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LAN030414ZXI865-2351-ZXI
Capital Markets Governance of Corporates: How Can Capital Markets Exert Better Governance on Corporates
5th Annual Financial Markets and Development ConferenceApril 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.
Bob Felton, McKinsey & Company, Inc.
CONFIDENTIAL
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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
*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
Percentage of investors
Eastern Europe/Africa
Latin America
Asia
North America
Western Europe
2002
How important is corporate governance* relative to financial issues, e.g., profit performance and growth potential, in evaluating which companies you will invest in?
15
16
18
43
44
66
61
50
41
40
18
21
7
15
45
2000
20
33
36
25
32
44
39
39
48
23
25
36
Less important
Equally important
More important
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CORPORATE GOVERNANCE IS NOW AN ESTABLISHED INVESTMENT CRITERION
Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
Decrease/increase holdings in certain companies
Avoidance of certain companies
Avoidance of certain countries
Decrease/increase holdings in certain countries
Percentage of investors selecting this option; multiple responses possible
How does corporate governance affect your investment decision?
31
28
57
63
“Our investment group would never approve an investment in a company with bad governance”
– U.S. investment manager, $20 billion private equity fund
“‘Good governance’ is a qualitative cut-off criteria”
– Analyst, $62 billion European Asset Manager
“I simply would not buy a company with poor corporate governance”
– CFO, $ 3 billion European Private Bank
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6Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
A SIGNIFICANT MAJORITY OF INVESTORS SAY THEY ARE WILLING TO PAY A PREMIUM FOR A WELL-GOVERNED COMPANYPercentage of investors
Western Europe
Asia
North America
Latin America
Eastern Europe/Africa
2002
78
78
76
76
73
22
22
24
24
27
2000
81
89
81
83
19
11
19
17
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THE AVERAGE PREMIUM INVESTORS WOULD BE WILLING TO PAY DIFFERS BY COUNTRY . . .Average percent
Source: McKinsey investor opinion survey
18
20
22
24
26
28
30
0Anglo-Saxon
U.S.
U.K.
Asia
Japan
Indonesia
Korea
ThailandMalaysia
Taiwan
Continental Europe
Italy
Switzerland
Germany
France
Spain
Latin America
ChileArgentina
MexicoBrazil
ColumbiaVenezuela
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8
245
138
106
72 65
120
42
Market cap per GDP (%)
KOREA’S EQUITY MARKET SIGNIFICANTLY UNDERDEVELOPED AND UNDERPERFORMING
Japa
n
U.K.
U.S.
Ger
man
y
Fran
ce
Korea
Significantly undersized equity market compared to leading economies
Bench
mar
k
aver
age
Source: Bloomberg; EIU; McKinsey analysis
Equity market capitalization comparison*June 2001
Underdeveloped
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COMPOSITION OF PRIVATE SECTOR LIABILITIES, 1997 Percent
Source: Bank for International Settlements; International Monetary Fund; International finance Corporation (IFC); International Federation of Stock Exchanges (FIBV); World Bank
25
44 4855 56
76 77 7787
25
5151
29
42
16 18 168
50
5 1
16
28 5 7 5
Bank loans
Bonds
Equity
U.S. Hong Kong Taiwan Malaysia Singapore Indonesia China Korea Thailand
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
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TOTAL RETURN TO SHAREHOLDERS: S&P 500 VS. KOSPI
Source: Datastream; McKinsey analysis
0
100
200
300
400
500
600
'91 11/2001
1991-2001, percent
S&P500 : 13.0% per annum return
KOSPI : -3.8% per annum return
1991-2001
• $100 invested in the S&P500 index would be worth $340
• However, $100 invested in the KOSPI index would only be worth $68
• Korean shareholders have been seriously unrewarded for their investments
Poor performance over time
‘96
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3.48
2.48 2.382.05 2.05
2.25
0.96
MARKET-TO-BOOK COMPARISON
U.S. U.K.JapanFrance Germany Korea
June 2001, ratio*
*Sum of 2001 market cap (January-June) divided by sum of book value (2000)
Source: Bloomberg; McKinsey analysis
Bench-mark average
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PE RATIO COMPARISONJuly-Dec 2001, ratio*
*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
Korea’s PE ratio is significantly lower than that of other countries
2826
2422
19
24
9
Japan U.K.U.S.Germany France KoreaBench-mark average
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June 2001, PE ratio INDUSTRY PE COMPARISON*
*Only compared for those industries in which Korean companies operate
Source: Bloomberg; McKinsey analysis
Tel
eco
mm
un
icat
ion
s
Div
ersi
fied
Fin
anci
al
Ser
vice
Tra
nsp
ort
atio
n
Ele
ctri
cal C
om
po
n &
E
qu
ip
En
erg
y
Iro
n/s
teel
/bas
ic
mat
eria
lF
oo
d &
Bev
erag
eP
har
mac
euti
cals
&
Bio
tech
Ret
ail
Ch
emic
als
Au
to &
Co
mp
on
ents
Insu
ran
ce
Ban
kin
g
34
16
25
20
29
20
29 29 28
19
25
16
24
9 8 8 7 7 7 6 5 5 5 52
20
Benchmark
Korea
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MARKET VOLATILITY* OF KEY INDICES OVER THE PAST 5 YEARS (1997-2001)
*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
Percent
3835
29 29 28
21
57
41
KOS-DAQ**
KOSPI S&P 500
Kuala Lumpur
NAS-DAQ
Hang Seng***
Singa-pore Straits Times
Taiwan
The KOSPI and KOSDAQ have been most volatile, when compared to their peers in South East Asia and the United States
Highly volatile
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ENTREPRENEURS ACCESS TO CAPITAL
United States
United Kingdom
Luxembourg
Hong Kong
Netherlands
Switzerland
Singapore
Canada
New Zealand
Ireland
Germany
Australia
Finland
Sweden
Taiwan
Spain
Japan
France
Belgium
Denmark
Austria
Israel
Portugal
Chile
South Korea
Malaysia
Norway
Iceland
Thailand
Italy
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
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
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
Rank
16
17
18
19
20
21
22
23
24
25
26
27
28
28
30
Source: Milken Institute
Country Country
Ranking, 2001
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TOTAL STOCK VALUE CONTROLLED BY INSTITUTIONAL INVESTORS
Source: KSE; GAI; National Accounts; NYSE
13
29
37
51
Korea France Germany U.S.
Presence of institutional investors is a sign of an advanced equity market
2001, percent
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1. Complicated ownership structures with heavy cross-ownership
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
WHILE THESE FINANCIAL PENALTIES RESULT FROM MANY FACTORS, WEAK GOVERNANCE IS A MAJOR CONCERN
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PYRAMIDAL EQUITY OWNERSHIP
SamsungElectronics
SamsungCorpSamsung
Life Ins
Samsung Foundations
SamsungSDI
SamsungCard
Samsung Mech. Elec
Samsung Heavy Ind.
SamsungCapital
CheilTextile
HotelShilla
SamsungEverland
CheilComm.
SamsungSecurity
SamsungTechwin
SamsungF&M Ins
SamsungEngineering
SamsungPrec.Chem
S-one
Samsung group
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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”