COVID-19 and Comparative Corporate Governance

Martin Gelter is Professor of Law at Fordham University School of Law; and Julia M. Puaschunder is a Post-Doctoral Researcher at Columbia University, and a faculty member at The New School of Public Engagement and affiliate of its Department of Economics. This post is based on their recent paper, forthcoming in the Journal of Corporation Law. Related research from the Program on Corporate Governance includes The Elusive Quest for Global Governance Standards by Lucian Bebchuk and Assaf Hamdani.

COVID-19 accounts for a once-in-a-lifetime external economic shock coming down on world society. When the novel coronavirus SARS-CoV-2 emerged in December 2019, the general public in much of the world, let alone business leadership, was not yet particularly concerned. A year into the outbreak of the pandemic, over two million individuals have died directly from the pandemic, which has sickened over hundred million counted people but also affected all of us in the way we live, interact and perform in markets. Country governments have taken harsh measures to combat the disease, including lockdowns that have caused unprecedented disruptions to work life and to the economy.

Not surprisingly, corporate governance is at a critical juncture. Firms have struggled to adapt to lockdowns with severe and drastic effects on their performance. Restrictions have caused GDP drops estimated to likely become 50 times larger than those experienced during the 2008 world financial recession. Unemployment levels increased worse than during the Great Depression, already now also exhibiting worse inequality.

Our paper speculates whether COVID-19 will have a lasting effect on corporate governance around the world. How will large corporations be run and controlled differently? Will the interaction between firms and their shareholders and other stakeholders change due to a different balance of powers between interest and the political environment?

The overall argument of our paper is an evolutionary one. While corporate governance tends to evolve gradually during times of peace, prosperity and growth; historical examples we address prove that it takes leaps during periods of severe social and economic disruptions. The corporate governance structures of the second half of the 20th Century emerged from disruptions during its first half, most of all the Great Depression and World War II, in some of the major wealthy jurisdictions. The United States and the United Kingdom developed dispersed ownership structures and maintained deep capitals markets, while other developed economies, in particular Continental European jurisdictions such as Germany, had concentrated ownership and lacked similarly developed stock markets.

By contrast, during the second half of the 20th Century, corporate law and governance developed incrementally. Especially during its last decades, many jurisdictions gradually moved toward a greater focus on the interests of outside investors, resulting in a debate about convergence in corporate governance toward a shareholder primacy model. We argue that the COVID-19 pandemic will push corporate governance away from shareholder orientation by creating a number of new trends and by accelerating ongoing shifts. We focus on three areas, namely resiliency, nationalism, and stakeholderism.

Resiliency

Our paper suggests that sometimes there is a tradeoff between efficient practices and resiliency to disruption. Examples include cross-border supply chain networks and just-in-time logistics, which are difficult to maintain as countries re-erect economic barriers. On the financial side, companies may need to maintain corporate ‘fat’ and avoid dividends and share repurchases.

In addition, while convergence in corporate governance was expected to lead to more dispersed ownership, resiliency may be strengthened by integrating firms into a larger network that facilitates survival during hard times. This could herald trends to integration into a corporate group, concentrated ownership, or close links to the government. Or it might favor a trend of firms toward integration into corporate networks characterized by concentrated ownership, family control, or close links to the government.

Resiliency is also requiring firms to develop a healthy workforce. Traditional human capital theories of the capital-labor interaction will have to be supplemented by ‘healthy human capital.’ In part, this means that firms will have incentives to hire staff that does not fall into a risk group, which raises the specter of discrimination. However, firms will also need to develop practices that avoid contagion with their long-term workforce to the extent that it still needs to interact physically. The degree of physical interaction depends on the nature of the job, and the extent to which jobs can be performed remotely. These developments will likely have an impact on the relative bargaining positions of capital and labor.

Nationalism

Second, we propose that we will see a greater significance of nationalism and protectionism in corporate law, which has generally receded in Western countries because of its perceived inefficiencies. Governments will not be only inclined to bail out key firms, but also prevent international investors with political motives from coming in, such as firms affiliated with the People’s Republic of China. The US and the EU have already strengthened foreign direct investment rules in recent years. On a broader scale, we may see a greater acceptance of instruments such as ‘Golden Shares,’ where public actors reserve the right to veto certain decisions, as well as the permissibility of takeovers defenses, which will likely garner increasing political favor again.

Stakeholderism

Third, we are likely to experience a return of ‘stakeholderism’ in corporate governance. In addition to concerns of labor, two major public policy issues are likely come to the foreground again. First, the pandemic has exacerbated economic inequality in many jurisdictions. With industries being disrupted by digitalization and rendering past human capital investment useless, workers are losing their livelihood. Pandemic-related lockdowns are exacerbating this trend. Second, climate change has not disappeared from the public eye and is likely to come back as a more intense discussion during the coming years given the Green New Deal efforts in the US and the European Green Deal. On both issues, we are seeing pressure from the financial industry for corporations to adjust and address them on the company level.

Even before the pandemic, the stakeholder trend was advancing in public debates. The Business Roundtable’s 2019 statement on corporate purpose has abandoned shareholder wealth maximization for a stakeholder conception of the corporation. Moreover, from an international perspective, it is surprising that employee participation on the board has seriously been proposed by Senators Warren and Sanders in their presidential campaigns. In Europe, employee participation has gained ground in recent years after decades of criticism. For example, France expanded its very limited employee representation requirements in large firms in June 2013 and 2015, for better or for worse. Our paper argues that various aspects of “stakeholderism” and ESG (environmental, social and governance) issues will gain ground in future years, partly because of pressure from governments, institutional investors and the public. To the extent that governments have become more involved in the economy with COVID-19, it is possible that it will use these ‘war powers’ to address other pressing concerns.

Conclusion: The Evolution of Corporate Governance

Overall, these consequences allow us to draw larger lessons for comparative corporate governance. We may see a reconfiguration of institutions in many jurisdictions. For corporate governance to maintain its position as a cornerstone of the capitalist system, it must also be seen as legitimate. As Mark Roe wrote in 2003, “[b]efore a nation can produce, it must achieve social peace.” While Roe was referring to the structures emerging in Europe and Japan after World War II because of political turmoil, the socio-economic fallout of the pandemic may result in new corporate structures that may not necessarily be efficient in the sense of creating a global optimum. Conventional efficiency analysis that corporate governance scholars emphasize in most of their research may predominate in times of incremental economic development. But when the economic, social and public health environments change rapidly, the evolution of corporate governance also reaches a punctuated equilibrium and will develop in leaps. This is because the political sphere starts to exercise a greater influence on the economy, to which corporate governance must adjust.

The full paper is available for download here.

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