84 CORPORATE GOVERNANCE

Corporate Governance Mechanisms:

a plea for less code of good governance
and more market control
Alvaro Cuervo*

This paper provides a critical comparative analysis of corporate governance mechanisms in

market-oriented (Anglo-Saxon) and large shareholder-oriented (Continental European)
systems of corporate governance. Deficiencies in shareholder protection in the legal systems
of both corporate governance systems have been addressed through the use of codes of good
governance, a set of norms that regulate the behaviour and structure of the board of directors.
However, the lower enforceability of norms in Continental Europe limits the applicability of
such codes. Therefore, we argue that in Continental Europe, rather than promoting codes of
good governance, it is necessary to expand market control mechanisms to facilitate the
maximisation of firm value.

Keywords: Corporate governance systems, market for corporate control, codes of good
governance, managerial defence mechanisms, core shareholders

Introduction by large incumbent shareholders or leverage

(Jensen, 1986); and second, mechanisms ex-

T he separation of owners and managers

* Address for correspondence:
Complutense University of
Madrid, Facultad de Ciencias
Económicas y Empresariales,
Campus de Somosaguas s/n,
28223, Madrid, Spain. Tel:
34-91-3942505; Fax: 34-91-
3942371; E-mail: acuervo@
ccee.ucm.es
creates the need for corporate govern-
ance, which comprises mechanisms that en-
sure efficient decision-making, maximising the
value of the firm. Moreover, the expansion of
capital markets in the 1990s, with increasing
numbers of companies listed, and the global-
isation of investors increase the need for good
corporate governance mechanisms, as the
separation of ownership and control in-
creases. The broad question that we analyse
in this paper is: what are the corporate
governance mechanisms that solve or reduce
the problem of the separation of owners and
managers and facilitate efficient decision-
making that optimises the value of the firm?
Traditional finance literature has indicated
several mechanisms that help solve corporate
governance problems (Fama, 1980; Fama and
Jensen, 1983b; Turnbull, 1997): first, mechan-
isms internal to the firm, such as managerial
compensation, the board of directors, control
ternal to the firm such as the market for
corporate control, the market for managers,
and the market for products and services.
However, the use of these mechanisms
depends on the corporate governance system
prevalent in the country; that is, whether it is
market-oriented or large-shareholders oriented
(Franks and Mayer, 1997; Shleifer and Vishny,
1997). Market-oriented systems tend to rely
more on managerial compensation and the
market for corporate control to solve corpo-
rate governance problems, while large-share-
holder oriented systems tend to use control
by large incumbent shareholders to align the
behaviour of managers and owners.
Nevertheless, both systems show limitations
to the efficiency of the mechanisms used to
solve deficiencies in corporate governance.
On the one hand, the market for corporate
control is expensive and requires large devi-
ations from appropriate behaviour by man-
agers in order to function properly, while

# Blackwell Publishers Ltd 2002. 108 Cowley Road, Oxford OX4 1JF, UK
Volume 10 Number 2 April 2002 and 350 Main Street, Malden, MA 02148, USA.
CORPORATE GOVERNANCE MECHANISMS
being subject to further deficiencies in the
form of anti-takeover measures that protect
incumbent managers (Jensen, 1993). On the
other hand, control by large shareholders is
limited, since these large shareholders seek
their private objectives at the expense of
minority owners (Barclay and Holderness,
1989; Barclay et al., 1993; Cuervo-Cazurra, 1999).
There are other corporate governance me-
chanisms at a higher level that, until recently,
have been overlooked in the literature: the
legal system and the codes of good govern-
ance. The legal system, commonly classified
into common law and civil law, establishes
norms that regulate the behaviour of the firm
and protect the rights of minority share-
holders, offering different levels of protection
of the rights of minority shareholders (La
Porta et al., 1997), and influencing the devel-
opment of capital markets (La Porta et al.,
1997) and the growth of the country (Levine,
1999). The codes of good governance, a set of
‘best practice’ recommendations regarding
the behaviour and structure of the board of
directors (Dalton et al., 1998), act as a sub-
stitute for deficiencies in the protection of
minority shareholders in the legal system
(Aguilera and Cuervo-Cazurra, 2000).
