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Peter A. Gourevitch & James Shinn

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"Peter Gourevitch and James Shinn brilliantly question the received wisdom about state regulation of corporate governance in this resolutely empirical and resolutely political book. They challenge arguments that countries can't change and that business dominates policymaking, showing that what determines a nation's regulatory system is the particular coalition that has emerged between workers, owners, and managers. This book should be required reading for students of corporate governance in the United States and beyond."--Frank Dobbin, Harvard University, author of Forging Industrial Policy: United States, Britain, and France in the Railway Age

"Peter Gourevtich and James Shinn are here onto one of the important inquiries of economic development today: To understand how the largest firms are run, why they are owned as they are in different nations, and what explains the variation-some nations with deep stock markets and some without. Much of the academic writing to date focuses on the economics of finance and the underlying legal structure. Get the law right, it's widely thought, and financial markets will flourish. Less attention has been paid to how, whether, and to what extent finance and law are both surrounded by a nation's politics; in short, why it sometimes is so hard to get the law right. Gourevitch and Shinn bring to bear on this subject today's thinking in political science, reaching closer to what seems to be where the basic causes of corporate governance variation around the world lie-not just in economics and law, but in political institutions and preferences."--Mark Roe, Harvard University, author of Strong Managers, Weak Owners: The Political Roots of American Corporate Finance and Political Determinants of Corporate Governance

"This seminal book underlines the vital political importance of corporate governance, a subject typically viewed only from legal and business perspectives. It will become a classic in political economy."--Peter J. Katzenstein. Walter S. Carpenter, Jr. Professor of International Studies, Cornell University

"Many comparative corporate governance studies like to pit bank-based systems against market-based systems, or civil-law against common-law countries. Gourevitch and Shinn make a compelling case that the reality of corporate governance is much too rich and complex to fit into these simple categories. They paint a fascinating picture of the evolution of corporate governance in Asia, Europe, and North America as driven primarily by changing political coalitions and ideologies, pension reform, privatization, and globalization."--Patrick Bolton, Princeton University, coauthor of Contract Theory

"A major contribution by leading scholars of corporate governance, this book brings together insights from economics, political science and law. Highly recommended for anyone interested in the relationship between governance and development, it sheds helpful new light on the key debate about whether and how legal origin is destiny."--Simon Johnson, Sloan School of Management, Massachusetts Institute of Technology

"Political Power and Corporate Control is the first serious, book-length political science treatment of the two-way interaction between corporate form and politics. There is nothing comparable."--Merritt Fox, Michael E. Patterson Professor of Law, Columbia University School of Law

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Political Power and Corporate Control

Princeton University Press

Chapter One

ENRON, WORLDCOM, TYCO, Adelphia, Ahold (a Dutch firm), Hollinger (Canadian), Vivendi (French), Parmalat (Italian)-these names have long been staples of the Financial Times and Wall Street Journal, but more recently they have become scandalous and exotic fare on news dailies and TV networks. Since the Enron scandal began in the fall of 2001, these firms, their bankruptcies, and their miscreant executives have become "above the fold" headlines and evening news clips.

In addition to providing entertainment, these examples of financial failure have graphically demonstrated that there is, in fact, what some delicately refer to as a "corporate governance problem." Scholars and media mavens alike frequently dismissed the corporate implosions that followed in the wake of the financial crises in the mid-1990s-mostly in Latin America and developing Asia-as a regional problem specific to the "crony capitalism" of developing regions. By the turn of the millennium, it became clear the problem was more widespread. Scandals of one kind or another were occurring around the world. At first, people saw Enron as a "one-off" case, a singular event caused by unscrupulous or incompetent people and requiring no special response. As more scandals emerged, however, it became clear that something deeper was at work.

This book is not about these scandals, but about the underlying structures of corporate accountability. We will not try to say why any specific individual abused trust, but rather are interested in the variance among systems of corporate governance around the world. There was a "corporate governance problem" long before Enron and Parmalat. Fiske and Gould were famous nineteenth-century American examples of stock manipulation, with counterparts around the world. Their behavior led to efforts, private and public, to protect investors. Those efforts are the central concern of this book.

