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Lecture 1: International comparative corporate governance
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Corporate Governance Debate: 200 Years of Controversy
“It’s only when misgovernment grows extreme enough to produce a revolutionary agitation among the
shareholders that any change can be affected” - Herbert Spence, 1854
...

● Maxwell Group (UK) – massive industrial conglomerate with a publishing house in the core of
the group, which published most of student textbooks; was found that Robert Maxwell stole from
the group’s pension fund, then supposedly drowned and disappeared
...

● LukOil (Russia)
● Hyundai (Korea) etc
...

● “2/3 UK investors no longer feel confident investing in the Stock Market as a result of fraud and
accounting problems at Enron and Worldcom” (Survey of UK investors by Cavendish Asset
Management, October 2002)
● “If fund managers are truly to fulfil their duty of seeking to maximise value for their
shareholders, then there will be times – certainly more than at present – where intervention is the
right action to take” (Paul Myners, Institutional Investment, March 2001) à Roles of the
participants etc
...
Arthur Andersen was auditing Enron and disappeared after the collapse; huge chuck of
revenues comes from activities aside of auditing - strategic, tax advice, personal wealth
management functions etc
...

government investigation into Carillion’s management because the executives were paid
ever-increasing bonus packages while the company is going into liquidation
Why is Corporate Governance so important? → “Good Corporate Governance” provides a system of
transparent, efficient and effective monitoring and control over strategic decisions at all levels of
management
...

Purely financial perspective: corporate governance is a line of defence to make sure the
shareholder interests are protected from managerial discretion
...
The fundamental question of corporate governance is how to assure financiers that they
get a return on their financial investment
...
Vishny, 1997)
II
...

“
...
Boards of directors are
responsible for the governance of their companies
...
” (The UK
Department of Trade and Industry, 2005)
The Regulator’s Response in the UK: series of government-commissioned reports
...

● 1994 Greenbury Report
● 1998 Hempel Report
● 1998 Stock Exchange Combined Code 1999 Turnbull Report – assembled all the above reports;
the first attempt to codify the principles of good corporate governance
...

The UK regulation is based on a “comply-or-explain” principle (the way the principles are reinforced) →
companies don’t have to follow every part of the conduct code as long as they can explain the changes to
shareholders and shareholders accept it
...
Separateness rule for the CEO and the Chairman = delegating important responsibilities of running
the company and running the board that monitors the company to different people
...

Corporate Governance in the USA
2002 Sarbanes-Oxley Legislation
● Increase in directorial (=Board) independence, should maintain distance from managerial team
● Constraints on non-audit services of audit firms; rotation of auditors
● “Section 404”
○ Directors report on the effectiveness of internal controls – taking personal responsibility
○ Auditors report on management’s assessment of controls – certification, double signature
○ Potentially unlimited legal liability
● Disclosure of voting records by institutions
Corporate Governance: Current Debates
● Roles of non-executive directors
● Disclosure practices: How transparent can companies be in the light of intensified competition?
● Companies’ relationships with auditors
● Executive remuneration issues
● Roles of institutional investors – Should they take more proactive role by engaging with
companies, approving/disapproving the strategies?
New Perspectives on Corporate Governance
Shifting functions from monitoring (finance perspective) to more collaborate
model (resource support, legitimacy, strategy service)
Monitoring and control
Resource and ‘legitimacy’
Strategy/Service

⇒

Access to resources
Strategic leadership
Strategic restructuring expertise
Corporate venturing

Corporate Governance and ‘Entrepreneurial Leadership’
● Moving from “Wealth protection” function to “wealth creation” roles of corporate governance
...

● Individual entrepreneurship, corporate venturing and innovation
Stakeholder Model of Governance
● The roles of stakeholders in the strategy process
● “Responsible” corporate behaviour
● Business ethics
● Stakeholders and innovation
Readings: The Oxford Handbook of Corporate Governance Chapters 1 , 3

Chapter 1- Introduction
Wright, Siegel, Keasey & Filatotchev
Global financial crisis has reduced confidence in the quality of corporate governance (Walker)
...

Symptoms of the stress within the current corporate governance regime:
- pressures on the businesses to perform short term
- directors now face almost unlimited responsibilities
- financial crisis has undermined the efficacy of audit
Impact of private equity and hedge funds on asset stripping and short termism
● The Walker Guidelines 2007 (UK): require private companies to report the same kind of
information as publicly traded companies
...

However, the term “corporate governance” was coined in 1970s and was made official by the federal
Securities and Exchange Commission (SEC) in the US in 1976
...

→ SEC introduced requirements to disclose information on independence of directors and use of audit,
nomination and compensation committees
...

1980s experiences a political shift to the right with the election of Reagan
- Stalled the Protection of Shareholders Act in 1980
- Counter reaction to the corporate governance project by American Law Institute that proposed
mandatory rules requiring boards to have majority of independent directors
- Criticism stemmed from market-oriented “law-economics” perspective that argued for
governance structures that maximise shareholder value
- In 1992 ALI published modified “Principles of Corporate Governance” that replicated the
existing laws
1980s is referred to as “Deal Decade”, where bidders relied on innovative financial and legal techniques
to takeovers offering generous premiums to shareholders to secure voting control
...

→ 1990s institutional investors began to pressure companies’ CEOs with pay-for-performance schemes
...

2001 Review of Financial Economics discovered failure to address the economics of corporate
governance → Problems associated with the market for corporate control
- US executives, pressured by takeovers and financial markets, experienced “time horizon”
problems → no such problems in Germany or Japan, where corporate governance regimes
focused on long-term relational investment
- Liberalisation of capital markets lead to institutional investors increasingly aiming to diversify
their holdings beyond domestic markets
Weaknesses of corporate governance arising from family control of publicly traded companies were cited
as major cause of Asian markets crash in 1997 → McKinsey reported in 2000 that institutional investors
would pay nearly 30% premium for shares in well-governed companies operating in countries with weak
shareholder rights
...


Lecture 2: “Shareholder Supremacy” and the Global Standards in Corporate Governance
⇒ Why do we have firms (companies)?
Industrialisation – emergence of an institution “a firm”
...

Principal-Agent Relationship and the Firm
Berle & Means The Modern Corporation and Private Property (1932):
The Principal (shareholders) delegates to the Agent (managers) the responsibility for selecting
and implementing an action (production of goods and services)
...

Evolution of modern economic life = Because of the complexity and the transactional diversity of
economic activities, people who own the business do not manage it
...
Senior managers are in a position to
enrich themselves at the expense of the shareholders
Basic Problems of Information Asymmetry
The essence of the Agency Theory is that the Principal has inferior information to the Agent
...
= Ensuring
that managers will fulfil the promise and make the interests of shareholders a priority
Agency Costs and the Firm

●

●

CEOs may derive non-pecuniary benefits (=’perks’) from their actions: managerial incentives are
more complex (salary, bonuses, perks and benefits – which are not directly associated with
performance of the company) à create massive incentives to expand businesses BUT size is not
correlated by profitability, especially when driven by M&A
o managers’ perquisites
o maximisation of growth versus profits
Different risk attitudes:
o shareholders have their risk diversified across a portfolio of companies, which is not
the case for managers
o managers may be more risk-averse and, for example, under- invest in R&D and
innovation = risk associated with innovation is correlated with chance of failure and
redundancy

Adam Smith, “The Wealth of Nations”, 1776
“The directors of companies, being managers of other people’s money than their own, it cannot
well be expected that they should watch over it with the same anxious vigilance with which the
partners in a private copartnery frequently watch over their own”
= Separation between management and control (fundamental principle of corporate
governance) à Inevitable consequences of pursuing economies of scale – corporations are simply
too big for someone to own 100%
Case example: Carillion
Conglomerate with construction at its core, also management facilities
...

