CORPORATE FINANCIAL ARCHITECTURE

Transcription

1 CORPORATE FINANCIAL ARCHITECTURE IRINA IVASHKOVSKAYA ORDINARY PROFESSOR, HEAD OF FINANCE DEPARTMENT, HEAD OF CORPORATE FINANCE RESEARCH CENTER, NATIONAL RESEARCH UNIVERSITY-HIGHER SCHOOL OF ECONOMICS

2 Outline Why corporate financial architecture (FA)? Why corporate design? Can we observe optimal ownership structure for the firm? Corporate governance and board s roles. Can we observe optimal governance in the firm? Research models and results in emerging capital markets

3 CORPORATE FINANCIAL ARCHITECTURE: COMPONENTS FINANCIAL DESIGHN CONFLICST OF INTERESTS& GOVERNNACE CAPITAL STRUCTURE OWNERSHIP STRUCTURE FINACIAL ORGANIZATION BENEFIT PLANNING CENTERS OF FINANCIAL RESPONSIBILITIES INTERNAL CAPITAL MARKET FINANCIAL (MONETARY) CAPITAL INVESTED INTELLECTUAL&RELATIONAL

4 CORPORATE FINANCIAL ARCHITECTURE: S.MYERS Financial architecture of the firm means the combination of different structural dimensions, including ownership (concentrated or dispersed), financing (allocation of risk between debt- and equity holders), corporate control and incentives through governance and board s processes. provides the frames for co-investments in intellectual as well as in financial capital. should provide the right incentives for the holders of both types of capital. different architectures are needed to accomplish different business goals and personal tasks. to explore corporate performance one should build all components of firm s financial design into the research model.

5 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 1: OWNER S FREE-RIDING WHEN THE COMPANIES HAVE DISPERSED OWNERSHIP. PLUS: Disciplinary force of external capital market to offer some from of protection against expropriation of controlling shareholders and against managerial opportunism MINUS: Free-riding contributes to lower performance. Lack motives for and the means to address managerial agency problem rejected in almost all papers (Short et al. 1994; Gugler 2001; Leech and Leahy 1991) due to low or absent statistical significance of independent variable.

6 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 2 : CONCENTRATED OWHERSHIP POSITIVE EFFECTS: Direct influence on managers (Bolton,von Thadden, 1998; Coffee, 1991; Maug, 1998; Schleifer,Vishny, 1986) 1988 Grossman,Hart: conflict of interests between minority and majority shareholders: the higher the share, the higher the yield earned by investor depends on that company s performance, the ownership concentration stimulates the shareholders interest to maximize the company value. More powerful incentives and the means for control over management by the threat of using their voting rights (David, Hitt,Liang,2007)

7 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 2 : CONCENTRATED OWHERSHIP POSITIVE EFFECTS: Can stimulate corporate leadership to work in their interest Can use their vast resources and knowledge to enhance organizational capabilities Greater control over firm fills the institutional void (Khanna,Palepu,2000) Useful in times of crisis if owners choose to transfer private resources to into the firms ( propping ) (Friedman, Johnson,Mitton,2003) Stutz (1988) harp-shaped or non-monotonic relationship between concentrated ownership and market capitalization.

8 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 2 : CONCENTRATED OWHERSHIP NEGATIVE EFFECTS: TUNNELING :Large shareholders expropriate minority rights (Bae, Kang,Kim, 2002; Johnson,La Porta,Lopez-de Silanes,Schleifer,2000; related party transactions( Djankov et al.,2008) artificially deflated prices (Johnson et al.,2000) Dominant shareholders have control rights in excess of their voting rights (cash flow rights) ; Barclay M., Holderness C., 1989: minority discrimination by private benefits of control and consequently increase in agency costs Shareholder-shareholder agency problem Fama, Jensen, 1983: negative consequence of high ownership concentration related to lower stock s liquidity that may increase company s cost of capital

9 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 2 : CONCENTRATED OWHERSHIP Stultz (1988) ; Morck et al., 1988: NON-MONOTONIC RELATIONSHIP BETWEEN CONCENTRATED OWNERSHIP AND MARKET CAPITALIZATION. Demsetz. Villlalonga,2001; MacConell,Servaes,1990; positive and negative effects cancel each other

