1.1.1 A Brief historical framework ...... 7 1.1.2 Issues in a global marketplace: R&D decline and regulatory changes ...... 11 1.1.3 The last pharmaceutical paradigm: the overwhelming rising of Emerging Markets...... 17 1.1.4 The global pharmaceutical market: competitive analysis ...... 29 1.1.5 Five Forces Analysis ...... 32 1.1.6 Industry Leaders ...... 35 1.2.1. The remarkable role of corporate governance in the globalisation process ...... 40 1.2.2. The relation between emerging markets and corporate governance ...... 45 1.2.3. The process of convergence towards archetypical models ...... 48

2. The Republic of Korea ...... 53

2.1 Corporate governance evolution ...... 59 2.1.1 Regulatory elements ...... 62 2.1.2 Code of Best Practice of Corporate Governance ...... 64 2.1.3 Ownership structure ...... 67 2.2 The Korean Pharmaceuticals Industry ...... 70 2.2.1. Background ...... 70 2.2.2. Regulatory framework ...... 72 2.2.3. Business environment ...... 75 2.2.4. Healthcare system ...... 76 2.3. Pharmaceuticals market overview...... 79 2.3.1. The Over-the-counter products market ...... 84 2.3.2. The Biotech Market ...... 86 2.3.3. Industry Leaders ...... 89 2.4. Corporate Governance Issues ...... 91 2.4.1. Corporate governance profile in Industry Leaders ...... 92

LB 2011\2012 1 2.4.1.1. Ownership structure ...... 92 2.4.1.2. Board of directors ...... 93 2.4.1.3. Directors’ Independence and position held in other companies ...... 95 2.4.1.4. Compensation ...... 96 2.4.1.5. Committees ...... 97 2.5. Concluding remarks ...... 98

3. People’s Republic of China: road towards economic leadership ...... 101 3.1. The Corporate Governance Evolution ...... 106 3.1.1. Regulatory elements ...... 111 3.1.2. The CSRC Code of Corporate Governance for Listed Companies in China...... 114 3.1.3. Ownership structure ...... 116 3.2. The Chinese Pharmaceuticals Industry ...... 122 3.2.1. Background ...... 122 3.2.2. Regulatory framework ...... 125 3.2.3. Business environment ...... 127 3.2.4. Healthcare system ...... 130 3.3. Pharmaceuticals market overview...... 133 3.3.1. The Over-the-counter products market ...... 138 3.3.2. Industry Leaders ...... 140 3.4. Corporate Governance Issues ...... 145 3.4.1. Corporate governance profile in Industry Leaders...... 145 3.4.1.1. Ownership structure ...... 146 3.4.1.2. The Board of Directors and the Supervisory Board ...... 150 3.4.1.3. Directors’ Independence and position held in other companies ...... 154 3.4.1.4. Compensation ...... 157 3.4.1.5. Committees ...... 159 3.5. Concluding remarks ...... 161

4. The Republic of India: one of the fastest growing economies ...... 164 4.1. Corporate governance evolution ...... 170

2 LB 2011\2012 4.1.1. The Clause 49 of Listing Agreement of Stock Exchange ...... 175 4.1.2. Ownership structure ...... 177 4.2. The Indian Pharmaceuticals Industry ...... 179 4.2.1. Background ...... 179 4.2.2. Regulatory framework ...... 180 4.2.3. Business environment ...... 182 4.2.4. Healthcare system ...... 183 4.3. Pharmaceuticals market overview...... 187 4.3.1. The Over-the-counter products market ...... 192 4.3.2. Industry Leaders ...... 194 4.4. Corporate Governance Issues ...... 197 4.4.1. Corporate governance profile in Industry Leaders ...... 197 4.4.1.1. Ownership structure ...... 197 4.4.1.2. Board of directors ...... 199 4.4.1.3. Directors’ Independence and position held in other companies ...... 200 4.4.1.4. Compensation ...... 202 4.4.1.5. Committees ...... 204 4.5. Concluding remarks ...... 205

5. Conclusions ...... 208

6. Appendix ...... 214

7. Reference List ...... 218

3 LB 2011\2012

4 LB 2011\2012 Abstract

The pharmaceutical industry has historically been one of the most important industry in the economic landscape in terms of innovation and relevance of its role for mankind. Inside the industry operate several Fortune 500 companies such as Pfizer Inc., Johnson & Johnson, Merck and other enterprises with a long business history and an impressive geographical presence. During the last century, multinational pharmaceutical companies, also known as “Big Pharma” had as main sources of profits, Western mature markets such as United States of America, European countries and Japan. The centrality of those markets were the expression of the XX century zeitgeist: the American success in the World War II gave to the country the political and economic leadership resulted in a period of an impressive economic development for all Western countries under the Pax Americana which was reaffirmed and reinforced after the collapse of the Soviet Union. The coming of the XXI century brought a new emerging political and economic paradigm: the weakening of the Western primacy1 together with globalization is gradually giving power and importance to countries which played a marginal role during the XX century. The rising power of the “Emerging Economies” is creating very attractive markets which probably will be the biggest ones for multinational companies in less than two decades. As a glaring proof, only in the two “Rising Giants”, China and India, lives more than two billion and a half people experiencing a sharp increase in life standards and purchasing power, opening up new horizons for all industries, included the pharmaceutical one. Although several pharmaceutical multinationals penetrated these markets, investing on emerging economies still remain as “ Entering uncharted waters where long term success is by no means assured”2.

1 Which prodrome was the 2001 recession and reached its acme with the 2008\09 financial crisis which still reverberates its effects among American and European markets. 2 Le Deu F., Parekh R., Zhang F. & Zhou, 2012, “ Health care in China: Entering ‘uncharted waters’”, McKinsey Quarterly, available at: https://www.mckinseyquarterly.com/Health_Care/Hospitals/Health_care_in_China_Entering_uncharted_waters_3028 consulted on the 6th of November 2012

5 LB 2011\2012 The threats are countless: from the patent protection to the diversity of social and cultural contexts. This work identifies the development of corporate governance as the “compass” to sail the uncharted waters of emerging economies making easier and more profitable to penetrate these markets in order to set the basis for a future market leadership. The paper is structured as follows: in the first chapter the main characteristics and dynamics of pharmaceutical industry are outlined in order to assess the present situation of the market; at the same time, the importance of corporate governance in setting a global marketplace is stressed. In order to have a complete focus on the fil rouge connecting pharmaceutical industry, emerging countries and corporate governance we analyzed three of the most important and active realities of the rising South-East Asian region: the second chapter reviews the growth path of the Korean Republic analyzing the corporate governance stadium of development both in the general environment and among pharmaceutical companies. In the third and fourth chapter the same analysis is implemented on the two “Rising Giants”: the Republic of India and the People’s Republic of China. In the end of every chapter, that is structured as a working paper, we tried to sort out corporate governance situation and market attractiveness in order to identify remediation to fill in the gap from the international standards and converge towards an internationally regulated marketplace.

6 LB 2011\2012 1. The Pharmaceutical Industry and Corporate Governance: setting

a global field

1.1.1 A Brief historical framework

Industrial pharmaceutics sink its roots in the two most active economic realities which competed for the for Western economic leadership during the 19th century: Germany and the United States of America. The first step in Europe is to be indentified when Heinrich Emanuel Merck changed the way of conducting his pharmacy in Darmstadt applying industrial practices to the production and selling of alkaloids while in United States of America, one important producer of fine chemical, Pfizer, specialized in supply of painkillers and antiseptics during the American Civil War (1861 –1865). In the second half of 19th century, Switzerland started to occupy an important position in pharmaceutical production as there weren’t patent laws to avoid copycats, fact that led to a blossom of new companies such Sandoz and Roche which later became market leaders with innovative products. After the World War I, German companies lost its leadership in the pharmaceutical market due to the war defeat in favor of emerging realities such as Wyeth, Sandoz and Eli Lilly which began the “industry internationalization” setting up subsidiaries in United Kingdom. The World War one aftermath experienced two revolutionary events in the pharmaceutical world, namely the extraction and industrial production of insulin made possible by the collaboration between F.Banting and Eli Lilly and the discovery of penicillin by A.Fleming in 1928 which was backed up by a government-supported international cooperation between big pharmaceutical players such as Merck, Pfizer and Squibb in order to

7 LB 2011\2012 implement a penicillin mass production during the World War II, conflict which led to several innovations also in analgesics production. Another element that sparked the pharmaceutical industry development was the establishing of a social healthcare system in Great Britain. This kind of welfare system was structured to reach all the British population while ensuring the drug manufacturers a reasonable return: the National Health Service increased sharply the demand for pharmaceutical products while together boosted investments on research for new medicine ensuring stable profits to pharmaceutical companies. Moreover, the mass production of pharmaceutical products together with new discoveries in the chemical and biological field led to an outstanding growth of the market which fostered the process of globalization already in fieri before the war: one clear example was the Pfizer’s foundation of subsidiaries in nine countries3. On the other hand, this wave of expansion led to several cases of misconduct with pharmaceutical products commercialized before proper tests which the most important of all was the Thalidomide case, an anti-morning sickness drug created in 1953 which side effects were proved to be severe, especially in patients’ newborn children (who presented physical deformations4). In response of pharmaceutical scandals the first attempt to implement stricter regulations both in USA and Europe took place: in 1962 US Food and Drug Administration published the Kefauver Harris Amendment supporting an increased attention on pre-selling testing of drugs requiring also proof of efficacy of the remedies and a wider disclosure on side effects. The main problem laid in the gap between the dimension of the competitive pharmaceutical field that was already international and regulatory responsibility and standard setting activities which remained at a country level. In the end of the 1970s the pharmaceutical business model changed: instead of realizing profits through the development of new drugs, pharmaceutical companies tried to create

3 Pfizer History, Pfizer Website: http://www.pfizer.com/about/history/history.jsp consulted on the 23rd of September 2012 4 The Guardian, “ Thalidomide scandal: 60-year timeline”, 1 September 2012, available at: http://www.guardian.co.uk/society/2012/sep/01/thalidomide-scandal-timeline consulted on the 23rd of September 2012

8 LB 2011\2012 and exploit the so-called “blockbuster” that are pharmaceutical products with extraordinary success in sales. The first case of pharmaceutical blockbuster was the SK&F’s ( Smith, Kline & French, GlaxoSmith Kline after the 2000 Merger between Glaxo Wellcome plc and SmithKline Beecham plc) Tagamet5, which earned ca. $1 billion a year; after it other lucrative products were commercialized such Eli Lilly’s Prozac in 1987. In the late eighties a new entity, the European Community, forerunner of the European Union, was the first to try to set a single European market in terms of regulations but it became reality only in 1989 when the World Health Organisation planned to create a global pharmaceutical regulator.6 In 1990 the first supranational entity was created: the International Conference on Harmonisation of Technical Requirements for Registration of Pharmaceutical for Human Use, also known as ICH, was a board of representative of regulatory bodies of United States, Japan and Europe, in charge to set guidelines which should inspire legislations. The ICH invested also several ICH observer to implement a liaison policy with non-ICH countries and to communicate constantly with the World Health Organization. ICH divided its guidelines in four categories: quality, safety, efficacy and multidisciplinary topics. The first one comprises guidelines about impurities in new drugs and specifications for test procedures and acceptance criteria while the safety topics include provisions for toxicity tests; the efficacy ones include ethnic factors and special population situations and multidisciplinary topics was a residual category7. In the last decade also the Food and Drug Administration, which was quite reluctant in creating a common field, started to be more involved sharing information with other regulatory bodies and working proactively together with the International Conference on Harmonisation of Technical Requirements for Registration of Pharmaceutical for Human Use.

5“ Cimetidine: a drug (trade name Tagamet) used to treat peptic ulcers by decreasing the secretion of stomach acid”; Princeton WordNet; (http://wordnetweb.princeton.edu/perl/webwn) consulted on the 23rd of September 2012 6 V.V.A.A.,2007, “The Global Pharmaceutical Industry International Trade and Contemporary Trends”, Duke University Online, available at: consulted on the 24th of September 2012 7 Ibid.

9 LB 2011\2012 In addition to the regulatory issue, in the 90s and in the beginning of new century a new issue merged up: the problem of innovation. After the great productivity of R&D in the whole 20th century which led to several new products, the coming of blockbuster drugs changed the pharmaceutical companies’ strategy making it more aggressive in terms of marketing rather than research: company tried to maximize their profit widening their market share with different versions of the same product instead of investing in order to get alternative treatments. One clear example was the success of the British company AstraZeneca which had a great commercial success with a modified version of an old product which was out of patent protection (namely, the Nexium8). Companies tried to face the slowdown in R&D outsourcing the research activity to small companies or laboratories where the entrepreneurial spirit seemed to go together with innovation, but, despite this strategic device, in the last years pharmaceutical industry, considered in its most representative members and also called “Big Pharma”, experienced a period of growth below the expectations in mature markets such as Europe and North America both for endogenous and exogenous causes. On one hand, the 2007 financial crisis drove several countries in a period of recession lowering down the consumption pace, especially in the two main markets: USA and Europe which account respectively for the 50%, together with Latin America, of the overall and 27,7% 9. On the other hand, the process of generating new products is more costly and risky than in the past and the number of new products are decreasing, i.e. in USA, the Food and Drug Administration declared that the new products on the market in the period span 2000-2009 are 24 comparing to 31 of the previous decade. The main reasons are both bureaucratic, with stricter regulatory provisions in terms of quality and trials, and competitive because during the last decade fewer companies invested on R&D preferring to compete with a more aggressive intellectual property rights

8 Nexium, Astrazeneca; available at http://www.astrazeneca.com/Medicines/Gastrointestinal/Product/Nexium consulted on the 24rd of September 2012 9Datamonitor, 2012, “Global Pharmaceuticals, Biotechnology & Life Science”, Industry profile, p.12

10 LB 2011\2012 management trying to extended patent rights through minor changes to existing drugs rather than develop new solutions. This strategic choice seems to be one of the most viable for pharmaceutical companies as the cost of a radical innovation, expressed by the development of a completely new molecular entity10, is estimated to cost from a minimum of $800 mln to $1.3 bln11.

1.1.2 Issues in a global marketplace: R&D decline and regulatory changes

The research and development activity, one of the pillars of the pharmaceutical market, declined sharply in its productivity in the last decade in terms of new drugs obtained per billion USD invested, experiencing the “Eroom’s Law”, antithetical idiomatic expression of the “Moore’s Law”, which defined “the exponential increase in the number of transistors placed at a reasonable cost onto an integrated circuit”12. Surely, the length of the drug development and approval process is a problem for the pharmaceutical industry because it takes at least from ten to fifteen years and needs heavy investments which payback is totally uncertain. The process13 is articulate in several phases: first of all the drug has to pass through a preclinical stage comprising studies on animals in order to assess the toxicity of the drug and the pharmacological effects, then the developing drug needs to pass the clinical trials, the most expensive, time consuming and difficult stage of the process, which comprises four phases14:

10 NME: “New and innovative chemical structures never used before in clinical practice”, FDA Definition available at http://www.fda.gov/Drugs/DevelopmentApprovalProcess/DrugInnovation/ucm285554.htm consulted on the 25th of September. 11 Hedner T., 2012, “ Change in the Pharmaceutical Industry – Aspects on Innovation, Entrepreneurship, Openness and Decision Making”, Linköping Studies in Science and Technology Dissertations, No. 1393 12 Scannell J.W., et al., 2012, “ Diagnosing the decline in pharmaceutical R&D efficiency”, Nature Review Vol.11, March 2012, p.191 13 The US FDA process is analyzed as the most representative 14 Janodia M.D., 2007, “ Drug Development Process: A Review”, Latest Reviews, Vol.5, Issue 6 available at http://www.pharmainfo.net/reviews/drug-development-process-review consulted on the 25th of September 2012

11 LB 2011\2012 - First Phase: studies are carried out on a small number of healthy volunteers ( 20- 100) in order to identify metabolic and pharmacological effects and side effects on humans - Second Phase: clinical studies are conducted on a large sample of patients to obtain preliminary data on effectiveness on patients with the disease and on short-term side effects - Third Phase: studies are expanded to a sample of more than a thousand people in order to have additional information about effectiveness and safety - Fourth Phase: implementation is delayed in time after the approval and marketing of the new drug in order to prove the safety on a large patient pool on every market.

.1 Sources: EFPIA (2007) and PhRMA (2007)

The governmental investigational committee usually operates in the preclinical and clinical stages giving the nihil obstat for the passage to the next phase assessing the soundness of tests and their results. After the preclinical and clinical stages the investigational committee makes as sort of “risk-benefit” analysis assessing again the relative safety of the new drug, controls the proposed packaging of the product and its labeling and also makes controls on the process

12 LB 2011\2012 to certify the compliance to protocols in order to provide adequate quality and purity of the product15. As a matter of fact, the research by Scannell, Blanckley, et al. shows how the FDA approved-drugs per billion USD of R&D invested, from 1950, has halved every nine years.

.2 Source: US FDA

The consequences of this phenomenon are quite harsh as in the last five years, domestic players as well as established multinational companies, acknowledging such problems in terms of cost\result efficiency, engaged even further in a strategy focused on cost cutting in R&D investments; multinational companies, moreover, are reducing investments in mature markets in order to capture larger market shares in emerging markets, especially the south- eastern Asian countries where the increasing purchasing power and the potential dimension of a new coming Indian and Chinese middle class is attracting the foreign capitals of the Big Pharma with MNCs starting to move their R&D facilities benefitting to cheaper skilled workforce16 too. The reduction of investments in pharmaceutical research and development has a double negative effect: it withers the percentage of new discoveries, such as drugs with an innovative chemical structure which are very important in order to increase patients

15 Food and Drug Administration, 2008, “ Rules and Registration”, Federal Register, Vol.73, No.133, pp.1-24 16 PriceWaterHouseCoopers, 2012, “ Global pharma looks to India: prospects for growth” Pharmaceuticals and Life Sciences publications, pp.23-27

13 LB 2011\2012 satisfaction and drugs’ efficacy, but also, depresses the efficacy in pursuit the mere “blockbuster” strategy. 17

THE LEVEL OF INNOVATION OF NEW CHEMICAL ENTITIES LAUNCHED BETWEEN 1975 AND 2002 CHEMICAL STRUCTURE

NEW ALREADY KNOWN "Very Innovative" Therapeutic Improvement 143 (10%) Clinical Interest 295 (18%) "Less Innovative"

No Therapeutic Improvement

201 (14%) 821 (56%) .3 Source: OECD Survey (2004)

The main causes of the declining of the R&D productivity are several. One of the most important of all lies in the retailing of “blockbuster” pharmaceutical products also because “Yesterday’s blockbuster is today’s generic”18: prosaically, investing heavily in discovering New Molecular Elements treating diseases which are already effectively cured by generic drugs, more convenient for healthcare providers and final users19, is unprofitable for pharmaceutical companies. Another cause is the progressive lowering of tolerance in countries’ regulations in Western countries, together with the difficulty of complying with different regulations in several countries.

17 Considering that research and development activity has always been based on incremental improvement ameliorating already existing treatments. 18 Scannell J.W., et al., 2012, “ Diagnosing the decline in pharmaceutical R&D efficiency”, Nature Review Vol.11, March 2012, p.193 19 As producers can commercialize generics with lower prices than the branded or the “state-of-art” product.

14 LB 2011\2012 The problem of heterogeneity in regulation will be gradually solved with a desirable and ineluctable international harmonization. Other important aspects in which is important to implement a regulatory convergence are: the setting of specific thresholds for obtaining the “bioequivalence”, that is the necessary qualification for a product to be sold as a generic, and the extent of privative rights matter, namely patents and intellectual property rights. The main challenge is finding an equilibrium between competition, promoting generics producers activities, and protection for companies committed to research and development avoiding situation where patent rights are almost inexistent such as the Indian case where generic drugs totally dominated the market until the TRIPs agreement20. Also clinical trials are to be better defined because they are a time-consuming and expensive process that now is required to be done twice for every new drug in some Western countries. Moreover there are problems for companies trying to commercialize a new drug worldwide using clinical trials produced in only one countries as “[…].In order to get an approval for marketing of their product, regulatory bodies are insisting on clinical trials of land for the safety concerns of the people of their region and suspecting and questioning the efficacy of the product. In this scenario, the pharmaceutical companies are bound to go for global clinical trials. In contrast to routine trials, there are multiple technical, procedural, and legal hurdles in conducting global clinical trials varying from site selection to regulatory clearances to precede a trial.”21 The lack of harmonization is also burdening the medical devices industries which usually is a commercial segment of several pharmaceutical company, absorbing capital and investments. The regulatory challenge is strong especially in Asia-Pacific countries where multinational companies are moving and almost every single nation is facing regulatory evolutions jeopardizing the soundness of strategic plans: the most evident hurdles are the long timing

20 V.V.A.A., 2007, “A Gathering Storm”, The Economist, Print Edition, Jun 9th 2007, available at http://www.economist.com/node/9302864 consulted on the 26th of September 2012 21 V.V.A.A., 2011, “ Meeting the Challenges of Global Clinical Trials”, HarNeedi.com online, available at http://www.harneedi.com/index.php/pharma-articles/3424-regulatory-challenges-in-global-clinical-trials consulted on the 26th of September

15 LB 2011\2012 in drug review and approval which is in average 2.5 years longer than in U.S22, the Nippon “diffidence” towards drugs with clinical trials carried out outside the Japanese borders and the bureaucratic backlogs in People’s Republic of China where a clinical trial needs averagely 9-12 months for approval together with additional 2 months for Independent Review Board approval23. On the other hand, the three important Asiatic markets, People’s Republic of China, Republic of Korea and Japan started in the over mentioned process of international harmonization: Japan, the Asian country that is closer to Western countries for historical reasons, adopted in 1998 the “Guideline on Ethic Factors in the Acceptability of Foreign Clinical Data” and in 2007 the “ Basic Concepts for international Joint Clinical Trials” opening the boundaries to drugs tested in foreign countries and the Republic of Korea, which its regulatory committee permitted in 2002 to companies conducting multinational studies to include Koreans patients in order to provide Koreans new therapies. In the end it’s important to stress also the relevance of the last economic downturn, which reduced dramatically pharmaceutical companies’ margins forcing them to rationalize costs; of course one of the most affected areas was the R&D one for its intrinsic characteristics needing heavy investments with uncertain results and long pay-off periods.

22 Yadav V. & Deepak,2011, “Regulatory Challenges in global pharmaceutical market”, Vol.3, No.2, pp.340-345 23 Ibidem.

16 LB 2011\2012

.4 Souce: OECD Survey (2006)

Undoubtedly, the R&D activity is critical for the future growth of the pharmaceutical as the discovery of New Molecular Elements, and innovation in general terms, is the only path leading companies to set, in the author’s opinion, a win-win scenario, a sort of going back in time with companies specialized in particular therapeutic areas, also if the presence and the dimension of MNCs seems to prevent this possible evolution, and the strategic decision of “going global” could boost this kind of paradigm shift from a blockbuster-exploitation model to an innovation-based one offering skilled workforce at lower costs and potential lucrative markets through which financing the depressed R&D activities.

1.1.3 The last pharmaceutical paradigm: the overwhelming rising of Emerging

Markets

Pharmaceutical industry has always been open to international commerce; however the sharp conversion towards globalization came with the creation of the World Trade Organisation in 1995 and the consequent process of convergence and internationalization of

17 LB 2011\2012 patent protection through the Trade Related Aspects of Intellectual Property, also known as TRIPs24 The main results of TRIPs were to require, for each subscriber, a patent protection of at least 20 years on both products and processes with a possible delay in compliance for emerging markets to the year 2016. This achievement revolutionized pharmaceutical companies, from vertically-integrated, concentrated-production and little-FDI companies to structured enterprises with a international, global value chain.25 The progressive shift towards an international institutional framework created a new wave of mergers and acquisition processes, in order to provide companies of the essential structures for competing worldwide in terms of market and value chain organization and to gain know-how in new therapeutic areas creating new market spaces; between 1995 and 2005, 60 mergers took place. Although developed countries remain the main market for Big Pharma, the emerging markets will play such an important role that MNCs started to modify their global value chain in order to be closer to the end market and benefit, apart from overcoming trade barriers, from more efficient lead times and lower costs. One of the most evident proof of the globalization process implementation is the behavior of companies coming from developing countries: TRIPs, at the same time, helped and forced companies to start acting globally such as multinationals. They take advantage of their lighter cost structures, exporting low value generics in areas with large population and low purchasing power to increase their profits, (i.e. Indian companies exporting to the Sub-Saharan Africa and Chinese companies exporting to Uganda) and to find new spaces in different markets to substitute the lost market share in the homeland, due to MNCs and foreign companies activity. The nature of these kind of companies led them to structure a global value chain setting for different reasons, manufacturing facilities in Western and least developed countries.

24 Haakonsson S.J..2009, “ The Changing Governance Structures of the Global Pharmaceutical Value Chain”, Competition & Change, Vol.13, No.11, March 2009, pp.75-77 25 Ibidem

18 LB 2011\2012 So the TRIPs brought a massive change in the pharmaceutical industry as before value chains were divided in two categories defined by the end markets: a mature one, with high entry barriers dominated by branded drugs where private rights were enforced, and the second one with no patent law nor intellectual property rights protection dominated by low quality generic drugs. By 1995, when WTO started their activity, as Haakonsson identifies in its 2009 paper, there are three new configurations of value chain in the pharmaceutical industry: branded products, quality generics and low-value generics. The companies involved in the production of branded drugs act globally to sustain the high pace of investment in innovation and marketing and their main markets are in the Western countries where entry barriers are high for high costs of clinical trials and to patenting the new chemical elements and this kind of products are not available in the emerging markets. The value chain organized for such markets is focused on the production of blockbuster drugs and in financing marketing activities and companies usually experience market shocks when their products lose the patent protection. The branded drugs producers started to implement “preparation activities” to penetrate developing countries with several M&As and creating networks with cross-licensing arrangements and multi-firms alliances as they tend to operate in these areas with wholly- owned subsidiaries (i.e. Pfizer)26. In terms of corporate strategy, companies usually outsource non-core activities (including R&D activities in non-core therapeutic areas), implementing, in the “Porterian” dichotomy between “lower costs or superior quality”27, the third way that is the focalization on core activities, moreover companies implement an adjacency expansion from the core trying to save costs using the same “technology” in different therapeutic areas. The second category is embodied by companies which produces quality generics having grew in the new century; quality generics are products containing a chemical element with an expired patent and comprise also over-the-counter products such as painkillers.

26 Haakonsson S.J..2009, “ The Changing Governance Structures of the Global Pharmaceutical Value Chain”, Competition & Change, Vol.13, No.11, March 2009, pp.75-77 27 Porter M.E., 1996, “What is Strategy”, Harvard Business Review, November-December 1996, pp.1-20

19 LB 2011\2012 Generic pharmaceutical products, now widespread both in develop and developing countries, especially in the second ones, experienced an impressive increase in popularity as the healthcare providers are keen to reduce the reimbursement costs buying the generic version, which means buying the active pharmaceutical ingredients, rather than more expensive branded ones; Western healthcare providers are one of the main end market together with the high income individuals in the developing countries. The producers usually realize these products through the off-shoring, setting production especially in India, where generic drugs are largely produced and widespread also because of the inexistent of patent protection before TRIPs, and the same manufacturers create the same API for different brands. The entry barriers are lower than in the branded drugs because there’s no particular need for reputation, companies are price takers and don’t need high investments in R&D to arrange a wide set of generic products because nowadays generic producers are not ask to go through the all process of clinical trials but only to give proof of the bioequivalence28 of their product relying on the approval process that has already been done by the branded drugs producers. The lower end of the value chain continuum are the producers of low-quality generics targeting healthcare providers of low-income and lower-middle income economies29 where customers are highly price sensitive and markets account for a very small part to the overall global pharmaceutical market in terms of value30. In this business segment entry barriers are extremely low as no high investments are needed and the production doesn’t need specific manufacturing facilities. Moreover this kind of products represent obsolete treatments and old off-patent drugs which efficacy and quality are not focal as long as they comply with World Health Organization and the main focus is price.

28 FDA on Bioequivalance: “the absence of a significant difference in the rate and extent to which the active ingredient or active moiety in pharmaceutical equivalents or pharmaceutical alternatives becomes available at the site of drug action when administered at the same molar dose under similar conditions in an appropriately designed study”; Center for Drug Evaluation,2003,” Guidance for industry”, U.S. Deparment of Health and Human Services documents, pp.1-26 29 http://data.worldbank.org/about/country-classifications 30 Haakonsson S.J..2009, “ The Changing Governance Structures of the Global Pharmaceutical Value Chain”, Competition & Change, Vol.13, No.11, March 2009, pp.87-90

20 LB 2011\2012 Usually production is unorganized and outsourced through rent-a-plant relationships between companies of the same area, buying the access to plant in case they win a large tender. The main players are Indian and Chinese companies that usually produce for both domestic and foreign markets and they are not necessarily big enterprises, on the contrary several small-middle enterprises operate in the market. Beyond the taxonomy of value chains structured to operate in different market segment in the global pharmaceutical market itself, the common aspect merging up is the globalization of value chain and the international expansion of former domestic business realities which is a direct consequence of the process of harmonization and convergence of different patent law regulations to a shared standard. The next step, in terms of pharmaceutical industry globalization, it should and probably will be a process of convergence of several countries’ business law and corporate governance: the results of TRIPs are clear, so creating a common global playfield is, in author’s opinion, a must to continue in the process of industry internationalization and for sure will be object of lobbying by multinational companies tried to mitigate the risk of their foreign direct investments and cutting costs of complying to different regulations, also because penetrating profitably new economic realities is a primary goal. This kind of thesis is corroborated by the recent growth of new and already known economic realities such as the Eastern and South Eastern part of Asiatic continent with two emblematic examples such as People’s Republic of India with an aggregated population of 2.548.313.5353132, settling in 2011 respectively on the third and fourth position for Gross Domestic Product. An important data, in order to better understand the size of the “emerging markets phenomenon”, is the GDP ranking for 2011: half of the first twenty countries for Gross Domestic Product is occupied by new economic powers.

31 CIA, The World Factbook, PRC: https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html Consulted on 22nd of October 2012 32 CIA, The World Factbook, India: https://www.cia.gov/library/publications/the-world-factbook/geos/in.html Consulted on 22nd of October 2012

21 LB 2011\2012 Year 2012

GDP - nominal USD Country Million USD United States 15.731.172 China 8.170.997 Japan 5.751.369 Germany 3.478.030 France 2.660.378 United Kingdom 2.438.117 Brazil 2.374.577 Italy 2.076.225 Russian Federation 2.023.533 India 1.826.637 Canada 1.803.342 Korea, Rep. 1.571.106 Australia 1.567.603 Spain 1.442.805 Mexico 1.185.427 Indonesia 932.896 Netherlands 805.925 Turkey 789.680 Saudi Arabia 633.087 Switzerland 611.911 .5 Source: World Bank – Databank (2012) Comparing the top twenty countries by GDP in 1990, 2002 and 2012, radical changes occurred in the chart as the over mentioned countries rose dramatically and other countries which were critical for pharmaceutical industry reduced their specific weight in the balance of economic power. As it’s possible to assess through a rough analysis of the Word Bank data on Country GDP in 1990 United States of America played a prominent position followed by other mature markets such as Japan and several European powers.

22 LB 2011\2012 Year 1990

GDP - Nominal USD Country Million USD United States 5.800.525 Japan 3.056.093 Germany 1.584.917 France 1.244.597 Italy 1.138.996 United Kingdom 1.012.576 Canada 582.723 Spain 520.968 Russian Federation 516.814 Brazil 461.952 China 356.937 Australia 318.973 India 316.582 Netherlands 295.208 Korea, Rep. 263.777 Mexico 262.710 Sweden 244.414 Switzerland 238.213 Belgium 197.244 Austria 164.848 .6 Source: World Bank – Databank (2012)

After twelve years the status quo changed sharply with the progressive relative loss of importance by European countries such as Italy, France and Spain, which always have been important markets for pharmaceutical industry and the impressive growth of the People’s Republic of China which overtook six positions in twelve years.

23 LB 2011\2012 Year 2002

GDP - nominal USD Country Million USD United States 10.642.300 Japan 3.982.168 Germany 2.009.825 United Kingdom 1.611.763 China (+6) 1.453.828 France 1.453.049 Italy 1.225.072 Canada 734.662 Spain 686.247 Mexico (+6) 649.076 Korea, Rep. (+4) 575.929 India (+1) 510.726 Brazil (-3) 504.221 Netherlands 438.386 Australia 407.462 Russian Federation 345.110 Taiwan, China (NE) 301.098 Switzerland 278.621 Belgium 252.738 Sweden 250.961 .7 Source: World Bank – Databank (2012)

Ten years later, People’s Republic of China became the second biggest economy of the world with the outlook of overtaking the United States of America’s primacy which lasted almost a century and other countries such as Brazil, India and South Korea gained importance and positions making an important leap forward in terms of Gross Domestic Product amount and market attractiveness. In the 2012 there’s the first evidence of a changed paradigm: Western markets such as United States of America, Germany and France are still important but is inevitable for Big Pharma to shift its main focus from Western countries to the “new economic princes” to

24 LB 2011\2012 timely catch the new trend in order to be well established realities when the last step of the process33 countries will take place.

2012 Year

GDP - nominal USD Country Million USD United States 15.731.172 China( +3) 8.170.997 Japan 5.751.369 Germany 3.478.030 France 2.660.378 United Kingdom 2.438.117 Brazil (+6) 2.374.577 Italy 2.076.225 Russian Federation 2.023.533 India(+2) 1.826.637 Canada 1.803.342 Korea, Rep. (-1) 1.571.106 Australia 1.567.603 Spain 1.442.805 Mexico (-5) 1.185.427 Indonesia(NE) 932.896 Netherlands 805.925 Turkey 789.680 Saudi Arabia (NE) 633.087 Switzerland 611.911 .8 Source: World Bank – Databank (2012)

33 In the author’s opinion the new paradigm will culminate with the realization of the Chinese primacy and the overtaking of countries characterized by mature markets such as Japan, Germany and France by emerging markets as Brazil, Republic of Korea and Mexico.

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Analyzing the forecasted situation for the year 2014, through the World Bank databank data, the presence of several countries, which ten years ago were classified as under developed countries, such as Venezuela and Indonesia merges up outstandingly.

Year 2014 (est.)

GDP - nominal USD Country Million USD United States 17.209.390 China 10.755.278 Japan 5.165.256 Germany 3.517.292 Brazil(+2) 3.030.301 France 2.652.561 United Kingdom 2.548.435 Russian Federation 2.481.917 India(+1) 2.392.174 Italy 2.064.491 Korea, Rep.(+1) 1.923.000 Canada 1.913.342 Australia 1.658.488 Spain 1.427.868 Mexico(0) 1.410.923 Indonesia(0) 1.214.025 Turkey 1.011.392 Netherlands 824.332 Venezuela, RB (NE) 715.360 Saudi Arabia(-1) 682.973 .9 Source: World Bank – Databank (2012)

The attempt by new economic realities to undermine the primacy of western economies which defined the characteristics of the ninetieth and twentieth century capitalism is a

26 LB 2011\2012 direct consequence 34of two interacting elements : technological globalization and demographic growth of developing countries. The creation of new market opportunities brought by the coming of globalization for western companies gave, at the same time, the opportunity for developing countries to gain access to technological know-how which helped developing countries to grow technologically and consequently economically. According to the Economist Intelligence Unit study on technology and emerging markets: “[…] citizens of these countries won’t just be richer; they will be healthier and better educated, too.”35 On the demographic side, developing countries are experiencing a relevant growth triggered by improved life standards reducing mortality rate which gives to these countries an impressive supply of young workforce and a large market at the same time. The evidence of the likelihood of the birth of an “Emerging Markets Primacy” is given by the number of people involved in this ”economic revolution” as only India and China alone gather more than two billion people and the vast majority of the top twenty countries for population is made by developing countries experiencing a sharp economic rising at different stages.

YEAR: 2011 Country Name Population China 1.344.130.000 India 1.241.491.960 United States 311.591.917 Indonesia 242.325.638 Brazil 196.655.014 Pakistan 176.745.364 Nigeria 162.470.737 Bangladesh 150.493.658 Russian 141.930.000 Federation Japan 127.817.277 Mexico 114.793.341 Philippines 94.852.030

34 Economist Intelligence Unit, 2007, “ Path to growth: the power of technology in emerging markets”, The Economist, available at http://graphics.eiu.com/upload/Cisco_Path_to_Growth.pdf, consulted on the 28th of October 2012 35 Ibid

27 LB 2011\2012 Vietnam 87.840.000 Ethiopia 84.734.262 Egypt, Arab Rep. 82.536.770 Germany 81.726.000 Iran, Islamic 74.798.599 Rep. Turkey 73.639.596 Thailand 69.518.555 Congo, Dem. 67.757.577 Rep. .10 Source: World Bank – Databank (2012)

Summarizing, the technological evolution of developing countries will give a solid base for an economic blossom and for setting a new economic paradigm through the creation of an educated and skilled middle class which is incomparably larger than the mature countries ones as Chinese middle class alone accounts nowadays around 300 million people36, the overall population of the most populous Western country, and is expected to reach 520 million people by the 202537. Considering this unstoppable trend, which makes the emerging markets the zeitgeist of the new century capitalism, Western pharmaceutical companies are expected to penetrate efficiently these realities and settle down investing in order to overcome in a timely manner the organizing forces of domestic players as they can be a threat both domestically and internationally.

36 Luhby T., 2012, “ China’s growing middle class”, CNN Money, available at: http://money.cnn.com/2012/04/25/news/economy/china-middle-class/index.htm consulted on the 28th of October 2012 37 Farrell D., Gersch U.A. & Stephenson, 2006, “ The value of China’s emerging middle class”, McKinsey Quarterly, available at https://www.mckinseyquarterly.com/The_value_of_Chinas_emerging_middle_class_1798, consulted on the 28th of October 2012

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1.1.4 The global pharmaceutical market: competitive analysis

The global pharmaceuticals, as over mentioned, experienced a sharp growth in terms of innovation and market dimensions in the last century and it’s likely to continue its economic expansion in the 21st century. The market is expected to experience a stable growth in the period span 2010-2015, that will be slightly superior of the previous growth rate, after having accounted a 6.8% compound annual growth rate in the period 2006-201038, reaching a market value of $1.4 trln by the 201539. Actually the 2007 financial crisis affected the market only in 2010 when the growth rate after having registered rate over the 7% for three years in a row ( 2007-2009) decreased dramatically in 2010 accounting a growth of 4.6%. The industry breakdown shows that the most important market remains America capturing the 50% of the overall market value comprising the biggest mature market in the world, the United States of America one and several emerging markets located in South America such as Brazil and Argentina. The second area by market value still remains Europe also if the synergic effect of the economic downturn and the exponential growth of emerging markets, where people are ageing due for a new wellness and the buying power is rising, will be soon overthrown by the Asian-pacific countries that now are settled on the 19,9% of the pharmaceutical market value40.

38 Datamonitor, 2012, “Global Pharmaceuticals, Biotechnology & Life Science”, Industry profile, p.9 39 Ibid. 40 Datamonitor, 2012, “Global Pharmaceuticals, Biotechnology & Life Science”, Industry profile, pp.9-15

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GLOBAL PHARMACEUTICAL SALES AT EX-MANUFACTURER PRICES, BY REGION, 2006 USD Billion As % of Global Sales North America 290 47,7 United States 274 45,1 Canada 16 2,6 Europe 182 29,9 France 34 5,6 Germany 32 5,3 United Kingdom 21 3,5 Italy 21 3,5 Spain 16 2,6 Other 58 9,5 Asia/Africa/Australia 109 17,9 Japan 57 9,3 China 11 1,8 South Korea 9 1,5 Other 32 5,3 Latin America 18 4,5 Brazil 10 1,6 Other 8 2,9 Total 599 100,0 .11 Source: IMS Health 2007

The global marketplace of pharmaceutical products shows a similar situation in every segment of the marketplace that are recognizable as every single national pharmaceutical market: in every market there are domestic players that are both big and small-medium companies commercializing, usually, specialized product, i.e. some companies sells generic drugs while others are active on the over-the-counter products, competing with multinational companies that are all big corporations selling both OTC and prescription drugs. In terms of product categories, as 2006 OECD study assesses, that the top ten therapeutic classes account for the 36% of the overall sales. The breakdown of sales shows that Statins account for the 35% of the top ten therapeutic classes, followed by oncology therapies (34.6%), B-2 stimulants and corticoids(24,6%) and Proton pump inhibitors(24.1%).

30 LB 2011\2012 The role of generic drugs in the pharmaceutical industry is mixed: despite their diffusion worldwide, in some countries such as Italy, Spain or Ireland, represent only a minority of the market value ranging from 2% (Italy) to 5% (Eire), while in Asia Pacific country as well as in Turkey or Poland they catch the majority of market value (40%-65%)41, the reason of the different degree of penetration of generics lies in two causes: in some countries, government set a good policy to create a sound price competition which lowered the price of generic drugs and in other countries, where the generics have less success the price gap it’s risible as generic drug prices are higher. The process of realization of medicines is not different from other chemical products and is articulate in two phases: manufacturing and distribution. The manufacturing phase which is usually the core activity of the vast majority of pharmaceutical company comprises the bulk manufacturing of active pharmaceutical ingredients through chemical reaction, this process is usually internalized in MNCs and big players while it’s outsourced to chemical companies or laboratories by smaller companies. The second phase, never outsourced, is called F/F/F process, that is the flow of process spanning from forming the product combining the API with incipient ingredients to enhance efficacy, then processing the chemical product in its final form and then package it42. The distribution reality is divided in two segments: wholesale and retail; the wholesale segment is a sort of intermediate entity interfacing manufacturers to retailers and they could be full-line wholesalers, which presence is mandatory in Europe (at least one full-line wholesaler per country), that is capable to manage the stocking and the distribution phases in the distribution process, and the short-line wholesalers carrying small inventories of high-demand products. Retailers are licensed pharmacies and usually are the only retailers allowed to sell prescription-only drugs and in several European countries there are restriction for pharmacies ownership avoiding the creation of pharmacy chains unlike in USA and UK where large chains are widespread.

41 OECD, 2008, “ Pharmaceutical Pricing Policies in a Global Market”, OECD Health Policy Studies,p.64 42 OECD, 2008, “ Pharmaceutical Pricing Policies in a Global Market”, OECD Health Policy Studies,p.54

31 LB 2011\2012 The main global players are mainly four multinational companies: Pfizer Inc, settled on the 5.8% of the market share, Roche Holding AG retaining the 3.5% and the other two position are occupied by Novartis AG (3.1%) and Johnson&Johnson(2.2%).

1.1.5 Five Forces Analysis

The five forces analysis is an analytical tool provided by Michael Porter in 197943 useful to provide a better screening about market characteristics and to indentify market drivers which will outline the global market’s new trends. The degree of rivalry in the industry has changed together with the market dynamics: especially in the eighties and in the nineties too, the market was highly fragmented both under a global and a national point of view and there was an high degree of specialization with different companies processing only certain classes of drugs44 and the strong growth rate of the market avoided market saturation. In the new century the situation changed as several companies, in order to maximize their profits, expanded their product portfolio and their geographical reach; despite the market still remained highly fragmented, nowadays companies compete on a wide range of similar products. Moreover the diffusion of generic drugs enhances the market rivalry as it’s easier also for smaller companies to catch a percentage of market share offering drugs at lower prices. On the other hand the rivalry is weakened by the presence of large and established multinationals, often setting standards and having a prominent position in the market; some of them started in the last years processes of consolidation which lowered the degree of rivalry: the clearest examples are the Pfizer’s acquisition of the big company Wyeth in 2009 and the merger between one of the industry leaders, Novartis AG and Alcon in 2011 in order to create the largest eye care company.

43 Porter, M.E. (1979) How Competitive Forces Shape Strategy, Harvard Business Review, March/April 1979. 44 Mullins J., 2007, “ A Recent History of the Pharmaceutical Industry – Based on All Five Forces”, The New Business Road Test, Financial Times/ Prentice Hall; 2nd Edition, available at http://www.venturenavigator.co.uk/content/154 consulted on the 26th of September

32 LB 2011\2012 In the bio-pharma market the situation is similar of the pharmaceutical industry in the eighties one: companies are specialized in certain classes of products and compete on scientific discoveries, moreover the bio-pharma market is continuously growing during the last years assuring growth possibility to companies without striving for market share45. Also in terms of threat of substitutes, the situation has deeply changed with market maturation. In the eighties, such treat was almost inexistent because the relationship between the final user, the patient, and the product was completely mediated by the doctor who prescribed a specific branded drug without possibility of comparison; moreover the patent laws in Europe and North America were well enforced and the 17 years protection deterred other companies to develop generic equivalent drugs. The diffusion of technological devices together with the consolidation of the internet, which gives an easy and cheap tool to compare the price of products, and the rising predominance of emerging markets as the new main source of profits increased dramatically the threat of substitutes: first of all the possibility to compare prices, effects of similar products retailed by different companies partially dismissed the figure of the doctor as the only source of medical expertise; in secundis, the companies’ expansion in countries with law enforcement problems jeopardized the companies’ privative rights and offered to these countries’ patients cheaper alternatives through illegal copycat production or generic drugs retailed in infringement of patent laws as happened in India.46 The generic products are now widespread also in Western countries and are the main global substitutes to branded drugs as they are cheaper, as manufacturers are exempted from costly clinical trials relying on the efficacy data obtained by the product originator. Moreover the threat increased with recent cuts in healthcare in several European countries, overwhelmed by the economic crisis and by sovereign debts, tending to privilege generic drugs to branded one in their reimbursement lists47.

