The prestige of the West’s governance model relying on rules and transparency has been severely damaged by the recent financial crisis. The East’s approach, which depends more on trusted relationships, has shown that it can contribute to long-term corporate thinking.
This is the conclusion of a CIMA report, Global perspectives on governance: lessons from East and West, which will be launched in conjunction with the coming World Congress of Accountants (WCOA) 2010, to be held in November in Kuala Lumpur.
The report says that the Western corporate culture, with its emphasis on complying with rules, principles and laws, has been held up as a model for how companies should be run globally. In contrast, Asia and much of the rest of the world place particular emphasis on trust and relationships. This reliance on relationships with trusted individuals has often been branded as cronyism.
However, following the collapse of major Western institutions including Lehman Brothers, it has become clear that the Western way of doing business can lead to short-term thinking and a lack of sustainable strategies. The increasingly rapid turnover of chief executives and flawed incentives schemes have helped to promote this.
And while reliance on trusted relationships can be vulnerable to corruption and cronyism, some Eastern business leaders have an ingrained focus on the long-term, for example in family businesses where the wish is to hand a successful and sustainable business on to the next generation. The Chief Executive of CIMA, Charles Tilley, had said that the key responsibility of company boards, wherever they are located, is to ensure the long-term sustainability of their businesses.
Questioning the West
The recent financial crisis in the West has led many to question whether the heavy focus on maximising shareholder value is the best way of achieving this goal and to reconsider the role of business. There is much the West can learn from the Eastern approach, in particular the emphasis on the long-term and the view that the fundamental purpose of business is to help improve the well-being of the wider community.
If in running a company, the aim of management is purely short-term shareholder value creation, the enterprise may wind up failing to build a sustainable business or contributing to society generally.
Corporate governance can be defined as the way in which organisations are directed and controlled. Although practices may vary, the core underlying principles of governance are the same throughout the world. They strive to protect the rights of shareholders, to create an environment of transparency and appropriate disclosure, and to define the roles and responsibilities of stakeholders in running a company.
These principles are necessary to establish a stable and competitive business and, in the case of publicly quoted companies, an attractive destination for investment. National economies also benefit from good governance as a critical component for safeguarding wealth, employment and GDP growth.
CIMA has long advocated a holistic approach to corporate governance wherever it is practised. Its philosophy of enterprise governance emphasises that all organisations need to focus on both conformance and performance. The measure of good governance in a company should be whether the board of directors is truly focused on the long-term sustainability of the organisation. There should be confidence that the business model will deliver this, with appropriate risk mitigation, and that performance indicator and incentives reinforce the desired behaviour.
Broadly speaking, transparency and agreed rules of engagement are paramount in the West. The focus is on rules (including principles-based accounting standards and codes of practice as well as legislation) and transparency, creating a level playing field for competitors. This Western model has led globalisation, produced most of the strongest multinationals and is the bedrock of the world’s developed economies.
Understandably, it is widely viewed as best practice. Major corporate failures have historically led to the tightening of governance codes and legislation in order to improve transparency and accountability. But in light of the disproportionate impact of the global financial crisis on Western institutions, there is now widespread recognition that there are limits to what such measures can achieve. There is now much more emphasis on behavioural issues.
In Asia, Africa and most emerging markets, the approach to business is somewhat different: relationships sometimes take precedence over transparency. This has its roots in systems in which regulations are not always strongly enforced and legal redress can take years or even decades.
In this environment business is based on trust and loyalty. The practical emphasis on relationships prevails among most businesses in these regions. Yet many are formally adopting Western practices in their journey towards globalisation at the very time that the financial crisis has cast a shadow over the Western governance model.
John Kay, a leading British economist, recently analysed how the two approaches played out in the car industry. In a recent column for the Financial Times, he observed: ‘Lawyers for American companies spent hundreds of billable hours drawing up contracts to which no one ever referred. Their Japanese counterparts engaged in complex business relationships with no formal agreements at all, or ones that covered a single sheet of paper. But the commercial relationships that emerged in Japan’s car industry were more successful in securing component reliability and just-in-time inventory than those hammered out by the hard-nosed negotiators of Detroit.’
The CIMA report urged companies to make ethics and building sustainable businesses their highest priority and take the best from both approaches. This will ensure the development of strong and healthy companies that earn the respect and trust of the wider community. This is crucial if business is to be perceived as a force for good in contributing to future global prosperity.
Best of Breed
Business leaders in the East and West who understand the differences and can extract the best from both styles may stand to benefit. On the other hand, underestimating the challenge can cause problems. Some Western companies stumbled as they expanded into Asia when their rules-based processes clashed with the local culture, for example. At the same time, Eastern companies aspiring to become powerful multinationals found that their personal networks became strained and ineffective when stretched across vast distances and different cultures.
This report takes a closer look at the Eastern model and analyses its advantages and disadvantages. It also discusses the role of management accountants in finding a common ground between the models.
Many would agree that the challenge for Asian companies is to retain the advantages of individual relationships while finding tools to compensate for the disadvantages. The challenge for management accountants is to recognise the benefits inherent in the Eastern model and to guide a strategy that mitigates the dangers without diluting these benefits.
Now that the Western model of governance looks far more fallible than it did before the global financial crisis, the time is ripe for examining the model that helped to insulate Asian companies from the worst of its effects.
If the Western model were to lose its pre-eminence and the Asian alternative were to gain followers globally, what else would be lost and gained?
The basis of such a model could be CIMA’s boardroom leadership framework, which stresses the importance of people and behavioural issues as well as appropriate frameworks, processes and structures. This is considered in the third article in this series, which will appear on CFO Innovation on November 22, 2010.
Individual relationships have been an integral part of business for centuries throughout Asia. Entertaining and getting the measure of your prospective business partner were often the first steps in making a deal, well before benefits and money were even mentioned. Relationships in companies could trump performance and leaders were greatly respected – their word was law and their decisions indisputable.
While giving individual relationships such weight creates difficulties, it also brings advantages that can easily be overlooked. A 2003 white paper on corporate governance in Asia by the Organisation for Economic Co-operation and Development (OECD) noted: ‘The informal nature of Asian stakeholder/ company interaction can produce real and lasting benefits for stakeholders that equal or exceed those offered through more formalistic approaches based on “rights”.’ The paper also noted that, with the advent of globalisation, there was an increasing tendency in Asia towards creating more formal corporate structures.
Furthermore, John Hooker, Professor of business ethics and social responsibility at the Tepper School of Business, discussing various shades of nepotism and cronyism, recently wrote: ‘Many such cultural differences arise from the fact that Western cultures are built on rules and transparency, while most of the world’s other cultures are relationship-based. Westerners trust rule-based institutions; others trust their friends and family far more and are therefore especially keen to cultivate strong relationships.’
About the Authors
Victor Smart is CIMA Head, Profile and Communications, while Gillian Lees is CIMA Enterprise Governance Specialist. CIMA’s report, ‘Global Perspectives on governance – lessons from East and West’ will be launched at the World Congress of Accountants 2010 in Kuala Lumpur (November 8-11). CIMA is the proud Gold Sponsor of WCOA 2010. For more information, please visit www.cimaglobal.com/wcoa
CIMAplus is a new member offering to enhance employability. Visit www.cimaglobal.com/cimaplus
This sponsored article is the first in a four-part series.