Table of Contents
Chapter 1 Origin and Development of
Independent Director System in US
Introduction
1.Background of initiating independent director system in US
1.1 From shareholder dominance to board of director dominance
1.2 From board of director dominance to managerial dominance
2.Expected function of independent director system in US
3.Adoption of independent director system in US
3.1 Regulatory rules influence
3.2 Institutional shareholder activism
3.3 ALI Corporate Governance Project
3.4 Market participants internal incentive
4.Effectiveness of independent director system in US
4.1 Positive views on effectiveness of independent director system
4.2 Negative views on effectiveness of independent director system
4.3 Other mechanisms monitoring
5.Corporate scandals: failure of gatekeepers in corporategovernance
5.1 Case of Enrons collapse
5.2 Case of Adelphia Communications
5.3 Case of Tyco International
5.4 Case of Global Crossing Ltd.
5.5 Case of WorldComs bankruptcy
6.New rules after the ENRON collapse
6.1 SarbanesOxley Act of 2002
6.2 New Stock Exchange Rules: NYSE（the New York Stock Exchange） and NASD （the National Association of Securities Dealers）Summary
Chapter 2 Adoption of Independent
Director System in China
Introduction
1.Shareholding structure in Chinese listed corporations
1.1 Transformation from Stateowned enterprises to modern corporations
1.2 Shareholding structure in Chinese listed corporations
2.Motivation of introducing independent director system in China
2.1 Invalidity of board of supervisors
2.2 Exploitation of small shareholders by large shareholders
2.3 Influence from government
3.Expected role of independent director system in China
4.Regulations of independent director system in China
4.1 Process of introducing independent director system into China
4.2 Substantial rules of independent director system in China
5.Differences in rules regarding independent director system between China and the US
5.1 Different expected roles
5.2 Different requirements on proportion
5.3 Different definition of independence
5.4 Different requirement on committee structure
5.5 Different requirement on nomination
5.6 Necessity to reconcile independent director and board of supervisors
Summary
Chapter 3 Actual Effect of Independent
Director System in China
Introduction
1.Appointment of independent directors in China
2.Nomination of independent directors in China
3.Composition of independent directors in China
4.Participation of independent directors in China
5.Working environment of independent directors in China
6.Replacement of independent directors in China
7.Link between independent directors and corporate performance
8.Two cases about independent directors in China
Summary
Chapter 4 Inherent Weaknesses of
Independent Director System
Introduction
1.Rationale in independent director system
2.Competence problem in independent director system
2.1 Delimitation of “independence”
2.2 Capacity and nomination of independent director
2.3 Tenure and proportion of independent director
3.Incentive problem in independent director system
3.1 Compensation of independent director
3.2 Duties and liabilities of independent director
3.3 Concern for reputation
Summary
Chapter 5 Board of Supervision vs.
Independent Director System
Introduction
1.Analysis of Board of Supervision in Germany
1.1 Arrangement of Board of Supervision in Germany
1.2 Analysis of Board of Supervision
1.3 Marked traits of board of supervision in Germany
2.Appraisal of Board of Supervision in Germany
2.1 The merits of board of supervision
2.2 The weakness of board of supervision
3.Comparison between the two internal monitoring systems in Germany and US
3.1 Structural differences in the two internal monitoring systems
3.2 Endogenetic differences derived from the local forces
3.3 Special concerns on efficiency of internal control
4.Trend of functional convergence
4.1 Evidence of convergence from American side
4.2 Evidence of convergence from German side Summary
Chapter 6 Coexistence of Two Internal Monitoring
Systems in One Company
Introduction
1.Different opinions on the coexistence of two internal monitors
2.Arguments for supporting coexistence of two internal monitors
3.Coexistence causes conflicts in regulation
3.1 Overlapped powers and duties between board of supervisors and
independent directors under Chinese regulations
3.2 Conflicting legal status of independent director system and board
of supervisors
4.Coexistence causes conflicts in practice
4.1 Overlapped role of independent director system and board of
supervisors in practical view
4.2 Functional similarity between independent director system and board of supervisors
4.3 Criticism on certain proposals
4.4 Competition for power on oversight
4.5 Weakening of actual effect on oversight
4.6 Freeriding problem
4.7 Increased cost for the company
4.8 Cost and benefit analysis
Summary
Chapter 7 Mandatory approach or
Optional approach
Introduction
1.Different approaches to implementing independent director system
1.1 Mandatory approach
1.2 Recommendatory approach
1.3 Optional approach—a hybrid solution
2.Government regulation theory and marketoriented theory
2.1 Government regulation theory
2.2 Contractual or marketoriented theory
