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Beyond shareholder vs. stakeholder

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The common practice of companies aligning themselves with one of two corporate governance models — one oriented toward the needs of shareholders, the other toward those of stakeholders — is often not as effective as it may seem. In their essay “Bundles of Firm Corporate Governance Practices: A Fuzzy Set Analysis,” Roberto Garcia-Castro, Miguel A. Arino and Ruth V. Aguilera argue that hybrid systems, incorporating practices from both models, can produce better results.

The shareholder-oriented or “outsider” model, followed by most companies in countries such as the United Kingdom and the United States, is characterised by deep stock-market capitalisation, lax employee protection, weak collective bargaining and high investment in general training. Top managers are monitored by the market and by market-based incentives, and firms typically have only a low level of commitment toward labour and capital.

Conversely the stakeholder-oriented or “insider” model, followed by most companies in such countries as Germany and Japan, is characterised by a dominance of bank financing, a dense network of firm collaborations, comprehensive employee protection, strong collective bargaining and high investment in occupational and firm-specific training. Under this model, firms tend to be constrained by the claims of multiple stakeholders.

These two models obviously contain important differences. The prevailing logic is that firm practices are aligned with each other, as well as with the institutional environment in which they operate.

As such, the more similarity there is between these forces, the more effective the performance. Garcia-Castro, Arino and Aguilera challenged this reasoning by researching different companies that currently use a mix of both systems. Their results suggest that the opposite approach, mixing elements of both systems, actually works well.

For comparative analysis, six key variables were identified and combined into different bundles. Five variables — board independence, board information disclosure, remuneration disclosure, performance-related compensation and employee loyalty — capture company-level systems.

One variable, an efficient market for corporate control, captures national systems. For example, the use of the stakeholder model for corporate control varies according to the market efficiencies of, say, continental European countries versus Anglo-Saxon ones.

Garcia-Castro, Arino and Aguilera applied these variables to a sample of 363 firms from 31 countries operating in different market sectors, measuring firm performance through the return on equity ratio.

What do high-return companies have in common?

For one thing, there is no one automatic path or necessary condition for achieving high performance. The authors came up with eight possible combinations for success, and the evidence suggests that there will be more.

Their findings suggest, however, that at least two practices are needed to achieve high performance. Following one system does not necessarily ensure the best returns.

In fact, it presents clear dangers of over-governance, along with high, superfluous costs of layering on more of the same. Firms do not need to be fully aligned with either of the two recognised models. The results show that some high-performing firms in countries using the insider model have adopted outsider-model practices, such as an independent board, high external information disclosure to investors and performance-related compensation.

A combination seems to work best, allowing some practices to complement others. There are synergies that can arise from employing relatively different practices, such as board independence and loyalty to employees, or managerial incentives and an efficient market for corporate control.

The best combinations of governance practices presumably do not stop at eight. Further research into corporate-governance systems may provide a more complete picture of how, in the same institutional environment, some firms can adopt practices less aligned to their national model and still go on to achieve higher performance, while others do not adapt as well.

© The New York Times 2013 From IESE Insight

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