Creating

40 DOING BUSINESS IN 2006
action voided if its terms are unfair. And they permit
shareholders who take the company directors to court to
access all relevant documents.
Several developing countries protect investors well.
Mauritius and South Africa are among the top 10 on
the strength of investor protections, and Pakistan is not
far behind. But on average poor countries regulate selfdealing
less than rich countries, especially in requiring
disclosure. Albania, Guatemala, Tunisia and 7 other
countries require no public disclosure on “related-party”
transactions like the one involving Mr. James. They also
permit the top manager to approve the transaction rather
than requiring that the “disinterested shareholders”
—those who do not stand to gain personally—approve
the deal.
Some poor countries try to compensate for the lack
of shareholder access to information and the courts by
relying on government inspectors (figure 7.1). “Shareholders
find this cheaper, more efficient and more effective
than bringing the suit themselves, both because
they don’t have to pay for it and because inspectors
can require more information from the defendant,” a
Tunisian lawyer explained. This is a second-best choice
when private action is unlikely to bring results. But government
regulators may have different incentives than
the minority investors—for example, in deciding which
cases to investigate.
The payoff from protecting investors is large. Where
expropriation of minority investors is curbed, equity
investment is higher and ownership concentration
lower. 4 Investors gain portfolio diversification. Entrepreneurs
gain access to cash. Without investor protections,
equity markets fail to develop and banks become
the only source of finance. Yet weak collateral or property
registration systems block many businesses in poor
countries from obtaining even bank loans. The result:
businesses do not reach efficient size for lack of financing,
and economic growth is held back.
Who is reforming?
Fifteen economies reformed investor protections in 2004
(table 7.2). Thailand was the top reformer. It now requires
that in listed companies, directors and shareholders
without personal interest in the deal must approve
any related-party transaction. Such transactions are defined
broadly—for example, by including family members
and other entities controlled by a director—cutting
off many loopholes.
Spain introduced directors’ duty of loyalty into its
corporate law for public firms. Directors must now put
the best interests of the company above any personal
gains they might receive through the company’s operations.
Spain also requires a semiannual “corporate
governance report.” Listed companies must report any
related-party transactions and document their compliance
with the new corporate governance guidelines.
Turkey now requires companies to post an “investor
relations” page on their website. The page must reveal
directors’ ownership and information on privileged
shares as well as board minutes and transactions made
by directors. Vietnam asked managers and directors to
publish their ownership stakes in the company for the
first time, including the ownership interests of spouses
and children.
Jamaica defined standards of care for directors in
its new Companies Act. For example, directors with
accounting training will have to review the company’s
financial statements with the eye of an accountant, not
merely “with the judgment and care of a reasonable
person,” as before.
Pakistan introduced tough penalties for violating
self-dealing regulations. In July 2004 the National Accountability
Ordinance mandated criminal liability for
managers and directors who “fraudulently misappropriate
any property entrusted” to them. Conviction comes
with unlimited fines and up to 14 years in jail. But experience
in other countries—including those with the toughest
liability for directors (table 7.3)—suggests that judges
are seldom willing to put businesspeople behind bars.