Maintained 50k homes for military personnel
£400m Battersea power station
11,5k hospital beds
Maintained 50 prisons
School meal services
In January 2018, the company collapsed under £1
...
5
January 2018 company is worth nothing
BUT Management received high salaries and benefits
Corporate Governance is the process by which society exerts some control on the corporation and
corporate managers through markets or regulatory system
...
)
•
Product and factors markets
•
The internal control system (Corporate Boards, managerial hierarchy, etc
...
)

Instruments of corporate governance
1
...

● Legally entitled to participate in the Annual General Meeting of Shareholders = where main
decisions are approved
● Board of Directors that include the representatives of the owners and has the responsibility to
oversee the direction of the organisation chosen by the CEOs = Fiduciary duty to shareholders to
ensure that the company runs properly, legal responsibilities to protect shareholder interests
● Internal control is the process by which the Board oversees the management of a corporation
● Incentive clauses in managers’ contracts (ESOs; LTIPs)
Principles of “Good Corporate Governance “
● Separate the roles of Chairman and Chief Executive Officer = Board has to be independent
● Not less than one half of the Board should be Non Executive (Independent) Directors, and their
independence and effectiveness should be strengthened = unitary system
● Establish committee dominated by Non Executive Directors and independent of management
(e
...
, nomination, audit and remuneration committees) = creating Board structures
● Short-term contracts for executive directors, etc
...
5 average contract for FTSE100
Board Committees (=Board structures) – all with functional focus
❖ Nomination committee is responsible for recruitment of executive and non-executive board
members, including the CEO
...

❖ Remuneration committee determines director’s remuneration packages, including bonuses, ESOs
and LTIPS
...

Board Independence
● “CEO duality” is when the roles of CEO and Board Chairman are combined
● Non-executive (UK) or independent (USA) directors board members who are not employed by
the firm in any executive position, do not have business links with the firm and not involved in
any long-term relationships with the executives (friends, family, etc
...


2
...

● accumulation of shares by a ‘core’ investor – spotting poor management and starting to
accumulate control in a takeover attempt (pushing out the management team) – creates a
hypothetical threat when the company is underperforming
● corporate take-over is initiated when the managers of one firm, the raider, make an offer for
another firm, the target, that is resisted by the management of the target
● leveraged buy-out (LBO) occurs when investors acquire a relatively large proportion of the
outstanding stock of a firm using debt
...
Internal governance
Board Power
● Board independence and compensation
○ Median board independence is 80%, typically 1-2 are insiders
○ Problem of “gray” outsiders appointed by sitting executives
○ Increases in structural board independence generate larger increases in subsequent CEO
compensation due to higher levels of CEO interpersonal behaviour such as ingratiation
and persuasion
● Boards and committees
○ Compensation committees with more members and that meet more often have better
disclosure practices
○ Aligning incentives with strategic incentives, link pay and performance more directly
Ownership
● Institutional - 70% of total ownership for S&P 1500 firms in 2009
○ Serves as substitute for board monitoring because greater institutional ownership
concentration can lower total CEO compensation
○ Pressure-sensitive investors (those dependent on the business) are unable to influence
compensation consistent to shareholder interests
● CEO ownership
○ Useful for creating alignment with shareholder interests
Future considerations:
- 37% of shareholder resolutions included executive compensation
- At least one member of audit committee has to be “financial management expert”
- “Compensation expert” with appropriate training for compensation committees
2
...
CEO Characteristics
● External successors received on average 13% higher initial salary and bonus than internal
● CEOs facing R&D investment face a “horizon” problem when close to retirement and require
additional incentives to take on the risk
4
...
Institutional governance
Regulatory

●

Firms are not passive recipients of regulations but actually lobby rule makers to avoid fuller
disclosure of compensation
Normative
● Recently, move from stock options to restricted stock
Mimetic
● Adherence to industry-wide practices such as pollution prevention and outputs affects executive
compensation
● CEO labour markets and “bidding up” the compensation
6
...
Consequences
Intended
● Revisions of executive pay mix = discourage inappropriate risk taking and improve operational
performance
Unintended
● Fraud to manipulate accounting and increase stock options value
● Short-termism = future poor earnings news
Chapter 11: Ownership Interests, Incentives and Conflicts
Boss, Connelly, Hoskisson & Tihanyi
Firm ownership has emerged as one of the most compelling forms of corporate governance
...
⇒ These differences create
edit complexity for managers
...
⇒ Pressure managers to make changes in R&D, competitive strategies, executive
compensation, investment and divestment, and other business decisions
...

● Use of bondings mechanisms (golden hellos, golden parachutes, bonuses, stock options) should
align insiders’ own self-interest with those of the owners they serve
● Main bodies of insiders:
○ Executives - top management; often consultants when promoted to partners have to buy
into their position to align interests; the greater ownership executives have, the more
likely they are to employ firm’s resources towards long-term profitability; BUT managers
can become entrenched and willling to maintain high risk profile → need for outsider
control
...

○ Employees; incentivises + enables a psychological bond with the company and its
objectives
...

● Collective control - outside investors are in position to implement monitoring tactics
...

■ Corporations often become blockholders before engaging in takeover or
completing sale of stock
■ Government is either state ownership or SWFs; often has negative effect on
performance of the firm = 1) governments invest often in emerging markets, 2)
creates “soft” budget constraints that impede innovation and increase corruption,
3) lower monitoring results in random diversification, 4) political interests
ex
...

■ Mutual funds = “broad but shallow” approach, financial controls over strategic
○ Venture capitalist / Private Equity / Angel investors

○

Hedge funds - portfolios are protected from declines in market value while maximizing
the gain during growth; often seek deep and lasting changes in organisations
...

Ex post mechanism: outside owners strive to control and monitor behaviour of managers
...
institutional funds, which represent clients
Ways to handle conflict:
- Impression management when CEO displays understanding and sympathy with shareholder
objectives
- Integration tactics for CEO to achieve board membership and deter institutional owners from
using their power to make decisions
- Attracting the “right” investor based on the objectives of the company (short-term vs long-term)
- Ownership management = friendly or unfriendly (ex
...
The probability of replacement following the acquisition
incentivises managers to perform well
...
e
...


●
●
●

●

2 ways: tender offer to shareholders directly or through negotiations with the Board (of Board
accepts = friendly takeover, if Board rejects = hostile)
2 motivations for Board to reject the bid: 1) management fear to lose their jobs; 2) as negotiation
tactic to benefits from a subsequent higher bid
Since 1990s in the UK, decline in hostile takeovers and increase in friendly takeovers ⇒ The
introduction of “best practice” government codes in the UK resulted in stronger internal
governance and reduced the need for takeovers as disciplinary mechanism
Mixed evidence on whether a particular corporate governance mechanism affects the likelihood
of a hostile vs friendly takeover

Public-to-private transactions (PTP): publicly owned entity is acquired and the new company is made
private, creating a new independent entity
...

- New structures usually have stronger governance and incentive mechanisms, closer monitoring
by debt holders, participation of PE and greater equity stakes for executives → explained by
majority of MBI, MBO and LBO transactions
...

○ Misclassification of takeovers as friendly when they are hostile: disciplinary in nature but
do not face opposition → issue regarding the clear-cut definition of hostile vs
...

○ There is no public information regarding private bidding → by examining irrevocable
commitments it is possible to gain insight into the bid process at the private stage →
serve as a signal about the quality of the bid and reduce likelihood of a subsequent higher
bid
● Anti-takeover defences
○ Managerial resistance to bid
○ Pre-bid anti-takeover defence = supermajorities, staggered board appointments1, poison
pills2 and dual class shares ⇒ create higher cost to overcome defences
○ Post-bid defences; friendly shareholders, white knights, litigation → increase successful
opposition; divestment of assets reduces changes of successful defense
1
2

only a fraction (typically 1/3) of the members of the board of directors is elected each year, rather than all at once
make shares of the company's stock unfavorable to the acquiring firm

●

●

Side payments
○ Friendly bid is likely to involve side payments to management or Board, such as offer of
a position in the new structure
Competition policy issues
○ Regulated market for corporate control = antitrust laws regarding horizontal mergers

Lecture 3: Boards, Internal Controls and Shareholder Activism
Carillion Case:
- Biggest asset on BS was Goodwill £1
...