However, the type of legal system limits the
efficiency in the application of the codes of
good governance. In common law countries
(in the Anglo-Saxon tradition) judges can
apply the codes of good governance directly,
allowing these to become enforceable regu-
lation, whereas in civil law countries (in the
Continental European tradition) judges can-
not apply the codes of good governance with
the force of regulation, since the law can only
be developed in parliament.
Hence, we argue that in civil law countries
the codes of good governance can be applied
formally, following the letter but not the spirit
of the law, since they cannot be legally en-
forced. In these countries, some companies
use the publication or approval of the codes
of good governance in order to adapt them
and establish systems of corporate govern-
ance that go against the spirit of the codes,
developing anti-takeover measures that pro-
tect incumbent managers and large share-
holders. Moreover, in these countries the
authorities require that all takeover plans be
submitted for approval in order to analyse
their impact on competition. This analysis has
destroyed the market for corporate control,
since it reduces the surprise impact of the
takeover and increases governmental inter-
vention in the strategy of companies.
Therefore, we contend that rather than
extending the use of codes of good govern-
ance in civil law countries, it is necessary to
# Blackwell Publishers Ltd 2002
85
expand the realm of action of market control
mechanisms, avoiding managerial defences
and core shareholders, to facilitate the maxi-
misation of the value of the firm in the market.
The rest of the paper is organised as
follows. In the next section, corporate govern-
ance systems are introduced and the use of
different corporate governance mechanisms
as part of a system is discussed. Following
this, the legal system and codes of good
governance as alternative corporate govern-
ance mechanisms are presented, and limita-
tions in the applicability of codes of good
governance are reviewed. It is argued that
there is a need to introduce more market
mechanisms in the large-shareholder corpo-
rate governance systems. Finally, implications
for future research are discussed.
Corporate governance systems
Corporate governance mechanisms vary
across institutional environments (Mayer,
1996). These can be separated into two main
systems (Shleifer and Vishny, 1997): large-
shareholder control systems, such as those in
Germany, France or Spain, and market con-
trol systems, such as those in the USA and the
UK. For simplicity, we term the first system
the Continental European system, and the
second the Anglo-Saxon system.
The large-shareholder control or Conti-
nental European system is characterised by
the following features: (1) ownership is con-
centrated; banks, companies, and families are
large shareholders; (2) control is assumed to
be exercised by large shareholders; (3) the
board of directors is controlled by internal
directors or external directors linked to large
shareholders; (4) capital markets are rela-
tively illiquid and have limited control ability;
(5) there exist implicit contracting and close
personal trust relationships among managers;
(6) long-term lender–borrower relationships
and bank ownership of equity are main-
tained; (7) there is no active market for
control; that is, management does not face
hostile takeover bids; and (8) banks play a
major role in corporate governance, trough
equity stakes, proxies given to them by small
investors and bankers’ position on the boards
of firms (Baums, 1993; Kester, 1997).
The market control or Anglo-Saxon system
is characterised by the following features:
(1) ownership is diffuse except for institu-
tional investors; (2) control is vested in the
board of directors, with external directors
playing an important role; (3) capital markets
are very liquid and there is a developed
market for corporate control and takeover
Volume 10 Number 2 April 2002
86
market; and (4) there is more defence of the
ownership rights of shareholders over the
rights of debtholders than in the Continental
European model; that is, legal protection acts
as a substitute for ownership structure (La
Porta et al., 1997).
Neither system is perfect. In the market
control system, the reduction in the operation
of the market for corporate control gave rise
to activism by large institutional investors
(Useem, 1993). In the large-shareholder con-
trol system, abuses by managers and large
shareholders led to the establishment of codes
of good corporate governance (Cadbury
Commission, 1992).
Although neither system has achieved a
perfect corporate governance system, we con-
tend that in the case of the large-shareholder
control system, there is a need for more
market control and less use of codes of good
corporate governance to achieve the ultimate
objective of the maximisation of the firm’s
value. The Continental European model was
justified as it evolved in its historical institu-
tional framework, where it was useful to deal
with the hazards associated with information
asymmetries, investment in specialised assets,
R&D, and long-term investments (Baums,
1993, p. 180), and the agency problems of
large organisations. However, the desirability
of corporate takeover activity and greater
operating efficiency in contrast with the long-
term strategies creates the need to revise the
benefits of this system (Kester, 1997, p. 240).
