University of Economics – Varna

“International Economic Relations” Department

BACHELOR THESIS

In support of the International Economic Relations

Bachelor of Economics degree

TOPIC:

Governance and Corporate Control Around The World

Author: Supervisor:

Petar Murginski Assoc. Prof. Dr. Orlin Todorov

Matr. Nr.: 98965 (................................)

Bulgaria

2016

Governance and Corporate Control Around The World

Attestation

This document is written by student Petar Murginski, matriculation number 98965,

who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no

sources other than those mentioned in the text and its references have been used in

creating it.

The University of Economics Varna is responsible solely for the supervision of

completion of the work, not for the contents.

Contents

Introduction .................................................................................................................................. 1

Chapter I. Fundamental Issues of Corporate Governance .......................................................... 3

1. Historical Background: Why Corporate Governance Is Nowadays Such An Important

Issue? ........................................................................................................................................ 3

1.1 The Worldwide Privatization Wave ............................................................................ 4

1.2 The Hostile Takeover Wave ...................................................................................... 5

1.3 Series of Scandals and Failures at Major Corporations ............................................ 7

2. Corporate Governance and Agency Costs ....................................................................... 7

Chapter II. Internal Governance Mechanisms: Evidence and Analysis ..................................... 10

1. The Board of Directors .................................................................................................... 10

1.1 Types of Directors ................................................................................................... 11

1.2 Board Independence ............................................................................................... 12

1.3 Board Size and Performance .................................................................................. 15

2. Executive Compensation ................................................................................................. 17

2.1 Stock and Options ................................................................................................... 18

2.2 Pay-for-Performance Sensitivity .............................................................................. 19

3. Ownership and Control .................................................................................................... 21

3.1 Pyramid Structure .................................................................................................... 23

3.2 Dual Class Share Structure ..................................................................................... 24

3.3 Cross Holdings ........................................................................................................ 26

Chapter III. External Governance Mechanisms: Evidence and Analysis ................................... 29

1. The Governance Role of Takeovers ............................................................................... 29

2. International Regulation and Legal Systems ................................................................... 32

2.1 The Cadbury Commission ....................................................................................... 33

2.2 The Sarbanes-Oxley Act ......................................................................................... 34

2.3 The Dodd-Frank Act ................................................................................................ 35

2.4 Insider Trading ......................................................................................................... 37

Chapter IV. Comparative Analysis of Governance and Corporate Control around the World ... 39

1. Comparative Analysis of Internal Governance Mechanisms .......................................... 40

1.1 Board Models .......................................................................................................... 40

1.2 Executive Compensation ......................................................................................... 45

1.3 Ownership and Control ............................................................................................ 47

2. Comparative Analysis of External Governance Mechanisms ......................................... 51

2.1 The Governance Role of Takeovers ....................................................................... 51

2.2 International Regulation and Legal Systems ........................................................... 56

3. Which System is the Best? .............................................................................................. 59

Conclusion ................................................................................................................................. 62

Bibliography ............................................................................................................................... 65

1

Introduction

Corporate governance may be defined broadly as the system of rules, practices,

mechanisms, processes and relations by which a company is being directed and

controlled, according to the formally established guidelines which determine how the

corporation is actually intended to be run. The rights and responsibilities of the

participants (e. g. board of directors, executives, shareholders and regulators) vary

significantly across countries. Therefore, to provide a universal and clear definition of

governance and corporate control around the world is a difficult task.

The purpose of this thesis is to explain why corporate governance is an issue of

worldwide importance, as the corporations play an important role in encouraging

economic development and social progress. The object of the theoretical part is to

review prior corporate governance studies, evidence, data and analysis. My personal

contribution is to conclude a comparative analysis of governance and corporate control

around the world, in order to find out what are the differences, and if there is a best

system. The focus is on the wealthiest economies, because the likelihood of

inappropriate actions taken under vague motives is the greatest. By answering those

questions empirically and systematically, I hope to provide a personal and

comprehensive description of governance issues, models and patterns around the

world, as follows:

(i) Why corporate governance is such an important issue nowadays? (ii) Why

corporations need to check on manager behavior? (iii) What are the types of agency

problems? (iv) Which are the internal and external governance mechanisms? (v) What

is the role of the board of directors? (vi) What kind of executive compensation policies

exist? (vii) What are the advantages and disadvantages of corporate ownership

structures? (viii) What is the role of the market for corporate control? (ix) How do the

regulation laws and legal origin around the world affect the firm performance and

protect the shareholders? (x) Which system is the best?

The subject is approached through several perspectives, including economics, law,

management, political science, sociology and culture. The independent analytical work

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consists of four chapters. First, we begin with the fundamental issues of corporate

governance – we explore why it has become such an important issue through a brief

historical sketch, and then we discuss the arising conflict of interest, between on one

hand the principal (shareholders) and agent (management), and on the other

hand – between controlling (large) and minority (small) shareholders. Second, we review

the key internal control and governance mechanisms, such as the board of directors,

executive compensation policies, and ownership structures. Third, we investigate the

external control and governance mechanisms through the role of takeovers, and

international regulation. Those components are based entirely on own research and

conclusion, reached on the ground of evidence and reasoning. We do not to examine in

details the legal differences, but rather support the world problem related to

transparency and moral hazard. Fourth, we explore and analyze how comparative

governance and corporate control systems differ across countries through highlighting

some of the main mechanisms and characteristics, by the example of the previous three

chapters. In order to provide the best possible logical sequence, and to better

understand the complex interaction between mechanisms and participants, the most

important points are summarized in the form of inferences, after each section. Finally,

we discuss if there is “one right system” or “best practice model”, and some

convergence opportunities – a potential area for future research. We conclude the

thesis with an explanation of why transparency is needed and why to have knowledge

about the different systems around the world is essential.

Over seventy sources were used for writing this thesis. Unfortunately, the topic in

Bulgaria is not that popular or applicable. Bulgaria currently needs significant

modernization of its markets and business funding channels. Furthermore, the sluggish

business interaction between the public and private enterprises needs improvement to

promote the economic stability and integration of the country as an equal member of

the European Union. Speaking as an international student, it pays to think globally and

act locally. The review literature is therefore mainly in English and German. For sure

there are also many other foreign sources, other than those mentioned, such as

Japanese, Chinese, Spanish, Hungarian, Polish and Czech, but they were not explored

due to a language barrier and limited time, for which I apologize in advance.

3

Chapter I. Fundamental Issues of Corporate Governance

1. Historical Background: Why Corporate Governance Is Nowadays Such

An Important Issue?

The fundamental issue concerning governance by shareholders nowadays, is

how to regulate large shareholders, so that the correct balance between manager

decisions and small shareholder protection to be achieved. Nevertheless, the term

corporate governance is inevitably connected with listed corporations, as the separation

of ownership and control, and therefore the arising agency conflicts are obvious. Before

exploring in deeper details the different aspects of this issue and the basic mechanisms

described in the next chapters, it is essential to begin with a brief historical background

and previous writings about the topic.

The word “governance” comes from the Greek “kubernan”, meaning to guide or

control, used for the first time by the ancient philosopher Plato. However, the term

“corporate governance” became popular recently and was spread widely during the

early 1960s by economists, political scientists and institutions, such as the United

Nations (UN), International Monetary Fund (IMF) and World Bank. 1 It was first used to

indicate the structure and the functioning of the corporate polity. The expression

derives from an analogy between the government of states, nations or cities, and the

governance of corporations. Today, for the world economy, the governance of

corporations is as important as the government of countries.2

Since the beginning, the main subjects in the corporate governance literature,

have been the role and duties of the board of directors and the institutional

arrangements around the corporate elections. The dilemma of how to obtain the right

balance between manager decisions and small shareholder protection is still actual and

existing in fact. Should the power of large shareholders be limited, or to tolerate less

1 See The European Commission Official Website. A Document on Corporate Governance Etymology. Accessed on May 24, 2016. <http://ec.europa.eu/governance/docs/doc5_fr.pdf>. 2 See Braendle, Udo and Alexander Kostyuk. Corporate Governance: Origin and Evolution. Accessed on 24 May 2016. <http://virtusinterpress.org/additional_files/book_corp_govern/sample_chapter01.pdf>.

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concentrated voting power through establishing democracy and eliminating special

privileges, and thus limiting manager decisions?

Sometimes investors want to gain control of the company as they believe the

management is not doing a good job, because of poor performance – mainly bad

investments, worker rights or issues related to the environment.3 However, the most

efficient method used by shareholders to discipline management for their own good, is

to replace it through a hostile takeover. Although corporations have improved a lot

during the last decades, some of the main problems – such as “the market for corporate

control” and “moral hazard”, have remained central topics in the academic and business

spheres.4 But why corporate governance is nowadays such an important issue? To

answer this question, the following reasons have been identified:

(1) the worldwide privatization wave; and

(2) the takeover (mergers and acquisitions) wave of the 1980s;

(3) series of scandals and failures at major corporations;

1.1 The Worldwide Privatization Wave

The privatization wave (Figure 1) raised the question of how the newly formed

companies should be owned and controlled. The privatization increased the role of the

stock market, as most of the sales were accomplished through public offerings, which

has further increased the attention on the small shareholders protection and whether

firm performance improved. In Figure 1 we compare privatization revenues (current $US

bn.) by region in the period between 1980 and 2000, as then was the peak of the wave.

3 See The Official Website of Investopedia. What is a Shareholder Activist? Accessed on 24 May 2016. <http://www.investopedia.com/terms/s/shareholderactivist.asp>. 4 Murginski, Petar. Mergers and Acquisitions: An Economic Analysis. University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, p. 2.

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Figure 1. Privatization Revenues by Region 1980-2000

Source: Bortolotti, Fantini and Siniscalco5 & own improvements.

As shown in Figure 1, the privatization played an important role in Western Europe, Asia,

Latin America, quite significant in Oceania and the former Soviet Union (some of which

countries joined the European Union recently), but not in the United States as state

ownership of companies has always been very small. In the early 1990s, the United

Kingdom was responsible for 90% of the European privatizations. By contrast, several

years later, in 1995, only Italy, France, Spain, Japan and Australia generated about 60%

of total privatization revenues around the world.6

1.2 The Hostile Takeover Wave

The takeover wave (Figure 2) in the USA in the 1980s and in Europe in the 1990s, has

further focused the attention on corporate governance. According to the size of the

deals and the numbers of transactions for the last 20 years, mergers and acquisitions

(M&A) activity has reached its highest point. The global takeover market is highly active

with transaction value of more than $1 trillion average per year.7 Next we discuss the

announced M&A deals in the period between 1985 and 2014.

5 By the example of: Becht, Marco, Patrick Bolton and Ailsa Roell. Corporate Governance and Control. ECGI Working Papers Series in Finance, 2005, No. 02/2002, p. 5. 6 Ibid., p. 4. 7 Mendenhall, Stahl. Mergers and Acquisitions. Stanford Business Book. California, 2005, p. 3.

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Figure 2. Announced Mergers and Acquisitions 1985-2014

Source: Institute of Mergers, Acquisitions and Alliances (IMAA)8

Figure 2 indicates that periods of the greatest takeover activity also occurred in the last

20 years between the 1990s and 2000s. It represent us that the worldwide volume of

takeovers remains at a highest level, even though this unknown wave of M&A has drop

in the beginning of the century, as the global economy settled down and went into

recession after the dot-com bubble (e.g. the largest deal happened the previous year, in

1999, where the acquirer was Vodafone AirTouch PLC and the target – Mannesmann

AG, for a record value of $202.8 bn.). The hostile takeovers were typical for the 1980s.

By contrast, the 1990s, were known for its global or strategic deals which were more

likely to be friendly, rather than hostile. The next jump in the takeover activity began 10

years ago. 2004 was characterized by consolidation in many industries such as

information technology (IT) or software, and telecommunications. The world financial

crisis in 2008 brought a sudden end to the latest merger wave as the trend since then is

almost the same, without any significant fluctuations.9 The catastrophe has led

international policy makers to conclude that macro-management is not prepared to

8 See more on: The Official Website of IMAA Institute. Accessed on April 9, 2016. <https://imaa-institute.org/statistics-mergers-acquisitions/#TopMergersAcquisitions_Worldwide>. 9 Murginski, Petar – ‘Mergers and Acquisitions: An Economic Analysis’, University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, p. 5.

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prevent global economy crisis. It is worth to mention that since then, corporate

governance reform in Russia, Asia and Brazil has been a top priority for the Organization

for Economic Co-operation and Development (OECD), the World Bank and institutional

investor activists.10

1.3 Series of Scandals and Failures at Major Corporations

In the beginning of the century, we have witnessed many scandals and corporate

frauds in the United States (e. g. companies like Enron, WorldCom and other filled the

news. Enron, with stock worth $68 billion at its peak, became almost worthless in a

matter of months, wiping out the retirement savings of thousands of employees and

stockholders. In 2002, WorldCom filed what was at the time the largest bankruptcy

ever11). The accusation of fraud is the common between those corporations, through

manipulation of accounting statements, which of course ended in total collapse, similar

to the crisis. But how did this happen? Were the managers acting in the shareholder’s

interest? Where were the boards of directors? Next, we discuss various governance

mechanisms, designed to mitigate the agency conflicts between managers and owners,

and prohibit managers from taking certain acts which are not in the shareholders’

interest.

