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Corporate governance: putting theory into practice

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Ronald Freeman, former EBRD Vice-President

Nerses Yeritsyan, Chief Adviser to the Chairman of the Central Bank of Armenia

Petra Alexandru, Executive Director at the Bucharest Stock Exchange

Evgeny Gavrilenkov, Russian Troika Dialog

“Fifty years ago, corporate governance was just an issue of taking care of shareholders. Now it is much more complicated and adopting good legislation for corporate governance is just not enough. Enforcement of laws is the hard part,” said Ronald Freeman, former EBRD Vice-President and Adviser to Troika Dialog, a Russian investment bank, to the participants of the 2006 Annual Meeting roundtable on corporate governance.

EBRD, the largest single investor in eastern Europe and central Asia, is concerned with corporate governance in its countries of operations. Simply put, corporate governance is about the balance between ownership and control in companies and aims at maximising shareholder value while ensuring that those dominating the company -- managers and majority shareholders -- do not run away with other investors’ money.

In 2004 the Bank completed a corporate governance assessment of its countries of operations, and in 2005, the Legal Indicator Survey. Working with leading law firms in the EBRD countries of operation and Mongolia, the survey assessed the effectiveness of corporate governance legislation in transition countries. This time, it did not assess the ‘laws on the books’ but how the laws work in practice.

To do this, the survey took the perspective of a minority shareholder trying to find out whether the controlling shareholder had abused its power. An example of abuse would be when the controlling shareholders divert corporate assets to themselves without disclosing information to the minority shareholders.

In such cases, the law and its enforcement institutions should be able to prevent insider opportunism and strengthen minority investors’ rights. This is a particularly important issue for the EBRD whose mandate restricts it to a minority position in any company in which it invests.

No matter how excellent the law, poor implementation undermines the usefulness of good legal provisions and is the perfect recipe for diminishing the confidence of foreign investors in the legal system as a whole.

“Several transition countries have developed outstanding corporate governance legislation, but this legislation is not always effective,” said Luca Enriques, a law professor at the University of Bologna and an EBRD consultant who helped conduct the survey.

In line with the letter of the law, investors should be able to obtain disclosure on information about a company’s structure and relevant transactions, and obtain redress when fraud has been detected.

But the reality can be gloomy in some transition countries. The average time needed to obtain a court order for obtaining disclosure varies from a few months in Bulgaria, Romania and Poland, to two years in the Czech and Slovak Republics, to three or more years in Bosnia and Herzegovina and Kosovo where procedures are particularly complex and difficult to enforce.

The survey found that legal procedures are generally very long in Azerbaijan, the Kyrgyz Republic and especially complex in Tajikistan. Enforcing the law is also a problem in Georgia and Ukraine.

However, some countries are already shifting their priorities towards improving the effectiveness of corporate governance. “We saw how companies were starting to do better and better after implementing our Corporate Governance Code,” said Ms Petra Alexandru, Executive Director at the Bucharest Stock Exchange. In Armenia, the Central Bank has started rating companies: “After six months of publishing the ratings, we have four companies issuing bonds this summer,” said Nerses Yeritsyan, Chief Adviser to the Chairman of the Central Bank of Armenia. These are positive developments, but much work still needs to be done.

Corporate governance in Russia

“Russia is not the strongest country regarding corporate governance,” Evgeny Gavrilenkov of the Russian Troika Dialog said to the numerous participants interested in knowing why the Russian market has been performing so well despite poor corporate governance in companies.

With a slowly growing economy in the 1990s, the Russian economy has delivered strongly since recovering from the 1998 rouble crisis. Corporate governance became an apparent issue only after 2001, with enterprises realising the need to borrow in order to fund growth. And in order to borrow, a company must be transparent and disclose clean balance sheets.

Only in 2002 did Russia introduce a Corporate Governance Code developed with EBRD technical assistance and financial support from the government of Japan.

The Russian market is still very attractive notwithstanding the risks connected to the generally poor corporate governance practices in place. Investors are just summing up corporate governance with the other risks related to the investment and still find very profitable businesses in Russia.

“But times have changed for Russia and the country’s good economic performance cannot last forever without sound corporate governance principles,” Mr Gavrilenkov told participants, adding that Troika Dialog is the only Russian bank employing corporate governance analysts.

Written by Marjola Xhunga, EBRD Communications Adviser.

Photos: R. Le Merle

22 May 2006