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Business and Society Programme
DP/108/1999
ISBN 92-9014-616-8
First published 1999
Financial Markets, Corporate Governance, and the Role of Business in Society
By
Howard Gospel
King's College, University of London
and Centre for Economic Performance,
London School of Economics
Andrew Pendleton
Manchester Metropolitan University
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| Financial Markets, Corporate Governance, and the Role of Business in Society |
 Introduction
I. Definitions and concepts
II. Dimensions of national systems
III. Linkages with social policy and initiatives
IV. Evidence from national systems
V. Conclusions
Notes
References
Introduction
This paper explores links between financial markets, corporate governance, and the role
of business in society. Students of industrial relations and human resource management have
always been aware of the importance of labour markets and their effect on aspects of work and
employment. They have also long been aware of the significance of product markets and how
these may also influence work and employment. However, research in industrial relations and
human resource management has usually neglected the importance of financial markets.
Similarly, industrial relations scholars have always had some interest in what is now
conveniently referred to as corporate governance. Thus, there has over the years been an
interest in the effects of foreign ownership, in forms of employee ownership, and in small
owner-managed firms. However, investigation has not focused on corporate governance
mechanisms as a primary area of interest.
In contrast to this neglect, there has recently been a growing interest in financial markets
and corporate governance among both academic analysts and within popular and political
debate.(Endnote 1) The interest in financial markets may well attest to the so-called globalisation of such
markets, greater competition within them, and fears of financial market instabilities. A similar
growth in interest in corporate governance has in part been influenced by questions of company
performance and allegations of corporate wrongdoing. This interest in governance has been
reflected in a number of major reports in several countries.(Endnote 2)
In the academic literature, there has
also been a burgeoning of interest, both theoretical and empirical, in aspects of corporate
governance.(Endnote 3)
To date, these developments are only just beginning to feed through to the
literature on the broader social role of business.
The purpose of this paper is to explore the possible connections between financial
markets, corporate governance, and the social role of business. The intention is to suggest how
certain core aspects of enterprise social activity may be influenced by the types of finance used
by firms and the characteristics of governance within firms. At the 'micro-level', we explore
how specific aspects of financial and governance systems may be related to specific human
resource characteristics within the firm. We also consider the possible relationships, using a
comparative approach that draws on systemic differences between major countries, primarily
the United States, United Kingdom, Germany, and Japan. Throughout, our focus is on large
firms with share capital, since such firms have been the main area of interest in the finance,
corporate governance, and public policy debates. We draw on a number of bodies of literature,
in particular from financial economics, industrial relations, and human resource management.
In the next section, terms are defined and analytical concepts are identified. In the following
section, a number of major typologies of financial market and corporate governance systems are
delineated. On the basis of this, certain linkages are outlined. The following section then
presents evidence illuminating and investigating these relationships. Finally, some broad
conclusions are drawn and an agenda for further research is suggested.
I. Definitions and concepts
For the purposes of analysis, some terms are defined narrowly, others are given a
broader definition.
Enterprise social policies and initiatives are of various kinds. First, one may distinguish
between internal and external activities. Internal policies refer to employment, training, and
welfare measures undertaken by organisations for their own employees. This is the traditional
area of enterprise social or human resource policy. Such policies may be benign and have
positive effects or they may be less benign and have more deleterious consequences. By
contrast, external initiatives are those measures which are undertaken by enterprises for actors
outside the organisation and within the broader community. These can be either individuals,
groups, or other organisations. Individuals and groups are usually to be found within the
localities where the firm operates. Outside organisations include business partners and
subcontractors, suppliers, customers, and other usually smaller companies; initiatives might also
extend to local and national community groups such as schools and voluntary organisations
such as charities.(Endnote 4) Broadly speaking, internal policies are mainly concerned with the firm's own
human capital; external initiatives have more of an effect on broader social capital (Putnam,
1995).
Social initiatives can be further subdivided into those which are clearly based on
business priorities and those which are less business orientated. The former category covers
initiatives such as the promotion of job related training, the development of subcontractor skills,
or the creation of local infrastructure conducive to business in a community. These are clearly
in a company's interest and have a pay-off for the specific firm. The latter category includes
initiatives which are charitable and artistic in nature, such as general educational provision or
sport and artistic sponsorship. Of course, some of the latter will have a reputational effect and
may have a long-term return - they are not therefore entirely disinterested.
Internal social policy is taken to cover three main areas - work relations, employment
relations, and industrial relations (Gospel, 1992). Work relations cover the way work is
organised and the deployment of workers around technologies and production processes. It
therefore relates to the division of labour and the surrounding work processes. Employment
relations deal with the arrangements governing such aspects of employment as training, job
security, and the reward of employees. It concerns the content of such arrangements and how
they are regulated. Industrial relations is defined to cover the voice aspirations of employees
and the resulting institutional arrangements which may exist, such as joint consultation, works
councils, and collective bargaining. It is therefore concerned with representational systems and
methods of social dialogue. There may be trade-offs and complementarities between internal
and external social activities, some of which will be explored below.
Financial markets as defined in this paper are conceived somewhat narrowly to cover
how firms raise financial resources and how they reward those who provide such resources.
The role of currency markets, futures, and derivatives markets is therefore largely excluded
from the current analysis. Although we do not deal explicitly with movements in interest rates,
the cost of capital is obviously important since this will have an effect on the financing
decisions made by the firm. A similar comment applies to taxation systems. The focus of the
paper is therefore on the capital structures of firms, an approach which parallels the interest in
the financial economics literature.
The term corporate governance is often used narrowly to cover the structure and
functioning of boards of directors and the formal systems of accountability of senior managers
to shareholders. In this paper, corporate governance is defined more broadly to cover the whole
relationship between owners, managers, and other groups or stakeholders with an interest in the
firm. It is therefore concerned with who controls the firm and how that control is exercised.
There is, of course, an important link between capital structure and ownership since most large
firms raise capital by selling ownership. Here the particular focus is on how the relationship
between owners and managers may impinge on social activities of the firm.
Since most readers will be familiar with human resource and industrial relations issues,
we do not propose to elaborate on our definitions at this point. However, financial and
corporate governance issues may be less familiar. In the remainder of this section, therefore, we
consider some major aspects of each of these as a prelude to considering linkages with human
resource and social activities of the firm.
In terms of capital structure, large firms may acquire investment and working capital in
any one or a mixture of three ways: by drawing on retained earnings out of current cash-flow;
by borrowing money from individuals, banks, and other companies; and by issuing share equity.
