Corporate Governance States Role In Corporate Governance In

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Corporate Governance State’s Role In Corporate Governance In South East Europe Thomas Wels, Partner

Corporate Governance State’s Role In Corporate Governance In South East Europe Thomas Wels, Partner September 21, 2001

Overview • Importance of corporate governance in SEE • Barriers to improved governance •

Overview • Importance of corporate governance in SEE • Barriers to improved governance • State attempts to improve governance • A pan-regional response? • Options for the State

Importance of quality of board practices when evaluating investments % “In evaluating companies for

Importance of quality of board practices when evaluating investments % “In evaluating companies for potential investment in the following regions, how important is the quality of board practices relative to financial issues? ” More 25 33 48 Same 39 44 32 Less 36 Europe Source: Mc. Kinsey Investor Opinion Survey 1999/2000 23 20 Asia Latin America

Average premium investors would be willing to pay for a well-governed company Average %

Average premium investors would be willing to pay for a well-governed company Average % 30 28 Venezuela 26 Columbia 24 22 20 Brazil Mexico Argentina Chile Indonesia Thailand Malaysia Korea Taiwan Japan 18 0 16 Over 80% of investors willing to pay a premium Greece Italy Germany France Spain Switzerland Latin America Asia Source: Mc. Kinsey Investor Opinion Survey 1999/2000 Continental Europe US UK Anglo-Saxon

Overview • Importance of corporate governance in SEE • Barriers to improved governance •

Overview • Importance of corporate governance in SEE • Barriers to improved governance • State attempts to improve governance • A pan-regional response? • Options for the State

The market model governance chain* Shareholder environment Dispersed ownership Nonexecutive majority boards Sophisticated institutional

The market model governance chain* Shareholder environment Dispersed ownership Nonexecutive majority boards Sophisticated institutional investment Institutional context Aligned incentives Corporate context OECD Principles Active private equity market (incl. IPOs) Capital market liquidity Independence and performance Active takeover market High disclosure Shareholder equality *Examples can be found in Australia, Canada, U. K. and U. S. Source: Mc. Kinsey Transparency and accountability

The control model governance chain* Shareholder environment Institutional context Concentrated ownership Reliance on family,

The control model governance chain* Shareholder environment Institutional context Concentrated ownership Reliance on family, bank and State finance OECD Principles Under-developed new issue market Capital market liquidity ‘Insider boards’ Limited takeover market Independence and performance Incentives aligned with core shareholders Corporate context Limited disclosure Inadequate minority protection Transparency and accountability *Examples can be found in Asia, Latin America and many Continental and South Eastern European countries Source: Mc. Kinsey

Importance of institutional factors when selecting emerging market countries in which to invest Average

Importance of institutional factors when selecting emerging market countries in which to invest Average response Irrelevant Enforceability of legal rights (e. g. contracts) Quality of economic management Independence of judiciary/quality of legal system Level of corruption Predictability and level of taxation system Quality of accounting standards Effectiveness of regulatory system Administrative efficiency of government Effectiveness of banking sector Scale and liquidity of local investment market Source: Mc. Kinsey Emerging Market Investor Opinion Survey 2001 Relevant Highly Relevant

Importance of corporate level factors when selecting emerging market companies in which to invest

Importance of corporate level factors when selecting emerging market companies in which to invest Average response Irrelevant Distinctions between company and family interests Clearly defined governance arrangements Accuracy of financial reporting Legally enforceable minority shareholder protection Use of performance-related pay for top management Timeliness of financial reporting Coverage of financial reporting Presence of independent (non-executive) directors Establishment of conflicts of interests committee Source: Mc. Kinsey Emerging Market Investor Opinion Survey 2001 Relevant Highly Relevant

Overview • Importance of corporate governance in SEE • Barriers to improved governance •

Overview • Importance of corporate governance in SEE • Barriers to improved governance • State attempts to improve governance • A pan-regional response? • Options for the State

A radical reduction in State involvement – a crisis response Economic crisis • Large