● Establish committee dominated by Non Executive Directors and independent of management
(e
...
, nomination, audit and remuneration committees)
...

Board Committees
● Nomination committee is responsible for recruitment of executive and non-executive board
members
...

● Remuneration committee determines director’s remuneration packages, including bonuses, ESOs
and LTIPS
○ Often outsourced to remuneration consultancies ex
...

Board committees structures are rapidly becoming even more complicated:
● Business ethics committee makes sure that a company complies with laws, regulations and
general social norms and expectations
...

Board Independence
● CEO duality is when the roles of CEO and Board Chairman are combined
● Non-executive (UK) or independent (USA) directors board members who are not employed by
the firm in any executive position, do not have business links with the firm and not involved in
any long-term relationships with the executives (friends, family, etc
...

Internal Control
A process, effected by the company’s board of directors, management and other personnel, designed to
provide reasonable assurance regarding the achievement of objectives in the following categories:
- Effectiveness and efficiency of operations = company is a going concern
- Reliability of financial reporting = information for general public is accurate
- Compliance with applicable laws and regulations
...

Indemnity insurance policy: in times of trouble, Board members will be bailed out by insurance
...

External Audit
● The “certification” role of external auditors: “reporting to shareholders with integrity, objectivity
and independence”
○ Ex
...
to the directors, the
audit committee or an appropriate level of management”
● Non-audit functions and independence of the auditor
● Information disclosure to shareholders and third parties
○ Should it be based on past performance or should it be forward-looking disclosure
● “Enhanced business reviews” debate in the UK
“Does Corporate Governance Really Work?”
The effectiveness of shareholder activism is generally reduced by a ‘free rider’ problem:
- AGM attracts a very small fraction of shareholders (vote by proxy);
- Gathering of information is expensive and time consuming
- Why to bother if you can benefit from the result in any case?
Managerial Incentives
The salary a potential manager can command is assumed to reflect performance to date, but:
● Lack of complete information about the manager’s abilities
● Management is a teamwork, recognising the influence of a single manager may be difficult
...

● There may be other personal utility-creating activities which seem to the manager superior to
seeking performance improvements in the firm = perks and benefits
Market for Corporate Control
Most managers fear takeovers because of the implied or direct threat to their jobs, but:
● Anti-takeover strategy:
○ ‘poison pill’
○ ‘golden parachutes’ - ‘greenmail’, etc
...

New perspectives on corporate governance
Cooperative view of Corporate Governance rather than confrontational:

-

Directors might facilitate access to certain resources (if a Director has banking background,
he/she could connect the company to right lenders)
Visible public figures can help gain legitimacy

Corporate Governance and ‘Entrepreneurial Leadership’
● “Wealth protection” and “wealth creation” roles of corporate governance
● Resource and strategy roles of corporate boards
● Boards as a “knowledge pool”
○ Tech-savvy directors, cultural diversity when operating globally, women on Boards
● The new roles of non-executive directors
● CEO’s corporate entrepreneurship and innovation
From Board Structure to Board Processes
● Are structural characteristics (% of independent directors, CEO/Chairman, etc) really important?
Conflicting evidence
● Emphasis on board processes (engagement, involvement, support and advise)
● What should a Chairman do?
● Strategic roles of corporate boards: from monitoring to legitimacy?
U
...
defense contractor Raytheon’s explanation for the power it invests in its CEO:
“The Company has found that in our industry having a combined Chairman and CEO is
particularly advantageous when doing business internationally, especially with foreign
government customers who value unified leadership and a single ultimate executive decision
maker “ - Raytheon Company Proxy Statement (2010: 7)
Legitimacy in Product Markets
● Whereas an organization pursues regulative legitimacy in order to demonstrate compliance with
governance rules, it pursues cognitive legitimacy in order to reduce stakeholders’ uncertainty
about the organization
● An organization possesses legitimacy within the cultural-cognitive sphere when external
assessors see the firm as acting in ways that are comprehensible, recognizable, and culturally
supported
...

● It is entirely feasible that firms will respond to cultural power distance in their foreign markets by
altering their board structures to improve cultural-cognitive legitimacy among customers in those
markets
...

Gaining legitimacy through corporate boards
Structural power distance between a firm’s CEO and its board is positively associated with the
firm’s exposure to cultural power distance in its product markets
...

⇒ Dismantle the fortress of agency theory by adopting a process-oriented “sensemaking”
...

Major question: how does a small group of people run a large company?
Periods of recent business history is highlighted by significant changes
...

1) Economic and political change
● Thatcher’s deregulation of financial markets had significant effect on the City of London
● Crash in dot
...

● The scale has changed in terms of sales and assets internationally → implications for
directors, skills and competencies
5) Technological changes
● Tech and database manipulation
● Investor rating agencies and risk assessment organisation
● “Nanosecond” shareholding

Cross-fertilisation in corporate governance:
Formal structure

Behavioural structure

Behavioural process

Org - inwards

Economics: designing
optimal incentive and
monitoring structures

Power: how positions
affect power/politics
within organisations

Social psychology: the
biases of decision-making

Org - outwards

Legal: creating and
enforcing regulations for
societal benefit

Social networks: power
and info flows in inter
organization networks

Symbolic management:
understanding symbols and
compliance with social
norms and values

1980s average Board helf 4-6 meetings per year, commonly three hours long over lunch
...

Relationship between CEO and Chairman:
- Chairman acts as “back-stop” for CEO when those roles are separated
- Requires clear lines of communication and boundary lines, as well as respect, trust and due regard
- Chairman also has the following broader functions: ensuring board effectiveness is
reviewed annually, conducting annual performance reviews, giving personal feedback to
directors
...


Chapter 7: Process matters - Understanding Board behaviour and effectiveness
Terry McNulty
Key to making Boards work better: engaging in constructive conflict and avoiding destructive conflict;
working together; being involved in strategy; and addressing decisions in comprehensive fashion
...
⇒ 3 critical Board roles: service, strategy and control
...

● Boards that had power equal to or greater than CEO, described CEO as being more efficient,
better informed, more careful and quicker in decisions than weaker Boards
○ Power sources: relevant expertise and experience, director will and skill
● Participative Boards are associated with higher level of company financial performance
● Minimalist Boards - those where non-executive directors have limited involvement and influence
=/= maximalist Boards
Corporate directing = strategizing, governing, and leading
...

Board directors are often blamed for the lack of involvement - meet episodically through an informal
leadership structure and have little interaction with each other
...


Chapter 8: Board committees
Philip Stiles
Governance mechanisms: Audit, Remuneration, Nomination committees (+required by law/regulation)
...

Audit committees
- Knowledgeable about the business environment + finance/accounting
- Meet no fewer than 3 times a year
Primary role: ensure integrity of financial reporting and audit process
...

