National Research University

Higher School of Economics

Faculty of Economics

Magistrate of Finance of the Firm Second Year

Program of the Course

«Corporate Governance»

Author: Settles A.М. (Ph.D.)

Moscow

2011

I.Introduction

The prerequisites for the course include knowledge of micro and macroeconomics, principle agent theory, and basic exposure to Russian company law. The purpose of this course is to develop an understanding of corporate governance, boards of directors, corporate social responsibility, role of the board in strategic management, and the value of good corporate governance for firm valuations. Approaches and theories that will be discussed include principle-agent theory, stewardship theory, contractual theory, corporate risk analysis, and social responsibilities of corporation amongst others.

Students are expected to complete all required readings prior to the class these readings are assigned. Students will be expected to be prepared to discuss these readings during the lectures and seminars.

The grade will be determined based on the following method:

Class Attendance (20%)

Final Exam (40%)

Research Project(40%)

Those students that do not attend any lectures will not be able to take the final exam or submit their essay.

All students must be honest and forthright in their academic studies. To falsify the results of one's research, to steal the words or ideas of another, to cheat on an assignment, or to allow or assist another to commit these acts corrupts the educational process. Students are expected to do their own work and neither give nor receive unauthorized assistance. During exams there will be no talking – no warnings will be given.

Overview of the Subject

Corporate governance is the internal means by which corporations are operated and controlled and governance structures involve a set of relationships between a company’s management, its board, its shareholders and other stakeholders. To understand the importance of corporate governance to the development of market economy it is important to have a clear understanding of a joint stock company. The concept of corporation is rooted in the classical concept of the company developed in the mid-nineteenth century. The key concept was the incorporation of a legal entity, separate from the owners, which nevertheless had many of the legal property rights of a real person - to contract, to sue and be sued, to own property, and to employ. The company had a life of its own, giving continuity beyond the life of its founders, who could transfer their shares in the company. Crucially, the owners' liability for the company's debts was limited to their equity investment. Yet ownership remained the basis of power. Company law became the underpinning of corporate governance. It is important in the Russian context to remember that the open joint stock company (OAO) was not design as a measure to privatize government assets. In the UK, Canada and other countries the royal charter was method of managing such assets.

The classic work by Berle and Means (1932) indicated the modern realization of the role of the corporation and the importance of corporate governance (though not stated as such in their article) to economic development. They observed that:

The rise of the modern corporation has brought a concentration of economic power which can compete on equal terms with the modern state - economic power versus political power, each strong in its own field. The state seeks in some aspects to regulate the corporation, while the corporation, steadily becoming more powerful, makes every effort to avoid such regulation…The future may see the economic organism, now typified by the corporation, not only on an equal plane with the state, but possibly even superseding it as the dominant form of social organization. (Berle and Means, 1932)

The received wisdom on corporate governance indicates that the board of directors rests at the center of the system and that the primary roles of the board are (1) establishing basic objectives, corporate strategies, and board policies: (2) asking discerning questions; and (3) selecting the CEO (General Director or Chair of the Management Committee in Russia). The practice has indicated that boards in the west and in Russia that boards do not fulfill these roles. Typically management controls these actions in widely-held corporations and that in closely-held corporations principle owners or groups of owners control these decisions with boards merely fulfilling their statutory roles.

Managers at all levels of a publicly traded company should have a clear understanding of the corporate governance practices of their corporation. Even if these managers play no role in the board of directors or corporate secretary office governance practices play a central role in the development of corporate culture of firms both public and private. Corporate governance is also significant explanatory variable of firm performance and should included in financial valuation of firms. This course will focus on the classic models, the practice in developed and transitional economies and the recent history of governance failures and the rules and practices adopted to fulfill the promise of a well governed company.

. Table of Work Hours

№ / Name of Themes / Classroom Hours / Form of Control/Grading / HomeworkHours / Total Hours
Lectures / Seminars / Total
1. / Corporate Governance Introduction, Theoretical Background, Models of Corporate Governance from the International Experience / 4 / 0 / 4 / Exam / 4 / 8
2. / Functions and Responsibilities of the Boards of Directors and Composition of the Boards of Directors and the Role of the Board of Directors in Decision-Making and Assessment of Board’s Effectiveness and The Boards of Directors in Complex Corporate Entities / 8 / 0 / 8 / Essay and Exam / 4 / 12
3. / Corporate Social Responsibility & Corporate Social Reporting / 8 / 0 / 8 / Exam / 4 / 12
4. / Corporate Governance and Firm Valuation / 4 / 0 / 4 / Essay and Exam / 4 / 8
5. / Shareholder Rights, Information Disclosure, Transparency and Audit Procedures / 4 / 0 / 4 / Essay and Exam / 4 / 8
6. / Corporate Governance Ratings / 4 / 0 / 4 / Exam / 2 / 6
Total: / 32 / 0 / 32 / 22 / 54

III. Content of the Program

Theme 1. Corporate Governance Introduction, Theoretical Background, Models of Corporate Governance from the International Experience.

