Corporate Governance and Complexity Theory

by Robert Kropp

"The authors use complexity theory to argue that the inclusion of the voices of all stakeholders leads to improved corporate governance.

SocialFunds.com -- Despite the increased attention to good corporate governance that has occurred over much of the last decade, failures of governance such as those that led to the financial crisis have continued. The situation has led to various calls for improvements in governance, from increased regulation to more power residing in shareowners.

In their book entitled "Corporate Governance and Complexity," the authors call for an approach to corporate governance that encompasses more than one or two approaches to the problem. Using the framework of complexity theory, they argue that the concerns of all stakeholders—regulators, institutional investors, management, employees, etc.—are inter-connected in a "corporate governance social ecosystem," in which the most effective approaches to improvements in corporate governance are not simply top-down, through increased government regulation, but simultaneously "at both the micro and macro levels of interaction."

Because the many dimensions of corporate governance "do not exist in isolation," the authors argue, "both the endogenous and exogenous conditions are in constant flux;" that is, conditions specific to each corporation, as well as the larger environments in which corporations act, have the potential to influence the governance practices of a firm. The relationship between management and shareowners, for instance, is of course paramount, as is the interaction between the corporation and regulators. However, the authors argue, while these relationships are important, they are "not sufficient to understand the intricate web of connectivity and interdependence within the corporate governance social ecosystem."

Defining feedback as "a process that influences behavior," that authors assert that the practice "maintains stability in a system" and "provides greater clarity through the consultation process, which often leads to greater engagement."

"Feedback is also necessary in the process of emergence," the authors continue, by which is meant the interaction among stakeholders that leads to the evolution of a new corporate culture. As an example of emergence, the authors point to the increasing emphasis upon the election of independent directors, which they attribute to such factors as "a change in society regarding the importance of ethical values in corporate behavior and in the relative value of non-financial objectives," as well as the increased activity of institutional investors.

According to the authors, the financial crisis provided evidence that "corporate governance at company and industry level, as well as regulation on corporate governance more widely, is deficient in the sense that it does not properly deal with the complex nature of these relationships and the potential conflicts of interests therein." Considering that many bank failures occurred in Anglo-Saxon countries such as the US and the UK, where shareowner rights are considered to be strongest, the authors suggest further that "no one corporate governance system is superior, despite the widely accepted view in the academic literature claiming that investor protection is higher in common-law countries (such as the UK and the US)."

It should be noted, however, that in the view of the authors the concept of shareowners is one that focuses on short-term gains, with the exception of the aforementioned institutional investors whose increased activity has led to a grater focus on the election of independent boards. Most observers would agree with the statement of the authors, that "one of the possible reasons for the latest series of corporate scandals may have been managerial remuneration packages that focused too much on short-term profits without any regard for the long-term future and survival of the organization and ignoring the basics of proper risk management." However, the authors attribute the development to the focus of directors on "the principle of shareholders' primacy in the short run," instead of the long-term interests of all stakeholders.

An important finding of the book is "that the mere threat of disciplinary action may force organizations to change their behavior and set in motion the creation of a new order." As an example, the authors point to the experience of Gap, the apparel company that came under fire in 2007 because of the use of child labor in its supply chains. Not only did Gap respond to stakeholder pressure by removing products associated with child labor from its shelves; it also instituted more stringent guidelines for its supply chain partners.

Complexity theory as applied to the governance of corporations may well be a subject too arcane for everyday application. Indeed, this review only makes reference to it inasmuch as its most general applications can be seen as relevant to sustainable investors and others who wish to effect improvements in corporate governance.

That said, what is of value in the theory is the democratization of the role of all stakeholders. In the theory as espoused by the authors, all stakeholders add their voices to the effort to improve corporate governance, and as a result of the added perspectives the chances for improved governance increase. It is appealing to consider that a democratic process can improve the governance of institutions such as corporations, which are better known for being managed autocratically."

Book Review: Corporate Governance and Complexity, Social Funds

Corporate Governance and Complexity Theory, Marc Goergen, Christine Malline, Eve Mitleton-kelly, Ahmed Al-Hawamdeh and Iris Hse-Yu Chiu, Edward Elgar, 2010, 141 pp