Corporate Governance: Its Scope, Concerns and Theories, Research Paper

This report, titled "Corporate Governance: Its scope, concerns and theories", provides a comprehensive overview of corporate governance, encompassing its conceptual, cultural, contextual, and disciplinary dimensions. It begins by defining corporate governance inclusively, covering all types of firms and institutional arrangements involved in production and sales. The report explores the diverse viewpoints and concerns surrounding corporate governance, considering the perspectives of various disciplines like microeconomics, organizational theory, and law. It examines key terminology, such as 'control,' 'regulate,' and 'governance,' highlighting the ambiguity and need for clarity in interdisciplinary contexts. The report reviews surveys of corporate governance, including those by the National Bureau of Economic Research and the OECD, and considers the fit of firm theories within these contingencies. It suggests approaches for analyzing productive activities through culture, power, and cybernetic architecture. Finally, it discusses research opportunities in areas like limited life enterprises, worker ownership, and self-governance, concluding with a discussion on the importance of clear definitions and the evolving nature of corporate governance.

Corporate Governance:Its scope,
concerns and theories
Shann Turnbull
This paper outlines the conceptual,cultural, contextualand disciplinary scope of the
rapidly evolving topic of corporate governance.As a basis for improving the rigour of
research and analysis,some definitions are suggested.Reasons for the diversity of view-
points and concerns are considered.To provide an orientation for new scholars and those
from specialised disciplines, recent surveys of corporate governance are reviewed from the
ethnocentric,contextual,and intellectual contingencies.The prospects of developing the
topic as a "science of organization" are considered along with areas for future research.
Key words: agency,control, corporations,culture, cybernetics,directors, firm, finance,
governance,information theory,institutions, ownership, political, power, regulation,self-
regulation, self-governance,shareholders,stakeholders,stewardship,theory of the firm,
transaction costs.
Introduction
T he purpose ofthis paper is to provide
an orientation in corporate governance
for both new scholars and specialists in
disciplines which intersect with the topic.
These disciplines include micro-economics,
organizational economics, organizational
theory,information theory,law, accounting,
finance,management,psychology,sociology
and politics. Each may view corporate
governancein a different way, somewhat
like the apocryphal group of blind people
trying to identify an elephant through touch
by each describing quite differentparts of
the animal.
To encompassmost perspectives,an in-
clusive definition of corporategovernance
is introduced in the nextsection to include
all types of firms and other institutional
arrangementsinvolved in productive ac-
tivities. The third section considers how
some key words are used in differentways
within, and between,disciplines.To assist
in integrating the knowledge ofthe various
disciplines, some common language is
suggested.
A diversity of agents is shown to be in-
volved in influencing,controlling,regulating
and managing firms, productive networks
and associations. Again, an inclusive ap-
proach is used to encompassthe diversity
of ways in which leading workers in the
field define the topic of corporate governance.
The next section considersthe origins of
the diverse viewpoints. The various per-
spectivesare related to the discipline and
professional affiliations of various writers
in the field as well as to their culturaland
contextualsituations.We then consider how
well theoriesof the firm fit these various
contingencies and how governance practices
differ between cultures.
Two surveys of corporate governance
undertaken in 1996 by US scholars are then
reviewed from the perspectivesdeveloped
by the paper. One survey undertaken by
the National Bureau of Economic Research
comprehensively reviews the extensive,but
narrow,financial perspective used by econo-
mists who base much of their analysis on
transaction costsand agency theory. The
other survey prepared for the OECD, pre-
sents four viewpoints. These are: (i) a
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CORPORATE GOVERNANCE180

simple finance model, (ii) stewardship theory,
(iii) stakeholder theory and (iv)the politics
of shareholder controlat the micro levelof
the firm.This fourth perspective is reviewed
from a macro political context which includes
an historical outline of how state and federal
governments in the US concerned themselves
with the control and regulation of companies.
The section concludes by considering some
emerging politicalissues raised by Monks
(1996) in the governance of US firms and the
national economy.
Three additional approaches are suggested
for analysing how productive activities are
governed by social institutions.These are
based on analysing respectively:(i) culture;
(ii) power and (iii) their information and
control (i.e.cybernetic) architecture.
Research opportunitiesare identified in
such topics as: (i) limited life enterprises;
(ii) worker ownership and control;(iii) com-
pound boards with two, three and more tiers;
(iv) information theory;(v) productive net-
works; (vi) holonic structures;and (vii) self-
regulation and self-governance.Concluding
remarks follow.
Definitions
Corporate governance describes all the influ-
ences affecting the institutional processes,
including those for appointing the controllers
and/or regulators, involved in organizing the
production and sale ofgoods and services.
Described in this way,corporate governance
includes all types of firms whether or not they
are incorporated under civil law.
Firms can existas either common or civil
law companies,partnerships,joint ventures,
limited liability partnerships,co-operatives,
mutual associations, building societies,
friendly societies,trading trusts,etc.Fama &
Jensen (1983b)even considered churches.
However, organizationslike a church, not
engaged in the production and sale of goods
and services, do not meet the generally
accepted description of a firm.
Firms may be publicly traded, privately
held, for profit, or not-for-profit. Much of the
literature on corporate governance implicitly
assumes thatonly publicly traded firms are
the subject of analysis (e.g.Blair 1995:3).This
would limit the topic to less than 40,000 firms
world-wide and involve only a fraction of all
economic activity in even the most advanced
market societies (FIBV 1993; Economist
1995:116).
Restricting the study of corporate govern-
ance to publicly traded corporations would
limit investigation into the most efficient
institutional arrangementsfor undertaking
productive activities.It may well turn out
that privately held entities could provide the
most efficacious form of enterprise.A possi-
bility supported by Jensen's (1993:869)view
of `a proven modelof governance structure'
discussed later, and the outstanding record of
firms found around the town of MondragoÂn
in Spain (Turnbull 1995d).
If firms include all social institutions
engaged in the production and sale of goods
and services,then both public and private
sector organizations such as schools,hospi-
tals,clubs and societies,need to be included.
