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Chapter 4 Corporate Governance in the Ece Region

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Chapter 4 Corporate Governance in the Ece Region ________________________________________________________________________________________________103 CHAPTER 4 CORPORATE GOVERNANCE IN THE ECE REGION The recent financial scandals at major United States corporations have highlighted the costs of corporate governance failures and have put corporate governance reform firmly on the policy agenda. Within the ECE region, there are basically two established models of corporate governance, one prevalent in the Anglo-Saxon countries, the other in continental Europe. They differ from one another in several ways, including who exercises control, in the structure of the board and of ownership at large, in their focus on shareholder or stakeholder interests and in the degree of protection they offer to shareholder and creditor rights. However, neither system has proven demonstrably superior to the other. Powerful forces, such as the need to access foreign capital markets, the pressure of institutional investors and the drive to create a single European market in financial services, are creating considerable pressure for convergence of these systems. However, a system of corporate governance, like a society’s other important institutions, is not easily transplanted. Even more so than in mature market economies, the corporate governance systems in central and eastern Europe and in the CIS remain works in progress. While progress on the legal protection of shareholder and creditor rights has been quite impressive, considerable enforcement gaps persist, particularly in the CIS, constraining firms in their access to outside finance. 4.1 Introduction corporat e governance since the creat ion of the count ry’s securit ies regulation regime in the 1930s. Viewing the Corporate governance has become a subject of situation in the United States with alarm, European heightened import ance and attent ion in government countries, mindful of earlier financial scandals of their policy circles, academia and the popular press throughout own, are examining their own syst ems of corporate the ECE region. Various reasons explain the current governance in an effort to guard against similar abuses. prominence of what many persons might otherwise consider an arcane and t echnical topic. The recent Even before the recent scandals, significant effort s, financial scandals affect ing major American firms, such propelled to a certain extent by earlier financial abuses, had as Enron, WorldCom and Arthur Andersen, and the been underway since the early 1990s within the OECD,246 result ing loss of confidence by the investing public in the the European Commission247 and individual European stock market have led to dramat ic declines in share prices countries248 to understand the economic consequences of and substantial financial losses to millions of individual investors. Both the public and the experts have identified failed corporate governance as a principal cause of these 246 Organisation for Economic Co-operation and Development, OECD scandals. Since half of all adults in the United States own Principles of Corporate Governance (endorsed by Ministers at the OECD stock either direct ly or indirect ly, corporate governance Council Meeting, 26-27 May 1999) (Paris), October 1999 [www.oecd.org]. In the wake of the financial scandals in the United States and the growing reform has become a highly charged polit ical issue. The international concern over corporate governance, the OECD Council at American Congress rapidly responded by passing the Ministerial level at its meeting of 15-16 May 2002 launched a new initiative Sarbanes-Oxley Act of 2002,244 wh ich the New York to strengthen corporate governance. Its final communique stated: “… the St ock Exchange (NYSE) quickly followed by adopting OECD will survey developments in OECD countries on governance in the 245 corporate and financial sectors, with a view to identify ing lessons to be sweep in g new rules for list ed co rpo rat ion s, thereby learned and the implications for the assessment of the OECD Principles of effect in g the mo st sign ificant refo rm in Un ited St ates Corporate Governance as a bench mark” [www.oecd.org]. The assessment is to be completed by 2004. 247 Weil, Gotshal & Manges, LLP, on behalf of the European Commission, 244 Sarbanes-Oxley Abnct of 2002 (Senate), H.R. 3763, 107th Internal Market Directorate General, Comparative Study of Corporate Congress, July 2002. Governance Codes Relevant to the European Union and its Member States, January 2002 [www.europa.eu.int/comm/internal_market/en/index.htm]. 245 “Corporate governance rule proposals reflecting recommendations to the NYSE corporate accounting and listing standards committee, as 248 In addition to numerous articles and studies, prestigious groups approved by the NYSE Board of Directors, 1 August 2002” and organizations within individual countries have produced over 30 [www.nyse.com]. The new standards are subject to approval by the recommended codes of best practices in corporate governance over the United States Securities and Exchange Commission, which had not last decade. For a comprehensive listing of these codes and reports, see formally approved them as of 1 December 2002. Weil, Gotchal & Manges, op. cit., pp. 14-16. 104_______________________________________________________________ Economic Survey of Europe, 2003 No. 1 corporat e governance and t o formulat e recommendat ions compet it ive market economies, effective systems of on appropriat e governance struct ures and pract ices. In corporate governance are seen as a key variable enabling emerging market economies in eastern Europe, countries to derive real economic benefit s from these experience over the last decade has clearly shown that fundament al economic changes. successful privatizations and the development of vibrant Corporate governance also has diverse international private sectors depend t o a significant extent on the 249 implications. Companies that list their securities on existence of effective systems of corporate governance. foreign markets in order to gain access to new sources of For example, the ability of “oligarchs” in Russia to capital subject themselves in varying degrees to the dominate and raid corporations and to engage in asset corporat e governance standards of the count ries where stripping and self-dealing at the expense of foreign and they are listed. In addit ion, one of the grounds upon domestic investors was clearly due to systems of which opponent s of “ globalizat ion” have challenged corporate governance that gave little or no protection to m ult inat ion al co rporat ion s, th e prim e m overs of investors who were not insiders. Following rapid globalization, is that flawed systems of governance allow privatization in the Czech Republic, which gave corporat e decisions to be made without taking account of insufficient att ention to the prot ect ion of shareholder the interests of all “stakeholders”, other than those of property rights, thousands of small investors sustained corporat e managers and shareowners. One recent st udy254 significant losses as “tunnelling” by insiders stripped has also concluded that important int ernational economic asset s from privat ized companies.250 disputes, such as those within the European Union over More generally, the ability of countries to attract the right of state-controlled public utilities to remain immune from takeovers, or the tensions between the foreign capital is affect ed by their syst ems of corporate Unit ed States and Japan over Japanese bank debts, arise governance and the degree to which corporate out of corporate governance problems. management is compelled to respect the legal rights of lenders, bondholders and non-controlling shareowners.251 In view of the current concern with corporate Individual and institutional investors will refrain from governance and it s far reaching implications for providing capital or will demand a higher risk premium economic activity, financial strength and international for their capital from enterprises in countries without relat ions, this chapter considers the nat ure of corporate effect ive syst ems of corporate governance than from governance, the various models and forms that it takes in similar enterprises in count ries having strong corporate Europe and North America and the challenges that it governance standards.252 One can also say that because poses for economic and legal policy in the ECE region. of its role in capital format ion, corporat e governance has important consequences for economic efficiency and 4.2 Defining corporate governance growth.253 Effective corporat e governance imposes a The t erm “ corporate governance” appears t o have discipline on firm managers to maximize returns to the arisen and entered into prominent usage in the mid- to firm. With the movement throughout the world toward late 1970s in the United States in the wake of the the expansion of privat e sectors and the creat ion of more Wat ergate scandal and the discovery that major American corporat ions had engaged in secret polit ical contributions and corrupt payments abroad.255 Eventually it also gained 249 A. Dyck, “Privatization and corporate governance: principles, evidence and future challenges”, The World Bank Research Observer, currency in Europe as a concept distinct from corporate Vol. 16, No. 1, Spring 2001, pp. 59-84; S. Estrin, “Corporate governance management, company law or corporate organizat ion. and privatization: lessons from transition economies”, Journal of African Economies, Vol. 11, February
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