Corporate governance is necessary and important in order to facilitate long-term owners’ goals, reducing conflicts of interests’ risks. Summarizing the key models of corporate governance was the purpose of this article, deeper dynamics will be further investigated in future works. Here, the main differences between models of corporate governance have been enlightened, but above all, the focus was on additional approaches to corporate governance based on information, cognitive distortions and latest asymmetries from a behaviorist perspective, going beyond the well-known principal-agent problem. Finally, the work is concluded by highlighting the role of lawgivers and related correctives adopted to mitigate the governance issues.
Table of Contents
- What is corporate governance?
- The information dilemma
- Which corporate governance model is the best
- Comparison: model per function
What is corporate governance?
Corporate governance represents a complex relationships’ system that involves parties with divergent needs about direction and control of the company. Actually, this is not the unique definition due to the pervasive diffusion of the topic across the world, but luckily, we got help from International Finance Corporation IFC, where corporate governance is defined as “[…] the structures and processes for the direction and control of companies.”
Better, the Organization of Economic Cooperation and Development add value to our definition in their Principles of Corporate Governance:
In this sense, we can notice that Corporate Governance seems a relatively new concept, because it was definitively established after 90s/00s scandals (e.g. Enron), but the need of independency, accountability, integrity, fairness and transparency already existed since 1600s, when The East India Company elected a Court of Directors in order to split ownership from control (IFC, 2010). (Dis)Honest corporations were such even before Corporate Governance began to be studied in business schools. In the present understanding of Corporate Governance, we must include the new ways in which information flows throughout the company (internally and externally) and related accelerators technologies (or retarders technologies), in the achievement of owners’ objectives.
The information dilemma
Beyond the basic information asymmetry obstacles, extensively stemmed – but not yet sufficiently – in recent years, there are some exquisite mechanisms – still hardly verifiable – that could generate distortions in the information flows, mostly towards weaker parties. Here, corporate governance still fails. Cognitive biases are frequently exploited in order to bypass best practices (Camilleri et al., 2019). The way information is provided to shareholders, the way of developing some KPIs, the emphasis of some data rather than others. It is not by chance that cherry picking, Framing effect, apophenia or base rate fallacy are catching on companies. The information scarcity era is gone: today’s accountability issues derive from too much information available (and not those poor of yesteryear).
Furthermore, consider the cost allocation criteria: this could encourage some choices at the expense of others, but above all, it could make stakeholders perceive different economic-financial results (e.g. about inventory valuation).
On the other hand, more and more correctives have been adopted in virtuous management; for instance, we know that convertible bonds are able to deal with agency theory and signaling theory’s consequences (Berk J. & De Marzo P., 2017). Moreover, academic studies in the field of corporate governance modesl have supported the notion that greater managerial ownership is associated with fewer value-reducing actions by managers (Walkling & Long, 1984).
Boundaries are fuzzy, today it is hard to identify, at first blush, behaviors like adverse selection (ex-ante behavior) or moral hazard (ex-post behavior), and so will until long term benefits of corporate governance will be shared across all company levels, by each stakeholder. This can be a starting way to improve corporate governance.
Which corporate governance model is best
In today’s fast-paced business environment, there are four main models of corporate governance: the Monistic model (also called Anglo-US model), the Dualistic model (also called German model), the Traditional model and the Nordic model.
Corporate governance models are substantially abstractions of reality and should be considered as such. Therefore, there is no single “winner system” today.People make difference, models are ways to (attempt to) ensure that the company is run in the best interest of its owners. Regulations, correctives, policies surround the governance approach.
The best model is the one that ensures the maximum adherence in the long run by the parties involved.
Among models of corporate governance, the monistic represents the most common internationally governance configuration, especially in commonwealth countries. It was designed to focus on shareholders’ goals. Indeed, although there is a single board (i.e. one-tier), we can find two grades of directors:
- Inside directors: in charge of business management;
- Outside directors: in charge of corporate monitoring.
Hence, the entire board of directors is appointed by the shareholders meeting, but it includes non-executives independent members that form the audit committee. In fact, the board of directors is allowed to delegate day-to-day managerial powers to one or more executive directors or to a specific executive committee. The idea is to obtain an unitary system encouraging outsiders as a better management monitoring system (Weisbach, 1988). Typical of England, Australia, Ireland, Belgium, Israel, Korea, Spain, United States, Switzerland and Singapore, it is also called the “Anglo-Saxon Model” or principal-agent model.
A variant of the canonical monistic model is the French PDG model, where the roles of chairman and CEO are merged into the Président-Directeur Général.
