Law and Agency: The Micro-Foundations of Institutional Change in National Corporate Governance Systems

Lead Research Organisation: King's College London
Department Name: Management

Abstract

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Description The main objective of this project outlined in the proposal was the creation of a longitudinal database, in order to investigating how legal reforms influence firm-level changes in corporate governance (CG) practices. As anticipated, given the ambitious nature of the research design (four countries, several hundred companies over two decades), the data collection lasted for the whole duration of the project. The main empirical results can therefore be expected to emerge over the coming months. Nevertheless, two key findings have already emerged.

Key finding 1: The sense and non-sense of CG indices

To achieve the objective of developing a shareholder orientation index (SOI), the existing commercial and academic CG indices (CGIs) have been reviewed. We found that virtually all existing CGIs, and authors using them, ignore issues of measurement reliability and validity, which are considered key criteria for good measurements in other disciplines. Therefore, rather than following existing methodologies of index creation - as originally planned -, the focus turned to improving the quality of CG measures. This involved a conceptual reflection on CG measurement and the search for the most appropriate methodology to create indices. The PI attended various statistical training courses. As a result of the statistical skills acquired, Structural Equation Modelling (SEM) has been chosen as a promising methodology that can help create valid and reliable measurements based on the new dataset. SEM can also accommodate recent insights from the so-called 'bundles approach' into the interplay between CG mechanisms. To the best of our knowledge, this constitutes a completely novel approach to index construction in the field of CG.

A working paper entitled 'Measuring Corporate Governance: Lessons from the Bundles Approach' summarises this finding (Cambridge Centre for Business Research (CBR) working paper no. 438). It has been presented at the following conferences and institutions: Conference on National Corporate Governance Bundles, Judge Business School Cambridge; London Centre for Corporate Governance and Ethics; SOAS, University of London; Linnaeus University, Sweden.

As part of this line of research, the PI co-organised a panel on Bundles in CG Research, which was held at the University of Chicago during the 26th annual SASE conference and included: Prof. Christina Ahmadjian, Hitotsubashi University, Tokyo, Prof. William Judge, former editor in chief of Corporate Governance International Review (CGIR), and Prof. Thomas Clarke, University of Technology, Sydney. The panel allowed the PI to present the project to world-renowned CG scholars, benefit from their input, and engage in exchanges after the conference.

Key finding 2: The "Law & Finance" School's "thin" conceptualisation of law

A second key finding relates to the fundamental research question outlined in the research proposal: 'Does law matter for firm-level CG change?'

The literature review revealed that most empirical studies investigating whether 'law matters' are not based on any consistent conceptualization of the link between law and corporate outcomes. The Law & Finance School implicitly assumes that law impacts economic actors either through i) threats or ii) incentives. However, legal scholarship shows that these two channels are not the only ways in which law affects corporations. A second paper focuses on this issue. Drawing on fundamental legal theories, it suggests that legal theory needs to be taken more seriously and the above-mentioned channels need to be complemented by an additional one, i.e. the signalling of appropriate behaviour by the law.
This finding also has implications for empirical studies. It suggests that the research designs of existing studies are inappropriate, because they do not capture all possible effects of law on practices. The new data set will allow us to test more appropriate empirical strategies in the coming months.

This paper has since been published a State of the Art paper for Socio-Economic Review and is now co-authored with Prof. Ruth Aguilera (Northeastern University, Boston, MA, USA) and Prof. Mathias Siems (Durham Law School, UK).

Key finding 3: New Types of "Decoupling"
A further key finding that has recently emerged from the empirical data analysis, concerns the differential impact that corporate governance regulation and law has in different countries. Thus, my paper "Minority Shareholder Protection in Law & Practice: Investigating new types of decoupling" shows that an increase in legal minority shareholder protection has a stronger impact on corporate practices in the UK than in the continental European countries Switzerland, Sweden, and the Netherlands. Even among the continental cases, there are differences: Swiss companies react more strongly to legal change than Swedish companies; and in the Netherlands the impact is even negative (increases in legal MSP leads companies to adapt more control enhancing mechanisms). This finding is consistent with my previous research on differences in insider-corporate governance systems in continental Europe: In countries with more dispersed ownership structures, such as the Netherlands, insiders will substitute new control mechanisms for legal mechanisms that are abolished by legal changes; in countries with more concentrated ownership structures - such as Switzerland and Sweden - the incentives for insiders to adapt new control practices are lower. The Law & Agency project allowed me to confirm this finding based on qualitative data. It also provided the further insight that low levels of ownership does not have the same effect on the relationship between law and practice in the UK case. This hints at a different impact of law on practices in more adversarial legal systems compared to the more cooperative-coropratist systems of continental Europe. This empirical finding has two important implications for theory: firstly, it shows that 'decoupling' between institutional rules and firm practices is a highly-contextual phenomenon that may be strongly influenced by country-level factors; secondly, the difference between the civil law and the common law cases in our sample suggest that the 'legal style' (adversarial or cooperative) that prevails in a given country may have an important impact on 'how law matters' for corporate practices;

Key finding 4: The "Legal Signalling" effect of CG law

The project has led us to formulate a more fine-grained theory of how law affects companies. Specifically, our framework distinguishes between the 'efficiency effect' or the law (i.e. its impact on transaction costs that firms and investors face) versus the laws signalling effect, i.e. how law can signal good standards that have an impact on real economic outcomes, without necessarily having a concrete impact on firm-level practices. A recent paper (under review at British Journal of Management) addresses this aspect by distinguishing the impact of laws actual effect from the effect of its perception on Initial Public Offering (IPO) valuations. We find that indeed the laws' signalling or perception effect is a more important driver of firm value at IPO than the actual quality of the law.
Exploitation Route The objectives have been met. Some parameters of the project had to be changed, however, due to data availability and methodological reasons. Thus, the number of companies for which data was collected has been increased from 40 to a target of 100 per country and year, as it was feared that otherwise the statistical analysis might not have generated sufficiently robust results. Conversely, due to the larger number of companies in the sample and to data availability issues, the number of variables that were collected has been reduced compared to the initial list of potentially interesting variables. Generally, speaking the data collection process was more challenging and time-consuming than anticipated, in part because of issues with the recruitment of appropriate research assistants.

The PI has presented the project to various possible end-users, including on several occasions to PIRC (Adam Rose) and Deloitte & Touch (Oleg Shvyrkov). The PI has also established regular contacts with the European Bank for Reconstruction & Development (EBRD). This involved meetings at the EBRD to present the project and a guest lecture at King's by Gian Piero Cigna, senior counsel at the EBRD on related issued.
The practitioners were particularly interested in the measurement and methodological considerations, as well as the bundles approach, because many of them are aware of the limitations of existing CGIs methodologies and are eager to improve them. The Institute of Directors (IoD) has referred to the results of this study in a project aiming at developing a good corporate governance index: https://www.iod.com/Portals/0/PDFs/Campaigns%20and%20Reports/Corporate%20Governance/IoD%20Good%20Governance%20Index%202015.pdf?ver=2016-08-31-153353-510
Sectors Financial Services, and Management Consultancy,Government, Democracy and Justice,Other
URL http://www.gerhardschnyder.com/law-and-agency/
 
Description With Dr. Julien Etienne from ICF Ltd. we successfully bid for a short-term consultancy project on behalf of the Department for Business, Energy and Industrial Strategy (BEIS) on the subject: Comparative Analysis of Regulatory Regimes in Global Advanced Economies (Sourcing reference number CR18010 Lot 1). As part of this bid, we ran two half-day training sessions for public officials working for BEIS and other government departments. The training sessions were informed by findings gained from the Law & Agency bid, in particular the insights into comparative regulatory dynamics in Britain versus continental European countries and processes of decoupling between law/regulation and corporate practices. The Institute of Directors has cited output from the L&A project in a 2015 working paper on a new Good Corporate Governance Index (see relevant section), which was finally published in 2017: https://www.iod.com/Portals/0/PDFs/Campaigns%20and%20Reports/Corporate%20Governance/GGI-report-2017-IoD.pdf
First Year Of Impact 2017
Sector Environment,Financial Services, and Management Consultancy,Government, Democracy and Justice
Impact Types Economic,Policy & public services
 
Description 'More Teeth Needed for Corporate Governance Reforms': Response to the Dept. BEIS Green Paper on Corporate Governance Reform
Geographic Reach National 
Policy Influence Type Contribution to a national consultation/review
URL https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2921800
 
Description Mention in the report 'Corporate Governance for a Changing World' published by FrankBold in relation with 'The Purpose of the Corporation' project
Geographic Reach Europe 
Policy Influence Type Influenced training of practitioners or researchers
URL http://www.purposeofcorporation.org/corporate-governance-for-a-changing-world_report.pdf
 
Description Report and Training for BEIS on "COMPARATIVE ANALYSIS OF REGULATORY REGIMES IN GLOBAL ECONOMIES"
Geographic Reach National 
Policy Influence Type Influenced training of practitioners or researchers
URL https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/7557...
 
