The SAGE Handbook of Corporate Governance

Thomas Clarke, Douglas Branson, Thomas Clarke, Douglas Branson, Author

• Publisher: SAGE Publications Ltd
• Year: 2012
• Print ISBN: 9781412929806
• eBook ISBN: 9781473971820
• Edition: 1
• Topic: Business
• Subtopic: Business Ethics
• Index: Business

The urgent and sustained interest in corporate governance is unprecedented, with the connections between corporate governance and economic performance being emphasized by the World Bank, the

IMF and others in the global economic community.

In this timely and definitive intellectual analysis of a key discipline, The SAGE Handbook of Corporate Governance offers a critical overview of the key themes, theoretical controversies, current research and emerging concepts that frame the field. Consisting of original substantive chapters by leading international scholars, and examining corporate governance from an inter-disciplinary basis, the text highlights how governance issues are critical to the formation, growth, financing, structural development, and strategic direction of companies and how corporate governance institutions in turn influence the

innovation and development of industrial and economic systems globally.

Comprehensive, authoritative and presented in a highly-accessible framework, this Handbook is a significant resource to those with an interest in understanding this important emerging field.

PART 1

Origins and Development

1

The Evolution of Corporate Governance

R.I. (Bob) Tricker

Corporate governance is as old as trade. Only the phrase ‘corporate governance’ is relatively new. Shakespeare understood the challenges involved. Antonio, his Merchant of Venice,¹ worried as he watched his ships sail out of sight. But his friends reminded him that he had entrusted the success of the venture and his fortune to others: no wonder he was worried.

In this chapter we trace the development of corporate governance ideas and practices through the years, from the governance of merchant ventures, through companies set up by trading empires, to the brilliant invention of the limited liability company (LLC) in the 19th century, which opened the door to the bludgeoning ambiguity, complexity, and rapid changes in corporate governance today.

Whenever the owners or members of an organization hand responsibility for running their enterprise to agents, corporate governance issues inevitably arise. Corporate governance is about the challenges that principals face as they try to exercise power over their agents. Corporate governance is relevant to profit-orientated companies, both public and private, not-for-profit organizations including health authorities, educational institutions, charities, and sports organizations, as well as governmental corporate entities and quangos.²

THE EARLY DAYS − MERCHANTS AND MONOPOLISTS

The father of modern accountancy, Luca Pacioli, born in Italy around 1446, undertook voyages for the Venetian merchant Antonio de Rompiasi. Later, he wrote a mathematical treatise, which included an explanation of double-entry book keeping. At that time, most merchants used single-entry accounts, recording each transaction as a movement of cash. Pacioli’s system reflected relationships between buyer and seller, debtor and creditor, principal and agent. It was an early exercise in corporate governance. In the 1470s, Pacioli became a Franciscan monk, which is why he is sometimes called Frater (Brother) Luca de Pacioli.

Throughout the 17th and 18th centuries, Holland, Portugal and Spain competed with England to build empires both economically and militarily. The Dutch East India Company was granted a charter by the Republic of the Netherlands in 1602 to carry out colonial activities and trade with Asia. The Dutch West India Company was chartered in 1621 to run the slave trade between Africa, the Caribbean and North America. Both companies were joint-stock companies, issuing stock to their investing stockholders.

In 1600, England’s Queen Elizabeth I granted a Royal Charter to the ‘Governor and Company of Merchants of London trading to the East Indies’. The charter gave the company, known as the Honourable East India Company, a monopoly over all trade between England and Asia. The East India Company was a joint-stock company, with over 1,000 stockholders at one time, who elected a governing body of 24 directors each year. The company was a powerful force for nearly three centuries, trading principally with India and China in cotton, silk, tea and opium. At one time the company administered parts of the British Indian Empire and ran a private army. The company was finally wound up in 1874.

