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Working papers: 2010

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WP417: Corporate Governance & Financial Crisis in the Long Run

Simon Deakin

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Prior to the global financial crisis which began in 2007, corporate governance reforms of the preceding thirty years had promoted a shareholder-value based model of management for which there was little historical precedent. The underlying legal model of the firm retained a vestigial sense of the corporate form as a mechanism for promoting group cooperation, but it became increasingly ill suited to achieving this end in a period of hyper-liquidity in capital and credit markets. The destabilising effects of the shareholder value norm included growing income inequality for which asset price inflation in the Anglo-American economies served as partial compensation, thereby helping to create the conditions which led to the global financial crisis. The failure of individual financial institutions cannot plausibly be ascribed to poor governance practices in those firms; there were more immediate factors at play, including ineffective regulation. However, the general trend towards shareholder value since the 1980s was implicated in a wider, systemic failure of the corporate governance system, of which the banking crisis was simply the most visible manifestation. Under these circumstances, a reassessment of the shareholder value based approach to the governance and management of large corporations is urgently required.

WP416: Employee Ownership in the European Company: Reflexive Law, Reincorporation & Escaping Codetermination

Wanjiru Njoya

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This article assesses the effects of reincorporation on codetermination, focusing on the scope for escaping codetermination by restructuring under the European Company (SE). This is usually associated with the prospect of corporate flight from codetermined jurisdictions. The article presents an alternative possibility, arguing that because the self-regulatory framework of employee participation in the SE encourages diversity and experimentation, it does not inevitably erode the institution of codetermination. Viewed within a framework of reflexive harmonisation, the effects on codetermination are better understood as part of an open-ended process of evolution in the ownership and control structures of the firm. This points to the potential for codetermination to become more, rather than less, integrated as part of the ownership landscape of European firms.

WP415: The Global Economic & Financial Crisis: A Review & Commentary

Ajit Singh and Ann Zammit

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This paper provides a review and commentary on the current financial and economic crisis. It considers important analytical and policy issues from a global and North-South perspective. The analytical questions cover issues such as the better than expected performance of the world economy, the role of global financial imbalances, and whether or not economic theory has been helpful. It is argued that close international cooperation and policy coordination are essential to recovery and an improved distribution of the fruits of growth. Cooperation and financial regulation are particularly necessary in order to prevent international contagion and cascading sovereign debt defaults.

WP414: Globalisation, Structural Adjustment & African Agriculture: Analysis & Evidence

Deborah Bryceson, Prabirjit Sarkar, Shailaja Fennell and Ajit Singh

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A major purpose of this paper is to examine the effects of poor governance or ‘state fragility’ in African countries on their overall economic and agrarian performance. The results of our econometric analysis show that a higher level of public security is conducive to lower levels of conflict, whether of an ethnic, religious and regional nature. It also corresponds with greater agricultural value-added per capita. The analysis further indicates that trade openness and aid do not have a substantial impact on agricultural development. Our institutional and historical examination of the structural adjustment programmes in African countries suggest that African agriculture’s poor performance is not necessarily due to the negative influence of African governments, but could also, in large part, be attributed to the policies advocated by the international financial institutions and donor countries. The resolution of the problems associated with these policies lies in improving the ability of African farmers to benefit from new agrarian technologies that raise staple food productivity and thereby enhance food security and national stability. The paper also provides, inter alia, a nuanced analytical description, based upon available aggregate statistics, of the short- and long-term performance of African economies and their agricultural sectors during the last 25 years.

WP413: Turning Digital: Diversification in UK Design Consultancy Services

Karl Wennberg, Bruce Tether, Cher Li and Andrea Mina

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Why do small firms in emerging industries choose to diversify? Theories of strategic management suggest that diversification is driven by search for exogenous market opportunities, deployment of slack resources, or the exploitation of current knowledge. Institutional organisation theory suggests that firms may diversify for reasons unrelated to performance, such as by mimicking similar firms. We analyse the diversification of small UK design consultancies into the field of digital design between 1996 and 2009, a period characterised by the dot-com ‘boom’, ‘bust’ and recovery. Panel data analyses reveal that financial performance had little causal impact upon diversification. Instead, most firms diversified into digital design triggered by internal growth aspirations or by the following of similar firms. We contribute to the literature on small firm growth and diversification by highlighting the interactive nature of strategic and institutional drivers to diversification, and their relationship with firms’ internal growth aspirations.

WP412: Knowledge & the Evolving Economy

Andrea Mina

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This paper addresses the problem of knowledge and the far-reaching implications it bears upon innovation and the functioning of economic systems. It develops a stylised analysis of the micro-dynamics of knowledge generation, exchange and absorption.It discusses the properties of knowledge accumulation as a complex process: adaptive, path-dependent, context-dependent, open-ended and creative in the sense that it always entails the potential to endogenously generate radical novelty, in line with theory and evidence from the economics of innovation, but fundamentally at odds with a number of important tenets of equilibrium economics.