Traditional finance theory views these sources of capital as standing in a hierarchy of
preferences for firms (Modigliani and Miller 1958; Hart 1995a). Retained earnings are the most
attractive source of finance to the firm, since in principle the direct cost of capital is zero
(though there may well be opportunity costs). For owners of share capital, it can lead to a net
increase in the value of the firm. Since capital gains taxation is typically less onerous than
income tax on dividends, shareholders may prefer that investment is financed this way. Debt is
the next preferred option, since, although interest payments reduce earnings and may lead to
financial distress, they can be set against corporate taxation. The least attractive option tends to
be equity, since the net earnings upon which dividend payments are drawn are usually subject to
taxation. Furthermore, the holders of shares are taxed on the dividends received, so in effect
dividend earnings are taxed twice. However, a countervailing attraction of equity finance is that
dividend payments, unlike debt servicing, are voluntary. Given these costs and benefits,
corporate finance theory has traditionally suggested that debt-equity ratios have been a function
of a trade-off between the lower tax cost of debt and the higher risk of financial distress
associated with debt (Blair, 1995: 37).(Endnote 5)
Each type of financing is intertwined with corporate governance issues, as each
impinges on managerial decision-making. The use of retained earnings as a source of capital
provides managements with greatest control, since in effect they are suppliers of their own
capital and are able to determine the level of returns. By contrast, debt exerts discipline on
management. As Hart puts it, 'debt limits how inefficient management can be, at least if
management wants to repay its debt' (1995b: 685). However, debt does not usually provide
explicit rights per se to lenders in relation to either residual earnings or control. Instead lenders
typically have a prior claim on the assets of the firm in last resort. The power of lenders to
influence management is therefore essentially indirect, though of course lenders may attach
conditions to loans. Debt can thereby underpin an implicit dependency relationship, with
substantial lenders acquiring an informal say in management decisions. The fact that the lender
clearly has an interest in the performance of the firm over the lifetime of the debt may facilitate
long-term relationships in certain circumstances. In Germany, for instance, long-term lending
has facilitated intimate relationships between firms and banks, with substantial flows of
corporate information to the latter. In turn this provides banks with the knowledge, motivation,
and authority to influence management decision-making (Charkham 1994a: 43).
Equity finance also has disciplinary powers, subject to possible weaknesses in the
principal-agent relationship to be discussed below. The successful issue and subsequent re-sale
of shares requires that the prospects for the firm are reasonable either in the short or long term
(depending on investor preferences). In contrast to debt finance, equity investors are usually
residual claimants, with their returns being dividends financed out of profits, or gains in stock
value, or a combination of the two. Since there is a higher degree of risk associated with the
provision of equity finance, investors typically acquire some control rights. In practice, in
Anglo-Saxon countries, these tend to be minimal. They usually provide share-owners with the
power to vote periodically on board composition, to attend and vote at annual general meetings,
and to vote on the acceptance of company accounts.(Endnote 6) In the corporate governance literature, it
has usually been argued that in reality control rights are more effectively exercised via the
power to dispose of the shares (the 'Wall Street Walk'). In this way, equity finance feeds into
the market for corporate control, since there is the possibility that new owners may acquire
sufficient holdings to obtain effective control and to replace the incumbent management
(Manne, 1965). Fear of this leads the incumbent management to incorporate the interests of
current owners in management decisions.(Endnote 7)
Turning to corporate governance, the starting point for any analysis is the growth of
giant firms and the beginning of the separation of ownership and control from the late
nineteenth century onwards. From that date, in certain countries such as the United States and
United Kingdom, the capital requirements of large firms meant that individual or family owners
have increasingly been superseded by a much larger group of stock-holders. Simultaneously,
the size and complexity of managing such firms has led to the emergence of a cadre of
professional managers distinct from the suppliers of capital. It has long been suggested that the
interests of these two groups may well differ (Berle and Means, 1932).
In recent times, analysis of the relationship between these groups has been approached
primarily through the medium of agency theory. Viewing owners as principals and managers as
their agents, analysis has focused on the problems which principals have in ensuring that agents
function in the desired manner. Two sets of governance problems have been identified in this
literature. The first revolves around the costs of monitoring managerial behaviour. Monitoring
problems arise because there are typically too many shareholders to exercise daily control of the
large corporation (Hart, 1995b). There is little incentive for any one shareholder actively to
check the day-to-day actions of managers, because monitoring is essentially a public good and
any gains will be shared with all other shareholders. Thus, there is a powerful incentive for
shareholders to free-ride on the efforts of others. Information asymmetries compound this
problem, since managers are likely to have greater access to relevant information than owners
and can manipulate information to their advantage. The second problem follows from the first
and relates to the provision of appropriate incentives to align agents' behaviour with principals'
interests. As managers do not have access to residual earnings, managerial incentives derive
from other sources. Typically, it is thought that managers attempt to satisfy their promotional
and income maximisation objectives by seeking to increase the size of the firm (given the
tendency for managerial pay to correlate with company size). Thus, the possibility exists that
managerial strategies may take the firm beyond its optimal size and into activities which reduce
profitability or otherwise diverge from the interests of shareholders (Williamson 1964; Marris
1964).(Endnote 8)
Hence, in the parlance of modern economic theory, there are problems of how
principals (shareholders) control their agents (managers) and how they seek to align their
respective interests. At the same time, in the parlance of modern social theory, there are also
problems where, if the interests of principals and agents are well aligned, other stakeholders
may be excluded from economic benefits.
II. Dimensions of national systems
Having considered some basic features of financial markets and corporate governance,
we now turn to how these differ between national systems.
In the United States, traditionally capital requirements of large firms were mainly met
by retained earnings. Until the 1980s, managers were wary of debt finance, in part because of
fears of excessive bank power (Donaldson 1994; Roe 1994). Those writing from an agency
perspective see this aversion to debt finance as a way of evading constraints on managerial
discretion (Hart, 1995a). Equity issues meanwhile were used mainly to finance acquisitions of
other firms. The modern development of equity finance was therefore closely intertwined with
diversification strategies in the 1960s and 1970s (Donaldson, 1994). In the 1980s, however, the
use of debt grew substantially in the form of leveraged buy-outs and other restructuring
transactions. This restructuring was viewed by some as a reaction to earlier managerial
strategies of 'excessive' growth via merger and acquisitions (Jensen, 1993).(Endnote 9) In the United
Kingdom, a traditional aversion to debt is often attributed to the high cost of loan finance,
emanating from a reluctance of City financiers to provide long-term capital to industry (Hutton,
1995; Scott, 1997). This, it is argued, has led to a reliance on equity finance to supplement the
use of retained earnings.
By contrast, in Germany, there is much greater use of debt finance provided by banks
and other companies. A high proportion of large companies are privately rather than publicly-owned. This is reflected in market capitalisation rates. Thus, in the early 1990s, stock market
capitalisation in Germany as a proportion of GDP was only 29 per cent compared with 65 per
cent in the United States and 112 per cent in the United Kingdom (Clarke and Bostock 1997:
235). As a result, governance structures have been different in Germany, with major bank
lenders typically acquiring seats on supervisory boards of industrial firms. In addition, the
voting rights attached to equity shares held by banks on behalf of investors accrue to the banks,
thus entrenching the power of lender institutions. The central role of the banks in the German
system may be attributed to the development of large universal bank which from an early date
supplied funds for rapidly growing firms. A further difference between Germany and both the
United States and United Kingdom has been a much greater emphasis on company expansion
through organic growth. This orientation to growth has meant that large and sudden injections
of capital, which at various times have propelled major expansions of equity markets in the
United States and United Kingdom, have been less in demand.
