There are many models of corporate governance in the world and there is no universal best choice.
The choice of the best model for a company depends on not only on its goals, motivations, mission and business context but also on their economic, legal, political and social frameworks. Nevertheless, there are 2 dominant governance models. Find them below.
The Anglo-American Model Of Corporate Governance
According to Ooghe and De Langhe, in Anglo-American countries, shareholders hold few percentages of the total number of shares that are publicly traded and most shares are in the hands of the agents of financial institutions. Moreover, in the USA and the UK, many companies are listed and their shares are publicly traded which means that there is little personal contact with their shareholders. Also, blockholders (owners of large blocks of companies’ shares) in the USA are less common than in Europe meaning that the shareholders’ voting power is smaller and therefore it’s not so relevant for companies to consider them.
Because of this greater focus on the interests of independent persons and individual shareholders, this model is commonly referred to as the shareholders model. Hence, in countries where most companies follow this governance model, there is a higher individual power to hold shares and make investments in the capital markets. As a consequence, there’s a higher dispersion of capital and there isn’t a structured shareholder map.
In companies with this kind of governance structure, where there may be many shareholders, it is common to hear about the agency or stewardship theory. But what does this theory stand for?
Agency Or Stewardship Theory: What Does It Mean?
“Broadly, agency theory is about the relationship between two parties, the principal (owner) and the agent (manager). More specifically, it examines this relationship from a behavioral and a structural perspective. The theory suggests that given the chance, agents will behave in a self-interested manner, behavior which may conflict with the principal’s interest. As such, principals will enact structural mechanisms that monitor the agent in order to curb the opportunistic behavior and better align the parties’ interests.”
This old but recent excerpt from a paper written in 1991 by Lex Donaldson and James H. Davis provides a holistic view of this theory. Using business vocabulary, this theory means that pursuing the interests of the shareholders (that own a company) may not be of the best interest of the board of directors managing it.
This happens because the success of managers is commonly measured according to short-term goals whereas the shareholders are interested in the long-term performance of the company. The capacity for managers to act according to their self-interest is because they are able to influence strategic and investment decisions as they have more information available and are better aware of the context of the company.
On the other hand, shareholders may be many and disperse and sometimes see companies as one among many investments, lacking the knowledge about the situation or business context, being left vulnerable. Because of this, control mechanisms in order to ensure the long-term profitability and success of companies are needed.
Agency Or Stewardship Theory: What Control Mechanisms Exist?
Becht et al. distinguish five main ways to mitigate shareholders’ collective action problems:
- Election of a board of directors representing shareholders’ interests, to which the CEO is accountable;
- When the need arises, a takeover or proxy fight launched by a corporate raider who temporarily concentrates voting power (and/or ownership) in his hands to resolve a crisis, reach an important decision or remove an inefficient manager;
- Active and continuous monitoring by a large blockholder, who could be a wealthy investor or a financial intermediary, such as a bank, a holding company or a pension fund;
- Alignment of managerial interests with investors through executive compensation contracts;
- Clearly defined fiduciary duties for CEOs and the threat of class-action suits that either block corporate decisions that go against investors’ interests, or seek compensation for past actions that have harmed their interests.
The Continental European Model Of Corporate Governance
On the other hand, in Continental European countries such as Italy, France or Germany, shareholders groups hold large percentages of the total number of shares that are publicly traded and most shares are held by private companies, followed by financial institutions and in the last place by private persons.
In these countries, fewer companies are publicly traded and people tend to invest their savings on an individual basis, instead of betting on the capital market. This means that in this model there is a high concentration of capital in a few shareholders that made big investments and took big risks too.
This model is often associated with the stakeholder theory, as it also assumes the importance of companies having stakeholder engagement processes to strengthen the firms’ legitimacy to operate.