According to a 2001 report by the World Bank, in order to be more in line with the Organization of Economic Corporation and Development (OECD) Principles of Corporate Governance, Croatia needed to strengthen its corporate governance system in a number of areas. In its 2004 "Corporate Governance Sector Assessment Project," the European Bank of Reconstruction and Development (EBRD) gave Croatia a rating of "Medium Compliance" with the OECD Principles of Corporate Governance. The EBRD cautioned however that reforms in the area of corporate governance are a top priority in order to improve the enforcement of existing legislation,. At the same time existing laws should continue to be refined. Particular attention should be paid to improving disclosure and transparency and protection of minority shareholders and general company's operations.
General Overview
According to the January 2004 EBRD Corporate Governance Sector Assessment, Croatia's existing corporate governance related laws (i.e. the "law on the books"), was rated as being in "medium compliance" with the Organization of Economic Corporation and Development (OECD) Principles of Corporate Governance.
Nonetheless, the January 2004 EBRD assessment emphasizes that reforms in the area of corporate governance are a top priority in order to improve the enforcement of existing legislation, while continuing to refine their existing laws. Particular attention should be paid to improving disclosure and transparency and protection of minority shareholders and general company's operations. For example, the requirement for interested parties to timely disclose conflicting interests in transactions with the company should be strengthened, if a person, who has influence in a joint stock company, causes damages to the company. In addition, the way that audited financial statements are disseminated should be improved. Oversight of auditors' work also needs to be enhanced.
Furthermore, there is a need to improve various corporate governance requirements, such as to broaden shareholders access to information, to detail the functions of the board better, to introduce independent board members - and define the condition of independence - and to establish board committees (e.g. audit committee) remarks the EBRD in its 2005 assessment. A Corporate Governance Code has been posted at the Zagreb Stock Exchange. However, there is neither information available if the code has been applicable nor if the code still has to be introduced as per Art. 272 of the Law on Companies, which deals with the obligation for listed companies to report regarding their compliance with the Code.
The Investor Protection Index is a subcomponent of the World Bank's 2006 Doing Business Indicators. The Investor Protection Index consists of three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index) and shareholders' ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index). The indexes vary between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection. Croatia scores 3 in the disclosure index against a regional average of 4.7 and an OECD average of 6.3. It scores 8 in the Director Liability Index against a regional average of 3.8 and an OECD average of 5.0 and 6 in the Shareholder Suits Index against a regional average of 6.0 and an OECD average of 6.6.
According to the EBRD the Law on Companies of Croatia came into force in January 1995, but has been amended since than several times: 1999, 2000 and 2003. As a classical example of a country whose economy is in transition, Croatia adopted two sets of corporate governance laws from different foreign legal backgrounds. The Law on Companies is based upon the German model, while Croatia's initial securities market legislation made a strong reference to the laws and regulations of common-law countries. The German system of corporate governance is "bank-based" (i.e., driven by creditors), whereas the Anglo-American one is market-oriented (i.e., driven by investors). The compatibility between the Law on Companies and the securities market legislation has been widely criticized, especially on how to implement these conflicting regulations in practice. Recently the situation has improved since the adoption of the Securities Market Law and the Law on the Take-over of Joint Stock Companies in 2002, although there remains room for improvement. The World Bank in its 2001 assessment points out that the primary legal framework in Croatia for publicly traded companies consists of the 1993 Company Law, the 1995 Law on Issuance and Sale of Securities (replaced in July 2002 by the Securities Market Law) and the 1997 Law for the Takeover of Joint Stock Companies. All traded securities must be in the legal form of shares in joint stock companies, which are governed by the Company Law.
The 2002 Securities Market Law, the 2002 Takeover Law, the 2005 Law on Investment Funds, and the 2006 Act on the Croatian Financial Services Supervisory Agency primarily govern the securities market. The Croatian capital markets are supervised by two different institutions, namely the Croatian National bank (CNB) and the Croatian Financial Services Supervisory Agency (CFSSA). The CNB supervises credit institutions and similar financial institutions, and the CFSSA supervises the securities market, pension funds, and insurance companies. The CFSSA was established in January 2006 and replaced the Insurance Companies Supervisory Authority, the CSEC, and the Agency for Supervision of Pension Funds and Insurance (EBRD 2007).
