Corporate governance (CG) represents the system by which company operations are directed and controlled, including principles, codes and conducts, accounting reports, board of directors (BoD), roles and responsibilities and stakeholder relations (ICAEW, N.D). The debate is ongoing as to whether there is one perfect model. Without one absolute definition of corporate governance can a perfect model be found? Even the World Bank definition has changed six times in the last 15 years. Without universal laws and regulations finding and enforcing a perfect model has proved difficult. I believe the optimal model depends on; the nature of the business, company size, availability of resources and legal and regulatory requirements – no ‘one size fits all’ can be adopted. Path dependence considers the current state of a system and the path it took. Given that no two countries have the same historical events or societal responses to them the net result is persistence of existing systems and potential divergence across them (North, 1990, p. 243)
Using the Anglo-American (AAM), Germanic (GM) and Japanese (JM) models I will be focusing on the trend towards hybridisation through their characteristics, BoD, reforms and an evaluation of the convergence, divergence, and hybridity argument. I believe certain elements of each model could stand to create one ‘perfect’ model and thus hybridity is the way forward. I believe convergence is superficial, countries appear to take steps towards the AAM yet are still adhering to their own model. For example, Sony increase their number of independent directors to 10 yet only three of them were actually from outside Japan (Sony, 2017). With ever-increasing globalisation and evolving market trends, CG needs to be continuously evolving.
History
During the 1980s there was considerable interest from researchers into the strengths of both German and Japanese systems of CG. However, rapidly increasing economic growth in the US and UK in the mid to late 1990s switched focus onto the AAM. Since then studies have shown the AAM enables capital market expansion which helps with economic growth (La Porta, et al., 1998, pp. 1113-1115). Until recently, the US widely assumed the rest of the world would converge towards their model simply because other countries would require access to American capital. However, corporate ownership has long been dispersed in the UK and US and property rights and government structures in Europe and remain under the control of wealthy families and government officials, emphasising the need for hybridisation. Governance-related subject matter has a long running tradition in Germany under the heading of corporate constitution, where the rules and duties of company’s organs and its members are characterised by the international governance perspective (Clarke, 2017, p. 36). Topics of auditing and accounting were not tackled under Germany’s former definition yet the Universal Bank remains central.
Japanese CG, unlike the other models, was built on the emphasis of incumbency and promotion within. Prior to World War II the financial clique, known as Zaibatsu, was a family-controlled conglomerate that controlled the economy with the main four families being Mitsubishi, Sumitomo, Yasuda, and Mitsui. However post-war Japan saw a shift towards a more bank-oriented financial system which is still prevalent today as CG centres around banks and other financial and industrial institutions (keiretsu), with the majority of corporations retaining a close relationship with the main banks. Since the 1990s CG has been in transformation as the post-war system, marked by a balanced set of intertwined stakeholders, has been unravelling with foreign investor’s pressuring firms to adopt more Anglo-American practices (Clarke, 2017, p. 247).
Characteristics
The AAM, also known as shareholder-value, favours maximising asset values with all actions of hired and paid managers primarily focused on shareholders ensuring generated returns belong to them. Agency theory forms the basis of this as dispersed ownership creates managerial incentives to manipulate income resulting in agency costs which can lead to market failure (Coffee, 2005, pp. 198-211). Defined as the outsider model, individuals have share ownership and there are a number of institutional investors who are unaffiliated with the corporation. This promotes a strong separation of ownership and control as, on the one hand, there’s a huge demand for money which cannot be financed by a single person or family, but on the other hand, firms need specific managerial skills that are often not in-house (Euschen, 2016, pp. 1-5). The alignment of management and shareholder interests are achieved through the market for corporate control; poorly performing companies become hostile takeover targets and failing managers are dismissed if the takeover is successful (Clarke, 2017, p. 42). By focusing on shareholder value and allowing the market to influence business, scholars believe the AAM to be more efficient, innovative and competitive in market globalisation. Hence many perceive it, at least in theory, as having the foundations to become the perfect model.
