Effects on Management Decisions
Management decisions, in terms of varying corporate governance in different countries, are affected by the primary focus of each system. In the United States, the corporate governance system emphasizes the role of a free market which means that most of the decisions are done by corporate owners. The key owners are individuals who are passive investors whose primary concern is financial return whereas institutional shareholders have a primary interest in financial appreciation and income. They have little power to influence corporate policies and are expected to refrain from interfering with the ongoing operations of companies. If they happen to disagree with the way the management runs the company, they sell their shares (Rubach and Sebora, 1998). With individuals as the main shareholders through direct holdings or indirect holding and pension funds, the management tends to be independent and almost in full control in decision-making (Rothaermel, 2013). In the U.S., the corporate governance structure allows minimal impact of shareholders in management decisions.
In Japan, the emphasis of the corporate system which affects management decisions is the business network through which the interdependent, mutual self-interests of all stakeholders check one another. The key participants in Japan are businesses, banks, individuals, and institutions. Like in the U.S. corporate governance, individual shareholders tend to be passive. While the relationship with main bank systems is generally stable, inside directors tend to be more dominating of the managerial decisions. The Japanese board of directors is very influential in managerial decisions (Rubach and Sebora, 1998). However, in recent years, Japanese firms have been slowly diverting towards Japan’s traditional system of corporate governance to follow Western-like corporate governance features (Bauer et al., 2008). In Japan, corporate governance structure directs the management’s decision-making inwards.
In Germany, the management decisions are inclined towards the corporation as a wealth-producing entity which protects the self-interest of corporate employees and creditors (often large banks) that provide control and incentive (Rubach and Sebora, 1998). In Germany, banks are crucial shareholders. German corporations get the majority of their outside funding from large banks, which function as financers of the industry. Later on, German banks took on equity shares to monitor firms. This is why banks hold over 10% of shares in Germany. Aside from banks having a major role as shareholders, there is also the tradition of cross-holdings in Germany. Domestic non-bank firms have about 40% of the shareholder seats in the supervisory boards. As a result, in Germany, shareholder representation on the supervisory board is heavily weighted towards banks and other firms; thereby making the management’s decision making more complicated (Rothaermel, 2013). Main bank involvement resulted in a stable structure allowing managers to pursue long-term corporate objectives (Rubach and Sebora, 1998). In Germany, the corporate governance structure directs the management’s decision-making outwards.
In sum, the effects of the differences in corporate governance in these countries towards management decisions revolve around ownership and control of firms. In the U.S. where the owner tends to be of passive individuals and institutions, managers are in control. In Japan and Germany, where ownership is of controlling the board of directors and banks that serve as primary creditors and shareholders, managers tend to be limited (Aguilera and Crespi-Cladera, 2016). In light of this comparison, it should be kept in mind that a well-designed corporate system is one that should align managers’ incentives with those of nonfinancial stakeholders and reduce the perceived conflicts of interest between the management and stakeholders (Jo et. al, 2016). Nonetheless, it is inevitable for the management to have varying approaches towards the corporation’s decision-making process vis-à-vis the corporate governance structure in their country.
Criteria for Allocation
In general, the criteria for allocating capital within the corporation should primarily be the potential return on investment. Generally, firms with good governance are expected to provide transparent disclosures of capital allocation. Good corporate governance also allows firms to access capital markets on better terms and should positively impact a firm’s valuation and market performance (Anderson and Gupta, 2009). However, resource allocation criteria tend to vary depending on the type of corporate governance in each country. This difference could be attributed to the dominant financial structure per country and priority.