2. Corporate Governance and Agency Costs

As mentioned, corporate governance refers to the system of rules, practices,

processes and relations by which a company is being directed and controlled12 according

to the formally established guidelines that determine how it is actually intended to be

run. The company’s board of directors approves and periodically reviews the guidelines

which have to match the company’s direction, performance and regulatory practices.

Corporate governance specifies the rights and responsibilities of company stakeholders,

which includes its’ shareholders, management, employees, customers and suppliers,

10 Becht, Marco, Patrick Bolton and Ailsa Roell. Corporate Governance and Control. ECGI Working Papers Series in Finance, 2005, No. 02/2002, p. 7. 11 Berk, Jonathan and Peter DeMarzo. Corporate Finance. 3rd Global Edition. Boston, Pearson Education, 2014, p. 961. 12 Shukla, Kedar. A Study of Structure of Corporate Governance in Central Government Organizations in India. International Journal of Management and Social Science Research Review, 2015, Vol. 1, Issue 10, p. 181.

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financiers and creditors, auditors and regulators, government and the community.13

Each company is trying to achieve a high level of governance, but to be profitable is no

longer enough as corporations nowadays have to take responsibilities beyond their

shareholder interests such as environmental issues and to demonstrate good practices

according to which its’ businesses are socially responsible for meeting ethical behavior

expectations by the society.14

The key function of corporate governance is to balance and define how power is

distributed optimally between those groups with particular emphasis on the

shareholders, board of directors, and management which runs the daily operations.

However, as long as we discuss corporate governance, there will always be a potential

conflict of interests, and respectively an effort which is trying and having the difficult

task to minimize them.

The separation of ownership and control in a company leads to a conflict of interests,

primarily between the managers and the investors. This is the most important stage

according to the success of the corporate organizational form15, especially because

managers are not required to own a stake in the firm and by this, their risk exposure is

lower than if ownership and control were combined, not separated. Once they are

separated, a conflict of interests emerge between the owners (investors/shareholders)

and the people who control the company (managers/executives). The more the interests

of the managers are aligned to the performance of the corporation, the smaller the risk

for the investors is. Such an effect could be achieved by linking the executive’s

compensation to the performance of the company but this action is not as reasonable

as it sounds. Moreover, it can be defined as a double-edged sword, where the company

might do poorly although it is not management’s fault or due to external factors. But on

the other hand managers can manipulate the actual situation inside the firm through

“cooking the books”, “dressing the bride” or other vague motives. Those kind of

13 See The Official Website of Investopedia. What is Corporate Governance? Accessed on 24 May 2016. <http://www.investopedia.com/terms/c/corporategovernance.asp>. 14 Ibid., Breaking Down Corporate Governance. 15 Berk, Jonathan and Peter DeMarzo. Corporate Finance. 3rd Global Edition. Boston, Pearson Education, 2014, p. 962.

9

problems “lie” on the foundations of the Agency cost theory, as in large corporations is

difficult for the shareholders to control and observe the managers.

In particular, almost any contractual relationship, in which one party (agent)

promises performance to another (principal), is potentially subject to an agency

problem.16 The core of the difficulty is that, because the agent commonly has better

information than does the principal about the relevant facts, the principal cannot assure

himself that the agent’s performance is exactly what was promised. There are supposed

to be methods which are in support of the anti-agency problems, but still, many

observers believe that it is impossible to deal with.

A common explanation is that managers sometimes have their own point of view

and reasons to become larger through mergers and acquisitions. They are more focused

on their own self-interest which most of the time is not in the best interest of the

shareholders. Managers are driven mainly by the financial award through takeover

bonuses or pure personal ambition. They behave selfish, their ego leads them often to

overconfidence as they want to attract the attention of the media in order to gain better

reputation.17 The key factor between the conflict of interests and overconfidence is

actually that when overconfidence occurs, managers really believe they are taking the

right decision and in the interest of the shareholders. However, the end result is quite

similar and have basically the same impact, as both actions are increasing the

managements’ wealth and decreasing the shareholders’.

Effective corporate governance structure combines various internal and external

mechanisms that drive the organization toward its objectives while also satisfying

stakeholders' needs, and is therefore essential if a business wants to set and meet its

strategic goals. In Chapter 2, we discuss the internal control and governance

mechanisms.

16 Hansmann, Henry and Reinier Kraakman. Agency Problems and Legal Strategies. Yale Law School Research Paper, 2004, No. 301, p. 21. 17 Murginski, Petar. Mergers and Acquisitions: An Economic Analysis. University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, pp. 22-23.

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Chapter II. Internal Governance Mechanisms: Evidence and Analysis

1. The Board of Directors

In the beginning, any non-expert person would think at first sight that monitoring

the top management closely is a simple solution to the principal-agent problem. The

only issue with this reasoning is that it ignores the cost of monitoring. When the

ownership of a corporation is distributed over a large number of people, none of the

shareholders has motives to carry this responsibility, nor to pay the price as he/she bears

the full cost of monitoring, but the benefit is divided among all shareholders.

As an alternative, the shareholders elect a board of directors to monitor managers.

However, the directors themselves have the same conflict of interest as monitoring is

expensive and in many cases directors do not get significantly greater benefits than

other shareholders from monitoring the managers closely.18 Accordingly, in most cases

shareholders understand that there are certain limits on how much monitoring they can

expect from the board of directors. This does not mean that keeping an eye on

management is not important, because it is, but is not the main purpose. First the board

has to guide and give directions to the executives, and then it has something to keep an

eye on.19 Monitoring is the process of comparing actual results against the targets and

standards created. This suggests that boards give two explicit messages to the CEO:

(1) what must be accomplished (what results are expected to be achieved); and

(2) what is not allowed to be done in order to meet the expectations (what are the

barriers to effective management and how executive actions are limited);20

In principle, the board of directors hires the executive team, sets its compensation,

approves major investments and acquisitions, monitors and dismisses executives if

18 Berk, Jonathan and Peter DeMarzo. Corporate Finance. 3rd Global Edition. Boston, Pearson Education, 2014, p. 963. 19 Scholl, Marylin. Boards Role in Performance: Assurance Policy Governance. University of Wisconsin Center for Cooperatives, 1995. Accessed on May 20, 2016. <http://www.uwcc.wisc.edu/issues/Governance/monitor.html>. 20 Ibid., The ideas (1) and (2) come from the book ‘Boards That Make a Difference’, written by John Carver, and published by Jossey-Bass in 1990.

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necessary – all with an eye towards maximizing shareholder value.21 Regular board

meetings allow potential problems to be identified, discussed, solved or postponed. In

the United States, the board of directors and the owners of the firm are supposed to

have a transparent and clear relationship, as the first are responsible for the protection

of the interests of the second. Other countries give some weight to the

interests of other stakeholders in the firm, such as the employees. In Germany, this

practice is legalized through a two-tier board structure that guarantees half of the seats

on the upper board (also known as supervisory board) to employees. In France firms can

elect a single board of directors, as in the United States, United Kingdom, and Japan, or

a two-tiered board, as in Germany – models, which are going to be discussed and

compared more detailed in Chapter 4. The board needs sufficient relevant skills and

understanding to review and challenge management performance. It also needs

adequate size and appropriate levels of independence and commitment.22

1.1 Types of Directors

On the whole, analysts have classified three types of directors: inside, gray, and

outside (or independent). Inside directors are employees, former employees, or family

members of employees. They typically include officers, such as the chief operating

officer (COO), the chief financial officer (CFO), or other representatives who are

appointed and expected always to act or speak in the best interests of major

shareholders and lenders, or other stakeholders such as labor unions.23

A strong board of inside directors has an important role according to the success of the

organization as they possess special or hidden knowledge about the inner situation of

the company. Gray directors, on the other hand, are people who are not as directly

connected to the firm as insiders are, but who have existing or potential business

relationships with the firm, such as bankers, lawyers, and consultants who are already

engaged with the firm, or who would be interested in being engaged, could become

21 Dennis, Diane and John McConnell. International Corporate Governance. ECGI Working Paper Series in Finance, 2003, No. 05/2003, p. 2. 22 See The Official Website of OECD. Principles of Corporate Governance. 2004, Article VI. Accessed on May 21, 2016. <http://www.oecd.org/corporate/ca/corporategovernanceprinciples/31557724.pdf>. 23 See The Official Website of Investopedia. Definition of Inside Director. Accessed on May 21, 2016. <http://www.investopedia.com/terms/i/insidedirector.asp?layout=orig>.

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members of the board. Thus, their judgment could be compromised by their desire to

keep the CEO happy. Finally, all other directors who are not employees or stakeholders

in the company are considered outside (independent) directors and are the most likely

to make decisions entirely in the interests of the shareholders.

1.2 Board Independence

The outside (independent) directors are widely believed to play a larger role in

monitoring management than inside board members do, even though they are

extremely busy – the most active and dedicated independent directors spend only

couple of days per month on firm business, and many independent directors sit on

several different boards (meaning more than three)24, which is dividing their attention

even more. Because of the fact that the probability of top management to harm

shareholder wealth is supposed to be lowered, researchers have hypothesized that

boards with a majority of outside directors are better monitors of managerial actions.

Thus, an early study25 showed that directors are not typically involved in important

corporate decisions, but in crisis situations, a board was more likely to fire the firm’s

CEO for poor performance if the board had a majority of outside directors (60% or

more). This is because outside directors have incentives to develop reputations as

experts in decision control – the value of their human capital depends primarily on their

performance as an internal decision managers in other organizations.26 Therefore,

outside directors have motives and reasons to guarantee the effective running of the

company, because being directors of successful and well-run companies proves that:

(1) they are competent decision experts;

(2) they understand the importance to separate control; and

(3) they can deal with such control systems when necessary.

24 Fich, Eliezer and Anil Shivdasani. Are Busy Boards Effective Monitors? Journal of Finance, 2006, Vol. 61, No. 2, pp. 690-705. 25 Weisbach, Michael. Outside Directors and CEO Turnover. Journal of Financial Economics, 1988, Vol. 20, No. 1, pp. 431-436. 26 Fama, Eguene and Michael Jensen. Separation of Ownership and Control. Journal of Law and Economics, 1983, Vol. 26, No. 2, p. 315.

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Another study27 has found that firms with independent boards make fewer value

destroying acquisitions and are more likely to act in shareholders’ interests if targeted

in an acquisition. Although, the key to economic efficiency in the takeover market is:

(1) not the price, paid by the acquirer; but instead

(2) whether there is a reliable long-term vision and good strategic fit between the

acquirer and the target;

Taken as a whole, these studies provide evidence only that outside directors behave

differently than inside directors, but is not clear whether majority-independent boards

make better or worse decisions on average. Even that non-executive directors are

thought to be more independent, they may not always result in more effective

corporate governance and may not increase firm performance.28 Outside directors are

paid benefits and/or stock options, or retainer (fixed) fee, which is a method used

usually to individual third-parties. Those kind of payments are made in advance and

guarantee only the commitment of the receiver, not the end result.

Most corporate standards require public companies to have certain percentage of

outside directors as they have very little or insignificant conflict of interest and are less

likely to provide fair and neutral opinions. The only issue is that the less involved with

the company the outside directors are, the less information they possess, which

respectively reduces their effectiveness and competences paradoxically in terms of

decision-making.

Despite evidence that board independence matters for major activities such as firing

CEOs and making corporate acquisitions, finding a connection between board structure

and firm performance is a struggle. There are so many other factors which influence firm

performance that the effect of a more or less independent board is very difficult to be

detected. Moreover, the longer the CEO has served (especially when that person is also

a chairman of the board), the more likely the board is to become captured.

27 Byrd, John and Kent Hickman. Do Outside Directors Monitor Managers? Evidence from Tender Offer Bids. Journal of Financial Economics, 1992, Vol. 32, No. 2, pp. 196-204. 28 Bhagat, Sanjai and Bernard Black. The Uncertain Relationship between Board Composition and Firm Performance. Center for Law and Economic Studies, 1999, Business Law No. 54, p. 3.

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A captured board is when monitoring duties have been compromised due to pure

social and/or personal influence. As mentioned earlier, shareholders elect a board of

directors, who in turn hire a CEO to lead management. The primary responsibility of the

board is to select and control the CEO. When both roles are held by the same person,

this naturally creates a conflict of interest between management and the board. If the

CEO is also a chairman of the board, the nominating letter offering a seat to a new

director comes from him/her. Then, the independent directors are nominated by the

CEO, which in most cases makes the outside directors feel that they owe their positions

to him/her, and that they work for the CEO, rather than for the shareholders. Empirical

evidence29 indicated that in 2004, 73.4% of U.S. companies had combined roles.

However, this fell to 57% by 2012, and further to 52% by 2015 (Figure 3).

Figure 3. Chairman Relationship with the Company 2015

Source: Spencer Stuart30

German and UK companies have generally split the roles in nearly 100% of listed

companies, which does not indicate one model is superior to the other in terms of

performance. Hopefully, the latest statistics31 shows that the chairman role is

increasingly independent, the average compensation rose and fewer first-time directors

joined boards last year:

29 Smith, Magdalena. Should the USA Follow the UK’s Lead and Split the Dual CEO/Chairperson’s Role? Cambridge, Judge Business School Press, 2013, p. 2. 30 See The Official Website of Spencer Stuart. US (S&P 500) Board Index 2015, p. 24. Accessed on May 22, 2016. <https://www.spencerstuart.com/research-and-insight/spencer-stuart-us-board-index-2015>. 31 Ibid., Spencer Stuart Board Index, p. 12.

