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Chapter 20
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Corporate Governance and
Performance
©2001 Prentice Hall
Takeovers, Restructuring, and Corporate Governance, 3/e
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Corporate Governance
Systems in the United States
• Diffuse stock ownership
– Limited liability public corporation
– Diffuse ownership of voting equity shares
– Large number of individual share owners
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• Requires little direct monitoring of
individual firms by investors
– Limited liability of investors
– Diversification allows investors to ignore
idiosyncratic risks of individual companies
– Equity ownership shares actively traded
• Commercial banks and insurance
companies limited in their ability to hold
large equity positions in individual
companies
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• Contractual theory of the firm
– Firm as network of actual and implicit
contracts
• Contracts specify roles of stakeholders and
define their rights, obligations, and payoffs
• Potential conflicts
– Contracts unable to envisage many changes in
conditions that develop
– Participants may have personal goals
– Separation of ownership and control
• Operations of firm are conducted and controlled
by managers without major stock ownerships
• Conflicts of interest arise between owners and
managers
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– Jensen and Meckling (1976)
• Agency problem — divergence of interests
between owners (the principal) and
management (their agent)
• Fractional firm ownership by managers can
lead managers to work less and to consume
excessive perquisites
• Additional monitoring expenditures (agency
costs) are required
– Auditing systems
– Bonding assurances
– Organization systems
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• Divergent interests of stakeholders
– Business firms must recognize wide range
of expectations of diverse stakeholders
– Business firms must recognize external
influences — job safety, product safety,
environmental impacts
– Business firms must recognize wide range
of stakeholders and external influences to
achieve long-run value maximization
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Internal Control Mechanisms
• Shareholders elect board of directors to
represent their interests
• Problems of how all stakeholders can
obtain representation of their views and
interests have not been resolved
• Public expectations look to board of
directors to balance interests of all
stakeholders
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• Campbell, Gillan, and Niden (1999)
– Analyzed how shareholders used proxy mechanism
in 1997 proxy season
– Shareholder-proposal rules (Rule 14a-8) allow
shareholders to include proposal and 500-word
supporting statement in proxy materials
– Sample of 287 social policy proposals and 582
corporate governance proposals at 394 companies
– 43.3% of all proposals were considered for vote
• Corporate governance proposals — 49.2% were voted on
and 35.2% were either omitted or withdrawn
• Social policy proposals — 31.4% were voted on and 61.6%
were either omitted or withdrawn
– Rule 14a-8 remains an important avenue for
shareholders
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Role of the Board of Directors
• Views of role of monitoring board
– Pro: In theory, monitoring by board of
directors can deal with problems of
corporate governance
– Con: Boards have been ineffective
• Board fails to recognize problems of firm
• Board does not stand up to top officers
• External control devices such as hostile
takeovers have multiplied because of failure of
boards
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• Composition of the board
– Role of outside directors
• Outside directors — directors who neither work
for the corporation nor have extensive dealings
with company
• Outside directors play larger role in monitoring
management than inside directors
– Fama (1980)
• Outside directors enhance viability of board in
achieving low-cost internal transfers of control
• Lower probability of collusion with top management
– Fama and Jensen (1983a) — outside directors have
incentives to protect and develop reputation as experts
in decision control
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– Weisbach (1988)
• Tested hypothesis that inside and outside
directors behave differently in monitoring top
management
• Outsider-dominated boards more likely to
remove CEO
• Replacement of CEO
– Statistically significant inverse relation between firm's
market-adjusted share performance in a year and
likelihood of subsequent change in CEO
– For outsider-dominated boards, responsiveness of
removal decision to stock market performance is
three times larger than for other board types
– Replacement decision takes place relatively quickly
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– Rosenstein and Wyatt (1990) — CAR for
total sample was significantly positive
when company appointed outside
directors
– Borokhovich, Parrino, and Trapani (1996)
• Positive relation between proportion of outside
