Model of corporate Governance
Learning outcomes
In which we consider:
- How context and culture affect corporate Governance
- The American rules-based model
- The UK/Commonwealth principles-based model
- The continental European two-tier model
- The Japanese business network model
- The Asian family-based model
- Corporate governance convergence of differentiation?
- Institutions necessary for successful corporate governance
How context and culture affect corporate governance
In chapter2, we compared unitary boards and two-tier boards, and in the last chapter we saw conceptually different approaches to corporate governance between the legalistic, rules-based, and the discretionary, principle-based. In this chapter, we widen our search for the basic underlying models of corporate governance around the world. Five broad classifications are identified: the American rules-based model; the United Kingdom/ commonwealth principles-based model; the continental European two-tier model; the Japanese stakeholder-oriented network model; and consider whether corporate governance systems around the world are covering, as some suggest. We will explore corporate governance in the Islamic countries, the chaebol in South Korea, and the BRIC nation-Brazil, Russia, India and China – in a later chapter.
Two primary influences can be suggested for the basic difference in corporate governance around the world: context and culture. Looking first at the context in which corporate governance is practiced, we review the implications of different patterns of ownership, alternative markets for corporate control, and different ways of financing corporate entities. Then we will look at cultural influences on corporate governance.
Pattern of ownership
Ownership in listed companies around the world varies, from the highly disperse to the singularly concentrated table 6.1 shows. country by country, the proportion of voting shares held by individuals, institutional investors, banks and government, holding companies, and overseas investors.
Notice how, in the United States, individuals and institutional investors together account for 92% of the shareholdings and in the UK 77%, whereas in France it is only 35%. In fact, the dispersed ownership found in UK and US companies is the exception rather than the norm around the world. The foreign investors in countries such as the Netherlands (41%) or France (37%) may be an overseas parent company, or the holdings may be dispersed among overseas shareholders. In Germany, Japan, and the Netherlands many listed companies are held within corporates groups and their boards find themselves responsible to a holding company.
In a company in which the voting shareholders are highly differentiated -that is, where the shares are held by many dispersed external shareholders as in the US and the UK – the directors need to respond their varied expectations, while recognizing that shareholders can occasionally act together. On the other hand, where there is a dominant owner, with the other shareholders being in a minority, the directors need to respond to the expectations of that dominant shareholder. Examples include a listed company that is nevertheless part of a corporate group, a company with a dominant shareholder such as a government or financial institution, or cases in which there is a block of connected shareholders.
Obviously, in the longer term, the pattern of ownership fundamentally affects the ability of a board to exercise power over a company. In a company that has a widespread of shareholders, a board will have more freedom to act on its own initiative than in one the shares of which parties have the potential to influence their decisions. Unfortunately, some commentators on corporate governance fail to make this distinction.
Markets for corporate control
In countries with a high proportion of external investors, as in the United States and the United Kingdom. A board can be faced with a hospital takeover bid and a consequential loss of its control. In the other words, the markets for corporate control is strong. Merger and acquisition activity is likely to be widespread. In countries with a relatively low proportion of external investors, the market for corporate control will be weaker, and merger and acquisition activity less. Hostile takeover bids in British companies have been commonplace for over fifty years: the first contested takeover bid for a German company occurred in the 1990s.
Financial corporate entities
In countries where equity markets are relatively large, with high liquidity and significant turnover, shareholdings are often widely spread. So, as we have already seen, boards can wield significant power over companies, even though ultimate power lies with the voting shareholders. In other countries, however, where stock markets are relatively small. Listed companies may rely on non-equity loan capital. In companies that have leveraged their equity capital, with a high loan to equity gearing, ultimate power over the company may be in the hands of the lender through the terms of the loan agreement.
Culture influences on corporate governance
Intuitively. Board-level behavior differs from culture to culture. Later in this chapter we will see how, around the world, board relationships and activities vary, directors' expectations differ, and individual directors behave differently. So apparently, corporate governance has a cultural component. Not everyone agrees. David Webb, a Western commentator based in Hong Kong, has written:
People who defend bad corporate governance on the grounds of Asian values or some cultural difference are talking nonsense. Yes, there is a different structure of ownership; it's somewhat Victorian in that most companies (in Asia) are family-controllers, but had I been around in Victorian times in England I think I would have seen similar bad corporate governance.
