The Role of Corporate Governance in Developing Economy - Dissertation Example

Topic: Measuring the role of corporate governance in developing economy Corporate governance in developing countries has been a topic of hot discussion off late. Efforts in both public and private sectors have been taken in developing countries to develop detailed and all-encompassing rules of corporate governance. A number of developing countries have added their own legal processes and some have taken the lead from the developed countries. All countries do not follow the same set of framed rules; they differ from country to country and company to company. It is significant to find out whether corporations are adhering to or not to such formulated rules and practices in day-to-day corporate governance practices. There has been a tendency not to follow the stipulated guidelines. Actually, the problematic issue is not the making of regulations and governing laws but their implementation, which the policy makers find lacking in developing countries (Berglöf & Claessens 2004). Difficulty comes in measuring the role of corporate governance in developing economies as rules and regulations are not followed and implemented earnestly. The Nobel Laureate Douglass North [1991] has rightly observed that “how effectively agreements are enforced is the single most important determinant of economic performance”. Actually, implementation of corporate governance rules is the primary difference in the working of both developed and developing economies. Such countries that do not follow the corporate behaviour thoroughly face external risks to private property rights more in comparison to the countries that fully enforce corporate culture [Acemoglu, Johnson and Robinson 2002]. Such a scenario is quite visible in the developed and developing economies of Central and Eastern Europe where difference appears in abiding by the law and writing the law text [Pistor, Raiser and Gelfer 2001]. Not enforcing the rules affects a firm’s outside financing, as financial deals require adherence to rules so that stakeholders know the risky areas before investing in a firm. There is less scope of financial agreements reaching final stages if enforcement of corporate rules is not effective. Related data confirms to the fact that it is not the insider trading laws but actions taken against insider trading that gives a glimpse of how securities markets function [Bhattacharya and Durnev 2001]. In developing economies, commitment to corporate practices is weak, which affects the ownership and functioning of corporate governance mechanism. Ownership concentration has its own potential costs, which could entrench the owner besides causing lack in performance, limiting risk transfer and increasing liquidity costs as it becomes difficult to sell stakes. Such potential costs risks hinder the growth of capital market at country level. Corporate governance rules are also affected in developing countries where ownership of the company is in the hands of selected few, favouring their interests, thus increasing potential social costs (Berglöf & Claessens 2004). Overall, corporate governance mechanism gets disrupted because of this concentration of corporate structure. Reform in governance mechanism is required for proper functioning of processes in such countries where law enforcing agencies do not ensure effective governance. The solutions need to be less dependent on public enforcement. Rather their effectiveness should be tested against the background of governance issues in emerging markets. Solutions should encourage practices of governance rules, not just be law books on the shelves (Berglöf & Claessens 2004). Literature Review There is sufficient literature on measuring the role of corporate governance and bettering the bad performance enforcement environments prevalent in developing economies. The Corporate Governance Problem in developing countries is weak enforcement of corporate governance mechanisms. To comprehend the enforcement, it can be understood with a conceptual model of a firm and how it is financed from outside. Different mechanisms can help in zeroing the problems resulting from outside finance. Problem of commitment appears which needs to be mitigated first to arouse the confidence of investors. Shleifer and Vishny have defined corporate governance in their 1997 review: “Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment” [1997, p. 737]. These commitment mechanisms are not as robust in developing economies as they should be for investors to monitor and punish those responsible for it. In developing countries the costs of gathering relevant information and enforcing contracts is high. It discourages investors and crucial economic growth remains suspended due to lack of outside finance (Berglöf & Claessens 2004). Enforcement of corporate governance takes into consideration both – the commitment issue related to property rights and application of mechanisms. Both are although different issues but combined. In some developing countries, property rights may not be robust but resolution mechanisms are strong. Studies indicate, for example, a CEO being fired because of bad performance in a country with different corporate governance ruling ((Kaplan 199X and Gibbons 2003). Not adhering to corporate governance rules in both spheres – poor enforcement of property rights and weak resolution mechanisms create problems such as decreased capital market development, insufficient outside financing, lowering firm’s credit rating and increased cost of capital, etc. (see survey by Claessens 2003). In this literature review we will address the enforcement problem; how to resolve conflict of interests among different stakeholders through different mechanisms. Strategic control mechanisms and effective regulations missing in the developing economies could be in large numbers. Large blockholders are relatively very important governance mechanisms in developing economies. There is good scope for policy intervention. Governance mechanism to control corporate market is not as potent because of ownership concentration but it can still exist via debt contracts, which requires bankruptcy system. Market for corporate control has scope to remove managerial bottlenecks by disclosing ownership and control and developing a banking system. Similarly, there are governance mechanisms regarding proxy fights, board activity, bank monitoring, shareholder activism, employee monitoring, litigation, media & social control, reputation and self enforcement, bilateral private enforcement mechanisms, arbitration, auditors, other mutual mechanisms and competition. In the context of developing economies, governing mechanism on arbitration, auditors and multilateral mechanism plays a very significant role in the making of public law. Although the issue of enforcement is very crucial, audit also doesn’t remain neutral. Interests of major stakeholders clash. Scope-wise, private third party mechanisms are developed. Conflicts of interests can be taken care of as well as it encourages competition. What mechanism is suitable for a country depends on the developed institutions, particularly its contracting environment. You can not make a generalised statement on what governance mechanisms would be prevalent in a particular country. A mechanism does not remain strong if any policy intervention affects its working. That way, it is not a strong mechanism if it is susceptible to policy intervention. Hostile takeover through the mechanism of market for corporate control is a significant mechanism, the fear of which can impact the working of management although such a takeover may not take place. If management is not following rules and corporate regulations in the functioning of the business, new shareholders cannot do anything to put pressure. As they themselves are lacking in gathering enough resources to put stake, they can only hope that board members will take the initiative to bring improvement in the functioning even if they need to recruit new managers, so that new stakeholders’ interests are