COMPANY LAW-II

Convergence of Corporate Governance systems: Good or bad?

-Surabhi Mathur

BA0130064

1. Introduction:

The progress achieved by field called Corporate governance is tremendous. In the past few
decades, reforms in corporate governance reforms have emerged as an important center of
corporate law in countries across the globe. India has emerged as a hub of new corporates and
with that, constant emerging laws. With the recent developing trends of globalization, it has been
presumed by many scholars that these corporate laws will merge or converge gradually. This
was deeply thought and analyzed by various scholars and among them some of them agreed but
few disagreed. The main contention of supporters of this convergence is that, it will lead to
development of a commodity market to permit free flow of economic resources from one use to
another across national economic boarders. Also that freeing of capital flow will lead to the more
efficient allocation of capital by improving savers access to investment opportunities.

Henry Hansmann and Reinier Kraakman were the people who came up with this idea of
convergence first from their article "The end of history for corporate governance"1 in 2000. But
very few actually thought about what will be the repercussions and consequences of the
convergence. Will it be helpful for few countries or most of them? Can there be a single best
corporate governance model which can be adopted by everyone? If so, will international
competition, force all countries to adopt this type of systems? Few of the scholars are of the view
that convergence has already started happening because of the globalization, decreasing in
proximity of resources and capital flow, legal mechanisms but it cannot be argued with a
conclusive proof. This paper tries to understand whether such convergence is possible or not and
what will be the effects of it on domestic markets and governance. Also the paper goes by
understanding the basic concepts and models of corporate governance first, then in part 5 it will
give arguments against convergence of corporate governance.
1
Henry Hansmann & Reinier Kraakman, The End of history for Corporate Law, Harvard Law School, Cambridge,
MA. ISSN 1045-6333.

1
 1.1. Research Methodology:

In the present research paper, the methodology used is from the doctrinal and secondary sources.
Various scholarly articles, books and web sources are being used to make a brief study on the
given project title.

1.2. Research questions:

This paper will try to find an answer for whether the idea of convergence of corporate
governance systems proves good or bad? And can there be any best model for governance
which can be adopted?

1.3. Brief Background:

If we have to refute to the convergence idea, we can continue with our primary hypothesis that,
since every nation state have their own cultures, laws, working circumstances and governance
structure it will become difficult to choose any similar model which will be accepted and easy to
adopt by all. The researcher will proceed with the ideology that convergence will be very
difficult to make because of the differences of thoughts and traditions. The paper also tries to
connect the concept of convergence with the neo-classical school of thought and then examine
whether it will be useful or not.

2. Important concepts involved:

Following are few concepts which are important to understand before proceeding with the main
content of the paper.

2.1. Corporate Governance: Corporate governance broadly refers to the systems by which a
corporation is directed and controlled by its shareholders, directors and officers. This also
specifies the rights and responsibilities of different participants in the corporation. So, it
includes the entire categorization of the group including, board of directors, shareholders,
employees, promoters and all those people who have direct link with welfare of the

2
 company. Corporate governance is concerned with the institutions that influence how
business corporations allocate resources and returns (O'Sullivan 2000)2.
2.2. Convergence: By Convergence in the current context, it is equivalent to merging of merit
points of all the kinds of corporate governance systems across the globe and makes an
ideal best model which will be adopted by all the states. According to Oxford
Dictionary, Converge means to come together or towards same point 3. Convergence will
lead to merging of all the governance systems of nations in one model which will have all
the special characteristics.
2.3. Neo Classical view: It is one among the schools of thought which talk about integration of
nation states for a common motive and collective security which is being adopted in order
to have a collective decision making and peaceful coexistence. In the present scenario, this
school of thought has relevance as convergence of corporate governance systems is
similar to coming together of nations states with a common intention and understanding4.
The scholars supporting this ideology foster the idea of collective security and decision
making by making an ideal model which will be adopted by majority of states.
2.4. Globalization: It involves buying, selling and exchange of goods and services from all the
markets in world at the same time which involves import and export and also exchanging
of cultures and traditions. Since every state has a different perspective about law and
customs, globalization will help in mixing of traditions and ideologies but it will be totally
hypothetical when it comes to actual merging of these traditions. The concepts of
convergence and globalization are almost synonymous in the current context.

3. BEST MODEL Theory:

For being counted as the Best model for convergence, we should first understand an
international group of counties called Organization for Economic Cooperation and Development
(OECD). Its aim is similar to that of OECDs which is, basic principles of good corporate
governance. As to what constitutes good corporate governance, there is little dispute among
globalists. It is the Anglo-American model of corporate governance that generates pressures on

2
Mary OSullivan, Corporate Governance and Globalization, Saga Publications, Inc. in association with American
Academy of Political and Social Science, Vol.570, Jul 2000.
3
Julia Elliott, Oxford Dictionary & Thesaurus, 11 th Edition 2007, Oxford University Press, New Delhi.
4
Dag Eniar Thorsen and Amund Lie, What is Neo-Liberalism?, Department of Political Science, University of Oslo.

