Corporate Governance Law - Assignment Example

? CORPORATE GOVERNANCE LAW Corporate Governance Law Introduction Corporate governance is a system that has gained prominence in the management of organizations across the world and plays a critical role in facilitating organizations to be effective and efficient hence attainment of organizational goals and objectives. According to Turnbull (1999, p. 189), corporate governance is defined as executive procedures and structural organization that is used to manage and direct business towards ensuring financial stability and achievement of objectives. Corporate governance is concerned with the relationship among the Board of Directors, minority shareholders, controlling shareholders, and the management. The history of corporate governance dates back to the nineteenth century when there was increasing emergence of limited liability companies in Europe and America (Klapper and Love, 2003, p. 28). Since then, the system has increased in prominence in many countries across the world because it has proved to contribute to sustainable economic development and the performance of companies. Minow (2002, p. 16) notes that the principles of corporate governance provide the framework for the following: disclosure and transparency, the role of non- financial stakeholders, the Board of Directors responsibilities, rights of shareholders and other stakeholders and their equal treatment. OECD (2005) states that corporate governance law is at the core of corporate governance and further argue that it provides basis for various aspects of corporate governance hence making it effective. Corporate governance law provides framework for intellectual property, litigation, mergers and acquisitions, and other vital decisions that relate to corporate governance (Minnow, 2002, p. 71). It is nearly undisputable that corporate governance is a critical aspect in the economic growth and development of any given country and the performance of companies (Bhagat and Bolton 2008, p. 268) In order to understand the concept of corporate governance law clearly, this discussion will compare and contrast the Anglo- American model and the European model of Corporate Governance. Thereafter, it will comment on which model more accurately reflects emerging corporate trends on Saudi Arabia and some other Arab Gulf countries. Importance of Corporate Governance Before comparing and contrasting Anglo- American model and European model of corporate governance, it is crucial to understand why corporate governance is important and relevant to countries and companies. According to Bhagat and Bolton (2008, p. 260), numerous studies have shown that corporate governance plays an important role in facilitating and guiding the development processes of countries and organizations towards achievement of their objectives. Klapper and Love (2003, p. 33) argue that even though corporate governance is important for all the countries regardless of their social and economic status, the concept is more crucial in achieving public policy objectives in emerging market countries. Good corporate governance is essential in reducing the vulnerability of emerging market to financial crises, contributes to capital market development, reduces cost of capital and transaction costs, and reinforces property rights (La Rocca, 2007, p. 312). Basically, corporate governance is critical in addressing the issue of integrity especially regarding how the management and board of companies are discharging their duties. Apart from that, corporate governance provides the basis for setting up regulatory entity; it allows an organization to introduce regulation and oversee the proper implementation of the regulation. Additionally, this concept is vital in enhancing the institutions’ remunerations and financial policies which enable institutions to make profits and prevent the institutions from effects of financial crises (OECD, 2005). According to Minow (2002, p. 30), strong corporate governance practices significantly increase productivity, reduces the risk of financial failures, and increases economic value added of firms. Each institution should ensure it has strong corporate governance frameworks so as to gain from its benefits. Weak corporate governance frameworks have negative consequences to any institution as it discourages external investments and reduces investor confidence (Turnbull, 1999, p. 205). Due to the role of corporate governance in the economic performance, the international financial community has adopted it as one of the core best- practice standards (Bhagat and Bolton 2008, p. 260). The OECD Principles of Corporate Governance is usually assessed by the World Bank. OECD (2005) explains that this assessment is part of the IMF and the World Bank program on Reports on the Observance of Standards and Codes (ROSC). ROSC initiative goal is to identify a country’s weaknesses and how the weaknesses can contribute to its financial and economic vulnerability. It does this through Corporate Governance ROSC assessment for each country that reviews the regulatory and legal framework, compliance and practices of listed firms, as well as assessing the framework relative to a benchmark which is internationally accepted (OECD, 2009). Models Even though the system of corporate governance is entrenched in nearly if not all institutions and countries in the world, the models of corporate governance applied in these countries often differ (Minow, 2002, p. 38). However, it is important to note that corporate governance principles are almost similar across the world with very small differences. Du and Dai (2005, p. 66) argues that although corporate governance principles are nearly similar across the board, their differences usually differ on the basis of application depending on the context of a particular country or