GOVERNANCE AND CORPORATE CONTROL AROUND THE WORLD

A Narrative Report
Presented to
The Faculty of Graduate School
University of Batangas
Batangas City

PhDBM 708: Corporate Finance

In partial fulfillment of the requirements for the degree of

Doctor of Philosophy in Business Management

Submitted to:

Dr. Napoleon P. Hernandez

by:

Daisy D. Maghirang, RPm, Lpt

October 2019

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 GOVERNANCE AND CORPORATE CONTROL AROUND THE WORLD

I. INTRODUCTION:

Understanding the driving forces and consequences of the various types of

corporate control are core inquiries of corporate finance. While most theory
distinguishes between widely-held corporations with dispersed ownership and
controlled firms where a dominant shareholder or family exert, corporate structures
are complex Pyramids that allow shareholders to influence corporate decisions in
excess of their cash-flow rights and cross-holdings of equity in business groups are
pervasive. At the same time, ownership and control are often hidden behind holding
companies incorporated in financial off-shore centers. Moreover, a binary distinction
between controlled and widely-held firms may be coarse, as in many widely-held
corporations’ families or institutional investors hold equity blocks. Following the
influential contribution of La Porta, Lopez-de-Silanes, and Shleifer, a voluminous
literature has studied the patterns of ownership concentration and control across
countries or in a single country over time. These literatures have searched for the
correlates of corporate control, placing an emphasis on investor protection rights and
legal origin, though other institutional, political, and cultural features may be relevant.
However, there are many open issues. First, stands measurement. It is inherently
hard to identify ultimate controlling shareholders from the complex network of equity
holdings. Previous works have either focused on a relatively small number of firms
and countries or used large-firm samples from a single economy. Another concern
regards the main data patterns that can shed light on the factors explaining
corporate structure. While many studies connect corporate control with a country’s
legal origin, this association has been questioned. And there is still uncertainty on
the interconnections between corporate structure and countries’ institutional

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 environment, investor protection, court efficiency, red tape, and labor regulation.
Even setting aside the key issue of causality, isolating the role of these institutional
features is challenging.
In this report, contribution on comprehensive description of corporate control
for the widest-possible sample of countries is provided. Analysis reveals large
differences in corporate control around the world, across and within continents.
Corporate structure patterns are persistent and the 2007 − 2009 global financial
crisis did not alter it much. Re-examine the “reduced-form” link between legal origin
and corporate control (and ownership concentration). There are economically large
differences in corporate control across legal families. The share of controlled firms is
the highest in French civil-law countries, followed by German and then Scandinavian
civil law countries. The share of controlled firms is the lowest in common law
countries. Legal origin correlates strongly with state-control and family-control, the
two dominant categories of controlled corporations. The patterns are similar when
looked at ownership concentration. Corporate control and ownership concentration
are not much related to entry barriers. Political theories of corporate finance; in
particular support Roe’s argument that corporate control got reinforced during the
Great Depression and World War II with welfare-state policies that aimed to protect
(unionized) labor.

II. CONTENT:

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 Factors to be considered

Ownership – is the state, act, or right of owning something, i.e. possessing

something. The term may also refer to an organization or group of owners. It is the
exclusive and ultimate legal right to a lawful claim or title. If you have of something it
means that you are the owner; it belongs to you. The term does not only refer to
people, but also to other entities. For example the government is the owner of a
state company. Also, a holding company owns its subsidiary businesses.

Control - involves the processes and procedures that regulate, guide, and protect
an organization. It is one of the four primary managerial functions, along with
planning, organizing, and leading.

Governance - is the system of rules, practices, and processes by which a firm is

directed and controlled. Corporate governance essentially involves balancing the
interests of a company's many stakeholders, such as shareholders, senior
management executives, customers, suppliers, financiers, the government, and the
community.

Questions to be answered

1. What are the differences between market-based financial system and bank-
based financial system in the world?
2. Do these differences matter?
These questions are intended to illicit the best practices of different countries in
order to find something which is suitable to the Philippine situation. The presentation
used the US, UK, European countries, Japan and other Asian countries as
examples.

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 How do corporations raise cash?

Financial Markets - A financial market is a broad term describing any marketplace

where trading of securities including equities, bonds, currencies, and derivatives
occur. Some financial markets are small with little activity, while some financial
markets like the New York Stock Exchange (NYSE) trade trillions of dollars of
securities daily. A sample economy that utilizes the financial market is the Anglo-
Saxon economies which refer to an economic model of capitalism which enforces
low taxes and government regulations. It promotes reduced government involving
providing public services and a greater freedom for private property and business
rights such as the US, UK and other Western Countries around the world.

Financial Institutions - A financial institution (FI) is a company engaged in the

business of dealing with financial and monetary transactions such as deposits,
loans, investments, and currency exchange. Financial institutions encompass a
broad range of business operations within the financial services sector including
banks, trust companies, insurance companies, brokerage firms, and investment
dealers. Commonly, this source is being utilized by the Eastern countries of the
world such as the Germany and Japan.

