International Corporate Governance

Slide 4.
International Corporate
Governance
Taxonomies of Corporate Governance
Systems
Goergen, International Corporate Governance, 1st Edition Pearson Education Limited 2012
Slide 4.2
Lecture Aims
This lecture reviews the main taxonomies of corporate
governance systems.
Before proceeding with this review, the lecture discusses
the economic and political context in which global
capitalism has risen.
This lecture reviews both the classifications based on the
law and finance literature (La Porta et al. on the quality of
law and investor protection; Pagano and Volpin on electoral
systems; and Roe on political orientation of governments in
power) and the varieties of capitalism (VOC) literature.
An important distinction between the two is that the
former prescribes a hierarchy of systems whereas the latter
argues that very different institutional arrangements may
generate similar economic performance.
Slide 4.3
Learning Outcomes
By the end of this lecture, you should be able to:
1. Understand the economic and political context which
has enabled global capitalism to rise
2. Critically review the assumptions underlying the
taxonomies from the law and finance literature and
those from the VOC literature
3. Assess the possible limitations of the various
taxonomies as well as the validity of their predictions
4. Explain path dependence and distinguish between the
two types of path dependence.
Slide 4.4
Introduction
This lecture reviews the various taxonomies of
corporate governance systems.
It is important to realise that the various
taxonomies have very different premises.
The taxonomies from the law and finance
assume that
individuals maximise their utilities in the presence
of institutions which constrain their behaviour, and
there is a zero-sum game between improving the
rights of investors and those of workers.
Slide 4.5
Introduction (Continued)
In contrast, the varieties of capitalism
literature
focus on the concept of complementarities, and
do not assume that there is a zero-sum game
between worker and investor rights.
Slide 4.6
The Rise of Global Capitalism

We will briefly discuss the political and economic
context of the rise of capitalism first.
In their 1932 book, Adolf Berle and Gardiner
Means identified a new social phenomenon and
major step in the development of capitalism.
This was the emergence of a class of professional
managers running firms on behalf of their owners.
The first challenge faced by this new class was
the stock market crash of 1929 and the Great
Depression of the 1930s.
Slide 4.7
The Rise of Global Capitalism (Continued)

The Great Depression gave start to large-scale
government programmes globally to revive the
economy.
The most famous one was US President Franklin
Delano Roosevelts New Deal.
As a response to the recent failures of its
commercial banks, the USA introduced the
Glass-Steagall Act in 1933.
The Act introduced a segmentation between
commercial banks and investment banks.
Slide 4.8

In summer 1944, the Bretton Woods
agreement created new global economic
institutions for the post-WWII period
the International Monetary Fund (IMF), and
the International Bank for Reconstruction and
Development (IBRD) or World Bank.
It also set up a system of fixed currency

exchange rates.
At the end of WWII, the USA and the USSR
emerged as the two pillars of political power.
Slide 4.9

The post-WWII period saw substantial
improvements in workers rights and the
emergence of the welfare state.
The class of professional managers now faced
a class of blue- and white-collar workers
represented by powerful unions.
In Germany, the Co-determination system
was put in place consisting of workers councils
and workers board representation.
Slide 4.10

During the 1960s, Western economies
experienced unprecedented economic growth.
However, at the beginning of the 1970s the
Bretton woods system was in crisis
The USA had a massive trade deficit due to the
Vietnam war
The deficit was financed by printing more dollars
which fuelled inflation
In 1971, President Nixon put an end to the
convertibility of the dollar into gold.
Slide 4.11

The 1973/4 oil crisis further fuelled inflation.
By 1976, the Bretton Woods agreement had broken
down and all major currencies were now floating.
Developed countries were now experiencing
stagflation, i.e. stagnation combined with high
inflation and unemployment, caused by high oil
prices as well as a spiral of wage and price
adjustments.
Few believed that Keynesian economic policies
would be a way out of the crisis.
Slide 4.12

The crisis gave rise to neoliberalism as a new
political ideology.
Neoliberalism is the doctrine that
markets are better at allocating economic resources,
and
individuals are better at making economic decisions
than governments.
The next few decades were to be dominated by
this new doctrine, also called financialisation
or globalisation.
Slide 4.13

Financialisation refers to different, but related
phenomena
the increasingly important role of capital markets
and the financial services industry compared to the
manufacturing industry, and
the process of turning any asset generating cash
flows into a financial security or a derivative.
Slide 4.14

