Convergence and Divergence in Corporate Governance
The increase in globalization as corporations venture into new economies has led to the adoption of foreign corporate practices and the modification of the local policies. Convergence refers to where the corporate practices become similar in the legal and institutional framework (Yoshikawa and Rasheed, 2009, p. 393, p. 389). The integration of the financial markets facilitates convergence because foreign shareholders pressure the management to implement policies borrowed from their home country. Competition in the product markets due to globalization forces companies to adopt efficient policies to maintain competitiveness. However, the convergence faces various impediments that inhibit the homogenization of organizational practices. The barriers to the convergence of corporate practices include the economic nationalization where a country has certain accepted norms, and the local governments are unwilling to adopt foreign ideologies (Yoshikawa and Rasheed, 2009, p. 393). Additionally, the lack of consensus on ideal practices deters the homogenization of governance practices resulting in different systems of leadership. Nevertheless, the convergence of corporate practices is evident despite the prevalent impediments to the overlapping of leadership practices. It is, therefore, vital to understand the factors behind the unanimous application of corporate practices as well as the rationale behind varied organizational policies.
Convergence of the corporate practices results from the mimetic, coercive, and normative pressures that cause isomorphism. The capital markets are coercive factors because investors and regulatory bodies require firms to adopt transparency and protection policies of the minority shareholders resulting to the adoption of similar practices. Companies imitate the practices of highly competitive companies to increase their innovation and market value, representing a mimetic force for convergence of corporate codes. Where the corporate codes lack, investors, businesses and governments enforce certain codes that are considered acceptable hence the normative force for convergence. This section shall cover the drivers of convergence in detail.
Since the last two decades, the financial markets no longer operate in isolation; instead, foreign investors have gained interest in the stocks of listed companies in overseas. Moreover, companies opt to issue their shares in offshore markets such as the London and New York stock exchanges that have high regulatory requirements such as adequate disclosures. The regulation causes high compliance costs, but companies willingly embrace the corporate governance requirements to gain legitimacy, attract investors, and benefit from rapid share appreciation. The foreign investors demand companies to adopt corporate practices existent in their home countries especially the protection of the minority shareholders in a process called coercive isomorphism (Yoshikawa and Rasheed, 2009, p. 390).
Corporations have to meet the expectations of these foreign investors to avoid huge stock sell-offs that adversely affect the share price. Additionally, cross-border acquisitions cause a company to reform its corporate practices to integrate foreign governance rules resulting in a hybrid of home and foreign governance practices. Notably, mimetic isomorphism increases convergence because firms that intend to float shares overseas embrace the protection of the minority shareholders, financial disclosures that are prevalent in the target market because they consider them best practices, whose benefit is to increase the competitiveness of the shares in a process (Arvidsson, 2011, p. 281). Thus, the globalization of financial markets has led to the convergence of company law and practices.
The advancement of transportation and communication systems have facilitated the globalization of the product market that has led to the convergence of the corporate policies. Globalization intensifies competition among firms compelling companies to adopt efficient and innovative strategies to cut costs and boost quality (Cuñat and Guadalupe, 2009, p. 181). Yoshikawa and Rasheed claim that enterprises consider good corporate governance as an innovation that gives them the flexibility necessary in the dynamic global trade (2009, p. 391). Thus, companies tend to diversify and adopt similar strategies including corporate practices, hence the convergence at the firm level. At the institutional level, governments compete to attract foreign investors and thus enforce laws that require firms to adopt the particular corporate practices such as independent directors and protection of the minority shareholders because most foreign investors own non-controlling stakes (Yoshikawa and Rasheed, 2009, p. 391). Thus, the competition resulting from the globalization of the product market compels companies to adopt similar corporate practices resulting in the convergence.
Globalization allows companies to float their shares in overseas stock exchanges and investors to diversify their financial portfolios by investing in offshore equities markets. However, the difference in accounting policies in offshore markets compels companies to restate their financial records and investors to change their standard interpretation of the accounting reports. This creates inefficiency, hinders competitiveness in the global capital markets, and prompts the harmonization of accounting policies that also constitute the corporate practices (Chen and Rezaee, 2012, p. 185). This leads to convergence because similar accounting policies and regulations are enforced on companies across different countries.
Highly liberated markets with poor protection of shareholders and a high proportion of foreign investors facilitate the convergence of governance practices. The foreign investors introduce the practices from their home country leading to the diffusion of management practices. Companies in these markets face legitimacy pressures from investors and governments resulting in the adoption of corporate codes (Haxhi and van Ees, 2010, p. 715). Moreover, the codes are developed by professional bodies, an association of directors, governments to boost the investor confidence that is necessary to attract and retain investors. The best practices represent the acceptable norms that benefit the organization and stakeholders. Convergence, for this case, will occur where the corporate codes in these markets are similar to those in other countries.
