Pakistan Administrative Review

Vol. 2, No. 4, 2018

Corporate Governance Systems and their Impact on

Performance of Companies

Nida Masroor
Jinnah University for Women
Karachi, Pakistan
[email protected]

Shabeeb ul Hassan,
Hamdard University
Karachi, Pakistan

Abstract: Lack of governance has always been an issue in Pakistan, restricting growth of its
companies. The increased competition due to arrival of MNCs, well-equipped with best
practices, emphasizes the need of good corporate governance systems according to socio-
economic culture of Pakistan. A good corporate governance system helps accelerate the socio-
economic growth of a country by maintaining a balance between rights of all stakeholders. The
corporate governance models adopted by most of organizations in Pakistan and other developing
nations include Anglo-US, German and Japanese models. The same are reviewed to evaluate
their application in Pakistan. The study will help understand benefits and problems of mentioned
corporate governance systems and also help design a system best for Pakistan ensuring balance
of power and representation of all stakeholders that is one of the main reasons behind poor
governance in Pakistan.

Keywords: Anglo-US model, German model, Japanese model, Corporate Governance,

Stakeholders model

Reference: Reference to this article should be made as: Masroor, N. & Hassan, S. (2018).
Impact of Corporate Governance Systems on Performance of Companies. Pakistan
Administrative Review, 2(4), 373-382.

1. Introduction
With the changing global scenario and transformation of Multinational Companies into
Multinational Economies, the concept of corporate governance is also broadened. According to
OECD “Corporate Governance is the system by which business corporations are directed and
controlled. The corporate governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board of directors,
managers, shareholders and other stakeholders, and spells out the rules and procedures for
making decisions on corporate affairs. By doing this, it also provides the structure through which
the company objectives are set” (OECD, 1999). Simply corporate governance refers to the
manner in which the affairs of a corporate body are or should be conducted in order to serve and
protect the individual and collective interests of all stakeholders (Butt, 2008).

Copyright@2018 by the authors. This is an open access article distributed under terms and conditions of the
Creative Commons Attribution (CC BY) license (http://creativecommons.org/license/by/4.0). 373
 Pakistan Administrative Review
Vol. 2, No. 4, 2018
Corporations are of vital importance for the economy of a country. Pakistan is a developing
country with a GDP of 304.952 billion US$ and per capita income of 1580 US$ (World Bank ,
2018). Lack of availability of finance has always been a major hurdle in the growth of the
corporate sector especially in under developing economies. Pakistan is also among those
countries dealing with the same problem (Beenish, 2013). World Bank declared lack of access to
finance as one of the major barriers to growth of more than 50% of SMEs (WBR, 2015). Certain
manufacturing companies need huge investments and such capital intensive organizations can
only be set up in the form of a joint stock company. The presence of joint stock companies
ensures distributed profits and losses among all the people of the society as the total assets of a
company are divided into easily purchasable and transferable shares. It also provides individuals
the opportunity to invest (even with limited amounts) and harvest the profits, therefore
maintaining equality and balance in the society (Pepelasis, 2011).
The corporate sector in Pakistan is mostly based on SMEs. According to IFC report (2012), out
of 3.2 million enterprises in Pakistan, 3 million are SMEs contributing 30% to GDP and
employing 70% of labor force whereas only 0.2 million are large scale manufacturing, that are
mostly government or foreign owned. The limited number of large scale manufacturing
organizations is also due to lack of investments. According to SME Policy 2007 by SMEDA,
SME may be defined as the entity with a paid up capital of Rs.25 million providing employment
to up to 250 people (Waheed, 2013). The investment of Rs. 25 million in sole proprietorship or
even in partnership is also beyond capacity of so many people. Therefore the development of
sound and stable stock market, facilitating ease in share investment and maintaining
transparency, will not only help in growth of SMEs but also large scale capital intensive
organizations can easily be established (SECP, 2002). Moreover, in the Islamic societies where
“Halal Haraam” is always a consideration, providing ease in share investment would gain more
positive response than bank fixed deposits (FD), bonds or certificates (Hussain, 2005). Secondly,
the employment opportunities generated by SMEs are also limited as compared to those
generated by large corporations. SMEs provide employment up to maximum of 250 persons
whereas organizations having greater number of employees i.e. more than 250 are considered
large scale organizations. In Pakistan, 3 million SMEs are quite insufficient to generate
employment for majority of population. Apart from the limited number of large scale
manufacturing organizations, lack of growth in SME sector is also evident by the similar
statistics reported by SMEDA in 2018. Hence an increase in number of corporations is also
required to increase employment opportunities (Muhammad, 2010).

