Basic Information of Corporate Governance Revisited: What Do We Know and What Do We Teach Future Business Leaders?
Author: Gentile, Mary C.; Scully, MaureenPublisher: Aspen Institute Business & Society Program
Case Number:
Publication Date: 2004
Course Category: Management
Case Summary of Corporate Governance Revisited: What Do We Know and What Do We Teach Future Business Leaders?
This summary shares many of the themes that emerged from our 2003 interviews on “Corporate Governance and Accountability.” We interviewed 29 faculty members in the areas of accounting, business law, economics, finance, and strategy. We asked about the current state of research, practice, and teaching on corporate governance and what new approaches may be needed. We note some of the differing points of view that we heard across the interviews. We organize the summary in a question and answer format, to capture issues that are open for exploration. The questions are not the literal questions we asked in the interviews, but rather questions that arise for scholars and teachers in this area. These ideas serve as a springboard for the convening on January 30, 2004, which was designed around the topics and insights raised in the interviews.Shareholder Value Maximization and Alignment of Interests
Are shareholders’ interests and other stakeholders’ interests in alignment or in conflict?
In the business case for attending to multiple stakeholders, they are aligned. The business takes care of other stakeholders in order to maximize shareholder interests in the long term. The current model does thereby take into account multiple stakeholders. They must be considered as part of doing business well if shareholder value is to be maximized. Treating employees and customers well is part of creating good firm performance.
However, while in theory these interests align, interviewees noted some areas or instances in which they fall out of alignment, including:
--Information asymmetries.
--Imperfect contracts.
--Externalities that are not internalized, where the government does not have an adequate role or the issue does not rise to the attention of government.
--Validating the wrong stakeholders – investment and risk bearing are not what they appear. For example, some interviewees argued that labor bears greater risk and/or makes more “firm specific” investments than the models recognize. Other interviewees pointed out that even within the realm of shareholders, in some instances certain investors are protected at the expense of others.
--Lack of clarity over the definition of the “long term.”
--The inability to measure the “costs and benefits” of various social and environmental impacts, such that they can be weighted and compared to other more defined costs and benefits and factored into long term cost/benefit assessments.
There appears to be a spectrum of views about shareholders’ and stakeholders’ interests:
Aligned - - - - - - - - - - - - - - - - Some departures - - - - - - - - - - - - Not aligned/In conflict
Does the maximize shareholder value model need replacement, adaptations large or small, or is it just fine?
Most interviewees felt that the shareholder primacy model was fine, with perhaps a few adaptations or the inclusion in the theory of a role for regulation where markets alone will not suffice. There was some difference of opinion over its appropriateness globally. Many, however, acknowledged the practical challenges to the model noted above and reported a lack of useful managerial frameworks and guidance on how to respond to those challenges for use in the MBA curriculum.
Are stakeholder concerns just the pathway to maximizing shareholder value, or should corporate citizens do more for stakeholders?
Most interviewees articulated the business case for attending to stakeholders and felt that anything more was too vague to specify. What is the community as a stakeholder? How can the firm be said to have a responsibility to it? Certainly the firm or the board can’t command the community. But yet, there was a sense that the community in which the firm operates does deserve some consideration, even if it could not be specified in terms as precise as other elements of the theory.
What are the limits or boundaries on maximizing shareholder interests?
Interviewees mentioned that shareholder maximization occurs within the constraints of law and regulation. Anything more? Some interviewees mentioned other items: a sense that the corporation has responsibilities to its community, just as citizens have responsibilities to their country; the recognition that managers are people who are bound by certain behavioral norms, regarding for example their actions toward their employees; the social and political realities of NGOs and coalition politics; etc. [Note: Milton Friedman notes in his famous 1970 essay that firms must operate within the guidelines “embodied in law and in ethical custom.”]
How can one address the problem of externalities and the issue of public goods?
Interviewees vary in their faith in regulation. A few mentioned specific concerns, such as how layoffs and plant sitings create externalities for communities. A few mentioned that the theory allows firms to create externalities as long as they don’t break the law, get caught, or take on reputation losses.
Abuses
How big a problem is self-dealing? Or, is managerialism the root problem?
