The Effects of Corporate Governance Codes

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The Effects of Corporate Governance Codes

A comparison between the Netherlands and the United States

J.E. Santegoeds Kerklaan 103a 9717 HD Groningen Student number: s1742817 Email: jorn@santegoeds.net Date: September 2012

First Supervisor: M. Paping, MSc

University of Groningen

Faculty of Business and Economics MSc Business Administration

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Executive Summary

This paper discusses the effects of corporate governance codes in the Netherlands and the United States on the corporate governance design of organizations. The demand for corporate governance and corporate governance codes rose after several scandals worldwide in the beginning of this millennium. These corporate governance codes were implemented with the intention to stop such scandals from happening in the future and to keep a better oversight over organizations and their business.

The goal of this research is to look at the effects of these corporate governance codes on the organizations. In this research the Dutch governance code and the Sarbanes-Oxley act from the United States are analyzed to see the effects on Dutch listed firms and firms listed in the United States. Many studies have researched the effects of the introduction of corporate governance codes and the specific content of them, but an analysis between the effects in The Netherlands and the United States has not been made. The reason for the selection of the Netherlands and the United States lies in the fact how both countries contain a different law system. The Netherlands is based on a civil-law system while the United States has a common-law system. This difference between law-systems could provide a difference in the content of the corporate governance codes.

The research question is formulated as follows:

What are the effects of the corporate governance code for listed companies on the corporate governance design of organizations?

This question is answered by looking at the content of both codes, which is analyzed on the basis of the OECD principles of corporate governance. Semi-structured interviews were also held with two managers from the Netherlands and two managers from the United States.

The conclusion of this research showed that both codes contain different elements and therefore have different effects. In the Netherlands the Code had the most effect on the disclosure of information, whistle-blowers in the organization and caused a shift of power to the shareholders. In the United States the SO-act has greatly affected the disclosure of financial information, the responsibilities of the CEO and CFO, and rules about whistle blowing.

Key words: Corporate governance, Corporate governance codes, Dutch governance

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1. Introduction

The subject of this research is the corporate governance codes which apply in the United States and in the Netherlands and their effects on the design of the corporate governance for those companies. These codes were made after several accounting scandals at listed firms in the United States like Enron, Ahold and WorldCom. It increased the attention and demand for better corporate governance worldwide. Corporate governance systems and management control systems have a great linkage with each other. The focus of corporate governance is slightly broader than the focus of a management control system, because it also focuses on the behavior of the top management in an organization. A change in the corporate governance mechanisms will have an immediate and direct effect on the management control system practices and its effectiveness (Merchant & Van der Stede, 2012). In this paper, the effect of two corporate governance codes for listed firms from the United States and the Netherlands will be examined, and their effects on the corporate governance design of that organization.

For the owners of companies it is important that the managers of those companies act in the way equal to fulfill their goals. To make sure these goals will be aligned corporations make use of corporate governance. Corporate governance is defined as “the set of

mechanisms that induce the self-interested controllers of the company to make decisions that maximize the value of the company to its owners, the suppliers of capital” (Denis & McConnell, 2003, p.1) According to these authors these set of mechanisms are both institutional and market-based. The mechanisms of corporate governance consist of the board of directors, the equity ownership structure of the firm, the takeover market and the legal system and equity markets (Merchant & Van der Stede, 2012).

In this research the focus will be on the effects of the rules from the governance codes on the corporate governance of companies. The importance of legal rules on a good

corporate governance system is emphasized by a study which stated that good corporate governance systems are a combination of a form of concentrated ownership and legal protection of investors (Shleifer & Vishny, 1997).

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the reasons is that in Common law countries the judges make the legal rules, based on general rules and precedents, which are previous cases. The judges can judge about a case by applying general rules and looking at the fairness of a case to outside investors. This gives a strong boundary for insiders to transfer wealth to themselves (Denis and

McConnell, 2003). In the Civil law countries, laws are made by legislatures, and judges don‟t have the possibility to interpret these statutes according to a certain degree of “fairness”. Consequently, the more interpretative rules of common law provide a better protection than the clearer lines of Civil Law. Another difference is the fact that courts in civil law countries need a higher standard of proof in conflict of interest situations than countries with a common law system (Johnson et al, 2000). The legal system in the United States also focuses more on behaving in the best interest of the shareholders, while the focus in continental Europe is more on the large group of stakeholders of the company (Merchant & Van der Stede, 2012).

These different studies showed the differences and consequences of the law system on the laws in this country. For this reason a difference between the rules and effects of the corporate governance codes from the different law systems might be expected. Another research showed the main differences between governance codes from common law and civil law countries (Zattoni & Cuomo, 2008). A specific comparison of the content between the Sarbanes-Oxley act and the Dutch governance code however has not been made.

These corporate governance codes became more important and relevant after a series of events in the beginning of this millennium. In the early 2000‟s one of the biggest changes in American business law occurred, when the introduction of the Sarbanes-Oxley took place in 2002. Partially introduced because of scandals from Enron and WorldCom the law has several rules for all US public companies and non-American listed companies. This act covers several topics like auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure. It provides several different corporate board responsibilities and act in violation of this code could lead to criminal penalties like facing jail time. In this research the Sarbanes-Oxley act will be referred as the SO-act

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studies have shown the effects of the corporate governance codes and the difference between the pre-code period and the period after the codes have been implemented. A study showed that legal effects shift power from the management to the shareholder, which makes the organization act more in favor of the shareholders (Shleifer & Vishny, 1997). An increase in legal compliances for the organization could therefore lead to less freedom for management to act in their favorite way. Another study even claimed how the weakness of legal institutions for corporate governance in Asia had an important effect on the extent of depreciations and stock market declines in the end of the last century (Johnson et al., 2000). This shows how the corporate governance rules from governance codes can have a big impact on how an organization performs and how its corporate governance is designed.

An analysis of the content from the Dutch governance code and the Sarbanes-Oxley act will be made to see how the rules affect different aspects of the design of the corporate governance system. The codes were implemented after several scandals, to prevent similar situations; therefore it would be interesting to see what the differences in governance rules are compared with the situation before these rules were implemented. Based on the previous information the main research question is formulated as follows: What are the effects of the corporate governance code for listed companies on the corporate governance design of organizations?