Description Research output cited in Institute of Directors (IoD) Good Corporate Governance Index project
Geographic Reach National 
Policy Influence Type Citation in other policy documents
URL https://www.iod.com/Portals/0/PDFs/Campaigns%20and%20Reports/Corporate%20Governance/IoD%20Good%20Gov...
 
Description Successful Bid with ICF for Consultancy Mandate for BEIS including delivery of training workshops on comparative analysis of regulatory regimes
Geographic Reach National 
Policy Influence Type Influenced training of practitioners or researchers
 
Title Law and Agency: The Micro-Foundations of Institutional Change in National Corporate Governance Systems 
Description This data collection contains the data generated by the Law & Agency project (ESRC award number RES-061250518). It constitutes the basis for a firm-level Shareholder-Orientation Index (SOI). The project aimed to collect data for a sample of approximately 100 large listed companies for four countries (The Netherlands, Sweden, Switzerland and the United Kingdom) for the time period 1990-2010. The data are longitudinal in nature (1990-2010) and contain firm-level corporate governance practices and mechanisms as well as financial control variables. 
Type Of Material Database/Collection of data 
Year Produced 2016 
Provided To Others? Yes  
Impact none as of yet 
URL http://reshare.ukdataservice.ac.uk/851977/
 
Description Law & Finance Collaboration 
Organisation Northeastern University - Boston
Country United States 
Sector Academic/University 
PI Contribution The Law & Agency project has given rise to a continuing collaboration between the PI and Prof. Ruth Aguilera at Northeastern University, Boston, MA, USA. The collaboration has so far led to two co-authored research papers drawing- and building on the insights gained from the L&A project. My contribution was to draw on the findings from the L&A project to suggest new interpretations and theories of how law impacts corporate governance practices and economic outcomes. I also contributed to writing up these ideas, collecting further data and analyse it together with my colleagues. As lead author, my contribution also involved presenting the two papers at various conferences and managing the peer review process.
Collaborator Contribution Prof. Aguilera contributed to both papers through discussion of ideas, theoretical arguments, writing, presenting and discussing drafts of the papers at international conferences.
Impact Article published in Socio-Economic Review https://academic.oup.com/ser/advance-article/doi/10.1093/ser/mwy041/5156181 Interdisciplinary: Law, legal philosophy, management studies, economics Article entitled "Legal Perception and Finance: The Case of IPO Firm Value" under review at British Journal of Management (Second round R&R) Interdisciplinary: Law, legal philosophy, management studies, economics
Start Year 2015
 
Description Law & Finance EUI colllaboration 
Organisation European University Institute
Country Italy 
Sector Academic/University 
PI Contribution The Law & Agency project has furthered a continuing collaboration between the PI and Prof. Mathias Siems, EUI, Florence, Italy on topics related to Law and Finance. The collaboration has so far led to two co-authored research papers drawing- and building on the insights gained from the L&A project. My contribution was to draw on the findings from the L&A project to suggest new interpretations and theories of how law impacts corporate governance practices and economic outcomes. I also contributed to writing up these ideas, collecting further data and analyse it together with my colleagues. As lead author, my contribution also involved presenting the two papers at various conferences and managing the peer review process.
Collaborator Contribution Prof. Siems has contribute with insights into the theoretical framing, development of theory and research design, writing of draft papers and presenting them in various international conferences.
Impact SER article BJM article (see other entry - Law & Finance collaboration)
Start Year 2014
 
Description Say on Pay regulations project 
Organisation King's College London
Country United Kingdom 
Sector Academic/University 
PI Contribution This collaboration follows up on a particularly important change in the recent legal changes in corporate governance rules in one of the countries analysed in my project, i.e. changes to the say on pay regulations in the UK. Since the legal change in question fell outside the time period covered in my project, this collaboration was set up to carry out a study on this particularly relevant legal change and how it affects the corporate governance practices of companies (in terms of CEO pay reporting) and of institutional investors. I contributed to the design of the study and to the management of two research assistants.
Collaborator Contribution This was a collaboration with a colleague from accounting who contributed to the design of the study notably through her expertise in the area of managerial compensation and who managed the two research assistants together with me.
Impact This collaboration has led to the creation of a new dataset on voting dissent on say on pay topics during FTSE 100 companies' AGMs.
Start Year 2015