Corporate Governance ROSC Assessment

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Report on the Observance ofStandards and Codes (ROSC)Corporate Governance

Corporate Governance

Country Assessment

Bulgaria

June 2008


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WHAT IS CORPORATE GOVERNANCE?

Corporate governance refers to the structuresand processes for the direction and control of com-

panies. Corporate governance concerns the relation-

ships among the management, Board of Directors,

controlling shareholders, minority shareholders and

other stakeholders. Good corporate governance con-

tributes to sustainable economic development by

enhancing the performance of companies and

increasing their access to outside capital.

The OECD Principles of Corporate Governance

provide the framework for the work of the World

Bank Group in this area, identifying the key practical

issues: the rights and equitable treatment of share-

holders and other financial stakeholders, the role of

non-financial stakeholders, disclosure and trans-

parency, and the responsibilities of the Board of

Directors.

WHY IS CORPORATE GOVERNANCE IMPORTANT?

For emerging market countries, improving corpo-

rate governance can serve a number of important

public policy objectives. Good corporate governance

reduces emerging market vulnerability to financial

crises, reinforces property rights, reduces transaction

costs and the cost of capital, and leads to capitalmarket development. Weak corporate governance

frameworks reduce investor confidence, and can dis-

courage outside investment. Also, as pension funds

continue to invest more in equity markets, good cor-

porate governance is crucial for preserving retire-

ment savings. Over the past several years, the impor-

tance of corporate governance has been highlighted

by an increasing body of academic research.

Studies have shown that good corporate gover-

nance practices have led to significant increases in

economic value added (EVA) of firms, higher produc-

tivity, and lower risk of systemic financial failures for

countries.

THE CORPORATE GOVERNANCE ROSC

ASSESSMENTS

Corporate governance has been adopted as one

of twelve core best-practice standards by the inter-

national financial community. The World Bank is the

assessor for the application of the OECD Principles of

Corporate Governance. Its assessments are part of

the World Bank and International Monetary Fund

(IMF) program on Reports on the Observance of

Standards and Codes (ROSC).

The goal of the ROSC initiative is to identify

weaknesses that may contribute to a countrys eco-

nomic and financial vulnerability. Each Corporate

Governance ROSC assessment reviews the legal and

regulatory framework, as well as practices and com-

pliance of listed firms, and assesses the framework

relative to an internationally accepted benchmark.

Corporate governance frameworks are bench-

marked against the OECD Principles of Corporate

Governance.

Country participation in the assessment process,

and the publication of the final report, are volun-

tary.

The assessments focus on the corporate gover-

nance of companies listed on stock exchanges. At

the request of policymakers, the ROSCs can alsoinclude special policy focuses on specific sectors

(for example, banks, other financial institutions,

or state-owned enterprises).

The assessments are standardized and systematic,

and include policy recommendations. In response,

many countries have initiated legal, regulatory

and institutional corporate governance reforms.

Assessments can be updated to measure progress

over time.

By the end of June 2005, 48 assessments had been

completed in 40 countries around the world.

Overview of the Corporate Governance ROSC Program


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REPORT ON THE OBSERVANCE OF STANDARDS AND CODES(ROSC)

Corporate governance country assessment

BulgariaJune 2008

Executive SummaryThis report assesses Bulgarias corporate governance policy framework for publicly traded

companies. It highlights recent improvements to laws and regulation, makes policy

recommendations, and provides investors with a benchmark against which to measure

corporate governance in Bulgaria. This report updates the 2002 Corporate Governance ROSC

(CG ROSC).

Achievements: Since 2001, Bulgaria has undertaken substantial legal, regulatory, and

institutional reforms that have led to improvements to the corporate governance framework, in

particular in the areas of: (i) board practices; (ii) shareholder rights; and (iii) disclosure. Toestablish a set of good practices that regulators, investors and the companies themselves can

benchmark corporate governance practices against, Bulgaria launched a national code of

corporate governance (NCGC) in late 2007. In doing so, it implemented one of the key

recommendations of the 2002 CG ROSC. Forty companies have agreed to implement the

NCGC, although only 19 are formally required to do so.

Key Obstacles: Substantial challenges, however, remain. While the legal framework,

including the NCGC, has a few remaining gaps, actual practices lag behind the law on the

books. Boards in particular do not fulfill their role of guiding and overseeing management,

ensuring for appropriate disclosure, and building robust control frameworks. The largest

obstacle to board reforms is ownership concentration, with majority owners dominating board

and governance processes. It is this group that ultimately wields the key to improved

corporate governance.

Key Opportunities: On the other hand, corporate governance is currently being brought to the

forefront of the reform debate, mainly due to: (i) improvements to the legal and regulatory

framework; (ii) the launch of the NCGC, which has led to increasing awareness of the business

case for corporate governance; and (iii) a nascent trend of ownership dispersion, which,

combined with the growth of institutional investors, is loosening the grip of majority owners

and encouraging stakeholders to engage in corporate governance reforms.

Next Steps: As Bulgaria continues its dynamic pace of reforms, all key stakeholders involved

in the reforms process may wish to focus on the following four reform priorities: First, the

Financial Supervision Commission (FSC) should continue to strictly enforce existing laws and

may wish to focus on how the following three groups comply or explain with the recently

issued NCGC: (i) holding companies, in which governance practices are consideredinsufficient; (ii) the largest ten issuers that make-up most of the trading and market

capitalization; and (iii) principal issuers on the Unofficial Market that are driving much of the

markets growth. Second, the task force that launched the NCGC may wish to eventually

review the NCGC to offer more practical guidance on how to implement good practice. Third,the government and regulators may wish to make minor amendments to the legal and

regulatory framework. Fourth and finally, the most important factor to improve corporate

governance will be to train and thus, over time, build a cadre of qualified, experienced, and

professional directors who are empowered to ensure that the law on the books translates into

actual practice.


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AcknowledgementsThis CG ROSC report reflects technical discussions with a number of

private and public sector institutions, as well as other relevant stakeholders, whom

the World Bank would like to thank for their time and invaluable insight into

corporate governance practices in Bulgaria. The World Bank would like to

expressly thank the: Financial Supervision Commission; Bulgarian Stock

Exchange-Sofia; Bulgarian National Bank; Bulgarian Privatization Agency;

Ministry of Finance; Registry Agency, Ministry of Justice; Central Depository;

Association of Bulgarian Investor Relations Directors; Bulgarian Investor

Relations Society; Bulgarian Industrial Capital Association; the Institute of

Certified Public Accountants in Bulgaria; in addition to a number of banks and

other financial institutions, publicly listed companies, law and accounting firms, aswell as investors and financial sector institutions. The information received on

current corporate governance practices and issues was indispensable for the

development of this corporate governance policy assessment, and for developing

the resulting conclusions and policy recommendations.

This Corporate Governance ROSC assessment of Bulgaria was carried out

by Sebastian Molineus, Senior Operations Officer, with the support of David

Robinett, Private Sector Development Specialist, both with the Global Capital

Markets Development Department. Orsalia Kalantzopoulos, Country Director,

Florian Fichtl, Country Manager, Stella Ilieva, Senior Economist, Evgeny

Evgeniev, Consultant, and Albena Samsonova, Program Assistant, all from the

World Bank Bulgaria Country Team; Marie-Laurence Guy, Senior Projects

Officer, IFC-Global Corporate Governance Forum; George R. Clarke, Senior

Private Sector Development Specialist; and Luc Cardinal, Senior Financial

Management Specialist, World Bank, readily offered their expertise and support to

help finalize this CG ROSC report.

The ROSC is based on a corporate governance template-questionnaire

completed by a team from the Institute of Economics at the Bulgarian Academy of

Sciences, under the coordination of Dr. Mitko Dimitrov and including Dr. Plamen

Tchipev, Dr. Spartak Keremidchiev, Dr. Valchin Daskalov, and Dr. Radostina

Bakurdjieva, with technical support from Diana Dimitrova.


