In this article we will discuss about:- 1. Introduction to Corporate Governance 2. Market and Financial Indicators of Corporate Governance 3. Mergers and Acquisitions (M&A) 4. Corporate Governance Environment 5. European Union and Corporate Governance.


  1. Introduction to Corporate Governance
  2. Market and Financial Indicators of Corporate Governance
  3. Mergers and Acquisitions (M&A) of Corporate Governance
  4. Corporate Governance Environment
  5. European Union and Corporate Governance

1. Introduction to Corporate Governance:

Continuous and Systematic efforts have been made to classify the panoply of corporate governance mechanisms in the industrialised countries. Although these systems are the result of national traditions and legislation, including taxation rules, some global classifications seem feasible.


Commonly used is the distinction between the outsider and insider systems, proposed by Franks and Mayer (1992). The former, currently dominant in the UK and the US, is characteristic of economies with a large number of quoted companies, a liquid capital market where ownership and control rights are frequently traded, and little concentration of shareholdings.

The so-called insider system, attributed to continental Europe and Japan, is characterised by a small number of listed companies, an illiquid capital market where ownership and control are not frequently traded, and a high concentration of shareholding in the hands of corporations, institutions, families or government. The outsider system relies on the market and outside investors for corporate control; the insider model uses a system of interlocking networks and committees.

The problem with that definition is that there are no ‘systems’ that are different to such an extent as to explain the various factual phenomena. The fact that there are more large holdings in one country than in others is rarely, if ever, the consequence of a ‘system’. The differences are in reality of degree only. The systems classified as insider, for example, are too divergent to be considered in one category. Each of the continental European systems has to a different extent some elements of the outsider system.

From a legal point of view, some are very close to the English system, but are at the same time very different in the development of financial markets. On the other hand, two of the most closed systems, Switzerland and Japan, have a large number of domestic listed companies and a high stock market capitalisation. Citing Germany and Japan as examples of the insider system is also rather problematical. Both might have some similar mechanisms of control, but their dissimilarities are even greater.


A distinction along the lines of outsider/insider strengthens the popular views of different systems. The myths about the German corporate governance system are commonplace but do not seem to correspond with reality, as was illustrated in a recent book by Edwards and Fischer (1994). According to their findings, there is no evidence to support the view of the house-bank relationship, whereby a single bank provides all the loans to a firm, or the relationship between a bank’s voting power and its supervisory board representation.

Certainly, the average capitalisation of European stock markets is low, but other elements influence its importance. A political- ecological perspective on corporate-governance systems might prove more useful. An ecological perspective sees a corporate governance system as being embedded in a rich web of mutually dependent and interactive relationships.

A corporate governance system has to be understood and studied in the political and economic environment in which it developed. An efficient model can be designed in theory, but each time it will have to be adapted to local conditions and the political decisions of the society in which it operates. The importance of the market in the governance of corporations is dependent on other elements that influence its role.

As the main element explaining the importance of capital markets, this report will examine the structure of share- ownership. Some basic market and financial data on the importance of capital markets, the occurrence of mergers and acquisitions, and the structure of the financing of industry will first be compared.


2. Market and Financial Indicators of Corporate Governance:

Stock Markets:

Despite increasing globalisation and the integration of European markets, the relative size of stock markets in EU member states still differs widely. By the end of 1993, stock market capitalisation as a percentage of GDP ranged from 132% of GDP in the UK and 61% in the Netherlands to 25% in Germany and only 13% in Italy. The number of domestic listed companies ranged from 1,927 in the UK to 664 in Germany, 726 in France and 242 in Italy.

Overall, the average stock market capitalisation in the EU, expressed as a percentage of GDP, falls far below the levels registered in Japan and the US. By the end of 1993, the EU 15 had a stock market capitalisation of only 44% of GDP, compared to 73% in Japan and 83% in the US (NYSE and NASDAQ).