Although, in theory, large shareholders have
incentives to exercise monitoring (Schleifer
and Vishny, 1986), there is evidence of a lack
of control of banks as large shareholders on
the firm (Zoido, 1998; Cuervo-Cazurra, 1999).
Meanwhile, there is other evidence suggest-
ing that there is no relationship between large
shareholders and firm value (Holderness and
Sheenan, 1998). Moreover, environmental
changes associated with the opening and in-
tegration of European markets highlight the
fact that this model is inefficient when the
institutional environment changes (Baums,
1993, p. 182; Cuervo and Villalonga, 2000);
thus, it is recommended that there be a move-
ment towards increasing transparency and
market control.
One factor that allows differentiation be-
tween Anglo-Saxon and Continental Euro-
pean corporate governance systems and
affects the efficiency of corporate governance
mechanisms, in particular the market for
corporate control, is the difference in owner-
ship structure. There is an extraordinarily
high degree of concentration of shareholder
voting power in the Continental European
system relative to the Anglo-Saxon system.
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CORPORATE GOVERNANCE
Thus, it is at least as important to understand
the relationship between large controlling
shareholders and weak minority shareholders
as it is to understand the more commonly
studied interface between management and
dispersed shareholders. In several countries,
the median largest voting stake in listed
companies is over 50 per cent, suggesting
that voting control by a large blockholder is
the rule rather than the exception; and in no
European country studied was the median
largest shareholder small enough to fall
below the 5 per cent disclosure threshold.
To illustrate the striking differences in con-
centration of voting power among countries,
consider the size of the largest voting block.
The median size in percentage of the largest
ultimate outside voting block for listed in-
dustrial companies in the US is under 5 per
cent, and in the UK it is a modest 9.9 per cent,
while, at the other extreme, in Germany,
Austria and Italy it exceeds 50 per cent, in
the Netherlands it is 43.5 per cent, in Spain it
is 34.2 per cent and in France it is 20 per cent
(Becht and Roell, 1999, p. 1051).
Another characteristic which differentiates
between corporate governance in the Con-
tinental European and Anglo-Saxon systems
is the importance of the fiduciary capital, or
institutional investors. In the USA, insti-
tutional investors hold 51.5 per cent of all
domestic corporations and 57 per cent of the
outstanding equity of the largest US corpor-
ations in 1994 (Hawley and Williams, 1997).
Many who support the agency model regret
the passing of the market for corporate
control that characterised the 1980s. In that
era, the market was seen as the ultimate
mechanism for aligning managers’ actions
with owners’ wishes (Hawley and Williams,
1997, pp. 207–8). After the decline in the
market for corporate control, owners (insti-
tutional investors primarily) were then forced
to turn their attention to: (1) the removal of
impediments to the market for corporate
control; (2) the enactment of governance
reforms that give owners more influence on
boards and (3) the development of initiatives
to influence the Securities and Exchange
Commission and other agencies to adopt
rules that either force institutions to act
aggressively or compel managers to maximise
long-term shareholder wealth. Now there is a
new problem: can agents watch agents?
Sometimes, institutional investors have been
captured by management or exist in a tight
commercial network of firms. The remaining
active institutional investors – primarily pub-
lic pension funds – are relatively free from
corporate pressure, but may be subject to
strong political pressure. The rise of fiduciary
# Blackwell Publishers Ltd 2002
CORPORATE GOVERNANCE MECHANISMS
capitalism with its great concentration of
wealth in the hands of relatively few institu-
tional investors raises serious concerns about
the monitoring of the monitors (Hawley and
Williams, 1997).
