CAPITAL MARKET WORKSHOPS
1st Workshop – April 15th
 “Overview of the Financial System”, Almir Mirica, executive director SASE
 “The Role of Privatization in the development of the capital market”, Dr. Matej
Živković, Securities Commission FBiH
2nd Workshop – May 13th
 “Sarajevo Stock Exchange – An Overview”, Dr. Tarik Kurbegović, CEO SASE
 “Trading on the Sarajevo Stock Exchange”, Almir Mirica, executive director SASE
 “Introduction to Valuation”, Feđa Krivošević, SASE
3rd Workshop – May 27th
 “Regulation of the Financial System”, Dr. Matej Živković, Securities Commission
of FBiH
 “Corporate Governance, Reporting & Disclosure”, Almir Mirica, executive director
SASE
 “Municipal Bonds”, Feđa Krivošević, SASE
LOGO
Contents
 The
Big Corporate Scandals
 What is Corporate Governance?
 Differences in Corporate Governance Regimes
 OECD Principles of Corporate Governance
 What is Disclosure?
 Importance of Disclosure for investors, issuers and the
economy
 Documents of Disclosure
 Importance of non-financial information
 Corporate Governance, Transparency and Disclosure in
the Federation of Bosnia-Herzegovina
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Enron Corp., 2001.
 American energy company, founded in 1985 in Houston,
Texas, by Keneth Lay. 7th largets company in the US ranked
by revenue.
 Filed for bankruptcy after severe malpractices in accounting
procedures went public; biggest bankruptcy (until then) in UShistory and biggest audit failure
 Share price went down from 90$ in mid-2000 to under 1$ in
November 2001
 Brought down Arthur Andersen, the 5th largest audit and
accounting partnership in the world, who were their auditor
 By using accounting loopholes, special purpose entitites
and poor financial reporting Enron managed to hide billions of
$ of debt from failed deals and projects
 Primary motivation for Enron’s accounting and financial
transactions was to keep reported income and cash-flow up,
asset values inflated, and liabilities of the book (through
SPV’s)
 Special Purpose Entity/Vehicle: limited partnership or company
created to fulfil a temporary or specific purpose. Enron’s SPV’s
were called JEDI, Chewco, Whitewing, Raptors...Primary use:
keep debt of Enron’s balance sheet
 Why? Focus on short-term earnings to maximize management
bonuses
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
WorldCom, 2002 (now: MCI)
 Telecommunications giant; 2nd largest long-distance
telephone company in US (after AT&T)
 Problem: Slowing-down of the main telecom-business
and need to finance their other business endeavors
(yachting, timber) threatened the share price (and
management bonuses)
 Solution: “cook the books”: Declining financial condition
was masked by falsely professing financial growth and
profitability
 Normal operating expenses (line costs, i.e. interconnection
expenses with other telecom-companies) were treated as
investments and recorded over a number of years
 In total, 3,8 billion US-$ worth of expenses were
“capitalized”, leading to a net profit in 2001 of 1,3 billion US-$
 2003 estimation: Companie’s total assets were inflated by
11 billion US-$
 July 21, 2002, WorldCom filed for Chapter 11
Bankruptcy protection
 Largest bankruptcy in US-history (until Lehman Brothers
in 2008)
 Share price went down from 60$ to under 20 Cents.
 In 2005, CEO Bernard Ebbers was sentenced to 25
years in prison.
International Burch University, May 27th, 2013
Bernard Ebbers, WorldCom
CEO
“CG, Reporting & Disclosure”, Almir Mirica
Tyco International, 2002
 Tyco Int., Swiss-based electronic-components
manufacturer, health care and safety equipment.
 CEO Dennis Kozlowski
 Business Week 2002: One of the Top 25
corporate managers in USA
 Kozlowski received (or took?) 170 million US-$ in
low-or no interest loans from Tyco, without
shareholder approval
 Kozlowski arranged the selling of 7,5 million of
unauthorized shares of Tyco, receiving 430 million
US-$
 As the news came out in early 2002, share price
decreased 80% in just 6 weeks
 During the (first) trial, much focus on his shower
curtain (6.000 $) and wife’s 2 million US-$ birthday
party on Sardinia
 On second trial in 2005: convicted of grand
larceny, conspiracy, and fraud, and sentenced to 8
and 1/3rd years to 25 years
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
What do they have in common?
Interests of shareholders
(owners)
≠
Interests of managment
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
What is Corporate Governance?
