Globalization and the changing role of finance have transformed capitalism.
The global financial capitalism brings a new landscape to the business world. It
provides a fertile area for public-listed companies to consider the expansion of the
fund raising activities from the domestic capital market to the international capital
market. It has increased both the opportunities and threats of running international
business in a global economy. Since the collapse of Lehman Brothers in the global
financial crisis of 2008-2009, the debt investors become more cautious and careful.
External financing in the international capital market is competitive and more exposed
to a political-economic environment. It is argued that this global financial crisis was
largely caused by opportunistic behavior of directors tolerated by poor regulation,
weak corporate governance, and inadequate risk management. As one of the debt
capital suppliers, the interests of corporate bondholders are deserved much attention
from the regulators, legislators, company directors and professionals.
In corporate finance, debt capital in form of corporate bond is a part of the
capital structure of a company. Corporate bond is a very traditional debt security in
the business world. Most corporate bonds issues are often unsecured. The
characteristics of a debt security are negotiable, transferable, and marketable.
Corporate bondholders are given a contractual relationship to a public-listed company.
In the pre-contractual stage, the investment decision of a debt investor is made on the
basis of material information available in the prospectus and annual financial
statements of a company issuer as well as the financial commentaries by financial
analysts. Debt investor subsequently becomes a corporate bondholder of a public-listed company after the bond subscription in the post-contractual stage. As
the result, a corporate bondholder becomes one of the unsecured creditors of a
public-listed company after the bond subscription.
Debt investors make the informed decisions on the debt investment based of
the doctrine of caveat emptor ("Let's the Buyer Beware"). Material information is
treasured to the corporate bondholders. Debt investors are expecting the provision
of the reliable and representative information from the investee company for the
long-term investment in the international capital market. Not every debt investors
could derive and evaluate the necessary company information from annual financial
statements in order to make informed decisions. On the other hand, financial expert
advices including financial analysts or even financial press is taken close observation
on providing unbiased information for each debt investors. This unbiased
information for debt investors is supposed to free from material conflicts of interest
that might compromise the integrity of their analysis or advice.
A public-listed company is engaged at the very heart of the fund raising
activities in the international capital market. Acting as an agent of a company issuer,
an investment bank takes a leading role to issue, market, and distribute the bond.
The bond issuance must be offered at the right time in the right place. However, the
standard terms and conditions of the corporate bond indenture are drafted by these
international financial intermediaries. Numerous corporate bondholders have not
taken part in the negotiation process of contract drafting. The freedom of contract
prevails. A unilateral financial covenant is drafted by this financial agent from a
financial institution for binding two parties between a company issuer and corporate
bondholders worldwide. Serving as an administrator and custodian, an English trustee or a German bondholder's representative is appointed by a company issuer to
take care of the bond issue for numerous corporate bondholders worldwide.
In the perspective of the debt investors, the motto of "high risk, high return" or
low risk, low return" prevails. In technical sense, corporate bond is classified as the
low-risk investment vehicle. In fact, corporate bond bears not only the credit default
risk but also financial risk and insolvency risk of a company issuer. All corporate
bonds are exposed to credit risk. Any bond investment carries with the uncertainty
whether a company issuer will make timely payment of interest and principal as
prescribed by the bond indenture. Debt financing puts an obligation on a company.
If the company is failed to honor the interest payments or the repayment of principal
sum when due, it constitutes legal default in accordance with the terms and conditions
of the bond indenture. Court proceedings can be introduced to enforce this financial
contract.
However, a "no-action" clause is imposed on a financial covenant.
Corporate bondholders are prevented from taking independent action by a "no-action
clause. The clause states that no corporate bondholder is to be entitled to enforce
unless a trustee fails to do so within a reasonable time. This failure action is
continuing to retain the rights of the corporate bondholders to take sole action being
suspended. Court rules may allow a corporate bondholder to bring a class action and
or a representative action on behalf of himself and all other members of the class.
The essence of the class action by a representative is used for numerous claimants on
common issues. All members of the class are bound by a judgment or
court-approved settlement. The court must certify the class to ensure fairness among
corporate bondholders. Class actions may encourage litigation and floodgates.
Company assets are typically claimable under a hierarchy on insolvency in the
following orders: debt, hybrids and shares. Debt is ranked senior on insolvency.
As the result, corporate bondholders as the unsecured creditors have a prior legal
claim over preferred and original shareholders. This legal priority does not insulate
the corporate bondholders from financial loss where they may not be able to get the
full value of the assets. In fact, corporate bondholders fully rely on a company's
ability to generate sufficient cash flow to pay its obligations when due. For the
protective reason, the growing numbers of the debt investors are looking for
subscribing the listed debt securities over the public stock exchanges in the
international capital market. Self-protection for the corporate bondholders is
deemed necessary.