This research question will be answered, with the following sub-questions:

1. What are the characteristics of the SO-act and the Dutch governance code and their similarities and differences?

2. How do the corporate governance codes affect the design of the corporate governance structure of companies?

3. How can the differences in corporate governance codes explain a difference in the design of the corporate governance in different countries?

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interpreted. The chapters four and five will contain an analysis based on the methodology chapter of the Dutch governance and the Sarbanes-Oxley act. These chapters will provide information regarding the different rules which are stated in both codes. In chapter six a comparison of the content of the Dutch code and Sarbanes-Oxley act is made. This comparison will look at to what extend different topics have been covered by the codes and what the differences and similarities between the coverage of the codes is.

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2. Corporate Governance

2.1 Agency Theory

One of the leading theories behind corporate governance is the agency theory. The agency theory is about the relationship between the principle and the agent. The agent performs the work which is delegated to him by the principal.

The agency theory focuses on two problems that can occur in relationships between and agent and a principal (Eisenhardt, 1989). The first problem of the agency theory is the agency problem. This occurs when the principal and the agent have different goals, and it is expensive or difficult for the principal to verify what the agent is doing. The second problem is the problem of risk sharing, where the principal and agent have a different preference for actions because of their different attitudes towards risks. This problem is caused by the different preference for actions because of a different preference of risk from the agent and principal. One of these differences in risk perceptions occurs when the rewards of the principal, a high stock return, and the agent, his salary, are not aligned (Eisenhardt, 1989).The potential for problems with the separation of the control of the company and the ownership of the company is not a new problem, and was already mentioned by Adam Smith more than two centuries ago (1776) in his famous work Wealth of Nations. The phenomenon of top managers of the company pursuing courses of actions which are inconsistent with the interest of owners have been shown in different studies (Murphy, 1985; Jensen, 1986; Malatesta & Walking, 1988). Managers tend to increase the size of their companies for higher prestige and better compensation, even if this harms the interest of the shareholders (Murphy, 1985). They also tend to not

distribute excess money to the shareholders when the company doesn‟t have any

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In these kinds of companies there can be a discrepancy between the goals of the shareholders, such as higher stock prices, and the goal of the managers like financial rewards. Other problems of too little control over management are managers engaging in empire building (Jensen, 1986) and managers affecting the design of executive

compensation (Bebchuk & Fried, 2003). A study showed that managers also made it more difficult for the firm to fire them when they were underperforming (Schleifer & Visnhy, 1989).

Another important aspect of the agency problem is the problem of information

asymmetry, when there is a difference for the principal and agent regarding the access to the amount of information. The agent will have an advantage over the principal because he has more information (Mallin, 2010). The costs of managers mishandling their position and the costs of monitoring and controlling them have been called agency costs by Blair (1996). The size of these agency costs is dependent on the monitoring costs, the preference of managers for non-pecuniary benefits and the law and the sophistication of contracts (Jensen & Meckling, 1976). The agency costs will increase with asymmetric information and lack of goal congruence between the managers and the owners of a company (Nyberg et al, 2010). These costs will lower the value of the company; therefore there is a need to reduce these costs to a minimum. To make sure the goals of the

managers and shareholders are aligned and to reduce the agency costs, corporations make use of corporate governance.

2.2 Corporate governance

There are different definitions of the term corporate governance. The OECD (1999) defines it as follows: „a set of relationships between a company‟s board, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, and the means of attaining those objectives, and monitoring

performance, are determined.‟ A slightly broader definition of corporate governance is: „the set of mechanisms and processes that help ensure that companies are directed and managed to create value for their owners while concurrently fulfilling responsibilities to other stakeholders, e.g. employees, suppliers, society at large.‟(Merchant & Van der Stede, 2012 p.553). A more financial definition of corporate governance is: „Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment‟ (Shleifer & Vishny, 1997 p.1). These three definitions show that corporate governance is concerned with the

shareholders of an organization, and with the stakeholders. It can help the company to attain its goals and it monitors its‟ performance. After the accounting scandals of Enron, WorldCom and Ahold the area of corporate governance has gotten much more attention worldwide. Mallin (2010, p.8) states five different reasons how good corporate

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 It helps to ensure that an adequate and appropriate system of controls operates within a company and hence assets may be safeguarded

 It prevents any single individual having too powerful an influence

 It is concerned with the relationship between a company‟s management, the board of directors, shareholders, and other stakeholders.

 It aims to ensure that the company is managed in the best interest of the shareholders and the other stakeholders

 It tries to encourage both transparency and accountability, which investors are increasingly looking for in both corporate management and corporate

performance.

Governance mechanisms can be characterized as being internal or external to the organization. Internal mechanisms are the board of directors of the organization and its ownership structure. External governance mechanisms are the takeover market and the legal system (Denis & McConnell, 2003). Corporate governance codes can be placed as part of the legal system of the governance mechanisms.

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11 2.3 Corporate Governance Codes

After various scandals worldwide at Enron, Ahold and WorldCom in the early 2000‟s and Royal Bank of Scotland in 2008 not only got corporate governance more attention, but the demand for specific rules concerning the behavior of large organizations rose. Several corporate governance codes were implemented in a large number of countries worldwide, to prevent the earlier mentioned scandals which had such a large impact on the society as a whole. The reason why corporate governance codes were implemented instead of changing the legal system is because of the easiness. Reinventing the legal system is a not an easy accomplishment. First of all because the process of introducing changes in an existing legal system is a very difficult and will take a lot of time. The second reason is that the legal system is so deeply embedded in a certain country (Aguilera & Cuervo-Cazurra, 2004). As an alternative, corporate governance codes can be introduced in order to chance the rules regarding corporate governance in a country. In absence of a clear definition of corporate governance code, it will be defined in this research as a collection of rules regarding corporate governance for listed firms.