The position taken in this book is that cultural differences do exist and that, while they should not be used to defend poor governance practices, failure to appreciate their significance is short-sighted. We will now review the context and culture of corporate governance using the five basic models mentioned in the first paragraph.
The American rules-based model
As we was in the last chapter, in the early days of corporate governance thinking experts tended to write about the Anglo-American (or Anglo-Saxon) unitary board model of corporate governance contrasted with the continental two-tier board model. Indeed, many expected a convergence of corporate governance practices towards the Anglo-American model, but, as we also saw, some fundamental differences have appeared between the US rules-based and the United Kingdom/Commonwealth principles-based models. So we need to explore each model separately.
The American model reflects corporate governance practices throughout the United States and in other counties influenced by the US. As we have seen, companies in the US are incorporated in individual states and are subject to those states' company law and corporate regulation. Investor protection, auditing requirements, and financial disclosure of public companies, however, are federal responsibilities, predominantly overseen by the US Securities and Exchange Commission (SEC). Company law is based on common law, which is rooted in legislation that evolves with a continually growing body of case law at both the federal and the state levels.
The basic governance model in the United States is the unitary board, with a predominance of independent outside directors. The SEC and stock exchange listing requirements also call for mandatory board audit, nomination, and remuneration committees. In the United States, Shareholders have little influence on board membership, other than expressing dissatisfaction by not voting, selling their shares, or resorting to litigation.
Similarly, whereas in the United Kingdom/Commonwealth model the roles of the board chairman and the chief executive officer are separated, in the United States they are often held by the same person, although there have been some calls for separation, as we saw in Case study 3.3 in chapter 3. The board of Exxon Mobil has resisted a strong bid from shareholders in recent years to split the roles of chairman and chief executive – but, even if passed by a majority of shareholders voting, the decision would not be binding on the board. Interestingly, in the now infamous case of the failed company Enron (see Appendix 2), the roles of chairman of the board and CEO were separated.
In the United States, governance is regulated by legal statute and mandatory rules, which are inherently inflexible. Litigation levels are high. Directors face legal penalties for noncompliance. The 2002 Sarbanes-Oxley Act strengthened this emphasis on governance under penalty of law, with disclosure requirements that proved more expensive and burdensome than expected. The role of the regulators is to ensure that the rules are being obeyed. The American financial markets are the largest and most liquid in the world, but their lead, particularly in initial public offering (IPOs), has been eroded.
Generally Accepted Accounting Principles (GAAP) in America call for compliance with the rules. There are signs that the US is moving towards international standards (the SEC recently dropped its requirement for foreign companies listed in the US to reconcile their international standard accounts with GAAP accounts). But progress may be slow.
The UK/Commonwealth principles-based model
The law that recognized the incorporation of the joint-stock, shareholder limited-liability Company originated in the United Kingdom in the mid-19th century, as we saw in chapter 1. Purists might argue that France can claim a slightly earlier form of legal incorporation, but that only granted limited liability to investors who were not involved in managing the company. Membership of the old British Empire, in the later 19th and early 20th centuries, meant that UK company law influenced the development of company law in Australia, Canada, India, New Zealand, South Africa, Singapore, and indeed throughout what is now known as the Commonwealth.
As in the American model, company law in the UK/commonwealth model is based on common law, rooted in legislation extended by case law, but, by contrast with the American model, in the United Kingdom and in Commonwealth countries, corporate governance is "principles-based". Codes of corporate governance principle or good practice determine board responsibilities, not the rule of law. Companies are required to report that they have not followed the governance principles laid down in the codes or to explain why they have not. Consequently, this model is often referred to as the "comply or explain" approach to corporate governance. Self-regulation is the underlying theme. Compliance is voluntary with the sanctions being the exposure of corporate governance failings to the market and, ultimately, delisting from the stock exchange. The role of the regulators is to ensure that investors and potential investors have accurate information on which to base their judgments.
Through the commonwealth, corporate governance codes for listed companies, although differing slightly in detail. All call for independent non-executive or outside directors, audit, remuneration, and nomination committees, and high levels of transparency and accountability. The codes also call for a separation between chairman and CEO.
The principle-based versus the rules-based view of governance is also reflected in accounting standards. The UK/Commonwealth countries apply standards that are predominantly based on international accounting standards, which emphasize compliance with principle.
In the United Kingdom, unlike the United States, shareholders with 10% of the voting rights in a public company can force an extraordinary meeting and vote on strategic decisions or the removal of a director. Even though that seldom occurs, the possibility can affect board actions.
