Importance of Corporate Governance - Essay Example

Importance of Corporate Governance Table of Contents Introduction 3 Corporate Governance 3 Convergence of Corporate Governance Systems 4 Reasons behind convergence 5 Arguments against the convergence 7 Comparative Analysis 9 Conclusion 10 References 11 Introduction The concept of corporate governance is not as new as the concept of ‘corporation’. Bob Tricker believes that the term ‘corporate governance’ was hardly in use before 1980s (du Plessis, et al, 2010). Many think that the phrase was started to be visible in the picture of global business after 1990s. It is such a concept that is still believed to be indefinable by several experts. However, different types of definitions are provided in various reports. A very simple definition can be found in the reports like South African King Report and Kingdom Cadbury Report. In these reports corporate governance is defined as a “system by which companies are directed and controlled” (du Plessis, et al, 2010). Clearer definitions began to come after two big companies namely Enron and HIH Insurance Ltd collapsed. In 2007, Australian Securities Exchange (ASX) released a proper definition where corporate governance is said to be a framework of rules, systems, processes and relationships by and within which authority is controlled and exercised in corporations (du Plessis, et al, 2010). With the rise of globalization an aspect that has come up as a significant issue is the convergence of corporate governance systems. This paper attempts to gain insight into this issue. It tries to find out whether the convergence of various governance systems is actually possible or not. In the process of doing that, the paper includes several important data that are collected from different books and previous research works. Not just facts, but a major portion of the paper is consisted of the analysis of these facts. Corporate Governance Before getting straight into the main subject i.e. ‘convergence of corporate governance systems’, one must have enough idea about the concept known as ‘corporate governance’. The introductory paragraph contains few definitions of the term, but they are needed to be further explained. According to Prasad, corporate governance is the relationship that has existence among various participants and that define the performance as well as the direction of corporate firms (Prasad, 2006). He believes that the main actors who play crucial role in corporate governance include the CEO, the shareholders and the board of directors. Beside them there are actors like employees, customers and suppliers who are also capable of influencing the governance system in a particular organization (Prasad, 2006). There are number of essential elements that are associated with corporate governance. Seven of such elements which are mentioned in South African King Report (2002) are transparency, discipline, independence, responsibility, accountability, social responsibility and fairness. In 2003, ASX recognized important principles that are basis of good corporate governance (du Plessis, et al, 2010). Strong foundations for management’s roles, structure of the board that is capable of adding value, responsible and ethical decision making are some of these crucial principles that make the governance an effective one. Convergence of Corporate Governance Systems Over the past few years experts from both professional as well as academic world have been arguing whether the governance systems that are present across various nations should be converged or not. It is observed that there are different governance models that are in use in several countries. For instance, the outsider model has been followed mainly in US and United Kingdom. On other side, there is insider model which has been followed in other OECD countries like France, Germany and Australia. Another system namely, the family/state system is found in nation like Sweden (Nestor & Thompson, n.d.). Over the years global business environment has experienced significant changes. Changed situations have pointed out the benefits and pitfalls of these governance systems (Nestor & Thompson, n.d.). Some experts have argued that in order to run the organizations smoothly and efficiently it is important to have convergence of various governance models, whereas there are experts according to whom the convergence is not possible. There are certain reasons because of which people are either supporting the convergence or not. These reasons are properly analyzed below. Reasons behind convergence It is found that there are number of factors that have made the experts in giving opinion in favor of convergence of different governance systems. One of the main reasons is certainly the ‘globalization’. Globalization has resulted in the integration of various financial markets from different countries. Consensus has been growing among the investors regarding the fact that the risk of holding a global equity portfolio is certainly lesser than the risk of holding a portfolio that is purely domestic in nature (Nestor & Thompson, n.d.). As a consequence, number of specialized mutual funds as well as pension funds includes international equalities. Such phenomenon of global diversification is mainly observed in the countries where there are strong communities of institutional investors. It is expected to be a generalized phenomenon as such communities grow in many of emerging economies as well. Non financial companies, on the other hand have realized that they can reduce the cost of capital by widening the investor base. In order to attract international investors many companies are listing themselves in the overseas markets. The increasing desire of both the issuers and investors for operating in the global capital market needs some common standards and values that will be accepted in all the markets (Nestor & Thompson, n.d.). Apart from globalization, politics of governance and path dependency are two other important factors that act in favor of convergence of governance systems. The exposure of the policy makers to the global policy related debates has grown significantly over the past few years. Increasing number of discussions among the global leaders has changed the way in which they used to think about reforms years ago. In simple words, the importance of reforms has intensified (Nestor & Thompson, n.d.). The issue of regulations and laws is very important in case of convergence of various governance systems. It is important to note that the existence of different corporate law as well as regulations regarding securities has played great role in favoring divergences among national control and ownership environments. There are experts who have identified the distinctions between the countries having common law and countries having civil law. Existence of two different laws has supported the existence of different governance systems (Nestor & Thompson, n.d.). Furthermore, company law can be found in several different shapes. In fact, the main concept regarding limited liability is treated differently under different jurisdictions. It is found that in some nations the ‘firewall’ that exists between a company and several of its shareholders is almost impenetrable, whereas in other countries situation is otherwise. However, it