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Corporate Governance and Economic

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Dennis C. Mueller
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 International Review of Applied Economics,
Vol. 20, No. 5, 623–643, December 2006

Corporate Governance and Economic Performance

DENNIS C. MUELLER
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University of Vienna
International
10.1080/02692170601005598
CIRA_A_200454.sgm
0269-2171
Original
Taylor
502006
20
Dennis.Mueller@univie.ac.at
DennisMueller
00000December
and
& Article
Francis
(print)/1465-3486
Francis
Review2006
Ltd
of Applied
(online)
Economics

ABSTRACT What is the best corporate governance system? Is the Germanic corporate
governance system the best? The Japanese? The Anglo-Saxon? This article reviews some of
the relevant literature for answering this question. Particular attention is devoted to corpo-
rate governance problems in developing countries. It emphasizes that the nature of problems
that corporate governance systems must deal with can be expected to vary with the state of
development of a country. Central to any discussion of corporate governance is the question
of how well a particular set of institutions mitigates the various principal/agent problems
that arise in a firm. The article thus reviews the basic principal/agent problem and discusses
its relevance for countries in different stages of development. It examines the advantages and
disadvantages of each type of corporate governance system in mitigating principal/agent
problems, and reviews the relevant empirical evidence for assessing their performance.

KEY WORDS: Corporate governance; principal/agent; developing countries.

JEL CLASSIFICATION: L21, K22

Introduction
Over the last 25 years the term ‘corporate governance’ has entered vocabulary of
both students and practitioners of business. The focus was naturally enough on
corporate governance systems in highly developed countries. Is the Germanic
corporate governance system best ? The Japanese? The Anglo-Saxon? More
recently, however, attention has also been devoted to corporate governance insti-
tutions in developing and transition countries.1 This paper examines some of the
issues that arise concerning different corporate governance systems. In particular,
we shall emphasize that the nature of problems that corporate governance systems
must deal with can be expected to vary with the state of development of a country.
Central to any discussion of corporate governance is the question of how well a
particular set of institutions mitigates the various principal/agent problems that
arise in a firm. We thus begin by reviewing the basic principal/agent problem and
then go on to discuss its relevance for countries in different stages of development.
We then examine the advantages and disadvantages of each type of corporate gover-
nance system in mitigating these principal/agent problems, and review the relevant

Correspondence Address: Dennis Mueller, University of Vienna, Brünner Strasse 72, A-1210 Vienna,
Austria. Email: Dennis.Mueller@ univie.ac.at

ISSN 0269-2171 print; ISSN 1465-3486 online/06/050623-21 © 2006 Taylor & Francis
DOI: 10.1080/02692170601005598
 624 D. Mueller

empirical evidence for assessing their performance. The paper closes with a discus-
sion of the relative merits of the different forms of corporate governance systems.

Agency Problems and Agency Costs

The Problem
In the neoclassical theory of the firm, managers are assumed to maximize profits
or shareholder wealth. Implicitly the theory assumes that the manager is also the
sole owner of the firm, and that she is only interested in profits. In a classic paper,
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Jensen & Meckling (1976) showed that even under the assumption that the manager
owns all of the firm’s shares, she is unlikely to maximize the value of the firm, if
she maximizes her utility and she gets some utility from on-the-job-consumption.
Although a Fiat might suffice as a company car, if the firm is successful enough so
that the owner-manager can afford an Alfa Romeo as her private car, she can afford
also to sacrifice some of the profits and value of the firm to have an Alfa Romeo as
the company car. A utility-maximizing owner-manager will sacrifice some of her
wealth as owner for some on-the-job-consumption as manager.
The incentive to sacrifice shareholder wealth increases, if the manager sells some
of the firm’s shares. Where each euro of on-the-job-consumption costs an owner-
manager one euro in wealth as the owner when she owns all of the company, each
dollar of on-the-job-consumption costs her only ten cents in wealth as a share-
holder, when she owns only 10% of the company’s shares. At the time when an
owner-manager chooses to issue shares to outsiders, on-the-job-consumption
becomes cheaper, and the manager can be expected to engage in more of it. We
now have the classical principal/agent problem.
If the capital market is efficient, then potential shareholders will recognize that
a manager who owns only 5% of a company’s shares has a greater incentive to
engage in on-the-job-consumption than does a manager owning 100% of the
shares. Rational expectations on the part of potential shareholders at the time of an
initial public offering will lead them to discount the potential value of the shares
in recognition of the greater levels of on-the-job-consumption in which the manag-
ers are likely to engage. The fall in the value of the firm from the value it would
have, if the managers engaged in no additional on-the-job-consumption, measures
the agency costs of the principal/agent problem that is created at the time when an
owner-manager chooses to issue some shares to outsiders.
Under the assumption of rational expectations on the part of potential share-
holders, the value of a share of the firm falls at the time a sale of shares is
announced by the full amount of the additional on-the-job-consumption that will
occur. This fall in price occurs prior to the sale of any shares. Thus, the owner-
manager bears all of the agency costs of the additional on-the-job-consumption
(Jensen & Meckling, 1976). This gives the owner-manager a strong incentive to
minimize these agency costs, by somehow bonding herself not to engage in addi-
tional on-the-job-consumption. Corporate governance institutions can play a role
in reducing these agency costs.

The Nature of the Costs

In their analysis of the principal/agent problem, Jensen and Meckling model
the manager as choosing a vector of inputs for the firm. The conflict between the
 Corporate Governance and Economic Performance 625

principal/stockholder and his agent/manager takes the form of the manager’s

purchasing some elements in the vector of inputs in excess of the amounts that
would maximize the value of the firm’s shares. What are these inputs and what is
the effect on the welfare of the shareholders and of society as a whole?

Theft of the company’s assets The most obvious way in which managers can harm
shareholders is by stealing some of the company’s assets. During the 19th century,
the main goal of corporate governance institutions was to prevent this kind of
theft (Shleifer & Vishny, 1997). Berle & Means (1968) were also primarily
concerned about their celebrated separation of ownership and control leading to
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corporate theft by the managers. Many examples of such thefts were discovered
during the early 1930s in the aftermath of the Great Crash, just as the Enron and
WorldCom scandals in part involved corporate thefts in the form of large loans to
managers at negligible interest rates. The Parmalat scandal in Italy was of a similar
nature.