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 Value of Financial Claims

US not only have a large amount of bank loans outstanding, but there is also
a large stock market and a large corporate bond market. Thus the United States is
said to have a market-based financial system. Stock market value is also high in the
UK and Asia, but bank loans are much more important than the bond market, but the
the stock market is relatively small. Most countries in Europe, including Germany,
France, Italy and Spain, have bank-based financial systems.

Household Portfolio

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 Household portfolio is divided into 4 categories bank, insurance and funds,
equity and other. Summing the columns of each country and region, the amount of
financial assets is 275 (US), 288% UK, 185% Europe and 286% Japan. This does
not mean that European investors are poor, just that they hold less wealth in the
form financial assets. Financial assets (value derived from a contractual claim or
ownership i.e. cash, stocks, bonds, mutual funds)

Financial Institutions Portfolio Allocation

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 This shows the financial assets held by financial institutions including banks,
mutual funds, insurance companies, pension funds, and other intermediaries. These
investments are smaller in US relative to GDP, than in other countries (as expected
in the US market-based system). Financial institutions in UK, Europe and Japan
have invested large sums in loans and in deposits and currency. Holding of equity
are the highest in the UK. These holdings are mainly owned by insurance
companies and pensions funds.

Non-financial Corporations’ Portfolio Allocations

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 Most striking feature is the large amount of equity held by firms in Europe.
The amount of equity held by in Japan and the UK is also large. In United States it is
relatively small. These holdings of shares but other non-financial corporations have
important implications for corporate ownership and governance. Another interesting
aspect is the large amount of intercompany loans and trade credit in Japan. Many
Japanese firms rely heavily on trade-credit financing, that is, on accounts payable to
other firms. Trade credit is buying goods or services without immediate payment of
cash.

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 What is Investor Protection?
“Investors should not lose money if their investments fail”

Investor protection is the biggest factor considered as to why financial

markets are important in some countries, while others rely less on the market and
more on banks and other financial institutions. Stock and bond markets thrive where
investors in these markets are protected reasonably well. Thus investors property
rights are much better protected in some parts of the world than others. Investors
should be protected since it is understood that they invest in the business expecting
returns.

What affects Investor Protection?

• Investor protection is affected by the origin of legal systems in place.

• The English (UK) legal system is based on common- law tradition; while the
French and German systems evolved using civil law.

A common- law is usually unwritten and usually observed by virtue of tradition.

On the other hand, civil law is written and is usually made, altered, repealed and
enacted by a legislative body.

With the advent of western imperialism led by England, France and Germany,
these systems have spread around the world by conquest and imitation.

Ownership, Control and Governance

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 Ownership and Control in Japan

• The most notable feature of the Japanese corporate financial system is the
Keiretsu.
• Keiretsu is a network of companies organized around a major bank.
• Japan is said to have a main bank system with long- standing banks and
firms.
Keiretsu

The bank and other financial institutions at the keiretsu’s center own shares in most
of the groups companies.

Essential features of the Keiretsu

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 • Banks and other financial institutions owns most of the shares in the group of
companies.
• Most debt financing comes from the keiretsu’s main bank or from affiliated
institutions.
• Power is divided among the main bank, the group’s largest companies, and the
group as a whole.

Perceived advantages of the Keiretsu

1. Firms have access to additional “internal” financing. “Internal” means within the
group of the keiretsu.
2. When the Keiretsu firm or operating agency falls into financial distress, new
management from the group may be brought in and financing will be obtained.
For example, when an operating company’s capital budget exceeds the
operating cash flow, it can turn to the main bank or other companies in the
keiretsu for financing. This then avoids the bad representation of a possible
public sale of securities which would be detrimental to the operating company.
Take note…for the Japanese, image is everything! Honor!

Ownership and Control in Germany

• Traditionally, banks in Germany played a significant role in corporate

governance. Banks role in corporate governance includes providing loans, owning
large amounts of equity directly, and the proxy voting of shares on behalf of
customers.

Daimler- Benz AG

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 This pattern of ownership is somewhat similar to the U.S. ownership pattern, where
many large companies are widely held.

• However, a drastic change in the German tax system dramatically changed

the ownership structure.
• The change in the tax system exempted capital gains on shares held for more
than one year from corporate taxation.

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 • Banks are now more primarily invested in using board representation to promote
lending and investment banking activities.

Ownership and control in other countries

• La Porta, Lopez- de- Silanes and Shleifer in their article “Corporate ownership
around the world”, they surveyed 27 developed economies and found relatively
few firms with actively traded shares dispersed ownership.
• Instead, firms are typically controlled by wealthy families or the state.

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 Family ownership and control

• Family ownership and control, which is common in Europe and Asia, does not
generally mean direct majority stake in the public firm.
• Control is usually exercised by either of three methods:
– Cross- holdings
– Pyramid
– Dual class equity

Cross- holdings

• Taking Japan’s keiretsu as an example, the banks and financial institutions at

the center own shares in most of the groups companies.
• Take for example Sumitomo Corporation. In 2009, it held 10% of Sumitomo
Metal Industries, which in turn holds 2% of the shares of the former.
• Because of the cross- holdings, the number of shares available for purchase
by outside investors is much lower than the total number outstanding.

