Institutional Framework of Corporate Governance in Italy
Major Corporate Scandals
In his study of corporate frauds in 12 countries around the world, Jones (2011: 3) pointed out that frauds are “perennial” and “occur in all eras and in all countries.” Although some characteristics of these corporate scandals seem to be almost universal (Jones 2011), different types of scandals tend to characterize different systems of corporate governance. In particular, dispersed ownership systems of corporate governance (such as the U.S. and the U.K. models) have been found to be prone to forms of earnings management and sophisticated accounting fraud committed by top managers; in contrast, corporate systems with a high level of ownership concentration—which usually characterize Asian and European economies—tend to be much more vulnerable to the appropriation of private benefits of control by controlling shareholders (Coffee 2005).
Italy is not an exception to this rule. In the last 50 years, the Italian Stock Exchange has seen several major scandals that have damaged a large number of small investors. Among them we can cite the financial scandals involving the raider Michele Sindona and its Banca Privata Italiana, the financial distress of Banco Ambrosiano under the management and control of Roberto Calvi, the failure of the chemical group Sir controlled by the Rovelli family, the tentative attempt of the criminal group P2 to take the hidden control of Corriere della Sera, the financial collapse of the Ferruzzi group after the acquisition of Montedison, the financial distress of Banco di Napoli and Banco di Sicilia mainly due to corruption and poor management. In the new millennium, we have seen the unexpected collapse of Cirio, Giacomelli, Parmalat and, more recently, of Mariella Burani and Fondiaria-Sai. In almost all these scandals there is a relevant and influential role of a family, who—wielding its power of controlling shareholder to appoint family members or friends as directors (including the CEO)—was able to extract excessive private benefits at the expense of minority shareholders and sometimes also of several stakeholders (e.g., employees, debt-holders, suppliers).
Parmalat, the most significant corporate fraud in Italian history, both in terms of size and length of the fraud, is arguably the most spectacular corporate scandal and symbolizes corporate frauds in Italy. Founded in 1961 by the Tanzi family, Parmalat quickly expanded internationally through acquisitions and became a world leader in the dairy food business. Parmalat revenues were €7,590 million in 2002 and the company obtained this result, thanks to 139 plants worldwide and about 36,000 employees. Unexpectedly, in December 2003, the Parmalat group collapsed and entered bankruptcy protection after acknowledging massive holes—in terms of over €14 billion—from the company’s accounts. The Parmalat case is an example of a deliberate misstatement of information reported in its financial statements in order to deceive investors and creditors (including bondholders).
Often labeled as “European Enron,” for the size of the fraud and the economic impact on the national economic system, Parmalat was characterized by relatively less sophisticated fraudulent schemes. Fraudulent financial reporting practices included both the falsification of earnings (via double billing, overbilling, the creation of artificial revenues through sales to controlled nominee entities, etc.) as well as the overstatement of assets (via the use of nominee entities or forged depository bank accounts to increase reported liquidity), and the understatement of liabilities (via improperly recording debt as equity or writing off debt from the consolidated financial statements).1
Parmalat’s corporate governance was characterized by the dominant role of the Tanzi family. Mr. Calisto Tanzi, the founder of the group, owns a controlling shareholding (over 50 percent of the shares) and held both the CEO and Chairman posts. Four members of the Tanzi family held executive and nonexecutive positions within the board of directors. The chief financial officer (CFO) was a member of the audit committee and the three directors named as independent were more independent in form than in substance. In sum, the Tanzi family had sufficient power to extract private benefits from the Parmalat group and exploited this opportunity to tunnel corporate resources to family members either directly or indirectly, via related-party transactions. For example, when Parmalat arranged to receive a discounted price in a deal with a supplier, it would often record the full price as paid, while the total amount of the discount was deposited by the supplier directly to a Tanzis’ personal bank account. Moreover, important resources were tunneled to the Tanzi family indirectly, via overbilling schemes with transactions with firms that were not part of the Parmalat group, but were privately fully owned and operated by some members of the family (Melis 2011).