These corporate governance codes seemed to have a positive effect on organizations. According to Mallin (2010) the introduction of those corporate governance codes has been driven by the need to protect the rights of shareholders and to restore investor confidence in capital markets. A study researched how the compliance of firms with the German corporate governance codes has affected the stock prices of those firms

(Goncharov et al., 2006). They found that firms with higher compliance to the code were more favored by the capital market, and had higher stock prices. Another study noticed the growth that corporate governance codes have made around the world, and the authors state that the governance of the countries that adopted codes of good governance has generally improved (Aguilera & Cuervo-Cazurra, 2009). A study conducted in the United Kingdom provided evidence which showed that after the introduction of several

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12 2.4 Common law and Civil law

Which kind of law system a country has, affects the design of the corporate governance codes in that country. The world is divided into two corporate governance orientations, the continental Europe system, with a broad concern for the rights of all stakeholders and the Anglo-American system which focuses primarily on the shareholders as the receivers of fiduciary duties (Merchant & Van der Stede, 2012). Some examples of countries which have a common law system are Canada, The United States, The United Kingdom and Australia. The system of civil law is being used in Continental Europe by countries such as The Netherlands, Germany, Spain and France.

These codes can be forced upon companies in the form of acts or can be based on the comply-or-explain principle. This means that companies are not forced to comply with certain rules from the code, but if they don‟t comply they have to explain the reason for this non-compliance. According to a study the main difference among the coverage of codes is explained by the national governance system and law (Gregory & Simmelkjaer, 2002). A recent study analyzed the strictness, timing of issuing and scope of corporate governance codes in common- and civil law systems (Zattoni & Cuomo, 2008). One of the findings was that civil law countries are on average slower with the issuing of

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These differences common- and civil law systems affect the design of the corporate governance and the differences among issues covered by the codes. The conclusions from Zattoni and Cuomo are put in the table below.

Common law Civil law

Issuing of governance codes

On average earlier with the release of governance codes than civil law countries.

It took on average 1.8 years longer for civil law

countries to issue governance codes. Coverage of codes The number of items

covered is roughly the same.

The number of items covered is roughly the same.

Scope of the codes Codes mostly contained recommendations to listed firms.

Also codes with

recommendations to non-listed firms.

Focus on which principles - evaluation of board performance - separation of the

chairman and CEO - board directorship

- the role of employees

- conflicts of interest - shareholder rights Strictness of the code

recommendations

Stricter recommendations on separation between chairman and CEO.

Less strict

recommendations on boards of directors than their common law counterparts.

2.5 OECD Principles of Corporate Governance

In 1999 the OECD developed the first principles of corporate governance, which are now regarded as the international benchmark for corporate governance. The OECD is an abbreviation for the Organization for Economic Co-operation and Development and is a well-respected organization to encourage world trade and economic progress. At the moment it has 34 different members which are almost all developed countries. Some countries which are a member of the OECD are The United States, Canada and many countries from Europe including the Netherlands.

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importance of good corporate governance in contributing to maintain stable and good economies (Jesover & Kirkpatrick, 2005). The principles of corporate governance by the OECD have been used in different studies. From studies showing how the principles have affected corporate governance in Russia (Jesover, 2001), how they were implemented in non-OECD member countries (Jesover & Kirkpatrick, 2005) and how these principles are perceived in Saudi Arabia (Robertson et al, 2012). The OECD principles of corporate governance formed the basis for the corporate governance in many different countries, slightly adjusted to the local conditions (Wei, 2007). The OECD acknowledges that the model isn‟t „one size fits all‟ but the principles of the model do represent certain general characteristics that are applicable to all countries (Mallin, 2010).

The OECD principals of corporate governance contain six different principals. These principals will be discussed below and form the basis for the methodology chapter. The first principle is “Ensuring the Basis for an Effective Corporate Governance Framework”. This principle is the broadest principle of the six, and serves more as an overarching principle. This principle focuses on issues like how the code impacts on overall economic performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets. The code should also be consistent with other rules of law, transparent and enforceable.

The second principle focuses on “The Rights of Shareholders and Key Ownership Functions”. This principle aims to look at to what extend the rights of the shareholders are protected by the rules of the governance code. This principle consists of many different sub-principles which focus on specific points of shareholders protection and ownership functions. Important issues are the right to convey or transfer shares, obtain relevant information on the corporation on a regular base, participate and vote in

shareholder meetings, elect and remove members of the board and share in the profits of the corporation. Shareholders should also be allowed to consult with each other on issues concerning their basic shareholder rights.

The third principle focuses on “The Equitable Treatment of Shareholders”. There are different kinds of shareholders for every company, from shareholders with just a few shares, major shareholders to managers who own shares of the company. This principle focuses on the equitable treatment of all these shareholders. A sub-principle is that minority shareholders should be protected from abusive actions in the interest of the controlling shareholders. This phenomenon of strong shareholders operating in their own interest is called tunneling, and occurs more in civil law countries than in common law countries because of weaker laws (Johnson et al, 2000). The focus of the third principle is also on insider trading and abusive self-dealing which should be prohibited. If these rules are violated it also concerns with what kind of sanctions are presence. The last sub-principle states that member of the board and key executives should be required to

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principle would however be difficult to analyze because of the complex amount of information that would have to be gathered from different people involved with the company like the auditor, the CEO and someone from the board. For this reason this principle will not be tested with the Sarbanes-Oxley act and the Dutch governance code. The fourth OECD principle of corporate governance is called „The Role of Stakeholders in Corporate Governance‟. Firms acting in a bad way not only affect the shareholders but also the employees, suppliers and the economic environment. It is therefore important for corporate governance to also focus on the interest of the stakeholders of the company. Especially after the scandals at Enron it showed how big the negative effects were and how many people were affected by this. An important issue is how stakeholders, like individual employees or their representative bodies, should be able to communicate their concerns about illegal or unethical practices to the board without any of their rights being compromised for doing so. This process is called whistle-blowing and has been reported numerous times in the media (Gundlach et al, 2003). Employees reporting illegal or unethical behavior of the company often lose their jobs and have problems finding new employment because other companies appear to avoid employing these „trouble makers‟. The fifth OECD principle of corporate governance is about “Disclosure and Transparency”.

