Corporate governance definitions and international convergence constraints

International Developments in Corporate Governance

The proper governance of companies will become as crucial to the world economy as the proper governing of countries... strong corporate governance produces good social progress. The two go together. -- James Wolfensohn, President of the World Bank, 2002

The epigraph above is a reflection of the increased amount of attention being directed at corporate governance and the part it plays in promoting international trade and stakeholder confidence. In a day and age characterized by high-profile corporate bailouts in the United States and a shaky global economy, identifying opportunities to improve investor confidence and corporate governance represent timely and valuable enterprises. Today, in Anglo-American contexts, the term "corporate governance" is typically used to describe the means by which a firm's shareholders and lenders control the decisions of a company's senior leadership team. While this definition is expanded to also include affected stakeholders when it is used some other countries, the trend is clear and an increasing number of analysts are suggesting that more transparent and effective corporate governance techniques are needed to reassure investors of the viability of an enterprise and to ensure that an organization's resources are used to their best effect. This study provides an overview and background of corporate governance, followed by a review of the relevant peer-reviewed and scholarly literature concerning international developments in corporate governance and constraints to international convergence in this area. A summary of the research and important findings are presented in the conclusion.

Review and Discussion

Background and Overview.

The term "corporate governance" is being increasingly bandied about in the media in different ways and the casual observer may be left wondering what the term means at all. In this regard, Shu-Acquaye (2007) advises that, "While the exact definition of corporate governance should be specifically tailored to the requirements of each jurisdiction in which it is maintained, one concept utilized by both the United States and Europe is consistent: Corporate governance relates to some form of company 'control.'" This general definition is congruent with a study by Buck and Shahrim (2005), where the authors note that, "Corporate governance and governance institutions in general terms are concerned with the means by which a firm's stakeholders control the decisions of senior managers. These stakeholders can include shareholders, executive directors, employees who are not executives, customers, creditors, suppliers (including banks as suppliers of credit), competitors, and the State."

While the term "corporate governance," then, connotes some form of company "control," the source and respective impact of the sources of such controls may differ in fundamental ways from country to country. From the broadest perspective, corporate governance functions differently in two fundamentally discrete environments:

In an Anglo-American context, the governance definition is narrower, and is usually restricted to shareholders, that is, the means by which a firm's outside investors (mainly shareholders, but also lenders) try to ensure that they are not exploited by opportunistic senior managers within the firm.

Beyond the Anglo-American context, corporate governance usually refers to the means by which any of the firm's stakeholders (not just investors) may control managers' decisions. This is what is referred to as welfare capitalism, where executives are influenced mainly not by stock prices and shareholders but by the voice of other stakeholders who are highly committed to the firm and are prepared to contribute formally to its governance.

In many ways, corporate governance practices are directly related to a firm's business systems and the definitions for these terms are likewise related According to Pedersen and Thomsen, business systems "are particular ways of organizing, controlling and directing enterprises or particular arrangements of hierarchy-market relations which become institutionalized and relatively successful in particular contexts, which is almost exactly equivalent to some of the broader definitions of corporate governance." Taken together, business systems and corporate governance practices can be viewed in the same light, particularly as they regard the important differences that exist among the members of the international community in terms of the relative importance of government regulation and oversight, as well as what role the corporate world is supposed to play in contributing back to the larger society in which it competes. In this regard, Pedersen and Thomsen also note that such "distinctive ways of organizing economic activities become established and effective because of major differences in key social institutions, such as the state, the financial system and the education and training system, including labor-market organization as well as the indirect influence of more general and diffuse attitudes and beliefs about work, material values and authority relations, family and kinship relations, identities and authority structures." This author suggests that the following differences exist in corporate governance practices, like their corresponding business systems:

Business systems consist of differences in [f]irst, the nature of the firm;

The connections that firms develop with each other;

How activities and skills are coordinated within firms;

Although business systems often coincide with national economies, it is recognized that [a]s well as distinct systems within nation states, there are of course substantial differences between firm structures and connections across industries.

Furthermore, nation-states need not have equally homogeneous business systems. It is stressed that [i]n societies where major social institutions are highly differentiated and have been established for some time since industrialization took place - such as Britain and the U.S.A. - business systems are not as internally homogenous and mutually distinct as those in recently industrialized societies which are less institutionally pluralistic.

