MODULE-1 Flashcards
The Anglo-US Model
The Anglo-US model is characterized by share ownership of individual, and increasingly
institutional, investors not affiliated with the corporation (known as outside shareholders or
“outsiders”); a well-developed legal framework defining the rights and responsibilities of three key
players, namely management, directors and shareholders; and a comparatively uncomplicated
procedure for interaction between shareholder and corporation as well as among shareholders during
or outside the AGM.
Equity financing is a common method of raising capital for corporations in the United
Kingdom (UK) and the US. It is not surprising, therefore, that the US is the largest capital market in
the world, and that the London Stock Exchange is the third largest stock exchange in the world (in
terms of market capitalization) after the New York Stock Exchange (NYSE) and Tokyo.
There is a causal relationship between the importance of equity financing, the size of the capital market and the development of a corporate governance system. The US is both the world’s largest capital market and the home of the world’s most-developed system of proxy voting and shareholder activism by institutional investors. Institutional investors also play an important role in both the capital market and corporate governance in the UK.
Key Players in Anglo-US Model
Players in the Anglo-US model include management, directors, shareholders (especially
institutional investors), government agencies, stock exchanges, self-regulatory organizations and
consulting firms which advise corporations and/or shareholders on corporate governance and proxy
voting.
Of these, the three major players are management, directors and shareholders. They form
what is commonly referred to as the “corporate governance triangle.”
The Anglo-US model, developed within the context of the free market economy, assumes the separation of ownership and control in most publicly-held corporations. This important legal distinction serves a valuable business and social purpose: investors contribute capital and maintain ownership in the enterprise, while generally avoiding legal liability for the acts of the corporation. Investors avoid legal liability by ceding to management control of the corporation, and paying management for acting as their agent by undertaking the affairs of the corporation. The cost of this separation of ownership and control is defined as “agency costs”.
The interests of shareholders and management may not always coincide. Laws governing corporations in countries using the Anglo-US model attempt to reconcile this conflict in several ways. Most importantly, they prescribe the election of a board of directors by shareholders and require that boards act as fiduciaries for shareholders’ interests by overseeing management on behalf of shareholders.
Composition of the Board of Directors in the Anglo-US Model
The board of directors of most corporations that follow the Anglo-US model includes both “insiders” and “outsiders”. An “insider” is as a person who is either employed by the corporation (an executive, manager or employee) or who has significant personal or business relationships with corporate management. An “outsider” is a person or institution which has no direct relationship with the corporation or corporate management.
A synonym for insider is executive director; a synonym for outsider is non-executive director or independent director. Traditionally, the same person has served as both chairman of the board of directors and chief executive officer (CEO) of the corporation. In many instances, this practice led to abuses, including: concentration of power in the hands of one person (for example, a board of directors firmly controlled by one person serving both as chairman of the board of directors and CEO); concentration of power in a small group of persons (for example, a board of directors composed solely of “insiders”; management and/or the board of directors’ attempts to retain power over a long period of time, without regard for the interests of other players (entrenchment); and the board of directors’ flagrant disregard for the interests of outside shareholders.
Beginning in the mid-1980s, several factors contributed to an increased interest in corporate governance in the UK and US. These included: the increase in institutional investment in both countries; greater governmental regulation in the US, including regulation requiring some institutional investors to vote at AGMs; the takeover activity of the mid- to late-1980s; excessive executive compensation at many US companies and a growing sense of loss of competitiveness vis-а-vis German and Japanese competitors.
In response, individual and institutional investors began to inform themselves about trends, conduct research and organize themselves in order to represent their interests as shareholders. Their findings were interesting. For example, research conducted by diverse organizations indicated that in many cases a relationship exists between lack of effective oversight by the board of directors and poor corporate financial performance. In addition, corporate governance analysts noted that “outside” directors often suffered an informational disadvantage vis-а-vis “inside” directors and were therefore limited in their ability to provide effective oversight.
Several factors influenced the trend towards an increasing percentage of “outsiders” on boards of directors of UK and US corporations. These include: the pattern of stock ownership, specifically the above-mentioned increase in institutional investment the growing importance of institutional investors and their voting behavior at AGMs; and recommendations of self-regulatory organizations such as the Committee on the Financial Aspects of Corporate Governance in the UK and shareholder organizations in the US.
Regulatory Framework in the Anglo-US Model
In the UK and US, a wide range of laws and regulatory codes define relationships among management, directors and shareholders.
