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CONFIDENTIAL

Capital Markets Governance

of Corporates: How Can
Capital Markets Exert Better
Governance on Corporates

Bob Felton, McKinsey & Company, Inc.

5th Annual Financial Markets and Development Conference
April 14-16, 2003

This report is solely for the use of client personnel. No part of it may be
circulated, quoted, or reproduced for distribution outside the client
organization without prior written approval from McKinsey & Company.
This material was used by McKinsey & Company during an oral
presentation; it is not a complete record of the discussion.
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OVERALL, GOVERNANCE REFORM IS KEY TO IMPROVED

ECONOMIC CONDITIONS IN EMERGING ECONOMIES

1. Emerging economies suffer major penalties due to

weak governance and other market factors

2. Important barriers inhibit movement to improved

governance

3. A combination of strong legal/regulatory reform and

“free market” supervision appropriate path forward

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EMERGING ECONOMIES SUFFER MAJOR PENALTY DUE

TO WEAK GOVERNANCE AND OTHER MARKET FACTORS

1. Quality of governance important factor in investment

decisions

2. Investor say they are willing to pay a premium for

good board governance

3. This survey information is supported by financial

analysis

4. This lack of robust capital markets leads to weak and

unstable corporate financial structures

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GOVERNANCE REMAINS IMPORTANT COMPARED TO Less important

FINANCIALS, PARTICULARLY IN EMERGING MARKETS Equally important

More important
Percentage of investors

2002 2000

Eastern Europe/Africa 15 45 40

Latin America 16 66 18 20 32 48

Asia 18 61 21 33 44 23

North America 43 50 7 36 39 25

Western Europe 44 41 15 25 39 36

How important is corporate governance* relative to

financial issues, e.g., profit performance and growth
potential, in evaluating which companies you will invest in?
*Defined as effective boards of directors; broad disclosure, and strong rights and equal treatment for
shareholders
Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 4
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CORPORATE GOVERNANCE IS NOW AN

ESTABLISHED INVESTMENT CRITERION

“Our investment group would never

How does corporate
approve an investment in a company
governance affect your with bad governance”
investment decision?
– U.S. investment manager,
$20 billion private equity fund
Percentage of investors selecting this option;
multiple responses possible

“‘Good governance’ is a qualitative

Avoidance of certain
companies 63 cut-off criteria”
– Analyst, $62 billion
European Asset Manager
Decrease/increase holdings
in certain companies 57

Avoidance of certain
countries
31
“I simply would not buy a company
with poor corporate governance”
Decrease/increase holdings – CFO, $ 3 billion
28
in certain countries European Private Bank

Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 5

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A SIGNIFICANT MAJORITY OF INVESTORS SAY THEY ARE

WILLING TO PAY A PREMIUM FOR A WELL-GOVERNED COMPANY
Percentage of investors

2002 2000

Western Europe 78 22 81 19

Asia 78 22 89 11

North America 76 24 81 19

Latin America 76 24 83 17

Eastern Europe/Africa 73 27

Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 6

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THE AVERAGE PREMIUM INVESTORS WOULD

BE WILLING TO PAY DIFFERS BY COUNTRY . . .
Average percent

30

28 Venezuela
Columbia Indonesia
26
Thailand
Malaysia
24 Korea
Brazil
Mexico Italy
22
Argentina Germany
Chile Taiwan
20 France
Japan
Spain
U.S.
18 Switzerland
U.K.

