Overview of Corporate Governance Models
Some scholars hold the view that corporate governance models around the world are converging on the shareholder-oriented system. Others disagree and talk of continued divergence especially between the shareholder-oriented and the stakeholder-oriented models. Using appropriate examples, critically discuss these views.
Corporate governance in simplest terms refers to the system of practices, processes and rules that define a company’s functioning. According to the 1992 Cadbury report published in the United Kingdom, corporate governance implies the structure by which organizations “are directed and controlled” (Cadbury.cjbs.archios.info, 2018). Corporate governance in recent years has become a topic of much debate as scholars around the globe continue to provide diverse views. According to the 1999 definition of corporate governance as mentioned in the Principles of Corporate Governance under OECD, it is a concept of management where there is a relationship between a company and its management, the shareholders, the board and other stakeholders. The 1999 principles of CGO were updated in 2004 that on one hand maintained the previous principles but on the other, improvised and added additional points. The 2004 OECD principles included “ensuring basis for effective corporate governance framework and the institutional investors, stock markets and other intermediaries” (Oecd.org, 2018).
The essay tries to provide a critical discussion on this topic and find out whether corporate governance is a shareholder-oriented system or a divergence of stakeholders and shareholders-oriented system. The essay initially provides a detailed overview of the corporate governance models followed across the globe and then do the critical analysis. Further, the essay presents arguments and reasoning put forward by different scholars in order to prove their point. The essay focuses in Agency theory in order to provide evidence and arguments that justify both the claims. As per Agency theory, there is always conflict between the interests of the principal and the agent.
The corporate governance model is based on the Agency problem where the board has the responsibility to resolve the “conflict of interests” between managers and shareholders. This is understood in a better way by applying the Agency theory that clarifies the reasons for the problems in corporate governance (Charitou, Louca and Panayides, 2007). As per the theory, a principal appoints an agent to carry out any specific task on her or his behalf. When the agent agrees to do the task given by the principal, he or she becomes answerable to the principal. In the larger context of CGO, this principal-agent relationship becomes a prime reason behind a company’s failure. Here, the principal is the shareholder and the agent is the director.
Agency Theory and Corporate Governance
Across the globe, three major models of corporate governance are followed that include the Anglo-American model, the European model and the Asian model. The Anglo-American model of corporate governance focuses primarily on market and competition. The European model on the other hand, emphasizes cooperative relationship and reaching agreement. In contrast to these two models, the Asian model of CGO puts major emphasis on family ownership in the private sector. The complicated network of refined personal relationships also characterizes the Asian model.
A study of the insider and outsider model of CGO in Europe reveals that although the nations follow similar model, it has variations. The UK follows the outsider model that follows market culture, relies on equity, has a relatively large stock exchange and shareholders have less influence (Aguilera, 2005). In contrast to it, the insider model is followed by countries like the Netherlands. As per the insider model, the emphasis is on consensus culture, network oriented, relies on debt, small stock exchange and controlling shareholders assert more influence.
An assessment of the various models gives the idea that the Anglo-American model of CGO is shareholder-oriented whereas the European models of CGO inclines towards stakeholders values. The modern corporate governance witnessed in the firms of U.S. hold shareholder representation as the pillar of CGO. However, shareholders do not have the authority or the power to nominate their representatives in the boardroom. Instead, the serving board proposes new directors who are consequently elected. The shareholders of these firms do not have any idea about the recruitment of the new directors because these public firms never advertise vacancies. The passing of the 2002 Sarbanes Oxley Act by the U.S. Congress further ensured that all the corporations in the country were answerable to their stakeholders and transparent as well.
In case of Germany, the modern CGO scenario had been tarnished by the recurring incidences of frauds and scandals. Big companies like Siemens, Deutsche Bank and Volkswagen amongst others came under heavy scrutiny (Gates et al., 2018). The scandals that had implications on the higher officials at these firms were so severe that many experts opined Germany should adopt the Anglo-American model of CGO. In the German model of CGO, the ownership is mostly widely concentrated that is around 50% members of the supervisory board must represent the employees (Bottenberg, Tuschke & Flickinger, 2017). Further, the supervisory board has the power to sack members of the management board. After the debacle at the top managements in the country, experts argued that German firms need to be more transparent and accountable similar to the Anglo-American firms. It would also ensure that the banks would have limited powers on the functioning of the company. Some scholars argue that the CGO model of Germany gives the impression that it is on the crossroads between the stakeholder-oriented model of Asia and Western Europe and the shareholder-valued stock market capitalism of America.
