Future Corporate Governance Challenges
January 2, 2019
With the new year it is timely to look into the future - this time as regards corporate governance. An update on the HLS forum on corporate governance provides a short overview of future trends.
The mission of the corporation is being challenged - and perhaps rightly so. It is claimed that it is no longer sufficient for the corporation to pursue maximum shareholder value. There is an expectation that the corporation has a mission to serve the community - a problem to solve - and that profit will derive in that context. There have certainly been corporate missions to do good in years past, but now it seems there may be an expectation that it is more than just a slogan. That demand is already coming from both customers and employees, and may also be coming from investors with a long-term outlook. In fact, it may be investors themselves who will be placing limits on shareholder primacy. The now famous letter of BlackRock's CEO set the tone from investors and professor Colin Mayer's book Prosperity provides an academic and political perspective to these developments.
This trend relates to a rise in the "external governance relationships" of the corporation, as the political aspects of corporate governance have been highlighted. The increased complexity of the regulatory environment reflects the political pressures facing corporations worldwide. Legal and political compliance have become strategic matters dealt with in the boardroom. Corporations are expected to do not only what is legal but also what is right. Setting the tone at the top is an increasing requirement at board level and board focus on oversight of corporate culture is a current phenomenon.
The "internal governance relationships" of the corporation are also in flux. The imperial status of the shareholder is decreasing as other constituencies make claims to corporate profits. The ever-increasing importance of intellectual property and know-how highlight the truth in the statement that the key assets of a company walk out the door every evening. It is increasingly difficult to see managers and employees as agents of shareholders - and increasingly easy to see the different stakeholders are independent actors bargaining over corporate control and profits. It has already become evident that the bargaining positions of stakeholders vary depending on the status of the company's balance sheet as corporate and insolvency regimes have been deemed too blunt instruments to be applied in fluid situations. The differences between equity and debt have also become more fluid as the corporate finance instruments become more sophisticated.
Another factor destabilizing corporate governance is the decreasing stewardship of shareholders with the increase of indirect holdings. Institutional shareholders create their own incentive problems and the increase of index-based investments increases the share of passive investors (see Lucian Bebchuk and Scott Hirst, Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy). A large increase in passive index-based instruments has a negative impact on the functioning of governance based market mechanisms. For example, smaller minority positions have a higher voice than earlier with resulting skewed risk profiles. One result is that the ability of activist investors to have a governance impact will increase.
In this volatile environment, steering the corporation has become an ever-more demanding endeavour. Corporations face situations requiring strategic decisions more frequently than earlier. This puts pressure on the internal organization of the corporation. In fact, the role of the board has increased as a result of these developments. In one way or another, almost every board meeting should be a strategy meeting in that the board must be aware of the demands of the rapidly evolving environment in real time. It does not seem satisfactory that board members receive their board packs of hundreds of pages and show up at meetings to review them. The requirements on board membership have increased both as regards engagement and expertise - board work is more than a part time job. In this regard, corporate governance regulation seems to be in need of updates, including the role and liability of board committees, the use of external advisors and the accounting related duties of boards. There will also be more demands on board leadership with an increasing role for chairpersons. Increasing board diversity and expert views must be structured to provide strategic guidance in business matters. As the role of the board increases, managing the relationship between the board and the top management becomes more important as well.
At the same time, the economic environment seems to become more challenging, and performance expectations for the coming year(s) are being tuned downwards. Not only may the cycles be making their turns, but political volatility has introduced a new level of uncertainty to the economy. Dealing with corporate governance matters in such circumstances will not be easy.