Alternative corporate governance
instruments: institutional investors and
codes of good governance
The reduction in the takeover movement in
the 1990s in the Anglo-Saxon system led to
the search for solutions to the limitation on
corporate governance mechanisms. With the
threat of takeover gone, and corporate boards
powerless or unwilling to act, the manage-
ment of many underperforming companies
faced no serious pressure to make reforms
necessary to restore profitability. In the
Anglo-Saxon system, a stronger institutional
voice could be expected to benefit share-
holders in a number of ways by prodding
reluctant corporate boards into decisive ac-
tion. As a consequence, institutional investors
had no choice but to protect their investments
by becoming more vocal and active (Pound,
1997); by discouraging empire-building
through acquisitions and thus sharpening
corporate focus; by persuading management
to pay out excess capital and dismantle value-
reducing barriers to takeover; and by en-
couraging management to take a longer view
of the corporate future (Black, 1997).
In the European system, the market for
corporate control and the takeover system for
disciplining management did not function
efficiently. There are three kinds of reasons
that explain the limitation in the European
market for corporate control. First, there are
socio-cultural reasons for this; politicians and
managers try to create a climate and a state of
prevailing opinion against a simple takeover
offer that shareholders can accept or reject. In
this regard, they speak of speculative acquisi-
tions, hostile attacks, aggression, assaults to
the companies, ‘sharks’ or ‘capitalism without
soul’. This is highlighted when the takeover is
performed by a foreign person or company
(Roe, 1993; Buhmer et al., 1998).
Second, there are reasons linked to the
ownership structure, that is, the weight and
behaviour of active shareholders, including
institutional investors. Among these, it is
important to consider the connection between
the ownership system in Germany and the
banking system, the special relationships
between private and public sectors and the
cross-shareholdings among companies in
France, or the high degree of ownership
concentration in the hands of families, the
banking system and pyramidal groups in
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87
Italy or Spain. Moreover, in the Continental
system, individual investors with shares in
the custody of banks delegate the voting
rights to the banks. This limits control,
communication and collective action of share-
holders since banks, and not the ultimate
shareholders, control the voting rights of the
shares (Cuervo-Cazurra, 1999; La Porta et al.,
1999).
Finally, there are reasons linked to legal
defences and managerial defences. Although
the adoption of defensive measures by the
incumbent management team might be illegal
once a takeover has been announced, as in the
case of Spain, in practice, they have either
previously reformed the firm’s by-laws or
they will use the Shareholders General Meet-
ing to make these measures possible. The
opposition of incumbent managers to take-
overs may arise from their receiving compen-
sation above the value of their contribution
to the company, compensation they might
lose in case of takeover. They may also face
limited employment alternatives, or they may
have made investments in human capital
specific to the company, investments they
will lose if they leave the firm. Managers’
opposition to a takeover is manifested in
several forms, such as publicising its rejection
of the takeover offer and recommending to
shareholders that they, too, oppose the sale.
Their opposition may also be expressed in
establishment of anti-takeover defences, in-
struments that cause delay, make it more
expensive or otherwise hinder the takeover
operation, which lead to the alternative
management’s withdrawal of the offer.
A distinctive feature to compensate for the
lack of a well-functioning market for corpor-
ate control in Europe has been the adoption of
codes of good corporate governance. Starting
with the Cadbury report in the UK in 1992,
successive countries adopted versions of
corporate governance norms to improve
corporate governance practices. Norms and
codes of good governance are designed to
facilitate the establishment of the appropriate
attitude towards a problem, and the search
for solutions to it. Whereas these codes have
been adopted by most large European corpor-
ations, their effectiveness in promoting effi-
cient corporate governance has been limited.
Moreover, although the concentrated owner-
ship and limited takeover activity of the
European system would seem to be more
conducive to longer-term relationships be-
tween the company and its investors, such
concentrated insider ownership can also lead
to costly delays in undertaking necessary
corrective action, particularly if owners re-
ceive non-monetary benefits from owning
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88
and running a business. The existence of core
shareholders and the adoption of managerial
defences that protect both managers and
incumbent large shareholders have limited
the efficiency of corporate governance me-
chanisms.
Corporate governance in Continental
Europe: a plea for market control
mechanisms
Nowadays, there is a trend towards homo-
geneity of control systems in the markets,
with marked movements towards greater
transparency, shareholder empowerment
and director oversight in the Anglo-Saxon
style of corporate governance, and with no
clear differences among the nations – USA,
UK, Germany, France – in managerial incen-
tives to manage for the short-term or the long-
term. Privatisation, the growing presence of
US investors in Europe and globalisation of
capital markets are forces propelling initia-
tives such as more transparent disclosure
standards and raised oversight standards for
boards of directors. Changes in legislation
facilitate the convergence of corporate gov-
ernance systems (Kester, 1996; Berglof, 1997).
