Grade: 74 Comment: this is a very good tma1.

You clearly analyse the diverse range of corporate governance structures, and provide a comparison between systems of corporate governance and market developments. You also clearly explain the importance of investor protection in the financial market, considering the difference between dispersed and concentrated ownership. Finally, you present a critical analysis of recent developments in the field of corporate Governance, using a a good range of literature and good examples. Good luck with the rest of the programme.
Formatted: English (U.S.) Formatted: English (U.S.) Formatted: English (U.S.) Formatted: English (U.S.) Formatted: English (U.S.)

Full Name: Labhjeet David Singh Sahota Student Reference Number: 110002527 Module Code: C244 Assignment: TMA01 Word Count: (maximum 2500 words) 2350

..Empirically, strong investor protection is associated with effective corporate governance, as reflected in valuable and broad financial markets, dispersed ownership of shares, and efficient allocation of capital across firms. Using investor protection as the starting point appears to be a more fruitful way to describe differences in corporate governance regimes across countries than some of the more customary classifications such as bank or market centeredness. (La Porta et al., 2000: 29) Critically evaluate the above statement with reference to the major theories on corporate governance and recent unconventional developments.

Corporate governance involves a set of relationships between a companys management, its board, its shareholders and other stakeholders(OECD, 2004). This definition provided by the OECD is further elaborated as being one of many elements improving economic efficiency and growth as well as enhancing investor confidence. Investor confidence is complimented by strong investor protection and accordingly,an examination into the numerous iterations of investor protection exhibits the many subtle differences, in corporate governance regimes in place across the many economies; certainly with more success than bank or market centeredness classifications. Most typically, shareholders and creditors finance firms with the understanding that their rights are protected by law. As investors, it is crucial that they feel protected from any means

of expropriation and are easily able to exercise their voting and associated share ownership rights. Absent of this means, investors are likely to fall victim of expropriation, which although occurring in a myriad of forms, ultimately leads to a loss in investment. The legal element of corporate governance relies on laws and their enforcement to act as the primary mechanism protecting investors from expropriation.The La Porta, Lopez de Silanes, Shleifer and Vishny (hereafter LLSV), (1999)research report into corporate governance,established that diverse elements of countries financial systems such as the breadth and depth of their capital markets, the pace of new security issues, corporate ownership structures, dividend policies, and the efficiency of investment allocation appear to be explained both conceptually and empirically by how well the laws in these countries can be enforced, by regulators and courts(La Porta et al, 1999).The significance of the report being that it was able to effectively explain and justify the many forms of corporate governance uniquely employed by a similarly large number of economies. To impartially examine the efficiency and effectiveness of laws across economies and then categorise them from the most investor friendly to the least, it is essential to assess the laws on two key properties. The first order of assessment to consider is to consider how well the legislation itself protects investors, and secondly how well the legislation can be enforced to protect investors. It is evident that agreeable circumstances for both criteria would provide the most suitable investing scenario, however, it should be noted thatsuch a scenario is not always implemented in practice; a trend which was established in the LLSV report (1998), see Appendix A. There are four legal traditions which can arguably lay claim to have influenced the compilation of legislation in many economies. The first to be examined is the common law system of England which through conquest, colonization and voluntary adoption has been adopted by many of its current and former colonies including the United States, Australia as well as many African and South East Asian nations. These nations are described as having a dispersed or outsider corporate governance system; which is primarily characterised by increased shareholder protection, when compared to the global populace. In a similar disseminating fashion to England, the former French and Spanish colonies; including Latin America, implement French or Napoleonic civil law which based on Roman law is the second legal tradition. The third legal system is the German civil law tradition which is also based on Roman law and is implemented by the Germanic nations of Europe and East Asian countries. And the final legal tradition is a unique system employed by the Scandinavian nations.Continental Europe is defined as having implementing a concentrated or insider corporate governance system. This system, allying the European economies, most commonly offers weaker shareholder protection than the dispersed system.In recent years a third system defined as a family based system has also been intensely studied. This third, family based system offers a completely unique perspective to shareholder protection and is most prominent in the East Asian economies(CeFiMS, 2012a).