In contrast, the GM is unique in nature due to its corporations being intertwined among themselves (Cromme, 2005, pp. 362-367). Its market orientation is relatively oligarchic and influenced by networks of shareholders families and banks. Equity ownership in Germany is more concentrated than in America with banks possessing strong voting powers and therefore having significant control over firms (Denis & McConell, 2003, pp. 12-15). Unlike the AAM, there is a considerably small market for corporate control, and the dominance of large shareholders was widely seen as a fundamental reason for the virtual absence of takeovers (Goergen, et al., 2005, pp. 243-268). Poor performance triggers changes in ownership but complex ownership based on pyramids and cross-ownership pose as an obstacle (Köke, 2000, pp. 1-5). Concentrated ownership and insider control remains the prominent characteristic of Germany’s CG system with industrial banks, mainly in oligarchic groups inclusive of employee representation, being the primary stakeholder. I believe Germany’s cooperation of capital and people should be central to the perfect model of corporate governance; it bodes well for sustainable business.
JM is based around network orientation with keiretsu organisational networks spreading power around a group of interconnected companies, known as cross-shareholding. The interaction between key players (banks, the affiliated companies, management, and the government) serves to link relationships rather than balance power as it does in America (EWMI, 2005). Business here typically involved relationships with all stakeholders (including shareholders), which is seen as a more sustainable method for the future. Similar to Germany, banks are key shareholders who retain strong relationships with corporations due to overlapping roles and the multiple services they provide (Berglöf, 1993, pp. 259-272). This is dissimilar to the AAM where such relationships are prohibited by antitrust legislations causing firms to obtain financing and other services from a vast range of sources. In the past Toyota provided a strong illustration of how pursuing the interests of all stakeholders can help achieve a superior allocation of resources; despite focusing on all stakeholders Toyota performed very well for its shareholders, even outperforming General Motors who concentrate on shareholder maximisation.
According to fundamental theories of welfare economics, maximising shareholder wealth is Pareto efficient provided markets are complete, competition is perfect, and information is symmetric (Mody, 2008, pp. 12-18). However for most markets, this is seldom the case and, as seen in Japan, imperfect markets obtaining a broad objective can achieve a more efficient allocation of resources by not solely focusing on shareholder interests leaving everyone better off (Allen & and Gale, 2000). Studies show there is already a normative consensus to converge towards shareholder value maximisation due to alternatives not being viable competitively in globally integrated markets (Hansmann & and Kraakman, 2001). However while it may appear the outsider-monitoring model found in the AAM is emerging as a global standard, local rules in many countries are yet to be dismantled. Continuity and change in institutions often co-exist to create hybrid systems (Jackson & and Moerke, 2005) allowing companies some discretion when choosing governance structures. Furthermore, merger and acquisition activity in Germany and Japan suggest businesses are striving to achieve a balance between external pressures, from shareholder oriented practices, and locally embedded rules to develop hybrid practices (Yoshikawa, et al., 2007). The degree of hybridity, however, depends on the firm’s size, as large firms may be more willing to embrace new customs due to their international operations or their desire to operate internationally.
Board of Directors
The shareholder model of CG operates a one-tier BoD in which executive and non-directors operate together in one organisational layer. Often large American corporations combine the role of CEO, however, it’s argued these roles should be separated as CEOs are professional managers rather than chief promoters of shareholder interests (Monks & Minow, 2011). Companies are required to have unitary boards, independent outside directors and board committees (e.g. finance, nominating and audit).This aids communication and allows board members to focus their attention on specific aspects (Hopt, 1997), something Germany is currently attempting to implement. Legal duties and responsibilities of the board are not differentiated in such a strict way as Germany. Nevertheless, regulatory authorities like the US Securities and Exchange Commission aim to prevent privileged groups from acquiring exclusive information (e.g. insider trading).
When it comes to the composition of the BoD, all models have been subject to scandals which have instigated various reforms to reduce the risk of corruption within the board. The Anglo-American boards have received backlash following the global financial crisis and the Enron/WorldCom scandals, brought about by failures in risk management, monitoring and remuneration systems (Kirkpatrick, 2009). Furthermore, personal links between inside and independent directors has led to bias (Management Today, 2000), as seen in Carnival Cruises Corporations where the former CEOs son was the new CEO and nine of the 16 board directors were his family members. This model lacks a power base truly independent of management to clamp down on accountability.
