Tag: corporate governance

Rethinking the Purpose of the Corporation

Rethinking the Purpose of the Corporation

Our second article from the (JACF Spring/Summer issue), written by Edward Waitzer, reviews how over the last forty years, corporate governance and corporate law have focused on minimizing “agency costs” by aligning the interests of shareholders and managers through a series of techniques, including regulatory standards, independent directors, take-overs and activist shareholders.

These means, combined with implicit acceptance of the “Efficient Market Hypothesis” (EMH) reinforced belief that share prices reflected objective corporate performance and that maximizing shareholder wealth was the purpose of the corporation.

This author, however, argues that proper corporate governance requires more than just faith in efficient equity markets and strong managerial incentives. Despite the desire for simplicity, there is no one “right” governance model. Governance is highly contextual and, ironically, the existing corporate law and regulation have tended to frustrate dynamic adaption and have led to governance systems that underperform.

The author offers Systems Theory as a better way to think about corporate purpose and governance. Systems are more than the sum of their parts, they are comprised of subsystems which in turn are comprised of other subsystems on so on, and the overall health of the system depends on the continued health of each of its essential subsystems, as well as of the larger system.

Systems theory counsels against focusing on any single metric (and in favor of the need for new ones – the relevance of metrics inevitably run down over time). Metrics such as profits, employee turnover, and customer satisfaction are not ends in themselves. Rather, they are a source of information about whether the corporation is relevant, resilient and sustainable. The systems challenge is to bring about a paradigm shift that restores connectivity between investors, employees, management, other corporate stakeholders and governments. This will require thinking differently about how the constituent elements interact and produce results.

Authored by Edward J. Waitzer, Stikeman Elliott LLP

Investors as Stewards of the Commons?

Investors as Stewards of the Commons?

In our first article from the (JACF Spring/Summer issue) George Serafeim makes the case that business generally, not just government, should assume responsibility for social and environmental problems. The Sustainable Development Goals (SDGs) formally recognize the role of the private sector in addressing some of the world’s most pressing environmental and social challenges. What started as a corporate social responsibility movement now a focuses on integrating positive social impact into the core mission of the organization.

Encouragingly, studies document that improving firm performance on business-relevant ESG issues has a positive association with future financial performance. Investors can enable better societal outcomes by exercising ‘voice’ and voting rights in corporate governance.

He acknowledges that competitive businesses face a “commons” or “free-rider” problem where a defector avoids the full cost of his actions. Overcoming this problem requires legally sanctioned collaboration between business enterprises and large institutional shareholders, particularly pension funds. He also acknowledges that the corporate level free-rider problem has a counterpart that at the investor level. Investor engagement with companies involves resources, money and time. It is no simple matter to justify increased costs in the context of asset managers that compete on the basis of low management fees, such as index funds.

Collaboration between companies can mitigate some of these free riding problems. Large institutional investors with long time horizons and significant common ownership across different companies may have the best opportunities for collaboration. But, smaller activist funds and retail investors also have an important role in pushing large institutional investors to engage. While it is unlikely that investors will be able to solve all of the pressing societal problems, progress can be made.

Authored by George Serafeim, Harvard Business School