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2.1 Introduction to the Chapter
2.2 Different Models of Corporate Governance
2.3 Reviewing the Models in Context of the Agenc !aradig"
2.# Driving $orces %ehind the Different Models
2.& A Review of the Convergence vs. Divergence De'ate
2.( )ransplant *ffect
2.+ Conclusion to the Chapter
2.1 Introduction to the Chapter
,hile the specific focus of this dissertation is on the role of independent directors- that focus co"es
within the 'roader context of different tpes of regi"es in the field of corporate governance.
*ssentiall- the purpose is to exa"ine the i"plications of extracting the concept of independent
directors fro" one tpe of corporate governance sste" and transplanting the sa"e into another
tpe. .ence- it is i"perative to stud certain aspects and theories of co"parative corporate
governance that 'ear direct relevance to the focus of this dissertation- which is the efficac of such
a transplant. )hese theories will then 'e applied to the specific topic of independent directors. )he
represent the tools or i"ple"ents that will 'e e"ploed for the "ore focused stud- and the lenses
through which the topic of independent directors in e"erging econo"ies will 'e analsed.
,hile there are rich and extensive de'ates and literature in the area of co"parative
corporate governance- " effort in this Chapter is to confine the discussion to certain core
principles that act as a fra"ewor/ within which the topic of independent directors can 'e
studied "ore carefull. )he goal here is twofold0 1i2 to identif these principles in a precise and
cogent "anner3 and 1ii2 to provide a suita'le criti4ue of the principles and theories so as to set
the tone for the discussion on independent directors.
$irst- this part of the stud see/s to deter"ine the various sste"s of corporate governance
that are currentl in vogue- along with a description and discussion of these various sste"s. )his
would answer the 4uestion0 hat is the current position in the area of co"parative corporate
governance5 6econd- I explore so"e of the underling reasons for the current position 'eing what it
is. )hese reasons include "atters pertaining to law- histor and political econo". )his would
answer the 4uestion0 h! are there differences in various sste"s of corporate governance5 )hird- I
consider if these sste"s are li/el to re"ain in status 4uo or whether the sste"s are li/el to
undergo changes and result in a convergence at so"e point. )he 4uestion here is0 what does the
future hold for co"parative corporate governance- and hen" if at all- will there 'e an
convergence5 7n the contrar- is there li/el to 'e further divergence5 $inall- I loo/ at the theor
and concept 'ehind legal transplants- which "a perhaps 'e one "echanis" that is used 1' its
proponents2 to achieve convergence. )his then see/s to answer the 4uestion0 ho will corporate
governance sste"s change in order to 'ring a'out convergence- or the alternative of further
2.2 #i$$erent Mode%& o$ Corporate Go'ernance
As we have seen- independent directors originated pri"aril in the 8.6. and the 8.9.- and were
thereafter exported to other countries. A /e 4uestion that arises for consideration is whether this
concept can 'e i"ple"ented across various :urisdictions with ease or whether there are an
funda"ental differences in the :urisdictions so as to "a/e it conducive for i"ple"entation in so"e
1pri"aril the countries where it originated2- 'ut not in others. )his naturall leads "e to a stud of
the differences in corporate governance sste"s in various countries.
)raditionall- corporate governance sste"s have 'een divided into two categories- viz:,
the ;outsider; "odel and the ;insider; "odel.
A. )he 7utsider Model of Corporate Governance
)he outsider "odel of corporate governance can 'e found "ostl in the developed world. At the
outset- it would 'e appropriate to descri'e the core features of an outsider sste" of corporate
governance- which are ;12 dispersed e4uit ownership with large institutional holdings3 22 the
recognised pri"ac of shareholder interests in the co"pan law3 32 a strong e"phasis on the
1 6ee <estor = )ho"pson- supra note 1>. )he expression ;"odel; is used pri"aril with
reference to the tpe of corporate structures and governance followed- viz,, the insider or
outsider- while the expression ;sste"; is used with reference to a :urisdiction or countr that
follows a particular "odel.
of "inorit investors in securities law and regulation3 and #2 relativel strong re4uire"ents for
?et us now consider these in greater detail.
Ownership Structure
)he pri"ar deter"inant of each "odel relates to the ownership structure. )he outsider "odel
displas dispersed share ownership with large institutional shareholdings.
)his largel trac/s the
%erle and Means corporation
where dispersion in the ownership of co"panies is inherent in the
corporate sste"-
due to which ;the position of ownership has changed fro" that of an active to that
of a passive agent;.
)he "odel is referred to as the ;outsider; "odel 'ecause shareholders tpicall
have no interest in "anaging the co"pan and retain no relationship with the co"pan except for
their financial invest"ents@the separation of ownership and control is at its 'est.
)his "odel is
also so"eti"es referred to as the ;ar"AsBlengthA sste" of ownership and control. As one corporate
scholar aptl notes0
)he AoutsiderA tpolog is used to descri'e the situation that exists 'ecause share ownership is
dispersed a"ong a large nu"'er of institutional and individual investors rather than 'eing
concentrated in the hands of a s"all nu"'er of fa"ilies- 'an/s or fir"s. )he ter" Aar"AsB
lengthA signifies that investors ... are rarel poised to intervene and ta/e a hand in running a
2 Ibid. at &.
3 Ibid.
# )he theor propounded ' %erle and Means and its i"plications on "odern corporate
governance is discussed in detail later- see infra Chapter 3- 6ection 3.21A2.
& %erle = Means- supra note 21 at #+.
( Ibid. at (#.
+ <estor = )ho"pson- supra note 1> at &. 6ee also %rian R. Cheffins- Putting Britain on the
Roe Map, supra note 2C at 1&1.
'usiness. Instead- the tend to "aintain their distance and give executives a free hand to "anage.
Due to the existence of diffused shareholding and the separation of ownership and control- the
pri"ar effort of corporate law in :urisdictions that for" part of the outsider "odel of corporate
governance is to cur' the ;agenc costs arising fro" selfBserving "anagerial conduct;-
' acting as
a chec/ on the activities of "anagers and ' enhancing their accounta'ilit towards shareholders.
Focused Constituency
)hat naturall leads "e to the second essential characteristic of outsider sste"s- where the focus of
corporate law is on the protection of shareholdersA interests- which are considered core.
)his is
otherwise also /nown as the AshareholderA "odel. Corporate law revolves around shareholders- and
no others. )he sole goal of the law is to enhance longBter" shareholder interest. )his is however
achieved through a "ore expansive approach to shareholder supre"ac- as noted 'elow0
)he shareholderBoriented "odel does "ore than assert the pri"ac of shareholder interests-
however. It asserts the interest of all shareholders- including "inorit shareholders. More
particularl- it is a central tenet in the standard "odel that "inorit or nonBcontrolling
shareholders should receive strong protection fro" exploitation at the hands of controlling
D %rian Cheffins- ;Corporate Governance Refor"0 %ritain as an *xporter;- in D Hume Papers
on Public Policy: orporate !overnance and the Reform of the ompany "a# 1David .u"e
Inst. *d.- 2CCC2- online0 Ehttp0FFssrn.co"Fa'stractG21&>&CH at > $Britain as %&porter'.
> Ibid. at 11.
1C Digna" = Galanis- supra note 3> at 2C23 Arthur R. !into- ;Glo'aliIation and the 6tud of
Co"parative Corporate Governance; 12CC&2 23 ,is. IntAl ?. J. #++ at #++B#+>.
11 .enr .ans"ann = Reinier 9raa/"an- ;)he *nd of .istor for Corporate ?aw; 12CC12 D>
Geo. ?.J. #3> K (he %nd of History'.
)here is no tendenc to consider the larger interests of various actors involved in the functioning of
co"panies. If at all other interests such as those of creditors- e"ploees- consu"ers and the pu'lic
are considered- the are secondar to those of shareholders- who are pri"ar owners of the
co"pan. )his is otherwise /nown as the Apropert conceptionA of the corporation.
At one level- it
"a 'e argued that ownership structure has nothing to do with the shareholder "odel of corporate
governance. .owever- it is found that the AshareholderA "odel is often prevalent in econo"ies that
follow diffused shareholding pattern-
and hence 'oth these characteristics go handBinBhand in the
context of the outsider sste" of corporate governance.
Other Systemic Factors
7ther /e characteristics of the outsider "odel relate to the e"phasis it places on the efficienc of
the securities "ar/ets and on disclosure and transparenc. )he outsider "odel involves a "ar/etB
'ased sste" 1with lesser reliance on "andator rules- and greater e"phasis on default rules2 that
provides a significant role to "ar/et plaers as opposed to regulators and the state. )his regi"e-
which focuses heavil on capital "ar/ets- can 'e characterised as infor"ationBforcing
where' high
disclosure standards re4uire co"panies to disclose infor"ation and leave decisionB"a/ing on
invest"ent "atters to the various plaers in the "ar/et.
12 ,illia" ). Allen- ;7ur 6chiIophrenic Conception of the %usiness Corporation; 11>>22 1#
CarodoIo ?. Rev. 2(1 at 2(#B(& K7ur .)chizophrenic onception'.
13 !into- supra note (& at #+D.
1# Infor"ationBforcing rules are default rules that co"pel parties with superior infor"ation to
divulge that infor"ation to other parties the deal with so that the pro'le" of infor"ation
as""etr is o'viated- or at least reduced. 6ee Lair ?isto/in- ;?earning )hrough !olic
Mariation; 12CCD2 11D Lale ?.J. #DC at &C1BC2.
It also presupposes the existence and predo"inance of proper "ar/et sste"s and sophisticated
plaers 1such as /nowledgea'le professionals- 'eing lawers- accountants and invest"ents 'an/ers- a
co"petent :udiciar and other i"portant fiduciaries such as a cadre of independent directors with a
strong foundation in
corporate laws and practices2. In fact- since ;diffuse ownership ields "anagerial agenc costs as a
pro'le"- . it is associated with institutions li/e
independent and transparent accounting- which "itigate these costs;.
)he depth of the "ar/ets and sophistication of "ar/et plaers ena'le a "ar/etBoriented
approach towards regulation and governance and less involve"ent ' the state through regulation-
except ' laing down default rules as opposed to "andator rules. Due to these preBre4uisites in an
outsider sste" of corporate governance- such a sste" can thrive onl in developed econo"ies
which can 'oast of advanced sste"s of selfBregulation with "axi"u" disclosure and transparenc-
coupled with the availa'ilit of experienced and sophisticated plaers such as an expert cadre of
independent directors- accountants- rating agencies and other gate/eepers who can ensure proper
conduct on the part of the "anagers. 6uch a sste" also relies "ini"all on state regulation that is
of a "andator nature.
%. Constituents of the 7utsider Model
Ownership Structure
)he assertion that the 8.6. and the 8.9. are leading countries that follow the outsider "odel of
corporate governance receives nearBunani"ous support in
existing literature. $irst- loo/ing at the ownership structures in these countries- it is found that in the
8.6. and the 8.9.- ;and unli/e "ost of the rest of the world-
"ost large corporations are pu'lic and not fa"ilBcontrolled;. In these
countries- shareholding is diffused and it is not co""on to find co"panies that have a do"inant or
controlling shareholder.
Focused Constituency
1& 6ee Cheffins- Putting Britain on the Roe Map, supra note 2C at 1&1. )here are indeed exceptions
in 'oth the 8.6. and the 8.9. )he 8.6. does have co"panies that are fa"ilB owned- while the
8.9. has co"panies that are predo"inantl owned ' financial institutions- 'ut that does not ta/e
awa the general character of ownership in these econo"ies where shares are diffusel held.
In recent ti"es- there is an e"erging 'od of literature that suggests that the %erle = Means
corporations do not exist even in outsider sste"s such as the 8.6. 6ee ?eslie .annah- ;)he Divorce
of 7wnership fro" Control fro" 1>CC0 Recali'rating I"agined Glo'al .istorical )rends;- 12CC+2 #>
%usiness .istor #C# at #233 Joao A.C. 6antos = Adrienne 6. Ru"'le- ;)he A"erican 9eiretsu and
8niversal %an/s0 Investing- Moting and 6itting on <onfinancialsA Corporate %oards; 12CC(2 DC J. $in.
*con. #1> at #3(3 Clifford G. .olderness- ;)he Mth of Diffuse 7wnership in the 8nited 6tates;
12CC>2 22 Review of $inancial 6tudies 13++. .owever- this "ove"ent has not gained sufficient
support and has also 'een the su':ect "atter of i""ediate challenge. 6ee %rian Cheffins- ;Is %erle
and Means Reall a Mth5; 8C?A 6chool of ?aw- ?aw = *cono"ics Research !aper 6eries-
Research !aper <o. C>BC&- availa'le online0 Ehttp0FFssrn.co"Fa'stractG13&2(C&.
)he second aspect of shareholder pri"ac is also present in the 8.6. and 8.9- al'eit to a "arginall
lesser extent in the 8.9. than in the 8.6. It is usuall found that ;corporations in the 8nited 6tates
and 8nited 9ingdo" operate pri"aril for the 'enefit of shareholders;.
.ere- the focus is on
protection of shareholdersA interests fro" the actions of "anagers. $or exa"ple- ;KcNonsistent with
such reasoning- %ritainAs Cad'ur- Green'ur and .a"pel Co""ittees have . sought to influence
"anagerial 'ehaviour ' enhancing the role of the nonBexecutive directors and ' i"proving lin/s
'etween pa and perfor"ance;.
even 8.6. corporate governance recognises the superiorit of shareholder interests over other
Although there have 'een so"e fairl recent departures fro" this principle 'oth in the
8.6. through the constituenc statutes
and the
1( ?awrence A. Cunningha"- ;Co""onalities and !rescriptions in the Mertical Di"ensions of
Glo'al Corporate Governance; 11>>>2 D# Corn. ?. Rev. 1133 at 113#.
1+ Cheffins- Britain as %&porter, supra note (3 at 11.
1D )his principle has 'een esta'lished al"ost a centur ago in the case of *odge v. +ord Motor
Co.- 1+C <.,. ((D 1Mich. 1>1>2- where the Michigan 6upre"e Court re"ar/ed0
)here should 'e no confusion ... A 'usiness corporation is organiIed and carried on
pri"aril for the profit of the stoc/holders. )he powers of the directors are to 'e e"ploed
for that end. )he discretion of the directors is to 'e exercised in the choice of "eans to attain
that end- and does not extend to ... other purposes.
Ibid. at (D#.