The collapse and the financial scandal of Parmalat had a wide-reaching impact on Italian business and society. The whole Italian corporate system was put under pressure. Even the ability of Italian companies to access international capital markets was severely affected because of the lack of trust in the entire national economy. For example, Ferrarini and Giudici (2006) reported that the number of Italian companies who were able to access the international bond market remarkably reduced the years after the Parmalat scandal.
Despite the fact that Parmalat is not necessarily an Italian case,2 such a sizeable and wide-reaching corporate scandal raised major concerns and led to a profound questioning of the soundness of the Italian financial reporting standards and regulation as well as corporate governance practices. As a result of such event, the Government promoted changes in regulation regarding the external auditing firm’s engagement and the representation of minority shareholders on the board of directors.
Major Corporate Governance Legislation
Understanding how well investors, both shareholders and creditors, are protected from expropriation by corporate insiders (i.e., senior managers and controlling shareholders) is crucial to understand corporate governance in a given country. Aspects of national legal frameworks are able to influence significantly the intensity of agency conflicts within corporate stakeholders and the effectiveness of internal corporate governance mechanisms in safeguarding outside investors (i.e., minority shareholders and creditors) (Kumar and Zattoni 2016). Indeed, investor protection—that is, how well the laws in a country protect outside investors—contributes to explain the important differences among countries, such as ownership and control concentration in listed firms, dividend policies, and the access of firms to external finance. Investor protection turns out to play a crucial role because outside investors finance firms, but do not run them. Therefore, they face a risk that the returns on their investments will never materialize due to the fact that corporate insiders (controlling shareholders or senior managers) can expropriate them. Indeed, in many countries, expropriation of outside investors by corporate insiders is extensive. Investors typically obtain certain rights that are generally protected through the enforcement of regulations. In this perspective, corporate governance is, to a large extent, a set of mechanisms through which outside investors are protected against expropriation by corporate insiders (La Porta et al. 2000). The introduction of both “hard” and “soft” (i.e., code of best practices) law mechanisms represent a country’s combination of informal and formal institutions that guide firms and boards in taking decisions in an uncertain environment (North 1990).
For this reason, in the next subparagraphs we will provide a brief overview of the evolution of regulation (including both hard law and codes of best practices) that influences internal governance mechanisms in Italian listed firms.
The Evolution of Hard Law
The first systematic tentative to regulate corporate governance practices of Italian companies dates back to 1882 when, 21 years after Italy’s re-unification, the Commercial Code was issued. The code included an advanced regulation of limited liability companies and introduced the board of statutory auditors, a unique feature of Italian corporate governance (see Chapter 6 for more details). Since then, several legal reforms occurred in this area, especially during the last decades. As pointed out by Enriques (2009), two often connected drivers behind their adoption are: the need to make the Italian equity market more attractive to (domestic and foreign) investors by ensuring them higher protection against the risk of expropriation and, more recently, the pressure of European Union on its member countries to implement the EU directives (and regulations).
The code of 1882 remained in force with minor modifications for several decades as the legislator issued a new commercial code only in 1942. The new code was developed to regulate new economic phenomena not well managed by the previous one, for example the creation of business groups and the use of mechanisms to separate ownership and control. Despite these positive aspects, the code almost ignores most of the corporate governance issues related to listed companies, including the consequences associated with the separation between ownership and control (Ferrarini 2005).
In the mid-1970s, three important legislative actions affected corporate governance of Italian companies. In 1974, the reform of corporate governance of listed companies introduces Consob, the Italian Securities and Exchange Commission, as an independent administrative authority, having legal personality and full autonomy. The Commission has competencies with regard to regulation, supervisory, and control activities related to the Italian financial markets. Its main objective was to guarantee the efficiency and transparency of the Italian Stock Exchange (see Chapter 3 for more details). In the same year, Italian firms were required to adopt generally accepted accounting practices (GAAP) for the preparation and presentation of their annual reports. One year later, the same firms were required to have their financial statements audited by an external auditing firm.
