Pension funds and corporate governance in developing countries: what do we know and what do we need to know?

Abstract

Conventional wisdom holds that pension reforms from pay-as-you-go to fully funded systems spur the development of stock markets through a corporate governance channel, i.e. pension funds become large shareholders of publicly traded firms and therefore have the incentives to monitor managers and improve investor protections. This paper reviews the literature on the corporate governance channel associated with pension reforms in developing countries, and asks what we know and need to know about it. We know that pension funds are not yet large shareholders of publicly traded firms in developing countries. However, econometric results suggest that pension reforms lead to stock market development, but do not allow us to identify and separate the corporate governance channel. We know that pension reforms are followed by pro-investor legislation, but there is no convincing evidence that the pro-investor laws are enforced. We need to know more about the effects of pension reform on stock prices and performance of publicly traded firms, and whether pension fund management companies act in the best interest of pensioners. The paper also reviews the political economy explanations of the links between pension fund specific capital controls and the corporate governance channel, and suggests that there is a trade-off between the objectives of pensioners' welfare maximization, and corporate governance reform and stock market development.The largest institutional investors, the group that includes the largest collection of investment capital in the world, are the pension funds. One of the most important elements to understanding the current state of corporate governance, as well as its future direction and potential, is an understanding of this group. (Robert Monks and Nell Minow, Watching the Watchers : Corporate Governance for the 21st Century).

Does pension privatization increase economic growth? Evidence from Latin America and Eastern Europe

“…Transition costs were severely underestimated and neglected during preparatory reform stages on both continents (Mesa-Lago, 2002;Azra, 2008;Drahokoupil and Domonkos, 2012). Groundbreaking privatization in Chile was accompanied with strict and long-lasting austerity measures that produced a surplus of 8.5% of GDP in the non-pension part of the public sector over the 1981-2004period (Arenas De Mesa and Mesa-Lago, 2006.…”

Pension reform and capital market development in Central and Eastern European countries

“…Some authors refer to the positive impact of the pension funds on the domestic capital markets, both for the economies with developed financial systems and for those that have less developed financial systems, the influence being somewhat diminished for the latter (Dayoub & Lasagabaster, 2008). Other papers outline the effect of deepening of bond and equity markets produced by the development of the activity pension funds (Catalán, 2004;Corbo & Schmidt-Hebbel, 2003;Davis, 1996;Vittas, 1999).…”

Pension Fund Management: The Case of Ethiopian Social Security Agency

“…As a group, the developed countries have the most advanced social security and pension fund management systems. With very few exceptions, institutionalized social security and pension fund management in the developing world is of relatively recent origin having appeared only after the Second World War, following the emergence of several independent states at the end of the colonial era (Catalan, 2004).…”

“…According to Catalan (2004) in the last two decades, many developing countries implemented pension reforms from publicly managed pay-as-you-go defined benefit systems to privately managed fully funded defined contribution schemes. One of the potential macroeconomic benefits typically associated with such pension reforms is the development of domestic financial markets.…”

“…Pension funds could trade frequently, increasing the liquidity of the domestic stock markets, and thus crowding in savings and new investors. Similarly, the intense trading of stock by pension funds and their large size may induce them to seek the introduction of innovations and new financial instruments to lower transaction costs, again attracting additional savings and new market participants (Catalan, 2004)…”