Corporate Governance Models

3.
Corporate Governance: Models
• Path Dependence Theory and Development of CG Model
• International CG models
 Anglo-American models (US and UK)
 Network-Oriented models (Germany, Japan and France)
 Emerging Market Model

Corporate Governance: Models
What is a public corporation ?
Why did different systems of corporate governance developed in

different countries from the basic premise of a public corporation?
What are the governance challenges in a each system?
How each system strives to solve these governance problems?

Public Corporation – Basis for CG Systems and Models
• Comparative corporate governance and development of different

systems of corporate governance primarily focuses on the public
“corporation”.
• Aguilera and Jackson (2010), public corporation is a
“legal institution, where the rights and the responsibilities of

different parties are anchored in law and thereby also created
and changed through politics” (p.492).
• Public corporation that evolved, perpetually guided the development

of the dissimilar governance system in different countries.
Path Dependence Theory and Development of CG Model
• CG system in a country dependent on what economic path they

followed in the past that been steered present day governance
models and its regulatory framework
• Path dependence theory : Roe (1994) and Bebchuk and Roe (1999)
• Critical choice about a given corporate governance system in a

country:
 economic efficiency of its corporations’, and
 institutional arrangement and different legal customs and

traditions
 political forces devising ways of regulating and controlling

the corporation
Path dependence theory highlights
• Political forces in the US in early 1930s were against the

concentrated ownership and or industrial monopolies
establishment of corporation with dispersed ownership and
financing through the stock market
• Corporate laws, such as Glass-Steagal Act and other regulations,

critical in establishing a shareholder oriented outsider corporate
governance system in the US.
• Absence of political determinants that were prevalent in the US, the

banks based financial system got prominence in other countries
• Development of a relationship based system in European countries,

particularly in Germany and Japan, with corporate control through
bank based system
Path dependence theory and other arguments
In addition to historical and political developments,
• social and cultural values (Licht, 2001),
• institutional arrangement (Aguilera, Filatochev, Gospel & Jackson,

2008; Aguilera & Jackson, 2003) and
• different legal customs and traditions (La Porta et al., 1998, 1999,
2000)
Corporate Governance Systems around the World
• Every country, therefore, has its own unique system of corporate

governance with peculiar traits and features.
• What characterizes a CG systems around world -
- Together with ownership structure, the legal system and its related
corporate law,
- the development of capital and product market, other political and

economic institutions define the myriad varieties of capitalism
• Distinct corporate governance systems predominate in the

contemporary world that is explicitly linked to the nature of capitalism.
Corporate Governance Systems around the World
Emerging (family based) corporate

governance system
Network based corporate governance Market based corporate

system governance system

Personal
Capitalism
Alliance Managerial
Capitalism Capitalism
Stakeholder Orientation Shareholder Orientation

Market Oriented Corporate Governance System
• Market oriented model, is also known as “Anglo-Saxon model” or

“shareholder model” and often referred to as outsider system of
corporate governance.
• the ownership structure of corporations is characterized by diffusion

across a plentiful number of shareholders.
• The model is exemplified by the separation of ownership of the

corporation among a large number of arms-length investors
• This manifestation of control of the corporation by managers in Anglo-

Saxon economies is termed as “Managerial Capitalism”.
• Anglo-American countries, primarily exemplified by the United States

and United Kingdom, while Canada, Australia, New Zealand and
Ireland are rapidly imitating it.
• Shareholders are only contemplated stakeholders, whose interest

maneuvers the managerial decision-making.
• Equity financing of the corporations through a large number of

investors makes the capital markets of outsider economies like that
of the US and UK, highly developed, strong and very liquid.
• Ownership structure of the corporation in the outsider system

necessitates that all the agents (including shareholders) have equal
access to sufficient and timely information, so that, they can make
prudent decisions before investing.
• These countries have stringent norms for shareholder protection with

robust accounting and disclosure standards that clearly represents
the economic position of the firm to the public.
• The common law system followed in these countries accords greater

protection to the investors.
• A well-developed legal framework exists:
- for demarcating the rights and responsibilities of major actor of

corporations (management, directors and shareholders),
- and enforcing the contractual obligation between them
• Public corporations financed predominately through equity capital

have very low debt to equity ratio.
• A thriving equity culture prevails in outsider system countries

allowing investors and corporations to contribute significantly
towards economic growth of these economies
Strength of Capital Market in Different Corporate Governance Systems
Year 2010 France Germany India Japan UK US
Market Capitalization Of
Listed Companies
(Mkt Cap) ( in Bn US$) 1926.49 1429.71 1615.86 4099.59 3107.04 17138.98
Gross Domestic Product

