Openness Issue in the US and Europe - Case Study Example

Introduction The issues of Openness, accountability and efficiency are inter-wined in many respects. The financial scandals occurred in last few years have thrust more attention on the issues like independence. Openness and freedom has a different meaning both in the European governance models as well as in the US model and it has to be established and defended against a different set of interests and forces1. There are a large number of independence impairments which can be observed quite often in the corporate governance models from all over the globe. Finance and Corporate Governance Systems There are many definitions of corporate governance. But they all address a common central theme in their own ways. Corporate governance is the collection of laws, rules and ways that regulate the interactions and relationships between the owners i.e. capital providers, the governing body i.e. the board or boards in the two-tier system), senior managers and other people that take part in the decision making process and are affected by the dispositions and business activities of the company. Calpers defines it as, “the relationship among various participants in determining the direction and performance of corporations” Corporate governance exists in its own space. It shows the economic, historical, cultural and legal characteristics of a nation along with its business history and corporate sector. It is shaped by the ownership structures, ways of that particular economy and the available financing options. It includes the role of the financial markets, the banking and insurance sectors and the government in the form of shareholders and capital providers in some nations. “Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment”, says Andrei Shleifer and Robert W. Vishny. The system of corporate governance may give rise to a number of patterns of executive pay, which may occur because different board structures are associated with different arrangements for establishing executive pay (Schwalbach, Joachim, Conyon, Martin J., 2000). Variations present in these areas shows some of the considerable differences among all the governance models. Corporate governance has inevitable relationship with the ownership, control structures and patterns prevalent in an economy, adds Miguel A. Mendez. Eventuating ownership and explaining the agency factor i.e. the owners of the firm hire managers in order to control and manage the assets of the firm is an internal feature of the firm and central to every corporate governance model. “Britain and the US are viewed as similar enough to contrast with Japan and Germany, the benefits of external shareholding, capital markets and the profit-motive competing with committed investors, insider control and the mixed objectives of several stakeholders”, says Robert Fitzgerald and Etsuo Abe (Fitzgerald and Abe, 2004). The role of Openness and Efficiency The space of the board i.e. its freedom to execute a judgment in the motive of the benefit of all shareholders and can be defined on behalf of all stakeholders is both inevitable as well as crucial. The freedom of the governing body depends on the way it is organized including the factors like who are the chairman of the board and the top-most leadership positions of other crucial genre like chairmanship of nomination and audit committees, vice-chairmanship, and managing directorship. It also depends upon the composition of the main governing body. A common independence impairment that can be observed across most of the governance models is the placing retired executives as the board members of the company which they have managed for a long time. They bring the continuity and the core knowledge about the company that must be valued against their tendency to advocate for the status quo, and to side with the management team they were instrumental in installing, says Miguel A. Mendez (Mendez). The retired members of the Management board go on to serve on the Supervisory board in the countries with the two-tier system. The retired executives become board members in the unitary board. Directors to be elected from a small group of candidates from a restricted business circles is another drawback. Extensive cross-shareholding links give birth to cross-board memberships and reciprocal directorships in a number of European countries. One company holding a seat in the board of directors of another company and which in turn has a seat on the board of the first company. Openness is closely linked to the shareholding structure type prevalent in an economy. In economies with a majority of closely held companies, most shareholders are shown on the governing body and have access to all critical information whereas in broadly held companies, it becomes quite complex and difficult to provide information to all shareholders and the markets at large2. Hence, the economies characterized by a broad shareholding base like the UK and the US presents a high degree of openness and efficiency. On the other hand, Continental Europe containing a fairly concentrated shareholding base presents a much lower degree of openness and efficiency. But this openness and efficiency level is rising with the financial markets across continental Europe becoming more developed and sophisticated. Openness issue in the US Freedom must be established by the management in the US that is forcefully represented on the board and through its senior most members, like the CEO or a chairman and hence, resulting a dark shade over the affairs and freedom of this body. Corporations in all over the world have board of directors especially in the US, the board of directors is specifically charged with representing the interests of shareholders (Denis and McConnell, 2003). Corporate governance issues have also come under scrutiny as an essential part of the ongoing public policy debates about the capability of U.S. corporations to provide a growing standard of living for American citizens in order to compete effectively in international markets (Blair, 1995). The financial scandals occurred recently have rocked the US and have focused much attention on the matter of independence. The ethics of regulatory and best practice measures has had three primary objectives: 1. To make sure that a significant number of directors are independent. 2. Critical functions of the board like audit, control, nomination and remuneration, are carried out with the required freedom. 