Japan shares some important capital market features with the United States and United
Kingdom. There are a large number of publicly-listed firms and stock market capitalisation rate
is 125 per cent of GDP (Clarke and Bostock 1997: 235). However, it has more significant
features in common with Germany. Hence, a significant proportion of shares in large firms are
held by banks and other firms; firms have tended to grow organically, drawing on retained
earnings and on long-term funds from banks and other firms; and there is no significant market
in corporate control.
In terms of equity ownership, in the United States, the traditional pattern has been one
of highly dispersed ownership. Typically, the largest shareholders in a company have only a
small proportion of equity. In part, this dispersal of ownership stems from legal regulations
designed to protect the interests of small private investors relative to those of financial
institutions and to preserve the security of the financial system (Blair 1995). In the United
Kingdom, the role of small private investors in equity markets has been in decline for many
years and financial institutions have come to occupy the dominant role in such markets.
However, such institutions seek a diversified portfolio and hence own only a small proportion of
each company's stock. In Germany and Japan, as already stated, the holding of large stocks by
a relatively small number of major investors has been a traditional feature of the financial
system.
Recently there have been some changes in the Anglo-American structure of equity
ownership in the direction of concentration.(Endnote 10)
Institutional investment has come to dominate at
the expense of private shareholders, though households are still substantial investors in the
United States. Such institutional dominance has been most marked in the United Kingdom,
where over 60 per cent of equity shares are held by financial institutions, compared with 48 per
cent in Japan, 29 per cent in Germany, 11.3 per cent in Italy, and 6.5 per cent in France.(Endnote 11)
Within these structures, there are also differences in the balance of institutional investment. In
the United Kingdom and United States, pension funds and insurance companies occupy a
central role, whereas banks play a relatively minor role in equity markets. In Germany and
Japan, by contrast, banks are very significant holders of equity capital. A further difference
between the Anglo-American and other systems of ownership is that equity ownership by other
non-financial firms is much lower in the United Kingdom (3.1 per cent of total equity) and
United States (14.1 per cent), compared with France (55 per cent), Germany (39 per cent), Japan
(25 per cent), and Italy (23 per cent) (Clarke and Bostock 1997: 238).
An important differentiating feature between Anglo-American and other financial
markets resides in pension provision. In both the United Kingdom and United States, pension
funds are not usually managed directly by the firm but are held by trustees with a fiduciary duty
to manage them in employees' long-term interests. This typically precludes significant
investment in the firm itself as this is seen as generating an unacceptable level of risk. Indeed,
in the wake of recent scandals, regulations distancing the firm from the management of pension
funds have become more stringent. Pension funds typically contract the management of their
assets to specialist fund managers. In turn, given their fiduciary responsibility, the primary
objective of such managers is to maximise returns, and monitoring is typically based on
quarterly performance. Fierce competition between fund managers leads to pressure to achieve
high short-term returns (Sykes, 1994). The situation is different in other countries. In
Germany, pension contributions are typically held within firms as retained earnings and
substantial proportions of them are used for investment in the firm. In Japan, pensions are also
paid out of retained earnings and are not placed in funds which invest in equity markets.
Although institutional investors play a dominant role in the United States and United
Kingdom systems, the ownership stakes of any individual investor tend to be insufficiently large
to promote any identity with the long-term development of the firm. Frequently the investment
in any particular firm will be part of a 'balanced portfolio', with the possibility that ownership
can be transferred to other firms in the event that the returns from the initial firm fail to meet the
investor's objectives. Thus, the current structure of ownership in the United States and United
Kingdom would seem to provide owners of publicly-listed firms with a high degree of
influence, but this influence focuses primarily on stock market returns and is exerted through
the market for corporate control. As is commonly remarked in the literature, influence is
achieved through 'exit' rather than 'voice' (Blair 1995; Keasey, Thompson, and Wright 1997).
By way of final comments on the finance literature, it is relevant to note that two main
forms of investor behaviour have been deduced from the above (Charkham, 1994b). Type A
investors concentrate on a small number of stocks, tend to maintain large holdings over a long
period of time, and take considerable interest in the internal management of firms. Type B
investors hold diversified portfolios, with a relatively small number of shares in each company,
are primarily interested in short-term returns, and have little interest in active governance.
Drawing on the arguments outlined earlier, we might expect Type A owners to display an
interest in social initiatives, either internal or external. By contrast, Type B owners are likely to
exhibit little interest in such matters, other than in key outcomes, and only then in so far as these
affect asset management.
Pulling together various dimensions of financial markets and corporate governance,
some commentators have attempted to develop broad classifications of systems. A suggestive
typology distinguishes between 'market' and 'relational' methods of financing and between
'outsider' and 'insider' methods of governance (Mayer, 1990). The market model is one where
the firm raises a significant proportion of its capital from equity markets. These shares have
voting power and are widely dispersed. This creates a decentralised 'outsider' system of
governance where control and monitoring of the firm is market-based, with performance in
terms of share price and dividends being a crucial factor in judging the firm's performance.
Under such a system, good performance by senior management is rewarded by their survival at
the top of the firm and by higher salaries and benefits; poor performance is punished by the risk
of take-over and dismissal. Under such an outsider system, there is thus an active corporate
control market, with firms or parts of firms being bought and sold. By contrast, the 'relational'
model is one where ownership is less dispersed, with extensive individual or family, bank, and
inter-corporate shareholdings. In such a case, there is a less active equities market and less of a
market in corporate control. Governance and monitoring of the firm's performance take on
more of an 'insider' form, with representatives of families or banks or other firms sitting on the
company's board. Subject to caveats to be mentioned below, these two systems are sometimes
taken to be broadly typical of Anglo-American as opposed to German or Japanese
arrangements.
In the remainder of the paper we will attempt to link these systemic variations in capital
markets and corporate governance to characteristics of social aspects of business. In so doing,
we are conscious that the outline of financial systems presented above is a stylised one that does
not explore the complexities of these systems or their evolution over time. Nevertheless, we
hope that this discussion has outlined the major elements necessary for the ensuing analysis.
These include both micro and systemic level features. Within the main forms of capital
provision, we can discern variations in structure between short-term and long-term debt,
between institutional and private investors, and between equity and debt financing. Each of the
main forms of financing tends to have distinct implications for the management of firms,
emanating from the interests and objectives of capital providers. It is for this reason that we
anticipate that there will be significant differences in the social activities of firms under different
types of financial system.
III. Linkages with social policy and initiatives
In this section we attempt to outline possible linkages between the elements of financial
markets and corporate governance and the social activities of the enterprise. Before we do so,
we make some brief observations on the possible form these linkages take.
The relationship between capital markets and social policy may be direct or indirect.
For instance, where there is a shock, emanating from the capital market (e.g. a lender calls in a
large debt), this may lead directly to changes in social activities, such as lay-offs of staff or
cutbacks in external initiatives. Here, however, we are more concerned with the less visible, but
more pervasive, indirect effect of financial markets. An illustration of this is provided by the
cost of capital. Where the cost of finance capital is consistently perceived to be high, this may
encourage managers to make products requiring relatively unsophisticated or stable
technologies and may well discourage process and product innovation. This in turn will have
implications for the structure and capabilities of the workforce and for investment in training
(Keep and Mayhew, 1998).
