Corporate Governance

State’s Role In
Corporate Governance In
South East Europe
Thomas Wels, Partner
September 21, 2001
Overview

• Importance of corporate
governance in SEE

• Barriers to improved governance

• State attempts to improve

governance

• A pan-regional response?

• Options for the State

Importance of quality of board practices when
evaluating investments
%
“In evaluating companies for potential investment in the following regions,
how important is the quality of board practices relative to financial issues?”

More 25 33
48

Same 39
44
32

Less 36
23 20

Europe Asia Latin America

Source:McKinsey Investor Opinion Survey 1999/2000
Average premium investors would be willing to pay for
a well-governed company
Average %

30 Over 80% of
investors willing
28 Venezuela to pay a premium
Indonesia
26 Columbia Thailand
Malaysia
Greece
24
Brazil Korea Italy
22 Mexico Germany
Argentina Taiwan
20 Chile France
Japan
Spain
18 Switzerland US
UK
0
16
Latin America Asia Continental Europe Anglo-Saxon

Source:McKinsey Investor Opinion Survey 1999/2000

Overview

• Importance of corporate
governance in SEE

• Barriers to improved governance

• State attempts to improve

governance

• A pan-regional response?

• Options for the State

The market model governance chain*
Shareholder Independence
environment Non- and performance
Dispersed executive
ownership majority
boards

Sophisticated
institutional Aligned incentives
investment
Institutional OECD Corporate
Principles
context context
Active private
High
equity market
disclosure
(incl. IPOs)

Active
Shareholder
takeover
equality
Capital market market Transparency and
liquidity accountability

*Examples can be found in Australia, Canada, U.K. and U.S.

Source: McKinsey
The control model governance chain*
Shareholder Independence
environment and performance
Concentrated ‘Insider
ownership boards’

Reliance on Incentives
family, bank and aligned with
State finance core shareholders
Institutional OECD Corporate
Principles
context context
Under-developed
Limited
new issue
disclosure
market

Limited Inadequate
takeover minority
Capital market market protection Transparency and
liquidity accountability

*Examples can be found in Asia, Latin America and many Continental and South Eastern European countries
Source: McKinsey
 Importance of institutional factors when selecting
emerging market countries in which to invest
Average response
Highly
Irrelevant Relevant Relevant
1 2 3 4 5

Enforceability of legal rights (e.g. contracts) 4.5

Quality of economic management 4.3
Independence of judiciary/quality of legal system 4.0
Level of corruption 3.9
Predictability and level of taxation system 3.9
Quality of accounting standards 3.8
Effectiveness of regulatory system 3.8
Administrative efficiency of government 3.5
Effectiveness of banking sector 3.3
Scale and liquidity of local investment market 3.3

Source: McKinsey Emerging Market Investor Opinion Survey 2001

 Importance of corporate level factors when selecting
emerging market companies in which to invest
Average response
Highly
Irrelevant Relevant Relevant
1 2 3 4 5

Distinctions between company and family interests 4.5

Clearly defined governance arrangements 4.4
Accuracy of financial reporting 4.4
Legally enforceable minority shareholder protection 4.3
Use of performance-related pay for top management 4.3
Timeliness of financial reporting 3.9
Coverage of financial reporting 3.9
Presence of independent (non-executive) directors 3.8
Establishment of conflicts of interests committee 3.3

Source: McKinsey Emerging Market Investor Opinion Survey 2001

Overview

• Importance of corporate
governance in SEE

• Barriers to improved governance

• State attempts to improve

governance

• A pan-regional response?

• Options for the State

A radical reduction in State involvement – COUNTRY EXAMPLE

a crisis response

Financial reform . . .
• Banking sector reform
• Public, agricultural, and social security spending
Economic crisis reform
• Large currency • Plan to remove barriers to foreign investment
devaluation • Government asset management company to be
• High unemployment established Will buyers for
state-owned
• Falling stock market
enterprises be
capitalizations
. . . coupled with significant corporate reform found?
• Increased non-
• Privatization of Turkish Telecom, TUPRAS (oil
performing bank debt
refinery), POAS (petrol distribution), TEKEL
• Falling corporate (tobacco/alcohol), and SEKER (sugar)
profitability • Preparations being made to facilitate further
private investment in gas, electricity generation,
and distribution rights, Petkim (petrochemicals),
Turkish Airlines, and ERDEMIR (steel)

Source:Turkish Treasury; IMF; clippings

 Decreasing State ownership in corporate COUNTRY EXAMPLE

sector . . .

Objectives
• Attract local and foreign investors
• Boost entrepreneurship Challenge
• Encourage mergers and strategic alliances Lack of interest
Expected results from international
• Over 3 billion investors. For ex:
Euros revenues • Prolonged
• Market negotiations for
Measures consolidation selling of Olympic
• Undertake large scale privatization plan, incl. 12 • Boost market Airways and
major banks and companies in 2002 (e.g., OTE, confidence in Hellenic
PPC, Agricultural Bank, Postal Savings Bank) Stock Exchange Shipyards
• Introduce tax incentives to encourage more • Motor Oil’s
companies to merge disappointing IPO
• Introduce new legal and fiscal environment to
encourage more venture capital

Source:Clippings; McKinsey analysis

 . . . and radically reduced State influence in COMPANY EXAMPLE

specific companies
% owned by state
Other measures planned
100 • Revoke trade union right to
appoint board director
• Management to be appointed by
shareholders for 5-year tenures**
• Stock options introduced – to be
External influences on open to all employees over time
telecomms sector
51
• Deregulation
42
• Competition from new
market entrants 33

