Corporate Governance
Content
Good corporate governance contributes to a company’s competitiveness and reputation, facilitates access to capital markets, and thus helps develop financial markets and spur economic growth. With this in mind, the International Finance Corporation Corporation and the U.S. Department of Commerce have combined their efforts to provide Russian managers, directors, and shareholders with a practical tool to implement good corporate governance practices – the Russia Corporate Governance Manual. This Manual refers to and is based on the principal laws and regulations that apply to open joint stock companies. It follows the recommendations of the FCSM’s Code of Corporate Conduct and refers to internationally accepted principles of good corporate governance.
The Th e Ru Russia
Corporate Governance
“Corporate governance is vital to the interests of every economy, and government has a role to play in establishing the framework for reform - but it is companies that have the tough job of putting governance reform into practice. This is where the Corporate Governance Manual can provide excellent help. It offers a comprehensive workbook for company directors, officers, and advisers in taking up the challenge of corporate governance improvement. Shareholders and stakeholders alike should applaud IFC for bringing practical, and professional advice within reach of every boardroom.” Anne Simpson, Manager, Global Corporate Governance Forum “Corporate governance reform in Russia is the continuation of the more general processes of change affecting the country as a whole. Taken together, these developments have created a new environment, new rules regulating the relationships between the market and regulators, between shareholders, shareholders and managers, etc. In the business community there is a growing awareness of the benefits of corporate governance reform, and comp anies are now working on improving the quality of their corporate governance ...” ...” Ruben K. Vardanian, President of Troika Dialogue; Chairman of the Board,
Manual
I
Part I
Corporate Governance Introduced
OJSC Rosgosstrakh; and Chairman of the RSPP Corporate Governance Committee “Good corporate governance is a key driver of financial transparency and managerial accountability, essential ingredients for national prosperity in a global economy. We congratulate the U.S. Department of Commerce and the International Financial Corporation of the World Bank for their initiative in bringing about the publication of the Russia Corporate Governance Manual.” Andrew B. Somers, President, American Chamber of Commerce in Russia Questions on corporate governance should be addressed to the IFC Russia Corporate Governance Project, via [email protected]
An electronic version of the Manual is available on the website of the International Finance Corporation under www.ifc.org/rcgp and the U.S. Department of Commerce under www.mac.doc.gov/ggp
Prepared and Published by the International Finance Corporation and the U.S. Department of Commerce In Partnership with the Agency for International Business and Cooperation of the Dutch Ministry of Economic Affairs and the Swiss State Secretariat for Economic Affairs
The Russia
Corporate Governance
Manual Part I
Corporate Governance Introduced P r e p a r e d a n d P u b l i s h e d b y t h e I n t e r n a t i o na na l F i n a n c e C o r p o r a t i o n and the U.S. Department of Commerce In Partnership with the Agency for International Business and Cooperation of the Dutch Ministry of Economic Affairs and the Swiss State Secretariat for Economic Affairs
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First edition: 10,000 copies in Russian, 1,500 copies in English. Published in 6 Parts Printed in Moscow, Russia. ISBN 5-9614-0085-9
Copyright © 2004 International Finance Corporation 2121 Pennsylvania Ave. NW, Washington, DC 20433, United States of America A Member of the World Bank Group Design copyright © 2004 Alpina Business Books All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, for commercial purposes without the prior permission of the International Finance Corporation.
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Disclaimer The Russia Corporate Governance Manual (Manual) is distributed with the understanding that neither the authors, nor the organizations and countries they represent, nor the publisher is engaged in rendering legal or financial advice. The material in this Manual is set out in good faith for general guidance, and no liability can be accepted for loss or expense incurred as a result of relying on the information contained herein. This publication is is not intended to be exhaustive. exhaustive. While the utmost care has been taken in preparing the Manual, it should not be relied upon as a basis for formulating business decisions. On all financial issues and questions, an accoun accounttant, auditor, or or other financial financial specialist should be consulted. A lawyer should be consulted on all legal issues and questions. As the laws laws in the Russian FedFederation are constantly changing, legal rules referred to herein may be obsolete or superceded by new legislation at the moment of the publication of this Manual. References to laws and regulations in this Manual reflect those in effect as of
March, 2004. All references to the male gender throughout this Manual apply to both sexes, unless otherwise indicated. Any views in this Manual are those of the authors and do not necessarily represent the views of the governments of the Netherlands, Switzerland, or the United States; or the U.S. Department of Commerce, the International Finance Corporation, or the World Bank Group. This Manual is distributed subject to the condition that it shall not, by way of trade or otherwise, be lent, re-sold, hired out, or otherwise circulated on a commercial basis without the International Finance Corporation’s prior consent. An electronic version of the Manual is available on the Website of the International Finance Corporation under www.ifc.org/rcgp, as well as the U.S. Department of Commerce under http://www.mac.doc.gov/ggp.
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“Russia has a strategic goal: to become a country that makes competitive goods and renders competitive services. services. All our efforts are committed committed to this goal. We understand that we have to solve questions pertaining to the protection of owners’ rights and the improvement of corporate governance and financial transparency in business in order to be integrated into world capital markets.” President Vladimir Putin at a Session of the World Economic Forum, Moscow on 30 October 2001
“All successful companies are successful in the same way. All unsuccessful companies are unsuccessful in different ways.” Adapted from Leo Tolstoy’s “Anna Karenina”
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The Importance of Good Corporate Governance for Russia During the last decade, policy makers, regulators, and market participants around the world have increasingly come to emphasize the need to develop good corporate governance policies and practices. An increasing amount of empirical evidence shows that good corporate governance contributes to competitiveness, facilitates corporate access to capital markets, and thus helps develop financial markets and spur economic growth. Today, both domestic and foreign investors place an ever greater emphasis on the way that corporations are operated and how they respond to their needs and demands. Investors are increasingly willing to pay pay a premium for for well-governed well-governed companies that adhere to good board practices, provide for information information disclosure and financial transparency, and respect shareholder rights. We Well-governed ll-governed companies are also better positioned to fulfill their economic, environmental, and
social responsibilities, and contribute to sustainable growth. Improvement in corporate governance practices can improve the decisionmaking process within and between a company’s governing bodies, and should thus enhance the efficiency of the financial and business operations. operations. Better corporate governance also leads to an improvement in the accountability system, minimizing the risk of fraud or or self-dealing by company officers. officers. An effective effective system of governance should help ensure compliance with applicable laws and regulations, and further, allow companies to avoid costly litigation. Also, Russian companies should stand to benefit from a better reputation and standing, both at home and this in the It is with in international mind that thecommunity. International Finance Corporation — a member of the World Bank Group — the U.S. Department of Commerce, and the governments of the Netherlands and Switzerland have combined their efforts to provide Russian open joint stock companies with a practical tool to implement good corporate governance practices. practices. The Russia Corporate Governance Governance Manual outlines structures and procedures for establishing and maintaining effective corporate governance, governance, and shows how the various parts of of a company interact. In addition, model internal corporate documents and other practical tools are annexed to assist companies in implementing the many recommendations made throughout this Manual. The Manual targets those individuals individuals directly involved involved in the governgovernance of Russian companies (Russian shareholders, directors, and managers) and
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The Russia Corporate Governance Manual
is designed to inform them of their respective rights and responsibilities within the corporate system. As most of Russia’s large and mid-size enterprises were privatized into open joint stock companies, this Manual refers to and is based on the principal laws and regulations that apply to open joint stock companies. In addition, it follows the recommendations of the Russian Code of Corporate Conduct, developed under the auspices of the Federal Commission for for the Securities Securities Market. Finally, the Manual refers to generally accepted international principles of corporate governance. We at the International Finance Corporation and U.S. Department of Commerce look forward to continued cooperation with Russian companies, market participants, government authorities, and other stakeholders in advancing ongoing corporate governance reforms. reforms. A concerted effort can move move the corporate governance debate from theory to practice, helping Russia in its progress toward a better business and economic environment.