Excessive managerial compensation The first form of theft involves taking of assets
of the company like bank balances. The second form involves stealing some of the
cash flows of the company through excessive compensation packages. While the
first form of theft is obvious once disclosed, and usually implies that the managers
have committed a crime punishable by jail sentences, compensation packages are
agreed to by the boards of directors, and are sometimes approved by the share-
holders. Although they may be excessive, they are not illegal, and even whether
they are excessive or not is in part a matter of subjective judgement. Nevertheless,
the general impression in both the popular press and in academic circles is that
managerial incomes in the USA, at least, increased during the 1990s by far more
than could be accounted for by increases in managerial productivity.
Bebchuk & Grinstein (2005), for example, first use 1993 data to estimate the rela-
tionship between managerial compensation and various measures of firm size and
economic performance. They then use the estimates from this equation to predict
managerial compensation in 2003 and compare their predictions with the actual
figures. They found that CEO incomes were 215% higher than predicted by the
1993 estimates, the top five officers’ compensation was 179% higher. In 2004,
the ratio of CEO compensation to average employee compensation was 531:1 in
the USA. The comparable figures in other countries were 21:1 in Canada, 16:1 in
France, 11:1 in Germany, 10:1 in Japan, and 25:1 in the UK.2 Somehow it is difficult
to imagine that managers are so much more productive in the USA than in other
countries, particularly when one compares the performances of companies like
General Motors and Ford with BMW and Toyota.3

Manipulation of earnings An important cause of the dramatic increase in manage-

rial earnings during the 1990s was the booming stock market. Rising share prices
encouraged managers to request generous stock options and boards of directors
complied. These stock options did not substitute for cash payments, but rather were
added on to them (Bebchuk & Grinstein, 2005, pp. 289–295). The result was both a
significant increase in total managerial earnings and in the fraction of earnings
stemming from the exercise of stock options (Bebchuk & Grinstein, 2005, pp. 289–
295; Coffee, 2005, p. 202).
Stock options are valuable only if share prices rise. Share price increases are tied
to earnings increases. Thus, the growth in importance of stock options during the
 626 D. Mueller

1990s gave managers a strong incentive to increase the reported earnings of their
companies. To the extent that this led managers to take actions that produced real
increases in earnings, as for example spinning off unrelated and poor-performing
divisions, this incentive effect of stock options benefited shareholders and might
justify them, but the stock options also gave managers an incentive to manipulate
their reported earnings to keep them in line with the annalists’ expectations.
Declines in earnings were to be avoided at all costs. Thus, the growth in stock
options led managers to engage in creative accounting during the 1990s usually
taking the form of shifting future earnings forward. The wave of earnings restate-
ments that opened the 21st century is a consequence of the earnings manipulations
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of the 1990s, which in turn were a consequence of the incentives introduced by the
generous use of stock options.

The consumption of perks One reason for managers to favor stock options as a
source of income is that they are less conspicuous to shareholders. The value of the
option cannot be accurately judged at the time it is granted and when it is exercised
shareholders may not be cognizant of the option’s cost to them. Corporate perks
are another way in which managers can benefit at their shareholders’ expense
without the shareholders knowing about it. Heavily subsidized lunches in the
executive dining room are likely to appear as miscellaneous expenses on a
company’s income statement. Company jets have proven to be a particularly
popular form of corporate perk.

Empire building There are several reasons to expect that managers may wish to
pursue growth in excess of the rate, which would be optimal for the shareholders
(Marris, 1964, 1998). First of all, managerial salaries are directly related to the size
of a company. Indeed, company size, not profitability, is the best predictor of mana-
gerial compensation.4 Growth through mergers may also be a way in which manag-
ers can use accounting tricks to artificially inflate earnings. Equally, if not more
important than the pecuniary incentives to pursue growth, are the non-pecuniary,
psychological rewards from managing a giant firm. Managers of small companies,
however profitable, seldom get their picture on the cover of leading business maga-
zines or appear on CNN.
The conflict of interest between managers and their shareholders over a
company’s growth rate is likely to be most severe for mature companies with
limited, internal investment opportunities. Young firms with attractive investment
opportunities should and can grow fast without harming their shareholders. Their
managers can fulfill their desires for growth and maximize their shareholders’
wealth at the same time. The optimal rate of growth for a mature company could
even be negative, however, and is quite likely to be less than its managers would
like to see. Empire building and maintaining are most likely to come at the share-
holders’ expense with large, mature companies.5

The Magnitudes of the Costs

It is difficult to assess the relative magnitudes of the various losses that might be
imposed on the owners of companies because of agency problems. A major part of
this difficulty arises, of course, because managers wish to conceal these losses from
the owners, but it is also difficult to determine what the optimal amounts of
compensation, perks and investment should be.
 Corporate Governance and Economic Performance 627

Bebchuk & Grinstein (2005, p. 284) estimate the cumulative compensation of the
top five managers in public US companies between 1993 and 2003 to be US$350
billion – 6.6% of the aggregate net income of these companies. Over the 2001–2003
period, top-five managerial compensation amounted to 9.8% of aggregate net
income. As noted above, the ratio of CEO compensation to average employee
compensation was 531:1 in the USA toward the end of this period. Let us suppose
that the average compensation of the top-five executives was 400:1. If the appro-
priate compensation of these executives should have been relatively the same as
for CEOs in UK, then this ratio should have been 25:1. Top managers in the USA
were paid eight times what they should have been paid. Instead of receiving
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US$350 billion in aggregate, they should have received US$43.75 billion. Managers
of public US companies were able to transfer over US$300 billion from their share-
holders to themselves over an 11-year period.
Mueller & Reardon (1993) estimated marginal qs for a sample of 698 large US
corporations over the period 1970–1988. Their marginal qs are estimates of the
ratios of the return on a company’s investment to its cost of capital and should be
equal to or slightly greater than 1.0. Eight of 10 US companies had an average
marginal q of less than one over this period, however, with the median marginal q
estimate being 0.71. A marginal q of 0.71 implies that each dollar of investment
creates 71 cents worth of physical and intangible capital with the remaining
29 cents being effectively thrown away. Mueller & Reardon (1993) estimated that
the 698 corporations in their sample threw away roughly US$1000 billion over the
period 1970–1988 by investing in projects with returns less than their cost of capi-
tal. General Motors alone squandered US$150 billion on bad investments.
To these sums need to be added the amounts of money simple stolen by manag-
ers, the excessive amounts spent on perks and perhaps some of the losses imposed
on shareholders through the restatements of earnings as a result of earlier account-
ing irregularities. One study by the US General Accounting Office estimates a loss
in market value for firms, which restated their earnings over the 1997–2002 period,
totalling US$100 billion (GAO, 2002, p. 5). To the extent that earnings were over-
stated prior to the restatements, they did not actually destroy real wealth, but
rather destroyed wealth that would never have existed had earnings always been
honestly reported.
These estimates of the losses to shareholders as a result of agency problems are
huge, and obviously suggest that shareholders and even all of society might bene-
fit greatly from reducing the scale of these agency problems. We turn now to a
discussion of how the different types of corporate governance systems deal with
these problems.