safeguarded. In case, board members’ attitude is not helpful, shareholders can choose the harder way of going to the court in the hope that creating bubble outside will impress upon the management to look after shareholders’ interests. Board characteristics and participation can be instrumental in strategic decision making. Taking a country specific example of Nigeria, Ogbechie et al. (2009) has examined the relationship between board size, CEOs complex responsibility, board structure and participation in strategy making in a research paper on Nigeria, Africa’s most populous nation. Empirical research was made by sending a questionnaire to the chairmen of 138 public limited companies of Nigeria in November 2004. Only a small percentage of 28, numbering 39 companies answered the questionnaire. Taking into consideration the primary as well as secondary data, it reached the conclusion that in Nigeria, public sector companies, mainly from stock market were adhering to principles of the Code of Best Practices. The main purpose of the research was to find correlation between the board participation and other issues like size of the board, work freedom given to board members and CEOs duality. In the matter of strategic decision making, involvement of members was noticed at high level. Board activity is one of the important corporate governance mechanisms relatively important in developing countries and provides scope for policy intervention. Sufficient literature is not available generally on developing countries and particularly on the role of board among a list of corporate governance mechanisms. It is a known fact that owners can indulge in hiring and firing activity. As such it is not a dependable mechanism although it can play an effective role in strategising long term policy initiatives if freedom, training, disclosure of voting and collective voting is practiced by board members, turning the tables in favour of shareholders. Ogbechie et al. (2009) by selecting Nigerian public listed companies of stock market enriches the experience on the strategic functions performed by the board in Nigeria. Questionnaire included questions about the size of the board, number of outside directors and inside directors and number of independent and affiliated directors. By following the Judge and Zeithaml [1992] survey standards, board participation in the strategic decision making was requested to be graded on the seven point Likert scale by the chairmen on the following traits of strategic decision making. 1. Deciding on the company’s values to base the strategic direction and be guided by it. 2. Deciding and revaluating strategic targets. 3. Deciding and applying company policies. 4. SWOT analysis 5. Developing second line of action 6. Deciding business unit-wise strategies 7. Checking and validating organisation structure and capabilities 8. Examining strategy enforcement. Dependable variable was created on the board participation in the strategic decision making as based on the chairmen’s grading on the seven point scale. It was derived by the average score of eight factors used to measure board involvement in strategic decision-making. Independent variables were created on the sitting members of board of the company. Full time directors and members of the high profile management team were named insiders. The number of directors divided by sitting directors got the percentage of outside directors. An imaginative number 1 for CEO duality was created if both the CEO and the Chairman were represented by one identity and deriving a value of 2 if both designations belonged to different identities. Findings Responses were analysed in phases by descriptive way and by checking correlation among board features and strategic participation in decision making. Board size Questionnaire results indicated that the average size of the Nigerian public limited companies was within the range of internationally agreed standards. The average number of board strength was 7.8 with 38 percent of companies having less than 8 members on their boards. 20.5 percent companies had strength of 10 directors. The results of 2004 matched with the yearly reports of Nigerian listed companies [Okike 2000] indicating the numbers of board members between 7 and 10. Board composition As per survey results, Nigerian listed companies have more percentage of outside directors. Inside directors’ (executive) percentage range is 3.2 and average of outside directors (non-executive) is 5.2. It is significant to know that 90 percent of firms have 4 outside directors. Average number of outside directors who are company affiliates is 1.5.; independent directors are 4.3. As per results derived for independent directors, a part of outside directors – felt least restricted to participating in strategic functioning. This finding matches with the finding of Ruigrok [2006] although Ogbechie et al. (2009) outside directors’ number is lower than as reported by Ruigrok [2006]. CEO duality As per the recommendations of the Committee on Corporate Governance of Public Companies in Nigeria, the chairman and the company CEO should be different identities, which is a positive feature in governance. Research indicates that 30 out of 39 participating companies have chairmen who are not CEOs as well. Again, it matches with the annual reports for Nigerian listed companies by Okike [2002] which shows that 80 percentages of companies have different heads on these designations. (Ogbechie et al. 2009, pp. 178-179) Participation of the board of directors in strategic process Eight questions were asked to the chairmen to rank them in the order of preference for knowing the participation of the board directors in the company’s strategy making process as stated ]reasons behind them so that they may constructively play their part in the strategy development process. Next and the fourth important trait of strategic decision making favoured by more than 61 percent respondents is setting of corporate and financial strategic choices besides taking decisions on company policies by backing and implementing them. Next and fifth preference order is the directors’ participation in deciding on the company’s organizational structure and potentials in the implementation of the company strategy. The questionnaire analysis finds the percentage of such respondents to 56 who agree that it is a very important feature of strategic decision making. Hypotheses testing As argued above, different board features such as BS, CEO, DU and board IND impact the board to the limit of its members’ participation in strategic decision-making. To examine the impact, following relationship is maintained where SI is a function of BS, CEO, DU and IND: SI=F (BS, DU, IND). Through correlation (Pearson’s) matrix, dependent and independent variables have no statistically important relationship. There was found no negative relationship between the board size to its participation in strategic decision-making by using p-factor. It was also found that no negative relationship between the percentage of outside directors and CEO, DU in the matter of board participation in strategic decision making. This research is similar to the research by Ruigrok [2006] and his associates on Swiss public companies as they also found no proof that board size and percentage of outside directors is negatively related. Earlier studies are not similar where such a negative impact has been reported [Goodstein et al., 1994; Judge and Zeithaml 1992] (Ogbechie et al., 2009, pp. 180). See tables on pages 178-179. Meanings derived Further research is necessary to include not-listed companies as out of 50,000 companies registered in Nigeria; only 200 companies are listed on the stock exchange. Also a good number of companies are not public listed. Further research is necessitated to know why the board traits (size, composition and CEO DU) have no impact on board SI. The above discussion on Nigerian public limited companies shows that some sort of process is going on in public limited companies to start a system of corporate governance. This is a positive sign for