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Donald L. Evans Secretary of Commerce U.S. Department of Commerce
James D. Wolfensohn President World Bank
Peter L. Woicke Executive Vice President International Finance Corporation
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Forward by the Federal Service for Financial Markets The development of financial markets in Russia is inseparably linked to corporate governance reforms. reforms. The quality of corporate governance is one of the key factors affecting the country’s investment climate. Political and macroeconomic stability in Russia have resulted in high rates of economic growth and have created a favorable environment for Russian businesses to shift their strategic focus from short-term to long-term development. Positive changes have also occurred in the legal and regulatory corporate governance framework. framework. New regulations provide for for better shareholder rights protection, protection, establish new rules for conducting General Meetings of Shareholders, and significantly nificant ly improve improve information disclosure regimes. The national corporate governance standards set forth in the Code of Corporate Conduct have established a comprehensive benchmark for analyzing corporate governance practices and for-
mulating standards of corporate ethics. Compliance with the provisions of the Code of Corporate Conduct will make companies more transparent and thus attractive to potential investors. Recent developments demonstrate that corporate governance improvements are beginning to be viewed by Russian companies as an important method to gain a competitive advantage. Compliance with corporate law and provisions provisions of the Code of Corporate Conduct is a necessary precondition for the companies to participate in the capital markets and, as a result, reduce their cost of capital. The Federal Service for the Financial Markets considers the translation of corporate governance principles into company practices as one of its most important tasks. The Russia Corporate Governance Manual, developed by the International Finance Corporation and the U.S. Department of Commerce, allows Russian companies to better understand the economic value of good corporate governance, and recommends practical steps that companies may take to improve their corporate governance. I am confident that the publication of this Manual will help many Russian companies fulfill their goals and raise capital in financial markets. O.V. Vjugin, Head of Federal Service for the Financial Markets
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Forward by the Ministry of Economic Development and Trade The to improve corporate governance is one of key challenges faced by Russian need business today. Better corporate governance, inthe addition to improved improv ed economic performance, allows companies to reduce their financial and operational risks, and significantly raises their attractiveness to investors. That is why the government of the Russian Federation works systematically to improve the corporate governance framework framework for Russian companies. Over the period from 2001 to 2002 two fundamental corporate governance documents were published in Russia: the Code of Corporate Conduct and the White Paper on Corporate Governance. The Code of Corporate Conduct is a summary of the key principles of best corporate governance practices, setting a standard for Russian companies on how to develop their own system of corporate conduct and providing practical recommendations on how to implement these principles. The White Paper on Corporate Governance in Russia, published by the OECD together with the Russian Ministry of Economics, offers an overview of the exist-
ing state of corporate governance in the country and presents recommendations for policy makers and legislators, as well as best practices for the private sector. The publication of these documents came as a result of a comprehensive analysis of corporate governance standards and practices both in Russia and the developed economies of the West, and marked an important milestone of Russia’s integration into the global economy The Russia Corporate Governance Manual pays significant attention to the recommendations of both the Code of also Corporate Conduct and the Paperofonthe Corporate Governance in Russia, and provides comments on White a number most important provisions of said documents. At the same time the Manual takes into account not only the practices of Russian joint stock companies and the specifics of the national stock market, but also the experience of many other developed and emerging economies. The Manual further further offers a vast number of practical examples based on corporate governance practices of many large and well-known international companies. An international team of Russian and Western experts from the World Bank’s International Financial Corporation prepared the Manual. Well known scholars, businessmen, specialists in finance, stock market and corporate corpo rate law, including experts from the Ministry of Economic Development and Trade of the Russian Federation, participated in the preliminary discussion and reviews of the publication. We believe that this Manual will help raise awareness of important corporate governance issues, assist our companies in strengthening their competitive position, and become a useful tool for implementing international standards of corporate governance in Russian companies. German Gref, Ministry of Economic Development and Trade
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About the U.S. Department of Commerce The U.S. Department of Commerce (USDoC) seeks to increase trade opportunities for U.S. companies and promote U.S. exports and investment. Weak rule of law, lack of adequate intellectual property rights protection, and corruption create barriers to trade, investment, and overall economic development, particularly in emerging markets. To address these concerns and establish a level playing field for U.S. companies, USDoC created a Good Governance Governance Program. Currently, the Program is engaged engaged in activities in 11 countries in the Caucasus, Central Asia, Eastern Europe, Latin America, and Russia. The Program works works with the private and public sectors sectors in promoting sustainable sustainable reform in the following four program areas: • • • •
Business Ethics/Anti-Corruption; Commercial Dispute Resolution; Corporate Governance; and Intellectual Property Rights.
The Good Governance Program encourages fairness, transparency, and accountabi accountability lity in corporate governance practices in emerging market economies by engaging in cooperative programs with private sector organizations and by establishing a private-public sector dialogue. In Russia, the Program supported efforts efforts of several several non-governmental organizations (NGOs) to develop an Independent Director Code and a Declaration of Princi-
ples of of the Profe Professio ssional nal Commu Community nity of of Corporat Corporatee Director Directors s . The Program conducts intensive “train-the-trainer” programs that provide select professionals the skills and expertise to implement good business and corporate governance practices at all levels, including companies, business associations, NGOs, stock exchanges, and educational institutions.
About the International Finance Corporation
The International Finance Corporation (IFC) is a member of the World Bank Group. IFC was established in 1956 to encourage private sector activity in developing countries. It does this primarily through three types of activities: financing private sector projects, helping companies in the developing world to mobilize financing in international financial markets, and providing advisory services and technical assistance to companies and governments. IFC is a leader among multilateral financial institutions in integrating corporate governance considerations into all phases of the investment investment process. IFC’s long history of and practical experience in structuring investments, appraising investment opportunities, and nominating board members has allowed it to put corporate governgover nance principles into action. A focus on good corporate governance governance practices in client companies allows IFC to manage risks and add value to its clients. In addition to to the benefits to individual client companies, working to improve corporate governance,
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contributes more broadly to IFC’s mission to promote sustainable private sector investment and strengthen capital markets in developing countries. The IFC Russia Corporate Governance Project (RCGP) is a technical assistance project within the framework of the IFC Private Enterprise Partnership that aims to improve corporate governance governance practices in Russia. Its four main objectives are to: • • • •
Assist Russian companies in implementing corporate governance through corporate trainings, consultations, and assessments, and thus facilitate their access to outside capital; Advise public sector officials on legislative and regulatory reform reform in corporate governance; Develop curricula for universities and other educational institutions to help train the next generation of managers, investors, and policy makers; and Support key institutions institutions and change agents, including the press and NGOs to help help build sustainable practices and raise awareness.
About the Swiss State Secretariat for Economic Affairs The Swiss State Secretariat for Economic Affairs (seco) is the Swiss government’s department in charge of economic policy. In terms of foreign trade policy, seco is active in shaping efficient, fair, and transparent rules for the world economy. Seco represents Switzerland in the large multilateral trade organizations as well as in international negotiations. negotia tions. Seco is also involved in efforts to reduce poverty in the form of economic development development assistance. Its development development cooperation division is the competence center for sustainable economic development and the integration of develdeve loping and transition countries and their companies into the global economy. Seco included corporate governance in its economic development assistance programs in 2000. Its overall overall support for the IFC Private Enterprise Partnership and its RCGP is one such example of development assistance.
About the EVD, the Agency for International Business and Cooperation of the Dutch Ministry of Economic Affairs The Agency for International and isCooperation is part of the Dutch Ministry of Economic Affairs. Business Its mission to promote (EVD) and encourage international business and international cooperation. As a state agency and a partner to businesses and public-sector organizations, the EVD aims to help them achieve success in their international operations. A growing network of organizations, government government institutions, and companies have come to rely on the EVD for information about foreign markets, governments, and trade and industry. Many of them do benefit from the financial programs, previously run by Senter Internationaal and now administered by the EVD.
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PREFACE Background In April 2002, the USDoC and IFC, in partnership with Senter Internationaal and seco, agreed to jointly and cooperatively develop, publish, and distribute a corporate governance manual for for open joint stock stock companies in Russia. Russia. This effort effort was initiated by and undertaken in cooperation with the Federal Commission for the Securities Market, the Ministry of Economic Development and Trade, the American Chamber of Commerce in Russia, the Russian Institute of Directors, the Independent Directors Association, and the Investor Protection Association. The RCGP along with the USDoC’s Good Governance Program coordinated
the development of this Manual. Representative Representativess from the private private sector, regulators, educational institutions, international organizations, the Russian government, and others provided feedback through a series of roundtables and public commentary. In total, six six roundtables were were organized in cooperation with leading Russian organizations active in the field of corporate governance, and the Manual Man ual was placed on the internet for further public public commentary. The result of this inclusive consultation process is guidance that meets the needs of business, is practical in nature and easy to use, and provides detailed insight into the evolving Russian corporate governance system.