As a result, current proposals are looking at mandatory term limits for directors and the number of directorships a single individual can hold across corporations. An increasing number of independent directors are also becoming more motivated to protect shareholder interest to protect their own reputational capital, causing them to introduce significant changes including the replacement of CEOs at General Motors, Kodak, and American Express. These directors will also be responsible for dealing with remunerations, conflicts of interest and controlling management and CEOs, as directed by the American Law Institute Project (Douglas, 1986). The US Sarbanes Oxley Act (2002) came in response to the collapse of Enron and WorldCom to recover the loss of market confidence and address the accountability of auditors of the board and shareholders.
Japan also employs a one-tier board consisting almost solely of inside directors with comparatively low levels of input from outside stakeholders. Contrary to the AAM, non-affiliated shareholders have little or no voice thus there are few truly independent directors representing outside shareholders. Japanese boards are considerably larger in size than other countries and CEOs hold tremendous power by virtue of controlling the nominations for directors positions. Many directors tend to lack executive managerial experience with on average one board member having prior experience compared with the US where six board members had prior experience (Hiura & Ishikawa, 2016). Nonetheless, Japan does maintains some characteristics of the GM such as the appointment of an audit and supervisory board (kansayaku-kai), whose primary duties include the supervision of board members and auditing financial statements alongside the independent auditors (Japan Audit). Board membership in Japan is conditional, based on the company’s continuing profits, as keiretsu can remove directors and appoint their own candidates if profits are continuously declining. Japans lack of board independence has yielded insufficient information disclosure allowing persistent instances of corporate fraud and scandals as seen in Olympus and Toyota during the financial crisis.
The hierarchical structure of ‘insiders leading management’ meant effective supervision of leadership proved more difficult (Clarke, 2017, p. 312). Olympus emphasised this as its traditional management model encouraged a weak sense of duty to shareholders and fostered a secretive culture which has inevitably prompted its collapse (Clarke & Chanlat, 2009).
Having said that, Japanese companies are under sustained assault from overseas investors to introduce a greater number of independent directors, in a bid to improve accountability and enhance transparency. The general sentiment against independent boards is widespread but board reforms are gradually progressing. In response to globalisation pressures, Japanese corporations reduced their board size bringing them more in line with UK and American boards, a practice known as shikko yakuin, which saw Sony reduce their board of 38 down to 10. Commercial law in Japan is being revised every couple of years to combat board wrongdoings by enhancing the powers and authority of kansayakus. In 2005 it became mandatory for the audit-supervisory board of larger companies to select at least half of its members from outside the company (Seki & Clarke, 2014). Since 2015, when the Japanese Corporate Governance Code took effect, rules regarding whistle-blowing, disclosure, and stakeholder rights have been put in place. Even though compliance is voluntary, there has been strong support from the government and Tokyo Stock Exchange (STE) in pressuring companies to comply. The code states companies should appoint at least 2 independent directors whose aims are contributing to the sustainable growth of companies and increasing corporate value. From these reforms it appears Japan is converging towards the AAM, however, there is still some resistance; as of July 2015, only one-quarter of Japanese boards actually included outside directors (Hiura & Ishikawa, 2016).
Unlike other models, German boards comprise of two-tiered structures with employee representation on supervisory board (Denis & McConell, 2003, pp. 12-15), and the management board being a joint legal representation of the company (Euschen, 2016, pp. 1-5). The supervisory board acts as a forum where the concerns of various interest groups are represented and they appoint the management board to ensure a balanced accountability. It functions as the guardian of shareholder interests by examining financial statements and providing an audit of them. This is something Anglo-American firms could seek to implement (as Japan has done) to ensure employees have better representation.
