THE GOVERNANCE OF FIRMS CONTROLLED BY MORE THAN ONE BOARD:

THEORY DEVELOPMENT AND EXAMPLES

by

Shann Turnbull

A tbesis :.ubmittcd in fulfilment of the requirements

fonhe degree of Doctor of Philosophy

August 2000

1\-lacquaric Graduate School of ;'Vlanagcmcnt

1\lacquarie Unhcrsit~~ Sydney

Australi~

TABLE OF CONTENTS

Table o.fContems Lis! of Tables and Figures Summary

Certljlcate of exdusivitp Foreword

LO INTRODUCTION 1.1 Choice of research lopic 1.2. Aim of the study L3 Relevance of the research l ,4 Kt..'Y concepts 1.5 Rescan;h methods and outline of the thesis 1.6 Contributions to knowledge 1. 7 Assumptions and limitations

Page

ii

v

vi

Vll

VIII

I 3 4 6

10 13 16

2.0 CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES 19 2. J Introduction 2.2 Definitions 2.3 Factors which affect the operations of firms 2.4 Different corporate govcmancc perspectives 2.5 Comparative studies and theories 2.6 Models and explanations of corporate governance

2.6. t The simple finance model 2.6.2 The stewardship model 2.6.3 The stakeholder modd 2.6.4 The political model 2.6.5 Culture 2.6.6 Power 2.6. 7 Biological model of the fim1

2. 7 Outstanding issues in corporate governance scholarship 2.7.1 Limited life 2.7.2 \Vorker ownership and control 2.7.3 Compound boards 2.7 .4 Information theory 2. 7.5 Networks 2.7.6 Holonic structures 2.7.7 Self-regulation and self-governance

2.8 Conclusions

3.0 THEORY DEVELOPMENT BASED ON BYTES AND CYBERNETICS 3.1 Introduction 3.2 Definitions 3.3 Human cooperation dependent upon transacting bytes

19 21 30

37 44 48 50 54 56 60 62 67 70 70 71 72 74 76 77 79 80

83 83 84 89

3.4 Methods of human communication and control 95 3.4.1 Sensory 97 3A2 Semiotic 97 3.4.3 Voice!word in hierarchies 98 3.4.4 Price/cost 100

3.5 Human behaviour and tbc tra..Jsaction of bytes t 01 3.6 The processes of human thinking and action I 07 3.7 Hierarchies: their control, regulation and sdfgovemancc 113

3.7.1 Information overload 120 3.8 The necessity for requisite variety in infonnation and control 123

3.8.1 Variety in decision making 124 3.8.2 Variety in infonnati-on channels 124 3.8.3 Variety of control channels 125

3.9 Cybernetic strategies for economising information 126 3.9.1 Amplifying control through supplementation 126 3.9.2 Economising bytes through the "Principle ofSubsidiary Function" 127 3.9.3 Economising bytes through a hierarchy ofholons 129 3.9.4 Economising bytes through tensegrity 134

3.10 The thesis and the structure of its defence 136 3.10.1 Originality 137 3.10.2 Theoretical utility 137 3.10.3 Evidence of compound boards and utility of the TBA framework 139

4.0 THE EVOLUTIO!'I OF CORPORATIONS AND COMPOUND BOARDS 141 4.1. Evolution of finn control structure

4.1, l Ownership and control taxonomy 4.1 .2 Management structures

4.2 D4.3 Nutional ditlCrencc in control architecture 4.3.1 Anglo 4.3,2 Dutch and Indonesian 4.3.3 German 4.3.4 French 4.3.5 Japanese 4,3.6 Overview

5.0 INTERNAL COMPOUND BOARDS IN ANGLO NATIONS 5.1 Introduction 5.2 US case studies

5.2. 1 American plywood industry 5.2.2 The American Cast Iron and Plpc Company

5.3 United Kingdom case swdics 5.3.1 Scott Bader Commomvcalth 5.3.2 The John Le\vis Partnership

5.4 Review and conclusions

141 146 148 \50 ISO 157 159 160 t60 164 165 167 I 71 173

177 177 179 179 !84 186 186 190 194

6.0 STAKEHOLDER CONTROLLED FIRMS WITH COMPOUND BOARDS 199 6.1 Introduction 6.2 ~v1ondrag6n Corporncion Cooperativa

iii

199 200

6.3 The founder of MondragOn 6.4 Building Mondragon 6.5 The governance of MondragOn fim1s

6.5.1 \Vorkcr cooperatives 6.5.2 Distribution of cooperative profits 6.5.3 The Bank and other second order cooperatives 6.5A Jntcr~firn1 govcmancc 6.5.5 Holonic architecture

6.6 Japanese Keiretsu 6. i Rcviev .. -of compound boards with stakeholders

7.0 UTILITY OF TRANSACTION BYTE ANALYSIS 7.1 Introduction 7.2 TBA grounded in science

203 205 208 209 214 215 217 220 225 228

235 235

7.3 Application ofTBA in investigating MondragOn compound boards 239 7.3.1 Minimisi11g bytes and bounded rationality through holonic subsidiarity 239 7 .3.2 Identifying the operating advantages of a division of power 241 7 .3.3 Identifying the decomposition of decisiot1 making labour 243 7 .3.4 Evaluating sclf-govcmance 248

7.4 Relationship ofTBA with other theories 249 7 .4.1 TBA based on power model rather than efficiency model of the fim\ 249 7.4.2 TBA as a micro~elemcnt and extension ofTCE 251 7.4.3 Comparison \'lith TCE, resource and evolutionary theories of the firm 264

7.5 Propositions for testing TBA 268 7.6 \Vider implications ofTBA framl.!work 274 7. 7 Limitations ofTBA framework and areas for future research 280 7.8 Concluding remarks 283

REFEREtiCES 286

iv

Table No.

Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 2.5 Table 2.6 Table 3,1 Table 3.2 Table 3.3 Table 3.4 Table 3.5 Table 3.6 Table 3.7 Table 3.8 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table G.! Table 7.1 Table 7.2 Table 7.3 Table 7.4

Figure No.

Figure 2.1 F. ? 0 tgurc ~ .... Figure 4.1 Figure 4.2 Figure 4.3 Figure 4.4 Figure 5,1 Figure 5.2 Figure 5.3 Figure 5.4 Figure 6.1

Fi~Ur'C 6.2 Figure 6.3 Figure 7.1 Figure 7.2 FJgure 7.3 Figure 7.4

LIST OF TABLES AND FIGURES

Title Page

Stakeholders affecting the operations of publicly traded tlm1s: 31 Scope und diversity of corporate governance conccms 36 Characteristics of governing mechanisms 40-41 Models of corporate governance 45 Efficiency and power model oflhe tlm1 63 Comparison of biology with economics 68 Methods of communicution and their attributes 91 Characteristics of communication and control methods 96 Loss and distortion of information in a hierarchy 99 Difll:rcnccs between "economic" and "real" people 103 Human constraints in transacting bytes Ill Corrupting powers of a unitary board 115 Evaluation of hierarchies to control, regulate or sc!f.govem ! ! 8 Holarchy: hierarchy ofholons l30 Ownership and control taxonomy of corporations !46 l'.'umber of listed "Anglo" companies 157 Nature of German and UK (rwncrship !67 Cultural differences in corporate ownership and control 174 Holon typology of MondragOn 221 Comparison ofTCE and TBA boundaries 255 An Organisa!ional Failures Framework 258 Comparison ofTBA with other theories of the fim1 266-267 Role of communication channels in governing society 276

Title Page

Investor view of a fim1 33 Stakeholder view of a finn 33 Management structures and control architecture of firms 149 Evolution of"Anglo" corporate control architecture 155 International comparison of control architecture 163 Anglo and Japanese dispersed ownership and control architecture 172 USA LabourOwncd plywood firms: lnfonnation and control architecture 181 ACIPC: Infom1ation and control architecture 185 Scott Bader Commonwealth: Information and control architecture 188 The John Lewis Partnership: Infonnation and control architecture 191 MondragOn Cooperative System: With dates of establishmcni 207 Information and control architecture of MondragOn cooperatives 210 Control network of MondragOn activities 218 Functions and activities of a unitary board 244 Functions and activities of MondragOn compound board 245 Y1ondrag6n -compound board compared with unitary board 245

~'lodes of governance in political systems 277

v

SUMMARY

The contribution of this thesis is to present a framework to analyse firms controlled by more

than one board. The literature survey of Chapter 2 revealed that there is little recognition of

this phenomenon and no accepted way to investigate firms governed by multiple control

centres described as a "compound board". The framework is developed in Chapter 3. The

historical emergence of compound boards is outlined in Chapter 4 with examples of their

architecture described in Chapters 5 and 6. Chapter 7 shows how the framework provides

insights not available from other theories of the fim1 and how self-governance can be

furthered by utilising contrary human attributes of competition/co-operation, trust/suspicion

and self-interest/altruism.

