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IFC’s Corporate Governance IFC’s Corporate Governance MethodologyMethodology

Background, Experiences aand Applicability to Background, Experiences aand Applicability to

Pension Funds / Institutional InvestorsPension Funds / Institutional Investors

Mike LubranoMike LubranoHead, Investor & Corporate PracticeHead, Investor & Corporate PracticeCorporate Governance DepartmentCorporate Governance Department

Seminario Anual FIAPSeminario Anual FIAPSantiago, 18/19 mayo de 2006Santiago, 18/19 mayo de 2006

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IFC PortfolioIFC Portfolio Established 1956Established 1956 Private Sector Arm of World Bank GroupPrivate Sector Arm of World Bank Group US$19 billion invested for own account in US$19 billion invested for own account in

Emerging Markets (Loans and Equity)Emerging Markets (Loans and Equity)– 625 Equity Investments625 Equity Investments

Approximately 250 New Commitments Per Year; Approximately 250 New Commitments Per Year; 1400 Portfolio Companies1400 Portfolio Companies

New Money in Existing Publicly-Listed / Unlisted New Money in Existing Publicly-Listed / Unlisted Companies (All Industrial Sectors and Financial Companies (All Industrial Sectors and Financial Sector) as well as Greenfield JVsSector) as well as Greenfield JVs

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Why Does IFC Care About CG?Why Does IFC Care About CG?

Portfolio PerformancePortfolio Performance– Poor Governance Increases RiskPoor Governance Increases Risk– Improving Governance is a Value Proposition Improving Governance is a Value Proposition

(Private Equity Funds; Hikma; BCR)(Private Equity Funds; Hikma; BCR) Development MissionDevelopment Mission

– Along with Social, Environmental,and other Along with Social, Environmental,and other Elements of Elements of SustainabilitySustainability

Reputational Risk / Reputational AgentReputational Risk / Reputational Agent

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Support for The Value PropositionSupport for The Value Proposition

S&P, Moody’s and Fitch > CG Explicit Part of S&P, Moody’s and Fitch > CG Explicit Part of Credit Rating (BCR Upgrade)Credit Rating (BCR Upgrade)– Reflects Increasing Empirical EvidenceReflects Increasing Empirical Evidence

Experience of Activist Institutional InvestorsExperience of Activist Institutional Investors– CalPERS Governance Portfolio PerformanceCalPERS Governance Portfolio Performance

Listing Requirements Listing Requirements CG Funds (Dynamo’s Puma II)CG Funds (Dynamo’s Puma II) IFC is in a Unique Position to Test the IFC is in a Unique Position to Test the

Governance Thesis in Emerging MarketsGovernance Thesis in Emerging Markets

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CG is a Natural Fit for IFCCG is a Natural Fit for IFC Participation in Governance Worldwide Participation in Governance Worldwide

– Access to DataAccess to Data– Skills, Experience to DeliverSkills, Experience to Deliver

““Grass Roots”/PEP ProjectsGrass Roots”/PEP Projects Global PartnersGlobal Partners

– OECDOECD– Global CG Forum / Private Sector Adv. GroupGlobal CG Forum / Private Sector Adv. Group– Regional PartnersRegional Partners– National advocacy, b-schools, training institutes National advocacy, b-schools, training institutes (NACD)(NACD)

IFC-Nominated DirectorsIFC-Nominated Directors– Training ProgramTraining Program

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Challenge for any Institutional Investor:Challenge for any Institutional Investor:Developing a Workable MethodologyDeveloping a Workable Methodology

Create a Common Definition/Vocabulary Create a Common Definition/Vocabulary within the Institutionwithin the Institution

Be Consistent with the IFC Mission: Be Consistent with the IFC Mission: Sustainability / Value AddedSustainability / Value Added

Tailored to our Unique PortfolioTailored to our Unique Portfolio Fit with Existing Operating ProceduresFit with Existing Operating Procedures

– Project Prep and Decision MeetingsProject Prep and Decision Meetings Accessible to Staff and others (website)Accessible to Staff and others (website) Avoid Compliance Mentality / Box TickingAvoid Compliance Mentality / Box Ticking

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What is a Workable Definition for What is a Workable Definition for UsUs??

