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Blackwell Publishing Ltd.Oxford, UK CORGCorporate Governance: An International Review0964-8410Blackwell Publishing Ltd. 2005 September 2005135CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXTCORPORATE GOVERNANCE

Corporate Governance in an International Context: legal systems, financing patterns and cultural variables*
Steven M. Mintz**
Corporate governance systems develop as a result of cultural underpinnings, legal structures and different forms of financing business. This paper describes these factors in the US and UK, two examples of strong shareholder ownership patterns of financing, and Germany, a country with a tradition of strong creditor financing. Recommendations are made for best practices in governance. Although enhanced governance mechanisms is a sound goal to pursue, the results may be meaningless unless internal controls are strengthened and top management and the board of directors establish an ethical tone at the top. Keywords: Convergence, corporate governance, culture, Sarbanes-Oxley

inancial statement fraud and asset misappropriations at companies such as Enron, WorldCom, Tyco and Adelphia illustrate the failure of corporate governance systems in the US. In each case, senior executives and board of director members did not live up to the legal standards of “duty of care” and “duty of loyalty”. According to the American Law Institute’s (ALI) Principles of Corporate Governance (1994, pp. 117–119), the former obligates top corporate officials “to act carefully in fulfilling the important tasks of monitoring and directing the activities of corporate management”, while the latter requires a commitment to place the interests of the corporation and its shareholders above self-interests and to “not use [one’s] corporate position to make a personal profit or gain other personal advantage”. In response to these and other scandals, the Sarbanes-Oxley Act (SOA) was adopted by


*This paper was presented at the 7th International Conference on Corporate Governance and Board Leadership, 11–13 October 2004, at the Centre for Board Effectiveness, Henley Management College. **Address for correspondence: Department of Economics, Claremont McKenna College, Claremont, 91711 CA, USA. Tel: 909-607-1572; E-mail: steven.mintz@

Congress and signed into law by President Bush in August 2002. The Act seeks to strengthen corporate governance systems in response to corporate failures. However, companies in the US complain that the cost of compliance exceeds the benefits of requiring, for example, the certification of financial statements by the CEO and CFO and internal control assessments. The average estimated cost of first-year implementation for large companies is upward of US$35 million. This is in large part due to the requirements imposed by the Public Company Accounting Oversight Board (PCAOB). PCAOB Standard No. 2 directs the auditor to perform a series of “walkthroughs” of transactions to assess internal controls. In short, it appears that the SOA may be a costly example of the many paying for the mistakes of the few. Early efforts to reform corporate governance systems in the UK and restore trust in the financial reports of UK companies
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Volume 13

Number 5

September 2005

in Brussels on 26 January (http://www. The first section briefly reviews on-going efforts to establish one set of international accounting standards. 6– 7). an Italian company. The forgery of a letter saying Parmalat. Following that. However. a Combined Code on Corporate Governance (Code) was adopted (2003) and it is now a securities listing requirement in the UK (http://www. accountability and board of director oversight (1992.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 583 occurred after the collapse of BCCI in the late 1980s. The final section presents concluding comments. Definitions of corporate governance and elements of an effective system are discussed in the following section. In the US. The value of international securities offerings in 2002 was nearly US$1. the approach is rule-based and can create a “tick-the box” mentality that works against complying with the spirit of governance requirements. UK and Germany. 4.2 trillion – or quadruple the level in 1991. a foreign company using accounting standards other than US In a speech to the Committee of European Securities Regulators (2004). In the US. there is a discussion of the cultural factors that provide the foundation for different systems of corporate governance. International accounting standards Existing SEC regulations require foreign companies that list their shares on US stock exchanges to prepare financial statements in accordance with accounting standards generally accepted in the US (GAAP) or with another comprehensive body of accounting standards such as the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). The paper primarily emphasises differences between the US and UK systems that are represented by strong shareholder ownership of equity and the German system that relies more on creditor financing. over 1300 foreign companies are listed on US stock exchanges. The purpose of this paper is to explore the differences in corporate governance systems that result from cultural variables and different methods of financing business operations. The collapse caused a financial panic spanning four continents and engulfing the Bank of England. Americans own more than US$1. Cross-border equity flows reached nearly US$320 billion in recent years. Next. Regulation No. must provide an audited reconciliation to US GAAP. © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 .ecgi. which is triple the number of listings in 1991. had US$4. The Committee investigated accountability of the board of directors to shareholders and society.4 trillion – up from US$300 billion in 1991. Ultimately. The goal is to better understand why corporate governance systems differ around the world and whether a narrowing of these differences is feasible or even desirable. Securities and Exchange Commission (SEC) Chairman William Donaldson noted the following facts as evidence of an increased level of integration of the world’s capital markets. The primary driver behind the significantly expanded use of IFRSs is a decision made by the European Parliament and the Council of the European Union (2002. and it was the impetus for the 1992 Report of the Committee on the Financial Aspects of Corporate Governance (Cadbury Committee). The paper proceeds as follows. 3. Differences between governance systems in the US and UK and in Germany exist in large part because the Germans rely more on bank financing for both equity and debt and a codetermination system of governance that emphasises the rights of employees in the governance process. A coordinated worldwide accountancy profession Efforts to coordinate global accounting standards have been on-going since the early 1970s. 2.useu. 5. especially in light of recent efforts to converge international accounting standards. shareholder and stakeholder theories that underlie the different corporate governance systems in the US and Germany are explained. Foreign holdings of US stocks are nearly US$1.html). The next four sections describe differences in corporate governance systems in the US. including IFRS.9 billion on deposit at Bank of America and the draining of company funds by top management led to a series of initiatives in the European Union (EU) to modernise corporate governance systems. The report and associated “Code of Best Practices” made recommendations to improve financial reporting. up from less than US$15 billion in 1990. pp. The following section identifies future considerations and recommendations are made to develop “best practices”. 1.5 trillion worth of foreign stocks. an increase from just US$279 billion in 1991. Regulators in the UK and EU utilise a principles-based approach to governance that incorporates a comply or explain requirement with mandatory disclosure when a listed company fails to follow governance