the economic growth and creating investors’ faith in the country’s capital market (Ogbechie et al. 2009). Proxy fight is yet another mechanism in the hands of company shareholders to discipline the functioning of the firm. Smaller shareholders can come together and wage a proxy war. Creditors are other important claims holders. Similarly labour could also be a potential ally as it is important functionary to check and enforce contracts; a shareholder can depend on them to fight collectively. So that there are no negative repercussions, they transfer the responsibility to the bigger player, which in most cases is the bank or in some situations the labor union to see that interests of all stakeholders are pursued by the incumbent management. All these governance mechanisms have limited application as per the prevalent contracting and enforcement environment in a country. If one of the mechanisms is weak, it affects the whole enforcing environment, e.g. if litigation is not an effective mechanism in an economy, it is because enforcing organisations are not strong enough. Proxy fights can be a potent mechanism only if shareholders’ registries are maintained properly. When shares are not liquid, market for corporate control can not be easily prepared. Similarly without enforcing credit contracts and collecting collaterals, bank lending is not easy to avail or in case, banks are flooded with non-performing loans and their regulatory and invigilation framework is not robust, lending becomes difficult to avail. As a result, it becomes difficult to arrange finance from outside and firms have to depend on inside resources or financial contribution from knowledgeable investors only. As the enforcing environment improves, outside finance becomes more readily available. For such closely knitted firms, literature is not in plenty as there is no clash of interests. To obtain outside finance, firms need to make governance matters practical and workable. A weak contracting environment affects the growth of SMEs and new firms as pointed out through statistical evidence [Beck, Demirguc-Kunt, and Maksimovic 2003]. Owners also bear the brunt of poor contracting environment of increased costs, limiting risk transfer and low level of liquidity for inside investor (Berglöf & Claessens 2004). In such a scenario, solution to the problem is derived by empowering the biggest shareholder to interfere the governing process when required. In developing economies major companies have concentrated shareholdings. On the other side, investors in such weak markets create their own big enough stock of controlling stakes to promote monitoring. Such a tendency among shareholders has been noticed in Central and Eastern Europe where shareholdings were scattered intentionally but got consolidated in the next five years surpassing concentration level in Western Europe as well as of developing countries [Berglof and Pajuste 2003]. Such a practice is getting reinforced with the segregation of ownership and control. It is happening mainly via pyramiding and to some extent via cross-ownership and dual class shares. Large blockholders are a solution to some degree only of corporate governance issues as one aspect of outside financing is no more required. By managing directly and controlling the firm, the large blockholder doesn’t face the problems of principal agent and ex-post resolution. Ownership concentration has different significant costs that come associated, as detailed out [Morck and Yeung 2003 review]. No doubt, such transference of power creates another problem of inspecting the functioning of large shareholder. The large shareholder may misuse powers for personal benefits in stead of shareholders value and involve in confiscation of minority shares via tunneling and other mechanisms. In developing economies, asset stripping and tax-evasion happens by managers of such companies that are listed on stock exchange. What happens in such weak environments is that controlling shareholders is the inevitable result. Minority shareholders always seem to be fighting with controlling shareholders. Both try to reach a balanced position where interests of both parties are safe. In a number of developing economies, corporate governance systems are tuned in favour of controlling owners, any exodus of corporate standards on the large scale from developed countries to developing countries may create problems for big investors to shy away from taking controlling powers. This may, most probably result in undervaluation of the most powerful controlling mechanism in transitional and developing market economies. Corporate mechanisms like proxy fight and market for corporate control can not be effective in the presence large blockholders in developing markets’ contracting environment. Board members being on the roll of the company cannot be effective and dependable spokespersons of small shareholders. Same happens to the executive compensation schemes, which are not enough governance mechanisms; they can be fired by the controlling investors. This analysis of different corporate governance mechanisms provides a hint on how to apply reform, taking into consideration the weak governance environment; how to prioritise a particular mechanism to increase the field of policy interference. If legal system in a developing country is functioning well, minority stakeholders can knock at the doors of courts to express their fears and compel the controlling shareholders to protect their interests. Thus, scope for improving the functioning of major mechanisms of large shareholder monitoring can be achieved through litigation. Actually, it doesn’t happen in weak enforcement environments. Information remains the only means of empowering small shareholders as a way of encouraging private mechanisms. Next, we will discuss the relationship between the general enforcement environment and the specific enforcement mechanisms. Enforcement: Specific mechanisms Enforcement of corporate governance standards is crucial to economic growth. Literature exists but there is lack of a proper framework. For ease of segregating, there are two forms of enforcement: private and public. Private enforcement mechanisms come outside the preview of legal system. Private initiatives can be unilateral, bilateral or multilateral. They are different from private law enforcement means like litigation by individuals or public enforcement. Framework of law is used to punish the violators on the basis of signed contracts by court adjudication and final decision is enforced by the state. In public enforcement, the government plays both the roles – of prosecutor and final enforcer. Certain situations may demand the government to act as arbitrator; not conceding to any property rights of contracts to enforce and can go to any extent beyond law to safeguard the interests of all other stakeholders other than the owner. So, an enforcement system is not rigid; there occurs continuity of all the three mechanisms crossing their line of control from private ordering through private law enforcement laws to government enforced rules to total government control [Djankov et al. 2003]. All mechanisms have their own flaws and benefits but private and public initiatives are not replacements of each other but complementary. Private enforcement is crucial particularly in weak institutional environment. In some developing economies where general institutional environment is very weak, some system of social control is necessary to follow in the absence of government control so that markets function properly. Another issue relating to law is that all laws are not written. Unwritten laws need to be codified first. Codification depends on the social and economic characteristics of the country; it may differ as per the social and economic features. Greater the development level of society, more economies would be market based, necessitating codification. Where laws are not clear, cost of private ordering and enforcement would not be definite. There is more scope of evolution if laws are broader. Private Ordering In developing