Corporate Governance Outside the United States and United Kingdom Randall Morck University of Alberta Canada National Bureau of Economic Research National.

Corporate Governance Corporate Governance Outside theOutside the

United States and United Kingdom United States and United Kingdom

Randall MorckRandall Morck

University of Alberta University of Alberta CanadaCanada

National Bureau of Economic Research National Bureau of Economic Research Cambridge MA USACambridge MA USA

In Whom We Trust …In Whom We Trust …

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

ArgentinaAustralia

AustriaBelgiumCanada

DenmarkFinlandFrance

GermanyGreece

Hong KongIreland

IsraelItaly

JapanMexico

NetherlandsNew Zealand

NorwayPortugal

SingaporeSouth Korea

SpainSweden

SwitzerlandUnited

United States

Wealthy family Widely held non-financial firm Widely held financial institution

No controlling shareholder Government Other

Family Firms & Corporate PerformanceFamily Firms & Corporate PerformanceEmpirical studiesEmpirical studies

CanadaCanada Family firms perform worseFamily firms perform worse

ChileChile Family firms perform betterFamily firms perform better

DenmarkDenmark Family firms perform worseFamily firms perform worse

IndiaIndia Family firms perform betterFamily firms perform better

USAUSA Mixed evidence, but true family Mixed evidence, but true family

firms do worse than othersfirms do worse than others ““Definition” issues is some Definition” issues is some

studiesstudies

Standard LectureStandard Lecture

Professional Professional FamilyFamily▼▼

Agency problemsAgency problems

▼▼

Agency problemsAgency problems

▼▼

CEO’s career sets CEO’s career sets planning horizon?planning horizon?

▲▲

Legacy issues lead to Legacy issues lead to long term horizon?long term horizon?

▼▼

CEO trained at CEO trained at business schoolbusiness school

▲▲

CEO trained from CEO trained from infancy by familyinfancy by family

▲▲

Select CEO from Select CEO from whole gene poolwhole gene pool

▼▼

Select CEO from Select CEO from blood relativesblood relatives

▲▲

Business run as a Business run as a businessbusiness

▼▼

Family conflicts affect Family conflicts affect the businessthe business

▲▲

Junior managers can Junior managers can become CEObecome CEO

▼▼

Junior managers can Junior managers can never become CEOnever become CEO

Billionaire Wealth, by Source, per Dollar of GDP

0 10 20 30 40 50 60 70 80 90 100 110 120 130 140

South East Asia

Latin America

Western Europe

Israel

Canada

United States

Turkey

Japan

South Africa

India

United Kingdom

Australia

New Money Old and New Money Probably Old MoneyOld Money Political Family

Table 2 The Cross-Country Relationship Between Economic Growth and CapitalOwnership Structure Controlling for Current per Capita Income, CapitalInvestment Rate, and Level of Education

2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8Intercept 1.43 1.58 1.59 1.65 1.75 1.73 1.86 1.78

(..32) (.30) (.27) (.28) (.22) (.26) (.20) (.25)

Log of per capita GDP: ln(Y/L)

-1.76 -1.77 -1.80 -1.79 -1.54 -1.66 -1.62 -1.69(.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00)

Capital Accumulation Rate: I/K

.210 .216 .208 .214 .173 .199 .178 .199(.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00)

Average Total Years of Education: ln(E)

.238 .203 .253 .214 .242 .200 .259 .213(.27) (.35) (.23) (.32) (.24) (.35) (.21) (.32)

Business Entrepreneur Billionaire Wealth Over

GDP: B/Y

.440 .37 .42 .37 .495 .382 .45 .37(.00) (.00) (.00) (.00) (.00) (.00) (.00) (.00)

Heir Billionaire Wealth Over GDP: H/Y

-.292 -.168 -.268 -.157 -.407 -.191 -.33 -.17(.03) (.10) (.03) (.09) (.01) (.09) (.01) (.08)