Agency Costs and Corporate Governance

The Underlying Logic
The assumption rational expectations on the part of the capital market implies
that the capital anticipates that a manager will consume more perks, pay herself a
higher salary, issue more stock options to herself, and so on, after she sells shares
in her company. The rational expectations assumption further implies that the
price of the shares falls immediately upon the announcement of an equity sale to
reflect the expected loss, and all of the agency costs fall on the owner-manager.
Two further implications follow. First, the owner-manager has an incentive not to
 628 D. Mueller

issue equity to finance investment, because all of the agency costs arising from its
sale fall upon her. Second, if she does decide to issue equity, perhaps because her
firm has particularly attractive investment opportunities, she has an incentive to
try to minimize the agency costs by somehow bonding herself not to undertake
self-serving actions that harm the shareholders.
It follows from the first implication that a company, which is located in a country
with strong corporate governance institutions, which offer shareholders consider-
able protection against the opportunistic behavior of managers, should suffer a
smaller fall in share price when it announces that it will sell shares to finance
investments than a company in a country with weak corporate governance insti-
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tutions. Thus, both the supply and the demand curves for new equity should shift
to the right in countries with strong corporate governance institutions. Ceteris pari-
bus more companies in countries with strong corporate governance systems will
find selling equity to be an attractive way to raise funds for investment, equity
markets should be thicker and shareholdings more dispersed. These are the char-
acteristics that one associates with the so-called Anglo-Saxon corporate gover-
nance systems.
In contrast, in countries with weak shareholder protection, one anticipates thin
equity markets and concentrated ownership structures. Individuals are reluctant
to risk their money in companies, when a country’s corporate governance institu-
tions provide them little protection against managers. The original founders of
companies protect themselves by retaining large equity stakes in their companies,
when they choose to turn over control to professional managers. These character-
istics are generally associated with continental European countries.
Yet a third kind of corporate governance system can be identified, which we
shall refer to as the Japanese system, since Japan is the leading example of it. In
Japan, shareholdings are widely dispersed as in Anglo-Saxon countries, but a
company’s shares are often not held by individuals or institutional investors who
have no relationship to the company, but rather by other firms, which form part of
a group of companies called a keiretsu. Prior to the Second World War, Japan might
have been characterized as a European-style insider system with families control-
ling vast corporate empires called zaibatsu, which resembled some of the pyrami-
dal empires found in continental Europe. Immediately after the Second World
War, the occupying Americans separated the controlling families of the zaibatsu
from their empires. The empires did not disappear, however, but rather reconsti-
tuted themselves with control of companies within a group in the hands of other
firms in the group. Although Japan is in many ways a special case, corporate struc-
tures similar to the zaibatsu, if not the keiretsu, can be found in Brazil, India, Italy,
Korea, Russia, South Africa (Kantor, 1998), and Turkey (Yurtoglu, 2000).

Agency Problems in Anglo-Saxon Systems

The Anglo-Saxon corporate governance system is often referred to as an ‘outsider’
system, because control is supposed to be in the hands of owners of the firm who
are outside of it in that they hold neither positions in management nor on the
board of directors. Berle & Means (1968) highlighted the fact that effective control
in such a system is likely to rest with the managers, because the outside share-
holders with their small stakes in the company do not have sufficient incentives
and power to monitor and constrain managers effectively. Hypothetically, outsid-
ers can exercise control over managers in four ways: (1) through a proxy contest in
 Corporate Governance and Economic Performance 629

which an alternative slate of candidates for the chief executive officers of the firm
is proposed and elected, (2) through a board of directors selected by the share-
holders, (3) through a hostile takeover in which control is secured through the
purchase of a majority of a firm’s outstanding shares, and ultimately (4) through
the courts should managers commit acts that violate their fiduciary duties to their
shareholders.
Each of these outside constraints can be costly to exercise, however, thus leaving
managers with considerable discretion to pursue their own goals. How effective
they are at controlling managers is likely to depend on the particular set of legal
and regulatory institutions in a country. For example, during the 1980s numerous
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hostile mergers took place in the USA for the expressed purpose of replacing
company managers who were not perceived to be acting in their shareholders’
interests. The results were an increased interest on the part of managers in ‘share-
holder value’ and the like, but also and intensive and highly successful lobbying
effort with state legislatures to make hostile takeovers more difficult.6

Agency Problems in Continental European Systems

With a large blockholder, managers have less discretion to enrich themselves at
their shareholders expense. Accordingly, managerial compensation is much lower
in continental Europe than in the USA. This does not imply that agency problems
disappear in the presence of large blockholders, they simply take on a different
form. The conflict is now between the large blockholder and minority sharehold-
ers. Where managers of companies in Anglo-Saxon countries can enrich them-
selves legally through lucrative compensation contracts, large blockholders must
find ways to transfer resources to themselves from the company or companies they
control. Often, as in the case of Parmalat, this involves an illegal theft of assets
(Coffee, 2005). Morck et al. (2005) describe the many ways in which large block-
holders can enrich themselves at the minority shareholders’ expense. Nenova
(2003) and Dyck & Zingales (2004) show that the private benefits from control can
be quite substantial.
A particularly serious agency problem in continental European countries is
likely to be the excessive pursuit of corporate growth. In response to the question
of whether (1) a company exists for the interest of all stakeholders, or (2) share-
holder interest should be given the first priority, 83% of senior corporate managers
surveyed in Germany, and 78% in France chose the interests of all stakeholders. The
corresponding figures for the UK and USA were 29 and 24%.7 As Mark Roe (2000)
has argued, these differences reflect differences in political ideology between conti-
nental Europe and the USA and the UK. France, Germany and other continental
European countries are characterized by a left-of-center, social-democratic ideol-
ogy that puts the preservation of jobs ahead of stockholders’ interests. In effect, the
entire workforce behaves as growth maximizers wishing to see their company
invest and reinvest to preserve jobs, even when the returns on these investments
are low. Vote-maximizing politicians espouse the goals of the workers.
Even though individual companies are pursuing growth in excess, the effect of
their investment policies on macroeconomic growth can be negative because of the
resulting misallocation of capital across the economy. The large pyramidal struc-
tures that arise in countries with weak corporate governance systems and large
blockholders can also lead to misallocations of capital and slower economic
growth. Morck et al. (2000) present evidence that this occurs.
 630 D. Mueller

Agency Problems in Japan

In Japan, 97% of the senior managers poled stated that their firms should pursue the
interests of all stakeholders.8 The corporate culture in Japan with its emphasis on
life-time employment, the steady advancement of managers up through the corpo-
rate hierarchy and so on makes Japanese managers growth maximizers par excel-
lence (Odagiri, 1981, 1994). The managers of group firms are free to pursue growth
and ignore their shareholders, because substantial fractions of their shares are held
by other group firms (Hoshi & Kashyap, 2001, p. 126). These cross-shareholdings
by group firms explain why hostile takeovers are so rare in Japan, and why there-
fore this constraint on managers is lacking despite the fact that shareholdings are
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widely dispersed by European standards. Should the possibility of a hostile take-

over arise, managers of group firms side with their colleagues and vote against the
takeover.9
Just as politics in continental Europe tends to favor large companies in mature
industries, politics in Japan in the form of industrial policy has favored large,
declining industries (Beason & Weinstein, 1996).

