New Compendium Hits the High Points

Corporate Governance: A Synthesis of Theory, Research, and Practice (Robert W. Kolb Series) edited by H. Kent Baker and Ronald Anderson provides an excellent overview of contemporary issues in corporate governance with a primary focus on the relationship between managers and shareowners, as well as other stakeholders.

One of the more interesting and creative chapters is Alex Todd’s discussion of best practices. Like many, Todd observes that corporate governance is being overwhelmed by the complexity of its issues and environment. As we all know, one size does not fit all but how do you take into account all the variables?

Todd introduces the concept of “aspirational corporate governance” to facilitate both the diagnosis of current practices and for designing future best practices through a framework that considers requisite organization, requisite variety and adaptive capacity parameters.

Requisite organization, for example, varies according to work complexity. Todd argues that generally, managers at every incremental level of the hierarchy need to be able to see further than their subordinates. Likewise the collective cognitive capacity of the board should be at a higher level than the CEO, looking out 25 years, for example, rather than five.

Requisite variety seeks to minimize the number of choices needed to resolve uncertainty. Todd sees applications here for autonomous systems using network governance. Inputs might include advisory councils, employee assemblies, customer forums and supplier panels that provide quick feedback of the important interests of stakeholders.

Adaptive capacity involves balancing these systems in a state of dynamic disequilibrium. This could involve, for example, granting stakeholder a variety of voting rights.

Todd also discusses the fact that different governance practices are likely to be best for different stages. Those seeking a high valuation strategy will need to establish trust with investors, whereas early stage companies are more likely to favor revenue growth, usually associated with more management control.

He goes on to compare the AGG framework with OECD and NACD principles. Much of Todd’s work builds off that of Shann Turnbull, who also contributes a chapter to the volume. Turnbull discusses current failings and concludes that one option might be for corporations to establish their own firm-specific co-regulators to match the concerns of their stakeholders.

The role, cost, and intrusion of government into corporate activities would be displaced by corporations acting as co-regulators to further and protect the interests of citizens. Corporations in turn would need to distribute and share powers with their stakeholders and other citizens so these constituents could obtain power to protect themselves directly and/or though others to safeguard their interests.

The recommendation reminds me of the federal commission investigating the Deepwater Horizon oil spill, which urged an independent “safety agency” to oversee offshore drilling, increased funding for agencies that oversee spill response and planning, and an industry “safety institute” to audit safety practices of companies that drill offshore.

By contrast, the systems envisioned by Todd and Turnbull seek to install stakeholders directly within corporate systems of power, perhaps avoiding the need for so much government oversight.

In another interesting chapter, Lawrence E. Mitchell and Dalia T. Mitchell argue: “The idea that directors were representatives of the shareholders was suitable for a time when internal finance was the norm and public shareholdings modes and correlated well with a rule of deference to the directors’ expert judgment.” But directors “could not be presumed to be experts” and the business judgment rule “could only be a rule shielding directors from liability.” As internal financing receded, “the stock market became the principle governor of corporate behavior and stock price appreciation became an end in and of itself.” “Delaware courts simply advised directors as the shareholders’ agents to maximize shareholder profit so as not to trigger the ire of their principles.”

Andres, Betzer, Goergen and Metzger note, “Banks and other financial institutions from the United Kingdom and the United States, two countries deemed to have the highest levels of shareholder protection, seem to have expropriated their shareholders while banks from countries believed to provide weak shareholder protection seem to have been left relatively unscathed the crisis.” Although since this was written we now see more European economies in trouble.

After surveying the literature, Bhagat, Bolton and Romano conclude that ownership of stock by board members is a better measure of the quality of corporate governance, both in terms of future operating performance and in the probability of management turnover in poorly performing firms, than the more complex indexes used by proxy monitoring services and academics.

Other chapters of this hefty volume of almost 700 pages deal with the empirical facts of boards, their composition and changing duties, such as the growing variety of subcommittees. Here’s a real shocker (I jest) from Geiler and Renneboog: “The available empirical evidence indicates that managerial self-dealing and the skimming of corporate profits by managers through compensation packages create a real problem. Executive compensation often seems to be in conflict with shareholder value creation. This situation is further exacerbated by evidence suggesting that hidden compensation is used to transfer wealth to executives.”

Cris Mallin contributes a chapter on institutional shareowners, discussing the trustee relationship and the increasing recognition of activism, using the examples of Hermes and CalPERS. She discusses their role in tamping down overly generous pay packages for CEOs. “Institutional shareholders will also be looking for better risk management in investee companies, for a balanced board with no one individual being too powerful, and for better succession planning. Issues relating to ethical, environmental, and social aspects are also likely to be the focus of more attention in the future.”

Donald Nordberg reviews arguments that an increase in shareowner power of pension and other institutional funds should be accompanied by more focus on the governance and accountability of such funds. Nordberg’s central discussion focuses on the differences between investors, primarily long-term vs. short-term. How are managements and boards supposed to parse such disputes? He advises them to appeal beyond the firm’s narrow circle of shareowners to government to impose greater transparency on voting by institutional investors, exposing risks and conflicts of interest. Governance reforms should also be applied to shareowners if their demands are to been seen as legitimate.

An interesting finding highlighted by Anderson, Mansi, and Reeb in their study of managerial ownership from the perspective of creditors is that options and stock ownership don’t provide the same incentives to managers. “Ownership reduced creditor risk. Stock options increase creditor risk.” With regard to boards, they play a valuable role in monitoring management but impact weakens as CEO equity increases.

Peter Szilagyi’s discussion of proxy contests concludes that proxy access rules will increase shareowner control of boards at the same time they reduce dissident incentives to wage expensive proxy contests. Or as I would say, democracy, even if limited, is more cost-efficient than war.

In another chapter Mike Stegemoller argues overregulation has weakened the stick of the market for corporate control. Comparing CEOs to a bull in a china shop, he concludes: “The approach thus far has been to spend an exorbitant amount of time and money herding the bull and erecting better corrals, while attention should perhaps be on finding out what makes a bull appreciate fine dinnerware.” Similarly, Renee Jones writes, “the best hope for responsible management seems to be the broad inculcation of proper moral standards in the individuals who run our corporations.”

The volume is a virtual encyclopedia of contemporary thought on many of the most important issues in corporate governance. Hopefully, the recent financial crisis has demonstrated the value of such discussion and what happens when accountability mechanisms are lacking, misplaced, or fail.

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