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PART I
CORPORATE GOVERNANCE:
LEGAL FRAMEWORKAND CODES
OF BEST PRACTICES
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Corporate Governance Bundles for Emerging Markets
Rahul Bedi
Berkeley College, New York, NY
Darshan Desai
Berkeley College, New York, NY
Abstract
Many scholars have argued that the globalization forces should create pressures on firms to adopt a common set of corporate governance practices, and eventually these practices should converge. However, there are many hurdles on the way of such convergence. Different organizations across the world have different corporate governance practices because of their different historical paths and contexts. To better explore the impact of these contextual differences, scholars have argued that instead of looking at corporate governance mechanisms in isolation of each other, it is important to see them as complementary and substitutable bundles of mechanisms. In this chapter, we develop an understanding of the bundles of effective corporate governance in the context of emerging markets. The bundles of corporate governance approach are rooted in an agency perspective and address howfirm-level mechanisms effectively combine to solve the agency problems generated by a separation of ownership and control. In the emerging countries, where attributes of corporate governance are based on different institutional norms, the theory of corporate governance bundles needs to be adjusted. Here, we describe how the emerging market context influences the theory of corporate governance bundles and highlight its implications on the corporate governance practices in these countries.
Keywords: Corporate governance bundles, emerging countries, institutional norms, agency perspectives.
1. Introduction
âThe directors of companies, being managers of other peopleâs money than 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 company frequently watch over their own. (Smith 1776, rev. Edn 1976: 264).
Even though Adam Smith did not use the term âCorporate Governanceâ, he succeeded in identifying its crucial concern in the above statement. Means (1931) captured the general premise of corporate governance through the observation that âOwnership of wealth without appreciable control, and control of wealth without appreciable ownership, appear to be the logical outcome of present corporate development.â
By the early 20th century, the number of corporations and their shareholders had grown dramatically. Stockholders had become more numerous and geographically diverse. Consequently, their relationship with management had started to become remote. This, in turn, led researchers, legislators, and regulators to search for measures to improve corporate governance. Such mechanisms included setting standards for effective corporate governance, separation of Chairman and Chief Executiveâs roles, selection of independent directors, role of Lead Director, and holding of minimum number of âExecutive Sessions.â Recently, researchers have tended to advocate âBundle Approachâ under which a set of these measures should improve the corporate governance far more than any single measure on its own. Furthermore, they have explored whether and how these components of âbundleâ complement or substitute for one another.
In the last few years, with the accelerating pace of globalization, investors have started to look toward emerging markets to improve the yield from their investments. In a similar vein, the businesses in emerging nations are keen to attract foreign investors to increase and diversify their investor base. This would seem to be a perfect fit. However, potential investorsâ anxiety about corporate governance in these markets is a major hurdle.
The inherent risks of emerging markets require investors to have a better understanding of corporate governance mechanisms in these contexts. Emerging market nations and firms are also trying to figure out a way to improve the corporate governance practices to compete successfully and attract foreign capital. In practice, there has been a high need for better tools, knowledge, and analytical frameworks to understand corporate governance in an emerging country context. However, in the context of academic research literature, despite enormous attention placed on corporate governance in last 3 years, surprisingly, only 1% of this recent research focuses on the emerging markets (Dallas, 2011). Few scholars, who explored corporate governance in the emerging countriesâ contexts, address the impact of institutional forces on the different type of agency problems (principalâprincipal conflict), and on specific corporate governance practices. However, the effect of emerging countriesâ institutional contexts on the bundles of corporate governance has not yet been explored. Whether and how the emerging countryâs contextual differences influence the composition of the bundles and complementarity or substitutability of different corporate governance mechanisms needs to be studied and researched.
This leads us to quite a few crucial questions such as what should be investors minimum acceptable corporate governance standards for businesses operating in such different legal/regulatory, cultural and ethical emerging market environments? Can âbundleâ approach apply in this context? If so, what corporate governance mechanisms are essential and which ones are just desirable? This chapter provides useful guidance to the emerging market companies and policy makers through suggesting that it is not necessary to copy and paste all the âbest practicesâ of the developed world. It is important to sustain what is valuable and replace only what is required to change.
