The Globalization of Corporate Governance

Alan Dignam, Michael Galanis

• Publisher: Routledge
• Year: 2016
• Print ISBN: 9780754646259
• eBook ISBN: 9781317030065
• Topic: Law
• Subtopic: International Law
• Index: Law

The process of economic globalization, as product and capital markets have become increasingly integrated since WWII, has placed huge, and it is argued by some, irresistible pressures on the world's 'insider' stakeholder oriented corporate governance systems. Insider corporate governance systems in countries such as Germany, so the argument goes, should converge or be transformed by global product and capital market pressures to the 'superior' shareholder oriented 'outsider' corporate governance model prevalent in the UK and the US. What these pressures from globalization are, how they manifest themselves, whether they are likely to cause such a convergence/transformation and whether these pressures will continue, lie at the heart of the exploration in this volume. The Globalization of Corporate Governance provides a detailed analysis of the evolution of the key corporate governance systems in the UK, the US and Germany from the perspective of the development of economic globalization. As such it is a valuable resource for those interested in how economic and legal reforms interact to produce change within corporate governance systems.

PART 1
Theorizing Corporate Governance Change

Chapter 1
Corporate Governance Convergence and Corporate Theory

Introduction to the Corporate Theory Debate

In this first chapter we attempt something both difficult and necessary – an overview of the major influences on the development of corporate theory. This is difficult because it involves distilling centuries of thought and numerous complex theories into a few pages. It is necessary because, as we will observe in Chapters 5 and 6, theory and subsequent change in the corporate governance systems of the US and the UK are closely linked. Additionally as we noted in the preface the theoretical approach of convergence scholars forms a large part of the assumptions they bring to their comparative work. So we start this chapter with a ‘health warning’ – while hopefully the following section provides an accessible overview of the progression of corporate theory over the past 200 years it is not complete or simple. In order to give it form we emphasize major influences and ignore minor ones even though they may have been important in their time. Where there is a choice of theorists to discuss we have chosen the one whose work we think epitomizes the theory best. Where we discuss a theory it is just an overview of its major contribution to corporate theory and not a complete description. This also applies to our theoretical discussions in other chapters. However, before we turn to the theoretical overview we need briefly to describe some key practical developments in corporate history that relate to our theoretical context.

The Emergence of the Managerial Firm¹

In the eighteenth and nineteenth centuries despite the existence of few large joint stock companies created to promote foreign trade and colonization or to manage some utilities, all major economies were dominated by unincorporated business forms owned and controlled by individuals. The volume of firms’ operations was limited and owners were generally able to manage their businesses.² As Bratton notes:

[v]ery little tension arose between economic practice and individualist economic and legal theory in the early nineteenth century. The economy closely resembled the atomistic type described in Adam Smith’s classical theory.³

Therefore, the managers of the firm could easily be regarded as its owners and vice versa.

During the nineteenth century the enactment of general incorporation statutes dispensed with the need for special state corporate charters and made the creation of incorporated companies much easier. Gradually, what Chandler has called the ‘traditional enterprise’ began to be replaced as a business form by the incorporated company.⁴ Initially, incorporated companies were still ‘entrepreneurial’ in their nature. Ownership and control were integrated since the owners of shares were also the managers of the company’s business without the need for extra managerial input. Segregated economies, small productions and slow movement of goods generally meant that the operational workload was still manageable by the entrepreneurs themselves. So the use of salaried managers was minimal and even where it occurred those managers were acting under the guidance of the owner–entrepreneur.

The first big change came during the second industrial revolution at the end of the nineteenth century, with the emergence in the US and Europe of large infrastructure and utility ventures like the railways, the telegraph, and mining companies. These ventures could only be undertaken by large corporations run not by owners–entrepreneurs but by extensive salaried managerial hierarchies who provided very little capital. The finance for such large capital intensive projects was only available by pooling the funds of thousands of investors and financiers. The owners of stock had neither the knowledge nor the power to administer these pioneers of ‘big business’.⁵ As Chandler, states:

[t]he building and operating of the rail and telegraph systems called for the creation of a new type of business enterprise. The massive investment required to construct those systems and the complexities of their operations brought the separation of ownership from management. The enlarged enterprises came to be operated by teams of salaried managers who had little or no equity in the firm. The owners, numerous and scattered, were investors with neither the experience, the information, nor the time to make the myriad decisions needed to maintain a constant flow of goods, passengers, and messages. Thousands of shareholders could not possibly operate a railroad or a telegraph system.⁶

Thus, the first management controlled or ‘managerial’, as they are commonly called, companies emerged as one of the by-products of the second industrial revolution. The significance of this development is twofold. First, these managerial corporations provided a previously non-existent managerial and administrative know-how, such as accounting and statistical controls, which emerged as the basis for modern business. The second contribution was the creation of the transportation and communication infrastructure that created the opportunities for mass production in many other industries that transformed the nature of capitalism – from classical to ‘managerial’ – and of markets – from rural, agrarian and commercial to industrial and urban. Fast and large volume transportation, created large integrated markets which presented vast opportunities for industrial growth in scale and scope.⁷

These growth opportunities that emerged from the enlarged markets and changing technologies during the late nineteenth and early twentieth century demanded new organizational structures similar to those that had been developed by railway companies. In the 1890s and early 1900s intense merger activity in the United States and to a lesser extent in Germany resulted in the dilution of the original entrepreneurs’ stock ownership. Similar developments also occurred in Britain and Japan but at a slower pace which accelerated after World War II. By the 1940s commentators such as Burnham were claiming that this ‘managerial revolution’ would give rise to a new ‘ruling class’ of managers.⁸ This dominance over industrialized economies led Chandler to claim that the ‘visible hand’ of the managerial hierarchy had come to replace Adam Smith’s ‘invisible hand’ of the market.⁹ Thus, the giant managerial corporation emerged, first in the United States and Germany and later in Britain and Japan, as the dominant economic player of the twentieth century.