Financial structure refers to the process through which risks are transferred and resources are channeled to the most productive uses. This also ensures that managers pursue capital providers’ interests over their own. A country’s well-developed financial structure facilitates the transfer of savings to invest in a cost-effective manner while creating an avenue for corporate control and governance. Across different countries, there tend to be two types of financial structures: bank-based and market-based. In a bank-based financial system, banks tend to have an upper hand in capital allocation as they are better in mobilizing savings and investments and exerting corporate control (Anderson and Gupta, 2009). Germany remains its bank-centered financial system with the underdeveloped capital market. Companies in Germany continue to show strong demand for bank finance and as banks are allowed to own equity, banks tend to have a strong influence over capital allocation. In Japan and Germany, resource allocation tends to be directed towards long-term corporate strategy because shareholders and employees are stable (Jackson and Moerke, 2005). On the other hand, market-based financial structure operates through competition and disclosure. The presence of competition and financial disclosure leads to diversification and customization of risk-management devices. This leads to more risk-taking capital allocation that encourages economic growth (Anderson and Gupta, 2009). In the United States, it is the board of directors’ duty to administer the corporation’s business by allocating funds and reviewing corporate performance. As the board of directors tends to mimic the interests of shareholders, capital allocation tend to be inclined towards short-term financial gains (Rothaermel, 2013). In sum, the criteria for capital allocation differ in terms of who primarily makes the decision as reflected in the dominant financial structure per country.
Moreover, the criteria for capital allocation also differ in terms of the corporations’ priority. In the U.S., capital allocation is in line with the dominant definition of corporate success, returns on invested financial capital. In Japan, capital allocation tends to reflect an emphasis on returns on social capital. In Germany, the allocation of capital shows an emphasis on returns on human capital. Each system recognizes the value of each of these inputs in terms of capital allocation but the differences in priority are attributed to the diversity in corporate governance structures (Rubach and Sebora, 1998). These differences also explain the typical responses of companies in these countries in case of capital shortage or economic downturn. For example, in the U.S., companies tend to reduce capital allocated to labor, which results in lower employment. While this behavior is increasingly being observed in Japan and Germany too in the recent years, this trend is much lower and less rapid as compared to the U.S. Moreover, managers in Japan and Germany are noted to be less finance-oriented and more focused on long-term product strategy (Jackson and Moerke, 2005). Criteria for capital allocation differ in terms of what the corporations prioritize as reflected in their corporate governance system.
Effects of Globalization
Despite the stark differences in management decision-making and capital allocation in countries depending on corporate governance, globalization is exerting immense pressure for change. Due to increasing economic integration worldwide, companies must not compete only with firms in their countries but also with companies from around the world. These changes result in rethinking corporate governance structures (Gugler et al., 2004). One of the most prominent change that redefines corporate governance in Germany and Japan is financial liberalization. In both countries, banks have been strongly involved in long-term planning including financial services and advice, monitoring proxy votes, holding seats in corporate boards, and even owning equity or shares. However, financial liberalization has eroded the bank’s influence on corporations because it eased corporations’ access to external capital markets and increased competition among banks too. In Japan, the main banks’ relationship with corporations had dramatically weakened (Jackson and Moerke, 2005). For Germany, the effects of globalization were largely felt due to its membership in the European Union. To harmonize domestic policies with EU’s, Germany had to overhaul its banking and finance system, driving corporate governance away from being exclusively bank-controlled into more or market-controlled governance (Crane and Schaede, 2005). Along with these changes brought about by globalization, Japan and Germany-based corporations have to make difficult trade-offs and undergo the difficult process of transition towards a corporate governance structure that reflects that of the U.S. type of corporate governance.
Recommendation and Conclusion
The basic structure of corporate governance is composed of representatives as selected by stakeholders, who will select management to run corporations. This major premise of corporate governance, however, varies depending on a structure. One factor that distinguishes one factor from another is the role played by banks. In the U.S., banks generally play no role in corporate governance, whereas in Japan, and most especially in Germany, banks play a major role in corporate governance. In Japan and Germany, banks influence managerial decision-making and capital allocation. However, as globalization sets in and market capital has been liberalized, Japanese and German companies witness decreasing role and influence of banks in corporate governance. As these countries take the shape of U.S. corporate governance, they should also keep in mind, especially with the current global financial crisis that financial liberalization can have its disadvantages. Japanese and German firms should not abandon its traditional priorities such as stakeholder-centered corporate governance and long-term corporate objectives to protect themselves with the inefficiencies of market-based corporate system of the U.S.
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