The Role of The Role of StakeholdersStakeholders In In Corporate GovernanceCorporate Governance

Dr. Demir YenerDr. Demir YenerCenter for International Private EnterpriseCenter for International Private Enterprise

Washington, D.C.Washington, D.C.

Fourth Meeting of the Fourth Meeting of the EurEurasian Corporate Governance Roundtableasian Corporate Governance Roundtable‘‘The Responsibilities of Boards of Directors’The Responsibilities of Boards of Directors’October 29-30, 2003, Bishkek, KyrgyzstanOctober 29-30, 2003, Bishkek, Kyrgyzstan

Purpose of the PresentationPurpose of the Presentation

To discuss: To discuss:

Objectives of the firmObjectives of the firm: Wealth : Wealth

MaximizationMaximization

Responsibilities of the boardResponsibilities of the board

The role of The role of stakeholdersstakeholders in in

corporate governancecorporate governance

Stakeholders and ShareholdersStakeholders and Shareholders

Primary StakeholdersPrimary Stakeholders ShareholdersShareholders Boards of Directors/Managing BoardsBoards of Directors/Managing Boards Executive ManagementExecutive Management

Other StakeholdersOther Stakeholders ManagersManagers EmployeesEmployees CustomersCustomers Community at LargeCommunity at Large SuppliersSuppliers Financial Financial Institutions: CreditorsInstitutions: Creditors Environment in generalEnvironment in general

Enabling EnvironmentEnabling Environment

• International Auditing & Accounting Standards (IAS&ISA)International Auditing & Accounting Standards (IAS&ISA)• Securities Markets Legal and Regulatory Frameworks (IOSCO)Securities Markets Legal and Regulatory Frameworks (IOSCO)• Financial Sector Participants : investors, issuers, intermediaries Financial Sector Participants : investors, issuers, intermediaries (interaction between participants)(interaction between participants)

• FiFinancial Market Infrastructure and Architecturenancial Market Infrastructure and Architecture• Product and Factor CompetitivenessProduct and Factor Competitiveness• Foreign Direct InvestmentsForeign Direct Investments• Corporate Control (Corporate Governance: OECD Principles)Corporate Control (Corporate Governance: OECD Principles)• Enabling, prudentially regulated business environment, with creative incentive structureEnabling, prudentially regulated business environment, with creative incentive structure

Enabling EnvironmentEnabling Environment

• International Auditing & Accounting Standards (IAS&ISA)International Auditing & Accounting Standards (IAS&ISA)• Securities Markets Legal and Regulatory Frameworks (IOSCO)Securities Markets Legal and Regulatory Frameworks (IOSCO)• Financial Sector Participants : investors, issuers, intermediaries Financial Sector Participants : investors, issuers, intermediaries (interaction between participants)(interaction between participants)

• FiFinancial Market Infrastructure and Architecturenancial Market Infrastructure and Architecture• Product and Factor CompetitivenessProduct and Factor Competitiveness• Foreign Direct InvestmentsForeign Direct Investments• Corporate Control (Corporate Governance: OECD Principles)Corporate Control (Corporate Governance: OECD Principles)• Enabling, prudentially regulated business environment, with creative incentive structureEnabling, prudentially regulated business environment, with creative incentive structure

Factors of Sound Factors of Sound Corporate GovernanceCorporate Governance

• Shareholders rights protectionShareholders rights protection• Rights and responsibilities of Board Rights and responsibilities of Board

of Directors and Shareholdersof Directors and Shareholders• Quality of DisclosureQuality of Disclosure• MonitoringMonitoring• Effectiveness of the core Effectiveness of the core

management functionsmanagement functions

Factors of Sound Factors of Sound Corporate GovernanceCorporate Governance

• Shareholders rights protectionShareholders rights protection• Rights and responsibilities of Board Rights and responsibilities of Board

of Directors and Shareholdersof Directors and Shareholders• Quality of DisclosureQuality of Disclosure• MonitoringMonitoring• Effectiveness of the core Effectiveness of the core

management functionsmanagement functions

Principal FactorsPrincipal Factors

• StakeholdersStakeholders• Takeovers/acquisitionsTakeovers/acquisitions• Bankruptcy frameworksBankruptcy frameworks• Collateral and Foreclosure rulesCollateral and Foreclosure rules• Enterprise RestructuringEnterprise Restructuring• Investor and CreditorsInvestor and Creditors• Agents: ManagementAgents: Management

Principal FactorsPrincipal Factors

• StakeholdersStakeholders• Takeovers/acquisitionsTakeovers/acquisitions• Bankruptcy frameworksBankruptcy frameworks• Collateral and Foreclosure rulesCollateral and Foreclosure rules• Enterprise RestructuringEnterprise Restructuring• Investor and CreditorsInvestor and Creditors• Agents: ManagementAgents: Management

External ElementsExternal Elements of Corporate Governanceof Corporate Governance

External ElementsExternal Elements of Corporate Governanceof Corporate Governance

Internal ElementsInternal Elements of Corporate Governanceof Corporate Governance

Internal ElementsInternal Elements of Corporate Governanceof Corporate Governance

Benefits of Corporate GovernanceBenefits of Corporate Governance

Good corporate governance has a Good corporate governance has a positive effect on:positive effect on: Share valuationShare valuation Risk assessmentRisk assessment Reduction of market volatilityReduction of market volatility

Good Corporate governance can:Good Corporate governance can: Reduce the cost of capitalReduce the cost of capital Increase the pool of investorsIncrease the pool of investors Improve management accountability and Improve management accountability and

performanceperformance

Efficient OwnershipEfficient Ownership

Sufficient Sufficient concentrationconcentration ofof

controlcontrol in a firm by owners to in a firm by owners to

be able to be able to monitormonitor and and

influenceinfluence management management

effectively.effectively.