1> In the 1>DCs- several states in the 8.6. enacted constituenc statutes- which differ in a
nu"'er of was in the detail- 'ut have a co""on approach- which is to authorise the 'oard of
directors to ta/e into account the interests of all sta/eholders in a co"pan. ,illia" ). Allen-
,ur .)chizophrenic onception, supra note (+ at 2+(. It is- however- argua'le that these
constituenc statutes were occasioned ' the need of incu"'ent "anagers to hold on to their
positions within the co"pan in the wa/e of hostile ta/eover offers- rather than with an
altruistic sense of o'ligation or voluntaris" towards societ. 6ee George ,. Dent Jr.-
;Acade"ics in ,onderland0 )he )ea" !roduction and Director !ri"ac Models of Corporate
Governance; 12CCD2 ## .ous. ?. Rev. 1213 at 122+.
8.9. under the new ompanies -ct 2CC(-
the 'asic principle of shareholder supre"ac has not
'een eli"inated- or even eroded.
Other Systemic Factors
?astl- the 8.6. and the 8.9. possess wellBdeveloped securities "ar/ets with stringent
disclosure and transparenc re4uire"ents.
)hese "ar/ets have strong securities regulator
authorities as well as selfBregulator "echanis"s that i"pose disclosure nor"s so as to "itigate the
infor"ation as""etr pro'le"s in securities "ar/ets.
)he also possess several reputational
inter"ediaries such as accountants- lawers and rating agencies- who sta/e their reputation to
protect investors that rel on their :udg"ent and opinion.
)hese countries also i"pose detailed and
upBtoBdate accounting standards. All these "a/e the 8.6. and the 8.9. co"parativel transparent
and li4uid as far as their securities "ar/ets are concerned.
)here is therefore no dou't that the 8.6. and 8.9. are part of the outsider sste" of
corporate governance. In fact- the epito"ise the outsider "odel without a dou't. It is for this ver
reason that the have 'een chosen for this stud
2C )he ompanies -ct .//0, s. 1+2112 enshrines the principle of enlightened shareholder value
1*6M2 which re4uires the 'oard of a co"pan to pa so"e regard to sta/eholder interests. $or a
detailed discussion on this aspect- see infra Chapter 3- 6ection 3.#1%2.
21 %ernard 6. %lac/- ;)he Core Institutions that 6upport 6trong 6ecurities Mar/ets; 12CCC2 &&
%us. ?aw. 1&(& at 1&(& $ore Institutions'.
22 Ibid. at 1&(D. It is a different "atter that funda"ental 4uestions have 'een raised with regard to
the utilit of this approach and the institutions involved owing to their ina'ilit to prevent the
recent 1and ongoing2 glo'al financial crisis.
23 Ibid, at 1&(>.
as constituents of such a sste"- and to ena'le co"parison with sste"s that follow the insider
"odel of corporate governance.
C. )he Insider Model of Corporate Governance
Ownership Structure
)he insider "odel is characterised ' cohesive groups of ;insiders; who have a
closer and "ore longBter" relationship with the co"pan. )his is true even in
the case of co"panies that are listed on the stoc/ exchanges- let alone privatel held co"panies.
)he insiders 1who are essentiall the controlling shareholders2 are the single largest group of
shareholders- with the rest of the shareholding 'eing diffused and held ' institutions or
individuals constituting the Apu'licA.
)he insiders tpicall have a controlling interest in the
co"pan and there' possess the a'ilit to exercise do"inant control over the co"panAs affairs.
In this regi"e- the "inorit shareholders do not have "uch of a sa as the do not hold
sufficient nu"'er of shares in the co"pan so as to 'e in a position to outvote or even veto the
decisions spearheaded ' the controlling shareholders.
As to the identit of the controlling shareholders- the tend to 'e "ostl 'usiness fa"il
2# .ere again- as in the case of outsider sste"s- there could 'e exceptions where so"e
co"panies de"onstrate diffused shareholding. .owever- that does not dilute the general
position that co"panies in the insider sste"s have concentrated shareholdings.
or the state.
)his tends to 'e particularl true of Asian countries- which are ;"ar/ed with
concentrated stoc/ ownership and a preponderance of fa"ilBcontrolled 'usinesses while stateB
controlled 'usinesses for" an i"portant seg"ent of the corporate sector in "an of these
)his is also otherwise referred to as the ;fa"ilFstate; "odel.
In so"e *uropean
countries- co""ercial 'an/s pla a do"inant role in the control of co"panies there' 'eco"ing
AinsidersA in a 'an/Bcentric for" of governance.
)his 'an/ "odel is different fro" the fa"ilFstate
"odel of concentrated ownership.
2& )here is a preponderance of fa"ilBowned 'usinesses in developing countries. Jaati 6ar/ar
= 6u'rata 6ar/ar- ;?arge 6hareholder Activis" in Corporate Governance in Developing
Countries0 *vidence fro" India; 12CCC2 103 International Review of $inance 1(1 at 1(D.
2( Ra"pant state ownership in several countries is unsurprising on account of the fact that
privatiIation is et to 'e co"pleted in those countries. 6ee ?a !orta- et, al,, -round the 1orld,
supra note 2( at #>(.
2+ Ra:esh Cha/ra'arti- ;Corporate Governance in India B *volution and Challenges; 12CC&2-
online0 Ehttp0FFssrn.co"Fa'stractG(#>D&+H at 11 $%volution and hallengesN.
2D 6ee <estor = )ho"pson- supra note 1> at 12.
2> Ibid. at 11.
3C In the 'an/ "odel of corporate governance- 'an/s pla an i"portant role in corporate
governance. 6uch a regi"e is to 'e found in continental *uropean countries such as a Ger"an
and in other countries such as Japan. 6ee Denis = McConnell- supra note #3 at 1#1&3 ?a !orta-
et, al,, -round the 1orld, supra note 2( at #+#3 Mar/ J. Roe- ;6o"e Differences in Corporate
6tructure in Ger"an- Japan and the 8nited 6tates; 11>>32 1C2 Lale ?. J. 1>2+ $)ome
*ifferences'. .owever- it is necessar to clarif that the purpose of this dissertation is to
underta/e a co"parative stud of the role of independent directors in the outsider sste"s 1with
diffused shareholding2 and the insider sste"s 1that follow the fa"ilFstate "odel2. It is not
intended to underta/e a stud or co"parison of the 'an/ "odel of corporate governance as
sste"s that follow that "odel face an entirel different set of issues- "an of which "a not
'e not ger"ane to the 4uestions raised in this dissertation.
Another co""on feature of the insider sste"s is that the do"inant shareholders often
i"prove their position in the co"pan ' see/ing control and voting rights in excess of the shares
the hold. In other words- their controlling rights far exceed their econo"ic interests in the co"pan.
)his is achieved
through crossBholdings- pra"id structures- tunnelling and other si"ilar devices. )he concept of
pra"id structures is descri'ed as follows0
Control in excess of proportional ownership can also 'e achieved through pra"id structures
or ' crossBholdings. In a pra"id structure- one fir" owns &1O 1for exa"ple2 of a second
fir"- which owns &1O of a third fir"- and so on. )he owner at the top of the pra"id there'
has effective control of all the fir"s in the pra"id- with an increasingl s"all invest"ent in
each fir" down the line. CrossBholdings exist when a group of co"panies "aintain
interloc/ing ownership positions in each other. )o the extent that the interloc/ing of their
ownership positions "a/es group "e"'ers inclined to support each other- voting coalitions
are for"ed.
6uch pra"id structures are utilised ' controlling shareholders to indulge in tunnelling- which is
the process ' which such shareholders "ove profits or tunnel the" across fir"s so that the profit
finall resides in fir"s in which the have high cash flow rights 1' virtue of a greater percentage of
shareholding2 as opposed to fir"s in which the have low cash flow rights.
)his sche"e ensures
that controlling shareholders receive a greater share of the profits than the "inorit shareholders-
there' creating discri"ination a"ong econo"ic rights of
31 Denis = McConnell- supra note #3 at 23.
32 M. %ertrand- !. Mehta = 6. Mullainathan- ;$erreting 7ut )unneling0 An Application to
Indian %usiness Groups; 12CC22 11+112 Puarterl Journal of *cono"ics 121 at 121. 6ee also
Cha/ra'arti- %volution and hallenges, supra note D> at +- 12.
% virtue of their control rights 1which are supple"ented ' additional "echanis"s such as
pra"iding and tunnelling2- these do"inant shareholders are a'le to exercise co"plete control over
the co"pan.
)he are virtuall a'le to appoint and replace the entire 'oard and- through this-
influence the "anage"ent strateg and operational affairs of the co"pan. $or this reason- the
"anage"ent will li/el owe its allegiance to the controlling shareholders. )he controlling
shareholders no"inate senior "e"'ers of "anage"ent- and even "ore- the often appoint
the"selves on the 'oards or as "anagers. It is not unco""on to find co"panies that are controlled
' fa"il groups to have senior "anagerial positions occupied ' fa"il "e"'ers. 6i"ilarl- where
co"panies are controlled ' the state- 'oard and senior "anagerial positions are occupied '
Another co""on feature of the insider sste" is that the do"inant owners- whether
the are 'usiness fa"ilies or the state 1in the latter case
represented ' the 'ureaucrats2- are politicall influential and wellBconnected.
)his interconnectivit 'etween the corporate sste" and the political sste" is a crucial factor in such
"ar/ets- as co"panies use these connections in order to perpetuate their role in the functioning of
the "ar/ets.
All corporate governance re4uire"ents in these :urisdictions ought to ta/e this factor
33 6ee ?a !orta- et. al., -round the 1orld, supra note 2( at &C2.
3# )he pro'le" here arises 'ecause there are no significant outside interests in the co"pan. 6ee
%erglof = von )hadden- supra note D& at 12.
3& 6uch a nexus 'etween corporate governance and the political econo" owes its
significance to ;high entr 'arriers- hidden su'sidies to the local industr- and o'stacles to
foreign invest"ent;. Ibid. at 13. $or exa"ple- in India- the licenseBra: and industrial capacit
4uota sste" ensured that onl a few 'usinesses thrived. Although that sste" has 'een largel
a'olished now- so"e of the vestiges of that old sste" continue to date. 6ee Ra:esh
into account.
Focused Constituency
Apart fro" the ownership aspect- it is i"portant to note that the insider sste"s are not entirel shareholderB
centric- 'ut also do ta/e into account the interests of other sta/eholders.
6uch sta/eholders include
the creditors 1such as 'an/s and financial institutions2- e"ploees- consu"ers and the general pu'lic
who "a 'e affected ' the actions of co"panies in these sste"s. In other words- co"panies in
these countries are thought to operate ;for the co""on good@for the 'enefit of shareholders-
wor/ers- creditors- and co""unities;.
.ere again- as discussed earlier in the context of the outsider
there is so"e correlation 'etween ownership structure and the shareholderBsta/eholder
focus. Interesting political explanations have 'een proffered for this pheno"enon. !rofessor Roe
notes that ;when we line up the worldAs richest nations on a leftBright political continuu" and then
line the" up on a closeBtoBdiffuse ownership continuu"- the two correlate powerfull;.
Cha/ra'arti- ,illia" ?. Megginson = !radeep 9. Ladav- ;Corporate Governance in India; 12CCD2 2C112 J.
App. Corp. $in. &> at (2 $orporate !overnance in India'.
3( Digna" = Galanis- supra note 3> at 2C2 1stating that ;insider sste"s are "ore responsive
to sta/eholder concerns 'ecause the often for" part of a wider protective social
infrastructure;2. !rofessor Cheffins o'serves that the insider regi"e0
is characteriIed ' a co"parativel high degree of state intervention and ' a consensusB
"inded approach to potentiall contentious issues. Moreover- the "axi"iIation of profits for
investors is not an overriding priorit. Instead- there is a desire to stri/e a 'alance 'etween
various constituencies lin/ed with co"panies and the "ain concern is said to 'e sustaina'le-
sta'le and continuous econo"ic growth.
Cheffins- Putting Britain on the Roe Map, supra note 2C at 1&3.
3+ Cunningha"- supra note +( at 113#.
3D 6ee supra note (D and acco"paning text.
3> Mar/ J. Roe- ;!olitical !reconditions to 6eparating 7wnership fro" Corporate Control;
12CCC2 &3 6tan. ?. Rev. &3> at &3>. In other words0
'roadl spea/ing- the "ore leftBwing a govern"ent is- the "ore li/el it is that the
corporate governance sste" will 'e an insider sste" and- the "ore rightBwing a
Other Systemic Factors
$urther- the insider sste"s displa other characteristics that are specific to the". )he possess
neither ro'ust capital "ar/ets nor sophisticated "ar/et plaers3 if at all- these are in an earl stage
of evolution in so"e countries that have experienced significant capital "ar/ets explosion in the last
$or this reason- the state continues to perfor" a greater role in regulation of corporate
activit ' i"posing "andator standards and 'rightBline rules. )here is a perceived reluctance on
the part of the state in reling on "ar/et participants or a "ar/etB'ased regulation- perhaps owing to
their lac/ of sophistication as co"pared to the outsider sste"s. Al"ost all countries other than the
8.6. and the 8.9. follow the insider sste" of corporate governance.
)hese include various
*uropean countries that de"onstrate the 'an/ sste" of governance as well as "ost e"erging
econo"ies that de"onstrate the fa"ilFstate controlled sste". 6everal Asian countries such as
China and India- the latter two 'eing the su':ect
govern"ent is- the "ore li/el it is that the sste" is an outsider one.
Digna" = Galanis- supra note 3> at 2C2. )his is consistent with rightBwing govern"entsA tendenc to 'e
shareholderBcentric- while leftBwing govern"ents tend to 'e sta/eholderB centric. )his perhaps 'est
explains the lin/ages 'etween ownership concentration and the shareholderBsta/eholder focus- which
is pri"aril through political sste"s.
#C )he %RIC countries 1%raIil- Russia- China and India2 are apt exa"ples of econo"ies that have
historicall 'een 'ereft of developed capital "ar/ets- 'ut that have "ore recentl "igrated at a
rapid pace to adopt sste"s and practices fro" "ore developed econo"ies so as to ensure
ro'ustness of their "ar/ets and to attract not onl greater nu"'er of investors- 'ut also those
with high 4ualit and credi'ilit.
#1 Joseph McCaher = ?uc Renne'oog- ;Introduction; in McCaher- et al.- supra note 2C at 13 ?a
!orta- et, al,, -round the 1orld, supra note 2( at #+#. )here have 'een o'servations 'oth was
as to whether countries such as Japan- Australia- Canada and <ew Qealand follow the insider
"odel or the outsider "odel. 6ee <estor = )ho"pson- supra note 1> at 12. .owever- that
de'ate is not relevant to the present discussion as this dissertation does not focus on those
"atter of " research- are classic insider sste"s where "ost pu'lic co"panies are controlled 1'
virtue of do"inant shareholding2 either ' 'usiness fa"ilies or the state.
D. Constituents of the Insider Model
)he insider "odel of corporate governance is fairl u'i4uitous-
particularl a"ong the
developing or e"erging econo"ies.