However, the efficiency of corporate gov-
ernance in Continental Europe is limited due
to the existence of core shareholders and the
adoption of managerial defence mechanisms
that establish barriers to corporate govern-
ance. Only through the adoption of more
market control measures will corporate gov-
ernance improve in Continental Europe.
Limitations to efficient corporate
governance in Continental Europe
The existence of large shareholders in Con-
tinental Europe has been accompanied by the
development of business groups and pyra-
midal structures that separate ownership
from control. By enabling this separation, pyra-
midal groups have facilitated the growth of
entrepreneurial projects, and internal capital
markets may have helped deserving projects
to be financed. However, the perceived risk
of expropriation may have imposed severe
limits on the overall performance of the system,
leading to a dynamic efficiency problem, in
that the concentration of ownership may have
insufficiently contestable control, hampering
the efficient selection of controlling agents
(Bianco and Casavola, 1999, p. 1056).
Besides the private benefits that are en-
tailed by the presence of large shareholders,
this presence also may result in liquidity
problems. There is a tradeoff between control
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CORPORATE GOVERNANCE
by large shareholders and liquidity, but with
passive shareholders. The liquidity of mar-
kets has two opposing effects on corporate
governance (Kyle and Vila, 1991). On the one
hand, it facilitates corporate control, because
it allows large shareholders to exit. On the
other hand, liquid markets permit large
shareholders to dispose of shares in the face
of a drop in price, instead of having to be
involved in the control of the company. In
such a way, ownership dispersion is a pre-
requisite for liquid stock markets, but it
entails a collective action problem (Becht,
1999): individual investors have no incentives
to engage in direct monitoring. Empirical
evidence analysing the relationship between
corporate governance and liquidity indicates
a tradeoff between monitoring and liquidity
(Burkart et al., 1997), both in the Anglo-Saxon
and the Continental European systems.
Whereas in the USA many institutional in-
vestors deliberately trade-off control against
liquidity (Coffee, 1991), voting power con-
centration through blocks had a negative
effect on liquidity in the German and Belgian
stock markets (Becht, 1999). Moreover, ‘‘if
the Netherlands had imposed one-share-one-
vote by law we might have observed con-
centrated voting power, concentrated owner-
ship and lower levels of liquidity’’ (Becht,
1999, p. 1076).
In Continental Europe, aside from the
difficulties faced by corporate governance
mechanisms to work efficiently, especially in
the market for corporate control, companies
actively adopt defensive measures that pro-
tect not only management, but also large or
core shareholders. These measures, which
introduce restrictions into the market for
corporate control, are presented by managers
as necessary for developing stable manage-
ment of shareholders’ benefits. These man-
agerial defensive measures lead to changes in
by-laws, with the objective of maintaining
control by means of ‘‘entry barriers’’ that will
limit changes in the control and management
of the firm.
The behaviour of control shareholders,
‘‘core shareholders’’ or active shareholders
explains the use of these defence mechanisms.
In most cases, defence mechanisms involve
the defence of minority interests (managers
and core shareholders), although they are
presented as a defence of the general inter-
ests. Thus proponents of such changes talk of
defences against hostile takeover bids and
external aggression. However, if there is such
hostility, it is against the incumbent manage-
ment team and board of directors, certainly
not against all the shareholders or the
company, although this is how it is presented.
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CORPORATE GOVERNANCE MECHANISMS
At present, empirical evidence suggests that
managers and control groups use these
defence measures to protect their private
interests, rather than to serve the interests of
shareholders (Jarrell and Poulsen, 1987). This
is a way to maintain control for the manage-
ment of the firm who have a small share in
the capital and control shareholders who can
be compensated through the achievement of
their private goals.
