The OECD Principles of Corporate governance were originally developed in 1999, with an update coming in 2004 and another revision at the meeting of the G20 Finance Ministers and Governors of Central Banks in Ankara on 4-5 September 2015. In his address, the OECD Secretary General noted that:
Good corporate governance is not an end in itself. It is a means to create market confidence and business integrity, which in turn is essential for long term investment. Access to equity capital is particularly important for future oriented growth companies and to balance any increase in leverage.
The Principles offer guidelines and provide an international benchmark which policy makers can use in the evaluation and improvement of their respective corporate governance legal, regulatory and institutional framework. Their aim is to achieve “economic efficiency, sustainable growth and financial stability through the provision of the right incentives to shareholders, board members, executives, financial intermediaries as well as service providers to perform their roles within a framework of checks and balances.”
Whilst the Principles are mainly the initiatives of OECD members, they have gained international acceptance and the approval of various international organisations and therefore provide a basis for cooperation between OECD and non OECD member states in the area of corporate governance. During the revision of the Principles both in 2004 and 2015, lessons, experiences and recommendations from non OECD countries were also taken into account.
The principles come in six main chapters which are each supplemented by annotations and commentary on each principle which may describe dominant or emerging trends and offer alternative implementation methods helpful in making the Principles operational. The main headings are on: ensuring the basis for an effective corporate governance framework; the rights and equitable treatment of shareholders and key ownership functions; institutional investors; stock markets and other intermediaries; role of stakeholders in corporate governance; disclosure and transparency and the responsibilities of the board.
Janis Sarra said of the Principles: “They are essentially a reproduction of the Anglo-American governance norms with only very cursory acknowledgement of both the challenges and benefits of other governance structures.” The principles emphasise shareholder protections, that is, regarding transfer of shares, accurate and timely disclosure of all material corporate matters including the financial situation, operating results, the objectives, ownership structure, voting rights, board membership, executive remuneration as well as governance structure and policies. Central to the Anglo-American model of corporate governance is the concept of shareholder primacy and value maximisation. It is premised on the neo classical economics which suggests that a firm which operates in a competitive product market and meets its capital needs should maximise the welfare of its owners.
Nestor and Thompson however went on to observe and acknowledge that, in the real world, the situation is not that simple. There are other interested parties and factors to the equation. There are creditors, employees, suppliers and the community at large. Managers can pursue their own interests and major shareholders can pursue selfish interests at the expense of minority shareholders. As such, an optimal corporate governance structure is one that tries to minimise the costs resulting from these divergent interests.
Different countries within and without the OECD have different corporate governance regimes. This is owing to factors ranging from historical issues like capital market mechanisms, legal structures and other corporate institutions to other social and political traditions. Ronald J. Gilson made the observation that:
National corporate governance systems differ dramatically along a number of seemingly important dimensions. Some corporate governance systems, notably of the United States and other Anglo- Saxon countries, are built on the foundation of a stock market centred capital market.
Others, like those of Germany and Japan on bank centred capital market
Systems of corporate governance have been divided along two main lines based on the ownership structure, and consequently, how the entities are financed. One wide and traditional way of distinguishing the two models has been to term one the ‘insider’ and the other the ‘outsider’ model. The Anglo-American system is a classic example of the outsider model. This system is characterised by dispersed equity ownership and exalts the primacy of the shareholder. It emphasises the protection of minority shareholders and has strong disclosure requirements. Despite being traditionally characterised by individual shareholders, there has been an increase in institutional shareholders like pension funds and insurance companies. Nestor and Thompson further observe that the legal and regulatory framework in the outsider model is market based and tilted towards supporting the rights of shareholders to control the company through designs made to ensure the board and management are ultimately accountable to the shareholders. Due to the isolated and dispersed nature of the equity owners, there is need for adequate disclosure mechanisms to enable reliable and ample flow of information to the shareholders.
