Lec 3

Corporate Governance Around the

World

To discuss corporate governance structures,

which vary a great deal across countries,
reflecting divergent cultural, economic, political,
and legal environments.
 AGENCY THEORY

 STEWARDSHIP THEORY

 STAKEHOLDER THEORY

 PROPERTY RIGHTS THEORY

 A key weakness is the conflict of interest
between managers and shareholders.
 In principle, shareholders elect a board of
directors, who in turn hire and fire the
managers who actually run the company.
 In reality, management-friendly insiders often
dominate the board of directors, with
relatively few outside directors who can
independently monitor the management.
 In the case of Enron and other dysfunctional
corporations, the boards of directors grossly
failed to safeguard shareholder interests.
 Furthermore, with diffused ownership, most
shareholders have strong enough incentive to
incur the costs of monitoring management
themselves.
 It’s easier to just sell your shares a.k.a. “The Wall
Street Walk”.
 Shareholders allocate decision-making
authority to the managers.
 That’s why the managers are hired in the first
place.
 Many shareholders are not qualified to make
complex business decisions.
 A shareholder with a diversified portfolio would
not have the time to devote to making the
numerous decisions at each of his many
companies anyway.
 Having the short-term control of the firm’s
assets, managers might be tempted to act in
the manager’s short-term best interest
instead of the shareholder’s long-term best
interest.
 Consumption of lavish perquisites is one example.
 Outright stealing is another example.
▪ Some Russian oil companies are known to sell oil to manager-
owned trading companies at below market prices.
▪ Even at that, they don’t always bother to collect the bills!
 In the U.S., shareholders have the right to
elect the board of directors.

 If the board remains independent of

management, it can serve as an effective
mechanism for curbing the agency problem.
 The structure and legal charge of corporate
boards vary greatly across countries

 In Germany the board is not legally charged with

representing the interests of shareholders, but is
rather charged with representing the interests of
stakeholders (e.g. workers, creditors, etc.) as well
as shareholders.
 The structure and legal charge of corporate
boards vary greatly across countries

 In England, the majority of public companies

voluntarily abide by the Code of Best Practice on
corporate governance.
 It recommends there should be at least three
outside directors and the board chairman and the
CEO should be different individuals.
 The structure and legal charge of corporate
boards vary greatly across countries

 In Japan, most corporate boards are insider-

dominated and primarily concerned with the
welfare of the keiretsu to which the company
belongs.
 Scandal-weary investors around the world are
demanding corporate governance reform.
 It’s not just the companies’ internal governance
mechanisms that failed; auditors, regulators, banks, and
institutional investors also failed in their respective
roles.
 Failure to reform corporate governance will damage
investor confidence, stunt the development of capital
markets, raise the cost of capital, distort capital
allocation, and even shake confidence in the capitalist
system itself.
• The Board: Are they cozy with Mgt?
– Is it largely independent?
– Are the directors qualified?
– Do they have access to outside resources?
– How are they elected?
– Do any directors have cross-company relationships?

• Management: Are they vendors or customers?

– Do they have a code of ethics?
– Are there lots of perquisites?
– How is their compensation structured?
 Key Board Committees
• Audit Committee:
– Oversees financial reporting.
Should watch out for Accounting shenanigans
• Executive Compensation Committee:
– Approves compensation packages including
bonuses, stock options, severance, loans, etc.
What incentives are being created?
• Nominations Committee:
– Recruits and proposes new board members.
Are they “stacking” the board?
 The relationship among stakeholders used to
determine and control the strategic direction
and performance of an organization is
termed corporate governance
 The corporate governance of the
organization is therefore the way in which
order and process is established to ensure
that decisions are made and interests are
represented – for all stakeholders - properly
 Do the owners manage the business
themselves?
 Most companies start as 100% family owned
and move toward being 100% publicly traded
 Sometimes, publicly traded firms return to
being privately held
 Family controlled firms often out-perform
publicly traded firms
 Moving from family to public firms brings
agency issues
 As companies become more deeply
committed to multinational operations, a
new constraint develops – one that springs
from divergent worldwide opinions and
practices as to just what the firms’ overall
goal should be:
 Shareholder Wealth Maximization – As
characterized by Anglo-American markets
 Stakeholder Capitalism Model – As characterized
by Continental European and Japanese markets
 Shareholder Wealth Maximization
 A firm should strive to maximize the return to
shareholders (those individuals owning equity
shares in the firm)
 This view defines risk in a very strict financial
sense
 Risk is defined as the added risk a firm’s shares
bring to a diversified portfolio (a fully diversified
portfolio represents systematic risk)
 The added firm-specific risk is known as
unsystematic risk
 Stakeholder Capitalism Model
- Risk : Total risk, both operating and financial risk,
is important
- Single versus Multiple Goals : Avoids the problem
of impatient capital but fails to give clear
expectations about tradeoffs among different
groups of stakeholders

Copyright © 2009 Pearson Prentice Hall. All rights reserved.