The framework is described as transaction byte analysis (TBA) as it is based on the limited and inconsistent ability of humans to transact units ofinfonnation described as "bytes". TBA

identifies cybernetic principles and strategies that can mitigate human limitations in

processing bytes. These provide organisational design criteria for finns to obtain operating

advantages. As infom1ation is a common clement in varies theories of the fim1, TBA relates

and subsumes them while allowing any type of organisation to be analysed.

Propositions arc presented in Chapter 7 for illustrating how TBA provides insights into

explaining: (i) why non-trivial employee owned industrial firms have more than one board; (ii) why self-regulation and self-governance of non-trivial fim1s cannot be assured without a compound board; (iii) how compound boards can simplify the role, knowledge, duties and liabilities of directors; (iv) the competitive advantages of appropriate compound boards in

relation to unitary control systems; (v) how to compare and evaluate the relative advantages and disadvantages of firms with different ownership and control structures; (vi) how to compare the relative efficacy of hierarchical and non-hierarchical firms be they in the private

or public sector.

vi

CERTIFICATE OF EXCLUSIVITY

1 hereby certify that this work has not been submitted fOr a

higher degree to any other university or institution,

Shann Tumbull

FOREWORD

This thesis has its origins in my first published academic paper, 'Time Limited Corporations'

(Turnbull 1973a). This article was motivated by the need to find a way for Australia to attract fOreign investment while at the same time eliminate long tcnn foreign ownership. I presented

the paper to the 45th Annual Congress of the Australian and New Zealand Association for the

Advancement of Science and it was subsequently also published by the Economic Society of

Australia and New Zealand (1973b). At that time I was a corporate raider and company promoter who had learnt how to manipulate ownership and control rights for the profit of

individuals.

It became evident that the framework of analysis used by mainstream economists did not

provide a basis to understand my proposals for distributing property rights or analysing

distributed control into two or more control centres. Then, in 1974 I discovered that a US

lawyer, Louis Kelso ( 1967) was putting into practice an alternative proposal to my own for distributing corporate ownership through Employee Share Ownership Plans (ESOPs). In 1975, I organised Kelso to visit Australia. In order to introduce both his ideas and my own to

the general public for his visit, I wrote Democrarising the Wealth ofNations (Turnbull l975a) which was launched and reviewed by the fonner Deputy Prime Minister (Cairns 1976). I also

undertook consulting work to put the ideas of my book into practice in a number of

assignments for leading corporations, national and provincial govenunents.

Starting in I 976, the US Congress introduced a number of major tax incentives to promote "Kelso Plans". In 1999, around 10% of the US work force had equity in their employers and

15% of the largest publicly owned corporations in the US were more than I 0% owned by

their employees (ESOP 1999). Kelso publicly debated his vision of "universal capitalism"

with leading US economists, which resulted in mutual ridicule. No refereed journal ever published any work by Kelso.

VUJ

My own approach was to constructively engage with economists and other academics. This

became my principal vocation from 1991 when I re-wrote 'Time Limited Corporations' as 'Re-

inventing Corporations' (Turnbull 1991a). This and other articles published in refereed journals since then have analysed both distributed ownership (Turnbull 1998a) and distributed control (Turnbull 1997i). However, this thesis is restricted to analysing only distributed control as it arises from firn1s controlled by more than one board whether or not the boards

arc internal or external to the firm.

The literature search for the thesis in Chapter 2 forn1cd the basis for 'Corporate Governance:

lts scope, concerns & theories', published as an invited contribution to mark the completion of

the first five years of publication of the first specialist corporate governance journal, Corporate Governance: .An International Re\'iew (Turnbull 1997a). This survey was updated and translated into French, as the lead article to launch the first Francophone academic journal on corporate governance (Turnbull 2000a).

Transaction Byte Analysis (TBA) developed in Chapter 3 had its origins in a professional assignment undertaken for the Australian Minister for Aboriginal Amlirs in 1977 to study the

impact of mining royalties on Aboriginal communities in the Northern TerritO!)'. The initial clement of the methodology was published in my report fOr the Australian Parliament

(Turnbull 1978b: 5,51) and later used in 'Stakeholder Democracy: Redesigning the governance of firms and bureaucracies', (Turnbull 1994d). Grounding of the methodology in the theory of the finn was first undertaken in a paper, 'Beyond markets & hierarchies:

Extending the theory of the firm', presented to the Twenty-third Annual Conference of

Australian Economists (Turnbull 1994a). Additional grounding in the management literature was included in an invited paper 'The application of cybernetic knowledge in governing

society', presented to an international conference on 'Knowledge, Economy and Society' held

at the University of MontrCal (Turnbull 1997j). The development of the methodology into TBA, grounded in clements of physiology and the principles of cybernetics is a major contribution of this thesis.

The analysis of the weaknesses in undistributed control in Section 3.7 was developed as a

fOunding author of The Company Directors' Diploma Course (Turnbull l975b). This was the first educational qualification developed for company directors. The analysis was later

published in refereed international journals (Turnbull l993b; Guthrie & Turnbull 1995; Turnbull I995c,t).

Information on the history of the development of the corporate concept in Chapter 4 and the

examples of distributed control, through two or more boards, in Chapter 6 also had their

origins in material prepared by the author tOr The Company Directors' Diploma Course. The

case studies of distributed control in employee owned firms in Chapter 5 were researched for

the thesis as was the detailed analysis of the stakeholder-controlled cooperatives located

around the town of MondragOn in Spain published by Corporate Gmerna11ce: An

!nremational Review (Turnbull 1995d).

Dr. John Mathews, at the School of Industrial Relations & Organisational Behaviour

supervised my initial PhD work in 1993 at the University of New South Wales. In 1997, I

transferred my enrolment to the Macquarie University Graduate School of Management,

Sydney. Supervision of my work was taken over by Professor James Guthrie, who became

Deputy Dean of the Graduate School of Management and Director of Research. Dr. John

Mathews joined the staff of the Macquarie University Graduate School of Management, Sydney in 1998 and took on the role of Director of Research in 2000. Both John and James

also guided me through my qualifying topics when they were at the University of New South

\Vales. I thank my supervisors, my various editors and many anonymous referees.

I also thank my wife, Pauline Markwell tOr her support and our three teenage children,

Karinya, Christopher and Melysha. Perhaps one day they may accept that one can facilitate

distributed control and democracy while not always practicing it in the home.

X

CHAPTER 1

INTRODt:CT!ON

1.1 Choice of research topic

The first three sections of this Chapter explain respectively: an explanation of how the

research toptc was seli.X:ted, the aim of the research, and why the research is important for

the analysis of firms controlled by more than one board. St.>ction lOur outlines the key

concepts of the analytical ffomework developed for investigating finns controlled by more

than a single board described as Transaction Byte Analysis (TBA). TI1e process of developing TBA is outlined in Section l.5 and this aiso describes the structure of the

thesis. The following Section J ,6 describes the contribution to knowledge provided by the

thesis, The Chapter concludes with Section 1.7, which also reviews the assumptions and

limitations of the process by which the framework was developed.

The experience and interests of the author descr~bed in the Fore-word motivated the

research topic. One of the most inrorcsting bur cha!knging concerns about inv..:stignting

tirms controlled by more than one board was that then: was little previous published work

into this phenomenon described as a "compound b-oard''.

The lack of previous published research into compound boards had been identified by the

author from his work in pioneering the study and teaching of comparative corporate

govcnumce as a foundation author of the Company Directors Diploma Course (Turnbull 1975b). ::vfotivation fOr researching the topic arose from the author's work with employee owne-d finns \Vherc compound boards arc ubiquitous; also, from his experience in

establishing a two tiered control system fOr raising funds from the public for a large cotton

fam1 jn 1980 and tOr a new technology company h!! established in 1988.

There arc a number of empirical studies on the structure of unitary boards such as provided

by Monks & Minow {1995) and Tricker (1994}. There arc also many studies investigating the rdationship of board variables to fim1 pcrfommncc (Blair 1995, Donaldson & Davis

INTRODUCTION

1994, Gordon & Pound 1991; Hawley & Williams 1996). In a number of instances compound boards were involved but this was not recognised. Gertner & Kaplan ( 1998) provide an example. The invisibility of two tiered boards might be explained from the

insights of Kuhn ( 1970: 24) that described "normal science" which does not "call forth new sorts of phenomena: indeed those that will not fit the box are often not seen at all".

Compound boards arc not uncommon in Anglo cultures such as the USA, UK and

Australia. They arc created whenever one company controls another with outside

shareholders. Even in the Fortune 500 companies, around 20% of these arc controlled by a

dominant investor/shareholder (Zcy, 1999). Compound boards are even more common in emerging economics where a family company of the founding entrepreneur, or a

multinational, typically controls publicly traded corporations (La Porta, Lopez-dc-Silancs & Shlcifcr, 1999).