- Review the director's remuneration report - for quoted companies this report is submitted
to shareholders for approval at AGM
- Firms with higher paid compensation committee members have greater CEO compensation and
lowe incentives ⇒ evidence that management pay was significantly higher in companies that had
compensation committees ⇒ desire of remuneration committees to demonstrate ex-post that the
pay is in alignment to governance codes (rather than to strategic profile)
Nomination committees
- Primary role: Lead the process for Board appointments and make recommendations to the Board
- Identifying and nominating for approval of the Board candidates to fill Board vacancies
as and when they arise
- Should meet at least 2 a year, one close to the end to particularly reconsider whether
directors retiring by rotation should be put forward for re-appointment at the AGM

-

-

-

Further governance duties
- Conduct the Board’s annual governance review
- Monitor compliance with governance guidelines
- Establish process of Board’s self-assessments
- Recommend director compensations
In practical terms, CEO or other executives are usually best at identifying suitable candidates ⇒
the role of nomination committee, therefore, is not to allow CEO recommendations to overlay
director selection process
Diversity is argued to have strong benefits: broadened range of task-relevant resources, crossfertilisation of ideas and synergetic combination of resources + Ensure composition optimal in
terms of functional and professional capabilities
- S&P 500 only 16% of directors are women
- Firms with nomination committees are more likely to have more foreign and independent
directors, but not more women

Interactions between committees
- Director overlap - the extent to which directors sit on a number of committees within the
company
- Benefits = transfer of knowledge across committees
- Dangers = same outside directors should not sit on multiple committees to avoid much
influence focused on one individual
Audit, Remuneration, Nomination = “committees of oversight”
- Overcoming self-serving and manipulative behaviour
- Resource dependency theory: states that Board’s main role is to assist management in securing
key organisational reccourses
- Demographic similarity of Board directors affects independence ⇒ similar social demographic
encourages mutual reinforcement or “consensual validation”
- Understanding the real drivers of Board effectiveness
- Behavioural dynamics, web of interpersonal and group relationships
- Function of composition, authority, resources and diligence
- Substantive vs
...

Auditing evolved from an activity aimed primarily at fraud detection and direct inspection of transactions
to a system of second order “controls of controls:, concerned with verifying systems of governance and
management control
...

Classic agency problem: auditors as “gatekeepers” that contribute to reducing the cost of agency problem
by enhancing governance mechanism
...

- Audits increasingly adopted a systems based approach: examining information flows and internal
controls
- Auditors now need to conduct analytical reviews, understanding the business environment of the
entity
Levels of audit risk:
- Inherent risk = financial statement misstated despite of internal controls
- Control risk = material misstatements will not be prevented by internal controls
- Detection risk = auditor’s measures will not detect material misstatement

Elements of audit quality: 1) competence of the auditor, 2) motivation to report negatively, should the
need arise i
...
independence
...

- Growth of consulting services by auditing firms jeopardises independence
- Sarbanes-Oxeley Act aimed to re-establish auditing as a primary role of auditing firms;
companies in the UK and US are required to disclose details on both audit and non-audit
fees
- Number of reforms in the UK and Europe have increased emphasis on independence of auditing
- Eg
...

- Can be defined as public good because all firms above certain size must have an external auditor;
but auditors also have their own incentives
- High degree of concentration: in 2003 Big Four audited 78% of US public companies + in 2010,
95% of FTSE 250 in the UK ⇒ may lead to diminishing quality of auditing
- “Too big to fail” potentially creates a moral hazard
Corporate governance is described as “accountant’s friend”
- Creating of markets for internal auditing - firms begin to outsource this function
- New forms of reporting, such as sustainability auditing
- Audit risk model generated markets for advice and assurance of internal audit
- Expands beyond technical aspects into “quality objects”

Lecture 4: “Relationship Model” of Corporate Governance and Family Control
International Patterns of Corporate Governance
● UK/USA models of “shareholder activism”
● “Relationship Governance” in Germany and Japan
● Models of family control (India, South-East Asia)
● Governance in business groups (South Korea, Japan)
“Shareholder Activism” in the UK/USA
Shareholder activism - shareholders take an active role in the firm’s operations and attempt to secure
drastic changes in the organisation when performance declined
...

“Relationship Governance” in Germany and Japan

●
●
●

Banks are very active shareholders in industrial organisations (their clients)
...

● Germany: German boards are two-tier for firms with over 2,000 employees
...
→ System of codetermination
...
VW rule = places reserved for local authorities on supervisory board
● Japan: Banks are the main relationship investors, offering internal voice and stable shareholding
virtually without exit
...
AGMs are usually a
mere formality, and all directors are nominated by an insider stockholder group and can exercise
a significant voice
...

Relationship Model of Governance
Advantages
●

●
●
●

Banks and industry partners may obtain
information that helps them to voice at
Board meetings = Banks are informed
shareholders
Banks can aid company restructuring in a
liquidity crisis, rather than seeking the
repayment of outstanding overdraft
Banks and industry partners encourage
long-term views by senior managers
Customers and suppliers have very
significant voice but not through
traditional shareholder channels
...

“Dual roles” of banks
These problems are particularly
pronounced in family-controlled firms
...
Volvo, Scania,
Ericson etc
...
Raju with the “Entrepreneur of the Year” award and
“Golden Peacock Award” for the best governed company
❏ Audited by an Indian affiliate of PwC
❏ 2008: Satyam Computers announces buying a 100 per cent stake in two companies owned by the
Chairman Raju’s sons – Maytas Properties and Maytas Infrastructure (power stations)

❏ The proposed $1
...
He and the
Managing Director (Mr Rama Raju, his brother) confessed that the company’s cash and other
information in balance sheet have been inflated and fudged = 10 years of fraud
❏ Analysts in India have referred to the Satyam scandal as “India’s Enron”
Implications for Corporate Governance
● Family control is a typical example of “relationship governance” based on mutual trust, kinship
and personal ties
● May be helpful at early stages of the firm’s life-cycle (e
...
entrepreneurial growth)
● At later stages, family owners may have too much “emotional wealth” associated with the firm
● Without proper checks and balances, family interests may dominate over interests of external
shareholders
● Decisions based on family ties may underpin cases of managerial misbehaviour and destroy value
for shareholders
● When is the right time for a transfer of family control to external managers/investors?
Business Groups Around the World
A collection of legally independent firms that are linked by multiple ties, including ownership and/or
social relations, that are used as relationship governance mechanisms
● Business houses in India ex
...

● “Tunneling“: controlling shareholders transfer profits and assets out of firms for their own
benefit
● Cross-subsidization: healthy parts of a group help out the loss-makers
...
g
...


Success stories: Samsung - fast growing, market dominance in many segments ⇒ but son of the founder
recently charged with corruption
...

Relevant theories: agency theory (Fama and Jensen, 1983), stewardship theory (Davis et al
...
, 2007)
...

- “Contractual governance” = ways in which owners (principals) monitor the management (agents)
through formal written agreements designed to hold management accountable
- “Relational governance” = based on informal social controls, mutual trust, shared vision,
commitment to success of the company
- Family governance practices = mechanisms to facilitate family relationships with the business
1) Effects of family ownership on performance
- Stewardship theory - family owners have long-term commitment and higher personal investment
than non-family owners = likely to be better stewards in terms of looking after firm’s interests
- Three rationales explain positive relationship 1) parsimony - people are more prudent with their
own wealth, 2) personalism - firms that concentrate authority are less subject to external
constraints, 3) particularism - culture, resilience, tacit knowledge, flexibility
2) Effects of family ownership on contractual governance
- Predictions: 1) boards are smaller, with fewer independent directors, 2) member of the family is
likely to serve as CEO and/or Chairman ⇒ evidence showed family firms have more independent
directors + greater likelihood of CEO equity-based pay + less likely to establish audit committees
- Depends on the firm objectives: retain family culture vs
...

- In developing countries, emerged in order to fill institutional void and to mitigate governance
failures
...

2) Pyramidal ownership - parent company exercises control over affiliates through hierarchy
...

- Aligns affiliates incentives with the group’s
- Facilitates sharing of knowledge and resources
- Protects affiliates from short-term failures
Horizontal governance mechanisms
1) Cross-shareholdings (direct or indirect through a complex, pyramidal or circular chain)
...

3) Relational governance - high level of relationship-specific assets and interim trust
...

- Most common in countries where protection for minor shareholders is weak (China, India etc
...


-

Conflict with profit maximisation agenda of individual affiliates but increase overall profitability
of the group
3) Mutual entrenchment - the extent to which managers are not subject to discipline from the full range of
corporate governance mechanisms such as Board monitoring or threat of takeover
...

