Transparency, Corporate
Governance, and Capital Markets
Ronald J. Gilson
Stanford & Columbia
Universities
Latin American
Corporate
Governance
Roundtable
São Paulo Brazil, April 26-28,
2000
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Corporate Governance Roundtable
The Subject is Summarized in
Three Simple Statements
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Equity investment requires good corporate
governance.
Good corporate governance requires credible
disclosure by the issuer.
The absence of credible disclosure by issuers
will have macroeconomic effects: bank
financing and conglomerate internal capital
markets will not support the development of
economically significant new industries.
Corporate Governance
Roundtable
Step One: Corporate Governance is
the Equity Contract
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We are all familiar with the debt contract: a detailed
document specifies the interest rate, the repayment
date, the debtor’s covenants, and the events of default.
What is the equity contract?
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The corporate governance system specifies the rights of an
equity holder and the steps available if management breaches
its responsibilities
Gilson’s rule of value: you pay for what you get!
Corporate Governance
Roundtable
Step Two: Good Governance
Requires Credible Disclosure
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The corollary to Gilson’s rule of value:
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You get what you can measure.
The algebra of governance and disclosure:
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You pay for what you get = you get what you can measure
Canceling yields:
You pay for what [you get] = [you get what] you can measure:
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You pay for what you can measure!
The difference between disclosure and credible
disclosure.
Corporate Governance
Roundtable
Step Three: The Effect of a Bad
Equity Contract
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A bad equity contract – an issuer’s inability or
unwillingness to make credible disclosure – makes it
difficult for the market to distinguish good risks from
bad.
The increased cost of capital shifts financing and the
capital market toward debt.
Consequences:
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Debt is ineffective at financing high risk, high return early
stage investment.
The capital market will not support cutting edge industries.
Corporate Governance
Roundtable
The Institutions Necessary to
Support Credible Disclosure
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Legally Mandated Disclosure Requirements.
Good Accounting Standards.
Independent Auditors.
Effective Enforcement.
Corporate Governance
Roundtable
Legally Mandated Disclosure
Requirements
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Problem:
–
How do we distinguish between those who disclose
accurately and those who do not?
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Absent effective private intermediaries, a reputation model
will not work.
By imposing penalties on false disclosure, a legal mandate
allows honest companies to distinguish themselves.
Corporate Governance
Roundtable
Good Accounting Standards
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The critical characteristic is not the particular standard
– the metaphysics of accounting – but that the form of
disclosure allow users to rearrange the information to
their own use.
Good rule of thumb: an accounting system that has no
use for the adjective “hidden.” Examples:
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German hidden reserves.
U.S. debate over charging the value of employee stock options
to earnings.
U.S. pooling vs. purchase accounting for acquisitions.
Corporate Governance
Roundtable
Independent Auditors
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Credible disclosure requires honest, competent, and
independent auditors.
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The annual audit process is more effective than a government
agency.
The problem is independence.
–
What is the impact on auditor independence of the
consolidation of the profession into 5 multi-national, multidisciplinary professional service firms.
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What happens to independence when non-audit fees climb?
Current focus of the U.S. Securities and Exchange Commission.
Corporate Governance
Roundtable
Enforcement
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Mandatory disclosure is no more effective that
the expectation that the rules will be enforced.
We need:
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A politically insulated regulatory agency with the
independence to impose significant sanctions on the
country’s largest economic actors.
An independent, effective judiciary.
Effective private enforcement.
Corporate Governance
Roundtable
A Piggybacking Strategy
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How does a high quality firm establish its
credibility while local disclosure institutions are
developing?
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Foreign stock listing.
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E.g., NYSE listing imposes on a foreign company
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Governance standards imposed by contract.
– U.S. regulatory standards triggered by listing.
– Israeli companies going public on NASDAQ.
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Strategy limited to larger companies.
Corporate Governance
Roundtable
Summary
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Equity investment requires good corporate
governance.
Good corporate governance – the equity contract –
requires credible disclosure by the issuer.
The absence of credible disclosure by the issuer will
have macroeconomic effects: bank financing and
conglomerate internal capital markets will not support
the development of economically significant new
industries.
Corporate Governance
Roundtable