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National systems of corporate governance

What is corporate governance and why is it an important issue? It is a “system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs” OECD April 1999. This provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance. In broad terms, corporate governance includes the “structures, processes, cultures and systems that engender the successful operation of the organizations” (Keasey and Wright 1993)1 or as its relationship to society, but more narrowly defined corporate governance concerns the accountability of senior management to shareholders. This narrow concept has been fostered in the UK.

For companies, good governance means securing access to broader-based, cheaper capital. For investors, a commitment to good governance means enhanced shareholder value. Good governance equals good business. Corporate governance is important for the economic health of corporations and the well being of society as a whole. Corporate governance in the UK and US is characterized by exceptionally high levels of external intervention through

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a number of forms.

Firstly, the UK has an extremely high level of takeover activity. Franks and Mayer(1990) believe that there are twice as many takeovers in the UK than there are in France or Germany. While in Germany there have been only four cases of hostile takeovers since the second world war Jenkinson and Mayer(1993) reported that one quarter of takeovers of publicly listed targets in the UK since the 1970s have been hostile in nature. A hostile takeover is one that has been rejected by the management of the target bid.

A high level of takeover activity results in a high level of executive changes. While this coincides with the theory for the market for corporate control it simply means that the exertion of control over companies come indirectly through the takeover market rather than directly through investor intervention. Hostile takeovers are however expensive and it is not altogether clear that takeovers are good at identifying poorly performing firms. While there is clear evidence of gains to shareholders around the time of the announcement of a bid the performance of merged firms is little better than the performance before the merger, and in some cases may even be worse.

[ex post failure describes the correction of poor management in the past and ex ante failure describes the prospect of superior performance by an alternative management in the future] Takeovers have two primary roles to play concerning the reallocation of resources to their most productive use, the mere threat of takeover could contribute to more efficient management by focusing concentration on the maximization of shareholder value as opposed to the persual of personal objectives and in the event of management failure, takeovers allow poor management to be replaced.

Institutional interventions may be substitutes for takeovers. Interventions take the form of exhortations to changes in management policy and ultimately to dismissal. These can be prompted by specific announcements of poor performance e.g. dividend reductions, and are commonly associated with firms in which there is limited corporate governance, particularly when positions of executive and non executive chairman are combined. High levels of external control in the UK could be due to differences in bankruptcy procedures in the UK and US. UK bankruptcy is credit orientated system which has high liquidations and closures, the US runs a debit orientated system. The lasting implication of this means less protection of owners and managers in the UK compared to the US.

Regulatory rules, in particular the issuance of dual classes of shares, contributes to the differences in forms of corporate governance and control across countries. Some countries have minimum ratios of votes that different classes of shares may take to each other e.g. in Denmark, class B shares cannot have less than one tenth of the voting rights of class A shares. Only about one percent of companies in the UK have dual class shares and four per cent in the US – German and Japanese firms also have low proportions Rydqvist while 75% of quoted firms in Denmark have dual class shares, a trend which is mirrored throughout Scandinavia, Israel and Italy. Dual class shares could be related to the threat of takeover as dual class shares may be viewed as a form of defense as well as a tool to extract higher bids from acquiring companies.

In Germany voting right restriction are employed and limit the maximum proportion of votes that any one shareholder can cast, irrespective of how many shares they possess. This can be a considerable hurdle that hostile takeover find difficult to overcome. If there was an attempt to create one single system of corporate governance and limiting dual class shares to a proportion of issued capital and discouraging voting right restrictions were conditions, it would have the effect of permitting predators access to new markets just as takeovers in the UK allow acquiring companies to fulfill their corporate strategies.

Control through supervisory boards are dependent upon a stable ownership structure which discourages hostile outside acquisitions. Most countries do not need hostile takeovers. If we look at industrial groupings, particularly in Japan where they are most formally organized, we will observe that the groupings are sustained by interrelated shareholdings e.g. the Mitsubishi Group: 18% of the shares in Mitsubishi bank, 25% of the shares in Mitsubishi Corporation and 17% of shares in Mitsubishi heavy industries are cross shareholdings by the three companies.

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