WP411: The Impact of the Patent System on SMEs

Alan Hughes and Andrea Mina

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The authors consider the theory and evidence on the propensity of small and medium-sized enterprises (SMEs) to patent their innovations.Drawing on UK, European and US literature and data sources, they show that small firms are less likely to use patents as a means of protecting their investment than other means such as confidentiality, secrecy or time to market. SMEs are also less likely than larger firms to use others’ patents as a source of information for their own innovation activities, preferring customers, suppliers and trade fairs. Conversely, smaller firms are more likely than larger firms to put their patents to productive use or to licence out their technology, a pattern that is likely to reflect relatively higher cost and capacity pressures. Among the emerging trends, of particular interest for high tech SMEs is the role of patents as an increasingly important factor in obtaining financial backing by venture capitalists. A survey of UK and US small businesses conducted jointly by the Centre for Business Research (CBR) at Cambridge and the Industrial Performance Unit at the Massachusetts Institute of Technology provides data for further analyses which reveal that small firms in the United States are twice as likely as those in the UK to patent innovations, but are still much less likely to patent than larger US firms. The authors conclude with a general discussion of main findings from a UK and European perspective.

WP410: The Mechanism of Voting Efficiency

Michael C Schouten

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In the wake of the financial crisis, shareholders are increasingly relied upon to monitor directors. But while much has been written about directors’ flawed judgments, remarkably little is known about shareholders’ ability to make accurate judgments. What determines whether shareholders make the right decision when asked to vote on, say, a merger? This paper takes a novel approach to this question by drawing an analogy between corporate voting and another system to aggregate information on estimated values: stock trading. Using insights on stock market efficiency, the paper makes three contributions to our understanding of voting efficiency. First, the paper identifies four key mechanisms of voting efficiency: (1) informed voting, which implies that shareholders have some information to base their voting decision on; (2) rational voting, which implies that such information is processed in a rational, unbiased way; (3) independent voting, which implies that each shareholder arrives at a judgment by making use of his or her personal cognitive skills, and (4) sincere voting, which implies that shareholders vote with a view to furthering the common interest of maximising shareholder value rather than their own private interest. The paper explores the operation of each mechanism, and demonstrates that the mechanisms interact in unexpected ways. Second, the paper shows that share trading, proxy solicitation and vote buying can usefully be viewed as arbitrage techniques that reallocate voting power in the hands of shareholders with superior information and processing skills, and with appropriate incentives. By reducing information asymmetry, arbitrage techniques potentially play an important role in improving voting efficiency. In practice, however, they are subject to cost constraints as well as legal constraints. The limits of voting arbitrage are significant, and affect voting efficiency much in the same way as limits of securities arbitrage affect market efficiency. Third and finally, the paper analyses two issues that are currently being studied by the U.S. Securities Exchange Commission and policymakers around the world: voting without corresponding financial interest (’empty voting’) and the major influence of proxy advisers. By showing that these issues each involve a trade off between the various mechanisms of voting efficiency, their costs and benefits are brought into sharper focus. Several policy options are then presented to mitigate the costs while fostering the benefits.

WP409: Autopoetic Social Systems Theory: The Co-evolution of Law & the Economy

Ana Lourenço

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This paper explores the relationship between regulation and contracts from the point of view of autopoietic social systems theory. Building on the notions of contract as a structure of governance, and of regulation as a system of rules intended to govern the behaviour of its subjects that involves standard setting, monitoring and enforcement, the paper discusses the contributions of Teubner (1993), Collins (1999) and Deakin (2002) for understanding the relationship between the legal and the economic subsystems in society. The paper argues that regulation and contracts co-evolve: the influence of regulation upon contracts is mediated by the system of shared meanings that the contract develops and, reciprocally, the influence of contracts on regulation depends on each regulatory element’s own network of communications. The paper concludes that reflexive regulatory strategies, by facilitating the emergence of shared meanings, may be more successful in governing the behaviour of economic actors. However, given the disturbances involved in the process of co-evolution, this is not straightforward.

WP408: Competition & Public Service Broadcasting: Stimulating Creativity or Servicing Capital?

