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What Determines the Content of Corporate Governance Codes?

By Caroline Oliver interviews Carsten Gerner-Beuerle March/April 2016

CAROLINE: Can you tell me a bit about your background?

Carsten: I am an Associate Professor of Law at the London School of Economics and Political Science who conducted research on corporate governance, securities regulation, and law and economics and prepared reports on corporate governance and financial regulation for the European Commission and the European Parliament. One strand of my research on corporate law and securities regulation deals with the legal and nonlegal determinants of regulatory reform, the international diffusion of legal innovations, and the interrelationship between the regulatory environment and economic variables. I generally use a comparative and interdisciplinary approach. My current projects include analyzing the European Union (EU) harmonization program in company law and capital markets regulation to facilitate discussions about how regulatory authority should be allocated between the EU and the Member States to promote integrated markets and ensure efficient regulatory outcomes. I am also working on a comprehensive treatise on comparative company law that examines in-depth some of the main legal traditions of the world, compares the regulatory strategies employed, and explains the observed differences in historical perspective.

Caroline: What got you interested in the origins of corporate governance codes?

Carsten: Having worked on corporate governance for some time and teaching at LSE, I saw that corporate governance codes are very influential in creating what is seen as best practice for boards and others involved in corporate governance. It therefore seemed to me important to analyze how such codes are developed and lead to the dissemination of new techniques in regulating corporate governance in a changing political, economic, and legal environment.

Caroline: How did you go about your research?

Carsten: I analyzed 106 corporate governance codes of 23 European countries and tried to classify them according to:

  • the extent to which the drafting committee was dominated by representatives of the investment community, issuers' representatives, public regulators, or others. It is important to note that most codes are not legislative initiatives but private initiatives for example, by stock exchanges and industry bodies; and
  • the type of legal framework used by the relevant country.

I then looked at the provisions of the codes and analyzed them according to:

  • how prescriptive they are, and
  • whether they strengthen the position of outside investors

… in relation to a number of issues including:

  • independence,
  • board and board committee composition, and
  • separation of the roles of CEO and chairman of the board.

Caroline: What did you find?

Carsten: Certainly, some codes are more onerous and more prescriptive than others. For example, some specify the number of nonexecutive versus executive directors (senior managers) that should be on the board, whereas other codes use terms such as sufficient nonexecutives, leaving wide room for interpretation by individual boards. Some codes are clear that the roles of chair and CEO should be separated and, for example, specify a “cooling-off period” before a retiring CEO can become a chair. Others are much less prescriptive on such separation. In some codes what represents “independence” is spelled out (for example, the United Kingdom's code gives a list of criteria2). In other codes what is meant by the term is left much vaguer.

I had also thought that it was likely that we would find that the content of codes was heavily influenced by the composition of the committees that produced them. For example, I thought we might find that codes produced by committees with significant representation from investors would be more onerous and prescriptive than the content of codes produced by other groups. In fact, I found no correlation between composition of code-authoring committees and the code content.

However, I did find clear differences between different countries when grouped by legal families. By “legal families” I mean groups of countries that operate in accordance with different legal frameworks such as English Common Law, the Civil and Commercial Codes of France, or the German or Scandinavian systems. I also found differences related to the nature of typical corporate ownership—concentrated or dispersed, relative proportions of foreign and institutional investors.

Furthermore, I found that regulatory reform in corporate governance is significantly influenced by changes to international benchmark models of good governance.

It is remarkable that, although the probability of one country adopting a particular regulatory mechanism in a corporate governance code increases the more other countries have adopted a similar term, the amount of legal variance between European countries' corporate governance regimes has not significantly diminished. So in spite of much cross-border legal learning, the convergence of corporate governance regimes, defined formally as the lower variance of legal variables over time, has not yet occurred in Europe.

Caroline: How influential are corporate governance codes on practice?

Carsten: My research did not cover this, but certainly the number of codes is increasing around the world. The European Corporate Governance Institute's (ECGI) website3 makes available the full texts of corporate governance codes, principles of corporate governance, and corporate governance reforms both in Europe and elsewhere.

The United States does not have one major recognized corporate governance code, although they do have the New York Stock Exchange listing rules. Generally, the United States operates in a more rules-based manner when it comes to corporate governance and accounting. Codes tend to be more influential in other parts of the world where guidance based on principles is the preferred approach.

There is evidence that the compliance rate with the UK Corporate Governance code is very good when compared with that of other countries. We do know, from an annual survey of compliance by FTSE 350 companies carried out by Grant Thornton,4 that, in 2014, 94 percent of companies complied with all but one or two of the Code's 54 provisions, while 61 percent reported full compliance with the Code—an increase of 4 percent over 2013.

On the other hand, the relationship between high rates of compliance with corporate governance codes and firm performance is still unclear. And that link is never going to be easy to identify given the difficulty of separating out all the other factors that influence performance. However, there is some evidence showing an association between compliance with corporate governance codes and the proper functioning of certain corporate governance mechanisms within firms, such as compliance with disclosure regulation.

Caroline: Do you have any opinions or questions about the validity of the determinants of corporate governance codes that you found?

Carsten: It is heartening to find that, holding all other factors constant, group politics—one group trying to create corporate governance norms to advantage their interests over others' interests—is not what seems to be happening.

What does seem to be happening, holding all other factors constant, is that the more countries that have adopted a particular code provision, the more likely that other countries will adopt the same provision when introducing or revising their codes. Therefore, what seems to be important to authoring committees is what are the common perceptions in the wider world beyond themselves about what good corporate governance is and isn't.

Corporate governance codes therefore seem to be seen as important signals of best practice. Corporations in every country want to send out signals that they are well governed—good places to do business—and having corporate governance codes that measure up to those of other respected jurisdictions is one way of doing this.

One example of this in action is that the whole idea of “independent directors,” which was originally proposed by the Cadbury Committee,5 which created the very first national corporate governance code in 1992, now appears in nearly all codes. Another example is that one often finds code provisions that seem to have been copied from another code almost word for word.

It is as if everyone is measuring themselves against an internationally emerging standard—code authors think they need to do the same as everybody else in order not to be seen as substandard. It is a different question whether the drafting committee believes what they are calling for improves performance or is well aligned with the domestic legal and/or economic environment, but they seem to feel obliged to meet what is seen as a common standard.

This could be used to say that good corporate governance is more a matter of “groupthink” than anything else, but I will leave that for readers of Board Leadership and others to discuss.