15

(1) 29% of the companies now have a truly independent chairman

(a non-executive director or former executive who has met the requirements of

independence over time);

(2) average per-director compensation rose 5% to $ 277,237.00; and

(3) only 26% of newly elected directors in 2015, compared to 39% in 2014

(drop by a third);

1.3 Board Size and Performance

There is no universal rule about the optimum size of a board of directors. A large

number of members represents a challenge in terms of using them effectively and/or

having any kind of meaningful individual participation. Most boards range from 3 to 31

members, but the average size is 9 (Figure 4). Still, most of the observers believe that

the ideal size is seven.

Figure 4. Board Size 2015

Source: Spencer Stuart32

Figure 4 shows that the trend from 2005 and 2010 has not changed significantly and

the results are similar, respectively for 2005 – 16% for ‘8 or fewer directors’, 66% for ‘9

to 12 directors’ and 18% for ‘13 or more directors’; for 2010 almost nothing has changed

and the numbers are nearly the same – 14% for ‘8 or fewer directors’, 68% for ‘9 to 12’

32 Ibid., p. 16.

16

and 18% for ’13 or more’; and for 2015 – only 9% for ‘8 or fewer’ (drop by two-fifths/40%

compared to 2005 and 2010), 74% for ‘9 to 12’ (rise to one-tenth/10% compared to the

two previous periods) and 17% for ’13 or more’.

A previous research33 has found the clear correlation and robust result that smaller

boards are connected with greater firm value and performance, because smaller groups

make better decisions than larger groups. In addition, there are two critical board

committees that must be made up of independent members – the compensation, and

the audit committee.34

The audit committee works with the auditors to make sure that the books are correct

and that there are no conflicts of interest between the auditors and the other consulting

firms employed by the company. The audit committee should meet at least four times

per year. The compensation committee is responsible for setting the pay of top

executives and should meet at least twice per year. The minimum number for each

committee is three. This means that a minimum of six board members is needed so that

no one is on more than one committee. The seventh member is the chairperson. His/her

responsibility is to make sure that the board is functioning properly, and the CEO is doing

his/her job.

A conflict of interests may occur when both roles are performed by the same person.

Having members doing double duty may compromise the important wall between the

two committees. Although most corporations prefer to start with less directors, boards

tend to grow over time as members are added for various reasons, especially after an

expansion or acquisition.

Inference

To sum up, thorough and systematic monitoring is the key to transparent

governance as it assures the board that current executive activities are appropriate.

While the board is an effective corporate governance mechanism in theory, in practice

33 Yermack, David. Higher Market Valuation of Companies with a Small Board of Directors. Journal of Financial Economics ,1996, Vol. 40, p. 189. 34 See The Official Website of Investopedia. Evaluating The Board. Accessed on May 23, 2016 <http://www.investopedia.com/articles/analyst/03/111903.asp>.

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its value is less clear. Boards of directors include some of the very insiders who are to be

monitored. In some cases they (or parties sympathetic to them) represent a majority of

the board. In addition, it is not uncommon that the CEO is also the chairperson of the

board. Finally, the nature of the selection process for board members is such that

management often has a strong hand in determining who the other members will be.

The primary board-related issues that have been studied are board composition and

executive compensation. Board composition characteristics of interest include the size

and structure of the board:

(1) the number of directors that comprise the board;

(2) the fraction of these directors that are outsiders; and

(3) whether the CEO and chairperson positions are held by the same individual.

Executive compensation is yet another primary issue (especially in the United

States), which is going to be discussed next, as it is fundamentally concerned to the

degree to which managers are compensated, in ways that align their interests with those

of their companies’ shareholders.

2. Executive Compensation

Besides monitoring and control of CEO actions, another way of improving

shareholder protection is to structure the CEO’s compensation package, so as to align

his objectives with those of shareholders, and is generally viewed as a key internal

mechanism. This is what executive compensation is supposed to achieve through a basic

salary, bonuses, stock options, and other benefits such as pension rights or “golden

parachutes”.35

The role of the corporate governance system is to make less severe and painful the

conflict of interests that is the outcome from the mentioned earlier separation of

ownership and control, but without loading the managers with unnecessary

responsibilities related to the risk of the company. Therefore, in the absence of

35 Becht, Marco, Patrick Bolton and Ailsa Roell. Corporate Governance and Control. ECGI Working Papers Series in Finance, 2005, No. 02/2002, pp. 24-25.

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monitoring a simple system is formed, in order to align their interests by giving a reward

for taking the right actions and decisions, or accordingly to penalize the wrong such. One

way to do that is by giving a compensation that is sensitive to performance, or from

owning stock in the firm, but the situation is complex. Although the incentives of the

manager become better and stronger related, it becomes harder to remove or fire

him/her as well, because in the case when the executive owns more stock, he/she

receives notable and important voting rights during the meetings which leads to the

second agency problem – the conflict between, on one hand, owners who possess the

majority or controlling interest in the firm and, on the other hand the minority or

non-controlling owners.

To summarize, reducing agency costs is in the interest of all participants in the

corporate governance system, and there are many mechanisms through which

compensation policy can provide value-increasing incentives36, including stock options

or performance-based bonuses and salary revisions.

2.1 Stock and Options

Executive’s pay could be related to the performance of a company in many ways.

The most common method used is through bonuses based on the earnings growth.

Involving stock and options in the compensation policies gives managers good reasons

and motives to increase the attractiveness and value of the company, respectively to

make the stock price as high as possible.

Early studies37 show that for every $1000 increase in firm value, CEO pay changed

on average by $3.25, of which $2 (60%) came from changes of their stock

ownership – the difference of $1.25 (40%) was driven primarily by options and bonuses.

However, the authors argued this incentives were too small or insignificant, and at the

end of the day it depends on the ethics and desire for optimal results of the executive,

which remains subjective.

36 Jensen, Michael and Kevin Murphy. Performance Pay and Top Management Incentives. Journal of Political Economy, 1990, Vol. 98, No. 2, p. 3. 37 Ibid., p. 45

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2.2 Pay-for-Performance Sensitivity

The level of compensation and the extent of pay-for-performance for CEOs has been

a topic of serious contradictions in both the business and academic spheres.38 Figure 5

shows the average cash pay, stock and option, bonuses and other types of payouts over

the period 1992-2013 and illustrates the substantial increase in chief executive officer

pay during the last two decades.

Figure 5. CEO Compensation

Source: Compustat ExecuComp39

The average cash pay, consisting of salary and bonuses, increased slightly and remained

quite the same. Instead of that, the most important factor which contributed to the

increased compensation of the CEO was the rise in the value of stock and options.40 The

median value of options given increased from less than $200,000 in 1993 to more than

38 Core, John, Robert Holthausen and David Larcker. Corporate Governance, Chief Executive Officer Compensation, and Firm Performance. Journal of Financial Economics, 1999, Vol. 51, p. 372. 39 By the example of: Damodaran, Aswath. CEO Compensation: The Pricing and Valuing of Top Managers. Accessed on April 12, 2016. <http://www.valuewalk.com/2015/04/ceo-compensation-the-pricing-and-valuing-of-top-managers/>. 40 See Beckerman, Josh. Tesla CEO Elon Musk’s Salary $37,584 Reflects California Minimum Wage. The Wall Street Journal Article. Accessed on April 18, 2016. <http://www.wsj.com/articles/tesla-ceo-elon-musks-37-584-salary-reflects-california-minimum-wage-1460759161?mod=e2fb>.

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$1 million in 2001. Therefore, the solid use of stock and option grants in the 1990s

greatly increased managers’ pay-for-performance sensitivity.

Accordingly, recent evaluations show that CEO wealth increases with $25 for each

change of $1000 in firm value.41 In contrast to that, recently companies have been

decreasing the part of stock and option grants used in CEO compensation packages

(Figure 5), stating that the level of sensitivity is too big.

Yet, this was not the only problem. Sometimes options are given frequently “at the

money”, which means the strike price and the current stock price are the same. Thus,

the top-management has a reason and motivation to manipulate the interpretation and

release of financial forecasts, so that the bad news go out before options are granted

(to drive the strike price down), and good news go out after options are granted.

Another study42 prooved that the practice of timing the release of information in order

to maximize the value of CEO stock options is very popular and frequently used.

Inference

As mentioned above, the design of performance incentives for managers in

corporations is an enormously important issue. Aligning the incentives of executives

with those of owners is the easiest way to reduce the conflict of interests. If there is no

reasonable connection between CEO pay and firm performance, it is questionable if the

public corporations are being managed efficiently. Shareholders want CEOs to take

specific actions – for example, deciding which problem to solve, which project to pursue

or drop – whenever it is in the owners’ interest. But most of the times, the CEO takes

into consideration only his private gain and cost from pursuing a particular activity. That

is why a compensation policy which ties the CEO’s welfare to shareholder wealth helps

to align the private and social costs and benefits of alternative actions and thus, provides

incentives for CEOs to take the correct decisions.

41 Hall, Brian and Jeffrey Liebman. Are CEOs Really Paid Like Bureaucrats? The Quarterly Journal of Economics, 1998, Vol. 103, Issue 3, p. 676. 42 Yermack, David. Good Timing: CEO Stock Option Awards and Company News Announcements. The Journal of Finance, 1997, Vol. 52, Issue 2, p. 473.

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Nevertheless, shareholder wealth is affected by many factors in addition to the CEO,

including actions of other executives and employees, demand and supply conditions,

and public policy. It is appropriate, however, to pay CEOs on the basis of shareholder

wealth since that is the most important aim, considering the shareholders’ goal and

perspective.

3. Ownership and Control

Up till now, the central agency problem in large corporations around the world was

focused on irresponsible professional managers, who are not loyal to the shareholders’

interests, but a conflict of interests between the minority, and controlling shareholders

(who own more than 20% of the shares) may arise as well. Typically, large corporations

have large shareholders, who are also active in corporate governance. The degree to

which the rights of the shareholders are protected vary widely around the world, and is

determined by the legal origin – whether it is based on the Anglo-Saxon common law

(shareholders are well-protected), or the French and German civil law (shareholders are

not so well-protected).43

Most of this chapter has been dedicated to the agency conflict between

shareholders and managers, which usually occurs in the United States and the United

Kingdom. However, in Continental Europe and Asia, the conflict is typically between the

minority and controlling shareholders (wealthy families).

Control and ownership structure refers to the types and composition of shareholders

in a corporation. But due to the existence of dual class shares and pyramids, ownership

does not necessarily mean control (Table 1). Nevertheless, they are rarely entirely

separated in the corporation. As mentioned earlier, according to the executive

compensations policies, ownership by the corporation’s management better aligns their

interests with those of the shareholders, and therefore reduces the agency conflict.

But on the other hand, large shareholders with more significant ownership positions,

have motives to spend huge amount of resources on monitoring the management, than

43 La Porta, Rafael, Florencio Lopes and Andrei Shleifer. Corporate Ownership around the World. Journal of Finance, 1998, Vol. 54, Issue 2, pp. 26-29.

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minority shareholders. If large shareholders use their control for private benefits, the

firm value will decrease, together with the private benefits of the minority shareholders.

Thus, the ownership structure is an extremely important internal governance

component. For Germany44, Japan45 and South Korea46, pyramids and cross-holdings are

the most important ownership structures, and represent a major part of the business

and corporate culture. The question is:

(1) whether the voting power of large shareholders must be limited, in order to

avoid the disadvantages for the minority shareholders; or

(2) whether concentrated voting power should be encouraged, in order to limit the

vague and irresponsible managerial behavior.

Corporate ownership and control structures can differ significantly across the

countries. The two basic cases, where ownership and control overlap, are represented

in Table 1.

Table 1. Ownership and Control

Source: Goergen, Manjon and Renneboog47

As Table 1 indicates, dispersed ownership and weak control (Panel A) describes the

agency conflict between management and shareholders, and is typical for the

44 See more on: Köke, Jens. New Evidence on Ownership Structures in Germany’. ZEW Discussion Paper, 1999, No. 99-60, pp. 23-25. 45 See more on: Lichtenberg, Frank and George Pushner. Ownership Structure and Corporate Performance in Japan. National Bureau of Economic Research Working Paper, 1992, No. 4092, pp. 25-26. 46 See more on: Lee, Leon. Mega Corporations in Japan and Korea. Association for Asian Research, 2003, Article No. 1397. Accessed on June 1, 2016. <http://www.asianresearch.org/articles/1397.html>. 47 By the example of: Keasey, Kevin, Steve Thompson and Mike Wright. Corporate Governance: Accountability, Enterprise and International Comparison. UK, J. Wiley & Sons Publishing, 2005, p. 287.