region. That explains why there may be differences between Anglo- American model and the European model of corporate governance despite the fact they may be similar in numerous fundamental aspects (Clarke & Rama 2006). It is important to examine the corporate governance of each model and then compare and contrasts them. i) European Model of Corporate Governance According to International Finance Corporation [IFC] (2008), the European model of corporate governance is majorly concerned with the following aspects; Board of Directors, disclosure, and shareholder rights. It is worth noting that this model focuses more on the interest of stakeholders rather than shareholders. This is because of the context in which this model is applied; this model was formulated on state ownership of most of the companies, existence of family enterprises, and few listed companies (Du and Dai, 2005, p. 70). In regard to the board of directors, the model sets the minimum standards for the independence of supervisory directors or non- executive directors, commitment, and qualifications. Clarke & Rama (2006) observe that the model emphasizes Board of Directors that is composed of the executive and the non- executive directors. This system for Board of Directors is informed by the need to diminish the possibility of an individual or a group of individuals to take undue control of decision making. The model also provides for disclosure; it provides directive on company law, auditing and accounting rules (Laksmana, 2008, p. 52). This principle is aimed at protecting the economic and financial interests of the company and the public entities. The directive has established two major minimum requirements on directive on Company Law, Auditing and Accounting rules namely; the periodic financial reporting and disclosure of major shareholdings. In addition, European model of corporate governance is concerned with shareholder rights. Ooghe (2002) observes that the shareholder rights principle has set the minimum standards such as all shareholders who are of the same class should be treated equally, company’s board should provide shareholders with guidance on the effects of bid on the company, the shareholders of the company should have adequate information and time to make a decision on whether to accept an offer, and that the takeover process should not hinder unreasonably the business of the company among others. ii) Anglo- American Model of Corporate Governance Clarke & Rama (2006, p. 42) says that Anglo- American model of corporate governance is considered to be one of the oldest and advanced models of corporate governance. The model is also referred to as the unitary system. The model put emphasis on the single-tiered Board of Director system which is comprised of executives and non- executive directors who are all elected by shareholders. The number of non- executive directors is expected to be higher than that of executive directors and should hold key positions especially in compensation and audit committees (Clarke & Rama, 2006, p. 47). Also, the model has created basis for disclosure which provides the rules for accounting and auditing in the company. Additionally, the model provides for shareholder rights where it has set standards to the rights of the shareholders in the companies. It should be noted that this model is shareholder- oriented. The model emphasizes on the need to meet shareholders’ expectations; shareholders are given utmost priority and any concern they raise is given utmost attention. The model aims at boosting the earnings of shareholders through increased revenue in companies hence increased profitability (Ooghe, 2002). Similarities As is evident from the brief description of the Anglo- American model and the European model of corporate governance, both models have set standards in respect to key corporate governance aspects namely; Board of directors, shareholder rights, and disclosure. As will be noted, most of these aspects are similar in both the models but there are minor differences as well. In regard to similarities, the models are similar in so many ways. Firstly, both models have provisions on the Board of Directors. Turnbull (1999, p. 190) argues that both models recommend that companies should have boards comprising of executive and non- executive directors so as to prevent monopoly of decision- making on an individual or a group of individuals (Clarke & Rama2006, p. 80). They also recommend the audit, remuneration, and nomination committees should be set up in companies. In order to enhance performance within companies, both models recommend that board should carry out evaluation of their performance, and effectiveness and competence of each member of the board. In addition, both models require that the board of their companies should determine the judgment, experience, and knowledge that are needed on the board. Moreover, both models demand that directors should limit the number of their other commitments in order to devote adequate time to their respective companies. The board should also ensure that shareholders are informed on the company’s affair, the risks it faces, its strategy, and how conflicts of interests are managed (Ooghe, 2002). Anglo- American model and European model of corporate of governance are similar in regard to disclosure. They have directive on Company Law, auditing and accounting rules. The directive stipulates the adherence to ethical standards, independence, oversight, and clarifies the auditors’ duties (Ooghe, 2002). The models demands that public- interest entities should undertake certain audit functions such as the effective internal control and the financial reporting process. The principle of disclosure as stipulated in these models are aimed at ensuring that transparency and accountability is maintained within an organization in