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The spectacular growth of the U.S. economy in the 1990s, spurred by the Internet boom, encouraged policymakers and business leaders around the world to look for new models of development that would reinvigorate existing firms, encourage innovation and spark entrepreneurial activity. But the Asian Financial Crisis and the collapse of Enron and WorldCom in the U.S. called for a new look at corporate governance and corporate culture. Observers on both sides of the Pacific questioned whether corporate America's apparent emphasis on the relentless pursuit of higher share prices and its appetite for risk, were sustainable.
In response to the governance crisis in the U.S., the Congress enacted the Sarbanes-Oxley legislation as a means of readjusting the power relationships between corporate stakeholders. In Asia, while reformers quickly tried to adapt the "Sarbox" framework to the local environment, others questioned whether forced corporate restructurings and hostile takeovers are really appropriate in an Asian context. In short, the concepts of law, corporate governance, the structure of financial markets, development models and culture itself, are being seriously reexamined.
In the time that is available today, I will not offer a final resolution to these vexing problems but will advance some ideas as to how we should begin to think about the interrelationship between law, culture and financial sector development.
As General Counsel of the Asian Development Bank (ADB), many of my efforts are focused on how to best use the rule of law as a development tool. The essence of the rule of law is that all authority is subject to, and constrained by, agreed upon legal order. In the course of my work, I have often been asked whether the rule of law, as promoted by our bank and other development institutions, is in essence a "Western ideology" that we seek to impose on developing countries or is it a "technology" that helps countries resolve certain specific problems. This question may have arisen because the rule of law has been considered, since Weber’s time, as one of the foundations of the modern Western state.
According to Niall Ferguson1 the main features of the states that emerged in Western Europe in the nineteen century were
Some Definitions
If, for example, ideology is defined as a "systematic body of concepts about human life and culture", certainly the rule of law comes within the scope of such a broad statement. Of course, in this day and age, the word "ideology " itself has a negative connotation and the term "Western ideology" certainly contains at least a hint that whatever it refers to is incompatible with or perhaps even destructive of local culture and values. On the other hand, if "technology" is defined as the "practical application of knowledge to a particular area", certainly it fits within this rubric as well. Obviously, dictionary-type definitions are not of much help here.
If we think that "culture" is defined as the sum of "customary beliefs, social forms and shared values, goals and practices", then culture can be viewed as supporting both ideology and technology. In my view, it is more productive to think of the rule of law as a technology with certain imbedded values. Among those values are
The nexus between rule of law and culture
A development lawyer attempting to promote rule of law must ensure that the process is done in congruence with the circumstances prevailing in a particular society. The concept of rule of law itself may have certain universal characteristics but will only be effective as a development tool if it is broadly accepted by society. Thus, compatibility with the local culture is essential.
That said, the nexus between rule of law and culture is not merely unidirectional. I argue here that rule of law leads to certain choices about which institutions will govern a particular society. Those institutions, in turn, have a profound effect on the choices we make. Douglas North has defined institutions as the way we structure human interactions and are the incentive framework of a society. These include formal rules, informal constraints and their enforcement.2 The chosen institutions, conversely, may also lead to certain changes of the culture and values which are highly regarded in a particular society and the state plays a crucial role in shaping the institutional framework.
As Francis Fukuyama has pointed out, the strength of state institutions and the scope of state functions have a profound effect on social outcomes. Strength in this context is the "ability to formulate and carry out policies and enact laws, to administrate efficiently and with a minimum of bureaucracy; to control graft, corruption and bribery; to maintain a high level of transparency and accountability in government institutions and, most important, to enforce laws". Scope refers to the different goals and functions taken on by government, such as the provision of public goods and services.3 Thus, the performance of different countries can be plotted along an (x) strength and (y) scope axis. To take an extreme example, a failed state (such as Afghanistan under the Taliban) has neither the institutional capacity nor the "political will" to deliver public goods and services.
Indeed, the proper scope of state functions is a matter of constant debate in most, if not all, countries. It is not my purpose here to outline what I think the proper balance is, as between the state and the private sector, in the provision of goods and services but I would like to point out that the government, as the regulator of business and financial activity, can indeed change culture. The few examples below will demonstrate how institutions created by the legal and financial system can radically alter behavior (and thereby contribute to economic development) by changing the way we perceive, evaluate and mitigate risk and thereby create different outcomes and attitudes.
Innovation centers
In Asia, many countries are trying to replicate the success of Silicon Valley by establishing innovation centers. The creation of such centers requires both
Let’s take a look at bankruptcy law. No one in his right mind in Asia or anywhere else will take the risk of starting a new business if the consequence of failure is long-term residence in debtors’ prison (which, by the way, still exist in some Asian countries) or to be excluded from engagement in future commercial activities. One of the ways to measure the level of temperateness of a bankruptcy law is whether it is possible and how long it takes to obtain a discharge from obligations in accordance with the prescribed insolvency procedure.
