Corporate Governance and International Business

Corporate governance relates to the structure of rights and responsibilities among the parties with a stake in the firm (Aoki, 2001). Effective corporate governance employs mechanisms to ensure executives respect the rights and interests of company stakeholders, as well as making those stakeholders accountable for acting responsibly with regard to the protection, generation and distribution of wealth invested in the firm (Aguilera et al., 2008). Effectiveness may relate to different dimensions of corporate governance, ranging from monitoring and control over managerial discretion to promoting entrepreneurial leadership and innovation. On this basis, a large and diverse set of research now looks at corporate governance based on agency theory in economics, organizational and institutional literatures in sociology, or law and economics approaches — to name just a few.

It is nearly twenty years since the process of transition in Central and Eastern Europe (CEE) began, and more than fifteen since privatization began in earnest. There has been considerable hypothesizing in the literature that the mechanisms of corporate governance that pertain under private ownership are better than those under state ownership, and hence that privatization would lead to superior enterprise performance (Estrin and Perotin, 1991; Megginson and Netter, 2001; Megginson, 2005). Privatization has been nowhere so extensive nor so rapid as in the former communist countries, so these represent an important laboratory for us to test the impact of privatization on company performance. In this chapter,1 I provide an overview of the findings from the huge economics literature that has emerged to explore this issue. I will concentrate on the former Soviet bloc but also consider the evidence that is now emerging from China.

Many emerging and transition economies welcome inflows of foreign equity capital as a means of augmenting the funds available for domestic capital formation. There are three main channels though which such foreign capital may be introduced into the host economy: foreign direct investment (FDI), foreign portfolio investment (FPI), and the issuance of shares by domestic firms on overseas stock exchanges. However, the relative importance of these three sources of funds varies considerably between advanced and less developed economies, with FDI typically dominating inflows of foreign capital in the latter group whilst FPI and overseas share issues are more important for the former group (Cornelius and Kogut, 2003). These empirical observations raise two important questions. First, why is so little capital introduced through FPI and overseas share issues in less developed economies? Second, does this imbalance matter?

Africa’s securities markets have seen unprecedented change over the last fifteen years with the rapid growth and development of existing bourses and the establishment of new markets. Despite this growth, very few of these markets and listed stocks have been included in popular investment benchmark indices (such as the Standard amp; Poor’s frontier market range), demonstrating the marginalization of this region in terms of attracting much needed investment capital from worldwide flows. Historically, banking has dominated the economies of many of the countries within Africa, with stock markets only playing a sizeable and active role in financing in South Africa and Egypt. However, the role this has played in development finance has been limited by severe credit rationing from incomplete credit markets. Ironically, development is hindered not by a lack of funds within the banking sectors but rather an excess of liquidity caused by a lack of investment-grade opportunities in which banks are able to invest accumulated savings. Domestic investment is further hindered by the low savings rates in many countries, where investors prefer to invest in physical commodities or livestock in line with traditional beliefs, as well as uncertainty over the ability of savings to retain value due to macroeconomic mismanagement and instability.

Corporate governance and strategic management research has found some empirical support for the proposition that diversity in the management team engaged in the strategy development process is of value for firms’ long-term performance (e.g. Dalton et al., 1998, 1999; McNulty and Pettigrew, 1990). The management implications of differences in the formal mechanisms and structures within which firms are guided and controlled have been a recent focus of interest (see Daily et al., 2003).

The role of corporate governance issues in strategic decision-making and in building organizational capabilities is of considerable contemporary significance. According to Filatotchev (2006: 90), ‘Corporate governance is not an exogenous mechanism that only provides checks and controls over the efficiency with which companies are run and whether managers make decisions in the interest of shareholders. It is also closely related to the distribution of power and experience among executive and non-executive board members.’ In particular, the contribution of corporate governance to the process of internationalization decision-making and to performance is not explored sufficiently in the literature, and further dedicated research is required (Filatotchev, 2006; Carpenter et al., 2003).

