corporate governance.doc

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How does Corporate Governance affect internationalization, globalization and

performance of firms?

Title of the dissertation How does Corporate Governance affectinternationalization, globalization and performance

of firms?

Student's name

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Your department and name of university

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Abstract

Corporate governance is on the reform agenda all over the world. The remarkable

political economy of the post-Cold War era has made both democracy and market-

oriented capitalism ascendant, even if not inevitably linked. Competition among radically

different economic systems communism vs. capitalism has abated. States are

withdrawing from ownership of the means of production by privatizing state-firms and

withdrawing from strong control by deregulating widely. Economic decisions once made

by the state are increasingly left to autonomous, privately owned firms. Even if private

corporate governance characteristics continue to differ, the most general of economic

contrasts private vs. government direction is fading. Global economic integration has

been a key factor in the salience of corporate governance questions. Once confined to

local economies differently governed firms now compete with one another, as

multilateral trade agreements and regional economic blocks such as the European Union

have internationalized product markets, capital markets, managerial markets, and, to a

lesser extent, labor markets.

Globalization affects the corporate governance reform agenda in two ways. First, it

heightens anxiety over whether particular corporate governance systems confer

competitive economic advantage. As trade barriers erode, the locally protected product

marketplace disappears. A countrys firms performance is more easily measured against

global standards. Poor performance shows up more quickly when a competitor takes

away market share, or innovates quickly.


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Corporate governance is on the reform agenda all over the world. How will global

economic integration affect the worlds various national systems of corporate ownership

and governance? Is the Anglo-American model of shareholder capitalism destined to

become standard or will sharp differences persist? If there is change, which institutions

will converge? Which will persist? This volume contains classic work from leading

scholars addressing these questions as well as new essays. In a sophisticated political

economy analysis that is also attuned to the legal framework, the authors bring to bear

efficiency arguments, politics, institutional economics, international relations, industrial

organization, path dependence, and property rights.

Despite the increased interest in corporate governance (CG), gained recently at the high

price of corporate scandals, there is always some confusion, characterizing its general

understanding and it is not surprising to see the extreme hesitation expressed by

governments, all over the world, regarding the appropriate solution to face CG

challenges. For some people, this is actually the result of the relative novelty of the

concept, inevitably expected to be characterized by some lack of deep understanding. For

others, it is mainly the confusion of the concept of governance with the concept of

control, which creates the problem. They are alarmed to see CG often reduced to a simple

question of separating control from ownership, within the organization a simple

technical problem of supervision some would argue. Progressively, however, and under

the pressure of daily life, we were forced to concede to governance a much larger

recognition, a wider extent and a bigger framework (Cornell and Shapiro, 1987; OECD,

1999).

At the corporate level, transparency and management rigor are becoming two basic

organizational values. It is becoming obvious that each organization and all its partners

have real interest in having in place, policies, procedures, and equitable and transparent


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practices of CG. As representative of shareholders, the Board, assisted by its different

committees, has the responsibility of overseeing the respect CG, to which everyone in the

organization must adhere with honesty and conviction.


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ACKNOWLEDGEMENTS


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TABLE OF CONTENTS

I

TITLE OF THE DISSERTATION1

IIABSTRACT

2

IIIACKNOWLEDGEMENTS

3

IV TABLE OF CONTENTS 4

1 INTRODUCTION 5

1.1 PROBLEM STATEMENT 5

1.2 SIGNIFICANCE OF THE STUDY 6

2 FINDINGS AND DISCUSSION 11

2.1 IN EUROPEAN CONTEXT 12

3 RECOMMENDATIONS 15

4 CONCLUSION 16

5 BIBLIOGRAPHY 22


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INTRODUCTION

Corporate governance has gained an increasingly high profile in the last decade. The

interest in corporate governance spans countries and continents, and applies not only to

large public corporations but also to a wider range of business forms including state-

owned enterprises, family-owned firms and not-for-profit organizations. Sir Adrian

Cadbury, who chaired the UKs Committee on the Financial Aspects of Corporate

Governance which reported in 1992, stated that corporate governance was the system by

which companies are directed and controlled (Cadbury 1992, p. 15). This definition is

succinct but clearly conveys the importance of controls in the company. A wider

definition was given by the Organization for Economic Cooperation and Development

(OECD 2004), which stated that corporate governance was a set of relationshipsbetween a companys management, its board, its shareholders and other stakeholders. [It]

also provides the structure through which the objectives of the company are set, and the

means of attaining those objectives and monitoring performance are determined (p. 11).

As we can see, this definition views corporate governance from a much wider perspective

and takes account of the various stakeholder groups, not just the shareholders. It also

emphasizes the importance of corporate governance as an enabling device for setting,

achieving and monitoring corporate objectives and performance. From just these two

definitions, it is easy to understand why corporate governance is so important to

companies, investors and stakeholders, and why it is a topic that has a pan-European and

indeed global appeal. It is fundamental to well-run firms and helps ensure that the assets

of the firm are secure and not subject to expropriation by individuals or groups within the

firm who could wield excessive power. Corporate governance therefore helps a firm to be

sustainable in the longer term. The evolution of corporate governance in the UK is

discussed, together with the influential growth in ownership of UK equity by institutional

investors such as pension funds and insurance companies.

At the same time that local governance has grown more complex and difficult to map, the

world beyond the nation state has moved on. Not only has regional governance developed

rapidly (in Europe, to the point at which a Constitution for the enlarged Union is under


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debate), but manifold international agencies whose brief is global governance are now

operating to regulate fields that are, in some cases, narrow and specialised but, in other

cases, broad and general. If mapping municipal law has become more challenging, this

applies a fortiori to governance at the regional or global level where the regulatory

players and processes may be considerably less transparent. Moreover, these zones of

governancethe local, the regional, and the globaldo not operate independently of one

another. Accordingly, any account of governance in the Twenty-First Century must be in

some sense an account of global governance because the activities of global regulators

impinge on the activities of those who purport to govern in both local and regional zones.

