New insights to improving corporate governance

Pioneering research into why traditional corporate strategy and power structures are failing is explored in a new book by a group of leading experts in business, finance and law.

The book, ‘Corporate Governance and Complexity Theory,’ was launched at London School of Economics recently.

It explains how the traditional and structure based approach to corporate governance has not fully taken into account the complexity of relationships between a company, its shareholders, employees, customers and suppliers. It provides important new insights into what can be done to improve this situation and, in doing so, potentially help avoid the corporate scandals that still occur.

The book explains: ‘The recent ‘credit crunch’ is a reminder that corporate governance at company and industry level, as well as regulation on corporate governance more widely, is deficient in the sense that it does not properly deal with the complex nature of these relationships and the potential conflicts of interests therein.

“Banks over the last few years have not only failed their shareholders, but also their customers, the tax payer and society at large. The fact that bank failures have to a large degree been concentrated in Anglo-Saxon countries also suggests that no one corporate governance system is superior, despite the widely accepted view in the academic literature claiming that investor protection is higher in common-law countries (such as the UK and the US) than in civil-law countries (such as France and Germany).

“The recent events have included UK banks, such as HBOS, being rescued by banks (such as the Spanish Santander Group) based in countries with corporate law that has been accused by academics and policymakers alike of failing to protect shareholders adequately. The fact that no one corporate governance system is infallible is an important lesson. This lesson is particularly important in the light that much of the cross-national regulatory reform over the last decades – such as that undertaken by the European Union – has been heavily influenced by the Anglo-American view of corporate governance, including the supremacy of shareholders.

“Looking after one’s stakeholders is likely to be in the long-term interest of companies. While the definition of corporate governance in some countries (such as Germany) explicitly states that managers should look after the interests of shareholders and stakeholders alike, Anglo-American legislation is firmly based on the principle of shareholders’ supremacy. Although the UK Companies Act 2006, as a result of the recent Company Law Review, now states that directors may consider the interests of their stakeholders, they are only expected to do so if this benefits the shareholders. Hence, we argue that there has been no substantial departure in the UK from the shareholders’ supremacy principle.

“In the light of the credit crunch and the scandals in the banking industry, this may be a disappointing development. Indeed, one of the possible reasons for the latest series of corporate scandals may have been managerial remuneration packages that focused too much on short-term profits without any regard for the long-term future and survival of the organisation and ignoring the basics of proper risk management. One may argue that, by enabling directors to consider stakeholders’ interests and allowing them to depart from the principle of shareholders’ primacy in the short run, shareholders’ interests may end up being better served in the long run.”

Eve Mitleton-Kelly, Director of the Complexity Group at LSE and one of the authors, said: “Most top FTSE 100 CEOs realise that just focusing on making money for the shareholders is not enough. They are adapting to their environments by taking a more active interest in the role of employees, customers and suppliers.”

The book is the result of an Ideas Factory held by the Economic and Social Research Council, the Department for Trade and Industry and the Advanced Institute of Management Research.