With firms defined in this way,the scope of
corporate governance includes nearly allthe
economic activity of a nation. It was by asking
the question, `Why is not all production
carried on by one big firm?' that Coase
(1937) laid the foundations for developing a
`theory of the firm'.
Coase considered the existence of a `master
and servant relationship',or an `employer
and employee relationship' as a defining
feature of a firm. However, this condition
would exclude activities carried out by
teams, partners, joint venturers, strategic
alliances, associationsand networks. This
led Alchian & Demsetz (1972) to ask the
question `whatis meant by a firm?' They
concluded that `The term firm as commonly
used is so turgid of meaning that we can not
hope to explain every entity to which the
name is attached in common or even tech-
nical literature'.
However, Coase (1937)also stated: `the
distinguishing mark of the firm is the
supersession ofthe price mechanism'.This
definition avoids the problem of identify-
ing the institutionalform of a firm. It does
not necessarily avoid the problem ofident-
ifying the boundaries of a firm (Barney &
Ouchi 1986:78).The boundary problem
emerges when analysing joint ventures,
strategic alliances,associations and networks
which some scholars treat as `economic
entities which have a coherence,a struc-
ture, and an individuality of their own'
(Mathews 1996b:116).Ambiguous bound-
aries are found with Mondrago Ân firms,
their relationship groupsand their supra-
organizationalsystems,as pointed out by
Turnbull (1995d).
The need to identify firms and their
boundaries may notbe required to develop
the most efficacious institutional arrange-
ments for organizing productive activities in
society. The problem of defining firms or their
boundaries is avoided by defining corporate
governance as proposed atthe beginning of
this section.
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Terminology
The literature on the theory of the firm,cor-
porate governance,and information theory
attributes different meanings and nuances to
a number of words in common usage.As
words are the tools of thinking,they need to
be clearly defined to provide a basis for clear
communication and rigorous analysis.
Ambiguity exists in the meaning of key
words such as `control',`regulate',`manage'
`govern'and `governance'.Both the ambigu-
ities and circular dictionary definitions need
to be resolved to develop rigour in the study
of corporate governance.
Tannenbaum (1962) defined control as `any
process in which a person or group of persons
or organization ofpersons determines,i.e.,
intentionally affects,what another person
or group or organization willdo'. This defi-
nition provides a word to describe a situation
where no standard of performanceis re-
quired. Other writers (Etzioni, 1965:650;
Downs, 1967:144)use the word control in
the sense of meeting some standard of
performance.In these situations,the word
`regulate'will be used whether or not the
`regulator'is a manager ofthe organization
concerned or an externalbureaucrat.Defin-
ing `control' and `regulate'in these ways
provides a common language with the science
of information and control described as
`cybernetics'(Ashby 1968). This facilitates
the use of information theory in corporate
governance analysis.
The word control,as defined above,infers
that a person or group possess the power to
determine what actions are taken. Self-control
then means thatnot all the power available
is used to further the self interestof the
controller(s). Self-control simply becomes
the avoidance of using power in some
degree,rather than meeting a given result.
This is a requirement of directors, or a board,
wishing to behave as `stewards',and will be
discussed later.
The word `manage'will be used to com-
municate the responsibility for executive
action.It could be ambiguous to mean either
control or regulate.The word `govern' is
likewise ambiguous.`Governance'will be
used to describe a system of control or
regulation which includes the process of
appointing the controllers or regulators.
Self-regulation means that the standards of
performance are established by those being
regulated.Self-governancemeans that the
system of control or regulation includes
the appointmentof the controllersby the
governed. By this means, self-regulation
can be introduced through self-governance.
Self-governance involves a politicalprocess
within institutions to appoint the controllers
responsible for regulation. Self-governance in
a politicalcontext means `government of the
people,by the people for the people'.This
describes democracy.The introduction of
elements ofself-governance into institutions
involved in productive activities would
enrich democracy. There are arguments
and evidence that this produces operating
advantages (Turnbull 1997c,e).
In discussing systems of corporate control,
economists frequently use the word `capital'
in different ways. In their `Corporate Govern-
ance Survey',Shleifer & Vishny (1996)used
the word in four differentways to indicate:
(i) the means of production (p.6); (ii) an
investmentwhich may not be represented
by the means of production (p.3); (iii) finance
(p.2) and `external capital' (p.6); or even
(iv) just credit created by contract(`bank
debt' and `junk bonds').
The problem introduced by such ambiguity
is illustrated by their reference to `the people
who sink the capital'(p.3).It is not clear if
these `people' are: (i) investors subscribing for
new shares;(ii) shareholders who purchase
existing shares from others;(iii) bankers who
lend money;or (iv) the managers/'entrepre-
neurs' who purchase the means of production
or what Moulton (1935:7)describes as `pro-
creativeassets'.The agency costs,benefits
and risk, change according to the various
meanings of the word capital.
Clarity of the Shleifer & Vishny statement is
fundamentalfor their survey as they define
corporate governance as `the ways in which
suppliers of finance to corporationsassure
themselves of getting a return on their
investment'(p.2). With this perspective of
considering the moral and other hazards
of investors obtaining satisfactory returns,
Shleifer & Vishny provide a comprehensive
literature review.
Confusion aboutthe word capital can be
compounded by accountants who introduce
their own professionalmeanings which can
also be ambiguous.Clear analysis and com-
munication would be advanced with less
ambiguous words,especially when the con-
text does not make the meaning clear.In an
interdisciplinary topic like corporate govern-
ance it may be safer simply notto use the
word `capital'.
However,ambiguous words can be useful.
Alchian & Demsetz (1972:note 1) use the
word `meter'in the sense of both measuring
and control. In other words, they are discuss-
ing regulation as defined above. Ambiguity in
the words `manage' and `govern' can likewise
be useful.However, care needs to be taken
Ambiguity in the
meaning of
`governance'
But ambiguity can
be useful
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not to use ambiguous words un-necessarily.
The term `governance' is often used when the
word `control'or `regulate'would be more
appropriate or provide greater clarity of the
process involved.The study by Porter (1992)
rarely uses the word governance.