3. Board is free to work. The unitary board system is more prone to failures regarding freedom as per organizational point of view. The reason can be just because the combination of the management and supervisory functions will result in confusion or with over-lapping of the functions. The emphasis has always been on the management or leadership aspect of the equation in the US and enabling the regulatory bodies as well as the financial markets to supervise the management of the company. The alleged globalization of finance may seem to make our distinctions between financial systems meaningless (Tylecote, 2000). Openness issue in Europe Freedom/independence in EU excluding UK stands for independence from powerful shareholders i.e. the block holders that always dominate the board and aim to fulfill their own interests to the detriment of the rest of the shareholders (Mendez). Freedom from the block holders is attained successfully by appointing a sufficient number of independent directors. A new concept has been observed in Continental Europe, the independent director not representing a shareholder and not tied or related to the management team. In fact a large number of the governance codes enacted recently marked the essentiality for companies to nominate independent directors, Spanish, French code to name a few. It indicates the recognition that normal shareholders lack representation in the major part of Continental Europe and that their interests are too often trampled (Mendez). The topic of freedom and the limits of the presence of an independent director on the board are comparatively new and treated with importance in governance codes all across the EU. The governance model in UK places the greatest emphasis on independence from dominant shareholders as well as from management. At least half of the members of the board excluding the chairman should be independent non-executive directors as per the recommendations by 2003 Derek Higgs Report. It provides a proper definition of independence. The British boards achieve the highest standard of independence of any the governing bodies all over the globe owing to the fact that the chairman is also independent in the British governance model. Accountability A sound governance model rests on two separate accountability relationships: a. Between the governing body and the shareholders and other stakeholders. b. Between the governing body and the management team. Accountability is a direct consequence of the agency factor, says Miguel A. Mendez. The owner of the firm hires managers who control and manage the assets. The supervisory board is accountable to the shareholders and others for its supervision of management of the company and the management team in return is accountable to the board and the shareholders and others for its assistance of the operations of the company. The initial part of the equation to a large extend is dependent on the involvement of the shareholders and other stakeholders. The rights are provided to them as per the law and the by-laws of the company and the type of participation mechanism. All of these factors facilitate their involvement in the governance process. The outcome is a strong accountability relationship. Accountability is as good as the quality and scrutiny of oversight shown by the shareholders towards the administration and through it above the management group. It completely relies upon timely and exact information. The second part of the equation inevitably relies on the board exercising its free judgment, effective control of management. The accountability of management to the board is weak or even non-existent in the American governance model. But the accountability of the governing bodies for the activities of the corporation is a central principle of every governance models. The way accountability is expressed and its direction varies a lot as per the way the primary objective of the corporation is basically defined. There are very minor but still quite important differences across the EU and between the EU and the US. Conclusion The financial scandals recorded recently in the US have aroused new emphasis on corporate governance models. A comparison with European corporate governance will be quite instructive in this context. “The U.S. corporate governance system has recently been heavily criticized, largely as a result of failures at Enron, WorldCom, Tyco and some other prominent companies”, says Bengt Holmstrom and Steven N. Kaplan (Holmstrom and Kaplan, 2003). Accountability is always related to markets. It is generally accepted in continental Europe that the board is accountable to different areas especially in countries where employee are represented on the board. But in US, the concept is gaining better support that directors are accountable to areas above the shareholders. Corporate governance remains a difficult to perceive issue for business students all over. Usually it is mixed and confused with the issue of ethics. Ethical behavior is expected from everyone participating in the corporate governance process and inevitably from the directors and executives. Corporate governance basically is all about the characteristics of a governing process instead a particular behavioral trait. Openness, accountability and efficiency are an indications of finance and corporate governance systems in the US and Britain. References 1. Berglof, Erik (1997) ‘Reforming corporate governance: redirecting the European agenda’. Economic Policy, April, pp.93-123. 2. Blair, Margaret M (1994). Ownership and Control. Brookings Institution Press. pp 2. 3. Blasi, Joseph and Kruse, Douglas (1991) The New Owners: The mass emergence of employee ownership and what it means to American business. NewYork: Harper Business. 4. Charkham, Jonathan (1994). Keeping Good Company: A study of Corporate Governance in Five Countries. Oxford: Oxford University Press. 5. Denis, Diane K. McConnell, John J (2003). International Corporate Governance. January 2003. 6. Fitzgerald, Robert. Abe, Etsuo (2004). The Development of Corporate Governance in Japan and Britain. Ashgate Publishing, Ltd. pp 32. 7. Gaved, Matthew (1995) Ownership and Influence. LSE Report 95.19807. 8. Holmstrom, Bengt. Kaplan, Steven N (2003). The State of U.S. Corporate Governance: Whats Right and Whats Wrong?. NBER Working Paper No. 9613. April 2003. 9. Jenkinson, Tim and Colin Mayer (1992) The Assessment: Corporate Governance and Corporate Control, Oxford Review of Economic Policy, 8 (3) : 1-10. 10. Kay, John and Aubrey Silberston (1995): ‘Corporate Governance’, National Institute Economic Review, August, pp.84-97. 11. Mayer, Colin (1996) Corporate Governance, Competition and Performance, OECD Economics Department Working Paper no.164. Paris: OECD 12. Mendez, Miguel A. Corporate Governance A US/EU Comparison. University of Washington. 13. Schwalbach, Joachim, Conyon, Martin J (2000). European differences in executive pay and corporate. Humboldt-Univ. 14. Shleifer, Andrei. Vishny, Robert W (1997). A Survey of Corporate Governance. The Journal of Finance, Vol. 52, No. 2. Jun., 1997. 737-783. 15. Tylecote, Andrew. Conesa, Emmanuelle (2000). Corporate Governance, Innovation Systems and Industrial Performance. Read More