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Articles on Governance

Good governance calls for the board’s role in long-range planning to consist chiefly in establishing the reason for planning [that] planning is to increase the probability of getting somewhere from here [and recognise that] enunciation of that “somewhere” is the board’s highest contribution. In a manner of speaking, boards participate most effectively in the planning process by standing just outside it… a model of governance is a framework within which to organize the thoughts, activities, structure, and relationships of governing boards.

John Carver 1990

Important articles include a series from the Academy of Management Review, Vol 28/3 July 2003 and a paper by Jeffrey Sonnenfeld from Yale University proclaims strongly that most of the mandated reforms of governance such as increasing the proportion of outside directors on boards does not achieve the desired results.

Agency Theory, Resource Dependence, etc: is it relevant?

A special issue of the Academy of Management Review, Vol 28/3 July 2003 surveyed important aspects of governance and contained numerous articles dealing with firm performance and agency and resource dependence and many other matters. A major review by Catherine Daily of the Kelley School of Business, Indiana University and colleagues at the beginning of the issue is of special interest.

Dialogue and Data

Catherine M Daily, Dan R Dalton & Albert A Cannella Jr, “Corporate Governance: Decades Of Dialogue And Data”, Academy of Management Review, Vol. 28/3, p371, 12p (2003)

Daily and colleagues define governance as the determination of the broad uses to which organizational resources will be deployed and the resolution of conflicts among the myriad participants in organizations. They observe, “Corporate governance researchers have a unique opportunity to directly influence corporate governance practices through the careful integration of theory and empirical study. It has not always been clear, however, whether practice follows theory, or vice versa. As important, it is not clear that there is concordance between the guidance provided in the extant literature and the practices employed by corporations.”

The overwhelmingly dominant theoretical perspective applied in corporate governance studies is agency theory. This serves as an explanation of how the public corporation could exist, given the assumption that managers are self-interested, and a context in which those managers do not bear the full wealth effects of their decisions. The theory responds to the observation 70 years ago of some of the key problems inherent in the separation of ownership and control.

Monument to Colonel Shaw, Boston Common (More)
In nearly all modern governance research governance mechanisms are conceptualized as deterrents to managerial self-interest. Corporate governance mechanisms provide shareholders some assurance that managers will strive to achieve outcomes that are in the shareholders’ interests. Shareholders have available both internal and external governance mechanisms to help bring the interests of managers in line with their own.

By way of contrast, Daily and colleagues observe that resource dependence theory provides a theoretical foundation for directors’ resource role. Proponents of this theory address board members’ contributions as boundary spanners of the organization and its environment. They further observe that stewardship theory has also garnered researchers’ attention, both as a complement and a contrast to agency theory. Whereas agency theorists view executives and directors as self-serving and opportunistic, stewardship theorists describe them as frequently having interests that are isomorphic with those of shareholders.

Daily et al observe that executives have reputations that are interwoven with the financial performance of their firms. In order to protect their reputations as expert decision makers, executives and directors are inclined to operate the firm in a manner that maximizes financial performance indicators, including shareholder returns. In being effective stewards of the organization, executives and directors are also effectively managing their own careers.

The conclusion from meta-analyses however, would perhaps be startling to the proponents of agency theory. Daily and colleagues say, “Two meta-analyses provide some context and illustrate the general state of corporate governance research relying on agency theory. While agency theorists clearly would prescribe boards composed of outside, independent directors and the separation of CEO and board chair positions, neither of these board configurations is associated with firm financial performance. Importantly, this conclusion holds across the many ways in which financial performance has been measured in the literature. Similarly, another meta-analysis found no support for the agency theory-prescribed relationship between equity ownership and firm performance. Neither inside nor outside equity ownership is related to firm financial performance. Both accounting and market-based measures of financial performance were used.

Daily et al also comment on the important changes in executive compensation, the means by which executive compensation packages are structured. The rules governing these changes (by the Securities and Exchange Commission) required clear and concise reporting of the packages together with comparisons with industry benchmarks estimates of stock option values and listing of the criteria by which executives were evaluated. There were also tax changes in respect of executive compensation. These changes, in concert with shareholder activism aimed at better aligning executive pay with shareholder performance, encouraged executive compensation practice to move toward stock options and other incentives.

