This chapter examines how cultural, legal, political, and institutional differences affect a firm's choice of financial goals and corporate governance.

Who owns the business?

Who owns the business and do the owners of the business manage the business themselves? Most of the companies are created by entrepreneurs who are either individuals or a small set of partners who own 100% of the business. Over time, some firms choose to go public. Some companies may sell more and more of their equity interests into the public marketplace, and become totally publicly traded.

Even when the firm's ownership is publicly traded, it may still be controlled by a single investor or a small group of investors. This means that the control of the company is much like the privately held company, and therefore reflects the interest and goals of the individual investor.

After the initial sale of the shares to the public, the firm becomes subject to many of the increased legal, regulatory, and reporting requirements in most countries surrounding the sale and trading of securities. For example, in the U.S. the firm will now have to disclose a sizable degree of financial and operational detail, publish this information at least quarterly, comply with Securities and Exchange Commission (SEC) rules and regulations, and comply with all the specific operating and reporting requirements of the specific exchange on which it is traded.

The possibility that the firm may be managed by professionals may result that the firm may face the agency problem. The agency comes up when the ownership and management do not perfectly aligned in their business and financial objectives.

The U.S. and U.K. stock markets have been characterized by widespread ownership of shares. Management owns only a small proportion of stock in their firms. In contrast, in the rest of the world ownership is usually characterized by controlling shareholders such as: Government (e.g. privatized utilities); institutions (e.g. banks in Germany); family (e.g.in France and Asia); consortiums (e.g. keiretsus in Japan and chaebols in South Korea).

Control is enhanced by ownership of shares with dual voting rights, interlocking directorates, staggered election of the board of directors, takeover safeguards, and other techniques not used in the Anglo-American markets.

What is the goal of management?

As Trident becomes more deeply committed to multinational operations, a new constraint develops -one that springs from divergent worldwide opinions and practices as to just what the firm's overall goal should be from the perspective of top management.

Although the idea of maximizing shareholder wealth is probably realistic both in theory and in practice in the Anglo-American markets, it is not always exclusive elsewhere.

Shareholder Wealth Maximization (SWM) Model:

The Anglo-American markets have a philosophy that a firm's objective should follow the shareholder wealth maximization (SWM) model. Alternatively, the firm should minimize the risk to shareholders for a given rate of return. The SWM model assumes as a universal truth that the stock market is efficient, meaning that the share price is always correct because it captures all the expectations of return and risk as perceived by investors. It quickly cooperate s new information into the share price, and share prices, in turn, are deemed the best allocators of capital in the macro economy. Risk is defined as the added risk that the firm's shares bring to a diversified portfolio. The total operational risk of the firm can be eliminated through portfolio diversification by the investors. Therefore, this unsystematic risk, the risk of the individual security, should be a prime concern for management unless it increases the prospect of bankruptcy. Systematic risk, the risk of the market in general, cannot be eliminated. This reflects the risk that the share price will be a function of the stock market.

Agency theory is the study of how shareholders can motivate management to accept the prescriptions of the SWM model.

During the 1990s, the economic boom and rising stock prices in the U.S. and abroad exposed a flaw in the SWM model, and several U.S. corporations sought short-term value maximization. This short term focus has been labeled impatient capitalism. In contrast to impatient capitalism is patient capitalism that focuses long-term value maximization.

Stakeholder Capitalism Model:

Non-Anglo-American markets are more constrained by other stakeholders such as labor unions and governments. Banks and other financial institutions are more important creditors than securities markets. This model has been labeled the Stakeholder Capitalism Model (SCM).

The SCM model does not assume that equity markets are either efficient or inefficient because the firm's financial goals are not exclusively shareholder-oriented since they are constrained by the other stakeholders.

The SCM model assumes that total risk does count. Risk is measured more by product market variability than by short-term variation in earnings and share price.

Although the SCM model typically avoids a flaw of the SWM model, it has its own flaw. Trying to meet the desires of multiple stakeholders leaves management without a clear signal about the trade-offs.

In contrast to the SCM model, the SWM model requires a single goal of value maximization with a well-defined score card.

In recent years both models have led to an increasing focus on shareholder wealth form. First, as more of the non-Anglo-American markets have increasingly privatized their industries, the shareholder wealth focus is seemingly needed to attract international capital form outside investors, many of whom are from other countries. Second, and still quite controversial, many analysts believe that shareholder-based MNEs are increasingly dominating their global industry segments.