23

Anglo-Saxon system. The monitoring is quite insufficient, but the takeover market is

highly active. Dispersed ownership and strong control (Panel B) is dedicated to the

conflict between minority and controlling shareholders, and usually occurs in

Continental Europe, where pyramids exist. By contrast, the monitoring of management

is very efficient, which reduces the takeover possibility. Concentrated ownership and

weak control (Panel C) describes again the agency conflict between management and

shareholders, and is typical for Germany. The rights of the minority shareholders are

well-protected, and the motives for monitoring are insignificant. Concentrated

ownership and strong control (Panel D) is related to the agency conflict between the

minority and controlling shareholders, and typically occurs in Continental Europe

and Asia.

The motives for monitoring are very high, and thus the takeover possibilities are

reduced.48 The classical problem of separation of ownership and control suggests that

large shareholders have the power and the incentives to closely monitor management,

no matter what the cost is. Thus, when protection of minority is weak, they become

exploited by the controlling shareholders. In the same way, pyramid structures and

cross holdings limit efficient monitoring of management, where the shareholder

structure does not only involve the first level of owners, but the owners of the

owners as well.

3.1 Pyramid Structure

One possible way to control a corporation without owning more than 50% of the

equity, is to create a pyramid structure (Figure 6). They are common in Continental

Europe and Asia, where control is applied through several layers of companies, typically

owned by wealthy families.49 A three-row level example of a structure is presented in

Figure 6. The purpose is to clarify how a pyramid actually works.

48 Ibid. 49 Bebchuk, Lucian, Reinier Kraakman and George Triantis. Stock Pyramids, Cross-Ownership and Dual Class Equity: The Mechanisms and Agency Costs of Separating Control from Cash-Flow Rights. Harvard Law School Olin Discussion Paper, 2000, No. 249, p. 5.

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Figure 6. Pyramid Structure

Source: Köke50 & own calculations

In a pyramid, as shown in Figure 6, a family first creates a firm Z in which it owns more

than 50% of the shares, and thus has a controlling interest. Then the same firm Z owns

a controlling interest, which is about 50.1% of the shares in another firm Y. Therefore,

the family controls the two firms Z and Y, but owns only 25% of the second firm Y.

Consequently, if the second firm Y purchases 50.1% of the shares of a third firm X, then

the family would control all the three, despite of the fact it would own just 12.5% of the

third firm X. The more we move down to the bottom of the pyramid (where the actual

operating companies are), the less ownership the family has, but still remains in a

complete control of the three companies (e. g. if Firm X is an operating company

worth $1 bn., a large shareholder in Firm Z could control it with an investment of just

$125 million).

3.2 Dual Class Share Structure

Another way for families to obtain control over firms even when they do not own

50%+ shares, is to issue dual class shares, where companies have more than one class

of shares, and one class have privileged voting rights (superior over another). This

method is common for Continental Europe, Scandinavia and South Korea.51

50 By the example of: Köke, Jens. New Evidence on Ownership Structures in Germany’. ZEW Discussion Paper, 1999, No. 99-60, p. 7. 51 See The Official Website of Investopedia. Dual Class Stock. Accessed on June 3, 2016. <http://www.investopedia.com/terms/d/dualclassstock.asp>.

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As in the pyramid structure, the dual class share structure allows large shareholders

to maintain control through extra voting rights, while minority shareholders with less

voting power (lower class of shares) provide sufficient part of the capital (e. g. Facebook,

where Mark Zuckerberg controls more than 50% of the voting power, because he owns

the majority of Facebook’s class B shares, and each class B share has 10 votes against

only 1 vote for each share of class A).52

Usually is not necessary to own more than 50% of the shares, so that effective

control to be achieved. To further extend the complexity, a combination of both

structures is possible (Figure 7), which results in a pyramid structure with special right

voting shares, efficient especially for family control purposes (e. g. Pesenti Family).

Figure 7. Pesenti Family Structure

Source: BerkDeMarzo & Volpin53 and own improvements

52 By the example of: Brealey, Richard, Stewart Myers and Franklin Allen. Principles of Corporate Finance. 10th Int. Edition. McGraw-Hill Publishing, 2006, p. 857. 53 By the example of: Volpin, Paolo. Governance with Poor Investor Protection: Evidence from Top Executive Turnover in Italy. London Business School and CEPR, 2002, p. 43.

26

Figure 7 describes a real pyramid controlled by the example of Pesenti family in Italy.

Each box includes ownership and voting rights, which vary depending on the class of

shares, whether extra voting rights are used. The black numbers show the rights of the

previous company above the pyramid. The red numbers indicate the Pesenti Family

rights itself. Even though the Pesenti Family does not possess 50%+ of the

shares (only 7% at the bottom of the pyramid), it effectively controls all the five

companies – Italmobiliare, Italcementi, Franco Tosi, Cementerie Siciliane, and Cementeri

de Sardegna.

Although the family receives small amount of the dividends from the companies at

the bottom, it still controls them. When the companies are in a similar industry (e. g.

construction business), a conflict of interest may arise, as the family has reasons and

motives to try moving profits, thus dividends up the pyramid, from companies in which

it has few cash flow rights – towards companies in which it has more cash flow

rights – an illegal process known as tunneling.54 Furthermore, why not even for giving

false and tricky financial statements to the public – both potential and existing investors

on one side, and on the other potential acquiring companies (“cooking the books” and

“dressing the bride” approaches) – or for tax avoidance purposes, both legitimate

offshore moves and/or money laundering. That is why regulation is essential and needed

(described in Chapter 3), as well as accountable and transparent governance.

3.3 Cross Holdings

Cross-holding occurs when listed corporations own shares in another publicly-traded

corporation, which can result in estimating the wrong value of the companies, as

inferred in the previous section.55 Thus, especially in the M&A sector, the valuation

should be done very precisely, as sometimes takeovers may result from stock market

valuation mistakes. The valuation process is complex as it often includes matters like

synergy and control, which go beyond just valuing a target firm. There are valuation

methods that rely on cash flows, which are divided in direct (absolute) or indirect

54 See The Official Website of Investopedia. Definition of Tunneling. Accessed on June 3, 2016. <http://www.investopedia.com/terms/t/tunneling.asp>. 55 See The Official Website of Investopedia. Cross Holding Definition. Accessed on June 3, 2016. <http://www.investopedia.com/terms/c/cross-holding.asp>.

27

(relative) valuations methods, such as discounted cash flow (DCF) or price-to-cash-flow

ratio. There are also valuation methods that rely on a financial variable other than cash

flow like economic income models and value analysis, or other ratios such as

price-to-earnings ratio (P/E), sales and enterprise value multiples, which show the total

value of the target company.56 Future cash-flows forecasts and discounting rates for

target’s share price are needed, if the purpose is valuation of a company as an individual

business. However, if the takeover is hostile, not friendly, the lack of such information

and other potential gaps in the analysis, can block and fail the valuation process due to

inaccuracies. 57

In the United States and the United Kingdom, it is not typical for a company to be

the largest shareholder of another company. By contrast, it is quite usual in Germany,

Japan, and South Korea58. In Japan, a group of companies connected through

cross-holdings and common relation to a bank, are known as “keiretsu” – a network of

companies organized around a major bank, traditionally known as the most notable

feature of Japanese corporate finance, as Japan is said to have well-established

relationships between banks and firms in the long term. 59 Thus, the keiretsu is a

corporate governance system, where power is divided between the main bank, the

group’s largest companies, and the group as a whole, which respectively gives certain

financial advantages.

In South Korea, huge conglomerate groups such as Samsung, LG, SK Group and

Hyundai, are involved in widely diversified lines of business and are known as “chaebol”.

The 10 largest conglomerates control approximately 70% of the corporate economy (e.

g. SK Group has subsidiary and group companies in energy, chemicals, pharmaceuticals,

and telecommunications, with a total revenue of $156 bn.60 as per 2015 – 37% increase

compared to 2011’s revenue of $99 bn.). Typically in Asia, many well-diversified

56 Murginski, Petar. Mergers and Acquisitions: An Economic Analysis. University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, p. 23. 57 Ibid., p. 27. 58 Lee, Leon. Mega Corporations in Japan and Korea. Association for Asian Research, 2003, Article No. 1397. Accessed on June 4, 2016. <http://www.asianresearch.org/articles/1397.html>. 59 Brealey, Richard, Stewart Myers and Franklin Allen. Principles of Corporate Finance. 10th Int. Edition. McGraw-Hill Publishing, 2006, p. 851. 60 See The Wall Street Journal Official Website. 5 Questions about SK Group. Accessed on June 4, 2016. <http://blogs.wsj.com/briefly/2015/07/31/5-questions-about-sk-group/>.

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conglomerates such as the chaebols are very efficient and profitable – they grow with a

fast and constant pace for decades in a row. Nevertheless, the tunneling mentioned

earlier in the pyramid structure, overlaps in the conglomerate as well. Actually, business

observers believe that the most recent Asian crisis 20 years ago, was due to both

tunneling and poor corporate governance.61 An important difference between the

Japanese keiretsu and the South Korean chaebol, is that South Korean conglomerates

do not share a common relationship with a single bank.

Inference

To sum up, in Continental Europe and Asia, the conflict is usually between the

minority and controlling shareholders (wealthy families), which indicates that the

central agency problem in large corporations across the world could be focused on the

minority and controlling shareholders, rather to the irresponsible professional

executives as in the United States.

Large corporations have large shareholders, who are also active in corporate

governance, thus the ownership and control structure is extremely important

governance mechanisms. The degree to which the rights of the shareholders are

protected vary widely – whether the legal system is bank-based (civil law – Asia and

Continental Europe) or market-based (common law – Anglo-Saxon).

Some types of control and ownership structure involve corporate groups, and

include different kind of pyramids and cross holdings, recognized with their complex and

difficult for tracking structures. Japanese keiretsu and South Korean chaebol (said to be

family controlled) are corporate groups, which consist of compound overlapping

business relationships and shareholdings. Cross-holdings are an essential feature of

keiretsu and chaebol groups. However, corporate engagement with shareholders and

other stakeholders, can differ substantially across the different control and ownership

structures around the world.

61 See Ref. 59, p. 858.

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Chapter III. External Governance Mechanisms: Evidence and Analysis

Even though agency theory emphasizes the contractual nature of firms and the

potential for a variety of internal governance mechanisms to reconcile the interests of

shareholders and managers in public companies, it also recognizes that in some

instances internal governance may not adequately monitor the behavior of managers.

Consequently, it is often suggested that takeovers and regulation environment

represent important external governance mechanisms, whereby shareholders can

replace underperforming or opportunistic managers, and make the regulation of the

governance of a company easier and more transparent.

1. The Governance Role of Takeovers

When internal governance mechanisms such as board of directors, compensation

policies and ownership fail, the one remaining way to remove poorly performing

managers is by mounting a hostile takeover. Takeovers play an important role in

protecting shareholders when the company’s internal controls are ineffective.62 This

governance role of takeovers is grounded on the argument that the stock market

represents an objective evaluation of managerial performance.63

The launch of a hostile takeover bid is generally perceived as a signal by the bidder

that the target’s assets are not being maximized for the benefit of shareholders, and/or

the performance could be improved. The main motivation behind a takeover is to

remove management inefficiency. Thus, the effectiveness of the corporate governance

structure of a company depends on how well protected its executives are from removal

in a hostile takeover. If the target company chooses to resist a takeover bid, it needs to

consider the defensive strategy it wishes to pursue. The regulatory environment will

heavily influence the strategy chosen.

62 Jensen, Michael. The Takeover Controversy: Analysis and Evidence. Midland Corporate Finance Journal, 1986, Vol. 4, No. 2, pp. 5-9. 63 Manne, Henry. Mergers and The Market for Corporate Control. The Journal of Political Economy, 1965, Vol. 73, No. 2, p. 113.

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Almost all countries have some level of takeover regulation in place but the details

vary considerably between countries. An active takeover market is part of the system

through which the threat of dismissal is maintained. Some countries have much more

active takeover markets than others. In particular, hostile takeovers are far more

common in the United States than in other parts of the world, according to the series of

‘takeover waves’, each identified with its own characteristics and motivations earlier in

Chapter 1.

Companies sometimes use mergers to expand by acquiring control of another

company. The motives for a takeover should be the potential synergies which improve

the firm’s share value, economies of scale, scope or vertical integration, complementary

resources, expertise, technology transfer, the use of the surplus funds and other reasons

such as tax considerations, diversification in terms of risk reduction, debt capacity and

lower financing costs, and increasing liquidity.

The rational reason for M&A, and some large strategic investments are often

explained with a creation of synergy. This is the additional value that is created by

combining two firms, generating such opportunities that would not been available to

these firms operating independently, without outside support or influence in terms of

control. Synergy is what allows acquirers to pay billions of dollars in premiums in

acquisitions. By far, no doubt, this is the most common explanation that bidders give for

the premium they pay for acquiring a target.

But in most cases, if the company is not run well by the management, it becomes an

attractive target for the “corporate control market”. It is supposed that the main reason

for an unsuccessful company is the inefficient management of the target company and

that is why it should be replaced. There are also other assets and liabilities despite cash

which could be managed inefficiently, and companies with unexploited opportunities

will always exist. As a result, because of the poor management, they end up acquired by

other companies.