The overarching statement for this principle states that the code should ensure that „timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the

company‟. Non-transparent practices and weak disclosure can contribute to illegal and unethical behavior of the company which could harm the company, its shareholders and other stakeholders. This principle focuses on disclosure which should include, but not limited to, material information on financial and operating results, company objectives, major share ownership, compensation policy for members of the board and key

executives, other issues regarding stakeholders and the company‟s corporate governance policy.

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The different principles of the OECD principles of corporate governance and their content are summarized in a table below:

Principle Content

1. Ensuring the basis for an effective corporate governance framework

The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.

2. The rights of shareholders and key ownership functions

The corporate governance framework should protect and facilitate the exercise of

shareholder‟s rights. 3. The equitable treatment of

shareholders

The corporate governance framework should ensure the equitable treatment of all

shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

4. The role of stakeholders in corporate governance

The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

5. Disclosure and transparency

6. The responsibilities of the board

The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.

The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board„s accountability to the company and the shareholders.

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17 2.6 Conclusion

The separation of ownership and control of the organization, and the additional agency problem, can lead to several different problems for the organization. From empire building (Murphy, 1985), not distributing money to the shareholders (Jensen, 1986) to implementing golden parachutes (Malatesta & Walkling, 1988). With the use of

corporate governance this agency problem can be reduced. Especially after the different accounting scandals worldwide from companies as Enron, WorldCom and Ahold the awareness and importance of corporate governance became much bigger. Because of the difficulty and time of the processes of changing laws, corporate governance codes were implemented in many different countries worldwide. Studies showed that the stock prices and the market reacted positive when firms complied with governance codes (Fernandez-Rodriguez et al, 2004; Goncharov et al, 2006). Study showed also how the amount of corporate governance codes around the world grew and how the governance of the

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3. Methodology

This chapter will describe how research will be done to answer the main research question. The main research question of this research is stated as follows:

What are the effects of the corporate governance code for listed companies on the corporate governance design of organizations?

To answer this research question a qualitative research will be held. Based on the

previous chapter and the relevant theory, hypotheses will be made regarding the effects of corporate governance codes on the governance design of organizations, and the

potentially differences between the Sarbanes-Oxley act and the Dutch governance code. These hypotheses are then tested by acquiring information about how the codes have affected the design of corporate governance for existing organizations in real life. Because of the differences between the codes from countries with a common law system and codes from countries with a civil law system an analysis will be made between listed companies in the two different law systems.

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For the common law system interviews from managers in the United States will be held, and for the civil law systems interviews from the Netherlands. The countries the United States and the Netherlands are chosen because of their practicality. Because the author is Dutch, and therefore has easier access to information of the Dutch corporate governance code and its effects on the Dutch organizations, the Netherlands is chosen as the civil law type kind of country. Another reason is that the Dutch Corporate governance code has been implemented in 2004, which would be long ago enough for organizations to notice effects caused by the implementation of the code. The choice as the United States as the common law type of country has several explanations. The Sarbanes-Oxley act was one of the first corporate governance codes introduced right after the accounting scandals at various companies. Secondly there is the English language which minimizes the language barrier between the author and the people being interviewed. The last argument for the United States has to do with the fact that it is large country with a lot of companies compared to other common law countries. This increases the chance of finding potential people for the interviews.

The Sarbanes-Oxley act and the Dutch governance code are rules for listed firms;

therefore only managers of listed companies will be interviewed. In the United States and in the Netherlands four people will be interviewed from in total four different companies, of which two are subject to the Sarbanes-Oxley act and two are Subject to the Dutch Governance code. The amount of two interviewees per country is chosen because of several reasons. The first reason for looking at two companies per country is to increase the change and reliability of findings effects of the corporate governance codes on the organization. The more companies subjected to the research the better and the higher the validity of the research would be. With regards to shortage of time the amount is set at two companies per country however.

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The content of the codes will be analyzed by taking the OECD principles of corporate governance as our classification. The OECD principals of corporate governance contain six different principals which were discussed in the previous chapter. For every principle the OECD developed several critical elements to test how much a certain principle has been covered. The relevant rule from the Code or SO-act will be mentioned when discussing the implementation of the elements. For practical reasons however not all of the elements were used. Elements which more or less covered the same topic as another element were let out to analyze the principles not on a too detailed level. The principles which are applicable to test corporate governance codes are used to test the hypotheses. These critical elements from the OECD which were used for the analysis can be found in appendix 1 of this research. The hypotheses of this research will be made following these principles of corporate governance together with the existing literature.

The first principle is “Ensuring the Basis for an Effective Corporate Governance Framework”. This principle is the broadest principle of the six, and serves more as an overarching principle. Important issues of this principle which will be tested are about the coverage, understandability, implementation, costs, compliance and sanctions of the codes. This is such a broad and wide principle which makes it hard to form hypotheses based on the literature. The Sarbanes-Oxley act is however obligated for firms to comply with, while the Dutch governance code is formed on the comply-or-explain principle. This results in more freedom for firms to decide if they want to comply with certain rules. Primarily for this reason the first hypothesis is formed as follows:

Hypothesis 1: The Sarbanes-Oxley act will cover the principle of ensuring the basis for an effective corporate governance framework stronger than the Dutch governance code. The second principle focuses on “The Rights of Shareholders and Key Ownership Functions”. This principle aims to look at to what extend the rights of the shareholders are protected by the rules of the governance code. The different critical elements on which this principle will be tested are all about the rights of shareholders and their possibility to have an influence on the business on the company. According to a study by La Porta et al. (1998) the common law protects investors better than civil law does. The legal system in the United States is also known for focusing more on behaving in the best interests of the shareholders, compared to the focus of Continental Europe which is more on the large group of stakeholders of the company (Merchant & Van der Stede, 2012). Although Zattoni & Cuomo (2008) came to the conclusion that governance codes from civil law countries often contain more rules about shareholder rights, because of the stronger focus on the shareholder in the United States it is expected that the rules

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provide less shareholder protection than the Sarbanes-Oxley act. The second hypothesis states as follows:

Hypothesis 2: The Sarbanes-Oxley act will provide stronger rules regarding the protection of the rights of shareholders than the Dutch governance Code.