0
Latin America Asia Continental Europe Anglo-Saxon

Source: McKinsey investor opinion survey 7

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KOREA’S EQUITY MARKET SIGNIFICANTLY

UNDERDEVELOPED AND UNDERPERFORMING
Underdeveloped

Equity market capitalization comparison*

June 2001
245

Significantly
undersized
Market 138 equity
cap per 120 market
106
GDP (%) compared to
72 65 leading
42 economies
.

ag k
y

a
K.

ce
S

an

er a r

re
pa
U.
U.

e
an

av hm

Ko
m

Ja
Fr

er

nc
G

Be

Source: Bloomberg; EIU; McKinsey analysis 8

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COMPOSITION OF PRIVATE SECTOR LIABILITIES, 1997

Percent In 2000, Korea
improved to
In 2000, U.S. 55% bank
changed to 50% loans, 25%
equity, 35% bonds, bonds, and
and 15% bank loan 20% equity

5 1 2 5 5
8 7
16 8
16 18 16

Equity 50 42
51
51 29

87
Bonds 25 76 77 77

55 56
44 48
Bank
loans 25

U.S. Hong Kong Taiwan Malaysia Singapore Indonesia China Korea Thailand

Source: Bank for International Settlements; International Monetary Fund; International finance Corporation (IFC);
International Federation of Stock Exchanges (FIBV); World Bank 9
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TOTAL RETURN TO SHAREHOLDERS: S&P 500 VS. KOSPI

Poor performance over time
1991-2001, percent

S&P500 : 13.0%
per annum
return 1991-2001
600
• $100 invested in the
500 S&P500 index would
be worth $340
400
• However, $100
invested in the KOSPI
300 KOSPI : -3.8%
index would only be
per annum
worth $68
200 return
• Korean shareholders
100 have been seriously
unrewarded for their
investments
0
'91 ‘96 11/2001

Source: Datastream; McKinsey analysis 10

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MARKET-TO-BOOK COMPARISON
June 2001, ratio*

3.48

2.48 2.38 2.25

2.05 2.05

0.96

U.S. France Japan Germany U.K. Bench- Korea

mark
average

*Sum of 2001 market cap (January-June) divided by sum of book value (2000)
Source: Bloomberg; McKinsey analysis 11
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PE RATIO COMPARISON
July-Dec 2001, ratio*

28
26
24 24
22
19
Korea’s PE
ratio is
significantly
lower than that
9
of other
countries

Japan Germany U.S. France U.K. Bench- Korea

mark
average

*Sum of market cap divided by sum of forecasted earnings

**Companies whose market cap combines to account for 80% of total country market cap; excludes outliers
(companies whose PE ratios were 3 standard deviations away from country average)
Source: Bloomberg; McKinsey analysis; I/D/E/C 12
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INDUSTRY PE COMPARISON* Benchmark

June 2001, PE ratio Korea

34

29 29 29 28
25 25 24
20 20 20 19
16 16

9 8 8 7 7 7 6 5 5 5 5
2

king
ents

e
Biot s &
mat sic

e
Equ &

Serv ial
ions

cal s
il

on
rgy

i ce
ip

ech
l

ranc
er ag
er i a

Reta
n

ati
l
mpo

inan

ti c a
Ene

el / b

mi

pon

Ban
at

Insu
Bev

port
unic

Che
ceu
/ st e
l Co

ed F

Com

s
d&
omm

Tran
r ma
Iron
trica

r s i fi

o&
Foo

Pha
c

Dive
E l ec
Tele

Aut

*Only compared for those industries in which Korean companies operate

Source: Bloomberg; McKinsey analysis 13
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MARKET VOLATILITY* OF KEY INDICES

OVER THE PAST 5 YEARS (1997-2001)
Highly volatile
Percent
57

41
38
35
29 29 28 The KOSPI and
KOSDAQ have
21 been most
volatile, when
compared to their
peers in South
East Asia and the
United States

KOS- KOSPI Kuala NAS- Hang Singa- Taiwan S&P

DAQ** Lumpur DAQ Seng*** pore 500
Straits
Times
*The relative rate at which the price of a security/index moves up and down, found by calculating the annualized
standard deviation of day-over-day differences in daily price charge
**KOSDAQ 50 was developed on Jan. 4, 1999; thus only the last 3 years have been provided for this index
***Hang Seng Composite Index was developed on Jan. 3, 2000; thus only the last 2 years have been provided
for this index
Source: Bloomberg 14
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ENTREPRENEURS ACCESS TO CAPITAL

