Corporate Accountability and Governance Reform

An Alternative Logic of Value to Agency Theory’s Dead End

Charl du Plessis

University of Virginia

The Accountable Corporation

February 2005

Questions: Corporate Accountability • Who or what is it that we hold accountable?

• For what is it being held accountable?

Focus of Discussion• Cultural perceptions of two concepts

– The Corporation: From production system to investment system (Fligstein)

– Shareholder Value: From profit-maximization to a plurality of sentiments (Smith and Sen)

• Mapping governance reform past and present to perceptions

• Explore origin of cultural conceptions, and the shift to the agency logic of the firm as investment system

• Introduce the more progressive governance reform proposals of MacAvoy and Millstein (”MacMill”)

• Review evolvement of governance to locate MacMill amidst other new reforms (Congress, SEC & Exchanges, Conference Board, Delaware Courts)

• Identify central role of agency logic and its impact on reforms• List problems associated with the agency logic• Investigate viability of a so-called value logic as an alternative• Consider implications for governance practice

Paper Structure

From Corporate to Agency LogicAssumptions Corporate Agency

Management Professionals with unique knowledge, Stewards of firm

Fungible agents of shareholders, Self-dealing

The Firm Unique core competencies Nexus of contracts

Resource Allocation Management allocate Shareholders diversify

High-order Cultural Frame

Professional autonomy, production-function

Capitalist markets, investment-system

Theory of Organization

Managerialist Theory (Chandler, 1962)

Agency Theory (Jensen & Meckling, 1976)

Compensation Used to attract scarce management talent

Used to align management and shareholder interests

Allocation of Cash Retain and reinvest Redistribute to shareholders

Evolvement of Governance• Separation of owners & management (Berle and Means, 1932). • 1962 – Chandler’s managerialist theory and corporate logic of

unique knowledge and strategic contribution of management• 1960s onwards - rise of managerial capitalism, with management

following own dictates. Conglomeration and merger activity focused on growth over profitability

• 1976 – Jensen & Meckling on agency theory. Higher-order cultural framing of economy adopts the agency logic of the capital market’s emphasis on share price (Zajac and Westphal, 2004)

• Late 1970s – inflation and the rise of the CFO (Zorn, 2004)• Fligstein (1990) – legislative triggers and conceptions of control

within firm. Cultural conception of firm as investment-system • Agency logic dominates governance reform during earlier reforms

(FASB & CalPERS) and with new reforms. Progressive proposals like MacMill and Conference Board follow same logic of separation, and the centralization of authority

The MacMill Proposals

• Stated Objective: Board conduct > structure• Complete separation of Chair and CEO• Sarbanes-Oxley certification of financial statements

extended to the board• Board takes responsibility for strategy, risk-

management and financial reporting• Board must assure itself of the integrity of

management• Board to appoint internal auditors, and also own

consultants, advisors and counsel

New Reforms & The Agency Logic

• Congress: Sarbanes-Oxley 2002• NYSE/NASDAQ & SEC: Majority of independent directors,

independent board committee activities, additional committees• Conference Board Commission 2003: Separation, self-evaluation,

executive sessions, presiding director, “ethical tone set at the top”• Delaware: Expansion of good faith requirement to cover new

reforms

Dominant Themes> Separation as independence> Still more oversight

Problems with Agency Logic

• Separation - wrong metaphor for independence of mind and conduct (Reiter & Williams, 2004). Generic threats within homogenous groups: Self-interest, self-review, advocacy, familiarity, intimidation, self-serving bias, confirmation bias, anchoring, optimism, overconfidence and recency

• Leadership issues - informational, motivational, and relational

• Compliance cost and competitiveness

Impoverishment of Value• Smith: Selfish, social and unsocial passions. No distinction

between citizen and economic agent• Sen: “Universal selfishness as actuality may well be false,

but universal selfishness as a requirement of rationality is patently absurd”

• Enron thought-experiment in unscrambling the omelet– Prima facie evidence of market for trust and integrity– Doing the right thing– Doing things right

• Plurality of investor sentiments not exhausted by profit-maximization

Which way now?• Start at a logic of value that allows for plurality of investor

sentiments • Requires democratization of shareholder voice• Stakeholder theory offers example of workable discourse model• Feminist critiques against Habermas’ discourse ethic relevant

and limits stakeholder theory’s contribution due to power differential between owners and rest

• Introduce Knightian uncertainty and its centrality to profit to augment ownership when determining discourse participation under stakeholder model

• Relate these ideas back to current structures?

Knightian Uncertainty• Frank Knight, Nobel Prize Economist, in what Stigler

describes as “condensed restatement of the theory of value”

• 1921: Distinction between– Risk: Probabilistic and measurable– Uncertainty: Immeasurable “known unknowns, and

unknown unknowns”

• Examples: – Shareholders, risk-less rate of T-bonds, exit through selling,

risk only exist on aggregate– Employee training, and supplier asset specificity

The Search for Alternatives

Agency Problem &

Moral Hazard

Corporate Governance Reform

Private Ownership:-Scale-Transaction Cost-Transparency

ALTERNATE LOGIC?Discourse Approach :-Stakeholder Theory -Power Asymmetry

AGENCY LOGICSeparation Approach:-Compliance Cost-Leadership Issues-Logical Impossibility

OWNERSHIP

UNCERTAINTY VALUE LOGICCo-Evolutionary Approach:-Beyond Ownership-Knightian Uncertainty & True Economic Profit-Creation and Mitigation of Uncertainty

A Value Logic of GovernanceAssumptions Value Logic

High-order Cultural Frame

Organizations function as co-evolutionary systems of uncertainty creation and mitigation amongst citizens

The Firm Replaces church and state as pre-eminent social institution. Controls vast resources, cross borders, affect human lives. Creator and disseminator of value

Management Plurality of talent and motive. Oversight as necessary as is empowerment. Leadership sets normative tone

Resource Allocation Stakeholder Capitalism: Asset-specificity of both financial and social capital. Credible commitments reduce mobility

Theory of Organization Stakeholder Theory, modified from firm-centric organizational position, to democratizing discourse model

Compensation Equitable meritocracy: contribution of resources and bearing of uncertainty determine participation and reward

Allocation of Cash Flow According to democratically communicated value ordering of legitimate stakeholders within context of each firm

Implications for Governance• Operationalize shareholder value concept beyond

profit/CSR dichotomy • Professionalism of board – old boys weekend model

needing protection of lawyers unacceptable • Directors have duty to create channels for low-cost and

frequent shareholder voice. Distinguish between:– Explicit (equitable) right to vote, and– Implicit (equal) right to participate in the voting process

• Nominating/governance committee to create forum for stakeholder participation – uncertainty as metric

• Neutralize relative power of institutional investors