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Table of Contents

Market Profile.......................................................................................................................................1

Key Findings ........................................................................................................................................3

Protecting the Rights of Investors...................................................................................................3

Strengthening Information Disclosure and Transparency...............................................................5

Building Strong Board Practices and Control Structures................................................................7

Enforcement..................................................................................................................................10

Recommendations ............................................................................................................................12

Status of Implementing the Recommendations Contained in the 2002 CG ROSC .....................16

Summary of Observance of OECD Corporate Governance Principles ........................................21

Corporate Governance Landscape ..................................................................................................24

Principle-By-Principle Review of Corporate Governance .............................................................31

Section I: Ensuring the Basis for an Effective Corporate Governance Framework.........................31

Section II: The Rights of Shareholders and Key Ownership Functions............................................34

Section III: The Equitable treatment of Shareholders......................................................................46

Section IV.: The Role of Stakeholders in Corporate Governance....................................................51

Section V.: Disclosure and Transparency........................................................................................56

Section VI.: The Responsibilities of the Board.................................................................................65


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Corporate Governance ROSC Assessment Bulgaria

Country assessment: Bulgaria

This 2nd

CG ROSC

aims to strengthen

corporate governance

in Bulgaria through an

in-depth assessment

and policyrecommendations.

In November, 2007, the World Banks Corporate Governance Policy Practice was

formally invited by the Bulgarian Financial Supervision Commission (FSC) to

carry-out a Corporate Governance Report of the Observance of Standards and

Codes (CG ROSC) in Bulgaria, the second such CG ROSC since 2002.

Related recommendations in the area of disclosure and transparency are presented

in the 2008 Accounting and Auditing ROSC for Bulgaria.

Market Profile

The results of the

privatization process

have impacted the


practices of a number

of companies.

The privatization process in Bulgaria was launched in 1992 and largely

implemented from 1996 to 2004. Today, the share of the state ownership has

been greatly reduced. Growth is led by the private sector, which now accounts

for 75 percent of GDP with an equal share of total employment. The total amount

of assets privatized amounts to 60.44 percent compared to the amount of all state-

owned assets and 91.53 percent compared to the assets subject to privatization.

Bulgarias mass privatization program impacted todays corporate governance

framework and practices. More specifically:1. Privatization funds collected over 80 percent of the vouchers and acquired 87

percent of the shares purchased in auctions. Of the original 81 privatization

funds, around 30 are still listed on the exchange as holding companies. First

and foremost, the governance of these holding structures remains an issue.

Moreover, the corporate governance of their subsidiaries, and governance

relationship between the holding structure and subsidiaries, is thought to be of

concern as well, for example, with respect to abusive related party

transactions and poor consolidated financial reporting.

2. Legal and regulatory changes in 2003 led to the broader use of the BulgariaStock Exchange-Sofia (BSE) as a means to privatize. Prior to the enactment

of the Privatization and Post-Privatization Control Act in 2002, only 46 saleswere made through public offerings on the BSE; the total number of the sales

made thereafter is 1,743 (77.9 percent of all privatizations for the period).

While this has had a positive effect on the development of the market, not all

issuers had the necessary structures or culture in place to embrace good

corporate governance. The government reacted in 2004 and allowed a

number of smaller companies to de-list from the exchange, however, partially

reversed its decision in 2006 and required all companies with over 1,000

shareholders to re-list again. Today, of the nearly one thousand firms that

were initially listed on the BSE, approximately one-third remain listed and of

these, only a few are actively traded.

3. Following mass privatization Bulgaria, as its neighboring countries, witnessed

a wave of ownership concentration, largely by insiders who diluted minorityshares to gain control of companies. It was not until later that revisions to the

law were passed to try to protect minority shareholders from dilution. As a

result, ownership is highly concentrated. The minority stakes, in turn, are

often considered abandoned as they are held by individuals who are

unaware of their rights, e.g. to participate in the profits of the company.

The current market

conditions should be

As of June 30, 2007, the market capitalization of the BSE was BGN 20,8 billion

(USD 16,32 billion) and 41 percent as a percentage of GDP, up dramatically from

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viewed as an

opportunity to build on

the legal and

regulatory reforms to

now implement good

practice at the

company level.

June 2002 (BGN 1,375 billion and 4.2 percent, respectively). The number of

listed companies on the BSE reached 509 in December 2007, 46 issuers more

compared to the end of 2006. A substantial increase was registered on theUnofficial Market, i.e. lowest and least regulated market segment, where the

number of listed securities rose by 10 percent over a one year period. Turnover

and trading volume, too, increased significantly. However, the market has

recently experienced a sharp correctiondue to, inter alia, the sub-prime

mortgage crisis in the United Stateslosing just under 30 percent of its valueover the past six months, with the main indices, SOFIX and BG-40, loosing 41.5

and 46.5 percent, respectively since the historical high in mid-October 2007. The

total market capitalization of the stock market has shrunk to BGN 22.9 billion on

May 12, 2008 down from over BGN 28 billion in October 2007.

Three key issues

should, however, be

taken into account

during the next phase

of the reform process:

(i) trading is limited to

a few issuers; (ii)growth stems from

issuers on the largely

unregulated unofficial

market; and (iii)

ownership

concentration.

The governments and regulators commitment to improve-upon the corporate

governance framework, however, remains strong, despite (or precisely because) of

the current market downturn. Three key issues need to be taken into account by

all stakeholders during the next phase of the reform process: (i) trading is

concentrated to the top 10 issuers, which account for 88 percent of trading volume

and 47 percent of market capitalization; (ii) growth in terms of market

capitalization is mainly coming from the Unofficial Market, which is largelyunregulated in terms of corporate governance; (iii) ownership is highly

concentrated.

These three issues are a risk to capital market stability, yet at the same time pose a

unique opportunity for the market in general and regulatory agencies in particular

to focus their monitoring, respectively regulatory efforts on: (i) the top 10 to 20

issuers; (ii) bulk of companies listed on the official market, as well as growth

companies on the Unofficial Market; and (iii) leading shareholder groups.

In particular the fact

that ownership is

concentrated in the

hands of a few private

investor groups, the

state and, increasingly,

institutional investors,

should be viewed as a

risk and an

opportunity.

Three distinct ownership groups can be distinguished from one another:

Today, private ownership is highly concentrated in the hands of a few

domestic investors, estimated to number 130 to 150. The average size of the

largest equity stake was found to be equal to 60 percent of outstanding shares,with the second and third biggest shareholders averaging 12.7 percent and 5.5

percent. The free float of publicly listed companies is, however, visibly

increasing, e.g., from 17. 9 percent in 2006 to 24.7 percent in 2007. These

majority investors have not traditionally embraced corporate governance,

however, present a unique opportunity to effectuate reforms should they learn

to appreciate the business case for good corporate governance. The fact that anincreasing number of minority shareholders are entering the market increases

the business case for the regulator to ensure that their minority rights are

protected from the very beginning, thus ensuring for trust and confidence in the

capital markets.

State-ownership has been greatly reduced due to privatization, but the size of

the public enterprise sector and the extent to which the state controls strategicdecisions of public enterprises is still significant. Moreover, the governance of

approximately 115 state-owned enterprises (SOEs) remains underdeveloped in

the absence of a clear legal framework, ownership policy, and corporate

governance improvement program by the state over its assets.

Institutional investors are relatively new to Bulgaria, however, todays number

is close to 100, with some six pension funds, 40 mutual funds (12-15 mutual

funds alone were launched in the past two years) and 46 investment companies.

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It is estimated that institutional investors own approximately BGN 1 billion or

5 percent of equity in terms of market capitalization and approximately 70-80

percent of equity that is floated, with the rest disbursed among retail investors.

This investor group can play an important role in engaging with their investee

companies, in particular in the area of corporate governance and should be

encouraged to vote their shares.

