Compare and contrast the Anglo/American model of corporate governance with that of at least one other country. Comment on which model is likely to lead to superior corporate performance.
By Michael A. Braun, ERASMUS-Student
Recently the image of top-managers has been attacked by several cases of fraud. To name only some, Enron and WorldCom are probably the best known ones. In both companies, managers acted impudent shameless and greedily. And this seems to be dreadful not only for shareholders and stakeholders of that particular firm, but also for the entire economy. Therefore Biggs, a strategist at Morgan Stanley, says, ‘corruption and greed have poisoned the climate at Wall Street.’ (Cited in N.N., 2002, p1)
Based on this, the essay is dealing with the question of corporate governance. Therefore, after a further introduction, the basic idea and especially its two concepts will be explained. Later on, these models will be contrasted against each other and an evaluation which model is likely to lead to better corporate performance is made.
Breuer argues such mentioned situation of greed, boundlessness and breach of trust that is found currently comes from an individual lack of moral and ethics. (Breuer, 2003, pp42) And after all these scandals, politicians, bankers and managers have to co-operate to gain back trust. Thus they are looking to improve corporate governance. But maybe, the problems can be compared with the ones in the end of the ‘Golden Twenties’. (N.N., 2003, p20) They ended 1929 with a crash at the stock exchanges, which was followed by a huge depression. And, after this stiff time, strong balance checks and as well as a stock exchange committee were introduced in the US.
But, spoken generally, what is ‘corporate governance’? And why are there different ways to execute this concept? To explain sufficiently, it might be appropriate to expand. Nowadays ownership and control of large companies, but not necessarily only in joint stock ones, often is separated. A reason might be, that there is, on one hand, a huge demand for money, which mostly cannot be financed alone by a single person or even one family. On the other hand, these firms need specific managerial skills that are often not in-house. Additionally, especially joint stock companies have got several advantages, such as the sharing of total risk as well as the relatively easy generation of risk capital. However, the interests of managers and owners diverge. Managers are assumed to search for prestige; power and good wages, while shareholders only are looking for profits. (Douma and Schreuder, 2002, p110)
Especially this fact of managers’ aims makes the current system of corporations rather complex. (Douma and Schreuder, 2002, p119) The higher the number of shareholders is, the lower is the incentive for a single one to monitor top-management’s behaviour. (Monks and Minow, 2001, p95) There would be so many free riders that benefit from such action as well while the monitor has to bear these agency costs alone. However, because of a small number of shares hold, monitors’ influence within the firm might be limited. And therefore the success of monitoring is low. In addition to the effort of individual monitoring, Farrar defines corporate governance as a complex circle of different aspects. (Farrar, 2001, pp4) This contains, as the very basis for everything, the legal regulations, which monitor indirectly as well. Followed by stock exchange listing requirements and statements of accounting practise. Additionally guidelines of best practise and codes of conduct play a role. Furthermore, individual and business ethics seem to be the overall framework of business behaviour.
Nevertheless, corporate governance as ‘the system by which companies are directed and controlled’ (Cited in Smerdon, 1998, p11) consists of more. It also deals with the balance of all different driving forces within a company and how their competences and control are allocated. Additionally questions of remuneration, as a motivation of managers, are asked as well as of transparency within the firm. (Witt, 2000, pp159) But finally can be argued; corporate governance is looking at the ‘right’ balance between principals and agents. In this context, corporate governance means the organisation of management and control. (Witt, 2000, pp159) Therefore especially the yet mentioned question of manager-motivation seems to be interesting. Mainly this was the problem for the two mentioned corporations. Their top-managers tried to get much more compensation than they should, related to their contracts.
When it comes to the comparison of the two models of corporate governance, three mechanisms (Douma and Schreuder, 2002, pp111) are seen as prevention of such behaviour. They are important for both but have got a completely different influence in these systems: First (1), the stock market. If a firm is not successful, the share price will go down. And this leads to the fear of being taken over hostile on the market for corporate control. Later on the responsible managers will have to leave, which is not wanted by them. Secondly (2), if these managers have left, the market for managerial labour becomes important. So they have to care about their own reputation in order to get a job afterwards. And finally (3), the intensity of competition on product markets. The stronger this competition is, the less are managers able to spend money for themselves, so-called on-the-job-consumption. Otherwise the cost of products would be higher then the ones of competitors, which again leads back to the first point.
In large corporations questions of corporate governance arise for several reasons more often: To start with, usually owners (principals) are not involved in tasks of management. Therefore employed managers (agents) are responsible for the firm. They act, according to the principal-agent-theory, on behalf of the owners. But these have no guarantees for good behaviour of their agents (agency-problem). They often have to trust - and hope the best. (Cited in N.N., 2003, p20) Following, employees seldom are stockholders of their employer, which gives them less influence on the firm strategy. Continuing, also the tricky distribution of management power and control leads to questions as mentioned. And finally the existence of banks that have lent money to the company, but are stockholders as well is problematic.
Within the Anglo/American approach of corporate governance, the shareholder-value-model is favouring the maximization of asset-value as the main aim. This means, all actions of hired and paid managers are primary for the shareholders, the owners of the firm. (Smerdon, 1998, p3) And generated returns are seen as belonging to them. They are an incentive for future investments, a reward or even the price for risk bearing (economical, technological) and the price for waiting as well. (O’Sullivan, 2000, p43) In this context, value creation and value distribution are linked only with investors. Therefore this theory promotes the idea of market control as outlined above, rather than control via stakeholders. Additionally, Kay sees firms within this model as a private rather than a public body, which is only defined by the relationship between principal and agent. (Cited in Smerdon, 1998, p7) It is assumed, this behaviour leads in the long-term to remarkable advantages, not only for shareholders but for all other stakeholders as well. It also diminishes the cost of money, either for equity capital as well as for debits. Therefore this behaviour is positive for all. (Witt, 2000, pp159)
In the US and Britain, a one-tier board system is used. This means, decision-making and decision-control are often in one hand. For example, in the US the CEO of large corporations is nearly always (93%) the chairman as well. (Monks and Minow, 2001, p175) But therefore there are several critiques who argue, CEOs are professional managers rather than chief promoters of shareholders interests. They are not seen to represent the owners properly, while to judge themselves at the same time. (Cited in Monks and Minow, 2001, p175) Moreover, according to the same source, former CEOs might also impose problems on the current top-management while they also are capable to block creative and new thinking within the board of directors.