1.1 Important Considerations in Corporate Governance system

The health of the corporate sector of a country defines its effective corporate governance system.
According to OECD (OECD, 2015), the key considerations for Good Governance are:
i. Rights of Shareholders
ii. Equitable treatment of shareholders
iii. Role of stakeholders
iv. Disclosure & Transparency
v. Responsibilities of Board of Directors

OECD elaborated its corporate governance mechanism with the help of effective management in
five dimensions that helps builds up good will and corporate image of the company in the
market. These five dimensions give a brief but concrete outline of rights and obligations of all

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stakeholders and the way to manage them efficiently. Safeguarding the rights of share holders
along with equitable treatment of all shareholders builds up the board’s image, investor’s trust
and the company’s goodwill in the stock market. The role of directors towards stakeholders and
timely disclosure of all required financial and management details builds up the credibility and
trustworthiness of board. This behavior consequently affects the perception and attitude of
stakeholders regarding company’s acts and strategies. The positive or negative attitude of
stakeholder including creditors, employees, customers, and investors ultimately defines the
company standing in the market. The above mentioned guidelines help understand the
mechanism along with the rights and responsibilities of all the stakeholders. (Fernando, 2015)
A good corporate governance model properly elaborates the rights of all the stakeholders.
Different mechanisms are followed by different countries as per their socio-economic cultures.
The socio-economic culture of a country also helps understand the primary considerations of the
people of the country and their approach towards investment (Al-Malkawi & Pillai, 2018). The
constructive role and healthy participation of all the stakeholders also ensures good governance.
These stakeholders can either be employees actively contributing to company’s performance or
the customer’s feedback or complain regarding the quality of product. Positive role of
stakeholder improves company’s performance and guarantees transparency (Fernando, 2015).
Although the organizations try to achieve economies of scope through implementation of same
corporate governance mechanism but the practices of an organization vary from country to
country. This is due to difference in the macro environments of countries. A company has to
modify, adjust or manage the components of their micro environment (infrastructure, employees,
distribution channel etc.) according to the macro environment of the operating country (Waheed,
2013).

1.2 Corporate Governance in Pakistan

Corporate governance plays a significant role in strengthening the long-term economic
development of companies and countries. SECP was the first to introduce the Code of Corporate
Governance for Pakistan in 2002 (SECP, 2002).
According to a survey of corporate governance practices in Pakistan, conducted by International
Finance Corporation and SECP in 2007, 92% respondents prepare “annual statement of Ethics
and Business Policy”, 48% had “vision and Mission Statement”, and none of the respondents
have Code of Corporate Governance. On the other hand, it was also found that 53% have not
implemented a formal remuneration system, and 55% did not have corporate governance
improvement plan; whereas, 31% respondents did not identify the barriers to improve the
corporate governance, 69% identified the barriers, 42% did not have qualified staff to implement
the corporate governance practices (IFC, 2007).
This might be due to the reason that the basic knowledge of corporate governance is delivered at
higher level studies whereas most of the people get into their professional lives after the
completion of 14 years of education or sometimes less than that. The lack of awareness about the
stock market, its mechanism, regulatory forces defining the corporate control mechanism and the
corporate sector is a big threat for the whole economy. This barrier restricts the policy makers in
making and implementing policies and strategies (Muhammad, 2010).

