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CONFIDENTIAL
Capital Markets Governance
of Corporates: How Can
Capital Markets Exert Better
Governance on Corporates
Bob Felton, McKinsey & Company, Inc.
5th Annual Financial Markets and Development Conference
April 14-16, 2003
This report is solely for the use of client personnel. No part of it may be
circulated, quoted, or reproduced for distribution outside the client
organization without prior written approval from McKinsey & Company.
This material was used by McKinsey & Company during an oral
presentation; it is not a complete record of the discussion.
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OVERALL, GOVERNANCE REFORM IS KEY TO IMPROVED
ECONOMIC CONDITIONS IN EMERGING ECONOMIES
1. Emerging economies suffer major penalties due to
weak governance and other market factors
2. Important barriers inhibit movement to improved
governance
3. A combination of strong legal/regulatory reform and
“free market” supervision appropriate path forward
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EMERGING ECONOMIES SUFFER MAJOR PENALTY DUE
TO WEAK GOVERNANCE AND OTHER MARKET FACTORS
1. Quality of governance important factor in investment
decisions
2. Investor say they are willing to pay a premium for
good board governance
3. This survey information is supported by financial
analysis
4. This lack of robust capital markets leads to weak and
unstable corporate financial structures
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GOVERNANCE REMAINS IMPORTANT COMPARED TO
FINANCIALS, PARTICULARLY IN EMERGING MARKETS
Less important
Percentage of investors
More important
2002
Equally important
2000
Eastern Europe/Africa
15
Latin America
16
66
18
Asia
18
61
21
45
North America
43
Western Europe
44
40
50
41
7
15
20
32
48
33
44
23
36
39
25
25
39
36
How important is corporate governance* relative to
financial issues, e.g., profit performance and growth
potential, in evaluating which companies you will invest in?
* Defined as effective boards of directors; broad disclosure, and strong rights and equal treatment for shareholders
Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
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CORPORATE GOVERNANCE IS NOW AN
ESTABLISHED INVESTMENT CRITERION
“Our investment group would never
approve an investment in a company
with bad governance”
How does corporate
governance affect your
investment decision?
– U.S. investment manager,
$20 billion private equity fund
Percentage of investors selecting this option;
multiple responses possible
Avoidance of certain
companies
63
Decrease/increase holdings
in certain companies
Avoidance of certain
countries
Decrease/increase holdings
in certain countries
“‘Good governance’ is a qualitative
cut-off criteria”
– Analyst, $62 billion
European Asset Manager
57
31
28
“I simply would not buy a company
with poor corporate governance”
– CFO, $ 3 billion
European Private Bank
Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
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A SIGNIFICANT MAJORITY OF INVESTORS SAY THEY ARE
WILLING TO PAY A PREMIUM FOR A WELL-GOVERNED COMPANY
Percentage of investors
2002
2000
Western Europe
78
22
Asia
78
22
North America
76
24
81
19
Latin America
76
24
83
17
Eastern Europe/Africa
73
27
Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
81
89
19
11
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THE AVERAGE PREMIUM INVESTORS WOULD
BE WILLING TO PAY DIFFERS BY COUNTRY . . .
Average percent
30
28
Venezuela
Columbia
26
Indonesia
Thailand
Malaysia
Korea
24
22
Brazil
Mexico
20
Argentina
Chile
Italy
Germany
Taiwan
Japan
France
Spain
18
Switzerland
U.S.
U.K.
0
Latin America
Source: McKinsey investor opinion survey
Asia
Continental Europe
Anglo-Saxon
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KOREA’S EQUITY MARKET SIGNIFICANTLY
UNDERDEVELOPED AND UNDERPERFORMING
Underdeveloped
Equity market capitalization comparison*
June 2001
245
Market
cap per
GDP (%)
138
120
106
72
65
42
Source: Bloomberg; EIU; McKinsey analysis
Significantly
undersized
equity
market
compared to
leading
economies
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COMPOSITION OF PRIVATE SECTOR LIABILITIES, 1997
Percent
In 2000,
Korea
improved to
55% bank
loans, 25%
bonds, and
20% equity
In 2000, U.S.
changed to 50%
equity, 35% bonds,
and 15% bank loan
5
1
2
8
5
7
16
18
16
16
Equity
50
42
51
51
5
8
29
87
Bonds
76
25
44
Bank
loans
48
55
77
77
China
Korea
56
25
U.S.
Hong Kong
Taiwan
Malaysia
Singapore Indonesia
Source: Bank for International Settlements; International Monetary Fund; International finance Corporation (IFC);
International Federation of Stock Exchanges (FIBV); World Bank
Thailand
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TOTAL RETURN TO SHAREHOLDERS: S&P 500 VS. KOSPI
Poor performance over time
1991-2001, percent
S&P500 : 13.0%
per annum
return
600
1991-2001
• $100 invested in the
500
S&P500 index would
be worth $340
400
• However, $100
invested in the KOSPI
index would only be
worth $68
KOSPI : -3.8%
per annum
return
300
200
• Korean shareholders
have been seriously
unrewarded for their
investments
100
0
'91
Source: Datastream; McKinsey analysis
‘96
11/2001
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MARKET-TO-BOOK COMPARISON
June 2001, ratio*
3.48
2.48
2.38
2.05
2.05
2.25
0.96
U.S.
France Japan
Germany U.K.
* Sum of 2001 market cap (January-June) divided by sum of book value (2000)
Source: Bloomberg; McKinsey analysis
Bench- Korea
mark
average
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PE RATIO COMPARISON
July-Dec 2001, ratio*
28
26
24
24
22
19
9
Japan
Germany
U.S.