Simon Turner and Ana Lourenço

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In UK public service broadcasting, recent regulatory change has increased the role of the private sector in television production, culminating in the BBC’s recent introduction of ‘creative competition’ between in-house and independent television producers. Using the concept of ‘cognitive distance’, this paper focuses on the increasing role of the independent sector as a source of creativity and innovation in the delivery of programming for the BBC. The paper shows that the intended benefits of introducing new competencies into public service broadcasting have been thwarted by, on the one hand, a high level of cognitive proximity between in-house and external producers and, on the other, a conflict in values between the BBC and the independent sector, with the latter responding to a commercial imperative that encourages creativity in profitable genres, leaving gaps in other areas of provision. While recent regulatory reform appears to have had a limited impact on the diversity of programming, it does suggest a closer alignment of programme content with the imperatives of capital. Implications for the literature on communities of practice are noted.

WP407: Flexible or Not? The Comply-or-Explain Principle in UK & German Corporate Governance

Paul Sanderson, David Seidl, John Roberts and Bernhard Krieger

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The current financial crisis has given rise to calls to toughen considerably the codes of corporate governance put in place in many countries to regulate corporate behaviour (e.g. the UK Combined Code). These codes vary slightly in form but tend to contain a mix of non-discretionary regulations and discretionary guidance and information. Almost all such codes embody some variation or other of the comply-or-explain principle. Companies should comply with the rules or explain why they do not. In this way the code framers avoid, or perhaps enable, a one-size-fits-all approach. It is this discretion that governments are under pressure to limit, but little is known about how it is used, in what circumstances, and to what effect? In this paper we report the findings of research carried out in the UK and Germany to investigate the extent to which large public companies comply with the rules, and the attitudes of company directors and legal counsel to using comply-or-explain. We find that positive conformance with codes depends on factors such as the extent to which regulatees are engaged in the formation and revision of the code, and thus feel a sense of ownership; the existence of interested and relevant monitors; and the extent to which soft regulation is a traditional means of control in a domain. We also found that pressure, both internal and external, both real and imagined, can lead to the establishment of a norm of full compliance, with perhaps perverse outcomes, and that in any event the majority of the contents of codes become akin to hard law, where deviation is not considered acceptable. There are however a very small number of rules where temporary deviation may be unavoidable from time to time and where non-compliance accompanied by a valid explanation is accepted.

WP406: Varieties of Insider Corporate Governance: Centre-Right Preferences & the Determinants of Reform in the Netherlands, Sweden & Switzerland

Gerhard Schnyder

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The impact of centre-left political parties’ preferences on a given country’s corporate governance system has been widely debated and empirically investigated. Comparatively few efforts have been made to analyse the preferences of centre-right parties and to link these to the ’employer side’ of the corporate governance equation. Recent scholarship sought to explain centre-right preferences in corporate governance reforms by electoral strategies that appeal to the median voter, arguing that the aggregate ownership structure that prevails in a country is the main determinant of the politics of corporate governance reforms. In this paper, I challenge this electoral strategy explanation by opposing it to an interest group power explanation of centre-right preferences. Based on the cases of the Netherlands, Sweden and Switzerland I show that the ownership patterns do not explain political preferences. Instead, opening up the black box of insider-orientated corporate governance systems is necessary in order to explain why centre-right parties’ preferences concerning shareholder primacy vary from one country to the other. My findings suggest that the extent to which insider control relies on control enhancing mechanisms (CEMs) and the importance of the financial sector in a given economy strongly influence centre-right preferences in the political struggles over corporate governance.

WP405: Financial Globalisation & Crisis, Institutional Transformation & Equity

Philip Arestis and Ajit Singh

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This paper comprises the long introduction to the symposium of five papers on financial globalisation published in the Cambridge Journal of Economics, volume 34, no 2. The paper discusses the impact of financial globalisation in a variety of spheres and shows how the five papers link together to provide a coherent view of the current economic and financial crisis. In this paper we also examine the globalisation of finance more broadly both in historical terms as well as in relation to the current widespread failure in the financial markets. We take up the policy question of how the interests of the poor in particular, and developing countries in general, could be safeguarded from the vagaries of financial globalisation, questioning how much choice communities and countries have and what can the international community do to extend these choices?

WP404: Globalisation, Openness & Economic Nationalism: Conceptual Issues & Asian Practice

Ajit Singh

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This paper considers the question of economic nationalism through the lens of economic openness. Complete economic openness, which connotes close or total integration of a country with that of the world economy, is the antonym of economic nationalism. The paper argues that economic openness is a multi-dimensional concept. A country can be open, or not so open to all or some of the following: trade, exports, imports, finance, science, culture and education, migration, foreign investment, investment by its citizens and companies abroad, among other things. There is no economic theory that suggests that a country has to be open in all dimensions simultaneously. Given its economic and geo-political situation, a country may choose to be open in some areas and not in others. The paper examines the analytical question: what is the optimum degree of openness for an economy? This theoretical framework is used to illustrate and explain the Asian experience, specifically of Japan and Korea. The implications for policy for these and other national economies as well as those for the global economy are outlined. The main policy message of the paper is that countries should seek, whenever they can, ‘strategic’ rather than close integration with the international economy. In that sense economic nationalism, notwithstanding globalisation is still the order of the day in many Asian countries. They need to maintain national control over volatile capital movements and prudently regulate the financial sector in the national interest.