31

Of course the motives and potential synergies are simply driven by the intension to

eliminate the duplication through removing and replacing the existing management.64

As mentioned, takeovers often take place because the acquirer’s management believe

that they can run the company better. However, the takeover market has its dark side

for shareholders. In addition to being a potential solution to the manager/shareholder

agency problem, it can be a manifestation of this problem.

Managers interested in maximizing the size of their business empires can waste

corporate resources by overpaying for acquisitions rather than returning cash to the

shareholders. Most of the time, takeovers present problem and conflict of interests

between management and shareholders, as acquisition is one possibility for the

managers to spend large sum of money, instead of paying it out to the shareholders. It

is typical for managers to take on and to commit less-beneficial deals and takeover

actions, especially if they have a lot of free cash flow or borrowing power. In such cases,

usually managers will gain more than shareholders due to bonuses, commissions and

other motives, described by the Agency theory.

Managers are supposed to look from the perspective of the shareholders, as they

are the one who elect the board and the one who pay, but in practice, this loyalty should

not be expected in the financial world, as everything is up to self-interests and private

gains, especially when large sums of money are involved and still, shareholders cannot

control the managers efficiently. In result of this lack of control by the shareholders, the

managers make worse decisions and work less, but get paid more. Even are stimulated

to grow the size of their corporations through mergers and acquisitions, because of their

contracts and payment details. Agency theory, or the overconfidence combined with

lack of transparency by the management, could easily explain why the biggest merger

failures have involved large firms.65

64 Murginski, Petar. Mergers and Acquisitions: An Economic Analysis. University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, p. 17. 65 Ibid., pp. 39-40.

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Inference

To summarize, central to the governance role of takeovers is a belief that takeovers

seek to correct for inadequate company performance and occur primarily to reconcile

the interests of shareholders and managers by improving the performance of target

companies. Even though takeovers occur for a variety of reasons, not least synergistic.

Researchers continue to investigate the precise role of takeovers in the governance

environment of firms, because the regulatory environment will heavily influence the

strategy chosen, and almost all countries have some level of takeover regulation which

vary considerably around the world.

The past decade has seen a renewed desire on the part of corporate policymakers

to improve companies’ governance structures, focusing specifically on seeking to ensure

that management behavior is sensitive to the interests of shareholders. The purpose of

section 2 is to present a brief sketch about regulation, based on own conclusions in the

area, as in section 1. After exploring the most important legal systems, a review was

made in order to highlight the most significant recent reforms and guidelines.

2. International Regulation and Legal Systems

So far, the focus was on those parts of the corporate governance system that have

evolved over time as economic responses to the need for shareholders to mitigate the

conflict of interest between themselves and managers. Boards of directors came into

being long before there was any regulation of the governance of a company, and

CEOs have long appointed independent directors to their boards without being required

to do so.

In addressing agency problems, the law turns repeatedly to a basic set of legal

strategies. The legal origin is historically predetermined and highly correlated with

shareholder protection, and thus the legal system is a fundamentally important

corporate governance mechanism, because the extent to which a country’s laws protect

investor rights and the extent to which those laws are enforced, represent the most

33

basic determinants of the ways in which corporate finance and corporate governance

evolve in that country.66

The purpose is not to examine the different legal regimes across countries, but

rather to provide a more complete understanding of the roles of firm-specific corporate

governance mechanisms described above, such as the board of directors and equity

ownership. A note about the legal systems and regulation allow meaningful comparison

(Table 2) of external control and governance mechanisms. Recent examples include:

(1) the Cadbury commission of 1992 (Codes of Best Practices);

(2) the Sarbanes-Oxley Act of 2002 (SOX);

(3) the Dodd-Frank Act of 2010; and

(4) the Insider Trading (the Security and Exchange Commission).

2.1 The Cadbury Commission

The commission was named after its chairman – Sir Adrian Cadbury, who submitted

its report “Codes of Best Practices” in December 199267 and the stated objective was:

“to help raise the standards of corporate governance and the level of confidence in

financial reporting and auditing by setting out clearly what it sees as the respective

responsibilities of those involved and what it believes is expected of them”.

The committee presented many recommendations for the executive directors,

non-executive directors, and those responsible for reporting and control. According to

the Cadbury commission’s findings, audit and compensation committees should be

made up entirely of independent directors or, at least, have a majority of them, auditors

should be rotated, and the CEO should not be chairman of the board.68 Although these

recommendations are not mandatory, all publicly traded UK corporations are expected

66 La Porta, Rafael, Florencio Lopes and Andrei Shleifer. Corporate Ownership around the World. Journal of Finance, 1998, Vol. 54, Issue 2, p. 28. 67 See The Committee on Financial Aspects of Corporate Governance Official Website. Report with Code of Best Practices. London, Gee Publishing, 1992. Accessed on May 27, 2016. <http://www.ecgi.org/codes/documents/cadbury.pdf>. 68 Ibid., pp. 16-58.

34

to follow them. The London stock exchange, for example, requires the listed companies

to declare if they comply with them, and if not, to explain why.69

The problems that the Cadbury Commission identified are the same as those that

the Sarbanes-Oxley Act aimed to address in the United States 10 years later. Not

surprisingly, the resulting recommendations described next are quite similar.

2.2 The Sarbanes-Oxley Act

The Sarbanes-Oxley (SOX) of 2002 is an act passed by the U.S. Congress70, and is the

most significant piece of corporate securities legislation since the Securities Act of 1933

and The Securities and Exchange Act of 1934.71 The idea of SOX originated from Michael

Oxley (Republican) and Senator Paul Sarbanes (Democrat). The Act has to protect

investors from the possibility of fraudulent accounting activities by corporations.

The fundamental issue is that there was pressure on the corporation to show the

results, which the market expected. But there is also pressure on the auditors, who did

not want to lose their jobs. Auditing firms are supposed to ensure that a company’s

financial statements accurately reflect the financial state of the firm. In reality, most

auditors receive huge fees, which leads to a good relationship with their audit clients,

and therefore are less willing to challenge executives. However, public concern over

series of unexpected collapses of audited firms and over big rises in executive pay

occurred. This led to an extremely strong public reaction of anger, followed by corporate

governance reforms, which had to strengthen the independence of the board and

address the conflicts of interest in the auditing process. The Act achieved this goal

through more severe criminal penalties for providing false information.72

69 See Definition of Cadbury Rules. Accessed on May 27, 2016. <http://www.businessdictionary.com/definition/Cadbury-rules.html>. 70 See more on: The Official Website of Investopedia. Sarbanes-Oxley Act of 2002 (SOX). Accessed on May 27, 2016. <http://www.investopedia.com/terms/s/sarbanesoxleyact.asp?layout=infini&v=5C&adtest=5C&ato=3000>. 71 Keating, Elizabeth and Eli Goldston. Sarbanes-Oaxley Act: Was it Wrought? Harvard University Press, 2007, p. 2. 72 Ibid., p. 4.

35

2.3 The Dodd-Frank Act

This act is named after U.S. Senator Christopher Dodd and U.S. Representative

Barney Frank, who were significantly involved in the act’s creation and passage, which

is supposed to lower risk in various parts of the U.S. financial system.73 The law was

initially proposed by the Obama administration, in an attempt to prevent the repetition

of events that happened the previous year, and caused the 2008 financial crisis.

Regulatory change is often prompted by crisis. Many people believed poor corporate

governance was an important factor that contributed to the crisis and so the act has

numerous clauses designed to strengthen governance by improving accountability and

transparency in the financial system. The Act is categorized into sixteen titles and, by

one law firm's count, it states that regulators create 243 rules, conduct 67 studies, and

issue 22 periodic reports.74 It changes the existing regulatory structure, by creating a

number of new agencies, including the Financial Stability Oversight Council (FSOC)75, the

Office of Financial Research (OFR)76, and the Bureau of Consumer Financial Protection

(CFPB)77.

Because the act is still in the process of being implemented and because those

provisions that have been implemented are still relatively new, it will probably be years

before the full implications of the Dodd-Frank Act become clear.78

73 See The Official Website of Investopedia. Dodd-Frank Wall Street Reform and Consumer Protection Act. Accessed on May 27, 2016. <http://www.investopedia.com/terms/d/dodd-frank-financial-regulatory-reform-bill.asp?layout=infini&v=5C&adtest=5C&ato=3000>. 74 Polk, Davis. Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Enacted into Law in July, 2010, p. 2. 75 See The Official Website of the Financial Stability Oversight Council (FSOC). U. S. Department of the Treasury. Accessed on June 10, 2016. <https://www.treasury.gov/initiatives/fsoc/Pages/home.aspx>. 76 See The Official Website of the Office of Financial Research (OFR). Accessed on June 10, 2016. <https://financialresearch.gov/>. 77 See The Official Website of the Bureau of Consumer Financial Protection (CFPB). U. S. Government. Accessed on June 10, 2016. <http://www.consumerfinance.gov/>. 78 See The Official Website of Investopedia. Fontinelle, Amy. What is the Dodd-Frank Act and How Does

it Affect Me? Accessed on May 27, 2016. <http://www.investopedia.com/ask/answers/13/dodd-frank-

act-affect-me.asp>.

36

After exploring the most important recent reforms, a brief summary (Table 2) was

made in order to highlight the most significant results, which were achieved. Table 2

compares the regulation rules of the Cadbury Commission of 1992, the Sarbanes-Oxley

Act of 2002, and the Dodd-Frank Act of 2009.

Table 2. Regulation Rules

* Own conclusion based on evidence and reasoning.

The Cadbury Commission The Sarbanes-Oxley Act The Dodd-Frank Act

Division of top

responsibilities

Senior management has to

certify the accuracy of the

reported financial

statement

Compensation

committees must be

composed entirely of

independent board

members

No one individual has

powers of decision

Management and auditors

have to establish internal

controls and reporting

methods on the adequacy

of those controls

Companies are required

to disclose whether they

permit employees to

hedge against decreases

in the stock market.

Majority of independent

outside directors

The independent directors

must be rotated

Vote on executive

compensation policies at

least once every 3 years

At least 3 non-executive

in the audit committee,

selected by the whole

board

The problems are basically

the same as those that the

Cadbury commission

identified 10 years earlier

Shareholders owning over

3% of the company’s stock

for at least 3 years, can

nominate candidates for

the board of directors

37

2.4 Insider Trading

Insider trading is another aspect of the conflict of interest between managers and

outside shareholders that we have not addressed yet. It actually encompasses both

illegal and legal trading of securities, and is monitored by the Security and Exchange

Commission (SEC).79

Insider trading occurs when a person makes a trade based on confidential

information. The SEC has prosecuted insider trading cases against officers, directors and

employees of involved corporations, as well as potential friends of the mentioned above

such as lawyers and accountants. Even the involved printing companies, who had access

to tender offer documents, before they were issued to the public, as the law is

specifically strict with takeover announcements.80 Recently, a former Barclays PLC

director was charged with passing inside information to his plumber, in exchange for a

free bathroom remodeling. He was responsible for the “M&A: Global Weekly Business

Update”, which included deals that were likely to become public soon.81

The managers of the companies have access to asymmetric information82 that

outside investors do not have, and by using this information, managers can benefit from

potential profitable trading opportunities that are not available to outside investors.

Insider trading regulation was passed to address this problem – the penalties for

violating insider trading laws include jail time, fines, and civil penalties. Only the U.S.

Justice Department, on its own or at the request of the SEC, can bring charges that carry

the possibility of jail time and/or be fined.83

79 See The Official Website of the U.S. Security and Exchange Commission. Accessed on May 27, 2016. <http://www.sec.gov/>. 80 See The Official Website of Investopedia. Insider Trading. Accessed on May 27, 2016. <http://www.investopedia.com/terms/i/insidertrading.asp?layout=infini&v=5C&adtest=5C&ato=3000>. 81 See more on: Hong, Nicole. Ex-Barclays Banker Charged with Passing Inside Information to Plumber. The Wall Street Journal Official Website. May 31, 2016. Accessed on June 1, 2016. <http://www.wsj.com/articles/barclays-banker-charged-with-passing-inside-information-to-plumber-1464712099?mod=e2fb>. 82 Murginski, Petar. Mergers and Acquisitions: An Economic Analysis. University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, p. 29. 83 See Ref. 73.

38

Inference

To conclude, the process of creating efficient rules is very complex and costly,

because there are many parties involved in the bargain, and is very difficult not to

benefit one party over another. Even with the best intentions, regulators may not have

all the necessary information to design efficient rules. The regulations imposing

particular governance rules (required by stock exchanges, legislatures, courts or

supervisory authorities) are necessary, but the corporate governance “codes” and

“guidelines”84 are formally mostly voluntary, although the codes related to stock

exchange listing requirements may have a forcible effect.

Nevertheless, it matters to know and understand the differences around the world,

thus experts and consultants are absolutely needed. The most important thing for each

corporation is to obey the local laws and political conditions in which it operates, as the

extent to which those laws are implemented, defines the basic determinants of the ways

in which corporate governance and finance develop and progress in that particular

country.

84 See one of the most influential guidelines on corporate governance: The G20/Organization for Economic Co-operation and Development. OECD Principles of Corporate Governance, 2004, Accessed on May 28, 2016. <http://www.oecd.org/daf/ca/corporategovernanceprinciples/31557724.pdf>.