shareholders. and accountability of persons within the organisation. one of the top three priorities and among the top ten priorities. p. p. p. corporate governance principles must be part of the culture of an organisation. On 6 March 2005.584 CORPORATE GOVERNANCE 1606/2002) that all listed European Union companies (including banks and insurance companies) must prepare their consolidated financial statements in accordance with IFRS. suppliers and the community” (Hurst. These definitions imply that important elements of any governance system include compliance and accountability. 741) emphasises the separation of ownership and control in corporations. announced on 28 July 2003 ratings of 1600 global companies. To be effective. However. respectively. with Canada second and the US Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . 2003. The principles should emphasise conducting business and managing the company in a manner that promotes ethical and honest behaviour. If the EU decides that Japanese standards are not the equivalent of IASB standards. “many Japanese companies will have to revamp their accounts to maintain access to the EU”. While the results to date are mixed. GMI reported the UK scored highest among 23 nations. like clients. the SEC has identified a “roadmap” that aims to eliminate by 2009 the SEC requirement for foreign private issuers to reconcile financial statements prepared under IFRSs to US GAAP. Not all countries are supportive of EU efforts to harmonise accounting around the IASB standards. generally from 2005 onward. 6). There is no one generally accepted definition of corporate governance. a survey conducted by the Economist Intelligence Unit (2001. 18) that indicates 70 per cent believe the perception of good governance standards have a positive impact on stock prices and. The European Commission is assessing the difference between Japanese accounting standards and IASB reported the results of the most recent governance survey. an independent governance ratings agency. compliance with applicable laws and regulations. in a related question. defined it as “the system by which companies are directed and controlled”. A fairly narrow definition of corporate governance given by Shleifer and Vishny (1997. In response to calls for measuring good governance. effective management of the company’s resources and risks. rate corporate governance as a top priority in their organisation. Only 23 per cent indicate it is not a priority (Economist Intelligence Unit. it was reported by the Financial Times (Jopson. For example. where more than 20 Japanese companies trade. The importance of good governance to share prices can be seen in the results of a survey of 310 international executives by the Economist Intelligence Unit (2003. chaired by Sir Adrian Cadbury (1992). p. On 8 December 2004. p. financialexpress. the IASB and US Financial Accounting Standards Board announced on 29 October 2002 their joint commitment to achieving real convergence between their respective accounting standards by 2005. They define corporate governance as dealing with “the ways in which the suppliers of finance to corporations assure themselves of getting a return on their investment”. The foundation of corporate governance systems Corporate governance is part of the vast field of business ethics that “addresses the entire scope of responsibilities that a company has to each of its stakeholders: those who have a vested interest in the decisions and actions of a company. their role as corporate leaders is to set the appropriate ethical tone for the company and communicate these principles throughout the organisation. 2004. 2004) that Japanese companies will not change to international standards because of the cost. employees. the Financial Express (http://www. Governance Metrics International (GMI). Once the board of directors and executive officers have agreed on the principles. These responses are consistent with the finding that 8. Following the adoption of the resolution in 2002. The Cadbury Committee. 32 and 37 per cent. they fail to include the ethics of an organisation and the tone set by top management and the board as integral parts of establishing a culture that promotes open and honest communication between all parties involved in governance and an accountability system that ensures compliance. 2) indicates that more than 80 per cent of European and US institutional investors say they would pay more for companies with good governance. 20). The threat to pull their stock listings might create a problem for the London Stock Exchange. The OECD in its Principles of Corporate Governance (2004) took a broader perspective describing corporate governance as “a set of relationships between a company’s board. Various survey results in the early 2000s indicate that the investment community is willing to pay more for a company with strong and effective corporate governance policies. its shareholders and other stakeholders”. 79 per cent state that a negative impact will occur if the perception is poor.

According to the Employee Benefit Research Institute (Smith. Shareholder versus stakeholder theories Agency theory maintains that shareholders receive returns only after other corporate claimants have been satisfied.3 million shares for US$123. Employee ownership in the US and the growing use of employee stock options. A basic assumption is that managers are likely to place personal goals ahead of corporate goals. Japan and Greece ranked at the bottom of the country ratings. She believes that economic sovereignty evolves and should include employees and the community. agency costs also arise whenever there is an “information asymmetry” between the corporation and outsiders because insiders (the corporation) know more about a company and its future prospects than outsiders (investors) do. These incentives aim at encouraging managers to maximise the value of shares. On this view. pp. shareholders have a claim on the corporation’s residual cash flows. Agency costs can occur if the board of directors fails to exercise due care in its oversight role of management. The market dominance wielded by employee pension funds. corporate governance also implicates how the various constituencies that define the entity serve. over 12. thereby allowing top executives to “hype” the company’s stock so that employees would add it to their 401(k) retirement plans. Ken Lay.4 million. this occurs by creating longterm compensation packages and by the possibility to issue stock options related to the firm’s stock price. implicit or explicit “contracts”) to © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 . The shareholder model of corporate governance that underlies the discussion in the next section relies on the assumption that shareholders are entitled (morally. 1–7). According to Hawley et al. not merely legally) to direct the corporation because their capital investments provide ownership rights that are an extension of their natural right to own private property. resulting in a conflict of interests between stockholders and the management itself. followed by Australia and Ireland. Since the shareholder’s claim is consistent with the purpose of the corporation to create new wealth. 3. Enron’s board of directors did not properly monitor the company’s incentive compensation plans. 2001). In other words. the report date. p. which represent at least potential employee voice in corporate governance.000 Enron employees experienced massive losses in their retirement accounts. As that stock value fell from more than US$90 per share to under 50 cents. However. Overcoming the agency problem The agency problem can never be perfectly solved and shareholders may experience a loss of wealth due to divergent behaviour of managers. German companies adhere to a stakeholder model. Kelly disputes the notion that “capital providers – stockholders – lay claim to most wealth that public corporations generate”. While this occurred the former CEO. effectively align the behaviour of managers (agents) with the desires of the principals (owners). According to Kelly (2003. sold about 2. She points out that equity investments reach a public corporation only when new common stock is sold and that most investment dollars do not go to corporations but to other speculators (2003. The practice of codetermination in Germany that guarantees board seats to employees. (1999). the desires and goals of management and shareholders may not be in accord and it is difficult for the shareholder to verify the activities of corporate management. almost 58 per cent of the assets of Enron’s 401(k) plan was invested in company stock.. It considers corporate governance to be more than simply the relationship between the firm and its capital providers. 2. While the shareholder model historically has been followed in the US. This is often referred to as the agency problem. 2002). 91) the beginnings of such structures can be seen in the following ways: 1. In general. and are served by. Jensen and Meckling (1976) demonstrate how investors in publicly traded corporations incur (agency) costs in monitoring managerial performance. the central problem in corporate governance then becomes to construct rules and incentives (that is. Investigations by the SEC and Department of Justice of 20 corporate frauds that are reported on the SEC’s website indicate that US$236 billion in shareholder value was lost between the time the public first learned of the fraud and 3 September 2002. the corporation. Typically. agency theorists reason that corporate directors are singularly accountable to shareholders (Brickley et al.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 585 third. and the shareholders are allegedly at greater risk than other claimants. One of the most common approaches to the problem is to tie managerial compensation to the financial performance of the corporation in general and the performance of the company’s shares.