1.3 FDI Influence on Corporate Governance in Pakistan:

The economy of Pakistan is mostly based on foreign direct investment (Mir, 2010). Investments
are made in different sectors including agriculture, mining, FMCG etc. A form of foreign

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investment is multinational companies or SBU’s (Strategic Business Unit). Currently, among the
listed 165 companies in Pakistan, 47 are multinational companies. Moreover, these 47 companies
have a number of brands that are working as separate SBU’s. Apparently, the contribution of
MNC's in stock market seems to be around 30% but this stake is magnified due to the number of
SBU’s working under these companies. Moreover, the volume of the investment of these 47
companies is much greater in comparison with the rest of 118 companies. Due the volume of
these companies, the stake associated with them is also increased. This has resulted in a greater
influence of these companies on the society, government, customers and rest of the stakeholders.
Their stake in the economy also blesses them with the power to modify the macro environment
of the host country (Beenish, 2013).
The CEO or head of these multinationals is mostly a person appointed from the home country.
Besides investment, these companies also apply their home country’s management, HR practices
and corporate governance models in the host country to achieve economies of scope. The CEO
from host country also governs and monitors the smooth application of these managerial
practices (Dariana, 2015). Most of the MNCs operating in Pakistan are from the American
origin. Therefore, the corporate governance model mostly adopted is Anglo American
governance model. There are other companies as well with different models like different
Japanese organizations that are working in Pakistan (Tahir & Sabir, 2012).
Dr Shahid Javaid Burki- a long observer of Pakistan’s economy has stated “Pakistan can
generate a greater bounce in its economy than India by creating better governance. It has
occurred before in the country’s difficult economic history and could happen again.” (Improved
Governance: Dawn, 12th, October 2010). Although the corporate governance models of highly
developed countries are followed by so many foreign companies or the domestic firms but still
the progress of the organizations present in Pakistan is not remarkable. Some organizations make
modifications according to the changing scenario and the socioeconomic environment that are
proved beneficial for the organization. Some of the examples include Askari bank and Bolan
Castings etc (Gwadar, 2009).
The purpose of the study is to achieve the below mentioned objectives:
 To find out the loop holes that exists in the Anglo American, German or Japanese
corporate governance system
 To make Comparison of companies working with anglo American model and any other
model i.e. Japanese or German model
 To find out the different socioeconomic features that restricts its applicability in Pakistan.
 To highlight the features of different models supportive to their application in Pakistan.
 To elaborate guidelines for drafting a corporate governance model according to the
socioeconomic culture of Pakistan.

2. Literature Review
The concept of corporate governance varies from country to country (Epstein, 2018). A very
diversified and emergent literature is available showing the success stories of the capitalist
nations, their strengths and weaknesses and their applied strategies, structures and mechanisms.
Below is the literature evidences focusing on three of the selected and mostly adopted models.

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2.1 Anglo-American Model

Board of Directors
Shareholders Stakeholders

Managers

Regulatory/ Legal
Creditors
system
COMPANY

Figure 2.1: Anglo-American Model (Adopted from corporate governance by A.C. Fernando)

The American model is also known as unitary model in which a single board is formed,
comprising executive and non- executive directors. The power to elect a director that is the
voting right lies with the shareholders. In such cases, where the directors are elected by the
shareholders of the company, the directors seem more inclined towards them and the approach of
governance tends to be more shareholders oriented. The legal and regulatory environment has
most comprehensive policies also ensuring the protection of shareholders right. The excess
inclination towards shareholders rights sometimes results in ignorance towards rights of other
stakeholders (Davies, 2016). Although most of the MNC's are from US origin, defining the
success of American governance model but apart from their strict regulatory environment, there
are also numerous cases of violation of other stakeholder’s rights. The application of shareholder
wealth maximization model and ignorance towards employee participation in Director’s
selection may risk employee rights and their satisfaction level (Yermack, 2017). The application
of such model in societies with weak regulatory environment results in violation of employees
rights consequently reducing their morale and satisfaction. Employees are an asset for the
organization but dissatisfied employee can sometimes ruin the company’s progress (Wenger &
Kaserer, 1998).
Although American model seems to go with equity financing but still institutional investors have
a great contribution in American economy. Majority of top most brands have more than 50% of
their capital structure based on debt financing allowing them to well reap the leverage benefits
(Desender & Epure, 2015).
Contrary to Japanese and German models, banks or the financial institutions are not given the
right to take part in the governance. This somehow reduces the level of trust between both
parties. Although the disclosure policy is too strict but still the creditors can only see what is
disclosed. As per the US anti monopoly legislation, no single bank can provide multiple services
(Desender, Aguilera, Lópezpuertas & Crespi, 2016). Although this was to eliminate the influence
of bank in the organization but expanding the borrowed financing to multiple investors
sometimes proved to be the worst experience for the whole economy especially in times of
crunch or slump in the economy. This is evident by the fact that the American economy
experiences a slump after every 12-15 years which is mostly due to the bankruptcy of a
company. Due to the expanded operations of MNC's and the presence of their stakeholders all

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over the world, these slumps in the economy also turn into global crunches. As the bankruptcy of
a single company results in decline or the bankruptcy of the banks or institutions that had their
stake in the company and so the chain goes on (Ducassy & Montandrau, 2015).

