Corporate Governance and IPO Case Study

1. Corporate Governance and IPO Case Study Professor Alexander Settles Faculty of Management, State University – Higher School of Economics Email: asettles@hse.ru

2. Corporate Governance and Initial Public Offerings • Corporate Governance is a principle variable in evaluating risk / setting discount for IPOs • Firms reaching the market make significant CG changes to their board structure and practices to conform to market expectations

3. Snapshot of the Issuers Why? VimpelCom, 1996 New York Stock Exchange (NYSE); American Depository Receipts (ADRs); $110,8 m Raised. MobileTeleSystems, 2000 NYSE; ADRs; $353 m Raised • Insufficient volumes on Russian Market; • Perception that without US investors sufficient capital could not be raised; • NYSE was significantly larger and more prestigious than LSE; • Undeveloped legal regime in Russia; and Tatneft, 1996 London Stock Exchange 144A (LSE); Global Depository Receipts (GDRs); $ 120 m Raised Wimm-Bill-Dann, 2002 NYSE; ADRs; $207 m Raised Gazprom, 1996 LSE 144A; ADRs; $ 430 m Raised LUKOIL, 2002 LSE 144A; ADRs; $775 m Raised GoldenTelecom, 1999 NASDAQ; Ordinary shares; $144,2 m Raised RBC Information Systems, 2002 RTS/MICEX; Ordinary shares; $ 13,28 m Raised The First Wave (1996-2002)

4. Recent History • In 2006 LSE IPO Market exceeds NYSE IPO Market • 2007 IPO pipeline from Russian companies reached $28 bln. compared with $20 bln. in 2006 • “We are very concerned about corporate governance, transparency of company financials and protection of minority shareholders and, with a number of Russian companies, these things are called into question”, Mr. Thair, the New York Stock Exchange (April, 2007; www.ft.com); • Number of US listings of Russian companies since 2004: 2 • Mechel (2004) • CTC Media (2006) • Number of LSE/AIM listings of Russian companies greater than $200 mln. during 2005/2006: >17

5. Listing Rules • NYSE – SOX/NYSE Rules • LSE – UK Combined Code. Governance Metrics International (2005) ranks UK as leading country in terms of Corporate Governance • LSE GDR/London AIM – Combined Code not required but usually insisted by underwriters as “Best Practice”

6. Sarbanes Oxley • Accounting regulation • Public accounting oversight board • Restricting consulting/auditing • Audit committee • Independent financial experts • Internal control assessment • Assessment by auditors and company (Section 404) • Deemed costly and contested • Cross-listing elsewhere… • Executive responsibility • CEOs and CFOs must sign off on the company’s quarterly and annual financial statements. If fraud causes an overstatement of earnings, these officers must return any bonuses.

7. Sarbanes Oxley • Many argue that SOX is hurting U.S. capital markets. • SOX undermines CEO’s appetites for risk • SOX is a full employment act for Accountants (404) • The Committee on Capital Markets Regulation, set up by U.S. Treasury Secretary Hank Paulson, advocates rolling back the Sarbanes-Oxley Act.

8. Sarbanes Oxley • U.S. is losing out on new international listings… • London is beating the U.S. in the number of IPOs it draws. • Last year, the NYSE drew 192 IPOs and Nasdaq 126. • The LSE, often cited as the example of how SOX is chasing companies away, attracted a robust 617 IPOs, 510 of which were on the AIM, the exchanges small-cap market.

9. Sarbanes Oxley • However, the U.S. IPOs are larger. • Of a total of $118.2 billion raised through IPOs in 2006 • $17.5 billion occurred on the LSE, $4.2 billion on AIM • $16.9 billion on the NYSE • $9.4 billion on Nasdaq • $0.2 billion on AMEX, according to Thomson Financial.

10. NYSE Corporate Governance • Listed companies to have boards of directors with a majority of independents • The compensation, nominating, and audit committees to be entirely composed of independent directors • The publication of corporate governance guidelines and reporting of annual evaluation of the board and CEO

11. Cadbury Code of Best Practice • Cadbury Code • Boards of directors of public companies include at least three outside (non-executive) directors • The positions of CEO and chairman of the board of these companies be held by two different individuals • Cadbury Code is not legislated into law • LSE requires companies to “comply or explain.” • Empirical research suggests the code has been effective despite not being enforceable in courts…

12. Role of the Board in a Public Company IPO / Listing Experience • The Board • Effectiveness • Talents and background of board members • Tying board remuneration closely to performance • Strategic thinking by the Board • Managing risk effectively

13. Role of the Board in Listing - IPO • Developing a robust audit committee • Taking corporate social responsibility on board • Encouraging and active dialogue with shareholders

14. The Effective Board • Clear strategy aligned to capabilities • Vigorous implementation of strategy • Key performance drivers monitored • Effective risk management • Sharp focus on views of the capital market and other key stakeholders • Regular evaluation of board performance