To a considerable extent, global governance has grown alongside the activities of

organisations whose predominant concerns have been international security and the

promotion of respect for human rights. However, it has been the push towards a

globalised economy that has perhaps exerted the greater influencethat is to say,

globalisation has served to accelerate both the actuality, and our perception, of global

governance. With the lowering of barriers to trade and the making of new markets

(traditional as well as electronic), the processes of integration and harmonisation have

been set in motion and the governance activities of bodies such as the IMF, the World

Bank and the WTO have assumed a much higher profile.

If nation states still rule the world, their grip on the reins of governance seems much

less secure.

Against this background, Global Governance and the Quest for Justice is a four-volume

set addressing the legal and ethical deficits associated with the current round of

globalisation and discussing the building blocks for modes of global governance that

respect the demands of legality and justice. To put this another way, this set explores the

tension between the order that is being instated by the governance that comes with

globalisation (the reality, as it were, of globalised governance) and the aspiration of a

just world order represented by the ideal of global governance.

Each volume focuses on one of four key concerns arising from globalised governance,

namely: whether the leading internationl and regional organisations are sufficiently


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constitutionalised, whether transnational corporations are sufficiently accountable,

whether the distinctive interests of civil society are sufficiently represented and respected

and whether human rights are given due weight and protection. If the pathology of

globalised governance involves a lack of institutional transparency and accountability,

the ability of the more powerful players to act outside the rules and to immunise

themselves against responsibility, a yawning democratic deficit, and a neglect of human

rights, environmental integrity and cultural identity, then this might be a new world order

but it falls a long way short of the ideal of global governance.

In the opening years of the Twenty-First Century, the prospects for legitimate and

effective governancethat is to say, for lawful governanceare not overwhelmingly

good. Local governance, even in the bestrun regimes, has its own problems with regard to

the effectiveness and legitimacy of its regulatory measure; regionalisation does not

always ease these difficulties; and globalised governance accentuates the contrast

between the power of those who are unaccountable and the relative powerlessness of

those who are accountable. Yet, in every sense, global governance surely is the project

for the coming generation of lawyers. If the papers in these volumes set in train a

sustained, focused and forward looking debate about the co-ordination of governance in

pursuit of our best conception of an ordered and just global community, then they will

have served their purposeand, if law plays its part in setting the framework for the

elaboration and application of such global governance, then its purpose, too, will have

been fulfilled.


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Research Proposal:

How does Corporate Governance affect internationalization, globalization and

performance of firms?

1.1 PROBLEM STATEMENT

Essentially, corporate governance failures may come about for two broad reasons. First,

management may operate the firm inefficiently, resulting in an overall decrease in firm

profits, compared to the potential profitability of the firm. Second, while managers may

operate the firm efficiently and generate maximum profits, they may divert a proportion

of those profits from shareholders via the consumption of excessive perquisites, for

example by paying excessive remuneration not limited to performance. Hence a system

of corporate governance needs to consider both efficiency and stewardship dimensions of

corporate management. Stewardship emphasizes issues concerning, for example, the

misappropriation of funds by non-owner managers. Equally important, however, is the

issue of how the structure and process of governance motivates entrepreneurial activities

which increase the wealth of the business. Corporate entrepreneurship concerns the

reallocation of economic resources in new combinations and may involve both new

innovations as well as major corporate restructuring (Guth and Ginsberg, 1990). Good

corporate governance is thus as much concerned with correctly motivating managerial

behavior towards improving the performance of the business as it is directly controlling

the behavior of managers. Given the above, it is clear that policy recommendations on

corporate governance need to address both the accountability and enterprise aspects of

governance.


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Corporate governance issues, arising from the agency problems engendered by the

separation of ownership and control and the inability to write complete contracts for all

possible future eventualities (Hart, 1995; Shleifer and Vishny, 1997), have been

recognized for many decades, if not centuries (Berle and Means, 1932; Marshall, 1920;

Smith, 1776). Although a longstanding issue, the debate was given fresh impetus in the

UK by a number of well-published corporate problems in the late 1980s. These involved

creative accounting, spectacular business failures, the apparent ease with which

unscrupulous directors could expropriate other stakeholders funds, the limited role of

auditors, the claimed weak link between executive remuneration and company

performance, and the roles played by the market for control and institutional investors in

generating apparently excessive short-term perspectives to the detriment of economic

performance.

National decision makers must consider whether to protect locally favored corporate

governance regimes if they regard the local regime as weakening local firms in product

markets or capital markets. So, the Americans debated in the 1980s whether bank-

centered systems in Japan and Germany better monitored management and better

encouraged long term Investment than the home-grown variety. Today, Europe wonders

whether it will lag in product markets if it does not get active securities markets.

International development institutions believe that corporate governance affects the rate

and sustainability of developing country growth. A famous case is the International

Monetary Funds (IMF) criticism of the governance of Korean conglomerates, the

chaebol, as allegedly producing unsustainable borrowing patterns that helped ignite the

East Asian financial crisis of 1998. Concern about comparative economic performance

induces concern about corporate governance.

Globalizations second effect comes from capital markets pressure on corporate

governance. First, firms have new reasons to turn to public capital markets. High tech

firms following the US model want the ready availability of an initial public offering for

the venture capitalist to exit and for the firm to raise funds. Firms expanding into global

markets often prefer to use stock, rather than cash, as acquisition currency. If they want


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American investors to buy and hold that stock, they are pressed to adopt corporate

governance measures that those investors feel comfortable with. Despite a continuing

bias in favor of home-country investing, the internationalization of capital markets has

led to more cross-border investing. New stockholders enter, and they arent always part

of any local corporate governance consensus. They prefer a corporate governance regime

they understand and often believe that reform will increase the value of their stock.