10 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 3: IDENTITY OF THE CONCENTRATED OWNERS FORIEGN VERSUS DOMESTIC OWNERS : : Foreign owners expect higher performance, easier to select effective strategies, easier to align manager s interests to their own (Douma et al.,2006) Tend to contribute positively to organizational and managerial capabilities More resources to knowledge transfer, generic kmowledge (expertise) (Djankov, Hoekman, 2000) Domestic ownership is associated to lower performance

11 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 3: IDENTITY OF THE CONCENTRATED OWNERS ALTERNATIVE CLASSIFICATION OF OWNERS WITH RESPECT TO THEIR PREFERENCES TOWARDS RISK, GROWTH, STABILITY (Gedajlovic et al.,2005; Gerlach, 1992): (1) STABLE INVESTORS= tend to have multiple ties with the firm in addition: become creditors, debtors, buyers, suppliers Complex set of non-shareholder relationship, often create cross-holdings (Roe, 1994) Profitability is the secondary objective (Gedajlovic, Shapiro,2002) (2) INSIDE investors = equity PLUS direct management control (corporae founders, families) profit generation primary goal Appoint family members rather then external manageres (Granovetter, 2005)

12 OWNERSHIP STRUCTURE AND PERFORMANCE GROUP 3: IDENTITY OF THE CONCENTRATED OWNERS ALTERNATIVE CLASSIFICATION OF OWNERS WITH RESPECT TO THEIR PREFERENCES TOWARDS RISK, GROWTH, STABILITY (Gedajlovic et al.,2005; Gerlach, 1992): (3) MARKET INVESTORS = operate in arm s-length from management Maximal equity returns The firm must be sensitive to their powerful disciplining force (La Porta, et all,2000) Selling off large blocks will decrease the value and increase the cost of capital Risk premiums for management entrenchment and tunneling THE FIRM WITH MARKET INVESTORS WILL OUTPERFORM OTHER TYPES of investor s identities

13 GROUP 4: MANAGERIAL OWNERSHIP FIRST GROUP OF SCHOLARS rejects the possibility of such relationship (Lloyd et al. 1986). SECOND GROUP (Stulz 1988; Schellenger et al. 1989): positive influence THIRD GROUP (Morck et al. 1988; McConell and Servaes 1990; Holderness et al. 1999): o non-monotonic, reversed U-shaped relationship that is positive for small share holding and negative for large share holding. o o Morck et al. (1988) proposed the convergence-of-interests hypothesis for the positive relationship and the entrenchment hypothesis for the negative relation. - 5% to 50% Kole (1995) supposed that such a great variability could be explained with company s size

14 OWNERSHIP STRUCTURE: SETTING THE TARGETS? VALUE Vmax α opt MANAGERIAL OWNERSHIP (α)

15 GROUP 4: MANAGERIAL OWNERSHIP EXISTENCE OF NON-MONOTONIC RELATIONSHIP WITH THE BREAKPOINT DEPENDING ON GEOPOLITICAL FACTORS [Holderness et al., 1999; Kesner, 1988; Kole, 1995; Lloyd et al., 1986]. Non-monotonic relationship could be explained with 2 hypotheses. According to 'interest alignment' hypothesis, the firm value should grow with the increase in insiders' ownership because of the increase in managers' motivation to maximize company's performance. According to management entrenchment hypothesis, managers prefer to lower the risk level instead of maximize the value when they have very large holdings in the company since their personal risks are too concentrated in one company [Morck et al., 1988]. The results in Russia are not robust [Кузнецов, Муравьев, 2000; Радыгин, Энтов, 2001; Ivashkovskaya, Stepanova, 2011].

16 GROUP 5: GOVERNMENT OWNERSHIP -Out of 68 empirical studies 41 conclude that private companies are more efficient than public. -6 papers exactly the opposite results (some industry specific factors utilities) papers could not identify a significant difference in the corporate performance of two types of property or the dependence appeared to be non-monotonous

17 GOVERNMENT OWNERSHIP IN EMERGING CAPITAL MARKETS CHINESE COMPANIES: significant negative influence of state ownership over corporate performance (E.g. Xu X., Wang Y.,1997), fail to prove hypothesis,but negative influence (Tian L.,2001) U-shaped relationship between state ownership and performance in emerging markets. (Sun Q., Tong W., Tong J., 2002)

