Corporate governance, finance and growth: Unravelling the relationship

• Jurisdiction: South Africa
• Published date: 15 August 2019
• Pages: 191-218
• Date: 15 August 2019
• Citation: 2010 Acta Juridica 191
• Author: Simon Deakin

Corporate governance, f‌inance and growth:

Unravelling the relationship

SIMON DEAKIN*

Company law systems around the world have seen a considerable strengthen-

ing of shareholder rights in the past 15 years, with board structure and the

regulation of takeover bids among the areas most affected by change. This shift

ref‌lects a widely held consensus to the effect that shareholder-orientated

company law has an important role to play in stimulating f‌inancial develop-

ment and improving managerial performance. This paper looks empirically at

the evidence behind this assumption. The view that promoting independent

boards and an active market for corporate control contributes to greater

f‌inancial development and f‌irm-level performance is seen to have little

support at the empirical level. Analysis of newly constructed longitudinal data

on changes in company law in a sample of 20 developed, developing and

transition systems shows no correlation between the strengthening of share-

holder rights since the mid–1990s and f‌inancial development indicators over

the same period. While stock markets are a signif‌icant source of external

f‌inance for f‌irms in a developing country context, there is evidence of their

decreasing effectiveness in fulf‌illing this role in developed countries, particu-

larly in those with shareholder-orientated company law and corporate gover-

nance systems. For developed and developing countries alike, reforms based

on the promotion of independent boards and hostile takeover bids could well

have been a distraction in the search for the right institutional mix.

I INTRODUCTION

Company law systems around the world have been reformed in the past

decade and a half in a way that ref‌lects a widely held consensus concerning

the relationship between corporate governance, f‌inance and growth. The

consensus view is that shareholder-value orientated rules of corporate

governance, by reducing managerial agency costs, stimulate the f‌low of

external f‌inance to f‌irms, thereby promoting economic growth. This

implies a company law regime which protects the interests of investors

against the risk of expropriation by managerial insiders or, in certain

contexts, by majority shareholders or ‘blockholders’. Changes to compa-

nies legislation and to related codes of practice have followed a broadly

similar path in many countries, with two reforms standing out: changes to

* Professor of Law, University of Cambridge. This article is the text of the inaugural Mike

Larkin Memorial Lecture, delivered at the Faculty of Law, University of Cape Town, on 11

March 2009. I am deeply grateful to the members of the UCT Faculty of Law for this

opportunity to honour the memory of Mike Larkin. I would also like to thank Rochelle Le

Roux and TshepoMongalo for their advice on the preparation of the lecture and comments on

an earlier draft.

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2010 Acta Juridica 191

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board structure, with a growing role for independent directors, and the

regulation of takeover bids, with a view to safeguarding the position of

minority shareholders. Through this process, a ‘global template’ for

corporate governance emerged, with implications for developed and

developing countries alike.

The global convergence of company law regimes along the lines just

described is a relatively recent phenomenon which began in the mid–

1990s. It has, however, been going on long enough now for some

assessment to be made of its effects. Alongside the process of legislative

and regulatory change, there has been a transformation of company law

scholarship, which has become increasingly multidisciplinary and empiri-

cal in its orientation. There is also a growing stress on comparative

analysis. As a result of this body of work, we are starting to get a clearer

picture of the consequences of corporate governance reforms for f‌inancial

development and, more generally, for economic growth. The picture is,

in many respects, still incomplete. However, it is becoming clear from a

growing number of empirical studies that the linear relationship between

governance, f‌inance and growth, which theory had assumed to exist and

on which policy-making was predicated, may not hold.

To explore this set of issues more deeply, two questions will be

addressed. The f‌irst is: what is the role of the f‌inancial system in general,

and of stock markets in particular, in promoting economic growth? This

involves a consideration of the functions that stock markets are in

principle capable of performing, in terms of allocating resources in the

economy and enhancing organisational eff‌iciency. This is the focus of

section II below. The second question is: what is the role of company law

systems, and of corporate governance regimes more generally, in enhanc-

ing the eff‌iciency of the f‌inancial system? More precisely, is there a link, in

practice, between legal reform and stock market development? This will

be the focus of section III. Section IV will provide an assessment of the

evidence and a conclusion.

II STOCK MARKETS, SHAREHOLDER VALUEAND

ECONOMIC PERFORMANCE

(1) Stock markets and growth: Changing views

The argument that deep and liquid stock markets are essential for

sustained economic growth became so f‌irmly entrenched in the policy

and practice of the international f‌inancial institutions and of individual

countries in the past f‌ifteen years as to be practically beyond argument, at

least prior to the f‌inancial crisis of 2008. Yet, as recently as the early 1990s

certain commentators took a very different view of this issue in the

context of the American economy. In 1992 a commission of 25 leading

economists headed by Michael Porter argued that ‘the US system of

192 MODERN COMPANY LAW FOR A COMPETITIVE SOUTH AFRICAN ECONOMY

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