|
| |
Corporate Finance Around the World
From: Cambridge University Press
| By:
Jonathan Barron BaskinPaul J. Miranti, Jr. |
EDITOR'S INTRODUCTION |
Despite globalization, regulation of securities markets remains essentially a local responsibility. So is an international convergence of structures for financial ordering likely to occur? In this extract from their book A History of Corporate Finance, Jonathan Barron Baskin and Paul J. Miranti, Jr., compare the Anglo-American markets with their German and Japanese counterparts. |
 orporate finance has been influenced by two distinct patterns of governance in the world's leading securities markets. At one end of the spectrum are the similar systems that have emerged in the United States and the United Kingdom and are characterized by freely competitive markets, transparency in corporate affairs and regulatory structure to protect investors from the incompetency or dishonesty of agents. These are quite different from the uninformative, opaque regimes of Japan and Germany, where powerful private and/or governmental institutions dominate local markets through informal, cooperative relationships. (See Ingo Walter, The Battle of the Systems: Control of Enterprises and the Global Economy, 1993). |
Reliable information strengthens the Anglo-American financial markets, facilitating the pricing of securities and thereby enabling the market to allocate capital efficiently. In addition, it augments economic growth by increasing opportunities for profitable transacting by investors. |
Complementary monitoring patterns--one professional and the other governmental--provide assurances in the Anglo-American markets of the reliability and currency of corporate information. The agencies were originally limited to boards of directors, public accountants, attorneys, investment bankers and other professionals whose scope of fiduciary responsibility derived largely from a path-dependent process involving legal precedents. The state later provided a second level of monitoring, which also reinforced the position of professional groups. |
Britain and the US
In Britain the connection to government was initially defined in various companies acts that mandated filing corporate financial statements with the Board of Trade (now the Department of Industry and Trade). Before 1986, regulation of the share market remained largely in the hands of the Stock Exchange, attorneys, accountants and other professional groups. In a highly homogeneous society like Britain, such an informal system worked relatively well because of a more general willingness of the public to defer to the judgments of respected professionals. Moreover, the authority of practitioners was further reinforced by strong laws prohibiting libel. For example, shareholders who lost suits brought against professionals could in turn be sued for defamation. |
In response to the "big bang" that made British financial markets more open to international competition, the Financial Services Act of 1987 established the Securities Investment Board (SIB) to support the traditional self-regulatory system of governance. The SIB monitored the activities of a host of self-regulatory organizations such as the Institute of Chartered Accountants of England and Wales, whose activities were vital for the efficient functioning of the financial markets. The SIB basically required professional groups to enforce meaningful codes of professional conduct, as well as qualifying standards to certify practitioner competency. Although the SIB had the power to intervene in special cases, the individual self-regulatory organizations remained the primary focal point for professional governance. In addition, the Financial Services Act delegates authority for banking and public debt markets to the Bank of England and mergers to the Takeover Panel. (See Michael J. Mumford, Corporate Governance and the Cadbury Report; William Kay, The Big Bang: An Investor's Guide to the Changing City, 1986; Ian M. Kerr, Big Bang, 1986; and W. A. Thomas, The Big Bang, 1986.) |
Although similar to British practices in many respects, corporate regulation in the United States differs to the extent that government's role is far more pervasive and direct. Federal securities law enables investors to sue for damages in cases of agent malfeasance. Federal sanctions also provide professionals with leverage to countervail the improper intentions of aggressive clients. Finally, public perceptions that investors have not been protected might induce Congress to authorize more active intervention by federal agencies. The threat of such governmental encroachment on professional prerogatives provides a strong incentive for due diligence in practice. (P. J. Miranti, Accountancy Comes of Age, 1990, chapts. 8-9 passim.) |
Germany and Japan
In both Germany and Japan, post-World War II prosperity came initially from the expansion of the industrial rather than the financial sector. Consequently, their financial institutions remain less developed than those in Britain or the United States. The information systems that support corporate governance are calculated to satisfy a few dominant banking institutions rather than a broad, anonymous universe of investors. |