Case study 6.1 Lehman Brothers Inc.
Before the global financial crisis. Which began in 2007, Lehman Brothers was a fabled New York-based brokerage firm and investment bank. Founded 157 years earlier, it had survived the major economic depressions of the 19th and 20th centuries, and two world wars. By 2007, it was the fourth largest investment bank in the United States: only Goldman Sachs, Morgan Stanley, and Merrill Lynch were bigger. But that was not to last much longer.
The Lehman Brothers' board was dominated by Richard S. Fuld Jr, who served as chairman of the board, chairman of the company's executive committee and chief executive officer. Early in 2008, the company's stock was trading at US $65. By October 2008, it had sunk to US $ 3.65, following the company's filing for bankruptcy in September 2008. The Federal Reserve refused to provide funds, as it did with other banks, as mentioned in Chapter 1.
The problems had begun to appear earlier in the year: dramatic losses on sub-prime mortgage, devaluation of the company's credit rating by the rating agencies, and the loss of clients. In June 2008, the company announced a US $ 2.8 Billion loss for the second quarter, and the stock dropped to its lowest.
Level for eight years. Yet the board seemed unable to grasp the depth of the problems facing the company; there was no investigation by the independent directors, no special study by the board's finance and risk committee, no call for a capital infusion, although it was apparent that one was needed.
The board of Lehman Brothers Inc. had ten independent directors, half aged over 70, with two in their 80s. The executive committee consisted of Fuld, the COO, the CFO, and 80-year-old independent director, John D. Macomber. The board's finance and risk committee was chaired by 80-year-old Henny Kaufman, although this committee met only twice in the financial year 2007-08, despite the growing global financial crisis.
Why were the directors apparently blind to the reality of risk that the bank was facing? Where were the auditors? Why was the investigative media ignored? Could the culture of the board have encouraged delusions of invincibility? Was this hubris after 158 successful year?
Fuld did change his top management team: president and COO, Joseph Gregory, and CFO, Erin Callan, were "let go". In June 2008, Fuld announced that he would decline his bonus for that year. He made no offer to return any of the previous five yeasr' compensation, which in total had been more than a billion dollars.
After the collapse of the company, Fuld was summoned before the Committee on Oversight and Government Reform of the US House of Congress. His air of invincibility had gone. Although he accepted personal responsibility, he blamed the circumstances, not himself, saying that:
In the end, despite all our effects, we were overwhelmed … (the) destabilizing factors, rumors, widening credit default swap spreads, naked short-selling, attacks, credit agency downgrades, a loss of confidence by clients and counterparties, and strategic buyers sitting on the sidelines waiting for an assisted deal- these were all part of Lehman's story.
He added that this had been a familiar table for many other financial institutions at the time, but that they had been bailed out by the government.
The company had not been immune from regulatory challenge previously. In 2003, the US Securities and Exchange Commission (SEC) settled charges against Lehman Brothers that had arisen when Lehman's research analysts gave supposedly independent investment advice on companies in which Lehman had an interest. Along with nine other brokerage firms, Lehman reached a settlement with the SEC, the New York Stock Exchange, the New York Attorney General, and other state regulators; Lehman agreed to pay US $ 50 million to settle the conflicts of interest case; one half to state regulators; the other half into a fund for the benefit of customers. In addition, Lehman paid US $ 25 million over five years to provide the firm's client with independent research, and US $5 million for investor education.
In March 2010, an examiner appointed by the Bankruptcy Court reported questionable activities in 2007-08, claiming that Lehman had used period-end repurchase agreements, which temporarily removed securities from the balance sheet, showing them as sales to improve its financial standing.
Following the collapse, the British Barclays Bank attempted to buy the company, but was prevented Australia, Asia-Pacific, European, and Middle East businesses.
Discussion question
- The case claims that Lehman Brothers was dominated by Richards S. Fuld Jr. was this desirable? What steps could have been taken to avoid it? Who could have initiated these steps?
- The case highlights Lehman's elderly directors.
- Dose the age of directors matter?
- Is it possible for the research analysts of a financial institution to give independent investment advice to clients about a company when the financial institution has an interest in that company?