The legal andregulatory framework

has seen important

improvements, most of

which were

implemented to meet

relevant EU Directives

but also in response to

the 2002 CG ROSC.

An impressive number of changes have been made to all principle laws andregulations relating to corporate governance, in particular the Commerce Act

(CA) and Law on the Public Offering of Securities (LPOS), which have served to,

inter alia: (i) better protect shareholder rights, e.g. the right to elect and dismiss

directors; (ii) improve upon disclosure, e.g. to disclose a corporate governance

improvement plan in the annual report; and (iii) strengthen board practices, e.g.

by requiring at least one-third of the (supervisory) board to be composed of

independent directors. These changes have prompted a number of market

participants to cite improvement to market transparency and confidence.

the launch of the new

NCGC sets-out good

practices and has

raised awareness ofgood corporate

governance, even if it

could provide more

practical guidance.

The launch of the National Code of Corporate Governance (NCGC) in late 2007

implements one of the main recommendations of the 2002 CG ROSC. The

NCGC does set out good practice, however, could be revised in a number of areas

and provide for more practical guidance on implementing good corporategovernance. Due to the participatory process in developing the NCGC, Bulgarias

Corporate Governance Task Force managed to raise awareness of good corporate

governance. The NCGC is to be implemented on a comply or explain basis by

all issuers listed on the BSEs most heavily regulated market segment, the Official

Market, Segments A and B, but not the Unofficial Market (where most of the

growth comes from). Forty companies representing approximately BGN 7,065

billion of market capitalization have publicly announced that they intend to fully

apply the NCGC, and 22 of these 40 have already developed corporate

governance improvement plans, albeit of varying quality. Finally, a corporate

governance scorecard is currently being developed to better allow stakeholders to

assess a companys governance against the NCGC.

Key Findings

The following key findings section summarizes the principle-by-principle

assessment of Bulgarias compliance with the OECD Principles of Corporate

Governance.

Protecting the Rights of Investors

The corporate

governance framework

protects basic

shareholder rights to

participate and vote inthe GSM.

Ownership registration is secured, shares of publicly listed companies are freely

transferable, and shareholders are generally able to obtain material information for

the general shareholder meeting (GSM) on a timely basis. Shareholders are able

to participate and vote in the GSM, and elect or remove directors to the board.

Cumulative voting1 is neither required nor recommended in the corporategovernance framework and is not carried-out in practice, decreasing the

1Cumulative voting allows minority shareholders to cast all their votes for one candidate. Suppose that a publicly traded company hastwo shareholders, one holding 80 percent of the votes and another with 20 percent. Five directors need to be elected. Without acumulative voting rule, each shareholder must vote separately for each director. The majority shareholder will get all five seats, as s/hewill always outvote the minority shareholder by 80:20. Cumulative voting would allow the minority shareholder to cast all his/her votes(five times 20 percent) for one board member, thereby allowing his/her chosen candidate to win that seat.

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opportunity for minority shareholders to elect directors to the board. Shareholders

may exercise their rights, including the right to participate in the GSM, by proxy,

however, in-line with detailed and cumbersome guidelines. Also, the CA allowsfor different classes of shares with different voting rights, although virtually all

traded companies use one-vote one-share voting in practice. Preferred

shareholders are accorded an advisory vote. Finally, the law states that the

board must provide true, exhaustive, and to-the-point answers to questions posed

by shareholders during the GSM, in-line with good practice.

Take-over provisions

to protect shareholders

are regulated

according to good

practice.

Companies are required to disclose acquisition of shares in 5 percent increments

and a shareholder who acquires 50 percent or more of the shares must provide a

tender offer to the remaining shareholders. Shareholders who acquire 95 percent

of the shares are provided with a squeeze-out right2 and minorities in turn with

a sell-out right. Anti-takeover devices are not known to exist.

Special qualified

voting requirements

exist to further protect

shareholders and

shareholders are able

to file suits.

Qualified (two-thirds) and super-majority (three-fourth) voting on key issues

exists, such as a qualified two-thirds voting majority for restricting or cancelling

preemptive rights;3

a three-fourth voting majority for restricting the rights of

preferred shareholders; and unanimity, with a blocking quota of one share, exists

for placing additional items on the GSM agenda not previously announced.

The legal framework allows shareholders to seek redress before the courts, both

via direct and derivative suits.

The concept of a

shadow director is

introduced in the law,

in-line with good

practice and most

relevant for Bulgarias

concentrated

ownership structure.

Of note is that Art. 118a LPOS introduces the concept of the shadow director,

in-line with good practice, and specifies that any person who controls or exerts

influence over a public companys directors or managers, and induces them to act

or to refrain from acting against the interest of the company, shall be held liable

for damages inflicted on the company. This rule is particularly relevant in

Bulgaria, with the high concentration of ownership. On the other hand, it does

not appear that this rule has been successfully used by minority shareholders.

There are no major

obstacles to cross

border voting.

There are only a few sectors that restrict foreign investors and, though not

desirable, these fall into the EU norm. Foreign shareholders may vote by proxy

or through their custodian, and electronic voting is encouraged by the NCGC,

albeit not carried-out in practice. The cumbersome requirements for the

notarization of proxies may limit foreign participation. There is little to no

practice of custodians voting shares on behalf of shareholders.

Shareholders are able

to effectively

participate in

decisions concerning

fundamental corporatechanges. However,

with respect to

A three-fourth majority vote by the GSM is required for changes to the

companys articles of association and when new shares are issued by, in-line with

good practice. Shareholders are accorded pre-emptive rights to prevent the

dilution of their equity stake. Finally, the legal and regulatory framework

requires the board to seek shareholder approval of extraordinary and related partytransactions above a certain monetary thresholds.

2The squeeze-out right (sometimes called a freeze-out) is the right of a majority shareholder in a company to compel the minorityshareholders to sell their shares to him. The sell-out right is the mirror image of the squeeze-out right: a minority shareholder maycompel the majority shareholder to purchase his shares.

3Pre-emptive rights give existing shareholders a chance to purchase shares of a new issue before it is offered to others. These rightsprotect shareholders from dilution of value and control when new shares are issued.

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remuneration, the law

may overshoot good

practice.

The law even allows shareholders to determine, rather than expressly vote or

provide an advisory opinion on, board and executive remuneration. This may

actually run counter to good practice as it could politicize executive remunerationand hinder the companys ability to offer remuneration packages deemed

attractive enough for high-caliber managers.

Corporate governance

concerns remain whenit comes to dividend

policies and payments,

The legal framework accords shareholders the right to participate in the profits of

the company. However, there are two issues with respect to the payment ofdividends. The first is that hardly a company has a dividend policy. The second

is that declared dividends do not appear to be paid-out to a number of minority

shareholders by the custodians.

and capital structures

and arrangements that

enable shareholders to

obtain a degree of

control

disproportionate to

their equity ownership.

Beneficial ownership structures are still difficult to determine despite the best

efforts of the regulator, largely due to difficulties of obtaining information from

entities registered in off-shore jurisdictions. Golden shares arrangements do exist

in practice, if only in a limited number of cases, for example in Bulgaria Air,

Neftochim (now Lukoil), and Bulgaria Telecom, and good practice would call for

such arrangements, at a minimum, to be disclosed.

Finally, the corporategovernance framework

does not require or

recommend for

institutional investors

to vote or disclose

their voting policies.

Institutional investors have played an important role in driving the market thesepast years, however, have tended to play a passive role in exercising their voting

rights, largely due to the limited ability to effect change in the current

environment of concentrated ownership. There is little practice of disclosing

voting policies or engaging with boards and senior management to discuss issues

related to corporate strategy or governance.

The rights of

stakeholders as

established by law are

respected.

Whistle-blowingmechanisms and basic

information rights to

employees are,

however, not provided.