2.2 Japanese Model

The Japanese model is also known as the business network model, as it reflects the cultural
relationship seen in the Japanese keiretsu. Keiretsu is a name given to a corporate structure in
which a number of organizations link together, usually by taking small stakes in each other and
usually as a result of having a close business relationship, often as suppliers to each other (Yafeh,
2001). The members of keiretsu are expected to collaborate as partner due to their assured long
term relationships mutually providing technical assistance to the company. Although the
American officials dislike it as they consider it a kind of family ownership but the Japanese firms
often prosper due to the same strong and long term linkage as many issues of trust and
transparency are resolved. The developed long term supplier and distribution channel relation
results in effective supply chain management and timely distribution of goods thus contributing
good governance within the organization and ensuring company’s success in the global scenario
(McCahery, Sautner,, & Starks, 2016). The key stakeholders in Japanese model are the inside
shareholders which comprises of affiliated companies or keiretsu and a main bank. Although this
policy is against the US anti-monopoly legislation, that restricts one bank from providing
multiple services, but proved beneficial results for the capital intensive organizations of Japan.
Manufacturing companies need huge finances and availability of a strong financial institution
plays a supportive role for them (Dariana, 2015). Mostly, the main bank plays the role of major
shareholder instead of being a creditor. Although the absence of borrowed financing prohibits
from reaping the leverage benefits but somehow this also reduces the chances of bankruptcy.
Therefore, the Japanese model ensures slow and steady safe growth instead of the fast but risky
growth present in American model due to multiplier leverage effect. Moreover, there also exists
a difference between the natures of prosperous industries in both countries. Japan is famous for
its automobile and electronics industry as it is home to world’s largest electronics companies
such as Sony, Casio, Mitsubishi, Panasonic, Canon, Nikon, Yamaha etc. and the top automobile
manufacturers of the world including Toyota, Honda, Suzuki and many others that are known for
their innovative and quality vehicles and products. However, the prominent brands from
American origin are mostly top FMCG / food brands like Unilever, P&G, Nestle, McDonalds,
KFC, Star Bucks, and Dunkin Donuts etc.
Secondly, in both the cases i.e. either in borrowed or equity financing, one bank is selected to
ensure and maintain long term relationship. The development of such long term relationship is
proved to be a success especially for the development of capital intensive industries where it
takes time to achieve economies and recover investment. This fact is also evident by the
development of Japanese firms in the fields of technology and electronics (Yafeh, 2001).
Contrary to Anglo-US model, non-affiliated shareholders have no active participation in
Japanese governance. Instead, the main decision making power lies with independent directors.
Although the disclosure requirements are not very strict in Japanese model but that sometimes
does not have much effect due to the fact that the level of trust is high because of long term
relationships maintained in keiretsu (Ducassy & Montandrau, 2015).

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Supervisory
Board

Shareholders President Main Bank

Executive
Management

COMPANY

Figure 2.2: Japanese Model (Adopted from corporate governance by A.C. Fernando)