directors and likelihood that outsider is
appointed CEO
• Market views appointment of outsider to CEO
position more favorably than appointment of
insider
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• Compensation of board members
– Well-structured compensation systems may
motivate directors
• Director stock ownership better aligns director
interests with stockholders
– Stock ownership requirements for directors and/or
payment of part or all of directors' annual retainer in
stock and stock options
– Finance directors' retirements with stock
• Studies find directors of top-performing
companies hold greater number of shares than
do counterparts at poor-performing firms
– Critics argue that compensation should not
be motivating factor
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• Evaluating a board of directors
– Business Week (11/25/96)
• Rated boards by how close they came to
meeting these recommendations:
–
–
–
–
Evaluate CEO performance annually
Link CEO pay to clear performance criteria
Review and evaluate strategic and operating plans
Require significant stock ownership and
compensate directors in stock
– No more than three insiders
– Require election each year and mandatory
retirement at 70
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– Key committees should be composed of outside
directors
– Limits on number of boards and ban on interlocking
directorships
– Disqualify (from board) anyone receiving fees from
company
• Some pension funds and mutual funds judge
boards by stock market performance of their
companies — a "blinkered view"
– Millstein and MacAvoy (1998)
• Better board rating (based on either board
independence or performance) associated with
higher spread of return on invested capital
(ROIC) over cost of capital (WACC)
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Ownership Concentration
• Equity ownership by managers must
balance
– Convergence or alignment of interests
– Entrenchment considerations —
managerial ownership and control of voting
rights may allow pursuit of self-interest
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• Ownership and performance
– Stulz (1988)
• Model in which at low levels of management
ownership, increased equity holdings improve
convergence — enhance firm value
• At higher levels of insider ownership, managerial
entrenchment prevents takeovers — decrease
firm value
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– Morck, Schleifer, and Vishny (MSV) (1988)
• Study based on 1980 data
• Performance (measured by q-ratio) related to
management or insider ownership percentages
– Ownership concentration increased from 0 to 5%
• Performance improved
• Alignment-of-interest effect
• Direction of causality may be reversed — high
performance firms more likely to give managers
stock bonuses
• High performance firms may have substantial
intangible assets that require greater ownership
concentrations to induce proper use of these
assets
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– Ownership concentration in range 5% to 25%
• Performance deteriorated
• Management entrenchment dampens
performance
– Ownership concentration above 25%
• Performance improved but slowly
• Incremental entrenchment effects attenuated
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– McConnell and Servaes (MS) (1990)
• Replicate MSV study using 1976 and 1986 data
– For 1976, relationship between ownership
concentration and performance relatively flat with
moderate convergence of interest effect up to 50%,
after which curve flattens and then declines
moderately
– For 1986, relationship curve rises relatively sharply
to 40%, after which it is relatively flat to 50% followed
by sharp decline
• Leverage, institutional ownership, R&D
expenditures, and advertising expenditures do
not change initial findings
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– Cho (1998)
• Replicates MSV patterns using ordinary least
square regressions and 1991 data
• Tests for endogenous ownership structure
• Finds that corporate value affects ownership
structure, but not reverse
– Bristow (1998)
• Sample of consistently derived insider holdings
on 4,000 firms during 1986-95
• Relationship between management ownership
and performance varies for each of the ten
years
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• Economic variables influence ownershipperformance relationship
– Relative growth rates of industries
– Differences in demand-supply relationships among
industries
– Relative value change patterns among industries and
firms within them
– Stock price movements
• Interpretations of diverse data patterns
– May reflect economic identification problem
discussed by Cho
– True relationship may be Demsetz-Lehn theory of no
relationship between ownership level and
performance
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– Holderness, Kroszner, and Sheehan (1999)
• Percentage of managerial equity ownership
– Mean increased from 12.9% in 1935 to 21.1% in 1995
– Median increased from 6.5% in 1935 to 14.4% in 1995
• Doubling of managerial ownership may imply
improvement in corporate governance in U.S.