Excluding the UK, the average stock market capitalisation amounts to 29% of GDP or 30%, including the three new member states. Countries like Sweden and the Netherlands are notable exceptions. Neither is known to have especially transparent or open corporate governance mechanisms, but their stock market capitalisation is much higher than that of other continental European countries. This is even more the case in Switzerland.

The number of domestic listed companies in the EU, especially when those of the new member states are added, comes closer to the figure for the US, NYSE and NASDAQ taken jointly. The difference within the EU, however, between the UK on the one hand and the other member states on the other is great.

3. Mergers and Acquisitions (M&A) of Corporate Governance:

One might expect that the more important are stock markets in the trading of control rights in a given country, the more important might be the takeover activity. This correlation does not seem evident, however, from data on the nationality of firms in mergers and acquisitions in the EU for the period 1991-94.


Classification by nationality of the purchasing firm shows British and French firms being the most active in the take-over market in this period. British companies dominated with an average share of 29.8% in total cross-border mergers and acquisitions in the European Union. French firms followed with a share of 21.5%, and German and Dutch companies occupied the third and fourth place with 17.6% and 10.5%, respectively.

A breakdown according to the nationality of the targeted corporation in take-overs shows Germany playing the largest role. In fact, German companies were much more often the object of foreign take-overs than they were the initiator, which was due to the privatisation process in East Germany. A negative balance was recorded in six member states, including the four Mediterranean countries.

Financing of Industry:

Although a certain convergence can be discerned over time, patterns of corporate financing show substantial differences compares the own-funds ratios of six EU member states, on the basis of consolidated balance-sheet data of the non- financial industry states (BACH data).


Generally speaking, it reveals the differences between countries where industry predominantly finances itself through the issue of equity securities, with high own-funds ratios and by other means, such as debt or internal reserves. Generalisations about differences between continental versus Aiglo-American systems, however, are not justified. Not only does the UK have a high own-funds ratio, but so does the Netherlands and in recent years, Spain. Overall, the differences between low and highly leveraged countries are becoming less pronounced.

Furthermore, although BACH data are processed according to harmonised procedures, they should be considered with care. The Deutsche Bundesbank (1994) investigated the reason for the persistently low own-fund ratios of West German enterprises, as revealed in their consolidated corporate balance-sheet statistics, and found that they do not differ significantly once some important methodological discrepancies are eliminated.

In a comparison of four EU countries (France, Germany, Italy and Spain), it found that the national balance-sheet data, used for the BACH data bank, differed considerably in legal form, total amount and sectorial distribution of enterprises covered, the own-funds definition used, and in the accounting principles employed. These differences generally have the effect of presenting a weakened German capital base, compared to the other countries.

The form of enterprises covered for France, Italy and Spain includes almost 100% limited-liability corporations, whereas in Germany, one-half of the data consists of partnerships and one- person companies. Accounting rules also show major national differences, diluting the own-funds in the German case. If the data are adjusted and methodological differences eliminated, the average German own-funds ratio amounts to 30% for the period 1981-92 a result that is comparable to the other countries of the sample.


The Deutsche Bundesbank argued that the result would be similar if other European states were included in the analysis, for example the UK, and, it particularly noted, if the German method of accounting for occupational pension provisions (the book reserves) were to be adapted to the English method. Occupational pensions in Germany are invested in the sponsoring enterprise and are shown as provisions on the liability side of a company’s balance sheet, whereas they are kept in a separate fund and capitalised in the UK.

In our example, taking provisions out of liabilities increases the own-funds ratio of German companies by 7 to 8 percentage points — to a level of 32% in 1991. Balance sheet provisions are on average four times higher in Germany than in the other countries studied.

4. Corporate Governance Environment:

Shareholding Structures:

Fundamental differences in the shareholding structure in European countries are the key to explaining the variations in the importance of their stock markets. The largest share owners of quoted companies in the UK are the institutional investors (pension funds, insurance companies, banks and unit trusts), which possess an average equity of 59%. Households are the second largest group in the UK with 19%, and industry (including investment trusts) owns 4%.