The functions and concerns of directors on a board controlled by another board, or by an

individual, who is the major shareholder, an:: substantially different from those mr.::mbers of a board without a dominant or influential sharr.::holdr.::r. Thr.:: most important rolr.:: of a

unitary board is to appoint, direct, monitor, control, remunerate and when necessary, retirc

the chief executive. However, this role can become largely irrelevant if thc dominant

shareholder is also the Chief Executive officer (CEO), such as Bill Gates of Microsoft Corporation (Microsoft, 2000) or Rupert Murdoch of News Limited (News, 2000). Succession in their corporations may be detem1ined and/or maintained by their family

interests rather than the board directors who hold their position at the grace and favour of

the family.

The presence of a controlling shareholder also provides a way to resolve the most sensitive

and contentious conflicts of interest, which arc inherent in a unitary board in regards to

control of the auditor or the detem1ination of dircctor remuneration, nomination or

retirement. These conflicts involve the motivations of individuals and so people rather

than boards arc the focus of the investigation. The capability and integrity of individuals

2

CUAPTE~ I

in transacting infomnttion to fl.!rther thdr own interests provides a basis for investigating

compound boards. This h!(\ds to the development of a framework of analysis described in Chapter 3 as TBA.

1.2 Aim of the study

The

INTRODUCTION

However, many firn1s may not have a board such as with a joint venture, alliance or a network fim1. Many publicly traded companies may be controlled by an individual rather

than by a board of a dominant shareholder or parent company. To allow these situations to

be included, the definition of a compound board includes a "control centre".

As noted in Chapter 7, this inclusive definition of a compound board means that TBA can

bt.! applit.!d to any type of social organisation or institution used for coordinating any social

activities. The origins of TBA arose in this general context as it is based on a

methodology developed by the author to investigate economic development of Aboriginal

communities in Australia (Turnbull 1978b: 5,52). The development of TBA was restricted to firms to allow it be grounded in, and compared with, established theories of the fim1

articulated by Coase (1937), Williamson (1975), Ouchi (1980) and Nelson & Winter (1982).

Both TBA developed in Chapter 3 and the case studies in Chaptt.!rs 5 and 6 make a partial

contribution to the original aim of explaining how compound boards operate and how they

can affect pcrfomnmce. TBA represents the revised aim of the rcsearch with examples of

its application presented in Chapter 7.

1.3 Relevance of the research

The research makes a contribution to the current stock of knowledge in at least five ways:

First, the research identifies a significant gap in the literature on corporate governance in

neglecting the study of compound boards. The thesis documents and analyses the

neglected and unrecognised phenomena in Anglo countries of compound boards. It

provides both an empirical and conct.:ptua\ foundation for other researchers to extend such

research and analysis. For researchers investigating unitary boards, it provides a basis for

re-interpreting their findings in the event they were investigating a board controlled by

family interests or one that was a component of some other more complex control system.

4

CHAPTER I

Second, the research provides a framework for comparing unitary boards with compound

boards. In this way it provides a foundation for studies in comparative systems of

corporate govcmance. This has practical and political importance as the European

Community is striving to harmonise company law in all the member states. Two and three

tier boards arc found in a number of member states. A proposal to mandate dual boards

was made but has currently been deferred (Skog 1994: 122). In Australia, as a direct result

of the contributions by the author, the Parliamentary Joint Standing Committee on

Corporations and Securities (JSCCS, 1998), invited public submissions into the desirability of a "corporate governance board" being established by each publicly traded

company in Australia.

Third, the research grounds organisational analysis in the natural sciences of cybernetics

and human biology. The neurophysiological limits of individuals to process bytes

introduces criteria for designing organisational architecture to minimise the exposure of

people to transact bytes beyond their capabilities. Cybernetic principles provide design

criteria for minimising errors in communication and control and for organisations to

manage complexity. TBA offers a basis for developing "the elusive 'science of

organisation' to which Chester Bamard made reference fifty years ago" (Williamson, 199Ja: 12). Both Williamson (1990: xi) and Simon (1984: 40) saw the nc!.!d "f{)f

observing the phenomena at a higher level of resolution". Bytes provide an answer in this

regard and also answer the question raised by Williamson ( 1990: xi) "how micro is micro'?"

Fourth, TBA provides a way to relate and compare various theories of the fim1 as they all

depend upon the communication of infonnation. A comparison of Transaction Cost

Economics (TCE), resource based theories of the finn and evolutionary theories arc

presented in Section 7 .4.3. As TBA can be applied to any type of institution it provides a

way to compare all types of integrating mechanisms found in society. Institutions can

become a variable rather than a given in the analysis of industria! organisation and

5

INTRODUCTION

organisations m general. TBA also provides a way to relate and compare the vanous

approaches to corporate governance identified in Chapter 2.

Fifth, the research relates the infonnation and control systems found in organisations to

those found in humans and those designed by engineers for complex machinery, devices

and computer software. In this way it provides a way to design organisations to most

efficiently and effectively match the capabilities of humans. TBA provides a perspective

for evaluating organisations and provides a tool tOr designing social institutions to fit their

purpose as proposed by Hirshleifer (1977: 366). This contribution could have profOund implications for the role of both government and non-government institutions and so the

architecture of society as indicated in Chapter 7.

1.4 Key concepts

The key concepts on which TBA is based arc set out belo\v. Some of these concepts arc

not found in other theories of the finn. It is by applying concepts developed in related

disciplines to finns that TBA makes an original contribution for understanding the

operation of compound boards, complex firms and organisations in general. A unique

feature of TBA in organisational analysis is that it is based on units of infOrmation rather

than costs. As outlined in Chapter 3, TBA subsumes the economics of information by

being based on all types of infom1ation used in organising social action.

TBA is based on the fOllowing key concepts which arc explained in Chapter 3:

(a) Infom1ation quanta, in the form of bytes, are used as a unit of analysis;

(b) The governance of all social activities is dependent upon communicating

bytes;

(c) There are physical limits on the volume of bytes that can be transacted

within a person and between people;

(d) The transaction of bytes within and between people, fim1s and organisations

arc subject to the laws of cybernetics;

6

CHAPTER I

(c) People are variable. The way in which they transact bytes can vary, both between people and with the same person at diftCrent times. People can

transact bytes in an inconsistent, contradictory manner;

(t) The transaction of bytes within and between people is subjected to errors;

As described in Chapter 3, TBA is so named to illustrate both its connection to, and

ditlCrcnce from Transaction Cost Economics (TCE). Infonnation represents the dominant cost in governing transactions as noted by Coase (1937: 83). From the TBA perspective, costs represents a proxy for bytes. It is argued that TBA subsumes TCE because bytes

represent a microelement of transaction costs. The five key clements of 'The

Organizational Failures Framework" of TCE identified by \Villiamson (1975: 20) arc based on infonnation. The five clements arc (i) Bounded rationality; (ii) Uncertainty/complexity; (iii) Opportunism; (iv) Small numbers and (v) Infonnation impactcdncss.

The key concepts (c), (c) and (f) of TBA set out above explain causes of "bounded rationality". Bounded rationality describes the limited ability of people to handle

infonnation. Williamson (1975: 21) explained that: "the physical limits take the fonn of rate and storage limits on the powers of individuals to receive, store, retrieve ;;md process

inforn1ation without error." The need to limit the volume of bytes transacted by an

individual within his or her reasonably reliable operating capacity provides one of the most

important criteria for designing the infom1ation and control architecture of finns.

By economising the infom1ation required by individuals to coordinate their activities, the

cost of infOnnation to organise and/or govern transactions is also economised.

Economising information then cconomises costs consistent with TBA being a

microclement ofTCE. The economising of bytes also reduces the problem of complexity,

an clement on which the Williamson framework is based.

7

INTRODUCTION

However, "opportunism" and "small numbers" arc not key concepts in TBA because it

recognises that people arc variable and contradictory. People can also be altruistic even if

they arc in a superior bargaining position because of "small numbers". Likewise,

infonnation compactcdness is not a key concept fOr TBA although it can be recognised, as

it is dependent upon bytes being possessed by one party to a transaction but not available,

or available economically, to another party.

TBA uses the Principle of Subsidiary Function, which is explained by Schumacher ( 1975: 203) who stated "that no higher order association should undertake any function, which can be undertaken at a lower level". TBA also has two derivative, or second-order

concepts, which are based on the key concepts listed above. One is the concept of

"holonic architecture" which provides the basis for nature to create and manage

complexity. Mathews (1996a: 30) notes that holons allow a "prodigious reduction in data transmission and in data complexity". They provide the most efficient way to construct

organisations to manage complexity to keep the transaction of bytes within the reliable

operating limits of individuals. A weak fonn of holonic architecture recognised by TCE is

the multi-divisional type finn, which reduces the intOnnation overload of head oflice

(\Villiamson 1985: 280). The Principle of Subsidiary Function can be utilised by a hierarchy ofholons described by Koestler (1967) as a holarchy".