3
corporate enterprises to maximize shareholder value as their primary objective, about which it
has been discussed in coming sections5. OECD is an international economic organization
formed in 1948 with 34 states as its member states describing themselves as committed to
democracy and the market economy, providing a platform to compare policy experiences,
seeking answers to common problems, identify good practices and coordinate domestic and
international policies of its members6. Therefore, the scholars are pretending to make an
idealistic model by combining merit points from different corporate governance systems. For
getting on to a best corporate governance model, one needs to categorize and understand
different prominent models and check their merits which should be adopted in case of
convergence7. Broadly the systems can be classified as, the insider-oriented system and the
outsider-oriented system. The distinction between these two corporate governance systems
relates to the different structures of ownership which is reflected in the corporate governance
structure by envisaging different models of shareholding8.

3.1. Insider model- An insider-situated arrangement of corporate administration is one

in which a nation's openly recorded organizations are possessed and controlled by
little number of major shareholders. In this model, a concentrated ownership model
is portrayed by controlling shareholders, powerless securities markets, low levels of
straightforwardness, and divulgence norms and perhaps a focal observing part for
extensive banks9. Moreover, share ownership in the insider-situated framework is
concentrated and the real partners are straightforwardly spoken to on the board that
screens supervisors what's more, now and again additionally administration itself10.
The insider-arranged framework has been prevailing in mainland Europe and Japan

5
ibid
6
See generally: Organization for European Economic Co-operation Official website Available on-
http://www.oecd.org/general/organisationforeuropeaneconomicco-operation.htm (last seen- 5:00pm 18th March
2016).
7
Umaknath Varottil, A cautionary tale of the Transplant effect on Indian Corporate Governance, Published in
National Law School of India Review, 21(1) Nat. L.Sch.Ind.Rev.1 (2009).
8
Brian Ikol Adungo, An analysis of the view that the corporate governance systems worldwide are inevitable
converging towards a model based on shareholder primacy and dispersed ownership structure, Available at-
http://SSRN-id2049764.pdf (last seen- 5:00pm 16th March 2016).
9
T. Clarke and M. Rama, Corporate Governance and Globalization- Vol,1: Ownership and control (London: SAGE,
2006).
10
K. Gugler , D.C. Mueller and B.B. Yurtoglu, Corporate Governance and Globalization, (2004) 20(1) Oxford
Review of Economic Policy 129-156.

4
 in light of the fact that traded on an open market enterprises play a similarly minor
part in the economy and their shareholding is more gathered than in the US.

3.2. Outsider model- An outcast situated administration framework is one in which

share possession is scattered, furthermore, proprietors exercise backhanded control
over administration by choosing delegates to the voting so as to observe sheets or
maybe on particular proposition of administration. This framework is by and large
described by scattered possession, an unmistakable partition of possession and
control, strong and liquid securities markets, high revelation models, high market
straightforwardness, in which the business sector for corporate control is a definitive
teaching instrument11. As far as responsibility for organizations, this model is
portrayed by high fracture of ownership, where single shareholders can barely ever
independently influence the administration of the company.
The above mentioned models are the broad classification of the corporate governance system
models in general. In the present research paper, three kinds of models are considered as
standard: (i) Anglo-Saxon model (ii) German model (iii) Japanese model. They are nowhere
mentioned to be as the only best models available across the globe but they have gained at least
significant reputation to be called so. Let us examine each of these models and find out whether
Best Model theory can be fulfilled or not.

1. Anglo-Saxon:

This model is adopted by USA, UK, Australia, Canada and other Commonwealth countries. The
key players in this model include management, directors, shareholders, government agencies,
stock exchanges, self-regulatory organizations and consulting firms which advice corporations
and shareholders on corporate governance and proxy voting. Here, the shareholders are
responsible for selecting the directors and in turn, the directors appoint the managers of the
company which maintains the separation between ownership and control. Members of
management hold seats on the boards, but each board is required to have some directors who are
not members of management, and roughly 90 percent of corporations have a majority of outsider

11
T. Clarke and M. Rama, Corporate Governance and Globalization- Vol,1: Ownership and control (London:
SAGE, 2006).

5
directors12. The board usually consist of executive directors and few independent directors. The
board often has limited ownership stakes in the company.

