Corporate Governance Models
In many countries, companies are run mostly for the benefit of the shareholders, the rightful owners 0. However, there are circumstances in which the corporation is also run for the benefit of other interest groups such as customers and employees or the general public at large -1. This is the substantive difference between the two primary models of corporate governance namely the outsider model, which is used in Anglo-American countries such as the United States or United Kingdom 1 and the insider model, which is used predominantly in European countries such as Germany or France 4343.
If you need assistance with writing your essay, our professional essay writing service is here to help!Essay Writing Service
The outsider model, also known as the Anglo American model of corporate governance because it is predominantly used in Anglo American states like the United States and United Kingdom, is consistent with the narrow definition of corporate governance in that it has a bias towards shareholders over other stakeholders in the corporation 2. This bias is justified on the premise that in most instances, other stakeholders have recourse to protect their interests through contractual agreement, whereas the shareholder remains unprotected as corporate decisions and activities cannot be predicted in advance 3. Since the shareholders carry the risk of the investment decisions made by the corporation, it is argued they should have the primary say in corporate governance.
The justification for this ideology is that the primary function of a corporation is the creation of wealth 4. Permitting corporations to focus on profit maximizations as their primary function ensures that businesses create economic growth as oppose to dealing with social considerations which distract them from this objective. It has been argued that directors are not sufficiently experienced in balancing social interests with economic ones and as a result to require them to do so would result in an inefficient system, which would not promote the economic welfare of the market.
The Anglo American model starkly contrasts to the stakeholder-oriented approach which is commonly associated with European countries such as Germany and France 5. Under this model, corporations must not only take into account the interest of shareholders but also those of a wide range of constituencies, as well as of the communities within which they operate 6. This helps to assure that corporations operate for the benefit of society as a whole and not solely in the interests of its shareholders. Such a system places less emphasis on the interests of shareholders for the benefit of the wider community 7. There are several characteristics which distinguish the Anglo American model from the stakeholder-oriented approach. Those unique to the Anglo American model are discussed below.
Responsibility for Corporation Management
The effective functioning of a corporation is dependent on the interrelationship and interaction of its various institutions 1. These institutions consist of the board of directors, the executive management and shareholders 2. The shareholders of the corporation are the owners who have financially invested in the corporation and the board of directors, as well as executive management, are responsible for the operation of the corporation 3 . The Anglo American model’s primary focus is on maximising profits for the benefit of its shareholders 4. This model does not facilitate input into the corporation’s affairs by other parties nor does it permit the managers of the corporation to prioritize issues, such as employees or the environment, unless they are compatible with the profitability of the corporation 5.
The executive management is charged with the responsibility of operating the company with the view to maximising shareholder profit. The essential role of the management team, who is lead by the corporation’s Chief Executive Officer (CEO), is to perform the day-to day operations of the corporation 5555. The CEO plays a critical role in administering the company’s affairs. The CEO chooses the management team and, from a practical perspective, has the final say in many issues relating to the corporation despite the provisions of many corporate statutes and procedures.
The Board exists primarily to be an effective corporate governance mechanism for hiring, firing, monitoring and compensating management 6666. The Board, by legislation and corporate by-laws, are delegated a wide variety of responsibilities which enable them to set the company’s main objectives and monitor their application by the executive management. The Board of Directors is therefore the main organ of the company and acts as agents for its owners by supervising the actions of the managers.
There are two popular forms of boards of directors namely, the unitary (one-tier) and dual (two-tier) boards 6. The Anglo American model favours the unitary board 7. Under this system of management, the number of directors is usually set in the corporation’s by-laws and they are elected by the shareholders at the AGM for a set period of time, normally a one year term 8. The Board consists of executive directors (EDs), who are considered employees of the corporation, and non-executive directors (NEDs), who tend to be professionals or experts that are independent of the corporation 9. While an ED’s sole responsibility is to increase profits for the shareholders, there is a potential risk that their interests may conflict with those of the corporation 10. The function of NEDs is to strike a balance between the interest of the shareholders and EDs 11. As independent third parties, they should have no conflict of interest and are therefore equipped to monitor the performance of the EDs impartially to the benefit of the shareholders should EDs try to deviate from their principal objective.
