Comparative Corporate Governance
#4: The law and Economics of Self-dealing
Self-dealing is a form of investor expropriation such as executive perquisites to excessive compensation, transfer pricing, taking of corporate opportunities, self-serving financial transactions, personal loans, and outright theft. Law is seen as playing a crucial role in its control. Differences in legal investor protection across countries shape the ability of insiders to expropriate outsiders, and thus determine investor confidence in markets and consequently their development. Several approaches can be used, such as private enforcement of good behavior, with a focus on extensive disclosure, approval procedures for transactions, and private litigation, or public enforcement, including fines and prison terms for self-dealing.
The self-dealing index measures the hurdles that the controlling shareholders must jump in order to get away with a transaction. The higher the hurdles, the higher the index.
The private enforcement concerns the approval process. Examples are mandating extensive disclosures by the company and the related party on the view that sunshine is the best disinfectant or a review by independent third parties. The data on the approval requirements is summarized through an index of ex-ante private control of self-dealing by investors. A second area that the law may regulate is the ease with which minority shareholders can prove wrongdoing: disclosure requirements in annual reports, who has the standing to sue?, can transactions be rendered void?, the access to evidence. The proxies for ex-post disclosure and the ease of proving wrongdoing are summarized in an index of ex-post control of self-dealing. Ex-ante and ex-post private control of self dealing together constitute the anti-self dealing index. Finally, the public enforcement index measures the extent to which the involved parties are liable to fines and prison-sentences.
The regulation in Italy is solely based on trusting disclosure after the fact and on disinterested directors doing the right thing. Directors are unlikely to be found negligent if they lend their support to a transaction. The strength of the regulation of self-dealing in the UK lies in the heightened scrutiny of transactions involving related parties before they may be approved rather than in favoring litigation by minority shareholders. UK and Italy are representative of the most pronounced differences between civil and common law countries. Common law countries typically require both extensive disclosures and the approval of the transaction by disinterested shareholders, while civil law countries typically have fewer disclosure requirements and entrust the approval of self-dealing transactions to the CEO or the board of directors. Litigation and access to evidence is also high in common law countries. France and the US differ from their legal families in these indexes. There is little evidence that the index varies by income level. However, access to evidence is more extensive and James is more likely to be held liable in rich countries than in middle-and low-income ones.
In theory, public firms are larger, more valuable, and more plentiful in countries with better protection of shareholders. It is shown that common law countries have sharply more valuable stock markets relative to their GDPs, a lower value of control, more listed firms, more IPOs, and less concentrated ownership. All six measures of the regulation of self-dealing are statistically and economically significant predictors of stock market development. All three measures of the regulation of self-dealing are statistically significant for both stock-market-capitalization-to-GDP, block premium, and IPOs-to-GDP. In contrast, both the ex-post private control of self-dealing index and the overall anti-self-dealing index are significant for firms per million inhabitants. Only the ex-post private control matters for ownership concentration. Finally, public enforcement is never significant, although these findings may be dismissed by arguing that what deters self-dealing is the likelihood that criminal sanctions are actually imposed, rather than their mere existence.
To deal with the problem of validity of the instrument, the authors replaced the anti-self-dealing index with the revised anti-director-index, prospectus disclosure, and prospectus liability. The general principle behind the construction of the anti-director-index is to associate better investor protection with laws that explicitly mandate, or set as a default rule, provisions that are favorable to minority shareholders. In sum, it was found that the anti-self-dealing index remains significant in two regressions when combined with the anti-director-rights or prospectus liability . However, it is never significant when combined with disclosure in the prospectus (issue of multicollinearity)
Finally, alternative interpretations are that effective tax enforcement can prevent some self-dealing transaction. It is shown that tax evasion and anti-self-dealing knock each other out.
Implications are in three areas: the measurement of shareholder protection, the interpretation of legal origin, and the design of regulatory strategies. Laissez-fair – the strategy of no involvement at all – does not lead to developed financial markets. The public sector has a role to play, but only as the designer of the rules of the game, which are enforced by private action.