The legal and regulatory framework accords important rights to the companys

stakeholders, in particular employees and creditors. These basic rights are

thought to be respected. On the other hand, few companies have adopted specificpolicies that go beyond basic requirements, for example, by including a social

balance sheet or similar discussions on stakeholder relations in their annual

report or company website. Most Bulgarian companies do not offer their

employees performance enhancing mechanisms. Moreover, Bulgaria has of yet to

introduce whistleblower protection in its corporate governance framework

Strengthening Information Disclosure and Transparency

While the disclosure of

financial information

has improved

Financial disclosure has improved dramatically since 2002, yet can still be

improved upon.4

The law requires companies to provide shareholders with a

complete set of financial statements on an annual (audited) and quarterly basis,

prepared and disclosed according to EndorsedIFRS, both individually and on a

consolidated basis.5 The legal framework also requires these financial statements

to remain publicly available for a period of at least five years, much in-line with

4The Accounting and Auditing ROSC, which is being prepared and launched simultaneously to this CG ROSC, contains more detailedanalysis and recommendations on financial disclosure and audit issues. A copy is available underwww.worldbank.org/ifa/rosc_bgr.pdf.

5It must be noted that because Bulgaria is an EU Member State, it has to comply with the acquis communautaire, which is the body oflaw of the EU, and with the endorsedIFRS, which are the IFRS that the EU has endorsed. Since the EU was not in agreement withthree paragraphs of the IAS 39, the entire IFRS was carved out. It should also be noted that Bulgaria now obtains a timely translationof the adopted changes to the endorsedIFRS by the European Commission.

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good practice.

the disclosure of non-

financial information

remains haphazard

and generally under-

developed

The legal framework calls for the financial statements to be accompanied by an

activity report,6 however, the activity reports are generally thought to be

insufficient in practice. Companies are not required or encouraged to publicly

disclosure their commercial and non-commercial objectives, and do not do so in

practice. The same holds true for the disclosure of ownership, in particular

beneficial ownership, and voting rights; remuneration policy for directors andsenior executives, as well as the actual remuneration on an individual basis;

related party transactions; material foreseeable risk factors; and issues regarding

employees and other stakeholders. On the other hand, the legal framework

requires companies to disclose their corporate governance policies and

improvement plan, yet not all companies do so in practice, or do so in varying

quality; also, the law does not specifically refer to the NCGC, the new corporate

governance standard for Bulgaria.

and relevant

information is rarely

found on company

websites.

While the legal framework calls for material information to be disseminated in an

equal, timely, and cost-efficient manner, most companies do not have dedicated

sections on corporate governance or investor relations (IR) on their website, in-

line with good practice.

It should be noted that the EU in the acquis communautaire7 has not approved

international standards on auditing, notably the International Standards on

Auditing (ISA) as prepared by the International Federation of Accountants

(IFAC), and has allowed its member states to adopt more stringent rules.

Bulgaria has chosen to move beyond the acquis communautaire and all annual

financial statements have to be audited by a certified public accountant in

compliance with IFACs ISA. The audit profession is also required to carry-out

its audits according to IFACs Professional Code of Ethics, in-line with good

practice. And while most of the larger audit firms generally do comply with ISA

and the Code of Ethics, few of the smaller firms are thought to do so in practice.

The EUs acquis

communautaire allows

its members to adopt

their own rules on

auditing, and Bulgaria

has chosen to follow

ISAs.

On the other hand,

auditor independence

remains an issue.

Specific provisions in the accounting and auditing framework fall short of good

practice, for example, with respect to the definition of related parties (e.g., in-laws

are not included in the definition) and conflicts of interest (e.g. the case of the

chief accountant of the enterprise being a former employee of the audit firm is notmentioned). Moreover, there are no restrictions or limitations on the provision of

tax and business advisory services, which for some of the accounting firms is

known to constitute an important element of their overall client fees and thus

likely to impede their independence. Similarly, audit partners are known to stay

with their clients for more than ten years, which could similarly impede their

independence.

Finally, while the GSM is required to elect the external auditor, the legal

framework and NCGC is silent on the nominating process.

The ICPAB, the SROfor the audit

profession, should

The Bulgarian Institute for Certified Public Accountants in Bulgaria (ICPAB), theself-regulatory organization for the audit profession, carries out examinations,

registers auditors, and conducts quality reviews of its members via a peer review

6The activity report is referred to as the directors report or management discussion and analyses in other jurisdiction, and generallyaims to provide qualitative information and analysis on the companys financial statements.

7The acquis communautaireis the body of legislation of the European Communities and Union. All applicant countries to theEuropean Union (EU) must accept the acquisbefore they can join the EU.

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better follow-up on its

quality review process.

process every three years, which could be strengthened. A disciplinary committee

follows-up on transgressions, although, to date only a few reprimands have been

issued and ICPAB has not issued a fine or suspended an auditors license inpractice, despite the weaknesses recognized by many in the profession.

Building Strong Boards and Control Structures

Regardless of whether

companies follow aone or two-tiered

board structure, good

practice calls for the

board to guide and

oversee management

in the interest of

shareholders. Yet the

Bulgarian corporate

governance framework

does not properly

define the role of the

board.

As a result, the role of

the board is not

understood and under-

developed in practice.

The Bulgarian corporate governance framework is unique as it allows for boards

to adopt a one or two-tiered board structure. Approximately 75 percent of listedcompanies have adopted the one-tiered structure, with most citing the ability to

better hire and fire the chief executive officer (CEO) as the key reason for

choosing the one- over the two-tiered structure. The older, privatized companies

and holding companies typically have a two-tiered board structure, as do the

banks which are legally required to do so. And while important differences

between these two governance structures exists,8 in the end, good practice calls

for directors under either board structure to adhere to the underlying principles of

good corporate governance, namely: responsibility, accountability, fairness and

transparency.

While the CA defines the competencies of the GSM and makes some references

to board duties, it does not explicitly define the competencies of the (supervisory)

board and management board (under the two-tiered model). The NCGC, on the

other hand, clearly addresses the key functions of the (supervisory) board,

however, there are a number of inconsistencies with good practice that may serve

to obfuscate the respective roles and responsibilities of the (supervisory) board

vis--vis management. More specifically, good practice calls for management to:

(i) develop and the board to approve strategy, yet the NCGC calls for the board to

determine strategy; and (ii) ensure for the companys compliance with relevant

laws and regulations, and not the board as stated in the NCGC.

In practice, it appears that the majority of (supervisory) boards generally lack an

appropriate understanding of and do not effectively carry-out their roles and

responsibilities. Almost all market participants cited two key factors in this

respect: (i) most companies continue to be dominated by majority shareholderswho typically either serve as CEO or board chairman; and (ii) the absence of a

deep pool of professional directors with the necessary experience and expertise to

constructively guide and when necessary challenge management.

The responsibility for

implementing a robust


framework is assigned

to the IR officers;

however, the board is

not involved, contrary

Another key (supervisory) board duty is to establish a robust corporate

governance framework, in the interest of the company and its shareholders.

However, in practice, it is the IR officer that has played the leading role in

developing the corporate governance framework, in particular in drafting the

above-mentioned corporate governance improvement plans. The IR officers in

effect take on most of the duties typically performed by the company secretary in

most other legal jurisdictions (e.g. taking minutes, helping to disclose

information, and serving as a liaison between the governing bodies). And while

8Important differences between these two governance structures exist. More specifically, the management board under the two-tieredsystem carries legal responsibility for its business decisions, whereas management under the one-tiered system has delegatedauthority from the board, i.e. it is the board of directors that still carries the responsibility for the management of the company.However, it should be noted that a great deal of convergence is currently taking place. For example, in the United States one-tieredboards are increasingly acting as a supervisory organ, with the non-executive members of the board meeting on their own withoutexecutive directors, in what are called executive sessions to discuss sensitive issues. Similarly, in Germany, supervisory boards areincreasingly strengthening their role within the strategic decision-making process, which was hitherto the sole responsibility of themanagement board.