The more homogeneous, less pluralistic systems develop particularly distinctive managerial rationalities and practices. The social institutions that emerge from this process do not obstruct the market mechanism, but provide institutional foundations for efficiency, being key phenomena in the constitution of different competitive orders and should not be counterposed to market efficiency.

The basic components of this approach to assessing important differences that exist among the various corporate governance practices around the world are as follows:

National business systems differ - in particular with respect to corporate governance;

The differences stem from differences in key social institutions (government regulation, the financial system, labor-market institutions, culture);

In contrast, business systems and governance are presumably less influenced by microeconomic factors like transaction costs;

The more differentiated the key social institutions are, the more differentiated the nature of the business system, and differentiation may be expected to increase over time as a function of economic development - in particular, greater differentiation is expected in the Anglo-American business system, and,

Individual business systems develop distinctive, viable business philosophies and ways of doing business.

Given these diverse definitions and differences in corporate governance practice, as well as the drastically different settings involved with corporate governance, there is little wonder that there have been some significant cross-cultural issues emerge in the debate over the proper amount and type of corporate governance that is most appropriate and effective for a given organization and the larger society in which it competes. Some current trends in international corporate governance, though, can help shed some light on what is taking place in corporate governance approaches being used in various countries around the world and how these trends have affected corporate management and performance, and these issues are discussed further below.

Current Trends in International Corporate Governance.

Although international commerce is as ancient as mankind itself, the current trends in international corporate governance are being fueled in large part by the same forces that are driving the globalization of the world's marketplaces and the increasing interdependence of these nations on each other for economic security. A study by Pedersen and Thomsen reports that an increasing amount of research has been focused on the existence of significant international variations in corporate governance over the last two decades or so; however, there remains a paucity of systematic research concerning the precise determinants of international differences in corporate governance. According to these authors, "Instead, the existence of international differences as such has been advanced as an argument against economic ownership theory. The differences suggest that differing histories, cultures and paths of economic development better explain the differing structures than economic theory alone."

Therefore, one of the more interesting - and challenging - issues involved with the globalization of the world's marketplace has been the need to develop more harmonious approaches to trade where business leaders and investors can be confident of the viability of the enterprises with which they conduct business despite a wide range of disparities in corporate governance practices. For example, in her essay, "Broadening Corporate Responsibility," Aaronson (2002) notes that, "Given that capitalism today is global as well as local, the U.S. must work with its allies to write international corporate governance norms. But we need to use this opportunity to think more broadly about how to reassure global economic confidence long-term. All of the reform efforts to date focus on a narrow definition of corporate responsibility." According to the International Corporate Governance Network (2008), "As global markets are gripped by volatility, corporate governance reform is yet again at the head of the legal and regulatory agenda." Indeed, as will be seen below, the same forces that are driving globalization are also focusing attention on the need for more transparency in how organizations conduct their operations, how financial information is treated, and the relative roles played by the organization's stakeholders. For example, Shu-Acquaye (2007) cites the basic differences in the legal systems in various parts of the world as contributing to the different approaches to corporate governance. Likewise, Shu-Acquaye cites these differences and adds, "The American corporate governance system adheres to the idea of shareholder primacy. Because the United Kingdom, Austria, and Canada share a legal system based on English common law and equity principles, they are similar to the United States -- shareholder primacy is the predominant norm in each of these countries."

By sharp contrast, other countries such as Japan and Germany are characterized by stronger protection for their employees, creditors, and other nonshareholder stakeholders in general, representing examples of a stakeholder-orientated system. In their book, the Control of Corporate Europe, Barca and Becht point out that, "Germany has always had a prominent place in the international corporate governance debate. The country is among the largest and richest industrial economies, and many German companies are world leaders in their fields. Moreover, German institutions often differ significantly from those found in other Continental European countries and even more markedly from those of the Anglo-Saxon countries." In fact, as a current example of trend in international corporate governance, Buck and Shahrim cite the example of the "diffusion and translation of German stock-based executive pay, one element of U.S.-style governance, in the face of prevailing stakeholders. Executive stock options (ESOs) can be viewed as a recent governance innovation so far as Germany is concerned, but subject to a national culture and institutions quite different from those in the U.S.A. And UK."