(GDP) ( In US$) 2560.0 3309.67 1729.01 5497.81 2246.08 14582.40
Mkt Cap /GDP

( In Percentage) 75.25 43.20 93.46 74.57 138.33 117.53
Stock Traded/ GDP

( In Percentage) 32.34 42.45 61.12 77.86 133.86 208.85
(Source: World Bank

Market Oriented Corporate Governance System- Issues
• Apart from shareholders, other stakeholders, in particular the labor and

other business suppliers have minimal say in the functioning of the
corporation.
• Information asymmetry creates opportunity for managers to involve in

insider trading, a customary practice in market centric governance
system.
• Managers also reward themselves with excessive remuneration, even for

non-performance.
• Excessive power to wanton manager creates sufficient apertures to

instigate huge fraud like Enron, WorldCom, Maxwell, Tyco, BCCI and
many others.
• Short-term economic horizon of investment by shareholders conditions

managers to behave only myopically.
Market Oriented Corporate Governance System- Mechanism
• Market for corporate control is one of the dominant forms of

external market based governance control mechanism to punish
erring or under-performing managers.
• If managers do not perform as per the expectations of the
investors, they may discount company share value.
• Company valuation in that case may plunge to such a level that it
easily becomes a target for a hostile takeover.
• Mergers, acquisitions, tender offers, proxy fight and leveraged
buyouts are common the takeover devices and recurring feature of
the market centric model.
• The single tier board structure is characteristic of outsider system

• Abodes both executive and non-executive directors of the
corporation.
• Both decision management (executive directors) and decision
control (non-executive directors) functions are combined in a
single board.
• A board with a majority of independent directors upholds stringent
internal decision control over the decision management of
executive directors.
Governance
N
N
N
N
N
O O
O - executive directors
N – non executive
directors
Management
• Model has the prominence of insurance companies, pension funds

and mutual funds as the institutional investors.
• The majority of individual investors in the US and UK invests in

companies through these institutional investors
• They are the principal investors in the US and UK, and play an active
role in safeguarding shareholder rights
• The national association of pension funds (NAPS) in the UK and

CalPERS in the US are such examples, who are actively engaged in
fostering governance standard in their invested companies.
• Availability of sound managerial labor market in the Anglo-Saxon

economies also helps in alleviating the governance problem
• In a corporation, an ill-functioning manager can be easily replaced

with outside competent managerial people.
• Long-term incentive based executive remuneration tools like

stock-option have been designed as a governance mechanism
• Persuade managers think like an owner of the corporation, which

may align their interest with shareholders of the corporation
Network Oriented Corporate Governance System
• Network oriented model, is also known as “relationship based model” or

“stakeholder model” and often referred to as insider system of corporate
governance.
• Insider system is characterized by confederacy ownership and control of

the corporation by relatively closely held identifiable network of insiders
• Insider system adopts a pluralistic approach of withholding all

stakeholder interest.
• Insiders, including company stakeholder such family shareholders,

banks, allied and affiliated companies and labor through a network of
their ties (including equity, debt and commercial) provide
• an effective basis for monitoring each other behavior in insider system,

referred to as Alliance Capitalism.
• Corporations here are controlled through complex network of

cross-shareholding between companies, families and banks.
• Most of companies reciprocally own and control each other

through interlocking shareholding, resulting in network of
relationship that has mutual ownership.
• Network oriented system of corporate governance has been

embraced by a number of the Continental European countries,
and Japan.
• Corporation conceived as a nexus of contract among multiple

stakeholders: bankers, creditors, laborer, customers and shareholders.
• CG issue here due to “the conflict between the firm itself – including,
particularly, its owners- and other parties with whom the firm contracts,
such as creditors, employees, and customers.
• Difficulty lies in assuring that firm, as agent, does not behave