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And while the law calls

for one-third of the

board to be composed

of independent

directors

The legal framework calls for at least one-third of the (supervisory) board to becomposed of independent directors. The NCGC recommends that the chairman

of the board be an independent director, in-line with good practice; no such

provision, however, exists for the chairman of the supervisory board. On the

other hand, the definition of independence in the CA fails to cite key conflicts that

would impede a director from being independent, for example, when a directors

remuneration constitutes a significant portion of his or her annual income or has

served on the (supervisory) board for more than seven years.

Finally, the corporate governance framework does not require companies to

identify which directors are independent or provide guidance on the role of

independent directors. In practice, independent directors are not thought to have

the necessary qualifications, skills, and personal characteristics to effectively

guide and control management. A number of market participants specifically

cited a lack of financial and accounting skills to effectively guide and control

managers in preparing and disclosing the financial statements.

the election criteria

fall short of good

practice and the

nominations process isnot considered fair and

transparent.

The fit and proper

criteria for banks, too,

fall short of good

practice.

Any natural person possessing the legal capacity to act and who does not have a

criminal record may become a director of a joint stock company. The CA,

however, states that a legal person may become a director, in which case the legal

person designates a representative to perform its board duties. This runs counterto good corporate governance practice, largely because it is difficult for

shareholders to determine the personal experience, qualifications, and

characteristics of a legal as opposed to a natural person.

For banks, new fit and proper criteria issued by the Bulgarian National Bank

(BNB) now call for, inter alia, management board members to have a masters-

level university degree in economics or law; possess qualifications in banking,

and demonstrate at least five years of professional experience in a senior banking

position. Supervisory board members, on the other hand, have to meet less

onerous fit and proper criteria, which runs counter to good practice as the

supervisory board should arguably have more, not less, experience and

knowledge to properly oversee management.

The legal and regulatory framework is silent on how candidates to the

(supervisory) board are nominated, a key corporate governance issue. The

NCGC, in particular, should offer guidance on how to organize a transparent

nomination process, including the role of an independent nominations committee.

In practice, directors are formally appointed and approved by the majority

shareholder; at times, the exact numbers of board seats a majority owner may fillare specified by a shareholder agreement.

As a consequence,

boards are not thought

to play a major role in

effectively: (i)

overseeing extra-ordinary and related

party transactions, and

generally protecting

shareholder rights; (ii)

guiding and

controlling the

preparation and

Of particular concern is the apparent lack of oversight by the board over the

companys control framework, notably in the areas of risk, internal controls,

internal audit, and external audit processes. And while the NCGC does indeed

cover these control and audit issues, and generally recommends for the

(supervisory) board to establish a corporate-wide risk management policy, controlprocedures and compliance function, practical guidance as to how to structure and

implement these control structures and processes is not offered, as the U.K.s

national corporate governance code does for example in its annexes.

It should be noted that banks, in turn, are required to submit to the BNB a

description of the risk management and internal control systems. However, the

legal and regulatory framework for banks deviates from good practice in a

number of important areas, in particular with respect to: (i) reporting structures,

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disclosure of financial

information; and (iii)

ensuring for a robust

and defensible control

environment.

e.g. the internal control function is accountable to shareholders, whereas it should

be to management; (ii) internal audit function, where the head of internal audit

should have a direct reporting line to the board and its independent auditcommittee; (iii) compliance function, which is not required by law; and (iv) the

lack of a requirement or recommendation for the board to establish an audit

committee.

Board effectiveness isfurther hampered as

most companies have

not established board-

level committees

The NCGC recommends for (supervisory) boards to establish committees, inparticular an audit committee comprised of independent directors and experts, and

for these committees to be established according to formal terms of reference.

However, the NCGC does not offer any practical guidance on the role, structure,

composition, and working procedures of these committees, or mention other key

board committees, such as committees on remuneration, nomination and

corporate governance. In practice, it was thought that but a handful of listed

companies had established board-level committees.

and board working

procedures were

generally deemed

sufficient, yet could be

improved upon.

(Supervisory) boards were thought to meet on a regular basis, on average four

times per year, slightly short of what most would consider being the necessary

minimum. Company secretaries, who according to good practices ensure for

efficient board procedures and practices, do not exist, however, their role is

currently being carried outeffectively at thatby the IR officer. With that said,the duties and responsibilities of these two functions are distinct and, because the

IR officer reports to management and the company secretary to the (supervisory)

board, the board is unable to effectively ensure for efficient board practices.

While there is ad-hoc

training offered, in

particular for bank

directors, there is no

comprehensive

director training

program on corporate

governance, eithermandatory or

voluntary.

With respect to continuous professional education, the Association of

Commercial Banks and Bulgarian International Banking Institute both train

managers and directors on relevant banking issues (e.g. on credit and risk);

similarly, the BNB itself offers seminars and lectures on relevant topics.

However, no similar institute appears to exist for companies in the real sector; and

while the Bulgarian Investor Relations Directors Association, Bulgarian Investors

Association, and the Institute of Certified Public Accountants of Bulgaria are all

known to include corporate governance and related issues in their activities andtraining programs, these are geared to their respective members and do not

include senior managers and (supervisory) board members. Similarly, board

induction programs are not known to exist.

Finally, management

boards appear to make

use of outside

members, against good

practice

Finally, it should be noted that a number of interlocutors stated that some

management boards under the two-tiered system made use of outside (or non-

executive) management board members. These were commonly thought to be

individuals who had a full seat on the management board yet were not formally

employed by the company or retained as consultants. This clearly runs counter to

good practice in that lines of accountability and responsibility become blurred

when outsiders actively participate in the day-to-day management of the company

but are not formally responsible for their actions.

Enforcement

The institutional

framework has been

strengthened to

support enforcement

The institutional framework has been strengthened, in particular with respect to

the enforcement capacity of the FSC and BNB, both of which enjoy positive

market reputations as tough yet fair regulators. The Central Depository AD

(CDAD) and Registry Agency (RA) also play important roles, in particular withrespect to information disclosure, and have traditionally enjoyed positive

reputations, though they have recently been struggling to implement relevant EU

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directives.

and the division of

responsibilities

between the FSC and

BNB is clearly

articulated.

Regulatoryenforcement takes

place, however,

enforcement by the

courts remains an

issue.

Both the FSC and BNB are financially independent and both have sufficient

budgetary resources necessary to carry-out their respective roles and

responsibilities, and do so in practice. The division of responsibilities between

these two regulators is captured in a memorandum of understanding, signed in

2003, and both are thought to coordinate well with one another. Both, as

previously stated, have positive reputations among market participants as beingtough, yet fair and consistent. Moreover, both are committed to improving

corporate governance practices and have played key roles in promoting and

furthering reforms in this important area. The commercial courts, on the other

hand, are considered to be time-consuming and cost ineffective.

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Recommendations

The following section details three policy recommendations to improve the corporate governance framework.

Recommendation 1: The private sector should lead and regulators encourage thedevelopment and implementation of a comprehensive training course for directors oncorporate governance and related issues. Status: High priority (months 1 12)

The National CG Task

Force that developed

the NCGC, under the

leadership of and with

support from the BSE,

FSC and BNB, should

launch a

comprehensive

director training

program

The private sector, under the leadership of the various business associations

and with the strong support from the FSC, BNB and BSE, should lead a

public-private sector initiative to launch a training program for directors and

senior managers on corporate governance and related issues.

Such training could be organized by a new institute of directors or corporate

governance institution for Bulgaria or, alternatively, be a part of current

institution or university should such an institute prove unsustainable

following a market study and business plan.

This program should focus on corporate governance issues, including the

above-mentioned duties of care and loyalty, but also focus on topics of

relevance to directors in carrying-out their responsibilities, such as on

finance and accounting, strategy, and risk. This institute would ideally be

established with the support of all key stakeholders, including the FSC and

BSE, all relevant associations, university institutions, and private sector.

