Corporate governance systems worldwide.

Discuss the view that the corporate governance systems worldwide are inevitably converging towards a model based on shareholder primacy and dispersed ownership.

The past decade has seen a rapid development in corporate governance systems worldwide. The result of disastrous corporate scandals has been hitting effective corporate governance systems worldwide, from Anglo-Saxon countries like USA and UK to continental Europe. However recent debates have sparked surrounding the subject of global convergence of corporate governance systems. Commentators are questioning global convergence of corporate governance systems and whether it is taking place all around the world. If it is taking place then how does the process take place? Where is the evidence and whether it is useful to have a unified corporate governance system in all countries. This paper sets out to answer some of these issues. There is evidence to support the view that corporate governance systems worldwide are inevitably converging towards a model based on shareholder primacy and dispersed ownership. However, this paper seeks to establish the evidence in support of this argument and whether it is true. There are bound to be determining factors in specific countries where the presence of convergence is felt. This paper will start by analysing the presence of global convergence of corporate governance systems towards shareholder primacy and dispersed ownership by comparing the regulatory frameworks in Anglo-Saxon countries to continental Europe, which are not based on dispersed ownership. Secondly, it will go on to examine the changes in shareholder structures, cross border activity and complimentary regulation of Germany to establish whether convergence is or has taken place towards the Anglo-Saxon dispersed ownership model. The paper will finally attempt to analyse how this convergence took place and whether it is a sustainable process. During this analysis this paper will also establish the discrepancies of the shareholder/dispersed ownerships model, which may cause disturbances in sustaining this global convergence.

Theoretical Debate around Convergence

There are a number of different types of corporate governance systems. They differ from each other through a number of criteria including dispersal of ownership, stakeholder involvement and political theory. The changes, or barriers that these criteria create, illustrates the transition of corporate governance systems. La Porta etal (LLSV)[1] argue that the legal origins of the particular country determine the corporate governance systems. The basis of their theory is that corporate governance is a mechanism through which outside investors protect themselves from expropriation. If a legal system allows expropriation of minority shareholders by controlling shareholders and managers then minority ownership disappears or is unenforceable due to lack of rights. State investor protection determines the state of financial markets, patterns of ownership, control and economic growth. Researchers like Goergen[2] argue that the shareholder model may be superior according to LLSV theory. However there is lack of evidence to support this. Some evidence suggests that individual corporate governance devices are divided on policy and control. Both the stakeholder and shareholder-based systems have their own advantages and disadvantages, and therefore should not be studied in isolation. These researchers provide a basis for establishing how and why this transition of diverse corporate governance systems takes place. Herrigel[3] argued that the systems of corporate governance are based on the balance of power between shareholders and managers under two typical property systems, concentrated ownership and dispersed ownership. The system of corporate property in each country is based on broad social, institutional and power arrangements i.e. financial systems (banks), governance role of shareholders versus stakeholders and the political government of economy (is it state driven or market driven?). Herrigel illustrated a historical transition in the USA and stated that the liberal economy and dispersed ownership, the current model, was not the only system, because previously there were closely held firms which dominated the economy. These firms gradually transferred to disperse ownership as the securities market became more robust and managerial control overtook family powers. Chandler[4] supported a similar view towards the transition of different corporate governance systems into the dispersed ownership model as he argued that states open markets and political support for competition allows an ideal model to unfold naturally. Roe[5]’s theory of political involvement was backed by Chandler in his research. Once states were able to lift political barriers to open markets and competition, corporations would automatically abandon commitments to families and inter-firm co-operation.

Does this mean that now the Anglo-Saxon model prevails and is the best suited to all countries around the world? Proponents of convergence Hansmann and Kraakman[6] state that three principle drivers lead to one converging model of shareholder value. The drivers consisted of a failure of alternative models (manager-oriented, labour oriented, state-oriented, and stakeholder model). Their research identifies that competitive pressures of global markers and the shift to an emerging ‘shareholder’ class is enough proof of convergence towards an Anglo-Saxon model of corporate governance. Their argument is very convincing as most corporations i.e. multinationals, are widely held, with limited liability, delegated management and transferable shares. However, their argument lacks substantial evidence. It is possible to assume corporations have all these Anglo-Saxon characteristics and may even converge through economic pressure, competition or successful examples of the shareholder model. The question is how effective is this convergence? Is it altering legislation or changing political views in countries with strong principles (Germany with Stakeholder view)? Puchniak[7] on the other hand raises a credible argument where he believes ‘the argument for a converging shareholder model is fundamentally flawed and not worth fixing” and fails to determine or include evidence towards convergence. It is agreeable that what Haansmann and Kraakman consider a ‘good corporate governance system’ in itself lacks effectiveness when examining the characteristics. For example a staggered argument by Baird and Rasmussen[8] argue those banks are still more important in the USA. They state that lending agreements are very important and plenty of provisions allow them to become important in corporate governance. They state that banks are more important as a mechanism than takeovers are in replacing non-performing managers. Puchniak’s argument, based on the changing characteristics of Anglo-Saxon corporate governance model in the USA, illustrates that corporate ownership in America has become more concentrated in the USA since the 1990s. However whether his argument holds any standing is yet to be established. Does a change in ownership structure demonstrate an involvement in corporate governance systems over time, or can it be seen as a form of convergence towards a hybrid model? This paper will analyse the underpinning arguments these theorists have presented towards the existence of a common converging corporate governance system.