At the center of the German governance system are the leading banks (Hausbanks). The state's role is peripheral, being confined to the limited securities legislation passed by regional assemblies (Lander). The banks' dominance in finance derives in part from their ownership of substantial blocks of equity in both large and medium-sized public companies. In addition, trust departments of banks serve as intermediaries for investors who wish to maintain share portfolios. Moreover, because of the sparsity of information about corporate affairs and the thinness of equity market volume, few Germans own shares directly, preferring instead the less risky debt of public entities. |
The governance process is informed by two channels of corporate information. The more important one, from the perspective of the leading banks, is informal and privileged: information is transferred through interlocking directorates and reports rendered by specialized trustees or agents (Treuhander), who are engaged by the banks to monitor client business activities. (See David F. Lindenfeld, "The Professionalization of Applied Economics: German Counterparts to Business Administration," in Geoffrey Cocks and Konrad H. Jaurausch, eds., German Professions, 1800-1950, 1990, pp. 222-23; and Robert R. Locke, The End of the Practical Man: Entrepreneurship and Higher Education in Germany, France and Great Britain, 1880-1940, 1984, pp. 260-67.) The second channel is public, but less useful because of the underdeveloped state of German financial reporting. Financial statements issued by public companies are certified by a second category of professional agents, the Wirtschaftsprüfer, roughly equivalent to Anglo-American public accountants. (Walter, Battle of the Systems, pp. 17-23.) |
Although the leading banks also play a key role in Japanese finance, the relationship between these organizations and corporations and government differs from that of Germany. Japanese banks are the central elements in keiretsu, consortia of firms drawn together by cross-ownership of equity and by supplier relationships. Japanese banks not only maintain investment positions; they play a key role in the financial planning of the affiliated companies. The primary informational linkages are informal and private. They include communication through interlocking directorates and through the coordination of business plans of the group. As in Germany, relatively few investors are direct owners of equity because of the thin share float and the sparsity of reliable information about corporate affairs. |
However, government plays a much more active role in guiding corporate policies in Japan than in Germany. The Ministry of Finance (MOF) is the primary contact point between the government and the leading banks. Although information channels are often informal, they can also be highly effective. Recall the MOF's achievement in mobilizing Japanese financial institutions in stanching the October 1987 stock market decline. (Walter, Battle of the Systems, pp. 11-16; also see M. Y. Yoshino and Thomas B. Lifson, The Invisible Link, 1986; Eisake Sakakibara and Robert Alan Feldman, "The Japanese Financial System in Comparative Perspective," in Edwin J. Elton and Martin J. Gruber, eds., Japanese Capital Markets, 1990, pp. 27-54; and James E. Holder and Adrian E. Tschoegl, "Some Aspects of Japanese Corporate Financing," in ibid., pp. 57-80.) |
Innovation and long-term investment
The open Anglo-American markets are more conducive to innovation in finance. It is unlikely that either LBOs (leveraged buyouts) or conglomerates could have arisen in the German or Japanese markets because banks, the nucleus of economic interest, are held together by shareholding and by interlocking directorates. It is difficult for outsiders to acquire control of companies that are part of these broad groups. Witness, for example, the frustration encountered by U.S. investor T. Boone Pickens in his unsuccessful attempt at a hostile takeover of one of Toyota's main suppliers. (W. Carl Kester, Japanese Takeovers, 1991, pp. 254-60; and Walter, Battle of the Systems, pp. 15-16.) |
 | |
| |
Ironically, Anglo-American receptivity to financial innovation creates an unfavorable environment for long-term internal investment. The emphasis on maximizing investor returns by conglomerates and LBOs reflects the prevailing climate. Strong pressure for the growth of earnings induces managers to prefer projects that promise short-term payoffs. Long-term developments are inherently unattractive because delayed payoffs often seem like evidence of managerial opportunism or incompetence. Although this perspective has been perceived as an impediment to long-term investing, a recent study by the McKinsey Global Institute argues that it is one important factor explaining the much higher level of capital productivity (defined as the value of output produced by a dollar's worth of capital input) in the United States as compared with either Germany or Japan. According to this study American corporate managers are more discriminating in their selection of capital investment projects because of the stronger pressures exerted by investors for superior financial performance. (See "America's Fantastic Factories," Economist, June 8, 1996, pp. 19-20; and "America's Power Plants," ibid., p. 82.) |
