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LAN030414ZXI ZXI LAN030414ZXI ZXI CONFIDENTIAL Capital Markets Governance of Corporates: How Can Capital Markets Exert Better Governance on Corporates Bob Felton, McKinsey & Company, Inc. 5th Annual Financial Markets and Development Conference April 14-16, 2003 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.
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2. Important barriers inhibit movement to improved governance
LAN030414ZXI ZXI LAN030414ZXI ZXI OVERALL, GOVERNANCE REFORM IS KEY TO IMPROVED ECONOMIC CONDITIONS IN EMERGING ECONOMIES 1. Emerging economies suffer major penalties due to weak governance and other market factors 2. Important barriers inhibit movement to improved governance 3. A combination of strong legal/regulatory reform and “free market” supervision appropriate path forward
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1. Quality of governance important factor in investment decisions
LAN030414ZXI ZXI LAN030414ZXI ZXI EMERGING ECONOMIES SUFFER MAJOR PENALTY DUE TO WEAK GOVERNANCE AND OTHER MARKET FACTORS 1. Quality of governance important factor in investment decisions 2. Investor say they are willing to pay a premium for good board governance 3. This survey information is supported by financial analysis 4. This lack of robust capital markets leads to weak and unstable corporate financial structures
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LAN030414ZXI ZXI LAN030414ZXI ZXI GOVERNANCE REMAINS IMPORTANT COMPARED TO FINANCIALS, PARTICULARLY IN EMERGING MARKETS Less important Equally important Percentage of investors More important 2002 2000 Eastern Europe/Africa Latin America Asia North America Western Europe How important is corporate governance* relative to financial issues, e.g., profit performance and growth potential, in evaluating which companies you will invest in? * Defined as effective boards of directors; broad disclosure, and strong rights and equal treatment for shareholders Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
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CORPORATE GOVERNANCE IS NOW AN ESTABLISHED INVESTMENT CRITERION
LAN030414ZXI ZXI LAN030414ZXI ZXI CORPORATE GOVERNANCE IS NOW AN ESTABLISHED INVESTMENT CRITERION How does corporate governance affect your investment decision? “Our investment group would never approve an investment in a company with bad governance” – U.S. investment manager, $20 billion private equity fund Percentage of investors selecting this option; multiple responses possible “‘Good governance’ is a qualitative cut-off criteria” – Analyst, $62 billion European Asset Manager Avoidance of certain companies Decrease/increase holdings in certain companies Avoidance of certain countries “I simply would not buy a company with poor corporate governance” – CFO, $ 3 billion European Private Bank Decrease/increase holdings in certain countries Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
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LAN030414ZXI ZXI LAN030414ZXI ZXI A SIGNIFICANT MAJORITY OF INVESTORS SAY THEY ARE WILLING TO PAY A PREMIUM FOR A WELL-GOVERNED COMPANY Percentage of investors 2002 2000 Western Europe Asia North America Latin America Eastern Europe/Africa Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002
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LAN030414ZXI ZXI LAN030414ZXI ZXI THE AVERAGE PREMIUM INVESTORS WOULD BE WILLING TO PAY DIFFERS BY COUNTRY . . . Average percent 30 28 Venezuela Indonesia Columbia 26 Thailand Malaysia 24 Korea Brazil Mexico Italy 22 Argentina Germany Taiwan Chile 20 France Japan Spain U.S. 18 Switzerland U.K. Latin America Asia Continental Europe Anglo-Saxon Source: McKinsey investor opinion survey
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KOREA’S EQUITY MARKET SIGNIFICANTLY UNDERDEVELOPED AND UNDERPERFORMING
LAN030414ZXI ZXI LAN030414ZXI ZXI KOREA’S EQUITY MARKET SIGNIFICANTLY UNDERDEVELOPED AND UNDERPERFORMING Underdeveloped Equity market capitalization comparison* June 2001 Significantly undersized equity market compared to leading economies Market cap per GDP (%) U.K. U.S. France Germany Japan Benchmark average Korea Source: Bloomberg; EIU; McKinsey analysis
