“does corporate governance matter for publicly listed ... · “does corporate governance matter...

OECD Conference on Intellectual Asset-Based Management

“Toward Innovation and Sustainable Growth”

“Does Corporate Governance Matter for Publicly Listed Company Shareholders?”

Tokyo, Japan December 8, 2006

Roland BurgmanAssetEconomics, Inc.

530 BroadwayNew York, NY 10012

© All rights reserved.

Public company shareholders benefit from good governance (perceived &/or measured) … some research examples …

Credit Lyonnais Securities Asia, and Asian Corporate Governance Association & Credit Lyonnais Securities Asia studies (2000, 2001, 2002, 2003, 2004, 2005 and 2006)

McKinsey & Co., e.g., Felton, Hudnut & van Heeckeren(1997), Barton, Felton & Song (2000), Coombes & Watson (2000), Newell & Wilson (2000), Hoschka, Nast & Villinger(2000), Hoschaka ( 2000), Campos, Newell & Wilson (2002), Barton, Coombes & Wong (2004)

Independent studies, e.g., Gugler, Mueller and Yurtoglu(2001), Gompers, Ishii and Metrick (2001)

Reviews, e.g., Melvil and Hirt (2004), Burgman (2005), Eisenhofer and Levin (2005)


Returns from good governance … some CLSA results (1)

“Companies with high scores in our corporate governance survey have much more resilient share prices during market downturns.

Those with weaker governance see their shares collapse when market turmoil results in a higher discount for mismanagement. Transparency, accountability, independence, fair treatment of

minorities, management discipline and responsibility – key features of good governance – are crucial in assessing and reducing

investment risk in emerging markets.

Stocks with good governance have significantly outperformed – over the past three years, the average return of our sample was 170%,

but the top 30 stocks for good governance provided an average return of 370% and the bottom 30 returned an average 113%. The out performance of these stocks has become more pronounced in

more recent years.”

CLSA, 2000, p. 1


“… for the five markets ranked in the lower half of our country rankings for macro CG determinants - Indonesia, Philippines, China,

Thailand and Malaysia - the top-quartile CG companies outperformed over one, three and five years against the country

average. For 2002, the top-quartile CG companies outperformed the average of the quartiles in these five markets by 5.6ppts, by a much wider 24.1ppts over three years and by an impressive 53.9ppts over

five years. Companies in the top half for CG in these markets outperformed the bottom half by 11.4ppts in 2002, and by 23.4ppts over three years and 57.8ppts over five years. The bottom-quartile CG companies underperformed the respective country averages for

these five markets by more than double the underperformance of the overall sample of ten markets - whether for one, three or five years. Over the past five years, for instance, the underperformance of the

bottom CG quartile was minus 57.8ppts for the five poorer CG markets, versus minus 25.1% for the whole basket of markets

covered.”

CLSA, 2003, pp. 6-7

Returns from good governance … some CLSA results (2)


Content of corporate governance

Any top-down analysis of a company’s governance will include structure; policies, processes and procedures; and conduct of:

Voting rights

Shareholder meetings

Board of directors

External auditor

Audit committee

Internal controls

Management of risk

Disclosure of material information


What is good governance? Good governance is a relative concept … with both international and local interpretations

Equity-based (e.g., U.S.A.)

Debt-based (e.g., Germany)

Social responsibility-based (e.g., Sweden)

State Owned Enterprise-based (e.g., China)

Family-based (e.g., Singapore) / Familial-based (e.g., Italy)


Three types of business reporting

1. Financial Statement reporting required by listing bodies, e.g., Form 20F (annual report filings for foreign registrants in the U.S., 8-K disclosures (material write-offs or changes), Form 10-K (annual report filings for U.S. listed companies)

2. Compliance reporting required by legal and regulatory authorities, e.g., pharmaceutical companies and Federal Drug Administration New Drug Application (NDA) in the U.S., chemical manufacturing companies and U.S. Environmental Protection Agency (EPA)

3. Elective reporting, e.g., intellectual capital reporting, triplebottom line reporting, corporate social responsibility reporting, environmental and sustainability reporting


Value Chains1 create value by transforming inputs into products (e.g., Toyota Motor Corporation, Nike Inc.)

Value Shops create value by mobilizing resources to create individual solutions to customer problems or exploit market opportunities (e.g., Apache Corp., Harrah’s Entertainment Inc.)