18 OWNERSHIP STRUCTURE AND PERFORMANCE: ENDOGENEITY GROUP 6: ENDOGENEITY. - KOLE,1995:The reverse causation: corporate performance predetermined the structure of the ownership. -DEMSETZ AND VILLALONGA, 2001: -The ownership structure an endogenous outcome of decisions that reflect an influence of shareholders and of trading on the market -When the performance is more likely to fluctuate due to opportunistic managerial behavior, it is better to be managed by concentrated owners -When performance is more predictable, dispersed owners are safe. -Equilibrium outcome = no relationship at all -HEUGENS ET ALL, 2008: the endogeneity argument depends on the liquidity and information efficiency of the markets. -Ownership is engenous when shareholders have sufficient information on behavior of firms and future cash flows

19 ENDOGENEITY : CAPITAL STRUCTURE AND OWNERSHIP STRUCTURE In late 1990s and 2000s the problem of endogeneity of capital structure and ownership structure has been actively discussed [Brown, Earle, 2000; Himmelberg et al., 1999; Claessens, Djankov, 1999; Kumar, 2004] together with the problem of potential reversed relationship. Instrumental variables and systems of simultaneous equations became the key instruments for regression analysis taking into account the endogenous capital and ownership structures. Results are quite different but there is evidence proving, for example, capital structure dependence of company size [Brailsford et al., 2002].

20 GOVERNANCE COMPONENT OF FINANCIAL ARCHITECTURE. GOVERNANCE MEASURES: RATINGS GOMPERS ISHII,METRICK(2003) GIM G- INDEX: Index of 24 corporate governance provisions from Investor Responsibility Research Center Equally weighted BEBCHUK, COHEN, FERRELL (2004) BCF-E INDEX: Entrenchment index: 4 provisions that limit shareholder s rights PLUS 2 provisions to prevent hostile takeovers BROWN, CAYLOR (2004) 52 provisions from Institutional Shareholder Services THE CORPORATE LIBRARY PRIVATE DATA (TCL): weighted scheme to include about 100 variables (Boards, management compensation, antitakeover) BHAGAT,BOLTON (2008): composite measure COMPOSIT G-Ownership score Ranking by GIMG-index AND median director dollar ownership value The sum of 2 ranks=composite measure

21 GOVERNANCE MEASURES: INDIVIDUAL CHARACTERISTICS BOARD INDEPENDENCE ( Herman, Weisbach, 2003), Bhagat,Black (2002): STOCK OWNERSHIP OF BOARD (Bhagat, Carey, Elson(1999): CHAIRMAN-CEO DUALITY (Brickley, Coles, Jarrell, 1997)

22 PERFORMANCE MEASURES OPERATING PERFORMANCE RETURN ON ASSETS: based on operating income before depreciation based on operating income after depreciation MARKET VALUE BASED (EXPECTATIONS BASED) TOBIN Q: (total assets+market value equity-book value equity-differed taxes)/ total assets TSR - INDUSTRY PERFORMANCE: TOTAL SHAREHOLDER RETURN on the basis of 4digit SIC code (excluding sample firm) VALUE BASED ECONOMIC PROFIT (RESIDUAL INCOME)

23 ECONOMIC PROFIT : STRATEGIC PERFORMANCE MEASURE EVA = ( ROCE WACC ) CE WACC = K (1 t ) d D D + E + K e D E + E D debt capital E equity CE capital employed ROCE return on capital employed Kd - market cost of debt, based on credit rating (Ke) - cost of equity hybrid capital asset pricing model, equal country risk exposure for the firms in the sample, adjusted on the size premium by Ibbotson Associates. industry beta adjusted to financial leverage risk free rate - the annual yield on 30-year US Treasury bonds plus spread. country

24 CORPORATE GOVERNANCE AND PERFORMANCE. RESEARCH MODELS AND RESULTS: TYPE I QUALITY OF THE BOARD S ACTIVITY SINGLE indicator: frequency of board s meetings institutional investors s share shares owned by directors and managers, separation of the CEO from the Chairman of the board of directors number of independent directors CORPORATE PERFORMANCE TRADITIONAL ACCOUNTING RATIOS: return on assets (ROA), return on equity (ROE), return on sales (ROS). Drobetz, Schillhofer and Zimmermann, 2003; La Porta R, Lopez de Silanes, Shleifer, Vishny, 2000; Hermalin, Weisbach,1991; Mehran, 1995; Klein, 1998; Peng et al, 2003 NEGATIVE: Erickson et. al. (2005); Bhagat,Black, 2002; Bhagat, Bolton,2008 board independence, POSITIVE: Bhagat,Bolton (2008): median director dollar ownership value and current and next year ROA; CEO-Chairman duality also positive