Similarly, even local investors may make demands that upset a prior local consensus. The

internationalization of capital markets means that investment flows may move against

firms perceived to have suboptimal governance and thus to the disadvantage of the

countries in which those firms are based.

An independent factor in the corporate governance debate is the wave of privatizations of

large state-owned enterprises in the infrastructure, natural resource, and manufacturing

areas. This has often been accompanied by deregulation. Corporate governance reformers

have sought accountability from large economic actors when privatization and

deregulation have devolved important decision making authority away from governments

and into private firms. Often, political accountability and economic efficiency point in

different directions. For example, in privatizing former state-owned enterprises, the state

wants to maximize the price it gets from selling the firm, but it also wants to preserve

political influence, often to control employment and service. The two do not always

match.

Corporate governance is onthereformagenda all over the world.How will global

economic integration affect the worlds various national systems of corporate

ownership and governance? Is the Anglo-American model of shareholder

capitalism destined to become standard or will sharp differences persist? If there is

change, which institutions will converge? Which will persist? This volume contains

classic work from leading scholars addressing these questions as well as new

essays. In a sophisticated political economy analysis that is also attuned to the legal

framework, the authors bring to bear efficiency arguments, politics, institutional

economics, international relations, industrial organization, path dependence, and


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property rights. The Enron-induced corporate governance events and reforms in the

United States heighten the importance of this inquiry. Will Enron hold up a

convergence that was in the works? Convergence and Persistence in Corporate

Governance sets up the issues for study and analysis.


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1.2 SIGNIFICANCE OF THE STUDY

Before moving directly into a discussion of good Corporate Governance, it is important

to create a foundation based on the initial concepts of the corporation, its role in society,and its organization. The corporation, like no other fictional entity, has created an

unprecedented volume of debate and discussion. There are those who argue for its

existence, its reform, and its abolishment. There are groups that study the corporation in

terms of its sociological impact on individuals and those who study the corporation in

terms of its impact on itself. At the core of all meaningful discussions of the corporation

is the concept of Corporate Governance.

Corporate Structure

It is sometimes helpful to think about corporations as imaginary people. In many ways

they do have the same rights and powers that the average citizen does; they are able to

open bank accounts, file taxes, make purchases, and own property. Unlike non

incorporated businesses that do these things under their company name, the corporations

assets are not directly owned by the company owner or partners. Specifically, when a non

incorporated business purchases property, the deed is held by the company owner

However, when a corporation does the same, the deed is held by the corporation itself.


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In todays economy, the concept of the borderless corporation is becoming increasingly

ubiquitous. There are few restrictions placed on investors who would like to purchase

shares in international companies. There is also a strong trend toward the globalization of

markets in which corporations themselves do not operate within confined borders but

hold subsidiaries in several countries. The international marketplace creates very specific

complications for the establishment of good Corporate Governance practices. As

previously discussed, corporations and their structure are unique to the countries in which

they are situated. Their structures and practices have evolved from the unique political

and social landscapes in which they are embedded. This is the primary reason why

Corporate Governance best practices are designed as guides to be adapted for specific

circumstances rather than uniform implementation. Complications arise when companies

are established in several unique marketplaces or when partnerships are created across

international borders. In these situations the corporation may find it difficult to create a

company wide set of policies, since not every subsidiary will fit the bill.

In the past, international corporations have benefited from diminished regulations, the

ability to operate in regions with fewer laws, and a perception of unlimited freedom.

Additionally, inexpensive labor and lower tax rates have been large factors in drawing

company activities away from developed countries and into emerging nations. These

activities have created the image of corporations living a lawless existence in which they

are able to manipulate their international standing to avoid penalties, labor codes, and

environmental regulations. Although such an existence can assist the company in

increasing revenue by limiting expenditures, the actions are frequently unsavory to

investors and the general public. Past years have shown increasing interest in the

international activities of corporations, especially those that originate in developed

markets and shift all or part of their operations to emerging countries. Public concern

centers on environmental and labor practices as well as the effects that international

accounting has on share values.


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Overall, the message is becoming clear that shareholders and societies do care what

happens beyond their borders. As a result, many corporations and organizations are

working to improve the image of the international corporation and instill at least a

semblance of good Corporate Governance practices. The difficulty that arises in these

efforts stems from the unique nature of each marketplace. It is feasible, and common, that

an international corporation will exist concurrently in several nations, all of which have

their own unique market structures. Frequently, differences in laws and customs will

hinder a corporations ability to apply one uniform set of Corporate Governance policies

to all of its subsidiaries.

The purpose of this study is to examine the forces within the process of economic

globalization that might be giving rise to pressures on institutions in insidercorporate governance systems to conform to a shareholder orientation. As we see it,

through the process of economic globalization led by capital and product market

liberalization, conditions that promote securitization of financial systems, externalization

of labor markets, promote shareholder corporate law norms and introduce highly

competitive product markets, have been created which have the potential to cause change

in insider systems. In doing so we examine in turn the economic history of

globalization, to get a picture of the overall process we are dealing with, before then

turning to examine the interaction between economic globalization and national

institutional structures that determine corporate governance. However, before doing so,

some conceptual clarifications are necessary.

Defning globalization

Although the phrase had been used much earlier, in 1983 Levitt popularized the term

globalization among key opinion formers in observing that increasing integration

of product markets provided the opportunity for frms to offer globally standardized

products.