Succinctly, the primary difference between the legal traditions is that the common law system is an adaptive system where judges create law based on precedents and fiduciary duty. In instances where statute law or precedents fail to describe or prohibit specific conduct, judges still have the responsibility to make a ruling. In doing so, the law via legal precedent is expanded to further limit expropriation. In stark contrast, civil law systems incorporate strictly defined legislature which must be strictly adhered to by judges when making rulings. As a result, expropriation under civil statute may only be admonished if it is explicitly forbidden by legislation. Subsequently, it is apparent that the use of fiduciary duty principles in defining common law offers more protection to investors than the specifically defined civil law; which can easily be circumvented with some ingeniously imaginative thinking. The four primary legal traditions have been defined by LLSV (1998) and their examination into the efficiency and effectiveness of the associated legislature, indicated that the countries with common law offered the strongest protection to outside investors and that French civil law countries offered the least amount of protection. It was observed that all the systems did protect investors; however it was the extent of protection on offer that varied significantly.The legal heritage which forms the basis of present legislature far exceeds the advent of the market economy. And whilst it has been specified that all legal traditions do offer a degree of investor protection, it has been the ability of the legislature to develop and mould to modern economic advances; remaining pertinent, that has defined their effectiveness. Similarly, while there are numerous differences of varying degrees between the legal structures in place across the many countries, there are also significant variances in the quality of enforcement. The quality of enforcement is considered, by examining all aspects of the administration; this includes the entire legal and corporate systems. And unlike the legislation itself, which doesnt appear to be dependent on economic development, the trends of enforcement indicate that the quality of enforcement decreases as the level of economic development in a country declines(CeFiMS, 2012b). LLSV (2009) state that the direct consequence of investor protection has been shown to influence ownership patterns of firms, the development of financial markets and the allocation of resources. When investor protection is more pronounced via a higher level of legal protection, it is generally reflected by a well dispersed shareholder base. In such circumstances, stock markets see constant activity with large volumes of shares perpetually traded. Listed companies must comply with rigorous disclosure standards and markets are highly transparent. Conversely, a concentrated ownership structure has many of the opposite features of dispersed systems. Ownership is characterised by large controlling block-holders and stock markets are significantly less active having low standards of disclosure and market transparency. The dispersed ownership system represents the ultimate disciplinary role of the market for corporate control whereas in a concentrated ownership system, the large number of block-holders indicates that there is a limited market for corporate control (CeFiMS, 2012b).

The legal assessment assumes that the level of investor protection affects ownership structure, with investors; feeling that there is less opportunity for expropriation, providing financing to firms in exchange for receiving control rights. This is reflectedwith concentrated ownership in countries with poor protection. Investor protection assists the development of financial markets, influencing the real economy. Laws protecting investors encourage savings; through investment into stock markets and other financial intermediaries. In this manner, the legal protection of investors allows capital to flow to more productive uses. Based on the above reasoning, LLSV (2000) argue that legal protection of outsiders under common law judicial systems make expropriation less efficient. This can be used to explain why in the UK and US, stock markets have played an important role in financing economic development, while countries such as Germany and Japan with weaker protection for investors rely more on banks as a source of finance. Empirical research conducted by LLSV (1997, 1998 and 2000) substantiates their statements above; defining a strong positive correlation between the depth and liquidity of equity markets and the quality of legal protection of investors. And yet, the legal assessment as explained by LLSV presents an unrealistically bleak forecast for the development of the financial market of developing or transition economies. Their conclusion implies that the only way for emerging or developing nations to strengthen and advance their financial markets is to adopt a common law legal system. Coffee (2001) realises that correlation does not imply causality, finding little evidence that strong legal rules encouraged the development of either the New York or London Stock Exchanges, stating in the absence of a legal system that protects shareholder rights, the U.S. and U.K. experience are to the contrary and suggest that functional substitutes for close governmental regulation can be developed(Coffee, 2001). In continued assault to the legal explanation, the report continues stating the existence of evidence to suggest that strong legal rules negatively affected the growth of the Paris Bourse (now a part of the NYSE Euronext). The results of the legal assessment conducted by LLSV must be regarded with a little caution.It must be noted that the comparisons made between the varying legal systems are difficult to quantify. Being time-invariant, the study fails to account of legal changes over time for the legislature analysed. Subsequently, the correlations established don not reflect the historical sequence of development. This statement has been justified multiples times in recent history with legislation emerging as a response to the collapse of large corporations including Enron, WorldCom, HIH and Parmalat. Furthermore, the recent instability of the European Union and its member nations, in particular that ofGreece and Ireland has resulted in substantial legislation and amendments emerging in reaction. Recognising the inherent flaws of the legal explanation, it still provides substantial evidence to assert itself as being the critical determinant defining corporate governance systems; however, many remain otherwise convinced. Mark Roe and Lucian Bebchuk are the chief proponents against the legal explanation, believing it is a political explanation which better defines the shaping of the corporate governance systems. Roe contends that the political and social predicates that make the large firm possible and that shape its form are not scrutinized as carefully, or at all, despite that variation in political and social conditions can deeply affect