Value Networks create value by mediating exchanges between their customers (e.g., eBay Inc., FedEx Corporation)

Three business model archetypes and their value logics

Note:1. For further on Chains, shops and networks see Thompson (1967), Stabell &

Fjeldstad (1998) and Harris & Burgman (2005)


Business Model Value Logic

Chain Shop Network

Asset Lite

Accenture

IBM

Infosys Technologies

Coca Cola Company

Marsh & McLennan

Avon Products

Yum Brands

EDS

Pixar Animation

Trump International

Apache Corp.

Intuit

Goldman Sachs (M&A)

Macquarie Bank (infrastructure investment)

SubSea Resources

eBay

Marriott Hotels

Apple (iMusic)

Reuters

Microsoft

American Express (Cards)

Amazon (2nd hand)

London Stock Exchange

Asset Heavy

Toyota Motor

Amazon (new)

Dow Chemical

Merck

Nike

Sara Lee

Best Buy

McDonald’s (owned)

Boeing Company

Apple (iPod)

Harrah’s

Amgen

Convergys

MGM Mirage

Walt Disney Company

Bovis Lend Lease

FedEx

Southwest Airlines

Dubai World Ports

New York Times

Starwood Hotels

J.B. Hunt Transport

AT&T

Club Meditterranee

Fixed Physical Resource or Asset Intensity


Good governance … where am I? And what does mean for reporting to the market?

Governance Model

Business Model

Equity-based Governance

Model

Debt-Based Governance

Model

Social Responsibility

-based Governance

Model

State Owned Enterprise-

based Governance

Model

Family-based or Familial-

based Governance

Model

Value Chain

Value Shop

Value Network


If governance & business reporting are inextricably bound … what to report, when, to whom, and why?

For shareholders to benefit from good governance, listed companies need to have capital markets understand their business models

For value shops and value networks, financial statement reporting is insufficient for valuation determination …information on operational and intellectual capital value drivers is also needed

What information, under what conditions?


Enterprise ValueReporting

FinancialReporting

OperationalReporting

TraditionalOperationalReporting

IntellectualCapital

Reporting

Operational and intellectual capital reporting in context1

Note:1. For further on the reporting architecture for operational and intellectual

capital reporting see Burgman & Roos (2007)


How much choice about this? Existing & emerging global regulations in relation to financial reporting will contribute but not realize their primary objectives.

Global & Emerging RegulationsUSA: SOXJapan: J-SOX

UK: Combined CodeFrance: LSF

Italy: 231 & 262

Sweden: Corporate CodeSwitzerland: Swiss Code

EU: 4th, 7th & 8th DirectivesBrazil: Governanca Corportiva

Russia: Order No. 04-1245India: Clause 49

China: SASAC Directive

Australia: CLERP 9Global: BASEL II

etc.

Primary ObjectivesIncreased investors’ trust

Increased management responsibility & accountability

Increased transparency

Reduced number of financial surprised and related business failures

More reliable financial reporting

Reference:Ernst & Young LLP, 2006, Leveraging Value from Internal Controls, Ernst & Young EYGM Limited, p. 3


RelativeBenefit

Relative Cost

Low

Medium

High

Medium

Low High

“Und

er Rep

ortin

g”Zo

ne

“Ove

r Rep

ortin

g”Zo

ne

“Bala

nced

Rep

ortin

g”Zo

ne

Incremental operations and intellectual capital information value = relative benefit (to users) / relative cost (to users) …


Improved insight into operations

More information introduced into valuation estimates

More comprehensive investment decision-making

Greater correspondence between share price and enterprise intrinsic value

Reduced share price volatility

Reduced responsibility for over or under valuation vis-à-vis intrinsic value

Improved strategic advantage through transparency

Consistency with principles-based reporting

Increased trust built in relationship with investors

Better legal protection of intellectual capital (including IP)

Extra costs involved in data gathering and information disclosure by company

Disclosure as a two-edged sword (less private insight – real or otherwise and the paradox that the more information is provided, the more investors believe may be being withheld)

Providing competitively usable information when competitors are not so providing (disclosure asymmetry)

Changes to IT & reporting systems

More extensive data gathering procedures

Changed reporting protocols (including ‘continuous’ post-reporting event reporting)

Increased potential for shareholder law suits

Benefits

Costs

Users Providers

Considerations in providing operating and IC information … for users and providers


Effort to Gather/Provide Information to Users

0% 100%

Use

fuln

ess

of In

form

atio

n to

Use

rs*

0%

100%

* Usefulness is defined in terms of content quality relevant for those who have form a view about the investment value of the entity

1. 2.

