The primary function of corporate governance in the United States has been to address the managerial agency cost problem that afflicts publicly traded companies with dispersed share ownership. Berle and Means threw the spotlight on this type of agency cost problem—using different nomenclature—in their famous 1932 book The Modern Corporation and Private Property. Nevertheless, it was only in the 1970s that the now ubiquitous corporate governance movement began. Why did the corporate governance movement gain momentum in the U.S. when it did? And given its belated arrival, why did it flourish during ensuing decades?
Posts Tagged ‘Corporate governance’
Since 2001, eight stock exchanges around the world have launched corporate governance indices (CGIs), sometimes as part of a broader environment, social, and governance (ESG) initiative. The comprehensive analysis of these indices is presented in our World Bank/IFC study: “Raising the Bar on Corporate Governance – A Study of Eight Stock Exchanges Indices”. The study is the first of its kind, and it reveals that CGIs may have a positive impact in enhancing legal and regulatory frameworks by contributing to the development of objective and measurable governance benchmarks. The study also shows that CGIs offer companies an opportunity to differentiate themselves in the market and be more attractive to foreign and domestic capital; and, ultimately, CGIs incentivize companies to adopt better governance practices. Nevertheless, as the process for vetting companies to access the indices continues to evolve, the scrutiny of underlying methodologies, the disclosure of company ratings or company self-assessments, and the on-going monitoring process have still room to improve.
Over recent decades, corporate governance has become an increasingly high profile aspect of legal scholarship and practice. But despite this widespread interest, there remains considerable uncertainty about how exactly corporate governance should be defined or understood. Of particular concern is whether corporate governance is most appropriately understood as an aspect of ‘private’ (facilitative) law, or else as a part of ‘public’ (regulatory) law. In my recent book, Corporate Governance in the Shadow of the State (2013, Hart Publishing), I demonstrate that this question is not just an academic one in the pejorative sense. On the contrary, it is arguably the most important issue confronting those who study or teach the subject of corporate governance in any level of depth or analytical rigour.
Bebchuk, Cohen, and Wang Win the 2013 IRRCi Academic Award for “Learning and the Disappearing Association between Governance and Returns”
In an award ceremony held in New York City on Tuesday, the Investor Responsibility Research Center Institute (IRRCi) announced the winners of its the 2013 prize competition. The academic award, coming with a $10,000 award prize, went to HLS professor Lucian Bebchuk, HLS Senior Fellow and Tel-Aviv University Professor Alma Cohen, and HBS professor Charles Wang. Bebchuk, Cohen, and Wang received the award for their study, Learning and the Disappearing Association between Governance and Returns, available on SSRN here.
The Bebchuk-Cohen-Wang study was published last month by the Journal of Financial Economics. In presenting the award, IRRCi chair announced that the winning paper “will be valuable … for investors, policymakers, academia, and other stakeholders.”
The study seeks to explain a pattern that has received a great deal of attention from financial economists and capital market participants: during the period 1991-1999, stock returns were correlated with the G-Index, which is based on twenty-four governance provisions (Gompers, Ishii, and Metrick (2003)) and the E-Index, which is based on the six provisions that matter most (Bebchuk, Cohen, and Ferrell (2009)). The study shows that this correlation did not persist during the subsequent period 2000-2008. Furthermore, the study provides evidence that both the identified correlation and its subsequent disappearance were due to market participants’ gradually learning to appreciate the difference between firms scoring well and poorly on the governance indices. Consistent with the learning hypothesis, the study finds that:
There has been a recent surge in research that seeks to understand the sources of variation in tax avoidance (e.g., Shevlin and Shackelford, 2001; Shevlin, 2007; Hanlon and Heitzman, 2010). The benefits of tax avoidance can be economically large (e.g., Scholes et al., 2009) and tax avoidance can be a relatively inexpensive source of financing (e.g., Armstrong et al., 2012). However, aggressive tax avoidance may be accompanied by substantial observable (e.g., fines and legal fees) and unobservable (e.g., excess risk and loss of corporate reputation) costs. Although understanding the factors that influence managers’ tax avoidance decisions is an important research question that has broad public policy implications, relatively little is known about why some firms appear to be more tax aggressive than others.
