Interview: For emerging markets, the corporate governance starting point is anti-corruption and rule of law

Corporate Governance Insights Interview Series: Top corporate governance experts report on the latest research in emerging markets.

Simon Deakin is Professor of Law at the Faculty of Law, Cambridge, and a Fellow of Peterhouse, Cambridge. He is a director of the Cambridge Centre for Business Research, and Fellow in Corporate Governance at the Judge Business School. Professor Deakin holds a BA and a PhD in Law from the University of Cambridge. Areas of research interest include the relationships between law, finance, corporate governance and development. 

The most interesting piece on corporate governance in emerging markets I read recently is…

… A fascinating … a fascinating book by French author Alain Supiot called La Gouvernance par les Nombres (Governance by Numbers). His premise is that metrics and data, like the quantitative indicators on business regulations and the protection of property rights in the World Bank’s Doing Business publications, are now driving important policy changes, not always for the better. 

I’m not sure I agree with everything in Alain’s critique as I have used metrics in my own work, but he is right to highlight the danger in relying on metrics alone to form conclusions. You can’t find out everything from numbers-based, desk-top analysis. You have to go out and talk to people and see with your own eyes what is actually happening. 

Right now I am working on…

…the role of corporate governance and the development of financial markets and legal systems in the BRIC economies—Brazil, Russia, India and China. Starting with China, we are taking a hybrid research approach that includes quantitative analysis as well as face-to-face interviews. These conversations have yielded insights we can’t get from numbers. 

For example, take the widely-held notion that trust based on informal interpersonal relationships is a substitute for a western style legal system in China. On the basis of our face-to-face interviews with company executives and others in China, our initial take on this is that the trust story has been greatly exaggerated.

In fact, what’s known as “guanxi”— interpersonal connections and clan-based relationships among businesspeople—is increasingly associated in China itself with corrupt business practices, such as collusion or bid-fixing. Many Chinese businesspeople, particularly entrepreneurs in sectors like IT and private investors, see “guanxi” declining as market transparency improves and the judiciary becomes more professional. 

This type of insight is not something one can uncover by analyzing data at a desk. It’s a key reason the anthropological perspective is equally as important as quantitative analysis. 

I think the most relevant CG research topic for emerging markets now is… 

….understanding more about this interplay between corporate governance, legal systems, financial markets, economic development, and company performance. It is a core issue, because on the one hand, we are keen to see corporate governance standards adopted. Compliance with corporate governance standards should increase investor confidence, which in turn helps to deepen financial markets. On the other hand, I’m not convinced that complying with the specifics of a corporate governance code means that your company will be better run. 

Following the enactment of Slovenia’s corporate governance code for listed companies in 2004, which included a comply-with-the-rule-or-explain-why-you-did-not component, few companies chose the latter option. The same thing happened in the UK. Interestingly, though, it turns out that “non-standard compliance” – departing from the code but explaining why – is often associated with high performance by firms. The point here is that firms and investors alike need to avoid a one- size-fits-all approach to corporate governance. Sometimes, the codes themselves create conditions that promote this one-size-fits-all approach, particularly if companies opt for straight compliance with the rules. 

For emerging markets, the corporate governance focus should be on... 

… having more faith in the rule of law. Unfortunately, it’s not something that happens overnight. Building effective institutions is time consuming and expensive, as Elinor Ostrom’s work shows. Sequencing is also important. If you have a non-functional or underdeveloped state, as in many low income countries, simply focusing on the rule of law would be premature. You need to build state capacity first. 

As economies grow, the government has to understand the limits to its powers, so that it doesn’t over-regulate or create otherwise difficult business conditions. And everyone needs to embrace the value of following the rules. Middle income countries are in a good position to transition to the rule of law. 

Let’s look at the China example again. Despite extraordinary growth, development is unbalanced and the fruits of growth are unevenly shared. This is fuelling social discontent. Those who have reaped the rewards of growth are keen to hold on to their power. Can the elites be persuaded that giving up some of their power and buying into the idea of the rule of law, will help stabilize Chinese society and ultimately preserve its distinctive model, which has taken hundreds of millions out of poverty in the past three decades? This is a critical question for China and for the world.

For further reading, Professor Deakin recommends: 

Arcot, Sridhar; Bruno, Valentina; Faure-Grimaud, Antoine. "Corporate Governance in the UK: Is the Comply or Explain Approach Working?" International Review of Law and Economics, July 2009. 

Cankar, Nina K.; Deakin, Simon; Simoneti, Marko. “The Reflexive Properties of Corporate Governance Codes: The Reception of the ‘Comply-or-explain’ Approach in Slovenia.” Journal of Law and Society, Volume 37, Issue 3, August 2010. 

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