45 Datamonitor, 2012, “Global Pharmaceuticals, Biotechnology & Life Science”, Industry profile, pp.22-24 46 A.A.V.V., 2012, “ Taking Pains”, The Economist print edition, Sept 8 2012, available at http://www.economist.com/node/21562226 consulted on the 27th of September 47 Frye A., 2012, “ Monti’s Cuts may cost Italians new pills as drug firms protest”, Bloomberg BusinessWeek Online, available at http://www.businessweek.com/news/2012-07-04/monti-s-cuts-may-cost-italians-new-pills-as-drug-firms- protest consulted on the 1st of October 2012

33 LB 2011\2012 There is also a threat coming from the alternative medicine although its efficacy and safety is not proved by scientific clinical trials leaving doubts in the medical community and , for this reason, its characteristic of no prescription needed is likely to be compared to OTC products. Another important emerging substitute will be the bio-pharmaceutical version of chemical drugs that is gaining importance and efficacy through the time. Another proof of the increased difficulty in competing in the pharmaceutical market lies in the rising force of the threat of new entrants because the situation inside the market in the eighties and nineties was easier for company compared to now: considering the over mentioned patent law protection in western countries and the almost inexistent diffusion of generics, the barriers to entry were almost insurmountable because a new entrant needed to face a process of product development which required 12 years and more than $ 150 mln dollars 48to bring a product to trials and also in the post production stage several investments in sales forces and marketing activities were required to market a new product. Nowadays the expansion towards Asia Pacific market, due to the economic downturn which led to several reforms to contain the costs of the healthcare system in Western countries especially through the limitation of reimbursements, increased the likelihood of new entrants as in Asiatic countries privative rights are weakly enforced and contemplate a lower time of market exclusivity for the patent winner. Furthermore the expiration of several important patents created a strong market of generics which is, nonetheless, very developed in Asian countries as well as in Western ones, reinforcing the threat of new entrants for both MNCs and domestic players. In the bio-pharmaceutical sector, the situation is quite different as the market still relies on product innovation, process which contemplates long development periods, high fixed costs and uncertain profits avoiding almost totally the threat of new entrants. The supplier power force in a global marketplace is moderate as the main elements of supply are the active pharmaceutical ingredients.

48 Mullins J., 2007, “ A Recent History of the Pharmaceutical Industry – Based on All Five Forces”, The New Business Road Test, Financial Times/ Prentice Hall; 2nd Edition, available at http://www.venturenavigator.co.uk/content/154 consulted on the 26th of September

34 LB 2011\2012 The sources of APIs are two: companies can buy APIs from chemical companies or develop them internally. Usually MNCs are vertically integrated with a dedicated department or one or more wholly owned subsidiaries developing and providing APIs to the company in every part of the world, reducing greatly supplier power49. National companies, on the contrary, tend to obtain APIs from third parties and their strategy to mitigate supplier power is to have a wide portfolio of suppliers also if their force remains remarkable because contracts usually contemplate several years of collaboration with high switching costs. In the end, the buyers power has gained strength during the last years as in the nineties it was almost inexistent with branded drugs appeal over price-insensitive and almost uninformed consumer overwhelming every market force. Nowadays the buyer power depends on the market, in case it’s dominated by healthcare providers or drug retailers50. Drug retailers’ power is weakened by the need for a prescription while healthcare providers have an important power as they provide drugs for all the country healthcare system. The main measure for companies to reduce buyer power is patent protection which guarantees for some years an exclusivity on a particular product before expiration of patent protection and the appearance of generic versions of the drug which enhance greatly buyers power.

1.1.6 Industry Leaders

The industry leader is Pfizer Inc, a New York based multinational, founded in 1849 and grown exponentially through a policy of mergers & acquisitions especially implemented in

49 Datamonitor, 2012, “Global Pharmaceuticals”, Industry profile, pp.15-16 50 Ibidem

35 LB 2011\2012 the last twelve years with the Pfizer-Warner-Lambert51, a pharmaceutical group already became a big player through several acquisition of American drug producers and retailers, merger in 2000 and with the acquisition of Wyeth in 2009 when the listed company Wyeth became a wholly owned subsidiary of Pfizer who implemented a buyout with a subsequent delisting of the target company. This acquisition had a capital importance as Pfizer reorganized itself in two main market segments: biopharmaceutical and diversified; the first category comprises primary care, anti-cancer products and several drugs to treat cardiovascular diseases, nervous system disorders et al. The diversified products includes animal health products and over the counter products such as analgesics, cough & cold products and personal care items. The company is very active in R&D activities yearly setting aside a part of its net profit in these kind of activities in order to escape the logic of “cash cow products” and commercialize new solutions. Following this strategic purpose Pfizer created, after the Wyeth acquisition in 2009, two structures for R&D operating mainly in UK and United States of America called BioTherapeutics and PharmaTherapeutics and the corporation is expanding its research and development activities in emerging countries, namely in South Korea52. Pfizer Inc. operates in 81 countries with established manufacturing plants and retail networks, and in 2010 Pfizer Inc. accounted revenues for $67,8 bln with a double digit growth that is stable from 2006; however the economic downturn affected also the American corporation which accounted a sharp contraction on its profit margin growth from 2007, considering that in 2006 the figure was settled on 40%, settling on around 16,8% per year due to a considerably strong increase of liabilities with enlarged the debt/asset ratio and depressed the company’s profitability.

51 Pfizer History Timeline, available at http://www.pfizer.com/about/history/timeline.jsp consulted on the 2nd of October 2012 52 Pfizer Inc: Exploring Our History; available at http://www.pfizer.com/about/history/2000_present.jsp consulted on 2nd of October 2012

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.12 Source: Datamonitor (2012)

Also the Basel-based multinational company F. Hoffmann -La Roche Ltd, experienced a downturn in its profitability as the over mentioned problems of rising costs in new drugs development and the drop in private consumption in mature markets affected hard also the MNCs’ operating activities. The common aspect linking industry leaders such as Pfizer Inc, F. Hoffmann -La Roche Ltd and Novartis AG is a stable growth of liabilities with a sharp decrease of profitability. 53

53 53 Datamonitor, 2012, “Global Pharmaceuticals”, Company Profile, pp.24-45

37 LB 2011\2012 USD million

.13 Source: Datamonitor (2012)

The LaRoche’s revenues are settled on $ 47,1 bln in 2010 registering a decline comparing to 2009 results but the company managed to improve the depressed profitability that was dropping from 2007. The group divides its operating activities in two segments: pharmaceuticals and diagnostics; the first segment is managed by a group of wholly owned subsidiaries “labeled” as Roche Pharmaceutical except for Genentech in US and Chugai in Japan and active worldwide with retail network in 150 countries. The main products are both chemical and biochemical treatments for cancer, respiratory diseases , inflammatory and central nervous system diseases which are all prescription drugs. The diagnostics segment is particularly successful in in-vitro diagnostics to test blood for preventive diagnosis and offers services and products for both genetic researches and blood monitoring. The third-ranked industry leader is Novartis AG, a Swiss multinational based in Basel, which is the only one that was able to maintain the growth of its profit margin assuring a growing profitability for shareholders and stable funds to invest in R&D and in asset.

38 LB 2011\2012 As a matter of fact Novartis raised its exposure to debts but contained the debt\asset ratio maintaining an high level on investments in asset especially in emerging countries54.

.14 Source: Datamonitor (2012)

Novartis AG organizes its activities in four categories: pharmaceuticals, vaccines and diagnostics, Sandoz and consumer health. Sandoz is the name of the wholly owned subsidiary which commercializes Novartis’ generic pharmaceuticals, works in the production of active elements providing Novartis of APIs (active pharmaceutical ingredients) and supplies to third parties. The pharmaceutical division researches, develops, produces and retails branded drugs in all the main treatment areas and operates globally; the vaccines and diagnostics division is in charge from the 2006 of manage the whole value chain of vaccines, especially meningococcal and influenza vaccines, of blood screening tools. The consumer health deals with one of the most emerging segments in the pharmaceutical industry that is the over the counter medicines together with animal health and the marketing of lenses and lens care products.

54 Datamonitor, 2012, “Global Pharmaceuticals”, Company Profile, p.31

39 LB 2011\2012 1.2.1. The remarkable role of corporate governance in the globalisation process

“The literature shows that good corporate governance generally pays—for firms, for markets, and for countries. It is associated with a lower cost of capital, higher returns on equity, greater efficiency, and more favorable treatment of all stakeholders, although the direction of causality is not always clear. The law and finance literature has documented the important role of institutions aimed at contractual and legal enforcement, including corporate governance, across countries. Using firm-level data, researchers have documented relationships between countries’ corporate governance frameworks on the one hand and performance, valuation, the cost of capital, and access to external financing on the other. Given the benefits of good corporate governance, firms and countries should voluntarily reform more. Resistance by entrenched owners and managers at the firm level and political economy factors at the level of markets and countries partly explain why they do not.”55 This abstract taken from Stjin Claessens’ “Corporate Governance and Development” synthesizes perfectly why corporate governance will be the critical tool to transform attractive market such as Republic of India, People’s Republic of China or Republic of Korea in stable and secure markets where pharmaceutical companies could invest more in order to re-launch innovation and defend the continuous growth the industry experienced in the twentieth century. At the same time is important to identify what is corporate governance. There are several way to define corporate governance: Robert Ian Tricker gives a clear definition of corporate governance in his “ Corporate Governance: Principle, Policies and Practices” stating that “ Essentially, corporate governance is about the way power is exercised over corporate entities. It covers the activities of the board and its relationships with the shareholders or members, and with those managing the enterprise, as well as with external auditors, regulators, and other legitimate stakeholders”56.

55 Claessens S., 2006, “ Corporate Governance and Development”, The World Bank Research Observer, Vol.21, No.1, p.1 56 Tricker B., 2012, “ Corporate Governance: Principle, Policies and Practices”, Oxford University Press, p.4

40 LB 2011\2012 Tricker depicts admirably the idea of corporate governance and dates back it to a noble birth: the Shakespearian play “The Merchant of Venice” (1597), where the British play- writer identifies the struggle of the agency problem, expressed in the separation between ownership and control, depicting Antonio’s deep anxiety watching his ships sailing out of the harbor, having entrusted his property to others. From this definition it’s possible to sort out the two main theories which propose respectively a broader and a narrower vision of the categories involved in the corporate governance and for who the company has to create value: the stakeholder theory and the shareholder theory. The stakeholder theory made its first appearance in the thirties of the twentieth century when General Electric identified four main groups of stakeholders: the shareholders, the employees, customers and the social environment in general. The stakeholder theory isn’t a unique theory but comes up, and is analyzed, by different economic areas such as corporate planning and different theories as systems theory, corporate social responsibility theory or organizational theory but the first organic theory is formalized by Freeman stating the existence of a cosmos of interests around the company which rights couldn’t be ignored due to their legitimacy.57. The stakeholders are represented by different individuals, groups of people or organizations and mainly they are:

- Customers - Suppliers - Lenders - Employees - Shareholders - The State and social environment

57 Zattoni A., 2006, “ Assetti Proprietari e Corporate Governance”, EGEA, pp.70-74

41 LB 2011\2012 The narrower vision of corporate governance is set in the shareholder theory, which one of the main endorser is the economist Milton Friedman, stating that the only privileged beneficiaries of the company’s activities are shareholders for two main reasons: in primis, shareholders bear the risk of economic activity being remunerated in a residual way while the other categories of stakeholders are compensated with periodical and fixed amount of money; this situation embodies also an important disciplinary tool because shareholders are directly committed in enhance company’s performance “deserving” the right of strategic guidance. Moreover shareholders are the most exposed to agency hazards such as events of dispossession perpetrated by the management as they are the less protectable through a contractual solution as they expose their investment totally at the risk of loss while other categories can be juridically protected. The two contrasting theories are based on the same vision of the enterprise as a network of contractual relationships but they have different visions about the efficiency and the role of controller carried out by the market as the stakeholder theory contrasts the basis of shareholder theory which are:

- The maximization of shareholder leads to the maximization of the whole enterprise value - Efficiency of financial markets: the stock price is a real indicator of enterprise value becoming the best value indicator - Maximizing shareholder value is the best disciplinary tool to apply to management behavior58 - Management tends to strive for maximization of shareholder value if their prizes are monetary - Market for Corporate Control disciplines the top management as if the company underperforms it becomes subject to likely takeovers - The shareholders’ primacy over other stakeholders which creates upon directors a duty of loyalty and a duty of care towards shareholders.

58 Because of the efficiency of Capital Markets

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On the contrary, the stakeholders theory refuses these axioms stating, prosaically, that it’s impossible to assess the proper contribute of every stakeholder so the contractual solution is not always satisfactory, market prices aren’t a sound value indicator because of information asymmetries and the market for corporate control works perfectly as a disciplinary tool only theoretically as directors can set anti-takeover measure to create a shelter against change59. Analyzing the context in emerging markets, especially in our case studies in People’s Republic of China, India and South Korea, merges up how transparency and regulatory frameworks are far from ensuring pre-conditions for shareholder theory to be applied. In all the three countries which will be analyzed it’s possible to find inefficiencies such as lack of disclosure, conflict of interests and, consequently, inefficient financial markets and a barely inexistent market for corporate control (which are a common features of People’s Republic of China, India and Republic of Korea). Another reason which avoided the application of a shareholder value maximization in past times is the kind of model of corporate governance adopted by those countries: the socialist past of China and India created, for different reasons and through different paths, fertile conditions for the blossom of stakeholder value maximization philosophy. In the Chinese case, the party’s intelligencija, led the economy to undertake a path leading to a Sinitic version of the German model which is fully orientated towards the satisfaction of every stakeholders’ request, while in India, as a part of the Commonwealth, is legally and economically inspired by the Anglo-Saxon model but the socialist policies implemented for more than forty years from the Independence Day in 1947, created a widespread awareness on the importance of the role of stakeholders and the role of the company for the nation, as a matter of fact the economic system was mainly made by state- owned enterprises. Lately, the three states undertook a path of convergence towards the Anglo – Saxon model recognizing it as the most efficient, implementing several reforms in term of codes of corporate governance and legal reforms, which will be explain properly in the next

59 Zattoni A., 2006, “ Assetti Proprietari e Corporate Governance”, EGEA, pp.68-78

43 LB 2011\2012 chapters, in order to embrace the shareholder value philosophy and attract foreign investments. The process is, however, long-lasting because, as the abstract outlines above, managers and often also owners tend to make lobbying activities to avoid major change in the establishment or macroeconomic factors prevent the corporate governance development. One of the most severe inefficiencies defending their status and avoiding corporate governance reforms in several emerging countries lies in the agency dilemma60 defined, country by country, by the way how the property is aggregated. The principal-agent issue, archaic dichotomy as over mentioned, was formalized for the first time by Means & Bearl in 1932 stating, after an analysis on listed companies, that as companies grew and shareholders become more diversified, the separation between ownership and control increase centralizing power and diminishing the soundness of monitoring on directors61. According to LaPorta’s Law & Finance theory62, the ownership structure is linked to the legal framework of the country stating that the weaker the legal framework is the more concentrated are the ownership patterns. This kind of legal-economic behavioral pattern is meant to mitigate the risk of agency events as in weaker legal environments, shareholders have less possibilities to protect themselves from action of impoverishment perpetrated by managers which are likelier to do so. The ownership structures, together with legal frameworks, defines two systems: the outsider system and the insider system. The outsider system, typical of United States of America and United Kingdom, is based on fragmented ownership of public companies, where conflicts between managers and outside owners are central (i.e. Enron scandal), and high degree of shareholders protection is intended to settle them, totally fitting with the shareholder value philosophy while in other parts of the world the main model is the insider system based on high concentrated,

60 Agency issue is defined as “ whenever the owner of wealth ( the principal) contracts with someone else (the agent) to manage his or her affairs”(Tricker 2011) 8a 61 Berle A. and Means G.C., 1967, “The Modern Corporation and Private Property”, Brace and World, New York 1967 62 La Porta R., et al., 1998, “Law and Finance”, Journal of Political Economy Vol. 106, no.6

44 LB 2011\2012 pyramidal ownership with low level of shareholder protection with a marginal role for the financial market. The legal system is common law that base its decisions on prior judicial pronouncements instead of basing them on legislative enactments differentiating to the civil law systems, typical of Latin countries and insider systems in general, which derives its decisions on written codes. The typical ownership pattern of insider system is based on family-owned firms through direct ownership, through other companies or through webs of shareholdings such as Peugeot in France, Quandts in Germany, powerful families linked with government such as in South Korea or Communist party member or government members in general in People’s Republic of China and the Republic of India. In the insider system, separation between ownership and control doesn’t exist but there are several conflicts between majority and minority shareholders as the last ones can’t exercise the “exit” option because financial markets are inefficient and they have also little power exercising the “voice” option. Especially in emerging markets this kind of conflict has a particular relevance because there is a complete absence of special provisions and protection of minority rights as it is in Germany or in Japan.

1.2.2. The relation between emerging markets and corporate governance

Emerging economies is a term which was coined by the International Finance Corporation in order to define a list of developing countries where foreign investors could buy securities and lately was applied to every country transforming from a developing to a developed nation comprising several kind of nations regardless the stadium of development and the speed of the process63.

63 Pillani R.K., 2009, “ Multinationals and emerging markets”, Business Strategy Series, Vol.10, Iss:2, pp.100-103

45 LB 2011\2012 Emerging economies are defined also, by the Center for Knowledge Societies, as countries that “ are experiencing rapid informationalization under condition of limited or partial industrialization”64 The FTSE made a sharp distinction separating countries in three categories dividing those which already now are consolidated industrial and economic realities and attractive markets to other countries having lower standards of living and lower economic performance but abundance of natural resources and, again, from those developing countries which have for some reasons are considered to have similar risk and return profile as emerging markets but they are small emerging or backward countries. The first category is labeled by FTSE as Advanced EM comprising Taiwan, Brazil, Mexico, Poland, Hungary and South Africa; the second category is the Secondary EM including Argentina, Chile, People’s Republic of China, Colombia, India, Indonesia, Malaysia, Morocco, Pakistan, Peru, Russia, Thailand and Turkey while the borderline category is the Frontier Markets with countries such as Albania, Bahrain, Botswana, Croatia, Estonia, Ivory Coast, Lithuania, Nigeria, Qatar, Serbia, Vietnam. Emerging countries are the strategic target and the hope, at the same time, for several industries and for the pharmaceutical market too as they are becoming the growth drivers of the global market, providing greater purchasing power to their citizens and creating a new middle-class willing of fill the gap between western lifestyle and theirs through consumerism. This emersion of new buying power is possible because these countries experienced in the past decade an impressive growth which make them account now for one third of the global gross domestic product65 changing radically economic and political dynamics. The increasing importance of emerging markets varies accordingly to the regions but they share the characteristic of benefitting from the globalization trend triggered by technological changes and trade-policy liberalization. Another common aspect of emerging markets is the strong will and need of sustain the growth process they are going through and to attract foreign investments, goal that is

64 Wankel C., 2009, “ Encyclopedia of Business in Today’s World”, SAGE Publications,Inc, July 2009, pp 585-588 65 V.V.A.A., 2011, “ Emerging Markets Snapshots”, NTK Numbers, available at www.directorship.com consulted on the 4th of October 2012

46 LB 2011\2012 possible to achieve focusing on soundness in corporate governance for several reason as a good corporate governance framework:

1.Increases access to external financing by firms, leading consequently to greater investment, higher growth, and more employment creation as a sound property rights protection create trust in owners and investors which are more likely to operate in the financial market, the first category, partially abdicating to direct control in favor of less costly cost of financing66, and the second category relying on the easier marketability of shares in case of disagreement with strategic guidance.

2. Lowers the cost of capital and associated higher firm valuation, which makes more investments attractive to investors and leads to growth and employment as conflicts between controlling and minority shareholders are higher in contexts of weak corporate governance, for example in the Republic of India, and investors wants higher rates for financing the company as they can’t have a proper rate of return investing in shares. Moreover is proved that investors tends to discount their firm evaluation for companies with poorer corporate governance67 making this kind of investments less attractive

3. Provides better operational performance, through a more efficient allocation of resources and management, which creates wealth; the main reason is the mitigation of agency costs and is also consequential to the lower cost of capital and the easier access to external financing which provide a good corporate governance framework.

4. Reduces the risk of financial crises, a particularly important effect, as financial crises can impose large economic and social costs, because corporate governance is a disciplinary

66 La Porta R., et al., 1998, “Law and Finance”, Journal of Political Economy Vol. 106, no.6 67 Doidge C., Karolyi G.A. & Stultz, 2007, “ Why do countries matter so much for Corporate Governance?”, Journal of Financial Economics, Vol.86, Issue.1, pp.1-39

47 LB 2011\2012 tool avoiding expropriation, ensuring shareholders’ property rights protection and affecting firms’ behavior in term of risk-taking. This issue is particularly relevant considering the recent corporate scandals such as Enron, Arthur Andersen, Parmalat and Satyam Computer Services, showing that these events are widespread in both developed and developing countries, creating crises of trust and confidence among investors generating stock markets declines and high social costs such as massive lay-offs

5. Creates better relationships with all stakeholders, which helps improve social and labor relationships and areas such as environmental protection: this consequence is the result of adopting the point of view of the stakeholder theory. Focus company’s attention on stakeholders’ requests can be a costly decision but, on the other hand, can deliver superior performance to the company or adopting a contingency approach can draw closer suppliers or customers helping company in its operating activities. Moreover corporate governance, in its social declination, helps the company in be “socially-friendly” with the Corporate Social Responsibility smoothing contrasts with employees, trade unions and State in general which generates a decrease in social costs for both Social system and company68.

1.2.3. The process of convergence towards archetypical models

During the analysis of the corporate governance changes in People’s Republic of China, Republic of Korea and in Republic of India of the following chapters, a path of convergence in corporate governance codes and frameworks will merge up.

68 Claessens S., 2006, “ Corporate Governance and Development”, The World Bank Research Observer, Vol.21, No.1, pp.9-10

48 LB 2011\2012 This trend is consolidating as the globalization is firmly establishing creating a global marketplace; it’s possible to univocally define convergence as “ increasing isomorphism in the governance practices of public corporations from different countries”69 The main unity of measures for convergence are kind, dimensions and directions: the kind of convergence identifies mainly two different kind of convergence: in form( or de jure) and in function (or de facto); - In form: a convergence related to similarity of legal framework or corporate governance code (as it’s happening in Republic of India) - In function: when in a country some practices of disclosure and disciplne are in use although are not codified; defined by La Porta as “ decentralized, market-driven changes at the firm-level”70

The direction of convergence is the way to identify towards which model of corporate governance countries are going to: the most common event it’s possible to record it’s the shifting from an insider system towards an outsider system also if, in most of cases, the change is at an institutional level rather than a firm level which is the dimension of convergence, the third unity of measure. The institutional level comprises changes in regulatory frameworks or in corporate governance codes, as Chinese economy is experiencing and South Korea experienced in recent times; usually this kind of change doesn’t affect immediately and deeply the economic system of countries as companies are usually resilient to abandon the status-quo, especially groups of owners are suspicious of abdicating the absolute control of their companies. Changes at firm level, the other dimension of convergence, usually determine convergence in function. As Rasheed and Yoshikawa (2011), stated the effects of convergence are result of the force of drivers and impediment to convergence on the institutional and firm level.

69 Rasheed A.A., & Yoshikawa, 2012, “ The Convergence of Corporate Governance: Promise and Prospects”, Palgrave Macmillan, p.3 70 La Porta R., et al., 1998, “Law and Finance”, Journal of Political Economy Vol. 106, no.6

49 LB 2011\2012 The most powerful drivers to convergence are linked with the process of economic globalization leading to a financial and commercial market integration: is not unusual in the pharmaceutical market, for example, to account cross-border mergers and acquisition, especially in the last years when the Big Pharma strived to enhance the penetration power for its products in the Asian Pacific countries and in Latina America71 and to companies listings in foreign markets working with relevant amount of different currencies and different regulations which gradually will converge under the effects of lobbying actions. Also commercial forces helped and are operating towards a process of convergence in institutional and corporate levels: the free-trade agreements lowered the barriers to operate in different countries and several governments tried to attract companies and, consequently, investment setting favorable conditions for companies and converging to the Anglo – Saxon model (i.e. South Korea and India). The convergence towards a specific model of corporate governance is boosted also by the diffusion of code of corporate governance: they contribute to convergence in two ways, “voluntarily”, when , for example, government wants a country to effectively converge to the Anglo – Saxon model and imposes Anglo – Saxon regulations and in lato sensu, which happens when a developing country or a “frontier” country start to improve their business regulatory framework publishing a code inspired to international codes like the 2004 OECD Principles of Corporate Governance, which are modeled on shareholder value principles which are peculiarities of a particular model of corporate governance contributing indirectly to convergence. However, despite corporate governance convergence is an unstoppable, emerging situation, in several cases the process is delayed by forces of resistance. The main sources of resistance identified by the corporate governance literature comprises evolutionary nature in conformation of social systems determined by historical dynamics and events that are country specific and non-imitable which creates differences also in

71 Kang N. & Johansson, 2000, “ Cross-Border Mergers and Acquisitions: Their Role in Industrial Globalisation.”, OECD Science, Technology and Industry Working Papers, OECD Publishing, pp.1-41

50 LB 2011\2012 countries adopting the same corporate governance model and the same cultural background such United Kingdom and United States of America72. Another element of disturbance in the corporate governance convergence is identifiable in the characteristics of the dynamics of functioning of a national socio-economic reality: the economic, legal and political dynamics are strongly tied together and it’s possible that operate in one aspect of the society alone in order to increase its efficiency can lead to an overall loss of efficiency of the whole systems because of high transition costs. The process of convergence can be slowed down also by the conformation of ownership structure which, as LaPorta stated in his Law & Finance theory, is affected by the property rights regimes, that is the way property rights are defined and enforced in every country. In primis, in countries were property rights are poorly enforced, as most of all emerging markets such as Republic of India or People’s Republic of China or several European countries, the ownership patterns presents situations of property rights aggregation to protect owners to the uncertainty of legal protection: in these cases to boost, or even make convergence feasible, government needs to implement a legal reform to avoid long time in trials resolution and backlog of lawsuits which is a difficult and time-consuming process. In secundis, in countries where ownership structures are aggregated on family groups or property is individual there are strong activity of resistance against changes as these so- called interest groups try to defend the status quo. Also if the national economic system works in sub-optimal conditions, interest groups oppose fiercely to changes as the possibility of reduction in private benefits is high; moreover, considering that interest groups are usually politically powerful in both European and emerging markets, a potential convergence could be really time-consuming. In the end there are two country-level variables affecting the likelihood and the timing of corporate governance convergence: the consensus on a chosen model and economic nationalism. The first variable identifies the possible disunion among decision makers on a chosen model to converge to, as a corporate governance system which represent the optimum

72 Rasheed A.A., & Yoshikawa, 2012, “ The Convergence of Corporate Governance: Promise and Prospects”, Palgrave Macmillan, p.11

51 LB 2011\2012 doesn’t exist (i.e. the Anglo – Saxon model, which is one of the most widespread has several problems in terms of agency costs as well as the European standards such as the German model has problems with minority shareholders property rights). Economic nationalisms can be another hurdle to convergence as trends like globalization and international legal harmonization are not unanimously accepted and welcomed because they are seen as attempts to expropriate weaker nation from their political sovereignty, consequently every instance of change needs time to be considered and often opposed.

52 LB 2011\2012 2. The Republic of Korea

The Republic of Korea experienced a strong economic development based on exportation between the 1960 and the 1990, in the aftermath of the Korean War. Since the 1960 the growth model adopted by the Republic was a state-led one until the liberalization occurred in the early years of the 90es: Korean government created “from the basement” brand new domestic industry which one of the most relevant was the chemical in which is comprised the pharmaceutical industry that is still a competitive and interesting market for domestic and international companies. The Republic of South Korea has its roots in 1948 when, after ten years of Japanese occupation, the Korean peninsula were divide in a communist country ( North Korea) and in a US-influenced country (South Korea) and had to cope with a North Korean invasion two years later which was the spark to the Korean War lasted three years. From 1960 South Korea adopted an autocratic regime under the leadership of General Park that undertook a path of economic reform transforming South Korea in an export oriented country. The main policy countermeasures to fight the effects of a war aftermath were investments in education increasing the literacy rate and putting the base to defend and enhance the quality of a economic future uprising created by the structuring of a labor-intensive manufactured\outward-looking economy73. The economic growth was fully state-led with government implemented a series of five- year plans based on incentives to business, centralized fiscal policy and a devaluation of domestic currency resulting in thirty years of stable GDP growth of 9% and a commodity trade volume rising from 480 million US dollars in 1962 to 127.9 billion US dollars in 199074 Main pillars of economic growth were the business groups, better known as chaebols, created by the Korean government intendment to individuate which industries to develop at

73 Datamonitor, 2011, “Country Analysis Report: South Korea”, Political landscape, p.38 74 Ibid. pag.43

53 LB 2011\2012 most allowing only a selected number of firms offering them low-interest loans and tax incentives. Chaebols were a private alter-egos of state-owned enterprises as this kind of business groups were highly functional to operate with their business branches maintaining a unity of control. The main chaebols were always been Samsung Group, LG Group, Hyundai Kia Automotive Group, SK Group and GS Group accounting for half of South Korea’s GDP. The impressive expansion of business groups was totally linked with the exports explosion in the decades 1960-1990 with government guaranteeing on Chaebols stability “inflating” low interest loans in order to widen the companies’ productivity and sustain the exportation growth. In the eighties the government tried to alleviate the burden of a strong central direction promoting a support focused on financial incentives such as tax-free reserves allowing chaebols to invest in R&D in a competitive way: in these years LG and Samsung started to create the conditions to be leaders in technological goods and semiconductors. In the 1990s after forty years of a state-led economy, South Korea started a process of economic and financial liberalization which was boosted in 1993, leading to heavy consequences in the 1997 Asian crisis. During the financial liberalization, in order to embrace the overcoming wave of globalization, the Republic of Korea shifted rapidly from a developmental state75 to the archetypical weak state of the liberalist model: the government role in enhancing economic development was sidelined, the amount of short-term foreign debt rose dramatically and Koreans tried to built from the basement an orthodox Anglo - Saxon economic model in South Korea.

75 Johnson (1982) coined the term ‘developmental state’ to describe the institutional foundations of the relationship between the state and the market which underpinned the rapid industrial development of post-war Japan. He identified the five key features of the developmental state model as: the prioritization of economic growth and production over all other goals; the existence of a small, inexpensive but elite bureaucracy, staffed by the best managerial talent in the system; concentration of bureaucratic talent in a pilot agency charged with the task of industrial transformation; a political system in which the bureaucracy is given sufficient scope to take initiative and operate effectively; and implementation of policies by virtue of institutionalized cooperative relations with business and control over key resources such as finance (Johnson 1982: 305–24).

54 LB 2011\2012 The government in the period span 1990-97 liberalized the exchange rate management, the foreign borrowing activities of financial institutions and opened Korea’s doors to a free establishment of merchant banks. In the end, the non-intervention policy on the exchange rate affected deeply Korean competitiveness on exportations (especially the semiconductors industry, the most relevant one) , the possibility to borrow funds overseas without a central “green light” signal created a harmful maturity structure of Korean debts as they were almost all short-term.76 The number of new merchant banks rose sharply and all of them performed in a complete different way to the old established six that arrived in the 70s77 that were high lucrative, exacerbating the Asian crisis of 1997. The Asian republic undertook several regulatory and economic reforms in order to escape the crisis, softening the liberalization path but insisting on the shifting towards a free market system and received a bailout of 55 billion US dollars. The bailout loan was subjected to preconditions for economic restructuring such as monetary and fiscal tightening and a capital market and trade liberalization together with a deep reform of chaebols78 South Korea recovered sharply from the 1997 crisis but then the structure of its debts , that accounted for the vast majority of foreign debts, put the country on another threatful position as its banking system became vulnerable to the global credit crisis and the national financial sector needed a financial rescue package of 130 billion of USD in order to stabilize market. Government undertook in 2004 a process of support to corporate sector with a particular focus on small-medium enterprises which account, despite to the prominent role of chaebols in terms of economic and political power, for the 99,8% of firms, 87% of employment and 50% of manufacturing output79 and were affected in a greater way by the depressed consumption created by the 1997 Asian financial crisis and by the unbearable

76 Thurbon E., 2001, “ Two paths to financial liberalization: South Korea and Taiwan”, The Pacific Review, Vol.14, No.2, p.6 77 Ibid. p.7 78 “Chaebols are large multinational family-controlled conglomerates in South Korea, which have enjoyed strong governmental support.”( Emerging Market Spotlight, 2010, Thomas White International, Ltd) 79 OECD, 2005, “ OECD Economic Surveys – Korea”, OECD Publishings, Volume 2005/21 – Nov.2005, pp.153-155

55 LB 2011\2012 debt situation created by the 90s liberalization with debt\equity ratio ranging from 100% to 400%.80 The main measure in fighting SME decline were the creation of two public entities, Korea Credit Guaranteeing Fund and the Korea Technology Guarantee Fund, guaranteeing on corporate loans only for viable companies while deciding not to support the non-viable SME in order to start a process of restructuring of the whole sector.81 The support to the corporate sector reinforced the economic tissue demonstrating a great resilience as after the economy downturn in 2008-2009, when Korea was severely affected because of the cyclical nature of high-technology products and the depression of international trade, the GDP bounced back to a growth rate of 6.1% in 201082. Other important reasons were the irrelevance of the exposure of Korean banks to sub- primes, the depreciation of the Won83, which boosted again exportations giving new competitiveness to Korean products, and the stimulus policies undertook by PRC which supported Korean exportations in China mainland: all these factors gave new force to domestic demand.

80 Ibidem 81 Kang K., 2006, “Overview and macroeconomic issues – Outlook and reforms for the Korean Economy in 2006”, Keia Publishing, pp.1-4., available at http://www.keia.org/sites/default/files/publications/10kang.pdf consulted on the 4th of September 2012. 82 Datamonitor, 2011, “Country Analysis Report: South Korea”, Overview, p.2 83 “Domestic banks, which had accumulated large external debt in the years prior to the crisis, found it difficult to roll over these loans given the global liquidity crisis. These adverse developments put additional downward pressure on the won, which by the first quarter of 2009, was 31% below its year-earlier level, the second-largest drop in the OECD after Iceland” (OECD Ecomomic Surveys: Korea, pag.22)

56 LB 2011\2012

.15 Source: World Bank – Databank (2012)

South Korea is also known to benefitting from a stable and centralized political system in which the president is the main reference for economy and politics and , has stated before, SK has a resilient economy that experienced a sound increase in private spending, investments and demand for exports. The main threat in terms of economical stability is the situation of SMEs that have weak fundamentals as they were sustained through the IMF bailout loan and never restructured their debt situation, so they are highly indebted with a high probability of default in case the financial situation get worse.84 Comparing to the Chinese and Indian situation, South Korea shows a more mature economic structure, closer to a western country than an emerging one with a light primary sector impact on GDP, a reducing secondary with the 24,3% of the GDP, although South Korea remains the largest producer of semiconductors in the world and still has a dominant position in exports, and an expanding services sector accounting for more than a half of national GDP (68,4%)85. The employment structure experienced a major change from 1960, when the vast majority of Koreans were low-skilled workforce employed in the primary sector, with an increasing percentage of skilled, high educated workers operating in tertiary sector. The unemployment rate reached its acme during the 1997 financial crisis with a rate of 8% and

84 Datamonitor, 2011, “Country Analysis Report: South Korea”, Economic Analysis, p.8 85 Datamonitor, 2011, “Country Analysis Report: South Korea”, Economic Landscape, pp. 49-50

57 LB 2011\2012 then decreased with a worsen in 2009 with a 3.7% rate due to the global economic downturn86. In the near future South Korea is expected to endure in the process of recovery from economic downturn, especially for the benefic effects of expanding international exports stimulating business investments, (already above the pre-crisis level87)and an increase in average wages. Moreover government declared in January 2009 that will foster the development of five service sectors: healthcare, education, green financing, contents and software and convention and tourism. Other important measures will comprise eliminating entry barriers, reducing barriers to trade and support new flows of FDI in order to ease the possibilities of starting new businesses, in “compliance” with the 2004-2005 objective of restructuring the SME sector, and the streamlining of anti-competitive regulations following OECD provisions. One of the most important aspect of South Korean economy is the heavy investment both public and private in R&D, spending the 3.2% of GDP88 and the attention to foster R&D in Korea paid by government.

86 Ibid., pp.56-57 87 OECD, 2010, “ OECD Surveys – Korea”, OECD Publishings, Volume 2010/2012, June 2010, p.27 88 Ibid., p.36

58 LB 2011\2012 2.1 Corporate governance evolution

The corporate governance system went through a process of reform in South Korea in order to give the country an important tool to strengthen an economic system recovering from the dreadful crisis of 1997. Formerly the corporate governance model was totally based on an insider-system model with the overlap between ownership and control exercised by small group such as families or banks. The corporate governance model was close to the French one benefitting from rare cases of agency problems and a better focus on long term value but on the other hand the system was susceptible to problems of transparency, a total absence of a market for corporate control and minority shareholders rights infringements. The main economic paradigm in South Korea was, and is still nowadays, the Chaebol, the Korean version of Japanese Keiretsu. The first corporate governance model was completely stated by the Korean government which implement a state-led development for South Korea: the nationalization of banks gave the government a tool to drive the development in specific industries through the allocation of low interest and long maturity loans to strategic companies, namely chaebols, groups which became large and diversified as they were fostered by government to operate in certain industries such as heavy industries and semiconductors89 The reason of structuring an insider-system lies in the goal of the government in creating a stable system after the Korean war: main companies controlled by business-families with strict connections with the government were easy to control and to defend from Communist uprisings and from systemic crisis. Especially in the period span 1960-1980, business-families owning chaebols were heavily supported by government with funds, and in exchange, they were expected to act as import-

89 Kang N., 2010, “ Globalisation and Institutional Change in the State-Led Model: The case of corporate governance in South Korea”, New Political Economy, 15:4, pp.14-15

59 LB 2011\2012 substituting in several industries and drive exports creating a heavily indebted, systemic- companies-dominated corporate sector. The close ties between politics and economy in South Korea resulted in a new wave of change in the middle of 80s, especially from 1986 when the constitution was changed to allow direct election of president after years of military government90 The government disengaged from the direct influence on chaebols through financial institutions, the system slowly shifted in a market economy system with a new privatization of banks, the liberalization of non-financial institution, showing the first proofs of a will to converge towards the Anglo – Saxon model. The liberalization brought a new autonomy to chaebols’ managers giving them new opportunity of investment and development together with a new focus on the short term: the period between late 80s and the crisis occurred in 1997 is called “the managerial uni- lateralism”91 as the accountability given to the stakeholders or state was almost inexistent increasing the cases of misconduct thanks to the weak corporate governance framework that supported in previous years on the relation state-corporate sector. When in 1997 the Asian crisis reached its peak, the dangerous synergic effect of “short- termism” and weak corporate governance foundations led to a the financial leverage of chaebols which was completely out of control; “In particular, by the end of 1997, the debt/equity ratio of the 30 largest chaebols reached 519%, about 130 percentage points higher than a year earlier. Owing to the high leverage, the ratio of financial expenses to sales in Korea is three times as large as in Japan or in Chinese Taipei”92, and the situation ended with the default of nine Chaebol, among them also the large KIA group. The Chaebols, and the country situation in general, led the government to undertake a wave of changes in several main areas such as corporate governance, financial sector, labour market and chaebols. Actually the corporate governance reform in Korea failed in reaching its goal to converge toward a “global standard”.

90 Datamonitor, 2011, “Country Analysis Report: South Korea”, Political Landscape, p.34 91 Kang N., 2010, “ Globalisation and Institutional Change in the State-Led Model: The case of corporate governance in South Korea”, New Political Economy, 15:4, p.19 92 OECD, 2001, “ Corporate Governance in Asia,” OECD publishing, p.158

60 LB 2011\2012 In the aftermath of the 1997 financial crisis the Korean academic world argued that corporate governance global standard existed and a process of convergence was needed in order to solve inefficiencies in chaebol governance and to attract again foreign investments in a country that was slowly sinking under the burden of debts. The main incoherence made by Korean institutions was to adopt blindly the anglo-american corporate governance model not considering the Korean institutional and economic context: the American corporate governance model has the centrality of shareholder value, dispersed ownership of public companies, board of directors independence, a functioning stock market and , consequently, a sound market for corporate control as the main features while the Korean economic structure is based on big groups with a concentrated ownership similar to the European countries such Germany and France rather than Anglo – Saxon countries. This discrepancy between “reality and model” brought to several frictions inside the companies, especially between the controlling families and minority shareholders that are usually foreign investors, as the power of non-controlling shareholder were enhanced.93 The regulatory reform implemented to converge towards the Anglo – Saxon model comprised peculiar features: first of all the board restructuring required the appointment of INEDs for listed companies as before the crisis the board appointment was a sort seniority- based promotion scheme94 creating hierarchies within the board making the check and balance mechanism ineffective. The second characteristic was the nature of the reform itself that was driven by government and by the International Monetary Fund instead of be driven by companies’ needs; this particular aspect leads to the third characteristic that is the timing of the reform that occurred in a short span of time avoiding lobbying. The government, and the IMF that provided the bailout funds to government, instead of negotiating the corporate governance

93 Kim Y., 2007, “ Last 10 Years’ Corporate Governance reform in retrospect”, SERIWORLD online : http://www.seriworld.org/05/wldColumnV.html?mn=F&mncd=0103&key=200704250001§no=0 consulted on the 8th of July 94 Min. B & Bowman, 2012, “ Corporate Governance, Regulation and Globalization: Lessons from Korea”, Griffith University Research, pp.1-48

61 LB 2011\2012 innovation with the “economic system”, namely the five big chaebols, imposed the change in the corporate governance system. The fourth aspect is the revolutionary nature of the reform itself that is a clear sign of discontinuity with the past: the Korean “establishment” identified, correctly indeed, the traditional relationship-based system as one of the main causes which lead the country to the crisis and decided, as explained above, to converge towards the outsider Anglo–Saxon model in order to increase efficiency and transparency. Thus the Republic of Korea is an important hub for foreign investments and is expected that the role of MNCs will be increasingly important on every Korean market, the level of information disclosure doesn’t meet the western standards and neither is close to the Indian situation where, although corporate governance institutions are still weak, the level of information disclosure, especially in English language, is higher than the average of the Asian countries.

2.1.1 Regulatory elements

The process of reform brought new regulatory agencies and amendment to business law in order to provide the country with a more effective system of ruling both the capital market and the commercial trade in general. The two main pillars are the Commercial Code for corporations and the Financial Investment Services and Capital markets for stock markets Act. The Commercial Act is defined as “law that regulates the existence and the relationships of the enterprises that have the purpose of profit-making”95, it was enacted in 1962 and it was involved in the reform being amended in 2001. The Act is administered by the Ministry of Justice and contains stipulations on corporate governance structures. . The Commercial Act groups companies in four categories: partnership companies, in which

95 Ministry of Legislation, 2001, “Commercial Act (Republic of Korea)” : http://www.moleg.go.kr/ consulted on the 20 of July 2012

62 LB 2011\2012 members are unlimitedly liable for the company, limited partnership companies, dividing members with unlimited liability and members with limited liability, limited liability company, that has a minimum amount of capital of ten million won and shall have at least one director managing the company and stock companies, that shall be incorporated at least by one person and the C.A. identifies the general shareholders’ meeting as the highest organ appointing who will manage the company: the board of the directors. The Commercial Act openly states that the model of governance to be adopted by a stock companies shall comprise the board of directors and an audit committee confirming the Anglo – Saxon process of convergence. In 2007 the Financial Services commission promulgated the Financial investment services and capital markets Act superseding the former law ruling the stock markets which was the Securities and Exchange Act. The Act comprises law and regulations ruling the commercial banks, securities and the Korea Stocks Exchange and it was amended in 201096. Another important regulation was promulgated in 2005 governing class-actions and it’s applied to listed companies with a total asset base of 1.98 billion US Dollars while for companies with a lower total asset base the law was enforced from 2007.97 In 2005 were also formulated new listing rules for Korea Stocks Exchange and they were divided in two documents, the KOSPI Market Listing Regulations and KOSDAQ for smaller companies. The lower level of Korean regulations is represented by the Korea Corporate Governance Code that was published in 1999 and amended and updated in 2003; the code was openly inspired by the 2002 Sarbanes-Oxley Act in order to “comply with global standards”

96 Korea: Code and rules, from: http://www.acga- asia.org/content.cfm?SITE_CONTENT_TYPE_ID=12&COUNTRY_ID=268 consulted on the 21st of July 2012

97 A class-action suit can be filed against a company listed and traded in the KSE or KOSDAQ for these reasons:

1. False disclosure in the company’s prospectuses, or its quarterly, semi-annual or annual reports; 2. Insider trading & market manipulation; 3. Negligent external audit.

