CHAPTER 11
GOVERNING THE CORPORATION AROUND THE WORLD
CHAPTER OUTLINE
I. OPENING CASE: Global Competition in How to Best Govern Large Firms
A. In global competition, large firms not only compete in product markets, but also in terms
of how they are organized, financed, and governed
1. Definitions of “large firm” varies, but a reasonable definition is that if a firm is large
enough to be publicly listed, then it would be a “large firm” in that country
2. The Modern Corporation and Private Property (1932) by law school professor Adolf
Berle and economist Gardiner Means
a. Almost all large firms started as small firms
b. Small firms typically feature concentration of ownership and control—the
3. Generalizing, Berle and Means argued that such transformation would be inevitable
4. What if the founding families refused to let go?
a. In 1983, economists Eugene Fama and Michael Jensen asserted that failure to
separate ownership and control “tends to penalize the corporation in the
competition for survival”
B. The other two major forms of corporate governance are family ownership and state
ownership
1. Berle and Means theory characterizes the evolution of large firms in the United States
(and, to a lesser extent, Britain), but it does not explain the ownership and control
pattern in the rest of the world well
C. The Fama and Jensen prediction that large firms with concentration of ownership and
control would suffer from terrible performance cannot really be supported
1. In South Korea, Samsung Group, led by the Lee Kun-hee family, contributes 20% of
GDP
2. In India, Tata Group, in the hands of the House of Tata, contributes 5% of GDP
Chapter 11 Governing the Corporation Around the World
3. An extension of the Fama and Jensen prediction is that while some large family firms
may do well domestically, once they go overseas they would surely fail to become
world-class in global competition, but this does not hold up
a. In Britain, Tata Group is now the single largest private sector employer,
supporting 50,000 jobs—an accomplishment unmatched by UK-owned (and non-
family-managed) firms
D. State ownership remains a rival form of corporate governance
1. During the Great Recession of 2008–09, to rescue ailing firms, Western governments
nationalized numerous private firms and turned them into state-owned enterprises
(SOEs)
4. In Russia, the figure is 62%, in Brazil 38%, and in Norway 38%
5. SOEs include some of the largest oil and gas companies (such as Sinopec), the
biggest telecom service provider (China Mobile), and the biggest ports operator
(Dubai Ports)
6. In 2014, they also represented six of the top ten most profitable firms globally
(measured by the amount of profits): Fannie Mae and Freddie Mac of the United
States, ICBC of China, Gazprom of Russia, China Construction Bank, and
Agricultural Bank of China (in descending order)
E. Publicly listed corporation seem to be under siege
1. In 1997, the number of U.S. listed firms reached a high watermark: 7,888
2. Since 1997, their number has dropped dramatically—by 38% in the United States and
by 48% in Britain
5. Many new firms do not bother to list at all
a. Between 1980 and 2000, on average there were 311 IPOs a year in the United
States
b. The average went down to a mere 99 a year between 2001 and 2011
6. Commenting on the global competition in terms of how to best organize, finance, and
govern large firms, the Economist suggests that “there is every reason to celebrate the
fact that businesses have more corporate forms to choose from”
