Corporate Governance Models

Types of Corporate Governance Models

Countries with developed economies apply two different systems of corporate governance Group based system -Insider system Market-based -outsider system

Insider System
The insider system ownership and control is concentrated in the hands of a small number of individuals, families, managers, directors, holding companies, banks and other non- financial corporations. Most countries specially those governed by civil law , have concentrated ownership structures.

Advantages of Insider System

Insiders have power and incentive to monitor management closely thereby minimizing the potential for mismanagement and fraud Due to significant ownership and control rights, insiders tend to keep their investment in a firm for long periods of time As a result, insiders tend to support decisions that enhance a firms long-term performance as opposed to decisions designed to maximize short-term gains.

Disadvantages of Insider System

Insider systems lead a company to certain corporate governance failures

Dominant owners or vote holders can bully/collude with management to expropriate firm assets at the expense of minority shareholders
Lack of legal rights for minority shareholders put company at stake Managers with are large share/vote holdings may use their power to influence board decisions that may directly benefit them at the companys expense For Example: managers persuade boards to authorize excessive managerial salaries and benefits or to approve the purchase of over-priced inputs from a firm in which the manager owns large shares

Large share or vote holders have other means of damaging companies up their sleeves
Large/dominant shareholders encourage the board to approve the purchase of a rival firm for the sole purpose of extending the companys market share and muting competition
Dominant shareholders convince the board to reject takeover offers for fear of losing control over the firm even though a takeover might improve the companys performance. Family-owned or insider-controlled companies ,shielded from market pressures enhances such dangers because they are not listed on the stock market.

Short view
Insiders who wield their power
Irresponsibly waste resources Drain company productivity levels Foster investor reluctance and illiquid capital markets Shallow capital markets In turn, deprive companies of capital Prevent investors from diversifying their risks

Mitsubishi Internal Control system

Outsider System
In contrast to insider systems, owners in outsider systems rely on independent board members to monitor managerial behavior and keep it in check.

Advantages :
Independent board members tend to disclose information openly and equitably, assess managerial performance objectively, and to protect shareholders rights vigorously As a result, outsider systems are considered more accountable and less corrupt and tend to foster liquid capital markets.

Disadvantages of Outsider system

Dispersed ownership structure has following disadvantages:

Dispersed owners tend to be interested in short-term profit maximization Hence, they tend to approve policies and strategies that will yield short-term gains, but that may not necessarily promote long-term company performance this can lead to conflicts between directors and owners Due to frequent ownership changes shareholders may divest in the hopes of reaping higher profits elsewhere both of which weaken company stability.

 Small-scale investors have less financial incentive to vigilantly monitor boardroom decisions and to hold directors accountable. As a result, directors who support unsound decisions may remain on the board when it is in the companys interest that they be removed

Mitsubishi Corporate Governance Framework

What can be done: Merge Insider and outsider system

As both insider and outsider systems have inherent risks ,Corporate
governance systems are designed to minimize these risks and to promote political and economic development

Internal controls are arrangements within a corporation that aim to minimize risk by defining the relationships between managers, shareholders, boards of directors, and stakeholders
These measures to have a meaningful effect, they must be buttressed by a variety of extra-firm institutions tailored to a countrys environment (referred to as external controls)

Corporate governance focus on simple model:

1. Shareholders elect directors who represent them 2. Directors vote on key matters and adopt the majority decision 3. Decisions are made in a transparent manner so that shareholders and others can hold directors accountable 4. The company adopts accounting standards to generate the information necessary for directors, investors and other stakeholders to make decisions 5. The companys policies and practices adhere to applicable national, state and local laws.

Developing Corporate Governance Framework

There are three different ways that owners maintain control over the work of management: 1. The owners directly influence the corporate strategy and selection of the top management team 2. The owner delegate their rights to the board, but ensure that compensation and other incentives are aligned with share price maximization

3. The owner rely on the market mechanism of corporate control such as takeover when due to decreasing share price new take overs can rehabilitate company

Modern Corporations disciplined by Internal and External agencies

Internal agencies are formed by shareholders when they buy shares, as they are too scattered, they can not manage company. Directors and management act as internal agencies to shareholder. External agencies include government and non government institutions who govern system of companies e.g. stock market, auditing standards, banks etc. Figure 1 shows: Interplay between internal forces (which define the relationship among the key players in the corporation) and External forces (notably policy, legal, regulatory, and market) that together govern the behavior and performance of the firm.

