Corporate Governance Models

A Critical Assessment

Marco Mastrodascio

• Verlag: Routledge
• Jahr: 2021
• ISBN:
  9781000530094
• Auflage: 1
• Thema: Business
• Thema: Corporate Governance

The activities carried out in a business organization stem from the contribution of subjects who cooperate in the expectation of obtaining adequate rewards. The ability of organisations to reach a specific level of performance is influenced by the ownership structure, while the management is directed and controlled through a set of rules and incentives. This set regulates the distribution of rights and responsibilities among the board, company management and stakeholders, and it defines the corporate governance model adopted by the organization.

The collapse of global organisations across the world have undoubtedly revealed the inherent flaws in the contemporary corporate governance practices. As a result of these international scandals, a great deal of multidisciplinary research has been growing restlessly to define the specificities of each corporate governance model, however, lacking a specific investigation into the presumed existence of the most suitable one. By favouring the synthesis and the inductive procedure, this book analyses the potential existence of the most appropriate corporate governance model based on comparative international analysis of cultural, social and economic factors influencing the organization's choice regarding the corporate governance model to be adopted.

This volume will be of interest to researchers, academics, professionals and students in the fields of corporate governance, international business and law.

1 Origins and Definitions of Corporate Governance

DOI: 10.4324/9781003225805-1

1.1 Importance of the Corporate Governance Concept

Although the concept of CG¹ has become a major issue within the business world only in the past three decades, the word governance dates back to the fourteenth century. The word governance, from its Latin root ‘gubernare,’ is generally identified either as the action or method to wisely and responsively govern organisations (Cadbury, 2002). Since the Cicero’s view of the role of governing according to which ‘he that governs sits quietly at the stern and scarce is seen to stir,’² the concept of CG has been developed throughout the years becoming a topic of extensive interdisciplinary reflection such as legal scholarships, studies of pure and applied economics, management and business strategy disciplines. The reasons behind this interdisciplinary interest stem from the fact that corporations still remain the fundamental units of modern market capitalist nations. The organisational structure of these corporations, their functioning mechanisms, the sources of the financial resources available and, above all, the relationship among those who own, manage and control these resources are all necessary elements to fruitfully assess the impact of these organisation on the economic growth both at the national and global level. Within the relations established among these elements, an important role is played by the ‘ownership structure’ which is, in fact, able to drive power, rights and responsibilities within corporations (Colli, 2006). Consequently, the ownership structure of a firm is crucial for its ability to influence the level of performance and how resources are used at both microeconomic and macroeconomic levels.

The concept of CG It is known that the expression was defined for the first time by the Cadbury Report³ as the system by which companies are managed and controlled or, more generally, constitutes the set of rules, procedures and mechanisms that define the decision-making process at the highest corporate levels by giving, to a greater or lesser extent, the subjects involved a ‘voice’ in this process, in order to be able to protect their interests and investments.⁴ Among its purposes, this set of rules has the effect of reducing the agency and transaction costs and favouring the alignment of possibly diverging interests and the reduction of existing information asymmetries.

The issues relating to the CG system of a company have been the subject of analysis by scholars for a long time, although the attention around the topic has grown significantly only in the last two decades. However, initially, only blue chips were the first to adopt CG rules, even the smallest companies, mid or small caps, decide to adopt them in order to access the capital market.

Overall, the importance of this theme has grown enormously in recent years basically due to the following three main reasons:

1. the increase of privatisations that have taken place around the world,⁵ which averagely, this kind of operations, from 1990 to today, has generated for the countries that have carried out revenue from 2.7% to 27% of GDP. Privatisations have been conducted by following two roughly alternative approaches: favouring the creation of a widespread shareholder base in order to avoid the concentration of power (e.g. Apple in the USA) and supporting the creation of a batch of reference shareholders (e.g. Telecom Italia in Italy).

The intense privatisation process has definitely provoked some questions such as:

• Does the new public company need to implement new strategies and targets?
• What role should the state play as a shareholder?
• Can a corporate raider reach the control of a public company?

The type of influence that the privatisation process exerts on CG depends not only on the severity of the rules, but also on the interpretation given to them and on the aims pursued by the political sphere, which plays a crucial role in the privatisation process, which is closely linked to the objectives that privatisation sets itself. In fact, the purposes of the privatisation are not only derived from what is sanctioned by the rules. The plentiful situations that the CG is called to face and the extent of the discretion that the political sphere has can vary the range of objectives and priorities pursued especially in the case of intensive privatisation process where companies operate in very different contexts while the surrounding conditions change significantly. The multiplicity of the purposes that privatisations aim to can be deduced from the extent of the privatisation process itself, which has affected a great variety of countries in recent decades, each of them characterised by different conditions and maturity of the economic, entrepreneurial, financial and legal system.

The purposes of the privatisation process, which has robustly influenced the adoption of CG systems by companies, can be categorised into three broad types of motivations:⁶ ideological, functional and competitive.

From an ideological point of view, privatisations are the offspring of the great social and political evolution which, on a world level, has experienced the historical defeat of command or planned economies. The competition between market systems and centralised ones has seen the latter losing especially since market systems began to increasingly and consistently base their development on innovation.