On the other hand, governance practices in Germany and Japan do not produce a bias in favor of short-term investment since corporations there are not under intense shareholder pressure to maximize returns. The Germans and Japanese are more willing to tolerate long-term investment horizons because of the close integration of the interests of management, debt holders and equity investors. The most important investors are the leading banking institutions, which, besides being well informed about affiliates, function effectively as coventurers. Such circumstances enable managements to consider the merits of long-term development projects with little worry about losing control over the entity. |
In addition, the greater tolerance for the concentration of political and economic power that exists in Germany and Japan influences the costs of financial governance (H. Peter Gray, "The Influence of Financial Intermediaries and International Competitiveness," Weltwirtschaftliches Archiv 130 (December 1994): pp. 828-40). These national systems that are closely controlled by insiders have tended to devote fewer resources to the governance process than the outsider system that prevails in the Anglo-American economies. This seeming advantage, however, can be a drawback when trying to attract substantial amounts of foreign capital to domestic financial markets. |
The lack of transparency and prevailing patterns of governance weaken the attempts in Germany and Japan to transform their local markets into major centers of international capital. For example, it is difficult for outsiders to gather sufficient data to analyze corporate performance. This makes the accurate valuation of securities more difficult, which in turn encourages speculation based on rumors and inaccurate projections. Foreigners are reluctant to risk their capital, fearing insider trading on privileged information. There is also evidence of discrimination in favor of the larger clients of local brokerage houses. This was most prevalent in Japan, where important customers were reimbursed for trading losses on the Tokyo exchange in the 1980s. Finally, rules inhibiting corporate control by foreigners are a barrier to the free international flow of capital. These restrictions invite retaliatory actions by trading partners who follow more liberal policies. |
International convergence?
Patterns of governance and communication raise the question, Is there a likelihood of an international convergence of structures for financial ordering? In the United States the size of the portfolios of financial intermediaries enable them to exercise strong countervailing power in dealing with corporate management. Had pension and mutual funds not grown so large, the contractual view of the firm emanating from agency theory would probably have remained an inert academic artifact. What transformed finance was the leverage of these institutions to advance client interests. |
Yet in spite of institutional transformation, it is doubtful that U.S. practice will follow in the path of either the German Hausbank or the Japanese keiretsu. A major barrier is the deeply ingrained belief that great concentration of political or economic power is evil. Jefferson and Jackson, who shared a vision of an egalitarian society, expressed this prejudice in the early years of the republic. Such notions reconcile differences in a polity divided along regional, ethnic, national, political, religious, functional and other lines. Consistent with this perspective is the need for vigilance against the threat of a tyrannical plutocracy. Such an outlook partly motivated the federal intervention to control the great shifts of power and wealth in the rise of nineteenth century railroads and twentieth century conglomerates and LBOs. (See, for example, K.M. Davidson, Mega-Mergers, 1985, pp. 109-12; L. Galambos and J. Pratt, The Rise of the Corporate Commonwealth, 1988, chapt. 3; E.W. Hawley, The New Deal and the Problem of Monopoly, 1966, pp. 404-19 and 456-71; E.C. Kirkland, A History of American Economic Life, 1969, pp. 319-46; Arthur M. Schlesinger, The Age of Jackson, 1945; and M.J. Roe, Strong Managers, Weak Owners, 1995, chapt. 4.) |
The strong vested interest in the status quo of the investing public and the professional groups serving the financial markets is another deterrent to broad change. The public has no incentive to abandon institutional arrangements that ensure transparency of corporate financial affairs and afford protection against incompetency and fraud in financial dealing. In addition, a vast array of attorneys, accountants and other specialists depend on these governance structures to apply their professional skills. |