Since then it has assumed a ubiquitous but vague status. As Cotterrell notes:


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the idea of globalization embraces so much, and entails such huge claims about social

and economic forces and the movements of history that it is hard to grapple with.

It is also widely seen as weighed down with valuations positive or negative. Attempted

descriptions of phenomena associated with globalization usually carry with them

arguments or assumptions about the causes of these phenomena. They are seen, for

example, sometimes as the product of inevitable, almost natural forces (a global

invisible hand), or as the result of more deliberate political, economic, cultural or other

strategies (often seen as imperialistic). And judgments are made about the consequences

of globalization.

As a result before we can even begin writing about globalization we must take a position

within contested territory as to the nature of globalization, as some regard it as a theory,

others as a historical epoch or new paradigm, and others as a process. In this study we

view it as a process as it appears to be the most accurate for a number of

reasons. Firstly, globalization, it seems to us, cannot be a theory because it does not

contain and prove any hypotheses that would help us understand or explain any

phenomenon. On the contrary, globalization requires a theory or theories to aid our

understanding of it as a socio-economic phenomenon. Secondly, globalization cannot be

regarded as a specifc historical epoch or a new paradigm, because as we will demonstrate

it is a phenomenon that has occurred before and it can also be reversed as well as

reoccur in the future. Finally, the grammatical ending of the word itself, although not

determinative, signifes that it is a process rather than a static state of affairs.

The term should also be distinguished from the process of internationalization.

This term, which is also a process, contains the word nation as one of its main

ingredients whereas globalization does not. This is because internationalization

describes a world of nations which increasingly act and interact with each other as

separate and autonomous units, either directly or through their citizens. Similarly

regionalization projects such as the European Union (EU) exhibits elements of both

increasing internationalization and denationalization as partial sovereignty is passed to


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the EU regional level. Globalization on the other hand, does not contain this national

element. This is because it inherently involves national units going through a process of

becoming increasingly integrated, until they eventually disappear as separate entities

and are replaced by the holistic state of affairs that globalism describes; that is,

globalization contains the element of loss of national autonomy. However,

internationalization, regionalization and globalization are processes that are closely

linked with each other, because the former pair can ultimately lead to the latter. That

is, increasing international and regional activity and interaction can cause and promote

global integration. This perhaps explains why the terms are sometimes used

interchangeably. As such because we view globalization as a process in which

internationalization and regionalization play a part.


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2. FINDINGS AND DISCUSSION

THE TERM CORPORATE governance has a range of meanings. For present purposes

two stand out. The first refers to the various ways in which society attempts to controlcompany behaviour in the public interest. 1 Here what is being governed is the

company itself, the most obvious modality being regulation by the state external to the

company, for example, the requirements of employment law, consumer law, or

environmental law. The second meaning is the one more familiar to company lawyers, of

company-level governance: in the words of the Higgs review, the architecture of

accountability or structures and processes that ensure that those responsible for

managing companies do so in accordance with the legitimate objectives of the business.

Directors duties, boards that contain members with a monitoring role, and disclosure of

financial and other information are examples of mechanisms of governance so

understood. While some would argue otherwise, corporate governance in the second

sense can be regarded as a sub-set of governance in the first. That is, company-level

controls reflect at least in part a state determination of what corporate objectives should

be and of corresponding accountability arrangements. In the Anglo-American corporate

world the purpose of such controls is generally viewed as being to enforce a goal of

shareholder wealth maximisation, justified as the best means of maximising the wealth of

society as a whole. The aims of governance need not, however, be so narrowly defined. It

is with using company-level governance (from now on, just corporate governance) for

the wider purpose of influencing the social and environmental performance of companies

that this is concerned. While policy makers normally look to external regulation as the

means of controlling the social and environmental impacts of business, corporate

governance is important as well, for two reasons. First, governance arrangements are

likely to affect a companys propensity to comply with regulation. Companies are

complex organisations and internal accountability structures that can cope with this

complexity are needed to secure conformity with law down the lines of command. At a

more general level, the commitment to compliance is likely to be affected by the

incentives that governance frameworks create. Where, for instance, the culture of the

organisation is short-termist because of pressures or inducements to maximise current


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share price, obeying the law may not be regarded as an issue of overriding importance.

6 The second reason for a concern with governance is the well known limitations of

regulation as a means of prescribing socially desired outcomes. These limitations result in

part from problems inherent in the use of general rules. For example, regulation has a

tendency to be under- (or over-) inclusive, to set only base-line standards when many

companies without undue cost could perform to a higher level, and to offer few

incentives for continuous improvement. Of particular relevance to this volumes themeof

globalisation, there may also be gaps in regulatory coverage. The standards imposed on

multinationals by host jurisdictions are often non-existent or inadequate, and there is an

absence of binding norms of international law to compensate.

The analyses of corporate governance systems remain one of the most fascinating

research topics. They deliver even more interesting insights and observation when

they refer not to individual countries but when they attempt to track characteristics or

differences of the wider geographical region. The comparative analysis of corporate

governance systems that evolved in Europe may seem to be a relatively easy task due to

the assumed harmonization or unification of solutions adopted across Europe. However,

the deeper discussion on the current stage of control structure, the development of

the regulatory framework and predominantly the historic experience and recent

reform efforts become an evidence for great variety of the existing systems. Thus the

comparative analysis of corporate governance in Europe shows the variety of possible

solutions applied. The differences depicted in national systems are substantial and their

analyses deliver interesting insights on control mechanisms development process and

efficiency. Corporate governance, its shape and efficiency has been for many years, and

remains, up-to-date in the centre of management research and business debate.

Comparative analysis of national systems deliver more insights and understanding to

what corporate governance really is, how it is created as well as what challenges it needs

to face within the nearest future (Morck, 2002).