The effort of Italian policymakers to improve corporate governance practices continued in the late 1980s, when a number of Parliamentary initiatives were formulated to fill the gap with major European countries that had widened following their reforms in financial markets regulation. As a result, some important reforms are issued in the early 1990s: the ban on insider trading in 1991, the modernization of investment services and stock exchange regulation still in 1991, and a regulatory framework for takeover bids in 1992. In the same period, European harmonization initiatives prompted the Italian Government to introduce important new laws. For instance, disclosure in listed—as well as unlisted—companies improved after the implementation of the 4th and the 7th company law directives on financial statements happened in 1991 (Enriques 2009).
In the last two decades, further legal reforms have been enacted in Italy to improve internal governance mechanisms, empower shareholders, enhance disclosure, and strengthen public enforcement. In 1998, the Government consolidated financial market laws into a single act and amended the laws on listed firms. The main aim of the Financial Markets Consolidated Act (Testo unico sulla Finanza) was to strengthen the protection of savings and minority shareholders.3
The Draghi reform can be considered the “cornerstone” of the Italian corporate governance legislation as it streamlined the legal framework for securities offerings, takeover bids, disclosure obligations, external audit firms as well as board of statutory auditors. As underlined by a leading Italian scholar, Enriques (2009), “the mere consolidation of a number of scattered and uncoordinated sets of rules made it easier to become familiar with Italy’s capital markets regulation.”
The act changed the composition and strengthened the responsibilities of the board of statutory auditors, at least on paper. The representation of minority shareholders within the board of statutory auditors was mandated: one member if the board consists of three statutory auditors and at least two members if it consists of more than three auditors could be elected by small investors. The powers of the board of statutory auditors as well as the powers of individual members were strengthened, and its mission clarified by requiring it to focus on internal controls (see Chapter 6).
A restyling of the legal regime of external audit firms was implemented, by clarifying their tasks (see Chapter 3). Consob’s statutory objectives in supervising listed firms were spelt out (investor protection and efficiency and transparency of the market for corporate control and of capital markets), its regulatory authority was broadened, and its powers to request information, execute on-site inspections and impose ad hoc disclosure duties extended (see Chapter 3).
The act strengthened the protection of minority shareholders by granting shareholders representing a minimum threshold governance rights previously either unavailable or subject to higher ownership thresholds: (i) shareholders representing at least 10 percent of the shares can call an assembly meeting; (ii) shareholders representing more than one-fifth of the shares are enough to hold an extraordinary assembly meeting at third call; (iii) shareholders representing at least 5 percent of the shares may bring a company action for liability against directors, members of the board of auditors, and general managers. The threshold for a shareholder suit was then reduced to 2.5 percent in 2005.4 Since 1998, a two-thirds majority of the shares represented at the shareholder meeting has been required for “extraordinary” resolutions, including new issues, mergers, and amendments to corporate bylaws. By allowing voting by mail, the Draghi reform also aimed to make the exercise of voting rights easier and less costly for shareholders, in order to “revive” the shareholder meeting.
The Draghi reform also tackled shareholder agreements, by introducing full disclosure and a three-year time limit. The law also provides that in the event of a takeover bid the parties are free to tender their shares, no matter what restrictions the agreements would impose on their sale. Last but not least, it made room for Consob to mandate the disclosure of each director’s compensation in the annual report.
The privatization of the stock exchange in 1998 led to the creation of Borsa Italiana, a joint stock company whose main activity concerns the organization of the regulated markets in financial instruments. Its primary function is to guarantee the development, transparency, competitiveness, and efficiency of those markets. With this decision, the Italian Parliament assigned to Borsa Italiana the functions of regulation and management of the regulated markets, while Consob exclusively performs the supervisory duties.
