Relation-based Versus Rule-Based Governance Systems


A colleague of mine and former Associate Editor for this journal, Shaomin Li, has written for many years about relation-based versus rule-based governance systems. The basic idea is relatively simple, but it is also powerful – rule-based governance systems rely on public rules – formal laws and government regulations to encourage and facilitate economic exchange. In other words, economic transactions are publicly ordered. In contrast, relation-based governance systems rely on private guidelines – informal relationships and norms of reciprocity – to encourage and facilitate economic exchanges. In other words, economic transactions are privately ordered (Li, 2009). A provocative insight from Li's framework is that the choice of governance system is a matter of scale and stage of development – when the economy is local and limited, relation-based governance can be effective and efficient. As the overall economy expands and globalizes, it will lose its cost advantages and thus must evolve into a rule-based governance system. Traditionally, developed economies operate with rule-based governance systems and developing economies operate with relation-based governance systems. However, each national economy is constantly evolving, and there is no pure governance type in practice.

It occurs to me that the articles in this issue reveal where various economies exist within this typology, and provides some nuanced insights into this overall governance perspective. Our lead article, authored by Pindado, Requejo and de la Torre, explores the idea that family firms use dividends to overcome the potential agency problem associated with controlling ownership by the family. Employing a longitudinal sample of firms in nine European countries, they find that family firms can alleviate expropriation concerns by making higher dividend payments. However, the higher dividend payments are primarily explained by family firms with no separation between the largest owner's voting and cash flow rights, and those with non-family second blockholders. Hence, the size and type of the two largest ownership stakes are highlighted in this multinational empirical study. In Chapter 2 of Li's (2009) book, he argues that there are three types of trust used to govern economies: (1) generalized trust, (2) family-based trust, and (3) extended particularized trust. As such, this study appears to uncover how generalized and family-based trust interact to govern European economies where concentrated family ownership is the norm. Young and Marais are the authors for our second study which examines CSR reporting in two diverse government environments: Australia and France. Their examination of 220 Australian and French firms in 2009 reveals that CSR reporting is stronger and CSR practices are more transparent in France than those in Australia. Interestingly, industry characteristics override the influence of national institutions in high-risk industries. Overall, it highlights the relative institutional influence of national and industry context for determining voluntary governance practices and reporting procedures. In Chapter 4 of Li's (2009) book, he explores this idea that disclosed information is treated differently in different governance contexts. This study supports that argument, and it refines this notion by bringing into focus how industry context can influence governance dynamics as well as the overall governance system.

Our third article focuses attention on governance within China, a major transition economy with growing importance within the global economy. Using China's 2003 banking reform legislation as a naturally occurring experiment, Hsieh and Wu find that borrowers' earnings management behavior declined after the reform. Furthermore, they report that this practice is more pronounced in state-owned borrowers and lenders than in non-state-owned enterprises. As such, this study suggests that China might be moving slowly away from its relationship-based to a more rule-based economy, at least with respect to its state-owned enterprises. In Chapter 8 of Li's (2009) book, he compares Russia's “big bang” approach to transition as opposed to China's gradualist approach. This study illustrates how governance systems might play out differently between state-owned and non-state-owned entities.

Kaczmarek, Kimino and Pye are the authors of the fourth article in this issue. In this study of large public firms based in the United Kingdom, the authors seek to better understand how the composition of the board's nomination committee might influence the diversity of the overall board. Specifically, they illustrate that when the nominating committee is composed of more females and more non-British nationals, the overall board is typically composed of more females and non-British nationals. Furthermore, they also demonstrate that the presence of the CEO on the nominating committee may hinder the independent functioning of that same committee. In Chapter 5 of Li's (2009) book, he discusses boardroom deliberations as either “mafia boss” or “modern manager” styles. This particular study suggests that nominating committees can either function like a mafia meeting where the CEO dominates the group, or like an independent, meritocratic arbiter of the best talent to enable the firm to compete in an efficient and effective manner.

Our fifth and final article is authored by Wu, and it examines share repurchase agreements in Taiwan. Many firms announce that they intend to repurchase their own shares in order to signal that they believe the stock to be undervalued. Some firms make repurchase announcements even if they do not believe their stock to be undervalued with the hope that misinformed investors will bid up the stock price. Wu explores the idea that the overall quality of corporate governance helps the marketplace sort out those firms that are legitimately undervalued, and those who are not. Overall, both internal and external corporate governance mechanisms are shown to influence the capital market's reactions to share repurchase announcements. Li (2009) argued that Taiwan is undergoing a transition from a relation-based to a rule-based governance system (p. 114). The above findings lend credibility to this claim with the increasingly efficient functioning of its capital markets.

Overall, I commend Shaomin Li's book as well as these five empirical studies for all those interested in developing a global perspective on corporate governance. The journal is now classified in three journal categories in Thomson ISI: (1) Management, (2) International Business, and (3) Finance. This interdisciplinary focus of the journal is flourishing in no small part to literally dozens of talented governance scholars operating all over the world and trained in many different disciplines. And finally, I want to draw attention to Ms. Krista Lewellyn, our energetic and dedicated Managing Editor. Without Krista's 24/7 approach to the journal and commitment to excellence, I know that the journal would not be enjoying the great success that it is currently experiencing.