THE IMPACT OF PENSION REFORM ON
CORPORATE GOVERNANCE
PRACTICES AND REGULATIONS: THE
CASE OF CHILE *
Augusto Iglesias P.
PrimAmérica Consultores
September, 1999
*
Presented at the thirteenth Plenary Session of the Advisory Group on Privatisation, Organisation
for Economic Co-operation and Development. Paris, France, 21-22 September, 1999.
I. Background information
 Since the early eighties, pension funds have
become important players in capital markets of
many Latin American countries. This has been
the consequences of radical reforms to their
social security systems.
 Corporate governance practices depend, among
other variables, on the size of capital markets, the
characteristics of their regulation, and the
ownership structure of firms.
All these
dimensions are affected by the development of
institutional investors.
Pension Reform
in Latin American
(as of march 1999)
COUNTRY
CHILE
PERU
COLOMBIA
ARGENTINA
URUGUAY
BOLIVIA
MEXICO
EL SALVADOR
TOTAL
YEAR OF AFFILIATES
REFORM
(number)
1981
1993
1994
1994
1996
1997
1997
1998
5.984.508
2.035.621
3.770.349
7.200.934
514.704
448.927
14.209.678
622.374
34.787.095
PENSION
FUND
(MMUS$)
32.663
1.871
2.459
12.503
427
395
6.889
83
57.289
...
 To understand discussion on relationship
between corporate governance and institutional
investors in L.A. is necesary to know some
basics facts regarding each one of this
dimensions.
Fact N° 1:
In L.A., pension fund investments are strictly
regulated.
All countries apply quantitative
restrictions that include a list of authorized
assets; diversification rules; conflicts of interest
regulation; valuation rules; etc.
Investment rules for pension funds
in Latin America
MAXIMUM OF PORTFOLIO IN EACH ASSET CLASS
ARGENTINA
CHILE
COLOMBIA
GOVERNMENT DEBT
50%
50%
50%
30% 40%
60%
TIME DEPOSITS
28%
50%
50%
40% 30%
30%
BONDS
28%
45%
20%
40% 49%
15%
STOCKS
35%
37%
30%
20% 35%
25%
MORTGAGE BONDS
28%
50%
30%
40% 40%
20%
FOREIGN INVESTMENT
10%
12%
--
CLOSE END INVESTMENT FUNDS
14%
5%
10%
2%
9%
--
FUTURES AND EXCHANGE RISK COVERAGE
EL SALVADOR
--
PERU URUGUAY
10%
--
20% 15%
--
--
10%
--
...
Fact N° 2:
Allthough, in general, investment rules do allow
investment in stocks in some countries the stock
market is non-existent or is too small. So, only
the pension funds of few countries invest in
stocks.
Equity investments of pension
funds in Latin America
(as of march 1999)
Country
CHILE
PERU
COLOMBIA
ARGENTINA
Pension
Fund
MMUS$
32.663
1.871
2.459
12.503
Equity
Investment
MMUS$
5.203
644
79
2.301
Equity
Investment
as a % of total
15,9%
34,4%
3,2%
18,4%
...
Fact N° 3:
a Pension
funds
face
important
liquidity
constraints. In many cases they can not sell their
holdings of shares of one company without
putting downward pressure on prices.
b Also, there is no “index investment” because
trading by pension funds would “move the
index”.
 Because of these particular characteristics of the capital
market, pensions funds have a “bias” in favor of an
active role on corporate governance.
...
Fact N°4:
Pension funds that are part of the social security
system are not “company plans”. Individuals
select the pension fund manager they want. Also,
regulation limits the investments of the fund in
assets issued by firms related to the pension
fund managers.
...
Fact N°5:
The particular design that has been selected for
the new pension fund systems in L.A. (private
management and individual freedom to select
pension fund manager), means that there is low
risk of political interference on investment
decisions (and so, on corporate governance).
...
Fact N°: 6
In general, ownership is concentrated (“family
ownership”). So, as pension funds invest in
stocks of one company they become “partners”
of few big shareholders. Maybe because of this
reason, the main purpose of regulation seems to
be the control of conflicts of interest between
minority and majority shareholders, and not the
control of conflicts of interest between
shareholders and the management of the firm.
