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Corporate Governance and Social Welfare

In the last decades, Corporate Governance (CG) has invaded the academic and regulatory worlds, as it has been considered a (at least partially) solution for many social problems, such as gender inequity, inequality, systemic risk, etc.

Mariana Pargendler, a visiting professor at Standford, published an article in september 2014 where she investigates the origin and consequences of this dominance. (1)

 A) As for the causes, she outlines a factor that could make sense; Corporate Governance having emerged in the USA in the 1970`s, in a period in which government activity generated distrust, a logic conclusion proposed the private sector as responsible for social welfare, so that the pressure for “better” Corporate Governance surged. And three premises were adopted, according to Prof. Pargendler: (i) the social weight of corporations was acknowledged; (ii) some government features –checks and balances…- were included; (iii) it was assumed the internal control equilibrium in the firm was crucial to social welfare.

Soon after CG emerged in the 70`s, the nature of problems changed and evolved, but CG remained a solution: from government distrust and corporate failures, to USA underperformance versus Japan and Germany in the 80`s, to emerging countries economic development in the 90`s, and then corporate scandals and financial crisis after 2000.

Prof. Pargendler wonders whether CG`s dominance of the political agenda is currently justified in terms of its results, and also in terms of other government alternative regulations being put aside in the debate and the agenda.

In the 70`s CG`s regulation was meant to increase corporate accountability, so it pursued to reinforce the role of both the board of directors and the power of shareholders, (so as to counterbalance the power of managers); through independence and an increased focus on oversight functions, in the first case, and through increased “democracy and voice” in the case of shareholders, so that they disciplined boards more effectively.

In the 80`s and 90`s international agencies charged with economic development, such as the OECD, adopted CG as a useful tool; in a liberal environment, governments were thought to be in charge of the economic environment and the private sector was supposed to be responsible for development itself, thus the need for an improved CG. The USA and UK economies led the world in this period, so that their CG approach received more attention than the German or Japanese ones, which relied more on controlling shareholders or institutional ones. Financial development, (so investor protection) was pushed forward as a tool to engender economic development.

In the early 2000`s the big scandals brought again CG into the spotlight. These financial frauds were surprising, and brought the SOX legislation in the USA, that appart from increasing disclosure obligations by corporations, also rose the CG enforcement within companies: independence of audit committees and accounts certification by Ceo and Cfo. Prof. Pargendler defends the ineffectiveness of these measures, as they were already partially in place, and even some of the companies having been at the center of the scandals surpassed the new CG standards.

The 2008 financial crisis has also been connected with CG failures, and as a logical result, CG provisions have since been introduced. Pay for performance “without the correct oversight mechanisms” would have led companies to assume risk or even pursue outright fraud. The stock options misalignment results was also to blame, as the failure of boards in monitoring risk management processes, etc. And Dodd-Frank introduced an incremental focus on independence (compensation committees) and shareholder empowerment, (say on pay, proxy access, broker voting provisions,etc).

Prof. Pargendler deeply believes the CG obsession has been a way for political parties to pursue their agendas, (avoid regulation, introducing some internal controls within corporations, etc).  She doesn`t really think CG regulations were meant to solve the previously cited problems, (as it is not meant to solve inequality, gender inequity, or any other social or environmental issues).

 B) As for the consequences, or merits of Corporate Governance, Prof. Pargendler also seems to be skeptical. Citing a paper by Marcel Kahan and Edward Rock (2) she explains that the hot CG debate isn`t justified for the social value at stake, (that she thinks to be reduced). She states that none of the two channels through which CG could exert a certain effect on social welfare are not so effective:

  1.  Corporate Governance and its effect on Shareholder Value, thus in Social welfare, at a reduced cost; although she recognizes CG has a positive effect in shareholder value according to empirical studies, she nevertheless rejects that shareholder wealth increase necessarily leads to higher social welfare. Firstly, she presents cases where shareholder value entailed big social welfare losses, (such as the financial institutions in the financial crisis), and secondly, she dismisses as a fiction the idea that our current society can be considered a “society of shareholders”.
  2. About Corporate Governance and other social objectives, she believes the links are not sufficiently demonstrated, as the tasks has only very recently introduced in the academic agenda.

Finaly, Prof. Pargendler analizes the alternatives to CG efforts; wouldn`t all these objectives have been more effectively or efficiently been tackled with different tools? In particular she defends the idea, (as she has done through her article) that CG replaces the regulation and government intervention agenda, although (she states) intervention measures would for sure have been more effective in many cases. And even if she doesn`t really put enphasys in guessing about differential costs, it is evident that CG efforts are costly, when she affirms many of the measures are adopted without a clear empirical analysis about their effectiveness.

As a matter of fact, Prof. Pargendler doesn`t make an effort to empirically defend her thinking; she strongly believes the CG effort is flawed in the sense that regulation would have been more effective; but many of the objectives she thinks were pursued with CG have also been tackled with many other measures, (just think of income or gender inequity). She apparently thinks the different alternative courses of action are mutually exclusive (or have been exclusive in the political agenda), but this has really not been the case. Nevertheless, I really appreciate her effort to put into question the current trend or “obsession”, as this will for sure help locate Corporate Governance in its correct place.

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