Corporate Governance Deviance

Ruth V. Aguilera is Distinguished Professor of International Business and Strategy at Northeastern University and Visiting Professor at ESADE Business School; William Q. Judge is E.V. Williams Chair of Strategic Leadership & Professor of Strategic Management at Old Dominion University; and Siri Terjesen is Dean’s Faculty Fellow in Entrepreneurship and Director of the AU Center for Innovation at American University and Adjunct Professor at Norwegian School of Economics. This post is based on their recent article, forthcoming in Academy of Management Review.

Societies throughout the world utilize a wide range of corporate governance mechanisms to govern their corporations. Normally, most societies use rules and norms to get corporations to conform to traditional corporate governance practices; and most corporations do conform to this national governance logic. However, some corporations do not conform to the logic in which they are embedded. When this deviation happens, we note that corporate governance deviance has occurred. The purpose of our article was to explain what corporate governance deviance is, and why, when, and how firms engage in governance deviance.

This phenomena of corporate governance deviance is demonstrated when some firms deviate by adopting governance practices that fall short of the country’s governance standards (under-conform), while other firms deviate by exceeding these prevailing governance norms (over-conform). As a simple example, in the U.S. there is a shareholder-oriented logic that boards ought to be comprised of a majority of outsiders; however, some pre-IPO firms operate with a majority of insider directors. This is a clear case of under-conformance with respect to the dominant governance logic. Conversely, an example of over-conformance with respect to the majority of outside directors norm is American Airlines, which removed all inside directors except the CEO.

Central to our model are institutional logics—the socially-constructed assumptions, values, beliefs, formal rules, and practices that equip organizations with a toolkit to interpret their experiences, direct their attention towards specific choices, define their goals, and limit their potential organizational choices in order to be perceived as legitimate (Berger & Luckmann, 1966; Friedland & Alford, 1991; Thornton et al., 2012). Each institutional logic suggests to firms an acceptable zone of conformity (Bundy & Pfarrer, 2015). In practice, there are a wide variety of institutional logics operating throughout the global economy, and extant comparative corporate governance research advances many typologies outside the shareholder-stakeholder-oriented models (Aguilera & Jackson, 2010). However, previous literature suggests that there are four ideal types operating within the global economy (O’Riann, 2000). For example, the liberal country type endorses a shareholder-oriented governance logic where the market defines the firm’s primary goal and its governance, prioritizing the maximization of shareholder value (Shleifer & Vishny, 1997) to provide firms with legitimacy. This shareholder-oriented logic is predominant in Anglo-Saxon countries, which tend to follow detailed and precise binding governance regulation (i.e., “hard law”), such as the United States’ 2002 Sarbanes-Oxley Act (Hansmann & Kraakman, 2000). In contrast, social rights country types adopt a stakeholder-oriented governance logic in which the primary goal of the firm and its governance is to balance the interests of all stakeholders involved in the firm (Jackson, 2005). Stakeholder-oriented countries often enact more flexible governance regulation based on “comply or explain” codes of good governance, such as the Dutch Peters Report which exerts normative pressure to adopt certain practices in line with the country’s governance logic (Aguilera & Cuervo-Cazurra, 2004). The third ideal type is what we call the developmental country type adopts a relational-oriented governance logic with the primary goal to contribute to the country’s economic development, while also aspiring to incorporate values, norms, and beliefs from the stakeholder and shareholder governance logics, despite historically strong relational ties to other economic actors to which it must attend (Almeida & Wolfenzon, 2006; Chang, 2003; Fogel, 2006; Schneider, 2013). Countries with a relational logic are likely to develop more flexible, multi-tiered norms, such as the varying levels of governance requirements offered to firms listed on the Brazilian stock exchange (Braga‐Alves & Shastri, 2011) or different normative expectations for South Korea’s core (chaebols) versus peripheral firms (Chang, 2003). Finally, the socialist country type adopts a statist-oriented governance logic where the primary goal of the firm and its governance is to perpetuate state authority and power in the overall economy (Pearson, 2005).

Central to our theorizing is the concept of the firm’s entrepreneurial identity, which Navis and Glynn (2011: 480) define as “the constellation of claims around the founders, organization, and market opportunity of an entrepreneurial entity [organization] that gives meaning to questions of ‘who we are’ and ‘what we do’” and argue that “conformity to established standards is antithetical to entrepreneurship, which tends to be more concerned with novelty, distinctiveness, and nonconformity” (479). We argue that the centrality of an organization’s entrepreneurial identity as part of its overall organizational identity is the missing link in explaining the source of agentic behavior given isomorphic pressures to conform to the prevailing institutional logic. This entrepreneurial identity construct applies to the overall organizational self-concept as it refines the specifics of organizational identity related to proactiveness and willingness to deviate from established norms. We claim that entrepreneurial identity is applicable to all firms that are early adopters of corporate governance practices operating outside of the zone of conformity specified by the national governance logic.

Next we turn two key contingencies that will moderate the governance discretion-governance deviance relationship. The first moderator, regulatory enforcement, works at the country-level and it is an important modifier of governance logic. The second moderator, governance capacity, operates at the firm level and it seeks to evaluate the ability to implement, beyond the cognitive latitude and accessibility of the opportunity. Our model advances four distinct types of corporate governance deviance which we label: (1) Commercial Mavericks, (2) Social Rebels, (3) Commercial Rate-Busters, and (4) Social Angels.

Taken together, our theory attempts to understand when and how firms deviate from their prevailing national governance logic with respect to corporate governance practices. The concept of governance deviance describes how a practice can be evaluated as deviant or conforming depending on the prevailing governance logic surrounding the organization. We describe how a firm’s entrepreneurial identity is the primary driver of corporate governance discretion, and that the range of socio-cognitive governance discretion will make deviance more or less likely.

Our study has several practical implications that may be of interest to financial regulators. First, since financial regulation deals with the formal “rules of the game,” it is important for regulators to recognize that these rules are unlikely to have the same impact throughout the global economy due to the different institutional logics in operation. As such, there is no global standard that is likely to work in all governance environments. Second, our model points out that regulatory enforcement is likely to have a bigger influence on corporate governance practices than actual regulations. As such, formulating effective regulations is less important than promoting consistent rule-based enforcement in our view. Third, financial regulations force conformity to a single standard. Consequently, care must be exercised in not stifling innovation while preserving financial order and avoiding reckless behavior. Finally, there needs to be a transnational nongovernmental entity that monitors and regulates multinational firms since these firms often co-opt, dilute or ignore the national regulations advanced in their home or host countries.

The complete article is available here.

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