In November 2000, ten of Russia’s notorious oligarchs gathered in a private Moscow conference room to do something rather out of character. They listened to investors’ complaints. The message they heard was straightforward: clean up the corruption and improve corporate governance standards, or continue being shut out by the foreign investment community.
That the Russians, each controlling vast chunks of the country’s corporate sector (and arguably a good deal of the government), would even grant an audience let alone listen to the criticism after years of running roughshod over investors, speaks volumes about their desire to attract more foreign funds. But it also demonstrates the influence of the OECD/World Bank Private Sector Advisory Group on Corporate Governance, which includes some leading institutional fund managers, as well as its famously outspoken chairman, Ira Millstein.
‘It was one of the most exciting meetings I’ve ever attended. Our investors told them flat out why they don’t invest in Russia and why they are looking aghast at the funny business going on there. I would say it was a vigorous meeting. There was a guy there who looked like he was going to tear Ira’s arms off,’ says Holly Gregory, a partner of Millstein’s at Weil Gotshal & Manges.
The success of the meeting is open to interpretation – major reforms have yet to emerge. But Gregory says some positive signs have appeared, at least at the regulatory level. ‘We’ve had some good feedback. We had the current and former heads of the Russian’s SEC there, and I think we’ve seen the Russian regulator’s backbone firm up a bit post-meeting. We can’t take full credit, but a message came through loud and clear.’
Common issues
The event may have been more emotionally charged than most, but it was one of many exchanges on corporate governance that take place each year at roundtables sponsored by the OECD and organized with local participants and the World Bank. The message differs slightly from place to place, but the goal is the same: to improve the legal, institutional and regulatory framework for corporate governance.
‘In the US, we have disclosure-based securities regulation, which is unusual,’ says Gregory. ‘Most countries don’t have that.
We have company law at the state level, we have good bankruptcy laws, good accounting standards – it’s an entire framework that comes together. In emerging markets, they’re coming from different stages of development and from different pasts.’
At the private sector level, the problems stem from the degree of autonomy of the managers running companies. That autonomy comes in two types, says Andrew Clearfield, managing director at TIAA-Cref. ‘The first is family capitalism, where the founders grow the company and suddenly need capital from outside. So they float shares but are not eager to reduce their own scope for independent activity; they don’t want to surrender power just because they issued shares. Then there are companies whose managers don’t have significant stakes. They really have no economic tie to the performance of the company other than their continued job tenure. This can be a thornier problem, especially since in most of these countries the idea that management would become significant shareholders has been discouraged.’
Communist fallout
Of all the countries that fall under the emerging label, none attracts as much criticism as Russia. In the early 1990s, the sheer size of its market and resources lured many foreign investors to bet on the rewards outweighing the risks. The reality has been sobering. Minority shareholders have been victimized by inefficient and corrupt managements, watching helplessly as assets were sold off in self-enriching backroom deals. As for seeking redress via the courts, the odds for success have been slim to hopeless.
Further west, the picture is a bit brighter, especially if you skip over the Ukraine and Romania. The central European countries – the Czech Republic, Hungary and Poland – have made significant strides toward reform as they strengthen their bids for EU membership. Both the private and government sectors have improved disclosure and accounting standards and addressed, to varying degrees, minority shareholders. Though even smaller, Estonia and Lithuania are also singled out for their strong commitments to minority shareholder rights.
‘Russia is realizing it has to be more accountable to minority shareholders. There is some movement, but we’re not yet in full swing. In central Europe, they’ve understood this a lot better,’ says Maryam Mansoury, head of global emerging markets at Skandia Asset Management. The key motivation for improvement has been foreign investment, which tends to encourage corporate governance reform. ‘Because over 45 percent of our shareholders are from the UK or the US, we have to pay attention to the issues brought up by minority shareholders. We make sure that we give an equal amount of information, and that we’re responsive to all investors, regardless of who they are,’ says Szabolcs Czenthe, head of investor relations for Hungarian oil and gas company MOL.
Most reforms have been limited to larger companies. Smaller ones lag far behind, and since most have zero foreign investment, reform seems remote. Companies like MOL, on the other hand, which have received financing through foreign investment and have shares listed on foreign exchanges, have raised their standards.
‘We follow many of the listing requirements for Nasdaq, where we have a listing,’ says Avi Hochman, CFO of Polish broadcasting group Netia. ‘We use international accounting standards and US Gaap for our quarterly results, and we are very sensitive to disclosure issues. Once a year, we invite all investors to the company for a site visit, and we make senior management available. We also travel to the US every few months. So we do go above and beyond the listing standards in Poland because of our Nasdaq listing.’
A family affair
Unlike in Eastern Europe, poor corporate governance in Latin America and Asia is an issue largely at family-dominated companies. But foreign investment has played a role for a much longer period in these regions than in some of the other emerging market countries, which is one reason the reforms have been more profound.
‘We went public 25 years ago. We were the first Indian company to tap the international markets, and we have GDRs listed in Luxembourg, on Nasdaq and in London,’ says Pankaj Nagrath, director of IR at Bombay-based Reliance Industries, India’s largest private sector enterprise.
While the Ambani family still holds a 40 percent stake, Nagrath says shares are widely held, and there are no differential voting rights. ‘We’re very open with regard to being more transparent and respecting minority shareholders. We’ve also been very open with targets – we were the first Indian company to announce return targets a few years ago. We were issuing quarterly reports before it was mandatory.’