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COMPOSITION OF PRIVATE SECTOR LIABILITIES, 1997
LAN030414ZXI ZXI LAN030414ZXI ZXI COMPOSITION OF PRIVATE SECTOR LIABILITIES, 1997 Percent In 2000, Korea improved to 55% bank loans, 25% bonds, and 20% equity In 2000, U.S. changed to 50% equity, 35% bonds, and 15% bank loan Equity Bonds Bank loans U.S. Hong Kong Taiwan Malaysia Singapore Indonesia China Korea Thailand Source: Bank for International Settlements; International Monetary Fund; International finance Corporation (IFC); International Federation of Stock Exchanges (FIBV); World Bank
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TOTAL RETURN TO SHAREHOLDERS: S&P 500 VS. KOSPI
LAN030414ZXI ZXI LAN030414ZXI ZXI TOTAL RETURN TO SHAREHOLDERS: S&P 500 VS. KOSPI Poor performance over time , percent S&P500 : 13.0% per annum return $100 invested in the S&P500 index would be worth $340 However, $100 invested in the KOSPI index would only be worth $68 Korean shareholders have been seriously unrewarded for their investments KOSPI : -3.8% per annum return ‘96 Source: Datastream; McKinsey analysis
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MARKET-TO-BOOK COMPARISON
LAN030414ZXI ZXI LAN030414ZXI ZXI MARKET-TO-BOOK COMPARISON Finally, we see that Korea’s PE ratio is significantly lower than that of our benchmark countries. The discount that Korean stock prices experience is due to many different factors. Once we identify and fix these factors, the stock prices of Korean companies should return to a level near global parity. June 2001, ratio* U.S. France Japan Germany U.K. Bench-mark average Korea * Sum of 2001 market cap (January-June) divided by sum of book value (2000) Source: Bloomberg; McKinsey analysis
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PE RATIO COMPARISON July-Dec 2001, ratio*
LAN030414ZXI ZXI LAN030414ZXI ZXI PE RATIO COMPARISON Finally, we see that Korea’s PE ratio is significantly lower than that of our benchmark countries. The discount that Korean stock prices experience is due to many different factors. Once we identify and fix these factors, the stock prices of Korean companies should return to a level near global parity. July-Dec 2001, ratio* Korea’s PE ratio is significantly lower than that of other countries Japan Germany U.S. France U.K. Bench-mark average Korea * Sum of market cap divided by sum of forecasted earnings ** Companies whose market cap combines to account for 80% of total country market cap; excludes outliers (companies whose PE ratios were 3 standard deviations away from country average) Source: Bloomberg; McKinsey analysis; I/D/E/C
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INDUSTRY PE COMPARISON*
LAN030414ZXI ZXI LAN030414ZXI ZXI INDUSTRY PE COMPARISON* Benchmark Korea The Korean PE gap phenomenon is felt in all industries. June 2001, PE ratio Energy Transportation Electrical Compon & Equip Diversified Financial Service Iron/steel/basic material Pharmaceuticals & Biotech Food & Beverage Retail Chemicals Auto & Components Insurance Banking Telecommunications * Only compared for those industries in which Korean companies operate Source: Bloomberg; McKinsey analysis
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MARKET VOLATILITY* OF KEY INDICES OVER THE PAST 5 YEARS (1997-2001)
LAN030414ZXI ZXI LAN030414ZXI ZXI MARKET VOLATILITY* OF KEY INDICES OVER THE PAST 5 YEARS ( ) Highly volatile Percent The KOSPI and KOSDAQ have been most volatile, when compared to their peers in South East Asia and the United States KOS-DAQ** KOSPI Kuala Lumpur NAS-DAQ Hang Seng*** Singa-pore Straits Times Taiwan S&P 500 * The relative rate at which the price of a security/index moves up and down, found by calculating the annualized standard deviation of day-over-day differences in daily price charge ** KOSDAQ 50 was developed on Jan. 4, 1999; thus only the last 3 years have been provided for this index *** Hang Seng Composite Index was developed on Jan. 3, 2000; thus only the last 2 years have been provided for this index Source: Bloomberg
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ENTREPRENEURS ACCESS TO CAPITAL