With 2003 corporate law reform, Italy revised its previously lax regime on self-dealing transactions. Directors now have to disclose to the whole board as well as to the board of statutory auditors any direct or indirect interest they might have in a transaction. Prior board of directors’ approval is required for transactions in which the CEO has an interest (Enriques 2009). In contrast with the previous regime, directors with an interest in a company’s transaction could cast their vote on the transaction, the only requirement for the board being to state in the board’s minutes the grounds for entering into the transaction.
In the same year, the provision that shareholders had to deposit their shares with a bank five days prior to the shareholder meeting was repealed. The default rule is now no deposit obligation, although corporate bylaws may require an up to two-day deposit obligation. Deposit of shares has been replaced by a (usually electronic) communication. In addition, the communication does not entail share blocking unless—according to the prevailing interpretation—the charter expressly forbids trading after the communication is sent; rather, if shares are sold, voting rights are reduced accordingly (Enriques 2009). This reform reduced a hurdle to institutional shareholder activism, as when shares are deposited, shareholders could not sell their shares.
Since 2004, Italian listed companies are no longer obliged to adopt the Italian traditional board structure, that is, a sort of “half-way house” between the American unitary board and the German two-tier board structure. The reform introduces, in addition to the traditional model, two supplementary models of corporate governance: (i) a British type of unitary board structure, with an audit committee, entirely composed of independent nonexecutive directors, and (ii) a German type of two-tier board structure, with a management committee and a supervisory council (see Chapter 6).
The serious financial frauds and scandals happened at the beginning of new millennium (e.g., Parmalat, Cirio, and Giacomelli) showed that corporate governance practices and disclosure rules were not adequately enforced. The scandals emphasized that controlling shareholders of listed companies could circumvent both internal and external controls and expropriate small investors (including institutional ones), posing doubts about the real independence and effectiveness of boards of directors and of statutory auditors, external auditors, banks, and other control mechanisms (Melis and Melis 2005).
As a reaction to the corporate scandals and following the example of other countries (e.g., the United States with the Sarbanes–Oxley Act), the Italian Government issued an Investors Protection Act (the law 28/2005, n. 262). The so-called Saving Law (Legge sul Risparmio) enacted in 2005 addressed the problem of minority shareholders’ representation on the board of directors. Italian listed firms were required to introduce a slate system and to reserve at least one seat of the board of directors to minority shareholders who are unrelated to the controlling shareholder (see Chapter 7). Minority shareholders were also significantly empowered by lowering the threshold (from 10 to 2.5 percent of the shares) to add items to the meeting agenda.
The 2005 law required all listed companies to appoint an officer responsible for the reliability of all public information about the company’s financial position and performance (Dirigente preposto alla redazione dei documenti contabili societari). This officer is required to sign all company’s financial reports and to certify that, based on his/her knowledge, they do not contain any untrue statement of a material fact (or omit to state a material fact), and fairly present, in all material respects, the financial conditions and results of operations of the company as of, and for, the periods presented in the report. It also required that the chief external auditing firm takes the responsibility for the actions of other auditing firms that work as its “subcontractors” (see Chapter 3).
In 2010, Consob comprehensively regulated related parties transactions and introduced both stricter procedural requirements and heightened disclosure obligations. The disclosure and procedural requirements are differentiated depending on the materiality of the transaction’s magnitude. Following the 2004 and 2009 recommendations by the EU Commission, Italian listed firms have been mandated to publish an annual compensation report at least 21 days before the annual general meeting. The new regulation enriches the information publicly available under the previous regulatory regime. First, all the information on the compensation policy, general principles, and procedures (e.g., the role of the compensation committee and, if any, of the independent compensation consultant) was not to be reported. Secondly, data on awarded compensation have been extended either by introducing new information (e.g., the individual nonequity variable salary) or by improving the quality of existing information (e.g., the requirement for each single stock-based compensation plan to be disclosed separately).
