Investor Protection and Corporate Governance
Investor protection turns out to be crucial because, in many countries, expropriation of minority shareholders and creditors by the controlling shareholders is extensive. When outside investors finance firms, they face a risk, and sometimes near certainty, that the returns on their investments will never materialize because the controlling shareholders or managers expropriate them. (We refer to both managers and controlling shareholders as “the insiders”.) Corporate governance is, to a large extent, a set of mechanisms through which outside Investor Protection themselves against expropriation by the insiders.
As Investor Protection improves, the insiders must engage in more distorted and wasteful diversion practices such as setting up intermediary companies into which they channel profits. After a point, it may be better just to pay dividends. As the diversion technology becomes less efficient, the insiders expropriate less, and their private benefits of control diminish. Firms then obtain outside finance on better terms. By shaping the expropriation technology, the law also shapes the opportunities for external finance. One way to think about legal protection of outside investors is that it makes the expropriation technology less efficient.
The Investor Protection Act is a component of the Wall Street Reform and Consumer Protection Act of 2009 designed to expand the powers of the Securities and Exchange Commission Pakistan (SECP). The act established a whistle blower reward for reporting financial fraud, increased liability for aiding and abetting and doubled funding to the SECP over a five-year period. The act was part of regulators’ attempt to prevent some of the problems that caused the financial crisis of 2008–2009 from reoccurring in the future. The Wall Street Reform and Consumer Protection Act of 2009 was created to improve accountability and transparency in the financial system.
The Investor Protection Act increased safeguards and rights for whistle blowers. This included granting the SEC the authority to recommend granting whistle blowers monetary rewards of up to 30% of sanctions that exceed $1 million. The law also established the SECP Investor Protection Fund, which pays awards to whistle blowers. The fund also supports investor education initiatives. Further whistle blower protections offered through the act include prohibitions on employers from demoting, suspending, firing, threatening or otherwise discriminating against employees or agents who provide information to the SECP or assist in investigations.
The legal approach to corporate governance has emerged as a fruitful way to think about a number of questions in finance. In Section 2, we discuss the differences in legal Investor Protection among countries and the possible judicial, political, and historical origins of these differences. In Section 4, we compare the legal approach to corporate governance to the more standard focus on the relative importance of banks and stock markets as ways to explain country differences. In Section 5, we discuss both the difficulties and the opportunities for corporate governance reform. Section 6 concludes. When investors finance firms, they typically obtain certain rights or powers that are generally protected through the enforcement of regulations and laws.
The changes to SECP include an increase to the minimum assessment paid by Securities Investor Protection Corporation members from a flat $150 per year to 0.02% percent of the member’s gross revenues from the securities business. The borrowing limit on U.S. Treasury loans was also increased from $1 billion to $2.5 billion. Put your trading skills to the test with our FREE Stock Simulator. It’s the ideal platform to get your feet wet in the markets! Submit trades in a virtual environment with $100,000 in cash before you start risking your own money. An amendment to Sarbanes-Oxley added brokers and dealers to the Public Company Accounting Oversight Board’s sphere of oversight.
To explain Investor Protection, it is not enough to focus on judicial power; a political and historical analysis of judicial objectives is required. From this perspective, important political and historical differences between mother countries shape their laws. This is not to say that laws never change (in Section 5 we focus specifically on legal reform) but rather to suggest that history has persistent effects. The judicial perspective on the differences is fascinating and possibly correct, but it is incomplete. It requires a further assumption that the judges have an inclination to protect the outside investors rather than the insiders.
When Investor Protection is poor, dissipating control among several large investors — none of whom can control the decisions of the firm without agreeing with the others — may serve as a commitment to limit expropriation. When there is no single controlling shareholder, and the agreement of several large investors (the board) is needed for major corporate actions, these investors might together hold enough cash flow rights to choose to limit expropriation of the remaining shareholders and pay the profits out as efficient dividends. An entrepreneur has a number of ways to retain control of a firm. He can sell shares with limited voting rights to the outsiders and still retain control by holding on to the shares with superior voting rights.