Corporate Governance and Foreign Investment: Trend and Relationship

1. Corporate Governance and Foreign Investment: Trend and Relationship Mohammed Omran Vice Chairman, Cairo & Alexandria Stock Exchange

2. Contents • Trends of Governance and Foreign Investment. • Foreign investment and governance: Macro level. • Foreign investment and governance: Firm level. • Relationship between governance and macro and firm level. • Corporate Governance and foreign investment in Egypt.

3. Trends of Governance and Foreign Investment. • Corporate governance quality in most countries has overall improved, although to varying degrees and with few notable exceptions. • The impact of improvements in corporate governance quality on traditional measures of real economic activity (GDP growth, productivity growth, and the ratio of investment to GDP) is positive, significant, and quantitatively relevant(1). • The growth effect is particularly obvious for industries that are most dependent on external finance. 1.Trends ofgovernance (1) De Nicolò, G., Luc, L., and Ueda, K., (2006), “Corporate Governance Quality: Trends and Real Effects”, IMF Working Paper No.06/293. (Washington DC.: IMF).

4. Trends of Governance and Foreign Investment: (Continued) 2.Trends offoreign Investment • Three important features predominated FDI flows to Emerging Market Countries “EMCs” in the 1990s and beginning of the 2000s(1): • The rapid increase in FDI in EMCs in the 1990s could be largely attributed to the adoption of macroeconomic and structural reform programs. • The surge in FDI, was led by Merges and Acquisitions activity. • For a number of countries, there was a significant shift of FDI into the services sector. • Recorded FDI Inflows to developing countries the highest level ever, raising its share of FDI inflows to 36% of total FDI in the last 3 years(2). • Most FDI inflows still targeting services, particularly finance, telecommunications and real estate, however the sharpest rise in FDI was in natural resources. • International Monetary Fund, (2003), Foreign Direct Investment In Emerging Market Countries. Working Group of the Capital Markets Consultative Group (Washington DC.: IMF). • UNCTAD, World Investment Report 2006.

5. Foreign Investment and Governance: Macro Level(Continued) • According to theIMF-Capital Markets Consultative Group, the investment regimeand the environment for business ranked second in order of importance among factors determining foreign investment location(1). • Stability of investment environment (climate)-consisting of transparent and predictable investments’ regulations and rules-is very important to attract FDI. This climate can be provided through good governance practices on macro level. • On the macro level, to attract foreign investment, there are four main elements thatshould be taken into consideration:Predictability, Accountability, Transparency and Participation. (1) International Monetary Fund, (2003), Foreign Direct Investment In Emerging Market Countries., Working Group of the Capital Markets Consultative Group (Washington DC.: IMF).

6. Foreign Investment and Governance: Macro Level (Continued) • Predictability:Refers to the existence of clear policies, a sound legal framework for investment and the rule of law, with an increasing importance of enforceability of contracts. Predictable rules and regulations implies that regulations should be minimized and simplified to the greatest possibility. • Accountability: Through the establishment of performance standards, benchmarks, timeframes and monitoring, the accountability, efficiency and effectiveness of government officials increase, while the chances of corruption could be reduced. In addition, investors and the public should be informed of these standards so that they are fully aware of the level of service they are expecting.

7. Foreign Investment and Governance: Macro Level (Continued) • Transparency:The interface between government and investors is most effective when there is timely information disclosure, easy availability of information and a helpdesk for investors. Transparency also implies greater openness to the media and the public on investment policies and practices. • Participation:Dialogue with stakeholders could contribute to policy development and the implementation of policy decisions. By establishing various forums, including consultative committees, through which civil society, business associations, research centers and think tanks could provide inputs, a government would ensure that its policies and programs better reflect development goals and stakeholders’ interest.

8. Foreign Investment and Governance: Firm level (Continued) The relationship between corporate governance and foreign investments, can be discussed through the direct effects of governance on the firm's investment level, and the firm's behavior towards investment opportunities. 1. Empirical Studies • well governed firms invest more than badly governed ones.Within a broad sample of US manufacturing firms, the study finds that increased governance quality leads to higher levels of investment and greater responsiveness of investment to growth opportunities. High quality governance mitigates the underinvestment problem that arises from incentive problems between managers and shareholders(1). (1) Øyvind, B., Cooper, I., and Priestley, R., (2007) “Corporate Governance and Real Investment Decision“, working paper series, Norwegian School of Management.