If the term `management'is reserved to
describe processes which involve execu-
tive action then it describes a subset of
governance processes.However, the kudos
perceived by some writers in corporate
governance matters has resulted in the word
governancebeing over used. Many board
activities are subject to managementpro-
cesses such as establishing sub-committees.
Greater clarity and focus would be achieved
by using terms such as `board management',
`board conduct', `corporatemanagement',
`corporate organization',or `corporate con-
duct', rather than the less specific, more
ambiguous and ambitious phrase `corporate
governance'.
A useful definition for the word `stake-
holder' has been provided by Donaldson &
Preston (1995).`Stakeholdersare identified
through the actualor potentialharms and
benefitsthat they experienceor anticipate
experiencing as a result of the firm's actions
or inactions'.In 1963,the Stanford Research
Institute defined as stakeholders `those
groups withoutwhose supportthe organiz-
ation would cease to exist' (Freeman 1984:31).
This class of stakeholders are described by
Turnbull (1997c,e,f ) as `strategic stakeholders'
as strategic issues concern the ability of a firm
to exist. Strategic issues transcend discounted
cash flow analysis based on a relative per-
formance measure of an `opportunity rate of
return'.
The term `compound board'will be used
to describe the existence of two or more con-
trol centres whether or not they are required
by law, the constitution ofthe firm or are
created by relationships externalto the firm.
Compound boards are commonly found in
Anglo cultures although they may not be
recognised as such.Publicly traded corpor-
ations controlled by a parent company,con-
trol group, relationship investoror family
shareholder create a compound board.Two
and three tiered boards may be required by
law in Europe (Analytica 1992) and are found
in Japanese firms where the shareholders
elect`statutory auditors'to oversee the con-
formance role of the board described as
Kansayaku (Charkham 1994:93).A Keiretsu
Council creates a third control centre.
Influences which Affect the
Operations of Firms
Firms whose securitiesare publicly traded
generally have more externalinfluences on
their operations than other firms. One way of
indicating the scope of corporate governance
is to consider the more obvious influences
which can affectthe operations ofpublicly
traded firms as indicated in Table 1. The
influences can be either internalor external
with externalinfluences arising from either
the private or public sector.
The multitude of stakeholders identified in
Table 1 are consistent with the definitions of
Table 1.Influences affecting the operations of publicly traded firms
Private sector influences Public sector laws/regulators
Customers Trade practices
Competitors Anti-monopoly
Shareholders Securities
Employees Labour & Equal Opportunity
Unions Arbitration courts,etc.
Suppliers Fair trading
Bankers & financiers Credit & bankruptcy
Auditors Corporate
Stock Exchange rules Federal/State/Local tax
Market for shares Health & safety
Media Environmental
Professional associations Quality
Trade associations Building
Directors & Advisers Community
Defining
`stakeholder'
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corporate governance provided by a number
of authorities in the field.Demb & Neubauer
(1992a)state that`Corporate Governance is
the process by which corporations are made
responsive to the rights and wishes of
stakeholders'. Monks & Minow (1995:1) wrote
that: `It is the relationship among various
participants in determining the direction and
performance ofcorporations'.While Tricker
(1994:xi)states `Corporategovernancead-
dresses the issues facing boards of directors,
such as the interaction with top management,
and relationships with the owners and others
interested in the affairs of the company,
including creditors,debt financiers,analysts,
auditors and corporate regulators'.
However, other writers like Sternberg
(1996)do not accept that publicly traded
corporationsshould be `responsiveto the
rights and wishes of stakeholders'as pro-
posed by Demb & Neubauer (1992a).Stern-
berg states that`stakeholdertheory is both
misguided and mistaken',and that `stake-
holder theory of accountability is unjustified',
it `undermines private property,agency and
wealth',`is incompatible with business'and
`with corporate governance'.
Even before the contribution by Sternberg,
the diversity of views about corporate
governance led Pound (1993b) to state:`The
lack of a broad defining paradigm has created
a sense of intellectualvertigo in the increas-
ingly intense debate over corporate govern-
ance reforms'. An objective of this paper is to
provide some orientation for debate and
research.
Differences in Viewpoints
One reason why diverse views can existis
that different scholars investigate firms from
different viewpoints.Donaldson & Preston
(1995)point out that a firm was viewed by
Adam Smith (1937) and by contemporary
investors as an organization which obtained
resources from its investors,employees and
suppliers to produce goods and services for
its customers.Marxists,financial economists,
and Sternberg, view a firm as an organization
which obtains resources from its employees
and suppliers, with cashflows contributed by
its customers to service its owners.In other
words, Marxists and others view firms as
servicing their owners rather than their
customers,employees and suppliers.
The stakeholder view of a firm is different
again.It considers that investors,employees,
suppliers,customers and stakeholdersgen-
erally both contribute and receive benefits
from a firm. In addition, other parties may be
involved in relationships such as unions,
trade associations,government and even
political groups (Donaldson & Preston 1995).
The various views on corporate governance
can also be related to different cultural
contexts,intellectualbackgrounds and inter-
ests of scholars.Workers in the field come
from different academic disciplines.There is
often little, or incomplete,integration be-
tween the various disciplines.The overlap of
corporate governance with other disciplines
is rarely articulated or even recognised.To
indicate how different viewpoints arise,and
to provide an overview of the topic, some
examples are considered.
`The phrase corporate governance is often
applied narrowly to questions about the
structure and functioning of boards of
directors'(Blair 1995:3).This view is found
amongstsome business schoolscholars and
managementconsultants. Lex Donaldson
(1990:376),defined corporate governance as
`the structure whereby managers at the
organizationalapex are controlled through
the board of directors,its associated struc-
tures,executive incentive,and other schemes
of monitoring and bonding'.This view was
reflected by his colleague, a former McKinsey
consultant, in Strictly Boardroom (Hilmer
1993).
The definition of corporate governance
quoted above by Tricker (1994) is focused on
the board room but extendsthe scope to
include `owners and others interested in the
affairs of the company,including creditors,
debt financiers, analysts, auditors and corpor-
ate regulators'.Such wider concerns reflect
the audience for company financialreports,
consistentwith both Tricker's accounting
background and the targetaudience for his
publication.