among others. they are “complementary and mutually beneficial”. the United States and United Kingdom Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . then management should be rewarded for their performance and for helping to control agency monitoring costs. such as creditors (to remain solvent so as to repay debts) and to employees (in the management of a pension fund)” (1994. As the recent scandals indicate. top executives at Tyco used hundreds of millions of dollars from interest-free loans for personal purposes. He believes that employee involvement in corporate governance can work as a potentially powerful additional mechanism to control managerial opportunism and to direct the corporation towards greater efficiency. p. For example. directors are owed not to shareholders but to the corporation as an entity with interests of its own.586 CORPORATE GOVERNANCE Financial reports as a monitoring device The financial reports can be used to mitigate the conflict between owners and managers posited by agency theory. which can. This “enlightened self-interest” position has been expanded upon by others (Donaldson and Preston. and Vishny (LLSV) in 1997 redefined the analytical framework for comparative research of corporate governance by introducing an integrated approach to finance and law. the success of a corporation is not merely an end in itself but should also be seen as providing a vehicle for advancing the interests of stakeholders other than shareholders. LLSV (1997. on occasion. When employees perceive that the CEO and board condones the use of company assets for personal purposes. 1995. 1993) who believe that the interests of stakeholders have intrinsic worth irrespective of whether these advance the interests of shareholders. The auditors fail in their oversight role when they ignore management’s manipulations of the financial statements or its unauthorised use of company resources. and employee involvement in quality circles. however. even the best internal control system will fail if top management overrides the controls or the directors turn away from their responsibilities. He identifies three approaches: employee share ownership. Management has a stewardship responsibility to protect company assets. public companies must hire independent auditors to render opinions on the fairness of the presentations in the financial statements. Cultural dimensions that underlie corporate governance Research conducted by La Porta. electing employee representatives to the board of directors. If owners perceive that accounting reports are reliable. 13) supports employee governance as a way to ensure that corporations are governed in part in the interests of employees. He also believes that their respective forms of governance support the needs of each group “to protect their firm-specific assets and to satisfy their risk preferences”. Under this perspective. The strength of shared governance is that “the two groups make decisions on matters where they have superior information and an incentive to increase the value of the firm”. Boatright (2004. Lopez-deSilanes. Shleifer. Instead. This paper focuses on common law countries that include. work councils or the like. Stakeholder theory Freeman’s (1984) seminal book on stakeholder theory posits that successful managers must systematically attend to the interests of various stakeholder groups. as was the case in all of the aforementioned accounting scandals. conflict with those of shareholders. 1131–1132) advocated what they call “the legal approach” as the preferred way to understand corporate governance. p. pp. While the management is responsible for the preparation of the financial reports. Evan and Freeman. 403). They cast new light on the connection between investors’ legal rights in each country and the structure of capital markets and corporate finance in that country. Internal controls An important component of internal control is the processes in place to safeguard company assets. 16) addresses whether employee governance conflicts with shareholder governance and concludes these two forms of governance are not conflicting. Further. The board claimed to have been uninformed about the nature and purpose of the loans. p. a culture can develop that fosters self-interested behaviour to the detriment of those who have the most at stake – shareholders and employees. Employee governance McDonnell (2002. Boatright (1994) suggests that the shareholder–management relation is not unique because the fiduciary duties of officers and Linking laws and financial structures The legal approach groups countries according to legal families. “corporations have some fiduciary duties to other constituencies.