The World Bank report from 2001 shows that just over two percent of all enterprises are joint stock companies in Croatia and approximately 3,000 joint stock companies exist in Croatia. Under the 1993 Company Law, other legal forms are permitted but only joint stock companies may trade on the two organized exchanges: the Zagreb Stock Exchange (ZSE) founded in 1991 with three tiers; and, a smaller exchange, the Varazdin Over-the- Counter (OTC) Market, founded in 1993 which lists companies on three primary tiers (plus special trading for auctions and government certificates.
According to the U.S. Department of Commerce 34.2 billion HRK (approximately $6.1 billion) were the total of Transactions on the Zagreb Stock Exchange in 2005, of which 25 billion HRK (approximately $4.5 billion) was in institutional turnover. "As of December 2006, transactions totaled 45.3 billion HRK (approximately $8.1 billion) of which 29.4 billion HRK (approximately $5.3 billion) was institutional turnover. In 2005, transactions on the Varazdin Stock Exchange totaled 2.2 billion HRK (approximately $390 million) and in 2006 transactions totaled 3.7 billion HRK(approximately $660 million). There are three tiers of securities traded on the ZSE. Companies must meet highdisclosure and operating requirements to be fully listed" (U.S. doc, p.59).
However, as the World Bank (2001) reports the majority of companies are placed on the third tier, which has the lowest level of disclosure and listing requirements. The small number of companies on the first tiers (four companies at ZSE, two at Varazdin) has been reduced significantly through the successful takeover of companies by strategic investors.
In the 2006 Article IV consultations with the International Monetary Fund, IMF staff expressed strong reservations on aspects of the draft privatization law still under discussion with social partners. The draft law contains some welcome provisions to simplify privatization procedures without loss of transparency. But it would also introduce a new option for employee-management buyouts under an employee stock ownership program (ESOP). The IMF notes that "the government considered the ESOP essential for securing consensus for privatization and proposed an ESOP stake of up to 25 percent in enterprises being privatized, at a large discount. Social partners have argued for even higher ESOP stakes". (p. 17) However, IMF staff cautioned that an "ESOP component as large as proposed would risk deterring potential strategic investors and entrench insider control of enterprises, thereby worsening corporate governance problems and limiting the possibility for new investment". (IMF 2007, p. 17)
The Principles
Principle I: Ensuring the Basis for an Effective Corporate Governance Framework
According to the January 2004 EBRD Corporate Governance Sector Assessment, Croatia's existing corporate governance related laws (i.e. the "law on the books"), was rated as being in "medium compliance" with the Organization of Economic Corporation and Development (OECD) Principles of Corporate Governance. However the assessment does not directly address Croatia's compliance with the following principles. However, the report does not directly address Croatia's compliance with this and the following principles.
The legal framework for basic corporate governance standards and rules are detailed in the Law on Companies of 1995 with amendments through 2004 points out the January 2004 EBRD report. This law is based on the German two-tier model: the meeting of shareholders elects the members of the supervisory board which in turn appoints the management board. Other relevant legislations are the Securities Law of 25 July 2002 and the Take-over Law 25 July 2002.
As the January EBRD (2004) assessment reports, in January 1995 the Law on Companies of Croatia came into force, but has been amended since than several times: 1999, 2000 and 2003. As a classical example of a country whose economy is in transition, Croatia adapted two sets of corporate governance laws from different foreign legal backgrounds. As stated above the Law on Companies is based upon the German model, while Croatia's initial securities market legislation made a strong reference to the laws and regulations of common-law countries. The German system of corporate governance is "bank-based" (i.e., driven by creditors), whereas the Anglo-American one is market-oriented (i.e., driven by investors). The compatibility between the Law on Companies and the securities market legislation has been widely criticized, and on how to implement these conflicting regulations in practice. Recently the situation has improved since the adoption of the Securities Market Law and the Law on the Take-over of Joint Stock Companies in 2002, although there remains room for improvement.
Principle II: The Rights of Shareholders and Key Ownership Function
The Company and Securities Law of Croatia regulates the requirement of maintaining a central or company share register where every shareholder is documented. The registration shows proof of ownership and is maintained by an external and independent organization. The EBRD (April 2004) remarks that the Company Law provides shareholders with the right to be notified of, and have the power to vote in respect of, the following corporate changes: Amendments to the company charter, Issue of additional shares, merger or reorganization of the company, winding up or voluntary liquidation of the company, amendment of the specific rights attached to any class of shares. Croatia's shareholder rights include as well the right to elect, appoint and dismiss members of the board only during the shareholders' meeting, which is the sole legally authorized body. Furthermore the body has the power to appoint auditors and request additional information regarding the auditors' report. The dividends and proceeds of liquidation are distributed to shareholders in proportion to their holdings. However, the report does not directly address Croatia's compliance with this principle.
