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Protecting investors.


Investing in Costa Rica can be a risky business. Diego, a Costa Rican entrepreneur, is well aware of that: "Why would I buy shares in a company if I know its management can approve large transactions between interested parties without ever disclosing them to its shareholders?" In Costa Rica, as in many other countries around the world, minority investors are not protected against self-dealing--the use by[degrees] company insiders of corporate assets for personal gain.

Companies grow by raising capital--either through a bank loan or by attracting equity investors. Selling shares allows companies to expand without the need to provide collateral and repay bank loans. But investors worry about getting their money back--and look for laws that protect them. A recent study finds that the presence of legal and regulatory protections for investors explains up to 73% of the decision to invest. In contrast, company characteristics explain only between 4% and 22%. (1) Thus both governments and businesses have an interest in reforms strengthening investor protections.

Without investor protections, equity markets fail to develop and banks be come the only source of finance. The result: businesses fail to reach efficient size for lack of financing, and economic growth is held back. Research in 22 emerging market economies shows that where investors have little recourse The right of an individual who is holding a Commercial Paper, such as a check or promissory note, to receive payment on it from anyone who has signed it if the individual who originally made it is unable, or refuses, to tender payment.  against actions that damage the company, they invest in a few companies in which they take majority stakes. (2) In contrast, good protections for minority shareholders are associated with larger and more active stock markets.

Vibrant stock markets are not the only reason to introduce stronger investor protections. Tanzania started reforms of investor protections as part of a larger initiative to reduce corruption and create an environment that inspires the trust needed to do business. (3) Such an environment strengthens investor confidence in local businesses and government alike.

Economies that rank high on the strength of investor protection index have extensive disclosure requirements and give shareholders broad access to information both before and during trials to determine director liability. New Zealand New Zealand (zē`lənd), island country (2005 est. pop. 4,035,000), 104,454 sq mi (270,534 sq km), in the S Pacific Ocean, over 1,000 mi (1,600 km) SE of Australia. The capital is Wellington; the largest city and leading port is Auckland.  and Singapore, which top the rankings on the index with 29 and 28 of 30 possible points, both require immediate enclosure enclosure (inclosure) n. land bounded by a fence, wall, hedge, ditch or other physical evidence of boundary. Unfortunately, too often these creations are not included among the actual legally-described boundaries and cause legal problems.

 of a related-party transaction Related-Party Transaction

A business deal or arrangement between two parties who are joined by a special relationship prior to the deal. For example, a business transaction between a major shareholder and the corporation, such as a contract for the shareholder's company to perform
 and of the conflict of interest (table 7.1). They require prior approval of the transaction by the other shareholders. They enable the shareholders to hold the directors liable and to have the transaction voided void·ed  
adj. Heraldry
Having the central area cut out or left vacant, leaving an outline or narrow border: a voided lozenge. 
 if it damages the company. And in New Zealand shareholders can inspect all internal documents before deciding whether to sue.

Vietnam shows the benefits of reforms to strengthen investor protections. In 2005, before Vietnam adopted clear legislation, its unregulated Adj. 1. unregulated - not regulated; not subject to rule or discipline; "unregulated off-shore fishing"
regulated - controlled or governed according to rule or principle or law; "well regulated industries"; "houses with regulated temperature"

 stock market saw 60-100 daily trades with a value of $10,000-16,000. That was 3-6 times the trading volume Trading volume

The number of shares transacted every day. As there is a seller for every buyer, one can think of the trading volume as half of the number of shares transacted. That is, if A sells 100 shares to B, the volume is 100 shares.
 of the regulated Ho Chi Minh Ho Chi Minh (hô chē mĭn), 1890–1969, Vietnamese nationalist leader, president of North Vietnam (1954–69), and one of the most influential political leaders of the 20th cent. His given name was Nguyen That Thanh.  Stock Exchange. (4) After reform of the Law on Securities and the Law on Enterprises, the number of listed firms climbed from 41 in 2005 to 193 today--and 107 of these are listed on the Ho Chi Minh Stock Exchange. Despite the recent difficulties in the Vietnamese securities markets, market capitalization Market Capitalization

A measure of a public company's size. Market capitalization is the total dollar value of all outstanding shares. It's calculated by multiplying the number of shares times the current market price. This term is often referred to as market cap.
 increased from less than $1 billion in 2005 to more than $13 billion today.

