The generally accepted definition of the phrase "corporate governance" comes from the seminal report of the Committee on the Financial Aspects of Corporate Governance, which was chaired by Sir Adrian Cadbury. (1) The Cadbury Report defines corporate governance as "the system by which companies are directed and controlled." (2) It has been defined by others as "a system of checks and balances between the board, management and investors to produce an efficiently functioning corporation, ideally geared to produce long-term value." (3) At its most basic, corporate governance deals with the relationships among various stakeholders with respect to the control of corporations. Above all, corporate governance addresses the relationship between the owners of a company--the shareholders who are the principals--and those who manage the company's operations--the executives hired to run the company as agents of the principals. (4) Corporate governance encompasses the weight given to various factors in connection with the process for making strategic decisions, the adequacy and transparency of disclosures, the reliability of financial reporting, and compliance with laws and regulations. (5)
Over the past several years, scholars have written extensively about the convergence of corporate governance practices around the world. (6) In the post-Enron era and with the passing of the first anniversary of the Sarbanes-Oxley Act, (7) we can clearly see that the pace of change has hastened; in some markets where corporate governance was nascent, it has advanced considerably in a short period of time as regulators around the world are united by a desire to restore the confidence of investors in the world's securities markets. Despite the swirl change, the convergence of governance practices will never be complete for many reasons, although certain core principles will be recognized in virtually every country as fundamental to a market economy.
This article reviews some of the factors affecting this convergence process and also looks at the status of convergence between the United States' governance laws and practices and those of certain other major markets. Specifically, the article briefly reviews recent corporate governance changes in Canada, Germany, Japan, Mexico and the United Kingdom from the perspective of a practitioner who has been involved in various governance issues in subsidiaries and acquisitions in these markets. In each of these countries, one constant is that the corporate governance principles to which companies are subject are imposed through several sources. In the United States, for example, principles of corporate governance applicable to a public company created under the laws of Delaware are derived from the Delaware General Corporation Law, (8) state and federal securities laws, and the listing standards of any stock exchanges upon which that company's stock is listed. (9)
FACTORS AFFECTING CONVERGENCE
Internal and external factors influence companies to establish good governance practices. While certain factors that influence companies in the area of corporate governance are specific to the country, or even the state or province in which a company is domiciled, many of these factors transcend geographic borders. Many different factors, such as the philosophical approach, market forces, political forces and the cooperation of various global entities, have played a role in the progress toward convergence. (10)
THE PHILOSOPHICAL APPROACH TO GOVERNANCE
One impediment to complete convergence is the varying philosophical approach to governance regulations. Some countries approach corporate governance in a manner that differs substantially from the approach adopted in the United States. With the passage of the Sarbanes-Oxley Act and the adoption by the Securities and Exchange Commission of various enhanced corporate governance standards, the United States has progressed even further into a law-based, or rules-based, approach to governance. (11) The legislation, regulations, and stock exchange listing requirements relating to governance are extremely detailed. Failure to comply with these highly specific rules may result in penalties.
Conversely, in some of the world's other markets, the approach is a principles-based approach. (12) In those countries favoring a principles-based approach to the regulation of corporate governance, the government may adopt--or even allow self-regulatory organizations such as the stock exchanges to adopt--general principles of corporate governance. (13) A simple explanation of the difference between the two approaches is illustrated by the different concepts conveyed by the terms "law" and "guideline." (14) The result is a different mindset with respect to corporate governance in the United States, which applies a rule- or law-based approach, where what is not prohibited is permitted, compared to a principles-based approach where greater discretion is vested in a company's management to make decisions regarding governance activities.
A principles-based approach to governance is one in which guidelines are clear, but compliance with them is voluntary. Some countries have adopted a "comply or disclose" approach to corporate governance, which requires corporations to disclose whether they comply with governance guidelines. (15) Other countries have adopted a "comply or explain" approach, which requires corporations not only to disclose whether they comply with governance guidelines, but also require the explanation of any reasons for non-compliance. (16) Typically, the compliance or non-compliance disclosure is made in a filing with either the stock ex-change or a government agency. (17)
THE EFFECT OF MARKET FACTORS ON GOVERNANCE
Good corporate governance is of utmost importance in today's economic environment because it affects investors, capital markets and the companies themselves. In a recent study, sixty-three percent of investors said that they would avoid investing in certain companies if those companies had poor corporate governance practices. (18) Fifty-seven percent of investors said they would change their holdings in companies based on the corporate governance practices of those companies. (19) In the alternative, investors in many countries are willing to pay substantial premiums to invest in well-governed companies. In Africa and Eastern Europe, the premiums can be as high as thirty percent, while in Western Europe and North America, the premiums are in the low teens. (20)
These same investors indicated that corporate governance can have a profound effect on the capital market of particular countries. (21) Thirty-one percent of investors said they would avoid holdings in certain countries based on the general governance practices in those countries. (22) Companies from around the word compete against each other for capital in the global markets. (23) The need to go outside the country for capital may be due to the lack of depth of the capital markets in a company's home country, or the possibility of obtaining lower rates abroad. (24) Companies from those countries viewed as having lax laws governing transparency and disclosure will have a competitive disadvantage as the rates they pay for capital in the global markets will be higher. (25)
Rating agencies such as Moody's, Standard & Poor's and Fitch now evaluate, in addition to the financial ratios they have always reviewed, governance issues in assigning a debt rating to companies. (26) In a competitive marketplace, the rate at which a company can finance debt is directly related to the company's credit rating. (27) Where a company's risk of default is determined to be high by the ratings agencies, the company must pay a higher rate to raise capital, possibly issuing junk bonds which require high interest rates to compensate investors for the high risk of default, than a company which can issue investment grade bonds.