Legend:1. Statuary financial

accounts compliance disclosure SOX; risk-oriented MD&A, minimum content in Forward Looking Statements (FLS)

2. Integrated Operational & Intellectual Capital (O & IC) value driver focused reporting in MD&A and FLS with comprehensive value driver O & IC information and performance metrics consistently provided over time

Information usefulness/effort ratios for publicly listed company valuation determination … Where are we? Where should we be?


Summary

WHAT do we need: An Enhanced Business Reporting (EBR1) framework incorporating adequate operating & intellectual capital information to complement financial reporting conditioned by the relevant (i) governance model jurisdictions and (ii) business model type

WHY do we need it: Financial reporting does not provide sufficient information to information users to make reasonable investment decisions for all business models

HOW do we do it: Adopt (something like) the EBR framework enabled by eXtensible Business Reporting Language (XBRL2) technology and relevant operating reporting and intellectual capital taxonomies

WHEN do we do it: As enabling conditions are in place, (i) regulation to require consideration of EBR based on the legal concept of neglect, (ii) a framework for reporting, and (iii) standard definitions and measures

WHERE do we do it (first): In developed economies where (i) non-manufacturing business models are increasingly important to the national economy, (ii) reporting requirements and compliance therewith bycompanies are advanced (iii) the enabling technology is available and able to be integrated easily into companiesNotes:1. The EBR framework is available in more detail at the Enhanced Business Reporting

Consortium web site at http://www.ebr360.org/2. Information on XBRL is available at http://www.xbrl.org/Home/

http://www.ebr360.org/

http://www.xbrl.org/Home/


EBR Consortium

Enhanced Business Reporting

"Greater transparency in business reporting is needed to help strengthen our economy and protect investors. The Enhanced Business Reporting Consortium is working to develop the tools that companies can use to communicate the information that is most important to their stakeholders."

David M. WalkerComptroller General of the United States

U.S. General Accounting Office


C. Resources & Processes

C.1 Resources & Processes Summary C.2 Resource Form

C.2.a Monetary CapitalC.2.b Physical Capital

C.2.c Relationship (Social) CapitalC.2.d Organizational (Structural) Capital

C.2.e Human CapitalC.3 Key Processes

C.3.a Develop Vision & StrategyC.3.b Manage Internal ResourcesC.3.c Manage Products & Services

C.3.d Manage External RelationshipsC.3.e Manage Governance & Risks

B. Strategy

B.1 Corporate Strategy SummaryB.2 Vision & Mission

B.3 Goals & ObjectivesB.4 Corporate Strategy

B.5 Business Unit StrategiesB.6 SWOT/s

B.7 Business Portfolio

A. Business Landscape

A.1 Business Landscape SummaryA.2 Economic

A.3 Industry AnalysisA.4 Technological Trends

A.5 PoliticalA.6 Legal

A.7 EnvironmentalA.8 Social

D. Performance

D.1 Performance SummaryD.2 GAAP-based

D.3 GAAP-derivedD.4 Industry-based

D.5 Company-specificD.6 Capital market-based

Enhanced Business Reporting

Framework

The Enhanced Business Reporting Framework

Appendix“Duty of Care”


Duty of care as a legal and possible regulatory construct

The legal criterion that can be drawn upon within a principles-based reporting environment for determining what operating and intellectual capital information should be provided to users can be drawn from the legal test for negligence. Elements of negligence testing are, inter alia:

Gravity of harm – the potential damage from not knowing what could have been know

Likelihood or risk

Cost to prevent

Duty of care

Standard of care

Gross departure from standard of care


Key concepts

Duty of care, standard of care and gross departure from standardof care (and gross negligence) are industry specific concepts and argue for an industry or sub-industry approach to the issue –rather than for a firm-level approach or even a general approach to this aspect of reporting

Duty of care for an organization will describe the relationship between the parties and sets the level of responsibilities owed from one to the other

Standard of care for an organization will mean that which organizations of comparable size and sophistication do under thesame circumstances

Neither gross departure from standard of care, nor gross negligence, nor standard of care have any meaning in the absence of duty of care

Duty of care (to investors) is the key concept for operational and IC reporting

Appendix“References”