The Task Force should seek guidance from the Global Corporate

Governance Forum (GCGF), which has developed toolkits on how to build

director training institutions and director training programs.

Recommendation 2: The regulatory institutions should ensure that the existing legal andregulatory framework with respect to corporate governance, as well as NCGC, is strictlyenforced in practice. The role of the various regulators, in particular the FSC and BSE, butalso BNB, should be clarified in this respect. Status: High priority (months 1 18)

The FSC should: Informally yet firmly encourage all directors of listed companies to undergo a

minimum amount of training on corporate governance and related issues, withthe implicit understanding that this could be made mandatory should

companies not send their directors to attend. This can, for example, be done

by issuing a letter to the chairman of the (supervisory) board.

Be vigilant in monitoring compliance with the NCGC from the very

beginning to ensure that it is properly being implemented, together with

institutional investors and shareholders. Along with the BSE, the FSC may

consider developing a model corporate governance disclosure template, which

it can make available on its website to guide all companies in their corporate

governance disclosure, in particular those not actively traded.

Ensure that directors disclose any transactions in company shares.

Launch an awareness-raising campaign on the issue of abandoned shares.

Moreover, the FSC should require the CDAD or custodians to contact and

inform minority shareholders of the fact that they are entitled to dividends,

and ensure that they do in practice receive declared dividends.

Require or encourage institutional investors to develop and disclose their

voting policies, as well as to actually vote during GSM meetings.

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Launch a public awareness-raising campaign to inform shareholders dating

back to mass privatization of their basic rights, including to participate in the

profits of the company (by claiming the dividends) or selling their shares.

Consider strengthening the legal and regulatory framework with respect to

institutional investors, requiring them to develop and disclose their policies

on conflicts of interest.

Launch an investor education program with a particular focus on educatingminority shareholders of the rights accorded to them in the CA and LPOS.

(The NCGC could, in this respect, also recommend for companies themselves

to help educate their shareholders, for example, by issuing information sheets

describing their rights and obligations.)

Stringently enforce the disclosure of related party transactions, with a

particular focus on such transactions carried out by holding companies as well

as companies that are on the Unofficial Market or are not actively traded (and

hence considered to be the biggest group at risk).

Ensure that there is a single definition for related parties within the context of

related party transactions.

On a periodic basis, review its own salary structure to ensure that it is able to

attract, motivate, and retain quality staff.

Encourage the use of alternative dispute resolution (ADR) mechanisms, such

as mediation, in the area of corporate governance. The GCGF can provide

guidance on establishing such ADR mechanisms.

(Or relevant authority) should ensure that custodians vote on behalf and under

the instruction of the beneficial owner. The same should hold true for

depositor receipt holders.

(Or relevant authority) should ensure that the legal and regulatory framework

specifies who is entitled to control the exercise of voting rights attached toshares held by foreign investors.

Consider implementing the 2002 CG ROSC recommendation to criminalizeinsider trading and abusive self-dealing.

Ensure that the regulatory framework effectively covers conflicts of interests

by credit rating agencies in Bulgaria disclose conflicts of interests.

Ensure that the regulatory framework requires (and then enforce) both

companies and shareholders to disclose beneficial ownership structures.

The BNB should: Extend the NCGC to all banks, and not only those publicly listed.

The BSE should: Consider establishing a tier on the Unofficial Market which requires

companies to comply (or explain non compliance) with the corporate

governance code, allowing growth companies to differentiate themselves

from their peers.

Set a positive example to its members and clients by itself following and fully

complying with the NCGC, in particular with respect to independent directors

on the board.

Ensure that the regulatory framework effectively covers conflicts of interests

by sell-side securities analysts and other financial advisory firms.

The CDAD should: Implement the recommendations contained in its recent report on theCDADs operations.

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Page 14 out of 78

Itself follow and fully complying with the NCGC.

The government

should:

Ensure that it develops a corporate governance and ownership policy towards

its SOEs, and should consider conducting an in-depth review and

improvement plan on corporate governance for its SOEs.

Guide, support and control the activities of the CDAD and RA to ensure that

these institutions properly fulfill their role in the market.

ICPAB should: Pay closer attention to audit partner rotation and the issue of auditor

independence in general.

Better enforce existing rules and regulations to ensure that audits are being

carried-out in a professional and independent manner.

Recommendation 3: A number of minor, but important amendments to the legal andregulatory framework, as well as NCGC, should be made to ensure that the corporategovernance fully meets good practice. Status: Medium priority (months 18 36)

The CA should be

amended to:

Lower the maximum term of directors to three instead of five years.

Clarify the process of nominating candidates to the (supervisory) board,

including possible ownership thresholds.

Specify that the executive board members under the one-tier board system are

under the same obligation as management board members under the two-

tiered board system to furnish the non-executive board members with relevant

information in a timely manner (see Art. 244 CA).

Specify that non-executive remuneration should be approved, but not

determined by the GSM. The GSM may further be accorded a right to

approveor provided with an advisory vote onexecutive remuneration.

The LPOS should be

amended to:

Specifically recommend for listed companies to follow the NCGC in Art.

100m (4) 3. LPOS, as well as Art. 54 RR-BSE.

Oblige board members and key executives to publicly disclose information

that could have a material effect on the share price of company or helpidentify and avoid conflicts of interest.

Specify that it is the (supervisory) board that sets executive compensation and

not the GSM, which should have an advisory vote, however, only be able to

approve executive compensation when shares and options are offered as part

of the executive compensation package due to the risk of dilution (see Art.

116c LPOS).

Better define an interested party in Art. 114 (5) LPO.

Art. 115 (6) LPOS should be amended to ensure that the external auditor also

attends the GSM and provides answers to shareholder queries.

Require (or the NCGC recommend) for companies to declare who they regard

as independent and why. Good practice calls for the independent directors tobe clearly identified both on the companys website and annual report.

Review the definition of an independent director, for example, clarifying that

if a directors remuneration constitutes a significant portion of his or her

annual income, or the director has served on the (supervisory) board for more

than seven years, the director is no longer considered to be independent.

Specify that while the IR officer has a full reporting line to management s/he

should have unfettered access to the board, in particular when the IR officer


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Page 15 out of 78

carries-out the duties of the company secretary related to corporate

governance (see Art. 116 LPOS). Over time, the position of company

secretary should be developed and separated from that of the IR officer.

The Accountancy Act

(AA) and/or Law on

the Independent

Financial Audit (LIFA)should be amended to:

The definitions of what constitutes an audit should be made to correspond to

IFACs definition of an independent external audit.

Specify that the management letter should be issued to both management and

the board, ideally its audit committee See Art. 33 (3) LIFA. Strengthen the independence of the external audit process. For example, there

should be more specific restrictions or recommendation pertaining to the

provision of non-audit services to an audit client and the external auditor

should interact and report to the independent audit committee (while of

course keeping its accountability to shareholders).

The Law on Credit

Institutions (LCI)

should be amended to:

Specify that the supervisory board is responsible for establishing appropriate

policies in the area of risk management, internal control, and internal audit

procedures, whereas management is responsible for developing specific

processes and generally implementing a robust risk management, control,

and audit framework.

Clarify the issue of internal audit independence, in particular with respect toreporting structures.

Require banks to establish an audit committee, which oversees the internal

control, compliance, internal audit, and external audit processes, and

encourage supervisory boards to establish a board-level risk committee that

focuses on establishing the banks risk appetite and policies.

Ensure its fit and proper criteria, in particular with respect to supervisory

board members, are up-to-date with respect to international good practice.

The NCGC should be

amended.

The Bulgarian Corporate Governance Code Task Force (BCGTF) should

reconstitute on the agreed-upon date (18-months following the publication of

the NCGC) to amend the NCGC. A set of detailed recommendations can be

found in Table 1 below. In this respect, it might be useful to institutionalizethe BCGTF and to provide it with a clear mandate.