which firms, which ownership structures, and which corporate governance arrangements survive and prosper(Roe, 2000). Roe and Bebchuk adopt a path-dependency approach to their analysis, and using an underlying assumption that politics is the critical variable, they explore how institutions act in what can be classified as a pre-determined manner.Equipped with the necessary settings, the political explanation suggests that any resultant outcome can be predicted; as institutions evolve in a manner shaped by historic occurrences and pre-existing conditions. Roe argues that the historical lacking of social democracy is what developed the US economy to adopt the dispersed ownership system. In adopting the dispersed system, the wedge which is often seen driven between investors and management; through social democracy, is avoided.Social democracy can press managers to stabilize employment, to forego some profit-maximizing risks with the firm, and to use up capital in place rather than to downsize when markets no longer are aligned with the firm's production capabilities; these political tendencies correspond closely to managers' historical tendencies(Roe, 2000). The impact resulted on corporate governance through strong stakeholder pressures, results in poor transparency, poor market controls and declined shareholder value and influence. This political environment was pronounced throughout continental Europe over the 20th century, and large-block shareholding; concentrated ownership, was seen to be the continuous solution for investors to retain control over the socialist induced costs. The correlation that Roe devised between the political standing of the richest economies and the trending ownership patterns provides evidence, to further strengthen the assertions of the political explanation. Bebchuks work applies a rent-protection model to corporate ownership structures, which is used to explain share ownership and voting controls. The findings of his work identifies how elements of political control influence the decision of a company's initial owner whether to maintain a lock on control when the company goes public. When private benefits of control are large, founders of companies that take them public will be reluctant to leave control up for grabs. When control is valuable, leaving it up for grabs will invite attempts to grab it and will not constitute an equilibrium. Furthermore, when private benefits are large, maintaining a lock on control can enable the initial shareholders to increase the fraction of surplus that they would be able to capture in a surplus creating transfer of control (Bebchuk, 1999). Like the legal explanation, the political explanation also contains weaknesses in the argument defining the elements of corporate governance. The most significant weakness in the political explanation to consider is that the theory primarily focuses on the effect that social democracy has on corporate governance. While the analysis correlates a relationship between the influences of social democracy, ownership configurations, economies, macro and micro markets, cause-effect relationships cannot be drawn. In addition, there is a major flaw in the logic of the explanation, where it cannot be explained why it is not the case that it is politically safer and easier for a government to pressure a few large block holders than an anonymous herd of small investors (CeFiMS, 2012b).

Roe can be quoted to say, I do not offer a theory of all political determinants, but a theory and data on this one powerful political determinant(Roe, 2000). That Roes powerful political determinant contains such prominent flaws, the empirical research and the conclusions drawn from them must be acknowledged with great care. It has been determined that both the political and legal explanations of corporate governance structures contain inherent flaws, and the overlying assessment can conclude; based on the examination of this paper, that neither explanation is omnipotent in responding to the multitude of facets which corporate governance entails. However, using investor protection as a starting point to describe differences in corporate governance regimes across countries, this paper suggests the legal explanation is the more able in defining the subtle distinctions which uniquely separate one economy from the next.

References Bebchuk, L A, 1999. A Rent-Protection Theory of Corporate Ownership and Control [online], NATIONAL BUREAU OF ECONOMIC RESEARCH - WORKING PAPER SERIES:1-37. Available from: <http://www.nber.org/papers/w7203>. CeFiMS, 2012a. Unit 1 Introduction to Corporate Governance,1-16 p (University of London. CeFiMS, 2012b. Unit 3 Corporate Governance and the Role of Law,1-16 p (University of London. Coffee, J C, Jr, 2001. The Rise of Dispersed Ownership: The Role of Law in the Separation of Ownership and Control, The Yale Law Journal, 111(no.1 (October)):1-82. La Porta et al, R, 1999. Investor Protection: Origins, Consequences, Reform [online], Financial Sector Discussion Paper No. 1:1-27. Available from: <http://www1.worldbank.org/finance/assets/images/Fs01_web1.pdf>. La Porta, R, et al, 1998. Law and Finance, Journal of Political Economy, 106:1113-55. OECD, 2004. OECD Principles of Corporate Governance [online]:Preamble. Available from: <http://www.oecd.org/dataoecd/32/18/31557724.pdf>. Roe, M J, 2000. Political Determinants of Corporate Governance: Political Context, Corporate Impact, Stanford Law Review, 53(3 (Dercember)):1-67.

Appendix A

Figure 1 - Shareholder Rights around the World. Source (La Porta, 1998)