Purpose and Target Audience This Manual provides executives, directors, and shareholders of Russian open joint stock companies with a comprehensive summary of the corporate governance framework framew ork and practices prevalent in Russia today, and a practical toolkit designed to help implement good governance governance in practice. It provides provides readers with: •
•
An overview of the legislative and regulatory requirements related to corporate governance, as well as references to the Federal Commission for the Securities Market’s Code of Corporate Conduct (FCSM Code) and internationally recognized corporate governance principles; Recommendations on how how to fulfill the governance obligations of open joint stock companies;
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•
Practical examples of how corporate governance standards can be implemented, and guidance for executives and directors in meeting their obligations with respect to the governance of the enterprise; and
•
General outlines of authorities, obligations, and procedures procedures of the governing bodies of open joint stock companies.
This Manual also provides government officials, lawyers, judges, investors, and others with a framework for assessing the level of corporate governance practices in Russian companies. Finally, it serves serves as a reference reference tool tool for the educational institutions that will train the next generation of Russian managers, investors, and policy makers on good corporate governance practices.
How to Use this Manual This Manual has been divided into and is published in six parts: Part Part Part Part Part Part
I: II: III: IV: V: VI:
Corporate Governance Introduced Good Board Practices Shareholder Rights Disclosure and Transparency Special Focus Section Annexes
The first four parts contain chapters that focus on core corporate governance issues, such as a company’s board structure, information disclosure practices, and shareholder rights. Part five focuses on corporate corporate governance governance issues of particular importance in the Russian context, namely corporate governance concerns during a company’s reorganization, within holding structures, and relating to enforcement. Part six, finally, offers practical tools in the form of model documents, for example company codes, by-laws, by-laws, and contracts. All issues are closely examined examined through Russian law and regulations, the FCSM Code and, when applicable, internationally internationally recognized best practices. While it is recommended to read the entire Manual to gain a full understandunderstan ding of the corporate governance framework in Russia, it is not necessary to read all the chapters in chronological order. The reader is encouraged to begin with with a topic of interest and follow the links and references included in the text for gui dance to other chapters.
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Examples, illustrations, and checklists are included to make the Manual clear and useful. The following tools will reappear at various intervals in the text: •
The Chairman’s Checklist is intended to help the Chairman of the Supervisory Board focus Board discussions on key corporate governance issues faced faced by companies. The Chairman’s Checklist ✓
Does the the company company have a clear distribution distribution of authority between between shareholders, Supervisory Supervisory Board members and managers? Has the company properly established an Executive Board
✓
Do the General Director and all members of the Executive Executive Board possess the knowledge and skills necessary to manage the company? Is there a transparent division of tasks among the members of the Ex-
ecutive Board, such as operations, marketing, finance, legal, etc.?
•
Best Practices summarizes the main provisions of the FCSM Code, the OECD Principles of Corporate Governance, as well as leading national standards from other countries. Best Practices: Independent directors can make a substantial contribu-
tion to important decisions of the company, especially the evaluation of executive execu tive performance and in the resolution resolution of conflicts of interest. interest. Independent Board members give investors additional confidence that the Supervisory Board’s deliberations will be free of obvious bias.101 Companies are advised to disclose information about independent Board members in the annual report.102
•
Company Practices in Russia illustrates how Russian companies currently approach corporate governance governance issues. It highlights red flags, i.e. common corporate governance abuses that occur, and model company practices in good corporate governance. Company Practices in Russia: Many Russian companies are controlled by a single shareholder or group of shareholders that are well informed about the affairs of the company and able to closely monitor the company’s management. On the other hand, the remaining ownership is often widely dispersed and many of these, often minority, shareholders lack the resources and information to effectively monitor management and defend themselves against the potential abuses of large shareholders. In these types of companies, independent directors take on special importance.
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•
Figures, tables, and other illustrations are included to illustrate key concepts. Figure 1: The Corporate Governance System Shareholders (the General Meeting of Shareholders) l a t i p a C e d i v o r P
Elect and Dismiss Represent and Report to
Directors (the Supervisory Board) Guide and Oversee Report and Answer to
y l t n e r a p s n a r T t r o p e R
Managers (the Executive Bodies) Source: IFC, March 2004 Source: IFC,
Figure 8: Ratio of Different Categories of Supervisory Board Members
Independent/Non-Independent Directors
Executive/Non-Executive Directors
% of Supervisory Board Members Source: IFC, Regional Survey on Corporate Governance Practices, August 2003
•
Mini-cases illustrate abstract concepts and show the real problems that companies face. Mini-Case 1: A company has 2,500 minority shareholders holding a total
of 3,000 voting shares and one majority shareholder holding a total of 12,000 voting shares. The Supervisory Board has nine members. The 2,500 shareholders hold 27,000 votes (3,000 shares 9 votes) and the majority shareholder has 108,000 votes (12,000 shares 9 votes). The total number of votes that all shareholders can use to elect the candidates to the Supervisory Board is 135,000 votes (9 votes 15,000 shares). shares). The nine candidates that receive the most votes are elected to the Supervisory Board.
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•
Detailed references to law and regulation guide the reader to original texts.
•
The IFC RCGP Corporate Governance Progression Matrix Companies is included in Annex 1 to allow the reader to assessfor theRussian level of corporate governance in Russian companies, c ompanies, develop areas for improvement, and measure progress made. IFC RCGP CORPORATE GOVERNANCE PROGRESSION MATRIX FOR RUSSIAN COMPANIES Level 1: Compliance with legal and regulatory requirements ✓ e c n a i l p m o
The company has developed and follows a valid charter according to Russian legislation with provisions on the protection of shareholder rights and the equitable treatment of shareholders, distribution of author-
Level 2: Initial steps to improve corporate governance are made ✓
The company has developed and follows by-laws regulating the activities and working procedures of the corporate bodies approved by the GMS (the GMS, the Supervisory Board, the Executive Board,
Level 3: Advanced corporate governance system ✓
The company has developed and follows a comprehensive set of internal documents that are recommended by the Federal Commission of the Securities Market Code of Corporate Con-
Level 4: Corporate Governance leadership ✓
The company has adopted a company level corporate governance code and code of ethics, and follows internationally recognized best practices of corporate governance.
C l a g
ity between the General Meeting of Shareholders (GMS), the Supervisory Board and executive bodies, and information disclosure and transparency of the company’s activities.
e G L C o t t n e
m t i m m o C e c i . t I
✓
n/a
c a r P y n a p m o C
and Revision Commission).
✓
✓
The company has a person/officer responsible for the implementation of corporate governance policies in the company. The company follows the main recommendations of the FCSM Code and discloses information to the FCSM on a comply or explain basis.
duct (FCSM Code) and are approved by the Supervisory Board.
✓
✓
The company has a designated office(r) responsible only for ensuring the development of, compliance with, and periodic review of corporate governance policies and practices in the company (for example, the Corporate Secretary). The company has an explicit and clearly stated plan in place to improve its governance practices and has taken initial steps to implement this plan.
✓
✓
The company has formally established a committee of the Supervisory Board responsible for supervising the governance policies and practices of the company (e.g. Corporate Governance Committee). The Company is publicly recognized as a national leader and among the global leaders in corporate governance.