63 LB 2011\2012 2.1.2 Code of Best Practice of Corporate Governance

The Code of Best Practice of Corporate Governance was published in 2003 in order to follow the American “state of art” in corporate governance expressed by the Sarbanes- Oxley Act. The Code is another tangible proof of the process of convergence implemented by the Korean institutions towards the Anglo – Saxon model. The Code is structured in five chapters setting rules for shareholders, board of directors, audit systems, stakeholders and management monitoring by the market recommendations and it’s the model of conduct for Korean listed company but complying with the code is not mandatory as is considered as disclosure following the “comply or explain policy”98. First of all the code sets definite duties to the Board such as the function of strategy, supervision and politic as the board is accountable to set goals and strategies, supervise compliance with regulations, monitoring expenditures and mediating the conflicting interests of directors. The relationship between company and stakeholders is ruled with the code provisions about setting corporate means of redress for infringement rights and recommendation about the importance of respect all kind of stakeholders, not only creditors or shareholders, explicitly recommending to observe labour-related statues, environmental and consumer protection regulations. In the section regulating the board of directors the Code recommend transparency in the appointment process and in the disclosing process to the shareholders’ meeting with also a brief reference to the minority shareholders right of using the “voice” option in the process of director appointment. Although, as expressed before, the Code is inspired by an American Code of corporate governance there is no mention about the necessity of separation between the main roles in the board of directors namely the Chief Executive Officer and the Chairman of the Board

98Gregory J.H, 2002, “ International comparison of corporate governance guidelines and codes of best practice – developing & emerging markets”, Weil, Gotshal & Manges publishing, Fall edition, pp.1-215

64 LB 2011\2012 and also the role of Lead director, the “primus inter pares” outside director, is reduced to the role of representative of outside directors with no particular powers. There are no provisions about the board size as the code states “ There is no perfect number of directors appropriate for all the different circumstances of corporations. The reason lies with the many different factors that may influence the Board’s size, i.e., the corporation’s size, the business environment and special characteristics.”99 The minimum number of outside directors is three and is strongly recommended in order to ensure transparency and independence that the number of outside director should be at least one quarter. Considering the absence of provision about the separation between CEO and Chairman and the Anglo – Saxon imprinting of the Code, a model basing its foundation on independence of the board with requirements of half of the board made by INEDs100, the request made by the Korean code is to be considered inadequate and a sign of incapability of breaking the traditional business dynamics by the Korean institutions. Moreover the Code doesn’t give a clear definition of independence disclosing that to be considered an outside director is important not to have interest in companies’ operating activities or being a related party of a director and it’s stressed the importance of the duty of loyalty, particular for conflict of interests, for all directors INEDs and EDs101. The code contemplates the creation of special committees of corporate governance namely an audit committee, a nomination committee and a compensation committee and are especially recommended for large listed companies but not for those which are controlled for the majority by a single entity. The duties of committees are expressed by the Code as: “The audit committee oversees and ensures that the management performs its responsibilities in an appropriate manner and in accordance with the laws and regulations. The nomination committee recommends the candidates for the positions of CEO and the director nominees for the general meetings of shareholders, and upon the request of the board, it also makes nominations for the

99 Committee on Corporate Governance, 2003, “ Code of Best Practice for Corporate Governance”, KSE publishing, p.16 100 The Senate and House of Representatives of the United States of America in Congress, 2002, “ Sarbanes-Owley Act of 2002. Corporate Responsibility.”, U.S.Congress, pp.1-66, available at http://www.sec.gov/about/laws/soa2002.pdf, consulted on the 3rd of September 2012 101 We define independent directors as INEDs and Executive Directors as EDs.

65 LB 2011\2012 members of the board committees. Accordingly, the nomination committee replaces the existing nomination committee of outside directors. Furthermore, the nomination committee should take a lead role in guiding the corporation to adopt the Code of Best Practices for Corporate Governance. The compensation committee reviews and evaluates the management performance against the management goals, and sets the appropriate compensation level for the management on the basis of such evaluation ”102. The committees must comprise outside directors, especially the remuneration committee has to be completely made of outside directors. The Code recommend a wide use of stock option and stock granting plans for both officers and employees in order to commit them to the performance of corporation and especially for those who contributes to technology development, expression of the centrality of R&D in the Asiatic country. The internal audit systems are ruled by the Code too, with provisions for audit committee: it shall be made by at least three board members, preferably outside directors, must be chaired by an outside director and all the members have to be financially literate. The main duties of the audit committee are to supervise the legitimacy of business conducts of directors, review the accounting standards of the company, evaluate external audit activities, and review the financial operations inside the company. In the fifth section of the code the market for corporate control is ruled because of its new role in enhancing efficiency of corporate management. The first indication is that every takeover process shall be implemented in complete transparency avoiding defensive strategies damaging the new potential shareholders benefitting the old ones and the management. In terms of disclosure the Code isn’t demanding as is not required a corporate governance report nor stock option plans for remuneration requiring only:

• Business goals and strategies; • Financial condition and business performance; • Status of shareholders and the exercise of shareholder rights;

102 Committee on Corporate Governance, 2003, “ Code of Best Practice for Corporate Governance”, KSE publishing, p.21

66 LB 2011\2012 • Cross-shareholdings and cross-debt guarantees; • Details of capital raising and capital expenditure for the fiscal year; • Business climate and risk factors; • Important information on executives, employees and others who perform work of the corporation; • Details of transactions with the largest shareholders, etc. as well as the contents of transactions with the executives, employees and other stakeholders; • Audit opinions of the external auditors and appraisals of credit rating agencies and others; • Accounting standards or accounting estimates that have significant effect on investment decisions; and • Details of unfaithful disclosures and sanctions thereof.103 Another recommendation about disclosure is to explain the gaps between corporate governance in the company and the Code’s provisions following the “comply or explain” policy and is “desirable” for corporation with large number of shares, so more likely to be subject of interest for foreign investors, to produce disclosures in both Korean and English language. Lastly is important to stress the introduction in the Code of CEO and CFO responsibility for the soundness of disclosure since the Code accepted the S-OX Code’s way, giving more responsibilities to the high officers of companies through the mandatory certification of accuracy and completeness of the financial report by the CEO and CFO

2.1.3 Ownership structure

The ownership structure hasn’t change in terms of corporate control despite the corporate governance reform implemented in order to open South Korean ownership structures to foreign and domestic investors increasing ownership dispersion, and consequently,

103 Committee on Corporate Governance, 2003, “ Code of Best Practice for Corporate Governance”, KSE publishing, p.39

67 LB 2011\2012 corporate governance efficiency through the market for corporate control and shareholders activism. Indeed the Korean business environment shows a dualistic situation: the Chaebols reality that changed after the 1997 financial crisis because of external pressures of IMF104 decreasing their ownership concentration opening to the foreign investors, due also to their main characteristic of operating globally, and the small and medium enterprises that are still unattractive to foreign investors and have a concentrated ownership with, usually, a single controlling ownership. The law inefficiency in protecting minority shareholders’ rights and the traditional way of doing business in the Asiatic country confirmed the LaPorta’s theory of Law&Finance105 which states that in a system where property rights protection is low, the ownership tends to concentrate in few people’s hands reducing agency problems and unclear situations. The ownership structure in Korea is really close to the European one and the reasons are several: first of all there is an historical reason as from the foundation of HCI106 the ownership was centered in one family’s hands, and also when the HCI became big conglomerates the government preferred to have a unique person107 or at least one defined leading group the government prefers to deal with. The concentration has its roots also in political reasons: the Chaebols were the designed groups to lead the Korean economic development during the three decades between 1960 and 1990 through international exports. Government set rules to ease the production for exportation indentifying particular areas in the country to establish companies working for exportation, set tax exemptions for them and invested deeply in the chaebols with loan at low interests in order to make chaebols competitive in the international market. This state-led development policy needed a corporate counterpart having a strong control on the company in order to guide the business strategy and protect the high investments undertook in the chaebols, and this was easier to implement with a concentrated ownership rather than with an Anglo – Saxon model of dispersed ownership.

104 The International Monetary Fund 105 La Porta R., et al., 1998, “Law and Finance”, Journal of Political Economy Vol. 106, no.6 106 Heavy and chemical industries: state-led companies founded in order to guide the country’s development. 107 Park S.R., Drysdale P., Kang S.I. & Hong, 2004, “ Ownership structure of Northeast Asian countries”, Major Research Paper, KERI Publishing pp.17-44

68 LB 2011\2012 Also when chaebols became totally unrelated to government in the first years of the 90s, it was forbidden for foreign investors, who could be the most active entities in capital market considering that domestic investors were only the 5% of population, percentage that declined to 2,9 in 1997108, to penetrate in Korean companies’ capital structure. South Korea opened partially its capital market only in 1992 making possible for chaebols to defend their concentrated ownership. Other possible reasons to explain such ownership concentration, despite the intentions of the government to change the Korean model from an insider system to an outsider one, lay in the lack of minority shareholders’ rights protection which was improved only after the 1997 financial crisis lowering the threshold ownership requirements for exercising the “voice” option. Their position remains however weak as for them it’s difficult to exercise the “exit” option as the capital market is not as efficient as in the Anglo – Saxon countries. The minority shareholders’ protection still remain a marginal matter as the recent financial crisis that affected the Asian republic slowed down dramatically the process of ownership diversification. Moreover, minority shareholder rights in related-party transactions are not soundly protected, as also the world bank in a 2010 study shows; South Korea is at the bottom of the ranking after other emerging countries like India and Brazil109 Chaebols are the dominating paradigm and are still family-controlled and strongly diversified and usually they are structured as a pyramid holding together the group through cross-shareholding and interlocking directorates. The level of cross-shareholding increased as a response to the 1997 Asian financial crisis and was significantly higher than in other companies in South Korea with the 27.8% against the 17.8% of non-chaebol firms110, but on the other hand the efforts of government to attract foreign investments in Korean capital markets, especially the removal of the barrier which prohibited to foreign investors to hold more than the 7% of shares in a single

108 OECD, 2001, “ Corporate Governance in Asia,” OECD publishing, p.164 109 IFC, 2010, “ Doing Business 2010 Korea, Rep.”, The International Bank for Reconstruction and Development / The World Bank publishing, p.32 110 Aguilera R.V., de Castro L.R.K, & al., 2011, “Corporate Governance in Emerging Markets”, Working paper forthcoming in G. Morgan and R. Whitley, “Capitalisms and Capitalism in the 21st Century.” Oxford: Oxford University Press, p.15

69 LB 2011\2012 company, sorted results since the foreign ownership in Korea lifted from the 13% of publicly listed firms in 1997 to the 42% in 2006 with a prevalence of British and American investors. The main result of Korean government is to have lowered the threshold of the controlling stake that now is settled on the 4% of the capital ca. 111

2.2 The Korean Pharmaceuticals Industry

2.2.1. Background

The Republic of South Korea is nowadays the 15th largest economy and it’s the 7th exporter in the world112; this extraordinary result, considering that the country was devastated by the Korean War in the 1950s, was achieved throughout a strong national industrial policy that in the 1960s started to support exports with tax benefits and establishing export- oriented development plans. In the 1970s and 1980s the government boosted the development of chemical industry, with a consequent development of the pharmaceutical industry, and the restructuring of the industrial environment.113 South Korea has high living standards, close to the Japanese and Western ones but on the other hand is one of the most aged societies in the world: this kind of social settings creates a very interesting market for pharmaceutical companies. South Korea presents the highest wage average in Asia with a minimum wage of $ 868.27 per month and the best Asian standards of living; this relevant buying power goes together with a median age of 38,4114, that is only lower than Japan (44.8)115 and sensibly higher

111 Ibid., p.18 112 U.S. Department of State, Background Note: South Korea. “http://www.state.gov/r/pa/ei/bgn/2800.htm” consulted on the 11th of July 2012 113 Korea.net, Overview. “http://www.korea.net/AboutKorea/Economy/Overview”, consulted on the 11th of July 2012 114 CIA, The World Factbook, The Republic of Korea,: https://www.cia.gov/library/publications/the-world- factbook/geos/ks.html Consulted on the 15th of July 2012

70 LB 2011\2012 than the other emerging countries in East and South East Asia such as India (26.2)116 and People’s Republic of China (35.5)117. Moreover the 11.4% of Korean citizens are 65 years and over and the 72,9% is between 15 and 69 years with a population growth rate of 0,204% that is the 175th rate in the world and an even lower birth rate that outlines a country that is ageing causing great concern for productivity on one hand but also creating a huge opportunity for pharmaceutical companies on the other. In last decades longevity improved as water supply, sanitation and hygiene standards increased together with the impressive economic growth that the Republic experienced from the 80s and nowadays the leading causes of death are stroke (17.19%), coronary heart disease ( 9.15%), lung cancer (7.34%), suicide (5.10%) that are typical diseases of a “developed country”118. In 1977 South Korea went through a process of Healthcare reform that switch the Korean healthcare paradigm from an American voluntary private health insurance model to a mandatory public health insurance inspired to the Japanese model in term of administrative structures, population coverage and how to finance the system. One of the most important trends in South Korea in the last decade is the development of the biotech industry that affected the pharmaceutical industry as biopharmaceutical products are one of the most important output of the biotech industry ( 32%)119 and they are a valuable substitute to the traditional chemical pharmaceutical products. The biotech industry grew with a CAGR of 18.7% in the period span 2001-2006 with a peak of 31% for bio-medicines. The birth of biotechnology reality in Korea was a government initiative which in the early 1980s started to sponsor the biotech research aggressively and now the industry is in the world’s top 10 and in 2000s is one of the nation’s leading industries.

115 CIA, The World Factbook, Japan, https://www.cia.gov/library/publications/the-world-factbook/geos/ja.html Consulted on 15th of July 2012 116 CIA, The World Factbook, India: https://www.cia.gov/library/publications/the-world-factbook/geos/in.html Consulted on 29th of June 2012 117 CIA, The World Factbook, PRC: https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html Consulted on 29th of June 2012 118 National Statistical Office,2010, “Causes of Death Statistics in 2010”, NSO ,pp.1-3 119 InvestKorea, 2008, “ Overview of Korea’s Industries: Pharmaceutical/BT”, Korea Trade-Investment Promotion Agency, pp.1-14

71 LB 2011\2012 The innovation in biotechnology is one of the most clear example that South Korea is one of the most innovative country in the world and experienced in the last 10 years a relevant increase in the establishing of corporate R&D centers(901 centers)120 considering also the Korean policy that will allow foreign laboratories to have access to local R&D projects and also allow to foreign agencies and companies to become equal participants in R&D Korean projects.

2.2.2. Regulatory framework

In the Republic of Korea the main healthcare regulator is the Korea Food and Drug Administration, an agency working under the supervision of the Ministry of Health and Welfare. The KFDA is ruled by a commissioner that manage five different bureaus and one division that is the General services Division: - The risk prevention policy bureau in charge of plan and implement the Korean risk information and prevention policy and manage the clinical trials. - The Food Safety Bureau with responsibilities on prevention of food borne diseases, controls on food importations and planning and implementation of Food Safety Policy - The Pharmaceutical Safety Bureau that make the Narcotics control, test the pharmaceutical quality of products, and plan and implement the Pharmaceutical safety policy. - The Biopharmaceuticals and Herbal Medicine bureau is in charge to manage the administrative process for approval of Biopharmaceuticals, Herbal Medicine and cosmetics

120 Datamonitor, 2011, “Country Analysis Report: South Korea”, Future Prospects, p.25

72 LB 2011\2012 - The Medical Device Safety Bureau manage the imports and the quality of medical devices adopted for healthcare services.121

KFDA promote public health and ensure the safety of pharmaceuticals, medical devices etc. and serve also as a support for food and pharmaceutical industry. South Korean control model is strongly centralized with KFDA in charge to completely regulate the pharmaceutical industry.122

121 KFDA Official Website: http://www.kfda.go.kr/eng/index.do?nMenuCode=32 consulted on the 18th of July 2012 122 - Pharmaceutical safety control:

Development of policies and establishment of comprehensive plans on the pharmaceutical safety control E stablishment and revision of the laws and notifications on drugs Provision of information on the proper use of pharmaceuticals Post-marketing safety control Re-evaluation of the safety and efficacy of human placenta based pharmaceuticals Introduction of Plasma Master File (PMF) system for plasma derivatives reinforcement of a management standard for imported blood plasma E stablishment of guidelines on an excellent management standard for human tissues (GTP) and management of tissue bank

- Pharmaceutical quality control

E stablishment of planning on management standards for Good Manufacturing Practices (GMP) GMP inspection and evaluation for domestic and imported drugs Introduction of GMP system for herbal medicines

- Safety control on Narcotics Review of narcotics related acts and systems E stablishment/adjustment of basic plan for narcotics control, and management of statistics Approval of the manufacturing, import and export of narcotics

- Pharmaceutical approval and review Pharmaceutical manufacturing and import approval Reviewing and approval of herbal medicines and Korean traditional medicines Operation of management system for pharmaceutical approval and application E stablishment and operation of pharmaceutical standards such as the Korean Pharmacopoeia, etc. Reviewing of the quality, safety, and efficacy of pharmaceuticals Reviewing of protocols Reviewing of the bioequivalence test protocols, result report, re-evaluation, etc. Approval of shipping bio pharmaceuticals based on the national verification system

- Establishment of basis for nurture and support Supporting policies for new bio pharmaceuticals based on selection of growth engine industry E stablishment of evaluation system for safety and efficacy of high tech fusion technology pharmaceuticals Simplification of licensing/approval of bio pharmaceutical area E stablishment of the approval and review standards for biosimilar

73 LB 2011\2012 In term of support to the pharmaceutical industry, the KFDA provide consulting services in the Research& Development stadium of the pharmaceutical product. The approval pathway comprises five bureaucratic steps that starts in the pre-clinical stage with the Investigational New Drugs approval that takes 30 days, than there are controls on quality assessing the soundness of specifications and testing methods within 90 days, then tests for safety and efficacy are implemented in the next sixty days, and successively takes place the Good manufacturing process Audit on site and, at the end of the approval path lies the official approval in 85 days.123 There are also strict controls and precise timing for pharmaceutical products to be included in the Health insurance plan. In 240-270 days the Ministry of Health and Welfare through its agencies can include a new drug in the HIP: the Health Insurance Review and Assessment Service decides within 150 days is a new product is eligible to be included in the plan; in the next 90 days the National Health Insurance Corporation lead the negotiation of Drug Price with the company and then, if there is a positive solution on negotiation, the Ministry announces officially the new drug.124 In terms of protection of intellectual property rights the standards are high as South Korea is committed to the TRIPs agreements and the control of IPR protection is centralized in one agency that provides registration services but also acts in order to enforce the intellectual property rights. The main laws ruling the IPR are not different from the Western countries as South Korea promulgated the KCA, Korean Copyright Act, amended in 2003 to conform to international treaties ruling the IPR protection on the Internet. Moreover Korea’s patent regulations are included in the Patent Act and in the Utility Model Act with a strong distinction between major and minor invention as in Italy and France. The patents for major inventions, as new drugs, protects for twenty years while the utility model guarantees a protection for 10 years only, it also allows to gives the inventor a

Source: KFDA Official website 123 Suh C.W., 2009, “Korean Pharmaceutical regulation trend & market review” ISIS’s 7th Annual eSolutions conference, pp. 14-18 124 Ibid.

74 LB 2011\2012 monopolistic right to license it for royalties. In 2007 Korea signed a Free Trade Agreement with the United States of America that brought several improvement in the enforcement of IPR and patent rights in general, the same kind of FTA is to be signed also with EU.125

2.2.3. Business environment

South Korea is a changing country as it is experiencing the effects of a deep structural, regulatory and healthcare reform. The Republic answered to the 1997 and 2008 financial crisis; as the economic downturn started to jeopardize the Korea economic system tightening the lending activities of the banking sector and increasing the higher credit risks, the government together with the national bank implemented a strong depreciation of the won that improved dramatically its competitiveness in exports especially towards countries that suffered less from financial crisis such as PRC. This boosted the demand growth that together with explicit crisis-driven fiscal policies126 bring South Korea to the pre-crisis wealth level. The soundness of recovery is perceptible through the Korea’s short-term outlook that shows a fifth consecutive quarter of growth, with exports expected to grow further as the won is still weaker than the Japanese yen as the Nippon products are in open competition with Korean ones in the export markets127. Also private consumption will rise despite a reduction in government consumption: this could be a threat for the pharmaceutical industry but it’s important to stress that Korean government is implementing an healthcare reform through which it will cut public expenses in favor of the increase of the private sector.

125 Hunter Rodwell Consulting, 2008, “Intellectual Property Rigths Primer for Korea – a guide for UK Companies”, UK Trade & Investment, pp.1-40 126 OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.25-40 127 Datamonitor, 2011, “Country Analysis Report: South Korea”, Future Prospects, pp.43-56

75 LB 2011\2012 Another important factor affecting the pharmaceutical industry is the low productivity of the service sector as Korea were drove by manufacturing, activities where the government focused their intervention, leaving the services industry overwhelmed by strict regulations on investments and competition. The Republic is planning to revitalize services through a process of economic reform equalizing the level of tax incentives between services and the manufacturing that were sustained with more favorable taxing conditions. Moreover in 2009 the government focused on five service sectors in order to develop each of these, creating job opportunities and supporting proactively services eliminating also entry barriers: one of the five industries is the healthcare sector.128

2.2.4. Healthcare system

The healthcare system changed radically in last 35 years. Before the 1977 South Korea had a voluntary insurance system, on the American- Australian model that is provided by private funds and marginally subsidized by the government. In 1977 the government publicly mandated the medical insurance for employers and dependents in large firms with more than 500 employees; in the 1989 South Korea extended health insurance to the all citizens, allowing everyone to be cured in any institution also if in a regime of co-payment; the system evolved further becoming an universal health coverage system limiting the range of services and fixing prices at low levels.129 In the Korean healthcare system the organizing entity is the NHI, throughout resources from the government are allocated to consumers, corporations and service providers; consumers have total freedom of choice to go in public rather than in a private structure and the Health insurance funds are collected through tax contribution but also through private funding.

128 OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.99-126 129 Lee J.C., 2003, “ Healthcare Reform in South Korea: Success or Failure?”, American Journal of Public Health, Jan. 2003, Vol.93, No.1, pp. 48-51

76 LB 2011\2012 In financing NHI, a large role is also played by the private sector as only the half of expenses are financed publicly through social contributions (38.6%), and the 16.9% are covered by government sources while the other half is financed jointly by out-of-pocket payments for non covered services, which not falling under the NHI cover, are not subjected to price regulation, co-payments, that is quite a particular feature of the Korean system as the citizen is asked to contribute to the expenses of in-patient and out-patient care basing on a percentage of the total cost, and by private insurance.130

.16 Source: OECD Economic Survey: South Korea

In order to cut expenses and increase efficiency the Republic of South Korea reformed the Healthcare system through the Integration Reform.

130 OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.104

77 LB 2011\2012 Before 2000 NHI was an aggregation of health insurers based on workplace or region that offered the same coverage creating extra overhead expenses and NHI financial distress. In the new century all public insurers became one big one through a process of merger: the new entity is a cost-saving solution as, in primis in terms the administrative costs were cut of the 4% with a rationalization process and, in secundis its bargaining power increased as NHI became a monopsonistic agency.131 The reality of healthcare providers is dominated by the private sector as the 96% of hospitals and clinics are private-held and they strive in order to maximize their profit in a high competitive environment, even if the main purchaser of services is public.132 The Korean healthcare providers standards are higher than the Asian average and are totally comparable to American and European health standards and the hospital beds supply is wide. In 2008 Korean government, considering the relevant lengthening of life expectancy, implemented the Long-term Care Insurance Program based on co-payment system financing it for the 20% and the other coverage is up to the insured. Despite the advanced and high standard of healthcare services in South Korea there’s still one major weakness point that is the regional inequality because of the nature of the system: South Korea basing its healthcare services and their quality improvement on private companies competition created a situation where the profit maximization strategy based on the concentration of medical facilities on the urban areas left the rural area where almost 20% of population lives almost un-served.133

131 Kermani F., 2008, “ New interest in an old market: South Korea”, Pharmaceutical technology Europe, July 2008, pp.12-15 132 OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.99-126 133 OECD, 2007, “ Korea – Progress in implementing regulatory reform”, OECD Publishing, pp.1-191

78 LB 2011\2012 2.3. Pharmaceuticals market overview

The Pharmaceutical industry in South Korea experienced a growth rate that was mimetic to the growth of GDP settled on a CAGR of 6% but in 2010 went through a negative growth with a market value that decreased of 1.8% due to the rationalization in public expenses by the monopsonistic buyer NHI. The Korean pharmaceutical market is the third by value in the East Asian Countries after Japan and People’s Republic of China with the 6.9% of the overall value134. The pharmaceutical market in Korea is established in the end of 1800s but the affirmation arrived in the 1987 with a western product patent system that helped SK to become one of the most important full scale R&D hub. Nowadays the industry accounts over two thousands companies operating in manufacturing (ca. 553), OTC(200) and cosmetics135 and several small start-ups focused on research in biotechnologies.136 According to the KFDA studies the Korean market is the second most important in terms of opportunities for companies calculating an aggregate score considering Pharmaceutical market growth rate, the current size of the market and the current and future needs of healthcare137 . The main player in Korean market are domestic with Daewoong Pharmaceutical Co Ltd. holding a market share of 6.4%, Hanmi Pharmaceutical Co. Ltd. (3.4%) and Don-A Pharmaceutical Co. Ltd with the 3.2% of the overall138; also important MNCs are operating in the market such as Pfizer, GSK and is important the contribute to the market of the pharmaceutical divisions of Korean Chabols like Hyundai Pharmaceuticals Co. Ltd. and Samsung Pharmaceuticals Co. Ltd.

134 Datamonitor, 2012, “ Pharmaceuticals in South Korea”, Industry Profile, pp.7-12 135Korea Drug Research Association, 2008, “Korean Pharmaceutical Industry profile”, KDRA report, pp.1-26 136 Ibid. 137 KDRA Overview: http://kdra.or.kr/e_overview_1.html consulted on the 16th of July 2012 138 Datamonitor, 2012, “ Pharmaceuticals in South Korea”, Industry Profile, pp.24-28

79 LB 2011\2012 The Korean pharmaceutical industry was completely changed by a reform in the 2000 when, after the 1997 financial crisis, the whole Korean economy felt the need of radical reform. Prior to the reform the Korean situation was quite similar to the Indian and Chinese situation where copycats drugs absorb a relevant percentage of demand creating a layer of small and medium enterprises that operate on the market selling their product in state of total infringement of patent rights at low prices. This kind of situation was created by the Korean law regime that contemplated the possibility for doctors to sell directly to their patients prescription drugs and receive a profit margin consisting in the spread between the cost of purchasing from wholesaler and the selling price.139 This spread was set to at 24% of the price at max but law enforcement was totally absent and the lack of controls together with such a distorted system of incentives created a dangerous situation: illegal marketing was implemented by small companies with less than 100 employees that copied branded drug and sell them to the physicians and, moreover, physicians were motivated to prescribe the less effective antibiotics in order to sell more units to every patients140. Moreover the drug prescription rate was sensibly more than the OECD average and the abuse of antibiotics brought to a weakly effective fighting in diseases in Korea as they tended to be antibiotics-resistant. The so-called Separation Reform was implemented in order to limit the prescription of drugs by doctors and pharmacies as the first couldn’t sell directly anymore and the second couldn’t prescribe drugs but only distribute them: results were contrasting. On one hand the government provided South Korea of a more effective system of drug distribution, a more effective diseases fight under a sanitary point of view and a crunch in the public expenses for drug reimbursement, on the other hand the Ministry of Health and Welfare had to increase the doctors’ average wages in order to smooth the harsh opposition of doctors to the reform, moving to 9.8 trillion won in 1999 to 12.9 trillion won in 2001141 , the pharmaceuticals SME encountered a period of crisis and the NHI went through a

139 OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.99-126 140 Ibid. 141 Kim H & Ruger, 2008, “ Pharmaceutical Reform in South Korea and the Lessons it provides”, Health Affairs, pp.1-11

80 LB 2011\2012 financial crisis in 2001-2002 as , in the end the drug reimbursement expenses decreased but the overall health expenditures rose dramatically. After two years a study were conducted by government and merged up that the drug expenditures didn’t decrease as expected as doctors started to prescribed more new branded drugs as MNCs, with this new wave of enforcement against copycats, started to expand in Republic of Korea and to increase the number of days of prescription, and especially the increase in high-end drugs may reflect illegal rebates from pharmaceutical companies. For the over mentioned reasons the government decided to rationalize the expenditures through the strategic plan of “ Drug Expenditure rationalization plan” published in 2006. For pharmaceutical companies the profit margin on products are now compressing as through this plan the drugs that are eligible for reimbursement list of NHI are put under strict analysis by the agency in terms of quality but, more important aspect, also are tighten to an analysis of economic feasibility. Also the products already on the reimbursement list will be tested in term of cost-effectiveness in order to reduce the number of drugs in the list, number which is already cut from twenty-three thousand to fifteen thousand; moreover the price negotiation, as seen before in the NHI election process in the regulatory framework paragraph, is not external determined by the average price applied in other countries but is directly negotiated with the manufacturing company. In the end, also rules about generics are reviewed as when a first generic is included in the list, the original product price is reduced by the 20% and the price of the generic drug is set at the 68% of the branded drug. Analyzing the pharmaceutical market with the tool of the five forces it’s possible to assess that the most powerful threat for pharmaceutical companies is the substitutes as in South Korea there are two main drivers boosting the importance of substitutes to chemical drugs: the focus on cut expenses of the national health insurance system and the rising of the bio- similar products. In the last years the national healthcare system tried to review clinical evidences to assess the possibility to substitute the medical treatments for chronic diseases with surgical procedures in order to reduce drug reimbursement; in this case the switching costs are the training costs of new surgical teams.

81 LB 2011\2012 The other substitute to pharmaceutical products is the bio-similar array of products that, assuming the comparable effectiveness, is a developing sharply in South Korea as the government allocated funds on biotech R&D and the switching costs are low. The third substitute set of products is the “generic” which price is lower for economical and law reasons as the producers of generic drugs can offer the product at a lower price as they benefit from the efficacy data provided by the branded producer without conducting clinical trials and also because Korean law mandate for generic drugs to set their price at the 68% of the branded product price. Another relevant force is the buyer power as there are two powerful purchasing realities in Korea: the NHI that after the 2000 reform became a monopsonistic buyer enhancing its bargaining power and the other players are the wholesalers to whom the manufacturers may sell which are themselves large companies as Pfizer for example.142 The presence of generic drugs and bio-similar products strengthens the buyer power of wholesalers and NHI that also benefit from governmental price control regime143. The main factor weakening the buyer power is in the nature of the product itself: the strong importance of the pharmaceutical products regardless the price is a critical factor that becomes even more important if there are no generic alternatives on the market. On the suppliers side the power is lower as many pharmaceutical companies both domestic and MNCs made investments to integrate vertically their value chain including the chemical manufacturing in order to be autonomous from active pharmaceutical ingredients producers. The companies that are not integrated are supplied on contractual basis that increases the switching costs enhancing suppliers’ power. The only case in which supplier’s power could be strong is in case of creation of an innovative API that, in case it reaches the market successfully, can create a favorable situation for the supplier increasing its bargaining power. Also the new entrants force is moderate as it’s possible to assess from the regulatory framework that increase the difficulty the ease to penetrate the Korean market: the path to

142 Datamonitor, 2012, “ Pharmaceuticals in South Korea”, Industry Profile, pp.12-24 143 Health Insurance System in Korea: http://live.econ.berkeley.edu/, consulted on the 15th of July 2012

82 LB 2011\2012 is time-consuming and controls and tests and effectiveness and economic feasibility are getting stricter. Moreover the government decision to cut the reimbursement list and negotiate directly with the company the selling price of the drug compress the profit margins making, especially for small and medium companies, very difficult to cover development costs. Moreover the good enforcement of Intellectual property rights in Korea weakens the threat of new entrants also on the illegal copycats perspective. The degree of rivalry is low too as barriers to exit are weak as patents, and trademarks are easy to sell, the market concentration in moderate and the nature of the regulated market weaken the harshness of competition with MNCs and domestic players coexisting. The leading companies are Pfizer Co. Ltd Korea, GSK Co. Ltd Korea, MNCs that penetrated the market with Wholly-owned subsidiaries and domestic companies such as Daewoong Pharmaceutical Co. Ltd, Dong-A Pharmaceutical Co. Ltd. and Hanmi Holdings. Co. Ltd. MNCs are mainly committed in R&D in Korea with strong investments and alliances in order to develop new drugs: Pfizer invested 30 million dollars in 2011 for basic research in R&D144 e GSK signed a strategic alliance with Dong-A in order to develop new products jointly145. All companies sell both prescription drugs and OTC products but the particularity is that domestic companies also are involved in development and selling of non-medical and biological products. Dong-A and Daewoong provide also medical services, diagnostics and APIs.146

144 Pfizer South Korea: http://www.pharma.focusreports.net/index.php#state=CompanyDetail&id=1614 consulted on the 15th of July 2012 145 GSK Official website, “GSK extends presence in Asia with new strategic alliance in South Korea”, from http://www.gsk.com/media/pressreleases/2010/2010_pressrelease_10044.html consulted on the 15th of July 2012 146 Marketline , 2012, “ Dong-A company Profile”, Company Profile, pp.1-15

83 LB 2011\2012 2.3.1. The Over-the-counter products market

The Over-the-counter pharmaceutical products are “defined as drugs that are safe and effective for use by the general public without seeking treatment by a health professional”147. Although the OTC market is to consider completely part of the pharmaceutical industry and has no legal recognition, it’s subjected to different regulations; for example OTC doesn’t need any prescriptions, is subjected to a different tax system and different retail prices. The OTC market includes traditional medicines, cough & cold preparations, vitamins and minerals, analgesics and other products. The South Korean OTC market grew sharply in the period 2006-2010 also as a consequence of the cutting expenses policy of the Korean healthcare system accounting 2.9 billion US dollars in 2010.148 The compound annual growth rate of the period 06-10 settled on 4.9% but the market seems to gain gradually more importance in terms of dimension and market value as in the years 2009 and 2010 reached a growth of 6.1% overcoming the national GDP growth rate.149 The most lucrative and important market segment is the traditional medicines as represent the 40.4% of the overall value accounting for 1.171 billion US dollars and in the period 2006-2010 gained more weight inside the OTC market with a decrease of cough & cold products and analgesics.

147 U.S. Food and Drug Administration: Definition of OTC product: http://www.fda.gov/drugs/developmentapprovalprocess/howdrugsaredevelopedandapproved/approvalapplications/over- the-counterdrugs/default.htm consulted on 12nd of May 2012 148 Marketline, 2012, “ OTC Pharmaceuticals in South Korea”, MarketLine Industry Profile, pp.1-33 149 Ibid.

84 LB 2011\2012

.17 Source: Marketline(2012)

In 2011 the Ministry of Health and Welfare decided to allow the selling of OTC drugs, namely cough & cold preparations, analgesics and digestion pills, in the supermarkets, but the result of the negotiation with pharmacists and doctors was a liberalization of minor OTC products that were reclassified as non-drugs that were mainly energy drinks and herbal digestive drinks. It is expected that the OTC liberalization on the US, UK and Swedish model won’t happen in South Korea as pharmacists still have to cope with the Separation reform and the resistance to other threats to their activity is strong. The Korean market is the third in the East Asia, as it is for the pharmaceutical market, after Japan and People’s Republic of China representing the 7.1% of the East Asian market value in 2010. The OTC market is concentrated with the first three companies retaining almost the 43% of the market share: Dong Wha Pharm Co. Ltd. has a market share of 21.2%, is listed in Seoul and produces mainly ethical drugs, OTC and food.150 Their main OTC products are tonics and analgesics. The second company in the ranking holding the 11.6% is the MNC Johnson & Johnson that operates in 60 countries151 and competes in South Korean market with three segments: the

150 Marketline, 2012, “ OTC Pharmaceuticals in South Korea”, MarketLine Industry Profile, pp.1-33

85 LB 2011\2012 consumer segment, which included some OTC products and cosmetics, the medical devices segment and the pharmaceutical152. J&J is active in both OTC and prescription drug market mainly with nutritional products , allergy products for over the counter for the first segment and in the main areas for prescription drugs153. Whalan Parmaceutical Co. Ltd., a Seou-based medium company, holds the 9.8% of market share and is specialized in prescription drugs especially in the treatment of central nervous system disorders and pain management but succeded in OTC market with traditional medicines and vitamins and mineral business. The distribution channels for OTC products are mainly pharmacies where more than the 60% of the all production is distributed with the remain percentage absorbed by independent and specialist retailers which sells low-value products or energy drinks, herbal preparation and homeopathic remedies.154

2.3.2. The Biotech Market

South Korea individuated biotechnology as a strategic area of investment for the future also considering that the country is the cradle of innovation par excellence. The decision to invest strongly on biotech was inspired by the impressive results of US biotech industry that in almost ten years increased its revenues from 4 billion dollars to 40 billion US dollars.155. South Korean government from 2003 invested in infrastructures for advanced and prepared workforce and in 2005 the Ministry of Commerce, Industry and Energy launched a 10 year plan called “ The Bio-star project” that included a USD $253 million investment in biotech industry and planning to assist companies’ R&D, clinical development and later commercialization.

151 Johnson & Johnson official website: http://www.jnj.com/connect/about-jnj/company-structure/ consulted on the 10th of July 2012 152 Marketline, 2012, “ OTC Pharmaceuticals in South Korea”, MarketLine Industry Profile, pp.1-33 153 Marketline, 2012, “ OTC Pharmaceuticals in South Korea”, MarketLine Industry Profile, p.21 154 Ibid., pp.1-33 155 Skelly J.P., 2005, “ A viewpoint on South Korean Biotech”, Biotech Focus, Vol.10, No.10, pp.1-4

86 LB 2011\2012 The major Korean Biotech companies are Estech Pharma, SD, Dae Han NewPharm, Sewoncellontech, that are all committed in the development of Biopharmaceutical that is also the main field of study and commercialization in South Korea. In the last years biopharmaceutical industry grew with a growth rate of 18.7% also thanks to the aggressive sponsorship of the government and is expected that in 2015 the Biotech industry will reach a market value of 21.4 Trillion Won that accounts for the 6.9% of global market share156. Moreover biotechnology is one of the main sectors where venture capitalist are investing in Korea as a another evidence of the relevance of the uprising industry that is also an important hub of skilled workforce, that predicts an important likelihood of important discoveries under the health and commercial point of view, as biotech is the industry with the highest ratio of Ph.D and master’s degree holders in South Korea.157 INVESTMENT IN BT BY GOVERNMENT BODY (2006) PERSONNEL R&D INFRA TOTAL TRAINING Ministry of education and Human KRW Resources Development 26.400 Mil 34.500 60.900 KRW Ministry of Science and Technology 219.733 Mil 12.730 232.463 KRW Ministry of Agriculture and Forestry 77.045 Mil 11.234 400 88.679 Ministry of Commerce, Industry and KRW Energy 59.191 Mil 91.214 1.501 151.906 Ministry of Information and KRW Communication 21.799 Mil 4.530 26.329 KRW Ministry of Health and Welfare 162.541 Mil 162.541 KRW Ministry of Environment 22.478 Mil 22.478 KRW Ministry of Marine Affairs and Fisheries 10.700 Mil 10.700 Government-sponsored research KRW institutes 61.568 Mil 9.420 70.988 TOTAL 661.455 129.128 36.401 826.984 .18 Source: InvestKorea 2007

156 Korea BioVenture Association, 2008, “ Biotechnology Industry Overview – Republic of Korea”, KBA publishing, pp.1-5 157 InvestKorea, 2008, “ Overview of Korea’s Industries: Pharmaceutical/BT”, Korea Trade-Investment Promotion Agency, pp.1-14

87 LB 2011\2012 Also MNCs started to invest in Biotech industries as witness the case of Novartis and Pfizer that in 2007 and 2008 decided to sustain financially Korean start-up committed in biopharmaceuticals R&D. Novartis created a fund of US $550 Million through its controlled company Novartis Venture Fund and Pfizer Inc. invested US $ 300 million in new drug development and signed an alliance with the Korea Research Institute of Bioscience and Biotechnology158. Biotech is already one of the key industries in Korea and it’s also one important aspect of the Korean pharmaceutical market, and in future it will be even more important as the government decided to boost foreign investments in biotech with a wide array of incentives as tax reduction, site location support( FIZ, FTZ, FEZ) and financial support to companies all over Korean region as it’s possible to assess by the chart below.

.19 Source: InvestKorea (2007)

88 LB 2011\2012 2.3.3. Industry Leaders

The Korean pharmaceutical market is characterized by the presence of both domestic players and MNCs. Although the first three positions in the industry leaders ranking are occupied by three domestic companies, multinational companies are really active in the market especially in terms of research and development. The alliances that MNCs signed in South Korea with domestic companies are more focused on the development of new drugs rather than to improve or consolidate their position in the market as South Korea, and Seoul in particular is one of the most advanced hub for research of steam cells, bio-similar and vaccines.159 The main MNCs operating in Korea are Pfizer Korea, Sanofi Aventis Korea, GSK Korea, Novartis Korea and MSD Korea, controlled by Merck. Multinational operates through wholly-owned subsidiaries and they are strengthening their position accounting a double digit growth in the last two years: their position were reinforced also by the synergic effects of the Free Trade Agreement signed by the Korean government with the United States of America that intensified the Patent Act enforcement and the Separation reform that cut off the vast majority of producers of copycats.160 The undeniable proof of the MNCs rising is the result of the government research that found out an increasing in high-end products prescriptions by doctors. Despite the impressive growth of MNCs the three industry leaders are Korean industry that are not even tied to the domestic conglomerates called Cheabol: Daewoong Pharmaceutical Co. Ltd., Dong-A Pharmaceutical Co. Ltd. and Hanmi Holding Co. Ltd. Daewoong Pharmaceutical is a Seoul-based pharmaceutical manufacturer committed in the treatment of different diseases.161

159 Verma A., 2011, “ Established and Emerging Biotech Clusters”, SCRIP Business Insight, pp.1-8 160 KORUS FTA legal text: http://www.ustr.gov/trade-agreements/free-trade-agreements/korus-fta/final-text consulted on the 15th of July 2012 161 Daewoong Official website: http://www.daewoong.com/ consulted on the 11th of July 2012

89 LB 2011\2012 The company retails its products under three brands: URSA, production of soft capsules for treating liver dysfunctions, LUPHERE, injections for cancer treatments, and EASYEF, liquid medicines for ulcers and mucositis. Daewoong, through its controlled companies, diversified the business producing and manufacturing medical devices, food, managing facility services and developing software. Dong-A162 operates in three segments called Ethical drugs, Over-the-counter and healthcare, medical equipment and diagnostics. ETC products treat cardiovascular problems, biological problems, neurotic diseases and others; OTC are focused on cough & cold and vitamins. The healthcare, medical and diagnostics is committed in selling equipment to hospitals and clinics. Hanmi Holdings is a mainly a research and development company having its main activities set on South Korea and PRC.163 Hanmi array of products is divided in three segments: prescription drugs, active pharmaceutical ingredients and OTCs. Hanmi develop and retails treatments for the main disease areas such as cardiovascular, central nervous system and others and sells APIs to other pharmaceutical companies having this double nature of a pharmaceutical companies’ supplier and competitor. The Korean company has also controlled companies involved in production of diagnostics and information technology systems for pharmacies and hospitals. All the three industry leaders experienced a slightly decrease in profit margins as the 2006 government policy started to show its effects through the price negotiation and the stricter new drug admission to NHI process that reduced the profitability of the pharmaceutical business.

162 MarketLine, 2012, “ Dong-A Pharmaceuticals Co. Ltd.”,MarketLine Company Profile, pp.1-15 163 MarketLine, 2011, “ Hanmi Holdings Co. Ltd. .”,MarketLine Company Profile, pp.1-15

90 LB 2011\2012 2.4. Corporate Governance Issues

The South Korea business reality is dominated by chaebols that are conglomerate groups driving the Korean economy. The five biggest chaebols represented by Samsung Group, LG Group, Hyundai, SK Group and GS Group account for almost an half of the country’s gross domestic product and more than an half of the overall Korean exports.164 The chaebols were , and still are, the engine of the Korean Republic, and were set up by the Korean government in the sixties under the form of Heavy and chemical companies in order to rebuild the country in the war aftermath and revitalize its economy creating export industries such as heavy, chemicals and sub-conductors165. Chaebols grew in the following thirty years widening its business focus through a sharp policy of diversification and increasing their strategic importance for South Korea. The creation of business groups led by Korean family and supported by the government created a problem of independence and transparency from the very beginning: in order to create national champions in the strategic industries the South Korean government provided massive financial support in form of loans with low interest rates to Chaebols. In the period span 1960-1990 the awareness on corporate governance in Korea was far from merging up, inefficiencies and episodes of moral hazard were widespread: during the “golden age” of economic growth in Korea chaebols started to make risky investments financing them with debt.166 Another relevant problem is transparency: the mandatory disclosure is merely financial and in Korea there weren’t cases of moral suasion towards listed company by the regulatory bodies to enhanced the qualitative disclosure about corporate governance mechanisms and independence of directors.

164 Campbell II T.L. & Keys, 2002, “ Corporate Governance in South Korea: the Chaebol experience”, Journal of Corporate Finance, Vol.8, pp.373-391 165 OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.21-44 166 Kang N., 2010, “ Globalisation and Istitutional change in the State Led-Model: The Case of Corporate Governance in South Korea”, New Political Economy, Vol.14, No.4, pp.519-542

91 LB 2011\2012 Moreover, despite the Code recommendation to publish annual reports in both Korean and English language, there are no evidences of compliance with this provisions as the top ten pharmaceutical companies in Korea don’t disclose nearly anything about their corporate governance situation

2.4.1. Corporate governance profile in Industry Leaders

The large inadequacy of qualitative disclosure in English language doesn’t permit a sound analysis on the corporate governance state-of-art in the pharmaceutical industry in South Korea. The corporate governance analysis is based on secondary sources such as scientific articles rather than from corporate governance reports.

2.4.1.1. Ownership structure

Analyzing the pharmaceutical market situation is difficult and is not scientifically reliable since the only annual report in English language published by the first ten pharmaceutical company for revenues is disclosed by Dong-A Pharmaceutical Co. Ltd. and LG Life Science and they don’t provide a sound corporate governance report. The only sources for information are company websites and information providers reports, but still the Korean corporate disclosures is deeply insufficient in transparency and completeness. The high ownership concentration in the industry it’s easily assessable as two main domestic competitors are Hyundai Pharmaceutical Co. Ltd and Samsung Pharmaceutical

92 LB 2011\2012 Co. Ltd., 167pharmaceutical divisions of two of the most important Korean Chaebols controlled by the main group, respectively Hyundai Group and Samsung Group, in which annual report there is no disclosure about ownership nor corporate governance and the only thing that is possible to understand is that the group is controlled through several situation of crossholding between companies belonging to the Groups. Also LG Life Science168 belongs to a Korean business group, which control directly the pharmaceutical company. Dong-A169 doesn’t belong to any business group as it is a autonomous company working in the pharmaceutical industry. Dong-a publish its annual report on the website but doesn’t disclose anything about the ownership structure.