Definition of “Heir”a H1 H2 H3 H4 H5 H6 H7 H8

R squared 0.519 0.488 0.531 0.489 0.545 0.491 0.536 0.491Note: Numbers in parenthesis are two tailed t-test probability levels for rejecting a zero coefficient. Coefficients inboldface are statistically significant at 90% confidence or more. Sample of 39 countries consists of the countrieslisted in Table 1 minus the U.K. and U.S. a H1 includes only the wealth of billionaires known positively to be heirs, politicians or politicians’ relations. H2

also includes the wealth of billionaires who are probably heirs. H3 includes H1 plus fortunes jointly controlled by afounder and his heirs. H4 includes all the above. H5 through H8 are analogous to H, H2, H3 and H4 but do notinclude politician billionaires and their relations.

Old Money Families and Old Money Families and Slow Economic Growth Slow Economic Growth

New Money Entrepreneurs and New Money Entrepreneurs and Fast Economic GrowthFast Economic Growth

Das KapitalDas Kapital Internal Contradictions of Internal Contradictions of

CapitalismCapitalism Competition Competition

Firms try to steal each Firms try to steal each others’ customers by others’ customers by cutting pricescutting prices

Economic profits fallEconomic profits fall

InvestmentInvestment Why invest if no profitWhy invest if no profit Investment fallsInvestment falls

The inevitable collapse ofThe inevitable collapse of

capitalismcapitalismKarl Marx

The Great ExperimentThe Great Experiment

Political leaders of the 20Political leaders of the 20 thth century ran a monumental century ran a monumental economic experimenteconomic experiment Socialism collapsed and Socialism collapsed and

capitalism prosperedcapitalism prospered Economic profits did not fallEconomic profits did not fall Investment did not fallInvestment did not fall Marx was wrongMarx was wrong Why?Why?

Creative DestructionCreative Destruction

Innovative firms have no real Innovative firms have no real competitors competitors For a while …For a while …

Innovators steal other firms’ Innovators steal other firms’ customers by offering customers by offering New, better productsNew, better products Old products made more Old products made more

cheaplycheaply

Non-innovative firms are Non-innovative firms are destroyed by innovatorsdestroyed by innovators

Innovators continue making Innovators continue making profits until more creative profits until more creative innovators destroy them innovators destroy them

Joseph SchumpeterA Theory of Economic Growth 1914

Corporate GovernanceCorporate Governance

Schumpeter argued that the ultimate purpose of Schumpeter argued that the ultimate purpose of financial markets is financing creative financial markets is financing creative destruction destruction There are two kinds of peopleThere are two kinds of people

Entrepreneurs (Ideas, no money)

Capitalists(Money, no ideas)

$

0% 25% 50% 75% 100% 125%

AustraliaAustria

BangladeshBarbados

BelgiumCanada

ChileColombia

CyprusDenmarkEcuador

EgyptFinlandFrance

GermanyGreece

Hong KongIndia

IndonesiaIran

IrelandIsrael

ItalyJapan

JordanKenya

Korea (South)Kuwait

MalaysiaMexico

MoroccoNetherlands

New ZealandNigeria

NorwayPakistanPanama

PeruPhilippines

PortugalSingapore

SpainSri Lanka

SwedenTrinidad & Tobago

TunisiaTurkey

United KingdomUnited States

VenezuelaZimbabwe

Stock Market CapitalizationRelative to GDP

(1996)

Lies, Damn Lies, and StatisticsLies, Damn Lies, and Statistics

The following are all strongly statistically The following are all strongly statistically correlated …correlated …Economic growth Economic growth New money wealthNew money wealthStock market activityStock market activityCorporate governanceCorporate governance

PuzzlePuzzleIf good governance and active stock markets If good governance and active stock markets

are so important to economic growth, why do are so important to economic growth, why do so many countries opt to do without them?so many countries opt to do without them?

There is a strange charm in the There is a strange charm in the thoughts of a good legacy.thoughts of a good legacy.