OECD Principles Provide an OECD Principles Provide an accepted/supported accepted/supported

Framework:Framework:

Financial Stakeholders (e.g., Financial Stakeholders (e.g., Shareholders) Shareholders)

Checks and Balances (Boards Checks and Balances (Boards of Directors) of Directors)

Control Environment (Audit, Control Environment (Audit, Internal Controls)Internal Controls)

Transparency and DisclosureTransparency and Disclosure

A Practical Investment-Driven A Practical Investment-Driven DefinitionDefinition

Distinguish from:Distinguish from: Corporate CitizenshipCorporate Citizenship Corporate Social Corporate Social

ResponsibilityResponsibility Socially Responsible InvestingSocially Responsible Investing Other Elements of Other Elements of

SustainabilitySustainability Political GovernancePolitical Governance Business EthicsBusiness Ethics Anti-Corruption / AMLAnti-Corruption / AML

(But CG does reinforce all of (But CG does reinforce all of these!!!)these!!!)

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IFC’s MethodologyIFC’s Methodology

Break Governance Into Digestible BitsBreak Governance Into Digestible Bits Company Company archetypes, paradigmsarchetypes, paradigms (non-exclusive): (non-exclusive):

– Listed companiesListed companies– Family- or Founder-Owned Unlisted Companies Family- or Founder-Owned Unlisted Companies – Financial InstitutionsFinancial Institutions– Transition Economy CompaniesTransition Economy Companies– [SOE Paradigm in Progress][SOE Paradigm in Progress]

Five Five attributesattributes of effectiveness of effectiveness Four Four levelslevels, from “acceptable” to “leadership.” We , from “acceptable” to “leadership.” We

call this our Progression Matrix. This approach call this our Progression Matrix. This approach parallels the approach taken in the other areas of parallels the approach taken in the other areas of sustainability (social and environmental)sustainability (social and environmental)

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IFC’s Corporate Governance ToolkitIFC’s Corporate Governance Toolkit

CG Progression MatricesCG Progression Matrices Instruction SheetsInstruction Sheets CG Information Request ListsCG Information Request Lists Why Corporate Governance?Why Corporate Governance? Model CG Improvement ProgramsModel CG Improvement Programs Indicative Independent Director DefinitionIndicative Independent Director Definition Supervision ChecklistSupervision Checklist

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Using the ToolsUsing the Tools

Step 1: Step 1: First ImpressionsFirst Impressions Step 2: Step 2: Client Self-AssessmentClient Self-Assessment

– Open the DialogueOpen the Dialogue Step 3: Step 3: Corporate Governance ReviewCorporate Governance Review

– Articulate the Risks / OpportunitiesArticulate the Risks / Opportunities Step 4: Step 4: Address the Risks and Opportunities Address the Risks and Opportunities

– Terms and ConditionsTerms and Conditions Step 5: Step 5: Documentation and ImplementationDocumentation and Implementation Step 6: Step 6: SupervisionSupervision

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Core Tool – Simple Progression MatricesCore Tool – Simple Progression Matrices

A Self-Assessment and Client Orientation ToolA Self-Assessment and Client Orientation ToolLEVELS

AT

TR

IBU

TE

S

PROGRESSION

1. Acceptable 2. Extra Steps 3. Major Contributions

4. Leadership

Commitment to Good Corporate Governance

Structure and Functioning of the Board of Directors

Transparency and Disclosure

Treatment of Minority Shareholders

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Fit with the Appraisal / Supervision ProcessFit with the Appraisal / Supervision Process

Staff evaluate client companies and work with them to add Staff evaluate client companies and work with them to add value to their governance:value to their governance:

By following a series of By following a series of stepssteps -- that fit into existing -- that fit into existing appraisal / supervision patternsappraisal / supervision patterns

The time and effort involved in each step varies in nature The time and effort involved in each step varies in nature depending on the type of depending on the type of enterpriseenterprise – listed companies, – listed companies, family/founder firms, financial institutions, etc.family/founder firms, financial institutions, etc.

The intensity of project team effort depends on The intensity of project team effort depends on risk and risk and opportunityopportunity..

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CG Throughout the IFC Deal ProcessCG Throughout the IFC Deal Process

Supervision; Monitoring; Support; Feedback; Lessons

Structure Deal; Terms and Conditions; Pricing and Disbursement

Evaluate, Articulate, Prioritize CG Risks and Opportunities

Identify Issues;

Engage Client

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When We Focus on Corporate GovernanceWhen We Focus on Corporate Governance

Risks and/or Opportunities – Financial Return and Risks and/or Opportunities – Financial Return and Development ImpactDevelopment Impact

RisksRisks may be: may be:– attitudinal (little or no commitment to governance)attitudinal (little or no commitment to governance)– financial/operational (weak controls)financial/operational (weak controls)– legal (weak compliance)legal (weak compliance)– reputational (negative image)reputational (negative image)

