in invest in these emerging markets. 2. Driving

in emerging economies (compared with their counterpartsin developed countries) are discounted infinancial markets because of their weak governance(LaPorta, Lopez-de-Silanes, Shleifer, & Vishny,2000). As such, improvements in corporate governancecan enhance investor confidence in firms inemerging economies and increase these firms’ accessto capital.

According to a 2002 McKinsey investoropinion survey, investors who were open to payingpremiums were, on average, willing to pay a 25%premium for well-governed Chinese firms and a 23%premium for well-governed Indian firms (Barton,Coombes, & Wong, 2004). From the perspective offoreign investors, emerging economies such as Chinaand India have become increasingly importantsources of growth and investment opportunities.For example, foreign investors are now allowed — forthe first time since China started permitting foreigndirect investment (FDI) in the late 1970s — to acquirea significant shareholding in state-owned enterpriseson China’s renminbi-dominated, A-shareexchanges in Shanghai and Shenzhen. The changingof rules for the types and extent of direct investmentin both China and India increases opportunity foreconomic gains, but it also increases exposure torisks and problems posed by under-developed andlax governance. The governance rules in thesecountries are both opaque and evolving, and foreigninvestors need to appreciate the domestic sensitivitiesand complexities stemming from countryspecificpolitical and institutional landscapes sothat appropriate types and levels of involvementcan be designed to protect their short-term andlong-term interests.Emerging economies also represent unique challengesfor corporate governance practices.

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First,many emerging economy firms are noted for theirlack of transparency and are unwilling to acceptglobal best governance practices. Second, due tothe institutional differences between developed andemerging economies, governance practices employedin Western developed economies may notbe applicable in the emerging economy context.Significant differences in the legal and institutionalenvironments exist between China and India, andbetween either one and the US or other Westerncountries. Fundamental differences in ownershipstructures, business practices, and enforcementstandards imply major gaps between formal adoptionof progressive and sophisticated governancecodes and the actual implementation of thesecodes. While regulators in emerging economiesmay be quick to adopt best corporate governancepractices from the West, the presence of thesepractices is no guarantee that they will be strictlyimplemented to uphold investors’ interests. In thefollowing sections of this article, we will highlightfurther implications for firms seeking to invest inthese emerging markets.2. Driving forces behind corporategovernance reforms in China and IndiaWhile many factors have contributed to governancereforms in China and India, the most important arearguably privatization and globalization.

In thissection, we will discuss how these two forces haveshaped corporate governance reforms in China andIndia, while also identifying differences in theireffects between the two emerging economies.2.1.

The effect of privatization on corporategovernance reformsIn the past few decades, emerging economies havelaunched ambitious plans to privatize their stateownedenterprises (SOEs). The volume of privatizationin emerging economies has increased from$8 billion in 1990 to about $65 billion in 1997(Dharwadkar, George, & Brandes, 2000). In privatization,ownership is transferred from the state tonew private and public owners, which may includemanagement, employees, local individuals, institutions,and foreign investors, with the state also retaininga certain percentage of ownership afterprivatization. The new diversified ownership structureafter privatization makes corporate governancean important issue in emerging economies.

1 On theone hand, the new ownership structure creates thetraditional principal agency problem whereby selfinterestedexecutives aim to maximize their privateinterests rather than the owners’ interests. To addressthis problem, it is necessary to design effective incentivemechanisms to align management interestswith owners’ interests and/or to design effectivecontrol mechanisms to regulate management behaviors.On the other hand, the new ownership structurecan also create principal–principal agencyproblems that are unique to emerging markets. Inthese unique agency contexts, large or majorityshareholders often control the firm and expropriateminority shareholders’ interests in the firm (Dharwadkaret al.

, 2000). As a result, it is also importantto design governance mechanisms and safeguards toprotect minority shareholders’ interests from expropriationby majority shareholders.