Objectives

To define the significance of corporate governance mechanisms;
To explain the importance of Corporate Governance as a field of management research;
To introduce the framework for corporate governance analysis;
To identify parties involved in corporate governance process and corporate environment; and
To introduce the national models of corporate governance and to place the Russian model within that context.

Learning outcomes:

The students should be able:

To explain the development of Corporate Governance as an issue;
To analyze the difference between Corporate Governance, corporate administration, and management;
To present key factors affecting Corporate Governance;
To demonstrate understanding of the importance of the main components of Corporate Governance;
To describe place and role of different players in corporate governance;
To describe main theories dealing with corporate governance issues and recognize their place in historical development process;
To differentiate components of Corporate Governance theoretical model;
To understand the general framework for different models;
To analyze strengths and weaknesses of different models of CG; and
To identify key factors driving each model.

Themes covered include:

The main stages in the history of the modern corporation

The development of private enterprise for partnership to joint stock company/corporation

The issue of separation of management from ownership

The evolution of corporate governance and corporate control.

The theme will cover the participants of the corporate governance process (shareholders, board of directors, committees, management, CEO, and Chairman) as well as their role in corporation. The evolution of theoretical understanding of corporate governance will be covered along with an analysis of how to use the differing theories as a tool to understand the concepts of corporate governance. The theme will focus on principle –agent, stewardship, stakeholder, and contractual theories to explain board management interaction. The principle-agent theory focuses on the agency problem and agency costs in running the corporation. The stewardship theory focuses on the board as stewards of the corporation and on the role of accountability of the firm’s managers and directors. Stakeholder theory provides a framework for internal and external stakeholders to be represented through corporate governance structures to balance the different interests of these groups of stakeholders. The contractual theory treats the corporation as the network of contracts as means to explain corporate governance relationships.

Corporate governance has been described as a series of relationships between the providers of capital (investors), the board of directors, and the management of the company (OECD 2003). The factors that describe these relationships include the transparency of the firm disclosure, the composition of the board of directors, protection of minority shareholder’s interests, accountability and monitoring of the firm by the board of directors and the general meeting of shareholders, and the development of measures of internal control. The general theory of the model firm first developed by Berle and Means (1932) describes these relationships as a set of contracts between owners and directors and directors and managers that align the interest of agents with their respective principles. A break down in these relationships results in a situation where managers are able to shirk their responsibilities or misappropriate firm’s (and therefore owners) assets for their own use. The failure or misuse of the corporate governance system in a manner where effective control over the actions of managers is lost results in an ineffective use of capital, a long term reduction in share value, and a serious threat to firm sustainability. At a country level poor corporate governance practices result in an underinvestment in productive activities and a misallocation of scare resources.

The models to be examined include the Anglo-American Model, Continental Model (France and Germany), and the Japanese Model. The discussion will also focus on the models of CG developing in transitional and developing countries and the influence of dominant “western” models upon these countries. The historical roots of each model will be discussed along with its major features and criticisms. The Anglo-American model will be discussed in the framework of the board of directors structure and shareholder’s control via the representation in the Board of Directors; independence of the Board of directors; structure of the financial market and the role of Institutional investors in the ownership of UK and US companies; and the methods of corporate control. The Continental model discussion will focus on issues related to the principle of social cooperation, the two-tier board structure that consists of a supervisory board and executive board, whose interests are represented on these boards, the role of banks as major shareholders, and role of cross–shareholding in financial – industrial groups. The Japanese model discussion will focus on the formal role of large and almost entirely executive boards, the historical roots of the Keiretsu network, the existence of significant cross holdings and interlocking-directorships, the role that lifetime employment system plays in corporate policy, the evolution of bank-centered system.

The theme will involve a comparative analysis of existing models and the role of international organizations in the development of corporate governance in the global economy. An examination of the key drivers of each model: the ownership structure, the patterns of financing, culture, and social traditions will be conducted. Also an understanding of the key international factors affecting national models: globalization of the financial markets; unification of principles of corporate governance will be considered.

An analysis of corporate governance issues related to IPO (initial public offerings) will be discussed in relation to improving financial disclosure, internal controls, and restructuring the board of directors to meet listing criteria. IPO have rapidly become a means to increase liquidity and raise capital for Russian firms both in the natural resources and consumer retail and telecommunications sector. As firms list issues related to ownership structures, financial disclosure, internal controls, board membership, structure and subcommittees and other governance issues increase in importance from legally required mechanisms to key components of firm valuation. This theme will examine the basics of governance for a firm considering flotation and the impact of MICEX, RTS, LSE, NYSE, and NASDQ listing rules on corporate governance practices of listed firms. Also the topic will explore the benefits and risks of listing and delisting and the experience of firms that have listed deposit receipts.