Chapter 11 Governing the Corporation Around the World
II. OWNERS
A. Owners provide capital, bear risks, and own the firm
B. Concentrated versus Diffused Ownership: Founders usually start up firms and completely
own and control these enterprises
1. This is known as concentrated ownership and control
2. If the firm aspires to grow and needs more capital, owners must accommodate other
C. Family Ownership: The founding family maintains controlling interest. Firm control is
passed down to founder’s children, usually sons
1. Advantages:
a. May provide better incentives for the firm to focus on long-term performance
b. Minimizes conflicts between owners and professional managers
D. State Ownership: A means of production owned by the government, central or local.
Managers employed by the state; firm governed by the state
1. Other than families, the state is a major owner of firms in many parts of the world
2. Since the 1980s, state ownership has been largely discredited, as one country after
III. MANAGERS
A. Led by the CEO, the executives represent an important group of players in corporate
governance
B. Principal-Agent Conflicts: The relationship between shareholders and professional
managers is a relationship between principals and agents
1. To the extent that the interests of principals and agents do not completely overlap,
there will inherently be principal–agent conflicts
2. These conflicts result in agency costs, including (1) the principals’ costs of
monitoring and controlling the agents and (2) the agents’ costs of bonding (signaling
Chapter 11 Governing the Corporation Around the World
C. Principal-Principal Conflicts: such conflicts are between two classes of principals:
controlling shareholders and minority shareholders
1. Family managers may have the potential to engage in expropriation of minority
shareholders, defined as activities that enrich controlling shareholders at the expense
of minority shareholders
IV. BOARD OF DIRECTORS
A. Role
1. Acts as an intermediary between owners and managers
2. Oversees and ratifies strategic decisions and evaluates, rewards, and if necessary
C. Leadership Structure
1. The board can be led by a separate chairman or by the CEO who doubles as a
chairman—a situation known as CEO duality
D. Board Interlocks
1. When one person affiliated with one firm sits on the board of another firm, an
interlocking directorate has been created
E. The Role of Boards of Directors
1. Perform
a. control
b. service
c. resource acquisition functions
V. GOVERNANCE MECHANISMS AS A PACKAGE
A. Voice-based mechanisms refer to shareholders’ willingness to work with managers,
usually through the board, by “voicing” their concerns
B. Exit-based mechanisms indicate that shareholders no longer have patience and are willing
to “exit” by selling their shares
Chapter 11 Governing the Corporation Around the World
1. The Market for Corporate Control: This is the main external governance mechanism,
otherwise known as the takeover market or the mergers and acquisitions (M&A)
market
2. The Market for Private Equity: Instead of being taken over, a large number of
publicly listed firms have gone private by tapping into private equity—equity capital
invested in private (non-public) companies. Private equity is primarily (but not
always) invested through leveraged buyouts (LBOs)
VI. A GLOBAL PERSPECTIVE
A. Different corporate ownership and control patterns around the world lead to a different
mix of internal and external mechanisms
B. The two most common ones are:
VII. A COMPREHENSIVE MODEL OF CORPORATE GOVERNANCE
A. Industry-Based Considerations
1. Having more outside directors on the board is often regarded as a performance-
boosting practice. However, in industries characterized by rapid innovation requiring
significant R&D investments (such as information technology), outside directors may
have a negative impact on firm performance
prescribing universal “best” practices
B. Resource-Based Considerations
1. Some of the most valuable, rare, and hard-to-imitate resources are the skills and
abilities of top managers and directors—often regarded as managerial human capital.
Some of these capabilities are unique, such as international experience. Executives
without such first-hand experience are often handicapped when their firms try to
expand overseas
2. The last crucial component is organizational
C. Institution-Based Considerations
1. Formal Institutional Framework
Chapter 11 Governing the Corporation Around the World
a. Formal legal protection encourages founding families and their heirs to dilute
their equity. Lack of it encourages them to run their firms directly and
ownership/control becomes more concentrated
b. Ownership concentration is higher for firms in emerging economies than
developed economies
2. Informal Institutional Framework: Why and how have informal norms and values
concerning corporate governance changed to such a great extent?
a. The rise of capitalism has affected governance
VIII. DEBATES AND EXTENSIONS
A. Opportunistic Agents versus Managerial Stewards
1. Agency theory assumes that managers may engage in self-serving, opportunistic
activities if left to their own devices. However, critics contend that most managers are
likely to be honest and trustworthy. Recently, a “pro–management” theory,
stewardship theory, has emerged that suggests that by and large; managers can be
viewed as stewards of owners’ interests
B. Global Convergence versus Divergence
1. Convergence advocates argue that globalization will unleash a “survival-of the-
fittest” process by which firms will be forced to adopt globally the best practices
exemplified by Anglo-American practices
C. State Ownership versus Private Ownership
1. The debate on privatization has lead to the following conclusions: Private ownership
is good and state ownership is bad
2. This debate underpins much of the global economic evolution in the 20th century
IX. THE SAVVY STRATEGIST
A. First, understand the nature of principal–agent and principal–principal conflicts to create
better governance mechanisms
Chapter 11 Governing the Corporation Around the World
CHAPTER ELEVEN – LECTURE NOTES AND TEACHING TIPS
SUMMARY OF THE OPENING CASE: Global Competition in How to Best Govern Large
Firms
Teaching Tip: Ask students to find one or two global companies and research their beginnings
and current status. Was it begun as a family-owned business? A state enterprise? What is its
current structure? Students should also consider why the firm did or did not change structure.