The third OECD principle of corporate governance used in this research is called „The Role of Stakeholders in Corporate Governance‟. The different elements which will be tested for this principle cover different rights for stakeholders which are given by the governance codes. The focus of the civil law countries is considered broader than the focus of the common law countries and more on the stakeholders of a company

(Merchant & Van der Stede, 2012; Malin, 2010). In codes from civil law countries there were often more principles like the role of employees (Zattoni & Cuomo, 2008). Because of these findings expectations are that the Dutch governance code will contain more rules regarding stakeholders‟ rights. Therefore the following hypothesis states:

Hypothesis 3: The Dutch governance code will have implemented more rules regarding the rights of stakeholders compared than the Sarbanes-Oxley act.

The fourth OECD principle of corporate governance is about “Disclosure and

Transparency”. The elements of this principle are about which kind of information the

organization is obligated to disclose to its shareholders and other stakeholders. There is a strong focus on the disclosure of financial information. Based on the existing literature it is difficult to expect which kind of governance code would provide more and stricter rules on the disclosure of information. Although common law countries more often provide stringent rules than civil law countries (Zattoni & Cuomo, 2008), it hard to make a hypothesis regarding the disclosure of information solely based on this. For this reason it is unexpected whether the SO-act or the Dutch code would have implemented more rules of this principle and therefore no hypothesis has been stated.

The fifth and last OECD principle of corporate governance used is about the

„Responsibilities of the Board‟. The critical elements of this principle are about the duties of the board members, their selection and their remuneration policy. In the study by Zattoni & Cuomo (2008) they conclude that codes from common law countries were more common to cover topics like the evaluation of board performance, board

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Hypothesis 4: The Sarbanes-Oxley act will have implemented rules regarding board responsibilities broader than the Dutch governance code.

In the report about the OECD principles of corporate governance there is a gradation made based on how much these principles have been assessed. This assessment scheme will be used in this research to determine to what extend rules about a certain principle have been implemented in the Sarbanes-Oxley act and the Dutch governance code. The OECD has five different gradations of assessment ranging from fully implemented till not applicable. These different gradations will be discussed into further depth and based on how implemented, the principles are numbered. The stronger a principle is covered the higher the number will be, ranging from 0 till 3. The gradation of implementation is shown below.

Not Applicable (-): This assessment is appropriate where an OECD Principle (or one of the Essential Criteria) does not apply due to structural, legal or institutional features (e.g. institutional investors acting in a fiduciary capacity may not exist).

Not Implemented (0): A not implemented assessment likely is appropriate where there are major shortcomings, e.g. where:

 The core elements of the standards described in a majority of the applicable essential criteria are not present; and/or

 Incentives and/or disciplinary forces are not operating effectively to encourage at least a significant minority of market participants to adopt the recommended practices.

Partly Implemented (1): A partly implemented assessment is likely appropriate in the following situations:

 One or more core elements of the standards described in a minority of the applicable essential criteria are missing, but the other applicable essential criteria are fully or broadly implemented in all material respects (including those aspects of the essential criteria relating to corporate governance practices, enforcement mechanisms and remedies);

 The core elements of the standards described in all of the applicable essential criteria are present, but incentives and/or disciplinary forces are not operating effectively to encourage at least a significant minority of market participants to adopt the recommended practices; or

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appears that the reason for low implementation levels is the newness of the

standards (rather than other factors, such as low incentives to adopt the standards). Broadly Implemented (2): A broadly implemented assessment is likely appropriate where one or more of the applicable essential criteria are less than fully implemented in all material respects, but, at a minimum:

 All of the applicable essential criteria are implemented to some extent;

 The core elements of the standards are present (e.g. general standards may be in place although some of the specific details may be missing); and

 Incentives and/or disciplinary forces are operating with some effect to encourage at least a majority of market participants, including significant enterprises, to adopt the recommended practices.

Fully Implemented (3): The OECD principle is fully implemented in all material respects with respect to all of the applicable essential criteria. Where the essential criteria refer to standards (i.e. practices that should be required, encouraged or, conversely, prohibited or discouraged), all material aspects of the standards are present. Where the essential criteria refer to corporate governance practices, the relevant practices are widespread. Where the essential Criteria refer to enforcement mechanisms, there are adequate, effective

enforcement mechanisms. Where the essential criteria refer to remedies, there are adequate, effective and accessible remedies.

This research only focuses on two companies per country. This will also have

consequences for the validity of the research. Because of a total of four companies, which also don‟t operate in the same industry, it is impossible to say the results of this research will be relevant for every company operating in the United States or the Netherlands. It does however provide an analysis and comparison of the two different corporate

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4. Dutch governance code

On 30 December 2004 the code was implemented after being developed by a commission led by Morris Tabaksblat, hence the name the Code Tabaksblat. On January the first of 2009, the code was revised for greater efficiency, and now simply is referred to as the Dutch governance code. The preamble of the code states that it contains principles and best practice provisions that regulate relations between the management board, the supervisory board and the shareholders. The code works according to the comply-or-explain principle. This means that companies aren‟t obligated to comply with the principles of the code, but when they don‟t apply they have to explain why they don‟t comply. The Dutch governance code contains 5 different chapters; compliance with and enforcement of the Code, the management board, the supervisory board, the shareholders and the general meeting of shareholders and the audit of the financial reporting and the position of the internal audit function and the external auditor. The code applies to all companies whose registered offices are in the Netherlands and whose shares or depositary receipts for shares have been admitted to listing on a stock exchange. The numbers in parentheses explain in which rules of the code the information was found. 4.1 Ensuring the Basis for an Effective Corporate Governance Framework

The first principle is “Ensuring the Basis for an Effective Corporate Governance

Framework”. This principle is the broadest principle, and serves more as an overarching principle. It focuses on issues like how the code impacts on overall economic

performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets. The code should also be consistent with other rules of law, transparent and enforceable. This principle consists of four different critical elements.