Another second order and original concept ofTBA is that ofsocial tenscgrity". The word

tensegrity is used to describe physically strong structures found in nature which can now

be engineered. These structures possess flexibility and stability to a degree greater than

their component parts which have contrary properties like their ability to withstand tension

or compressiOn. Likewise, social tenscgrity describes strong reliable relationships in

organisations that possess flexibility and stability to a degree greater than can be provided

by their component attributes with contrary properties such as

compel i ti veness/ cooperativeness. Love/hate, dam i nan t! su bm iss i ve, trusti ngl suspicious

relationships provide other examples. Trust provides an ctlicient basis fOr goveming

8

CHAPTER I

transactions in teams and organisations. But to survive, teams and organisations also need

processes fOr detecting and managing activities when trust is misplaced.

A compound board is relevant to both derivative concepts. Organisational holons require a

division of power to achieve their self-governing capabilities and a division of power

provides a basis to develop constructive tensions between individuals.

The key concepts (c), (c) and (f) of TBA recognise the limits and Jack of integrity in transacting bytes to govern human activities as required by key concept (b). A unique contribution of TBA is the key concept (c) that introduces instrumental rather than nom1ative, empirical or descriptive principles to:

(i) Identify strategies for overcoming limited information processmg capabilities of people and the existence of errors,

(ii) Explicate the informational and control advantages of different organisational architectures and

(iii) Provide design criteria to create an organisational architecture, which best matches the capabilities of members of a finn to its purpose.

Compound boards can provide a technique tOr decomposing decision making labour and

so a way to economise the information load on individuals. The division of infOrmation

and power inherent in compound boards introduces checks and balances on self-dealing

and agency costs. With sufficient plurality of infom1ation, control and processing

channels, the opportunity tOr self-dealing, communication biases, distortions, errors and

omissions can be reduced as much as desired. This statement is elaborated in the

cybernetic principles identified in Chapter 3.

Compound boards facilitate the usc of cybernetic principles by introducing a division of

power, decision making labour and multiple communication and control channels. A

division of power allows checks and balances to be introduced in organisations to provide

a basis for them to become self-governing as demonstrated with employee owned firms. It

9

INTRODUCTION

also reduces power differentials, introduces interdependencies and so establishes a rational

basis fbr developing trust in organisations.

Holonic architecture is of profOund significance. The complexity of life and the universe

is based on holonic architecture. Holonic organisational architecture provides a strategy

fbr individuals to \vork together to manage far greater complexity than they could

individually or by working through markets and/or hierarchies. It is by providing this

insight that TBA could indicate how to design changes in the role of govemment and non-

govemment institutions as the complexity of society increases.

1.5 Research methods and outline of the thesis

The research grew out of extensive and varied experiential knowledge obtained as

explained in the Foreword. This included work by the author as a corporate govemance

practitioner and educator. The theory development of Chapter 3 was based on the

literature survey of Chapter 2 and earlier consulting research described below. To

understand the t!volution of compound boards, research was carried out into the history of

corporate concepts and the dewlopment of companies with two or mon! boards as reported

in Chapter 4. Some field visits into contemporary firms with compound boards werl: used

to complement the research documented in Chapter 5. The case studies of Chapters 5 and

6 provided the basis for obtaining insights to illustrate the utility of TBA in Chapter 7.

Consideration of the utility of TBA in Chapter 7 was based on the literature research into

other theories of the firm identified in Chapter 2. Also, Chapter 7 considers the

implications of TBA tOr future research and its wider application for 1mprovmg the

govcmancc of society.

Chapter 2 presents a rev1ew of the corporate govemance and related literatures. It

identified a number of shortcomings in accepted theories of the firm by some of the

leading scholars working on the topic. No theoretical basis was discovered tOr analysing

fim1s that were controlled by more than one board. The theory of a firm was based on the

assumption that an entrepreneur or other type of centralised authority system controlled the

10

CHAPTER I

business. Even in the political science literature, Dienncier & Myerson (l999: 1185) state: "there arc n~\V theoretical papers that probe the consequences of dividing legislators into

separate chambers which represent the same voters". To fill this gap. re:st':arch was

extended to the cybernetic and management literature and later to human evolutionary

biology to develop an approach utilised by the author in 1977 to undertake the first

economic study into !he economic development of Australian Aboriginals (Turnbull 197Sa: 95- l 02; 1978b: 52).

\Vhilc the 1977 methodology \vas based on the .. amount of information" utilised by

various "integrative mechanisms" in society" it was not based on either bytes or

transactions, However, it did provide a basis !Or comparing markets and hierarchies with

other ways of governing society as utilised by traditional Aboriginals, It was these

tbmi1y", "dan/community" and "associative" relationships~ identified and defined by

Hollingsworth & Lindberg (1985) which are most relevant to the activities of boards.

Chapter 3 develops TBA ifom the 1977 methodology, which was re-published at the

bcginning of the current research work in 'Stakeholder Dcrnocracy: Redesigning the

goverrw.nce of firms und bureaucracies' {Turnbull, 1994d}. TBA devdoped h-om fOcussing on the intOnnational dimt:nsion of the work ofCo

ll'TROIJUCTION

leading industrial countries was reviewed from the 16th century to the pn::sent. This

research identified how continental Europe and Japan took different evolutionnry paihs

from those taken in England and how in the last century this was also different from the

USA. This work provided a context in which to examine how firms controlled by more

than one boards evolved historically in Europe, but not in England and other Anglo

cuJlurcs except for employee owned finns.

Employee owned flnns provided a basis for investigating internal compound boards m

Anglo cultures. To both illustrate and explore the phenomena of compound boards m

greater detail, two employee owned firms based in England and two based in the USA arc

described as reported in Chapter 5.

A case study is presented in Chapter 6 of the complex intcr~related system of stakeholder

controlled fim1s. with compound boards located around ~he to\vn of MondragOn in

Northern Spain. The :V1ondmg6n system provided compelling evidence ibr applying

infbmmtion nnd control d1eory to the analysis of organisations because 1t reveals a number

of cyb.::mctic principl.::s, In particular the study showed ihc holonic architecture tlmnd

throughout the universe for creating and managing complexity. Chapter 6 atso idcntiticd

similaritie.s betwci.!:n MondragOn and the stukcholdcr-controllcd firms round in a Japanese

keiretsu, which are also controlled by compound bourds.

Chapter 7 consi-ders the utility of the TBA tfamework by comparing it with others such as:

TCE; the power model; resource based and evolutionary theories of the finn. Because

these other theories arc dcp;;:ndent upon the exchange of infomlation, TBA also provides a

way of comparing each theory. In this way TBA meets the tcsl used by Kuhn to describe a

"paradigm shitl" in that TBA represents a ''higher lcve) theory than those known before. one that linked together a whole group of lower level theories without substantially

changing any" (Kuhn 1970: 95). The power and relevance ofTBA is illustrated by using it to reveal novel insights into the structure of MondragOn firms. The architecture of

MondragOn illustrates derivative concepts ofTBA, auxiliary concerns and other principles

CIIAPTER l

ofTBA. This leads to the development of~t number of propositions for illustrating the usc

ofTBA.

Chapte-r 7 then considers the wtder implications of TBA in providing a basis fOr a deeper

and more rigorous understanding of institutional structures of society. This includes

consideration of the role of govcmn1cnt and markl.!ts. One conclusion is that cybernetic

principles require other governance mechanisms besides mmkc!s andlor hierarchies to

effectively regulate a complex society. The requisite variety required to managl.! a

complex society leads to a related conclusion that the usc of compound boards will

Increase as the complexity of society increases.

1.6 Contributions to knowledge

As noted above, TBA meets the test of being a paradigm shift as it presents what Kuhn

(1970: 95} described as a "higher level theory than those known before, one that linked together a whole group of lower le\'d theories \Vitbout substantially changing any".

TBA provides a framework for identifying the components of"boundcd rationality" which

provides the foundation for leading theories of the tinn and a "rational economic order''

{\Villimnson !975: 5). Human physiology, neurology and psychology all place limits on the volumt! and consistency of humans to transact bytes to create bounded rationality, ln

this way, TBA provides a common basis to link other theories of the finn and provide a

framework for integrating organisational analysis into physiology, neurology and

psychology. As any transaction of bytes require a change in physical state, TBA grounds

the study of firms, organisations and the architecture of society in the natural sciences.

Because TBA is not based on costs' or other social constructs, which do not have a

physical form, TBA can be applied quite generally to ali fonns of organisations whether or

not costs are involved. This provides a bas1s for directly comparing the intOmmtion and

control systems within and between individuals m1d organisations with those found in

l3

1:'\TI\OI)VCTION

nature and maclunc. Cybernetics was defined by its founder a'i "the science of control and

communication, in the animal and the machine" (\Viener 1948).