The success of the Anglo American model is dependent on the extent to which the Board can effectively supervise the actions of the executive management 12. While legislation and regulations seek to ensure a balance between the two entities, in practice the executive management is by far more powerful than the Board 13. The nature of publicly held companies is that the executive management has a great deal of flexibility in determining how they discharge their responsibilities in attaining the objectives of the corporation 14. To encourage them to do so, they are more often than not enticed with substantial compensation packages with performance based remuneration. It has been argued that such compensation packages encourage the executive management to concentrate on short term results as oppose to the company’s overall or long-term interests 15. This problem is further compounded by the dominant role the CEO plays in the relationship between the executive management and the Board. While in board meetings the Board is technically supervising the CEO and his management team, the former have a large degree of control over the meetings. The CEO sets the agenda for board meetings and decides what information is to be provided to other directors. With this sort of control, it is very easy for the CEO to limit the powers of the Board 16. However, over the past few years, the dominance of the CEO has been challenged not only by the increasing influence of the board of directors 17,but also by legislation. A clear example of this can be seen from the requirement for the CEO to certify personally in quarterly and annual SEC reports that as far as they know these contain no untrue statements or omissions of material facts which might mislead shareholders and that the firm’s financial condition and results have been fairly presented 18.
The Rights of Shareholders
The ability of a shareholder to exercise its ownership rights and protect its investment is a key to the Anglo American model of corporate governance. Due to the fact that the focus of the Anglo American system focus is on the interest of shareholders, this model tends to focus on the nature of ownership and the ability of that ownership to protect its investment 0.
One of the clear challenges which arise from the separation of ownership and management is to strike the right balance between the rights of the owners with the control of the managers 1. There are several mechanisms which the Anglo American model utilises to deal with this issue 2. These come in the form of rights which are afforded to the shareholders which enable them to monitor and control the managers of the corporation 3. The Anglo American model utilizes an outsider/arm’s length system of ownership and control, where share ownership is widely dispersed. Most of the largest corporations in the US and UK are quoted on the stock market and offer their shares to the general public 4. This sort of dispersed ownership is a main feature of this type of model. According to one study, less than one-fifth of the Britain’s publicly traded companies have an owner who controls more than 25% of the shares 5. It has been argued that the reason for this is because the general public in these communities prefer not to own a high percentage of equities in large firms 6. Having said so, even countries who share a similar trend in ownerships are not always identical. For example, one major difference between the US and UK in terms of ownership is the stronger presence of institutional shareholders in the UK 7.
This trend towards ownership by institutional shareholders has an impact on the efficiency of the Anglo American model. The institutional shareholder represents a large number of smaller investors and therefore has the clout to effectively monitor and address managerial misconduct 8. In the UK context, it has become conventional wisdom that prompting institutional investors to consider their responsibility as an important corporate constituent is an additional way to improve managerial accountability 9. Unfortunately, this has not always been the case primarily because many institutional shareholders are driven by short term strategies which may not have as their paramount concern the long term welfare of the corporation. As Hutton says, ‘the consequence [of tax arrangements] has been a flood of institutional savings and acute demand for dividends and the foreshortening of investment time horizons 10.’
In addition, it has been shown that when dissatisfied with the performance of a corporation, many institutional shareholders would prefer to sell their shareholding than to play some sort of supervisory or monitoring role in the corporation 11. Another problem facing institutional shareholders is how to reconcile their roles as shareholders owning shares in many listed companies with their role as investors of funds 12. Given that their primary motivation is to make profit for their investors, they compete fiercely with each other to attract funds in order to ensure a high return on their investments 13. Consequently, when faced with mismanagement it is easier for them to sell than to hold management to account. Further, it has been argued that even when institutional shareholders were willing to intervene in the corporation’s affairs, there are practical obstacles which make it difficult for them to do so. One of these is what is commonly referred to as the motivation factor. Proctor and Miles define it as follows ‘There is a disincentive for single institutional shareholders to expend time, effort and resources correcting what they perceive as bad management if other fellow institutional shareholders do not also support this action. Institutional shareholders have different priorities and agendas at any one time. It may be difficult to pool resources to tackle together what to some institutional shareholders may not be a problem at all. 14’
In light of the challenges institutional shareholders face in monitoring management of companies, the Anglo American model can only be successful if there are other mechanisms in place which can be used to protect shareholders 15. The main focus of the Anglo American model is in the protection of shareholders 16. In this respect, both the UK and US system are similar in the way corporate directors and senior managers are held accountable to their shareholders 17. Both systems encourage shareholders to work as monitors over managers and senior executives 18. To facilitate this monitoring process, shareholders have many statutory rights and common law rights.