Evidence of Performance Differences

La Porta et al. (1997, 1998) have examined the content and historical development
of legal institutions in different countries to determine which ones best align share-
holder and managerial interests. They have concluded that the common law
systems found in the Anglo-Saxon countries and former British colonies offer
outside and minority shareholders greater protection against managerial abuse of
their authority than do civil law systems. Within the civil law systems, La Porta
et al. differentiate between the system in the Scandinavian countries, and in those
whose legal systems have a German or French origin. La Porta et al. claim that the
Scandinavian system offers shareholders the best protection among the three civil
law systems, while the French system provides shareholders the least protection
among the three.

Country-Specific Empirical Evidence

In Table 1 a large group of countries are listed according to the legal classifications
of La Porta et al. (1997, p. 1138). Differences in views concerning the desirability of
paying dividends lie at the heart of the conflict between managers and sharehold-
ers. Column 3 presents mean dividend payout ratios for each country for which La
Porta et al. (2000) report figures. The pattern of dividend payouts across countries
corresponds to the prediction that strong legal protection for shareholders leads to
higher dividend payouts.10
Although disagreements over dividend payments lie at the heart of the conflict
between managers and shareholders over the use of company cash flows, they are
an imperfect signal of whether managers are maximizing shareholder wealth. For
a company with attractive investment opportunities, the optimal dividend payout
ratio from the point of view of a shareholder can be zero. Estimates of marginal q,
the ratio of a company’s returns on investment to its cost of capital, are thus more
accurately measures of the quality of the managers’ investment decisions. Column
4 of Table 1 presents these estimates for the countries for which Gugler et al. (2004)
had data for the period 1985–2000. In many of the developing countries data were
 Corporate Governance and Economic Performance 631

Table 1. Differences across countries in legal systems and various economic

statistics
Dividend External
No. of pay-out (% Return capital/ Domestic IPOs/ GDP
Country firms sales) qm=r/i on equity GDP firms/Pop Pop growth

Australia 346 0.048 0.94 0.082 0.49 63.55 – 3.06

Bermuda 215 0.046 0.91 – – – – –
Canada 1478 0.027 1.16 0.097 0.39 40.86 4.93 3.36
Cayman Islands 42 – 0.58 – – – – –
Great Britain 1331 0.035 0.85 0.129 1.00 35.68 2.01 2.27
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Hong Kong 127 0.113 0.78 0.177 1.18 88.16 5.16 7.57
India 246 0.022 0.80 0.122 0.31 7.79 1.24 4.34
Ireland 63 0.017 1.10 0.138 0.27 20.00 0.75 4.25
Israel 56 0.008 1.27 – 0.25 127.60 1.80 4.39
Kenya – 0.053 – – – 2.24 – 4.79
Malaysia 381 0.039 0.86 0.021 1.48 25.15 2.89 6.90
New Zealand 66 0.040 0.86 0.059 0.28 69.00 0.66 1.67
Nigeria – – – 0.059 0.27 1.68 – 3.43
Pakistan 46 0.021 0.40 0.116 0.18 5.88 – 5.50
Singapore 208 0.034 0.97 0.123 1.18 80.00 5.67 1.68
South Africa 118 – 1.07 0.146 1.45 16.00 0.05 7.48
Sri Lanka – – – 0.002 0.11 11.94 0.11 4.04
Thailand 243 0.037 0.64 0.079 0.56 6.70 0.56 7.70
United States 8591 0.026 1.05 0.118 0.58 30.11 3.11 2.74
English-origin – 0.038 1.02 0.098 0.60 35.45 2.23 4.30
average
Denmark 101 0.014 0.65 0.138 0.21 50.40 1.80 2.09
Finland 79 0.015 0.96 0.088 0.25 13.00 0.60 2.40
Norway 103 0.018 1.04 0.123 0.22 33.00 4.50 3.43
Sweden 156 0.019 0.65 0.152 0.51 12.66 1.66 1.79
Scandinavian – 0.017 0.78 0.125 0.30 27.26 2.14 2.42
average
Austria 82 0.031 0.71 0.105 0.06 13.87 0.25 2.74
Germany 425 0.015 0.57 0.117 0.13 5.14 0.08 2.60
Switzerland 160 0.022 0.64 0.136 0.62 33.85 – 1.18
European- – 0.023 0.64 0.119 0.27 17.62 0.16 2.17
Germanic-
origin average
Japan 2219 0.007 0.86 0.126 0.62 17.78 0.26 4.13
South Korea 82 0.006 0.70 0.064 0.44 15.88 0.02 9.52
Taiwan 126 0.016 1.26 0.179 0.88 14.22 0.00 11.56
Asian-Germanic- – 0.010 0.94 0.123 0.65 15.96 0.09 8.40
origin average
Germanic-origin – 0.016 0.74 0.121 0.46 16.79 0.12 5.29
average
Argentina 24 0.027 0.78 0.223 0.07 4.58 0.20 1.40
Belgium 79 0.026 0.51 0.114 0.17 15.50 0.30 2.46
Brazil 133 0.013 0.25 0.103 0.18 3.48 0.00 3.95
Chile 73 0.029 1.24 0.251 0.80 19.92 0.35 3.35
Columbia 15 0.025 0.43 0.283 0.14 3.13 0.05 4.38
Ecuador – – – – – 13.18 0.09 4.55
Eqypt – – – – 0.08 3.48 – 6.13
France 495 0.020 0.57 0.116 0.23 8.05 0.17 2.54
 632 D. Mueller

Table 1. (continued)
Dividend External
No. of pay-out (% Return capital/ Domestic IPOs/ GDP
Country firms sales) qm=r/i on equity GDP firms/Pop Pop growth

Greece 49 0.036 0.54 0.043 0.07 21.60 0.30 2.46

Indonesia 132 0.022 0.84 −0.128 0.15 1.15 0.10 6.38
Italy 150 0.014 0.64 0.067 0.08 3.91 0.31 2.82
Jordan – – – 0.086 – 23.75 – 1.20
Luxembourg 12 0.010 0.70 – – – – –
Mexico 81 0.003 0.50 0.155 0.22 2.28 0.03 3.07
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Netherlands 174 0.034 0.69 0.155 0.52 21.13 0.66 2.55