economies, Berglöf & Claessens (2004) financial deals take place through private ordering, without any interference of law and public enforcing institutions. Such a practice as private ordering is prevalent in most of the world economies historically. Greif [1992, 1993] has quoted such historical examples of enforcement in trade in the Mediterranean and Ostrom [1990] has described how it has been taking place by management of common resources in developing societies. Ellickson [1991] has given the example of cattle farmers of California in the protection of property rights. McMillan and Woodruff [2000] have given proof of private enforcement in the developing economy of Vietnam. Besley [1995] has examined the protection of property rights of Ghana farmers. Gambetta (1993) has recorded the role played by the Sicilian mafia in managing private enforcement. In this discussion, varied types of private enforcement mechanisms related to corporate governance and the role of public policy in backing these mechanisms will be discussed. There are, as per existing literature, differences in unilateral, bilateral, and multilateral forms of enforcement mechanisms (e.g., Rubin 1994). In unilateral enforcement mechanisms, firms create their own assets through commitment. Such assets get evaporated if standards are not followed. The most known unilateral mechanism is reputation, created through effective advertising. If a firm is lacking in enforcement environment, it can be compensated via unilateral mechanism of creating reputation or goodwill. In this context, reference of the Russian company Yukos is relevant. It got recognition from the stock market by improving the management and governance regulations. Earlier, it had a bad governance record. Had Yukos violated its agreed rules, investment would have perished. Some investment strategies can also be a part of the unilateral mechanism, which give positive results if outside financing is being used by a firm. Self enforcement through reputation, as happened in the case of Yukos, has one shortcoming, of depending on future dealings; for future funding needs, Yukos will have to revisit stock market. Another problem with reputation mechanism is that people’s memory is short. New investors won’t heed to the losses earlier incurred by the company. As a result, commitment power of reputation mechanism weakens in the financial markets. Considering further the bilateral mechanisms regarding reputation, commitment of two firms for each other can strengthen such enforcement like Yukos did by taking the consultancy services of McKinsey for bringing improvements in corporate governance through bilateral mechanisms. McKinsey, on its part, couldn’t have agreed to partnering with Yukos, had it not the faith that Yukos was committed to improve its corporate image. Reputation as a bilateral mechanism can also help companies by sharing or transferring vertical or horizontal control over decision making. Third party services can also be engaged. Some industries separate their production and distribution arms to create dependencies and incentives not to withdraw from the given commitments. Dividing the investment ratios to 50:50 is another type of bilateral mechanism, quite popular in developing economies. In such a control taking structure, there is one single largest shareholder owning 50% stakes. Scope for problems in such an arrangement may be high due to weak contracting environment but the contribution of each partners’ assets add to the bilateral private contracting commitment level. Two parties in bilateral mechanisms can also involve in hostage exchange. It means leaving your valuable assets to the other party for whom they don’t carry any value. It is not easy to exchange hostage assets for companies as they are not in plenty with the hostages’ offering company and have less value for the outside investors. Asking some assets to be held offshore is one of the terms of private shareholder agreements. Conditions to bilateral mechanisms are time duration and reputation besides extra returns, above the market to further carry on the mechanism. The most important type of mechanisms for corporate governance is through multilateral arrangements. Through regular interactions and learning, parties develop customs across different industries and jurisdictions. All information transfer on these customs and any deviation from them calls for penalties. Such enforcement mechanisms may provide opportunities to intermediaries to benefit via economies of scale, thus obstructing free riding in enforcement. There are a number of examples of such multilateral arrangements like trade unions developing their own codes of corporate behavior, leading to such institutions to resolve an issue. Other examples are in financial sector like broker associations, investment banks, clearing houses – developing their own rules to avoid clashes of interests and information bartering. Intermediaries sell relevant information, thereby create rules and regulations. Similarly, rating agencies gather data, set standards and provide information for quality check. Stock exchanges create the membership terms for interactions and develop their own mechanisms for punishing those not adhering to their practices. All and one – follow some mechanisms, like investment banks also can attest and check firms for lending purpose and underwriting activities as well. All these players are involved at a time in a number of relationships; they become instruments of multilateral enforcement mechanism. Next, private arbitration is another class of multilateral enforcement mechanism where different stakeholders sign up to a mechanism bearing commitment as comes due to repeated dealings but finally, some sort of public enforcement has to be applied to enforce private arbitration. Challenges to private enforcement mechanisms All private enforcement mechanisms, Berglöf & Claessens (2004) particularly multilateral arrangements, face challenges. Opportunistic attitude of players is a hurdle. Greater the number of parties involved more is the chance of breaks in collaboration unless supported by some public control. Any number of players can affect corporate governance standards. It happens more often in small markets where self-regulating bodies are not strong enough to incorporate high standards and most often seem excited to show rent-seeking attitude. Competitive behaviour, to some extent, can control opportunity seekers but it cannot be guaranteed. Reputation can help in maintaining bilateral and multilateral settings but problems appear due to more than one equilibrium point. Difficulty level rises in maintaining contractual obligations in developing economies, as reputation is low. Opportunities to develop reputation get shrunk. Moreover, lack of surety that reputation will pay minimises the scope of getting future rewards of current good behaviour. This makes difficult to walk out of low reputation equilibrium. Critical appraisal of private mechanisms Private mechanisms in all the three classes of mechanisms – unilateral, bilateral or multilateral – have been effective in enforcement of good governance practices. Black (2001) has provided some indicative data from Russia, pointing out the chances of individual firms bettering their corporate governance unilaterally by increasing their value even in low corporate environment. Same is true of Korea (Black, Jang and Kim 2003), but methodological problems appear as in the case study of Russia, lessen the value of such tests. When outside firms following strict corporate standards enter such a market, it creates a congenial environment of following regulations as followed by outside firms. Cross-border mergers and acquisitions initiated from countries following higher corporate standards to be targeted at lower standards following countries help poor environ countries in strengthening and bettering their corporate standards [Rossi and Volpin 2003]. Foreign investors coming to developing countries have an inclination to settle down with the environment or even take undue advantage of the