- Managers collectively pursue their own interests (making themselves difficult to replace) at the
expense of shareholders = more autonomy in decision-making and exercising their own benefit
Variations across different groups
1) Family controlled business groups
- Prevalence of pyramidal control structure - families can employ limited investment to control
large amounts of assets to maximise their own wealth
- More subject to severe agency problems
- Pyramidal ownership has negative effects only when managers have high level of control
rights
- Horizontal mechanisms do not function effectively because family owners and directors do not
exert same level of control over one another
- Family ties allow founding family to abuse their control rights and result in inefficient allocation
of resources
2) State-owned business groups
- Associated with generally low level of monitoring intensity
- Often have pyramidal ownership to facilitate control and monitoring
- Extensive horizontal linkages can enhance monitoring control over state agents who might neither
act to maximize shareholder benefits neither to protect state assets
3) Widely held business groups
- Bank ownership is linked positively to performance at high ownership levels
- Concentrated ownership implies strong strategic control
- Cross-shareholdings facilitate productive exchange and reduce opportunism

Lecture 5: Stakeholder Model of Corporate Governance
Corporate stakeholders are individuals and entities that can be influenced by, or can impact on, a firm
...
M
...

Managers must satisfy the following:
a
...
Care for the interests of employees (working environment, training, retirement arrangements,
etc
...
Needs of environment and the local community;
d
...
Legal and regulatory requirements
Stakeholders’ Channels of Influence
● Monitoring executives
● Incentive systems for executives
● Exit = shareholders through sale, labour through leave, suppliers/customers leave
● Legal and regulatory
● Bargaining power (in relevant markets)
Stakeholder salience ⇒ The degree to which firms should give priority to the claims of different
stakeholders depends on their salience:
● Stakeholder’s power to influence the firm, usually market power
● The legitimacy of a claim (a stakeholder's risk of loss)
● The urgency of the claim, determined by the dedicated nature of the asset supplied to the firm
...
Corporate Social Responsibility (CSR) principles
2 competing models of CSR:
1) Business legitimacy to society
2) Philanthropy and voluntary efforts to do “good” in environments and social spheres
Society provides ‘license to operate’ and firms can be sanctioned:
- social licence to operate (SLO) refers to the level of acceptance or approval by local communities
and stakeholders
- levying of corporation tax and regulation on health and safety and the environment
- Contrast to: Andrew Carnegie’s principles of charity and stewardship (his 1899 book ‘The
Gospel of Wealth’ set forth the classic statement of corporate social responsibility)
...

Corporate responses to CSR debates:
● Ethical CSR = compliance with the firm’s economic, legal and ethical functions
...

● Strategic SCR = the potential to increase the social performance of business by translating the
identified social needs into a business case
...
4m worth of business from 41
companies on the grounds of human rights, animal welfare, arms trading, sweatshop
labour, environmental considerations ⇒ positive impact on overall profits = private
customers joining for ethical reasons
2
...

Individual level - the behaviour and actions of individuals within the organisation, in particular the role of
managers in the strategic management process
...
Statoil), achievement of CSR goals determines annual bonus and forms part of
performance review of CEOs
...

Organisational hybridity: non-profit organisational body spans as means of securing resources
(depending on whether they serve public or business purposes) ⇒ governance implications
...

CEO = operational leadership
...

CEO = empowered by Board but vulnerable to
changes

Unitary; innovation

“Entrepreneurial”

Board & CEO = effectiveness and efficiency, success
of core business
...


Pluralistic; innovation

“Emergent cellular”

Small core Board
...


Regulation
- Model of “charity” - heavy emphasis on transparency and financial controls to safeguard
charitable gifts; while minimalist system for other nonprofits
- Strict limits on admin and fundraising costs, and on political/business activities ⇒ challenged by
the growing hybridity
- Emergence of self-regulation and voluntary codes ⇒ “regulatory society”, decentred approach to
regulation (Black, 2002)
Chapter 28: CG and Labour
Pendleton & Gospel
CG ⇒ power relationships between owners, managers and labour
...
) ⇒ “common law” vs “civil law”

⇒ Patterns of labour representation affects the governance and ownership structures (ex
...

Involvement of labour in CG
- 18/24 EU countries have legal mandates for workers to be represented on the Board
- Germany - codetermination
- Issues with Board representation: “dilute” pursuit of profits, leading to economic
inefficiency; lack of expertise, exclusion by other directors
- Other ways of employee involvement: shareholder bodies, involvement in management of
pension funds; or, direct ownership of company shares
- In France, shareholders with over 3% have rights of representation on the Board
- Information sharing by employees
- Germany, France, Netherlands mandate managers to disclose information to employees
- Labour may form alliances with managers to protect themselves against investors
(prevent takeovers and replacement)
How labour is affected by CG
1) Allocation of resources and returns
- In liberal market economies, favours shareholders not workers
- Incentive pay and active market for corporate control
- Rise of debt finance; share buy-backs; special dividends - constrain cash flows and ability
of managers to distribute resources to employees
2) Decision-making time frames: short-termism
3) Nature of business practices and strategies
- Reluctance to make investments in long-term human capital in liberal market economies
Employment
- Constrained capacity to offer long-term employment & reduced employee commitment ⇒ breach
in PC
- M&A lead to employment cuts, leaving ill-fit employees, reducing quality of labour
Rewards
- Option rewards can encourage risky behaviour
- Growth in executive pay can be constrained through employee involvement on remuneration
committee
Skill development and work organisation
- No employment for life → no company-specific skills
- Rise in flexible workforce and subcontractors with no representation
Industrial relations
- Reduction in union voice, collective bargaining is discouraged

Chapter 31: Financialisation and its limits
Wood & Wright
Financialisation = pattern of accumulation whereby profits accrue through financial channels rather than
through commodity production and trade ⇒ changes in CG = pressure on managers to prioritise owner
interests
...

Regulation theory (Jessop, 2001): seeking to explain underlying conditions for growth and prosperity ⇒
periods of growth are made possible through a supportive institutional framework ⇒ assumes that
institutions operate together coherently, which is not the case in many countries
...

→ purpose of contemporary firm
→ nature of professional managers (opportunistic and self serving?)
→ relevance of Boards for CSR
→ need to evaluate the process by which individuals obtain Board positions
- Both CG and CSR are shaped by institutional context
- Explicit CSR = corporate activities, voluntary policies and strategies; implicit CSR = norms and
values emerging from society itself
- Better CG and CSR are both associated with improvements in corporate financial performance
- Prospects for convergence between the two concepts: hybridization between people-friendly
business practices and traditional CG models
Board of Directors and CSR

-

Become more actively engaged with CSR
Diversity affects CSR
- Boards with more independent directors lead to higher environmental and social
performance
- Higher proportion of women was found to lead to higher charitable contributions

Ownership and CSR
- Agency problem: absence of substantial shareholders permits managers to engage in prosocial
activities at expense of shareholders
- Insider ownership reduces social responsiveness
- Majority shareholders are interested in protecting long term propensity through CSR (enhances
reputation)
- Family controlled companies have better environmental performance
- Higher percentage ownership by institutions (pension funds) is associated with higher CSR

Lecture 7: Corporate Governance in Emerging Markets
Transition Economies: Institutional Context

● Different setting of constitutions, development
● Centrally planned, command economies, state controls the economic life => profiled state
ownership
○ East Germany, Hungary, Russia : agriculture facilities were owned and controlled by the
state
○ Market structures didn't existed in those structures : state pricing committees
○ Employment would have no alternative : only public with wages set by ministers
○ In growing economies, state-owned economies are a common practice
● ⇒ political pressure to facilitate a rapid change towards qualifying EU entry standards
⇒ One solution is “Hybrid” corporate governance = people from the past such as managers + new
individual shareholders
Transition Economies: Emergent New Owners
● Mass (“voucher”) privatization (Russia, CEEs)
○ mainly manufacturing industries;
○ a “give-away” privatization mode;
○ strong position of insiders
● “Loan-for-shares” scheme in Russia
○ mainly resource-rich industries;
○ partial “give-away” privatization mode;
○ strong position of dominant individual investors (“oligarchs”)
● Direct State involvement (China, Russia, Brazil)
○ key industries (resources, finance, media);
○ increase in “administrative governance”
The vast majority of firms in Russia were privatized through “give-away” schemes which left assets
under the control of insiders:
- Employees and managers are the predominant groups of shareholders
- Companies’ boards are dominated by insiders
- State ownership was reduced to a minority holding
- Share ownership and board involvement of financial institutions and foreign investors do not
counterbalance insider control
- Employee share ownership is gradually transferred to managers
Research project 1995-2003 conducted in private companies:
- Insiders took advantage of mass privatisation
- Private individuals emerged later - most often, friends and family of insiders
- Other entreprises = cross-holdings, customers and suppliers
- Most tangible outcome: state control from 100% in 1991 to 9% in 1995 = massive transformation
of the fundamentals of corporate governance