Netherlands 19 0.014 1.19 – – – – –
Antilles
Panama 4 – 1.25 – – – – –
Peru 20 0.001 0.11 0.207 0.40 9.47 0.13 2.82
Phillippines 83 0.028 1.00 0.226 0.10 2.90 0.27 0.30
Portugal 49 0.010 0.46 0.231 0.08 19.50 0.50 3.52
Spain 117 0.035 0.54 0.098 0.17 9.71 0.07 3.27
Turkey 29 0.026 0.52 0.233 0.18 2.93 0.05 5.05
Uruguay – – – – – 7.00 0.00 1.96
Venezuela 10 0.001 0.58 0.156 0.08 4.28 0.00 2.65
French-origin – 0.020 0.59 0.147 0.21 10.00 0.19 3.18
average

Sources:
Columns 2–4: Global Vantage Database; 1985–1998.
Column 5: Lombardo and Pagano (2000); 1970–1997 for most countries.
Columns 6–9: LaPorta et al. (1997); 1994–96; Col 9: 1960–1992.

available for only a few firms and for the last few years of the sample period. In
column 2 the number of firms used to calculate marginal q is given. When this
number is small, the estimates are not very reliable. As with the figures in column
3, the estimates of marginal q follow the pattern implied by La Porta et al.’s ranking
of legal systems. The estimate of marginal q for the pooled sample of English-
origin countries is 1.02, for the pooled sample of French-origin countries it is only
0.59. Where each dollar invested in an English-origin country produced US$1.02
worth of assets, each dollar invested in a French-origin country created only
59 cents worth of assets. The four Scandinavian and six Germanic countries fall in
between these two extremes. With respect to the countries with Germanic-origin
legal systems, however, a dramatic difference between the three Asian countries
and their three European counterparts can be observed. The average of the
marginal qs for the three Asian countries is 0.94, for the European countries it is
only 0.64, barely above that for the French-origin countries. These differences in
investment performance between the Asian and European members of the
Germanic-origin group may be due to differences within their legal systems that
have emerged over time, or they may reflect differences in investment opportuni-
ties between Asia and Europe. The latter explanation is consistent with the
dramatic differences in growth rates reported in column 9 discussed below.
The figures in column 4 are estimates of the returns on company investments
relative to their costs of capital. They need have no relationship to the returns
shareholders earned on their investments in these countries. Indeed, under the
 Corporate Governance and Economic Performance 633

efficient capital market assumption, no such relationship should exist. Once share-
holders in a country with weak legal protection realize that they are vulnerable to
the opportunistic behavior of managers and large blockholders, they adjust their
willingness to pay for shares accordingly and can be expected to earn the same
returns on their investments as do shareholders in English-origin countries.
Column 5 of Table 1 reports geometric means of returns on equity for the period
1970–1997 for a sample of countries as reported in Lombardo & Pagano (2000). As
can be easily seen, the pattern of returns does not match the ordering of La Porta
et al., quite the contrary, shareholders in the French-origin countries earned the
highest returns on equity, those in English-origin countries earned the lowest
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returns. Lombardo & Pagano (2000) present evidence that the pattern reverses,
however, once one adjusts for risk differences across companies in the different
countries.
Columns 6–8 in Table 1 present evidence taken from La Porta et al. (1997) consis-
tent with the prediction that the equity capital markets will be bigger in countries
with strong corporate governance institutions. Column 6 measures the size of the
external capital market as the ratio of stock market capitalization in a country to its
GDP in 1994. According to the La Porta et al. evaluation of legal systems we should
expect the relative sizes of external capital markets in the four country groups to
be English > Scandinavian > Germanic > French. This ranking appears, if we restrict
our attention to the three European countries with Germanic legal systems. The
average for the six Germanic-origin countries is higher than for the Scandinavian
countries when the three Asian countries with Germanic-origin legal systems are
included. Clearly legal institutions are not the only determinants of the size of the
external capital market.
Column 7 measures the size of the external capital market as the ratio of the
number of domestic firms listed in a country to its population in millions in
1994. Here the numbers correspond to the predicted ranking exactly, and there
are no discernable differences between European and Asian countries in the
Germanic-origin group.
Column 8 measures the size of the external capital market as the ratio of initial
public offerings of equity in a country (IPOs) to its population in millions for the
one-year period beginning in July of 1995. The English-origin and Scandinavian-
legal-system countries both have slightly more than two IPOs for every one
million inhabitants, a figure which is more than 10 times larger than the numbers
of IPOs in the Germanic- and French-origin countries. Thus, all three sets of
comparisons do seem to suggest that English-origin legal systems lead to the larg-
est external capital markets and French- and German-origin systems to the small-
est markets with the Scandinavian countries generally coming closest to the
English-origin group.
Several additional studies have emphasized the importance of legal institutions
as determinants of the size of a country’s external capital markets. Modigliani &
Perotti (1997) develop a model in which legal protections for minority sharehold-
ers influence the size of a country’s equity market, and present some evidence
consistent with their model. Demirgüç-Kunt & Maksimovic (1998) present
evidence linking the efficiency of a country’s legal system to size of its external
capital markets, where efficiency is measured using several indexes of the ease
with which suppliers of credit can write and enforce debt contracts. Beck et al.
(2003, 2005) relate the origins of country legal systems to levels of financial devel-
opment in countries and the obstacles companies face in financing investments.
 634 D. Mueller

Rajan & Zingales (1998) also present evidence that thin external capital markets
make it difficult for firms with attractive investment opportunities to raise the
funds required to invest optimally. Industries that require large amounts of capi-
tal, like drugs and pharmaceuticals, develop relatively more rapidly in countries
with larger external capital markets. More generally, Levine & Zervos (1998) and
Beck et al. (2000) have established a positive relationship between the size of a
country’s equity market and its rate of economic growth.
If legal institutions affect the size of a country’s external capital markets, and the
size of a country’s external capital markets affects its growth rate, then there should
be a relationship between the characteristics of a country’s legal system and its rate
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of economic growth. Column 10 of Table 1 suggests that such a relationship exists,

once one takes into account the significant differences between the European and
Asian members of the Germanic-origin group. The three Asian, Germanic-origin
countries have the highest average growth rates in GDP per capita over the 1970–
1993 period. They are followed in order by the English-origin, Scandinavian,
French-origin and last of all the three European countries with Germanic legal
systems. French-origin and, at least within Europe, German-origin countries have
the slowest growth rates, English-origin and Scandinavian countries the fastest
growth rates.
Paul Mahoney (2001) has confirmed the importance of legal institutions in
explaining country growth rates using growth equations that control for other
variables as for example initial level of GNP. Mahoney restricts his attention to the
common law–civil law distinction. Holding other variables constant, countries
with civil law legal institutions grew more slowly over the 1960–1992 period than
did countries with common law systems. Mahoney argues that it is not the protec-
tion that common law systems afford to stockholders that explains their superior
economic performance in terms of things like growth, but rather the protection
they offer to the citizens of these countries. By providing stronger protection of
property rights, common law systems protect citizens from the arbitrary expropri-
ations of property that can and do occur in civil law systems. This protection
provides greater incentives to start businesses, enter into contracts, make invest-
ments and the like, and thus leads, according to Mahoney, to greater growth. The
results in Table 1 can also be interpreted as offering support for Mark Roe’s (2000)
prediction that the ideological differences between Europe and the USA, as they
manifest themselves in the politics of the various countries, affect the corporate
governance structures and relative sizes of external capital markets on the two
sides of the Atlantic.