These fundamental differences in corporate governance approaches provides researchers with some rich fodder concerning the responsibilities of German business leaders compared to their counterparts in other countries. According to Shu-Acquaye, "German corporate law creates a fiduciary duty between managers and a diverse group of constituencies, including shareholders, employees, and society. Consequently, the hallmark of the corporate system is its codetermination regime -- a regime that provides employees with structural protection through representation in corporate institutions." As a result, the two-tiered board system used by German companies requires them to be managed by a managing board (i.e., the "Vorstand") which is responsible for the day-to-day conduct business of the company; in addition, a second board comprised of a supervisory council (i.e., the "Aufsichtsrat") (156) is responsible for the election and monitoring of the company's management and are even empowered to approve major corporate decisions.

Likewise, employee participation in the supervisory board is mandated in countries such as Austria, Denmark, Holland, Luxembourg, and Sweden, France, Ireland, Portugal; however, other EU member states have also passed laws concerning corporate governance, but these only require employee participation in certain aspects corporate governance. In this regard, Shu-Acquaye reports, "For example, in France, when employees' shareholding reaches 3%, employees are given the right to nominate one or more directors subject to certain exceptions. Although employee representation on the board does not give them decision-making power per se, their structural involvement as nonshareholder constituencies of the firm is effective in mitigating informational asymmetries, thereby facilitating informal negotiations among corporate constituencies."

The same constituents of globalization (i.e., economic integration, democratization, and global governance networks) are transforming the nature of international corporate governance today. In this regard, Detomasi (2002) differentiates between several characteristics of globalization from the broader concept of interdependence:

Globalization interlinks more countries and occurs over greater, generally transoceanic, distances;

The volume and rapidity of international exchange of ideas, information, and goods and services continues to increase dramatically, fueled primarily by improvements in information technology; and,

Globalization involves numerous and diverse agents that encompass a broad range of issue areas, with the number of interested actors in each issue area continuing to broaden and diversify.

Some authorities go so far as to suggest that improperly administered corporate governance can threaten the world's outlook for peace because of the economic disparities that can be attributed to past business practices. According to Tavis (2002), "Multinational enterprises are the instruments of economic integration. As such, multinationals as a group deserve credit for the positive productivity-related wealth effects of the process. As the implementing institutions, these enterprises are also inextricably related to the inequality -- the social void -- resulting from globalization that threatens peace." These issues are compounded in immediacy and intensity as well by some changes in demographic patterns that have emerged in just the last 5 decades or so. According to O'Sullivan, "Of particular importance in recent decades as a source of pressure for the transformation of existing systems of corporate governance has been the growth of intergenerational dependence. In virtually all of the advanced economies, growing life expectancy and a decline in fertility below that which is required for the replacement of the population have contributed to a 'double' ageing process." In other words, as the life expectancy in developed nations continues to increase while the birth rate continues to decline, emerging nations will be able to exert additional influence in how and why various corporate governance approaches are shaped and when they will be implemented. In this regard, O'Sullivan emphasizes that, "Pressures from the labor market, especially the striking trend towards early withdrawal from the labor force in most of the advanced industrial economies, have exacerbated the rising intergenerational dependence induced by these demographic changes."

Today, the debate over what type and how much corporate governance is needed is also surrounded by a dynamic marketplace as well as the international regulatory mechanisms that are associated with globalization. Indeed, Tavis suggests that the type of corporate governance adopted by multinational corporations in the future will play a large role in shaping the type of world that will exist in the 21st century. According to this author, "The regulatory power of the nation-state, particularly in developing countries, is eroding while a loose web of global governance networks is evolving. Multinational enterprises are involved with many of the global governance networks and, increasingly, are the target of others." Somewhat disingenuously, this author also concludes that, "The balance of globalization pressures and the activities of multinational firms will encourage more peace or greater conflict in our world."