#5 – Corporate Ownership around the World
Deviations from one-share one-vote should be larger when private benefits of control are higher, which must be the case in countries with poorer shareholder protection. The controlling shareholders face strong incentives to monitor managers and maximize profits when they retain substantial cash flow rights in addition to control. The definition of this paper of ownership relies on voting rights, rather than cash flow rights. Moreover, firms can be widely held or held by ultimate owners such as a family, the state, a financial institution, a widely help corporation, or miscellaneous. A firm controlled by a widely held corporation or financial institution can be thought of either as widely held since the management of the controlling entity is not itself accountable to an ultimate owner, or as controlled by that management. A corporation has a controlling shareholder if this shareholder’s direct and indirect voting rights in the firm exceed 20 percent. This is usually enough to have effective control of a firm. All firms who do not have such a 20 percent chain is classified as a widely held firm. Moreover, we say that a firm’s ownership structure is a pyramid if it has an ultimate owner, and there is at least one publicly traded firm between it and the ultimate owner in the chain of 20 percent voting rights.
The results show that the good shareholder protection subsample is dominated by common law countries. Only slightly more than one-third of the firms in the richest countries are widely held, which suggests that this is not the dominant ownership structure. The principal owner types are the families and the state, which families being the most dominant one. Widely held firms are more common in countries with good protection. If we look at the largest firms in the world and use a very tough definition of control, dispersed ownership is as common as family control. If we move to medium-sized companies, widely held firms become an exception.
26 percent of firms that have ultimate owners are controlled through pyramids. Pyramids can be used by controlling shareholders to make existing shareholders pay the costs, but not share in all the benefits of new ventures, particularly in countries with poor shareholder protection. Through pyramids, shareholders acquire power disproportionate to their cash flow rights. Finally, cross-shareholders are rare. However, in the countries where it is restricted by law, it appear to be more common.
Only five percent of the large firms are controlled by financial institutions. One reason for this may be that such institutions control small, though influential, ownership stakes.
In summary, widely held firms are uncommon, unless we look at specific countries. Family control is very common and families often have control rights over firms significantly in excess of their cash flow rights, particularly through pyramids. Moreover, financial institutions do not play a large role, although they may exercise influence through board representation and lending. The question is risen: who keeps the controlling families from expropriating the minority shareholders, especially in countries with weak legal protection? This could be done by other large stakeholders or not at all. Evidence shows that the controlling shareholders does not have another large shareholder in the same firm in 75 percent of the cases.
Alternative interpretations are that greater ownership in countries with poor investor protection might simply reflect greater reliance on debt rather than equity finance in such countries. Moreover, differences may be the result of the general structure of the financial system in a country (untrue). Cross-ownerships can also be used as a defense mechanism to prevent takeover, leading to more widely held firms (untrue).
The agency conflict between the controlling and minority shareholders can be reduced by improving the legal environment. An alternative view is that corporations seeking external capital will opt into legal regimes that are more protective of minorities without explicit legal reforms. However, it seems more likely that the existing ownership structures are primarily an equilibrium response to the domestic legal environments that the companies operate in.
#11 – Governance Regimes and Nationality Diversity in Corporate Boards: A Comparative Study of Germany, the Netherlands and the United Kingdom
Globalization may lead into transnational companies that are detached from their national origins and might be governed by a transnational business class. This rate differs due to differences among companies and stubborn country-of-origin effects. In the end, one might expect that even boards of MNCs will be characterized by increasingly higher nationality diversity. Company characteristics affect levels of national diversity within the executive boards, such as the level of foreign activities of a company, its corporate size, and the presence of cross-border M&As. However, board member recruitment is determined by different structural aspects of recruitment practices in different countries.
A country’s corporate governance regime has a number of different levels that include issues such as corporate governance codes and practices, laws, characteristics of business systems, and dominant elite ideologies. Within the CME (Germany), relations among firms typically engage in more strategic interactions with trade unions, suppliers of finance, and other actors. It has a clear two-tier system. Recruitment of executives is the responsibility of a nomination committee, whereas recruitment of the supervisory board is organized on the principle of codetermination, implying that one-their of the supervisory board seats are reserved for employee representatives (likely to be germans), and the other part for shareholder representatives. Since few firms are widely held in Germany, this leads to a dominant group of large blockholders. Finally, CMEs favor long-term relationships, which stimulates recruitment within Germany’s managerial ranks. All in all, this will create structural opportunities for Germans leading to H1a: the supervisory segment of the German board of directors will generally posses the lowest level of nationality diversity, compared with the Netherlands and UK. Often, the level of nationality diversity within the group of supervisory board members should correlate with the levels within the executive board, leading to a similar hypothesis for the executive board.