such as mutual funds and pension funds. The financing patterns in different countries emphasise different stakeholders in the corporate governance process. The results were statistically analysed for 40 countries. This dimension deals with the extent to which the members of a society accept that power in institutions is distributed unequally. This dimension concerns the relationship between individual and group. Weak uncertainty avoidance societies maintain a more relaxed atmosphere in which practice counts more than principles and deviance is easily tolerated. Cultural foundations Recent research conducted by Licht et al. The four dimensions of culture are described in Exhibit 1. Masculinity versus Femininity. pp. for example. p. by determining whether the welfare of individual shareholders is seen as the focus of governance efforts. 36). on average. The culture of a country influences corporate governance. Cultural regions and corporate governance regimes Licht et al. as major holders of public equity.1 The Organization for Economic Cooperation and Development (OECD. as in the US and UK. This dimension deals with the social implications of gender. People in small power distance societies strive for power equalisation and demand justification for power inequalities. Strong versus weak Uncertainty Avoidance. refer to the culture of a country as a “set of common ideas. whereas in the US most funds are raised through public capital markets. 12) provides a basic working definition of culture that it is “the collective programming of the mind that distinguishes the members of one human group from another”. while femininity emphasises relationships. regions differentiated by cultural profiles differ systematically in investor or creditor protection. Exhibit 1: Hofstede’s cultural variables Individualism versus Collectivism. assertiveness and material success. it is not surprising that corporate governance issues in Germany traditionally emphasise the role of banks. 22–23) investigate whether.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 587 and civil or code law countries that include Germany. operate. (2004) makes the case for the importance of cultural foundations that underlie the laws in different countries to establishing corporate governance practices. Table 1 summarises the scores and rankings on cultural variables. Large versus Small Power Distance. clan or other in-group to look after them in exchange for unquestioning loyalty. while the US emphasises the conflict between shareholders and corporate executives that may be affected by the increasing importance of institutional investors. (2004. caring for the weak and interpersonal harmony. heroism. Roberts et al. p. The more market-oriented economies of the US and UK score relatively high on being individualistic societies compared to Germany and the former tolerate uncertainty more easily. Masculinity stands for preference in society for achievement. For example. The results are measured using two indices constructed by LLSV: (1) the anti-director rights index and Cultural dimensions Hofstede (1984) surveyed over 116. economic and cultural circumstances. People in large power distance societies accept a hierarchical order in which everybody has a place which needs no further justification. Therefore. Hofstede (1984. It refers to a preference for loosely knit social relations in which individuals are expected to care only for themselves and their immediate families versus tightly knit relations in which people can expect their relatives.000 respondents in 50 countries and three regions and developed four cultural dimensions to describe how a society and its institutions © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 . Uncertainty avoidance is the degree to which members of a society feel uncomfortable with uncertainty and ambiguity. codes of belief and behaviour and are intolerant of nonconformists. The need to take culture into account in comparative corporate governance analysis is seen by the actions of large institutional investors that find it necessary to adopt culture-sensitive corporate governance principles for the major foreign markets in which they invest. or employee groups take on a more important role. Strong uncertainty avoidance societies maintain rigid rules. beliefs and values that are shared by the members of a group of individuals” (2002. 2004) adopted non-binding principles of corporate governance that recognise the need to tailor the systems to varying legal. in Germany corporations rely heavily on bank loans for external financing. The reasons why countries belong to a particular legal family range from voluntary adoption decades or centuries ago to forced imposition by past colonial powers. modesty.

25) indicate that common law regimes grant a higher level of anti-director rights to minority shareholders than cultural regions in which the dominant legal origins are code law. A description of the two indices appears in Exhibit 2.588 CORPORATE GOVERNANCE Table 1: Scores and rankings on Hofstede’s cultural variables Individualism versus collectivism Large versus small power distance Strong versus weak uncertainty avoidance Score 65 35 46 Rank 20 34/35 31 Low nurture (masculinity) versus high (femininity) Score 66 66 62 Rank 8/9 8/9 13 Score Germany UK US 67 89 91 Rank 15 3 1 Score 35 35 40 Rank 29/30 29/30 25 (2) the creditor protection index. They also note a positive correlation between individualism and anti-director rights. there are three main committees that support the work of the board of directors of Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . The relatively high ranking of creditor protection in Germany as compared to the US might be explained by the emphasis on creditor financing of German corporations. the US ranks relatively low compared to Germany and the UK ranks higher than Germany. While there are virtually no differences in levels of creditor protection among cultural regions. (2004. This result seems consistent with an emphasis on equity financing in Anglo-Saxon countries and the greater reliance on individual initiative. The latter measures creditor rights by evaluating how the law protects the legal rights of creditors when debtors default on their obligations. One-share-one vote Proxy voting by mail Shares blocked before shareholder meeting Cumulative voting for directors Oppressed minority Pre-emptive rights to new issues Percentage of capital needed for extraordinary meeting Anti-director rights (sums previous variables) Mandatory dividend The creditor protection index: Measures creditor rights by evaluating how the law protects the legal rights of creditors when debtors default on their obligations. Restricts reorganisation No automatic stay on assets Secured creditors paid first Management does not stay in reorganisation Creditor rights (sums previous variables) Legal reserves required as a percentage of capital Relationship between cultural variables and rights Licht et al. The authors also found that high scores on creditor protection rights correlate negatively with uncertainty avoidance. (2004. 34–42) found that antidirector rights correlated negatively with uncertainty avoidance. This could be explained by the uncertain environment created when a variety of creditor rights are emphasised instead of focusing on shareholder rights as might be the case in a corporate reorganisation or bankruptcy. Exhibit 2: LLSV Corporate Governance Indices Anti-director rights index: Measures shareholder rights by determining how strongly the legal system protects minority shareholders against managers or dominant shareholders. pp.2 This implies that the greater rights granted to minority shareholders in common law countries create more uncertainty in the business environment. a finding to be expected since those rights support the importance of individual shareholders in dealing with managers or dominant shareholders. The findings of Licht et al. The former measures shareholder rights by determining how strongly the legal system protects minority shareholders against managers or dominant shareholders. p. Corporate governance reforms in the US Typically.

Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act imposes additional obligations on top management and the board of directors. the SEC recently delayed the implementation date for foreign issuers under Section 404. other than for service on the board.” The SEC eliminated a potential conflict for German companies by allowing non-management employees to serve as audit committee members. especially when these employees actually represent non-management interests” (Atkins. and as not being an affiliated person of the issuer or any of its subsidiaries. and that all significant deficiencies in internal controls have been disclosed to the auditors and audit committee. SEC Commissioner Paul S. shareholders. chairman of BT. or other compensatory fee from the including the audit committee. Foreign registrants will have until the first fiscal year ending on or after 15 July 2006 to comply. Sir Christopher Bland.6 million to comply with the legislation (Maitland. Audit committee independence Each member of the audit committee of the board must be independent of the public company defined by the Act as: “Not receiving. The following describes the most important provisions of the Act and the implications for foreign company registrants that have to comply with the Act.kodak. the only way a foreign company with US shareholders can officially withdraw from US regulatory oversight. The nominating committee of the board in most US companies has assumed the responsibility of reporting on corporate governance practices. Atkins. Since similar certification requirements do not exist in the EU. in all material respects. German corporate governance Historically. the top officials of all non-US companies are expected to comply with this requirement. noted that while these employees would often not meet the SEC’s definition of independence.3 An exception is Eastman Kodak Company that on 30 July 2002 appointed the company’s first Chief Governance Officer and created a Corporate Responsibility and Governance Committee to oversee Kodak’s corporate governance efforts.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 589 a public corporation in the US. nominating committee and the compensation committee. Assessment of internal controls According to Section 404 of the SOA. In response to increased criticism by foreign companies. any consulting. a UK company that is listed in the US. does not believe compliance with the SOA for foreign companies is money well spent and that the US has gone too far. there appears to be no basis to find a common ground between the approach of the US and the EU on this issue. For example. some European companies are considering withdrawing their securities from US stock exchanges and deregistering with the Securities and Exchange Commission (SEC). the Commission “has no interest in creating conflicts with local law. he said delisting was out of the question because BT has “American shareholders and US dollardenominated bonds”. screening and recommending candidates to the board for board membership (http://www. in a speech to the 2nd German Corporate Governance Code Conference on 26 June 2003. the most costly provision of the SOA that requires compliance with provisions related to internal control over financial reporting. However. 2004). British Telecom (BT). managers and employees in the interests of © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 . the operations and financial condition of the company. advisory. The high cost of compliance with the SOA affects not only US companies but also foreign companies listing their stock in the US. the German system of corporate governance emphasised cooperative relationships among banks. In reaction to the high cost of compliance with the SOA and the belief that additional regulation is unnecessary. 2004) that German e-commerce software firm Intershop Communications AG had completed an eightmonth process to deregister its securities. management should make an assessment of internal controls and disclose its findings in an “internal control report”. it was reported in the Wall Street Journal on 20 September 2004 (Ascarelli. reported on 23 November 2004 that it was costing the group US$18. that the statements fairly present. and it strengthens the role of the audit committee in corporate governance. 2003). The auditors must attest to and report on management’s report including the effectiveness of the framework used to make the assessment. including identifying. boards. a 16-month delay past the original implementation date February 2004. Financial statement certifications Under Section 302 of the SOA. the CEO and CFO must certify in a statement that accompanies the audit report: the appropriateness of the financial statements and disclosures. Indeed.

banks gain valuable information that might not be available to other stakeholders. When a bank also is a shareholder of the borrower. According to Siebert (2004). the German Justice Ministry issued the Corporate Governance Code (http://www. there is no guarantee that a company will disclose everything to the bank and that the bank will use the information wisely as the Parmalat scandal demonstrates. consists of non-management members and it appoints. this information helps to determine whether the need for external funds is due to temporary illiquidity or bad firm management. One advantage of bank involvement is that it mitigates problems stemming from information asymmetries. supervises and advises the members of the Management Board on policy but does not participate in the company’s day-to-day management. a bank might encourage borrowers to assume more debt. A possible downside is that banks may emphasise their creditor relationship with the borrower to the detriment of shareholders. Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . Work councils have extensive participation rights and employees are represented in the corporate boardroom. Typically. In relying on a two-tier structure. The Supervisory Board (Aufsichtsrat). Germany has formalised the distinction between managing the company and supervising the management of the company.4 per cent in the US. the Code does recommend that the Supervisory Board should set up an audit committee. there are cross holdings between banks and other financial intermediaries in Germany such as insurance companies that together own nearly a quarter of the shares. Schmidt (2003.5 per cent of the shares of German public companies whereas they owned only 3. pay higher interests Codetermination Germany has a strong employee codetermination programme. employee representatives (either company employees or union representatives chosen to represent employees) make up half of the representatives of the Supervisory Board. an emphasis on individualism supports the focus on investor rights and related agency considerations. both the Supervisory Board and the Management Board must declare annually whether these recommendations have been met and the disclosure must be made available to the shareholders. The Management Board must state in the notes to the financial statements that the compliance statement has been given and made available to the shareholders (Institut der Wirtschaftsprufer. for the emphasis in Germany on collective responsibility in managing a company. that establishes recommendations which go beyond legal regulations. In the US. The latter accounts. A relatively strong emphasis on uncertainty avoidance and high collectivism underlies the system. financial reporting and disclosure in Germany. especially the big commercial banks such as Deutsche Bank and Dresdner Bank. The Management Board (Vorstand) is charged with managing the enterprise for the benefit of a wide array of interests. The willingness to tolerate higher levels of uncertainty in society seems to provide the basis for the flexible system of GAAP in the US as compared to the more rigid approach to accounting. by the end of the 1990s banks owned 13. The role of banks Banks in Germany frequently exert control by directly participating in the management of their borrowers through representation on a borrower’s supervisory board. often those of the company’s founder. The first are shareholders that own large blocks of stock (25 per cent or greater) that give it the power to veto important decisions. Under the “comply or explain” principle. The second group of blockholders is wealthy families. Moreover. For example. The third are financial institutions. at least in part. On 26 February 2002. The most likely “blockholder” is another business enterprise. 9–11) identifies three groups of powerful and influential stakeholders on the supervisory board.590 CORPORATE GOVERNANCE labour peace and corporate efficiency. Through the extensive information gained from their lending activities. pp. 2003).ebundesanzeiger. Shareholder participation The German system of corporate governance builds on insider relationships while the US system relies on external participation. Board of directors The distinguishing characteristic of German corporate governance is the two-tier board of directors system. whose members are elected by the shareholders at the annual meeting. While German companies are not required to have audit committees. Banks also represent a larger share of equity investors in Germany than in the US.