order to safeguard the interests of the company and that of shareholders. Both models have established minimum requirements on the following aspects that relate to disclosure; disclosure of major shareholdings and periodic financial reporting. Lastly, the similarity of the Anglo- American and European model of corporate governance is in relation to shareholder rights. The models recommend that the shareholders of the companies have the right to information that are relevant and necessary to them (Turnbull, 1999, p. 195). In addition, it requires the company to give shareholders enough information and time to decide whether to accept a given offer. Furthermore, both models have provided for the rights of shareholders to vote. In this regard, they should be informed in advance of the general meetings, the agenda of the meeting, and be furnished with the mechanism to vote. Apart from that, the shareholders are allowed to ask questions and table resolutions (Clarke & Rama, 2006, p. 88- 89). Various reasons have been cited for the similarities of the Anglo- American model and the European model. According to Hove (2000, p. 60), economic and legal transitions that have been taking place have greatly contributed to the convergence of these corporate governance models. The first reason cited for the similarities is the rules on disclosure and harmonization off securities that has been adopted in Europe, the US, and the UK. The US and the UK adopted these rules earlier on. On the other hand, most of the European countries have been entrenching these rules in their corporate governance with the aim of empowering shareholders, enhancing disclosure requirements, increasing public enforcement, and strengthening mechanisms of internal governance (Klapper and Love, 2003, p. 22). OECD (2009) notes growth of the stock market both in Europe as critical to increasing convergence of these models. He notes that, traditionally, European stock market was characterized by slow stock market growth. However, this has been changing in the recent past with the stock markets in Europe experiencing relatively high number of initial public offerings (IPOs). Another factor that has been cited for the increasing similarities of the models is the increased globalisation that has resulted to increased competition among companies across the world. As a result, there have been increased acquisitions and merges which have led to creation of bigger companies (Turnbull, 1999, p. 189). Companies have also been forced to shift their focus to shareholder’s value, hence the need to adopt ‘tried and tested’ corporate governance principles in order to boost profitability. Also, harmonization of International Accounting Standards has been a critical factor in the increased similarities of the Anglo- American and European models of corporate governance. The standards have eliminated the need for reconciliation of financial statements in the securities markets in the world (Hove, 2000, p. 58). Differences The similarities notwithstanding, Anglo- American model and European model of corporate governance are different. The existence of the differences between these two models is mainly because they operate in business contexts that are different (Klapper and Love, 2003, p. 16). Therefore, consideration of these differences should be within their given business contexts. It is noteworthy that the differences in the corporate governance models are not as a result of the companies’ financial systems in those contexts but rather as a result of the way in which control and ownership are organized (Clarke & Rama, 2006, p. 38). There are several differences between Anglo- American model and European model; the first one is the shareholder identity. In the United States and the United Kingdom, most of the company’s shares are held by financial institutions (over 50%) while private persons have around 20- 30% shares. This is not the case in Europe where shares are held in the following pattern: financial institutions about 10- 30%, private persons about 15- 35% and private companies about 20- 40% (Du and Dai, 2005, p. 63). Regulations in Anglo- American countries do not allow many financial institutions to hold public limited companies shares; these institutions mainly work as agents. Whereas in European countries private persons and companies are allowed to act directly hence no need of using agents in management of their affairs. Due to this nature of shareholder identity, most shareholders in Anglo- American countries do not have significant power compared to shareholders in Europe (Hove, 2000, p. 61). Decision making is largely controlled by shareholders in European companies unlike in Anglo- American countries where their decisions are limited. Differences in Anglo- American model and the European model of corporate governance is evident n respect to Chief Executive Officer (CEO) / Chairman roles and responsibilities. European model recommends that the CEO roles and that of the Chairman should be separate (IFC, 2008, p. 5). It also recommends that the CEO should not become Chairman immediately of either a supervisory or a unitary board. Under the Anglo- American model, the CEO also serves as the Chairman; that is, having the dual role. The separation of role in the European model is based on the belief that such separation of roles will prevent decision- making powers to be vested on a single person, hence, reducing the possibility of abuse of power that may arise (Hove, 2000, p. 62). Model that Reflects Emerging Corporate Trends Anglo- American model of corporate governance accurately reflects the emerging corporate trends. Compared to European model, Anglo- American model has proved to fit in well in the principles of corporate governance that focuses more on the shareholders (La Rocca, 2007, p. 313). European model of