The Role of Competition in Determining Corporate Governance Outcomes: Lessons from Australia's Corporate Governance System
| Published date | 01 September 2005 |
| Author | Alan Dignam |
| DOI | http://doi.org/10.1111/j.1468-2230.2005.00560.x |
| Date | 01 September 2005 |
The Role of Competition in Determining Corporate
Governance Outcomes: Lessons from Australia’s Corporate
Governance System
Alan Dignam
n
Successive waves of corporatecollapse in every decade of Australia’shistory suggest that there is a
signi¢cant unresolved corporate governance problem in Australia. Corporate collapse has been
followedby reform but with little e¡ect on the overall pattern of collapse and reform every dec-
ade.Th is article suggests that one of the elements which entrenches corporate governance pro-
blems in Australia is the competitivee nvironment in which companies operate, which currently
is not regulating management. Iti s argued that this anti-competitive environment has two sig-
ni¢cant e¡ects. First, key shareholders haveretained controlling blocks of shares as the bene¢ts of
control and the costs of unconstrained managementare high in such distorted markets. Secondly,
management skills havestagnated, so that bad managementa ndregular management failure have
become features of the corporategovernance system.
INTRODUCTION
Australia has in almost every decade of the past century and more experienced
waves of corporate collapses.
1
In general the reform response was weak until an
enormous wave of corporate collapses in the late1980s and early 1990s. Between
1986 and 1995 some 500 listed companies collapsedwhich ¢nally sparkedwhole-
sale reform of corporate, securities, banking and accounting regulation.
2
This
response however had little e¡ect on the overall pattern of corporate collapse
every decade as another wave of corporate collapses swept through the Australian
economy at the beginningof this century
3
This article argues that one of the ele-
ments in embedding corporate governance problems in Australiamay be that the
competitive environment inwhich companies operate is not actingas a disciplin-
ary force on management.
In Part I the article examines the theoretical literature oncompetition and cor-
porate governance which suggests that managers operating in a concentrated
n
Readeri n CorporateLaw,Department of Law,Queen Mary,University of London. This workcould
not have been completedwithout the assista nceof the Law Faculties of the University of Melbourne
and Sydney. My thanks go to JusticeAustin of the New South Wales High Court and to Ian Ramsay,
Brian Che⁄ns, David Tomkin, Jayanthi Naidu, Geof Stapledon, Charles Mitchell, Jennifer Hill,
Michael Bryan and DavidMerrett. Particular thanks go to the anonymous referees, whose comments
were invaluable.
1SeeT.Sykes,Two Centuries of Panic: A History of CorporateCollapses in Australia(Sydney: Allen and
Unwin,1988);The Bold Riders(Sydney: Allen and Unwin,1996) 2.
2 See F. Carke, G. Dean and K. Oliver, CorporateCollapse: Accounting, Regulatory and Ethical Failure
(Cambridge: CUP, 2003) 145; on the reform response see A. Dignam and M. Galanis,‘Australia
Inside/Out:The Corporate Governance System of the Australian Listed Market’ (2001) 28 Mel-
bourneUniversity Law Review1.
3 See F.Carke, G. Dean and K. Oliver, ibid,ch14.
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Published by BlackwellPublishing, 9600 Garsington Road,Oxford OX4 2DQ,UK and 350 Main Street, Malden, MA 02148, USA
(2005) 68(5)MLR 765^797
economy such as Australia, in the absence of mitigating factors such as growth
and/or strong anti-trust regulation, are likely to be unconstrained leading to an
agency problem for shareholders. It then continues to test these theoretical
assumptions and ¢nds indicators of signi¢cant distortions to competitive forces,
that growth is not mitigatingcompetitive distortions and that in general permis-
sive competition regulation operates.
In Part II the article argues that this anti-competitive environment has in turn
two signi¢cant e¡ects. First, key shareholders have retained controlling blocks of
shares as the bene¢ts of control and the costs of unconstrained management are
high in such distorted markets. Secondly, the anti-competitive environment has
stagnatedmanagement skills which whencombined with a lackof accountability
created by key blockholders exercising control has meant that bad management
and regular catastrophic management failure has become a feature of the corpo-
rate governance system.
This workhas important implications for corporate reform both in theAustra-
lian context and for corporate reform generally. Traditionally corporate reform
has focused on the obvious solutions when there are corporate governance fail-
ures, usually company and securities law changes. Alternately, if there were an
obvious competitive issue, reform to competition legislation would be the usual
solution. This discrete approach however fails to recognise the links between the
competition environment and corporate governance outcomes. Aweak competi-
tive environment can in turn cause weakness in the ownership and control sys-
tems of companies operating in such a marketplace which in turn can cause
persistent corporate governance problems. In such a case in order for reform to
be successful it must take a more holistic approach which would include not just
reforming company and securities law but also addressing the anti-competitive
environment which has a role in corporate governance outcomes.