This chapter looks at the impact of ownership structure on the performance of firms in Russia and identifies, within the domain of corporate governance theory, the factors that may explain any revealed differences in such performance and that of their counterparts in other industrialized countries. When market reforms started in Russia, it was anticipated that mass privatization would create ‘responsible’ owners and, as a result, produce a foundation on which economic reconstruction and growth would flourish. These expectations have on the whole failed to materialize. Restructuring in privatized firms has been slow, fixed production assets show a significant rate of wear, and innovation activity is low as is the competitiveness of domestic goods. Significantly, the inability of new owners to lead the firms forward has been consistently identified by experts as one of the causes of the poor economic performance of Russian companies (Nellis, 1999; Desai and Goldberg, 2000).

In recent years, corporate stakeholders and academic scholars have expressed increased concern about the expropriation of minority shareholders by controlling shareholders (La Porta et al., 1999). Johnson et al. (2000) define the term ‘tunnelling’ as the transfer of assets and profits out of firms for the benefit of their controlling shareholders. Tunnelling can take various forms, such as outright theft or dilutive share issues that discriminate against minority shareholders. These activities are perceived to be particularly serious in companies with concentrated ownership structures and where there is a weak market for corporate control. Dyck and Zingales (2004) find that the private benefits of control are larger in countries where the capital markets are less developed, ownership is more concentrated, and privatizations are less likely to take place. Furthermore, they find a negative association between the degree of statutory protection for minority shareholders and the level of private benefits of control. And Nenova (2003) concludes that over two-thirds of the cross-country variation in the value of private benefits is explained by differences in the legal environments, law enforcement, investor protection, takeover regulations and power-concentrating corporate charter provisions.

Scholars of international business (IB) know that ‘institutions matter’, but how they matter remains a hotly contested question. Multinational enterprises (MNEs) operate in different business environments and face challenges in strategically locating themselves and adapting to the diversity of institutions across countries and regions. MNEs bring different home country endowments in the way of routines, standard practices and capabilities, but operate in diverse host country environments where very different sets of institutional constraints and opportunities may exist. MNEs’ experience in emerging markets, including Central and Eastern Europe, has highlighted the importance of institutions for understanding business strategy and performance across national borders.

Over the past two decades much has been written on the subject of corporate social responsibility (CSR). From an international business perspective, several papers in a recent focused issue of theJournal ofInternational Business Studies (JIBS) reviewed some of the firm-specific organization and strategic managerial issues and challenges posed by them (Eden et al., 2006). A more multifaceted and interdisciplinary approach is taken by van Tulder and van der Zwart (2006). They view CSR as part of a business—society management nexus, which has become more varied and complex as a result of globalization.1 The ethical implications of CSR have been addressed by several scholars, such as Sethi (2003a, 2003b), van Marrewijk (2003), Kolk and van Tulder (2004) and Garriga and Mele (2004). In this chapter, we shall attempt to integrate these alternative approaches to CSR by relating each to the ‘big picture’ now emerging in international business (IB) scholarship. In so doing we shall suggest that this can best be done by embracing a more institutional perspective on the subject.

A large social science literature has emerged on the role of mergers and acquisitions (M&A) in corporate strategy. Yet the frequency, motivation and type of takeover activity across countries are strongly influenced by various institutional characteristics of the national business system (Goergen et al., 2005; Hall and Soskice, 2001; Rossi and Volpin, 2003). In the United States and the United Kingdom, the level of M&A is high and hostile takeovers are seen as being common (or at least a realistic possibility). In Japan and other continental European countries such as France or Germany, the level of M&A activity has been much lower prior to the 1990s. Moreover, hostile takeovers were extremely infrequent or even perceived as being impossible to implement.