local corporate governance environments, as some bad image of foreign investors in usurping the firms in developing countries have come to light. Entry of foreign firms in developing economies increases the level of competition; putting pressure on local firms to come up to the agreed market standards of corporate governance although they don’t get any such boost individually (Berglöf & Claessens 2004). Whether private enforcement mechanisms in the field of corporate governance are effective or not depend on the particular area’s general institutional environment. Taking for example the scenario in mechanism of private arbitration, it works well if legal enforcing bodies like courts play their role well. In the context of Korea, Black, Jang and Kim [2003] government backing is must for the right functioning of private mechanisms. As substantiated by Durnev and Kim [2003] and Klapper and Love [2003] individual firms can not fill up the vacuum created due to lack of local governing practices even if their own corporate governance standards are higher. Given the needed support through incentives, private enforcement mechanisms, no doubt, would perform as if hey are the primary corporate governance mechanisms. Such a scenario will be more visible in countries where public law and public enforcement mechanisms are not as effective as they should be. It is significant to acknowledge that public law emerges out of private ordering in ordinary circumstances; courts notices working of good contractual settings in private initiatives and makes them laws [Cooter X.] Same can be said of securities law in the United States. Private initiatives in governance are practiced by related markets, which finally become laws or regulations Berglöf & Claessens (2004). Private Law Enforcement Rules ad regulations on how to conduct business are built by the relevant governments of the countries to be followed in most of the societies by private parties. When a party is at the receiving ends, it goes to the court. It works if the law is effectively obeyed and easy to get. One can not get justice if court decisions are principle based. Specific statutes for proving facts make the job of the court as well as the plaintiff easy as it lessens the power of the judges to give benefit of doubt to the other party. When courts are weak and have no experience of handling such cases, private law enforcement becomes effective in such situations (Black and Kraakman (1996) and Hay, Shleifer, and Vishny (1996)). Private law enforcement Berglöf & Claessens (2004) is effective in capital market growth in the securities regulation in comparison to public enforcement [La Porta etal. 2003]. Securities regulation has lot to do with corporate governance; as a result, private law enforcement applies more on issues of corporate governance [Lopez-de-Silanes 2003 reviews]. In securities markets, incentives are necessary to follow governance regulations; stock markets have such incentives like checking whether firms are abiding by the listing regulations or not or different stock exchanges may have competition incentive for the services provided by them to the listed companies. Such organizations are need of the hour that can rein in private players for abiding by the law. It can either be self-governing organizations or government functionaries or courts and specifically appointed judges. All business related permissions like obtaining licenses and applications’ handling should be delegated to a quasi-government agency. Such associations already exist for lawyers and doctors. In financial markets such authority to control market transactions by the self regulating organisations is taken from public law. Stock exchange is typically a private body but it may be given powers to control securities market functions; definitely, it need not and should not be a government organization to monitor these functions (Berglöf & Claessens 2004). Such type of delegated enforcement of public law through self regulating organisations (SROs) may be more effective if they are equipped with relevant information, resources and wide scale of sanctions. Applications can be better evaluated by local agencies for sanctioning permits; how the market is being exploited and can better verified by local bodies as they have a better knowledge level than outside agencies. They would have powers to cancel a license, issue a warning, and inflict financial limits, actions not easy to implement by a government or court of law (Berglöf & Claessens 2004). Public Enforcement There is enough literature available in the category of public enforcement. Three things are significant in literature on public enforcement in relation to corporate governance: reciprocation between thoroughness of law and dependence of law; the positive theory of enforcement and responsiveness of enforcing institutions; and the inter-relation between law, corruption and enforcement. So far as written law is concerned, it has no functional issues. The important thing is what section of the law is being enforced while other academics have a different view, as the written law can be more or less exhaustive and its enforcement more or less efficient. Enforcement of some laws can be easy than others indicating the importance of enforcement environment in promoting application of some laws as they are written for enlarging their scope for enforcement. A matrix appears in this context of two-by-two – either basic or thorough and either weak or strong corporate governance rules. Legal parameters can be low or high for differentiation purpose of breaking the law. Sufficient literature exists enumerating the differences between extensiveness of law, i.e. horizon of law and effectiveness of law, i.e. limit of the application of law. Pistor and Xu [2003] have analysed the relevant data on the issue and disclosed that it helps in foretelling what to select between regulatory and legal advances to financial market rules. Some academics have discussed the choices between complex and vast rules and easy to digest rules, popularly known as bright-line rules [Glaeser and Shleifer 2002]. Getting feedback from Gary Becker’s (1968) writing, academics have written on economic enforcement. According to Becker, greater the penalty imposed, maximum would be enforcement. Fines can not play an effective role because of sufficient liquidity lying with those punished. Some have pointed out the role of technology in enforcement as a number of factors and choices are there in technology enforcement, which need to be analysed further. However, it is not possible to study the technological effectiveness and efficiency of enforcement bodies such as courts, stock exchanges and quasi-government bodies as statistics are not easy to analyse. Regarding efficiency of regulatory bodies, it is difficult to map output against input. Number of cases settled is not the only criterion but reach of the poor to the judiciary and fair play as well as foretelling play a crucial role. Effectiveness of decisions implemented again can be over-riding as in the Microsoft anti-trust case where millions were spent to reach the right decision for others to take a lesson. Other significant issue is how decisions are taken, against what input and when. By input efficiency we mean to know the type of funding and attractions offered. Output should resultantly provide total satisfaction to customers, their belief in the effectiveness of court rulings. An analysis of the efficiency of law should not be limited to the courts only but encompass and fit in to the larger system application. Empirical analysis is limited on the issue of efficiency of legal system (Berglöf & Claessens 2004). Relevant literature exists on the significance of sovereign regulators and monitoring institutions that have sufficient powers, workforce and maneuvering as well as monetary functioning and freedom. Central banks, competition policy and regulatory agencies come in such category of financially sound bodies whose independence operations can be crucial in enforcement. In a number of countries, securities