It is stated that the proliferation of the stewardship code in Asia adds a new layer—faux convergence—to Ronald Gilson’s observations on the distinction between formal and functional convergence. At first glance, faux convergence seems to challenge Gilson’s claim that functional convergence occurs first because formal convergence is expensive. However, it has been noted that Gilson’s taxonomy did not account for a superficial model of convergence, which is why it is now proposed to be added to his framework.[1]
Path dependency means that initial conditions, such as the design of political systems, set the economy on a specific path. Gilson argued that path dependency—one of the factors in faux convergence—is not the only influence shaping corporate governance institutions.[2] For instance, the corporate governance system in Singapore, as I mentioned in my previous post, is the result of cultural and political design.
Existing institutions are subject to powerful selection mechanisms driven by their surrounding environment. This should also be viewed from a competitive perspective. If existing institutions cannot compete with differently organized competitors, they will eventually fail. Path-dependent formal characteristics of national governance institutions will not prevail against operational selection mechanisms that encourage functional convergence to become a more efficient structure than formal convergence. Thus, national institutions are shaped by the situation, in which the demands of the current environment clash with the initial conditions. From this perspective, functional convergence, where barriers to formal institutional change are avoided, comes first. According to Gilson, formal convergence—where additional costs, including political costs, may arise—comes as a last resort, and therefore, functional convergence is likely the first response to competitive pressure.[3]
In my last post, I mentioned that faux convergence is a cost-effective tool for market players to pursue their own interests.[4] Moreover, it is efficient because it is neither time-consuming nor resource-intensive to implement. For example, it does not require changes in local regulation or existing institutions. Ultimately, it signals that a state has good corporate governance, even though it only disguises the existing system with the superficial implementation of another model.
Hansmann and Kraakman have suggested that divergence does not necessarily reflect inefficiency. According to them, efficient divergence can arise either through the adaptation of local social structures or through fortuity. They argue that neither logic (i.e., alternative models do not offer greater efficiency) nor competition will create pressure for this form of divergence to disappear. Additionally, they claim that there is good reason to believe that even efficient divergence will diminish relatively quickly.[5] However, recent research, as well as my previous post, shows that faux convergence is a rather efficient form of divergence. Ultimately, according to recent findings, Hansmann and Kraakman were wrong. We are witnessing an increase in divergence, in the form of faux convergence, in Asia and other jurisdictions.[6]
Gilson also emphasizes efficiency as a key driver of functional convergence and argues that it comes first. In the case of faux convergence, functional convergence in form of disvergence indeed comes first, as it does not alter the underlying structure, keeping efficiency as the main driver behind this choice. Moreover, the original theory does not fully address faux convergence, as it claims that formal convergence is costly. While this may be true in typical situations, in this case, a soft law instrument is relatively cost-effective to implement.
Gilson, Hansmann, and Kraakman presented their theses in the early 2000s, so they could not have fully anticipated the developments that would take place in the following twenty years.
[1] Koto & Koh & Puzniak. Diversity of Shareholder Stewardship in Asia: Faux Convergence [ Vanderbilt Journal of Transnational Law vol 53, issue 3, May 2020] p. 837.
[2] Gilson, R. (2001). Globalizing corporate governance: convergence of form or function. [American Journal of Comparative Law. 49, p. 329-358] p. 334
[3] Ibid 2, p. 336,338.
[4] Ibid 1, p. 836.
[5] Hansmann & Kraakman. The End of History for Corporate Law Essay [ Heinonline, Georgetown Law Journal, 89, 2001-2001] p. 464.
[6] Ibid 1, p. 837.
