Company Governance Structure: Law and Practice

Author: Ni Jianlin
Publisher:
Publish Date: 2001-12-01
Features: Corporate governance structure is both a legal and an economic issue. This book argues that implementing shareholder rights, strengthening the duties of directors, and clearly defining the power boundaries between the shareholders' meeting and the board of directors are essential components of achieving a balance between the two. Promoting the independent director system, advocating the separation of the chairman and the CEO, establishing subcommittees under the board of directors, and creating a standardized board evaluation mechanism are effective ways to achieve internal balance within the board. Equity incentive plans for the management team must comply with the principle of reasonableness. Information disclosure mechanisms and shareholder litigation mechanisms should play a primary role in constraining the management team. The supervisory committee models of common law and civil law should be integrated.
Corporate governance structure is both a legal and an economic issue. This book approaches the legal study of corporate governance structure from the perspective of interest balancing mechanisms. The book posits that the essence of corporate governance structure is an internal interest balancing mechanism among stakeholders such as shareholders, the board of directors, and the management team. Accordingly, the book explores the interest balancing between the shareholders' meeting and the board of directors, internal interest balancing within the board, interest balancing for the management team, and the balancing of the supervisory committee. To better understand the interest balancing mechanism, the book first analyzes the property rights structure of companies and the principal-agent problem.
The book first points out that corporate governance structure arises from the modern arrangement of property rights in companies. The separation of ownership and management rights, more precisely, the separation of shareholder equity ownership, corporate legal ownership, and operational rights, necessitates the framework of a corporate governance structure based on interest balancing. For China's listed companies, optimizing the equity structure is an important prerequisite for improving corporate governance. Secondly, from the perspective of the principal-agent theory, corporate governance structure is a mechanism to address various principal-agent problems within a company. For China's state-owned enterprises, analyzing corporate governance structure through the lens of agency theory holds practical significance.
The primary issue in the interest balancing mechanism of corporate governance is the interest balancing between the shareholders' meeting and the board of directors. Protecting shareholder rights is the foundation for shareholders to control the board. Through a comparative analysis of common law and civil law, the book argues that strengthening shareholder voting rights is crucial for achieving genuine shareholder democracy, yet China's legislative framework in this regard is clearly deficient. Strengthening the duties of directors is another important aspect of shareholders' balance with the board. While the duties of directors (duty of care and duty of loyalty) primarily originate from common law, civil law has gradually improved in this area in recent years, further highlighting the importance of strengthening director duties in constructing corporate governance mechanisms. The flexibility of common law in establishing the principles of director duties of care and loyalty, particularly the application of the business judgment rule in U.S. law in regulating the duty of care, is well-suited to modern commercial practice and us to learn from.
The debate between "shareholder-centricism" and "board-centricism" touches on the core issue of power allocation between the shareholders' meeting and the board of directors. The book argues that the decline of "shareholder-centricism" and the rise of "board-centricism" do not mean excluding shareholders from ultimate control over the board and management team. Experiences from both common law and civil law systems demonstrate that while it is clear that the management authority of the company belongs to the board of directors, it is also essential to clearly delineate the decision-making power of the shareholders' meeting and the board of directors on major issues.
Regarding the internal balancing mechanism of the board of directors, its essence is an extension of shareholders' balance with the board. The book discusses the internal balancing mechanism of the board of directors in terms of the independent director system, the balanced structure of the board, and the board evaluation mechanism. Although the independent director system has played a positive role in enhancing the independence of the board, preventing insider control, and protecting shareholder interests in the corporate practices of common law countries, doubts about its ability to truly function and improve corporate performance persist. The book argues that the independent director system is not without flaws, and given the strict limitations on "independence," the limited role of independent directors is understandable. However, in the context of China's listed companies, where insider control is excessively severe, promoting the independent director system undoubtedly has positive significance.
Due to the completeness of the U.S. independent director system, the practice of the chairmanCEO (Chief Executive Officer) has been widely supported. However, analyzing the objections from other countries, if corresponding constraints are lacking, the practice of the chairmanCEO is clearly unrealistic. In China, the author agrees that the law should not support the chairmanCEO. To better achieve internal balance within the board, the subcommittee system of the board has proven to be an effective method. The establishment of audit committees, compensation committees, and nomination committees can effectively address internal control issues of the board. U.S. practices show that these three committees are primarily composed of independent directors, while other countries require them to be mostly composed of independent directors. From a more realistic perspective, the book advocates that China should mandate the establishment of audit committees, with other subcommittees varying by company, and that the composition of subcommittees should require most members to be independent directors. Regarding the evaluation mechanism of the board, U.S. practices focus on procedural regulation of evaluation, particularly emphasizing the involvement of external advisors, which is worth learning from.
The principal-agent relationship between the management team and the board of directors determines that the management team must be guided and controlled by the board. In terms of the source of the management team's power, common law provides more flexibility. Through a comparative analysis of the two legal systems, we find that while the management team has ample operational execution power, its power is always directly constrained by the board. In this sense, directly stipulating the powers of the manager in China's corporate law may not be appropriate. The decision-making power of operations and the operational execution power should be exercised jointly by the board of directors and the management team.
Stock option-based incentive plans are the primary means of motivating the management team. The book points out that incentives for the management team must adhere to the principle of reasonableness. Incentive plans that deviate from this principle will result in shareholders giving up more of their interests. Moreover, incentive plans do not necessarily correlate positively with improvements in corporate performance, so they should be approached with caution. The constraint mechanism for the management team should primarily rely on the control of shareholders and the board, as well as the functions of information disclosure mechanisms and shareholder litigation mechanisms. The book particularly emphasizes that in China, only the judicial practice of truly initiating shareholder litigation can effectively deter the management team.
Through a comparative analysis of common law and civil law, we find that the two systems have significantly different arrangements for supervisory committees. Due to differences in capital structure and legal traditions, it is difficult to say whether the supervision model combining audit committees and external auditors in common law countries is better or worse than Germany's strong supervisory committee model. There is no need to simply criticize one model for the sake of adapting to another. The orientation of China's supervisory committee system is to integrate both models. For this purpose, it is necessary to consider strengthening the power of the supervisory committee, improving the appointment mechanism for supervisors, establishing an independent external supervisor system, and implementing an audit committee system.