KWR International Advisor #12 December 2001

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(The views expressed here are solely those of the author and do not express those of Dresdner Kleinwort Wasserstein, where he is the Director of Corporate and External Affairs. Mr. Hartzell had previously worked as a Deputy Comptroller at the Office of the Comptroller of the Currency in Washington, D.C.).

We are currently living through a tidal wave of interest in the forces of corporate governance. This has much to do — at least in the United States — with the prominent and increasingly activist role of institutional fund investors as corporate shareholders, bent on securing top performance from their investments. An aggressive shareholder demand for corporate responsiveness has spilled over into other countries, as fund managers have diversified their portfolios internationally and set an example for local investors elsewhere.

But there is also an international public interest in good corporate governance that intersects in many ways with what the investor and corporate communities are pursuing. This is especially the case for financial institutions and their public sector supervisors, regardless of whether those institutions are widely-held stock companies of interest to professional asset managers.

Internationally active financial institutions find themselves particularly challenged by the need to promote a corporate governance ‘tidal wave’. First, they must work hard to understand, and adapt strategies and operations to, a great diversity of national practices, traditions, laws, regulations, and political and market structures. And second, their possibilities for implementing an American style of "good corporate governance" are often constrained in a given context or a given country by legal, cultural, economic, or even purely logistical factors.

Some institutions do a better job of pressing ahead than others. But all of them, because they must have some kind of dialogue with their supervisors, shareholders, and other ‘stakeholders’, have the possibility to accelerate international awareness of good corporate governance practice. Over time, this awareness can force public authorities and business leaders in different countries to recognize where their policy and practice may fall short, and give them incentives to do better.

Despite all the discussion and analysis that we encounter these days, succinct definitions of corporate governance are not easily found. Before offering one definition — let me precede it with a brief bit of history.

According to Norman Veasey, Chief Justice of the State of Delaware, the concept of corporate governance began in the U.S. early in this century when a number of states, most notably Delaware, passed "enabling statutes" known as general corporation laws. These created a legal framework in which stockholders invested in corporations — becoming owners — which were separated from the managers of those corporations. Board of directors were formed which included managers and the officers they hired. Over time it was held that boards had fiduciary duties of loyalty and care in the wise management of the corporation in the best interests of its owners. A key element in this was the independence of directors from undue influence by interested parties at the expense of the corporation’s welfare.

In the 1930s and in the aftermath of the stock market crash, there was something of a public debate over the evident inability of shareholders, often small and widely dispersed, to assure that boards and their appointed managers were in fact operating in the best interests of owners. Flash forward to the 1980s and you will recall, perhaps vividly, the climate of excitement and controversy surrounding the wave of hostile takeovers, leveraged buyouts, management buyouts, junk bond financing, ‘poison pills’, and the general merger frenzy of those days. With shareholder interests again at issue, the corporate governance debate revived and large institutional investors began to be heard.

In the 1990s, it has been primarily these institutional investors in the form of pension and retirement funds — along with the legal, accounting, and consulting professions — who have driven the development of concepts of corporate control and accountability. Their main focus has been on the role of the board of directors and more particularly, those directors who are not also senior executives of the corporation, i.e., the outside directors.

At the same time, for U.S. banking institutions and their supervision by public sector regulatory authorities, there has been a very distinct shift over the last two decades to a supervisory approach based effectively on corporate governance — the accountability by boards of directors for the condition and performance of the bank. While the ultimate objectives of bank supervisors are somewhat different from those of bank shareholders, many of the precepts and tools are the same.

There are also other groups of interested parties, in addition to shareholders and regulatory authorities, who have a stake in the sound management of a corporation. These may include creditors, employees, customers (including, for banks, the special category of depositors), government policy-makers, and even the general public. All of these groups are represented by the term "stakeholders", those whose interests could be materially affected by good or bad corporate governance.

With so many groups and different viewpoints, trying to find a comprehensive definition of corporate governance may be dubious. Nevertheless, I prefer one suggested by former colleagues in the staff of the Basle Committee on Banking Supervision, the international committee of bank regulatory authorities sponsored by the Bank for International Settlements. In their formulation, "corporate governance is defined as the system of rights, processes, and controls established internally and externally over the management of a business entity with the objective of protecting the interest of all stakeholders."

That may seem too broad to be practical, but it does convey the reality that different stakeholder groups will focus on different criteria and elements in deciding what makes up good corporate governance as they see it. For example, shareholders probably attach greatest importance to maximizing the market value of company shares on a sustained basis. They will look for devices, primarily strong board oversight of management, independence of boards from the influence of insider and other special interests, and accessibility of boards to shareholders, to protect that possibility. Policies to control excessive board and management compensation also play an important role here. Of course, not all enhancements to a corporation’s intrinsic or book value are necessarily reflected in the market price of its shares — which can present a shareholder-conscious management with difficult business decisions from time to time.

A bank regulator’s corporate governance view, on the other hand — while it might include a secondary interest in the share price in terms of an institution’s greater or lesser ability to raise capital, or how the market perceives the bank’s quality — is relatively more focused on bank policy and operational issues. These might include whether there is demonstration of a strong board commitment to effective risk management and internal control systems; or whether the board has the will and skill to correct serious problems, once detected. This supervisory point of view is well represented in the excellent corporate governance guidelines from the BNA. You may have noticed that, as a supervisory policy document, the guidance notes make very few references to shareholder issues.

Yet another perspective comes from the general public, which wants to be sure the corporation treats customers fairly and has sensitivity to its impact — socially, environmentally, fiscally — on the local community. And corporate employees, for their part, want assurance the company will compensate them properly, provide opportunities for advancement, offer training and career development assistance, and help with their retirement planning.

All of these responses to stakeholder expectations or needs are examples of some kind of good corporate governance. They actually appear in some formal statements of corporate government policy by large business entities like Philip Morris and General Motors. They make the point that "corporate governance" is a fairly elastic concept, with a multitude of practices and guidelines that respond to the concerns of particular groups.

At the same time, there are elements that can be distilled from the various concepts and are commonly recognized, at least in the U.S., as indicating a company’s strong commitment to good corporate governance. These include:

All of this can reduced to one sentence: although good corporate governance generally begins with a strong, independent board of directors, there is a lot more to the story, in terms of policies, systems, and performance.

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin, Uwe Bott, Jonathan Lemco, Jim Johnson, Andrew Novo, Joe Moroney, Russell Smith, and Jon Hartzell