According to the EBRD (April 2004) the law provides that shareholders should be notified of corporate changes, and have the power to vote in respect of amendments to the company charter, merger or reorganization of the company, winding up or voluntary liquidation of the company and amendment of the specific rights attached to any class of shares. Share holders have the pre-emption right to subscribe to new issue of additional shares, and any restriction to these pre-emption rights have to pass a vote of super-majority among the shareholders. In addition by law shareholders have the opportunity to participate effectively and vote in the annual general shareholder meetings (to be held after the company's fiscal year) and be informed of the rules including voting procedure that govern general shareholder meetings.
The World Bank's 2001 assessment shows that Croatia has effectively introduced a number of mechanisms to protect the rights of shareholders. Some of the elements of the principle are largely observed, but, at the time of the assessment, shortcomings remained in the following areas: share transfer, access to information, authorization of additional shares, extraordinary transactions and the requirement to weigh the costs and benefits of exercising voting rights. The World Bank emphasizes that the fundamental rights of shareholders and their treatment by the governing bodies is clearly described and set out in the Company Law. Herein regulated are voting rights as obtained only upon full payment for shares, but the company status may permit voting rights for lower levels of payment proportional to the amount of paid shares. The Law explicitly outlines the maintenance of the share register, which is a responsibility of each company to maintain the register themselves or have another company maintain the shareholder list. All securities issued to the public (which are most likely privatized former state enterprises) are specified under the 1995 Securities Law and must be registered with the Securities Depository Agency (SDA). The SDA is the only authorized agency to receive the deposit of dematerialized securities and to clear and settle the securities. According to the 2001 World Bank report the described SDA's regulation policy is a major step forward in corporate governance in Croatia: With the prior regulation all share registries were held by the issuing companies or by companies designated by the issuers. Without effective regulations, share registries were sometimes incomplete or inaccurate.
Financial information for companies listed on the Zagreb Stock Exchange is widely available to the public or to the shareholder, though not that much information is available about ownership, criticized the World Bank (2001).
Principle III: The Equitable Treatment of Shareholders
Under the Company Law all shareholders of the same series of class are to be treated equally. Shareholder restrictions regarding voting rights and/or procedures at a shareholders meeting are not specified, according to April 2004 EBRD assessment. Furthermore there are no specific provisions protecting minority shareholders. In addition the Securities Law prohibits insider trading and abusive self-dealing. However, minority rights, one of the key issue according to the World Bank (2001), should be strengthened by reviewing them carefully regarding introducing cumulative voting, confidential voting, promotion of an organization to represent minority shareholders, a rule to mandate equitable treatment (to avoid oppression of minority shareholders by majorities) and effective forms of redress. All these provisions are more effective in coordination. Introducing only one provision is not sufficient to guarantee effective protection of minority rights. However, the report does not directly address Croatia's compliance with this principle.
The EBRD (2004) criticizes that so far the Company Law does not provide any legal binding obligations for members of the board or managers to disclose any material interests (either directly or indirectly) in transactions or matters affecting the corporation. Nevertheless, disclosure is required by the company of loans made to related parties and the law can abject transactions made by companies, which are not based on fair market value.
Principle IV: The Role of Stakeholders in Corporate Governance
According to the World Bank (2001) and the EBRD (January 2004), the law does not contain any provisions for protecting the rights of employee or stakeholders or suppliers and creditors as stakeholders. There is no defined legal requirement for consideration of the interests of all stakeholders. Stakeholders in Croatia do not have the right by law to seek effective redress for violations of their rights. However, the World Bank (2001) criticizes that Croatia does not accede with a number of OECD recommendations on the role of stakeholders in corporate governance. Although Croatia corporate governance framework provides a number of legal stakeholder rights, major drawbacks are remaining: the opportunity to obtain effective redress for the violation of the rights of stakeholders; the provision of performance-enhancing mechanisms for stakeholder participation; stakeholder access to relevant information.