Company-Specific Empirical Evidence

Virtually all of the research on the effects of corporate governance institutions on
performance has been cross-national, not surprisingly. Gompers et al. (2003) have
shown, however, that corporate governance institutions can also affect company
performance within a country. They construct an index of the strength of share-
holder rights and show that shareholders of companies in the highest decile of
shareholder rights earned significantly higher returns on their shares than did
shareholders of companies with weak shareholder rights. Among the institutions
that go into the index are provisions in state laws governing corporate governance,
and provisions in corporate charters governing things like the existence of golden
parachutes and poison pills, voting rules, compensation plans and the like. Thus,
 Corporate Governance and Economic Performance 635

the Gompers et al.’s results point to some firm-specific corporate governance insti-
tutions that affect company performance and could affect their ability to raise capi-
tal in the equity market. Additional evidence demonstrating that individual
company corporate governance institutions can compensate to some extent for
weak national institutions can be found in Klapper & Love (2004) and Durnev &
Kim (2005).

Corporate Governance and Social Welfare in Developed Countries

The figures in Table 1 and the discussion of the previous section lead to the follow-
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ing conclusions. Strong corporate governance institutions, which protect share-

holder interests, lead to higher returns on corporate investment, thicker external
capital markets and faster economic growth. Weak corporate governance institu-
tions do not simply harm shareholders. All of society suffers from poor investment
performance and slow economic growth.
There is something ironic in this conclusion, because the common impression—
at least in continental Europe—is that its corporate governance systems are supe-
rior to Anglo-Saxon systems precisely because they place society’s interests,
captured under the term stakeholders, above shareholders’ interests. In practice,
however, the main stakeholders whose interests are advanced in continental
Europe are those of the workers—who hold existing jobs. The cost of having thou-
sands of euros wasted in bad investments to preserve jobs is not simply that the
money is not paid out in dividends to shareholders. These lost dividends cannot
flow back into the capital market and be used to finance the founding of new firms.
Poor corporate governance plus an emphasis on stakeholders and not sharehold-
ers leads to too much money being retained and reinvested in old industries and
firms, and too little being made available for new firms. In continental Europe jobs
are preserved in old industries at the expense of creating jobs in new ones.

Corporate Governance and Social Welfare in Emerging Markets

In emerging markets many firms have attractive investment opportunities. To
finance their investments companies must choose among the available sources of
capital—internal funds, borrowing from banks and other financial institutions,
issuing bonds, issuing equity and perhaps subsidies from the state. For young
companies with attractive investment opportunities, internal fund flows are often
inadequate and they must turn to external sources of finance. In emerging markets
banks may lack the experience to differentiate between companies with good and
not so good investment opportunities. Bond markets may also be thin, because the
weak laws and weak enforcement of the laws in emerging markets fail to offer
debt holders adequate protection. Thus, equity may be a particularly attractive
source of finance for the kind of high-risk projects that characterize the investment
opportunities of many companies in developing countries. Indeed, given the
possible weaknesses and imperfections in relying on bank financing and the bond
market, equity is likely to be an even more attractive source of funds for firms with
attractive investment opportunities in emerging markets than it is in developed
countries.
Thus, there would appear to be no obvious advantage in not having a thick
equity market in an emerging market. To do so would eliminate one possible
source of investment funds for firms with attractive investment opportunities. If
 636 D. Mueller

then emerging market countries tend to have weak corporate governance institu-
tions, and these in turn lead to thinner equity markets, these countries are likely to
pay a price for their weak corporate governance institutions in the form of less
investment than is optimal, and slower economic growth than would be possible.
This conclusion has been questioned in recent papers by Singh et al. (2005) and
Allen (2005). Singh et al. claim that the Anglo-Saxon model is ill suited to develop-
ing countries and that the state can and should play a lead role in supplying capital
to firms in these countries. They give South Korea as an example of a country
whose development was spurred by state subsidies. Obviously it is possible for the
state to replace or supplement private lenders or equity buyers as a source of
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investment funds and it may play this role well.

The usual economic argument for state intervention assumes the existence of
some sort of market failure, which the state corrects by intervening in the market.
To defend state subsidies to firms one must then assume that the ‘markets’ for
financing the investments of private firms fail to provide needed finance to firms
with attractive investment opportunities, or perhaps fail to take into account posi-
tive externalities from the investments of certain firms or industries. The state
corrects these market failures by choosing which firms and industries should grow
faster as part of a development plan rather than just allowing the capital markets
to make these choices.
While admitting the possibly beneficial role of the state in financing private
investment and stimulating growth and development, one must also recognize
that the state can make bad choices and create soft budget constraints for firms.
Having invested a great deal of money in a company, the state—i.e. the bureau-
crats in the ministry of industry who chose to supply money to this particular firm
in the first place—may feel that they cannot let it go under should it get into trou-
ble. Thus, the state may wind up propping up losers rather than picking winners
with the accompanying inefficiencies.11
Some evidence in favor of the argument that state intervention can improve the
performance of companies is provided by the estimates of marginal q made by
Gugler et al. (2004). They looked for differences in performance across five differ-
ent control categories—individual/family control, control by another firm other
than a financial institution, control by a financial institution (bank or insurance
company), control by the state, and dispersed ownership (no person or institution
owns at least 10% of a company’s shares). Although state-controlled companies in
the three European countries with Germanic legal systems (Austria, Germany and
Switzerland) had the poorest investment performance of any ownership category
(marginal q = 0.37), state-controlled companies in the three Asian countries with
Germanic legal systems (Japan, South Korea and Taiwan) had an estimated
marginal q of 1.32. Because of large standard errors, this estimate was not signifi-
cantly larger than that for the rest of the control categories in the three Asian coun-
tries. Nevertheless, only three of the estimates of marginal q for the 20 ownership
categories in the civil law countries exceeded one. That one of these three was for
the three Asian countries suggests that the state in these countries at least does not
harm and perhaps even improves company performance.
If equity and bond markets are not going to be a major source of finance for
private firms, than either the state or banks must fill this role. The claim is often
made that banks may be better at allocating capital to companies and curtailing
agency problems than the equity and bond markets.12 Gugler et al. (2004) found
little evidence to support this claim. In all of the civil law countries, the estimate of
 Corporate Governance and Economic Performance 637