$urther"ore- leading Asian econo"ies fall within the real" of
the insider "odel of corporate governance.
In this 'ac/ground- this dissertation is particularl
concerned with the two such econo"ies- i.e., China and India- which I shall exa"ine in detail. ,hat
"a/es this stud even "ore interesting is the fact that one econo" 1China2 involves the do"inance
of the state in the corporate sector- while the other 1India2 the do"inance of fa"il 'usiness groups.
#2 $or an analsis of ChinaAs shareholding structure and controlling shareholder do"inance- see
)an ?a .ong = Jiangu ,ang- ;Modelling an *ffective Corporate Governance 6ste" for
ChinaAs 6tate 7wned *nterprises and Challenges in a )ransitional *cono"; 12CC+2 + J. Corp.
?. 6tud. 1#3 $Modelling for hina'. $or India- see Cha/ra'arti- %volution and hallenges,
supra note D>.
#3 6ee supra note 1C& and acco"paning text.
## 6ti:n Claessens- 6i"eon D:an/ov- = ?arr ..!. ?ang- ;)he 6eparation of 7wnership and
Control in *ast Asian Corporations; 12CCC2 &D J. $in. *con. D1 at 11C.
#& Ronald J. Gilson- ;Controlling $a"il 6hareholders in Developing Countries0 Anchoring
Relational *xchange; 12CC+2- online0 Ehttp0FFssrn.co"Fa'stractG>&+D>&H.
2, hina
Ownership Structure
)he two /e aspects of ownership structure in Chinese co"panies are first- the predo"inance of
state ownership- and second- the a'sence of li4uidit in the stoc/ "ar/ets due to the li"ited
availa'ilit of freeBfloat shares.
3a4 ,#nership concentration: Indeed- there are historical reasons for this position. In the
past- all factors of production in the Chinese econo" were controlled ' the state. It is onl
pursuant to econo"ic refor"s that were introduced since the 1>+Cs that the process of privatisation
In this process- the erstwhile state owned enterprises 167*s2 were converted into :oint stoc/
corporations under the ompany "a#
so that the could access the capital
"ar/ets to cater to their financing re4uire"ents. Despite such privatisation- the state continues to
own a su'stantial part of the vast "a:orit of co"panies that are
listed on the Chinese stoc/ exchanges- 'eing the 6hanghai and 6henIhen exchanges.
6everal e"pirical studies support this assertion. 7wnership concentration was ra"pant in the
initial ears of refor". A decade ago- Ru and ,ang found that the ;ownership concentration is high
#( ,ang Jiangu- ;Dancing with ,olves0 Regulation and Deregulation of $oreign Invest"ent in
ChinaAs 6toc/ Mar/et; 12CC#2 & AsianB!acific ?aw = !olA J. 1 at 1CB11 $*ancing #ith 1olves'.
#+ ,ang Jiangu- ;7verview of the Chinese Co"pan ?aw; in ompany "a# in hina
1forthco"ing2- online0 Ehttp0FFssrn.co"Fa'stractG1222C(1H $ompany "a# in hina'.
#D ompany "a# of the People5s Republic of hina, as a"ended on 2& 7cto'er 2CC&- ch. #
K!RC ompany "a#'.
#> 6ee Clar/e- ibid, at 131. 6ee also Luwa ,ei- ;An 7verview of Corporate Governance in
China; 12CC32 3C 6racuse J. IntAl ?. = Co". 23 at 3DB3>.
with the five largest shareholders accounting for &D percent of the outstanding shares in 1>>&-
co"pared to the &+.D percent in CIech Repu'lic- #2 percent in Ger"an and 33 percent in Japan;.

Another stud- referring to state ownership- notes that in the earl part of this decade ;KaNccording to
a Dow Jones 6urve- the average govern"ent ownership in ChinaAs stoc/ "ar/et was #& percent- as
of Januar 31- 2CC2- with a "axi"u" of #> percent. 6uch a high percentage of state ownership does
not exist in an other stoc/ "ar/et in the world;.
7ne other stud finds that ;' the end of 2CC1-
approxi"atel D#O of co"panies listed on Chinese stoc/ "ar/et are ulti"atel controlled ' the
state- co"pared with a'out 1(O of nonBstateBcontrolled ones in
our fir" sa"ple;. All these de"onstrate not onl concentrated ownership in Chinese listed
co"panies- 'ut do"inant control exercisa'le ' the state.
6uch state control gives rise to peculiar pro'le"s in corporate governance.
,ith a do"inant owner- it would nor"all 'e expected that such owner would
exercise tre"endous influence over decisions pertaining to the co"pan.
.owever- that does not appear to 'e the case in China. $irst- the do"inant owner
'eing the state is not a single entit or individual in a general sense- 'ut it is ;the
&C Riaonian Ru = Lan ,ang- ;7wnership 6tructure- Corporate Governance- and Corporate
!erfor"ance0 )he Case of Chinese 6toc/ Co"panies;- online0
Ehttp0FFssrn.co"Fa'stractG#&3C3H at 3.
&1 ,ang- *ancing #ith 1olves, supra note 11C at 11.
6tate- or the people as a whole;. )he state is an a'straction that acts through its agent in the for" of
'ureaucrats and govern"ent officials- whose interests "a not alwas 'e aligned with the controlling
shareholder- 'eing the state.
$urther- the state itself "a not 'e acting through a unitar 'od. $or
instance- the state shares "a 'e held ' different depart"ents within the govern"ent- who "a not
alwas act in unison- and instead "a act at crossBpurposes.
$or this reason- ownership concentrated
with the state "a give rise to a uni4ue corporate governance pro'le" due to the virtuall nonB
existent actual control ' the state- which is another "odel of ;insider control- na"el the soBcalled
guan6ianren 7onghzhi K/eBpersonBcontrolN in ChinaAs listed 67*s;-
with the /eBperson usuall
'eing the chief executive officer 1C*72 of the 67*. )he attitude of the state is a/in to the case of
a'sentee ownership. )his exacer'ates the agenc costs in 67*s.
3b4 "ac7 of "i8uidity. Co"pared to other :urisdictions in developed "ar/ets- s"all
shareholders lac/ a freeBflowing exit "echanis" due to the illi4uidit of the shares the hold- even
though such shares are listed on the stoc/ exchange. In order to appreciate this issue 'etter- it would
'e useful to 'riefl consider the capital structure of Chinese listed co"panies. *ven though the
PR ompany "a# treats all shares of a listed co"pan on the sa"e footing- differences arise as to
their tradea'ilit depending on the person who holds such
shares. 6hares are 'roadl divided into two categories- i.e., tradea'le shares and
&2 )an = ,ang- Modelling for hina, supra note 1C( at 1#>B&C.
&3 6ee Clar/e- Independent *irectors in hina, supra note 3+ at 13D.
&# )an = ,ang- Modelling for hina, supra note 1C( at 1&C. $or this reason- the agenc
pro'le"s 'etween "anagers and shareholders are not entirel a'sent in such entities
&& 6ee Luwa ,ei- supra note 11# at ##. 6eparate fro" this discussion- it "ust 'e noted- however- that
there are so"e argu"ents that favour "a:orit state ownership- particularl when a co"pan has
'een privatised in the recent past. 6ee ?incoln L. Rathna" = Miswanath
9haitan- ;!rivatiIation0 An InvestorAs !erspective; 11>>#2 132 !u'lic 8tilities $ortnightl 13 at 1+.
nonBtradea'le shares. 8nder the tradea'le categor- there are further su'divisions. AAA 6hares are
tradea'le shares held ' individuals- entities or specificall approved foreign institutional investors3
these are listed and traded on the do"estic stoc/ exchanges. A%A 6hares- which are listed on these
stoc/ exchanges- are availa'le for purchase and trading ' foreigners using foreign currenc onl.
7ther tpes of tradea'le shares are listed on foreign stoc/ exchanges such as .ong 9ong 1A.A shares2-
?ondon 1A?A shares2- <ew Lor/ 1A<A shares- represented ' A"erican Depositar Receipts- or ADRs2
and 6ingapore 1A6A shares2.
7n the other hand- nonBtradea'le shares are held ' the state and other legal persons- and
these are not generall availa'le for trading on the stoc/
6ince a large portion of the co"paniesA capital co"prised nonB tradea'le shares- that left ver little
li4uidit in the "ar/et for s"all shareholders such as individuals to 'u and sell tradea'le shares.
an opti"istic note- however- so"e of these differences have recentl 'een strea"lined ' the
govern"ent- where' do"estic Chinese investors can now invest in A%A shares utilising foreign
currenc- and "ore i"portantl- the distinction 'etween state shares- legal person shares and individual
shares has now 'een eli"inated there' 'ringing a'out a refor" in the ;split share structure;.
these refor"s are fairl recent- it is still unclear whether these differences will 'e o'literated in
practice- and if so the exact ti"eBfra"e within which that will 'e achieved. !ending that- it is li/el
that the differences will continue at least at so"e level- there' i"peding li4uidit for s"all
&( 6ee ,ang- ompany "a# in hina, supra note 111 at 3CB31.
&+ Clar/e- Independent *irectors in hina, supra note 3+ at 132.
&D )an and ,ang note that ;KtNrada'le ABshares and %Bshares onl constitute oneBthird of the total
shares of the listed co"panies. )he other twoBthirds co"prise nonBtrada'le ;state shares; 3guo6ia
gu4 and ;legal person shares; 3faren guy. )an = ,ang- Modelling for hina, supra note 1C( at 1&2.
&> ,ang- ompany "a# in hina, supra note 111 at 3CB31.
)he rather low li4uidit in the Chinese stoc/ "ar/ets has 'een e"piricall verified. )he
evaluation of one e"pirical stud finds as follows0
)he freeBfloat ratio represents a stoc/ "ar/etAs li4uidit and investa'ilit- and refers to the
proportion of freel trada'le shares availa'le to investors. Due to widespread state ownership-
the float ratio in ChinaAs stoc/ "ar/et- close to 3C percent since 1>>3- appears to 'e extre"el
low. Although things have 'een changing due to recent regulator relaxation allowing foreign
investors to have greater participation in 67*s- in "ost listed co"panies which were converted
fro" 67*s- onl oneBthird of the co"panAs shares are tpicall issued to the pu'lic- with the
re"aining in the hands of the govern"ent- the co"pan itself- or other
stateBowned enterprises.
In concluding the discussion on ownership- we find that not onl are listed co"pan shares
concentrated in the hands of a few shareholders 1predo"inantl the state itself2- 'ut the relative
illi4uidit in the "ar/ets also i"pedes exit options for s"all shareholders. 6uch a shareholding
structure necessitates 'etter protection for "inorit shareholders.
Focused Constituency
An discussion of corporate governance in China "ust necessaril 'e set in the 'ac/drop of the
countrAs socialistic origins.
)he countr followed the principle of ;planned econo"; for several
ears- and several ideas and concepts that were engendered during that period continue to re"ain
e"'edded in "uch of the current thin/ing as well- although there appears to 'e a concerted effort
recentl towards a "ore "ar/etB'ased approach. )his socialistic approach see/s co""on good of
societ- as opposed to the 'etter"ent of individuals- which is the principle "ore consistent with the
sta/eholderBcentric approach.
)he focus of co"pan law extends 'eond the frontiers of
shareholder protection- and extends to cover the interests of other sta/eholders such as e"ploees-
creditors and even
the societ at large- who also find favour under co"pan law. )he following instances reinforce this
(C 6ee David *u- ;$inancial Refor"s and Corporate Governance in China; 11>>(2 3# Colu". J.
)ransnatAl ?. #(> at #D(.
(1 )his also resonates with RoeAs assertion that a leftBleaning govern"ent is li/el to lead to
concentrated shareholding in such a corporate governance sste"- which then correlates with the
sta/eholder theor. $or a previous discussion of RoeAs o'servation on the relevance of the
political sste" to this point- see supra note 1C3 and acco"paning text.
1i2 )he PR ompany "a# recognises a for" of codeter"ination. In addition to the 'oard of
directors- each co"pan is re4uired to esta'lish a supervisor 'oard- which shall include
an appropriate ratio of the representatives of the co"panAs staff and wor/ers- with such
ratio not 'eing less than one third.
1ii2 )he law re4uires co"panies to protect the rights of staff and wor/ers- sign la'our
contracts with the" and provide social securit and la'our protection- and it further
provides for trade unions and de"ocratic
1iii2 )he concept of corporate social responsi'ilit has 'een specificall legislated for.
Co"pan law re4uires co"panies to ;a'ide ' laws and ad"inistrative regulations-
o'serve social "orals and 'usiness ethics- act in good faith- accept supervision ' the
govern"ent and the pu'lic- and 'ear social responsi'ilities;.
)hat apart- su'sidiar
legislation i"poses "ore specific o'ligations on co"panies in the real" of corporate
social responsi'ilit. )hese include opinions and regulations issued ' the 6henIhen
stoc/ exchange- the 6tateBowned Assets
6upervision and Ad"inistration Co""ission 16A6AC2 1which ad"inisters state
assets in enterprises2 and certain industrial 'odies 1particularl for la'our welfare and
wor/er protection2.
(2 )his re4uire"ent of appointing representatives of staff and wor/ers on the supervisor 'oard
applies to 'oth the li"ited lia'ilit co"pan 1!RC ompany "a#, art. &22 and co"pan li"ited
' shares 1!RC ompany "a#, art. 11D2.
(3 PR ompany "a#, art. &.
(# 6ee ,ang- ompany "a# in hina, supra note 111 at 3#.
.ence- owing to ChinaAs historical allegiance towards socialistic policies coupled with the current
co"pan lawAs focus 'eond shareholder pri"ac- it is clear that China follows the sta/eholder
theor. In this context- the role of co"pan law is re4uired to cater to the interests not onl of
shareholders 'ut also those of nonB shareholder constituencies such as creditors- e"ploees-
consu"ers and societ.
Other Systemic Factors
Although China follows the principle of state intervention in regulating "ar/ets 1consistent with it
'eing an insider sste" and an e"erging econo"2- there are several shortco"ings in the regulator
fra"ewor/ governing Chinese co"panies. It has 'een pointed out that ;conflict of interests and
a"'iguous identit caused ' "ultiple role of the regulators- in con:unction with lac/ of experience-
have led to underBregulation and overBregulation- as well as a"'iguous laws;.
7ther pro'le"s
include the lac/ of a proper disclosure and transparenc regi"e under securities regulation-
failure to provide "inorit shareholders with effective re"edies such as :udicial protection through
derivative actions and other law
(& Ibid.
(( ,ang- *ancing #ith 1olves, supra note 11C at #CB#1. 6ee also )an = ,ang- Modelling for
hina, supra note 1C( at 1(C 1noting that ;KiNn China- there has 'een a huge gap 'etween law
and realit with regard to corporate disclosure;2.