39

Chapter IV. Comparative Analysis of Governance and Corporate Control

around the World

The world’s governance and corporate control is divided between two broad and

different systems – the Anglo-Saxon, characterized by dispersed ownership,

well-protected shareholder rights and active corporate control markets; and the

Continental European, characterized by concentrated ownership, weak shareholder

protection and less active market for corporate control. Although without any doubt

that these two main systems are extremely important, they have contributed only to a

limit extent for significant major improvements in Asia, more precisely Japan.85

However, the traditionally based corporate governance models have evolved in the

past decade significantly, due to the rapid pace of the globalization, the market

internationalization, and deregulation.86 Therefore, pure Anglo-Saxon, Continental

European or Asian models do not longer exist so vividly, but rather are combined and

unified with the local practices and legal institutions. The potential benefits and costs of

governance systems depend on one highly underestimated fact – cultural norms.

Various structural differences occur across countries, due to the fact that some

business practices are accepted in one culture, but on the other hand are totally

inappropriate in another culture. As a consequence, only some specific but not all

mechanisms could be implemented, which often leads to new models or hybrid

practices. Thus, is it possible to identify which international practice is the “best” and

“right”, or it is up to pure economic, social, cultural, and political perspective challenges?

To answer this question, the comparative analysis is going to be supported by

empirical evidence of prior studies87 and own interpretation. International comparison

of corporate governance and control raises many issues. Although no particular

theoretical method exists to portray the differences and similarities across models, the

85 Aguilera, Ruth and Gregory Jackson. Comparative and International Corporate Governance. The Academy of Management Annals, 2010, Vol. 4, No. 1; p. 486. 86 Ibid., p. 487. 87 For the following comparative analysis see more empirical evidence based primarily on: Ref. 89, Ref. 91, Ref. 92 and Ref. 95, including own conclusion about the key strengths and weaknesses.

40

most important common approach between all types of practices is supposed to be

responsible governance, as it increases the value. Respectively, implementing

transparent managerial discretion is essential and needed, because it is something the

investors look for.

The purpose of this chapter is not to define which system is the most effective and

efficient, but rather what the main differences between the corporate practices around

the world are, and to explore them based on the key internal and external governance

mechanisms, described previously in Chapter 2 and 3.

1. Comparative Analysis of Internal Governance Mechanisms

Corporate governance is focused on the internal control within a corporation. The

most important questions according to the internal balance, by contrast to the external

corporate governance, is dedicated to the relationships between the board models, be

it a unitary or two-tier board; shareholders, both controlling and minority; executive

pay; work force, especially when employees are involved; and of course the ownership

and control structures through pyramids, dual class shares, cross-holdings, or

combination of all.

An efficient internal management control is the central corporate governance

problem. First, we are going to compare the board models. Second, we analyze the

executive compensation policies through the most recent evidence and data. Then, we

continue with an ownership and control comparison.

1.1 Board Models

In the Anglo-Saxon and Asian model, boards are most often one-tiered and unitary.

One-tier boards are composed usually of executive and non-executive

directors – where in theory the first manage, and the second monitor, but in practice

are closer to management. Actually, until recent times, it was common for both the

chairman of the board and the CEO positions to be held by the same person, as discussed

in Chapter 2 (e. g. – Cadbury Commission’s “UK Code of Best Practices” recommends

41

that the board includes at least three independent directors, and the separation of the

chairman and CEO role).

By contrast, in some Continental European countries such as Germany and Austria,

a two-tiered board structure is required by law, regardless of size or listing. Two-tier

boards have separate management board which includes executives of the company,

and is monitored by a supervisory board, in which a representation of employees is

mandatory by law (Table 3). The central role and purpose of the two-tiered structure, is

to divide management and control. While the obvious responsibility and main target of

the management board is the firm performance, the role of the supervisory board

remains difficult to explain. From legal perspective, its duty and functions are mainly

nomination, monitoring and firing of management board members. In practice, the

supervisory board controls the management and looks after the balance of interests

within the corporation. The existence of co-determination prevents potential social

conflicts or strikes. In Table 3 is presented the employee participation across the world.

Table 3. Employee Participation around the World

<Table 3 continues>

42

<Table 3 continues>

Source: OECD88

In Table 3 is shown whether the employees have rights to appoint board members, if

works council is mandated by law (especially in state-owned enterprises), and employee

participation rights in the management decisions. Only 7 countries require

representatives on the board of directors, in 12 countries works councils are mandated

by law, and only in 3 countries constitutional rights of employee participation in the

management of the company is allowed. The role of the employees as stakeholders is

complex and difficult to analyze – there is a lack of empirical evidence, and thus cannot

be answered how much exactly employees are efficient.

However, various internal governance actions occur. By contrast, the Anglo-Saxon

stakeholder model does not allow valuation of how much exactly the executive decisions

are responsible, thus do not need to be approved, or respectively negotiated. The

one-tier approach (e. g. in the United Kingdom) is more flexible than the two-tier (e. g.

in Germany), because from legal point of view, the acts and law regulation according to

the directors, concern aspects such as duties, nomination and removal, but corporations

are free to adopt rules on compensation policies, thus a self-regulatory approach exists.

88 See The Official Website of Organization for Economic Cooperation and Development. Corporate Governance: A Survey of OECD Countries. 2004, p. 72. Accessed on June 5, 2016. <https://www.oecd.org/corporate/ca/corporategovernanceprinciples/21755678.pdf>.

43

The common between the one and two-tier structures remain to be the size of the

board – the less people are involved, the easier decisions are taken, and the smaller the

possibility of information to leak is. Unofficially, both board structures are equally prone

to be captured by management or large shareholders, especially if the directors of the

supervisory board are former members of the executive board, and/or are simply

friends with the CEO or a large shareholder. A board is said to be captured when its

monitoring duties have been compromised by connections or perceived loyalties to

management. The problem could be solved by giving special importance or prominence

to independent directors, who have no previous relationship with the company,

management or large shareholders.

However, in other European countries, such as France, Italy and Finland, the board

choice is optional – they can choose whatever type of structure fits them, either one or

two-tiered. The explanation may be that shareholders do not agree the employees to

have voice in all corporate decisions, thus for a structural flexibility, a freedom of choice

was integrated. This leads automatically to organizational flexibility and a positive

potential tendency towards more transparent separation of governance and control.

Japan corporations on the other hand concentrate on the appointment of outside

directors to their boards, where outside directors are defined as individuals previously

employed by banks or other non-financial corporations, who over time proved to be

effective and stable corporate governance mechanism.

Actually, the structure, the composition, size and performance, and the role of the

boards could vary widely between individual corporations and governance systems as

well. The supervisory authorities and stock exchanges impose specific governance rules

such as Codes of Best Practices, which are mostly voluntary, although as already

mentioned, the codes related to public listing requirements may have forcible effects.

Thus, it is absolutely necessary to know and understand the differences across the

countries.

The board of directors’ role varies widely in terms of approving corporate decisions.

In one system a decision may need approval by the shareholders, but in another could

be ratified by the board. Mergers and acquisitions, huge investments and important

44

long-term strategic changes, and other major decisions require shareholder approval

almost everywhere.

In some countries boards have a formal face-to-face duty to the employees of the

company, or in other (e. g. in Germany), the employees have the right to nominate board

members. Nevertheless, the tendency points towards an increased flexibility, and

hopefully, improvements could be expected due to the global convergence efforts.

The shareholder rights can also vary significantly across the countries, which makes

difficult to analyze and compare the actions and effects of large shareholders, due to

institutional differences and legal origin. Most of the time, the interest of the large

shareholders is directed through the board, which appoints the managers, and thus have

the indirect power to hire or fire executives.

Inference

To conclude, the board characteristic, explored in detail and most comprehensive,

are the board size and independent directors’ board proportion, no matter in which part

of the world the corporation is located. Thus, the following conclusions can be made:

(1) The size of the board is negatively related to both firm performance and the

quality of decision-making, due to a simple social explanation that fewer groups

make better decisions – thus the smaller the board, the better the firm

performance; and

(2) Higher independent directors’ board proportion does not necessary mean higher

quality firm performance, but leads to better decisions in terms of executive

compensation, or acquisitions and other major investments, and is more likely

irresponsible top management to be fired;

45

1.2 Executive Compensation89

As discussed in Chapter 2, determining the compensation of executives is generally

viewed as a key internal governance mechanism, because monitoring is imperfect. Thus,

compensation packages must be design in order to give managers the right motives, and

to better align their interests with those of the shareholders. Figure 8 compares next the

CEO compensation level in large corporations around the world.

Figure 8. Average CEO Compensation Level for Large Corporations in the Wealthiest

Countries for 2015

Source: PatrickJuli90

As Figure 8 indicates, the United States, no doubt, has abnormal level of executive pay.

The CEOs in the USA ($12.1 million) receive more than two times the German CEOs pay

89 See more empirical evidence on: Bebchuk, Lucian and Jesse Fried. Executive Compensation as an Agency Problem. Journal of Economic Perspectives, 2003, Vol. 17, No. 3; Hall, Brian and Jeffrey Liebman. Are CEOs Really Paid Like Bureaucrats? The Quarterly Journal of Economics, 1998, Vol. 103, Issue 3; Murphy, Kevin and Michael Jensen. Performance and Top-Management Incentives. Journal of Political Economy, 1990, Vol. 98, No. 2; Core, John, Robert Holthausen and David Larcker. Corporate Governance, Chief Executive Officer Compensation, and Firm Performance. Journal of Financial Economics, 1999, Vol. 51. & own conclusions. 90 By the example of: Juli, Patrick. Why Is There a Corporate Ladder? Human Economics, 2016. Accessed on June 5, 2016. <https://patrickjuli.us/tag/ceo/>.

46

($6 million), more than three times the UK CEOs pay ($3.9 million) and twelve times the

Japanese CEOs pay ($1 million). Although, CEO compensation levels fell all over the

world due to the 2008 world financial crisis, and in the United States before that in 2001

during the dot-com bubble, the trend remains progressive. The US CEO package alone

is more than the total combined value of the packages in Germany, United Kingdom and

Japan; and not much lower than the total combined value of the packages in Switzerland

and France.

The executive pay in the USA is relatively high, but this is due to the fact that

compensation policies are depending on firm performance. However, back in the 1990s

this co-relation was low and quite insignificant. Executives then did not receive big

bonuses after good corporate performance, and did not suffer great losses after poor

performance. The same could be concluded for other countries as well, and more

precisely Japan. Since then, the pay-for-performance sensitivity increased more than 10

times, as indicated in Chapter 2. By contrast, in the United Kingdom has risen from 10%

in 1980s to more than 90% in the 1990s. Even though, the level is nowhere close to the

United States, and furthermore is about 4 times lower.

Inference

To infer, a large part of the packages nowadays come from various bonuses, stock

option, and other incentives. Still, US executives own more stock options than Japanese,

German or any other country’s executives do. Thus, it can be inferred that high levels of

pay-for-performance sensitivity and stock options packages, encourage CEOs to work

harder, which respectively increases the value of the corporation.

However, the amount of the compensation is less important that the way of how

exactly it is structured. Therefore, the compensation package must encourage

executives to maximize the wealth of the shareholders. It is important to highlight the

fact again that board composition and executive compensation policies do not occur in

vacuum, and empirical evidence on the relationship between those and other

governance mechanisms across the world remains limited. Nevertheless, the following

can be concluded:

47

(1) A big part of the pay-for-performance sensitivity packages have increased during

the last decade all over the world;

(2) This sensitivity comes through executive ownership of stock and options, which

is indeed the fastest growing factor of CEO compensation policies everywhere;

(3) All evidence indicate that executive pay remains sensitive to performance, and

thus the degree to which CEO compensation packages are aligned to the

shareholders’ interests, is absolutely important;

1.3 Ownership and Control91

As already discussed in Chapter 2, the most comprehensively studied corporate

governance mechanism outside the United States, is the ownership structure, primarily

focused on the evidence of the United Kingdom, Germany and Japan.

In Germany, the equity ownership is more concentrated than in the United States.

The banks in Germany and Japan have more significant role compared to the

Anglo-Saxon model. Consequently, the equity ownership in the United Kingdom is close

to that in the United States – a large amount of listed corporations with dispersed

ownership exist. Thus, it can be inferred that two basic economic systems occur:

bank-based (e. g. Germany and Japan), and market-based (e. g. the United States and

the United Kingdom).

Although both Germany and Japan are bank-based systems, there are several

sufficient differences according to the equity ownership. In Japan, the financial

institutions are the most important owner, but for Germany is typical the largest

shareholder to be another corporation, which is usually family-owned. Nevertheless, the

banks in Germany also play central role through voting power, and thus could be

inferred, that financial institutions have significant control over corporations in both

91 See more on: Köke, Jens. New Evidence on Ownership Structures in Germany. ZEW Discussion Paper, 1999, No. 99-60; Becht, Marco, Patrick Bolton and Ailsa Roell. Corporate Governance and Control. ECGI Working Papers Series in Finance, 2005, No. 02/2005; Denis, Diane and John McConnell. International Corporate Governance. ECGI Working Paper Series in Finance, 2003, No. 05/2003; La Porta, Rafael, Florencio Lopes and Andrei Shleifer. Corporate Ownership around the World. The Journal of Finance, 1998, Vol. 52; Aguilera, Ruth and Gregory Jackson. Comparative and International Corporate Governance. The Academy of Management Annuals, 2010, Vol. 4. No. 1. & own conclusions.