II. Impact of pension reform on
corporate governance
 The development of institutional investors has
influenced corporate governance (in Chile) in
three differents ways:
Pension funds and life insurance companies have an
important presence in capital markets;
 To protect social security funds, new regulations have
been introduced to capital markets with impact on
corporate governance practices;
 Pension funds have appointed independent board
numbers in many firms were they hold participation.
a. Pension funds, capital markets and
corporate governance
 Pension funds plus reserves of life insurance companies
amounted more than US$40 billion in 1998 (55% of GNP).
Social security savings are 14% of total savings and 3.4% of
GNP.
Chile: pension funds and reserves
of life insurance companies
(december of each year)
Year
Life Insurance
Pension Funds Companies
(MMUS$)
1981
1982
1983
1984
1986
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
300
606
1.136
1.244
1.533
2.117
2.708
3.584
4.470
6.658
10.064
12.395
15.942
22.296
25.143
27.198
30.525
30.716
Total
%GNP (MMUS$) %GNP (MMUS$) %GNP
0,92
3,73
6,50
8,51
10,63
12,69
14,19
15,06
17,73
24,27
31,44
30,61
38,04
42,06
39,54
40,88
42,19
43,34
735
544
594
623
660
838
835
1.078
1.320
1.885
2.538
3.339
4.130
5.896
7.116
8.039
9.845
N.D.
2,25
3,18
3,32
4,15
4,67
5,26
4,72
4,87
5,74
7,49
7,96
8,54
9,65
10,87
10,85
11,97
13,40
N.D.
1.034
1.150
1.730
1.867
2.192
2.954
3.543
4.662
5.791
8.544
12.603
15.735
20.072
28.192
32.259
35.237
40.369
N.D.
3,17
6,91
9,82
12,66
15,53
17,95
18,91
21,08
25,17
31,76
39,40
39,15
47,69
52,93
50,39
52,48
54,93
N.D.
Social
Security
Savings
%GNP
1,40
1,86
1,76
1,87
1,91
2,08
2,13
2,50
2,76
3,13
3,74
3,44
3,74
3,88
3,49
3,00
3,16
3,35
a. Pension fund, capital markets and
corporate governance
 Pension funds plus reserves of life insurance companies
amounted more than US$40 billion in 1998 (55% of GNP).
Social security savings are 14% of total savings and 3.4% of
GNP.
 Pension funds hold more than 50% of the outstanding debt
of the government; 16% of total time deposits and bonds
issued by commercial banks; 50% of mortgage bonds; 53%
of long term corporate debt; and 10% of the stock traded in
the market.
Chile: share of pension
funds in financial markets 1/
ASSET CLASS
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
GOVERNMENT DEBT
31,9
40,7
39,5
38,0
39,9
46,3
52,6
52,7
55,3
50,9
TIME DEPOSITS AND
BANK BONDS
22,5
19,1
20,1
18,8
14,9
11,3
10,8
11,0
9,1
15,9
MORTGAGE BONDS
53,0
52,1
57,7
58,6
60,8
57,3
57,4
55,7
55,4
50,0
CORPORATE BONDS
48,1
47,8
59,2
62,4
60,3
54,9
57,2
53,9
53,8
53,2
4,2
4,8
5,5
8,6
10,0
9,9
10,6
10,5
10,5
9,7
STOCKS
1/ Pension fund holdings of each asset class as a % of total assets in each class
...
 Until 1986, pension funds only invested in debt. So, their
influence on corporate governance was only because their
role as lenders of corporations who began to issue bonds
as the market for long term debt developed:
 Pension funds and life insurance companies helped to the
development of the market for long term debt;
 Corporation who wanted to issue debt were forced to have an
independent risk rating;
 Pension funds and life insurance companies did use their
bargaining power to improve protections being offered to
creditors.
In short, the cost of long term debt did decrease; the cost of
monitoring corporations was reduced; and the quality of the
information that firms provide to the market did improve.
...
 Since 1986, pension funds have been active investors in the
stock market.
As a proportion of the portfolio, investment in stocks did
reach a maximum in 1994 (32,2%).
Since then the
proportion has decreased, mainly because international
diversification of the portfolio.