This model is also known as the contractarian model. This is based on the notion that “contracts are the mechanism by which stakeholders (both implicit and explicit) exercise control over managers in order to protect their interests.” In this paradigm, shareholders are deemed residual claimants to the firm`s assets after settlement of all debts. The school of thought postulates that the purpose of the firm therefore is specifically shareholder wealth maximisation. As such officers of the firm are ultimately accountable to the equity owners.
Scholarly debate on this theory acknowledged the agency inefficiencies that may arise from this sort of set up where management might pursue selfish interests at the expense of the shareholders. There has therefore been a suggestion for structural measures and incentives meant to reconcile and align the interests of different players. The different interests of directors and managers and that of shareholders can be balanced by setting up a distinction between the rights on business decisions as exercised by managers, the monitoring and/or ratification function of directors and the rights of shareholders to control fundamental change through voting. This has been described as the co location of decision power and together with other mechanisms reduces the agency costs.
The capital market then provides the means by which shareholders can discipline management through the voice and/ or exit mechanisms where investors can sell their shares and depress their value thereby exposing the company to hostile takeovers, or by using their voting rights. The model garnered traction and support throughout history whenever there was evidence of considerable success of companies in the US and UK.
In the other OECD countries outside the US and UK as well as almost all non members, the equity in companies is usually held by core shareholders who are essentially insiders with a longer term relationship with the company other than their equity investment. Examples are family members, banks and suppliers. The financing model for such companies is mainly banks and this results in less developed capital markets in this system. In countries such as Germany and Japan, firms rely on banks for external financing, with large companies having one bank, the ‘main bank’, in Japan, which the firm has a special relationship with. It typically provides loans and holds equity in the firm, so it is therefore expected to closely monitor performance. Germany has ‘universal banks’ providing a range of financial services including deposits and securities services. The banks specialise in monitoring the companies with which they are involved and are likely to interfere more actively in troubled companies compared to their American counterparts.
Brett McDonnell goes on to note that “in Germany there are wealthy individuals and families who are blockholders, and Japan has a series of cross holdings among related groups of firms, and generally, the norm is that companies are run in the interests of both shareholders and employees.” There is generally weaker shareholder protection by corporate laws.
The regulatory systems found in market based systems are not as fully developed in the insider system. Taking the German example, it did not have a national securities regulator until recently, with the function being exercised by the state or being left to the exchanges. Regulatory policy functions by prohibiting speculative activity rather than insisting on strong disclosure. The disclosure requirements are more for the creditors than they are for shareholders.
As has been stated earlier on, the OECD Principles seek to harmonise corporate governance practice amongst OECD and non OECD countries, and the Principles themselves are heavily steeped towards the Anglo American model of corporate governance. The question then is whether the Principles aid convergence towards the Anglo American model. The debate as to whether there is need to move towards a particular model of governance has dominated academia for quite long time. What is clear is that throughout history, the pendulum has swung between the two main systems depending on the economic performance of the countries using each system. The debate has mainly turned on efficiency, that is, on establishing which system is more competitive than the other and therefore preferable.
Brian Cheffins analyses the history of corporate governance and made the following observation:
Following World War 2, it was implicitly assumed that the US managerial corporation characterised by executive dominance in a context of dispersed ownership was the pinnacle in the evolution of organisational norms, and the dominance of this model as exemplified by US global corporate success meant corporate governance arrangements in other countries that differed were largely ignored.
The US economy however dipped in the 1990s and perceptions also changed. There was competition from Japan and Germany and their governance systems were also acknowledged as competitive. There was a criticism to the US managerial system along the line that their executives focused on short term results at the expense of long term plans merely to avert the threat of takeovers. The problems associated with this approach were non-existent in the German and Japanese systems. There were some who even suggested that the US could benefit from adopting, in a modified form, some elements from these countries` system.
When the US economy took a rebound in the mid 1990s, and the German and Japanese economies suffered, the Anglo American model was hailed as the optimal one again. Weaknesses were identified in corporate governance systems arising from family control of major publicly traded companies. These were cited as contributing towards the Asian stock market crash of 1997 and led to calls for reforms aimed at protecting minority shareholders.