Additionally this study of the connection between the competitive environ-
ment and unusual corporate governance outcomes in Australia may assist our
general understanding of the role and interaction of institutions in an economy.
As Zysman notes‘national institutional structure shapes the dynamics of the poli-
tical economy and sets the boundaries within which government and corporate
strategies are chosen.
4
Institutions that a¡ectcorporate governance outcomes in a
particular jurisdiction are many and varied. They range from the more obvious
such as company and securities laws to the less obvious such as trade barriers,
media ownership rules, industry norms and competition environment.
5
As well
as a¡ectingcorporate behaviourdirectly, i nstitutions also interact with eachother.
Obvious interactions occur between formal institutions such as company and
securities laws as they are designed to be complementary. Less obviously, institu-
tions such as informal industry norms interact with formal institutions, by for
4 J.Zysman,‘HowInstitutions Create Historically RootedTrajectoriesof Growth’(1994)3 Industrial
and Corporate Change 271. Institutions here means ‘the humanly devis ed constraints that s hape
human interaction. In consequence they structure incentives in human exchange, whether poli-
tical, social, or, economic. . .’ D. North, Institutions, Institutional Change and Economic Performance,
(Cambridge:CUP,1990) 3^4.
5 For a detailed range of institutions that a¡ectcorporate governance, see B.Black,‘The Legal and
Institutional Preconditions for StrongSecur ities Markets’ (2001) 48 UCLA Law Review781.
Determining Corporate Governance Outcomes
766 rThe Modern Law ReviewLimited 2005
example, shaping the boundaries of emerging formal laws covering the same
conduct.
Where signi¢cant corporate governanceproblems arise, they may not necessa-
rily be the result of a failing in a particular institution but rather an unfortunate
side e¡ect ofthese complex institutional interactions. As a result, reforming com-
pany law to deal with a particular corporate governance problem may not pro-
duce the desired result as the problem may stem from the interaction of di¡ering
and/or sometimes seemingly unrelated institutions for example company law,
media regulation, securities regulation, trade barriers and competition law. The
only way to solve such a problem is, ¢rst, to recognise the institutions involved
in the problematic interaction and, secondly, to produce a solution addressed at
the interaction. As such, in arguing that the Australian anti-competitive environ-
ment and Australian corporate governance outcomes are linked this article is not
arguing that competition is necessarily the root cause of Australia’s corporate gov-
ernance outcomes, although it may indeed play a key role, but rather that the
range of institutions that have been assumed so far to be involved in the negative
outcomesis wider than has hithertobeen assumed and mostcertainly includes the
competitive environment in which Australian companies operate.
THE COMPETITIVE ENVIRONMENT
Competition and corporate governance theory
Competition and its e¡ecton managerial discretion are wellestablished aspects of
the academic literature on corporate governance and the theory of the ¢rm. In
neo-classical terms product market competition acts as a discipline to keep man-
agementfocused on pro¢t-maximisation. For example, Hart in what has become
something ofa primary referencepoint on competition and management discre-
tion argues that the more competitive the environment the less discretion a man-
ager has and therefore the les s opportunity to act i n their own self-interest.
6
Gilson and Roe
7
consider ‘the most elegant monitoring mechanism is intense
product market competition’,
8
and as Allen and Gale explain:
competition is important . . . A ¢rmca n lose its entire marketto a stronger compe-
titor. In fact, this kind of competition may be seen as an alternative to the takeover.
Instead of having a raider take control of the assets of a company with a weak man-
6 O. Hart,‘The Market Mechanism as an IncentiveScheme’ (1983) 14 BellJournal of Economics 366.
Within the general debate on the e¡ect of competition on managerial discretion there are some
who while not disagreeing with the general thesis would qualify that position. See M. Jensen,
‘The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems’ (1993)48
Journal of Finance850.
7 R. Gilson and M. Roe,‘Understanding the JapaneseKeiretsu: Overlaps Between CorporateGov-
ernance and Industrial Organization’(1993) 102Yale LJ 871.
8 See also F. Mayer,‘Corporate Governance, Competition, and Performance’ in: S. Deakin and
A. Hughes (eds),Enterpriseand Community^ New Directions in CorporateGovernance(Oxford: Black-
well, 1997) 171^194. See also E. Fama,‘Agency Problems and the Theoryof the Firm’ (1980) 88
JournalofPoliticalEconomy288.
Alan Dignam
767rThe Modern LawReview Limited 2005
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