A similar causal relationship may be posited in relation to ownership and corporate
governance. Again the influence of ownership may be direct. In owner-managed firms, owner
philosophies are likely to have a direct influence on the pattern of employment relations (e.g.
the preference for a particular reward package). Typically, however, the influence of ownership
on social policy will again be more indirect. Thus, where owners are primarily concerned with
returns from the business, owner pressure may force managers to divest or withdraw from
markets viewed as unprofitable or unpromising. Again, such pressures will affect the size and
structure of the workforce.
Going beyond these general observations, a number of broad but interrelated arguments
may be outlined which seek to relate financial and governance patterns to the main areas of
internal social policy as outlined in the introduction.
In the area of employment relations, linkages between financial markets, corporate
governance, and the management of employment revolve in large part around issues of time-horizons and of returns to investment. A common argument is that market-based financial
systems lead to a greater emphasis on the short-term than do relational systems (Hutton 1995;
Blair 1995; Porter 1997). Where there are active markets in corporate control, firms will be
under pressure to perform well in the short-term. Thus, the system of pension provision in the
United Kingdom and United States is likely to intensify pressures towards short-termism
because monitoring of quarterly performance is a central feature of fund management. These
pressures may discourage investment in human capital, since the pay-off to the firm from
training may not be achieved in the short-term. Furthermore, they are likely to discourage long-term 'claims' against the firm in terms of long-term job tenures (either explicit or implicit) and
internal labour markets. In other words, externalised financial systems are likely to lead to
externalised employment relationships, with an emphasis on securing trained labour from
outside the firm and on shorter term employment relationships. By contrast, systems of
financing based on retained earnings and relational arrangements at least permit higher levels of
investment in human capital and longer-term employment relationships.
These pressures deriving from the time-scale of capital providers are intensified by the
nature of returns associated with the two types of financial system. Under market-based
systems, monitoring of performance by capital providers tends to focus on tangible performance
measures such as earnings per share rather than on more intangible measures such as potential
market share. Recently, equity owners have utilised more vigorous performance measures such
as 'economic value-added' (which incorporates the opportunity cost of capital and assets) to
assess the performance of their investments (Cappelli, Bassi, Katz, Knoke, Osterman, and
Useem 1997: 38). The interest in short-term profitability on the part of capital providers
inevitably leads to a desire to control labour costs, especially where these form a substantial
proportion of total costs. To some extent, there may be a zero-sum relationship between returns
to investors and to labour, with the pressures emanating from financial markets encouraging
firms to give priority to the former. A deeper point, made by Blair amongst others, is that an
emphasis on 'shareholder value' diverts attention from the value of the firm. The value of
human assets may well contribute to the value of the firm, especially in knowledge-based
industries, but these are not recognised in the concept of 'shareholder value'. From the
employees' point of view, it has been argued that they will be unlikely to invest in training in
firm-specific skills, since the employment systems associated with market-based financial
systems are unlikely to reward such investments (Blair, 1995). Equally, shareholder pressures
are unlikely to encourage training in general skills, since, where training costs detract from the
residual available to shareholders, the benefits are not readily quantifiable in measures of
shareholder value and presumably appropriate training can be secured outside and at little cost
to the firm. Therefore, the development of human capital through training and internal labour
markets seems unlikely to be positively associated with market-based system of financing and
corporate control.
A further feature of market-based systems is the potential turnover in corporate control.
It has been suggested that changes in control disrupt the implicit contracts that have been made
between managements and employees under previous ownership regimes, and hence
restructuring and lay-offs will be a more pervasive feature of market-based financial systems.
Cappelli et al (1997: 36) note that take-overs have a powerful downward effect on employment,
citing research which shows that over a quarter of the stock-price mark-up following take-overs
is attributed to lay-offs (Bhagat, Schleifer, and Vishny, 1990).
Systems of employee rewards seem likely to differ under different financial regimes.
Under market-based systems, the nature of the agency relationships and monitoring difficulties
are likely to lead to the use of incentives, such as stock options or profit shares, to align
managerial interests with those of owners. By contrast, in debt-based systems, the debt itself
acts as a disciplining force on management. At subordinate levels, in market-based systems, it
might be argued that more emphasis will also be placed on variable pay for lower level
employees, with a preference for performance- and profit-related schemes. In relational, insider
systems, it is more likely that pay will be based on other internal administrative criteria, such as
grading position or service seniority. We may also expect to see a wider dispersion of pay and
benefits in firms under market-based systems for several reasons. First, there exist strong
systems of incentive payments and rewards to top managers. Second, the market for corporate
control is likely to encourage a labour market for top managers who, in so far as it is driven by
shareholder interests, is distinct from other labour markets and is not organisationally specific.
Third, the pressures for short-term financial returns are likely to lead to constraints on incomes
at lower levels of the firm. Fourth, a lower incidence or greater fragmentation of internal labour
markets in such firms is likely to reduce the chances of integrated, organisation-wide pay and
grading systems extending up to high levels of management.
A complicating factor, however, is that agency considerations suggest that profit
sharing and share distribution schemes are likely to be offered to lower level employees in
market-based financial systems (Jensen and Meckling 1976). Provision of incentives should
assist to overcome agency problems within the firm and help to align employee interests with
those of shareholders. In so far as the compensation benefits of these schemes are usually
deferred, they are a way of securing some degree of longer term commitment from employees in
a context where the firm is limited in providing other long-term bonding devices (such as
internal labour markets). At the same time, these flexible remuneration devices avoid long-term
fixed claims against the firm. A further reason for the use of financial participation in these
environments is that well-developed equity markets result in high liquidity. Share-based
rewards may be easily converted into cash, and hence may be relatively attractive to employees
(especially if combined with fiscal concessions).(Endnote 12)
A further explanation for the greater
incidence of share schemes in this type of environment is that they can provide some protection
for the firm and managers in the market for corporate control. Managements may control the
votes attached to employee shares or employees may be presumed to side with managements on
the 'better the devil you know' principle. In other words, employee share schemes can be a
power resource for managers in resisting pressures from investors or from those mounting take-overs. However, it must be added that a countervailing factor is shareholder fear about share
dilution and reductions in shareholder value where employee shares are newly-issued. In fact,
major shareholders have often fought management proposals for employee share schemes, even
though the schemes may be viewed as advantageous to them on agency grounds. So, though
employee share schemes may be more common in situations where market-based financing is
important, these schemes are likely to be limited in size and significance.
In the area of work relations, it may at first sight be more difficult to conceive of a link
between financial markets, corporate governance, and the organisation of work. However, it
could be argued that, under market-based systems, production methods are more likely to be
based on 'command and control' systems rather than team-work or 'responsible autonomy'.
Short-term pressures, lower investment in human capital, concentration of skills in managerial
and supervisory staff all seem to be important factors here. In turn, as argued above, higher
output from such lower level workers will be elicited by means of performance-based pay
systems. By contrast, under relational and insider systems, given greater investment in human
capital and longer term jobs, firms will look for more functional flexibility to capitalise on the
skills acquired and to compensate for any loss of numerical flexibility. There is thus likely to be
a greater propinquity in terms of managerial and worker skills and more discretion for lower
level workers. Thus, to go beyond Adam Smith's proposition about the division of labour being
a function of the scope of product markets, the argument here is that it should also be seen as
being shaped by financial market and corporate governance pressures (Smith, 1904 ed.: 9-19;
Stigler, 1951).