2. German model:

This model consists of two tier board model consisting of the Supervisory board (Aufsichtsrat)
and the management board (Vorstand). Countries like Germany, Holland, France etc. the
shareholders can appoint 50 % of members in supervisory board13. The rest is appointed by
employees and labour unions. The board of directors is responsible for day to day activities of
the company unlike other countries. The fact that employees have equal representation on these
supervisory boards obviously suggests that it is not only the interests of the shareholders which
are upheld against those of the management.

3. Japanese model:

Japan has single board similar to that of in UK and USA but in this, the company is dominated
by members by members of management covering over 3/4th of a boards members are
managers14. This system is many-sided, centering around a main bank and a financial/industrial
network or keiretsu. The supervisory board which is made up of board of directors and a
president, who are jointly appointed by shareholder and bank/financial institutions.

The main models which are prominent enough across the globe have now being discussed. Since,
different situations of economic stability and culture have been observed in different states they
have adopted corporate governance model according to their own convenience.

Then why will any state adopt a model which is equal for everyone? Will not that lead to
conflicts in cultures and believes? Proponents of the convergence theory generally argue that

12
Klaus Gugler, Dennis C. Mueller and B. Burcin Yurtoglu, Corporate governance and Globalization, Oxford
University Press, Vol. 20 , pp. 129-156.
13
ibid
14
ibid

6
corporate governance laws are converging around the shareholder- oriented Anglo- American
model, in part because they view this model as most efficient.15

4. Root causes of corporate governance convergence:

There is an ongoing debate on the convergence of corporate governance systems, the causes are
also quite important to understand. The causes come out from the situations which happens
according to the scenario happening in that particular state.

4.1. Globalization- the growing integration of financial markets is a key factor of

convergence of corporate governance systems. Investors in most countries
increasingly accept the proposition that holding an international equity portfolio
leads to higher returns and lower risk than a purely domestic portfolio16.
4.2. Legal convergence- legal infrastructure and its dynamics are an important part of
the institutional apparatus, but it might make practical sense to look at them
separately from the rest of political and social institutions. Convergence is also the
result of an increasing tendency of large firms to choose their regulatory
environment. This, of course, is not due to legal eclecticism but rather to the need to
tap the most liquid and cheap sources of capital. To list their shares in New York
Stock Exchange, large companies from a growing number of jurisdictions become
subject to US securities rules and accounting norms.17

5. Arguments against convergence:

Different scholars have had different perspectives on convergence and as student of corporate
governance it becomes important for us to understand their ideas also. According to the article by
Henry Hansmann and Reinier Kraakman, a principal reason for convergence is a widespread
normative consensus that corporate managers should act exclusively in the economic interests of

15
See, e.g., Paul Davis & Klaus Hopt, Control Transactions, in THE ANATOMY OF CORPORATE LAW: A
COMPARATIVE AND FUCNTIONAL APPROACH 157, 172 (Reinier Kraakman et al. eds. 2004) stating that
regulation of the control transactions is a timely reminder that Anglo-American company law is not the unity that
I sometimes assumed); Henry Hansmann & Reinier Kraakman, The end of History for Corporate Law, 89 GEO.
L.J. 439 (2001).
16
See, Article by Stilpon Nestor and John K. Thompson on Corporate Governance patterns in OECD economics: Is
convergence under way?
17
ibid

7
shareholders, including non-controlling shareholders18. The main argument of the supporters of
convergence focus upon the welfare of shareholders worldwide. Now, corporate governance is
not about supporting or looking after the welfare of few classes of any corporation, rather it
should be for the welfare of maximum people who are involved in working of the corporation.
Therefore, this argument made by the supporters will be struck down completely if convergence
happens in future.

Supporters argue about the impact of increasing globalization in corporate among the countries.
Globalization of companies is also, obviously a force for convergence. Firms that are truly global
in strategic outlook, with world-wide production, service provision, added value chain, markets
and customers, which call on international sources of finance, whose investors are located
around the world, are located around the world, are moving towards common governance
practices19. Scholars argue that, with the help of globalization, free flow of economic goods and
resources can be done which will lead to more efficient allocation of capital by improving savers
access to investment opportunities & companies access to financing20. If convergence happens,
the companies will lead to improved access to goods and services outside state but will lead to
conflicts as the cost of its production and manufacturing will differ which will cannot be solved
if the laws applicable are similar in those two nation states. The burden to prove one wrong will
be too much. Also, the competition among corporations will decrease and will become difficult
to handle as the main basis of competition is fulfilled when there is difference in costs, economy
and laws. The so called best corporate governance model will have to support both the
companies situated in two different counties and create an ambiguous situation. Let us now see
the main arguments as to why convergence will not be a great success:

5.1. Differentiation of Cultures and traditions: Corporate governance is the field linked with
all welfare of employees, board of directors and managers of the company. Removing the
conflict of interests among the people is the main aim of this governance system. The idea
of convergence as discussed in previous sections is an idea given by scholars but they

18
Supra note 1.
19
Bob Tricker and Chris Mallin, Corporate Governance, Wordpress,com, (16th March 2016, 4:15pm),
https://corporategovernanceoup.wordpress.com/tag/convergence-2/.
20
Klaus Gugler, Dennis C. Mueller and B. Burcin Yurtoglu, Corporate Governance and Globalization, Oxford
University Press, Vol.20, 2004.

