Kirt C. Butler, Multinational Finance, 6e, 2015, John Wiley & Sons Ltd

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Chapter 17 Corporate Governance and the International Market for Corporate Control Learning objectives National corporate governance systems in selected ports-of-call The international market for

1 Chapter 17 Corporate Governance and the International Market for Corporate Control Learning objectives National corporate governance systems in selected ports-of-call The international market for corporate control Terminology Merger and acquisition (M&A) activity The international evidence on M&A The winners and losers Executive turnover and firm performance Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-1 Corporate governance refers to the way in which stakeholders exert control over the corporation Methods for obtaining control over another firm s assets Joint venture or strategic alliance Acquisition of another firm s assets Merger or acquisition of stock (M&A) Cross-border M&A is a common entry method into international markets Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-2 Investment-based cross-border market entry Source: Ernst & Young Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-3 Effective corporate governance systems Transparency Active & accountable supervisory boards Protection of shareholders rights, particularly those of minority shareholders A key issue in cross-border corporate governance is whether the controlling shareholder has the opportunity to expropriate the assets of the firm or of other shareholders Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-4 National corporate governance systems Market-based Australia Canada Ireland U.K. U.S. Bank-based Germany Japan Families or the State State China Singapore Family Mexico Italy Spain Family/State Indonesia S. Korea Saudi Arabia National corporate governance systems Capital markets United States Japan Germany China Commercial banks Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-5 Families or State Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-6

2 Equity ownership (La Porta et al, Corporate Ownership Around the World, J. of Finance 1999) Widely-held Family State Bank Corp. Other Large firms United Kingdom Japan United States South Korea Germany Italy Hong Kong Mexico Medium-sized United States United Kingdom Japan South Korea Germany Italy Hong Kong Mexico Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-7 The importance of large banks China Germany Japan U.K. U.S. Assets of the four largest banks Estimated 2015 GDP ($ trillions) Ratio of Assets/GDP Assets/GDP ratio relative to U.S Sources. Bank assets: The Banker (thebanker.com). GDP estimates: oecd.org Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-8 Importance of institutional blockholders Germany Japan U.K. U.S. Institutional blockholders 34% 49% 73% 69% Fund managers as blockholders 12% 6% 62% 56% Financial institutions as blockholders 9% 39% 3% 8% Institutional blockholder as largest shareholder 11% 19% 46% 43% Source: Li, Moshirian, Pham and Zein, When Financial Institutions are Large Shareholders, Journal of Finance 2006 Commercial banking in the United States The Glass-Steagall Banking Act of 1933 prohibited banks from most equity-related activities; i.e., owning stock for their own account, voting shares held in trust, investment banking, equity market making, and brokerage activities The Financial Services Modernization Act of 1999 repealed Glass-Steagall s separation of commercial banking, investment banking, insurance, and brokerage Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-9 Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Universal banking in Germany German banks offer a full range of financial services, including - Commercial banking - Investment banking - Insurance - Brokerage Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control National legal traditions Tradition Countries Characteristics Civil Continental Europe, Brazil Reliance on a codified set of laws law & Latin America, S. Korea, administered by judges trained Japan, Taiwan, Philippines in the application of the laws Common Australia, Canada, H.K., Reliance on judges law Ireland, India, S. Africa, interpretations of judicial New Zealand, Singapore, precedents set in previous United Kingdom, U.S.A. court decisions Sharia Afghanistan, Egypt, Iran, Reliance on a code of conduct law Indonesia, Iraq, Pakistan, based on the Quran and other Palestine, Saudi Arabia holy scriptures Evolving China, Russia, and other China is an example with former Communist Confucian, Communist, Socialist, nations and Western influences Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-12