China has still not full esta'lished ;necessar "ar/etB'ased corporate governance "echanis"s
while those which have 'een esta'lished have largel failed to function;.
7n the other hand- ChinaAs
effort to induce governance through co"pan law goes to the extre"e of i"posing all re4uire"ents
through "andator rules 1rather than default rules2.
China also lac/s a cadre of co"petent
professionals such as auditors- independent directors and rating agencies who can potentiall act as
gate/eepers in the governance of co"panies.
All these are s"pto"atic of the issues faced '
developing countries or e"erging econo"ies while esta'lishing for the"selves a suita'le corporate
governance fra"ewor/. )hese are not the tpes of issues faced ' developed econo"ies such as the
8.6. and the 8.9.
., India
?i/e their Chinese counterparts- Indian co"panies too displa ownership concentration in the hands
of a few persons- and hence India is considered as part of the insider "odel of corporate
.owever- unli/e in China- 'usiness fa"ilies predo"inantl own and control
co"panies 1even those that are
(+ ,ang- *ancing #ith 1olves, ibid, at #3. 6ee also )an = ,ang- Modelling for hina, ibid, at
(D )an and ,ang- Modelling for hina, supra note 1C( at 1#(.
(> Donald Clar/e- ;Corporate Governance in China0 An 7verview; 12CC32 1# China *cono"ic
Review #># at &CC.
+C 6ee .ua Cai- ;%onding- ?aw *nforce"ent and Corporate Governance in China; 12CC+2 13
6tan. J.?. %us. = $in. D2.
+1 )here is one strand of thought that descri'es India as a ;h'rid of the outsideBdo"inated "ar/etB
'ased sste"s of the 89 and the 86- and the insiderBdo"inated 'an/B'ased sste"s of
Ger"an and Japan;. 6ar/ar = 6ar/ar- supra note D+ at 1(3. .owever- this o'servation
1contained in a single stud2 does not find 'roader acceptance in the literature pertaining to
ownership structures in India.
listed on stoc/ exchanges2 in India.
)his is largel owing to historical reasons where' fir"s were
"ostl owned ' fa"il 'usinesses.
In addition- it is 4uite co""on to find stateBowned fir"s as
7ther categories in which ownership structures can 'e found are0 1i2 control ' "ultinational
co"panies3 and 1ii2 diffused ownership. .owever- diffused ownership 1in the sense of the %erle and
Means corporation2 can 'e found onl in a handful of Indian listed co"panies- where such structures
exist "ore as a "atter of exception rather than the rule. *ven though so"e co"panies have undergone
"eta"orphosis fro" controlled co"panies to those with diffused shareholding structures over a period
of ti"e- pri"aril through repeated offerings of shares to the pu'lic to raise capital- it is expected that
this would 'e a considera'l slow process as a general "atter. $urther- despite the era of li'eralisation
that was ushered in ' the Govern"ent in 1>>1 which extensivel opened up Indian 'usinesses to
"ar/et forces- ownership structures continue to 'e concentrated for the "ost part. After
+2 6ee Cha/ra'arti- %volution and hallenges, supra note D> at + 1noting that ;fa"il 'usinesses
and corporate groups are co""on in "an countries including India;2.
+3 !rior to 1>>1- Indian 'usinesses were su':ect to tight control and regulation ' the
Govern"ent. $or this reason- all 'usinesses were concentrated in the hands of rich and
influential 'usiness fa"ilies and entities who had the wherewithal to o'tain licenses fro" the
Govern"ent- which were re4uired for various aspects of running the 'usiness- including
esta'lish"ent- operation- expansion and closure. 6ee 6arita Mohant- ;6ar'anesB7xle0 Can 7ne
Model $it All5; 12CC(2 12 <ew *ng. J. IntAl = Co"p. ?. 231 at 23&.
+# )here are indeed several listed co"panies that are Govern"entBowned- where either the
Central Govern"ent or the govern"ent of a state owns the "a:orit 1usuall a su'stantial2
ownership interest in the co"pan. 6uch co"panies are also referred to as pu'lic sector
underta/ings- or !68s.
such li'eralisation- onl ver few co"panies have restructured their ownership so as to "a/e the
shareholding pattern trul dispersed in the 86 sense of the ter".
*xa"ining the ownership aspect e"piricall- we find that even as late as 2CC2- ;the average
shareholding of promoters in all Indian co"panies was as high as #D.1O;.
A "ore recent stud
confir"s this position- even in the case of listed co"panies.
)hat stud is 'ased on infor"ation
availa'le on the we'sites of the two "ain stoc/ exchanges in India- the %o"'a 6toc/ *xchange
and the <ational 6toc/ *xchange-
and the shareholding pattern of ;1CC co"panies constituting the
%6* 1CC- ... with a total "ar/et capitaliIation of nearl SD&C 'illion- and the &CC co"panies of the
+& At a "ore general level- even where there is a plausi'le scenario that ;pu'lic ownership
will 'eco"e increasingl prevalent ... controlling shareholders will continue to pla a do"inant
role;. Cheffins- "ondon to Milan to (oronto, supra note +3 at 3&.
+( Cha/ra'arti- %volution and hallenges, supra note D> at 11 1e"phasis supplied2. In this
context- it "ust 'e noted that the concept of ;pro"oter; has specific legal significance in the
Indian context. )he expressions ;pro"oter; and ;pro"oter group; are defined to include 1i2 the
person or persons who are in overall control of the co"pan- 1ii2 the person or persons who are
instru"ental in the for"ulation of a plan or progra" pursuant to which securities are offered to
the pu'lic- and 1iii2 the person or persons na"ed in the prospectus as pro"oters. 6ee
*xplanation to clause (.D.3.2 of the 6ecurities and *xchange %oard of India 1Disclosure and
Investor !rotection2 Guidelines- 2CCC- online0
Ehttp0FFwww.se'i.gov.inFactsFipguidelines.pdfH. Controlling shareholders holding a
su'stantial nu"'er of shares in the co"pan would 'e treated as ;pro"oters; or ;pro"oter group.;
In that sense- the expressions ;controlling shareholders; and ;pro"oters; are used interchangea'l
in this dissertation- 'ecause the for"er expression is fa"iliar to readers of corporate governance
literature in ,estern :urisdictions- while the expression ;pro"oters; is fa"iliar in the Indian context.
6uch pro"oters have additional disclosure and other o'ligations such as loc/Bin of shares when an
Indian co"pan engages in a pu'lic offering of shares.
++ 6haun J. Mathew- ;.ostile )a/eovers in India0 <ew !rospects- Challenges- and Regulator
7pportunities; 2CC+132 Colu". %us. ?. Rev. DCC.
+D )he ownership structure of Indian listed co"panies can 'e ascertained 'ased on infor"ation
filed ' each of these co"panies with the %6*. 8nder the relevant provisions of the listing
agree"ent that pu'lic listed co"panies enter into with stoc/ exchanges- the are re4uired to
file a state"ent showing the shareholding pattern as of the end of each 4uarter. In such
state"ent- the shareholding of the pro"oter and the pro"oter group are to 'e indicated
%6* &CC- which represents nearl >3O of
the total "ar/et capitaliIation of the entire %o"'a 6toc/ *xchange;.
stud found that0
the average %6* 1CC co"pan has a pro"oter who owns over #DO of the co"pan. 7nl
ten of the %6* 1CC co"panies have pro"oters holding sta/es 'elow the critical 2&O
threshold .... ?oo/ing at the 'roader %6* &CC set of co"panies produces si"ilar results0
the average pro"oter owns roughl #>O- and fewer than >O of pro"oters have sta/es
'elow 2&O. )his high average concentration of pro"oter holdings was consistent with the
prediction of practitioners;.
6u""ar of %6* 1CC and %6* &CC 6hareholding Data
)a'le 1 sets out a su""ar of the shareholding pattern of co"panies reported in that stud0
+> Mathew- supra note 1#D at D32.
DC Ibid, at D33. 6i"ilar conclusions e"erge fro" another recent stud of fift large pu'lic
co"panies on the <6* 1the ;6=! C<R <ift;2. George 6. Geis- ;Can Independent
%loc/holding !la Much of a Role in Indian Corporate Governance5; 12CC+2 3 Corp.
Governance ?. Rev. 2D3. As regards private co"panies- the ownership concentration a"ong
'usiness fa"ilies is even "ore acute. !hani- et al. note that ;fa"il fir"s or fa"il owned
fir"s in India constitute >>.> percent of all private Indian co"panies; and that the ;control of
these fa"il enterprises usuall vests with a s"all group of shareholders- often 'elonging to
the sa"e fa"il- with invest"ents as low as 1CO in the fir"As assets .;. %.M. !hani- M.<.
Redd- <. Ra"achandran = Asish 9. %hattachara- ;Insider 7wnership- Corporate
Governance and Corporate !erfor"ance; 12CC&2- online0 Ehttp0FFssrn.co"Fa'stractG(>(#(2H
at #.
D1 Mathew- ibid, at D33.
As to the exact nature of the pro"oters who hold these concentrated shareholding percentages- I conducted a
stud in 2CC(- which reports an overwhel"ing concentration of shares in the hands of 'usiness
fa"ilies- although the are closel followed ' Govern"entBowned co"panies and "ultinational
)a'le 2 sets out the details regarding predo"inance of different tpes of controlling
owners in %6* 1CC co"panies.
Ta(%e 2
6u""ar of !ro"oter Data in %6* )op 1CC Co"panies <ature of Controlling
6hareholder !ercentage of Co"panies
112 )his includes shares held directl ' fa"il "e"'ers and also indirectl through other entities
such as co"panies- partnerships- trusts wherein the 'eneficial ownership is held ' the fa"il.
122 )his refers to co"panies where no individual pro"oter or pro"oter group held 2CO or "ore
shares in the co"pan.
D2)his stud was 'ased on the shareholding pattern of %6* 1CC co"panies elicited fro"
infor"ation filed ' each of these co"panies with the %o"'a 6toc/ *xchange as of 3C
6epte"'er 2CC(. Ad"ittedl- these results can onl 'e said to have 'een arrived at on a rough
'asis. )his is on account of the fact that the filings on shareholding pattern does not re4uire
co"panies to disclose whether the pro"oters are fa"ilies- the state- foreign colla'orators and so
on- and this infor"ation was therefore ' necessit o'tained fro" other circu"stances- including
" own understanding and fa"iliarit with leading listed Indian co"panies. $urther-
shareholding structures of Indian co"panies are co"plex- particularl in the case of fa"il
'usinesses. $a"il "e"'ers own shares either directl or through holding co"panies
incorporated for the purpose or through trusts- partnerships- .indu 8ndivided $a"il and other
ownership structures recogniIed ' law. )hese structures are further co"plicated through crossB
ownership of these entities wherein each of these inter"ediate entities owns interests in one or
"ore of the others. )here could 'e difficulties in ascertaining the precise extent of fa"il
ownership in a pu'lic listed co"pan through the we' of inter"ediate entities.
)here is "ore to it than a'solute ownership percentages. )he power of concentrated ownership is 'olstered
' controlling shareholders through other "echanis"s such as crossBholdings- pra"id structures
and tunneling.
)hese pheno"ena ;"ar/ the Indian corporate landscape;.
)he often lead to
greater 'enefits to the controlling shareholders at the cost of the "inorit shareholders.
practices can also have an adverse effect on the develop"ent of capital "ar/ets as "inorit
shareholders are considera'l exposed to the actions of controlling shareholders.
)his is 'ecause
controlling shareholders are in a position to shape the co"position of the 'oard of directors- in that
all directors owe their allegiance to the controlling shareholders as their appoint"ent-
D3 $or an introductor discussion of these concepts- see supra notes >3 to >( and acco"paning
D# Cha/ra'arti- %volution and hallenges, supra note D> at 1.
D& Ibid. at 12- noting that0
Recent research has also investigated the nature and extent of ;tunneling; of funds within 'usiness groups
in India. During the >CAs Indian 'usiness groups evidentl tunneled considera'le a"ount of funds up
the ownership pra"id there' depriving the "inorit shareholders of co"panies at lower levels of
the pra"ids of their rightful gains.
D( %ertrand- Mehta = Mullainathan- supra note >&- o'serving the concept of crossBholdings
in Indian fa"il 'usiness groups0
As in "an other countries- group fir"s in India are often lin/ed together through the
ownership of e4uit shares. In "ost cases- the controlling shareholder is a fa"il3 a"ong the
'estB/nown 'usiness fa"ilies in India are )ata- %a:a:- %irla- 7'eroi- and Mahindra.
Ibid. at 12(. )he then go on to discuss the 'enefits that fa"il owners "a extract fro" their co"panies
through these "echanis"s such as tunneling and o'serve that ;Indian fa"ilies tpicall control the
fir"s the have financial sta/es in ' appointing fa"il "e"'ers or fa"il friends to the 'oard of
directors and to top "anagerial positions;. Ibid. at 12D.
D+ In India- the appoint"ent of each director is to 'e voted on individuall at a shareholdersA
"eeting ' wa of a separate resolution. *ach directorAs appoint"ent is to 'e approved ' a
renewal and continuance in office 1without re"oval2
are su':ect to the wishes of the controlling
Managers who are not on the 'oard also owe their allegiance to controlling
shareholders as the 'oard of directors that appoints "anagers is within the control of such
shareholders. All these are evidence of ownership concentration in Indian listed co"panies- with
significant powers to the controlling shareholders that are pri"aril 'usiness fa"ilies.
Focused Constituency
As in the case of China- the Indian corporate governance and ownership prototpe has 'een shaped '
IndiaAs socialistic origins. IndiaAs policies and legislation in the postBindependence era was overlaid
with socialistic policies. It has 'een noted that ;the govern"ent i"ple"ented a socialist refor"
"a:orit of shareholders present and voting on such resolution. .ence- controlling shareholders-
' virtue of 'eing a'le to "uster a "a:orit of shareholders present and voting on such
resolution- can control the appoint"ent of ever single director on the 'oard. 6ee Co"panies Act-
1>&( 1Act <o. 1 of 1>&(2 $Indian ompanies ActN- s. 2(3. )he position of the controlling
shareholders further gets reinforced due to the dispersed nature of the re"aining shareholding in
the co"pan. In "ost Indian co"panies- institutional shareholders do not individuall hold
significant percentage shareholding- even though the aggregate shareholding of all institutional
shareholders "a 'e fairl su'stantial. $urther- although esta'lish"ent of
coalitions of institutional shareholders is generall not su':ect to restrictions under law 1unli/e in the 8.6.2-
institutional shareholders in practice rarel for" coalitions except in dire circu"stances- such as
where the co"pan is on the verge of 'an/ruptc or the pro"oters or "anagers of the co"pan have
'een involved in egregious conduct. )his factor adds to the vast powers alread availa'le to
controlling shareholders in deter"ining the 'oard co"position of an Indian co"pan.