It must be, however, emphasized that the majority of research conducted so far

refers predominantly to the most developed countries including the United States,


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United Kingdom, Germany and Japan (Kojima, 1997). Recently there has been more

work on other countries of Western Europe as well as South East Asia (Wallace and

Zinkin, 2005)

Understanding Globalizations Corporate Governance impact:

As was noted the experiences of the Great Depression and WWII gave rise to an

unprecedented consensus for the establishment of a stable international system, along

Keynesian interventionist lines, which would provide the foundations for the

reconstruction of devastated economies worldwide. The institutional arrangements

that emerged from the Bretton Woods agreements ensured that a stable

macroeconomic environment was in place to stimulate continuous investment and

growth. Within that international order, national governments were able to

implement expansionary policies which ensured that effective demand was suffcient to

absorb increasing industrial output. This was combined, with the managerial corporation

emerging as a signifcant force in society. Crucially, management exercised a wide

discretion as to the allocation of retained earnings which played a key role in managers

making long-term commitments to stakeholders.

Therefore, managerial autonomy from shareholders allowed managers to undertake acentral coordinating role within the frm and deploy resources in a way that resolved

conficts among different resource providers within a macroeconomic frame work that

allowed governments to pursue policies that complemented the managerial corporation.

The result was a period of unprecedented economic growth, stability and wealth creation

often referred to as the golden age of capitalism.

In trying to understand the impact of globalization on corporate governance

systems we draw upon aspects of macroeconomic theory that emphasize the

connection between frm growth and government demand policy. In 1928, the

economist Allyn A. Young departed from traditional equilibrium theory and argued that,

contrary to the neoclassical assumption that an output increase is impossible without a

proportional increase of costs, increases in scale also lead to increases in returns.


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This is because the division of labour associated with increases in scale reduces the

cost and price of commodities, which leads to an expansion of the market. In turn, a

growing market makes further increases in the division of labour proftable, and starts a

new circle of cumulative growth.

In other words, an increase in production creates a virtuous production cycle where the

more you produce, the more demand you create, which in turn leads to a further increase

in production. To use Youngs terminology, growth, i.e. Increasing output creates

reciprocal demand that absorbs the growth and initiates a new cycle. However, others

recognized that there were weaknesses at the heart of this model because frms may

lack the funds to increase production, and even if they do increase production, the

element of reciprocal demand may not be triggered.

To address these failings, Kaldor argued that, provided that frms can retain and use

their earnings, higher proftability translates into increased investment in

organizational and production technologies and results in an increase in

productivity and output. To ensure that demand is present, Kaldor argued that

government demand-management policies are crucial for the completion andperpetuation of this virtuous circle of cumulative economic growth. If suffcient demand

is ensured to absorb increased output, a new cycle can begin which will further promote

growth and economic welfare. Kaldor argued, along Keynesian lines, that demand was

not only a key to sustainable economic growth but also the weak link which markets

cannot always provide without intervention; hence the important role of government

as a regulator of effective demand through the implementation of full employment

policies, protective trade and public investment spending. Ideally, for the cumulative

causation model, government trade policy should be an imbalance of protective home

markets and open access to foreign markets. In such a model the frm can expand abroad

from a protected home base. If these conditions were in place they should sustain a

sequence of rising industrial growth leading to increased consumption, which would


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increase proftability, which would promote investment and ultimately lead to

industrial growth.

Without government demand intervention, demand slumps can in turn lead to vicious

circles of diminishing output, investment, growth, and demand; with negative welfare

consequences.

Understanding Globalizations Corporate Governance impact: ii

The dramatic reduction of trade barriers after a series of GATT negotiations during the

second half of the twentieth century has enabled frms to gradually view the world, rather

than each particular country, as a single product market. As a result FDI has grown

enormously. As we noted, one of the key differences between this current globalization

period and the late nineteenth/early twentieth century one, has been the growth of FDI in

the form either of locating manufacturing abroad or M&As in the developing world.

These patterns need to be explained in detail if we are to draw some lessons about the

impact of FDI on core institutions that affect corporate governance outcomes. Indeed,

these patterns at frst sight contradict standard neoclassical theory of foreign

investment which tends to regard trade and FDI as substitutes so that an increase in

trade impediments stimulates factor movements and an increase in impediments tofactor movements stimulates trade and suggest something other than trade barriers is

driving FDI.

The international corporate governance research that we label first generation is patterned

after a large body of US research. In this section, we review the international evidence on

internal control mechanisms, in particular the board of directors and equity ownership

structure, and on the external market for corporate control. The first generation of

research on corporate governance mechanisms generally concerns itself with two

questions regarding a particular mechanism. First, does that mechanism affect firm

performance, where performance is typically measured by profitability or relative market

value? Second, does that mechanism affect the particular decisions made by firms; for


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example, with respect to such issues as management turnover and replacement,

investment policy, and reactions to outside offers for control?

CG BENEFITS

There still subsists a general feeling of incomprehension with regard to the potential

benefits which can be withdrawn from CG improvement. CG opponents often, however,

try to justify their opposition based on the Smithsonian notion of the invisible hand.

Adam Smith claims that, in capitalism, an individual pursuing his own good tends also to

promote the good of his community, through a principle that he called the invisible

hand of the market. Such a hand ensures that those activities most beneficial and

efficient will naturally be those that are most profitable (Smith, 1776). Free enterprise

systems can certainly emphasize the best part of each individual, by developing hiscreativity, his energy while increasing his aspiration to a better life. But such a system

can function without a minimum of good governance and such governance would be

realizable, given the multiple challenges which confront it?

