Convergence of Corporate Governance Systems - Term Paper Example

RUNNING HEAD: Convergence of Corporate Convergence of Corporate Governance Systems of Introduction This paper seeks to prepare an analysis whether or not the two major corporate governance systems – the ‘outsider’ and ‘insider” systems, will converge along with the issue of globalization. One group of scholars argues for the possibility and other disagrees. By considering available information, this hopes to take the more applicable position after the analysis. 2.1 Importance corporate governance Corporate governance is materially relevant issue both for policy makers and academics as the concept is tied up with collapse of companies which had disastrous economic effects to countries like US and Australia. The issue of convergence of non-convergence can be reduced to whether one type of system is more effective than the other. Globalization which has become a big reality for many business organizations is material factor also to the issue of convergence since companies with global orientation would have to be concerned on whether they could choose a corporate governance system in the country where they operate. The same reason can be put forward whether such will be determined by other factors that would not make it possible to have convergence as independence of states are maintained. It is also argued that corporate governance has its unavoidable effects on the development and functioning of capital markets of each nation or country in terms of the requirement from companies to comply with rules enacted by local authorities on how corporate governance should be observed (Wei, 2009). It is logical also to deduce that corporate would also exert necessary influence on resource allocation since it could be considered as one form of regulation where companies need to comply with certain rules for its effective operation in areas or countries of operation by a business organization. Since the same corporate governance is theoretically linked to the functioning of the capital market, the same must have a direct relation with the economic performance of a country and as such it is logical to infer that it has an effect on the competition of one economy in relation to the other. In other words, viewed externally, international investors would be attracted to whether they would have a greater probability of increasing or maximizing their wealth. 2.2.1 Outsider systems Under outsider systems, found mostly in Anglo-Saxon countries, the stockholders or owners of the company tend to have a transitory interest (Zu, 2008) in the said company and are basically unrelated or not closely related with senior managers within the company. The relationship between management and shareholders can be viewed fluid and arms-length. As a protection against market failure, the same system assumes the existence of an active ‘market corporate control’- takeovers. This would particularly include hostile ones if unrelated senior managers would have to be disciplined for possible failure. This has the effect of creating disciplinary mechanisms on managers as a way to make sure that the interests shareholders are amply protected (Edwards, 2002). 2.2.2 Insider System Under the insider systems, found in Japan and Continental Europe, on the other hand, the owners of firms are inclined to have a long-term interest rather than temporary in the company (Zu, 2008). This would normally have the effect of owners often holding positions on the board of directors or other senior managerial positions. There is therefore a stable and close relationship between management and shareholders under this type of corporate governance. There exist also formal rights of employees that could influence managerial decision via the practice of having supervisory boards or council-type bodies. This insider system is believed to be observed with shifting forms in continental Europe and Japan (Edwards, 2002, Barker, 2006). Those under insider systems, may include number of firms that are primarily state and family-owned. There exist also along with such system a stock market that may normally include a degree of ownership by financial institutions that are empowered to buy and sell shares freely (Edwards, 2002). 2.3 Arguments why it is possible to have convergence of the two systems. The convergence may become easier because of the effect of globalization and the need to have a strategy that is not only applicable in one state but also in other states. The possibility for converge can be seen in some European countries towards becoming the outsider type of corporate governance system. Economic theory and wealth maximization objective appear to favor convergence. It can argued that the issue of why the difference of the corporate governance systems cannot be detached from nature of the firm to behave in relation to economic theory. The choice of corporate governance must be therefore being implied as still aligned with the wealth maximization framework for business organizations. Such corporate governance can be considered as firm coordination and which sometime supersedes price-mechanism coordination in the market (Dignam and Galanis, 2009, citing Coase, R., 1937). In dealing with the question of firm coordination, Coase focused on a single exchange transaction or more simply the contract between economic agents and he actually discovered that the use of price mechanism necessarily entails transaction cost (Dignam and Galanis, 2009 citing Coase, 1937). He argued that such cost can arise from how entities draft, negotiate, and enforce contracts because natural prices of goods are not automatically known to the transacting parties. The real work is one of uncertainly where, contrary to the assumption of global rationality, economic agents can be fully assumed to have the full knowledge about relevant contingencies. Thus, Coase argued that in order to save on the costs of using the market in production, or allocation of corporate resources, transaction parties must allow an entrepreneur to coordinate the distribution of resources at its command. With the contracts entered and negotiated transaction within the firm, transaction cost is deemed to be reduced. This is the essence of economic theory of market where the series of contracts between the entrepreneurs and other agents required in market transaction would contemplate a situation where the latter agree to follow the direction of the former. This transaction is not however without remuneration as agents would expect the same. So Coase’s definition of a company’s hierarchical structure as a system of relationships presupposes the direction of resources to be dependent from the entrepreneur. When interpreted in the context of present corporate structure, the term entrepreneur could refer to shareholders while the agents would refer to senior managers of the firm. Thus shareholders put these senior managers to manage the business while managers are paid in return. Corporations need then to maximize wealth of shareholders and the senior managers must realize their roles as a result. This also explains the reason why optimal firm-size is necessary part of the wealth maximization objective which can determined by balancing the