Miguel de Cervantes Miguel de Cervantes 

1547-1616, Spanish1547-1616, Spanish writer writer  

A man who dies rich dies disgraced.A man who dies rich dies disgraced.

Andrew Carnegie, Andrew Carnegie, American TycoonAmerican Tycoon

CultureCulture

AbilityAbility Intelligence is, at most, only party inheritedIntelligence is, at most, only party inherited

Political Rent SeekingPolitical Rent Seeking

TwoTwo sorts of investment sorts of investment1. 1. Creative destructionCreative destruction

Invest in new factory Invest in new factory profits profits After: Country has new factoryAfter: Country has new factory Positive externality: Country is richerPositive externality: Country is richer

2. 2. Political rent-seekingPolitical rent-seeking

Invest in politician Invest in politician profits profits After: Politician has a Swiss bank accountAfter: Politician has a Swiss bank account Negative externality: Whole country is poorerNegative externality: Whole country is poorer

Anne KruegerStanford University

How fast an economy grows depends on how it sets up the How fast an economy grows depends on how it sets up the relative profitability of these two sorts of investmentrelative profitability of these two sorts of investment

RegulationRegulation

““As the deer pants for As the deer pants for cooling streams, cooling streams,

so do I pant for regulation.”so do I pant for regulation.”

Alfred Krupp Alfred Krupp (1812-87), (1812-87), heir to the Krupp heir to the Krupp

steel &steel & armaments businesses armaments businesses

Old money wealthy are better at lobbying for Old money wealthy are better at lobbying for favorable regulations than at building efficient new favorable regulations than at building efficient new factories?factories?

Dynastic CapitalismDynastic Capitalism

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Part of Large Corporate Sector Family Controlled

Pre

va

len

ce

of

Fre

e M

ark

et

Pri

ce

s

Dynastic CapitalismDynastic Capitalism

2

3

4

5

6

7

8

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Part of Large Corporate Sector Family Controlled

Ab

sen

ce o

f Bu

reac

ratic

Red

Tap

e

Financial ReversalFinancial Reversal Old money wealthy fear ‘creative destruction’ and don’t really want an Old money wealthy fear ‘creative destruction’ and don’t really want an

active stock market?active stock market? They lobby forThey lobby for

Opaque corporationsOpaque corporations Weak governance standardsWeak governance standards

Or maybe it’s simpler …Or maybe it’s simpler … Ideological confusion?Ideological confusion? Just didn’t think of it?Just didn’t think of it?

Transparency & TrustTransparency & Trust

Source: La Porta et al. (2003)

Governance Standards & TrustGovernance Standards & Trust

Source: La Porta et al. (2003)

Good Governance ModelGood Governance Model

Large US and UK firms are: Large US and UK firms are: 1.1. Free-standingFree-standing

Publicly traded companies do not own stock in each otherPublicly traded companies do not own stock in each other

2.2. Widely heldWidely held Corporate managers own very little stock; most stock owned by Corporate managers own very little stock; most stock owned by

“widows and orphans”“widows and orphans”

Resulting governance (agency) problemResulting governance (agency) problem Hired managers spend “other people’s money” and Hired managers spend “other people’s money” and

so grow careless or self-indulgentso grow careless or self-indulgent

Minnesota Mining and Manufacturing

Public Shareholders

US Solutions?US Solutions?After Earlier ScandalsAfter Earlier Scandals

The SECThe SEC Dividend taxationDividend taxation BankruptcyBankruptcy Executive stock options Executive stock options Hostile takeoversHostile takeovers

The Current ViewThe Current View Sarbanes Oxley, etc. Sarbanes Oxley, etc.