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Corporate Governance ROSC Assessment

Boards should develop a succession policy and oversee the development of a succession plan by management.

Boards should conduct self-evaluations to improve upon their efficiency and effectiveness.

Companies should introduce whistle-blowing procedures.

A model policy and terms of reference (ToRs) on risk management and internal controls should be annexed to the

A model policy and ToRs on compliance procedures should be annexed to the NCGC.

A model policy and ToRs on the internal audit function should be annexed to the NCGC.

ChapterTwo:Audit

andInternal

Control

A model policy and ToRs on the external audit function should be annexed to the NCGC.

The NCGC should recommend for companies to introduce the concept of a sliding quorum when the GSM derights or when changes are made to the companys articles of association.

The NCGC should recommend for institutional investors to disclose their voting policies and vote.

Companies should adopt cumulative voting when electing (supervisory) board members.

Companies should develop dividend policies.

Over time, the position of corporate secretary should be introduced and distinguished from that of the IR officer.

Boards should develop an effective information disclosure policy on non-financial disclosure.

The NCGC should recommend that companies only be allowed to institute anti takeover defenses with shareholde

A brief discussion should be added to the NCGC on the advantages and disadvantages of performance-enhancinshares.

The company should provide shareholders with withdrawal rights, i.e. the right to sell back their shares to thchanges take place.

The NCGC should encourage shareholders to consult with one another, in particular when electing directors to the

The NCGC should provide guidance on how best to carry-out voting.

Cha

ptersThreetoFiveon

ShareholderRigh

ts,

Disclosureand

Stakeholders

Further, the NCGC should contain a set of annexes, which contain practical guidance on how to implement a nuthe area of how to implement a code of ethics, including an actual model code of ethics.

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Corporate Governance ROSC Assessment

Page 20 out of 78

Key 2002 CG ROSC recommendations Status as of June2008

Comments

Section VI: Responsibilities of the Board

21. Strengthening (supervisory) boards of directors will require amending the CA toclearly define the duties of due care and diligence for board members

Implemented Art. 237 (2) CA, altthese duties.

22. Strengthening (supervisory) boards of directors will require developing avoluntary code of best practice in corporate governance providingrecommendations on the operation, structure and functioning of (supervisory)boards of directors.

Implemented As previously menupdated to betteimplementing good

23. Consideration should be given to establishing an institute of directors to providetraining and disseminate best practice approaches.

Not implemented The regulatory authhigh-priority movin

24. Amend the CA to further define the roles and responsibilities of boards ofdirectors. Establish a corporate governance code to provide guidance on theoperation, structure and functioning of boards of directors.

Partially implemented The CA has been u

responsibilities of provide for practica

25. The board should have broad access to company information, records,documents and property where needed to make informed decisions on matterswithin the authority of the supervisory board. Directors should also be able toobtain independent professional advice at the companys expense.

Partially implemented While this has been(see Art. 243 (1) Cmade so under the o


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Corporate Governance Policy Assessment Bulgaria June 2008

Summary of Observance of OECD Corporate Governance Principles9

2008 2002

No. Principle FI BI PI NI NA

I. ENSURING THE BASIS FOR AN EFFECTIVE CORPORATE GOVERNANCE FRAMEWORK

IA Overall corporate governance framework x NA --

IB Legal framework enforceable /transparent x NA --

IC Clear division of regulatory responsibilities x NA --

ID Regulatory authority, integrity, resources x NA --

II. THE RIGHTS OF SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS

IIA Basic shareholder rights BI

IIA 1 Secure methods of ownership registration x --

IIA 2 Convey or transfer shares x --

IIA 3 Obtain relevant and material company information x --

IIA 4 Participate and vote in the GSM x --

IIA 5 Elect and remove board members of the board x --

IIA 6 Share in profits of the corporation x --

IIB Rights to part in fundamental decisions NI

IIB I Amendments to statutes, or articles of incorporation x --

IIB 2 Authorization of additional shares x --

IIB 3 Extraordinary transactions, including sales of major corporate assets x --

IIC Shareholders GSM rights PI

IIC 1 Sufficient and timely information at the general meeting x --

IIC 2 Opportunity to ask the board questions at the general meeting x --

IIC 3 Effective shareholder participation in key governance decisions x --

IIC 4 Availability to vote both in person or in absentia x --

IID Disproportionate control disclosure x PI

IIE Control arrangements allowed to function BI

IIE 1 Transparent and fair rules governing acquisition of corporate control x --

IIE 2 Anti-take-over devices x --

IIF Exercise of ownership rights facilitated x NI

IIF 1 Disclosure of corporate governance and voting policies by inst. investors x --

IIF 2 Disclosure of management of material conflicts of interest by inst. investors x --

9Note: FI=Fully Implemented; BI=Broadly Implemented; PI=Partially Implemented; NI=Not Implemented; NA=Not Applicable. Note thatthe arrows on the right of the table denote whether the OECD Principle in question has improved (green) or remained the same(yellow) since 2002.

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2008 2002


IIG Shareholders allowed to consult each other x NA --

III. EQUITABLE TREATMENT OF SHAREHOLDERS

IIIA All shareholders should be treated equally BI

IIIA 1 Equality, fairness and disclosure of rights within and between share classes x --

IIIA 2 Minority protection from controlling shareholder abuse; minority redress x --

IIIA 3 Custodian voting by instruction from beneficial owners x --

IIIA 4 Obstacles to cross border voting should be eliminated x --

IIIA 5 Equitable treatment of all shareholders at the GSM x --

IIIB Prohibit insider trading x BI

IIIC Board/Mgrs. disclose interests x NI

IV. ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE

IVA Legal rights of stakeholders respected x PI

IVB Redress for violation of rights x PI

IVC Performance-enhancing mechanisms x PI

IVD Access to information x BI

IVE Whistleblower protection x NA --

IVF Creditor rights law and enforcement x NA --

V. DISCLOSURE AND TRANSPARENCY

VA Disclosure standards PI

VA 1 Financial and operating results of the company x --

VA 2 Company objectives x --

VA 3 Major share ownership and voting rights x --

VA 4 Remuneration policy for board and key executives x --

VA 5 Related party transactions x --

VA 6 Foreseeable risk factors x --

VA 7 Issues regarding employees and other stakeholders x --

VA 8 Governance structures and policies x --

VB Standards of accounting & audit x PI

VC Independent audit annually x PI

VD External auditors should be accountable x NA --

VE Fair & timely dissemination x PI

VF Research conflicts of interests x NA --

VI. RESPONSIBILITIES OF THE BOARD

VIA Acts with due diligence, care x NI

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2008 2002


VIB Treat all shareholders fairly x NI

VIC Apply high ethical standards x NI

VID The board should fulfill certain key functions NI

VID 1 Board oversight of general corporate strategy and major decisions x --

VID 2 Monitoring effectiveness of company governance practices x --

VID 3 Selecting/compensating/monitoring/replacing key executives x --

VID 4 Aligning executive and board pay x --

VID 5 Transparent board nomination/election process x --

VID 6 Oversight of insider conflicts of interest x --

VID 7 Oversight of accounting and financial reporting systems x --

VID 8 Overseeing disclosure and communications processes x --

VIE Exercise objective judgment NI

VIE 1 Independent judgment x --

VIE 2 Clear and transparent rules on board committees x --

VIE 3 Board commitment to responsibilities x --

VIF Access to information x NI

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Corporate Governance Landscape

I. Capital Markets and its Effects on Corporate Governance

As of June 2007, the market capitalization of the BSE was BGN 20,8 billion (USD 16,32 billion) and 41.1 percent as apercentage of GDP, up dramatically from June 2002 (see Figures 1 and 2). Turnover and transactions have also witnessedsignificant increases (see Figures 3 and 4). Similarly, the number of new issuers has steadily increased, from 51 in 2005,76 in 2006 to 81 in 2007, and a number of IPOs were massively over-subscribed. This growth is largely explained to the

many market reforms undertaken by the Bulgarian government, EU accession, and rising influence of institutional investorsin Bulgaria, which have led to an increase in private investment.

