Comparative Corporate Governance and the Theory of the Firm: The Case Against Global Cross Reference

This paper takes up the main questions addressed by the literature on comparative corporate governance: Whether national governance systems can be expected to converge in the near future, and whether the focal point of that convergence will be a new, hybrid governance system comprised of best practices drawn from different systems. The paper advances the view that neither global convergence that eliminates systemic differences nor the emergence of a hybrid best practice safely can be projected because each national governance system, rather than consisting of a loose collection of separable components, is tied together by a complex incentive structure. Interdependencies between each system's components and the incentives of its actors create significant barriers to cross reference to and from other systems. In contrast, the cross-reference hypothesis widely advanced in the comparative governance literature presupposes divisible institutions?a world in which one system's components can be adapted for use in the other system without significant frictions or perverse effects. The paper draws on models of monitoring and blockholding articulated in the incomplete contracts theory of the firm. Under incomplete contracts theory, different governance systems have incentive structures that entail different trade offs?trade offs between ownership concentration and liquidity, between monitoring and management initiative, and between private rent seeking and activity benefitting shareholders as a group. The trade offs delimit opportunities for productive cross reference. More particularly, blockholder systems, such as those in Europe, subsidize monitoring by permitting blockholders to reap private benefits through self dealing and insider trading. Market systems, such as those in the United States and Britain, regulate such private rent seeking toward the end of maintaining an institutional framework that supports diffuse share ownership and liquid trading markets. It follows that a legal framework conducive to blockholding may be ill equipped to foster dispersed equity ownership and thick trading markets, and that a legal framework conducive to liquid trading markets may have properties that discourage blockholding. There result questions for law reform agendas on both sides of the Atlantic. In the United States proponents ask for deregulation of controls on institutional investors, looking to encourage blockholding and more effective monitoring. In Europe proponents ask for stronger securities regulation, looking to encourage deeper trading markets. The paper projects that each reform program may lead to disappointing results because neither assures conforming adjustments to the pertinent actors' incentives. Alternatively, strict reforms that materially change prevailing incentive patterns could perversely destabilize workable (if imperfect) arrangements without assuring the appearance of more effective alternatives.