If organisations are just a group of people gathered together around a common purpose; why has corporate governance drifted so far away from this? Is it because you can't actually 'codify humans', possibly. This article argues that if we want better governance, we need to bring humans back as the focus.
There are many definitions of corporate governance. Perhaps one of the most used in the academic literature is this by Bloomfield in 2013,
“…[It's] the governing structure and processes…that exist to oversee the means by which limited resources are efficiently directed to competing purposes…including maintenance of the organisation and its long run sustainability, [all] set and measured against a framework of ethics and backed by regulation and laws.”
As this suggests, corporate governance is a collection of different mechanisms, processes and relationships used by various parties to control, steer and operate organisations.
Modern corporate governance, it could be argued, originated from the publication of the Cadbury Review in 1992 and has become a mainstay within listed and large private organisations, as well as recently in regulated financial services firms. One of the reasons for this emergence and necessity is because of the possibility of conflicts of interests between different stakeholders, primarily between shareholders and directors.
In addition, there have been a catalogue of organisational failures, such as Enron and Carillion, as well corporate fraud cases such as Boeing, VW and most recently Wirecard.
All of these have brought the importance of corporate governance to the fore.
There are primarily three theories, which endeavour to describe the challenges within corporate governance, Agency, Stewardship and Stakeholder. Here we discuss the differences between Agency and Stewardship and how by bringing them together, perhaps you can create an operating model of governance that meets the challenges of human beings.
Agency Theory directs its attention at the relationships between Agents and Principals. Agents being the directors or managers of an organisation and Principals being the owners or shareholders. Jensen and Meckling (1976) noted that,
“Agency Theory involves a contract under which one or more persons (e.g. the shareholders) engage other persons (e.g. the managers) to perform some service on their behalf which includes delegating some decision-making authority to the agent.”
So, generally speaking, Agents should be acting in the best interests of the Principals, however this may not always be the case. Hence the Principal/Agent problem.
Essentially, according to Jensen and Meckling, “If both parties to the relationship are Utility Maximisers, there is good reason to believe the Agent will not always act in the best interests of the Principal.”
There is an inherent conflict.
Principals rely on Agents to execute certain transactions, particularly financial, resulting in a potential difference in position on both the priorities and perhaps the methods used to achieve these priorities.
It relies on the idea that individuals, humans, will make decisions as a ‘rational actor’. In other words, they will always make the rational decision. Of course, humans are not rational.
In most, if not all of the cases of fraud or mismanagement noted above, it was management [the human] that did something wrong, or perhaps failed to do something right.
The regulatory response to these failures has been substantive, as would be expected, and some examples include:
Various enactments of company law and other laws and acts
Introduction of accounting standards
Introduction of corporate governance codes
Introduction of corporate governance reporting requirements
But the failures continue…
Stewardship Theory looks at things a little differently. Perhaps first presented by Donaldson and Davis it suggests that Stewards are company executives and are the managers working for the shareholders, both protecting the business and making profits for the shareholders.
It works on the presumption of trust.
It has its roots in evolutionary psychology and behavioural science, as well as having connections with Maslow’s Hierarchy of Needs.
Under Stewardship, the Stewards are generally satisfied and motivated when organisational success is attained. In its broader sense, it refers to the essential role that individuals and communities play in the careful management of organisations and it emphasises the importance of these Stewards in acting more autonomously, so that the shareholders’ returns are maximised.
It allows the importance of humanity back into the role of governance, ensuring that it does not ignore the complexity of human action and where the managers, left on their own, will indeed act as Responsible Stewards of the assets they control.
Stewardship supports and focuses on structures and systems that empower people rather than monitor and control them.
Generally speaking, organisations and regulators have tended towards the Agency model as opposed to the Stewardship model. This has been primarily because there is a view that the Principals will assume that their Agents will act in a self-serving manner and is therefore above the threshold of risk they are prepared to take.
So, why not a combination of both?
Well this is exactly what was proposed by Davis et al in 1997 in their paper, Towards a Stewardship Theory of Management. Within this they put forward a number of propositions, in summary these amount to,
The motivation of people can be more altruistic, and if it is, then this can lead the people towards more high order needs, intrinsic motivational behaviours, high value commitment, purpose driven behaviours and collective cultural action and this leads to outcomes of maximising performance and minimizing costs.