DD An director "a 'e re"oved 'efore the end of her ter" without cause ' a "a:orit of
shareholders present and voting on such resolution. 6ee Indian ompanies -ct, s. 2D#.
D> )his rule applies e4uall to the appoint"ent and tenure of independent directors that are
li/ewise su':ect to a "a:orit vote of the shareholders- and hence su':ect to concurrence of the
controlling shareholders.
agenda in enco"passing all areas of co""ercial activit- including corporate finance;.
$urther- in an e"erging econo" li/e India- consistent with its socialistic origins- the role
of co"pan law extends 'eond "erel the protection of
>C John Ar"our = !ria ?ele- ;?aw- $inance- and !olitics0 )he Case of India; 12CCD2- online0
Ehttp0FFssrn.co"Fa'stractG111((DCDH at 1#.
It would extend to protection of e"ploees- creditors- consu"ers and societ
1represented ' the wide expression ;pu'lic interest;2. Indian corporate law and corporate
governance regulation does recognise the sta/eholderBcentric approach- at least partiall. $or
instance- e"ploees o'tain certain special rights under co"pan law- such as preferential pa"ent
for dues in case of winding up of a co"pan-
and also the right to 'e heard in case of significant
proceedings involving a co"pan such as in a sche"e of arrange"ent 1"erger- de"erger or other
corporate restructuring2
or in a winding up
of the co"pan. As far as creditors are concerned-
>1 )arun 9hanna = 9rishna !alepu- ;Glo'aliIation and Convergence in Corporate Governance0
*vidence fro" Infoss and the Indian 6oftware Industr; 12CC#2 3& J. IntAl %us. 6tudies #D# at
&CC $%vidence from Infosys', aptl laing out the de'ate in the context of protection of
e"ploees using the sta/eholder theor0
.ow should this discussion 'e "odified to suit the realities of an e"erging "ar/et li/e India5 $irst-
the idea that la'or can protect itself against expropriation ' shareholders is less plausi'le in such a
countr for several reasons. )he prospect of controlling shareholders reaping private 'enefits fro"
co"panies that the control is vast. $urther- the court sste" does not function well enough to chec/
this. $inall- the a'sence of s"oothl functioning "ar/ets for hu"an capital i"pl that exploited
talent cannot si"pl vote with its feet in the face of shareholderBinduced adversit. $or all these
reasons- a plausi'le case can 'e "ade that corporate governance should 'e sensitive to the interests
of "ore than :ust shareholders.
>2 Indian ompanies -ct, s. &2>BA.
>3 Indian ompanies -ct, s. 3>1. 6ee also In Re, River )team 9avigation o. "td., 11>(+2 2 Co"p.
?.J. 1C( 1Cal.2 1holding that in considering an sche"e proposed- the Court will also consider
its effects on wor/ers or e"ploees23 In Re, Hathisingh Manufacturing o. "td, 11>+(2 #(
Co"p. Cas. &> 1Gu:.2 and Bhartiya :amgar )ena v. !eoffrey Manners ; o. "td., 11>>22 +3
Co"p. Cas. 122 1%o".2 1approving the proposition that while sanctioning a sche"e of
arrange"ent the court should consider not "erel the interests of the shareholders and creditors
'ut also the wider interests of the wor/"en and of the co""unit2.
># Indian ompanies -ct, s. ##3. 6ee also 9ational (e&tile 1or7ers5 <nion v. Rama7rishnan
3P.R.4, A.I.R. 1>D3 6C +& 1holding that wor/ers of a co"pan have a right to appear and 'e
while co"pan law does provide the" with the standard rights and re"edies-
other special laws
confer other
heard in support or opposition of a winding up petition2.
>& )hese include the right to initiate a winding up of the co"pan. Indian ompanies -ct, s.
#3>1121'2- which is a custo"ar co"pan law right conferred on creditors in "ost
corporate law rights such as the a'ilit of the creditors to convert their loans into e4uit of the de'tor
co"pan and- "ore specificall fro" a corporate governance standpoint- to appoint no"inee directors
on 'oards of de'tor co"panies.
)hese rights are see"ingl provided to protect the interests of the
creditors. $inall- ;pu'lic interest; constitutes an i"portant ele"ent of Indian co"pan law. Affected
parties "a exercise re"edies in case the affairs of a co"pan are carried out in a "anner pre:udicial to
pu'lic interest-
or if a sche"e of arrange"ent is not in consonance with pu'lic interest.
provisions of Indian corporate law point towards the fact that Indian corporate governance leans 1at
least partiall2 towards a sta/eholderBcentric approach- which is consistent with the fact that it is a
developing econo" that follows the insider "odel.
Other Systemic Factors
?i/e "an other e"erging econo"ies- the legal and regulator fra"ewor/ in India is not
entirel conducive to corporate activit and investor protection- although significant
i"prove"ents have 'een effected to the sste" after the li'eralisation process 'egan in 1>>1.
$or instance- the Indian ompanies -ct, which was enacted in 1>&( and has su'se4uentl
undergone several a"end"ents- is undul co"plex and still contains vestiges of strong
govern"ent control of
>( 6ee e,g, )tate Ban7 of India -ct, 2=>>1Act <o. 23 of 1>&&2- s. 3&A.
>+ Indian ompanies -ct, s. 3>+1221a2.
>D Indian ompanies -ct, s. 3>#112 proviso.
>> $or the correlation 'etween the sta/eholderBcentric approach and the insider "odel of
concentrated corporate ownership- see previous discussion at supra note 1C3 and
acco"paning text.
)here are a nu"'er of procedures to 'e co"plied with for incorporating co"panies-
and "oreover- winding up of co"panies involves a cu"'erso"e- costl and ti"e consu"ing
.owever- there is opti"is" at least on two counts. $irst- there has 'een tre"endous
progress in the area of investor protection since 1>>1. )he 6ecurities and *xchange %oard of India
K;6*%I;N- IndiaAs securities "ar/ets regulator- was esta'lished in 1>>2 to regulate the Indian capital
"ar/ets- and 6*%I has since enacted a plethora of su'sidiar legislation governing the stoc/ "ar/ets
1'oth pri"ar and
secondar2. 6econd- there does exist an increasingl ro'ust 'od of law to deal with "inorit
shareholder grievances.
.owever- law on the statute 'oo/s is one thing- and its enforce"ent another. *ven where
laws are availa'le- the are so"eti"e a"'iguous and ridden with uncertainties- there' causing
pro'le"s in enforce"ent. $urther- there are serious deficiencies in enforce"ent of laws and
regulations due to the ineffectiveness of the enforce"ent "achiner such as the courts and other
specialised tri'unals. )hese courts and tri'unals are over'urdened resulting in significant dela in
dispute resolution and :ustice deliver. )his holds good even in the area of corporate governance and
1CC IndiaAs corporate insolvenc regi"e is also notoriousl wea/. Ar"our = ?ele- supra note 1(1 at
1C1 In the Doing %usiness Report 2CC> pu'lished ' the ,orld %an/- India ran/s 122 out of a total
of 1D1 countries surveed in relation to the ease of doing 'usiness. It ran/s 121 for starting a
'usiness and 1#C for closing a 'usiness. 6ee 1orld Ban7 *oing Business Report .//=, online0
1C2 Indian ompanies -ct, ss. 3>+ and 3>D- provides re"edies to "inorit shareholders when affairs
of the co"pan are conducted in a "anner pre:udicial to the interests of the co"pan- the
shareholders or pu'lic interest- or if it is oppressive to the shareholders. )his is /nown as the
re"ed of ;oppression and "is"anage"ent;. Apart fro" a rich 'od of precedents having 'een
esta'lished in this area of law- there is also a special tri'unal in the for" of the Co"pan ?aw
%oard to deal with cases on this count. 6ee Ar"our = ?ele- ibid. at 31.
investor protection.
$urther- unli/e in the "ore developed econo"ies- it is hard to find a sufficient nu"'er of
co"petent professionals such as auditors- independent directors and rating agencies who can
potentiall act as gate/eepers of corporate governance. $or this reason- the affected parties and the
legal sste" are co"pelled to rel on courts- tri'unals and other regulator 'odies to see/ re"edies-
and those "a not 'e effective in law enforce"ent altogether.
.ere again- these are issues faced
' "ost developing countries in co""on- which are also part of the insider "odel of corporate
*. 6u""ar
)he preceding parts of this 6ection first co"pare and contrast the outsider "odel and the insider
"odel in general- and then explore the specifics with reference to two constituencies in each "odel-
with the 8.6. and the 8.9. 'eing the outsider sste"s and China and India 'eing the insider
sste"s. )his has 'een effected through a stud of the features of these sste"s across three 'road
1C3 More generall- it has 'een o'served e"piricall that ;in securities law- we find that several
aspects of pu'lic enforce"ent- such as having an independent andFor focused regulator or
cri"inal sanctions- do not "atter .;. Rafael ?a !orta- $lorencio ?opeI de 6ilanes = Andrei
6hleifer- ;,hat ,or/s in 6ecurities ?aws5; 12CC(2 (1 J. $in. 1 at 2+B2D K 1hat 1or7s in
)ecurities "a#s'.
1C# In the Doing %usiness Report 2CC> pu'lished ' the ,orld %an/- out of a total of 1D1 countries
surveed in relation to the ease of doing 'usiness- India is onl second fro" the 'otto" 1after
)i"orB?este2 when it co"es enforce"ent of contracts. 6ee 1orld Ban7 *oing Business Report
.//=, supra note 1+2.
viz. ownership concentration- focused constituenc and other sste"ic factors. In the case of the
outsider sste"s- we find that 1i2 diffused shareholding in co"panies is the nor"- 1ii2 the focus of
corporate law is on the protection of shareholder interests 1largel to the exclusion of all other
interests2- and 1iii2 "ar/etB'ased institutions and sste"s are sophisticated and developed- with heav
reliance on capital "ar/ets and disclosure. 7n the other hand- with the insider sste"s- we find that 1i2
concentrated shareholding is the nor" 1with concentration predo"inantl with the state in China and
with fa"il 'usiness groups in India2- 1ii2 the focus of corporate law extends 'eond shareholders and
caters to the interests of other sta/eholders such as e"ploees- creditors and the pu'lic or societ- and
1iii2 the lac/ significant capital "ar/ets and rel "ore on "andator regulation and 'rightBline rules as
opposed to "ar/etB'ased regulation and disclosures onl.
2.) Re'iein* the Mode%& in Conte+t o$ the A*enc! Paradi*,
At this stage- it is appropriate to review the insider and outsider "odels against the ;agenc
pro'le"s; paradig".
As explained in an influential 'oo/ on the su':ect-
the effort of corporate
law is to ;control conflicts of interest a"ong
1C& )hese agenc pro'le"s can 'e exa"ined in the light of the various corporate actors descri'ed
earlier. 6ee supra note # and acco"paning text. It is to 'e noted- however- that the agenc
concept is used ' acade"ics in corporate governance literature in a wider econo"ic sense and
ought to 'e distinguished fro" the legal 1contractual2 concept of agenc. %rian Cheffins- ;)he
)ra:ector of 1Corporate ?aw2 6cholarship; 12CC32- online0 Ehttp0FFssrn.co"Fa'stractG#2>(2#H at
2( K (ra6ectory of )cholarship'.
1C( 9raa/"an- et, al,, (he -natomy of orporate "a#, supra note 2#.
corporate constituencies;.
)hese conflicts are referred to in econo"ic literature as ;agenc pro'le"s;.
Corporate law and corporate governance literature define three generic agenc pro'le"s.

)he first agenc pro'le" relates to the conflict 'etween the co"panAs "anagers and its owners
1'eing the shareholders2.
.ereinafter referred to as the ;"anagerBshareholder agenc pro'le";-
such conflict exists largel in :urisdictions which "anifest diffused shareholding in co"panies. )his
is due to collective action pro'le"s and the resultant ina'ilit of shareholders to properl "onitor
the actions of "anagers. )he second relates to the conflict 'etween the "a:orit or controlling
shareholders on the one hand and "inorit shareholders on the other.
6uch conflict- which is
referred to hereinafter as the ;"a:oritB"inorit agenc pro'le"; is largel prevalent in :urisdictions
that displa concentrated shareholding where the interests of "inorit shareholders are significantl
diluted. )he third agenc pro'le" relates to the conflict 'etween the owners and controllers of the
1C+ Ibid at 21.
1CD $or a detailed analsis of agenc theor in econo"ic literature- see Jensen = Mec/ling-
(heory of the +irm, supra note 23. $or a si"pler expression of the agenc analsis- see
9raa/"an- et. al., (he -natomy of orporate "a#, ibid. at 21- noting that0
an Aagenc pro'le"A@in the "ost general sense of the ter"@arises whenever the welfare of one part- ter"
the Aprincipal-A depends upon actions ta/en ' another part- ter"ed the Aagent.A )he pro'le" lies in
"otivating the agent to act in the principalAs interest rather than si"pl the agentAs own interest.
Miewed in these 'road ter"s- agenc pro'le"s arise in a 'road range of contexts that go well 'eond
those that would for"all 'e classified as agenc relationships ' lawers.
1C> 9raa/"an- et. al., (he -natomy of orporate "a#, ibid, at 213 !aul ?. Davies- ;)he %oard of
Directors0 Co"position- 6tructure- Duties and !owers;- !aper on Co"pan ?aw Refor" in
7*CD Countries0 A Co"parative 7utloo/ of Current )rends 12CCC2- online0
Ehttp0FFwww.oecd.orgFdataoecdF21F3CF1D&+2>1.pdf.H at 2.
11C 9raa/"an- et. al., (he -natomy of orporate "a#, ibid, at 223 Davies- ibid. at 2.
111 Ibid.
fir" 1such as the shareholders and "anagers2 and
other sta/eholders 1such as creditors- e"ploees- consu"ers and pu'lic2- with "an of who" the
co"pan "a enter into a contractual arrange"ent governing their affairs inter se.
)his conflict-
referred to hereinafter as the ;controllerB sta/eholder agenc pro'le"; exists 'oth in :urisdictions that
have diffused shareholding as well as those that have concentrated shareholding- 'ut its role is
accentuated in those that have concentrated shareholding as we have previousl
Advancing this discussion in the context of the insider and outsider sste"s- we find that the
outsider sste"s are largel concerned with the "anagerBshareholder agenc pro'le". )his is true
even in respect of the 8.6. and the 8.9.- which are the su':ectB"atter of stud in this dissertation as
outsider sste"s. )he roles of corporate law as well as "easures to enhance corporate governance
are designed to address this agenc pro'le". It is precisel in addressing this ver pro'le" that the
concept of an independent 'oard e"erged initiall in the 8.6. and su'se4uentl in the 8.9.
