CHAPTER 4
Corporate Governance Around the World
1. The Agency Problem
- Shareholders allocate decision-making authority to the managers
- Managers can exercise substantial discretion over the disposition and allocation of
investors’ capital
- With the control rights, managers may allow themselves to consumer exorbitant
perquisites
- Managers may also steal investors’ funds
- Self-interested managers may also waste funds by undertaking unprofitable projects
that benefit themselves but not investors
- Managers may also adopt antitakeover measures to ensure personal job security
2. Remedies for the Agency Problem
1. Independent board of directors
2. Incentive contracts
3. Concentrated ownership
4. Accounting transparency
5. Debt
6. Shareholder activism
7. Overseas stock listings
8. Market for corporate control
3. Law and Corporate Governance
Commercial legal systems of most countries derive from a relatively few legal
origins.
English common law
French civil law
German civil law
Scandinavian civil law
The content of law protecting investors’ rights and the quality of law enforcement
varies a great deal across countries.
2 most influential legal systems
Protection to investors English > French
4. Consequences of Law
Protection of investors’ rights has major economic consequences.
The pattern of corporate ownership and valuation.
Development of capital markets.
Economic growth.
Ownership and Control Pattern
Companies in countries with weak investor protection may require concentrated
ownership as a substitute for legal protection, allowing large shareholders to
effectively control and monitor managers.
Dominant investors may acquire control through various schemes
1. Shares with superior voting rights
2. Pyramidal ownership structure
3. Interfirm cross-holdings
Large shareholders, who are often founders and their families, can use a pyramidal
ownership structure in which they control a holding company that owns a controlling
block of another company, which in turn owns controlling interests in yet another
company, and so on
Equity cross-holdings among a group of companies (keiretsu/chaebols), can be used
to concentrate and leverage voting rights to acquire control.
Private Benefits of Control
Once large shareholders acquire control rights exceeding cash flow rights, they may
extract private benefits of control that are not shared by other shareholders on a pro-
rata basis
Studies demonstrate large shareholders tend to extract significant private benefits of
control in those countries where the rights of minority shareholders are not well
protected
Capital Markets and Valuation
Investor protection promotes the development of external capital markets.
When investors are assured of receiving fair returns on their funds, they will be
willing to pay more for securities.
Thus strong investor protection will be conducive to large capital markets.
Weak investor protection can be a factor in sharp market declines during a financial
crisis.
Existence of well-developed financial markets, promoted by strong investor
protection, may stimulate economic growth by making funds readily available for
investment at low cost
Financial development can contribute to economic growth in 3ways:
- Enhances savings
- Channels savings toward real investments in productive capacities, thereby fostering
capital accumulation
- Enhances efficiency of investment allocation through monitoring and signaling
functions of capital markets
5. Corporate Governance Reform
Scandal-weary investors around the world are demanding corporate governance
reform
Failure to reform corporate governance will damage investor confidence, stunt the
development of capital markets, raise the cost of capital, distort capital allocation, and
even shake confidence in capitalism itself
Objectives
Strengthen the protection of outside investors from expropriation by managers and
controlling insiders.
Among other things, reform requires:
strengthening the independence of boards of directors with more outsiders,
enhancing the transparency and disclosure standard of financial statements
energizing the regulatory and monitoring functions of the SEC (in the US) and
stock exchanges.
Political Dynamics
Reform is easier said than done
Reformers should understand the political dynamics surrounding governance issues
and seek help from the media, public opinion, and nongovernmental organizations
(NGOs)
7/2002, The U.S. Congress passed the Sarbanes-Oxley Act.
Protect investors by improving the accuracy and reliability of corporate disclosure,
thereby restoring the public’s confidence in the integrity of corporate financial
reporting.
Accounting regulation
Audit committee
Internal control assessment
Executive responsibility
British government appointed the Cadbury Committee (1991)
Committee issued its report (12/1992), including the Code of Best Practice (i.e.,
Cadbury Code) in corporate governance, recommending:
BODs of public companies include at least three outside (nonexecutive) directors
Positions of CEO and COB be held by two different individuals
7/2010: U.S. Congress passed the Dodd-Frank Wall Street Reform and Consumer
Protection Act
Volker rule:
Resolution authority:
Derivative securities:
Systematic risk regulation:
Consumer protection:
5/2018: U.S. Congress passed the Economic Growth, Regulatory Relief, and
Consumer Protection Act, that significantly weakened the Dodd-Frank Act