48

economies. Furthermore, corporations are highly valued and preferred when banks are

involved due to transparency factors.

In Western Europe, publicly-traded corporations could be either widely-held (e. g.

the United Kingdom and Ireland), or owned by families which is more common for

Continental Europe and Scandinavia (e. g. Netherlands, France, Italy, Germany and

Sweden).

By contrast, most of the ownership in China is separated equally between the

government (state-owned), institutions and local individuals. In Latin America, and more

precisely Brazil, most of the large shareholders are either individuals, or corporations.

By far, almost everything varies significantly across the world – the relationship

between firm performance and ownership structure is not an exception, both by

countries and the identity of large shareholders. Concentrated ownership has a positive

effect on firm performance, and the level of bank involvement is important. Therefore,

it can be concluded that the relationship is stronger co-related in the Continental

European and Asian models, than in the Anglo-Saxon – where banks are forbidden to

play central role, and respectively their involvement is reduced.

However, the relationship between ownership structure and firm performance

could be taken into consideration from a privatization perspective, especially when prior

state-owned enterprises are transited from government ownership to private

ownership (as already explored in Chapter 1). Almost all over the world, the relationship

remains positive, and thus firm performance increases when the company becomes

privately-owned from state-owned, alongside with the efficiency (reduced costs per 1

unit of production) and work force (higher employment, and more employees

accordingly).

In contrast to Western Europe, Eastern European enterprises (e. g. Czech Republic,

Slovakia and Bulgaria) are associated with higher productivity growth, after being

privatized. However, the way which they have been transited in Bulgaria from

state-owned to privately-owned companies, remains vague due to pure greed and moral

hazard issues by the government representatives. Nevertheless, state-owned

49

companies are less profitable than privately-owned such, as private ownership is

associated with better firm performance. The same could be concluded for foreign and

concentrated private ownership, and post-privatization changes.

However, private and shared benefits of control occur as well – private, in terms of

that they are available only to the large shareholders – and shared, to the degree that

large shareholders have good enough reasons and stimulus to both monitor, control and

influence the top-management. This could be achieved all over the world through dual

class shares (explored in Chapter 2) with superior voting rights. The extent to which they

are used and private benefits are extracted varies – from 0% (e. g. Denmark) to 80%

(e. g. in Italy). Most often, this approach is common for the corporations from the United

States, United Kingdom and Netherlands.

Control can be achieved through pyramid or cross-holding ownership structures as

well (described in Chapter 2). A combination of all is not something unusual across the

world. In East Asian countries, voting rights are greater than cash-flow rights typically

because of the existence of pyramid structures and cross-holdings, which in most cases

lead to an effective control of the company by a large shareholder. In Western Europe,

this effect is usually achieved through dual class shares and pyramid structures.

However, group ownership is something normal for many countries, such as the keiretsu

in Japan, the chaebol in South Korea, and the financial-industrial groups in Russia.

Groups in Brazil, Italy, India and many other countries, where families and founders have

made only little and insignificant amount of investments, often possess control over

individual corporations, which reduces the fair market value of the company, or even is

value-destroying.

The process of tunneling, or assets and profit transfer, both mentioned in Chapter 2,

are the two basic methods where large shareholders take advantage of private benefits,

and are more typical for the civil law countries (e. g. Germany and France) than for the

common law countries (e. g. the United States and the United Kingdom), achieved

through pyramid structures. Large shareholder of the corporation at the top controls

most or all of the subsidiaries down the pyramid, and thus can transfer profit, move

technologies or value from lower-leveled companies with less cash-flow rights, to

50

higher-leveled companies with more cash-flow rights. Furthermore, due to personal

interest, it gives them the financial opportunity to control the board, and thus to elect

the top management interest. This approach is typical for the family-owned

corporations (e. g. in Japan and Germany).

However, the structure of governance depends highly on the legal origin and the

extent to which the rights of the shareholders are protected. In section 3 of this chapter

is going to be discussed what the convergence possibilities in corporate governance are,

and if there are such – how could they be achieved.

Inference

Based on the analysis of this section, the following can be inferred:

(1) Foreign-ownership is associated with better firm performance, and

government-ownership is associated with worse firm performance;

(2) Ownership is more concentrated in non-Anglo-Saxon countries;

(3) For Anglo-Saxon countries the ownership structure is not as important as for

the rest of the world – and respectively, in the United States and the United

Kingdom the influence on firm performance is lower, but private ownership is a

value-enhancer;

(4) Dispersed ownership is typical for countries, where shareholder are

well-protected, thus in the Anglo-Saxon countries;

(5) In countries with less-protected shareholder rights by law, family control is more

common, and higher proportion of private benefits for large shareholders occur,

such as in the Continental European and Asian countries;

(6) If the rights of the shareholders are not well-protected by the law, optimal

ownership structure is difficult to be achieved;

(7) Pyramid structures are more common than cross-holdings across the largest

corporations;

(8) Tunneling and transfer of assets occur most often in civil law countries than in

common law countries.

51

2. Comparative Analysis of External Governance Mechanisms

When all the internal control mechanisms fail, the only option left is to mount a

hostile takeover, so that the shareholders can replace underperforming or opportunistic

managers and make the regulation of the governance of a company more transparent,

according to the legal origin of the local system. Thus, in this section, first a comparative

analysis of hostile takeovers by region is going to be introduced, and second a brief

comparison of international regulation and legal systems around the world is going to

be made. Both external control and governance mechanisms, which were already

discussed in the previous Chapter 3.

2.1 The Governance Role of Takeovers92

Poorly-performing corporations are likely to become takeover targets, and

respectively poorly-performing executives to become fired. The takeover market is one

of the most significant external corporate governance mechanism, because the hostile

takeover gives the possibility to encircle the inefficient management to take control of

the corporation by concentrating shareholder rights such as voting and cash-flow.

However, to do so, they have to obey the local regulatory system and anti-takeover

laws. Even though not that active, compared to the United States, the corporate control

market works better in regulatory systems, where shareholders are less-protected such

as France and Germany, because of the absence of insider trading acts. Nevertheless,

the hostile takeovers are difficult financed all over the world, even in the richest liquid

capital markets, and thus is the last mechanism preferred, but still of high importance.

The takeover market in the United States is highly active, as targets are not always

poorly-performing. However, in the Anglo-Saxon model, comparing the United States

and the United Kingdom, the US executives tend to avoid better hostile takeovers than

their colleagues in the UK, simply because the first are allowed to mount a takeover

92 See more on: Murginski, Petar. Mergers and Acquisitions: An Economic Analysis. University of Applied Sciences Worms Bachelor Thesis. Germany, 2016, p. 2; Becht, Marco, Patrick Bolton and Ailsa Roell. Corporate Governance and Control. ECGI Working Papers Series in Finance, 2005, No. 02/2002, p. 5; Denis, Diane and John McConnell. International Corporate Governance. ECGI Working Paper Series in Finance, 2003, No. 05/2003.

52

defense, and the second are not (e. g. “poison pills”, “white knight”, etc.). In Asia-Pacific

countries (e. g. Australia, New Zealand, Hong Kong, Singapore), the takeover market is

less regulated, but from proportional perspective, plenty of takeovers occur. By

contrast, hostile takeovers in Germany are not usual, due to the fact that ownership is

concentrated in large shareholders. However, after consecutive poor-performance, it is

quite possible for top-management and board members to be released from their

duties, and/or ownership to be changed.

To summarize, excluding some of the wealthiest economies (e. g. the United States),

takeover activity is not an extremely important governance mechanism all over the

world (e. g. Netherlands – family-owned companies, and China – state-owned

companies).

We have already explored the takeover wave in Chapter 1, and further observed the

governance role of takeovers in Chapter 2. The takeover market in the United States is

the most active one (Figure 9). Nevertheless, the analyzed takeover wave of the USA in

the 1980s concludes that takeover rates occur rare – the takeover bids were for less

than 2% of the listed companies. As mentioned, the hostile takeover peak took place in

the following decade (the period between 1990 and 1999), but takeover bids have never

represented more than one-third (30%) of all the deals in the United States, of which

not more than 4% were hostile. Moreover, only 2.5% of the hostile takeovers were

completed, representing two-thirds (63% of success) in total, which is quite low and

insignificant.

In the rest of the world the takeover activity is even less active, despite of the

unusual European high hostile activity in the early 1990s. Therefore, to predict how

much approximately the hostile takeovers will be in the following decade, a brief

analysis of the current mergers and acquisitions (M&A) worldwide trend has been made.

Figure 9 describes the level of recently announced global deals by each region around

the world.

53

Figure 9. M&A Deals by Region in 2012

Source: Statsia93 & own improvements

As Figure 9 indicates, most of the deals (42.2%) occurred in the North American region,

followed by the combined value of Europe with 30.8% market share (respectively in the

Eurozone 13% and outside the Eurozone 17.8%), then North Asia with 8.2%, followed by

Central and South America (4%), low share for Japan with just 3.3%, and the least active

markets of Africa and Middle East (2.3%), Australasia (2.2%), and South and Central Asia

(2%). But what do those percentages mean and what value stays behind them (Fig. 10),

93 By the example of: The Official Website of Statista. Volume of M&A Worldwide. Accessed on June 7, 2016. <http://www.statista.com/statistics/267369/volume-of-mergers-and-acquisitions-worldwide/>.

54

is going to be described next, in order to further clarify. Figure 10 shows the value of the

recent worldwide deals ($ 4.5 trillion) by region.

Figure 10. Value of M&A Deals by Region in 2015.

Source: Statista94

Figure 10 represents the value of mergers and acquisitions deals around the world, and

thus further clarifies the meaning behind the percentages in Figure 9. In 2015,

companies announced over 44 thousand transactions with a total value of more than

$ 4.5 trillion. The numbers of deals grew by 2.7%, while the value rose to 16%, compared

to 2014. It can be inferred that the value of M&A transactions in the United States is

almost $ 2 trillion in 2015. By contrast, in Europe is about half that amount – $ 1.1 trillion

(55% compared to the US). In Asia Pacific the transaction value of the deals is close to

the European – $927 billion (85% compared to the European value, and 47% compared

to the US). Consequently, in Japan, Central and South America, and Africa and the

Middle East, the numbers are low and insignificant compared to the rest of the regions.

Japan, and Central and South America have the same value of average $62 billion in 2015

94 Ibid., Value of Global M&A Deals by Region. Accessed on June 7, 2016. <http://www.statista.com/statistics/387545/value-of-global-merger-and-acquisition-deals-by-region/>.

55

(only 3% compared to the US, 6% compared to Europe and 7% compared to Asia Pacific).

The transaction value in Africa and the Middle East is the lowest – $47 billion (2%

compared to the US, and less than 0.5% for the rest).

To return to the main idea, so far we have discussed the current worldwide market

share of deals, and respectively their value by each region, in order to estimate to what

extent hostile takeovers will play an important corporate governance role in the near

future, based on own predictions.

After the dot-com bubble in the beginning of the millennium, and the recent world

financial crisis, hostile takeovers have been making up the highest proportion of global

deal activity, as corporations predict the economy will be stable and thus feel confident.

This will lead to rejection of acquisitions, and/or a demand of greater premium to be

paid (usually the premium is between 40 and 50% above the highest recent stock price).

By far, this year 25 big acquisitions have been made with a combined value of about

$300 billion, which represents about one-fifth (20%) of all the previous year deal activity.

Furthermore, the largest deal ever between Pfizer (USA) and Allergan (Ireland) is

expected to happen soon, with an initial offer of $ 220 bn. (recently fell to $ 160 bn.).

Improving economy, cheap debt and high liquidity, can lead only to the next

progressive takeover wave. To buy a good-performing business is always easier, rather

than to integrate it with an existing yours on a later stage. On one hand, shareholders of

the acquiring companies will try to further expand through mergers and acquisitions, as

this is the fastest way to improve your business, transfer technology, or to acquire

expertise and other resources, which eventually lead to the synergy effect.

On the other hand, shareholders of target companies will try to defend and resist

potential offers, due to the economic factors and current business environment. Thus,

if not paid a high enough premium, the bids will become hostile, and according to that,

the hostile takeover activity as well (approximately 4 to 5 times more) – an interesting

potential area for further and deeper research.

56

Inference

From the analysis up to now, it can be inferred that:

(1) Excluding some of the largest and richest economies (e. g. the United States),

takeover activity is not an extremely important governance mechanism

all over the world (e. g. Netherlands – family-owned companies, and

China – state-owned companies);

(2) According to the takeover market activity, the governance role of takeovers is

most important in North America countries (e. g. the United States and Canada),

then to Europe (e. g. the United Kingdom and Germany), less to Asia Pacific (e.

g. Australia) and almost insignificant to Japan, Central and South America, Africa

and the Middle East;

(3) The mergers and acquisitions trend is progressive, and the activity is going to

increase even more, so in the long term we should not be surprised by the

implementation of more frequent and huge deals.

2.2 International Regulation and Legal Systems95

A vast literature of corporate law exists, but the purpose of this section is not to

explore the various regulatory and law system across the world. Still, much of the most

important acts, commissions, codes and guidelines have been already explored in

Chapter 3, and accordingly a brief comparison has been already made in section 2.