Several interviewees raised this classic view (e.g., Berle & Means, Modern Corporation and Private Property, 1932) that managers’ “capturing” the firm and deviating from shareholder interests is an ongoing struggle and the root cause of current problems. It is failing to maximize shareholder value that is the problem – not trying too hard to maximize it. Had managers at Enron and Tyco stayed close to shareholder interests, certainly employee shareholders’ pensions would be in better shape. The corporate culture and environment fueled this bad behavior, with inappropriate incentives with respect to share price.
In another take, interviewees cited managers’ judgment biases, rather than greed or misbehavior, as the source of problems.
Did the current abuses stem from lack of investor protection? Lack of protection for other stakeholders?
Lack of investor protection may be more obvious in some global contexts, and in egregious cases where cronyism leaves investors vulnerable. Several interviewees made a point of saying that many boards are actually quite well run, whether or not they adhere to the Sarbanes-Oxley provisions. Others, however, talked about the capture of the board by the CEO and how so-called “independence” does not protect against that.
What is the role of capital market intermediaries in ensuring alignment of interests and the efficient and fair functioning of the market?
Interviewees discussed auditors, analysts, regulators, investment banks. All of these are checks and balances that the public thinks have failed. Some interviewees agree that the checks and balances failed, but some argued that the system was actually fairly robust in the face of several factors that added up to a “perfect storm” and that we should not create new problems by over-zealously fixing a system that is not really broken.
Share Price and the Short-Term / Long-Term Question
Is share price a good indicator of value?
A short-term focus on boosting share price is sometimes cited as a source of problems in corporations (managerial self-interest, earnings management, downsizing that hurts employees but gets a positive reaction from Wall Street, etc.).
Many of our interviewees emphasized that share price, correctly understood, does capture long-term value. The theory argues that share price reflects an evaluation of future circumstances. However, behavior toward maximizing share price can have a short-term emphasis. The role of share price as an indicator of value and the problem of share price maximizing behavior need to be distinguished. And some interviewees noted that the ability of the market to actually understand and evaluate longer-term value is not always adequate.
Is communication – to investors and to others – at the heart of balancing short-term and long-term interests?
Interviewees mentioned transparency, completeness, credibility. Managers need to communicate to shareholders about decisions, particularly if decisions appear not to be in shareholders’ short-term interests but might generate long-term value. [Note: See Jensen and Fuller, in Journal of Applied Corporate Finance, Winter 2002, on communication: “Just Say No to Wall Street…”.]
Unpacking Shareholder Interests
What are shareholder interests?
If maximizing shareholder value, or operating in shareholder interests, is the goal, several questions nonetheless remain: What are shareholder interests? Who are the shareholders? They might prefer maximization at the level of the industry or of their diversified portfolio, not maximization at the firm level. Category destroying behavior, such as the famous example of Al Dunlap at Sunbeam, hurts shareholders with diversified portfolios looking for good market performance over time.
Also, many shareholders wear multiple hats – they also are, or represent, employees and customers. Shareholders in pension funds might not want to see downsizing – of fellow employees – as the route to maximizing their returns. Finally, shareholders have different risk tolerance, investment objectives, and time horizons. The market and trading behavior are supposed to reflect this variety.
Stakeholders: Their Interests, Risks, and Protections
Who can diversify their risk?
Shareholders can diversify their risk by having investments in multiple firms in their portfolio. There was disagreement over whether other key stakeholders, such as employees, can diversify their risk. The “yes” view claims that employees have mobility and bargaining power in the labor market. The “no” view emphasizes that employees invest in a firm as they acquire firm-specific human capital (good for the firm as well) and therefore have more of their capital at risk (and not mobile) than shareholders. By this argument, employees are claimants on the returns of the firm.
Who are the multiple stakeholders and what are their different interests?
The multiple stakeholders tend to be lumped together in an undifferentiated way. There are shareholders, and then there are employees, customers, suppliers, banks/lenders, the community, etc. In some instances, employees are singled out as distinct from the rest of the group, as being subject to the incentives in the firm. In several accounts, the key tension or bilateral negotiation was said to be between shareholders and employees, or classically, between capital and labor. Some began to point out the potential for alliances between different groups, such as long-term investors and labor. [Note: See, for example, Roger Martin’s “Capital Versus Talent: The Battle that’s Reshaping Business,” Harvard Business Review, July 2003.)