Dynastic CapitalismDynastic CapitalismBut large US and UK firms are very atypicalBut large US and UK firms are very atypical

Large firms in most other countries are Large firms in most other countries are 1.1. Organized into business groupsOrganized into business groups

Publicly traded companies control each otherPublicly traded companies control each other2.2. Narrowly heldNarrowly held

Wealthy ‘old money’ families control large blocks of stock, Wealthy ‘old money’ families control large blocks of stock, directly or indirectly, and cannot be ignored by hired directly or indirectly, and cannot be ignored by hired managers managers

This difference is so fundamental to political This difference is so fundamental to political economy discussions that people in the USA and economy discussions that people in the USA and people elsewhere simply fail to comprehend each people elsewhere simply fail to comprehend each other's conceptions of how a free market economy other's conceptions of how a free market economy worksworks

Edper GroupEdper Group

OTHER SUB'S INHEES INTL.

Double-click to return to previouspage.

Double-click to proceed to the nextpage.

HEESINTERNATIONALBANCORP INC.

B.C. PACIFIC

BRLENTERPRISES

COLLINGWOODREAL ESTATE

DUNBARINVESTMENT

CORP.

FT CAPITALLIMITED

MORGANFINANCIAL CORP.

MORGANBANCORP INC.

KANANASKISRESORT

C.J. FOODSERVICES

52.4

100

100

35

48.6

100

100

100

DEXLEIGH CORP.

ALBEMONTARTICTIC

ALBEMONT LTD.

GOLDALEACCEPTANCE

CANADIANINTERCONTINENTA

L EQUITIES

CANADIAN CORP.SERVICES

CANADIANEXPRESS

PAGURIAN LTD.

LESTER & ORPENDENNYS

EDPERENTERPRISES

LTD.(HIL CORP. LTD)

EDPERHOLDINGS INC.

AXE CANADA

AMERICANRESOURCES

ENFIELDCANADIANEXPRESS

INVESTMENTS

REVELTEK CORP.

WESTFIELDMINERALS

NORTHGATEEXPLORATION

COMPLEX

TARXIEN

36 42.6

100

99.8

100

40

40

50 A

71.9 12

100

49 49

49.9 50

74.2

19.5

100

100

54.3

23.9

49

5148.9

46.7

100

41

A Governance Map of ChileA Governance Map of Chile

Corporate Governance ElsewhereCorporate Governance Elsewhere Wealthy families control firms indirectly, so Wealthy families control firms indirectly, so

they are also basically spending other they are also basically spending other people’s moneypeople’s money

One wealthy family controls a group of firms, One wealthy family controls a group of firms, and can direct one to lose money to help and can direct one to lose money to help anotheranother

Wealthy families cannot be dislodged from Wealthy families cannot be dislodged from control, even if the patriarch becomes senile control, even if the patriarch becomes senile or the heir is blatantly unqualified or the heir is blatantly unqualified

If very few families control most of the large If very few families control most of the large business sector, weak corporate governance business sector, weak corporate governance can become a macroeconomic problemcan become a macroeconomic problem

The Relevance of US Solutions? The Relevance of US Solutions? Sarbanes-OxleySarbanes-Oxley Independent directorsIndependent directors Independent chairIndependent chairBoard committeesBoard committees Institutional investorsInstitutional investorsProxy fightsProxy fights

All designed for Anglo-American

capitalism

Will any of this work in dynastic capitalism?

Back to basics?Back to basics?

Milgram, Stanley. Obedience to Authority. Milgram, Stanley. Obedience to Authority. New York. Harper and Row. 1974. New York. Harper and Row. 1974.

Stanley Milgram

Milgram Obedience Experiment

100

90

80

70

60

50

40 0 75 150 225 300 375 450

moderate strong very intense severe XXX

strong

Percent of Subjects still obedient

Voltage

Learner complains of pain

Learner pleads to be let out

Learner screams and

Refuses to answer

The Importance of Dissent

100

90

80

70

0 0 75 150 225 300 375 450

moderate strong very intense severe XXX

strong

Percent of Subjects still obedient

Voltage

Stranger steps in and expresses

disapproval of the experiment

Corporate Governance Solutions Corporate Governance Solutions Sarbanes-OxleySarbanes-Oxley Independent directorsIndependent directors Independent chairIndependent chairCommitteesCommittees Institutional investorsInstitutional investorsProxy fightsProxy fights

All encourage

dissent

Can this be done

in dynastic

capitalism?