.owever- we find that the insider sste"s are not concerned with the "anagerBshareholder agenc
pro'le" B that pro'le" does not exist at all in those sste"s. )here is no separation of ownership
and control as the "a:orit or controlling shareholders are wellB endowed with the power to hire and
fire "anagers and therefore oversee "anagerial aspects of a co"pan. )he insider sste"s are
instead inflicted with the "a:oritB"inorit agenc pro'le" due to the concentration of corporate
ownership. )he controlling shareholders are in a position to enhance their control through
"echanis"s such as crossBholdings- pra"iding and tunneling- so as to dilute the interests 1and
returns2 of the "inorit shareholders. $urther- the insider sste"s do also suffer fro"- and pa
particular attention to- the third agenc pro'le"- 'eing the controllerBsta/eholder agenc pro'le"-
"ore so than the AoutsiderA sste"s. )his is 'ecause the sta/eholders are co"pelled to rel on legal
protection in order to secure their interests. )o a large extent- as we have seen-
corporate laws in the
112 Ibid.
113 As regards China and India- 'eing the su':ect "atter of discussion in relation to Ainsider
sste"sA- see supra 6ection 2.21D2112 and 1D2122 respectivel.
insider sste"s do grant a certain level of protection to sta/eholders.
.ence- the insider sste"s suffer fro" the "a:oritB"inorit and- to so"e extent- the
controllerBsta/eholder agenc pro'le"s 1'eing the second and third agenc pro'le"s2 and not the
"anagerBshareholder agenc pro'le" 1'eing the first2. I argue that corporate governance
"echanis"s that are designed to suit one tpe of agenc pro'le" "a not 'e appropriate to deal
with another tpe. Moreover- "echanis"s that are designed to suit one tpe of sste" of ownership
and corporate governance 3e.g., outsider2 "a not 'e suita'le in another sste" 1e.g.- insider2. )o 'e
"ore specific- it is the "ain conceit of this dissertation that the "echanis" of altering 'oard
structure and co"position 1' "andating a "ini"u" nu"'er of independent directors2 that has
'een introduced to deal with the "anagerBshareholder agenc pro'le" that is prevalent in the
outsider sste"s 1with the 8.6. and the 8.9. 'eing exa"ples discussed herein2 will not produce the
sa"e results in dealing with the "a:oritB"inorit and the controllerBsta/eholder agenc pro'le"s that are
do"inant in the insider sste"s 1with China and India 'eing exa"ples discussed herein2.
2.- #ri'in* .orce& /ehind the #i$$erent Mode%&
In order to appreciate the differences 'etween the "odels of corporate governance as well as ownership
structures and the different agenc pro'le"s that affect these "odels- it would 'e appropriate to
consider so"e of the driving forces and reasons 'ehind these differences. Marious theories have 'een
propagated in the stud of co"parative corporate governance. ,hile the de'ate as to which theor is
"ore feasi'le appears et inconclusive- it is possi'le to identif so"e of the /e factors that are
under discussion. 6everal reasons have 'een proffered for differences in ownership structures-
focused constituencies and other sste"ic factors 'etween the outsider sste"s and the insider
sste"s. )here include legal reasons- political reasons as well as historical reasons.
A. )he ;?aw Matters; *xplanation
In an influential series of studies- a group of econo"ists 1hereinafter referred to as ;??6M;2 conducted
e"pirical research concluding that corporate ownership in various :urisdictions is dependent upon
the level of legal protection availa'le to
As for legal protection- e"phasis was placed on two aspects0 1i2 the legal rules that
11# ?a !orta- et. al. present evidence that ;legal rules protecting investors and the 4ualit of their
enforce"ent differ greatl and sste"aticall across countries;. ?a !orta- et. al., "egal
*eterminants, ibid. at 1131.
appl to protect investors- and 1ii2 the 4ualit of enforce"ent of those legal rules.
)heir thesis is
that if a :urisdiction provides 'etter legal protection to investors 1'oth in ter"s of the law and its
enforce"ent2- that will lead to capital "ar/ets- which are 'roader and 'etter valued as co"pared to
econo"ies with lower protection that "a not en:o li4uid "ar/ets.
8pon a co"parison of the
co""on law sste" and various civil law sste"s- the conclude that co""on law provides 'etter
access to e4uit finance than civil law countries.
As a corollar to this- law also "atters in the wa ownership structures are shaped in various
:urisdictions. Co""on law sste"s that encourage 'roader capital "ar/ets end up with diffused
shareholdings as co"panies constantl access the "ar/ets for finance ' diluting their e4uit sta/e.
6hareholders are not hesitant in holding "inorit sta/es owing to the protection that law offers
the". 7n the other hand- the stud finds that civil law sste"s provide wea/er investor
protection. As a result- there is not onl a lac/ of 'road and li4uid capital "ar/ets in civil law
sste"s generall- 'ut shareholders see/ ownership
concentration as a su'stitute to legal protection.
,here law provides poor protection to investors-
the tend to ac4uire controlling sta/es in co"panies so as to protect the"selves through exercise of
control over "anage"ent of the co"pan.
In other words- the ;4ualit of legal protection helps
11& ?a !orta- et. al, Investor Protection, supra note &# at 21B22.
11( In other words- ;legal environ"ent has large effects on the siIe and 'readth of capital "ar/ets
across countries;. ?a !orta- et. al., "egal *eterminants, supra note 1D+ at 1132.
11+ ?a !orta- et. al, "egal *eterminants, ibid, at 113+3 ?a !orta- et. al., "a# and +inance, supra
note D# at 111(.
11D Ibid at 11#&.
11> ?a !orta- et, al, offer specific explanation for ownership concentration in countries where
legal protection is wea/. )he state0
)here are at least two reasons wh ownership in such countries would 'e "ore concentrated.
$irst- large- or even do"inant- shareholders who "onitor the "anagers "ight need to own
"ore capital- ceteris pari'us- to exercise their control rights and thus to avoid 'eing
deter"ine ownership concentration;.
Conse4uentl- ??6M conclude that co""on law countries
that offer greater investor protection witness diffused shareholding- while civil law countries that
offer low investor protection witness concentrated shareholding in co"panies.
According to ??6M- other sste"ic factors too correlate with the co""on law sste" and the
civil law sste". )he note that in the co""on law countries laws are attuned towards investor
protection- and these are enforced ' "ar/et regulators- the courts as well as ' the "ar/et
participants the"selves.
In co""on law countries- the :udiciar plas an i"portant role in
enforcing investor
rights- there' enhancing the value of capital "ar/ets. In these countries- investor protection is
ensured through a co"'ination of rules and regulations- enforce"ent ' the :udiciar as well as
through selfBregulation ' "ar/et participants. 7n the other hand- civil law countries tend to rel
heavil on govern"ent intervention in regulating capital "ar/ets.
)his is usuall achieved
through 'rightBline rules- although the downside to this approach is that it ena'les defaulters to
circu"vent the rules i"aginativel ' structuring their affairs in such "anner as to sta outside the
proscription of the legal regulations.
,hile the approach of ??6M has largel set the tone for the de'ate on co"parative corporate
it has 'een su':ect to constant challenge fro" other scholars on various grounds.
the context of the present dissertation- the challenge can focus s4uarel on two aspects that
specificall cover its su':ect "atter. $irst- as regards China and India- the two countries studied
herein- the theor professed ' ??6M does not answer certain i"portant 4uestions. %oth China and
India have recentl witnessed tre"endous growth in their capital "ar/ets 1at least over the last
decade2 although the are et to attain the siIe and depth of the capital "ar/ets in the 8.6. and the
8.9. )his runs contrar to the predictions of the ??6M thesis. As far as China is concerned- it is a
civil law countr and hence is su':ect to a lesser degree of investor protection. Conse4uentl- it is
expected to possess a s"aller siIed capital "ar/et. As far as India is concerned- although it is a
co""on law countr- there are considera'le
growing capital "ar/et despite pro'le"s with enforce"ent of the law. )o a large extent- 'oth China and
India def the ??6M thesis- due to which the efficac of their thesis is certainl 4uestiona'le in the
context of these two e"erging "ar/ets.
6econd- on the issue of independent directors too- the ??6M theor e"its so"e confusing
signals. As discussed earlier-
co""on law countries tend to rel on selfBregulation ' "ar/et
participants- while other :urisdictions tend to i"pose govern"ental regulation on corporate
governance. If that 'e the case- the role of corporate actors such as independent directors 1who are
"ar/et participants forcing selfBregulation2 should augur well in the context of co""on law
countries such as the 8.6. and the 8.9.- rather than other :urisdictions such as China 1which is a civil
law countr2 and India 1which is a co""on law countr- 'ut with li"ited enforce"ent of corporate
legal rights2. )he ??6M approach fails to explain the pheno"enon where' a greater nu"'er of
countries are adopting the selfBregulator approach of corporate governance 1followed in the 8.6.
and the 8.9.2 although those other countries lac/ the sophisticated laws and institutional fra"ewor/
that are prere4uisites to selfBregulation. If ??6MAs thesis is that concentrated ownership is the answer
to corporate governance in countries that do not possess strong investor protection "echanis"s- it
does not explain the need for gate/eepers such as independent directors in those :urisdictions.
)herefore- there is a "is"atch 'etween the ??6M thesis and the introduction of independent
directors in :urisdictions such as China and India which are said to have li"ited legal protection
1with ade4uate enforce"ent2 for investors. )his "is"atch can 'e resolved in one of two was0 either
the ??6M thesis cannot withstand scrutin on this count- or the i"position of the re4uire"ent
independent directors in :urisdictions such as China and India is incongruous. I would venture to ta/e
the latter position- a "atter I shall ela'orate upon later in this dissertation.
%. 7ther *xplanations
In addition to the ;law "atters; thesis- there are certain other theories that see/ to explain the differences
'etween various corporate governance sste"s. )hese explore "atters 'eond the law- such as
histor- politics- interest groups and even anthropolog and culture.
A"ong these other theories- an influential series of wor/ can 'e ascri'ed to !rofessor Mar/
Roe. .e essentiall exa"ines the genesis of the 8.6. "odel of corporate governance and provides
political explanations for the lac/ of strong owners and the presence of strong "anagers instead.

.e asserts that ;A"erican politics deli'eratel frag"ented financial institutions- their portfolios- and
a'ilit to aggregate stoc/ into influential voting 'loc/s;. 6uch forced frag"entation of shareholding
resulted in the diffused shareholding pattern of 8.6. co"panies there' resulting in agenc pro'le"s
'etween shareholders and "anagers. Most other :urisdictions have different corporate structures
involving concentrated 'loc/s of shareholders due to the ;role of politics- histor and culture;.

Apart fro" ownership structures- !rofessor Roe offers si"ilar explanations for the focused
constituenc. As regards *urope- an i"portant factor is social de"ocrac that tends to involve nonB
shareholder interests such as e"ploees and so"eti"es creditors-
unli/e the 8.6. which focuses
pri"aril on shareholders as the principal constituenc that corporate law see/s to protect.
therefore has a role to pla in wh so"e countries such as the 8.6. and the 8.9. have diffused
shareholding and focus on shareholder interests- while others such as China and India have
concentrated shareholding and focus on
sta/eholder interests as well.
)hese political factors also pla a significant role in perpetuating the
prevailing sste"s in each of these countries- and such factors also oppose an change.
Let another theor loo/s at the role of interest groups in shaping the structure of corporate
According to this theor- several countries that supposedl followed the social
de"ocrac "odel did so with a view to protection of local interests and to /eep the "ar/ets awa
fro" co"petition rather than with a view to protecting the interests of sta/eholders. )his theor
furthers the argu"ent of rentBsee/ing a"ong interests within these econo"ies.
A theor developed ' !rofessor A"ir ?icht explores cultural and anthropological factors of
corporate governance that see/ to explain differences
a"ong various countries. !rofessor ?icht states that national cultures are relevant to corporate
governance and securities regulation as the "a have a role in inducing path dependence a"ong
various sste"s. 8sing the fra"ewor/ of cultural value di"ensions 1CMD2- he suggests producing
testa'le hpotheses with regards to cultural features of corporate governance sste"s. )his theor-
which is perhaps underButilised in existing literature- "a explain reasons for disparit 'etween
corporate governance structures and sste"s 'etween outsider sste"s and the insider sste"s.
,hile one set of the econo"ies 1the outsider sste"s2 adopts li'eral cultural values- the other 1the
insider sste"s2 tends to retain traditional values3 while the for"er focuses largel on the
individual- the latter offers i"portance to social groups such as the fa"il. )hese differences do
have a significant 'earing on corporate governance aspects- such as the role of the independent
director- as I shall discuss in detail su'se4uentl.
C. I"pact of *xplanations on Models of Corporate Governance
)hese various explanations for differences in corporate governance are i"portant in understanding
the reasons wh structures var fro" countr to countr. )his also helps explain the relevance of
law- histor- politics and interest groups in the corporate governance sste" of each countr. )he
role of independent directors- which is the su':ect "atter of this dissertation- in the 8.6. and the
8.9. on one hand- and China and India on the other- has to 'e seen in the light of these differences.
)hese differences also help deter"ine whether the use of corporate governance concepts developed
in one countr can 'e suita'l i"ple"ented in another countr. More i"portantl- the 4uestion
would 'e whether such i"ple"entation of corporate governance concepts across 'orders can 'e
effect to without considering these crossBcountr differences in corporate governance and
the reasons for such differences.
2.0 A Re'ie o$ the Con'er*ence '&. #i'er*ence #e(ate
After having seen that different sste"s of corporate governance do exist across various countries- it
is apt to consider whether these different sste"s are li/el to converge into one single "odel or
whether it is li/el that status 4uo will continue due to the forces of divergence. I now discuss two
co"peting points on view on this issue and delve into the relevance of this de'ate with reference to
the concept of independent directors.
A. $actors for Convergence
)he pri"ar force 'ehind convergence of corporate governance sste"s is glo'alisation. %usinesses
and invest"ents increasingl transcend national 'orders. ,hen co"panies raise finance in the
capital "ar/ets- the are forced to issue securities to investors in other countries. $urther"ore- the
need for additional capital forces co"panies to even list the"selves on overseas stoc/ exchanges.
Due to this pheno"enon- co"panies are re4uired to co"pl with corporate governance nor"s that
"ost investors understand. Co"panies therefore depart fro" their own nor"s and "i"ic standards
prevalent in other countries. )he result of internationalisation of capital "ar/ets with respect to
e"erging econo"ies is that ;invest"ent flows "a "ove against fir"s perceived to have
su'opti"al governance and thus to the disadvantage of the countries in which those fir"s are
If there is 'ound to 'e convergence- which "odel of corporate governance would all
econo"ies converge upon5 In an influential stud- !rofessors .ans"ann and 9raa/"an argue that
such convergence would result in the supre"ac of the shareholder "odel- where' ;corporate law
should principall strive to increase longBter" shareholder value;.
