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1.2 Path-dependence

The prediction of convergence has been challenged by a number of academic contributors who, as we have been, point to obstacles that stand in the way of a global model for corporate law. Subsections 1.2.1–1.2.5 will analyse these barriers in turn.

1.2.1 Politics

Prominent legal scholars have propounded the view that political forces cause legal systems to develop path-dependently. Mark Roe points out that there are still significant differences between the corporate governance in different jurisdictions, caused by differences in their political orientation. He shows that there is a correlation between a social democratic form of government and certain corporate governance patterns.7 Roe’s view is, in principle, also endorsed by Peter Gourevitch, who refines it by pointing to the fact that it is not so much the form of present government, but the type of government that was in place when corporate governance structures established themselves, that matters. Gourevitch also stresses the fact that a distinction between leftand right-wing politics is too simplistic to account for the relevant political forces, in particular the influence of political interest groups that cut across the left/right political divide on corporate governance patterns.8

7For a comprehensive statement of this theory, see Mark J. Roe, Political Determinants of Corporate Governance (Oxford: Oxford University Press, 2003); for a discussion of Roe’s central political thesis of corporate governance, see Peter A. Gourevitch, ‘The Politics of Corporate Governance Regulation’, (2003) 112 Yale L. J. 1864; for an international relations perspective, see Jeffrey N. Gordon, ‘An International Relations Perspective on the Convergence of Corporate Governance: German Shareholder Capitalism and the European Union, 1990–2000’ (February 2003), European Corporate Governance Institute (ECGI), Finance Research Paper Series, http://ssrn.com/abstract=374620.

8The same point was made by Otto Kahn-Freund in the mid-1970s (Otto Kahn-Freund, ‘On Uses and Misuses of Comparative Law’, [1974] MLR 1–27). Notwithstanding differences in the terminology used, Kahn-Freund’s view is similar to that put forward by Roe and Gourevitch, in that all three think that politics determines if convergence is possible. Otto Kahn-Freund argues that differences in the respective political systems determine whether or not legal rules can be transplanted from one legal system into another. Unlike Roe, Kahn-Freund does not point to a path-dependent form of legal development. He nevertheless stresses the importance of political factors. Kahn-Freund also anticipates the refinement of Roe’s theory suggested by Gourevitch, pointing to the division of power between different interest groups as an influential factor which operates as a determinant of whether the transplantation of legal rules will be successful.

10	P R O P E R T Y I N S E C U R I T I E S

Having identified the political orientation of a jurisdiction as a factor that influences corporate governance Roe, in an article written jointly with Lucian Bebchuk, criticises the convergence thesis.9 Bebchuk and Roe do not say that convergence is impossible; they also do not say that convergence will occur. They point out only that there is one important obstacle that global forces driving towards convergence need to overcome: path-dependence. They distinguish between structure-driven and rule-driven path-dependence.

Structure-driven path-dependence occurs because the present relative distribution of power is a function of the distribution of power that existed at earlier times. To give an example, a jurisdiction in which companies were originally dominated by large shareholders has a tendency to continue to have concentrated ownership structures. There are two reasons for this. The first is that it may be cost-efficient to maintain a division of power; change costs money and, assuming that efficiency is what drives development, change will occur only when its benefit outweighs its cost. The other reason is politics. Incumbent power holders tend to have the ability to influence the political process in their favour. By influencing the political process, large German stakeholders, for example, are able to prevent a change to a structure with dispersed ownership even if such a change were efficient.

The concept of rule-driven path-dependence assumes that law influences ownership structures. If the law succeeds in effectively preventing majority shareholders from taking advantage of their influence, for example, concentrated ownership structures will not arise. Bebchuk and Roe refer to law as ‘an additional, indirect (but important) channel through which the initial corporate structure might affect subsequent structures’.10 Again, change will occur only when lawmakers conclude that the benefits of the change outweigh its cost. Moreover, the political pressure exercised by interest groups who disproportionately benefit from the current legal regime may prevent changes of legal rules, even if these changes were efficient and therefore in the public interest.11

It is important to note that in Bebchuk and Roe’s analysis, ownership structure comes first and is in itself a function of politics or even ‘historical accidents’.12 Ownership structure then influences the

9 Bebchuk and Roe, ‘A Theory of Path Dependence’ 127.

10Bebchuk and Roe, ‘A Theory of Path Dependence’ 138, 153–154.

11Bebchuk and Roe, ‘A Theory of Path Dependence’ 154–162.

12Bebchuk and Roe, ‘A Theory of Path Dependence’ 129.

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law – which in turn, and alongside other factors – influences future ownership structure. Law is only a secondary force that facilitates the influence of institutions. It shapes institutions, but only as a function of the original institutional setup and also a function of politics. Moreover, there do not seem to be limitations on the degree to which law can be changed.13 Law appears to be changeable in any desired way. Leaving efficiency, politics and other forces aside, the assumption underlying the Bebchuk–Roe thesis is that the rules of one legal system can be changed to become identical to the rules of another.