OpportunitiesOpportunities (to add value) may be: (to add value) may be:– attitudinal (strong commitment to governance)attitudinal (strong commitment to governance)– financial (access to capital/better valuations)financial (access to capital/better valuations)– legal (model codes/compliance/documentation)legal (model codes/compliance/documentation)– reputational (fulfilling IFC’s mission)reputational (fulfilling IFC’s mission)

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(Some) Corporate Governance Problems(Some) Corporate Governance Problems

Developed MarketsDeveloped Markets Dispersed ownership: agency Dispersed ownership: agency

problems between shareholders problems between shareholders and managersand managers

Empire building of CEOs Empire building of CEOs Excessive remuneration (stock Excessive remuneration (stock

options)options) Insider tradingInsider trading Defense mechanisms (poison pills, Defense mechanisms (poison pills,

staggered boards)staggered boards) Non-disclosure of information Non-disclosure of information

(manipulation with SPEs)(manipulation with SPEs) Internal control problems Internal control problems

(independence of auditor)(independence of auditor)

Emerging/Transition EconomiesEmerging/Transition Economies Concentrated ownership: agency Concentrated ownership: agency

problems between controlling and problems between controlling and minority shareholdersminority shareholders

Ineffective BoardsIneffective Boards– Poor CapacityPoor Capacity– Passive ApproachPassive Approach– Low independence Low independence

Conflicts of Interest; RPTsConflicts of Interest; RPTs Minority Shareholder Minority Shareholder

mistreatment, especially in change mistreatment, especially in change of control situationsof control situations

Succession / Family Business Succession / Family Business IssuesIssues

Transparency / Internal Transparency / Internal Controls / Audit FunctionControls / Audit Function

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Sample Diagnoses - ResponsesSample Diagnoses - Responses

Concentrated Ownership Concentrated Ownership IssuesIssues

Minority Shareholder Minority Shareholder MistreatmentMistreatment

Founder/Family Business Founder/Family Business IssuesIssues

Conflicts of InterestConflicts of Interest Ineffective BoardsIneffective Boards

– Poor CapacityPoor Capacity– Passive ApproachPassive Approach

TransparencyTransparency– Internal ControlsInternal Controls– Audit FunctionAudit Function

Clearly Articulated Clearly Articulated Shareholder Treatment Shareholder Treatment PoliciesPolicies

Strengthen Boards Strengthen Boards Succession PlanningSuccession Planning Committees and other Committees and other

mechanisms to handle mechanisms to handle conflictsconflicts

Audit CommitteesAudit Committees– Internal AuditInternal Audit– Financial ProfessionalsFinancial Professionals

Accounting and Auditing Accounting and Auditing ImprovementsImprovements

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Role of IFC-Nominated DirectorsRole of IFC-Nominated Directors

Rights to nominate in equity deals over ~ 10%Rights to nominate in equity deals over ~ 10%– Directors are both staff and outsidersDirectors are both staff and outsiders

– Currently about 150 directorsCurrently about 150 directors

What we expect from directors:What we expect from directors:– Duty is to the company, not usDuty is to the company, not us

» But open communication with IFCBut open communication with IFC

– Director is not doing portfolio supervisionDirector is not doing portfolio supervision

– Active role in governance improvementActive role in governance improvement

What we provide:What we provide:– Selection, training and Selection, training and ad hocad hoc support support

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www.ifc.org/corporategovernancewww.ifc.org/corporategovernance

Home PageHome Page

Why CG? IFC’s Approach CG Tools Resources

4 Types of Company• Listed companies• Family companies• Financial institutions• Transition economies

Six Steps:1. First Impressions2. Client Self-Assessment3. CG Review / Decision Mtg4. Addressing the Risks and

Opportunities 5. Documentation/

Implementation6. Supervision

• Instruction Sheets• Why CG?• Progression Matrices• Information Request

Lists • Independent Director

Definition• Model CG

Improvement Programs• Supervision Checklist

• By Topic• By Country• OECD Principles• IFC-nominated directors• Share Voting (to come)

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Hikma Pharaceuticals

IFC’s Approach in Practice

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Hikma in 2003Hikma in 2003 Generic Drug ProducerGeneric Drug Producer Operations in Several Middle East / North African Operations in Several Middle East / North African

Countries, Portugual, USA (1/4)Countries, Portugual, USA (1/4) Domiciled in Jordan / Listed in Amman / Family-Domiciled in Jordan / Listed in Amman / Family-