WP403: Varieties of Liberalism: Anglo-Saxon Capitalism in Crisis?

Sue Konzelmann, Marc Fovargue-Davies and Gerhard Schnyder

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‘Global financial crisis’ is an inaccurate description of the current upheaval in the world’s financial markets. The initial banking crisis did not affect all countries to the same degree. Notably, while the US and UK banking systems were badly hit, those of the other two major Anglo-Saxon economies, Canada and Australia, remain largely unscathed and have even gained in terms of global market share. The national business systems and comparative corporate governance literatures underscore the similarities among these four ‘liberal market economies’ (LMEs) and would predict similar trajectories. This paper investigates the reasons behind the differing performance of the Anglo-Saxon banking systems, which defy a verdict of failure of the LME variety of capitalism as such.

WP402: The Impact of Foreign Corporate Ownership on Downsizing & Labour Cost

Dominic Heesang Chai

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This study examines the impact of foreign ownership on the firm’s labour cost using a panel data of 496 publicly traded Korean companies during the post Asian financial crisis period of 1998-2003. It shows that foreign ownership is positively related to labour cost but this positive effect is significantly weaker for firms with weak financial performance than those with strong financial performance. These results provide support to the view that foreign investors take both monitoring and disciplinary roles for publicly traded firms.

WP401: Foreign Corporate Ownership & Dividends

Dominic Heesang Chai

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This paper investigates the relatively unexplored relationship between dividends and ownership structure in an emerging market setting. Using a unique panel dataset of foreign ownership and firm attributes of listed Korean firms, we first characterise foreign ownership after the full capital market liberalisation in 1998. Foreign investors in Korea tend to overweight larger and profitable firms with large export sales and underweight highly leveraged firms with low market-to-book ratio. Then we explore the effects of the rise in foreign ownership on dividend policies in Korea. Firms make higher dividend payouts as the shareholdings of foreigners increase. This result is consistent with the agency theory view of dividends, i.e. dividends can substitute for direct monitoring of firms by large external shareholders.

WP400: Firm Ownership & Philanthropy

Dominic Heesang Chai

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This paper empirically examines the relationship between firm ownership structure and corporate charitable donations. Using a panel data set of 1,017 listed Korean firms, we find that larger firms with higher advertising intensity and lower export intensity ‘give’ relatively more, suggesting that charitable donations are both strategic and discretionary corporate expenditures. In addition, the study explores the effects of ownership structure on corporate philanthropy. We find a positive relationship between charitable donations and foreign ownership. However, we do not find a significant effect of corporate philanthropy on financial performance, indicating that donations appear to be “revenue” neutral.

WP399: Law & Financial Development: What We Are Learning from Time-Series Evidence

John Armour, Simon Deakin, Viviana Mollica and Mathias M Siems

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The legal origins hypothesis is one of the most important and influential ideas to emerge in the social sciences in the past decade. However, the empirical base of the legal origins claim has always been contestable, as it largely consists of cross-sectional datasets which provide evidence on the state of the law only at limited points in time. There is now a growing body of data derived from techniques for coding cross-national legal variation over time. This time-series evidence is reviewed here and is shown to cast new light on some of the central claims of legal origins theory. Legal origins are shown to be of little help in explaining trends in the law relating to shareholder protection, although the classification of legal systems into English-, French- and German-origin ‘families’ has greater explanatory force in the context of creditor rights. The widely-held view that increases in shareholder rights foster financial development is not supported by time-series analyses. More generally, the new evidence casts doubt on the suggestion that legal origins operate as an ‘exogenous’ force, independently shaping both the content of laws and economic outcomes. It is more plausible to see legal systems as evolving in parallel with changes in economic conditions and political structures at national level.

WP398: Green Values in Communities: How & Why to Engage Individuals with Decarbonisation Targets

Michael Pollitt

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We suggest that engaging individuals and changing norms of behaviour will be crucial if substantial decarbonisation is to be achieved and if the full costs of climate change and related development challenges are to be willingly met by societies around the world. Engaging individuals and changing norms fundamentally relate to individual moral values. This brings us to a consideration of how organised religion can play a role in providing the moral basis for individual action in this area. We also suggest implications for how business will need to engage with the challenges posed by decarbonisation. Our discussion links the underlying ethical issues raised by The Economics of Climate Change (Stern, 2007) with Vandenbergh’s (2005) emphasis on the need for ‘personal norm activation’ to engage individuals in protecting the environment.