1. 1 CORPORATE GOVERNANCE IN SOUTH EAST EUROPE BUCHAREST, 20 - 21 SEPTEMBER, 2001 Session 2 Ownership Structures and corporate governance framework in South East Europe by: Mathilde Mesnard Consultant, Corporate Affairs Division OECD mathilde.mesnard@oecd.org

2. 2 Objectives The main objectives of this paper/presentation: Illustrate the main common characteristics and differences among South East Europe countries Identify main issues and difficulties regarding corporate governance practices Clarify which are the areas for which we do not have enough information The major challenge is the comparative perspective : We do not have the same level of knowledge and information on all countries This first assessment will have to be completed, refined, detailed and even corrected by: - this session’s discussants - the whole Roundtable process

3. 3 Structure Objectives and Structure Part 1: Background landscape A new political era An improved macroeconomic climate Recent progress in privatisation and foreign investment Part 2: The corporate governance framework Ownership structures Financial sector The legal framework Part 3: Main issues in corporate governance: first assessment Shareholders’ rights Equitable treatment Transparency and disclosure Board responsibilities

4. 4 Background Landscape A new political era Fundamental political changes in Croatia and more recently in Yugoslavia have broken their international isolation Positive evolution, but still remaining problems, tensions and unrest in Bosnia-Herzegovina, FYROM and Kosovo Less radical changes in remaining SEE countries, where democratic elections brought to power new parties or coalitions that do not question the reform path (except in Albania, where the same party was recently reelected, although election results are being contested) Most SEE countries are now targeting EU integration This favorable political climate may facilitate regional cooperation on economic issues

5. 5 Background Landscape An improved Macroeconomic climate Different transition trajectories but common factors explaining lagging transition Growth has turned positive throughout the region. The SEE region has not yet been hit by the economic slowdown Nevertheless, SEE has not caught up with pre-transition levels. The average GNP per capita in SEE is less than 10 % of the EU average, and the gap is widening. Macro stability has occurred in almost all countries, except in Romania, even though there are still large government deficits and problematic external position sustainability Overall, all SEE countries underwent high rise in unemployment, sharp decrease in living standards and increased inequality A stabilized, though fragile macro economic climate and a new growth, but the bulk of industrial restructuring remains to be done

6. 6 Background Landscape GDP Growth 1989 - 2000 Sources: EBRD Transition Report 2000 and Investment Profiles 2001

7. 7 Background Landscape GDP 1999 / 1989 Source : EBRD Transition Report 2000 ( Except for Yugoslavia, it is industrial output, from Alpha Bank Monthly Economic Update)

8. 8 Background Landscape CPI Inflation 1995 - 2000 Sources: EBRD Transition Report 2000 and Investment Profiles 2001

9. 9 Background Landscape GDP per Capita in 1999 in US D Source: EBRD Transition Report 2000

10. 10 Background Landscape Recent progress in privatisation and foreign investment Progress in privatisation and methods used have a significant impact on corporate governance practices Privatisation programs have taken various forms but have had in common to begin late and to be still in progress Further improvement in macro economic performances and a continuation or acceleration of privatisation programs would at the same time trigger and be facilitated by f10oreign investment Untill now, SEE ranked badly in terms of foreign investment, especially FDI Acceleration in industrial restructuring and effective increase in foreign investment requires the second stage set of reforms, i.e. building the institutional foundations of a market economy, of which corporate governance is a key element

11. 11 Background Landscape Graph 6: Cumulated FDI, 1989 – 1999, in US D Source: EBRD Transition Report 2000

12. 12 Background Landscape Graph 7: Cumulated FDI per Capita, 1989 – 1999, in US D Source: EBRD Transition Report 2000