Under the heading of work relations, it might also be argued that different financial
systems may well have an effect on innovation patterns and therefore on work organisation.
Thus, under outsider systems, low levels of workforce skills and of employee involvement and
discretion may well discourage incremental process innovation. However, it may encourage
product innovation. As proposed by Soskice, the ready availability of financial capital and of
managerial skills at higher levels (emanating from more active managerial labour markets),
means that there will be a tendency to innovate in terms of new products, often in new start-up
and spin-off firms. Under relational-based, insider systems, there is a different innovation
dynamic. With both capital and labour less readily available in the external market, but more
readily available within the firm, there is an incentive to utilise internal technical capabilities
and human resources at all levels and to innovate more incrementally in terms of process
innovation and the adaptation of existing products (Soskice, 1996).
These factors may arguably also affect workers attitudes towards the ownership of skills
and the protection of jobs. Under market-based, outsider systems, workers are likely to be
highly protective of existing skills and jobs. This may manifest itself in forms of worker
activity which stress job control and restrictive practices. By contrast, under relational-insider
financing, where in-house training is more extensive and where jobs are more secure, such
forms of worker activity will be less pronounced and worker cooperation in production will
arguably be more forthcoming.
In the area of industrial relations and social dialogue, at first sight it might again seem
difficult to make links with financial markets and corporate governance. Here, indeed, it could
be argued that there exist a number of paradoxical relationships.
Under market-based, outsider systems, firms will be reluctant to enter into voice
arrangements which will constrain market monitoring, managerial discretion, and the ability to
maximise short-term profit. Hence social dialogue and employee participation in decision-making will be limited. As outlined above, employers may seek to compensate for this with
various forms of financial participation to reduce the conflict between shareholders, managers,
and employees. However, where such firms are forced to recognise employee voice, this is
likely to take either a manipulative or an adversarial form. Thus, firms will in the first place
seek to establish management-sponsored works committees or company-dominated unions.
Where, they have to recognise employee voice aspirations in the form of autonomous unions,
they are likely to enter into adversarial-type bargaining arrangements so as to win back
productivity increases for wage and benefit concessions. Bargaining is therefore likely to be
zero-sum. Moreover, under these atomistic arrangements, the firm will have little incentive or
likelihood of joining with other firms in the industry to bargain collectively with trade unions,
and collective bargaining will therefore be an economic exchange at the level of the company or
its constituent parts (Ulman, 1974).
By contrast, under more relational, insider systems, it may be hypothesised that firms
will be less reluctant to enter into voice arrangements, since the very constitution of the firm is
posited on the accommodation of various interest groups in its governance. In turn, such voice
arrangements will be of two possible types. Within the firm, insider systems may encourage
various kinds of joint consultation and works councils of a kind which are less manipulative and
more thoroughgoing. Outside the firm, within the industry or national economy, links between
firms may encourage regulation of the labour market by employers' organisations and multi-employer bargaining with trade unions. Where there is extensive cross-ownership of firms, it
can be in the interest of firms to regulate wages across firms and sectors. To take a simple case
of two more or less similar firms. Where one (a) owns part of the other (b), it is not in the
interest of a for b to pay lower wages than a, since this may take market share away from a.
Equally, higher wages are also unattractive since these may lead to the loss of a's employees. If
b also owns part of a this set of considerations will be replicated. All things being equal, we
would expect wage levels to be more similar across the two firms. It will therefore be possible
and in the interests of companies to regulate wage levels on a multi-employer basis.
Of course, tracing these links with industrial relations is fraught with difficulties as
many other factors (e.g. union behaviour, labour law, government policies) are likely to have a
strong influence on industrial relations. With this proviso, it seems feasible that firms in
market-based, outsider systems will have a preference for low levels of employee voice in
decision making; whilst in situations where there is insider governance and co-operative
financial and ownership relations, there will be pressures for both enterprise - and industry -wide joint regulation. Where unions are unavoidable for firms in market-based systems, it
seems likely that the preference will be for internalised bargaining, on the grounds that
shareholders will be unwilling to have the level of their returns determined by actors situated
outside the firm. Indeed, in such circumstances, plant- rather than company - level bargaining
may be more attractive on the grounds that it excludes unions from the key sites where decisions
are made about shareholder value and from issues which have an important bearing on
shareholder returns. This distance between bargaining and key decisions will be both
encouraged by shareholders (using the threat of exit) and by managers (valuing their freedom).
By contrast, in firms under relational financing systems, where there is internalised bargaining,
this is likely to take place at company-level. This is because the firm is likely to be considered
as more of a community, and the greater likelihood of comprehensive internal labour markets in
such firms provides strong grounds for regulating wages across the company.
In terms of external social policies, which affect individuals, groups, and other
organisations outside the firm, there are again relationships which may be posited.
Under market-based, outsider systems, it might be argued that pressures emanating from
both time horizons and investment returns may make firms disinclined to such activities.
Hence, they may be less likely to make investments in such areas, unless they are clearly
business-related and have a pay-off for the firm. Of course, companies may take such initiatives
for public relations and reputational reasons, but such activities tend to be relatively small and
localised. In the longer term, however, such practices may have a deleterious effect on broad
social capital in terms of low employability of local people, weakness of community
infrastructure, and lack of sophistication in local consumer demand. In turn, a belated
realisation of these negative consequences may prompt corrective action. Indeed, there may be
a further realisation that social initiatives can constitute a distinctive additional source of
competitive advantage. As traditional sources of advantage, such as technological and
marketing capability, become more easily imitated, then new advantages need to be found.
These may be based on a recognition of new consumer concerns and on the ability to leverage
social reputation. However, the problem then arises for such firms as to how genuinely to
integrate these realisations into their broader routines and core competencies which have
traditionally been so dominated by considerations of shareholder value.
Under relational-based, insider systems, we have argued that firms are more disposed to
look after their own direct employees. However, there is a potential danger here that this can
create islands of good jobs for the employees of such firms, especially in big firms, but within a
sea where those who do not come within the community of the firm are excluded. For example,
this is indeed a danger which has always been evident for outsiders in Japan. However,
offsetting this, it might be argued that what then becomes crucial is where the firm draws its
boundaries. Given the links which exist between firms and given tendencies for interfirm
organisation, these boundaries may cover suppliers and customers and may also extend to other
firms in the industry. These vertical and horizontal interrelationships can have a positive effect
on social capital within a locality or industry where firms provide supports for other firms in a
non-competitive, non-atomistic manner.
IV. Evidence from national systems
Linkages between financial systems, corporate governance, and enterprise social policy
and initiatives may be investigated historically and contemporaneously, at a micro or systemic
level, within one country or across countries. As a preliminary foray, we offer an eclectic
perspective on national systems in order to explore arguments about the effects of different
financial and governance arrangements.