LAN030414ZXI ZXI LAN030414ZXI ZXI ENTREPRENEURS ACCESS TO CAPITAL Ranking, 2001 Rank Country Score Rank Country Score 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 United States United Kingdom Luxembourg Hong Kong Netherlands Switzerland Singapore Canada New Zealand Ireland Germany Australia Finland Sweden Taiwan 5.72 5.63 5.59 5.58 5.49 5.46 5.36 5.25 5.14 5.10 5.09 5.08 5.04 5.02 5.00 16 17 18 19 20 21 22 23 24 25 26 27 28 30 Spain Japan France Belgium Denmark Austria Israel Portugal Chile South Korea Malaysia Norway Iceland Thailand Italy 4.90 4.85 4.81 4.79 4.78 4.77 4.74 4.72 4.64 4.63 4.62 4.56 4.54 Source: Milken Institute
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TOTAL STOCK VALUE CONTROLLED BY INSTITUTIONAL INVESTORS
LAN030414ZXI ZXI LAN030414ZXI ZXI TOTAL STOCK VALUE CONTROLLED BY INSTITUTIONAL INVESTORS 2001, percent Presence of institutional investors is a sign of an advanced equity market Source: KSE; GAI; National Accounts; NYSE
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LAN030414ZXI ZXI LAN030414ZXI ZXI WHILE THESE FINANCIAL PENALTIES RESULT FROM MANY FACTORS, WEAK GOVERNANCE IS A MAJOR CONCERN 1. Complicated ownership structures with heavy cross-ownership 2. Weak minority shareholder rights 3. Conflicted boards of directors 4. Weak and intransparent financial reports and limited reporting to international standards 5. Impediments to takeover activity 6. Weak investor relations practices
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PYRAMIDAL EQUITY OWNERSHIP
LAN030414ZXI ZXI PYRAMIDAL EQUITY OWNERSHIP Samsung group Samsung Electronics Samsung Corp Samsung Life Ins Cheil Comm. Samsung Mech. Elec Samsung SDI Samsung Foundations S-one Samsung Card Samsung Heavy Ind. Samsung Security Samsung Everland Hotel Shilla Samsung Prec.Chem Samsung F&M Ins Samsung Techwin Cheil Textile Samsung Engineering Samsung Capital
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LAN030414ZXI ZXI LAN030414ZXI ZXI A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD 1. Important legal projections necessary Clean up ownership structure, probably by establishing legal framework for holding company Strengthen minority shareholder rights Remove barriers to hostile takeovers, including foreign investors Regulate third-party transactions Hold management and directors accountable for illegal/inappropriate activities
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LAN030414ZXI ZXI LAN030414ZXI ZXI A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD (CONTINUED) 2. Improve regulatory activities Require majority of directors to be independent, especially on audit committee Mandate that financial reporting complies with international standards; demand transparency and periodic reporting Install consistent, aggressive, and effective regulatory enforcement
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LAN030414ZXI ZXI LAN030414ZXI ZXI A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD (CONTINUED) 3. Encourage companies to improve investor relations for all shareholders* More transparency More open about risks/challenges Encourage Q&A More CEO-led discussions Give investors advance notification about meeting dates If listed globally, make announcements after markets open Install information-rich Web sites
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LAN030414ZXI ZXI LAN030414ZXI ZXI A COMBINATION OF STRONG LEGAL/REGULATORY REFORM AND “FREE MARKET” SUPERVISION APPROPRIATE PATH FORWARD (CONTINUED) 4. Work to improve quality of director pool Director pool often weak in emerging markets Important to establish training/recruiting programs to develop adequate supply of strong directors Consider non-executive certification program
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LAN030414ZXI ZXI LAN030414ZXI ZXI HOWEVER, GOVERNMENTS SHOULD RESIST TEMPTATION TO MICROMANAGE PRIVATE SECTOR 1. Establish limited, focused legal/regulatory framework and enforce aggressively 2. Ensure transparency of financials and independence of boards 3. And let free market provide disciple and “regulation”
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