Acknowledgements The preparation publication of this Manual efforts of a largeand number of dedicated people. has involved the participation and This Manual was prepared in its entirety by Dr. Davit Karapetyan (Deputy Project Manager, IFC), under the supervision of Sebastian Molineus (Project Manager, IFC) and Igor Abramov (USDoC, Good Governance Program Director). Chapter 13 was drafted by Tatiana Ivanova (Deputy Project Manager, IFC); Chapters 11, 15, and 16 by Leiden University’s Institute of East European Law and Russian Studies (Dr. Rilka Dragneva, Associate Professor and Prof. Dr. William B. Simons, Director). Chapter 17 was was drafted by Coudert Brothers LLP (Barry Metzger, Senior Partner, Derek Bloom, Partner, Dr. Kirill Ratnikov, Senior Se nior Associate, and Peter Baranovsky, Baranovsky, Paralegal). The following following people worked worked on or contributed to the development of earlier versions of this Manual, under the
supervision of Dr. Gregory Maassen (Senior Corporate Governance Specialist,
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IFC): Dr. Davit Karapetyan (Chapters 1, 2, 8, 9, 10, 12, and 14); Igor Aksenov (Chapters 4 and 5); Polina Kalnitskaya (Chapters 3, 6, and 7); Galina Efremova (Chapter 14); and Natalya Kosheleva Kosheleva (Chapter 15). The following following people people contributed to the development of the model documents contained in the Annexes: Igor Aksenov (Annexes 6, 9, 11, 13, 14, and 26); Galina Efremova (Annexes 7, 20, 26, 28, and 29); Alexander Kaleniouk (Annex 27); Polina Kalnitskaya (Annex 3, 12, and 15); Irina Krassikova (Annexes 20, 25, and 26); and Ilya Poluyakhtov (Annexes 22 and 23). The IFC and USDoC would like to thank Alexander Berg (Senior Specialist, the World Bank), Dr. Rilka Dragneva and Prof. Dr. William B. Simons (both Leiden University), Richard Frederick (Independent Consultant), Tatiana
Medvedeva (Senior Advisor on Legal Issues, Center for Capital Market Develop ment), Dr. Gunila Molineus (Associate, Salans), Motria Onyschuk-Morozov (Senior Operations Manager, IFC), and Roswell B. Perkins (Retired Partner, Debevoise & Plimpton LLP) for their in-depth reviews and invaluable comments on the entire entire Manual. This Manual benefitted benefitted greatly greatly from their contribucontributions. Further important contribution contributionss on specific chapters were received from Garry Black, Oleg Sokolov and Peter Gyarmati (Partner, Principal and Consultant, respectively, KPMG), Marc-Andreas Klein (Sr. Compensation and Benefits Officer, the World Bank), Darrin Hartzler and Desmond O’Maonaigh (Senior Program Officer and Deputy Project Manager, respectively, IFC), and Simon C.Y. Wong Wong (McKinsey & Company). The IFC and USDoC received numerous comments and suggestions, namely from Catherine Duriez, Elena Abrosimova (Senior lawyer and lawyer, respectively, EU TACIS Russia Corporate Governance Facility) and Dashko, Fianna Jesover (Administrator, OECD); andAndrei within Buthe IFC RCGP, from Karina Maria Gracheva, Natalya Arabova, shev, Andrei Kozlov, Alexander Eliseev, Maxim Titov, Alexander Kaleniouk, Natalya Sayfuranova, Ilya Poluyakhtov, Egor Paschina, Svetlana Kravchuk, Olga Anikina, Mikhail Kuznetzov, Olga Martynova, Yan Fedyanin, Irina Detochka, Nikolay Piotrovich, Piotrovich, and Paul Jude Baker. Finally, the IFC and USDoC jointly extend their gratitude to the over 50 roundtable participants that provided further comments and offered helpful suggestions. The final edit of the English version of this Manual was conducted by Richard Frederick (Independent (Independent Consultant). Paul-Jude Baker (Intern, IFC), Janet Katz (Liaison, American Bar Association, Central European and Eurasian Law Initiative),
and Elizabeth Ramborger (Good Governance Program Officer, USDoC) also made valuable contributions to the editing process. This Manual was was translated into
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Preface
Russian by Tatyana Tatyana Rybina and Olga Nikiforov Nikiforovaa (independent consultants). The translation of Annexes 3, 5, 17, 18, 24, 29, and 30 was conducted by Tatiana Govorukhina (Translator, (Translator, IFC). Maria Gracheva (Editor, IFC) also played an imporimportant role, translating Annexes 4, 8, and 9, and editing the initial translations for the roundtable discussion. discussion. IFC RCGP staff also provided provided valuable editorial comments. The final edit of the Russian Russian version of this Manual was conducted by Olga Nikiforova. This Manual was produced with the generous support from the Dutch MinMi nistry of Economic Affairs (Annelies M.L. Drost, Coordinator for International Financial Institutions, and Jasper K. Wesseling, Manager, Central and Eastern Europe, both with the Agency for International Business and Cooperation (EVD))
and the Swiss State Secretariat for Economic Affairs (Davorka Rzehak, Projects Officer, and Claude Barras, Head of Division, both with the Investment Promotion Division). Overall supportIFC) was provided provide d by Christian Grossmann (Directo (Director, r, Private Enterprise Partnership, and Mike Lubrano (Principal Financial Specialist, Corporate Governance Unit, IFC). This Manual could not have been produced without the organizational support of Elizabeth Ramborger and Zarema Arutyunova (Good Governance Program Managers, USDoC), and Anna Turina and Marina Vorobyova (Project Assistant and Communications Associate, respectively, IFC). Additional thanks go to Igor Igor Belikov (General Director, Director, the Russian Institute of Directors); Alexander Filatov (General Director, the Independent Directors Association); Alexander Ikonnikov (General Director, the Investor Protection Association); Andrew Somers (President, the American Chamber of Commerce in Russia); and Tatiana Raguzina (Senior Director for Strategic Planning and Policy, the American Chamber of Commerce in Russia); and, finally, to the American Chamber of Commerce, Russian American Business Council, and Russian Union of Industrialists and Entrepreneurs.
Igor Abramov Director Good Governance Program USDoC
Edward Nassim Director Central and Eastern Europe IFC
__________________________
_________________________
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Frequently Used Abbreviations and Acronyms Annual General Meeting of Shareholders
=
AGM
Board of Directo Directors rs
=
Supervisory Super visory Board or Board
Chairman of the Supervisory Board
=
Chairman
Closed Joint Stock Company
=
Closed Company
Collective Executive Body, Directorate, Management Board
=
Executive Board Ex
Extraordinary General Meeting of Shareholders
=
EGM
Federal Commission for the Securities Market FCSM Code of Corporate Conduct
= =
FCSM FCSM Code
General Meeting of Shareholders
=
GMS
Law on Joint Stock Companies
=
Company Law or LJSC
Limited Liability Company
=
LLC
Meeting of the Supervisory Board
=
Board meeting
Member of the Board of Directo Directors rs
=
Supervisory Board member
Non-Governmental Organization
=
or director NGO
Open Joint Stock Company
=
Company
OECD Principles of Corporate Governance
=
OECD Principles
Sole So le Exe Execu cuti tive ve Bo Body dy,, Ch Chie ieff Ex Exec ecut utiv ivee Of Offi fice cerr
=
Gene Ge nera rall Di Dire rect ctor or
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Preface
Contents PREFACE ..................... .......................................... ........................................... ........................................... ..................................... ................XI XI Background .............. ............................. ............................. ............................. .............................. ............................. ............................. ..................... ...... xi Purpose and Target Audience .............................. ............................................ ............................. .............................. ....................... ........ xi How to Use this Manual.............. ............................. ............................. ............................. .............................. ............................. ................. ... xii Acknowledgements ............... ............................. ............................. .............................. ............................. ............................. ......................... .......... xv Frequently Used Shortenings and Acronyms.............. ............................. ............................. ...........................xviii .............xviii
PART I – CORPORATE GOVERNANCE INTRODUCED
Chapter 1. An Introduction to Corporate Governance ............. ............................ .............................1 ..............1 Chapter 2. The General Governance Structure of a Company ............... ...........................2 ............27 7 Chapter 3. The Internal Corporate Documents .............. ............................. ............................. ...................... ........ 44
PART II – GOOD BOARD PRACTICES
Chapter 4. The Supervisory Board.............. ............................ ............................. .............................. .............................1 ..............1 Chapter 5. The Executive Bodies ............. ............................ .............................. ............................. .............................75 ...............75 Chapter 6. The Role of the Corporate Secretary Secretary .............. ............................ ............................. .................. ... 103
PART III – SHAREHOLDER RIGHTS Chapter Chapter Chapter Chapter Chapter Chapter
7. 8. 9. 10. 11. 12.
