Question

There are basically two major corporate governance models in the world: the market-based and control-based models.

Compare these two models and critically discuss (with reasons) which model would be more appropriate for listed companies.

Answer 1

A market-based corporate governance system relies on the investors in a public company to exert influence over how the corporation is to be managed. It defines the responsibilities of the different participants in the company, including shareholders, the board of directors, management, employees, suppliers and customers. Market-based corporate governance is one of several approaches to ensuring proper protections to shareholders and company adherence to existing regulations. The U.S. and India are examples of market-based corporate governance systems that do not have national governance policies companies must follow, but instead rely on securities laws and regulations. The global trend in governance is toward a “comply or explain” system where companies are required to adhere to state or market exchange-developed governance codes.

One of the biggest challenges to effective corporate governance is short-termism, according to governance experts. Public companies are managed to meet quarterly earnings targets set by sell-side analysts on Wall Street. Companies have a repertoire of accounting maneuvers they can utilize to meet or consistently beat Wall Street forecasts, thus boosting their stock price. A quarterly earnings miss, however, can cause a sharp stock decline and send company management scrambling for a short-term solution. Governance experts suggest eliminating earnings guidance as way to promote a more long-term view of a company’s goals and give the companies more time to accomplish them.

While governance broadly encompasses the processes necessary to establish and structure exchange, it also subsumes control issues required to maintain the exchange (Heide 1994). Control-based processes of governance operate following initiation, directing and managing the partners during the lifetime of the exchange.

Rather than fighting issue by issue, as boards and shareholder activist groups currently do, they should take a bundled approach that allows for give-and-take across issues, thereby increasing the likelihood of meaningful progress. The result would be a step change in the quality of corporate governance, rather than incremental meandering toward what may (or may not) be a better corporate governance regime for U.S. public companies.

A best of the breed hybrid system is best for world class listed companies

1) Board of Directors should have the right to manage the Company for Long Term -  Dispensing with earnings guidance would mitigate the obsession with short-term profitability

2) Investors should install mechanisms to ensure the Best Quality Professionals in the Boardroom - An individual director’s contribution has little to do with either age or tenure

3) Directors should give shareholders and orderly voice - Directors should guarantee a reasonable process whereby shareholders get to decide and participate

A fundamental question in today's governance - what goals are the activists, governance rating agencies, boards, and everyday shareholders all trying to achieve? The answer is clear: insulation from frivolous litigation, but meaningful exposure to liability in the event of a dereliction of duty in the boardroom. In the old days, activists and their allies agreed on this shared goal. In the late 1980s, when most U.S. states enabled boards to waive liability for certain breaches of fiduciary duty, ISS encouraged directors to take up the invitation, on the understanding that they should be focused on shaping strategy and monitoring performance rather than worrying about shareholder litigation. Today's Corporate Governance would return to this old wisdom through exclusive forum provisions. Directors would be accountable for their actions, but only as judged by a corporate law expert. The result would be greater willingness among directors to make longer-term decisions, without fear of a jury’s hindsight.