References (1)

Barton, Dominic and Ryan Song, 2003, McKinsey/KIOD Survey on Corporate Governance, McKinsey & Co, January, Pp. 19

______________, Paul Coombes and Simon Chiu-Yin Wong, 2004, “ Asia’s Governance Challenge”, The McKinsey Quarterly, Number 2, pp. 55-61

Brown, Lawrence D. and J. Mack Robinson, 2004, Corporate Governance and Firm Performance, Georgia State University, December 7, Pp. 53

Burgman, Roland J., 2005, Corporate Governance and Market Performance – A Review of the Empirical Literature, Organizational Compliance & Ethics Group, Pp. 28, http://www.oceg.org/Default.aspx

_______________ and Göran Roos, 2007, “The Importance of Intellectual Capital Reporting: Evidence & Implications”, Journal of Intellectual Capital, Vol. 8, Issue 1, forthcoming

Campos, Carlos E.; Roberto E. Newell and Gregory Wilson, 2002, "Corporate Governance Develops in Emerging Markets", McKinsey on Finance, McKinsey & Company, pp. 15-19

Coombes, Paul and Mark Watson, 2000, "Three Surveys on Corporate Governance", The McKinsey Quarterly, Number 4, pp. 74-77

Credit Lyonnais Securities Asia, 2000, The Tide’s Out: Who’s Swimming Naked, CLSA, October, Pp. 78

_________________________, 2001, Corporate Governance in Emerging Markets: Saints and Sinners, Who's got Religion?, CLSA, April, Pp. 224

_________________________, 2002, Make Me Holy … But Not Yet!, CLSA, February, Pp. 128

http://www.oceg.org/Default.aspx


References (2)

Credit Lyonnais Securities Asia & Asian Corporate Governance Association, 2003, Fakin’ it –Board Games in Asia, CLSA/ACGA, May, Pp. 104

___________________________________________________________, 2004, Spreading the Word: Changing Rules in Asia, CLSA/ACGA, September, Pp. 132

___________________________________________________________, 2005, The Holy Grail: Quality at a Reasonable Price, CLSA/ACGA, October. Pp. 100

Eisenhofer, Jay W. and Gregg S. Levin, 2005, Does Corporate Governance Matter to Investment Returns?, Corporate Accountability Report, Bureau of National Affairs, Pp. 11

Felton, Robert F. and Mark Watson, 2002, “Change Across the Board”, The McKinsey Quarterly, Number 2, pp. 31-45

Gompers, Paul A., Joy L. Ishii and Andrew Metrick, 2001, Corporate Governance and Equity Prices, Harvard University and National Bureau of Economic Research, July, Pp. 70

Gugler, Klaus, Dennis C. Mueller and B. Burcin Yurtoglu, 2001, Corporate Governance, Capital Market Discipline and the Returns on Investment, University of Vienna, Discussion Paper FS IV 01-25, December, Pp. 59

Harris, Jeanne G. and Roland J. Burgman, 2005, “Chains, Shops and Networks: The Logic of Organizational Value”, Accenture Research Report, May, Pp. 6


References (3)

Hoschka, Tobias C., 2002, "A Market for the Well Governance", The McKinsey Quarterly, Number 2, pp. 26-27

________________, George R. Nast and R. Villigner, 2002, "Better Boards in Thailand", The McKinsey Quarterly, Number 2, pp. 23-26

McKinsey & Co., 2005, $118 Trillion and Counting: Taking Stock of the World’s Capital Markets, McKinsey Global Institute, October, Pp. 163

Melvil, Colin and Hans Hirt, 2004, Corporate Governance and Performance, Hermes Pensions Management Limited, December, Pp. 8

Newell, Roberto and Gregory Wilson, 2002, "A Premium for Good Governance", The McKinsey Quarterly, Number 3, pp. 20-23

Stabell, Charles B. and Oystein D. Fjeldstad, 1998, “Configuring Value for Competitive Advantage: On Chains, Shops and Networks”, Strategic Management Journal, Vol. 19, pp. 413-437

Thompson, James D., 1967, Organizations in Action: Social Science Bases of Administrative Theory, New York: McGraw Hill, see pp. 15-17

Rivet Software, PR Newswire & EDGAR Online, Inc., XBRL: Leveraging Effective Corporate Governance for Efficient, Transparent Reporting and Return on Investment, White Paper, April, Pp. 10

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