Governing Globally: Convergence, Differentiation, or Bridging By: Marc J. Epstein Rice University © Marc J. Epstein - Corporate Governance - Nice 2011 1

Corporate Governance: Controversy Some have suggested that countries will (and should) move toward convergence of global governance practices Some disagree - - often in law (form) - and in practice and implementation (function)

Q1) Should (or will) corporations move toward - convergence Two Questions: Q1) Should (or will) corporations move toward - convergence - differentiation, or - bridging based on common principles of good governance? A1) Not convergence, but understanding differences. Using different lenses in evaluating corporate and board performance © Marc J. Epstein - Corporate Governance - Nice 2011 3

Q2) Which system is best? A2) Not much research, classification, or analysis to answer this question. This presentation tries to frame that discussion. This has major implications for corporate practice and creates critical need for more academic research. © Marc J. Epstein - Corporate Governance - Nice 2011 4

Background Corporate governance issues have become more visible and critical – globally: - scholarly research - regulation to improve performance - corporate practice .

Many examples of failures: - Satyam - Parmalat - Enron Some failures caused by fraud Some failures caused by poor oversight Significant differences in global views (academic and managerial) of problems, causes, results, and solutions.

The Model In 2002, developed a set of principles and a model (Corporate Board Performance Model) including inputs, processes, outputs, and outcomes necessary for superior board and corporate performance.

The principles do apply: globally, For profits / non profits, Large and small, and Publicly / privately controlled But, how the principles are applied globally varies significantly. And, the evaluation of success must differ significantly.

The model addresses management control and performance measurement. What are the actions that managers, directors, investors, and other stakeholders can take to ensure superior board performance (and corporate performance)? What are the appropriate measures of success – both internally and externally? © Marc J. Epstein - Corporate Governance - Nice 20101 9

Board Roles and Responsibilities Financial issues Accountability Corporate behavior Governance issues Performance evaluation Board roles and responsibilities Senior level staffing and evaluation Selection and compensation Director’s nomination and training Strategy formulation Strategic oversight Strategy implementation Strategy monitoring © Marc J. Epstein - Corporate Governance - Nice 2011 10

Corporate Board Performance Model • Independence • Diligence • Competence • Ethics INPUTS Board Composition • Board and committee structure • Productive meetings • Succession planning system • Financial reporting & communication/risk mgmt. • Strategic information system/information availability • Performance evaluation / compensation systems Board Systems and Structure PROCESSES Board Performance Feedback • Superior strategic guidance and oversight • Accountable organization • High quality senior executives OUTPUTS Corporate Performance ▪ Long term financial success OUTCOMES © Marc J. Epstein - Corporate Governance - Nice 2011 11

Global Applicability of the Model The model and its elements are surprisingly applicable globally But, its implementation will differ globally This will significantly impact: the inputs and processes needed to achieve the desired outcomes, and the evaluation of success of both board and corporate performance since country differences are substantial.

Current Research So - examined the extensive prior literature on corporate governance throughout the world Paucity of cross country analyses Developed a classification of three primary global corporate governance systems and key differences in practice Highlights primary similarities and differences © Marc J. Epstein - Corporate Governance - Nice 2011 13

Based heavily on historical and cultural factors – and impact on management control and performance measurement Gives context to question of “which system is best?” Examines differentiation vs. convergence vs. bridging Provides significant foundation and important questions for future research

Governing Globally Three Systems of Corporate Governance (articulated by Choi et al (1999) and others): - Anglo American - Communitarian - Emerging Markets

General Characteristics of Global Corporate Governance Systems   ANGLO-AMERICAN COMMUNITARIAN EMERGING MARKETS EXAMPLES OF COUNRIES United States, United Kingdom, Australia, Canada, South Africa Japan, Germany, Belgium, Scandinavia China, Eastern Europe, Brazil, Mexico, Russia GENERAL CHARACTERISTICS Shareholder-primacy Financing by capital markets prevails Financial markets influence corporate governance practices Unitary board structure Primarily composed of non-executive directors (and independent directors) Stakeholder-centric Banks and suppliers own significant equity in a company Legislation mandates governance standards Two-tier board structure (supervisory  & management ) Labor, founding family, and bank are common members - interlocking common State participation in corporate ownership Government regulates equity markets Board structure varies   Large corporate shareholders, such as the state, families, or conglomerates dominate  

Determinants of Corporate Governance Performance External - Markets - Legal Systems - Ownership and Control Structures Internal - Board Composition - Board Systems - Board Structure - Executive Compensation

External Determinants of Corporate Governance Performance CORP. GOVERNANCE MECHANISM ANGLO-AMERICAN COMMUNITARIAN EMERGING MARKETS MARKETS Financial Markets Strong and deep Weak and thin Dynamic and volatile Investment purpose Short-term return Long-term return Policy and Political goals Methods of finance Financial markets Bank credit and retained earnings Private and state-owned banks LEGAL SYSTEMS Legal history Common law system Civil law system Combined systems that are still rapidly evolving Transactional methods Contracts Relationship-based transactions Relationship-based transactions OWNERSHIP & CONTROL STRUCTURES Ownership structure Diverse individual and institutional ownership Concentrated family and corporate ownership Concentrated family, corporate, and gov’t ownership Minority shareholder protections Strong Weak Non-existent Dominant control mechanisms Voting and board representation Cross-holding, pyramidal groups, lending relationships Internal and external mechanisms © Marc J. Epstein - Corporate Governance - Nice 2011 18

Internal Determinants of Corporate Governance Performance CORP. GOVERNANCE MECHANISM ANGLO-AMERICAN COMMUNITARIAN EMERGING MARKETS BOARD COMPOSITION, SYSTEMS, & STRUCTURE Board composition Basic requirements for independent directors Strong requirements for both inside and independent directors Nominal requirements for independent directors Board evaluation No requirements for board evaluation Strong requirements for board evaluation Nominal requirements for board evaluation Board structure Single-tier Two tier Board accountability Shareholders Stakeholders (including entire value chain and employees) Stakeholders and government Executive Compensation Large performance pay Less performance pay Little performance © Marc J. Epstein - Corporate Governance - Nice 2011 19

So, which system is best? Contingent on objectives, systems, countries Need to evaluate accordingly Principles and performance measures need more clarity System differences need more clarity More research is needed

Future Research These three corporate governance systems are based on significantly different historical, legal, and cultural contexts To understand the applicability of corporate governance research in a global context, a clearer understanding of the similarities and differences of the management control mechanisms and measures of board and corporate success is necessary © Marc J. Epstein - Corporate Governance - Nice 2011 21

This leads to unanswered research questions such as: This is required for both the application in practice and the foundation for governance research. This leads to unanswered research questions such as: © Marc J. Epstein - Corporate Governance - Nice 2011 22

Which system (and/or mechanisms) leads to higher levels of performance? Is higher level of performance of systems or mechanisms contingent on certain elements or conditions? Recognizing some differences in objectives, how should success (of both processes and outcomes) be measured and for whom?

Summary Corporations, capital markets and corporate governance are becoming more global. This is likely to be more about bridging theory and practice rather than either differentiation or convergence. The global applicability of the model has been striking. But, it is how to work with multiple systems where corporations and stakeholders have different objectives in different countries. © Marc J. Epstein - Corporate Governance - Nice 2011 24

In research there is a need to evaluate governance based on the differentiation and accommodation of the various systems in the research design. Which is better? When? For whom? For what purpose? What are benefits and limitations of each? There is a significant need for further research on the implementation of the model, and the relevant management control and performance measurement mechanisms.