Recent financial audacious frauds were surprising by both their impact and

ingeniousness, they draw attention, not only on the dramatic consequences of weak CG,

but they also give the CG issue urgent priority. Such frauds have underscored the critical

importance of structural reforms in the governance of companies and financial

institutions. They also show that CG issues transcend national boundaries. Although the

Western corporations have been the home of the bulk of recent corporate controversies,

no doubt other economies of the world are not innocent either.

Weak CG has always borrowed the vehicle of financial information opacity. Information

transparency, as we know, occurs only when there is no obstacle to

the harmonious flow of quality information which is also relevant and credible. Similarly,

information opacity occurs whenever irritants are deliberately placed on its harmonious

flow, preventing users its free access. Weak transparency and uncertainty are, however,

financial information inherent characteristics. The main reason is that financial markets

are constantly engaged in a timeless and dubious trade, not only in monetary terms, but


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especially in informational terms. Information collected and treated by the market relates

mainly to project selections and performance monitoring and follow-up. Interest for good

governance (or concern as for its absence) comes mainly from its triple action,

particularly its impact on organization effectiveness on market effectiveness, and on

social harmony.

With regard to organization effectiveness, it is easy to understand, at least at the

theoretical level, that a transparency culture would have many benefits to any

organization. Although the primary objective of corporations remains the maximization

of their shareholders wealth, it becomes progressively obvious that if a wealth

maximization objective has to be achieved it must go through the respect of other

corporate stakeholders interests, including community interests. These diverse interests

must, not only be assured, but also harmonized. Indeed, one organization is likely to

create more wealth, for itself and for the whole society, by an ethical strategy, and this

will gain the corporation an integrity reputation. As shareholders agents, members of the

board of directors play a crucial and determinant role in organization governance. They

should themselves be transparent and such transparency must be reflected in the first

place, in their own selection criteria. For example, board transparency can also facilitate

the separation of management from the capital and avoiding the negligence of

shareholders interests and non respect of other stakeholders rights. Such a situation, as

we know, is capable of weakening employees corporate commitment and leading to

much skepticism by customers and suppliers. The board then becomes value creator. One

can only deplore (until recently) the absence of interest at this level.

Concerning the financial market, financial literature abounds with arguments suggesting

the positive impact of good CG on scarce resources allocation, capital movement and

general economic effectiveness, since CGs main component financial transparency

makes direct investment more productive and this in turn leads to more efficiency and

growth. But the highest cost of CG absence resides in the excess of corruption and frauds

it leads to, along with the misallocation of resources it ends up to. iii At the social level,

good CG makes it possible for honest individuals to be consolidated in their honesty and


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to those which are less convinced, to think seriously before committing themselves to

transforming their job into a one- man business, for the sole purpose of maximizing their

own utility, even at the price of fraudulent acts, creating a harmful corporate atmosphere

of injustice and frustration.


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3. RECOMMENDATIONS

The literature on international corporate governance tells us much about corporate

governance but the message in the information is far from clear or complete. Much

more work remains to be done. Our understanding of the relationship between

systems of governance and the value of economies and the firms within them is of

increasing importance as emerging markets around the world look to the developed

markets to decide how to set up their own economic and corporate governance

systems. We review existing international corporate governance research. The first

generation of this research is broadly patterned after the large body of evidence on

governance mechanisms in US firms. These first generation studies examine

governance mechanisms that have been studied in the US particularly board

composition and ownership structure for one or more non-US countries. The first

generation of international corporate governance research examines individual

countries in depth and establishes that there are important differences in

governance systems across economies. Early international research focused

primarily on Germany, Japan, and the UK. Even across these very developedeconomies, significant differences in ownership and board structure were observed.

As international research expanded into other countries, the differences in corporate

governance systems mounted. Of particular note are the very distinct differences in

ownership structure across countries. The typical large US Corporation, with its

diffuse equity ownership structure and its professional manager, appears to be

typical only in the US and the UK. Ownership concentration in virtually every

other country is higher than it is in these two countries. In many countries, majority

ownership by a single shareholder is common. It is also common in many countries

that major shareholders control rights exceed their cashflow rights. The realities of

ownership and control are such that the primary agency conflict in the US that

between professional managers and their widely dispersed shareholders is

relatively unimportant inmany other countries. In its place, however, there is a


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different agency conflict, that between controlling shareholders and minority

shareholders. Evidence suggests that the private benefits of control of companies

can be significant and that they are value reducing. The typical first generation

international corporate governance study examines one particular country. Taken

together, these studies reveal differences in governance systems across countries.

Such a fragmented approach, however, does not yield much understanding of why

we observe the differences we do. To be able to explain these differences,

examination of many countries in a unified framework is required. This task is

taken up in the second generation of international corporate governance research.

An important insight generated from the second generation research is that a

countrys legal system in particular, the extent to which it protects investor rights

has a fundamental effect on the structure of markets in that country, on the

governance structures that are adopted by companies in that country, and on the

effectiveness of those governance systems. This insight, along with newly

developed measures of the strength of countries legal protection of investors, will

continue to generate a rich body of comparative corporate governance studies.

Strong legal protection for shareholders appears to be a necessary condition for

diffuse equity investment. The relatively diverse ownership of US firms can be

attributed, at least in part, to the relatively strong legal protection available to

potential investors in the US. The general lack of a relationship between ownership

structure and firm value could simply mean that the strong legal protection in the

US allows US firms to pick and choose among a menu of potential governance

mechanisms to achieve optimal structures. In countries with weak protection,

however, it appears that only ownership concentration can overcome the lack of

protection. While there is a large body of evidence on individual corporate

governance mechanisms in the US, there is much less published evidence

addressing the interrelationships among them and the factors that determine the

optimal governance structure for a particular firm. In addition, the recent evidence

on the importance of legal structure poses new questions even for the US. LLSV

(1998) argue that, while protection of shareholder rights in the US is the strongest

in the world, such protection is not particularly strong anywhere. Would greater


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protection in the US improve corporate governance, and with it firm values?