Monks & Minow (1995) have an interest in
`relationship investing' as described by
Monks (1994).Their definition of corporate
governanceis based on `relationships'as
quoted earlier.Monks & Minow formed a
commercialmutual fund which they called
`Lens'to focus on under-performing corpor-
ations.As active shareholders they seek to
add value to companies by relating to the
boards of their investee companies as owners.
In making recommendations to change
the pattern ofownership and controlof US
firms to make them more competitive,Porter
(1992) targeted policy makers,investors,and
corporations.He identified the need to in-
volve strategic stakeholderssuch as em-
ployees,customers,suppliers and members
of the host community, in the ownership and
controlof corporations,to make them inter-
nationally competitive.
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The rejection by Sternberg (1996)of such
stakeholderinvolvementwas made in the
context of the author being based in England
where intense politicalinterestarose in the
nature of a `Stakeholder Economy' which was
raised by the leader ofthe then parliamen-
tary opposition party (Tony Blair 1996)one
year before a generalelection.As a former
electronics engineer,and motivated by being
a founder and former President of the
Australian Employee Ownership Association,
Turnbull (1997f )utilised information theory
to provide counter arguments to Sternberg
based on his re-interpretation ofthe theory
of a firm (1994a,d).
Table 2 indicates some ofthe diversity in
corporate governance analysis and concerns.
The interests ofeach of the scholars listed
could be far greater than those particularly
noted. The scope of the inquiry into `The
FinancialAspects of Corporate Governance'
was limited by the terms of reference of the
committee chaired by SirAdrian Cadbury
(1992).The committee was established as a
`damagecontrol' initiative by the City of
London following some high profile failures
of publicly traded corporations. Similar
failures occurred in Australia during the
1980's when Henry Bosch (1995) chaired the
National Corporationsand SecuritiesCom-
mission.The contribution by Shann Turnbull
(1975b)was part of the first educational
qualification for company directors and arose
from concern over earlier corporate failures
in Australia and from his activities as a cor-
porate raider,company promoter and chair-
man of publicly traded companies. Corporate
failures in the US during the 1980's led
Michael Jensen (1993) to analyse `the failure
of corporate internalcontrol systems',John
Pound (1992; 1993a,b) to review the politics of
corporate control,and MichaelPorter (1992)
to compare the US system of corporate
governance with those found in Japan and
Germany.
Cultural Specificities in Theories
and Practice
Research into the theory and practice of cor-
porate governance has been heavily focused
on English speaking countries and the US in
particular.All scholars listed in Table 1 are
from `Anglo' countries. `Most of the available
empiricalevidence in the English language
comes from the the United States'(Shleifer
and Vishny 1996:6). Hollingsworth, Schmitter
& Streeck (1994:4)state:`In the 1950sand
1960s,hardly anyone disagreed with the
assumption thatthe more traditional and,
therefore,backward economieslike Japan,
Germany,or Europe as a whole would have
to adopt American patterns of industrial
organization'. The lack of research in compar-
ing different systems of corporate control was
Table 2.Subjects of analysis and variables relating to corporate governance
Authors (date order) Subject of analysis Variable
Simon 1962 Information Managing complexity
Turnbull 1975b & 1993b Directors' responsibilities Managing conflicts
Jensen & Meckling 1976 Agency costs Financial structure
Williamson 1985 Transaction costs Industrial organization
Hollingsworth & Lindberg 1985 Four modes of governance Social organization
Monks & Minow 1991;1995;1996 Board accountability Relationship investing
Demb & Neubauer 1992a Stakeholders Firm responsiveness
Cadbury 1992 Financial aspects Board conformance
Porter 1992 Nature of ownership Firm competitiveness
Hilmer 1993 Boardroom Firm performance
Pound 1993b Politics of ownership Economic efficiency
Jensen 1993 Publicly traded firms Failure in control systems
Bosch 1995;AIMA 1995 Directors' duties Code of conduct
Sternberg 1996 Stakeholder appropriation Shareholder value
Hawley & Williams 1996 Fiduciary capitalism Corporate performance
Shleifer & Vishny 1996 Moral hazards Investment returns
Persson,et.al. 1996 Separation of powers Welfare of stakeholders
Turnbull 1997c,e,f Cybernetic architecture Operating advantages
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only recognised in the US in the 1990's.This
neglectwas explained by Gilson (1994:132)
who noted that `the American system seemed
to represent the evolutionary pinnacle of
corporate governance,so other systems were
either less far along the Darwinistpath, or
evolutionary deadends;neither laggards nor
neanderthals made interesting objects of
study'.
This view was exacerbated by the US being
the most powerful economy in the world, the
`citadel of capitalism', and a widely rec-
ognised role modelfor other countries seek-
ing to better themselves.The importance of
Porter's (1992)study is that it provided a
counter view for academics and policy
makers.
The US has also dominated the develop-
ment of the theory of the firm which was
based on the assumption, some might
say paradigm,that `in the beginning there
were markets'(Williamson 1975:20) and that
firms existbecause markets fail,i.e.. `super-
session of the price mechanism' (Coase 1937).
US scholars developed the theory ofthe
firm during the height of the ideological
contest between capitalism and communism.
It would have been unpatriotic to entertain
the possibility that markets were not the
natural order of a free society.The failure of
communism has reinforced the hegemony of
market ideology with widespread political
interest in privatisation based on the US
model of a firm. The problems of using this
model in the US are identified by Jensen
(1993), in Russia by Blasi & Gasaway
(1993)and in Australia by Turnbull (1993a;
1995a,c,f ).The problems of the US modelin
either the US or former socialisteconomies
are outlined by Shleifer & Vishny (1996).
However, faith by political ideologues in
replicating the dominant, but flawed US
governancemodel, has so far been little
inhibited by scholarly research, empirical
evidence or the competitive success of other
approaches.