is also found that all these differences may be considered less important. In fact, over the years, their importance has significantly gone down. According to a report “All countries recognize the preponderance of owners as the final arbiters of corporate strategy and make the concept of ‘residuality’ central to the governance structure of the corporation, albeit at differing degrees” (Nestor & Thompson, n.d.). Furthermore, the equity markets across the world are now considered more important as compared to earlier. This has made a significant portion of corporate sector subjected to ‘securities laws and regulations’ and this can be found in most of countries irrespective of the law (civil or common) that they follow. If one look at the few initiatives that were taken in the past decade by some of the European countries, it would be clear that legislation related to corporate governance has been converging. For instance, in Germany role of shareholders in the decision making process has been given more recognition and the way through which accounts are maintained has been made more transparent. In France also company law has gone through significant up-gradation especially after the release of Marini Report (Nestor & Thompson, n.d.). Arguments against the convergence There are several arguments that do not support the convergence of the corporate governance systems. The legal argument among all is found to be the strongest. It says that corporate law is very closely related to the social customs of a particular nation. Furthermore, it is also strongly associated with various areas like labor, banking, competition law and taxation. Hence, it would be extremely difficult to change the law at a single attempt (Guillén, 1999). The corporate governance system in America has emerged from a legal tradition that tends to limit the banks’ activities and acknowledge the management’s rights over the workers’ right. Furthermore, the system allows taxing dividends that are gained from shares. On the other side, in Japan and Germany, corporate governance systems allow regular interactions among the managers and workers. A strong argument against the convergence is based on the fact that the systems of executive compensation cannot converge as the long-term incentives and taxation of perquisites are different across the countries (Guillén, 1999). Another crucial aspect is institutional practice which indicates that there is no base for attempting to identify the model that is best in the world. This is simply because different countries have different ‘institutional equipments’ which make them famous. Corporate governance is actually institutional equipment. Many scholars believe that a nation can be remembered for its distinct model of corporate governance just like Germany is renowned for two-tiered governance model, dual apprenticeship system and engineering intensive industries like luxury automobiles and machine tools. On the other hand French are renowned for large scale technological developments like high-speed trains (Guillén, 1999). America is famous for ‘individualism’ and ‘entrepreneurship’ and the industries that are knowledge and skills intensive. Undoubtedly a governance model that is shareholder-centered and capital market oriented suits the American system. Experts believe it is difficult to find a common model of governance that suits systems of all the nations which are famous for different reasons (Guillén, 1999). Domestic political situation is considered to be another important factor that acts as constraint in the process of convergence of corporate governance practices. Worldwide trend of financial and economic globalization is subjected to political interests. Domestic politics often plays great role in shaping the outcomes. Djelic has provided enough evidence that shows how French and German politicians, labor leaders and industrialists resisted the implementation of the governance model of America. They actually modified the American version in accordance to their priorities. Guillen has analyzed how normative and coercive factors affected the process of transferring the ‘management models’ during 20th century (Guillén, 1999). Comparative Analysis Considering the above mentioned facts and analysis one can say that there are enough evidences that are either favoring or opposing the convergence of governance models. Most of these evidences are backed by practical facts. However, there are still not enough supporting materials that would bring the consensus among the experts. Researches show that there is great deal of likelihood of convergence as compared to divergence as the basic form of corporation has been achieving significant extent of uniformity (Keasey, Thompson & Wright, 2005). Economies throughout the world have come close to a consensus regarding the fact that managers’ activities should be directed towards the maximization of shareholders’ wealth. Factors like ‘competitive nature of global commerce’, ‘increasing importance of shareholders’ value’ and ‘lack of effective alternative models’ have been driving the nations toward the consensus (Keasey, Thompson & Wright, 2005). One must note that most of the experts believe that ‘convergence of corporate law’ is more difficult as compared to ‘convergence of governance models’. Hence, the legal system can be kept aside while governance practices get converged. In fact, such practices are found in countries like Japan, Germany and US (Keasey, Thompson & Wright, 2005). Today, globalization is such a strong force that no one country or firm can avoid it. This force is driving the firms and nations in adopting a common set of practices. However, there is significant problem in the process of implementation. Still it can be said that the forces favoring the convergence are much stronger than the forces against the convergence and hence convergence may take place in near future despite of the existence of several ‘opposing forces’. Conclusion Corporate governance, undoubtedly, an important aspect that needs to be taken care of for ensuring smooth and transparent running of businesses. There are different sets of systems of governance across the world. There are factors like globalization, path dependency and legal issues that have made the experts in saying in favor of convergence of various systems, albeit there are factors that oppose such convergence. Analyzing all factors, it can be said that in order to run global businesses more efficiently there should be a common set of systems. References du Plessis, J. J. et al, 2010, Principles of Contemporary Corporate Governance, Cambridge University Press Guillén, M. F. 1999, Corporate Governance and Globalization: Arguments and Evidence Against Convergence, The Wharton School and Department of Sociology, [Pdf] Available at: http://knowledge.wharton.upenn.edu/papers/839.pdf Accessed on September 7, 2011 Keasey, K, Thompson, S & Wright, M. 2005, Corporate Governance: Accountability, Enterprise and International Comparisons, John Wiley and Sons Nestor, S. and Thompson, j. k. No Date, Corporate Governance patterns in OECD economies: is convergence underway?, OECD, [Pdf] Available at: http://www.oecd.org/dataoecd/7/10/1931460.pdf Accessed on September 7, 2011 Prasad, 2006, Corporate Governance, PHI Learning Pvt. Ltd Read More