The emerging view is that perhaps one theory is not better than the other, but that they can work together to achieve a more effective framework.
Stewardship Theory can in fact complement Agency Theory, addressing its limitations, whilst at the same time bring the humanity back into the modeling of governance.
In the most recent Stewardship Code [which originated from ‘The Responsibilities of Institutional Shareholders and Agents:
Statement of Principles’; First Published in 2002 by the Institutional
Shareholders Committee (ISC)] issued by the Financial Reporting Council, they note that it,
“aims to promote the long term success of companies in such a way that the ultimate providers of capital also prosper. Effective Stewardship benefits companies, investors and the economy as a whole.”
If we agree that there are indeed problems with Agency Theory and that by merging elements of Stewardship we can better model governance, then we need to decide what that model looks like.
We might all be comfortable with the fact that organisations are inherently just a group of people gathered together around a single purpose. If we can, then the start point for governance [or steering towards that purpose], should be Purpose itself.
The research around Purpose is interesting. It’s clear that there is a connection between Purpose and a sense of belonging.
According to the John Templeton Foundation in their paper, The Psychology of Purpose, published in 2018, they state that purpose in fact is not just connected to belonging, but actually creates a sense of belonging.
What’s also important and links with the role of Stewards is that high levels of belonging actually result in a,
56% increase in job performance
50% drop in turnover risk
75% reduction in sick days.
Betterup Report, 2019
Belonging is in fact, good for business.
So, perhaps bringing back humanity into governance also is good for business. The integration of both Theories into a model is therefore paramount.
Whilst having a sense of Purpose is clearly important, if we are to keep to the heart of Stewardship Theory, we need to align this Purpose with both a value led and behaviour led culture.
The leadership of an organisation, therefore, needs to be clear on Purpose, clear on the values that frame this Purpose, and perhaps most importantly of all, ensure their own behaviours are lived according to both the Purpose and the values.
These principles are at the centre and foundation of The Perrin Carey Model of governance.
Culture, described by Seth Godin, as
“People like us, do things like this”,
is at the core of any organisation and therefore its governance.
The three components in this model that make up Culture are:
Purpose, Values and Beliefs
Behaviour and Ethics, and
The research in social sciences, evolutionary psychology, neuroscience and behavioural science, all say the same thing,
you cannot disconnect decision-making from the cultural, behavioural and evolutionary needs of human beings.
This is a founding principle of Stewardship Theory and as noted, is intricately linked with Purpose, Belonging and Leadership.
This article is part of a series looking at the humanising, modelling and measuring of governance with a view to enhancing organisational performance as well as ensuring compliance.
Governance: It needs re-humanising
Governance: It needs re-modelling [to be published]
Governance: It needs re-measuring [to be published]
Governance: It enhances performance [to be published]
Sign up to receive them direct to your inbox here, Subscribe
Arjoon, S. Striking a Balance Between Rules and Principles-based Approaches for Effective Governance: A Risks-based Approach. J Bus Ethics 68, 53–82 (2006).
Bebchuk, Lucian, Alma Cohen, and Allen Ferrell, 2004, What matters in corporate governance?, Working paper, Harvard Law School
Betterup Report. 2019., The Value of Belonging at Work. New Frontiers for Inclusion. Betterup Labs.Acknowledgements.
Bloomfield, S., 2013. Theory and Practice of Corporate Governance: An Integrated Approach. Cambridge University Press.
Cadbury, A., 1992, The Financial Aspects of Corporate Governance (Cadbury Report), London, UK: The Committee on the Financial Aspect of Corporate Governance (The Cadbury Committee) and Gee and Co, Ltd
Davis, J. H., Schoorman, F. D., & Donaldson, L. 1997. Toward a stewardship theory of management. Academy of Management Review, 22, 20–47.
Lajili, Kaouthar and Lin, Lauren Yu-Hsin and Rostamkalaei, Anoosheh, Corporate Governance, Human Capital Resources, and Firm Performance: Exploring the Missing Links (July 20, 2020). 45(4) Journal of General Management 192-205
Jensen, M. and Mecklin, W. 1976. ‘Theory of the Firm: Management Behaviour, Agency Costs and Ownership Structure’
John Templeton Foundation. 2018., The Psychology of Purpose. Adolescent Moral Development Lab at Claremont Graduate University for Prosocial Consulting and the John Templeton Foundation