Corporate governance: conceptual framework and evidence on Italian case

1. Corporate governance: conceptual framework and evidence on Italian case Magda Bianco Banca d’Italia Ufficio Diritto dell’economia

2. Structure of presentation • Corporate governance: some conceptual framework • What is it/how is it described • Why it matters • What instruments make it work better • Some international comparisons • Some facts on Italian governance • Non listed companies • Listed companies • Problems and possible reforms

3. What is corporate governance? • Takeovers, independent directors, Enron, Parmalat… all related to governance issues • Governance  exercise of authority, direction, control; seem strange in market context (isn’t market allocating resources?) • When transactions create “quasi-rents” (that have to be divided ex-post) that cannot be divided ex-ante on the basis of a contract (which is necessarily incomplete)  need a governance system • Zingales: a governance system is the complex set of constraints that shape the ex-post bargaining over the quasi-rents generated in the course of a relationship

4. Example: the purchase of a customized machine • Buyer must contact manufacturer, agree on specifications + price • Machine is produced: many events can occur which alter its production cost + once production has begun, buyer and seller are trapped in bilateral monopoly  machine has higher value to buyer than to the market; the producer has lowest production cost as compared to market • Difference between what parties generate and what can obtain on market: quasi-rent that has to be divided ex-post • There may be an initial contract, but it will be incomplete: cannot specify how rents are divided in every possible contingency

5. Example: the purchase of a customized machine Result will depend on: • Initial contract • Who owns machine during production • Alternatives available • Institutional environment (law enforcement, norms, reputation, information…) Effect of: rents + incomplete contracts  Apply this to corporate governance (1. - 4.): reference to theory of firm based on property rights

6. Why it matters? • Affects incentives to invest in value enhancing activities • Affects the availability of obtaining financial resources • Affects the possibility to allocate control to the most able ones • Effects on possibility to grow, efficiency, competitiveness • Recent interest of international institutions: OECD (Principles of corporate governance); World Bank (ROSC evaluations + DoingBusiness reports), EU (Action Plan on Company law)

7. Why competition on product market is not enough? • It takes time, especially if a lot of fixed capital • Sometimes not strong enough • Complement each other

8. Instruments to make it work • Incentives to invest • Obtain enough financial resources: separation ownership/control • Efficient allocation of control There isn’t a unique solution  trade –offs  Different possibilities in terms of ownership concentration and structure, control instruments, methods of separation ownership-control, legal settings

9. 1. Incentives to controlling agent • Possibility to defend increased value; • “Good” private benefits of control • Require certainty/stability of control (at least for some time)

10. 2. How to ensure enough separation between ownership and control • Guarantees for financiers  depend on nature of separation • Family relationship –coalitions: guarantees = trust among agents • Pyramidal groups – dual class shares: risks of expropriation (entrenchment + separation) • Dispersed ownership: expropriation; empire building, consumption of perquisites

11. 2. How to ensure enough separation between ownership and control • efficient market for corporate control (only if ownership not concentrated) • Monitoring by: a) boards (but…); b) large shareholders (institutional investors; banks) (but…) • Fiduciary duties (need efficient judiciary) • debt

12. 3. How to ensure efficient allocation of control a. Efficient market for corporate control (friendly or hostile acquisitions) Problems: • No private benefits (otherwise pressure to tender) • Free riding (no one sell) • High costs • Ambiguous empirical evidence b. In general, possibilities to “monetize” control (e.g., golden parachutes)

13. International comparisons: different solutions US: dispersion of ownership • Stability through antitakeover measures • Separation through minority shareholders’ protection (good enforcement) • Dynamic efficiency through market for corporate control (instruments to favor exit of controlling agents..) UK: dispersion of ownership • Stability? • Separation through: laws that favor dispersion + minority shareholders’ protection + monitoring by institutional investors + market for corporate control • Dynamic efficiency through market for corporate control

14. International comparisons: different solutions Sweden: separation through dual class shares + pyramids • Stability: through the two instruments • Separation: guaranteed more through social norms • Dynamic efficiency: ? Continental Europe: concentration of ownership (limited separation through pyramids or cross-shareholdings) • Stability: through concentration • Separation: through some monitoring by banks.. • Dynamic efficiency:?