Would investors object to a multi-stakeholder model?
It depends on what is the implicit contract by which they’re investing. The importance of meeting shareholder expectations with regard to the terms under which they invested their capital was emphasized as critical to the maintenance of trust and an ability to attract investment. For example, socially responsible investing is an explicit, up-front agreement to regard other stakeholders.
Board Roles and the Law
What kinds of discretion do management and boards have?
The guidance of the
How do boards play a role in keeping interests in alignment or balancing them when they are in conflict?
Good boards already know how to do this. Boards with too much control can create their own problems. Sarbanes-Oxley may or may not codify, stimulate, or disseminate the best practices of good boards. The popularity of executive education for board members shows that boards are looking for models to guide their practices and drawing from many business disciplines. Some of the issues noted for further research and consideration included: independence and how it is defined; nomination power; term limits; constituency seats; board performance assessment; etc.]
Does Sarbanes-Oxley address a problem that needs fixing? If so, does it provide the needed fixes?
Several interviewees wondered if board independence was the root problem or would help fix problems like earnings management. Research streams are developing to find the right measures and assess the impact of board independence and other Sarbanes-Oxley provisions.
Contracts and Incentives
How can we improve contracts to address current concerns?
Contracts were supposed to align CEO interests to shareholder interests. But contracts are incomplete, hard to enforce, may contain perverse incentives. A few people mentioned that the board focuses only on the CEO or top leadership and that firm performance is only assumed to follow from their motivation, ignoring that of other employees down the chain.
What does incentive economics teach us about governance?
It translates to concrete problems (and makes them mathematically tractable). It addresses how boards can create contracts that (re)align managers’ interests with those of shareholders. Students like and find useful the principal/agent formulation. They use its language for a lot of problems, framing problems in these convenient, crisp terms.
Some of the interviewees suggested various ways to align incentives for short-term gain with rewards for creating long-term value, such as:
--Provide more information, for more parties, reducing asymmetries.
--Lag the rewards. For example, reward CEOs for firm and share performance three years after their departure; make CEOs announce in advance their intention to sell shares.
--Government regulation.
Lessons from Cross-National Comparisons
What does corporate governance look like in other national contexts?
The issue of globalization-driven convergence in corporate governance models and institutions was broached by a number of interviewees. Many believed that such a convergence was essential and inevitable, but some argued that there are many paths to economic profitability. Examples were given on both sides: the EU as an example of convergence;
Some said that the shareholder primacy model made little sense in contexts where legal, institutional, and cultural norms did not provide the protections to investors and to labor that made the system “work” in other contexts. Others argued that it was only through the development of those norms and realities that investor trust would be developed to fuel a stable, functioning market, and that “cronyism, connections, and corruption” among the very rich could be controlled.
The interviewee comments made it clear that international comparative examples are the source of learning about alternative institutions. They are also the dataset that provides enough variance to make conclusions about what factors determine stable financial markets as an outcome.
Corporate Governance in the Classroom and in Practice
How can we teach issues that arise at the public policy, regulatory, system, or social analyst level in the MBA classroom?
Many MBA students experience the topics herein as removed from their immediate careers and likely entry jobs as middle managers. They encounter them as external factors to which they should react. It is difficult to teach them in an action-oriented way. One framing is to emphasize that, as businesspeople, they should think about how business exerts influence at the public policy level. In light of some of the alignment challenges raised above, it might be best to think critically before joining the chorus of business interests resisting regulation.
What is the status of business law in the business school curriculum?
There were various views on whether it has received legitimate standing. It seems to be removed as a required course more often than it is added these days. However, students – and other faculty members – may be newly appreciating its relevance given current scandals. There was also a call for teaching business law from a managerial perspective, to make it more accessible and more relevant to MBAs.
What are the incentives or resources for teaching new material?
Some faculty members explained that they are not trained nor incented to approach the social impacts in corporate governance. But they would like to, inasmuch as they are frustrated in the classroom and see that students want more. Interviewees noted that they were uncomfortable raising in the classroom many of the thorny and important questions discussed in our interviews, because there were not enough frameworks and even data to help them go beyond “chatting” and actually provide managerial guidance.
Where are the case examples to help us teach?
The question is out there – and it motivates our mission to create teaching modules.
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