 The relationship among stakeholders used to
determine and control the strategic direction
and performance of an organization is
termed corporate governance
 The corporate governance of the
organization is therefore the way in which
order and process is established to ensure
that decisions are made and interests are
represented – for all stakeholders - properly
 The single overriding objective of corporate governance
in the shareholder wealth model is the optimization
over time of the returns to shareholders
 The most widely accepted statement of good corporate
governance (established by the OECD) focus on the
following principles;
 The rights and equitable treatment of shareholders
 The role of stakeholders in corporate governance
 Disclosure and transparency
 The responsibilities of the board
 The Board of Directors
 The legal body accountable for the
governance of the corporation
 Officers and Management
 Creators and directors of the firm’s
strategic and operational direction
 Equity Markets
 Reflect the market’s constant evaluation of
the promise and performance of the
company
 Debt Markets
 Provide funding and are interested in the
financial health of the firm
 Auditors and Legal Advisors
 Provide an external professional opinion as to
the fairness, legality, and accuracy of financial
statements
 Regulators
 Require a regular and orderly disclosure
process of corporate performance
 Market-based regimes (U.S. and U.K.) are
characterized by relatively efficient capital
markets with dispersed ownership
 Family-based regimes (Asia, Latin America)
involve strong concentrations of family
ownership
 Bank-based and government-based regimes
result in only marginal public ownership and
sometimes significant restrictions on
business practices
 Does good governance matter?
 Certainly, as in the case of Enron, many of the
improprieties were overlooked as long as the
company’s share price continued to rise
 However, after the fall of Enron, and the
substantial losses sustained by investors,
employees and society as a whole, many
would say that corporate governance matters
a lot
ANGLO-AMERICAN
MODEL

GERMAN MODEL

JAPANESE MODEL

INDIAN MODEL
•Corporate governance systems vary around the world,
as in some cases, it focuses on link between a
shareholder & company, some on formal board
structures & board practices, and yet others on social
responsibility

•However, basically, corporate governance is seen as

the process by which an organization is run

•There are many models of corporate governance

being followed
•Used in U.S.A., U.K., Canada, Australia, and some
commonwealth countries

•Shareholders appoint directors who in turn appoint the

managers to manage the business – thus leading to
separation of ownership & control

•The board usually consists of executive directors & few

independent directors. The board often has limited
ownership stakes in the company. Moreover, a single
individual holds both the position of CEO & chairman of
the board
•This is a 2-tier Board model as there are 2
boards…the supervisory & the management Board

•Used in countries like Germany, Holland, France

•Usually a large majority of shareholders are banks

& financial institutions

•The shareholder can appoint only 50% of

members to constitute the supervisory board, and
the rest is appointed by employees & labor unions
Also called the Business Network Model, usually
shareholders are banks/financial institutions, large
family shareholders, corporate with cross-shareholding

There is a supervisory board made up of board of

directors & a president, who are jointly appointed by
shareholders & banks/financial institutions. Outside or
independent directors rarely found on the board
•The model of Corporate Governance found in India is
a mix of Anglo-American & German Models because
in India there are 3 types of corporations : private
companies, public companies & public sector
undertakings

•Each of these have a distinct pattern of shareholding

– e.g. in case of companies where the promoter & his
family have almost compete control over the
company, they depend less on outside equity capital
& hence in such private companies the German Model
is followed
 To sell their stock
 To vote in general meetings
 To get info. about the company
 To sue the managers for alleged misconduct
 Certain residual rights in case of liquidation
 Duty to run the company in the interest of the
shareholders
 Duty to act for the benefit of the company
 Duty of care & skill
 Duty of diligence
 The relationship between the shareholder &
the company is a delicate one with well-
defined rights of shareholders and ill-defined
duties for managers/firm, leading to conflicts
 Corporate Governance : a principal-agent
relation
 Seeks profit, rising share price, etc.
Principal: Agent:
Shareholder Manager

Seeks remuneration, power, esteem,

etc.
 Executive accountability & control
 Executive remuneration
 Ethical aspects of mergers & acquisitions
 Role of financial markets
 Insider trading
 Role of Accountants
 Size & structure of the board
 Independence of supervisory or non-
executive directors
 Frequency of supervisory body meetings
 Rights & influence of employees in C.G.
 Disclosure of executive remuneration
 General mtg. participation & proxy voting
 Role of other supervising & auditing bodies
 Technological advances free financial
markets from locations & time slots

 So trade takes place around the clock &

regardless of geography of supply/demand
 Governance & control

 Speculation

 Unfair competition with developing nations

 Space for illegal transactions

 They are the most important factor of
production or resource of the firm
 On the “legal” level, usually a contract that
stipulates rights & duties of the two parties
 On the “economic” aspect, the relation
between firms & employees is subject to
certain externalities/costs not incl. in contract
 These hidden costs tend to create “moral
hazards” for both parties, opening a wide
range of ethical issues
 EMPLOYEE RIGHTS ISSUES INVOLVED
Right to freedom from discrimination l Equal opportunities
l Affirmative action
l Reverse discrimination
l Sexual and racial harassment
Right to privacy l Health and drug testing
l Work-life balance
l Electronic privacy and data protection
Right to due process l Promotion
l Dismissal
l Disciplinary proceedings
Right to participation and association l Participation of workers works councils and trade
unions
l Participation in the company’s decisions