4 this section will focus on corporate governance initiatives in the UK that differ from those in the US. or undertake less risky projects than would be optimal from the point of view of shareholders. Jackson et al. and agreed by the board. The result may be to exert financial market-type pressures on the corporate governance system creating conflicts between the interests of public investors and German cultural traditions. oversee the regulatory activities of the professional accountancy bodies. . 23). Led by the senior independent argue this might not be the case “because work councils may work in coalition to promote greater accountability and thereby actually decrease agency costs by monitoring managerial pay. The chair of the board should meet with non-executive directors without the executives present. Linking corporate governance and cultural differences Supported by the cultural variable of collectivism as opposed to individualism that marks decision-making in the US. Moreover. p. the historical reliance of German companies on creditor financing and bank participation through shareholdings supports high uncertainty avoidance in that banks can use their greater knowledge to guide the entity away from more risky endeavours that might enhance value for shareholders in countries like the US. The greater reliance on creditors for financing German companies supports the higher creditor protection index in Germany as compared to the US. . The following is a list of requirements that differ from those enacted in the US. fighting for transparency . an independent regulator. the non-executive directors should meet without the chair present at least annually to appraise her performance and on such other occasions as are deemed appropriate. 2.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 591 rates on their debt. A PCAOB-type regulatory board. the Germans rely on a consensus approach to decision-making primarily through the efforts of the supervisory board. Privatisation of state-held ownership interests in companies such as Deutsche Telekom and the maturing of family-owned companies’ need for capital have led to growth in the number of shareholders (both domestic and foreign) in German companies from 3. While one might expect Germany’s emphasis on employee rights in corporate governance to increase agency costs. 41). 1. The Code was revised in 2003 following the Higgs Review of the role and effectiveness of non-executive directors and the Smith Review of audit committees. © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 .org. 2004. Compliance with this Code is a Stock Exchange requirement. The division of responsibilities should be clearly established. were expanded in the aftermath of accounting scandals in the US. This increase in shareholding and the participation by individuals directly or through intermediaries such as pension funds is expected to continue in the future. Recent changes in corporate governance in the UK Given the similarities in legal system between the US and UK. The Parmalat fiasco notwithstanding. In the UK a series of reports followed the Cadbury Committee recommendations for disclosure of directors’ emoluments and led to the issuance of The Combined Code on Corporate Governance in 1998. the Professional Oversight Board for Accountancy (POBA). such as collectivism in decision-making and uncertainty avoidance. p. and also siding with shareholders in corporate restructuring” (2004. The roles of the chair and CEO should be separated. employee participation informs decision-making through representation on the supervisory board and the influence of works councils on management board functions. set out in writing.asb. was formed to support the work of FRC. The resulting broadening of the shareholder base in German companies has created a subtle shift towards an equity culture. 3. The role of POBA is to provide independent regulation of the auditing and accountancy profession (http:// www. and promote high standards of corporate governance. These responsibilities now include to: coordinate regulation of accounting and auditing standards. The structure of regulation in the UK changed when the responsibilities of the Financial Reporting Council (FRC). Trend toward equity financing Recent trends indicate an increased reliance by German companies on equity financing through both domestic and international capital markets as a result of increased crossborder merger and acquisition activity.2 million at the end of the 1980s to about twice that amount today (Siebert. regulate the audit function.

Future considerations and recommendations: convergence of corporate governance systems Even though a great deal of progress has been made on the convergence of international accounting standards. UK directors have responsibilities that. A foreign issuer with an exemption must disclose in its annual reports filed with the SEC each requirement from which it is exempted and describe the home country practice. If disclosure is made only on its website. followed by the company in lieu of these requirements. The causes of differences in corporate governance are deep rooted and any attempt to create a “one size fits all” model is likely to fail. The mechanism means that a company should comply with the code or explain why it cannot. A foreign private issuer also must disclose. Mallin points out that the “Cadbury Report recommends a ‘Code of Best Practice’ with which boards of listed companies registered in the UK should comply. The new standards narrow the differences between corporate governance standards in the US and UK as a result of the adoption of the following. The CEO must promptly notify the NYSE and Nasdaq in writing after any executive officer becomes aware of any material non-compliance with the corporate governance standards. Non-management directors must meet at regularly scheduled executive sessions without management. Inc. 8. 1. The disclosure provides detailed information about any instances of non-compliance and enables investors to decide whether the company’s non-compliance is justified (2004. excluding the chair. 2. if any. the SEC approved new corporate governance standards for listed companies as proposed by the New York Stock Exchange (2003) and the Nasdaq Stock Market. (Nasdaq). either on its website or in its annual report to shareholders. should comprise non-executive directors determined by the board to be independent. it is not practical to expect convergence of corporate governance systems.592 CORPORATE GOVERNANCE 4. The Nasdaq takes a different approach in providing an exemption to a foreign private issuer if the listing requirements are contrary to a law. 7. are the sole purview of management including the preparation of financial statements and review of internal controls. The senior independent director should be available to shareholders if they have concerns that have not been alleviated by top company officials. The Listing Rules require a Corporate Governance Report to be included in the annual report and there must be a “Statement of Compliance” whether the company meets the provisions of the Combined Code on Corporate Governance. The new standards enhance corporate governance requirements by requiring each listed company to adopt corporate governance guidelines and publish them on its website. listed companies that are foreign private issuers are permitted to follow home country practice in lieu of the NYSE corporate governance standards. except to the extent such an exemption would violate US securities laws. Narrowing the differences in corporate governance between the US and UK: improved corporate governance standards of the NYSE and Nasdaq On 4 November 2003. In a concession to the general notion that home country standards should take precedence over conflicting listing requirements in the US. rule or regulation of any public authority with jurisdiction over the company or to generally accepted accounting principles in its home country. The problem is illustrated in Table 2. in the US. The board should appoint one of the independent non-executive directors to be the senior independent director. pp. The CEO of each listed company must certify to the NYSE annually that s/he is not aware of any violations by the company of the corporate governance standards. p. a brief summary of the significant differences between the NYSE’s corporate governance standards and those of its home country. except for audit committee requirements and the required notice to the NYSE of material non-compliance with corporate governance standards. Shareholders should be invited specifically to approve all new long-term incentive arrangements and significant changes to existing schemes unless prohibited by the Listing Rules. Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . the annual report must state that the information is available on the website and provide the website address. 21–22). At least half of the board. 5. The board of directors of a listed company must consist of a majority of independent directors. and utilizes a ‘comply or explain’ mechanism” (2004. 6. 22).