Corporate Governance models around the world
The Asian, in particular the Japanese model of Corporate Governance shows the tendency of cross-shareholding that involves banks and client companies (Seki & Clarke, 2013). Further, this model puts the interests of the stakeholders like employees and clients before the interests of the shareholders. The Japanese model of corporate governance provides a fine example of the type of governance Asian firms follow. As per the Japanese model, banks hold an important position in the firms boasting a high level of ownership (Chizema & Shinozawa, 2012). However, after the financial crisis that hit the Asian countries during 1998-1999 changed the face of corporate governance. Prior to the economic crisis, the Japanese companies followed the trend to create steady relationships with shareholders through cross-shareholding (Tricker & Tricker, 2015). It meant that the management was directly under Bank’s surveillance. The firms depended on debt rather than on equity and there was absence of control mechanisms from the outside. The board of directors was in great numbers with only a few non-executive directors. This structure of corporate governance followed by the Japanese firms led to a great debacle from which it was difficult to bounce back. However, after the economic crisis it the Asia markets, the Japanese companies began receiving surveillance from the stockholders. The companies therefore have the authority to management so that the shareholder value and long-term corporate could be enhanced.
Corporate governance has witnessed great changes over the years and continues to do so especially after the introduction of globalization. Corporations have now become more active and attentive towards the stakeholders and shareholders. The stakeholders too have become more aware of the day-to-day functioning of the firms. In the contemporary setting, firms cannot easily get away with any scandal or fraud. The inclusion of concepts like the corporate social responsibility (CSR) has made firms more accountable towards the people and the environment. It is however important to remember that corporate governance has different interpretations in different types of firms.
The above discussion sheds light on the different models of corporate governance that are followed across the globe. This section shall discuss the views of scholars who state that corporate governance is shareholders-oriented. At first, it is important to understand the meaning of shareholders and the importance they have to any firm. Shareholders are those who own shares of any company. The shareholders earn profit through the increased stock value that comes when a company achieves success. Shareholders are not liable to the rules and regulations that outline the functioning of the company. Chassagnon and Hollandts (2014) raise an important point that questions the ownership of a firm. The authors cited the contractarian theory that states that shareholders have the rightful ownership of a firm because they own shares of that firm. The proponents of the legal theory who stated that shareholders do not have any legal rights to own the firm criticized this view of the theory.
Convergence and Divergence of Corporate Governance Models
The shareholder-oriented view of corporate governance bases its assumptions by Adam Smith who stated that social welfare automatically evolves from free markets that has its origin in the neoclassical theory of companies. Garcia-Torea, Fernandez-Feijoo and de la Cuesta (2016) while explaining the shareholder view, state that the shareholder-oriented model of corporate governance would work efficiently if the “shareholders invest considerable time and money in order to control decisions of the management”. The author further explains that due to the principal-agent problem of governance, managers of large public firms aim less to maximize profit when the desired profit is earned. In contrast to this, shareholders achieve their desired goals, the manager aim at enhancing their own profit thus giving rise to conflict. Al Mamun, Yasser and Rahman (2013) on the other hand believes that the recent cases that occurred around the world indicate the fact that the shareholder-oriented model of CG is the apt model for today’s corporations. The cases of breach of ethics and CSR in the German companies and the consequent changes in corporate governance laws reveal that companies around the world are inclining towards the shareholder-oriented model.
According to Ruggie, (2014), the new trend indicates that companies across the globe are converging towards the Anglo-U.S. model of CG that upholds shareholders’ value. The author gives reasons his argument by stating that the increasing global power of capital investors has urged the firms around the world to adopt the shareholder-oriented view. Yoshikawa and Rasheed (2009) while agreeing upon the views, states that the presence of the International Corporate Governance Network (ICGN) leads to the inevitable fact that the future of corporate governance will be centered on the shareholder-oriented model. The proponents also cited the follow up of the Sarbanes-Oxley Act of 2002 in other countries as being an indicator of the increasing convergence of shareholders-oriented model of CGO.