costs arising from market and entrepreneur coordination. This would be expected to happen as firm expands to reach the point where both types of costs are equal (Dignam and Galanis, 2009). Coase’ insights effectively provided a new twist to theories of the firm with the demonstration that firms do exists and they should be made different from markets or individuals. To therefore compare coordination by organizations against the market mechanism, the transaction cost approach of Coase provided theoretical stage for the firms a governance structure to have relevance for analysis (Dignam and Galanis, 2009 citing Coase, 1988). Williamson rediscovered and expanded the Coase Theory into a form of economic analysis based on transaction costs. This was noted by Zingales by saying that market has its cost which firms must alleviate by exchanging the price mechanism with the exercise of authority. This makes easier the study of corporate governance on how authority should be allocated and exercised in manner that will accomplish the ultimate purpose of the firm (Dignam and Galanis, 2009 citing Zingales, 2000), which is to maximize shareholders’ wealth. 2.4 Arguments why convergence of corporate governance systems is not possible. Convergence may become difficult or impossible because of the difference in the local laws of each state on corporate governance. Corporate governance may refer to authority to govern the organizations and as such it has more of the local or state authority that would have its influence felt rather than what other or external things would want to happen. The existence of striking differences among the corporate governance systems can discourage the possibility of convergence. Each country can adopt its own type of corporate governance systems which can be distinguished from each other according to the degree of ownership and control and the identity of controlling shareholders. The outsider systems that can be noted from the US and UK experience on corporate governance, the basic conflict of interest exist between strong managers and widely dispersed shareholders. On other hand, under insider systems as can be gleaned from those of Japan and Continental Europe, basic conflict can be evidently found between shareholders or those holding blocks of shares and weak minority shareholders (Maher and Anderson, 1999). Thus converge could be difficult to achieve along with the other differences. The absence therefore of a single model of good corporate governance for both insider and outsider systems can make it difficult to aim for convergence. Each country has its own priority and the economy may not come necessarily above political considerations. Each type of system for each country may have its strengths and weakness, and the economic implications could also vary. The difference in legal and regulatory frameworks, cultural and historical factors as well as the structure of product and factor markets are realities in the design of corporate governance system for each country. The convergence issue can be viewed also just like the convergence or harmonization on the accounting standards which is not easy to happen. If on small things convergence is impossible, it would make sense to consider that it would be more difficult to have convergence of bigger things like corporate governance. 2.5 Conflicting evidence of convergence and divergence Convergence was perceived to may have been the result of shaping similar patterns of industrial restructuring in Europe. Whether there is convergence of corporate governance systems that can be observed across Europe in terms of the nature of corporate governance systems in relation to the shaping the patterns of industrial restructuring said, is still a question that is worth looking into. It is claimed that many countries from the region have traditionally been described by evolving insider systems. One cause of the evolution of changes could be from the reduction of the role of the state over privatization. Another cause would be the increasing role of foreign ownership, via the use pension funds. Still another cause would be the internationalization of large, domestic companies. Furthermore, deliberate changes by governments as to the nature of domestic institutions really contributed to evolution. One can consider these trends as one constituting a process of convergence along the lines of the Anglo-Saxon countries. These countries would include Finland, Spain, Netherlands, France, Finland and Spain (Edwards, 2002)) The experience of other countries on nature of corporate governance and employee representation systems appear to show contradictory to convergence. Divergence greater in kind can be observed in Europe. Thus Austria, Denmark and Luxembourg show barely noticeable erosion of their insider system, while Belgium, Denmark, Sweden, Germany, Portugal, Greece and Italy exhibit detectable changes but their effect although is certainly not transformational. A more significant evidence of changes toward outsider systems can be found in the experiences of Finland, France, Spain and Netherlands. None however has come closely to the UK-Irish model of convergence. (Edwards, 2002). 3. Conclusion This paper has found evidence of some convergence of corporate governance in certain countries in certain period of time. The convergence have their explanations which be readily supported with evidence primarily because of globalization and the finance theory of wealth maximization. This paper has also found evidence about the seeming impossibility of convergence of corporate governance in some countries. The reasons that could be found include the differences in their local laws which are influenced of course by the difference in cultures and histories. It can be concluded convergence will most probably be influenced when it becomes desirable by the players in the economic and social world. This paper therefore would like to believe that convergence would more likely to happen if business entities will have to sustain their life over the long-term in relation to the wealth maximization theory and economic theory. References Barker, R. (2006). Insiders, Outsiders and Change in European Corporate Governance. Department of Politics and International Relations. University of Oxford Coase, R. (1937). The Nature of the Firm. Economica, vol. 4 (4), 386 Coase, R. (1988) Lectures of the Nature of the Firm, Journal of Law, Economics, and Organization, Vol, 4 (1), 33-47 Dignam, A. and M. Galanis (2009). The globalization of corporate governance .Ashgate Publishing, Ltd. Edwards, T. (2002). Corporate governance systems and the nature of industrial restructuring. Retrieved 12 Sept 2011 from < http://www.eurofound.europa.eu/eiro/2002/09/study/tn0209101s.htm > Maher and Anderson (1999): Corporate Governance: Effects on Firm Performance and economic growth. Organization for Economic Co-operation and Development Wei, Y. (2009). Securities Markets and Corporate Governance: A Chinese Experience. Ashgate Publishing, Ltd., Zingales, (2000) In Search of New Foundations, Journal of Finance, 55, 1623-1653 Zu, L. (2008). Corporate social responsibility, corporate restructuring and firms performance: empirical evidence from Chinese enterprises. Springer PM Read More