From a functional point of view, the reasons for privatisation stem from the belief according to which economic activities carried out by government-owned companies usually deliver a lower levels of efficiency than those delivered by companies subjected to market discipline. The assumption is based, rather than on empirical evidence, on the logical impossibility of obtaining better results in the long term than those ensured by a correctly functioning market, which is presumably able to evaluate every single initiative and invest resources and knowledge most prolifically, thus allowing the growth of the most efficient operators and the elimination of inefficient ones. Based on these assumptions, the best that the government as an operator could aspire to obtain would be to imitate the market, but at that point, the usefulness of keeping the company in government hands would cease.

Finally, there is the competitive perspective which is the most influential reason leading to the privatisation of the largest government-owned enterprises, even where consolidated political beliefs and traditions of good bureaucratic efficiency seemed to presume the indefinite survival of the public control of some enterprises. Therefore, if the CG rules and the spirit through which those rules are followed within a country, it is likely that the operator that gives greater reliability to the market is the State with a large privatisation program and adequate technical skills to manage it.

2. the growing access to the financial market by small investors who are generally disinterested or poorly informed about the performance of the company they are investing.

This new type of investor represents an increasing part among the operators of the stock market, especially in Europe and the United States. Therefore, in joint-stock companies is relevant for two reasons:

• the greater diffusion of equity investments makes shareholders’ protection a political problem;
• small shareholders generally have less skills than professional shareholders to monitor management behaviour, and therefore, have less ‘voice’ within the decision-making system as they rarely attend to shareholders’ meetings, and when they are present they do not actively participate to the meeting.

3. the so-called corporate scandals which have highlighted how investor protection is often lacking.

In industrialised countries, the economic and financial crisis that occurred in 2007/2008, which followed the period of strong growth in the second half of the 1990s, was characterised by a series of cases that highlighted bad governance behaviours, such as off-balance loans; self-dealing; communication of biased information to investors and insider trading; fraud. The result of this misbehaviour was the loss of billions of dollars which, subsequently, destroyed companies and peoples’ lives. Among the main corporate scandals which occurred worldwide, there are:

• Waste Management Inc. (over $1.7 billion in fake earnings);
• Enron Corporation (loss of over $74 billion as Enron’s share price collapsed from around $90 to under $1 within a year);
• WorldCom (almost $11 billion);
• Tyco International (loss of over $150 million and inflation of $500 million in the company reports);
• Lehman Brothers (hidden over $50 billion in loans);
• Madoff Investment Security LLC (tricking investors out of over $64.8 billion);
• Ahold (inflated profits by $700 million);
• Parmalat and Cirio (€14 billion, which represents approximately 1% of the Italian GDP).

All these defaults “have shown that something was out-of-line with corporate governance, financial reporting and above all with auditing, at the end of the twentieth century” (Fera P., Pizzo M., Vinciguerra R., and Ricciardi G., 2021).

1.1.1 Definitions and Approaches to Corporate Governance

The change occurred in the dynamics of the capitalist system and the great wave of financial scandals that took place at the end of the last century and the beginning of the millennium, and have made CG become one of the most relevant issues in recent decades both academically and a practice/business level.

Corporate governance concerns the governance of companies and the management of relationships between the shareholders/owners of the company (the principals) and the management (the agents). More specifically, CG refers to the articulated system of relationships and interests between controlling shareholders of a company, investors (minority or outside shareholders) and the management structure of the company (Fiori & Tiscini, 2014).

Large corporations are now owned by a large number of shareholders who, on the one hand, have to delegate a small group of people to direct and manage the corporation and, on the other hand, implement an effective control system on their work.

Adam Smith in the An Inquiry Into the Nature and Causes of the Wealth of Nations (1776) pointed out that ‘if whoever manages a business is a different person from the one who owns it, it is legitimate to suspect that managers, administering other people’s money, do not put the same effort and care that they would put in administering their own.’ Therefore, one of the main issues related to CG is the relationship between shareholders and the management.

However, the concept of CG goes far beyond the simple relationship between shareholders and managers. In fact, it involves whoever has an interest in the company such as lenders, employees, customers and suppliers. Therefore, there is the need to identify rules and practices of CG in order to guarantee the protection of the stakeholders’ interests.

Overall, CG refers to the system of rules according to which companies are managed and controlled and this is the result of traditions, behaviours and rules elaborated by the single economic and juridical systems and it is certainly not attributable to a single model easily exported and imitated in all legal systems.

Despite the large number of contributions that have been produced on the CG over the last few decades, it should be noted that, to date, a shared definition of CG has not yet been reached. In general, definitions differ from each other in terms of extent and a variety of both stakeholders that are considered in the economic governance process (shareholders, managers, suppliers, employees, financial intermediaries, consumers) and for corporate bodies or mechanisms that are held responsible for the CG function (board of directors, auditing firm, top management, board of statutory auditors, etc.).

In regard to first aspect (extent and variety of stakeholders), CG ranges from definitions that consider the interests of shareholders and capital investors in general to be worthy of protection, to others in which it is argued that the activity of governance must balance the interests of all stakeholders.

In relation to the second aspect (authorities responsible for the control function), there are two extreme positions: those who believe that the body responsible for defining and resolving CG issues is mainly the board of directors and, oppose at those who are convinced that CG is a complex set of structures and rules aiming at composing different interests that converge into the company. In order to represent the different conceptual structures of CG, Figure 1.1 combines structures and mechanisms of CG and the interests considered in the CG process.

Figure 1.1 Conceptual structures of corporate governance.

In the first quadrant, only the interest of the shareholders is considered as worthy of protection and the board of directors is the only authority proposed to ...