The continental European two-tier model
Company law in continental European countries is typically rules-based. In France, for example, it is based on Napoleonic law, in which required corporate behavior is determined by legally binding rules and evolves by further legislation, not by the precedents of case-based common law. In these European countries, finance markets tend to be smaller and less liquid. The market for corporate control is weak. Bank and loan finance is widely used to fund companies, and banks wield more influence on corporate affairs, particularly in Germany. Investors tend to be more concentrated, often with dominant family shareholdings, particularly in France and Italy. As we will explore later, gearing chains of companies are sometimes used to leverage controlling shareholders'' investment, particularly in Italy.
Two-tier boards, explained in chapter2, are required in Germany and Holland and are found in France and Italy. Moreover, in line with the social contrast found in many European societies, corporate governance practices frequently have a social component. For example, the co-determination rules in Germany require one half of the supervisory board to represent labor, with employee representative directors elected through the trades unions; the other half is to represent capital, elected by the shareholders. Many countries in the European Union also require works councils in which representative of the employees wield power. The European company (the Societas Europaea), enacted under the rules of the European Union, provides for either Anglo-American or continental European approaches. But, despite the political orientation of many European centuries towards social democracy European firms have nevertheless lent towards strategies based on the maximization of shareholder value.
Critics of the continental European model of corporate governance argue that the management board is often dominated by top management and lacks the information inputs, advice, and wise counsel that can be provided by unitary boards outside independent nonexecutive directors. Other critics question the effectiveness of supervisory boards, their lack of real power, and their ability effectively to control the management board. Others argue that the representative character of the supervisory board provides the potential for conflict of interest.
There was a time when counters that employed the two-tier board believed that this was a superior model to the unitary board. Indeed, at one time, the European Union tried to impose the two-tier model on all companies in member states – a proposal strongly resisted in the unitary board countries. Today, the limitations of each model are more widely recognized.
The Japanese business network model
Keiretsu are networks of companies Japan connected through cross-holdings and with interlocking directorships. Member companies tend to inter-trade extensively. Frequently, the network includes a financial institution. The classical model of the Keiretsu reflects the social cohesion within Japanese society, emphasizing unity throughout the organization, non-adversarial relationships, lifetime employment, enterprise unions, personnel policies encouraging commitment, initiation into the corporate family, decision-making by consensus, cross-functional training and promotion based on loyalty and social compatibility as well as performance. This model is currently under pressure, as we will see, but fist let us review this traditional approach to corporate governance in Japan.
In the classical Keiretsu model, boards of directors tend to be large and are, in effect, the top layers of the management pyramid. People speak of being "promoted to the board". The tendency for managers to progress through an organization in tenure rather than performance means that the mediocre can reach board level. A few of the directors might have served with other companies in the Keiretsu network, and in that sense might be able to represent the interests of suppliers or down-stream agents; others might have been appointed to the company's ranks in retirement from the Keiretsu's bankers, or even from among the industry's government regulators (known as a amakaduri, or "descent from heaven").
But independent non-executive directors, in the Western sense, would be unusual, although the proportion in increasing. Many Japanese do not see the need for such intervention from the outside. Indeed, they have difficulty in understanding how outside directors operate. How can outsiders possibly know enough about the company to make a contribution, they question, when the other directors have spent their lives working for the company? How can an outsider be the corporate culture? He or she might even damage the harmony of the group. A study by the Japanese Independent Directors Network, in November 2010, showed that of all the companies on the Nikkei 500 index, outside directors made up 13.5 % of the board, women 0.9%, and mom-Japanese 0.17%.
The Japanese ringi approach to communication encourages dialogue up and down the management hierarchy, leading, over time, to an agreed position. This meaning that boards tend to be decision-ratifying bodies rather than decision-initiating and decision-taking forums, as in the West. Indeed, in some companies, meeting of the entire board tend to be ceremonial, with honorable titles used in social occasions, although that aspect of society is in transition.
Chairman and senior directors of companies in the Keiretsu meet regularly and have close, informal relationships. Meetings of the meaning directors with the directors in their teams are also crucial, as are the informal relationships between the top echelons of the board. Ultimate power lies with the top managers, particularly the president and the chairman.
The Japanese Commercial Code calls for "representative directors" to be elected by the board. Whereas, from a Western viewpoint, these might be expected to represent the interests of various stakeholders in the firm, their actual role is to represent the company in its dealings with outside parties such as the government, banks, and other companies in the industry. Typically, the representative directors include the chairman and president and other top directors. The Code also calls for the appointment of individuals as full-time statutory auditors. They report to the board on any financial problems or infringements of the company code or the company articles. They can call for information from other directors and company employees, and can convene special meetings of the board. These internal board-level auditors, of course, liaise with the external professional auditors.
