12.2 Corporate governance in emerging markets
4 min read•july 31, 2024
in faces unique challenges due to underdeveloped institutions and concentrated ownership. Weak regulations, limited market infrastructure, and create hurdles for effective oversight and investor protection. However, rapid growth and global integration offer opportunities for innovative governance structures.
play a crucial role in promoting better practices, while and present distinct governance issues. and enforcement mechanisms hinder and corporate transparency. Strategies for improvement include enhancing and promoting market development.
Corporate Governance in Emerging Markets
Challenges in Institutional Frameworks
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- Underdeveloped institutional frameworks in emerging market economies create distinct corporate governance challenges
- Weak regulatory environments hinder effective oversight
- Limited market infrastructure impedes efficient capital allocation
- Concentrated ownership structures lead to conflicts between controlling and minority shareholders
- Necessitates robust protection mechanisms for minority investors
- Weak law enforcement creates opportunities for unethical business practices
- Insider trading and become more prevalent
- Cultural norms influence governance practices
- Sometimes conflict with (guanxi in China)
Opportunities for Innovation and Growth
- Rapid economic growth presents opportunities for innovative governance structures
- Balance local needs with global best practices
- Implement
- Increasing global integration creates pressure for improved governance
- Attracts foreign investment
- Enhances competitiveness in international markets
- Technological advancements offer chances to leapfrog traditional systems
- Implement cutting-edge solutions for transparency ()
- Enhance accountability through digital reporting platforms
Institutional Investors vs Family Ownership
Role of Institutional Investors
- Institutional investors promote better governance practices through influence and voting power
- Push for and transparency
- Advocate for
- Presence of impacts governance
- Long-term investment horizons shape strategic decisions
- Balance commercial and political objectives
- Institutional investors from developed markets push for international standards
- Creates tension with local practices
- Drives adoption of global best practices ()
Family Ownership and State Control
- Family-owned businesses face unique governance challenges
- becomes critical for long-term sustainability
- often conflicts with family control
- State-owned enterprises operate under different governance structures
- Balance political objectives with commercial interests
- Often lack and shareholder oversight
- Concentrated ownership leads to potential issues
- Entrenchment of management
- Expropriation of minority shareholder rights (tunneling in Russian oligarch-controlled firms)
Legal Frameworks and Minority Shareholder Rights
Weak Legal Frameworks and Enforcement
- Inadequate protection for minority shareholders results from weak legal frameworks
- Potential exploitation by controlling shareholders (asset stripping)
- Limited enforcement capabilities render well-designed laws ineffective
- Undermines investor confidence in the market
- Absence of robust hampers corporate transparency
- Creates information asymmetry between insiders and outside investors
- Weak legal systems struggle to address complex governance issues
- often go unchecked
- Insider trading remains prevalent in many emerging markets
Impact on Corporate Transparency
- Lack of efficient judicial systems hinders resolution of corporate disputes
- Enforcement of shareholder rights becomes challenging
- Inadequate discourages reporting of misconduct
- Compromises overall transparency and accountability
- Interplay between formal and informal institutions creates governance gaps
- can override formal legal structures
- Addressing these gaps through legal reforms alone proves challenging
Strategies for Improving Corporate Governance
Enhancing Regulatory Framework
- Implement comprehensive corporate governance codes tailored to emerging markets
- Enhance investor confidence and market integrity
- Address specific local challenges (family ownership in Latin America)
- Strengthen regulatory bodies with adequate resources and authority
- Improve oversight and enforcement capabilities
- Empower agencies like
- Promote development of independent directors and board committees
- Enhance quality of corporate decision-making
- Protect minority shareholder interests (, )
Promoting Market Development and Innovation
- Encourage adoption of
- Improve financial transparency and comparability ()
- Develop robust capital markets with stringent listing requirements
- Incentivize better governance practices among firms seeking capital
- Implement tiered markets like China's for tech companies
- Foster growth of institutional investors and shareholder activism
- Create internal pressure for improved governance standards
- Support the development of
- Implement technology-driven solutions for governance processes
- Use blockchain for shareholder voting to enhance transparency
- Leverage and compliance monitoring
Key Terms to Review (32)
Ai for risk management: AI for risk management refers to the application of artificial intelligence technologies to identify, assess, and mitigate risks within organizations. This use of AI enables companies to process large volumes of data quickly and accurately, helping them to make informed decisions that reduce potential threats and enhance overall governance. By leveraging predictive analytics and machine learning, organizations can proactively manage risks, particularly in complex environments such as emerging markets.
Audit committees: Audit committees are specialized subcommittees of a company's board of directors that oversee financial reporting and disclosure, ensuring the integrity of the company’s financial statements. They play a crucial role in corporate governance by helping to mitigate risks related to financial misstatements and fraud, thereby enhancing transparency and accountability within the organization.