8
 forgot to see the differentiations in cultures, laws, traditions and society. Therefore, it
becomes difficult to predict that whether convergence can be possible or not.
5.2. Baseless assumption: the assumptions which the supporters of convergence give are
totally baseless because they take only few aspects for calculation not full information in
their hand. Hence, their arguments become baseless and mere assumption. Though we
might be moving towards convergence but full convergence is never possible.
5.3.Differentiation in economies: growth of economies is different in different states and the
policies or schemes of that domestic states will always come in such a situation where
they will have to give up their identity and come into contract with the other world
countries. Many international conventions with a common objective are signed by
multiple states but those are for the betterment of the international peace and harmony,
whereas convergence of corporate governance systems will lead to weakening of the base
of all the economies of the world at a very large level.
5.4. Complex Mechanism involved: the idea of converging is a very long process, it cannot
happen in one night. There has to be a lot of technicalities and method involved so that all
the aspects are covered and taken into due consideration. While merging the thoughts of
each and every state, there might be a situation where one state is unhappy to have lost
the identity, hence there has to be equal representation on every part. A proper committee
should be setup for having a clearer thoughts and approach.
5.5. Reduction in competition: the corporations being setup in the different states have a
different kinds of setup, working environment, capital structure and profit & loss
statements. Competition among these corporations determine the efficiency and goodwill
of any particular company. It is equivalent to a force created in the market which urges
the companies to perform their best. Therefore, after convergence all the governance
systems will come to a constant and static position which will reduce the level of
competition among corporation, which in turn will lead to weakening of the base of
economy. A lot of scholars have argued that convergence will lead to stock market
efficiency which will lead to economic efficiency. For all the talk of the merits of free-
flowing capital for economic growth, there is little evidence that the stock market
performs its assumed function as a crucial conduit of resources from savers to investors.
Nor are there strong theoretical grounds for the widespread assumption that the stock

9
 market should play such a role. There is, in fact, no theory within mainstream economics
that supports the idea that stock market efficiency leads to economic efficiency.21

In an article the following was observed,

There is a large body of research on welfare economics, and an equally large one on efficient
markets theory. However, there has been relatively little work linking these two literatures. By
and large welfare economists have not studied corporate control or asset pricing, while
efficient- markets researchers have taken for granted that informational efficiency implies
economic efficiency.22

There can be many reasons of convergence being a failure but there is a lot which needs to be
studied, analyzed and looked upon. The economists corporate governance experts should see to
all such aspects in order to be prepared for the any contingent situation in future.

6. Conclusion:

We have seen from the above discussion that convergence is indeed taking place for reasons
related to the globalization of financial and product markets, an increasing proximity of legal and
institutional norms and a more open circulation of and attitude towards foreign ideas. Having
said this, one should not expect uniform corporate governance institutions and arrangements in
the world, just as one cannot expect the end of nation states in the foreseeable future. The
argument that stock market efficiency will lead to economic efficiency is vehemently baseless.
The fact, the relationship between active stock markets and economic performance is based on
conjecture rather than empirical proof. The weak conceptual and empirical underpinnings of the
globalization argument, at least if we interpret it as an economic argument, make it unsuitable as
the basis on which to interpret recent development in corporate governance systems.
Apart from discussing the ideas of converging and making a best model for the governance, it is
better to repair the domestic and international governance systems so that the current
shortcomings can be looked after with proper care. Given the importance of corporate resource
allocation to economic and social outcomes, it is crucial that we develop a more sophisticated

21
Supra note 2.
22
Dow and Gorton, Stock market efficiency and Economic efficiency: Is there a connection? 1997 Journal of
Finance 52(3) 1087-129.

10
analysis of national and international developments that determines who makes investment
decisions in corporations, what types of investments they make, and how returns from
investments are distributed.

Therefore, it is now understood that convergence of corporate governance systems is now a

distant dream and very difficult to happen because of the above mentioned arguments and
reasons of its failure. Even if it happens it will become difficult for the states to join their
identities and work towards a similar understanding because corporates are made to compete and
that very essence will be lost by convergence.

11