In the Netherlands there is a monitoring commission of corporate governance. The monitoring commission corporate governance tasks are promoting and monitoring compliance of Dutch listed firms to the Dutch governance code. This commission presents annual reports about the compliance of firms with the code. According to a survey 88% of the large institutional investors are well-known with the principles of the code. The other 12% responded to be somewhat familiar with the principles. The

compliance of firms to the code reaches on most points almost the 100% (Report

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first two elements of this principle. The Corporate Governance Code Monitoring

Committee seems not subject to commercial and political influences. Ministers can form the committee for a period of 4 years. The committee has right to implement rules to the code, but the compliance to the code isn‟t required when the organizations explains why it doesn‟t follow that rule. This principle tends to decrease the regulatory impact ability of the committee. In the Netherlands only the government is responsible for and capable of making laws. The government code was developed by a commission on behalf of the government. The cost and size of complying with the code was in 16% of the time in 2010 the reason of not complying with the code (Akkermans et al, 2011). The committee which was responsible for creating the governance code had contact with variously public organizations to encompass the public interest. These findings suggest a lot of the third element is covered in the Netherlands.

The four elements of the principle are all covered by the Dutch Code. The biggest

weaknesses however are the fact that organizations aren‟t required to follow the different rules created by the committee. As long as an organization explains why they don‟t comply with a certain rule it seems to be alright, as long as the shareholders don‟t disagree. In the code there isn‟t any mention about any sanctions when not applying to the rules. Mr. van der Scheer mentioned how this freedom for companies is necessary, because firms sometimes can have good reasons to not comply with certain rules. An example could be if firms don‟t want to disclose certain information to keep this information away from competitors. Eventually the shareholder will decide whether or not non-compliance of a rule will be accepted. Therefore the first principle of the OECD is regarded to be partially covered by the Dutch governance code.

4.2 The Rights of Shareholders and Key Ownership Functions

The second principle focuses on “The Rights of Shareholders and Key Ownership Functions”. This principle aims to look at to what extend the rights of the shareholders are protected by the rules of the governance code. This principle consists of many different sub-principles which focus on specific points of shareholders protection and ownership functions. Important issues are the right to convey or transfer shares, obtain relevant information on the corporation on a regular base, participate and vote in

shareholder meetings, elect and remove members of the board and share in the profits of the corporation. Shareholders should also be allowed to consult with each other on issues concerning their basic shareholder rights.

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meeting (IV 1.4). The second rule states how a resolution to pay a dividend should also be a separate agenda item at the meeting (IV 1.5). Material changes in the design of the corporate governance structure of the company will be presented to the shareholders as a separate issue on the shareholders meeting (I.2). Material amendments to the articles of association of the company will also be presented as a separate agenda item at the general meeting (IV 3.9). The management board and supervisory board must supply the general meeting will all the necessary information that it requires for the exercise of its powers (IV 3). Other rights of shareholders are about big corporate changes. Important corporate changes are subjected to the approval of the meeting of shareholders (IV 1). Mechanisms for when the authorization of shareholders wasn‟t obtained, or the information flow wasn‟t sufficient are not mentioned in the code however.

The shareholder has the right to put an issue on the agenda of the shareholders meeting, after he consulted the board of directors. When one of these issues however might leads to a change in the strategy of the company, the board gets a certain response time to react to this issue (IV 4.4). The general meeting of shareholders of a company not having statutory two tier status has extra rights. These shareholders are able to elect or remove board members by an absolute majority of votes. An additional requirement to this majority of votes can be that these votes represent a certain amount of the issued capital of shares, which proportion shall not exceed one third of the issued capital. If this proportion is not represented at a meeting, but the absolute majority of votes take a decision, then a new meeting can be convened at which the absolute majority of votes cast, regardless of how much issued capital is represented at that meeting (IV 1.1). Means of redress are not mentioned in the code.

Concerning the compensation policy of board members and other executives, no rules providing opportunities for shareholders to make their views known about the

compensation policy for board members and key executives are found in the code.

The board has the duty to provide the meeting of shareholders with all relevant

information, unless an overriding interest of the company is opposed (IV 3.5). A way of preventing amajority of shareholders from controlling the decision-making process as a result of absenteeism at a general meeting is the depositary receipts for shares (IV 2). In this case on time a year a report has to be made containing information like the number of shares for which depositary receipts have been issued and an explanation of changes in this number, the work carried out in the year under review and the voting behavior in the general meetings held in the year under review (IV 2.6, IV 2.7).

Based on these findings the rights of shareholders and key ownership functions are partially implemented in the Dutch governance code. This is because most of the

elements are implemented in the code, except some issues like possibility to check the list of shareholders and making views known about the compensation policy of the board. Important issues like the right to create a topic on the agenda on the shareholders

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in the Dutch Code. Enforcement of these rights is however not broadly described. The most important issue is how important corporate changes are subjected to the approval of shareholders. According to Mr. van der Scheer the change created by the introduction of the Dutch Code was the biggest on the topic concerning the rights of shareholders. The anonymous interviewee also confirmed the Code created changes regarding the rights of shareholders. The introduction of the code seemed to have created a large shift of power to the shareholders of the company.

4.3 The Role of Stakeholders in Corporate Governance

Firms acting in a bad way not only affect the shareholders but also the employees, suppliers and the economic environment, it is therefore important for corporate governance to also focus on the interest of the stakeholders of the company. Elements contain rules regarding employee participation, pension-funds, creditors and whistle-blowers.

In the preamble of the code they speak about how they see the Dutch companies as long term collaborations between the various parties involved in the company. The

stakeholders are the groups that directly or indirectly influence how the company achieves its objectives, like the employees, shareholders, suppliers, customers and the government. It is therefore remarkable that the roles of these different stakeholders aren‟t mentioned in a special chapter. Regarding the development of forms of employee

participation the code doesn‟t mention a specific rule. It does however doesn‟t prevent or inhibit the development of different forms of employee participation. The Dutch Code neither contains rules about pension-funds or about the different classes of creditors and the possible actions they can take or information about possible compensation. Neither does it contain a rule for other stakeholders how to participate in the process of corporate governance.