Across regions, Latin America Latin America, the Spanish-speaking, Portuguese-speaking, and French-speaking countries (except Canada) of North America, South America, Central America, and the West Indies.  regulates related-party transactions the least, imposing the weakest requirements for disclosure and approval. Many Latin American economies have commercial laws that have not been reformed since the 1920s. Economies in Eastern Europe Eastern Europe

The countries of eastern Europe, especially those that were allied with the USSR in the Warsaw Pact, which was established in 1955 and dissolved in 1991.
 and Central Asia have stronger requirements for disclosure and approval. But once a transaction is approved and disclosed, the company directors are not liable for any damage resulting from it.

Economies in the Middle East and North Africa, such as Djibouti and Oman, limit access to information. That makes it difficult for minority shareholders to obtain the evidence needed to prove their case in court.


Twelve economies strengthened investor protections in 2007/08 (table 7.2). Albania was the top reformer. It adopted the Law on Entrepreneurs and Commercial Companies, which regulates conflicts of interest by requiring shareholder approval of related-party transactions involving more than 5% of company assets. The law also provides for extensive disclosure requirements and makes it easier for minority investors to sue directors. And minority shareholders can now request compensation from directors for harm resulting from a related-party transaction, including repayment of all profits from the transaction. With the new law, Albanian company directors have strong incentives to be responsive to investor interests.

The runner-up reformer was Thailand. After being the top reformer in protecting investors 3 years ago, Thailand made new efforts to strengthen minority shareholder rights, particularly in the area of director liability. Directors damaging the company's interests can no longer rely on having obtained shareholder approval of a transaction to avoid liability. If they are held liable, sanctions Sanctions is the plural of sanction. Depending on context, a sanction can be either a punishment or a permission. The word is a contronym.

Sanctions involving countries:
 will be harsh. They will have to compensate the company for all damages, pay back all profits made from the transaction and pay fines to the state. They even risk jail time.

Central Asian economies also strengthened minority shareholder rights. Tajikistan, Azerbaijan and the Kyrgyz Republic brought their company laws into line with modern regulations and corporate governance Corporate Governance

The relationship between all the stakeholders in a company. This includes the shareholders, directors, and management of a company, as defined by the corporate charter, bylaws, formal policy, and rule of law.

Tajikistan adopted a new joint stock companies act. The law defines "interested parties" and requires shareholder approval of transactions between such parties. It also requires interested parties to immediately disclose conflicts of interest to the board of directors. In addition, derivative suits are now possible: shareholders with at least 10% of shares can file a lawsuit on behalf of the company against company directors.

Azerbaijan reformed its civil code, and its State Securities Commission adopted new rules regulating related-party transactions. The new law defines what is meant by "related transactions between interested parties" and requires shareholder approval when such transactions exceed 5% of company assets. However, interested parties are allowed to vote at the shareholders meeting. The law also includes requirements for disclosure both to the market regulator regulator,
n the mechanical part of a gas delivery system that controls gas pressure that allows a manageable flow of drug vapor to escape.


see reducing valve.
 and through the company's annual reports. As in Albania, minority shareholders can now request compensation for damages to the company resulting from related-party transactions.

The Kyrgyz Republic reformed its joint stock companies act. From now on, shareholders can sue in their own name the directors who damaged shareholders' interests and request compensation from them.

Botswana defined related-party transactions and clarified disclosure provisions in its Companies Act of 2004, which came into force in July 2007. Establishing the liability of directors is now easier: shareholders can file suit against them if the transaction proves prejudicial prej·u·di·cial  
1. Detrimental; injurious.

2. Causing or tending to preconceived judgment or convictions:
 to the company. If directors are held liable, they not only have to cover damages but also have to pay back all profits made--a good reason to think twice before attempting to misuse company assets.

