In Germany, labor unions traditionally have had seats on corporate boards. At Japanese firms, dozens of loyal managers cap off careers with a stint in the boardroom. Founding families hold sway on Indian corporate boards. And in China, Communist Party officials are corporate board fixtures.

Just as different nations have developed languages, foods and local customs, they also have adapted their own forms of corporate governance and board structures. Now, as business continues to globalize, new pressure from international capital pools and government regulators may diminish the local and national flavor of corporate boards, according to Wharton faculty and other experts in corporate governance.

Wharton management professor Michael Useem says companies around the world are increasingly converging on a model developed largely in the United States in response to the growing power of global capital investors. As a result of new technology and liberalization of government controls on capital flows, massive pools of investment can move in and out of countries more freely than ever before. Companies that globalize operations or ownership know that adoption of internationally accepted governance standards would help them compete against other firms, he argues.

“Put yourself in the shoes of Fidelity or Vanguard or other investors out there who are diversifying out of U.S. stocks. You want to assure yourself that the companies you are going into are reasonably well governed — that they have acceptable accounting standards and are transparent,” says Useem.

Perhaps the central focus of corporate governance is the structure of the corporate board. In general, according to Useem, firms are moving to create boards that are more independent from management, populated by non-executive members and organized around committees overseeing management, compensation and auditing. “All these factors point to good governance and thus the company becomes more attractive to investors and legitimate in the eyes of suppliers and customers,” says Useem. “An investment manager anywhere in the world looking to put cash in the stock of a company in Lithuania or Italy will come at the company with an eye to whether it is following good practices.”

In the next 15 years, he predicts, corporate boards around the world will move toward a model in which boards typically have 10 to 15 members and three or four major committees. A board size of 11 members is “the sweet spot at the moment for U.S. companies,” he says.

Independent of Management

Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, agrees with Useem. He points to the International Corporate Governance Network (ICGN), whose members control $10 trillion in assets. “They are large pension funds in the world and they have a common interest in creating boards that are independent of management and that act as an appropriate monitor of investor interaction. That’s the model we’re moving to. No matter where you happen to be, that model produces the best potential returns.”

According to the ICGN Statement on Global Corporate Governance Principles regarding corporate boards, “Independent non-executives should comprise no fewer than three members and as much as a substantial majority. Audit, remuneration and nomination board committees should be composed wholly or predominantly of independent non-executives.”

U.S. board structures have evolved over time, Elson says. Originally, boards were made up of a subgroup of shareholders acting as stewards for other shareholders’ interests. By the 1920s, diverging shareholders’ interests began to arise, creating a vacuum that was filled by management members of the board — i.e., executives employed by the company. About 15 years ago, when large institutional investors such as pension funds and retirement plans began to demand better oversight, shareholders were able to start reasserting their interests. As a result, management influence on boards has waned, according to Elson.

Another force driving convergence is regulation. Following the passage of the Sarbanes-Oxley Act of 2002 in the United States, other countries enacted similar regulatory provisions that also focus on some of the key elements of board structure and overall governance.

Jay Lorsch, professor of human relations at the Harvard Business School, also contends that boards are converging toward a common model, a trend he says has been developing over the past seven to 10 years. “It’s particularly strong among the industrialized nations of Europe and the United States,” Lorsch notes, adding that the impetus comes from regulatory requirements for publicly listed firms, particularly provisions of the Sarbanes-Oxley Act, which apply to companies seeking capital investment by trading shares on the New York Stock Exchange and other U.S. exchanges.

At the same time, he adds, companies have increased listings in London where there is also new scrutiny. He notes that the United Kingdom’s Combined Code on Corporate Governance, adopted in 2003, sets out standards for good practices. The Code does not demand compliance in the way Sarbanes-Oxley does, but it requires companies to disclose how they conform to the Code’s standards and where they differ.

“Maybe the Code does not have the impact of law, but there are strong expectations,” says Lorsch, noting that similar regulatory actions outlining good governance practices have taken place in The Netherlands, Scandinavia and France. “All these initiatives have some parallel ideas underlying them.”

As far back as 1997, Sony rocked Japan Inc. when it reduced the size of its board from 38 to 10 and adopted other Western-style characteristics. In 2002, Japan enacted a new provision of its Commercial Code allowing boards to establish committees that include outside directors to provide more independent monitoring of management. Traditionally, Japanese boards were subject to oversight by statutory auditors appointed by executive managers. Research by NLI Research Institute in Tokyo found that two years later, only a third of 639 publicly traded Japanese companies had failed to implement some type of significant board reform, such as a decrease in the size of its board or the appointment of independent directors. However, NLI says most Japanese corporations continue to operate as a hybrid between the traditional Japanese system and the Western, independent model.

India, too, has taken steps to increase the independence of its board members with a provision known as Clause 49 of the country’s listing agreements. The clause states that half of all directors must be independent. Compliance with the regulation, which took effect January 1, 2006, has been somewhat spotty — with government-owned companies slow to respond.

According to an analysis by the Asian Corporate Governance Association, Indian enforcement of Clause 49 is weak and many companies ignore governance codes. “Most mid- and small-cap companies do not see the value of corporate governance. Most listed companies, including many large ones, take merely a box-ticking approach,” the association states in a review of Indian governance.

Divergent Opinions

Wharton management professor Mauro Guillen says that despite new regulatory codes and well-meaning attempts at initiating good governance practices, he is not sure worldwide convergence on one model is inevitable. He says there was some movement toward U.S. models in the 1990s, but following the scandals at companies like Enron and WorldCom, other nations became concerned that the U.S. model is flawed. At the same time, Guillen says, passage of Sarbanes-Oxley has led companies to steer clear of U.S. listings, moving instead to exchanges in London and elsewhere to avoid some of the provisions of the U.S. law.