Analysis of managerial defence mechan-
isms and the restrictions of corporate control
in the market should not be made based on
moral judgments, but on the effects of a
system on the creation of value for share-
holders, the efficiency of the company and the
economy in general. The response to and
valuation of these defences that the market
makes will be conditioned by why and when
they are made. First, defence measures against
a concrete threat in general and preventive
defence measures in general interfere with the
firm’s ownership structure and, in turn, firm
performance. In fact, Cole and Mehran (1998)
found that after the anti-takeover provisions
expire, insider ownership increases and firm
performance improves significantly. Second,
measures established at the outset of the firm
might be legal, but one can doubt about their
compatibility with the by-laws of public
firms. This also includes modifications once
the firm becomes public, which alter rights
and the characteristics of shares in ways that
differ from that which was stated in IPO
documents (Sánchez Andrés, 1994, p. 37).
Third measures may depend on the valuation
of the strength of the board of directors,
although the empirical evidence regarding
this issue is not conclusive. On the one hand,
Sundaramurthy et al. (1997) find that the per-
ception of the board’s power and the sep-
aration of functions (chairman of the board
and CEO), leads to a less negative reaction
to this restriction by the market. Similarly,
other studies conclude that the participation
of external directors limits green-mail pay-
ments (Kosnick, 1987) and it supports share-
holders’ protection (Kesner and Johnson,
1990). On the other hand, Jarrell and Poulsen
(1987) find a direct relation between the level
of insider ownership, as well as the presence
of certain types of institutional investors, and
the negative wealth effects associated with
anti-takeover defences. Thus, it is not clear
what the monitoring role played by the board
of directors and core shareholders is when
the firm decides to adopt defence measures.
Actually, studies conducted in Continental
European countries, where ownership con-
centration is fairly high, reveal the negative
impact on stock prices of anti-takeover
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89
measures (see, for example, Fernández et al.,
1998 for the Spanish market). These findings
show that core investors do not always
protect all shareholders’ wealth.
In conclusion, core shareholders may pro-
vide the benefit of monitoring, but also lead to
less liquid capital markets, the possibility of
consumption of perquisites and the achieve-
ment of voting power that exceeds their cash
flow rights. On top of that, they may prevent
the existence of an active corporate control
market that may discipline these large share-
holders, as well as managers, when they do
not monitor or manage the firm efficiently
and in the best interests of all shareholders.
Solutions to the limitations of the
Continental European system: not codes
of good governance but market control
mechanisms
The limitations in the European corporate
governance system have been addressed
through the development of codes of good
governance, a set of ‘‘best practice’’ recom-
mendations regarding the behaviour and
structure of the board of directors (Aguilera
and Cuervo-Cazurra, 2000). However, the
type of legal system limits the efficiency in
the application of the codes of good govern-
ance. In common-law countries, or Anglo-
Saxon countries, which have also adopted the
codes of good governance, judges can enforce
the use of the codes of good governance
directly, and these become enforceable regu-
lation once the codes are part of the usual
practices of business. Nevertheless, the effec-
tiveness of the codes of good governance can
be questionable. Actually, studies that analyse
the wealth effects associated with compliance
with the Cadbury Report do not find sig-
nificant abnormal returns (Weir and Laing,
2000). In civil law countries, such as Con-
tinental European countries, judges cannot
enforce the application the codes of good
governance with the force of regulation. In
the civil law tradition, laws that guide the
behaviour of the firm toward its shareholders
can only be developed in the parliaments,
where practices are codified. The codification
of new laws that increase the protection of
minority shareholders is possible, but these
laws take an inordinate amount of time to
be codified and are not flexible enough to
adapt to changing conditions in the corpor-
ate governance arena. This characteristic of
the legal system results in situations where
the codes of good governance are applied
formally following the letter but not the
spirit of the law, since they cannot be legally
enforced.
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90
Hence, we argue that rather than extending
the use of codes of good governance in civil
law countries, it is necessary to expand the
realm of action of market control mechan-
isms, avoiding managerial defences and core
shareholders, to facilitate the maximisation of
firm value in the market.
Ownership rights are managerial discipline
and stimulus elements. Protection of the
rights of shareholders should be centred on
that simple principle, ‘one share, one vote’, as
the best guarantee of efficiency. This implies
freedom in the exercise of voting rights,
access to appropriate information on the per-
formance of the company, facilitating the
presentation of proposals to the board of
directors and the promotion of active mem-
bers of the board of directors to strengthen
its role. The protection of shareholders’ rights
benefits the company by attracting investors,
reducing the cost of capital, motivating
management by limiting their freedom, and
avoiding the risk of the use of funds in
unprofitable operations, or outside the control
of the minority shareholders, in search of
benefits by reference shareholders.
