in asset value.”
We will now outline the prominent aspects of the most lenient tier, Level 1, and the middle tier, Level 2.
Corporate Governance Level 1 (Nível 1):
Bovespa’s Corporate Governance Level 1 listing requirements represent the most lenient set of listing requirements among the three-tiered scheme of the Novo Mercado. (See NÍVEL 1 Listing Rules). Bovespa’s cited goal for Level 1 companies is “to improve methods of disclosure to the market and to disperse their shares among the largest number of shareholders possible.” Currently there are 35 companies listed on Level 1. (See list). Bovespa’s Level 1 requires compliance with the following principal practices:
Lastly, it is also important to note that companies must disclose information regarding related-party contracts valued in excess of R$200,000 (≈US$112,000) that are entered into between the company and its controlled companies and associated companies, senior managers and the controlling shareholder, and between the company and controlled companies and associated companies of its senior managers and controlling shareholder. (§3.1(vi); §4.6).
Corporate Governance Level 2 (NÍVEL 2):
Level 2 represents the middle ground between the relatively lax listing requirements of Level 1 and the strictest level of corporate governance listing requirements of the Novo Mercado. (See, Level 2 Listing Rules) According to the Bovespa website for Level 2, “[t]o be classified as a Level 2 company, in addition to the obligations of Level 1, the company and its controlling shareholders must adopt and observe a much broader range of corporate governance practices and minority shareholder rights.” Currently, there are 19 companies on Level 2. (See, list) The website outlines the prominent aspects of the Level 2 listing requirements:
a. “Independent Member” is a member of the Board of Directors who: (i) has no ties to the Company except for owning an equity share of its capital stock; (ii) is not a Controlling Shareholder, the Controlling Shareholder’s spouse or a relative to the second degree, is not or has not been linked in the last 3 (three) years to a company or entity with ties to the Controlling Shareholder (this restriction does not apply to people linked to governmental institutions of education and research); (iii) has not been a Senior Manager of the Company or employed by or worked for the Company, the Controlling Shareholder or any other company controlled by the Company; (iv) is not a direct or indirect supplier or purchaser of the Company’s services or products or both, to a degree that results in loss of independency; (v) is not an employee or manager of a company or entity that supplies services or products or both to, or buys these from, the Company; (vi) is not a spouse or a relative to the second degree of any Senior Manager of the Company; (vii) does not receive any compensation from the Company except for that related to its activities as member of the Board of Directors (this restriction does not apply to cash from equity interests in the capital stock). (§2.1).
In the next post, we will introduce readers to Bovespa’s strictest tier of corporate governance listing rules, the Novo Mercado.
]]>Brazil is Latin America’s largest economy, and the eighth largest economy in the world according to the World Bank. With an estimated 198,739,269 citizens, Brazil also comprises South America’s largest populace. The Economist reported that the Brazilian middle class rapidly expanded from 42% of the population in 2004, to 52% in 2008, coinciding with a halving of extreme poverty in Brazil during roughly the same period.
Generally, the BRIC economies have bounced back faster than many more developed economies from the recent global financial crisis (Goldman Sachs). Brazil’s economy has experienced unprecedented growth since the early 2000s and is poised to continue its impressive expansion. As the Economist reported in Latin America’s big success story, Brazil’s growth is bound to pick up even more speed as it continues to develop oil fields, Asian countries’ demand for Brazilian food products increase, and further exploitation of the nation’s vast natural resources. The report further notes that projections show Brazil will grow to become the world’s fifth largest economy, overtaking such countries as Britain and France, in the next ten to fifteen years. Brazil’s plans to host both the 2014 FIFA World Cup and the 2016 Summer Olympics in Rio de Janeiro represent token symbols of the nation’s rise as a global economic and cultural influence.
The Challenges to Effective Corporate Governance in Brazil:
Traditionally, the primary challenge to effective corporate governance in Brazil has been concentrated ownership. Anderson, Jr., John William, 9 Law & Bus. Rev. Am. 201, 205 (2003), Corporate Governance in Brazil: Recent Improvements and New Challenges. (available via Hein Online). Most major corporations in Brazil are under state control or controlled by Brazil’s elite families. Id. A related problem, the balance of preferred and common shares, has also presented challenges. Until recent reforms of Brazilian corporate law, enacted by Law No. 10,303/01 in October 2001, preferred shares, without voting rights, could represent up to 67% of the total equity capital of a given corporation. Id. at 208-9. This led to an investing environment in which the vast majority of shareholders of many companies had absolutely no ability to influence management. However, newly forming corporations may issue no more than 50% of their total shares without voting rights. Id. at 209.
Brazil’s courts offer additional challenges to the effective regulation of corporations and their corporate governance practices. According to a Standard and Poor’s report, Brazil’s courts are viewed as unpredictable and ineffective, particularly when dealing with shareholder rights cases. Additionally, Brazilian courts and legal institutions are seen as lacking the sophistication and manpower to effectively confront issues pertaining to shareholders’ claims and controversies. Gorga, Érica, 27 U. Pa. J. Int'l Econ. L. 803, 827 (2006), Culture and Corporate Law Reform: A Case Study of Brazil. (available via Hein Online). Notably, there are no class-action mechanisms available to shareholders in Brazil. Id.