Under the French PDG model, the CEO is the highest-ranking officer in the company and is responsible for making all major business decisions. The Board of Directors is responsible for overseeing the CEO’s decisions and ensuring that they align with the company’s long-term goals.
The PDG, as a single position, has both advantages and disadvantages. On the one hand, it allows for more decisive decision-making since the CEO is empowered to make decisions without having to consult with the Board of Directors. On the other hand, it can also lead to a concentration of power, which may make it more difficult for the Board of Directors to exercise oversight.
The French PDG model has been criticized by some who argue that it may not be effective in promoting transparency and accountability in corporate governance. However, it has also been praised for allowing for greater flexibility and agility in decision-making, which can be especially important in rapidly changing industries.
Whereas, the monistic form is associated to a single tier, the dualistic model is fundamentally two-tiered.
In some nations (e.g. Netherlands), it is mandatory to adopt a dualistic corporate governance model for big companies. Indeed, it could fit well for insurances and banks, because, from a purely theoretical point of view, compared to monistic, the dualistic model offers a higher protection for conflicts of interests and a more sophisticated risk management framework. Actually, this does not always result in practice.
Here, the general meeting elects the supervisory board, where we can find non-executives with supervisory powers, even if it is not uncommon that they could be entrusted with “high level” management powers. Even employees may have specific seats here. In turn, vertically, they elect the executive board, with day-to-day executives managers.
Typical of Germany, French, Netherlands, Hungary, Slovenia, Romania and Austria, it is also called the “German Model” or vertical dualistic model.
This approach is “traditional” only for some jurisdictions, especially where it is established as a standard model by the legal order (e.g. Italy). Actually, it is a horizontal dualistic model, where the board of directors and the board of statutory auditors are both, horizontally, appointed by the shareholders meeting.
As in the monistic model, the board of directors may delegate day-to-day managerial powers to one or more executive directors or to an executive committee.
Typical of Italy, Portugal and Japan (where companies are allowed to choose one of these models), it is very much present in some nations, mainly thanks to the fact that, when founders do not express preference, it represents the default model (Goglio & Goldstein, 2010).
In Japanese corporate governance model, it is particularly relevant the principle of internalism: according to this argument, the management approach adopted by large Japanese corporations is characterized by internal recruitment, cohesiveness, and expertise. Senior managers place great importance on the knowledge generated within the organization and are often skeptical about the contributions of external candidates who lack the shared experiences of the internal management team (Buchanan, 2007).
Typical of Nordic states, here the Annual General Meeting (AGM) elects the board of directors, made up of non-executives only. The board, in turn, elects the Executive Management. Here, employee representatives are appointed by the employee organizations.
The separation is pronounced and in line with international standards: at least half of the board of directors members have to be independent. Moreover, the same person cannot be CEO and chairman of the board of directors.
The statutory auditors of a Nordic company are appointed by the shareholders meeting to audit the company’s annual accounts and hence present their reports to the shareholders at the AGM in their annual audit report. In this scenario, the auditor answers primarily to the AGM and then to the board.
Both in Denmark and in Finland, it is allowed to choose between German and Nordic model: actually, right in Finland, only five listed companies adopt the vertical dualistic system, probably why it is not recommended by the Finnish corporate governance code.
Comparison: corporate model per governance function
|Monistic model||Dualistic model||Traditional model||Nordic model|
|Control/Audit||Audit committee||Supervisory board||Board of statutory auditors||Statutory auditors|
|Strategic oversight||Board of directors||Supervisory board*||Board of directors||Board of directors|
|Management||Executive committee*||Executive b.||Executive committee*||Executive management|
|*Law allows discretion|
Increasingly regulations are coming to aid of latest corporate governance issues, let’s think about the Corporate Governance Code, or the recent Corporate Insolvency and Governance Act 2020: an innovative bundle of measures for UK companies in financial distress as a result of the COVID-19 pandemic and the resulting economic crisis. However, we have to bear in mind that laws come after the issue is endemic. Ethics and Corporate Social Responsibility (CSR) represents good partners to mitigate this (bad)timing of the lawgiver, if and only if they are honestly adopted and internalized, not for marketing reasons. Further, it is necessary to continuously adjust the balance of the correctives’ mix: linking shareholders performance to managers remuneration is not enough anymore (the more stocks given, the more voting rights become significant, the harder will be to fire the manager), CEO’s turnover rate is only a variable in the ocean, as well as outsiders’ multiple boards attended or the boards’ size themselves.
Besides, hostile takeovers and insider trading are at the corner, at the same time, shareholders have to deal with bondholders. But this is another conflict.
In conclusion, Corporate Governance is a short blanket and it is, of necessity, constantly updated.
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