A Primer on Corporate Governance

Felix J. Lopez-Iturriaga, Fernando A. Tejerina-Gaite

• Publisher: Business Expert Press
• Year: 2014
• Print ISBN: 9781606497609
• eBook ISBN: 9781606497616
• Topic: Business
• Subtopic: Finance
• Index: Business

Spain has a civil law-based legal system, and court decisionsare not a source of law but are of interpretative value. Theprivatization of large state-owned firms, liberalization, integrationwith the European Union, and the launch of the euro haveall contributed to the transformation of Spain's financial systeminto a modern market. This book covers the main featuresof the Spanish model of corporate governance and will helpyou understand the characteristics of a civil law and a bank-orientedfinancial system in which banks play an active rolerelative to markets.For example, the bank orientation within Spain is built sothat the corporate governance system relies heavily on theinternal mechanisms of governance. Spain also bypasses thestandard procedures of controlling shareholders mitigatingconflicts between management and minority shareholders;instead, Spain allows controlling shareholders to mitigate theconflict between controlling shareholders and minority shareholders.Each chapter provides an inside look at the functioningof both internal and external mechanisms of corporate control.

CHAPTER 1

Introduction

1.1 Foundations of Corporate Governance

As Bloomfield (2013) states, corporate governance has been the single most significant issue on the business agenda internationally and globally for the past 30 or more years. Both in the academia, the politics and the practitioner’s arena, new initiatives constantly arise in order to improve and strengthen how corporations are governed. One could invoke two types of reasons to explain the worldwide diffusion of this concern: The increasing importance of capital markets and the growing concern of political authorities, partially as a response to managerial excesses that led to the financial crisis.

According to the World Federation of Exchanges, in 1990 there were 21,033 quoted companies in capital markets all over the world, and 46,674 companies in 2012. The same source shows that the world market capitalization increased from US$11.8 billion in 1990 to US$58 billion in 2012. This evolution can be seen in Figure 1.1.

Figure 1.1 Number of quoted firms and market capitalization worldwide

Source: World Federation of Exchanges (n.d.).

Note: Annual statistics.

Given the widespread flourishing of corporate governance, there are a number of definitions. One of the most cited is the one contained in the Cadbury Report (1992), according to which corporate governance is the system by which companies are directed and controlled. It is a ­pioneering and very general definition, so that different regulatory bodies and authors have provided complementary definitions. In this vein, the Organization for the Economic Cooperation and Development released, in 2004, the Principles of Corporate Governance, which conceives the corporate governance as a set of relationships between a company’s management, its board, its shareholders, and other stakeholders that 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.

From an academic point of view, Shleifer and Vishny (1997) understand corporate governance as the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. It implies a clear financial approach to the topic and allows dividing the mechanisms of corporate governance into two broad groups: the internal mechanisms and the external ones. The internal mechanisms have to do with the relationships and incentives within the company (primarily the board of directors and the equity ownership of the firm), whereas the external mechanisms are related to the means that outside parties have to influence the control of the firm (namely, the market for corporate control and the legal and regulatory system).

This way of understanding the corporate governance concerns a number of constituencies such as the managers, the directors, the shareholders, and other stakeholders. Nevertheless, to effectively understand this set of relationships it cannot be removed from the contextual issues that shape the corporate governance. Research has suggested some of these underlying factors which explain how corporate governance regimes vary across countries. Among these factors, the institutional issues such as the legal tradition, the capital markets, and the accounting rules play an outstanding role. Some of these factors are reviewed in the next section.

1.2 Institutional Elements of Corporate Governance

Obviously, the optimal combination of external and internal mechanisms of corporate governance is deeply affected by the institutional architecture of each country. Financial systems have been traditionally divided into two main groups on the basis of their orientation or the weight of financial intermediation (Allen and Gale 2001). There is a continental or bank-oriented system in which money flows from ultimate creditors to ultimate debtors through financial institutions. In this system, financial intermediaries play a critical role; it is the system predominant in Japan and a number of continental European countries, such as Germany, France, Italy, or Spain. On the contrary, there is also an Anglo-Saxon or market-oriented system in which money is directly channeled by capital markets instead of financial intermediaries (the United Kingdom, the United States, and others).

Levine (2002) remarks the positive role of banks in acquiring information about firms and managers and thereby improving corporate governance. The bank-based view also stresses the shortcomings of markets because they create a myopic investor climate that reduces the incentives for long-run relationships between firms and financial intermediaries. In contrast, the market-based view highlights the role of markets in enhancing corporate governance by easing takeovers and making it easier to tie managerial compensation to firm performance. This view also underlines how financial markets can facilitate risk management.

A special case of the financial services view is the so-called Law and Finance approach (La Porta et al. 1998). According to these authors, bank versus market centeredness is not an especially useful way to distinguish financial systems. Furthermore, a well-functioning legal system facilitates the operation of both markets and intermediaries. It is the legal system that det...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Abstract
• Contents
• List of Figures
• List of Tables
• Preface
• Chapter 1: Introduction
• Chapter 2: The Spanish Institutional Context
• Chapter 3: Internal Mechanisms of Corporate Governance in Spain
• Chapter 4: External Mechanisms of Corporate Governance in Spain
• Conclusion
• References
• Index
• Ad page
• Backcover