Clearly, then, the study of international trends in corporate governance represents an important initiative today, but how can it be that the corporate governance actions of large multinational corporations can have such a powerful effect on the state of the world? The answer is in the manner in which capital is controlled and channeled in ways that have traditionally placed developing nations at a disadvantage. For instance, according to Milhaupt and West, "Focusing on venture capital casts the debate over bank-versus market-oriented governance systems in a new light. The institutions supporting American governance fortuitously facilitate a complex contracting structure that makes venture capital flourish." Likewise, Mayer (2002) makes the point that, "The idea that corporations may co-create the conditions of peace is contrary to the more customary view that in matters of creating or maintaining peace the role of government completely dominates. Yet, while many corporations may have an insignificant role in co-creating peace -- or in disturbing it -- larger companies do seem to have an impact."

This Article contends that many large corporations have an important role to play in establishing and revising the rules of the global economic game. Moreover, corporations should support those rules providing structural efficiencies that promote full-cost pricing, phase out perverse subsidies, and provide more meaningful information to investors and consumers. In so doing, corporations, consumers, and governments can create more peaceful, sustainable societies even while allowing maximum freedom of movement of people, goods, and services across international borders.

While the Anglo-American approach to corporate governance has not been without its failures, of course, it would seem that this approach encourages new venture creation in ways that other corporate governance systems do not. For example, Milhaupt and West also point out that, "Entrepreneurial finance and the firms it funds, while increasingly crucial to Japanese economic competitiveness and vitality, have been constrained by the institutional framework supporting its postwar corporate governance system." The desirable new venture creation that is associated with the Anglo-American approach, then, is not something that should be simply washed away in the rush to scrub out the inconsistencies that exist in international corporate governance.

This point is also made by Glassman (2007) who points to the increasing transparency of the Anglo-American approach to corporate governance that is used in the United States as a prime example of how this approach can contribute to new venture creation: "America's dominance in the global economy is not about its physical infrastructure. Rather, its competitive market economy, intolerance of corporate governance flaws, risk-taking culture, and dynamic capital markets all reward entrepreneurs for transforming ideas into useful goods and services. Its dominance comes from the flexibility of its businesses to reinvent themselves amid sweeping global changes."

The recent downturn in the U.S. economy as a result of the subprime mortgage fiasco and a crippled automobile industry and their concomitant rippling effects in the global economy suggest that while things may be changing, the Anglo-American approach to corporate governance will continue to have an inordinate impact on trends in international corporate governance in the foreseeable future, and these issues are discussed further below.

Future Trends in International Corporate Governance.

According to Charkham and Simpson, the inexorable forces of globalization will create the need for more harmonization in international corporate governance. For instance, these authors report that, "There will inevitably be further convergence on accounting practices; the more firms seek to raise capital internationally or seek quotation on overseas stock exchanges, the more likely this becomes." Furthermore, Charkham and Simpson also suggest that based on powerful national self-interests and preferences, the international community will likely continue its march to harmonize its corporate governance practices in the future, but only to the extent that it will serve to facilitate international trade and promote a competitive advantage in the globalized marketplace. For instance, Charkham and Simpson note that, "The trends to globalization will not lead to an erosion of differences in domestic markets, other than what is absolutely essential for transparency of information and protection of shareholder rights to attract international capital; but beyond this, nations will cherish their special emphasis on particular aspects of corporate purpose (emphasis added)."

Notwithstanding this significant obstacle to across-the-board harmonization of international corporate governance practices, the research to date and empirical observations all suggest that current approaches are in need of reform in some substantive ways. As Gray and Clark point out, "We have come to realize that the self-interest motive which creates the energy and drives our market economy is in need of careful study. The dynamic homeostasis between the penalties and incentives that are used to control and regulate our capital market is in need of fine tuning." The problem confronting corporate governance reformers in a free market environment, though, involve the tendency of companies to maximize their shareholder value to the detriment of the larger constituency of stakeholders involved. For instance, Gray and Clark emphasize that, "Some of the current methods used in maximizing shareholders value at the expense of other stakeholders, who are dependent on the long run success of the organization, have not proven viable. The proclivity towards a short run myopic vision for success is not the ideal approach for all the stakeholders who have a vested interest in the prosperity of the organization."