In response to Anglo-Saxon model of free trade economy, the arm's-length
finance in the UK implies dispersed ownership of debt and equity, and therefore,
promotes liquid markets. Investors in the arm's-length financial systems are flat to
portfolio orientation. The market for corporate control operating over the public
stock exchanges is an important mechanism for correction of managerial failure.
The terms of the bonds are drafted by the investment bankers acting on behalf of the
owners by the instruction of company management. Debt investors are not involved
in the negotiation process of drafting their own contract.
Followed by German model of social market economy, the control-oriented
finance in Germany dominates more concentrated ownership structures in private
entity and develops a less liquid market. Control-oriented financial systems breed
control-oriented investors. The opportunities for diversification are less and the
costs of trading tend to be high. The mechanism for corporate control operates in
form of large block trades outside the public stock exchanges. The terms of the bonds are negotiated between the controlling owners and the debt investors. If the
mechanism of corporate control is altered, it may be unfavourable arrangement in the
eyes of serving management.
With a nation's specific economic conditions, history, heritage and tradition,
the opportunity and challenged are realized by the United Kingdom and Germany to
use a various combination of legal and regulatory instruments as hard law on one
hand, and voluntary codes as soft law on the other hand to implement their
governance models. These English arm's-length finance and German
control-oriented finance place different demands on the general legal environment and
enforcing institutions. Both systems rely on property rights, but the role of courts is
likely to differ. The English arm's-length finance places greater demands on courts
by requiring detailed enforcement of specific rights to assets and cash flows, whereas
German control-oriented finance merely requires the protection of voting rights.
These two forms of financial systems may potentially influence the evolution of the
legal system. They determine the nature of conflicts between a company and its
investors, as well as between shareholders and corporate bondholders.
In the era of global interdependence, the common set of ground rules are
established in the accordance with international standard to facilitate the mutual
understanding in interpreting the principles, and eliminates the unnecessary
transaction costs between the parties in the international business. The English and
German systems have closely observed the internationally recognized standards and
universal norms for enhancing the national systems. The structural regulations are
designed through the established corporate governance framework complemented by
an efficient insolvency framework and effective enforcement of creditor rights.
There are various insolvency methods of handling the financial distressed
companies before and during the liquidation: corporate rehabilitation, informal
corporate workouts, restructuring and formal liquidation. The hierarchy of debt
claims on insolvency for corporate bondholders is prioritized and governed by the
national insolvency statutes. The World Bank Principles and UNCITRAL
Legislative Guide provide a reference guideline for the national legislators to develop
an internationally recognized standard for its own national insolvency statute. There
are national differences on the insolvency proceedings between the United Kingdom
and Germany.
The traditional protective measures for corporate bondholders are used which
are centered on an internal measure through a contractual agreement between a
company issuer and the debt investors. It is supplemented by the external measures
from the assistance of institutional guardian through English trustee or German
bondholder's representative and accompanied by the company evaluation through the
professional gatekeepers from certified accountants and commercial insurers as well.
This traditional mode of protective mechanism is implemented by the combination of
statutory and self-regulations in the private enterprise under these English-typed and
German-typed market economies to provide its basic protection for the corporate
bondholders in the domestic market. The contractual relationship between a
company issuer and the corporate bondholders acts as a focal point of the protective
measures in industrial capitalism. However, improved corporate bondholders'
protection is required especially in financial capitalism. Good board governance and
director professionalism are operating at the heart of the governance instrument in the
era of financial globalization. It directly and indirectly strengthens the position of
corporate bondholders.
In financial capitalism, it goes beyond the importance of financial
intermediation in the modern capitalist economy. It also encompasses the significant
influence of the capital holders on the political process and the goals of economic
policies. In contrast with industrial capitalism, financial capitalism is characterized
by a predominance of the pursuit of profit from the purchase and sale of financial
products. The 21st century predominance of financial capital has led to a preference
for speculation over investment for entrepreneurial growth in the global economy.
The traditional protections of corporate bondholders are required to be reviewed and
further enhanced to suit a new political-economic environment.
Good governance model has an economic and social effect. It enriches the
society governance by allowing corporate bondholders to obtain the material
information and empower them to protect their capital contribution toward a
public-listed company. An effective corporate governance framework requires an
effective legal, statutory and self-regulations, and institutional foundation that all
market participants including company issuers can rely upon when they enter into
different types of contractual relations. The regulatory cost is the extensive concern
for the national regulators.
In view of a new and imperative political-economic environment under
financial capitalism, a multi-layered integrated governance approach is developed for
strengthening the interests of corporate bondholders in the international capital market.