 Renewed interest regarding CG after the big corporate scandals
in the beginning of 2000’s – Enron, WorldCom, Tyco, Parmalat...
 Corporate Governance (CG) is often confused with the issue of
ethics or ethical behaviour
 Although ethical behaviour is expected from all the actors in CG process, CG at its
core is about the characteristics of a governing process and not about a particular
behavioral trait.
 Definitions of CG:
 Corporate governance is the framework of laws, rules, and procedures that regulate
the interactions and relationships between the providers of capital (owners), the
governing body (the board or boards in the two-tier system), seniors managers and
other parties that take part to varying degrees in the decision making process and are
impacted by the company’s dispositions and business activities. Corporate governance
defines their respective roles and responsibilities and their influence in steering the
course of the company. (Miguel A. Mendez)
 “The relationship among various participants in determining the direction and
performance of corporations” (California Public Employees' Retirement System –
CalPERS)
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Differences in CG Regimes
 CG is needed as a result of the seperation between the ownership
and managment function in modern corporations
 CG does not occur in a vacuum.
 It reflects the economic, historical, cultural and legal characteristics of a
country, it’s business history and corporate landscape
 It is also shaped by the ownership structures...and by the financing options
available to businesses.
 Differences in these areas account for some of the notable differences
in the governance models found on either side of the Atlantic.
 Characteristic for the United States
 High dispersion of ownership (and thus voting power) weakens the ownership/control
link  gives managers great power, who are tempted to use it for their sole benefit
 Monitoring must focus on alligning the interest of the management with the interests of
the shareholders (owners)
 Characteristic for Europe (except UK)
 Blockholders have significant voting power over the dispersed minority owners (who
together may have the majority of ownership!)  incentives for blockholders to exercise
monitoring of managment, but also to extract benefits for themselves (but not for the rest
of the owners)
 Monitoring must focus on insuring that large voting blockholders look after the interest of
all shareholders, not merely their own.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
OECD Principles of Corporate Governance
“Organisation of Economic Co-Operation and Development” (OECD)
 1999: Definition of 6 Principles on Corporate Governance
 2004: Revision of Principles
 Principles:
I - Ensuring the Basis for an Effective Corporate Governance
Framework
 The corporate governance framework should be developed with a view to its
impact on overall economic performance, market integrity and the incentives it
creates for market participants and the promotion of transparent and efficient
markets.
 The legal and regulatory requirements that affect corporate governance
practices in a jurisdiction should be consistent with the rule of law, transparent and
enforceable.
 The division of responsibilities among different authorities in a jurisdiction
should be clearly articulated and ensure that the public interest is served.
 Supervisory, regulatory and enforcement authorities should have the authority,
integrity and resources to fulfil their duties in a professional and objective
manner. Moreover, their rulings should be timely, transparent and fully
explained.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
OECD Principles
II – The Rights of Shareholders and Key Ownership Functions
A - Basic shareholder rights should include the right to: 1) secure methods of ownership
registration; 2) convey or transfer shares; 3) obtain relevant and material information on
the corporation on a timely and regular basis; 4) participate and vote in general
shareholder meetings; 5) elect and remove members of the board; and 6) share in the profits
of the corporation.
B - Shareholders should have the right to participate in, and to be sufficiently
informed on, decisions concerning fundamental corporate changes...
C - Shareholders should have the opportunity to participate effectively and vote in
general shareholder meetings and should be informed of the rules, including
voting procedures, that govern general shareholder meetings (date,location and agenda of
meetings, full information about the agenda items; should have opportunity to ask questions to the
board...)
D - Capital structures and arrangements that enable certain shareholders to obtain a degree of
control disproportionate to their equity ownership should be disclosed (ie crossshareholdings)
E - Markets for corporate control should be allowed to function in an efficient and
transparent manner (i.e. take-over procedures)
F - The exercise of ownership rights by all shareholders, including institutional
investors, should be facilitated.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
OECD Principles
III – The Equitable Treatment of Shareholders
A - All shareholders of the same series of a class should be treated equally.
B – Insider trading and abusive self-dealing should be prohibited.
C – Members of the board and key executives should be required to disclose to the board
whether they, directly, indirectly or on behalf of third parties, have a material interest in
any transaction or matter directly affecting the corporation.
IV - The Role of Stakeholders in CG
A - The rights of stakeholders that are established by law or through mutual
agreements are to be respected.
B - Where stakeholder interests are protected by law, stakeholders should have the
opportunity to obtain effective redress for violation of their rights.