In 1998, a report by the OECD advisory group which formulated the basis for the issuance of the 1999 OECD Principles for Corporate Governance stated that companies that strengthened their corporate governance arrangements should be advantageously placed in terms of attracting capital.
Around 2000, the US was riding high, but the perception was short lived and changed with the post 2000 stock market decline caused by the fall in dot com driven bull market in shares as well as major US corporate scandals such as Enron. As a result, the US model of corporate governance was discredited again.
To address the corporate governance failures of the day and to incorporate the concerns of emerging markets, the OECD Principles were revised in 2004. In this revision, input was incorporated from consultations of five Regional Corporate Governance Roundtables; Asia, Eurasia, Latin America, Russia and Southeast Europe, including additional special meetings from 43 non member countries. This casts the OECD Principles in their revised form as both a facilitator of convergence and a result of moves towards harmonisation.
There has clearly been a positive response by a number of jurisdictions towards adoption of the Principles, but as should have been expected, this was not without challenges. It would appear though that some of the criticisms raised against adoption of the principles appear exaggerated. A variety of reasons have been given, and it seems the major problem arises from the fact that different countries are at different levels of economic and legal development. This makes a direct transplant of one system over another impracticable. However, the principles are flexible and non-prescriptive in nature. They only offer guidelines which can be modelled to suit particular circumstances.
Focusing on Asia, a paper by Justin Iu and Jonathan Batten suggests that different cultural, legal and philosophical approaches make it difficult for reform in line with the Anglo-American model in Asian economies . It would appear though that the analysis contains wide generalisations. In that general sense, the assertions made are true, but they seem to have ignored the aforementioned aspect that, whilst the principles are rooted in the Anglo-American model of governance, they are open ended and only offer a flexible framework from which different situations can be adapted in the development of corporate governance norms.
In fact, there is scholarly view to the effect that the laws of most western and developed countries widely correspond with the OECD Principles; so focus is now mainly aimed at the policy makers of emerging markets. A number of countries have, as a result of the influence of the OECD Principles, issued their own codes of corporate governance as a voluntary way to improve their corporate governance framework. Brazil and Mexico are examples .It was observed that the level of shareholder protection in both Brazil and Mexico improved between 1995 and 2005.
The OECD has also carried out some studies to assess compliance with certain aspects of the principles in some Latin American countries like Mexico, Brazil, Columbia, Panama and Peru. Generally, it was noted that there was substantial compliance, especially with the main principles. Whilst the OECD lacks any formal powers of enforcement, states` policies are assessed for compliance through surveys and peer reviews. There are indeed numerous benefits to OECD membership and compliance with the principles. As a requirement for joining the OECD, a country`s positioning with the existing OECD instruments is considered. For instance, the roadmap to the accession of Russia includes an extensive range of market reform activities, an assessment of regulatory reform, investment environment and corporate governance among other things. It is also important to note that the Principles have gained wide international acceptance and have been approved by a number of influential international organisations. They have been adopted by the Financial Stability Forum as part of its twelve key standards for sound financial system. There is also influence from the IMF and most importantly, the World Bank, in particular through the Reports on the Observance of Standards and Codes.
In Asia, the OECD Asian Roundtable on Corporate Governance is a regional forum set up for the purpose of exchanging experiences and encouraging best practice in advancing the good corporate governance agenda. It promotes the application of the OECD Principles through peer reviews as well as raising awareness. It has been held since 1999, and the fact that a significant number of countries participate is confirmation of their willingness to adopt the Principles into their systems.
As regards the African region, there is very limited scholarly work dedicated to the analysis of the development of corporate governance. However, the little that there is shows that the influence of Western practices is also being felt. Naomi Cahn noted that multilateral institutions like the IMF and World Bank play a significant role in influencing corporate governance culture in sub Saharan Africa. Her study focused on the Democratic Republic of Congo and neighbouring countries. The study makes the observation that when governments are less democratic and lack accountability to their citizens, these multilateral institutions can influence change. As noted earlier, the IMF and World Bank endorse the OECD Principles and encourage their adoption and use compliance and their implementation as a measure of good governance reform. The World Bank also exerts pressure on member countries` governments to improve the operational environment for business and gives financial support to companies doing business in less developed countries.