The assumption that in the beginning
there were markets is notsupported by the
evidence ofhistory as noted by Ben Porath
(1978),North (1985:558),Turnbull (1978b:
52;1994d:328)and others.In the beginning,
economic transactionswere governed by
social relationships rather than by markets,
hierarchy or even whatWilliamson (1990:x)
refers to as `hybrid modes oforganization'
combining both markets and hierarchy.
Sociologists, Hollingsworth & Lindberg,
(1985:221/2)state that there are `four dis-
tinctive forms of governance. . . market,
hierarchies, the clan or community and
associations'.Each form relies on a different
type of information and control channel as set
out in a typology described by Turnbull
(1978b:6;1994d:328).Two of the these addi-
tional forms of governance are outside the
discipline of economics and so beyond the
field of vision and analysis by economists.
This means that Coase (1937), trained as an
economist,was asking and answering the
wrong question. Instead of inquiring why
economic transactions are organized through
the `authority system'of a firm rather than
through the market,he should have asked
when are economic transactions organized by
any combination of the four different ways in
which transactions can be governed.
Each of these four institutionalmodes for
integrating human activities have `a separate
logic of collective action and socialorder' as
described by Streeck & Schmitter(1985:11).
The existence offour rather than two insti-
tutional modes of organizing human co-
operation means that existing theories of the
firm are incomplete (Turnbull 1994a).This
does not necessarily mean that existing
theories ofthe firm are incorrect,only that
they may have limited application,in a way
analogousto Newtonian `laws of motion'
providing correctanswers when the effects
of relativity are not present.In other words,
the theory of the firm becomes most relevant
in cultures committed to competition with
strong anti-trust laws and large scale imper-
sonal publicly traded firms withoutrelated
party transactions, and are not strongly
bonded through cultural,clan, trade,indus-
try, vocational or other associations, including
strong interlocking directorships.This de-
scribes the US economy.
The US based theory of the firm becomes
less relevant when economic transactions are
mediated by cultural priorities, business
related associations, trade, vocational, family,
social and political networks. These are more
prominentin continentalEurope,Japan and
other Asian countries (Hollingsworth & Lind-
berg 1985; Analytica 1992;Hollingsworth,
Schmitter& Streeck 1994;Hollingsworth &
Boyer 1997). However, `the social governance
of markets'in the US is not insignificant,as
detailed by Bruyn (1991). The operating
advantages ofa greater reliance on associ-
ations and networks in the governance of
firms has been reported by Franks & Mayer
(1993),Gilson & Roe (1993), Kester (1992),
and Turnbull (1995d).Blair (1995),Fukao
(1995:74,77,78),and Porter (1992:16-17)also
recommend that the US firms establish
stakeholder associations and networks.
While Streetand Schmitter(1985:1),Hol-
lingsworth & Lindberg (1985:221) and Turn-
bull (1994a:325-8,d) have outlined a possible
A flawed model of
corporate
governance
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theoreticalframework for analysing govern-
ance systemsbetween cultures,their work
has not yet been used by corporate govern-
ance scholars.Hollingsworth, Schmitter&
Streeck (1994:5)state that `Contemporary
mainstream economics postulates essentially
two mechanisms ofgovernance:markets and
corporate hierarchies.' They go on to say: `In the
limited institutionalrepertory envisaged by
mainstream economics,corporate hierarchies
are the preferred, and in fact the only
"economic",alternative to markets'.
Failure by many economists to recognise
that there are modes of organizing trans-
actions outside markets and hierarchy,and
the hegemony of market ideology, has re-
sulted in there being `no accepted theoretical
framework for comparing systems of corpor-
ate governance within or between cultures'
(Demb & Neubauer 1992a).Radner (1992)
goes further to state `Iknow no theoretical
research to date thatcompares the relative
efficiency of hierarchical and non-hierarchical
organizations within a common model'. More
generally, Jensen (1993:873)observed that
`we're facing the problem ofdeveloping a
viable theory of organizations'.This problem
has been identified by a number of other
leading workers in the field.
Coase (1991b:72) saw the need for `a more
comprehensive theory' and stated that `theory
is outrunning our knowledge of the facts in
the study of industrialorganization and that
more empirical work is required if we are to
make progress'(1991a:451).North (1985:572)
noted that there is an `additionaldimension
currently missing in the discipline ofecon-
omics'. Williamson (1990:xi) sees the need for
`observing the phenomena at a higher level of
resolution'.Williamson (1991:10)noted that
`In Demsetz's judgment, however, recent
work ± of team theory (Alchian and Demsetz,
1972),agency theory (Jensen and Meckling,
1976)and transaction costkinds ± has not
gone far enough'.Demsetz (1991:159) stated
that `a more complete theory of the firm must
give greater weight to information cost than is
given either in Coase's theory or in theories
based on shirking and opportunism which
have not gone far enough'.To meet these
concerns, a theory of the firm based on econ-
omising information ratherthan just costs
has been proposed by Turnbull(1994a),and
is considered later.
The lack of a framework for comparing
different systems of corporate governance has
resulted in comparative corporategovern-
ance research being principally empirical.
Notable contributions to this relatively recent
field have come from scholars outside the US
such as those ofAnalytica (1992),Demb &
Neubauer (1992b),Franks & Mayer (1993),
Isaksson & Skog (1994),Charkham (1994),
GoÈnencË(1994),Tricker (1994),Wymeersch
(1994),Garrett (1996)and Turnbull (1975b;
1995a,b,c,d,f;1997e,f ).US contributions have
focused on Japan or Germany such as those
by Kester (1991;1992),Porter (1992),Roe
(1993),Gilson & Roe (1993) and Aoki(1993),
with other countries considered by Black &
Coffee (1993), Blasi & Gasaway (1993), Monks
& Minow (1995), Fukao (1995)and Preston
(1996).
Theories Relevant to Corporate
Governance
Hawley & Williams (1996) undertook a
literature review of corporate governance in
the US as a background paper for the
Organization for Economic Cooperation and
Development(OECD). They identified four
models of corporate control:1. The Simple
Finance Model;2. The Stewardship Model;
3. The Stakeholder Model; and 4. The Political
Model. While the Survey ofCorporate Govern-
anceby Shleifer & Vishny (1996) for the
National Bureau of Economic Research was
not restricted to the US, its scope was limited
to the finance model consistentwith the
specialised definition of corporategovern-
ance adopted by the authors quoted earlier.