Pyramid

• Pyramids are common in Asian as well as in several European countries.

• In this type of set-up, control is exercised through a sequence of controlling
positions in several layers of companies.

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 Wallenberg Family Control

This figure shows the control exercised by the Wallenberg family over ABB, one of
Sweden’s biggest corporations.

Dual- Class Equity

• This method of control applies when shares are classified according to the
voting rights allocated to it.
• For example, a firm’s Class A shares have 10 votes while a Class B share
only has 1 vote.
• Usually, these values are calculated from differences in prices between
ordinary shares and shares with extra votes.

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 Transparency and Governance

Transparency in Market- based corporations

• If the firm is transparent to outside investors- if the investors can see its true
profitability and prospects- then problems will show up right away in a falling
stock price, which would prompt security analysts, bond rating agencies and
investors to scrutinize.
• With transparency, corporate troubles generally lead to corrective action.
Market-based corporations should be transparent in order for it to be
scrutinized by outside agencies to avoid insolvency or bankruptcy.
•
Transparency in bank- based corporations

• Transparency in not so dangerous a problem with bank- based system since

firms have long- standing relationships with banks, which can monitor it
closely and urge staunch losses or to cancel excessively risky strategies.
Banks are logically expected to conduct their own examinations before
investing or releasing money to operating agencies.

Governance

• Take note that complete protection of investors against potential threats is

impossible. In fact complete protection is unwise and inefficient even if it were
feasible.
• In terms of governance, managers must be given discretion to act in response
to unanticipated problems and opportunities. Once given discretion,
managers will consider their self- interest as well as investors’ interests.

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 • Agency problems are inevitable. The best thing for a financial system can do
is to protect investors reasonably well and try to keep managers’ and
investors’ interests congruent.

Do these differences matter?

YES!!! “A GOOD FINANCIAL SYSTEM APPEARS TO ACCELERATE ECONOMIC

GROWTH”
• Widely available credit information reduces the cost of lending and increases
the availability of credit.
• It also means that no one lender has monopoly of information, which
increases competition among suppliers of credit and reduces the cost to
borrowers

In contrast, good credit information is not readily available in most developing

countries, and lenders to small businesses are both few and expensive…like in the
Philippines.

LEARNINGS AND INSIGHTS:

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 Agriculture is one of the underrated profession in the Philippines. It seems
that many people think there’s no money in agriculture. Agricultural education
attracts fewer students than other fields of study, probably due to perceptions of
agriculture as a less prestigious and profitable profession. Not knowing that through
proper education, training and willingness, there’s unlimited opportunities that awaits
them.

Investment in agriculture not only reaps benefit directly, but more importantly,
it helps improve the lives of millions of Filipino farmers and their families nationwide.
It should be noted that agriculture industry does not stop at the farm. Very much part
of the agricultural system are the agricultural processing enterprises, the packaging
industry, the agricultural input manufacturers and importers, trade, storage and
transportation sectors.

In Agribusiness, accounting for its financial transaction is not that complicated

compared to other business. Since farmers don’t like paperwork’s, it is suggested
that one book is maintained for their financial records. Understanding that nature of
transactions in agribusiness gives the farmers a better idea on how the business
should be run and managed. Farm record keeping is an activity most farmers try to
avoid. They say it is time-consuming and that they do not have the time for it but
since the objective is to be a prominent farmer with productive farms, record keeping
is something that is very essential to business and they cannot avoid.

Having a good record keeping system gives a better farm planning and
forecasting. Farming is a business and good farm records keeping helps the farmer
to plan and do a realistic forecasting. Records keeping provides valuable information
on the methods that work and why others did not. Through proper financial record
keeping, financial reports or what we call financial statements are being formed.
These are Balance Sheet, Income Statement, Statement of Cash Flow and
Statement of Owner’s Equity. Balance Sheet shows the financial standpoint of the
business. Income Statement show how the business is performing. Statement of
Cash Flow shows the cash inflow and outflow of the business categorized in three
activities such as operating, financing and investing. Statement of Owner’s Equity
shows the changes in the capital of the business either in the form of additional
investment or withdrawal.

When it comes to decision making, decision makers are required to make

several process decisions which help to increase the overall profitability of the
business. They have many tools which help them take decision but the most
important of all are the financial statements which give a good understanding of the
company’s financial position. To make sound business decisions, even the most
basic types of financial statements and the ability to interpret the numbers behind

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 them are immensely essential. Overall, understanding the Financial Statement of the
business allow to make strategic decisions that support growth and long-term
profitability.

SOURCE:

Brealey, R., Myers, S., & Allen, F. (2011). Principles of Corporate Finance. 10 th
Edition. McGraw-Hill Companies, Inc.

https://www.investopedia.com/terms/f/financialinstitution.asp

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