The EBRD (April 2004) reports that in Croatia employees have legally the right to stock ownerships and other profit sharing mechanism within the company. Also allowed is participation in decisions by employee representation on boards. The Bankruptcy Law permits creditor involvement in the decision-making process in the context of insolvency proceedings.
The World Bank (2001) states that no stakeholder incentives schemes through performance-enhancing instrument, such as employee shares, are in place. However, employees are widely offered discounted prices on shares for companies undergoing privatization. In addition Croatian company ownership information is significantly limited. Only through the public reference facilities of the Securities Commission and the commercial court registers, the same financial information is available to shareholders as it is publicly available to other stakeholders.
On paper the policies related to disclosure and transparency are fairly strong, but serious problems exist in practice, according to the 2001 assessment by the World Bank. However, according to the EBRD (2004) all companies are required by law to disclose financial and operating statements of the company such as: annual and quarterly audited financial statements; and group accounts on a consolidated basis. However, there are legal regulation in Croatia for disclosure of information (employment history, board positions in other companies, etc.) of board members and their remuneration. The EBRD (January 2004) criticizes that companies are not required by law to disclose reasonably foreseeable material risk factors, such as risks specific to the industry or geographic area; dependence on commodities; financial market risk; risk related to derivates and off-shores; and environmental liabilities. Furthermore companies are not required to disclose their governance structures and policies. There is however, based on the Company Law, the requirement to disclose material issues regarding employees and stakeholders. The Accountancy Law stipulates that Croatian companies have to disclose financial and operating data in accordance with internationally recognized accounting standards and financial results are required to be audited by an independent auditor, remarks the EBRD (January 2004). The law does not ensure that the auditor is truly independent though. However, the report does not directly address Croatia's compliance with this principle.
According to the EBRD (April 2004), the requirements of the Accountancy and the Company Law are the following: companies disseminate information to shareholders annually; companies disseminate information to the securities commission and the stock exchange annually; the company publishes audited financial statements, as approved by the shareholders' meeting; the company publishes amendments to the company charter or other constitutional documents of similar nature; the company publishes the names of any resigning or removed directors and of newly elected directors; and the company publishes Information on bankruptcy proceedings.
The World Bank (2001) points out that the Company law of Croatia sets a very high liability for supervisory board members (including the possibility of imprisonment), though there remains an absence of guidance (or established training programs) regarding the roles, responsibilities, qualifications, operation and structure of the supervisory boards. However, under the law, the responsibilities of the board include functions such us overseeing the process of disclosure and communication, states the EBRD. The board is legally required to act in best interest of the company and its shareholders and to fulfill their key functions by law. However, the board is not always able to exercise objective judgment on corporate affairs, independent, in particular, from management. In addition board members have the right to review key executive and board remuneration, and ensuring a formal and transparent board nomination process. However, the report does not directly address Croatia's compliance with this principle.
European Bank for Reconstruction and Development, "Corporate Governance Sector Assessment Project: Report on the 2003, Assessment Results," January 2004. Available from European Bank for Reconstruction and Development website,. Accessed on June 19, 2007. (EBRD 2004)
European Bank for Reconstruction and Development, Croatia: EBRD Corporate Governance Sector Assessment Project - 2004 Assessment," April 2004. Available from European Bank of Reconstruction and Development website. Accessed on June 19, 2007. (EBRD 2004)
European Bank for Reconstruction and Development, "Commercial Laws of Croatia," April 2007. Available from European Bank for Reconstruction and Development website. Accessed on June 19, 2007. (EBRD 2007)
U.S. Department of Commerce, "Doing Business in Croatia: A Country Commercial Guide," February 2007. Available from U.S. & Foreign Commercial Service and U.S. Department of State website. Accessed on July 26, 2007. (U.S. DoC 2007)
World Bank, "Croatia: Corporate Governance Country Assessment," Report on the Observance of Standards and Codes, September 2001. Available from The World Bank website. Accessed on June 19, 2007. (World Bank 2001)
World Bank, "Doing Business: Snapshot of Business Environment - Slovenia," 2006. Available from World Bank website. Accessed on June 18, 2007. (WB 2006)
International Monetary Fund, "Croatia 2006 Article IV Consultation: Staff Report, Staff Statement, Public Information Notice and Press Release on the Executive Board Discussion, and Statement by the Executive Director for the Republic of Croatia," Country Report No. 07/81, Washington, D.C.: IMF, February 2007. Available from International Monetary Fund website. Accessed on July 31, 2007. (IMF 2007)
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