3.Appraisal of mandatory approach
3.1 The values of mandatory approach
3.2 Problems with mandatory approach
4.Appraisal of recommendatory approach
4.1 Advantages of recommendatory approach
4.2 Disadvantages of recommendatory approach
5.Evidence from Japanese experience
5.1 Amendment of Japanese Commercial Code in 2002
5.2 Actual effect ofthe amendment in 2002
5.3 Indications from Japanese experience
6.Values of optional approach
6.1 Overcome the detriments of mandatory approach
6.2 Overcome the detriments of recommendatory approach
6.3 Provide competition among corporate governance rules
Summary
Chapter 8 Which Approach is Suitable for China
Introduction
1.Chinese market needs governmental intervention
1.1 Lack of mature free market in China
1.2 Special concern on protecting minority shareholders
2.Improper to mandate independent director system in China
2.1 Inherent problems in the independent director system
2.2 Problems with “transplant effect”
2.3 Doubts on best practice debate
2.4 Weakness of mandatory rules
2.5 A onesizefitsall approach is both costly and unnecessary
3.Suitable and feasible for China to make independent director
system optional
3.1 Wasteful to abandon the independent director system in China
3.2 Improper to mandate the coexistence of independent director system and supervisory board system in one company
3.3 Feasible to make independent director system optional
Conclusion
Bibliography
Introduction
……
2.Opinion of this book
As to the issue of searching for best practice in corporate governance, this paper holds the opinion as following.
First, this book disagrees with the assertion that“AngloAmerican” model is the best practice.
The analysis in Chapter 4 indicates that “AngloAmerican” internal monitor, the device of independent director system itself is not perfect as we thought. On one side, from the objective aspect, difficulty in defining independence, constraint from limited time and lack of information, cause independent directors not able to fulfill their monitoring role effectively. On the other side, from the subjective aspect, independent directors are lack of sufficient incentive to devote their time and energy, as study shows that compensation and liability can not provide enough incentive for independent directors. Socalled incentive from reputation is still uncertain. Hence, uncovering the ostentatious veil of independent director system, we can find that there are also many dilemma and unsolved weakness in it. It is not a perfect system as we assumed.
In addition, the history of the evolution of independent director system in US analyzed in Chapter 1 indicates that management may utilize independent directors as a protection, precluding management from being suspected, brought suits. It will cause the result that management can conduct frauds under the camouflage of independent directors, which give investors fake image that management are well supervised and further decrease the shareholders monitor and alert. This is tested by the series of scandals happening in US. The failure of these corporations further reflects the inability of independent director system as a corporate gatekeeper to detect and curtail managements wrongdoing.
The controversial opinions held by even American scholars on the effectiveness of independent director system and the unsatisfactory effect brought by the independent director system in China and Japan, analyzed in Chapter 3 and Chapter 7, from another aspect testifies the doubts on the best practice of “AngloAmerican” independent director system.
Second, this book holds the opinion that the universal best practice applicable to all the countries may not exist. The focus on searching for the universal best practice may overlook the effect and constraints from path dependence.
Even though we assumed “AngloAmerican” model is the best practice, the analysis in Chapter 1 indicates that many factors, including dispersed shareholding structure, political influence, the emergence of institutional shareholders, and other local forces brought independent director system into existence and influenced the evolution of independent director system in US. At the same time, the operation of independent director system needs many complementary institutions. “AngloAmerican” model of corporate governance may not be the only reason for the success of American business, which also gets constraints from other factors in the local markets.
The complicated “transplant effects” make the efforts on searching for best practice kind of useless, since even though we found the model of best practice, it is hard to transplant and even seems impossible to get the same functions and benefits from the so called best practice. The Chinese transplanting experience as analyzed in Chapter 2 and 3, indicates that it is difficult to transplant the identical system due to the path dependence, and further even though assuming China could adopt the exactly same system, it still can not ensure China can adopt the same functions of the system, again due to the path dependence and complementary problems. The Japanese transplanting experience as analyzed in Chapter 7 reinforces this argument.
