Monitoring and corporate governance
In spite of our attempts to control conflicts between the various stakeholder groups, the conflicts do still occur. They can and do occur between basically any of the stakeholder groups. For example managers and employees, or managers and stockholders. We frequently will speak that stockholders, as residual claimants, are in the best position to monitor the firm. However, even given that, any individual stockholder generally does not have much incentive to bear the costs of monitoring.
Why monitor? Suppose you knew that by monitoring you could improve operations at a company you owned stock in. It will raise the price of the stock by $2.00 a share but will cost $3,000 to monitor. If you own 100 or even 1000 shares will it be worth your while to monitor? Of course not. You are incurring all of the costs but only getting a fraction of the benefits. Shareholders elect a board of directors to look out for shareholder interests. There is much evidence however that the board does not always do a sufficient job of monitoring.
One solution to this is that in recent years institutional investors have assumed a more active role in monitoring and in corporate governance. Calpers prides themselves on monitoring firms and used to publish an annual list of firms that have not lived up to their expectations. Additionally Calpers frequently urges shareholder to vote with them in proxy contests against the firm. Here is a list of those votes and their outcomes. If the internal controls do not work, the external market for corporate control will generally come to the rescue! When this happens a poorly performing firm will be taken over and the managers will generally be replaced. It must be noted that the mere threat of this is often enough to keep managers looking out for shareholder’s interests.
However this threat is not always there. For example in many countries hostile takeovers are difficult to do. In these countries we have seen different corporate governance models and subsequently firms look and behave differently. The working paper entitled “‘Big Bang’ Deregulation and Japanese Corporate Governance: A Survey of the Issues” by MICHAEL S. GIBSON of the Board of Governors of the Federal Reserve System and the University of Chicago, Grad. School of Business provides an interesting look at how corporate governance works (or does not work) in Japan. To summarize, the paper says that the Japanese financial system is less adept at assuring shareholder interests. The three main explanations for this are that inside stakeholders dominate, institutional investors are weak, and there is virtually no market for corporate control in Japan. (Compare this to US financial system where the reverse of each is true.) The paper can be downloaded at http://papers.ssrn.com/paper.taf?abstract_id=133552