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Corporate governance: The variants

S. Venu

It should be noted that as globalisation of the economy proceeds, there will be some, though perhaps limited, convergence, and indeed there already is evidence of that. In continental Europe there is evidence of a trend towards more market-oriented indus trial organisation and a greater role of shareholders in corporate control.

OVER the last few years, corporate control and governance have been in focus, both in India and abroad. In India a chamber of commerce has set out guidelines for efficient corporate governance. This article analyses three major forms of governance outsid e India -- the Anglo-American, European and Japanese forms, the last of which has spilled over to Korea.

The Indian style of governance is similar to the German-Japanese variant, while the other two styles are reflected in the functioning of MNCs originating in those countries.

The perspective here is that of ``voice'' versus ``exit'' (Hirschman). Exit is associated with market governance, with arms-length and spot-contracting between autonomous, rivalrous firms. When dissatisfied with performance, agents exit to the best alter native. While there are outside directors as well as executive directors on boards, they act more as experts, or lobbyists, than as instruments for influencing managements. Dissatisfied owners sell their firms. Activities are co-ordinated either by marke t price or by the hierarchy within firms. Ownership of firms is subject to public trade on the stock market.

Voice, on the other hand, is associated with partly rivalrous and partly co-operative relations among firms connected in networks with more or less durable relations. Agents voice their dissatisfaction and try to eliminate it in the course of ongoing int eractions. There are many forms of governance ``between market and hierarchy''. Ownership is in part shielded from public trade through private ownership, cross-ownership between firms, ownership by banks, shares with restricted tradability, and protecti on against takeovers. Owners of firms try to correct or influence managerial actions through non-executive directors (sometimes through a separate supervisory board).

The difference between the exit and the voice systems is not limited to the external organisation of ownership and relations between firms, but also applies to the internal organisation of relations between management and labour and between the central m anagement and management of divisions. It is embedded widely in a society's institutional environment. In the exit system, firms are oriented towards more fragmented and short-term relations within the firm, with short-term labour contracts based on indi vidual performance, more autonomous divisions within the firm. This is based on an institutionally embedded, normative judgment of markets as fields of rivalry between autonomous firms. In the voice system, firms are oriented towards ongoing relations, b oth within the firm and between the firm and its environment. The orientation is more towards teams rather than individuals, remuneration is according to seniority, there is longer-term employment, and the sharing of competencies between divisions. This is based on an institutionally-embedded view of communities of firms in trades or industries, with shared interests and arrangements for partial co-operation.

In short, in the voice system, human resources are seen as investments, rather than as inputs in a production function, and outside relations are seen as sources of information and competencies, rather than mere sources of inputs and sinks of outputs.

Roughly speaking, the exit model applies, to a greater or lesser extent, to Anglo-American countries, and the voice model, to continental European nations, Japan, India, and Asia, generally.

It should be noted from the start that as globalisation of the economy proceeds, there will be some, though perhaps limited, convergence, and indeed there already is evidence of that. In continental Europe there is evidence of a trend towards more market -oriented industrial organisation and a greater role of shareholders in corporate control. Central questions are how much the voice system will gravitate towards the exit model, and how desirable that would be.

Another perspective is the ``competence view'' of the firm. The main cause of a firm's profit is its unique set of competencies. This view complements the ``positioning'' view from industrial organisations that a firm's profit is due to market conditions such as market concentration, oligopoly, collusion, and entry barriers. The two views meet in their joint recognition of the importance of product differentiation to evade pure price competition and of the need to protect one's differentiated product by basing it on competencies that are at least temporarily unique and inimitable. This implies the rejection of any notion of the ``representative firm''. The essence of markets is precisely their heterogeneity, and that is why they cannot always be identi cally copied.

A dominant approach for analysing corporate control is the principal-agent mode; the owners (shareholders) are seen as the principal, with the management to serve their interests. The problem then is that the management may have other objectives than max imising shareholder value, such as maximising market share, firm size, growth, or minimising the risk of effort. The exit model then entails that if shareholders are dissatisfied with managerial performance, they sell shares or the whole or a part of the firm. In principle, an alternative is to monitor management's actions, but that is complicated by the fact that information is asymmetric (management can withhold much relevant information), and shareholders may not be better able than management to jud ge what proper managerial action should be. But managers can be rewarded when opportunities for maximising shareholder value have been taken. The analysis thus yields the following well-known instruments of corporate control:

AThe capital market, which disciplines the management in two ways. If the management does not utilise the firm's potential for maximising shareholder value, the share becomes under-valued. First, this creates a threat of takeover, whereby the management stands to lose its position. Second, the yield from share issues is relatively low, which constrains management in its drive to expand.

AThe firm's market where, to survive competition, the management must exert itself to achieve utmost efficiency and innovation.

AThe market for managers. By utilising opportunities for maximising shareholder value, managers create opportunities to further their careers.

AShare options for management. Here the management is identified with the owner's interests.

The resulting hypothesis is as follows:

The principal-agent model of corporate control pre-judges the issue in favour of shareholder value.

Further, the principal-agent view is inherently static. It is aimed at the optimal utilisation of capital, given the present opportunities. From a more dynamic, competence-based view, one should take into account the role that corporate governance can pl ay in the development of novel competencies.

The ITC-BAT imbroglio was a classic example of a principal clashing with an agent, though the principal had a minority shareholding.

(The author is a management consultant.)