13. 13 Corporate governance framework Ownership structures Ownership structures in SEE share three main characteristics: –the significant ownership by insiders (managers and employees) –the importance of remaining state ownership and control (especially regarding big utilities) –the emergence of institutional investors, mainly former privatisation funds These three common characteristics engender specific problems and difficulties regarding corporate governance practice and will be addressed during this or subsequent Roundtables Changes are in process with strong common trends: –increased concentration in individual companies. This derives from: initial excessive ownership dispersion inability or great difficulty for minority investors to have their rights respected –de-listing of public companies –formation of holding companies on the basis of former privatisation funds

14. 14 Corporate governance framework The Financial Sector / The banking sector The financial sector is a strategic but often weak sector in SEE Major banking crisis happened in the second half of the 90’s: –they resulted from poor banking supervision and mounting bad debts –they were very costly –remedies have been changes in the regulatory frameworks (mainly improved banking supervision) and privatisation (mainly through sales to foreign banks) This resulted in a significant increase of foreign capital in the banking sector (from 50 % in Romania to 85 % in Croatia) Further concentration is expected in the banking sector SEE economies are characterized by the very low level of banking intermediation –regarding international standards –regarding their stage of development –in comparison with other European transition countries This low intermediation level can be explained by numerous, obvious and well- known reasons

15. 15 Corporate governance framework The Financial Sector / Stock Exchanges (1) Stock exchanges in SEE have been created early on in the transition, but really became operational and regulated by Securities Commissions in the second half of the 90’s They usually enjoy a good technical and legal infrastructure SEE Stock Exchanges remain quite under-developed, with low capitalisation and low liquidity. Moreover, the bulk of their capitalisation derives from the most flexible market segments (except in Croatia) They were created as privatisation devices. The initial trading was linked to re- distribution of property and they remain mainly secondary markets dedicated to these functions.

16. 16 Corporate governance framework The Financial Sector / Stock Exchanges (2) Their under-development derives from the lack of demand, but also and perhaps first of all from the lack of supply –lack of large companies with substantial free-float –lack of interest from companies in being listed, as: they are too small to bear unnecessary and costly listing requirements constraints given the low liquidity, the cost of capital is high they may be reluctant to disclose information Consequently, SEE Stock Exchanges are not able to fulfil their traditional roles: –they are not a source of funding for enterprises (very limited number of IPOs) –they are not a disciplining mechanism through the take-over threat –they do not provide adequate information nor fair valuations there is a current tendency to de-list What could possibly give an impulse to SEE Stock Exchange development ? –The recently launched Pension Reforms –Regional cooperation may be a necessary step

17. 17 Corporate governance framework The Legal Framework Laws themselves are usually of good quality, as reflected in the EBRD “extensiveness” legal indicators –Company laws have been adopted at an early stage of the transition –Securities laws have been adopted later in conjunction with the development of financial markets –Bankruptcy laws have been adopted quite recently One of the main drawbacks of this legal framework has been in a few cases the discrepancies between civil law based company laws and more common law based securities laws Recent or current improvements of the legal framework have been undertaken But the main difficulty lies in implementation, as reflected in the EBRD “effectiveness” legal indicators. The underlying fundamental difficulty is in the judicial and administrative system able to enforce the law This discrepancy between the corporate governance framework and effective corporate governance practices is the main challenge

18. 18 Main Issues in Corporate Governance Practices Shareholders Rights Access to information on ownership structure Information on shareholders meetings Clear provisions concerning voting procedures during the AGM Capacity for shareholders to vote in absentia, by proxy or mail Rights to receive dividends

19. 19 Main Issues in Corporate Governance Practices Equitable Treatment Dilution of minority stakes during capital increases Fair treatment of minority shareholders in case of de-listing Related parties transactions Insider dealing and self-trading Possibility of legal redress

20. 20 Main Issues in Corporate Governance Practices Transparency and disclosure Accounting and auditing standards Easy access for shareholders to Financial Statements and capital structure Enforcement power of Securities Commissions Information on material events Information on conflicts of interests

21. 21 Main Issues in Corporate Governance Practices Responsibilities of the Board Understanding of the Board’s role Independence of Board members Nomination process allowing representation of minority investors Disclosure of material interests Transparency on Board practices and compensation