Figure 1: Market capitalization (in billions of BGN)

-

5,000

10,000

15,000

20,000

25,000

2002 2003 2004 2005 2006 2007

Source: Report of the BSE-Sofia for 1997

Figure 2: Market capitalization to GDP (in %)

0%

10%

20%

30%

40%

50%

2002 2003 2004 2005 2006 2007


Figure 3: Turnover (in millions of BGN)

0

500

1000

1500

2000

2500

3000

2002 2003 2004 2005 2006 2007


Figure 4: Avg. monthly number of transactions

0

5000

10000

15000

20000

25000

30000

35000

2002 2003 2004 2005 2006 2007


However, as can be seen from Figures 5 and 6, the market has recently experienced a sharp decline losing just under 30percent of its value over the past six months, with some companies losing up to 60 percent of shareholder value. The totalmarket capitalization of the stock market shrunk to BGN 22.9 billion by May 12, 2008 down from over BGN 29 billion inDecember of 2007.

Figure5:TheBulgarianStockMarketJune2002toJune2008

Source: BSE website

A number of factors have been cited inconnection with this downturn, first andforemost the turmoil in the internationalfinancial markets due to the sub-primemortgage crisis in the United States,which has led to an abrupt contraction inglobal liquidity and hence a negative

impact on investors appetite for emergingmarket risk; and second, the risk of the EUsuspending structural fund allocations forBulgaria and the potential fundingimplications for specific sectors, inparticular agriculture and infrastructure.

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Figure 6: The Bulgarian Stock Market (SOFIX) December 2007 to June 2008

Source: BSE website

It is precisely during such market downturns that corporate governance reforms come to the forefront of the reform agenda.Indeed, the current market conditions should be viewed as an opportunity for all stakeholders to build on the notable legaland regulatory reforms already introduced in the area of corporate governance and to introduce good corporate governancepractices at the (supervisory) board and management (board) levels. However, three key issues need to be taken intoaccount by all stakeholders.

1. Trading is concentrated in the top-10issuers, which account for 88 percentof trading volume and 47 percent ofmarket capitalization. In late June2007 the share of the 20 largestcompanies in market capitalizationwas 71.4 percent.

2. Growth in terms of market

capitalization is not from the Officialbut Unofficial Market, which is lessregulated, in particular in the field ofcorporate governance (see Figure 7).

3. Ownership is highly concentrated.

These three factors pose a risk to capitalmarket stability yet at the same time aunique opportunity for the market ingeneral and regulatory agencies inparticular in terms of focusing theirmonitoring, respectively regulatory effortson: (i) the top-10 to 20 issuers; (ii) growthcompanies listed on the UnofficialMarket; and (iii) leading investors and

shareholder groups.10

Figure 7: Market Capitalization, 2001-2006

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Year

Bulgarian

leva

(in

thousands)

Official Market Segment

A

17.65 31.02 28 53.42 122.1 319.26


B

44.43 94.87 283.47 423.33 688.46 3,239.13


C

132.9 126.98 674.51 898.12 1,337.70 2,084.15

Unofficial Market 908.85 1,122.31 1,736.02 2,658.32 6,285.70 9,671.47

Total: 1,103.83 1,375.18 2,722.00 4,033.19 8,433.96 15,314.01

2001 2002 2003 2004 2005 2006

10In the late 1990s there were over 1,400 issuers listed on the stock exchange. A wave of de-listings occurred around 2002, largely dueto a recognition by the government that the great majority of companies listed on the exchange were simply too small for a listing. Anumber were required to re-list in 2006, when the government required all companies with 1,000 plus shareholders to re-list on anexchange. The government is now encouraging shareholders to sell their shares, which would allow a great number of companies tode-list again. Today there are approximately 1,700 issuers, however, as of December 2007, only 509 were publicly listed on the BSE,and only 40 are considered to be actively traded.

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II. The Ownership Framework and its Effects on Corporate Governance

1. Ownership by Individual Investors and Investor Groups

As a result of privatization in the 1990s, hundreds of thousands of small shareholders acquired shares through vouchersand employee share purchase programs. In many cases company insiders either initially secured or eventuallyaccumulated a significant portion of the shares. Today, ownership is highly concentrated in the hands of a few, individualshareholders and private investor groups, estimated to number 130 to 150. For example, a recent study found that of asample of 104 enterprises, consisting almost exclusively of the large Bulgarian public holding companies, more than 50percent only had two different shareholders, and 95 percent no more than four shareholders.

11The average size of the

largest equity stake was found to be equal to 60 percent of outstanding shares, with the second and third biggestshareholders averaging 12.7 percent and 5.5 percent. In banking, foreign institutions hold the largest stakes while localentrepreneurs own most companies in the non-banking financial sector and real sector. Most of these individual ownersand investor groups have not traditionally embraced good corporate governance and are now only beginning to implementcorporate governance. If properly engaged, this investor group might seek to preempt further regulatory action andimplement good corporate governance, and the government might thus wish to target this group with an awareness-raisingcampaign to build the business case for good corporate governance, followed by increased regulatory oversight shouldaction not be taken.

The free float of the top-10 listed companies is 14 percent and the overall free-float on the BSE was 24.7 percent in 2007,up from 17.9 percent in 2006. A visible, if nascent trend towards an increasing dispersion of ownership can thus beconfirmed. However, overall, ownership remains concentrated in the hands of one or two individual shareholders orshareholder groups. Of note is that the free float of the public companies in the BG40 portfolio was higher than the averagefor the Exchange and reached 36.3 percent. Figure 8 shows that the ownership of most issuers on the Official Market islargely limited to a single majority shareholder.

Figure8: OwnershipstructureofissuersontheOfficialMarket

0%

20%

40%

60%

80%

100%

Less

than20%

2040%

4060%

6080%

80100%

%ofequitystakeby numberofshareholders

%ofcompanies Companieswithasingle

shareholder

Companieswithtwoshareholders

Companieswiththreeormoreshareholders

Source: Mintchev, V. et al , Corporate Governance in Bulgaria, IE-BAS, Sofia, 2007.

Market liquidity remains low with a turnover ratio of 20 percent in 2006. Low turnover is largely explained by the largenumber of companies with low free-float in the Unofficial Market segment that were listed in the early stage of massprivatization, and the low share and trading activity of foreign investors, in particular institutional investors, who are usuallythe most active traders in more advanced countries in the EU. The latter is due to the BSEs frontier market status, thusits miniscule weight in emerging market portfolios.

It should further be noted in this respect that foreign investors largely pulled-out of Bulgaria in early 2008, along with themarket downturn, and so today ownership is mostly in the hands of domestic owners, save for the banking industry which

largely remains foreign-owned. This has further exacerbated the already low trading activity. On the other hand, foreignersstill constitute the single largest investor class in terms of market capitalization, as Bulgarias largest company, BulgariaTelecom, is 90 percent foreign-owned.

11Mintchev, V., R. Petkova, P. Tchipev. Public Companies and Stock Exchanges Development in Bulgaria: Contraversial Trajectories ofBulgarian Corporate Model, Sofia, 2007, p. 133.

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2. The State as an Owner

The privatization process in Bulgaria has been dynamic. The share of state-owned enterprises (SOEs) among the largestcompanies has seen a significant decrease. Whereas almost one-third of the largest 100 companies were owned by thestate or municipality not five years ago, this number was reduced to 13 in 2006. Overall, the number of privatizations nowexceeds 5,000 and has served to generated revenues of BGN 11,067 million. Today, the privatization process has largelybeen completed. For 2008, an estimated 20 companies are to be privatized, for example, in the power sector. Once thesecompanies

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