This article was originally published on Corporate Compliance Insights on May 26, 2010.
Especially in light of current economic challenges, the globalization of business is more crucial, and challenging, than ever.
Just as the U.S. and Europe have different accounting standards – GAAP and IFRS – their corporate governance standards differ widely as well. Corporate governance, at heart, is designed to help protect the interests of the shareholders. The U.S. Congress chose to do that by enacting Sarbanes-Oxley, designed to increase disclosure and fight potential corruption through rigid audit and reporting requirements. The European Union (EU) has also enacted a number of directives in recent years which, unlike “SOX”, are less punitive and center more on shareholder empowerment and the “comply or explain” principle deriving from largely voluntary governance standards.
Why such different approaches? Each change is rooted in the history of the respective regions and markets. Recent laws and directives react to the local problems of the day, whether those problems are corporate corruption and off-balance-sheet accounting in the U.S., or “asset tunneling” in Europe and Asia.
There’s also the deeper history of who runs the companies and who owns the stock. There are distinct differences between equity ownership in U.S. and in Europe. American companies have large numbers of investors ranging from households to large institutions, while European companies generally have more concentrated holdings. Boards and shareholders of European companies face very different circumstances and challenges than their U.S. counterparts.
Due to the pyramidal structure of many European companies, an investor with a very small percentage of the cash flow rights could accrue an extremely large share of the voting rights. Investors controlling those voting rights could order a company to sell assets to third parties, or even themselves, to the detriment of other shareholders. Such “asset tunneling” has been a significant problem in both Europe and Asia.
The U.S., however, pursues a culture of disclosure since the 1934 Securities and Exchange Act- followed by the passage of Sarbanes-Oxley in 2002, which was designed to right the wrongs of Enron and other corrupt public companies. The question in the U.S. is whether the board is acting in the interest of the shareholders: is enough pressure being put on them to exercise their roles efficiently and correctly?
European shareholders have far more access to board members and company leaders than Americans do. A European investor may be able to pick up the phone and talk to a board member directly; in America, the idea of getting a board member or top executive on the phone is laughable. Since shareholders in Europe are more likely to feel that companies represent their interests well, they are more likely to accept a more flexible, less adversarial system.
Shareholders in the United Kingdom can propose binding resolutions, nominate directors on the spot and even force a significant board action, such as unexpectedly demanding consideration of a merger. But dissenting American shareholders are generally considered gadflies, or worse yet, nuisances.
In Sweden, the election committee that nominates board members is comprised of the four largest shareholders. (That’s both good and bad news; The board will generally reflect the shareholders’ views, yet it’s important to have rules and disclosure governing who has right to propose, approve and/or reject asset transactions to prevent tunneling.) In America, shareholders have little to no control over who sits on the board. Chances are shareholders can’t even get on the agenda, much less win a proxy contest.
In the U.S., the combination of weak shareholder rights and the business judgment rules system, by which courts are predisposed to rule in favor of the board, make it hard for shareholders to take action. In many cases the only recourse for dissatisfied shareholders is to sell their stock.
Class action suits, which are commonplace in America, are the sources of much debate. Some argue that they serve an important role in righting wrongs against investors and keeping companies honest. Others view them as cold hard business deals conducted by profit-driven plaintiffs’ attorneys, which discourage many capable people of accepting board seats for fear of being sued.
While shareholder lawsuits have recently begun catching on in Europe, they lack the strong foothold they have in America. In Norway, for example, the losers in shareholder suits pay court costs, which has had a chilling effect.
The Cost of SOX
Bloomberg reported in 2006 that America’s biggest securities firms were doing record overseas business with IPOs on markets from London to Tokyo. Of the 25 largest companies to go public outside their home markets by fall of that year, Bloomberg reported, only six chose U.S. exchanges, compared with 22 in 2000. SOX is frequently blamed when cross-border companies decline to list on the U.S. stock markets, but that is only part of the story; plus, the U.S. now has the world’s best disclosure system.
It definitely costs money to hire auditors and set up the systems SOX requires, but keep in mind that companies tend to go where the money is. The large families of Europe used to hold the capital; the U.S. was the first to channel household savings into stock markets. Overseas companies had to come to America to get the cash they needed. As pools of investment arose in other parts of the world through pension funds and sovereign wealth funds selling resources-based industries, more local pools became available for Europeans and Asians. While SOX has indeed been a deterrent, the major driver for listing outside New York is the availability of cash.
All these economic, financial and cultural differences raise the question of whether a global governance standard could ever be possible. Another complication is that even though the European Union issues directives, Europe has dozens of stock markets which individual member states regulate. There’s also the question of – to what extent the legal system is binding. That is, are companies able to “contract around” a country’s governance weaknesses? For example, if bondholders have few rights in bankruptcy in Bulgaria, does that necessarily mean that foreign investors will not invest there – or are there ways for private contracting parties to solve the problem anyway (such as placing export revenues in foreign jurisdiction before repatriating)? If the answer is yes, then global convergence in governance practices is closer than the diverse legal systems per se would indicate.
The Road to Convergence
One option that could help speed up international governance convergence are efforts to streamline shareholder voting. The Lindenauer Center for Corporate Governance at the Tuck School of Business at Dartmouth College is in the midst of a major research project that examines the difficulties encountered in cross-border voting on the stock exchanges of a number of countries.
The basic premise for this research is the fact that institutional shareholders around the world increasingly use active share-voting to protect their portfolios and improve corporate governance. But exercising these voting rights involves costly and often arcane country-specific legal rules. Until now, no one has attempted to map and communicate about the many challenges. The Lindenauer Center is developing a series of reports examining the potential for harmonizing cross-border share-voting systems and proxy voting. The first landmark step was to map out the share-registration system and voting chain for publicly-traded companies in Italy. This is available on the Social Science Research Network Electronic Library: http://ssrn.com/abstract=1431733. Subsequent reports on Sweden, Norway, U.K. and the U.S. are in the making – with Sweden out in June.
The project is being performed in collaboration with Norges Bank Investment Management (NBIM) in Oslo, which manages the $450 billion Norwegian Sovereign Wealth Fund, the largest international stock market investor in the world today. Despite its size, like other cross-border investors, fund managers have encountered tremendous obstacles to exercising their votes.
If cross-border shareholder voting is streamlined and improved, investors will be able to express their views much more effectively, which would be a monumental improvement. When even the smallest shareholder may stand up and say, “Let’s do things another way,” shareholder voices are likely to be heard, which could create enormous positive pressure on the system. Overall, adopting a more efficient cross-border voting system which lowers the cost of shareholder voting would be a significant step toward international convergence.
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About the Author
John F. Sandy Smith, Partner at law firm Womble Carlyle, Sandridge & Rice, has extensive experience serving in an advisory role for boards of directors regarding corporate governance, independent director duties and the fiduciary duties of directors and management.
He is on the board of the MBA program at the Tuck School, where he is also Executive in Residence. He is also Executive in Residence at Emory University, and serves on the boards of several educational institutions and charitable organizations.
Mr. Smith would like to thank Professor B. Espen Eckbo for his significant contributions to this article. Dr. Eckbo, who holds the Tuck Centennial Chair in Finance at the Tuck School of Business at Dartmouth College, is the Founding Director of Tuck’s Lindenauer Center for Corporate Governance. He teaches advanced MBA courses in the areas of corporate finance, corporate takeovers, and international corporate governance.
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