2.4.1.2. Board of directors

South Korea adopted the monistic model of corporate governance as mandatory for listed companies: the board of directors has a great power among the company having double- natured duties of decision making and supervision. The corporate code invests the board of the duty of strategic guidance, supervision and evaluation of the management, financial supervision and risk management and suggest that only trivial matters should be delegated to management. A powerful board of directors, which is directly appointed by the Shareholders meeting, is a threat for minority shareholders, and under this point of view, the choice to converge towards an outsider system for South Korea damages their rights as the controlling families appoints the directors they prefer. The appointing process it’s simple as the nominated directors’ names should be disclosed before the general shareholders’ meeting ensuring an well-informed vote by shareholders.

167 Hyundai Group Official Website: http://www.hyundaigroup.com/eng/ consulted on the 16th of July 2012 168 LG Life Science Official Website: http://www.lgls.com/ consulted on the 16th of July 2012 169 Dong-A Official Website: http://en.donga.co.kr/ consulted on the 16th of July 2012

93 LB 2011\2012 Korean regulations don’t give definite limits to the board size and no particular board membership criteria, moreover from 1999 the institution of independent director was included in South Korean corporate governance under the name of outside director having mainly supervision duties. There are no provisions about the separation between chairman and CEO, and as a matter of fact Daewoong Pharmaceutical, Hanmi Pharm as well as Dong-A Pharmaceutical Co Ltd. appointed their leading persona both as Chief Executive Officer and Chairman of the Board. Under the independence point of view, the Code suggest a Lead INED to be nominated to supervise and handle important issues delegated to independent directors. The code states also that “ large-scale public corporation gradually increase the ratio of outside directors to more than half of the total number of directors ( minimum three outside directors)”170 and also the stock-listing rules ask to listed companies for INEDs to be more than a quarter of the board. By law board meetings should take place at least once every quarter and is required that, before the meeting, managing directors provide outside directors with necessary information to implement a sound board activities supervision. Taking in consideration the board of directors of pharmaceutical domestic leaders as they are disclosed prevalently on the company’s official website, it’s possible to assess that boards are relatively small ranging from 6 members in Daewoong171 from to 10 in Hanmi Holdings.172 Moreover not every company comply with code request of the minimum threshold of three outside director: for example Daewoong Pharmaceutical Co. Ltd. presents a board of six members with four executive and two non-executive.

170 Committee on Corporate Governance,2002, “ Code of Best Practice for Corporate Governance”, p.12 171 MarketLine, 2011, “ Daewoong Pharmaceutical Co. Ltd. .”,MarketLine Company Profile, pp.1-12 172 MarketLine, 2011, “ Hanmi Holdings Co. Ltd. .”,MarketLine Company Profile, pp.1-15

94 LB 2011\2012 2.4.1.3. Directors’ Independence and position held in other companies

The lack of disclosed annual reports and corporate governance reports in English language by Korean pharmaceutical companies and by MNCs subsidiaries operating in the Asian republic make impossible to assess the situation about companies’ compliance to the code provisions. Moreover the criteria of independence for outside directors are not precisely explained by the Code of corporate governance, which last publishing date was the 2002, neither by the Commercial Act The proof of a corporate governance that has to improve in the country is the lack of criteria for independence, the extremely vague provision that outside director “shall hold no interests that may hinder their independence from the corporation, management or controlling shareholder”173 and the absence of a system of independence assessment. Companies don’t disclose directors’ positions held in other companies and, on the contrary, is quite common, especially in large business groups, that directors serve different boards of companies, linked through crossholding, belonging to the same chaebol. Analyzing the board composition of Daewoong, Hanmi, Dong-A, Samunsung Pharmaceuticals and Hyundai Pharmaceutical disclosed on their official website or in company reports it’s possible to say that is no interlocking directorates between industry leaders in the same sector but it’s not possible to state if there are phenomenon of interlocking directorates with the financing banks in order to gain better loan conditions.

173 Committee on Corporate Governance,2002, “ Code of Best Practice for Corporate Governance”, p.15

95 LB 2011\2012 2.4.1.4. Compensation

The Code of Corporate Governance set recommendation about the remuneration of managerial services, namely the provision 9.1 in the “ Evaluation and Compensation” section of the code. In the provisions it is said that remuneration should be reflect the fairly evaluation of managerial performances, contemplating a performance based remuneration. Remuneration is decided by the board or by an internal committee of outside directors in case company created one and is submitted to the General shareholders meeting’s approval. The Code requires also a disclosure about calculation criteria of stock option plans, a requirement that is not possible to test the compliance as mentioned before there is no availability of pharmaceutical companies qualitative nor quantitative disclosure. However , citing the OECD 2001 study on Corporate Governance in Asia, “Data on performance management contracts are generally not available, although chaebol families are believed to have been using compensation schemes for top managers of the firms under their control that are not fixed-sum payment types. We expect that incentive bonuses received by top managers of chaebol affiliated firms are based more on their contribution to dominant shareholders rather than their contribution to the value of the firm to which they belong”174 This statement gives reasonable elements to think that also companies controlled by the Groups175 such as Samsung Pharmaceutical Co. Ltd. and Hyundai Pharmaceutical Co . Ltd. provide performance-based remuneration to directors and managers.

174 OECD, 2001, “ Corporate Governance in Asia,” OECD publishing, p.171 175 Chaebols

96 LB 2011\2012 2.4.1.5. Committees

South Korea adopting the monistic corporate governance model created two kind of committees: the mandatory and the voluntary committees. The mandatory committee is the audit committee that main entity with supervisory duties, the code requires that shall be composed by at least three members of the Board of Directors, two-thirds of them shall be outside director, chairman included and they are selected by the general shareholders meeting. The audit committee members are expected to be expert in corporate finance and accounting but is not required a professional license. The Code identifies eight main functions of the audit committee:

· Audit the appropriateness of the manager’s execution of operations; · Review the soundness and reasonableness of financial activities and the accuracy of the corporation’s financial reports; · Review the adequacy of major accounting standards and changes in accounting estimates; · Evaluate internal control systems; · Approve the appointment or dismissal of persons heading internal auditing divisions (for only audit committees); · Evaluate the auditing activities of external auditors; · Recommend nominees for external auditors (for only audit committees); · Check measures on those matters corrected as a result of auditing.176

The audit committee has in some cases, such as the duty of supervise the appropriateness of manager’s execution of operations or review the adequacy of accounting standards, overlapping responsibilities with outside directors and external auditors, but they still are one of the few counter alter to the monocratic power of controlling shareholders.

176 Committee on Corporate Governance,2002, “ Code of Best Practice for Corporate Governance”, pp.23-28

97 LB 2011\2012 The other kind of committees are the special committees of corporate governance that are voluntary and in the Code the Operation and the Remuneration committees are contemplated. The first one have strategic functions, operating like a sort of steering committee and composed by executive directors while the remuneration is the committee in charge of setting the managers’ and directors’ compensation but there are no provisions about the independence of such board in Korean Code of Corporate Governance, while in the Western countries is one of the most important and independent committees. It is not possible to assess if effectively pharmaceutical companies created the over mentioned corporate governance committees even if considering the high ownership concentration and the cultural Korean inclination to centralize powers in only one decision- making entity probably Operation and Remuneration committees are only contemplated in the code but not so widespread in the industry.

2.5. Concluding remarks

The Republic of Korea is one of the most developed emerging countries: the level of personal income is higher than China, India and other Asian economy, poverty is almost inexistent and the bureaucratic and public apparatus is more efficient than the average in Asia. South Korea went through a deep process of reform in the healthcare sector and in its economic reality in general after the 1997 financial crisis : the Integration Reform and the Separation Reform changed deeply the healthcare system in order to provide the country with a more cost-effective and closer to Western standards system of pharmaceutical distribution and reimbursement. The reform failed in some of its goals as in the short term the healthcare costs for the government rose instead of decrease leading the National Healthcare Insurance system close in a financial crisis between 2001 and 2002 but rethinking the whole system will bring several advantages in term of costs and efficiency in the long term.

98 LB 2011\2012 However the healthcare reform was only one aspect of a country that changed completely its “aspect” shifting from an insider economic system towards the Anglo – Saxon model in order to converge to a “global standard” and attract again foreign investments after the economic downturns of 1997 and 2008. South Korea still remains one of the most important exporters in the world with big diversified business groups such as Samsung or Hyundai group leading western electronic and semiconductors markets but the country it’s gradually becoming an important cradle for innovation, especially in the pharmaceutical market with several multinational companies establishing their R&D centers nearby the capital city Seoul. The peculiar aspect of South Korea is the government steering role that is still strong despite during the last decade the domestic market opened its boundaries to the free market: after the creation of Chaebols in the last century investing in family-owned companies operating especially in heavy industries and in the chemical sector, in the 2000s the government created favorable conditions for new industries such as the biotech lowering taxes and creating foreign investment zones in order to create a competitive advantage in emerging sectors. Although the Republic of Korea is a dynamic and growing country still present a lacking corporate governance system and some inconsistencies. First of all, the choice made in the first years of the new century to converge towards an Anglo – Saxon corporate governance model adopting a monistic model despite the high degree of ownership concentration, a weak capital market and consequently an inexistent market for corporate control reinforced the majority shareholders penalizing the minority shareholders’ interests, that are often foreign investors, is objectionable. In secundis, the problem of transparency, especially in English language is serious: the only kind of disclosure is quantitative and often is synthetic and there is no availability of corporate governance report both from domestic or multinational players. The lack of transparency is a transversal problem affecting not only the pharmaceutical industry but the whole system in general. If in 1997 the financial disclosure was inexistent, in fifteen years something changed and listed companies have to publish semi-annual report and chaebols have to publish combined

99 LB 2011\2012 financial statements177 but still the culture of a sound corporate governance is not rooted in the Korean system. Considering that the Republic of Korea in the 90s opened its economy to foreign investor and nowadays the Government is striving to attract bigger shares of foreign capital , something for corporate governance disclosure must be done together. Moreover, for a future development and growth of the Korean economy, the convergence towards the American model should be accomplished in all its aspects “breaking” the granitic controlling ownerships of Groups and enhancing capital markets efficiency using the tool of corporate governance for two important goals: protect foreign investors (and minority shareholders in general) and improve corporate performances.

177 OECD, 2001, “ Corporate Governance in Asia,” OECD publishing, p.202

100 LB 2011\2012 3. People’s Republic of China: road towards economic leadership

From 1949, when the People’s Republic of China was established, China undertook a process of gradual opening to the global economy through reforms which leading the country to a future potential world economic leadership. The first years of the newborn socialist nation were troubled and afflicted by the consequences of several civil and international conflicts in order to affirm and consolidate the country’s sovereignty over its own territories: in this situation, the “back-up” support of the CCCP was vital for China providing a loan of 1.4 billion USD and 10.000 technicians to assist the country rebuilding its infrastructures after the war against Japan. The first attempt by Mao Zedong to start an industrial revolution in China in 1958 with the Great Leap Forward policy178, was a failure causing a pernicious famine lasting for three years. The first intendment was to reach Great Britain’s production of steel within 15 years, plan that was implemented increasing the public spending on heavy industry from 38 to 56 of the overall state investments179 together with the mobilization of citizens towards the iron and steel factories. Other resources to finance the process of industrialization were provided exporting food, strategic choice which led the country to famine180.

178 “In an attempt to break with the Russian model of Communism and to catch up with more advanced nations, Mao proposed that China should make a “great leap forward” into modernization. He began a militant Five Year Plan to promote technology and agricultural self-sufficiency. Overnight, fertile rice fields were ploughed over, and factory construction work began. Labour-intensive methods were introduced and farming collectivized on a massive scale. The campaign created about 23,500 communes, each controlling its own mean of production. But former farmes had no idea how to actually use the new factories and what was once fertile crop land went to waste on a disastrous scale. The Great Leap Forward was held responsible for famine in 1960 and 1961. Twenty million people starved, and Mao Zedong withdrew temporarily from public view.” (BBC – China, 50 years of communism) available at http://news.bbc.co.uk/hi/english/static/special_report/1999/09/99/china_50/great.htm consulted on the 28th of August 2012. 179 Available at http://chronicle.uchicago.edu/960314/china.shtml consulted on the 14th of August 2012 180 NY Times Online: available at http://www.nytimes.com/2010/12/16/opinion/16iht-eddikotter16.html?_r=4 consulted on the 15th of August 2012

101 LB 2011\2012 The changes in rural policy and the true opening towards modernity came after Mao’s death in 1976, namely with the Den Xiaoping’s Open Door Policy which opened gradually to foreign investments, technology and trade creating an export-led model of development with a growing pace of an average of 9% per year. The most important features of the Policy were the establishment of Special Economic Zones in Guangdong and Fujian benefitting from their position near Hong Kong that attracted the first foreign capitals in China and the Costal development strategy181 encouraging the productivity of firms in the coastal provinces. The manufacturing firms in the coastal zone were the engine of an export-led model implemented through a devaluation of the domestic currency, the Renminbi, which was consolidated in the Nineties with several reform creating a stable trading environment. The entry in the World Trade Organization in 1998 made China a competitive place to invest as the tariff barriers were lowered from 43% in 1992 to 17% in 1999. PRC still held the control of Chinese economy through the State Owned Enterprises but gradually the corporate ownership shifted to individual Chinese and foreign investors’ hands, except for strategic industries were the government remained totally in control. The Open Door Policy had also social consequences with a gradual improvement of health conditions and education and the creation of a Chinese middle class, especially among the coast in the metropolitan area of Shanghai, of barely 200 million people. Den Xiaoping achieved were Mao Zedong failed years before as in the period span 1978- 2005 the share of workers in the primary sector declined from 70% to 45% 182 with a potential outlook of further reduction reaching the average of 10% of workers of a developed country that several years of structural change and a potential increase of labor productivity.

181 Knight J. & Ding, 2012, “ China’s Remarkable Economic Growth”, Oxford Scholarship Online: May-12 182 Holtz C.A., 2008, “ China’s Economic Growth 1978-2025: What we know today about China’s economic growth tomorrow”, World Development, Vol.36, No.10, p.1669

102 LB 2011\2012

.20 Source: C.A. Holtz (2008)

The turn towards a market oriented system was stressed with the 10-year development plan for the 90es183 increasing government investment abroad, establishing more than two thousand Special Economic Zones and giving more freedom to private enterprises; as a result PRC reached a growth rate of 10% per year in 1996 and the Asian financial crisis affected the country partially depressing its growth to 7.8% and 7.1% in 1998-1999. In the new century the country continued through its process of reform with the 11th five- year plan which was aimed to consolidate relevant margins of economic private freedom and improve health and education for citizens. In the period span 2003-2008 PRC grew with an average annual rate of 10% slightly slowing down in 2008 because of the global financial crisis to 8.3% in 2009. The process of reform lead People’s Republic of China to be the second largest economy by the 2011 after United States of America184 with a flow of foreign direct investment of 98 Billion USD in 2009. The GDP grew in the new century with a CAGR of 10,14% and in present times China still relies on exportation as its vast majority of GDP belongs to the industrial sector185 (46.8%)

183 Datamonitor, 2011, “ Country Analysis Report: China”, Datamonitor Report, p.46 184 Datamonitor, 2011, “ Country Analysis Report: China”, Datamonitor Report, p.45 185 “Producing around 8% of the total manufacturing output produced in the world” (Datamonitor – Counrty Analysis Report: China; pag 52)

103 LB 2011\2012 with particular mentions for heavy industries ( iron & steel), machinery, petroleum and consumer electronics. The exports reached 1770 bn $ in 2010 with the three most significant partners including Hong Kong(12,3%), US( 20%) and Japan(8.32%). Although PRC is experiencing a strong economic growth, government has to face a dangerous risk from the rising unemployment: this is partially due to the Chinese citizens mobilization from rural areas in order to find an occupation in the urban areas and to the economic downturn which forced companies to a 11 million workers laid off leading the unemployment figure to 4.2% of population in 2008 and to potential social unrest. In order to fight unemployment and adopt effective measures against the economic downturn People’s Republic of China implemented a policy of heavy investments in infrastructure making networks more effective with one of the widest railway network and one of the largest road networks too (53,000 km). The investment package established in 2008 accounts for 586 billion USD and the country invested also in airports and seaports structuring one of the most effective commercial network of the world lowering the average cost of supply chain management for companies. The government is also trying to be more autonomous on energy supply as China planned to ultimate the construction of 31 nuclear power plants by 2020186. In terms of workforce it’s important to stress that China has a relevant availability of workforce as the country is the most populous in the world with 1.34 billion people with the 73.6% of the overall concentrated in the 15-64 age span187. However, although the high availability of workforce is a competitive advantage on other countries, under the social point of view People’ Republic of China is experiencing several problem. First of all the high population growth rate in the 70s and the 80s jeopardized the development of PRC as an “overcrowded” country would have required too much in

186 Datamonitor, 2011, “ Country Analysis Report: China”, Datamonitor Report, pp.20-21 187 Ibid.pp.60-62

104 LB 2011\2012 investments and resources: this fact led government to implement the one child policy in 1980. The policy is still enforced and the 35% of citizens live in areas where only one child per family is allowed and the 54% of population can have two son if the first child is a girl or if there is an interval of four year between the two births188. The policy, on one hand, helped to mitigate the high birth rate but on the other hand created a severe gender imbalance with 128 males for every 100 females189 and a population that it’s dramatically ageing forecasting that in 2020 the percentage of people over 65 will almost double from 6.5% to 11.8%190. High concern is also created from the juridical situation that presents inefficiencies especially in terms of enforcement. The system is inspired by the German legal system also if lately PRC is looking towards the US legal system to regulate banking and securities sectors. The set of laws in the economic area was reformed in 1979 streamlining local courts that were the solver of Chinese civil disputes in order to reduce the time needed to solve disputes but there are still backlogs and delays. The judicial organs of the state are the people’s courts that are divided in local people’s court and special people’s court for military issues; people’s courts have four layers of power: grassroots courts, intermediate courts, higher courts and Supreme people’s courts which reports directly to the National People’s Congress.

188 OECD, 2010, “ OECD Economic Surveys: China”, OECD Publishings, pp.184-186 189 Datamonitor, 2011, “ Country Analysis Report: China”, Datamonitor Report, pp.60-65 190 Ibid.

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3.1. The Corporate Governance Evolution

China experienced an exponential, continuous growth at an average rate of 10,4%191 in the period 2001-2010 representing the highest country growth rate in the world during the last thirty years. Thus the People’s Republic of China is having a great period of economic bloom, this result is achieved in spite of a deep-rooted weak corporate governance situation. The Chinese government tried to reform the economic systems from the basis in the early 1980s but the reform stops and, although the Asiatic giant managed to avoid the dreadful social consequences experienced by the Eastern Europe countries of the shifting from an orthodox communist regime towards the market system, there is a widespread awareness that economic growth won’t continue without the development of sound corporate governance institutions. The company models in the modern China are state-owned enterprises (SOE), town and village enterprises, joint-ventures, foreign owned companies and Chinese listed public companies192. The SOE model was predominating from the 50es to the 80es as they were the pivot of the centrally planned economy. State-owned enterprises started a process of corporatization in the late 80es when a national law decreed the separation between SOEs and government and in the 1992 when Deng Xiaoping opened PRC definitively to the market system with national companies transformed in state-owned corporation or in listed public companies. The town and village enterprises are a wide array of small and medium enterprises direct expression of Chinese private entrepreneurship that form also the vast majority of pharmaceutical domestic players; some successful town and village enterprises grew in the

191 Datamonitor, 2011, “ Country Analysis Report: China”, Datamonitor Report, pp.2-4 192 Clarke T.,2010, “ International Corporate Governance: A comparative approach” Routledge – Taylor & Francis Group, pp. 196-200; 200-227

106 LB 2011\2012 last decade through processes of mergers and acquisitions becoming large diversified conglomerates with unclear ownership structure and weak corporate governance structures. Corporate governance in China has never been a real urgency because, despite the restructuration of SOEs and the gradual privatization of the Chinese economy through the TVE started at the end of the 1980s, the term corporate governance made its first appearance in 1999193. The importance of an effective legal system, a sound definition in a legal and economic way of property rights, the centrality of accountability has not yet penetrated China basically because of the impressive pace of growth. The companies’ capability of growing in size and business without a sound system of corporate governance is also due to the centrality that personal relationships have in the Chinese culture. Chinese economy bases its operations on the importance of social networks, also called guanxi, and still right now relationships and guanxi influence businessmen decisions with a super ordinate position on law and regulations and it works like a surrogate of the ill- defined property rights. The exercise of property rights remains unclear especially for western observers as “ can be a complex mixture that does not constitute a simple binary set of possibilities state vs. private. In China a bundle of property rights is exercised by different bodies and de facto property rights tend to emerge from continuing processes of negotiation between central, regional, community and private interests”194. This deeply rooted cultural practice, for sure, bypassed the dramatic inefficiencies of the legal system and the lack of transparence in the enterprises’ ownership and control but ,on the other hand, slowed down the process of development of corporate governance institutions. The corporate governance evolution in China experienced different phases: the starting point was a State ownership model with the totality of companies under the strict control of

193 Braendle U.C., Gasser T. & Noll, 2005, “ Corporate governance in China – is economic growth potential hindered by Guanxi? “, Business and Society Review, Vol.110, No.4, p.391 194 Clarke T.,2010, “ International Corporate Governance: A comparative approach” Routledge – Taylor & Francis Group, pp. 196-200; 200-227

107 LB 2011\2012 the government with no autonomy for companies which were included in a orthodox socialist planned economy. Executives were government officials and were required to follow the five-year plans guidelines instead of maximize profits for the State; the assessment of executives performance was based on their capability of respect the plans. In the first period of the state ownership model enterprises were just an economic appendix of a political decision maker, not a legal person at all, and had also a social role as usually employees in lower and higher level kept their position for the whole life assuring them salary, medical treatment and pension195. The relevant inefficiency of SOEs led the Communist Party to an attempt of revitalization of them in the Third Plenary Session of the 11th Communist Party of China’s National Congress in 1978196. The National congress gave more autonomy to SOEs’ executives adopting a management model rather than an administration-driven one, linking the executives’ autonomy to economic incentives in order to assure disciplinary tools to companies; the formal document which introduced the change in the governance model was the SOE Management Responsibility System (1981). From 1981 a new way of conceiving SOEs was implemented: the reform introduced responsibility on SOEs for their own profits and losses following the theory of “ separation between the state ownership and the SOE management rights”197 and in 1986 took place the first apparition of the concept of the company as a legal person in the official document “Terms of reference for Managers of State-owned Industrial enterprises”198 with which the manager became representative of a legal personality and gave to managers the supervisory and guarantee role for the company. The completion of the reform was set with the State-Owned Industrial Enterprises Law of China in 1988 which officially introduced three aspects: the over mentioned representation

195 Schipani C.A. & Liu, 2002, “ Corporate Governance in China: then and now”, Colum.L.Rev.1 2002, pp.5-12 196 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, p.15 197 Schipani C.A. & Liu, 2002, “ Corporate Governance in China: then and now”, Colum.L.Rev.1 2002, p.9 198 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, p.16

108 LB 2011\2012 of a legal entity by the company’s manager, in secundis the decentralization of political power over SOEs from the National Communist Party to the local organizations of Chinese Communist Party and the possibility to practice “democratic management” by the company’s executive together with employees congress and trade unions. The SOE Law in 1988 lifted the central power to the burden of a widespread exercise of power on strategic issues delegating responsibilities to local and economic authorities introducing the dualism of factory director(control) and State (ownership) typical of western systems based on contracts. The contractual system reduced the State intervention in the SOEs’ operating activities and increased the companies’ efficiency but on the other hand created the problem of the short- term focus on results and several events of moral hazard. Usually companies invested too little capital for development focusing on short term project, enjoyed benefits when they created profits and share losses with the State when they weren’t profitable and it was quite common to experience events of personal use of company’s assets by executives. These kind of inefficiencies and the several cases of misconduction by managers led central government to implement another process of reform pushing the country to a real market economy trying to define rights and responsibilities inside and outside the company. The process of reform led to a wave of restructuration of SOEs which were transformed into LLC o JSC199 and the privatization of small and medium state owned enterprises and a removing of limits to private economy which boosted its growth. On the other side the reform brought the redaction of the Company Law in 1993 and the Securities Law in 1998 creating a legal and economic background that was closer to the western realities. The Company Law putted the basis of a corporate governance framework adopting a two- tier system with three governmental bodies, namely, a shareholders group gather in a general meeting, a board of directors and a supervisory board. In its path to convergence to one of the main corporate governance model, the People’s Republic of China approached the German two-tier model with some differences as there is

199 Limited Liability Company; Joint-Stock Company

109 LB 2011\2012 no hierarchical difference between the SB and the BOD200 and the general meeting appoints both supervisors and directors guaranteeing less independence to the system than in Germany. The Chinese entry in the World Trade Organization in 2001 forced the country to comply to the OECD guidelines for corporate governance, event that led the China Securities Regulatory Commission to publish the Code of Corporate Governance of Listed Companies in 2002. The country was focused, during the new century, to solve corporate governance issues and enhance the framework. The amendment to the Company Law and to the Securities Law improved mechanisms to protect shareholders’ rights, adopting a legal framework rather than rely on guanxi, it clarified legal responsibilities and obligations of directors and supervisors and improved the financial accounting system. The Securities Law focused on transparency of supervision and control of listed companies, increased the responsibilities of controlling shareholders in order to strengthen minority investor protection, establishing also a securities investor protection fund and setting a civil responsibility framework for compensation for damages201. The process of reform of corporate governance proceeded together with a gradual development of the capital market experiencing an relevant growth in listed companies from 1990 also considering the transformation of several SOEs becoming JSC from government bodies. Government focused on the importance of developing capital markets with the official document “ Opinions on Promoting the reform, opening and steady growth of capital markets” and introduced several reform to ensure equal rights in terms of tradability of shares and market valuation of them among the shareholders, both private and public.

200 SB: Supervisory Board, BOD: Board of Directors 201 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, p.16-18

110 LB 2011\2012 3.1.1. Regulatory elements

The institutional regulatory framework in China is made three macro categories with different governmental bodies belonging to them: the security market is ruled and supervised by the China Securities Regulatory Commission, the corporate governance related issues ruled by different agencies such as The SOE Assets Supervision and Administration Commission, the General Administration of Industry and Commerce and the Ministry of Finance202 and the Stock exchanges and companies registering by the CSRC and the Ministry of Finance too. The corporate governance regulatory framework is made by four kinds of regulations: basic laws, administrative regulations, regulatory provisions and self-disciplinary rules203. The first tier of regulations are fundamental laws emanated by the National People’s congress or by the Politburo Standing Committee of the Communist party such as the Securities Law, Company Law, the Criminal Law Amendment Act, the Accounting Law and the Law on the State-owned assets of enterprises. The elder basic law that affect the company’s activities is the Accounting Law that individuates required accounting practices, the qualifications for accounting personnel and set special provisions on accounting practices for certain companies. The Company Law, amended in 2006, is intended to regulate the behavior of company and set the standards for enterprises. This law comprises the respect of rights and interests and is focused on the fair development of the blooming of the “socialist market economy” 204. The company law sets the qualification for directors, supervisors, rules for accounting and control, capital increases and reductions, legal liabilities. The securities Law, also emitted in 2006 in order to standardize securities transactions methods , listing of securities, mergers of a listed company and set the rules of the stock exchanges.

202 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, pp.1-108 203 Ibidem, pp.18-28 204 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, pp.1-108

111 LB 2011\2012 The Amendment VI to the Criminal Law in 2006 is focus though on legal liabilities in the securities transfers and sets penalties for disclosure breaches, non-disclosure, breach of trust or damage of companies’ interests, insider trading and leaks. Considering that the state owned enterprises are a leading economic reality in China, in 2009 the PRC government emitted a Law on the State-Owned Assets of Enterprises in order to safeguard and develop the national champions in strategic industries. This kind of regulation let SOEs to play a leading role in the national economy with the government investing in them, funding their M&A processes and rules the managers and directors selection and the way to assess their performances. The second tier of regulations is made by administrative regulations promulgated by the State Council such as the 2004 Opinions on Promoting the Reform, Opening-up and Steady Growth of Capital Markets that set the guidelines, as a socialist government, for the development of Capital Markets in order to standardize operations from Listed Companies, to develop and standardize the role and the professional skills of market intermediaries and points out the need of an effective supervision over capital markets. In 2005 the State Council published the Circular of the S.C. on its approval of the CRSC’s Opinion on Improving quality of Listed Companies that statue the extreme need for Listed Companies to improve corporate governance processes in order to raise performance and quality of management especially in the SOEs and published also Regulations on the Administration of Company Registration providing confirm on qualification of companies as legal personality, standardizing corporate registration and termination processes205. It’s possible to find more focused regulations on corporate in governance in the third level of laws that are regulatory provisions and normative documents that are promulgated by Ministries, Commissions, The Chinese National Bank and by other councils that are subordinated to the state council. There are several regulatory provisions ruling corporate governance practices, takeovers, disclosures, setting guidance on Companies’ Articles of association and other corporate governance issues.

205 State Council, 2005, “Regulations on the Administration of Company Registration”, available at http://tradeinservices.mofcom.gov.cn/en/b/2005-12-18/17120.shtml consulted on the 23rd of June 2012

112 LB 2011\2012 The most important provisions are the Code of Corporate Governance for Listed Companies published in 2002 that following the basic law of Chinese system aimed to create a modern enterprise system setting rules for Listed companies. The code set rules for shareholders meetings, controlling shareholders, supervisors, disciplinary systems, and set the level to assess whether or not a company as a sound system of corporate governance and to detect the level of transparency in information disclosure. Information disclosure are set also in the 2007 Regulations on Listed Companies’ Information disclosure that depicts requirements for IPOs prospectus, periodic reports, ad- hoc reports and information disclosure management. The elder provision dates back to 2001 when the institution of Independent directors was introduce in the Chinese system with the Guiding Opinions on the Establishment of the System of Independent Directors in Listed Companies206, that set the desirable requirements of independence and set the rules to appoint or elect the independent directors and oblige listed companies to provide to its INEDs207 the adequate information they need to perform their role. In 2004, in line with the Chinese socialist business models and in order to strengthen independent directors’ role, Provisions on Strengthening the Protection of the Rights and Interest of Public Shareholders were published introducing a trial public shareholder voting system on major issues and giving more freedom to INEDs. In the end there are the less cogent rules defined as Self-disciplinary that are usually trading rules of different markets such as Rules Governing the Shanghai Stock Exchange or the Shenzhen Stock Exchange.

206 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, pp.1-108 207 Independent Directors

113 LB 2011\2012 3.1.2. The CSRC Code of Corporate Governance for Listed Companies in China

The Code, published in 2002 by the China Securities Regulatory Commission, was aimed to establish solid basis of corporate governance in order to regulate the expanding financial markets introducing the institution of independent directorship, accounting procedures and information disclosure. The Code of Corporate Governance was inspired, as in the Indian and Korean cases, by the US regulatory acts, especially by the Sarbanes-Oxley Act published in 2002. Probably one of the main reasons for CSRC to look at the American example was the similar experience in terms of financial reporting and management provision infringement as China went through several scandals, one of those also called the Chinese Enron208. The big scandals in 2001 of two pharmaceutical listed companies, Guangxia Industry Co. Ltd which “cooked the books” for several years in order to appear as a cutting-edge company declaring 90 USD million of inexistent net profits and put under the CSCR lens in August 2001, and the Sanjiu Pharmaceutical Co. which, its management, had appropriated of 302 million USD without the consent of shareholders, reclaims for a modern code, a milestone for Chinese history of corporate governance, and although the Chinese two-tier system was different from the Anglo – Saxon way of govern a company, the American code seemed the most effective. Actually the code is detailed and one of the most demanding code of the emerging countries209 as membership qualification are strict requiring supervisors to be accounting and law literate and ensure the capability to the board to be independent, while to be a member of the board of directors shall have professional background; the code requires also, for appointing directors in the board, the introduction of a standardized system for election in the Articles of association.

208 Shi S. & Drake, 2002, “ Corporate Governance with Chinese Characteristics”, The China Business Review, Sept-Oct 2002 pp.42-44 209 Gregory J.H, 2002, “ International comparison of corporate governance guidelines and codes of best practice – developing & emerging markets”, Weil, Gotshal & Manges publishing, Fall edition, pp.1-215

114 LB 2011\2012 In terms of separation between Chairman of the board and CEO of the company, the Chinese Code shows not to “comply” with the Anglo – Saxon way of thinking not disclosing provisions about the matter neither the presence of a Lead Independent Director in the board. There also no provisions nor requirements about supervisory board or board of directors size only general suggestions. Moreover the supervisory board is not covered with provisions for the mix of inside and outside directors while is required that one-third of directors shall be independent; independence is defined in point 49 and 50 of the code as: “49. Independent directors shall be independent from the listed company that employs them and the company's major shareholders. An independent director may not hold any other position apart from independent director in the listed company. 50. The independent directors shall bear the duties of good faith and due diligence toward the listed company and all the shareholders. They shall earnestly perform their duties in accordance with laws, regulations and the company's articles of association, shall protect the overall interests of the company, and shall be especially concerned with protecting the interests of minority shareholders from being infringed. Independent directors shall carry out their duties independently and shall not subject themselves to the influence of the company's major shareholders, actual controllers, or other entities or persons who are interested parties of the listed company”210. Director compensation shall be decided by the board of directors and approved by shareholders’ meeting or studied by the remuneration and appraisal committee while the evaluation of performance shall be conducted by BOD or the special committee of corporate governance, namely the remuneration and appraisal committee, during the board meetings. There are no provisions nor specific roles individuated to be in charge of accountability but it’s stated the board of directors has to provide the needed materials and documents in a timely manner before board meetings in order to clarify the situation about business development.

210 China Securities Regulatory Commission, 2002, “ Code of Corporate Governance for Listed Companies in China”, p.7

115 LB 2011\2012 The Code is also focused on the importance of establishing special committees of corporate governance and sets requirements to comply: every board of directors should establish a corporate strategy committee, that is a sort of executive committee focused on defining the way the company compete, an audit committee and a remuneration and appraisal committee to define the directors’ remuneration. Moreover the chairmanship of the audit and the remuneration and appraisal committee has to be independent. The Code is also the witness of a step towards free market in China because it openly states that CEO’s performance evaluation is up to the board of director and the way to assess the quality of his work should be defined in the Articles of Association of the company, a relevant progress comparing the system of evaluation until the 90s that was completely prerogative of the central government. Furthermore the Code of Corporate Governance suggest that, to enhance directors’ performances, the remuneration committee should create a compensation policy that is linked to the company’s performance and the performance itself should become the basis to calculate the major part of directors’ compensation. Remuneration policy has to be disclosed during the shareholders’ meeting and in the annual report and has to show performance and evaluation of the board of directors according to the remuneration policy. There are no particular provisions about the function of shareholders’ meeting which ruling activity is delegated to the articles of association and about Anti-takeover devices.

3.1.3. Ownership structure

The creation of the Chinese companies’ structure reflects the political hesitations in the first years of the 1990s when the Communist Party decided to put the focus on efficiency and profit introducing the contract responsibility system triggering ownership rights retention.

116 LB 2011\2012 This situation created three kinds of shareholders: the state, individual investors and legal person; the first two categories deal with non-tradable shares while individual investors can buy and sell tradable shares in the Chinese stock exchange.

.21 Source: G. Wei & Geng 2008

The non-tradable shares are two kind of shares, State-owned shares and social legal person share, which belongs to sponsors of a corporatized SOE before an IPO; SOEs share are transferable to non-SOEs or institutional investors to become legal person shares under the approval of CSRC and the Ministry of Finance211. State-owned shares were divided by the National State-Owned assets administration bureau in two kind of non tradable shares itself: state shares, obtained by governative investment entities when they invest in stock corporations while state-owned legal person shares are shares obtained by enterprises or government affiliated institution( so not directly belonging to the state). In order to clarify the shares taxonomy it’s useful to directly cite the Article 8 of “provisional administration ways for SO-shares in stock corporations.

211 Wei G. & Geng, 2008, “ Ownership structure and corporate governance in China: some current issues”, Managerial Finance, Vol.34, Iss.12, pp.934-952

117 LB 2011\2012 Article 8. When stock corporation is founded, definition of state-owned share ownership should distinguish whether it is restructured from existing SOE or newly set up enterprise.

(1) Defining state-owned share ownership if stock corporations are restructured from former SOE:

- When SOE that founded by government institutions or departments representing the central government uses all of its assets to set up stock corporation, it should be dissolved and its net state-owned assets should be defined as state share.

- When SOE that founded by government institutions or departments representing the central government uses part of its state-owned assets (with part of its liabilities) to set up stock corporation, the state-owned share should be defined as state share and state- owned legal person share if net assets (before assessment, following is same) invested into the stock corporation is accumulatively no less 50 per cent or less 50 per cent than those in the former SOE, respectively. Or, if SOE invests all or main portion of its operation assets into the stock corporation, the share should be defined as state share.

- Firms, which are owned by state-owned legal person enterprises (excluding national industrial firms and companies that have government administrative functions), including 100 per cent or holding subsidiaries owned by SOEs whose equity relationship has been defined, use all or portion of its assets to set up stock corporation. The net assets invested into the corporation should be defined as state-owned legal person share.

(2) Defining state-owned share ownership if stock corporations are newly set up:

When government institutions or departments representing the central government invest capitals into a newly setup stock corporation, the share should be defined as state share. SOE (excluding national industrial firms and companies that have government

118 LB 2011\2012 administrative functions), or 100 per cent or holding subsidiaries owned by SOEs uses all or portion of its legal assets to directly invest into a newly setup stock corporation, the share should be defined as state-owned legal person share.

According to a CSCR study conducted in 2008, the non-tradable shares are the majority with 454.4 billion shares on 714.9 billion shares (64% ca.) issued in the market. The tradable shares comprises three categories: A share, B share and H share issued and traded in different financial markets and with different currencies212. The ownership structure situation shows an endemic presence of government in listed companies, creating a highly concentrated structure, with the 10% of direct and indirect voting rights in the 43.8% of listed companies while the five largest shareholders account for the 56% of total issued shares. There are several cases of listed companies owned by one main shareholder ( usually government)213. Although the state ownership is the dominant paradigm, inside the Chinese economic environment there are two different realities: the public and the private. The shareholder structure of private companies is dominated by Chinese families as the 60% of companies are fully family owned and the 27% are majority-family-owned214. This situation reflects, on one hand, the cultural background of People’s republic of China in which the familiar relations are tight forming a pillar of Chinese society and , on the other hand following the Law & Finance approach, the necessity of close ownership structure in order to defend property rights because of weak system of enforcement of business laws. There are three forms of private firms in China: sole ownership enterprises, partnership enterprises and limited liability companies.

212 The complete taxonomy of tradable shares is delined at page 40 213 China Securities Regulatory Commission, 2010, “ Brief Review of the development of China’s capital markets”, CSCR publications, pp.163-165 214 Liao C., 2009, “ The Governance Structures of Chinese Firms”, Innovation, Technology and Knowledge Management, pp.60-65

119 LB 2011\2012 The first two forms provide unlimited liability for company’s owners and the third accept only limited liability and LLC is the most common form of private company with family members as owners and managers of the company. Private companies are not inclined to become limited liability shareholding companies as although the institution of non-tradable shares ensures families the control of the company the potential risk of control expropriation avoid several transformations from LLC to LLSC. Inevitably the concentrated ownership reflects its characteristic on corporate control as usually owners are also managers and directors giving the strategic imprimatur to the company’s activity and implementing it. The fact that in private companies CEOs are usually owners themselves give a dimension of “superpower” to the board of directors, and affecting the independence of the decision making process. Moreover, in terms of corporate control, the private management model presents two peculiar aspects: high centralization of power and low degree of bureaucracy215. The reason of both characteristics lies in the over mentioned concentrated ownership which tend to enlarge the “span of control” reducing the degree of specialization of control systems and the formal organizational hierarchy in favour of personal control. In the dominant paradigm, the State-owned sector, the role of the state is prominent controlling the majority of stakes in listed companies through the institution of non-tradable shares. A peculiar aspect is that the State doesn’t usually directly control SOEs through the Ministry of Finance but the government ensure the property rights on several companies holding shares through wholly state owned companies or non-listed holding completely controlled by the government. The corporate governance model in SOEs is definitely an insider-dominated model as ownership structure is highly concentrated with the major shareholder holding in average

215 Liao C., 2009, “ The Governance Structures of Chinese Firms”, Innovation, Technology and Knowledge Management, pp.102-104

120 LB 2011\2012 the 47% of the overall216 and in several cases the three largest shareholders hold 60-80% of all shares. In terms of corporate control the Chinese Communist Party masterminds the appointment of directors and plays a dominant role in the shareholders’ meetings, so also in cases where the controlling shareholder holds less than the 50%, it controls more than the 50% of voting rights.217 The independence of the board from management and ownership control is deeply affected such as in the private sector, and is not uncommon that the role of Chairman of the Board and General manager are combined.

.22 Source: G. Wei & Geng 2008

216 Ibid. pp. 36-58 217 Because of the distinction between State-owned legal person shares and state held shares it may happens that the controlling shareholder, (i.e. a legal person controlled by the government) holds less than the 50% of shares but benefit from more than the 50% of voting powers because of the presence of state held shares working like a voting trust

121 LB 2011\2012 Minority shareholders are usually weak with no power to elect board of directors and consequently to prevent their property rights from expropriation. Considering the socialist imprinting of Chinese political views, the worker participation in corporate governance is primary as they are organized in workers’ congress having right to access to information on production plans and other strategic decisions that could affect employees’ life. Moreover SOE managers have to report to the workers’ congress and trade unions representatives, which usually are expression of the Chinese communist party, can be appointed to the board of directors or to the supervisory board reinforcing the “feeling” of central government control over the state-owned companies.

3.2. The Chinese Pharmaceuticals Industry

3.2.1. Background

Since the transition that led The People’s Republic of China from a totally socialist-based to a market economy in 1978, the country experienced an impressive growth, exceeding the 10% annual on average and resisted to the economic crisis maintaining a growth rate of 10.3%218 Chinese economy shows great heterogeneity in terms of governmental entities, infrastructures and economic activity; circa the 60% of the economy is concentrated in the eastern provinces where approximately the 30% of population lives219. In this context, the pharmaceutical industry represents an excellence as the growth rate skyrocketed in the period 2006-2010 to 18.5% at a compound average growth rate220.

218 Datamonitor, 2012, “ Pharmaceuticals in China”, Macroeconomic indicators, p.33 219 Brueckner M., Phillip M & Luithle, 2005, “ The chemical and pharmaceutical industry in China”, p.91 220 Datamonitor, 2012, “ Pharmaceuticals in China”, Market value, p.10

122 LB 2011\2012 The market presents limited short-term returns but pharmaceutical companies are striving to penetrate the Chinese market in order to benefit from long-term returns from a high- potential market. In 2012 China pharmaceuticals market is accounted to be the fifth largest market and if the 18% growth rate will remain steady it will be the second largest market in the world after United States of America by 2015221.