In addition, comparison between independent director system and board of supervision system analyzed in Chapter 5 indicates that the merits and demerits of certain governance system, partly relate to the structural device of the system itself, however on the other side, are highly relating to the endogenetic factors that inextricably linked to the system. If putting aside endogenetic differences derived from the local forces, the functions of those formally different systems are in reality quite similar. It is difficult to tell which system is better. At the same time there is a tendency of functional convergence between different governance rules. The functional convergence happening in independent director system and board of supervision system, as mentioned in Chapter 5 again demonstrates that the form of the corporate governance rules is not as important as we assumed.
Hence, even though assuming certain system X can achieve best effects in country A, but system X can only be identified as the best practice for country A, and further it can not come to the conclusion that system X can also achieve best effects in other countries. Therefore, the efforts on searching for best practices may not be as important as we assumed. It may be more important to focus on searching for the most suitable governing structure for each specific market.
Third, as to whether corporate governance matters, this books opinion is corporate governance to some extent, can provide the necessary disciplining mechanisms to make conflicts of interests manageable, solve agency problems, and in addition may benefit the performance of the company. But corporate governance is merely a small piece of the whole regime. We can not exaggerate the importance of the formal corporate governance. Even though the form of certain corporate governance model may be good, but may not benefit every company. As proved by John Pound, “Obviously, not all wellgoverned companies do well in the marketplace. Nor do the badly governed always sink”
Chaobin, Xie, Research On Legal Regime Of Independent Director, Beijing: Law Press China, 2004, p.315..
As to the second issue, the approach to implement corporate governance rules, this book holds the opinion as following.
Exclusively mandatory approach would cause serious problems in relation to activities involving company participants since mandatory rules are not suitable in all circumstances. One drawback is that they can deter the use of arrangements which meet the specific needs of parties and thereby serve to increase the joint welfare of those affected.
Richard A. Epstein, Simple Rules for a Complex World, Mass: Harvard University Press, 1995, pp.246~247. Larry E. Ribstein, The Mandatory Nature of the ALI Code, George Washington Law Review, 1993, Vol.61, pp. 985, 996,1008~1009. Companies are heterogeneous and the preferences of company participants vary. One choice may be suitable for company A, but may be not optimal for company B. As a result, what is good for many kinds of companies may not be suitable for the others. Mandatory rules preclude parties from customizing their operating environment to meet distinctive, private requirements. Such measures therefore can inhibit the achieving of efficient outcomes.
In order to be competitive in the market, all companies have the motivation to choose the most efficient and suitable model for themselves. The marketbased theory believes that investors are more likely than lawmakers to pick good rules, because investors have their own money at risk. As assumed by Professor Black, todays investors can choose better corporate rules than todays lawmakers.
Bernard S. Black, Is Corporate Law Trivial?: A Political and Economic Analysis, Northwestern University Law Review, 1990, Vol.84, pp.542, 576. Corporate lawmaking by the states is not fiat but rather a dialogue between lawgivers and the corporate community.
Id. at 574
The different companies have different optimal preferences, so a regulatory rule should allow all these preferences. It is obvious that more choices for companies are better than no choice. This approach suggests a mechanism for providing minimum level of market fairness and security by governmental rules, but leaving certain space for each listed company to design its own optimal corporate structure. Hence, quasimandatory regime attempts to ensure that each company has a degree of flexibility to modify its governance structure within the confines of certain minimum requirements.
Exclusively mandatory regime is risky. Paternalism in state corporate law is a twoedged sword. The costs of paternalism is tremendous because lawmakers may choose the wrong rules and mandatory rules prevent experiments with new sets of rules, the exclusive mandatory rules as unwise restrictions on freedom of contract. However, solely voluntary regime is also problematic. Because market forces dont adequately constrain managers from abusing the discretion that regulation give them. In addition, market forces have advantage to pursue market efficiency but are weak in protecting overall marketfairness and security. Based on such concern, appropriate government intervention is needed. Hence it turns out that it is tough but important to find a balance between government interference and market influence and in addition the balance between market fairness and efficiency. The quasimandatory regime provides a novel combination of mandatory and voluntary governance rules.
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