The Egyptian Capital Market Authority made improving disclosure requirements a priority when it amended the listing rules of the Cairo Stock Exchange. The amendments are aimed at increasing transparency (1) The quality of being able to see through a material. The terms transparency and translucency are often used synonymously; however, transparent would technically mean "seeing through clear glass," while translucent would mean "seeing through frosted glass." See alpha blending.  both before and after related-party transactions are concluded. Such transactions now have to be assessed by an independent financial adviser before they take place, ensuring that shareholders will be better informed. The amendments also clarify requirements for disclosure through companies' annual reports. In March 2008 Turkey undertook similar reforms. The listing rules of the Istanbul Stock Exchange Istanbul Stock Exchange

The sole securities exchange in Turkey.
 now require an independent body to assess all related-party transactions before they are approved.

Saudi Arabia Saudi Arabia (sä`dē ərā`bēə, sou`–, sô–), officially Kingdom of Saudi Arabia, kingdom (2005 est. pop.  amended provisions of its company law. Interested directors may no longer vote at a shareholders meeting to approve related-party transactions. And just as in Albania, Botswana and Thailand, directors found liable for damage to a company due to a related-party transaction will have to repay all profits made from it.

Greece adopted a new company law that lowers the threshold for derivative suits. Now shareholders need to have only 10% of the company's shares, down from 33% before. Slovenia changed its laws to allow minority investors with at least 10% of shares to bring derivative suits before the court.

Tunisia adopted a law giving shareholders the right to directly access internal company documents and to ask for the appointment of an independent inspector. That will make it easier to gather evidence to support a court claim. The new law also gives 10% shareholders the right to request a judge to rescind To declare a contract void—of no legal force or binding effect—from its inception and thereby restore the parties to the positions they would have occupied had no contract ever been made.

rescind v.
 prejudicial related-party transactions.

Reforms of corporate governance and, in particular, of company laws took place worldwide--from Syria to Sri Lanka Sri Lanka (srē läng`kə) [Sinhalese,=resplendent land], formerly Ceylon, ancient Taprobane, officially Democratic Socialist Republic of Sri Lanka, island republic (2005 est. pop. , from Indonesia to Vietnam. Argentina further strengthened corporate governance principles by introducing a comprehensive set of "comply or explain" rules for listed companies.

Ongoing reforms to implement the European Union Transparency Directives are taking place in several EU member countries, such as Austria and Luxembourg, and in candidate member countries, such as Croatia. Implementing these EU directives often requires amending the company and securities laws. Bulgaria and Romania amended their company laws in the past 2 years, and both countries are now implementing these amendments.


Experience over the past 4 years shows that economies can successfully enhance the protections they provide to minority shareholders. It often takes time, even when the necessary political will exists. But economies like Albania, Azerbaijan and the Kyrgyz Republic demonstrate that it can be done in months, not years.

Sometimes the private sector opposes reforms that are designed to protect minority investors, especially in economies with a high concentration of ownership. One possible reason is that complying with extensive disclosure requirements can represent a financial burden for companies, particularly in developing economies. In Mexico, for example, the most vocal opponent of reform was one of the country's wealthiest businessmen. (5) In Georgia it was one of the largest commercial banks.

Such opposition has not prevented reform: Doing Business has recorded more than 50 reforms to strengthen investor protections in 41 economies over the past 4 years. Eastern Europe and Central Asia and the OECD OECD: see Organization for Economic Cooperation and Development.  high-income economies have had the most reforms, with 12 each (figure 7.3).


In Eastern Europe and Central Asia the main driver of the reforms was accession Coming into possession of a right or office; increase; augmentation; addition.

The right to all that one's own property produces, whether that property be movable or immovable; and the right to that which is united to it by accession, either naturally or artificially.
 to the European Union. Economies such as Poland, Romania and Slovenia updated company and securities laws to EU standards. These reforms focused on developing regulations requiring more transparency in the day-to-day management of companies. The reforms raised the region's average score on the extent of disclosure index from 4.7 in 2005 to 5.8 today.

