Political Determinants of Corporate Governance: Political Context, Corporate Impact.

• Author: Gourevitch, Peter A.
• Position: Book Review

Political Determinants of Corporate Governance: Political Context, Corporate Impact. By Mark J. Roe. * New York: Oxford University Press, 2003. Pp. 250. $29.95.

Why do corporate governance systems differ quite substantially around the world? The American model supervises managers through a board representing a diffuse mass of external shareholders whose rights are defended by a variety of institutional rules (such as those governing insider trading, antitrust, and an open market for corporate control) and by watchdog "reputational intermediaries" (such as accountants, securities analysts, and bond-rating agencies). The claims of employers, suppliers, and buyers are subordinated to shareholder rights. The German model, in contrast, supervises managers by concentrating ownership in blockholders, permitting insider relationships, allowing substantial horizontal coordination among producers, and accepting a variety of "stakeholder" claims on the firm besides those of the shareholders. Japan, as well as Sweden, Austria, and other continental European countries, resembles the German model to varying degrees, while the United Kingdom, Canada, Australia, Ireland, and New Zealand bear closer resemblance to the American system. Just why these differences exist has been the object of vigorous debate both in the legal academy (1) and across many other fields.

Mark Roe's new book, Political Determinants of Corporate Governance, vigorously presents the "politics school," of which he is the pioneer and an important leader. Political forces, he argues, account for the difference in choice of corporate governance models among advanced industrial countries. Researchers ask: What are the "legal and institutional preconditions for strong securities markets"? (2) Roe adds politics to the list and puts it in first place. Corporate governance arrangements inside the firm, Roe argues, interact deeply with a nation's politics. Political forces--party systems, political institutions, political orientations of governments and coalitions, ideologies, and interest groups--are the primary determinants of the degree of shareholder diffusion and the relationships among managers, owners, workers, and other stakeholders of the firm. Whatever the formal specifications of corporate law, politics shapes daily the calculations made by all players.

Roe argues that where social democracy is strong, shareholder rights are weak, and shareholder diffusion is low. (3) Social democracy gives voice to claims on the firm in addition to those of the shareholders: employee job security, income distribution, regional or national development, social welfare and social stability, and nationalism, to name a few. To counter these competing claims, blockholders resist diffusion of shares in order to maintain leverage in the boardroom, and investors shy away from a system in which they lack protection or dominance.

To test this theory, Roe first correlates the degree of shareholder concentration with various indicators of social democratic power, such as partisan composition of governments, employee protection in labor law, and income equality. He finds strong evidence that weak labor correlates with strong diffusion. He then provides qualitative process-tracings (country case studies of the historical evolution of governance patterns) that show how strong labor power inhibits diffusion, and examines the impact of other economic variables--the degree of economic competition and monopoly power--on the degree of shareholder diffusion.

Finally, Roe uses his political argument to confront directly a very influential alternative interpretation--the Quality of Corporate Law (QCL) argument, developed by Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny (LLS&V). (4) Countries with similar levels of QCL, Roe observes, differ in the degree of shareholder diffusion. Therefore, other variables must be in play. The critical one is politics. He demonstrates that for his sample of countries, the political account correlates more strongly than QCL with shareholder diffusion. Advanced industrial countries with high QCL vary considerably in the degree of shareholder diffusion; thus, something else must be at work. That something is the degree of social democratic influence. Roe tests LLS&V's impressive data collection with his own substantial data on political variables, and concludes, in my view convincingly, that politics does better than QCL. QCL can matter, Roe argues, when politics enables it to matter--that is, when property rights are assured, when enforcement and independent judges are allowed to work, and when the political balance in society gives it a place. Even then, the consequences for corporate governance of any given set of laws are driven by politics. Roe's is the only account in the law-and-economics tradition that makes politics explicitly central to an explanation of corporate governance in a comparative and international perspective. For him, political forces not only define the law--they also determine how the law actually operates.

In stressing politics, Roe directly challenges other leading interpretations that stress the primacy, and autonomy, of economics, law, and private processes of reputational bonding. Roe's book provides an important opportunity to examine the status of politics in the conflicting interpretations of corporate governance. No one really doubts that politics has something to do with corporate governance, but theorists vary considerably in the status they give to politics in a causal model. Roe is unique among major authors in seeing politics as continuous, ongoing, and primary. For other theorists, politics operates in the distant past, or indirectly, or barely at all.

Specifically, Roe's book allows us to examine a contest between his political theory and LLS&V's version of QCL. Although the essays contained in Political Determinants of Corporate Governance are not intended to confront QCL directly--Roe's concern with politics, dating back to the late 1980s, (5) precedes the LLS&V publications that emerged in the late 1990s--they in fact do so. In LLS&V's argumentation, the difference between governance systems arises from the effects of common-versus civil-law legal traditions; politics exists only in the initial choice of legal system in a given jurisdiction. LLS&V then focus on the consequence of this initial act upon the development of corporate governance systems and shareholder diffusion. Yet what a country does with its legal tradition and system turns on politics: the rules that determine the extent of economic competition within and between countries; the laws and decrees that structure banking, corporate finance, and the securities industry; the rules that shape the markets for capital and labor; and the degree of state involvement in the economy. LLS&V make allusions to politics in their analyses of QCL, referring to rule of law, judicial efficiency, and corruption. (6) But politics has no distinct causal status in their argument and, after the initial choice of systems, no longer plays a role in shaping the actual content or use of law.

Roe's political theory and the QCL theory are themselves criticisms of an important literature in economics that argues that the efficacy of the market makes regulation unnecessary and renders variation among governance forms unimportant or nonexistent. Competition in product and capital markets forces firms to adopt "rules, including corporate governance mechanisms," (7) that minimize costs in the drive to efficiency. In situations of vigorous competition, the remaining details of corporate governance are irrelevant. (8) The logic of risk diversification will lead to shareholder diffusion. Securities regulation is unnecessary and possibly harmful. (9) An open world economy will lead to convergence. Observed variance in systems among countries would reflect differences in economic competition, shaped by objective characteristics such as size or factor endowments. The empirical critique of this approach, made by Roe and LLS&V, notes that despite increasing international competition, the Berle-Means (10) separation of owners from managers by no means has become universal, and thus other forces must be at work. (11)

Another interpretation of diffusion, developed by Brian Cheffins (12) and John Coffee, (13) argues for the private capacity of markets to develop mechanisms of reputation without state intervention, thus implicitly without politics. John Coffee groups Roe with LLS&V and Lucian Bebchuk (14) as sharing the view that "[o]wnership and control cannot easily [be] separate[d] when managerial agency costs are high." (15) Although they disagree "about the causes of high agency costs--i.e., weak legal standards versus political pressures that cause firms sometimes to subordinate the interests of shareholders--they implicitly concur that the emergence of deep, liquid markets requires that the agency cost problem first be adequately resolved by state action." (16) In disagreement, Coffee quite persuasively argues that the Berle-Means model emerged from the behavior of private actors in the United States--bankers such as J.P. Morgan seeking to reassure foreign investors and the leaders of the New York Stock Exchange seeking to attract a particular kind of listing--and out of a particular situation in which state authority was absent. (17) The legal protections came afterward, as shareholders created a constituency seeking the aid of state authority. It is not the law that causes corporate governance, but the reverse. I read Coffee as agreeing that there was a managerial agency problem--investors sought protections--but believing that state regulation was not required to solve it.

Coffee rejects Roe's version of a political account, (18) but politics does appear in his analyses in two ways. First, the shareholders lobby for regulation after diffusion...