Blockchain-based voting systems: Blockchain-based voting systems are digital voting platforms that utilize blockchain technology to record, verify, and secure votes cast in an election. This technology provides a decentralized and tamper-proof method for managing the electoral process, ensuring transparency and enhancing trust among voters. These systems aim to improve voter participation, streamline the voting process, and protect against fraud, which is particularly relevant in regions where traditional voting methods face challenges.
Board Independence: Board independence refers to the ability of a company's board of directors to make decisions free from conflicts of interest and undue influence from management or other stakeholders. This concept is crucial in ensuring that the board can effectively oversee and monitor management, protect shareholder interests, and maintain the integrity of the corporate governance framework.
Corporate Governance: Corporate governance refers to the system of rules, practices, and processes that directs and controls a company. It establishes the framework for achieving a company’s objectives while balancing the interests of its various stakeholders, including shareholders, management, customers, suppliers, financiers, government, and the community. Good corporate governance is crucial as it enhances accountability and transparency within an organization and fosters trust among stakeholders.
Corruption: Corruption refers to the abuse of power for personal gain, often manifesting through bribery, embezzlement, or favoritism. It undermines trust in institutions and can severely hinder economic development, particularly in emerging markets where governance structures may be weaker. The prevalence of corruption can lead to a lack of accountability and transparency, eroding the effectiveness of corporate governance.
Cultural norms: Cultural norms are the shared expectations and rules that guide behavior within a society or group. These norms shape how individuals interact with one another and influence organizational practices, particularly in corporate governance, where understanding local customs and values is crucial for success, especially in emerging markets.
Cultural Norms (Guanxi in China): Cultural norms refer to the shared expectations and rules that guide behavior within a group or society. In the context of China, 'guanxi' emphasizes the importance of personal relationships and networks in business and governance, influencing how decisions are made and resources are allocated. This concept highlights how cultural norms shape corporate governance practices, particularly in emerging markets where traditional Western approaches may not apply.
Disclosure requirements: Disclosure requirements refer to the legal and regulatory obligations that companies must follow to provide pertinent information to their shareholders and the public. These requirements ensure transparency and accountability in corporate governance, allowing stakeholders to make informed decisions about their investments. They are crucial for maintaining trust in financial markets and can impact shareholder voting rights, information asymmetry, and the effectiveness of governance in emerging markets.
Emerging markets: Emerging markets are economies that are in the process of rapid growth and industrialization, characterized by increasing economic development, improving financial markets, and a rising middle class. These markets often offer high potential for investment, but they also come with higher risks due to political instability, economic volatility, and less developed regulatory environments.
Esg reporting: ESG reporting refers to the disclosure of data related to environmental, social, and governance practices and performance of a company. This type of reporting is crucial for investors, stakeholders, and regulators as it provides insights into how a company operates sustainably, manages risks, and impacts society. Companies in emerging markets may face unique challenges and opportunities in ESG reporting as they work to meet global standards while addressing local issues.
Family-Owned Businesses: Family-owned businesses are enterprises that are owned and operated by members of a single family, often across multiple generations. These businesses are characterized by a strong family influence on their operations, decision-making processes, and long-term strategies. The dynamics of family involvement can greatly impact corporate governance mechanisms and principles, as well as the unique challenges faced by such businesses in emerging markets.
IFRS adoption in Brazil: IFRS adoption in Brazil refers to the process through which Brazilian companies transitioned to the International Financial Reporting Standards (IFRS) from the previous Generally Accepted Accounting Principles (GAAP). This shift aimed to enhance the transparency, comparability, and consistency of financial reporting, ultimately improving corporate governance and investor confidence in the Brazilian market.
Institutional Investors: Institutional investors are organizations that invest large sums of money on behalf of their clients or members, such as pension funds, insurance companies, and mutual funds. They play a significant role in corporate governance by influencing company policies and decisions through their substantial ownership stakes and active engagement strategies.
International Accounting Standards: International Accounting Standards (IAS) are a set of accounting principles developed to provide a common framework for financial reporting across different countries. These standards aim to enhance transparency, comparability, and consistency in financial statements, facilitating cross-border investments and economic activities. By aligning financial reporting practices globally, IAS plays a critical role in corporate governance, particularly in emerging markets where diverse accounting practices may hinder investor confidence and economic growth.
International standards: International standards are established norms and guidelines that provide a consistent framework for practices, processes, and policies across different countries and industries. They aim to enhance quality, safety, and efficiency in various sectors, ensuring a level playing field for businesses operating globally. These standards are particularly relevant in corporate governance as they help improve transparency, accountability, and ethical conduct in emerging markets.
Market discipline: Market discipline refers to the mechanism by which investors and stakeholders hold corporations accountable for their performance and governance practices. It plays a vital role in emerging markets, where companies may face challenges such as weaker regulatory frameworks and less transparency. By fostering competition, enhancing information availability, and enabling investors to react to corporate behavior, market discipline encourages firms to adhere to better governance standards and operate efficiently.