the audit committee should encourage the external auditors to bring all matters of concern out in the open. For example. Best practices Enhancing board independence To enhance the independence of the corporate governance system. While agreement can be reached to narrow differences in countries such as the US and UK that follow similar systems. This elevates corporate governance to the same level of importance as financial statement certification by the CEO and CFO. from chairman of the board of directors. a more productive suggestion is to encourage US regulators to take a fresh look at the growing importance of employees and employee stock ownership in the US. Indeed. To create an ethical corporate culture and foster integrity in the financial reporting system. including creditors and employees. the comply or explain principle followed in the UK and Germany provides better protection for the public as a non-compliant com- Separate meetings with the audit committee Notwithstanding the NYSE requirement that non-management directors should meet regularly without the presence of members of management. Some US companies have already moved in this direction perhaps out of necessity as evidenced by Disney’s separation of the role of its CEO. Corporate governance compliance statement The Listing Rules in the UK require a statement to be included in the annual report relating to compliance with the Combined Code. the internal auditors should © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 . the auditors are more likely to bring their concerns to the audit committee if management is not present. The external auditors also should meet separately with the audit committee. the audit committee needs to know about it as soon as possible since the integrity of the financial reporting process is at stake. management should not even be told about the meeting in advance as they might fire the auditors. if the external auditors have been pressured by management to go along with questionable accounting practices. Michael Eisner.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 593 Table 2: Factors underlying the convergence of corporate governance systems Country Legal family Predominant Key cultural variables Emphasis on Structure source of protecting of board of funds directors Uncertainty Individual shareholder vs creditor avoidance vs group rights Individual Shareholder Group Creditor Unitary Two-tier US/UK Common law Stockholders Low Germany Code (civil) law Creditors High Any attempt to move towards the convergence of corporate governance systems on a worldwide basis should be viewed in the context of the different laws. the internal auditors must be free to openly discuss matters of concern with the audit committee of the board. financial markets and the cultural variables that underlie governance systems. The new NYSE listing requirements close a major gap that exists in the SOA by requiring listed companies to publish their corporate governance guidelines on their website and for the CEO to certify annually compliance with the guidelines. Rather than debating the question of whether a shareholder-oriented system is better than one that recognises the interests of a variety of stakeholders. the roles of the chair of the board of directors and CEO should be separated. these employees not only put their jobs on the line for the company but often have their retirement money vested in company stock and they might provide investment funds through employee stock ownership plans. if a situation arises where management overrides internal controls or fires an employee for whistleblowing. as evidenced by adoption in the UK of the POBA. it is less likely that similar results can be achieved in the US and Germany. After all. also meet separately with the audit committee. For example. In comparison with US requirements. To fulfil its responsibilities to create a more ethical corporate culture.

The primary responsibilities of the board would include: a. 2. and b. institutional investors such as Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . However. Other members should be independent of management. In the US. any other form of compensation or business relationship with top executives that might qualify as a related party transaction. establish committees as needed to carry out these and other responsibilities including the audit committee. and any important communications with internal auditors and the external auditors. report to the supervisory board the profitability of the business particularly the return on equity. These would be informational items to remind the public of top management’s responsibility for the accuracy and reliability of the financial statements and the company’s corporate governance system. review and approve accounting principles and the financial statements. review and approve the financial statements and management’s report on internal controls. including the CEO. d. This brings into question the transparency of corporate governance regulations in the US. and e. b. 3. CalPERS and other influential shareholders have become more active in seeking a stronger role in the director nominating process. In response to concerns about the size of executive pay packages. monitor the internal control system including risk assessment. evaluate management’s performance and determine management remuneration. c. An independent member of the board should serve as its chair. Where the board does not accept the audit committee’s recommendation on the appointment. Management’s report on internal controls. Two-tier board Another complex issue not addressed in the paper is shareholder democracy. reappointment or removal of an external auditor. its oversight of the financial reporting process and internal controls. Executive Board: Representation on the executive board should consist of members of top management. This also is an informational item since the report would appear elsewhere in the annual report. but it is not necessarily reported to the public either on the company’s website or in its annual report. 1. 2. Supervisory Board: a. the SOA does identify at least two issues that should be addressed: a. One way to strengthen the shareholders’ participation in corporate governance is to establish a dual board system such as the one that exists in Germany.594 CORPORATE GOVERNANCE pany must disclose the reasons for noncompliance. work with the external auditors on matters relating to the financial reports and internal controls. 6. There should be a separate section (or report) describing the work of the audit committee in discharging its responsibilities to include the independence of committee members. and human resource issues. 5.5 The following provisions should be addressed in the compliance statement. Putting aside the systemic issue of employee governance. 4. the audit committee should explain the recommendation and the reasons why the board has taken a different position. and that board would appoint (and dismiss) the executive board as explained below. financial and investment activities. unless it chooses to do so. 1. An explanation of why the company has not adhered to any of its own corporate governance policies (comply or explain). whether there have been any loans to top executives during the year. CFO and chief operating officer. While shareholders rights in the US rank high on LLSV’s anti-director rights index. c. nominating committee. To overcome this deficiency. b. review and approve the corporate governance compliance report. the SEC should require that a public company provide a compliance statement in its annual report. the shareholders have very little right to become actively involved in overseeing how the company operates. report to the supervisory board on operational strategies and major questions about corporate planning. such information may be submitted to the NYSE. The complex issue of management compensation is beyond the scope of the paper. The shareholders could be allocated a number of seats on the supervisory board. Certification of the financial statements and corporate governance policies. remuneration committee and a separate corporate governance committee. the following discussion briefly outlines how the responsibilities of the board of directors might be changed to accommodate a two-tier system that supports shareholder rights. d.