Limitations or restrictions to the exercise of
shareholders’ rights in Continental Europe
have negative effects, especially since there is
no tradition of proxy fight as there is in the
USA, where shareholders delegate their votes
to certain people or institutions with the com-
mitment of demanding changes in company
management. In Continental Europe, the
widespread delegation of voting in the banks
and in the board (chairman) destroys in
practice the board of shareholders’ capacity
to be controlled by shareholders.
Following this line of thinking, in the
summer of 1995, The Center for European
Policy Studies issued a new set of guidelines
for corporate governance standards in the
European Union (OEDE, 1998). Among the
principal recommendations were (Chew,
1997, p. 279): (1) one-share one-vote, unless
shareholders approve a dual class structure;
(2) an expansion of shareholders’ voting
rights including the right to vote on the
election of directors, dividends, capital
authorisations and company by-laws; (3) fair
treatment of minority shareholders in take-
overs; and (4) a greater use of outside direc-
tors capable of exercising independent
oversight.
We should place more importance on these
facts than on formal execution of the good
governance code, if we want to maintain the
competitive pressure in all markets, including
the market for corporate control and the
market for managers. Better market mechan-
isms and more information are necessary. We
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CORPORATE GOVERNANCE
need fewer morality speeches and less reg-
ulation, constraints that end up harming the
interests of those they aim to benefit; or, if
they are formally complied with, operate in a
way that is contrary to the spirit that
motivated their formulation or enactment
into law.
The most effective protection for share-
holders is to facilitate the exercise of their
rights: access to enough quality information
to evaluate company performance, active
participation in meetings, with stimulation
of voting rights and, perhaps, promotion of
the culture of the ‘proxy fight’. This might
start with institutional investors, whose in-
vestment is less mobile since its sale would
affect prices, and who face higher demands
for a more active role in control. Nevertheless,
as long as institutional investors are part of
the banking system in Continental Europe,
it is doubtful that they will act as leaders
of active shareholders. At this time, the dis-
cussion about comparative corporate govern-
ance, insider versus outsider systems, is still
open (Macey, 1998). The key to resolving it
lies not in the existence of institutional in-
vestors with controlling stakes but in the
market for corporate control, which provides
a form of continuous monitoring, unlike the
more episodic monitoring of institutional
investors. Moreover, it monitors all firms in
the market and not just those in which
institutional investors have a significant stake.
Hence, all firms are at risk of being taken
over.
The literature on corporate governance
indicates that the market for corporate control
provides for a broader, more effective and
more efficient form of monitoring. The litera-
ture also asks why institutional investors
should get involved in monitoring when they
could simply diversify their holdings, reduc-
ing risk. Moreover, it is not at all clear that the
skills required to manage an investment fund
are the same as those required to give good
advice to firms. If the two sets of skills are
different – as modern financial theory sug-
gests – then there are no synergies or scale
economies associated with having investors
actively involved in managing companies.
Hence, it is necessary to promote the func-
tioning of the market for corporate control to
facilitate the achievement of efficient cor-
porate governance in the face of core share-
holders and managerial defence measures
that limit the achievement of maximisation
of firm value.
However, change is not easy. In favour of
the transformation of the Continental Euro-
pean model towards the Anglo-Saxon model
we find: (1) the globalisation of markets and
# Blackwell Publishers Ltd 2002
CORPORATE GOVERNANCE MECHANISMS
the need to find governance models that
promote efficiency and enable competition
in the marketplace; (2) pressures from insti-
tutional investors for change towards the
Anglo-Saxon corporate governance system;
and (3) pressure for standardisation of in-
formation across companies for accessing
international capital markets. Against the
movement towards the Anglo-Saxon model
in Continental Europe we find: (1) difficulties
in changing legal systems and institutions;
(2) the political power of interest groups, such
as the German lobby, which limited the intro-
duction of the European Directive on take-
overs; (3) the culture of the stakeholder model,
linked to the Social Democrat ideology prev-
alent in Continental Europe; (4) political
pressure that limits change; and (5) dif-
ferences in development of countries and
markets, which limit homogenisation.