In the US, a federal agency, the Securities and Exchange Commission (SEC), regulates the securities industry, establishes disclosure requirements for corporations and regulates communication between corporations and shareholders as well as among shareholders.
Laws regulating pension funds also have an important impact on corporate governance. In 1988, the agency of the Department of Labor responsible for regulating private pension funds ruled that these funds have a “fiduciary responsibility” to exercise their stock ownership rights. This ruling had a huge impact on the behavior of private pension funds and other institutional investors: since then, institutional investors have taken a keen interest in all aspects of corporate governance, shareholders’ rights and voting at AGMs.
Readers should note that because US corporations are registered and “incorporated” in a particular state, the respective state law establishes the basic framework for each US corporation’s rights and responsibilities.
In comparison with other capital markets, the US has the most comprehensive disclosure requirements and a complex, well-regulated system for shareholder communication. As noted above, this is directly related to the size and importance of the US securities market, both domestically and internationally.
The regulatory framework of corporate governance in the UK is established in parliamentary acts and rules established by self-regulatory organizations, such as the Securities and Investment Board, which is responsible for oversight of the securities market. Note that it is not a government agency like the US SEC.
Although the framework for disclosure and shareholder communication is well-developed, some observers claim that self-regulation in the UK is inadequate, and suggest that a government agency similar to the US SEC would be more effective.
Stock exchanges also play an important role in the Anglo-US model by establishing listing, disclosure and other requirements.
Disclosure Requirements in the Anglo-US Model
As noted above, the US has the most comprehensive disclosure requirements of any jurisdiction. While disclosure requirements are high in other jurisdictions where the Anglo-US model is followed, none are as stringent as those in the US.
US corporations are required to disclose a wide range of information. The following information is included either in the annual report or in the agenda of the annual general meeting (formally known as the “proxy statement”): corporate financial data ( this is reported on a quarterly basis in the US); a breakdown of the corporation’s capital structure; substantial background information on each nominee to the board of directors (including name, occupation, relationship with the company, and ownership of stock in the corporation); the aggregate compensation paid to all executive officers (upper management) as well as individual compensation data for each of the five highest paid executive officers, who are to be named; all shareholders holding more than five percent of the corporation’s total share capital; information on proposed mergers and restructurings; proposed amendments to the articles of association; and names of individuals and/or companies proposed as auditors.
Disclosure requirements in the UK and other countries that follow the Anglo-US model are similar. However, they generally require semi-annual reporting and less data in most categories, including financial statistics and the information provided on nominees.
Corporate Actions Requiring Shareholder Approval in the Anglo-US Model
The two routine corporate actions requiring shareholder approval under the Anglo-US model are elections of directors and appointment of auditors.
Non-routine corporate actions which also require shareholder approval include: the establishment or amendment of stock option plans (because these plans affect executive and board compensation); mergers and takeovers; restructurings; and amendment of the articles of incorporation.
There is one important distinction between the US and the UK: in the US, shareholders do not have the right to vote on the dividend proposed by the board of directors. In the UK, shareholders do vote on the dividend proposal.
The Anglo-US model also permits shareholders to submit proposals to be included on the agenda of the AGM. The proposals - known as shareholder proposals - must relate to a corporation’s business activity. Shareholders owning at least ten percent of a corporation’s total share capital may also convene an extraordinary general meeting (EGM) of shareholders.
In the US, the SEC has issued a wide range of regulations concerning the format, substance, timing and publication of shareholder proposals. The SEC also regulates communication among shareholders.
Interaction Among Players in the Anglo-US Model
As noted above, the Anglo-US model establishes a complex, well-regulated system for communication and interaction between shareholders and corporations. A wide range of regulatory and independent organizations play an important role in corporate governance.
Shareholders may exercise their voting rights without attending the annual general meeting in person. All registered shareholders receive the following by mail: the agenda for the meeting including background information an all proposals (“proxy statement”), the corporation’s annual report and a voting card.
Shareholders may vote by proxy, that is, they complete the voting card and return it by mail to the corporation. By mailing the voting card back to the corporation, the shareholder authorizes the chairman of the board of directors to act as his proxy and cast his votes as indicated on the voting card.
In the Anglo-US model, a wide range of institutional investors and financial specialists monitor a corporation’s performance and corporate governance.