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• Managerial ownership and bond returns
— Bagnani, Milonas, Saunders, and
Travlos (1994)
– No relation between bond returns and
managerial ownership below 5%
– Positive relation for managerial ownership
between 5% and 25%
• Increased incentives for managers to act in
shareholders' interest, taking risks that are
potentially harmful to bondholders
• Rational bondholders required higher returns
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– Weak negative relation for ownership
above 25%
• Managers become more risk averse
• Managers have high stake in firm — greater
incentives to protect their private benefits and
objectives
• Managers' interest more aligned with
bondholders — lower bond premia
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• Financial policy and ownership
concentration
– Share repurchases financed by debt
• Insider group does not tender its shares in
repurchases — percentage equity shares
increased
• Increased convergence of interest effect
– Incentive effects of high management
ownership percentages performed positive
role in LBOs and MBOs
©2001 Prentice Hall
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– Safieddine and Titman (1999)
• Sample of 573 firms that successfully resisted
takeover attempts during 1982-1991
• Effects on leverage
– Increased leverage is one form of defensive strategy
– In 207 firms, median leverage ratio increased from
60% to 71.5%
• Corporate restructuring activity
– Turnover of top management during three-year window
• 30% for low leverage increasing group
• 37% for higher leverage increasing firms
– Turnover of top management after takeover attempts
• 44% replaced in hostile takeover attempts
• 29% replaced in friendly takeover attempts
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• Operating performance improves and long-run
post-termination performance of leverageincreasing targets superior to benchmark
– Returns grow by about 55% after five years
– Level of returns same as what would have been
realized by accepting takeover offer
• Manager's behavior of leverage-increasing target
firms consistent with long-term interest of their
shareholders
– Strong long-term abnormal stock price performance
despite initial drop at takeover termination
announcement
– Associated productivity improvements
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– Amihud, Lev, and Travlos (1990)
• Sample of firms that made cash acquisitions
of over $10 million of other firms during
1981-1983
• Cash acquisitions are associated with
significantly larger insider ownership levels
than stock financed acquisitions
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Executive Compensation
• Conflict of interest between owners and
managers reduced if executive
compensation plans more tightly related
pay to performance
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• Executive compensation and changes
in value of firm
– Jensen and Murphy (1990)
• Executive pay changes only $3 for $1,000
change in firm wealth — elasticity of 0.3%
• Low elasticity indicates executive pay is not
closely linked to performance
• But low elasticity partially explained by large
value of firm in relation to executive
compensation
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– Haubrich (1994) — derived Jensen-Murphy
results using principal-agent theory models
– Schleifer and Vishny (1995) — JensenMurphy relationship would generate large
swings in executive wealth and would
require considerable risk tolerance for
executives
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• Executive compensation and firm's
corporate governance —
Core, Holthausen, and Larcker (1999)
– Sample of 495 observations for 205 publicly
traded U.S. firms during 1982-1984
– Board of director characteristics and ownership
structure significantly related to CEO
compensation
• CEO compensation higher
–
–
–
–
–
CEO was also board chair
Board was larger
Greater percentage of outside directors appointed by CEO
More outside directors considered 'gray'
Outside directors older and served on more than three other
boards
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• CEO compensation lower
– Greater percentage of inside directors in board
– Lower CEO's ownership stake
– Existence of non-CEO internal board members or external
blockholders who owned at least 5% of equity
– Significant negative relationship between
compensation predicted by board and ownership
variables and subsequent firm operating and
market performance
• Board and ownership variables are proxies for
effectiveness of firm's governance structure
• CEOs of firms with greater agency problems were
able to obtain higher compensation
• Firms with greater agency problems perform worse
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• Executive compensation and
performance measures
– Criticism that compensation had been based
on accounting measures rather than stock
market-based performance measures
– Rappaport (1986)
• Early executive compensation performance plans
were market based
• In 1970s, performance measures for granting
options shifted to accounting-based measures
• In recent years, performance is moving to marketbased measures
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• Other proposals for improved payperformance policies
– Limit base salaries of top executives
– Bonus and stock option plans based on
stock appreciation
– Stock appreciation benchmarks should
consider
• Close competitors
• Wider peer group
• Broader stock market indexes
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– Stock options based on premium of 10-20%
over current market and should not be
repriced
– Company loan programs should enable top
executives to buy substantial amounts of
firm's stock
– Directors should be paid mainly in stock
with minimum specified holding periods
©2001 Prentice Hall
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Outside Control Mechanisms
• Stock prices and top management
changes
– Warner, Watts, and Wruck (1988)
• Poor stock price performance likely to result in
increased rate of management turnover