9. Foreign Investment and Governance: Firm level (Continued) 1. Empirical Studies: (Continued) • Better governance qualityimproves the efficiency of capital allocationwithin firms,whereas lax governance produces under-investment rather than over-investment. • Well-governed companies receive higher market valuations, whichincrease the inflow of capitalfrom both domestic and foreign sources in the form of debt and equity. • The higher the marginal product of capital, the higher the quality of corporate governance(1). (1) Øyvind, B., Cooper, I., and Priestley, R., (2007) “Corporate Governance and Real Investment Decision“, working paper series, Norwegian School of Management.

10. Foreign Investment and Governance: Firm level(Continued) 1. Empirical Studies: (Continued) • Well governed firms, hasbetter investment opportunitiesas reflected by both: higher output to capital ratio, and higher Tobin's Q measured by the market to book ratio(1). • Well-governed firms have considerablybetter access to outside financingthanfirms with weaker governance. • Equally important and, irrespective of the need to access capital, improved governance structures and processes helpinsure quality decision making, encourage effective succession planning for senior management and enhance the long-term prosperity of companies, independent of the type of company and its sources of finance(2). (1) Øyvind, B., Cooper, I., and Priestley, R., (2007) “Corporate Governance and Real Investment Decision“, working paper series, Norwegian School of Management. (2) La Porta, R., Lopez-de-Silanes, f., Shleifer, A., and Vishny, R., (2002), “Investor Protection and Corporate Valuation,” Journal of Finance. 57 (3), 1147-70.

11. Foreign Investment and Governance: Firm level(Continued) 1. Empirical Studies: (Continued) • A study of S&P 500 firmsby Deutsche Bank shows that companies with strong or improving corporate governanceoutperformedthose with poor or deteriorating governance practices by about 19% over a two-year period(1). • An ABN/AMRO studydemonstrates that Brazil-based firms with the best corporate governance ratingsgarnered 2004 P/E ratios that were 20% higherthan firms with the worst governance ratings(2). • A study of Russian firmsshows that a worst-to-best improvement in corporate governance predicteda huge 700-fold (70,000%) increase in firm value. The study’s sample size was small (21 firms), so it’s unlikely that such a huge increase would take place in a larger, more representative sample. However, the study still demonstrates a correlation between improved corporate governance and firm value(3). (1) Grandmont, R., Grant, G., and Silva, F., (2004) Beyond the Numbers—Corporate Governance: Implications for Investors. Deutsche Bank. (2) Erbiste, B., (2005), Corporate Governance in Brazil: Is There a Link Between Corporate Governance and Financial Performance in the Brazilian Market?” Abn Amro Asset Management. (3) Black, B., (2002), “The Corporate Governance Behavior and Market Value of Russian Firms”, Emerging Markets Review, 2 (2), 89-108.

12. Foreign Investment and Governance: Firm level(Continued) 1. Empirical Studies: (Continued) • A study by Korean and US researchersfinds that a well-governed firm in Korea traded at apremium of 160 percentto poorly governed firms(1). • A Harvard/Wharton studyshows that if an investor bought shares in US firms with the strongest shareholder rights, and sold shares in the ones with the weakest shareholder rights, that investor would have earnedabnormal returns of 8.5 percentper year (2). (1) Black, B., Jang, H., and Woochan, k., “Predicting Firms’ Corporate Governance Choices: Evidence from Korea.”, Journal of Corporate Finance, 12, (3), 660-91 (2) Gompers, P., Ishii, J., and Metrick, A., (2003), “Corporate Governance and Equity Prices.” Quarterly Journal of Economics,118(1), 107-155.

13. Foreign Investment and Governance: Firm level(Continued) 2. Investor Surveys • Investors state that they still putcorporate governanceon par with financialindicators when evaluating investment decisions. • 80% of the respondents would pay a premium forwell-governed companies, (premiums averaged 12-14% in North America and Western Europe; 20-25% in Asia and Latin America; and over 30% in Eastern Europe and Africa) (1). (1) MaKinsey & Company (2002) “Global Investor Opinion Survey 2002”.

14. Relationship between governance: macro and firm level • An inter-related relation-as it had started first with inflows of foreign investments to emerging markets. This led to the introduction of corporate governance concepts and practices on the firm level. (Corporate Governance) • Governments started issuing “corporate governance code” to enhance firms performance. • In addition to increased importance of stable investment climate, governments work on achieving governance principles to provide a predictable, transparent and stable investment environment.

