Convergence and International Corporate Governance

Find and summarise (in no more than 1000 words) some of the work that has been done by Katherine Pistor and others on Convergence, Divergence and ‘Path Dependency’ of legal systems as it relates to International Corporate Governance.

In recent years the issue of corporate governance has become a keenly debated topic in international finance. In developed countries, some of the biggest corporate collapses in history have brought about a change in focus. No longer are governments and lawmakers trying to deregulate and reduce the controls and disclosure requirements of corporations. The deregulation boom has ended, as regulation comes back into the picture.

After the Latin American Crisis of 1995 and the Asian Currency crisis of 1997-1998, corporate governance is also a key area of concern in developing countries. Questions about the optimal set of rules and regulations that govern corporations are being posed. One of the biggest points of discussion in this debate is how corporate governance and legal systems are developing of their own accord, and in particular relative to one other. There are two schools of thought in relation to this issue: those who believe in convergence and those who believe in divergence. The convergence school says that countries select the laws that have been shown to be the most effective in other countries, because of competition between regulators. On the other hand, the divergence approach says that laws are path dependent, meaning that legal rules are determined by pre-existing structures and laws.

Convergence

In an increasingly globalized world, efficient new technologies and production systems spread rapidly, as competition quickly removes those producers who are slow to react. Those who believe in the convergence argue that “just as the founders of a firm have incentives to make the kind of products that people want to buy, lawmakers have the incentive to make the kind of firm, governance structure and securities that customers want to buy” (Easterbrook & Fischel 1991, pp. 212).

As barriers between countries fall, firms can more easily move to countries with the most attractive corporate governance rules. Inevitably, it is argued, the world will move towards have one set of harmonious legal rules.

Divergence

Why is it then that the legal rules we see throughout the world differ so greatly? This is the question that is asked by the divergence school of thought. The most widely accepted answer to this question is path dependency of legal systems. One of the first papers on path dependence in corporate governance was written by Bebchuk and Roe in 1999. They say that “Path dependence focuses on reasons why countries that are otherwise similar in all other aspects of their economy might still differ in their corporate structures” (Bebchuk & Roe 1999, pp. 4). Bebcuk and Roe use path dependency to explain why it is that countries don’t always choose the most efficient governance structure. The key to path dependency is that not only is the current location of a country’s legal systems important, but also the path they took to get there. As an example, taking a photograph of an object in motion tells us where it is but does not tell us where it came from, and where inertia will lead it.

Two sources of path dependence are identified: structure driven and rule driven. Structure driven path dependence is about the way in which initial structures in an economy directly influence subsequent structures (Bebchuk & Roe 1999).

The main reason given for the persistence of existing structures is rent seeking. Parties that enjoy rents under existing structures may impede or direct changes to those structures.

Rule driven path dependence states that initial ownership rules affect subsequent ownership rules as well as other aspects of corporate governance. The most important aspect of rule driven path dependence is the role of interest groups. Legal rules which affect corporate players will themselves