C - Performance-enhancing mechanisms for employee participation should be permitted
to develop.
D - Where stakeholders participate in the corporate governance process, they should
have access to relevant, sufficient and reliable information on a timely and regular basis.
E - Stakeholders, including individual employees and their representative bodies,
should be able to freely communicate their concerns about illegal or unethical practices to the
board and their rights should not be compromised for doing this.
F - The corporate governance framework should be complemented by an effective,
efficient insolvency framework and by effective enforcement of creditor rights.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
OECD Principles
V – Disclosure and Transparency
VI – Responsibilities of the Board
A - Board members should act on a fully informed basis, in good faith, with due diligence and
care, and in the best interest of the company and the shareholders.
B - Where board decisions may affect different shareholder groups differently, the board should
treat all shareholders fairly.
C - The board should apply high ethical standards. It should take into account the interests of
stakeholders.
D - The board should fulfil certain key functions, including:
1. Reviewing and guiding corporate strategy, major plans of action, risk policy, annual
budgets and business plans; setting performance objectives; monitoring implementation and
corporate performance; and overseeing major capital expenditures, acquisitions and
divestitures.
2. Monitoring the effectiveness of the company’s governance practices and making
changes as needed.
3. Selecting, compensating, monitoring and, when necessary, replacing key executives and
overseeing succession planning.
4. Aligning key executive and board remuneration with the longer term interests of the
company and its shareholders.
5. Ensuring a formal and transparent board nomination and election process.
6. Monitoring and managing potential conflicts of interest of management,
board members and shareholders, including misuse of corporate assets and
abuse in related party transactions.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
What is Disclosure?
 Transparency: “letting the information be available”
 Information disclosure: publication of information regarding the business
operations of a company; “disclosure”; “reporting”
 Process through which companies inform the market about their business operations
Materiality of information (OECD):
 “Material information can be defined as information whose omission or
misstatement could influence the economic decisions taken by users of
information.
Classification of disclosure
 Financial vs. Non-financial information
 One-time (prospect) vs continuous disclosure (periodic financial reports)
 National legislation prescribes the minimum disclosure level
 CG Codes and other “soft laws” advance the disclosure level
 International standards which define disclosure requirements
 OECD i IOSCO
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
OECD Principle V
 OECD CG Principles - Principle V (2004): “Disclosure and Transparency”
A – Disclosure should include, but not be limited to material information on:
1.
2.
3.
4.
5.
6.
7.
8.
Financial and operating result of the company
Company objectives
Major share ownership and voting rights
Renumeration policy of board members and key executives
Related party transactions
Foreseeable risk factors
Issues regarding employees and other stakeholders
Governance structures and policies
B – Information should be prepared and disclosed in accordance with high
quality standards of accounting and financial and non-financial
disclosure
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
OECD Principle V
C - An annual audit should be conducted by an independent,
competent and qualified, auditor in order to provide an external
and objective assurance to the board and shareholders that the
financial statements fairly represent the financial position and
performance of the company in all material respects.
D - External auditors should be accountable to the shareholders and
owe a duty to the company to exercise due professional care in the
conduct of the audit.
E - Channels for disseminating information should provide for equal,
timely and cost-efficient access to relevant information by users.
F - The corporate governance framework should be complemented
by an effective approach that addresses and promotes the
provision of analysis or advice by analysts, brokers, rating
agencies and others, that is relevant to decisions by investors,
free from material conflicts of interest that might compromise the
integrity of their analysis or advice.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Efficient Market Hypothesis
 Theoretical foundation for importance of disclosure
 Developed by prof. Eugene Fama (University of Chicago) as an
academic concept in 1965; refined in 70’s
 Theory about how securities are priced and about the question if
anyone can (in the long run) outperform the market
 Three forms of efficiency:
 Weak form: examines whether securities prices fully reflect past information. If they do
 technical analysis cannot be used to outperform the market
 Semi-strong form: deals with publicly available information (financial statements and
economic forecasts) and whether security prices fully reflect this information. If true,
superior security returns cannot be achieved through fundamental analysis.
 Strong form: security prices reflect all information. If true, even inside information
(insider trading) won’t work for superior returns.
 Until the beginning of the 90’s, EMH was the fundament of the theory
of financial markets.
 Today still influental, although heavily critized:
 EMH says the “market is always right”: Really?
 EMH assumes a majority of rational players on the market: Are humans really rational?
 Whether EMH is right or not, the basis for any form of efficency is the
availability of information about the issuers
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Warren Buffet on market efficiency...
