1.2 Historical development and evolution of corporate governance

Corporate governance has evolved significantly since the early 20th century. It began with the separation of ownership and control in modern corporations, leading to the need for mechanisms to protect shareholder interests and oversee management.

Key events like financial crises and corporate scandals have shaped governance practices. These led to reforms such as the Securities Act of 1933, Sarbanes-Oxley Act, and Dodd-Frank Act, establishing stricter oversight and accountability in corporate management.

Corporate Governance Origins and Development

Early Foundations and Theoretical Underpinnings

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• Corporate governance emerged in early 20th century due to separation of ownership and control in modern corporations
• Adam Smith articulated principal-agent problem in 1776 formed theoretical foundation for corporate governance
• Limited liability companies in 19th century necessitated governance structures to protect shareholder interests
  • Shareholders could invest without risking personal assets
  • Required mechanisms to oversee management and protect investor interests
• Great Depression of 1930s prompted increased government regulation of corporations and financial markets
  • Led to creation of Securities and Exchange Commission (SEC) in United States
  • Established oversight and enforcement mechanisms for public companies

Evolving Perspectives on Corporate Purpose

• 1970s witnessed shift towards shareholder primacy
  • Emphasized maximizing shareholder value as primary corporate goal
  • Influenced by economists like Milton Friedman
• Institutional investors rose to prominence in 1980s and 1990s
  • Brought new pressures for improved corporate governance and accountability
  • Large pension funds and mutual funds wielded significant influence
• 21st century marked shift towards stakeholder-oriented governance models
  • Recognized interests of employees, customers, and communities alongside shareholders
  • Reflected growing awareness of corporate social responsibility and sustainability

Shaping Events in Corporate Governance

Financial Crises and Corporate Failures

• Stock market crash of 1929 exposed weaknesses in corporate oversight
  • Led to passage of Securities Act of 1933 and Securities Exchange Act of 1934
  • Established framework for modern securities regulation
• Penn Central bankruptcy in 1970 highlighted need for improved financial reporting and audit practices
  • Largest corporate failure in U.S. history at the time
  • Revealed inadequacies in financial disclosure and auditor independence
• Savings and loan crisis of 1980s and 1990s revealed systemic weaknesses in financial regulation
  • Resulted in failure of numerous savings and loan associations
  • Prompted reforms in banking regulation and oversight
• Asian financial crisis of 1997-1998 exposed governance weaknesses in emerging markets
  • Led to reforms across the region (South Korea, Indonesia, Thailand)
  • Emphasized importance of transparency and minority shareholder protection

High-Profile Corporate Scandals

• Collapse of Barings Bank in 1995 emphasized importance of internal controls and risk management
  • Caused by unauthorized trading activities of a single employee
  • Highlighted need for robust risk management systems and oversight
• Enron scandal of 2001 and subsequent corporate failures led to sweeping reforms
  • WorldCom and Tyco scandals followed shortly after
  • Exposed widespread accounting fraud and executive misconduct
  • Resulted in passage of Sarbanes-Oxley Act in 2002
• Global financial crisis of 2008 revealed systemic failures in risk management and oversight
  • Collapse of Lehman Brothers and bailout of numerous financial institutions
  • Prompted further governance reforms and increased regulation of financial sector

Reforms for Improved Governance

Legislative and Regulatory Responses

• Securities Act of 1933 and Securities Exchange Act of 1934 established foundation for modern securities regulation
  • Required registration of securities and periodic financial disclosures
  • Created SEC to oversee and enforce securities laws
• Foreign Corrupt Practices Act of 1977 addressed bribery and corruption in international business
  • Prohibited U.S. companies from bribing foreign officials
  • Required maintenance of accurate books and records
• Sarbanes-Oxley Act of 2002 mandated stricter financial reporting standards and internal controls
  • Established Public Company Accounting Oversight Board (PCAOB)
  • Required CEO and CFO certification of financial statements
  • Imposed criminal penalties for securities fraud
• Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 introduced sweeping financial reforms
  • Created Financial Stability Oversight Council to monitor systemic risks
  • Established Consumer Financial Protection Bureau
  • Introduced new regulations for derivatives and credit rating agencies

Corporate Governance Best Practices and Guidelines

• Cadbury Report of 1992 in UK introduced "comply or explain" approach to corporate governance
  • Influenced governance codes worldwide (Germany, Japan, Australia)
  • Emphasized role of independent directors and audit committees
• Introduction of "say on pay" provisions empowered shareholders to vote on executive compensation
  • Adopted in various countries (United States, United Kingdom, Australia)
  • Aimed to address concerns over excessive executive pay
• Development of stewardship codes improved engagement between institutional investors and companies
  • UK Stewardship Code of 2010 set global standard
  • Encouraged active ownership and responsible investment practices

Globalization's Impact on Governance

Convergence and Challenges in Global Governance

• Globalization led to convergence of corporate governance practices across countries and legal systems
  • Adoption of similar governance structures (board committees, independent directors)
  • Increased focus on shareholder rights and transparency
• Multinational corporations faced challenges in applying consistent governance standards
  • Navigating diverse cultural and regulatory environments (China, India, Brazil)
  • Balancing local practices with global standards
• International organizations developed global principles of corporate governance
  • OECD Principles of Corporate Governance (first published 1999, revised 2004 and 2015)
  • World Bank and International Monetary Fund governance guidelines

Global Capital Markets and Emerging Economies

• Growth of global capital markets increased pressure for improved transparency and disclosure
  • Companies seeking international listings adopted higher governance standards
  • Cross-border investors demanded comparable governance practices
• Cross-border mergers and acquisitions necessitated harmonization of governance practices
  • Increased focus on due diligence in international transactions
  • Alignment of governance structures post-merger (Daimler-Chrysler merger)
• Emerging markets adopted and adapted governance practices from developed economies
  • BRICS countries (Brazil, Russia, India, China, South Africa) implemented governance reforms
  • Contributed unique perspectives to global governance standards (state ownership models)

Technology and New Governance Challenges

• Digital transformation introduced new governance challenges
  • Data privacy concerns (Facebook-Cambridge Analytica scandal)
  • Cybersecurity risks (Equifax data breach)
  • Protection of intellectual property in global context
• Rise of technology companies created unique governance issues
  • Dual-class share structures (Google, Facebook)
  • Rapid scaling and disruption of traditional industries (Uber, Airbnb)
  • Balancing innovation with regulatory compliance