He stresses that nations and companies will continue to exhibit local characteristics because different countries have followed varying patterns of economic development. A complex mix of historic, legal, political and economic factors shapes each nation’s corporate landscape, according to Guillen. As a result, corporate governance and board structures vary around the world. “We continue to see companies in different parts of the world continuing to do things the way they always have,” he notes. “Often there are many cross-national differences.”

According to Guillen, the U.S. model evolved in a country where companies typically have a wide and diverse base of shareholders and where banks, governments and other interests have little stake in corporations. In Europe, by contrast, there are fewer, larger stakeholders and often cross-holdings by banks that demand representation on the board. In Germany, labor unions play a far more important role in society than in the United States, and have long had a place in corporate governance that reflects their position in society.

In Asia, corporate structures based on diversified business groups, with cross-shareholding by banks, have propelled national economies out of rice cultivation into sophisticated manufacturing in just a few generations. Not surprisingly, they are somewhat reluctant to alter a system that has worked so well.

Guillen argues that different systems of governance are appropriate for different industries and that global investors stand to benefit from diverse governance structures which might actually enhance corporate performance.

For example, he says the Japanese system, which traditionally has featured large boards of management directors, might actually be effective for companies in industries that are heavily capitalized and require a long-term horizon, such as the auto industry. The U.S. system, which is more independent of management, is more flexible and creates a good environment for start-ups and innovative companies, such as those based in Silicon Valley. “One system is not better. It depends on what we’re talking about,” he says. “The whole idea that we would be better off in a flat world, a homogeneous world, is not going to happen because that’s not the way the world works. But even from the point of view of investors, it’s not clear at all that they would like that.”

Investors thrive on differences that are reflected in the balance between risk and return. Some want low-risk secure investments while others may be drawn to higher-risk companies with a greater potential to pay off big. “What investors want,” says Guillen, “is for the rules to stay the same, not change unexpectedly. If the rules are different in the United States and Japan, they can cope with that as long as the rules don’t change suddenly.”

‘Parent’ Firms and Their Offspring

Wharton management professor Marshall Meyer, who specializes in studying Chinese businesses, says Sarbanes-Oxley has been a force in setting global standards for governance, although that may be changing. “In the view of many scholars, Sarbanes-Oxley has had the effect of unilaterally imposing U.S. corporate governance standards on the rest of the world,” he says. “But lately there has been some pushback against Sarbanes-Oxley.”

He points to a Duke Law School analysis stating that “Nontrivial criticism has been expressed about the extraterritorial reach of U.S. securities laws in relation to issues such as insider trading and, more recently, corporate governance, suggesting that cultural attitudes toward the behavior targeted by these laws also vary widely across the globe.”

In China, corporate boards typically have 12 or 13 members, including three outside directors. However, Meyer says boards have a different role in China than in the United States. Typically, Chinese business organizations are built on a subsidiary system with “parent” firms having many children, grandchildren and even great-grandchildren. Often, the parent does not have a board because it is fully state-owned, but the other companies in the network have their own boards, although individual members are often the same.

“The argument that we will have a single model of governance so global capital can compare company fundamentals is interesting,” says Meyer, “but the fact is, the Chinese model isn’t going to change to the U.S. model.” Independent directors in China typically bring some kind of professional expertise, such as accountants, lawyers or professors, Meyer adds. These directors help with technical issues, but are not expected to provide strong strategic or management direction the way an outside director would at a U.S. firm.

In Hong Kong, where the business community is tightly woven, independent directors are appointed largely on personal strengths. Less consideration is paid to the industry they work in or the size of their own company, than might be true in the West. “In Hong Kong, they simply prefer to look at the track record of an individual,” Meyer notes.

In other parts of the developing world, institutions such as the World Bank and the International Monetary Fund, which provide financing for emerging economies, have attempted to initiate governance reforms, particularly in protections for creditors, according to Lorsch. “What makes it so complicated in the developing world is that the majority of assets are owned by private capital. The public markets are a small percentage of the total ownership of equity.”

Strong controlling families still dominate companies in many of these countries, he adds. “Whether they are interested in corporate governance in a particular country or not depends on the financial interests of these investors. We see a lot of lip service, but it is never clear where they really stand. That’s just the way it is. Capital formation has come about through family and private wealth, and public markets are less developed.”

Wharton management professor Peter Cappelli agrees that global capital will play a role in convergence toward a favored model, but he says it remains to be seen how much local character will persist in corporate board structures and in governance practices.

“The international investment community is the force that would drive convergence if it happens. Companies that want that money will have to play by their rules. So the question will be: How much commonality will they want across systems of governance?” Cappelli asks. “My guess is that they want the same outcome around the world, which is transparency with respect to finances. As long as they get that, exactly how it occurs is less important. Different national practices can still exist if they provide acceptable levels of transparency.”

Cappelli says global investors will be less concerned about government efforts to drive good governance practices. “So my guess is that such reform efforts will play out differently across countries and may create some variance.”

Elson agrees with Capelli that the most important consideration in governance practices, such as board configuration, is transparency. “The point is not that our standard should take over the world, but that it is our standard that [has always respected] capital and that is becoming global. A strong, independent board creates greater managerial accountability and better performance long-term.”

Useem, too, says it is not so much the path to transparency that matters, but that companies and countries protect shareholders and generate higher returns over time. Even small steps that lead to marginal improvement could have an important impact on the global economy. “Over millions and millions of shares, that can make a difference. If hundreds of thousands of companies become just a little better governed and a little higher performing, the world would be a better place.”