As a result executives today hold greater percentages of firm equity than they did during the early 1990s. However, “despite the increase in equity-based compensation during the past decade, extant research has not provided compelling evidence of a strong relationship between executive compensation and shareholder wealth at the firm level. A recent meta-analysis of pay studies, for example, showed that firm size accounted for eight times more variance in CEO pay than did firm performance”

The conclusion is “In sum, while issues of control over executives and independence of oversight have dominated research and practice, there is scant evidence that these approaches have been productive from a shareholder-oriented perspective. These results suggest that alternative theories and models are needed to effectively uncover the promise and potential of corporate governance. “

* In another article in the same issue Chamu Sundaramurthy and Marianne Lewis, report on Control And Collaboration: Paradoxes Of Governance. Academy of Management Review Vol. 28/3 p397, 19p, 2 diagrams (2003) the contrasting approaches of control and collaboration are accommodated within a paradox framework, using agency and stewardship theories to elaborate the underlying tensions and to emphasize the value of monitoring, as well as empowerment. Building from these tensions, they examine reinforcing cycles that foster strategic persistence and organizational decline. Means of managing control and collaboration are discussed, highlighting the implications for corporate governance.

Amy J Hillman and Thomas Dalziel, in “Boards Of Directors And Firm Performance: Integrating Agency And Resource Dependence Perspectives” (Academy of Management Review; Vol. 28/3, p383, 14p, 2 diagrams (2003) talk of boards of directors serving two important functions for organizations: monitoring management on behalf of shareholders and providing resources. Agency theorists assert that effective monitoring is a function of a board’s incentives, whereas resource dependence theorists contend that the provision of resources is a function of board capital. We combine the two perspectives and argue that board capital affects both board monitoring and the provision of resources and that board incentives moderate these relationships.

Governance is how people work together

Jeffrey A. Sonnenfeld of Yale University in “What Makes Great Boards Great”, Harvard Business Review, Vol. 80/9, p106, 8p, 1c (2002) has written one of the most important articles on governance I have read. He points out, “It’s not rules and regulations. It’s the way people work together.”Sonnenfeld observes that following recent high profile corporate collapse of companies such as Enron, Tyco, and WorldCom in America much attention turned to the companies’ boards. Yet a close examination of those boards has revealed no broad pattern of incompetence or corruption. In fact, they followed most of the accepted standards for board operations. Sonnenfeld asserts that “It’s time for some fundamentally new thinking about how corporate boards should operate and be evaluated.”

How companies pursue the most common practices in developing boards, including regular meeting attendance, equity involvement, board member skills, board member age, the past CEO’s presence, independence, and board size and committees are shown to not make the difference. What does distinguish the exemplary boards is creating robust, effective social systems. “The key to generating such a team includes creating a climate of trust and candor, fostering a culture of open dissent, utilizing a fluid portfolio of roles, ensuring individual accountability, and evaluating the board’s performance.”

Pressing ahead is not the answer!

“Learning from Corporate Mistakes: the Rise and Fall of Iridium” (in Organization Dynamics 29 (2), pp 138-148, 2000) gives an account of not only how the Iridium Project failed but more importantly why! Sydney Finkelstein (from Dartmouth College) and Shade H Sandford (of Mercer Management Consulting in Washington DC) outline how this project, envisioned originally by Bary Bertiger of Motorola, to put a constellation of low earth-orbiting satellites up to allow phone calls from anywhere on earth collapsed with huge debt (although Motorola did well financially) (Note: There are parallels in the museum exhibition touring world.) More about the class action against Motorola can be found on the website of Finkelstein Thompson.

A failure to recognise the rapid spread of cellular phones, technological limitations, poor operational execution and failure by partners to provide adequate sales and marketing support all contributed. Iridium filed for bankruptcy in August 1999.Finkelstein and Sandford identify three forces which combined to create the failure: escalating commitment despite a deeply flawed business plan; leadership of Iridium driven by a belief on the part of CEO Staiano – who had shown at Motorola a style which was both intimidating and demanding – that his heavy level of stock options would be saved only by pressing ahead; and a failure by the Iridium Board – made up mostly of employees and directors of the company – to provide adequate corporate governance.

There are good references to the numerous sites and articles dealing with the Iridium collapse. Among the important ones are “Strategic Leadership: Top Executives and their Effects on Organizations” by S Finkelstein & DC Hambrick, West Publishing, St Paul, MIN 1996 and “Boards at Work: How Corporate Boards Create Competitive Advantage by Ram Charan, Jossey-Bass, San Francisco 1998. This article has relevance to museums, leadership and governance issues.