Corporate governance is concerned basically with the agency problem that arises from the separation of finance and management (or, in popular terms, ownership and control). It refers to the mechanisms and arrangements employed by financiers (shareholders and lenders) to induce managers, who tend to acquire considerable residual control rights in practice, to care for their interest. As Andrei Shleifer and Robert W. Vishnu say: "Much of the subject of corporate governance deals with constraints that managers put on themselves, or that investors put on managers, to reduce the ex post misallocation and thus to induce investors to provide more funds ex ante."5 It deals with questions like: How do financiers exercise control over managers? How do financiers ensure that managers do not steal the resources placed with them, or squander them on uneconomic projects? More specifically, corporate governance covers issues like the legal rights of financiers, the role of large investors, the method of electing boards of directors, the composition of the board, the composition of various sub-committees of the board, the appointment of the auditors, the ability of the board to maintain surveillance, the system of checks and balances instituted over managerial behaviour, the incentives offered to managers to protect financiers from dissipation of capital, the standards of financial reporting and corporate disclosure, and so on.
A great deal of concern has been expressed all over the world about the shortcomings in the systems of corporate governance. This has been articulated very eloquently by Michael Jensen6, Jonathan Charkham7, and others. In his highly perceptive presidential address to the American Finance Association in 1993, Jensen argued persuasively that the general failure of large companies to restructure and redirect themselves in the absence of external compulsions reflects an inadequacy in the corporate governance mechanisms. To understand corporate governance in developed countries, we will look at two significantly different models, the Anglo-American model and the German-Japanese model.
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