Minority shareholder rights: Minority shareholder rights refer to the legal protections and privileges afforded to shareholders who own less than 50% of a company's shares. These rights are essential for ensuring that minority shareholders can participate in corporate governance and are not oppressed by majority shareholders. In the context of corporate governance in emerging markets, these rights help to foster transparency, accountability, and fairness in business practices, promoting a balanced power dynamic between different classes of shareholders.
Nomination Committees: Nomination committees are specialized groups within a corporation responsible for identifying and recommending candidates for the board of directors and other key executive positions. These committees play a crucial role in corporate governance, ensuring that the selection process for leadership is transparent, fair, and aligned with the company's strategic goals, particularly important in emerging markets where governance structures may still be developing.
Professionalization of management: The professionalization of management refers to the process of developing and establishing management as a recognized profession, with specific standards, practices, and ethical guidelines. This movement is particularly significant in emerging markets, where it plays a crucial role in enhancing organizational effectiveness, accountability, and adherence to corporate governance principles.
Proxy advisory firms: Proxy advisory firms are specialized organizations that provide recommendations and advice to institutional investors regarding how to vote on corporate governance issues at shareholder meetings. These firms analyze various factors such as executive compensation, board structure, and shareholder proposals, influencing the decisions of institutional investors on important governance matters. Their role is particularly significant in the context of reforming executive compensation practices and enhancing corporate governance in emerging markets.
Regulatory Frameworks: Regulatory frameworks refer to the set of rules, laws, and guidelines established by governing bodies to regulate various sectors, including corporate governance. These frameworks aim to ensure compliance, protect stakeholders' interests, and promote fair practices within emerging markets, where governance structures may be less developed and more vulnerable to issues such as corruption and mismanagement.
Related-party transactions: Related-party transactions refer to business dealings between parties that have a pre-existing relationship, such as between a company and its executives, directors, or major shareholders. These transactions can lead to conflicts of interest and may not always be conducted at arm's length, meaning they may not reflect the fair market value. Understanding related-party transactions is crucial in emerging markets where governance structures may be less robust, potentially exposing companies to risks like fraud and mismanagement.
Securities and Exchange Board of India (SEBI): The Securities and Exchange Board of India (SEBI) is the regulatory authority for securities markets in India, established in 1992 to protect investor interests, promote market development, and regulate the securities market. SEBI plays a crucial role in enhancing corporate governance standards by ensuring transparency, accountability, and fairness in the functioning of the capital markets, which is especially important in the context of emerging markets.
Shareholder rights: Shareholder rights are the entitlements and protections that shareholders have regarding their ownership in a corporation, including voting on important issues, receiving dividends, and accessing information about the company. These rights empower shareholders to influence corporate governance and hold management accountable, ultimately ensuring that their interests are represented in decision-making processes.
Sovereign Wealth Funds: Sovereign wealth funds are state-owned investment funds or entities that manage a country's reserves for the purpose of investment. These funds can invest in a variety of assets, including stocks, bonds, real estate, and other financial instruments, providing countries with a means to stabilize their economies, fund future generations, or finance national development projects. They play a significant role in corporate governance, especially in emerging markets, where they can influence local economies and businesses.
Stakeholder-focused models: Stakeholder-focused models are frameworks in corporate governance that prioritize the interests and needs of all stakeholders involved in a company, including employees, customers, suppliers, the community, and shareholders. These models advocate for balancing the various interests rather than solely focusing on maximizing shareholder value, promoting sustainability and ethical decision-making in business practices.
Star Market: The Star Market is a designated trading platform in China that allows companies to raise capital and access public markets, particularly aimed at innovative and high-tech firms. It represents a significant step in enhancing corporate governance and providing a structured environment for emerging companies to grow while meeting regulatory requirements, thereby attracting domestic and foreign investors.
State-controlled enterprises: State-controlled enterprises are organizations that are owned or significantly controlled by the government, often operating in sectors considered essential to the economy, such as utilities, transportation, and natural resources. These enterprises can play a critical role in shaping economic policy and providing public services, especially in emerging markets where they may dominate key industries and influence corporate governance practices.
Succession Planning: Succession planning is the process of identifying and developing new leaders who can replace current leaders when they leave, retire, or move on. This practice ensures that an organization has the right people in place to continue operations and maintain stability, especially during transitions. Effective succession planning is vital for monitoring management performance, forming key board committees that govern these processes, and adapting corporate governance practices in emerging markets.
Weak legal frameworks: Weak legal frameworks refer to insufficient, poorly enforced, or ambiguous laws and regulations that fail to provide adequate governance and protection for businesses and investors. In emerging markets, such frameworks often lead to uncertainty in business operations, impacting investor confidence and corporate governance practices.
Whistleblower protection: Whistleblower protection refers to legal safeguards designed to protect individuals who report unethical or illegal activities within an organization from retaliation. These protections encourage transparency and ethical behavior by allowing employees to expose wrongdoing without fear of losing their jobs, facing harassment, or suffering other negative consequences. This concept plays a crucial role in promoting ethical decision-making, fostering a positive corporate culture, and ensuring accountability in corporate governance.