The Hudson Bay Company was created by Royal Charter in 1670. Two Frenchmen, Radisson and des Groseilliers, had developed a profitable fur trading business in the Hudson Bay area of what is now Canada, but failed to raise capital from France or the America states to develop it further. Prince Rupert, cousin of King Charles II, saw the opportunity and persuaded the English King to grant the ‘lands of the Hudson Bay watershed to the Governor and Company of Adventurers of England trading into Hudson Bay’. This company survived until the 1820s, when it merged with a rival concern.

As happened many times subsequently, as we shall see, the success of corporate ventures and the lack of sound corporate governance led to unrealistic expectations, corporate collapses and fraud.

The South Sea Company was given a monopoly in 1720 by the British House of Lords to trade with Spain’s South American colonies. The company undertook to guarantee the British national debt at a guaranteed interest rate, which led to massive speculation in its stock. Then the bubble burst. Many of the British gentry, including two mistresses of King George I, lost their fortunes. The directors of the South Sea Company were arrested and their wealth confiscated.

In France in 1716, John Law set up a private company, the Banque Générale Privée, which issued paper money for the first time. In 1718, with the support of King Louis XV, this company became the Banque Royale. Then Law created the joint-stock company Compagnie d’Occident, otherwise known as the Mississippi Company, to develop the French colony in Louisiana. Law marketed the economic potential of Louisiana aggressively and the company prospered. Stockholders were paid dividends in paper money. The bank and the company merged, with Law as the Controller-General. Then in 1720, the bubble burst. Stockholders tried to redeem their paper money, which the bank could not meet. The company failed and Law fled to Belgium.

Just as today, voices were raised against such corporate excesses and risks. Adam Smith (1723–1790), a moral philosopher at the University of Glasgow and for a while at Oxford, was prominent. Many consider Adam Smith to be the father of modern economics.³ He argued that society benefitted as individuals pursued their own self-interest, because the free market then produced the goods and services needed at low prices. But he was suspicious of businessmen, as are many academics to this day. His oft-quoted comment on their behaviour offers a classic corporate governance perspective:

The directors of companies, being the managers of other people’s money rather than their own, cannot well be expected to watch over it with the same anxious vigilance with which they watch over their own. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

THE ADVENT OF THE JOINT-STOCK, LIMITED LIABILITY COMPANY

By the 19th century, Britain was a dominant power both economically and militarily. Her empire embraced Australia, Canada, India and much of Africa. The Industrial Revolution was at its height and businesses needed capital to expand faster than could be achieved by ploughing back profits. Moreover, an increasingly affluent British middle class had money to invest. But there was a significant dilemma: if a business became bankrupt, its creditors could sue the owners until, ultimately, they too became bankrupt. Worse, in those days not paying your debts was a crime leading to debtors’ prison and the possibility of your family ending up in the parish work-house, which was something of a disincentive to invest in businesses run by others. Non-executive investment in proprietorships, partnerships and joint-stock companies was suspect. Then all that changed: the limited liability company was invented.

In 1855, the British Parliament passed an act, extended by another in 1862, which created a form of incorporation that limited the liability of shareholders for their company’s debts. A study of Hansard⁴ at the time suggests that some legislators thought they were just protecting ‘sleeping’ partners, those not involved in management. France had had such a system − the société en commandité par actions − since 1807, which limited the exposure of non-executive investors, but gave executives unlimited liability. In the event, the British Parliament’s form of incorporation exempted all shareholders, non-executive and executive alike, from liability for companies’ debts.

Incorporation with limited liability was made available in Germany in 1884, but as in France, German company law, being based on prescriptive civil law, lacked the ability of the common law in Britain to learn from case precedents. Developments in the United States reflected the British experience, with individual states creating their own company law jurisdictions in the later years of the 19th century. Incorporation at the federal level was not, and is still not, available.

The classical concept of the limited liability company proved to be one of the finest systems man has ever designed. The key concept was the incorporation of a legal entity, separate from the owners, which nevertheless had many of the legal property rights of a real person − to contract, to sue and be sued, to own property and to employ. The company had a life of its own, giving continuity beyond the life of its founders, who could transfer their shares in the company. Crucially, the owners’ liability for the company’s debts was limited to their equity investment. Yet ownership remained the basis of power. Shareholders elected their directors, who reported to them. Company law was the underpinning of corporate governance.