TBA provides a framework grounded in the natural sciences tbr comparing and

understanding empirical, normative and instnnnental theories of the fimL The application

ofTBA it not limited by culture, form or type of finn. It provides a basis for investigating

firms. independently of the number uf boards or control centres involved and so provides a

way to compare firms wlth unitary control to those that possess two or more boards or

control ccntn::s. As a result. TBA provides a basis lOr investigating comparative corporate

governance.

TBA grounds the study of corporate governance in cybcml!tics. The application of

cybernetics to corporate governance has not been undertaken bc!On: according to StaffOrd

Beer1, th!.! fOunder of management cybernetics.

TBA identifies cybcmetics principles and strategies as a basis for mitigating the problems

created by the limited quantity of bytes, which can be pmee:sscd by humans, n:nd the

variability in thcir processing. The prlnciplcs and strategies identify criteria for dcsignirlg

the infom1ution and controf architecture of finns, organism ions and the structure of society

to improve their operations.

The thesis makes a contribution to understanding in the following areas:

(a) The development of corporate governance pructiccs in diffCrcnt cultures (Cimpter 4);

(b) The strengths and weaknesses of the infOrmation and control sys!Cms m

finns found in dift0rent countries (Chapters 3 & 4);

1 Stafford Be1.!'r {1959, !966. 1985. l987, !995a,h,c) has been a pioneering practitioner in management cybernetics, scholar ;;:md pa_'>t PrL,;idc-nt of the World Organization of General Systems and Cylxmctics. In Toronto, Augu:>t 3'4 1996 he reviewed the m>lnuscript ofTumbull {l997i} and advised the author that lle wat( not aware of cybernetics being applied to corporate governance. Beer's work involved communlcuiun;; and con!rol uithitz fim1s cr bureaucr;u;iC$, :mC this was ba"'Xl on information rather than bytes. Pres idem Allende retain~.>d Beer in 1971 to assist him in managing lhe Chilean t~conomy. h::p:iiflh:mbc r.111:w;.gu y. n>nV mavdav !:::rvptn't.Typtn6U. htm I hnp :i ipe~pmc 1 . vull.ac .bd :/CST!l INK. hl ml

14

CHAPTER 1

(c) The ability of the infonnation and control system of a t1rm to provide operating advantages (Chapters 3 & 7);

{d) Why employee and/or stakeholder owned fim1s cannot be sustained with a unitary board (Chapter 3);

(e) How intcmal compound boards can be introduced m Anglo cultures

(Chapter 5) without a change in the law; (f) How and why stakeholder govemancc provides competitive advantages

(Chapter 6); (g} Criteria for improving the self-regulation and sdt:govcmance of fim1s,

organisations, and other institutions of society (Chapters 3 & 7).

In investigating the phenomenon of compound boards it bccame evident rhat one of their

bcnetits was that they provided a technique tOr mitigating the problem of 'bounded

rationality through decomposing the labour of decision making, The research problem

becatnc one of finding a method for understanding and cvaluatmg the process of

decomposing decision making labour. TBA is pn.:semcd as a tool to b;; used in the

solution of this problem and a ffamcwork for identifying how to design the infOrmation

and control structur ... ~ of organisations to manage complexity. TBA helps to identify

general guidelines on how individuals can be organis!.!d to mnnngc complexity beyond

their indi\idual cnpabilitics. In this way it provides the architectural design criteria tOr

dctem1ining how to establish effective relationships betwc:l.!n people in organisations to

cope with managing complexity.

Eight propositions arc presented in Section 7.5 to test the utility of the TBA tfamework.

The basic proposition of the thesis is:

The limited abili~v of individuals to transact bylf!s can be ameliomted by jinns being governed by more than one board vd;ich app~v rlu: principles of if~{ormarion and control science.

15

Ii'TRODUCTION

1.7 Assumptions and limitations

The contributions to knowledge set out above arc based on some basic assumptions and

limitations considered below. Chapter 2 identifies how accepted theories of the finn and

organisations have many culturally embedded assumptions. Some of the most important

may not be made explicit especially in regard to human behaviour.

Many theories of the firm assume people arc homogeneous "agents" whereas TBA

assumes the characteristics of people arc variable between and with each individual. The

specific assumptions made by TBA are considered in Chapter 3 as set out below:

(a) Individuals have a limited ability to handle infom1ation; (b) Individuals reduce, condense and summarise infom1ation; (c) The behaviour of individuals may be neither logical nor consistent; (d) Differences between individuals arc significant and important; (c) The behaviour of individuals can be changed by the infom1ation they

obtain;

(f) Individuals can be both sdf-sl!rving agents and/or self-less stewards; and (g) Individuals can bl: both competitive and/or cooperative, tmsting/distmsting.

Cybernetic principles provide strategies for overcoming the variability and unreliability of

infOnnation processing. The most fundamental assumption of TBA is that cybernetics

principles arc just as valid with social systems as they arc in nature and machines. Specifically, the following six cybernetic principles are identified in Chapter 3 and utilised

in analysing fim1s with compound boards and developing the propositions in Chapter 6 as

listed in the previous section:

(a) Errors in processing infom1ation with unreliable components (i.e. individuals) can be reduced as much as requin:d by employing sufficient number of components/individuals;

(b) Errors in communicating information can be made as small as required by using a suflicicnt number of infOrmation channels;

(c) The control of many variables requires a requisite variety of controllers;

16

CHAPTER I

(d) Infonnation is economised by utilising controllers that arc most directly

connected to the variables;

(c) Regulation cannot be amplified without supplementation;

(f) Sclf~govcming components provide the most eflicient way to create complex organisations and for managing complex variables.

Other assumptions on which TBA is based arc:

(a) Information is required to establish coordination between individuals;

(b) Information is the principal cost in organising economic transactions;

(c) Economising the bytes required to coordinate activities reduces costs;

(d) The transaction of bytes is required to establish trust between individuals or

groups;

(c) Trust economises the bytes required to govem transactions;

(t) Trust is improved as individuals or groups become more interdependent; (g) Trust is reduced by power differentials between individuals or groups;

(h) The ability of individuals to trust others is limited to about 150 people.

A basic limitation of the current research was the limited choicc: of case studies and their

limited variety. However, the selected cast: studies were considerc:d sufficient to illustrate

the phenomena under investigation and to indicate how TBA could provide a useful

fi-amework for validation. The limited number of case studies considered in this thesis

means that there is much "mop~mop work" (Kuhn 1970: 24) that can and should be

undertaken to work out the finer details of TBA. An important dimension that requires

development is to take much greater cognisance of the qualitative dimension of bytes.

\Vhile TBA recognises the differences in the "richness" of information transacted through

the various modes of governance, this needs to be developed much further both within and

between modes.

All six case studies in this thesis involved stakeholder ownership without any external

investors. All case studies were based on compound boards created within the fim1.

17

11"\TRODUCTIO!"\

However, external control existed with MondragOn firms fforn their banker and/or their

relationship group. MondragOn also involved compound boards external to the fim1.

External control and compound boards also exist in a keiretsu and VISA International.

There remains much work to be undertaken in the many compound boards created but not

noticed, when one company becomes the dominant investor in another to obtain the

influence or power to take over some of the activities of its board.

18

CHAPTER2

CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES

2.1 Introduction

The purpose of this chapter is to review the various literatures that have relevance to corporate

governance and theories of the firm. Also reviewed arc elements of infonnation and control

theory in which TBA is later grounded. Definitions of specialist words used in the literatures

arc presented to explain how they may vary and to establish ngour in integrating the

contributions of the disciplines.

The scope of corporate governance is then considered and a critique made of two corporate

governance surveys to illustrate the variety and limitations of their different perspectives.

Some additional perspectives arc identified and gaps in the cmvoratc governance literature

reviewed arc identified. The Chapter concludes by identifYing the facts relevant to

investigating fim1s controlled by two or more boards and the theoretical gaps which might be

filled by TBA.

Corporate governance literature intersects with several of disciplines such as microeconomics,

organisational economics, organisational theory, information theory, law, accounting, finance,

management, psychology, sociology and politics. Each may view corporate governance in a

different way.

To encompass most perspectives an inclusive definition of 'corporate governance' is

introduced in section 2.2 to include all types of organisations and other institutional

arrangements involved in productive activities. To assist in integrating the knowledge of the

19

C1IAPTER2

various disciplines some common language is suggested, The word 'finn' is used to describe

aU organisations involved in productive activities. Section 2.2 defines various key words that

may have various meanings within, and between, disciplines.

Section 2,3 identifies a diversity of agents who are involved in influencing, controlling,

regulating and managing fim1st productive networks and associations, Again, an inclusive

approach is used to encompass the diversity of ways in which leading scholars in the field

dct1nc the topic of corporate govemance.