Japanese company law dose provide for independent outside directors, where they exist, to form a separate committee outside the board. Although the basic governance model is of a unitary board, this committee could be seen as a form of supervisory board. Recently, some independent outside directors have appointed, usually under pressure from international investor.
Traditionally, investors have played a relatively small part in corporate affairs. The classical model of Japanese corporate governance had a stakeholder, not a shareholder, orientation. Power lay within the Keiretsu network. There was no market for corporate control since hostile takeover bids were virtually unknown.
However, in the past decade, the extent of cross-holdings of shares between companies has fallen and, in 2007, the first apparently hostile takeover in the Tokyo Stoke Exchange was reported. The Japanese Pension Fund Association, which has 29 million members and over US $100 billion in assets, has tried to put pressure on boards by calling for a return on equity of at least 8%. But the effect has been marginal to date.
With the Japanese economy facing stagnation in the 1990s, traditional approaches to corporate governance were questioned. A corporate governance debate developed and the bank-based, stakeholder-oriented, rather than shareholder, corporate governance model came under scrutiny. The poorly performing economy had weakened many of the banks at the heart of Keiretsu. Globalization of markets and finance put further pressure on companies. The paternalistic relationship between company and lifetime "salary-man" slowly began to crumble. Some companies came under pressure from instructional investors abroad. Company laws were then redrafted to permit a more US style of corporate governance. But few firms have yet embraced them. More emphasis has, however, been placed on shareholders, with board restructuring and directors receiving performance incentives. Some companies experimented with alternative, hybrid forms of governance structure. Consequently, there is now more diversity in the approaches to corporate governance in Japan, although changes tend to be gradual and incremental. But some have predicted moves towards the US or UK/commonwealth model, as Japan responds to the pressures of the globalization of business and finance.
Signs of movement include calls in 2008 by eight international investment funds for greater shareholder democracy, and a report from the Japanese Council for Economic and Fiscal Policy to the Japanese Prime Minister proposing that anti-takeover defenses be discouraged and the takeover of Japanese firms be made easier.
Recognizing the importance of corporate governance to the long-term development of Asian economies and capital markets, the Asian Corporate Governance Association (ACGA) was founded in 1999 as an independent, non-profit membership organization dedicated to working with investors, companies, and regulators in the implementation of effective corporate governance practices throughout Asia. A 2008 report the ACGA provide a critique of corporate governance in Japan:
We believe that sound corporate governance is essential to the creation of a more internationally competitive corporate sector in Japan and to the longer-term growth of the Japanese economy and its capital markets. While a number of leading companies in Japan have made strides in corporate governance in recent years, we submit that the system of governance in most listed companies is not meeting the needs of stakeholders or the nation at in three ways:
- By not providing for adequate supervision of corporate strategy
- By protecting management from the discipline of the market, thus rendering the development of a healthy and efficient market in corporate control all but impossible.
- By failing to provide the returns that are vitally necessary to protect Japan's social safety net – its pension system
Case study 6.3 Tokyo Electric Power and the disaster at Fukushima Daiichi
In an unlikely outburst, Naoto Kan, Japanese Prime Minister, Shouted "what the hell is going on?" to executives of the Tokyo Electric Power Company (TEPCO) following Japan's worst nuclear crisis at the Fukushima Daiichi nuclear power plant, after the tsunami and earthquake on 11 March 2011. Were the directors or the corporate governance systems and procedures at fault?
The company appeared to have a commitment to sound corporate governance. As it stated on its website:
At TEPCO, we have developed corporate governance policies and practices as one of the primary management issues for ensuring sustainable growth in our business and long-term shareholder value. We believe in strengthening mutual trust through interactive communication with our valued stakeholders, including shareholders and investors, customers, local communities, suppliers, employees and the public, so we can move forward solid future growth and development. Therefore, TEPCO considers enhancing corporate governance a critical task for management and is working to develop organizational structures and policies for legal ethical compliance, appropriate and promote decision-making effective and efficient business practices and supervisory functions.