France
U.K.
Korea’s PE
ratio is
significantly
lower than that
of other
countries
Bench- Korea
mark
average
* Sum of market cap divided by sum of forecasted earnings
** Companies whose market cap combines to account for 80% of total country market cap; excludes outliers
(companies whose PE ratios were 3 standard deviations away from country average)
Source: Bloomberg; McKinsey analysis; I/D/E/C
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INDUSTRY PE COMPARISON*
Benchmark
Korea
June 2001, PE ratio
34
29
29
29
28
25
25
20
20
20
24
19
16
16
9
8
8
7
7
7
6
5
5
5
5
2
* Only compared for those industries in which Korean companies operate
Source: Bloomberg; McKinsey analysis
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MARKET VOLATILITY* OF KEY INDICES
OVER THE PAST 5 YEARS (1997-2001)
Highly volatile
Percent
57
41
38
35
29
29
28
21
KOSDAQ**
KOSPI
Kuala
NASLumpur DAQ
Hang
Singa- Taiwan
Seng*** pore
Straits
Times
The KOSPI and
KOSDAQ have
been most volatile,
when compared to
their peers in
South East Asia
and the United
States
S&P
500
* The relative rate at which the price of a security/index moves up and down, found by calculating the annualized
standard deviation of day-over-day differences in daily price charge
** KOSDAQ 50 was developed on Jan. 4, 1999; thus only the last 3 years have been provided for this index
*** Hang Seng Composite Index was developed on Jan. 3, 2000; thus only the last 2 years have been provided for
this index
Source: Bloomberg
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ENTREPRENEURS ACCESS TO CAPITAL
Ranking, 2001
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Country
United States
United Kingdom
Luxembourg
Hong Kong
Netherlands
Switzerland
Singapore
Canada
New Zealand
Ireland
Germany
Australia
Finland
Sweden
Taiwan
Source: Milken Institute
Score
5.72
5.63
5.59
5.58
5.49
5.46
5.36
5.25
5.14
5.10
5.09
5.08
5.04
5.02
5.00
Rank
16
17
18
19
20
21
22
23
24
25
26
27
28
28
30
Country
Spain
Japan
France
Belgium
Denmark
Austria
Israel
Portugal
Chile
South Korea
Malaysia
Norway
Iceland
Thailand
Italy
Score
4.90
4.85
4.81
4.79
4.78
4.77
4.74
4.74
4.72
4.64
4.63
4.62
4.56
4.56
4.54
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TOTAL STOCK VALUE CONTROLLED BY INSTITUTIONAL INVESTORS
2001, percent
51
37
Presence of
institutional
investors is a
sign of an
advanced equity
market
29
13
Korea
France
Germany
Source: KSE; GAI; National Accounts; NYSE
U.S.
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WHILE THESE FINANCIAL PENALTIES RESULT FROM MANY
FACTORS, WEAK GOVERNANCE IS A MAJOR CONCERN
1. Complicated ownership structures with heavy crossownership
2. Weak minority shareholder rights
3. Conflicted boards of directors
4. Weak and intransparent financial reports and limited
reporting to international standards
5. Impediments to takeover activity
6. Weak investor relations practices
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PYRAMIDAL EQUITY OWNERSHIP
Samsung group
Samsung
Life Ins
Samsung
Electronics
Samsung
Mech. Elec
S-one
Samsung
Corp
Cheil
Comm.
Samsung
SDI
Samsung
Heavy Ind.
Samsung
Everland
Hotel
Shilla
Samsung
Prec.Chem
Samsung
Foundations
Samsung
Card
Samsung
Security
Samsung
F&M Ins
Samsung
Techwin
Cheil
Textile
Samsung
Engineering
Samsung
Capital
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A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE
MARKET” SUPERVISION APPROPRIATE PATH FORWARD
1. Important legal projections necessary
–Clean up ownership structure, probably by establishing legal
framework for holding company
–Strengthen minority shareholder rights
–Remove barriers to hostile takeovers, including foreign
investors
–Regulate third-party transactions
–Hold management and directors accountable for
illegal/inappropriate activities
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A COMBINATION OF STRONG LEGAL/REGULATORY
REFORM AND “FREE MARKET” SUPERVISION
APPROPRIATE PATH FORWARD (CONTINUED)
2. Improve regulatory activities
–Require majority of directors to be independent,
especially on audit committee
–Mandate that financial reporting complies with
international standards; demand transparency and
periodic reporting
–Install consistent, aggressive, and effective regulatory
enforcement
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A COMBINATION OF STRONG LEGAL/REGULATORY
REFORM AND “FREE MARKET” SUPERVISION
APPROPRIATE PATH FORWARD (CONTINUED)
3. Encourage companies to improve investor relations for all
shareholders*
–More transparency
–More open about risks/challenges
–Encourage Q&A
–More CEO-led discussions
–Give investors advance notification about meeting dates
–If listed globally, make announcements after markets open
–Install information-rich Web sites
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A COMBINATION OF STRONG LEGAL/REGULATORY
REFORM AND “FREE MARKET” SUPERVISION
APPROPRIATE PATH FORWARD (CONTINUED)
4. Work to improve quality of director pool
–Director pool often weak in emerging markets
–Important to establish training/recruiting
programs to develop adequate supply of strong
directors
–Consider non-executive certification program
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HOWEVER, GOVERNMENTS SHOULD RESIST
TEMPTATION TO MICROMANAGE PRIVATE SECTOR
1. Establish limited, focused legal/regulatory framework . . .
and enforce aggressively
2. Ensure transparency of financials and independence of
boards
3. And let free market provide disciple and “regulation”
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