In terms of employment relations, it could be argued that broad links may be discerned
in terms of national systems of financing and governance and the management of key aspects of
human resources. Thus, in the United States and United Kingdom, two broad periods may be
discerned. In the first period up to the early 1970s, capital requirements of large firms were
satisfied mainly by retained earnings and, to a more limited extent, by equity finance. There
was a long term shift away from private towards institutional ownership, but ownership was
sufficiently dispersed and shareholder activity sufficiently quiescent to allow for effective
managerial control of large enterprises. This allowed for investment in human capital and the
growth of internal labour market-type arrangements, with labour being treated as a quasi-fixed
cost (Donaldson, 1994). According to Cappelli et al, firms developed a psychological contract
with their employees in which the employer's investment in employment development and job
security was repaid by employee loyalty and performance (1997: 38). In the second period, the
two Anglo-Saxon countries moved away from financial self-sufficiency and towards more
equity-based systems, partly to finance expansion by merger and acquisition. Later, shareholder
reactions to the declining performance of large conglomerates led to major restructuring in the
1980s and 1990s. The market for corporate control became much more intense, with a very
high level of take-over activity. At the same time, new forms of ownership developed, financed
by innovative methods of short-term debt-financing (e.g. junk bonds). Coupled with continuing
consolidation of the role of institutional investors, ownership interests were able to exert a
greater degree of influence on the management of firms. As a result, in the United States and
United Kingdom, internal labour market-type arrangements started to come under pressure, with
labour being treated more as a variable cost and with low levels of investment in human capital.
By contrast, in Germany, finance and governance systems have for a long time been
relationship-orientated and based on insider arrangements. As a result, financial market
pressures are less strong on firms. This in part explains the development and persistence of
strong internal labour markets, with more in-house training, longer job tenures, and greater job
security. This is not to say that financial pressures are absent. The presence of banks on
supervisory boards means that financial interests operate in close proximity to the management
of the firm. However, these institutions tend to view their interests and those of the firm as
essentially intertwined rather than potentially contradictory. In Japan, there has also been more
reliance on long-term borrowing and on insider governance arrangements. This in turn
facilitated the growth of long-term employment, in-house training, and seniority-based pay
systems over the postwar period. It has been suggested that close banking relationships mitigate
the agency problems found in arms-length relationships in equity-based capital markets with the
result that such firms have been less prone to cut investment when there are cash-flow shortfalls
(Bolton and Scharfstein 1998: 106). In both Germany and Japan, less use is made of short-term
performance related pay, and wage dispersion within the enterprise is less than in the Anglo-Saxon countries (Aoki, 1994).
In terms of work relations, again there is broad comparative evidence to support the
contention that market-based financial systems may be more likely to generate command and
control systems of production management and that relational-based financial systems may be
more likely to facilitate greater choice in terms of work organisation. Thus, the United States
developed mass production systems and so-called Taylorist or Fordist work organisation for a
number of reasons, including a relative scarcity of skilled labour and large product markets.
However, the availability of capital, including equity capital, also facilitated massive
investments which were the basis of extensive divisions of labour. Thus, in the United States
and later Britain, there developed production systems which tended towards the command and
control model, with management concentrating expertise at the top and with lower level
employees given minimal training or discretion (Habbakuk 1962; Hounshell, 1984; Lazonick,
1990). From the perspective of employees, the unwillingness of managers to provide
guarantees that worker investment in skill would lead to long-term pay-offs meant that
employees attempted to protect their investment by seeking to impose job demarcations and
restrictive practices. Therefore, the system of work relations found in the United States and
United Kingdom have tended to be characterised by a rigid organisation of production and by
worker attempts at job control, which have then been reinforced by other aspects of their
industrial relations systems, such as union behaviour. Whilst the industrial relations obstacles to
flexible working practices are in decline in both countries, the tendency to organise work in
relatively inflexible ways remains. The financing systems are of some importance here since
the short-term pay-back requirements that are commonly necessary to secure investment finance
often result in the use of advanced flexible machinery as a more intensive and efficient form of
mass production rather than as a tool for process innovation or more flexible production (Jones,
1988).
By contrast, historically German industry moved more slowly to adopt mass production
based on Taylorist and Fordist work organisation. Again, this can in part be explained by a
number of factors - including a relative abundance of skilled labour and smaller and more
differentiated product markets. However, relational financing and insider governance also set
up a dynamic, whereby firms were prepared to invest more in human capital and were more
ready to enter into longer term relations with employees. This in turn then encouraged flexible
quality production of a German kind (Streeck, 1992; Soskice, 1996).(Endnote 13) In Japan, also, relative
insulation from financial markets and the strength of insider governance have facilitated
investment in skills and have encouraged co-operative labour relations. Together these have
facilitated flexible forms of work organisation. In part, this might explain why Japanese firms
such as Toyota were early developers of so-called 'lean' production systems, based on more
flexible techniques, more decentralised control over operations, and broader jobs and team
working (Aoki, 1994; Womack, Jones, and Roos 1990: 13-14, 80-82, 186-7). Others have
pointed to the development of wide-ranging skills through frequent job rotation and the
discouragement of specialisation (Koike, 1988; Hashimoto, 1990).
In industrial relations, it is also possible to chart linkages with financial and governance
systems, though the role of trade unions and state intervention may constrain their influence.
Starting once again with market-based financing and outsider governance, in the United States,
for the most part, employers were historically hostile to any independent employee voice
mechanisms. A variety of reasons, including a strong ideological preference for individualism,
may be found for this, but it is arguable that security market pressures also predisposed
American employers not to share rents with their employees through collective bargaining.
Instead American employers historically showed a preference for weak forms of employee
participation and contemporaneously have favoured profit sharing schemes as an alternative to
voice in decision-making. When they had to recognise unions, American employers preferred
to bargain at company or plant level in order to obtain trade-offs through decentralised atomistic
bargaining. In some instances, from the Second World War onwards into the 1970s, there also
developed pattern bargaining arrangements, whereby firms co-operated in wage fixing (Ulman,
1974). Recently, pressure to maximise shareholder value has led firms to break with pattern
bargaining arrangements and to decentralise bargaining. It has also pressurised firms to break
with collective bargaining altogether, where this is seen as a constraint on profitability and
company performance. In the literature, product and labour market reasons are commonly cited
as important reasons for these developments (Kochan, Katz, and McKersie 1986), but there is
now an emerging recognition that financial and governance factors are important also (Cappelli
et al 1997).
In Britain, historically employers were less able to avoid trade union recognition and
early entered into collective bargaining at industry level. For many years, this system was
supported by relatively weak equity market pressures. Under these circumstances, industry-wide, multi-employer bargaining developed. However, from the mid-1960s onwards, pressure
(including increasing financial market pressure) pushed firms towards single-employer
bargaining where they looked to gain quid pro quos for wage increases through productivity or
flexibility-type agreements (Gospel, 1992). More recently, in the 1980s and 1990s, increased
financial market pressure has been one factor in pushing firms away from collective bargaining
and towards more emphasis on weaker forms of consultation and participation.
