Financialization and Corporate Governance



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Financialization and Corporate Governance



Paddy Ireland

Professor of Law

Kent Law School


ABSTRACT

It used to be thought that what we now call ‘corporate governance’ was a rather complex affair. Which models of the corporation and corporate governance were productively superior? Which most encouraged research and development and investment in new technologies? Which best contributed to job satisfaction, to social cohesion and to the realisation of a ‘good life’? In the 1970s and 80s, as the developed capitalist world lurched from one economic crisis to another, many commentators came to believe that the more-stakeholder-friendly models of the corporation found in Germany and Japan were not only socially more cohesive than their more shareholder-oriented counterparts, but economically more efficient. Some continued to make this argument well into the 1990s. In 1992, for example, one of America’s most influential management writers, Michael Porter, argued that American corporate ownership and governance structures were seriously defective, prioritising short-term shareholder returns over long-term productive investment. In the UK commentators like the business economist John Kay were making very similar cases for the adoption of a conception of the corporation as a social or quasi-social institution.


By this time, however, the issues surrounding corporate governance had been radically redefined and simplified. Beginning in the US in the 1970s and 80s, with financial economists taking the lead and corporate lawyers following sheepishly in their wake, corporate governance came widely to be seen as involving a relatively simple ‘agency problem’. Far from being a social institution, it was argued, the corporation was a pure ‘fiction’, a legal construct which served to facilitate private contracting. It was nothing more than a nexus of contracts, including, crucially, one between managers and shareholders, the suppliers of capital. The key governance question was how could agent-managers be made to act in the interests of their shareholder-principals? The rights-based arguments for shareholder primacy which resulted from these assertions about the contractual nature of corporations were reinforced by consequentialist claims that the exclusive pursuit by managers of the shareholder interest also served to maximise productive efficiency and aggregate social wealth and welfare. The result was that by the early 1990s, the mainstream corporate governance agenda had been radically stripped down and many of the issues it had previously encompassed dismissed as irrelevant.
These ideas paved the way for the emergence, initially in the US and the UK but spreading elsewhere, of the ‘shareholder value’ model of the corporation, according to which the object of corporate governance is simply to ensure that managers act so as to maximise the dividends and capital gains accruing to shareholders. To achieve this end, various strategies have been deployed. Some of them operate from within the corporation and focus on such things as the use of (allegedly) independent non-executive directors to monitor managers and executive remuneration packages linked to performance as measured by share price. Others, like the encouragement of an active take-over market – the ‘market for corporate control’ - operate from without.
By the mid-late 1990s, when the US and UK economies seemed to be faring better than their main rivals, the Anglo-American, ‘shareholder value’ model of the corporation and corporate governance was being widely lauded as economically superior, leading two American academics famously to announce ‘the end of corporate history’. Indeed, during this period the establishment of Anglo-American corporate style corporations around the world became a key element of the neoliberal, `Washington Consensus’, policy packages that international agencies such as the World Bank and the International Monetary Fund set about imposing on the developing world. When the OECD Principles of Corporate Governance first emerged in 1999 following the East Asian financial crisis of 1997-98, it was clear that they were firmly rooted in an Anglo-American, stock-market-based, shareholder-oriented model of the corporation, notwithstanding nods in the direction of diversity.

Enron and the other corporate scandals that greeted the new Millennium made claims about the ‘end of corporate history’ seem a tad premature, but did little to shift the focus of the corporate governance agenda. The protection of investors and the maximisation of ‘shareholder value’ remained the principle policy goal. It still is. The working assumption of policymakers continues to be that corporate governance is an agency problem and that the standard devices for protecting shareholders would work if only they were better designed and implemented. Thus far, therefore, the goal of reform has been to try to create improved versions of the standard 1990s measures; to do more of the same only better. It remains to be seen how far this consensus will be shaken by the current economic and financial crisis. This paper argues that it is to be hoped that it will, for corporate governance, and Anglo-American corporate governance in particular, is in need of radical rather than ameliorative reform.


Among the things that the current economic and financial crisis has highlighted is the deeply dysfunctional nature of the highly financialized corporate culture and system of governance that has developed in recent decades, particularly in places such as the US and the UK. In order to develop a better understanding of the nature of this financialized form of governance, the paper briefly sketches the rise, retreat and recent resurgence of financial power and traces its impact on the way in which corporations have been run. En route, it examines the critiques of financialization and financialized corporate governance developed by writers such as Thorstein Veblen, Adolf Berle, R H Tawney, Harold Laski and John Maynard Keynes in the opening decades of the twentieth century. Against this backdrop, the paper suggests that the simplistic conception of corporate governance as an ‘agency problem’, a straightforward question of investor protection, is itself a product of resurgent financial power and needs to be discarded. Corporate governance reform, it argues, is a complex, multi-faceted matter which demands that we rethink the way in which we conceptualise the large public corporation and radically revise our understanding of what corporate governance is about. The crisis in the financial system and the measures that governments around the world are being forced to take to try to rescue it, the paper concludes, may provide us with a historic opportunity to do this. In trying to map ways forward, it advocates a return to these earlier critiques for guidance as to the direction in which we should be heading.

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