In 1979, the Conservatives won the elections in the
UK and Margaret Thatcher became Prime Minister.
In 1980, Ronald Reagan, A Republican, became the
President of the USA.
Both engaged in programmes of market
liberalisation and deregulation.
Thatcher curbed trade union power with a
succession of laws during the 1980s.
Trade union membership fell from roughly 50% to
34% in 1990.
Slide 4.15

The UK was the first country in Europe to start
an ambitious programme of privatisation.
Two of the major aims of the privatisation
programme were
to widen share ownership, and
to encourage employee share ownership.
Other European countries were to follow with

their own privatisation programmes.
Slide 4.16

In the USA, Ronald Reagan was a fervent
follower of supply-side economics.
According to supply-side economics, a
necessary and sufficient condition to achieve
economic growth is to reduce barriers to the
supply side of the economy.
Reagonomics consisted of keeping inflation
low by controlling the supply of money,
reducing tax and government spending.
Slide 4.17

The 1970s and 1980s also saw a wave of
deregulation of the major financial markets.
On 1 May 1975 (May Day), the US stock
exchanges moved from a system of fixed
commissions to negotiated commissions.
As a result of this decrease in trading costs
a lot of foreign companies applied for a cross-listing
in the USA, and
a major chunk of the trading in their shares moved
to the USA.
Slide 4.18

In response to the loss of business to the USA,
the London Stock Exchange underwent major
changes in 1986 (Big Bang).
The most important change was to remove
minimum commissions on stock trades.
The 1980s and 1990s also saw the
demutualisation of British building societies,
i.e., converted to joint stock companies.
Slide 4.19

In 1985, Mikhail Gorbachev succeeded Leonid
Brezhnev as head of state of the USSR.
He is famous for
his glasnost (opening of the USSR), and
perestroika (economic and political reform)
policies.
During the late 1980s, revolutions swept

across the Communist Bloc resulting in
the reunification of West and East Germany, and
the breakdown of the USSR.
Slide 4.20

In 1992, the Single European Act came into
effect in the European Union
It removed barriers to capital flows and the movement
of EU citizens within the EU
It brought about a liberalisation of financial and labour
markets.
In the USA, the Gramm-Leach-Bliley Act of 1999

practically repealed the 1933 Glass-Steagall Act.
Banks were now allowed to conduct both
commercial and investment banking.
Slide 4.21
First Attempts to Classify

Corporate Governance Systems
The British economist John Hicks and the
American business historian Alfred Chandler Jr.
were the first to attempt to categorise the
different systems of capitalism.
Hicks distinguishes between
market-based economies, and
bank-based economies.
The former rely on well developed capital

markets and the issue of publicly traded
securities to finance corporate investments.
Slide 4.22

Corporate Governance Systems
(Continued)
Chandler studied the differences between

American, British, German and Japanese
capitalism from a historical perspective.
Mark Roe highlights the importance of past
regulation to understand differences in
corporate governance across countries.
In particular, banking regulation has had a
major impact on whether a national economy
develops into a market-based or bank-based
system.
Slide 4.23

Corporate Governance Systems (Continued)
Julian Franks and Colin Mayer have developed a more
nuanced classification which does not just focus on
the sources of financing for corporations.
They distinguish between insider systems and
outsider systems.
Insider systems are characterised by
concentrated control and complex ownership structures,
managers being monitored and disciplined by the large
shareholder, and
underdeveloped takeover and stock markets.
Continental Europe is a representative of this system.
Slide 4.24

Outsider systems are characterised by

dispersed ownership and control,
well developed takeover and stock markets,
managers being disciplined by hostile raiders.
The UK and the USA are representatives of the

outsider system.
Slide 4.25

Lucian Bebchuk and Mark Roe formalise how the
past shapes a countrys corporate governance
system.
They distinguish between two forms of path
dependence
Structure-driven path dependence is about how
current corporate governance arrangements and
corporate control structures depend on the structures that
were initially in place
Rule-driven path dependence is about how current
regulation is influenced by the corporate structures that
were initially in place.
Slide 4.26

The characteristics of national systems will

tend to persist over time given the structuredriven and rule-driven path dependences.
Slide 4.27
Legal Families
Rafel La Porta, Florencio Lopez-de-Silanes,
Andrei Shleifer and Robert Vishny have started
the law and finance literature.
Their theory is based on the importance of
property rights, in particular investor protection.
They argue that in countries where investor
protection is high capital markets are highly
developed.
Ultimately, the degree of investor protection
drives economic growth.
Slide 4.28
Legal Families (Continued)