Three additional ways of analysing corporate
governancewill be suggested in the next
section.
The two corporate governance surveys re-
ferred to above were written by US scholars.
Both surveys contain some unstated cul-
turally determined boundary conditions and
assume that the US context provides a univer-
sal reference.Shleifer & Vishny (1996:6)
explicitly state that `while we pay some
attention to cooperatives,we do not focus
on a broad variety of non-capitalistowner-
ship patterns, such as worker ownership and
non-profit organizations'. Nor are these types
of firms considered by Hawley & Williams
who do not state their boundary conditions.
Tricker (1996:31) states:
Stewardship theory, stakeholdertheory
and agency theory are all essentially
ethnocentric. Although the underlying
ideologicalparadigms are seldom articu-
lated,the essential ideas are derived from
Western thought,with its perceptions and
expectationsof the respective roles of
individual,enterprise and the state and of
the relationships between them.
Neither Shleifer & Vishny or Hawley &
Williams define the type of `capitalistic' firms
Viable theory of
organizations
needed
Current
governance theories
are ethnocentric
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subject to their survey,the basis,if any, that
their securities are publicly traded and the
characteristics ofthe securities which exert
some controlling influence on the firm. In the
tradition of US scholarly corporate govern-
ance research,the US legal/political/regula-
tory system and the division of power
between directorsand shareholders,as set
out in corporate constitutions, is mostly
implicitly accepted as the given `state of
the world'. There are, however, important
variations between US States (Monks 1996;
Gordon 1993), between Anglo cultures (Black
& Coffee 1993)and between other cultures
(Analytica 1992, Porter 1992, Fukao 1995, and
Charkham 1994).
For example, publicly traded firms in
Europe may have two or three tiered boards
(Analytica, 1992). Between and within Europe
and the US there are different ways of
publicly trading the securities of a firm.
Different stock exchanges have different
rules governing the powers of directors in
relation to their shareholders. These introduce
differentregulatory regimes to produce sig-
nificant differences in the managementdis-
cretions ofthe firm, e.g. the requirementto
have audit, remuneration and nomination
committees;methods of electing or appoint-
ing directors; shareholderapproval to pay
directors, new share issues, establishing
employee share plans, changing auditors,
merging with another firm or changing the
corporate charteror place of incorporation,
etc. The voting rights of shares and the
percentage required to achieve changesin
control, capitalisation orcorporate charters
may also vary according to each firm,stock
exchange,place of incorporation or national
laws and regulations.
The Hawley & Williams survey is im-
plicitly limited to corporationswhich have
their shares publicly traded and explicitly
limited to US based firms.Not being limited
to either US firms or the `simple finance
model' of Hawley & Williams, Shleifer &
Vishny consider additional dimensions of
the finance model. Consistent with their
concern of how financiers `assure them-
selves of getting a return on their invest-
ment' they also survey how corporate con-
trol is influenced by debt securities and
bankers.
Implicit assumptions of both surveys seem
to be that all publicly traded firms have:
1. rights of perpetualsuccession;2. limited
liability; 3. unitary boards;4. management
hierarchies without related party trans-
actions, strategicalliances or networks as
found in non Anglo firms;and 5.unambigu-
ous boundaries.
To provide a perspective of the relative
importanceof publicly traded firms, it is
interesting to note thataround 75% of the
40,000 publicly traded corporationsin the
world are found in cultures which have
adopted Anglo corporate concepts (FIBV
1993;Economist 1995:116).The only non-
Anglo countries with more than 1,000
publicly traded corporations(excluding in-
vestmentfunds) are Japan (2,953),Germany
(1,297)and Brazil (1,129).France and Italy
all have less than 1,000 listed companies.
The FeÂdeÂration Internationale des Bourses de
Valeurs (FIBV) records four Anglo countries
with more than 1,000 listed companies: the US
(10,546),Canada (3,079),United Kingdom
(2,412), and Australia (1,107). India has
around 7,000 listed companies(Economist
1995:116) not included in the FIBV statistics.
1. The simple finance model
`In the finance view,the centralproblem in
corporate governance is to construct rules and
incentives (thatis, implicit or explicit `con-
tracts')to effectively align the behaviour of
managers (agents) with the desires of princi-
pals (owners)',(Hawley & Williams 1996:21).
However, the `rules' and `incentives'con-
sidered,are generally only those within the
existing US system ofpublicly traded firms
with unitary boards.
The rules and incentives in the finance
model refer to those established by the firm
rather than to the legal/political/regulatory
system and culture ofthe host economy or
the nature ofthe owners.The finance view
represents a sub-section of the political model
of corporate governance.The political model
interacts with the `cultural', `power' and
`cybernetic'models raised in the following
section.
It is the nature of the owners which
exacerbates corporate control problems found
in Anglo countries like the US,Canada,UK
and Australia. In each of these countries,
institutionalinvestorsown the majority of
the shares in most of the largest publicly
traded firms unlike in continental Europe
and Japan (Analytica 1992).Institutionalin-
vestors,such as pension and mutualfunds,
collectively owned more than 57% of the top
US 1,000 firms in 1994 (Hawley & Williams
1996:8). The problem with institutional
ownership is that their investment managers
are fiduciary agents of the beneficialowners
and so the situation is created of agents rep-
resenting agents.Hence the term `Fiduciary
Capitalism' or what Peter Drucker (1976)
more provocatively described as `Pension
Fund Socialism'.
Owners exacerbate
control problems
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The problem of agents being responsible
to agents is that it compounds the agency
costs identified by Jensen & Meckling (1976).
A basic assumption is that managerswill
act opportunistically to further their own
interests before shareholders.Jensen and
Meckling showed how investors in publicly
traded corporations incurcosts in monitor-
ing and bonding managers in bestserving
shareholders.They defined agency costs as
being the sum of the cost of: monitoring
management(the agent);bonding the agent
to the principal (stockholder/`residual claim-
ant'); and residual losses. Their analysis
showed amongst other things: why firms
use a mixture ofdebt and equity;why it is
rational for managersnot to maximise the
value of a firm; why it is still possible to raise
equity;why accounting reports are provided
voluntarily and auditors employed by the
company;and why monitoring by security
analysts can be productive even if they do not
increase portfolio returns to investors.