By contrast, in Germany and Japan, following on their post-war industrial relations
settlements, management-union relations have been characterised by a paradoxical equilibrium
of internal and external arrangements. In Germany, board level representation and works
councils within the firm fit well with a long-term historical preference for insider governance
systems (Teuteberg, 1961). Simultaneously, there is also a strong system of external multi-employer bargaining through employers' organisations outside of the firm. This later system
can be explained by a number of factors, such as the post-war reconstruction of trade unions and
labour law in West Germany. However, it also fits well with a kind of 'organised capitalism'
(to use Hilferding's term) or 'co-operative capitalism' (to use Chandler's term), where firms,
often with interlocking ownership and links with major banks, historically co-operated in both
product markets (trade associations) and labour markets (employers' organisations) (Hilferding,
1910; Chandler, 1990). In Japan, the paradoxical equilibrium of internal and external
arrangements is rather different in form, but has certain similarities in substance with Germany.
Within the firm, Japanese managers have shown a long-term preference for internal dealings
with their employees via enterprise-based unions and joint consultative systems (Gordon 1985;
Aoki 1984 and 1994; Hazama, 1997). This provides a form of insider voice for employees.
Outside the firm, however, there has also been effective co-ordination of the labour market via
co-operation between firms through their industry organisations and the annual Shunto wage
round. For many years, basic wage increases have thus been fixed on a multi-employer basis
(Sako, 1997). Again this links with a system where firms hold shares in one another, sit on one
another's boards, and have common links to a related bank.
In terms of external social policies and initiatives, there is at present a lack of good
research on which to base sound empirical conclusions. Indeed, this is still an area where it is
difficult to see the wood (long term trends) for the trees (a plethora of small, often public
relations, initiatives by firms). In this area, there is clear need for further empirical research.
External social initiatives have always been taken by firms. Historically, there were
many enterprises which provided schools, community assistance, and cultural and recreational
amenities. During the course of the twentieth century, many of these paternalistic initiatives
died out, as national and local government provision expanded and as individuals and groups
ceased to look to 'favours' from paternalistic employers. In recent years, however, in some
countries, new political and economic pressures have placed constraints on state provision, and
there are clearly limits to individual and small group self-help. Simultaneously, there has been a
growth in public expectations and demands for business to act with greater social responsibility
in areas such as employment maintenance and generation, social protection, and community
development. Indeed, it might be argued that these public concerns are being translated into
new demand pressures, through new consumer preferences, trade regulation, and corporate
reputation.
Let us take market-based, outsider systems, such as the United States and United
Kingdom, countries also where welfare state provisions are less extensive or where they have
been curtailed in recent years. Many firms in these countries take initiatives in these areas, and,
indeed, they have tended to be leaders in terms of inventiveness. However, such initiatives are
subject always to strong financial constraints. Firms have undertaken practices, which are
clearly business-related and which have a pay-off. Many other initiatives are small and
localised and have a strong public relations dimension to them. It is only recently that a
growing number of firms have realised that a failure to take social responsibilities seriously may
have a deleterious effect on social capital and on the best long-term interests of the firm. There
has thus been a growth in social initiatives of various kinds, sometimes set out in company
codes of social practice. These cover projects such as the training and education of local people,
community volunteering by employees, staff secondment programmes, and local entrepreneur
development projects. Many such programmes target women, young people, and ethnic
minorities. However, the problem has arisen for many such United States and United Kingdom
firms as to how genuinely to integrate these concerns into their broader routines and strategies,
which have traditionally been so dominated by considerations of shareholder value (Clutterbuck
and Snow, 1990). In this respect, a forceful (but largely untested) proposition is that greater
social awareness and responsible action can give firms a new source of competitive advantage
(Vallance 1996).
By contrast, under relational-based, insider systems, firms are well disposed to look
after their own internal employees. However, the danger here is that this can create islands of
good jobs, but within a sea where those who do not come within the community of the firm are
excluded. This has always been a problem in Japan: large firms have not always treated
contingent labour well, have not been particularly orientated towards local community outreach
programmes, and have not always had a good record in terms of environmental matters.
However, there are offsetting factors. Given the links which exist between firms and given
tendencies for interfirm cooperation in many matters, enterprises have often drawn their
boundaries quite broadly. Thus, they have been prepared to help other firms in their supply
chains, have seconded employees to other firms, and have helped establish small start-up
companies. This can have a positive effect on social capital within a locality or industry.
Similarly, in Germany, the community can cover other firms in the locality or industry within
which the firm is embedded. Examples here are local links within industrial districts such as in
parts of Baden Wurtemburg and Bavaria. It would also include links which are strong in
industries such as in metal working and chemicals, where employers' organisations play an
important role. These links can have positive effects in terms of disseminating information,
raising product market standards, and providing labour market training. In these instances in
Japan and Germany, external social initiatives are well built into the routines and strategies of
large firms. They equate with their systems of relational finance and insider governance which
have encouraged a form of cooperative capitalism.
At the present time, the conventional wisdom is that there are major pressures on the
German and Japanese financing and governance systems which may move them more in an
Anglo-Saxon direction. Thus, there is a growth of equity market pressures and some loosening
of long-term lender relationships in both countries. These may be significant factors making for
changes in their systems e.g. for a weakening of internal labour markets and a strengthening of
firm-specific industrial relations. However, change is slow and uneven. There may also be
some less powerful pressures on the American and British systems making for stronger insider
governance. In the United States, both Useem (1993) and Blair (1995) have shown how
managers have been able to resist shareholder pressures and in some states have been able to
secure legislation which has constrained the market for corporate control. In both countries,
there have been pressures for greater involvement of institutional investors in governance by
making it mandatory for them to exercise their voting powers. As institutional investors come
to occupy a larger role in financial systems, their fortunes may become dependent on those of
companies in their portfolio with the result that exit becomes a less viable approach to
governance. Such developments would have important implications for internal and external
social policies.
V. Conclusions
This paper has sought to perform three main functions. These may be summarised as
follows, and certain qualifications may be registered.
First, the paper has highlighted aspects of financial markets and corporate governance
systems which may influence the firm's internal and external social policies. In the outer
environment, the paper has stressed the nature of capital markets; in the inner environment, it
has stressed the corporate governance system of the firm. We do not discount the importance of
other factors, such as product and labour markets, the role of the state and trade unions, or
differences in national culture, but here we wish to draw attention to the potential importance of
the largely neglected factors of capital markets and governance arrangements.
Second, the paper has explored a typology of financial and governance systems in terms
of relational-insider and market-outsider systems. These different approaches to finance and
governance have plausible consequences for enterprise social activities. In the area of
employment relations, this typology can be used to understand such tendencies as long- and
short-term approaches to job tenure and training, a tendency to use fixed or variable pay
systems, and the size of pay differentials within firms. In the area of work relations, it may be
used to analyse the division of labour and work organisation. It also has implications for
variations in functional flexibility and approaches to innovation. In industrial relations, it can
be used to point up the difference between a greater preparedness to establish internal voice
arrangements and external co-ordination via multi-employer bargaining and social dialogue as
opposed to employer refusal to accept voice arrangements or reluctant entry into adversarial
collective bargaining at the level of the firm or plant. In the area of external social policies, it
can be used to understand the degree of integration of various policies and initiatives into the
actual routines and strategies of firms.