La Porta et al. distinguish between two broad
legal families, i.e. common law and civil law.
Common law is case-based law.
Judges pronounce judgements on the cases
presented to them in a court of law.
These judgements then create precedents for
other similar future cases.
Civil law originates from Roman law.
It relies on extensive codes of law.
Slide 4.29

The role of judges is limited to interpreting the
law texts in court.
La Porta et al. argue that the reliance on codes
of law makes civil law less flexible and more
reactive than common law which can easily
adjust to new ways of managerial abuses.
Common law is the law of the UK, the USA and
most of the former colonies of the UK.
Slide 4.30

Within the broader family of civil law, La Porta
et al. distinguish between
French (or Latin) law prevailing in French speaking
and Southern European countries,
German law prevailing in Germanic countries as
well as China and Japan, and
Scandinavian law.
Their antidirector rights index measures

how well shareholders are protected against
the management or the large shareholder.
Slide 4.31

Their creditor rights index measures how
creditor rights are protected.
La Porta et al. find that shareholder protection
and creditor protection are
highest in common law countries,
lowest in French law countries, and
somewhere in between in countries of German and
Scandinavian law.
Slide 4.32

They also study the link between
investor and creditor protection on one side, and
the size of capital markets on the other side.
They find that the size of stock markets, as

measured by the number of domestic listed
firms, is
largest in common law countries,
smallest in French law countries, and
somewhere in between in countries of German and
Scandinavian law.
Slide 4.33

However, when stock market size is measured
by the value of IPO firms, the relationship with
investor protection is less clear.
The relationship between creditor protection and
the size of the debt market is also somewhat
ambiguous as German law countries have much
larger debt markets than common law countries.
Finally, La Porta et al. find a negative link
between investor protection and the
concentration of control.
Slide 4.34

They conclude that control remains
concentrated in countries with weak investor
protection to avoid expropriation by the
managers.
Slide 4.35
Political Determinants of
Corporate Governance
Mark Roe proposed politics and political
ideology as the main driver of corporate
governance.
Political ideology determines how countries
achieve social peace.
The Continental European social democracies
have achieved social peace by favouring
employees over investors.
Layoffs will be relatively hard, unemployment
benefits and unemployment will be high.
Slide 4.36
Corporate Governance (Continued)
Managers will less likely focus exclusively on the
maximisation of shareholder value.
High incentive packages for managers will also be
less common to avoid the envy of other social
classes.
There will be less takeover activity as takeovers may
generate layoffs.
In summary, social democracies seek social equality
at the cost of economic efficiency.
Control will stay concentrated as this is the only way
to keep managers and employees at bay.
Slide 4.37
In countries with more conservative

governments, the focus will be on improving
investor rights.
Given the strong investor rights, ownership
and control will separate.
Roe tests his prediction on OECD countries
and finds support for it
Ownership and control are more concentrated in
countries with left-wing governments.
Slide 4.38
Marco Pagano and Paolo Volpin propose an

alternative theory based on electoral systems.
Their theoretical model is based on three
different types of economic actors
managers,
employees, and
rentiers.
Slide 4.39
Managers run the firms on behalf of the rentiers, but
do not themselves own shares.
Rentiers live off the revenues of their investments.
Both managers and employees prefer weaker
investor rights.
Weaker investor rights give more power to
managers and facilitate the extraction of private
benefits of control.
They also provide better job security for employees,
in particular less productive employees.
Slide 4.40
While managers and employees have similar
preferences, rentiers are assumed to be a less
homogenous group.
Pagano and Volpin distinguish between
majoritarian electoral systems and
proportional electoral systems.
Under a majoritarian system, the political party
with a majority of districts wins the elections.
Pagano and Volpin assume that the pivotal
district is the district of the rentiers.
Slide 4.41
Hence, under a majoritarian system political
parties will cater for the rentiers and focus on
improving investor rights.
Under a proportional system, the political party
that obtains a majority of votes wins the
elections.
Under the latter, political parties will focus on the
homogenous group of the managers and workers.
The focus will be on employee rights at the
expense of investor rights.
Slide 4.42
Pagano and Volpin test their theory on 21 OECD
countries.
In line with their predictions, they find that countries
with more proportional voting systems have stronger
employment protection and weaker investor rights.
However, they only find that the La Porta et al. legal
families only explain the levels of employee rights,
but not those of investor rights.
They conclude that the proportionality of the
electoral system is better at explaining the level of
investor rights than the legal family.
Slide 4.43
The Varieties of Capitalism Literature

