Digital Garden of Paul

Governance

Governance can be viewed from a theoretical and empirical stance. Theoretically it is what governments or organisations do tho their constituents or employees. Governance can be done via hierarchy, but also via markets or network of actors. They can govern, produce, coordinate, and make decisions. As an abstract, theoretical concept, governance refers to all processes of social organisation and social coordination.

Empirically, governance refers to a shift in public organisations since 1980's. Increasingly governments rely on private and voluntary sector actors to manage and deliver. Empirically the theory refers to changing organisational practices within corporations, the public sector, and the global order.

Important features of governance are:

  • It combines established administrative arrangements with the features of the market.
  • Often it is multi-jurisdictional and often transnational
  • Increasing range and plurality of stakeholders.

Bevir mentions the following typology of organisational structure.

HierarchiesMarketsNetworks
GovernanceAuthorityPricesTrust
Basis of relations among membersEmploymentContracts and property rightsExchange of resources
Degree of dependence among membersDependentIndependentInterdependent
Means of conflict resolution and coordinationRules and commandsHagglingDiplomacy
CultureSubordinationCompetitionReciprocity

What is corporate governance

Corporate governance concerns the rules and practices by which companies are administered. Its main purpose is to ensure that the rights of the shareholders are properly safeguarded. Especially when ownership and control of a company are separate. Separation of ownership and control creates a potential conflict of interest between the owners and the managers. Most modern organisations have shareholders (owners) that have ownership of the organisation, but not daily involved with the operation of that organisation. Managers are responsible for the operation of the company, mostly free of scrutiny from the shareholders.

Principal-agent theory and corporate governance

The conflict of interests between shareholders and managers has been labeled as principal-agent theory. The theory largely is concerned with the delegation of responsibilities. As shareholder of an organisation I (principal) delegate my responsibilities to a manager (agent). The agent speaks and acts on behalf of the principal. Agency theory concerns the hazards and problems that can arise out of such delegation.

Economists provided a formal analyses of the agency problem. First, economist assume that individuals are rational actors pursuing their own preferences. As shareholders pay the manager, the manager needs to ensure they keep the shareholder content. Secondly, shareholders cannot oversee everything that managers do to incomplete information. Offering managers some leeway to pursue their own interest.

Delegation, according to economists, gives rise to three costs:

  • The principal has to pay costs of overseeing the agents. For example by hiring auditors
  • The agent has to pay the costs of proving to the principals that their actions are matching their interests.
  • The principals bears any costs that results from the agents nonetheless pursuing their interests, not his or hers.

Economists usually identify two main strategies to reduce these costs. The optimal response to an agency problem is a combination of these two.

  • Monitoring of the agents
    • e.g. CEO need to get approval from the board for certain key-decisions.
  • The principal can share the consequences of their actions
    • e.g. buy providing stock and/or stock options to the agents.

A successful element in corporate governance is the composition of the board of directors that oversees the managers. When the board consists of insiders and a majority of outsiders, performance is improved. Outsider meaning a member that is independent from the organisation. They can prevent group-think and collusion by insiders, therefore protecting the interests of the stakeholders. Insiders provide specific insights into the organisation.

Market mechanisms and compensation counter the hierarchic form of control as provided by having a board. A board does not necessarily protect the best interests of shareholders. It is suggested that financial incentives and other market tools are more effective. A well-functioning stock exchange is essential for this to work. If organisation A is underperforming and organisation B spots an opportunity they can take it over and become successful. The threat of a take over and the right form of executive compensation will provide enough motivation to take actions in the best interest of shareholders.

Stakeholder theory and corporate governance

Corporate governance originally aimed at the relation between shareholder and managers. Nevertheless, more parties have interest in certain behaviour and performance of an organisation. Stakeholder theory suggest that organisations should not only optimise for the shareholder, but also respond to the concerns and interests of other actors. Meaning, a shareholder not being the only principal. Environmental groups or employee representatives are principals as well.

Corporate social responsibility

Corporate social responsibility typically relies on non-binding agreements and understandings within networks. It is a voluntarily act to consider environmental and social factors when making business decisions. Moral and practical motives can apply. Moral motives are positive contributing to the common good. Practically CSR highlights the economic benefits of good relations with the network they are in embedded.

Examples of CSR are compensation CO2, installing an ethical code in your organisation or applying demands towards suppliers regarding their products.

References

Mark Bevir. Governance, A very short introduction

Governance