In this chapter, authors present the following findings:
(1)Foreign investors and multinational corporations (MNCs) should not judge the corporate governance of emerging country corporations based on their adoption or non-adoption of firm-level corporate governance âbest practiceâ bundle.
(2)Emerging market contexts are significantly different from those of the developed world.
(3)While the preference in the developed world context is clearly for diversified shareholding model, there are some merits of the predominant family-owned structure in the emerging markets.
(4)Under family-owned structures, protection of minority shareholdersâ rights causes far more concern than the typical agency related issues that are common in the developed nations.
(5)Minority shareholdersârights suffer further when, as is the case in many developing countries, the state becomes a shareholder in addition to being a regulator.
(6)In the emerging markets, the firm-level analysis of governance mechanisms would be too narrow because the national-level mechanisms, such as, shareholder protection, transparency and disclosure requirements, and anticorruption measures, plays a very crucial role in affecting corporate governance effectiveness.
(7)Emerging market governance bundles are likely to be composed of both types of governance mechanisms: informal mechanisms at the individual and social network levels and formal mechanism.
(8)One of the most important factors influencing these formal/informal mechanism interactions is national-level actions and institutions.
(9)Informal corporate governance mechanisms undermine the impact of (firm-level) formal corporate governance mechanisms in the absence of national-level actions and structures.
In this chapter, we first present a brief literature review on corporate governance bundles. Next, we discuss corporate governance characteristics in the emerging markets and present an analysis of emerging countriesâ national corporate governance indicators. Next, we develop an understanding of effective bundles of corporate governance in the emerging markets context. We conclude this chapter by describing its implications for corporate governance practices.
2. Corporate Governance Bundles
Globalization forces are making the world smaller and more homogeneous, thus causing convergence in a wide range of practices. Many scholars have argued that these forces facilitate firms in adopting a common set of corporate governance practices, and eventually these practices should converge. Globalization forces such as efficiency forces, product market forces, and capital market pressures push local governance practices toward the dominant international model (Hansmann and Kraakman, 1991). In addition, due to the financial market integration, the institutional investors from the developed world influence corporate governance of large firms in many different countries. These factors eventually create pressure on transferring the corporate governance âbest practicesâ such as increased shareholder protection and independent board of directors. These, in turn, facilitate the development of more transparent markets (Monks and Minow, 2004). However, this is not a universally accepted point of view.
There is an alternate viewpoint in the literature that suggests that such convergence will not occur because of the path dependences of the corporate structures (Bebchuk and Roe, 1999). The corporate governance models and practices are not easy to change and replace because they are deeply embedded in the local organizational and institutional contexts (Aoki, 2001). In the words of Khanna et al. (2001), âthe irresistible force of global competitionâ eventually meets the immovable object of path dependence. Different organizations across the world have different practices because of their different historical paths and contexts. These differences possibly continually exist. However, that does not mean that the firms, which do not adopt the prescribed set of practices, do not have effective corporate governance and resultant firm outcomes. Hence, there must be multiple potential ways to obtain effective corporate governance and firm outcomes.
Despite the discussions of path dependence in corporate governance literature, scholars have given significant attention to find the âone best way.â They have attempted to see the effects of isolated corporate governance mechanisms such as board of directors, auditing, and executive pay, on firm outcomes. These mechanisms are expected to mitigate self-serving behaviors of managers and enhance firm outcome. Despite significant scholar attention, the empirical results on the link between the governance mechanisms and firm outcomes continue to be inconclusive (Aguilera et al., 2011). According to Filatotchev (2008), the mixed results may be due to the neglect in exploring patterned variations in corporate governance contingent to different organizational contexts. Therefore, instead of looking at corporate governance mechanisms in isolation of each other, it may be more useful to see them as complementary and substitutable bundles of mechanisms. The idea of bundles of corporate governance mechanisms emphasizes that the firms can achieve effective corporate governance through different configurations of such governance mechanisms.
The popular corporate governance mechanisms such as independent directors, audit committees, executive compensation, etc. are important in aligning managerâshareholder interests and enhance effectiveness of corporate governance. However, these mechanis...