A radical reduction in State involvement – a crisis response Economic crisis • Large currency devaluation • High unemployment • Falling stock market capitalizations • Increased nonperforming bank debt • Falling corporate profitability Source: Turkish Treasury; IMF; clippings Financial reform. . . • Banking sector reform • Public, agricultural, and social security spending reform • Plan to remove barriers to foreign investment • Government asset management company to be established. . . coupled with significant corporate reform • Privatization of Turkish Telecom, TUPRAS (oil refinery), POAS (petrol distribution), TEKEL (tobacco/alcohol), and SEKER (sugar) • Preparations being made to facilitate further private investment in gas, electricity generation, and distribution rights, Petkim (petrochemicals), Turkish Airlines, and ERDEMIR (steel) COUNTRY EXAMPLE Will buyers for state-owned enterprises be found?

Decreasing State ownership in corporate sector. . . Objectives • Attract local and foreign

Decreasing State ownership in corporate sector. . . Objectives • Attract local and foreign investors • Boost entrepreneurship • Encourage mergers and strategic alliances Measures • Undertake large scale privatization plan, incl. 12 major banks and companies in 2002 (e. g. , OTE, PPC, Agricultural Bank, Postal Savings Bank) • Introduce tax incentives to encourage more companies to merge • Introduce new legal and fiscal environment to encourage more venture capital Source: Clippings; Mc. Kinsey analysis Expected results • Over 3 billion Euros revenues • Market consolidation • Boost market confidence in Stock Exchange COUNTRY EXAMPLE Challenge Lack of interest from international investors. For ex: • Prolonged negotiations for selling of Olympic Airways and Hellenic Shipyards • Motor Oil’s disappointing IPO

. . . and radically reduced State influence in specific companies COMPANY EXAMPLE %

. . . and radically reduced State influence in specific companies COMPANY EXAMPLE % owned by state Other measures planned • Revoke trade union right to appoint board director • Management to be appointed by shareholders for 5 -year tenures** • Stock options introduced – to be open to all employees over time External influences on telecomms sector • Deregulation • Competition from new market entrants *Legislation passed enables changes **Previously, State-appointed Source: Clippings Prior to 1996 June 2001 Septembe r 2001 Planned in future*

Investors react favorably to improved corporate governance COMPANY EXAMPLE High/low points Spread of response

Investors react favorably to improved corporate governance COMPANY EXAMPLE High/low points Spread of response Institutional changes Governance changes • Liberalisation of foreign ownership of equities and bonds • Strengthening of shareholder rights Premiums for wellgoverned companies Percent 36 • Elimination of cross guarantees • Installment of transparency and accountability measures • Liberalisation of the M&A market • Increased legal activity by shareholders 30 • Corporate and banking restructuring • Accumulation of governance knowledge and practice 26 • More independent boards Source: Mc. Kinsey analysis, Mc. Kinsey Investor Opinion Surveys 1999/2000 34 32 28 24 22 Before changes (1998) After changes (1999)

Overview • Importance of corporate governance in SEE • Barriers to improved governance •

Overview • Importance of corporate governance in SEE • Barriers to improved governance • State’s attempts to improve governance • A pan-regional response? • Options for the State

Most capital markets – and companies listed – in South East Europe are small…

Most capital markets – and companies listed – in South East Europe are small… Total market cap – end 2000 Millions USD Number of companies listed (main and parallel markets) – end 2000 WIP Average company market capitalization Millions USD Athens Istanbul Sofia * Bucharest ** Skopje London 2, 612, 230 * 25 listed on the official market and 478 on the free market ** Estimates Source: Fi. BV. com; EIU; ASE; BSE; FEAS; EBRD 1, 100

…although in relative terms, ASE is quite successful Selected examples Value of S. E.