In 2011 (effective in 2012), on the wake on the international debate on women rights’ and their role in decision making, the Italian policy-maker followed other European countries (e.g., Norway, France, Belgium, and so on) and decided to introduce gender quotas for the boards of Italian listed firms. In particular, the law has required a one-third (one-fifth for the first term) gender quota for listed and state-owned firms, with a three-term sunset clause.5
New procedures for the approval of the compensation policies has also been introduced, by requiring that all listed firms have to cast a mandatory “say on pay” vote, binding only for banks and insurance firms, at the annual shareholders’ general meeting on the first section of the compensation report (i.e., the section on remuneration policy), whose result needs to be adequately disclosed to the public through the corporate website.
The Evolution of Soft Law
The evolution of the corporate governance practices of Italian listed companies has been influenced not only by the several legal reforms of the last two decades, but also by the issue and the update of the code of good governance. The code does not contain compulsory rules, but presents a model of good governance that listed companies are encouraged to follow. More precisely, listed companies should comply with codes’ recommendations or explain to (current and potential) investors the reasons for the (total or partial) noncompliance. The code is based on the principle of freedom with accountability and the only penalization for not compliance is the moral suasion of the market (see Chapter 4 for a more in-depth examination).
The momentum following the Draghi reform, the privatization of the Italian Stock Exchange, together with the seek for legitimization due to the emergence of codes of best practice around Europe,6 were the key drivers of the adoption of a corporate governance code of best practices (Enriques 2009). The committee for the corporate governance was established at the beginning of 1999 with the aim to write a code of good governance for Italian listed companies. The committee was chaired by Stefano Preda (chairman of Borsa Italiana at that time) and consisted of distinguished representatives of both the Italian industrial and financial community, and institutional investors.
The Italian code of best practice focused on the “gaps” left by the 1998 Draghi reform, in particular on the role, structure, and composition of the board of directors (see Chapter 4). The code issued in 1999 has several merits as, for example, it identifies the major responsibilities of the board of directors, underlines directors’ duties, specifies the responsibilities of the chairman, invites shareholders to elect an adequate number of nonexecutive and independent directors, and encourages boards to create remuneration and control or audit committees. Despite all the benefits associated with its introduction, the first code has been criticized by some commentators arguing that some principles were vague and too broad and that it did not advance radical improvements to Italian corporate governance practices.
The corporate governance code has been updated several times in parallel with the evolution of the international best practices and to address deficiencies underlined by scandals and frauds. In particular, the revised version of the code issued in 2002 enlarged the definition of independence, reinforced governance practices of companies controlled by another listed company, strengthened the procedure for internal handling and disclosure to third parties of private information, better specified the responsibilities of compensation and audit committees, and imposed substantial and procedural fairness in related-parties transactions.
A second revision of the corporate governance code was issued in 2006 in order to align its content with the evolution of the European and the national law and regulations. The main changes regarded in this case the board’s annual evaluation of directors’ independence, the definition of the main functions of the nomination, compensation and audit committees, a better specification of the functions of the board of statutory auditors, and the specification of the recommendations in case of dualistic (i.e., two-tier, with a supervisory council and no board of statutory auditors) or monistic (i.e., one-tier, with only a board of directors and an audit committee) governance models.
After a partial revision of the Article 7 about directors’ compensation in 2010, the new entirely revised version of the code was issued in 2011. Also in this case, the code has been updated to take into account all legislative changes about corporate governance practices. The revision involved four aspects (board composition, board’s role and functioning, organization and task of the internal committees, control’s and risk management’s system) and was intended to discriminate code’s recommendations between large and small companies, to strengthen the centrality of the board and to rationalize the controls’ system.