It is therefore clear that the Principles do have a global impact on various corporate governance regimes. They are quite useful as a benchmark and in the provision of a framework for use in advancing corporate governance best practice everywhere. What is not practicable is their wholesale adoption without considering prevailing local culture and related factors. Due to their non prescriptive and open ended nature, different regimes can benefit from that flexibility and develop their own codes and legislation deriving from the values advanced by the Principles.
A number of countries have issued corporate governance codes. The European Corporate Governance Institute`s website lists the various codes. Most of these codes are in response to, or to a large extent incorporate the OECD Principles. Infact, there is a widespread general shift towards the use of codes and similar norms in corporate regulation. Trends show that there is an attempt at finding an “optimal mix of corporate law and other forms of corporate regulation.” Feiran starts by noting that “ UK corporate regulation ranges from detailed rules set out in primary legislation supported by criminal sanctions, through to non legally enforceable , but commercially powerful guidelines or norms developed by market participants.” This is also true of many other jurisdictions.
Eddy Wymeersch also stated that, “ Corporate governance rules are a mixture of basic rules laid down in statutory instruments, legislation covering more complex issues, securities regulation, stock exchange rules, the companies` articles of association, internal rules and traditions and good practice.” He went on to note that there is a recent trend towards streamlining the more informal sources of corporate governance into codes.
There are various types of codes, depending on their content, origin and legal status. The general trend, however, is that the substance of the codes is not binding in nature. The entities subject to them are not necessarily bound to follow their provisions, but are expected to justify their failure to do so. This principle has come to be known as the “comply or explain” principle. It originated from the UK code. A number of codes in the EU, including countries like Belgium, Poland and Hungary are based on that principle. In the Netherlands and Germany, there are certain statutory provisions enjoining compliance with their respective codes, but there is still room for explaining derogations.
Some codes, instead of using the ‘comply or explain’ principle, employ a slightly different approach and use what they term ‘apply or explain’. This variation largely appears merely a matter of semantics, but it could be interpreted as slightly more flexible. For instance, in South Africa, the King 3 Report on Corporate Governance, employ this concept. Unlike the UK and similar codes which , based on the comply or explain principle require listed companies to state their compliance and explain any non compliance, South African companies are expected to make a statement indicating how they have applied the principles and explain their deviation. Such a softer approach is obviously more open to abuse. Not everyone will be able to pick deviations from the principles.
In the same vein, the ‘comply or explain’ concept suffers from related weaknesses. Explanations given for non compliance might be untrue. Questions have therefore been raised as to whether it might be better to make codes mandatory and to establish the veracity of explanations given for non compliance. Such an approach is clearly undesirable as it will detract from the flexibility of codes, driving them into the realm of hard law and its challenges. Flexibility is an essential component in the regulation of certain aspects of corporate governance in a dynamic market.
Corporate Governance codes certainly represent a new form of market regulation, and in that, a very welcome development because their nature and design enable a quicker and more fluid adaptation to the ever changing economic environment. Hard law takes longer to adapt and keep pace with developments in other facets of the economy. The legislative process for hard law is by its nature more formal and time consuming.
Proponents of soft law also assert that apart from its flexibility, “our innate desire to conform with social norms produces genuine compliance.” Sanderson and Seidl go on to note that whilst codes could be criticised for their lack of legal sanction which might lead to soft compliance, the mechanism works in corporate governance because those regulated are high profile and are under constant monitoring by self interested investors who are usually powerful financial institutions with the necessary resources and sufficient interest to scrutinise.
Academics have also observed that the level of compliance with soft regulation has to do with the corporate culture. A comparison of UK and Germany has shown that the UK had shift towards soft regulation, this does not mean that codes are effectively taking over the role of hard law in corporate governance. Both systems of regulation will always have their roles and continue to complement each other for the foreseeable future. It has to be acknowledged though that there has been a significant proliferation of codes in the area of corporate governance. It is a positive development.considerably higher levels of compliance and more fully justified explanations for non compliance.
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