So far, the focus has been on the law and
finance literature which argues that the main
role of institutions is to constrain the
behaviour of managers and employees.
Contrary to La Porta et al. and Pagano and
Volpin, Roe does not advocate the superiority
of one particular system.
Nevertheless, he also assumes that strong
investor rights cannot coexist with strong
employee protection.
Slide 4.44

(Continued)
In contrast, the varieties of capitalism (VOC)
literature does not favour a particular system.
Peter Hall and David Soskice study a wide range
of questions relating to the distribution of
wealth and the resolution of economic
coordination problems.
They argue that economic systems are not just
about investments in assets and technologies.
They are also about investments in human
capital.
Slide 4.45

(Continued)
The way economic coordination problems are
solved depends on whether an economy is
a liberal market economy (LME) or
a coordinated market economy (CME).
In LMEs, the coordination mechanism is the

markets.
Labour markets and markets for assets are
highly flexible and developed.
Firms tend to invest in highly marketable and
liquid assets.
Slide 4.46

(Continued)
There is an emphasis on assets with relatively
short payback periods.
In-house training of employees is kept to a
minimum to avoid competitors from free-riding
on the firms efforts.
Innovation is mainly of the blue skies nature.
LMEs tend to excel in highly competitive,
innovative industries as well as low value-added
services industries.
The UK, the USA and Australia are LMEs.
Slide 4.47

(Continued)
CMEs are based on complex networks to
coordinate economic decision making.
Markets, including labour and capital markets, are
fairly illiquid and inflexible.
Hence, there is less focus on highly liquid and
generic assets.
The emphasis tends to be on more specific, less
marketable assets.
Firms provide more in-house training and powerful
employers associations avoid free-riding.
Slide 4.48

(Continued)
High employee protection and inflexible labour

markets provide incentives for workers to
invest in firm-specific skills.
CMEs tend to do well in industries associated
with incremental innovation such as high
value-added manufacturing.
France, Germany and Italy are examples of
CMEs.
Slide 4.49

(Continued)
The concept of complementarities is key to

the VOC literature.
Two institutions have complementarities if
their joint existence increases the efficiency of
one or both of them.
This concept implies that substantially
different sets of institutions may still have
very similar levels of economic output and
wealth creation.
Slide 4.50
How Do the Various Taxonomies Perform?

The first attempts to arrive at taxonomies
consisted of finding commonalities as well as
differences across countries in terms of corporate
governance.
More recent attempts have been based on
theoretical foundations, generating predictions as
to
how institutional arrangements come about, and
how existing institutional arrangements explain
differences in corporate governance and corporate or
economic performance.
Slide 4.51

(Continued)
A basic criticism of La Porta et al. is its static
nature.
Taken to an extreme, todays characteristics of
the Italian corporate governance system are
mainly due to what happened in the distant past,
starting with the 12 Tables that laid down the
foundation of Roman law in the 5th century BC.
La Porta et al. justify the static nature of their
theory by the fact that law only changes slowly
over time.
Slide 4.52

(Continued)
There also exist four more specific critiques of La
Porta et al.
The first critique has been formulated by Michael
Graff.
He argues that the La Porta et al. antidirector rights
index includes criteria that are irrelevant whereas
other, relevant criteria have been excluded.
When the index is adjusted as proposed by Graff,
there is no longer a link between investor protection
and legal origin.
Slide 4.53

(Continued)
Holger Spamanns critique is based on errors

of encoding.
He finds errors for 33 out of the 49 countries
covered by La Porta et al. due to their use of
secondary sources.
After these errors have been corrected, the
link between legal families and investor
protection no longer exists.
Slide 4.54

(Continued)
Amir Licht, Chanan Goldschmidt and Shalom

Schwartz argue that culture is the true driver
behind differences in corporate governance.
Using survey evidence, they find that countries
that were under British rule are much more
willing to deal with conflicts of interests in a
court of law.
They find a strong relationship between
cultural attitudes and investor and creditor
protection.
Slide 4.55

(Continued)
They argue that the persistence of cultural

attitudes may explain why the countries of the
former Communist Bloc have failed to improve
investor protection despite wide-ranging legal
reforms.
Finally, Julian Franks, Colin Mayer and Stefano
Rossi find that the separation of ownership
and control in the UK can be traced back to
the period before 1930 when investor
protection was still low.
Slide 4.56

