This paper surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world.

A Survey of Corporate Governance

This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world. CORPORATE GOVERNANCE DEALS WITH the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers? At first glance, it is not entirely obvious why the suppliers of capital get anything back. After all, they part with their money, and have little to contribute to the enterprise afterward. The professional managers or entrepreneurs who run the firms might as well abscond with the money. Although they sometimes do, usually they do not. Most advanced market economies have solved the problem of corporate governance at least reasonably well, in that they have assured the flows of enormous amounts of capital to firms, and actual repatriation of profits to the providers of finance. But this does not imply that they have solved the corporate governance problem perfectly, or that the corporate governance mechanisms cannot be improved. In fact, the subject of corporate governance is of enormous practical impor

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Since 1973 technological, political, regulatory, and economic forces have been changing the worldwide economy in a fashion comparable to the changes experienced during the nineteenth century Industrial Revolution. As in the nineteenth century, we are experiencing declining costs, increasing average (but decreasing marginal) productivity of labor, reduced growth rates of labor income, excess capacity, and the requirement for downsizing and exit. The last two decades indicate corporate internal control systems have failed to deal effectively with these changes, especially slow growth and the requirement for exit. The next several decades pose a major challenge for Western firms and political systems as these forces continue to work their way through the worldwide economy.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.1993.tb04022.x

The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems

Oliver E. Williamson University of California, Berkeley This paper combines institutional economics with aspects of contract law and organization theory to identify and explicate the key differences that distinguish three generic forms of economic organization-market, hybrid, and hierarchy. The analysis shows that the three generic forms are distinguished by different coordinating and control mechanisms and by different abilities to adapt to disturbances. Also, each generic form is supported and defined by a distinctive type of contract law. The costeffective choice of organization form is shown to vary systematically with the attributes of transactions. The paper unifies two hitherto disjunct areas of institutional economics-the institutional environment and the institutions of governance-by treating the institutional environment as a locus of parameters, changes in which parameters bring about shifts in the comparative costs of governance. Changes in property rights, contract law, reputation effects, and uncertainty are investigated.'

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Comparative Economic Organization: The Analysis of Discrete Structural Alternatives

This paper examines the progressive development of the new institutional economics over the past quarter century. It begins by distinguishing four levels of social analysis, with special emphasis on the institutional environment and the institutions of governance. It then turns to some of the good ideas out of which the NIE works: the description of human actors, feasibility, firms as governance structures, and operationalization. Applications, including privatization, are briefly discussed. Its empirical successes, public policy applications, and other accomplishments notwithstanding, there is a vast amount of unfinished business.

The New Institutional Economics: Taking Stock, Looking Ahead

The boards of directors of American public companies are dominated by independent directors. Many commentators and institutional investors believe that a "monitoring board," composed almost entirely of independent directors, is an important component of good corporate governance. The empirical evidence reported in this Article challenges that conventional wisdom. We conduct the first large-sample, long-horizon study of whether the degree of board independence (proxied by the fraction of independent directors minus the fraction of inside directors on a company's board) correlates with various measures of the longterm performance of large American firms. We find evidence that low-profitability firms increase the independence of their boards of directors. But there is no evidence that this strategy works. Firms with more independent boards do not perform better than other firms. Our results support efforts by firms to experiment with board structures that depart from the conventional monitoring board. I. INTRODUCTION Over the last thirty years, American corporate boards have undergone a gradual but dramatic change. In the 1960s, most had a majority of inside directors. Today, almost all have a majority (usually a large majority) of outside directors, most have a majority (often a large majority) of independent directors, and an increasing number have only one or two inside directors. This pattern reflects the conventional wisdom that the board's principal task is to monitor management, and only independent directors can be effective monitors. In contrast, an insider-dominated board is seen as a device for management entrenchment.1 For example, guidelines adopted by the Council of Institutional Investors call for at least 2/3 of a company's directors to be independent; guidelines adopted by the California Public Employees Retirement System and by the National Association of Corporate Directors call for boards to have a "substantial majority" of independent directors.2 American corporate governance experts and institutional investors are now exporting this conventional wisdom around the world. It has only an occasional dissenting voice.3 Even the Business Roundtable (an organization of large-firm CEOs), which once opposed proposals for more independent boards, now recommends that boards have a "substantial majority" of independent directors.4 Yet there are numerous anecdotes where a highly independent board hasn't prevented large-scale wealth destruction. Enron (with eleven independent directors on its fourteen-member board) is only the most recent example. When we turn from anecdote to quantitative evidence, the conventional wisdom favoring highly independent boards lacks a solid empirical foundation, in this or other studies. We study in this Article three related questions. First, does greater board independence produce better corporate performance, as conventional wisdom predicts? Second, and conversely, does board composition respond to firm performance? Third, does board size predict firm performance? Prior quantitative research on the first two questions has been inconclusive; for the third, two studies report that firms with large boards perform worse than firms with smaller boards. We report here evidence from the first large-scale, long-time-horizon study of the relationship among board independence, board size, and the long-term performance of large American firms. We study measures of financial performance and growth from 1985-1995 for 934 of the largest United States firms, using data on these firms' boards of directors in early 1991 and board data for a random subsample of 205 firms from early 1988. Our principal findings: We find evidence that low-profitability firms respond to their business troubles by following conventional wisdom and increasing the proportion of independent directors on their boards. There is no evidence, however, that this strategy works. …

The Non-Correlation Between Board Independence and Long-Term Firm Performance

https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?article=2152&context=faculty_scholarship