The TEPCO website explains the company's corporate governance processes:
The Board of Directors currently comprises 20 directors, including 2 outside directors. Also, TEPCO has 7 auditors, including 4 outside auditors. The Board of Directors generally meets once a month and holds additional special meetings as necessary. Based on interactive discussion with objective outside directors, the Board establishes the promotes TEPCO's business and overseas its directors' performance TEPCO has also established the Board of Managing Directors, which meets once a week in principle, and other formal bodies to implement efficient corporate management through appropriate and rapid decision-making on key management issues, including those deliberated by the Board of Directors. In particular, we have established internal committees to deliberate, adjust and plan the direction of the whole Company across a range of key management concerns, including internal control, CSR and system security as well as stable electricity supply.
For more appropriate and quicker decision-making TEPCO also has the managing Directors Meeting generally held once a week and other formal bodies to implement key corporate management issues efficiently, including those to be discussed by the Board of Directors. In particular, the Board has inter-organizational committee such as the internal Control Committee, CSR Committee, System Security Measures Committee, and Supply and Demand Measures Conference to discuss directions of key management issues intensively across the entire company.
But behind the reassuring corporate governance explanations on the TEPCO website lay a different reality. The company's opaque handling of the situation at the stricken plant was widely criticized. The extent of the danger was minimized and the full extent of the damage only gradually became apparent, as the risk severity level was gradually increased to rank alongside Chernobyl as a most severe nuclear accident.
The company's handling of the incident exposed failings in its risk management systems. The company had history of safety violations: in 2002, it had falsified safety test records, and in 2007, following an earthquake, its Niigata nuclear plant had a fire and a lead of radioactive water, which were concealed.
In fact, the board was dominated by inside directors, qualified by their seniority within the company. Out of the 20 directors, 18 were insiders, while of the nominally outside directors, one of them, Tomijirou Morita, was chairman of Dai-Ichi Life Insurance, which was connected financially with TEPCO. In 2008, Tsunehisa Katsumata, the company president at the time of the 2007 problem, was elevated to chairman, being replaced by Masataka Shimizu, another careers-long TEPCO.
The company held its AGM on 23 June 2011 and faced withering criticism from shareholders. The president Masataka Shimizu apologized for the 1.25 trillion yen (US $ 15 billion) loss. But a motion to cease generating nuclear power was defeated with the support of institutional investors.
Also in June 2011, the Japanese government appointed a five-man team to look into the company's finances. This committee was forced on the TEPCO board as a condition of financial support from the government to compensate those affected by the crisis at the Fukushima plant.
Discussion question
- Did the structure of the board contribute to the failures?
- How do you account for the discrepancies between the company's alleged concern for corporate governance on its website and the catastrophic failure?
- What advice would you give to the chairman of TEPCO?
The Asian family-based model
"Overseas Chinese" is the term used to describe Chinese business people who, over the users, as a result of the Chinese diaspora from the mainland, now play a functional part in the business life of South East Asia. Many companies in the significant Asian economies – Singapore, Taiwan, Malaysia, Thailand, Indonesia, Hong Kong, and the Philippines – are in the hands of Chinese families. For example, nearly half of the share capital invested in Malaysian companies is owned by Chinese residents and a quarter by foreign-controlled companies. Fewer than twenty families control the companies that dominate the local stock market foe Honk Kong Chinese companies.
In the governance of overseas Chinese companies, the board tends to play a supportive role to the real exercise of power, which is exercised through relationships between the key players, particularly between the dominant head of the family and other family members in key top management positions. Some of these companies are quite diverse groups with considerable delegation of power to the subsidiary unit, but with the owner-manager, or a family-oriented small group, still holding a strategic hand on the tiller.
Research into the management of overseas Chinese companies has suggested some distinguishing characteristic, which may help to interpret the evidence on governance practices. These studies suggest that overseas Chinese firms are:
- Family-centric with close family control;
- Controlled through an equity stake kept within the family;
- Entrepreneurial, often with a dominant entrepreneur, so that decision-making is centralized, with close personal links emphasizing trust and control;
- Paternalistic in management style, in a social fabric dependent on relationship and social harmony, avoiding confrontation and the risk of the loss of "face";
- Strategically intuitive, with the business seen as more of a succession of contrasts or ventures, relying on intuition, superstition, and tough-minded bargaining rather that strategic plans, brand-creation, and quantitative analysis.