Countries like Japan and Germany tend to rely on the stakeholder-oriented model of corporate governance. As per this model, companies give more prominence to its various stakeholders that include the employees and the labor union amongst others. Scholars who argue that shareholder and stakeholders models continue to diverge, state that the shareholder model does not fit into the old established stakeholders’ model. After a series of scandals that hit the German corporate world, Chancellor Angela Merkel took the decision to appoint a commission that could scrutinize the codetermination system. The commission was given the responsibility to see whether the stakeholders’ model of CG could be modified. The commission found that the current system in Germany required no real change. This instance confirms the views of the proponents who opine that divergence between shareholder-oriented and stakeholder-oriented model of CG is the new reality.
Examples of Corporate Governance Models
Another recent example of Carillion Construction Company in the UK where it was found that the directors had arranged for exorbitant amount of bonuses after the company received a shock profit warning. The directors continued to receive bonuses and salary even after their term had ceased. Many experts addressed this issue as the failure of corporate governance. Although the UK follows shareholder-oriented model of CG, this lack of proper governance within the corporation raised many questions. Evangelinos et al. (2016) while commenting on the governance at the UK construction and building companies, states that stern law need to be implemented for the companies to disclose their CSR report. The CSR is an important element of the modern day corporation that makes the firms accountable to the people and the environment. The inclusion of CSR however, also indicates that the stakeholder-oriented model of corporate governance is in play in most organizations (Chan, Watson and Woodliff, 2014). It has to be mentioned that the CSR policy and concept revolves around upholding the interests of the key stakeholders that include the employees and the customers.
In developing nations, the corporate governance laws and models followed by firms differ largely from those in developed countries. It is largely because developing nations have different political and economic system. Even the social system also plays a role in corporate governance in the developing countries. This intricate link between the different systems within the country gives rise to complicated CG problems. The CG structures within the developing nations are weak. Firms in these nations lack the equipments and ideas to incorporate a model like the U.S. or even that of Japan and Germany. However, Kim and Lu (2013) argue that the recent trends of globalization have allowed the developing countries to accept and follow CG models that best suit their system. Reforms and regulations concerning the governance of corporations have been introduced in the developing nations during the beginning of the 21st century. Examples may be given of the Kumar Mangalam Birla Committee Report introduced in India in 2002, the SEC Corporate Governance introduced in Philippines in 2002 and the Indonesia Code of Corporate Governance introduced in 2001.
Ntim et al. (2017) counter the views of the convergent proponents and states that although countries around the globe have implemented and introduced new regulations and laws, it is not possible to have one model for all. A trend was visible during the 1990s when other economies showed an inclination towards the U.S. model but after the Enron and WorldCom debacle, the trend changed. Nations believed that the shareholder-oriented model followed by the U.S is defective. Kimbro and Xu (2016) extend the argument by stating that the shareholders’ model evolved in the U.S. due to its typical economic condition where banks and governments had little stake in firms. Therefore, to state that convergence of shareholders model is the new trend would be wrong.
Conclusion to Critical Discussion on Corporate Governance Models
In the end, it is imperative to state that although the shareholder-oriented model is followed in the strongest economies of the world, it is not possible to apply it in other nations. The nature and style of corporate governance in different countries is different based on that country’s political and economic scenario. The above essay focused on the corporate governance system that companies across the globe follow. Further, the essay tried to provide a balanced reply to the question as to whether the CGO model is converging on shareholder-oriented or whether it continues to diverge. In order to provide claims and evidences that support either view, the essay first provided a detailed explanation of corporate governance. Further, it also provided a detailed overview of the different countries that uphold the two different models. The essay found that the shareholder model emerged from the Anglo-U.S. economy whereas the stakeholder model emerged from the Japan and German economy. In addition, the essay presented the cases that showed flaws within both the models. These included the cases of Siemens, Volkswagen and Deutsche Bank in Germany, the Enron and WorldCom case in the U.S. and the Carillion case in the UK. The essay has also included the situation of corporate governance in the developing countries. In the developing countries, the corporate governance structure is markedly different from the developed nations owing to the unique political, social and economic systems. As concluding remarks, it can be reiterated that the divergence of corporate governance model based on shareholders and stakeholders value is more feasible an idea than the convergence of the shareholder-oriented model
References:
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