In Germany, on the other hand, the situation is rather the reverse- industry is the largest owner of quoted companies with 42%, institutional investors possess a much smaller part with only 15% (of which banks hold 10%) and households possess 17%. Households — in these case families — are the most important owners of quoted stock in France and Italy.


Government is the second most important shareholder of quoted companies in Italy with 27%. No reliable data exist for the other EU member states not shown in the table. Only Sweden has a system in which ownership data are constantly followed by the stock exchange authorities.

Seen in comparison with the US and Japan, the dominating role of institutional investors in the UK is fairly exceptional. Foreign investors, on the other hand, are of minor importance in the US and Japan.

Over the time, a strong growth can be noticed in the shareholding by institutional investors in several European countries. In Germany, the pattern of share ownership by industry remained constant over the last 30 years, whereas shareholding by private investors and government decreased, and institutional and foreign investors increased their share.

In the UK, institutional investors strengthened their position significantly in the stock market over the last 30 years. Whereas their share was 19% in 1963, it went up to 59% in 1993, and the share of individual investors declined to 19%. Foreign investors increased their share to 16%.

France shows a similar decline in ownership by households over the last 15 years and an increase by foreign investors. The stake of industry and institutional investors remained stable. The overall data for France, including the non-listed companies, show a much greater decrease in government share-ownership, namely from 22 to 4%. This figure severely understates reality as many nationalised companies are not included.

The Nordic countries also show a general increase in foreign ownership and a decline in household share ownership. In Norway, for example, foreign ownership increased from 18.2% in 1984 to 28.3% in 1993, while private ownership decreased from 26.9 to 11.4% in the same period.


Differences in concentration of ownership are substantial in the EU. Single majority stakes account for about 60% of total stock market capitalisation in Italy, compared to about 5% in the UK, the US and Japan. The largest five shareholders hold on average 87% of outstanding shares of listed companies in Italy, compared to 41% in Germany, 33% in Japan, 25% in the US and 21% in the UK.2

Legal and Board Structures:

All of the member states of the Union have comparable legal structures for limited liability companies. A limited liability company is a separate legal entity owned by an individual or an association of individuals who own the firm and share in its profits according to the proportion of the company’s capital they own. Their liability for the company’s debt is limited to the share they contributed. Limited liability companies can be subdivided into private and public limited companies, in which the former may not, but the latter may, offer their shares for sale to the general public.

Corporate governance problems will, thus, most likely occur in public limited liability companies, since ownership can be transferred without restrictions and is divorced from management. Such companies are subject to additional administrative requirements.

Public limited liability companies in the EU differ in minimum capital requirements, the structure and composition of their boards, and the responsibilities of the assembly of shareholders. Most EU countries have a one-tier board structure, where responsibilities are shared between representatives of management (executive directors) and representatives of the shareholders (non-executive or outside directors).

In principle, the latter are appointed because of their wisdom, experience and contacts. In a two-tier structure, the management board is subject to and nominated by a supervisory board, composed of non-executive directors. This type of structure is in place in Denmark, Germany, and the Netherlands, and is optional in France, Portugal and Spain.


The former three countries also give employees, or their representatives, seats on the supervisory board, a practice that is best known in Germany, where employee representatives can occupy up to one-half of the seats on the board, in the case of corporations with more than 2,000 employees. The practice of appointing employee representation on the board is also current in Sweden and optional in France.

The board of directors, or the supervisory board in case of the two-tier board structure, is in most countries appointed or approved by the assembly of shareholders at the annual meeting (AGM). The notable exception is the Netherlands, where the supervisory board elects itself and can therefore be self-perpetuating. The other principal tasks of the AGM include the approval of the accounts and dividends, the (re)appointment of auditors, the issue of shares and the agreement on by-laws.

Regarding the composition of the supervisory boards in Germany, aggregate data of the 100 largest German enterprises indeed show that the single most important group comprises trade union and employee representatives, who possess close to one-half of the mandates. Representatives of industry are the second-most important group with 25% of the seats, whereas banks and other financial companies occupy only slightly more than 10%.