With outside shareholders in the minority, the regulatory authorities tend to emphasize the importance of disclosure and the control of related-party transactions. Although many corporate governance codes require independent non-executive directors, the independence of outside directors is less important to the owner that their character, trustworthiness, and over-all business ability. Of course, corporate governance problems exist in chines and overseas Chinese companies: corruption, insider trading, unfair treatment of minority shareholders, and domination by company leaders, to name a few. But these are unfortunate attributes of corporate governance that reflect human behavior everywhere.
Corporate governance: convergence or differentiation?
Are corporate governance practices around the world converging? This is a question that is often posed by corporate governance practitioners and frequently answered in the affirmative. Certainly, there are many forces that could lead towards convergence, as the following factors show.
Forces for convergence
Corporate governance codes of good practice around the world have a striking similarly, which is not surprising giving the way in which they have been influenced by each other. Although different in detail, all emphasize the importance of independence, transparency, and accountability. The codes published by international bodies, such as the world back, the Commonwealth of Nations, and the OECD, clearly encourage convergence. The corporate governance policies and practices of major corporations operating around the world can also be global influences.
Securities regulations for the world's listed companies are certainly converging. The International Organization of Securities Commissions (IOSCO), which now has the bulk of the world's securities regulatory bodies in membership, encourages convergence. For example, its members have agreed to exchange information on unusual trades, thus making the activates of global insider trading more hazardous.
International accounting standards are also leading towards convergence. The International Accounting Standards Committee (IASC) and the International Auditing Practices Committee (IPAC) have close links with IOSCO, and are further forces working towards international harmonization and standardization of financial reporting and auditing standards. US General Accepted Accounting Principles (GAAP), although some way from harmonization, are clearly moving in that direction.
In 2007, the US Securities and Exchange Commission announced that US companies could adopt international accounting standards in lieu of US GAAPs. However, American accountants and regulators are accustomed to a rules-based regime and international standards are principles-based, requiring judgement rather than adherence to prescriptive regulations.
Global concentration of audit practice into just four firms, since the demise of Arthur Andersen, encourages convergence. Major corporations in most countries, wanting to have the name of one of the four principle firms on their audit reports, are then inevitably locked into that firm's worldwide audit, risk analysis, and other governance practices.
Globalization of companies is also, obviously, a force for convergence. Firms that are truly global in strategic outlook, with production, service provision, added-value chain, markets and customers worldwide, calling on international sources of finance, and the shares of which are held around the world, are moving towards common effective, transparent, and accountable governance practices. Unfortunately, the composition of the boards of the parent companies of such groups seldom reflects such globalization, because they are still dominated by nationals of the country of incorporation. However, the proportion of "foreign" directors – that is, not nationals of the home country – although small, has been increasing. Companies such as Arcelor incorporated in Belgium, Novartis in Switzerland, Cable and Wireless in the UK, and ABN Amro in the Netherlands do have a significant proportion of directors who are not from the "home country", significantly, no companies incorporated in the United States figure in this list.
Raising capital an overseas stock exchanges, clearly, encourages convergence as listing as listing companies are required to conform to the listing rules of that market. Although the governance requirements of stock exchanges around the world differ in detail, they are moving towards internationally accepted norms through IOSCO, as we saw above.
International institutional investors, such as Calpers, explicitly demand various corporate governance practices if they are to invest in a specific country or company. Institutional investors with an international portfolio have been an important force for convergence, of course, as developing and transitional countries grow, generate and plough back their own funds, the call for inward investment will decline, along with the influence of the overseas institution.
Private equity funding is changing the investment scene. Owners of significant private companies may decide not to list in the first place. Major investor in public companies may find an incentive to privatize. Overall, the existence of private equity funds challenges boards of listed companies by sharpening the market for corporate control. As the power of private equity grows, expect calls for more transparency, accountability, and control.
Cross-border mergers of stock markets could also have an impact on country-centric investment dealing and could influence corporate governance expectations, as could the development of electronic trading in stocks by promoting international securities trading.
Research publications, international conferences, and professional journals can also be significant contributors to the convergence of corporate governance thinking and practice.
Forces for differentiation
However, despite all of these force pushing towards convergence, there are others that, if not direct factors for divergence, at least cause differentiation between countries, jurisdictions, and markets.
Legal differences in company law, contract law, and bankruptcy law between jurisdictions affect corporate governance practices. Differences between the case law traditions of the US, UK, and commonwealth countries, and the codified law of continental Europe, Japan, and China distinguish corporate governance outcomes, as we have seen.