Chile: Pension funds
investment portfolio
Year
Central
Bank
Treasury
Time
Deposits
a/
1981
1983
1985
1987
1989
1991
1993
1995
1997
1998
27,40
14,10
20,40
29,80
38,10
37,40
38,30
37,50
36,40
37,50
0,70
30,40
22,20
11,70
3,50
0,90
0,50
1,90
3,20
3,40
61,90
2,70
20,90
28,50
21,50
13,30
7,60
6,60
12,40
15,10
a/ Include Debt issued by Financial Institutions
Mortgage Corporate Stocks Closed-end Foreign Pension
Bonds
Debt
Investment Investment Funds
Funds
(MM US$)
9,40
50,60
35,40
21,30
17,70
13,40
13,10
15,80
17,00
16,60
0,60
2,20
1,10
2,60
9,10
11,10
7,30
5,20
3,30
3,80
0,00
0,00
0,00
6,20
10,10
23,80
31,80
30,10
23,40
14,90
0,00
0,00
0,00
0,00
0,00
0,00
0,30
2,50
3,10
2,90
0,00
0,00
0,00
0,00
0,00
0,00
0,60
0,20
1,10
5,60
300
1.136
1.533
2.708
4.470
10.064
15.942
25.143
30.525
30.805
...
 Since 1986, pension funds have been active investors in the
equity market.
As a proportion of the portfolio, equity investment did reach
a maximum in 1994 (32,2%). Since then the proportion has
decreased, mainly because international diversification of
the portfolio.
 First, they did invest in state owned firms that were being
privatized (most of them in the public utilities sector). Then
they begin to invest in a broader range of firms.
Chile: Participation of pension
funds in ownership of stocks
Year
1986
1989
1992
1995
1998
* 1997
% of Pension Funds
in stocks
3,8%
10,1%
24,2%
32,1%
17,8%
% of stocks market in the
portfolio of pension funds
N.D.
4,8%
10,0%
10,5%
9,7% *
Chile: Participation of pension funds in
ownership of open public corporations
(december 1998)

Pension funds hold 10% of equity of open public
corporations:






They participate in 99 firms (total number of firms
traded in the market is 286).
In two firms participation is greater than 30% (but
less than 35%).
In four firms, participation is between 20% and 30%.
In seven firms participation is between 15% and 20%
In twelve firms participation is between 10% and 20%
In seventy four firms, participation is less than 10%
...
 The incorporation of pension funds and - to some extent - life
insurance companies to the stock market did help to increase
its liquidity (at least for small investors, exit became an
alternative in case of firms performing below expectations).
 Also, pension funds did begin to produce regular and
independent opinions on the performance of firms. Later, they
became the main clients for investment banks doing the same
job.
 Because they are part of the mandatory social security system,
pension funds are exposed to close public scrutiny. This also
apply to firms were they invest.
 Firms who want to go public and sell shares to pension funds,
must meet certain minimum conditions (positive results in the
last years; disclosure of relevant information; etc.).
b. Pension funds and capital market
regulations
 The development of pension funds has had an effect on the
design of capital market regulation. In turn, this regulation
has had an impact on the role of institutional investors in
corporate governance.
 Pension funds were created by law. They are part of a
mandatory social security system. Therefore, there are
some implicit - and explicit - state guarantees over results
of the system. Capital market regulation was reformed with
the purpose of reducing the cost of these guarantees.
These changes in regulation have benefited not only
pension funds, but also small investors and minority
shareholders.
...
 The changes in capital market laws and regulations with direct
influence on corporate governance practices are:
 Mandatory risk rating
 Control of conflicts of interest
 Because of this, for shareholders and creditors, the conditions
to participate in corporate governance have improved after
pension reform.
c. Pension funds and monitoring of
conflicts of interest
 Because of regulation, pension funds are forced to
participate in shareholders meetings and to vote in each
one of the decisions (including the election of board
members), that are presented to the shareholders (this is
not only in Chile but also in other L.A. countries).
Bolivia
Perú
Colombia
Argentina
Chile
Latin America: regulation on
the vote of pension funds in
shareholders meetings
1. Are pension funds allowed to participate in shareholders meetings?
Yes Yes Yes Yes Yes
2. Are pension funds forced to participate in shareholders meetings?
Yes Yes No
3. Election of board members:
∙ Board of the pension fund must select the candidate to the board
∙ Pension funds must make their vote public
∙ Is it possible to vote for:
- Candidates related to mayority shareholders?