• Evidence of several internal control mechanisms
— monitoring by large blockholders, competition
from other managers, discipline by board
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– Denis and Denis (1995)
• Announcement of changes in management
– Forced resignations: Positive 1.5% (significant)
– Normal retirements: Insignificant effects
• Forced top management changes
– Preceded by significantly large operating
performance declines and followed by significant
improvements
– Associated with significant downsizing measured by
declines in employment, capital expenditures, total
assets
– Improvements did not result from effective board
monitoring
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– 13% of 853 sample were forced changes
• Two-thirds of forced resignations associated with
blockholder pressure, financial distress,
shareholder lawsuits, and takeover attempts
• 56% of firms with forced changes became target
of corporate control activity
– Internal control mechanisms were inadequate;
required pressure from external corporate control
markets
©2001 Prentice Hall
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– Role of stock market
• Schleifer and Vishny (1997) survey does not
develop potential role of stock market and
security price movements in disciplining
managers
• Security price movements provide scorecard
measuring management performance
• Bad scores on stock market increase likelihood
of managerial turnover
©2001 Prentice Hall
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• Public pension funds
– Public pension funds have ability and size to
become significant factors in corporate
governance
• California Public Employees' Retirement System
(CALPERS) publicly announced names of
companies that failed to negotiate adoption of
corporate reforms
• World’s largest pension plan, TIAA-CREF,
encourages companies to have independent,
diverse boards
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– Carleton, Nelson, and Weisbach (1998)
• Described negotiation process between TIAACREF and target firms on governance issues
• All firms agreed to institute confidential voting
• Most firms contacted added women or
minorities to board
• Most firms that were asked to limit use of blank
check preferred stock as antitakeover defense
complied
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– Wahal (1996)
• Nine activist pension funds in period 1987-1993
• Activist proposals shifted from takeover-related
proxy proposals in late 1980s to governancerelated proposals in 1990s
– Takeover-related proxy proposals — poison pills,
greenmail, antitakeover provisions
– Governance-related targeting — golden parachutes,
board composition, compensation
©2001 Prentice Hall
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• Abnormal returns
– Zero average abnormal returns for shareholder
proposals
– Small positive abnormal returns for attempts to
influence target firms in using shareholder proposals
(nonproxy targeting)
– No significant long-term improvement in either stock
price movements or accounting measures in posttargeting period
©2001 Prentice Hall
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Weston - 45
– Strickland, Wiles, and Zenner (1996)
• Studied United Shareholders Association (USA)
from 1986 to 1993
• USA developed a Target 50 list of firms
• USA successfully negotiated corporate
governance changes in 53 proposals before
inclusion in proxy statements
• Abnormal return to target firm = 0.9% at
announcement of negotiated agreements —
wealth increase of $1.3 billion
• USA effective when target firm was poor
performer with high institutional ownership
©2001 Prentice Hall
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Multiple Control Mechanisms
(Agrawal and Knoeber, 1996)
• Sample of 400 largest firms
• Consider seven control mechanisms
– Insider shareholdings
– Outside representation on board
– Debt policy
– Activity in corporate control market
©2001 Prentice Hall
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– Institutional shareholdings
– Shareholdings of large blockholders
– Managerial labor market
• Firm performance measured by Tobin's q
• Results
– Considering influence of each control
mechanism separately — first four control
mechanisms statistically related to firm
performance
– Considering all mechanisms together, but not
within simultaneous equation system —
influence of insider shareholdings drops out
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– Considering all mechanisms together and
using simultaneous equation system —
only negative effect on firm performance
from outside representation remains
– Concluded that control mechanisms chosen
optimally except for use of outsiders on
boards (most other studies find positive
benefits from use of outsiders)
©2001 Prentice Hall
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Proxy Contests
• Background
– Definition: Attempts by dissident groups of
shareholders to obtain representation on
board of directors
– Success of proxy contests
• Most fail to get majority representation
• Better measure of success: Whether dissident
group gains at least two members on board —
one to make motion, another to second it
©2001 Prentice Hall
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– Proxy reform rules
• Under old rules: Any shareholder who wanted to
communicate with more than ten other
shareholders required to submit comments for
SEC approval prior to circulation
• Under new rules of October 1992: Ease
requirements for shareholders not seeking
control to communicate with one another
– Focus of empirical studies
• Disciplinary value of proxy contests in
managerial labor market
• Relationship between proxy contests and other
forms of takeover activity
• Value of vote
©2001 Prentice Hall
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• Wealth effects — Earlier studies
– Dodd and Warner (1983)
• 96 proxy contests over period 1962-1978
• Dissidents won majority on board in only 20%
of cases
• Returns to target shareholder positive and
significant = 6.2% from 39 days before
announcement through outcome
• Hypothesis to explain positive returns
– Even minority board representation allows dissident
