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CORPORATE GOVERNANCE IN SOUTH EAST EUROPE

BUCHAREST, 20 - 21 SEPTEMBER, 2001

Session 2

Ownership Structures and corporate governance framework in South East Europe

by: Mathilde Mesnard

Consultant, Corporate Affairs Division

OECD

mathilde.mesnard@oecd.org

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Objectives

The main objectives of this paper/presentation:• Illustrate the main common characteristics and differences among South East

Europe countries

• Identify main issues and difficulties regarding corporate governance practices

• Clarify which are the areas for which we do not have enough information

The major challenge is the comparative perspective:• We do not have the same level of knowledge and information on all countries

This first assessment will have to be completed, refined, detailed and even corrected by:

- this session’s discussants - the whole Roundtable process

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Structure

Objectives and Structure

Part 1: Background landscape

A new political era

An improved macroeconomic climate

Recent progress in privatisation and foreign investment

Part 2: The corporate governance framework

Ownership structures

Financial sector

The legal framework

Part 3: Main issues in corporate governance: first assessment

Shareholders’ rights

Equitable treatment

Transparency and disclosure

Board responsibilities

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Background Landscape

A new political era

• Fundamental political changes in Croatia and more recently in Yugoslavia have broken their international isolation

• Positive evolution, but still remaining problems, tensions and unrest in Bosnia-Herzegovina, FYROM and Kosovo

• Less radical changes in remaining SEE countries, where democratic elections brought to power new parties or coalitions that do not question the reform path

(except in Albania, where the same party was recently reelected, although election results are being contested)

• Most SEE countries are now targeting EU integration

This favorable political climate may facilitate regional cooperation on economic issues

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Background Landscape

An improved Macroeconomic climate

• Different transition trajectories but common factors explaining lagging transition• Growth has turned positive throughout the region. The SEE region has not yet

been hit by the economic slowdown• Nevertheless, SEE has not caught up with pre-transition levels. The average GNP per

capita in SEE is less than 10 % of the EU average, and the gap is widening.• Macro stability has occurred in almost all countries, except in Romania, even

though there are still large government deficits and problematic external position sustainability

• Overall, all SEE countries underwent high rise in unemployment, sharp decrease in living standards and increased inequality

A stabilized, though fragile macro economic climate and a new growth, but the bulk of industrial restructuring remains to be done

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Background Landscape

-35-30-25-20-15-10

-505

101520

Albania Bulgaria Croatia

FYR Macedonia Romania

GDP Growth 1989 - 2000

Sources: EBRD Transition Report 2000 and Investment Profiles 2001

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Background Landscape

020406080

100120140

GDP 1999 / 1989

Source : EBRD Transition Report 2000 (Except for Yugoslavia, it is industrial output, from Alpha Bank Monthly Economic Update)

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Background Landscape

CPI Inflation 1995 - 2000

Sources: EBRD Transition Report 2000 and Investment Profiles 2001

-10

0

10

20

30

40

50

60

70

1995 1996 1997 1998 1999 2000

Albania Bulgaria

Croatia FYR Macedonia

Romania

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Background Landscape

0

2000

4000

6000

8000

10000

12000

B-H

Albania

Russia

Bulgar

ia

Roman

ia

FYR Mac

edon

ia

Latv

ia

Lithu

ania

Eston

ia

Slovak

Rep

ublic

Poland

Croat

ia

Hunga

ry

Czech

Rep

ublic

Sloven

ia

GDP per Capita in 1999 in US D

Source: EBRD Transition Report 2000

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Background Landscape

Recent progress in privatisation and foreign investment

• Progress in privatisation and methods used have a significant impact on corporate governance practices

• Privatisation programs have taken various forms but have had in common to begin late and to be still in progress

• Further improvement in macro economic performances and a continuation or acceleration of privatisation programs would at the same time trigger and be facilitated by f10oreign investment

• Untill now, SEE ranked badly in terms of foreign investment, especially FDI

Acceleration in industrial restructuring and effective increase in foreign investment requires the second stage set of reforms, i.e. building the institutional foundations of a market economy, of which corporate governance is a key element

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Background Landscape

0

5000

10000

15000

20000

25000

Graph 6: Cumulated FDI, 1989 – 1999, in US D

Source: EBRD Transition Report 2000

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Background Landscape

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Graph 7: Cumulated FDI per Capita, 1989 – 1999, in US D

Source: EBRD Transition Report 2000

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Corporate governance framework