(For example, why is Ford still family-owned but most car manufacturers are not?)
OWNERS
Although ownership patterns vary around the world, the three broad patterns are (1) concentrated
versus diffused ownership, (2) family ownership, and (3) state ownership.
Concentrated versus Diffused Ownership
Teaching Tip: In many countries, the owner or controlling family does not need 50% of firm
shares to control the firm. In the U.S., if the owner controls 5% of the shares, that owner must
disclose this position as a “blockholder” (holder of a large block of firm shares), and can
essentially control the company. In most developing economies, the amount need to control a
firm is usually higher, though this can also be less than 50%. But in some East Asian economies
such as Hong Kong and Thailand, a family may be able to control all of a firm and its subsidiary
firms by holding a relatively small percentage of firm shares through cross holdings or concealed
ownership schemes. This is a source of concern for corporate governance reformers in Asia that
want to make firms more responsive to minority shareholders—shareholders not part of the
controlling family of the firm.
Founders usually start up firms and completely own and control these enterprises on an
individual or family basis. If the firm aspires to grow, the owners’ desire to keep the firm in
family hands will have to accommodate the arrival of other shareholders.
In contrast, diffused ownership is the opposite of concentrated ownership, more common in
North America and Europe. Many firms do not have a controlling shareholder, whereas in Asia it
is more common to have a controlling shareholder.
Chapter 11 Governing the Corporation Around the World
holdings limits the institutional investor’s ability to dump the stock, because when an investor’s
stake is large enough, selling out depresses the share price and harms the seller.
While the image of widely held corporations is a reasonably accurate description of modern large
U.S. and UK firms, it is not the case in other parts of the world. Outside the Anglo-American
world, there is relatively little separation of ownership and control. Most large firms are typically
owned and controlled by families or the state, which participate in management.
Family Ownership
Although most small firms in the world are owned and controlled by families, interestingly, the
vast majority of large corporations throughout continental Europe, Asia, Latin America, and
State Ownership
Other than families, the state is a major owner of firms in many parts of the world. State
ownership has been largely discredited, as one country after another—ranging from Britain to
Brazil to Belarus—realized that their state owned enterprises (SOEs) often perform poorly. In a
most cynical fashion, SOE employees in the former Soviet Union summed it up well: “They
pretend to pay us and we pretend to work.” But even the SOEs that existed outside of the
Communist bloc performed very poorly. In brief, SOEs suffer from an incentive problem.
MANAGERS
Managers, especially executives on the top management team (TMT) led by the chief executive
officer (CEO), represent another crucial leg of the corporate governance tripod. This section
discusses how to govern professional, SOE, and family managers.
Principal-Agent Conflicts
The relationship between shareholders and professional managers can be characterized as a
relationship between principals and agents; or an agency relationship in short. Principals are
persons (such as owners) delegating authority, and agents are persons (such as managers) to
Chapter 11 Governing the Corporation Around the World
Principal-Principal Conflicts
Primary conflicts are between two classes of principals: controlling shareholders and minority
shareholders—in other words, principal-principal conflicts.
Teaching Tip: The principal-principal problem bears some surface similarity to the principal-
agent problem in that two major firm stakeholders are in conflict over firm resources and goals.
The well-known example of media magnate Rupert Murdoch’s firms helps to illustrate this
problem. In 2003, Rupert Murdoch’s thirty-year-old son James Murdoch was appointed CEO of
British Sky Broadcasting (BSkyB), Europe’s biggest satellite broadcaster, in the face of loud
minority shareholder resistance. Rupert Murdoch controlled 35 percent of BSkyB and chaired
the board.
Although as owners, family managers have incentives to maintain firm value, their dominant
position as both principals and agents (managers) may allow them to override traditional
governance mechanisms designed to curtail principal-agent conflicts. For example, the board of
directors, a mechanism designed to supervise the CEO, will be hardly effective when the CEO
being evaluated is the son of the board chairman. In East Asia (excluding China), approximately
57 percent of the corporations have board chairmen and CEOs from the controlling families. In
continental Europe, the number is 68 percent. The families are able to do so, because they are the
controlling (although not necessarily majority) shareholders.