Venture capital and the structure of capital markets: banks versus stock markets

We report strong OLS and instrumental variable evidence that an overall corporate governance index is an important and likely causal factor in explaining the market value of Korean public companies. We construct a corporate governance index (KCGI, 0~100) for 515 Korean companies based on a 2001 Korea Stock Exchange survey. In OLS, a worst-to-best change in KCGI predicts a 0.47 increase in Tobin's q (about a 160% increase in share price). This effect is statistically strong (t = 6.12) and robust to choice of market value variable (Tobin's q, market/book, and market/sales), specification of the governance index, and inclusion of extensive control variables. We rely on unique features of Korean legal rules to construct an instrument for KCGI. Good instruments are not available in other comparable studies. Two-stage and three-stage least squares coefficients are larger than OLS coefficients and are highly significant. Thus, this paper offers evidence consistent with a causal relationship between an overall governance index and higher share prices in emerging markets. We also find that Korean firms with 50% outside directors have 0.13 higher Tobin's q (roughly 40% higher share price), after controlling for the rest of KCGI. This effect, too, is likely causal. Thus, we report the first evidence consistent with greater board independence causally predicting higher share prices in emerging markets.

Does Corporate Governance Predict Firms' Market Values? Evidence from Korea

We survey the evidence on the relationship between board composition and firm performance. Boards of directors of American public companies that have a majority of independent directors behave differently, in a number of ways, than boards without such a majority. Some of these differences appear to increase firm value; others may decrease firm value. Overall, within the range of board compositions present today in large public companies, there is no convincing evidence that greater board independence correlates with greater firm profitability or faster growth. In particular, there is no empirical support for current proposals that firms should have "supermajority-independent boards" with only one or two inside directors. To the contrary, there is some evidence that firms with supermajority-independent boards are less profitable than other firms. This suggests that it may be useful for firms to have a moderate number of inside directors (say three to five on an average-sized eleven member board). We offer some possible explanations for these results, based on board dynamics, the informational advantages possessed by inside (and, often, affiliated) directors, and the value of interaction between different types of directors who bring different strengths to the board. published in 54 Business Lawyer 921-963 (1999) Columbia Law School, Center for Law and Economic Studies Working Paper No. 137 Stanford Law School, John M. Olin Program in Law and Economics Working Paper No. 175 available from the Social Science Research Network Electronic Library at: _______________ * Respectively, Professor of Finance, University of Colorado at Boulder; Professor of Law, Stanford Law School. 1 NATIONAL ASS'N OF CORP. DIRS., REPORT OF THE NACD BLUE RIBBON COMMISSION ON DIRECTOR PROFESSIONALISM 9 (1996). 2 THE BUS. ROUNDTABLE, STATEMENT ON CORPORATE GOVERNANCE 10 (1997). 3 See Adam Bryant, Calpers Draws a Blueprint for its Concept of An Ideal Board, N.Y. TIMES, June 17, 1997, at D5. 2 The Uncertain Relationship Between Board Composition and Firm Performance By Sanjai Bhagat and Bernard Black

The Uncertain Relationship between Board Composition and Firm Performance

In Russia and elsewhere, proponents of rapid, mass privatization of state-owned enterprises (ourselves among them) hoped that the profit incentives unleashed by privatization would revive faltering, centrally planned economies. Instead, the Russian economy has shrunk steadily since 1991 and suffered a major collapse in 1998, which exposed deep structural flaws in the privatization effort. We offer here some partial explanations. First, rapid mass privatization of medium and large firms is likely to lead to massive self-dealing by managers and controlling shareholders unless (implausibly in the initial transition from central planning to markets) a country has a good infrastructure for controlling self-dealing. Russia accelerated the self-dealing process by selling control of many of its largest enterprises cheaply to crooks, who got the funds to buy the enterprises by skimming from the government, and transferred their skimming talents to the enterprises they acquired. Second, profit incentives to restructure privatized businesses and create new ones can be swamped by the burden on business imposed by a combination of (among other things) a punitive tax system, official corruption, organized crime, and an unfriendly bureaucracy. Third, while self-dealing will still occur (though perhaps to a lesser extent) if state enterprises aren’t privatized, since self-dealing accompanies privatization, it politically discredits privatization as a reform strategy and can undercut longer-term reform efforts. A principal lesson is that developing the infrastructure to control self-dealing is central to successful privatization of large firms -as important, and in the early stages, perhaps more important than privatization itself. Please address comments to: Professor Bernard Black Stanford Law School Stanford CA 94305 bblack@stanford.edu * We thank Kevin Covert, Richard Craswell, David Ellerman, Itzhak Goldberg, Dale Gray, Hugh Patton, Michael Klausner, Peter Murrell, John Nellis, Katarina Pistor, Andrei Shleifer, Alexander Yushkevich, and [to come], and participants in workshops at the American Law and Economics Association, an OECD Conference on Corporate Governance in Russia, an IMF Workshop on Comparative Corporate Governance in Developing and Transition Economies, Stanford Law School, and University of California Berkeley, Haas School of Business and [to come] for helpful discussions and comments. Special thanks to James Fenkner of Troika Dialog for the data on Russian market capitalization and comparable Western values for Russian companies reported in Part III of this article.

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Bernard S. Black

Papers

The Non-Correlation Between Board Independence and Long-Term Firm Performance

Venture capital and the structure of capital markets: banks versus stock markets

Does Corporate Governance Predict Firms' Market Values? Evidence from Korea

The Uncertain Relationship between Board Composition and Firm Performance

Russian Privatization and Corporate Governance: What Went Wrong?