Right to healthy and safe working conditions l Working conditions

l Occupational health and safety
Right to fair wages l Pay
l Industrial action
l New forms of work
Right to freedom of conscience and speech l Whistle blowing

Right to work l Fair treatment in the interview

l Non-discriminatory rules for
 EMPLOYEE DUTIES ISSUES INVOLVED
Duty to comply with labour l Acceptable level of performance
contract. l Work quality
l Loyalty to the firm

Duty to comply with the law. l Bribery

Duty to respect the employer’s l Working time.
property l Unauthorized use of company
resources for private purposes.
l Fraud, theft, embezzlement
 Most common corporate misdemeanour has
been the ill treatment of employees in
developing countries by MNC’s
 National culture & moral values differ
 Absolutism vs. Relativism
 The ‘race to the bottom’
 Only if gainfully employed in useful work, and
feel respected as human beings can
employees contribute to sustainability in the
‘economic’ sense
 What is reqd:a)Re-humanized workplaces
b)Wider employment
c)Work-life balance
 It is a core tenet of business strategy that
organizations succeed by outperforming
competitors in providing superior value to
their customers
 Yet innumerable ethical abuses of consumers
continue to hit headlines
 E.g. drug co.’s exploiting poor in developing
countries, fast food and snack co.’s targeting
kids, banks offering easy credit to customers
already in serious debt,etc.
Area of Some Common Main Rights
Marketing Ethical Problems Involved
Marketing Product Policy Product safety • Right to safe
Management Fitness for Purpose and efficacious
products.
Marketing • Deception • Right to honest
Communications • Misleading claims and fair communications
• Intrusiveness • Right to Privacy
• Promotion of
materialism
• Creation of artificial
wants
• Perpetuating
dissatisfaction.
• Reinforcing
stereotypes
Pricing • Excessive Pricing • Right to fair prices
• Price fixing
• Predatory pricing
• Deceptive pricing
Distribution • Buyer-seller • Right to engage in
relationships markets.
• Gifts an bribes
• Slotting fees
Marketing • Targeting vulnerable • Right to be free
Strategy consumers from discrimination
• Consumer exclusion • Right to basic
freedoms and amenities
Market research • Privacy issues • Right to privacy
 Producing environmentally responsible
products-Toyota’s Prius
 Product recapture
 Service replacements for products
 Product sharing-Swiss company ‘Mobility’
 Reducing demand-pricing for carrier bags
 Firms & their suppliers are mutually
dependent on each other for their own
success
 However, their interests are not always
convergent
 E.g. Whilst the buying co. may wish to reduce
costs by sourcing cheaper products, the
supplier will seek to obtain best possible deal
and maximize revenue
 Misuse of power
 The question of loyalty
 Preferential treatment to favored suppliers
 Conflicts of interest
 Gifts, bribes, and hospitality
 Ethics in negotiation
 Overly aggressive competition
-Intelligence gathering & indl. espionage
-Negative advertising
-Stealing customers
-Predatory pricing
-Sabotage
 Insufficient competition
-Collusions & cartels
-Abuse of dominant position
 Key forces driving globalization in business are
convergence of markets, global competition,
cost advantages, and govt. influence
 This has lead to a dramatic reshaping of ethical
considerations & problems when dealing with
suppliers & competitors in a global business
network
 This reshaping brings to the fore:
-Diff. ways of doing business
-Impacts on indigenous businesses
-Differing labor & envl. standards
-Extended chain of responsibility
 CSO’s have always been involved in the
business ethics field
 Corporate donations, organizing employee
resistance to labor practices, leading
consumer boycotts of products, etc.
 CSO’s do not have a direct link or
contribution to the firm like other
stakeholders
 CSO’s stake is one of representing interests
of individual stakeholders
 The 3 elements of sustainability – social,
environmental,and economic- have been
typical focus of CSO’s
 The 2 challenges in addressing sustainability:
-Balancing competing interests
-Towards participation & empowerment
 Govt. consists of a variety of institutions &
actors at diff. levels that share a common
power to issue laws
 Laws serve as explicit rules of social consensus
about what a society regards as right & wrong
Drivers Development
Economic and business • Increased productivity and product
opportunities differentiation.
• Lean thinking and total quality management
• Ethically, environmentally responsible investment
• Risk reduction

Population • Population decrease in developed economies and

increase in emerging economies
• Urbanization and migration
Technology • Clean technology and renewable energy
Environmental crisis • Restoration natural capital, management
environmental disasters
Inequality • Refugees, services to the poor, trade barriers

Ethics/staying ahead of • Corporate best practices, ethical investing,

regulation • marketing