Corporate governance: Context and ‘inside-out’ practices
By Petros Florides
Around the world, two systems of corporate governance have developed in response to different contexts.
The “Outsider System” is mostly found in Anglo-Saxon countries that have embraced capitalism and prefer risk capital to fund commerce and industry. Some characteristics of this system are: dispersed shareholders, an institutional investor base, focus on maximizing shareholder returns, separation of ownership and management, board composition determined by knowledge and experience, moderate control by a large range of shareholders, opportunity for shareholder democracy, hostile takeovers considered an effective market discipline, shareholder dissatisfaction often registered by selling shares, and strong minority shareholder protection.
The “Insider System” can be found in Rhineland countries and Asia, for example. These have traditionally utilized bank loans as the main source of funding. Companies throughout the value chain also work in mutual cooperation. Some characteristics of this system are: concentrated shareholders, family or cross-company shareholder base, focus on meeting debt obligations and other wider stakeholder concerns, little separation of ownership and management, board composition determined by stakeholder representation, dominant control by a small group of shareholders, limited shareholder democracy, transfer of wealth from minority to majority shareholders, hostile takeovers considered disruptive, shareholder dissatisfaction often registered by voicing concerns, and weak minority shareholder protection.
Germany developed an Insider System to unite the country after the declaration of its empire in 1871. This provided for “Mitbestimmung” (Co-Determination) between business owners, providers of capital and workers and supports Germany’s social democratic values. Japan’s Insider System is referred to as “Keiretsu”, with interlocking business relationships and shareholdings. South Korea’s equivalent is known as “Chaebol”, dominated by large family-owned conglomerates. Both reflect the culture in much of Asia that may be described as more consensus-orientated, introverted and tribal compared to Anglo-Saxon cultures. Business tends to be conducted between parties within a ‘circle of trust’, and loyalty is nurtured throughout the value chain with relatively long term interests of stakeholders taken into consideration. This can be contrasted with the Anglo-Saxon business culture that depends to some extent on hostile takeovers to secure growth and market dominance, with an emphasis on increased shareholder returns in the relative short term. Business relationships in Outsider Systems are dominated by contractual agreements rather than a sense of interdependency more common in Insider Systems.
Neither system is “better” than the other. The US and UK provide examples of success with an Outsider System, whilst Germany and Japan do the same for the Insider System. What is important is whether the system applied is appropriate to the context, and whether the underlying principles of good governance are being upheld.
Upon reflection, it can be seen that Cyprus has many characteristics that sit comfortably within an Insider System including, inter alia: big business dominated by a few large companies with concentrated ownership, limited protection or concern for minority shareholders, the tendency to support friends and family through business arrangements, limited alternatives to bank funding, a general consensus to maintain social cohesion, and powerful unions exerting influence in business and politics.
Part of the reason for Cyprus’ catastrophic failure of corporate governance may be the adoption of practices applicable to an Outsider System. This was influenced by our tendency to follow the lead of the United Kingdom in such areas, but with too little consideration of context. Whilst Outsider System governance practices are appropriate for the United Kingdom with decades of experience as a major financial center with international corporations and institutional investors, Cyprus’ profile and experience is somewhat different. The result is that although Cyprus appears to have implemented generally accepted governance practices, they may never have been suited to our context. If this is true, a failure of governance was always more likely than not.
In any case, two things are beyond doubt. Firstly, the existing system of governance was no match for the culture within the public sector and banking that proved to be the antithesis of transparency, accountability, probity and sustainability. Secondly, to have any hope for the future, ‘the way we do things around here’ must change.
Since nobody is able to defend the status quo, we now have the opportunity for root and branch reform of governance in Cyprus. To this end, a wide cross section of professional bodies, academia, civil society and individuals are collaborating on a new “New Governance for a New Cyprus” initiative. This will include promoting the concept of a “Governance Charter” of ethics, values and principles reinforced by new laws if necessary. A holistic approach to good governance is also being advocated, with each stakeholder group exercising their rights and responsibilities to contribute to the overall governance process.
Any organization, institution or individuals interested in joining the initiative for a better Cyprus through better governance are invited to contact Petros Florides (firstname.lastname@example.org ).
The views in this article represent those of the author and not any other individual or organization.
Petros Florides is Regional Governance Advisor for World Vision International, and Executive Officer of World Vision Cyprus. Petros is also on the board of Institute of Directors (Cyprus), co-founder of the Cyprus National Advisory Council for the Chartered Institute for Securities & Investments, co-founder of the Institute of Risk Management Cyprus Regional Group, and a Chartered Management Accountant.
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