These include: a variety of specialized investment funds (for example, index funds or funds that target specific industries); venture-capital funds, or funds that invest in new or “start-up” corporations; rating agencies; auditors; and funds that target investment in bankrupt or problem corporations. See the diagram “Diversified Monitoring in Anglo-US Corporate Governance” for a pictoral explanation of this phenomenon. In contrast, one bank serves many of these (and other) functions in the Japanese and German models. As a result, one important element of both of these models is the strong relationship between a corporation and its main bank.
The Japanese Model
The Japanese model is characterized by a high level of stock ownership by affiliated banks and companies; a banking system characterized by strong, long-term links between bank and corporation; a legal, public policy and industrial policy framework designed to support and promote “keiretsu” (industrial groups linked by trading relationships as well as cross-shareholdings of debt and equity); boards of directors composed almost solely of insiders; and a comparatively low (in some corporations, non-existent) level of input of outside shareholders, caused and exacerbated by complicated procedures for exercising shareholders’ votes.
Equity financing is important for Japanese corporations. However, insiders and their affiliates are the major shareholders in most Japanese corporations.
Consequently, they play a major role in individual corporations and in the system as a whole. Conversely, the interests of outside shareholders are marginal.
The percentage of foreign ownership of Japanese stocks is small, but it may become an important factor in making the model more responsive to outside shareholders.
Key Players in the Japanese Model
The Japanese system of corporate governance is many-sided, centering around a main bank and a financial/industrial network or keiretsu.
The main bank system and the keiretsu are two different, yet overlapping and complementary, elements of the Japanese model. Almost all Japanese corporations have a close relationship with a main bank. The bank provides its corporate client with loans as well as services related to bond issues, equity issues, settlement accounts, and related consulting services. The main bank is generally a major shareholder in the corporation.
In the US, anti-monopoly legislation prohibits one bank from providing this multiplicity of services. Instead, these services are usually handled by different institutions: commercial bank - loans; investment bank - equity issues; specialized consulting firms - proxy voting and other services.
Many Japanese corporations also have strong financial relationships with a network of affiliated companies. These networks, characterized by crossholdings of debt and equity, trading of goods and services, and informal business contacts, are known as keiretsu.
Government-directed industrial policy also plays a key role in Japanese governance. Since the 1930s, the Japanese government has pursued an active industrial policy designed to assist Japanese corporations. This policy includes official and unofficial representation on corporate boards, when a corporation faces financial difficulty.
In the Japanese model, the four key players are: main bank (a major inside shareholder), affiliated company or keiretsu (a major inside shareholder), management and the government.
Note that the interaction among these players serves to link relationships rather than balance powers, as in the case in the Anglo-US model.
In contrast with the Anglo-US model, non-affiliated shareholders have little or no voice in Japanese governance. As a result, there are few truly independent directors, that is, directors representing outside shareholders.
Share Ownership Pattern in the Japanese Model
In Japan, financial institutions and corporations firmly hold ownership of the equity market. Similar to the trend in the UK and US, the shift during the postwar period has been away from individual ownership to institutional and corporate ownership. In 1990, financial institutions (insurance companies and banks) held approximately 43 percent of the Japanese equity market, and corporations (excluding financial institutions) held 25 percent. Foreigners currently own approximately three percent.
In both the Japanese and the German model, banks are key shareholders and develop strong relationships with corporations, due to overlapping roles and multiple services provided. This distinguishes both models from the Anglo-US model, where such relationships are prohibited by anti- trust legislation. Instead of relying on a single bank, US and UK corporations obtain financing and other services from a wide range of sources, including the well-developed securities market.
Composition of the Board of Directors in the Japanese Model
The board of directors of Japanese corporations is composed almost completely of insiders, that is, executive managers, usually the heads of major divisions of the company and its central administrative body. If a company’s profits fall over an extended period, the main bank and members of the keiretsu may remove directors and appoint their own candidates to the company’s board. Another practice common in Japan is the appointment of retiring government bureaucrats to corporate boards; for example, the Ministry of Finance may appoint a retiring official to a bank’s board.
In the Japanese model the composition of the board of directors is conditional upon the corporation’s financial performance.
Note the relationship between the share ownership structure and the composition of Japanese boards. In contrast with the Anglo-US model, representatives of unaffiliated shareholders (that is, “outsiders”) seldom sit on Japanese boards.
Japanese boards are generally larger than boards in the UK, the US and Germany. The average Japanese board contains 50 members.