15. Italy • Evolution over last 10 years: how did ownership and control change? • 10 years ago: A. non listed: high concentration, families, groups B. listed: groups (mainly pyramidal, but not only) were very common and important for governance • what consequences of changes? what policy responses?

16. A. Unlisted companies: Bank of Italy surveys 1993 • INVIND : annual representative survey on 1.500 manufacturing firms (specific questions on c.g.) • ESETRA1: ad hoc survey, (non representative) sample of 289 firms 2003 • INVIND: 1875 firms (specific questions on c.g.), 722 firms (questions on infra-family transfers) • ESETRA2: ad hoc survey, (non representative) sample of 468 firms

17. Ownership concentration (Invind)(largest share)

18. Ownership structure (Esetra)

19. Clauses in by-laws that limit the transferability of shares

20. Age of controlling agent(in family controlled companies)

21. A. Unlisted firms:a synthesis • No change even after 10 years of reforms • Search for stability (concentration + clauses) • Transfer problems

22. B. Listed “groups” • “listed groups”: groups which include at least one listed company • source of data: communications to Consob on ownership of voting rights in listed companies (larger than 2%) + shares of listed companies in other companies (larger than 10%)  algorithm to construct “listed groups”

23. Object of analysis 3 dates: • 1992: first available set of information + beginning of privatization process; • 1998: conclusion of first phase of privatization process; • 2001: last available set of information • 2003: only listed companies

24. Caracteristics: a) firms in listed groups

25. a) groups

26. b) How representative of the economy is this set(% empl. with respect to Census > 20 empl.)

27. c) diversification

28. Ownership and control: direct, group, integrated ownership HEAD OF GROUP 51% INVESTOR A 5% 44% 51% 49% B MARKET 51% 49% C

29. Direct ownership: concentrationDistribution of firms by largest and 3 largest shares

30. Direct ownership: identity of owners

31. Banks’ direct ownership

32. Direct ownership group ownership  integrated ownership HEAD OF GROUP INVESTOR 51% 5% SHARES OF THE DIFFERENT SUBJECTS IN ALL COMPANIES Ownership direct group integrated head of group 17.00 51.00 30.09 intermediate 34.00 0.00 0.00 investors 1.67 1.67 2.95 market 47.33 47.33 66.96 TOTAL 100 100 100 A 44% 51% MARKET B 49% 51% 49% C

33. From direct to group ownership

34. From direct to group ownership: banks

35. From group to integrated ownership  voting leverage

36. From group to integrated ownership  voting leverage (banks)

37. Separation between ownership and control

38. Listed companies: recent evolutiona) Ownership concentration: largest share

39. Listed companies: recent evolutiona) Banks’ ownership concentration: largest share

40. Listed companies: recent evolutiona) Ownership structure

41. Listed companies: recent evolutiona) Banks’ ownership structure

42. Listed companies: recent evolutionc) control modes

43. Listed companies: recent evolutiond) how is control exercised (blue chips only, 2003)

44. B. Listed firms: a synthesis • listed groups less representative of Italian economy especially in industry: (signal of growth problems; crises in industrial sectors + repositioning towards less competitive sectors) • high ownership concentration but decreasing, due to privatization process • Role of pyramids still important but less used to separate ownership and control • Increasing role of coalitions to separate (more unstable)

45. Issues • Incentives to controlling agents/stability: • obtained with concentration • when some separation: stability through pyramids or clauses • Separation: • obtained through pyramids + families (limited degree) • need more proptection from expropriation (international evidence suggests private beenfits of control very high; new company law?) + instruments for entrenchment (new financial instruments?) 3. Dynamic efficiency: • main problem • often through infra-family transfers: limited efficiency • coalitions might be more unstable