INTERNATIONAL
FINANCIAL
MANAGEMENT
Lecture 4:
Topics: Corporate Governance and
Corporate Goals/Objective Models -- A
Global View
Corporate Governance: Background
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Recently has become an issue in this country
and abroad.
Interest has been driven by three events:
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Expanding shareholder base of corporations and
the resulting separation of owners and manager.
Corporate abuses.
The globalization of companies into non-resident
financial markets.
We will develop these themes throughout this
lecture series.
What is Corporate Governance?

Bank for International Settlements definition:
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“The system of rights, processes, and controls
established internally and externally over the
management of a business entity with the objective of
protecting the interest of stakeholders".
Central Issue of corporate governance: How best to
protect the interest of stakeholders.
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But who are the relevant stakeholders that companies
need to protect?
Possible Stakeholders
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McDonalds: “good corporate governance is critical
to fulfilling the Company’s obligation to
shareholders.”
Honda: “Our [corporate governance] aim is to
have our customers and society, as well as our
shareholders and investors, place even greater
trust in us and to ensure that Honda is a company
that society wants to exist."
Why Might We Be Concerned About
Corporate Governance?
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Macro Implications:
 Because corporations play a key role in the generation and
allocation of a country’s resources.
Micro Implications:
 In the increasing world of globalization, firms need to practice
good corporate governance so as to:
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Continue to attract consumers and workers
Have access to global financial markets!
Historically, corporate governance appears to have been of
greater concern among developed country corporations than
developing country corporation!
 However, globalizations is forcing these developing country
corporations to assess their corporate governance structures
Concerns of Different Stakeholders
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In reality, it is likely that different stakeholder groups will
focus on different criteria and elements in deciding what
makes up good corporate governance as they see it.
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Shareholders probably attach the greatest importance to
maximizing the market value of the company’s shares.
The general public wants to be sure the corporation treats
customers fairly and has sensitivity to its impact – socially
and environmentally -- on the local community.
Corporate employees want assurances the company will
compensate them properly, provide opportunities for
advancement, offer training and career development
assistance, and help with their retirement planning.
The issue then for managers is what stakeholders do we
focus on.
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This impacts on corporate goals and objectives.
Note the difference between McDonalds and Honda.
Early 20th Century History of
Corporate Governance in the U.S.
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In the decades leading up to the 20th century, most
US corporations were dominated and controlled by
wealthy individuals.
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The Morgans, Rockefellers, Carnegies and du Ponts.
However by the 1920s/1930s, pattern of US
ownership of corporate equities had changed from
these entrepreneurs to a wide range of investors.
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At that time it was recognized that there was a growing
disparity between owners of firms and managers of firms.
And thus the issues of agency problems and agency costs
became relevant.
Agency Problems and Agency Costs
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Agency problems arise when a principal
(owner) hires an agent (manager) to perform
certain tasks, yet the agent does not share
the principal's objective.
Issue of agency costs in corporations:
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Refers to the potential conflict of interest between
principals (shareholders) and agents (managers)
in which agents have an incentive to act in their
own self-interest because they bear less than the
total costs of their actions.
State Statues to Address Corporate
Governance
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Because of the changing ownership of US
corporations and the issue of agency costs.
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The concept of corporate governance was
addressed when a number of states, most notably
Delaware, passed "enabling statutes" known as
general corporation laws.
These state statutes created a legal framework for
stockholders investing in corporations who were
finding themselves increasingly separated from
the managers of those corporations.
Key Element in Early 20th Century
Corporate Governance
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Boards of directors were seen as important to the
agency cost issue.
 Boards were set up to exercise control and
management over the company; thus they were
seen as representatives of the stockholders
It was argued that these boards had fiduciary (legal)
duties of loyalty to owners and they should ensure
the “wise management of the corporation in the best
interests of its owners.”
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A key element in this process was the “independence of
directors” from undue influence by interested parties
(including managers).
But were these boards truly independent?
The Stock Market Crash in 1929
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The stock market crash of 1929 brought the federal
government into the regulation of corporate
governance for the first time.
Congress passed the Securities Acts of 1933 and
1934 to restore confidence in the equity markets.
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1933: Established the Securities and Exchange
Commission (SEC); requires registration with the SEC of
securities offered for public sale and outlaws fraud in the
sale of securities.