Prior to June September Planned

*Legislation passed enables changes
**Previously, State-appointed 1996 2001 2001 in future*
Source: Clippings
 Investors react favorably to improved corporate
governance COMPANY EXAMPLE

High/low points
Spread of response

Institutional changes Governance changes Premiums for well-

• Liberalisation of foreign • Strengthening of governed companies
Percent
ownership of equities and shareholder rights
36
bonds • Installment of
34
• Elimination of cross transparency and
guarantees accountability measures 32
30
• Liberalisation of the M&A • Increased legal activity by
market shareholders 28

• Corporate and banking • Accumulation of 26

restructuring governance knowledge 24

and practice 22
Before After
• More independent boards changes changes
(1998) (1999)

Source: McKinsey analysis, McKinsey Investor Opinion Surveys 1999/2000

Overview

• Importance of corporate
governance in SEE

• Barriers to improved governance

• State’s attempts to improve

governance

• A pan-regional response?

• Options for the State

Most capital markets – and companies listed – WIP

in South East Europe are small…

Total market cap – Number of companies Average company
end 2000 listed (main and parallel market capitalization
Millions USD markets) – end 2000 Millions USD

Athens 102,032 342 298

Istanbul 69,508 315 221

Sofia 574 503* 1

Bucharest 366 115 3

Skopje 7 141 >1**

London 2,612,230 2,374 1,100

* 25 listed on the official market and 478 on the free market

** Estimates
Source:FiBV.com; EIU; ASE; BSE; FEAS; EBRD
…although in relative terms, ASE is quite successful

Selected examples
Value of S.E. as a percentage of GDP – end 2000

Athens 93

Istanbul 34

Sofia 2

Bucharest 5

Skopje <1 *

London 185

*Estimates
Source:FiBV.com; EIU; ASE; BSE; FEAS; EBRD
 Yet, core shareholders dominate Greece’s largest
publicly-listed companies
Shareholder structure of top 15 companies ranked by market capitalization, end 2000
Domestic shareholders > 5%
InterAmerican Foreign shareholders > 5%
Shareholders < 5%
Panafon
ETVA
DOL
HBC
Viohalko Domestic shareholder’s
average holding ~33%
Intracom
EFG
CBG
OTE
Foreign shareholder’s
Titan average holding ~13%
Alpha
NBG
Bank of Cyprus
Piraeus
Source:ASE; McKinsey analysis
Two recent initiatives in South East Mediterranean

Negotiating: Discussing
• Open respective increased
markets to investors in cooperation:
Turkey and Greece via • Create common
cross-membership of index comprising
companies on both shares of all three
markets
• Common technical stock exchanges
application to follow • JV is planned
stocks on both within 2001
markets

Source:Clippings
A more radical solution – a combined pan-regional
exchange?
Percent of total, USD millions, number of companies
Equivalent to Brussels Equivalent Toronto
Stock Exchange Stock Exchange
Skopje >1 172,485 1,416
Bucharest >1
Bulgaria >1
10
8
Istanbul 40 • While combined number of
companies is high, aggregate
36 market capitalization is still
relatively small

• Without more dynamic pooled

22 equity markets, difficult for
Athens 59 privatisation programs to access
(foreign) equity financing option
24

Market Number of
capitalization companies
Source:FiBV.com; EIU; ASE; BSE; FEAS; EBRD
Requirements for pan-regional South East ILLUSTRATIVE

Europe exchange

Requirements Models

• Common trading platforms • Euronext

• Coming listing/tracking • Euronext

standards

• Common corporate • SEC-regulated

governance standards exchanges/OECD Principles

• Effective market • SEC-regulated exchanges

makers/traders

• Complementary, if not • U.S. SEC/U.K. FSA

common, securities regulations
legislation
Overview

• Importance of corporate
governance in SEE

• Barriers to improved governance

• State attempts to improve

governance

• A pan-regional response?

• Options for the State

Moving from control model governance chain
Shareholder environment Independence
- Attract foreign equity and performance
capital Concentrated ‘Insider - Encourage more
- Reduce State ownership ownership boards’ independent
boards
- Facilitate stock-
Reliance on Incentives related
family, bank and aligned with compensation
State finance core shareholders
Institutional OECD Corporate
Principles
context context
Under-developed
Limited
new issue
disclosure
market

Limited Inadequate
Capital market liquidity takeover minority Transparency and
• Encourage equity- market protection accountability
based financing - Mandate international
• Remove barriers to accounting standards
takeovers - Create and enforce
shareholder rights
Source: McKinsey
Where the State can contribute to improve Corporate
Governance
Objective Examples

• Create an • Internationally
Adequate adequate accepted governance
regulatory Institutional and rules (e.g.,OECD,
frameworks Corporate SEC, IAS/US-GAAP)
Alternatives to framework to
state share- • Create broad
holdings – attract Direct distribution of stock in
Investment population
Liquidity of
exchanges – Indirect • Reduce State stakes
Investment to create market for
control

• Incentivise stock
exchange co-
operations to improve
liquidity
 250401LNZXC483TSMW-P1

For further information contact:

Thomas Wels: +30 (1) 3672 777
Mark Watson: +1 212 446 8021

McKinsey Investor Opinion Survey 1999/2000

can be downloaded from
www.mckinsey.com

Also, available on www.mckinseyquarterly.com,

“Corporate reform agenda in the developing
world", an article that includes findings from the
McKinsey Emerging Market Investor Opinion
Survey

25