The main right afforded to shareholders that provide them with a means of controlling the management of the company is their statutory right to vote on decisions at the Annual General Meeting (AGM) 19 . The AGM is an annual meeting which shareholders are entitled to attend 20. At this meeting, the shareholders are informed about the previous and future activities of the corporation 21. It is an opportunity for them to receive copies of the company’s accounts as well as review fiscal information for the past year and ask any questions regarding the directions the business will take in the future 22. In addition, the shareholders are able to elect the Board of Directors 23. This right is designed to operate as a check on the managerial actions of the Board of Directors and executive management. Shareholders are able to participate in discussion regarding the company’s welfare and vote on important affairs relating to the company 24.
While the right to vote at a corporation’s AGM may at first glance appears to be an effective means for shareholders to protect their interest, in practical terms this is often not the case. Publicly held companies usually consist of a large number of small owners who own very small fractions of the corporation’s shares 25. Having a small proportion of the corporate equity means that shareholders have little influence on managerial decisions 26. Furthermore, due to the fact that their shareholding is insignificant, it is unlikely to give them any real power at AGMs where they are suppose to be able to exercise their legal rights. As a result, many shareholders are not incentivised to attend AGMs. For this reason, the Anglo American model has additional mechanisms which are designed to enhance the control of the managers by shareholders. Most, if not all, of these legal and organisational safeguards have been devised in response to abuses of corporate power by managers who fail to put the interests of shareholders first. These mechanisms are intended to encourage minority shareholders to be active in protecting their rights and holding directors accountable for actions 27. The three main mechanisms which will be discussed below are cumulate voting, appraisal rights and shareholder’s derivative action 28.
Cumulative voting is a process by which minority shareholders are permitted to cast all their votes in the election of directors for a single candidate 29. Through this process, the power of the minority is strengthened because they are able to pool their votes together and secure a member of the Board who they feel confident will look after their interests in the corporation 30.
Shareholders are also given the right to seek appraisal of their shares in certain fundamental transactions for example where a merger takes place. In these circumstances, a shareholder can seek a court valuation of their shares based upon fair value and be paid in cash 31. This right to sell one’s shares can be seen as a protective measure for shareholders, because it encourages directors to seek the highest price in such transactions so as to avoid several shareholders exercising this right 32. Having said so, there are some disadvantages to this right. In most cases the methods of valuation are conservative and therefore shareholders do not necessarily benefit in real terms. The process is time consuming and payments need not be made until the process is complete. Attorney’s and expert’s fees can be high and interest is not assured.
Of all of these rights, the derivative suit against directors is probably the strongest tool which can be used by shareholders, particularly minority shareholders. A derivative suit is a claim brought by a shareholder on behalf of the corporation against parties allegedly causing harm to the corporation 33 . This right strengthens the position of shareholders, in particular minority shareholders. As a common law country where case law principles are well developed and where shareholders are said to be better protected, judicial intervention is believed to be an essential element of good corporate governance.
A derivative action would not be effective unless the management of a corporation has a duty to its shareholders. The board of directors is a critical part of the corporation and as a result must be held to account to the corporation’s owners if good corporate governance is to prevail. In the UK, directors are subject to common law fiduciary duties and case law still plays a central role in holding managers and board of directors accountable to the corporation as a separate legal entity.
Seeing the relationship between the directors and shareholders as one of agency implies that directors should be elected by shareholders and can be dismissed by them at the AGM.
The focus therefore is clearly on ensuring that those who manage the corporation are always acting in the best interest of the corporation’s shareholders. The lean of the Anglo American system to protect the interests of shareholders is most evident when looking at the manner in which it deals with takeovers and acquisitions of corporations. In instances where there is a takeover bid, shareholders need to be given an opportunity to decide on the merits of a takeover so as to ensure that shareholders of the same class are afforded equivalent treatment by an offeror and thus are being treated fairly. The Anglo American model therefore provides a degree of protection to shareholders in instances where a corporation is subject to a takeover bid. For example, in the UK, the City Code on Takeovers and Mergers 7777 (the City Code) ensures that shareholders are treated fairly and are not denied an opportunity to protect their interest’ 8888. The City Code essentially essentially all defensive actions when a takeover bid is pending or when the target has reason to believe that a bona fide offer might be imminent’ 9999. Once a bid is made, any defensive action requires shareholder approval. This means management of the corporation cannot supersede the interests of its shareholder, who so ever it shall be. UK case law emphasises that the fundamental decision on takeovers belongs to shareholders, not incumbent managers and generally holds that management actions which go against shareholders’ rights are not pursuant to a proper purpose and therefore fall outside the scope of the delegated management authority afforded by the common law.