An Introduction to Shareholder Rights ............. ............................ ............................. ................... ..... 1 The General Meeting of Shareholders .............. ............................. ............................. ................. ... 33 Corporate Governance Implications of the Charter Capital ..............91 Dividends ............... .............................. ............................. ............................. .............................. ............................. ................ 119 Corporate Governance Implications of Corporate Corporate Securities.... Securities......... ....... 137 Material Corporate Transactions Transactions ............. ............................ .............................. ......................... ..........171 171
PART IV – INFORMATION DISCLOSURE AND TRANSPARENCY Chapter 13. Information Disclosure .............. ............................ ............................. .............................. .............................1 ..............1 Chapter 14. Control and Audit Procedures............... .............................. ............................. .............................49 ...............49
PART V – SPECIAL FOCUS SECTION Chapter 15. Corporate Governance in Groups of Companies ............... .............................. ................. .. 1 Chapter 16. Corporate Governance Implications of Reorganizations .............. ................... ..... 25 Chapter 17. Enforcement and Remedies ............. ............................ ............................. ............................. .................... ..... 51
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PART VI – ANNEXES IMPORTANT NOTE ................. .................................. ................................... ................................... ................................... ..........................1 ........1 PART I – CORPORATE GOVERNANCE INTRODUCED ....................................................3
Annex 1: Annex Annex Annex Annex
2: 3: 4: 5:
The IFC Corporate Governance Progression Matrix for Russian Companies ............................ ........................................... .............................. .............................4 ..............4 A Model Charter ................. ................................ .............................. ............................. ............................. ...................... ....... 9 Table of Charter Provisions ............... .............................. ............................. ............................. .................... ..... 41 A Model Company Corporate Governance Code ..................... ............................... ..........55 55 A Model Code of Ethics ................. ................................ .............................. ............................. ...................... ........ 73
PART II – GOOD BOARD PRACTICES .................. ................................... ................................... .................................81 ...............81
Annex 6: Annex 7: Annex 8:
Annex Annex Annex Annex
11: 12: 13: 14:
A Model By Law for the Supervisory Board ............. ............................ ......................... ..........83 83 A Model By-Law for the Supervisory Board’s Audit Committee ..... 109 A Model By-Law for the Supervisory Board’s Corporate Governance Committee ...................................... ..................................................... ............................. ................ 119 A Model By-Law for the Supervisory Board’s Nominations and Remuneration Committee ............. ............................ .............................. ............................. ................ 127 A Model By-Law for the Supervisory Board’s Strategic Planning and Finance Committee ................................ .............................................. .................... ...... 135 A Model By-Law for the Executive Bodies .................... ................................... .................. ... 143 A Model By-Law for the Corporate Secretary Secretary.............. ............................ .................... ...... 155 A Model Contract with the Non-Executive Director ............... ......................... ..........163 163 A Model Employment Contract with the General Director .............. ..............171 171
Annex Annex Annex Annex
15: 16: 17: 18:
A Model Employment Contract with the Corporate Secretary ........ ........ 183 Model Minutes for a Supervisory Board Meeting Meeting............... ............................19 .............191 1 A Model Checklist for the Supervisory Board’s Self-Evaluation .....195 .....19 5 A Model Definition of an Independent Director ............. ............................ .................. ... 199
Annex 9: Annex 10:
PART III – SHAREHOLDER RIGHTS ............... ................................. ................................... ................................... ...................201 .201 Annex 19:
A Model By-Law for the General Meeting of Shareholders ............ ............ 203
Annex Annex Annex Annex Annex
A Model By-Law on Dividends............... ............................. ............................. ............................22 .............229 9 A Model Notice of the General Meeting of Shareholders ............... ............... 235 A Model Power of Attorney (from an individual) ............... ............................23 .............237 7 A Model Power of Attorney (from a legal entity) ............... ............................23 .............239 9 Time Charts for the Preparation of the Extraordinary General Meeting of Shareholders ............. ............................ .............................. ......................... ..........241 241
20: 21: 22: 23: 24:
PART IV – INFORMATION DISCLOSURE AND TRANSPARENCY ............... ................................. ......................245 ....245
Annex Annex Annex Annex Annex
25: 26: 27: 28: 29:
A Model By-Law on Information Disclosure ............. ............................ ....................... ........ 247 A Model By-Law for the Revision Commission ............. ............................ .................. ... 263 A Model By-Law on Risk Management .................. ................................. ......................... ..........273 273 A Model By-Law on Internal Control ...................... ..................................... ......................... ..........283 283 Guidelines on the Annual Report ................ .............................. ............................. ....................... ........ 303
Annex 30:
Glossary of English-Russian Corporate Governance Terminology ............................. .............. .............................. ............................. ............................. ............................31 .............315 5
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h pter 1 Chapter
An Introduction to Corporate Governance
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Table of Contents .................................. ................................... ..........................4 ........4 A. CORPORATE GOVERNANCE EXPLAINED ................. 1. 2. 3. 4.
Defining Corporate Governance ................. .................................. ................................... .............................4 ...........4 The Role of Stakeholders ................. ................................... ................................... .................................. ....................7 ...7 A Brief History ............................ .............................................. ................................... ................................... ..........................8 ........8 The International Scope of Good Corporate Governance .....................10
5. Distinguishing Corporate Governance ...................................................11
B. THE BUSINESS CASE FOR CORPORATE GOVERNANCE ................. .................................. ..................12 .12 1. Stimulating Performance and Improving Operational Efficiency ..........13 2. Improving Access to Capital Markets................ .................................. ................................... ..................15 .15 3. Lowering the Company’s Cost of Capital and Raising the Value of Assets ...........................................................16 4. Building a Better Reputation................ ................................. ................................... .................................18 ...............18
C. THE COST OF CORPORATE GOVERNANCE ................. ................................... ................................... ..................18 .18 D. THE CORPORATE GOVERNANCE FRAMEWORK IN RUSSIA .................. ..............................20 ............20 1. 2. 3. 4.
Specifics of Corporate Governance Governan ce in Russia .................. ................................... .....................20 ....20 The Legal and Regulatory Framework............... ................................. ................................... ..................21 .21 The FCSM Code of Corporate Conduct C onduct ................ .................................. .................................23 ...............23 The Institutional Framework ................ ................................. ................................... .................................25 ...............25
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The Chairman’s Checklist ✓
Do all directors and and key executives understand the concept of of corporate corporate governance and its significance to the company and its shareholders?
✓
Has the Supervisory Board developed a clear and explicit explicit governance governance policy, and a plan to improve the company’s governance practices? Have steps been taken to implement this plan?
✓
Has the company formally formally nominated an individual, for example example the Corpo-
rate Secretary, or established a Supervisory Board committee or similar body responsible for supervising the corporate governance policies and practices of the company? ✓
Are key officers familiar with the Federal Commission for the Securities Market’s Code of Corporate Conduct (FCSM Code) and the OECD PrinciPrinci ples of Corporate Governance? Does the company follow the main recommendations of the FCSM Code and disclose information on compliance to shareholders and stakeholders in its annual report?
✓
Is the company company familiar with the main main institutions active in the field of corporate governance that can serve as external resources for the company?
Corporate governance governance has become an increasingly popular term in Russia since the late 1990s. Not only has Russia witnessed witnessed a transformation transformation in the role of the private sector in economic development and job creation, but corporate scandals, global competition, and various domestic and international efforts have made corporate governance governance a household name. Unfortunately, few companies appear to truly appreciate the depth and complexity of this topic. Indeed, corporate governance governance reforms are often introduced superficially and used as a public relations exercise rather than as a tool to introduce the structures and process that enable the company to gain the trust of its shareholders, reduce vulnerability to financial crises, and increase
the company’s ability to access capital. Introducing internal internal structures structures and processes builtison the principles of fairness, accountability, responsibility a difficult task that requires transparency, an ongoing commitment by and the company.
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The Russia Corporate Governance Manual
This chapter defines corporate governance, makes a business case for its implementation, and provides an overview of the legal, regulatory, and institutional frameworks for corporate governance in Russia today.
A. Corporate Governance Explained
1. Defining Corporate Governance There is no single definition of corporate governance that can be applied to all situations and jurisdictions. jurisdictions. The various definitions definitions that exist today largely depend on the institution or the author, as well wFederal ell as country and legal For example, a regulator such as Russian Commission fortradition. the Securities Market (FCSM) is likely to define corporate governance differently than a corporate director or institutional investor.1 The International Finance Corporation and its Russia Corporate Governance Project define corporate governance as “the structures and processes for the direction and control of companies.” The Organization for Economic Cooperation and Development (OECD), which in 1999 published its Principles of Corporate Governance offers a more detailed, definition of corporate governance as
“the internal means by which corporations are operated and controlled […], which involve a set of relationships between a company’s management, its board, its shareholders and other stakeholders. stakeholders. Corporate governance governance also provides provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and
1
The FCSM takes a broad, public sector sector view and its definition states states that “corporate gover governance nance
affects the performance of economic entities and their ability to attract the capital required for economic growth.” On the other hand, the Council of Institutional Investors, an organization of large labor and corporate pension funds whose assets exceed US$2 trillion, takes the shareholder perspective and asserts that “in general, […] corporate governance structures and practices should protect and enhance accountability to, and ensure the equal financial treatment of, shareholders.” (See also: http://www.cii.org/dcwascii/web.nsf/doc/governance_index.cm).