The most compelling issue in the recent history of U.S. financial governance is not whether there should be regulatory regimes; it is whether these regimes come within the purview of professional or governmental agencies and what the boundaries of supervisory authority are. Thus, in the mid-1990s, issues on the Securities and Exchange Commission (SEC) policy agenda include the evaluation of regulatory practices for the vastly expanded mutual fund industry and the sufficiency of corporate disclosure for innovative financial derivative contracts. (See, for example, "SEC Wants Mutual Fund Risk Disclosed," New York Times, September 27, 1994, D, p. 1.) Other critics warn of the limitations of contemporary accounting models and call for changes that would provide more useful insights into the nature of corporate affairs. (See, for example, Robert K. Elliott and Peter D. Jacobson, "U.S. Accounting: A National Emergency," Journal of Accountancy 172 (November 1991): pp. 54-58; and Robert K. Elliott, "The Third Wave Breaks on the Shores of Accounting," Accounting Horizons 6 (June 1992): pp. 61-85.) |
Toward the future
Although emphasis on the advancement of earnings in the U.S. corporate governance system has inhibited long-term investment, several factors promise a corrective to this problem. One is an exposition by scholars of the trade-off inherent in two competing views of the firm: the first stresses the importance of contracting for the division of cash flow between stakeholders; the second emphasizes the critical role of corporations as centers of industrial learning and progress. Heightened investor sensitivity to these issues might be achieved by widening the scope of corporate communications and increasing the detailed disclosure of the prospective costs, benefits and special issues associated with internal investment activities. Although more costly than current reporting practices, this would establish a clearer understanding of the enterprise's economic potential. It would also provide investors with a future-directed framework for evaluating managerial performance based on well-documented objectives. |
Alternatively, corporations could implement strategies for shifting developmental costs. One option is to contract with outside entities specializing in the development of a particular type of product. IBM, for example, has contracted with Cyrix Technologies for the design of a new line of computer chips and with Microsoft, Inc., for the development of its DOS operating system for small computers; both Pfizer and Becton-Dickinson have engaged specialized research enterprises like Oncogene Science Corporation to develop specialized diagnostic products. In addition, corporations might form joint ventures to defray developmental expenses and to share firm-specific skills. This was done by Dow Chemical and Corning Glass in producing fiber-optic cable. Another alternative would be joint business-government promotion of promising technologies. A highly successful precedent was the World War II programs that developed synthetic rubber, high-octane gasoline, penicillin, electronic computers and atomic energy. |
British governance began to incorporate some American practices during the 1970s and 1980s in response to malpractice litigation resulting from a number of corporate failures, for example, those of Guiness Peat, Polly Peck Stores, the Bank of Commerce and Credit International and Maxwell Publications. One response was the further extension by British chartered accountants of formal professional standards beginning in the 1970s. In 1992, the Cadbury Commission recommended that boards of directors include more external members who saw their role as monitors rather than as advocates of management. ("The Invisible Band," Economist, October 8, 1994, p. 81.) |
In Germany and Japan, on the other hand, two different reforms helped to create more vibrant financial markets with a capacity like that of London and New York for raising capital worldwide. In Germany the initiative bolstered the protection afforded shareholders. One aspect of this was the 1994 passage of a ban on insider trading. Another was improvement in the transparency of corporate affairs by standardization of accounting and disclosure practices. ("Insider Law for Germany," New York Times, November 4, 1994, D, p. 15; and "Bridging the GAAP," Economist, September 17, 1994, p. 89.) But progress is likely to come slowly in this case because of the difficulties of the European Union in resolving national differences in accounting professionalism. (Louis H. Orzack, International Authority and Professions, 1992, pp. 23-27.) Japan has emphasized increasing the direct access of foreign investment organizations to trading on the giant Tokyo exchange. This is a high priority because it defuses criticism of the closed nature of the Japanese economy and the persistence of enormous trade surpluses. Ultimately, however, Tokyo's position as an international center for raising capital will compel the Japanese to establish a reputation for financial transparency and probity. (Sensitivity to the need for reform is reflected in Jun Ikeda and Noriyasu Osawa, "A Summary of Reports by the Fundamental Research Committee of the Securities and Exchange Council," in Foundation for Advanced Information and Research, ed., Japan's Financial Markets, pp. 553-61.) |
|
| |