A basic conclusion of agency theory is that
the value of a firm cannot be maximised
because managers possess discretions which
allow them to expropriate value to them-
selves.In an ideal world, managers would
sign a complete contract that specifies exactly
what they could do under all states ofthe
world and how profits would be allocated.
`The problem is that most future contin-
gencies are too hard to describe and foresee,
and as a result, complete contracts are
technologically unfeasible' ( Shleifer & Vishny
1996).
As a result, managers obtain the rightto
make decisions which are not defined or
anticipated in the contract under which debt
or equity finance is contributed (Grossman &
Hart 1986; Hart & Moore 1990). This raises the
`principal's problem' (Ross 1973) and `agency
problem'(Fama & Jensen 1983a,b).How can
publicly traded firms with such incomplete
contracts with their managers be effective in
efficiently raising funds?
The `agency problem' is particularily acute
in Anglo cultures with dispersed ownership
where corporations do not have a supervisory
board or what Monks (1994)describes as a
`relationship investor'. When all shareholders
own small minority interests to create diverse
ownership it is not rational for any investor to
spend time and incur costs to supervise
managementas this provides a `free ride'
for other investors. In any event, small share-
holders may lack the power and influence
to extract information which could reveal
expropriation or mismanagement.
In many Anglo countries, the law may
limit the ability of shareholders to become
associated together to form a voting block to
influence or change management unless they
make a public offer to all shareholders.
Insider trading laws may also inhibit or
prohibit shareholders from obtaining the
necessary information to monitor and super-
vise management. Monks (1996), an Assistant
Secretary of Labor in the Reagan Administra-
tion, describes how US managers have influ-
enced law making to protect themselves from
shareholder interventions.
2. The stewardship model
In the stewardship model, `managersare
good stewards ofthe corporations and dili-
gently work to attain high levels of corporate
profit and shareholders'returns (Donaldson
& Davis 1994). Both Lex Donaldson and Davis
teach in business schools.Their arguments
supports the investmentof business schools
and their studentsin the developmentof
managementskills and knowledge. It also
reinforces the socialand professionalkudos
of being a manager.
Donaldson & Davis note that `Managers are
principally motivated by achievementand
responsibility needs' and `given the needs of
managers for responsible,self-directed work,
organizations may be betterserved to free
managers from subservience to non-executive
director dominated boards'. According to
Donaldson & Davis, `mostresearchers into
boards have had as their prior belief the
notion that independent boards are good' and
`so eventually produce the expected findings'.
There are influentialand powerful sources
who recommend the need forindependent
non-executive directors such as the Council of
InstitutionalInvestors in the US, Cadbury
(1992)in the UK, Australian Institutional
investors (AIMA 1995),existing professional
directors,and all those would like to become
non-executive directors.
However, supporting stewardship theory
are the individuals who contribute their own
money and other resourcesto non-profit
organizations to become a director. In analys-
ing the welfare distributed to stakeholders
through introducing a division of powers,
Persson, Roland & Tabellini (1996)made
provision in their equations to include the
welfare contributed by controllers.
In commenting on stewardship theory,
Hawley & Williams (1996:29)state that
`The logicalextension is eithertowards an
executive-dominated board ortowards no
board atall'. Donaldson & Davis pointout:
`the non-executive board ofdirectors is,by
its design,an ineffective controldevice'and
cite evidence to supportthe view that `the
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whole rationale for having a board becomes
suspect'.Brewer (1996) reported that `One of
Canada's best-known business leaders sug-
gested lastmonth that boards of directors
should be abolished and replaced by a formal
committee of advisors'.This view arose from
the businessman in question being sued as
a director of an insurance company for over
a billion dollars from actions taken by man-
agement.
Boards can become redundant when there
is a dominant active shareholder,especially
when the major shareholderis a family or
government.One could speculate thatsome
boards are established from culturalhabit,
blind faith in their efficacy, or to make
government or family firms look `more busi-
ness like'.
However, research by Pfeffer (1972)has
shown that the value of externaldirectors
is not so much how they influence man-
agers buthow they influence constituencies
of the firm. He found that the more regu-
lated an industry then the more outsiders
were presenton the board to reassure the
regulators, bankers, and other interest
groups.
Tricker (1996:29) points out:`underpinning
company law is the requirementthat direc-
tors show a fiduciary duty towards the
shareholdersof the company'.Inherent in
the idea of directors having a fiduciary duty is
that they can be trusted and will act as
stewards over the resources of the company.
Thus in Anglo law, directors' duties are based
on stewardship theory.This duty is higher
than that of an agent as the person must act as
if he or she were the principalrather than a
representative.
Many writers, and especially the propo-
nents of stewardship and agency theory,see
each theory contradicting the other.Donald-
son & Davis raise the possibility thatthere
is some deficiency in the methodologies of
the numerous studies they cite which pro-
vide support for both theories.Some possi-
bilities are thatthe studies did notseparate
out the effectof firms being in a regulated
industry as analysed by Pfeffer (1972)or
possessing a dominant shareholder acting as
a supervisory board or `relationship investor'.
The existence ofan influential supervisory
investor is not uncommon in Anglo cultures
and it is the rule rather than the exception in
other cultures (Analytica 1992;Tricker 1994;
Turnbull 1995c,d,f ).
Ghosal & Moran (1996:14) raise the possi-
bility that the assumption of opportunism on
which agency theory is based,`can become a
self-fulfilling prophecy whereby opportunis-
tic behaviour will increase with the sanctions
and incentives imposed to curtail it, thus
creating the need for even stronger and more
elaborate sanctions and incentives'. Likewise,
stewardship theory could also become a self-
fulling. This would appear to be the situation
in firms around MondragoÂn which have no
independentdirectors.All board members
are either executives or stakeholders (Turn-
bull 1995d).However, each firm and each
group of firms in the MondragoÂn system is
controlled by three or more boards/councils
or control centres which introduces a division
of power with checks and balances.