15. The audit committee’s main responsibilities • To monitor the integrity of the financial statements • To review the company’s internal financial controls, internal control and risk management systems. • To monitor/review the effectiveness of the internal audit function. • To make recommendations to the board on the appointment/removal of the external auditor

16. The audit committee’s main responsibilities • To monitor/review the external auditor’s independence/objectivity and the effectiveness of the audit process. • To develop/implement policy on the engagement of the external auditor to supply non-audit services • To review arrangements by which staff may raise concerns about possible improprieties (‘whistleblowing’)

17. Stakeholders in the IPO Process • Owners & employees • Stock Exchange • Government (SEC, FSFM, etc.) • Institutional shareholder • Public Investors

18. Google: Time to Cash Out? • Reports valued Google’s IPO at $16 billion • Estimated 2003 revenue: $1 billion, profit: $300 million • In order to compete with the giants (Yahoo! and Microsoft), it would be in Google’s best interest to raise more money

19. Google’s naïve attempts to stay private • Why stay private? • Eric Schmidt: “We’re generating cash. We don’t ever need to go public.” • Google didn’t want to become a “short-sighted” company • However, Google was bound to become publicly traded • SEC regulation forcing them to report because of stock options offered to employees • Companies funded by venture capitalists almost always result in IPOs • During 2003, they unsuccessfully toyed with different strategies to remain private

20. Google’s IPO Process • Decision to become public in early 2004 • Debate over filing for public offering • Using investment bank vs. auction method • Ended up using a Dutch auction • Proposed S1 (formal public offering document) • Sell $2,718,281,828 worth of shares

21. S1 “An Owner’s Manual for Google’s Shareholders” • Outlined how Brin/Page planned on running the company • Claimed Google was different, so it would not act as a traditional public company • Proposed corporate structure that protected Google’s ability to “innovate and retain its distinctive characteristics” • “Dual class shareholding structure”: Founders and executives have far more control than common shareholder (common in media companies)

22. Google’s IPO Process • Google IPO did not follow Wall Street practices: • S1 represented a destruction of the traditional share selling, corporate governance, investor communications, and management structure of public companies • However, it showed tremendous numbers in the income statement • Profits, Cash, Operating Margins

23. Google’s Struggle to IPO • Bad Reputation • Google increased Secrecy • Slow amendments to S1 and entire process • Playboy Interview • Relentless scrutiny (SEC) • Companies uneven management of overwhelming growth • Reporting requirements would require a great deal of restructuring (e.g. Advertising) • Founders’ reluctance about the public path

24. Initial Public Offering (Finally) • Auction on August 12, 2004 • Revealed market price range: $85 to $108 • Public on August 19, 2004 • Price was $85/share

25. Post-IPO steps? • Created “Tablets” (declaration of what makes Google itself) • Post-IPO Organization (core groups) • Core search • Advertising Products • “20 Percent” (Gmail, Google News, Orkut) • “10 Percent” (Google Keyhole, Picasa) • Could now execute on its two core businesses, while other groups could pursue projects that could potentially turn into core businesses or useful products

26. Brin and Page: Still in Power • Brian Reid (former senior manager) sued Google for age discrimination • “Google is a monarchy with two kings” • Culture: “youth obsessed” • However, somehow they have succeeded • 5 year revenue growth is 400,000% • Fastest growing company ever

27. Russian IPO Examples - VTB

28. VTB Overview • The Group has three principal areas of business: • Corporate banking • Retail banking • Investment banking

29. Offering Size • 1,399,835,420,000 shares or 20.82% of the capital of VTB was offered as GDRs • 79.15% was retained by the Federal Property Administration

30. Investment Banks • Joint Global Coordinators • Citi • Deutsche Bank • Goldman Sachs • International Joint Bookrunners • Citi • Deutsche Bank • Goldman Sachs International • Renaissance Capital

31. Corporate Governance Issues • The interests of VTB’s principal shareholder may conflict with those of other shareholders; • VTB’s management has recognised a material weakness in the Group’s internal controls; • Some interested party transactions of Russian banks in the Group require the approval of disinterested directors or disinterested shareholders; • Shareholder liability under Russian law could cause the Group to be liable for the obligations of its subsidiaries; • There are weaknesses in legal protections for minority shareholders and in corporate governance standards under Russian law;

32. Corporate Governance Issues • Of the eleven seats on VTB’s Supervisory Council, six are held by representatives of various Government ministries and agencies, one is held by representatives of each of the CBR and the Russian President, one is held by VTB’s President-Chairman, and two are held by independent directors.

34. IPO Process • Global Offering: • Russian securities legislation does not permit VTB to sell more than70% of the total number of ordinary shares authorised in the Global Offering in the form of GDRs. • Retail Offering - retail investors in Russia “People’s IPO” • The Institutional Offering • 13.60 Kopecks or $0.00528 per Share and $10.56 per GDR. • Dec 2, 2008 share price is $2.05

35. VTB GDR price rebased to 100 Source: Factset Good deal announced – bad deal delivered?