On the other hand, the presence of rule of law is prerequisite for venture capital investments since most of these investments rely on complex contractual arrangements. Thus, sanctity of contract and effectiveness of its enforcement are imperative. In this way, both the users and the suppliers of capital are encouraged to take risks; and both with the expectation that the legal system will protect their interests.
Strengthening Financial Market Development
Many countries in Asia have bank-centric financial systems. This has created vulnerabilities in financial stability in the event of banking crisis. The Asian Financial Crisis is often cited as an example of what happened when certain economies focus too heavily on a single financial intermediation avenue. This has led to a tremendous debt overhangs in many Asian countries which are still being resolved.
In order to achieve diversification, the development of capital markets is essential since it is one of the most significant sources of long-term funding for enterprises and government within any market-based system. For example, it has been estimated that the development of infrastructure alone in Asia over the next ten years will require an investment of over $200 billion4 per year. On the one hand, the international capital markets are awash with cash but it will be impossible for the supply of capital to be matched with the demand on the scale contemplated unless the proper institutional framework is in place in developing countries. Without the framework, the risks will be deemed too high.
This means having a fair, transparent and accessible market. The integrity of the market can be assured by a system which mandates disclosure of information, compliance with high-quality and transparent auditing standards and the availability of a reliable and functioning enforcement mechanism.
Financial sector development also requires that new ways to raise capital be created. Securitization is one of those channels. This channel will not grow without a proper enabling environment. This includes having legal and regulatory frameworks which allow for:
Corporate Governance in Asia
When we further look into the legal and regulatory framework required for capital market development, the issue of corporate governance is of paramount importance. This means that appropriate mechanisms should exist in the market for
Nevertheless, there are important cultural aspects that shape the existing corporate governance regime and its effectiveness. As such, the focus of corporate governance varies across countries. The focus of corporate governance in any country is heavily influenced by its ownership structure such as the degree of concentration of ownership and the type of owners. Studies have shown that the prevalence of certain ownership structure in a particular society relates to the level of property rights protection accorded by the state5. If the state lacks either the ability or the political will to enforce property rights, then individuals must resort to their own devices. This fosters relationship-based rather than market-based commercial transactions.
For example, in Indonesia, where there is heavy concentration and family-dominant corporate ownership, the company law attempts to provide protection for the minority shareholders. In the law, minority shareholders who suffer loss due to any unlawful action by the company or its management may seek judicial remedies. There is also provision to allow the piercing of the corporate veil in the event certain shareholders misuse the assets of the company for personal gain. However, to date, very few cases have been filed in the courts on the grounds provided in the law.
The reason for this is not simply because of the non-litigious nature of the Indonesian society. The perception of the lack of capacity and integrity of the enforcement agencies may have been the more compelling reason. If the judiciary, as one of the institutions dealing with law enforcement is seen to be effective in providing fair and transparent judgments, then the society may rely more on it to seek remedies.
Contests for Corporate Control
Several months ago, an unprecedented contest for corporate control took place in Japan, a country which is generally thought to disdain public conflict and eschew litigation. In that case, Livedoor, a relatively new Internet company, tried to takeover control of the well-established Nippon Broadcasting Company in order to gain access to its affiliate, Fuji Television. The contest ended in a kind of stalemate but the Japanese public, which largely supported the activities of the raider, became intimately familiar jargon like "crown jewels", "white knights" and "poison pills".
Of course, all of these anti-takeover defense techniques were developed in the United States in the 1980s when management underperformance was not unlike the situation in today's Japan. Given the fact that a large number of public companies are trading well below their asset values and are flush with cash, I expect that we will see more hostile takeover attempts in Japan. But what I find most interesting about the Livedoor episode is that both sides tried to use the legal system as a means of achieving their ends and that the courts (both at the district and appellate levels) responded in a definitive way, in record time.
More specifically, the Commercial Code was amended a few years ago to provide for the issuance of stock options in order to create some of the Silicon Valley effects I have previously discussed. That made it possible under Japanese law to create a poison pill device When the defense technique was challenged in the courts, they held that in the circumstances of this particular case, the device was being used to entrench management and not for the purpose of enhancing shareholder value. They quite clearly left open the possibility that a poison pill can be used by a Japanese company under appropriate circumstances.
Conclusion
Culture is so pervasive in our lives that we rarely need to think about how it actively shapes our attitudes and behavior. It just seems "natural". But a close examination of the choices that are made when public institutions are formed demonstrates that economic development can only happen when we are persuaded that some kind of change is appropriate. Broadly speaking, the financial system serves as a means by which actors in economic life, both private and public, distribute risk. The institutions we choose change the perception and evaluation of risk and as such have impact on our corporate as well as public culture. I trust that the few examples I have given today illustrate how these occur.
Thank you.
__________
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URL: http://www.asianlii.org/asia/other/ADBLPRes/2005/18.html