opportunistically towards these various other principles- such by
expropriating creditors, exploiting workers, or misleading consumers”
• Different stakeholders have their own interest in the corporation that

giving rise to a conflict of interest among these stakeholders.
• CG mechanism are aimed at harmonizing and safeguarding each of

the stakeholder’s interest.
German relationship based system –
• commercial banks play a dominant role and a major actor of

corporate control, in a relatively less developed capital market.
• Apart from holding equity ownership of themselves, they are in a

leadership position of monitoring the management as
representative of all the shareholders
• Many other European countries, such as the Netherlands, Austria,

Switzerland and other Scandinavian countries imitate the German
based governance model.
Latin System
• French system is the epitome of the Latin system with Italy, Spain
and Belgium
• The state is the dominant shareholder and companies mutually

control each other through a web of complex cross holding known
as “verrouillage”.
• The state plays a central monitoring role through its direct or

indirect control over the French entities commonly referred as
“dirigisme”.
Japanese System
• The main bank ( a major insider shareholder)
• The affiliated company or “Keiretsu” ( a major insider shareholder)
• ownership and control of the corporations is through “Keiretsu”

system, where bank and other financial companies playing the
apex role
• banks take a leadership role and performing monitoring role in

guiding the firm activities
• Banks are axis for corporate financing for corporations
• Corporations are generally dependent on the corporate financing

by banks for their requirements and show debt equity ratio.
• Banks have a complex relationship with a corporation with long-

term commitment of the capital
• Driven by sustained firm growth rather than myopic market

returns.
• Capital markets are generally less developed and illiquid
• Low market capitalization as compared to market centric

governance model
• Transparency and disclosure norms are low, insiders can have

selective exchange of inside information
• Insider oriented economies largely endorse the civil law system
• Grant less protection to investors as compared to market centric

economies.
Network Oriented Corporate Governance System - Issues
• All the stakeholders have mutual trust and commitment that helps
them in forging long-term and stable relationship with each other
• Sustainable relationship drives the creation of firm resources and

competencies.
• Good benefit due to the strong relationship between multiple

stakeholders in firms in the relationship based system
• Averse to innovation, entrepreneurship, risky ventures,

professionalism of management and restructuring in the case of
discontinuous change due to culture of reciprocity and ponderous
stakeholder consultation
Network Oriented Corporate Governance System - Issues
• Recurring infringement by state in the governance process, either

through its ownership or through regulatory control
- may hamper efficient functioning of corporations.
• Ownership concentration and illiquid capital market results in

condensation of risk to the bank / state
- may result in the collapse of an entire economy in case of

extreme business contraction or crisis.
• Due to non-institutionalization of ownership among retail and

institutional investors like mutual funds, insurance and pension funds,
play
• a minor role in the governance process.
• Banks on the other hand assume a leadership role
• in presence of different stakeholders and have significant

influence on managerial decision-making.
• External market mechanism like market for corporate control through

takeovers is absent
• due to high ownership concentration and strong contractual

relationship between management and stakeholders.
• The system, entrust internal corporate governance mechanisms

• family, bank and intertwined corporate relations, alliances and
cross-holdings, interlocking directorships and a two-tier board
system to monitor the management.
• An important feature of German and Japanese governance model is
“relational board structure” that
• include the key stakeholders such as labor, lenders, customers
and other suppliers, and employee playing a dominant role in
board decision making process.
• Relationship based system generally abides to two tier board
structure, with option for unitary structure (in France single tier board
structure is allowed, in Japan a different board system).
• Supervisory board appoints executive/management board and closely
monitors its functioning.
Governance N N N
N N
N N
N N
O - executive directors O
N – non executive O O
directors Management
O O
• Unlike the external market for managerial labor in the Anglo-American

economies, network oriented economies have a strong internal labor
market.
• The managers' performance is directly monitored by both by the firm,
and the employees executive (through representation on the board)
• Reduces moral hazard problem faced by managers in outsider
economies, and guide them in establishing long term stable
relationship with a corporation
Comparsion between Market and Network based System
CG Systems Market Oriented CG System Network Oriented CG System
Countries US, UK, Australia, Canada, Ireland Continental Europe ( Germany,

