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Internal Corporate Governance A health check on global best practices

Pavan Gandhok Deputy MD – South and South-East Asia Jakarta: 5 March 2002

80 Raffles Place #28-02 UOB Plaza 1 Singapore 048624 Copyright © 2002. All rights reserved. No part of this presentation may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system without the express written consent of Stern Stewart & Co. EVA® is a registered trademark of Stern Stewart & Co.

Size versus Value Added

• Nearly a third of Pan-Asia’s 20 largest companies by capital are amongst the 20 biggest wealth destroyers • Nearly half the top 20 Pan-Asian banks ranked on Total Assets, are amongst the 20 biggest wealth destroyers in the financial services sector

The case for improving Corporate Governance in Pan-Asia Positive MVA Companies

Negative MVA Companies

MVA/Cap %Capital MVA/Cap %Capital USA Europe

1.65 1.54

87% 82%

(0.18) (0.18)

13% 18%

Pan-Asia

0. 81

56%

(0.30)

44%

Source: Stern Stewart research

The Bad News : An incremental $139b has been invested in the wealth destroying sectors over the past five years Incremental Capital Investment (1996-2000)

Wealth destroyers 53% US$139b

Source: Stern Stewart research

Wealth creators 47% US$124

The system of internal corporate governance defines a company's "constitution" • Governance should precede governing, just as a constitution must precede legislation … • The challenge for managers is to implement an organisational strategy that makes their company more effective in meeting the demands of financial, labour and product markets • The potential for value creation from implementing effective internal governance and control is large … • … but what changes in organisational strategy result in sustainable value creation?

Study Sponsors

– The world’s most comprehensive ongoing best practice studies in knowledge worker functions – More than 1,600 global participants, including 80% of the Dow Jones Industrials, 2/3 of the Fortune 100, and 60% of the Dow Jones Global Titans Index – Part of Answerthink, a provider of technology-enabled business transformation solutions

–

International corporate finance and governance advisory firm • Performance measurement • Management decision-making • Incentive compensation • Financial and business training • Financial policy – Clients served from our offices in 10 countries – Developer of the EVA® management framework – Publisher of the Journal of Applied Corporate Finance

Participants span a representative range of companies around the world $500 MM - $1 B

3

Finance

Utilities/ Telecom Oil / Gas

Ownership

Asia

One and several minor

Primarily Communicate financials

Basic Strategy

Latin America

North America

Geography

Africa

Private

Number of countries

2-5

1

6 - 10

11 - 40

> 40

< 1,000

Employees

> 50,000

1,000 - 5,000

5,000 - 9,999

10,000 - 49,999

State owned

0%

20%

40%

60%

80%

100%

0%

20%

40%

60%

80%

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

100%

Value aligned companies significantly outperform non aligned ones over time 5 years ending 31 Dec 2001

20%

16%

15% 10% 5% 0% -5%

-4% Average annual excess return vs. peers

Value aligned

Non aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Our survey uncovered a consistent pattern of best practices for value-aligned companies •

Leadership

•

Culture and organization

•

Decision-making

•

Management reporting

•

Incentives

– Board focuses on long-term shareowner value and viability – Management makes value-adding decisions – Middle managers have high degree of business and economic literacy – Leaders communicate success consistently

– Focus on a few key value-aligned metrics, seamlessly integrated across all processes – Projects are funded solely on the basis of value – A consistent focus on value metrics – Earnings & asset information is tracked at many levels, and is widely shared – Bonus pool is uncapped – Bonuses based on a few value aligned metrics

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

The best SAI score is 85 out of 100, the average score is 66, and the worst score is 35 Shareowner Alignment Index score Highest Highest85 85 Average Average66 66

85 72 66 62

Quartile 1 Quartile 2 Quartile 3

Quartile 4

Lowest Lowest35 35

35

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

The litmus test for the state of your internal corporate governance processes

• Do your business leaders consistently celebrate your firm's business successes? • Do your people focus on improving a few overarching value metrics? • Are your bonus plans uncapped?