Despite the multinational presence of Rupert Murdoch’s media empire (News Corporation, Fox
Network, The Times of London, The New York Post, in addition to BSkyB), probably few
would have heard of his 100 percent privately owned firm, Cruden Investments, which sits on
top of the entire “pyramid” of his companies.
BOARD OF DIRECTORS
As an intermediary between owners and managers, the board of directors oversees and ratifies
strategic decisions and evaluates, rewards, and, if necessary, penalizes top managers.
Chapter 11 Governing the Corporation Around the World
Key features of the board include: (1) composition, (2) leadership, and (3) interlocks. Each is an
important dimension of board functions.
Board Composition
The trend around the world is to introduce more outside directors, who are defined as
nonmanagement members of the board. In the United States, less than a half century ago, most
Board Leadership
Board leadership: Whether the board is led by a separate chairman or the CEO who doubles as a
chairman (CEO duality), brand leadership is an important issue. From an agency theory
standpoint, if the board is to supervise agents such as the CEO, it seems imperative that the board
be chaired by a separate individual.
However, a corporation led by two top leaders—a board chairman and a CEO— may lack a
unity of command and experience a top-level conflict. In other countries, both practices can be
Board Interlocks
When one person affiliated with one firm sits on the board of another firm, an interlocking
directorate has been created. Firms often establish relationships through such board
appointments. For instance, outside directors from financial institutions often facilitate financing.
Outside directors experienced in acquisitions may help the focal firms engage in these practices.
The Role of Boards of Directors
In a nutshell, boards of directors perform
(1) control,
(2) service, and
(3) resource acquisition functions.
Control
Control is dependent on (1) independence, (2) deterrence, and (3) norms.
First, the ability to effectively control managers fundamentally boils down to how independent
directors are. While inside directors (executives) who report to the CEO are not likely to properly
Chapter 11 Governing the Corporation Around the World
Finally, when challenging management, directors have few norms to draw on. Directors who
“stick their necks out” by confronting the CEO in meetings tend to be frozen out of board
deliberations.
In addition to monitoring and control, another important function of the board is service—
Directing Strategically
How directors prioritize strategically differs significantly around the world. In U.S. and UK
firms, the traditional focus, which stems from their separation of ownership and control, is on the
boards’ control function.
Teaching Tip: Ask students why firms should have outside directors at all. What is the
significance of the Sarbanes-Oxley Act of 2002? Or why might outside directors be better at
financial control than inside directors?
A board informed by such inside views is able to exercise strategic control, basing its judgment
beyond a mere examination of financial numbers. It seems that a healthy board requires both
kinds of control, thus calling for a balanced composition of insiders and outsiders.
GOVERNANCE MECHANISMS AS A PACKAGE
Governance mechanisms can be broadly classified as internal and external—otherwise known as
voice-based and exit-based mechanisms, respectively.
Teaching Tip: Ask students why executive compensation is so high in the U.S. and increasingly
in the UK and other countries. Are boards just paying off their buddies and cronies in hopes of
their own big payoffs later on? Did GE chairman Jack Welsh deserve regular compensation in
the tens of millions of dollars? Are the executives all just greedy and lazy crooks, as is regularly
stated on television? What are the other reasons why executive compensation has risen so much
in the U.S., UK, and other countries in the past two decades?
Internal (Voice-Based) Governance Mechanisms
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and shareholders have become increasingly popular. The underlying idea is pay for performance,
which seeks to link executive compensation with firm performance. However, when facing
continued performance failures, boards may have to use the “stick”; that is, dismiss the CEO.
External (Exit-Based) Governance Mechanisms
The external governance mechanisms are (1) market for corporate control, and (2) market for
private equity.
The Market for Corporate Control
Different management teams contest for the control rights of corporate assets. As an external,
hostile governance mechanism, the market for corporate control serves as a disciplining
mechanism of last resort when internal governance mechanisms fail.
The underlying mechanism is agency theory, which suggests that when managers engage in self-
The Market for Private Equity
Instead of being taken over, a large number of firms have been bought out by incumbent
managers. In a leveraged buyout (LBO), managers and investors issue bonds and use the cash
raised to buy the firm’s stock—in essence replacing shareholders with bondholders and
transforming the firm from a public to a private entity.