Ownership structures

• Ownership structures in SEE share three main characteristics:– the significant ownership by insiders (managers and employees)– the importance of remaining state ownership and control (especially regarding big utilities)– the emergence of institutional investors, mainly former privatisation funds

• These three common characteristics engender specific problems and difficulties regarding corporate governance practice and will be addressed during this or subsequent Roundtables

• Changes are in process with strong common trends: – increased concentration in individual companies. This derives from:

• initial excessive ownership dispersion

• inability or great difficulty for minority investors to have their rights respected

– de-listing of public companies– formation of holding companies on the basis of former privatisation funds

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Corporate governance framework

The Financial Sector / The banking sector

• The financial sector is a strategic but often weak sector in SEE

• Major banking crisis happened in the second half of the 90’s:– they resulted from poor banking supervision and mounting bad debts

– they were very costly

– remedies have been changes in the regulatory frameworks (mainly improved banking supervision) and privatisation (mainly through sales to foreign banks)

• This resulted in a significant increase of foreign capital in the banking sector (from 50 % in Romania to 85 % in Croatia)

• Further concentration is expected in the banking sector

• SEE economies are characterized by the very low level of banking intermediation– regarding international standards

– regarding their stage of development

– in comparison with other European transition countries

• This low intermediation level can be explained by numerous, obvious and well-known reasons

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Corporate governance framework

The Financial Sector / Stock Exchanges (1)

• Stock exchanges in SEE have been created early on in the transition, but really became operational and regulated by Securities Commissions in the second half of the 90’s

• They usually enjoy a good technical and legal infrastructure

• SEE Stock Exchanges remain quite under-developed, with low capitalisation and low liquidity. Moreover, the bulk of their capitalisation derives from the most flexible market segments (except in Croatia)

• They were created as privatisation devices. The initial trading was linked to re-distribution of property and they remain mainly secondary markets dedicated to these functions.

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Corporate governance framework

The Financial Sector / Stock Exchanges (2)

• Their under-development derives from the lack of demand, but also and perhaps first of all from the lack of supply– lack of large companies with substantial free-float– lack of interest from companies in being listed, as:

• they are too small to bear unnecessary and costly listing requirements constraints• given the low liquidity, the cost of capital is high • they may be reluctant to disclose information

• Consequently, SEE Stock Exchanges are not able to fulfil their traditional roles: – they are not a source of funding for enterprises (very limited number of IPOs)– they are not a disciplining mechanism through the take-over threat– they do not provide adequate information nor fair valuations

there is a current tendency to de-list

• What could possibly give an impulse to SEE Stock Exchange development ?– The recently launched Pension Reforms– Regional cooperation may be a necessary step

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Corporate governance framework

The Legal Framework

• Laws themselves are usually of good quality, as reflected in the EBRD “extensiveness” legal indicators

– Company laws have been adopted at an early stage of the transition– Securities laws have been adopted later in conjunction with the development of financial markets– Bankruptcy laws have been adopted quite recently

• One of the main drawbacks of this legal framework has been in a few cases the discrepancies between civil law based company laws and more common law based securities laws

• Recent or current improvements of the legal framework have been undertaken

• But the main difficulty lies in implementation, as reflected in the EBRD “effectiveness” legal indicators. The underlying fundamental difficulty is in the judicial and administrative system able to enforce the law

This discrepancy between the corporate governance framework and effective corporate governance practices is the main challenge

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Main Issues in Corporate Governance Practices

Shareholders Rights

• Access to information on ownership structure

• Information on shareholders meetings

• Clear provisions concerning voting procedures during the AGM

• Capacity for shareholders to vote in absentia, by proxy or mail

• Rights to receive dividends

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Main Issues in Corporate Governance Practices

Equitable Treatment

• Dilution of minority stakes during capital increases

• Fair treatment of minority shareholders in case of de-listing

• Related parties transactions

• Insider dealing and self-trading

• Possibility of legal redress

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Main Issues in Corporate Governance Practices

Transparency and disclosure

• Accounting and auditing standards

• Easy access for shareholders to Financial Statements and capital structure

• Enforcement power of Securities Commissions

• Information on material events

• Information on conflicts of interests

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Main Issues in Corporate Governance Practices

Responsibilities of the Board

• Understanding of the Board’s role

• Independence of Board members

• Nomination process allowing representation of minority investors

• Disclosure of material interests

• Transparency on Board practices and compensation