“I’d be a bum on the street with a tin cup if the
markets were efficient ...
Investing in a market where people believe in
efficiency is like playing bridge with someone
who has been told it doesn’t do any good to
look at the cards.”
Warren Buffett
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Importance of Disclosure
DISCLOSURE IS
IMPORTANT FOR:
INVESTORS
International Burch University, May 27th, 2013
ECONOMY IN
GENERAL
ISSUERS
“CG, Reporting & Disclosure”, Almir Mirica
Importance for investors
 During the investment decision:


Financial information: basis for all valuation models (fundamental valuation, ratio
analysis etc)
Non-financial information: assesment of the overall business risks of the
company (e.g. higher risk  higher required rate of return)
Special importance for company analysts and rating agencies

“Investing without research is like playing poker without looking at the cards.” (Peter Lynch)

 Importance for shareholders


Without timely and accurate information about the business operations no
control of the management is possible
How to exercise voting rights on the Shareholder’s Assembly without proper
information?
 Decreasing information assymetry between investors


Decreased risk for investors for trading with better-informed (inside) investors 
information and transaction costs are reduced
Higher liquidity (and value) of company shares, which is important for the
shareholders.
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Importance for the Economy
 Information: “Lifeblood” of the capital markets
 Lack of information  Lack of investors  Smaller liquidity, higher volatility
higher market risk  higher risk premium required by investors  higher financing
costs for issuers
 If the market functions, the economy’s scarce resources are efficiently allocated
 Strong transparent disclosure regime is pivotal for market-based monitoring
of companies
 Weak disclosure can contribute to unethical behaviour and loss of market
integrity, costing not only company but economy as a whole.
 Connection between the quality of the corporate governance regime and
the economical development of the country
 Robert M. Bushman i Abbi J. Smith : “Transparency, Financial Accounting
Information and Corporate Governance” (2003)
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Importance for issuers
 Disclosure and reporting requirements are generally seen as an additional
burden for the company
 However, a transparent and pro-active approach to disclosure is in the
interest of the company.
 “Closed” company:
• Difficult to gather capital through issuance of securities
• Investors avoid investing in “black box” companies
 Transparent, open company:
• Ensures the critical mass of trust between the company and (potential) investors
• Decreased costs of adverse selection increases the interest of investors  higher
liquidity of the issuers securities
• Higher liquidity decreases the costs of external financing
• Price of security can be a control mechanism for the managment of the company
• McKinsey’s Emerging Markets Investors Opinion Survey 2001: investors would pay a
premium of up to 30% for a well governed, transparent company.
 In B&H, most financing needs of companies are met by bank loans
 Issuer still do not see the need for a more transparent approach vis-a-vis the investors
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Documents of Disclosure
 Annual Report
 “Glossy Annual Report”, contains CEO message to shareholders; financial report with auditor’s
opinion (internal and external auditor); information about the Supervisory Board and Managment
Board members; overview of the operations of the company in the last year.
 Periodic financial reports (annual, semi-annual and quarter-reports)
 Balance sheet
 Income statement
 Cash-Flow Statement
 Auditor’s Report
 Managment Discussion and Analysis of financial condition and results of operations(MD&A)
 Prosepectus
 Required before issuing securities
 Fundament for the investment decision
 Contents defined by regulator and stock exchange
 Price sensitive information (Ad Hoc Disclosure)
 All information which can affect the price of the security (information which relates to the financial
and legal position of the issuer, affects the capital structure etc.)
 Disclosure in a way which treats all shareholders / investors equally
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Importance of non-financial information
 Company Book Value ≠ Company Market Value
 Especially pronounced with “knowledge companies”
 Baruch Lev (1996): Market value of average Wall Street company is 40%
higher than its book value; high tech companies: more than 50% higher market
valuation
 Proof that the market values intangible assets
 Traditional accounting cannot adequately quantify intangible assets
 Double negative effect on the balance sheet
 Intangible assets: rare verbal defintions; mainly defined through
classifications
1. Leonard N. Stern School of Business: classification according to
GAAP:
- Narrow definition: “nonphysical sources of probable future economic benefits to an
entity that have been acquired in an exchange or developed internally from
identifiable cost, have a finite life, have market value apart from the entity, and are
owned or controlled by the entity”
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Importance of non-financial information
 6 classes of intangible assets






General: goodwill (e.g. beneficial relations with government – Goldman Sachs)
Brand equity: capacity of brands to sustain and encourage economic demand and other
market capabilities such as advertising (e.g. Coca Cola)
Intellectual capital: including trade secrets, internally developed computer software,
drawings; intellectual property (patents, trade names, trademarsk, copyrhights)
Structural capital: relationship with employees, leadership, organisational capacity...