In our paper, Corporate Governance, Incentives, and Tax Avoidance, which was recently made publicly available on SSRN, we examine whether variation in firms’ corporate governance mechanisms explains differences in their level of tax avoidance. We view tax avoidance as one of many investment opportunities that is available to managers. Similar to other investment decisions, managers have personal incentives to engage in a certain amount of tax avoidance that may not be in the best interest of shareholders, thereby giving rise to an agency problem. From the perspective of the firm’s shareholders, unresolved agency problems with respect to tax avoidance can manifest as either “too little” or “too much” tax avoidance. As with other agency problems, certain corporate governance mechanisms can mitigate agency problems with respect to tax avoidance.
Imagine that a corporation holds a shareholder vote on a project like a merger, and, under the corporation’s bylaws, each shareholder can cast a number of votes equal to the square root of the number of shares that he holds. This might seem like a gimmick, but it actually provides a natural, smooth form of minority shareholder protection without the external intervention of the courts. In fact, under reasonable conditions square root voting (SRV) ensures that the project is approved if and only if it maximizes the value of the firm and thus achieves the efficiency goals of minority shareholder protection without the messy legal procedures that usually accompany them.
To see why, suppose that a corporation proposes a merger. An investor believes that the merger will increase the value of the corporation by $1000 per share, and that a vote in favor of the merger increases the probability of approval by 0.01. Thus, the marginal benefit from buying a share is $10. The investor can buy shares of the corporation at an opportunity cost of $1 (in the sense that she would rather use her money in another way and she incurs brokerage fees, but can otherwise sell the share for net expected profit of $0 if the merger is not approved). Because of the square-root rule, however, she must buy the square of the number of shares for every vote she casts. Thus, if she wants to cast 1 vote, she must buy 1 share at a cost of $1; if she wants to cast 2 votes, she must buy 2 shares at a cost of $4; if she wants to buy 3 shares, she must pay $9; and so on.
I am delighted to be able to participate in this conference, and especially proud as an Irish-American that it is being held in conjunction with Ireland’s Presidency of the Council of the European Union. This conference is particularly valuable because it provides a forum for executives, directors, investors, and policy makers to have a frank and productive dialogue on important corporate governance issues.
I would like to talk about the increasing role that governments – particularly, in the United States, the federal government – play in corporate governance as well as the increasingly prominent influence of proxy advisory firms on how companies are governed and on how shareholders vote. These changes have led to, among other things, new limitations and requirements being imposed on boards of directors and companies. And while the resulting costs to investors are easily apparent, the purported benefits are harder to discern. Although today I will for the most part discuss these issues as they apply to U.S. companies, I note that there is a related trend in Europe. As such, I hope that my comments may help inform your approach to regulating corporate governance as well.
About a year ago we restated Vanguard’s mission to read: “To take a stand for all investors, treat them fairly, and give them the best chance for investment success.” While the words were new, the ideals were not; they’ve been the consistent principles by which we’ve managed our enterprise since our founding.
As we stand on the cusp of “proxy season”—when investors in most U.S. companies will vote at shareholder meetings on matters including the election of directors and the approval of compensation plans—it strikes me that nothing better exemplifies our mission in action than our efforts to ensure that the companies in which our funds invest are subject to the highest standards of corporate governance.
Complaints that investors only look for short-term gains are nothing new. As early as 1990 an Economist article proclaimed: “The old bugbear of businessmen — that fund managers are too obsessed with the short term, and unwilling to buy shares in companies with ambitious research projects — is back on the prowl.”
Recently, the turnover of shares in listed companies has grown to numbers far exceeding those of 1990. Does this change in investor behavior influence the behavior of managers in listed firms?
The institutional innovation of freely tradable shares, traceable to Holland in the 17th century, made it possible for companies such as the Dutch East India Company to have longer investment horizons than individual investors. Listing shares ensured that an investor could recoup his money from other investors and that, as a result, companies didn’t have to repay individual investors. Seen in this light, one might assume that investor short-termism would have little influence on board decisions at listed companies and much more influence on board decisions at privately held companies. General opinion, however, disagrees.
PwC U.S. recently released two reports on corporate governance considerations relating to public offerings. The first, titled “Going Public? Five Governance Factors to Focus on,” outlines key governance considerations companies should address when pursuing a public offering. Its companion document, “Governance for Companies Going Public: What Works Best™,” guides directors and executives of companies planning an IPO through the many governance decisions necessary; offers insights from interviews with directors, executives, investors and board advisors; reports results of PwC’s proprietary research on pre-and post-IPO governance structures; and assists those involved understand the governance landscape.
The five key governance considerations detailed in the report titled “Going Public? Five Governance Factors to Focus on” include: