Paper No. 02
February 2006
Better corporate governance:
More value for everyone
Mehmet Can Atacik
and Michael Jarvis
Mehmet Can Atacik
and Michael Jarvis are
consultants at the World
Bank Institute.
The state of corporate governance can have an important effect on the availability and cost of capital
for all firms, and good corporate governance of financial firms is essential in fostering financial stability
and healthy economic growth. Good corporate governance frameworks help firms and countries
improve accountability, more efficiently use capital, and attract quality and long term investors at
lower costs. These, in turn, contribute to a country’s competitiveness and thereby its development.
Corporate governance failures in developed
that are in the interests of the company and its
countries, and their impact on not only the
shareholders.
shareholders but also other stakeholders have attracted widespread attention. Employees, banks,
Rationale for Good Corporate
consumers, governments, regulatory agencies
Governance?
and multilateral organizations area all paying
A good corporate governance regime is central
increasing attention to the accountability mech-
to the efficient use of capital. First, it promotes
anisms that are in place for the private sector.
market confidence; helps to attract additional
The state of corporate governance can have an
long-term capital, both domestic and foreign;
important impact on the availability and cost of
and fosters market discipline through appropri-
capital for firms and financial stability, a critical
ate disclosure and transparency. Second, good
ingredient to sustainable development.
corporate governance helps to ensure that cor-
Corporate governance constitutes a set of
porations take into account the interests of a
relationships among a company’s management,
wide range of constituencies, particularly when
its board, its shareholders, and other stakehold-
the board recognizes that corporate social re-
ers. Those relationships define, among other
sponsibility can mutually benefit the company
things, the property rights of shareholders, the
and its operating environment. Those actions,
mechanisms of exercising and protecting those
in turn, help to ensure that corporations operate
rights, and the path of ensuring a fair return.
for the benefit of society as a whole, and induce
Corporate governance also sets the structure
stable business development and growth, lower
through which a firm sets its objectives, as well as
risk, and sustainability.
determining the means of attaining those objec-
The experiences of economic transition
tives and monitoring performance. Good corpo-
and all too frequent financial crises in devel-
rate governance provides proper incentives for
oping and emerging market economies have
the board and management to pursue objectives
confirmed that a weak institutional framework
Better corporate governance: More value for everyone
OECD Principles of Corporate Governance:
Overview of the Main Areas of the OECD Principles
1. The Basis of an Effective Corporate Governance
Framework
The corporate governance framework should promote
transparent and efficient markets, be consistent with the
rule of law, and clearly articulate the division of responsibilities among different supervisory, regulatory, and
enforcement authorities.
4. Role of Stakeholders in Corporate Governance
The corporate governance framework should recognize
the rights of stakeholders established by law or through
mutual agreements and should encourage active cooperation between corporations and stakeholders in creating wealth, jobs, and sustainability of financially sound
enterprises.
2. Rights of Shareholders and Key Ownership Functions
The corporate governance framework should protect and
facilitate the exercise of shareholders’ rights.
Seven core principles in this category spell out the
various rights of shareholders and call for effective
shareholder participation in key corporate governance
decisions.
5. Disclosure and Transparency
The corporate governance framework should ensure that
timely and accurate disclosure is made on all material
matters with respect to the corporation, including the
financial situation, performance, ownership, and governance of the company.
3. Equitable Treatment of Shareholders
The corporate governance framework should ensure the
equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.
6. Responsibilities of the Board
The corporate governance framework should ensure the
strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders.
Note: Information in this box is based on the OECD Principles of Corporate Governance, 2004.
for corporate governance is incompatible with
cable to countries with a civil and common-law
sustainable financial markets and private sec-
tradition without being unduly prescriptive.
tor development. As a result, good governance
The principles have been devised with four
structures are valued increasingly highly by in-
fundamental concepts in mind: responsibility,
vestors, particularly those seeking to diversify
accountability, fairness, and transparency, and
their portfolios to include stakes in developing
enabling diversity of rules and regulations. They
countries. They also mitigate the risks posed by
outline the following: (a) the basis for an effec-
weak institutions. Furthermore it is expected
tive corporate governance framework, (b) the
that poor corporate governance is going to a
rights of shareholders, (c) equitable treatment of
become critical foreign policy issue as cross-
shareholders, (d) the role of stakeholders in cor-
boarder investors and the importance of secur-
porate governance, (e) disclosure and transpar-
ing their rights gain more importance.
ency, and (f) the responsibilities of the board.
2
The 2004 revisions covered four main areas:
OECD Principles of
(a) a new set of principles on the development
Corporate Governance
of regulatory framework to underpin corporate
In response to a call by its council, the OECD
governance mechanisms for implementation
issued the OECD Principles of Corporate
and enforcements; (b) additional principles to
Governance in 1999 after extensive consultations.
strengthen the exercise of informed ownership
These were later revised in 2004 following a com-
by shareholders that call on institutional inves-
prehensive survey of corporate governance prac-
tors to disclose their corporate governance poli-
tices in and outside the OECD area. Since their
cies and to strengthen the rights of shareholders
launch, the principles have formed the basis for
when choosing Board members; (c) strength-
corporate governance initiatives in both OECD
ened principles to reinforce Board oversight and
and non-OECD countries alike. They represent
enhance Board members’ independent judg-
the minimum standard that countries with dif-
ment; and (d) new and strengthened principles
ferent traditions have agreed on, being appli-
to contain conflicts of interest through enhanced
disclosure and transparency (for example, on re-
nance practices among the country’s public
lated party transactions), thus making auditors
and private sector stakeholders.
more accountable to shareholders and promoting auditors’ independence.
Participation in corporate governance ROSC
assessment is voluntary and is conducted at the
3
Most recently, in April 2005, the OECD ad-
invitation of country authorities. Although the
opted new guidelines on corporate governance
assessments are relevant to all countries, they
of state-owned enterprises which provide sug-
are particularly pertinent in middle-income
gestions on finding a balance between the state’s
countries seeking to build strong capital mar-
responsibility for actively exercising its owner-
kets. They are a useful instrument for transi-
ship functions while at the same time refraining
tional economies, where mass privatization has
from imposing undue political interference in
created a large pool of listed companies with
the management of the company. The guide-
thousands of shareholders, and for low-income
lines are also designed to foster a level playing
countries seeking to attract international portfo-
field in markets where private sector compa-
lio investors. The assessments also serve as a tool
nies can compete with state-owned enterprises.
for communication between policy makers and
Furthermore, experience demonstrates that
domestic and international investors to reach
good corporate governance benefits SOEs in the
a common understanding in an environment
same way it does private companies. Moreover,
where countries are grappling with the establish-
as in the case of private companies which may
ment of new capital markets and are competing
aspire to go public, SOEs which may be under
to attract capital investments.
consideration for privatization can gain signifi-
The assessments are complementary to
cant value by early adoption of a good corporate
private sector rating activities in this field. The
governance regime.4
World Bank assessments focus on country anal-
The OECD principles have been endorsed by
ysis, whereas some rating agencies have started
the Bank and the Fund executive boards, and they
to focus on corporate governance of companies.
form the basis of the corporate governance component of the World Bank–IMF Reports on the
Key Findings from
Observance of Standards and Codes (ROSCs).
Country Assessments
The work of Fremont and Capaul (2002)6 re-
World Bank ROSC Corporate
views the lessons of corporate governance as-
Governance Assessments
sessments and its findings are discussed in this
As part of the ROSC initiative, the World Bank
section. In most countries surveyed, there is a
has established a program to assist its member
growing interest toward improving corporate
countries in strengthening their corporate gov-
governance practices. A large number of coun-
ernance frameworks. The objectives of this pro-
tries, including Brazil, Croatia, the Philippines,
gram are to accomplish the following:
and Romania have developed their own corpo-
5
• Benchmark the country’s corporate gover-
rate governance codes of best practice.
nance framework and company practices
Some of the key policy issues that have aris-
against the OECD Principles for Corporate
en in corporate governance assessments can be
Governance.
accessed at http://www.worldbank.org/wbi/bus
• Assist the country in developing and im-
inessanddevelopment/.
plementing a country action plan for im-
Studies have demonstrated that, at the firm
proving institutional capacity with a view
level, (1) investors will pay a higher premium for
to strengthening the country’s corporate
good corporate governance, (2) good corporate
governance framework.