The inclination of individuals to act as
stewards or self-seeking agents may be con-
tingent upon the institutional context. If this is
the case,then both theories can be valid as
indicated by the empirical evidence. Steward-
ship theory,like agency theory,would then
be seen as sub-set of political and other
broader models of corporate governance.
Psychological analysis supports both theories.
Waring (1973),a professor of psychology,
states that:`differences between individuals
are significantand important';the need for
money and approval,etc.is `determined and
limited by the necessity ofmaintaining the
organism in a state of dynamic equilibrium';
people stand `in an interactive cybernetic
relationship to his/her community and en-
vironment,and is changed as a result of any
interaction'and individuals are `sometimes
competitive, sometimes collaborative: usually
both'.
The inclination of individuals to act as
selflessstewardsmay be culturally contin-
gent. The `company man' in Japan may place
his employerbefore family. The voluntary
resignation ofexecutives is notuncommon
when a firm is disgraced and instances of
suicide are still reported.
3. The stakeholder model
In defining `Stakeholder Theory' Clarkson
(1994) states:`"The firm" is a system of stake
holders operating within the larger system of
the hostsociety thatprovides the necessary
legal and market infrastructure for the firm's
activities. The purpose of the firm is to create
wealth or value for its stake holders by
converting theirstakes into goods and ser-
vices'. This view is supported by Blair
(1995:322) who proposes:
. . . the goal of directors and management
should be maximizing total wealth creation
by the firm.The key to achieving this is to
enhance the voice of and provide owner-
ship-like incentives to those participants in
the firm who contribute or control critical,
With a dominant
shareholder boards
can be redundant
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specialized inputs (firm specific human
capital) and to align the interests of these
critical stakeholders with the interests of
outside,passive shareholders.
Consistentwith this view by Blair to pro-
vide `voice'and `ownership-like incentives'
to `criticalstakeholders',Porter (1992:16±17)
recommended to US policy makers that
they should `encourage long-term employee
ownership' and `encourage board represen-
tation by significant customers,suppliers,
financial advisers, employees, and com-
munity representatives'.Porter (1992:17) also
recommended thatcorporations `seek long-
term owners and give them a direct voice in
governance'(i.e. relationship investors)and
to `nominate significantowners, customers,
suppliers, employees,and community rep-
resentatives to the board of directors'.
All these recommendationswould help
establish the sort of business alliances,trade
related networksand strategicassociations
which Hollingsworth and Lindberg (1985)
noted had not evolved as much in the US as
they had in continental Europe and Japan.In
other words,Porter is suggesting thatcom-
petitiveness can be improved by using all four
institutional modes for governing trans-
actions rather than just marketsand hier-
archy.This supports the need to expand the
theory of the firm as suggested by Turnbull
(1994a).
However, the recommendations ofPorter
to have various stakeholderconstituencies
appoint representativesto a unitary board
would be counter-productive for the reasons
identified by Williamson (1985:300),Guthrie
& Turnbull (1995) and Turnbull (1994e;
1995e).Williamson (1985:308)states:`Mem-
bership of the board, if it occurs at all, should
be restricted to informationalparticipation'.
Such information participation is achieved
in Japan through a Keiretsu Counciland in
continentalEurope through works council
and supervisory boards.These provide the
model for establishing `stakeholder councils'
as described by Guthrie & Turnbull (1995)
and Turnbull (1994d;1997c,e,f ).
Hill & Jones (1992) have built on the work
of Jensen & Meckling (1976) to recognise both
the implicit and explicit contractualrelation-
ships in a firm to develop `Stakeholder±
Agency Theory'. The interdependencebe-
tween a firm and its strategic stakeholders is
recognised by the American Law Institute
(1992)which states: `The modern corpor-
ation by its nature creates interdependences
with a variety of groups with whom the
corporation hasa legitimate concern,such
as employees, customers, suppliers, and
members ofthe communities in which the
corporation operates'.
Both stakeholder voice and ownership,as
suggested by Porter and Blair,could be pro-
vided by `re-inventing'the concept of a firm
as proposed by Turnbull (1973,1975a,1991a,
1994d,1997f ).The proposalis based on tax
incentives providing higher short term profits
to investors in exchange for them gradually
relinquishing their property rights in favour
of strategic stakeholders. Control of the firm is
likewise shared between investors and stake-
holders through multiple boards to remove
conflicts of interest and so agency costs in a
manner similar to thatfound in continental
Europe and especially in MondragoÂn.
4. The political model
The politicalmodel recognises thatthe allo-
cation of corporatepower, privileges and
profits between owners,managers and other
stakeholders is determined by how govern-
ments favour their various constituencies.
The ability of corporate stakeholders to
influence allocations between themselves at
the micro level is subject to the macro frame-
work, which is interactively subjected to the
influence of the corporate sector.
According to Hawley & Williams (1996:29):
`the politicalmodel of corporate governance
has had immense influence on corporate
governance developments in the lastfive to
seven years'.However, Hawley & Williams
focus their discussion only on the micro
aspectsof how shareholderscan influence
firms. Firms have also been influential in
moulding the US political/legal/regulatory
system over the last few centuries. According
to Justice Felix Frankfurter of the US Supreme
Court, the history of US constitutional law is
`the history of the impact of the modern
corporation upon the American scene',
quoted in Miller (1968:1).
Roe (1994)provides an elaboration ofthe
historical evolution of the political model and
like Black (1990) and others,argues thatthe
finance model's nearly exclusive reliance on
the market for corporate control,was pri-
marily the result of the political traditions of
federalism/decentralisation dating back to
the American Revolution. However, these
traditions have been subjectto substantial
changes.
After the Revolution, there was concern
that newly won politicalfreedoms could be
lost through foreignersgaining control of
corporations(Grossman & Adams 1993:6).
As a result, the life of all corporate charters
were limited to 50 years or less up until after
the Civil War. Nor did these charters provide
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