OECD high-income economies protect minority investors the most. Why would they continually reform? There is a logical reason: sophisticated and active financial markets must respond rapidly to challenges that are constantly evolving, such as fraud. Among the repeat reformers are Hong Kong Hong Kong (hŏng kŏng), Mandarin Xianggang, special administrative region of China, formerly a British crown colony (2005 est. pop. 6,899,000), land area 422 sq mi (1,092 sq km), adjacent to Guangdong prov.  (China) and the United Kingdom--both in the top 10 on the strength of investor protection index. Both economies reformed twice during the past 3 years, by strengthening disclosure requirements and expanding shareholder access to internal corporate documents.

Fewer reforms have taken place in Latin America and the Caribbean, Africa and South Asia This article is about the geopolitical region in Asia. For geophysical treatments, see Indian subcontinent.
South Asia, also known as Southern Asia
. In 2007/08 only one reform was recorded in these regions--in Botswana. But in previous years reforms strengthened investor protections in such economies as Colombia and Mexico in Latin America and Mozambique and Tanzania in Africa.


Across regions, the most popular reform feature has been to require greater disclosure of related-party transactions (figure 7.4). The results of a 2002 global survey on corporate governance provide one explanation: around 90% of the investors surveyed want more transparency in the day-to-day management of companies. (6) What do they mean by more transparency? Unified accounting standards, immediate disclosure of major transactions and more involvement of minority investors in major decisions and transactions.

Requirements for greater disclosure, while popular, are unlikely to succeed everywhere. Extensive disclosure standards require the necessary infrastructure to communicate the information effectively and, more importantly, people such as lawyers and accountants to comply with the standards. Many poor countries lack both. They may have stock exchanges--but no website to post the information on. And they may have certified See certification.  accountants--but in such small numbers that complying; with disclosure requirements is virtually impossible. Take Vietnam. Its securities law has significant disclosure and reporting requirements, but the country still lacks the systems to store and monitor the information electronically. (7)


Crisis can be an important engine of reform. The East Asian financial crisis and corporate scandals such as those involving Enron, Parmalat and WorldCom triggered regulatory reforms around the world. These crises exposed weaknesses in markets previously considered models of sound regulation. Countries affected by the crises reformed their laws. So did other countries, using the experiences to avoid the same mistakes. Mexico, for example, used the U.S. experience to create impetus Impetus is a stimulus or impulse, a moving force that sparks momentum.

Impetus may also refer to:
  • Theory of impetus, an obsolete scientific theory on projectile motion, superseded by the modern theory of inertia
 for its regulatory reforms.

Countries that want to reform can choose to amend existing regulations or start from scratch to start (again) from the very beginning; also, to start without resources.
- Thackeray.

See also: Scratch
, depending on how up-to-date their current legislation is. In 2007 Georgia amended its securities legislation by adding provisions regulating disclosure and approval of transactions between interested parties. Belarus, Colombia and Thailand did the same. Other countries, such as Mozambique and Slovenia, started from scratch. Adopting an entirely new law offers an opportunity to reform other areas--such as business registration, directors' duties, disclosure rules and issuance of shares.


Reformers often find inspiration in economies with a similar legal origin or in their main commercial partners. Mexico's securities law reform took into account aspects of a U.S. law--the Public Company Accounting Reform and Investor Protection Act of 2002, commonly known as the Sarbanes-Oxley Act See SOX. . Botswana and Mozambique followed the South African model. As a reformer from Mozambique explains, "Our previous code was inherited inherited

received by inheritance.

inherited achondroplastic dwarfism
see achondroplastic dwarfism.

inherited combined immunodeficiency
see combined immune deficiency syndrome (disease).
 from Portugal. Today our main commercial partner is South Africa South Africa, Afrikaans Suid-Afrika, officially Republic of South Africa, republic (2005 est. pop. 44,344,000), 471,442 sq mi (1,221,037 sq km), S Africa. , and we are surrounded by countries that have the same model. We prefer to adopt legislation that would enable us to attract more investment from South Africa and make life easier for our main investors."