Evidence Examined

Characteristics of the Anglo-Saxon (Shareholder Dispersed Ownership) Model versus Continental Europe (Stakeholder Concentrated Ownership) Model

The important characteristics of the Anglo-Saxon model differentiate this market-based system from other corporate governance systems. In order to determine whether this is on the increase, it is feasible to determine the main aspects which may illustrate a convergence towards this model in Continental Europe or Asia (Japan). Shleifer and Vishny (1997)[9] state “corporate governance deals with the way in which suppliers of finance to corporations assure themselves of getting a return on their investment”. This is only demonstrated when shareholders as residual owners, delegate day-to-day running of firm to management, forming a separation of ownership and control. The main features of the Anglo-Saxon model consist of dispersal of ownership, priority given to shareholder value, large number of listed corporations and capital markets are the main source of financing which in turn weakens the stakeholders especially banks. Several mechanisms granted to shareholders enhance the shareholder model of this corporate governance system. These mechanisms include various shareholder voting rights, takeover mechanisms and market-based remunerations. Examples include proxy contests and shareholder proposals granted under legislation[10] of Anglo-Saxon countries. Other traditional elements of the shareholder model consist of a strong presence of independent directors to sit on Board committees with stricter independence standards under various legal instruments. For example the Sarbanes-Oxley Act 2002 asking for stricter independence standards for board audit committee members. However how true is it to state, that if priority is given to shareholders and there is greater independence on the board, then this corporate governance system leads to a comfortable market-based system without any flaws. The assumption that the Anglo-Saxon model is a ‘good corporate governance system’ is debatable. There are elements which enhance the effectiveness, but it does not fulfil or solve the agency conflicts inherent within the shareholder model. On the other hand, bank-oriented (concentrated ownership) corporate governance systems are dominant in Continental Europe (Germany). Direct control of banks through equity shares, internal control of regulation, long-term relations with banks and employee participation are some of the characteristics that are completely different to the Anglo-Saxon model.

Is Continental Europe Converging towards Anglo-Saxon Model?

In order to establish convergence one needs to identify changes in the typical characteristics of current corporate governance system in continental Europe. Firstly most of the evidence illustrating global convergence initiates from regulatory changes in countries heading towards a specific structure i.e. the shareholder model with dispersed ownership. The installation of new company law in Continental Europe can be seen as evidence of convergence towards Anglo-Saxon model. For example the Sarbanes-Oxley Act of June 2002 mimicked in the German Law of Transparency and Disclosure 2002. The adoption of common international/regional corporate governance standards[11] illustrate convergence towards the Anglo-Saxon dispersed ownership model, for example the OECD Principles of 2004, which are rules widely accepted and used in conjunction with domestic codes in 29 leading countries, ranging from West to East. Most of the recommendations focus on shareholder protection i.e. shareholder rights[12], proportionality of cash and control[13] and equal treatment of all shareholders.[14] The fact that most of these recommendations are an image of Anglo-Saxon dispersed ownership corporate governance model means it is quite possible to assume that inevitably, regardless of countries wanting to converge towards the stakeholder model, they are in effect being forced to converge towards a shareholder model. This is because international standards are confined to the characteristics of the shareholder/dispersed ownership model. However Baran[15] argues that “ethical codices” which mainly include rules protecting shareholders, transparency of board committees, etc. are of a self-regulatory nature. This determined feature allows them to acquire character of law in common law countries (UK), whereas they lack substantial importance and are only present formally in civil law countries. An example which contradicts this argument is a statement by Viag Chairman[16] Georg Obermeier: “We need international capital markets and therefore we inevitably need to meet international standards” and less social consensus, although it is important, and more value added. Therefore plenty of examples support Obermeier’s statement. For example Deustche Bank[17] and Daimer Benz have introduced stock option schemes for senior management, which is one of the mechanisms used by Anglo-Saxon countries to build strong incentives for management to excel firm performance. Some of these changes in corporate governance systems are a result of growing institutional investors from the US.