marginal q for companies controlled by financial institutions was less than one.
Although the estimate of marginal q for companies controlled by financial institu-
tions was significantly greater than the estimate for the four other ownership cate-
gories in the countries with French-origin legal systems, it was still only 0.69 as
against 0.58 for the other ownership categories.
In developing countries, banks are often controlled at least in part by the state.
Thus, in these countries bank loans become a vehicle for carrying out the state’s
plans for economic development. Huang & Xu (1999) present evidence indicating
that the Asian crisis was worsened by soft loans by Asian banks, which again
points to the potential costs of using the state or banks to channel investment
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funds.
Allen’s (2005) critique is not so much of Anglo-Saxon corporate governance
systems, but of the hierarchical corporate structures that one tends to find in these
countries. He favors what Aoki (1990) calls the ‘J-mode’ of corporate structure.
‘The J-mode stresses (i) horizontal coordination among operating units based on
(ii) the sharing of ex post on-site information’ (Allen, 2005, p. 170). It is not clear
why these sorts of organizational structures cannot be adopted by Western compa-
nies, or why they are incompatible with strong shareholder protection. Indeed,
many organizational innovations by Japanese firms have been adopted by West-
ern companies.
There is no question that Toyota is one of the world’s best run and most success-
ful firms. Its organizational innovations have been copied by companies around
the world. What is less clear is whether Toyota owes its success to Japan’s corpo-
rate governance institutions. Were these institutions to strengthen and offer more
protection to shareholders, Toyota would not obviously be adversely affected.
Although there are several Japanese companies like Toyota and Mitsubishi, which
have been outstanding successes, in sectors like pharmaceuticals and chemicals,
where R&D and innovation are of high importance, Japanese companies have not
secured leadership positions in the world. It is not obvious to me that Japan has
necessarily benefited from having weak corporate governance institutions.
Allen (2005, p. 175) cites China as an example for the proposition ‘that ensuring
that emerging economies have efficient legal systems and institutions is neither
necessary nor sufficient for ensuring good economic performance’. Its corporate
governance institutions are weak by any measure, and yet it has managed to
achieve quite spectacular levels of growth over the last quarter of the twentieth
century. Allen et al. (2005) argue that this has been possible, because in China infor-
mal reciprocal relationships and reputations for fair dealing substitute for formal
governance institutions to ensure that contracts are fulfilled and loans are repaid.
Moreover, family firms dominate in China and principal/agent problems do not
arise in these. Chinese companies also rely heavily on internal cash flows to
finance their investments, and thus do not have a great need of large external capi-
tal markets (Allen, 2005, p. 175).
Of course, trust relationships can be a substitute for legal institutions that
enforce contracts and property rights, but they take a long time to develop and lack
the flexibility of well-functioning impersonal markets. Internal funds may not
suffice to fund all of the attractive investment projects small, innovative firms
have, and thus the lack of low-cost external sources of capital may hamper the
growth of these firms. China has benefited greatly from direct foreign investment
from Taiwanese companies, and many of the long-run trust relationships that
Allen et al. emphasize are between Taiwanese and mainland companies. These
 638 D. Mueller

relationships have grown up because the two countries share a language and to
some extent a common culture, and are separated by a small stretch of water.
Taiwanese companies have been willing to make heavy investments on the main-
land, because they needed cheaper sources of labor. Counterparts to Taiwan for
Indonesia, Thailand and Brazil are not easy to identify.
Virtually all firms start out as family firms. The life cycle of the typical family
firm sees it passing into the hands of professional managers at some point in time,
when members of the founding family either do not have the ability or inclination
to manage it. The need for professional managers is often particularly acute for
companies, which need to grow large either to take advantage of economies of
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scale or because the demand for their product is very high. Here the example of
Taiwan is instructive. Its economy is dominated by family firms, and it has been
very successful in industries where large scale is not essential for economic effi-
ciency. Where large scale is needed, as say, in the automobile industry, Taiwanese
firms have been conspicuous by their absence.
When courts are slow and judges are corrupt, enterprising entrepreneurs will
find substitute institutions—like long-run trust and reputation arrangements—to
fill their place. When external capital markets are thin, entrepreneurs will find
other sources of finance. So it has been with China. I think it is hard to make the
case that China’s economic performance has benefited from having weak corpo-
rate governance institutions and thin external capital markets. The costs to China
from these deficiencies are likely to grow over time, as its most successful firms
outstrip their internal sources of capital, and their family firms transform them-
selves into professionally managed companies.

Conclusions
A little more than a decade ago, many students of the business world were
concluding that the German or perhaps the Japanese corporate governance
system was the best. The US system in particular was plagued by managerial
abuses of their positions.13 Estimates of marginal qs for the 1970s and early 1980s
for US companies supported that view (Mueller & Reardon, 1993). The median
estimated marginal q for the USA for this period, 0.71, was very similar to esti-
mates for Austria and Germany for the 1985–2000 period (Gugler et al., 2004). The
estimate of marginal q for the USA for the 1985–2000 period was, however, 1.02—
exactly what one expects if a firm’s managers are maximizing their shareholders’
wealth. Why the dramatic improvement in US performance between the 1970s
and 1990s? Why did the German and Japanese miracles seemingly become
undone?
Following the Second World War, opportunities for investment and growth were
great in war-torn Germany and Japan and in other parts of Europe. Companies in
these countries could invest and grow to benefit both their employees and their
shareholders. Following the Great Depression and the Second World War, there
was also a great, pent-up demand for goods such as automobiles and washing
machines in the USA, so its firms also were able to invest and grow while rewarding
their shareholders. Estimates of marginal qs for large US companies during the
1950s and 1960s exceed 1.0 (Mueller & Yun, 1997).
By the end of the 1960s, the opportunities for profitable internal growth for
many mature companies in the USA had disappeared, and thus they turned to
growth by mergers and the conglomerate merger wave ensued—an event that
 Corporate Governance and Economic Performance 639