Celebrate success

Leaders of value-aligned companies consistently communicate and celebrate business success 80%

67%

60% 40%

29%

20% 0% Leaders communicate and celebrate successes consistently

Value-aligned

Non-Aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Value aligned companies have a clear definition of success – unambiguous goals, value-centric metrics 50%

9%

Focus on value based metrics Value-aligned

Non-aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Value aligned companies track revenues, expenses, and assets at many levels – better able to measure progress Percent tracking revenues, expenses, assets

80%

73%

70% 60%

Value aligned 49%

47%

50%

33%

34%

40%

Unaligned

27%

30%

25%

20% 13%

20%

9%

10% 0%

Major divisions

Revenues are tracked, Expenses are tracked, Assets are tracked

Geography Revenues are tracked, Expenses are tracked

Product lines Revenues are tracked, Expenses are tracked

Individual products

As low as possible

Revenues are tracked, Expenses are tracked

Expenses are tracked

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Value- aligned companies share data widely, empowering people at all levels to make better decisions How freely are the financial and operational results of the company shared internally? 60%

Freely shared at all levels (in summary or detail)

26%

0%

10%

20%

Unaligned

30%

40%

50%

60%

Value aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Value aligned middle managers are more economically literate and business savvy Middle managers 53% Take an economic view of short and long term operating/financial results

18%

33% Understand business model, value proposition, and key strategy elements

0%

11%

10%

20%

Unaligned

30%

40%

50%

60%

Value aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Value-aligned companies are more inclined to innovate, take intelligent risks, grow from within, and view business failures as a form of learning

93%

Value-aligned Non-aligned

100% 80%

60% 47%

60% 40%

18%

20% 0% We highly encourage internal new business creation

Failure is viewed as a form of learning

Concentrate on a few metrics

Value-aligned companies fund projects more strictly on value considerations alone

80%

72%

60% 40% 18%

20% 0%

All projects are funded on value

Value-aligned

Non-Aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Incentive Compensation

Value-aligned companies offer the unlimited upside potential of an owner by not capping bonuses 73%

29%

Do not cap bonus

Value-aligned

Non-aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Aligned firms also make managers accountable through a simple focus on one or two key value metrics for determining bonuses, but most firms use three or more Number of measures to drive compensation

Percent of companies using one or two measures to drive compensation 49%

Senior corporate managers

79% 45%

Senior business unit managers

79% 47%

Middle managers / front line managers

64% 50%

Non management-sales force

83% 61%

Non management-all other

91%

0%

20% 1

2

40% 3 to 4

60% 5 or more

80%

100% Value-aligned

Non-aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

Value aligned companies break the link to budget by setting performance targets by formula, not plan numbers Percent using annual or strategic plans to set targets 20%

Senior corporate managers

20%

Senior business unit managers

56%

13%

Non management--sales force

0%

58%

13%

Middle managers / front line managers

Non management--all other

51%

7%

49% 31%

20%

Unaligned

40%

60%

80%

Value aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

100%

Value-aligned companies foster an ownership culture by ensuring annual results are sustainable before bonuses are paid … Is any part of the annual cash bonus dependent on cumulative performance over a period of years?

45% 55%

Value Valuealigned aligned 73% 73%yes yes Non Nonaligned aligned 49% 49%yes yes

Yes

No

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.

… and by giving employees tools to simulate long range payoffs from current decisions Percent able to simulate short and long term payouts Senior corporate managers

18%

Senior business unit managers Middle managers / front line managers Non management--sales force Non management--all other

0%

47%

9%

27%

4% 20%

2% 5%

47%

18% 20%

10% 15% 20% 25% 30% 35% 40% 45% 50%

Unaligned

Value aligned

Source: SAI Study conducted by Stern Stewart &Co in association with Hackett Benchmarking and Research, a Division of Answerthink.