In contrast to the numerous studies on CG in developed countries, limited research studies have been undertaken on the extent to which the CG issues of developed economies are applicable to emerging economies. The minimal research, conducted on the use of CG in developing countries, mainly focuses on the CG practice of an individual country. The increasing pace of globalisation and democratisation in most developing countries, however, calls for the enhancement of governance practices in these countries (Reed, 2002). The attention to the developing world‘s CG becomes more necessary when it is realised that the success of on-going economic reforms largely depends on the quality of CG (Nenova, 2004). Oman (2001) stressed the importance of implementing sound CG for the sake of development, suggesting that its use can
increase the flow, and decreases the cost of financial capital and can stimulate productivity growth. Developing countries are constantly seeking investment, particularly foreign investment, into trade and industry, and CG plays an important role in tapping investment by boosting investor confidence. Deregulation and privatisation has created scores of new firms with millions of new investors, including: shareholder-suppliers of equity finance, creditor shareholder-suppliers of debt finance, and employee-shareholder-suppliers of human capital (Oman, 2001).
Several studies have regarded the development of appropriate CG system as one of the greatest challenges of low-income countries in achieving sustainable financial sector development and economic growth (e.g. Nenova 2004; Oman and Blume 2005;
Iskander and Chamlou 2000). The particular importance of a robust CG regime in developing countries is evident in several recent studies that have advocated a strong system for encouraging inward investment and nourishing long-term economic growth (Johnson et al., 2000; Lynham et al, 2006; Visser et al., 2006). Important changes have indeed been occurring in CG systems in all major industrialised, and even some emerging countries, in recent years (De Nicolo et al., 2008 cited in Yoskikawa and Rasheed, 2009). CG in developing economies is gradually attracting attention (Oman, 2001; Lin, 2001). This has been given impetus as the East Asian crises, along with debt crises in Russia and Brazil, have exposed the problems of poor CG in developing, as well as emerging, markets (Allen, 2005; Oman et al., 2003). The growth in international capital flows to developing countries stresses the importance of improved CG.
Apart from the widely discussed Anglo-Saxon and Continental European models, another governance system seems to aggregate multiple related shareholders acting within and across business groups in Asia and Latin America (Cuervo 2002). In most developing economies the most common pattern of ownership is family-based rather than the Berle and Means (1932) pattern of dispersed ownership. Singh et al. (2002) argued that the family-based system of CG is often associated with relationship banking. This means that the family-based system is almost identical to the bank-based
relationship based system is fairly different from that of the market-based systems in the Anglo-Saxon economies (Tsui and Gul 2000; Singh et al. 2002; La Porta et al., 1999a).
As Rajan and Zingales (1998) stated: "... Market-based systems require transparency as a guarantee of protection ... By contrast; relationship-based systems are designed to preserve opacity, which has the effect of protecting the relationship from the threat of competition”. The actual ownership of family-run companies is opaque given the widespread use of pyramiding, cross-holdings, and the use of non-public trusts (Chakrabarti et al., 2008). The study of Ehikioya (2009) found an adverse effect on a firm‘s performance if its board includes two or more members from the same family.
The characteristics of family-owned businesses are that they are expected to have unique agency problems which are linked with CG and a firm‘s performance (Jackling and Johl, 2009). The uniqueness of this agency problem was explained by La Porta et al.
(1999b) who suggested that although the agency problem in developed countries is between managers and shareholders, in developing countries the problem exists between the majority and minority shareholders.
Ahunwan (2002) argued that in some cases where the conflict between managers and shareholders arises in developing countries, it is worsened by ill-functioning capital markets, information asymmetry, and a lack of adequate infrastructure. Developing countries‘ corporate structures are characterised by the majority shareholder‘s desire to maintain control over firms, the reliance on debt finance, weak financial markets, and an ineffective legal system (Rabelo and Vasconcelos, 2002). An optimal solution to a firm's governance problem seems to be constrained by the institutional, legal and political environment in a developing economy. Western governance mechanisms might not be suitable for use in Asia because of the dominance of family-controlled and relationship-based governance structures (Prowse 1994; Tsui Gul, 2000). Singh et al. (2002) argued that the market-based system has specific governance problems, which involve agency costs, asymmetric information and incomplete contracting. They also argue that the family-based system not only solves the agency problems far better than the Anglo-Saxon model, but also escapes from short-termism as well as the speculative problems of the stock market-based model. Moreover, this system tends to be more beneficial to
the long-term economic development of emerging economies. The relationship-based system of some emerging markets (as well as of European countries like Germany) has very successful records of fast long-term growth, which is often superior to that of the Anglo-Saxon countries. Nevertheless, Van Den Berghe and Carchon (2003) outlined several pitfalls of the family based governance system, including: conflicts of interest, higher monitoring costs, and higher asymmetries. Shleifer and Vishny (1997) and Barclay et al. (1993) also observed that large controlling shareholders can cause agency problems because they tend to maximise their wealth at the expense of minority shareholders.