Section 2.4 considers diffcn.:nt corporate governance perspectives and these arc related to the

discipline and professional affiliations of various writ~rs in the fic:ld. This section also

considers how well theories of the firm: tit the various perspectives and how governance

practices differ between cultures,

Section 2.5 details shortcomings in the th..::or)' of firm as identific:d by scholars who

contributed to its dcvdopmcnt in thl! USA. In addition, the ctlmoccntric mlturc of the theory

of the fim1 developed in the USA is identified. The Section describes how leading scholars

sec the need fOr further developing the theory of the finn as well as for establishing a

framework tOr analysing and comparing the different fom1s of corporate governance found

within and between in nations.

Section 2.6 uses the broad perspective of corporate governance identified in Scclion 2.2 to

analyse a corporate governance survey by Hawley & Williams (l 996) prepared for the OECD

and another survey undertaken by Shleifer & Vishny (1996). Hawley & Williarns present

four viewpoints: (i) Simple finance model; (ii) Stewardship theory; (iii) Smkeholder theory

and (iv) The politics of shareholder control at the micro level of the firm. The more extensive

20

CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES

Shleifcr & Vishny survey is based on the narrow financial viewpoint of economists who base

much of their analyse on transaction costs and agency theory. Three additional viewpoints

based on culture, power and biology are considered to provide seven different viewpoints of a

finn.

Section 2.7 identifies gaps in corporate govemance scholarship such as: (i) Limited life

enterprises; (ii) Worker ownership and control; (iii) Compound boards with two, three and

more control centres; (iv) Information theory; (v) Network forms; (vi) Holonic structures; and

(vii) Self-regulation and self-govemance. The Chapter concludes with Section 2.8

summarising the findings of tht: literaturt: review and gaps in corporate govemance

scholarship in relation to the analysis of compound boards.

2.2 Definitions

The literature on the theory of the firm, economics, organisational behaviour, management,

COI]Jorate govcmancc and infonnation theory attributes different meanings and nuances to a

number of words in common usage. To avoid ambiguities some general words and concepts

are defined below.

Some scholars use the word 'organisation' to refer to a particular type of institution such as

a corporation, club or govcmment department. In this thesis the word 'organisation' and

'institution' will be interchangeable to refer to any network of people who become associated

for a common purpose. Firms then represent a sub-set of organisations and corporations

become a sub-set of finns that can include unincorporated enterprises.

The tcnn 'corporate governance' is used to includes all the influences affecting the

institutional processes for appointing and regulating the individuals involved in organising the

21

CHAPTER 2

production and sales of goods and services. Described in this way, corporate governance

applies to all types of firn1s whether or not they arc incorporated under civil law. In Chapter

7, TBA is applied to the governance of any type of organisation/institution.

Finns can exist as either common or civil law companies, partnership, joint ventures, limited

liability partnerships, cooperatives, mutual associations, building societies, friendly societies

or trading trusts. Fama & Jensen (1983b: 293-4) even considered churches. However,

organisations like churches, not engaged in the production and sale of goods and services, do

not meet the generally accepted description of a finn.

Firms may be publicly traded, privately held, for profit or not-for-profit. Much of the

literature on corporate governance implicitly assumes that only publicly traded fim1s arc the

subjects of analysis (e.g. Blair 1995: 3, and Zingales 2000). This would limit the topic to less

than 60,000 finns worldwide and involve only a fraction of all economic activity in even the

most advanced market societies (FIBV 1999). Restricting the study of corporate governance

to publicly traded corporations would deny investigation of compound boards in employee

owned finns and leveraged buy-out (LBO's) finns which Jensen ( 1993: 869) states represent

"a proven model of governance structure".

If finns include all social institutions engaged in the production and sale of goods and

services, then both public and private sector organisations such as schools, hospitals, clubs

and societies need to be included. With firms defined in this way, the scope of corporate

governance includes nearly all the economic activity of a nation. It was by asking the

question, "Why is not all production carried on by one big finn?" that Coase (1937: 86) laid

the foundations for developing what is referred to as a 'theory of the finn'.

22

CORPORATE GOVER~ANCE AND RELATED RELEVA~T LITERATURES

Couse (1937: 94) considered the existence of a "master and servant relationship" or an

"employer and employee relationship" as a defining feature of a fim1. However, this

condition would exclude activities carried out by teams, partners, joint venturers, strategic

alliances, associations and networks. This led Alchian & Demsctz (1972: 137) to ask the

question, "what is meant by a fim1?" They concluded," the tenn fim1 as commonly used is so

turgid of meaning that we can not hope to explain every entity to which the name is attached

in common or even technical literature".

However, Coasc (1937: 82) also stated "the distinguishing mark of the finn is the

supersession of the price mechanism". This proposition avoids the problem of identifying the

institutional fom1 of a fim1. It docs not necessarily avoid the problem of identifying the

boundaries of a finn (Barney & Ouchi 1986: 78). The boundary problem emerges when

analysing joint ventures, strategic alliances, associations and networks which some scholars

treat as "economic entities which have a coherence, a structure and an individuality of their

own" (Mathews J996b: 116). Ambiguous boundaric.::s arc found with MondragOn firms, their

relationship groups and their supra~organisational systems, as pointed out by Turnbull ( 1995d:

174).

The need to identify fim1s and their boundaries may not be required to develop the most

efficacious institutional arrangements for organising productive activities in society. The

problem of defining fim1s or their boundaries is avoided by defining corporate governance as

proposed at the beginning of this sub~section.

In discussing systems of corporate control, economists frequently usc the word 'capital' in

different ways. Shleifer & Vishny ( 1996) used the word in four different ways in their survey

of corporate governance. The word was used to indicate: (i) "the means of production" (p.6);

23

CIIAPTER2

(ii) an investment which may not be represented by the means of production (p.3); (iii)

"finance" (p.2) and "external capital" (p.6); or even (iv) just credit created by contract, ("bank

debt" and "junk bonds").

The problem introduced by such ambiguity is illustrated by their reference to "the people who

sink the capital" (p.3). It is not clear if these "people" are: (i) investors subscribing for new

shares; (ii) shareholders purchasing existing shares from others; (iii) bankers lending money;

or (iv) the managers/"entrcprcneurs" purchasing the means of production or what Moulton

(1935: 7) describes as "procreative assets". The agency costs, benefits and risk change

according to the various meanings of the word 'capital'.

Clarity of the Shleifer & Vishny statement is fUndamental for their survey as they define

corporate governance as "the ways in which suppliers of finance to corporations assure

themselves of getting a return on their investment" (p. 2). \Vith this perspective of

considering the moral and other hazards of investors obtaining satisfactory returns, Shkifer &

Vishny (1996) provide a comprehensive literature review of their perspective. But their

definition is limited to corporate entities that attract investment and so exclude corporate

entities which do not provide returns to investors as found in the non-profit sector, fim1s not

incorporated and other types of organisations in the public and private sector. Accountants

usc the word 'capital' with other meanings. So in an interdisciplinary topic like corporate

governance, it is safer to avoid the usc of the word 'capital'

The tenn stakeholder is used and defined in various ways as noted by Donaldson & Preston

(1995). Freeman (1984) defined stakeholder as "any group or individual who can affect or is

affected by the achievement of the finn's objectives". Clarkson (1994) points out some

problems in this definition and suggests a "risk based model". This defines stakeholders as

24

CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES

those who arc exposed to costs or gains from the operations or activities of a finn. Risks can

be assumed on a voluntary basis by employees, customers and suppliers or on an involuntary

basis such as when tinns cxternalise its costs. Clarkson ( 1994: 8) states:

A corporation will be both responsible and successful when its relationships

with its stake holders arc managed in such a \vay that: (i) Its stake holders

an! reasonably satisfied with the gain in value, or the anticipation of gain, of

their stakes; and (ii) Risks and potential harm to involuntary stake holders

resulting from the corporation's activities and operations arc minimized and

the potential costs of such risks arc internalized.

Clarkson ( 1994: 8) includes stockholders as part of the "core group of primary stake holders

essential for its survival". However, this statement is not relevant for common ownership

fim1s considered in Chapters 5 and 6, mutual organisations and for public sector enterprises.

Indeed, investors may not be requirt.!d in many mature publicly traded firn1s which become, or

can become, self~ financing as demonstrated by LBO's and firms which unde11akc stock buy-

backs and/or do not make any share issues to raise additional cash. Stockholders may not

always meet the test of being essential for the past and/or continued existence of a fim1. So,

this thesis identifies a sub~sct of stakeholders, "Strategic stakeholders" as described above to

distinguish them from the more general definition of stakeholders presented below.

Donaldson & Preston (1995: 85) state: "Stakeholders arc identified through the actual or

potential banns and benefits that they experience or anticipate experiencing as a result of the

firm's actions or inactions". Donaldson & Preston organised a network of scholars to

establish a consensus statement on the meaning of "stakeholder" which is accepted by this

thesis. Rede..flning !he corpora/ion ( 1999) stated:

25

CHAPTR2

Stakeholders participate in wealth-creation by contributing inputs, incurring

costs and experiencing inconveniences or hanns. They correspondingly

have som!!thing at risk in the process~ the risk that benet!rs will be less, or

costs or harms greater. than anticipated or appropriate.