1934: Regulates stock exchanges and requires corporate
officers to report their trading in securities.
These acts also require that public companies undergo an
annual independent audit of their financial statements.
The 1980s
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The decade of the 1980s was characterized by
a wave of hostile takeovers, leveraged buyouts,
management buyouts, junk bond financing,
"poison pills", and the general merger frenzy of
those days.
Within this environment, shareholder interests
again became an issue.
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The corporate governance debate was revived.
But what was different now was the role and voice
of large institutional investors as these institutions
played an increasingly activist role as corporate
shareholders.
The 1990s to the Present
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In the United States, by 1990, the direct ownership of
equities by households had fallen below 50%.
Thus, by the 1990s, it was primarily these institutional
investors (e.g., banks, mutual funds, public and private
pension funds) who were driving the issues of corporate
control and accountability.
 Their focus was (and currently is) on securing top
performance from their investments.
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Critical to this is the role of the “independent” board of
directors.
Today, these institutional investors hold about 60% of all
listed corporate stock in the United States (about 70% in
the largest 1,000 corporations).
Impact of Corporate Abuses in the US
on Corporate Governance
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In recent years corporate governance has become (relatively)
well defined in the United States.
 Undoubtedly recent corporate abuses have contributed to
this:
 Waste Management and Sunbeam (1998) and Enron
(2001).
 Abuses resulted in passage of Sarbanes-Oxley Act (2002)
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Among other requirements is the certification of financial reports by
chief executive officers and chief financial officers
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Assumes if companies are more transparent in what they are
doing, managers will be less tempted to act in a way detrimental
to owners.
But there is no similar regulation in foreign countries.
Issue of applying this act to foreign companies listed in the U.S
Global Corporate Governance
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Globally, there are two major challenges to the
development of “good” corporate governance.
First, there is a great diversity of national practices,
traditions, laws, regulations, and political and market
structures.
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For example, common law versus civil law and differences
in ownership patterns
Second, the possibilities for implementing "good
corporate governance" are often constrained in a
given country by legal, cultural, and/or economic
factors.
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For example, differences management models
Global Variations in Ownership
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Separation of ownership and management (i.e.,
potential control):
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Varies widely among countries.
When measured by ownership concentration:
Country
United States
United Kingdom
Italy
Germany
Brazil
Mexico
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Average ownership of 3 largest shareholders
20%
19%
58%
48%
57%
64%
United States and U.K. have a “diverse shareholder
base.” In other countries, often founding families control
the companies!
Ownership Impacts
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If ownership is concentrated, it is likely that a small
number of owners will find it easy and
advantageous to monitor managers.
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This may be the case of countries like Italy, Brazil
and Mexico, but not the U.S. and the U.K. (see
previous slide).
Agency cost may be reduced as owners and
managers become better aligned due to ownership
concentration.
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Thus large shareholders may play a role in corporate
governance.
Studies also suggest that concentration of ownership
may have a positive impact on a company’s
performance and value.
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Japan (1995) and Germany (2000)
Legal Variations
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Currently we can identify 4 main legal systems on a
global basis:
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English common law
French civil law
German civil law
Scandinavian civil law
Studies have suggested that variations in corporate
governance from country to country can be
attributed to differences in legal systems.
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Why: Legal systems determine how well investors are
protected.
Common Versus Civil Law
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Common Law
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Based on precedent, formed by the rulings of independent
judges regarding specific disputes.
Originated in U.K. and spread throughout the world through
British colonization (as well as independent adoption):
 United States, Australia, Canada, India, South Africa,
Singapore, New Zealand.
Civil Law
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Codification of legal rulings.
Dominates legal systems globally.
 France, Germany, Japan, Mexico, China, Latin America,
Shareholder Rights and the Legal
System
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Historically, in civil law countries, the “state” has
played a greater role in regulating economic activity
but a less active role in individual (e.g., private
property) rights.
On the other hand, English common law appears to
be more protective of private property and investor
rights.
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Conclusion for investors: English common law tends to
offer the strongest protection for investors.
Studies also suggest that countries with strong shareholder
protection have more company listings on stock markets
and more value stock markets (capitalization of
companies).
Law and Ownership Concentration
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Civil law countries generally have greater ownership
concentration ratios.