Corporate governance has been defined as ‘the system by which companies are directed and controlled’ (Committee on the Financial Aspects of Corporate Governance, 1992: 15), or more specifically as ‘the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment’ (Schleifer and Vishny, 1997: 737). Such definitions, however, do not address the pluralism of corporate governance regimes, reflected, for example, in the growing number of national codes. The past decade has witnessed extraordinary global change, driven by heightened competition, and characterized by extensive corporate restructuring across national boundaries. At the same time, partly as a corollary of this, there is an increasing focus on matters of corporate responsibility, accountability and transparency. Internationalization has raised questions regarding the extent to which best practice may be transported, or transplanted, from one national business system to another (Cheffins, 2001a; Djelic, 1998; Whitley, 1999), spawning numerous studies on the likelihood of international convergence (Carati and Tourani Rad, 2000; Peck and Ruigrok, 2000; Rhodes and van Apeldoorn, 1998; Toms and Wright, 2005). Yet, as Aguilera and Jackson (2003: 447) observe, the diversity of corporate governance practices around the world is such as almost to defy a common definition.

The literature on governance is generally organized within an international, national or industry framework of analysis, taking either a political economy or economic perspective. There is a need for governance because of a general reorientation of international, national and local economies away from political blocks to a neo-liberal paradigm of global free product, labour and capital markets. At a national level, withdrawal of the state further strengthens the demand for local governance which, in turn, requires new forms of regulatory institutions and policy frameworks around, for example ‘participative governance’. The political economy debates on governance stress the importance of institutions and how changed relations between society and markets can, possibly, be controlled and regulated. On the other hand, an economic perspective would place more weight and emphasis on the role of markets and particularly ‘non-market’controls which are employed to correct market imperfection(s).

This chapter focuses on one element of German corporate governance — executive pay, specifically, executive stock options (ESOs) — as an American pay innovation dating from around 1960 (Lewellen, 1968). ESOs have been transplanted into many countries, even in Germany, with its distinctive cultural institutional environment. However, institutional theory has predicted conformism, isomorphism, path dependency and resistance to this kind of potentially illegitimate transplant (Tuschke and Sanders, 2003; Sanders and Tuschke, 2007). Perhaps this could explain why ESOs took over thirty years to penetrate German firms.

Corporate social responsibility (CSR) reporting is not mandatory in most countries, but has been adopted by many large companies from around the world. The terms corporate social responsibility, global citizenship and sustainability can now be found in the corporate reports and websites of large and small corporations from around the world. However, considerable variation exists among firms worldwide. While some companies (e.g. Henkel, BHP, Johnson and Johnson) have a long-standing tradition in reporting information and have created separate internet sites to show all facets of their corporate responsibility and sustainability, other companies provide only limited information, in many cases related to corporate giving and sponsorship, or in some cases no information at all.

Emerging market companies are increasingly undertaking dual registrations on local and foreign stock exchanges to access global finance, and consequently are becoming exposed to wider concerns with corporate governance. These wider concerns are fostered by globalization as emerging economies increasingly develop ties with other countries, either regionally or with more distant economies in the developed world. Aguilera and CuervoCazurra (2004) postulate that this convergence of economies leads to the diffusion of organizational practices, such as corporate governance practices, and potentially creates both a greater efficiency of these processes and greater external legitimation. The challenge for corporate governance acceptance lies in the type of convergence that corporate governance measures can take, which can be either in form or in function (Palepu et al., 2002; Gilson, 2000). While formal convergence implies the coalescing of legal rules and institutions, functional convergence implies adaptations within different existing institutions to perform the functions of good governance. Although formal convergence may not be in evidence in an emerging market, de facto convergence may well be encouraged by the requirements that increasing numbers of dual listed companies face. Coffee (1999) also adds contractual convergence, where foreign companies submit to United States stock exchange governance rules and stock exchange regulation in order to expand their organization for potential growth opportunities. Thus this chapter explores the impact of dual registration on corporate governance and the potential for changing the nature of emerging market governance conditions.