In recent years, corporate governance has attracted more and more attention among professionals, academics and officials involved in the economy. Concern for improving and strengthening mechanisms of corporate governance has grown worldwide.


The separation that exists between corporate owners and corporate managers generates conflicts of interest between the two parties. That separation is at the core of recent business practices that have damaged the value of the company and the assets of its owners.


Depending on the environment, there are various ways to adopt good governance practices. In those countries where civil law and legal protections are weaker, good governance codes tend to incorporate more explicit measures for good governance than in those countries where common law is stronger and there is greater legal protection.


Félix J. López Iturriaga and María Liduina Pereira do Carmo, professors of financial economics and accounting at the University of Valladolid in Spain have completed a study entitled “An international analysis of good governance codes,” which analyzes the contents of good governance codes in 29 countries on every continent. Their study provides an international comparison of those codes using 22 different yardsticks for corporate governance, ranging broadly from the structure of shareholding to the board of directors to the functioning of audits. Their findings confirm that the good governance movement is attempting to make up for the inability of the legal and institutional environment to provide better protection for investors in those countries where the law does not do enough to protect their interests.


The study identified two types of financial systems, depending on their legal origin: First, there are countries whose legal origins are based on common law. In those countries, the legal interpretations drawn by courts have great significance. Second, there are countries where a codified tradition and the law constitute the basic component for making legal judgments.


Conditioned by the Legal Environment


The study also found that the content of good governance codes is affected by the legal and institutional environment in a country and by the legal protections investors enjoy in that country. Thus, in common law countries, where the interests of investors are better guaranteed, codes of good practices include fewer means of protections for shareholders than in those countries based on civil law. The researchers believe that codes of good business behavior emerge as a response to situations where there is insufficient legal coverage. These codes attempt to compensate for the deficiencies.


But what does a code of good practices really mean? While it is a very complicated term to define, López and Pereira agree that a code is “a body of recommendations about the appropriate structure of the institutions for good governance, and about the appropriate behavior of members of the same institutions.” Codes of good practice represent an effort to improve corporate governance in those circumstances where the external discipline of the marketplace and the legal environment are insufficient to guarantee the goal of corporate management, which is to create value for the company’s ownership.


In the study, the good governance codes of the 29 countries were classified into six categories: codes that affect stock markets, corporate management, corporate boards, groups of corporate directors, groups of professionals and groups of investors.


Finance systems and Legal Protection for Investors


López and Pereira classified financial systems according to the origin of the country and the nature of its legal coverage for investors. Some countries have a common law system, and others have a system based on civil law. The latter group of countries can be divided into three great legal traditions: French, Scandinavian and German. Companies in both systems can be differentiated in terms of the provisions in their codes that relate to indebtedness, concentration of ownership, the presence of institutional investors and the role of the managerial team in the ownership of the company.


In common law countries, the environment is generally more favorable for providing protection and guarantees for investors.


Of the 29 countries in the study, 21 are civil law countries, and 8 are common law countries. Thus, these countries represent, respectively, 72.41% and 27.59% of the total countries covered by the study. Starting with the good governance codes published on the web site of the European Corporate Governance Institute, the researchers chose codes from countries whose legal roots are sufficiently documented in the relevant literature.


According to the study, the two measures included most frequently in codes of good governance relate, first, to compensation for corporate directors and, second, to ways to avoid conflicts of interest. Measures for compensating executives are another key concern. Otherwise, the interests of ownership can conflict with the interests of the company and its shareholders.


The study also makes suggestions about codes affecting the corporate board of directors — its size, the specialization of its membership and the frequency with which it meets. The area that is least important when drawing up a code of good governance is whether to create non-voting shares.


Good governance codes can also be segmented by nation and by the type of financial system in a country. To facilitate comparisons, the sampling in the study was divided into two groups, reflecting the degree of legal protection that is granted to investors in that country.


Civil law countries, which are characterized by a lower level of legal protection, incorporate a greater number of specifics in their [good governance] codes than do countries that are guided by common law. On average, common law countries incorporate five of the ten best practices for corporate board of directors, while civil law countries incorporate an average of only 6.1 such measures for the corporate board of directors.


In countries that are based on civil law, or which have fewer measures to protect investors, good practice codes generally stipulate a greater number of governance measures than codes in common law countries. In civil law countries, these codes also show greater concern for the interests of investors.


Good governance codes are becoming more popular because they aim to compensate for any deficiencies in the legal and institutional environment where companies operate. Nevertheless, codes can have results that are sometimes counter-intuitive.


Although concern for good governance reform has spread around the world, the epicenter of this movement is in the English-speaking countries.


The average common law country has a code that is seven years old, but the average code in a civil law country was established only five years ago. This suggests that the higher level of protection for investors built into good governance codes in civil law countries reflects a desire to make up for deficiencies [in good governance codes] that only became apparent after a series of financial scandals erupted about five years ago.


In conclusion, the research reveals that codes established in civil law countries or in countries where legal protections are weaker, provide a greater number of explicit measures for good governance than do codes in common law countries and in those countries where there is [already] a higher level of legal protection for investors.


The evidence also shows that codes that were drafted only recently provide broader coverage to investors than do the codes that pioneered good governance practices several years ago. Thus, the current movement for reforming corporative governance is an attempt to make up for deficiencies in the legal and institutional environment. Its ultimate goal is to provide stronger protection to investors in countries where the law does not provide coverage that is sufficiently broad.