Standards n legal process, too, can differ. Some countries have weak judicial systems. Their courts may have limited powers and be unreliable. Not all judiciaries are separate from the legislature. The state or political activities can be involved in jurisprudence. In some countries, bringing a company law case can be difficult and, even with a favorable judgment, obtaining satisfaction can be well-nigh impossible.
Stock market differences in market capitalization, liquidity, and markets for corporate control affect governance practices, as we saw earlier. Obviously, financial markets vary significantly in their scale and sophistication, affecting their governance influence.
Ownership structures also vary between countries. Some countries have predominantly family-based firms; other have external investors, but the proportion of individual investors compared with industrial investors differ; while some adopt complex networked, chained, or pyramid structures.
History, culture, and ethnic groupings have produced different board structures and governance practices, as we have also seen. Contrasts between corporate governance in Japan with her Keiretsu, continental European countries with the two-tier board structures and worker co-determination, and the family domination of overseas Chinese, even in listed companies, in countries throughout the Far East emphasizes the differences. Views differ on ownership tights and the basis of shareholders power.
The concept of the company was Western, rooted in the notion of shareholder democracy, the stewardship of directors, and trust – the belief that directors recognize a fiduciary duty to their companies. But today's corporate structures have outgrown that simple notion. The corporate concept is now rooted in law, and the legitimacy of the corporate entity rests on regulation and litigation. The Western world has created the most expensive and litigious corporate regulatory regime the world has yet seen. This is not the only approach – and certainly not necessarily the best. The Asian reliance on relationships and trust in governing the enterprise may be closer to the original concept. There is need to rethink the underlying idea of the corporation, contingent with the reality of power that can (or could) be wielded. Such a concept would need to be built on a pluralistic, rather than an ethnocentric, foundation if it is to be applicable to the corporate groups and strategic alliance networks that are now emerging as the basis of the business world of the future.
Case study 6.4 Tyco
Dennis Kozlowski became chief executive of Tyco in 1992. Treating the company as a private fiefdom, he siphoned off some hundreds of million in private expenditure, including an infamous gold-and-burgundy shower curtain, allegedly costing $ 6000 and a lavish US $ 2 million toga party on a Mediterranean island for his wife's birthday. His compliant board gave Kozlowski a contract saying that he would not be dismissed if convicted of a felony, unless it directly damaged the company. Subsequently it transpired that he had also authorized funding of US $ 4 million to support a chair in corporate governance at Cambridge University. He claimed that this was jointly funded by the company and himself. Some irate Tyco shareholders, hoping to retrieve some of their squandered funds, tried to recover these university funds. But the powers behind the chair of corporate governance insisted that they would hang on to the cash: no matter how tainted by corporate excess it might 2005, Kozlowski was fined US $ 70 million and jailed for up to 25 years.
Discussion question
What should a board do to ensure that a CEO dose not treat the company as a private fiefdom?
Consider that the CEO probably played a major part in the appointment of the other directors, and that resignation from the board may have little effect on the CEO's behavior.
Institutions necessary for successful corporate governance
Having seen some of the different ways in which countries and cultures apply corporate governance, we van now identify the institutional arrangements that are needed to support successful governance. There include:
- A reliable legal system including an independent judiciary, courts that are bias-and corruption-free, and judgements that are enforceable, free of state or other political pressures;
- A stoke market with liquidity, international standing, and institutional investor;
- Financial institutions, including brokers, sponsors for new issues, and financial advisers;
- Regulatory authorities, including securities and futures market regulators;
- A companies registry that facilities comprehensive disclosure, with high levels of transparency;
- Accounting and legal professions that are internationally respected, and able to discipline their members, and to ensure compliance with accounting standards and legal requirements;
- Auditing firms that are professional, reliable, and independent of their clients;
- Professional organizations, such as director and company secretary qualifying and disciplining bodies;
- Educational institutions able to educate and train for relevant qualifications;
- Consulting organizations able to advise companies and directors;
- Financial and corporate governance training, plus continuous professional development;
- Corporate governance research reported in academic and professional publications.
Obliviously, in many countries, particularly those with emergent economies, not all of these institutions yet exist and, where they do, they are still in the process of being developed. Moreover, even in this countries recognized as having relatively high standards of corporate governance, there are opportunities for further development and improvement. However, taking a longitudinal view, it is interesting to see just how far many countries have come in developing their corporate governance influence infrastructure in a relatively few years.
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