25 RESEARCH MODELS AND RESULTS: TYPE II Quality of the Board s Activity Single leading indicator Corporate Performance market ratios instead of accounting ratios or combined with accounting Q-Tobin, Price-to Sales ROA, ROE Independent directors: Bhagat, Black, 2000; Hermalin, Weisbach 1991, 2003: no relationship Yermack, 1996; Eisenberg et. al. (1998) negative relationship; Leblanc, Gillies, 2005 CEO (duality): Dalton, Dalton, 2005 Smith and Amoako-Ada, 1995

26 RESEARCH MODELS AND RESULTS: TYPE III Quality of the Board s Activity - Official ratings of corporate governance - OR independently developed ratings f corporate governance. Corporate Performance Market value (capitalization) Q-Tobin, Price-to Sales NEGATIVE RELATION WITH COST OF CAPITAL: Dalton, Dalton, 2005; Ashbaugh-Skaife et al., With market value: Positive : Zheka, 2005; Durnev, Kim, 2005; Black, 2000; Negative: Bebchuk et al, 2005; Bhagat, Bolton, 2008 (GIMindex and next year Tobin-Q Not significant : Cheung et al, 2008.

27 Research Models and Results: Type IV Quality of the Board s Activity - ratings of corporate governance - or the independently developed indices of quality of corporate governance Corporate Performance Economic profit: Residual income (RI), Economic value added (EVA) MacAvoy, Millstein 1998: USA Adjaoud et al, 2007: Canada POSITIVE SIGNIFICANT RELATIONSHIP

28 EMERGING MARKETS BLACK, JANG & KIM (2006) : KOREA Tobin Q (market -to-book), Governance score, not significant CHOI, PARK & YOO (2007): KOREA Tobin Q, positive relation with share of independent directors, not significant with size of Boards BLACK, 2001; BLACK,LOVE,RACHINSKY, 2006: RUSSIA Tobin Q, governance scores, S&P governance score : significant positive relationship with market capitalization differences between the predictive power of different corporate governance ratings: SP& transparency and disclosure VERSUS S&P governance score IVASHKOVSKAYA, SETTLES, PONOMAREVA (2006): S&P transparency &Disclosure and Residual income (RI), large scale public Russian firms. Positive relationship IVASHKOVSKAYA (2009 IN Russian): S&P transparency &Disclosure and Residual income (RI), 26 large scale public Russian firms with IRFS. Positive relationship

29 CORPORAE FINANCE CENTER PROJECTS GOVERNANCE AND PERFORMANCE The Model and Variables used Data: 26 Russian companies with IAS reports; Period of the research: ; Source of data: Bloomberg. Methodology: Correlation analysis; Panel data regressions and tests for the best model; Analysis of variance (ANOVA) Variables: Dependent variable: Economic Value Added (EVA) normalized value Independent variables: Quality of corporate governance: the scores of the S&P Transparency and Disclosure index Control variables: size, business risk, growth rate, capital structure, capital expenditure, sector of operation, government ownership

30 THE BEST FIT MODEL 2 SPECIFICATIONS Tests for the best fit model: Choice between pooled and fixed-effect model: Wald test is significant (F=2.50), hence, the fixed-effect model; Choice between pooled and random-effect model: Breush-Pagan test is significant, hence, random-effect model; Hausman test allowed to reject the hypothesis that all random effects are equal to zero.» The best fit model is random-effect Final regression equation:

31 INDUSTRY AND OWNERSHIP EFFECTS Metals and mining, oil and gas industries the normalized value of EVA is higher than for the whole sample by The coefficient for S&P rating increased by 0.4 point. Energy sector: EVA lower by 0.85 than in the sample. the coefficient for S&P rating is 0.15, but lower for the whole sample. Telecommunications: most significant influence. The increase by 1 point improves performance by Average EVA is lower than for the sample. Transport and machinery: no influence. The coefficient for S&P rating is insignificant at 10% level. Government ownership: not significant impact for the overall sample.

32 Contributions and Future Developments PROMISING ANALYTICAL TOOLKIT: Captures strategic performance, consistent with risk and return strategic trade-offs Fits for various organizational forms Fits the firms at different stages of their life cycle Makes it possible to decrease the risk of endogenous effects of the dependent and independent variables. Future needs: new governance score for New Governance Approach (Hilb) focused on Stakeholder Model