Nagrath notes that it is mostly the top-tier international companies that are doing the most in terms of corporate governance, but he believes India is ahead of other emerging markets. ‘India has 125 years of experience with a stock exchange. So we’re far ahead of the curve, and it was easier for us to adapt because of that background than it may have been for Russia, China or, say, Poland.’
But it is Latin America, more than anywhere else, that analysts and investors say shows the greatest commitment to improving corporate governance standards. Companies in emerging markets like Chile and now Brazil have significantly cleaned up the environment for minority shareholders just as their governments have shown a willingness to improve regulation. Argentina and Mexico are also making strides in that direction.
‘Of all the regions, Latin America is the one that moves most closely in step when it comes to good governance practices,’ says Mike Lubrano, senior securities markets specialist at the International Finance Corporation and an organizer of the Latin American Corporate Governance Reform Roundtable (and the meeting between the Russian oligarchs and the Private Sector Advisory Group). ‘There are a number of reasons for this, from Nafta and regional integration, to the similarity of language and legal tradition, which has allowed them to be better organized. They also don’t have many sources of local finance, and because local pension funds are investors, the governments don’t want their constituents being ripped off.’
Besides having a lengthy history of exposure to foreign investment, Latin America also has more ADRs than any other continent, which raises the scrutiny of corporate governance practices and minority shareholder rights. ‘When we issued our ADR in 1997, we created an investor relations department so that we could respond to analysts and investors,’ says Ricardo Portugal Alves, director of investor relations at Brazilian utility giant Copel, which has received several awards for transparency from the Sao Paulo Stock Exchange. ‘We hold roadshows, invite investors to our plants, and put out detailed quarterly reports in English and Portuguese,’ he explains. ‘And all of this is on our web site.’
Alves stresses that Copel is not alone in its commitment to governance reform. He notes that the National Congress has just passed a strong bill to bolster the environment for minority shareholders, and it’s now with the Senate. And he points to the Bovespa, the Sao Paulo Stock Exchange, which is launching a new market with much higher standards for disclosure. ‘We’re evaluating joining this new market. This would not be difficult for us, because as an NYSE-listed company, we already follow all of the proposed guidelines,’ he says.
All for nothing
In nearly every instance, companies like MOL, Reliance and Copel represent the high end of the governance spectrum in their respective countries. Surprisingly, those involved with IR in emerging markets exhibit little concern for the inequalities. Nearly all of those polled – eight out of nine – said that so long as their companies demonstrated good corporate governance, they weren’t worried about the rest of their respective markets.
But according to TIAA-Cref’s Clearfield, all companies, regardless of their progress toward good governance, suffer if their domestic markets are perceived as lacking. ‘We would be investing considerably more if there was a better corporate governance picture,’ he says. ‘There’s no doubt of that. Corporate governance considerations weigh unconsciously in the judgment at all times. Even if a company has high standards of corporate governance, there is a problem that in many cases the legal environment doesn’t properly respect the property rights of shareholders.’
Exactly how companies and governments plan to address governance and minority shareholder rights is impossible to gauge. But Clearfield believes that so long as the globalization of capital flows continues, more and more investors not only see the rewards outweighing the risks, but the risks diminishing substantially.
‘Corporate governance reform will grow,’ Clearfield concludes optimistically. ‘As more companies get on the bandwagon, a couple of very influential business people get involved, then others will be compelled to follow suit. There are those who won’t, because they want to have an absolutely family controlled enterprise, or because they really have criminal intent on their minds. But most companies will want to reduce their cost of capital by getting involved with better corporate governance.’
High risks, low rewards
Romania has not been a success story. Foreign direct investment over the last decade amounts to a paltry $6.1 bn compared with roughly $20 bn for Hungary, a much smaller market. The dismal figures have not been helped by a poor environment for minority shareholders. In November 2000, the Romanian government offered a ray of hope when it issued rules increasing minority shareholder protection, but a little over a year later, the legislation was repealed. ‘The foreign and domestic majority investors were very much against it and they threatened the Romanian government that they’d leave Romania. But they never tried to discuss how the ordinance could be improved,’ says Gratiela Iordache, executive director of the Romanian Shareholders Association. The current government has promised new regulation, but minority shareholders remain skeptical, given that the country’s largest majority shareholder is writing the new draft. Without stronger laws, Iordache says the outlook is bleak. ‘In other countries such as Poland, the Czech Republic and Hungary, there are specific legal provisions concerning minority shareholder protection, and as a result their capital markets are much stronger than Romania’s, even though it is among the largest in the region.’
Stepping up
Hungarian oil giant MOL is one of the leaders when it comes to respecting minority shareholder rights. Apart from holding six or more roadshows each year and issuing quarterly results according to international accounting standards, it has addressed inequities in voting rights – shareholders can only represent 10 percent of a vote, regardless of how many shares they own – and holds open conference calls and meetings in which investors can speak directly to top management.
Perhaps even more impressive is the company’s commitment to retail investors, a highly unusual stance in Eastern Europe. ‘Our retail investors complained because foreign investors were able to have one-on-one meetings and make site visits, and they were not. So we established a small shareholders’ club. We advertised or got the news out everywhere – on the web, in Hungarian newspapers and on Reuters – and we invited everyone to a meeting with the chairman and CFO and held a Q&A for nearly three hours,’ says IR head Szabolcs Czenthe.
