(Post-Merger)

Board architecture at Arcelor Mittal

The merger of steel makers Arcelor and Mittal in 2006 produced the world's largest steel company, with 330,000 employees and forecast earnings of $15.6 billion. Arcelor had fought a long defensive battle against the hostile takeover, valued at around $35 billion. Arcelor was incorporated in Luxembourg and had adopted European governance architecture, with a supervisory board, including employee representatives, and a management board.

Mittal was a family company with a tradition of growth through acquisition, in which the founding family still played the dominant role. Arcelor had criticised Mittal for its inadequate controls, because it had many Mittal family members and few independent directors on its board.

In the merged Arcelor Mittal company, the Mittal family retained 43.5% of the voting equity. The new board was 18 strong, with chairman Joseph Kinsch, who was previously chairman of Arcelor, president Lakshmi Mittal, nine independent directors, plus employee representative directors and nominee directors to reflect the interests of significant shareholders.

The General Management Board was chaired by the CEO Roland Junck, with the son of Lakshmi Mittal, Aditya Mittal as CFO.

(Pre-merger)

Financial Times

Anger is threatening to boil over on Friday at Luxembourg's Luxexpo centre as Arcelor, the big European steelmaker, holds its annual meeting, writes John Plender. Irked by questionable corporate governance practice - part of an attempt to shore up its defences against a bid from the rival Mittal Steel - dissident shareholders have turned the gathering into a referendum on Arcelor's board.

Yet ironically, the row has served to distract attention from equally pressing governance issues at Mittal Steel itself. The Dutch-based company is listed on Euronext in Amsterdam and on the New York Stock Exchange and is controlled by Lakshmi Mittal and his family. Since the currency of the bid, first mooted in January, is expected to be 75 per cent in Mittal paper, corporate governance could have a crucial bearing on the outcome.

A trawl through Mittal Steel's voluminous filings with the US Securities and Exchange Commission, its articles of association and the governance disclosures on its website suggests that its existing governance arrangements - which Mittal says would remain in place after a takeover - raise questions that may worry investors.

The FT has discovered that a number of the company's independent directors have close business ties to the Indian billionaire. It is among findings that, taken together, suggest Mr Mittal is destined to remain a de facto monarch in his own industrial kingdom unless an improvement in the bid terms results in his control falling significantly below 50 per cent.

Mittal Steel has a two-tier voting structure. Mr Mittal and his family currently own 67.2 per cent of the A shares, which carry one vote, and all the B shares, which have 10 votes. Overall, Mr Mittal controls 98.3 per cent of the votes. To assuage concerns about the voting structure he has said that the ratio of voting to non-voting shares will change from 10:1 to 2:1.

Yet this change in ratio means little in practice - because the powers conferred on outside shareholders in Mittal Steel's articles of association will remain academic as long as Mr Mittal retains a voting majority. Shareholders controlling one-hundredth of the capital or 50m can, for example, seek to influence the conduct of the company's business by putting an item on the agenda of a general meeting. Yet there is little point in trying when Mr Mittal can reject a resolution by a simple majority.

Even if he reduces his voting control to below 50 percent, the board can still decide not to place such items on the agenda if it believes that do so "would be detrimental to the vital interests of the company". The articles contain no definition of vital interests. So the directors have limitless latitude in exercising their discretion. Other powers conferred on outside shareholders by the articles, such as those relating to the appointment and dismissal of directors, are similarly valueless if Mr Mittal chooses to exercise his voting power against them.

That said, this is a family model of governance that is familiar to European investors. And the model often works well, since there is no divorce between ownership and control of the kind that plagues quoted companies with dispersed ownership. Yet the outside investors' share in the corporate bounty is at the discretion of the inside shareholders unless there are protections in law and in the company's governance rules to prevent the insiders extracting private benefits of control at outside shareholders' expense.

The most important areas of protection concern the integrity and transparency of accounts, governance arrangements that apply across all subsidiaries, the existence of genuinely independent non-executive directors and good rules to prevent the abuse of conflicts of interest. A key question for Arcelor shareholders, in considering Mittal Steel's bid, is whether the protections are adequate.

At first sight, the picture is acceptable. The accounts are prepared under generally accepted US accounting principles and from this year Section 404 of the Sarbanes-Oxley Act, which requires management to assess and report on the effectiveness of internal controls. This potentially offers important reassurance in a business that operates in many developing countries with weak property rights and poor accountancy.

Mittal's Form 20F filing with the SEC says there are no significant differences between its current corporate governance practices and those required of US domestic companies under the NYSE listing standards. Yet closer investigation throws up less comforting evidence.

