Market versus Internal Factors in Corporate Governance

• Date: 01 September 2015
• Published date: 01 September 2015
• Author: Praveen Kumar,Alessandro Zattoni
• DOI: http://doi.org/10.1111/corg.12128

Editorial

Market versus Internal Factors in Corporate

Governance

Praveen Kumar and Alessandro Zattoni

There is a long-standing distinctionin the corporate gover-

nance literature between market and internal factors that

drive f‌irm performance. In their seminal formulation of the

separation between ownership and control, Berle and Means

(1932) were skeptical of both internal institutions (such as

boards) and outside shareholder pressure as effective means

to monitor powerfulmanagers. Starting in the 1960s,building

especially on the inf‌luential work of Manne (1965), the focus

of many scholars, at least in the US and UK, turned to the

disciplining role of f‌inancial markets implemented through

an active market for corporate control (Shleifer & Vishny,

1986). In essence, while powerful managers may be invulner-

able against internal mechanisms and shareholder proxy mo-

tions, market actors (in the form of large shareholders,

competing f‌irms, etc.) would target underperforming f‌irms

for acquisitions and displace ineff‌icient incumbent manage-

ment. More generally, f‌inancial markets can discipline

self-serving and underperforming managers or controlling

shareholders through low equity and debt valuations

(e.g., Aslan & Kumar, 2012, 2014;Claessens, Djankov, & Lang,

2000) that expose t hem to takeover threats. This view f‌inds i ts

broad culminationin the inf‌luential law and f‌inance literature

(La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998), which

emphasizes strong investor rights as the central determinant

of corporate governance performance.

It is noteworthythat the market disciplineperspective tends

to view market and internal institutional factors in corporate

governance as substitutes (see, e.g, Cyert, Kang, & Kumar,

2002), whereby market pressure offsets weak internal gover-

nance mechanisms and related institutions. However, there

is now a substantial literature that theoretically and empiri-

cally shows that themarket for corporate control may not un-

ambiguously be a substitute for weak internal governance. In

practice, there is a complex interaction between market and

internal mechanisms, especially in international contexts

(Kumar & Zattoni, 2014; Schiehll, Ahmadjian, & Filatotchev,

2014). For example, external market pressures can interact

with internal mechanisms as both substitutes and comple-

ments, which is seen in the complex determinants of board

performance (Kumar & Zattoni, 2013a).And the effectiveness

of market disciplinefor good governance is mediatedsubstan-

tially by country-level variables (Kumar & Zattoni, 2013b).

Furthermore, the fact that bidders typically do not gain from

acquisitions (Jensen & Ruback, 1983) is consistent with the

view that powerful managers may pursue value-destroying

acquisitions. Similarly, the implications of concentrated own-

ership, such as in family f‌irms, for f‌irm performance in inno-

vation are subtle (Lodh, Nandy, & Chen, 2014).

In this issue, four papers signif‌icantly expand our under-

standing ofthe multi-dimensional interactionbetween market

forces and internal factors in corporate governance. The stud-

ies use sound, and sometimes novel, theoretical frameworks

on interestinginternational datato rigorously generate a num-

ber of interesting insights.

The f‌irst paper, by McCann and Ackrill, presents a novel

perspective on the interaction between the market for corpo-

rate control and the board. These authors pose an intriguing

question:Do internal institutions get strongerfollowing acqui-

sition bids that are abandoned? In particular, do weak boards,

who may not have the power to confront or monitor

entrenched managers before the acquisition bid, become

emboldened to confront management following the failure

of the bid? Hence, interestingly, the likelihood of post-

abandonment may be higher with weak boards. In this case,

the external market forces and internal governance mecha-

nisms would have a complementary and not substitute rela-

tionship. Surprisingly, this issue, which appears to be of

signif‌icant importance to the understanding of internal corpo-

rate governancedynamics, has been essentiallyunexplored in

the literature.And even the few studies that have studiedthis

issue tend to use narrow measures of post-abandonment per-

formance. The paper goes further and asks whether boards

use the information content in negative price responses to

bids, acquisition attempts on unrelated targets, and the use

of cash (which is of strategic value to f‌irms, and henceref‌lects

value-destroying bids) to strengthen their position vis-à-vis

powerful CEOs. The study usesUK data on abandoned bids,

f‌irm-level data on board independence, market data on price

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12128

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Corporate Governance: An International Review, 2015, 23(5): 399–401