Corporate governance in an international perspective: a survey of corporate control mechanisms among large firms in the United States, the United Kingdom, Japan and Germany

Introduction

To what extent are firms in different capitalist countries organised and governed in different ways? What are the reasons for the striking differences we see in corporate finance and corporate governance mechanisms across countries? What are the costs and benefits of these different mechanisms of corporate control? Is one system of corporate governance inherently better than any other? If so, why do we not see this system operating in all countries?

These issues are of course fundamental to the theories of the firm, corporate finance and corporate governance that have exercised academics for many years. Recently, however, they have acquired a policy relevance that they have not enjoyed before. In the United States and the United Kingdom there has been a long-standing debate about the preferred methods of corporate control of large non-financial firms. In addition, many industrialised countries, such as Japan and Germany, have recently initiated significant changes in their financial markets. Others, such as France and Italy, are considering vast privatisation efforts and concomitant changes in their financial systems. Finally, the ex-communist countries are putting in place entirely new systems of property rights, business law and financial markets. In deciding on what changes to make and how to design their new financial markets policy-makers must decide which is the optimal way to organise the financing and governance of the large non-financial firms whose success is vital to the economic health of their country. In doing so, they would clearly benefit from an understanding of the factors behind the differences between the current models of corporate finance and governance operating in the major industrialised countries, and the costs and benefits of each. This paper attempts to shed light on these issues by describing in detail the important characteristics of the corporate control mechanisms in large non-financial firms in the United States, the United Kingdom, Japan and Germany by examining why such differences exist and by comparing some of the strengths and weaknesses of each system.

Even the casual observer notices large differences in the ways in which firms are organised and governed in the major industrialised countries. Firms in the United States and the United Kingdom are widely thought of as relying primarily on the threat of a takeover by outsiders to ensure that managers abide by shareholders' wishes, while German and Japanese firms are thought to be governed by the banks, with which they typically have close ties. One purpose of this paper is to bring together the large amount of data and empirical results from a variety of sources on these issues that illustrate the important differences in methods of corporate control across countries and allow analysis of this conventional wisdom. In doing so, the paper will draw on a large number of sources in the academic literature to make its argument. Quite apart from its newly acquired status as a relevant policy issue, such an inquiry may be valuable at the current moment as a summary of the recent burgeoning of research on these issues in different countries.

One theme of this paper is that the differences observed between countries are not simply accidents of history or culture but a result of striking differences in the firm's legal and regulatory environment which affects the degree to which the concentrated holding of the firm's financial claims (both debt and equity) is achieved. Concentrated holdings are important from a corporate control perspective because they provide investors with both the incentive and the ability to monitor and influence management. In the absence of such concentration, alternative mechanisms of corporate control must be relied upon to ensure management discipline. Regulatory restrictions on investors' (particularly financial institutions') holdings of large debt and equity stakes in individual firms in the Anglo-Saxon countries has led to relatively dispersed holdings of such claims. Conversely, the absence of such restrictions in Japan and particularly Germany has encouraged concentrated holdings of corporate debt and equity by both financial institutions and other corporations. In these countries, concentrated holdings have also been encouraged by legal and regulatory impediments to the development of securities markets which have meant that, particularly in Japan, firms have had to rely on banks to provide a large share of their total financing needs. These differences appear to be a root cause of the reliance on different mechanisms of corporate control in different countries.

Of course, as the legal and regulatory environment in a particular country changes, so may the method of corporate control. There have been significant regulatory changes in Japan throughout the 1980s and in Germany more recently. This paper will consider what these changes and the slower evolution of the regulatory environment in the Anglo-Saxon countries imply for the methods of corporate control in use in each country. In Japan, for example, regulatory changes already appear to have brought about a weakening of the power banks to monitor and influence firms, as many corporations have taken advantage of newly available sources of external finance to become more independent of bank financing.

A second theme of the paper is that concentrated holdings of a firm's financial claims may, in general, be the most efficient way of resolving agency problems in firms. This is reflected in a number of theoretical results which compare the costs involved with those of other mechanisms of corporate control such as takeovers. It is also reflected in the available empirical evidence, which suggests that the concentrated holding of debt and equity claims may mitigate a number of agency problems inherent in the firm. In light of this, the recent movement away from the close relationships between firms and banks in Japan appears somewhat paradoxical. It suggests that the legal and regulatory structures that determine the mechanisms of corporate control themselves have costs which may affect a much broader range of aspects than those associated with issues of corporate control. The recent Japanese experience is an example of a legal and regulatory structure becoming untenable in the wake of both market-driven financial innovation and pressure from domestic interest groups and from abroad for financial system reform. It suggests that mechanisms of corporate control that rely on too rigid a regulatory structure may not be viable in the long run, even though they appear to be efficient means of resolving corporate agency problems.

The paper is structured as follows. The first section provides an overview of the nature of the problems facing the firm's various stakeholders and the primary mechanisms for resolving these problems. The second section details the main differences between the legal and regulatory systems under which firms operate in the four countries under study that are important in determining the corporate control mechanisms employed. These include the antitrust environment, severity of insider trading laws, restrictions on financial institutions acting as "active" investors and restrictions on non-bank sources of external finance for firms. The third section details the main differences in corporate control mechanisms between countries. It looks at differences in the ownership of the equity and debt of the firm, the structure of the board, methods of management compensation and the frequency of takeovers. The fourth section evaluates some costs and benefits of the various methods of corporate control. The final section concludes the analysis and derives some lessons for policy-makers who have the task of developing systems of corporate finance and governance.

JEL classification: G21, G32, G3