15. Relationship between governance: macro and firm level(Continued) Macro level Increasing FDI in the 1990s Emerging Market Countries Technology Transfer Corporate Governance Practices $ 1214 billions (1990s) Attracting FDI to Emerging Market Countries Implementing Corporate Governance $ 1436 billions (2000-2005) Firm level Figures source: Inflows of FDI to Developing Countries, UNCTAD, World Investment Report 2006.

16. Corporate Governance and Foreign Investment in Egypt. • New Income Tax Law (No. 91/2005):It introduces a 50% reduction in personal and corporate taxes to a maximum rate of 20%. • Financial sectorhas witnessed an enormous reform program, including introduction of restructuring program for“Banking Sector”which aims at strengthening the performance and competitiveness of banks in Egypt. • Regulating the process of merger and acquisitions in financial market, by introducing theMerger and Acquisitions article to the Capital Law (95/1992). Economic Reform

17. Corporate Governance and Foreign Investment in Egypt (Continued). • Developing the institutional framework for investment, through establishingone-stop-shopallowing the completion of the firm’s establishment procedures in a maximum time of 72 hours only instead of 3 months. • Introducing new economic law and regulations: • Competition and Anti-Trust Law (No. 3/2005): To eliminate anti competition and monopoly practices. • Central Bank of Egypt, the Banking Sector and Financial Services Law (No. 93/ 2005) • Government Budget Law (No. 87/ 2005). • Consumers’ Protection Law Economic Reform:(Continued)

18. Corporate Governance and Foreign Investment in Egypt(Continued) • ReactivatingThe Public Asset Management Program ; in which a newapproach incorporating three main measures: • Privatization of state owned enterprises (SOEs); • Effective restructuring of the remaining SOEs; and . • The enhancement ofCorporate Governance principlesrelated to the publicly managed firms. Economic Reform: (Continued)

19. Corporate Governance and Foreign Investment in Egypt Corporate Governance in Egypt • Corporate governance standards in Egypt have improved significantly. • Establishingthe Egyptian Institute of Directors (EIOD), providing research, technical advisory services, and promoting awareness on the benefits of corporate governance • The firstCorporate Governance Code was issued by the EIOD, in addition to another Code for SOEs, both based on the OECD principles and guidelines.

20. Corporate Governance and Foreign Investment in Egypt Net Foreign Direct Investment Inflows in Egypt (US$ Billions) e Estimated 2006/2007. Source: Ministry of Investment, www.investment.gov.eg, May 2007.

21. Corporate Governance and Foreign Investment in Egypt • As an evidence for improving corporate governance quality in Egypt, the FDI had been increased, specially in terms of M&As. Cross Border Merger and Acquisition Overview Egypt (2004-2006)

22. Corporate Governance and Foreign Investment in Egypt Market Capitalization and Number of Listed Companies (Number of listed Companies) (L.E Billions) Source: Cairo and Alexandria Stock Exchange.

23. References: • Black, B., (2002), “The Corporate Governance Behavior and Market Value of Russian Firms”, Emerging Markets Review, 2 (2), 89-108. • Black, B., Jang, H., and Woochan, k., “Predicting Firms’ Corporate Governance Choices: Evidence from Korea.”, Journal of Corporate Finance, 12, (3), 660-91 • De Nicolò, G., Luc, L., and Ueda, K., (2006), “Corporate Governance Quality: Trends and Real Effects”, IMF Working Paper No. 06/293. (Washington DC.: IMF). • Erbiste, B., (2005), Corporate Governance in Brazil: Is There a Link Between Corporate Governance and Financial Performance in the Brazilian Market?” ABN Amro Asset Management. • Gompers, P., Ishii, J., and Metrick, A., (2003), “Corporate Governance and Equity Prices.” Quarterly Journal of Economics,118(1), 107-155. • Grandmont, R., Grant, G., and Silva, F., (2004) Beyond the Numbers-Corporate Governance: Implications for Investors. Deutsche Bank. • Inflows of FDI to Developing Countries, UNCTAD, World Investment Report 2006 • International Monetary Fund, (2003), Foreign Direct Investment In Emerging Market Countries. Working Group of the Capital Markets Consultative Group (Washington DC.: IMF). • La Porta, R., Lopez-de-Silanes, f., Shleifer, A., and Vishny, R., (2002), “Investor Protection and Corporate Valuation,” Journal of Finance. 57 (3), 1147-70. • MaKinsey & Company (2002) “Global Investor Opinion Survey 2002”. • Ministry of Investment, www.investment.gov.eg, May 2007. • Øyvind, B., Cooper, I., and Priestley, R., (2007) “Corporate Governance and Real Investment Decision“, working paper series, Norwegian School of Management.