 The internal architecture defines the relationships among key players in the corporation
In its narrowest sense, corporate governance can be viewed as a set of arrangements internal to the corporation that define the relationships between managers and shareholders

External rules provide a level playing field and keep players in line
These internal mechanisms for corporate governance are strengthened by external laws, rules, and institutions that provide a level, competitive play in field and discipline the behavior of insiders, whether managers or share- holders

Institutional framework for effective corporate governance

Nutrients to institutional framework

Property rights:
Until investors does not know what company owns, how it uses its property and where they will not invest in that company, they will not invest.

Contract law: For Suppliers, creditors, employee security Well regulated banking sector: Transparent disclosure about
its own operations and about borrowers

Exit mechanism:

Ease of exit and invest money elsewhere,Transperant disclosure of debt and liabilities to file bankruptcy

Sound securities market:

regulated through law governing issuance and purchase of debt and equity securities, liabilities of issuers and adequate disclosure

 Independent well-functioning judicial system Anticorruption strategies: Excessive controls, governance and
bureaucratsation leads to corruption, government should relax level of control
houses)

Reform government agencies: Remove red tapism (e.g. custom

Strengthening administrative and enforcement capacity of government: through recruitment of qualified human resource
Establish routine mechanism of participation of public to form policies Investigative and well informed media who will condemn misdeeds

 Competitive markets
A. B. C. D. E. F. Remove entry barriers Enact competition and anti-trust laws Eliminate protection against monopolies Eliminate preferential treatments e.g. taxes, subsidies Eliminate restrictions on trade and FDI Reduce cost of starting business

Transparent and fair privatization procedure and taxation regimes: Clarity of rules regarding privatization, check
adequacy of reports before allowing tax regimes

Strengthening reputational agents:lawyers,NGOs,Environmentalists,media,auditing

professionals who bridge up information gap between insiders and outsiders. They must be independent and fair.

Corporate Governance Challenges in Developing, Emerging and Transition Economies

Challenges
Proper ruled based corporate system Dismantling pyramid ownership structure that allows insiders to control Establishing cross shareholdings between banks and corporations Establishing distinguished property rights system between owners and companies De-politicizing decision-making process and protect corporate from government if it is dominating Protecting and enforcing minority shareholders rights

Preventing asset stripping after privatization Finding active owners and skilled managers Educating investors about their rights and duties Encouraging corporate governance practices through benchmarking Establishing regulating bodies to facilitate good corporate governance and promoting it in family-owned businesses

Corporate Governance is Not only a Private Sector Affair

In many transition economies public sector companies contribute more to nations GNP, employment, income and capital. They also often shape policies and rules. If the public company has to privatized it must be corporatized before that. Some public companies can not be privatize because;
These are vital to the economy, so, it is benefitted for these to be corporatized And it will reduce political interference, nepotism, corruption, etc.

Successful Strategies One Size Doesnt Fit All

Most of the corporate governance practices are of western countries and there is great difference between the western/developed and developing/transition countries. Even among the developing economies their culture, work ethics, employer-employee relationship, etc are different . So, it is difficult to implement that practices as it is. Thats why one code or practices doesnt apply to all the countries corporations.

Current CG Settings in Transition Economies

The corporate sector has:
No legal and institutional structures Dominant companies which discourages entrepreneurship Unpredictable environment and so, the managers depart their objectives.

The role of state is ambiguous , on one hand it has great political influence and on the other hand it has no any legislation regarding CG. From governance perspective state-owned firms are controlled by bureaucrats with no formal rules and ownership.

 There is lack of institutions associated with successful economies, as, institutions are the rule of society. In this setup the institutions have three components; Formal Informal Enforcement mechanism Institutions theory states that: When formal institutions are weak then informal constraints play a great role in shaping the behavior.