Multinational Corporations (MNCs) and the Agency Problem: Separating Owners and Managers

1. 3 Robert Uberman, Multinational Corporations (MNCs)

2. Owners vs managers - „agency problem” • Separation of owners and managers • Hired managers to be less effective in management than owners • Research made in the US considering 1307 companies covering period 1992-1997 showed that the ones managed by hired professionals could increase their equity by 1871 bln. USD if managed directly by owners (M. Habib, A. Ljungvist,”Firm Value and (..)”, JofB, Nov., 2005, str. 2054) Robert Uberman, Multinational Corporations (MNCs)

3. „Agency problem” • „Agency problem” – conflict of interests between MNCs’ owners (shareholders) and managers Robert Uberman, Multinational Corporations (MNCs)

4. „Agency problem” – asymmetric access to information • Growing complexity of MNCs operations and fractioning of shareholdings gives management boards an overwhelming advantage as regarding access to information as well as an ability to interpret them.(Koźmiński, str. 187-204) • Role of Supervisory Boards (non-executive directors) • Regulatory roleof financial markets • Role of the Law Robert Uberman, Korporacje międzynarodowe

5. „Agency problem” - history • Adam Smith w „The wealth of nations” stated that: „To buy in one market, in order to sell, with profit (…), to watch over (…) greater and more frequent variation in competition (…) cannot long be expected from the directors of a joint stock company” • and „It is merely to enable the company to support negligence, profusion and malversation of their own servants” Source: Adam Smith: „Inquiry into the Cause and Nature of the Wealth of Nations”, Part 10 Harvard Classics, Harvard, 1909, Book V, Part. III, p. 472 Robert Uberman, Multinational Corporations (MNCs)

6. „Agency problem” – present • Warren Buffet, President and a controlling shareholder of the Berkshire Hathaway stated: „I am a better businessman because I am an investor and a better investor because I am a businessman. If you have a mentality of both, it aids in each field.” Source: Harvard Business Review, Sept. ‘06, p. 70 Robert Uberman, Multinational Corporations (MNCs)

7. Corporate bodies (Shareholders Meetings, Supervisory Boards, Executive Boards) in Continental Europe and the US • Supervisory Board and Executive Board vs Board of Directors • „Prezes Zarządu” vs CEO i President (Chairman of the Board) • Institutional environment Robert Uberman, Multinational Corporations (MNCs)

8. Governance structure USA vs continental Europe – „PrezesZarządu” vs CEO and President • Advantages of merging CEO with Chairman of the Board: • clear responsibility • lean decision making process • Advantages of merging CEO with Chairman of the Board: • obstacles to controlling functions • overloading with duties • According to a Spencer Stuart’s report in 61% US MNCs positions of Chairman and CEO were occupied by the same person (2008). Source: FT, 14th Nov. ‘08, p. 16 Robert Uberman, Multinational Corporations (MNCs)

9. Separating Chairman and CEO functions in USA – a hardly visible trend • Reaction to 2002 and 2008 financial scandals • European influence • Usefulness of the separation – UK experience shows that benefits of such split-up are questionable Robert F. Felton and Simon C. Y. Wong. „How to separate the roles of chairman and CEO?”, McKinsey Quarterly, 2004, no 4. Robert Uberman, Multinational Corporations (MNCs)

10. Agency problem and corporate governance • Separation of ownership and managerial functions required regulations of their reciprocal relations. • From the legal and real point of view a relation between managers and a MNC is set by an employment or civil contract • There is no natural incentive for managers to pursue the best interests of their MNCs as in case of owners Robert Uberman, Multinational Corporations (MNCs)

11. 2002 and 2008 greatest scandals (1) • World Com: • reporting false revenues of 11 billions USD, SEC investigation, • Chapter 11 (near bankruptcy procedure applied), • Renaming to MCI • Enron: • hiding real indebtness level („parking off shore” transactions valued at 8,5 billions USD with related parties) • bankruptcy • „destroying” Arthur Andersen LLP – the biggest audit company of the world • However: „[Enron] was, for all its flaws, an important trading academy for the industry”.(Izabella Kamińska. „Market for traders is hottest one of all”, FT, June 1st, 2010) Robert Uberman, Multinational Corporations (MNCs)

12. 2002 and 2008 greatest scandals(2) • Parmalat (2003) • Auditor – Deloitte concealed with prosecutors and submitted to a hefty financial punishment • 4 investment banks: Citigroup, UBS, Deutche Bank and Morgan Stanley were prosecuted for „stirring the market” (FT, June 14th, 2007) • Vivendi • In January 2011 r. a Paris court sentenced Messier for 150 th. EUR fine i 3 years delayed prison for presenting false information to investors and financial fraud and his deputy - Bronfman – for 5 mln. EUR fine and 15 months delayed prison for „inside trading”. Colchester Max: Messier, Bronfman fund guilty in Vivendi trial. The Wall Street Journal Europe, 24 January 2011. Robert Uberman, Multinational Corporations (MNCs)

