Referece
Nonprofit Organizations as Investor Protection: Explaining the Puzzle of Corporate Law Enforcement in East Asia
Curtis J. MILHAUPT
Visiting Fellow, RIETI
RIETI is hosting the policy symposium on "Corporate Governance from an International Perspective: Diversity or Convergence." RIETI interviewed Visiting Fellow, Curtis J. MILHAUPT on his views on corporate law enforcement trend in East Asia.
Milhaupt: Something very interesting and unusual is happening in Japan, Korea and Taiwan, the three largest market economies in the East Asia. In all three countries, non-profit organizations (NPOs) are playing the major role in enforcing corporate law. Aside from the government, they are the principal shareholder activists in these three countries. That is very puzzling because NPOs by definition cannot distribute their profits to their members, so there is no financial incentive for them to be playing this role. Another puzzling thing is that East Asia generally does not have a long history of non-profit activity, yet this is the only region in the world where we see NPOs playing this role.
So at the conference, I will try to explain why this is happening. There are many theories on why NPOs exist around the world. While there is no single theory that everyone views as dominant, one very persuasive theory is known as the "government failure, market failure theory." This theory predicts that NPOs will emerge where public goods have not been supplied either by government or by the market. Corporate law enforcement (investor protection) is a public good because the benefits are enjoyed by many people in the form of deterrence and predictability of law, but the costs fall entirely on the people who are actually engaged in the enforcement effort.
A second theory focuses on the supply side: This theory recognizes that NPOs will emerge only if there is supply of "social entrepreneurs" to found and operate such organizations. For example, in Korea and Taiwan, both recent democracies, there is a large supply of social entrepreneurs. This is particularly true in Korea, where there was history of protests against the government.
In the paper I wrote for the symposium, I applying these theories to explain why NPOs are playing the role of corporate law enforcers in these three countries. I first analyze the corporate law enforcement environment in all three countries, and show why this public good has not been supplied adequately either by the government or by the market. According to the theory discussed above, this is a classic situation where NPOs should emerge to fill the gap in the supply of an important public good. I analyze the different organizational structures of the NPOs in the three countries, their successes, failures and their limitations. I try to explain why in each country the specific NPO looks the way it does, drawing on both the "supply side" theory and the distinctive legal and political environments of the three countries.
I end the paper by looking at the some of the implication of these unusual developments in East Asia. The conference is called "Corporate Governance from an International Perspective: Diversity or Convergence." NPO shareholder activism is a very unusual illustration of both phenomena. It illustrates convergence in the sense that the three countries have spontaneously converged toward this very distinctive mechanism of enforcement. But it also is a diversity story in the sense that even though NPOs emerged in these three countries, the way each NPO is organized and functions reflects the different local environments in which they emerged. It is also an important story for another aspect of corporate governance literature. Today, there is a lot of discussion about how law matters to corporate governance around the world. It is widely accepted that the quality of law enforcement is at least as important to investor protection as the quality of law on the books - statutory law. This is a very interesting illustration of how you might overcome problems in enforcement by using a novel organizational form that is neither state nor market.
Finally, I think there are very practical implications to be drawn from this example. For example, China might use the Taiwanese model, and in fact they are studying it. It may have application for other transitional economies as well where there are law enforcement problems.
Are these three countries you mention, Japan, Korea, and Taiwan, taking the U.S. model of law enforcement?
Milhaupt: No. That is what's so interesting about this development. The U.S. addresses enforcement problems principally by providing attorneys with financial incentives to sue. That is the American way of ensuring a supply of this public good. But these East Asian countries have found a different way to supply this public good.
Japanese influence is very heavy in Korea and Taiwan in the corporate area, and also in the basic structure of the legal profession and civil litigation system. And of course Japan's legal system originated in Germany and other civil law countries. So in effect, all three countries have Japanese adaptations of the German system. That is another reason why it is an interesting issue, because of the commonality of the three legal systems, and the common solution that they spontaneously developed to the problem of weak corporate law enforcement.
In these three countries, do these NPOs take similar actions toward corporate governance, for example if they find some inappropriate corporate activities? What would they do?
Milhaupt: Similar but not identical. For example, the Korean group which is called PSPD (People's Solidarity for Participatory Democracy) holds a portfolio of stock. It is a stockholder itself. It has consciously targeted the biggest and the most famous companies in Korea, the largest chaebols, because it wanted to make an example of them. The leaders of PSPD thought if they could improve the corporate governance at these firms, then the rest of the companies would follow. And they filed shareholder derivative suits against management and won two huge victories in the courts.One suit was against the management of Samsung Electronics, and another against Korea First Bank, for various forms of mismanagement. The cases were highly publicized and sent a powerful message that managers are legally responsible to shareholders. PSPD has also pursued an aggressive national agenda of legislative reform. It is very big, highly diversified and ambitious organization that is not afraid of political involvement. In that sense, it is like the chaebol that it is fighting. There must be something about the Korean institutional environment that gives rise to similar organizations both the for-profit and non-profit level.
By contrast, the Japanese group, called Shareholders Ombudsman, is much smaller and less well known. They have also filed suits against some companies, but they have tended to settle their cases. Some say this is because they view their role as changing one company at a time. Rather than pursuing a big national agenda like the PSPD, Shareholders Ombudsman has a "one-company-at-a-time approach." So for them, settling the case is fine, because when they settle the case they often get a promise from the company not to engage in the bad behavior again. This strategy very much fits the tradition of NPO activities in Japan - smaller, more localized, and less aggressive in its tactics. I think this relates to the limited supply of social entrepreneurs in Japan, as well as the government's restrictive attitude toward NPOS. Another interesting aspect is that the Shareholders Ombudsman is not legally NPO. Why? Because it is too hard to set up an NPO under the very strict Japanese law. So they informally act as an NPO by donating most of the attorney fees earn from their cases back to the organization.
In Taiwan, the shareholder activist NPO is completely different. A nonprofit foundation known as the Securities and Futures Institute was set up in the 1980s with the encouragement and assistance of the Taiwanese SEC, with funds supplied by the financial industry. So there is very close cooperation between the government, the market, and the NPO. The government is in effect co-opting the NPO to help it supply this public good, investor protection. The Foundation's primary role is to organize small investors to sue as a group. As you know, it is very hard for an individual who has only a few shares to sue because of the expense, time, and information problems involved. So this NPO gathers shareholders together and funds the litigation. Thus, there are very real differences in structure and strategy among the three NPOs.
(Interview and report by Akiko Kumagai)