The board does have the duty to provide the meeting of shareholders with all relevant information, unless an overriding interest of the company is opposed (IV 3.5). The rights of possible whistle-blowers in a company are also described. The code contains a special rule regarding the whistle-blowing of employees. This rule states how the board should ensure that employees can report about alleged irregularities in the company of a general, operational and financial nature, without endanger their position in the company. Alleged irregularities about the functioning of management board members shall be reported to the chairman of the supervisory board. The arrangements for whistleblowers shall be posted on the company‟s website (II 2.7). Mr. Van der Scheer acknowledged how these new rules about whistle-blowers was a change with the previous rules and the company formulated a whistle-blowing regulation according to the Dutch Code.

The analysis showed how much the role of stakeholders is covered in the Dutch

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one element completely covered. The opportunity to blow the whistle in case of irregularities seems to be well covered by the Dutch Code. It is also required for the companies to put the arrangements for whistle blowers on the website of that company. Other rules regarding other stakeholders like suppliers, creditors, customers or the government are not present in the Dutch code. This is remarkable considering how the preamble of the Code speaks of how there are various parties involved with a company. Mr. van der Scheer stated that in his opinion the lack of rules for stakeholders is the biggest weakness of the Dutch Code. For these reasons the principle of the role of stakeholders is regarded as not implemented in the Code.

4.4 Disclosure and Transparency

This principle focuses on disclosure which should include, but not limited to, material information on financial and operating results, company objectives, major share ownership, compensation policy for members of the board and key executives, other issues regarding stakeholders and the company‟s corporate governance policy. A total of nine OECD elements are used to analyze the content of the Dutch code regarding

disclosure and transparency.

In the annual report there has to be information relevant for shareholders, financial ratios and other important financial multi-years figures (II 1.4). Another requirement is that the preconditions concerning the strategy will be included in the annual report (II 1.2). It contains a full analysis of the balance sheet and development of the balance sheet and the results of the company (explanation III 1.2). The board is accountable for the annual report (II 1). The annual report also needs to include the operational and financial goals of the organization (II 1.2). This also should include the main risks related to the strategy of the organization (II 1.4). The external auditor has to give an analysis of the

developments of the financial results and equity of the company (V 4.3). The board is required to disclose information regarding operational and financial goals, as well as the for the organization relevant social aspects of entrepreneurship. These commercial and non-commercial objectives are required to be put in the annual report (II 1.2).

The code mentions a selection- and nomination committee which has to create selection criteria and an appointment procedure for members of the supervisory board and

directors. They also have to include how to keep the directors independent (III 5.14). Every year the supervisory board should present a remuneration report about the directors of the company (II 2.12). The supervisory board shall determine the level and structure of the remuneration of the management board members by reference to the scenario

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company, with due regard for the risks to which variable remuneration may expose the enterprise. This report also includes the variable remuneration components (II 2.13). The importance of how the remuneration policy should align with the strategy and the

associated risks is shown by the fact how it is separately mentioned in the preamble under number 12.

The external auditor reports about the fairness of the financial statements (V 2.1). The external auditor is independent of the managers and board members. The external auditor is appointed by the general meeting of shareholders. The supervisory board shall

nominate a candidate for this appointment, while both the audit committee and the management board advise the supervisory board (V 2). To be considered as an external auditors there are several different requirements mentioned in the code (V 2). This

profession meets specified qualifications which are stated in a specific accounting law. At least once every four years, the supervisory board and the audit committee shall conduct a thorough assessment of the functioning of the external auditor within the various entities and in the different capacities in which the external auditor acts. The main conclusions of this assessment shall be communicated to the general meeting of shareholders for the purposes of assessing the nomination for the appointment of the external auditor (V 2.3).

The Dutch governance code seems to cover almost every element to a great amount. There are a lot of rules regarding the disclosure of information from the board and from the external auditor. The board is required to disclose information about operational, financial and non-financial goals and a full analysis of the balance sheet and development of the balance sheet and the results of the company. The board is accountable for the annual report. The external auditor, which needs to have several qualifications, is

independent of the board of the company. The core elements of the standards are present and there are forces to encourage the practices of these rules. One of the consequences of the introduction of the code according to Mr. van der Scheer was how the external auditors were a lot stricter. “Koninklijke Reesink” also has devoted a separate part on their website disclosing information about the corporate governance design and rules which are relevant for them. The anonymous interviewee explained that their annual report has increased significantly in size because of compliance to the Dutch Code. For all these reasons the coverage of disclosure and transparency is regarded as broadly implemented in the Dutch Code.

4.5 Responsibilities of the Board

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board to prevent actions from managers with negative effects for the company and its shareholders. This principle focuses thus mostly on the agency problem which can occur with separation of ownership and control.

In the Dutch code there are several rules about the responsibilities of the board. One of those rules is how the management board shall submit corporate social responsibility issues that are relevant to the enterprise to the supervisory board for approval. The main issues of this shall be mentioned in the annual report (II 1.2). Other rules are concerned with the duty of loyalty. The duty of loyalty is defined in the Dutch code in several rules. A management board member shall not enter into competition with the company, not demand or accept gifts from the company for himself or relatives, not provide unjustified advantages to third parties to the detriment of the company and not take advantage of business opportunities to which the company is entitled for himself or for his family (II 3.1). A management board member shall immediately report any conflict of interest or potential conflict of interest that is of material significance to the company and/or to him, to the chairman of the supervisory board and to the other members of the management board and shall provide all relevant information (II 3.2). Decisions to enter into

transactions in which there are conflicts of interest with management board members that are of material significance to the company and/or to the relevant board members require the approval of the supervisory board and these transactions shall be published in the annual report (II 3.4).

The organization shall have an internal risk management and control system that is suitable for the company. It shall, in any event, employ as instruments of the internal risk management and control system like a code of conduct. This code of conduct should also be published on the company's website (II 1.3).

There are several key functions of the board gives by the Dutch Code. These state that the role of the management board is to manage the company, which means, among other things, that it is responsible for achieving the company‟s aims, the strategy and associated risk profile, the development of results and corporate social responsibility issues that are relevant to the enterprise. The management board is accountable for this to the

supervisory board and to the general meeting (II.1).