group to have positive impact on corporate policy
– Challenge alone (even if no seats change hands)
may lead incumbents to improve policy
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• No evidence of stock price declines when
contests fail
– Possibilities of increased efficiency exposed during
contests
– Negative abnormal returns at contest outcome
announcement for contests in which dissidents failed
to win any seat at all (-1.4%), not large enough or
significant to offset earlier gains
©2001 Prentice Hall
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• Information leakage
– Inevitable due to mechanics of waging proxy contest
– Significant abnormal returns of 11.9% over period
starting 60 days before announcement through
announcement itself
– Returns not attributable to merger activity — results
are similar regardless of whether or not dissident
group included another firm
– No unexpectedly higher earnings in
preannouncement period to explain runup
– Conclude proxy contest is source of positive returns
©2001 Prentice Hall
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– DeAngelo and DeAngelo (1989)
• 60 proxy contests during 1978-1985
• Dissidents successful in one-third of contests
• Returns to shareholders
– 40 days before contest through outcome
announcement = 6.02% significant
– 40 days preceding any public indication of dissident
activity = 18.76% significant
– Gains not dependent on contest outcome
©2001 Prentice Hall
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• Negative returns at outcome when dissidents
won no seats
– Two-day outcome announcement period = -5.45%
– When incumbents prevailed in shareholder vote —
insignificant negative return (-1.73%)
– When dissidents defeated by other means —
significant negative return (-7.19%); include:
• Expenditure of corporate assets to buy off
dissidents
• White knight acquisition of target
• Court approval of validity of incumbent's defense
causing dissidents to withdraw
©2001 Prentice Hall
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• Strong link between proxy contests and takeover
activity
– Follow-up on targets for three years after contest
• Only 20% remained independent public firms
under same management
• In 20 of 39 firms in which dissidents failed to win
majority, there were 38 resignations of CEO,
president, or chairman of board
• 25% (15 cases) were sold or liquidated
– Most of the gains to proxy contest activity are closely
related to merger and acquisition activity
• Initial precontest gains (about 20%) reflected
increased likelihood of eventual sale of firm at
premium after proxy contest
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– Split sample results
• Firms eventually sold/liquidated — abnormal
returns over full contest period = 15.16%
• Firms not sold/liquidated — less significant
abnormal return = 2.9%
• Initial runup for both classes revised as more
information becomes available about likelihood
of sale
– Goal of proxy contests — get representation on
board to persuade rest of board to sell or liquidate
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– Sridharan and Reinganum (1995)
• 79 hostile tender offers and 38 proxy contests
• Proxy contest more likely to take place
– Target firm performance is relatively poor as
measured by return on assets and stock returns
– Managerial inefficiency
– When shareholdings of management are high
• Tender offers more likely when
– Firm fails to pursue new and profitable investment
opportunities
– Tender offer targets tend to be less leveraged than
firms experiencing proxy fights
©2001 Prentice Hall
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• Wealth effects — Later studies
– Borstadt and Zwirlein (1992)
• 142 firms involved in proxy contests during 19621986
• Sample divided into two groups
– Full-control sample — Dissident success rate = 42%
– Partial-control sample — Dissident success rate = 60%
• Turnover rate of top management after proxy
contest higher than average
• Positive abnormal return of 11.4% (significant)
during proxy contest period (60 days prior to
announcement of contest through contest
resolution announcement)
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– Ikenberry and Lakonishok (IL) (1993)
• 97 election contests during period 1968-1987
• Test hypothesis that proxy contest represented
referendum on management's ability to operate
firm and can act as disciplinary mechanism
– Contest targets underperformed control firms by 39.3%
(significant) over five-year period prior to
announcement of election contest
– Proxy contest appears to be stimulated by poor
performance
• Return to shareholders
– For period from month -60 to month -5 relative to
announcement of contest, CAR of proxy contest
targets = -34.4% (significant)
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– Incumbent board members retain all their seats: CAR
not significantly different from zero for five-year period
following contest
– Dissidents gain at least one board seat: CAR from
month +3 to +24 = -32.4% (significant)
– Dissidents gain control of board: CAR from month +3
to +24 = -48% (significant); negative return due to
• Overoptimistic expectations of improved
performance
• Dissidents' discovery that company faced more
serious problems than anticipated
• Negative returns different from positive returns
found in earlier studies
©2001 Prentice Hall
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– Mulherin and Poulsen (1998)
• Sample of 270 proxy contests for board seats
during 1979-1994
• Returns to shareholders
– Day 0 = date of contest initiation; Day R = contest
resolution date
– Initiation period [-20,+5]; CAR = +8.04% (significant)
– Post-initiation period [+6,R]; CAR = -2.82% (not
significant)
– Full-contest period [-20,R]; CAR = +5.35% (significant)
– Post-contest period of one year following contest
resolution; CAR = -3.43% (borderline significant)
©2001 Prentice Hall
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• Results contradict substantial decline in postcontest period reported by IL
– Performance measurements sensitive to
survivorship bias arising from minimum data
requirements
