The theory and practice of governance have been grossly influenced by the supposed agency problem. Much of this influence has unwittingly, and perhaps even naively, shaped what we herald as ‘good governance’. Governance research conducted over the past two decades has been almost exclusively based on this theory. Emerging best-practice, notably the Anglo-American model, is derived almost exclusively from it and the search for alternate theories continues to remain elusive.
Agency theory assumes that the interests of the principal, the owner and in the case of joint stock company the shareholder, will not be best served by the agent, the manager and/or employee. The theory predicts that the manager will act in his or her own interests, namely, to behave opportunistically or to be self-serving.
Enron is classic example of where the agency problem, as demonstrated by the behaviour of its successive CEOs and CFOs, was rampant to the extent that their opportunism led to the business’ collapse. However, that all CEOs and members of top management teams behave in similar manner is real stretch for even the greatest cynic’s imagination. To be sure, relatively small and highly visible cadre of CEOs worldwide appear to attract remuneration that is grossly out of step with their businesses’ performance. But to cast the aspersion that all of them can neither be trusted nor expected to operate in the best interests of the providers of capital appears to be well short of reality.
I suspect that if this were the case then business in free economies would have long since perished. Incidentally, business in centrally planned and owned economies appears to suffer far greater malaise. According to Marx, there ought to be considerably less to distinguish agents from principals in these poorly performing economies. In these ‘economies’ there is no longer an asymmetric relationship between the classes – capitalists and workers being one and the same. Therefore, the ills of the agency problem should well and truly have been put to rest.
Sadly, the emerging paradigms of governance have become besotted with the explanatory power of agency theory. Alternatives such as trust, an essential component of almost any transaction worldwide, have been ignored as plausible alternative to explain behaviour. system of governance predicated on agency theory increases the costs of contracts between the board and the CEO, and other members of the top management team. It also increases the contract costs where other potential agency relationships may exist, say those between directors and shareholders as well.
Unsurprisingly, recent academic research has sought to identify the agency relationship that may exist between board members and shareholders. Not content with the lack of knowledge produced from decades of research on the agency problem associated with CEOs and top management teams, academics are now focusing their trade on the behaviour of board members themselves. The agency problem must be there somewhere; if only we could find it!
We have then system of governance that has been developed almost exclusively on the single theory of agency. Alternate perspectives of trust and the subsequent positive alignment of behaviour between the providers of capital and management have, to date, held little sway. The now blanket recommendations for majority (or more) of independent directors, because executive directors can’t be trusted; the demands for separating the roles of the chair and the CEO, because the chair can then counter-balance the CEO’s opportunism; the classification of directors on the basis of their ownership interest, because they too may otherwise be self-serving, all result from lack of alternate theory.
Armed only with agency theory, researchers and practitioners have left no stone unturned. Any potential source of the agency problem must be removed. I suspect that in doing so we have introduced significant contracting costs. Are we introducing system to business that truly enhances performance, or merely adding an additional burden? Global research has not consistently been able to identify positive relationships between any of these best-practice governance phenomena and organisational performance. Not one. Not consistently, and certainly not systematically.
In considering good governance are we not better interested in outcomes, rather than the prescriptive approach (box ticking) of process? Surely good governance is about creating and driving high performing businesses (and other organisations). Businesses that legally and ethically outperform their competitors; set new benchmarks for performance; deliver fair and reasonable rewards to shareholders for the risks involved; and, balance the conflicting demands of stakeholders – employees, buyers, suppliers and the environment may be well governed regardless of the makeup of their boards or the existence of duality.
However, as the governance debate unfolds we are in danger of losing sight of the outcome we originally sought – high performing organisations. I suspect that these organisations perform because there is trust and commitment between directors, chairs, CEOs and the top management team regardless of their ownership relationship with the business.
We have known for centuries the extraordinary power that may be generated through the pursuit of far-reaching common goal – vision; power that is created, directed and unleashed through strong leadership and sound management. Why the various paradigms contributing to our knowledge of governance exclude the more conventional wisdom offered by astute management, sound leadership, and entrepreneurship, may also be explained.
These concepts are complex, difficult to define, and their direct effects are nigh on impossible to measure. It is far better to consider governance as an outcome achieved rather than process to be followed; visible to all who may be interested, irrespective of their ownership relationship with the business. In the meantime we remain stuck with the parsimony offered by agency theory, sound in the knowledge that this is part of the problem rather than the solution.
James Lockhart is director of Massey University’s Graduate School of Business.
