The BRIC Project -- Brazil -- The Novo Mercado: A Giant Step For Corporate Governance, A Small Step For Brazil (Part 7)

As mentioned in previous posts, in December of 2000, the Sao Paolo Stock Exchange, Bovespa, initiated a three-tiered scheme of corporate governance 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.  Compliance with the scheme is voluntary.  Ten years after its creation, the existence of the Novo Mercado is undoubtedly significant in Brazil, both in terms of the rise of meaningful corporate governance and the benefits that such a trend has helped to bring to the nation’s once stagnant economy.  Currently, the strict Novo Mercado tier of corporate governance accounts for approximately 18.59% of the market capitalization of Bovespa. Gorga, Érica, 29 Nw. J. Int'l L. & Bus. 439, 452 (2009), Changing the Paradigm of Stock Ownership From Concentrated Towards Dispersed Ownership?  Evidence From Brazil and Consequences for Emerging Countries.  Among corporations listed on the Novo Mercado, the only tier that requires a strict one-share-one-vote rule, the controlling shareholder represents approximately 36.39% of total ownership of its corporation.  Id. at 448. 

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.