exchange regulators are financially sound as they earn through trading and fee-collection but they have to get the sanction of the related governments in reserving finances for this purpose from the general budget. It minimises their freedom to use finances. Simultaneously, in weak institutional environments as found in developing countries, powerful governing bodies can only provide limited benefits. Opposite reactions may be seen in such environments, where governing bodies and supervisors are not paid well, resulting in misuse of power by indulging in weak governance as pointed out by Bath, Caprio and Levine [2000], promoting corrupt practices (Berglöf & Claessens 2004). Enforcement Technologies and the General Environment The Selection of Enforcement Technologies Enforcement technologies, Berglöf & Claessens (2004) differ by kinds of functions performed and are country-specific. In some countries social customs play a predominant role than formal systems in technology selection. Media can be used as a potential tool in application and usage of technologies in local and national scenarios but it has no legal prowess. Such social norms as happened and found expression in a Dutch Grocery Chain Albert Heijn where customers revolt saw the shrinkage in the store manager’s pay package besides compelling the chairman and board directors to resign. Such social outbursts create a corporate governance mechanism of their own. A free media can help in making such mechanisms a success. Technology also plays a positive role as it happened in Korea where all corporate concerns came to light through the internet. Enforcement of technology in a specific industry is determined by its cost and benefits; if costs are higher than its benefits, outside options like courts will be tried. In developing countries, there are static and dynamic technological capabilities. It depends what type of technologies are required. Technology usage will depend on the limit of one technology needing the support of another technology to measure the performance on finance and help in reaching the final decision that can be measured. Shareholders’ lobbies in the formal system need some legal support [Milhaupt 2003]. Regulatory environment being not as robust as it should be in developing countries, dedication to corporate governance needs the support of court for compelling management to refrain from misusing the powers and foregoing shareholders’ interests. Monitoring by banks can be a significant governance mechanism but banks need a regulatory framework and require collateral for public enforcement of mechanisms. Choice of technologies surely depends to a degree on cost-benefit thinking but remaining limited to a selected path only although more effective and efficient technologies come into practice, can be an obstruction. For example registration of collateral through courts cannot be the best choice in the presence of electronic registries but shift from one practice to another is time consuming and sometimes institutions withdraw from taking such technology based initiatives. As a result, change is slow to happen. Business of securitisation works on information technology, which permitted the sale of secondary assets while guaranteeing the intactness and enforcement of base contracts. Mix of technologies to be selected by developing economies will differ from developed economies. Public enforcement cannot be much effective in weak environments of developing and emerging economies. It is also because powerful owners and management will succeed in having their say. Another important thing is that trends are different from country to country in entering into litigation over such matters, which is conditional to the robust functioning of public enforcement institutions. For example in Russia, according to Zhuravskaya and Zamulin [200] investors don’t prefer going to courts as due to weak enforcement environment even if they win in the courts, they fail in the implementation of the courts’ verdicts. But at least exceptions are there as well. Taking the example of China where state owned companies are technologically sounder than private ones and there are no obstructions in the way of improvements in corporate governance. On the contrary, privatisation is not encouraged, particularly of bigger firms (Cai and Tylecote 2008). While testing the hypotheses on the impact of finance and corporate governance over the selection of technologies in manufacturing firms in mobile equipment sector in China, Cai and Tylecote (2008) found that technological advancement differed among kinds of firms and their transparency standards as well. State ownership, i.e. public sector control didn’t help to tackle low transparency in governing standards but it also didn’t obstruct the way to get finance. In becoming technology-efficient, public firms were far ahead of private ventures but where transparency types and levels were low, such differences were smaller. Cai and Tylecote (2008) reached some positive conclusions on authenticity of data and the effects it had on technological advancement in developing economies. Poor corporate governance in China paid dearly where degree of transparency was low. If enforcement mechanisms of courts are weak, banks’ policies on lending and financial development can help in application of governing standards but here also relative costs are a major factor. In China, institutional environment is not robust but investors prefer to go to the court for safeguarding their interests although court decisions are not certain and their enforcement as well not sure [Pistor and Xu, 2003; and Xu and Pistor, 2003]. It is because other governance mechanisms like banking system are either costly or not updated. It is very much evident (Pistor, Raiser, Gelfer 2000) that in developing economies getting outside finance remains a challenging task in weak environments even if revolutionary steps to safeguard shareholders’ and creditors’ rights are taken. Judicial system has been powered to raise the benchmark level to any standard but as it has been seen in many countries of erstwhile Soviet Union taking legal and technical support mainly from the US to reach the standards of developed countries for investors’ rights safety, but yet there is less hope that progress made on the legal front will match the growth of financial markets. There is lack of effective legal bodies. As per the regression analysis (Pistor, Raiser, Gelfer 2000) there is difference between the quality of law on the books and higher detailing power of legal effectiveness or the standard of equity and credit market development. The analysis on law and finance of the 49 countries substantiates the fact that effective law enforcement can not replace weak judiciary. There has been a need to reconstruct legal bodies from the base level so that new pillars provide a sound legal structure based on a country’s socio-political and economic history and not imitated from outside (Berglöf & Claessens 2004). The General Enforcement Environment Selection among the different technologies depends to a great extent on the total environment. Many interconnected factors are going to impact the general applicable environment of the courts and other implementing institutes [Slinko, Yakovlev and Zhuravskaya 2002]: motivation by local and national authorities, political interference at different government platforms, and the hold of the society. These issues differ from society to society across local bodies and nationalities. In some countries and their states, there is big difference in implementation as found in Russia, Mexico and Brazil [Broadman, 2000, Pinheiro Castelar, 2001; Laeven and Woodruff 2003]. Add-on to it is the fact that in such countries where market functions inefficiently, it may be due to not-dependable legal system. On the other hand, markets where competitive products impact the area of catchment and the expansion of SME sector can impress the working of courts (Berglöf & Claessens 2004). Institutional development of countries including their implementation depends