-

Financial institutions still rudimentary in 2003; only countries that joined EU were able to
develop financial markets
Ownership got transferred to employees and managers ⇒ then got transferred from employees to
managers while outsiders started to gain ownership

‘Loans-for-shares’ and second phase privatisation have transferred state assets to a number of private
large-block investors:
● Industrial conglomerates in the key sectors of Russian economy
● Low insider ownership; private dominant owners
● Stock-market listing and minority shareholders
● 70% of board members are non-executive directors, but only 20% are independent from owners
● Rapid development of integrated Financial Industrial Groups (FIGs)
Ownership Structure of the Largest Listed Enterprises = Natural Resources Sector

- Large stakes (explained) = no supporting institutions to protect investment
...
g
...
)

●
●

Vertical (backward and forward) integration
Internationalization through JVs (TNK-BP) and FDI (e
...
, Norilsk Nickel and Gold Fields SA)

Areas of Concern
- Abuse of market power
- Concentration of control with a small number of owners/directors
- Lack of balance in Board composition
- Deficiencies in accountability and audit
- Lack of protection of minority shareholders
⇒ State regulation and rule of law were considered a powerful counterbalance to insider control and
power of oligarchs
⇒ However, State involvement in business life in Russia has created a number of new problems:
● Move from “setting the rules” to direct involvement in decision-making and governance
● A “hybrid governance”: Western governance systems combined with administrative control
● Involvement in strategic decisions, such as M&A, divestments, product diversification
● Administrative impact on competition (selective lawsuits and tax claims) and FDI
Case Study: Gazprom
- Controls a third of the world's gas reserves
- Accounts for 92% of Russia's gas production; Worlds 3rd largest corporation
- Annual earning in 2006 were £31
...
002%
- Listed abroad (New York, Frankfurt, and London)
● Chairman ofthe Board -Russia’sSpecial Presidential Representative for Cooperation with the Gas
Exporting Countries Forum
● Board members include 2 state ministers, chairman of state-owned bank, etc
...


-

2016 Operating profit RMB 78 bln
71% of shares owned by (state-owned) China Petrochemical Corporation
Listed in Hong Kong, minority shareholders include BlackRock, JPMorgan, Schroders
10-strong Board, with 4 independent directors, but strong prior connections to economic and
political elites
...
4 billion (sector: Technology)
- Dalian Wanda acquired US Legendary Entertainment for $3
...
7
billion (sector: Technology)
From Principal-Agent to Principal-Principal Conflicts
● Principal-Principal conflicts emerge between dominant owners and minority shareholders
● PP conflicts are often found in transition and emerging economies
● Associated with concentrated firm ownership and weak legal and institutional protection of
investors
● Weak institutions create incentives for controlling shareholders to extract “private benefits of
control” – benefits at expense of minority investors
○ “Tunneling” of profits = financial benefits + geostrategic = Gazprom as a political tool
● State ownership a major source of PP conflicts
Governance Aspects of Principal-Principal Conflicts
● State as an owner may pursue non-economic objectives
● Social goals: preserving employment and social provisions
● Political goals: business strategy as a tool of political influence
● Former “Red Directors” often occupy key managerial positions
● Interests of private (minority) investors have a secondary importance
● This governance model may limit external investment and strategic support by Western investors
and companies
● Transparency is a key aspect of governance reforms in countries like China, Russia, Brazil and
India
Are Governance Systems Converging?
● Cross-border mergers and acquisitions (Renault-Nissan)
● Dual listings (Russian firms’ ADRs on the NYSE and LSE)
● Corporate reforms (South Korean Chaebols)

●
●

Pan-European Governance Regulation
Global Codes of Corporate Governance (e
...
, OECD)

Readings: The Oxford Handbook of Corporate Governance - Chapter 29
Chapter 29: CG and Principal-Principal conflicts
Peng & Sauerwald
PP conflicts: goal incongruence between controlling and minority shareholders
...

1
...
What are consequences of PP conflicts?
a) Managerial talent: controlling shareholders run their business empires refusing to delegate →
lower financial performance results from entrenched managers (especially the case for family
firms)
b) M&A: controlling shareholders with stakes in both companies benefit, while neglecting interests
of minority shareholders
c) Executive compensation: U-shaped relationship between ownership concentration and executive
compensation; linking pay to performance creates PP conflicts; especially in FF
d) Tunneling / self-dealing
3
...


Lecture 8: Corporate Governance in Japan and East Asia
Japan and South Korea = “relationship” / “network” model of corporate governance; often considered
superior to the shareholder-supremacy Anglo-American model (too short-term, transactional,
confrontational) =/= collaborative way of doing business
...
Samsung)
...

South Korea:
● The economy is dominated by industrial groups (chaebols) similar to Japanese keiretsu
● They represent highly diversified holdings often controlled by a family
● Very opaque systems of ownership and control; “pyramids” of cross shareholding
Statistics:
- Japan is 36th in the International ranking of CG (UK is 1st, followed by Canada, Ireland, US)
- Japan is 21st in the ranking of Clarity and Completeness of CG Requirements (1st - UK, US,
Singapore, Australia)
- Global Financial Centre Index: Tokyo is 5th (London is 1st)
- Tokyo Stock Exchange is 3rd in the world by Stock Market Capitalisation
Japan in Context
1) Although China overtook Japan in 2011, Japan is still the 3rd largest economy in the world in
terms of GDP after the US and China, and per capita GDP is still larger than that of China
...

4) History of Japanese Law
1
...


2
...
The Civil Code was imported from France, while the
Commercial Code was modelled on the German Code
...
Stage 3: After the end of the Second World War in 1945, and under the Occupation,
Japan received a revised Constitution and other laws, such as the Securities and Exchange
Law, modelled on the US law
...

● For this type of governance structure, a company has a board of directors and the board of
kansayaku corporate auditors
...
However, a company is not required to have any external directors (shagai
torishimariyaku) under Japanese law
...

● However, it has not gained popularity among Japanese companies, and only approximately 60
listed companies have adopted this type of governance structure
...
Each committee consists of three
or more directors, and a majority of each committee must be external directors
...

CG Type 3: Company with Audit Committee with Supervisory Functions
● This third type of governance structure was made available with effect from 1 June 2015, when
the amendments to the Companies Act took effect
...
Instead, the audit committee is given certain supervisory functions as to the
nomination and compensation of directors (including the senior management)
...


Corporate Governance Reform in Japan

●

●

●

Forms a part of the ”Third Arrow” (Japan Revitalization Strategy, Revised in 2014)” of
“Abenomics” (the economic policies advocated by Japanese Prime Minister, ShinzōAbe), placing
a high priority on the enhancement of corporate governance of Japanese companies
...

New Corporate Governance Code, based on the “comply or explain” came into effect in June
2015 ⇒ for the first time in Japanese history, shareholder interests were emphasized!

Introduction of the Corporate Governance Code and Stewardship Code in Japan
● Keidanren (Japan Business Federation) had been fiercely resisting the introduction of the
corporate governance code, but those concerned about the endangered global position of the
Tokyo Stock Market and Tokyo as an international market, had been pushing for its introduction
...

Too early to assess the effectiveness of both codes
- The Corporate Governance Code is modelled on the OECD Principles of CG
...