This proposed interlocking and scaffolding check-and-balance mechanisms are further
intensified on the basis of the traditional model of the protective mechanism so as to
provide a wide-ranging preventive and protective measure with earlier warning
signals to a company and its investors. The concept of risk management is
emphasized. New paradigm is shifted to the effective shareholder engagement and the vision of sustainable companies. It avoids a company operating under negative
gearing. The interests of corporate bondholders are in jeopardy in the long run. A
considerable proportion of governance instruments are called for stronger safety
measures.
Good corporate governance is instigated with more enhancing transparency by
the engaged shareholders that make a regulatory framework more user-friendly for
protecting the interests of corporate bondholders. It does not create unnecessary
burdens for companies but strengthen them to increase their competitiveness in order
to promote long term success of companies so as to further enhance the total value of
the companies. It ultimately benefits companies, shareholders, bondholders and an
economy at large in a dynamic changing investment environment in the international
capital market.
Through the multi-layered integrated governance approach, a regulatory
framework of unifying the strategic cooperation is designed among different functions
of players from the board and its company directors. It is assisted by a team of
professional gatekeepers so as to strengthen the protective mechanisms of the
corporate bondholders. The philosophy of this new governance approach is
applicable to all companies regardless their company size. The management
philosophy is the universal applicable particularly in the public-listed companies
which are allowed to go public for fund raising and listed their debt securities on
public stock exchange domestically and internationally. The rationale behind this
governance approach is to adopt an internal corporate monitoring by an effective
board and the competent directors complemented by external monitoring from a team
of responsible professionals and capital market players to safeguard the interests of
corporate bondholders.
The company board should play a central role in an enhanced corporate
governance model in financial capitalism. In a global economy, effective
shareholder engagement with the vision of a sustainable company is one of the
cornerstones of a public-listed company. Its corporate governance model relies on
checks and balance among different organs and different stakeholders. Stewardship
is advocated to be a benchmark of prudential governance with ethical-driven decision
making in dealing with the company affairs.
The quality of company management is the critical success factor of a
company. Acting as the agent of the company itself, directors should maintain the
balance of the interests of shareholders and corporate bondholders when a company
has debt obligations. Where a company is solvent, a company's interests are
represented by the interests of its shareholders. When a company's solvency is in
doubt, there is gradual shift in whose interests represent that of the distressed
company away from the interests of shareholders in favour of the interests of
company's creditors where the corporate bondholders are one of the kinds. In the
vicinity of insolvency, a responsible and competent director must act in a way that he
considers, in good faith, would be mostly to make business viability for the benefit of
the corporate bondholders. The greater risk of insolvency involved, the greater
attention must be given to the interests of corporate bondholders.
Directors should act in the utmost good faith for a company. By improving a
quality of the supervision, good corporate culture and sound mind work well in
developing a high standard company. Acting as the crisis manager, the responsible
directors of a distressed company in approaching insolvent must decide at which point
the interests of corporate bondholders override the interests of shareholders. The
timing of this decision is critical. Directors must be able to identify when there is a risk of insolvency happening. When considering a company's insolvency position,
the cash flow or balance sheet tests can both be employed to determine a financial
position of a company's ability to pay debts when due. In the vicinity of insolvency,
it has not been set a time when a distressed company may be considered technically
insolvent on cash flow or balance sheet basis. During this twilight period, a
distressed company entering into transactions is still exposed to condemn and may
give rise to personal liability on the part of the directors and company wrongdoings.
The interests of corporate bondholders are in jeopardy resulted from the directors'
misconduct.
Essentially, the multi-layered integrated governance approach is advocated for
strengthening the protection of corporate bondholders through different stages of the
procedural protective measures by improving transparency and disclosure in the
financial reporting and insolvency regimes; by more active shareholder engagement at
board level; by reducing insolvency risks through stewardship program; by more
directors' accountability in the vicinity of insolvency; and by the company evaluation
through a team of professionals. Effective creditors' empowerment for corporate
bondholders minimizes reliance on the law and regulation. Prudential corporate
governance and effective shareholder engagement in the age of financial capitalism
goes far beyond the interests of corporate bondholders of a public-listed company. It
is also a public policy concern and economic stability.
Although both English and German insolvency laws take references to
evaluate a company's ability to meet its debt obligation, it is more important to see
that a company issuer has ability to honor its commitment involved in the financial
contracts. If a company fails to observe to certain obligations, in particular to the
interest payments and principal repayment to the corporate bondholders when it dues on time, a company's sustainability is at risk. Liquidation of a company will
adversely affect the interests of corporate bondholders and society at large. The cost
and benefit trade-off are particularly important to the multinational corporations and
international investment in a global economy.
| Date of Award | 15 Jul 2014 |
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| Original language | English |
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| Awarding Institution | - City University of Hong Kong
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| Supervisor | Xiao LI (Supervisor), Kong Shan John HO (Supervisor) & Dit Sang John HO (Supervisor) |
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