France, Italy, Netherlands) and Japan
Ownership structure Dispersed equity ownership, most of the Concentration of ownership with
shares are in hands of dispersed group interlocking and pyramidal structure
of individuals and particularly
institutional investors
Control of Corporation Separation of ownership and control by Control of corporation by reciprocal

management ownership by companies and families
Shareholder/Stakeholder Recognizes primacy of shareholders in Recognizes the role of all the
the company stakeholder (including employees)
Transparency and High transparency and disclosure Low level of transparency and
disclosure standards disclosure standards
Finance to corporations Preference to use equity capital as a Preference to use debt capital (Bank)
means of financing as a means of financing, high debt to
equity ratio
Comparsion between Market and Network based System
CG Systems Market Oriented CG System Network Oriented CG System

Strength of Capital Fully developed and liquid capital market Comparatively weak and illiquid
Markets capital
Legal System Common law system Civil law system
Board Structure Unitary board structure Predominately dual board
structure (unitary structure
optional)
Market for corporate Large and active market for corporate Weak market for corporate
Control control control
Relationship Orientation Short term relationship orientation Long term relationship orientation
Labor relationship Ready market for external managerial labor Strong internal labor market with
long term relationship
Engagement with Active role of institutional investors Active role of banks
Financers
Legal Protection Strong protection of shareholders in equity Comparatively weak protection to
market regulation shareholders but strong protection
to creditors

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3.

Corporate Governance: Models

• Path Dependence Theory and Development of CG Model

 Anglo-American models (US and UK)

 Network-Oriented models (Germany, Japan and France)

 Emerging Market Model

What is a public corporation ?

Why did different systems of corporate governance developed in

What are the governance challenges in a each system?

How each system strives to solve these governance problems?

• Comparative corporate governance and development of different

• Aguilera and Jackson (2010), public corporation is a

“legal institution, where the rights and the responsibilities of

• Public corporation that evolved, perpetually guided the development

• CG system in a country dependent on what economic path they

• Critical choice about a given corporate governance system in a

 economic efficiency of its corporations’, and

 institutional arrangement and different legal customs and

 political forces devising ways of regulating and controlling

Path dependence theory highlights

• Political forces in the US in early 1930s were against the

• Corporate laws, such as Glass-Steagal Act and other regulations,

• Absence of political determinants that were prevalent in the US, the

• Development of a relationship based system in European countries,

Path dependence theory and other arguments

In addition to historical and political developments,

• social and cultural values (Licht, 2001),

• institutional arrangement (Aguilera, Filatochev, Gospel & Jackson,

• Every country, therefore, has its own unique system of corporate

• What characterizes a CG systems around world -

- the development of capital and product market, other political and

• Distinct corporate governance systems predominate in the

Emerging (family based) corporate

Network based corporate governance Market based corporate

Stakeholder Orientation Shareholder Orientation

• Market oriented model, is also known as “Anglo-Saxon model” or

• the ownership structure of corporations is characterized by diffusion

• The model is exemplified by the separation of ownership of the

• This manifestation of control of the corporation by managers in Anglo-

• Anglo-American countries, primarily exemplified by the United States

• Shareholders are only contemplated stakeholders, whose interest

• Equity financing of the corporations through a large number of

• Ownership structure of the corporation in the outsider system

• These countries have stringent norms for shareholder protection with

• The common law system followed in these countries accords greater

• A well-developed legal framework exists:

- for demarcating the rights and responsibilities of major actor of

- and enforcing the contractual obligation between them

• Public corporations financed predominately through equity capital

• A thriving equity culture prevails in outsider system countries

Strength of Capital Market in Different Corporate Governance Systems

Year 2010 France Germany India Japan UK US

Gross Domestic Product

Mkt Cap /GDP

Stock Traded/ GDP

(Source: World Bank

• Apart from shareholders, other stakeholders, in particular the labor and

• Information asymmetry creates opportunity for managers to involve in

• Managers also reward themselves with excessive remuneration, even for

• Excessive power to wanton manager creates sufficient apertures to