for example. This includes a complicated and costly internal control assessment that has met with some resistance from US companies and bewilderment on the part of foreign companies that register their securities in the US.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 595 e. making it difficult for a non-compliant company to de-list from the exchange. even though it allows foreign issuers to follow home country governance standards. The “comply or explain” approach in the EU allows for judgement on how to comply with governance global/ or US company for that matter. and restricting the ability of corporate officials to approve self-serving actions that might be detrimental to the best interest of investors and the public good. 4. it still does not ensure that the financial statements are free of material misstatement and the internal control system is operating as intended. and Germany. This can only occur if top management and the board establish an ethical environment in the organisation. then why require the disclosure of differences? Of what value is this information to a US investor? It is unrealistic to expect that a US investor might not hold on to the stock of a foreign issuer because its home country governance standards are not “acceptable”. the results are discussed based on the predominant direction of these indices. The EU experience with failures at BCCI and Parmalat brought to light weaknesses in member countries’ corporate governance systems. the process may be costly and resentment may grow as foreign companies question the right of the SEC to force compliance while.calpersgovernance. strengthening the oversight of financial reporting by the audit committee. Perhaps this is the wrong goal to pursue. For simplicity.asp. with the exception of audit committee requirements. at http://www. 3. The NYSE listing rules expand on these requirements to include meetings of non-management directors without the presence of management and the certification of corporate governance governance_principles.html). A good place to start is to develop a set of governance principles that foster behaviour in compliance with the spirit of the SOA and NYSE listing requirements. Notes 1. See. one that promotes integrity. Acknowledgements The author wishes to thank Joshua Rosett. for example. New requirements imposed on public companies include: increasing the number of independent members on the board. top management and board members may pursue their own self-interests to the detriment of the shareholders and employees. at the same time. Eastman Kodak. After all. See. Some companies in the US. developing effective communication links between the external auditor and the audit committee. whereas in the US mandatory reporting is required. requiring the CEO and CFO to certify the financial statements and internal controls. For a discussion of these issues. report to the supervisory board on business development. As we discovered in the various scandals. While new regulations can impose penalties for violating governance standards. have voluntarily chosen to include a compliance statement by the chief governance officer that reports whether the company’s governance practices are consistent with legislative and regulatory requirements and the company’s own governance principles and policies. 5. accountability and transparency. Global Corporate Governance Principles. If the use of home country standards is acceptable. complies with all the governance standards that exist locally and internationally. We may never achieve true convergence of corporate governance systems given the differences in underlying financing and cultural variables in countries such as the US and UK. Conclusions The Sarbanes-Oxley Act began the process of evaluating corporate governance mechanisms in the US. see Nobes and Parker (2002) and Roberts et al. the Governance Principles issued by General Electric’s Nominating and Corporate Governance Committee (http:// www. The SEC has attempted to adopt an accommodating stance with non-US firms enabling them to apply in some cases for exemptions because of conflicts with local law. for his valuable insights in developing this paper. However. © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 . for example. It is somewhat ironic that the NYSE mandates that foreign private issuers must make their US investors aware of the significant ways in which their home-country practices differ from those followed by domestic companies under NYSE listing standards. Associate Professor in the Department of Economics at Claremont McKenna College. Cal PERS. The study used three different indices to measure shareholder protection. even if a foreign company. 2. they cannot create an ethical culture that fosters responsible behaviour. (2002).

Professor Mintz has worked with a variety of organizations on ethics and quality of financial reporting initiatives including the Volume 13 Number 5 September 2005 © Blackwell Publishing Ltd 2005 . A. N. London: Pearson Education Limited. Jackson. J. C. Jensen.. Consumers’ Research Magazine. 26 January. F. Economist Intelligence Unit (2003) Corporate Governance: Business under Scrutiny. L. E. California. and Kurdelbusch. Exchanges. 1–6. S.. (2004) Bland Attacks Cost of US Governance. B. W. (2002) International Financial Accounting: A Comparative Approach. D. http://www. J. Jr. P. Foreign Companies Flee U. H.rieti. A. (1999) Corporate Governance. (1994) Fiduciary Duties and the Shareholder-Management Relation: Or. Goldschmidt. A.oecd. http://www. Nobes. 51. (1997) A Survey of Corporate Governance. February. Shleifer. S. Combined Code on Corporate Governance (2003) http://www. Boston. R. http://www. 737– 782. 4. The Financial Times. 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He has published articles on ethics. is now in its third edition and is published by Irwin McGraw-Hill. corporate reporting and international accounting in Research in Accounting Ethics. entitled Cases in Accounting Ethics and Professionalism. His ethics casebook.CORPORATE GOVERNANCE IN AN INTERNATIONAL CONTEXT 597 Society of Management Accountants of Canada and the American Institute of CPAs. the Journal of Business Ethics and the International Journal of Accounting. © Blackwell Publishing Ltd 2005 Volume 13 Number 5 September 2005 .