The Netherlands lies between the two extremes, with a two-tier board, but a movement towards a one-tier board. There is no CEO duality. Neither employees nor shareholders have been granted influence on the selection of supervisory board candidates. The supervisory board is responsible for the quality of its own performance and is in charge of nominating, appointing, suspending, and dismissing executives and also decide on its own members. Shareholders, employee representatives, and the executive board may suggest new candidates or raise objections when they disapproved of a candidate. As a result, the Dutch system has long been characterized as an old boys’ network, though that has fallen due to new legislation. The appointment of new members of both board segment now requires shareholders consent, although the workers’ councils which contain a legal representation for employees, have an indirect influence on the list of candidates. With the new legislation, it is expected that once internationals enter, they will grow exponentially. This leads to H2a&b: the supervisory and executive segment of the Dutch board of directors will generally possess intermediate levels of nationality diversity, compared with Germany and the UK.
In LMEs, relationships among firms and other actors are primarily coordinated through competitive markets and has a one-tier system. All nominations need shareholder approval during the annual meeting. Non-executives share the responsibility for the success of the company with the executives, but they clearly represent the shareholders. This link between shareholder interest and nonexecutives is a direct one and is explicitly defined as being an indication of good corporate governance. Shares of UK companies are generally widely held and shows an increase in foreign and domestic institutional investors. Shares in the UK are easy to acquire and once investors have a substantial number of shares, they have easy access to the boards because nonexecutives are expected to have a dialogue with them. As such, H3a&b state that the nonexecutive and executive segment of the British Board of directors will possess the highest level of nationality diversity.
Next to governance regimes, developments within the company also have an effect on the diversity of the board. Foreigners should bring valuable knowledge related to contextual issues in foreign markets and should be able to increase the quality of strategic decision making. Having foreigners on the board will help a company develop successfully in the international arena. Thus, (h4), the more countries a company is active in, the higher the nationality diversity of its board. Moreover, larger companies are more likely to MNCs, which increases the necessity for foreign board members. As such, H5 states that the larger a company is, the higher the nationality diversity of its board. Finally, M&As may lead to a combination of two former boards, hereby increasing the level of nationality diversity. Thus, H6, the more a company has been involved in large cross-border M&As, the higher the nationality diversity of its board.
The results show that German boards are the largest. Germany also has the lowest percentage of foreigners. However, not the UK but the Netherlands has the higher level of nationality diversity. There is only a minor difference in the average between executive and nonexecutives. However, the executive segment is clearly more international in Germany than the supervisory segment. In the Netherlands, the mean proportions are high in both segments, with a marginal difference between them. Finally, the UK shows an opposite pattern. The nonexecutive segment has a mean proportion similar to the Dutch, but score substantially lower on executive levels. The hypotheses 4 and 6 are confirmed, through company size shows a unexpected significant negative effect on level of nationality diversity. The reason for this is probably that the Netherlands shows the highest nationality diversity, even though it has small companies compared with other countries.
Thus, a country’s governance regime has an effect on the structural opportunities for foreigners to enter company boards. There are no direct effects between the two board segments. However, the interaction effect between country and boards are strong, suggesting differences in terms of how quickly they absorb foreigners.
#12 – Does Top Management Team Diversity Promote of Hamper Foreign Expansion?
There is an increasing need for TMTs to identify expansion opportunities beyond familiar domains. Cognitive diversity, rooted in different experiences in terms of tenure, education, age, and so on promote constructive debate and innovation. Research suggests that the formation of subgroups is likely in the case of strong faultline settings, that is, if the subgroups differ in terms of several demographic characteristics at the same time. Strong faultline settings hamper constructive debate and the capacity of the TMT to enter new foreign countries and regions. AS TMT members exchange information and learn from each other, the cognitive diversity of the team, as well as strong faultlines are reduced over time.
Diverse TMTs are more likely to enter new product markets, are more innovative, and implement innovation. However, other studies found that TMT tenure diversity decreased technological innovation,, that tenure diversity and functional diversity decreased product innovation, and that more diverse TMTs made less comprehensive evaluations of opportunities and threats.