Shareholder return = Dividend/Price₁ + Price₂-Price₁/Price₁

Management generally believes it has the most direct influence over the dividend yield; and capital gain -the change in the share price as traded in the equity markets- is much more complex. In contrast, a privately held firm has a much simpler objective: maximize current and sustainable income. The privately held firm may also be less aggressive (take fewer risks) than the publicly traded firm. This may mean that it will not attempt to grow sales and profits as rapidly, and therefore may not require the capital (equity and debt) needed for rapid growth.

The MNE must be guided by operational goals suitable for various levels of the firm. The MNE must determine the proper balance between three common operational financial objectives: (1) Maximization of consolidated after-tax income; (2) Minimization of the firm's effective global tax burden; (3) Correct position of the firm's income, cash flows, and available funds as to country and currency.

Consolidated profits are the profits of all the individual units of the firm originating in many different currencies expressed in the currency of the parent company.

The ownership of companies of all kinds, including MNEs, is not necessarily purely public or purely private. In fact, family-influenced businesses in five regions of the globe were superior to their non-family publicly traded counterparts. There are three key catalysts for the performance of the stocks with significant family influence (SSFI): (1) management with a longer term focus; (2) better alignment between management and shareholder interest; and (3) stronger focus on the core business of the firm.

Corporate Governance:

The single overriding objective of corporate governance in the Anglo-American markets is the optimization over time of the returns to shareholders. Good governance practices should focus the attention of the board of directors of the corporation on this objective by developing and implementing a strategy, which ensures corporate growth and improvement in the value of the corporation's equity.

Organization for Economic Corporation and Development (OECD)'s statement of good corporate governance practices can be summarized as: (1)The corporate governance framework should protect shareholders' right; (2)The corporate governance framework should ensure the equitable treatment to all shareholders; (3)The corporate governance framework should recognize the rights of stakeholders; (4) The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation; (5) The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board's accountability to the company and the shareholders.

The modern corporation's actions and behaviors are directed and controlled by both internal forces (such as the board of directors and management) and external forces (such as equity markets, debt markets, auditors and legal advisers and regulators).

Corporate governance practices will differ across countries, economics, and cultures. The various corporate governance regimes can be classified as:

Regime basis	Characteristics	Examples
Market-based	Efficient equity markets; Dispersed ownership	United States, United Kingdom, Canada, Australia
Family-based	Management and ownership is combined; Family/majority and minority shareholders	Hong Kong, Indonesia, Malaysia, Singapore, Taiwan, France
Bank-based	Government influence in bank lending; Lack of transparency; Family control	Korea, Germany
Government affiliated	State ownership of enterprise; Lack of transparency; No minority influence	China, Russia

These regimes are therefore a function of at least four major factors in the evolution of corporate governance principles and practices globally: (1) the financial market development; (2) the degree of separation between management and ownership; (3) the concept of disclosure and transparency; (4) the historical development of the legal system.

Recent research indicated that family-owned firms in some highly developed economies typically outperform publicly owned firms.

Failures in corporate governance have become increasingly visible in recent years (e.g. Enron, WorldCom, Tyco).

Good corporate governance is dependent on a variety of factors, one of which is the general governance reputation of the country of incorporation and registration. Studies show important linkages between good governance and the cost of capital, the returns to shareholders, and corporate profitability.

In recent years, reform in the U.S. and Canada has been largely regulated. The U.S. Congress passed the Sarbanes-Oxley Act (SOX) in July 2002. SOX has four major requirements: (1) CEOs and CFOs of publicly traded firms must vouch for the veracity of the firm's published financial statements; (2) corporate boards must have audit and compensation committees drawn from independent directors; (3) companies are prohibited from making loans to corporate officers and directors; (4) companies must test internal financial controls against fraud.

Having gone over these topics, please answer the following questions:

1. Explain why the understanding of separation of ownership and management is important.

2. Explain the assumptions and objectives of the shareholder wealth maximization model.

3. Briefly compare the shareholder wealth maximization model and stakeholder capitalism model.

4. What are the five statements for good corporate governance established by OECD?

5. Briefly explain the internal and external factors that affect the corporation's actions and behavior.

6. Explain the differences between family business ownership and publicly traded business.

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