(Continued)
Franks et al. argue that the proximity of

shareholders to their investee companies via
local stock exchanges acted as a substitute for
strong investor rights.
There has also been criticism of the simple
version of the VOC literature.
The dichotomous version has been criticised to
fail to account for the distinct character of
Rhineland economies, the Nordic social
democracies and Southern Europe.
Slide 4.57
Conclusions
While the last few decades have seen major political,
economic and technological upheavals on a global level,
giving rise to global capitalism, national systems of
corporate governance and capitalism nevertheless are still
characterized by a series of idiosyncrasies. This chapter has
reviewed the various taxonomies of national systems that
have been proposed by business historians, as well as
financial, legal and management scholars.
This first attempts at categorising national corporate
governance systems were grounded in historic analysis and
were made by John hicks and Alfred Chandler Jr. Hicks
distinguished between market-based capitalism and bankbased capitalism. A major recent attempt by Julian Franks
and Colin Mayer distinguishes between insider and outsider
systems of corporate governance.
57
Slide 4.58
Conclusions
In insider system, stock markets are relatively underdeveloped,
corporate control is highly concentrated and badly performing
managers are disciplined by the large shareholder. In outsider
systems, organised capital markets are highly developed, most
companies are listed on the stock market and have dispersed
ownership and control and managerial disciplining is done via the
market for corporate control.
Lucian Bebchuk and Mark Roe have formalised the way history
shapes current corporate governance via their concept of path
dependence,
they distinguish between structure-driven path
dependence and rule-driven path dependence. Structure-driven
path dependence relates to how the original structures of a country
have influenced its current structures. Rule-driven path dependence
refers to how current regulation was influenced by the structures or
economic actors that initially dominated the countrys economy.
58
Slide 4.59
Conclusions
A new strand of the academic literature is the so-called law and
finance literature. This literature proposes taxonomies based on
legal families (La Porta et al.) and political determinants, i.e. the
countrys way of achieving social peace and the governments
political orientation (Mark Roe) as well as the type of electoral
system (Marco Pagano and Paolo Volpin). At the core of most of
the taxonomies originating from the law and finance literature is
the premise that highly flexible and liquid markets, such as
capital markets and labour markets, are better at allocating
resources than other mechanisms, such as informal networks
and governments. According to this school of thought, corporate
governance systems , which put in place regulation that
facilitates rather than constrains the operation of markets, are
superior to those that do not.
59
Slide 4.60
Conclusions
In contrast, the varieties of capitalism (VOC)
literature is based on the notion of
complementarities. This notion implies that
very different set of institutional arrangements
may generate similar levels of economic
growth and output importantly, the VOC
literature does not assume that welldeveloped
capital
markets
and
weak
employee rights are the only way of achieving
strong economic growth.
60
Slide 4.61
Conclusions
The rise of global capitalism.
First attempts at categorising corporate
governance systems.
Path dependence.
The law and finance literature and the
hierarchy of corporate governance systems.
The VOC literature and the concept of
complementarities.

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Slide 4.

The Rise of Global Capitalism

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

It also set up a system of fixed currency

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

Other European countries were to follow with

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

The Rise of Global Capitalism (Continued)

During the late 1980s, revolutions swept

The Rise of Global Capitalism (Continued)

In the USA, the Gramm-Leach-Bliley Act of 1999

First Attempts to Classify

The former rely on well developed capital

First Attempts to Classify

Chandler studied the differences between

First Attempts to Classify

Continental Europe is a representative of this system.

First Attempts to Classify

Outsider systems are characterised by

The UK and the USA are representatives of the

First Attempts to Classify

First Attempts to Classify

The characteristics of national systems will

Legal Families (Continued)

Legal Families (Continued)

Legal Families (Continued)

Their antidirector rights index measures

Legal Families (Continued)

Legal Families (Continued)

They find that the size of stock markets, as

Legal Families (Continued)

Legal Families (Continued)

In countries with more conservative

Marco Pagano and Paolo Volpin propose an

The Varieties of Capitalism Literature

The Varieties of Capitalism Literature

The Varieties of Capitalism Literature

In LMEs, the coordination mechanism is the

The Varieties of Capitalism Literature

The Varieties of Capitalism Literature

The Varieties of Capitalism Literature

High employee protection and inflexible labour

The Varieties of Capitalism Literature

The concept of complementarities is key to

How Do the Various Taxonomies Perform?

How Do the Various Taxonomies Perform?

How Do the Various Taxonomies Perform?

How Do the Various Taxonomies Perform?

Holger Spamanns critique is based on errors

How Do the Various Taxonomies Perform?

Amir Licht, Chanan Goldschmidt and Shalom

How Do the Various Taxonomies Perform?

They argue that the persistence of cultural

How Do the Various Taxonomies Perform?