The Goal of the FirmThe Goal of the Firm

To To maximizemaximize the the wealthwealth of of

its shareholders.its shareholders.

How To Determine Whether Corporate How To Determine Whether Corporate Governance Is Effective?Governance Is Effective?

Two testsTwo tests Is the corporation maximizing Is the corporation maximizing

shareholder value?shareholder value? Is the net present value of the corporation’s Is the net present value of the corporation’s

cash flows positive and is it being used or cash flows positive and is it being used or directed for the benefit of shareholders directed for the benefit of shareholders based upon their pro rata ownership based upon their pro rata ownership interests?interests?

If the corporation’s chief executive If the corporation’s chief executive officer is not performing well, does the officer is not performing well, does the board of directors have the power to board of directors have the power to remove him?remove him?

Responsibility of the BoardResponsibility of the Board

In pursuit of the wealth maximization In pursuit of the wealth maximization objective, boards must recognize the objective, boards must recognize the interests of all stakeholders.interests of all stakeholders.

No company ever survived that No company ever survived that ignored the interests of its:ignored the interests of its: CustomersCustomers EmployeesEmployees SuppliersSuppliers

Four Values of Four Values of Good Corporate GovernanceGood Corporate Governance

TransparencyTransparency

AccountabilityAccountability

ResponsibilityResponsibility

FairnessFairness

LinkagesLinkages

The four pillars of corporate The four pillars of corporate governance and the wealth governance and the wealth maximization concept serve as the maximization concept serve as the ‘aspirational benchmarks’‘aspirational benchmarks’

Investor Behavior Investor Behavior Investor behavior is characterized by the Investor behavior is characterized by the

‘fear and greed’ factors‘fear and greed’ factors Corporate governance is not an end in Corporate governance is not an end in

itself.itself. CG is about improving firm performance CG is about improving firm performance

and assuring access to capital at a and assuring access to capital at a reasonable cost.reasonable cost.

The end game of CG is achieving the most The end game of CG is achieving the most efficient allocation of the scarce resources efficient allocation of the scarce resources the firm has available within its economic the firm has available within its economic environment, and gaining access to the environment, and gaining access to the capital needed for growth and developmentcapital needed for growth and development

CG and Firm PerformanceCG and Firm Performance

The linkages between good CG and The linkages between good CG and firm performance is clearfirm performance is clear

Good CG will inspire investor Good CG will inspire investor confidenceconfidence

Good CG will assure investors of a Good CG will assure investors of a reasonable rate of return on their reasonable rate of return on their investmentinvestment

Good CG will generate operational Good CG will generate operational efficiency and increase the efficiency and increase the competitiveness of the firmcompetitiveness of the firm

Price DiscoveryPrice Discovery

Good CG will contribute to the Good CG will contribute to the further efficiency of the price further efficiency of the price discovery mechanism in determining discovery mechanism in determining the value of the firm.the value of the firm.

This serves the purpose of wealth This serves the purpose of wealth maximization conceptmaximization concept

Improved CG will help resolve the Improved CG will help resolve the problem of risk and help lower the problem of risk and help lower the cost of capital. Thus leading to an cost of capital. Thus leading to an increase in the value of the firm.increase in the value of the firm.

Stick and CarrotStick and Carrot

Effective CG will serve as the carrot if Effective CG will serve as the carrot if private sector is convinced that it private sector is convinced that it will gain from good governance. IN will gain from good governance. IN this case, reform will happen.this case, reform will happen.

IF private sector is not convinced, IF private sector is not convinced, reform will be resisted.reform will be resisted.

This is the dilemma.This is the dilemma. The main player in the maximization The main player in the maximization

of wealth through good governance of wealth through good governance is the board.is the board.

Responsibilities of the Board Responsibilities of the Board and Performance and Performance

Independent oversightIndependent oversight ContestabilityContestability Labor relationsLabor relations Corporate strategyCorporate strategy Corporate social responsibilitiesCorporate social responsibilities Respecting stakeholdersRespecting stakeholders Excellent performing managersExcellent performing managers Attracting low cost capitalAttracting low cost capital Increasing market capitalizationIncreasing market capitalization

Conclusion Conclusion The BoardThe Board has an important role to play has an important role to play

in development and progressin development and progress of the firm of the firm on behalf of its investors.on behalf of its investors.

Maximizing the shareholder valueMaximizing the shareholder value is the is the long term objective of the firm.long term objective of the firm.

StakeholdersStakeholders play an important role in play an important role in CGCG

A board, respectful of the legitimate A board, respectful of the legitimate expectations of all the stakeholdersexpectations of all the stakeholders should benefit all parties in the long run.should benefit all parties in the long run.