Teaching Tip: Although LBOs have been given a bad name in films and popular culture, these
corporate governance-based restructurings have helped a number of firms turn their
performances around. The fast food chain, Burger King, long number two in the North American
fast-food market, had fallen on hard times in the 1980s and early 1990s due to some very
questionable strategy. Burger King was bought out by a private equity firm in the 1990s, which
cut costs (being vilified in the process), and installed a new management team to implement the
new strategy and restructuring. Burger King has undergone an effective turnaround and is
reemerging as a more serious competitor in the important fast food sector. Ask the students if
they think it would be better for firms such as Burger King to continue with the status quo and
just try to hang onto the market share and head counts that they had in the 1990s. What do the
students think of Burger King? Is it getting better in their view?
Chapter 11 Governing the Corporation Around the World
Internal Mechanisms + External Mechanisms – Governance Package
Taken together, the internal and external mechanisms can be considered a “package.” These
various mechanisms operate interdependently and as potential substitutes or complements.
Michael Jensen, a leading agency theorist, argues that failures of internal governance
mechanisms in the 1970s finally activated the market for corporate control in the 1980s. Firms
that successfully defended themselves against such attempts ended up restructuring and
downsizing—doing exactly what raiders would have done had these firms been taken over. In
other words, the strengthened external mechanisms force firms to improve their internal
mechanisms.
A GLOBAL PERSPECTIVE
Different corporate ownership and control patterns around the world naturally lead to a different
mix of internal and external mechanisms.
The most familiar type is shown in Cell 4—strong external and weak internal governance,
exemplified by most large U.S. and UK corporations. While the external governance
mechanisms such as the market for corporate control are relatively active and well developed,
internal governance mechanisms are relatively weak because of the separation of ownership and
control, which gives managers significant de facto control power.
A COMPREHENSIVE MODEL OF CORPORATE GOVERNANCE
Industry-Based Considerations
The nature of industry sometimes questions widely accepted conventional wisdom regarding (1)
outside directors, (2) insider ownership, and (3) CEO duality.
Having more outside directors on the board is often regarded as a performance-boosting practice.
Chapter 11 Governing the Corporation Around the World
exists between inside management ownership and firm performance. Only in relatively high-
growth, turbulent industries has this relationship been found.
A third example is the often-criticized practice of CEO duality. In industries experiencing great
turbulence, the presence of a single leader may allow a faster and more unified response to
changing events. These benefits may outweigh the potential agency costs created by such
duality. Overall, governance practices need to fit with the nature of the industry in which firms
are competing. This cautions against prescribing universal “best” practices.
Resource-Based Considerations
Skills and abilities of top managers and directors, often regarded as managerial human capital,
are also important. Some of these capabilities are unique, such as international experience.
Executives without such first-hand experience are often handicapped when their firms try to
Teaching Tip: Ask students why it is difficult for a firm with little international experience at the
top to expand to foreign countries. Can firms not simply hire experienced managers in those
locations? Or do they need to send some top management with whom they are familiar to
initially run an overseas office?
The last crucial component in the VRIO framework is O: organizational. It is within an
organizational setting (in TMTs and boards) that managers and directors function. Overall, the
few people at the top of an organization can make a world of difference.
INSTITUTION-BASED CONSIDERATIONS
Formal Institutional Framework
Formal legal protection of investor rights, especially those held by minority shareholders, in the
United States and United Kingdom encourages founding families and their heirs to dilute their
equity to attract minority shareholders and delegate day-to-day management to professional
managers. Given reasonable investor protection, founding families themselves (such as the
Rockefellers) may feel comfortable over time becoming minority shareholders of the firms they
founded.
Chapter 11 Governing the Corporation Around the World
Among common-law countries, such ownership concentration is higher for firms in emerging
economies (such as Hong Kong, India, and Israel) than developed economies (such as Australia,
Canada, Ireland, and New Zealand).
Informal Institutional Framework
In the last two decades around the world, why and how have informal norms and values
concerning corporate governance changed to such a great extent? In the United States and United
Teaching Tip: In 1999, the OECD published the OECD Principles of Corporate Governance,
suggesting that the overriding objective of the corporation should be to optimize shareholder
returns over time. The principles are nonbinding even for the thirty OECD member countries,
and nonmember countries have no obligation to adopt them. Nevertheless, the global norms
seem to be moving toward the OECD Principles. For example, China and Taiwan, both
nonmembers of OECD, have recently taken a page from the Principles and allowed shareholders
to bring class action lawsuits, something that is very difficult to do in most Asian countries. In
Hong Kong, class action lawsuits are, for the most part, prohibited, thus the difficulty of doing
anything about the asset-tunneling problem at Hong Kong firms. Shareholders in many Latin
American firms experience a similar problem with asset tunneling and the lack of recourse, and
most Latin American countries are only beginning to adopt more detailed governance guidelines.
DEBATES AND EXTENSIONS
Opportunistic Agents versus Managerial Stewards
Agency theory assumes managers to be agents who may engage in self-serving, opportunistic
Global Convergence versus Divergence
Convergence advocates argue that globalization will unleash a “survival-of the-fittest” process
by which firms will be forced to adopt globally the best practices exemplified by Anglo-
American practices.
State Ownership versus Private Ownership
Private ownership is good. State ownership is bad. Although crude, these two statements fairly
accurately capture the intellectual and political reasoning behind three decades of privatization
Chapter 11 Governing the Corporation Around the World
around the world between 1980 and 2008. The consensus on this is matter of concern for
policymakers in developed countries.
THE SAVVY STRATEGIST
First, understand the nature of principal–agent and principal–principal conflicts to create better
governance mechanisms.
Second, savvy strategists need to develop firm-specific capabilities to differentiate on
governance dimensions.
Teaching Tip: Ask students to prepare their own summary of the key points that they learned in
this chapter. Are there any ideas expressed in the chapter that students are confused about? What
do they think about the global perspective of strategy that the author advocates in this book?
Chapter 11 Governing the Corporation Around the World
POSSIBLE ANSWERS TO CRITICAL DISCUSSION QUESTIONS
1. If you can choose to list your firm anywhere in the world, which country would you prefer?
Why?
Answers will vary, but students should provide one or two solid reasons for listing in a
2. Recent corporate governance reforms in various countries urge (and often require) firms to
add more outside directors to their boards and separate the jobs of board chairman and CEO.
Yet, academic research has not been able to conclusively support the merits of both practices.
Why?
Academic research has not been able to confirm that firms that are led by a separate board
chairman will outperform those with CEO duality. This is because the dynamism and
3. ON ETHICS: You are 30 years old and obtained your MBA from a top business school two
years ago. You are being promoted to be CEO of a multibillion-dollar firm that is publicly
listed in your country. There is loud minority shareholder resistance to your appointment
because you are too young. Too bad, your father and your family are the controlling
shareholders and you get the job. What are you going to say at your first press conference as
CEO, knowing that there will be some tough questions from reporters?
Answers might vary. It is indeed a tough situation to be in. The only way you can silence your
critics is by delivering. As this is your first conference as CEO, you could explain your plans
TOPICS FOR EXPANDED PROJECTS
1. Starting from Berle and Means (see the Opening Case), some argue that the Anglo-American
style separation of ownership and control is an inevitable outcome in corporate governance
for large firms. Others contend that this is one variant (among several) on how large firms
can be effectively governed and that it is not necessarily the most efficient form. What do
you think?
Chapter 11 Governing the Corporation Around the World
Historically, the Anglo-American style of governance seemed to be the most effective system
for governing large public firms and maintaining liquid capital markets. For example,
2. How do you participate in the debate on state ownership versus private ownership?
Answers might vary. This chapter provides a number of useful insights into this debate. Other
than families, the state is a major owner of firms in many parts of the world. Until the late
1980s, state ownership was extensive throughout communist countries—commanding 95
3. ON ETHICS: As a chairman/CEO, you are choosing between two candidates for one outside
independent director position on your board. One is another CEO, a longtime friend on
whose board you have served for many years. The other is a known shareholder activist
whose tag line is “No need to make fat cats fatter.” Placing him on the board will earn you
kudos among analysts and journalists for inviting a leading critic to scrutinize your work.
However, he may try to prove his theory that CEOs are overpaid. Who would you choose?
A safer choice is undoubtedly the CEO friend, who is probably quite competent, honest, and
respected by the capital markets and his/her peers. Under normal circumstances, this is