corporate Governance and national institutions

1. In the Name of Allah, The Most Merciful The Beneficent,

2. Corporate Governance and national instuitions

3. Abstract This study criticizes corporate governance research grounded in agency theory and proposes that cross national comparisons of corporate governance should consider how the nature and extent of agency relationship differ across different institutional context.

4. Performance outcomes of board of directors, owner ship concentration and executive incentive differ depending upon legal system and institutional characteristics in a specific country.

5. Institutions may also affect different firm level governance practices which cause variations in firm level governance mechanism.

6. This study suggests the need to complete and thorough research to develop institutionally embedded framework to analyze organizational outcomes of various governance practices.

7. Great work has been done in corporate governance studies around the world. Much corporate governance research has been inspired by the ideas from Agency theory and similar related ideas.

8. Agency theory states that managers, who are agents of shareholders, may act against the benefits of shareholders and may engage in self serving behavior.

9. To constrain managerial opportunism, shareholders may use diverse range of corporate governance mechanism like Monitoring by board of directors; Equity based managerial incentives and External market, such as threat of takeover, product competition and managerial labor market.

10. These concepts from Agency theory have informed growing number of attempts to understand cross national differences in corporate governance. But problem is that institutions modify the basic principal-agent relationship in a way that requires specific contextualization.

11. Institutions are important for corporate governance because these create different incentive, values and normative understandings.

12. In different countries many aspects of firms and related institutions are very different(ownership, legal institutions, managerial career patterns , social norms around shareholders)

13. We must understand these differences in order to understand specific corporate governance model( success or failure)

14. Before this study a little work was done on comparative understandings of the institutions

15. Corporate governance work was under contextualized and it was difficult to know and compare the effectiveness of different corporate governance mechanisms across different organizational environments and institutional context

16. Effectiveness means protection of shareholders wealth, fostering creation of new wealth and fair distribution of wealth among stakeholders

17. Effectiveness depends on environment of the organization, legitimacy within different institutions.

18. This new literature advocates (i) Moving away from focus of principal and agent as a universal phenomenon (ii) and looking at the patterned variations of corporate governance in different settings

19. This paper aims at understanding how corporate governance differs around the world and effectiveness of well known corporate governance practices

20. We develop a set of theoretically grounded illustrations of how effectiveness is influenced by institutions.

21. We illustrate how performance effects of corporate board, executive incentives and ownership may differ according to legal system and institutional characteristics in specific country.

22. This study suggests to go beyond more universalistic approach like Agency theory in the same manner in every country.

23. It attempts to integrate institutional theory within corporate governance research. From the Principal – agency dichotomy towards a comparative institutional analysis of corporate governance.

24. The principal – agency framework dominates research on corporate governance.

25. Here efficiency of various corporate governance mechanism is studied from shareholder perspective

26. This approach emphasizes that role of self interested opportunism and arm’s length contracting between shareholders and managers

27. Corporate governance is considered as a set of organizational practices for monitoring and possibly reducing managerial powers.

28. The principal – agent relationship is often assumed to be universal and endemic. But empirical research has cast a doubt on whether a clear universal link exists between these corporate governance mechanisms and firm’s performance

29. Comparative research has stressed the weaker effects of equity based incentives in U.K and Germany. Or the absence of a link between high pay for performance sensitivity in executive pay and financial performance in Japan.

30. Cross national comparative research also directed the researchers to know how institutions modify the basic Principal – agent relationship by providing different set of incentives, resources and understanding of corporate governance

31. We highlight two issues relevant for cross national comparisons. First critique argues that agency theory is an under socialized approach that remains insensitive to how institutions shape the identity, interest and interactions among actors in corporate governance. It considers only two actors; Shareholders and Managers.

32. According to agency theory institutions have very limited role in corporate governance

33. Sociological strand of institutional theory go further to provide on alternative explanation for firms behaviors in terms of “Understandings that organizational actors share, independent of their interests.

34. Rather than making predictions based on self interested actors , Institutional theory identifies regulative, normative and cognitive mechanism that shape the identities of wider set of stakeholders.

35. Second criticism -------- Notion of effectiveness within agency theory is too narrow to be applied to corporate governance in very different settings. In fact the effectiveness corporate governance depends strongly on their fit with the broader organizational environment.

36. Resources differ across organizations and create different demands on governance.

37. The alternative approach suggest that corporate governance practices are in dependent with the diversity, fluctuation and uncertainties of their environment and rejects universalistic context free proposition.

38. Institutional theory offers a way to understand how various corporate governance elements may work more effectively in certain combinations and thus give rise to institutionally diverse form.

39. * managers 1)Research focus *Shareholders shareholders Stakeholdrs Institutionalinvironment *managers *Focus on universalistic conflict of interest between managers And share holders. *Recognition of differences between the context and nature of agency conflicts in various institutional environments. 2) Organizational context * Recognition that national institutions may impact upon the 3) Organizational solutions * A set of universal corporate Governance remedies, including >board monitoring effectiveness of corporate governance solutions; Some of them >concentrated ownership >executive incentives >market for corporate control may have unintended consequences.

40. 4) Account for national *context free approach *Contextualization of agency conflicts Institutions *focus on US/U.K environment *Focus on moderating effects of national institutions 5) Policy implications *convergence of institutional *Diversity of institutional frameworks. frameworks. *Universal effectiveness *Functional equivalence, unintended consequences. *Law and codes shape markets *Laws and codes shape networks, associations, and professional orientations.

41. Corporate governance and legal institution.Institutional theory emphasizes that legal rules and norms form an important element of national institutional system. This research shows how different legal traditions are linked to the levels of investors protections, which in turn, shape agency relationships by influencing power of shareholders vis-à-vis the board as well as the relative influence of minority versus large shareholders

42. Institutional theorist extend their research by examining how the influence of the law on corporate governance is itself embedded within a wider institutional environment of a country, in particular its regulatory frameworks.

43. Large variation exists in the degree to which laws on the books is effectively enforced by the courts and other state agencies across countries

44. Mainstream corporate governance research begins from a universal notion of shareholders as principal and managers as agents. Most legal remedies to the agency problem lie within either strengthening the accountability of the board or promoting greater shareholder engagement for better control.

45. A close look at different legal system shows that agency relationship is itself is constituted in law, but on the basis of very different approaches to defining the rights and responsibilities of shareholders and directors.

46. National corporate laws confer authority on directors and interpret their roles as the “legal agents” of the shareholders in very different ways.

47. U.K company law defines the company as private association of shareholders. By contrast, German corporate law takes a more explicitly constitutional view of the corporation as an entity separate from any particular group. In U.S no federal corporation law exists and each state specifies its own law. These examples show that the basic principal – agent problem is always embedded within legal institutions that construct and legitimate the relationship between shareholders, the board and the wider interests of the company in different ways.

48. A key implication is that legal system may strongly influence the effectiveness of different internal and external corporate governance mechanism.Agency theory suggests a universal set of remedies that can mitigate agency conflicts within the firms, such as independent board of directors, shareholders engagement with managers, and so on. However the effectiveness of these governance measures depends crucially on how governance remedies are translated into legal options available to stakeholders.

49. The legal institutions vary across countries with regard to how the frameworks of rules strike a balance between constrains and constraining the potential abuse by managers of their power, while avoiding undermining the efficiency gains from having a strong centralized management.

50. In sum, this discussion clearly shows that it is important to recognize that national legal system have a very strong impact on how the rights of principals and the duties of directors are defined and executed, as well as how potential conflicts and breaches of directors ‘s responsibilities are dealt with.There is no universal solution to problems as stated by Agency theory but every phenomenon is to be considered in special context.