In all likelihood, there will also be some reciprocity involved in the harmonization process, but here again, even this give-and-take will likely be overshadowed by specific preferences for one approach over another based on longstanding traditional corporate governance practices. As Charkham and Simpson point out, "The Germans are not about to abandon the two-tier board just because Americans do not have it; what they will do is harmonize their accounting standards and probably raise dividend payments to satisfy a global audience of shareholders. This will also lead to growing shareholder activism internationally. The disposition of UK voters to abstain may invest foreign holders with an influence out of proportion to their numbers."

Other trends in international corporate governance can be discerned from the establishment of the International Corporate Governance Network (ICGN) in 1995, a private sector group that seeks to promote improved international corporate governance. In 2000, more than 330 delegates from 25 countries attended a meeting of the International Corporate Governance Network in New York City. The ICGN's Web site states that, "The International Corporate Governance Network ("ICGN") is a not-for-profit company limited by guarantee under the laws of England and Wales." The mission of the ICGN is "to develop and encourage adherence to corporate governance standards and guidelines, and to promote good corporate governance worldwide." Besides its mission, the ICGN has four stated purposes:

To provide an investor-led network for the exchange of views and information about corporate governance issues internationally;

To examine corporate governance principles and practices;

To develop and encourage adherence to corporate governance standards and guidelines; and,

To generally promote good corporate governance.

To accomplish the above-stated purposes, the ICGN maintains a number of standing committees with various mandates concerning international corporate governance issues as described further in Table 1 below.

Table 1.

Standing ICGN Committees.

ICGN Committee

Description/Responsibilities/Goals

Accounting and Auditing Practices Committee

The primary purpose of this committee is to represent the ICGN membership to regulators, national governments and international bodies in the development of corporate governance policies and proposals relating to accounting and auditing practices from an international investor and shareowner perspective. The committee reviews existing projects, exposure drafts and/or discussion papers at the International Accounting Standards Board and the Financial Accounting Standards Board and other regulatory bodies to determine where the Committee would like to comment, testify and engage to ensure a leadership role by ICGN on accounting and auditing issues that impact investors and shareowners. In addition, the committee considers other issues including the progress of the adoption of International Financial Reporting (Accounting) Standards (IFRS) in a number of countries, ensuring accounting standards serve the interests of investors and shareowners, the status of director and auditor liability, audit quality - governance of audit firms, investor representation on standard setting committees, auditor concentration and the quality of financial reporting and auditing

Cross Border Voting Practices Committee

This committee keeps a watching brief on issues concerning cross-border voting practices and is in active discussions with the European Commission over the EU's Corporate Governance Action Plan; it also consults with the American Bar Association jointly with the Shareholder Rights Committee.

Executive Remuneration Committee

The primary purpose of this committee is to influence the development of national and international corporate governance policies and proposals relating to executive and non-executive remuneration and other related matters. This committee also consults with the ICGN membership in the development of best practice guidance and provide information to members via the ICGN Web site.

Non-Financial Business Reporting Committee

This committee's primary purpose is to influence the development of national and international corporate governance policies and proposals relating to non-financial business reporting on behalf of ICGN members. This includes: intangibles, brand values, quality issues, corporate social responsibility issues, life cycle management, accounting and auditing practises, and reputation issues. The relevance of any one of these issues is its defined materiality to the control, governance and management of the corporation, and to shareowners' ability accurately to assess the underlying long-term value of the company. This committee also consults with the ICGN membership in the development of best practice guidance and provides information to members via the ICGN Web site.

Shareholder Responsibilities Committee

This committee is updating the ICGN's statement on shareholder responsibility, and developing a set of best practice guidelines on the internal governance of investors for consultation and discussion by and among member states.

Conclusion

The research showed that corporate governance generally refers to the control of a company, and corporate governance and governance institutions are the mechanisms by which a company's stakeholders exert control over the decisions of senior managers. The research also showed that such stakeholders can include shareholders, executive directors, employees who are not executives, customers, creditors, suppliers (including banks as suppliers of credit), competitors, and the state in which the company competes. Perhaps the most important theme to emerge from the research concerned the growing recognition that any effort to standardize and harmonize corporate governance practices around the world will require a collaborative approach that takes into account the important cross-cultural differences that exist concerning why companies exist in the first place and how they should best be controlled to maximize the benefit for their shareholders and stakeholders alike. In the final analysis, improved corporate governance practices are going to mean different things to different people in different countries, and the harmonization of these practices is going to take some time.