ControlledControlled Traditional Board (Founder’s Business Contacts)Traditional Board (Founder’s Business Contacts) Accounting, Auditing and Controls Inherited from Accounting, Auditing and Controls Inherited from

AcquisitionsAcquisitions Beginning of Corporate-wide Accounting and Beginning of Corporate-wide Accounting and

FinanceFinance

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Governance ChallengesGovernance Challenges

Objective: International IPO, MinimizeObjective: International IPO, Minimize National DiscountNational Discount

Confidence and Consistency of Controls / Confidence and Consistency of Controls / Accounts / AuditingAccounts / Auditing

International Financial ReportingInternational Financial Reporting Strengthening the BoardStrengthening the Board

– CompositionComposition– CommitteesCommittees– PracticesPractices

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Responses; OutcomesResponses; Outcomes

Unified, Corporate-Wide SystemsUnified, Corporate-Wide Systems Re-domiciled in JerseyRe-domiciled in Jersey New BoardNew Board

– Independent DirectorsIndependent Directors– Audit CommitteeAudit Committee

LSE/Dubai Listing – November 2005LSE/Dubai Listing – November 2005

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Banca Comerciala Romana

IFC’s Approach in Practice

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BCR in 2003BCR in 2003

Largest Commercial Bank in RomaniaLargest Commercial Bank in Romania US$1 billion book valueUS$1 billion book value State-owned (70%), with minority (30%) held by State-owned (70%), with minority (30%) held by

Investment Funds (SIFs)Investment Funds (SIFs) Two failed privatization attempts in 2002Two failed privatization attempts in 2002 Management and board indistinguishableManagement and board indistinguishable

– Board composed of senior managers and SIF Board composed of senior managers and SIF representativesrepresentatives

– met more than 25 times annuallymet more than 25 times annually

Risk management and internal controls systems weakRisk management and internal controls systems weak

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IFC’s InvestmentIFC’s Investment 12.5% + one share for US$11112.5% + one share for US$111

– .88x book value.88x book value– Negotiated Negotiated pari passu pari passu and in tandem with EBRDand in tandem with EBRD– Tag-along / drag-alongTag-along / drag-along

Medium-term trade sale anticipated (no IPO)Medium-term trade sale anticipated (no IPO) Subsequent distribution of 8% to Subsequent distribution of 8% to

management, employees and retireesmanagement, employees and retirees Institution-building programInstitution-building program

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Corporate Governance ProgramCorporate Governance Program

Philosophy – “Governance for the Interim”Philosophy – “Governance for the Interim” Introduced Two-Tiered Board StructureIntroduced Two-Tiered Board Structure

– Management off the Supervisory BoardManagement off the Supervisory Board– Redrafted CharterRedrafted Charter– Amendments to Banking LawAmendments to Banking Law– Audit & Compliance and Compensation CommitteesAudit & Compliance and Compensation Committees

IFC and EBRD-nominated directorsIFC and EBRD-nominated directors Active engagement at Shareholders MeetingActive engagement at Shareholders Meeting Two-Stage Training ProgramTwo-Stage Training Program

– IMD/IIF SeminarIMD/IIF Seminar– In-house ProgramIn-house Program

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Initial ResultsInitial Results Rating Agency UpgradesRating Agency Upgrades Board effectiveness – IFC nominee attended 14 board Board effectiveness – IFC nominee attended 14 board

meetings in 14 months, chaired audit committeemeetings in 14 months, chaired audit committee Professionalization of Shareholders MeetingsProfessionalization of Shareholders Meetings Implementation of IBPImplementation of IBP

– Improvement of Risk Management and Internal ControlsImprovement of Risk Management and Internal Controls

– IFC-sponsored Resident Advisor to Internal Controls UnitIFC-sponsored Resident Advisor to Internal Controls Unit

Transparency sufficient to privatizeTransparency sufficient to privatize

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Full PrivatizationFull Privatization 11 interested bidders initially11 interested bidders initially 7 bids submitted in mid-October7 bids submitted in mid-October 2 finalists: Erste Bank (Austria) and BCP 2 finalists: Erste Bank (Austria) and BCP

(Portugal) bid for Gov’t and IFC/EBRD (Portugal) bid for Gov’t and IFC/EBRD sharesshares

Erste wins bidding: €3.75 billion for 61.88%Erste wins bidding: €3.75 billion for 61.88%– ~6x book value of €1 billion at June 2005~6x book value of €1 billion at June 2005– IFC’s 12.5% stake worth €758 millionIFC’s 12.5% stake worth €758 million

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Many Thanks!!!Many Thanks!!!