BACKGROUND: WHY CORPORATE GOVERNANCE?

Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and its stakeholders. Corporate governance is only part of the larger economic context in which firms operate that includes, for example, macroeconomic policies and the degree of competition in product and factor markets. The corporate governance framework also depends on the legal, regulatory, and institutional environment. Another key driver for public policy involvement in corporate governance has been concern about the viability of pension fund systems, which increasingly depend on equity markets and the preservation of private savings for retirement. Corporate governance assists in the strengthening of the overall international financial system and reduces the vulnerability of emerging markets to financial crisis.

Over the past several years, corporate governance reform has been added as “the newest pillar of the post-Cold War economic architecture.” In 1998, following the Asian financial crisis and the Russian debt default, the leaders of the G7 nations announced a new focus on corporate behavior and incentives. By mid-1999, the Organization for Economic Cooperation and Development (OECD) adopted a set of basic principles. The international financial institutions (IFIs) all view improved governance practices as a key to spurring prosperity and jobs by strengthening corporations' ability to compete for global capital. In response, many World Bank client countries have initiated legal, regulatory and institutional corporate governance reform projects. Numerous studies agree that better corporate frameworks benefit firms through greater access to financing, lower cost of capital, better firm performance, and more favorable treatment of all stakeholders.

THE CORPORATE GOVERNANCE ROSC ASSESSMENTS

Given the importance of monitoring corporate governance reform, the World Bank has undertaken an institutional commitment to carry out assessments of corporate governance. These assessments are carried out under the overall program of Reports on the Observance of Standards and Codes (ROSC).

The assessment of corporate governance practices in a country measures the legal and regulatory framework, as well as practices and compliance of listed firms against the OECD Principles of Corporate Governance. Since the OECD Principles of Corporate Governance were agreed in 1999, they have formed the basis for corporate governance initiatives in both OECD and non-OECD countries alike. Moreover, they have been adopted as one of the twelve Core Standards for Sound Financial Systems by the Financial Stability Forum. Accordingly, they form the basis of the corporate governance template developed by the World Bank/IMF to conduct the corporate governance assessments under the Reports on Standards and Codes (ROSC) and Financial Sector Assessment Program (FSAP) programs.

The assessments:

• use a consistent methodology for assessing national corporate governance practices;
• provide benchmark indices by which countries can evaluate themselves and gauge progress in corporate governance reforms;
• strengthen the ownership of reform in the assessed countries by promoting productive interaction among issuers, investors, regulators and public decision makers;
• provide the basis for a policy dialogue which will result in policy recommendations.

METHODOLOGY

Selecting a benchmark

The first step in developing a methodology to assess a country’s corporate governance system was the identification of a benchmark. Fortunately, an internationally accepted standard had been in place since 1999. The OECD Principles of Corporate Governance were agreed upon by a large number of countries of varied legal, economic and cultural traditions and after extensive consultation with the World Bank, the IMF, the Bank of International Settlements, and representatives of the business community from Japan, Germany, France, UK and the U.S., as well as emerging market governments, international investors, trade unions and other interested parties. As such, the OECD Principles represent the minimum standard that countries with different traditions could agree upon, without being unduly prescriptive. They are equally applicable to countries with civil and common law traditions, different levels of ownership concentration, and various models of board representation.

The OECD Principles are primarily concerned with corporate governance of listed companies. They are organized into six sections: (1) ensuring an effective corporate governance framework; (2) the rights of shareholders and key ownership functions (3) equitable treatment of shareholders; (4) the role of stakeholders in corporate governance; (5) disclosure and transparency, and (6) the responsibilities of the board.

The OECD Principles are non-binding. They provide a framework for dialogue on country experience and identification of policy reform “without prejudice to the prerogative of each nation to find its own path to better corporate governance.” The aim is a common framework under which good practices can develop, in consistency with national regulations and traditions.

The assessment process

Countries voluntarily participate in a ROSC, and the World Bank is invited to participate by country authorities. After receiving an invitation, the World Bank commissions a local consultant to complete a “template” (questionnaire) designed to capture a country’s corporate governance legal and regulatory framework, and information on corporate governance practices. World Bank experts then visit a country to meet with government officials, market participants, investors, and issuers, and draft an assessment report.

The assessment is divided into four parts: (i) executive summary; (ii) capital market overview and institutional framework; (iii) principle by principle review, including policy recommendations and, (iv) summary of recommendations highlighting areas for legislative reform, institutional strengthening and voluntary/private initiatives. The assessments attempt to differentiate between compliance with the legal and regulatory framework and actual practices of market participants, and include a chapter on institutional strengthening. Hence, each OECD Principle is evaluated according to quantitative and qualitative standards.

Most countries then agree to the publication of the results of the assessment on the World Bank website. (Corporate governance ROSC assessments are published at www.worldbank.org/ifa/rosc_cg.html).