– IL's requirement that firm be listed in Compustat in
period around contest led to downward bias in
estimated wealth changes
– Compustat requirement excluded sizeable number
of firms that were acquired in period surrounding
proxy contest
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• Management turnover and shareholder returns
– Management turnover should be integral part of
interpretations of changes in shareholders wealth in
post-contest period
– IL reported wealth decline, whether dissidents
attained seats or not, but failed to observe that
wealth changes following proxy contests were
positive when there was management turnover
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The M&A Market for Control
• Market for corporate control most widely
recognized form of external pressure
• Empirical metrics demonstrate M&As do
impact business firms
– Mitchell and Mulherin (1996)
• 1,064 firms listed in Value Line Investment
Survey at end of 1981
• 57% of these firms had been either a takeover
target or had engaged in defensive asset
restructuring
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– Schwert (1996)
• Comment's M&A proprietary database of all
NYSE- and AMEX-listed target firms from 19751991
• 1,814 target firms, a substantial percentage of
total listed firms
• MBOs represented 11.4% of main sample of
1,523 firms
– Mergerstat Review
• Many M&A announcements in recent years
– 3,510 in 1995
– 9,278 in 1999
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• M&A market is major source of external
control mechanisms — indicates at
least some degree of failure of internal
control mechanisms
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Alternative Governance
Systems
• Summary of U.S. governance system
– Managerial stock ownership has increased
over time
– Large and small shareholders protected by
well-developed systems of laws, court
decisions, and financial market that facilitate
• Efficient transaction of securities
• Protect minority rights
• Enable shareholders to sue directors for violations
of fiduciary duty
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– Changes in stock market prices quickly
penalize companies for poor performance
and reward them for excellence
– Vigilant stock market may cause managers
to emphasize short-term results
– Bankruptcy laws are highly protective of
managers; after entering into bankruptcy
• Management remains in possession of company
• Provision is made for automatic stay
• Interest continues to accrue only on fully secured
debt
• New financing is facilitated since it has priority
status
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• Shleifer and Vishny (1997)
– German governance system
• Creditors have stronger rights than in U.S.
• Shareholder rights are weaker than in U.S.
• Large shareholders, often major banks and
financial groups, exercise control over large
firms as permanent investors and lenders
• Small investors have virtually no participation in
stock market
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– Japanese governance system
• Degree of protection to shareholder and
creditor rights fall between U.S. and Germany
• Powerful banks and long-term shareholders in
Japan not as powerful as in Germany;
anecdotal evidence questions this conclusion
– Japanese companies have financed in U.S. during
earlier periods of time when Japan supposedly had
lower financing costs than rest of world
– Japanese firms sought to avoid strong controls that
came with financing from Japanese banks
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• Industrial firms own shares in one another and
groups of firms become tied together by crossshareholdings (Kaplan, 1994)
• Governance system has facilitated participation
by small investors in stock market
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– U.S., Germany, and Japan have in
common well-articulated set of rules that
provide effective legal protection for at
"least some type of investors" and are
enforced by courts and regulatory agencies
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– Governance systems in other countries
• Italy
–
–
–
–
Predominantly family controlled
Difficulty raising outside funds
Investment mainly financed internally
Bank financing mainly by state banks for state firms
• Rest of world
– Similar to Italy
– Absence of system of laws, regulations, and courts
to protect minority investors and creditors
– Rules of game are deficient
– Large firms, mostly family controlled, rely on internal
financing, or obtain help from government controlled
banks
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• Economist (1994)
– German and Japanese corporate
governance differ from U.S.
• Stronger role of banks and financial groups
• In theory, large ownership position of ownerslenders lead to effective monitoring
– Critique of German and Japanese corporate
governance model
• Banks have not monitored closely firms to which
they provide both equity and debt capital; banks
become active only when client firms experience
difficulties
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• German and Japanese models appear good
only because of earlier favorable economic
environment — all parties have same long-term
interests and goals
• As economic growth slows, conflicts of interest
among different stakeholders arise
• Supervisory boards (in Germany particularly) did
not seem to meet often enough and acted slowly
– Incompetent managers permitted to complete
standard 5-year contract
– Chairman of board often leader of executive board
– Supervisory boards not adequately informed
• Large banking corporations have their own
governance problems
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• Conclusion: American-British systems of
shareholder control works better
– Market-based
– Increased activism of pension funds
– Active market for corporate control in form
of M&A activity
– Increased M&A activity in Japan and
Germany after 1999
• Consistent with deficiencies of internal control
mechanisms
• Outside market for corporate control was
needed to improve corporate performance
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