Clearly there are limits to the value of protection. For example, a system in which

shareholders have the right to approve or disapprove every decision made by

managers would be neither practical nor valuable. But what are these limits? Does

the US have an optimal level of shareholder protection, or is there room for

improvement? International governance structures are evolving as governments,

private parties, and markets seek to strengthen their economies and firms. Such

evolution will provide opportunities for rich new data. For many countries, there is

relatively little empirical evidence on governance mechanisms other than legal

protection and ownership structure. Such issues as board structure, compensation,

and changes in control have been extensively studied in the US, but have been

studied much less if at all for many other world economies. This may reflect the

dominant role of ownership structure in these economies, a dominance that appears

to be driven at least in part by weaknesses in legal systems. Evolutions in legal

structure provide for natural corporate governance experiments. What aspects of

legal systems evolve? What are the effects of such changes on the role of other

firm-specific governance mechanisms? What, ultimately, are the effects of such

changes on the strength of economies and on the actions and value of companies

within them? Answers to these questions will increase our understanding of the role

of corporate governance throughout the world.

A whole market to blame, but who dares?

It is commonly admitted that from early 2001 until the collapse of Enron in October of

the same year, all major investment banks analysts in the US were still strongly

recommending buying Enrons securities, stocks and bonds alike. Some of these

analysts admitted in their private emails that many of the shares they were

recommending to clients were actually junk stocks. After the collapse of Enron,

some analysts, linked to investment banks or funds houses, were even condemned

for conflicts of interests.


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Obviously weak governance, as a major evil, has more extent and ramifications than first

expected, it is actually a systemic crisis. Indeed, CG seems to be missing in many

organizations because of the favorable environment gradually encouraged and

instituted. For some time, for instance, it was believed that because of its efficiency,

the market was capable of separating wheat from the chaff. Quite naturally,

interest was shifted toward market value instead of accounting value. No one,

however, has yet successfully defined what market value exactly means or how it is

computed.

Consequently, it should be no surprise that having lost its bench- marks, the evaluation

process was confused and weakened and had ended up letting financial analysts and

rating agencies, armed with approximation and a lack of rigor, to have precedencein security evaluation. Gradually, their control over security evaluation activity

became without partition. Since then only one law prevails on the market

analysts law, a law that promises punishment for corporations unable to meet

analysts profit anticipations and blessing for those that conform to it. With the help

of the last stock exchange euphoria, conforming corporations had been indeed

largely but unduly rewarded for their assiduity, by exorbitant and abnormal market

returns, while others, although economically viable were ruined, quite simply

because they prove to be unable to conform to the irrational analysts desires. As

underlined previously, analysts decision models were never, neither proved nor

demonstrated, nor even commonly agreed on. Some analysts were, for instance,

recommending strong purchases of companies securities on the verge of collapsing

and some rating agencies did not, at certain times, hesitate to low down Japan

quotation to Malawi level. Often, inexperienced or unprofessional analysts make

subjective earnings forecasts on the basis of simple data that is supplied by listed

firms. Despite their illegitimate process, they can become market forces that drive

concerned firms to adjust their strategies. Many people are convinced that the

business relationship between an analysts investment bank and a client firm affects

the independence of the analyst to the point that they tend not to disclose, or delay

disclosing, any negative news about the client firm. It is, for instance, mentioned


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(The Economist, 2007) that some well-known international credit rating agencies

had intentionally, and for generous fees, delayed their announcements of negative

rating reports on Enron and certainly on other listed firms. Christopher Cox, as

chairman of the Security Exchange Commission (SEC) since 2005, keen for

regaining the lead, has made fighting insider traders a priority. According to Walter

Ricciardi from the SEC, the commission must prevent any buzz in the markets

that you can get away with it. He adds: Nothing paints a picture as well as people

being led away in handcuffs. It is believed the SEC will act even when it has no

one to put the cuffs on. Very recently, indeed, the SEC filed a suit against unknown

investors who had profited in the options market before the announcement of a

takeover of TXU (Texan utility).

(SEC). To match analysts predicted earnings and restraining their stock prices from

collapsing, some companies, unable to meet the challenge honestly, learned how to

use creative accounting methods to fix their account books and this opened the

door to all corporate abuses and scandals. Theoretically, managers can be

discouraged from undertaking suboptimal decisions, privileging their own interests

at the expense of the shareholders, quite simply by conceding them generous

employment conditions. Some managers had quickly, however, invented the

magic potion which will allow them to unduly inflate options value included in

compensation plans and which deflate only in future purchasers hands. Large

shareholding dispersion makes it possible for managements to control without

sharing company destinies. The extent of their hegemony is so strong it allows

them to treat all shareholders as minority interests. In these conditions voluntary

governance would seem difficult to achieve and public intervention becomes

desirable and unavoidable. Thinking must, however, precede legal action,

Intervention has to deal with relevance, cost benefit and market transparency.

Especially that those most eminent CG failures emanated from companies most

respectful of standards. Following Max Weber, we can assume individual actions to

be initiated by anticipating others reactions. Management fraudulent behavior can

thus be explained by the anticipation of investors behavior on the market, and CG


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weaknesses can only be the consequence of a favorable environment to fraud, one

which was gradually encouraged by the market. Interest for CG did not really wait

for the recent corporate crisis to impose itself. Actually, major accounting

legislations throughout the world were concerned, very early, with the issue, to the

point where most of their accounting conceptual frameworks were based on it.