- Borrowing other systems –received wisdom but effective? –Does ”one size” fit all?
- What is the reform trying to achieve?
- Local “experts” are adamant that the CG reform is not a reaction to any scandals –unlike the
various reforms introduced after the recent financial crisis in the West
- But Japan, like other countries, is not without corporate scandals
Case study: Olympus Scandal
● Massive losses in the early 1990s
○ Olympus made losses of more than US$1
...

● Concealment by the presidents
○ Top management concealed the losses for over 20 years through three presidents
○ All three presidents came from a small office in Olympus’ finance department that was
responsible for investments
○ No information on the losses was ever disclosed to the board of directors
● The scheme unravels
○ In 2011, Olympus felt safe enough to appoint an outsider as president

○

●

●

●

●

February 2011: Michael Woodford (a UK employee of Olympus) was appointed
president; later made CEO
○ Reports of impropriety surface: a small magazine published embarrassing articles on
Olympus’ large losses on its recent acquisitions
○ These articles were hidden from Woodford - didn’t even speak Japanese!
Outsider president fired
○ Woodford requested PwC London to examine adviser fees paid for acquisition of Gyrus
Plc
...

○ 14 October 2011: board fired Woodford as President & CEO
...

○ Woodford travelled back to London, passed information to the SFO, broke story to the
FT and contacted law enforcement in UK and USA
...

○ 26 October 2011: Kikukawa resigned
...
Foreign institutional investors were angry that
Olympus was being managed by a “discredited board”
...
e
...

○ April 2012: entire board replaced:-New chairman: former SMBC executive
...

Impacts of the scandal
○ By 2012, Olympus’ share price had dropped by 75-80%
...
6m by Japanese authorities
...

○ SFO charged Olympus and Gyrus PLC with offences of making a statement to an auditor
which was misleading, false or deceptive
...

● One size does not fit all –Are these reforms aimed at improving the performance of the TSE by
making its listed companies more transparent thereby making them more attractive to foreign
investors, and at the same time trying to deal with the ”dark side” of finance?
● What direction will Japan seek in this highly globalized world?
South Korea in Context
● One of the most dynamic economies, the “the Miracle on the Han River”
● 4th largest economy in Asia and the 11th largest in the world
...

● The holding is based on a system of cross-shareholdings when one member owns shares in
another
...

Governance Reforms in Korea
● “Korea discounts” stemming from an opaque governance structure and underwhelming
shareholder returns prompted government-led reforms in South Korea
...

● One potential model for restructuring would be to create a vertical ownership structure with a
holding company at the top, replacing the current spiderweb of interlocking shareholdings
...

Singh and Zammit, 2006 : “Corporate Governance, Crony Capitalism and Economic Crises”
❖ The Asian way of doing business was the deep cause of the Asian crisis
➢ IMF reform programme suggested : abandon Asian business model and adopt US
corporate model
❖ US and IMF “structural theory” of economic crisis in the Asian countries
➢ Crisis triggered by macroeconomic imbalances but fundamental causes rooted in the
deficient institutional structures of these economies
➢ Most important defects of the Asian way were regarded as follows: (a) poor corporate
governance, (b) poor state of competition, (c) close relationship between government,
business and banks, which was deemed as indicating crony capitalism
❖ Reasons : poor corporate governance and poor competition enabled Asian firms to disregard
profits in their pursuit of market share, leading to over-investment which in turn generated a crisis
➢ Close relationship between businesses and banks and the government ⇒ few leading
families able to control corporate assets on a vast scale through various legal and
financial devices
➢ High (external) debt–equity ratios (vulnerable to external economic shocks)

❖ Developing countries (DCs) advised to abandon the Asian business model and adopt US model
based on shareholders’ wealth maximisation subject to the discipline of liquid stock markets
➢ Change corporate governance, labour laws, financial system based on “relationship
lending” and, the nature of the relationship between government, business and finance
❖ Greenspan/Summers/IMF thesis (GSI thesis) : critique of corporate governance and crony
capitalism in Asian countries
➢ Morck et al
...
’s reasoning : as long as capital markets are not subverted by the controlling
elite, but function freely, they constitute the best means of achieving economic growth
❖ Government and Businesses : close relationships conducted through sectoral “deliberation
councils” used to coordinate investment plans ⇒ system of “administrative guidance” guardians
of the national interest
➢ Japan/Korea : “main bank” system – long-term relationships between firms and banks
➢ Lifetime employment ⇒ imperfections in the labour market yet benefits higher than cost
❖ Critical analysis of the US corporate model : it is not only unsuitable for DC economies but,
arguably, also inappropriate for the US economy itself
➢ Liberalisation in Asia but significant path persistence :
➢ (a) the nature of share ownership : family owned, or concentrated ownership (long-term)
➢ (b) ownership, control and company performance : widely held firms have the worst
business record (yet IMF assimilates it with good corporate governance) + (Joh 2003) for
Korea : profitability generally increases as ownership by controlling families increases
➢ (c) crony capitalism : no robust association between crony capitalism and financial crisis
(Assets as a proportion of GDP controlled by the top 15 families amounted to 84
...
2 percent in Malaysia) + (Sweden, almost 60 percent of
industrial assets controlled by Wallenberg family)
➢ (d) the relationship between corporate governance and the stock market : large
corporations in developing countries raise a large part of their finance on the stock market
(more than that of developed country firms ⇒ no argument here)
➢ (e) the state of competition in product markets : many leading developing countries have
high three- or four-firm concentration ratios compared with advanced countries
❖ Developed countries have strong stock markets too
...

○ The regulatory environment deals with the laws and regulations that promote or restrict
the behavior of firms and consumers
...

○ The cognitive environment specifies how “things should be done” in relation to cultural
factors
...

Regulatory Institutions and CG:
● “Law and economics” perspective – a primacy of laws and regulations in shaping firm-level
governance
● Focus on institutional/legal arrangements in protecting the rights of minority investors
● But even within this regulatory tradition, there are differences in national approaches to enforcing
“good governance”
● “Soft law” approach: voluntary “best practice”, Codes of good governance
● “Hard law” approach: “good governance” is enshrined in legal rules and court decisions
The “Comply-or-explain” Approach
● Trademark of corporate governance in the UK
...
It consists of principles (main and supporting) and provisions
⇒ principle of equifinality
The Listing Rules require companies to apply the Main Principles and report to shareholders on
how they have done so
...

The reasons for it should be explained clearly and carefully to shareholders, who may wish to
discuss the position with the company and whose voting intentions may be influenced as a result
...

○ Create critical mass of committed owners
...
publicly disclose their policy on how they will discharge their stewardship responsibilities
2
...
monitor their investee companies
4
...
be willing to act collectively with other investors
6
...
report periodically on stewardship and voting
“Hard” Corporate Governance in the USA: 2002 Sarbanes-Oxley Legislation
● Increase in directorial independence
● Constraints on non-audit services of audit firms; rotation of auditors
● “Section 404”
○ directors report on the effectiveness of internal controls
○ auditors report on management’s assessment of the controls
○ potentially unlimited legal liability
● Disclosure of voting records by institutions
Europe:
● Is the model of shareholder control still valid?
● Should regulators appoint auditors?
● Should bank boards have a formal duty of care to parties other than shareholders?
○ Italy, France - an enhanced model of
Corporate Governance in Emerging Markets

⇒ no such thing as emerging market economies - whole range of mixtures of institutions and
infrastructure with different levels of development ⇒ powerful relationship between level of economic
development and institutions
- Differences in legal frameworks in emerging markets
...
g
...
g
...
g
...
g
...
g
...
g
...

Relevance for IB research:
● Efficiency is only part of the firm’s legitimation process
...

● Institutional poly-centrism: it is important to consider multicountry institutional effects,
especially when EM firms are involved in global markets
...