Globalization? Globalization? Canada-US free Canada-US free

trade helped ‘new trade helped ‘new money’ firms and money’ firms and hurt ‘old money’ hurt ‘old money’ firmsfirms

Why?Why?New firms can New firms can

sidestep local sidestep local regulations?regulations?

New firms can New firms can raise funds raise funds abroad? abroad?

Table 10 Cumulative Abnormal Returns of Large Canadian Firms Upon the Newsthat the Canada-US Free Trade Would Be Ratified by the CanadianParliament

Controlling ShareholderCategories Compared

Mean Differences Mean Residual Differences controlling for firm age & sizea

heirs minusbusiness entrepreneurs

-.0993 -0.0729 -.0765 -0.0623(.03)15

(.04)23

(.12)15

(.10)23

heirs minuswidely held

.01347 .0260 .00034 .0188

(.37)24

(.26)37

(.50)24

(.33)37

heirs minusall other private sector firms

-.0317 -.0068 -.0316 -.0098

(.22)61

(.42)61

(.23)61

(.39)61

business entrepreneurs minuswidely held

.1128 .0989 .1328 .1271(.00)21

(0.04)28

(.00)21

(.02)28

business entrepreneurs minusall other private sector

.0802 .0767 .0916 .0857(.05)61

(.05)61

(.04)61

(0.04)61

Includes firms in pyramids no yes no yesNote: Categories are defined as in Table 3. Subsamples are smaller because we do not have stock returns for allfirms listed in that table. Numbers in parenthesis are probability levels from t-tests. Numbers below them aresample sizes. Boldface type indicates significance in a one-tailed t-test at 10%. The cumulative abnormal return isfor all trading days from November 10, the date of the first poll questioning the Liberal lead, through to November21 1988, the first trading day after a surprise Conservative majority government was returned. Cumulativeabnormal returns are returns minus the value weighted returns of all other firms in the 3 digit industry. Using equalweighting gives similar results. a This panel contains coefficients and p-levels for , a dummy variable set to one if the firm is in subsample 1 andzero if it is in subsample 2., in the ordinary least squares regression

CAR i 0 1log(agei) 2log(salesi) 3 i.zero if it is in subsample 2., in the ordinary least squares regression

CAR i 0 1log(agei) 2log(salesi) 3 i.

Table 13 Transition Matrix for Large Canadian Firms Relating ControllingShareholder Description in 1988 to Controlling Shareholder Description in1994

1988 controlling shareholder type(see left table margin for definitions)

Changesinto 1994Category1994 controlling shareholder type a b c d e f g h i j

a. heir 36 1 1b. business entrepreneur 18 0

c. no controlling shareholder (widely held) 4 4 47 2 1 5 3 4 23d. other individual or family 2 19 1 3

e. investment fund 2 1 3 2 1 1 7f. widely-held Canadian parent firm 1 1 6 1 3

g. foreign parent firm 1 1 1 42 1 4h. government 18 0

i. coop 1 1j. labor 1 1

k. bankruptcy 1 3 1 5l. acquired 3 1 1 5

m. unknown 1 1 2 4Total in Category for 1988 44 27 53 29 6 14 49 23 0 1

Sample is firms in the 1988 Financial Post 500 for which accounting and ownership data are available.

Bottom LinesBottom LinesUS solutions no good if your problems are US solutions no good if your problems are

different.different.The basic idea beneath a long sequence of The basic idea beneath a long sequence of

different reforms in the US, the UK, and other different reforms in the US, the UK, and other Western and Asian countries is to encourage Western and Asian countries is to encourage honest dissent. This is more universally useful honest dissent. This is more universally useful than the specifics of e.g. Sarbanes Oxleythan the specifics of e.g. Sarbanes Oxley

Globalization erodes the power of local elites, Globalization erodes the power of local elites, creating a window for genuine reform. creating a window for genuine reform.