Differences of course did exist as each version of managerial capitalism reflected national institutional sets and historical events that also determined the time when the separation of ownership from control took place. Such national differences, according to Chandler, give rise to a distinction between ‘competitive’ and ‘cooperative’ managerial capitalism.¹⁰ The US is an example of the former as the early prohibition of cartels, on the one hand, constrained close inter-firm cooperation and made merger combinations more attractive and, on the other, it enhanced competition between the large oligopolistic corporations that ensued. In contrast, as we will examine in Chapters 5 and 7, in the UK and Germany, cartelization was not illegal – at least not before the end of World War II – and consequently intra-firm cooperation was common in the home market, although in Germany’s case competition between German companies was intense in the international market.¹¹ Additionally, in the somewhat peculiar case of Japan, manager controlled firms were allowed to cooperate closely by forming extensive group networks, but competition between those groups has been very aggressive both at home and abroad.¹²

Despite those differences, the common denominator in major capitalist economies has been the managerial corporation with de facto separation of corporate ownership from control. Obviously, this major socio-economic development did not go unnoticed. Keynes for example observed this practical departure from economic classicism in 1926 when he wrote that shareholders had dissociated themselves from company management.¹³ However, the milestone work on the separation of ownership and control came from Berle and Means, a lawyer and an economist respectively. In 1932 they published The Modern Corporation and Private Property which was the first systematic study of corporate control in the United States.¹⁴

Berle and Means assumed that corporate control derives from the ability to select and appoint directors since the board of directors is the main decision-making body of the corporation. Their study of ownership structure of American corporations showed that shareholdings were so dispersed as to preclude shareholders from having sufficient interest in exercising their control rights over management. According to their analysis, 65 percent of the largest two hundred American corporations were manager-controlled, which in their view signified the de facto separation of ownership and control.¹⁵

However, in most other countries the shareholding pattern is rather different than the US even for large firms. In both Germany and Japan, for instance, ownership has historically been much more concentrated, as banks, families, the state and, most importantly, other non-financial corporations are large shareholders. This could lead one to assume that due to these ownership patterns the separation of ownership and control thesis has prima facie no relevance.¹⁶ However, the separation of ownership from control can occur in these insider systems through different means. A company with concentrated ownership can come within the managerial category due to the identity of its large shareholders, if the latter are not interested in controlling managers. For instance, as we note in Chapter 7 extensive cross-shareholding networks in Germany have this very effect since they are used as a shield against control oriented shareholders’ influence. But even where families are still present in large companies, their ability to direct company affairs can be substantially reduced by the scale of operations that demands the delegation of control to a large managerial hierarchy. As Veblen noted in 1924 there had by necessity been a gradual transfer of corporate control from capitalistic owners to engineer-managers who had objectives that were different from those of owners.¹⁷ Thus, concentrated shareholdings do not automatically imply the integration of corporate ownership and control.

The assertions of Berle and Means were not entirely original. Over a century earlier Adam Smith himself had made a similar observation about the joint stock companies of his time when he wrote:

[t]he directors of such companies, however, being the managers rather of other people’s 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.¹⁸

However, what made The Modern Corporation and Private Property a milestone was that, unlike in the eighteenth century, by 1932 the managerial corporation had emerged as a significant force in society, instead of being the exception to the rule. As Berle and Means explained:

[a] society in which production is governed by blind economic forces is being replaced by one in which production is carried on under the ultimate control of a handful of individuals. The economic power in the hands of few persons who control giant corporations can harm or benefit a multitude of individuals, affect whole districts, shift the currents of trade, bring ruin to one community and prosperity to another.¹⁹

As a result, the Berle and Means thesis not only gave a new spin to an old legal theory debate on the nature of the corporation but also attracted the interest of economic theorists. Both lawyers and economists searched for a solution to the problems of corporate legitimacy that the managerial corporation raised. The former examined the social legitimacy of managerial power over companies and the latter looked for the economic efficiency implications of the separation of ownership from control.

The Development of Corporate Theory

The corporation and its governance had been the subject matter of academic debate even before the rise of the managerial firm as the dominant economic actor in major economies. Incorporation and corporate personality raised legal and economic efficiency questions that gained importance as the company became a more common business form. As the following discussion will show, understanding the nature of the corporation is by no means a straightforward task. Different theoretical approaches can lead in a general sense either to viewing the corporation as being a real entity or as a pure fiction. These two perceptions of the corporation can broadly be categorized as corporate rea...

Table of contents

• Cover Page
• Half Title Page
• Dedication
• Title Page
• Copyright Page
• Contents
• List of Charts and Graphs
• List of Tables
• Preface
• Overview
• List of Abbreviations
• Part 1 Theorizing Corporate Governance Change
• Part 2 Observing Change and Transformation in the UK, US and Germany
• Index