Corporate governance in emerging countries’ markets: agency and institutional relationships

Introduction Corporate governance has become critical to firms in free markets. Increasingly, investors in international securities markets use corporate governance as an indicator of attractiveness, and then use their leverage to bring about more change in governance structures that pave the way for lucrative future investments (Francis et al. 2005). Furthermore, many emerging countries have embarked on ambitious quests to improve the corporate governance of domestic firms, motivated by the success of these programs in developed economies, and by the wish to attract foreign investment. Improving corporate governance is seen as a way to signal open and friendly markets for foreign investors, such as non-domestic individuals, banks, insurance companies, securities firms and mutual funds (Choe et al. 1999). While most emerging markets display some sort of progress in this direction, research provides mixed evidence as to what causes the changes, and how these changes reflect on the profitability of local firms. For instance, Hafsi and Farashahi (2005: 498) suggest that there is a “trend toward common practices all over the world” due to a “global institutional push toward isomorphism.” Likewise, Peng (2004) shows that there is a mimetic pattern in the adoption of Western governance practices in China. Roth and Kostova (2003) argue that changes in governance practices are a result of transition. In this chapter we focus on understanding local firms and their environment. More specifically, several questions spark our interest in the interaction between foreign investors and local firms in emerging markets. Specifically, we first need to understand why local firms of emerging countries adopt Westernized corporate governance practices. We further observe that not all firms of emerging countries make changes to their corporate governance. Thus, it becomes interesting to ask: In light of all the potential benefits as well as pitfalls, why do some firms in emerging countries adopt Western corporate governance practices? A subsequent question emerges in our quest to theoretically analyze response patterns: What are some of the differences in motivation and governance expectations between the local firms attempting to attract foreign investment and the foreign investors? To address these questions, we put forward three propositions which are documented with a real-life case study: the controversy surrounding the proxy fight attempt at KT&G, one of Korea’s largest conglomerates. Much of the research on corporate governance in emerging markets concentrates on the regulatory aspects (La Porta et al. 1997; Walker and Fox 2002; Allen 2004; Rossi and Volpin 2004). The premise is that emerging markets have poor financial and economic institutions as compared to developed countries, partly due to some form of transition. As such, changes in corporate governance practices can be initiated through the rule of law, and the implementation of these changes is ensured through coercive mechanisms. This view of corporate governance assumes an active regulative role for local governments and a somewhat passive role for local firms, which act in compliance with regulations (Allen et al. 2005). In our view, this perspective can be enriched by looking at the role of other entities – such as foreign investors, transnational organizations and other international forums – in stimulating direct changes in corporate governance practices in the local market, rather than through the regulative mechanism of the government. In so doing, we may be able to capture potential relationships formed among local firms, or between local firms and organizations other than the local government. Such interactions would be consistent with the institutional perspective of the firm, whereby the firm takes cues from a variety of actors in its environment, and strategic changes may occur because of these relationships, which are sometimes informal. With this chapter, we aim to add to the body of literature that utilizes an institutional logic to analyze relationships between foreign investors and local firms of emerging countries. We acknowledge the common assumption that firms are forced into adoption by mandates from their investors, consistent with the agency theory of the firm. But too often, this seemingly close-fitting assumption can be called into question. Therefore, we turn to the institutional perspective of the firm, which acknowledges other factors that may motivate firms making structural or strategic adjustments.