Although such early awareness and the various accounting standards have

contributed to CG improvement, they did not prove to be sufficient in avoiding

resounding accounting frauds. In any case perfect CG would prove difficult to

realize, as long as the financial market is not ready to adopt it, to require it and to

remunerate for it. Instead the market was always requiring non realizable higher

returns coupled with lower risks, and some corporations, looking for an alternative,

have discovered that it was possible to please the market by simply manipulating

the numbers. It was often stated that the market because of its supposed

efficiency was able to operate without accounting information. More seriously, it

was loudly announced that in the event of accounting method choices, any

accounting method will make it. The market was supposed to have the ability to go

to the heart of the problem. Market operators were always keen on getting freed

from accounting numbers burden, despite the fact that accounting information

constitutes the only measurable data that exists. Quite naturally interest was moved

toward the subjective and uneasy to handle concept of the fair value, neglecting

at the same token the much more objective concept of historical value, which of

course accuses its won limits, except non-measurability. Analysts insistence was

so strong as to bring the standard setter to require measuring assets and liabilities in

fair value terms, knowing that no one can yet explain what such notion means and

nobody has ever been able to test its usefulness. Consequently, having lost its

references, the evaluation process was weakened and so auditing activities,

information transparency and financial reporting quality, in a word CG.


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4. CONCLUSION

Overall, the message is becoming clear that shareholders and societies do care what

happens beyond their borders. As a result, many corporations and organizations areworking to improve the image of the international corporation and instill at least a

semblance of good Corporate Governance practices. The difficulty that arises in these

efforts stems from the unique nature of each marketplace. It is feasible, and common, that

an international corporation will exist concurrently in several nations, all of which have

their own unique market structures. Frequently, differences in laws and customs will

hinder a corporations ability to apply one uniform set of Corporate Governance policies

to all of its subsidiaries. International Corporate Governance practices. Those companies

that make conscious efforts to do so are not alone, however, and have the support of

internationally conscious Corporate Governance organizations such as the OECD.

Corporate structure and practices will be influenced by the political, legal, and cultural

environment of the corporations home country. _ International differences demand

flexibility in Corporate Governance practices to effectively compensate for varying

corporate structures. _ Corporations that exist between international borders are

becoming increasingly visible as the global economy spreads. _ International

corporations present unique problems for Corporate Governance because they must

contend with different structures and regulations within their own company. _ The OECD

and World Bank are key players in facilitating the establishment of flexible Corporate

Governance frameworks.

While the above has given an indication of the effects of economic globalization on core

institutional sub-systems such as fnance, competition and effective demand and

industrial relations we have not yet discussed the impact of globalization on

corporate law. Obviously the lack of a global corporate law is one reason for this.

Additionally our focus on economic globalization brings those institutions with

primarily economic functions into closer focus but the effects of economic

globalization are felt in corporate law too as international organizations have


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formulated strategies for the promotion of the shareholder supremacy principle

and therefore deserve a mention.

Organizations in modern economies were granted extraordinary privileges allowing them

to participate effectively in social and economic human advances. Unfortunately,

abuses were quickly emerging and becoming more and more unbearable and

subject to many citizens virulent denunciations and desperate protests. They also

proved to be extremely detrimental to economic growth and social development.

Not only were they of a doubtful morality, but they also seemed to be questioning

the free enterprise system basis. The most notable abuse resides in weak corporate

governance (CG) initiated under the cover of false transparency and misused

regulated financial reporting. We would obviously like to think that the majority ofour corporations aspire to a faultless behavior and that their advisers, lawyers, etc.

do not see themselves as simple legality traders for payment, allowing the respect

of the letter of the law, but disregarding its spirit. Unfortunately, in the field, little is

already too much and it was thus necessary to act and quickly, given that recent

corporate misconducts have proven to be extremely dangerous for all.

Given market globalization and information technology development, it is expected that

CG practices will converge more and more. It is necessary, however, to give

enough time to such convergence to materialize efficiently. It may be reasonable to

say that the CG system of any country has its advantages and limitations and that

cross fertilization through comparative studies among countries should be

performed to the mutual benefit of all. Companies in exchanges can, obviously,

recourse to either internal and/or external corporate mechanisms, as insured by the

board, financial markets, rating agencies, auditing firms, banks and institutional

investors, playing a significant role in detecting fraudulent behavior and reducing

information asymmetries. Shareholders of non-listed companies can benefit from

none of the previous CG external mechanisms and they seem to be neglected by the

majority of national systems of CG. This situation is also obvious especially when

we consider current efforts of international agencies to improve CG in developing

countries. They are advocating dynamic exchanges, diffused shareholdings and so


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on, whereas often there are no real exchanges and no real shareholders in those

environments. In our opinion, addressing the CG issue in developing environments

is like addressing the issue of development itself. Rich countries and international

organizations have all the reasons to underscore the fundamental role of

governance in development, but they should find a way to adapt their requirements

to the conditions of developing countries. Due to the complexity of the issue, the

road map toward the attainment of such objectives should be worked out with each

developing country. Of course, basic CG principles like transparency, corporate

democracy, etc., should be respected by all.

It is commonly believed that the 1997 Asian financial crisis was mainly the consequence

of a lack of effective CG and transparency within most of Asias financial markets andinstitutions and so the recent collapse of the Enron Corporation and similar frauds in

other developed countries. These events have underlined the critical importance of

structural reforms in the governance of large companies, particularly, and the financial

system in general. For sure the CG issue transcends national boundaries, but CG

responsibility within the organizations always remains shareholders own, via their

elected boards of directors. In this respect the board and its various committees must

work for sowing germs of good governance, by addressing problem causes and not

limiting themselves to symptom treatments. In others words, they must stay tuned to

corporate operations, so that internal tensions or external events will not affect

organization immunizing capacity against non ethical behaviors. Board members should

be encouraged and oriented toward corporate problem solving; it is only a simple

question of common sense and good governance.

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