UK Corporate Governance in the EU Winter Semester 20092010 Evgeni Peev

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UK Corporate Governance in the EU Winter
Semester 2009-2010 Evgeni Peev
I. Corporate Governance
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• I. Corporate Governance
• II. Systems
• III. Relevance
• IV. The EU

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I. What Is Corporate Governance?

• 1. The context
• Corporate governance issues usually include (i)
  the degree of ownership concentration and
  identity of owners
• (ii) the institutional structure by which owners
  monitor and control managers (e.g. board of
  directors, CEO compensations, and so on)
• (iii) the institutional structure for
  disciplining and replacing managers (e.g.
  takeovers, proxy context). Mueller, 2003, ch. 6.

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• 2. Narrow definition
• Narrowly defined, corporate governance concerns
  relations between top managers and shareholders,
  namely (i) specific conflict of interests
  between managers as decision-makers regarding
  other peoples money and shareholders as
  providers of capital
• (ii) mechanisms designed for resolving this
  conflict for the best interest of the providers
  of capital (firm value maximization).
• At the heart of corporate governance issues lies
  separation of ownership and control phenomenon.
  It can be defined as separation of decision and
  risk-bearing functions (Fama and Jensen, 1983) or
  separation of cash flow rights and voting rights
  (Shleifer and Vishny, 1997).

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• The directors of such joint-stock companies,
  however, being the managers rather of other
  peoples money than of their own, it cannot well
  be expected, that they should watch over it with
  the same anxious vigilance with which the
  partners in a private copartnery frequently watch
  over their own. Like the stewards of a rich man,
  they are apt to consider attention to small
  matters as not for their masters honour, and
  very easily give themselves a dispensation from
  having it. Negligence and profusion, therefore,
  must always prevail, more or less, in the
  management of the affairs of such a company.
  Adam Smith. The Wealth of Nations, 1776, Cannan
  Edition (Modern Library, New York, 1937) p. 700.

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• Corporate Governance deals with the ways in
  which suppliers of finance to corporations assure
  themselves of getting a return on their
  investment. How do the suppliers of finance get
  managers to return some of the profits to them?
  How do they make sure that managers do not steal
  the capital they supply or invest in bad
  projects? How do suppliers of finance control
  managers?(Shleifer and Vishny, 1997, p. 737)

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• 3. The Researchers
• Adolf Berle and Gardiner Means, The Modern
  Corporation and Private Ownership, (1932)
• Exhaustive history of the evolution of the
  corporate legal form
• Data on rise in aggregate concentration that
  occurred in first third of 20th century
• Concern on the corporate power that can compete
  with government
• Prediction that managers with little direct
  ownership will run U.S. businesses

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• The Modern Corporation did not change the way
  economists viewed corporations
• Corporations Firms
• Firms maximize profits
• 1982 conference to celebrate 50th anniversary
  of publication of the Modern Corporattion
• 1930s difficult or mainstream economists to
  digest

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• 1950s and 1960s more challenges to profit
  maximization
• William Baumol (1959, 1966) sales
• Oliver Williamson (1963) staff and emoluments
• Robin Maris (1963, 1964) growth of the firm
• Cyert and March (1963) five objectives
• Herbert Simon (1957, 1959) managers did not
  maximize at all they satisficed
• (for references , see Dennis Mueller, The
  Corporation An Economic Enigma in The Economics
  of the Firm, 2008.

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• 4. Broader definition
• The common broader definition of corporate
  governance includes the system of laws,
  regulations, law enforcement, institutions and
  informal norms that determine investment
  relations between savers (investors) and company
  managers.1
• 1 Corporate governance specifies the
  distribution of rights and responsibilities among
  different participants in the corporation, such
  as the board, managers, shareholders and other
  stakeholders, and spells out the rules and
  procedures for making decisions on corporate
  affairs. By doing this, it also provides the
  structure through which the company objectives
  are set, and the means of attaining those
  objectives and monitoring performance." (The
  Organization of Economic Cooperation and
  Development (OECD) Principles of Corporate
  Governance www.oecd.org).

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• However, such a kind of definition is rather
  vague. Corporate governance structures and legal
  environment in which corporations operate are two
  sets of institutions that are not synonymous
  (Mueller, 2003, ch. 6).

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• Three branches of the corporate governance
  literature
• Separation of ownership and control (for a survey
  see Shleifer and Vishny, 1997)
• Law and finance (papers by La Porta, Silanes,
  Shleifer and Vishny starting in 1996)
• Politics of corporate governance (Marc Roe,
  Political Determinants of Corporate Governance,
  2003)

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II. Corporate Governance Systems

• 1. Insider and outsider corporate governance
  systems
• Mueller, 2003, ch. 6
• (1) Outsider corporate governance system
  (Anglo-Saxon or market-based system)
  ownership stakes are dispersed, owners exercise
  indirect control on management by electing
  representatives to the board of directors. (US
  and UK)

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• (2) Insider corporate governance system
  (bank-based system) - ownership stakes are
  concentrated, major owners are directly
  represented on the boards that monitor managers,
  and perhaps in management itself (Continental
  Europe, Japan)

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• (2a) Germanic system (Germany, Austria,
  Switzerland, other Continental European
  countries) unidirectional control. A family,
  bank, or company X owns a substantial interest in
  a particular company Y and has representatives on
  Ys supervisory board. Company Y in turn owns a
  controlling interest in company Z, which in turn
  controls company W, and so on. Companies Y, Z, W
  on the other hand, do not own shares in the
  organisations that stand above them in the
  corporate pyramid.
• (2b) Japanese-form of insider system
  multidirectional control. Several companies are
  linked together through interlocking
  directorships, which are backed by cross-holdings
  of one and anothers shares.

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• Poor performance of US corporations in the 1970s
  and 1980s led some to proclaim the German model
  or the Japanese model superior to the
  Anglo-Saxon model.
• In 1990s it had been that the German and Japanese
  models tht have been called into question and the
  Anglo-Saxon model celebrated.
• Recent financial crisis focus the attention again
  on corporate governance problems and the main
  concern of Berle and Means, the rising power
  concentration (see e.g. Simon Johson, 2009 on the
  financil industry in the US)

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III. Relevance of Corporate Governance

• 1. World-wide wave of privatization
• How should the newly privatized firms be owned
  and controlled?
• Explicit goals of privatization like to establish
  shareholder democracy or to ensure the transfer
  of control to large (domestic) shareholders.

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• 2. Pension funds and active investors
• An increasing fraction of household savings are
• invested in equity.
• Emergence of service industry that makes voting
• recommendations and exercises votes for clients
  (e.g. pension funds)

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• 4. Deregulation and capital market integration
• Cross-listings
• Attract investors from different countries
• Comply to standards from different regulatory
  authorities
• 5. Crises and scandals
• Russia/East Asia/Brazil 1998 revealed weak
  shareholder protection in emerging markets.
• Enron self dealing of CEOs
• WorldCom deliberately misleading investors
• ImClone Systems Insider Trading
• Madoff state capture and regulation failure

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IV. The EU Response

• Milstein Report (1998)
• OECD Corporate Governance Principles (1999)
• UK Cadbury Code (listing rule for the LSE, 1992)
• Action Plan on Modernizing Company Law and
  Enhancing Corporate Governance in the EU (2003)
• Directive on the Exercise of Shareholders Rights
  (2007)
• (see for a summary, The EU Approach to CG, 2008)