Regulatory Framework in the Japanese Model
In Japan, government ministries have traditionally been extremely influential in developing industrial policy. The ministries also wield enormous regulatory control. However, in recent years, several factors have weakened the development and implementation of a comprehensive industrial policy. First, due to the growing role of Japanese corporations at home and abroad, policy formation became fragmented due to the involvement of numerous ministries, most importantly, the Ministry of Finance and the Ministry of International Trade and Industry. Second, the increasing internationalization of Japanese corporations made them less dependent on their domestic market and therefore somewhat less dependent on industrial policy. Third, the growth of Japanese capital markets led to their partial liberalization and an opening, albeit small, to global standards. While these and other factors have limited the cohesion of Japanese industrial policy in recent years, it is still an important regulatory factor, especially in comparison with the Anglo-US model.
In contrast, government agencies provide little effective, independent regulation of the Japanese securities industry. This is somewhat ironic, because the regulatory framework in Japan was modeled on the US system by US occupation forces after the Second World War. Despite numerous revisions, the core of Japan’s securities laws remain very similar to US laws. In 1971, in response to the first wave of foreign investment in Japan, new laws were enacted to improve corporate disclosure. The primary regulatory bodies are the Securities Bureau of the Ministry of Finance, and the Securities Exchange Surveillance Committee, established under the auspices of the Securities Bureau in 1992. The latter is responsible for monitoring corporate compliance and investigating violations. Despite their legal powers, these agencies have yet to exert de facto independent regulatory influence.
Disclosure Requirements in the Japanese Model
Disclosure requirements in Japan are relatively stringent, but not as stringent as in the US. Corporations are required to disclose a wide range of information in the annual report and or agenda for the AGM, including: financial data on the corporation (required on a semi-annual basis); data on the corporation’s capital structure; background information on each nominee to the board of directors (including name, occupation, relationship with the corporation, and ownership of stock in the corporation); aggregate date on compensation, namely the maximum amount of compensation payable to all executive officers and the board of directors; information on proposed mergers and restructurings; proposed amendments to the articles of association; and names of individuals and/or companies proposed as auditors.
Japan’s disclosure regime differs from the US regime (generally considered the world’s strictest) in several notable ways. These include: semi-annual disclosure of financial data, compared with quarterly disclosure in the US; aggregate disclosure of executive and board compensation, compared with individual data on the executive compensation in the US; disclosure of the corporation’s ten largest shareholders, compared with the US requirement to disclose all shareholders holding more than five percent of the corporation’s total share capital; and significant differences between Japanese accounting standards and US Generally Accepted Accounting Practices (US GAAP).
Corporate Actions Requiring Shareholder Approval in the Japanese Model
In Japan, the routine corporate actions requiring shareholder approval are: payment of dividends and allocation of reserves; election of directors; and appointment of auditors.
Other common corporate actions which also require shareholder approval include capital authorizations; amendments to the articles of association and/or charter (for example, a change in the size and/or composition of the board of directors, or a change in approved business activities); payment of retirement bonuses to directors and auditors; and increase of the aggregate compensation ceilings for directors and auditors.
Non-routine corporate actions which also require shareholder approval include mergers, takeovers and restructurings.
Shareholder proposals are a relatively new phenomenon in Japan. Prior to 1981, Japanese law did not permit shareholders to put resolutions on the agenda for the annual meeting. A 1981 amendment to the Commercial Code states that a registered shareholder holding at least 10 percent of a company’s shares may propose an issue to be included on the agenda for the AGM or EGM.
Interaction Among Players in the Japanese Model
Interaction among the key players in the Japanese model generally links and strengthens relationships. This is a fundamental characteristic of the Japanese model. Japanese corporations prefer that a majority of its shareholders be long-term, preferably affiliated, parties. In contrast, outside shareholders represent a small constituency and are largely excluded from the process.
Annual reports and materials related to the AGM are available to all shareholders. Shareholders may attend the annual general meeting, vote by proxy or vote by mail. In theory, the system is simple; however, the mechanical system of voting is more complicated for non-Japanese shareholders.
Annual general meetings are almost always pro forma, and corporations actively discourage shareholder dissent. Shareholder activism is restricted by an informal yet important aspect of the Japanese system: the vast majority of Japanese corporations hold their annual meetings on the same day each year, making it difficult for institutional investors to coordinate voting and impossible to attend more than one meeting in person.
