In 1999 the Organization for Economic Cooperation and Development (OECD) adopted the first multilateral set of guidelines. These “OECD principles” provide a conceptual framework for policymakers, companies, investors, and others to address corporate governance issues in terms that are commonly understood around the world.
The OECD principles define basic requirements a country must meet to be regarded as having an adequate corporate governance environment; they do not target harmonization, per se. Negotiated by lawmakers from 30 major developed economies with widely differing governance standards, they leave considerable room for country differences. They do insist all differences be made transparent, and thereby are a force for convergence. Since their adoption in 1999, the OECD principles have been explicitly used as a benchmark by a number of investor-related initiatives to set guidelines: the International Corporate Governance Network (ICGN)The International Corporate Governance Network (ICGN) is an association of large institutional investors from around the world with more than 10 trillion assets, under management whose aim is to promote better governance globally. For more details about the ICGN, go to their Web site, http://www.isgn.org guidelines on corporate governance; the guidelines of some of the largest institutional investors, such as the California Public Employees’ Retirement System (CALPERS) and the Teachers’ Insurance and Annuity Association–College Retirement Equities Fund (TIAA-CREF) in the United States; and Hermes Asset Management in the United Kingdom. In 2001 the International Institute of Finance (IIF), a grouping of the world’s most prominent financial institutions, also issued a set of global guidelines.
Convergence also does not imply a simple victory of one governance system over all others. Corporate ownership and control arrangements are deeply embedded in national laws and culture, and therefore will likely remain at least partly idiosyncratic. Rather, the focus of global alignment is on providing investors with a good understanding of how a company is governed in a particular country and the ability to fairly assess its performance and prospects. In other words, efforts to globally align governance systems and practices view the purpose of a high-quality corporate governance system in terms of generating trust in the investment community.
Convergence is principally occurring in three areas.
The first area concerns regulations, listing requirements, governance codes, and best practices. U.S. legislative changes have brought the American regulatory system closer to European norms, including
- the requirement that senior corporate officers must certify the fairness of corporate accounts or face criminal charges;
- the exposure of corporate executives and directors to criminal sanctions if they are found to have defrauded shareholders (the scope of criminal provisions on abuse of corporate property is broader in many continental jurisdictions, especially in France);
- a prohibition on company lending to senior executives (which is illegal in Germany).
Global convergence is also apparent in the new rule by the major U.S. exchanges requiring listed U.S. companies to adopt an internal corporate governance code and a code of ethics. Importantly, while the NYSE is not imposing its listing requirements on listed non-U.S. corporations, it does require them to explicitly comply or explain why they do not comply. This is another important way to stimulate convergence since many of the largest non-U.S. corporations in the world either have or aspire to have a NYSE listing. The new NYSE rules join a growing number of other “comply or explain” codes that have been adopted as part of listing requirements. This middle-of-the road approach between hard mandatory norms and purely voluntary market best practice was pioneered by the London Stock Exchange (LSE) when it integrated the various voluntary codes into a combined code that became a part of its listing requirements.
The second area concerns board independence and structure, the role and definition of independent directors, and shareholder representation. Board independence is also rapidly becoming a global benchmark. The new U.S. rules have set the independence bar high by requiring that a majority of directors be independent; that the audit, nominating, and compensation committees be comprised exclusively of independent directors and by tightening the definition of independence. But the main thrust of almost every code, whether international or national, is to enhance the independence of the board with regard to the controlling interests in a corporation: the managers in a widely held company or the controlling shareholder, where there is one. Almost all codes address this issue by requiring a “significant” number of independent, nonexecutive directors on the board. Most European codes do not specify a number; Korean listing requirements require that one fourth of the board should be independent; Malaysian listing requirements and the 2001 voluntary Singapore Code put the threshold at one third, following the example of the Vienot Code in France. According to the IIF guidelines, best practice consists in appointing independent directors to fill at least half of the board’s seats.
Convergence can also be observed in the opposite direction. Japan, for example, amended its commercial code in May 2002 to allow companies to choose their structure of governance. The choice is between the old company law scheme of a board of directors and a separate audit board, and a new, more U.S.-like structure that provides for an audit committee of the board with independent directors as a majority. Change will be slow; Japanese companies have shied away from instituting a clear board committee structure that would give real responsibilities to a largely ceremonial board.
In Europe, Deutsche Bank made a landmark change in the way its management board is organized, moving away from a focus on collective responsibility to a system that emphasizes individual responsibility of senior officers and the CEO, like that found in the United States. Siemens recently decided to establish an audit committee on its supervisory board (albeit not wholly independent) and to review its own corporate governance annually.
The third area concerns accounting, disclosure standards, and the regulation of the audit function. The convergence of financial reporting and accounting standards around the world is improving the ability of investors to compare investments on a global basis. It also facilitates accounting and reporting for companies with global operations and eliminates some costly requirements. Still substantially incomplete, it has the potential to create a new standard of accountability and greater transparency.
The goal is an improved reporting model built on principle-based standards. In Phase I of the convergence process (from 2001 to 2005), the European Commission decided on the use of a common financial reporting language (the International Financial Reporting Standards [IFRS]) and required the adoption of IFRS by more than 8,000 companies worldwide. Inaugurated by the February 2006 Memorandum of Understanding between the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB), Phase II (from 2006 to 2009) is reserved for rigorous market and regulatory testing of the IFRS and for generating further proposals aimed at addressing significant differences. The objective is the substantial equivalence of IFRS and U.S. GAAP and the elimination of the SEC’s reconciliation requirement for foreign private issuers. Looking into the future (Phases III and beyond), the separate standard setters are expected to coordinate their actions and issue substantially identical standards. Longer term elements of FASB could be merged into the IASB structure to create a single, global standard setter (IASB) and accounting framework (IFRS) used worldwide.PriceWaterHouseCoopers ViewPoint (2007, April).
Thus, global convergence does not simply imply a movement to globally uniform corporate governance norms and behaviors. Rather, it signals the adoption of principles and practices that allow investors and corporations to increasingly operate on a basis of trust across national borders. Corporations around the world also are beginning to value good corporate governance and are adopting global best practices. In the end, however, the primary force behind global convergence will be investors’ demands for better governance and their willingness to value it.