Research by Lehigh's Anne Anderson and Parveen Gupta earned international accolades for its insight into corporate governance.
With the economic crisis as the backdrop, many of the world’s largest corporations are aggressively seeking ways to better protect their shareholders, customers and employees. But new research from Lehigh’s College of Business and Economics
suggests that now, more than ever before, companies need to do a better job of studying their options.
, the Theodore A. Lauer Distinguished Professor in finance, and Parveen Gupta
, professor and department chair in accounting, studied 1,732 firms representing 22 countries before co-authoring a groundbreaking research study on corporate governance and firm performance.
This research paper is the most comprehensive of its kind to explore the intersection of a country’s financial structure and its legal system—and how this intersection impacts a firm’s governance behavior and its financial performance.
The study has earned international accolades for its insight into corporate governance—and why firms operating in different regions of the world need to be more judicious in deciding which actions will actually help their long-term performance.
It’s a focus that earned Anderson and Gupta the prestigious Vernon Zimmerman Best Paper Award at the 20th Asian-Pacific Conference on International Accounting Issues in Dijon, France last month.
Since then, the authors have fielded a host of questions about their findings. They will travel to opposite corners of the world the first week of January, presenting the paper at highly-regarded accounting conferences in both Hong Kong and Florida.
Corporate governance refers to the underlying set of principles that guide a company’s decision-making with the aim to protect and enhance shareholder value. Ultimately, the goal of any governance program is to align management and shareholder interests in ways that ensure a company’s long-term financial success, while balancing the authority of a company’s management and rights of its shareholders.
Unfortunately, many companies unintentionally pursue governance policies that are counter-productive to their financial and operating well-being. It’s a slate of mistakes that will continue to be made unless companies learn to implement the right kind of governance policies—policies that may not always be the most intuitive, the authors suggest.
“A ‘one-size-fits-all’ approach simply won’t cut it for companies attempting to align their governance structure to enhance their firm’s performance,” says Gupta.
After completing the analysis, Anderson and Gupta found that certain selective governance actions were consistently important and that companies need to understand the country in which they operate—and better understand the regulations and business climate in the region.
“When a significant problem arises, most companies begin imposing additional governance mechanisms without thinking,” says Anderson. “It’s a knee-jerk reaction. They believe they need to be visibly and quickly show their commitment to change to contain the damage.”
“The problem is, they enact the wrong measures,” she adds. “And that makes for a very costly mistake.”
The professors examined two key factors in coming up with regional recommendations. One included a look at how markets allocate capital. Countries like the U.S., United Kingdom and Australia promote a market-based approach that, proponents argue, efficiently allocates capital to promote economic growth at lower costs.
Conversely, countries like Japan, Germany, and France employ a bank-based financial system that is better at identifying good investments and facilitating credit access without employing costly governance controls. In this system, banks primarily work as “delegated monitors” explains Gupta.
They also examine the impact of different legal structures: one that relies on civil law, where judges are more apt to strictly follow the letter of the law, and common law, where judges focus more on spirit than letter of the law. Legal historians argue that in most countries laws generally “lag” the business development.
Hence, protection of contractual rights can be markedly different under these two common legal systems.
They then consolidated a list of more than 60 governance-related measures a company could take into eight broad categories: boards, audits, charters, states of incorporations, compensation, qualitative reviews, ownership, and education.
The result revealed that firms operating in countries characterized with market-based financial structure and common-law legal system can positively impact their financial performance by investing in boards, anti-takeover provisions, and audit related governance activities; the reverse holds true for bank/civil firms.
They also found that firms operating within bank-based financial structure and civil law-based legal system benefit most by implementing governance practices that deal with retirement age for directors and CEO succession plans, but incur a cost by implementing practices in the area of executive and director compensation.
“The definition of good corporate governance has not only changed over time, but is also vastly different across the world,” says Anderson. “Companies—and the people that run them—need to stay on top of these changes in their country’s financial and legal environments.”
Gupta agrees. He saw first-hand the changing face of corporate governance during 2006-2007, when he served as an Academic Fellow with the U.S. Securities and Exchange Commission (SEC). There he worked on a rule-making project related to the Sarbanes-Oxley Act of 2002 which enacted the most sweeping corporate governance reforms in the history of modern America.
“Our work is among the first to conclusively explain the joint effect that a host country’s financial structure and legal system have on a firm’s market performance,” says Gupta. “We’ve been able to prove that a highly-customized approach to corporate governance strongly enhances a company’s Return-On-Investment.”
“Our findings are particularly noteworthy during the current financial crisis, which has focused increasing attention on the role of regulation in protecting shareholder wealth,” he adds. “Our advice: Be careful and consider where you operate.”
Photo by Douglas Benedict