…although in relative terms, ASE is quite successful Selected examples Value of S. E. as a percentage of GDP – end 2000 Athens 93 Istanbul Sofia Bucharest Skopje 34 2 5 <1 * London *Estimates Source: Fi. BV. com; EIU; ASE; BSE; FEAS; EBRD 185

Yet, core shareholders dominate Greece’s largest publicly-listed companies Shareholder structure of top 15 companies

Yet, core shareholders dominate Greece’s largest publicly-listed companies Shareholder structure of top 15 companies ranked by market capitalization, end 2000 Domestic shareholders > 5% Foreign shareholders > 5% Shareholders < 5% Domestic shareholder’s average holding ~33% Foreign shareholder’s average holding ~13% Source: ASE; Mc. Kinsey analysis

Two recent initiatives in South East Mediterranean Negotiating: • Open respective markets to investors

Two recent initiatives in South East Mediterranean Negotiating: • Open respective markets to investors in Turkey and Greece via cross-membership of companies on both markets • Common technical application to follow stocks on both markets Source: Clippings Discussing increased cooperation: • Create common index comprising shares of all three stock exchanges • JV is planned within 2001

A more radical solution – a combined pan-regional exchange? Percent of total, USD millions,

A more radical solution – a combined pan-regional exchange? Percent of total, USD millions, number of companies Equivalent to Brussels Stock Exchange Skopje Bucharest Bulgaria 172, 485 Equivalent Toronto Stock Exchange 1, 416 • While combined number of companies is high, aggregate market capitalization is still relatively small Istanbul • Without more dynamic pooled equity markets, difficult for privatisation programs to access (foreign) equity financing option Athens Market capitalization Number of companies Source: Fi. BV. com; EIU; ASE; BSE; FEAS; EBRD

Requirements for pan-regional South East Europe exchange ILLUSTRATIVE Requirements Models • Common trading platforms

Requirements for pan-regional South East Europe exchange ILLUSTRATIVE Requirements Models • Common trading platforms • Euronext • Coming listing/tracking standards • Euronext • Common corporate governance standards • SEC-regulated exchanges/OECD Principles • Effective market makers/traders • SEC-regulated exchanges • Complementary, if not common, securities legislation • U. S. SEC/U. K. FSA regulations

Overview • Importance of corporate governance in SEE • Barriers to improved governance •

Overview • Importance of corporate governance in SEE • Barriers to improved governance • State attempts to improve governance • A pan-regional response? • Options for the State

Moving from control model governance chain Shareholder environment - Attract foreign equity capital -

Moving from control model governance chain Shareholder environment - Attract foreign equity capital - Reduce State ownership Institutional context Reliance on family, bank and State finance ‘Insider boards’ OECD Principles Under-developed new issue market Capital market liquidity • Encourage equity-based financing • Remove barriers to takeovers Source: Mc. Kinsey Concentrated ownership Limited takeover market Incentives aligned with core shareholders Independence and performance - Encourage more independent boards - Facilitate stockrelated compensation Corporate context Limited disclosure Inadequate minority protection Transparency and accountability - Mandate international accounting standards - Create and enforce shareholder rights

Where the State can contribute to improve Corporate Governance Adequate regulatory frameworks Alternatives to

Where the State can contribute to improve Corporate Governance Adequate regulatory frameworks Alternatives to state shareholdings Objective Examples • Create an adequate Institutional and Corporate framework to • Internationally accepted governance rules (e. g. , OECD, SEC, IAS/US-GAAP) – attract Direct Investment Liquidity of exchanges – Indirect Investment • Create broad distribution of stock in population • Reduce State stakes to create market for control • Incentivise stock exchange cooperations to improve liquidity

250401 LNZXC 483 TSMW-P 1 For further information contact: Thomas Wels: +30 (1) 3672

250401 LNZXC 483 TSMW-P 1 For further information contact: Thomas Wels: +30 (1) 3672 777 Mark Watson: +1 212 446 8021 Mc. Kinsey Investor Opinion Survey 1999/2000 can be downloaded from www. mckinsey. com Also, available on www. mckinseyquarterly. com, “Corporate reform agenda in the developing world", an article that includes findings from the Mc. Kinsey Emerging Market Investor Opinion Survey 24