governance reduces the cost of debt, and (3) good
• Raise awareness of good corporate gover-
corporate governance improves the stability, op-
The importance of corporate governance relative
to financial issues (percent)
standards of governance, particularly in the area
of transparency and disclosure have been a major factor behind instability in the financial markets across the globe. Building improved capacity for corporate governance, and fostering the
implementation and exercise of these measures
requires a multisectoral approach. Large companies can link with their suppliers and partner
with smaller local businesses to help them gain
access to markets, financing opportunities, tech-
Less important
Equally important
More important
nology and know-how.10 At the same time they
can create and capitalize on new business oppor-
Source: McKinsey Global Investor Opinion Survey on Corporate
Governance, 2002.
tunities in lower-income markets. Large firms
The Business and Development
Discussion Papers encourage debate
regarding the different forms of
private sector action for development
can lead by example, by setting high standards
and the sharing of best practices.
of corporate governance and accountability that
The series is one initiative of the
Business, Competitiveness and
erational efficiencies and sustainability of busi-
benefit not just their long term viability but
nesses. In a 2002 McKinsey survey, institutional
the economy as a whole. Good corporate gov-
investors said they would pay premiums to own
ernance is not only relevant for poor countries.
to fostering sustainable and equitable
well-governed companies. Premiums averaged
Investors everywhere worry about expropriation
development and effective multi-
30% in Eastern Europe and Africa, and, 22% in
by controlling owners and managers. Whether
Asia and Latin America. An ABN AMRO study7
in rich or poor countries, corporate governance
For information on the Business,
showed that Brazilian firms with above-average
creates more value for everyone.11
Competitiveness and Development
corporate governance had ROEs—returns on equity—that were 45% higher and net margins that
were 76% higher than those with below-average
governance practices. A study of the 100 largest
emerging market companies by Credit Lyonnais
Securities Asia (CLSA)8 in 2001 showed that
Notes
1. Financial Sector Assessment: A Handbook. 2005. World
Bank.
2. Klein, M., M. Capaul, S. Djankov, and T. Harford. 2005.
Proving Adam Smith Wrong.
3. OECD. 2004. OECD Corporate Governance Principles.
4. OECD. 2005. Guidelines on Corporate Governance of
State-Owned Enterprises.
in each of a large number of emerging market
5. Overview of the ROSC Corporate Governance Program,
countries had eight percentage points higher
last accessed on September 10, 2005 [http://www.worldbank.org/ifa/rosc_cg.html]
Governance: Experience from Country Assessments.”
studies that similarly highlight benefits that firms
World Bank.
Some countries, such as Brazil, have segmented their stock markets based on the com-
7. Erbiste, B. 2005. “Corporate Governance in Brazil:
Is There a Link Between Corporate Governance and
Financial Performance in the Brazilian Market?” ABN
AMRO Asset Management, July.
panies’ compliance with strict corporate gover-
8. Claessens, S. and L. Laeven. 2002. “Financial develop-
nance requirements. Longitudinal studies from
ment, property rights and growth.” Journal of Finance,
June.
such initiatives demonstrate that those compa-
9. IFC Corporate Governance Department website, last ac-
nies with strict standards perform better and
cessed Sept. 10, 2005. See also IFC. 2005. The Irresistible
have access to cheaper capital.
Case for Corporate Governance.
At the country level, improving corporate
governance contributes to the development of
the public and private capital markets. Poor
sectoral partnerships.
Petkoski, Program Leader, dpetkoski@
worldbank.org or visit http://www.
csrwbi.org/. For more information on
this subject, please visit http://www.
worldbank.org/wbi/businessand
development
For additional copies of this paper,
please contact Redley Pinkney at
[email protected] or at 202458-0565.
6. Fremont, O. and M. Capaul. 2002. “The State of Corporate
in their country average. There are many other
can derive from better corporate governance.9
Bank Institute. Authors are committed
Program, please contact Djordjija B.
companies with the best corporate governance
measures of economic value added than firms
Development Program of the World
10.Dervis, K. and R. Davies. 2005. “New models point the
way out of poverty.” Financial Times, 13 September.
11.International Finance Corporation. 2006. Doing Business
2006.
Disclaimer: The views published are
those of the authors and should not
be attributed to the World Bank or
any affiliated organizations. Nor
do any of the conclusions represent
official policy of the World Bank
or of its Executive Directors and the
countries they represent.
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