Although the convergence of the corporate practices through harmonization of accounting standards and protection of the minority stakeholders boosts market value and efficiency, it faces certain challenges. These impediments slow down or prevent the adoption of common organizational practices in different economies. The institutional and firm level factors influence the acceptance of foreign corporate policies as well as the development of new standards.
Even with the convergence of corporate law, the history of a country or firm influences the subsequent actions resulting in friction to change, thus divergence in corporate practices. Structure and rule driven forms of path dependence illustrate the resistance to the convergence of practices. The structure driven path dependence refers to how the historic economic structure influence the subsequent organizational policies. The adaptive sunk costs is a structural cause of divergence because the adoption of new practices is inefficient because the past regulations that a company or government has undertaken (Yoshikawa and Rasheed, 2009, p. 392). The ownership structure of other firms in a nation influence the governance of a company because it is beneficial to adhere to the conventional form resulting in the slow adoption of foreign best practices.
Conversely, the rule-driven path dependence relates to how the founding ownership characteristics influence the regulation of corporations (Beckert, 2010, p. 152). The policymakers protect the interests of the shareholders, labor unions, which prevents the adoption of practices that threaten the interests of existing stakeholders. Thus, the history of a company or country deters the convergence of corporate practices.
The prevailing market system in any economy is strongly linked, which discourages the alteration of one component since it interferes with the operation of the entire system. The improvement of governance practices, in isolation, is impossible due to the resultant disequilibrium. Difference in economic systems also deters convergence. The Anglo-American model values executive pay incentives, independent directors, and information disclosures while the Japanese system embraces high leverage, oversight of the management by the debt holders, and cross-shareholding (Yoshikawa and Rasheed, 2009, p. 393). The payment of high dividends in the US is acceptable because it reduces excess liquidity, but unacceptable in Japan since it would represent the payment of cash between firms and no reduction in free cash flows (Yoshikawa and Rasheed, 2009, p. 393). Thus, the existence of complementarities in the market institutions and the difference in corporate practices deter the adoption of similar organization policies.
Nations and agencies select a set of practices and standards that they believe are optimal because they cater to the interests of all stakeholders and thus a basis for sustainable corporate governance. Yoshikawa and Rasheed state that the firm link between the set of acceptable governance policies deters the convergence due to the high transaction costs and the interference from parties whose interests are threatened by such convergence (2009, p. 393). It is therefore difficult for companies and nations to adopt foreign policies because the resistance and transaction costs resulting from the change exceeds the resultant management efficiency.
Whenever foreign practices threaten the private benefits of any stakeholders, resistance to change arises. This prevails because the stakeholders act to protect their interests with no regard to the potential collective benefits of adopting best practices (David et al., 2010, p. 637). Labor unions advocate for job security and would oppose any practice that threatens the security of its members. Majority European nations allow the unequal voting rights to protect the interest of founding families of listed companies while the US advocates for the equal right to vote. Any attempt to change the voting rights in either market may, therefore, be futile due to opposition from interested parties at the firm level (Yoshikawa and Rasheed, 2009, p. 393). The labor unions, brokerage firms, and law societies are influential bodies and influence the outcome of elections. Thus, any attempt to enact legislations that interfere with the privileges of interested parties is unattractive to governments resulting in divergence of corporate practices at the institutional level.
Once a corporate practice proves to be efficient and beneficial to most stakeholders, it is widely adopted in the domestic and overseas markets. For instance, the Toyota model of Just in Time was efficient because it lowered inventory costs and many companies in Japan and overseas integrated it into their operations (Rios and Ríos-Solís, 2011, p. 290). However, its popularity has diminished because it assumes perfect conditions that are absent due to the diversity and external influences of the modern commerce. This therefore prevents the adoption of the just in time model by all firms. Additionally, the Anglo-American practices of information disclosure and independent directors was considered ideal but its inability to curb fraud deters its adoption across all economies (Yoshikawa and Rasheed, 2009, p. 394). Hence, the lack of a consensus on the ideal practice deters the convergence of best corporate policies.
The globalization of the financial markets opens up opportunities to invest in foreign shares and for companies to float shares in competitive stock markets. This leads to convergence of corporate practices since the companies have to meet the expectations of the foreign investors and comply with the corporate laws of the foreign market. The high competition in the product market encourages the adoption of best policies because they promote innovation and consequently the competitiveness of the products of a company and exports. Differences in the accounting standards prompts the harmonization of financial policies leading to convergence. However, path dependence discourages convergence due to the cost of modifying the established practices in a company or nation. The lack of an ideal strategy and resistance from stakeholders deter the universal application of corporate practices.
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