1.2.2 Economics

There also exists a view that economic reasons, by themselves, prevent convergence. William Bratton and Joseph McCahery argue that all existing governance models are based on trade-offs. A system such as the German one tolerates influential shareholders obtaining more than their pro rata share of the company’s assets, but achieves a high level of shareholder monitoring. The US and the UK governance model prevents asset diversion into the pockets of some shareholders, but at the price of discouraging shareholder monitoring. Built into each of these governance systems is an incentive structure supported by legal rules. This means that the legal rules conductive to blockholding may be illequipped to foster dispersed share ownership and liquid markets and the legal rules conductive to liquid markets may have the effect of discouraging blockholding. In a blockholder system, for example, the rules against self-dealing, if they exist at all, are not as sophisticated as they are in a market system. Blockholders monitor management because the cost of doing so is compensated by the private benefits they are able to obtain. If the law intervenes to prevent private rent seeking in a blockholder system, this can prevent blockholders from seeking benefits and may cause the system to transform itself into a market system. There is, however, no guarantee that the removal of the opportunity for rent seeking will in itself create incentives sufficient to facilitate the emergence of a liquid market. The conclusion of the argument put forward by Bratton and McCahery is that the introduction of

13Bebchuk and Roe, ‘A Theory of Path Dependence’ 164–165; see also Reinhard H. Schmidt and Gerald Spindler, ‘Path Dependence, Corporate Governance, and Complementarity’, International Finance 5 (3) 311–333; Schmidt and Spindler, ‘Path Dependence and Complementarity in Corporate Governance’, in Jeffrey N. Gordon and Mark J. Roe, Convergence and Persistence in Corporate Governance (Cambridge: Cambridge University Press, 2004) 114.

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the legal rules of one system into another (i.e. convergence of legal rules) could perversely destabilise workable (if imperfect) arrangements without assuring the appearance of more effective alternatives.14

Bratton and McCahery warn against disturbing the existing balance of influence between players. Legal intervention may backfire, by causing actors who currently monitor management to end their involvement while at the same time not stimulating other actors to take on a monitoring role. They do not suggest that there is anything inherent in the law that would prevent jurisdictions from amending their rules.

1.2.3 Culture

A third possible obstacle to convergence is culture.15 The argument that culture influences legal systems was notably propounded by Charles Montesquieu.16 In the context of the recent convergence and pathdependence debate, Amir Licht floats the idea that differences in corporate governance systems may be due to cultural differences.17 He uses work published in the field of cross-cultural psychology to determine whether there is a correlation between different corporate governance systems and cultural values predominant in the respective jurisdictions.18 He views law as a function of cultural values, and seems to suggest that, dependent on the degree of importance of such influences, legal rules can be selected indiscriminately ‘from a larger menu’.19

14William Bratton and Joseph A. McCahery, ‘Comparative Corporate Governance and the Theory of the Firm: The Case against Global Cross Reference’, (1999) 38 Colum. J. Eur. L. 213; Edward B. Rock, ‘America’s Shifting Fascination with Comparative Corporate Governance’, (1996) 74 Wash. U. L. Q. 392; on the efficiency of legal transplants, see also Ugo Mattei, ‘Efficiency in Legal Transplants: An Essay in Comparative Law and Economics’, (1994) 14 Int’l Rev. L. & E. 3.

15Amir N. Licht, ‘The Mother of All Path Dependencies: Towards a Cross-Cultural Theory of Corporate Governance Systems’, (2001) 26 Del. J. Corp. L. 147; see also Peter A. Gourevitch, ‘The Politics of Corporate Governance Regulation’, (2003) 112 Yale L. J. 1834, Mark J. Roe, ‘Can Culture Constrain the Economic Model of Corporate Law?’, (2002) 69 U. Chi. L. Rev. 1251 and Martin Krygier, ‘Institutional Optimism, Cultural Pessimism, and the Rule of Law’, in Martin Krygier and Adam W. Czarnota (eds.), The Rule of Law after Communism: Problems and Prospects in East-Central Europe (Aldershot: Ashgate, 1999) 39, on cultural hindrances to the convergence of legal rules.

16Charles Montesquieu, De l’Esprit des Loix (Amsterdam, 1784).

17Amir N. Licht, ‘The Mother of All Path Dependencies’ 147, 149.

18Amir N. Licht, Chanan Goldschmidt and Shalom H. Schwartz, ‘Culture, Law, and Corporate Governance’, (2005) 25 Int’l Rev. L. & Econ. 229; Amir N. Licht, ‘Legal Plug-Ins: Cultural Distance, Cross-Listing, and Corporate Governance Reform’, (2004) 22

Berkeley J. Int’l L. 195.

19Amir N. Licht, ‘The Mother of All Path Dependencies’ 186–187.