Corporate governance is about power and responsibility. It is the structure of power within each firm that determines who allocates money: who gets the cash flow, who allocates jobs, who decides on research and development, on mergers and acquisitions, on hiring and firing CEOs, on subcontracting to suppliers, on distributing dividends or buying back shares or investing in new equipment. Corporate governance is also about accountability: who takes the blame for corruption, misuse of funds, or poor performance.

Corporate governance systems reflect public policy choices. Countries pass laws that shape incentives, which in turn shape governance systems. Some countries have rigorous prohibitions on insider trading, vigorous markets for control, strong protection of minority shareholders (rules on accounting, corporate boards, securities), and effective rules for product-market competition and antitrust. These countries have diffuse patterns of share ownership and managerial supervision through boards elected by their shareholders. Other countries encourage block-holding by allowing pyramid leveraging and cross-shareholding, restricting markets for control, limiting competition, and offering weak protection to minority shareholders.

Such different regulatory policies concerning corporate governance turn on political differences among countries-on the interest groups that press for one set of rules or another and on the political institutions that aggregate preferences to produce policies. This book is about choices of corporate governance in countries around the globe. We make extensive reference to the United States, where the give-and-take of interest groups as they press their preferred arrangements for corporate accountability has been particularly visible. American political processes produced the Sarbanes-Oxley bill of 2002, the most extensive U.S. reform of rules on corporate governance in several decades.

Indeed, politics explains the great U.S. "reversal" in corporate governance. In the late nineteenth century, the U.S. system resembled those of Europe: large "trusts" or oligopolies were controlled by shareholder blocks in the hands of individuals and banks; minority shareholder protection was weak, insider trader scandals common. Then laws were passed: the Sherman Antitrust Act in 1890, several laws following the 1905 Armstrong Commission on the insurance industry, the Glass-Steagall Act on banking in 1933, the Securities and Exchange Act of 1934, and now Sarbanes-Oxley of 2002. It is this legislation, regulatory structure, and their enforcement that changed corporate governance in the United States.

In the United States, interest groups fought over these laws and regulations: owners; investors as outsiders and investors as insiders; workers as employees and workers as pension fund holders; managers of various kinds; the so-called reputational intermediaries consisting of accountants, lawyers, bond-rating agencies; and institutional investors. These groups fought through political institutions whose structure influenced the outcome: the separation of power between the U.S. Congress and the presidency, federalism, political parties, and electoral laws.

These elements of politics-interests, institutions, and political conflict-are in play all over the world. In Korea greater democratization in the 1990s broke the link between the big firms (chaebols) and the authoritarian government, leading to rules for greater transparency and accountability in corporate governance, backed by a coalition that included labor, previously excluded businesses, and regional reformers. In Germany, the various political parties have been battling over legislation that would create markets for control, shareholder rights, and transparency; contrary to most expectations, it is labor and the Social Democrats who are often on the side of the external investors, while the conservative Christian Democrats defend the established insider system preferred by managers and inside blockholders. In Italy, the Parmalat scandal, in France, the Vivendi controversy, and in the Netherlands, the Ahold case have all pushed issues of governance to the fore. The financial crisis of 1997 exposed weaknesses in governance mechanisms for several countries in Asia, particularly in Korea, Thailand, Indonesia, and Malaysia. In Europe, disagreement on takeover legislation and a variety of other measures has slowed development of European Community-wide policies on corporate governance.

WHY FIGHT ABOUT CORPORATE GOVERNANCE?

That corporate governance provokes political debate should not surprise us. Corporate governance-the authority structure of a firm-lies at the heart of the most important issues of society. That authority structure decides who has claim to the cash flow of the firm, who has a say in its strategy and its allocation of resources. As such, corporate governance affects the creation of wealth and its distribution into different pockets. It shapes the efficiency of firms, the stability of employment, the fortunes of suppliers and distributors, the portfolios of pensioners and retirees, the endowments of orphanages and hospitals, the claims of the rich and the poor. It creates the temptations for cheating and the rewards for honesty, inside the firm and more generally in the body politic. Corporate governance influences social mobility, stability, and fluidity:...