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E-MailLynne L. Dallas is Professor of Law at University of San Diego School of Law. This post is based on her recent paper.
Providing a useful perspective on corporate governance today is an examination of the evolution of conceptions of “good” corporate governance that have successively revolutionized the corporate landscape. “Evolution” in this context does not refer to some natural evolution, but changes in the beliefs of managers concerning how to run their businesses effectively. “Good” corporate governance refers to what is perceived as good from the point of view of firm managers and may or may not translate into what is good for society.
Corporate decision making has been influenced over the years by successive, rationalized ideals of good corporate governance. Changes in conceptions were precipitated by crises and environmental changes. They were reasoned, if often flawed, responses to complex macroeconomic forces, competitive conditions, regulations or the lack thereof, and other environmental factors. More importantly, they were reflections of the culture and thinking of the time, influenced by the views of successful business leaders, the business press, investors, and academics.
Managers were also influenced by their industry’s and firm’s practices and their backgrounds, for example in manufacturing or finance, that influenced their perceptions of the problems confronting their firm, the perceived causes of the problems, and how to respond to them. Additionally, once structures and strategies became generally accepted, firms were more likely to adopt them and less likely to abandon them even if the circumstances initially causing their adoption no longer existed. They would tend to persist until an economic crisis or future environmental change would cause a reassessment.
While changes in conceptions of good corporate governance have occurred over the years, there is some consistency in firm behavior. As the power model predicts, [1] firms have acted to decrease the uncertainty confronting them by not only reacting to their environment but also by seeking to change it through their business strategies and attempts to influence regulations. Over the years firms have sought to increase their market share, profits, and stock prices. More recently, with the increasing power of financial markets, they have focused on increasing their autonomy and discretion by seeking to meet the quarterly earnings expectation of security analysts and the demands of short-term shareholders.
Most legal scholars take the triumph of the current shareholder value maximization conception of good corporate governance as a given, so entrenched that it is unlikely to change. That is a mistake. Conceptions of good corporate governance change over time, and the beliefs and circumstances that produced the current round of corporate governance are waning, setting the state for far-reaching changes. A comprehensive examination of the forces that produced the current era of corporate governance explains why they are unlikely to determine the next round of corporate governance, and a new model is emerging better suited to the era on the horizon.
A broad definition of conceptions of “corporate governance” is utilized to make this examination. It refers to managers’ perceptions of proper corporate purposes, strategies, and structures. It embraces managers’ perceptions of their environment and their ideals regarding such matters as their firm’s interactions with competitors, stakeholders, and the government. Thus, this approach broadens the use of the term “corporate governance” that arose in the context of agency theory in the late 1970s that centers on the relationship between managers and shareholders and focuses on managerial self-dealing. This narrow perception is reflected in the shareholder value maximization conception of corporate governance.
The broader definition of corporate governance permits consideration of the period prior to dispersed shareholding concerns, at the turn of the nineteenth century, when the central issues of corporate governance were trusts and the concentration of power in a few firms. The focus of discussion about corporate governance, as broadly defined, was then on injury to small competitors and the public rather than shareholders. Moreover, during periods of our history, the power of autonomous, non-owner managers was viewed by many—not mainly as a source of managerial self-dealing—but as a means to encourage managerial professionalism and the emergence of industrial statesmen who would serve the interests of all stakeholders and society. Public shareholders were considered passive investors with major legislative protections of them mainly focused on their role as investors. It was only when agency theory became pervasive and institutional investors came to control large shareholdings in public firms that corporate governance, as narrowly defined, came to occupy fully the corporate governance space with corporate purpose, strategies and structures centered on shareholder value maximization.
In earlier periods in U.S. business history, the central purpose of corporate governance was not to maximize stock prices, but to achieve growth, with survival and profit mainly serving as constraints. Managers adopted a variety of strategies that dominated the economic landscape in different time periods to achieve these goals. They included cartels, trusts, holding companies, vertical integration, and the unitary/functional, multidivisional, and conglomerate organizational forms. These strategies had positive as well as negative consequences that often caused their use to be moderated or curtailed. Sometimes criticism of these strategies came from the public and demanded governmental attention. These strategies were not inevitable but resulted from managerial conceptions of what was “good” corporate governance during the different time periods.
This is also true for the modern era in which many managers have adopted strategies to maximize shareholder value. Disaggregation and cost-cutting strategies have dominated this time period. Like prior managerial strategies, they are not inevitable and have some negative consequences. These consequences include problematic managerial incentives, short-termism, the unsettling empowerment of short-term investors and financial firms, and adverse distributional consequences. As with prior eras, negative consequences are leading to changes.
I believe a new model of corporate governance—the sustainability conception—is emerging and will be supported by reforms that I propose. This conception has gained considerable traction in recent years among scholars, investors and business leaders. The sustainability conception I propose encourages firms to create economic value in a way that also creates long-term value for society by addressing its needs and challenges. Rather than focusing on shareholders solely, this conception requires firms to integrate into the very core of their strategic decision making the interests of all stakeholders. While this view may often coincide with seeking long-term shareholder value, sustainability is measured by a positive long-term relationship between firm value creation and social value.
An overview of my paper is as follows. I begin my paper by briefly examining earlier conceptions of corporate governance to provide a background for understanding how corporate governance changes over time. Looking at changes in the past provides hope for change in the future. I then examine the more current conceptions of corporate governance which includes a discussion of the shaky foundation of the shareholder value maximization conception that emerged in the late 1970s and 1980s. It was improperly based primarily on claims of self-dealing by managers in forming conglomerates in the 1960s and 70s. I also identify the adverse economic and social consequences of the shareholder value maximization conception. Having set the stage for change in the current era due to these adverse consequences, I discuss the sustainability conception of corporate governance.
In closing, I observe that the evolving conceptions of corporate governance show an ongoing dynamic at work where the changes we make in the world change the world in which we live. That world in turn changes our vision and the changes we then make, and so on. It is this process of learning from change that defines evolving conceptions of corporate governance as we look back and forward.
The complete paper is available for download here.