- Candidates related to the pension fund management firm?
NR: Not regulated
NA: Not available
No NA
NR NR
Yes
Yes NA
Yes
Yes NA
No
No NA
Yes
No NA
c. Pension funds and monitoring of
conflicts of interest
 Because of regulation, pension funds are forced to
participate in shareholders meetings and to vote in each
one of the decisions (including the election of board
members), that are presented to the shareholders (this is
not only in Chile but also in other L.A. countries).
 Pension funds face liquidity constraints (they can not sell
their holdings in a short period of time without depressing
prices). So, for them voice and vote are the most important
tools for monitoring performance of firms.
Then, because of regulations and market conditions,
pension funds have been active in shareholders meetings
and have elected independent board members.
Chile: Impact of pension funds on
the election of board members
Class of
firm
Chapter XII
Other
Total
Board members
(Total)
Board members
elected with votes
from at least
one pension fund
80
631
711
30 (37,5%)
41 ( 6,5%)
71 (10,0%)
...
 Independent board members are playing an important role
as monitors of potential conflicts of interest between
mayority and minority shareholders (foreign institutional
investors are playing a similar role).
 Because of the “demand” for independent board members
by pension funds (an other institutional investors), a new
“class” of professional board member is beginning to
develop.
III. Some unsolved problems
 In Latin America, there is some concern for the
large relative size of pension funds in capital
markets and the increasing concentration of this
industry.
Regulators fear that controllers of
pension fund companies could control the firms
in which the funds are invested, against the
interest of the affiliates.
Latin America: concentration in
pension fund industry
COUNTRY
CHILE
PERU
COLOMBIA
ARGENTINA
URUGUAY
BOLIVIA
MEXICO
EL SALVADOR
PENSION
FUND
MANAGERS
(number)
8
5
8
15
6
2
14
5
PARTICIPATION OF THREE
MAYOR PENSION FUNDS
% AFFILIATES
% FUNDS
77,9%
75,2%
62,3%
55,2%
69,1%
100,0%
43,8%
81,6%
70,8%
76,2%
62,4%
52,4%
76,8%
100,0%
50,4%
83,6%
PARTICIPATION OF FIVE
MAYOR PENSION FUNDS
% AFFILIATES % FUNDS
92,8%
100,0%
85,2%
77,6%
94,3%
100,0%
66,2%
100,0%
94,8%
100,0%
85,2%
76,6%
93,8%
100,0%
68,2%
100,0%
III. Some unsolved problems
a) Fist problem
 In Latin America, there is some concern for the
large relative size of pension funds in capital
markets and the increasing concentartion of the
industry.
Regulators fear that controllers of
pension fund companies could control the firms
in which the funds are invested, against the
interest of the affiliates.
 Regulators also understand that, effective
participation of pension funds in corporate
governance is important for the protection of
minority shareholders.
...
 A mix of regulations is being used to “balance”
both objectives:
 Maximum investment limits as a % of the outstanding
shares of the company;
 Special (reduced) limits, when there is some interest of
pension fund managers in the firms where they want to
invest;
 Mandatory and public voting of pension funds;
 Limits to form coalitions with other pension funds;
 Strong restrictions on voice.
...
 In our opinion, the result of all these regulations
is to weaken the potential influence of
institutional investors on corporate governance
(restrictions to voice and to form coalitions are
the most questionable regulations).
...
b) Second problem
 Some important institutions for corporate
governance have not yet been developed:
 Audit committes
 Compensation committes
III. Final Remarks
 Corporate governance practices evolve as a
result of both law and tradition. In Latin America,
pension reform did force regulators to create, in a
very short period of time, a new legal framework
for capital markets and the banking sector with
the purpose of reducing investment risk and the
cost of government guarantees in the social
security system. These changes in regulation
have had a strong influence on corporate
governance.
...
 Regulations plus liquidity constraints have force
pension funds to take an active role on corporate
governance.
However this situation could
change as local capital markets develop and as
pension funds begin to invest outside their
domestic market.