Ranking, 2001

Rank Country Score Rank Country Score

1 United States 5.72 16 Spain 4.90

2 United Kingdom 5.63 17 Japan 4.85
3 Luxembourg 5.59 18 France 4.81
4 Hong Kong 5.58 19 Belgium 4.79
5 Netherlands 5.49 20 Denmark 4.78
6 Switzerland 5.46 21 Austria 4.77
7 Singapore 5.36 22 Israel 4.74
8 Canada 5.25 23 Portugal 4.74
9 New Zealand 5.14 24 Chile 4.72
10 Ireland 5.10 25 South Korea 4.64
11 Germany 5.09 26 Malaysia 4.63
12 Australia 5.08 27 Norway 4.62
13 Finland 5.04 28 Iceland 4.56
14 Sweden 5.02 28 Thailand 4.56
15 Taiwan 5.00 30 Italy 4.54

Source: Milken Institute 15

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TOTAL STOCK VALUE CONTROLLED BY INSTITUTIONAL INVESTORS

2001, percent

51

37
Presence of
29
institutional
investors is a sign
of an advanced
13 equity market

Korea France Germany U.S.

Source: KSE; GAI; National Accounts; NYSE 16

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WHILE THESE FINANCIAL PENALTIES RESULT FROM MANY

FACTORS, WEAK GOVERNANCE IS A MAJOR CONCERN

1. Complicated ownership structures with heavy cross-

ownership

2. Weak minority shareholder rights

3. Conflicted boards of directors

4. Weak and intransparent financial reports and limited

reporting to international standards

5. Impediments to takeover activity

6. Weak investor relations practices

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PYRAMIDAL EQUITY OWNERSHIP

Samsung group

Samsung Samsung
Samsung Electronics Corp
Life Ins Cheil
Comm.
Samsung
Mech. Elec Samsung Samsung
S-one SDI Foundations
Samsung Samsung
Heavy Ind. Card
Samsung
Samsung Hotel Security
Everland Samsung
Shilla Prec.Chem
Samsung
F&M Ins
Samsung
Techwin
Cheil Samsung Samsung
Textile Engineering Capital

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A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND

“FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD

1. Important legal projections necessary

– Clean up ownership structure, probably by establishing legal
framework for holding company
– Strengthen minority shareholder rights
– Remove barriers to hostile takeovers, including foreign
investors
– Regulate third-party transactions
– Hold management and directors accountable for
illegal/inappropriate activities

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A COMBINATION OF STRONG LEGAL/REGULATORY

REFORM AND “FREE MARKET” SUPERVISION
APPROPRIATE PATH FORWARD (CONTINUED)

2. Improve regulatory activities

– Require majority of directors to be independent,
especially on audit committee
– Mandate that financial reporting complies with
international standards; demand transparency and
periodic reporting
– Install consistent, aggressive, and effective regulatory
enforcement

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A COMBINATION OF STRONG LEGAL/REGULATORY

REFORM AND “FREE MARKET” SUPERVISION
APPROPRIATE PATH FORWARD (CONTINUED)

3. Encourage companies to improve investor relations for all

shareholders*
– More transparency
– More open about risks/challenges
– Encourage Q&A
– More CEO-led discussions
– Give investors advance notification about meeting dates
– If listed globally, make announcements after markets open
– Install information-rich Web sites

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A COMBINATION OF STRONG LEGAL/REGULATORY

REFORM AND “FREE MARKET” SUPERVISION
APPROPRIATE PATH FORWARD (CONTINUED)

4. Work to improve quality of director pool

– Director pool often weak in emerging markets
– Important to establish training/recruiting
programs to develop adequate supply of strong
directors
– Consider non-executive certification program

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HOWEVER, GOVERNMENTS SHOULD RESIST

TEMPTATION TO MICROMANAGE PRIVATE SECTOR

1. Establish limited, focused legal/regulatory framework . . .

and enforce aggressively

2. Ensure transparency of financials and independence of

boards

3. And let free market provide disciple and “regulation”

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