The elusive quest for global governance standards.

• Author: Bebchuk, Lucian A.

Researchers and shareholder advisers have devoted much attention to developing metrics for assessing the governance of public companies around the world. These important and influential efforts, we argue, suffer from a basic shortcoming. The impact of many key governance arrangements depends considerably on companies' ownership structure: measures that protect outside investors in a company without a controlling shareholder are often irrelevant or even harmful when it comes to investor protection in companies with a controlling shareholder, and vice versa. Consequently, governance metrics that purport to apply to companies regardless of ownership structure are bound to miss the mark with respect to one or both types of firms. In particular, we show that the influential metrics used extensively by scholars and shareholder advisers to assess governance arrangements around the world--the Corporate Governance Quotient (CGQ), the Anti-Director Rights Index, and the Anti-Self-Dealing Index--are inadequate for this purpose.

We argue that, going forward, the quest for global governance standards should be replaced by an effort to develop and implement separate methodologies for assessing governance in companies with and without a controlling shareholder. We also identify the key features that these separate methodologies should include and discuss how to apply such methodologies in either country-level or firm-level comparisons. Our analysis has wide-ranging implications for corporate-governance research and practice.

INTRODUCTION I. THE QUEST FOR GLOBAL STANDARDS A. The Demand for Global Standards B. Shareholder Advisers' Efforts: The CGQ System C. Academics' Efforts: The Anti-Director Rights Index and the Anti-Self-Dealing Index 1. The Anti-Director Rights Index 2. The Anti-Self-Dealing Index II. INVESTOR PROTECTION AND OWNERSHIP STRUCTURE A. Some Fundamental Differences Between CS and NCS Companies 1. Nature of the Agency Problem 2. Contestability of Control 3. Ability of a Majority of Shareholders to Exercise Their Formal Power 4. The Main Ways in Which Opportunism Benefits Insiders B. Control Contests 1. The Difference Between CS and NCS Companies 2. Treatment by Governance Standards C. Voting Procedures 1. The Difference Between CS and NCS Companies 2. Treatment by Governance Standards D. Allocation of Power Between the Board and Shareholders 1. The Difference Between CS and NCS Companies 2. Treatment by Governance Standards E. Allocation of Power Between the Majority and the Minority 1. The Difference Between NCS and CS Companies 2. Treatment by Governance Standards F. Director Independence 1. The Difference Between CS and NCS Companies 2. Treatment by Governance Standards G. Arrangement Governing Potential Value Diversion 1. The Difference Between CS and NCS Companies 2. Treatment by Governance Standards III. GOING FORWARD A. Evaluating Companies 1. NCS Companies a. Control Contests b. Shareholder Voting Procedures c. Allocation of Power Between the Board and Shareholders d. Executive Compensation e. Director Independence 2. CS Companies a. Allocation of Power Between the Majority and the Minority b. Self-Dealing and Freezeouts c. Director Independence d. Control Contests e. Shareholder Voting Procedures f. Allocation of Power Between Boards and Shareholders g. Executive Compensation h. Controlling Minority Shareholders B. Evaluating Legal Systems CONCLUSION INTRODUCTION

Researchers, investors, and policymakers around the world have been focusing increasingly on corporate governance. (1) There is now widespread recognition that adequate investor protection can substantially affect not only the value of public firms and their performance (2) but also the development of capital markets and the growth of the economy as a whole. (3) This view has naturally led to heightened interest in identifying and bringing about corporate-governance improvements at both firm- and countrywide levels. (4)

These developments also have sparked substantial demand for reliable metrics for evaluating the quality of corporate governance in public firms. (5) Such metrics can facilitate research on corporate governance, inform investment decisions by institutional investors, and guide efforts to improve governance by both private and public decision makers. Both academic researchers and shareholder advisers have made considerable efforts to develop such metrics. (6) These metrics in turn have been used by more than one hundred academic studies, have been extensively utilized by practitioners, and have had a large impact on corporate-governance research and practice. (7)

The notion of a single set of criteria to evaluate the governance of firms around the world is undoubtedly appealing. Both investors and public firms are, after all, operating in increasingly integrated global capital markets. This Article argues, however, that the quest for a single, global governance metric is misguided.

The incidence of controlled and widely held firms varies considerably around the world. (8) In the United States and the United Kingdom, most public companies do not have a controlling shareholder. (9) In most other countries, companies with a controller dominate. (10) The literature has recognized the fundamental differences both in the nature of the agency problems underlying controlled and widely held firms and in the means for addressing these problems. (11) But the critical implications of these differences have not been adequately reflected in either the design or the use of governance metrics. (12)

Because the fundamental governance problems of controlled and widely held firms differ significantly, the effect of many governance arrangements critically hinges on whether the company has a controlling shareholder. Arrangements that enhance investor protection in companies without a controlling shareholder are often inconsequential--or even detrimental--to outside investors in companies with a controlling shareholder, and vice versa. As a result, as we explain in this Article, governance-rating methodologies that use a single metric for assessing investor protection worldwide, at either the firm or the country level, are likely to produce an inaccurate or even distorted picture. Indeed, we demonstrate that this is the case with respect to the most influential and widely used global governance metrics.

Academics and practitioners, we argue, should abandon the effort to develop a single governance metric. Rather, they would do better to develop separate methodologies for assessing the governance of companies with and without a controlling shareholder. Such a two-track approach would best serve researchers, investors, and policymakers in assessing investor protection at either the country level or the firm level. We further identify the key features that these separate methodologies should have, thereby providing the necessary framework for developing and applying a new approach for assessing corporate governance around the world.

Our analysis has wide-ranging implications for corporate-governance research and practice. Among other things, it indicates that researchers may need to reexamine the findings of the large number of academic studies based on existing global governance metrics and reevaluate the governance ratings currently used by institutional investors and shareholder advisers. Furthermore, our analysis provides an approach that can facilitate and improve future governance assessments by researchers and practitioners.

We begin in Part I with an overview of the quest for global governance standards and the most influential global governance metrics. Among academics, the most influential effort has been made by a team of financial economists who put forward successively two indices for measuring countries' level of investor protection, the Anti-Director Rights Index and the Anti-Self-Dealing Index. (13) These indices have been applied by more than one hundred academic studies and have had considerable influence on corporate-governance research. (14) Among practitioners, the most influential effort to date has been RiskMetrics's Corporate Governance Quotient (CGQ) system for rating firms' corporate governance arrangements. (15) The CGQ system has been widely used by investors and pubic firms, (16) and its use among academics is growing. (17)

In Part II, we discuss the relationship between firms' ownership structures and the governance arrangements that would best protect their investors. We begin by describing the basic differences between controlled and widely held firms in terms of the governance problems that their outside investors face. We then analyze the implications that these differences have for key sets of governance arrangements: those regulating control contests, voting procedures, the allocation of power between directors and shareholders, the distribution of power among shareholders (i.e., the allocation of power between majority and minority shareholders), director independence, and corporate transactions that may divert value to insiders.

With respect to each of these important areas, we show that the impact of governance arrangements on outside investors depends significantly on whether the firm has a controlling shareholder. As a result, the failure of the Anti-Director Rights Index, the Anti-Self-Dealing Index, and the CGQ system to properly take into account the relationship between ownership structure and corporate governance substantially undermines the indices' ability to serve as effective metrics for the governance quality of firms or countries worldwide.

Consider, for example, antitakeover defenses such as the poison pill. These arrangements determine the extent to which a widely held company is subject, for better or worse, to the discipline of the market for corporate control. (18) In companies with a majority shareholder, however, a hostile takeover is not feasible even in the absence of...