Legal System
Average ownership of 3 largest shareholders
English Common
French Civil
43%
54%
Perhaps higher concentration ratios are a response
to relatively weak investor protection laws in civil law
countries? Or perhaps of the high concentration
ratios are seen as reducing the need for strong
investor protection laws?
Corporate Goals
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Corporate Goals: Specified targets which the
company desires to achieve.
In the United States, companies tend to
produce rather well defined financial goals.
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For Example, FedEx Corporation
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Grow revenue by 10% per year
Increase EPS by 10%-15% per year
The American company focus on these types
of financial goals is driven by the corporate
model which we use.
Differences in “Corporate Model”
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We can identify 2 different corporate models in the
world today:
Shareholder Wealth Structure (aka, Anglo-American
or Anglo-Saxon) Model:
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Believes that a firm’s objective should be to maximize
shareholder wealth.
 “Shareholder Wealth” countries include the US,
Canada, Australia, United Kingdom.
Corporate Wealth Structure (aka, Non-AngloAmerican) Model:

Believe that a firm’s objective should be to maximize
corporate wealth (which includes all stakeholders; e.g.,
employees, community, banks, owners)
 “Corporate Wealth” countries include the EU, Japan
and Latin American countries.
Shareholder Wealth Model
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This model focuses on the importance of
shareholders to the corporate structure.
Wealth is seen as strictly “financial.”
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Within this context, management tools measure impact of
their decisions on equity (common stock) values.
Shareholder Wealth capital budgeting techniques include:
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Net Present Value
Internal Rates of Return
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These are aimed at securing returns greater than the firm’s
cost of capital and thereby increasing returns to
shareholders.
Within this model, there is a general acceptance of
“hostile” takeovers to ensure appropriate financial
performance.
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Again this is seen as benefiting shareholders.
Corporate Wealth Model
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The focus of the corporate wealth model is much
broader than the Shareholder Wealth viewpoint.
Under the Corporate Wealth Model,
consideration of corporate decisions is given
to a wider range of parties, including human
resources, community, state, shareholders,
lenders...
The Corporate Wealth model came about
because of distrust of unrestricted capitalism
especially in Latin America and post World War
II Europe (thus, the phrase a search for the
“Third-Way”).
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Corporate Wealth Model
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In Continental Europe and Asia we see this
model manifested in:
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Advisory Committees (with labor representation):
important in Europe as part of corporate structures
and involved by law in corporate decisions.
Strict labor laws (e.g., on firing employees) in Europe.
Life time employment concept in Japan in early post
war years.
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Weakened substantially in Japan in the 1990s.
Less attention in Japan of Anglo Saxon capital
budgeting techniques; especially equity cost of capital.
Friendly takeovers are the rule (although this is
changing as well, in Japan and in Europe).
“Equity” Cultural Differences
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Shareholder Wealth countries (U.S., U.K.,
Canada)
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Historically have had a well developed equity culture
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Within these countries there is an understanding and
acceptance of ownership and, especially, equity capital risk.
Thus, this sector is an important source of funds for
corporate financing.
But, perhaps, it also affects corporate goals.
Management tends to focus on shareholders.
“Equity” Cultural Differences
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Corporate Wealth countries (Continental Europe
and many Asian countries)
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Historically, relatively less developed equity culture
 Risk is not as well understood or tolerated.
Thus in these countries there has historically been a
reliance on debt and bank financing.
Globalization is changing this!
The Future: Are the Two Models
Finding a Middle Ground?
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Starbucks, Corporate Social Responsibility: “…
conducting business in ways that produces social,
environmental, and economic benefits for the
communities in which we operate.”
Many Japanese companies are now concern with
Anglo-American financial performance.
 Nissan hired “cost-cutter” Carlos Ghosn as their CEO
in 1999 to turn the company around.
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One year after he arrived, Nissan's net profit climbed to $2.7
billion from a loss of $6.1 billion in the previous year.
Sony hired an American, Howard Stringer as their
CEO in 2005.
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He has set operating profit margin goal of 5% for the company
by 2008.
The Future: Are the Two Models
Finding a Middle Ground?
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Financial markets and financial organizations (e.g.,
central banks) around the world are working to
become more transparent.
 All central banks now publishes their web sites in
English.
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http://www.bis.org/cbanks.htm