Brazilian laws regarding corporations and governance issues face similar challenges. Gorga briefly summarized this challenge for Brazil:
"Scholars have recently argued that law enforcement is a better predictor of equity and credit markets development than the law on the books itself. Nevertheless, in spite of the principal role played by enforcement, it is worthwhile to remark that, especially for civil law countries, the question of how to create good law on the books is pivotal. In most cases, it is impossible for a civil law country to enforce something that is not a legal rule on the books. Consequently, in civil law countries [such as Brazil], the proper enforcement of laws requires the passing of proper legislation." Id. at 806.
Gorga further noted that passing proper legislation is extremely difficult in Brazil. Id. at 809. Despite the reforms of Brazilian Corporate Law enacted in 2001, Brazil’s elite class of controlling shareholders were able to “capture” the legislative process, pressuring legislators and the Brazilian President to drop amendments aimed at increasing minority shareholder's rights. Id. The exemption of the then “existing” publicly held companies from the reduction of the issuance limit of non-voting preferred shares from 67% to 50% – mentioned above – is one poignant example. Id.
Brazil’s Regulatory Infrastructure:
Brazil’s rise to the status of economic powerhouse, and the increasingly globalized nature of the world economy, demand a discussion of the regulatory landscapes of this and other emerging markets.
In Brazil, the Brazilian Securities Market Commission (Commisão de Valores Mobiliários, or “CVM”), regulates publicly listed companies in Brazil. The CVM lays out the rules for corporate governance in a series of best practice principals known as the "Cartilha." The Cartilha principles outline standards for disclosure, transparency, and shareholders’ rights vaguely similar to some regulations required in the United States and Europe. However, formal compliance with the Cartilha is not mandatory in Brazil. Furthermore, the CVM has a very limited staff that some describe as “not yet sophisticated enough” and “lacking specialized prosecutors to bring complex securities cases.” Gorga, at 827. Understandably, when considering the ineffectiveness of the Brazilian courts and the voluntary nature of the Cartilha principles, the CVM has not emerged as a prominent component of Brazil’s regulatory landscape.
The Novo Mercado:
The BM&F BOVESPA (Bolsa de Valores, Mercadorias & Futuros de São Paulo), is Brazil’s largest, and the world’s third largest, stock exchange. Gorga, Érica, 29 Nw. J. Int'l L. & Bus. 439, 446 (2009), Changing the Paradigm of Stock Ownership From Concentrated Towards Dispersed Ownership? Evidence From Brazil and Consequences for Emerging Countries. In December of 2000, Bovespa initiated a three-tiered scheme of listing rules known as Level 1, Level 2, and Novo Mercado (New Market). The scheme is broadly known as the Novo Mercado, the strictest of the three tiers. Ironically, compliance with the scheme is also voluntary. As cited on Bovespa’s corporate governance website, compliance with the scheme is premised on the idea that “stock valuation and liquidity are positively impacted and assured by shareholder’s rights and by the quality of companies´ information.”
As of year-end 2003, only two companies listed with the Novo Mercado and three companies listed on Level 2. Gorga, at 452. While thirty-one companies listed on Level 1, Gorga did not consider this significant as Level 1’s listing rules were not significantly different from the lax Brazilian regulations and listing rules for the traditional Bovespa. Id. Despite this slow start, the three-tiered listing scheme has experienced an unprecedented period of success over the last six years, having expanded to a total of 161 listed companies as of February 2010: 107 on Novo Mercado, 19 on Level 2, and 35 on Level 1.
The next several posts will outline the standards of corporate governance required by Level 1, Level 2 and the Novo Mercado.
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In the same report, Goldman outlined four “Conditions for Growth”: macro-economic stability supported by price stability via fiscal deficit reduction, institutions, openness to trade and foreign direct investment, and education. The report further notes that “[t]hese core policies are linked: institutional capacity is required to implement stable macroeconomic policies, macro stability is crucial to trade, and without price stability a country rarely has much success in liberalizing and expanding trade.”
For the purposes of this blog, what Goldman describes as “Institutions” are of primary concern (Report, p. 13):
"Institutions. Institutions affect the ‘efficiency’ of an economy much in the same way as technology does: more efficient institutions allow an economy to produce the same output with fewer inputs: Bad institutions lower incentives to invest, to work and to save. ‘Institutions’ in this broad sense include the legal system, functioning markets, health and education systems, financial institutions and the government bureaucracy. Recent research argues that poor political and economic policies are only symptoms of longer-run institutional factors—a line of reasoning that could help explain the disappointing results of developing countries‘ adoption of macroeconomic policy reforms in the 1990s."
More specifically, the legal system, functioning markets, and government bureaucracy are of importance to this blog and the focus of this mini-series on the prevailing elements of each BRIC nation’s regulatory environment.
Corporate governance reform will also be necessary. In 2008, Standard and Poor’s reported that “corporate governance remains one of the most important factors constraining the BRICs' attractiveness to foreign capital providers and, in particular, potential long-term shareholders.” Addressing this problem, the report notes that:
Accordingly, over the course of this series, this blog will present the most significant elements of the four BRIC nation’s regulatory schemes and the attempts of each nation to confront the challenges presented by concentrated ownership and the lack of transparency and accountability that often plague corporate governance in emerging economies.
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