also on physical talents, distribution of natural resources and technology as well. Such relationships exist between institutional traits and countries’ ever-prevalent features like their culture, history and physical traits of people. Institutional features like the danger of expropriation to private property can have permanent impressions and bear a connection with a country’s physical traits (Acemoglu, Johnson and Robinson 2003 provide examples of this from a cross-section of countries). In the matter of implementation it matters how the system came into being – whether legal including common law and civil law or general institutional in different countries [LaPorta et al., 1997, and 1998]. Time has reduced the gap in the functioning of law but it is still an issue to be decided to maintain equality between private and public regulations. They still affect the general implementation of mechanisms. Total transformation of the system is still impractical in the dissemination of governance regulations [Berkovitz, Pistor and Richard 2003]. Functioning of legal mechanisms significant for investment and credit security, according to Berglöf & Claessens (2004) depends on the degree of general enforcement environment. A robust balance of investor rights and effective legal system creates well groomed financial markets. Thus, latest research has confirmed the guarantee of private property rights security depending on a country’s earlier prevalent traits and the founding of its judicial systems [Beck, Demirgüç-Kunt, and Levine 2003]. Nigeria – Case Study As we find in the case of Africa (Okike 2007) where governance practices are not evident, leaving the exception of South Africa. Nigeria is such a country where initial endowments and legal systems are missing although Yasaki [2001] has found its proofs in banking sector. Research has been made by Wallace [1987, 1989] and Okike [1989] evaluating the accounting and financial reporting structure in Nigeria. All governing issues in Nigeria are taken from the provisions of company legislation. Historically, this system of legislation has the impact on it of its colonial rule. Nigeria follows the pattern of UK in the matters of Companies Act 1968 based on the UK Companies Act 1948 but this Act lacked in finding solutions to country specific problems based on its socio-cultural and political environment. Essentially, Nigeria’s historical analysis of its corporate governance is “Anglo-Saxon” or the “Outsider control system” [Franks and Meyer 1994]. Nigeria’s initial endowment is historically colonial and follows the principles as given below: 1. Shareholders’ interests are major deciding factor in business transactions and management prime job is to increase shareholders’ wealth. 2. A functioning capital market caters to the interests of both – shareholders and management by sale and purchase of shares, as valued by investors. 3. A chain of accountability exists starting from company executives answerable to board of directors who in turn are responsive to shareholders’ interests. 4. As per Companies Act, all players’ rights and duties are set in the statute of corporate governance framework. All these rules notwithstanding corporate governance mechanisms are not as efficient as they are in developed countries. Nigeria’s capital market is no as effective as it is there in developed countries but certain governance mechanisms provide effective functioning of companies registered on the securities market of Nigeria (Okike 2007). The role of government, the corporate affairs commission, the role of Securities and Exchange Commission, the role of Nigerian stock exchange and company directors, the role of auditors are instrumental in the functioning of various mechanisms. Some commendable work has been done by the Nigerian government through company legislation [the CAMA 1990] by setting in effect the Code of Best Practices for all Public Listed Companies in Nigeria. But the fines imposed on non-compliance are not an effective deterrent. Corruption is the hurdle in not bringing foreign capital to the Nigerian financial market. Instead of blind-folded imitation of foreign and developed countries governance mechanisms based on their socio-political and economic environment, according to Charkham [1994] that mirror their history, assumptions and value-systems, developing countries should evolve universal governance principles. It will help each developing country to find out the inherent weaknesses of its systems depending on its management, board and shareholders. Borrowing principles from outside without critically judging their value won’t provide effective enforcement as Hampel committee in the UK concluded that they “found no support for the import into the UK of a whole system developed elsewhere [Hampel Report 1994, para. 1.4]. Taking the lead, Nigeria can borrow from South Africa, adopted by it since 1994 the corporate governance model that is universal (Okike 2007). Critical Evaluation -- Nigeria Literature review on Nigeria clearly indicates the importance of socio-political, economic and cultural factors in the enforcement of governance mechanisms other than different endowments and judicial factors. Basic customs and faith (Djankov et al. [2003] referred as the “civic capital”) impact enforcement environment. Countries where societies are culturally heterogeneous, natural types of enforcement is traditionally weaker. Financial sector development depends on tradition and openness. With the growth in societies set up, changes occur in nature and type of enforcement becoming formal in mode. Same is the case with political bodies as they are instrumental in general enforcement environment. If there is autocracy in a country, political freedom may not be given for enforcement. Serious governance issues can emerge regarding the safety of property rights from the dictatorial form of government in power. In the absence of real “market” dealings, corporate governance issues may not be many. Another type of countries – emerging markets have the tendency to mix business with politics. Big corporate enter and start taking active part in politics, thus affecting government reactive force to function in the interest of minority shareholders, putting at risk the minority interests. When the way to get justice gets obstructed by vested interests, legal system gets paralysed [Glaeser, Sheinkman, and Shleifer 2003]. When enforcing bodies are corrupt, internal forces become active to take undue advantages. It results in deficiency in enforcement level. Government can form codes to reduce the risk of not abiding by the law but it has its own costs. A welfare government balances the costs incurred on enforcement with the benefits of strictly enforcing law. Being complementary to each other, judicial parameters and enforcement level – both increase with the overall development of economy. It has been seen in developing countries that governments adopt lenient attitude to save themselves from higher enforcement costs (Berglöf and Claessens 2004). Mueller (2006) has applied Anglo-Saxon approach to corporate governance issues in relation to emerging markets. Empirical analysis has been done country-wise based on La Porta et al. (1997)), which is very comprehensive. There is difference in opinion between the management and shareholders on the payment of dividend which is the concerning issue. With the help of a table, differences across countries in legal systems and different indicators, Mueller has reached on the conclusion that the strength of a country’s corporate governance bodies definitely depends on the size of its equity market. Bigger the equity market, better growth prospects. Empirical data serves the end of both developed and developing countries. If done singularly on developing countries only, findings might be different. It is because companies in developing countries have different investment opportunities than from developed countries. As investment opportunities are comparatively better in developing countries, there is no clash over dividend between managers and