The general meeting of shareholders of a company, not having statutory two tier status, has extra rights. These shareholders are able to elect or remove board members by an absolute majority of votes. An additional requirement to this majority of votes can be that these votes represent a certain amount of the issued capital of shares, which proportion shall not exceed one third of the issued capital. If this proportion is not represented at a meeting, but the absolute majority of votes take a decision, then a new meeting can be convened at which the absolute majority of votes cast, regardless of how much issued capital is represented at that meeting (IV 1.1). Shareholders also can place specific items on the agenda of the general meeting (IV 4.4).

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Dutch governance code. The supervisory board shall determine the level and structure of the remuneration of the management board members by reference to the scenario

analyses carried out and with due regard for the pay differentials within the enterprise (II 2.2). In determining the level and structure of the remuneration of management board members, the supervisory board shall take into account, among other things, the results, the share price performance and non-financial indicators relevant to the long-term objectives of the company, with due regard for the risks to which variable remuneration may expose the enterprise. This report also includes the variable remuneration

components (II 2.13).

A company is required to compose a code of conduct and place this on their company‟s website (II 1.3). The supposed content of this code is however not mentioned. The

company shall place relevant information on a special part of their website. The chairman of the supervisory board is responsible that the supervisory board members receive in good time all information which is necessary for the proper performance of their duties. The Dutch Code covers all elements of the responsibilities of the board. Some elements are however better implemented than other elements. While the rules about the

remuneration of the board and the power of the shareholders are well defined, the rules about the corporate social responsibility are covered at a low level. The anonymous interviewee mentioned how the Code has made the company change the remuneration policy with a stronger focus on the long-term. All of the elements are covered by the board, albeit some less than fully, and the core elements of the standards are present and therefore this principle is regarded as broadly implemented by the Dutch governance code.

4.6 Conclusion

The analysis of the Dutch governance code showed that the different principles of the OECD are not as equally strong covered. The principles “ensuring the basis for an effective corporate governance framework” and “the rights of shareholder and key ownership functions” are only partially implemented by the Dutch governance code, while “the rights of stakeholders” can be considered as not implemented in by the code. This is especially strange when the preamble of the code speaks of “how they see the Dutch companies as long term collaborations between the various parties involved in the company”. This view is shared by Mr. van der Scheer who believes there should be an extra chapter concerning the rights of the different Stakeholders. The only right of

stakeholders, besides the shareholders, mentioned is the rule regarding whistle-blowing in the organization. The principles “disclosure and transparency” and the “responsibilities of the board” are better implemented by the Dutch code than the other principles. Almost all of the elements are implemented and most of these elements are implemented to a

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implemented. The interviewees stated how the external auditors became stricter and the amount of information disclosed in their annual report increased because of the

introduction of the Code. A pitfall of the Dutch governance code and the reason why the principles aren‟t regarded as more implemented is because of the „comply-or-explain‟ rule. According to Mr. van der Scheer this freedom for companies is however necessary because companies could have valid reasons for not complying with a rule. An example could be that firms don‟t want to disclose certain information to keep something secret for competitors. The anonymous interviewee had a similar opinion, stating that the comply-or-explain principle would be better than mandatory rules. Maintaining

compliance with the code lies largely in the hands of the shareholders. They may approve the deviations of compliance with the code, or make the board of the company change the corporate governance structure. For the purposes of this latter, they have different rights available to them. The code states different rights which the shareholders in general meeting of shareholders may use. They can approve the policy of the management board, they can change the remuneration policy and they have the opportunity to layoff the board or the supervisory board. According to the Mr. Van der Scheer the Dutch Code shifted the power more to the shareholders of the company. This is consistent with the research Shleifer & Vishny (1997) which showed that legal effects shift power from the management to the shareholder, which makes the organization act more in favor of the shareholders. This will however only happen if the shareholders are well aware of the corporate governance structure of the organization and indeed are willing to take these actions against the company. According to the people interviewed this freedom to companies to decide to non-comply with certain rules however is necessary. There is no other authority which has the rights to control the compliance of the Dutch governance code and has the possibility to intervene in case of no compliance. Overall the

introduction of the Code caused a big change on the corporate governance design of the companies of the interviewed executives. Adaption to compliance with the code has gone gradually over time, were the change to compliance to the rules concerning the

shareholders took the most effort and time. Mr. van der Scheer stated how the Code had effects on the corporate governance design in practice, where the role of stakeholders changed a little, but rules concerning the shareholders, disclosure and responsibilities of the board changed significantly. Concluding the code has affected several issues.

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Compliance of the Dutch Governance Code with the OECD Principles:

Principle Level of implementation

Ensuring the basis for an effective corporate governance framework

1 (Partially implemented) The rights of shareholder and key ownership

functions

1 (Partially implemented) The rights of stakeholders in corporate

governance

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5. Sarbanes-Oxley Act

The Sarbanes-Oxley act was enacted on July 30, 2002 in the United States. After the scandals from particularly Enron and WorldCom the demand for corporate governance rules became bigger in the United States. The democratic senator Paul Sarbanes and the republican senator Michael Oxley are the sponsors of the act, hence the name the Sarbanes-Oxley act. This code is formed as a federal law, unlike the Dutch governance code. This means all U.S. public company boards, management and public accounting firms are obligated to comply with the rules of the SO-act. The Sarbanes-Oxley act has eleven different sections. It requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the law. The act applies to all listed companies in the United States, irrespective of the country where the company is located. The numbers in parentheses explain in which section of the act the information was found.

5.1 Ensuring the Basis for an Effective Corporate Governance Framework The first principle is “Ensuring the Basis for an Effective Corporate Governance

Framework”. This principle is the broadest principle, and serves more as an overarching principle. It focuses on issues like how the code impacts on overall economic

performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets. The code should also be consistent with other rules of law, transparent and enforceable. This principle consists of four different critical elements.

Since the implementation of the code in 2002 some law suits have been about the code. One big court case about the SO-act had the intention to declare the act invalid. This because the Public Company Accounting Oversight Board (PCOAB), which is charged with overseeing, regulating, inspecting and disciplining accounting firms in their roles as auditors of public companies, would have been not legally appointed. The Supreme Court however disapproved and the code was declared valid. The rules are written in a difficult manner, which was acknowledged by Mr. Callahan in the interview. He also stated this led to the fact that compliance with the SO-act took a lot of effort.

The Effects of Corporate Governance Codes