3 Corporate governance systems USA Germany Japan (keiretsu) China (SOE) Key Shareholders, Shareholders, Shareholders, Governments and their stake- typically without employees, bank, business agencies, and stateholders a majority interest & bankers partners or keiretsu owned banks Bank owner- No direct equity Unlimited equity Limited equity Unlimited equity ship of ownership ownership ownership ownership equity (5% maximum) Super- Inside managers Outside directors, Inside managers, Two-tiered; independent visory and outside bankers, labor bankers, business board of supervisors & board directors representatives partners or keiretsu inside board of directors Manage- Managers often Heavily influenced Often collaborative Usually controlled by ment are relatively by the firm s with business the government or its independent bankers partners or keiretsu agencies Hostile Common thru Rare; approval of Rare; blocked by Rare in SOEs; otherwise acquisi- proxy contests lead bank and 75% business partners similar to other capital tions or tender offers of shareholders or keiretsu markets Executive Forced by market Initiated & managed Managed by main Rare in SOEs with turnover thru tender offers by the firm s lead bank, business politically connected, or proxy contests bank (Hausbank) partners or keiretsu entrenched managers Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control The main bank in the Japanese keiretsu Types of keiretsu - Horizontal keiretsu (industrially diversified) - Vertical keiretsu (along a supply-chain) Characteristics - Extensive share cross-holdings - Personnel swaps - Strategic coordination - Commercial transactions - Usually centered around a main bank Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Formal members of the Mitsubishi keiretsu Mitsubishi Corporation IT & communication Mitsubishi Electric Resources/energy/research JX Holdings Pulp & paper Mitsubishi Paper Mills Machinery Nikon Mitsubishi Kakoki Foods & beverages Kirin Holdings Mitsubishi Heavy Industries Chemicals & fibers Asahi Glass Mitsubishi Chemical Mitsubishi Gas Chemical Mitsubishi Plastics Mitsubishi Rayon Nonferrous metals & steel Mitsubishi Aluminum Mitsubishi Materials Mitsubishi Shindoh Mitsubishi Steel Real estate & construction Mitsubishi Estate P.S. Mitsubishi Construction mitsubishi.com Bank of Tokyo- Mitsubishi UFJ Consulting/research Mitsubishi Research Institute Warehouse/transport & eqpt Mitsubishi Fuso Truck & Bus Mitsubishi Logistics Mitsubishi Motors Nippon Yusen Kabushiki Finance & insurance Meiji Yasuda Life Insurance Mitsubishi UFJ Securities Mitsubishi UFJ Trust and Banking Tokio Marine and Nichido Fire Insurance Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Financial modernization in Japan is changing the keiretsu structures Mitsubishi UFJ Financial Group (MUFG) - Bank of Tokyo-Mitsubishi UFJ Mitsubishi, Sanwa, - Mitsubishi UFJ Trust & Banking and Tokai keiretsu Sumitomo Mitsui Banking Corp (SMBC) - Sumitomo Bank Sumitomo keiretsu - Sakura Bank Mitsui keiretsu Mizuho Financial Group (MHFG) - Dai-Ichi Kangyo Bank Dai-Ichi keiretsu - Fuji Bank Fuyo keiretsu Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control China s transitional system State sector - Businesses wholly-owned by the Chinese government Listed sector - State-owned enterprises (SOEs) SOEs among the world s largest firms include Sinopec ( # 5), China National Petroleum ( # 6), and State Grid ( # 7) (see Fortune magazine) Private sector - Family-owned and publicly-owned firms Still a relatively small but fast-growing sector Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Merger One firm absorbs another Acquirer usually retains its name & legal status Consolidation An entirely new firm is created Nevertheless, one firm usually dominates Acquisition of stock Acquiring firm buys the equity of a target firm Partial acquisitions are less than 50% ownership Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-18

4 Synergy Mergers and acquisitions are intended to create value synergy from an increase in revenues or a decrease in operating or financial expenses Synergy =V AT (V A +V T ) V A V T = acquiring firm value prior to announcement = target firm value prior to announcement V AT = value of combined firm after announcement Trust market prices and not the claims of the managers of acquiring firms Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Acquisition premium = Purchase price V T > 0 (or else the deal won t get done) Gain to acquiring firm =V AT (V A +V T + Acquisition premium) = Synergy Acquisition premium - Acquisition premiums typically are 10% or more, so target firm shareholders always win in a successful merger or acquisition - Acquiring firm shareholders may or may not gain Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Sample exam problem Given V A = billion and V T = 75.1 billion V AT = billion Purchase price = billion Solution Synergy = V AT (V A + V T ) = billion ( billion) = 70.0 billion Acquisition premium = Purchase price V T = = 62.7 billion Gain to acquiring firm = Synergy Acquisition premium = 70.0 billion 62.7 billion = 7.3 billion Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Rumors of a Vodafone (UK) offer for Mannesmann (Germany) surfaced on October 20, Vodafone eventually offered 266 per share. Mannesmann decided to accept the deal on December 17, October 21, 1999 December 17, 1999 VodafoneMannesmann Vodafone Mannesmann Share price # of shares 31 billion 518 million 31 billion 518 million FX rate ( / ) / / Calculate (a) the market s estimate of synergy (in euros) as of December 1999, (b) the acquisition premium, and (c) the gain or loss to Vodafone shareholders Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control The market s valuation of synergy October 1999: V A and V T V A = ( 2.70/sh)(31 billion shares)/( / ) = billion V T = ( 145/sh)(518 million shares) = 75.1 billion V A + V T = ( billion) + ( 75.1 billion) = billion December 1999: V AT V A = ( 3.11/sh)(31 billion shares)/( / ) = billion V T = ( 234/sh)(518 million shares) = billion V AT = ( billion billion) = billion Implied synergy = V AT (V A + V T ) = billion ( billion) = 70.0 billion Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Market estimate of synergy = V AT (V A + V T ) = billion ( billion) = 70.0 billion Acquisition premium = Purchase price V T = ( 266/sh 145/sh)(518 million shares)( / ) = 62.7 billion Gain to acquiring firm (Vodafone) = Synergy Acquisition premium = ( 70.0 billion) ( 62.7 billion) = 7.3 billion - As is typical of M&A, most of the synergies in the deal were captured by Mannesmann (the target firm) shareholders Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-24

