Saturday, January 12, 2008

Comparative Corporate Governance (Part II)

Continuing from the previous post on this topic:

4. The Convergence vs. Divergence Debate

The dominance of managers over shareholders in the US, the role of institutions in the UK, that of banks and labour unions in Germany, the existence of complex cross holding structures in East Asia (such as chaebol in Korea and the keiretsu in Japan), state-owned enterprises in China and finally family-owned businesses in India. These are just some of the special features of corporate ownership and management in various countries that are unique to each of them. On the face of this diversity, the question that is being raised is whether there can be a convergence in corporate governance. With globalization and increasing ease in the flight of capital across the world, will there be one single model of corporate governance that would emerge to fit all economies?

This very question has been the subject of a recent article (Is One Global Model of Corporate Governance Likely, or Even Desirable?) in Knowledge@Wharton. The article considers arguments in favour of both convergence and divergence. Convergence towards a single model appears to be driven by two factors, viz. (i) the need of global capital investors to see a common model of internationally accepted governance standards, and (ii) commonality in regulation, principally triggered by the Sarbanes Oxley Act of 2002 enacted in the US which is being adopted in one form or the other by several other countries. The article notes:

“Wharton management professor Michael Useem says companies around the world are increasingly converging on a model developed largely in the United States in response to the growing power of global capital investors. As a result of new technology and liberalization of government controls on capital flows, massive pools of investment can move in and out of countries more freely than ever before. Companies that globalize operations or ownership know that adoption of internationally accepted governance standards would help them compete against other firms, he argues.”

Another force driving convergence is regulation. Following the passage of the Sarbanes-Oxley Act of 2002 in the United States, other countries enacted similar regulatory provisions that also focus on some of the key elements of board structure and overall governance.”
On the other hand, there are several arguments that militate against the concept of convergence in corporate governance. As the article further notes:

“[Wharton management professor Mauro Guillen] stresses that nations and companies will continue to exhibit local characteristics because different countries have followed varying patters of economic development. A complex mix of historic, legal, political and economic factors shapes each nation’s corporate landscape, according to Guillen. As a result, corporate governance and board structures vary around the world. “We continue to see companies in different parts of the world continuing to do things the way they always have,” he notes. “Often there are many cross-national differences.””
Although the debate remains inconclusive, the article points to the fact that some basic aspects of governance are here to stay, with perhaps some variance in different countries. These include independence of the board and transparency.

To me, it appears that we continue to be a long way away from convergence. The country-specific factors that have been spoken about earlier cannot be wished away. Transplantation of legal and business concepts such as corporate governance, an independent board and the like from one legal system (such as the US) to other countries without proper adaptation to the local systems and practices would result in a situation that is not entirely desirable. For instance, the adoption of strict corporate governance systems (that are based on the western models) in countries like India and China have not been trouble-free. There is a tendency for companies to follow a “check-the-box” approach to corporate governance by complying with the procedure, but failing in substance (barring, of course, several companies that have voluntarily adhered to high standards of corporate governance). It is such legal transplantation that has resulted in lack of proper implementation (often even at a mere procedural level) of the new corporate governance standards in the emerging markets. Knowledge@Wharton observes:

“India, too, has taken steps to increase the independence of its board members with a provision known as Clause 49 of the country’s listing agreements. The clause states that half of all directors must be independent. Compliance with the regulation, which took effect January 1, 2006, has been somewhat spotty – with government-owned companies slow to respond.

According to an analysis by the Asian Corporate Governance Association, Indian enforcement of Clause 49 is weak and many companies ignore governance codes. “Most mid- and small-cap companies do not see the value of corporate governance. Most listed companies, including many large ones, take merely a box-ticking approach,” the association states in a review of Indian governance”
The outcome of the convergence debate has enormous implications indeed for India.

5. Empirical Evidence on Indian Corporate Governance

On a more optimistic note, an event study (Can Corporate Governance Reforms Increase Firms' Market Values? Evidence from India) by two US law professors, Bernard Black and Vikramaditya Khanna, shows some correlation between strengthening of corporate governance regulations and improvement in corporate performance. They report that the announcement of the introduction of Clause 49 into the listing agreement in 1999 resulted in an increase in share price of large publicly listed companies over a two-day event window, relative to smaller listed companies; mid-sized firms reported an intermediate reaction.

Here is the abstract of their paper:

“A central problem in conducting an event study of the valuation effects of corporate governance reforms is that most reforms affect all firms in a country. Share price changes may reflect the reforms, but could also reflect other information. We address this identification issue by studying India's adoption of major governance reforms (Clause 49). Clause 49 requires, among other things, audit committees, a minimum number of independent directors, and CEO/CFO certification of financial statements and internal controls. The reforms were sponsored by the Confederation of Indian Industry (an organization of large Indian public firms), applied initially to larger firms, and reached smaller public firms only after a several-year lag. The difference in effective dates offers a natural experiment: Large firms are the treatment group for the reforms. Small firms provide a control group for other news affecting India generally. The May 1999 announcement by Indian securities regulators of plans to adopt what became Clause 49 is accompanied by a 4% increase in the price of large firms over a two-day event window (the announcement date plus the next trading day), relative to smaller public firms; the difference grows to 7% over a five-day event window and 10% over a two-week window. Mid-sized firms had an intermediate reaction.

Faster growing firms gained more than other firms, consistent with firms that need external equity capital benefiting more from governance rules. Cross-listed firms gained more than other firms, suggesting that local regulation can sometimes complement, rather than substitute for, the benefits of cross-listing. The positive reaction of large Indian firms contrasts with the mixed reaction to the Sarbanes-Oxley Act (which is similar to Clause 49 in important respects), suggesting that the value of mandatory governance rules may depend on a country's prior institutional environment.”

This seems to indicate that at least the larger public listed companies and their investors favour strong corporate governance norms.

6. Collaboration Between Key Regulators

Earlier this week, the Securities and Exchange Board of India (SEBI) and the US Securities and Exchange Commission (SEC) announced terms for increased cooperation and collaboration between them. While corporate governance standards and internal controls would be part of the agenda, the collaboration would extend to other matters as well, such as oversight of dually regulated entities, regulatory and compliance issues relating to outsourcing, accounting and auditing standards, areas for continued capacity-building and technical cooperation and cross-border cooperation and information sharing in securities enforcement matters.

Further details are available in this press release issued by the SEC.

That brings us to an end of this two-part series on recent issues in Comparative Corporate Governance. However, there would certainly be more discussion on these issues as and when there are further developments.

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