The Stanford Research Institute (SRI) in 1963 &~fined as stakeholders, 11those groups without

whose support the organisation would cease to exist" (Freeman 1984: 31). Tumbull (l997h;i)

describes these types of stakeholders as 'strategic stakeho-lders' as stmtegic issues concern

the ability of a linn to exist. Strategic issues transcend discounted cash flow analysis based

on a relative performance measure of un 'opportunity rate of return'. No finn can exist

without suppliersj employees and customers so they must be strategic stakeholders tOr all

firms. However, ns by definition all viable fim1s must become self-financing, stockholders of

viable firms must loose their status of being a strategic stakcholdt:r after the time horizon of

their investors (Turnbull 1997i: 8}. The term :strategic stakeholder is used in this thesis in

accordance with the SRI definition,

The \Vord board' will be used to describe one or more people who have fom1a!ly been given

power by the constitutional members of an organisation to control and/or advise on aspects of

its administration. The organisation could be an unincorporated body. In the case of a finn it

ml!ans that the power to control ~tnd/or advise hns been defined by the owners. The owners

may be partners, investors or shareholders. The fonnal instrument of their r~ssociution would

respectively be a partnership- agreement, joint venture agn.>::cJnent or corporate constitution in

the form of articles of association and/or corporate by-laws. These instruments could in tum

delegate powe-r to non-0\vncrs !O establish boards that could be in the form of a committee,

COUllCil, assembly, forum, panel, senate etc. All these terms will generically be refern::d to as

"boards1'.

26

CORPORATE GOVERNANCE AND RELATE I) RELEVANT LITERA TliRES

However, such delegated control centres will not be considered to represent a separate board

unless parties other than those who have the delegated power to create them detennine their

membership. In other words, sub-committees of a board would not constitute a separate

control centre or "board" because its member, their tenure and role is at thl! grace and favour

of the board of directors. Likewise, the auditor would not be considered a separate board if he

or she was nominated or could be retired at the grace and favour of the board of directors.

Howevl!r, a separate board is created when a company makes provision for its shareholders to

appoint a "watchdog board" or for its other stakeholders to elect a customer forum, employee

council or supplier assembly. The test of the existl!nce of a separate board is in a separation

of powers in both the appointment of members and their role.

The term 'compound board' will be used to describe the existence of two or more control

centres whether or not they arc required by law, the constitution of the firm or arc created by

relationships external to the firm. Compound boards arc commonly found in Anglo cultures

although they may not be recognised as such. Publicly traded corporations controlled by a

parent company, control group, rdationship investor or family shareholder creates a

compound board. Two and three tiered boards may be required by law in Europe (Analytica

1992: 86, 104-5) and may exist in Japanese firms where the shareholders elect 'statutory

auditors' to oversee the conformance role of the board described as kansayaku (Charkam

1994: 93). When a Japanese finn is a member of a keiretsu, then the keiretsu council creates

another centre of control.

A board may be a single individual. The constitution of some corporations may make

provision for the board to appoint a managing director (chief executive officer- CEO) and

other officers. But if the terms of appointment arc at the discretion of the board it represents a

27

CHAPTER 2

delegation of the powers of the board rather than the establishment of a different board. The

same argument applies to wholly owned subsidiaries. The appointment of the subsidiary

board is an extension of the powers of the principal board. However, as soon as there arc

other shareholders, the delegation of power is not likely to be absolute and so a compound

board may be created. This is also likely to be the case when it is the shareholder(s) who

appoint the CEO rather than the board. The existence of board sub-committees, such as for

audit, nomination and remuneration, fail the test of being a compound board as they arc

created by the board rather than through the constitution of the company. They also usually

fail the test of having different roles and accountability.

\Vhile a European supervisory board described in Chapter 4 may have the power to appoint

all the members of the executive board, this is different from a parent company appointing

members of a subsidiary board. This is because the powers of the executive board arc defined

by the corporate constitution that is controlled by the equity holders. This separation of

powers had its origin in the need to provide the nominators and monitors on the supervisory

board with limited liability. To achieve this objective they could not be involved in

management. European supervisory boards typically specify that no individual can be a

member of both boards.

In somewhat an analogous fashion, shareholders' agreement to limit the power of directors of

a private company creates a compound board when there is more than a single shareholder.

These types of compound boards arc commonly found where shareholders of private

companies have entered into an agreement with one or more professional investors to attract

their funds as with venture capital fim1s. Compound boards arc created by LBOs when an

association of investors supcnriscs the operating board of employees. However, the existence

28

CORPORATE COVERNA:\CE ANO RELAT0 RELEVANT LITERATURES

of compound boards is not recognised in either practice or the litt!r.ature, as it is a term coined

by this thesis.

The existence of a compound hoard could be indeterminate anclior changeable. This could

arise from changes in corporate eonstitutions or the size of the investment one company has in

other. The ability of a dominant shareholder to undertake the role of being a supervisory

board would reduce as it reduced the size of investment in a company. However, TBA ust:s

individuals and infonnation ao;; the fundamental units of analysis and so transcends the need to

identitY if one or more boards exist

The term 'bolon' describes an "almost self-governing component" of an organisation which

can itself be a holon. Smuts (1926) coined the word "holism" to explain how the compkxity

of the universe arose from assembling simpler components that together as a whole (hol)

crl.!ated JitTercnt properties from themselYcs so that the wbotc was more ihan the sum of the

parts. Koestler (1967) coined the word "holo-n' to describe th.; components of complex

systems, which produced properties difTcrcnt from themselves~.

Simon ( 1962) did not usc the tcm1 "holon" in his lecture on the 'Architecture of Complexity'

but he was describing them when referring to components of complexity being ''sub

assemblies", .. stable intenncdiate fom1s" or "nearly decomposable systems, in which the

interactions umong the sub~systr.::ms arc weak, but not negligible". Beer (1985: 117) refers to

them as a "viable system" and describes a number of their attributes. The paradoxical

pluralistic characteristics of organisational holons described by Mathews (1996a: 414) are

discussed in Chapter 3. These attributes led another writer (Hock 1994: 1) to coin the word 11chaord!J to describe them by combining the words "chaos" and "order". Hock was the

founding CEO of VISA International Inc. when it "reconceived" its organisational fonn to

29

CHAPTERZ

adopt holonic architecture with over a hundred boards. In the context of organisational

analysis, this paper will also refer to holons or chaords as "almost self-governing

components" as this describes one of their most relevant characteristics for corporate

govemance research. A compound board is an inherent feature of holonic organisations as

explained in Chapter 3.

Koestler ( 1967) coined the word 'holarchy' to describe the hierarchy of complexity described

by Smuts ( 1926) and Simon ( 1962) in tenns of holons. Atomic particles represent holons,

which create atoms with different characteristics. Likewise, atoms represent holons, which

create molecules with different characteristics from their components. (A hierarchy of

ho1onic components creating a "holarchy" is illustrated in Tables 3.8 and 6.l.)

2.3 Factors which affect the operations of firms

The definition of corporate governance is based on "all the influences affecting the

institutional processes for appointing and regulating the individuals". Firms whose securities

arc publicly traded generally have more external influences on their operations than other

firms do. One way of determining the scope of corporate governance is to consider the more

obvious influences, which can af!Cct the operations of publicly traded firms as indicated in

Table 2.1, 'Stakeholders affCcting the operations ofpubliclv traded finns' .. The Table lists

private and public sector Stakeholders who influence the individuals who control and/or

manage a finn.

The multitudc of stakeholders listed in Table 2.1 is consistent with the definitions of corporate

governance provided by a number of authorities in the field. Demb & Neubauer (l992a: 9;

1992b: 187) state that, "Corporate governance is the process by which corporations arc made

responsive to the rights and wishes of stakeholders". Monks & Minow (1995: l) wrote that,

:--------~-~-----------------------

:This process is illustrated in Table 3.8 of Chapter 3.

30

CORPORATE GOVERNANCE AND RELATED RELEVA~T LITERATURES

"It is the relationship among vanous participants 111 detern1ining the direction and

performance of corporations". \Vhile Tricker (1994: xi) states, "Corporate governance

addresses the issues facing boards of directors, such as the interaction \Vith top management

and relationships with the owners and others interested in the affairs of the company,

including creditors, debt financiers, analysts, auditors and corporate regulators".

Table 2.1, Stakeholders affecting the operations of publicly traded firms

Private sector Public Sector Customers Trade practice laws Competitors Anti-monopoly laws Shareholders Securities laws Employees Labour & Equal Opportunity laws Unions Arbitration courts, etc. Suppliers Fair trading laws Bankers & financiers Cr!.!dit & bankruptcy laws Auditors Corporate law Stock Exchange rules Federal/State/Local taxes Market for shares Health & safety laws Media Environmentalla\vs ProfCssional associations Quality standards Trade associations Building regulations Directors & Advisers Community

However, other writers like Sternberg ( 1996) do not accept that publicly traded corporations

should be "responsive to the rights and wishes of stakeholders" as proposed by Demb &

Neubauer ( l992a: 9). Sternberg ( 1996: 17) states that, "stakeholder theory is both misguided

and mistaken", and that, "stakeholder theory of accountability is unjustified" (12), it

"undermines private property, agency and wealth" (15), "is incompatible with business" (7)

and "with corporate governance" (9).