Even the best regulations will make little difference if the court system is weak. Bangladesh and Montenegro have laws setting out strong disclosure requirements and extensive obligations for directors. But with the most basic commercial disputes taking more than 1,000 days to resolve in Bangladesh and more than 500 in Montenegro, these laws may not have the desired effect.


(1.) Doidge, Karolyi and Stulz (2007).

(2.) Dahya, Dimitrov and McConnell (2008).

(3.) Sitta(2005).

(4.) World Bank (2006c).

(5.) See Johns and Lobet (2007).

(6.) McKinsey & Company(2002, p. 8).

(7.) Lobet (2008).

Where are investors protected--and where not?

Most protected         RANK   Least protected        RANK

New Zealand             1     Micronesia             172
Singapore               2     Palau                  173
Hong Kong, China        3     Rwanda                 174
Malaysia                4     Venezuela              175
Canada                  5     Vietnam                176
Ireland                 6     Djibouti               177
Israel                  7     Suriname               178
United States           8     Swaziland              179
South Africa            9     Lao PDR                180
United Kingdom          10    Afghanistan            181

Note: Rankings are based on the strength of investor protection
index. See Data notes for details.

Source: Doing Business database.


Greater disclosure--the most popular reform feature in 2007/08

Increased disclosure requirements   Albania, Azerbaijan, Egypt,
                                    Saudi Arabia, Tajikistan

Made it easier to sue directors     Albania, Botswana, Kyrgyz
                                    Republic, Thailand

Allowed derivative or direct        Greece, Kyrgyz Republic, Slovenia

Regulated approval of               Albania, Azerbaijan, Tajikistan
related-party transactions

Passed a new company law            Albania, Botswana, Tajikistan

Required an external body to        Egypt, Turkey
review related-party
transactions before they take

Allowed rescission of               Tunisia
prejudicial related-party

Source: Doing Business database.


Where are investor protections strong-and where not?

Extent of disclosure index (0-10)

Most                           Least

Bulgaria                10     Ukraine                 1
China                   10     Afghanistan             0
France                  10     Lao PDR                 0
Hong Kong, China        10     Maldives                0
Ireland                 10     Micronesia              0
Malaysia                10     Palau                   0
New Zealand             10     Sudan                   0
Singapore               10     Swaziland               0
Thailand                10     Switzerland             0
United Kingdom          10     Tunisia                 0

Extent of director liability index (0-10)

Most                           Least

Albania                 9      Tajikistan              1
Cambodia                9      Togo                    1
Canada                  9      Zimbabwe                1
Israel                  9      Afghanistan             0
Malaysia                9      Dominican Republic      0
New Zealand             9      Marshall Islands        0
Singapore               9      Micronesia              0
Slovenia                9      Palau                   0
Trinidad and Tobago     9      Suriname                0
United States           9      Vietnam                 0

Ease of shareholder suits index (0-10)

Easiest                        Most difficult

Kenya                   10     Lao PDR                 2
New Zealand             10     Syria                   2
Colombia                9      United Arab Emirates    2
Hong Kong, China        9      Venezuela               2
Ireland                 9      Yemen                   2
Israel                  9      Guinea                  1
Mauritius               9      Morocco                 1
Poland                  9      Rwanda                  1
Singapore               9      Djibouti                0
United States           9      Iran                    0

Source: Doing Business database.


Ranking on protecting investors
are based on 3 subindicators

Liability of CEO and board of directors    33.3% Extent of directory
in related-party transactions              liability index

Type of evidence that can be collected     33.3% Ease of shareholder
before and during the trial                suits index

Requirements on approval and disclosure    33.3% Extent of disclosure
of related-party transactions              index

Note: See Data notes for details

Note: Table made from pie chart.


Top 4 reform features
in protecting investors

Reforms including feature since DB2006 (%)

Increased disclosure requirements         47%

Defined duties for directions             33%

Regulated approval of related-party       22%

Allowed shareholder access to corporate   13%

Note: A reform may include several reform features.

Source: Doing Business database.

Note: Table made from bar graph.
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Publication:Doing Business 2009
Date:Jan 1, 2009
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