2.3 German Model

The German model is also known as two-tier model as the governance is exercised by two
boards. One is the supervisory board and the other is the management board. The members of the
management board are selected by the shareholders. The bank representatives are also elected as
part of the German management board. This is due to the fact that the banks hold long term
stakes in German corporations (Bottenberg & Flickinger, 2017). Although, the German
corporations prefer to go with bank financing instead of equity financing so as to take the benefit
of the leverage effect. However, the participation of bank in the management board is
compulsory which is contrary to the Japanese model where the participation of bank in
management is kept optional (Davies, 2016). Therefore, the benefits of long term relationship are
also well reaped in German model as well. The advantages associated with long term relation
with the banks are easy availability of finance, low chances of bankruptcy, further growth
opportunities in capital intensive organizations etc. During the last decades, the significant
growth in the technology and electronics sector in Germany defines the success of German
model (Jürgens, U. & Rupp, J., 2001).
The second aspect, unique in the German model is the appointment of supervisory board, which
comprises of 50% of the total board and solely appointed by the employees and the labor unions
of the corporation. This depicts the stakeholder capitalism and societal welfare approach of the
German model (Wenger & Kaserer, 1998). Giving employees the right of participation in the
board provides a number of benefits to the organization. It helps management better supervise
employee’s affairs. The decisions are mutually taken by both the boards. This somehow reduces
the chance of violation of employee’s rights and helps in building up employee satisfaction level.
Therefore, the employees own the company, management and their decision as their own and
with free consent. Secondly it builds up employee’s confidence on management decisions thus
increasing their motivation and dedication towards work. The increasing level of employee
satisfaction in Germany is evident by the success of its organization, country performance and

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increasing number of immigrants in Germany during last decades (Desender, Aguilera,
Lópezpuertas & Crespi, 2016).

Supervisory
Board

Employees & Management Shareholders

Labor union Board

Company

Figure 2.3: German Model (Adopted from corporate governance by A.C. Fernando)

3. Discussion and Conclusion

From the above-mentioned discussion, following facts are revealed: Anglo American model,
although successful in so developed countries but due to ineffective system of legal compliance
and investor’s protection, fails to produce desired results in so many countries (Soltani &
Maupetit, 2015). The participation of creditors/ financial institutions in director’s selection
positively contributes to their trust thus enabling long term relationship. The creditor is deprived
of this right in Anglo-American system consequently affecting the level of trust due to limited
access to company’s internal information. This is also evident by the regular bankruptcy of
companies and slump in American economy that initiates from the bankruptcy of a single
company and spreads as a global crunch (Tahir & Sabir, 2012). Moreover, the Anglo-American
model works more on shareholder wealth maximization model that somehow seems ignorant
towards rest of stakeholders. It is also evident by their act of restricting employees and creditors
from voting rights for director’s selection. This ruins the level of confidence among the
stakeholders and consequently affects the performance of the organization (Aguilera & Crespi,
2016).
German model seems to be more inclined towards stakeholder capitalism model. Equal rights to
director’s selection are given to other stakeholders giving rise to the confidence on management
and the board (Jürgens, U. & Rupp, J., 2001). This act also helps reduce the agency problem.
Participation of employees in director’s selection also helps in encouraging whistle blowing
attitude within the employees of the organization. Moreover, in Pakistani scenario, where legal
compliance is not very effective, it is required to build trust with increased transparency that is
the core essence of German model and an essential part of organization performance. Giving
confidence to employees by making them a part of a big decision helps develop team attitude.
Many such HR management practices define a number of benefits to the organizations including
enhanced efficiency and creativity of employees (Gwadar, 2009).
The same is the case with Japanese model that resembles more to family ownership. Family
ownership is also more followed in Pakistan due to increased trust and reduced risk. This is also

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evident by the success of many family based organizations including Gul Ahmed, Younus,
Hashoo and Nishat group etc (Hussain, 2005). In absence of legal compliance, shareholders and
directors from being the part of same family help resolve many problems and dispute regarding
rights of shareholder and their equitable treatment. Moreover, the family people raised with their
future profession in mind not only play a beneficial role but prove to be an asset for the
organization in the form of employees and the prospective directors. Growth by means of
forward or backward integration helps define productive solution in supply chain and distribution
channels with enhanced integration between stakeholders. These strategies help maintain long
term performance of the organization (Mir, 2010).
It can be seen that all the Anglo-US Model, Japanese and German Models of corporate
governance have their respective pros and cons. No individual model/system of corporate
governance designed for any specific country can be applied in another country due to change of
their socio-economic environment. There is strong need to formulate and adapt a hybrid model
of corporate governance for the betterment of Pakistani economy. Therefore, a separate corporate
governance system is required, eliminating flaws of Anglo-American system by adding good
points of German and Japanese models as per the socio-economic environment of Pakistan. The
model should include major stakeholders (shareholders, banks and employees) in director’s
selection by giving them voting rights. This will help ensure the transparency and avoid
director’s inclination towards any specific stakeholder thus safeguarding all stakeholders’ rights.

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