The third function has been to apply this framework to the labour management
experience of a number of different countries. For analytical reasons we have focused on the
United States and United Kingdom, which tend towards market and outsider systems, and on
Germany and Japan, which tend towards relational and insider arrangements. It is hoped that
the framework may help discern certain patterns in these countries, while conceding that a more
detailed account will introduce nuances stressing diversity within national systems. Other
countries may tend towards one or other of the polarities, but will also provide more complex
hybrid examples. Nevertheless, taking a long-term perspective, it was tentatively suggested that
there appears to be movement towards market and outsider systems, especially in recent years,
though to-date this has been slow and uneven.
We hope that the observations in this paper will provide a starting point for more
detailed empirical research into the impact of capital markets and corporate governance systems
on the social role of business. We perceive the desirability of future research in three directions.
The first direction would involve a primarily macro approach and seek to explore statistically
the linkages between national systems of finance, governance, and social policies. It is to be
hoped that researchers will be able to show, in more detail and complexity than has been
possible here, the nuances of the possible relationships over time. The second direction of
research would involve a more micro- or firm-level approach. For instance, the impact of
specific aspects of financing and governance on labour management practices would be worth
investigating via case studies. A third direction would be to explore some of these linkages in
newly emerging markets where enterprise financial and governance arrangements are in the
process of construction and reconstruction. There is thus a rich agenda for research and we
hope that institutions and academics in the human resource and social policy areas will take full
advantage of the opportunities.
Table 1: Some relationships between financial markets, corporate governance, and labour
management
|
Financial markets |
Corporate governance |
Labour management |
|
Relational finance
Debt finance
Weak securities market
High debt-equity ratio
Longer-term
borrowing, from banks
and other companies
Stable owners
Mainly type A
investors
|
Insider system
Concentrated
ownership
Board made up of
insiders e.g. family,
bank, other firm, state,
senior managers, and
employees
Active owners
Weak market in
corporate control
Bankruptcy less of a
constraint
Voice as instrument of
corporate control
Management - more
stable, less powerful |
Employment relations: longer
employment relationships; more
investment in training; more
attempt to make employees
permanent; wages fixed according
to internal administrative principles
and firm-specific incentive
systems; more elaborate fringe
benefits; less wage dispersion.
Work relations: greater functional
flexibility; incremental process
innovation systems; fewer
restrictive practices.
Industrial relations: more employee
voice; internal representation
systems and external multi-employer bargaining.
|
|
Equity finance
Strong securities
market
Low debt-equity ratio
Shorter-term
borrowings Fluid
owners
Mainly type B
investors
|
Outsider system
Diffuse ownership
Board made up of
insiders and outsiders
Less active owners
Strong market in
corporate control
Bankruptcy more of a
constraint
Exit as instrument of
corporate control
Management - more
powerful, less stable |
Employment relations: more-arms
length relationships; recruitment
and lay-off according to demand;
less investment in training; wages
fixed according to market
principles; more variable pay; wide
wage dispersion.
Work relations: command and
control systems; radical product
innovation systems; restrictive
practices.
Industrial relations: little employee
voice; where unions, adversarial
bargaining at single-employer level
|
Notes
Endnote 1:
The main contributions are Blair (1995) in the United States and Hutton (1995) in the
United Kingdom.
Endnote 2:
In the United Kingdom, there have been a succession of reports into corporate
governance - Cadbury (1992), Greenbury (1995), and Hampel (1998). The main
concern of these has been the functions of directors, relationships between boards
and shareholders, and executive remuneration. In the United States a joint project
by the Council on Competitiveness and Harvard Business School has examined
capital market structures and corporate governance (Porter 1997). In France, there
has been the Viénot report (1995) and in the Netherlands the Peters report, both of
which have dealt with various aspects of corporate governance (1997).
Endnote 3:
The main debates are covered in collections edited by Chew (1997), mainly focusing on the
United States, and Keasey, Thompson and Wright (1997), mainly examining the United
Kingdom.
Endnote 4:
In a different manner, external initiatives may also be understood to cover activities which
affect the environment.
Endnote 5:
In practice, there are a number of factors which impinge on this trade-off. The
capacity to raise debt will be a function of cashflow and asset base (Hart 1995).
Some lenders (e.g. United Kingdom banks) are said to have an aversion to long-term lending to industry (Hutton 1995), resulting in high debt charges and hence a
preference by firms to use equity. In practice, there are a variety of financial
instruments which draw on both debt and equity. Preference shares, for instance,
pay a fixed rate of interest, have a set repayment date, and usually do not confer
voting rights. They are therefore essentially a form of debt finance. In some
European countries (e.g. Italy), preferred shares comprise both a guaranteed
dividend and a 'risk' dividend. Non-voting shares often give their holders
preferential treatment in the event of liquidation, but the trade-off for this is the
absence of voting rights. Dual class financial structures are common in Scandinavia
and the Netherlands.
Endnote 6:
Some observers have argued that equity ownership does not confer rights to control
of the company. The actual powers of owners are circumscribed and do not provide
equity holders with formal powers to direct management. Instead these are
delegated to the board of directors. On this basis, it has been suggested that share
ownership is just that: ownership of shares in a company rather than ownership of
the company itself (Kay and Silberston 1995).
Endnote 7:
Endnote 8:
Other formulations of the problem of ownership and control have placed agency theory
alongside theories of implicit contracts and transaction costs. Jensen and Meckling (1976)
see the firm as a 'legal fiction', made up of a set of governance structures based on contracts
and claims on the assets and cash-flows of the firm. The main claim on assets and residual
income typically accrues to owners and other suppliers of capital. Contracts involving
owners and other claimants are therefore of critical importance in the governance of the
firm. Given bounded rationality and divergent interests, attention has been drawn to the
difficulties of formulating explicit contracts. Transaction costs are therefore such that the
mechanisms for resolving the agency problem at the root of the management of the modern
corporation inevitably take the form of implicit contracts. Hart argues therefore that
governance structures can be seen as 'mechanisms for making decisions that have not been
specified in the initial contract (1995: 680).
Endnote 9:
A corollary of this perspective is that the interest in corporate governance in 1990s
is seen as a response to the reduced capability of capital markets to resolve
performance deficiencies via the market for corporate control. In the wake of
various financial scandals during the 1980s, financial markets came to be more
tightly regulated in the 1990s.
Endnote 10:
Scott (1997) has argued that the separation of ownership and control, which was
premised on widely dispersed equity ownership, has now been superceded by
control through a 'constellation of interests'. The ownership of firms is typically
dominated by a relatively small number of institutional investors who have separate
but broadly similar interests.
Endnote 11:
The United States has a similar level of institutional investment to Germany.
Endnote 12:
The apparently trivial fact that a characteristic of firms with profit sharing schemes
is that they have share capital becomes altogether more significant when the
observation is made comparatively and when national differences in the prevalence
of share schemes is seen to be correlated with types of financial systems.
Endnote 13:
The term flexible quality production is similar to Streeck's diversified quality production
(Streeck, 1992).
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