For the companies themselves, governance can have a great impact. Poor governance, as seen in the media over the past two years, can lead to the implosion of respected and successful companies. (28) Poor governance can also affect stock prices, as investors sell stock in companies that have a reputation for poor governance practices. (29) Not only can poor governance affect companies' stock prices, it may also affect courtroom outcomes. A recent study found that seventy-three percent of jurors believe auditors will lie for their clients, while seventy-eight percent believe companies destroy documents. (30) Particularly in the United States, this mistrust of corporations may lead to larger jury verdicts in the future for corporations that have a reputation for poor governance and, perhaps, for all corporations.
THE EFFECT OF CORPORATE STRUCTURE AND OWNERSHIP DISPERSION ON GOVERNANCE
The type of corporate structure common in some countries can lead to different results in the corporate governance arena, in Germany, for example, there is a two-tiered board structure consisting of a management board called the Vorstand and a supervisory board of outside directors called the Aufsichtsrat. (31) Members of the Vorstand cannot, at the same time, be members of the Aufsichtsrat. (32) The existence, at the highest level in the corporation, of a board of independent, outside directors, arguably abrogates the need in Germany for some of the corporate governance principles gaining traction in the United States, such as requiring independent audit or compensation committees.
Ownership dispersion also differs from country to country, creating different governance concerns in some other countries than those that exist in the United States. In the United States and United Kingdom, ownership dispersion is high, while in France, Canada and Germany, ownership dispersion is low. (33) The commonplace family or bank ownership structures in Canada, Germany, Japan and Mexico may make investors in those cultures more comfortable with control of the corporation resting in a limited number of individuals having a high percentage of ownership. Differences in the number of individual investors in comparison to institutional investors may also lead to apposite results in various countries. Institutional investors can be expected actively to monitor firm performance because of the expertise they possess. (34) Further, their large ownership stakes motivate them to engage in active monitoring.
In Japan and the United Kingdom, for example, companies may have commercial dealings with many banks, but rely heavily on one main bank as their primary source of funds. (35) These banks may exercise very little control during period of smooth sailing. Until the company faces a crisis, the banks are likely to eschew intervention. When a crisis occurs, the banks become more active, exercising their rights as lenders and at times, substantial shareholders, to guide the company through the crisis or oversee reorganization by replacing management, restructuring debt and trimming expenses.
During the past two decades, institutional investors such as mutual funds and pension funds have played an increasingly important role in corporate governance on both a domestic and international level. To some degree, this is the natural effect of the premium investors will pay for well-governed companies in markets recognized as leaders in the areas of transparency and adequate disclosure. Increasingly, however, these institutional investors act as internal insurgents proactively attempting to influence corporations by issuing corporate governance statements (36) and filing shareholder proposals.
The institutional investors will also vote against certain management proposals viewed by the investors as lacking the hallmarks of good corporate governance. For example, most institutional investors will vote against any proposed stock option plan that does not explicitly prohibit the repricing of options. (37) Institutional investments originating in the United States dominate those from other countries. Thus, the type of activism that institutional holders here exert will likely become more prevalent abroad over time. Another effect is that there is pressure exerted by these investors to bring disclosure in other markets up to the levels of disclosure United States investors have learned to expect. The activism of institutional holders helps to shape the goals set by companies with respect to governance. (38) It also helps determine the speed at which various governance issues are addressed by both companies and governments and how issues are prioritized.
This institutional investor activism, which has been prevalent for years in the United States, is being actively exported in the post-Enron era. The California Public Employees Retirement System (CalPERS), for example, has identified several "Global Corporate Governance Principles" that are, in its view, minimum standards of corporate governance. (39) CalPERS takes the position that in all markets, companies should adhere to these standards to attract investment from institutional holders. (40) In April of 2003, CalPERS issued a press release in which it announced a $200 million investment in The Taiyo Fund. (41) The fund, based in Japan, will function within Japan as an activist investor much as CalPERS has in the United States. (42) The Taiyo Fund, to avoid dissipating its influence, will make significant investments in a relatively small number of companies to effect change in the area of corporate governance in Japan. (43)
THE EFFECT OF COMPENSATION PRACTICES ON GOVERNANCE
Compensation practices in various countries also play a role in the development of governance practices. Boards of directors use base salaries, bonuses and equity awards, such as stock options or restricted stock, to compensate a corporation's senior management. Certain types of compensation more closely align the interests of the company's management with the interests of the company's owners. For example, long-term incentive plans and stock options will in theory encourage company managers to act in harmony with the long-term good …