GLOBAL PHARMACEUTICAL MARKET RANK

.23 Source: IMS Health (2009)

The Chinese pharmaceuticals industry went through a process of reform that has its roots in the twenties and the thirties of the twentieth century when the traditional Chinese medicine,

221 KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China), p.3

123 LB 2011\2012 which had a millenary tradition and a widespread use among the population, was condemned for the first time by Chinese Marxist as bounded to feudal imperial times222. Despite some kind of reevaluation, for political reasons and scarcity of resources, by the Communist party in the forties and the fifties this recognition was the first step to provide PRC of a modern healthcare system. The first legal step was the first drug code of 1953 that classified in a western-science- based fashion the material needed for medicines and setting general uses for preparation; Before the Xiaoping’s Open Door Policy in the late 1970es, the Communist party, namely the local governments, sustained the pharmaceuticals industry only in order to increase occupation and develop industrialization; the five-year plans created low-quality production facilities that were duplicative and with a small scale. Then in 1998 the State Drug Association was established becoming the first dedicated governmental regulator in PRC taking the responsibilities of the Drug Administration Bureau, an office of the Ministry of Health, the State Pharmaceutical Administration and the State Administration of Traditional Chinese Medicine.223 The SDA took a relevant part in affecting the industry activities, especially the foreign company marketing taking protectionist measure such as making difficult to gain patent protection for patents issued before 1993, delaying as much as possible approval for imported drugs and, most important of all, denying to maintain confidentiality during the application process.224 Things changed after the Chinese entry in the WTO with the SDA weakening its stonewalling towards imported drugs and a relevant decrease in taxes on importation, as it will be possible to assess in the following paragraph on regulatory elements.225

222 Unschuld P.U., 1986, “ Medicine in China: A history of pharmaceutics”, University of California Press, pp.276-280 223 M., Phillip M & Luithle, 2005, “ The chemical and pharmaceutical industry in China”, p.91 224 Ling R.E., Liu F., Lu X.Q. & Wang, 2011, “ Emerging issues in public health: a perspective on China’s healtchcare system”, Public health, Vol.125, pp.9-14 225 Ibid. p.10

124 LB 2011\2012 3.2.2. Regulatory framework

The last decade the pharmaceuticals regulatory framework experienced several changes due to a gradual process of bureaucratic simplification. First of all the promulgation of the Pharmaceutical administration law of China in 2001226 simplified the establishment of pharmaceutical manufacturing and enterprises requiring the only approval of the local drug administration and a continuative process of post-approval monitoring instead of two different approvals from health and drug local regulatory bodies. The Pharmaceutical law indicates that the pharmaceutical manufacturing must comply with good manufacturing practice and good sales practice and the wholesale activity must be approved by the regional commerce regulator. In terms of product registration the discipline was reformed with the establishment of the “ Measures for the Examination and Approval of New Pharmaceuticals”227, dividing the new products in five categories228. The Patent Law of the People’s Republic of China was amended in 2001 and extended the possibility of a product registration to products marketed since 1993; the patent law extended protection for patents codifying the method for calculation of damages, the statute of limitation for infringements litigation to two years and the possibility of ordering an injunction to the infringing entity. The patent protection for registered pharmaceuticals was lengthened to 12 years for Category I, 8 years for Categories II and III and 6 years for Cat. IV, V.229

226 The Pharmaceutical administration law of China, 2001, http://www.civillaw.com.cn/article/default.asp?id=41480 consulted on the 25th of June 2012 227 “New pharmaceuticals are defined as chemical pharmaceuticals and traditional Chinese medicines that have never been produced in the PRC, and pharmaceuticals and traditional Chinese medicines for which a new indication, a change in the route of administration, a change of dosage for or a new formulation is to be adopted” ( Li C., “ New Developments in China’s pharmaceutical regulatory regime”,2002) 228 - Pharmaceuticals that have not been approved in any country but for which studies have been reported fall within Category I of chemicals new pharmaceuticals - Pharmaceuticals that have obtained market approval, are not yet in pharmacopeias and have not been imported into the PRC fall within Category II - New formulations made from existing chemical pharmaceuticals fall within Category III - Formulations in non-PRC pharmacopoeia fall within Category IV - Existing pharmaceuticals that have new indications fall within Category V ( Li C., “ New Developments in China’s pharmaceutical regulatory regime”,2002) 229 Li C.L., 2002, “ New Developments in China’s pharmaceutical regulatory regime”, Journal of commercial biotechnology, Vol.8, pp.241-248

125 LB 2011\2012 Moreover, products that are not eligible for patent protection can ask for administrative protection that it’s subjected to the Examination Commission for Administrative protection of Pharmaceuticals. The imported drugs need to be registered through “Import drug registration certificates” issued by the State Drug Administration and must be imported through specific ports with all shipments signaled to the local drug administration. Also the distribution activity of imported pharmaceuticals is strictly controlled as every distributor must deposit at the SDA all relevant distributorship contracts within two months from the signing. Moreover with the New Pharmaceutical Administration Law of China the PRC separates prescription drugs and Over-The-Counter drugs submitting the two categories to different regulatory regimes. Another change brought by the New Pharmaceutical Law is the price control of pharmaceutical products, as for manufacturers and pharmaceutical companies in general is compulsory to follow government’s guided prices and they have to disclose to the SDA the actual prices and quantities of their products. The medical insurance side was firstly regulated in the late 1950s when government provided state health benefits for employees belonging to State Owned enterprises and the government; in the period span 1994-1998, PRC widen the medical insurance system to all employees and employers of the urban districts and set the State Drug List for Basic Medical Insurance identifying selected drugs reimbursable to citizens in addition to the Provincial Authorities’ List230. About regulation on doing business in the pharmaceuticals industry, government allows foreign company to make investments in joint venture together with a Chinese enterprise for hospitals requiring that the investment has to be higher than $ 2.5m and the Chinese party detain at least the 30% of the JV with a term of 20 years.231

230 Li C.L., 2002, “ New Developments in China’s pharmaceutical regulatory regime”, Journal of commercial biotechnology, Vol.8, p.244 231 Ministry of Health, 2000, “ Interim measures for Administration of Sino-Foreign Joint Venture and Cooperative Medical Institutions”, available at http://www.cuan.cn/engpro/WebLawDetail.aspx?ID=11 consulted on 22nd of June 2012

126 LB 2011\2012 Moreover the capital of the foreign company should be above $300m in the year before the joint venture creation and Chinese government allowed foreign company to invest also in distribution services as a result of PRC entry in the WTO. As over mentioned the WTO entry manifested its effects in lowering the importation tariff of the 60% and making possible that imported products can be marketed by any kind of entity.

3.2.3. Business environment

An important factor affecting the pharmaceuticals industry is a worrying age shifting that PRC is experiencing in late years; the main causes are two: very low fertility rate and the one-child policy. In the last decades the total fertility rate fell from 2.6 to 1.56 with an expected population growth in the forty years span 2010-2050 of -3,4% and an increase in the over 65 population of 17.4%232. China experience a dramatic ageing in less than 30 years as its average age in 1980 was 22 and now is 34.5 that is a figure very close to the European average233. The one-child policy, a policy set to face the risk of overpopulation in the urban areas introduced in 1979, contributed to slow down the fertility rate, especially in the Shanghai area where is enforced at max.234 The result is that PRC has a median age of 34.6, which reach 39 years in urban areas235, that is slightly lower the American one (39 years); this fact is quite worrying considering that the other developing countries such as India and Brazil have a median age of

232 UN projection (2012) 233 The Economist, “China’s Achilles heel - A comparison with America reveals a deep flaw in China’s model of growth”, April 21st 2012.: http://www.economist.com/node/21553056 consulted on the 15th of June 2012 234 Fitzpatrick L., 2009, “ A brief history of China’s One-Child Policy”, TimeWORLD, available at http://www.time.com/time/world/article/0,8599,1912861,00.html consulted on the 23rd of June 2012 235 CIA, The World Factbook, PRC: https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html Consulted on 29th of June 2012

127 LB 2011\2012 respectively 26.5 years236 and 29.3237 providing younger workforce to their rising economies and presenting a “healthier” population. Although this policy helped effectively to fight overpopulation, on the other hand created a youth labor shortage and created a relevant social stratum of retired workers with an expected ratio of two working adults every one retired. By the 2025 the percentage of over 65 will be the 13% of the all population and these figures together with the attention that Chinese people pay for health will skyrocket the pharmaceutical products demand especially of OTC products238. Moreover personal income is rising together with the awareness of the importance of pharmaceutical products and wellness in general nationwide. The improving of living standards permitted to eliminated common diseases that are linked with bad living condition in terms of hygiene and nutrition but, on the other hand, “created”, through new diet patterns, less physical exercise and decline of job security the emergence of stress-related diseases and cardiovascular problems. The major forms of disease that are trending in the last decade are HIV that, according to last estimates, now it’s affecting 700.000 Chinese239. The Government has started a plan to contain and prevent HIV in the mainland that will increase the public spending in medical devices and in prescription drugs. Another spreading disease is diabetes which proceeding is unpredictable and it’s expected to affect 150 million by the 2025 and it’s not linkable to particular causes. However considering how the social stratification is setting accordingly to the age the top causes of death in both rural and urban areas are malignant tumors, cardiovascular diseases, cardiac and respiratory system diseases.

236 CIA, The World Factbook, India: https://www.cia.gov/library/publications/the-world-factbook/geos/in.html Consulted on 29th of June 2012 237 CIA, The World Factbook, Brazil: https://www.cia.gov/library/publications/the-world-factbook/geos/br.html Consulted on 29th of June 2012 238 Deloitte, 2011, “ Life Sciences and Health Care in China – Opportunities, challenges and implications”, p.2 239 Webley K., 2009, “ With HIV/AIDS Deaths on rise, China struggle to improve outreach”, Time.com, available at http://www.time.com/time/world/article/0,8599,1890270,00.html?artId=1890270?contType=article?chn=world consulted on the 1st of July 2012.

128 LB 2011\2012 In the last years multinational companies started to feel the pressure of domestic players because they start to develop capabilities and skills in both manufacturing and sales240; moreover they benefit of a huge availability of workers and raw materials low cost (i.e. an average hourly wage is US$0.50 and procurement costs are 40% cheaper than in developed markets)241. Despite the entry in WTO, China decided to sustain its national champions in pharmaceutical industry applying import tariffs of 4.2% that are additional to a 17% VAT on biotech equipment and medical products and contrasting imported drugs through non tariff barriers242 establishing reimbursement lists for domestic drugs. Another question mark is about the consumer spending development: the pharmaceuticals market needs that the purchasing power increase together with the progression of diseases as the Chinese Middle Class is still too small in certain areas of the mainland to boost the local market243.

.24 Source: U.N. (2012)

240 KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China), p.19 241 Brueckner M., Phillip M & Luithle, 2005, “ The chemical and pharmaceutical industry in China”, p.93 242 Li C.L., 2002, “ New Developments in China’s pharmaceutical regulatory regime”, Journal of commercial biotechnology, Vol.8, p.246 243 Brueckner M., Phillip M & Luithle, 2005, “ The chemical and pharmaceutical industry in China”, p.94

129 LB 2011\2012 3.2.4. Healthcare system

In the period span 1978-2003 the healthcare spending increased at a superior pace than the Gross Domestic Product (11.5% against 9.6%) and China experienced a leveling of healthcare expenditure between the richest and the poorest regions. In 2011 the Healthcare sector generated $309 billion accounting a growth rate from 2007 and 2011 of 15,9% . Growth rate is expected to slow down in the period from 2011 and 2016 with a CAGR of 11% and expected growth rate in 2016 of 5.3%; the structure of Healthcare sector accounts for the 35% of expenditures to Outpatient care, 26,5% of Medical Goods and for 26% for Inpatient Care244.

.25 Source: UN (2012)

Since 1978 government implemented investments to improve public health and basic healthcare services reaching the 90% of population245 , despite this relevant commitment, in the last decade Chinese government cut the public spending creating some inequalities: first of all the out-of-pocket expenditures rose dramatically. In the period between 1993 and 2003, order to further contain the public spending, China adopted the “Shanghai Model” consisting in a welfare fund together with individual

244 Marketline, 2012, “ Healthcare providers in China”, Marketline Industry Profile, February 2012, pp.6-7 245 Ling R.E., Liu F., Lu X.Q. & Wang, 2011, “ Emerging issues in public health: a perspective on China’s healtchcare system”, Public health, Vol.125, pp.9-14

130 LB 2011\2012 insurance accounts and delegated local administration authorities to promote and manage the medical insurance subscription.246 The governmental abandon of the policy of communally funded healthcare led China to be the highest out-of-pocket payments developing country exacerbating the rural areas situation with population avoiding healthcare expenses because of the required high prices. Another driver for the increasing of healthcare prices is the rising demand for healthcare services in urban areas as China became wealthier bringing higher life expectations. Moreover the investments increasing have been unequally distribute from rural and urban areas, leaving the rural areas with insufficient healthcare infrastructures and with poor pharmaceuticals distribution system with some areas left unreached. As a matter of fact China’s healthcare spending is focused for the 50% on city hospitals and only a 7.3% for suburban health centers. In addition the healthcare professionals are much lower in rural areas than in urban ones with 2.6 professionals every 1000 people comparing to the 6.2 per 1000 of urban.247 Healthcare spending in general is focused in urban areas accounting for the 80% of the overall: Beijing, Shanghai, Jiangsu and Zhejiang account the 25% of total spending; in drug expenditures the situation is similar with peaks in the cities of Beijing and Shanghai Another deformity is a lacking price control that wasn’t able to face properly the commercialization of the healthcare system leading to rising prices and an inefficient system. In the middle of the 80s the public funding declined abandoning the price control activity that permitted to offer average low prices of services. This phenomenon together with the wide spreading of hospital commercialization brought to unfair pricing policies with fixed prices set above the real cost for services and an abnormal increasing of prescription drugs.

246 Dong W., 2008, “ Cost Containment and Access to Care: The Shanghai Healthcare Financing Model”, The Singapore Economic Review, Vol.53, Issue.1, pp.27-41 247 Ling R.E., Liu F., Lu X.Q. & Wang, 2011, “ Emerging issues in public health: a perspective on China’s healtchcare system”, Public health, Vol.125, p.11

131 LB 2011\2012

.26 Source: Deloitte & Touche(2011)

In order to solve these situations, Chinese government published a five year plan for the healthcare system setting 6 main goals.248 The first objective is to strengthen public healthcare infrastructures developing rural healthcare networks reforming the public hospital system with a customer focus, implementing preventive initiatives through education; another goal is to reinforce healthcare service network through investments in grassroots hospital and clinical infrastructures and introducing private players into medical institutions. Another ambitious, and costly, objective is to improve the reimbursement system and expand medical insurance coverage for the entire population together with improving the drug supply system regulating drug procurement by healthcare institution. This important healthcare reform will entail a renewed rising of public expenditures in order to limit out-of-pocket expenditures and expand the public subsidy coverage, a reorganization of pharmaceutical distribution and will trigger a process of consolidation among the market, in order to cut expenses, and an “reinforced” role for large SOEs.

248 KPMG, 2011, “ China’s 12th Five-year Plan: Healthcare sector”, KPMG Advisory China, p.3

132 LB 2011\2012 Probably there will be a new role for private investors as the government will allow and sustain a further private expansion in the sector. The main threats presented by the five year plan are higher compliance costs for companies as new regulations will be implemented and potential bottlenecks in healthcare services, especially in the rural areas, as government will try to expand medical coverage for the entire population.

3.3. Pharmaceuticals market overview

Pharmaceutical market experienced an impressive growth since the mid 1980s and had an explosion in 2003 because of the SARS outbreak, however the Chinese market remains relatively small comparing to country’s population. In the period span 2006-2010 the market grew with a relevant pace at a CAGR of 18,5% accounting $43,1 billion in 2010. The market structure shows that the 70% is represented by chemical drugs, the 24% by traditional Chinese medicine and for the 7% by Biodrugs and the main distribution channel for drugs are hospitals (85% of drugs sold) and the other 15% of drugs are sold through retail pharmacies;249 The retail channel grew significantly in the last decade as several important manufacturers integrated vertically their business. The dominant products sold in the market are unbranded generics followed by original brand products and licensed, the remaining part of the market is composed by copycat products, unlicensed products or non-patentable products. Chinese pharmaceuticals market is a “crowded marketplace” as there are more than 5000 companies which the 98% of them produces generic drugs.

249 Datamonitor, 2012, “ Pharmaceuticals in China”, Market Analysis, pp.9-12

133 LB 2011\2012 Local manufacturer are specialized in products which patent protection is expired or in copycats. Their activity create a typical phenomenon happening in China that new products price fall quickly as copycats start to invade the market.250 This aspect make the loss of patent protection and consequently the generic drug market , one of the main strategic aspect for multinationals to cope with in the next years in order to defend their profit margin and their survival in a hyper-fragmented and developing market. MNCs are entering in the Chinese generic drugs market through several acquisition of local drug companies in order to catch a relevant market share and offset losses from patent expiration. The industry is experiencing a period of consolidation as MNCs and big domestic players need a more integrated business model in terms of product portfolio, as seen before, and distribution channels because traditional Chinese distribution channels are focused on tier-1 cities251 while the future trends seems to outline that catching the tier-2 provincial users demand will be a source of competitive advantage and the control of wholesalers can bring relevant profits to integrated companies. Moreover Chinese distribution channels are highly fragmented, unstable and inefficient as the three biggest leading distributors account the 19% of market share and they distribute only to Tier-1 retailers and hospitals. Pharmaceutical distribution in China is extremely complex as every distribution Tier has different local business practice that also vary between city and city and often MNCs products are not available in the Tier 3 cities because their products are too expensive for rural wages252. Considering that a process of consolidation and vertical integration could improve cost and distribution efficiency with relevant savings for manufacturers.

250 KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China), pp.19-25 251 Tiers of Chinese cities are defined by relative economic and social importance: Tier 1 comprises the most developed cities, Tier 2 the fastest growing cities, Tier 3 reach cities of regional importance and Tier 4 is about the remote areas. 252 Bird B., Proctor B., Putzbach M. & Widjaja, 2010, “ Retail in China”, World Trade Center Buffalo, pp.1-61

134 LB 2011\2012

Pharmaceutical Industry Value Chain

.27 Source: Deloitte & Touche

Bayer Healthcare as well as Novartis, GSK and China Pharma were protagonist of relevant M&A process to embed both distributors and manufacturers The main business models adopted for penetrating Chinese market by MNCs are Join- Ventures and Wholly-owned subsidiaries (i.e. Roche) as the “import” model is really costly because of the focus in contrasting imported drugs enforced by Chinese government and the lower costs for raw material and workforce in China253. Despite the MNCs’ activism, domestic players dominates the market holding in overall the 65% of total sales; they are low-tech producers aiming to control the local markets throughout price competition. As a matter of facts the company that retains the biggest market share is the Yangtze River Pharmaceutical Group with 2,2% of market share followed by the MNCs AstraZeneca PLC

253 Accenture, 2011, “ Mergers & Acquisitions in the Chinese Pharmaceutical Industry”,pp.4-5

135 LB 2011\2012 with 2.2% and Pfizer with 1,8%, the other 94% of the market is divided in lower market shares between 5000 domestic and international pharmaceuticals companies254. In the late nineties Chinese producers started to gain some extra-profits, to reinvest in Chinese market to enlarge their market share, exporting to developed and unregulated markets and becoming important players in the international market of bulk products and in drug intermediary. Analyzing the market through the five forces analysis tool it’s possible to assess that the most powerful market force is the menace of substitute products for several reasons. First of all, as seen above, the generic drugs market is huge in China as the 60% of the market value is generated by generics; they are an widespread alternative to the branded drugs because their effectiveness is certain and generics manufacturers can provide their products at a lower prices benefitting from the testing and the R&D process made by the product innovator without sustaining any expensive and time-consuming clinical trials. Moreover there are also other substitutes considered by Chinese customers as alternative to chemical drugs: the traditional remedies that are deeply rooted in the health culture of PRC and now are considered as OTC pharmaceuticals and biosimilars. Biosimilars are the bio-tech version of generic drugs, and are products grown in cultures rathen than obtain through chemical processes, biosimiliars have the characteristic that blockbuster products are extremely cheap because of economy of scale in production while bio-tech products that are not sold in massive quantities are usually the most expensive pharmaceutical products on the market.255 Switching costs are sensibly low because of the same effectiveness of generics and a lower price than the branded alternative and the complete different approach of healing provided by traditional medicine and biosimilars. Although the substitute force is strong the threat of new entrants is to be defined as moderate because of the pressing regulatory framework imposed by Chinese government: in primis if the reason of a company start up is a new innovative product meeting the regulatory requirements could take from 10 to 15 years and several investments for

254 Datamonitor, 2012, “ Pharmaceuticals in China”, Market Analysis, pp.11-12 255 KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China), p.30

136 LB 2011\2012 development and then clinical trials. Another barrier is the use of restrictive formularies: so only certain drugs are allowed for certain kind of therapy and it could be very time- consuming and not sure for a new product to enter in a formulary On the other hand the likelihood of new entrants penetrating the market could be reinforced by the growth expectation for the future, however the new entrants force remain really moderate. The rivalry degree is a double-façade situation as the rivalry in the generics is quite strong especially among domestic players as they compete on low price consuming their profit margins, but on the other hand the R&D activity is dominated by MNCs and product innovators usually benefit from a monopoly position, generated by patent protection, for 6 to 12 years depending on the category of the patent. The buyer power is powered by the fact that the ultimate source of funds is public health insurer that creates a sort of monopsony and is controlled by government which has the power to implement price controls ad hoc such as direct price limit, reference price regimes, or profit controls256. On the other hand the buyer power is depressed by the importance and the centrality that a pharmaceutical products has itself and its importance is in inverse proportion to the availability of alternative generics, so the more the product is innovative or unique the less the buyer can bargain for better contractual conditions. Analyzing the suppliers power it’s possible to assess that the most relevant actors in selling inputs are active pharmaceutical ingredients that are the central element of the pharmaceutical product. In China the supply of API is set on contractual basis so it’s dangerous for pharmaceutical companies to switch from a supplier to another because they could face penalty clauses that increase sensibly the switching costs. On the other hand, the over mentioned process of consolidation by M&A process in the pharmaceutical market in order to cut costs and increase efficiency is taking place also towards the source in order to weaken suppliers’ power and gain autonomy. Considering that the integration strategy is widely spread in the pharmaceutical industry the suppliers power is moderate despite the importance of APIs.

256 Sun Q., Santoro M.A., Meng Q., Caitlin L. & Eggleston, 2008, “ Pharmaceutical Policy in China”, Health Affairs, Vol.27, No.4, pp.1042-1050

137 LB 2011\2012 3.3.1. The Over-the-counter products market

The Over-the-counter industry always has been an important reality in China because traditional Chinese remedies were the main source of treating diseases in past centuries and still nowadays in the rural areas that are inefficiently reached by the standard healthcare infrastructures. The OTC array of products consists in products for traditional remedies, cough&cold, vitamins, analgesics, first aid products and anti-smoking aids. The Chinese OTC market experienced a relevant growth during the period 2006-2010 with an annual CAGR of 6,9% in a business reality that generated $10.6 billion in 2010257. The main business segment is traditional medicines such as acupuncture, homeopathy and naturopathy with roughly the 30% of market share followed by analgesics with the 9% and Cough&Cold products settled on the 6% of market share. The predominant role of traditional medicines in the OTC market reveals how deeply are still rooted Para-scientific practices in China but is also an undeniable signal of inefficiency of the healthcare system in the Sinitic Mainland; in fact often the Chinese remedies are the only cheap alternative for citizens living in the rural areas. Probably, in the near future, consumption of traditional medicine will slowly decline as a result of the implementation of the five-year healthcare plan which goal is to enlarge healthcare coverage. The likelihood of a decline in consumption is reinforced also by pharmaceuticals companies’ interest as they are not committed in producing traditional medicine products but willing to intercept Tier-2 and Tier-3 cities demand that represent the new frontier in the Chinese market. Leaving the traditional medicine off from the analysis, OTC market remains an lucrative market for MNCs that operate from the beginning in this segment, especially Roche and Pfizer258and lately also domestic manufacturers penetrated the market because of an expected exponential growth that will bring China to be the first OTC market in the world by 2020259 .

257 Marketline, 2012, “ OTC Pharmaceuticals in China”, Marketline Industry Profile, pp.6-10 258 Brueckner M., Phillip M & Luithle, 2005, “ The chemical and pharmaceutical industry in China”, pp.266-272 259 Deloitte, 2011, “ Life Sciences and Health Care in China – Opportunities, challenges and implications”, pp.19-22

138 LB 2011\2012 This forecast is driven by two different assumption regarding China: first of all living standards will improve enhancing consumer awareness on health and OTC products and self-medication in general will be a cheaper and time saving option to an hospital check-up; moreover the market will grow in a relevant manner also because of the five-year healthcare plan that will enlarge the product array defined as over the counter in order to reduce prescription drugs and set a more defined drug classification system.260 A product that has the highest potential in terms of future growth in the OTC products are vitamins; together with the wide spreading of wellness and the increasing of purchasing power, vitamins will be an answer to a renovate attention to individual health. Probably vitamins will be the segment where competition will strive at maximum during the next years: the most important vitamins producer were Roche Vitamins and BASF that benefited of the early mover position penetrating the market through a joint venture with a Chinese party, later they had to compete with a wide set of domestic competitors that built their know-how through low-cost cooperation with universities and research institutes and international late comers. During the last decade the segment experienced a decline in product prices as Chinese manufacturers took advantage of lower raw materials costs and cheaper labour costs and MNCs cut expenses through a better financial and organizational management. The potential key strategic factor in vitamins market that will be essential for a future success in a growing segment will be cost optimization that would be achieve through a process of consolidation for Chinese manufacturers or through R&D, namely a technological innovation breakthrough, for international players. The vast majority of OTC products, unlike prescription products that are mainly retailed through hospital facilities, are sold by pharmacies and drugstores (68%)261 and for a minority part by independent and specialist retailers. Over-the-counter market is expected to account $14.4 billion by the end of 2015 with a CAGR of 6.3%262 overcoming the Japanese market, that will settle its revenues at $14 billion, becoming the first Asian market, the market growth will be sustained both by out-

260 Ibidem. 261 Marketline, 2012, “ OTC Pharmaceuticals in China”, Marketline Industry Profile, pp.12-16 262Ibidem. pp.10-12

139 LB 2011\2012 of-pocket expenditures and by public funding as forecasted by the five-year healthcare plan.

3.3.2. Industry Leaders

The presence of multinational companies in the Chinese market is strong from more than a decade and several international companies had the opportunity to structure a sound business structure to gain market share especially through JVs and wholly-owned- subsidiaries. Although several big companies both international and domestic are striving to gain a position of supremacy in the market none of them controls more than the 2.2%263. Despite MNCs’ financial power and established pharmaceutical know-how, competition is severe as big domestic players have branched distribution networks and a better knowledge about lower tiers distribution levels; moreover another element that avoid the creation of a strong competitive advantage for multinationals are the loss of patent on blockbuster drugs with domestic companies ready to produce the generic alternative. In the next five years Pfizer, Sanofi, GSK and other companies will lose intellectual property exclusivity on products that brought from 11 to 9 billion dollars per year putting strong pressure on companies’ margins creating a common strategy for all of them. The loss of patent led to a change in worldwide business strategy by MNCs that are restructuring their business downsizing at most every department in Western countries264 moving employees and facilities to Chinese mainland in order to reduce labor costs and follow closely the market trends: Pfizer slashed jobs in US and UK in 2011, Roche decide to move the main R&D activities in China in order to work on a complete value chain265

263 Datamonitor, 2012, “ Pharmaceuticals in China”, Market Analysis, pp.9-12 264 KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China),pp.19-22 265 Kwok D., Lyn T.E., 2010, “ Analysis global drug firms take aim at made for China healthcare” Reuters.com, available at http://www.reuters.com/article/2010/09/21/us-china-pharma-idUSTRE68K1EM20100921 consulted on the 21st of June

140 LB 2011\2012 and Merck reduced by 15% its personnel increasing the workforce in the Brazil, China and Russia. The MNCs operating in China with a relevant market share are Pfizer, AstraZeneca, Bayer, GSK, Roche and Sanofi. Pfizer penetrated the market in the 1980s and now is present in 200 cities employing more than 9,000 workers, its national headquarters and main manufacturing sites are in Dalian, Suzhou and Wuxi on the Eastern cost of China. Despite the main R&D activities are still based in UK and the United States, Pfizer enhanced its Chinese R&D facilities in 2005 opening the China Research and Development Center in order to gradually focus its pharmaceutical concepts and the development process in sinitic mainland working together with Chinese universities and local companies. Pfizer has two different business activities in the bio-pharma business and the diversified business as a result of a reorganization after the merger with Wyeth266: bio-pharma business develop and sell primary care, oncology products and includes also innovative solutions for prevention and treatment of cardiovascular diseases , central nervous disorders and others. The diversified business comprehend animal health, consumer healthcare products, namely over-the-counter products such as Cough&Cold remedies, dietary supplements and others. Another important player in pharmaceuticals market is the Anglo-Swedish AstraZeneca that operates in the prescription drugs headquartered in Shanghai; the company is one of the late comers considering the long time commitment in Chinese market of pharmaceuticals giants such as Bayer or Roche. The company is operating in the market with an wide set of products that covers all the seven major therapeutic areas: infections, respiratory, neuroscience , oncology, gastrointestinal, cardiovascular and inflammation.267 Despite that AstraZeneca’s, that produce through 26 manufacturing sites in 18 countries, operations are located principally in Europe, Australia and Puerto Rico, demonstrated a great attention on research settling a local clinical research base in China in 1993 the same

266 BBC News, 2009, “ Pfizer acquires Wyeth for $68 bn” available at http://news.bbc.co.uk/2/hi/7850680.stm consulted on the 21st of June 2012 267 Datamonitor, 2012, “ Pharmaceuticals in China”, AstraZeneca profile, pp.24-28

141 LB 2011\2012 year of entry in the Chinese market and in 2007 AZ opened an Innovation Center in the Zhangjiang Hi-Tech Park. AstraZeneca is basically active in the Tier-1 cities but it’s trying to enlarge its range enhancing its distribution channels in order to benefit from public spending from the five year healthcare plan and reach other 100 smaller cities and the rural areas (nota). Bayer established its operation in Chinese mainland in 1936, benefiting also from the past presence of a German colony in China, and after a long period of retailing imported drugs, in 1997 started to produce directly in Beijing and now manufactures a wide array of branded products and penetrated the OTC market through the acquisition of Roche’s OTC business. Bayer is also very active in the R&D activities in China together with Schering Pharmaceuticals establishing an invested capital of 100 million dollars. Sanofi and Roche, two giant MNCs covering with their product the main pathologies of cardiovascular, diabetes, and oncology and retailing OTC products, in the Sanofi case as Roche sold its OTC business to Bayer in 2005, has a particular focus on emerging markets. Sanofi tried to make a breakthrough in the OTC market acquiring a local company active in the Cough&Cold business and acquiring a vitamins domestic manufacturer while Roche tried to differentiate itself “betting” on innovation in order to create new pharmaceutical products and to develop healthcare services and products custom-tailored268. If multinational pharmaceutical companies are all big companies on the other hand the domestic players that are roughly 5000 enterprises vary from SME manufacturers, that are circa the 90% of the overall, or chemical producers to big state-owned companies. Domestic companies usually produce active pharmaceutical imports for internal use and exportation, that accounts the vast majority of China’s pharmaceutical export value, and generics unbranded products. During the last years, Chinese companies tried to build gradually a brand awareness around them starting to export to emerging markets, consolidating their presence in the domestic mainland and signing joint venture agreements with MNCs or research institutes in order to

268 Jie L., 2010, “ Roche to boost China headcount by 25%”, China Daily, available at http://www.chinadaily.com.cn/bizchina/2010-09/09/content_11281302.htm consulted on the 25th of June 2012.

142 LB 2011\2012 comply with western regulatory regimes and sells their products in Europe and United States of America. Chinese industry leaders are both private and state owned enterprises operating in manufacturing and distribution and by the first quarter of 2011 the main Chinese enterprises are as below.

Top listed local pharmaceutical companies according to market capitalisation Company Name State-Related Market Cap. (USDbn) Revenue T12M(USDmm) Sinopharm v 8,00 6.886,52 Shenzhen Hepalink 8,00 325,00 Jiangsu Hengrui Medicine v 6,52 544,00 Shanghai Pharmaceuticals v 6,35 5.512,73 Yunnan Baiyao Group v 6,12 1.044,00 Sichuan Kelun 5,52 590,00 Shandong Dong-E E-Jiao v 4,88 301,00 Kangmei Pharmaceutical 4,88 346,98 Harbin Pharmaceutical v 4,09 1.558,77 Hualan Biological Engineering 4,07 178,25 Shanghai Fosun v 3,74 563,60 .28 Source: BMI Pharmaceutical report (2011)

The domestic company for market cap. is Sinopharm a SOE committed in pharmaceutical distribution and logistics with the holding society Sinopharm Group Co. Ltd, in pharma retail with the controlled GuoDa Pharmacy, in chemical production through China National Pharmaceutical and also in traditional remedies (an unexplored segment for MNCs) with China National Group Corporation of Traditional & Herbal Medicine269. The first private company for market capitalization is Shenzen Hepalink is one of the most important APIs sellers and the most lucrative product is a high purified version of heparin which production of 5 trillion units per year make Shenzhen the first heparin producer of the world.

269 Sinopharm,2012, “Ten business cores”, Sinopharm Website, available at http://www.sinopharm.com/p382.aspx consulted on 26th of June 2012.

143 LB 2011\2012 After the Goldman Sachs entry in its capital for the 12,5%, the company made an IPO to enter the Shenzhen stock exchange with good results270. The Shanghai-based Shanghai Pharmaceuticals is the only Chinese enterprise that integrated vertically its business operating from the manufacturing to the distribution and it’s active in research and development of new products. The integration of its business model let the company to interrelate directly with the end consumers like hospitals, pharmacies and retailers for OTCs, cutting expenses and structuring a more efficient supply chain than the other national competitors. In 2011 S.P. signed a memorandum of understanding271 with Pfizer in order to develop the market position of both companies with Shanghai Pharmaceuticals opening its well- structured distribution channels to Pfizer, especially to market the pneumococcal conjugate vaccine Prevenar, with the possibility for the Chinese company to accede to the MNC’s know-how in terms of innovation and research272. Other two important players are Jiangsu Hengrui Medicine and Yunnan Baiyao Group, both state owned enterprises, that are active in the distribution of pharmaceutical products such as pharmaceutical tablets and raw materials. Jiangsu is strongly active also in the production of cardiovascular treatments in which invest roughly 430 million RMB273 also for the research and development of new products employing 1500 workers in the Chinese mainland. Jiangsu got the US FDA approval for clinical trials for a Type II diabetes treatment; this is , among the Chinese companies, a competitive advantage because, as stated before, getting a western approval for quality standard helps building a brand identity associated with

270 Xiang L., 2010, “ Pharma firm Hepalink tops IPO price, soars on debut”, China Daily, available at http://www.chinadaily.com.cn/bizchina/2010-05/07/content_9821222.htm consulted on 28th of June 2012 271 A document that expresses mutual accord on an issue between two or more parties. Memoranda of understanding are generally recognized as binding, even if no legal claim could be based on the rights and obligations laid down in them. To be legally operative, a memorandum of understanding must (1) identify the contracting parties, (2) spell out the subject matter of the agreementand its objectives, (3) summarize the essential terms of the agreement, and (4) must be signed by the contracting parties. Also called letter of intent. http://www.businessdictionary.com/definition/memorandum-of-understanding-MOU.html#ixzz1zdeA3GGS consulted on the 28th of June 2012 272 Pfizer, 2011, “ Pfizer and Shanghai Pharmaceutical sign memorandum of understanding for potential strategic partnership”, Pfizer news, available at http://www.pfizer.com.cn/news/news_en.aspx?id=274 consulted on 29th of June 2012 273 KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China), p.24

144 LB 2011\2012 quality that is a key factor to succeed in the Chinese market as the middle-class consumers still tend to prefer MNCs’ product. Yunnan Baiyao Group that is listed on the Shenzhen stock exchange, on the other hand, is committed on traditional medicines production, in which segment is one of the market leaders, and in the distribution of other companies’ products.

3.4. Corporate Governance Issues274

3.4.1. Corporate governance profile in Industry Leaders

Despite People’s Republic of China is an important hub for foreign investments and is expected that the role of MNCs will be increasingly important on every Sinitic market, the level of information disclosure doesn’t meet the western standards and neither is close to the Indian situation where, although corporate governance institutions are still weak, the level of information disclosure, especially in English language, is higher than the average of the Asian countries. In order to assess the soundness of corporate governance in the Chinese pharmaceuticals sector we analyzed the Corporate Governance reports of the industry leader for sales and market capitalization Sinopharm Pharmaceuticals Co. Ltd., and another State-owned enterprises that is an important player in the market such as Shanghai Pharmaceuticals Ltd. and we took in consideration the corporate governance structure of a private domestic companies as Shenzen Hepalink1 and Shangai Fosun and the dynamics in a domestic player incorporated in Hong Kong: the China Pharmaceutical Group. For private companies such as MNCs subsidiaries and Domestic private company publishing the Annual Report is not mandatory and there are no data about them.

145 LB 2011\2012 3.4.1.1. Ownership structure

The industry is lead by SOEs that went through a deep reform from 1993 when Chinese government in order to improve effectiveness of SOE management implemented the zhuada fangxiao ( Keep the large and let the Small go)275. This policy contemplated the disinvestment in the SME as they were in 1995 guided by county and city governments and performed poorly also because they were heavily leveraged with an average debt-to-equity ratio of 2.49; the inefficiencies in several industries where, in the mid of 90s, the non-state reality already became a major force was a serious risk for the Chinese industrial world. This brought to the privatization of SM-SOEs and to a corporatization of Large strategic SOEs introducing the shareholding system. Pharmaceuticals industry leaders as Sinopharm changed their ownership structure after the 1997 “Decision on Issues Related on SOE Reforms and Development” when the Chinese Communist Party decided to remain dominant in strategic industries such as pharmaceuticals, energy and in high-technology sectors but to convert the SOEs in commercial viable entities with the intentions of setting clear property rights (in order to alleviate the effects of guanxi 276), separation of government and company and the shareholding system. The shareholding system were pursued through corporatization that changed companies’ status from government departments to individual legal entities with defined property rights and structuring a dualistic governance model, that is mandatory, with a board of directors and a supervisory board.277 Together with a relevant change from a orthodox socialist system to a socialist market economy the reform included also the introduction of Corporate governance institutions. The other way was the ownership diversification allowing other private interests to enter in companies equity together with PRC, with a clause providing a minimum stake belonging

275 Liao C., 2009, “ The Governance Structures of Chinese Firms”, Innovation, Technology and Knowledge Management, pp.1-57 276 The Chinese view each event and transaction in the light of its possible effects on the social network because the maintaining of relations is almost always more important than the details of a single agreement. 277 Liao C., 2009, “ The Governance Structures of Chinese Firms”, Innovation, Technology and Knowledge Management, pp.1-57

146 LB 2011\2012 to government of the 35% of shares and other 30% to other public entities with only a third of the capital freely traded on the market. The creation of different kind of shares was a real reform of the capital market with Chinese listed company shares classified as A Shares, B Shares and H Shares. A shares are issued by national companies and are tradable only for national investors and are traded in the Renmibi currency, the B shares are issued by domestic companies too but are negotiated in hard currency by foreign investors, mainly institutions in Hong Kong and Taiwan. From 2001 the B shares are available also for individual domestic investors. The H shares are issued and listed by domestic companies in Hong Kong. Furthermore the shares belonging to a listed company are classified as state shares that usually are owned by the SASAC278, legal person shares and tradable shares with state shares having the status of non-tradable shares. Legal person share are usually held by company belonging to the government too delining an ownership structure that is really concentrated. PRC designed the so-called “national champions”(nota) being part of large enterprise groups organize and collaborating each other. A clear example is Sinopharm Pharmaceuticals that is directly controlled by China Pharmaceutical Group and control several subsidiaries following the German business model of Konzern279.

278 The state-owned Assets Supervision and Administration Commission, a special agency reporting directly to the State Council 279 Group of companies with a parent company that is typical of the German system

147 LB 2011\2012

.29 Source: Sinopharm Group Co. Ltd. Annual Report 2011

148 LB 2011\2012 The same ownership structure has the Shanghai Pharmaceuticals group with the vast majority of shares subjected to trade restriction and belonging to national investment group or a county government agencies and a third of capital traded.280

.30 Source: Shanghai Pharmacuetical Group Co. Ltd. Annual Report 2011

Namely one third of the Shanghai pharmaceuticals is traded on the Hong Kong Stock Exchange, as in the annual report 2011 is possible to assess the 28,42% is registered under HKSCC Nominees Ltd., but then is owned by Temasek Holdings Singapore Ltd ( holding the shares through its wholly-owned subsidiary Maxwell Pte Ltd. Incorporated in the Mauritius Island), by a Malaysian investment group and by Bank of China Investment Ltd. And Pfizer Corporation Hong Kong Ltd. Fosun281 is a big holding of a conglomerate group committed in Pharmaceuticals, Steel, Mining, Asset Management and Insurance. Fosun is controlled by Fosun International Ltd. that is the largest private conglomerate in China that runs its operations from Shanghai and its registered in Hong Kong.

280 Shanghai Pharmaceuticals Holding Co. Ltd., 2011, “ Annual Report”, pp.1-223 281 Fosun International Limited, 2011, “ Annual Report 2011”, pp.1-199

149 LB 2011\2012 Fosun owns the majority of shares in several companies, that are not labeled as Fosun companies with stakes varying from the 10% to the 100% constituting a group of 26 companies in 6 different industries. In the Pharmaceutical industry operates Fosun Pharma (the only controlled company that is labeled “Fosun”) and Fosun held also a relevant stake of shares in Sinopharm. Also the private owned China Pharmaceutical group Ltd., incorporated in Hong Kong, is structured as a Konzern with the group controlling 21 autonomous companies most of them employed in the pharmaceutical and chemical industry. The group was privatized in 2007 with the entering of Legend Holdings, an investment holding company established in China Mainland and Massive Giant Group Limited a special purpose vehicle created by Hony Capital Fund III L.P. a partnership established in Cayman Island which is controlled by Hony Capital Fund II GP L.P. controlled by Hony Capital Fund III GP Ltd.an investment company incorporated in Cayman Island that is owned by Hony Capital Management Ltd., an investment company incorporated in the British Virgin Island that is a Chinase Private equity investment company specialized in takeovers of SOEs282. As an another signal of the scarce disclosure it’s impossible to assess who is the controlling shareholder of China Pharmaceutical Group by the Annual Report.

3.4.1.2. The Board of Directors and the Supervisory Board

The Company Law promulgated firstly in 1993, allows two types of companies to be established: the LLC (limited liability company) and the JSC (Join stock limited company). By law the only way to govern a company in China is with the typical German corporate governance model that comprise a shareholders’ general meeting, a board of directors and a board of supervisors. The shareholders’ meeting has the power to appoint and dismiss members of the board of directors and the representative of shareholders in the supervisory board too.

282 The Hong Kong Stock Exchange, 2011, “Joint Announcement of China Pharmaceutical Group Ltd. Takeover”, pp.1-8

150 LB 2011\2012 The board of directors submit reports to the S.M. to be reviewed and approved. The company law states that board of directors can be between five and nineteen members elected by the shareholders’ meeting. The Company Law reinforced the duty of loyalty and diligence of the board with the 2006 amendment that introduced this sentence as the primary aspect of the board of directors “ to abide by the law, administrative laws and regulations, and articles of incorporation and have the duty of loyalty and diligence to companies”283, so directors account for their stewardship during the annual meeting. Moreover board of directors has the power to hire and dismiss managers and the board can decide that some members of the board can serve the company as managers; it also has duties of supervision and evaluation on managers and strategic guidance. In 2002 were introduced also the institution of independent director that should be at least 2 in every boards and at least one third of the overall in listed companies. Chinese law contemplate that a director, in order to be independent, has to have no relations with other directors, he shouldn’t be influenced by shareholders, controllers or people related to the company in general. The maximum amount of position he can serve is five in listed companies and they shouldn’t hold no other position but that of independent director. Independent directors have also the power to appoint and remove the accounting firm, to call an interim shareholders’ meeting, appoint external auditing and solicit proxies before the shareholders’ meeting. Looking to how the pharmaceuticals companies have comply to law requirements there’s a mixed situation. First of all it’s impossible to assess whether MNCs comply or not; then SOEs’ corporate governance structures are well structured as Shanghai Pharmaceuticals Holdings Co. Ltd. presents a board of 9 members with 3 executive directors and 4 INEDs. The executive director Mr. Lu Mingfang is also the Chairman of the Board, and also if the “western tradition” that in case the same director serves as Chairman and executive director

283 National People’s Congress, 2005, “ Company Law”, available at http://www.chinadaily.com.cn/bizchina/2006- 04/17/content_569258.htm consulted on the 1st of July 2012

151 LB 2011\2012 the board should be made by INEDs for at least the 50% is not respect there aren’t similar provisions in the Chinese regulations. Also Sinopharm comply to the requirements with a board of 13 members, with one executive director, 8 NEDs and 4 INEDs, the role of the chairman is served by Ms. Shen Linian that is a NED. The situation in Fosun is unusual though as the 11-member board of directors is made by seven executive directors, which one of them is also the chairman of the board, one member is a non-executive director and 3 members are independent. Thus Fosun states that the roles of CEO and Chairman are clearly separated, the fact that the chairman is an executive director that works together in the strategic guidance of the company with the CEO raise some doubts on the soundness of the check & balance tools of the board. In Shenzen Hepalink, the second largest Chinese company for market capitalization, more than one third of the board is independent and the role of Chairman and CEO are covered by a different professional. Also the private-owned China Pharmaceutical Group Ltd. shows a relevant percentage of executive directors (9 on 14) and 4 INEDs. In China Pharmaceutical Group Ltd. Mr. Cal Dongchen is the Chief Executive and the Chairman; the Company explain the lack of compliance to the Code of Corporate Governance stating that “ vesting both roles Mr.Cal will allow for more effective planning and execution of business strategies. As all major decisions are made in consultation with members of the Board, the Company believes that there is adequate balance of power and authority in place”.284 In the Hong Kong-based company is disclosed also that independent directors and non- executives are entered in a two years contract with the company started on January 2011. The Supervisory board is elected by the shareholders meeting and the company law set precise duties that has to perform: first of all S.B. is obliged to be loyal and diligent and to supervise the management in order to defend the interests of shareholders and company.

284 China Pharmaceutical Group Co. Ltd., 2011, “ Annual Report 2011”, pp. 1-95

152 LB 2011\2012 OECD defines the Chinese supervisory board as “ permanent supervisory body under the leadership of, and responsible to, the shareholders’ meeting 285”. The supervisory board monitors constantly the performances of directors and senior executives and has the power to remove any directors violating the law or AOA286 and filing suit against unlawful directors. Moreover supervisory board has the duty of carrying out the internal control together with the independent directors with a mutual collaboration: the INEDs implement an ex-ante control having control on the decision-making process and the supervisory board has an ex- post control role. Usually the supervisory board are made by three supervisors which one of them is the employee representative supervisor, another clear sign of how PRC inspired its corporate governance model to the German model of Mitbestimmung287 However, also if Chinese corporate governance model were designed loosely to the German dualistic model that are some relevant differences. The most relevant difference is the possibility for General shareholders’ meeting to appoint both the supervisory board and board of directors while in Germany shareholders appoint the supervisory board which, autonomously, appoints the board of directors. This situation deforms the two-tier system in China with a board of directors that is more powerful than in Germany leading the Chinese corporate governance model to be a quasi- one-tier system with a board of directors overseeing and aiding management in the decision making process as in the Anglo-Saxon model. Moreover the Chinese supervisory board is smaller than in Germany and has almost only a mere role of consultant with the B.O.D. making decisions. Also the legal power to overturn their decisions is almost never exercised making the supervisory board a representative governance body.

285 OECD, 2011, “ Corporate Governance of Listed Companies in China: Self-assessment by the China Securities Regulatory Commission”, OECD Publishing, pp.1-108 286 Articles of Association 287 The concept of co-determination refers to two distinct levels and forms of employee participation: co-determination at establishment level by the works council and co-determination above establishment level, on the supervisory board of companies.

153 LB 2011\2012 3.4.1.3. Directors’ Independence and position held in other companies

The board of directors is the fil rouge between shareholders and management and the main tool that it has been identified by western studies and business experience to avoid agency problem is a certain degree of independence of the board from both shareholders and management. The main issue about directors’ independence in China is the pervasive presence of government in companies and business environment; as seen before despite a process of privatization, Chinese SOEs are held by Chinese Government which de facto is the main shareholders’ of the vast majority of domestic leaders in pharmaceutical industry. This fact, together with the fact that in Chinese Governance model the shareholders’ meeting appoints both supervisory board and board of directors, lead to a situation of a monocratic power that appoints the executive and the controlling bodies of the company. The Company law provide some tools to increase directors’ independence such as the impossibility for directors’ to vote in board resolutions where they have direct or indirect conflict of interest and it’s forbidden for the company to concede loans or giving secures to receive a loan to directors, supervisors or senior managers. Moreover directors and supervisors may not have business relations with related parted, in which are considered family members, a partner, a trustee or a controlled company. In 2003 were published the Independent Director Guidelines in which is stated that at least one third of the board should be made by INEDs and they can be nominated by the board of directors, the supervisory board or by a shareholder holding more than the 1% of the shares. All nomination shall be revised and approved by the CSCR, they can be reelected only once and they cannot serve a board for more than six consecutive years; the maximum of contemporary roles in listed companies recommended is 5 and the only two reasons for which an INED could be removed is the missing of more than 3 consecutive meetings or in case a director finds himself as A person may not hold the position of the independent director in any of the following circumstances:

154 LB 2011\2012 “1. the person who holds a position in the listed company or its affiliated enterprises, their direct relatives and major social relations (direct relatives refer to their spouse, father, mother and children etc.; major social relations refer to their brothers, sisters, father-in- law, mother-in-law, daughter-in-law, son-in-law, spouse of their brothers, sisters, and their spouse's brothers and sisters etc.);

2. the person who holds more than 1% of the outstanding shares of the listed company directly or indirectly, or the natural person shareholders of the 10 largest shareholders of the listed company, or such shareholder's direct relative;

3. the person who holds a position in a unit which holds more than 5% of the outstanding shares of the listed company directly or indirectly, or of the unit which ranks as one of the 5 largest shareholders of the listed company, or such employee's direct relative;

4. the person meeting any of the three above-mentioned conditions in the immediate proceeding year;

5. the person providing financial, legal or consulting services to the listed company or its subsidiaries;

6.the person stipulated in the articles of association;

7. the person determined by the CSRC.”288

In the Chinese system, usually companies disclose about directors biography. Directors are usually very skilled in the pharmaceuticals industry with several position held in the past in other companies or in some government agencies; on the other hand, although the directors’ biographies are good snapshots of their experience and skills in the pharmaceutical as well

288 CSRC, 2001, “ Guidelines for introducing independent directors to the board of directors of listed companies”, available at http://www.csrc.gov.cn/pub/csrc_en/newsfacts/release/200708/t20070810_69191.htm consulted on the 1st of July 2012

155 LB 2011\2012 as in the chemical industry, there is no disclosures about other position held in other companies and it’s impossible to compute an average number of positions served. Surely, disclosure and directors’ independence are two consolidating realities that started to merge up after the zhuada fangxiao and there are still some lacks in the system. Another problem about directors is that most of them, both executive and non-executive are representative of public shareholders, as both supervisory board and board of directors are appointed by the general shareholders’ meeting, and also most managers are former governative officials. Moreover the often infringed institution of separation between chairman and chief executive officer make the accountability a forgotten reality with the chairman that usually are more focused on strategic guidance than in the production of information for investors; secondly considering that both B.O.D. and supervisory board are direct expression of shareholders, the role of independent supervision on management lose credibility and independence, and in the end incentives for managers are not so developed as the major part of listed companies are held by government. There is also a problem of independence in terms of macro dynamics as big SOEs are structure as a group interconnected in for ways: cross-shareholding, interlocking directorates, debt relations and management relations. After the corporatization SOEs started to acquire ownership of each other in order to create a mutual goal for SOEs’ management in the perfect guanxi philosophy. The interlocking directorates took place because of state appointments; a director serving the board of director of the main company of a group is usually also assigned to the board of two or three member firms as a representative of government. Interlocking directorates help Chinese firms in reducing information asymmetries and cut transaction costs as the informative flow is smoother than in firms without “shared directors” but this kind of business behavior increase the importance of informal relations and is undeniably a serious hazard for corporate independence. There are also cases of financing and management relation such as interfirm loans with the main company financing other firm members or firm members granting loans each other

156 LB 2011\2012 and management linkages with member firms developing long-term trading relations and developing jointly production projects.

3.4.1.4. Compensation289

Together with the reform of the economic system also changes in the compensation system were introduced gradually in the 90s. Government introduced some forms of performance- linked bonuses linking the managerial work with the profitability of the firm, that is one typical way to overcome the agency problems in the dualism between property and control. Several municipal governments reformed the compensation system of their controlled SOEs: for example Shenzen Municipal Government stated that al Shenzen City SOEs have a remuneration policy that comprises three components such as the performance rewards, annual bonuses and a basic wage differentiated for the three level of management of every SOEs.290 The first legal bind on disclosure on compensation comes from the Company Law that requires information to shareholders about payments to directors, supervisors and managers; also the Standards on Contents and Formats for A.R. ask for disclosure on total pre-tax remuneration and share option plans; companies shall also indicate the volume of shares outstanding, the market and strike price by the end of the reporting period, nevertheless the Code of Corporate governance requires the constitution of a Remuneration committee made by INEDs. Another compensation requirement coming from the Code is that Senior managers shall not receive payments from any other company linked with major shareholders of the enterprise that employs the manager with an enforcement tool there is the usual of codes: a comply or explain form.

289 The analysis was implemented through the examination of remuneration policies of companies that are pharmaceuticals industry leaders. For further information about salaries and benefits provided to directors and auditors we suggest to consult the Corporate Governance reports in the Annual Reports 2011 and 2010 the analyzed company as disclosed above 290 Tam K., 1999, “ The Development of Corporate Governance in China”, Edward Elegar Editions, pp.1-129

157 LB 2011\2012 Disclosure on compensation is not so detailed as in Sinopharm’s Note 11 on financial statements is available a breakdown of salaries and it’s only possible to assess that the executive director benefit from a combined remuneration that is half fixed and half linked to discretionary bonuses. Sinopharm pays also his contribution to pension scheme291 ; independent directors benefit only of basic wage. Although the performance appraisal system in remuneration policies is more common than before, Shanghai Pharmaceuticals Co. Ltd., that is a national champion, still has no share incentive plan for managers or employees with a basic wage for every director and supervisor. In the private-owned Fosun, the note 9 to financial statements discloses the directors’ emoluments but the remuneration is accounted as fees, salaries and benefits and pension schemes contributions. Also in Fosun has not an established stock option plan for management: this policy is probably to explain considering the Fosun history. The Company was founded by four of the executive directors being also the main shareholders. In the recently privatized China Pharmaceutical Group Ltd. bases its compensation policy on a share option scheme adopted in 2004 that interests the 10% of the company’s capital with a max amount of shares per capita settled on 1% issued upon the exercise of options. Also the INEDs are considered in the stock option plan but their exercise is subordinated to shareholders’ meeting approval. The strike price is set as the highest of the closing price of the shares as stated in the Stock Exchange’s daily quotations sheet on the offer date, the average closing price of the shares as stated in the S.E.’s daily quotations sheets for the five business days immediately preceding the offer date and the nominal value of a share292, the exercise period is circa 10 years from the date of grant of options. By Chinese law equity plans are to be approved by two-thirds of the general shareholders’ meeting and the company shall disclose the implementation of the plan, the scope of the

291 Sinopharm Group Co. Ltd., 2011, “ Annual Report 2011”, pp.1-223 292 China Pharmaceutical Group Co. Ltd., 2011, “ Annual Report 2011”, pp. 1-95

158 LB 2011\2012 incentives, the amount of rights and interests linked to the stock option plans and the accounting methods dealing with equity incentives293. Comparing to the SOEs, China Pharmaceutical Group and Fosun state that the remuneration policies are not only a way to remunerate the efforts of directors or to align the managers’ interests with the companies one but also a way to attract talented managers showing a compensation philosophy that is closer to the western way.

3.4.1.5. Committees

The role of specialized committees of corporate governance has gained importance in the new century as the institution of independent director was introduced as special committees are made of INEDs for the vast majority and are useful to improve the effectiveness of the controlling processes and to increase the independence of board’s operations. The Code of Corporate Governance states that a listed company could establish a corporate strategy committee, an audit committee, a nomination committee, a remuneration committee and other voluntary special committees that shall be composed only by directors. The chairmanship of audit, nomination and remuneration committee has to be independent and also INEDs shall be at least the 50% of directors has to be independent. Thus the creation of corporate governance committees is not so widespread in China yet and the main committees are the Audit and the remuneration that, in the writer’s opinion are just a façade considering the socialist business Chinese business model, in order to reinforce the sense of fairness and independence towards potential H shares foreign and domestic investors. As a matter of fact, in SOEs pharmaceutical industry leaders it’s possible to assess that audit and remuneration committee are present in both Shanghai Pharmaceuticals and Sinopharm.

293 China Securities Regulatory Commision, 2002, “ Code of Corporate Governance for Listed Companies in China”, pp.1-11

159 LB 2011\2012 The Audit committee is usually responsible for communication, supervision and review of the internal and external audit of the Company and has the duty to ensure that the board of directors exercises effective supervision on the management. The Code identifies five main tasks belonging to the special committee: - To recommend the engagement or replacement of the company's external auditing institutions; - To review the internal audit system and its execution; - To oversee the interaction between the company's internal and external auditing institutions; - To inspect the company's financial information and its disclosure - To monitor the company's internal control system.294 On the other hand there are no recommendation about an average number of directors for the committees so companies in the pharmaceutical industry made different choices about the size of the committee: Shanghai Pharmaceutical Co. Ltd established a three-members committee all INEDs while Sinopharm created an audit committee of six members all non- executive but half independent and half linked to the company. Also the private companies Fosun and China Pharmaceutical Group has a three-members committee with all INEDs. Another important special committee that enhance the independence of operations is the Remuneration committee that is established in whole set of the analyzed companies. The main duties of the committee is to make recommendation to the Board about policies and structure of remuneration of both Directors and senior managers, to determine the remuneration packages of executives and managers and to review and approve the performance-based remunerations and to assess their congruency with the companies’ goals. This special committee is usually smaller than in western countries with only three members in each analyzed company.

294 China Securities Regulatory Commision, 2002, “ Code of Corporate Governance for Listed Companies in China”, pp.1-11

160 LB 2011\2012 The nomination committee is established only by Fosun Ltd. and in Sinopharm, also for the over mentioned reasons of the preponderant control of government on companies’ guidance that weakens the nomination committee role. Although the Code of Corporate governance states that this is one of the main special committees and should formulate standards and procedure for the directors’ appointment, should make an active research for potential skilled directors and to review candidates for the appointment. The analyzed private-held companies adopt no other committees of corporate governance while the State-owned enterprises has an interesting one that is the Strategy committee. This committee in its purpose and composition is really close to an executive committee made usually by the chairman of the board, an executive director and INEDs and conducts research and make recommendations on the long-term strategic development plans and major investment decisions.295 Moreover the Strategic committee, in Shanghai pharmaceuticals and in Sinopharm, is in charge to supervising and reviewing the implementation of annual operation plans.

3.5. Concluding remarks

People’s Republic of China went through a huge reform that brought the country to introduce its economy inside capitalism with the form of socialist free market economy. This led more than 1200 companies in China296 to diversify partially their ownership structure with the entrance of foreign capitals too. The reform tried to give more independence also to the financial system and reinforced the regulators power and credibility separating the government functions of shareholder to the regulatory one with the creation of SASAC and CSRC .

295 Sinopharm Group Co. Ltd., 2011, “ Annual Report 2011”, pp.1-223 296 Clarke T.,2010, “ International Corporate Governance: A comparative approach” Routledge – Taylor & Francis Group, pp. 196-200; 200-227

161 LB 2011\2012 The progress were made not only in respect of economic freedom but also in the soundness of corporate governance: the introduction of independent directors, the publishing of a code of corporate governance and a process of convergence towards the Teutonic corporate governance model in order to create a “Chinese version” of mitbestimmung enhanced undeniably the quality of corporate governance in China. Moreover through the amendments of Company law several steps were made for equitable treatment of shareholders. Analyzing the ownership structure of Chinese pharmaceuticals leaders merged up a relevant ownership concentration with government agencies as main shareholders; in this case one kind of conflict of interest, the management-shareholders conflict is weak for two reasons: first of all, the concentrate and stable ownership, as the shares owned by government agencies are not tradable, has a superior capacity of control and guidance over management; in secundis the possibility for shareholders to appoint directors that are usually former governmental officers and the possibility to control directly with the appointment of supervisors reduce the likelihood of moral hazard events. Surely the concentrated ownership, where the reasons of its genesis quite differs from LaPorta’s Law & Finance theories and lies in the will of an “almost-obiquous” presence that is typical of socialist governments, make the majority-minority shareholder conflict of interests a relevant corporate governance question. The institutional framework tried to smooth the harshness of this kind of conflict through equal voting power, low-cost of participation in corporate governance, the reinforcement of independent directors’ powers and the right for shareholders to make proposals. Moreover Chinese legal framework regulate related party transactions of majority shareholders through the withdrawing their voting rights of shareholders in conflict of interests in some resolutions and the possibility for minority shareholders to request compensation for damage done by controlling shareholders or directors. Despite all there are still several aspects to develop and enhance in the Chinese corporate governance: SOEs performance are still sub-optimal because of a widespread lacking of performance-based forms of compensation for managers, the market for corporate control is almost inexistent as the two-third of companies’ capital are not tradable.

162 LB 2011\2012 There are also some problems about independence of boards and supervisory boards as directors and supervisor are appointed by the main shareholders and also “ key decisions are often made informally, with boards assuming decorative functions. Power effectively is exercised by controlling shareholders and government agencies”297. The centrality of informal relationship represented by the cultural institution of guanxi that binds people on a moral tradition based on mutuality and mutual duties should be weakened in order to move to a rules-based system of corporate governance. The main challenge for future China is to decrease the presence of government in companies and develop better rules of governance. This will encourage further international investments in the Mainland giving “fuel” to sustain and defend the high rates of growth, that the most populated country in the world experienced in the last twenty years , which otherwise will decrease dramatically in the next ten years to India’s advantage.

297 Clarke T.,2010, “ International Corporate Governance: A comparative approach” Routledge – Taylor & Francis Group, pp. 196-200; 200-227

163 LB 2011\2012 4. The Republic of India: one of the fastest growing economies

The Republic of India became in the last twenty years an important power center in Asia as is the second most populous country in the world with 1.2 billion of citizens with a young population (median age of 25 years in 2010298) having the 30% of Indians between 0 and 14 years which lets India benefit from a wide workforce in young age now and in the medium term. India experienced a prominent economic growth in the last decade settling on an annual average of 8.6% GDP growth in the period 2004-2010 that will bring the former British colony to become the third largest economy by 2012 overcoming Japan. Although the country was “eligible” to become a world leading economy since its independence from Great Britain in 1947, the development was slow and gradual as the Republic initially promoted a economic growth model based on a combination of capitalism and socialism with the government promoting at the same time industrialization but strictly controlling it through the ownership control of the industry leaders and implementing socialist five year plans on the CCCP model. In the post independence period the Indian government tried to reinforce the economy of the newborn country protecting it from shocks exercising state control and public intervention: an inward-looking development strategy was adopted contemplating nationalization of banks, the creation of State-owned enterprises in the heavy industry, high tariff barriers and a strict bureaucratic control and restrictions for foreign firms. Indian government established a peculiar path of development for the country that was quite different from the typical Asian strategy based on exportation of low-priced products: the Republic protected the economy with the over mentioned measures and relied on its domestic market adopting a consumption-driven model of development rather than an export-driven one299. On one hand the particular model of growth in the first forty years of independence, contemplating socialistic and capitalistic elements, gave a great stability to a

298 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, p.2 299 Gurcharan D., 2006, “ The Indian Model”, Foreign Affairs, Vol.85, No.4, p.6

164 LB 2011\2012 fragile economy coming out from a long period of colonization that impoverished the country leaving it in a situation of stagnation with an average growth of 0.8 per year from 1900 to 1950 that, considering the population growth, never improved the per capita income. On the other hand the country, even if it had the characteristics to meet the new demand coming from Western countries it didn’t, as the system was inward looking and set to create companies working for an import-substituting policy. Moreover the socialist policies created an over regulated economic environment with the vast majority of industries subjected to strict price regulations depressing the country development and making foreign investments unprofitable. A protectionist economic policy led India to a balance of payments crisis as the country had to bear the heavy burden of increasing debts with a poor economic development in 1991, which was the trigger of an intense period of reforms and liberalization. The current Prime Minister, who was the Finance Minister in the early 1990s, Manmohan Singh, denying the socialist imprinting of the former growth model, opened India’s doors to foreign investments lowering tariffs and trade barriers, reducing taxes and devaluating the national currency in order to boost exportations. The process of economic liberalization India undertook opening the national boundaries to foreign companies obtained a continuous increase of GDP growth rate: in the early years of 1990s the GDP grew constantly of a six percent for ca. ten years and from 2001 India became one of the fastest growing country in the world with a CAGR of 8.6% per year. Moreover foreign capital inflows boomed to over $280bn in 2009300 and amount of FDI topped $197.93bn in 2011.301

300 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, pp.60-62 301 Afsharipour A., 2009, “ Corporate Governance Convergence: Lessons from the Indian Experience”, 29 Nw. J. International Law & Business. 335 2009,pp.349-359

165 LB 2011\2012

.31 Source: World Bank – Databank (2012)

The steady inflows of FDI and the fast develop of domestic companies which was looking for a source of financing boosted the development of the Mumbai Stock Exchange founded in 1875, the oldest stock exchange in Asia, that since the foundation until the first years of the 2000’s remained a small and functioning market. The development of Mumbai Stock Exchange and the National Stock Exchange of India has been impressive, especially in 2005-2006, with a total equity issuance settled on $19.2 billion in India in 2006, a 22% more than in 2005, and more than 5000 companies listed in the two stock exchanges (considering that the MSE registered 5085 companies listed alone302) that is more than the number of companies traded in the NASDAQ and in the NYSE combined.

302 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, p.62

166 LB 2011\2012

Million Trades Million

.32 Source: Journal of applied corporate finance

The fast economic growth “elected” several technology-related industries as drivers of GDP increasing in the last years: this is due especially to the Indian education system which is focused on technical education turning out 60.000 computer professionals and 440,000 engineering graduates per year; the annual number of graduated engineers in India is significantly higher than any other country in the world creating a technical employee base of more than 3 million Indians.303 India experienced a real economic revolution: the telecommunication revolution bloomed, research and development activities grew sharply as the offer of skilled workforce was high 304 and low-cost . The most important industries in India deal with technological services such as fixed line and mobile telecommunication (particularly the second one accounted a growth rate of 23% per year from 2005), internet and the hardware and software industry accounting a annual growth rate of respectively 32% and 28% fairly higher than the Chinese and Japanese industries, the two main markets in Asia.

303 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, p.82 304 Research talent in India is available at a much lower cost in comparison with developed countries. The average salary of a researcher in India is $11,526, which is around 15% of a researcher’s salary in the US – Datamonitor, Country Analysis Report: India, 2011.

167 LB 2011\2012 The IT-related industries made a significant contribution to the sharp boom of Indian GDP and also contributed to “improve the quality” of it as before the boom of IT a consistent part of it was linked to the primary sector. The “dark side” of Indian economic revolution lies in the sudden shift from a socialist and prevalently rural economy to a technological-oriented, tertiary-led economy itself: India didn’t pass through a real industrial revolution that could have changed the life of millions rural inhabitants. Every country in economic history experienced a gradual shift of its GDP structure from primary sector through the secondary and then, in the late stadiums of development, in services activities: India in less than twenty years created an high-skilled and high-value services sector without building an industrial reality first. The fact that Gross domestic product part belonging to services now accounts for more than the 50% of the overall305 not necessarily imply that more people are working in the tertiary sector than twenty years ago, au contraire. This important information assesses that services are more valuable than before and undeniably are the engine of Indian economic system but other data depict a worrying situation as almost the 50% of Indians still work in the primary sector that contributes for the 16.1% of overall GDP306. So the real picture of the Indian situation is a double-faced country with an extraordinary availability of skilled English speaking workforce, especially in engineering and scientific fields, due to a sound system of higher education that created a new paradigm of development based on the exportation of technical expertise and high-quality services rather than low cost goods and a backward rural reality where more than a half of population lives with low living standards, barely unreached by basic services and education. Surely Indian should need a development policy focused on manufactory in order to create low-skilled array of jobs to reallocate the overabundant workforce employed in agriculture

305 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, p.65 306 Ibidem.

168 LB 2011\2012 to the secondary sector and increase country’s productivity and slowly create a wider middle-class. The rural problem could be solved or, at least, alleviate if in the near future the IT-based services will become the enabler of a “industrial revolution based on services” creating linked-industries with a wide array of back-up jobs of lower level that attract population from the countryside to the main cities307. The problem of social inequality, concomitant with the 1991 economic liberalization, needs to be solved in a short time as becoming a risk: in the regions of Kashmir, Himachal Pradesh and Uttarakhand the state of poverty of the vast majority of inhabitants led to social unrest giving birth to militancy.308 The unstable social environment exacerbates their situation as companies are reluctant to invest those regions creating a risky situation and anti-governative feelings the federal government is expected to solve. The other two main country weaknesses are the lack of efficient infrastructures and fiscal deficit. The lack of infrastructure is a severe weakness and threat at the same time: companies sustain higher costs in supply chain management as several bottlenecks happen because of the absence of proper railways, highways and ports to deliver in a timely manner goods and usually they have to create larger inventories in order to avoid disruptions. Moreover the endemic lack of infrastructure among the country inhibits foreign and domestic companies’ investments depressing the country economic development in present and future times. The second point of weakness is a growing fiscal deficit reaching the 4.7% of GDP309 that is low comparing to the overwhelming amount of debts of United States of America and countries in the Euro zone but still needs to put under control and reduced as is likely to increase in case India will start to invest in infrastructure and cut taxes.

307 Gurcharan D., 2006, “ The Indian Model”, Foreign Affairs, Vol.85, No.4, pp.6-10 308 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, p.24 309 Datamonitor, 2011, “ Country Analysis Report – India”, Country report, p.63

169 LB 2011\2012 4.1. Corporate governance evolution

Indian government has always been active in regulating the competitive arena through business law from the very beginning of the Republic, while voluntary codes of conduct came later in time with liberalization in order to attract foreign investments. The activism in business law and the zeal with which government promulgated its first Industries Act in 1951 was due to the “U-turn” of India that left the capitalist colonial past for socialism. Industries Act had a socialist imprinting as the main requirement was that every company needed licenses from central government in order to start its operating activities. The subsequent Act in 1956 formally created the basis of a socialist economy: the Industrial Policy Resolution stated that the vast majority of industries should be under control of government. The resolution classified Indian industries in three categories: Schedule A which identified industries directly controlled through a monopoly regime, Schedule B comprised industries on which government had to enhance development through a coexistence of state owned enterprises and private companies and a residual category called Schedule C where the remaining industries were gathered and in which private companies could freely operate with a government license310. The monopolistic industries were 17 in total and covered all the strategic areas for the development of a modern country such as defense, energy production and distribution, iron and steel, heavy industries in general comprising air, railway transports and ship building, communications and mining activities. Industries falling under the Schedule B umbrella were subjected to five year plans and were 12 ranging from road transport to chemical and pharmaceutical products. Moreover for more than forty years these industries were dominated by public sector undertakings, often called PSUs, state owned enterprises where more of the 51% of shares

310 Government of India, 1956, “ Industrial Policy Resolution”, available at http://www.fipbindia.com/changes_files/changes/chap001.pdf consulted on the 1st of August 2012

170 LB 2011\2012 belong to regional or central government and were thought in order to redistribute companies’ income among citizens in a more equitable way, following the socialist creed. The PSUs were classified as Public Sector Enterprises, Central Public Enterprises and Public Sector Banks, created in 1969 after the nationalization of the 14 major banks . The first bank nationalized was the National Bank of India which was India’s largest commercial bank serving 90 million users and by 1980 the 80% of banks was under the government ownership311. The taxonomy of CPSEs divides them in strategic and non-strategic companies: the first of them were, and still are, active in Schedule A industries, especially in Arms & Ammunition, Atomic energy and Railways transport. The creation of PSUs experienced two phases with an initial foundation of SOEs operating only in the Schedule A industries and the most important were the Oil and Natural Gas Commission, the Indian Telephone Industries and the Hindustan plants, aircraft and shipbuilding312. The second phase of PSUs consisted in a process of substituting private activities with state-managed situations: in the 70s and 80s many takeovers of private companies took place in several industries, many foreign firms such as Braithwaite & co were nationalized and the same happened with major banks. SOEs entered also in new Schedule B industries like pharmaceuticals, clothing and hotels313. The Industrial policy resolutions “plastered” the system and the synergic effect of absence of corporate governance regulations and a poor enforcement of business laws led India in long period of inefficiencies. Only one Act survived to the wave of liberalization: the Companies Act of 1956 deeply inspire by the British Act314 of 1948, amended recently, that was the milestone of business

311 Central Bank of India, Bank of Maharashtra, Dena Bank, Punjab National Bank, Syndicate Bank, Canara Bank, Indian Bank, Indian Overseas Bank, Bank of Baroda, Union Bank, Allahabad Bank, United Bank of India, UCO Bank, Bank of India (http://finance.indiamart.com/investment_in_india/nationalisation_banks.html consulted on the 2nd of August 2012) 312 Public Sector Undertakings in India, Spotlight: http://www.india.gov.in/spotlight/spotlight_archive.php?id=78 consulted on the 2nd of August 2012 313 Ibidem. 314 Afsharipour A., 2009, “ Corporate Governance Convergence: Lessons from the Indian Experience”, 29 Nw. J. International Law & Business. 335 2009,pp.354-358

171 LB 2011\2012 law in India ruling incorporation, functioning and closing of Indian companies, indifferently public or private. In this official documents were introduced in recent times by MCA315 in the sections 252 to 269, corporate governance principles and requirements even though limited and generic. Since the independence day until the 1991 liberalization policy undertook by Singh, companies operated in a suboptimal manner with no respect for minority shareholders’ rights, no independence of boards, that usually “were staffed by friends or relatives of management, and abuses by dominant shareholders and management were commonplace”316 The socialist economy in India depressed also the financial markets activity as they were not liquid; ipso facto the market for corporate control was inexistent until the first years of the 90s protecting inefficient boards from hostile takeovers. In 1991, when the liberalization period started, India undertook a process of convergence towards the Anglo-Saxon system, which was the closest model to Indian cultural background for 334 years of British colonialism. The first official step came in 1998, seven years after the process of liberalization with the creation of the Clause 49 of the Listing Agreement of Stock Exchange. The way that Indian regulators identified to obtain a corporate governance regulations was to follow the steps made in UK with the Cadbury Code of 1992 and take the path of convergence. Indeed, the trigger of a deep corporate governance reform was the lobbying activity of the most important industries and business association which created a commission in order to establish a first corporate governance code for Indian listed company after fifty years of a weak corporate governance regime; the resulting paper was an expression of a clear will of convergence with the Western standards317: the “Desirable Corporate Governace: A Code”318 also known as CII Code in 1998.

315 The Ministry of Corporate Affairs 316 Bhat V., 2007, “Corporate governance in India: Past, present and suggestions for the future”, Iowa Law Review, No.92, p.1438 317 Ibid.,pp.378-385 318 CII, 1998, “Desirable Corporate Governance: A Code”, Confederation of Indian Industry, pp.1-16

172 LB 2011\2012 The importance of the CII Code transcends the code itself, that was merely a copycat of western corporate governance code and was replaced by the first edition of Clause 49, as was the first step forward and the engine of a wave of reform and, above all, was a clear message by the Indian economic “aristocracy” of the will of ran out towards a wider environment, a global one, attracting foreign capitals in India creating a “playground” that was similar to the American and European ones. The main problem was that convergence was implemented through different paths with two contrasting main actors involved in ruling of corporate governance practices: the Securities and Exchange Board of India, originally created as an advisory board in 1988, which gained the power of regulating the securities market as an independent authority with the SEBI Act of 1992, (the SEBI Act of 1992 has been amended three times: in 1995, 1999, and 2002319) and the Ministry of Corporate Affairs (MCA) that was in charge to amend the Companies Act of 1956320 in order to improve India’s corporate governance framework. The two competing boards started a real battle of committees begun in 1999 when SEBI, in order to give a government answer to the lobbying activity of CII that was asking for a compulsory adoption of the CII Code by listed companies, appointed the Birla Committee, a commission on corporate governance gathering the major industry members. The focus of the committee was on independence and disclosure and the main recommendations made were centered on board representation and independence (Birla Report), on the importance of disclosing a Management Discussion and Analysis in company’s annual report and on the necessity of the formation of a corporate governance committee that answer to shareholders’ grievances: recommendations were introduced in the Clause 49 gradually between in the 2000’s. In 2002 the Ministry of Corporate Affairs gathered its first committee in late 2002 as an answer to corporate governance scandals in Western world and in order to adopt the new guidelines of the US SOX Act and the committee members concentrated especially on the

319 Asia Corporate Governance Association: http://www.acga-asia.org/public/files/Kania-rep_032005.pdf consulted on the 20th of May 2012 320 MCA Companies’ Act of 1956: http://www.mca.gov.in/Ministry/actsbills/pdf/Companies_Act_1956_Part_1.pdf consulted on the 18th of May 2012

173 LB 2011\2012 auditing and disclosure amending the 1956 Companies Act with new dispositions on roles prohibited to audit committee members and on rotation of audit partners. SEBI organized a committee on corporate governance the same year, the Murthy Committee to analyze the Sarbanes-Oxley Act and amend Clause 49 setting new parameters for directors’ independence321, recommending a sound financial background for audit committee members, requiring more detailed disclosure on annual report about board of directors, audit committees and CEO certification of internal controls. In 2004 MCA revised again the Companies Act distinguishing for the first time between requirements for small and big Listed companies in order to reduce compliance costs for SME, on the other hand MCA didn’t tighten requirements on directors’ independence setting no age limit nor term limits creating a contrasting situation with SEBI’s Clause 49. In terms of enforcement of the two corporate governance regulations there is a basic difference: Clause 49 is a part of the Listing Agreements of Stock Exchange and is the SEBI itself to operate to enforce the possible delisting as contemplated by the Section 26 of the SEBI Act while the MCA’s provisions are in a basic law and the main body in charge to law enforcement is Company Law Board. The judiciary in India is strongly weak because, despite the closeness of Indian Law System to the “agile” Anglo-Saxon common law system, and this is witnessed by the almost total absence of corporate judicial actions in the last decade: India moved away from the common law tradition of modeling the law on a case-by-case basis towards the rule- making system typical of civil law culture strengthened by public enforcement. This was due to the failure of Indian judiciary of resolving corporate disputes: Indian courts are characterized by delays in resolving a case by trial and the average time of a legal dispute is 20 years. This is, furthermore, the reason why the Clause 49 has more weight in ruling the corporate governance affairs than the MCA’s Corporate Act; MCA’s main judicial authority, the

321i.e. nominee directors (i.e., directors nominated by institutions, particularly financial institutions, with relationships with the company) be excluded from the definition of independent director

174 LB 2011\2012 Company Law Board, experienced in the last years several delays and over twenty million cases awaited for final judgment among different Indian courts by the end of 2001322. In 2002 Indian parliament tried to amend the legal structure creating a National Company Law Appellate Tribunal to give back strength to the Corporate Act. Moreover the NCLAT had the powers to remove management, direct an audit, and conduct inspections. Despite the important amendments to the juridical system to lift the high court from the burden of corporate disputes, the effective enforcement remained low creating backlogs and delays making the juridical system still ineffective. In the light of these inefficiencies, SEBI’s Clause 49, together with moral suasion as disciplinary tool for compliance, embodies a Anglo-Saxon, innovative and important Indian corporate governance code that, however, is designed only for big companies, as a large percentage of the SME companies doesn’t comply to the Clause 49 and with few tools to enforce its requirements.

4.1.1. The Clause 49 of Listing Agreement of Stock Exchange

The main provisions and requirements of corporate governance in India are included in the Clause 49 of the Listing Agreement of stock exchange and was created in the late 90s and firstly introduced in 2000 and then revised and amended by the Murthy committee in 2003. The Clause is directly inspired by the Anglo – Saxon codes of corporate governance, in the beginning by the 1992 UK Cadbury Report and then modified taking in consideration the new disposition of the US SOX Act. Clause 49 put great importance on the independence of independent directors, also considered the ominous scandal of Satyam323, requiring six criteria which the director has to comply with to be qualified as independent.

322 Afsharipour A., 2009, “ Corporate Governance Convergence: Lessons from the Indian Experience”, 29 Nw. J. International Law & Business. 335 2009,p.360 323 For further information about Satyam Scandal: http://online.wsj.com/article/SB123135583835961599.html consulted on the 2nd of August 2012

175 LB 2011\2012 First of all the director shouldn’t make transactions or receive money from the company, its promoters, its management or subsidiaries; the INED has to be unrelated to promoters or management and shouldn’t have been an executive of the company in the preceding three years. Moreover he has not to be a partner or an executive of the statutory audit firm or the legal firm working with the company, a supplier, a service provider or a customer of the company or a relevant shareholder of the company324. The Clause indicates that the percentage of independent directors inside the board should be at least fifty percent and in case the Chairman of the board is a non-executive director at least one third of the board. The matter of accountability is not treated directly and the Clause doesn’t indicate who should be in charge of interaction with investors and press leaving the decision to the board of directors’ will. The code recommend a separation between the role of Chief Executive Officer and Chairman of the board in order to preserve independence while there are no provisions about board size. Several changes to the Audit Committee325 discipline were implemented after the SOX Act as before the code required the majority of directors should be independent while, with the 2003 amendment, explicitly asks for two-third of the committee to be INED. Moreover is required to all members to be financially literate as against the preceding provision of at least one member. The Murthy committee increased the committee meetings from three to four in a year and the committee responsibilities were widened including review the functioning of Whistle Blower mechanism if existing and review the performance of statutory and internal auditors. The introduction of a MD&A document326 putted Audit committee in charge to review the soundness of this kind of qualitative disclosure too.

324 Two percent of voting shares 325 Gregory J.H, 2002, “ International comparison of corporate governance guidelines and codes of best practice – developing & emerging markets”, Weil, Gotshal & Manges publishing, Fall edition, pp.116-118 326 Management discussion and analysis

176 LB 2011\2012 Disclosure on remuneration is well coded as the Clause 49 requires companies to disclose in their annual report all elements of remuneration (salary, benefits, fees, stock options and pension), the nature of it (fixed or performance linked incentives) and stock options details. The Murthy committee introduced also requirements of disclosure for compensation of non-executive directors as the company has to disclose the limit for a maximum number of stocks granted every year and in aggregate. The amendment introduced new disclosure provisions as related party transactions in the ordinary course of business as well as not in the ordinary course shall be disclosed trying to give more transparence to disclosure on conflicts of interest.327 Other requirements affecting the board activity is the reduced gap between board meetings from four to three months, the CEO/CFO certification of internal control and the formulation of a code of conduct for board members and management that directors and managers have to comply annually with.

4.1.2. Ownership structure

In the Republic of India the Listing Agreement of Stock Exchange provides a taxonomy of owners depending on their nature and the percentage of shares they hold (Clause 35 and Clause 40A).328 Who holds the relative or absolute majority of shares and exercises the corporate control is defined as Promoter which could be national, foreign or could be created through a voting block of people acting in concert. Minority shareholders are defined as Non-promoters and they could be institutional or not: in the institutional shareholders array there are mutual funds, banks, insurance companies, sovereign funds and financial institution while the non-institutional are mainly composed by corporate bodies and individuals.

327 Sen D.K.,2004, “ Clause 49 of Listing Agreement on Corporate Governance”, The chartered accountant, p.810 328 Kaur P. & Gill, 2009, “ Patterns of Corporate ownership: evidence from BSE-200 Index companies”, Paradigm, Vol.13, No.2, p.16

177 LB 2011\2012 Before 1947 the common ownership model was the managing agency model where every corporate group had a held company or a partnership which was called managing agency. “Managing agencies would float companies, and their imprimatur sufficed to ensure massive over-subscription of shares. Given excess demand, most of these companies could split shareholdings into small enough allotments to ensure that nobody — barring the managing agency — had sufficiently large stocks to ensure their presence on the board of directors”329. Despite one of the main feature of this ownership model was the dispersed ownership, the managing agency model set the basis for the concentrated post-independence ownership structure as often the managing agencies were created as partnership between members of a family. In the managing agencies lied also one reason of the dramatic stagnation of the colonial India as the agencies originated their profits from intermediation activities, price fluctuation and inflation and for years, companies instead of strive to increase productivity or fostering innovation created artificial scarcities in order to gain profit from them330. In 1947, when British forces left the political control and India declared independence the role of the promoter was central in the constitution of the new economic environment as they floated several new ventures by investing in a minority amount of capital and then offering the rest to the market or, more often, to public financial institutions. The government, in order to foster the economic development under a socialistic point of view entered in several public limited companies acquiring large amount of shares and created several business conglomerates, giving the name of “business house model” to the period span 1947-1991, which were controlled and directed by the apex company which worked as a holding company. However the particular intent of protecting the public interests without being involved directly in the strategic control established a situation where government had the majority of capital through PFIs and business family directed the conglomerates with a minority

329 Oman P.C., 2003, “ Corporate governance in development – the experiences of Brazil, Chile, India and South Africa”, OECD Center for International Private Enterprise publishing, p.119 330 Reed A.M., 2002, “ Corporate Governance Reforms in India”, Journal of Business Ethics, Vol.37, p.251

178 LB 2011\2012 stake of the holding company and exercising control of the whole group through interlocking directorates and inter-corporate investments331. The situation of ownership structure remained the same also after the 1991 economic liberalization as business families maintained their majority ownerships in holding companies and controlled the whole group in the same manner as in the socialist period even if Indian government opened the Indian market to a process of convergence towards the Anglo – Saxon Model setting Anglo – American corporate governance rules and empowering both Bombay and National Stock exchange and encouraging foreign investments.

4.2. The Indian Pharmaceuticals Industry

4.2.1. Background

The Indian pharmaceuticals industry is one of the largest and most developed in the emerging markets ranking 3rd in terms of production volume and 14th in terms of value332. The industry grew from an almost nonexistent to a world leader pharmaceuticals producer in bulk drugs and generic drugs In 1947 when India became independent, its pharmaceuticals market was fully occupied by multinational companies that provided products through importation. Moreover, in that period, prices were particularly high due to the possession of almost all pharmaceuticals products under patent by foreign companies. In the seventies, Indian government, in order to weaken the dependence on foreign players, implemented some actions such as the foundation of five state owned companies333, the

331 “There are primarily two mechanisms through which intercorporate investments occur. The first is direct interlocking of equity between two companies belonging to the same house. The second is building circular chains of investment between companies of the same group”(Reed, 2002) 332 A.A.V.V. ,2011, “National Pharmaceutical Pricing Policy”, Dep. Of Chemicals and Petrolchemicals,p.2 333 The Bengal Chemical and Pharmaceutical Works (1930) as India’s first public sector drug manufacturer; The Hindustan Antibiotic Ltd. (1954) with the assistance of the United Nations and UNICEF; Indian Drugs and

179 LB 2011\2012 abolition of product patents on drugs, food and chemical substituted with the process patent and price regulations on formulations and drugs. By the beginning of the 90’s, India was able to fully supply the domestic demand for formulations and bulk drugs, enforcing its role in the pharmaceuticals industry and decreasing the presence of foreign producers on the domestic market. Although the Indian production for domestic market was high, the Hindi producers were lacking in exportation as in the 1995, when the Republic of India joined the WTO, were valued less than six hundred million dollars . After joining the WTO, Indian exports increased to $3.7 billion, especially in generic drugs334 and bulk drugs processed in formulations; this trend is intended to increased because in the 2005, Indian government introduced changes in its patent laws in order to comply with the WTO Trips agreements.

4.2.2. Regulatory framework

The regulatory framework is a result of the over mentioned government policy aimed to reinforce the domestic producers and lowering the prices of essential goods. The Patent Act of the 1970335 replaced the Anglo-Saxon law enacted before the independence in 1947 shifting the focus of protection from the pharmaceutical product itself to the specific process used to obtain a pharmaceutical product and halving the length of protection from 15 years to 7. This kind of Act allowed Indian chemicals to develop the research field of reverse engineering or even make cheap copycats of pharmaceuticals products selling them on

Pharmaceutical Ltd. (1961) with assistance from the former Soviet Union; Bengal Immunity Ltd; Smith Stanistreet Pharmaceutical; and the Indian Drugs and Pharmaceutical Corporation. 334 Greene W., 2007, “ The emergence of India’s Pharmaceutical Industry and implications for the U.S. generic drug market”, Office of economics working paper – U.S. International Trade Commission, p.1 335 The Patent Act of 1970: http://wbbb.gov.in/Legislations/rules/TheIndianPatentAct1970.pdf consulted on 10th of May 2012

180 LB 2011\2012 Indian market at lower costs. After India joined the WTO it had to comply to the TRIPs obligations336. In March 2005 the Patent Act was amended abolishing the process patent and restoring a “western” law regime with a 20-year monopoly with a fully granted protection against generic copycats and the possibility to put under patent protection products sold from 1995 to 2005. Foreign companies filed almost 9.000 applications to provide protection for an enormous amount of product sold as generic drugs in Indian market. The amendment to the Act stops several decades of protectionist policies towards the Indian producers outlawing also reverse engineering after January 1995 and permitting the sale of generic off-patent drugs or patented before 1995. Another important normative element is the Drug Price Control Order introduced in the early 70’s to moderate the drug price capping profit margins for traders. Throughout years products under price control fell dramatically from 347 in 1987 to 74 in 1995337 but after the regulatory changes in 2005 this Order gain newly importance and it has been filled with new bulk drugs considered as essential by the National Pharmaceutical Pricing Authority. The profit margin will be capped for these new bulk drugs at 15 percent for wholesalers and 35 percent for retailers.338 Other ruling bodies in the Indian Healthcare system are the Department of Health controlling various bodies such as the National Aids Control Organization, the National Health Programme, the Department of Family & Welfare that rules the NGO organizations and the technical operations in Rural areas, has a policy formulation responsibility, and administrates the Finance of Department of Health and Family Welfare.339

336 Tancer R.S., “The Pharmaceutical Industry in India – Adapting to TRIPS”, The Journal of world intellectual property, pp.176- 182 337 PriceWaterHouseCoopers, 2012, “ Global pharma looks to India: prospects for growth” Pharmaceuticals and Life Sciences publications, pp.5-8 338 A.A.V.V. ,2011, “National Pharmaceutical Pricing Policy”, Dep. Of Chemicals and Petrolchemicals,p.12 339 India Brand Equity Foundation, 2007, “ Healthcare – October 2007”, IBEF publications, p.12

181 LB 2011\2012 4.2.3. Business environment

The $19 billion sales in the industry registered in 2009 are expected to increase of the 163% in eleven years340. The main drivers of growth will be the rising of GDP per capita and the expected broadening of the middle class, considering rate of growth and the rising literacy rate sic stantibus, with the 34% of Indian citizens entering in the ranks of bourgeoisie with a new buying power341 that potentially create in the near future a market as big as UK. In order to improve the healthcare system and enlarge the basis of customers of pharmaceuticals products, the government implemented the openings of some “Jan Aushadhi”, people’s medicine shops, selling generic drugs that are cheaper than the branded ones. On the private side, some MNCs implemented policies to enlarge their market share and increase the patient population cutting prices and in some cases selling with prices that are five times cheaper than the global prices (i.e. Merck & Co.), or selling cheap monodose products. Another important environmental element is the epidemiological changes in India. Although the Indian population is young in average the population is ageing: by 2028 is expected that almost 200 million Indians will be older than 60; moreover the country has the highest number of diabetics. These evidences will change the set of demand for pharmaceutical products shifting from anti-infective and gastrointestinal to cardiovascular drugs and products for chronic diseases.342

340 PriceWaterHouseCoopers, 2012, “ Global pharma looks to India: prospects for growth” Pharmaceuticals and Life Sciences publications, pp.5 341 Ibidem, p.5 342 PriceWaterHouseCoopers,2010, “ India Pharma Inc.: Capitalising on India’s Growth Potential”, Pharma Summit 2010, p.10

182 LB 2011\2012 SHIFT IN DISEASE PROFILE TOWARD CHRONICS

.33 Source: PriceWaterHouseCoopers - Global pharma looks to India: prospects for growth (2012)

A major problem about business environment is the deficiencies in infrastructure in terms of energy supply and transportation. In late years government decide to implement an infrastructure spending policy with a part of foreign currencies reserve in order to improve efficiency for the companies operating in the country .

4.2.4. Healthcare system

Healthcare is a growing sector in India, during the 90’s healthcare grew at an annual rate of 16% and now is valued $34 billion. The main drivers are ageing of population as the life expectancy reached343 66 years for males and 68 for women creating a rise in degenerative diseases, cardio-vascular problems and wellness programs that are added to the return of resistant to drugs forms of dengue fever, tuberculosis and malaria associated with living standards that are still below the western levels with inadequate water systems and waste management system.

343 CIA, The World Factbook, India: https://www.cia.gov/library/publications/the-world-factbook/geos/in.html Consulted on 15th of May 2012

183 LB 2011\2012 Another driving force is the entering of women in the workforce, improving the household purchasing power, in the period 1991-2001 the percentage of employed women rose from 20% to 26%. Healthcare system in India is almost totally prerogative of private accounting for more than 80% of the total healthcare Indian spending and the public investments are bound to decline as the Government has planned to reduce its federal and state deficit. Historically, Indian state has been a marginal player in providing or financing healthcare, private providers both modern and traditional have been dominant in the market. In case of hospital care, the Government sustained the main expenditures from the colonial period until the early 70’s, when hospital sector became interesting and potentially lucrative for the corporate sector as the medical profession shifted towards western standards with post-graduate studies and specialization assuming greater importance in medical practice. Another element that made the hospital care sector lucrative was the entering of technological devices which quickened the commoditization of healthcare . Moreover in the early 80’s the National Health Policy stated a need for a privatization of the health care system in the 5-year plan; this brought to deceleration of public spending in the healthcare system and ,particularly, in the hospital care sector. The present situation shows that the for-profit hospitals are the vast majority, nearly 70%, providing the 40% of hospital beds. Latest statistical researches indicate that the healthcare expenditures reached the 6.5% of gross domestic product with the out-of-pocket expenditures accounting for the 5.5% of GDP344.

344 CIA, The world Factbook, India: https://www.cia.gov/library/publications/the-world- factbook/rankorder/2225rank.html?countryName=India&countryCode=in®ionCode=sas&rank=185#in consulted on 16th of May 2012

184 LB 2011\2012 PERCENTAGE OF PUBLIC AND PRIVATE HEALTHCARE EXPENDITURES

PUBLIC HEALTH PRIVATE HEALTH PER CENT PRIVATE YEAR EXPENDITURE(RS Bn) EXPENDITURE (RS Bn) TO TOTAL HEALTH PER CENT OF GDP PER CENT OF GDP EXPENDITURE

1975/76 6,78 0,90% 24,66 3,26% 78,43% 1980/81 12,86 0,99% 52,84 4,06% 80,43% 1985/86 29,66 1,19% 90,54 3,61% 75,32% 1991/92 56,4 0,96% 160,65 2,73% 74,01% 1995/96 96,01 0,89% 329,23 3,07% 77,42% 1999/2000 172,16 0,96% 835,17 4,76% 82,91% 2000/01 186,13 0,98% 981,68 5,18% 84,06% 2001/2 194,54 0,94% 1100 5,32% 84,90% 2002/3 197,32 0,88% 1250 5,60% 84,36% 2003/4* 235,06 0,84% 1400 5% 85,62% 2004/5* 249,28 0,83% 1650 5,50% 86,84% *Estimated .34 Source: US Trade Commission Report (2007)

These data show that the Indian healthcare system remains iniquitous, especially considering the conformation of Indian social classes with 300 million of Indians living below the poverty line, the 50% of all children malnourished345 and out-of-pocket expenditures financed by private debts or sale of assets346. The point of weakness of the healthcare sector are a mirror of the Indian society: the healthcare infrastructure are inadequate comparing to the Western standards and the quality of medical structures are strongly deficient. Moreover the hospitals are under numbered comparing to the population. A clear example of this phenomenon is the hospital bed density of 0.9 beds/1000 population347 that is 3 times lower than in USA ( 3.1 beds/1000 population) and 4 times lower than China (4.06 beds/1000 population). [fai grafico con beds population]

345 Unicef, India, Nutrition: http://www.unicef.org/india/children_2356.htm consulted on 16th of May 2012 346 National Sample Survey Organisation, 1995, “ Maternal and Child Healthcare in India”,Department of Statistics, NSS Fifty-second Round,pp1-153 347 CIA, The World Factbook, India: https://www.cia.gov/library/publications/the-world-factbook/geos/in.html Consulted on 18th of May 2012

185 LB 2011\2012 The public health funding is provided by state governments and national health programs but the public sector is overwhelmed by the private one that provide ca. the 60% of the Indian out-patient ( those who are not hospitalized) and the 40% of the Indian in-patient. This situation creates two different realities in the country, with the private sector providing good quality medical care to tourists and high class and a lower class that has limited access to basic medical care or not access at all. Another big issue is the rural reality that is deeply underserved as the two-thirds of Indian hospitals are located in the urban areas and a sensible percentage of citizens living in the countryside use alternative forms of treatment such as ayurvedic medicine. Lately the federal government implemented policies in order to improve the rural situation launching the National Rural Health Mission 2005-2012 with a special focus on 18 states with low public health indicators348. The third weakness point in the Indian healthcare system is the lack of health insurance; the government and major private companies provide an health insurance their employees, however only the 11% of Indians benefit of a form of insurance and only the 1% is covered by a private health insurance. The market for private insurance is growing also thanks to a policy of partnering between governmental entities and private companies to provide cheaper insurances349. On the other hand recent trends shows that a healthcare infrastructure expansion is likely to happen to meet the needs of medical tourists and growing population with an expected investment of 25.7 billion with a state participation for the 20% of the whole investment. This is a interesting opportunity for new private players such as investments fund or MNCs.

348 Regions: Arunachal Pradesh, Assam, Bihar, Chhattisgarh, Himachal Pradesh, Jharkhand, Jammu & Kashmir, Manipur, Mizoram, Meghalaya, Madhya Pradesh, Nagaland, Orissa, Rajasthan, Sikkim, Tripura, Uttaranchal and Uttar Pradesh 349 PriceWaterHouseCoopers, 2007, “ Healthcare in India – Emerging market report 2007”, Emerging markets reports, pp.6-8

186 LB 2011\2012 4.3. Pharmaceuticals market overview

Indian domestic industry was valued US $11 billion in 2009 and grew at an annual rate of 17.5% during the period 2006-2010 and is expected to grow with a lower rate for the next five years350.

.35 Source: Datamonitor (2012)

The total absence of a patent protection for more than 30 years created a complete domestic industry with competitive strategic and technological know-how ; the lack of intellectual property rights helped the blossom of several small and medium companies that using processes of reverse engineering had the possibility to compete in the pharmaceuticals market with cheaper copycats of branded products. The main features are the predominance of generic drugs production with price-taker companies as there are several companies using the same APIs and dramatically low profit margin.

350 Datamonitor, 2012, “ Pharmaceuticals in India”, Industry profile, p.34

187 LB 2011\2012

INDIA'S PHARMACEUTICAL FIRMS, BY SIZE, EXPORTS, AND R&d CAPABILITIES

Number Grouping of firms Description Largest firms, includes both wholly-owned Indian firms and subsidiaries of MNCs, have annual revenues of at least USD 650,00; have brand recognition and Group 1 100 are engaged in developing R&D capabilities; responsible for recent wave of cross-border acquisitions and alliances; export to regulated, semi-regulated and unregulated markets Mid-size firms with annual revenues between USD 210410 and USD 650000; they have limited investment capabilities and primarily serve the domestic Indian market. They are generic drug producers that subsist mainly on reverse engineering of patented and off-patent drugs ( primarily bulk drugs and APIs); also includes niche players specializing in contract research (CRAMS) and contract clinical trials in segments of the market where they have a competitive Group 2 200 advantage; export to semi-regulated and unregulated markets Smallest firms with annual revenues of less than USD 210410; primarily perform contract manufacturing services for MNCs or domestic firms. Many have been adversely affected and have been forced to close their doors due to revised Good Manufacturing Practices set by schedule M of India's Drug and Cosmetic Act, 1940 that came into effect from July 1, 2005. Those affected can't meet production standards of regulated market regulators and their production will be Group 3 5.700 limited to the domestic, semi-regulated, and unregulated markets .36 Source: US Trade Commission Report (2007)

The Indian pharmaceuticals market is fragmented in terms of number of players with more than 20.000 companies in overall351 but presents the supremacy of domestic big companies and MNCs subsidiaries with 10 companies controlling ca. the 40% of the market value352. The major part of Indian firms have less than $5million of annual revenues and after 2005 , after the patent amendment, the Indian market experienced a turmoil with a process of market consolidation through mergers and acquisitions from foreigner pharmaceuticals companies353;

351 PriceWaterHouseCoopers, 2012, “ Global pharma looks to India: prospects for growth” Pharmaceuticals and Life Sciences publications, p.9 352 Green W., 2007, “ The emergence of India’s Pharmaceutical Industry and implications for the U.S. generic drug market”, Office of economics working paper – U.S. International Trade Commission, p.10 353 Sreedhar D, Janodia MD, Ligade VS, 2011, “Buyouts of Indian pharmaceutical companies by multinational pharmaceutical companies: An issue of concern.”, J. Young Pharmacists 2011;3:343-4

188 LB 2011\2012 The spread of the merger phenomenon was a consequence of credit crunch in 2008 that, with the synergic effect of the Rupee volatility, has weakened the Indian pharmaceuticals company financial position and made them struggle for foreign investments. The main M&A processes were the buyout of Ranbaxy Laboratories, the leading pharmaceuticals firm in India, by the leading Japanese company Daiichi Sankyo, then in 2010, Hospira, an American a medication delivery company acquired the injectable business of Orchid Chemical and Abbott, a US-based company bought the domestic formulation business segment of Piramal Healthcare. Indian analysts expect that, if this M&A trend will continue in the next years, foreign company will control the 50% of domestic retail market with a undeniable potential rise of prices in drug market. Analyzing in details the Pharmaceuticals market through the five-forces-analysis tool we can underline that buyer power is low in the market for one main reason: the pharmaceutical products are the central element of healthcare. Even though health insurance companies are growing in Indian market, as seen above, doctors can influence the choice of a product through prescription and despite the fact that generic drugs, alternative to the branded ones, are widespread in Indian market, the buyer power remains moderate for the intrinsic importance of the product itself. This is enhanced by the amendment to the Patent act of 1970 that potentially reduced the possibilities of having substitute products on the market as the monopoly for a register pharmaceutical product is now guaranteed for 20 years. Also the supplier power is really low because the main pharmaceutical companies gradually integrated vertically their supply chain; the vast majority of companies produce internally active pharmaceutical ingredients for almost all of their product providing to the firm a high grade of self sufficiency. The only aspect that increases the bargaining power of suppliers is the high degree of innovation that characterizes the pharmaceutical industry: when a new therapeutic agent is discovered or developed, certain suppliers providing the above mentioned agent could

189 LB 2011\2012 benefit from a Schumpeterian rent354 for the period from the discovery to imitation that undeniably increase their strength towards market players. So we can split suppliers’ bargaining power in two realities: one that depict them in relation with big pharmaceutical companies in which both API and clinical trials suppliers have marginal power because of the companies’ integrated structure and another one in relation with the wide array of small and medium domestic pharmaceutical manufacturers competing in the market for which they play a more important role benefitting of a higher bargaining power. Analyzing the threat of new entrants there’s two kind of elements that vitiate the ease of entering the business: country-specific elements and business-specific elements. The pharmaceutical business is one on the most difficult and resource-requiring business in the economic scenario; developing a pharmaceutical product requires several clinical trials, long time of developing, high investments in terms of qualified workforce, technological devices and could have ineffective results. Moreover starting up a pharmaceutical business needs outstanding project management skills as one of the most common way of developing products is through the Phase Gate Methodology355.

354 Danneels E., 2012, “ Second-order competences and Schumpeterian rents”, Strat. Entrepreneurship J., 6, 42-5 8 355 Larson E.W., Gray C.F., 2011, “ Project Management – The Managerial Process”, McGraw-Hill International Edition, pp.568-579

190 LB 2011\2012 PHASE GATE METHODOLOGY PROJECT MANAGEMENT PROCESS IN PHARMACEUTICALS

.37 Source: Cooper (2008)

Regarding the country-specific factors is useful to remind that Indian pharmaceuticals industry is one of the most regulated country in the world and this factor affects the possibility to enter in this highly competitive market. The first barrier is to comply with the Drug Standard Control Organization standards that is both time and resource consuming; moreover the tests which the new start-up is required to pass are strict and obtaining the DSCO approval could last 10 to 15 years Another aspect to take into consideration is the average price of a pharmaceutical product that is sensibly lower than the world mean; it’s really difficult for a start-up enterprise to keep prices as low as competitors in the first period as the start-up costs need to be absorbed and it couldn’t benefit of economies of scale. The problem of low prices could be potentially pernicious from the beginning for both a domestic new entrant and a foreign company as the market is highly fragmented and customers can avail themselves to other players competing in the market.

191 LB 2011\2012 The wide set of substitute products are probably the main and strongest feature of Indian pharmaceuticals market as there is different kind of way to treat diseases that are common in India. First of all the ayurvedic medicine and other traditional remedies are rooted in Indian culture and in several rural areas of the country remain the main aspect of healthcare because of the absence of hospitals and the predominance of private sector in healthcare. Furthermore the availability of generic drugs alternative to branded drugs is significant and is a cheaper alternative because the products don’t need trials and approvals; so the switching costs are almost inexistent. Probably, in the future, the competition on substitutes will decrease significantly due to the effect of the enforcement of the post TRIPs agreement. Although the pharmaceuticals market is highly fragmented there are important players that retain high percentage of market share 356 such as Ranbaxy Laboratories, Piramal and GSK that creates a sort of oligopoly; the MNCs and Indian big companies primacy was reinforced during late years through several M&A processes that improved the companies’ competitive tools in term of financial capacity and network357.

4.3.1. The Over-the-counter products market

356 Green W., 2007, “ The emergence of India’s Pharmaceutical Industry and implications for the U.S. generic drug market”, Office of economics working paper – U.S. International Trade Commission, p.6 357 PriceWaterHouseCoopers,2010, “ India Pharma Inc.: Capitalising on India’s Growth Potential”, Pharma Summit 2010, p.6 358 U.S. Food and Drug Administration: Definition of OTC product: http://www.fda.gov/drugs/developmentapprovalprocess/howdrugsaredevelopedandapproved/approvalapplications/over- the-counterdrugs/default.htm consulted on 12nd of May 2012

192 LB 2011\2012 The OTC pharmaceuticals market grew with a CAGR of 6.4% during the period 2006-2010 reaching $1.7 billion in 2010; vitamins are the most lucrative segment corresponding to the 28,5% of market value359. The reason of this dramatic growth is due to the aggressive strategies of domestic companies and MNCs subsidiaries in penetrating the market in the last years through their brand equity and the new emphasis on wellness and prevention that the emerging Indian business class. Another reason that makes the OTC pharmaceuticals market worth of analysis is that the ayurvedic treatments360 are to be considered as OTC products and they are a widespread way to treat diseases in India, especially in the rural areas. The Indian market is expected to grow of 25% of its value until 2015361 with a forecasted value of $2.28 billion.

OTC MARKET EXPECTED GROWTH YEAR USD Million Rs.Million EUR Million % Growth 2010 1825,1 83836,6 1375 6,0% 2011 1923,3 88347,9 1449 5,4% 2012 2019,3 92760,1 1521,4 5,0% 2013 2110,7 96956,5 1590,2 4,5% 2014 2197,7 100954,4 1655,8 4,1% 2015 2280,7 104766,6 1718,3 3,8%

CAGR 2010- 15 4,60% .38 Source: Datamonitor (2012)

The features that differentiate OTC market from the pharmaceuticals market is that the supplier power is high, mainly because the active pharmaceutical ingredients needed for the production of OTC are provided by suppliers that develop these elements also for beverage and food industry reducing their dependence from pharmaceuticals industry demand.

359 MarketLine, 2012, “ OTC pharmaceuticals in India”, Marketline Industry Profile, p.7 360 “Ayurveda is a system of medicine that prevents and cures illnesses through natural means lifestyle interventions”,;Medicinenet.com: http://www.medterms.com/script/main/art.asp?articlekey=10787 consulted on 10th of May 2012 361 MarketLine, 2012, “ OTC pharmaceuticals in India”, Marketline Industry Profile, p.7

193 LB 2011\2012 This situation is particularly strong for Small-Medium Indian enterprises that don’t have sufficient financial capacity and specific expertise to develop APIs internally. The other differing aspect is the low availability of substitutes: if prescription products are not considered, the only alternative is the homeopathic medicine that remains a niche product in India , that strongly reduce the range of substitute products.

4.3.2. Industry Leaders

The Indian market industry leaders compete both in the domestic and internationally on generics and original products. In the set of the 10 biggest player in the market, 8 companies are big Indian companies that expanded their business in the global market place. Ranbaxy Labs Ltd.362 is a Gurgaon-based company recently took over by the Japanese giant Daiichi Sankyo. Ranbaxy’s presence is spread in 43 countries , mainly in Europe, and accounted $1.8 billion of revenues in 2010. Its principal production is generic drug for the 78% of the overall and bulk drugs for the 22%. Ranbaxy is specialized in anti-infectives, cardiovascular, central nervous, vaccines and operates also in the OTC market with its analgesics and cough&cold products. Dr.Reddy’s363 is an Indian pharmaceuticals multinational that accounted $1.67 billion of revenues in 2011 and it’s specialized in prescription drugs such as cardiovascular, gastrointestinal and pain management. Dr.Reddy’s divided it’s production in generics and bulk drugs. Cipla364 is a Mumbai-based private company firm that produces generic drugs and the company is focused on the production of antibiotics, anti-AIDS , anti-depressives and other prescription drugs. Cipla provides products for child care, critical care, pain care and competes on OTC market with vitamins and skin care products. Cipla diversifies its business with the production of agrochemicals, technological services and consulting.

362 Ranbaxy Laboratories Ltd. Official Website: http://www.ranbaxy.com/ consulted on 14th of May 2012 363 Dr Reddy’s Official Website: www.drreddys.com consulted on 14th of May 2012 364 Cipla Official Website: http://www.cipla.com/ consulted on the the 14th of May 2012

194 LB 2011\2012 Another important player is Piramal365 with $799.2 million in 2010,an Indian company engaged in the cardiovascular segment as a main business. In 2007 started to produce bulk drugs together with generic drugs. Moreover Piramal is engaged in diagnostics providing treatment in clinical chemistry, immunology and hematology; the critical care segment provides inhalation, intravenous and regional anesthesia. Piramal’s subs are competing in America and Europe with Piramal Healthcare(UK) Piramal Healthcare (Canada), PHL Fininvest, Piramal International and Piramal Healthcare (France). The main MNCs subsidiaries are GSK366 and Pfizer India: GSK is a global healthcare company headquartered in UK with widespread operations in 120 countries ; India isn’t a major market for GlaxoSmithKline plc but his leadership will be strategic to catch the forecasted rising of Indian Pharmaceuticals market; GSK registered $43.846 million of revenues in 2010, the 0,1% of its overall revenues. GSK operates in both prescription pharmaceuticals and vaccines and in the OTC market with oral healthcare and nutritional healthcare. Pfizer India367 has its headquarter in Mumbai with about 2000 employees and competes in OTC with his top brands Becosules (vitamins) and Corex (cough & cold). The MNC’s subsidiary registered gross sales for 121500.61 Crores in 2011 and it’s the fastest growing drug multinational company in India.368 The business models that are emerging to penetrate and distribute in Indian market are: export oriented business, licensing, franchising, Joint ventures and partially or wholly owned subsidiaries.369 The export-oriented business has been the “alpha” business model to penetrate Indian market, MNC approached Indian business environment setting contract manufacturing

365 Piramal Healthcare Ltd. Official Website: http://piramalhealthcare.com/ consulted on the 14th of May 2012 366 GSK India Official Website: http://www.gsk-india.com/ consulted on the 14th of May 2012 367 Pfizer India Official Website: http://www.pfizerindia.com/enewswebsite/index.aspx consulted on the 14th of May 2012 368 Mathew J.C., 2012, “ Pfizer fastest-growing drug MNC in India”, Business Standard Online: http://business- standard.com/india/news/pfizer-fastest-growing-drug-mnc-in-india-/460815/ consulted on the 21st of May 2012 369 PriceWaterHouseCoopers, 2012, “ Global pharma looks to India: prospects for growth” Pharmaceuticals and Life Sciences publications, pp.23-27

195 LB 2011\2012 agreements with Indian manufacturer in order to produce for exportation in Japan and selling in the domestic market with low manufacturing costs and benefitting of low wages. Multinationals tried to penetrate the Indian market through licensing agreement and in recent years several MNCs licensed out its protected by patent product to domestic companies; however, considering that patented products involve high developmental costs for the licensor, there are high fees for the licensee making the licensing a suitable way to market products. Another form of agreement is franchising that is particularly economical for the Indian franchisee because the franchisor can benefit of savings in large quantities buying and pass down the savings to the franchisee. Main franchising agreements are Medicine Shoppe India, franchisee of a US-based company that has 1000 shops in India now and Fortis Healthcare that is planning to open a chain in India by the end of 2012.370 The prevalent business model that pharmaceuticals MNCs adopted to spread their presence in the Indian market is Joint-ventures. The main reason is that this form of agreement committed the domestic partner to take advantage of their network capabilities and local expertise together with low costs and skilled labor. The MNCs use this kind of agreement not only to penetrate Indian market but also to build plants for western production and as a matter of fact India hosts more the 100 FDA approved plants. R&D joint ventures are also important forms of agreement, as the labor cost of skilled employees is lower than in western countries, to develop new vaccines to market both in India and globally like , for example, the joint venture between the America clinical-stage biotechnology company Novavax and the domestic company Cadila Pharmaceuticals Ltd for the development of new vaccines. This kind of agreement is gaining popularity also because Indian government allowed recently foreign direct investment up to 100% without government prior approval. MNCs like Pfizer and Novartis chose to create one or more wholly owned subsidiary in order to set up their strategic organization and maintain their critical know-how under a

370 India Brand Equity Foundation, 2007, “ Healthcare – October 2007”, IBEF publications, p.44-59

196 LB 2011\2012 strict control of the parent company. Moreover the wholly owned subsidiary business model suit better to the recent trend that Indian pharmaceuticals market is experiencing: the vertical integration on the value chain in order to cut expenses and catch more added value.

4.4. Corporate Governance Issues

4.4.1. Corporate governance profile in Industry Leaders

In order to assess the soundness of corporate governance in India we made a sample of 10 leader companies in the Pharmaceuticals Industry; the analysis is made through the Corporate Governance report in the 2011 Annual Report of Sun Pharmaceuticals Industries Ltd., Cipla Ltd., Wockhardt Ltd., Piramal Healthcare Ltd., Dabur India Ltd., Aurobindo Pharma Ltd., Lupin Ltd., Cadila Healthcare Ltd., Ranbaxy Laboratories Ltd, GSK India Ltd. and Pfizer-India.

4.4.1.1. Ownership structure

The aspect merging up from the ownership structure of companies in pharmaceutical industry is that company’s main shareholders are legally defined as promoters. According to the SEBI definition, a promoter is: “ any person or persons who are directly or indirectly in control of the company; or any person or persons named as "promoters" in the offer document or in the shareholding pattern disclosed by the Company under the provisions of the Listing Agreement, […] and includes where such person is an individual, his spouse , parents, brothers, sisters or children; any company in which 26% or more of

197 LB 2011\2012 the equity share capital is held by him or by the persons mentioned in sub-clause (i)[…]; any company in which a company specified in sub-clause (ii) above, holds more than 50% of the equity share capital; any firm in which the aggregate of his holding and the holdings of the persons mentioned in sub-clause is more than 50%”371 The interesting point is that usually the executive directors in company’s board of directors are direct expression of the promoter group or even individual promoters themselves. This strict relationships between property and control is a double-faced situation: if on one hand the effect of separation between ownership and control372 are softened, on the other hand this ownership concentration is unequivocal sign of ownership concentration that depict the typical situation represented by the Law & Finance approach by LaPorta & al.373. As the regulatory framework is unclear with several regulatory entities such as MCA and SEB bearing overlapping responsibilities together with a slow and a captious civil justice, major companies tend to centralize power with close ownership structures. The MNCs’ subsidiaries ownership structures present, as expected, the parent company as the promoter group of the subsidiary corporation accounting in the average the 70% of the total stake of shares. In the domestic companies, such as Sun Pharmaceuticals Ltd. and Piramal Healthcare Ltd., the majority stake is owned by private entrepreneurs that are also executive directors of the company. The highly concentrated ownership structure in a country that is based on a common law system is another proof of the deep weakness of juridical establishment and the unclearness of the regulatory framework with several ruling entities such as MCA and SEB bearing overlapping responsibilities. The ownership structure is a tangible evidence of shareholders’ distrust in their property rights protection by the Indian government and this phenomenon avoid a total convergence with the Anglo-Saxon system which provides public companies with fragmented shareholding structure.

371 SEBI, 1997, “ Public Shareholding – Proposed amendments to SEBI regulations”, http://www.sebi.gov.in/commreport/takeoveramend.html consulted on th 15th of May 2012 372 Berle A. and Means G.C., 1967, “The Modern Corporation and Private Property”, Brace and World, New York 1967 373 La Porta R., et al., 1998, “Law and Finance”, Journal of Political Economym Vol. 106, no.6

198 LB 2011\2012 Another meaningful element signaling that India is still far from setting an efficient corporate governance framework of standards is the lack of relevant foreign investments in domestic companies’ capital: the average percentage is settled on less than 5% except for the Piramal Healthcare Ltd. case in which foreign institutional investors own the 20% of the company’s shares. Other main actors involved in investing on pharmaceuticals companies are Mutual funds that own a relevant quote that varies between the 3% to the 8% , Insurance companies that in the average register shares for the 5% of the capital and also the Indian Government that varies from the average of 3% in the MNCs to a 13% in domestic companies like Wockhardt.

4.4.1.2. Board of directors

Analyzing the ten industry leaders merges up that the only corporate governance model is the one-tier system based on a board of directors with one ore more managing directors and an audit committee in charge of periodic control on the adequacy of internal controls, review of annual financial results, the compliance of the company’s policies with the regulation framework. The average dimension of the board of directors is 9 members with the lowest figure, 4 members, in the Pfizer India Ltd. board and the highest, 14 members, in the GSK India Ltd. board. The board dimension is mimic with the average dimension of other pharmaceuticals company operating all over the world such as the GlaxoSmithKline Group, Roche or Novartis. Complying with the SEBI’ Clause 49 requirements, and consequently demonstrating a total convergence towards the Anglo-Saxon model, in most of the cases the Chairman of the Board and the Managing Director are two different directors and the Chairman is an INED.

199 LB 2011\2012 In the cases which the CEO is also the Chairman, the percentage of independent director is relevant and they also have a prominent role in the company’s committees; however in these eventualities, INEDs are not the overwhelming majority, as the SEBI requires that only the 50% of directors must be independent, and inside the board is quite common to find more than one executive director (unusual phenomenon in Western pharmaceuticals companies). The only exception is the Cadila Pharmaceuticals Ltd.; in the board Mr. Patel is the Chief Executive Officer and the Chairman at the same time and INEDs are less than the 50% of the overall, but Cadila benefitting from the comply or explain procedure that is required by regulators points out that the Board of director is experiencing a period of change as several directors are close to their end of the term and reappointing procedures are in medias res.

4.4.1.3. Directors’ Independence and position held in other companies

As over mentioned the independence requirements are different in Clause 49 of the listing agreement and in the Companies Act. The Companies’ Act is still too vague about independence requirements for directors and the only relevant aspect is a weak recommendation that a director to be considered as independent should have been unrelated to the company for at least one year.374 Clause 49 is stricter on independence requirements and main industry leaders comply with recommendation.375 In recent years the demand for INEDs rose in big companies, we consider this practice essential to attract foreign investor, especially considering the role that they have on minority shareholders protection permitting foreign funds or institutional investors to

374 MCA Companies’ Act of 1956: http://www.mca.gov.in/Ministry/actsbills/pdf/Companies_Act_1956_Part_1.pdf consulted on the 1st of June 2012 375 Clause 49 of Listing Agreement, 2002, SEBI, p.1

200 LB 2011\2012 bankroll relevant amount of money with undeniable benefits for the pharmaceuticals industry. Also the mindset of Indian investors and shareholders changed during the last years because of global corporate governance scandals like Enron or WorldCom and domestic big scandals like Satyam Computer Service, occurred in 2009, where the Chairman “cooked the book” in order to withdraw money from the company by expropriating shareholders. Although it’s important to stress that, also if independent directors are mandatory for listed company, the private limited enterprises and the small and medium companies have absolutely no restrictions nor fines inadequate board structure and this surely affect and will affect the transparency of the pharmaceuticals market, considering the strong presence of SME domestic countries in the market. Analyzing the board constitution of industry leaders it’s possible to assess that directors are in general less involved in other companies activities, or at least they take part to private unlisted companies that have no obligations in publishing corporate governance reports, than their western counterparts. In the average the directors of the board in the Industry Leader companies take part of other 4 boards in Indian companies. A director that represents an outlier is Mr. R.A. Shah, in which lies a relevant conflict of interest as he attends meetings in Wockhardt Ltd., Lupin Healthcare Ltd. and in Pfizer India. Moreover Mr. Shah is qualified as independent director in all of the three companies: Pfizer India in which he is the Chairman of the board and president of Audit Committee and in Wockhardt Ltd. and Lupin, where he’s only a non-executive and independent director. In the author’s opinion the conflict of interest could be strong also if he was an non-executive director as the over mentioned director embodies the position of insider having access to sensible information of both companies; the fact that is qualified as independent director exacerbates the potentially harmful position of Mr Shah. However there aren’t measure to avoid this kind of potentially dangerous situation and the three companies don’t have even to explain the “strange” position of Director Shah.

201 LB 2011\2012 4.4.1.4. Compensation376

The compensation for managerial collaboration is ruled by the companies act and the Clause 49 and presents a wide set of recommendations. First of all the companies’ act prescribes that independent directors shall not be entitled to any remuneration, except for a sitting fee and a reimbursement of expenses for participation in the Board or at the Shareholders’ meeting. Furthermore the amended Corporate Act recommend that the total managerial remuneration, included the managing director and the whole-time director, payable should not exceed the eleven percent of the net profits of the company. The act sets also more specific requirements for remuneration: the remuneration to any managing director should not exceed the five per cent of net profits and the remuneration for non-executive directors, that are not independent, shall not exceed the one per cent of the net profit. In the paragraph E of the Clause 49, SEBI deal with remuneration but it doesn’t set fix parameters as the Companies’ Act but it’s focused on accountability of remuneration explaining when and how the remuneration policies both fixed and variable should be disclosed in the Annual Report. In the Indian pharmaceuticals industry, the directors remuneration policies are quite different from the western ones as the main part of their remuneration is fixed and stock option and stock granting plan are rare. Analyzing the leader companies it’s possible to find out that only 4 out of 10 have structured stock option plan while the others based the directors’ remuneration on a fixed salary and other kinds of perquisites that are untied to performance. Pfizer India adopt a performance linked remuneration policy that accounts for the 20% of the overall managerial remuneration.

376 The analysis was implemented through the examination of remuneration policies of companies that are pharmaceuticals industry leaders. For further information about salaries and benefits provided to directors and auditors please consult the Corporate Governance reports in the Annual Reports 2011 and 2010 of Dr Reddy’s Laboratories Ltd., Aurobindo Pharma Ltd., Lupin Ltd., GSK India, Pfizer India, Piramal Healthcare Ltd., Ranbaxy Laboratories Ltd., Cadila Healthcare Ltd., Cipla Ltd., Sun Pharmaceuticals Ltd., Wockhardt Ltd., Dabur Pharmaceuticals Ltd.

202 LB 2011\2012 Other companies, namely GSK India, Wockhardt Ltd., Cadila Ltd., Aurobindo and Cipla Ltd., add to the fixed salary also some contributes to a retirement plan for managers. For companies that adopted stock option plan that are different solutions implemented for rewarding and increase the commitment of management. For example, Dabur India Ltd., provided a stock option plan for its two managing directors P.D. Narang and S. Duggal: the company has allocated 2.001.697 shares each one setting a vesting spread from 1 to 4 years and exercisable at par over a period of three years after vesting. Piramal Healthcare Ltd., instead, set a policy that only non promoter executive are allowed to benefit of stock option plans, they give a disciplinary and motivational role to the variable remuneration, and in 2011 it allocated to its Executive director and Chief Operating Officer, 50.000 stock options an exercise price of Rs.200 eligible to exercise 25% immediately, 25% after 1 year of vesting and the remaining 50% after 2 years. Ranbaxy Laboratories decided to allocate a stock option plan of 13.000 elements to his managing director exercisable at par after a 3 year-vesting period. Also Lupin implement a stock option plan for an executive director granting option exercisable at the 50% of the market price for ten years after the date of the grant with a vesting period of one year. Some shareholders’ meeting in the industry leaders approved an employee stock option plan that is actually eligible for both employees and directors: Aurobindo approved two ESOP in2004 and 2006, Ranbaxy and Lupin did the same in 2008 and 2011. ESOP are incentive plan of deferred compensation that allocate shares of the company to the employees, recent studies found that employees stock ownership is associated with increasing organizational commitment.377 This phenomenon is also due to the profit sharing with employees that are motivated to perform better and to be loyal to the company.

377 For further clarification about Employee Stock Option Plans and Employee Commitment see: Selvarajan T.T., et al., 2006, “ Employee stock option plan and employee attitudes – A test of extrinsic versus intrinsic models”, International Journal of Sociology and Social Policy, Vol. 26, No. 5/6, 2006, pp.245-254

203 LB 2011\2012 4.4.1.5. Committees

In addition to the compulsory Audit committee, another committee that Clause 49 indicates as mandatory is the Shareholders/Investors Grievance Committee that has the duty to redress Shareholders’/Investors complaints. Moreover it’s in charge to supervise and improve the accountability to investors and monitor the share transfers. The committee has to be guided by a non executive director378. Committees that differ from the above mentioned two are to be consider as voluntary enactment of the Board of directors. Other kinds of committees in industry leaders corporate governance system are basically: Compensation/Remuneration Committee (9/10 companies), Science Committee (Ranbaxy Laboratories Ltd.), Committee of Directors (Sun Pharmaceuticals Industries Ltd., Cadila Healthcare Ltd.), Governance and Ethics Committee ( Piramal Healthcare Ltd.), Risk Committee (Piramal Healthcare Ltd.), Nomination Committee (Piramal Healthcare Ltd., Dabur India Ltd.), Bonus Committee ( Cadila Healthcare Ltd.),. The Compensation or Remuneration committee is widespread in the industry leaders; Clause 49 recommends that it should have at least 3 members all non-executives. In the average is made by INEDs but not completely like in the Western countries were this phenomenon is a best practice379. The main tasks are the decision of the remuneration packages for executive directors and non-executives and the way to implement the remuneration policies. Similar to the Compensation committee is the Cadila’s Bonus committee that was established in order to decide on stock granting remuneration policies for executive directors in the company. The Nomination Committee, that is a sort of “must have” in American and European corporations, is rare in the Indian business environment as only Piramal Healthcare and Dabur India adopted it. This committee is , in both companies, under the chairmanship of

378 Clause 49 of Listing Agreement, 2002, SEBI, p.9 379 Financial Reporting Council, 2010, “ The UK Corporate Governance Code”, The Financial Reporting Council Limited 2010, pp.25-40

204 LB 2011\2012 an INED and is also made by a vast majority of independent directors. Nomination committee cooperate with the board in defining the characteristics and skills for potential new board members and monitor the compliance with the independence requirements. Piramal Healthcare seems to be the closest-to-western-practices company with its Nomination Committee and the risk committee that is quite common in western pharmaceutical companies as the business environment became instable and changeable and a dedicated focus on the potential risks that a company has to face during its operating activity seems to be essential; moreover Piramal has a Governance and ethics committee that stress the importance that the company assign to sound corporate governance practices.

4.5. Concluding remarks

Indian pharmaceuticals industry is an expanding and interesting market for both domestic players and multinational companies. The Indian middle class is expanding as the GDP is rapidly growing and the percentage of households expenditures for pharmaceutical products is expected to increase until 2015. Furthermore the distribution in the age groups is changing bringing new kind of diseases that will feed the market growth. India has also an endemic deficiency in infrastructures with lower life standards and a big percentage of population left without assistance in the rural areas. However, the significant reserve of foreign currency that India dispose will be a good starting point to implement a infrastructure spending policy that undeniably will boost the domestic economy as transportation costs will decrease and a new section of population will reach the middle class status. MNCs’ subsidiaries like GlaxoSmithKline India and Pfizer India are back in activity in India after more than 30 years of “exile” because of the patent act amendment to comply with the TRIPs agreement and this fact will affect positively technological improvements in terms of healthcare services and the width of pharmaceutical products offer.

205 LB 2011\2012 In this turbulent environment another variable is linked to the corporate governance framework: citing the LaPorta’s380 work in which he linked the ownership structure to the level of protection we should expect that a country like India with a juridical structure based on common law system could ensure to shareholders the highest level of protection of the property rights, but actually it doesn’t. India has an old and uncompetitive law system with several conflicting competencies between regional and federal courts, with long trials giving ,often, ineffective judgment and high red tape costs. This situation brought to a concentration of ownership in order to protect the shareholders’ rights giving birth to an business oxymoron: a common law country with a concentrated ownership. Indian federal government and market regulators are still working in order to simplify the regulatory framework and boost the bureaucratic times, but it’s still a long way to reach western standards. The Clause 49 of Listing agreement is a modern code and it’s valuable that the regulators, especially the SEBI, put the focus on the independence of boards in a business environment where the vast majority of companies have a concentrated ownership or even a familiar structure. However, in the author’s opinion, the continuous struggling in the last decade between MCA and SEBI had a pernicious effect on the soundness of corporate governance in India and, nowadays, the main need is to identify a unique and shared set of rules or, at least, adopt the Clause 49 as the only corporate governance document, choosing the “civil law” way to rule corporate governance and work to provide a sound array of tools to enforce its requirements. In the Asian business environment that still presents several differences, compared to the Western capitalist world although in times of globalization, probably the deep roots of Anglo-Saxon culture will transform India in the privileged Asian partner for United States of America and Europe overtaking the People's Republic of China, also considering the

380 La Porta R., et al., 1998, “Law and Finance”, Journal of Political Economym Vol. 106, no.6

206 LB 2011\2012 population trend381 and , for sure, the focus on corporate governance could be, if will be implemented properly, an important atout for the Southeast Asian country.

381 “Between now and 2050 China’s population will fall slightly, from 1.34 billion in 2010 to just under 1.3 billion in 2050. This assumes that fertility starts to recover. If it stays low, the population will dip below 1 billion by 2060.”, The Economist, “China’s Achilles heel - A comparison with America reveals a deep flaw in China’s model of growth”, April 21st 2012.: http://www.economist.com/node/21553056 consulted on the 30th of April 2012

207 LB 2011\2012 5. Conclusions

The global economic landscape is experiencing a gradual change of paradigm: the American, and in general the Western, undisputed leadership lasting for more than a century is fading in favor of new economic realities which are increasing their political and economic power through the years. The rising of these emerging countries is the consequence of the synergic effects of a macro-phenomenon and country-specific conditions; more specifically some developing countries accumulated, in the last thirty years, economic resources which triggered a process of sharp growth, operating on an export-led growth model. People’s Republic of China and the Republic of India attracted flows of capital benefitting from the low cost of labor while other countries such as Russia, Mexico and Indonesia profited by the relevant supply of metals, minerals and natural gas. The globalization enhanced these country-specific features, encouraging international free trade and opening new markets to companies from all industries, and at the same time, providing developing countries of resources and technology to effectively effort a stable growth through life standards improvement and the consequent creation of a large, spirited middle class. The blossom of new countries is also stressed by the harsh crisis Western economies went through in the last five-year span which triggered a vicious circle involving the whole economic system both in Europe and United States of America which depressed national economies and companies’ profitability. The pharmaceutical industry didn’t escape this turbulence in the competitive environment as the main markets of the Big Pharma companies are developed countries: in the Global pharmaceuticals, biotech and life sciences market segmentation, mature markets account for the vast majority of value depressing especially multinationals’ growth potential in the last four years.

208 LB 2011\2012 Pharmaceuticals, bio-tech & Life sciences industry segmentation, % of share, by value (2010)

Category % of Share Americas 50,1% Europe 27,7% Asia-Pacific 19,9% RoW 2,3% Total 100,0% .39 Source: Datamonitor (2012)

The pharmaceutical market has been deeply affected by the economic downturn: the growth of pharmaceutical market value has been depressed of 1.2 percentage points in the period span 2006-2010 roughly corresponding to USD 7 bln. A World Health Organization study shows that already in 2009, so considering only the short-term effects: “The European region was the WHO region with the most severe decline (-6%, Q3 09 compared to Q1 08). The South East Asian region had the biggest increase in pharmaceutical consumption (+28% in Q4 09) and the American region had the smallest increase (+12% in Q4 09). Only the high income countries showed a small decrease in pharmaceutical consumption of -3% (Q3 09 compared to Q1 08), in the other income categories the pharmaceutical consumption increased ranging from +7% in the upper middle income countries to +17% in the low income countries (Q4 09 compared to Q1 08)” 382

GLOBAL INDUSTRY VALUE YEAR USD Billion EUR Billion % Growth 2006 768,4 578,7 7,4% 2007 825,3 621,7 7,6% 2008 887,7 668,5 7,8% 2009 957,7 720,7 4,6% 2010 1.001,5 754,2

CAGR 2006-2010 6,8%

382 Buysse I.M., 2010, “ Impact of the economic recession on the pharmaceutical sector”, WHO collaborating Centre for Pharmacoepidemiology & Pharmaceutical Policy Analysis, Universiteit Utrecht, p.4

209 LB 2011\2012

.40 Source: Datamonitor(2012)

Moreover, the same study, shows how the South-East Asiatic regions grew sharply in pharmaceutical consumption for both chronic and acute indications becoming the most attractive pharmaceutical market among the emerging markets and worldwide.

.41 Source: WHO (2009)

210 LB 2011\2012 Analyzing together the figures on the Asia-Pacific market value and the trend that is in progress in the world economic landscape merges up that there’s a big challenge ahead for both Big Pharma and small-medium western pharmaceutical enterprises. Several emerging markets, and especially the South-East Asian ones, are dominated by generic products depicting a univocal long term strategy for MNCs in order to defend profit margins and penetrate the market: investing on R&D in these markets taking advantage together of lower costs of skilled workforce and avoiding clinical trials problems in order to cut costs of development being able of retail products with a more competitive price. However, implementing such a strategy is not easy as South East Asian countries are still burdened with legal and business inefficiencies which make investing heavily in these country still risky. One of the most important aspect which can moderate sharply the riskiness of investing in an emerging country is the soundness of its corporate governance. Only country-level reforms in order to create solid regulations in governance can create a win-win scenario: as assessed in the first chapter corporate governance is proved to increase investments, bring higher growth, lower cost of capital, to create the basis for more efficient allocation of resources and better management, and also helps improve labor relationship creating better relationships with shareholders. These kind of improvements would have positive effects in both corporate and country sides as companies committed in penetrating effectively these markets would have lower costs in terms of compliance and a lower risks in creating subsidiaries or joint-ventures; moreover, with a good corporate governance framework, financial markets would be more efficient and liquid and would be easier to get external financing or having a large base of minority shareholders without investing heavily. At the same time, emerging countries could attract more foreign direct investments establishing a virtuous circle: transparency and efficiency would create better conditions for domestic companies and increase the country attractiveness towards foreign enterprises committed in enlarging their geographical markets .

211 LB 2011\2012 This process would allow to accumulate resources and coming in contact with the state-of- art technology in order to foster the process of development and consolidate the new paradigm that is still in fieri. In the preceding chapters three of the most important emerging countries were analyzed in order to assess the corporate governance situation and identify gaps at a country and industry-level. Considering the three countries together it’s possible to state there are common and country-specific characteristics and gaps to solve in order to reach a sound corporate governance. First of all, the Anglo – Saxon model influences are strong in all the three analyzed country also if there are different grades of convergence to the over mentioned model: The Republic of India, partly because of long lasting British colonial domination, and South Korea, a country strictly tied to United States of America for political reasons, lean out towards the outsider system with a common law legal system and an important role for the financial market in the national economy. On the other hand, People’s Republic of China built its corporate governance model on the European-inspired, more specifically German, insider system based on concentrated ownership, strong links with the institutional framework and a civil law legal system but still “looking West” in redacting its corporate governance code. Moreover India and South Korea adopted, as the only allowed corporate governance model, the one-tier system while People’s Republic of China chose, during the process of business law reform, the two-tier system with a board of directors, a supervisory board and giving employees an important role in the process of governing the company. Between the three countries there are a differences on the state of evolution of corporate governance which shows an Indian “primacy” which already have a framework that is close to the western standards in terms of accountability, transparency of disclosure and accuracy of provisions, also if still shows some problems as there are two competing regulatory bodies which operate on different sources of requirements (the Companies Act and the Corporate Governance Code). People’s Republic of China also made huge steps forward in promulgating regulations as the country is gradually moving from a socialist regime towards a free market system and is

212 LB 2011\2012 to be defined still where the country C.G. model will aim to in next ten years considering the power of attractiveness of the Anglo – Saxon model among South-East Asian countries and the country’s affinity with the German one. The Republic of Korea, on the contrary, shows a poor quality of its corporate governance situation as there is an endemic lack of disclosure, generic provisions and a corporate governance code which is merely an academic exercise. Apart from the stadium of evolution in China, Korea and India there is still a problem of enforcement: also if governments operated in order to trigger a process of convergence implementing laws and provision to fragment corporate ownership the uncertainty of property rights protection and long lasting trials are a strong glue to ownership patterns. In all the three countries corporate ownership is still over-concentrated: business family groups hold the absolute majority of big, medium and small companies in South Korea and India and a heavy state presence burden the Chinese economy affecting severely the economic efficiency. The reforms undertook during the last decades in South-East Asian countries are a positive beginning in order to implement an effective shift towards a better economic efficiency and transparency in the most important emerging area of the world. Still a wider intervention involving the legal structures of these countries is needed in order to plug the gap with western economies and to increase the profitability of investing in the future economic leaders of a totally-globalized economy.

213 LB 2011\2012 6. Appendix

.12 Pfizer Inc.: Key Financials ($)

Million USD 2006 2007 2008 2009 2010

Revenues 48371 48418 48296 50009 67809 Net Income (loss) 19337 8144 8104 8635 8257 Total assets 114837 115268 111148 212949 195014 Total liabilities 43479 50144 53408 122503 106749 Employees 98000 98000 86600 116500 116500 Profit Margin 40% 16,80% 16,80% 17,30% 12,20% Revenue Growth 2% 0,10% -0,30% 3,50% 35,60% Asset Growth -1,80% 0,40% -3,60% 91,60% -8,40% Liabilities Growth -15,10% 15,30% 6,50% 129,40% -12,90% Debt/Asset Ratio 37,90% 43,50% 48,10% 57,50% 54,70% Return on Assets 16,70% 7,10% 7,20% 5,30% 4,00%

.13 Hoffman – LaRoche: Key Financials ($)

Million USD 2006 2007 2008 2009 2010

Revenues 40.295,80 46.367,80 45.915,40 49.027,60 47.126,00 Net Income (loss) 7.552,90 9.335,80 8.596,70 7.460,90 8.306,30 Total assets 71.324,90 75.111,90 72.930,40 71.469,60 58.486,90 Total liabilities 26.454,30 23.887,40 21.342,60 62.446,40 47.309,00 Profit Margin 18,70% 20,20% 18,70% 15,20% 17,60% Revenue Growth 18,40% 15,10% -1,00% 6,80% -3,90% Asset Growth 7,30% 5,30% -2,90% -2,00% -18,20% Liabilities Growth -0,10% -9,70% -10,70% 192,60% -24,20% Debt/Asset Ratio 37,10% 31,80% 29,30% 87,40% 80,90% Return on Assets 11,00% 12,80% 11,60% 10,30% 12,80%

214 LB 2011\2012 .14 Novartis AG: Key Financials ($)

Million USD 2006 2007 2008 2009 2010

Revenues 37.020,00 39.800,00 41.459,00 44.267,00 51.561,00 Net Income (loss) 7.202,00 11.968,00 8.233,00 8.454,00 9.794,00 Total assets 68.008,00 75.452,00 78.299,00 95.505,00 123.318,00 Total liabilities 26.714,00 26.056,00 27.862,00 38.043,00 53.549,00 Profit Margin 19,50% 30,10% 19,90% 19,10% 19,00% Revenue Growth 14,90% 7,50% 4,20% 6,80% 16,50% Asset Growth 17,80% 10,90% 3,80% 22,00% 29,10% Liabilities Growth 8,70% -2,50% 6,90% 36,50% 40,80% Debt/Asset Ratio 367.499,00 405.295,00 428.663,00 443.406,00 516.467,00 Return on Assets 71.495,00 121.874,00 85.125,00 84.681,00 98.103,00

.15 Republic of Korea GDP Growth Rate

KOREA REP. 1993 6,134% 1994 8,537% 1995 9,169% 1996 6,999% 1997 4,651% 1998 -6,854% 1999 9,486% 2000 8,486% 2001 3,973% 2002 7,150% 2003 2,803% 2004 4,619% 2005 3,957% 2006 5,179% 2007 5,106% 2008 2,298% 2009 0,310% 2010 6,320% 2011 3,634% 2012 ..

215 LB 2011\2012 .17 Republic of Korea: OTC Market by Value

Ye Traditional Cough and Cold Indigestion Vitamins and Analge Othe ar medicines Preparations preparation minerals sics rs USD MILLION 20 290, 06 884,8 377,4 198,1 344,5 301,8 4 20 305, 07 946,9 359,6 209,9 363,4 293,0 5 20 322, 08 1.016,5 342,4 223,2 383,1 287,6 5 20 340, 09 1.091,3 350,1 237,6 404,9 308,1 8 20 360, 10 1.171,9 360,3 253,1 429,2 325,1 4

.31 Republic of India GDP Growth (annual %)

Indicator Name Indicator Code GDP growth (annual %) NY.GDP.MKTP.KD.ZG Country Name India

Year Ratio 2000 3,98% 2001 4,94% 2002 3,91% 2003 7,94% 2004 7,85% 2005 9,28% 2006 9,26% 2007 9,80% 2008 3,89% 2009 8,24% 2010 9,55% 2011 6,86%

216 LB 2011\2012 .35 Republic of India – Pharmaceutical Industry market forecast

Country Name India Market Forecast Year MILLION USD % Growth 2010 10884,7 17,60% 2011 12366,4 13,60% 2012 14145,3 14,40% 2013 16150 14,20% 2014 17980,3 11,30% 2015 20333,4 13,10%

217 LB 2011\2012 7. Reference List

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219 LB 2011\2012  Brueckner M., Phillip M & Luithle, 2005, “ The chemical and pharmaceutical industry in China”, p.93  Business Insights, 2010, “ The Medical Device outlook in emerging markets”, Business Insights, pp.1-103  Cadila Healthcare Limited, 2011, “ Annual Report 2010-2011”, pp.1-86  Cai F., 2002, “ Risks and Rewards for Pharma in post-WTO China”, Pharmaceutical executive, pp.1-7  Cai J., Yang Z., Webster D., Song T. & Gulbrandson, 2012, “ Chongqing: beyond the latecomer advantage”, Asia pacific viewpoint, Vol.53, No.1, pp.38-55  Campbell II T.L., Keys P.Y., 2002, “ Corporate governance in South Korea: the chaebol experience”, Journal of Corporate Finance, pp.373-391  Capie S., 2006, “ China’s pharmaceutical revolution and emerging contenders”, Journal of generic medicines, Vol.4, No.2, pp-98-105  Carney M., Gedajlovic E. & Sur,2011, “ Corporate governance and stakeholder conflict”, Journal of management and governance, Vol.15, pp.483-507  Chakrabarti R.,2005, “ Corporate Governance in India – Evolution and Challenges”,Working paper series, pp.1-31  Chakrabarti R.,et al.,2008, “ Corporate Governance in India”, Journal of Applied Corporate Finance, Vol.20, No.1, pp.62-78  Chen C.J. & Yu, 2012, “Managerial ownership, diversification and firm performance: Evidence from an emerging market”, International Business review,Vol.21,Issue 3, pp.518-534  Chen G., Firth M & Xu, 2012, “Does the type of ownership control matters?: Evidence from China’s listed companies”, Journal of Banking and Finance, Vol.33, pp.171-181  Chen G., Firth M., Gao D.N., & Rui, 2006, “Ownership structure, corporate governance and fraud: Evidence from China”, Journal of Corporate Finance, Vol.12, pp.424-448

220 LB 2011\2012  Cheung Y., et al., 2011, “ Corporate Governance, investments and firm valuation in Asian emerging markets”, Journal of international financial management and accounting, Vol 22, No.3 pp.1-28  Cheung Y., Ping J., Limpaphayom P. & Tong, 2010, “ Corporate Governance in China: a step forward”, European Financial Management, Vol.16, No.1, pp.94-123  Chiarlone G.,2010, “ A preliminary assessment of the recent reforms of the Chinese Banking Sector: NPL reductions and Global expansion”, Workshop “The Chinese Economy” , Venice – 25-27 November 2010, pp.1-36  China Pharmaceutical Group Co. Ltd., 2011, “ Annual Report 2011”, pp. 1-95  China Securities Regulatory Commision, 2002, “ Code of Corporate Governance for Listed Companies in China”, pp.1-11  Chittoor R., et al., 2009, “ Third-World copycats to emerging multinationals: institutional changes and organizational transformation in the Indian pharmaceutical industry”, Organization Science, Vol.20, No.1, pp.187-205  Cho D. & Kim, 2007, “ Outside Directors, Ownership Structures and Firm Profitability in Korea”, Corporate Governance, Vol.15, No.2, pp.239-250  Choi J. & Lee, 2012, “ Competitiveness and outlook for pharmaceutical and medical industries”, Samsung Economic Research Institute Quarterly, pp.1-13  Chool Y., Lee W.H.,2007, “ The politics of economic reform in South Korea: Crony Capitalism after ten years”, Asian survey, Vol.47,No.6, pp.894-914  Chun C.B., Kim S.Y. & Lee, 2009, “ Republic of Korea: Health System Review”, Health System in Transitions, Vol.11, No.7, pp.1-184  Chung H.M. & Chan,2012, “ Ownership structure, family leadership and performance of affiliate firms in large family business groups”, Asia pacific Journal of management, pp.1-27  Chung H.M., 2012, “ The role of family management and family ownership in diversification: the case of family business groups”, Asia pacific Journal of management,pp.1-21  Chung Y., 2007, “ South Korea in the Fast Lane: Economic Development and Capital Formation”, Oxford Scholarship Online, available at

221 LB 2011\2012 www.oxfordscholarshiponline.com, consulted on the 3rd of September 2012, pp.1- 60  CIA, The World Factbook, Brazil: https://www.cia.gov/library/publications/the- world-factbook/geos/br.html Consulted on 29th of June 2012  CIA, The World Factbook, India: https://www.cia.gov/library/publications/the- world-factbook/geos/in.html Consulted on 29th of June 2012  CIA, The World Factbook, PRC: https://www.cia.gov/library/publications/the- world-factbook/geos/ch.html Consulted on 29th of June 2012  Cipla,2011, “Seventy-Fifth Annual Report 2010-2011”, pp.1-103  Claessens S. & Fan, 2002, “ Corporate Governance in Asia: A Survey” International Review of Finance, Vol. 3, Part.2, pp.71-103  Claessens S., 2006, “ Corporate Governance and Development”, Oxford University Press,Vol.21, pp.91-122  Claessens S., 2006, “ Corporate Governance and Development”, The World Bank Research Observer, Vol.21, No.1, pp.92-127  Claessens. S. & Yurtoglu, 2012, “Corporate Governance in Emerging Markets: A Survey”, Working Paper, pp.1-77  Clarke T.,2010, “ International Corporate Governance: A comparative approach” Routledge – Taylor & Francis Group, pp. 196-200; 200-227  Committee on Corporate Governance,2002, “ Code of Best Practice for Corporate Governance”, pp.1-41  Confederation of Indian Industry, 1998, “Desirable Corporate Governance: A code”, CII publications, pp.1-16  Crabtree S., 2007, “ India’s Growing Pains: Views of Healthcare, Education vary by region”, Gallup Poll Briefing, January 2007, pp.1-4  CSRC, 2001, “ Guidelines for introducing independent directors to the board of directors of listed companies”, available at http://www.csrc.gov.cn/pub/csrc_en/newsfacts/release/200708/t20070810_69191.ht m consulted on the 1st of July 2012

222 LB 2011\2012  Cullinan C.P., Wang F., Wang P. & Zhang, 2012, “ Ownership structure and accounting conservatism in China”, Journal of International Accounting, Auditing and Taxation, Vol.21, pp.1-16  Dabur Ltd., 2010, “ Dabur Annual Report 2010”, pp.1-180  Danneels E., 2012, “ Second-Order competences and Schumpeterian rents”, Strat. Entrepreneurship J., Vol.6, pp.42-58  Dasgupta S. & Kesharwami, 2010,” Whistleblowing: A survey of literature”, The IUP Journal of Corporate Governance, Vol.9, No.4, pp.1-15  Datamonitor, 2010, “ Intellectual Property Protection and Regulatory Regimes in Emerging Markets – Drug Approval processes, patent issues and industry perspectives”, Business Insights series, pp.1-102  Datamonitor, 2010, “ Intellectual Property Protection and Regulatory Regimes in Emerging Markets – Drug Approval processes, patent issues and industry perspectives”, Business Insights series, pp.1-102  Datamonitor, 2010, “ The OTC Pharmaceutical Market in Emerging Countries”, Business Insights series, pp.1-121  Datamonitor, 2011, “Country Analysis Report: South Korea”, Country Analysis Report, pp.1-87  Datamonitor, 2012, “ Pharmaceuticals in South Korea”, Industry Profile, pp.1-41  Datamonitor, 2012, “Pharmaceuticals in China”, Industry Profile, January 2012, pp.1-40  Datamonitor, 2012, “Pharmaceuticals in India”, Industry Profile, January 2012, pp.1-40  Dellestrande H. & Kappen, 2012, “ The effect of spatial and contextual factors on headquarters resource allocation to MNE subsidiaries”, Journal of International Business Studies, Vol.43, pp.219-243  Deloitte, 2006, “ M&A in China – Making Decisions in a less than transparent deal environment”, China Issues: M&A series, pp.1-11  Deloitte, 2011, “ Life Sciences and Health Care in China – Opportunities, challenges and implications”, pp.19-22

223 LB 2011\2012  Department of Chemicals and Petrolchemical, 2011, “ National Pharmaceuticals Pricing Policy”,Draft,pp.1-29  Dixit A.,2009, “ Governance institutions & India’s development”, The Indian Journal of Industrial relations, Vol.44, No.4, pp.539-611  Doidge C., Karolyi G.A. & Stultz, 2007, “ Why do countries matter so much for Corporate Governance?”, Journal of Financial Economics, Vol.86, Issue.1, pp.1-39  Dong W., 2008, “ Cost Containment and Access to Care: The Shanghai Healthcare Financing Model”, The Singapore Economic Review, Vol.53, Issue.1, pp.27-41  Donville C. & Frank,2012, “ Sino-forest rises to company’s defence”, Bloomberg Online, http://www.vancouversun.com/Sino+Forest+chairman+rises+company+defence/61 50498/story.html#ixzz1p0CV9CTE, consultato il 16 Marzo 2012  Dorrucci E.,2010, “ The Chinese model: towards the end of producer-biased and export-led growth?”, Workshop “The Chinese Economy” , Venice – 25-27 November 2010, pp.1-41  Du Y., et al., 2011, “Active boards of directors in foreign subsidiaries”, Corporate governance: An international Review, Vol. 19, No.2, pp.153-168  Duggal R., 2007, “ Healthcare in India: Changing the Financing Strategy”, Social Policy & Administration, Vol.41, No.4, pp.386-394  Eng L.L. & Li Q., 2012, “ Disclosure and cross-listing: evidence from Asia-Pacific firms”, International Journal of Accounting and Information Management, Vol.20, Issue 1, pp.6-25  Estrin S. & Prevezer, 2011, “ The role of informal institutions in corporate governance: Brazil, Russia, India and China compared” Asia Pacific Journal of Management, Vol.28, pp.41-67  Fan Y.,2007, “ Guanxi? Government and corporate reputation in China: Lessons for international companies”, Marketing Intelligence & Planning, Vol.25, Iss.5, pp.499- 510

224 LB 2011\2012  Ferri G., Liu L.G., Mastromarco C.,2010, “ Technical efficiency and governance: the case of China” Workshop “The Chinese Economy” , Venice – 25-27 November 2010, pp.1-18  Financial Reporting Council, 2010, “ The UK Corporate Governance Code”, The Financial Reporting Council Limited 2010, pp.1-40  Firth M, Malatesta P.H., Xin Q. & Xu, 2012, “ Corporate investment, government control, and financing channels: Evidence from China’s Listed Companies”, Journal of Corporate Finance, Vol.18, pp.433-450  Firth M., Malatesta P.H., Xin Q. & Xu, 2012, “ Corporate investment, government control and financing channels: Evidence from China’s Listed Companies”, Journal of Corporate Finance, pp.433-450  Fitzpatrick L., 2009, “ A brief history of China’s One-Child Policy”, TimeWORLD, available at http://www.time.com/time/world/article/0,8599,1912861,00.html consulted on the 23rd of June 2012  Fosun International Limited, 2011, “ Annual Report 2011”, pp.1-199  Francis B.B., Hasan I. & Sun, 2012, “ Political connections and the process of going public: Evidence from China”, Journal of International Money and Finance, Vol.28, pp.696-719  Gao L., & Kling, 2012, “ The impact of corporate governance and external audit on compliance to mandatory disclosure requirements in China”, Journal of International Accounting, Auditing and Taxation, Vol.21, Issue 1, pp.17-31  GlaxoSmithKline Pharmaceuticals Limited, 2011, “ Annual Report for the year ended 21st December 2011”, pp.1-88  Globerman S., Peng M.W. & Shapiro,2011, “ Corporate governance and Asian companies” Asia Pacific Journal of Management, Vol.28, No.1, pp.1-14  Government of India, 1991, “ Industrial Policy Resolutions”, Industrial Policy Highlights, pp.1-18  Govindaraj S., 2008, “ Disclosure and governance policies and practices in India”, International journal of disclosure and governance, Vol.5, pp.183-185

225 LB 2011\2012  Greene W., 2007, “ The emergence of India’s Pharmaceutical Industry and implications for the U.S. generic drug market”, Office of economics working paper – U.S. International Trade Commission, p.1-41  Gregory J.H, 2002, “ International comparison of corporate governante guidelines and codes of best practice – developing & emerging markets”, Weil, Gotshal & Manges publishing, Fall edition, pp.1-215  Haakonsson S.J., 2009, “ The Changing governance structures of the global pharmaceutical value chain”, Competition & Change, Vol.13, No.1, pp.75-95  Hamm P., King L.P. & Stuckler, 2012, “ Mass privatization, state capacity and economic growth in Post-Communist countries”, American sociological review, Vol.77, pp.295- 226  Health Insurance System in Korea: http://live.econ.berkeley.edu/, consulted on the 15th of July 2012  Hillier D., Pindado J., de Queiroz V. & de la Torre,2011, “The Impact of country- level corporate governance on research and development”, Journal of International Business Studies, Vol.42, pp.76-98  Holz C.A., 2008, “ China’s Economic Growth 1978-2025: what we know today about China’s Economic growth tomorrow”, World Development, Vol.36, No.10, pp.1664-1691  Hua J., Miesing P. & Li, 2006, “ An empirical taxonomy of SOE Governance in transitional China”, Journal of management governance, Vol.10, pp.401-433  Huang Y. & Khanna, 2003, “ Can India overtake China?”, Foreign policy, No.137, pp.74-81  Hung M., Wong T.J. & Zhang, 2012, “ Political considerations in the decision of Chinese SOEs to list in Hong Kong”, Journal of Accounting and Economics, Vol.53, Issues 1-2., pp.435-449  Hunter Rodwell Consulting, 2008, “Intellectual Property Rigths Primer for Korea – a guide for UK Companies”, UK Trade & Investment, pp.1-40  India Brand Equity Foundation, 2007, “ Healthcare – October 2007”, IBEF publications, pp.1-77

226 LB 2011\2012  Institute of Health Management Research, 2007, “ A Parallel Health Care market: Rural Medical Practitioners in West Bengal, India”, June 2007, No.2, pp.1-4  InvestKorea, 2008, “ Overview of Korea’s Industries: Pharmaceutical/BT”, Korea Trade-Investment Promotion Agency, pp.1-14  Islam S.M.N. & Bonazzi, 2007, “ Agency Thoery and corporate governante: A study of the effectiveness of board in their monitoring of the CEO”, Journal of modeling in Management, Vol.2, Iss.1, pp.7-23  J.P., 2005, “ A viewpoint on South Korean Biotech”, Biotech Focus, Vol.10, No.10, pp.1-4  Jang H. & Kim J.,2002, “ Nascent Stages of Corporate Governance in an Emerging Market: regulatory change, shareholder activism and Samsung Electronics”, Corporate governance, Vol.10, No.2, pp.1-12  Jang, K.W., 2010, “ Korean Pharmaceutical Industry in the era of globalization”, KHIDI publishings, pp.1-15  Jeong Y.S., 2012, “ Low possibility for a repeat crisis in Korea”, SERI Quarterly publication, pp.115-121  Jie L., 2010, “ Roche to boost China headcount by 25%”, China Daily, available at http://www.chinadaily.com.cn/bizchina/2010-09/09/content_11281302.htm consulted on the 25th of June 2012.  Johannesson J., et al., 2011, “ UK, Russia, Kazakhstan and Cyprus governance compared” Research paper, pp. 1-24,  Jones R.S., 2009, “ Reforming the Tax System in Korea to promote Economic Growth and Cope with Rapid Population Ageing”, OECD Economics Department Working Papers, No.671, OECD Publishing, pp.1-45  Joshi V. & Little,2003, “India’s Economic Reforms, 1991-2001”, Oxford Scholarship Online, available at http://www.oxfordscholarship.com.ludwig.lub.lu.se/view/10.1093/0198290780.001. 0001/acprof-9780198290780  Jung H., 2012, “ Ten Global Trends of 2012”, Weekly Insight, Samsung Economic Research Institute, pp.9-13

227 LB 2011\2012  Junh H.S.,et al.,2012, “ Ten global trends of 2012” Samsung economic research institute publishing, pp.9-14  Kang N. & Johansson, 2000, “ Cross-border mergers and acquisitions: their role in industrial globalization”, OECD Science, Technology and Industry Working Papers, 2000/2001, OECD Publishings  Kang N., 2010, “ Globalisation and Istitutional change in the State Led-Model: The Case of Corporate Governance in South Korea”, New Political Economy, Vol.14, No.4, pp.519-542  Kang S.I., 2001, “ Determinants of Corporate Ownership structure and their effects on corporate governance in South Korea”, Keri publishings, pp.1-42  Kaur G. & Mishra, 2010,“ Corporate Governance failure in India: A study of academicians perception”, The IUP Journal of Corporate Governance, Vol.9, Nos.1&2,pp.1-15  Kearnyey C., 2012, “ Emerging markets research: trends, issues and future directions”, Emerging markets review, Vol.14, Issue.2, pp.159-183  Kermani F., 2008, “ New interest in an old market: South Korea”, Pharmaceutical technology Europe, July 2008, pp.12-15  Khanna T., Palepu K.G., 2004, “ Globalization and convergence in corporate governance: evidence from Infosys and the Indian software industry”, Journal of International Business Studies, Vol.35, pp.484-507  KHIDI, 2008, “ 2008 Korea Pharmaceutical Industry Directory”, Korea Health Industry Development Institute publishings, pp.1-307  Kiel G.C., et al, 2006, “ Corporate governance options for the local subsidiaries of multinational enterprises”, Corporate Governance, Vol.14, No.6, pp.568-575  Kim H., Bae J. & Bruton,2010, “ Business groups and institutional upheaval in emerging economies: corporate venturing in Korea”, Asia Pacific Journal of Management, Vol.10,pp. 1-24  Kim J. & Yi, 2006, “ Ownership Structure, Business Group Affiliation, Listing Status and Earnings Management: Evidence from Korea”, Contemporary Accounting Research Vol.23, No.2, pp.427-464

228 LB 2011\2012  Kim K.S., 1986, “ Corporate governance in Korea”, Journal of comparative business and capital market law, Vol.8, pp.21-38  Kim W., Lim Y. & Sung, 2007, “ Group control motive as a determinant of ownership structure in business conglomerates: evidence from Korea’s chaebols”, Pacific-basin Finance Journal 15, pp.213-252  Kirby J., 2011,” Really bad advice: in Sino-Forest and a host of other high-profile meltdowns, financial analysts failed to spot trouble. Why do they so often get things so wrong?", Global Issues In Context., consultato il 13 Mar. 2012  Knight J. & Ding, 2012, “China’s Remarkable Economic Growth”, Oxford Scholarship Online, www.oxfordscholarship.com , consulted on the 16th of August 2012  Koh Y.S., 2011, “ Megatrends in Korean Healthcare”, SERI Quarterly, pp.1-7  Korea BioVenture Association, 2008, “ Biotechnology Industry Overview – Republic of Korea”, KBA publishing, pp.1-5  KPMG, 2009, “KBuzz, Sector Insights”, KPMG Sector Insights series, Issue 8, August 2011, pp.1-6  KPMG, 2011, “ China’s 12th Five-year Plan: Healthcare sector”, KPMG Advisory China, p.1-8  KPMG, 2011, “ China’s pharmaceutical industry – poised for the giant leap”, KPMG Advisory (China), p.24  KPMG, 2011, “ The Indian Pharmaceutical Industry: Collaboration for Growth”, Industrial Markets report, pp.1-42  KPMG,2009, “India Pharma Inc.: Overcoming Challenges to Maximise Potential”, Pharma Summit 2009, 16 Semptember 2009, Mumbai, pp.1-88  Kripalani M., 2009, “Corporate India’s Governance Crisis” ,Business Week, Jan.25 2009, pp.78-79  Kurkkio M., 2011, “Managing the fuzzy front-end: insights from process firms”, European Journal of Innovation management, Vol.14, pp.252-269

229 LB 2011\2012  Kwok D., Lyn T.E., 2010, “ Analysis global drug firms take aim at made for China healthcare” Reuters.com, available at http://www.reuters.com/article/2010/09/21/us- china-pharma-idUSTRE68K1EM20100921 consulted on the 21st of June  Kwon J.K. & Kang, 2011, “The East Asian model of economic development”, Asian-Pacific Economic Literature, pp.116-130  Kwon S., 2003, “ Pharmaceutical reform and physician strikes in Korea: separation of drug prescribing and dispensing”, Social Science& Medicine, Vol.57, pp. 529- 538  La Porta R., et al., 1998, “ Law and Finance”, Journal of Political Economy, Vol 106, No.6, pp.1113-1155  La Porta R.,et al., 1999, “Investor protection and corporate governance”, Journal of financial economics, Vol.58, pp.3-27  Leblanc R.W., 2011, “ A black eye for bay street”, Canadian Business, Vol.84, Issue 15, pp.12-13  Lee J.C., 2003, “ Healthcare Reform in South Korea: Success or Failure?”, American Journal of Public Health, Jan. 2003, Vol.93, No.1, pp. 48-51  Lee Y., 2000, “ The failure of the weak state in economic liberalization: liberalization, democratization and the financial crisis in South Korea”, The Pacific Review, Vol.13, No.1, pp.115-131  Lee Y.,2011, “ American Views on South Korea’s Economic Development in Los Angeles Times and New York Times, 1970-1974”, Asian Social Science, Vol.7, No.5, pp.85-97  LG Life Sciences, 2008, “ Annual Report 2008”, pp.1-25  Li C.L., 2002, “ New Developments in China’s pharmaceutical regulatory regime”, Journal of commercial biotechnology, Vol.8, p.246  Li W., Xu Y., Niu J., & Qiu, 2012, “ A survey of corporate governance: International trends and China’s mode”, Nankai Business Review International, Vol.3, Iss.1, pp.4-30  Liao C., 2009, “ The Governance Structures of Chinese Firms”, Innovation, Technology and Knowledge Management, pp.1-57

230 LB 2011\2012  Ling R.E., Liu F., Lu X.Q. & Wang, 2011, “ Emerging issues in public health: a perspective on China’s healtchcare system”, Public health, Vol.125, pp.9-14  Liu S., 2005, “ Corporate Governance and Development: The Case of China”, Corporate Governance: An International perspective, Vol.26, No.7, pp.445-449  Lu T., Zhong J. & Kong J., 2009, “ How good is corporate governante in China”, China & World Economy, Vol.17, No.1, pp.83-100  Luo J.H., Wan D, 2012, “The non-monotonic governance effects of large shareholdings in Chinese listed companies: an overinvestment perspective” Journal of Corporate Governance, Vol 12, No 1, pp. 3-13  Lupin Ltd., 2011, “ Lupin Annual Report 2011”, pp.1-91  Ma L., 2009, “Indipendent directors in China”, Master thesis, University of Alberta, pp.1-24  Marketline , 2012, “ Dong-A company Profile”, Company Profile, pp.1-15  MarketLine, “ OTC Pharmaceuticals in China”, Marketline Industry Profile, February 2012, pp.1-36  MarketLine, “ OTC Pharmaceuticals in India”, Marketline Industry Profile, February 2012, pp.1-36  MarketLine, 2011, “ Company Profile: Piramal Healthcare Limited”, MarkerLine Company Profile, pp.1-19  MarketLine, 2011, “ Daewoong Pharmaceutical Co. Ltd. .”,MarketLine Company Profile, pp.1-12  MarketLine, 2011, “ Hanmi Holdings Co. Ltd. .”,MarketLine Company Profile, pp.1-15  MarketLine, 2012, “ Company profile: Hyundai Pharmaceutical Co., Ltd”, MarketLine Company profile, pp.1-10  Marketline, 2012, “ Healthcare providers in China”, Marketline Industry Profile, February 2012, pp.6-7  Marketline, 2012, “ OTC Pharmaceuticals in South Korea”, MarketLine Industry Profile, pp.1-33

231 LB 2011\2012  MarketLine, 2012, “Company Profile: Samsung Pharmaceutical Industry Co., Ltd.”, MarketLine Company Profile, pp.1-10  Marketline, 2012, “Healthcare providers in China”, Industry Profile, January 2012, pp.1-29  Martynova M.& Renneboog, 2005, “ A Corporate Governance Index: convergence and diversity of national corporate governance regulations” The university of Sheffield management school publishing, pp.1-34  McKinsey & Company, 2011, “ A wake-up call for Big Pharma”, McKinsey Quarterly, pp.1-6  Means C.G., 1931, “ The Separation of Ownership and Control in American Industry”, The Quarterly Journal of Economics, Vol.46, No.1, pp.68-100  Mikler J., 2008, “ Entrepreneurial States: Reforming Corportate Governance in France, Japan and Korea”,Governance, Vol.21, Issue 4, pp.609-612  Milchior R, Charbonnel A., 2010, “ Eu Legal and regulatory update”, Journal of Generics Medicines, Vol.7, pp.102-110  Min. B & Bowman, 2012, “ Corporate Governance, Regulation and Globalization: Lessons from Korea”, Griffith University Research, pp.1-48  Ministry of Health, 2000, “ Interim measures for Administration of Sino-Foreign Joint Venture and Cooperative Medical Institutions”, available at http://www.cuan.cn/engpro/WebLawDetail.aspx?ID=11 consulted on 22nd of June 2012  Ministry of Legislation, 2001, “Commercial Act (Republic of Korea)” : http://www.moleg.go.kr/ consulted on the 20 of July 2012  Mishra A.V., & Ratti, 2011, “ Governance, monitoring and foreign investment in Chinese companies”, Emerging markets review, Vol.12, pp.171-188  Mukhopadhyay K. & Thomassin, 2010, “ Features of the East and South Asian Economies”, Economic and environmental impact of free trade in East and south Asia, Springer Science, pp. 41-83  Mulrenan S., 2009, “ Satyam scandal could increase disclosure obligations”, Asia Law,p.5

232 LB 2011\2012  Nair.A, 2009, “ Report from: India”, Pharmaceutical Technology, March 2009, pp.18-22  Nakata M., 2003, “ Perspective on comparative corporate governance: understanding corporate governance patterns”, The international journal of asian management, Vol.2, pp.55-63  National People’s Congress, 2005, “ Company Law”, available at http://www.chinadaily.com.cn/bizchina/2006-04/17/content_569258.htm consulted on the 1st of July 2012  National Sample Survey Organisation, 1995, “ Maternal and Child Healthcare in India”, Department of Statistics, NSS Fifty-second Round,pp1-153  Nee V., Opper S. & Wong, 2007, “ Developmental state and corporate governance in China”, Management and organization review, Vol.3, No.1, pp.19-53  Nolan J., 2010, “ The influence of western banks on corporate governance in China”. Asia Pacific Business Review, Vol.16, Issue 3, pp.417-436  OECD, 2001, “ Corporate Governance in Asia,” OECD publishing, p.158  OECD, 2007, “ Korea – Progress in implementing regulatory reform”, OECD Publishing, pp.1-191  OECD, 2010, “ OECD Economic surveys: Korea”, OECD publishing, Volume 2010\2012, pp.1-159  OECD, 2011, “ Corporate Governance of Listed Companies in China: Self- assessment by the China Securities Regulatory Commission”, OECD Publishing, pp.1-108  Oman C.,2003, “ Corporate governance in development: the experience of Brazil, Chile, India and South Africa”, Organisation for Economic Co-operation and Development. Development Centre,pp.1-260  Park B.S., 2009, “ China’s corporate reform and its economic effects”, Seriworld publishing, pp.12-22  Park C. & Kim, 2008, “ Corporate Governance, regulatory changes, and corporate restructuring in Korea, 1993-2004”, Journal of World Business, Vol.42, pp. 66-84

233 LB 2011\2012  Park S.R., Drysdale P., Kang S.I. & Hong, 2004, “ Ownership structure of Northeast Asian countries”, Major Research Paper, KERI Publishing pp.17-44  Pattnaik C.,Chang J.J. & Shin, 2011, “ Business groups and corporate transparency in emerging markets: empirical evidence from India”, Asia Pacific Journal of Management, Vol.10, pp.1-18  Peters S., Miller M. & Kusyk, 2011, “How relevant is corporate governance and corporate social responsibility in emerging markets?” Corporate governance, Vol.11, No. 4, pp.429-445  Pfizer India, 2011, “ Annual Report 2011”, pp.1-77  Pfizer, 2011, “ Pfizer and Shanghai Pharmaceutical sign memorandum of understanding for potential strategic partnership”, Pfizer news, available at http://www.pfizer.com.cn/news/news_en.aspx?id=274 consulted on 29th of June 2012  Piramal Healthcare, “ Piramal Healthcare Annual Report 2011”, pp.1-148  Powers C.M., 2010, “ The Changing Role of Chaebol – Multi-conglomerates in South Korea’s National Economy”, Georgetown University Working Papers, pp. 105-116  PriceWaterHouseCoopers, 2007, “ Healthcare in India – Emerging market report 2007”, Emerging markets reports, pp.1-26  PriceWaterHouseCoopers, 2012, “ Global pharma looks to India: prospects for growth” Pharma 2020 series, pp.1-40  PriceWaterHouseCoopers, 2012, “ Pharma 2020: Challenging Business models - Which path will you take?”, Pharma 2020 series, 4th paper, pp.1-24  PriceWaterHouseCoopers,2010, “ India Pharma Inc.: Capitalising on India’s Growth Potential”, Pharma Summit 2010, pp.1-64  Rajagopalan N., Zhang Y., 2008, “ Corporate governance reforms in China and India: Challenges and opportunities”, Business horizons,Vol.51, pp.55-64  Ramesh G., 2010, “ India under the siege of reform”, Journal of Indian Business Research, Vol.2, No.2, pp.76-81  Ranbaxy Laboratories Ltd., 2011, “ Annual Report 2011”, pp-1-172

234 LB 2011\2012  Razmi A., 2010, “ Exploring the Sustainability of the Chinese Growth Model in Light of Some Key Structural Characteristics”, International Journal of Political Economy, Vol.39, no.1, pp.54-92  Reed A.M., 2002, “ Corporate Governance Reforms in India”, Journal of Business Ethics, Vol.37, pp.249-268  Reeves M., Wong J. & Dabbs, 2011, “ Pharma futures”, Pharmaceutical executive, pp.1-6  Sahoo A., 2008, “ Successful Pharmabiotech Alliance Strategies”, Business Insights, pp.1-143  Sakar J., 2009, “ Board Independence & corporate governance in India: recent trends & challenge ahead”, The Indian journal of industrial relations, Vol.44, No.4, pp.576- 592  Sampath P.G., 2006, “ Indian Pharma within Global Reach?”, United Nations University, Working Paper Series, pp.1-44  Samsung, 2011, “ Annual Report”, pp.1-51  Sanan N.,2011, “ Corporate Governance in Public and Private sector enterprises: evidence from India”, The IUP Journal of Corporate Governance, Vol.10, No.4,pp.1-24  Sarkar J. & Sarkar S., 2000, “ Large Shareholder Activism in Corporate Governance in Developing Countries: Evidence from India” International Review of Finance, pp.161-194  Sarkar J. & Sarkar, 2008, “ Debt and corporate governance in emerging economies – Evidence from India”, Economics of Transition, Vol.16, No.2, pp. 293-334  Sarkar J.,2009, “ Board Independence & corporate governance in India: Recent trends & Challenges Ahead.” Indian Journal of Industrial Relations,Vol.44, No.4, pp.539-611  Schipani C.A., & Liu, 2002, “ Corporate Governance in China: then and now”, Columbia Business Law Review, Vol.2002, pp.1-71  Scrip, 2012, “ The CMO Market Outlook to 2017”, SCRIP Insights series, pp.1-119  SEBI, 2002, “Clause 49 of Listing Agreement”, pp.1-15

235 LB 2011\2012  Seghal A. & Mulraj, 2007, “Corporate governance in India: moving gradually from a regulatory model to a market-driven model- A survey”, International Journal of Disclosure & governance, Vol.5, pp.205-235  Sen D.K., 2004, “ Clause 49 of Listing Agreement on Corporate Governance” The Chartered Accountant, December 200, pp.806-811  SERI, 2004, “ Challenges Facing Korea’s Pharmaceutical Industry”, SERIWorld publishings, pp.4-7  Shanghai Pharmaceuticals Holding Co. Ltd., 2011, “ Annual Report”, pp.1-223  Sharma M.,K, Agarwal P., Ketola T., 2009, “ Hindu philosophy: bridging corporate governance and CSR”, Management of environmental quality: an International journal, Vol.20, Iss.3, pp.299-310  Shen S. & Jia,2005, “ Will the independent director institution work in China” Loyola of Los Angeles International & Comparative Law Review, Vol. 27, Issue 2, p. 223-248  Siems M., 2010, “Convergence in Corporate Governance: A Leximetric Approach”, The Journal of Corporation Law, Vol.35:4, pp.729-755  Singh J.P., Kumar N. & Uzma, 2010, “ Satyam Fiasco: corporate governance failure and lessons therefrom”, The IUP Journal of corporate governance, Vol 9, No.4, pp. 30-38  Sinopharm Group Co. Ltd., 2011, “ Annual Report 2011”, pp.1-223  Sinopharm,2012, “Ten business cores”, Sinopharm Website, available at http://www.sinopharm.com/p382.aspx consulted on 26th of June 2012.  Solomon J., Solomon A. & Park, 2002, “A conceptual framework for corporate governance reform in South Korea”, Corporate governance, Vol.10,No.1 pp.1-18  Song S. & Zheng, 2011, “Roles between growth and flexibility options in the investment decisions of multinational firms: implications for corporate governance”, International Journal of Management, Vol 28, No. 4, Part 1, pp. 144- 149  Song Y.J., 2009, “ The South Korean Health Care System”, International Medical Community, Vol.53, No.3, pp.206-209

236 LB 2011\2012  Srivastava R., et al., 2005, “ Strategic Imperatives for Globalization of industries in Developing Countries”, Health Marketing Quarterly, 22:1, pp.57-69  State Council, 2005, “Regulations on the Administration of Company Registration”, available at http://tradeinservices.mofcom.gov.cn/en/b/2005-12- 18/17120.shtml consulted on the 23rd of June 2012  Struck H., 2011, “ Sino-Forest to default, raising doubts for investors” ,www.Forbes.com, p.36, consultato il 15-03-12  Suh C.W., 2009, “Korean Pharmaceutical regulation trend & market review” ISIS’s 7th Annual eSolutions conference, pp. 14-18  Sun Pharmaceuticals Limited, 2011, “ Annual Report 2011 – Corporate Governance Report”, pp.1-14  Sun Q., Santoro M.A., Meng Q., Caitlin L. & Eggleston, 2008, “ Pharmaceutical Policy in China”, Health Affairs, Vol.27, No.4, pp.1042-1050  T.A. Paredes, 2005, “ Corporate Governance and Economic Development”, Regulation , Vol.28, Issue 1, pp.34-39  Tam K., 1999, “ The Development of Corporate Governance in China”, Edward Elegar Editions, pp.1-129  Tancer R.S.,2001, “The Pharmaceutical Industry in India – Adapting to TRIPS”, The Journal of world intellectual property, pp.171- 187  The Economist, “China’s Achilles heel - A comparison with America reveals a deep flaw in China’s model of growth”, April 21st 2012.: http://www.economist.com/node/21553056 consulted on the 15th of June 2012  The Hong Kong Stock Exchange, 2011, “Joint Announcement of China Pharmaceutical Group Ltd. Takeover”, pp.1-8  The Ministry of Corporate Affairs, 2006, “ The Companies Act of 1965”, pp.1-311  The Pharmaceutical administration law of China, 2001, http://www.civillaw.com.cn/article/default.asp?id=41480 consulted on the 25th of June 2012  The Senate and House of Representatives of the United States of America in Congress, 2002, “ Sarbanes-Owley Act of 2002.

237 LB 2011\2012  The World Bank, 2012, “ Economy Profile: Korea, Rep.”, Doing Business Series, pp.1-103  Thomas White International, Ltd., 2010, “ The Chaebols in South Korea: Spearheading Economic Growth”, Emerging Market Spotlight, pp.1-12  Thurbon E., 2001, “ Two paths to financial liberalization: South Korea and Taiwan”, The Pacific Review, Vol.14, No.2, pp.1-27  Tochkov, K., 2010, "East Asian Economies." 21st Century Economics: A Reference Handbook. Ed. Rhona C. Free. Thousand Oaks, CA: SAGE,. 485-493  Tsui M., 2010, “Corporate Governance in China” Corporate governance eJournal, pp. 1-17, consultato il 5 Marzo 2012, < http://epublications.bond.edu.au/cgej/20 >  Unschuld P.U., 1986, “ Medicine in China: A history of pharmaceutics”, University of California Press, pp.276-280  Uran K.,2011, “ Evolution of Korea’s CEO system”, KET Issue report, pp.1-6  V.V.A.A., 2005, “ State Public Sector Undertakings”, Development Report, Uttar Pradesh Government of India, Chapter 15, pp.445-480  V.V.A.A., 2008, “ Pharmaceutical Pricing Policies in a Global Market”, OECD Health Policy Studies, OECD Publishing, pp.1-209  V.V.A.A., 2009, “The dark underbelly of Indian IT.” Money Today, p.15  V.V.A.A., 2011, “ Asia: taking corporate governance to a higher level” OECD publishing, pp.1-136  V.V.A.A.,2011, “ Clear waters needed”, Globe & Mail Online, http://find.galegroup.com.ludwig.lub.lu.se/gic/infomark.do?&source=gale&idigest= 5c347822409315cc218bc34d619933c2&prodId=GIC&userGroupName=lununi&ta bID=&docId=CJ258880015&type=retrieve&contentSet=IAC- Documents&version=1.0, Consultato il 13 Marzo 2012  V.V.A.A.,2011, “ Governance of listed companies in China”, OECD publishing, pp.1-105  V.V.A.A.,2011, “ Report – India’s Pharmaceuticals Industry”, Corporate Catalyst India, pp.1-27

238 LB 2011\2012  V.V.A.A.,2012.,” A Brief report pharmaceutical industry in India”, Working Paper, March 2012, pp.1-11  V.V.A.A.., 2005, “ OECD Guidelines on corporate governance of State-owned enterprises”, OECD publishing, pp.1-55  V.V.A.A.., 2011, “ Corporate governance in Asia – progress and challenges” OECD publishings, pp.1-90  V.V.A.A.., 2011, “ Enforcement of corporate governance in Asia – the unfinished agenda” OECD publishing, pp.1-124  Van Arnum P., 2010, “ Navigating the Global Pharmaceutical Supply Chain”, Pharmaceutical Technology, 34:1, pp.46-49  Verma A., 2011, “ Established and Emerging Biotech Clusters”, SCRIP Business Insight, pp.1-218  W.B.Gamble, 2011, “ Investing in Emerging Markets”, ???, pp.71-88  Wang J., Chen T., & Tsai, 2012, “ In search of an innovative state: the development of the biopharmaceutical industry in Taiwan, South Korea and China”, Development and Change, Vol.43, No.2, pp.481-503  Wang S., Hwang C., 2011 ,"Application of options to the pharmaceutical markets: The solutions of corruption and counterfeit drugs in emerging markets", International Journal of Accounting and Information Management, Vol. 19 Iss: 2 pp. 169 – 181  Webley K., 2009, “ With HIV/AIDS Deaths on rise, China struggle to improve outreach”, Time.com, available at http://www.time.com/time/world/article/0,8599,1890270,00.html?artId=1890270?c ontType=article?chn=world consulted on the 1st of July 2012.  Wei G. & Geng, 2008, “ Ownership structure and corporate governance in China: some current issues”, Managerial Finance, Vol.34, Iss.12, pp.934-952  Weiss S. & Forrester, 2004, “ China’s pharmaceutical industry”, The China Business Review, Nov-Dec 2004, pp.1-3  White L.,2011, “What’s behind the great China stock scandals?”  Winkler D., 2010, “ India’s Satyam Accounting Scandal” Iowa university, pp.1-10

239 LB 2011\2012  Wockhardt Ltd, “Annual Report 2010”, pp.1-104  Won K.,2011, “ Two Decades of Korea’s Management reform”, KET Issue Report, pp.1-6  Xiang L., 2010, “ Pharma firm Hepalink tops IPO price, soars on debut”, China Daily, available at http://www.chinadaily.com.cn/bizchina/2010- 05/07/content_9821222.htm consulted on 28th of June 2012  Xu X. & Wang, 1999, “ Ownership structure and corporate governance in Chinese stock companies”, China Economic Review,Vol.10, pp.75-98  Yadav V. & Deepak,2011, “Regulatory Challenges in global pharmaceutical market”, Vol.3, No.2, pp.340-345  Yakovlev, A., 2004, “Evolution of corporate governance in Russia: government policy vs. real incentives of economic agents”, Post-Communist Economies, Vol. 16 No. 4, pp. 387 – 403.  Yanagimachi I., 2004, “ Chaebol Reform and Corporate Governance in Korea”, Policy and Governance Working Paper Series No.18, pp. 1-22  Yang J., Chi J. & Young, 2011, “ A review of corporate governance in China”, Asian-Pacific Economic Literature, pp.1-14  Yang J., Chi J. & Young, 2011, “ A review of corporate governance in China”, Asian-pacific economic literature,pp.15-29  Yongkl K., 2008, “ Post-crisis reform & consequences” SERI quarterly report, pp.1- 5  You T., Chen X. & Holder, 2010, “ Efficiency and its determinants in pharmaceutical industries: ownership, R&D and scale economy”, Applied Economics, Vol.42, pp. 2217-2241  Yu M.,2011, “ Analyst recommendations and corporate governance in emerging markets” International Journal of Accounting and Information Management, Vol.19, No.1, pp.34-52

240 LB 2011\2012  Yuan N.,2009, “ A Brief analysis of the defects and countermeasures of the independent director system in China”, International Journal of Law and Management, Vol.51,Issue.4,pp.260-267  Zhang X.,2010, “Global Forces and Corporate reforms in South Korea”, International Political Science Review,Vol.21, No.1, pp.59-76  Zhang Y., 2006, “ Law, corporate governance and corporate scandal in an emerging economy: insight from China”, Draft available at: http://ssrn.com/abstract=957549, pp.1-41  Zollino F., 2010, “ The macroeconomic developments in China: the statistical challenges”, Workshop “The Chinese Economy” , Venice – 25-27 November 2010, pp.1-24

241 LB 2011\2012

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