To address agency problems, the law turns to a basic set of legal strategies, but the

legal origin is historically predetermined and highly correlated with shareholder

protection, and thus the legal system differs significantly across countries. The extent to

which a country’s laws protect the rights of the shareholders and the extent to which

95 See more on: Hopt, Klaus. Comparative Corporate Governance: The State of The Art and International Regulation. ECGI Law Working Paper, 2011, No. 170/2011; Denis, Diane and John McConnell. International Corporate Governance. ECGI Working Paper Series in Finance, 2003, No. 05/2003; Baums, Theodor and Kenneth Scott. Taking Shareholders Protection Seriously: Corporate Governance in the United States and Germany. ECGI Working Paper Series in Law, 2003, No. 17/2003.

57

those laws are implemented, are the most important factors according to the ways in

which corporate finance and corporate governance progress in that country.

The largest issue comes from the fact that law does not adequately address the

shareholder protection rights of minority shareholders, and thus gives potential

opportunities to the one who controls the company to do whatever he/she wants. By

contrast, in order to avoid this, precautions in Italy have been taken, so the premium of

voting shares is larger than most parts of the world. In the United States the central

focus is on the anti-takeover legislation, which was described earlier.

The legal system is highly important external governance mechanism all over the

world, but still, the extent to which shareholders protection varies across countries is

significant. Countries with low shareholder protection are distinguished by concentrated

ownership and insignificant or inefficient stock exchanges. Stock exchanges by nature

require larger part of self-regulation, but in some countries where the stock market is

developed (e. g. Deutsche Börse in Germany), still public law institutions occur and play

an important role – thus, a combination of both self-regulation and state-regulation.

However, with the recent trend of globalization, stock exchanges which competed

with each other, not only continental, but worldwide as well, have moved toward

transparent corporate governance observance requirements similar to the United

States, such as listing conditions (e. g. the “Combined Code” in the United Kingdom

according to the London Stock Exchange); or converging and harmonizing standards in

particular for auditing such as the International Accounting Standards Board (prior IASB),

currently known as International Financial Reporting Standards (IFRS)96.

The mission of the IFRS, is to develop common standards that bring transparency,

accountability and efficiency to financial markets all over the world. Nevertheless, the

rest of the stock exchanges have not yet improved as much as the previous two

mentioned, but still provide individual recommendations, which have similar forcible

effects to the UK Corporate Governance Combined Code of the Cadbury Commission.

96 See more on: The Official Website of International Financial Reporting Standards (IFRS). Accessed on June 8, 2016 <www.ifrs.org/>.

58

Despite the wealthiest countries mentioned, all over the world own guidelines have

been published, such as in Latin and Central American countries (e. g. Brazil, Peru,

Mexico), in Asian countries (e. g. South Korea, Singapore and Malaysia), and other.

Although, those codes are usually valid for the listed companies only, specific corporate

governance codes for family-owned companies have been made as well, where the

public or the state control shares, too.

The codes are basically focused on the board and its committees regulation, or as in

the two-tiered board example (e. g. in Germany and Austria) – both boards and the

connection between them. In Europe, in some countries the codes are observed and

followed strictly (e. g. in Germany and the United Kingdom), but less in other countries

(e. g. Spain and Denmark).

Shareholders in common law countries (e. g. the United States) are the

best-protected, and the shareholders in civil law countries (e. g. France) are the

worse-protected. Due to recent reforms, the German and Scandinavian countries (also

part of the civil law countries), are not as weak protected as in France, but still not good

enough, as concentrated ownership is a reasonable explanation why the shareholders

protection is low or almost entirely missing.

Inference

However, the inconsistency between the law and regulatory systems around the

world, provides good incentives for potential comparative corporate law research,

which is not our objective. The following could be inferred:

(1) If adequate local laws do not guarantee dispersed ownership rights,

concentrated ownership is the only possibility left to maintain control; and thus

(2) The law, which is historically predetermined, defines the ownership structure

and system of corporate finance and governance all over the world;

(3) Common law countries (e. g. the United States) protect their shareholders better

than in civil law countries (e. g. France);

59

(4) Codes play more important role in Europe than the rest of the world;

(5) Europe and North America are moving towards one common corporate

governance practice through combined efforts of accountability strengthening,

transparency bringing, economic efficiency improvements and standards

harmonization processes.

3. Which System is the Best?

To answer this question, we review next the continuing diversity in the corporate

governance systems around the world (Table 4). In Table 4 are summarized and

compared the differences explored up till now, in the Anglo-Saxon, Northern European,

Western Mediterranean and Latin American, and Japanese models.

Table 4. Comparative Corporate Governance.

Anglo-Saxon Northern European

Western Mediterranean

and Latin American

Japanese

Countries USA, Canada, UK, Australia, New Zealand

Germany, Austria,

Switzerland, Sweden,

Denmark, Netherlands,

Norway, Finland

Spain, Italy, France, Brazil,

Argentina

Japan

Board system One-tier (governance

with one level of

directors; only

executive and non-

executive separation)

Two-tier (executive and

supervisory board; large

shareholders on board and high bank pressure)

One-tier usually

(optional in France,

whether one or two-tier system)

One-tier

60

Executive compensation (pay-for-perf.)

High Low Medium Low

Ownership structure

High dispersed

(widely held)

Medium or high concentrated

(extremely high concentration especially in Germany)

High concentrated

Medium concentrated

Control (in terms of managerial discretion)

Shareholders Banks (including employee

representation/ codetermination

in Germany)

Families, cross-holdings,

the government

Banks, families, cross-

holdings

The role of takeover market

Large Small Small Insignificant

Strengths (+) Dynamic market, high

liquidity, extremely globalized

Stable market, strict

governance procedures, long-term strategies

Flexible, on-going skill development

Stable market, long-term strategies,

huge foreign investments

Weaknesses (-) Rapid fluctuation,

short-termism

Lack of flexibility, low diversification

Large shareholders control, weak governance,

lack of transparency

Lack of accountability,

complex governance procedures

Products Financial services,

Software and high-tech

High quality machines, precision

engineering

Luxurious goods, fashion, interior design

Consumer electronics, automobiles

and motorbikes

*Own conclusion based on evidence and reasoning.

Table 4 indicates a final comparison between all the internal and external control

and governance mechanisms, discussed in the previous chapters, according to the:

Anglo-Saxon (e. g. the United States, Canada, the United Kingdom, Australia, New

Zealand), Northern European – both Germanic (e.g. Germany, Austria, Switzerland) and

61

Scandinavian (e.g. Sweden, Denmark, Netherlands, Finland, Norway), Western

Mediterranean and Latin American (e. g. Spain, Italy, France, Brazil, Argentina), and

Japanese corporate governance systems. The continuing diversity of those systems is,

indicated through several distinctive features, such as board system, executive pay,

ownership structure, managerial decision-making control, the role of the corporate

control market, some pros and cons, and products focus.

The Anglo-Saxon corporate governance consist of a one-tier board, gives high

pay-for-performance executive packages. The ownership structure is widely held and

the decision-making process of the management is controlled by the shareholders. The

takeover market is highly developed and active. High liquidity and huge

internationalization are typical for its’ dynamic market, but the fluctuations are large. In

contrast, Northern European board is two-tiered with low pay-for-performance

executive incentives. The ownership is high or moderate concentrated, and the control

is done through banks and employees. The corporate control market is not very active.

The long-term strategies and the stable market represent key strengths, but lack of

flexibility exists. Western Mediterranean and Latin American boards are one-tiered, with

low pay-for-performance executive packages. The ownership is highly concentrated,

and usually families or governments control the management decisions. The takeover

market plays small role. The strengths are related to the ongoing desire for skill

development and flexibility. The governance could be described as weak and vague. And

last, but not least, the Japanese system has one-tier board with low executive pay and

moderate concentrated ownership structures. The managerial discretion control is

monitored by banks, families and cross-holdings. The takeover activity is insignificant.

The share of the overseas investments is huge, however lack of accountability occurs.

National and local barriers in terms of regulation exist, but they continue to be

negotiated, as the degree of convergence is rapidly growing – another interesting area

for potential future and deeper research. However, none of the systems could be

described as “the best”, as different systems are better at different things, and they vary

widely, clearly reflected by their leading industries, own dynamism and competitive

advantages. It is necessary to possess deeper knowledge about them in order to achieve

optimal results, as the quintessence of today’s world is to think globally and act locally.

62

Conclusion

The governance and corporate control around the world varies widely. Prior the

2008 financial crisis, the United States model seemed to be the most complete and

dominant, but nowadays, the world is less confident and will not be easily convinced of

the universal superiority. Thus, it can be concluded that there is no “one right

system” or “best practice model” – each governance system is better at doing different

things, and respectively with different outcomes for the economy and society.

The Anglo-Saxon system is better at deploying of huge amounts of liquid capital,

especially in terms of worldwide financial services or high-tech investments. But the rest

of the world’s governance systems have also their own dynamism and competitive

advantages, such as: the German precision engineering, the French luxury goods, the

Italian design, or the Japanese consumer electronics. By far, from this thesis, the

following could be concluded:

Internal Governance Mechanisms:

(i) Board: (1) the number of directors that comprise the board; (2) the fraction of these

directors that are outsiders; (3) whether the CEO and chairperson positions are held by

the same individual. (4) The size of the board is negatively related to both firm

performance and the quality of decision-making, due to a simple social explanation that

fewer groups make better decisions – thus the smaller the board, the better the firm

performance; (5) Higher independent directors’ board proportion does not necessary

mean higher quality firm performance, but leads to better decisions in terms of

executive compensation, or acquisitions and other major investments, and is more likely

irresponsible top management to be fired;

(ii) Executive Compensation Policies: (6) A big part of the pay-for-performance sensitivity

packages have increased during the last decade all over the world; (7) This sensitivity

comes through executive ownership of stock and options, which is indeed the fastest

growing factor of CEO compensation policies everywhere; (8) All evidence indicate that

executive pay remains sensitive to performance, and thus the degree to which CEO

63

compensation packages are aligned to the shareholders’ interests, is absolutely

important;

(iii) Ownership and Control Structure: Based on the analysis of this section, the following

can be inferred: (9) Foreign-ownership is associated with better firm performance, and

government-ownership is associated with worse firm performance; (10) Ownership is

more concentrated in non-Anglo-Saxon countries; (11) For Anglo-Saxon countries the

ownership structure is not as important as for the rest of the world – and respectively,

in the United States and the United Kingdom the influence on firm performance is lower,

but private ownership is a value-enhancer; (12) Dispersed ownership is typical for

countries, where shareholder are well-protected, thus in the Anglo-Saxon countries; (13)

In countries with less-protected shareholder rights by law, family control is more

common, and higher proportion of private benefits for large shareholders occur, such

as in the Continental European and Asian countries; (14) If the rights of the shareholders

are not well-protected by the law, optimal ownership structure is difficult to be

achieved; (15) Pyramid structures are more common than cross-holdings across the

largest corporations; (16) Tunneling and transfer of assets occur most often in civil law

countries than in common law countries.

External Governance Mechanisms:

(iv) The Governance Role of Takeovers (17) Excluding some of the largest and richest

economies (e. g. the United States), takeover activity is not an extremely important

governance mechanism all over the world (e. g. Netherlands – family-owned companies,

and China – state-owned companies); (18) According to the takeover market activity,

the governance role of takeovers is most important in North America countries (e. g. the

United States and Canada), then to Europe (e. g. the United Kingdom and Germany), less

to Asia Pacific (e. g. Australia) and almost insignificant to Japan, Central and South

America, Africa and the Middle East; (19) The mergers and acquisitions trend is

progressive, and the activity is going to increase even more, so in the long term we

should not be surprised by the implementation of more frequent and huge deals.

(v)The Legal System and International Regulation: (20) If adequate local laws do not

guarantee dispersed ownership rights, concentrated ownership is the only possibility

64

left to maintain control; (21) The law, which is historically predetermined, defines the

ownership structure and system of corporate finance and governance all over the world;

(22) Common law countries (e. g. the United States) protect their shareholders better

than in civil law countries (e. g. France); (23) Codes play more important role in Europe

than the rest of the world; (24) Europe and North America are moving towards one

common corporate governance practice through combined efforts of accountability

strengthening, transparency bringing, economic efficiency improvements and standards

harmonization processes.

Despite the global convergence, the regional approaches to corporate governance,

control and strategy vary widely across countries, which is clearly reflected by the quality

of their leading industries. Each of the systems is predicting to be changed, but creating

a unitary system is the least likely possibility. Thus, the supposed diversity through global

convergence will not change the models significantly, or at least not easily.

There will always be considerable diversity around the world. The culture as a factor

remains to be extremely underestimated, which have already led to the failure of some

of the largest deals and corporations. Business practices, traditions, values and

objectives are closely related to the decisions that people take, and that is why to have

knowledge about the different systems around the world is essential.

The causes of the crises are not that economic but moral. Transparency and honesty

are key to managing relationships and gaining trust from people. For sure, sometimes it

is hard to deliver a message you know somebody will not like, but in the long term to be

highly moral and ethical, or as transparent as possible about a situation, really pays off.

65

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