Corporate Governance: A Development Challenge

17 Sep, 2005 | by

I recently read an article, “Corporate Governance: A Development Challenge”, which was authored by two “organization for economic co-operation and development” (OECD) employees.  It peaked my interest as it articulated a compelling argument for global corporate governance that I had not heard before. 

The article touches on the broad spectrum of corporate governance and how it applies to the developing world specifically. I’ve been exposed to local corporate governance issues up to this point in my career and thought this article may expose me to a different perspective.

Article Summary:
The article opens by posing a key question: “Is corporate governance as important in the developing world?” This question was a consistent theme throughout the article as it methodically elaborated via subtopic headings which included “why corporate governance matters for development”, “oligopolistic rivalry and corporate-control rents”, “Pyramids, cross-shareholding, multiple share classes.” And closes with a “what to do?” section. I will comment on each of these sections below followed by some analytical commentary.

The article initially provides some corporate governance historical background by referencing the financial crisis of 1997-1999 in Asia . It described the immediate sense of urgency for global stability while countries such as Russia and Brazil asked for “crony capitalism” and poor corporate governance to be addressed in newly developed economies. The message was further bolstered by OECD perspective with such pointed comments as ”the quality of local corporate governance is critically important for the success of long-term development efforts throughout the developing world today”

The article then builds its argument by diving into the relevance of corporate governance. Such arguments included: well governed companies tend to be able to raise funds from non-controlling investors at much lower costs then poorly governed companies. This of course stems from a higher-risk premium a poorly governed company generally must contend with. The article goes on to point out that developing countries must face challenges unknown to many OECD countries. Some of these challenges include: how to move from heavily relationship based interactions to effective rule-based systems of corporate and public governance.

Oligopolistic rivalry and corporate control rents was the next focus in the article. This section focused mainly on two reoccurring circumstances: 1. “Considerable extent to which insiders are able to extract corporate control rents from other corporate stakeholders.” 2. “Impact of oligopolistic rivalry among powerful interest groups entrenched in local structures of economic and political power.” This is sometimes called “distribution coalitions” or “cronyism”.

The next item discussed in the article was that of pyramids, cross-shareholding and multiple share classes. This section was in my opinion the most interesting as is discussed three techniques widely used throughout the developing world by insiders to divert resources from corporations in clever ways that deprive non-controlling investors of potential financial benefits. The three techniques are: 1. Pyramidal corporate structures, in which one firm holds a controlling equity share in one or more firms each of which in turn holds a controlling share of one or more firms. 2 & 3. Cross-shareholdings and multiple share classes in which firms possess each other’s shares (cross shareholding) and shares in the same company have different voting rights, with insiders having disproportionately high voting rights (multiple shares classes).

The article closes by discussing some of immediate steps necessary to fight these obvious pockets of corruption. The article stresses the challenge for many developing countries is the difficulty in breaking this deeply routed cycle. In order to do so, it requires a better understanding of the importance of corporate governance for these developing countries. It then goes into an almost self congratulatory tirade on how much OECD has been working to increase this awareness in a slue of countries, which are then listed. From there it goes into other directives such as: Corporate governance laws need to be effectively enforced and acknowledging the difficulties from deeply rooted conflicting regulation which makes these new governance laws extremely difficult to implement. Also discussed are the issues of voluntary versus mandatory approaches, both of which would also need strong regulatory and judicial institutions to enforce them. The final few paragraphs are an extended discussion on these two approaches both of which have their own unique complexities.

The article was poignant and clearly made a solid case for global corporate governance. I whole heartedly agree with what the organization is ultimately trying to achieve.

I feel global corporate governance is absolutely imperative not only to developing countries but all countries alike. We’ve reached a point in today’s information age where “start to finish” products or services are rarely completed entirely in-house. Efficiency has emerged as one of the most important elements of business processes. In order to acquire efficient results organizations have taken business process reengineering to a whole new multi national level. Each and every component is identified and analyzed. If it’s cheapest to fulfill the process internally then it will be done internally. If not then outsource it to another organization that can. It’s that simple and this has been the clear trend in recent years. It’s nothing that can be avoided. In fact the circumstance should be embraced to help build a stronger global economy and global community. Many of these developing countries play significant roles in goods or services rendered. By instituting structured governing laws it may allow for these countries to pass along additional cost savings or better services.

The article provides a clear-cut benefit of corporate governance which can really make or break an organization’s future. A well governed company tends to be perceived as a lower risk company in the financial arena. This allows the need to raise capital to be done at a much lower rate then a poorly governed organization. This benefit is extremely difficult to quantify as it can do so much for an organization financially and strategically. Especially when a company must rely on it’s creditors to boost future revenues through strategic investments.

The article spent a good amount of time describing the various deficiencies or corruption in poorly governed countries. I thought some of these techniques used were appalling to say the least. From distribution coalitions to pyramids and cross-shareholding to multiple share classes, it was quite disturbing. It saddens me to think this type of behavior still persists for a few reasons. The first reason being: my own moral objectivity to a corruptly governed institution and the second being the obvious misdirection of so called ”global productivity”. I’ll only discuss the later as the first item more or less speaks for itself. By allowing this type of corruption to consistently occur it affects everyone. The only positive side I see in all this is the benefits those reap who themselves are engaging in corrupt behavior. However this might also only be a false positive as some engaging in the corrupt behavior may only be reaping fabricated profits. When corruption is involved it’s hard to tell sometimes whose doing well and whose not. Enron would be an excellent example. Without a establishing a standard or enforcing global corporate governance, how will anyone know what’s real and what’s fabricated? The various types of corruption scams are endless and not worth reiterating. The only true certainty is that developing countries out of the loop are never given an opportunity to rise from poverty. How are we to form a truly global economy if only a few players are involved whom may or may not be the best players in the game. By implementing these regulations in developing countries, not to mention ensuring that they are in fact being enforced, will in essence level out the playing field where new stars may then emerge in grand fashion.

The articles closes with several items that policy makers should or should not do in order to create this global utopia (I use this term loosely) but to really get countries to change their ways will require a fundamental change in leadership. The article briefly touches on that sentiment but I feel it’s the ultimate X factor. Without a change in leadership or introducing a new way of thinking…This corruption or lack of corporate governance will never stop in developing countries. It’s mind boggling to even try to understand the political ramifications to make those changes.  With that said, I consider myself an optimist.  I take great solace in the fact that there are organizations out there like OECD that are at the very least putting forth a concerted effort to make a difference.

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