Three big questions
❏ “International Mobility of Governance”:
- If firms in EM and Russia respond to multiple institutional pressures in DM host
countries, will their governance “import” Western standards? Will they “export” their
own standards to EM? (e
...
Do these dimensions complement or substitute each other?

❏ • How polycentric institutional systems in EM affect the inter-relationship between CG and
business strategy in EM MNCs?
- Are institutions and firm-level governance models in EM conducive for imitation or
innovation? (Kaspersky Lab in Russia; a growing applications of AI in China etc)
Readings: The Oxford Handbook of Corporate Governance - Chapter 2,4,5
Chapter 2: Regulation and comparative CG
Liberalised institutional environment:
- Important economic transformations - privatisation and deregulation
- Shift from interventionist state to regulatory
La Porta et al, 2000: law and economics perspective - dispersed ownership requires high investor
protection (stock exchange regulations, corporate law, high accounting standards)
...

Impact of regulations on CG
Agency theory & Controlling shareholder debates
a) Empowerment of boards of directors ex
...

Main weakness in the interaction between political institutions (immediate beneficiary of a strong capital
market is a minority of wealthy capital owners)
...
Power: during financial crisis, popular opinions may seek to punish
financiers and their institutions; can induce institutionalisation of anti-capital rules
c) Business elites vs masses: thinking and voting can be influenced by envy
d) Social democracy vs capital markets: in the former, national committed to private
property yet labour is powerful and economic equality is central to political agenda
2) The haves (owners and managers of capital) fight among themselves
a) If securities market is weak, the capital will flow through banking system, which benefits
bankers (19th century US: small local banks were stifling competition from large national
banks → enhanced demand for securities markets)
b) Managers vs owners of capital: managers seek rules that impede hostile takeovers, that
make is costly for shareholders to take active positions and difficult to elect directors
outside of those proposed by managers
Developing markets:
- Belief that better financial markets will lead to economic developments
- The actual path: 1) social and political stability, 2) financial market development, 3) legal
consolidation later
- Reputational market dealings supported development of stock market: a) 19th century US:
Morgan firm put partners as directors on the Board to protect shareholders from incompetent
managers, b) 19th century Japan - through directors with sterling reputations
- Stock markets can be enforced through soft laws - punishment by other financial players, such as
exclusion (was very important in the development of American stock market)
- Elites can oppose the development because it would give competitors access to their previously
monopolised capital → in closed-trade countries, elites are very likely to oppose capital markets
+ where settlement conditions are difficult, where plantation-style agriculture is most efficient,
elites have little incentive to support broad-based property rights → developing equalityimpeding institutions (and vice versa) ⇒ ex
...

Presidential (majoritarian, first-past-the-post) systems → center-right, low distribution outcomes; political
groups need to persistently recapture working majority working district by district; local interests
determine national outcomes
...

Strengthening the appointment rights of principals
- Voting rules and requirements
- Restrictions imposed on the length of directors’ contracts
II
...

Augmenting the trusteeship
- Two tiered vs unitary Boards + Board committees
IV
...

Adopting an affiliation strategy
- Provide entry and exit rights on fair terms

Quality of national laws at protecting:
1) Corporate shareholders (above)
2) Minority shareholders
- Grant minority shareholders a right to nominate representatives on the Board
- Use voting caps and one-share-one-vote principle (ban dual class shares)
- Lower minimum percentage ownership required to call an extraordinary shareholder
meeting
- Mandatory bid rule requires acquirer to take a tender offer to all shareholders first - exit
at fair price for minority holders
3) Creditors
- Granted rights to pull a collateral from a firm without waiting for a completion of
reorganisation procedure
- Ranked first in the distribution of the proceeds
- Decision making power to veto or approve reorganisation
- Difference between creditor-oriented vs debtor oriented = liquidation bankruptcy vs
reorganisation which enables company to continue operations after restructuring
LLSV Index:
a) English legal origin = Ireland, US, UK ⇒ leader in terms of quality of shareholder protection
b) German legal origin =Austria, Germany, Switzerland
c) French legal origin = Belgium, France, Greece, Italy, Spain, Netherland
d) Scandinavian legal origin = Denmark, Finland, Iceland, Norway, Sweden ⇒ stakeholder-oriented
e) 2004 EU Accession = Cyprus, Czech Republic, Poland …
f) 2007-9 EU Accession = Bulgaria, Croatia, Romania

Lecture 10: Corporate Governance and Comparative Law
(Professor Chizu Nakajima)
Law is an important institution - legal and regulatory environments differ from country to country
(comparative law perspective); increasing number of ”compliance” issues faced by companies
...

➢ What happens when no compliance and no explanation?
○ In theory, as the Code is attached to the Listing Rules, the Financial Conduct Authority
can impose a fine as a regulatory sanction
○ But in practice, “enforcement” is left to shareholders to “vote” or “exit”, or the company
voluntarily “delists” its shares
...

○ Created criminal fences for “cooking the books”

●

●

●

Corporate Governance practices and environment vary even between the US and the UK (despite
grouped together as “Anglo-Saxon business model”) – e
...
chair/CEO duality and shareholder
action (common in the US)
Within the EU, there is no single harmonised company law and no single CG Code is endorsed –
only standardisation of certain practices to facilitate cross-border shareholder participation in
AGMs
...
London, 2
...
Singapore, 4
...
Tokyo

Efficiency vs
...
Lawyers
● Law and Economics discipline started in the US - which system facilitates economic activity
better
● Some economists are more sceptical about statutory rules, believing that the case-by-case
development of the common law systems is likely to be more efficient and enable more
individual choice than the civil law systems
● But it is too simplistic to group all “common law systems” together and compare them to “civil
law systems” as they do differ, as per earlier discussions
● Legal systems are typically justified by reference to justice or fairness whereas economists justify
the cost of legal institutions and rules on the basis of the reduction of transaction costs
Dominant research: Good CG ⇒ Thriving financial markets ⇒ Economic growth
Advocated by leading economics/finance scholars and endorsed by intergovernmental organisations (WB,
IMF) = link between good CG and firms’ financial performance, i
...
maximizing shareholder value
...
”
○ But, at the time of Friedman, short-term vs long-term tension did not exist =/= hedge
funds of nowadays
➢ Case of Dodge v
...
172 - The duty to promote the success of the
company + Stewardship Code to encourage companies to take more long-term view
...
172: all stakeholders treated the same, long-term decision-making, interests of employees,
suppliers and customers, community and environment, reputation, act fairly between all members
of the company
...
g
...


Global Standard Setting using ‘Soft Law’ and Implementation via Mutual Evaluation
Example: Anti-money Laundering
Global Standard setting through

Financial Action Task on Money Laundering (FATF)’s 40
Recommendations on anti-money laundering (AML) &
counter-terrorist financing (CTF)

Compliance through

●
●

Mutual Evaluation = self-assessment + peer review
‘Blacklisting’ = ‘naming and shaming’

Implementation through

●
●

Each state introducing AML legislation
Resulting in global standardisation of AML regulation

UK Bribery Act 2010 ⇒ similar mechanism
Section 1 offence - bribing another person – active bribery
Section 2 offence – being bribed - passive bribery
Section 6 offence - bribery of a foreign public official
Section 7 offence - failure of a commercial organisation to prevent bribery by an “associated person“ ⇒
strict liability (Court action)
⇒ Only defence: adequate procedures, training of staff, reviews
Corporate Offence of “Failure to Prevent”
● The same concept is now being applied to tax evasion in another piece of UK legislation – The
Criminal Finances Act 2017
● Company is fined, but normally once the company is convicted, the responsible Directors will
end up in court through vicarious liability
How will “Corporate Governance” deal with these matters of global concern?
● Setting up “Compliance Committee”, “Risk Committee” and such like will help companies
identify current and potential legal risks that they face ⇒ alone will not be a solution
● Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) requirements made it too
costly or too risky for financial institutions to do business with vulnerable jurisdictions
...

○ Company’s compliance function will gain further importance
...


La Porta et al
...
The ordinary courts had no authority to review government action



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