corporate governance is more stakeholders- oriented rather than being shareholders- oriented. Emerging corporate trends imply that corporate trends are emerging in countries that had previously stagnated in terms of economic performance little or no corporate governance principles were being practiced (Creane et al, 2004, p. 11). According to Makdissi, Fattah and Liman (2000), emerging corporate trends are more evident in Middle East countries and some countries in Africa and Asia. Emerging corporate trends include increased listing of companies in stock markets, attracting foreign investments of companies that subscribe to corporate governance, privatisation of state- owned corporations, and increasing external shareholding in family businesses. Since most of these countries have instituted reforms and established institutions in the economic structure, corporate governance has become inevitable. State- owned companies and companies listed in the stock market have embraced corporate governance in order to boost their profitability and enhance satisfaction of their shareholders. Definitely, corporate governance in most of these countries is not as strong as is the case in the US, UK and most of European countries. Therefore, strengthening of corporate governance in emerging corporations should be given high priority in order to enable them realize their long term goals. Since strengthening of corporate governance should be grounded on strong model, Anglo- American model is the best in addressing corporate governance issues in countries with emerging corporate trends. Studies have shown that there is an increasing expectation on the part of shareholders that their value in the company they have invested in should be increasing unless unpreventable factors occur. Also, most people and institutions across the world are seeking for companies that show good prospects as investment vehicle. La Rocca (2007, p. 318) argues that potential investors are looking for investment companies that will guarantee them good return to investment. In order to enhance their economic performances, most developing countries across the world are seeking to attract investors so that the economy can be expanded and absorb some of the challenges that these countries are facing such as unemployment (Makdissi, Fattah, and Liman 2000). Anglo- American model of corporate governance will be essential in boosting these countries’ prospects of attracting investors and boosting confidence that shareholders have in their respective companies. European model does not accurately reflect on the emerging corporate trends because it is more stakeholders- oriented. Even though it focuses on some of the aspects that Anglo- American model focuses on, it falls short in instilling sufficient confidence in shareholders and potential investors. As such, it will not be the most appropriate model for emerging corporate trends. Besides, it does not adequately tackle the stock market aspect which is the emerging corporate trend especially in developing countries (Levine and Zervos, 1998, p. 550). Anglo- American model adequately covers this aspect since its principles are derived from countries with well- developed stock markets, that is, United States and the United Kingdom. Corporate Governance in Saudi Arabia and other Arab Gulf Countries Up to a decade ago, the economic growth and development performance in Saudi Arabia and other Arab countries was weak and disappointing. Al-Motairy (2003, p. 283) explains that the corporate culture was weak and most companies did not adhere some of the basic principles of corporate governance. As a result, these countries lagged behind in terms of financial performance of companies and economic development in general compared to most countries across the world that had embraced the corporate governance culture. As a result of the weak and disappointing performance of the businesses and country’s economy, numerous reforms were undertaken and new institutions established (Arun and Turner, 2004)). The first corporate governance awareness wave in Saudi Arabia and Arab Gulf countries began about a decade ago. Creane et al (2004, p. 14) note that apart from the mentioned poor performance of businesses and these countries’ economy, this wave was propelled by some other trends. One of the trends was the development of strong financial sector prompted by the expectation to provide efficient intermediation between banks or investors, and the body corporate (Makdissi Fattah, and Liman, 2000). Secondly, increased corporate governance awareness was driven by the need to attract foreign investments especially from countries that had no petroleum and chemical resources, and thus required substantial financial resources in order to develop their infrastructure. Additionally, some of these countries such as Syria and Bahrain shifted towards market- based economic organization which further accentuated this wave of corporate governance awareness (Creane et al, 2004, p. 10). Moreover, the 2006 stock market crash that affected the Gulf Cooperation countries triggered ‘new thinking’ on management of companies; it made regional regulators to reflect on how to protect the capital markets against future financial crises (Al-Motairy, 2003, p. 301). Creane et al. (2004, p. 12) state that most researches have indicated that weak corporate governance in Saudi Arabia and other Arab Gulf countries was attributed to the ownership structures of companies and other enterprises. Prior to the increasing prominence of corporate governance that was prompted by emerging financial and economic trends in these countries, these countries had very few listed companies, most corporations were owned by the state, family enterprises were dominant, and there were some policies that did not provide necessary frameworks for corporate