After a further revision in 2014, the most recent version of the code has been issued in 2015. The major changes introduced with this last revision invited to increase the board’s attention to the medium long-term risks, to strengthen the internal control and risk management systems in line with the international best practices, and the recent whistleblowing provisions (regulation EU 596/2014 on market abuse and EU directive 2013/36 on prudential supervision and capital requirements of banks), to draft minutes of each committee’s meeting and (for boards of the largest companies included, that is, those in the FTSE MIB) to evaluate the opportunity to establish a corporate social responsibility committee.
Table 2.1 Brief history of the most important regulatory acts on listed companies and financial markets in Italy since 1974
Corporate Governance Practices in Italy
Since 1974, Italy has developed a number of regulatory reforms aimed at aligning the national corporate governance system to the international best practices. Table 2.1 shows that this activity has been particularly intense in the 1990s and in the new millennium when legislative reforms or revisions of the corporate governance code have been approved almost every year.
The main drivers of this intense activity of legislative reforms have been the pressure to harmonization of corporate law coming from the European Union, and the need to increase the protection of minority shareholders to make the Italian system more transparent and attractive for potential investors. At the end of such a prolonged activity of legislative reforms, we can state that the corporate governance practices of Italian companies are largely improved and are now comparable to the international best practices.
The current corporate governance regulatory framework for listed firms is defined by a set of different documents:
– The Legislative Decree 58/1998 (Testo Unico della Finanza) (TUF), also known as Draghi reform, as amended and supplemented by several subsequent laws;
– The Rulings (Regolamenti) issued by Conbob;
– The Corporate Governance Code issued by Borsa Italiana;
– The Listing rules issued by Borsa Italiana S.p.A.
Key Points to Remember
Corporate scandals are worldwide but differ across corporate governance models. While in the Anglo-American model they are committed by top managers at the expense of shareholders, in other national settings (including Italy) controlling shareholders are the most powerful actors that expropriate minority shareholders.
Corporate governance regulation is crucial as it affects the level of investor protection, the intensity of agency conflicts within corporate stakeholders and the effectiveness of internal corporate governance mechanisms in a given country. Regulation can be classified in two groups, hard and soft law recommendations. The former consists of commercial law, and particularly of corporate law, and includes rules and norms that are compulsory and for this reason should be followed by companies. The latter consists of codes of good governance that are based on the “comply or explain principle,” that is companies can either comply or explain to the investors the reasons for their deviance.
Corporate governance regulation in Italy has been changed several times, and particularly in the last two decades, to increase investor protection. These changes significantly improved investor protection.
Code of Good Governance has been issued in 1999 to introduce good governance principles already diffused in other national contexts. The Italian Code has been revised several times in order to keep its content aligned with international best practices.
1 For a more in-depth analysis of the fraudulent accounting techniques adopted in the Parmalat fraud, see Melis (2011).
2 While the concentrated ownership and control structure has Italian traits, similarly to what happened in other corporate scandals, Parmalat’s corporate governance failed to comply with some of the Italian corporate governance best practices and both the external auditor and the audit committee failed to perform their monitoring role properly (Melis 2005).
3 The Act is better known as Draghi Law or Draghi reform, for the name of his committee’s chairman who was at that time the Director-General of the Treasury Minister. The MIT-trained economist Mario Draghi is the President of the European Central Bank at the time of writing.
4 The dichotomy between potentially “good” active institutional shareholders versus potentially “bad” active individual shareholders explains the preference for the granting of governance rights to “qualified” minorities rather than to individual shareholders. See Enriques (2009).
5 Ten countries have established quotas, ranging from 33 to 50 percent, for women representation in the boards of listed firms and/or state-owned enterprise, with various sanctions. 15 other countries have introduced nonbinding gender quotas in their corporate governance codes enforcing a “comply or explain” principle. For an in-depth analysis on the institutional factors driving gender quotas for boards of directors, see Terjesen, Aguilera, and Lorenz (2015).
6 Zattoni and Cuomo (2008) pointed out that the issuance of corporate governance codes in civil law countries seem to be prompted more by legitimation reasons than by the determination to improve the governance practices of national firms.