Mittal Steel is a Dutch holding company, with no business of its own. All the assets are in operating subsidiaries. Yet the Mittal website disclosures on corporate governance say nothing about whether subsidiaries have to apply and enforce the listed parent's governance rules, what governance information has to be disclosed to the board by the operating companies and what rights the nonexecutive directors have to extract information from the subsidiaries. The management board rules are described as being those of Mittal Steel International NV, not those of the quoted parent company, Mittal Steel NV. There are obvious errors and omissions in the website's draft text of the rules.

When the Financial Times raised these issues with Mittal Steel, a spokesperson admitted that a mistake had been made and there was no such company as Mittal Steel International. The rules were Mittal Steel's. As for the group-wide governance arrangements, she pointed out: "Each operating unit has its own board of directors, which includes independent external directors and unit board guidelines that determine what can be approved by the unit board and what needs to be referred to the parent company. These boards meet regularly during the course of the year."

From the point of view of outside shareholders in the parent company this is a somewhat opaque explanation of group-wide governance. And investors have access to limited governance information on the operating companies except where, as with Mittal Steel South Africa, they are quoted.

What protection to outside shareholders does the structure of the holding company board provide? Mittal Steel is unusual in having three different classes of directors, designated A, B and C. There are no longer any class B directors since the term of office of Malay Mukherjee, Mittal Steel's chief operating officer, expired last year - incidentally implying that the only source of information for the nonexecutive directors from a non-family board executive has gone.

Meantime, the class A directors, who enjoy most of the rights, consist of Mr Mittal, who combines the roles of chairman and chief executive, his son Aditya Mittal and daughter Vanisha Mittal Bhatia. The six non-executives are class C directors, with more limited rights to represent the company than the A directors. They are unquestionably poor relations, elected for one-year renewable terms, while the family directors are elected for four-year terms. In effect, they serve at Mr Mittal's pleasure. And while five of the six are described as independent, some have close outside business links with Mr Mittal.

On the key audit committee, for example, the chairman is Narayanan Vaghul - also chairman of ICICI Bank, India's second largest bank, of which Mr Mittal is a director. Alongside him sits Andrs Rozental, a distinguished Mexican former diplomat: he is president of the Mexican Council on Foreign Relations, whose website reveals Mittal Steel as a leading benefactor. The third member, Muni Krishna T. Reddy, is a director of Intercommercial Bank of Trinidad, of which Mr Mittal is a part-owner. So whatever the box-ticking position on independence, Mittal Steel is open to the accusation of cronyism in the boardroom.

Where conflicts of interest are concerned, the company's board rules offer detailed definitions, reporting requirements and processes. But in many circumstances falling outside legal and regulatory requirements the chairman has wide discretion to decide whether a potential conflict of interest is indeed a conflict and whether it should be published in the annual report. Where a potential conflict involves the chairman, the board is required to discuss the issue without him present. Here the questions about the independence of the non-executives could be a matter of concern, especially in relation to Mr Mittal's ability to run private businesses in competition with Mittal Steel.

When Mr Mittal put together his public and private steel interests in the merger that created Mittal Steel in 2004 he entered into a non-competition agreement with Mittal Steel, whereby he could not run private steel interests in competition with the quoted company without the consent of the audit committee. According to the Form 20F SEC filing, this runs out on June 30 2007. Asked whether the agreement would be extended, a Mittal spokesperson merely stated that "non-competition is also part of article 3.4 of our management board rules which clearly stipulate the principle of noncompetition by a director of the company".

The article in question is much less detailed in defining what constitutes competition than the legal agreement entered into in 2004 and makes no reference to audit committee consent. Whether this amounts to a weakening of the constraint, though, is moot, given the business and financial connections of the directors on the audit committee with Mr Mittal. But the issue of noncompetition does matter, since Mr Mittal was criticised over potential conflicts at a time before their merger when his quoted interests were significantly underperforming his private interests.

Mittal Steel says it has no plans for further changes to corporate governance apart from those already announced, which include expanding the board to include a majority of independent directors.

If the new directors are genuinely independent and competent, that will be something. But for shareholders in Arcelor, currently preoccupied with their own board's shortcomings, the next question will be whether Mr Mittal's remarkable business record, and the strategy he outlines in the forthcoming bid documents, outweigh the risks in a questionable governance structure.

Question:

1.Assess the post-merger board structure and discuss the pros and cons before reading the Financial Times article.

2.Since the Mittal family retain 43.5% of the voting equity can an institutional investor make a significant contribution to the governance of the company?

3.Discuss the positive and negative impacts on the effectiveness of the (pre-merger) Mittal Steel board after reading the article and compare its effectiveness with the post-merger board.