Even before the contribution by Sternberg, the diversity of views about corporate governance

led Pound (1993b: 1004) to state, "the lack of a broad defining paradigm has created a sense

of intelkctual vertigo in the increasingly intense debate over corporate governance reforms".

3!

CHAPTER 2

An objective of the rest of this Chuptcr is to provide orientation to the diverse views on the

topic,

2.4 Different corporate governance persp-l.'ctivcs

One reason why diverse views can exist is that different scholars investigate finns from

different disciplines, Donaldson & Preston (1995: 68} point out that a tirm \VHS viewed by

Adam Smilh (1937) and by contemporary investors as an organisation which obtained

resources from ils investors, employees and suppliers to produce goods and services for its

customers. Marxists, financial economists and Sternberg, view a finn as an organisation that

obtains resources from its employees and suppliers, with cashtlows contributed by its

customers to service its owners. In other words. Marxists and others view finns n.s servicing

their owners rather than their cus.tom~rs, employees and suppliers. In defining "Stakeholder

Theory", Clarkson ( 1994: 8) states:

"The firm" is a system of stake holders opcrnting willoin the !arger sysiem of

the host society that provides the no..:-c~ssary legal and market infrastructure

for the linn's activitil.!s. The purpose of the fim1 is to cr.::atc wealth or value

for lts stak\! holders by converting their smkcs into goods and services.

Figures 2.1, 'Investor view of a tirm and 2.2, 'Stakeholder view of a fi1111' were used by

Preston (1996: 7-8} to illustrate the difference between an investor view of a firm and a

stakeholder view. The arrows arc used to indicate the direction of contributions made by th~.!

various stakeholders from the various vic'>vpoints" As noted by Kay (1996: 29), the legal

obligation of directors is to investors rather than to customers (i.e. it follows the viC\\'pojnt of

1V1arxisEs and financial cconomisrs).

CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES

Figure 2.1, Investor view of a firm

lnvc>tors

Suppliers FIRM Customers

Employees

Figure 2.2, Stakeholder view of a firm

Government

Suppliers

Trade Assoc-iations

FIRi\'1

0 mployccs

Source: Preston (1996)

33

l\llitical Group~

Customers

Unions

CIJAPTER2

The stakcholdcr vic\v recognises that fim1s do not exist in isolation. Both their cxistencl.! and

their operating discretions are subject to other .agents in society. Society creates the laws,

which allows fimls to exist and operate. The various perspectives on corporntc governance

can also be n.:latt.'";l some business

school scholars ::md management consull

CORPORATE GOVERNANCE AND RELATED RELEVANT LITERATURES

Section 2.3. Monks & Minow formed a commercial mutual fund which they called 'Lens' to

focus on under~performing corporations. As active shareholders they seck to add value to

companies by relating to the boards of their in vestee companies as owners.

In making recommendations to change tht: pattern of ownership and control of USA firms to

make them more competitive, Porter ( 1992: 16-17) targeted policy makers, investors and

corporations. He identified the need to involve strategic stakeholders such as employees,

customers, suppliers and members of the host community, in the ownership and control of

corporations, to make them internationally competitive.

The rejection by Sternberg ( 1996) of such stakeholder involvement was made in the context

of the author being based in England where intense political interest arose in the nature of a

'Stakeholder Economy' 3 The then li.!adcr of the parliamentary opposition party (Tony Blair

1996) raised this tcrn1 one~ year be fori.! a gcnt.:ral l.!lection that elected him as Prime Minister.

Table 2.2, 'Scope and diversitv of con1oratc governance concerns', lists the authors discussed

earlier, and those bdow, \vith their concerns, to indicate the scopl.! of interests involved in the

study of how productive activities arc governed. The interests of each of the scholars listed

could be far greater than those particularly noted. For example, the scope of the inquiry

chaired by Sir Adrian Cadbury into "The Financial Aspects of Corporate Governance" was

limited by the tcm1s of reference of the committee. The City of London established the

committee fOllowing some high profile failures of publicly traded corporations (Cadbury

1992).

3 Counter arguments to those presented by Stemberg were published in the same edition of the journal by Turnbull ( l997i) who was motivated as a founder and fom1er President of the Australian Employee Ownership Association by having a commitment to stakeholders. The counter arguments were based on the cybernetic viewpoint developed in Chapter 3.

35

CHAPTER 2

Table 2.2, Scope and diversity of corporate governance concerns

Authors (date order) Subject of analysis Concern Simon 1962 Infonnation Managing complexity Turnbull 1975b; 1993c Directors' responsibilities Managing conflicts Jensen & Meckling, 1976 Agency costs Financial structure Williamson 1985 Transaction costs Industrial organisation Hollingsworth & Lindberg 1985 Four modes of govemance Social organisation Monks & Minow 1991/5/6 Board accountability Relationship investing Demb & Neubauer 1992a;b Stakeholders Finn responsiveness Cadbury 1992 Financial aspects Board conformance Porter 1992 Nature of ownership Finn competitiveness Hilmer 1993 Boardroom Finn perfom1ance Pound !993b Politics of ownership Economic etliciency Jensen 1993 Publicly traded finns Failure in control systems Bosch 1995; AlMA 1995 Directors' duties Code of conduct Sternberg 1996 Stakeholder appropriation Shareholder value Hawley & Williams 1996 Fiduciary capitalism Corporate perfomumcc Shleifer & Vishny, 1996 Moral hazards Investment returns Persson, ct. aL 1996 Separation of powers Welfare of stakeholders Aoki 1998 Infonnation Comparative governance Dienneier & Myerson 1999 Bicameralism Internal organisation Turnbull 1997c;c;t; 1998a;c Cybernetic architecture Operating advantages

Similar failures occurred in Australia during the 1980's when Bosch (1995) chaired the

National Corporations and Securities Commission. The contribution by Turnbull ( 1975b) was

part of the first educational qualification for company directors and arose ffom concern over

earlier corporate t:'lilures in Australia and from his activities as a corporate raider, company

promoter and chaimmn of publicly traded companies. Corporate failures in the USA during

the 1980s led Jensen (1993) to analyse "the failure of corporate internal control systems" and

Pound (1992; 1993a;b) to review the politics of corporate control and Porter (1992) to

compare the USA system of corporate governance with those found in Japan and Gem1any.

Aoki (1998) uses "an infom1ation theoretic approach" as a basis for comparing different

forms of corporate governance without considering cybernetic aspects or the limitations of

individuals to process bytes. DiemlCicr & Myerson ( 1999: 1182) state that "gamc~thcorctic

modelling can be applied to political competition as well as market competition" along the

36

CORPORATE GOVE!t_'IA;

CHAPTEH. 2

the firm which was based on the assumption, that "in the beginning there were markets''

(Williamson 1975: 20) and that fim1s exist because markets fail as proposed by Coase ( 1937:

82) who explained the existence of finns as the "supersession of the price mechanism",

US scholars developed the theory of the tim1 during the height of the ideological contest

between capitalism and communism. It would have been unpatriotic for them to entertain the

pm;sibility that markets were not the natural order of a free society, The t~Jilurt! of

communism has reinforced the hegemony of marker ideology with widespread political

interest in privatisation based on the US model of a finn. The problems of using this model in

the USA arc identified by Jensen (1993), in Russia by Biasi & Gasaway (1993) and in

Australia by Turnbull (I 993b; 1995a;c;f). The problems of the US model in dthcr the US or

former socialist economics nrc outlined by Shlcifer & Vishny (1996). Htlwcvcr, failh by

political ideologues in replicating the dominant, but t1awcd US governaacc model, has so tfir

been little inhibited by scholarly research, empirical evidence or the success of other

approaches.

The assumption that in the beginning there wen; markets is not supported by the evidence of

hi>tory a> noted by Bcn-Poralil (!978), North (1985: 558), Tumbull (l978h: 52; 1994a: 328)

and others. in the beginning, economic transactions \vcre governed by social relationships

rather than hy markets, hierarchy or even what Williamson (1990: x) refers to as "hybrid

modes of organisation" combining both markets and hierarchy. Hollingsworth & Lindberg,

( 1985: 221-2) slate that there arc "four distinctive tbrms of governance ... market, hierarchies,

the clan or community and associations". Each form rdics on a different type of infomtation

and control channel as set out in a typology described by Tumbull (1978b: 6; 1994d: 328).

Tv~o of these additional forms of governance arc outside the discipline of economics and so

beyond the field of vision and analysis by economists. The question asked by Coase