The notion was elegantly simple and superbly successful. It has enabled untold industrial growth, the generation of massive employment and the creation of untold wealth around the world. Although the mid-19th century model now bears little relationship to the reality of modern corporate structures, complex ownership patterns and corporate governance processes, the original corporate concept remains the essential basis of contemporary company law.

EARLY 20TH-CENTURY DEVELOPMENTS − PRIVATE COMPANIES, THE SEC, AND COMPLEX CORPORATE GROUPS

For the rest of the 19th century, all companies that were incorporated in Britain were public companies formed to raise capital from outside investors. But early in the 20th century the owners of some family firms realized that, even though they were not seeking external capital, incorporating their businesses as limited liability companies would protect them from personal liability for the firm’s debts. In Britain, a Private Companies Act was passed in 1907, which provided for the creation of companies that could not seek public subscription for their shares, and with restrictions on the number of shareholders, and reduced reporting requirements. Today, private companies on the state registers of companies vastly outnumber public companies.

The early years of the 20th century also saw significant developments among public companies. In the United States, the United Kingdom, and other economically advanced countries, the shareholders in many public companies had become numerous, geographically spread, with differing expectations of their investments. Many public companies were now listed on stock exchanges. For the first time institutional investors, such as pension funds and insurance companies, were investing. Owners were becoming remote from the companies they owned. Governance power had shifted towards top management.

Two American academics, Berle and Means,⁵ studied major public companies in America and noted a growing shift of power to executive management from increasingly diverse and remote shareholders. They expressed concern about the growing power of large companies in society, observing that:

The rise of the modern corporation has brought a concentration of economic power which can compete on equal terms with the modern state − economic power versus political power, each strong in its own field. The state seeks in some aspects to regulate the corporation, while the corporation, steadily becoming more powerful, makes every effort to avoid such regulation. … The future may see the economic organism, now typified by the corporation, not only on an equal plane with the state, but possibly even superseding it as the dominant form of social organisation.

Berle and Means’ seminal work remains one of the most frequently cited works in corporate governance research to this day. The need to provide investors with some protection from over-powerful corporate boards was recognized at the federal level and led to the creation of the US Securities and Exchange Commission (SEC).

Berle and Means left a vital intellectual inheritance for the subject that was to become known as corporate governance: but not for another 50 years. In the meantime, the spotlight swung to management, with management teaching, management consultants and management gurus proliferating. The board of directors did not appear on the organization chart. The activities of boards and their directors remained the province of accountants and lawyers, enlivened by occasional anecdote and exhortation.

But companies proliferated, with the arrival of large, complex corporate groups, often created through merger and acquisition. There had been mergers in the late 19th century, but then a new company was formed to acquire the assets and liabilities of the merging companies, which were then wound up. In the early 20th century it was realized that companies could own other companies, and corporate complexity had arrived. Pyramids, networks of complex cross-holdings, and chains of listed companies, leveraging the lead companies, all appeared.

DEVELOPMENTS IN THE 1970S − AUDIT COMMITTEES, INDUSTRIAL DEMOCRACY AND CORPORATE ACCOUNTABILITY

In 1972, the Securities and Exchange Commission in Washington required US listed companies to create a standing audi...

Table of contents

• Cover Page
• Title Page
• Copyright
• Contents
• About the Authors
• Preface
• Introduction: Corporate Governance – An Emerging Discipline?
• PART 1: ORIGINS AND DEVELOPMENT
• PART 2: MARKETS AND REGULATION
• PART 3: BOARDS AND DIRECTORS: LEADERSHIP AND ACCOUNTABILITY
• PART 4: BOARDS AND DIRECTORS: NEW CHALLENGES AND DIRECTIONS
• PART 5: COMPETING GOVERNANCE REGIMES
• PART 6: DILEMMAS OF CORPORATE GOVERNANCE
• PART 7: EMERGING ISSUES: GOVERNANCE AND SUSTAINABILITY
• Name Index
• Subject Index