5 Cross-border M&A over $40 billion in value Year Acquirer (Country) Target (Country) Amount Sector 2000 Vodaphone (UK) Mannesmann (Germany) $203 Telecom 2007 Royal Bank of Scotland ABN-AMRO (Netherlands) 99 Financial 2006 AT&T (U.S.) BellSouth (U.S.) 89 Telecom 2005 Royal Dutch (Dutch) Shell Transport Trading (UK) 74 Petroleum 1999 Vodaphone (UK) AirTouch Comm (US) 60 Telecom 2008 InBev (Belgian) Anheuser-Busch (U.S.) 52 Beverages 1998 BP Amoco (UK) Amoco (US) 48 Oil & gas 2009 Roche (Swiss) Genentech (U.S.) 47 Pharma 2000 France Telecom Orange PLC (UK) 46 Telecom 1998 Daimler (Germany) Chrysler (US) 40 Auto Source: Mergers and Acquisitions, various issues The winners and losers Target firms - Target firms shareholders receive large gains during the announcement period Acquiring firms - Within competitive markets such as the U.S., shareholders of acquirers may or may not win - Shareholders of acquirers in less competitive domestic markets are more likely to win - The shareholders of acquirers in cross-border M&A are more likely to win Butler / Multinational Finance 6eChapter Corporate governance & the and international corporate control market for corporate control Butler / Multinational Finance 6eChapter Corporate governance & the and international corporate control market for corporate control Contributing factors Method of payment - Cash offers are more likely to benefit bidding firm shareholders Free cash flow - Firms with free cash flow often waste it The tax environment - M&A can facilitate the transfer and realization of tax benefits Real exchange rates - A strong domestic currency helps domestic acquirers Butler / Multinational Finance 6eChapter Corporate governance & the and international corporate control market for corporate control Executive turnover Cross-border similarities - Higher executive turnover in firms suffering a sharp decline in equity value - Higher executive turnover in firms reporting poor earnings performance Cross-border differences - Bank-based systems: turnover tends to be initiated by the lead bank (Germany) or the principal shareholders (Japan) - Market-based systems: control contests are held through proxy contests or directly in the marketplace through tender offers Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control When the performance-turnover relation is weak Evidence from China - Executive turnover is related to performance, but only for firms in the private sector - Firms with politically connected CEOs underperform those without politically connected CEOs Fan, Wong, & Zhang, Politically Connected CEOs, Corporate Governance, and Post-IPO Perf of China s Newly Partially Privatized Firms Journal of Financial Economics, 2007 The value of corporate control benefits Tunneling is the expropriation of corporate assets by controlling managers, shareholders, or both - Self-dealing transactions (e.g. asset sales), excessive compensation, loan guarantees, expropriation of corporate opportunities, dilutive share issues, insider trading, and other transactions that discriminate against minority shareholders Foreign investors face threats to their control rights that are similar to those faced by minority investors Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-30

6 Caveats Increasing competitiveness in the market for corporate control is likely to change some of these conclusions Further research will surely modify or extend these stylized facts Butler / Multinational Finance 6e Chapter 17 Corporate governance and corporate control 17-31

Table 1: Foreign exchange turnover: Summary of surveys Billions of U.S. dollars. Number of business days

Table 1: Foreign exchange turnover: Summary of surveys Billions of U.S. dollars Total turnover Number of business days Average daily turnover change 1983 103.2 20 5.2 1986 191.2 20 9.6 84.6 1989 299.9