Required Readings:

Berle, Jr., A. A. and Gardiner C. Means, “Corporations and the Public Investor,” The American Economic Review, vol. 20 no. 1 (Mar., 1930) 54-71.

Monks, Robert A.G. and Nell Minow, "What is a Corporation?," 1-90, Corporate Governance 3rd ed., Blackwell Publishing, New York 2003.

Tricker, R.I. ed, Corporate Governance – a subject whose time has come, Corporate Governance, Ashroft Publishing, Aldershot, UK, 2000

Schleifer, Andrei and Robert W. Vishny, “A Survey of Corporate Governance,” The Journal of Finance, Vol 52, No.2 (Jun., 1997), 737-783

Долгопятова Т.Г., Ивасаки И. 2006. Исследование российских компаний: первые итоги совместного российско-японского проекта. Препринт WP1/2006/1. М.: ГУ-ВШЭ

Recommended Readings:

International Finance Corporation, The Russia Corporate Governance Manual, Part I Corporate Governance Introduced, Alpina Business Books, Moscow 2004

Theme 2: Functions and Responsibilities of the Board of Directors and Composition of the Boards of Directors, the Role of the Board of Directors in Decision-Making and Assessment of Board’s Effectiveness, and The Boards of Directors in Complex Corporate Entities.

Objectives

To define major functions and responsibilities of the Board of Directors;
To demonstrate composition of the Board of Directors;
To introduce the main fields of Board decision making and technique they use; and
To demonstrate the importance of board effectiveness assessment.

Learning outcomes:

After studying the theme the students should manage:

To discuss the functions of the Board and
To compare the responsibilities of the Board, the executive team and the CEO.

To compare the responsibilities of the Chairman and CEO;
To explain criteria for the Board’s membership; and
To discuss the role of independent directors.
To explain the specific role played by the Board of Directors in strategy formulation process;
To discuss the Board of Directors' role and analytical tools in risk assessment;
To explain the Board of Directors' role in cases that may substantially change company's status, ownership structure, or reputation;
The Role of the Dissident Director;
To discuss key characteristics of effective boards and elements of effective governance;
To explain different board styles;
To explain the structure and process of Board assessment and informational sources for assessment; and
To discuss the dependency of Board efficiency and company performance.
To explain what are complex group structures and reasons for creation;
To discuss the corporate governance relationships between holding (parent) and subsidiary companies; and
To discuss factors determining Corporate Governance structure of subsidiaries.

This theme will cover five core functions, for which the boards must be explicitly responsible. (1) Choosing the CEO and focusing the senior management team on company success. (2) Setting the board parameters within which the management team operates: the framework for adopting a strategic planning process and approving a strategic direction; defining a framework to monitor the management of business opportunities and risks; in defining circumstances, approving major corporate decisions; and approving a communications policy that includes a framework for investor relations and public disclosure policy, which may involve a process for monitoring the relationships between the corporation and investment dealers. (3) Advising the CEO and the management team. (4) Monitoring and assessing the performance of the CEO: setting the targets (the ends); setting the CEO's compensation and approving the compensation of senior management; taking remedial actions where warranted, including replacing the CEO if necessary. (5) Providing assurance to shareholders and stakeholders about the integrity of the corporation's reported financial performance.

This theme will also cover board membership, the difference between independent and dependent directors, the importance of board independence, strategies for selecting the right directors, directors and business ethics, and powers of the board. The theme will cover key positions on the board, such as Chairman, CEO, Directors, Committee Chairmen, and Corporate Secretary. This theme will also cover committees of the board, such as the audit committee, its composition and functions; the remuneration committee, its procedures; and the compliance committee.

The operations of the board of directors will also be covered, including procedures in the board room, board meetings, how to set board agendas, and the remuneration of the board, the executive’s responsibilities in preparing the information for the board’s meeting, the role and the functions of the corporate secretary, the roles and functions of chairman that include leadership of the board team, strategic leadership, board link with CEO and management, figurehead, and meeting management.

The theme will cover the division of functions and the division of responsibilities in strategic decision-making process between the board and CEOs and discuss the strategic decision-making process in the Board room, including the principle analytical tools used in the Board room and information required. The theme will also include a discussion of the role of the Board in risk assessment in understanding strategic risks, risk associated with mergers, acquisitions, restructuring, establishing strategic alliances, the possibility of bankruptcy, and threatened hostile takeovers. Also covered will be the role of the Board during takeovers, statutory takeover period, and takeover defenses.