shareholders. This was the situation in many Asian countries before the crisis of late nineties when the marginal qs were equally above 1. After the Asian crisis, a number of developing countries showed marginal qs below 1, indicating poor corporate governance. Brazil 0.25, Turkey 0.52, Columbia 0.43 as shown in table 1. (P: 210-211). With such poor shareholders’ security in these countries, it will be an arduous task raising money via equity, affecting future development although exceptions exist like India with a marginal q of 0.82, Indonesia 0.87 and Philippines 0.73 (Mueller and Yurtoglu 2000). Creating positive environment for a robust equity market in developing economies is foremost according to Mueller (2006) for establishing governance standards. Governance mechanisms and suspension of listed firms in South Africa – a new research angle Mangena and Chamisa (2008) have made research on the relationship between corporate governance mechanisms and suspension of listed firms by the JSE Securities Exchange (JSE) of South Africa (SA). Which governance mechanism is most important and how to make corporate boards more efficient became a burning issue after the failures and financial scandals of the 1980s. Against this background, corporate governance guidelines and codes of best practice were developed by all countries – developed or developing but a dearth of direct empirical research was felt on the efficient practice of corporate governance in Africa. South Africa is a developing country and was the first to initiate the publication of corporate governance guidelines and codes of best practices in 1994. South Africa has seen a number of corporate failures, worth mentioning Fidentia, JCI-Randgold, Masterbond, Leisurenet, Macmed and Regal Treasury Bank. The onus of most of these corporate failures was put on weak corporate governance structure, as judged by World Bank 2003. Hypotheses In South Africa, JSE seems to have a high rate of firm suspension. Mangena and Chamisa (2008) have analysed 81 JSE suspended firms by using a matched-pairs research design in the time period of 1999-2005. As per the results, it is hypothesised that corporate governance mechanisms are weak in suspended firms in comparison to control firms. Negative association is found between listing suspension and the ratio of non-executive directors and presence of audit committee. Suspension rate is also comparatively high in firms with block-share ownerships. Delving deep, mixed results are found between institutional and non-institutional investors by dividing block-share ownership. Further, positive association is noticed between suspension and non-institutional investors and no positive association is noticed with institutional investors. Also found non-existent is any relationship between suspension and board size, directors’ share ownership and duality of CEO/Chair. These results can guide policy makers in developing countries and help improve governance standards accordingly. Institutional structure for corporate governance in South Africa South Africa follows the King’s committee report’s recommendations known as the King Report of 1994. Worth mentioning about King Report is that it follows “inclusive approach” on corporate governance. As it is, it pays attention not on shareholder wealth increase but promotes the cause of vast community of stakeholders. King Report stresses importance to the board of directors, board playing a pivotal role in corporate governance system. Other than that, higher importance is attached to maintaining a balance between executive and non-executive directors, majority being of NED – Non-executive directors, again preferably more independent members. Further King Report recommends separate persons for the rank of chairman and CEO and chairman should be an independent NED. In the case of South African listed firms, although compliance with King Report recommendations is not compulsory but JSE Listing Requirements require listed firms to show the extent of compliance in their annual reports with the King Report and if not complying, firms need to give reasons thereon. Research methodology Mangene and Chamisa used a matched-pairs research design as it carries the advantage of “…parsimonious means of controlling for certain potentially important confounding (non-accounting) firm-specific characteristics” of firms under consideration (Peasnell et al., 2001: 297). Data is authentic as taken from companies’ annual reports sourced from McGregor Data System, company secretaries and the University of Cape Town library. A request was made to JSE for a list of 532 suspended companies between the time period of 1999-2005. Annual reports were made available for 114 suspended firms from this list. Taking lead from the previous literature by Beasley 1994 and Peasnell et al., 2001, each suspended firm was matched with a non-suspended firm on the parameters of industry, size and time period. Firms removed from the list due to lack of data were 10 and another 23 were deleted as no matching pair could be found. After processing data on matching of firms, 81 pairs were scrutinised for sampling. Descriptive statistics of Empirical results As per the analysis, suspended firms have a smaller board of directors than controlled firms. The mean (median) number of directors in suspended firms is 7.099 (6000) and controlled firms’ 7.654 (7000). Ratio of non-executive directors is lower in suspended firms regarding board structure with a mean (median) of 41.3% (45%) in comparison to 57.3% (60%) for firms under control. Further, the mean (median) director’s ownership share is about 20.4% (12%) for suspended firms and for under control firms, it is 50.1% (47.5%). So far as the control variable is concerned, suspended firms are found more in motion, showing a decrease in profit with a mean of 86.2% (89%) and -4.3% (4%) as compared to about 46.6% (45%) and 3.8% (5.1%) for firms under control, derived as such. The results also show that suspended firms have more chances of duality, i.e., sharing combined responsibilities of being the CEO as well as the chairperson of the firm in comparison to firms under control. There is seen the absence of audit committee in suspended firms than in under control firms. Astonishing as it is, there are implications that suspended firms employ big auditing firms than firms under control. Anyhow, it is clearly indicated by ch-square tests that remarkable differences are seen between suspended and control firms in the matter of audit committee presence. Summary remarks It is very much clear from the above empirical data description that there exists negative relation between ratio of non-executive directors and listing suspension as gathered from the relationship between corporate governance mechanisms and occurrences of suspension by the JSE. This is relevant with the concept that non-executive directors are better managers. It goes well with the King Report recommendation that members’ composition should favour more non-executive directors, which is a right approach. This concept has got validation from the recurrent incidents of corporate failures in South Africa, which is the result of poor corporate governance composition. Findings also indicate chances of block-share ownership firms being suspended by the stock exchange. Although no proof is found of any relation between suspension and institutional investors, indications for non-institutional investors are positive and important in the sense of offering policy implications on the issue of “shadow directors”. As per the King Report of 2002, shadow directors should not be encouraged, carries substance. Gist of the analysis points out that institutional directors have been passive role players in the past but they can turn the tables against block non-institutional investors as they (institutional investors) possess huge share on the JSE and can control such activities, which cater to the interests of only non-institutional investors. Audit committees don’t have a positive association with suspension. It goes well with the concept that aud Read More