Interview: Governance Model with Sole Focus on Shareholder Value Might Not Be the Optimal Way Forward

Corporate Governance Insights Interview Series: Top corporate governance experts report on the latest research in emerging markets.


Dr. Franklin Allen is a professor of finance and economics at the University of Pennsylvania’s Wharton School, one of the leading business schools in the United States. He is an expert on corporate finance, asset pricing, and the economics of information, and the author of numerous scholarly works, including on the role of corporate governance in building firm value.

The most interesting piece on corporate governance I read recently was...

A research paper on corporate governance and the performance of American banks during the financial crisis of 2007-2008. Among other intriguing propositions, the paper suggests that lack of proper corporate governance in the area of risk management may have contributed to the struggles of the financial services sector during this time. It looks at the evidence to understand the role shareholders played. And, in fact, there is some evidence that shareholders encouraged managers to take risks in a number of ways. It is an interesting finding, because it suggests that regulators should be exploring other interventions—they might need to take a rather different approach than what they are currently doing to curb bank risk-taking. For example, they might need to intervene into the executive compensation process more.

Right now, I am working on...

How different corporate governance models may have influenced the way different countries emerged from the financial crisis. Specifically, I’m analyzing accounting data from companies in a number of countries to see what companies did to address the economic situation, building on my earlier research. Did they fire people? Did they cut research and development?

If you look at countries like Germany and Japan, they experienced significant output shocks during the crisis: Germany’s GDP fell 7 percent and Japan’s fell 10 percent. And yet, unemployment in these countries did not increase very much. Meanwhile, the United States experienced a far smaller drop in GDP, but there’s been a doubling of unemployment, from 5 percent to 10 percent.

My theory is that this has to do with the approach to governance, and the focus on building shareholder value. For instance, in the U.S., when shareholders want to increase profits, they often fire people. But in Germany, boards of large companies include worker representatives, so firms don’t fire workers as routinely as U.S. companies do. Today, unemployment remains a major problem in the U.S., but it is not in Germany. In fact, the unemployment rate in Germany is now lower than it was at the beginning of the crisis.

I think the most relevant CG research topic for emerging markets now is...

Identifying a sustainable and effective corporate governance model. The traditional literature on corporate governance suggests that the U.S. /U.K. model is best. But now there’s some pushback, as we see some of the enduring problems with persistent unemployment in the American economy.

In emerging markets, unemployment is a huge issue. So, a governance model where focus is on building shareholder value—perhaps through cutting jobs or not hiring new workers, as U.S. companies have done—might not be the optimal way forward. Perhaps what’s needed is a hybrid approach that makes use of the best concepts pulled from a number of models.

The latest development in the field of research on financial crisis is...

An understanding that corporate governance matters and that different corporate governance models can yield different economic outcomes.

Countries should be worrying more about corporate governance in general and about identifying a model that works best in their context in specific.

Countries also may need to understand the notion of firm value in a different way. Should they focus on shareholder value or on stakeholder value? There’s a difference. When managers are incentivized by profit, this can lead to serious and enduring problems, as we are seeing in the U.S. today.

Other countries have done better than the U.S. on the unemployment issue, and I think that this has to do with the governance system that is typical for American companies. Now, we are seeing the downsides of this governance system, which embraced the shift toward leaner workforces and more efficient production processes in the 1990s, and elevates profit-making above all else.

The result is that the classic “Great American Dream” is not as reliable today as it once was. If this is an aberration, then the model may well prove to have enduring value. If not, then a broader shift to a different governance model may be needed.

For further reading on this topic, Franklin recommends:

Firms with Benefits, The Economist, January 7, 2012

Governance Models, the International Chamber of Commerce


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