13. „Corporate governance” reinvented • Independence and responsibility of supervisory boards (non-executive directors) • Independence and responsibility of committees for nominations and remunerations • Independence and responsibility of financial auditors • Clarity, materiality, promptness i and creditworthiness of information provided (NYSE recommendations, August, 2002) Robert Uberman, Multinational Corporations (MNCs)

14. „Corporate governance” – independence and responsibility of supervisory boards (non-executive directors) • Independence: lack of financial revenue dependent on Management Board decision (direct or indirect eg. Shares or employment in companies rendering services to a MNC audited) • Restriction as to number of seats in various boards (to prevent cases like the one of Hans Abs, one time a Deutsche Bank CEO, who held seats in ca. 250 supervisory boards) Robert Uberman, Multinational Corporations (MNCs)

15. „Corporate governance” – chairs in Supervisory Boards: a (plum) job? Lublin Joann S.: Are Executives Overboarded? The Wall Street Journal, March 7th, 2012, page 29 Robert Uberman, Multinational Corporations (MNCs)

16. „Corporate governance” – independence and responsibility of financial auditors • An (financial) auditor evaluates financial statements in view of their compliance with a biding law and accounting standards – he/she does not evaluate the company’s overall performance • An auditor can not simultaneously act on behalf of shareholders and management boards, even in different area (conflict of interests concept) • For shareholders the auditors renown is key Robert Uberman, Multinational Corporations (MNCs)

17. The role of a reliable financial reporting • „The key test of accurate financial reporting is trust” • „Our (US) markets must retain the integrity and efficiency that has contributed greatly to prosperity of America” Henry Poulson, US Treasury secretary, FT, May 17, 2007, page 11 Robert Uberman, Multinational Corporations (MNCs)

18. Clarity, materiality and up to date financial information – key for trust between managers and shareholders • Spirit of Transparency • Culture of Accountability • People of Integrity (See S. A. di Piazza, R. G. Eccles, Building Public Trust, John Wiley and Sons, New York, 2002), pp. 3-6 Robert Uberman, Multinational Corporations (MNCs)

19. Differences in „Corporate Governance” application between selected countries Robert Uberman, Multinational Corporations (MNCs)

20. Corporate Governance implementation in the AngloSaxon countries and continental Europe • Differences regarding primary approach to the Enron case on one side and Parmalat/Vivendi cases on the other. • Difference in applying International Accountig Standards: • in UK IAS was seen as a product of natural evolution adjusting reporting to the needs of stakeholders; • In France and Germany it brought a surprising discovery that not tax offices and state administration or banks but owners (shareholders) are ultimate clients of financial reporting. Nicolas Veron, Breugel Institute, FT, Sept 10, 2007, Robert Uberman, Korporacje międzynarodowe

21. „Corporate governance” – Continental Europe vs USA Robert Uberman, Multinational Corporations (MNCs)

22. Anglo-Saxon countries also struggle to implement corporate governance rules • In 2008 study made by the Grant Thornton only 125 out of 350 top UK companies claimed to implement governance rules in full. However only 11 of them had fulfilled disclosure requirements of the relevant code. • On the other side 110 which did not claim compliance provide robust explanations. • 4% neglected to respond. • Overall numbers were better than in 2006 „due to growing investor pressure and wider stakeholder interest” (See Ruth Sullivan: „FTSE 350 „slow” on corporate governance”, FT, January the 21st, 2008. Robert Uberman, Multinational Corporations (MNCs)

23. Financial crises 2008 – Germany and Japan • „The collapse of HRE, [..] shows Rheineland finance developed excesses just like those of the Anglo-Saxon world.” James Wilson: Hypo reality, FT May 20, 2009 • The Fall of Hypo Real Estate Group with 393 bln EUR (equal to 14 % GDP of Germany while value of Lehman Brothers’ assets matched only 5 % US GDP) – James Wilson: Hypo reality, FT May 20, 2009 • On the other hand Germany is the only European major economy to avoid deindustrialisation Robert Uberman, Multinational Corporations (MNCs)

24. Financial crises 2008 – Germany banks are less strong than they seem to be (See James Wilson, Gerrit Wiesman: Visibility needed, FT, April the 6Th, 2011) Robert Uberman, Multinational Corporations (MNCs)

25. Financial crises 2008 – Sources of stabilisation • Peace between major powers – since the end of II WW for the first time in human history majors do have not entered into a direct military conflict one against another • Battling inflation – since late 70s inflation ceased to be a mojor economic problem • Globalisation – creating a wide and storng network of multilateral dependences and information channels which allow for a balanced reaction to any crises. • Fareed Zakaria: The roots of stabiity, Newsweek, Special Edition – Issues 2010. Robert Uberman, Multinational Corporations (MNCs)

26. „Corporate governance” – is it profitable to be implemented? • According to a certain HBR study MNCs subjecting themselves to „corporate governance” brought in the period of 1990-99: 23,3 % in return, while the ones following these rule in a relaxed way brought only 14%(The Exchange, NYSE, June 2003) • Reasons: • Investros prefer to buy into companies following „Corporate governance” rules • Such MNCs are simply better managed Robert Uberman, Multinational Corporations (MNCs)