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Can U.S. regulators improve corporate governance at home by looking overseas?
Craig Schneider, CFO Magazine
October 1, 2002
Politicians, regulators, and corporate executives in the United States can be downright chauvinistic about the American way of doing business. Indeed, during the 1990s, many U.S. executives crowed about the superiority of their free-market system. Conversely, others privately belittled certain countries as bastions of crony-capitalism.
But in the wake of the recent accounting scandals, it appears America has its fair share of crony-capitalists. Ironically, outside of Vivendi Universal and Elan Corp., few financial controversies have come to light in Europe in the past year. And this lack of scandals has a few observers wondering if standards-setters over here can learn anything about corporate governance from over there.
At first blush, any attempt to gain such insight would seem a fool's errand. Despite the formalization of the European Union, governance in Europe is anything but uniform. The United Kingdom, for starters, operates under a one-tier board system much like the United States, but Germany's system is two-tier and France offers a choice. Disclosure requirements also can be fragmented, and suffer from the lack of a Securities and Exchange Commissiontype enforcer. Moreover, Europe is still pervaded by many family-owned and -controlled businesses as well as elaborate pyramid ownership structures. This leads to worries that minority shareholders are abused by such blockholders rather than all-powerful U.S.-style managers.
Nevertheless, some U.S. executives are pointing to several practices in Europe that they believe are worth importing. Specifically, they mention splitting the CEO-chairman role, enabling major shareholders to have more influence in corporate dealings, and instituting an independent governance-rating system.
Marco Becht, executive director of the European Corporate Governance Institute, can't wait. "The problem with Corporate America is that shareholders aren't involved enough, and some say they're not allowed to be more involved," he says. Europeans avoided U.S. problems "because we have shareholders that are generally larger, better informed, and better able to get directly involved," asserts Becht.
The European idea of separating the CEO and chairman roles is one of the more likely imports. And to date, about 80 percent of U.K. companies have adopted the practice.
The idea of the split is actually part of the U.K.'s Cadbury Report, landmark governance rules developed in the early 1990s after several corporate scandals. Elsewhere on the continent, however, countries are adopting their own versions of the rules. In France, for example, combining the chairman and CEO roles used to be mandated by law, but in 2001 French legislation gave firms the freedom to individually choose whether to separate them.
Still, U.S. executives are enamored with the idea: consider that a combined 69 percent of respondents in McKinsey & Co.'s 2002 Director Opinion Survey on Corporate Governance either very much support or somewhat support the move. To date, however, less than 20 percent of companies have actually adopted the practice, says Bert Denton, president of New Yorkbased investment firm Providence Capital Inc., who is planning a campaign to encourage American boards to switch to a nonexecutive chair.
To Denton, however, the initiative is "the most important single change that could be made to address the issue of a very powerful CEO who's driven by short-term aspirations related to his options package." But Thomas Weatherford contends the split won't work at companies of all sizes. As CFO of Business Objects SA, a cross-border software business that must comply with both French and U.S. regulators, Weatherford says that it's at the larger companies such as General Electric where two heads are better than one. "It's extremely hard to know everything going on in a complex company," he says. "In smaller companies, you need everyone to wear several hats."
In addition, the split may have ominous implications for CFOs. Jonathan Low, senior fellow at Cap Gemini Ernst & Young's Center for Business Innovation, says the movement to separate the offices "almost by definition diffuses the power of the CFO because it creates a third senior executive."
In the Telephone Booth
Dealing with another executive, however, may be less taxing than dealing with a chorus of stakeholders. The typically largest U.K. institutional investor, for example, owns about 9.5 percent of the voting power, Becht explains. Putting three to five such investors together equals some 30 to 35 percent of the votes at a meeting. In continental Europe, one shareholder or shareholder coalition can bring 20 to 25 percent of the voting rights. In Germany, companies have shareholders with more than 50 percent.
Patrick McGurn, vice president of Institutional Shareholder Services, says the concentrated ownership structure is jokingly referred to as "telephone-booth companies" because all majority shareholders could be squeezed into one. But it's no joke. The concentration allows for change to occur quickly, he says. (Consider Vivendi Universal and other firms that have ousted their CEOs in past months.) In contrast, U.S. CEOs are generally forced out because of bad news or scandal. "It's not because of investors," says McGurn.
In Germany, certain shareholders are powerful enough to have their own board. Under the country's two-tier governance system, employees and labor union representatives typically can be found on a supervisory board, which nominates and dismisses executives on the management board and can approve decisions such as those about acquisitions.
The setup has its critics, however, who contend that the supervisory board is beholden to the management board for information. In the case of the Daimler-Chrysler merger in 1998, for example, the supervisory board was reportedly informed on May 6, the same day the Wall Street Journal wrote of a potential merger.
That may be why France has recently taken a different track. There, managers have a choice of structures. "Companies in different situations may find advantage to the one-tier or two-tier," says Jean-Nicolas Caprasse, managing partner at Deminor Rating, a corporate-governance appraisal service. He adds that roughly 75 percent of French firms use the one-tier board system.
Suez SA, a large French utility, has used both. After it was formed in a merger in 1997, there was a question of who was going to lead, explains Caprasse. To accommodate both parties, one manager was made chairman of the supervisory board; the other, CEO of the management board. But in 2001, the company decided to switch back to the one-tier board system after the supervisory chairman resigned.
In the United States, shifting more decision-making power to shareholders is not in the offing. In fact, nearly three-quarters of the respondents to McKinsey's survey are against increasing the number of decisions requiring shareholder approval.
Many observers, however, would not say Europe has hit upon some magic combination of corporate-governance rules that will keep scandals at a minimum. For example, there are few uniform accounting rules throughout the EU, and regulatory oversight is still a country-by-country affair.
"We need a European version of the SEC's Edgar information system," says Clark Eustace, chairman of Prism, the European Commission's intangible-assets task force. But the big question is how the system would be approached politically, he says, since the hardest part is getting agreement between countries and regulators rather than setting up a database. In addition, there are only limited calls for increased disclosure, like that in the U.S.'s Sarbanes-Oxley Act of 2002.
Still, before crowing about the superiority of their system again, U.S. executives might consider how some European imports could make it better.
Craig H. Schneider is an assistant editor at CFO.com.