Corporate Governance

The Initiative for Policy Dialogue

Corporate Governance Task Force Meeting

September 25, 2003

Columbia University

New York, NY

Notes taken by Tomasz Michalski.

Bolton: What is corporate governance?

This is what I picked up from the NYT on Monday. It's not very encouraging for us. (shows slide) Here's our attempt to organize a few thoughts. What are the key issues for corporate governance in developing countries? We thought we'd take a mainstream approach. This is a very widespread view in the economics profession, a very simple textbook view.... Income per capita is a function of hours worked and hourly productivity... and the view is, well, what explains higher per capita income in the west, which is about $100 per hour, the difference between the US and a developing country, which is about $2, is that the US has a bigger stock of capital.... You make those observations and you conclude from there that the main problem of development is really a problem of transferring capital from a rich to a poor country... a lack of social capital and trade barriers, and this is really the consensus....

[Neoclassical perspective on development: income per capita is a function of hours worked and hourly productivity; higher physical or human capital increases hourly productivity; the lower the trade distortions and taxes are the higher is the marginal revenue product.

According to this, the main problem of development is thus how to transfer capital from rich to poor countries. The main obstacles to development are then lack of protection of capital income, trade barriers, rule of law etc.]

Millennium Challenge Account and US policy linking corporate governance with development aid is directly inspired by this analysis.

Is protection of capital income really the panacea of economic development? How does one go about protecting capital income? What form of corporate governance, what rules should be applied? How does one solve the enforcement problem?

Protecting capital income (corporate governance rules):

a) ownership concentration;

b) debt financing and bank supervision;

c) delegation of power to boards;

d) accounting standards;

e) legal protections of small investors;

f) regulatory agencies and tax authorities.

Problems common to all solutions: who monitors the monitor? There is a possibility of potential collusion between management and the delegated monitor (block holder, auditor, director, bank)

Other constituencies: in developing countries there is a relative abundance of labor and scarcity of capital; relative abundance of unskilled labor; these may not know how to manage a firm. It is not realistic to envisage the same form of worker participation as in OECD countries. Yet employee constituency cannot be ignored altogether. There exists an interplay between politics and corporate governance.

Stiglitz: Human capital is at risk when a firm is banished. We can even view it within the capital framework.

Bolton: This is something to be discussed. In developing countries human capital is very important.

Stiglitz: In developing countries, there is something about having a job. You move to a place, you have a house and that is what still is destroyed even if you belong to the unskilled labor pool.

Bolton: The politics of enforcement:

How can better enforcement of investor protection be achieved? Should development aid finance legal enforcement? Is there a role for private enforcement?

State ownership and privatization: is there a role for state ownership? How far should privatization go? What form should privatization take? Can governance of SOEs be improved? Privatization, corporate governance and competition?

Bhattacharya: Corporate governance is also about intermediaries - financial intermediaries. We should also talk about issues of currency crises and the externalities there. What is the role of the state ownership of banks?

Stiglitz: State ownership of banks in the Czech Republic was a major problem there.

Van Dyck: State involvement more broadly speaking - such as monitoring.

Stiglitz: In thinking about corporate governance, we have public policy focus. Why do private markets not solve the problem on their own? The Chicago school of thought is that if you don't interfere with competition, etc. corporate governance is fine - there are takeover markets. It says that the problems are a result of state intervention. The other view says that there are a whole variety of market failures, and there needs to be more of a role of the regulator.

Bolton: You all got the survey that we wrote on corporate governance as part of your background material. Often this is not discussed but it is right. We need to ask is there a role for public policy and what is it? What should be left to contracting and how can it be supplemented?

Stiglitz: It is important for developing countries, because they are different from developed countries. How you answer the question could be different because the market might be more effective in developed countries.

Zingales: I see your two points are different. The need for corporate governance is implicit in the moment you say you need firms. When firms exist where price mechanisms and contracting are not efficient, we need some authority. Once you have that you need something to monitor the authority. But you must have some market in order to have firms and to have corporate governance. We need to find a [market] inefficiency to talk about government intervention but we do have a room to talk about corporate governance even without it. Developing markets are nonfunctioning so a call for authority is bigger and the scope of [intervention] is bigger. Corporate governance is very important if institutions are weak.

OECD Corporate Governance Principles and McKinsey Opinion Surveys

OECD principles of corporate governance were formulated 1999 and are under revision.

It is widely seen as an international norm in corporate governance.

Summary protect shareholder rights, treat shareholders equitably, protect