Corporate Governance: USA Versus EuropeVW Staff
CORPORATE GOVERNANCE – USA & EUROPE
The term Corporate Governance relates to the manner in which an organization should be governed or managed. The concept is more relevant in the case of companies which have germinated or grown based on equity capital taken from investors. Stocks of many such companies are listed in stock exchanges, which exposes them to the public and automatically brings them under closer regulatory scrutiny. As per the principles enshrined in quintessence of corporate governance, the affairs of any organization should at all times be managed as per the relevant regulatory framework where the interests of shareholders/stakeholders is supreme. Here, corporate governance refers to the spirit of the statute rather than its letter alone. Thus morality, ethics etc. come into play in a big way. Though these “Utopian” ideas may seem irrelevant on the capitalistic turf, past experience has shown that similar philosophies could have prevented fraud & mismanagement, therefore ceasing the erosion of shareholder wealth.
It is also pertinent to mention that all enterprises are basically valued based on their present performance and expected long term success in achieving growth and profitability. For this purpose, there has to be a free flow of information (financial and strategic) amongst the shareholders, so that they can measure the economic potential and value of the organization’s strategies & activities. Also, since people (investors) have their money at stake in these companies, they have a right to decide on the selection of the Directors and influence the manner in which the organization should be run to achieve optimal results. Some schools of thought therefore highlight the importance of stakeholders as well as shareholders.
Historically, corporate governance principles have evolved in countries based on their political, economic & cultural philosophies. For example, if a country (e.g. France) has a socialistic ideology, it is somewhat natural that the corporate governance there is based on inclusion of all stakeholders, especially the employees. In Japan & Germany, if the banks have a major financial stake in the organizations through collaterals for credit, they will obviously give due weightage to what the banks think could be the best strategic course for the organization. Cultures where capitalism is at the core of strategic management ideology (e.g. USA), would like to concentrate on increasing wealth of shareholders alone and let the market forces determine the winner.
Obviously, these principles change with time and all countries learn from each other, especially from exceptional negative events. These disasters, like the collapse of huge organizations due to fraud, helps all concerned understand the gaps in regulatory or moral fabric of corporate governance which enable such mishaps. However, broad differences between the corporate governance models of various societies remain easily discernible. Here, some stark and a few subtle differences between the corporate governance models prevalent in USA & in Europe make an interesting comparison. It is, however, important to note that there are exceptions in all economies with hybrid approaches apparent in some cases.
THE US MODEL
The corporate governance system in USA is based on shareholder wealth maximization principles. The governing / influencing statutes / bodies include the Sarbanes-Oxley Act of 2002 (SOX), Securities & Exchange Commission (SEC) and guidelines of the stock exchanges like NASDAQ, NYSE etc. In addition, court judgments in various States are also relevant because US corporations are registered in particular States.
USA being an intensely capitalistic society, other stakeholders like creditors are not materially considered and do not have much say. This could be because all the other stakeholders are themselves governed by their own shareholders or owners. It is expected that shareholders of the stakeholders will suitably take care of their interests.
In the US model, there is separation of ownership and management to the extent that managers have a free hand in running the affairs of the organization. The Non Executive Directors monitor the performance of these managers (who may themselves be Executive Directors) and take appropriate action to encourage or discourage the strategies being attempted by them. The board is a single tier body with Executive & the Non-Executive Directors coming together to chart the course of the organization. The primary duty of the independent Directors is the oversight of all activities of the Management board. In most cases, one of the Executive Directors, who is the Chairman, is also the Chief Executive Officer of the organization. Managers are considered as agents of the owners and hence the Non-Executive Directors / Board may terminate these “agency contracts” in case of poor performance. On the other hand, these managers get rewarded for good performance, through bonuses and “free” stake in the organization through stock options etc. Of course, this leads to short-term orientation and a “micro” mindset of the managers in some cases. Mechanisms are being created to factor the impact of these stock options on the profit & loss statements of companies.
The ownership patterns of US organizations are such that they are widely held and capital is provided by people who are not involved in day to day management of the organization. The large institutional investors (mutual funds, pension funds etc.) are having maximum stake in these organizations and the capital markets are more liquid as equity is the preferred mode of business funding.
As an example, Citigroup Inc. (NYSE:C) has a single tier board structure with several Committees for managing the governance affairs and for oversight of management. As per the corporate governance guidelines of Citigroup, the standing committees of the Board are the Executive Committee, the Audit Committee, the Personnel and Compensation Committee, the Nomination, Governance and Public Affairs Committee and the Risk Management and Finance Committee. The presence of these Committees highlights the critical areas requiring supervision by the board. The philosophy of Citigroup Inc. (NYSE:C) emphasizes its focus on shareholder’s interests. As per the guidelines of the company, “the Board of Directors’ primary responsibility is to provide effective governance over the Company’s affairs for the benefit of its stockholders, and to consider the interests of its diverse constituencies around the world, including its customers, employees, suppliers and local communities”. The board keeps a close tab on the functioning of the management and the recent exit of CEO of the company (Vikram Pandit), was reported to be a case of the board being dissatisfied with management’s strategic management approach. Other companies like Bank of America Corp (NYSE:BAC) have similar board structures and committees.
In the USA, the rules emphasize compliance & disclosures with penalties for any deviation from the rules. The system is extremely strict with very little tolerance for avoidance. In fact, the SOX was a reaction to various frauds in firms like Enron, Adelphia, WorldCom etc. which originated due to laxity in the accounting & auditing systems. SOX emphasizes on financial disclosure, independence of audit, criminal liability for incorrect financial statements etc. In USA it is mandatory for companies which wants to be listed to have an audit committee in the board which interacts with the external auditors, ensures proper financial reporting / disclosures, risk management etc. This Committee comprises of Non-Executive Directors and has at least one financial expert so that the system of internal financial control is continuously practiced and improved. This committee furthers the principles of separation of ownership and management. The corporate Governance model in UK is pretty much similar to the US system and hence differs from the models prevalent in Continental Europe.