Conclusions
Corporate governance serves to create value
in the firm. Corporate governance mechan-
isms have been devised to facilitate the
control of management and groups of power
in the firm and facilitate the achievement of
maximisation of firm value. However, these
corporate governance mechanisms are far
from perfect. Their efficiency is limited by
tradeoffs between control of the firm and
protection of minority shareholders. More-
over, institutional differences in the broader
corporate governance system affect the rela-
tionship between the shareholder, the board
of directors and managers. The two main
systems of corporate governance, the Anglo-
Saxon system of market control, and the Con-
tinental European system of large-shareholder
control, have developed different ways to re-
duce the limitations; that is, active institu-
tional investors in the market control system
and codes of good governance in the large-
shareholder control system. However, an
analysis of the effectiveness of the Continental
European system in dealing with the en-
trenchment of managers shows that the large-
shareholder control system is limited in its
ability to control core shareholders and
managerial defences.
Hence, although codes of good governance
have been developed in these countries to
solve corporate governance problems, we
argue that rather than using these codes, the
Continental European countries should pro-
mote market development. In civil law
countries the codes of good governance can
be applied formally, following the letter but
not the spirit of the law, since they cannot
# Blackwell Publishers Ltd 2002
91
be legally enforced. Thus we contend that,
rather than extending the use of codes of
good governance in civil law countries, it is
necessary to expand the realm of action of
market control mechanisms, avoiding man-
agerial defences and core shareholders, to
facilitate the maximisation of firm value in the
market.
The paper has limitations. The discussion
has been conducted at a fairly high level of
abstraction; the Anglo-Saxon and Continental
European systems of corporate governance
have been studied as homogeneous systems.
However, there are differences across coun-
tries in the two systems that influence the
particularities of the operation of corporate
governance systems. Also, one has to consider
the difficulties involved in comparing and
studying the effectiveness of corporate gov-
ernance structures. The lack of homogenous
databases, the difficulty in identifying truly
independent directors, in measuring voting
powers and cash flow rights, and identifying
pyramids, makes this type of research diffi-
cult and truly laborious. Moreover, until
recently, the analysis has been centred on the
comparison of market control (Anglo-Saxon)
and large shareholder control (Continental
European) systems, with little reference to the
alternative systems of the aggregation of
multiple related shareholders that act as one
large shareholder in business group control in
Asia and Latin America. Further research on
alternative corporate governance systems and
their efficiency in control is required.
Despite the differences in corporate gov-
ernance systems, there seems to exist a trend
towards convergence. This convergence is not
only occurring in developed economies, but
also in transition economies, which are
adopting corporate governance mechanisms
as they develop their institutions, as well as in
developing economies, which face pressure
from international donors for more trans-
parent governance systems. This trend toward
convergence does not imply a movement
towards a single model of corporate govern-
ance, but a transition towards common guid-
ing principles of information, transparency
and accountability. Variation in national
contexts, especially in terms of legislation,
institutions the development of capital mar-
kets, concentration of ownership and separ-
ation of ownership and control, will sustain
differences in corporate governance and con-
trol systems. The degree of convergence
between models will depend on the political
influence of the interest groups affected, and
on the political ideology that tries to reenact
the stakeholder model in some European
countries.
Volume 10 Number 2 April 2002
92
Acknowledgements
This paper was developed while I was a
visiting scholar at New York University.
I would like to thank Ingo Walter, Director,
and Edward I. Altman, Vice Director of New
York University Salomon Center, for their
invitation and hospitality. The comments of
the anonymous referee and of Alvaro Cuervo-
Cazurra of the University of Minnesota and
Silvia Gómez Ansón of Universidad de
Oviedo helped to improve previous versions
of the paper. All errors remain mine.
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Alvaro Cuervo is Professor of Business
Economics at the Complutense University in
Madrid. His research interests include cor-
porate governance, privatisation and strategic
management. His current research focuses
on the role of the board of directors on the
corporate governance of the firm and privat-
isation, organisational changes and perform-
ance.
Volume 10 Number 2 April 2002