In a seminal World Bank study that outlines the CG agenda for developing nations, Nenova (2004) noted that developing countries face challenges in various areas in terms of sound CG. The author argued that the main governance problem in low-income countries is value transfer from non-controlling shareholders or stakeholders to that of dominant large shareholders. Such abuse becomes easier with concentrated ownership (which is often in the hands of a few families), ineffective disclosure practices, a weak legal framework and enforcement, and problems in the audit environment. The rise of governance in developing countries is the result of poor economic performance and the consequent high international debt levels which necessitate the intervention of international financial bodies such as the World Bank. Increased focus on governance issues is included by these bodies as part of the general reforms (Reed, 2002). Thus, the World Bank, the IMF, and the IFC have worked to encourage the improvement of governance levels in emerging markets (McKinsey, 2001). The OECD Principles of Corporate Governance, issued in 1999 and subsequently revised in 2004, also includes much guidance about corporate governance reform in developing economies. Measures to improve CG in developing countries that have been suggested include: encouraging the use of equity instead of debt for growth, increasing overall investor confidence through governance issues (such as shareholder rights and increased transparency), strengthening of capital market structures (such as listing requirements and banking reforms), and encouraging the use of competition to improve the performance of
A detailed picture of CG in the Former Soviet Union (FSU) states has been provided by the research of Estrin and Wright (1999). Taking advantages of provisions of the 1989 legislation, under which enterprises had options to buy out, insider dominance became overwhelming in these economies (Filatotchev et al., 1992; Estrin and Wright, 1999;
Frydman et al., 1996; Boycko et al., 1995; Buck et al., 1999). Following the initial transitions, inefficiency of the FSU states that capital markets exacerbated the CG problems by inhibiting the takeover mechanisms (Estrin and Wright, 1999). In many FSU countries, outside ownership was obstructed, as was evident in the Russian case.
Bleaney et al. (1999) reported that there was large entrenchment by management in terms of purchasing shares from employees, and resistance to takeover by outsiders.
Despite the official endorsement of relevant accounting legislation, there have been serious problems in its enforcement for financial reporting purposes in FSU states (Estrin and Wright, 1999). This problem is more severe in private companies: firstly, where there are pervasive effort to hide profit (EBRD, 1998); secondly, where the practice of tunnelling may imply that assets are transferred out of firms by controlling owners without other owners being aware (Harris, 1997); thirdly, where reported asset value could be fictitious (Shama and Merrell, 1997); and fourthly, where only a board seat may enable one to acquire necessary information (Wright et al., 1998).
A report by the World Bank (2003) highlighting the practices of CG in Chile revealed that the Chilean system attempts to ensure shareholder rights through formal ownership registration and full disclosure of information to shareholders. However, taking advantage of concentrated ownership many controllers maintain control at 67 per cent in order to make fundamental corporate decisions, thereby ignoring small and outside shareholders. Although Chilean corporate law restricts cross-holdings, dual class shares with restrictive/preferential rights to appoint directors are allowed. Firms in Chile must disclose the identities of their twelve largest shareholders. However, it is possible that conglomerates may be controlled through private holding companies and, therefore, in reality it can be difficult to identify a firm's controller. Chile has a market for corporate control to a limited extent (Walker, 2001). Abuse of corporate assets and abuse in connected party transactions remain a recurrent problem in Chile. The CG system
requires companies to disclose information (such as financial statements, directors' and auditors' reports, board members' compensations, purchase of shares and sale of company securities and any related party transactions) yet, despite these requirements, there are no obligations on the firms to disclose some important information (such as changes in equity, company objectives, material foreseeable risk factors, internal control, and material issues regarding stakeholders and governance structures and policies). Moreover, the accounting and audit standard followed in the Chilean corporate sector falls far behind the international accounting and audit standards.
Concerns are increasing (particularly in small to medium size Chilean firms) regarding the quality, qualification, and commitment of the board members (Spencer, 2000).
As in many other developing countries, the debate about, and developments in, CG in South Asia does not have a long history. Godbole (2002, 1996a, 1996b) indicated that the large business empires holding control of firms through family and/or concentrated ownership often ignore stakeholders' interest, which leads to a perspective that CG in India is still an ‗infant‘. In support of this view, Dadiseth (1997) and Basu (1999) suggested that the CG model in India failed to address important issues (such as corporate conscience and consciousness, and the culture of transparency in organisations). The need for a credible and strong regulatory mechanism is urgent in order to strengthen CG practice in India because the current situation is far from satisfactory (Mehta and Godbole, 2002). Various reforms were undertaken in the 1990s to improve CG in India. The formation of the Securities and Exchange Board of India (SEBI) in 1992 was a particularly significant event. The establishment of the SEBI resulted in the formation of four major committees, they are: Bajaj Committee in 1996, Birla Committee in 2000, Chandra Committee in 2002, and the Narayanan Murthy Committee in 2003. The aim of these committees is to review governance issues and to propose governance laws and reforms. Many of the governance reforms and recommendations advocated by these committees were formally implemented by the SEBI, for example through the enactment of ‗clause 49‘ of the listing agreements. These reforms include increasing the number of outside directors, dealing with the issue of
India is not alone in this move towards CG; for example, in Pakistan there is now a code for CG to which all listed companies are now required to comply. Sri Lanka also has a code of best practice on CG drawn up by the Institute of Chartered Accountants of Sri Lanka. In each country, the codes have begun the process of encouraging or requiring companies to recognise the importance of GCG practices. However, the mere emergence of detailed governance codes in developing countries does not necessarily mean that de facto practices will improve (Wanyama et al., 2009).
While this section has discussed on CG practices in developing economies (including the FSU, Chile, and India), the next section gives particular focus on the CG practices in Bangladesh.