destroyed much shareholder wealth.14 The stagnant 1970s only served to heighten
the conflict between shareholders and over-investment and growth policies.
Robin Marris (1964) claimed that the threat of a takeover would act as a check
on managers’ pursuit of growth, and Henry Manne (1965) went so far as to claim
that takeovers eliminated managerial discretion or—as we now call it—the princi-
pal/agent problem. At the time that Marris and Manne wrote, however, hostile
takeovers were rather rare in the USA. Their full potential for disciplining manag-
ers was only realized during the mid 1980s. It was this flurry of hostile merger
activity in the 1980s that led to the downsizing movement, emphasis on core
competencies and shareholder value, and the like that characterized the early
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1990s. It was the hostile mergers of the 1980s that led to the dramatic improve-
ment in investment performance by US firms that we observed over the 1985–2000
period.
As noted above, the second reaction of US managers to hostile takeovers was to
induce state legislatures to pass laws making them more difficult. Hostile take-
overs became much rarer during the 1990s, and it is yet to be seen whether the
good investment performance of US companies over the 1985–2000 period will be
sustained over the long run in the absence of the threat of takeovers. ‘Downsizing’
is not the first word that comes to mind when one looks at the great merger wave
of the late 1990s. Early estimates of the effects of this wave suggest that it resulted
in massive wealth losses to US shareholders.15
Here it is perhaps worth noting the important distinction between hostile take-
overs and friendly mergers. The number of friendly mergers is strongly correlated
with stock market booms. During these booms the constraints on managers seek-
ing to pursue growth weaken, and the proportion of mergers undertaken for
empire building and other reasons not associated with increases in wealth
increases (Gugler et al., 2006). Hostile takeovers, however, are generally driven by
the objective of replacing target managers, and are on average wealth creating.
Hostile takeovers reached a peak during the mid to late 1980s in the USA, but even
then accounted for less than a quarter of all mergers.
Hostile takeovers have been rare in both continental Europe and Japan.16 A
recent effort by the European Union Commission to make hostile takeovers easier
in Europe was thwarted by the governments of Germany and France, presumably
under pressure from managers of large firms in their countries. At the time of this
writing, the European-based, although Indian-led, steel firm, Mittal, has made a
hostile bid for European-based Arcelor. This bid has placed not only the manage-
ment of Arcelor into a state of apoplexy, but also members of the governments of
France, Luxembourg and Spain (Giridharadas, 2006). Unless hostile takeovers
become more common in Europe, they will not be able to exercise their disciplin-
ing role on managers, and continental Europe can be expected to continue to suffer
from poor investment performance and growth.
Companies in developing countries face different investment opportunities than
do companies in the mature, developed countries. Most may have sufficiently
attractive investment opportunities so that no conflict between managers and
shareholders over investment levels arises. Investors will be willing to buy the
shares of companies in emerging markets even without much legal or regulatory
protection, because they expect that the companies’ investments will reap high
returns. This situation seemed to prevail in many Asian countries prior to the crisis
of the late nineties. Estimates of marginal qs for Asian countries prior to the crisis
are almost uniformly above one.17
 640 D. Mueller

The Asian crisis revealed the weaknesses in many of the Asian countries’ corpo-
rate governance systems, however, and most of the estimates that include the
years after the crisis hit fall below one. Several studies have demonstrated that the
adverse effects of the Asian crisis were more severe in countries with weak corpo-
rate governance institutions.18 Low marginal qs have also been estimated for
several other developing countries (Brazil 0.25, Columbia 0.43, Turkey 0.52—see
Table 1). With such poor shareholder protection and investment performance, we
expect that it will be difficult for firms in these countries to raise again substantial
sums of money in equity markets. If this is true, it could have adverse long-term
effects on the growth prospects of these countries. Thus, while weak corporate
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governance institutions in developed countries might lead to wasteful over-

investment, weak corporate governance institutions in developing countries
might lead to under investment.
More is generally better than less. Four options for financing investment—cash
flows, bank borrowing, bonds and equity—are better than three. I can see no
advantage for a country in not having a large equity market. Markets do fail, of
course, and this is certainly true of capital markets. When they do, a case can be
made for state intervention to supplement and improve on the allocation of capital
that takes place through the market, but the fact that capital markets can fail is not
a good reason for doing away with them. The best development strategy for an
emerging market country would seem to be to create the conditions that produce
a large equity market. A first and most important step in this direction would be
to create the kind of strong corporate governance institutions that foster large
equity markets.

Notes
1. See, however, Claessens (1997); Blass et al. (1998); Claessens & Djankov (1999); Claessens et al.
(2000); Johnson et al. (2000); Mitton (2002); Gibson (2003); and Lins (2003).
2. See, Morgenson (2004) as cited in Coffee (2005, p. 203).
3. Mark Roe (2002) argues that managerial compensation is lower outside of the USA in part for cultural
reasons. Shareholders and workers exhibit greater outrage at high salaries in other countries.
4. See, Jensen & Murphy (1990) and Rosen (1992).
5. See, Mueller (1969, 1972).
6. With respect to the latter, see Romano (1987) and Roe (1993).
7. Yoshimori (1995) as discussed in Allen (2005).
8. See, again Yoshimori (1995) as discussed in Allen (2005). See, also Hoshi & Kashyap (2001, pp. 203–
205). There is some evidence that Japanese managers are becoming more concerned about share-
holder value, however (Hoshi & Kashyap, 2001, pp. 323–324).
9. See, Morck & Nakamura (1999). Miwa & Ramseyer (2002, 2005) has questioned the importance of
corporate groups (keiretsu) in Japan and even the notion that they exist. He demonstrates convinc-
ingly the weakness of the criteria usually employed to identify the members of groups, and the fact
that the importance of the ‘main bank’ in a keiretsu has been greatly exaggerated. His own figures
reveal, nevertheless, that substantial fractions of the shares of companies thought to be members of
a keiretsu are held by other members of the keiretsu.
10. See also Faccio et al. (2001).
11. Kornai et al. (2003) review the literature on the causes of soft budget constraints and their negative
economic consequences. See in particular, pp. 1129–1130, for references to studies of soft budget
constraints in developing countries.
12. After reviewing the advantages and disadvantages of different corporate governance systems,
Charkham (1994) concluded that the German system, with its heavy reliance on bank financing and
relatively thin equity markets, was superior to its competitors including the US and UK systems
with their heavy reliance on equity markets.
13. See, for example, Gilson & Roe (1993) and Charkham (1994).
 Corporate Governance and Economic Performance 641

14. See, Mueller (2003) and literature cited therein.

15. See, Moeller et al. (2005) and Gugler et al. (2006).
16. See, Kabir et al. (1997) for the Netherlands, Blass et al. (1998) for Israel, and for a general discussion,
Denis & McConnell (2003).
17. The important exceptions would be India (marginal q = 0.82), Indonesia (0.87), and the Philippines
(0.73), Mueller & Yurtoglu (2000).
18. See, Johnson et al. (2000), Mitton (2002) and Lemmon & Lins (2003).

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