governance. However, poor economic growth performance and failure of the economic structures in these countries to solve the economic and social problems became a major worrying factor to policy- makers hence prompting them to bring about economic reforms and establish new institutions (Creane et al, 2004, p. 8). As a result, most of these countries have witnessed increase in the number of listed companies in their stock markets. There are stock trading mechanism and rules that are followed. In addition, most companies are disclosing relevant, timely, and necessary information to shareholders. Furthermore, state- owned companies and family enterprises are also adhering to corporate governance practices. Institutions such as Hawkamah Institute of Corporate Governance and Egyptian Institute of Directors have been critical in creating and enhancing stronger appetite for corporate governance (The Hawkamah Institute for Corporate Governance, 2011). Saudi Arabia and other Gulf Arab Countries have adopted the Anglo- American model of corporate governance to a larger extent (Hove, 2000, p. 56). This is what has led to the accelerated performance in their economies in the recent past. For instance, a look at the Corporate Governance Regulations in the Kingdom of Saudi Arabia that was issued by the Board of Capital Market Authority in 2006 shows that the regulations was greatly based on the Anglo- American model. The 2010 amendment to the regulation further confirms that that this model is the most preferred especially to the emerging corporations (Capital Market Authority, 2006). Just like Anglo- American model, most of the corporate governance regulations in Saudi Arabia and Arab Gulf countries are shareholders- oriented. These regulations have provisions on rights of shareholders and the General Assembly in the form prescribed by the model. Hove (2000, p. 58) observes that the disclosure and transparency directives are well addressed in these regulations so as to not only protect the interest of the businesses entities but also that of shareholders. Lastly, provisions for Board of Directors are well- stipulated; actually, these provisions are greatly borrowed from the Anglo- American model (Capital Market Authority, 2006). Conclusion It is evident from the discussion that the concept of corporate governance is very critical in enhancing the economic performance of any give organization and country towards attainment of the set goals. As noted from the discussion, there are two main models of corporate governance namely; Anglo- American and European models. Even though these models bear numerous similarities, they differ in different aspects as well. Since emerging corporate trends calls for a model that is shareholders- oriented so as to accelerate economic performance and attract investors, Anglo- American model is considered the most appropriate in this respect. Reference List Al-Motairy, O 2003, Implementing corporate governance in Saudi Arabia, Arab Journal of Administrative Sciences, Vol. 10, No. 3, pp. 281 – 305 Arun, T.G. and Turner, J. D 2004, “Corporate Governance of Banks in Developing Economies: concepts and issues:, Corporate Governance, Vol. 12, No. 3 Bhagat, S. and Bolton, B 2008, “Corporate governance and firm performance”, Journal of Corporate Finance, 14(3): 257-273. Capital Market Authority 2006, Corporate Governance Regulations in the Kingdom of Saudi Arabia. Available at: www.cma.org.sa. Clarke, T & Rama, M 2006, Corporate Governance and Globalization, London and Thousand Oaks, CA: SAGE. Creane, S et al. 2004, “Evaluating Financial Sector Development in the Middle East and North Africa: New Methodology and Some New Results”, IMF Policy Working Paper. Du, J. and Dai, Y 2005, “Ultimate corporate ownership structure and capital Structures: Evidence from East Asian economies”, Corporate Governance, 13 (1): 60-71. Hove, M. (2000). ‘The Anglo-American influence on international accounting standards: the case of the disclosure standards of the international accounting standards committee’. Research in Third World Accounting Vol. 1: pp. 55-66. International Finance Corporation, 2008, The EU Approach to Corporate Governance, Available: http://www.ifc.org/ifcext/cgf.nsf/AttachmentsByTitle/EU+Approach+to+CG/$FILE/IFC_EUApproach_Final.pdf (Accessed: January 20, 2012) Klapper, L. and I. Love, 2003, “Corporate Governance, Investor Protection and Performance in Emerging Markets”, Journal of Corporate Finance. Makdissi, S., Z. Fattah, and I. Liman, 2000, “Determinants of Growth in the MENA Countries”, Arab Planning Institute Working Paper Series Number 03/01 (Kuwait). Minow, N, 2002, Corporate Governance, Wiley- Blackwell. La Rocca, M. (2007). “The influence of corporate governance on the relation between capital structure and value”, Corporate Governance, 7 (3), 312-325. Laksmana, I. (2008), Corporate board governance and voluntary disclosure of executive compensation practices. Contemporary Accounting Research, 25(4): 47-82. Levine, R. and Zervos, S, 1998, “Stock Markets, Banks and Economic Growth”, American Economic Review 88: 537-568. OECD, 2005, OECD Principles of Corporate Governance, Available: www.oecd.org/daf/corporateaffairs/principles OECD, 2009, Policy Brief on Corporate Governance of Banks in the Middle East and North Africa, available: www.oecd.org/dataoecd/32/26/44372710.pdf Ooghe, H, 2002, The Anglo-American versus the Continental European corporate governance model: empirical evidence of board composition in Belgium, European Business Review, Vol. 14, Issue 6. The Hawkamah Institute for Corporate Governance, 2011, Hawkamah Brief on Corporate Governance Codes of the GCC, Available: www.hawkamahconference.org Turnbull, S., (1999), Corporate governance: its scope, concerns and theories, Corporate Governance: An International Review, 5 (4): 180 – 205. Read More