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Chapter 1. An Introduction to Corporate Governance
shareholders, and should facilitate effective monitoring, thereby encouraging firms to use resources more efficiently.” 2 Most definitions that center on the company itself (an internal perspective) do, however, have certain elements in common, which can be summarized as follows: •
Corporate governance is a system of relationships, defined by structures
and processes: For example, the relationship between shareholders and management consists consis ts of the former providing capital to the latter to achieve a return on their (shareholder) investment. Managers in turn are to provide shareholders with financial and operational reports on a regular basis and in a transparent manner. Shareholders also elect a supervisory body, often referred to as the Board of Directors or Supervisory Board, to represent their interests. This body essentially provides strategic direction to and control over the company’s managers. Managers are accountable to this supervisory body, which in turn is accountable to shareholders through the General Meeting of Shareholders (GMS). The structures and processes that define these relationships typically center on various performance management and
reporting mechanisms. These relationships may involve parties with different and sometimes contrastcontrasting interests: Differing interests may exist between the main governing bodies of the company, i.e. the GMS, Supervisory Board and General Director (or other executive bodies). Contrasting interests exist exist most typically between between
•
owners and managers,may and are referred to as the principal-agent 3 problem. Conflicts alsocommonly exist within each governing body, such as between shareholders (majority vs. minority, controlling vs. non-controlling,
2
OECD Principles of Corporate Governance (see also: www.oecd.org).
3
The principal-agent problem is defined as follows follows by the Oxford Oxford Dictionary of Economics: “The problem of how Person (A) can motivate Person (B) to act for (A’s) benefit rather than following his his self-interest.” In a company setting, Person (A) is the investor investor (or principal) and (B) the manager (or agent). Managers at times may follow follow different goals than investors investors (e.g. building business empires rather than creating shareholder value), act dishonestly and,
at times, even in an incompetent manner. This essentially creates three types of agency costs: (i) divergence costs (i.e. managers that do not maximize the investors’ wealth); (ii) monitoring costs (investors have to develop and implement control structures), including replacement costs; and (iii) incentive costs (costs incurred by investors to remunerate and incentivize their managers). The core role of a corporate governance governance system is to reduce total agency costs, thus maximizing the value of the company to investors.
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•
individual vs. institutional) and directors (executive vs. non-executive, outside vs. inside, independent vs. dependent); and each of these contrasting interests needs to be carefully observed and balanced. All parties are involved in the direction and control of the company: The GMS, representing shareholders, takes fundamental decisions, for example the distribution distribution of profits profits and losses. The Supervisory Board is generally responsible for guidance and oversight, setting company strategy and con-
•
trolling managers. Executives, finally, run the day-to-day day-to-day operations, operations, such as implementing strategy, drafting business plans, managing human resources, developing marketing and sales strategies, and managing assets. All this is done to properly distribute rights and responsibilities — and thus how can outside, minority increase long-term shareholder value. For example, how shareholders prevent prevent a controlling shareholder from gaining benefits through related party transactions, tunneling, or similar means.4
The basic corporate governance system and the relationships between the governing bodies are depicted in Figure 1.
Figure 1: The Corporate Governance System Shareholders (the General Meeting of Shareholders) l a t i p a C e d i v o r P
Elect and Dismiss Represent and Report to
Directors (the Supervisory Board) Guide and Oversee Report and Answer to
y l t n e r a p s n a r T t r o p e R
Managers (the Executive Bodies)
Source: IFC, March 2004 Source: IFC,
The external aspect of corporate governance, on the other hand, concentrates
on relationships between between the company and its stakeholders. Stakeholders are those individuals or institutions that have an interest in the enterprise; such an interest 4
Corporate Governance: A Framework for for Implementation, the World World Bank. See also: http:// www.worldbank.org/html/fpd/privatesector/cg/docs/gcgfbooklet.pdf.
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may arise through legislation or contract, or by way of social or geographic relationships. Stakeholders include investors, investors, but also employees, employees, creditors, suppliers, suppliers, consumers, regulatory bodies and state agencies, and the local community in which a company operates. Some commentators also include consideration of the environment as an important entry on the list of stakeholders. 2. The Role of Stakeholders
Many international codes, including the OECD Principles, discuss the role of stakeholders in the governance governance process. The role of stakeholders in governance governance has been debated in the past, with some arguing that stakeholders have no claim on the enterprise other other than those specifically set forth in law or contract. Others have argued that ,companies fulfill important social function, have This a societal impact and must, must accordingly, act an in the broad interests of society. view recognizes that companies should, at times, act at the expense of shareholders. Interestingly, there is a consensus that modern companies cannot effectively conduct their businesses while while ignoring the concerns of stakeholder stakeholder groups. However, there is also an agreement that companies which consistently place other stakeholder interests before those of shareholders cannot remain competitive over the long run. Best Practices: A key aspect of corporate governance is concerned with ensuring the flow of external external capital to firms. Corporate governance is also also
concerned with finding ways to encourage stakeholders to undertake socially efficient levels of of investment in firm-specific firm-specific human and physical capital. capital. The competitiveness and ultimate success of a corporation is the result of teamwork that embodies contributions from a range of resource providers including investors, employees, employees, creditors, creditors, and suppliers. suppliers. Corporatio Corporations ns should recognize that the contributions of stakeholders constitute a valuable resource for building competitive competitive and profitable profitable companies. companies. It is, therefore, therefore, in the long-term interest of corporations to foster wealth-creating co-operation among stakeholders. The governance framework framework should acknowledge acknowledge that the the interests of the
corporation are served by recognizing the interests of stakeholders and their contribution to the long-term success of the corporation.5
5
OECD Principles of Corporate Governance, Annotations to Principle III on the Role of Stakeholders in Corporate Governance. See also: www.oecd.org.
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The degree to which stakeholders participate in corporate governance largely depends on national laws and practices, and may vary from country to country. Employee representation on the Supervisory Board is one example of such stakeholder participation mechanisms; governance processes that consider stakeholder viewpoints for certain key decisions is another. In any event, directors and managers will want to give due consideration to this complex issue and to the stakeholders’ role in the governance of the
company. 3. A Brief History Corporate governance systems have evolved over centuries, often in response to corporate failure s or systemic crises. firstwhich well-documented well-documented failure of goverof nance was failures the South Sea Bubble in theThe 1700s, revolutionized business laws and practices in England. Similarly, much of the securities law in the U.S. was put in place following following the stock market crash of 1929. There has been no shortage of other crises, such as the secondary banking crisis of the 1970s in the U.K., U.S. savings and loan debacle of the 1980s, and, closer to home, the 1998 financial crisis in Russia. The history of corporate governance has also been punctuated by a series of well-known company failures. The early 1990s saw the Maxwell Group raid raid the pension fund of the Mirror Group of newspapers and witnessed the collapse of Bearings Bank. The new century likewise likewise opened with with a bang, with the spectacular collapse of Enron in the U.S., the near-bankruptcy of Vivendi Universal in France, and the recent scandal at Parmalat in Italy. Each of these corporate fai faillures — often occurring as a result of incompetence or outright fraud — was swiftly met by new governance frameworks, most notably the many national corporate governance codes and the Sarbanes-Oxley Act. In Russia too, much has changed since the rampant asset stripping and transfer pricing abuses that took place during the early days of transition, not to mention the abuses that took place during Russia’s two privatization phases. The 1998
financial crisis perhaps brought the harshest response. Howev However, er, the legal and regulatory framework framework has improved improved dramatically dramatically in recent years. years. The adoption of the Company Law in 1995 and its subsequent update in 2001, together with the adoption of amendments to the Law on the Securities Market in 2002, are but two examples of the many positive changes to the legal and regulatory framework. The publication of the FCSM Code certainly must be hailed as a landmark for
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Russian corporate governance, providing the first ever benchmark on this subject for Russian companies. Figure 2 illustrates some highlights in the history of corporate governance, gover nance, largely from the western world. Figure 2: A Brief History of Corporate Governance
— — — — —
1600s: The 1600s: The East India Company introduces Company introduces a Court of Directors, separating ownership and control (U.K., the Netherlands) 1776: Adam Smith in 1776: Smith in the «Wealth of Nations» warns of weak controls over and incentives for management (U.K.) 1844: First Joint Stock Company Act (U.K.) 1844: 1931: Berle and Means 1931: Means publish their seminal work «The Modern Corporation and Private Property» (U.S.) 1933/34: The 1933/34: The Securities Act of 1933 is the first act to regulate the securities markets, markets, notably registration
— —
The the 1934 Actcompany delegated responsibility for enforcement to the SEC (U.S.) 1968: disclosure. 1968: The EU adopts first law directive (EU) directive (EU) 1987: The Treadway Commission 1987: Commission reports on fraudulent financial reporting, confirming the role and status of audit committees, and develops a framework for internal control, control , or COSO, published in 1992 (U.S.). calling Early 1990s: Polly 1990s: Polly Peck (‡1.3bn. in losses), BCCI and Maxwell (‡480m) business empires collapse, collapse, calling for improved corporate governance practices to protect investors (U.K.) 1992: The Cadbury Committee publishes 1992: Committee publishes the first code on corporate governance; and in 1993, companies listed on U.K.’s Stock Exchanges Exchanges are required to disclose governance on a «comply or explain» basis (U.K.) 1994: Publication of the King Report (S. 1994: Report (S. Africa) 1994, 1995: 1995: Rutteman Rutteman (on (on Internal Control and Financial Reporting), Greenbury Greenbury (on (on Executive Remuneration), and Hampel Hampel (on (on Corporate Governance) reports are published (U.K.) 1995: The Russian Law on Joint Stock Companies is 1995: Companies is adopted (Russia) 1995: Publication of the Vienot Report (France) 1995: Report (France)
— — — — — — —
1996: Publication of the Peters Report 1996: Report (the Netherlands) 1996: The Russian Law on Securities Market is 1996: Market is adopted (Russia) 1998: Publication of the Combined Code (U.K.) 1998: Code (U.K.) 1999: OECD Publishes the first international benchmark, the OECD Principles of Corporate Governance 1999: 1999: Publication of the Turnbull 1999: Turnbull guidance guidance on internal control (U.K.) 2001: The Russian Law on Joint Stock Companies is 2001: Companies is significantly amended (Russia) 2001: Enron Corporation, 2001: Corporation, then the seventh largest listed company in the U.S., declares bankruptcy
— —
(U.S.) 2001: The Lamfalussy 2001: Lamfalussy report report on the Regulation of European Securities Markets (EU) is published 2002: Publication of the German Corporate Governance Code (Germany) 2002: Code (Germany)
— —
— —
— —
— — — —
2002: Publication of the FCSM Russian Code of Corporate Conduct (Russia) 2002: Conduct (Russia) 2002: The Enron collapse and 2002: collapse and other corporate scandals lead to the Sarbanes-Oxley Act (U.S.); Act (U.S.); the Win Winter ter report on company law reform in Europe is published (EU) 2003: The Higgs 2003: Higgs report report on non-executive directors is published (U.K.) 2004: The Parmalat scandal shakes Italy, with possible EU-wide repercussions (EU). 2004:
t Source: IFC, Source: IFC, March 2004
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4. The International Scope of Corporate Corporate Governance Numerous codes of best practices and corporate governance principles have been developed over over the last ten years. Worldwide, over 100 codes have been written written in some 40 countries and regions. 6 Most of these codes focus on the role of the Supervisory Board (or (or Board of Directors) Directors) in the company. A handful are inter-
national in scope.7 Among these, only the OECD Principles address both policy makers and businesses, and focus on the entire governance framework (shareholder rights, stakeholders, disclosure, and board practices). The OECD Principles have gained worldwide acceptance as a framework and reference point for corporate governgovernance. Published in 1999 and revised in 2004, they were developed to provide principle-based guidance on good governance. The OECD corporate governance framework is built on four core values: •
Fairness: The corporate governance framework should protect shareholder rights and ensure the equitable treatment of all shareholders, including minorminority and foreign foreign shareholders. All shareholders should have the opportunity
to obtain effective redress for violations of their rights. Responsibility: The corporate governance framework should recognize the rights of stakeholders as established by law, and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.
•
•
Transparency: The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the company, including its financial situation, performance, ownership, and governance structure.
6
For a complete list of country codes of corporate governance, see the website website of the Euro-
pean Corporate Governance Institute under www.ecgi.com. 7
Corporate governance codes of international scope include the OECD Principles of Corporate Governance (www.oecd.org), recommendations of the European Association of Securities Dealers (EASD — www.easd.com), the Corporate Governance Guidelines of the Confederation of European Shareholders Associations (www.wfic.org/esh), the International Corporate Governance Network’s Statement on Global Corporate Governance Principles (ICGN — www.icgn.org), and the Commonwealth Association for Corporate Governance (CACG – www.cacg-inc.com).
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•
Accountability: The corporate governance framework should ensure the
strategic guidance theboard’s company, the effectiveto monitoring of management by the board, andofthe accountability the company and shareholders. Many national codes of governance, including the FCSM Code, have been
developed based on the OECD Principles. The OECD Principles can serve as an excellent reference point for international practice and are recommended reading for those interested in understanding some of the principles that underlie national standards.
Best Practices: The FCSM Code states that: “The principles of corporate conduct set forth in this chapter form the basis of the recommendations contained in the chapters of this Code that follow, and also serve as fundamental guidelines to be observed in the absence of specific recommendations. These principles have been drafted according to the OECD’s Principles of Corporate Governance, international […] practice, as well as experience ac-
cumulated in Russia since the enactment of the Federal Law On Joint Stock Companies.”8
5. Distinguishing Corporate Governance Corporate governance governance must not be confused with with corporate management. Corporate governance focuses on a company’s structure and processes to ensure fair, responsible, transparent, transparent, and accountable corporate behavior. behavior. Corporate management on the other hand focuses on the tools required to operate the business. Corporate governance is situated at a higher level of direction that ensures that
the company is managed in the the interest of its shareholders. One area of overlap overlap is strategy, which is dealt with at the corporate management level and is also a key corporate governance governance element. Figure 3 illustrates the difference difference between between corporate governance and corporate management.
8
FCSM Code, Chapter 1, Introduction.
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Figure 3: The Activities of Governance and Management Compared
Accountability and Supervision
Corporate Governance
Strategic Management Executive Management Decision and Control
Corporate Management
Operational Management
Source: Robert I. Tricker, Corporate Governance, 1984 Source: Robert
Corporate Governance must also not be confused with public governance, which deals with the governance structures and systems within the public sector. Corporate governance must further be distinguished from good corporate citizenship, corporate social responsibility, and business ethics. ethics. Good corporate governance will will certainly reinforce reinforce these important concepts. But while compacompanies that do not pollute and invest in socially responsible projects or run charitable foundations often benefit with superior reputation, public goodwill, and even better profitably, corporate governance is and remains distinct from these concepts.
B. The Business Case for Corporate Governance Good corporate governance is important on a number of different levels.
At the company level, well governed companies tend to have better and cheaper access to capital, and tend to outperform their poorly governed peers over the long-term. Companies that insist upon the highest standards of governance governance reduce many of the risks inherent inherent to an investment in a company. Companies that actively promote robust corporate governance practices need key employees who are willing and able to devise and implement good corporate governance policies. These companies will generally value and compensate such employees employees more than their competitors that are unaware of, or ignore, the benefits of these
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policies and practices. In turn, such companies tend to attract attract more investors investors who are willing to provide capital at lower cost. More generally, well-governed companies are better contributors to the national economy and society. They tend to be healthier companies that add more value to shareholders, workers, communities, and countries in contrast with
poorly governed companies that may cause job losses, the loss of pensions, and even undermine confidence in securities markets. Some of the building blocks, or levels, and specific benefits of good governance are depicted in Figure 4 and discussed in further detail below.
Figure 4: Levels and Potential Potential Benefits of Good Corporate Governance Governance The Four Levels of Corporate Governance
Potential Benefits
Improved Operational Efficiency Level 4: Corporate governance leadership
Access to Capital Markets Level 3: Advanced 3: Advanced corporate governance system Level 2: Initial 2: Initial steps to improve corporate governance are made
Lower Cost of Capital
Level 1: Compliance 1: Compliance with legal and regulatory requirements
Better Reputation of the Company, its Directors, and Managers Source: IFC, Source: IFC, March 2004
➜ See
also the IFC corporate governance progression matrix in Part VI, An nex 1.
1. Stimulating Performance and Improving Operational Efficiency There are several ways in which good corporate governance can improve performperfor mance and operational efficiency, as illustrated in Figure 5.
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Figure 5: Advantages of Corporate Governance
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Better Oversight and Accountability Improved Decision-Making Better Compliance and Less Conflict
Increases Operational Efficiency and Stimulates Performance
Source: IFC, March 2004 Source: IFC,
Improvement in the company’s governance practices leads to an improvement in the accountability system, minimizing the risk of fraud or self-dealing by the company’s officers. Accounta Accountable ble behavior, combined with effective risk management and internal controls, can bring potential problems to the forefront before a full-blown crisis occurs. Corporate governance improves the management and oversight of executive performance, for example by linking lin king executive remuneration to the company’s financial results. This creates favorable conditions not only for planning the smooth succession and continuity of the company’s executives, but also for sustaining the company’s long-term development. Adherence to good corporate governance standards also helps to improve the decision-making process. For example, managers, directors and shareholders are all likely to make more informed, quicker and better decisions when the company’s governance structure allows them to clearly understand their respective roles
and responsibilities, as well as when communication processes are regulated in an effectivee manner. This, in turn, should significantly enhance the efficiency of effectiv of the financial and business operations operations of the company at all levels. levels. High quality corporate governance streamlines all the company’s business processes, and this leads to better operating performance and lower capital expenditures,9 which, in turn, 9
Paul A. Gompers, Joy L. Ishii and and Andrew Metrick, Corporate Governance and Equity Prices, NBER Working Paper No. w8449, August 2001.
