Risk & Governance Weekly

Brazilian Firms Opt for Better Governance

By Lucas Medeiros, Research Analyst for Brazil

Foreign investment and increasing global visibility is driving corporate governance change among Brazilian companies this year.

In 2007, Brazilian issuers raised BRL 49.4 billion ($29 billion) in capital from foreign investments.  That year, out-of-country investors subscribed to 75.4 percent of all of the capital raised via public offering in the Sao Paulo Stock Exchange (BVSP), up from 66 percent in 2006.  Overall, BVSP figures show that foreign investors account for more than 30 percent of all exchange transactions.

As the interest of foreign investors in Brazil has grown, so has the focus of Brazilian issuers on corporate governance matters. Most new issuers in Brazil now choose to be listed in segments of the BVSP that require higher governance standards, including Bovespa, the holding company for the BVSP exchange.

In 2007, 42 companies that held initial public offerings elected to list on the BVSP’s Novo Mercado (or “new market”) listing segment, bringing the number of companies on that listing level up to almost 100. The Novo Mercado is the market segment with the highest governance standards within the BVSP. In order to list on the Novo Mercado, companies must agree to standards that go above and beyond the normal listing rules, including that the company have a single class of shares, and that the board of directors be at least 20 percent independent. These are significant departures from a system in which corporate boards have traditionally been dominated by the controlling shareholder and where non-voting shares are commonly used to allow companies to raise capital while maintaining the voting power of the controlling shareholder.

An additional 14 companies went public in either the Level 1 or Level 2 corporate governance segments of the BVSP in 2007. With 44 and 20 listed firms respectively, the two levels both demand stricter governance standards than those required from issuers in the main market segment of BVSP. In all, 75 percent of all companies going public in Brazil last year opted to comply with higher governance standards.

Another emerging trend in Brazilian corporate governance is the popularity of stock option plans, as companies try to more closely align executive compensation and shareholder returns. Few Brazilian companies, however, adopt performance criteria for the vesting of options, and many other firms offer options at a discount relative to the stock price on the day of issuance, diminishing the incentive value of such plans. Lojas Renner, CSU Cardsystem, Redecard, and TOTVS are among the few Brazilian companies that offer performance-based stock option plans.

While the popularity of differentiated corporate governance segments of the BVSP, as well as other initiatives like performance-based compensation, show that the Brazilian market is moving toward higher governance standards, corporate governance in Brazil is not at the same level as it is in “developed markets” like the United Kingdom or United States. While many new companies list in the new segments, few of the Brazilian blue chip companies have applied to the Novo Mercado. Moreover, despite improvements in corporate transparency, the level of disclosure in Brazil still lags behind international best practices.

For example, the process of director elections in Brazil is still very opaque. With very few exceptions, Brazilian issuers fail to disclose the names of board nominees before to the shareholders’ meeting.

Pushing for Improved Disclosure

An institution that has been advocating for additional disclosure is PREVI (Caixa de Previdência dos Funcionários do Banco do Brasil), Brazil’s largest pension fund. In a recent study, PREVI found that only 11 out of 150 Brazilian companies surveyed published detailed information on the matters to be discussed prior to annual meetings.  Out of the 11 companies that PREVI identified as having adequate levels of disclosure, only three of them—retailer Lojas Renner, aircraft manufacturer Embraer, and power company Energias do Brasil—have published information on board nominees prior to their annual meetings in the past.

The Brazilian Securities Commission (Commisão de Valores Mobiliários or CVM) is also pushing for governance improvements. According to Brazilian press reports, the CVM is considering revising Instruction 202, one of its regulations, to require public companies to produce something that more closely resembles a “proxy statement”, instead of simply publishing a meeting notice that is typically no more than a page long. 

Additionally, the CVM is contemplating the standardization of disclosure on executive and director compensation, according to press reports. Currently, most companies disclose the combined remuneration for all directors, both executives and non-executives together. There are many inconsistencies in how each issuer reports its remuneration figures. Some companies report a yearly figure while some others report a monthly figure. More importantly, some companies include the amount allotted to performance bonuses, while other firms do not. Any CVM regulation on this issue will likely be effective for the 2009 proxy season, beginning in March of next year.

Brazilian companies will also be subject to different financial disclosure standards this year. In late 2007, the Brazilian Corporations Law (Lei 6404/76) was amended to begin the process of aligning the country’s accounting practices with International Financial Reporting Standards (IFRS). IFRS is used by most developed markets, and the U.S. Securities and Exchange Commission is considering allowing American companies to use the standard as well. Brazilian companies are expected to fully adopt IFRS by 2010.

Finally, according to a report published following the 11th annual meeting of the Latin American Corporate Governance Roundtable in Medellín, Colombia, in October, the Brazilian Corporate Governance Institute (IBCG) is planning a possible reissue of its Code of Best Practice of Corporate Governance. Adopted in 1999 and last revised in 2004, the code has had great influence over the listing rules of Novo Mercado and the Level 2 listing segments of BVSP, the roundtable report suggested.

Increased Proxy Voting on the Horizon

While Brazilian investors have historically been apathetic to proxy voting, that may be changing.  Large pension funds like PREVI have implemented proxy voting policies since 2002.  Investment funds are also required by the CVM to have a proxy voting policy, but most funds simply adopt an explicit policy of not voting at shareholders’ meetings.

This could change, though, if investment funds comply with a recent recommendation of the Brazilian Association of Investment Banks (ANBID). ANBID recommends that all investment funds actively participate in shareholders’ meetings.  It is too early to say how many funds will adopt this recommendation. Few companies now report on proxy voting levels, as well, so it is difficult to tell whether the number of proxies voted in Brazil has risen so far this year.