Why corporate governance becomes a headache of the new era?

The word corporate governance becomes the focus of the public recently, not only because of the rapid development of the capital market, but also due to the high-profile collapse like Enron Corporation and Worldcom.

When the stock market was born in the world, buyers and sellers of corporation stocks are mostly individuals. Companies listed in the stock market aimed at the capital dispersed among the individuals, say the wealthy businessmen. But with the growth of the stock market, the buyers and sellers who are always pursuing the largest profit with the lowest risk possible grouped themselves together, formed some interest-common institutions. These institutions could be pension funds, mutual funds, hedge funds, insurance companies and banks. The appearance of the institutional investors enforced the regulation of the stock market on the one hand, because of the remarkable increase of the capital power in comparison with the listed companies. The improvement of the regulations encourages more and more individuals begin to invest in the stock market. But on the other hand, a large majority of individuals turn over their funds to professionals to manage, thus, these funds turned to be institutional investments in the benefit of the individual investors.

Once the balance of the powers is broken, inevitably, there will be some victims. Today, the institutional investors are so powerful that almost all of the large corporations are owned by large institutions. Generally, the principle shareholders, who usually invest both their money and emotion in the company, choose the board of directors. And Board is in charge of the high-level executives of the company, they can hire and fire the president of the company according to actual performance of the company. But the problem is that the actual shareholders rarely care about whether the CEO is the director of the Board or not, and that make it more difficult for the institutional investors to fire the CEO if the performance of the company is not satisfying. Fire a high executive became both time and money costing for the institutional investors because of the golden handshake (also known as golden parachute). Sacking the boss could be a way out to solve the performance problem, but what we often see is that some executives cash their golden parachute and leave their companies lost millions and thousands workers lost their jobs.

Furthermore, in order to disperse financial risks, the largest institutions usually invest in a large number of companies with their sufficient liquidity; therefore, it becomes even more difficult for investors to know what a particular company is exactly doing.

What’s more, thanks to the convenience of the Internet transaction, the appearance of the casual participants in the capital market brought the sale of derivatives to a highly welcomed level. And for investors, their interests are merely related to the performances and fortunes of the corporations.

Besides these reasons for the corporate governance problems for the Anglo-American companies, for the German-Japanese ones, although their capital markets are more rigid than the Americans and seems easier to take under control, they have their own pitfalls. Cross-holding, which means the holding by one corporation of shares in another firm, largely based on the family owned large consortium has threatened heavily by the cronyism and nepotism which has been well proved by the Asian financial crisis. Due to the globalization of the capital market, the Anglo-American equity culture also transformed the German bank model of corporate governance and not surprisingly, it then influenced a lot in the developing countries in east Asia.

Thus, corporate governance issues became the headache and are receiving attention in both developed and developing countries. It is quite clear that without a sound regulation system advance with time, a company’s corporate governance problem will both affect its economic performance and its ability to access long-term and low-cost investment capital.