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may contribute to the growth of sales and profits with a simultaneous decrease in capital expenditures and requirements. An effective system of governance practices should ensure compliance with applicable laws, standards, rules, rights, and duties of all interested parties, and
further, should allow companies to avoid costly litigation, including those costs related to shareholder claims and other disputes resulting from fraud, conflicts of interest, corruption and bribery, and insider trading. A good system of corporate governance will facilitate the resolution of corporate conflicts between minority and controlling shareholders, executives and shareholders, and between shareholdsharehol ders and stakeholders. Also, company officers will will be able to minimize the risk of personal liability.
2. Improving Access to Capital Markets Corporate governance practices can determine the ease with which companies are able to access capital markets. Well-gov Well-governed erned firms are perceived as investorfriendly, providing greater confidence in their ability to generate returns without violating shareholder rights. Good corporate governance is based on the principles of transparency, accessibility, efficiency, timeliness, completeness, and accuracy of information at all levels. With the enhancement of transparency in a company, investors investors benefit from being provided with an opportunity to gain insight into the company’s business operations operations and financial data. data. Even if the the information information disclosed by the company is negative, shareholders will benefit from the decreased risk of uncertainty.
Of particular note is the observable, if recent trend among investors to include corporate governance practices as a key decision-making criterion in investment decisions. The better the corporate governance governance structure and practices, practices, the more likely that assets are being used in the interest of shareholders and not being tunneled or otherwise misused by managers. Figure 6 illustrates that corporate gover governnance practices can take on particular importance in emerging markets where shareholders sharehol ders do not always benefit from the same protections as are available in more developed markets.
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Figure 6: The Importance of Governance Compared to Financial Statements How important is corporate governance relative to financial issues, e.g., profit perfomance and growth potential,
in evaluating which companies you will invest in? Western Europe
Less important Equally important
North America
More important
Asia
Latin America
Eastern Europe/Africa Percentage of investors Governance remains important compared to financials, particularly in emerging markets Source: McKinsey & Company, Global Investor Opinion Survey, July 2002 Source: McKinsey
Finally, new listing requirements on many stock exchanges around the world require companies to adhere to increasingly strict strict standards of governance. governance. Companies wishing to access both domestic and international capital markets will need to adhere to specific corporate governance standards. 3. Lowering the Company’s Cost of Capital and Raising the the Value of Assets Companies committed to high standards of corporate governance are typically successful in obtaining reduced costs when incurring debt and financing for
operations, and in this this way, they are able to decrease their cost of capital. The cost of capital depends upon the level of risk assigned to the company by investors: the higher the risk, the higher the cost of capital. capital. These risks include the risk of violations of of investor rights. If investor rights are adequately protected, the cost of equity and debt capital may decrease. decrease. It should be noted that investors provi providing ding governance debt capital,practices i.e. creditors, have recently tendedownership to includestructure a company’s corporate (for example transparent and appropriate financial reporting) as a key criterion in their investment decisionmaking process. Thus, the implementation implementation of a good corporate governance system system
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should ultimately result in the company paying lower interest rates and receiving longer maturity on loans and credits. The level of risk and cost of capital also depend on a country’s economic or
political situation, institutional framework, and enforcement mechanisms. Corporate governance at a particular company thus plays a crucial role in emerging markets, which often do not have as good a system of enforcing investor rights as countries with developed market economies. This holds particularly true in countries such as Russia where the legal framework is relatively new and still being tested, and where courts do not always provide investors with effective recourse when their rights are violated. This means that even modest improvements in corporate governance relative to other companies can make a large difference for investors and decrease the cost of capital. 10 Figure 7 tellingly demonstrates that a majority of investors are willing to pay a premium for a well-governed well-governed company; this premium amounts to 38% for Russian companies. At the country level, studies show that Russia has considerably higher borrowing costs than many other countries due to corruption, opaque legislation and judicial practices, weak corporate governance, uncertainty, and arbitrariness. 11 Figure 7: A Premium for Better Corporate Governance
Russia China Brazil Poland
U.S. Germany
Source: McKinsey Source: McKinsey & Company, Global Investor Opinion Survey, July 2002
10
11
Leora F. Klapper, Inessa Love, Love, Corporate Governance, Governance, Investor Protection and and Performance in Emerging Markets, World Bank Policy Research Working Paper 2818, April 2002. The Opacity Index, PricewaterhouseCoopers, PricewaterhouseCoopers, January 2001 (http://www.opacity-in (http://www.opacity-index.com). dex.com).
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At the same time, there is a strong relationship between governance practices and how investors perceive the value of company assets (such as fixed assets, receivables, product portfolio, human capital, research and development, and
goodwill).
4. Building a Better Reputation In today’s business environment, reputation has become a key element of a company’s goodwill. A company’s reputation and image effectively effectively constitute an integral, if intangible, part of its assets. Good corporate governance practices contribute to and improve a company’s reputation. Thus, those companies that respect the rights of shareholders and creditors, and ensure financial transparency transpa rency and accountability, will be regarded as being an ardent advocate of investors’ interests. As a result, such companies will enjoy more public confidence and goodwill. public confidence and goodwill lead tosales higher trust in the company and This its products, which in turn may leadcan to higher and, ultimately, profits. A company’s positive image or goodwill is moreover known to play a significant role in the valuation valuation of a company. Goodwill in accounting terms terms is the amount amount that the purchase price exceeds the fair value value of the acquired company’s assets. assets. It is the premium one company pays to buy another.
C. The Cost of Corporate Governance
Good governance governance entails real real costs. Some of the the costs include include hiring dedidedicated staff such as corporate secretaries, experienced and independent directors, internal auditors, or other governance specialists. specialists. It will likely require the payment of fees fees to external counsel, counsel, auditors, and consultants. consultants. The costs of additional disclosure disclosure can be significant as well. well. Furthermore, it requires considerable managerial and Supervisory Board time, especially in the start-up phase. These costs tend to make implementation considerably easier for larger companies that may have the resources to spare than smaller companies whose resources may be stretched quite thin.
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Best Practices: Corporate governance is most, if not solely, applicable to
larger, open joint stock companies that are publicly traded on an exchange. A large, dispersed shareholder base, where controlling shareholders and managmanagers can wield extraordinary powers and potentially abuse shareholder rights, often defines such companies. Large companies are moreover important elements of a country’s economy and thus require close public scrutiny and attention. This holds particularly particularly true in Russia, where the 23 largest largest business groups groups control 35% of the country’s industry by sales (RUR 1.7 trillion or approximately U.S. $ 60 billion) and at least 16% of its employment (1.44 million people).12 Moreover, the 42 largest companies by market capitalization make up 98% of the total value of all listed companies in Russia;13 and of these, three alone (RAO UES, Gazprom and MPS) make-up 13.5% of Russia’s GDP. Notwithstanding, corporate governance is beneficial to all companies, irrespective of size, legal form, number of shareholders, ownership structure or other characteristics. Of course, a one-size-fits-all one-size-fits-all approach should be avoided and companies should carefully carefully apply corporate corporate governance standards. For example, smaller companies may not require a full set of Supervisory Board committees or a full-time full-time Corporate Corporate Secretary. Secretary. On the other hand, even a small company may benefit from an advisory body.
A company will not always see instant improvements to its performance due to better corporate governance governance practices. Howev However, er, returns, while sometimes difdifficult to quantify, generally exceed the costs in particular over over the long term. This is especially true when one takes into account potential risks of losses in jobs, pensions, invested capital and the disruption that may be caused to communities when companies collapse. In some cases, systemic governance governance problems may
undermine faith in the financial markets and threaten market stability. Finally, it must be noted that corporate governance is not a one-time exercise but rather an ongoing process. No matter how many corporate governance governance structures and processes the company has in place, it is advisable to regularly update and review them. Markets tend to value long-term commitment to good governgovernance practice rather than a single action or “box-ticking” exercises. 12
The World Bank, From Transition To Development, A Country Economic Memorandum for for the Russian Federation, April 2004.
13
Standard & Poor’s, Concentration of Ownership Ownership and Corporate Governance Governance in Russia Russia – What Drives the Trend? EuroWeek, March 2003.
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D. The Corporate Governance Framework in Russia
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