The total number of bank representatives on the board is furthermore decreasing on a continuous basis. Data on the background of the non-executive directors of UK banks show that a great majority of them (80%) are company chairmen, chief executives or directors.4 In France, 25% of the board seats in the 100 largest enterprises are occupied by civil servants.

Accounting Rules and Regulations:

Accounting regulations establish a series of rules for the reporting of a company’s financial state and flows, with a view to giving a ‘true and fair view’ of its financial situation. The results are given in the annual balance sheet and the profit and loss account, and presented to the annual assembly of shareholders for approval. Apart from the shareholders, lenders, employees, clients and tax authorities also take an interest in company accounts which must be certified by the company auditors.


Two broad national traditions can be distinguished in accounting practices- countries in which the accounting process is driven by the needs of financial markets and those in which it is primarily driven by law—the former being mainly the English-speaking countries (and to a certain extent the Netherlands), the latter including most countries of continental Western Europe.

In the former grouping, the interpretation of a ‘true and fair view’ will be based on whether the accounts convey information of an adequate quality, in accordance with the currently accepted standards and practices developed by the profession. In the latter, it will be based on compliance with statutory requirements.

Generally speaking, legal prescription leads to more rigorous methods of reporting and tends to avoid soft information, such as current values, which is of particular relevance to financial markets.

An illustration of the scope for manoeuvre under different accounting systems. It was drawn from a case- study in which practising accountants from different countries were asked to prepare the profit and loss accounts of an international company.

They were instructed to perform this task on the basis of three different sets of accounting rules- the one most likely to be followed by companies preparing accounts in their country; one using acceptable alternative assumptions that would result in the net profit being as high as possible; and one using alternative assumptions that would result in the net profit being as low as possible.

As seen, comparable performances may be reflected in reporting profits within a range of 85 points for Germany and 12 points for the UK. A large discretionary margin can, other things being equal, be assumed to entail supplementary powers for management. The elements that most commonly cause differences are the depreciation of goodwill and the valuation of stocks.


5. European Union and Corporate Governance:

The above data and discussion have already suggested that further convergence and harmonisation have yet to occur to achieve a true single market. The question, however, is where are policies actively needed to eliminate distortions and where might convergence occur naturally through market forces? The EU has come a long way from the total harmonisation approach that dominated the 1970s. This approach did not succeed and resulted in years of obstruction on proposals in the Council of Ministers, or in heavy compromises and texts with many exceptions and derogations.

The method followed with the single market programme of 1985 was one of minimal harmonisation of essential rules and mutual recognition of additional requirements. Market forces would do the rest. It lead, together with the easing of the decision procedures through majority voting, to an impressive package of legislation, whose harmonising effects are only starting to emerge.

In the area of corporate governance in the strict sense, progress on the harmonising legislation was limited, compared to the overall rate of adoption of single market measures and achievements in other areas. On the one hand, harmonising legislation deeply affects areas that are considered to be an essential part of national economic and social traditions.

Setting rules on company structures and employee participation has a much greater impact on national systems than does legislation that harmonises rules for food labelling or additives. On the other hand, distortions caused by non-harmonisation of corporate governance rules are much less evident.

Differences in accounting systems and company structures do not distort free movement of goods or services directly, but may have an impact on the free movement of capital. The debate over whether the EU should enact harmonising legislation in this area, in the terms of the subsidiarity principle, and what instruments should be used, is highly relevant.

Nevertheless, the achievement of a single market in other sectors will not only highlight the shortcomings in other areas, such as company law, but it will also have a strong impact on the convergence of corporate governance standards, most importantly through financial market integration. What the EU has done will hereafter be discussed under two different headings: policies that affect corporate control directly, i.e. the harmonisation of legal forms of corporate organisation and control, and policies that have an indirect impact, that is, measures in the financial and social fields.