Customer equity: customer lists and customer based intangibles, customer loyalty
Supplier relations: equity interest in suppliers, contracts...
2. Classification according to Roos et al (1997):
Overall Value
Financial
Capital
Intelectual
Capital
Human
Capital
International Burch University, May 27th, 2013
Structural
Capital
“CG, Reporting & Disclosure”, Almir Mirica
Corporate Governance,
Transparency & Disclosure in
the Federation of BosniaHerzegovina
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Low adoption of CG Principles
The mass-privatization programm resulted very often in “insider
entrenchment”, with limited or no changes in the managment
practices
 High information asymmetry is in their interest
Failure to maximise shareholders’ value
 Modern principles of corporate governance are not widely adopted
 Majority owners often fail to acknowledge the seperation of the
ownership and the control function in the company
 Independent members of Supervisory boards are rarely appointed
 Members of the Supervisory boards represent the interests of those
shareholderholder who appointed them
 Profits are often not distributed to all shareholders, but extracted
through affiliated companies; in extreme cases: asset stripping
 State as an owner does not follow corporate governance principles
 “We are the state” vs. State as majority shareholder
 Dividends are first paid to majority owner (state), then to the rest?!
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Ongoing battle for more transparency
 “Socialist heritage”: Different function of financial reports in the
socialist economy
 Financial reports are often regarded as “top secret”
 Fosters inside trading
 Repels domestic and foreign investors
 Low market liquidity
 Unfavourable conditions for company development through the market
Until 2005:
 Only the most persistent investors could get financial reports from companies
 Legal obligation of issuers to submit their annual & semi-annual financial
reports to the AFIP’s (Sarajevo and Mostar) in PAPER FORM
 Ad-hoc informations has to be published in daily newspapers
2005:
 SASE signs commercial contract with AFIP’s in order to receive annual and
semi-annual financial reports from the issuers and publish them on its web-site
 SASE engages professional clipping-service and publishes ad-hoc information
on its web-site
 Many issuers fail to send their reports to AFIP or publish it in the newspapers
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Ongoing battle for more transparency
2007:
 Securities Commission enacts Bylaw on information disclosure; requires
more disclosure by companies
 Low effects, as the Securites Law does not proscribe sanctions
Today
 Issuers must publish their annual and semi-annual financial report in two ways:
 Electronic,full form: deliver it to SEC and SASE
 Short form: for publishing in daily newspapers, obliged to send publication proof to the
SEC
 Price-sensitive information must be published in daily newspapers and sent to
the SEC and SASE
 Result: Issuers either publish only the short form, only the electronic form, or they
do not publish anything
 September 2011: SASE delists 410 low-liquidity securities of non-transparent
issuers from the market and enacts strict disclosure rules
 Issuers who do not meet the disclosure requirements are demoted to the lower market
sub-segment and eventually delisted from the market
 SASE also created a disclosure manual for issuers, explaining them what is to be
published at which time and distributed it to the issuers
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Ongoing battle for more transparency
 What are the reasons for the low transparency?
 Lack of information: Issuer should, but do not know what their
obligations are
 Lack of sanctions for not disclosing information
 High costs for preparing and publishing information
 Starting from July 1st, 2013
 Last changes in Securities Market Law proscribe hefty penalties
for lack of disclosure
 New Disclosure Bylaw does not require publication in
newspapers
• Publication on company web-site AND on SASE web-site
• Significant cost reduction for issuers
• Streamlined publication procedures
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
Final words...
 “Corporate Governance” is a process, not a state
 On paper, Enron had a model board (“Chief Executive”
magazine ranked it as one of the Top 5 Corporate Boards in
the USA in 2000)
“If companies focus their thinking and communications on
short-term results or short-term stock market consequenes they
will, in large part, attract shareholders who focus on the same
factors. And if they are cynical in their treatment of investors,
eventually that cynicism is highly likely to be returned by the
investment community”
(Warren Buffett, CEO
Berkshire Hathaway)
 There is hope: Capital has no memory, it will flow where is
sees reward and understands the risks
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica
LOGO
THANK YOU FOR YOUR ATTENTION!
International Burch University, May 27th, 2013
“CG, Reporting & Disclosure”, Almir Mirica