)heir argu"ent is twofold0 112
A"erican corporate governance has reached an opti"all efficient endpoint ' adopting the
shareholder pri"ac and dispersed shareholding corporate "odel- and 122 the rest of the world will
inevita'l follow- resulting in a convergence of corporate governance around the world on the lines
of the 8.6. "odel.
)he also specificall exa"ine convergence with regard to 'oard structures in
the context of existing options- viz., the singleBtier 'oard structure 1with independent directors2 that
exists in the 8.6. and the 8.9. and the twoBtier 'oard structure 1with a "anage"ent 'oard and
supervisor 'oard2 that exists in continental *urope and other countries such as China. )he note
that there is "ove"ent in 'oard practices0
)he result is convergence fro" 'oth ends towards the "iddle0 while twoB tier 'oards
the"selves see" to 'e on the wa out- countries with singleB tier 'oard structures are
incorporating in their regi"es- one of the strengths
of the tpical twoBtier 'oard regi"e- na"el the su'stantial role it gives to independent
1outsider2 directors.
)he e"ergence of the independent director concept in the 8.6. and the 8.9. and
the i"position of that concept in other countries such as China and India is a sign
of an atte"pt in convergence towards the 8. 6.F8.9. "odel. )o that extent- there is certainl a
"ove"ent in various countries towards a singleBtier independent 'oard as a converged "odel of
corporate governance.
%. Divergence3 !ath Dependenc
)he convergence argu"ent has its fair share of detractors. !rincipal a"ong the" is the theor that
;there are significant sources of path dependence in a countrAs patterns of corporate ownership
)he ;path dependenc; approach advocated ' %e'chu/ = Roe states that ;a countrAs
pattern of ownership structures at an point in ti"e depends partl on the patterns it had
)his approach is grounded on two argu"ents0 112 one of efficienc- that ;the initial
ownership patterns influence the relative efficienc of alternative corporate rules3 the set of rules
that would 'e efficient ... "ight depend on the countrAs existing pattern of corporate structures and
and 122 one of rentB see/ing and interest group politics- where' ;KtNhose who
participate in corporate control under an existing structure "ight have the incentive and power to
i"pede changes that would reduce their private 'enefits of control even if the change would 'e
)he authors cite the exa"ple of controlling shareholders who "ight resist change
towards a diffused shareholding "odel 'ecause of a
reduction in private 'enefits of control. $or these reasons- the argu"ent goes- it
would 'e difficult for convergence to occur towards the 8.6. shareholding
Another theor argues against convergence of corporate governance 'ecause ;each national
governance sste" is a sste" to a significant extent;.
)his ta/es into account several do"estic factors that are the reasons for the specific features of
each corporate governance sste"- and these "a/e crossB referencing across :urisdictions a
difficult- if not i"possi'le- tas/.
Let another theor adopts a "ilder approach towards convergence. In a stud that is relevant
to the role of independent directors in corporate governance- 9hanna- 9ogan and !alepu explain
so"e nuances regarding functional aspects of convergence. )he state0
An aspect of the convergence de'ate recogniIed 'ut not e"phasiIed in the literature is the
distinction 'etween de :ure and de facto convergence. De :ure convergence is the adoption of
si"ilar corporate governance laws across countries. De facto convergence- on the other hand-
refers to a convergence of actual practices. !ut si"pl- nations "a for"all adopt other
countriesA corporate governance sste"s- 'ut the acceptance of the enshrined principles "a
significantl lag their codification. )his "a 'e for several reasons- including a lac/ of
understanding of what is i"plied ' good corporate governance- a'sence of co"ple"entar
institutions needed to i"ple"ent the principles- or si"pl poor enforce"ent.
In their e"pirical stud- the authors find that there is de 6ure si"ilarit in corporate governance
a"ong econo"icall interdependent countries. .owever- the find no evidence of de facto
convergence due to the continued operation of local vested interests. .ence- the conclude that
;glo'aliIation "a have induced the adoption of so"e co""on corporate governance standards 'ut
that there is little evidence that these standards have 'een i"ple"ented;.
C. )he Relevance of the De'ate to Independent Directors
)here can 'e no dou't that the adoption of the independent director concept in various countries
around the world signals a "ove towards convergence in corporate governance 1at least in so far as
'oard structure is concerned2. $urther"ore- it is also the case that this signals a "ove towards the
"odel of corporate governance followed in the 8.6. and the 8.9.- which essentiall involves a
shareholderBoriented approach in the context of diffused ownership in co"panies. )hat 'egs the
4uestion as to whether such convergence towards the 8.6. and the 8.9. "odels is li/el to succeed.
,ithin the convergenceBversusBdivergence paradig"- I argue 1for reasons I shall ela'orate on
su'se4uentl2 that the independent director concept presents onl signs of de 6ure convergence and
that de facto convergence is still elusive 1and does not exist at present2. *e 6ure convergence exists
due to the fact that several countries 1including China and India2 have adopted the concept of
independent directors within their regulator fra"ewor/ for corporate governance. %ut- how far that
can 'e effectivel i"ple"ented would depend on whether there is de facto convergence. I ta/e the
position in this dissertation that de facto convergence is unli/el to occur due to the forces of path
dependenc. In countries li/e China and India- the existing controlling shareholders 1'eing the
'usiness fa"ilies and the state2 indulge in rentBsee/ing there' preventing proper i"ple"entation of
the independent director rule. 7wing to this- there is still li/el to 'e divergence in the application of
the independent director concept to China and India fro" a functionalit standpoint. Incorporating a
re4uire"ent in the local
laws of a countr is one thing- 'ut effectivel i"ple"enting that re4uire"ent to realise its legislative
goal is another altogether. .ence- glo'alisation and the extension of the independent director concept to
various countries negates the convergence theor and leans "ore towards the divergence approach.
2.1 Tran&p%ant E$$ect
%efore concluding this Chapter- it would 'e necessar to identif certain principles 'ehind the
pheno"enon of legal transplants. A legal transplant involves the adoption ' one countr of laws or
legal concepts fro" another countr3 this could ;range fro" the wholesale adoption of entire sste"s
of law to the coping
of a single rule.; )ransplants have 'eco"e co""on in the area of corporate governance- pri"aril
due to glo'alisation and the exportation of capital "ar/ets
to various :urisdictions.
)here are several 'enefits of legal transplants. )he are not onl useful in setting co""on
standards for legal rights and o'ligations across :urisdictions- 'ut are also less costl and 4uic/ to
7n the other hand- transplants are acco"panied ' several disadvantages. Mere
i"portation of a legal rule without proper adaptation to local conditions is li/el to result in failure.
)his is on account of the fact that several social- political and econo"ic factors that are present in the
countr of origin "a not 'e present in the countr of i"port- or
"a 'e present with su'stantial variations- all of which "a/e the i"portation a fairl co"plex exercise.

8nless these factors are ta/en into account- there will 'e a lac/ of "otivation on the part of the
"ar/et plaers as well as regulators to
i"ple"ent the rule. In other words- if the transplanted rule is unli/el to find a ;fit; within the recipient
legal sste"- the transplantation is 'ound to result in
failure- as the rule "a never 'e i"ple"ented.
I"ple"entation failures "a occur on two counts.
$irst- the rule "a never 'e i"ple"ented at all. 6econd- the rule "a 'e i"ple"ented in a for"al
sense- 'ut not su'stantivel there' defeating the purpose of the transplant.
)he i"portation of the independent director re4uire"ent into e"erging econo"ies li/e China
and India fro" the developed econo"ies li/e the 8.6. and the 8.9. is a classic instance of legal
transplants. .owever- the efficac of the transplant is open for de'ate- particularl 'ecause there
have 'een no studies that exa"ine the i"pact of independent directors in e"erging econo"ies fro" a
theoretical perspective.
An pro'le"s with regard to transplantation of the independent director
rule are exacer'ated ' the differing political- social and econo"ic considerations that operate in
these two sets of :urisdictions- na"el the 8.6. and the 8.9. 1the outsider sste"2 on the one hand-
and China and India 1the
insider sste"s2 on the other.
It is the conceit of this dissertation that the transplantation of the
independent director concept is not i"ple"ented effectivel as et in certain :urisdictions which
have adopted it 1including China and India2- and this i"ple"entation failure raises 4uestions
regarding the via'ilit of the transplant itself. It is- of course- argua'le that ten ears presents too
short a ti"efra"e
to assess the via'ilit of a new piece of legislation.
.owever- such a
ti"efra"e will li/el provide preli"inar evidence of the accepta'ilit of the legislation- and an
earl assess"ent of its via'ilit will help regulators "ould their i"ple"entation strateg in a ti"el
2.2 Conc%u&ion to the Chapter
In su""ar- this Chapter exa"ines the different "odels of corporate governance- 'eing the outsider "odel
and the insider "odel. )here are significant differences in the two "odels- and there are several
theories proffered as to the reasons for these differences. As to the future though- there appears to 'e
a "ove in favour of convergence towards the 8.6. and the 8.9. "odels of corporate governance
involving diffused ownership and greater investor protection. .owever- there are e4uall strong factors that
restrain such convergence and indicate a strong tendenc towards divergence owing to path
dependenc. )his pro'le" can 'e su""arised and theorised as the "is"atch 'etween for"al
convergence and infor"al divergence of sste"s of corporate law. In this context- the role of the
independent directors that has 'een transplanted fro" the outsider sste"s to the insider sste"s
presents a suita'le case stud to deter"ine the i"pact of these factors- a "atter I shall ela'orate on in
the su'se4uent Chapters
3. 1 Introduction to the Chapter
3.2 )heoretical $oundations for the 7rigin of Independent Directors
expropriated ' "anagers. ... 6econd- when the are poorl protected-
s"all investors "ight 'e willing to 'u corporate shares onl at such
low prices that "a/e it unattractive for corporations to issue new shares
to the pu'lic.
Ibid, at 11#&.
12C Ibid. at 11&1.
121 ?a !orta- et, al, Investor Protection, supra note &# at +.
122 Ibid. at >.
123 Ibid.
12# !into- supra note (& at #>3 1noting that ;the set the agenda for
"uch of the current significant co"parative corporate governance
12& $or a 'rief surve of this literature- see Ar"our = ?ele- supra note 1(1 at 3BD.
12( As seen earlier- supra note 1D> and acco"paning text- in the ;law "atters;
thesis- the 4ualit of the rule as well as its enforce"ent are 'oth i"portant.
IndiaAs poor law enforce"ent record has 'een noted ' one corporate
governance scholar as follows0
)he Rule of law index is another stor. . India- for instance has a score
of #.1+ on this index B ran/ing #1st out of #> countries studies B ahead
onl of <igeria- ... )hus it appears that India laws provide great
protection of shareholdersA rights on paper while the application and
enforce"ent of those laws are la"enta'le.
Cha/ra'arti- %volution and hallenges, supra note D> at >B1C. 6ee also- 1orld
Ban7 *oing Business Report, supra note 1+(.
12+ )upra note 1>( and acco"paning text.
12D 6ee infra Chapter (- 6ection (.3.
3. 3 *"ergence of Independent Directors in 8.6. Corporate
!ractice 3.# *"ergence of Independent Directors in 8.9. Corporate
3. & *ffect of Independent Directors in 7utsider 6ste"s 3.(
Conclusion to the Chapter
12> Mar/ J. Roe- )trong Managers, 1ea7 ,#ners: (he Political Roots of
-merican orporate +inance 1!rinceton- <.J.0 !rinceton 8niversit !ress-
1>>#2 $)trongManagers 1ea7 ,#ners',
13C Ibid, at 1>>+. )his is particularl true of Ger"an and Japan- the
other two countries !rofessor Roe has studied in this wor/.
131 Mar/ J. Roe- Political *eterminants of orporate !overnance:
Political onte&t, orporate Impact 1<ew Lor/0 7xford 8niversit !ress-
132 6ee further discussion- supra note +( to +> and acco"paning text.
133 $or a discussion of ChinaAs and IndiaAs focus on sta/eholder
interest- see supra 6ection 2.21D2112 and 1D2122 respectivel.
13# )his is consistent with RoeAs theor of ;path dependenc; in corporate
governance. 6ee %e'chu/ = Roe- Path *ependence, supra note 2C. )he
argu"ent of path dependenc and its i"plications to our current discussion
on independent directors is explored in greater detail- infra Chapter (-
6ection (.&.
13& Raghura" G. Ra:an = ?uigi Qingales- ;)he Great Reversals0 )he !olitics
of $inancial Develop"ent in the )wentieth Centur; 12CC32 (> J. $in.
*con. &3 Raghura" G. Ra:an = ?uigi Qingales- )aving apitalism from
the apitalists: <nleashing the Po#er of +inancial Mar7ets to reate
1ealth and )pread ,pportunity 1!rinceton- <.J.0 !rinceton 8niversit
!ress- 2CC#2. 6ee also- !into- supra note (& at #>&.
13( 6ee infra Chapter (- 6ection (.#.
13+ Gordon = Roe- onvergence and Persistence, supra note #C at 2.
13D .ans"ann = 9raa/"an- (he %nd of History, supra note (( at #3>.
13> 6ee ibid. 6ince the 8.9. "odel of corporate governance is fairl si"ilar
to the 8.6. "odel- their argu"ent is 'roadl li/el to hold good for the
8.9. "odel as well.
1#C Ibid at +C.
1#1 %e'chu/ = Roe- Path *ependence, supra note 2C at 12>.
1#2 Ibid.
1#3 Ibid, at +C.
1## Ibid. at +CB+1.
1#& ,illia" %ratton = Joseph A. McCaher- ;Co"parative Corporate
Governance and the )heor of the $ir"0 )he Case Against Glo'al Cross
Reference; 11>>>2 3D Colu". J. )ranAl ?. 213 at 213- where the authors note
).1 Introduction to the Chapter
as follows0
*ach sste"- rather than consisting of a loose collection of separa'le
co"ponents- is tied together ' a co"plex incentive structure.
Interdependencies 'etween each sste"As co"ponents and the incentives
of its actors create significant 'arriers to cross reference to and fro"
other sste"s. )he cross reference hpothesis- in contrast- presupposes
corporate governance institutions@a world in which one sste"As
co"ponents can 'e adapted for use in the other sste" without significant
frictions or perverse effects.
1#( )arun 9hanna- Joe 9ogan = 9rishna !alepu- ;Glo'aliIation and
6i"ilarities in Corporate Governance0 A CrossBCountr Analsis; 12CC(2
DD112 )he Review of *cono"ics and 6tatistics (> at +1.
