Eric De Keuleneer

THE ORIGINES AND PURPOSE OF CORPORATE GOVERNANCE

Professor Eric de Keuleneer
Solvay Business School
The University of Brussels
21 Ave. F.D. Roosevelt, B-1050 Brussels, Belgium

In a market economy, every actor is supposed to pursue their self-interest, and an “invisible hand”
within competitive markets ensures that this translates into optimal efficiency and wealth creation1 for
the common good.

Competition and darwinian selection is a powerful economic engine, and so is cooperation;

companies behaving in a competitive market allow both mechanisms to develop. Alfred Chandler
(1977) said famously that the visible hand of Management could be more efficient than the invisible
hand of the market, justifying the rise of the company within the modern economy.

Corporate governance is the set of rules and laws that help and encourage companies to be well
managed and independent.

Who looks after the interest of the company?

Companies that are not managed by their owners are prone to institutional instability: those who
manage them are supposed to pursue the interest of the company rather than their self-interest, and
the two may diverge. This is what economist call the “agency problem”: the manager of a company is
an agent of the owner(s), and if the interests of the agent prevail, the true interest of the company may
be threatened. Some mechanisms try to somehow align both, but differences always remain.

Of course shareholders can control managers, but their interests also can be in conflict with that of
the company.

The problem of shareholders is not that an owner of 100 % of the shares would do anything
wrong: he would do it against himself, and thus in fact rarely does it. The problem is that large
shareholders can control a company while owning only 51 %, or even less if other shareholders are
silent (often the case when companies are listed); if they act against the interest of the company, they
hurt themselves for only the percentage they own. This is particularly the case when, thanks to
pyramidal financial structures or multiple-vote shares, the percentage of control is larger than
ownership. Even worse, people who represent a shareholder without owning shares can enjoy 100 %
of any benefit they get and suffer no harm; this is the case of people working for banks, companies or
state entities that have a big influence on companies: they can, at no cost for them, ask for various
kinds of advantages for themselves or their friends at the expense of the company. This problem can
be called the “shareholder abuse problem”.

Thus the all important role of the Board of Directors, where non-executive, or independent,
directors should be a large majority. With the help of auditors who look after the reliability of the
accounts presented by managers, they should both monitor managers and prevent large shareholders
of abusing their power.

The evolution of the US model

After a period of wild growth that culminated with dreadful excesses of the “shareholder abuse
problem” in the 1920’s, the US model of company came under strong regulation in the 1930’s;
professional managers, mainly Chief Executive Officers, or CEO, received the central role (hence the
term “managerial company” coined by Berle and Means in 1932),under the control of Boards of
directors whose members were chosen practically without any influence of shareholders. The system

1
For various ways to look at it Smith Adam, 1776, Coase, 1937 and 1960 ; von Hayek

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worked until the 1970’s, when excesses of the agency problem intensified and led to a wave of hostile
takeovers in the 1980’s.
The pursuit of profit has, increasingly since the 1980’s, been used to measure the efficiency of
companies and limit the agency problem. It also has lead to excesses, when the motivation of CEO
and management is excessively linked to short term profit. The use of stock options, which give large
capital gains in the case of stock price rises, has been associated with such excesses; it brings
windfall profits in many cases, and it has motivated many managers to concentrate on stock prices
and the “managed information” (read: accounting manipulation and propaganda) that make them rise
and, in fact, to become greedy. The central characteristic of the US model remains that it is
dominated by professional managers even though since the 1980’s they have been put under
pressure by shareholders. The profit objective and even more the stock price thus became their
dominant motivation; the term “shareholder value” summarizes what the company’s objective should
be.

This has increased the entrepreneurial spirit of managers and led companies to gain in efficiency,
but managers have become motivated to be greedy. Some companies behave in ways that are
detrimental to employees, the environment, their clients, etc…. A very potent alliance between CEO’s
and investment banks, both motivated by greed, led to the massive stock market manipulation in
1995-2002.

The alternative model

An alternative to this “shareholder value maximization” has been sought for some time2. This
alternative is the “stakeholder value maximization” whose theoretical basis goes back at least to the
1930’s as well3. It remains rather theoretical, as long as it does not offer objectives that are as easy to
quantify and monitor as economic profit, but it allows a discussion on the respective merits of the two
models, even though the first is still much more followed in practice.

It is up to the Board to put the right nuances in the objectives of the Company. The market system
is based on the analysis that it transforms every actor’s pursuit of their self- interest into the common
good; Adam Smith was the first to highlight this, but he also strongly underlined the difference
between useful self interest and destructive greed.
Who will monitor the system?

Corporate governance is thus about defining and monitoring the way in which the various actors in
and around the Company will be motivated to work in the interest of the company. CEO’s have to be
monitored by Boards, and Board members have to be monitored by shareholders. Good shareholders
are thus important for the whole process. In the case of listed Companies, many small shareholders
do not vote and some large shareholders may try to take advantage of this and use their power to
abuse the company. That is why various rules like nominating committees and professionalized
selection processes are used (almost systematically in the US and UK) to “guide” the appointment of
non executive Directors of listed Companies and, in practice, limit shareholders influence in the
process. Two main types of shareholders are globally rather positive for companies: entrepreneurs
and their families seem to give priority to the long term well-being of the company, and professional
asset managers are able to monitor with little risk of abuse.

Laws and rules are needed to prevent abuses by shareholders; that is the priority for the
corporate governance rules in the anglo-saxon tradition, with the risk of unchecked agency problems.
In most of the rest of the world, the corporate governance traditions are more favourable to large
shareholders, with the risk of shareholder abuses. There is a kind of convergence worldwide towards
the anglo-saxon system that seems very efficient, but everywhere in the world there is a strong feeling
that corporate governance is not only about laws and rules, but also about selecting and motivating
people that are able and willing to work with dedication and talent at managing a company and
monitoring its managers, for a decent salary and decent bonuses.

2
Freeman, 1984; Blair, 1995; de Woot, 2005
3
Dodd, 1932

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What lessons for Vietnam?

Where can Vietnam look for good and bad examples? Countries like Hong Kong, Singapore,
Thailand could count on an entrepreneurial tradition, and China benefited from the input of oversees
Chinese entrepreneurs to explain the rise of their enterprises. They all developed the institutional
framework of their stock market over the years, sometimes with foreign influences. Japan and Korea
had large trading groups for a long time, which make them a case apart.

Vietnam has a large state-owned sector, and it probably should take care not to privatise it too
quickly so as not to repeat the mistakes made in Russia, where premature privatisations led to a
rather cheap sale of state-owned assets and the emergence of a class of capitalists dominated by
greed and little concern for the common good. A progressive creation of the right market
mechanisms, good auditors, the appearance of local entrepreneurs, of some professional asset
managers, the appearance of a large enough group of people who could play the essential role of
non-executive board members, are all necessary before privatisation through the stock markets could
be done safely on a grand scale.

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