Germany has received its fair share of criticism, highlighting areas in need of reform. Interlocking directorships has been one of them, as members of one company are permitted to sit on the boards of others leading to corruption, as it did with the attempted hostile takeover of Krupp by Thyssen in 1997. Two directors on the supervisory board of Thyssen were also on the board of the banks financing the offer. Similarly, the separation of ownership and control has been scrutinised for its inability to reduce agency costs, as was the case with Volkswagen where there was a clear conflict of interest between shareholders and employees. German banks also have a tendency to manipulate supervisory boards in order to establish and maintain intercompany links which can reduce control intensity as banks pursue their own interests.
Codetermination was developed to represent employee interests in the supervisory board and promote trust, cooperation and harmony (Charkham, 1994). It involves viewing management as a stock corporation that should be responsible to all stakeholders not just shareholders. It is argued corporations globally should look at implementing some form of codetermination as it is viewed as a more sustainable approach to business due to its consideration everyone involved and affected by the business. Other major reforms can be found in the German Code of Corporate Governance which highlights the standards of good management and provides recommendations for managing and supervising, including promoting flexible and open structures of communication (e.g. meeting more regularly). These reforms provide evidence of hybridisation, they show Germany are adopting aspects from the AAM and aligning them with their own.
Reforms
Changes and reforms occurring in models tend to be the direct consequence of endogenous factors within countries rather than the result of global convergence (Hermes, et al., 2006). For example, the Sarbanes-Oxley legislation in the US responded to the breakdown of the AAM rather resulting from normative convergence. Reforms in Europe have primarily been aimed at making national capital markets more attractive due to increasing globalisation and deregulation. The UK Corporate Governance Code, applicable to all publicly listed companies, was written to protect and benefit shareholders. It invokes a ‘comply or explain’ principle offering flexibility to businesses that wish to deviate from the code. Alongside this, a code of best practice regarding appropriate senior management remuneration was produced by the Cadbury Committee in 1992 and derived from unacceptable excess by directors at Guinness and Maxwell. In Germany to restore confidence in management, authorities are implementing a Ten-Step Program which attempts to bolster protection of minority shareholders by enhancing transparency and disclosure. This has resulted in a hybrid system complementing traditional stakeholder oriented systems with crucial elements of the shareholder-oriented one thus giving outsiders more control. Starting from January 1st 2018 all companies listed by shares must report on environmental and ethical issues, proving Germany is not converging to a narrow Anglo-American view but rather a broader hybridisation of the two (Law, 2017). Early 1990 reforms in Germany were not aimed at establishing a dominant market-based system for corporate control, rather they pursued a hybrid system with corporate governance intended to rely on both insiders and outsiders (Noack & Zerzsche, 2005).
Japanese reforms have been focused on making corporations competitive again while trying to overcome problems posed by non-performing loans and the hegemony of Anglo-American capital markets (Maswood, 2002). Revisions of accounting regulations weakened cross-shareholdings as part of a ‘Big Bang’, designed as an antidote to the financial crisis to secure Tokyo as the global financial centre (Clarke, 2017, p. 255). Alongside this, the 2002 Japanese Commercial Code recommended large public companies “allow outside directors to gain control of the board of directors through committees”, however, the number of companies that applied the US-like committee system only increased from 44 to 70 (Itami, 2005). Prior to this the legal approval of accord between shareholders and managers was the introduction of stock options in 1997 and continued with “the recognition of share buy-backs in 1998, stock swaps in 1999 and transfers of undertakings in 2001, as well as removal of the prohibition of owning own-company stocks’ (Inagmi & Whittaker, 2005), something commonly found in Anglo-American corporations
Conclusion
In summary, no single model can be considered perfect as all have been subject to various corruptions and scandals. Each model is subject to the influence of activity within its own borders such as culture, economic and business practices and its history, all factors which influences its susceptibility and willingness to accept change. It appears that the majority of large corporations are adapting foreign practices to fit local institutional contexts, suggesting increasing globalisation will likely lead to hybridisation rather than convergence (Bebchuk & Roe, 1999). Countries have much to learn from the West about board leadership, directors’ duties, and accountability. Similarly, the West has much to learn from emerging markets about community and long-term business strategies. Certain characteristics of each model causes it to excel above others but equally, scandals prove certain areas require hybridisation to cement substantial business.
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