1#+ Ibid, at D#.
1#D 9anda = Milhaupt- supra note 2D at DD>.
1#> 6ee %er/owitI- !istor = Richard- supra note 231 at 1(+B(D o'serving as
,e develop a definition of the ;transplant effect; as a prox for the
process of legal transplantation and reception. ... 7ur 'asic argu"ent is
that for law to 'e effective- a de"and for law "ust exist so that the law on
the 'oo/s will actuall 'e used in practice and legal inter"ediaries
responsi'le for developing the law are responsive to the de"and. If the
transplant adapted the law to local conditions- or had a population that
was alread fa"iliar with 'asic legal principles of the transplanted law-
then we would expect that the law would 'e used. . .owever- if the law
was not adapted to local conditions- or if it was i"posed via coloniIation
and the population within the transplant was not fa"iliar with the law-
then we would expect that initial de"and for using these laws to 'e wea/.
?egal inter"ediaries would have a "ore difficult ti"e developing the law
to "atch the de"and. Countries that receive the law in this fashion are
)he twoBfold o':ectives in this Chapter are 1i2 to underta/e a stud to explore the
origins of the concept of the independent director which- as discussed earlier- can
'e related to the outsider econo"ies of the 8.6. and the 8.9- and 1ii2 to evaluate
the e"pirical evidence 1'oth 4uantitative and 4ualitative2 on the effectiveness of
independent directors in co"panies 'elonging to the outsider sste"s. ,hile such
a stud will necessaril involve delving into the histor of corporate governance-
it is not "eant to 'e a historical surve that stands on its own- 'ut rather to analse
the pro'le" that the concept of independent directors was evolved to address. )his
stud will indicate that the seeds of the independent director concept were sown in
the theor of the "onitoring 'oard that involves a co"'ination of law and
econo"ics. Apart fro" that- whenever independent directors have 'een 6ee
%lac/ = 9raa/"an- )elf?%nforcing Model, supra note &23 %ernard 6. %lac/- ;)he
?egal and Institutional !reconditions for 6trong 6ecurities Mar/ets; 12CC12 #D
8C?A ?. Rev. +D1 $"egal and Institutional Preconditions'.
+C+1 Gordon = Roe- onvergence and Persistence, supra note #C at 11.
thus su':ect to the ;transplant effect0; their legal order would function
less effectivel than origins or transplants that either adapted the law to
local conditions andFor had a population that was fa"iliar with the
transplanted law.
$urther"ore- !rofessor 7tto 9ahnB$reund has highlighted the i"portance of
understanding the political context in which a rule was developed 'efore it
was transplanted to other countries. .e notes0
It is the enor"ousl increased role which is plaed ' organised interests
in the "a/ing and in the "aintenance of legal institutions. Anone
conte"plating the use of foreign legislation for law "a/ing in his countr
"ust as/ hi"self0 how far does this rule or institution owe its existence or
its continued existence to a distri'ution of power in the foreign countr
which we do not share5
7tto 9ahnB$reund- ;7n 8ses and Misuses of Co"parative ?aw;- 11>+#2 3+
Mod. ?. Rev. 1 at 12. .e then goes on to caution0
)his however is precisel the point I have atte"pted to su'"it to ou in
this lecture- the point that we cannot ta/e for granted that rules or
institutions are transplanta'le. )he criteria answering the 4uestion
whether or how far the are- have changed .- 'ut an atte"pt to use a
pattern of law outside the environ"ent of its origin continues to entail the
ris/ of re:ection. . All I have wanted to suggest is that its use re4uires a
/nowledge not onl of the foreign law- 'ut also of its social- and a'ove all
its political- context.
9ahnB$reund- ibid. at 2+.
1&C Ibid. 9anda and Milhaupt exa"ine legal transplants through their stud of
the exportation of a single rule of corporate law- the directorAs dut of
loalt fro" the 86 to Japan- and find that the rule was dor"ant for nearl
fort ears after its i"portation into Japan. 9anda =
+2 As this "atter does not re4uire detailed ela'oration- this !art onl 'riefl deals
with the issue.
+3 %ernard 6. %lac/ = John C. Coffee- ;.ail %ritannia5 Institutional Investor
%ehavior under ?i"ited Regulation; 11>>#2 >2 Mich. ?. Rev. 1>>+ at
2CC1. %rian Cheffins- ;Current )rends in Corporate Governance0 Going
fro" ?ondon to Milan to )oronto; 12CCC2 1C Du/e J. Co"p. = IntAl ?. & at
+ $"ondon to Milan to (oronto', noting that a0
co""on feature in the 8nited 9ingdo" and the 8nited 6tates is
diffused ownership. In %ritain- ver few large co"panies are controlled
' fa"ilies- and fewer that oneBfifth of the countrAs pu'licl 4uoted
fir"s have an owner who controls "ore than twentBfive percent of the
shares. ?i/ewise- in the 8nited 6tates- large shareholdings- and
especiall "a:orit ownership- are unco""on.
+# Raghura" Ra:an = ?uigi Qingales- ;,hat do we 9now A'out Capital
Milhaupt- supra note 2D. 6ee also !aredes- supra note 2C at 1C&D 1arguing that
a ;danger of transplanting 8.6. corporate law to developing econo"ies is that
it "ight not fit with the ;i"porting; countrAs econo"ic structure- political
sste"- social order- or cultural values;2.
1&1 6ee %er/owitI- !istor = Richard- supra note 231 at 1(D.
1&2 )here is an interesting o'servation ' %ana:i and Mod who stud the
AngloBA"erican approach to corporate governance in the context of the
Cad'ur Co""ittee Report and its transportation to India. )he o'serve0
K7Nne should note that Cad'ur "a/es several assu"ptions. It assu"es
a corporate culture or sste" where there is already a widespread and
wellBesta'lished separation of ownership and control. Cad'ur is not
tailorB"ade to a context where do"inant shareholders- e,g. pro"oters-
control "anage"ent where the corporate governance pro'le" is chiefl
one of the protection of "inorit shareholder rights. ... Cad'urAs
assu"ption is dispersed ownership- and 6*%IAs overdependence on
Cad'ur see"s to have carried over so"e of the conse4uences of that
assu"ption into a "ar/et where concentrated ownership is the chief
source of the pro'le".
Jairus %ana:i = Gauta" Mod- ;Corporate Governance and the Indian
!rivate 6ector;- 8niversit of 7xford- Pueen *liIa'eth .ouse ,or/ing !aper
<u"'er +3 12CC12- online0
6tructure5 6o"e *vidence fro" International Data; 11>>&2 &C J. $in.
1#21 at 1##>.
Ehttp0FFwww3.4eh.ox.ac.u/FpdfF4ehwpF4ehwps+3.pdfH at D 1e"phasis in
1&3 6ee !aredes- supra note 2C at 1C&> dealing in general with the e"ploa'ilit
of 8.6.
corporate governance in other parts of the world. .e o'serves0
)he 'otto" line for "ost developing countries is that i"porting a corporate law
regi"e along the line of the 8.6. "odel- or otherwise depending on a "ar/etB
'ased "odel of governance- is not a via'le option. More to the point- i"porting
8.6. corporate law falls far short of replicating the 8.6. sste" of corporate
governance in developing countries leaving "an of the i"portant parts
1&# )he concept of independent directors has found its wa into the
corporate governance sste"s of 'oth China and India onl in the last
decade. $or a detailed ti"eline regarding the various specific efforts- see
infra Chapter #- 6ection #.&1A2.
1&& 6ee %er/owitI- !istor = Richard- supra note 231 at 1(& 1noting that ;KiNt
o'viousl ta/es ti"e for the law to gain "ore than a 'oo/Blife and to
influence household and fir"Blevel decision "a/ing- for lawers to 'e
trained in the new rules and for cases to 'e 'rought to court for clarification
D# <estor = )ho"pson- supra note 1> at >. 6ee also Rafael ?a !orta-
$lorencio ?opeIBdeB 6ilanes- Andrei 6hleifer = Ro'ert Mishn- ;?aw and
$inance; 11>>D2 1C( J. !ol. *con. 1113 $"a# and +inance'. Another
description of insider sste"s is that the are ;characteriIed ' the
significance of the state- fa"ilies- nonBfinancial corporations- e"ploees
and 'an/s as a source of funding andFor control;. 6ee Digna" = Galanis-
supra note 3> at 2C2. 6ee also ?a !orta- et. al., -round the 1orld, supra
note 2( at #+1 1where the authors find that contrar to the general
understanding of the %erle and Means corporation- in "ost econo"ies
1except those with good shareholder protection2 relativel few of the fir"s
are widel held2. %ut see Ronald J. Gilson- ;Controlling 6hareholders and
Corporate Governance0 Co"plicating the Co"parative )axono"; 12CC(2
11> .arv. ?. Rev. 1(#1 1pointing to the fact that there could also 'e
cultural factors that could lead to "aintenance of control in insider
sste"s- such as a desire to retain control within a 'usiness fa"il2.
D& 6ee *ri/ %erglof and *rnst ?udwig von )hadden- ;)he Changing
Corporate Governance !aradig"0 I"plications for )ransition and
Developing Countries; 11>>>2- online0
Ehttp0FFssrn.co"Fa'stractG1D3+CDH at 1+.
and interpretation;2.
>3 ?a !orta- et. al, -round the 1orld, supra note 2( at #+#.
>D Ibid. at +.
113 6ee Clar/e- Independent *irector in hina, supra note 3+ at 131.
11+ Gu 6. ?iu = !ei 6un- ;Identifing 8lti"ate Controlling
6hareholders in Chinese !u'lic Corporations0 An *"pirical 6urve;
Asia !rogra""e ,or/ing !aper- <o. 2 1June 2CC32- online0
Ehttp0FFwww.chatha"house.org.u/FfilesF3C>(Tstateshareholding.pdfH at
11D Luwa ,ei- supra note 11# at 32.
123 Clar/e- Independent *irectors in hina, supra note 3+ at 132.
12# )hese are also referred to as circulating shares and nonBcirculating
shares respectivel. 6ee Clar/e- ibid.
12> Ibid, at 1CB11- citing 6heldon Gao- ;China 6toc/ Mar/et in Glo'al
!erspective; *o# @ones Inde&es 16epte"'er 2CC22.
133 PR ompany "a#, arts. 1+B1D. 6ee also- ,ang- ompany "a# in
hina, supra note 111 at 32.
1+3 )he "ore i"portant of such legislation relates to the esta'lish"ent of a
detailed disclosure regi"e for co"panies- a share depositor for electronic
trading of shares and a sophisticated trading and settle"ent sste" in the
secondar "ar/ets. 6ee Ar"our = ?ele- supra note 1(1 at 2C.
1D& $or a "ore detailed discussion on this aspect- see supra 6ection 2.2.
1D+ )hese studies are encapsulated in a series of articles pu'lished in the late
1>>Cs. )hese are Rafael ?a !orta- $lorencio ?opeIBdeB6ilanes- Andrei
6hleifer = Ro'ert Mishn- ;?egal Deter"inants of *xternal $inance;
11>>+2 #2 J. $in. 1131 $"egal *eterminants', ?a !orta- "a# and
+inance, supra note D#3 ?a !orta- et, al,, -round the 1orld, supra note
2( and ?a !orta- Investor Protection, supra note &#.
1>2 ?a !orta- et. al, "a# and +inance, ibid. at 111(.
1>+ Ibid. Just ' wa of exa"ple- the concept of A fiduciar dut A is a
significant contri'ution of :udge "ade law in co""onBlaw countries- and
this concept has 'een used extensivel to protect investors against the
actions of directors and "anagers in co""on law countries.
2C3 Another theor that challenges ??6M in the context of India
ascri'es IndiaAs enhancing capital "ar/et position to political factors.
6ee Ar"our and ?ele- supra note 1(1.
2C+Roe- )ome *ifferences, supra note >2 at 1>3&.
21# A"ir <. ?icht- ;)he Mother of All !ath Dependencies0 )oward a
CrossBCultural )heor of Corporate Governance 6ste"s; 12CC12 2( Del.
J. Corp. ?. 1#+ $Mother of -ll Path *ependencies'.
22C Dan ,. !uchnia/- ;)he JapaniIation of A"erican Corporate
Governance5 *vidence of the <everB*nding .istor for Corporate ?aw;
12CC+2 > AsianB!ac. ?. = !olA J. + at #D- noting as follows0
)here is no 4uestion that the independent director has 'eco"e a ralling
cr for corporate governance refor"s in A"erica and around the world.
Indeed- the independent director is sold as 'eing an effective "ethod for
increasing shareholder voice- if not indirectl increasing shareholder
22& Ibid, at +1. 6ee also Coffee- (he +uture as History, supra note 2C at
((2 1noting that ;controlling 'loc/holders are also a'le to engage in
private rentBsee/ing that 'enefits the"selves as "anage"ent- 'ut not other
shareholders;2.)his would certainl 'e the case in China and India where
'usiness fa"ilies and the state are controlling shareholders. )he
o'servations ' two corporate governance scholars in the context of India
explains it all0
7ne feature that stands out in "ost studies of ownership and corporate
control in developing countries is the close ties 'etween 'usiness
interests and govern"ent- often called cron capitalis" B as %hagwati
11>>32 has put it nicel for the case of India- the econo" is en"eshed
in a :af7aes8ue maze of controls. )his ... affects corporate governance
in our wider notion- 'ecause large fa"il owners often use their
influence to li"it co"petition- o'tain favora'le finance fro" the
govern"ent and in other was alter the ga"e in their favor.
%erglof = von )hadden- supra note D& at 1D.
22( 6ee Ronald J. Gilson- ;Glo'aliIing Corporate Governance0 Convergence
of $or" or $unction; in Gordon = Roe- onvergence and Persistence,
supra note #C at 1#+. 6ee also !into- supra note (& at &C2 1o'serving that
the ;rise of shareholder pri"ac calls into 4uestion the role of other
sta/eholders- and the prevalence of concentrated ownership argua'l pushes
an A"ericanBstle sste"- further suggesting decreased power of the
23C9anda = Milhaupt- supra note 2D.
231 )ransplants have 'eco"e a wa of signalling to investors that a countr
intends to co"pl with the investorsA do"estic legal standards. 6ee Daniel
%er/owitI- 9atharina !istor = JeanB $rancois Richard- ;)he )ransplant
*ffect; 12CC32 &1 A". J. Co"p. ? 1(3 at 1(#.
23# 6ee Gordon = Roe- onvergence and Persistence, supra note #C at (
1o'serving that ;Ktransplanting so"e of the for"al ele"ents without regard
for the institutional co"ple"ents "a lead to serious pro'le"s later- and
these pro'le"s "a i"pede- or reverse- convergence;2.