Our academic experts are ready and waiting to assist with any writing project you may have. From simple essay plans, through to full dissertations, you can guarantee we have a service perfectly matched to your needs.View our services
Disclosure and Transparency
Disclosure and transparency are important in managing the relationship between shareholders on the one hand and the executive management on the other. Shareholders have a right to make decisions in relation to the corporation based on information that is accurate and correct 1. This is the only way they can be sure that the corporation is being managed properly. Financial reporting frauds have attracted high-profile attention recently provoked by widespread irregularities at large corporations 2. It is management’s responsibility to prevent such problems before they begin 31. To do so, it is necessary to establish a control environment designed to identify and immediately stamp out any fraudulent reporting that does occur 32.
One of the tools which is used to protect shareholder’s interests in this respect is the audit committee 3. An audit committee is an operating committee of the Board of Directors charged with oversight of financial reporting and disclosure 4 . Committee members are drawn from members of the company’s board of directors, with a Chairperson selected from among the committee members 33. To be effective, the committee must be composed of independent outside directors with at least one qualifying as a financial expert 34.
The audit committee plays an important role as a board subcommittee. The Smith Report 5 explains its role as follows: “While all directors have a duty to act in the interests of the company, the audit committee has a particular role, acting independently from the executive, to ensure that the interests of shareholders are properly protected in relation to financial reporting and internal control.”
An analysis of the corporate governance codes of twenty European countries by Collier and Zaman (2005) 6 showed that their codes assign a set of functions which should be fulfilled by an audit committee as follows: a) oversight of external audit; b) oversight of internal audit; c) involvement in external auditor selection or dismissal; d) oversight of risk and internal control reporting by the board; and e) oversight of financial reporting quality.
In carrying out these functions, the committee operates as a liaison between the Board, external auditors, internal auditors, the finance director and the operating 7 . They are for all intents and purposes the final safeguard in ensuring the financial statements of the corporation which are released to shareholders and other stakeholders are accurate. The Board often relies on the audit committee to notice and question any unusual business practices, aggressive accounting methods or violations of the company’s code of business conduct. But at many companies audit committee members may not have the expertise in matters of internal control 8. In addition, some people serving on audit committees have very little accounting or financial experience 9. Accordingly, audit committee members need a reference guide to their responsibilities. That is the function of an audit committee charter 10. A comprehensive charter enhances the effectiveness of the audit committee, serving as a road map for committee members 11. A well-thought-out charter also should describe the committee’s composition and specify access to appropriate resources.
Good corporate governance is key to the integrity of corporations, financial institutions and markets 1. They also play an important role in promoting the health and stability of a state’s economy. Many international organizations have come to understand the importance of good corporate governance including the Organization for Economic Cooperation and Development (OECD) 2. To this end, the OECD established the first set of internationally acceptable standards of corporate governance, known as the OECD Principles, which have become a reference point used by both developed and developing countries not only for self-assessment but also for issuing and developing codes of best practice 3. The OECD work in corporate governance is centered on promoting the implementation of these principles throughout the world. They are arguably one of the most substantial efforts made to highlight the importance which should be given to corporate governance.
The OECD Principles were first released in 1999 and revised in 2004 4. It sets out the key standards of corporate governance which are required for international financial stability.
The Principles are intended to assist governments to evaluate and improve the legal, institutional and regulatory framework for corporate governance in their own countries 5. The Principles primarily focus on publicly traded companies, but provide a good guideline for other forms of corporations. The main principles of the OECD Principles 6are:
The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.
The corporate governance framework should protect and facilitate the exercise of shareholders’ rights.
The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
The corporate governance framework should recognise the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.
The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.
The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders.
In addition to the OECD, business-related organizations like the Centre for International Private Enterprise have also considered corporate governance to be important in the promotion of good business practices 7. The Centre has an affiliate located in Egypt which was established to educate, raise the awareness of the importance of establishing suitable corporate governance standards in the Middle East and North Africa (MENA) region. 8
Cite This Work
To export a reference to this article please select a referencing stye below:
Related ServicesView all
DMCA / Removal Request
If you are the original writer of this essay and no longer wish to have your work published on UKEssays.com then please: