Management – Marketing - Tourism

DEVELOPING A GOOD CORPORATE GOVERNANCE

Assist. Ph.D. student Bocean Claudiu

University of Craiova
Faculty of Economics and Business
Administration
Craiova, Romania

Abstract: Good corporate governance is an important step in building

market confidence and encouraging more stable, long-term international
investment flows. The business corporation is an increasingly important
engine for wealth creation worldwide, and how companies are run will
influence welfare in society as a whole. In order to serve this wealth
creating function, companies must operate within a framework that keeps
them focused on their objectives and accountable for their actions. Many
countries see better corporate governance practices as a way to improve
economic dynamism and thus enhance overall economic performance.

Key words: corporate governance, ownership, shareholders, top management

1. Concept of corporate governance

The compatibility of corporate governance practices with global standards has
also become an important part of corporate success. The practice of good corporate
governance has therefore become a necessary prerequisite for any corporation to
manage effectively in the globalized market.
The term “corporate governance” is a relatively new one both in the public and
academic debates, although the issues it addresses have been around for much longer, at
least since Berle and Means (1932) and the even earlier Smith (1776).
In the last two decades, however, corporate governance issues have become
important not only in the academic literature, but also in public policy debates. During
this period, corporate governance has been identified with takeovers, financial
restructuring, and institutional investors' activism. One can talk about the governance of
a transaction, of a club, and, in general, of any economic organization. In a narrow
sense, corporate governance is simply the governance of a particular organizational
form - a corporation.
Viewing the corporation as a nexus of explicit and implicit contracts, Garvey
and Swan (1994) assert that governance determines how the firm’s top decision makers
actually administer such contracts.
Shleifer and Vishny (1997) define corporate governance by stating that it deals
with the ways in which suppliers of finance to corporations assure themselves of getting
a return on their investment. A similar concept is suggested by Caramanolis-Cötelli
(1995), who regards corporate governance as being determined by the equity allocation
among insiders and outside investors.
John and Senbet (1998) propose the more comprehensive definition that
corporate governance deals with mechanisms by which stakeholders of a corporation
exercise control over corporate insiders and management such that their interests are
65
Revista Tinerilor Economiti
protected. They include as stakeholders not just shareholders, but also debt holders and
even non-financial stakeholders such as employees, suppliers, customers, and other
interested parties. Hart (1995) closely shares this view as he suggests that corporate
governance issues arise in an organization whenever two conditions are present. First,
there is an agency problem, or conflict of interest, involving members of the
organization – these might be owners, managers, workers or consumers. Second,
transaction costs are such that this agency problem cannot be dealt with through a
contract.
Zingales (1997) defines corporate governance as the complex set of constraints
that shape the ex-post bargaining over the quasi-rents generated by a firm. All the
governance mechanisms discussed in the literature can be reinterpreted in light of this
definition.
An OECD study (1999) considers that corporate governance is the system by
which business corporations are directed and controlled. The corporate governance
structure specifies the distribution of rights and responsibilities among different
participants in the corporation, such as, the board, managers, shareholders and other
stakeholders, and spells out the rules and procedures for making decisions on corporate
affairs. By doing this, it also provides the structure through which the company
objectives are set, and the means of attaining those objectives and monitoring
performance.
A few studies have examined corporate governance in emerging markets,
although none has estimated the link between CEO turnover and corporate
performance. Researchers (La Porta, Lopez-de-Silanes, and Shleifer, 1999; Claessens,
Djankov, Fan and Lang, 1999; Lins, 2000) have studied the implications of the
concentrated corporate ownership that is common in many emerging and developed
markets and conclude that the principal agency problem in large corporations around
the world is that of restricting expropriation of minority shareholders by the controlling
shareholders.

2. Importance of corporate governance

Corporate governance matters for distribution of rents. Zingales (1997)
considers that are three main channels through which the conditions that affect the
division of quasi-rents also affect the total surplus produced:
1. Ex-ante incentive effects. The process through which surplus is divided ex-
post affects the ex-ante incentives to undertake some actions, which can create or
destroy some value, in two main ways. First, rational agents will not spend the optimal
amount of resources in value enhancing activities that are not properly rewarded by the
governance system. Second, rational agents will spend resources in inefficient
activities, whose only (or main) purpose is to alter the outcome of the ex-post
bargaining in their favor.
2. Inefficient bargaining. A second channel through which a governance system
affects total value is by altering ex-post bargaining efficiency. A governance system,
therefore, can affect the degree of information asymmetry between the parties, the level
of coordination costs, or the extent to which a party is liquidity constrained.
3. Risk aversion. Finally, a governance system might affect the ex-ante value of
the total surplus by determining the level and the distribution of risk. If the different
parties have different degrees of risk aversion (or different opportunities to diversify or

66
 Management – Marketing - Tourism
hedge risk), then the efficiency of a governance system is also measured by how
effectively it allocates risk to the most risk-tolerant party.

3. Principles for corporate governance

Corporate governance is only part of the larger economic context in which
firms operate, which includes, for example, macroeconomic policies and the degree of
competition in product and factor markets. The corporate governance framework also
depends on the legal, regulatory, and institutional environment. In addition, factors such
as business ethics and corporate awareness of the environmental and societal interests
of the communities in which it operates can also have an impact on the reputation and
the long term success of a company.
OECD have assembled a system of principles that are intended to assist
member and non-member governments in their efforts to evaluate and improve the
legal, institutional and regulatory framework for corporate governance in their
countries, and to provide guidance and suggestions for stock exchanges, investors,
corporations, and other parties that have a role in the process of developing good
corporate governance. The principles cover five areas:
I) The rights of shareholders;
II) The equitable treatment of shareholders;
III) The role of stakeholders;
IV) Disclosure and transparency;
V) The responsibilities of the board.
Briefly those principles are:
I) The corporate governance framework should protect shareholders’ rights.
II) The corporate governance framework should ensure the equitable treatment
of all shareholders, including minority and foreign shareholders. All shareholders
should have the opportunity to obtain effective redress for violation of their rights.
III) The corporate governance framework should recognize the rights of
stakeholders as established by law and encourage active co-operation between
corporations and stakeholders in creating wealth, jobs, and the sustainability of
financially sound enterprises.
IV) The corporate governance framework should ensure that timely and
accurate disclosure is made on all material matters regarding the corporation, including
the financial situation, performance, ownership, and governance of the company.
V) The corporate governance framework should ensure the strategic guidance
of the company, the effective monitoring of management by the board, and the board’s
accountability to the company and the shareholders.
The principles are primarily intended to provide assistance to governments.
They also provide guidance and direction for stock-exchanges, investors, corporations
and other parties that have a role in developing good corporate governance. They can
indeed be a useful point of reference for many emerging markets and economies in
transition. Not only do the principles provide a benchmark for internationally accepted
standards, they also offer a solid platform for analysis and practices in individual
countries taking into account country specific circumstances, such as legal and cultural
traditions.

67
Revista Tinerilor Economiti
4. The institutions of corporate governance
Mark Roe define corporate governance as the relationships at the top of the
firm - the board of directors, the senior managers, and the stockholders. In his opinion
institutions of corporate governance are those repeated mechanisms that allocate
authority among the three and that affect, modulate and control the decisions made at
the top of the firm.
Core corporate governance institutions respond to two distinct problems, one of
vertical governance (between distant shareholders and managers) and another of
horizontal governance (between a close, controlling shareholder and distant
shareholders).
The principal institutions are about ten: the market, the board, gate-keeping,
coalescing (via takeovers, proxy fights, and shareholder voice), incentive compensation,
professionalism, lawsuits, capital structure, and bankruptcy. Some institutions deal well
with vertical corporate governance but do less well with horizontal governance. The
institutions interact as complements and substitutes, and many can be seen as
developing out of a “primitive” of contract law. Arguably a system must get contract
enforcement, as well as basic property rights, satisfactory before it embarks on more
sophisticated corporate governance institutions.

5. The search for good corporate governance practices

Corporate governance affects the development and functioning of capital
markets and exerts a strong influence on resource allocation. In an era of increasing
capital mobility and globalization, it has also become an important framework
condition affecting the industrial competitiveness and economies.
Corporate governance mechanisms vary depending on industry sectors and type
of productive activity. Corporate governance framework can influence upon the
development of equity markets, R&D and innovative activity, and the development of
an active SME sector, and thus influence upon economic growth.
Identifying what constitutes good corporate governance practice, and under
what circumstances, is a difficult task. This is partly because the effectiveness of
corporate governance systems is influenced by differences in countries’ legal and
regulatory frameworks, and historical and cultural factors, in addition to the structure of
product and factor markets. The challenge, therefore, is not only to identify the
strengths and weaknesses in each individual system or group of systems, but also to
identify what are the underlying conditions upon which these strengths and weaknesses
depend.
One of the main challenges facing policy makers is how to develop a good
corporate governance framework which can secure the benefits associated with
controlling shareholders acting as direct monitors, while at the same time, ensuring that
they do not expropriate excessive rents at the expense of other stakeholders. The search
for good corporate governance practices should be based on an identification of what
works in defined countries, to discern what broad principles can be derived from these
experiences, and to examine the conditions for transferability of these practices to other
countries.

6. Corporate governance in Romania

Emerging Romanian system of corporate governance is characterized by the
big issue of the presence of major shareholders (who act as block holders) as a result of
68
 Management – Marketing - Tourism
privatization with strategic investors. Consequently, the problem of responsibility and
accountability of the senior management does not seem to be a fundamental issue in
this case, rather the main problem that affects the Romanian corporate governance may
be identified in the weakness of the minority shareholders. In fact, due to the strength of
the block holder, the senior management is usually effectively monitored, so that it does
not run the company according to its own interest. However, this fact does not lead to
the conclusion that the interests of all the shareholders are pursued, since the block
holder seems to be able to make the senior management pursue his or her interest,
which often differs from the interest of the minority shareholders.
Corporate governance in Romania tends to benchmark other system, especially
of the European Union country, where it seems likely that the potential future corporate
governance system will take more into account the stakes of the employees, due to the
relevance of the Germanic reality.

7. Conclusions
Corporate governance is a concern of great importance to owners of common
stocks, because stockholder wealth depends in large part upon the goals of the people
who set the strategy of the corporation. The objectives of corporate managers often
conflict with those of the shareholders who own their companies.
The objectives of a good corporate governance system should be:
1) to maximize the incentives for value enhancing investments, while
minimizing inefficient power seeking;
2) to minimize inefficiency in ex-post bargaining;
3) to minimize any governance risk and allocate the residual risk to the least
risk-averse parties.
Mechanisms for controlling the dimension of corporate costs are necessary and
they include external and internal disciplining devices. It was observed that due to
important theoretical and practical limitations, external disciplining devices including
takeover threat, the managerial labor market, and mutual monitoring by managers,
reputation, competition in product factor markets and financial analysts cannot alone
solve the corporate governance problem, although they may be important in some
particular circumstances. Firms therefore have to adopt complementary internal
disciplining devices in order to minimize their total agency costs. These internal devices
include the composition of the board of directors, insider ownership, large shareholders,
compensation packages and financial policies (dividends and debt).
Events of the last two decades indicate that even corporate internal control
systems have failed to deal effectively with these changes, especially excess capacity
and the requirement for exit. Making the internal control systems of corporations work
is the major challenge of our time.

REFERENCES
1. Berle Jr., A., The Modern Corporation and Private Property, Macmillan,
Means, G. New York, 1932
2. Caramanolis- External and Internal Corporate Control Mechanisms and
Cötelli, B. the Role of the Board of Directors: A Review of the
Literature, Working Paper No 9606, Institute of Banking
and Financial Management, 1995

69
Revista Tinerilor Economiti
3. Claessens, S., Who controls East Asian corporations?, World Bank Policy
Djankov, S., Research Paper 2054, February 1999
Lang, L.
4. Farinha, J. Corporate Governance: a Survey of The Literature,
November, 2003, accessed at www.ssrn.com, 22.09.2006
5. Garvey, G., The Economics of Corporate Governance: Beyond the
Swan, P. Marshallian Firm, Journal of Corporate Finance 1, 1994, p.
139-174
6. Hart, O. Corporate Governance, Some Theory and Applications, The
Economic Journal 105, 1995, p. 687-689
7. John, K., Corporate Governance and Board Effectiveness, Journal of
Senbet, L. Banking and Finance 22, 1998, p. 371-403
8. La Porta, R., Corporate ownership around the world, Journal of Finance
Lopez-de- 54:2, April 1999, p. 471-517
Silanes, F.,
Shleifer, A.
9. Lins, K. Equity ownership and firm value in emerging markets,
working paper, Kenan-Flagler Business School, University
of North Carolina at Chapel Hill January 2000
10. OECD Study OECD Principles of Corporate Governance, Paris, 1999
11. Roe, M. The Institutions of Corporate Governance, Discussion Paper
No. 488, Harvard Law School, 08/2004
12. Shleifer, A., A Survey of Corporate Governance, Journal of Finance 52,
Vishny, R. 1997, p. 737-783
13. Zingales, L. Corporate Governance, University of Chicago, NBER &
CEPR, 1997

70